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a/exam/original-files/Problem_1_Sample/2013-Apr-17-BAC.N-140727993387-Transcript.txt b/exam/original-files/Problem_1_Sample/2013-Apr-17-BAC.N-140727993387-Transcript.txt new file mode 100644 index 0000000..5ae448f --- /dev/null +++ b/exam/original-files/Problem_1_Sample/2013-Apr-17-BAC.N-140727993387-Transcript.txt @@ -0,0 +1,1115 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q1 2013 Bank of America Corporation Earnings Conference Call +04/17/2013 08:30 AM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Brian Moynihan + Bank of America Corporation - CEO + * Bruce Thompson + Bank of America Corporation - CFO + * Kevin Stitt + Bank of America Corporation - IR + +================================================================================ +Conference Call Participiants +================================================================================ + + * Chris Mutascio + Keefe, Bruyette & Woods - Analyst + * Thomas Laturneau + FBR - Analyst + * John McDonald + Sanford Bernstein - Analyst + * Eric Wasserstrom + SunTrust Robinson Humphrey - Analyst + * Mike Mayo + CLSA - Analyst + * David Hilder + Drexel Hamilton - Analyst + * Meredith Whitney + Meredith Whitney Advisory Group - Analyst + * Matthew Burnell + Wells Fargo Securities - Analyst + * Moshe Orenbuch + Credit Suisse - Analyst + * Nancy Bush + NAB Research LLC - Analyst + * Glenn Schorr + Nomura Asset Management - Analyst + * Matt O'Connor + Deutsche Bank - Analyst + * Brennan Hawken + UBS - Analyst + * Betsy Graseck + Morgan Stanley - Analyst + +================================================================================ +Presentation +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Welcome to today's program. At this time, all participants are in listen-only mode. (Operator Instructions). Please note today's call is being recorded. It is now my pleasure to introduce Kevin Stitt. Please begin, sir. + +-------------------------------------------------------------------------------- +Kevin Stitt, Bank of America Corporation - IR [2] +-------------------------------------------------------------------------------- + + Good morning. Before Bruce Thompson and Brian Moynihan begin their comments, let me remind you that this presentation does contain some forward-looking statements regarding both our financial condition and financial results and that these statements involve certain risks that may cause actual results in the future to be different from our current expectations. And please see our press release and SEC documents for more reference and with that, let me turn it over to Bruce. + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [3] +-------------------------------------------------------------------------------- + + Great. Thanks, Kevin and good morning, everyone. I am going to start on slide 4 as we work through the presentation. We earned $0.20 per fully diluted share during the first quarter, or $2.6 billion, up significantly from both the first and fourth quarters of last year. The one item we want to highlight upfront, since it only happens once a year, is approximately $900 million of expense related to retirement-eligible stock-based compensation awards that we have had in the first quarter for the past several years. +We believe first-quarter results demonstrate significant progress towards the goals we have discussed over the past several quarters. Global Markets client activity drove improved sales and trading results versus the fourth quarter of 2012 while investment banking performance remained strong. +Global Wealth & Investment Management reported record earnings post the Merrill Lynch merger. Expenses in most of our businesses continue to decline, although they are partially offset by higher revenue-related incentive compensation and the impact of expense related to annual retirement-eligible stock-based compensation awards. +Capital and liquidity both continue to strengthen and are at record levels by most metrics. The interest rate environment continues to be challenging, but moderate loan growth and reduced average long-term debt helped stabilize net interest income versus the fourth quarter. +Credit quality improved in almost all products and both consumer and commercial loss rates were the lowest in several years. And we continue to make strides in resolving legacy issues as we just recently reached an agreement to settle three class-action lawsuits involving Countrywide-issued RMBS. +On slide 5, if we look at the balance sheet, you can see the total balance sheet was down from both the fourth quarter of last year, as well as the year-ago period, although total loans are up slightly. If we look at commercial loans and leases, they are up 3% relative to the fourth quarter of 2012 and up 17% compared to the year-ago period. +If we move down to deposits, deposits were down slightly from the fourth quarter of '12 to the first quarter of '13, although up approximately $54 billion, or 5%, from the first quarter of 2012. Tangible common equity ratio was up 20 basis points from the fourth quarter to 6.94% and tangible book value was up about $0.10 to $13.46 at the end of the first quarter. +As you know, we started reporting under Basel I incorporating the Market Risk Final Rule this quarter. The change added approximately $87 billion to risk-weighted assets. As you can see on slide 6, at the end of March, our Tier 1 common capital ratio under Basel I, incorporating this change was approximately 10.6%, up from what we would have reported had we incorporated the change at the end of last year. +Under Basel III, on a fully phased-in basis, Tier 1 common capital was estimated to be $131 billion, or 9.4%, versus the fourth-quarter estimated calculation of $129 billion and 9.25% respectively. +I do want to bring to your attention that effective January 1 of this year on a prospective basis, we adjusted the amount of capital being allocated to the business segments. The adjustment reflects an enhancement to prior-year methodology and now considers the effect of regulatory capital requirements in addition to our internal risk-based economic capital models. On slide 22 in the appendix, we summarize the adjusted allocations for you. +If we turn to slide 7, our global excess liquidity sources remain very strong at $372 billion. Ending long-term debt did increase $4.1 billion from the fourth quarter of '12 as we funded the January payment for the Fannie Mae settlement and opportunistically accelerated our 2013 issuance plans. +While we issued $11.5 billion of vanilla parent company debt during the quarter, we still expect our long-term debt to decline over the remainder of 2013, as well as during 2014. Our parent company liquidity remains strong at $100 billion and time to required funding was 30 months. We would expect to continue to remain over two years of coverage. +If you turn to slide 8, net interest income, our net interest income increased from $10.6 billion, or a net interest yield of 2.35% in the fourth quarter, to $10.9 billion or 2.43% in the first quarter of 2013. If we adjust these numbers for FAS 91 in hedge ineffectiveness, on the upper right-hand chart, you can see that net interest income was effectively flat at $10.6 billion, or 2.37% during the first quarter of 2013. +As we look at these results, we benefited obviously from the market-related premium amortization expense. In addition, we also benefited from higher commercial loan balances, as well as the reduction in the average long-term debt, as well as the deposit rates paid. Those benefits were partially offset by lower consumer loan balances and yields, as well as two fewer days during the period. +Let's move to slide 9 and look at expenses. Total expenses were down from both the first quarter a year ago and the fourth quarter as we delivered on expense reductions in LAS, as well as ongoing cost savings in our other businesses from New BAC. LAS expenses, excluding litigation in the IFR acceleration agreement, were down approximately $500 million from the fourth quarter to $2.6 billion during the first quarter. This decrease marks the first quarter where the correlation between expenses and lower delinquent loan levels is visible. Delinquent loan levels started to drop during the middle of last year, but as we have previously said, there is a lag of one to two quarters before you see the associated expenses decrease. LAS headcount for March was down approximately 3000 from December while headcount, excluding LAS, was down approximately 1000. +As we have said previously, we believe that LAS expenses ex-litigation will be at $2.1 billion or lower in the fourth quarter of this year and we feel like the progress that we made during the first quarter in getting to that goal was quite strong. Excluding LAS expenses, litigation and annual retirement-eligible cost, expenses in the quarter in the red box on the slide were $13.8 billion, an increase of $558 million from the fourth quarter of '12 and down $920 million, or 6%, from the first quarter a year ago. +The increase from the fourth quarter was due to higher revenue-related incentive compensation, approximately $800 million, which more than offset the impact of cost savings. We continue to believe that we will achieve 75% of Project New BAC cost saves, or $1.5 billion per quarter by the fourth quarter of this year. +The effective tax rate for the quarter was 28% with nothing noteworthy to point out. We would expect a slightly higher effective tax rate for the rest of the year, plus or minus any unusual items like another UK tax rate reduction. This year's expected UK rate reduction of 3%, up from the previous assumption of 2%, should be enacted in the third quarter and will result in a charge of approximately $1.2 billion to write down our UK DTA in that quarter. +If we turn to slide 10, you can see that credit quality continues to improve. Net charge-offs declined 19% to $2.5 billion during the first quarter, which is the lowest level in several years. The consumer loss rate dropped 34 basis points to 1.7%, the lowest since the beginning of 2008 while the commercial loss rate declined 5 basis points to 25 basis points, the lowest since 2006. +Provision expense of $1.7 billion includes a reserve reduction of approximately $800 million, reflecting the improved trends. NPLs and reservable criticized balances also continue to decrease. In addition, 28%, or $6.4 billion, of our NPAs are current consumer loans that were modified and are now current after successful trial periods or our loans classified as NPAs due to regulatory guidance that was issued in the second half of 2012. Our allowance coverage to annualized charge-offs increased from 1.96 times in the fourth quarter of 2012 to 2.2 times in the first quarter of 2013. +If we turn to slide 11, we highlight the results of Consumer & Business Banking. Starting this quarter, we have combined business banking and deposits for reporting purposes. Pretax earnings for Consumer & Business Banking increased 4% versus the fourth quarter driven by improved credit costs, as well as lower expenses. However, net income was relatively flat due to a higher tax rate. Average deposit balances increased 4%, or $18 billion compared to the fourth quarter driven by $11 billion of organic growth and $7 billion related to transfers from Global Wealth & Investment Management. As you know, we periodically move customers across business segments after an evaluation of how they can be best served by us. +Rates paid on deposits during the quarter declined 3 basis points due to pricing discipline and a mix shift in our deposits. Brokerage assets increased $6.7 billion from the fourth quarter, or 9% due to market appreciation and increased customer flows. We reduced banking centers during the first quarter as we continue to optimize the delivery network. +Our mobile banking customer base reached $12.6 million, which is up 5% from the fourth quarter and 30% from a year ago. Combined credit and debit card purchase volumes had a seasonal decline of 6% from the fourth quarter, but increased 3% from a year ago. US consumer credit card retail spend per average active account increased 7% from first quarter a year ago. Average loans did decline $1.6 billion from the fourth quarter due to seasonality and continued noncore portfolio runoff. And as I mentioned earlier, credit quality continued to improve with some of our credit quality indicators at historic lows. +If we turn to slide 12, we address one of the two businesses within our Consumer Real Estate Services area, home loans. As you know, the home loans business is responsible for first lien and home equity originations within Consumer Real Estate Services. First mortgage retail originations of approximately $24 billion were up 11% from the fourth quarter and were up 57% compared with retail originations from a year ago. We believe these increases are reflective of improvements in our retail marketshare. +Consequently, we are adding employees to improve our sales and fulfillment capacity, which is the driver behind higher expenses in home loans during the quarter. However, given lower margins realized during the first quarter, core production income decreased from the fourth quarter. +If we turn to slide 13, Legacy Assets & Servicing had a loss of $1.4 billion in the quarter, a significant improvement from the fourth quarter that was impacted by our settlements with Fannie Mae. The provision for reps and warranties in CRES was $250 million during the quarter. The MSR asset ended the quarter at $5.8 billion, up slightly from the end of the fourth quarter. +Although we announced the sale of mortgage servicing rights in January, the accounting sale will be recorded throughout the year as the servicing asset is transferred. MSR results, including hedges, were positive for the quarter. The capitalized MSR rate ended the period at 61 basis points versus 55 basis points at the end of the year and 58 basis points a year ago. Results did include approximately $700 million of litigation during the first quarter of '13, as well as a similar amount during the fourth quarter of 2012. +As you can see from our press release this morning, as well as on slide 24 in the slide presentation, we did reach an agreement in principal to settle for $500 million three class-action lawsuits involving Countrywide-issued RMBS. We feel very good about resolving these exposures, which addressed original principal balance RMBS that exceeded $350 billion, or what we believed represents approximately 70% of the unpaid principal balance of all MBS as to which securities disclosure claims have been filed or threatened as to all Bank of America-related entities. +Servicing income decreased 17%, or $182 million, compared to the fourth quarter. 47% of this decrease was related to the legal sale of MSRs in connection with the sales that we announced in January, together with other smaller MSR sales. The balance reflected payoffs that exceeded originations in the portfolio due mainly to our exit from the correspondent channel in late 2011 combined with the seasonality and the timing of mortgage payments. +The number of loans in our servicing portfolio totaled approximately $6.5 million at the end of March, down 866,000 from the end of the year due to actual transfers of approximately 570,000 and the rest due to payoffs. 60-plus day delinquent loans dropped from 773,000 units at the end of December to 667,000 units at the end of March, of which a third of the decrease is associated with transferred servicing. We continue to believe that our 60-plus day delinquent loans at the end of this year will be at 400,000 units or below. +If we turn to slide 14, Global Wealth & Investment Management had a very strong quarter. Earnings increased 25% to $720 million from the fourth quarter and continued to set post-merger records in several metrics. The pretax margin of approximately 26% was impacted by low credit cost and a higher contribution from corporate ALM activities, some of which we would not expect to continue. +Overall client activity in the wealth management business in the quarter was strong across all categories. Client balances were up $82 billion, or 3.8% from the fourth quarter, due to higher market levels and net positive flows offset somewhat by the net migration of deposits to consumer and business banking. Period-end deposits dropped $26 billion driven by $19 billion of net migration once again to Consumer & Business Banking. The rest of the decrease reflected year-end seasonality heightened by the fiscal cliff in client investment activity, including long-term assets under management activity. Ending loan balances were at record levels and long-term AUM flows were a record $20 billion, the highest quarterly amount since the Merrill merger and the 15th consecutive positive quarter. +Net income in Global Banking, slide 15, was $1.3 billion versus $1.4 billion in the fourth quarter and down from the first quarter of last year primarily due to higher provision expense due to loan growth and asset quality stabilization. Revenue increased 2% from the fourth quarter reflecting increased business lending revenue. Asset quality continues to improve. Net charge-offs declined $117 million, or 51%. Reservable utilized criticized exposure declined 6% and NPAs dropped 20% to $1.7 billion. +On slide 16, you can see corporatewide investment banking fees increased 26% from a year ago, but were down slightly from a record-setting fourth quarter in debt issuance. Per Dealogic, Bank of America-Merrill Lynch gained marketshare compared to the fourth quarter of 2012 and based on our reported peer results, we believe at $1.5 billion in investment banking fees during the first quarter of 2013, we were a very strong number two. +Average loans increased almost $12 billion from the fourth quarter, driven by growth in C&I, as well as within commercial real estate. Ending loan balances continue to be higher than average balances reflecting the momentum that we saw throughout the quarter. Average deposit balances at $221 billion for the first quarter declined approximately $21 billion compared to the fourth quarter, partially impacted by the expiration of TAG. +If we switch to Global Markets and flip to slide 17, net income of $1.4 billion increased approximately $1 billion, excluding DVA from the fourth quarter reflecting increased sales and trading activity. We did record DVA losses of $55 million in the first quarter of this year versus losses of $276 million in the fourth quarter and losses of $1.4 billion a year ago. Total revenue ex-DVA was up $1.9 billion, or 58% from the fourth quarter and was down 11% from the first quarter a year ago. +Sales and trading revenue ex-DVA increased $1.9 billion from the fourth quarter driven by our FICC business due to improved market sentiment. FICC revenue ex-DVA was up 85% from the fourth quarter due to improved customer activity across all product categories. Versus a year ago, FICC revenue was down 20% ex-DVA as market-making opportunities and credit products were reduced due to spread tightening being much more significant a year ago than what we experienced in the first quarter of this year. +Also contributing to the decline was a gain in credit products in the first quarter of last year that did not repeat and a decline in commodities revenue. In equities, excluding DVA, results increased 61% from the fourth quarter due primarily to improved trading performance and increased volumes in cash markets driving higher commissions. Versus a year ago, equity results were up 8% due to increased client financing balances. Average VAR of $81 million in the quarter is down from $100 million in the fourth quarter and effectively flat with the year-ago period. +On slide 18, we show you the results of all other, which to remind you includes our global principal investments business, the non-US consumer card business, our discretionary portfolio associated with interest rate risk management insurance and the discontinued real estate portfolio, as well as the international wealth management business. +The loss of $867 million was driven mainly by first-quarter annual retirement-eligible costs. The $1.7 billion decline in net income versus the prior quarter was driven by the annual retirement-eligible costs in the absence of tax benefits that were recognized in the fourth quarter of last year. With that, let me turn it over to Brian. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - CEO [4] +-------------------------------------------------------------------------------- + + Thanks, Bruce. Before we take questions, I thought I would leave you with a few thoughts about the quarter. As you can see on slide 19, we continue to work to stabilize the revenue streams and begin to build the strength to drive in the future. At the same time, we continue to work on the cost structure, both reducing costs, at the same time investing in business, as Bruce talked to you earlier about the 4000 people we put to help drive our mortgage production or the 1000 more loan officers are examples. That in turn will help increase our profitability now and in the future. +We continue to see continued momentum in driving balance growth across all our customer groups. When you look in the consumer side this quarter, we were pleased with the growth in deposits, the continued stabilization and profitability of the credit card business and the ability to continue to drive the mortgage activity, the production activity the way we want to, up 50% plus year-over-year. +As you can see in our Global Wealth Management businesses, we have had a record level of assets under management come in from our industry-leading business and they had strong performance, including operating margins. As we think about the commercial lending business, you can see both year-over-year and linked quarter, we have had strong commercial loan growth as those businesses continue to produce strong profits for our Company. We remain strong in our investment banking revenue, as Bruce said, a number two positioning and we continue to drive our positioning in that business. +When you look at our capital markets business, as you can see, we continue to show good profitability and a strong increase from the fourth quarter, but we continue to maintain the low risk that's, in the methodology which you run that business, driven towards the customers we serve and making sure that we balance risk and reward at any turn. +We still have a lot of work ahead of us as a company. We feel good about where we are and the progress we made this quarter. We will continue to drive the earnings forward to deliver the results that you expect of us and we expect of ourselves. So let's open it up for Q&A. + + + +================================================================================ +Questions and Answers +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions). Glenn Schorr, Nomura. + +-------------------------------------------------------------------------------- +Glenn Schorr, Nomura Asset Management - Analyst [2] +-------------------------------------------------------------------------------- + + Hi, thank you. So good loan growth on the commercial -- C&I and commercial real estate side. Just curious what kind of yield is that bringing -- being brought on and from what I understand there's pretty reasonable competition for those new loans. So just curious on how you balance the growth and [marginal] pressure in the markets. + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [3] +-------------------------------------------------------------------------------- + + Good morning, Glenn. It is interesting, if we look at the commercial loan balances across the platform, the spread on the new originations was actually up slightly relative to both the fourth quarter of last year, as well as relative to the first quarter of last year. And it is interesting in that the loans that came on, not only were the spreads wider, but based on our internal risk ratings, the credit quality of what was being brought on was also stronger. +So we feel like we are doing -- the loans that we are bringing on, we are doing in a prudent way and you can see that, as you look at the -- in the supplements -- that a decent chunk of the loans that are being brought on are international, not any real concentrations, but both international, domestic and really across all products. + +-------------------------------------------------------------------------------- +Glenn Schorr, Nomura Asset Management - Analyst [4] +-------------------------------------------------------------------------------- + + That's great. I appreciate that. I wanted to get -- your thoughts on the expenses from slide 9. I wanted to make sure that I understood. Should the starting point -- being that the retirement-eligible is a first-quarter phenomenon, is the starting point, the 18.12 less the 900 or so, as we think about second quarter and then folding in the New BAC incremental efficiencies? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [5] +-------------------------------------------------------------------------------- + + Yes, I think, Glenn, that's exactly right, that that $18.2 billion included the 900 from the retirement-eligible employees that only happens once a year. So you're right. As you go to the second quarter, the starting point should be $17.3 million. +The two other things that I would point out once again is that if you look at the compensation expense in the first quarter relative to the last couple quarters of last year, it was elevated by about $800 million based on the revenues that we saw within the sales and trading, the Global Banking and to a lesser extent the wealth management business. So we hope those repeat, but I would just highlight that that is a delta relative to the last several quarters of last year. +And then obviously, from that starting point, we would look to continue to drive down expenses based on the work that we have spoken about with New BAC that we would expect to achieve throughout the year. + +-------------------------------------------------------------------------------- +Glenn Schorr, Nomura Asset Management - Analyst [6] +-------------------------------------------------------------------------------- + + Perfect. I appreciate that. And you also mentioned your long-term debt is down $75 billion year-on-year and you expect more maturities in '13 and '14 in the 20s. I guess that is perfectly straightforward. Does that include any adjustments for what is coming down the pike with OLA or do you just have to take a wait-and-see attitude on what those rules are? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [7] +-------------------------------------------------------------------------------- + + I think we obviously are paying close attention to the different OLA proposals. I think if you look at the mix between the Merrill debt, as well as the BAC debt and you compare those dollar amounts relative to risk-weighted assets and you compare us relative to our peers, at least all the work that we have done suggests that we are at the very high end of the amount of debt and related instruments that we have relative to risk-weighted assets. So the rules obviously are not clear at this point. We feel like we are positioned very well based on what we understand the different proposals are that are out there realizing it still is moving around. So as we go throughout the year, we would expect, as I said, to continue to drive that footprint down not only in 2013, but throughout 2014 and we continue to be very focused on that, Glenn. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - CEO [8] +-------------------------------------------------------------------------------- + + Glenn, I would add that there is also a rationalization of the footprint. Remember this was put on by various companies, not by one company that we have been restructuring. So even if there is an amount outstanding, the cost can come down because you can string it out. The rates paid are fairly high because they are different environments than we [bid] in and expect to be in the next couple years. So there is even value even if you said the notional wouldn't move as far based on some interpretation of the rules that gets the debt footprint more rational, more spread across time than it is today. + +-------------------------------------------------------------------------------- +Glenn Schorr, Nomura Asset Management - Analyst [9] +-------------------------------------------------------------------------------- + + All right, thank you both. I appreciate it. + +-------------------------------------------------------------------------------- +Operator [10] +-------------------------------------------------------------------------------- + + Matt O'Connor, Deutsche Bank. + +-------------------------------------------------------------------------------- +Matt O'Connor, Deutsche Bank - Analyst [11] +-------------------------------------------------------------------------------- + + Good morning. Just to follow up a little bit on the fixed income trading results, obviously, it can be lumpy quarter-to-quarter, but it was down a little bit more than we saw elsewhere. You talked about some of the mortgage areas. Was there a particular gain last year that was unusual or is it just activity? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [12] +-------------------------------------------------------------------------------- + + No, as I said, we referenced three things. The first was there was a gain that, as you look at that decline that was in the area of $250 million that I would categorize more quite frankly as a recovery than a gain that we had highlighted during the quarter last year. So a decent chunk of that was a gain that did not recur. +Then I think it is important, if you go and look at during the quarter what we saw, the financial spreads, which tend to be a fairly significant part of any FICC trading business, tightened significantly in the first quarter of last year and during the first quarter this year, start to finish, actually widened. So that was the second piece of it. +And then the third piece, as we referenced, is that commodities had a particularly strong quarter last year and did not have as strong a quarter this year. So those three general things. I would say flows generally continued to be very strong and as you look at where we were relative to the fourth quarter of last year, I actually think we continue to make good progress, but it was a little lumpy in the first quarter of last year. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - CEO [13] +-------------------------------------------------------------------------------- + + And Matt, I would add that, as you think about how we are running the Global Markets business, if you look at our VAR and our risk-taking, we are keeping a balance relative to the rest of the Company. And so there will be times when people do better than we are and times when we will do better than them, but we are keeping a balance. +The second thing that Tom Montag and the team have worked on is the expense side. So you can see the operating leverage when you look across the first quarter last year and this year and importantly the fourth quarter of last year to this year. You can see that, with a little bit of revenue, you generate a lot more profit. And so the idea is we are keeping this business so that we can make good money at a $3 billion -- some money at a $3 billion trading revenue level in the aggregate in the business, a lot of money at the $5 billion level and you are seeing that play out. +So if you think about it, we made money I think every trading day in the quarter. The VAR was down and so I think we should be careful to think that we may not roar as much as some people might, other people might because this is one of the many businesses we have and we drive it for the benefit of the investing customers and also the issuing customer. + +-------------------------------------------------------------------------------- +Matt O'Connor, Deutsche Bank - Analyst [14] +-------------------------------------------------------------------------------- + + Okay, thanks. That's helpful. And then just separately, in terms of your capital actions, I think many were positively surprised by the CCAR Fed approval for buybacks of both common and preferred. Just any commentary in terms of the pace of the common share repurchase and on the preferred side, the timing of that and do you have to issue any to replace what you are calling? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [15] +-------------------------------------------------------------------------------- + + Yes, two things on that. The first is you probably saw -- I believe on April 1, we actually went ahead and issued the redemption notices for the $5.5 billion of preferreds that are outstanding. It is just under $500 million of preferred dividend savings that we will have on that and there was no requirement to issue to replace that. So as you look at that redemption, that is a good redemption where you can look at those savings. +As it relates to the common, we would expect to be balanced and work through the share repurchase throughout the year and really don't have much more to comment on than that. + +-------------------------------------------------------------------------------- +Matt O'Connor, Deutsche Bank - Analyst [16] +-------------------------------------------------------------------------------- + + Okay, thank you very much. + +-------------------------------------------------------------------------------- +Operator [17] +-------------------------------------------------------------------------------- + + Chris Mutascio, KBW. + +-------------------------------------------------------------------------------- +Chris Mutascio, Keefe, Bruyette & Woods - Analyst [18] +-------------------------------------------------------------------------------- + + Thank you, Bruce and Brian, for taking my call. Bruce, I have a question. In the release you talk about -- I mean we have gone through expenses in terms of the stock compensation, if you will, in the quarter and also higher first-quarter compensation related to revenues. And you can kind of back that out and see what the run rate is for second quarter. +But you also mentioned that you expect to achieve $1.5 billion in cost saves per quarter by fourth quarter of 2013 related to Project New BAC. How do I account for that third piece of the pie? I know the stock compensation in the quarter, I know the overall compensation being high because of revenues. How do I account for New BAC and getting to a run rate of second quarter? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [19] +-------------------------------------------------------------------------------- + + Sure. So what we have said, it's a good question, we have said that, at the end of 2012 on a quarterly basis, we would achieve $900 million per quarter of New BAC cost saves at the end of in the fourth quarter of 2012. So as you look to adjust your models, we will take that $900 million a quarter that we would have had in the fourth quarter and that will grow to $1.5 billion by the fourth quarter of 2013. Some of that we achieved during the first quarter and we would expect to continue to achieve that throughout the year. +And then the second piece, outside of the more one-timers that we've talked about in the first quarter, were the LAS expenses where we have said we will get that number below $2.1 billion by the end of 2013 and we obviously got that from$ 3.1 billion in the fourth quarter down to $2.6 billion. So in addition to those compensation-related items, we have got those two levers to continue to drive expenses down during the balance of the year. + +-------------------------------------------------------------------------------- +Chris Mutascio, Keefe, Bruyette & Woods - Analyst [20] +-------------------------------------------------------------------------------- + + And just to be clear, the $1.5 billion in New BAC by fourth quarter 2013, what are the cost saves running in this quarter on New BAC? So with the delta I can kind of gauge. + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [21] +-------------------------------------------------------------------------------- + + We have not given an exact number. I think what you should do is, if you go back to slide 9 and look at the red bar, we have said that there was $800 million of increased incentives in that $13.8 billion. That gets the number down to $13 billion. You should assume that part of the benefit between $13.3 billion and $13 billion related to New BAC, but we have not given an exact number. + +-------------------------------------------------------------------------------- +Chris Mutascio, Keefe, Bruyette & Woods - Analyst [22] +-------------------------------------------------------------------------------- + + That's great. Thanks so much for the color. + +-------------------------------------------------------------------------------- +Operator [23] +-------------------------------------------------------------------------------- + + Meredith Whitney, Meredith Whitney Advisory Group. + +-------------------------------------------------------------------------------- +Meredith Whitney, Meredith Whitney Advisory Group - Analyst [24] +-------------------------------------------------------------------------------- + + Hi, good morning. I just wanted some commentary on sequencing of litigation reserves and what has been -- what has already been factored in in terms of the bulk of litigation settlements and then what is on the horizon. Thanks. + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [25] +-------------------------------------------------------------------------------- + + Sure. It's a good question. One of the things, and I am going to walk through the different pieces and as it relates to overall litigation, as well as the rep and warrant, and I would ask you to flip back to slide 23 where we lay this out. And I think one of the things, Meredith, that we feel very good about the progress during the quarter is, if you walk through what we have laid out at the bottom of page 23, if we start with the reps and warrants, between the settlements at the beginning of 2011, as well as the Fannie settlement that we had at year-end, you can see that, as we lay out here, we are generally through the GSE exposure as it relates to rep and warrant. +You then go down to the monolines. There are three significant monolines that we did business with, five in total. We obviously have had previous settlements with two of those three monolines. The one that obviously gets a lot of press is MBIA that continues to be out there. +You then go down to the private-label rep and warrant and obviously the most significant piece of that is the Gibbs & Bruns settlement that will work through -- continues to work through the court process and we would expect the outcome of that to be during the third quarter of this year. +So as you look at reps and warrants, we are through a significant portion of that. We then -- if you then flip to the securities litigation, which is the other significant piece of the litigation expense, one of the reasons that we think the settlement that we announced today was significant is as I referenced. If we look at the original unpaid balance companywide of all of the securities that were underwritten, this settlement today relates to companywide about 70% of that. +So I don't think anyone is going to ever, at this point, declare complete victory. We do think that between the Fannie and related settlements and the lookback in the fourth quarter, as well as the settlement that we have announced today, that we are moving through in a pretty meaningful way this pipeline of items. + +-------------------------------------------------------------------------------- +Meredith Whitney, Meredith Whitney Advisory Group - Analyst [26] +-------------------------------------------------------------------------------- + + Got it. Thanks. That seems to be the big question for investors. Thanks so much. + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [27] +-------------------------------------------------------------------------------- + + Sure. Thank you. + +-------------------------------------------------------------------------------- +Operator [28] +-------------------------------------------------------------------------------- + + John McDonald, Sanford Bernstein. + +-------------------------------------------------------------------------------- +John McDonald, Sanford Bernstein - Analyst [29] +-------------------------------------------------------------------------------- + + Hi, thanks. Bruce, just following up on that, you have, on that same page, the range of possible loss above additional accruals of up to $4 billion. There was some concerns that some of the recent legal decisions in the monoline cases, particularly around the causation issue, might have impacted your estimates there and it doesn't look like it did. Could you tell us why that hasn't changed any of your outlook on that RPL number? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [30] +-------------------------------------------------------------------------------- + + Sure. Once again, the RPL that we have within the rep and warrant will continue to be up to $4 billion. As we have said before, we cover -- at this point given we don't have repurchase history with the monolines, the monolines are covered within our litigation reserves and we have both litigation reserves, as well as range of possible loss for litigation and you should assume that there was some additional monies during the quarter in litigation expense that was set aside for the monolines. + +-------------------------------------------------------------------------------- +John McDonald, Sanford Bernstein - Analyst [31] +-------------------------------------------------------------------------------- + + Okay. And then you noted that the settlement that you announced today covers 70% of issuance on which claims have been made. Is that what you said? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [32] +-------------------------------------------------------------------------------- + + That is correct. Not only -- claims or threatened claims, John. + +-------------------------------------------------------------------------------- +John McDonald, Sanford Bernstein - Analyst [33] +-------------------------------------------------------------------------------- + + Got it. So what does that leave some of the higher profile government (inaudible) like FHFA and some of the things that we know about? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [34] +-------------------------------------------------------------------------------- + + Yes, the two most significant that are out there on the securities litigation that have been more public would be FHFA, as well as AIG. + +-------------------------------------------------------------------------------- +John McDonald, Sanford Bernstein - Analyst [35] +-------------------------------------------------------------------------------- + + Okay. And on the Gibbs & Bruns, the final hearing is in late May. I guess the deliberations could extend for a few months after that. Do you have any idea -- I guess you said third quarter. You hope to get the final resolution in the third quarter? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [36] +-------------------------------------------------------------------------------- + + That is our best sense. Far be it from us to forecast that process, but our best estimate, to your point, would be the third quarter. + +-------------------------------------------------------------------------------- +John McDonald, Sanford Bernstein - Analyst [37] +-------------------------------------------------------------------------------- + + Okay. And then switching gears on the net interest income, Bruce, do you expect maybe to do better than the core $10.6 billion now that you have a little bit of loan growth in the day count or do you expect to kind of stay around that level? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [38] +-------------------------------------------------------------------------------- + + Yes, I think, at this point, where we have guided is we have said that with the work that we have done that, ex any market-related impacts, that $10.5 billion is a good starting point. That number can bounce around, but I would continue to look at that $10.5 billion in the near term as the right starting point. + +-------------------------------------------------------------------------------- +John McDonald, Sanford Bernstein - Analyst [39] +-------------------------------------------------------------------------------- + + Okay. And how about on credit cost? You had a nice move down this quarter. Do you still have capacity to take the reserves down further and do you expect the provision to make further progress below the $1.7 billion that you did this quarter? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [40] +-------------------------------------------------------------------------------- + + Yes, it's a good question, John. I think as we look at the charge-off and the move in charge-off -- to have almost a 20% decline in charge-offs I think speaks to the quality of the portfolio and the work that we had said had been done back in late '08 and early '09 as it relates to consumer underwriting. We have previously said that, as we look at provision, charge-offs will come down about the time that the releases also come down to get you to a level between 1.8 and 2.2. If you look at what we experienced this quarter and with what we are seeing as a trend, it clearly feels like we will be at the low end of that going forward. + +-------------------------------------------------------------------------------- +John McDonald, Sanford Bernstein - Analyst [41] +-------------------------------------------------------------------------------- + + Yes, I mean this quarter you were below the range, right? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [42] +-------------------------------------------------------------------------------- + + Yes. + +-------------------------------------------------------------------------------- +John McDonald, Sanford Bernstein - Analyst [43] +-------------------------------------------------------------------------------- + + So are we setting a new range or you still think we should think about that range of 1.8 to 2.2? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [44] +-------------------------------------------------------------------------------- + + I would think about it at the bottom of the range at this point. + +-------------------------------------------------------------------------------- +John McDonald, Sanford Bernstein - Analyst [45] +-------------------------------------------------------------------------------- + + Okay. And then --. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - CEO [46] +-------------------------------------------------------------------------------- + + And John, as it is clear, it is all about the home finance side now. You see the credit card businesses continue to make some incremental improvement, but it has made a dramatic improvement from the high points going back several quarters. But it is really about mortgages and everything you hear about in the market that we are witnessing in our portfolios in terms of house price improvement. Activity level continues to -- will bear well on that as we look forward. + +-------------------------------------------------------------------------------- +John McDonald, Sanford Bernstein - Analyst [47] +-------------------------------------------------------------------------------- + + Okay. One more thing on, Bruce, on the revenue side. The servicing, mortgage servicing revenues seem to take a step down from the MSR sale. What should the cadence of that be going forward? Is part of the decline kind of built in from the phased-in sale? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [48] +-------------------------------------------------------------------------------- + + Yes, I think what we said is that roughly -- I think it was roughly $90 million to $100 million of the decline in servicing revenue was the result of the sales. We've said that we think, as we get to the end of the year, the sales will ultimately lead to a reduction in revenues of about $200 million related to the MSR sales. We obviously had a fair bit of that given that a decent chunk of the performing sales had an effective closed date on January 31. So we have clearly taken a piece of that and there's probably another $100 million a quarter to come relating to those sales by the end of this year. +Obviously, as you look at, and we tend not to just look at the revenue number, but we look at the contribution from a pretax perspective and obviously, as you see the work that we are doing within Legacy Assets & Servicing, we continue to think that the opportunities there are significant. + +-------------------------------------------------------------------------------- +John McDonald, Sanford Bernstein - Analyst [49] +-------------------------------------------------------------------------------- + + And one more follow-up. How do you guys think about the ultimate target of MSR size and maintaining a balance between origination and servicing in the mortgage business for when rates eventually rise? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [50] +-------------------------------------------------------------------------------- + + Yes, I think as we look at, at this point, the MSR balance was roughly $5.8 billion at the end of the first quarter. If we were to pro forma those sales throughout the year, assuming rates stay where they are, it gets you down to about a $5 billion number from an overall capital perspective. Plus or minus that feels about right. Obviously any change from that is going to be a function of the opportunities to originate things that make sense versus any type of accelerated prepayments that may or may not happen. But I think $5 billion from an MSR balance perspective is not a bad number to be looking at. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - CEO [51] +-------------------------------------------------------------------------------- + + John, from the origination side, the first order of business was to, after we got out of the correspondent business, was to kind of get the business on an upward trajectory and if you go back and look starting in the fourth quarter '11, we've basically grown retail originations quarter after quarter after quarter. In this quarter again, we had another 15% odd off the fourth quarter last year. +But if you actually look at the headcount that you see on the pages, remember that we have got 1000 plus loan officers working this quarter that we didn't -- that weren't here last year that are trained and getting up to speed in the closing [rate]. So the next order of business is how to overcome the HARP refinancing levels, which we have in the portfolio and sort of get to a core run rate. +But there is no cap on us in terms of retail origination. We will do as much as we can do for our clients and you have seen us drive it forward every quarter and now we have more people, more trained, more up to speed, 4000 more people in the fulfillment area and we don't see the pipeline slowing down. + +-------------------------------------------------------------------------------- +John McDonald, Sanford Bernstein - Analyst [52] +-------------------------------------------------------------------------------- + + Okay, thank you. + +-------------------------------------------------------------------------------- +Operator [53] +-------------------------------------------------------------------------------- + + Brennan Hawken, UBS. + +-------------------------------------------------------------------------------- +Brennan Hawken, UBS - Analyst [54] +-------------------------------------------------------------------------------- + + Good morning, guys. So in wealth management, just hoping to dig in. You guys highlighted a couple things that helped the margins move a bit higher, which it seems you don't think they are going to repeat. About how much of a tailwind were those items? And if we are looking ex -- how much of -- it seems as though maybe we might have enough draft anyway because we are looking at like a 500 basis point increase year-over-year and quarter-over-quarter. + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [55] +-------------------------------------------------------------------------------- + + Yes, a couple things. If you look at the -- we talked about credit costs. Credit costs, I think within the business there was roughly a $30 million reserve release during the quarter that we wouldn't assume is necessarily going to continue. But I think if you look at overall pretax margin, we have been at kind of in the 20%, 21% area. This quarter was 26%. I think the assumption going forward is that we will clearly be north of the 21%, but I wouldn't expect that in the near term we run at 26% either. + +-------------------------------------------------------------------------------- +Brennan Hawken, UBS - Analyst [56] +-------------------------------------------------------------------------------- + + Sure, sure. I think you also highlighted the ALM as a tailwind too. Is there any way to quantify that and can you, forgive the potentially ignorant question, but can you help me understand the mechanics of how ALM will run through GWIM? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [57] +-------------------------------------------------------------------------------- + + Yes, I think the easiest way to look at it is, if you look at deltas, we had some of the market-based benefits that we quoted that were roughly $300 million during the quarter. A portion of that gets allocated to GWIM and if you look at the GWIM business, you can see that the net interest income was up about $100 million. So I will give you those pieces of data, but we are not going to quote exact numbers as to how we allocate that out, but it is a piece of that. + +-------------------------------------------------------------------------------- +Brennan Hawken, UBS - Analyst [58] +-------------------------------------------------------------------------------- + + Okay, that helps. Thanks, guys. And then last one, and sorry, it's a little bit technical, but on the NPAs, I guess you guys had said that 20% were from MODs or regulatory requirements. And we have run through the regulatory requirements before. Just hoping to understand on the MODs, it was my understanding that, after about six months of payments, the TDRs are reclassified as current. Do you guys account for TDRs differently than that or can you help me maybe understand how that works? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [59] +-------------------------------------------------------------------------------- + + You are exactly right that once a borrower goes through the trial MOD period and gets to a permanent MOD, they need to be current for six months before we would look to bring those back in. And when you consider that number, realize that coming out of the National Mortgage Settlement, there was heightened modification activity during the third and fourth quarters in particular of last year. So we clearly would expect some of those to cross the six-month period during the second quarter, but realizing, if you go back to, I believe it was the third quarter when we adopted the regulatory guidance, the biggest of that $6 billion plus, north of $4 billion of that is the regulatory guidance that was given. So that is going to be the bigger piece of the two things. + +-------------------------------------------------------------------------------- +Brennan Hawken, UBS - Analyst [60] +-------------------------------------------------------------------------------- + + Okay, thanks. That helps. + +-------------------------------------------------------------------------------- +Operator [61] +-------------------------------------------------------------------------------- + + Betsy Graseck, Morgan Stanley. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [62] +-------------------------------------------------------------------------------- + + Hey, good morning. A couple questions, one on mortgage. You indicated in the past that you were interested in increasing the mortgage origination share and you have done that. I am just wondering how close you are to where you want to be or are you still in the process of building out what capacity you want to have there? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - CEO [63] +-------------------------------------------------------------------------------- + + As you can see, Betsy, on the page, you can see that the mortgage loan officers are up about 1000 year-over-year. We are still adding as we speak. The success of putting them in into the branch environments where you have the mortgage loan officer and FSA, personal bankers is multiples of the success in other branch environments and so we are just driving at that. +So I don't have -- the pipeline is still as strong as it has ever been. We are still -- we had thousands of people to get them closed on time and we are still working our tail off to get mortgage loans closed in time. I don't think there is any -- honestly there is any cap on where this could go. We still have tremendous opportunity within our client base that are unserved. The people, our clients go elsewhere to get their mortgages. +So we have seen it drive up 50% plus year-over-year, another $3 billion increase in (inaudible) production fourth quarter to first quarter. So I challenge the team, they have got to outrun the HARP at some point because that will die off, although it has been extended. But I just -- I wouldn't tell you there is any sort of cap. I think we should be able to drive it up to more of our natural share in things like deposits and stuff, which is more than the 10% level over time. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [64] +-------------------------------------------------------------------------------- + + Great, okay. So go from 4% a couple quarters ago up to 10% to 12%? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - CEO [65] +-------------------------------------------------------------------------------- + + Yes, but it's going to take time. I mean we are talking about -- we have been about 0.2% increase in marketshare each quarter. So this is a lot of activity, but at $24 billion of retail production, we are in the top couple there, top two or three and our view is we ought to be able to push that forward. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [66] +-------------------------------------------------------------------------------- + + And so two follow-ups on that. One is, on HARP you mentioned, how much of the production right now is HARP and how much HARP is in your footprint, your client base that you haven't done yet? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [67] +-------------------------------------------------------------------------------- + + If we look at both combined MHA and HARP, that is just under 50% of the total for the quarter. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [68] +-------------------------------------------------------------------------------- + + Okay. And what is left in your client base to do that you haven't done yet? I mean how many more quarters of this do you think you have? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [69] +-------------------------------------------------------------------------------- + + Yes, I think, I would say generally there was more of it this quarter than we probably would've thought coming into the year and we are headed, not to give an exact number, but as Brian referenced, I would say overall pipeline in activity, as we went through the first quarter, continued to be very strong. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - CEO [70] +-------------------------------------------------------------------------------- + + I would expect that component though is probably at a strong point right now and will come down over the next three or four quarters just because frankly as we sell some of the servicing, some of that opportunity goes away. That was part of the transaction value that we got. But the key is, if you look at the non-HARP/HAMP type production, the non-HARP type production on making homes affordable production, you are seeing that grow at as fast a rate. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [71] +-------------------------------------------------------------------------------- + + Okay. And you are just HARPing your current portfolio set? You are not going after other peoples? You have enough to do with your own portfolio. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - CEO [72] +-------------------------------------------------------------------------------- + + We have got enough to do with our own portfolio. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [73] +-------------------------------------------------------------------------------- + + Right, okay. And then just separately, on page 6, you go through the regulatory capital. Could you just remind us what your expectation is for RWAs going forward, passive mitigation, active mitigation? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [74] +-------------------------------------------------------------------------------- + + Sure. I would say generally throughout the quarter with some of the growth that we have seen, and I assume you are referring to Basel III, Betsy? + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [75] +-------------------------------------------------------------------------------- + + Correct. + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [76] +-------------------------------------------------------------------------------- + + I think we continue, as we go through over the next couple quarters, we would just say what we've continued to say, which is that with where we are from a DTA perspective as we go forward pretax should be the way that generally we are creating capital and I think as it relates to different mitigation opportunities, the biggest thing that we see out there is that as home prices continue to move up and we continue to see the home equity portfolio amortize, which has been about $3.5 billion a quarter, that there is a fairly significant tailwind as it relates to reductions in risk-weighted assets there. +As we go forward, the runoff of the structured credit portfolio that we have, we would expect to accelerate as we go into '14, '15 and '16. And that will obviously be gone by the end of '17. So that is an opportunity and then the third thing I would say is that we continue to work through, and you can see we made progress on the private equity portfolio this quarter and we will continue to wrap that up. +So I think -- but the biggest item as we go forward is just going to be the pretax income line. But I do think that there will continue to be other opportunities to drive that as well. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [77] +-------------------------------------------------------------------------------- + + And the runoff of the structured credit, how much is that right now? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [78] +-------------------------------------------------------------------------------- + + We have not given an exact number that we would expect that to run off, but you should assume it is north of $20 billion of risk-weighted assets. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [79] +-------------------------------------------------------------------------------- + + Today in 1Q? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [80] +-------------------------------------------------------------------------------- + + That's correct. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [81] +-------------------------------------------------------------------------------- + + Okay. And then the last question is on how you get to the $5 billion ask that you had for CCAR that got approved. Because with the 9.4% common Tier 1 ratio in [1Q3] and these RWA mitigation opportunities coming going forward, clearly you must know going into it that you were going to be well above the 8.5% FFC minimum that is out there and that you would be approaching the 10%, that kind of high end of the range scenario that people in business (inaudible) like yourself have targeted. So just wondering how you got to $5 billion and how we think about capital ask going forward. + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [82] +-------------------------------------------------------------------------------- + + Sure. Well, I think, and Betsy, as we have spoken, I think there are three different metrics and ways that you get to looking at capital allocation and capital return. The first is obviously where your ratios are after stress through the CCAR process. And as you look at the results that we had, we ended up just above 6% after our ask, which, relative to our peers, we think positioned us well. +The second item, which, as you referenced, you moved to Basel III and we feel like we have done a very good job on Basel III and to your point are above the minimums, above buffers and feel like we have done a good job there. +And then the third, which is what you have heard us talking a lot about, is just driving the core earnings as the third component. And so we balanced all of those three. And I guess the other thing I would say, as you look at the ask, obviously we have got $5 billion that will get returned to the shareholders based on our plan, but I think -- I don't think you should also minimize though the other $5.5 billion that will go to redeem preferred stock because that preferred stock had coupons between 8% and 8 5/8%. It is not tax-deductible and we are not replacing it with other preferred stock. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [83] +-------------------------------------------------------------------------------- + + Okay, thanks. + +-------------------------------------------------------------------------------- +Operator [84] +-------------------------------------------------------------------------------- + + Nancy Bush, NAB Research LLC + +-------------------------------------------------------------------------------- +Nancy Bush, NAB Research LLC - Analyst [85] +-------------------------------------------------------------------------------- + + Good morning, guys. How are you? A couple of questions for you on retail. You have closed I think 262 branches if I am looking at the numbers correctly over the past year. Can you tell me how that number looks for the coming year and if there is some, quote, optimal number of branches that you want to maintain? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - CEO [86] +-------------------------------------------------------------------------------- + + So I think, Betsy, we were clear that we, a few quarters ago, we said we would do the 750, and I would say -- excuse me, Nancy -- you were at 750 and I think we're -- and you can see that that number is close to 5000. So think about that as 5400 odd, getting down to 5000. The point was, at the time, we did an optimization thought process, looked at it, looked at customer behavior and got that number and we are busily doing that in a very thoughtful way so that we retain a lot of customers, especially on the consolidation side. And then also obviously, as you know, Nancy, we have exited some of the markets and sold community banks where they can get the leverage and the operations that we can't get in some of those markets. +So the question of what happens next I think is probably a question that we take up as we get into '14 and think about what the customer behavior change has been because we are seeing a fairly strong change in the behavior of the customers evidenced by the mobile volumes. And so not only do we have a number mobile customers -- mobile customers goes up to about 10,000 a day to 12,600. It is also what they do. So 100,000 checks a day get deposited by people taking pictures of them and type the numbers. +So that behavioral change we have got to keep monitoring. At the same time, we are building the centers to be these more destination with the [FFAs], which are brokers in branches, mortgage loan officers and so that configuration I think we are still testing. So I don't know the exact answer, but because the near term is to get the other 400 changed that we are talking about through. +If you step back from it, look year-over-year, the branches are down, the customer satisfaction is up and the deposits are up strongly, which is a nice combination. + +-------------------------------------------------------------------------------- +Nancy Bush, NAB Research LLC - Analyst [87] +-------------------------------------------------------------------------------- + + So what I hear you saying is that this, as you go into 2014, this 5000 branch number is not written in stone, is that correct? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - CEO [88] +-------------------------------------------------------------------------------- + + Think of us as a retailer looking at what the best way to get the most out of the market and serve our customers best. And that will always be a subject we will talk about and we are making massive investments in other ATM architecture, virtual ATMs in the mobile space to make sure that we are right with our customers. + +-------------------------------------------------------------------------------- +Nancy Bush, NAB Research LLC - Analyst [89] +-------------------------------------------------------------------------------- + + And my second part to the question would be, Brian, in addressing all these changes in consumer behavior, etc., I mean has part of this program also been to address some of the service issues that you guys had encountered over the past few years as other stuff took more attention? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - CEO [90] +-------------------------------------------------------------------------------- + + Absolutely. And part of it is continuing to upgrade the system. So if you look at our Company between 2009 and 2015, we will have rewritten all the systems and we will bring systems, which are more standalone product systems, into systems which are consistent with a customer approach, Nancy. +So the kinds of inquiries you get where we can see it first in one system, not in another system. Those are going away, frankly getting out of multiple deposit systems helps and so our complaints are down a lot, our attrition is way down and so we are seeing the benefits of this as we go through it. But absolutely, this is all geared at maintaining a customer posture, customer satisfaction posture, which is up year-over-year and driving it to places we haven't driven before honestly based on all the tools we have. + +-------------------------------------------------------------------------------- +Nancy Bush, NAB Research LLC - Analyst [91] +-------------------------------------------------------------------------------- + + And one question, one final question for Bruce. Bruce, the stock is down roughly about 3% in the market right now and there was some disappointment with the headline number. But all the ingredients for the quarter look pretty good. Was it your sense that the $900 million in seasonal costs was built into most estimates or was this a point of variance do you think? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [92] +-------------------------------------------------------------------------------- + + I think that there are probably two things. I think that the $900 million built into the estimates, which we have every period as we look out there, I think it was in some, not in others. So I don't think there was uniformity on that across. And then I think the other item that was out there is, as we look at a lot of the analysts, as they look at core, they don't include any litigation number and obviously there was a $900 million litigation number. We obviously need that to come down, but when I mentioned to Meredith's question, I think getting this class-action and shrinking the tale risk with respect to our mortgage-backed security litigation, tale risk was a significant item for us and we were able to get through that this quarter being generally in line with what you all had expected. + +-------------------------------------------------------------------------------- +Nancy Bush, NAB Research LLC - Analyst [93] +-------------------------------------------------------------------------------- + + Okay, thank you. + +-------------------------------------------------------------------------------- +Operator [94] +-------------------------------------------------------------------------------- + + Eric Wasserstrom, SunTrust Robinson. + +-------------------------------------------------------------------------------- +Eric Wasserstrom, SunTrust Robinson Humphrey - Analyst [95] +-------------------------------------------------------------------------------- + + Thanks. I just want to circle back to the litigation issues for a moment. And could you just help me understand what precisely at the upcoming hearing on the 30th is being debated? Is it simply the amount of the settlement or is it more the actual legitimacy of the process by which the settlement was derived? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - CEO [96] +-------------------------------------------------------------------------------- + + It's hard for us to predict what is going to happen on the 30th. But I think, as we have spoken to, that the process, and we are obviously not a part of this. This is Bank of New York Mellon in their capacity as trustee and obviously, the standard and what needs to be worked through is did they go through and were they prudent and did they follow a process to getting to the point to say that this settlement made sense for investors. And so that will be the general topic. We are not going to predict what exactly happens on the 30th besides that we obviously wouldn't have entered into the settlement if we didn't think that there was a basis for it. + +-------------------------------------------------------------------------------- +Eric Wasserstrom, SunTrust Robinson Humphrey - Analyst [97] +-------------------------------------------------------------------------------- + + Correct. I am certainly not asking you to anticipate an outcome. I just wanted to make sure it's not as narrow as the monetary settlement. It is the broader issue of whether BONY followed the appropriate procedures in terms of determining a settlement, is that correct? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - CEO [98] +-------------------------------------------------------------------------------- + + That's correct. + +-------------------------------------------------------------------------------- +Eric Wasserstrom, SunTrust Robinson Humphrey - Analyst [99] +-------------------------------------------------------------------------------- + + Okay, great. Thanks very much. + +-------------------------------------------------------------------------------- +Operator [100] +-------------------------------------------------------------------------------- + + David Hilder, Drexel Hamilton. + +-------------------------------------------------------------------------------- +David Hilder, Drexel Hamilton - Analyst [101] +-------------------------------------------------------------------------------- + + Thanks very much. Just another litigation question. Is it fair to assume that the Countrywide RMBS that were included in the settlement that you announced this morning are all included in the securities that were the subject of the settlement of the Gibbs & Bruns and Bank of New York as trustee process? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [102] +-------------------------------------------------------------------------------- + + There is clearly a significant overlap. I think as you look at the people that were part of the settlement today tended to be people that would have been original purchasers of the securities. With respect to Gibbs & Bruns, they could have either been original purchasers or subsequent purchasers, but there is overlap and as we have said in the release that the people that were part of the settlement today, to the extent that Gibbs & Bruns gets approved, they will receive whatever they would have otherwise received as part of Gibbs & Bruns. + +-------------------------------------------------------------------------------- +David Hilder, Drexel Hamilton - Analyst [103] +-------------------------------------------------------------------------------- + + Okay. But looked at from the perspective of the Countrywide securities issues, again, would all of the ones in today's settlement be included in the other -- in the Bank of New York as trustee settlement? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [104] +-------------------------------------------------------------------------------- + + Yes, because, as we said in the release, this covers 80% of the Countrywide securities, of which Gibbs & Bruns was obviously a more than -- a very significant piece. So you're absolutely correct in that. + +-------------------------------------------------------------------------------- +David Hilder, Drexel Hamilton - Analyst [105] +-------------------------------------------------------------------------------- + + Okay. And then I don't know if there is anything you can say on this, but any prospective statement about the settlement or possible timing of resolution for the various alphabet soup of remaining litigation, MBIA, FHFA and AIG? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [106] +-------------------------------------------------------------------------------- + + No, there is really nothing that we would say there. I think I would just reiterate though that, as you look at the component of what we settle today from a securities litigation perspective, as it relates to current outstanding amount, as well as what was originally underwritten, it is obviously a significant piece of that. We continue to want to resolve and get these legacy issues put behind us. At the same time, between the capital that we have built and the number of them that we have put behind us, it has to make sense for the shareholders. + +-------------------------------------------------------------------------------- +David Hilder, Drexel Hamilton - Analyst [107] +-------------------------------------------------------------------------------- + + Great. Thanks very much. + +-------------------------------------------------------------------------------- +Operator [108] +-------------------------------------------------------------------------------- + + Moshe Orenbuch, Credit Suisse. + +-------------------------------------------------------------------------------- +Moshe Orenbuch, Credit Suisse - Analyst [109] +-------------------------------------------------------------------------------- + + Great, just like on the trusts that were outside of the Bank of New York, you did provide, on a similar basis. Is there anything you can say about the other lawsuits as to whether there is a provision that has been in there for them based upon some of the experience in the other cases? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - CEO [110] +-------------------------------------------------------------------------------- + + I am not sure what you are talking about. + +-------------------------------------------------------------------------------- +Moshe Orenbuch, Credit Suisse - Analyst [111] +-------------------------------------------------------------------------------- + + Well, I mean you just (multiple speakers). Right, well you have had experience with some of the monolines. I don't know if it is like a facts and circumstances when you think about MBIA or -- so how do you think about whether there has been a provision there or -- and the same thing for the FHFA lawsuits? Are there elements of some of the others that cause you to have had some degree of provisioning for them or would that only happen once those get advanced? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [112] +-------------------------------------------------------------------------------- + + They are all in the litigation reserves, which are not on that page. Those are just the rep and warranty reserves. The monolines, the FHFA and those are in litigation reserves because FHFA and AIG are RMBS cases. + +-------------------------------------------------------------------------------- +Moshe Orenbuch, Credit Suisse - Analyst [113] +-------------------------------------------------------------------------------- + + Right. But I mean the question is is there -- should we think about there having been a component of them or is that all going to be pending? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [114] +-------------------------------------------------------------------------------- + + Well, the -- I want to make sure I understand the question. So within the -- as you go through the litigation reserves, we have reserves for those litigation items that we have the basis to reserve. To the extent that we don't have the basis to reserve, we have a range of possible loss. So as it relates to these items, those are the two ways that we work through the reserves. +In the litigation reserves, as we have said before, are where we house reserves for litigation matters, as well as, as I said, the monolines reside within that litigation bucket as well because we are in litigation with them. And then obviously as you move to the rep and warrant reserves, we have got the actual reserves and then we have also disclosed the range of possible loss for those items that we don't have the basis to reserve. + +-------------------------------------------------------------------------------- +Moshe Orenbuch, Credit Suisse - Analyst [115] +-------------------------------------------------------------------------------- + + Okay, thanks. I'll take that off-line. Just a second question with respect to the mortgage business and the gain on sale. The primary/secondary spread did end the quarter lower than where it was on average. Talk a little bit about how you see that gain on sale trending into Q2 and as we go forward. + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [116] +-------------------------------------------------------------------------------- + + Well, I think that there is -- as we look, I would say that if we look at where we ended the quarter relative to where we started, I would say that it feels at this point that the spreads at this point have somewhat settled out. But obviously those spreads are going to be a function of activity versus capacity and we will have to see how that unfolds over the quarter. +We have obviously built up, and as Brian referenced, have built up the capacity to do what we need to do for our customers and we will just need to see where those margins go throughout the quarter. But, at this point, there was obviously a stepdown in margins during the first quarter. It feels to some extent as if that has leveled out, but we will have to see how it plays out over the second quarter. + +-------------------------------------------------------------------------------- +Moshe Orenbuch, Credit Suisse - Analyst [117] +-------------------------------------------------------------------------------- + + Okay, thank you. + +-------------------------------------------------------------------------------- +Operator [118] +-------------------------------------------------------------------------------- + + Matthew Burnell, Wells Fargo. + +-------------------------------------------------------------------------------- +Matthew Burnell, Wells Fargo Securities - Analyst [119] +-------------------------------------------------------------------------------- + + Thanks for taking my question. Most of my questions have been asked and answered already. But just a quick question in terms of the deposit cost. You have got your domestic deposit costs down to sub 20 basis points. You have got somewhat higher costs outside the US, although obviously much smaller balances. Is there any -- how are you thinking about being able to reduce though the non-US deposit cost, particularly in the time deposit categories over the next 6 to 12 months? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [120] +-------------------------------------------------------------------------------- + + You are right. The international component is obviously a very small component. Those are large -- they are almost exclusively either wholesale deposits that are out there. I am not sure you're going to see much movement in that. I think to your earlier question, where the majority of the deposits are and where the majority of the cost of the deposits are those housed in the US. And you can see that as we build up the core deposits, the amount of time deposits that we have here in the US, we would expect those to continue to come down. And as those come down, all other things being equal, you would expect deposits here domestically, the cost of those to continue to move down. + +-------------------------------------------------------------------------------- +Matthew Burnell, Wells Fargo Securities - Analyst [121] +-------------------------------------------------------------------------------- + + Okay. And now a bigger picture question on OLA. You have got about $134 billion of long-term debt at Bank of America Corporation as of the end of the year, an additional $90 billion of Merrill Lynch debt. When you are thinking about OLA, does any -- do you think about potentially explicitly agreeing to support the Merrill Lynch debt? Does that help you at all under OLA or are you planning on just maintaining the status quo on that basis? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [122] +-------------------------------------------------------------------------------- + + I think as I have said before, I think the OLA rules continue to evolve. If you look out at our annual filings that we have put out there, we have said that we are looking at does it make sense to have a Mellon Co. merged into BAC. That is ongoing work that continues. We believe ultimately, as the Merrill debt runs off and to the extent there is reissuance, it's at the Bank of America level, so we pick up that benefit. Like I said, as we look at any ratio, and as we consider the different rules, it feels like we will have more than enough in total parent company debt relative to risk-weighted assets. + +-------------------------------------------------------------------------------- +Matthew Burnell, Wells Fargo Securities - Analyst [123] +-------------------------------------------------------------------------------- + + Okay. And then just one final question. You had mentioned the time to required funding has come down a little bit from the end of last year and you intend on maintaining that at above two years. Should we think about that coming down closer to 24 months over the next 6 to 12 months or is it too early to tell? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [124] +-------------------------------------------------------------------------------- + + Two things. The first is -- the one thing, when you mentioned it came down in the quarter, realize that one of the reasons why it came down is that we have included the $5.5 billion of preferred redemptions in the time to required funding, so that largely drove that. +But to your question, it is a good one. We would expect over time that the amount of parent company liquidity that we have would tend to come down over time. As we get through the '13 and '14 maturities, we still believe we can bring the parent company liquidity down, bring the cost of it down and you are right, we will keep time to required funding at at least two years. Initially given we work through maturities, that will stay elevated in the high 20s, 30, but the goal is to obviously flatten out the maturities and have that become more in the two-year area, which is consistent with what we have been saying for some time. + +-------------------------------------------------------------------------------- +Matthew Burnell, Wells Fargo Securities - Analyst [125] +-------------------------------------------------------------------------------- + + Right. Okay, thanks for taking my questions. + +-------------------------------------------------------------------------------- +Operator [126] +-------------------------------------------------------------------------------- + + Mike Mayo, CLSA. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA - Analyst [127] +-------------------------------------------------------------------------------- + + Hi, I had a question on litigation, but before we go there, just there was an article saying that, Brian, you were leading a revenue push at the Company and I was wondering if this is a tweak, a strategic change. And as far as a revenue push starting from the top, is that because of what Bank of America is not doing or is it because of the weaker-than-expected environment or both? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - CEO [128] +-------------------------------------------------------------------------------- + + We have been driving the Company and so there has been two basic pieces of strategy. One is to continue to push the legacy issues and costs (inaudible) out of the Company. At the same time, take the Company and drive the underlying business metric. So that has been going on and as we clean up more of the former, then the focus of the Company is on the latter. And involved in the latter -- in other words, driving the core Company was that we had say credit card, a big book of business that we were running off that, we are getting towards the end of that or less impact quarter-to-quarter and now we have got to grow the credit card business. So this quarter, I think we did 900,000 plus credit cards, which is the highest amount we have done in a quarter since 2008 or something like. 70% of those are through the branch structure and through the preferred business and things like that. +So the goal is to continue to drive this Company and get the value of the combination of all the pieces of businesses through it. It is not a new push. It is just as the other issues go away, this is what the team has to be focused on. So we are seeing great progress in some of the businesses and look at the GWIM business and look at the connectivity to the GWIM business. We literally have millions of referrals that go between businesses a year. We goal those at 30%, 50% increases every year and we see that number is being hit and it's tracked in every single market, 100 plus markets, with about 20 different pieces of business flows between businesses that we track and monitor on a monthly basis. +It is all geared to just driving the value of the franchise and frankly delivering the customers' entire franchise. And it appears in all the businesses, whether it is in the commercial business bringing our 401(k) platform, which is new to the Bank of America structure since Merrill came in and we just see that -- wins in that happening every day. It is bringing the capital markets expertise deep in our middle-market business. It is bringing the personal side of the wealth management business to our business entrepreneurs. It is all those things. +And so there is -- new is probably a word that overstresses it. It is what we have to do to drive the revenue and continue to work the expenses to produce the bottom line we need. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA - Analyst [129] +-------------------------------------------------------------------------------- + + All right. So as you finish or move further along with the cleanup, just more external focus? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - CEO [130] +-------------------------------------------------------------------------------- + + Yes, and I always -- Mike, one of the tough things is we have 260,000 people in this Company and a lot of them have been focused on this and it is just their time to shine and the rest of what Bruce and I have been working on and others, restructuring the balance sheet and getting the capital up, getting liquidity, legacy issues are starting to fade away. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA - Analyst [131] +-------------------------------------------------------------------------------- + + And then a separate question, back to the litigation. The 10-K and some 10-Qs say that if the courts disagree with the argument of loss causation then the reserves may need to go up and that has not taken place, your range of possible loss is about the same. So I'm trying to reconcile those two thoughts because it seems as though, with Assured versus Flagstar, loss causation was shot down and some other comments in the courts. So how do I reconcile what happened with Flagstar, some other court comments that shoot down loss causation with the comment in your 10-K? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [132] +-------------------------------------------------------------------------------- + + I think that the -- the couple things that I would say is that the first is, and I am not going to drill into the Flagstar case, but I want to be clear, Flagstar gave a borrower fraud reference and that was part of that case, which is not something we have done. But at a high level, Mike, I would go back to -- that is correct. It is in the disclosure and as I said in my earlier comments, within the litigation reserve during the quarter, we reassess those every quarter and we did provide, within the litigation expense, some element of cost with respect to monolines during the quarter. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA - Analyst [133] +-------------------------------------------------------------------------------- + + And the big question here is what happens if the $8.5 billion settlement doesn't go through? And I asked Bank of New York that question this morning and the answer from Bank of New York is well it is up to the courts to decide. But what if the courts decide the $8.5 billion agreement does not go through, what would be the impact on your reserves? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [134] +-------------------------------------------------------------------------------- + + I think that the first thing is that the court is not opining on a number. They are either opining on approving or not approving and obviously, if they don't approve, we have set up reserves within the Countrywide securities, assuming that every trust gets to the 25% threshold. And so, obviously, if it doesn't get approved, this will revert back to going individual trust by trust and working through it. But I don't think it is appropriate to comment on reserves on something that we don't even -- don't know what -- the extent it's not going to happen. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA - Analyst [135] +-------------------------------------------------------------------------------- + + So you have $8.5 billion in reserves for the $8.5 billion settlement and that may change, but you will wait and see what happens May 30th? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [136] +-------------------------------------------------------------------------------- + + That's correct. And I think the other important thing is when we set up the $8.5 billion to the Countrywide, we also used that same methodology with respect to bank-issued securitization rep and warrant to set up reserves based on the same methodology across the Company. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA - Analyst [137] +-------------------------------------------------------------------------------- + + All right. Thank you. + +-------------------------------------------------------------------------------- +Operator [138] +-------------------------------------------------------------------------------- + + Paul Miller, FBR. + +-------------------------------------------------------------------------------- +Thomas Laturneau, FBR - Analyst [139] +-------------------------------------------------------------------------------- + + Good morning. This is actually [Thomas Laturneau] on behalf of Paul. I have a quick follow-up and I just want to make sure I heard you guys right. Did you say that 50% of your total originations were HARP and if so, would that imply that -- I guess what I am asking is do you think you can replace that with sort of normal retail volume if HARP starts to dissipate in the back half of the year? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [140] +-------------------------------------------------------------------------------- + + To be clear, the 50% was both MHA as well as HARP. + +-------------------------------------------------------------------------------- +Thomas Laturneau, FBR - Analyst [141] +-------------------------------------------------------------------------------- + + Okay. + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [142] +-------------------------------------------------------------------------------- + + And it was slightly -- and in fact, if you think about it year-over-year, the growth rate of the non -- those activities -- has actually been as strong as the growth rate. And that is the challenge going forward is just how do we keep an originated broader product set. But right now, that is an opportunity, which is here and near and it goes away over time, but the rest of the production continues to grow at a fast pace also. + +-------------------------------------------------------------------------------- +Thomas Laturneau, FBR - Analyst [143] +-------------------------------------------------------------------------------- + + Okay, great. That's helpful. And one additional question real quick. Can you tell me what type of products you are actually portfolioing right now? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [144] +-------------------------------------------------------------------------------- + + Within the consumer mortgage business? + +-------------------------------------------------------------------------------- +Thomas Laturneau, FBR - Analyst [145] +-------------------------------------------------------------------------------- + + Yes. + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [146] +-------------------------------------------------------------------------------- + + Largely nonconforming. And obviously we are not looking to go out -- what we want to do is to provide the mortgage product and balance sheet for that, which there isn't another alternative and we are pressing hard within the different businesses. The mortgage activity within the wealth management business this quarter was very strong, as well as within the mass affluent client space. So that is largely the focus. + +-------------------------------------------------------------------------------- +Thomas Laturneau, FBR - Analyst [147] +-------------------------------------------------------------------------------- + + Okay, great. Thanks for taking my question. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - CEO [148] +-------------------------------------------------------------------------------- + + Just on the underwriting of those though, you should be rest assured that the underwriting is consistent with very strong underwriting that is going on in the industry totally right now. + +-------------------------------------------------------------------------------- +Thomas Laturneau, FBR - Analyst [149] +-------------------------------------------------------------------------------- + + Okay, great. Thanks, guys. + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [150] +-------------------------------------------------------------------------------- + + Okay, I think we are through the questions. So once again thanks for joining us this morning and we will be talking with you next quarter. + +-------------------------------------------------------------------------------- +Operator [151] +-------------------------------------------------------------------------------- + + This concludes today's program. Have a great day. You may disconnect at this time. + + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/exam/original-files/Problem_1_Sample/2013-Apr-25-AMZN.OQ-139339186971-Transcript.txt b/exam/original-files/Problem_1_Sample/2013-Apr-25-AMZN.OQ-139339186971-Transcript.txt new file mode 100644 index 0000000..6c2cf36 --- /dev/null +++ b/exam/original-files/Problem_1_Sample/2013-Apr-25-AMZN.OQ-139339186971-Transcript.txt @@ -0,0 +1,534 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q1 2013 Amazon.com Inc Earnings Conference Call +04/25/2013 02:00 PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Tom Szkutak + Amazon.com, Inc. - SVP & CFO + * Sean Boyle + Amazon.com, Inc. - VP of IR + +================================================================================ +Conference Call Participiants +================================================================================ + + * Ken Sena + Evercore Partners - Analyst + * Jordan Rohan + Stifel Nicolaus - Analyst + * Stephen Ju + Credit Suisse - Analyst + * Scott Devitt + Morgan Stanley - Analyst + * Ben Schachter + Macquarie Research - Analyst + * Justin Post + BofA Merrill Lynch - Analyst + * Doug Anmuth + JPMorgan - Analyst + * Jason Helfstein + Oppenheimer & Co. - Analyst + * Brian Pitz + Jefferies & Company - Analyst + * John Blackledge + Cowen and Company - Analyst + * Youssef Squali + Cantor Fitzgerald - Analyst + * Colin Sebastian + Robert W. Baird & Co. - Analyst + * Mark Mahaney + RBC Capital Markets - Analyst + * Matt Nemer + Wells Fargo Securities - Analyst + * Ross Sandler + Deutsche Bank - Analyst + * Anthony DiClemente + Barclays Capital - Analyst + +================================================================================ +Presentation +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Good day, everyone; thank you for standing by. Welcome to the Amazon.com first-quarter 2013 financial results teleconference. At this time all participants are in a listen-only mode and after the presentation we will conduct a question-and-answer session. Today's call is being recorded. And for opening marks I will be turning the call over to the Vice President of Investor Relations, Mr. Sean Boyle. Mr. Boyle, please go ahead. + +-------------------------------------------------------------------------------- +Sean Boyle, Amazon.com, Inc. - VP of IR [2] +-------------------------------------------------------------------------------- + + Hello and welcome to or Q1 2013 financial results conference call. Joining us today is Tom Szkutak, our CFO. We will be available for questions after our prepared remarks. The following discussion and responses to your questions reflect management's views as of today, April 25, 2013 only and will include forward-looking statements. Actual results may differ materially. +Additional information about factors that could potentially impact our financial results is included in today's press release and our filings with the SEC including our most recent annual report on Form 10-K. As you listen to today's conference call we encourage you to have our press release in front of you which includes our financial results as well as metrics and commentary on the quarter. +During this call we will discuss certain non-GAAP financial measures in our press release, slides accompanying this webcast and our filings with the SEC, each of which is posted on our IR website. You will find additional disclosures regarding these non-GAAP measures including reconciliations of these measures with comparable GAAP measures. +Finally, unless otherwise stated, all comparisons in this call will be against our results for the comparable period of 2012. Now I will turn the call over to Tom. + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com, Inc. - SVP & CFO [3] +-------------------------------------------------------------------------------- + + Thanks, Sean. I will begin with comments on our first-quarter financial results. Trailing 12-month operating cash flow increased 39% to $4.25 billion. Trailing 12-month free cash flow decreased 85% to $177 million. Trailing 12-month capital expenditures were $4.07 billion. This amount includes $1.4 billion in purchases of our previously leased corporate office space as well as property for development of additional corporate office space located in Seattle, Washington which we purchased in fourth quarter 2012. +The increase in capital expenditures reflects additional investments in support of continued business growth consisting of investments in technology, infrastructure including Amazon Web Services and additional capacities to support our fulfillment operations. +Return on invested capital was 1%, down from 12%. ROIC is TTM free cash flow divided by average total assets minus current liabilities excluding the current portion of long-term debt over five quarter ends. +The combination of common stock and stock-based awards outstanding was 471 million shares compared with 464 million one year ago. +Worldwide revenue grew 22% to $16.07 billion or 24% excluding the $302 million unfavorable impact from year-over-year changes in foreign exchange rates. We are grateful to our customers who continue to take advantage of our low prices, vast selection and shipping offers. +Media revenue increased to $5.06 billion, up 7% or 10% excluding foreign exchange. EGM revenue increased to $10.21 billion, up 28% or 30% excluding foreign exchange. Worldwide EGM increased to 64% of worldwide sales up from 60%. +Worldwide paid unit growth was 30%. Active customer accounts exceeded 209 million. Worldwide active seller accounts were more than 2 million. Seller units represented 40% of paid units. +Now I will discuss operating expenses excluding stock-based compensation. Cost of sales was $11.8 billion or 73.4% of revenue compared with 76.1%. Fulfillment, marketing, technology and content and G&A combined was $3.83 billion or 23.8% of sales, up approximately 289 basis points year-over-year. Fulfillment was $1.74 billion or 10.8% of revenue compared with 9.5%. Tech and content was $1.26 billion or 7.9% of revenue compared with 6.5%. Marketing was $616 million or 3.8% of revenue compared with 3.6%. +Now I will talk about our segment results and, consistent with prior periods, we do not allocate to segments our stock-based compensation or other operating expense line item. In the North America segment revenue grew 26% to $9.39 billion. Media revenue grew 14% to $2.51 billion. EGM revenue grew 28% to $6.13 billion representing 65% of North America revenues up from 64%. +North America segment operating income increased 31% to $457 million, a 4.9% operating margin. In the international segment revenue grew 16% to $6.68 billion. Adjusting for the $301 million year-over-year unfavorable foreign exchange impact revenue growth was 21%. +Media revenue grew 1% to $2.54 billion or 7% excluding foreign exchange and EGM revenue grew 28% to $4.09 billion or 32% excluding foreign exchange. EGM now represents 61% of international revenues up from 56%. +International segment operating loss was $16 million, a 0.2% negative operating margin compared with income of $49 million. CSOI increased 11% to $441 million or 2.7% of revenue, down approximately 27 basis points year-over-year. +Unlike CSOI, our GAAP operating income includes stock-based compensation expense and other operating expense. GAAP operating income decreased 6% to $181 million or 1.1% of net sales. +Our income tax benefit was $18 million and includes $46 million of discrete tax benefits primarily resulting from the retroactive reinstatement of the federal research and development credit that was enacted in January 2013. GAAP net income was $82 million or $0.18 per diluted share compared with $130 million and $0.28 per diluted share. +Turning to the balance sheet, cash and marketable securities increased $2.18 billion year-over-year to $7.89 billion. Inventory increased 27% to $5.4 billion and inventory turns were 9.5, down from 10.4 turns a year ago as we expanded selection, improved in-stock levels and introduced new product categories. Accounts Payable increased 29% to $8.92 billion and accounts payable days increased to 68 from 62 in the prior year. +I will conclude my portion of today's call with guidance. Incorporated into our guidance are the order trends that we have seen to date and what believe today to be appropriately conservative assumptions. Our results are inherently unpredictable and may be materially affected by many factors including a high level of uncertainty surrounding exchange rate fluctuations as well as the global economy and consumer spending. It is not possible to accurately predict demand and therefore our actual results could differ materially from our guidance. +As we describe in more detail in our public filings, issues such as -- settling intercompany balances and foreign currencies amongst our subsidiaries; unfavorable resolution of legal matters; and changes to our effective tax rates can all have a material effect on guidance. Our guidance further assumes that we don't conclude any additional business acquisitions, investments or settlements, record any further revisions to stock-based compensation estimates, and that foreign exchange rates remain approximately where they have been recently. +For Q2 2013 we expect net sales of between $14.5 billion and $16.2 billion or growth of between 13% and 26%. This guidance anticipates approximately 275 basis points of unfavorable impact from foreign exchange rates, GAAP operating income or loss to be between a $340 million loss and $10 million income compared to $107 million income in the prior year period. This includes approximately $340 million for stock-based compensation amortization of intangible assets. +We anticipate consolidated segment operating income which excludes stock-based compensation and other operating expense to be between zero and $350 million compared to $360 million in the prior year period. We remain heads down focused on driving a better customer experience through price, selection and convenience. We believe putting customers first is the only reliable way to create lasting value for shareholders. Thanks. With that, Sean, let's move to questions. + +-------------------------------------------------------------------------------- +Sean Boyle, Amazon.com, Inc. - VP of IR [4] +-------------------------------------------------------------------------------- + + Great. Thanks, Tom. Let's move on to the Q&A portion of the call. Operator, will you please remind our listeners how to initiate a question? + + + +================================================================================ +Questions and Answers +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions). Brian Pitz, Jefferies. + +-------------------------------------------------------------------------------- +Brian Pitz, Jefferies & Company - Analyst [2] +-------------------------------------------------------------------------------- + + Great, thanks. In February you changed your FBA fulfillment fees. Any comments on how this affected third party sales and what was the overall merchant response? And then just quickly, any update on your latest plans for new fulfillment centers in 2013? Thanks. + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com, Inc. - SVP & CFO [3] +-------------------------------------------------------------------------------- + + I will take the second part of the question first. In terms of new fulfillment centers, we have announced three in the US right now and then a few outside of the US consistent with prior years. It is early; we really like the growth that we are experiencing. We will be adding more FCs through the course of the year. But stay tuned and we'll update you as we go. +In terms of FBA, there's not a lot I can talk to there. We are very pleased with the FBA business. We think it is great for sellers, great for customers and we are pleased to offer that service. + +-------------------------------------------------------------------------------- +Brian Pitz, Jefferies & Company - Analyst [4] +-------------------------------------------------------------------------------- + + Great, thanks. + +-------------------------------------------------------------------------------- +Operator [5] +-------------------------------------------------------------------------------- + + Scott Devitt, Morgan Stanley. + +-------------------------------------------------------------------------------- +Scott Devitt, Morgan Stanley - Analyst [6] +-------------------------------------------------------------------------------- + + Thanks. Tom, the international segment sales growth of 21% (excluding foreign exchange rates) continues to show modest deceleration and I think with the exception of 4Q it has been trailing US growth. And I understand that AWS is mostly booked in the US so that is a piece of the delta. But you have talked in the past quarters about the investments in international driving margin to these breakeven levels in international. I was wondering if you could just talk through the deceleration in the revenue growth in those markets and whether that is comp related, Europe macro or otherwise? +And then secondly, shipping cost on a net basis is again leveraging, I think that is the second consecutive quarter. I just wonder if you could refresh us in terms of when the accounting change occurred in terms of the shipping revenue calculation for FBA to just understand if that is an organic number now. Thank you. + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com, Inc. - SVP & CFO [7] +-------------------------------------------------------------------------------- + + The second half of the question there's -- it is organic so there is no -- it is consistent year-over-year. So this is the first quarter that it will be consistent year-over-year. +In terms of your question on international, we are seeing still very solid growth, 21% on a local currency basis. As you have read, certainly there is some softness from a macro standpoint that others are seeing. Hard to know whether that is impacting us and how much; we are not a bellwether for the economy. But we are very pleased with the growth that we are seeing; again 21% on a local currency basis, unit growth is actually growing substantially faster than that. So again, that is what we are seeing. +In terms of investing, you're absolutely right; we are investing in a number of geographies including certainly China we have been investing for several years, we continue to invest in there. We think it is a great long-term opportunity, but we are in investment mode. And certainly some of the more recent additions that we have had with Italy and Spain, that's certainly in investment mode as well. + +-------------------------------------------------------------------------------- +Scott Devitt, Morgan Stanley - Analyst [8] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Operator [9] +-------------------------------------------------------------------------------- + + Mark Mahaney, RBC Capital Markets. + +-------------------------------------------------------------------------------- +Mark Mahaney, RBC Capital Markets - Analyst [10] +-------------------------------------------------------------------------------- + + Thanks. Just a broad question on demand, this kind of midteens at the low-end revenue growth that you have been kind of guiding to for a quarter or two now, that would seem well below the average that you've seen in the past. Are there any other factors you would want to call out or specifically not call out? +Do you think that things like the imposition of state sales taxes are having a near-term drag on growth rates? Last quarter I think you talked about consumer electronics at the high-end. Are there any particular categories there you would want to call out as maybe driving that low that could produce the low-end of the range outside of negative FX? Thanks, Tom. + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com, Inc. - SVP & CFO [11] +-------------------------------------------------------------------------------- + + Sure. As we've been consistently doing, we're giving a wide range. We think that's appropriate given all the factors. That is not something new that we are doing, that is something that we have been doing for some time. And you are right; the growth rate guidance for Q2 is 13% to 26%. Certainly foreign exchange is having an impact, that includes approximately 275 basis points of foreign exchange. So it is approximately 16% to 29% on a local currency basis. +So again, it's a wide range. And there's probably not a lot to add there, but it takes into account all of the things that we think we need to take into account as we give guidance. And in terms of the absolute dollar range, it is very similar to what we would have -- in terms of the dollar range; we would have given for Q1. I think it is maybe a $100 million difference in terms of the absolute value of that range that we gave. So again, a wide range; we think that that is appropriate. + +-------------------------------------------------------------------------------- +Mark Mahaney, RBC Capital Markets - Analyst [12] +-------------------------------------------------------------------------------- + + Thank you, Tom. + +-------------------------------------------------------------------------------- +Operator [13] +-------------------------------------------------------------------------------- + + Ben Schachter, Macquarie. + +-------------------------------------------------------------------------------- +Ben Schachter, Macquarie Research - Analyst [14] +-------------------------------------------------------------------------------- + + Are there any factors that are impacting the unit growth, particularly the shift from physical to digital? For instance a rented video versus purchasing a video? Or are there any other factors that you would highlight that are impacting the unit growth? + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com, Inc. - SVP & CFO [15] +-------------------------------------------------------------------------------- + + The one factor I would call out -- first of all in terms of overall unit growth, our overall unit growth is 30% year over year, again very solid growth. It compares to approximately 49% in Q1 of last year. So we are certainly overlapping a pretty strong growth last Q1. +In terms of the physical and digital, certainly one thing that we are seeing is certainly digital is growing at a much faster rate. And where you do see that a little bit is in our third-party units as a percentage of total units. You will see that that's approximately 40% this quarter. That compares to last year up about approximately 100 basis points. +But what we are seeing is because the digital units are growing at a faster rate and they are mostly first party, you are seeing that number impacted where that percentage as a percentage of our total is not growing as fast as it has the last few quarters. And again, that is largely driven by the digital units growth that you are seeing. +So again, that's -- if you were to back out, for example, and just look at our physical units, our third party physical units as a percentage of total physical units this year versus last year is up over 300 basis points. Again, that is 3P growth as a percentage of total physical units. + +-------------------------------------------------------------------------------- +Ben Schachter, Macquarie Research - Analyst [16] +-------------------------------------------------------------------------------- + + Thanks. + +-------------------------------------------------------------------------------- +Operator [17] +-------------------------------------------------------------------------------- + + Ross Sandler, Deutsche Bank. + +-------------------------------------------------------------------------------- +Ross Sandler, Deutsche Bank - Analyst [18] +-------------------------------------------------------------------------------- + + Thanks, guys. A question on the -- a follow-up question on the shipping. So just your shipping cost, not your net shipping margin, but just shipping cost relative to gross profit declined about 300 basis points, similar to what you have seen over the past four quarters. So as you start to comp some of these efficiency gains that you are seeing in shipping, do you think that line will continue to show leverage or is it going to start to level out from here? Thanks. + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com, Inc. - SVP & CFO [19] +-------------------------------------------------------------------------------- + + We are not giving -- certainly not giving guidance on any specific line item, but certainly over a long period of time we think there is opportunity to be more productive there and there are certainly efficiency gains to be had there. And that's something that certainly the team will continuously work on. + +-------------------------------------------------------------------------------- +Operator [20] +-------------------------------------------------------------------------------- + + Colin Sebastian, Robert W. Baird & Co. + +-------------------------------------------------------------------------------- +Colin Sebastian, Robert W. Baird & Co. - Analyst [21] +-------------------------------------------------------------------------------- + + A question on Web services. I wonder if you can comment on enterprise-level adoption and whether there are any meaningful barriers to that happening over time. We noticed you have been pretty aggressive in hiring enterprise-level salespeople. Thanks. + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com, Inc. - SVP & CFO [22] +-------------------------------------------------------------------------------- + + No, I don't think that there is. I think that the team is doing a fantastic job in terms of developing services that are great for many different customer types including enterprises. And the team is heads down focused on making sure we have a great operational -- these services are great from an operational standpoint and security standpoint and they are doing a terrific job. +And so, it is a very great opportunity for enterprises to adopt our Web services and the team is certainly focused on that along with the other customers, and so -- other customer sets. So again, it is a great opportunity for those customers and for us. + +-------------------------------------------------------------------------------- +Colin Sebastian, Robert W. Baird & Co. - Analyst [23] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Operator [24] +-------------------------------------------------------------------------------- + + Douglas Anmuth, JPMorgan. + +-------------------------------------------------------------------------------- +Doug Anmuth, JPMorgan - Analyst [25] +-------------------------------------------------------------------------------- + + Thanks for taking the question. You have clearly been more aggressive in terms of video content recently and you are sort of leading with it more in the release tonight in terms of the business content. I was hoping you could just add some more color here on the value that you think that TV and movie content adds to consumers' overall purchase patterns? Thanks. + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com, Inc. - SVP & CFO [26] +-------------------------------------------------------------------------------- + + Sure. It is certainly one of our digital offerings and we have a number of different -- a few different services. We have certainly content that we are using as part of our Prime offer that we have a lot of free content for customers. We think that is a great service to customers along with our express shipping offers, as well as other content that we have free, for example our Kindle owners lending library for books. +So again, we think it is a great -- Prime is a great value for customers and it's part of that value proposition. We also have a very good transaction business for video as well that's growing very, very fast and certainly customers like it and we are seeing that reflected in the results that you see today. + +-------------------------------------------------------------------------------- +Doug Anmuth, JPMorgan - Analyst [27] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Operator [28] +-------------------------------------------------------------------------------- + + Justin Post, Merrill Lynch. + +-------------------------------------------------------------------------------- +Justin Post, BofA Merrill Lynch - Analyst [29] +-------------------------------------------------------------------------------- + + I was wondering if you could help us a little bit about the Kindle ecosystem. On prior calls a few years ago you singled it out as a fast growth area and you were very happy with the performance. We haven't heard as much about it lately. Kind of the impact part of how units are doing against your expectations and then the impact it is having on Prime subs and also your gross and operating margins? Thank you. + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com, Inc. - SVP & CFO [30] +-------------------------------------------------------------------------------- + + We are very pleased with our Kindle and digital business and we are super excited. In terms of the ecosystem, you are certainly seeing that in our results that you see today. For example, if you look at our media growth we are certainly -- that ecosystem is more penetrated there than it is in international and you see that reflected in those associated growth rates. +Another way you see it is if you take a look at our top 10 best-selling items worldwide in Q1, the top 10 are all either digital or Kindle related, Paperwhite is our best-selling product worldwide. But again, all 10 spots in the Q1 were either Kindle or digital items and I believe that that is the first time that we have seen that. +We have been looking at that from a quarterly results standpoint for some period of time and we have had various levels of the top 10, but I think this may be the first quarter that we have had all top 10 being either or Kindle related or digital related. So again, we are very pleased with what we are doing there and we are going to continue to innovate on behalf of customers. + +-------------------------------------------------------------------------------- +Justin Post, BofA Merrill Lynch - Analyst [31] +-------------------------------------------------------------------------------- + + And any impact on your gross or operating margins that you want to call out? + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com, Inc. - SVP & CFO [32] +-------------------------------------------------------------------------------- + + The one thing I would say is we certainly are investing. It is certainly an area of investment and you are seeing that reflected. We are making a number of investments across the business and certainly we are investing in Kindle and our digital offerings, we are investing in some of the other things I mentioned earlier like China, some of the emerging geographies. So those are certainly some of the larger key investments we are making. + +-------------------------------------------------------------------------------- +Justin Post, BofA Merrill Lynch - Analyst [33] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Operator [34] +-------------------------------------------------------------------------------- + + Matt Nemer, Wells Fargo Securities. + +-------------------------------------------------------------------------------- +Matt Nemer, Wells Fargo Securities - Analyst [35] +-------------------------------------------------------------------------------- + + Good afternoon. We are hearing reports that there is refrigeration equipment going into some of your fulfillment centers outside of the Seattle area. Just wondering if you can update us on plans to expand AmazonFresh? Thanks. + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com, Inc. - SVP & CFO [36] +-------------------------------------------------------------------------------- + + No, have nothing to announce. We are very pleased with what we have seen in the Seattle area, but again it has been a test and we continue to monitor that test carefully. It is certainly something that we see that customers love the experience. The challenge has always been making sure we can get the economics right and that is something we will continue to focus on. + +-------------------------------------------------------------------------------- +Operator [37] +-------------------------------------------------------------------------------- + + Stephen Ju, Credit Suisse. + +-------------------------------------------------------------------------------- +Stephen Ju, Credit Suisse - Analyst [38] +-------------------------------------------------------------------------------- + + Anything you can say in terms of how much Amazon is in video as well as potentially your own in-house produced content currently helps and should in the future help reduce churn in Amazon Prime? Thanks. + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com, Inc. - SVP & CFO [39] +-------------------------------------------------------------------------------- + + Thanks for the question. Yes, it is something -- we haven't released any of the numbers, it is something that we are tracking very closely. It is something that we believe over time will reduce churn and is certainly helping today. +What we are seeing is great traction. We see a lot of usage of the service. Customers love it and we think it is a very interesting part of Prime offering and that is why we have been expanding and why you see some of the more recent announcements including some of the stuff included in the earnings release today around original content. So again, it is something that we find very interesting and we are excited about it. + +-------------------------------------------------------------------------------- +Operator [40] +-------------------------------------------------------------------------------- + + Ken Sena, Evercore Partners. + +-------------------------------------------------------------------------------- +Ken Sena, Evercore Partners - Analyst [41] +-------------------------------------------------------------------------------- + + I was just hoping you could maybe provide a little bit more color on the unit growth deceleration. And looking back over the last four quarters it seems like about 500 basis points or so each quarter of deceleration. You had about 200 basis points here which is an improvement, but anything you would say just to any signs of maturity in some of the businesses and maybe where that deceleration is specifically coming from? Thank you. + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com, Inc. - SVP & CFO [42] +-------------------------------------------------------------------------------- + + No, there is not a lot I can add. I think the -- 30% is still a very strong growth rate. Again, it is growing at a faster rate than revenue, revenue at 22%, revenue at a local currency growth of 24% very strong; third-party growth continues to be very strong. Retail growth is strong. +So again, there's not a lot I can provide you there. But again, keep in mind that we are overlapping 49% growth last year Q1 which is certainly a little bit of a difficult compare. But again, pleased with the 30% growth rate. + +-------------------------------------------------------------------------------- +Operator [43] +-------------------------------------------------------------------------------- + + John Blackledge, Cowen and Company. + +-------------------------------------------------------------------------------- +John Blackledge, Cowen and Company - Analyst [44] +-------------------------------------------------------------------------------- + + Great, thanks. Just a question on the Amazon advertising platform. Given the immense amount of purchase data you have on Amazon customers, how is that being used as a competitive advantage and maybe just provide an overall view on the direction of the Amazon ad platform over time? + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com, Inc. - SVP & CFO [45] +-------------------------------------------------------------------------------- + + In terms of the platform itself, we think it is a very sizable, very good long-term opportunity for us and it is something that we've been working on for some time and we just think it is very interesting. One thing you will notice on our site, we're being obviously very -- making sure the customer experience is great. +What we're really trying to do is we are trying to help customers find and discover what they want to buy online. So we are very -- again, it is very customer centric, but it is also from a business standpoint a very good long-term opportunity. We have a great team that is working on the opportunity and we are excited about the long-term potential of it. + +-------------------------------------------------------------------------------- +Operator [46] +-------------------------------------------------------------------------------- + + Anthony DiClemente, Barclays. + +-------------------------------------------------------------------------------- +Anthony DiClemente, Barclays Capital - Analyst [47] +-------------------------------------------------------------------------------- + + Thanks. I am just wondering what you are seeing in terms of the attach rate of your transactional video on demand business versus usage of Prime instant video. I am wondering just if your consumers tend to choose between the two when they are making a selection. Or does one sort of drive the other? Does a Prime subscriber have a higher transactional VOD attach rate than a non-Prime? So it would be helpful to hear what you are seeing there in terms of usage. + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com, Inc. - SVP & CFO [48] +-------------------------------------------------------------------------------- + + I think the only thing I can help you with is we see -- I will take Prime customers for example. We certainly see adoption of the service in terms of free content, but those same customers are purchasing content as well. And so there is a good attachment to it which we like. +And what we see Prime members doing not just within video content, but we see them doing a lot of cross shopping. So it is not surprising; we see them do -- maybe a customer comes and has been traditionally purchasing them pre-Prime in a few categories. We find that they do a lot more cross shopping. +Same thing with digital content. As they use the service they might start with free content and then they will also continue to view and stream free content, but they will also purchase paid content. So it is a nice effect that we are seeing which is why we like Prime so much. + +-------------------------------------------------------------------------------- +Operator [49] +-------------------------------------------------------------------------------- + + Youssef Squali, Cantor Fitzgerald. + +-------------------------------------------------------------------------------- +Youssef Squali, Cantor Fitzgerald - Analyst [50] +-------------------------------------------------------------------------------- + + Okay, thank you very much. Two quick questions please. Going back to the international question, what it causing international media to decelerate? I think last year Q1 I think it was up 22%, FX adjusted this quarter it was up 7%. Is it all macro or are there any maybe other factors that you can talk about maybe specific to SKUs or something? +And the other is more of a clarification. I know last quarter you gave the unit growth in aggregate versus the unit growth of 3P. I was wondering if you could give that to us as well. + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com, Inc. - SVP & CFO [51] +-------------------------------------------------------------------------------- + + In terms of the international media growth, this quarter it was 1% on a dollar basis, 7% on a local currency basis. In terms of the overall growth rate, certainly what you are seeing is digital content as part of that is growing very fast, but it is not as large or as penetrated or ecosystem isn't as developed I would say as it is in the US. +And so, when you compare the two geographies for a second, that is one of the more meaningful differences that you see between the two is you see that both are growing digital content very fast, it's just the ecosystem is more built out in North America. +But again, certainly we see very positive signs in that given the growth we are experiencing in international; it's just on a lower base. So that is -- again, to be helpful there. +In terms of the unit growth, we said that our overall unit growth was 30% for the quarter. Our 3P unit growth -- I don't have the overall growth rate but it is growing at a faster rate than the total. + +-------------------------------------------------------------------------------- +Operator [52] +-------------------------------------------------------------------------------- + + Jordan Rohan, Stifel. + +-------------------------------------------------------------------------------- +Jordan Rohan, Stifel Nicolaus - Analyst [53] +-------------------------------------------------------------------------------- + + I was hoping you could comment on the market entry and expansion strategy for Amazon in Brazil. There seemed to be a tremendous amount of press last year about it and it seems to have died down to some degree. I know the Company may already be there with Amazon Web Services and some Kindle offerings, but when do you think that might get a little bit broader? +And secondly, there have been some stories recently about an Internet streaming device box, a set-top box, something of the sort. Can you comment on any new hardware form factors including that plus some sort of a cell phone or handset that might be coming down the pike? Anything to look forward to in the Kindle family or related? Thanks. + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com, Inc. - SVP & CFO [54] +-------------------------------------------------------------------------------- + + In terms of geographic expansion, there is not a lot I can say specifically about Brazil. We think we are in the right geographies right now. We have expanded into a number of geographies over the past few years. That is certainly something we always look at and you should expect us to expand into additional geographies over time. +In terms of any questions related to our product roadmap -- we have a long-standing practice of not talking about what we might or might not do there. But we are certainly excited about the product roadmap that we have for the future. And again, we have a long-standing practice of not giving details until closer at launch. + +-------------------------------------------------------------------------------- +Operator [55] +-------------------------------------------------------------------------------- + + Jason Helfstein, Oppenheimer & Co. + +-------------------------------------------------------------------------------- +Jason Helfstein, Oppenheimer & Co. - Analyst [56] +-------------------------------------------------------------------------------- + + Thanks. Can you give us a little more color around customer growth? I mean, that number has been slowing not dramatically, but that is a slowing trend? Are you focused more on higher value customers to drive the business and any color around the quarter would be helpful? Thanks. + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com, Inc. - SVP & CFO [57] +-------------------------------------------------------------------------------- + + We are actually pleased with the growth from a customer standpoint. We have seen very good growth and we continue to -- we have many, many teams across Amazon that are just heads down focused on trying to improve the customer experience and inventing on behalf of customers. So we couldn't be more pleased with what they are doing, and you see that reflected in our overall growth rate this quarter with revenue up 24% on a local currency basis and units growing at 30% on top of a strong growth quarter last year Q1. + +-------------------------------------------------------------------------------- +Jason Helfstein, Oppenheimer & Co. - Analyst [58] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Sean Boyle, Amazon.com, Inc. - VP of IR [59] +-------------------------------------------------------------------------------- + + Great. Thank you for joining us on the call today and for your questions. A replay will be available on our Investor Relations website at least through the end of the quarter. We appreciate your interest in Amazon.com and look forward to talking with you again next quarter. + + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/exam/original-files/Problem_1_Sample/2013-Jan-17-BAC.N-137118030967-Transcript.txt b/exam/original-files/Problem_1_Sample/2013-Jan-17-BAC.N-137118030967-Transcript.txt new file mode 100644 index 0000000..08523f1 --- /dev/null +++ b/exam/original-files/Problem_1_Sample/2013-Jan-17-BAC.N-137118030967-Transcript.txt @@ -0,0 +1,834 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q4 2012 Bank of America Corporation Earnings Conference Call +01/17/2013 08:30 AM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Brian Moynihan + Bank of America Corporation - CEO + * Bruce Thompson + Bank of America Corporation - CFO + * Kevin Stitt + Bank of America Corporation - IR + +================================================================================ +Conference Call Participiants +================================================================================ + + * John McDonald + Sanford Bernstein - Analyst + * Paul Miller + FBR & Co. - Analyst + * Nancy Bush + NAB Research - Analyst + * Mike Mayo + CLSA - Analyst + * Glenn Schorr + Nomura Asset Management - Analyst + * Guy Moszkowski + Autonomous Research - Analyst + * Matt O'Connor + Deutsche Bank - Analyst + * Ed Najarian + ISI Group - Analyst + * Brennan Hawken + UBS - Analyst + * Betsy Graseck + Morgan Stanley - Analyst + +================================================================================ +Presentation +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Welcome to today's program. At this time, all participants are in listen-only mode. (Operator Instructions). Please note today's call is being recorded. It is now my pleasure to introduce Kevin Stitt. Please begin, sir. + +-------------------------------------------------------------------------------- +Kevin Stitt, Bank of America Corporation - IR [2] +-------------------------------------------------------------------------------- + + Good morning. Before Brian Moynihan and Bruce Thompson begin their comments, let me remind you that this presentation does contain some forward-looking statements regarding both our financial condition and financial results and that these statements involve certain risks that may cause actual results in the future to be different from our current expectations. For additional factors, please see our press release and SEC documents. And with that, let me turn it over to Brian. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - CEO [3] +-------------------------------------------------------------------------------- + + Thank you, Kevin and thank all of you for joining us on a busy day. In 2012, we laid out our four focus areas for the year -- capital, managing our risk, reducing costs and driving our core business growth. In each area, we achieved strong results this year and we are carrying that momentum forward as we look to 2013. So let's start on page 4 of our presentation. We positioned our Company with a strong balance sheet this year. The estimated capital ratios now are above current Basel 3 requirements and we have seen improving credit quality. And as you know, we have addressed many legacy issues that Bruce will talk about later. As a result, the [coring] power of the Company, the coring power that our team has been driving all year can now shine through more clearly as we look forward. +We've positioned our Company to driving our core customer relationship strategy. That strategy continues to accelerate our growth by simply helping those people we serve with their financial lives. We've positioned our Company by reducing costs, making our operations leaner and more efficient and investing in our growth initiatives at the same time. We continue to streamline all our businesses. We focus it on those three customer groups that we talk about on each call -- people, companies, institutional investors. And on page 5, we highlight some of the progress we have made in the last quarter and last year. +On the consumer side, our deposits continue to grow. Our retail mortgage production has increased by an average of 10% per quarter over the past three quarters. The pipeline today remains as strong as it was at the end of the third quarter. As you know, we continue to optimize our service network, our branch network as online and mobile banking numbers continue to increase. We are now averaging about 10,000 new mobile subscribers a day. +In our Preferred client area, the growth this year has been strong. The evidence of that is our brokerage assets in Merrill Edge are up 14% from a year ago. Moving to our wealth management businesses, US Trust and Merrill Lynch, those businesses had strong loan, strong deposit, strong revenue growth this year and earnings and pretax margin were also at record levels. +As we think about the companies, the corporations and middle market companies we serve across the country and around the world, our loan growth continues to expand, particularly in the second half of 2012. Global Banking ended with loans of $288 billion, up from $265 billion at the end of June. Investment banking fees for these clients are strong and we maintained our number two market position. In the fourth quarter, we had a leadership position in debt underwriting. +As we move to our Global Markets business, and it serves the institutional investors, our research capabilities continue to be recognized as the best in the world for the second straight year. As we look at 2012, sales and trading revenue did well in a relatively difficult environment. In 2012, our trading revenues were up 20% from 2011, excluding the impacts of DVA and we did that while we reduced cost in this business by over 10%. +So thinking about it, looking across every customer group we serve, you can see our strategy we put in place continues to drive results. We continue to fine-tune this strong core franchise focusing on those industry-leading capabilities we have to serve our clients and customers in every area. +But while we are doing that, we continue to work on our expenses. Bruce is going to take you through the highlights in a few pages. But if you think about it from the top, we reduced our delinquent mortgage count, which allowed us to reduce our LAS expenses. We have reduced our employee count in each quarter in the last five and we have done that while we continue to invest in our targeted growth areas. +Our strategy continues to work. We are seeing growth across all the core businesses. We are seeing that momentum continue to accelerate, so as we look forward to 2013, we are going to continue to drive this strategy and drive the earnings power of our Company. Thank you and I will turn it over to Bruce to take you through the results in detail. + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [4] +-------------------------------------------------------------------------------- + + Great. Thanks, Brian and good morning, everyone. I'm going to start on slide 6. As you all saw this morning, we reported net income for the quarter of $732 million, or $0.03 a share for the quarter. I am going to spend a moment on the previously announced items in the geography on the income statement so that you can better understand the quarter. +Reported revenues net of interest expense were $18.9 billion during the quarter. If you look in the bottom left-hand corner of this slide, you can see our revenues were negatively impacted by five items totaling approximately $3.7 billion. Those items included a $2.5 billion charge for reps and warranties with respect to the Fannie Mae settlement; approximately $0.5 billion related to the clarification of our obligations under mortgage rescissions; negative DVA and FVO of approximately $700 million relating to the significant tightening of our credit spreads that we saw during the quarter and then a positive $700 million between the change in the MSR valuation related to the servicing sales, as well as our sale in our Japan joint venture. +If we move to the right on the expense side, our expenses were negatively impacted by approximately $2.3 billion due to our previously announced independent foreclosure review acceleration agreement, as well as approximately $900 million of litigation expense and $300 million of compensatory fees. In addition, during the quarter, we did have a positive net tax adjustment primarily related to tax credits that are associated with certain non-US subsidiaries. +If we turn to slide 7, a lot of numbers. I would like to draw your attention to three line items. The first, deposits were up $42 billion, or 4%, from the end of the third quarter to the end of the fourth quarter. During the fourth quarter, we reduced our long-term debt footprint by approximately $11 billion, but more significantly, during all of 2012, our debt footprint came down by almost $100 billion, or 26%. We accomplished that reduction in our debt footprint while our overall liquidity sources remained in the range of $370 billion to $380 billion. +Turning to slide 8, and looking at Basel 1 capital, Basel 1 capital declined during the quarter to a still very strong 11.06%. The decline was the result of our pretax loss, as well as approximately $500 million of common and preferred stock dividends. In addition, during the quarter, our risk-weighted assets grew by approximately $10 billion as the strong growth that we saw in the investment and corporate bank more than offset the reductions in the consumer business. +If we turn to slide 9, I'd like to spend a few minutes on Basel 3 capital. We estimate that our Tier 1 common capital under Basel 3 on a fully phased-in basis would have been 9.25% at the end of the year. Our estimate once again assumes approval of all models with the exception of the change in the comprehensive risk measure for CRM after one year under the US Basel 3 NPRs. This 9.25% is a 28 basis point improvement over our estimate of 8.97% at the end of the third quarter of this year. +While our Tier 1 common capital declined as a result of the pretax loss, lower OCI and higher threshold deductions, this was more than offset by a reduction in our risk-weighted assets. Driving the RW decline during the quarter were lower exposures, particularly in consumer real estate and market risk, improved credit quality and updates of our recent loss experience in our models. We estimate that our Tier 1 common capital at the end of the quarter was $128.6 billion while our risk-weighted assets were approximately $1.4 trillion under Basel 3. And as you all know, Basel 3 ratios are more sensitive to changes in credit quality, portfolio composition, interest rates, as well as earnings performance. +If we turn to slide 10 and look at funding and liquidity, our global excess liquidity sources were at $372 billion at the end of the fourth quarter, down $8 billion from the prior quarter driven by a reduction of our long-term debt footprint of approximately $11 billion during the quarter. During the fourth quarter, we redeemed $5.3 billion of TruPS and other long-term debt. +You may have seen last week, we raised approximately $6 billion in the aggregate for 3, 5 and 10-year notes to take advantage of strong investor demand. As we look forward though, we do expect to continue to see long-term debt decline, primarily through maturities consistent with our overall goal of optimizing the cost associated with both our debt and capital. As we do so, we expect that our time to required funding will consistently remain above two years coverage and that metric at the end of 2012 was at 33 months. +On slide 11, net interest income, we reported an increase in net interest income from $10.2 billion in the third quarter to $10.6 billion in the fourth and an improvement in our net interest margin of about 3 basis points to 2.35%. As we consider that number, we benefited during the quarter from less negative impact of market-related premium amortization expense. We continued to benefit from the shrinkage in our long-term debt footprint, as well as improved trading-related net interest income. Partially offsetting those benefits were lower asset yields, as well as lower consumer loan balances. +If you adjust for the market-related items that I just referred to, we are in line with the estimated range of net interest income of $10.5 billion before market-related impacts we have discussed during our past earnings announcements. Given [long end] rate levels at the end of December, we estimate that quarterly net interest income may come in around a base of $10.5 billion plus or minus for FAS 91 and day count for the next several quarters. The impact of our liability management actions and long-term debt maturities are expected to help offset headwinds from continued pressure on consumer loan balances, as well as the overall low rate environment. +On slide 12, we highlight the results of our Consumer & Business Banking. Earnings were $1.4 billion for the quarter, an increase of $143 million, or 11% from the third quarter, driven by higher revenue more than offsetting higher non-interest expense. Service charges were lower due in part to our actions that we took around Hurricane Sandy to further support our customers in the region. Average deposits increased more than $6 billion, or 1.3% from the third quarter. +On the slide 13, we list some of the key indicators for our Consumer & Business Banking for the quarter. In our deposits business, the average rate paid on deposits declined 3 basis points -- 3 basis points during the quarter to 17 basis points. Our mobile banking customer base reached 12 million, which is an 8% increase from the prior quarter and up 31% from a year ago. We reduced banking centers as we continue to optimize the delivery network around customer behaviors. Credit card purchase volumes per active account increased 7% from the fourth quarter of 2011. The US credit card loss rate is at its lowest level since 2006 while the 30 plus day delinquency rate is at a historic low. +On slide 14, and before we get into Legacy Assets & Servicing, we summarize the specific mortgage items that we announced on January 7, including our settlements with Fannie Mae, sales of mortgage servicing rights and the acceleration agreement on the IFR. During the quarter, these items had a negative pretax income on fourth-quarter LAS revenue of $2.6 billion and in the expense category of $2 million resulting in an aggregate net income impact of $2.9 billion in LAS within our Consumer Real Estate Services segment. +If we turn to slide 15 now, we break out the two businesses within CRES -- Home Loans and LAS. Home Loans reported an increase in net income to $281 million while LAS reported a net loss of $4 billion, including the approximately $2.9 billion of items I just highlighted. As you all are aware, the Home Loans business is responsible for first lien and home equity originations within CRES. +First mortgage retail originations of $21.5 billion were up 6% from the third quarter driven by refinancings and up 42% compared with retail originations of approximately $15 billion in the prior year-ago quarter. You can see this same type of trend in our core production income, which is up from the third quarter and almost double results from a year ago. As you know, we exited the correspondent business in late 2011, so correspondent originations are non-existent versus volumes of approximately $6.5 billion a year ago. +The MSR asset within LAS ended the quarter at $5.7 billion, up $629 million from the end of the third quarter, due in part to the valuation adjustments previously discussed related to the sale of MSRs. MSR hedge results during the quarter were positive and we ended the period with the MSR rate at 55 basis points versus 45 basis points in the third quarter and 54 basis points one year ago. +If we turn to slide 16, we show some comparisons of certain metrics in Legacy Assets & Servicing on a linked quarter basis, as well as compared to fourth quarter a year ago to reflect the work done to reduce delinquent loans and find homeowner solutions. As you recall, Legacy Assets & Servicing reflects all of our servicing operations and the results of our MSR activities. +Total staffing in the quarter, including contractors and offshore, decreased approximately 9,000 from the third quarter. The number of first lien loans serviced dropped 7% in the quarter while the number of 60 plus day delinquent loans dropped 17% to 773,000 units. We expect this drop in 60-day plus delinquencies should have a positive impact on our staffing levels and servicing costs going forward as we were fully staffed in the second half of last year to handle the various new programs and regulations. +We have referenced our January 7 announcement of agreements to sell MSRs totaling $306 billion aggregate unpaid principal balance. This represents 2 million loans of which 232,000 are 60 plus day delinquent. The transfers of these servicing rights are scheduled to occur in stages over the course of 2013 with the delinquent loans scheduled to be transferred after the current loans. Currently, we recognize approximately $200 million in servicing fees per quarter associated with these loans, which is expected to decrease throughout the year as we actually transfer the servicing. However, the impact on earnings from lower revenue is expected to be negligible for the year as we expect expenses to also decrease as we transfer the servicing, especially the 60 plus day delinquent loans. +We believe our serviced 60 plus day delinquent loans at the end of 2013 may be around 400,000 units versus 773,000 units at the end of 2012, a decrease of approximately 50%. That implies an additional decrease of 150,000 units beyond the 232,000 units that are expected to go with the scheduled transfers. +Given the projected declines in 60 plus day delinquent loans and notwithstanding their being a one to two-quarter lag between delinquent loan transfers and expense decrease, we believe we can get expenses in the fourth quarter of 2013 down by more than $1 billion from the $3.1 billion in the fourth quarter of 2012, excluding the impact of IFR and litigation. +On slide 17, we show outstanding claims at the end of December, but, as you know, a significant portion of GSE claims has been addressed in our settlement with Fannie Mae. If we exclude the rep and warrant amounts addressed in the settlement of $12.2 billion from GSE outstanding claims of $13.5 billion, pro forma outstanding GSE claims would have been $1.3 billion at the end of the year. Total outstanding claims on a pro forma basis would then be $16.1 million. Remember that the table reflects unpaid principal amounts versus the actual losses projected on the loans. +Outstanding claims in the quarter from private-label counterparties increased approximately $1.7 billion from the end of September. And an anticipated increase in our aggregate non-GSE claims was taken into consideration when we developed our reserves at the time of the BNY settlement and we continue to review our assumptions on a quarterly basis. Unresolved claims with monolines remains static as much of our activity with the monolines revolves around litigation issues. +Reserves for representation warranties at the end of the quarter increased to $19 billion of which $8.5 billion is associated with the BNY settlement and approximately $6 billion is associated with the GSEs. We currently estimate that the range of possible loss for both GSE and non-GSE representations and warranties exposures could be up to $4 billion over accruals at December 31 compared to up to $6 billion over accruals at September 30. This decrease is the result of our settlement with Fannie Mae in the range of possible loss now principally covers non-GSE exposures. +On slide 18, in Global Wealth & Investment Management, earnings for the quarter of $578 billion -- excuse me -- $578 million were up slightly from record results in the third quarter. The pretax margin was 21%. This quarter, we did move two businesses that we agreed to sell, International Wealth Management and our brokerage joint venture in Japan, to the All Other segment, including the results in past quarters for comparability. +Overall, client activity in the Wealth Management business in the quarter across all categories was quite robust and was aided by client actions due to the fiscal cliff. Period-end deposit growth of approximately $23 billion and period-end loan growth of $3.5 billion helped offset the impact of the continued low rate environment. Ending loan balances were at record levels and long-term AUM flows of $9.1 billion were the second-highest quarterly amount since the Merrill merger and the 14th consecutive positive quarter. +Net income of $1.4 billion in Global Banking on slide 19 is an increase of more than 10% from the third quarter and reflects higher revenue and lower expenses. Average loans and leases increased $10.8 billion, or 4% from the third quarter, with growth across C&I, as well as commercial real estate. Average deposit balances increased $15.8 billion, or 6% from the third quarter, to $268 billion as our customer base continued to be very liquid. Asset quality continued to improve from prior quarters as we have seen over the last year. NPAs dropped 20% to $2.1 billion and reservable utilized criticized exposure declined 11%. +On slide 20, we outline our investment banking fees for the quarter. You can see that our debt underwriting area was up $213 million from the third quarter to $1.078 billion in revenues and our advisory business was up approximately $80 million to $301 million for the quarter. Corporation-wide investment banking fees were up 20% from the third quarter and 58% from the year-ago period. Debt underwriting fees were a record for the quarter and we believe number one on a global basis during the quarter. From an overall investment banking fee perspective, we maintained our number two global ranking in net investment banking fees during 2012 based on Dealogic data. +Switching to Global Markets on slide 21, earnings, excluding DVA, were $326 million. Excluding DVA and the UK corporate tax charge in the third quarter, net income decreased compared to the third quarter driven by lower sales and trading revenue reflecting a seasonally slower fourth quarter. Sales and trading revenue, excluding DVA, was down 23% from the third quarter, but improved substantially from levels a year ago. Within our FICC area, excluding DVA, revenues of $1.8 billion decreased from $2.5 billion in the third quarter primarily as a result of lower volumes and reduced client activity, but were up $1.3 billion, or 37% from a year ago. +In equities, excluding DVA, results were flat with the third quarter as lower volatility and continuing lack of investor appetite for equity products kept volume suppressed. Expenses declined from both the third quarter and the prior year primarily driven by lower personnel expense. +On slide 22, we show you the results of All Other, which includes our Global Principal Investments business, the non-US consumer card business, our discretionary portfolio associated with interest rate risk management, the international wealth management business we agreed to sell, insurance, as well as our discontinued real estate portfolio. The revenue improvement in All Other from the third quarter was mainly due to a lower negative valuation adjustment on structured liabilities under fair value option of $442 million compared to a negative $1.3 billion in the third quarter and higher equity investment income as a result of the sale of our brokerage joint venture in Japan. +Non-interest expense declined compared to the third quarter due to lower litigation costs as the third quarter included the Merrill Lynch class-action settlement. Also contributing to net income in the quarter was the foreign tax credit benefit that I mentioned at the beginning of the presentation. +As you can see on slide 23, total expenses increased compared to the third quarter, but were down from a year ago. Excluding LAS expenses, the independent foreclosure review and litigation, expenses in the quarter were $13.3 billion versus $12.9 billion in the third quarter and $14.7 billion a year ago. The $400 million increase from the third quarter reflects the normal seasonal trend and represented non-personnel costs. FTE at the end of the quarter was down approximately 5,000 from the third quarter and 15,000 from a year ago. +An important driver behind the reduction of $1.4 billion in expenses from fourth quarter a year ago is New BAC, which we have discussed with you several times. If you remember, total annual cost savings targeted with New BAC are $8 billion per year, or $2 billion on a quarterly basis, which we said we would hit sometime in mid-2015. In the fourth quarter, we achieved approximately $900 million of the $2 billion, which is 45% of our target. As a reminder, the first quarter every year includes the annual retirement eligible stock compensation, which was $900 million in the first quarter of 2012 and this year, we expect will be a similar amount plus or minus. +While we are talking about expenses, let me comment on taxes. Tax expense for the quarter was a benefit of $2.6 billion consisting of the expected tax benefit of the pretax loss, our recurring tax preference items and the $1.3 billion primarily related to the non-US restructurings. For 2013, we estimate the effective tax rate to be somewhere around 30%, including $800 million or so for another expected 2% UK tax rate reduction, which we would expect in the third quarter. +If we switch to overall credit quality on slide 24, provision was $2.2 billion versus $1.8 billion in the third quarter as lower charge-offs were more than offset by lower release. Overall credit quality trends continue to be positive even when we normalize for the events in the third quarter. If you'll recall, regulators provided new guidance to the industry in the third quarter of this year around loans discharged as part of a Chapter 7 bankruptcy, which resulted in increased net charge-offs of $478 million in the third quarter. +In addition, we incurred charge-offs of $435 million in the third quarter in connection with the National Mortgage settlement. We did not have impacts to net charge-offs of a similar magnitude in the fourth quarter, but did have $73 million related to the completion of the implementation of the regulatory guidance. Excluding these items, net charge-offs were down $178 million, or 6%. +We believe most portfolios are close to stabilization and overall reserve reductions are expected to continue but at reduced levels. Given our outlook for a slow growth but healthy economy, we believe provision expense in 2013 will range between $1.8 billion and $2.2 billion per quarter, the levels experienced between the second and fourth quarters of 2012. Excluding the fully insured portfolio, 30 plus day performing delinquencies continue to drop. NPAs were down $1.4 billion from the third quarter and $4.2 billion from a year ago. On the commercial side, reservable criticized levels showed a decline of 8% from the third quarter and 42% from a year ago. +Before we open up for questions, let me say and reiterate Brian's comments that we feel very good about our accomplishments in 2012. We improved the balance sheet, we managed risk and we addressed significant legacy issues and were successful in reducing certain of our exposures. We have stepped up our focus on growing the business and some of that focus is evident this quarter when you look at deposit growth across the franchise, loan growth in the Global Bank, solid Investment Banking results and in GWIM, strong deposit AUM and loan flows. +We enter 2013 all about moving the ball forward and winning in the marketplace with what we think is the best banking franchise in the world. And with that, let me go ahead and open it up for questions. + + + +================================================================================ +Questions and Answers +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions). Matt O'Connor, Deutsche Bank. + +-------------------------------------------------------------------------------- +Matt O'Connor, Deutsche Bank - Analyst [2] +-------------------------------------------------------------------------------- + + Good morning. A couple of follow-ups. I guess starting on the expenses, I appreciate the outlook on the legacy costs. As we think about kind of the All Other expenses that you pointed to of $13.3 billion, with some seasonal stuff this quarter, maybe you could just frame what we can expect for that level or for that bucket for 2013. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - CEO [3] +-------------------------------------------------------------------------------- + + You're saying expenses, not including LAS and the litigation? + +-------------------------------------------------------------------------------- +Matt O'Connor, Deutsche Bank - Analyst [4] +-------------------------------------------------------------------------------- + + Exactly. The $13.3 billion that you pointed to in the fourth quarter. + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [5] +-------------------------------------------------------------------------------- + + I think as you look at that number, and if we keep LAS out of this, obviously, the big new savings bucket that we have is New BAC. We have indicated that we are, on a quarterly basis, at $900 million a quarter as we leave 2012. We expect that our New BAC cost savings when we get to the fourth quarter of '13 will be at $1.5 billion per quarter. So you can expect to see, on a core basis with New BAC, about a $600 million increase from where we leave 2012 to where we leave 2013. + +-------------------------------------------------------------------------------- +Matt O'Connor, Deutsche Bank - Analyst [6] +-------------------------------------------------------------------------------- + + Okay. So as we think about that $13.3 billion, I guess we could take out $600 million for New BAC, but was there other bulk or how much I guess of the seasonal stuff is there that maybe we should adjust for? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [7] +-------------------------------------------------------------------------------- + + The seasonal stuff, if you are going Q4 to Q4, you would expect the seasonal stuff to be there, but, as we indicated, we looked at and for this quarter relative to the third quarter, there was $300 million to $400 million of stuff that we would characterize as seasonal. + +-------------------------------------------------------------------------------- +Matt O'Connor, Deutsche Bank - Analyst [8] +-------------------------------------------------------------------------------- + + Okay. And then just in terms of like underlying, call it, inflation or just normal investments, if we take that $13.3 billion 4Q to 4Q, would you expect that to be down, so you have kind of minus $600 million from additional BAC savings and there is always some offsets from inflation or investments? Do you think that net number will be down? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [9] +-------------------------------------------------------------------------------- + + We would expect -- and the one thing that we are being very cognizant of is that while we are investing in the business, we are not going to let inflation outrun the progress that we are working on New BAC. So I think on a net basis thinking about that $600 million number from New BAC is a good assumption. + +-------------------------------------------------------------------------------- +Matt O'Connor, Deutsche Bank - Analyst [10] +-------------------------------------------------------------------------------- + + Okay. And then just separately, if we look at the FICC revenue, a little bit weaker than maybe we have seen so far; although it is still early in the earnings process here. And I guess I noticed that the asset level in the trading book went up, the VAR doubles quarter-to-quarter and just wondering if there was anything unusual in terms of positioning that you would point to. + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [11] +-------------------------------------------------------------------------------- + + Sure. I think it is important when you look at the FICC business to go back and look at the progress that we have made during 2012. If you look at FICC revenues 2012 compared to 2011 pre-DVA, they were up 36% year-over-year. If you go back and look at each of our quarterly releases in 2012, in each quarter in 2012 pre-DVA, revenues were higher than 2011 at the same time that we were taking cost out. +The third thing I would say is that you have to realize that we run the FICC and overall debt underwriting business and look at that as one consolidated business and from a debt underwriting perspective at over $1 billion of revenue, we believe that was, as I indicated earlier, more than anyone else did this quarter on a global basis. And so we feel very good about that. Your point on the VAR is a fair one and we did see VAR increase during the fourth quarter and we would expect to see the benefits of that VAR flow through during the first quarter this year. + +-------------------------------------------------------------------------------- +Matt O'Connor, Deutsche Bank - Analyst [12] +-------------------------------------------------------------------------------- + + Sorry, benefits meaning higher revenue? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [13] +-------------------------------------------------------------------------------- + + That is correct. + +-------------------------------------------------------------------------------- +Matt O'Connor, Deutsche Bank - Analyst [14] +-------------------------------------------------------------------------------- + + Okay, all right. Thank you. + +-------------------------------------------------------------------------------- +Operator [15] +-------------------------------------------------------------------------------- + + John McDonald, Sanford Bernstein. + +-------------------------------------------------------------------------------- +John McDonald, Sanford Bernstein - Analyst [16] +-------------------------------------------------------------------------------- + + Hi, Bruce, does the goal of reducing the delinquents in LAS, the 150,000, does that include additional planned MSR sales that you might have in mind? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [17] +-------------------------------------------------------------------------------- + + It does not, John, because I think the one thing when we announced these sales that you have to realize is that it is very important that the transition of the loans that are being sold work through a process and go in a way that is as consumer-friendly as we can do it. So there is a lot of work that goes through that. So as we look at the servicing business, that does not include in any meaningful way incremental sales. There may be some small ones over and above that and at the same time, somebody could come and look to do something as well, but, at this point, I would consider that 150,000 to be more organic reduction. + +-------------------------------------------------------------------------------- +John McDonald, Sanford Bernstein - Analyst [18] +-------------------------------------------------------------------------------- + + Okay. And what kind of pace throughout the year would you expect for reducing that $3.1 billion LAS expense by your goal of $1 billion by the fourth quarter? Kind of steady throughout the year or is it lumpy? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [19] +-------------------------------------------------------------------------------- + + I would assume that you should generally expect it to come out throughout the year. It is not something you're going to have to wait for the fourth quarter to see. + +-------------------------------------------------------------------------------- +John McDonald, Sanford Bernstein - Analyst [20] +-------------------------------------------------------------------------------- + + Okay. And then getting to Matt's question earlier, if we -- just a lot of moving parts on your expenses. If we look top of the house, trying to think about a jumping-off point for total BAC expenses that you start in the first quarter, it seems like you might be in the $17 billion ballpark with the stock option expense. Does that feel like the right area? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [21] +-------------------------------------------------------------------------------- + + Yes, I am hesitant, John, to give you specific numbers in the quarter. What I would say is that we gave you guidance as to how much of the fourth quarter was seasonal that we obviously wouldn't expect in the first quarter. You have got the $900 million of stock compensation expense that will come through. Expect to see a little bit of benefit in the first quarter as we continue to implement New BAC and probably the biggest variable that you can see in the first quarter that I didn't mention is really compensation expense that varies based on actual business performance. But I think if you think and look at those different metrics, you will get pretty close. + +-------------------------------------------------------------------------------- +John McDonald, Sanford Bernstein - Analyst [22] +-------------------------------------------------------------------------------- + + Okay. And with the Fannie settlement this quarter, how should we think about the rep and warrant provisioning going forward here? Will you need to add on a quarterly basis to the rep and warrant provision? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [23] +-------------------------------------------------------------------------------- + + If you look back over the course of 2012, absent any settlements or any unusual activity, you had a run rate throughout the quarter of around $300 million per quarter in 2012. And with the Fannie settlements, as well as obviously the fact that Freddie was settled at Countrywide, you would expect that number to be $150 million or so going forward. + +-------------------------------------------------------------------------------- +John McDonald, Sanford Bernstein - Analyst [24] +-------------------------------------------------------------------------------- + + Okay. And then one last thing on NII. Was that a pretty clean number? Was there any impact from hedging or premium amortization in the NII number this quarter? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [25] +-------------------------------------------------------------------------------- + + There was a less than $100 million to the negative. + +-------------------------------------------------------------------------------- +John McDonald, Sanford Bernstein - Analyst [26] +-------------------------------------------------------------------------------- + + Okay. And your guidance of the kind of $10.5 billion is the run rate you think for the next couple quarters and that is excluding any of that, right? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [27] +-------------------------------------------------------------------------------- + + Excluding any of that and realize that we have got a couple less days in the first quarter of this year. + +-------------------------------------------------------------------------------- +John McDonald, Sanford Bernstein - Analyst [28] +-------------------------------------------------------------------------------- + + Okay. Thanks. + +-------------------------------------------------------------------------------- +Operator [29] +-------------------------------------------------------------------------------- + + Paul Miller, FBR Capital Markets. + +-------------------------------------------------------------------------------- +Paul Miller, FBR & Co. - Analyst [30] +-------------------------------------------------------------------------------- + + Thank you very much. Hey, guys, on your guidance for NII, which was really good, you talked about a steady -- I mean you can maintain that net interest margin at current levels. What about average earning assets? Do you think you can maintain your average earning assets at these levels or grow them? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [31] +-------------------------------------------------------------------------------- + + Well, I think the average earning asset levels are probably at a level that you are not going to see an enormous amount of growth. What we do hope that happens though is that the composition of those earning assets change so that we can look at, and particularly in the institutional business as I mentioned, as well as in GWIM, there was very strong loan growth during the fourth quarter. We are focused on continuing to drive that forward and that obviously reduces the need to invest in securities and other things, and we think ultimately has a positive impact on NII and is also quite frankly consistent with managing OCI risk going forward. + +-------------------------------------------------------------------------------- +Paul Miller, FBR & Co. - Analyst [32] +-------------------------------------------------------------------------------- + + Okay. And then I have to ask one mortgage question. I asked the same question in the third quarter, but I think, Brian, you have been out in a lot of interviews talking about how much you like mortgage banking. But you still really are just going to be focused on retail. Am I correct? And on retail, are you focusing just on your own customers or will you be focusing on customers outside of your deposit mix or your customer base? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - CEO [33] +-------------------------------------------------------------------------------- + + Well, Paul, focusing on the customers and our customer base is not real restrictive since you are one and two households, so there is plenty of marketshare to go. Our penetration of the product in our Preferred segment and our Wealth Management segment is still relatively low, so there is tremendous growth. +But as you think about shaping the mortgage business, we are kind of -- this quarter kind of moves us -- starts moving [announcements] as we close these servicing sales to where we end up with maybe 5 million serviced loans going forward producing $20 billion and growing a quarter direct to retail. And that is kind of what we want with a marketshare that steadily grows and that is kind of the equilibrium and the team has to go. +So the next challenge ahead is obviously replacing the HARP volumes over the next year. This year, we had to replace the correspondent volumes. Next year, we have to replace the HARP volumes and the team is working diligently on that, but it is really focused on the core customers. And if you think about the cost of servicing mortgages and stuff, we need to really focus on people that we are very comfortable with the credit and keep the delinquencies down and stay away from the stray products and just chase some volume. + +-------------------------------------------------------------------------------- +Paul Miller, FBR & Co. - Analyst [34] +-------------------------------------------------------------------------------- + + Guys, thank you very much. + +-------------------------------------------------------------------------------- +Operator [35] +-------------------------------------------------------------------------------- + + Glenn Schorr, Nomura. + +-------------------------------------------------------------------------------- +Glenn Schorr, Nomura Asset Management - Analyst [36] +-------------------------------------------------------------------------------- + + Good morning. First one is a question on risk-weighted assets. On one of your slides, you show Basel 1 assets going actually up a little in the quarter, Basel 3 coming down. It is all in the net change in credit and other risk-weighted assets. And I am just curious what do you see on the credit side that drives that model enhancement? And the reason why I ask is it makes sense. Intuitively, it is just different to the tune of half, the Basel 1 to Basel 3 jump. It is different versus all the other big banks. + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [37] +-------------------------------------------------------------------------------- + + It's a good question, Glenn. When you look at -- and let's just first spend a minute on Basel 1. As I think you know that the majority of regular way loans in Basel 1 are 100% risk-weighted so that as you look at our $10 million increase in risk-weighted assets under Basel 1, it is generally speaking the net increase in our loan book. +If you go to Basel 3, and I think you are referring to slide 9 where we talk about the different reductions, why don't I spend a moment on each of the buckets? The first is that we referenced that we had about $23 billion less through consumer real estate exposures and the way that Basel 3 works is that, as opposed to these general risk-weighted buckets, they look at loan-to-value, delinquency and other type metrics. So during the quarter, the $23 billion benefit we saw, we saw declines in the loan-to-value within our residential mortgage book. The percentage of loans that were 90 plus day delinquencies, each of those went down, which I think in large part is reflective of the changes in the underwriting standards that we have talked about before that we implemented in the fourth quarter of '08 and the first quarter of '09. +The second thing is if you look at our home equity book, the delinquencies, as well as the loan-to-value continue to improve there, as well as the notional amount outstanding has also gone down. So we benefit there as well. +And then the third bucket within consumer real estate are our other retail exposures, which generally represent the runoff portfolio that we have talked about, that decreased during the quarter as well. So those three different buckets within the consumer exposure are what drove the $23 billion decline there. +If you move to the $64 billion number that we referenced largely in market risk, really go through a couple different areas where we have benefits. The first is we did have a pretty significant decline on a net basis of CVA, stressed VAR, as well as our CRM risk-weighted assets during the quarter. Over and above that, you know that some of the securitization products have very high risk-weighted asset content. We were able to fairly significantly decrease some of those securitization exposures. And during the quarter, the industry also got some guidance from a regulatory perspective on risk-weighted assets with certain securitization products that was favorable, so that helped. +And then the last piece that we had is that there were some indexed tranches and other things within the markets business, which came down pretty significantly as well. So those were really the big items in the $64 billion bucket. +And then with respect to the $23 billion bucket, I want to spend just a moment on that because the $23 billion reduction is not a function of going in and changing models. The $23 billion is that, each year when you update your models for actual loss experience, it drives changes in risk-weighted assets and given the strength and improvement across the credit portfolios in 2012, we have benefited from that when the models were updated. +As you look forward, I would just say, looking forward, I think we are generally in a place now where we told you a couple quarters ago the optimization on Basel 1 was largely done and the risk-weighted assets would vary pretty proportionally with the amount of loans. From a pure risk-weighted asset perspective, I think we are largely through those reductions. But keep in mind, from a numerator or common perspective going forward, we will benefit given our deferred tax position in that the pretax number will generally grow capital on a pretax basis and we still do have some threshold deductions we can work down there. + +-------------------------------------------------------------------------------- +Glenn Schorr, Nomura Asset Management - Analyst [38] +-------------------------------------------------------------------------------- + + That is super helpful. I think you just said it, but I just want to confirm. This happens on an annual basis. In other words, whether the balances come down on paydown, run-off, charge-off, whatever or credit improves, the models get updated on an annual basis and there is no permission process. In other words, this just happens in real-time? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [39] +-------------------------------------------------------------------------------- + + There is not a permission aspect to it; it is required that we update these on an annual basis, so that is correct. + +-------------------------------------------------------------------------------- +Glenn Schorr, Nomura Asset Management - Analyst [40] +-------------------------------------------------------------------------------- + + Okay, really appreciate it. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - CEO [41] +-------------------------------------------------------------------------------- + + Hey, Glenn, the balances move every quarter. I think it is the models -- the factors that change on risk. + +-------------------------------------------------------------------------------- +Glenn Schorr, Nomura Asset Management - Analyst [42] +-------------------------------------------------------------------------------- + + Yes, that is super helpful. I appreciate all of that. Inside the average balance sheet, the securities yields went up 11 basis points in the quarter. Most banks are trending lower as things run off. This is part of your defending the NIM, so I get it. Just curious, is it just expanding a little bit on the duration curve? Just curious what you are doing on the asset side to help support those yields. + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [43] +-------------------------------------------------------------------------------- + + No, it is not extending duration. If you look at our securities portfolio, we continue to run that duration in and around two years. What you have to keep in mind is that we had -- during the third quarter, you had some of the FAS 91 amortization expense. That flows through and hits the yield on the securities portfolio, so we did not see a significant change in the actual yields during the quarter; it was really more FAS 91. +And I think, as you look at our Company going forward, I think we are a little bit different in that between the fact that the duration of what we have continues to be short, as we look forward, we clearly think the worst of the recouponing of the securities portfolio is behind us based on where rates are today. + +-------------------------------------------------------------------------------- +Glenn Schorr, Nomura Asset Management - Analyst [44] +-------------------------------------------------------------------------------- + + Okay, thanks, Bruce. I appreciate it. + +-------------------------------------------------------------------------------- +Operator [45] +-------------------------------------------------------------------------------- + + Ed Najarian, ISI Group. + +-------------------------------------------------------------------------------- +Ed Najarian, ISI Group - Analyst [46] +-------------------------------------------------------------------------------- + + Good morning, guys. With the capital ratios up significantly and credit quality getting better, the mortgage repurchase risk getting resolved over time, could you give us any thoughts in terms of how you are thinking about capital return for 2013? We have had a number of the other big banks -- JPMorgan, Wells, USB -- at least give us some insight in terms of how they are thinking about capital return for this year going into the CCAR and wondered if you would be willing to do the same? Thanks. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - CEO [47] +-------------------------------------------------------------------------------- + + I think I'd say, Ed, that we completed our results; we are in a better position this year than last year and we will let you know once we get through the test. I think it is -- the Fed is doing its work, but I think we have been clear with people that the issue for us is not necessarily capital levels, balance sheet cleanup and stuff. The issue is the recurring earnings levels that have been consistent on that and we will let you know once we get there. But Bruce and the team have done a great job on submitting it and we will see what happens. + +-------------------------------------------------------------------------------- +Ed Najarian, ISI Group - Analyst [48] +-------------------------------------------------------------------------------- + + Well, I mean you are already above the capital ratios that you need to be at, at least according to FSB guidelines. Now that you are generating -- continue to generate excess capital, is that something that you think you would like to return to shareholders over time or is that something that needs to be retained in the near term for safety and soundness reasons or till you get more litigation resolved? Or any thoughts in terms of the excess, above and beyond where you have indicated you sort of intend to run the Company? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - CEO [49] +-------------------------------------------------------------------------------- + + If you look at what we did in 2012, we took capital and redeemed preferred instruments and subordinated debt and other things and continuing to do that during the year. We were getting approvals to do so as we went along. So all the -- we have been clear that all the capital we have, now that we are above the levels, we will be in a position when we get the approvals to return to the shareholders. And you know the viewpoints of the relative preferences of the CCAR process in terms of dividends versus stock buybacks and things like that. So we would be no different than anybody else. +But it is clear; it is either on the balance sheet, tangible book value. It is not needed for the risk of the balance sheet because you can see that with all the risk-weighting and everything, the capital is there and it will all get returned as part of the business proposition. If we retain any to grow, that is actually a good problem, but, so far, we still have optimization left on the balance sheet, as Bruce described, that will allow us to continue to return capital. So our intention is to return it. The question is we have got to get through the processes and then we will do it. + +-------------------------------------------------------------------------------- +Ed Najarian, ISI Group - Analyst [50] +-------------------------------------------------------------------------------- + + Okay, thanks. And then I guess my second question is just fairly technical. But when I look at what you have outlined in terms of reserve recapture, it looks like about $900 million in terms of loan-loss reserve, a $2.2 billion provision and $3.1 billion of charge-offs. But it looks like the loan-loss reserve itself dropped by about $2 billion from the third quarter. Can you reconcile that for me? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [51] +-------------------------------------------------------------------------------- + + Yes, the reason it dropped by that amount is that, and you saw it in the third, as well as the fourth quarter, that with some of the DOJ/AG settlement modification and other things, that as you dispose, get repaid or write off the purchased credit-impaired portfolio, it reduces your loan-loss reserve. + +-------------------------------------------------------------------------------- +Ed Najarian, ISI Group - Analyst [52] +-------------------------------------------------------------------------------- + + Okay. And then that is not coming through the charge-off line? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [53] +-------------------------------------------------------------------------------- + + That is correct. + +-------------------------------------------------------------------------------- +Ed Najarian, ISI Group - Analyst [54] +-------------------------------------------------------------------------------- + + Okay. All right, thank you. + +-------------------------------------------------------------------------------- +Operator [55] +-------------------------------------------------------------------------------- + + Brennan Hawken, UBS. + +-------------------------------------------------------------------------------- +Brennan Hawken, UBS - Analyst [56] +-------------------------------------------------------------------------------- + + Good morning. Thanks for taking the question. So a quick one following up actually on one of Ed's questions. And it is related to your capital levels and the SIFI buffer. Is there any view from your guys' perspective that you will intend to run with a buffer above the required 8.5% because many of your money center competitors are going to be running at the 9.5% level. So maybe either for funding market reasons or potentially competitive reasons, is it in your mindset or strategic vision that you might run a bit above that 8.5% level or is that the wrong way to think about it? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - CEO [57] +-------------------------------------------------------------------------------- + + I would make a couple observations on that. The first is that, at 9.25% today, regardless of required SIFI buffers, we have more on the Basel 3 basis than anyone else. +The second thing I would say is given the position that we are in and the fact that we do have DTAs going forward, the rate at which we increase capital given it is on a pretax basis, we would expect to be more significant than our peers. +So I think going forward, we still think we have the opportunity as core earnings rebound to grow capital more quickly than our peers. As it relates to the exact level, we have always looked at it and thought that you want to run at least an extra 50 basis point cushion. Given that these ratios are more sensitive to changes in the market, depending on what the market looks like at the time your ratio is, you may vary that a little bit based on the market. +But I would say generally if we look at what we saw in the third quarter and what we saw today that we are generally in the range of where you would expect us to run and as we look out at and see how our counterparties from a credit perspective view the Company now and look at our credit spreads, we feel like we are doing the right things right now. + +-------------------------------------------------------------------------------- +Brennan Hawken, UBS - Analyst [58] +-------------------------------------------------------------------------------- + + Okay, that's fair. And then thinking about maybe the fact that you guys might be in the market to sell another chunk of MSRs or at least you hear about that through speculation from various sources. Is the idea behind that, we are at a point where that is not really a capital issue for you all anymore, right, because you are below the threshold from that perspective. So is it more about getting an opportunity to further eliminate and push down these legacy costs or is it that you just strategically don't view the business as very attractive and you just want to be out of it altogether? Can you help maybe give some color around that thought process? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - CEO [59] +-------------------------------------------------------------------------------- + + So if you go back and look what we did in the beginning of '11 when we split, we split our portfolio into two thought processes, our mortgage servicing portfolio. We split a chunk into what we called the Home Loans at that point and a chunk into what we called LAS and it was about, round numbers, $11 million, $12 million in loans at that time. Half went to LAS and half went to Home Loans. And the criteria which we looked at that was customers, products and loans and stuff that were going to be a go-forward business we think of in the Home Loans business. And the other half was products that were never going to be done again and the way we are going to run the business because frankly you lose a lot of money on them due to the delinquency levels and customer strife, etc. +So since that time, we have, and if you go back and look, we showed that exact break. Since that time, we have been busily trying to work the $6 million non-core loan book portfolio down. And we got it down around $2.5 million-ish now and with the sales, $2 million, not all of it comes out of that because of combined pools and stuff, but a significant amount, we are really accelerating the ability to get to the end state on the bad mortgage servicing book for lack of a better term. And that is what we are up to. +We had gotten it to a level from a capital level and all that stuff we were comfortable with and so once we get this out, these are products that we just aren't going to continue with and we have been focusing on rebuilding the business into the core business as I spoke about earlier. +So if you think about it in that context, think about something that might have taken us all the way into '15 to finish up and think about through the sales of a significant part of the $2.5 million how much -- the question is we are bringing that into '13 and early '14 as we finish up, which then accelerates our reposition of our Company away from products and services, which we didn't plan to continue two years ago. + +-------------------------------------------------------------------------------- +Brennan Hawken, UBS - Analyst [60] +-------------------------------------------------------------------------------- + + Cool. Thanks for that. And then last one, the $1 billion decline in mortgage costs, the legacy costs you guys provided from the $3.1 billion to the $2.1 billion by 4Q, just kind of curious about the starting point there. The $3.1 billion, I thought that included $0.3 billion of compensatory fees from this Fannie deal. So why is that the starting point rather than like $2.7 billion? Is there something in that $0.3 billion that is recurring or what is the deal there? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [61] +-------------------------------------------------------------------------------- + + Yes, the number was slightly less than $300 million, rounded to that number, but, in any one quarter in that business, you have some pluses and some minuses that are flowing through. So you are right. The $1 billion though is starting from a $3.1 billion base. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - CEO [62] +-------------------------------------------------------------------------------- + + Let's be clear here. We are still working through -- we have signed the sales transaction January 7, working through with the buyers the timing of the movement of the assets and finalizing that, then how fast you can move. There is transition issues that you have got to deal with in terms of people who are in the middle of the modification process and stuff. +But let me flip to the other thing. This quarter, the total resources you saw on the one slide dedicated to LAS went down by 9,000 between FTEs and contractors dedicated to this team. We will continue to drive that down. There is nothing more important to our Company to get this done as quickly as possible. +So Bruce has given you the outline and whether it is from this call item or that item, the idea is that we need to get the work out of here and that is what actually is taking the cost and the sales closing, the continued progress on the remaining piece that we have left, but think about, in a single quarter, 9,000 change in headcount and think about -- we are going as fast as we can. + +-------------------------------------------------------------------------------- +Brennan Hawken, UBS - Analyst [63] +-------------------------------------------------------------------------------- + + Yes, well, clearly, it has been really tough to try to forecast how this would run down and you guys are clearly not alone in having challenges. Everybody in the industry I think has been struggling with that. So just was kind of curious whether or not there was something in there. Better to understand it. Thanks for giving the color. + +-------------------------------------------------------------------------------- +Operator [64] +-------------------------------------------------------------------------------- + + Betsy Graseck, Morgan Stanley. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [65] +-------------------------------------------------------------------------------- + + Good morning. A couple of other questions on mortgage. One is around the Fannie settlement. So now you will be originating through Fannie as you used to, regular way mortgages for the Home Loan section. I am wondering how fast you think you can get your marketshare back up as a result of that. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - CEO [66] +-------------------------------------------------------------------------------- + + Our marketshare overall, when you put the whole thing together, I think has gone up about 2/10 of 1% per quarter as best I have. And remember, we are only competing in the direct-to-consumer part of the market. So I think it has moved from 4.2% to 4.4% to 4.6% type of numbers. And so expect us to keep driving our marketshare up. Now, again, we got the HARP volumes, which is in the $21 billion this quarter, $7 billion to $8 billion type of number, think of that, that we have got to replace. And so that is the team's challenge. +And on the other hand, we are not closing loans as quickly as we should honestly. And we have been adding significant resources as we have downsized LAS into the home loans business to increase our fulfillment capacity. So you put all that together, our marketshare continues to grow every quarter for the last three or four. We will continue to drive it. +Where it will settle in at, I am not exactly sure, but as I talked about earlier, if you think about us having about a -- think of an 8% share of servicing, we have got to get our origination share moving towards that direction over the next couple years in order to have sort of equilibrium for lack of a better term. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [67] +-------------------------------------------------------------------------------- + + Right. It is just that when you stopped originating through Fannie, the share came down rather sharply in a short period of time. So I was just wondering if, with higher throughput, you might be able to do more there. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - CEO [68] +-------------------------------------------------------------------------------- + + Look, the issue isn't liquidity in the market, but the kinds of loans going through. The issue was -- they happen to correspond to each other, but it really had nothing to do with each other. The issue is we stopped the correspondent business. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [69] +-------------------------------------------------------------------------------- + + Right. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - CEO [70] +-------------------------------------------------------------------------------- + + If you thought about our marketshare when it was at its strongest in the high teens, two-thirds of it or more were correspondents. And that is what dropped our share down. The retail marketshare is actually -- from this year, direct-to-retail, excluding even HARP, it is flat year-over-year in terms of production and fell a little bit and has grown every quarter. +So we are selling to Freddie and we will work it out with Fannie over time, but the point I am really saying is it is not the secondary market liquidity that caused our markets to drop; it was getting out of the correspondent business. And if you just look in this quarter, remember that there was $6.5 billion last year fourth quarter versus this year fourth quarter that was in the correspondent that is a carryover from when we quit it in the third quarter at the same time we announced that we were going to stop with Fannie. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [71] +-------------------------------------------------------------------------------- + + Right. Okay. And then lastly on Home Loans, should we expect -- are you anticipating more reinvestment in the Home Loans group to drive that faster throughput or do you think you are at the investment spend that you want to make in that business? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - CEO [72] +-------------------------------------------------------------------------------- + + If the volumes are there, we will continue to invest in the servicing fulfillment teams. We've moved -- Tony Meola has done a great job and Ron Sturzenegger in that business working through LAS has now taken over sort of the good side of production, along with a fellow named Steve Boland, Dean Athanasia in the Retail and the Preferred group under David Darnell drives the production side. We have added mortgage loan officers every single quarter, focused them on the branches and what we are seeing is tremendous uptake when we get them working with our teammates. We are better when we are connected as a company across things and so we have seen it. +So we are investing both on the front end and on the service and fulfillment, the middle office so to speak and we have moved I think 4,000 people increase this year so far in fulfillment and we will move some -- we will continue to move them because ultimately the retail production side is a good business right now. + +-------------------------------------------------------------------------------- +Operator [73] +-------------------------------------------------------------------------------- + + Nancy Bush, NAB Research LLC. + +-------------------------------------------------------------------------------- +Nancy Bush, NAB Research - Analyst [74] +-------------------------------------------------------------------------------- + + Good morning, guys. First question, on the credit card business, Brian, could you just give us some color about what is going on right there? I mean your numbers are not robust and I am wondering -- I know you have lost share there. What is being invested into that business? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - CEO [75] +-------------------------------------------------------------------------------- + + Well, so if we think about it starting in 2009, we started to reposition that business because it had gotten too far into the broader credit. And after the crisis, just remember, we charged off $60 billion, $70 billion of charge-offs in that business. So we started repositioning it. We have got it about now where we want it. In other words, we have an affinity group of businesses that is very core and we like it a lot and we have the core business. So this quarter, I think we did 840,000 new cards, about 350,000 or more or less through the franchise, another 100,000 some I think online. So we are producing what we need to do. +Balances grew, point to point, you've got to be careful of the fourth quarter. You get a little kick around Christmas obviously, but if you look at it, as we look across the last few quarters and we will have to wait until everybody gets out this quarter, we are holding around 14%-ish marketshare, which is fine. So now the question is we push a little bit harder on the -- and I use the broad context marketing, not direct mail market, but marketing and driving to the franchise. +So what we have done is position the credit quality well. It is a much more of a payment business now, 19% plus pay rate, which basically up from 14% probably six, eight quarters ago and so it is a higher quality business. It has drilled the core customer base, the 1-2-3 card and the rewards cards we have that drill off the core platform are working well in our Retail segments and then obviously in the Wealth Management segments, we have a great array of products. +So I would say that we have got this where we want it now; it is stabilized. The run-off book that we are fighting on a growth basis is down to $3 billion, $3.5 billion, down from $15 billion at the top. So I think they should start to see some growth. But it will take -- it is going to bump around where it is right now for a few quarters, but I would say that there is nothing wrong in the business and we are making a fair amount of money in it right now. The risk-adjusted margin is the highest it has ever been. + +-------------------------------------------------------------------------------- +Nancy Bush, NAB Research - Analyst [76] +-------------------------------------------------------------------------------- + + Okay. Secondly, Bruce, if you could just speak to the comp ratios in the Investment Bank and how you guys are trying to position yourself relative to your competition? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [77] +-------------------------------------------------------------------------------- + + Yes, I mean I think generally we are in that 40% area from a compensation perspective and obviously, given the performance and where we are, we need to be competitive with where the peers are. But I don't think you have really seen that change materially during the course of 2012. + +-------------------------------------------------------------------------------- +Nancy Bush, NAB Research - Analyst [78] +-------------------------------------------------------------------------------- + + Great, thank you. + +-------------------------------------------------------------------------------- +Operator [79] +-------------------------------------------------------------------------------- + + Mike Mayo, CLSA. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA - Analyst [80] +-------------------------------------------------------------------------------- + + Hi, first just a follow-up. The FAS 91 amortization expense, what would have been the change in the securities yield and the margin if not for that looking third quarter to fourth quarter? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [81] +-------------------------------------------------------------------------------- + + We will have to get back to you with that exact number. I think I have a gut, but I want to make sure I am right. So why don't we get back to you with that number. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA - Analyst [82] +-------------------------------------------------------------------------------- + + Okay. Do you just know generally I mean because you margin was up; that is good, and the securities yield is up 11 basis points, but do you think it would have been down if not for that? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [83] +-------------------------------------------------------------------------------- + + I want to think, Mike, it was somewhere between 9 and 11 basis points. I just don't have the exact number. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA - Analyst [84] +-------------------------------------------------------------------------------- + + Okay, that's fine. And then going to the mortgage putbacks, so the Fannie settlement, you got that done. It sounds like you are feeling better about the rep and warranty expense. I think I heard you say it might go from $300 million to $150 million per quarter. So I sense you are feeling better. +I'm trying to reconcile that with what is taking place with the MBIA versus Countrywide court moves and correct my thinking if anything is wrong here, but I think it is an issue of Bank America success or liability or is Bank America responsible for Countrywide? And as of January 9 and 10, the oral arguments were completed, so I understand it is in the hands of Judge Bransten, the New York State Supreme Court and the motion says that Bank America is responsible for Countrywide and if so, I guess that could put the $8.5 billion private-label settlement at risk. So my question is could that $8.5 billion settlement be at risk? Do I understand what is happening in the court correctly? And what happens if the $8.5 billion private-label settlement does not go through? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [85] +-------------------------------------------------------------------------------- + + I think a couple things on that, Mike. First, I think from our perspective, the $8.5 billion Gibbs & Brun settlement is going through the court process. Would likely get wrapped up sometime in the second quarter or early in the third quarter. And that is completely independent from what is going on at MBIA. +With respect to MBIA in the broader monolines, as we have said before, generally, if you look at geography within the financial statements, the majority of the work that we do and where the monolines are accrued for at this point is within the litigation line item as opposed to within our provision for reps and warranties. +And the third thing I would say is that, as it relates to kind of the general rep and warrant question, I think the most important thing to go back to is that the large majority of everything that was done with the GSEs at this point between our global settlement with Freddie and Countrywide and our global settlement with both Countrywide and Bank of America with the GSEs just takes away a significant amount of risk relative to where we have been before. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA - Analyst [86] +-------------------------------------------------------------------------------- + + So we are really just talking private label at this point? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [87] +-------------------------------------------------------------------------------- + + As I referenced, you have got the several monolines that we are working through on a litigation perspective and then you are right, you have got the private-label piece. And I think if you go back to the comments that we made about the geography of the representations and warranties, you can see we have a pretty sizable amount set aside to work through the private-label exposures. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA - Analyst [88] +-------------------------------------------------------------------------------- + + So what is the significance of the decision by Judge Bransten and the New York State Supreme Court? There was a Wall Street Journal article on January 11, some other chatter saying that if this motion goes against you and you are deemed responsible for the legal liabilities of Countrywide then that could be a negative event for you. Do you agree with that? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - CEO [89] +-------------------------------------------------------------------------------- + + Mike, we could -- I think as we think about it, this litigation goes back and forth and the judge has a lot of decisions to make in a lot of cases and we will play it out here. But we are comfortable with our legal positions across the board. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA - Analyst [90] +-------------------------------------------------------------------------------- + + Okay, but for that, we should, you think we will hear next month as opposed to midyear? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - CEO [91] +-------------------------------------------------------------------------------- + + I am not sure the exact timing. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA - Analyst [92] +-------------------------------------------------------------------------------- + + Okay. Just last question on that because I am just trying to -- how do we get our arms around that risk? That is really my question and so if you wanted to just give advice to somebody -- okay, here is the potential hit if things go wrong, what would be your answer to that or just is there no answer? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [93] +-------------------------------------------------------------------------------- + + I think what I would suggest you do, and I am not going to quote somebody else's financial statements, but I think you can go look on MBIA's financial statements and see how much that they believe that we're owed or that they are owed from us. That is disclosed in their financial statements, so you can look at that. And then the corollary is I think you have to keep in mind that there is a significant amount of money that they owe us within our Global Markets business that is very significant that we have marked at cents on the dollar. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA - Analyst [94] +-------------------------------------------------------------------------------- + + Great. All right, thank you. + +-------------------------------------------------------------------------------- +Operator [95] +-------------------------------------------------------------------------------- + + Guy Moszkowski, Autonomous Research. + +-------------------------------------------------------------------------------- +Guy Moszkowski, Autonomous Research - Analyst [96] +-------------------------------------------------------------------------------- + + Good morning. You guys have done a great job countering the net interest margin pressure obviously with managing your long-term debt down. And maybe it is too early to think about this, but obviously under orderly liquidation authority in Dodd-Frank, there is some provision for bail-in debt and I was wondering how you guys are thinking about that and how you might implement it over time. + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [97] +-------------------------------------------------------------------------------- + + I think the biggest thing that you have to go back to is that, and you have seen the different reports, that it is that people are looking at these amounts based on not only the amount of debt, but also the amount of equity that you have on the balance sheet. So if you go and look at our ratios, we obviously, as far as the amount of pure common equity and other equity-related instruments on the balance sheet now are more than virtually all of our peers and because of the way -- through the series of mergers that happened, our debt footprint on an absolute basis, as well on a relative basis is higher than our peers. +So as we look at this and as we talk about going forward, I think we still have a lot of work to do and opportunity to get our interest expense down through shrinking the size of the debt footprint and just bringing it down to where the rest of the industry is. So we can't predict with certainty where this goes, but we know as we look at the different ratios and the different metrics, we still have some opportunity to continue to benefit the interest expense line just to get to where our peers are from an overall debt and equity perspective. + +-------------------------------------------------------------------------------- +Guy Moszkowski, Autonomous Research - Analyst [98] +-------------------------------------------------------------------------------- + + Okay, that's fair. Just one last question regarding expenses. Obviously, you have stuck with your guidance on the New BAC and you told us where you are along the path of getting to those goals and you have updated us on the LAS expense reduction initiatives as well, but you are also talking about reinvesting and specifically around mortgage origination, but I think more broadly as well because obviously you don't want to ignore revenue growth opportunities. How do we reconcile those things and how much reinvestment at this point should we expect to see of the New BAC $8 billion and of the LAS $10 billion? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - CEO [99] +-------------------------------------------------------------------------------- + + On the LAS, I don't think you would see it. In the New BAC is net of the cost of achieving the results, which is largely technology implementation costs and if you look at our technology development costs over the last few years, we have gone from about $2 billion and change to $3.6 billion per year. And the investments we are making in New BAC are investments in the franchise. In other words, to get the efficiencies, we are -- embedded in there is the rework of our entire trading platform systems and things like that. But we are investing to get the savings, but investing to also strengthen the franchise at the same time. So it is all netted in there. + +-------------------------------------------------------------------------------- +Guy Moszkowski, Autonomous Research - Analyst [100] +-------------------------------------------------------------------------------- + + Okay, so you would encourage analysts to continue to bring those entire amounts to the bottom line by 2015? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - CEO [101] +-------------------------------------------------------------------------------- + + Yes. + +-------------------------------------------------------------------------------- +Guy Moszkowski, Autonomous Research - Analyst [102] +-------------------------------------------------------------------------------- + + Okay, that's great. Thank you. + +-------------------------------------------------------------------------------- +Operator [103] +-------------------------------------------------------------------------------- + + And this concludes our Q&A. I will go back to our presenters for any closing remarks. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - CEO [104] +-------------------------------------------------------------------------------- + + Thank you for your time and attention. Look forward to next quarter. + +-------------------------------------------------------------------------------- +Operator [105] +-------------------------------------------------------------------------------- + + This will conclude today's program. Have a great day. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/exam/original-files/Problem_1_Sample/2013-Jan-29-AMZN.OQ-139057386295-Transcript.txt b/exam/original-files/Problem_1_Sample/2013-Jan-29-AMZN.OQ-139057386295-Transcript.txt new file mode 100644 index 0000000..beb2d13 --- /dev/null +++ b/exam/original-files/Problem_1_Sample/2013-Jan-29-AMZN.OQ-139057386295-Transcript.txt @@ -0,0 +1,455 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q4 2012 Amazon.com Inc Earnings Conference Call +01/29/2013 05:00 PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Sean Boyle + Amazon.com, Inc. - VP of IR + * Tom Szkutak + Amazon.Com Inc - CFO + +================================================================================ +Conference Call Participiants +================================================================================ + + * Justin Post + BofA Merrill Lynch - Analyst + * Heath Terry + Goldman Sachs - Analyst + * Gene Munster + Piper Jaffray & Co. - Analyst + * Rohit Kulkarni + Citi - Analyst + * Ben Schachter + Macquarie Research - Analyst + * Ken Sena + Evercore Partners - Analyst + * Brian Pitz + Jefferies & Co. - Analyst + * Ross Sandler + Deutsche Bank - Analyst + * Jordan Rohan + Stifel Nicolaus - Analyst + * Mark Mahaney + RBC Capital Markets - Analyst + * Scott Devitt + Morgan Stanley - Analyst + * Brian Nowak + Nomura Securities Intl - Analyst + * Douglas Anmuth + JPMorgan - Analyst + * Tom Forte + Telsey Advisory Group - Analyst + * Anthony DiClemente + Barclays Capital - Analyst + +================================================================================ +Presentation +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Good day, everyone, and welcome to the Amazon. com fourth-quarter 2012 financial results teleconference. At this time, all participants are in a listen-only mode. After today's presentation, we will conduct a question-and-answer session. Today's call is being recorded. For opening remarks, I will be turning the call over to the Vice President of Investor Relations, Mr. Sean Boyle. Please go ahead. + +-------------------------------------------------------------------------------- +Sean Boyle, Amazon.com, Inc. - VP of IR [2] +-------------------------------------------------------------------------------- + + Hello, and welcome to our Q4 2012 financial results conference call. Joining us today is Tom Szkutak, our CFO. We will be available for questions after our prepared remarks. The following discussion and responses to your questions reflect management's views as of today, January 29, 2013, only, and will include forward-looking statements. Actual results may differ materially. Additional information about factors that could potentially impact our financial results is included in today's press release and our filings with the SEC, including our most recent Annual Report on Form 10-K. +As you listen to today's conference call, we encourage you to have our press release in front of you, which includes our financial results, as well as metrics and commentary on the quarter. During this call, we will discuss certain non-GAAP financial measures. In our press release, slides accompanying this webcast and our filings with the SEC, each of which is posted on our IR website. +You will find additional disclosures regarding these non-GAAP measures, including reconciliations to these measures, with comparable GAAP measures. Finally, unless otherwise stated, all comparisons in this call will be against our results for the comparable period of 2011. Now, I'll turn the call over to Tom. + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.Com Inc - CFO [3] +-------------------------------------------------------------------------------- + + Thanks, Sean. I'll begin with comments on our fourth quarter financial results. Trailing 12-month operating cash flow increased 7% to $4.18 billion. Trailing 12-month free cash flow decreased 81% to $395 million. Trailing 12-month capital expenditures were $3.79 billion. This amount includes $1.4 billion in purchases of our previously leased corporate office space, as well as property for development of additional corporate office space located in Seattle, Washington, which we purchased in the fourth quarter. +The increase in capital expenditures reflects additional investments in support of continued business growth, consisting of investing in technology infrastructure, including Amazon Web Services and additional capacity to support our fulfillment operations. Return on invested capital was 4%, down from 22%. ROIC is TTM free cash flow divided by average of total assets minus current liabilities, excluding the current portion of long-term debt over five quarter-ends. The combination of common stock and stock-based awards outstanding was 470 million shares compared with 468 million shares one year ago. +Worldwide revenue grew 22% to $21.27 billion, or 23% excluding the $178 million unfavorable impact from year-over-year changes in foreign exchange. We're grateful to our customers, who continue to take advantage of our low prices, vast selection, and shipping offers. +Media revenue increased to $6.51 billion, up 8%, or 10%, excluding foreign exchange. EGM revenue increased to $13.93 billion, up 28%, or 29%, excluding foreign exchange. Worldwide EGM increased to 65% of worldwide sales, up from 63%. Worldwide paid unit growth was 32%. Active customer accounts exceeded 200 million. Worldwide active seller accounts were more than 2 million. Seller units represented 39% of paid units. +Now I'll discuss operating expenses, excluding stock-based compensation. Cost of sales was $16.14 billion, or 75.9% of revenue, compared with 79.3%. Fulfillment, marketing, technology and content, and G&A combined was $4.45 billion, or 20.9% of sales, up approximately 293 basis points year-over-year. Fulfillment was $2.2 billion, or 10.3% of revenue, compared with 9.3%. Tech and content was $1.22 billion, or 5.7% of revenue, compared with 4.5%. Marketing was $833 million, or 3.9% of revenue, compared with 3.3%. +Now I'll talk about our segment results and consistent with prior periods, we do not allocate the segments, our stock-based compensation, or other operating expense line item. In the North America segment, revenue grew 23% to $12.17 billion. Media revenue grew 13% to $2.9 billion. EGM revenue grew 24% to $8.5 billion, representing 70% of North America revenues, up from 69%. North America segment operating income increased 114% to $608 million, a 5% operating margin. +In the International segment, revenue grew 21% to $9.09 billion. Adjusting for the $183 million year-over-year unfavorable impact from foreign exchange, revenue growth was 23%. Media revenue grew 5% to $3.61 billion, or 7% excluding foreign exchange. And EGM revenue grew 35% to $5.43 billion, or 37% excluding foreign exchange. EGM now represents 60% of international revenues, up from 54%. +International segment operating income decreased 61% to $70 million, at 0.8% operating margin. Excluding the unfavorable impact from foreign exchange, international segment operating income decreased 56%. CSOI increased 47% to $678 million, or 3.2% of revenue, up approximately 54 basis points year-over-year. Unlike CSOI, our GAAP operating income includes stock-based compensation expense and other operating expense. +GAAP operating income increased 56% to $405 million, or 1.9% of net sales. Our income tax expense was $194 million in Q4, resulting in a 58% rate for the quarter, and a 79% rate for the full year 2012. GAAP net income was $97 million, or $0.21 per diluted share, compared with $177 million and $0.38 per diluted share. +Now, I'll discuss the full-year results. Revenue grew 27% to $61.09 billion. North America revenue grew 30% to $34.81 billion and international revenue grew 23% to $26.28 billion, or 27% growth excluding year-over-year changes in foreign exchange. Consolidated segment operating income, or CSOI, increased 6% to $1.67 billion, or 7%, excluding the unfavorable year-over-year impact from foreign exchange. Operating margin decreased 54 basis points, 2.7%. GAAP operating income decreased 22% to $676 million, or 1.1% of net sales. +Turning to the balance sheet, cash and marketable securities increased $1.87 billion year-over-year to $11.45 billion. Inventory increased 21% to $6.03 billion and inventory turns were 9.3, down from 10.3 turns a year ago, as we expanded selection and improved in-stock levels and introduced new product categories. +Accounts payable increased 20% to $13.32 billion and accounts payable days increased to 76 from 74 in the prior year. In Q4 2012, we issued $3 billion of senior non-convertible unsecured debt and three-, five- and seven-year tranches with proceeds to be used for general corporate purposes. + I'll conclude my portion of today's call with guidance. Incorporated into the guidance are the order trends we've seen to date and what we believe to date to be appropriately conservative assumptions. Our results are inherently unpredictable and may be materially affected by many factors, including a high level of uncertainty surrounding exchange rate fluctuations, as well as the global economy, and consumer spending. It's not possible to accurately predict demand and therefore, our actual results could differ materially from our guidance. +As we describe in more detail on our public filings, issues such as settling intercompany balances and foreign currencies amongst our subsidiaries; unfavorable resolution of legal matters; and changes to our effective tax rates can all have a material impact on guidance. Our guidance further assumes that we don't conclude any additional business acquisitions, investments, or settlements, record any further revisions to stock-based compensation estimates, and that foreign exchange rates remain approximately where they have been recently. +For Q1 2013, we expect net sales of between $15.0 billion and $16.6 billion, or growth between 14% and 26%. This guidance anticipates approximately 122 basis points of unfavorable impact of foreign exchange rates. GAAP operating income or loss to be between $285 million loss and $65 million positive income compared to $192 million in income in the prior period year. This includes approximately $285 million for stock-based compensation and amortization of intangible assets. +We anticipate consolidated segment operating income, which excludes stock-based compensation and other expense, to be between $0 and $350 million, compared to $398 million income in the prior period. We remain heads-down focused on driving a better customer experience through price, selection and convenience. We believe putting customers first is the only reliable way to create lasting value for shareholders. Thanks. With that, Sean, let's move to questions. + +-------------------------------------------------------------------------------- +Sean Boyle, Amazon.com, Inc. - VP of IR [4] +-------------------------------------------------------------------------------- + + Great. Thanks, Tom. Let's move on to the Q&A portion of the call. Operator, will you please remind our listeners how to initiate a question? + + +================================================================================ +Questions and Answers +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Thank you. At this time, we will now open up the call for questions. In the interest of time, we ask that you limit yourself to one question. +(Operator Instructions) + Scott Devitt with Morgan Stanley. + +-------------------------------------------------------------------------------- +Scott Devitt, Morgan Stanley - Analyst [2] +-------------------------------------------------------------------------------- + + Tom, it looks to us that you have successfully begun the transition of your logistics cost in the direction of being more of a fixed fulfillment cost, with lower unit base shipping costs, given that the growth rate of up on shipping is now meaningfully below the fulfillment growth rate. So the question is, is that something that we should expect to continue now on the back of this meaningful fulfillment center expansion ramp? +Then separately, but on the same topic, we're also wondering, are there other parts of the business in which you can make this transition to more of a fixed cost in the future? Thanks. + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.Com Inc - CFO [3] +-------------------------------------------------------------------------------- + + In terms of fulfillment question, you're right in terms of, over the past few years, we have expanded our fulfillment network pretty extensively to the point where we are closer to customers; and you're seeing that reflected in our transportation costs. +You can obviously see the fulfillment expense is certainly not fixed in terms of in absolute terms. But you can see that we had the 20 fulfillment centers last year and that's reflected in the operating expense that you're seeing. But that is a benefit of adding to our fulfillment center network. We are closer and closer to customers, with a lot of great selection. You're seeing that reflected in the individual business gross margins, which shows up as benefits of transportation costs. +In terms of other opportunities, certainly there are a number of opportunities, as we invest in individual customer experience areas across the business; many of those would be on our website. We have a relatively fixed expense, as we launch those and we're able to amortize those costs over our full customer base. As they grow, they become more effective on a per-unit or per-customer basis. There is a number of opportunities that we have had and will have going forward to do that. + +-------------------------------------------------------------------------------- +Operator [4] +-------------------------------------------------------------------------------- + + Douglas Anmuth with JPMorgan. + +-------------------------------------------------------------------------------- +Douglas Anmuth, JPMorgan - Analyst [5] +-------------------------------------------------------------------------------- + + Just wanted to ask about the shift to third-party and in particular, I think last 4Q, you talked about shifting more of the business in the video game space in particular to third-party. Are there certain categories that you would specifically point to in this last 4Q where you made a similar shift? Thanks. + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.Com Inc - CFO [6] +-------------------------------------------------------------------------------- + + We did see a good expansion, as you've mentioned, in 3P. Our third-party units as a percentage of total units increased some 36% last year, Q4 to 39%, some expansion of approximately 300 basis points. Our overall unit growth rate for the quarter in total was 32% and our third-party growth rate was in excess of 40%. So, again, nice growth. +It is -- you're certainly seeing it in a number of areas. You see it certainly in our EGM business. If you look at our North America growth rates, you can see that our revenue was up 23%, but our third-party -- our total unit growth rate was substantially faster than that and our third-party units were growing very fast there as well. So there's a number of different areas that you're seeing that, but certainly you're seeing it there. + +-------------------------------------------------------------------------------- +Operator [7] +-------------------------------------------------------------------------------- + + Brian Pitz with Jefferies. + +-------------------------------------------------------------------------------- +Brian Pitz, Jefferies & Co. - Analyst [8] +-------------------------------------------------------------------------------- + + Looks like you're moving more in the direction of same-day shipping. Would you provide any thoughts or insights here? Should we anticipate a significant ramp-up of fulfillment center build-outs, particularly in Q2, Q3? Maybe you could just comment more generally on your FC build-out plans, US versus international. Thanks. + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.Com Inc - CFO [9] +-------------------------------------------------------------------------------- + + There's not a lot I can comment on in terms of our plans. Similar to last year, as we progress through the year, we can give you further updates on what we plan to do there. Last year, we opened up 20 new fulfillment centers and so we saw very rapid growth and fulfillment capacity last year. Stay tuned and we'll let you know more as the year progresses there. + +-------------------------------------------------------------------------------- +Operator [10] +-------------------------------------------------------------------------------- + + Mark Mahaney with RBC Capital Markets. + +-------------------------------------------------------------------------------- +Mark Mahaney, RBC Capital Markets - Analyst [11] +-------------------------------------------------------------------------------- + + The paid unit growth deceleration to 32%; there seems a bit of a disconnect versus an active customer growth that didn't decelerate as much on a per-customer basis. Are you seeing some change in overall activity? Is that the impact of newer international markets? Then just on the investment cycle, the last couple of calls, you've consistently called out future investments, whether the $1.4 billion for Seattle or distribution center expansion. You didn't do it this quarter. I don't want to over-read into it, but does that mean that we're at the end of a major investment cycle? Thanks. + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.Com Inc - CFO [12] +-------------------------------------------------------------------------------- + + In terms of unit growth, there's not a lot more I can add to it. We did see very strong -- we saw a substantially high unit growth and revenue growth in terms of paid unit growth in Q4 which we're seeing very strong third-party growth as well; it was up over 40%. In terms of investment cycle, yes, I wouldn't read into anything related to that. We will still be adding capacity during 2013. In terms of the levels of how much we'll add, as I mentioned earlier on the call, I'd just stay tuned and we'll let you know as the year progresses. + +-------------------------------------------------------------------------------- +Operator [13] +-------------------------------------------------------------------------------- + + Heath Terry with Goldman Sachs. + +-------------------------------------------------------------------------------- +Heath Terry, Goldman Sachs - Analyst [14] +-------------------------------------------------------------------------------- + + I was wondering if you could give us just a bit of a sense of what you're seeing as you roll out fulfillment centers into new states. Obviously, the sales tax issue has been one that's come up a good bit. But you've touched on the impact of being closer with faster delivery in those same states. Net-net, what do you see as being the impact on -- I'm not asking you to give us a state-by-state breakdown, but the impact of rolling out the fulfillment center footprint, taking both of those things into account? + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.Com Inc - CFO [15] +-------------------------------------------------------------------------------- + + I'm not really sure how best to answer your question. We certainly have expanded pretty dramatically over the past, coming out of 2009, so between 2010, '11 and '12, we've rapidly increased our footprint globally. Your comment was more directed towards the US, but we've also rapidly increased our footprint in the US. +As a result of that, we're able to carry selection, a much broader selection, closer to customers, just with the, as you would expect, with this rapid increase. We've also expanded selection during that time period. So we continue to be in the locations we would like to be in and we'll continue to expand our footprint over time and become even closer and closer to customers. Beyond that, there's not a lot I can add. + +-------------------------------------------------------------------------------- +Operator [16] +-------------------------------------------------------------------------------- + + Gene Munster with Piper Jaffray. + +-------------------------------------------------------------------------------- +Gene Munster, Piper Jaffray & Co. - Analyst [17] +-------------------------------------------------------------------------------- + + From a high level, can you remind us the margin difference between 1P and 3P? I know in the past you've talked about you being agnostic between the two. But the growth in 3P and what your CSOI margin as would imply that 3P has a little bit higher margin. Is that the correct read-through? Thanks. + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.Com Inc - CFO [18] +-------------------------------------------------------------------------------- + + There is some variation by business, but certainly that's -- what we attempt to do is, from a pricing standpoint, is to try to be agnostic. That's certainly how we run the business. Again, this is on a third-party versus retail and then we've always -- also added certainly a lot of other services over the past year in terms of fulfillment. So it really depends upon where we are in the investment cycle, what our utilization is. +As you know, certainly as you look at the last few years, we've been very heavily expanding in terms of fulfillment capacity because of the growth that we've been experiencing. That certainly would put pressure on our overall cost structure, certainly as a -- on a per unit basis because we're not getting the productivity. We don't get the full productivity for a number of years after expanding. +So depending on what type of customer is, whether it's a -- excuse me, whether it's a retail unit, a straight third-party unit, or an FBA unit. But again, we're certainly attempting, at least on a product basis, to be roughly agnostic. + +-------------------------------------------------------------------------------- +Operator [19] +-------------------------------------------------------------------------------- + + Brian Nowak with Nomura. + +-------------------------------------------------------------------------------- +Brian Nowak, Nomura Securities Intl - Analyst [20] +-------------------------------------------------------------------------------- + + On the device strategy, with Kindles and Kindle HDs, can you help us at all with what you're seeing with attach rate trends on digital goods, after people buy the Kindles? Then generally, do you see a higher overall GMV per customer on Kindle devices than users on Amazon apps through other devices? + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.Com Inc - CFO [21] +-------------------------------------------------------------------------------- + + In terms of attach rates, it's not -- we haven't given a lot of detail. But I think one thing certainly to look at, it doesn't give an attach rate, but it gives you at least a sense of the health of the business, is the number that was in the release today. We surely have a multi-billion dollar eBook business, growing approximately 70% year-over-year. That's total year, last year. That's growing at that rate after a -- really just launching the business approximately five years ago. So it's a pretty good, healthy growth rate, five years in. + We're seeing good -- I can't give you specific numbers, but we're seeing very good progress on a number of our other digital media categories. Video, I talked about a little bit earlier. We're seeing Prime customers, certainly the percentage of Prime customers who were watching free content through Prime Instant Video has gone up dramatically year-over-year. We've also increased Prime membership dramatically year-over-year. They are also purchasing paid content. + Those customers that are using the service, they watch free, but they are also paying for new content, which is great. We've launched a number of new services on the music side, most recently, certainly, our CD with free MP3, which we have on many titles. It's still very early, but we certainly like that service and pleased to offer it to customers. So I can't give you specific for attach rates, but the business is making good progress on the video content side and again, it's still very early. + +-------------------------------------------------------------------------------- +Operator [22] +-------------------------------------------------------------------------------- + + Ross Sandler with Deutsche Bank. + +-------------------------------------------------------------------------------- +Ross Sandler, Deutsche Bank - Analyst [23] +-------------------------------------------------------------------------------- + + As you guys build out the Prime membership and the SKUs available through FBA, you run into this challenge of increasing your unit volume of tail items. At the same time, you need to get products to customers in much shorter shipping cycles. So can you talk about how the new fulfillment footprint helps on that front -- is your reliance on air going down as a percent of total items shipped? +Then if I remember correctly, you guys reclassified some FBA revenue early in 2012. Can you just remind us how that flows through the shipping revenue line and what would happen as you comp that in the beginning of '13? Thanks. + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.Com Inc - CFO [24] +-------------------------------------------------------------------------------- + + Sure. Just in terms of overall selection, as we added to Prime, what I was talking about earlier in terms of having a -- just a more expanded footprint is, there's no question that's helping us add additional selection more economically to Prime. So that's both in terms of third-party selection as well as our retail selection. So that's something that we continue to have the benefit of as we get more and more members of Prime and have a bigger and bigger concentration of two-day shipping in the US for that. +So we did add the shipping portion of the FBA fees in Q1 of 2012 and we see some benefit year-over-year. But we're still seeing leverage in terms of our, ex the FBA fees, quite a bit of leverage there. So we don't have the specific number for you there, but we're still seeing quite a bit of leverage there, ex that reclass that you're referring to. + +-------------------------------------------------------------------------------- +Operator [25] +-------------------------------------------------------------------------------- + + Justin Post with Merrill Lynch. + +-------------------------------------------------------------------------------- +Justin Post, BofA Merrill Lynch - Analyst [26] +-------------------------------------------------------------------------------- + + Last year, you reported 4Q in the lower half of revenue range and you were able to call out Taiwan and video games category. Any reasons why revenues were in the lower half this quarter and then if you look at gross profit growth, it clearly has accelerated to 40% growth, but unit growth decelerated to 32%. Can you describe what's driving that accelerating gross profit in the face of lower unit growth? Is it possible maybe you're letting the third-parties handle some of the maybe less profitable categories for Amazon? Could you talk about that at all? Thank you. + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.Com Inc - CFO [27] +-------------------------------------------------------------------------------- + + If you take a look at our growth rate, we're -- we think the growth rate for Q4 was solid. It was up 23% on a revenue basis, quite a bit higher than that on a unit growth basis, up 32% year-over-year. In terms of some of the things that we saw, we, again, there's -- we saw solid growth across many different categories and geographies year-over-year. +Certainly, some things to call out in terms of things that may have been a little bit softer. A few examples would be we did see some of the higher average selling price items, particularly the items that are greater than $1,000, a little bit softer. A few of the consumer electronics sub-categories like TVs, MP3 players, digital cameras, to some extent, were softer. But, again, with the base that we have in Q4, still very solid growth. +Another one, we certainly were thrilled to have Paperwhite in our lineup. It's certainly the best eReader that's out there and we're very pleased with it. But we couldn't keep up with demand. We would have had more sales in Q4 if we were able to keep up with the demand. So the team is working very hard to make sure we have good in-stock going forward on that product. But we certainly could have sold more in Q4. + +-------------------------------------------------------------------------------- +Operator [28] +-------------------------------------------------------------------------------- + + Tom Forte with Telsey Advisory Group. + +-------------------------------------------------------------------------------- +Tom Forte, Telsey Advisory Group - Analyst [29] +-------------------------------------------------------------------------------- + + I wanted to ask you on Amazon Instant Video, how you felt about your current offering and your ability to add exclusive content in a cost-effective manner through Amazon Studios? And what the relationship is between adding more titles and uses on your hardware such as your Amazon Kindle devices? Thanks. + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.Com Inc - CFO [30] +-------------------------------------------------------------------------------- + + We'll continue to look at -- continue to expand our selection, both in terms of Amazon Instant Video as well as Prime Instant Video. We'll do that in a number of different ways. We think we have a very interesting selection right now. You should expect that we'll be spending more on content as it relates to Prime over time and we'll continue to add selection on Amazon Instant Video. Beyond that, you'll have to stay tuned. + +-------------------------------------------------------------------------------- +Operator [31] +-------------------------------------------------------------------------------- + + Ken Sena with Evercore Partners. + +-------------------------------------------------------------------------------- +Ken Sena, Evercore Partners - Analyst [32] +-------------------------------------------------------------------------------- + + Can you talk a little bit about the non-AWS drivers within that line, such as advertising? As you look out, are there advantages to you in terms of having AWS, as far as offering things like buying, serving analytics through the AWS platform to advertisers? Where are you in that roll-out phase now? Thank you. + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.Com Inc - CFO [33] +-------------------------------------------------------------------------------- + + In terms of the AWS business, we've -- the business is growing very fast. We've increased a number of services pretty dramatically over the past several years. The team's doing a fantastic job there and we'll continue to innovate on behalf of customers in that space. There's a number of other things that go into that line item, other. Some of the credit card, as well as other marketing revenue goes in there, so -- but again, AWS is in that line item. + +-------------------------------------------------------------------------------- +Operator [34] +-------------------------------------------------------------------------------- + + Anthony DiClemente with Barclays. + +-------------------------------------------------------------------------------- +Anthony DiClemente, Barclays Capital - Analyst [35] +-------------------------------------------------------------------------------- + + I wondered if you could comment on the pace of business throughout the fourth quarter. Did you see a particular deceleration in the month of December? Second question, on international, I'm wondering are there any callouts in terms of specific countries that may have been weighing on profitability, countries where there's outsized dollars of investment going on, or accelerated investment at the current time? Thanks. + +-------------------------------------------------------------------------------- +Tom Forte, Telsey Advisory Group - Analyst [36] +-------------------------------------------------------------------------------- + + In terms of -- there's not a lot of specifics. We have a long-standing practice of not talking about trends within the quarter, and -- but in terms of year-over-year growth or anything like that. Obviously, the Q4 is very seasonal. December is, by far, the largest month followed by November, but in terms of individual growth rates, don't have a lot of comments there. +In terms of international, yes, there certainly are geographies that we're investing in heavily. Certainly China would be one. Some of the newer -- some of the European countries, including some of the newer launches we're investing in. So those are certainly -- you're seeing those represented in those segment results. + +-------------------------------------------------------------------------------- +Operator [37] +-------------------------------------------------------------------------------- + + Rohit Kulkarni with Citi. + +-------------------------------------------------------------------------------- +Rohit Kulkarni, Citi - Analyst [38] +-------------------------------------------------------------------------------- + + In terms of your recent margin profile, that's truly comparing US and International, over the past four quarters, the vast majority improvement of other have been less worse margin continuing of -- seeing have been due to US margins improving, whether International was, planning in the range of 300, 350 basis points. +In Q4, international declined just 160 basis points, so my question is, should we read this as a big enough of a trend that we saw, how international -- how domestic margins increased over the last four quarters, whether international should follow the same route over the next foreseeable future? + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.Com Inc - CFO [39] +-------------------------------------------------------------------------------- + + Yes, there's not a particular callout that I can make on that. The only thing that I would, in terms of the change I'm referring to, but in terms of the difference between the two, keep in mind that a couple factors, one, mix of business is a little bit different. Our AWS business is in the North America segment. +You also have some newer geographies. Our geographies -- I shouldn't say that are necessarily newer, but geographies that we're investing in heavily that have a longer-term horizon for returns, some of the ones I mentioned earlier. So those are factors as you look at the two different segments. + +-------------------------------------------------------------------------------- +Operator [40] +-------------------------------------------------------------------------------- + + Ben Schachter with Macquarie. + +-------------------------------------------------------------------------------- +Ben Schachter, Macquarie Research - Analyst [41] +-------------------------------------------------------------------------------- + + It looks like the first-party gross margin is actually up fairly meaningfully year-over-year. I wonder if you can talk about that within the context of how Amazon Kindle hardware is impacting the gross margin. Then separately, just any view on how video game sales impacted the year-over-year growth rates for the quarter? Thanks. + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.Com Inc - CFO [42] +-------------------------------------------------------------------------------- + + Yes, I apologize. We're not -- we haven't broken out the first-party versus third-party. It's not something we've done for -- not something I'm doing today or we've done in previous calls, so there's not a lot I can help you with there. + +-------------------------------------------------------------------------------- +Operator [43] +-------------------------------------------------------------------------------- + + Jordan Rohan with Stifel Nicolaus. + +-------------------------------------------------------------------------------- +Jordan Rohan, Stifel Nicolaus - Analyst [44] +-------------------------------------------------------------------------------- + + The content cost for Prime Instant Video flow into the cost of goods line, even though there's no direct revenue associated with it, not into the tech and content line, right? Is that right? + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.Com Inc - CFO [45] +-------------------------------------------------------------------------------- + + That's correct. + +-------------------------------------------------------------------------------- +Jordan Rohan, Stifel Nicolaus - Analyst [46] +-------------------------------------------------------------------------------- + + Okay. So gross margins would have been even higher if those costs were included elsewhere or broken out separately. Do you have any common or -- to reduce the carrying value in your investment in LivingSocial, do you have a feel on a broad strategic level as to whether the local deals business through Amazon Local or through LivingSocial is something that you care to keep investing in? Thanks. + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.Com Inc - CFO [47] +-------------------------------------------------------------------------------- + + There's not a lot I can specifically talk about as it relates to LivingSocial beyond what's in our results today and what we'll have in our 10-K, which will be filed soon. So I would encourage you to take a look at our full disclosures related to that. But in terms of Local, there certainly is still a very interesting opportunity there. We do have a couple -- we have an investment in LivingSocial. +We also have a local business ourselves. So those are -- it's an interesting opportunity. It's a long-term opportunity and we'll continue to work on that -- for customers to make that experience even better. You should think about it not unlike a lot of the other businesses that we invest in, with it [budding] over long-term horizon and it's very early there. + +-------------------------------------------------------------------------------- +Sean Boyle, Amazon.com, Inc. - VP of IR [48] +-------------------------------------------------------------------------------- + + Okay. Thank you for joining us on the call today and for your questions. A replay will be available on our Investor Relations website at least through the end of the quarter. We appreciate your interest in Amazon.com and look forward to talking with you again next quarter. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/exam/original-files/Problem_1_Sample/2013-Jan-30-FB.OQ-140751793850-Transcript.txt b/exam/original-files/Problem_1_Sample/2013-Jan-30-FB.OQ-140751793850-Transcript.txt new file mode 100644 index 0000000..d201df9 --- /dev/null +++ b/exam/original-files/Problem_1_Sample/2013-Jan-30-FB.OQ-140751793850-Transcript.txt @@ -0,0 +1,531 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q4 2012 Facebook Earnings Conference Call +01/30/2013 02:00 PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * David Ebersman + Facebook, Inc. - CFO + * Deborah Crawford + Facebook, Inc. - Director of IR + * Mark Zuckerberg + Facebook, Inc. - CEO + * Sheryl Sandberg + Facebook, Inc. - COO + +================================================================================ +Conference Call Participiants +================================================================================ + + * Carlos Kirjner + Sanford C. Bernstein & Co. - Analyst + * Justin Post + BofA Merrill Lynch - Analyst + * Youssef Squali + Cantor Fitzgerald - Analyst + * Ben Schachter + Macquarie Research Equities - Analyst + * Ken Sena + Evercore Partners - Analyst + * Brian Pitz + Jefferies & Co. - Analyst + * Ross Sandler + Deutsche Bank - Analyst + * Heather Bellini + Goldman Sachs - Analyst + * Jordan Rohan + Stifel Nicolaus - Analyst + * Mark Mahaney + RBC Capital Markets - Analyst + * Scott Devitt + Morgan Stanley - Analyst + * Brian Nowak + Nomura Securities International, Inc. - Analyst + * Douglas Anmuth + JPMorgan - Analyst + * Neil Doshi + Citigroup - Analyst + +================================================================================ +Presentation +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Good afternoon. My name is Steve and I will be your conference Operator today. At this time, I would like to welcome everyone to the Facebook fourth-quarter earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks there will be a question-and-answer session. +(Operator Instructions) +Thank you very much. Ms. Deborah Crawford, Facebook's Director of Investor Relations, you may begin. + +-------------------------------------------------------------------------------- +Deborah Crawford, Facebook, Inc. - Director of IR [2] +-------------------------------------------------------------------------------- + + Thank you. Good afternoon and welcome to Facebook's fourth-quarter and full year earnings conference call. Joining me today to talk about our results are Mark Zuckerberg, CEO; Sheryl Sandberg, COO; and David Ebersman, CFO. +Before we get started, I would like to take this opportunity to remind you that, during the course of this call, we will make forward-looking statements regarding the future events and the future financial performance of the Company. We caution you to consider the important risk factors that could cause actual results to differ materially from those in the forward-looking statements, in the press release and this conference call. These risk factors are described in our press release and are more fully detailed under the caption risk factors in our quarterly report on Form 10-K, filed with the SEC on October 24, 2012. In addition, please note that the date of this conference call is January 30, 2013 and any forward-looking statements that we make today are based on the assumptions as of this date. We undertake no obligation to update these statements as a result of new information or future events. +During this call, we will present both GAAP and non-GAAP financial measures. A reconciliation of GAAP to non-GAAP measures is included in today's earnings press release. this call is being broadcast on the internet, and is available on the Investor Relations section of the Facebook website at investor.FB.com. A rebroadcast of the call will be available after 6.00 PM Pacific Time today. The earnings press release and an accompanying investor presentation are also available on our website. After management's remarks we will host a Q&A session. +And now I'd like to turn the call over to Mark. + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook, Inc. - CEO [3] +-------------------------------------------------------------------------------- + + Thanks, everyone, for joining us. 2012 was a big year for us. We made this big transition where now there are more people using Facebook on mobile every day than on desktops. This was challenging for us to navigate, since we started off the year with Apps that weren't as high quality as we wanted, and no ads in our Apps at all, but now we're coming out of the year with a strong foundation and a lot of momentum. Just last week, comScore put out a report, saying Facebook is now 23% of all time spent on Apps in the US, and one of the next biggest Apps is Instagram at 3%, so put together, we're now more than a quarter of the time spent in Apps. Today, there is no argument, Facebook is a mobile company. As I've said before, there are three main parts of our strategy, build the best mobile product, build the platform and services that leverage the social graph, and build a really strong monetization engine. +I'm going to use our time today the same way I will on most of these calls, to give my assessment of how I think we're doing in each of these big areas. Let's start with mobile. I think more people are starting to understand that mobile is a great opportunity for us. Mobile is the perfect device for Facebook for three reasons -- it allows us to reach more people; we have more engagement from the people who we reach; and I think we'll also be able to make more money for each minute people spend with us on their mobile devices. But mobile isn't just driving greater engagement on Facebook. Mobile enables many new experiences, and is growing overall share and across all Apps. This creates a very dynamic ecosystem, and one where there's a lot of room for us to create even more sharing through Facebook. +Often, doing a good job is just about focusing on basic issues like performance and stability. In December, we released a completely rewritten version of Facebook for Android. This was the Android version of the iOS rewrite we did earlier last year. Neither of these rewrites added big new features, but simply by improving speed and stability, we've made a much better user experience, enabling people to share even more. It's a good example of how early we are in the market that these changes made such a difference. +Photos and Instagram are doing really well too. We had our best day ever on New Year's Day with more than 600 million photos uploaded to Facebook. Instagram has continued growing very quickly, and hopefully we'll have some new milestones to share with you all soon. A lot of what we had to do last year was simply to improve our mobile development process. Now we're there. +We move fast and ship new versions of our Apps on a regular monthly cycle. You have a good version of all of the Facebook features you know and want on your phone. So now, the next thing we're going to do is get really good at building new mobile first experiences. That's going to be a big theme for us this year. If we do this well, we should be able to bring even more relevant content and connections to more people, and continue to deepen their engagement. +Next I want to talk about platform and building new services, using the social graph. Normally I'll use this section to talk about what's going on in the ecosystem outside of our Company, but this quarter, I think we built the most interesting new service using the social graph, Graph Search. This is an early beta product, but I'm really excited about it, because it's an entirely new kind of search. It's not web search, it's structured search over the whole graph of content that people have mapped out on Facebook. It's good for lots of things you wouldn't use a traditional search engine for; seeing where your friends have eaten or traveled to, browsing photos and content your friends have posted, finding new people to meet or recruit for a job, and many other things. +Some of these are big areas, where we think there's room for much better product. Down the line, if we do this well, this could potentially turn into a meaningful business for us. For now, we're going to continue working to refine the product and roll it out to everyone. Still, I think the way the Graph Search is different from normal web search is a good example of how there's going to be this market for a whole new crop of social services, in existing markets today that weren't designed with the principles of real identity and social connections, et cetera. +One platform development that I am really excited by is seeing how well our App install advertising product is doing. Developers are finding that Facebook is a great service for connecting with the right people who want to use their Apps, and getting a lot of installs. On mobile, our platform already enables developers to help you bring your friends to a developers App. We also want to be one of the primary ways that developers get new people to their Apps in the first place, and with App install ads, we're off to a good, if early, start in achieving that. +Now I want to talk a bit about monetization. Last year was a big year for us here. We started off the year with no ads at all in mobile, and we ended up with approximately 23% of our ads revenue coming from mobile in the fourth quarter. That's a pretty amazing change. One of the big drivers of this, has been that as we rolled out ads to News Feed, we found that it barely affected the level of engagement on Facebook. We thought that we could make this work over time without a big impact if we spent a long time tuning the ads, but the numbers turned out even better than we thought without much tuning, so this has enabled us to show people a few ads in News Feed each day. +So that means that now we have this News Feed ad business that we have barely tuned, and there's a big opportunity in front of us to make every ad that we're showing a lot better. The biggest ways that we're going to this are by improving targeting and relevance so we can show everyone content that they care more about, and by designing better ad products that aren't just about links and text and images. For targeting, I'm most excited about the work we're doing on Custom Audiences, our tool that lets advertisers upload their customer list and target against that, and information that is already on Facebook at the same time, perfectly. Say, my customers are in some age range and live in some states, you may not know which states your customers live in, but if they shared it on Facebook it's possible to create these kinds of experiences. +For new ad experiences, I'm looking forward to doing more with different kinds of media. As our News Feed design evolves to show richer kinds of stories, that opens up new opportunities to offer different kinds of ads as well. Aside from ads, I do want to temper near-term expectations a little bit on revenue items coming from other areas, like Gifts or Graph Search. I think these can be big opportunities for us long term, but for the foreseeable future, the most important thing for us is to continue building out great consumer experiences around these products. We're going to invest in these, but for the next year at least, our work around ads will have by far the biggest impact on our business. +Now, before I hand it off to Sheryl, there's one more thing I want to discuss. We're at an interesting point in our evolution, where there are lots of areas we need to invest in. We need to build the best mobile experiences, we need to build our platforms, and we need to build a really strong monetization engine. We can easily invest our entire engineering team just in building out the nuts and bolts of these areas today, but we also feel like there's an imperative to start planting seeds for tomorrow's businesses as well. +Products like Graph Search, that are in beta today, but will hopefully grow up to be pillars of the Facebook service and businesses, are things that we want to invest in aggressively, and things we feel like it's the right thing for our business over the long term to invest in aggressively. Based on this, we made the decision to continue to grow our headcount quickly in 2013, particularly in Product Development. This will likely cause our expenses to grow at a faster rate than we expect to grow our revenue this year, which means that aren't operating to maximize our profit this year, but we're doing what we think will build the best service and business over the long term. +Finally, I just want to take a minute to thank everyone who works at Facebook. Last year really was an amazing year for us, on many levels. We connected one billion people, we navigated the transition to becoming a mobile company, and we laid the foundation for some great new products I'm excited to show the world this year. And this is all because we have this unique culture, filled with some of the most talented people in the world, who are still mission-driven, who want to make the world a better place, and who work so hard to make the world that place. Thank you, all. Thanks to everyone who's on this call for taking the time to be with us today. I look forward to be able to report on all the progress we will make next quarter. +And now I'll hand the podium over to Sheryl. + +-------------------------------------------------------------------------------- +Sheryl Sandberg, Facebook, Inc. - COO [4] +-------------------------------------------------------------------------------- + + Thanks, Mark. So our ad business continued its positive trajectory in the fourth quarter. Total fourth-quarter revenue was $1.585 billion, with $1.329 billion coming from ads. This represents a 41% increase for advertising revenue. Ad revenue from News Feed increased across both desktop and mobile, and in Q4, approximately 23% of our ad revenue came from mobile, up from approximately 14% in Q3. +Our focus in the fourth quarter was to continue improving and scaling the products we launched in 2012. We know that our advertising products are delivering results for marketers, and one of the best indicators of this came over the holiday season, where more businesses, from big brands to small retailers, used us as a core part of their holiday outreach. Perhaps the biggest highlight in the fourth quarter was the increasing importance of mobile, not just to Facebook but also to our clients. Marketers are realizing more and more that Facebook is one of the best places to reach their customers on mobile, because of our unique ability to reach specific target audiences at scale. Another highlight is the traction our offers and Promoted Post products, which are really easy to use, have given us at local businesses. +As I described last quarter, our strategies focus on three priorities. One, building products and tools that create value for every type of marketer. Two, proving that value to marketers. And three, taking advantage of the unique opportunity we have in mobile. Starting with the first. We build products that create value for every type of marketer. We continue our focus on four key customer segments; brand marketers, direct marketers, local businesses, and developers. For brand marketers, we combine access to the largest community of real people in the world, with some of the industry's best targeting capabilities. We now work with every one of the Ad Age Global 100 Advertisers and overall revenue from these clients is growing through consistently with our ad revenue in 2012, which means it significantly out paced the estimates for our overall ad spend from the industry. +In the fourth quarter, we launched a new way for advertisers to buy guaranteed ad impressions, with the goal of helping them reach massive audiences on mobile. Wal-Mart used this target block over the important Thanksgiving weekend to deliver 50 million mobile ads to their existing and potential customers. We think this is a really important step in the evolution of mobile advertising, as these numbers rival the appeal of broader web and TV campaigns. Increasingly, companies use Facebook as the exclusive channel to launch new products. To share one example, Michael Kors used Facebook to launch a line of new sneakers. Many of the sneakers sold out online and in stores, and they achieved a 16 point increase in awareness of the sneaker among the 36 million people that the campaign reached on Facebook. That's the equivalent of 5.8 million new people in the brand's target audience, who are now aware of the new line of shoes. +For direct marketers, the products we launched in the third quarter continued to gain traction in Q4 as well. Since we launched our office products at the end of September, we have seen stronger advertiser adoption and user engagement, with nearly 42 million unique users claiming an offer. Cost per redemption compare favorably to those from e-mail, newspaper, paid search and display media, based on data from the Direct marketing Association. Discounts and promotions are often an important tactic for direct marketers and we think our Offers product is well-placed to compete in these media budgets. +As Mark said, one of the products we're most excited about is Custom Audiences, which lets marketers show their ads to exactly the right people, by coupling our rich targeting capabilities with their own customer data, or data from a third party. A large retailer, for example, can send one set of ads to customers who typically buy sporting goods, and a different set of ads to those who would purchase TV products. This results in some of the best targeting available on or off line today. +To share one example, [Jax Rags], an online shopping site for men, used Custom Audiences to target specific segments of its customer database, and target them with ads for products that the Company knew were most relevant to them, such as sneakers. As a result, the Company achieved a 30% lower cost per acquisition than other platforms, and saw a 6-times return on advertising spend. It's important to understand that Custom Audiences is not a separate standalone ad product, but rather a targeting capability that can be used with many of our ad products to drive greater accuracy and efficiency. For example, when Custom Audiences is used with Offers, marketers can customize discounts for exactly the right kind of customer. +The Facebook exchange or FBX allows businesses to bid on specific ad impressions in realtime, and it continues to gain momentum and drive solid results for advertisers. Despite only becoming available to all marketers in September, by December, FBX served nearly one billion impressions daily, and supported over 1,300 advertisers each day. Large and small advertisers alike are seeing higher click-through rates, lower costs for conversion and strong incremental reaches in FBX. +Revenue from local businesses was particularly strong in the fourth quarter. We're pleased that the number of local business pages that advertised and Facebook nearly doubled since the beginning of 2012. This is due in no small part to our Promoted Post product, which makes it easier for businesses to create and purchase ads directly from their Facebook page. Almost 500,000 pages have used Promoted Posts. About 30% of these are new advertisers to Facebook, and more than 70% have become repeat customers. +Finally, for developers, we continue to gain traction with our new mobile App install ads. Since their launch in October, they are already being used by 20% of the Top 100 grossing iOS Apps to accelerate growth. According to research conducted by comScore in December, Facebook is the top driver of awareness of new mobile App downloads, and among people who learn about new Apps on Facebook, 48% click directly from the Facebook App to download new mobile Apps. +Cie Games used this product to drive installs of its new game, Car Town 2. As a result, it broke into the Top 10 games list on iOS in many countries, while achieving a 40% lower cost per installation compared to their other advertising. In addition to games, we believe this will be a very useful product to help companies and industries like retail, travel and financial services shift their businesses to mobile. +Next, I want to focus on our commitment to proving value -- proving Facebook value to marketers. We designed all of our products to deliver a strong return on investment. Given that we are still a relatively new marketing platform, proving that our ads are effective remains an important and ongoing priority for us. We work with research companies like Nielsen, Aggregate Knowledge and Datalogix, to demonstrate how our ads drive sales and help inform our product development. For example, research from Aggregate Knowledge shows that Facebook is an increasingly powerful tool to help marketers reach more people and drive sales. +In a study of fourth-quarter marketing campaigns, they found that media plans that included Facebook reached people who would not have seen the campaigns otherwise. In fact, 45% of those reached were reached exclusively through Facebook. The study also found that Facebook had a 68% lower cost per acquisition, and drove 24% more new sales than other online channels. We also worked with clients directly to integrate with their own measurement systems, so they can better understand the ROI Facebook delivers. For example, we built a deep relationship with PepsiCo, where we worked with its Lays brand to drive significant sales ahead of plan, and a 5X return on ad spend, for their Do Us a Flavor campaign on Facebook. In the fourth quarter, we also made conversion tracking available in beta. Conversion tracking allows marketers of all sizes to more easily measure the impact of their Facebook advertising, whether the Facebook ad is the first ad or the last ad the person sees before taking an action. +Finally, I want to discuss how we are continuing to take advantage of the significant opportunity we have in mobile. As mentioned before, approximately 23% of our advertising revenue now comes from mobile. In addition, 65% of our advertisers are now using ads in News Feed, which run on both desktop and mobile, up from 50% at the end of the third quarter. Marketers are recognizing that our News Feed is the most efficient and effective place to reach their customers, due in large part to the fact that ads in News Feed see a higher click-through rate and ultimately a lower cost for conversion than ads on the right hand side of our site. By working with Datalogix, we have shown that ads in News Feed also drives more than 8 times the incremental off line sales than ads on the right hand side. Clients also recognize that, because our users share their real identities on Facebook, and because they are logged in when they use Facebook on mobile, we have a unique ability to serve advertising that people find relevant. This is an important competitive advantage for us, relative to other mobile platforms, and one we think we are very unique in. +Overall, we continue to make real progress advancing our advertising strategy. Our revenue and key metrics are growing nicely, and as we look ahead to 2013, we're very confident in the direction of our ad business. Over one billion people are on Facebook, and we are enabling businesses to engage with them directly wherever they are. Our massive scale, accurate targeting, strength in mobile, and new advertising products are driving measurable results for all types of businesses, and transforming the way people and businesses connect. We look forward to making even more progress in these areas in the year ahead. +Now, I'll hand it over to David. + +-------------------------------------------------------------------------------- +David Ebersman, Facebook, Inc. - CFO [5] +-------------------------------------------------------------------------------- + + Thanks, Sheryl, and good afternoon, everyone. We're pleased with the progress we have made in Q4 against our key financial priorities, growing revenue, investing aggressively in areas critical to our future performance, and positioning the Company to maximize long-term financial returns. We ended the year with 1.06 billion people using Facebook, up 25% from a year ago. In December, 618 million people accessed Facebook each day on average, up 28% from last year, and we grew monthly and daily users across all geographic regions. Mobile continues to drive our growth. 680 million people accessed Facebook from Mobile Devices in December, up 57% versus last year, and the numbers I just mentioned do not include Instagram, which continues to grow at an impressive rate. We ended 2012 with strong engagement across our products, and this engagement remains a foundation for everything we're trying to build. +Turning to revenue, in Q4, revenue was up 40% year-over-year, or 42% when adjusted for constant exchange rates. Q4 year-over-year growth would have been 34%, if adjusted to exclude the additional month of Payments transactions we recognized as planned. Ad revenue in Q4 was up 41% or 43%, when adjusted for constant exchange rates. Year-over-year advertising growth in Q4 was the strongest of any quarter in 2012, and we view this as a validation of our recent investments in mobile News Feed ads, growing our advertiser base, and launching new ad products. +In the fourth quarter, ad impressions were up 46%, and average price per ad was down 4% compared to last year. These trends were driven by significantly faster impression growth in developing markets such as Asia and Latin America, which have relatively lower pricing and thereby brought down our average price overall. The faster impression growth in developing markets in Q4 was significantly affected by product changes, primarily our decision to lower the market reserve price, or the floor price we accept in our auction, which increased the number of ads shown in these markets. We continue to see positive trends in price per ad in key developed markets, including an 18% increase in average price in the US and Canada in Q4. +Payments and other revenue was $256 million in Q4. As planned, in Q4, we recognized revenue from four months of payments transactions, for accounting reasons detailed in our last 10-Q. Adjusting for the extra month, Payments' revenues from games was essentially flat with the fourth quarter of 2011. This past quarter, Payments and other revenue also included around $5 million from sources outside of games, primarily user-Promoted Posts, and to a lesser extent, from our new Gifts product. +Shifting now to expenses. In Q4, our total GAAP expenses were $1.06 billion. Excluding the impact of stock compensation, total expenses increased 67% to $849 million, driven primarily by headcount and infrastructure. We ended 2012 with just over 4,600 employees, a 44% increase from last year, driven by hiring in our technical groups. We were recently ranked the number one place to work by Glass Door, which we view as a testament to how strong our culture remains, through this period of significant headcount growth. +In Q4, our GAAP operating income was $523 million. Excluding stock comp, our non-GAAP operating income was $736 million, representing a 46% operating margin. Our GAAP tax rate for Q4 was 87%, and our non-GAAP tax rate was 41%. For 2013, we expect our non-GAAP tax rate to be a few percentage points higher than the rate in Q4. Additionally, we ended the year with approximately $5.8 billion in NOL tax loss carryforwards, created by stock compensation. GAAP net income and EPS for the fourth quarter was $64 million or $0.03 per share, non-GAAP net income and EPS was $426 million or $0.17 per share, compared to $0.15 in Q4 last year. We ended Q4 with $9.6 billion in cash and investments, giving us great flexibility and risk protection. +Looking forward now, we believe we've built a solid foundation for continued growth in 2013 and beyond. In our ads business, we believe we have good momentum and plan to continue investing to grow advertiser demand and improve the quality, engagement and value of our ads, particularly in News Feed. In terms of 2013 expectations for Payments, our games ecosystem continues to show healthy signs of diversification, with new kinds of games growing engagement and monetization in Q4. However, we continue to face an offsetting headwind from declining desktop usage in developed markets, since our games payments revenue is essentially all from desktop computers. In terms of non-games payments revenue, while we remain excited about the long-term potential of commerce on Facebook, current revenue from user-Promoted Posts and Gifts is very small, and we expect 2013 contributions from these initiatives to remain very small, given current run rates. +In terms of infrastructure, we expect CapEx spend in 2013 will be in the neighborhood of $1.8 billion, as we continue to invest in servers, new data centers, and network infrastructure to enable us to bring Facebook speedily and reliably to everyone around the world. We're pleased that planned 2013 CapEx spend is up relatively modestly compared to 2012, which came in under forecast at a shade under $1.6 billion, as our investments in software and hardware efficiency are paying off nicely. As Mark noted, 2013 will be a year of significant investment in areas we believe are critical to drive long-term engagement and monetization, and we plan to continue to hire aggressively to accelerate product development, and deliver new products for users and advertisers. +As a result of our hiring and investment plans, we expect that our total expenses, excluding stock comp, will likely grow by somewhere around 50% in 2013, though actual growth will depend on hiring and project decisions we make through the year. We believe this level of near-term investment is the right strategic decision, to enable long-term value creation. We're excited about the potential returns from investing in our product. We continue to feel there's operating leverage inherent in our business, and we're committed to building a highly-profitable cash-generating business over the long term. +In summary, we believe we're entering 2013 in a strong position. We're working in very large markets that offer us great opportunities for growth. We have uniquely-valuable assets in terms of the size, identity, and engagement of the people who use Facebook, and we have a fantastic group of employees who have big aspirations to build on our financial performance from 2012. +Now, let's open the call for questions. + + +================================================================================ +Questions and Answers +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) +Your first question comes from the line of Douglas Anmuth from JPMorgan. Your line is open. + +-------------------------------------------------------------------------------- +Douglas Anmuth, JPMorgan - Analyst [2] +-------------------------------------------------------------------------------- + + Just wanted to ask two things. First, can you help us understand the mobile trajectory through Q4, just given the commentary you gave about exiting Q3 at a $270 million run rate, and doing more than $300 million in the fourth quarter? Did you open up more additional inventory in Q4 from the late Q3 levels, and did you see any notable change in pricing? And then can you also just comment on how you feel about the volume of ad load in the News Feed right now on both desktop and mobile, and perhaps in terms of baseball innings, where you think you are in terms of penetration? Thanks. + +-------------------------------------------------------------------------------- +David Ebersman, Facebook, Inc. - CFO [3] +-------------------------------------------------------------------------------- + + I'll take the first half. We think the most important thing is we think mobile can be a huge opportunity for us and we're really pleased with the progress we made in the fourth quarter. If you compare the averages Q3 versus Q4, well if you compare the overall revenue, our mobile revenue doubled from Q3 to Q4, and we continue to make progress also, in terms of the quality and the relevance of the mobile ads that we show. I think the most important thing here is we're still really early. A couple quarters ago, mobile revenues were 0% of our ads revenue, and now we're up to 23% and believe there's a lot more we can do, and a lot of growth ahead of us. + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook, Inc. - CEO [4] +-------------------------------------------------------------------------------- + + I'll speak to the quality piece. So one of the things that we measure for News Feed quality is the amount of feedback that we get, so likes and comments and things like that, and just to give a sense of the magnitude of these things, the ranking improvements and things that we did over the course of last year improved the amount of feedback in News Feed, on the order of about 50%. I don't know if it was quite exactly 50%, but it was on that order. And we measure very closely, when we take into account advertising and spend, in order to rank ads into News Feed, we're inherently not showing what would have organically shown up in that slot, so we want to make sure we're not decreasing quality by a big amount. So what we found was that when we did the tests to take out the ads, we were -- inserting the ads had about a 2% reduction in the amount of likes and comments. So over the period of last year, we had on the order of a 50% increase and a very marginal offset of 2% for putting ads in, which just makes us feel really confident that we're continuing to very strongly net improve the experience of Feed. And that's one of the things that I mentioned in my script before. We weren't that, we're confident we could get this to a good place over time in terms of being a good experience, but the amount of the improvements we've done have just dwarfed the quantitative feedback hit that anything that we've seen on the ads is very promising to us, in terms of what we're going to be able to do, going forward. + +-------------------------------------------------------------------------------- +Operator [5] +-------------------------------------------------------------------------------- + + Your next question comes from the line of Ben Schachter with Macquarie. Your line is now open. + +-------------------------------------------------------------------------------- +Ben Schachter , Macquarie Research Equities - Analyst [6] +-------------------------------------------------------------------------------- + + Mark, in the comments you said you're looking at different types of media for ads. I was wondering at a high level, if you could talk about how that would potentially change the overall Facebook experience, and if you could give real examples for how these different types of ad units would come into play. And also, just separately, engagement. I was wondering if you could give us any update on how you're viewing engagement, or any change to how you measure it, and any views on how that's going through the quarter? Thanks. + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook, Inc. - CEO [7] +-------------------------------------------------------------------------------- + + Sure. So one of the product design principles that we've always had is, we want the organic content to be of the same basic types of formats as paid content, right? So historically, advertisers want really rich things like big pictures or videos, and we haven't provided those things historically, but one of the things we've done in the last year, is you've seen the organic News Feed product that consumers use, moving towards bigger pictures, richer media, and I think you'll continue to see it go in that direction. And I think a lot of the success of products like Instagram is because of that, it's very immersive, even on a small screen, it's a wonderful photo product. And when you have those form factors for the content, that gives you the ability to offer those form factors for advertising as well, so I think you see the trend there in terms of where it's going, and that's naturally going to make it so we can deliver much more engaging advertising experiences than we were traditionally able to do when we didn't have those types of content in the system. David can speak to some of the stats you were asking about. + +-------------------------------------------------------------------------------- +David Ebersman, Facebook, Inc. - CFO [8] +-------------------------------------------------------------------------------- + + In terms of engagement, overall, everything continues to go very well. We passed a billion users, and in the fourth quarter, 59% of them used Facebook on an average day in December, which is up a couple percent from where we started the year, so just pretty remarkable how, as we continue to grow the user base, that number continues to grow and really speaks to the value of the service and the importance of mobile, which is really driving that. There's another metric we track which measures the number of people who have come to the site, in at least six of the last seven days, so it shows the audience for whom Facebook is a daily experience, and that, we ended the year with record highs on that metric as well. So everything continues to go well, and our job is to make Facebook a better, more useful product so we can continue to drive new kinds of engagement in the future. + +-------------------------------------------------------------------------------- +Operator [9] +-------------------------------------------------------------------------------- + + Your next question comes from the line of Heather Bellini with Goldman Sachs. Your line is now open. + +-------------------------------------------------------------------------------- +Heather Bellini, Goldman Sachs - Analyst [10] +-------------------------------------------------------------------------------- + + I had a question for Sheryl and then a question for Mark. Sheryl, I was wondering if you could share with us what you've seen from FBX. I know it's still early, but what milestones you're looking to hit with this business in 2013? And then, Mark, just wondering where you think we are in terms of the social ad revolution, and when you look out over the next 12 months, what do you think could surprise you the most in terms of revenue opportunities that are ahead of you when you look out for 2013? Thanks. + +-------------------------------------------------------------------------------- +Sheryl Sandberg, Facebook, Inc. - COO [11] +-------------------------------------------------------------------------------- + + So on FBX, as everyone knows, it's realtime bidding for specific instructions, we're very encouraged by what we see, both in terms of marketing demand and ad performance. And the numbers, as I said in my opening remarks, are getting higher. We see good data from our clients and customers that it's driving more conversions, we have data from one of our clients, Triggit, that FBX drives 36% more conversions than we target anywhere else, Shutterfly had a 4X higher return on ad spend than other platforms, and we have a bunch of other examples like that. I would say the importance of FBX is not just the product itself, but really what it represents, and the other opportunities around making the ads more targeted. So FBX is one way of making the ads better targeted and more useful to users, which makes a higher return from advertisers. Custom Audiences is another, but I think what you're seeing from us is a really big push to make our ads higher quality, better for users, higher return for advertisers, and FBX is just one of many ways we're working on doing that. + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook, Inc. - CEO [12] +-------------------------------------------------------------------------------- + + Yes, and I'll just add to that a little bit but you mostly covered it. I think we're really early, but what we really expected was to not be able to necessarily show everyone an ad every day because we weren't sure that we had the quality up front, and that was some of the engagement metrics I was talking about before. So we've been positively surprised that the quality has been naturally high, and there's been basically no engagement hit at all that's very meaningful. So what that means is that now, previously we thought we were going to have to spend 6 to 12 months just tuning in order to be able to get it to a quality level to incrementally rollout ads, whereas now we've had them rolled out. Now we can go straight into doing the same types of things to improve targeting, and improve the quality of the ad format, which obviously, when they're fully deployed has much more leverage to those changes than if we had to wait until we hit different quality thresholds to roll it out more, so I think we're pretty early. It's not that it's going in a completely different direction, it's mostly the two things that we talked about so far, good targeting and good ad formats, and there's just a lot of room to grow in both. + +-------------------------------------------------------------------------------- +Operator [13] +-------------------------------------------------------------------------------- + + Your next question comes from the line of Carlos Kirjner from Sanford Bernstein. Your line is now open. + +-------------------------------------------------------------------------------- +Carlos Kirjner , Sanford C. Bernstein & Co. - Analyst [14] +-------------------------------------------------------------------------------- + + Thank you. I have two questions. Can you help us understand why ad ARPU in the US grew 27%, while it grew only 7% in Europe? Is Facebook that sensitive to macro? And on the platform, can you help me understand what metric you track to evaluate the progress and adoption of the Facebook platform outside Facebook.com? Is that the number of pages or objects tagged with Open Graph, and are you in a race with Google's Knowledge Graph to be the basis of the semantic web, or can both co-exist? Thank you. + +-------------------------------------------------------------------------------- +David Ebersman, Facebook, Inc. - CFO [15] +-------------------------------------------------------------------------------- + + Carlos, I'll take the first one. So I think that when you compare the disclosure we make about the US and Canada to Europe, one of the notable differences is in Europe, as we continue to penetrate that market, we're getting into some of the lower monetizing countries in Europe, so there's sort of an inter-Europe lower price dynamic going on where the ads, the places that are growing more rapidly are starting at a lower price point and bringing down the average, either on a CPM basis or an ARPU basis, so I do think there are macro things that matter in Europe as well, but that's the bigger point. + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook, Inc. - CEO [16] +-------------------------------------------------------------------------------- + + Yes, and in terms of the point on structured data there's Open Graph in order to help developers and people map out all of the different connections between things outside of Facebook, but one of the things that we talked about when we rolled out Graph Search is there are more than a trillion connections between people and things in Facebook today, and that's the basis for Graph Search. I think a lot of the goal of having the utility like Graph Search is also to give people a reason to map out more of these structured connections themselves. You mentioned the Google comparison, I think we're just coming from a completely different place. Our whole product is people and structured connections to other people, and content, and things that they like, whereas traditional web search is the exact opposite, it's completely unstructured. Google and others may be trying to put in some of the structured foundation, but we just have years of having built that up and I think that we're just in a completely different place on that. + +-------------------------------------------------------------------------------- +Operator [17] +-------------------------------------------------------------------------------- + + Your next question comes from the line of Youssef Squali from Cantor Fitzgerald. Your line is now open. + +-------------------------------------------------------------------------------- +Youssef Squali, Cantor Fitzgerald - Analyst [18] +-------------------------------------------------------------------------------- + + Two questions, please. First, starting with David. First, thank you for helping quantify the increase in operating expenses next year. I was wondering if you can help us with the trajectory of that spend throughout the year, how long do you think this investment cycle is going to be? Is it mostly 2013, or is this a multi-year cycle? Then maybe, Mark, maybe can you talk just about the video opportunity for Facebook, video in the News Feed that is. Where are you in that process, will that be something that organically you can do or would that require you to maybe acquire? Thanks. + +-------------------------------------------------------------------------------- +David Ebersman, Facebook, Inc. - CFO [19] +-------------------------------------------------------------------------------- + + So Youssef, we think we've got some really big and important opportunities right in front of us now, and that's driving our decision-making around the level of investment we're making, which is important to us in 2013. That will moderate over time but I wouldn't want to make a firm commitment to exactly what it's going to look like in the future, because particularly the R&D part of it is going to depend on what the opportunities are, and how excited we are about the returns we can get from them. + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook, Inc. - CEO [20] +-------------------------------------------------------------------------------- + + Video ads? + +-------------------------------------------------------------------------------- +Deborah Crawford, Facebook, Inc. - Director of IR [21] +-------------------------------------------------------------------------------- + + Not just ads though. + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook, Inc. - CEO [22] +-------------------------------------------------------------------------------- + + Yes, I mean I think I touched on some of this earlier in terms of making it that News Feed is richer just enables more opportunity for this, and there are already the ability for pages to post videos in different content into the systems. We actually have a very large volume of this. Another thing we have the ability to support is people posting links on other services, so for video advertising, it's not necessarily critical that we host the video. We want to be the distribution platform for a lot of the stuff, but I think there's definitely an opportunity and over time, we'll have more to talk about. + +-------------------------------------------------------------------------------- +Operator [23] +-------------------------------------------------------------------------------- + + Your next question comes from the line of Scott Devitt from Morgan Stanley. Your line is now open. + +-------------------------------------------------------------------------------- +Scott Devitt, Morgan Stanley - Analyst [24] +-------------------------------------------------------------------------------- + + I had a different question on that regional ARPU slide, which is I guess wondering the pace or maybe where we are now from a Sponsored Story rollout, and relative ad load in the US relative to Europe and Asia? And then secondly, it looks like the absolute additions of mobile users and mobile-only users was quite strong in the quarter. It was up 25% in terms of mobile ads, and 30% in terms of mobile-only ads versus the third quarter, and Mark mentioned a few areas. I was just wondering if there's any one or two things that stand out in terms of driving that acceleration? Thanks. + +-------------------------------------------------------------------------------- +David Ebersman, Facebook, Inc. - CFO [25] +-------------------------------------------------------------------------------- + + Okay, in terms of the ARPU by geography, I don't know that I have a lot more color to offer. In terms of the mobile News Feed rollout, as you would expect with a new advertising product, really in the end of the second quarter and the third quarter it took off first in the US, and Europe followed and I think the growth was much more notable for that product area, in Asia and the rest of world in the fourth quarter, as compared to the third, and that's just sort of the natural progression of how roll-outs tend to go for us. In terms of your second question about the increase in mobile users and mobile-only users, which we agree is really important and impressive, I don't know that we would point to any one thing that drove that, just as much as continued penetration of smartphones and around the world in many markets, and our ability to make our products better, so that people are more inclined to use them. + +-------------------------------------------------------------------------------- +Operator [26] +-------------------------------------------------------------------------------- + + Your next question comes from the line of Mark Mahaney from RBC. Your line is now open. + +-------------------------------------------------------------------------------- +Mark Mahaney, RBC Capital Markets - Analyst [27] +-------------------------------------------------------------------------------- + + Great, thanks. I know it's very early stages, the rollout of the Graph Search, but any early signs of the impact that has had on engagement? And then, Mark, you mentioned just early on about the new products, maybe some mobile-specific products and features, any hint as to what those could be? Thanks a lot. + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook, Inc. - CEO [28] +-------------------------------------------------------------------------------- + + Unfortunately, I don't think there's that much that I can share with you on either of those. On Graph Search, it's still early. This is one of the products that I'm the most excited about that we've built. It is a completely new pillar of our ecosystem, and I think it's going to be an important utility that people use. Right now, the whole strategy around this is, it's a beta product, and we are primarily rolling it out in order to get more data, so that we can incorporate the data of how people use it to make ranking better before we do a full rollout. So right now it's rolled out to the order of tens or hundreds of thousands of people, not extremely widely, and I mean so we have data, but I don't think anything that is really relevant to share beyond that. +In terms of the new experiences, I think the big theme that we're just going to push on mobile is, people keep on asking if we're going to build a phone, and we aren't going to build a phone, because it's not the right strategy for us to build one integrated system, where so, let's say we sold 10 million units, that would be 1% of users. Who cares for us? But the big thing for us is we have a billion people using our products and we need to make Facebook really good across all of the devices that they use, and we're going to keep on pushing to get more integrated with the system. When Facebook is a product that people are spending almost 20% of their time or more on phones using, it really should be, and I think people want it to be very integrated into all of the different devices that they have, and that's what we're going to focus on. So rather than just building an App, that's a version of the functionality that you have today, making it so that we can go deeper and deeper, I think will be a big focus for us. + +-------------------------------------------------------------------------------- +Operator [29] +-------------------------------------------------------------------------------- + + Your next question comes from the line of Ross Sandler from Deutsche Bank. Your line is now open. + +-------------------------------------------------------------------------------- +Ross Sandler, Deutsche Bank - Analyst [30] +-------------------------------------------------------------------------------- + + Great, just one question for David, on the right hand rail revenue. So based on our math, the overall News Feed business may have been around $500 million-ish in the fourth quarter, which would imply about a 10% decline for right hand rail revenue. Does that make sense directionally? And if so, can you just talk about how you think right hand rail is likely to trend in 2013 and can the new ad tools like Custom Audiences help offset the desktop traffic decline that you're seeing in markets like US and Europe? Thanks. + +-------------------------------------------------------------------------------- +David Ebersman, Facebook, Inc. - CFO [31] +-------------------------------------------------------------------------------- + + Yes, thanks for your question, Ross. For us, the most important metric is that the overall ad revenue increased 41%. I think that the way we think about things, it's hard to really separate out the mobile and desktop or Feed in right hand column as separate and distinct businesses, because for most of our ads, marketers will tell us what ad they want to show and to what audience they want us to show the ad, and we choose where it goes. It's not true for 100% of the ads, but it's certainly true in the majority case. So our job is to find the place to put the ads that will create the most value for the user and the marketer. So the overall ad revenue number really provides a sort of just a better sense of how much advertising demand there is in the system that we're able to service, and over time, we'll continue to experiment with how to optimize that. In general, you can see from the user numbers that the growth in usage is coming from mobile, particularly in developed markets that desktop usage continues to be flat or declining, so that's obviously the macro trend that will affect what the future of the right hand column revenues are. + +-------------------------------------------------------------------------------- +Operator [32] +-------------------------------------------------------------------------------- + + Your next question comes from the line of Neil Doshi with Citi. + +-------------------------------------------------------------------------------- +Neil Doshi, Citigroup - Analyst [33] +-------------------------------------------------------------------------------- + + Mark, could you maybe tell us how far along you are in terms of developing tools, and providing more data metrics to large agencies and advertisers? And then, David, in terms of the gaming declines that we're seeing on Facebook desktop, is there an opportunity for Facebook to help monetize or to monetize games that are played on Facebook on the mobile site? Thank you. + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook, Inc. - CEO [34] +-------------------------------------------------------------------------------- + + Yes. These are important. Sheryl has more details on this, so I think she should take the first one. + +-------------------------------------------------------------------------------- +Sheryl Sandberg, Facebook, Inc. - COO [35] +-------------------------------------------------------------------------------- + + Yes, measurement is really important for us and it's one of the challenges we face. I remember, through the years I've worked on this, when search happened, people weren't able to measure it and then they figured out how to measure search, and more a new thing, and people need to think about measurement differently. One of the most important things we need to do in the market is help educate people that the click is not really the most important metric for us. In fact, now that we've been able to work with companies to look at in-store sales data, we find that of the people who saw a Facebook ad and then purchased a product in the store, 99% of them never clicked on an ad, so reeducating the market, what the metrics are that are right for us. +I would say in terms of our measurement capabilities, we're really early. We weren't able to tie into sales data at all until pretty late in 2012. In order to do those studies we have to work very deeply with retail providers and each client. A lot of our big clients have their own departments that do this measurement and we work with them individually, so we're pretty early. We're happy with the progress we've made. We launched conversion measurements in just mid-December, and that's broadly available on the system, but I think we have a lot of opportunity to do a lot more measurement, a lot more rapidly. We're particularly excited about our ability to do this on mobile. With customers who are using their data in a privacy protected way, we can now measure all the way from seeing a Facebook ad in a mobile device through to a purchase in a store, and that's a pretty exciting capability, we think is pretty unique in the market. + +-------------------------------------------------------------------------------- +David Ebersman, Facebook, Inc. - CFO [36] +-------------------------------------------------------------------------------- + + Neil, your second question was about mobile gaming and it's an interesting question as well. So while we're seeing now is really strong growth in adoption of our platform in games on both iOS and Android, and we want Facebook to be the default social infrastructure for mobile games, and feel like we're making progress in that direction, and convincing developers that they will get more users, more engaged users, and better monetizing users, if the users are able to connect with their friends and bring their Facebook identity with them. At this point, we don't have any payments integrations with these mobile games, but our belief is that if we can help game developers to grow users' engagement and monetization, it puts us in an interesting position to consider future financial relationships. And the only other thing I would add is that we really launched or ramped up the mobile App install ads in the fourth quarter, and are already seeing that's a pretty promising way for developers to try and get better distribution for what they've built, including games developers, and that's sort of a nice first step for us in trying to participate in the mobile gaming ecosystem. + +-------------------------------------------------------------------------------- +Operator [37] +-------------------------------------------------------------------------------- + + Your next question comes from the line of Brian Nowak with Nomura. Your line is now open. + +-------------------------------------------------------------------------------- +Brian Nowak, Nomura Securities International, Inc. - Analyst [38] +-------------------------------------------------------------------------------- + + I have two questions. First one, could you talk at all to some of the engagement trends you're seeing within the demos? Specifically what are you seeing in the younger post college demos? Are their engagement trends per user still rising, or are they starting to show signs of leveling off? And then the second one is, when you look at your biggest categories of branded advertisers and where you're at this point, what do you see as still the biggest near-term opportunities where Facebook and social budget share is still low and pretty underpenetrated relative to your larger categories? Thanks. + +-------------------------------------------------------------------------------- +David Ebersman, Facebook, Inc. - CFO [39] +-------------------------------------------------------------------------------- + + In terms of engagement, as we said, the overall engagement patterns remain really strong for us. We don't break out engagement metrics by self-reported demographics like age. I think that one thing we can say is that our view is that the overall marketplace is expanding really rapidly here, in terms of just the amount of time people, college-age, post-college are spending, connected, sharing with their friends, et cetera, and we think that's great for Facebook and our long term position, because we're a leader in such a rapidly-expanding market. + +-------------------------------------------------------------------------------- +Sheryl Sandberg, Facebook, Inc. - COO [40] +-------------------------------------------------------------------------------- + + And taking the second part we think we have really big opportunities across-the-board with the large brand spenders. If you just look at mobile, what you see, and [Merrymaker] just put out a report on this, mobile gets 1% of ad revenue and 10% of time consumed, so right there, you see a big gap. Our opportunities there are to ramp with the large advertisers, build more deeply into their measurement systems so we can measure, help them use the Custom Audiences and other targeting we offer because right now a lot of our advertisers aren't using that targeting so they are sending more generic ads to our whole system. And that's great, we have the scale to do that, but a better ad experience will take advantage of the targeting we offer. +We think in mobile, we think we're particularly really uniquely positioned. It's not just that we have unprecedented scale and huge engagement, that Mark talked about in his opening statement. We have a natural ad format, one of the big successes of 2012 was putting ads into News Feed and having them work, both for our clients on the marketing side, but also for our users, the engagement Mark talked about. On mobile, because we have real identity and people are logged in, we have a really unique ability to serve relevant ads, and so I think particularly in the mobile area, we are positioned in a very strong way, compared to anyone else. + +-------------------------------------------------------------------------------- +Operator [41] +-------------------------------------------------------------------------------- + + Your next question comes from the line of Justin Post with Bank of America Merrill Lynch. Your line is now open. + +-------------------------------------------------------------------------------- +Justin Post, BofA Merrill Lynch - Analyst [42] +-------------------------------------------------------------------------------- + + I have a couple questions. It definitely seems the mobile ramp slowed as the quarter progressed. Obviously, good numbers versus last quarter. Did you make an effort to maybe pull back some of the ad loads, or is there still a lot of opportunity to add more inventory in the mobile News Feeds, as we look forward? And then secondly, maybe you could just comment on the health of the Payments business. It looks like the US was up quarter-over-quarter, even if we back out the extra month, so was that some of the other new initiatives, or did the gaming business get a little bit better in Q4? Thank you. + +-------------------------------------------------------------------------------- +David Ebersman, Facebook, Inc. - CFO [43] +-------------------------------------------------------------------------------- + + On the mobile side, I think it's just really important to recognize we're very early in this. Of course we're still making changes in terms of what ads we show, how we select them, how many we show to different users, and under different circumstances, so this is still very early in the process of us trying to learn how to optimize that business as we develop it. Our perspective is that we're still we have a lot of opportunity there. In terms of Payments what you said is generally true. Note that this year as opposed to last year, we do have a little bit of revenue from non-game sources as I said, so you've got to neutralize or back that out of you want to compare games to games year-over-year. But having said that, if you make the year-over-year comparison, we do as I said, we see as I said earlier, we see a nice diversification happening in games, and it's a very interesting business to try and think about projecting going forward because some of the trends are really quite positive, but you have to be mindful of the macro trend, that we're not growing the sort of the essence of this user base in the developed markets right now. + +-------------------------------------------------------------------------------- +Operator [44] +-------------------------------------------------------------------------------- + + Your next question comes from the line of Jordan Rohan with Stifel Nicolaus. Your line is now open. + +-------------------------------------------------------------------------------- +Jordan Rohan, Stifel Nicolaus - Analyst [45] +-------------------------------------------------------------------------------- + + Thanks, a couple of questions. Any chance you can clarify more than just the impression volume metrics that you gave on FBX? Importantly, when do you anticipate mobile News Feed will be accessible through that platform? Separately, and given the promise of Gifts and e-commerce, why does it seem to be a business that you characterize as very small in the near term? What are the impediments to future growth so that you can call it big enough to matter or an important part of 2013 revenue mix? Thank you. + +-------------------------------------------------------------------------------- +Sheryl Sandberg, Facebook, Inc. - COO [46] +-------------------------------------------------------------------------------- + + On the first one, on FBX, when it's available, we have nothing to share at this point. + +-------------------------------------------------------------------------------- +David Ebersman, Facebook, Inc. - CFO [47] +-------------------------------------------------------------------------------- + + So second question on Gifts. I think that I really can just reiterate what Mark said earlier, which is that the focus for right now is trying to figure out what the right product is. We think Gifts is, if done well can be a very natural and positive part of the Facebook experience, so for example, when you're wishing someone a Happy Birthday the ability to send a gift along with that and just figuring out how the product needs to work, what the interfaces are, what the selection of products is, how the payment process works, all of that stuff is what we're going to have to optimize, to make the product grow as you're asking. And we're going to try to do that. That will be something we work on in 2013. + +-------------------------------------------------------------------------------- +Operator [48] +-------------------------------------------------------------------------------- + + Your next question comes from the line of Brian Pitz with Jefferies. Your line is now open. + +-------------------------------------------------------------------------------- +Brian Pitz, Jefferies & Co. - Analyst [49] +-------------------------------------------------------------------------------- + + Two questions. Mark, could you give us some examples of the kind of mobile first experiences you're working on that you mentioned at the beginning of the call? And also any comments on how integration with iOS 6 is benefiting your overall mobile strategy? Thanks. + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook, Inc. - CEO [50] +-------------------------------------------------------------------------------- + + I don't really think I can say anymore about things that we're developing, then directionally what I've already said. On iOS, I mean there are two really big platforms out there. Sorry, there are three. Android, iOS, and mobile web, and where we basically are, the strategy through each of those are a bit different. So mobile web, there's a limit to how the depths of how deep you can get into the system but we can go as deep as anyone else, so we feel pretty good about that, and we think our mobile web experience is really good, and has on the same order of magnitude of users as our App, so that's actually really good. +For Android, and then I'll get to iOS last, Android is a very dynamic and open platform, as long as Google keeps it that way. And even though our relationship with Google isn't one where the companies really talk, we are able to do a bunch of things, because they have an open platform that lets us get fairly deep into the system and build some really great experiences, which I think will be, which we're excited on about and we're working on. An example that we have already that I can talk about is for Messenger. On Android, you build an messaging app that can actually do SMS on the phone. You can't do that on iOS, because on iOS, iOS controls SMS on the phone. But on Android you can build something that does that, and our Messenger App does that. So that's a good example on what you can do on Android. +On iOS, because it's a more locked down system, the way that you can do deeper integration is by working directly with Apple. They've been a great partner for us so far, and we're really excited about doing more there, and people enjoy the integration that we have with them today, to be able to share photos and share web pages from anywhere across the experience, when you're on your iPhone or iPad, and we're really happy with it. So I don't think there's any meaningful numbers to share there, but qualitatively it's a really good experience and I'm really happy with the partnership we have with them. + +-------------------------------------------------------------------------------- +Deborah Crawford, Facebook, Inc. - Director of IR [51] +-------------------------------------------------------------------------------- + + Operator, we have time for one last question. + +-------------------------------------------------------------------------------- +Operator [52] +-------------------------------------------------------------------------------- + + So your last question comes from the line of Ken Sena with Evercore Partners. + +-------------------------------------------------------------------------------- +Ken Sena, Evercore Partners - Analyst [53] +-------------------------------------------------------------------------------- + + Thank you. Can you maybe give some color behind your decision to lower the price, the pricing floor, on the Marketplace? And also can I get just a clarification on FBX? Are you doing about a billion impressions per day? And then also within the 22% mobile number, is there any FBX within that? Thank you. + +-------------------------------------------------------------------------------- +Sheryl Sandberg, Facebook, Inc. - COO [54] +-------------------------------------------------------------------------------- + + On the last you're correct, we're doing a billion impressions per day and FBX is not available now on mobile. + +-------------------------------------------------------------------------------- +David Ebersman, Facebook, Inc. - CFO [55] +-------------------------------------------------------------------------------- + + On the reserve price, we're always iterating and experimenting to optimize what we show for the user experience, and for our business performance. The price floor has been something we've had in place. It's way below the average prices, and the purpose of it has been to both support higher prices and omit poor quality ads. Over time, we've developed other tools to help us achieve those objectives, so the floor has become less important for us. And interestingly there's non-intuitive benefits also that we've been realizing, which is that small businesses as you can imagine, often create some of the highest quality and most highly-engaging ads on Facebook. It makes sense because your local coffee shop feels like part of the community you live in and seeing an ad from them fits naturally into the experience that you want on Facebook, and small businesses are often the lowest bidders in our auction. So by lowering the floor, if we can bring in more small businesses into our network, get them comfortable advertising with us, and hopefully ramp them up over time, that should be a good thing. As I said, for the changes we happen to make this quarter, the impact was really primarily in international markets, because the price floor really wasn't coming into play in most of the developed markets anyway. + +-------------------------------------------------------------------------------- +Deborah Crawford, Facebook, Inc. - Director of IR [56] +-------------------------------------------------------------------------------- + + That's it. Thank you for joining us today. We really appreciate your time, and we look forward to speaking with you again next quarter. + +-------------------------------------------------------------------------------- +Operator [57] +-------------------------------------------------------------------------------- + + Ladies and gentlemen, this concludes today's conference call. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/exam/original-files/Problem_1_Sample/2013-Jul-17-BAC.N-138558829694-Transcript.txt b/exam/original-files/Problem_1_Sample/2013-Jul-17-BAC.N-138558829694-Transcript.txt new file mode 100644 index 0000000..573cc5f --- /dev/null +++ b/exam/original-files/Problem_1_Sample/2013-Jul-17-BAC.N-138558829694-Transcript.txt @@ -0,0 +1,1037 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q2 2013 Bank of America Corporation Earnings Conference Call +07/17/2013 08:30 AM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Brian Moynihan + Bank of America Corporation - President & CEO + * Bruce Thompson + Bank of America Corporation - CFO + * Lee McEntire + Bank of America Corporation - IR + +================================================================================ +Conference Call Participiants +================================================================================ + + * Chris Kotowski + Oppenheimer & Co. - Analyst + * Moshe Orenbuch + Credit Suisse - Analyst + * John McDonald + Sanford C. Bernstein - Analyst + * Paul Miller + FBR Capital Markets - Analyst + * Nancy Bush + NAB Research - Analyst + * Mike Mayo + Credit Agricole Securities - Analyst + * Guy Moszkowski + Autonomous Research - Analyst + * Matt O'Connor + Deutsche Bank - Analyst + * Brennan Hawken + UBS - Analyst + * Betsy Graseck + Morgan Stanley - Analyst + +================================================================================ +Presentation +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Welcome to today's program. At this time all participants are in listen-only mode. (Operator Instructions). We'll take questions in turn during the Q&A session. And please note, today's call is being recorded. It is now my pleasure to turn the program over to Lee McEntire. Please begin, sir. + +-------------------------------------------------------------------------------- +Lee McEntire, Bank of America Corporation - IR [2] +-------------------------------------------------------------------------------- + + Good morning to those on the phone joining us by webcast. Before Brian Moynihan and Bruce Thompson began their comments let me remind you that this presentation, available at BankofAmerica.com, does contain some forward-looking statements regarding both our financial condition and financial results and that these statements involve certain risks that may cause actual results in the future to be different from our current expectations. Please see our press release and SEC documents for further information. With that, let me turn it over to our CEO, Brian Moynihan. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - President & CEO [3] +-------------------------------------------------------------------------------- + + Thank you, Lee. Good morning, everyone. And just to start off, let me remind you where our focus is and has been for some time -- on capital generation, on managing our risk, on continuing to reduce our costs, and on addressing the legacy issues so that we can drive our growth strategy by simply doing more with our customers and clients. +This quarter shows very clearly how the focus is paying off as we earned $4 billion. We built our Company over the last several quarters to maintain stability while continuing to make progress; to withstand the volatility that we saw in part at the end of this quarter while delivering for our customers and shareholders, and that came true. Even as mortgage demand has decreased we still had a 40% increase in resale production over last year and an increase over last quarter. Even as interest rates rose we were able to add to our capital ratios. And keep in mind, with our $1 trillion deposit book, rising rates will continue to increase the value of those over time. +We have leading capabilities in the areas where our customers want us to be. We do more business with them; we're gaining momentum across every customer group we serve. And while we are doing that our balance sheet continues to strengthen, our capital ratios again move higher and, just as importantly, we have begun the process of returning capital to our shareholders. +Our credit quality continues to improve; expenses are down by $1 billion from a year ago. LAS expenses, or legacy asset servicing expenses, excluding our litigation, are down by nearly $800 million on a quarterly basis from the peak only a couple quarters ago and are ahead of our projections. +Our loans and our deposits continue to grow. All the businesses produced solid, stable revenues and in the focused areas where we are growing they grew their revenues. And we are seeing growing activity levels across all our customer and client groups. +So as we look forward we are closely following recent regulatory proposals around capital and leverage, just as you are. Obviously we have already taken significant steps in our Company to build her current strong levels of capital and liquidity and we maintain a comfort level here that Bruce will take you through the numbers later. +The good news in all this is that we are seeing in our business is reflected in an improving economy. The economy continues to improve across all areas, that benefits our Company across multiple fronts. But most importantly, with an improving economy it strengthens and creates opportunity for the people, companies and investors that we serve. And that opportunity will continue to provide opportunity for us to capture as we connect all our capabilities to help those that we serve realize their financial goals. With that let me turn it over to Bruce. + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [4] +-------------------------------------------------------------------------------- + + Great. Thanks, Brian, and good morning, everyone. I'm going to start on slide 5 of our presentation materials. Total revenues for the quarter were very solid at $22.9 billion. And we earned $4 billion or $0.32 per diluted share, which is up significantly both from the first quarter of this year as well as the comparable period in 2012. +We made significant progress in all of our primary businesses this quarter and on a linked quarter basis we had growth in four out of the five businesses. Consumer activity levels were solid as mortgage production increased, credit card loan balances stabilized and both deposits and brokerage flows increased from the previous quarter. +Global Wealth and Investment Management reported on another quarter of record revenues as well as earnings. Global banking revenue showed continued strength driven by increased lending in both our commercial as well as our corporate bank and investment banking performance remained strong and close to record levels. +Total noninterest expense of $16 billion represented a significant improvement in expenses both relative to the first quarter of this year as well as the comparable quarter in 2012. And asset quality improved significantly as our provision expense declined to $1.2 billion this quarter. +On slide 6 we give some balance sheet highlights. First, the overall size of the balance sheet came down this quarter to about $2.125 trillion. Importantly, customer activity remained strong with loans led by our commercial loans up $10 billion. Period end deposits were down driven by seasonality associated with tax payments. However, our average deposits did experience modest growth. +I'd also call out on the page the tangible book value per share remained relatively flat from the first quarter of this year. That is significant in the context of our $4 billion of earnings largely offset the negative after-tax impact from accumulated other comprehensive income driven by the increase in rates that we saw during the quarter. +Also helping our tangible book value per share in the quarter was the return of roughly $1 billion of capital through the repurchase of 80 million common shares at a price below tangible book value. And as we look forward we have an additional $4 billion available for common share repurchases. +The combination of the earnings that I discussed on slide 5, as well as the work that we did on our balance sheet, led to a return on tangible common equity of just under 10% for the quarter and a return on average assets of 74 basis points. +On slide 7 we walk through some of the different regulatory capital ratios as far as where we ended up at the end of the second quarter. If we start with Basel I Tier 1 common ratio, we ended the quarter at 10.83%, up 34 basis points from the first quarter of this year and 45 basis points on a pro forma basis at the end of 2012. +Moving to Basel 3, on a fully phased-in basis under the advanced approach and based on final rules, our Tier 1 common ratio was 9.6% showing progress from the first quarter of 2013 despite a 32 basis point negative impact from the change in OCI during the quarter. Risk-weighted assets under Basel 3 were $1.31 trillion or $43 billion lower than the first quarter of 2013 due to an improvement in both the composition as well as the overall credit quality on the books. +If we move to the proposed supplementary US leverage ratio requirement, which will kick in at the beginning of 2018, our preliminary analyses indicate that at the holding company our leverage ratio for the second quarter of 2013 was in the range of 4.9% to 5%, which positions us very well relative to the 5% minimum. +If we look at our primary bank subsidiaries, which we have two, BANA, our primary banking subsidiary, and FIA, our card subsidiary, during the second quarter of 2013 both of those were in excess of the 6% proposed minimum. So net-net from a regulatory capital perspective, we feel like we've made very good progress across all of the different measures that we'll be required to operate within. +On page 8, funding and liquidity, you can see long-term debt during the quarter declined $18 billion as maturities outpaced issuances during the quarter. Our global excess liquidity sources did decline during the quarter; it was expected as a result of our reductions in the long-term debt footprint, our preferred stock redemptions, as well as of the seasonal deposit outflows that I referenced earlier from tax payments. +At the parent company liquidity remains very strong at $95 billion due to capital returns from our subsidiaries during the quarter. Time to required funding increased to 32 months, up from 29 months in the first quarter of 2013 and well above our target of approximately 24 months. And as we've indicated before, over the next four to six quarters we will look to move that time to funding towards the 24 months as we repay the upcoming debt maturities in 2013 and 2014. +On noninterest income, if you look at slide 9, net interest income on an FTE basis was $10.8 billion, down just about 1% from the first quarter of 2013. If you adjust our net interest income for market-related items, it was $10.4 billion which was less than $100 million below our guidance as our trading-related net interest income declined as a result of reduced balance sheet utilization in our global markets business during the last month of the quarter. +On the positive side, we benefited during the quarter from lower long-term debt, higher levels of commercial land balances, as well as one additional day of interest in the second quarter relative to the first. On the flipside, in addition to the negative impact of lower asset balances on the trading books, we also had slightly lower consumer loan balances and yields driven by our runoff portfolios. +As we came into the second quarter of 2013 our interest-rate sensitivity, as we disclosed in the first quarter 10-Q, estimated a $1.6 billion annual benefit to net interest income from a 100 basis point instantaneous long end steepening if rates remained at that level. +During the second quarter the 10-year rate did increase by more than 60 basis points and we realized $300 million of that benefit immediately through the impact on FAS 91. We expect to realize the balance of the benefit, approximately $700 million, over the course of the next 12 months. As a result of those different factors we do expect net interest income, excluding any market-related impacts, to build off of the second quarter of 2013's $10.4 billion adjusted level as we move forward during the balance of 2013 and into 2014. +If you look at the work that we did on expenses on slide 10, total expenses were down significantly on both a linked quarter as well as a year-over-year basis as we continued to deliver on the expense reductions that we have discussed within our Legacy Assets and Servicing area, as well as the ongoing cost savings from our New BAC initiatives that we're implementing in the other businesses that we operate. +Our number of full-time equivalent employees in the quarter ended at just over 257,000, which was down 2% from the first quarter of 2013 and almost 7% from the comparable period a year ago. Total expenses did declined $3.5 billion from the first quarter of 2013 as we benefited from a $1.7 billion decline in litigation; our LAS expenses X litigation were down roughly another $250 million; our retirement eligible costs, which we only incur during the first quarter of each year, were down $900 million, and all other expenses were down approximately $600 million. +As we look at the progress that we make on our LAS, expenses from the fourth quarter of 2012 when they peaked at $3.1 billion, we are now down approximately $800 million from that peak and we did all of that within the last two quarters. As a result we previously had said that our LAS expenses X litigation would be approximately $2.1 billion by the end of 2013, meaning in the fourth quarter of 2013. And with the progress that we've made, we now believe our fourth-quarter LAS expenses will be below $2 billion in the fourth quarter of 2013. And keep in mind that as we work through these the realization of these savings can be somewhat lumpy. +In addition to our LAS expenses, the $600 million improvement in all other costs was driven primarily by lower incentive compensation costs during the quarter, as well as our New BAC efforts. We remain on track to achieve $1.5 billion of New BAC quarterly savings by the fourth quarter of 2013. +On slide 11 we give some information on the trends from an asset quality perspective. And as you can see, credit quality once again improved significantly during the quarter. Net charge-offs declined to $2.1 billion, an improvement of 16% on a linked quarter basis and 42% relative to the second quarter of 2012. +Our second-quarter of 2013 net loss rate of 94 basis points is the first time that we have been below 100 basis points since 2006. Given the improving trend in delinquencies and other metrics, we now expect our net charge-offs will come in below $2 billion in the third quarter of 2013. +Provision expense of $1.2 billion this quarter does reflect a reserve reduction of approximately $900 million reflecting improving credit trends. The allowance coverage remains strong and, given the pace of improvement in credit quality, we do anticipate continued reserve releases particularly in our consumer real estate portfolios. +Let's now move to a discussion of the performance within our lines of business on slide 12. Consumer and business banking -- before we go through the results I do want to highlight a technical change that this quarter we did move our direct and indirect auto and other specialty lending into the CBB business from global banking given that it more closely connects with consumer lending activity. This book does include $37 billion of loans and we have adjusted prior periods to have this data be comparable. +Earnings in the business were relatively stable compared to the first quarter of 2013 and up 15% from the prior year driven by both expense improvements as well as lower credit cost. We do continue to do more business with our core customers. Our average deposits were up almost $9 billion from the first quarter of 2013 excluding the transfers that we had from the Wealth Management business. Loans declined a modest 1% as a decline in our credit cards was mitigated by a balance growth in both small business as well as auto lending. +There's been a lot of discussion on use credit card balances. Those balances appear to have stabilized and at the end of the second quarter were at $90.5 billion, up from $90 billion at the end of the first quarter of this year. Our card issuance remained strong in the second quarter and is at its highest level since 2008. US consumer credit card retail spend per average active account was up 9% from the second quarter a year ago. We continue to optimize our delivery network and usage within the mobile channel continues to increase. +And lastly, expense levels reflect both the benefits of the network optimization as well as the investments to build out our specialty sales force. +If we move to consumer real estate services, on slide 13, we address home loans, one of the two businesses within our CRES segment. First mortgage retail originations were $25 billion and were up 6% from the first quarter and 41% compared with retail originations in the year ago period. Our market share in the retail mortgage space improved. We broke through 5% versus below 4% just over a year ago. +We do anticipate some slowdown in mortgage production resulting from recent increases in interest rates and that is seen by the 5% reduction in our mortgage origination pipeline at the end of June relative to what we had seen at the end of March this year. +While production has experienced a nice trajectory over the last year, we, not unlike the industry, have experienced compression on margins that affect revenue. While the margins do remain high relative to historical periods, the compression is most notable when you look at our year-over-year production revenue. +We continued to add mortgage loan officers during the second quarter primarily in the banking centers, as well as other employees in our sales and fulfillment area, in order to deliver a first-class mortgage experience for our customers. These actions did contribute to higher expenses in the quarter. +On slide 14 we move to Legacy Assets and Servicing, which still did report a loss in the quarter, but showed significant improvement from the first quarter which included the MBIA and RMBS litigation settlements as the reduction in expenses more than offset a decline in the revenues. Revenues were negatively impacted by a servicing revenue decline of $175 million as the servicing portfolio declined 17% and we had less favorable MSR hedge performance. That was partially offset by higher sales volume of loans that returned to performing status. +As you look at LAS, several key takeaways from this slide. The first is our level of 60-plus day delinquent loans, which is one of the primary drivers of the elevated cost, dropped below 500,000 units at the end of June, a 27% decline from the results at the end of the first quarter of 2013. Recall our number of 60-plus day delinquent loans peaked at almost 1.4 million units at the end of 2010. +Looking ahead, we now expect our amount of 60-plus day delinquent loans to come down further than we originally expected to below 375,000 units by the end of 2013. As we continue to reduce these loans the number of employees and contractors will come down and you can see that by the decrease of 5,000 people during this quarter. +Expenses ex-litigation once again were down roughly $250 million from the first quarter to $2.3 billion. +Global Wealth and Investment Management on slide 15 had a great quarter with our results once again reflecting records in revenues, earnings as well as pretax margin. Year-over-year revenue increased 10% and net income grew by 38%. Our second-quarter pretax margin of about 28% benefited from strong revenue performance as well as improved credit cost during the quarter. +Long-term AUM flows were solid at nearly $8 billion in the quarter, more than double the flows that we saw in the prior year ago period. Ending loan balances grew $5 billion in the quarter to record levels while ending deposits declined $5 billion due to the seasonality of tax payments. +Global banking, on slide 16, experienced strong loan growth and slightly higher investment banking fees compared to the first quarter of 2013, both of which helped drive $1.3 billion in net income and a 22% return on allocated equity. The Investment Banking strength kept fees near record levels and we retained our second-place ranking in net investment banking fees. +Within the Investment Bank, underwriting fees continued the momentum from near record levels during the first quarter of 2013 and were up 53% from the second quarter of 2012. Equity underwriting fees grew 10% relative to the first quarter of 2013 and up 86% from the comparable year-ago period due to the strong global IPO market as well as our focus on continuing to grow capabilities within this space. +On the balance sheet average loans increased by almost $12 billion from the first quarter driven by growth in both corporate C&I as well as commercial real estate. As you look at that loan growth I think it's important to note the strong diversity in lending to our global customer base as the US represented approximately 40% of the growth with the balance outside of the US. +If we switch to global markets on slide 17, we earned roughly $1 billion during the quarter on revenue of $4.2 billion, which is up significantly from the second quarter of 2012 results, but down from the first quarter of 2013. The business during the second quarter generated a 13% return on allocated equity. +Sales and trading revenue, if we back out DVA, was $3.5 billion, solidly above our 2012 results. FICC sales and trading was down versus the second quarter of 2012 as well as the first quarter of 2013 given the rate volatility and spread widening that we saw during the last month of the quarter. Equity sales and trading had a very strong quarter, actually the best that we've seen since the first quarter of 2011. Results ex-DVA were up 53% from the second quarter of 2012 and 4% over the first quarter of 2013 as we continued to gain market share in cash equities, improved our performance and equity derivatives and had higher client balancing -- balances in our financing area. +If you look at the balance sheet, trading asset levels did decline as we reduced risk during the end of the second quarter. Average VAR at a 99% confidence level was $69 million in the quarter, down from $80 million in the first quarter of last year(sic). +On slide 18 we walk you through the results of our all other segment which includes global principal investment, our non-US consumer card business, our discretionary portfolio associated with interest-rate risk management, insurance as well as our international Wealth Management area. +Gains on the sale of debt securities were $452 million in the second quarter of 2013 compared to $67 million in the first quarter and $354 million in the second quarter of 2012. That coupled with the prior quarter cost for retirement eligible compensation, lower litigation expense, higher equity investment income and lower provision for credit losses due primarily to the improvement in the residential mortgage portfolio drove the significant improvement in earnings in this segment compared to both the first quarter of this year and the prior year ago period. +Before we leave this slide, two things I would note for modeling purposes as it relates to preferred dividends and taxes. The first, preferred dividends -- we expect our preferred dividends to drop from $441 million this quarter to about $280 million in the third quarter and then settle in around $260 million per quarter as we move forward. These declines are the result of the redemption of the $5.5 billion of preferred stock this quarter. +If we move to taxes, the effective tax rate for the quarter was 27%. As we look out during the balance of the year we would expect the rate to be approximately 30% plus or minus any unusual items like the UK tax rate reduction. As we have disclosed previously, this year's expected UK corporate income tax rate is likely to be reduced by 3% and will be enacted in the third quarter of this year. +As a result, for modeling purposes, you should include a charge of approximately $1.1 billion associated with the write-down of our UK deferred tax asset in the third quarter of this year. But keep in mind, given where we are from a DTA disallowance position, this will not impact our Basel 1 or Basel 3 capital ratios. +And before we wrap up and take questions I would like to leave you with a couple of thoughts about the second-quarter performance. We achieved many of the objectives that we laid out for the quarter, revenue was solid, costs came down significantly, credit continued to improve and our capital ratios remain strong and improved despite the change in both OCI as well as the initiation of our share repurchase program during the quarter. +The higher rate environment, to the extent it stays with us allows us to improve our net interest income going forward and we plan to continue to drive forward, execute on our strategy and deliver on the earnings capability of our Company. And with that, operator, we will go ahead and open it up for questions. + + + +================================================================================ +Questions and Answers +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions). Betsy Graseck, Morgan Stanley. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [2] +-------------------------------------------------------------------------------- + + A couple of questions on improving RWA's. You mentioned that credit helped drive the RWA's down a little bit. Could you give a little bit more color on how much of the HPI improvement has already come through the RWA? Is there any more to come from what is happened so far in your 2Q -- in your 3Q and 4Q outlook? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [3] +-------------------------------------------------------------------------------- + + Sure. When we referenced, Betsy, the improving credit quality you can look at it in three different buckets. The first which you already pointed out, clearly HPI under Basel 3, as home prices go up there is benefit to that. And that improvement accounted for roughly a third of the improvement we saw during the quarter. +The other two things that we benefited from was at the end of the quarter we had less risk on the books so that obviously the reduction in risk provided some benefit. And then third, the overall credit quality of the wholesale book that we had seen also improved. So within that credit quality characterization it was those three things. As we look forward any improvement, any further improvement that we have with respect to risk-weighted assets is going to be a function of home prices. +Obviously the prints that we have seen during this quarter continue to be strong. And to the extent that the improvement continues we would expect to benefit from that. The other thing that is noteworthy and you see this is that we do continue to run off a fair bit of legacy positions within the consumer mortgage portfolio and you saw that the home equity lines of credit reduced by about another $3.5 billion during the quarter and that obviously provides some benefit as well. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [4] +-------------------------------------------------------------------------------- + + Okay, thanks. And then a follow-up on your comment regarding the outlook for NII, where you indicated that NII excluding market-related items could build from the $10.4 billion at 2Q 2013. Could you describe how you are thinking about that? I've had a lot of conversations over the last quarter of about what you put in your Q, which is 100 basis point (inaudible) rates, a meaningful increase in EPS that has got to come more from reinvesting the cash flow of the securities portfolio. So could you give us a sense of how you drive higher NII? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [5] +-------------------------------------------------------------------------------- + + Sure. Well, in the queue we put out two different numbers, the first that we put out is the parallel -- the 100 basis points parallel shift which at the end of this quarter I believe we said was either $3.6 billion or $3.7 billion. And then we had the steepening where just long rates went up and we had the $1.6 billion that. Obviously at we look at -- and look at net interest income in the future, we've not seen a parallel shift at this point. We've just seen a steepening. And that's why, in my comments, I referenced the $1.6 billion. +But as we look forward and look at -- and look forward from a net interest income perspective, to the extent that long end rates are higher and we are investing excess liquidity at the Company we will benefit from being able to invest at higher rates. +The other two items that we have that will benefit net interest income going forward is we do continue to take down the debt footprint. And you can see that commercial loan balances are moving up as well. And we would expect the combination of those things to more than offset some of the declines in both balances and yields we have seen on the consumer side. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - President & CEO [6] +-------------------------------------------------------------------------------- + + Bruce, I just would add, if you think about over the last several quarters we have been fighting the run off portfolios and the impact of those going forward continues to mitigate. So if you look at some of the information was -- and the card balances actually growing quarter to quarter, whether -- even the home equities, the size of the run-off portfolio in mortgages is lower. You assume those that had higher yields as a general case, so the stuff coming on replacement now helps replace those yields and is better in securities. So that gives us confidence that we are starting to see the growth that helps drive the core NIM up. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [7] +-------------------------------------------------------------------------------- + + And would you be looking to shift some of the liquidity pool into securities? Obviously it would be longer duration in a liquidity pool. + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [8] +-------------------------------------------------------------------------------- + + As we have always said, the first places we continue to build liquidity that we are looking to place it is within the lines of business to fund loan growth from those customers. And if you look at this quarter and you look at the balance sheet you saw some of that in that our overall securities balances I believe were down about $18 billion, whereas our average overall loans were up. +So clearly the lines of business, to the extent of that we continue to originate well structured well priced loans that return the way that we'd like, that is where the liquidity is going to go first. The excess liquidity is invested and in this environment we continue to be very mindful of the OCI risk and will manage with the mindset of mitigating that risk. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [9] +-------------------------------------------------------------------------------- + + Okay, great. And then just lastly on the GWIM gross -- pretax margin, pretty strong number this quarter. And I know last quarter you called out some one timers. Were there any one timers in that this quarter? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [10] +-------------------------------------------------------------------------------- + + Yes. The only one timer that I think jumps out is if you look at it you can say that we actually had a negative provision of about $15 million for the quarter, a more normalized provision number within that business is probably $25 million to $50 million, but not unlike the balance of our consumer real estate portfolio. The consumer lending with respect to mortgages and that segment benefits from the increasing home prices that we have seen. That is probably the one anomaly that merits mentioning. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - President & CEO [11] +-------------------------------------------------------------------------------- + + Betsy, we have been -- John Thiel and David Darnell -- John runs the business, and along with Keith Banks -- U.S. Trust, has done a good job. If you look at the revenue year-over-year, I think it is a 10% increase in expenses went up 3% in the business which, as you know, has high sensitivity to compensation increases. They just have been doing all the hard work and the New BAC work like everybody else. And so as the markets rose they benefited dramatically from it. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [12] +-------------------------------------------------------------------------------- + + So what is the targeted pretax margin there? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [13] +-------------------------------------------------------------------------------- + + Over time as we look at where we are, and I want to highlight over time, we think that can get to a margin of 30%. But at the same time I think of accurately called out we were at 28% this quarter and we did have some benefit from the provision line. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [14] +-------------------------------------------------------------------------------- + + Okay. Over time includes a higher interest rate environment? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [15] +-------------------------------------------------------------------------------- + + Yes. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - President & CEO [16] +-------------------------------------------------------------------------------- + + Remember, they've got a lot of loans, deposits, lending in there too that benefits as rates rise. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [17] +-------------------------------------------------------------------------------- + + Absolutely. All right, thanks a lot. + +-------------------------------------------------------------------------------- +Operator [18] +-------------------------------------------------------------------------------- + + Matt O'Connor, Deutsche Bank. + +-------------------------------------------------------------------------------- +Matt O'Connor, Deutsche Bank - Analyst [19] +-------------------------------------------------------------------------------- + + Just within fixed income trading businesses, I mean obviously June proved to be a tough month I think for a lot of folks. And it seemed like the trends were maybe a little bit weaker than we are seeing elsewhere when we factor in some of the charges that you had in the first quarter. + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [20] +-------------------------------------------------------------------------------- + + Sure. A couple things on the fixed income business. If we look at the -- and let's look at it year over year because this business probably has the most seasonality with respect to the first quarter. If you look at year-over-year and if you looked within the businesses, within both the rates and currencies area as well as the different credit trading areas which we look at investment grade, high yield as well as our loan sales and trading, the performance year over year was actually pretty good. +Where we had weakness in the second quarter this year was in three areas. The first is that we continue to run off the structured credit trading book and you had a pretty significant decline during the second quarter of 2013 relative to the prior year from the continued run off of that book. From a P&L perspective it is largely run off at this point so we are not going to have to discuss that much going forward. +The other two areas on a relative basis that were weaker, we have a very significant business that has got number one market shares in the municipal finance space. And if you look at the prices and the spread widening, it was very dramatic during the month of June in the muni space, that negatively affected us. And then in the mortgage space, obviously the market widened out significantly there and we had some lumpy items in the second quarter of 2012 as well. +So I think as you look at the quarter and you look at the fixed income business, once again we run it as a holistic business between new issue and sales and trading. The new issue business had a great quarter. Those areas where the markets were good, rates and currencies, fixed income -- or fixed -- excuse me, credit trading across the board actually performed pretty well in the three areas that I mentioned, one because it is running off; and two, given the market dynamics didn't perform as well as we would have expected. + +-------------------------------------------------------------------------------- +Matt O'Connor, Deutsche Bank - Analyst [21] +-------------------------------------------------------------------------------- + + Okay, that is very helpful color. So just as we think about FICC going forward, maybe a little bit of a lower run rate as you are running down the -- or ran down the structured trading, but also hopefully less volatility given that? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [22] +-------------------------------------------------------------------------------- + + I think that's fair. Just to give you a sense, Matt, the structured credit trading book this quarter was less than $100 million. So as you look at the go-forward basis, there is just not much left. + +-------------------------------------------------------------------------------- +Matt O'Connor, Deutsche Bank - Analyst [23] +-------------------------------------------------------------------------------- + + Okay. And then separately -- I'm sorry. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - President & CEO [24] +-------------------------------------------------------------------------------- + + Matt, just on that -- just as you look at slide 17, what Tom Montag and team have been able to do is to continue to take advantage of opportunities. The equities business last year, we were still in a work in progress, but they have rebuilt that business; it's doing well. The fixed income, Bruce just ran you through that, but look at the ability to drive the profit by getting the expenses lined up well. So, on the year-over-year basis, the profit increased by $450 million, $460 million because we are able to maintain the expense discipline at the same time as the revenue went up. +And so I think the key there is that we're trying to manage that business in the context of who we are as entire company in the markets business, and Tom and his team continue to drive where the opportunities are. And FICC aside I think had a very good quarter, but when you step back and look at it holistically, their ability quarter after quarter to drive the profit growth or a good return on capital even in more volatile spaces where we got -- obviously hit a little bit in FICC in the latter part of the quarter is pretty solid. + +-------------------------------------------------------------------------------- +Matt O'Connor, Deutsche Bank - Analyst [25] +-------------------------------------------------------------------------------- + + Okay. That is helpful color. I mean we do see good core trends in the iBanking fees and of course the equities business, as you mentioned. And then just separately, if we look at loan was provision expense going forward; you give us some components of charge-offs and then, just kind of big picture, some more reserve release. But any thoughts on just the specific level of provision expense going forward? I think you had been targeting $1.8 billion to $2.2 billion, which obviously you broke through that now for a couple quarters. + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [26] +-------------------------------------------------------------------------------- + + Yes, I think it is a good question. What I would point to is that credit quality across the board, and particularly as you look at early stage delinquencies, as well as what we are seeing as we move some of the consumer real estate out, is quite strong. As we have said, we think the charge-off number will come below $2 billion in the third quarter. +And as you look at the reserve release, the reserve release this quarter, roughly [$650 million] of it was from core reserves and roughly [$250 million] of it was from PCI. We can't project PCI, but I think if you look at the core $650 million and take the charge-off guidance that we have given, absent any change in home prices, you get a sense as to where we are trending. + +-------------------------------------------------------------------------------- +Matt O'Connor, Deutsche Bank - Analyst [27] +-------------------------------------------------------------------------------- + + Okay, that's helpful. Thank you. + +-------------------------------------------------------------------------------- +Operator [28] +-------------------------------------------------------------------------------- + + John McDonald, Sanford Bernstein. + +-------------------------------------------------------------------------------- +John McDonald, Sanford C. Bernstein - Analyst [29] +-------------------------------------------------------------------------------- + + Bruce, I was wondering if you had any sense of where we might think of legal expense going forward. It came down a lot this quarter; you got some things behind you. How should we think of that number going forward? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [30] +-------------------------------------------------------------------------------- + + Yes, I think, John, as we look at legal expense, it is always a little bit difficult to predict. But the just under $500 million that we saw this quarter is clearly at an elevated level from what we would expect long term. At the same time, within the $500 million there was nothing lumpy from the quarter. So it's -- I always hesitate to say too much on that because it is lumpy. But the $500 million number as it relates to a base level, at least what we can tell in the near term, is probably not a bad level to keep. + +-------------------------------------------------------------------------------- +John McDonald, Sanford C. Bernstein - Analyst [31] +-------------------------------------------------------------------------------- + + Okay. And putting expenses altogether, the $16 billion is probably a pretty good jumping off point for us to think going forward starting in the third quarter? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [32] +-------------------------------------------------------------------------------- + + That's correct. + +-------------------------------------------------------------------------------- +John McDonald, Sanford C. Bernstein - Analyst [33] +-------------------------------------------------------------------------------- + + Okay. And then on the quarterly LAS trend you mentioned getting below $2 billion by the end of this year. Any thoughts on what your destination for that might be by the end of 2014? Ultimately you want to get that number down to $500 million, right? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [34] +-------------------------------------------------------------------------------- + + Yes. I would -- as we make progress we previously said we would get $1 billion at this year and $1 billion in 2014. We will be at a lower level at the end of 2013, as we said today. And I don't think it is unreasonable to think we will get another $1 billion out in 2014 relative to that lower level. + +-------------------------------------------------------------------------------- +John McDonald, Sanford C. Bernstein - Analyst [35] +-------------------------------------------------------------------------------- + + Okay. Just separately, you mentioned the DTA. I assume the DTA consumption is still helping drive up your capital ratios. Could you remind us how much DTA you have right now and how much is disallowed? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [36] +-------------------------------------------------------------------------------- + + Right now on a disallowed basis under Basel 1.5 it is in the ZIP Code of $15 billion to $16 billion. I think the important thing to keep in mind is during the quarter we didn't get the benefit that you would think from DTA because the impact of OCI offset that. + +-------------------------------------------------------------------------------- +John McDonald, Sanford C. Bernstein - Analyst [37] +-------------------------------------------------------------------------------- + + Okay. But normally you would probably be building at close to the pretax rate you said before? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [38] +-------------------------------------------------------------------------------- + + Absolutely. + +-------------------------------------------------------------------------------- +John McDonald, Sanford C. Bernstein - Analyst [39] +-------------------------------------------------------------------------------- + + Okay. Last thing for me. On the NII, can you just review that again? The benefit you have talked about, that is a benefit from the 10 year moving up. And did you say that you received $300 million of that benefit that is already in the $10.4 billion that we see this quarter? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [40] +-------------------------------------------------------------------------------- + + No, the $300 million was in the $10.8 billion. The $10.4 billion backs out the $300 million. + +-------------------------------------------------------------------------------- +John McDonald, Sanford C. Bernstein - Analyst [41] +-------------------------------------------------------------------------------- + + Okay. So the benefit -- the $700 million, that is to come over the next 12 months? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [42] +-------------------------------------------------------------------------------- + + Yes, the $700 million would be the benefit, all other things being equal, off of that $10.4 billion number. And that is just the benefit from the move in rates, not anything else to do with the balance sheet. + +-------------------------------------------------------------------------------- +John McDonald, Sanford C. Bernstein - Analyst [43] +-------------------------------------------------------------------------------- + + Okay. But you are thinking of that as helping the core number grow, right, not the --? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [44] +-------------------------------------------------------------------------------- + + That's correct. The $700 million that is left is all core. The $300 million was in the adjusted -- or in the pre-adjustment number that we reported of $10.8 billion this quarter. + +-------------------------------------------------------------------------------- +John McDonald, Sanford C. Bernstein - Analyst [45] +-------------------------------------------------------------------------------- + + Okay, right, that $300 million wasn't core, but the next one to come is. Okay, got it. + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [46] +-------------------------------------------------------------------------------- + + Correct. + +-------------------------------------------------------------------------------- +John McDonald, Sanford C. Bernstein - Analyst [47] +-------------------------------------------------------------------------------- + + Okay, thank you. Bruce, so do you have -- and you have additional benefits beyond that if short rates rise, was that the point you were making earlier? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [48] +-------------------------------------------------------------------------------- + + That is correct and that is the important point. As you look at -- and I'm just going to speak to what we had in the first-quarter Q -- the difference between a 100 basis point parallel shaft and a 100 basis point on the long end is an incremental $2.1 billion which is to your short end question. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - President & CEO [49] +-------------------------------------------------------------------------------- + + John, the power of the deposit franchise and the short rate rise because the mix is so transactional and core oriented is just, that is where there is a lot of lift left. It's not showing up yet obviously because of the steepness of the curve. + +-------------------------------------------------------------------------------- +John McDonald, Sanford C. Bernstein - Analyst [50] +-------------------------------------------------------------------------------- + + Okay, thanks. + +-------------------------------------------------------------------------------- +Operator [51] +-------------------------------------------------------------------------------- + + Brennan Hawken, UBS. + +-------------------------------------------------------------------------------- +Brennan Hawken, UBS - Analyst [52] +-------------------------------------------------------------------------------- + + A quick question I just want to confirm. I believe you guys said in the past that there is -- when we look at the revenue decline from the sales and the MSR and the LAS business versus the corresponding reduction in expenses we should kind of count on a lag on that front, is that right? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [53] +-------------------------------------------------------------------------------- + + Yes, there is always a lag of three to six months from when the work goes away to when the actual employees that are working on that, as well as the expenses associated with it, leave the income statement. + +-------------------------------------------------------------------------------- +Brennan Hawken, UBS - Analyst [54] +-------------------------------------------------------------------------------- + + Okay, great. Thanks for confirming that. And in your experience generally how sensitive -- what is the MSR market -- the MSR purchase market like at this point? Are you guys still out there shopping MSRs and how sensitive are those buyers to home prices? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [55] +-------------------------------------------------------------------------------- + + Sure. I want to make sure we clear up one question that we get a lot on this. We worked hard to enter into the MSR sale that we entered into at the end of 2012. A lot of the goal associated with that was to be able to reduce the work so we could take the expenses out of our Legacy Assets and Servicing area. +We entered into a number of transactions in the fourth quarter of 2012 and those will close throughout 2013. The most significant sales have already closed and there will be some smaller sales that close during the balance of this year. +Outside of the closing of those sales any activity that you see from an MSR perspective will only be because it makes so much sense and it results in getting out loans that are very difficult to work out. But going forward you should not expect to see any incremental MSR sales. And all the guidance we've given you with respect to expense as well as 60-plus day delinquencies is solely based on us doing the work that we control. + +-------------------------------------------------------------------------------- +Brennan Hawken, UBS - Analyst [56] +-------------------------------------------------------------------------------- + + Okay, that's clear. Thank you. And then on your AFS portfolio, I think you guys have indicated in the past it was a roughly two year duration. Given your allocation to RMBS in that portfolio, did we see an extension of that duration? Can you kind of help us -- give an idea about what the impact might have been during the quarter? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [57] +-------------------------------------------------------------------------------- + + Yes, as you look at that, one of the conferences that we spoke at, the comment that we had made at that point was that as you look at the impact of OCI relative to net interest income that it took between two and a half to three years to be able to earn back the OCI that is lost through net interest income. And you are absolutely right that durations do widen in mortgage-backed securities. So as we leave 2012 it is more in the context of three years to earn it back as opposed to the two and a half to three years that we had spoken about previously. + +-------------------------------------------------------------------------------- +Brennan Hawken, UBS - Analyst [58] +-------------------------------------------------------------------------------- + + Terrific. Thanks for that. And then last one from me -- the results in GWIM have definitely been impressive. Can you guys speak to any change we've seen in high net worth risk appetite or behavior over the last roughly year or so and how sustainable you view that? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - President & CEO [59] +-------------------------------------------------------------------------------- + + Well, I think a year or so, I mean -- I think if you went back a little shorter than that in the first quarter as the markets moved people started putting money back in the market on a retail level -- on a high net worth retail level. And I think that trend has continued. But there is still a lot of cash out there. So if you look at some of the deposit dynamics you can see that repositioning. +And so, we feel people are constructive. I'm not -- we've got our research experts that can give you their view of the S&P levels and things like that. But from a general trend from both our private banking clients and the willingness to borrow money, put it to work for Private Banking and Wealth Management clients and their investment patterns we've seen they are willing to take risk go up. +And so, you've seen growth in our lending across the board and that has been -- that indicates that people are willing to take risk. I think if you look back a year ago people were not using lines and weren't asking for a lot of lines. And that has changed in the last couple quarters. + +-------------------------------------------------------------------------------- +Brennan Hawken, UBS - Analyst [60] +-------------------------------------------------------------------------------- + + Cool. That's helpful, thanks. + +-------------------------------------------------------------------------------- +Operator [61] +-------------------------------------------------------------------------------- + + Paul Miller, FBR. + +-------------------------------------------------------------------------------- +Paul Miller, FBR Capital Markets - Analyst [62] +-------------------------------------------------------------------------------- + + Switching to the mortgage banking side, you've got 5% market share which you have really built back -- you built back your market share over the last year, year and a half. But most of them are refi's. With the refi -- with rates going up where do you think that market share goes to or do you think you've done a pretty good job building up your purchase -- your purchase salesforce to maintain that? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - President & CEO [63] +-------------------------------------------------------------------------------- + + Bruce, why don't you hit on some of that and then I will give you some broader color. + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [64] +-------------------------------------------------------------------------------- + + So I think as you step back this quarter our purchase percentage of our overall total went up to 17% from what I believe was right around 7% during the first quarter. So we have started to see the purchase share go up. As we look forward we have roughly 12% deposit market share throughout the country. And if we are doing this business as well as we believe that we can we clearly would expect over time that that mortgage market share can grow from the 4% that we started at a year ago to the 5% that we are at today up to a high single-digit market share. +And as we look at where we are today relative to going forward and as we look at what some of our peers have said, the 5% decline in pipeline end of second quarter this year -- or end of second quarter currently versus the first quarter is reflective of the fact that we are picking up share because the pipelines aren't down as much as some others. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - President & CEO [65] +-------------------------------------------------------------------------------- + + Paul, the other thing is about 70% odd -- 72% to 74% I think it is of the activity that we do in mortgage is really off the customer base. And so, we now have more than half the mortgage loan officers that we have working through the branch -- the retail stores, on teams of people along with the financial advisors, what we call FSA's, in a branch and personal bankers and small business bankers. +And so, that business system is really taking hold and the amount they are producing continues to grow. And that is where we have placed a lot of the growth year over year. I think we are up 700 or 800 or so mortgage loan officers and mostly in that platform. That platform performs well from both realtor referral basis plus direct to consumer basis. And so, we think that serves us well as the market ebbs and flows between refi purchases. +And then when you look at our purchase statistics you also have to remember that we still have, probably more than other of our peers, a lot of the government-related refinancing business going through, which we identified for you. So if you sort of back that out you see a more represented picture of how we are doing in the purchase market. But we've got to make that transition happen and the team will work hard at it. + +-------------------------------------------------------------------------------- +Paul Miller, FBR Capital Markets - Analyst [66] +-------------------------------------------------------------------------------- + + And then can you add some color -- I mean we have been first -- rates have really moved up, gain on sale margins you know are coming down. But can you give some color where you are seeing gain on sale margin so far into the quarter or is it too early to tell? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - President & CEO [67] +-------------------------------------------------------------------------------- + + For this quarter -- for the third quarter? + +-------------------------------------------------------------------------------- +Paul Miller, FBR Capital Markets - Analyst [68] +-------------------------------------------------------------------------------- + + Yes. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - President & CEO [69] +-------------------------------------------------------------------------------- + + I think it's too early to tell because we have only had a couple of week's activity obviously. But they came down in the quarter. Bruce, why don't you --? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [70] +-------------------------------------------------------------------------------- + + Yes, they were down roughly, Paul, 50 basis points during the second quarter relative to the first. And as Brian indicated, it is too early to tell this quarter. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - President & CEO [71] +-------------------------------------------------------------------------------- + + Generally in this business, remember, we are -- this business is a business which ebbs and flows and you know it as well as anybody. Our goal in this business is to serve our customers well. And I think we have rebuilt the platform to do that and that is why we are having success. And so, as the margins have come in they're still strong, we still make money in the business, but we've got to monitor as we go forward. It doesn't mean that -- we will have to take expenses down like everybody else will if the volume is not there. + +-------------------------------------------------------------------------------- +Paul Miller, FBR Capital Markets - Analyst [72] +-------------------------------------------------------------------------------- + + And did you disclose what your HARP percentage is? If you did I missed it. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - President & CEO [73] +-------------------------------------------------------------------------------- + + The -- we can get you on that -- we will get you that. I don't know it off the top of my head. Do you happen to know, Bruce? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [74] +-------------------------------------------------------------------------------- + + It's in the 40%s. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - President & CEO [75] +-------------------------------------------------------------------------------- + + Yes, the 40% I thought. + +-------------------------------------------------------------------------------- +Paul Miller, FBR Capital Markets - Analyst [76] +-------------------------------------------------------------------------------- + + Okay. Hey, guys, thank you very much. + +-------------------------------------------------------------------------------- +Operator [77] +-------------------------------------------------------------------------------- + + Guy Moszkowski, Autonomous Research. + +-------------------------------------------------------------------------------- +Guy Moszkowski, Autonomous Research - Analyst [78] +-------------------------------------------------------------------------------- + + Thanks for the disclosure on the supplemental leverage ratio. I was wondering if you had any assessment of what the impact might be of the BIS proposal for add-ons on disallowed repo and CDS protection sold and disallowed derivatives collateral. + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [79] +-------------------------------------------------------------------------------- + + Yes, I think at this point, Guy, we have worked hard, given that these rules came out at the end of last week, to be able to get to both the parent as well as to be very specific about our two primary banking subsidiaries. From best that we can tell in the different releases that is what the US regulatory framework has focused on. There are obviously some different views that were put out in BIS, but we don't have a number for you on that. + +-------------------------------------------------------------------------------- +Guy Moszkowski, Autonomous Research - Analyst [80] +-------------------------------------------------------------------------------- + + Okay, that's fair. I know that is early days. How will you -- and stipulating to the fact that clearly based on what you have told us and some stuff that we have done you are pretty much where you would need to be on the supplemental leverage ratio per the US take. How would you think about managing your off balance sheet lending commitments to the extent that they do drive the denominator there? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [81] +-------------------------------------------------------------------------------- + + It's one of the questions and as we have different discussions that you raise, that as policy gets set on this there is a concern of do some of the policies out there possibly have an impact on the availability of undrawn credit. And so, directly to your point, to the extent that over time you are required to hold capital in this case in the form of a leverage ratio for committed undrawn facilities, by definition the cost of those facilities to have truly committed facilities will need to migrate up over time so there is a fair return that is generated on the capital that needs to get help for those. +To the extent that they are not committed, obviously the percentage that you need to hold is much less. But across the industry to the extent that you need to hold capital for those in greater amounts, the cost will need to change over time. Keep in mind, that doesn't kick in until 2018. + +-------------------------------------------------------------------------------- +Guy Moszkowski, Autonomous Research - Analyst [82] +-------------------------------------------------------------------------------- + + Yes, fair enough. And to the numbers you gave, you obviously don't have a lot of pressure to do anything there. But you are right, it would seem like pricing of those facilities probably has to get rationalized. On the shares, you did an initiate the share repurchase, you talked about that. But there was still a fairly meaningful amount of share creep in the quarter. Was that just employee grants? Although I would've expected to see those more in the first quarter. And should we expect that we are at this point kind of at a high for the year in terms of the share count; should it head back down to where it was say in the first quarter? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [83] +-------------------------------------------------------------------------------- + + Guy, I would ask you to take a look -- and if you flip back to the balance sheet data that we present on page 6, you can see that the actual number of outstanding shares for the quarter came down by 80 million which is the 80 million shares that we told you we repurchased. The only variation in the share count on a fully diluted basis is the treatment of the 700 million shares that were associated with the Berkshire investment. And depending on the price of the stock, as well as where the preferred shares are, that fully diluted share count can bounce around a little bit. But on a pure shares outstanding we came down by the 80 million that we show on slide 6. + +-------------------------------------------------------------------------------- +Guy Moszkowski, Autonomous Research - Analyst [84] +-------------------------------------------------------------------------------- + + Fair enough. Okay, I just have one more question -- thanks for the clarity on that. When do you expect at this point to have completed the rationalization of the branch system? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [85] +-------------------------------------------------------------------------------- + + As you go back through -- and the guidance and what we have spoken about is that we wrapped up and did the New BAC for the consumer businesses at the beginning of 2011 and we had a plan to work through and to rationalize that branch network down to in the ZIP Code of 5,000 branches by the end of 2014. And beyond 2014 at this point we will continue to evaluate and optimize the branch network going forward. +What we have been very pleased with as we look at that optimization of the network is two things. The first as we have rationalized the network in the markets that we operate, we have been very pleased with our retention of both consumer deposits as well as overall relationships in that as we have rationalized that network our customers have continued to do business with us and just use a different branch. +And the second thing that I would mention is that you have seen some announcements that in some of the more rural markets we've actually been able to sell those branches and generate decent premiums as we have sold those. But in the near-term we have got the plans through 5,000 and we will continue to look to optimize based on the environment that we are operating in. + +-------------------------------------------------------------------------------- +Guy Moszkowski, Autonomous Research - Analyst [86] +-------------------------------------------------------------------------------- + + But it almost sounds like, based on the success that you've had that you outlined, that might encourage you to take it a little bit further or would that be reading too much into it? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - President & CEO [87] +-------------------------------------------------------------------------------- + + No, I think -- if you look at page 12 you can sort of -- you have to sort of look at all of the dynamics in there. So deposits up $50 billion from last year's second quarter. The branch countdown about 270, and the rate paid on deposits from 19 basis points down to 12 basis points. But importantly look at the mobile banking customer and look at the -- and the uses behind that. +So this is a matter of continuing to optimize, as you said, Guy, the distribution system. But it is going to be led by the customer behavior change. In other words we are seeing, because of our customer base and because of our capabilities, like our online banking system was rated best in the business ninth year in a row and things like that. The mobile banking system gets great feedback from our customers seeing constant improvement. That our ability to do this is still in front of us because we got to watch the customer behavior and how we change. +There will be some point where the core store level will probably settle in, but you are seeing it work through that if you sit there and say -- have 10% more deposits and 5% less branches and 30% more mobile customers, that is a pretty good dynamic towards the expense basis of the platform. And so, we will continue to optimize it, but it is going to be led by our customers. + +-------------------------------------------------------------------------------- +Guy Moszkowski, Autonomous Research - Analyst [88] +-------------------------------------------------------------------------------- + + Great. Thanks so much for that. + +-------------------------------------------------------------------------------- +Operator [89] +-------------------------------------------------------------------------------- + + Chris Kotowski, Oppenheimer & Company. + +-------------------------------------------------------------------------------- +Chris Kotowski, Oppenheimer & Co. - Analyst [90] +-------------------------------------------------------------------------------- + + I am looking at the supplement on page 23 where you go through the consumer real estate services. And looking down the column that says home lending and year to date you have nearly $2 billion of revenues and only $94 million drops to the bottom line. And I am wondering is that lack of profitability some vagary of segment accounting or is it that the business is just -- or is the business just kind of so marginally profitable? And if so then why be in it? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [91] +-------------------------------------------------------------------------------- + + Yes, the big thing there, Chris, is remember in the home loan space that the only activity that is reflected within that is the front end or the origination side as well as a small amount of the home equity book that is held there. Keep in mind, relative to our peers the service -- all of the servicing asset and the profitability that comes out of the servicing asset for what I would characterize as the quote, good or current servicing, is all based within the legacy assets and servicing segment. So it's a little bit of apples to oranges relative to our peers as to how we report it. + +-------------------------------------------------------------------------------- +Chris Kotowski, Oppenheimer & Co. - Analyst [92] +-------------------------------------------------------------------------------- + + Wait, so I'm sorry, the servicing revenues are in the LAS? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [93] +-------------------------------------------------------------------------------- + + That is correct. + +-------------------------------------------------------------------------------- +Chris Kotowski, Oppenheimer & Co. - Analyst [94] +-------------------------------------------------------------------------------- + + And this is just origination? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [95] +-------------------------------------------------------------------------------- + + Correct. + +-------------------------------------------------------------------------------- +Chris Kotowski, Oppenheimer & Co. - Analyst [96] +-------------------------------------------------------------------------------- + + Okay. And is that kind of historically the norm that origination is sort of a loss leader almost? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - President & CEO [97] +-------------------------------------------------------------------------------- + + I wouldn't say loss leader. You've got to do it to make some money, but the value tends to be extracted through the servicing over time. But I think the reality is we have been building this up and investing in it. And as we sort of reach a level of where the investment is paying us back we still have a lot of efficiency to get in this business to in the front end. + +-------------------------------------------------------------------------------- +Chris Kotowski, Oppenheimer & Co. - Analyst [98] +-------------------------------------------------------------------------------- + + Okay. And then overall in terms of liquidity, I mean it looked like your non-loan earning assets were down by almost $40 billion this quarter. How much further do you suppose you can run those down as you reduce your debt footprint? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [99] +-------------------------------------------------------------------------------- + + Well, the liquidity, I think -- let me go back and you have to be careful with -- are you referring to on the liquidity side? Keep in mind, a big chunk, $18 billion of what you saw was a result of what we saw in running down the debt footprint. And, as we said, we've got $13 billion of maturities left in the balance of 2013 and just under $40 billion during 2014. So we will continue to be a net reducer of our debt balances and we would expect that to continue to benefit the net interest income line. + +-------------------------------------------------------------------------------- +Chris Kotowski, Oppenheimer & Co. - Analyst [100] +-------------------------------------------------------------------------------- + + Okay, great, thank you. + +-------------------------------------------------------------------------------- +Operator [101] +-------------------------------------------------------------------------------- + + Moshe Orenbuch, Credit Suisse. + +-------------------------------------------------------------------------------- +Moshe Orenbuch, Credit Suisse - Analyst [102] +-------------------------------------------------------------------------------- + + Could you talk a little bit about whether you either have -- it doesn't look like it, but whether you have or are planning to kind of retain mortgage loans in the second half of the year? And I have got a follow-up question, too. + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [103] +-------------------------------------------------------------------------------- + + I'm sorry, I'm not sure I understand your first question. + +-------------------------------------------------------------------------------- +Moshe Orenbuch, Credit Suisse - Analyst [104] +-------------------------------------------------------------------------------- + + Well, I mean, when you think about -- you said in terms of the investment portfolio you would kind of be cognizant of the AOCI impact. You could achieve a similar objective without that by retaining residential mortgages. + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [105] +-------------------------------------------------------------------------------- + + Sure, okay. So, we would expect and, if you look at during the quarter and you look at the composition, keep in mind, Moshe, that you do have loans repaid. But during the quarter, as it relates to the origination activity that we had with our core clients that there were about $13 billion of residential mortgage loans that were originated through the core platform, roughly a third of which were through our Wealth Management area and the balance through our CBB segment. So there is an origination of activity. +And as I said, the investment portfolio is there to invest the residual of what is used. There will be some incremental investments during the year, but I don't think in the aggregate you should expect to see the overall level of securities balances change dramatically between now and the end of the year. + +-------------------------------------------------------------------------------- +Moshe Orenbuch, Credit Suisse - Analyst [106] +-------------------------------------------------------------------------------- + + Got it. And maybe -- given that you have been kind of ahead of or meeting at least or regulatory capital levels kind of faster than some of your large peers. What are the areas that you think could benefit from incremental kind of capital investment or where they might be divesting? Are there any opportunities there? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [107] +-------------------------------------------------------------------------------- + + What we are focused on, and you have seen two different levels of activities amongst our peers. You have seen some looking to deploy and to invest in those areas where there are things that are being sold. What you are going to see us -- and I think you see some of it as you look at our commercial loan activities. We are very much focused given the capital and liquidity that we have built and using that capital and liquidity within our core customer segments. +And so, when you look at that liquidity if you look at our Wealth Management business you will see that the loan balances were up $5 billion Q1 to Q2 because of what we are doing from a securities lending perspective and a mortgage lending perspective, you look at the commercial loan balances. And so, they were up $10 billion, that is not from buying loans or doing anything else. +I do think though to your point some of that comes from being able to lend where other people are pulling back. So you are not going to see anything inorganic that we are doing. What you will see and what you should expect of us is to continue to driving those growth in those customer areas where because of the dynamics that you have mentioned other people may be doing less. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - President & CEO [108] +-------------------------------------------------------------------------------- + + So if you link this question to the last question about sort of the efficiency of the mortgage business, year over year we deployed about 5,000 people, about a 25% increase, to make sure we can close mortgages on time and meet the demands of the customers. So at the same time the headcount of the overall Company is down significantly, we've had that kind of investment go on. We have more commercial bankers today than we had a year ago, we have more small business bankers, financial service advisor branches, so we continue to make the investment. +It's not really about capital I think because we still have so many loan portfolios that are running off that if we replace them it would be good core growth to replace them. It is more about expense dollars and redeploying and that is where we make the judgments right now. And so, the business of returning our cost of capital on allocated capital which is regulatory minimums or above, but it is really the question of where we put the expense dollars and that is where we are focused on sort of the core business that we have the best opportunity. + +-------------------------------------------------------------------------------- +Moshe Orenbuch, Credit Suisse - Analyst [109] +-------------------------------------------------------------------------------- + + And so, maybe just to follow up on that, Brian, I mean do you have a number in mind as to how much you would look to kind of reinvest of the expense savings that you are generating? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - President & CEO [110] +-------------------------------------------------------------------------------- + + It's a net number, so we don't give you a number that doesn't take account. But for this year, just to give you an example, we will spend $1.1 billion in connection with the New BAC ideas, which are expense revenue and improving our Company basis that is on top of the $2.5 billion we spend otherwise and systems development work. That is pure systems development initiatives to help drive this Company. +So there is investment going in, but all of the numbers we give you are net of all the investments we are making. So we just -- we are giving you a net number, but we are investing significantly at the same time. And that was what Bruce and the team -- management team set out a few years ago was we had to make sure we progressed the core franchise at the same time we brought the expense base and headcount down. + +-------------------------------------------------------------------------------- +Moshe Orenbuch, Credit Suisse - Analyst [111] +-------------------------------------------------------------------------------- + + Great, thanks. + +-------------------------------------------------------------------------------- +Operator [112] +-------------------------------------------------------------------------------- + + Nancy Bush, NAB Research. + +-------------------------------------------------------------------------------- +Nancy Bush, NAB Research - Analyst [113] +-------------------------------------------------------------------------------- + + Two questions for you. You have made gains in market share and mortgage and you said that you have stabilized the credit card. Are you going to be able to gain share in credit card and how do you look to do that? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - President & CEO [114] +-------------------------------------------------------------------------------- + + I think we are in a position, Nancy, for the first time in a long while to -- we've been saying stabilizing credit card for a couple of quarters because we have seen it sort of settle in. We divested some portfolios, as you know. We sized out of some of the business that we didn't find attractive. In this quarter we saw it increase for the first time I think in almost five years. And so, the team produced about 975,000 cards through the -- new cards this quarter up from 950,000-ish last quarter. That is a multitier high in production, I think it goes back to 2008. So, we should see this go on. +Now, you have activity levels you've got to be careful of in the summer and things like that. But overall the baseline is set now. That restructured portfolio which we have shown you guys I think started $15 billion to $20 billion several years ago and is now down to a few billion. To set the underlying dynamics are there that we should be able to grow the business and hold our share. And if you look over the last couple quarters we are basically flattish share wise in card balances, a little bit down but in line with the peers. And so, we feel good that we finally have reached this point after five years of hard work of restructuring that business. + +-------------------------------------------------------------------------------- +Nancy Bush, NAB Research - Analyst [115] +-------------------------------------------------------------------------------- + + So though do you feel that -- I mean is it a business where you want to gain share? Or if you could just sort of give your overall philosophy on the credit card business right now. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - President & CEO [116] +-------------------------------------------------------------------------------- + + We will continue to drive share among our customers. We have low penetration in certain segments and low usage of our cards in other segments. And so, we are driving through the three or four core products, the Cash 123 product for people that feel that's what they want in a card through the travel awards and other awards products. And we are seeing the cards come in through those core products and we are driving. And, yes, we want to grow share in the context of our customers in the select affinity teams that we work with across the country. + +-------------------------------------------------------------------------------- +Nancy Bush, NAB Research - Analyst [117] +-------------------------------------------------------------------------------- + + The second question I have is somewhat imprecise and I apologize in advance. But I think what everybody is waiting for with your stock and with the earnings outlook is for this massive deposit gathering network to get profitable. And we understand that that is a function of short rates going up. Is there an ideal -- can you kind of walk us through this? Is there an ideal yield curve? Is there an absolute level of short rates? I mean whatever -- what do we have to see to begin to see the branches get massively profitable? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [118] +-------------------------------------------------------------------------------- + + Well, the first thing to your point, if we look at and if you go to the supplement that during the second quarter the deposit segment within CBB did make $500 million during the quarter. +As we look forward though, more directly to your point, to the extent that the overall yield curve shifts up -- and this is once again in our first-quarter Q -- that the benefit from a net interest income perspective on a 100 basis point parallel shift as of the end of the first quarter was over $3.5 billion, the lion's share of which is going to flow through the consumer segment. +So, as it relates to where we are now it is profitable, we made almost $500 million, we continue to optimize and to reduce the expenses to make it more profitable. And you are correct, once rates go up it will become much more so. + +-------------------------------------------------------------------------------- +Nancy Bush, NAB Research - Analyst [119] +-------------------------------------------------------------------------------- + + If I could just finally ask a corollary to that question. Because of all the issues that you have had in the past few years with closing branches, changing the branch model, several different sort of programs to change the retail footprint of the Company, is there going to be a need as rates go up to give more of that benefit to your customers? In other words, are you going to have to act differently in deposit pricing this time around than you have in previous rate cycles? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - President & CEO [120] +-------------------------------------------------------------------------------- + + I think -- Nancy, I think about a lot of the adjustments we made on the fee side for the general consumer customer have already been made. And I think they had -- the customers have benefited dramatically from our position and how we overdrafts and other types of fees. So I think that that will be -- that is the -- following off of your point, that payback to the customers. As deposit -- as rates rise we will meet the market and grow with the market as we have been doing. +But interestingly enough, remember the constitution of our deposits across the last three years, we have run off a lot of CDs and other things which are not advantage products and it has really become more and more core every single quarter. And that will play to our benefit because transactional deposits -- a checking account is non-interest at this point. So as rates rise there is no extra cost. + +-------------------------------------------------------------------------------- +Nancy Bush, NAB Research - Analyst [121] +-------------------------------------------------------------------------------- + + Okay, thank you. + +-------------------------------------------------------------------------------- +Operator [122] +-------------------------------------------------------------------------------- + + Mike Mayo, CLSA. + +-------------------------------------------------------------------------------- +Mike Mayo, Credit Agricole Securities - Analyst [123] +-------------------------------------------------------------------------------- + + I have three real small questions and then one bigger question. What tax rate should we assume to be normal? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [124] +-------------------------------------------------------------------------------- + + At this point -- as we have said, 30% is a reasonable effective tax rate for the last two quarters of the year realizing that you need to add about $1.1 billion to that for the UK tax. And as we go into 2014 and 2015 that 30% migrates into more of a 32% to 33% effective tax rate based on what we think we will be earning as we go into 2014 and 2015. + +-------------------------------------------------------------------------------- +Mike Mayo, Credit Agricole Securities - Analyst [125] +-------------------------------------------------------------------------------- + + All right. And then secondly, the GWIM margin of 28%, I'm just trying to compare that to the old Merrill Lynch Wealth Management margin and you have the Asset Management and US Trust in there. Can you just give us some estimate where that 28% margin would be? Would it be 26% or 25% or --? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - President & CEO [126] +-------------------------------------------------------------------------------- + + Where would it be? I'm not sure, Mike, what --? + +-------------------------------------------------------------------------------- +Mike Mayo, Credit Agricole Securities - Analyst [127] +-------------------------------------------------------------------------------- + + Excluding US Trust and excluding asset management. In other words, just the pure brokerage business, what kind of margin did that have? I'm just -- I'm trying to see if this is the highest brokerage margin ever perhaps if you can go back to the old Merrill Lynch? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [128] +-------------------------------------------------------------------------------- + + We don't disclose the difference between -- I think what you are asking is, is the margin in US Trust materially different than it is in the traditional Merrill Lynch Wealth Management model. And you should not assume that the margin improvement and the 28% is driven by a mix, virtually all of that margin is driven by overall what we are seeing within which you characterized as the traditional wealth management business of Merrill Lynch. + +-------------------------------------------------------------------------------- +Mike Mayo, Credit Agricole Securities - Analyst [129] +-------------------------------------------------------------------------------- + + Okay, thank you. And then, as far as net interest income, you said you had a $300 million benefit this quarter from the increase in the 10 year. So am I just drink the math right? You had $10.5 billion of net interest income, so it added 3% just this last quarter or really in the last month? It just seems like a lot. I mean that is a nice benefit. + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [130] +-------------------------------------------------------------------------------- + + Well, keep in mind, Mike, and if you flip to slide 9 we show both the reported as well as the actual number. And the reason why that increase in interest rates led to the improvement in NII is because you need to adjust the way you look at premium securities went rates go up to reflect the slowdown in the rate at which you would expect to be paid back. So that is more of a life of loan type adjustment and that is why it is $300 million, it's the reason why we show you the number both ways. + +-------------------------------------------------------------------------------- +Mike Mayo, Credit Agricole Securities - Analyst [131] +-------------------------------------------------------------------------------- + + Okay. And then lastly, the legal expense came we down, you expect to stay around $500 million. But I'm still focused on the $8.5 billion settlement. And I go down to the courthouse in lower Manhattan and what I think I hear, and again correct my thinking, what I think I hear some lawyers say that Bank of New York rubberstamped the $8.5 billion agreement therefore throw the $8.5 billion deal out. What I think I hear the Kathy Patrick side say is accept the $8.5 billion deal is the best economic alternative out there. +So my question is, you have $8.5 billion of reserves, the $8.5 billion settlement, your disclosures say if the judge does not approve the deal your reserves would go higher. So my question is, how much higher would your reserves go if the judge does not approve the deal and what part of my logic would you like to perhaps correct? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [132] +-------------------------------------------------------------------------------- + + The first is that we are not going to comment on the ins and the outs on the $8.5 billion because, as you know, technically we are not a part of that. The second thing as it relates to that that I would say is, and I think if you go back and look at one of the comments that was made, we accrued the $8.5 billion assuming that all 424 trusts were at the point where they got to the 25% two where there was a negotiation. +So at this point to comment whether or not we think the reserves would be higher or they could be lower is really not appropriate because right now there is an $8.5 billion settlement that is going through the process. We've accrued based on what 22 of the largest investors said was a fair deal, and as you know, when we set up the reserves we applied that same methodology to a variety of our other exposures. And to speculate or to comment before then given where we are in this, I just don't think is appropriate, Mike. + +-------------------------------------------------------------------------------- +Mike Mayo, Credit Agricole Securities - Analyst [133] +-------------------------------------------------------------------------------- + + Sure. I think last quarter you thought it would all be wrapped up by now. Any sense of when this might be wrapped up, when you might have this behind you? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [134] +-------------------------------------------------------------------------------- + + I'm not sure that we ever said that we thought it would be wrapped up in the second quarter. What we do know is what you know now given how you have followed the case that I believe that there is a court schedule set up through 26 July, it's not clear whether or not it will be wrapped up by the 26 or will go beyond that. We will just have to see how the process unfolds. + +-------------------------------------------------------------------------------- +Mike Mayo, Credit Agricole Securities - Analyst [135] +-------------------------------------------------------------------------------- + + All right, thank you. + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [136] +-------------------------------------------------------------------------------- + + Thank you. And I believe at this point that we are through all the questions. So thank you very much for joining us this morning and we will look forward to talking to you next quarter. + +-------------------------------------------------------------------------------- +Operator [137] +-------------------------------------------------------------------------------- + + This concludes today's program, have a great day. You may disconnect at this time. + + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/exam/original-files/Problem_1_Sample/2013-Jul-24-FB.OQ-140049061003-Transcript.txt b/exam/original-files/Problem_1_Sample/2013-Jul-24-FB.OQ-140049061003-Transcript.txt new file mode 100644 index 0000000..fc6ac2d --- /dev/null +++ b/exam/original-files/Problem_1_Sample/2013-Jul-24-FB.OQ-140049061003-Transcript.txt @@ -0,0 +1,556 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q2 2013 Facebook Earnings Conference Call +07/24/2013 05:00 PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * David Ebersman + Facebook, Inc. - CFO + * Deborah Crawford + Facebook, Inc. - Director of IR + * Mark Zuckerberg + Facebook, Inc. - CEO + * Sheryl Sandberg + Facebook, Inc. - COO + +================================================================================ +Conference Call Participiants +================================================================================ + + * Justin Post + Merrill Lynch - Analyst + * Youssef Squali + Cantor Fitzgerald Securities - Analyst + * Eric Sheridan + UBS - Analyst + * Briain Pitz + Jefferies & Co. - Analyst + * Laura Martin + Needham & Company - Analyst + * Ben Schachter + Macquarie Research Equities - Analyst + * Ken Sena + Evercore Partners - Analyst + * Ross Sandler + Deutsche Bank - Analyst + * Heather Bellini + Goldman Sachs - Analyst + * Jordan Rohan + Stifel Nicolaus - Analyst + * Mark Mahaney + RBC Capital Markets - Analyst + * Anthony DiClelmente + Barclays Capital - Analyst + * Scott Devitt + Morgan Stanley - Analyst + * Rory Maher + Hillside Partners - Analyst + * Douglas Anmuth + JPMorgan Securities - Analyst + * Mark May + Citigroup - Analyst + +================================================================================ +Presentation +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Good afternoon. My name is Jay and I will be your conference operator today. At this time I would like to welcome everyone to the Facebook second-quarter earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks there will be a question-and-answer session. +(Operator Instructions) +Thank you very much. Ms. Deborah Crawford, Facebook's Director of Investor Relations, you may begin. + +-------------------------------------------------------------------------------- +Deborah Crawford, Facebook, Inc. - Director of IR [2] +-------------------------------------------------------------------------------- + + Thank you. Good afternoon and welcome to Facebook's second-quarter earnings conference call. Joining me today to talk about our results are Mark Zuckerberg, CEO, Sheryl Sandberg, COO, and David Ebersman, CFO. +Before we get started, I would like to take this opportunity to remind you that during the course of this call, we will make forward-looking statements regarding future events and the future financial performance of the Company. We caution you to consider the important risk factors that could cause actual results to differ materially from those in the forward-looking statements in the press release and this conference call. These risk factors are described in our press release, and are more fully detailed under the caption Risk Factors in our quarterly report on Form 10-Q filed with the SEC on May 2, 2013. In addition, please note that the date of this conference call is July 24, 2013, and any forward-looking statements that we make today are based on assumptions as of this date. We undertake no obligation to update these statements as a result of new information or future events. +During this call we will present both GAAP and non-GAAP financial measures. A reconciliation of GAAP to non-GAAP measures is included in today's earnings press release. This call is being broadcast on the Internet, and is available on the Investor Relations section of the Facebook website at investor.fb.com. A rebroadcast of the call will be available after 6.00 PM Pacific time today. The earnings press release and an accompanying investor presentation are also available on our web site. I'd also like to mention that we recently launched our Facebook IR page at facebook.com/facebookinvestorrelations. While we don't currently intend to use the page as an exclusive vehicle for corporate disclosure, the IR page is designed as a curated resource for anyone interested in getting better acquainted with the Company. +Now I'd like to turn the call over to Mark. + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook, Inc. - CEO [3] +-------------------------------------------------------------------------------- + + Thanks, Deborah. And thanks, everyone, for joining us today. We made some really good progress this quarter with the growth and engagement of our community, the release of new products like Instagram video, and advertising growth, especially on mobile. When it comes to mobile, I'm very pleased with the results. We now have more daily actives on mobile than on desktop. Nearly 0.5 billion people use Facebook on their phones every day. And soon we'll have more revenue on mobile than on desktop, as well. This progress is the result of investments we started making more than a year ago and in some cases years ago. I appreciate the patience and trust of our team, our community, and our investors have given us. And we're looking forward to seeing our other long-term investments achieve great results, as well. +One of the questions I frequently get asked are what are the big changes we want to make in the world over the next five or ten years. Now that we've connected 1 billion people, what are the next big ambitions? There are three main goals I'd like us to achieve. Connect everyone, understand the world, and help build the knowledge economy. Connecting everyone is about growing our community to reach the next 5 billion people. Our mission is to give all people the power to share and make the world more open and connected. And that means everyone, not just people in developed countries. Most people in the world don't yet have smartphones or data access, but we know they want to be connected. We're focused on making this possible while also strengthening engagement within our existing community. +Understanding the world is about helping people share not just day-to-day updates, like text messages and photos, but also building up long-term knowledge about the world, like what people are interested in, which restaurants are good, which hotels your friends have stayed at, and so on. We should be able to build intelligent services that help you use your network to answer lots of questions for you that no other service can. And we want to lead our community to create a graph of all that understanding to power this intelligence. +Building the knowledge economy is about helping people create companies and jobs using information. The way I see our advertising products, we aren't just building a strong monetization engine for our Company. We're creating tools to enable new growth to jobs and businesses through our platform, and to support a larger economic shift in the world based on knowledge and information. I'm proud of the work we're doing here to help developers create apps to help local businesses find customers, to help great brands tell their stories. And this is a core part of our mission. +Now let's talk about the progress we've made in each of these areas, starting with connecting everyone. The Facebook community has grown steadily this quarter, adding 45 million new monthly actives. And the number of monthly actives is steady or increasing across demographics and countries. One thing that's surprised me as we've grown is I've always expected our ratio of daily actives to monthly actives would decrease as later technology adaptors used our service. The opposite has actually been true. And now 61% of monthly actives are daily actives. And that ratio has just continued to include. In our most penetrated markets like the US, more than 70% of our monthly actives use our services daily. And, now, more than 700 million people worldwide use Facebook daily as of today. +As more social services get created, one question is how it affects the sharing and time that people spend on Facebook. You could naively assume that more new services means people spend less time on Facebook, but that isn't happening. In fact, people on average are spending more time on Facebook than ever before. It's possible that, because the market is expanding due to mobile, even as time spent per person increases on Facebook, maybe our market share could decrease. But that doesn't seem to be happening either. According to third-party metrics like ComScore and Nielsen, Facebook's share of time spent in the US is either steady or increasing. And we believe it's either steady or increasing everywhere else, as well. This makes sense to me because Facebook helps you maintain your real identity in relationships, which are universal needs. We believe that if we execute well, we have a good shot at growing the amount of time that people spend using Facebook, while also maintaining or increasing our overall share of time spent. +One specific demographic I want to address is US teens. There's been a lot of speculation reporting that fewer teens are using Facebook. But based on our data that just isn't true. It's difficult to measure this perfectly, since some young people lie about their age. But, based on the best date we have, we believe that we have close to fully penetrated in the US teen demographic for a while. And the number of teens using Facebook on both a daily and monthly basis has been steady over the past year and a half. Teens also remain really highly engaged using Facebook. It's also worth mentioning that these stats are for Facebook only. Instagram is growing quickly, as well. So, if you combine the two services together, we believe our engagement and share of time spent are likely growing quickly throughout the world. +Next, let's talk about building more useful services on the path to understanding the world. The newest product I'm most excited about from our last quarter is Instagram video. Adding video fits really naturally with the Instagram mission of capturing and sharing the world's moments. And it's off to a great start. People are already uploading hours of video to Instagram every minute. I'm really proud of the team, and I think they did a great job with this product. When I first talked to Kevin about this he had a really smart insight. Instagram has always been about helping people capture moments in a way they are proud of. Filters were necessary for photos because when Instagram started most cameras weren't good enough to take high-quality photos. But lack of filters isn't what's holding back videos from being great. It's that they're shaky and feel unprofessional. Kevin realized that if we could deliver a product that helped people produce stable videos that would really change the landscape. And I think it already is. +Now, some products like video fit into the flow of what people are doing, and they take off quickly. Others, like Graph Search and Home, are completely new kinds of products, and they're just going to take longer to develop. I think it's the right strategy to have a balance of long-term foundational new products and ones that fit an immediate demand. We're committed to building all of these into market-leading products. +Finally, let's talk about building the knowledge economy and what that means for our core business. This quarter has been a strong period for us. A lot of new businesses have signed up to advertise with us. And we now have more than 1 million active advertisers. Our newsfeed ads products are working well for them. One of the things I watch most closely is the quality of our ads and people's sentiment around them. Right now ads, on average, make up about 5% or 1 in 20 stories in newsfeed. We haven't measured a meaningful drop in satisfaction when we ask people about their experience with Facebook. We're comparing that to the result we get when we ask the same question to people using a version of Facebook with no feed ads at all. +Now, that said, in recent studies people have told us that they notice the ads more. So we're going to invest more in improving the quality. Our top priority is to expand the number of marketers and overall demand in our system rather than just increasing the number of ads that we show. We believe that this will help us improve the quality of the ads that we show by creating a more competitive auction. And this will create the best experience for people who use our products, the best returns for more marketers, and the best results for us. +That's my update for this quarter. We made a lot of progress in the last three months on growing our community engagement, releasing a successful major product, and generating strong financial results. This quarter also marks the end of our first year as a public company. And I think we've created a good foundation for the future. I want to take a moment to thank everyone who works at Facebook, and everyone who's a part of this great community. You are all helping to connect the world and push it forward. I'm grateful to have the chance to work with all of you on this. So, thank you, and thanks to everyone on this call for joining us today. I'm look forward to having more to share next quarter. +And now, Sheryl. + +-------------------------------------------------------------------------------- +Sheryl Sandberg, Facebook, Inc. - COO [4] +-------------------------------------------------------------------------------- + + Thanks, Mark. Our advertising business gained significant momentum this quarter, growing 61% year over year to $1.6 billion. Our mobile ad revenue grew significantly, as well, and was approximately 41% of total ad revenue, up from about 30% in Q1. This growth was robust across all regions. And each of our four marketing segments increased spending with us this quarter. We believe this is because our ad products are delivering impressive ROI for each of these types of marketers. +Direct response marketers, including eCommerce companies, increased their spend significantly. Year-over-year ad revenue from eCommerce companies doubled in the second quarter. Direct response marketers are taking advantage of our high click-through rates and competitive CTCs to grow their businesses. These marketers are typically very measurement-focused. And they quickly increase their budgets as we deliver compelling ROI. +Revenue from mobile app install ads also continues to accelerate. The ad market is relatively new but is already large and growing very rapidly. We believe that Facebook is one of the most effective ways for developers to acquire new customers at competitive rates. We're increasing our share and helping to grow this market. +Local businesses also grew spend significantly. We surpassed 1 million active advertisers this quarter, more than double the number we had only a year ago. We believe that this rapid growth is being driven by our unique ability to target ads, and the simpler ad products we rolled out in the past year. We're all really excited that we can help local businesses grow around the world. One of my favorite local examples is right in our backyard, Artisan State, a San Francisco business that prints photos books. The owner told us that running newsfeed ads gained them so many customers so quickly that they had to pause their campaigns to let their manufacturing catch up. Nearly 18 million local businesses now have Facebook pages. While we are excited to hit 1 million active advertisers, we know that this is just a small fraction of the local businesses on Facebook. So this remains a large growth opportunity for us. +And, finally, brand marketers also continue to grow spend. We have a massive and engaged audience around the world that brands can use to grow awareness and drive scale. Every night 88 to 100 million people are actively using Facebook during prime time TV hours in the United States alone. One recent example is from Reckitt Benckiser, a global CPG company. Their campaign for Lysol targeted moms and drove a 2 times return on ad spend for their brand. Their campaign for Air Wick was even better, driving a 5 extra turn on ad spend. As they have seen these results, they have more than doubled their ad spend with us over the last year. +Newsfeed ads are performing very well. In an analysis by Datalogix of 55 ad campaigns on Facebook over the past six months, marketers saw a median return on ad sales of 3 times for campaigns that did not include ad in newsfeed, which is very solid performance. For campaigns that included newsfeed ads, the median return on ad sales was nearly double at 5.9X. During the second quarter we increased the number and type of ads in newsfeeds. At the same time, our click-through rates and cost per click metrics for newsfeed ads remained strong during the quarter, providing a good indicator of healthy and growing advertiser demand, and continued user interest in these ads. +Custom Audiences is another key product that continues to gain momentum. This product enables our clients to enhance their ad targeting by marrying their data with ours in a privacy-protective way. In Q2 the number of marketers using Custom Audiences more than doubled relative to Q1. +We also continue to innovate around our mobile ad products. In April, we launched ad targeting for future friends. This helps marketers, everyone from multi-nationals to local businesses, reach people in emerging markets who they could not easily reach before. While these ad markets are not especially large today, they'll become increasingly important in the years to come. +In summary, we believe we're making strong progress executing our strategy. As I have mentioned in previous quarters, we are investing in mobile, measurement and product innovation. The results we're reporting today demonstrate the early returns on these investments. Looking ahead, we're enthusiastic about the long-term prospects for our business. The time people are spending on mobile devices is increasing dramatically, yet mobile represents just 2% of ad spend globally and 3% in the US. We have a massive and growing mobile user base. We have an impressive share of mobile time spent. And we have one of, if not the, most effective mobile ad products. Together, this positions us well to lead the mobile ad market. +We believe that over time marketers will increasingly rely on Facebook, not just to reach people wherever they are but to fundamentally transform the way they build their businesses. As Facebook delivers personalized experiences to over 1.1 billion people, we also have a unique opportunity to deliver a more personalized advertising experience. As I meet with marketers all around the world, I find more and more that they are understanding the benefits of this opportunity. As a result, Facebook is poised to play a central role in the evolution of marketing. We know we still have a lot of hard work to do, but we're excited about this quarter and the opportunity in front of us. +Now David. + +-------------------------------------------------------------------------------- +David Ebersman, Facebook, Inc. - CFO [5] +-------------------------------------------------------------------------------- + + Thanks, Sheryl, and good afternoon, everyone. Today I'd like to update you on our progress in Q2 against our key financial objectives -- increasing revenue, investing to drive our future growth, and positioning the Company to maximize long-term returns for our shareholders. It was a great quarter across the board as we continue to benefit from and effectively navigate the transition to mobile. +Let's start with our network. Usage and engagement on Facebook remain extremely strong, as evidenced by the following. On an average day in June, 699 million people used Facebook, up 27% from last year. This represents 61% of the 1.15 billion people who accessed Facebook at any point during the month of June. Additionally, time spent per person on Facebook continues to increase. In aggregate across everyone in our network, time spent on Facebook exceeded 20 billion minutes each day in June. Separately, Instagram continues to grow rapidly with impressive engagement. And we announced last month we had over 130 million actives using the service. Overall, we're really pleased by the unprecedented growth and engagement of our community at this scale. +Now let's turn to the financials. In Q2, total revenue was $1.81 billion, up 53%, or 54% when adjusted for constant exchange rates. Ad revenue was $1.6 billion, up 61% in the quarter, or 63% when adjusted for constant exchange rates. This was our strongest quarter in terms of advertising revenue growth since the third quarter of 2011. The performance was strong throughout the world, with ad revenue in each of our geographic regions growing by greater than 50%. Growth in advertising revenue was driven by an increase in the number of marketers, overall advertising demand, and the strong performance of newsfeed ads. Newsfeed ads work. They've been remarkably effective at delivering high levels of engagement, a significant increase in click-through rates and overall number of clicks. And marketers have increased budgets meaningfully in response. +Overall ad impressions were up 43%. And the average price per ad was up 13% compared to last year. Ad impressions are up due to more people using our service worldwide, combined with the impact of reducing the price floor late in 2012, which resulted in more ads being shown, particularly in developing markets. In the US and Canada, where the price floor changes had a smaller impact, ad volume increased 6%. And average price per ad increased over 40% year over year, driven by the growth of higher performing newsfeed ads. Total payments and other fees revenue was $214 million in Q2, an increase of 11% versus last year. Payments revenue from gains specifically was up 7%. But we believe 11% represents the best apples-to-apples comparison if we adjust for items such as the change in revenue recognition timing we made late last year. +We were pleased to see King's continued rapid growth on our games platform in Q2. King's strategy of launching games, like Candy Crush Saga, on Facebook, and subsequently launching on mobile, has proved to be an effective approach that enables people to seamlessly play games across desktop and mobile. And we expect other game developers to pursue a similar strategy. We believe Facebook continues to offer a compelling platform for developers to build great games and businesses. +Overall RPU increased 25% compared to last year, to $1.60 per user for the quarter, including a 35% increase in the United States and Canada, as well as 30%-plus gains in all our other regions. +Turning now to expenses, in Q2 our GAAP total expenses were $1.25 billion. Excluding stock compensation, non-GAAP total expenses increased 52% to $1.02 billion, primarily driven by head count and infrastructure. We ended the quarter just shy of 5,300 employees, up 33% from last year. And we continue to be pleased with our success in attracting talent. Our Q2 GAAP operating income was $562 million, representing a 31% operating margin. Excluding stock comp, our non-GAAP operating income was $794 million, a 44% non-GAAP operating margin. +Our GAAP tax rate for Q2 was 39%. And our non-GAAP tax rate was 37%. GAAP net income was $333 million, or $0.13 per share. And non-GAAP income was $488 million, or $0.19 per share. We spent $268 million on CapEx in Q2 as we continued to invest in our data centers and facilities. While the relatively lower spend on CapEx in Q2 is partially the result of timing of purchases, it also reflects the returns from a significant effort by employees throughout the Company to make our software and hardware more efficient. CapEx will remain one of our primary areas of spend, since we need a powerful infrastructure to provide content-rich and personalized information to all the people who use our service around the world. But projects like Open Compute, and many others, are providing great returns for us. And helping ensure we're able to invest our resources in a disciplined and official manner. +Of note, free cash flow in Q2 was over $1 billion. This is much higher than we expect in coming quarters, as Q2 free cash flow benefited from a $419 million tax refund and light quarterly spend on CapEx. But, still, $1 billion in free cash flow is a nice milestone for us against an important financial metric. In Q2, similar to prior quarters, upon the vesting of employee RFUs, we withheld shares and paid the associated income taxes for our employees. Which provides an outcome similar to Facebook having repurchased approximately $153 million worth of shares in the quarter. We ended Q2 with $10.3 billion in cash and investments. +Now I want to conclude by sharing some thoughts about the second half of 2013. We expect newsfeed ads to remain the main driver of revenue growth in the second half of the year. And we believe we have a great opportunity to continue to drive long-term growth by improving the quality and relevance of these ads. However, remember that newsfeed ads really began to contribute to our revenue in the third and fourth quarters last year, which will make for more difficult year-over-year comparisons in Q3 and Q4 relative to Q2. Looking at expenses, consistent with what we've said previously, we plan to invest in our business. And continue to expect that our total non-GAAP expenses, including cost of revenue but excluding stock comp, will likely grow in the neighborhood of 50% for the full year 2013 compared to 2012. We also continue to expect that this over full-year expense growth rate will be faster than our year-over-year revenue growth rate for the full year 2013 compared to 2012. +In terms of our tax rate, we expect that our Q3 and full-year non-GAAP tax rate will be a few percentage points higher than our Q2 rate. And, finally, we expect 2013 CapEx to be in the neighborhood of $1.6 billion. This is down from our prior estimate of $1.8 billion due to a combination of efficiency gains and changes in timing of purchases. Overall Q2 was a very strong quarter for us. We believe we're executing well, in particular with regard to the mobile transition, the investments we've been making over the past year are paying off, the business is growing rapidly, and we're excited about the opportunities ahead of us. +Now let's open the call for questions. + + +================================================================================ +Questions and Answers +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) +Douglas Anmuth with JPMorgan. + +-------------------------------------------------------------------------------- +Douglas Anmuth, JPMorgan Securities - Analyst [2] +-------------------------------------------------------------------------------- + + Great, thanks for taking the question. Just wanted to drill down a little bit more on the ad revenue growth here in the quarter. And it was very helpful to get the four segments broken down. But can you just help us understand a little more, Sheryl, your comment on the increased number, and then the type of ads in the newsfeed in 2Q? I'm trying to understand if this is more specific product-driven or if this is just the combination of all the efforts that have been going into newsfeed ads essentially over the last year. Thanks. + +-------------------------------------------------------------------------------- +Sheryl Sandberg, Facebook, Inc. - COO [3] +-------------------------------------------------------------------------------- + + Over the past year on these calls we've been talking about our three priorities in growing our ads business -- mobile, measurement and product innovation. I think what you're seeing here is all three of these are paying off. Obviously the transition to mobile is a really big one. We had almost no mobile ads a year ago. We're up to 41% this quarter. We've done a lot on measurement. And product innovation newsfeed ads has been the most important thing we've done there. We've done other things, as well. In terms of the marketer segment, all four marketer segments are growing and contributing to our growth. So, we're seeing both the increased supply that we talked about with newsfeed ads, but also the increase in demand that all four of these marketer segments represent. + +-------------------------------------------------------------------------------- +Douglas Anmuth, JPMorgan Securities - Analyst [4] +-------------------------------------------------------------------------------- + + And just as a follow up, can you help us understand how impactful or how big mobile app install ads are within the mix? + +-------------------------------------------------------------------------------- +Sheryl Sandberg, Facebook, Inc. - COO [5] +-------------------------------------------------------------------------------- + + We don't break out by segment, the four market segments. But, again, all four are growing. Mobile app install ads, they're small but they're important and they're growing rapidly. It's basically a totally new market. People who are selling either mobile apps as their revenue, or things that are bought through mobile apps, are looking for a way to find new customers. And we represent one of the only ways and a very effective way to do that. So, we're growing quickly and I think we're helping to grow this market. + +-------------------------------------------------------------------------------- +Douglas Anmuth, JPMorgan Securities - Analyst [6] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Operator [7] +-------------------------------------------------------------------------------- + + Heather Bellini with Goldman Sachs. + +-------------------------------------------------------------------------------- +Heather Bellini, Goldman Sachs - Analyst [8] +-------------------------------------------------------------------------------- + + Great. Thank you very much and congratulations. I was wondering, you talked about before improved targeting and relevance of newsfeed ads that lies ahead. I was just wondering if you could share with us the progress you think you've made on this initiative and what's to come. + +-------------------------------------------------------------------------------- +Sheryl Sandberg, Facebook, Inc. - COO [9] +-------------------------------------------------------------------------------- + + Targeting is really important because what takes an ad and makes it a good ad is whether it's relevant to you. When I see something on Facebook or anywhere that I'm interested in, that's a great experience. When I see something that I'm not interested in, that's not. So we've done a lot of work around targeting. The most important work we've done over the past years, and I think you're seeing its results in this, is around Custom Audiences, which allows people to use their data in a privacy-protective way with us. It enables them to show different ads to people who are current customers versus new customers who are interested in different things. And I think we're really pleased with the adoption. The number of marketers using Custom Audiences more than double doubled in Q2. And we're now up to the 50 Ad Age 100 who have already started using the product. We also think there's room to improve. We can do more, and we will continue to do more to improve the targeting, the relevance of our ads. + +-------------------------------------------------------------------------------- +Operator [10] +-------------------------------------------------------------------------------- + + Mark Mahaney with RBC Capital Markets. + +-------------------------------------------------------------------------------- +Mark Mahaney, RBC Capital Markets - Analyst [11] +-------------------------------------------------------------------------------- + + Great, thanks. Two questions, please. Could you talk about thoughts on monetization on Instagram. And maybe just potentially how you think about the ability to monetize that versus your core Facebook asset. And then, secondly, Sheryl, could you talk about, on a vertical basis, where you think the biggest white space opportunities are for advertising revenue for Facebook Are there particular industries that you look at that, say, are materially under-represented on Facebook where you could have the greatest growth going forward? Thanks a lot. + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook, Inc. - CEO [12] +-------------------------------------------------------------------------------- + + Sure, I'll answer the Instagram question. Kevin has always been clear that we're building Instagram to be a business. And that we expect that over time we're going to generate a lot of profit from it, and probably through advertising. Now, that all said, right now it's just growing so quickly. The number that we just said was 130 million monthly actives. The video product is growing really quickly. There are so many directions to expand this in, that we think that the right focus for now is to continue just focusing on increasing the footprint of Instagram. And when the right time comes, then we'll think about doing advertising, as well. And I think that's going to be a really big opportunity. + +-------------------------------------------------------------------------------- +Sheryl Sandberg, Facebook, Inc. - COO [13] +-------------------------------------------------------------------------------- + + In terms of growth opportunities, I think in terms of vertical categories we have big growth opportunities across the board. There are certainly verticals where we're stronger than others. We're very strong, for example, in CPG. But even though we've grown spend significantly, we're still a tiny portion of the spend of CPG advertisers. So, even in the verticals where I think we've done very well starting to penetrate, there's a lot of room for growth. I think as you think about different industries using the power of online marketing, we see different levels of adoption. But I'm a believer that over time this is where people are spending their time. And any marketer who's trying to reach people is going to spend their resources here, as well. + +-------------------------------------------------------------------------------- +Operator [14] +-------------------------------------------------------------------------------- + + Jordan Rohan with Stifel Nicolaus. + +-------------------------------------------------------------------------------- +Jordan Rohan, Stifel Nicolaus - Analyst [15] +-------------------------------------------------------------------------------- + + Thanks so much. I think it's fairly easy, when talking to advertisers, to assess that there's been this latent demand for advertising on Facebook. But when you look across the globe it's a little bit harder to address the advertising community. Can you talk about the growth of the ad sales force and the ad ops, and all the people required to really bring that outside of the major US and Western European markets. And, specifically, is there a chance that you believe that Asia Pacific and rest of world markets can see a meaningful continued and sustainable shift higher in RPU than where we are today? Thank you. + +-------------------------------------------------------------------------------- +Sheryl Sandberg, Facebook, Inc. - COO [16] +-------------------------------------------------------------------------------- + + Yes, I'm a big believer that there are revenue opportunities that exist all over the world. And our growth was very strong across regions, including outside of the US for this time. We're up to over 40 offices, so we have sales teams on the ground in over 40 offices. And we're seeing really good adoption and really good growth across. You mentioned Asia. I was actually in Japan and Korea meeting with advertisers just a few weeks ago. And we are seeing companies that really weren't doing much with us a year ago increasingly adopt us as part of a core part of their spend. So I remain very optimistic about our growth across Asia and the rest of the world. + +-------------------------------------------------------------------------------- +Operator [17] +-------------------------------------------------------------------------------- + + Youssef Squali with Cantor Fitzgerald. + +-------------------------------------------------------------------------------- +Youssef Squali, Cantor Fitzgerald Securities - Analyst [18] +-------------------------------------------------------------------------------- + + Thank you very much. Two questions, please. Maybe, can you talk about the mix of growth in direct selling versus programmatic selling for you guys? And where do you see that going forward? And in terms of just on the cost side, looking at the investment -- and, by the way, David, thanks for the color about operating expenses guidance for the second half. But as you look at longer term, how far can you see that 50% increase in operating expenses still being sustained as you -- just looking at 2014, I know you're not guiding through 2014 right now, but just as we look at the model going forward, how far do you think you can sustain growth and operating expenses faster than growth in revenues? Thank you. + +-------------------------------------------------------------------------------- +David Ebersman, Facebook, Inc. - CFO [19] +-------------------------------------------------------------------------------- + + Thanks for your question. Your first question about direct selling versus programmatic, the mechanism that most people buy ads from, from Facebook, is through the option that we offer. But that doesn't mean that we don't have a sales force that's out calling on clients. Sheryl can expand on that, if she wants. + +-------------------------------------------------------------------------------- +Sheryl Sandberg, Facebook, Inc. - COO [20] +-------------------------------------------------------------------------------- + + Yes. We sell both directly through our own sales team, both in person and online -- what I think you mean by programmatic, which is through third parties, such as DSPs and others. One thing worth noting is that FBX, which is part of that programmatic selling, is actually a very small part of our business. And I think sometimes people don't understand that. That piece is quite small. We are expanding both our direct selling efforts, both the sales teams and online, as well as the third parties we work with. And we think having a healthy and growing ecosystem on both sides is really good for the development of our business. + +-------------------------------------------------------------------------------- +David Ebersman, Facebook, Inc. - CFO [21] +-------------------------------------------------------------------------------- + + And you asked about investments looking forward to next year. I think philosophically is the easiest way to answer that, which is, we still think we're early in the journey of building the service that we want Facebook to be. And there's lots of work ahead of us to do and lots of things to build. And our plan will be to continue to invest aggressively in the areas that we think are important to improve our strategic positioning, and to drive our ability to grow revenues and profits over the long run. We also know that to be the great company that we want to be, we have to be disciplined in everything that we do, and focus our spend on the areas that are really most important. So, the challenge for us, just like any company, is finding that right balance. I really can't comment on 2014 yet, honestly, just because I don't know what 2014 is going to look like. We tend to plan in six-month blocks, and I think have our act together pretty well for what we're going to try to do in the second half of this year. But haven't begun the conversation about next year yet. + +-------------------------------------------------------------------------------- +Operator [22] +-------------------------------------------------------------------------------- + + Anthony DiClemente with Barclays. + +-------------------------------------------------------------------------------- +Anthony DiClelmente, Barclays Capital - Analyst [23] +-------------------------------------------------------------------------------- + + Thanks a lot. I have one for Sheryl and one for David. Sheryl, I'd be interested in hearing a little bit about the relative progress of impression-based selling versus performance-based. I know you mentioned the e-commerce -- the doubling from e-commerce from direct response. And I just wanted to know if you've increased the amount of inventory that you're selling on an impression basis versus performance. And then, David, I had a follow up on the CapEx. It just seems like an interesting time for CapEx to be coming in when video usage and video uploads could be growing --. + +-------------------------------------------------------------------------------- +Sheryl Sandberg, Facebook, Inc. - COO [24] +-------------------------------------------------------------------------------- + + I think we may have lost the question, but I'll take the first half while we wait for the second piece to come back. On the first piece, our system works that you can buy by CPM or CPC, and we let advertisers choose. I think both parts of our business are healthy and growing. I think when people talk about impression-based purchasing or buying, what they're really trying to get at is brand. And brand is a very important one of our four segments, and one that's growing. When you think about what brand spenders are doing, they're trying to get discovery. And I think we've made a lot of progress there. We now work with every one of the global Ad Age 100 over the past year. Now that said, people are in different parts of that spectrum. We have brand advertisers who are looking for discovery, who have advertised with us for a long time, proven the value, and are really expanding. And we have others that are newer, that are experimenting, that aren't as convinced yet. And it's our job to get there and convince them. +I think what people are increasingly seeing is we have a big brand opportunity. We have a massive and engaged audience, 88 to 100 million people in the US during prime time hours on Facebook. We offer discovery. And we have a unique opportunity to take people all the way through the funnel. In one example, a recent one that I really like, T-Mobile did an ad campaign with us to attract people to sell new phones. They used our offer ads to do it. 9% of the people who claimed the offer converted to T-Mobile within 10 days. And they had over a 20 times return on their ad spend, which is just incredibly strong in the industry. And I think that shows the power of what we can do with impressions, taking people all the way through the funnel. + +-------------------------------------------------------------------------------- +David Ebersman, Facebook, Inc. - CFO [25] +-------------------------------------------------------------------------------- + + And, Anthony, I'll try and answer your question about CapEx, as best I could. You got cut off, as you probably know. So I only got -- well, I don't know how much of it I got. But I got enough to give it a shot. And, really, the best way I can think to answer it is to describe for you the variables that influence what CapEx requirements are for the Company. So, clearly, the number of users is near the top of the list. And also the time at which the users use the service. So, adding users who are off peak, the Facebook peak, provides less of a burden for our infrastructure than people who are using it at the same time as our peak hours, because we can leverage what we've built to peak. +A second thing is definitely the level of engagement of those users. And that seemed to be where you were going with your question about vide. That is and will continue to be, we hope, something that drives up requirements for our infrastructure, because it means people are really engaging and finding new ways to use the service. What has helped us, I think, is the two variables that come next. One is just the cost of the equipment itself in the data centers. And over time Moore's Law and other things, and competition in the market, have helped us to really be able to bring down the cost for each unit of equipment we use. +And then the next variable which I mentioned in my remarks, which I think is a really important one, is just the efficiency of what we build. So, over time, I think Facebook has impressively succeeded at making the hardware we use more efficient, and the software that we run on it more efficient in terms of how much compute power that it needs. The last variable, of course probably the hardest to predict, is product development. It's just what we build and how that influences what the compute requirements are. So, clearly, the variable you emphasized, which was engaging with higher content things, is one of the things that will influence CapEx over time. But it's a pretty complicated equation that I think right now we're managing well. I think we're pleased with how 2013 is coming together in that regard. + +-------------------------------------------------------------------------------- +Operator [26] +-------------------------------------------------------------------------------- + + Justin Post with Merrill Lynch. + +-------------------------------------------------------------------------------- +Justin Post, Merrill Lynch - Analyst [27] +-------------------------------------------------------------------------------- + + As we look back at this mobile ramp, back in 3Q last year, it's been pretty lumpy, and it bounces around quarter over quarter. But it looks like a pretty big inflection this quarter. Can you help us understand why it has been so lumpy, so we can think about going forward? And maybe what caused the inflection this quarter. And then I really appreciated the time spent metric. I think you said 20 billion minutes per day. Can you tell us how that compares to, say, a quarter ago or a year ago? Thank you. + +-------------------------------------------------------------------------------- +David Ebersman, Facebook, Inc. - CFO [28] +-------------------------------------------------------------------------------- + + In terms of the progression of mobile, we're really pleased overall that newsfeed ads, in general and on mobile in particular, are working so well in terms of the performance they're providing to marketers, and how users are engaging with them. For a new product like this, I don't think we should be that surprised that the quarter-to-quarter progression is going to be harder to predict than it would be for a more mature product. I think one of the things that happened in the second quarter is that, as the investments we've made started to really come together, we had a lot more demand in our system that met the quality bar that we set for feed. So, we were able to place that demand intelligently in a manner where it performed well, and didn't have a meaningful impact on the user experience. So I think that more feed-eligible demand was a big part of the story. +And I think one of the really good pieces of news for us is how well the price held up as we did that, as we increased the number of ads we showed in feed. For many of our ads, as you know, marketers are bidding for clicks in an auction, and the auction determines the price where supply equals demand -- the cost per click price. And in the second quarter -- and this statistic I'm going to give you is relative to the first quarter of this year because it's hard to do a year-over-year for mobile and for newsfeed because it just didn't really exist a year ago -- so Q2 relative to Q1, the number of clicks in our system went up a lot. And we might have assumed that price would decline as click number increased, because we're basically pushing out the supply curve and changing the point where supply would meet demand. And that's not what happened. Cost per clicks for feed ads increased, and really demonstrating to us that demand was growing rapidly, as well, as we were increasing the supply of ads we were showing. It's not a perfect comparison because Q2 is seasonally stronger than Q1, but I don't think the seasonality explains the trend I just provided. And I think that's a really encouraging metric for us. +Your second question was -- I wrote it down. Hold on. Oh, time spent. Unfortunately, we don't have a lot of longitudinal data for time spent. It's not something that we had instrumented well going back more deeply in time because it's hard. It's hard on every interface and it's particularly hard on mobile. We feel pretty good about where we are now in terms of the quality of the instrumentation. It is up on a per user basis. As you would imagine, quarter-over-quarter sequentially on a per user basis it will be growing slowly. On an aggregate basis, of course, it's benefited from the fact that we have such a nice and consistent increase in the number of daily users of this service. + +-------------------------------------------------------------------------------- +Operator [29] +-------------------------------------------------------------------------------- + + Ross Sandler with Deutsche Bank. + +-------------------------------------------------------------------------------- +Ross Sandler, Deutsche Bank - Analyst [30] +-------------------------------------------------------------------------------- + + Great. Thanks, guys. David, just a continuation of what you were just talking about. On the mobile newsfeed ads, is the 5% number -- 5% of stories being ads -- the right number? And is that consistent across geos? And then is the growth a function of -- you just said price is going up sequentially. Obviously your mobile DAUs are going up, or MAUs are going up sequentially. And you're probably also seeing improving click-through rates. So, of those three variables -- users, click-through rate, and price -- which is driving the sequential increase the most in mobile? Thanks. + +-------------------------------------------------------------------------------- +David Ebersman, Facebook, Inc. - CFO [31] +-------------------------------------------------------------------------------- + + In terms of the 5% number, again, what we know is where we are now, and we're pleased that things are going as well as they are at the current level. The number was zero a year ago. It's increased steadily over the past year. And the 5% number is an average number globally. It does differ by geography and it also differs by person. It will be higher for people for whom we have a lot more ads that are targeted towards them and are relevant for them. What we're trying to do is find the right balance ideally for each user, where we're balancing their experience with Facebook and the performance of the ads. And continually tweaking the product, learning from our experience, to try and do that as well as we can. Going forward, I think we've been consistent in saying the biggest opportunity for us is to improve the quality of the ads so that we can show ads that are engaging and relevant for the users involved. +Your question about what drove the increase, I think everything contributed. I think that's one of the things that's encouraging about where we are, is we do have more users, we have more demand that enabled us to show more newsfeed ads. We're really pleased with how click-through rates have held up. And I mentioned what was happening in terms of cost per click increasing sequentially. So it's a nice balanced contribution from the variables that determine what our revenue performance is. + +-------------------------------------------------------------------------------- +Operator [32] +-------------------------------------------------------------------------------- + + Brian Pitz with Jefferies. + +-------------------------------------------------------------------------------- +Briain Pitz, Jefferies & Co. - Analyst [33] +-------------------------------------------------------------------------------- + + I'm wondering if you could give us a sense for what the major hurdles are to overcome before deploying a major video ad product on the core site. As you're out talking to potential clients, can you help us understand what demand looks like for that product? And then maybe separately, just a sense for what you're seeing in Europe from a macro perspective, just given some of the mixed views we've heard on the economy over there. Thanks so much. + +-------------------------------------------------------------------------------- +Sheryl Sandberg, Facebook, Inc. - COO [34] +-------------------------------------------------------------------------------- + + On video ads, we have a current video ad product because marketers can embed a video in a page post. And we see a lot of marketers using that product and seeing good results. So the demand to do more on video on Facebook is there. And we're exploring how we can expand that, but we don't have anything new to announce today. In terms of Europe, we hear the same things, and obviously on the macro environment. But our growth has been very strong. We had a new head of our European operations, as well, Nicola Mendelsohn, who just started. We're excited to have her. And we are experiencing strong growth. + +-------------------------------------------------------------------------------- +Operator [35] +-------------------------------------------------------------------------------- + + Ben Schachter with Macquarie. + +-------------------------------------------------------------------------------- +Ben Schachter, Macquarie Research Equities - Analyst [36] +-------------------------------------------------------------------------------- + + Congratulations on a really outstanding quarter. Mark, I want to ask about the platform strategy. Just broadly, how has the strategic vision to allow third parties to provide services to the network evolved over the past year? And what needs to happen to have more of a contribution from non-advertising-based businesses? And then, David, just quickly, for modeling, the mobile ad revenue, can you talk about how that progressed through the quarter? Did it exit June much stronger than it was earlier in the quarter? Thanks. + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook, Inc. - CEO [37] +-------------------------------------------------------------------------------- + + Yes, I can take the platform question. The strategy for that, we've shifted a bit to focus on building more business tools for developers. A lot of what we're seeing is folks have shifted towards using products like mobile app installs. Originally we had a little bit of skepticism about how happy developers would be with a system where they would pay to get more distribution. But what we've actually found is that the NPS is really high for this because it's just a lot more stable than anything else that they've had in the past. And it's the most stable way they have to grow their apps. What we're basically focused on doing now is we think about advertisers in terms of these use cases that folks have. There's local businesses, there are great brands, there are developers who are building apps, there's eCommerce. And we're really focused on building out the platform to be one of those big verticals to be a big part of the business. There's also the games part of the platform, which is the first piece of platform that we launched. And that is just continuing to grow at a slower but steady rate. + +-------------------------------------------------------------------------------- +David Ebersman, Facebook, Inc. - CFO [38] +-------------------------------------------------------------------------------- + + Your second question was about progress through the quarter. Nothing notable to report there. It was really a strong quarter from the beginning to the end. + +-------------------------------------------------------------------------------- +Operator [39] +-------------------------------------------------------------------------------- + + Scott Devitt with Morgan Stanley. + +-------------------------------------------------------------------------------- +Scott Devitt, Morgan Stanley - Analyst [40] +-------------------------------------------------------------------------------- + + Thanks. I had a bigger picture question for Mark. I was hoping you could give a score card one year in relative to your founder letter. I know it's been only 14 months, and that's a short period of time. But it'd be interesting to hear your views on the Company's performance against the longer-term aspirations and core values that you put in the letter. Thanks. + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook, Inc. - CEO [41] +-------------------------------------------------------------------------------- + + I think we're early. One of the interesting things over the past six months or so is reaching 1 billion people was this big rallying cry for the Company for a long period of time. And I think as we've passed that, we've seen the ambition that the Company has, grow. Reaching 1 billion users was a great first thing to focus on because no one had ever built a service that had 1 billion active people who are signed in, had a real identity before. But, in a way, it's actually just an abstract. There's nothing magical about 1 billion. The real goal is to connect everyone in the world, and help people map out everything that there is. What I think what we're seeing as some of the products succeed is just the ambition increase to be able to do more of these, and taking on more longer-term things. +At the same time, I think what you have is, we weren't happy with the quality of our mobile experiences, rewinding 18 months. So we had just a lot of foundational work to do. And I think coming into this year we could tell internally that we were turning a corner on that. We were in good shape and could start to play a bit more offense. But, as I think the numbers from this quarter suggest, I think we're really starting to see the up side of some of the investments that we've been making over the last period. + +-------------------------------------------------------------------------------- +Operator [42] +-------------------------------------------------------------------------------- + + Mark May with Citigroup. + +-------------------------------------------------------------------------------- +Mark May, Citigroup - Analyst [43] +-------------------------------------------------------------------------------- + + Thanks for taking my question. I had two. One of the things that stood out in your prepared remarks was I think you mentioned a 40% year-on-year increase in average price for ad in North America in Q2. I was hoping you could remind us how that compared to, say, Q1. And given that I think you contributed that to higher-performing ads, if maybe you could call out specifically what one or two either ad units or ad targeting enhancements were the key contributors to that growth. And then, secondly, David, I think you called out the more challenging comps as you enter into the second half of the year. Are you suggesting that it's unreasonable for us to look at the sequential growth that you saw in the second half of 2012 and assume that that rate of growth is repeatable this year? + +-------------------------------------------------------------------------------- +David Ebersman, Facebook, Inc. - CFO [44] +-------------------------------------------------------------------------------- + + Okay. In terms of pricing, we were pleased with the pricing growth in the first quarter, too. The net across the world was a 3% average in the first quarter. But that was much higher in the US and Canada because, again, for the same reason it wasn't impacted by the price floor change. It was above 25% in the US and Canada, and was even stronger in the second quarter. And, similarly, in other territories, I think pricing's just going really well. And would be stronger than the results show if not for the impact of the price floor. We'd probably have numbers that are similar to the US and Canada, if not stronger, in our other regions, as well. +In terms of the comps, I don't think there's anything particularly complicated to what I was saying. It's just if you're looking at the percentage growth rates for Q2, you're comparing to a quarter last year that really didn't have much mobile revenue or newsfeed revenue in it at all. And that really started to ramp up in the third quarter and the fourth quarter. So it's there in one side of the comparison going forward. + +-------------------------------------------------------------------------------- +Sheryl Sandberg, Facebook, Inc. - COO [45] +-------------------------------------------------------------------------------- + + In terms of where the growth is coming from, in terms of ad units, in terms of our market segments, direct response marketers were a very big contributor to the growth. It's why I started with them in the remarks and in the Q&A. ECommerce doubled year over year, and they're doing that by using a bunch of our different ad products. Everything from posts to offers to other things. But it's really about looking for those contributions. We've also seen a lot of growth, as I said, in mobile app install ads. Small market but growing rapidly. And it's a market where we offer a product that there's almost nowhere else to get the kinds of return and opportunity we offer. + +-------------------------------------------------------------------------------- +David Ebersman, Facebook, Inc. - CFO [46] +-------------------------------------------------------------------------------- + + I'm just going to add one more thing just in case I, in any way, created any confusion. I have no evidence that I did yet. But the price per ad that I was talking about in this question reflects not the same thing as the cost per click that I answered in a question earlier, because price per ad will also incorporate the click-through rate as well as the class per click for a click-based ad. And also includes ads that are purchased on an impression basis. So, most of the pricing metrics we provide are per ad, inclusive of click-through rates and impression-based ads. The CPC metric I gave earlier was just, I think, a specific and useful metric in understanding how much strong demand contributed in the second quarter. + +-------------------------------------------------------------------------------- +Operator [47] +-------------------------------------------------------------------------------- + + Ken Sena with Evercore Partners. + +-------------------------------------------------------------------------------- +Ken Sena, Evercore Partners - Analyst [48] +-------------------------------------------------------------------------------- + + Just maybe if we could drill into the comment around eCommerce spending doubling. It seems as though FDX and third-party effort is growing fast, but it's small. And the same with the app install effort. But can you talk a little bit about what drove that doubling year on year? Thanks. + +-------------------------------------------------------------------------------- +Sheryl Sandberg, Facebook, Inc. - COO [49] +-------------------------------------------------------------------------------- + + I think direct response marketers have had more opportunities to use our system, use our product. And we've also made a very major investment in helping them measure returns, and helping them connect what's happening both online and, as well, as throughout the system. So, direct response marketers tend to be buyers, they have an ROI metric. They're looking for that ROI metric, and their budgets are flexible around those ROIs. So, as they've invested with us, and hit their ROI metrics, their budgets go up and they make those adjustments very quickly. That's why, when they start using the products and see the value they create, they're able to grow very quickly, even within a quarter or within a week or within a month, because they adjust to their budgets. + +-------------------------------------------------------------------------------- +Operator [50] +-------------------------------------------------------------------------------- + + Rory Maher with Hillside Partners. + +-------------------------------------------------------------------------------- +Rory Maher, Hillside Partners - Analyst [51] +-------------------------------------------------------------------------------- + + A couple quick questions. First, on hiring, there's been a lot of discussion in the press about tech companies' need for more highly skilled workers. And I'm curious if you're feeling pressure to find that kind of highly skilled talent. And what areas you find hardest to fill. And maybe some successful ways that you're finding good engineering talent. And then, secondly, on the advertiser mix, have you guys discussed your mix of brand advertisers by category, like auto, retail, telecom, that kind of category mix? And are there any that have grown particularly well the past year? + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook, Inc. - CEO [52] +-------------------------------------------------------------------------------- + + Yes, I can take this. Hiring great people, especially engineers, is one of the biggest challenges that any technology company has. We're doing really well against the hiring goals that we have. But there's a systemic issue where our country doesn't produce the volume of engineers that the companies would want to hire. And I think that that's a lot of what you hear these companies talking about. We're doing really well competitively right now. We have a really strong program on colleges where we can continue to attract a lot of the best people who are graduating. We do really well at hiring senior engineers from across the valley, as well. But it's just something that we invest a huge amount of time in. It's really important. + +-------------------------------------------------------------------------------- +Sheryl Sandberg, Facebook, Inc. - COO [53] +-------------------------------------------------------------------------------- + + In terms of where we're growing by category, I've mentioned CPG, gaming, retail. These are vertical categories where we're very strong. But, again, we're growing. You're watching people really experiment. One of the things that's been really fun to see, even though it's not a paid product, is GE's Instagram work. GE is doing super interesting photos on Instagram, which show us that other industries are also going to adapt to the social environment and to some of the new ways to reach customers globally. + +-------------------------------------------------------------------------------- +Operator [54] +-------------------------------------------------------------------------------- + + Laura Martin with Needham & Company. + +-------------------------------------------------------------------------------- +Laura Martin, Needham & Company - Analyst [55] +-------------------------------------------------------------------------------- + + Great numbers, guys. Congratulations. Two questions. One on, could you guys quantify the custom advertising bucket? I know you said it was up 100% quarter over quarter. And a lot of the brands are talking about this as a key growth area. So I'm real interested in how big it's starting for you guys. And then my second question is, we're also talking to a lot of companies that target your metrics using your UPI integrations. And that creates an arbitrage. I'm wondering if over time you foresee that being a stable ecosystem. Or are you guys going to try to ease those guys out over time and grab some of that upside that these arbitragers that are using your platform are garnering today? Thanks. + +-------------------------------------------------------------------------------- +Sheryl Sandberg, Facebook, Inc. - COO [56] +-------------------------------------------------------------------------------- + + On the first, Custom Audiences is small but growing in importance. We doubled -- what I said was we doubled the number of marketers using the product Q2 over Q1. And that also has included getting us to 50 of the Ad Age 100. As I've talked about, the large brand advertisers, the Ad Age 100, have a long sales cycle, and it takes a lot of work to get them to adopt products. So, seeing adoption this quickly of something, we think, shows how powerful that targeting is. In terms of some of the more programmatic ways people buy, we think it's really healthy for us to have multiple sales channels. We like having a direct sales channel, which we have in our over 40 offices. We like having online and robust sales because that means that, even in countries where we don't have offices, we have the ability to sell into those markets. We also like having an ecosystem of what we call PMDs -- third-party sellers who can work with our clients to provide some of the features that we don't have, or some of the capabilities that they may not have in-house. And so for us we'd like to see all of those sales channels continue to grow and thrive. + +-------------------------------------------------------------------------------- +Operator [57] +-------------------------------------------------------------------------------- + + Eric Sheridan from UBS. + +-------------------------------------------------------------------------------- +Eric Sheridan, UBS - Analyst [58] +-------------------------------------------------------------------------------- + + Thanks, guys. Congratulations on the numbers. Mark, a longer-term question focused on your initial comments. How have some of the recent products that are consumer-facing that you guys have launched, like Graph Search and Facebook Home, taught you what the consumer acceptance is for certain things, learnings about how the platform can be developed and evolved over time? I would love to get your take-aways on that. + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook, Inc. - CEO [59] +-------------------------------------------------------------------------------- + + I think that there are a bunch of different kinds of products that you can ship. Every day we ship a lot of tweaks to the products, or small changes to existing products. Then there are going to be products like Instagram video which is really doing well. And it fits very naturally into the current flow of how people use Instagram to capture moments that they're proud of. So that makes sense, and I think the team did a really good job there. Things like Home and Graph Search are really new use cases. In the case of Home, it's a new category of products that's different from anything that exists out there. And I think of it more of a seed that we're planting, that is going to create a completely new pillar of the ecosystem, rather than drafting off of behavior that people already have in the system today. So, I definitely think that we just have to look at this over the long term. And when we're building models for the Company, we basically think that this is going to be something that we will invest in for years. And we expect these to become market-leading products. And they're doing things that no one else really has the strategic position or content to be able to build these products. So we're excited about them. They're just going to be longer-term bets. But I think you want to look at the different things we're doing in terms of how naturally they fit into the flow of a person's day-to-day life today, to get a sense of how quickly it's going to ramp up over time. + +-------------------------------------------------------------------------------- +Deborah Crawford, Facebook, Inc. - Director of IR [60] +-------------------------------------------------------------------------------- + + Great. Thank you for joining us today. We appreciate your time. And we look forward to speaking with you again next quarter. + +-------------------------------------------------------------------------------- +Operator [61] +-------------------------------------------------------------------------------- + + This concludes today's conference call. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/exam/original-files/Problem_1_Sample/2013-Jul-25-AMZN.OQ-137712068210-Transcript.txt b/exam/original-files/Problem_1_Sample/2013-Jul-25-AMZN.OQ-137712068210-Transcript.txt new file mode 100644 index 0000000..d6dfe58 --- /dev/null +++ b/exam/original-files/Problem_1_Sample/2013-Jul-25-AMZN.OQ-137712068210-Transcript.txt @@ -0,0 +1,552 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q2 2013 Amazon.com Inc Earnings Conference Call +07/25/2013 02:00 PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Tom Szkutak + Amazon.com, Inc. - SVP and CFO + * Sean Boyle + Amazon.com, Inc. - VP IR + +================================================================================ +Conference Call Participiants +================================================================================ + + * Ken Sena + Evercore Partners - Analyst + * Jordan Rohan + Stifel Nicolaus - Analyst + * Stephen Ju + Credit Suisse - Analyst + * Scott Devitt + Morgan Stanley - Analyst + * Ben Schachter + Macquarie Research - Analyst + * Justin Post + BofA Merrill Lynch - Analyst + * Ron Josey + JMP Securities - Analyst + * Brian Pitz + Jefferies & Company - Analyst + * Douglas Anmuth + JPMorgan - Analyst + * Youssef Squali + Cantor Fitzgerald - Analyst + * Heath Terry + Goldman Sachs - Analyst + * Colin Sebastian + Robert W. Baird & Company, Inc. - Analyst + * Mark Mahaney + RBC Capital Markets - Analyst + * Mark Miller + William Blair & Company - Analyst + * Matt Nemer + Wells Fargo Securities, LLC - Analyst + * Ross Sandler + Deutsche Bank - Analyst + * Anthony DiClemente + Barclays Capital - Analyst + * Mark May + Citi - Analyst + +================================================================================ +Presentation +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Thank you for standing by. Good day, everyone, and welcome to the Amazon.com second quarter 2013 financial results conference call. At this time, all participants are in a listen-only mode. After the presentation, we will conduct a question-and-answer session. Today's call is being recorded. +For opening remarks, I'd like to turn the call over to Vice President of Investor Relations, Mr. Sean Boyle. Please go ahead, sir. + +-------------------------------------------------------------------------------- +Sean Boyle, Amazon.com, Inc. - VP IR [2] +-------------------------------------------------------------------------------- + + Hello, and welcome to our Q2 2013 financial results conference call. Joining us today is Tom Szkutak, our CFO, who will be available for questions after our prepared remarks. +The following discussion and responses to your questions reflect management's views as of today, July 25, 2013, only, and will include forward-looking statements. Actual results may differ materially. Additional information about factors that could potentially impact our financial results is included in today's press release and our filings with the SEC, including our most recent annual report on Form 10-K. As you listen to today's conference call, we encourage you to have our press release in front of you, which includes our financial results as well as metrics and commentary on the quarter. +During this call, we will discuss certain non-GAAP financial measures in our press release, slides accompanying this webcast and our filings with the SEC, each of which is posted on our IR website. You'll find additional disclosures regarding these non-GAAP measures, including reconciliations of these measures with comparable GAAP measures. +Finally, unless otherwise stated, all comparisons in this call will be against our results for the comparable period of 2012. +Now I will turn the call over to Tom. + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com, Inc. - SVP and CFO [3] +-------------------------------------------------------------------------------- + + Thanks, Sean. I will begin with comments on our second-quarter financial results. +Trailing 12-month operating cash flow increased 41% to $4.53 billion. Trailing 12-month free cash flow decreased 76% to $265 million. +Trailing 12-month capital expenditures were $4.27 billion. This amount includes $1.4 billion in purchases of our previously leased corporate office space as well as property for development of additional corporate office space located in Seattle, Washington, which we purchased in the fourth quarter 2012. The increase in capital expenditures reflects additional investments in support of continued business growth, consistent of investments in technology infrastructure, including Amazon Web Services, and additional capacity to support our fulfillment operations. +Return on invested capital was 2%, down from 11%. ROIC is TTM free cash flow divided by average total assets minus current facilities excluding the current portion of long-term debt over five quarter ends. The combination of common stock and stock-based awards outstanding was 474 million shares compared with 468 million shares. +Worldwide revenue grew 22% to $15.7 billion or 25% excluding the $392 million unfavorable impact from year-over-year changes in foreign exchange rates. We are grateful to our customers who continue to take advantage of our low prices, vast selection and shipping offers. +Media revenue increased to $4.4 billion, up 7% or 11% excluding foreign-exchange. EGM revenue increased to $10.42 billion, up 28% or 30% excluding foreign exchange. Worldwide EGM increased to 66% of worldwide sales, up from 64%. +Worldwide paid unit growth was 29%. Active customer accounts exceeded $215 million. Worldwide active seller accounts were more than 2 million. Seller units represented 40% of paid units. +Now I will discuss operating expenses excluding stock-based compensation. Cost of sales was $11.2 billion, or 71.4% of revenue, compared with 73.9%. Fulfillment, marketing, tech and content and G&A combined was $4.09 billion or 26% of sales, up approximately 275 basis points year over year. Fulfillment was $1.76 billion or 11.2% of revenue compared with 10.1%. Tech and content was $1.43 billion or 9.1% of revenue compared with 7.6%. Marketing was $651 million or 4.1% of revenue, consistent with the prior period. +Now I will talk about our segment results, and consistent with prior periods we do not allocate the segments, our stock-based compensation or other operating expense line items. In the North America segment, revenue grew 30% to $9.49 billion. Media revenue grew 16% to $2.17 billion. EGM revenue grew 31% to $6.48 billion, representing 68% of North America revenues, up from 67%. North America segment operating income increased 19% to $409 million, a 4.3% operating margin. +In the International segment, revenue grew 13% to $6.21 billion. Adjusting for the $391 million year-over-year unfavorable foreign-exchange impact, revenue growth was 20%. +Media revenue decreased 1% to $2.22 billion or grew 7% excluding foreign exchange. In EGM, revenue grew 22% to $3.94 billion, or 29% excluding foreign-exchange. EGM now represents 63% of International revenues, up from 59%. +International segment operating income was zero, down from $16 million in the prior-year period. Excluding the unfavorable impact from foreign exchange, International segment operating income increased 11%. +CSOI increased 14% to $409 million or 2.6% of revenue, down approximately 20 basis points year over year. Excluding the unfavorable impact from foreign exchange, CSOI increased 19%. +Unlike CSOI, our GAAP operating income includes stock-based compensation expense and other operating expense. GAAP operating income decreased 26% to $79 million, or 0.5% of net sales. +Our income tax expense was $13 million. GAAP net loss was $7 million or $0.02 per diluted share compared with net income of $7 million and $0.01 per diluted share. +Turning to the balance sheet, cash and marketable securities increased $2.49 billion year over year to $7.46 billion. Inventory increased 24% to $5.42 billion and inventory turns were 9.4, down from 10.1 turns a year ago as we expanded selection, improved in-stock levels and introduced new product categories. +Accounts payable increased 27% to $8.99 billion and accounts payable days increased to 73 from 68 in the prior year. +I will conclude my portion of today's call with guidance. Incorporated into our guidance are the order trends that we've seen to date and what we believe today to be appropriately conservative assumptions. Our results are inherently unpredictable and may be materially affected by many factors, including a high level of uncertainty surrounding exchange rate fluctuations as well as the global economy and consumer spending. It's not possible to accurately predict demand and, therefore, our actual results could differ materially from our guidance. As we've described in more detail in our public filings, issues such as settling inter-company balances and foreign currencies among our subsidiaries, unfavorable resolution of legal matters and changes to our effective tax rate can all have a material effect on guidance. Our guidance further assumes that we don't conclude any additional business acquisitions, investments, restructurings or legal settlements; record any further revisions of stock-based compensation estimates; and that foreign-exchange rates remain approximately where they have been recently. +For Q3 2013, we expect net sales of between $15.45 billion and $17.15 billion, a growth between 12% and 24%. This guidance anticipates approximately 300 basis points of unfavorable impact from foreign exchange rates. GAAP operating loss to be between $440 million and $65 million compared to $28 million in third quarter 2012. This includes approximately $340 million of stock-based compensation and amortization of intangible assets. We anticipate consolidated segment operating income or loss, which excludes stock-based compensation and other operating expense, to be between a $100 million loss and $275 million in income compared to $232 million of income in third quarter 2012. +We remain heads-down focused on driving a better customer experience through price, selection and convenience. We believe putting customers first is the only reliable way to create lasting value for shareholders. +Thanks, and with that, Sean, let's move to questions. + +-------------------------------------------------------------------------------- +Sean Boyle, Amazon.com, Inc. - VP IR [4] +-------------------------------------------------------------------------------- + + Great, thanks, Tom. Let's move onto the Q&A portion of the call. Operator, will you please remind our listeners how to initiate a question? + + + +================================================================================ +Questions and Answers +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator instructions) Ross Sandler, Deutsche Bank. + +-------------------------------------------------------------------------------- +Ross Sandler, Deutsche Bank - Analyst [2] +-------------------------------------------------------------------------------- + + Thanks guys, I just had one question on shipping. It looks like the unit efficiency in shipping continues to improve. What are you guys doing to drive the cost of shipping each unit lower? Are there more costs that can be taken out on a per-unit basis? +And then, as you start looking at same-day delivery in some of these markets, including the new grocery program, what incremental costs do you see around doing same-day fulfillment? Thanks. + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com, Inc. - SVP and CFO [3] +-------------------------------------------------------------------------------- + + In terms of the economics, we have a great operations team that's working on how do we serve customers reliably and faster. So, certainly, that is reflected in our transportation costs. Also, from a productivity standpoint, we're just -- as we add capacity, we're just getting closer and closer to customers with larger selection, which is certainly helpful from a productivity standpoint. +So those are some of the dynamics that you need to think about when you think about our transportation cost. The team has done a great job over the years of becoming even more reliable and faster and more productive. And, again, they will be working on ways to make that even better over time. + +-------------------------------------------------------------------------------- +Operator [4] +-------------------------------------------------------------------------------- + + Douglas Anmuth, JPMorgan. + +-------------------------------------------------------------------------------- +Douglas Anmuth, JPMorgan - Analyst [5] +-------------------------------------------------------------------------------- + + Great, thanks for taking the question. I was hoping you could talk a little bit more just on the profitability of the grocery business and how you will know when it's the right time to expand to more markets beyond Seattle and L.A. +And then also, if you could comment on the European macro environment, just given the growth that you saw in the International business just decelerating a little bit from last quarter. Thanks. + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com, Inc. - SVP and CFO [6] +-------------------------------------------------------------------------------- + + In terms of the fresh business, we started doing a pilot several years ago in Seattle. We did a number of -- the team has done a great job inventing on behalf of customers. It's a very good customer experience. The challenge that we've had over the past several years is how to make it economically viable. And so that's -- the team has done a lot of different experiments and invented well on behalf of customers to see what works. And we took a lot of that knowledge, which enabled us to launch fresh in L.A. And it's very early there; we're still in the trial period. It's a good customer experience and we like what we see so far, but it's very, very early. +So it's something that we will continue to work on, both from a customer experience and from an economic standpoint. There's not much more I can add to that right now, so you'll have to stay tuned and see where that ends up. + +-------------------------------------------------------------------------------- +Operator [7] +-------------------------------------------------------------------------------- + + Mark Miller, William Blair. + +-------------------------------------------------------------------------------- +Mark Miller, William Blair & Company - Analyst [8] +-------------------------------------------------------------------------------- + + Hi good afternoon. Could you help us understand the third-party unit growth? I think this is the first quarter in about three years that third-party unit penetration hasn't increased. +And then, additionally, I'm wondering if you could comment at all on potential to expand Prime membership options potentially to something like a super-Prime offering for expanded video content and fulfillment options. + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com, Inc. - SVP and CFO [9] +-------------------------------------------------------------------------------- + + In terms of the third-party unit growth, it was 40% this quarter, which compares to the 40% last year in Q2. So, again, it is flat as a percentage of total units. +One thing to keep in mind, though, is our digital units are growing at a faster rate than physical, and those digital units are primarily first-party units. So if you take out -- digital units out in both periods, we are actually up approximately 300 basis points. So our physical seller business is growing very nicely. It's growing at a faster rate than retail and it's doing very well. And so very pleased to see that. + +-------------------------------------------------------------------------------- +Operator [10] +-------------------------------------------------------------------------------- + + Brian Pitz, Jefferies. + +-------------------------------------------------------------------------------- +Brian Pitz, Jefferies & Company - Analyst [11] +-------------------------------------------------------------------------------- + + Great, thanks. Quick question on fulfillment centers -- any color on your current plan for the year in terms of locations, US versus International, timing, etc.? And then, separately, any comments on the weaker growth in International media? + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com, Inc. - SVP and CFO [12] +-------------------------------------------------------------------------------- + + In terms of FCs, we have announced to date five net new facilities in the US. We've also announced some in International. It's still early, as we did in prior -- last few years. We gave you updates as we went along, and so we can update you a little bit later in the year to see how that progresses, but we certainly are adding new capacity and that's reflected in the guidance that you see in Q3 as we get ready for our Q4 seasonal quarter. +In terms of growth in International media, what you are seeing there is, on a local currency growth basis, you see a 7% growth that's consistent with what you've seen in the last couple of quarters. We are at the very early stages. We are excited about what we are seeing so far in digital, but we are in that early stage of transformation from physical to digital within International. And so you see from the release that we have launched a lot of new things related to digital over the past 90 days and even prior to that. So we are very excited about those launches and excited about the transformation. +We are also excited, if you look at our total International business, we've got a lot of opportunities to invest in. I talked about the conversion from physical to digital. We also have selection still to add within existing categories, new categories, new geographies. So we are very excited about the opportunity that we have there. + +-------------------------------------------------------------------------------- +Brian Pitz, Jefferies & Company - Analyst [13] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Operator [14] +-------------------------------------------------------------------------------- + + Scott Devitt, Morgan Stanley. + +-------------------------------------------------------------------------------- +Scott Devitt, Morgan Stanley - Analyst [15] +-------------------------------------------------------------------------------- + + Hi, thanks. I guess the International topic again, but it has been asked a few times. So maybe specifically in China, Tom, in terms of what the Company hypothesis is in terms of the way that market plays out over time and how you think about investment spend in that market. +And then secondly, as it relates to AWS, it's nice, the event, the annual event and the quarterly events that happened. I was wondering when you think it makes sense to start talking more about it in releases and on calls. Is it just the 10% revenue threshold or something else that would lead to more discussions like that on calls like this? Thanks. + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com, Inc. - SVP and CFO [16] +-------------------------------------------------------------------------------- + + In terms of China, we are investing heavily in China, and we have been for some number of years. We have a good customer experience there. We continue to look at ways to make that even better. We are adding selection across many categories right now. It's a very interesting geography. +And so we will continue to work on that experience for customers. You should expect to see us to be in investment mode for some time, but it's a very sizable segment, very interesting long-term growth opportunity, and we will continue to work on making that better for customers and for investors over time. +In terms of AWS, the business is growing very, very strongly. We've got a great team that's innovating on behalf of customers, launching new services, becoming more productive, which allows us to be able to lower prices. We've had many price reductions since we started with AWS, and we share that very visibly. And so we are very excited about that business. Even though we are off to a very good start, it's a very big opportunity and we continue to invest in that business and we are very excited to do it. We think it's a great long-term opportunity and we have a great team working on it. + +-------------------------------------------------------------------------------- +Operator [17] +-------------------------------------------------------------------------------- + + Mark Mahaney, RBC. + +-------------------------------------------------------------------------------- +Mark Mahaney, RBC Capital Markets - Analyst [18] +-------------------------------------------------------------------------------- + + Great, thanks. Tom, just one question related to consumer packaged goods. Any comments there on whether you are seeing broader purchases by the Amazon customers of more traditional consumer staples than you've seen in the past, and is that something you are trying to promote? Thank you. + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com, Inc. - SVP and CFO [19] +-------------------------------------------------------------------------------- + + Yes, just to make sure I have your question, we are seeing -- when you look at our, for example, our North America growth, particularly EGM, we are seeing very good growth across many different categories. But a few callouts -- we are seeing very good growth in apparel, specifically, and also consumables. +And so the team has done a very nice job. Both teams have done a very nice job from a customer experience standpoint and been growing very nicely, and that is something that we are seeing and it does help with frequency to the site as well. + +-------------------------------------------------------------------------------- +Operator [20] +-------------------------------------------------------------------------------- + + Mark May, Citi. + +-------------------------------------------------------------------------------- +Mark May, Citi - Analyst [21] +-------------------------------------------------------------------------------- + + Thanks for taking my question -- another one on International in the media segment there. I believe that you now have a more comprehensive localized international strategy for the Kindle. I wonder if you could talk about what, if any, impact that you think that that might have over the next few quarters in terms of its impact on the International media segment. +And also on international, the AWS, I think one of the contributors of growth and, we suspect, margins in the US has been the success at AWS here. I wonder if you could talk about any plans for AWS outside the US. + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com, Inc. - SVP and CFO [22] +-------------------------------------------------------------------------------- + + Sure. In terms of Kindle, you are right. We now have Kindle stores, if you will, established in all of the Amazon domains that we have around the world. And recently we announced Kindle Fire HD; it's available to customers in over 170 countries. We introduced Kindle Paperwhite and Kindle Fire HD in China. That's both online on our website, and also in a number of off-line retail locations. +So, again, there's a lot of advancement in terms of the Kindle. But again, it's very early. I'm very encouraged by the opportunity that we have there for customers and our ability to try to capitalize on that from a digital content standpoint. +In terms of AWS, the business is expanding and it's an incredible opportunity globally. We recognize that. The team recognizes that, and we will continue to work on that on behalf of customers. + +-------------------------------------------------------------------------------- +Operator [23] +-------------------------------------------------------------------------------- + + Justin Post, Merrill Lynch. + +-------------------------------------------------------------------------------- +Justin Post, BofA Merrill Lynch - Analyst [24] +-------------------------------------------------------------------------------- + + Thank you. The Company and the business is going through a lot of transitions with digital media, AWS, obviously Prime and potentially same-day delivery. A long time ago, you used to give us a margin outlook for the Company. As you think about these businesses, do you think that they are better for Amazon in that you can have greater share of retail as these evolutions happen? +Also, what are the implications on Amazon's long-term margins as you go through these transitions over time? Any help on that could help. Thanks. + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com, Inc. - SVP and CFO [25] +-------------------------------------------------------------------------------- + + Sure. In terms of the way we are looking at them certainly is based on the free cash flow potential. And we have -- we are in some really interesting great businesses that have a lot of potential from a free cash flow generation standpoint, with good, high ROICs, which is exciting. +From a margin standpoint, always challenging to predict where that will come out in terms of absolute numbers, but what we will do is we want to make sure that we try to maximize free cash flow. That's something that we've always said. +So our strategy hasn't changed; our outlook hasn't changed in that regard. Frequently, we would be asked historically, is double-digit operating margins possible? And I still think it's possible. But, also, if it means -- if a good, high-single-digit operating margin gets us to better, higher free cash flow over time, that's fine, too. +So again, our goal is to -- we don't focus on individual margins. Our goal is to make sure that we generate free cash flow, large amounts of free cash flow, and use that capital efficiently. And so those are goals that we have. And we certainly think that opportunity is there in each of the businesses that we operate in. + +-------------------------------------------------------------------------------- +Operator [26] +-------------------------------------------------------------------------------- + + Ben Schachter, Macquarie. + +-------------------------------------------------------------------------------- +Ben Schachter, Macquarie Research - Analyst [27] +-------------------------------------------------------------------------------- + + Two quick questions on revenue recognition. Over the past some quarters, I believe that the -- certain digital media, at least, has moved around between the agency and wholesale model. Can you help us quantify how this has actually impacted the reported media revenue rates? In other words, would 2Q revenue rates have been meaningfully different if the model had been the same? +And then second question, just quickly -- on Prime, can you remind us how you recognize revenue from the Prime membership fee over the course of the year? Thanks. + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com, Inc. - SVP and CFO [28] +-------------------------------------------------------------------------------- + + Sure. In terms of Prime, we recognize it over the life of the subscription. And then in terms of third-party versus first-party, certainly we have had some shift within digital media. But again, digital media is primarily a first-party business and happens to be one portion of our business. +But you are absolutely right. In terms of our third-party business, which from a unit perspective is 40% of our total units this quarter, we recognize the share of that revenue; the rev share, if you will, as revenue, whereas the other parts of our business, largely, we are recognizing that first-party revenue, and so we are recognizing the full amount of revenue in the current period. + +-------------------------------------------------------------------------------- +Operator [29] +-------------------------------------------------------------------------------- + + Jordan Rohan, Stifel Nicolaus. + +-------------------------------------------------------------------------------- +Jordan Rohan, Stifel Nicolaus - Analyst [30] +-------------------------------------------------------------------------------- + + Thank you so much Sean, I'm curious about your expansion efforts in Spain, since it's a relatively new territory for you, how well situated you are and how ready you are for the fourth quarter there. +And, also, there have been a lot of stories about Amazon heading into Brazil, but I don't believe we have identified any fulfillment centers and things like that. Can you discuss the extent and breadth of your offering in Brazil; whether it's Kindle devices, digital media or something beyond that? Thank you. + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com, Inc. - SVP and CFO [31] +-------------------------------------------------------------------------------- + + In terms of Spain, we are very excited about what we see. It is growing very fast. We are in investment mode and it's an exciting geography for us. We are very optimistic over time it will be a great geography for us. So we are very happy to serve customers in Spain and we continue to, as we have done in other geographies, that we will continue to serve customers and continue to expand selection and get service levels even better over time. So we are very excited about that. +In terms of Brazil, we do have a Kindle Store and we have devices at physical retailers. So from a Kindle perspective, that's what we are doing in Brazil. + +-------------------------------------------------------------------------------- +Operator [32] +-------------------------------------------------------------------------------- + + Ron Josey, JMP Securities. + +-------------------------------------------------------------------------------- +Ron Josey, JMP Securities - Analyst [33] +-------------------------------------------------------------------------------- + + Great, thank you for taking my question. I'm wondering if you can talk a little bit about North America EGM. Just given the strength you saw in the business and continued re-acceleration, have you seen any sort of impact? I'm assuming no, but from price matching programs, from off-line retailers, and also on sales tax. Thank you. + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com, Inc. - SVP and CFO [34] +-------------------------------------------------------------------------------- + + In terms of North America total growth, we saw an acceleration from last quarter from 26% to 30%. We saw an acceleration in both North America media as well as North America EGM. +Within EGM, it was very broad in terms of growth. We saw very strong growth across many different categories, and so I'm very pleased with that. I called out a couple that were notable in terms of apparel, as well as in consumables. Certainly, those are getting larger and still growing very fast, which is why I called those out. +In terms of competitiveness, it has been very competitive. It is today; it has been since our inception. We have many different competitors online. We have many competitors off-line. As you go to your home or office, you pass our competitors every day. That's an environment where we are used to dealing in. It's something that's not new. It's something that we see in all of our geographies across many different categories. + +-------------------------------------------------------------------------------- +Operator [35] +-------------------------------------------------------------------------------- + + Heath Terry, Goldman Sachs. + +-------------------------------------------------------------------------------- +Heath Terry, Goldman Sachs - Analyst [36] +-------------------------------------------------------------------------------- + + Great, thanks Tom. As you get closer to customers with more FCs and more efficient shipping, what kind of impact is that having on conversion rates within customers in those areas as shipping times shorten or delivery times shorten? +And then as you look at the early adopters for fresh in L.A., any sense that you can share with us of what kind of cross-shopping you are seeing among new fresh customers? Are they bundling media and EGM in those other orders, or to any degree are these new-to-Amazon customers that have been brought in purely because of fresh? + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com, Inc. - SVP and CFO [37] +-------------------------------------------------------------------------------- + + If you take a look at L.A., it's just, again, very excited and it's very early. So I think on that one, you will just have to stay tuned. +But in terms of as we get closer and closer to customers with fulfillment, we have seen growth due to that. And it has manifested its way in a few different ways, but most notably you see it in Prime. We have -- because of our fulfillment logistics capability, we have been able to offer Prime broadly, and we just have selection that's just closer and closer to customers. And if you look back over the last several years, there has been different reasons why we have grown the way we've grown in terms of adding new selection and making sure that we have really sharp pricing. +But certainly, Prime, which includes speeded delivery, has certainly been a notable -- has had a notable impact. And we are very pleased with the Prime program. Customers like it. We see very strong growth in Prime subscribers. We see very good retention of Prime members. So it's a great program for us and certainly, again, delivery speed is certainly impacting that program, our overall growth. + +-------------------------------------------------------------------------------- +Operator [38] +-------------------------------------------------------------------------------- + + Anthony DiClemente, Barclays. + +-------------------------------------------------------------------------------- +Anthony DiClemente, Barclays Capital - Analyst [39] +-------------------------------------------------------------------------------- + + Thank you. On the topic of media, just wondering, Tom, if there are any call-outs in terms of categories of strength or weakness within physical or digital media that you could call out. And along those lines, just wondering if you could comment on your media device rollout strategy from here, if there is anything you could tell us. +And then, quickly, is there any reason Prime Instant Video isn't available for Android devices? Thank you. + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com, Inc. - SVP and CFO [40] +-------------------------------------------------------------------------------- + + In terms of media growth, not a lot of call-outs, except probably the obvious is digital units growing very fast relative to physical units, and we are excited to see that. And because of where we are, we are further penetrated in North America. You are seeing a bigger impact on our growth rate than you are in International, and we certainly see that. But not a lot of other call-outs there. +But, again, we are very pleased, and certainly customers are responding to many things, including selection and great prices and everything else within those digital offerings. But, also, they are responding to unique selection that we have. And if you take a look at our release, you will see the specific numbers related to some of the exclusives we have and, certainly, that is having an impact. So there's many, many different things that are working for us in that space as part of our overall ecosystem for digital that we are pleased with. +In terms of our device plan, we are very pleased with the devices we have to offer customers. We think we have a great offering, both in terms of Kindle and Kindle Fire. In terms of our future roadmap, we have a long-standing practice of not talking about what that will be prior to announcement. + +-------------------------------------------------------------------------------- +Operator [41] +-------------------------------------------------------------------------------- + + Youssef Squali, Cantor Fitzgerald. + +-------------------------------------------------------------------------------- +Youssef Squali, Cantor Fitzgerald - Analyst [42] +-------------------------------------------------------------------------------- + + Thank you very much. Two quick questions, please. Tech and content was up to 9% of revenues. I think that's the highest it has ever been. How much of that is actually streaming content-related? How do we look at it going forward? Does it stay at that elevated level? +And then on fresh, is that business profitable for you in the Seattle area? Thanks. + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com, Inc. - SVP and CFO [43] +-------------------------------------------------------------------------------- + + In terms of tech and content, we are spending in a number of different areas, but there's a few that I would like to highlight. One is certainly -- keep in mind that the infrastructure related to our very fast-growing Web services business is included in tech and content. So, certainly, as we ramp up that business and it is becoming more sizable and growing very fast, you are seeing that impacting that line item. +We are also investing very heavily in digital, and that is across many different parts of our digital offerings there. That's also included. Any of the tech teams that are working on customer experience across Amazon as we grow, so as we support both our seller businesses and our retail businesses, they are included in that line item. So certainly, that's what you are seeing there. +In terms of fresh, we are not breaking out the financials. But keep in mind that fresh was designed as a pilot and, certainly, the economics have improved over time through invention on behalf of the team there as well as operating efficiencies. So again, that was set up as a test, which has enabled us to launch L.A. + +-------------------------------------------------------------------------------- +Operator [44] +-------------------------------------------------------------------------------- + + Colin Sebastian, Robert Baird. + +-------------------------------------------------------------------------------- +Colin Sebastian, Robert W. Baird & Company, Inc. - Analyst [45] +-------------------------------------------------------------------------------- + + Thanks very much. A quick follow-up on the device strategy. Given the fairly quick pace of innovation in the tablet market overall, I wonder if you can contrast the benefits of that for Amazon, given the popularity of shopping and media apps with the costs and complexity of maintaining your own line of hardware. +And related to this, it seems as if the pace of new content acquisition and licensing has picked up a bit. So I wonder if that reflects any changes in either the competitive dynamics or pricing or some sort of other strategy shift on your part. Thanks. + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com, Inc. - SVP and CFO [46] +-------------------------------------------------------------------------------- + + In terms of some of the dynamics, we are very excited about our digital business. We are inventing -- you see a lot of different inventions, both on the hardware side as well as on the software side from a device standpoint. You are also seeing a lot of invention around the content side. And we think, for example, Prime instant video, which combines video and our Prime membership, is very compelling, and we are investing heavily in content. It's still very early there, but we are finding that customers, certainly existing Prime members, are more and more streaming content. We are having new Prime members come to Amazon largely because of video in terms of one segment of that population that's coming from new Prime members; it's because of Prime instant video, and we can see that based on the free trials and the conversion of those free trials related to Prime instant video. So that's certainly one portion of our growth in Prime memberships which we find exciting. +For us, we will offer exclusive content on the book side; it's very interesting. So again, we are inventing -- across a lot of different areas. And, yes, there are a lot of different dynamics, but we think we are well suited for both device software and content side of those businesses. + +-------------------------------------------------------------------------------- +Operator [47] +-------------------------------------------------------------------------------- + + Matt Nemer, Wells Fargo Securities. + +-------------------------------------------------------------------------------- +Matt Nemer, Wells Fargo Securities, LLC - Analyst [48] +-------------------------------------------------------------------------------- + + Afternoon, just two questions -- one, given your comments that International will be in investment mode for some time, can you just remind us what the priorities are there from either a geography or product standpoint? +And then, secondly, following the management changes at Quidsi, we would love an update on the plans for that business and maybe just a sense for how integrated it is to Amazon retail. Thanks. + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com, Inc. - SVP and CFO [49] +-------------------------------------------------------------------------------- + + In terms of the International piece, what I was referring to was as in investment mode for some time. I was referring to China specifically. We have a lot of opportunity to grow. We'll still continue to invest in International, but my comment was specifically around China. +And then your question around Quidsi? + +-------------------------------------------------------------------------------- +Operator [50] +-------------------------------------------------------------------------------- + + Stephen Ju, Credit Suisse. + +-------------------------------------------------------------------------------- +Stephen Ju, Credit Suisse - Analyst [51] +-------------------------------------------------------------------------------- + + Tom -- + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com, Inc. - SVP and CFO [52] +-------------------------------------------------------------------------------- + + Hello? Just to follow up, the Quidsi question, I think, was around the founders leaving. We will position with them leaving. I missed the last part of that, but we are fortunate to have the founders with us for a number of years. They did a great job while they were here and we have a great team at Quidsi. We are pleased with that business and the retail team works very closely with the Quidsi business and we are excited to have that as part of Amazon team. + +-------------------------------------------------------------------------------- +Stephen Ju, Credit Suisse - Analyst [53] +-------------------------------------------------------------------------------- + + Tom, is there anything you can share in terms of the situation in Germany with the workers' strike? Are you able to fulfill from unaffected fulfillment centers, or is it causing some hindrance to your operations there? +Also if you can update us on what you have been doing with Kiva since you have acquired it. Are you focusing more on internal integration, or are you selling more aggressively to external clients? Thanks. + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com, Inc. - SVP and CFO [54] +-------------------------------------------------------------------------------- + + In terms of Germany, there's not a lot I can add to there. We are certainly serving customers. Those results are reflected in our overall total results that you see today for Q2 as well as our International results. +In terms of Kiva, we certainly -- we have a great team there, love the technology. We don't have any announcements in terms of rollouts, but we are ahead of schedule from what we had set out at the time of purchase, which we are happy about. So we'll have to stay tuned on the actual rollout, but we are very encouraged by what we see there. + +-------------------------------------------------------------------------------- +Operator [55] +-------------------------------------------------------------------------------- + + Ken Sena, Evercore Partners. + +-------------------------------------------------------------------------------- +Ken Sena, Evercore Partners - Analyst [56] +-------------------------------------------------------------------------------- + + Hi, thank you. Just going back to your comments on unit acceleration, has the shift from agency to wholesale in terms of the DOJ e-book settlement -- has that completed, or are you still working your way through many of the US publishers? Thank you. + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com, Inc. - SVP and CFO [57] +-------------------------------------------------------------------------------- + + We are working through it. I wouldn't say that that's complete, but we are working through it. + +-------------------------------------------------------------------------------- +Sean Boyle, Amazon.com, Inc. - VP IR [58] +-------------------------------------------------------------------------------- + + Thank you for joining us on the call today and for your questions. A replay will be available on our investor relations website at least through the end of the quarter. We appreciate your interest in Amazon.com and look forward to talking with you again next quarter. + + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/exam/original-files/Problem_1_Sample/2013-May-01-FB.OQ-140634585149-Transcript.txt b/exam/original-files/Problem_1_Sample/2013-May-01-FB.OQ-140634585149-Transcript.txt new file mode 100644 index 0000000..532b486 --- /dev/null +++ b/exam/original-files/Problem_1_Sample/2013-May-01-FB.OQ-140634585149-Transcript.txt @@ -0,0 +1,557 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q1 2013 Facebook Earnings Conference Call +05/01/2013 05:00 PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Deborah Crawford + Facebook, Inc. - Director of IR + * Sheryl Sandberg + Facebook, Inc. - COO + * David Ebersman + Facebook, Inc. - CFO + * Mark Zuckerberg + Facebook, Inc. - CEO + +================================================================================ +Conference Call Participiants +================================================================================ + + * Ken Sena + Evercore Partners - Analyst + * Jordan Rohan + Stifel Nicolaus - Analyst + * Ben Schachter + Macquarie Research Equities - Analyst + * Justin Post + BofA Merrill Lynch - Analyst + * Brian Wieser + Pivotal Research - Analyst + * Douglas Anmuth + JPMorgan - Analyst + * Jordan Monahan + Morgan Stanley - Analyst + * Youssef Squali + Cantor Fitzgerald - Analyst + * Gene Munster + Piper Jaffray - Analyst + * Mark Mahaney + RBC Capital Markets - Analyst + * Aaron Kessler + Raymond James - Analyst + * Daniel Ernst + Hudson Square Research - Analyst + * Ross Sandler + Deutsche Bank - Analyst + * Anthony DiClemente + Barclays Capital - Analyst + * Heather Bellini + Goldman Sachs - Analyst + +================================================================================ +Presentation +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Good afternoon. My name is Jay and I will be your conference operator today. At this time, I would like to welcome everyone to the Facebook first-quarter 2013 earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks there will be a question-and-answer session. +(Operator Instructions) +Thank you very much. Ms. Deborah Crawford, Facebook's Director of Investor Relations, you may begin. + +-------------------------------------------------------------------------------- +Deborah Crawford, Facebook, Inc. - Director of IR [2] +-------------------------------------------------------------------------------- + + Thank you. Good afternoon and welcome to Facebook's first-quarter earnings conference call. Joining me today to talk about our results are Mark Zuckerberg, CEO; Sheryl Sandberg, COO, and David Ebersman, CFO. +Before we get started, I would like to take this opportunity to remind you that during the course of this call, we will make forward-looking statements regarding future events and the future financial performance of the Company. We caution you to consider the risk factors that could cause actual results to differ materially from those in the forward-looking statements in the press release and this conference call. These risk factors are described in our press release and are more fully detailed under the caption Risk Factors in our annual report on Form 10-K filed with the SEC on February 1, 2013. In addition, please note that the date of this conference call is May 1, 2013, and any forward-looking statements that we make today are based on assumptions as of this date. We undertake no obligation to update these statements as a result of new information or future events. +During this call we will present both GAAP and non-GAAP financial measures. A reconciliation of GAAP to non-GAAP measures is included in today's earnings press release. This call is being broadcast on the Internet and is available on the Investor Relations section of the Facebook website at investor.fb.com. A rebroadcast of the call will be available after 6.00 PM Pacific Time today. The earnings press release and accompanying investor presentation are also available on our website. After management's remarks, we will host a Q&A session. +And now I'd like to turn the call over to Mark. + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook, Inc. - CEO [3] +-------------------------------------------------------------------------------- + + Thanks, Deborah. And thanks, everyone, for joining us today. We got off to a good start this year with strong engagement in growth across the community, several major new product announcements and some good financial results. Sometimes it surprises me that our community can still grow so quickly beyond 1 billion active members. More than 100 million new monthly active members have joined in the last half a year. But now there are more than 650 million people who use Facebook every day. That's more than 60% of our community every day. We continue to see high levels of engagement globally across our whole community. We take our stewardship of this very seriously. We want to make sure we give every person in the world the power to share. And we're proud of these results. +Overall, there are three main parts of our strategy -- build the best mobile product, build a platform with new services that leverage the social graph, and build a strong monetization engine. I'm going to use my time here with you today to give my assessment of how I think we're doing in each of these areas. +Let's start with Mobile. One of the products I'm most excited about is Facebook Home. It's a family of apps that you can install on your Android phone to make the home screen of your phone much more personal and about people, not apps. We know that people spend an average of 20% or more of their time in apps on Facebook, staying up-to-date with the people they care about are doing. We each open the Facebook app maybe 10 to 15 times per day. But we probably check our phones over 100 times a day. So with Home, you can see fresh news and content from people and topics you care about every time you turn on your screen. It really brings your phone to life and provides a completely new experience. +This product is still very early and this is just the first release in a long journey. We're planning on iterating quickly and tuning things based on feedback. We haven't really started encouraging people to install it from within our apps yet and it's only available on a few phones. But over the next few months we hope to push this out much more broadly and get this in the hands of a lot more people. We're excited about Home because we think it's a great product. But Home is also an important milestone for our Company. This is a completely new kind of mobile experience based on people, not apps. And we think this is how phones and computers should work. I'm looking forward to sharing more with you on the experiences that are borne on mobile that we're building over the rest of this year. +Now, beyond Home, I'm really proud of how Instagram is doing. Kevin and his team have made amazing progress since last April. When we agreed to acquire them, the Instagram community had 22 million people actively using their service every month. And today, over 100 million people are using Instagram each month. The Instagram community is growing even faster than the Facebook community did when it was this size. And the two communities complement each other to create some great experiences where you can capture any moment in your life and easily share it across all the communities you care about. +Next I'd like to talk about platform and building new services using the social graph. A couple months ago, we announced a new, richer and simpler design for our newsfeed, that's more visual and engaging for all the content that you might want to consume. From news stories from the New York Times to pins from Pinterest, or activities from a game that you play. This new design opens up a nicer canvas for content for every developer and publisher out there and we think it's going to create a lot more opportunities for engagement. Early feedback has been positive on the versions we've rolled out on iPhone, iPad and desktop web and we're looking forward to rolling this out more widely soon. +For our development platform, we've had a long road map to build the tools for iOS and Android, to make building social apps and advertising with Facebook, as easy on mobile as it is on desktop web. We completed this transition by bringing Open Graph to mobile this month and our efforts are paying off, with now 81 of the top 100 grossing iOS apps, and 70 of the top 100 Android apps integrating with Facebook and continuing to grow. +One of the developments that's been interesting is seeing how big of an opportunity mobile apps can be for Facebook. Because of the roles Apple and Google have in this space with their app stores, it wasn't as clear early on what kind of role Facebook would play. But I think it's clear now that we can create a lot of value for developers by providing a platform for identity and distribution where we're starting to see real revenue through selling mobile app installs. We just announced the acquisition of Parse, a platform and service provider for mobile apps, as part of our strategy to provide greater support for developers. Both of these products make it easier for developers to create and grow their apps and this could be the start of something much bigger. +Now I want to talk a bit about monetization. I just mentioned mobile app install ads, which are growing quite well and have become one of our most important new ad products. This supports our hypothesis that Facebook should help you discover new apps and content that you may want to use. And even if not every recommendation we make is one that you take, I think this is still starting to provide some really good content for our community, in addition to the business opportunity here. This type of ad makes sense to me on mobile. On desktop web, most ads encourage you to visit a new website. On mobile, it makes sense that most ads encourage you to visit apps instead. And in order to visit apps you first need to install them. So these ads are the obvious first step. +On mobile, the set of companies that produce apps is much broader than what you might think of as traditional developers. Every major brand, company or service wants to build apps as a store front or interface for their customers. And each of these companies wants to reach their customers to encourage them to install their apps. This market is already big and I expect it to continue to grow quickly. +One more thing that's important to reinforce here is that we continue to measure people's satisfaction with all the content they see on Facebook, including ads. We haven't seen any meaningful impact on satisfaction and we're continuing to watch this very closely. This is important to us as stewards of this community. We aspire to have ads -- to show ads that improve the content experience over time. And if we continue making progress on this, then one day we can get there. +So that's my update on our strategy for this quarter. We've already accomplished a lot so far this year. We've seen strong growth and engagement across our whole community, several major product announcements and good financial results. We think the products like Home and Graph Search are big opportunities to deliver some unique and important services to the world, that we're positioned to do better than anyone else. But these services are also big, long-term investments. So I want to be clear up-front that we're making these big investments because I think these are important areas for us to focus on. +Now, finally, I want to take a moment to thank everyone who works at Facebook, and everyone who makes this community great. All of you are contributing to building these new experiences and helping more than 1 billion people stay connected. So thank you all. And thanks to everyone on this call for being with us today. I look forward to having more to share and report on next quarter. And now I'd like to turn the call over to Sheryl. + +-------------------------------------------------------------------------------- +Sheryl Sandberg, Facebook, Inc. - COO [4] +-------------------------------------------------------------------------------- + + Thanks, Mark. As Mark said, we had a very solid start to this year and we're excited about the opportunities ahead of us. Our first-quarter total revenue was $1.458 billion and total advertising revenue grew to $1.245 billion. This means that ad revenue was up 43% year over year, faster growth than we had in any quarter in 2012. We believe that this shows that our ad product innovations are helping marketers reach customers effectively. Our growth is particularly strong from new small and medium-sized marketers, direct response marketers, and app developers. I want to use my time with you today to update you on the progress we've made in our three strategic ads priorities -- mobile, measurements and product innovation. +First, mobile. As Mark has said, having billions of people carry social devices in their pockets, checking them multiple times a day, often checking Facebook, is a huge opportunity for us. A recent comScore report showed that in the US, people spend more time on Facebook than on any other app on their smartphones. The opportunity for us to connect people to each other and to marketers has never been greater. We are uniquely positioned to offer marketers massive reach on a daily basis. In Q1, mobile was approximately 30% of our ad revenue, up from about 23% in Q4. Importantly, we're seeing strong growth in our mobile ads business all around the world, particularly in Asia. +As an example, our mobile app install ads performed very well this quarter. We offer developers a unique opportunity to drive downloads of their mobile apps, as Mark talked about. During the quarter, 3,800 developers used these ads to drive nearly 25 million downloads. Of the top 100 grossing apps on both iOS and Android in the last week of Q1, about 40% of them used our mobile app install ads. In gaming, travel, eCommerce and financial service industries, the early indicators are that our cost per install are highly competitive. In one example, British Telecom provider O2 used Facebook as its only digital marketing channel to promote its new music app, O2 Tracks. In just three days, they reached 9 million people and got to sixth place in iOS apps in the UK. +Second, I want to discuss our progress in measurement. One of the challenges we face is helping marketers understand the value of our ads. This has been a major focus for us over the past several quarters. We're partnering closely with our clients to help them understand how their campaigns are performing and this measurement work also helps them gain a better understanding of their customers, which then makes their future campaigns even better. In the last nine months, we've conducted campaign effectiveness studies on over 100 campaigns across CPG, auto, retail and telco. +One of these studies was with Bud Light. Bud Light ran Page Post ads to its 5.8 million fans on Facebook and these ads appeared in all of our placements, including mobile newsfeeds. We worked with Datalogix and found that these ads reached 20% of US households and had a 3.3% sales lift, yielding a 6 times return on ad spend, A result we are very proud of and Bud Light is really excited about. We plan to continue to invest heavily in measurement with our clients throughout the upcoming year. +We're also really excited about our acquisition of Atlas which closed just last week, and I was able to welcome the team to Facebook earlier today. Atlas is a really important part of continuing to develop our measurement capabilities. For the past decade, digital marketers have primarily measured success by focusing only on click. But this oversimplifies how people make purchase decisions, both offline and online, because it ignores everything people do and see before they do that last click. Smart marketers are looking for a better way to value all of the impressions that they buy and engage, leading up to purchase. Multiple industry-wide studies have validated this multi-click attribution approach. For offline sales, both Nielsen and comScore have repeatedly shown that clicks are not a good predictor of sales lift. +For online sales, aggregate knowledge found in an analysis of more than 500 online campaigns, that when clients move from allocating their advertising spend using last-touch attribution to using multi-touch attribution, it saw a 33% increase in actions, conversions and sales. In a study of campaigns from Q4 2012, they found that when measured holistically, cost per acquisition on Facebook is 68% less than other online channels. Datalogix studies validate this finding as well, demonstrating that, on average, 99% of people who saw a Facebook ad and then bought a product in the store never clicked on an ad at all. We believe the Atlas platform will help us demonstrate even more clearly the connection between ad impressions and purchases. We can help marketers measure the effectiveness of their ad impressions better, not just on Facebook but across the entire Internet. This means we can take the advancements we've made in measurement on Facebook, including our integration with Nielsen and Datalogix, and extend them to a much larger audience and to many more purchases. +Third, I'd like to highlight product innovation in apps. Over the last year we've invested heavily in product innovation and I'm excited about what we've accomplished in a relatively short period of time. As always, our top focus is on the results we generate for marketers and we're pleased to see the ROI we can provide, as well as providing a good experience for our users. We continue to innovate new targeting capabilities that make it easier for businesses of all sizes to reach the right people, both on desktop and on mobile. +In Q1, we gained traction with our Custom Audiences product. This product allows marketers to reach their target audiences based on their own customer databases or databases maintained by third parties. For example, a marketer can target ads to customers who have not returned to their store in the past month, but who have made purchases before. This product improves our targeting and generates higher ROI for marketers and a better ad experience for our users. We're really pleased with our adoption of this product. In Q1, more than twice as many marketers used Custom Audiences than in Q4, including 23 of the Ad Age 100 top global marketers, and many other important clients. Companies from hotels.com to Intuit to Virgin America are seeing success with this product. +In April, we launched another powerful targeting product, Partner Categories. This enables marketers to use third-party data from Acxiom, Epsilon, and other data providers to target their ads. For example, we can deliver ads to the 12 million people in the US who are likely to purchase a car in the next six months, or to the 19 million people who are active purchasers of hair care products, households that purchase hair care products at multiples of other households. Or to the 23 million people in the US who are heavy soda drinkers. We apologize, Mayor Bloomberg. +We have also seen more customers begin to use FBX, and we recently launched FBX to newsfeed on desktop. We think this will continue to drive the advertisers' options, given that we generally see higher engagements for ads in the newsfeed. In the last six months of 2012 as one example, retargeting platform AdRoll saw 70% lower cost per click on Facebook than on traditional web retargeting. FBX was so successful for them that by the beginning of Q1, AdRoll reallocated 63% of their total impressions to Facebook. +Overall, we feel really good about our first quarter results. We've made tremendous strides in mobile; we continue to improve our measurement capabilities, most notably with our acquisition of Atlas; and we continue to innovate on our key advertising products and tools. We're still in the early days of developing our ads business and the huge opportunity ahead of us and we thank all of you for your continued interest in our business. +Thank you, and now I'll turn it over to David. + +-------------------------------------------------------------------------------- +David Ebersman, Facebook, Inc. - CFO [5] +-------------------------------------------------------------------------------- + + Okay. Thanks, Sheryl, and good afternoon, everyone. I'd like to share with you the progress we made in Q1 against our key financial objectives -- to increase revenue, to invest aggressively to drive our future growth and to position the Company to maximize long-term returns for our investors. In March, on average, 665 million people accessed Facebook each day, up 26% from last year, and representing 60% of the 1.11 billion people who used Facebook during the month. Consistent with last quarter, mobile continues to drive growth in visitation and engagement. 751 million people accessed Facebook from mobile devices in March, up 54% from last year. These numbers do not include Instagram, which continues to grow rapidly, as Mark mentioned. +Turning to revenue, in Q1 total revenue was up 38% and ad revenue was up 43% compared to last year, driven by the strong performance of newsfeed ads. Exchange rate had no meaningful impact on our revenue growth rates. Ad impressions were up 39% and average price per ad was up 3% compared to last year. The product changes we made and discussed last quarter -- primarily lowering the price floor in our auction -- had a significant impact on the price and volume year-over-year comparisons. In the United States and Canada, where the price floor changes had a smaller effect, average price per ad increased over 25% relative to Q1 of last year, driven by higher engagement and performance of newsfeed ads. +Mobile ad revenue came in at approximately 30% of ad revenue this quarter versus zero last year, and desktop ad revenue in Q1 was essentially flat with last year. As we've discussed in the past, most of our advertising clients do not specify that their Facebook ads be shown on desktop only or on mobile only, but rather they put their ads into our system and allow us to show the ads on whatever device where the ads will perform best. Because of this, the flat desktop revenue does not reflect a particular trend relative to desktop demand so much as it reflects the fact that more of our available ad inventory is being shown on mobile, because that's where people are spending increasing amounts of time and because the mobile ads perform well. We believe our aggregate ad revenue number remains the most important reflection of our performance in terms of increasing overall advertising demand. And the most important ways for us to continue to increase ad revenue are to grow users and engagement and to build advertising products and measurement tools that increase demand from advertisers of all types around the world. +Total payments and other fees revenue was $213 million in Q1, an increase of 15% versus last year. Payments revenue from games was up 12% so we believe 6% represents the best apples-to-apples comparison in terms of the increase for payments from games, if we adjust for items such as the Q4 change in revenue recognition timing. We're pleased that Q1 represented our largest three-month quarter of games revenue to date, despite a 37% drop in year-over-year payments volume from our largest developer, as our other developers increased their payments volumes by almost 60% and we saw a record number of people playing games on Facebook. Games revenue in Q1 benefited from the growth of games launched over the past year and also from our efforts to increase games distribution, usage and payments conversion. We believe Facebook continues to offer a compelling platform for developers to build great games and businesses and we will continue to invest in this area. Overall ARPU increased 12% to $1.35 for the quarter, including a 21% increase in the United States and Canada, and double-digit gains in the other major regions as well. +Shifting now to expenses, in Q1 our total GAAP expenses were $1.08 billion. Excluding stock compensation, total expenses increased 56% to $895 million, driven primarily by headcount and infrastructure spend to support our growth. We continue to expect that our total non-GAAP expenses, including cost of revenue but excluding stock comp, will likely grow in the neighborhood of 50% in 2013, consistent with what we said last quarter, as we continue to invest in products to grow engagement and monetization. +Our Q1 GAAP operating income was $373 million, representing a 26% operating margin. Excluding stock comp, our non-GAAP operating income was $563 million, representing a 39% non-GAAP operating margin. Our GAAP tax rate for Q1 was 38% and benefited significantly from the realization of a one-time $94 million R&D tax credit in the quarter. Our Q1 non-GAAP tax rate was 43% and we expect that our full-year non-GAAP tax rate will be similar to Q1. +GAAP net income and EPS for the quarter were $219 million, or $0.09 per share and non-GAAP net income and EPS were $312 million, or $0.12 per share. We spent $327 million on CapEx in Q1 and we continue to expect 2013 CapEx to be in the neighborhood of $1.8 billion, as we invest in servers and data centers to rapidly and reliably provide our products to people around the world. +In Q1, similar to Q4, upon the vesting of employee RSUs, we withheld shares and paid the associated income taxes for our employees which resulted in an outcome that's functionally very similar to Facebook having repurchased approximately $400 million worth of shares in Q1. We ended Q1 with $9.5 billion in cash and investments. +Overall we believe that 2013 is off to a good start. We're pleased with our financial performance, as well as our progress in product development. We're continuing to invest aggressively in new products that we think will drive long-term engagement, as well as products and tools to grow our revenues and increase returns for the advertisers and developers working with us. And we're excited about the opportunity ahead of us to build out the network of people using Facebook and to bring our unique assets in terms of reach, engagement and identity to our large and important market opportunities. +Now let's open the call for questions. + + + +================================================================================ +Questions and Answers +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) +Heather Bellini with Goldman Sachs. + +-------------------------------------------------------------------------------- +Heather Bellini, Goldman Sachs - Analyst [2] +-------------------------------------------------------------------------------- + + Mark, I was wondering, you shared with us the continued success of mobile install ads. I was wondering if you could share with us the other monetization initiatives that you have that you're most excited about for 2013. And then my follow-up for David would be if you can share with us qualitatively how CPMs trended in the various regions on a year-over-year basis. + +-------------------------------------------------------------------------------- +Sheryl Sandberg, Facebook, Inc. - COO [3] +-------------------------------------------------------------------------------- + + I'll take the first question. In terms of our ads priorities, they are what I mentioned -- mobile, measurements and product innovation. We are particularly focused on improving the quality of our ads because we think that is the best way to have a great experience for users on Facebook, as well as for marketers. I think if you look at the success of Custom Audiences, Partner Categories, FBX, what you see in that are products that all move us towards better targeting, more relevant, better experience for users and for our marketers. And we're going to continue to invest very heavily in making the ad experiences as high return as they can for everyone involved. + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook, Inc. - CEO [4] +-------------------------------------------------------------------------------- + + Yes, and I'll just emphasize the same point. The things that I'm most excited about are things that are driving quality. The two big levers for the business are, A, obviously a lot of people spend a lot of time using Facebook to stay connected with all the people around them, and that gives us an opportunity to advertise. But I actually think over the long term, the thing that's going to drive the business the most is getting the ads to be very high quality -- personalized, good content in there and a lot of the things that we're doing are aligned with that. So, app installs, a lot of that stuff is just good content that people are interested in. There's no great way besides app stores today to discover a lot of apps on mobile devices. Similarly, I talked about the newsfeed redesign that we are rolling out and the content in there is much more visual. We've always had this policy that the advertising content will display in exactly the same way that the consumer content display is. And making it so that people can share much more visual content makes it so naturally advertisements can now have the same kind of compelling creative, as well. Which I think will increase the quality of that and over time increase the effectiveness, as well. + +-------------------------------------------------------------------------------- +David Ebersman, Facebook, Inc. - CFO [5] +-------------------------------------------------------------------------------- + + Heather, in terms of your question about CPMs. Ads revenue grew well across all the geographic regions that we report on. I mentioned the US and Canada growth in CPMs. We saw a similar number, a little bit lower but similar, in Asia. For Europe and rest of world, the numbers were much lower. A little bit above zero in the case of Europe, a little bit below in the case of rest of world. The interesting question around this is what those numbers might have looked like if we hadn't made changes in the option dynamics, such as the price floor. And obviously we can't answer that question quantitatively because we don't have the data, but we feel pretty strongly and pretty confident that prices would have increased substantially more in all of the regions if we hadn't made those changes. + +-------------------------------------------------------------------------------- +Operator [6] +-------------------------------------------------------------------------------- + + Ross Sandler with Deutsche Bank. + +-------------------------------------------------------------------------------- +Ross Sandler, Deutsche Bank - Analyst [7] +-------------------------------------------------------------------------------- + + Just two questions. Engagement, first, was up across most of the geographies. We assume that's primarily driven by mobile but can you talk about anything else that's driving up engagement? And then just a follow-up on the geographies. It looked like the US had a normal seasonal downtick sequentially, whereas international, most of those regions held up sequentially. So, can you just talk about the difference between sell-through rate in the US in newsfeed versus some of those international markets? Thanks. + +-------------------------------------------------------------------------------- +David Ebersman, Facebook, Inc. - CFO [8] +-------------------------------------------------------------------------------- + + Yes. In terms of growth and engagement geographically, I think you can see from the numbers that growth was strong across all the areas of the world. We continue to add a lot of users in places like India and Brazil. And engagement trends, I think, were similarly strong throughout. And mobile is clearly a big part of that equation, and been very helpful to us in terms of getting more users, more daily users, and more engagement from those users. In terms of revenue by geography, I don't know that there's a lot to add to the numbers I've already said. Europe looked good in the first quarter after being a little bit softer towards the end of last year and we continue to grow well in Asia and the rest of world. So I think just pretty consistent performance there. + +-------------------------------------------------------------------------------- +Operator [9] +-------------------------------------------------------------------------------- + + Scott Devitt with Morgan Stanley. + +-------------------------------------------------------------------------------- +Jordan Monahan, Morgan Stanley - Analyst [10] +-------------------------------------------------------------------------------- + + It's Jordan Monahan on for Scott. Just two quick questions. The first is, one of your competitors recently said something to the effect of, if you're building for mobile, you're building for today but not tomorrow, suggesting that tomorrow is a multi-screen world with all sorts of personalized devices. And I'm just curious, what opportunities do you see when you think about tomorrow? Would you agree that screen fragmentation will continue to increase? And does moving ads toward newsfeed and away from right-hand side help you in that environment? And then the second question is just about engagement. Engagement continues to improve despite more ads, which validates your strategy. So every time you launch a new product people get concerned that engagement may actually tick down, but it seems to do the opposite. So, are there other ad formats that you're thinking about that are likely to be complementary to engagement? + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook, Inc. - CEO [11] +-------------------------------------------------------------------------------- + + All right, well, I'll start. I think that the trend of more different form factors, I think is somewhat orthogonal from the main trends that we see, which is just people sharing more in different ways. People want to stay connected with their friends and family and all of these different folks in their lives. And they're going to use whatever technology they have to enable that, whether that's desktop computers or laptops or phones or tablets or glasses. Whatever the products are. And I think that there's going to be good ways for people to be able to consume social content on all of those. So I think the big question for us is just which platforms do we see growing the quickest. We're not tooled up as a company right now to make 10 huge investments like that at a time, but we can do a couple. +Certainly tablets are growing very quickly and I think that's going to be increasingly important. But I think that consuming social content and staying connected with people is just such a fundamental human need that that that's going to be important on all of these. Getting ads in newsfeed was a valuable step in making it so that everywhere where someone is consuming content from Facebook, the business model goes along with that naturally. That was one of the early challenges that we had with mobile was ads for the first six or seven years of Facebook were just right-hand column, and that didn't translate to mobile. But it was fairly easy, with some amount of work, just to make that transition and we're there now. And now I think whatever the form factor is going forward, we'll be able to deliver advertising content in a proportion that we think is good, along with consumer content. +For the sentiment stuff, I think what we're seeing is really positive and it's better than expectations. We assumed that sentiment and satisfaction might drop some amount. We continue to watch this really carefully because there's no guarantee that it won't in the future. But right now, what we have seen has made us more confident that we can do more with advertising over time and can ramp that up. Our strategy isn't to have a ton of different ad units. We really want to make it so that we're delivering these end-to-end solutions for our customers, and only have a small number of simple things to make it easier for advertisers to work with us. We want to deliver that and we're underway on this long road map to execute that. + +-------------------------------------------------------------------------------- +Operator [12] +-------------------------------------------------------------------------------- + + Anthony DiClemente with Barclays. + +-------------------------------------------------------------------------------- +Anthony DiClemente, Barclays Capital - Analyst [13] +-------------------------------------------------------------------------------- + + Thanks a lot. I have one for Sheryl and one for David. Sheryl, you talked about Atlas and the measurement capabilities there, and you framed it in terms of click-based ads. I'm wondering, is there also an opportunity for Atlas to improve or standardize measurement for impression-based ads? The spirit of the question, more generally, can you just talk about, or update us on, the potential for impression-based ads in terms of increasing as a percentage of the mix versus performance-based ads on Facebook? +And then, David, question would be a little bit of a decel in the rate of growth of ARPU in the US. I'm wondering if there are other things you can call out in the first quarter, be it dollars from large events, TV events like the Super Bowl, or other things, other than seasonality. Or maybe you can quantify or comment on the seasonality factor in the US and Canada for 1Q. Thanks a lot. + +-------------------------------------------------------------------------------- +Sheryl Sandberg, Facebook, Inc. - COO [14] +-------------------------------------------------------------------------------- + + On Atlas, you're exactly right. Our focus with Atlas is on impression-based ads. And the idea is that, historically, a lot of ads online, which were more based on search, the attribution was always that last click. And as people have looked more holistically at all the ad spending they're doing, what they find is that it's not just the last click that matters, but it's all the impressions leading up to that click. +Importantly, we also drive sales offline. And offline, people aren't clicking through the purchase at all but they are actually walking into a store. So, in some sense, there is no last click. And so our focus with Atlas is to take that technology and enable us to improve our ability to connect ad impressions to purchase behavior, both offline and on. And not just on Facebook but across different ad purchases people do. So that's exactly why we made that purchase. + +-------------------------------------------------------------------------------- +David Ebersman, Facebook, Inc. - CFO [15] +-------------------------------------------------------------------------------- + + In terms of ARPU in the US and Canada, was up 21% versus last year so continuing to make good progress there. I really don't have anything unique to say about seasonality in 2013. We see it from Q4 to Q1 across the years that we've been an advertising business. And I'm sure there are unique things that impact each year, but there's nothing that we're aware of that was particularly important in 2013 in that regard. + +-------------------------------------------------------------------------------- +Operator [16] +-------------------------------------------------------------------------------- + + Jordan Rohan with Stifel. + +-------------------------------------------------------------------------------- +Jordan Rohan, Stifel Nicolaus - Analyst [17] +-------------------------------------------------------------------------------- + + Thanks so much. I'm curious about how you address markets where it's a little bit harder to sell advertising. Specifically, if I'm calculating correctly, then 41% of monthly active users are in the US, Canada and Europe, as you define those geographies in your slides. And that's 74% of ad revenues. How can the other geographies of the world step up to be an even more meaningful percentage of total revenue? Do you have to add a lot of heads, a lot of sales infrastructure and technology infrastructure that you don't currently have? And from that perspective, did you meet your objectives in terms of hiring and expenses? Because I know how hard it is to support a business as global as Facebook. Thank you. + +-------------------------------------------------------------------------------- +Sheryl Sandberg, Facebook, Inc. - COO [18] +-------------------------------------------------------------------------------- + + I'm very encouraged about our opportunity to sell ads all over the world. One thing I've learned in my time selling ads on the Internet, which is going over a decade now, is that markets that you don't expect to have ad markets develop faster than you would think. So, if had asked me seven years ago what Turkey's ad market would look like, I would not have predicted it as it is today. So I'm increasingly encouraged by small businesses around the world, and large businesses, and their adoption of the technology. +I think with small businesses, we had an actually really deep competitive advantage, which is that people all around the world use Facebook. So when small businesses, who are historically way too busy to spend a lot of time using technology, start to use the Facebook platform, they're using something they already use as users. So once you have a time line or a profile, setting up a page is not a very big ask because you understand it and you're doing it anyway. And that's why we think, with almost no direct effort, we have 16 million small businesses actively using Facebook pages. I think one of the things we've done well over the past number of quarters is rolled out simplified ad products like Promoted Posts, where it's easy for those people who are using pages -- and this happens all over the world -- to become advertisers. And we're increasingly optimistic that we can do more and more of that. + +-------------------------------------------------------------------------------- +David Ebersman, Facebook, Inc. - CFO [19] +-------------------------------------------------------------------------------- + + In terms of hiring, I think everything has gone quite well. And as we've discussed, 2013 is a year where we're investing for future growth and I think in the first quarter, both in terms of hiring and building out our infrastructure, we're on track with where we want to be. + +-------------------------------------------------------------------------------- +Operator [20] +-------------------------------------------------------------------------------- + + Youssef Squali with Cantor Fitzgerald. + +-------------------------------------------------------------------------------- +Youssef Squali, Cantor Fitzgerald - Analyst [21] +-------------------------------------------------------------------------------- + + Thank you very much. Two questions, maybe one for Sheryl and one for Mark. On ad pricing, can you maybe just talk about CPMs for ads in the newsfeed versus ads on the right-hand rail? Can you give us maybe just an idea as to the magnitude of the difference between the two? Was that a big driver for that 21% increase? And then on video advertising, I was just wondering what's the strategy to bring video advertising to Facebook, both in your newsfeed on the desktop, initially, and then eventually on mobile, assuming that there's enough bandwidth for that? Thanks. + +-------------------------------------------------------------------------------- +David Ebersman, Facebook, Inc. - CFO [22] +-------------------------------------------------------------------------------- + + This is David. I'll take the first one, which is about CPMs. The ads that we show in newsfeed are displayed more prominently and they are more in the flow of a user's attention. So, as you would imagine, we get more engagement with those ads and they end up commanding a much higher average price per ad, as you would expect. + +-------------------------------------------------------------------------------- +Sheryl Sandberg, Facebook, Inc. - COO [23] +-------------------------------------------------------------------------------- + + Video ads. Yes, sorry, I'll take the second part. So, video is a really exciting area because we had leveraged our scale and engagement and our ability to provide relevant ads. We have a video product out today. Advertisers can embed a video in their page posts and we're seeing really strong results. I think both because of that and because of marketers' inherent liking video as a format, we continue to explore new things as well, but we don't have anything to announced today. + +-------------------------------------------------------------------------------- +Operator [24] +-------------------------------------------------------------------------------- + + Justin Post with Bank of America Merrill Lynch. + +-------------------------------------------------------------------------------- +Justin Post, BofA Merrill Lynch - Analyst [25] +-------------------------------------------------------------------------------- + + Thank you. Two questions. First, on ad formats. Sheryl, do you think you really optimized the ad formats, especially on PC? Or is there a lot of room you can do to get better performance from that? And then, secondly, maybe you can just give us a business update on Instagram. Maybe you could compare where they are to where Facebook was when you turned on ads or any thoughts on how you could monetize that platform, maybe far down the road. Thank you. + +-------------------------------------------------------------------------------- +Sheryl Sandberg, Facebook, Inc. - COO [26] +-------------------------------------------------------------------------------- + + On the first, I think there's a lot of room to improve our ads. I don't know whether that will take the format of different formats. I think more of it will be in terms of quality because I think we feel pretty good about our format. But one of the main pushes we have is to make each ad a better experience for users. Content in those ads, which is as good as the content they'll see from a friend or anything else on the site, as well as make those higher return for marketers. And those two go hand in hand. I think the place you will see the most from us is more around targeting, around ability to take the formats we have and make the ad better within those formats. That's certainly our focus now. But as our site evolves and our product evolves we never rule out changing a format, as well. + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook, Inc. - CEO [27] +-------------------------------------------------------------------------------- + + And on Instagram, they are really doing well and growing really quickly. And I think that that is the right focus for them. And they have this opportunity to capture and basically build off this huge community, and I think that that should be 100% of the focus right now. I am really optimistic about the business opportunity there, too. You already have a lot of brands from folks who advertise with Facebook, putting content into Instagram, getting huge engagement rates. So people are coming to us and asking for ways to make that even richer and it's something that we're thinking about. But right now I think that -- I'm just really proud of the team and excited about how quickly they are growing. And we mentioned this in my comments early on, but they are growing a lot faster now and were faster to get to 100 million than Facebook even was. + +-------------------------------------------------------------------------------- +Operator [28] +-------------------------------------------------------------------------------- + + Gene Munster with Piper Jaffrey. + +-------------------------------------------------------------------------------- +Gene Munster, Piper Jaffray - Analyst [29] +-------------------------------------------------------------------------------- + + Good afternoon. You've seen some acceleration of revenue over the last three quarters. Can you just give us some guidelines in terms of should we continue to see that revenue accelerate. And if not, at some point, in the back half of this year or early next year, based on some of the investments in new products, could we see another inflection point in growth? Thank you. + +-------------------------------------------------------------------------------- +David Ebersman, Facebook, Inc. - CFO [30] +-------------------------------------------------------------------------------- + + I think we're still in the really early days of what we're doing and it's particularly true in mobile. A year ago we didn't have any mobile ad revenue and now it's 30% of our ad revenue. So this is great. We're really pleased with the progress and we still believe that mobile has the opportunity to be huge for us if we can execute well. We've got a really large mobile user base. They are very engaged and spend a lot of time with us. We have an ad format that works on mobile and we have identities so that we can put the right ads in front of the right people. +So I think the future for us is, I think, much more interesting than trying to project it from any particular quarter at this point, just because we've got a lot left to do. And obviously we'll continue to try and develop tools to enable us to monetize our advertising better and potentially in different ways, as well. But the big opportunity that's right in front of us is trying to make the mobile advertising products higher quality and more relevant over time. + +-------------------------------------------------------------------------------- +Operator [31] +-------------------------------------------------------------------------------- + + Ben Schachter with Macquarie. + +-------------------------------------------------------------------------------- +Ben Schachter, Macquarie Research Equities - Analyst [32] +-------------------------------------------------------------------------------- + + A couple issues for Mark. I was wondering, first, if you could talk about the platform strategy and maybe give some specific examples of third parties that have really been successful. And, in general, what are the lessons that you've learned around the platform strategy and how it has evolved. And then, secondly, just around the evolution of Graph Search, any lessons from the launch, positive or negative? Thanks. + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook, Inc. - CEO [33] +-------------------------------------------------------------------------------- + + Sure. One thing that I think has actually gone well with the platform recently is the gaming ecosystem. David was talking about this earlier. With the exception of our largest partner, Zynga, whose growth hasn't been as awesome as everyone would hope, the rest of the community has actually grown quite well and is quite healthy. And so we're pretty happy with that and it's a pretty diverse group. I mentioned in my comments at the beginning, we're up to -- I think it's 81 of the top 100 top grossing iOS apps and 70 of the top grossing Android apps are connected in with Facebook, so we're getting good coverage. And that's always been the vision, is making it so that any app and experience that you have can be social. That's working well. +And also we really want to be a source that developers can come to for distribution and make it so that they can come to Facebook and spread their apps. People have always had good tools to do it organically, but recently the app install ad product has been another tool in developers' arsenal in order to do that, and that's showing some real traction. So I'm pretty excited about that, as well. +Graph Search was your other question. The strategy around this, and where we are in rolling it out is we developed it over a period of time at the Company. And we knew that in order to get it to be really good we had to get some real world data, so we rolled it out to just a small percent of people in order to be able to tune the ranking and all that. We're getting it to a state where we're really happy with it before we roll it out to everyone. But we're really optimistic that that will happen over the coming months. +So I'm pretty excited about that. The people who use it, we've gotten very positive feedback from it and I think it's going to be a very big opportunity. But the launch wasn't this point where we expected a ton of people to start using it. We've gated who can use it quite aggressively, in order to just make sure that we get the data that we need, and the real rollout will hopefully start pretty soon. + +-------------------------------------------------------------------------------- +Operator [34] +-------------------------------------------------------------------------------- + + Mark Mahaney with RBC. + +-------------------------------------------------------------------------------- +Mark Mahaney, RBC Capital Markets - Analyst [35] +-------------------------------------------------------------------------------- + + Thanks. I was wondering if you could talk about engagement per cohort. There's an urban myth that those under 25 are disengaging from Facebook. It's hard for us to see that in, obviously, the data that you report. But you would know that. Is the mobile engagement, is that offsetting that? Could you talk about that engagement amongst younger cohorts? +And then, secondly, you talked about advertising on mobile devices performing well. Could you actually make the statement as to whether it performs as well as desktop ads do for advertisers on Facebook -- similar to, sometimes greater, sometimes less? Could you compare those two? Thank you. + +-------------------------------------------------------------------------------- +David Ebersman, Facebook, Inc. - CFO [36] +-------------------------------------------------------------------------------- + + Sure. I guess I'd start by saying we remain really pleased with the high level of engagement on Facebook by people of all ages around the world. You asked about people under 25. We continue to have really high penetration rates among that age group, both in the US and globally, and that the younger users remain among the most active and engaged users that we have on Facebook. And then, in addition, younger users are extremely active users of Instagram, as well. So that's great and makes our position even stronger. +From our standpoint, the urban legend you referenced flows, more often than not, from surveys people have done of younger users that indicate that they are using other social services. And we take this feedback seriously but our sense is much of the concern stems from the assumption that this is a zero sum game, and that's not how we see it. +We think the overall amount of time spent on services that enable you to connect and share is growing and will continue to grow, because these kinds of services are really engaging and good. And it's great for us to be the leader in a market that's expanding rapidly with the foundation we have with both Facebook and Instagram. And I guess the challenge for us is just to continue building great products that appeal to users of all ages. +Your second question about the engagement levels or the performance of mobile ads, I think it's fair to say that newsfeed ads on both mobile and desktop both perform extremely well and we're pleased with both formats. + +-------------------------------------------------------------------------------- +Operator [37] +-------------------------------------------------------------------------------- + + Ken Sena with Evercore Partners. + +-------------------------------------------------------------------------------- +Ken Sena, Evercore Partners - Analyst [38] +-------------------------------------------------------------------------------- + + I was just hoping that you could go back to Atlas for a second and maybe give us a sense of maybe the run rate quarter on quarter. And is it correct to see Atlas as an avenue into monetizing potential inventory off of Facebook? And how do Home and maybe your Mobile Open Graph tie into that strategy? Thank you. + +-------------------------------------------------------------------------------- +Sheryl Sandberg, Facebook, Inc. - COO [39] +-------------------------------------------------------------------------------- + + Our main focus with Atlas is our own measurement. That being able to measure Facebook ads all the way through to purchase, and net compare those in an apples-to-apples way with other ad purchases you make not on Facebook, is really important to drive marketer engagement with us. And that's our focus. We have no plans to launch in the network. We also don't break out -- we're not breaking out the revenues from Atlas. + +-------------------------------------------------------------------------------- +David Ebersman, Facebook, Inc. - CFO [40] +-------------------------------------------------------------------------------- + + And it's small. We didn't buy Atlas for the run rate of its revenues, but because we feel like it's a tool that can help us to grow our own business. + +-------------------------------------------------------------------------------- +Operator [41] +-------------------------------------------------------------------------------- + + Douglas Anmuth with JPMorgan. + +-------------------------------------------------------------------------------- +Douglas Anmuth, JPMorgan - Analyst [42] +-------------------------------------------------------------------------------- + + Thanks for taking the question. Sheryl, you talked about having strong traction with SMBs, and also in direct response in app developers, and also about Atlas and attribution. But can you help us understand the biggest hurdles that you have right now with big marketers? And then, secondly, David, if you could help us understand the percentage of mobile ads revenue that's coming from mobile app install ads. Thank you. + +-------------------------------------------------------------------------------- +Sheryl Sandberg, Facebook, Inc. - COO [43] +-------------------------------------------------------------------------------- + + There are lots of types of big marketers. There are big marketers out there who are direct marketers. There are also big marketers who are brand marketers. And I think first and probably it's the brands, so that's how I will answer it, even though it's worth noting that there are big advertisers across the spectrum of different types of ad buys. As I said before, the thing about brand advertisers is that they got very used to TV, then they got very used to search, and we are a third thing. And we will win that business client by client, CMO by CMO. It's something I personally spend a lot of time on and I think we have a great team in the field against. +With some of the big brand advertisers, we have been working with them for years and years. A lot of the data and measurement you hear us talking about are studies we've done with them based on campaigns that we've run with. And I think we have a lot of belief at the top, and in many of them we're in the process of going through their companies and getting that same commitment to buy. So we'll have a CMO who has seen the value, we've proven the value, and really wants the company to come along. And now we're in the process of working brand by brand, region by region, to get that same buy-in lower in the organization, which actually takes more time, not surprisingly. +But other brand marketers, they are just in the testing phase, and they really haven't done enough with us so that we can even do the studies to prove the value. And so the good news for us is we're engaged with all 100 Ad Age 100, so everyone is buying with us on an annual basis. And we're working client by client to bring them along that spectrum. The good news is, I think we're increasingly proving that we can return on ad spend in different parts of the purchase funnel. +To share one recent example, MGM Resorts has used a different suite of Facebook products to address different customers at different parts of the purchase funnel. They used offers to acquire new customers and they saw a 3 times return on ad spend. Then they used FBX to re-target people who were in their booking process and dropped out and that gave them a 15 times return on ad spend. And then for past guests who had completed a purchase but hadn't come back, they used Custom Audiences to target them to return, and they got a 5 times return. And I think it's experiences like that, where we show the breadth of what we can do, that really move us forward with the brand spender. + +-------------------------------------------------------------------------------- +David Ebersman, Facebook, Inc. - CFO [44] +-------------------------------------------------------------------------------- + + You asked about mobile app install ads. We launched that product, I think, at the beginning of the fourth quarter, more broadly. It's early in its development but really doing quite well. And we're pleased with both the quality of the experiences we're providing and with the revenue growth that we've seen. It really fits in nicely with the idea of putting content into newsfeed that we think will be of interest to users and provide value for developers. The only other thing I'd note is that it's an incremental audience for us, for the most part, from an advertising standpoint, which is also nice. Some of those developers were advertising with us before but for a lot of the mobile app install ad purchasers are new advertisers to Facebook. + +-------------------------------------------------------------------------------- +Operator [45] +-------------------------------------------------------------------------------- + + Brian Wieser with Pivotal Research. + +-------------------------------------------------------------------------------- +Brian Wieser, Pivotal Research - Analyst [46] +-------------------------------------------------------------------------------- + + Thanks for taking the question. First of all, I just wanted to go back into the segments of the advertisers between the brands, developers, small businesses and performance. Is there any way you can characterize what maybe the growth trends have been, even recognizing some of them blur the lines? Or, alternately, growth trends between the different ad products. I find it's useful to get a sense of where the relative growth is. That would be useful. +And then a second question, I just wanted to get updated thoughts on data centers and the role of data centers for Facebook. The degree to which you think that it is strategic in investing in and building these out. Or if it's really just about operational efficiency. Thank you. + +-------------------------------------------------------------------------------- +David Ebersman, Facebook, Inc. - CFO [47] +-------------------------------------------------------------------------------- + + In terms of the segments, it's really hard to break out the revenue because the same advertiser crosses multiple segments with multiple objectives, sometimes with the same ads. One of the ways we use the segments is to help focus our product development on understanding the different objectives that marketers might have, but then translating that into individual groups of revenue is difficult. I think that, as Sheryl mentioned, we're particularly pleased with small businesses as something that we can measure on Facebook and see the number of advertisers increasing. +In terms of data centers, I think it is both strategic and operational. There's no question that owning our own data centers removes another party from the mix relative to when we used to lease data center space. It also enables us to build the data centers to look exactly as we want them to look, so that the performance is optimized for precisely what Facebook needs to do with the servers that we put in there. And there's definitely some efficiency that comes from that. But I would also say that, given what we're trying to do and the world we're trying to reach, I do think it's strategic for Facebook to not be dependent on third parties to provide that critical part of our supply chain. + +-------------------------------------------------------------------------------- +Operator [48] +-------------------------------------------------------------------------------- + + Aaron Kessler with Raymond James. + +-------------------------------------------------------------------------------- +Aaron Kessler, Raymond James - Analyst [49] +-------------------------------------------------------------------------------- + + Yes, a couple questions. On the unpublished Page Post, can you just give us an update? I think that got released towards the end of the first quarter. Maybe what type of traction you're seeing there. And also just going back to the US versus Europe, can you just maybe detail? Europe definitely outperformed US on a sequential basis. Was that due to some of the later adoption of some of the sponsored stories in the newsfeed? Or was that something else? Thank you. + +-------------------------------------------------------------------------------- +Sheryl Sandberg, Facebook, Inc. - COO [50] +-------------------------------------------------------------------------------- + + On Page Post, Page Post ads first appeared May of last year, and then we just put them into newsfeed in March of 2013. In terms of unpublished, what that just means is the ability to target Page Posts only to the right people. So, for example, without posting it to everyone on your page. For example, if you're a retailer and there was a snow storm in one state, you could target snow shovels or other relevant stuff you want to sell for a snow storm only to people in that state. So it's just a really useful way of segmenting your audience. Again, part of our overall push to relevance, targeting and quality. +We're really excited about Page Post ads. Over 7.5 million posts have been promoted by pages. Over 30% of the people using the product are new advertisers to Facebook. And I think that speaks to one of the earlier questions on small to medium businesses and their adoption. If you say to an SMB, do you want to become an advertiser? That's a heavy lift. If you say to them, you have a page, you've posted something, do you want to pay a few dollars to promote this post to reach more people? That is a much easier on ramp to advertising spend with us and we think it's working really well. + +-------------------------------------------------------------------------------- +David Ebersman, Facebook, Inc. - CFO [51] +-------------------------------------------------------------------------------- + + In terms of US and Europe, I really don't have a lot more to add. The Europe number, as I said, was strong in Q1. I'm certain it's true that for some of the products that we roll out, the US represents the first adopters and then they spread their way to other clients around the world. But I don't have any specific evidence to support that that was key to the trends in Q1. + +-------------------------------------------------------------------------------- +Deborah Crawford, Facebook, Inc. - Director of IR [52] +-------------------------------------------------------------------------------- + + Operator, I think we have time for one last question. + +-------------------------------------------------------------------------------- +Operator [53] +-------------------------------------------------------------------------------- + + Daniel Ernst with Hudson Square Research. + +-------------------------------------------------------------------------------- +Daniel Ernst, Hudson Square Research - Analyst [54] +-------------------------------------------------------------------------------- + + Yes, good evening. Thanks for taking my call. Two questions, if I might. If we look at the broad base of all ad impressions across Facebook, whether it's desktop or mobile, can you give us a sense of what percentage of those are generated or conditioned by social statistics or socially relevant data that comes out of the Facebook experience versus ads conditioned by external data, like from Acxiom or from re-targeting traffic from other web sites? +And then, second, within the category of apps and other, can you give a sense of is there any materiality around the other category? So, not apps payments or what part of that might have been Facebook type services like gifts. Thank you. + +-------------------------------------------------------------------------------- +David Ebersman, Facebook, Inc. - CFO [55] +-------------------------------------------------------------------------------- + + To your first question on mobile, I think the question was on mobile ad load, is that right? + +-------------------------------------------------------------------------------- +Daniel Ernst, Hudson Square Research - Analyst [56] +-------------------------------------------------------------------------------- + + No. Whether it's mobile or desktop, what part of the --. + +-------------------------------------------------------------------------------- +David Ebersman, Facebook, Inc. - CFO [57] +-------------------------------------------------------------------------------- + + Okay. Sorry, I got lost in the second question, which I should have written down the first one. Right now, you asked about Acxiom and things like that. That's a very small percentage of the ad impressions we show. Hopefully over time we can bring tools to bear that can really increase our ability to do more targeting, or more effective targeting than we do today. +In terms of the second part, I think you're asking about the whole payments and other fees revenue line. I said the whole line grew by 15%. Games represented 12% growth. So the increment in between the 12% and the 15% came primarily from user-promoted posts, which is a product we launched last year. To a lesser degree, also, from our gifts product. + +-------------------------------------------------------------------------------- +Sheryl Sandberg, Facebook, Inc. - COO [58] +-------------------------------------------------------------------------------- + + Great. Thank you for joining us today. We appreciate your time. And we look forward to speaking with you again next quarter. + +-------------------------------------------------------------------------------- +Operator [59] +-------------------------------------------------------------------------------- + + This concludes today's conference call. You may now disconnect. + + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/exam/original-files/Problem_1_Sample/2013-Oct-16-BAC.N-137085760338-Transcript.txt b/exam/original-files/Problem_1_Sample/2013-Oct-16-BAC.N-137085760338-Transcript.txt new file mode 100644 index 0000000..6cd623f --- /dev/null +++ b/exam/original-files/Problem_1_Sample/2013-Oct-16-BAC.N-137085760338-Transcript.txt @@ -0,0 +1,968 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q3 2013 Bank of America Corporation Earnings Conference Call +10/16/2013 08:30 AM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Brian Moynihan + Bank of America Corporation - CEO + * Bruce Thompson + Bank of America Corporation - CFO + * Lee McEntire + Bank of America Corporation - SVP IR + +================================================================================ +Conference Call Participiants +================================================================================ + + * Derek De Vries + UBS - Analyst + * Moshe Orenbuch + Credit Suisse - Analyst + * John McDonald + Sanford C. Bernstein & Company - Analyst + * Mike Mayo + CLSA - Analyst + * Glenn Schorr + ISI Group - Analyst + * Guy Moszkowski + Autonomous Research - Analyst + * Matt O'Connor + Deutsche Bank - Analyst + * Vivek Juneja + JPMorgan - Analyst + * Betsy Graseck + Morgan Stanley - Analyst + * Jim Mitchell + Buckingham Research - Analyst + +================================================================================ +Presentation +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Good day and welcome to the Bank of America third-quarter earnings announcement. (Operator Instructions) Please be advised today's program may be recorded. +It is now my pleasure to turn the program over to Lee McEntire. You may begin. + +-------------------------------------------------------------------------------- +Lee McEntire, Bank of America Corporation - SVP IR [2] +-------------------------------------------------------------------------------- + + Good morning to those on the phone and joining us by webcast. Before Brian Moynihan and Bruce Thompson begin their comments, let me remind you that this presentation, which is available at BankofAmerica.com, does contain some forward-looking statements regarding both our financial condition and financial results, and that these statements involve certain risks that may cause actual results in the future to be different from our current expectations. Please see our press release and SEC documents for further information. +So with that, let me turn it over to our CEO, Brian Moynihan. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - CEO [3] +-------------------------------------------------------------------------------- + + Thanks, Lee. Good morning, everyone. I will cover a few points, and then I will turn it over to Bruce to go through the details of the quarter, as we have done in other quarters. +Consistent with prior quarters, our Company continued to show progress on the areas we have been focused upon -- capital generation, managing risk, achieving cost savings, addressing legacy issues, and driving our core growth strategies in our core lines of business. +On the capital front this quarter, we generated $3 billion-plus of Basel 1 Tier 1 common capital. Our Basel 3 ratios now approach 10% on a fully phased-in basis. That capital and liquidity and the balance sheet optimization that has been going on for the last several quarters holds us in good shape with regards to the regulatory suggested or proposed requirements that we see on the horizon. +The strength and capital is allowing us to return capital to shareholders. In the past six months we have repurchased 140 million shares, equalling about $2 billion of our $5 billion authorization. +Turning to the revenue side, we have experienced relative stability this quarter. But of course we felt the impacts of the industrywide headwinds on a slower refi business in mortgage and a slowdown in the capital markets from a typical summer slowdown as well as the investor concerns of a political and monetary uncertainty. +On expenses, this quarter we incurred additional litigation costs. Outside of that we continue to make progress on our expense initiatives, remaining on track to deliver the cost savings that we told you about two years ago in New BAC, and also reducing the costs in our Legacy Assets and Servicing area. +In the credit area we continue to see asset quality improve, and our net loss rates are at levels not seen since 2005. As the macro environment slowly improved we experienced a 20% drop in net charge-offs and a decline in delinquencies from the second quarter. +Our 248,000 teammates have been fully engaged with our customer clients to drive activity. We are pleased to see another quarter of solid loan growth in our commercial businesses, while we continue to see the consumer lending activity stabilize in our card balances and modest growth elsewhere, which has offset the runoff in our non-core portfolios. +As a Company, we reached record deposit levels this quarter, more than $1.1 trillion in deposits. Our client balance flows in our Wealth Management clients helped us maintain our industry-leading positions. And you have seen that Bank of America Merrill Lynch has assumed prominent roles in the marquee investment banking deals that have gone on this quarter. +We have also seen a nice trend of progress, absent some seasonality, of results in our equity trading business. It has been gaining market share and continuing to improve. +So to sum it up, it is another solid quarter of progress in our core businesses; and I'm going to turn it over to Bruce to cover in detail the presentation. Bruce? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [4] +-------------------------------------------------------------------------------- + + Thanks, Brian, and good morning, everyone. I am going to start my presentation on slide 5. During the quarter, we earned $2.5 billion or $0.20 per diluted share. +Before I address the core business trends let me mention a few noteworthy items from our results that we have disclosed to you previously. First, we sold our remaining stake in CCB, recording a pretax gain of $753 million, which was partially offset by a $443 million negative impact of FVO and DVA, as our as our credit spreads continued to tighten during the quarter. The net of these items benefited EPS by $0.02 in the quarter. +We also recorded a $1.1 billion charge to remeasure our UK deferred tax asset, given the 3% decline in the tax rate, which reduced EPS by $0.10 a share. The net of these is obviously a reduction of $0.08. +Moving to the core business, total revenues in the quarter on an FTE basis were solid at $21.7 billion, or $22.2 billion if we exclude the FVO and DVA charges. If we compare this to the second quarter, revenues declined on lower mortgage banking revenue as well as mostly seasonal declines within our sales and trading area. +Total non-interest expense of $16.4 billion included $1.1 billion in litigation costs, a $600 million increase in litigation cost from second-quarter levels. The increase in these costs was partially offset by the improvement in both our Legacy Assets and Servicing costs as well as the benefits of our New BAC initiatives. +Asset quality improved significantly, with net charge-offs improving 20% from the second quarter of 2013 to $1.7 billion. And with the reserve reductions we took in the quarter, we recorded provision expense of just under $300 million in the quarter. +On slide 6 you can see that our period-end balance sheet remained relatively stable versus the prior quarter at about $2.13 billion. Customer activity remained solid with loans, largely led by commercial loans, up $12.8 billion. +Consumer lending activity in the quarter improved as we saw increased loan generation in our Dealer Financial Services area and our continued stabilization of card balances, which was partially offset by the runoff within our home equity portfolio. Period-end deposits were up over $29 billion or 2.7%, led by commercial client activity and solid flows from our Wealth Management clients. +If we move down the page, tangible book value per share improved to $13.62, and our tangible common equity ratio increased above 7%. +A couple other things that I would like to mention during the quarter. We repurchased 60 million shares for roughly $900 million during the quarter. OCI increased by about $900 million during the quarter. And our preferred stock includes the completion of our previously announced preferred stock redemption for just under $1 billion. +On slide 7 you can see our Basel 1 Tier 1 common ratio of 11.08% increased 25 basis points from the second quarter of 2013. Under Basel 3 on a fully phased-in basis under the Advanced Approach, Tier 1 common capital increased by approximately $6 billion to an estimated $131.8 billion. Our Tier 1 common ratio is 9.94%, showing a 34 basis point improvement from the second quarter of 2013. +And our estimate of the Basel 3 Tier 1 common ratio on a fully phased-in basis under the Standardized Approach would be just over 9% above our proposed 8.5% 2019 minimum requirement. +If we move to the supplemental leverage ratio, based on the proposed US requirements that don't take effect until 2018, at the end of the third quarter our bank holding company leverage ratio improved to above the proposed minimum of 5%; and our two primary banking subsidiaries, BANA and FIA, continue to be in excess of the 6% proposed minimum. +So to reiterate what Brian mentioned, there are a lot of new capital regulations proposed or finalized, and we already exceed the requirements for the various known rules on Basel 3 capital and the supplementary leverage ratio. +On slide 8, funding and liquidity, you can see our long-term debt ended the quarter $7 billion lower as maturities and the completion of our $5 billion tender offer outpaced issuances. We have $40 billion of parent Company maturities through 2014; and as we look forward, we expect issuances to be materially below that number as we continue to reduce and smooth the maturity profile of our debt footprint. +Global excess liquidity sources of $359 billion increased from $342 billion at the end of the second quarter of 2013, and parent Company liquidity remained strong at $95 billion. That translates into a Time to Required Funding of 35 months, well above our two-year coverage that we target. +I would also like to highlight that on October 1 of this year we have completed the legal entity merger of the Merrill Lynch Holding Company into Bank of America Corporation as part of our continued efforts to both simplify the Company and reduce cost. +We turn to slide 9, net interest income. Net interest income on a reported basis was $10.5 billion, down from the second quarter of 2013, as the improvement in our core net interest income was more than offset by a negative impact from market-related impacts. If we exclude those market-related impacts, net interest income built off of Q2 2013's $10.4 billion to be just north of $10.5 billion. +During the quarter, we benefited from higher rates in our discretionary book, lower long-term debt levels, higher commercial loans, and lower rates paid on deposits. These positives were partially mitigated by lower loan yields and lower trading-related NII. +As you will note on the slide, the net interest yield excluding market-related impacts improved from 2.36% to 2.44%, driven by the lower balance sheet levels as well as our lower funding cost. And consistent with what we mentioned last quarter, we expect to realize the benefit of higher long-term rates as we reinvest, but note that some of those benefits will occur through time. +On slide 10, we will spend a few minutes on expenses. Total expenses for the quarter were $16.4 billion, a $1.1 billion improvement from the year-ago quarter, but up $371 million from the second quarter of this year. +I want to be clear. As you look at expenses and see the uptick in the linked-quarter expense, we continue to deliver on our non-litigation expense reductions in our Legacy Assets and Servicing area as well as the ongoing benefits from our New BAC initiatives in the balance of the Company. +Compared to the second quarter of 2013, progress on LAS and New BAC, in addition to lower revenue-related incentive compensation, was more than offset by increased cost of litigation as well as some marketing initiatives that were accelerated from the fourth quarter of 2013. Our litigation expenses did increase as the continued evaluation of legacy exposures led to an addition to reserves. +Our LAS expenses ex-litigation, which are shown on the gray bar on slide 10, of $2.2 billion declined $110 million from the second quarter of 2013. And we continue to expect our fourth-quarter LAS expenses ex-litigation to be below $2 billion as we continue to make very good progress on reducing the number of 60-plus-day delinquents that we have in that business. +Our New BAC savings in the third quarter were approximately $100 million and are included in All Other, the red bar. We also remain on track to achieve the expected $1.5 billion of New BAC quarterly cost benefits by the end of 2013 and ultimately the $2 billion quarterly benefit upon completion of the project. +From an employee staffing perspective, our number of FTEs ended the quarter at 248,000, a decline of more than 9,000 or 3.6% from the second quarter of 2013. That was driven by staff reductions within our Legacy Assets and Servicing area, declines in home loans given the slowdown in mortgage production, as well as the continued optimization of our branch network. +While we were down by 3.6% from the end of the second quarter to the end of the third quarter, the average FTEs only declined 2.3%. So we will get some additional benefits during the fourth quarter relative to the third from those reductions. +We touched on asset quality, slide 11. You can see that credit quality once again improved significantly. Net charge-offs declined to $1.7 billion, a 20% improvement on a linked-quarter basis. +As Brian referenced, our third quarter of 2013 loss rate of 73 basis points declined 21 basis points from the second quarter and is now at 2005 levels. Delinquencies, a leading indicator of charge-offs, again declined nicely. +During the quarter, we did reduce reserves by $1.4 billion on the back of steadily improving consumer data, which resulted in a provision expense of just under $300 million. Given what we see from the improving delinquencies as well as the current HPI trends, absent any unexpected changes in the economy, we expect net charge-offs to decline again in the fourth quarter and stabilize sometime in 2014 at approximately $1.5 billion per quarter. +Let's move into the individual lines of business on slide 12. Our Consumer and Business Banking segment, we were very pleased with the results during the third quarter as we delivered improved earnings, with revenues growing modestly and expenses declining from both the previous quarter as well as the year-ago quarter. This, coupled with lower credit costs within the segment resulted in net income of approximately $1.8 billion during the quarter, a 28% improvement over the previous quarter and a 32% improvement over last year. +That was achieved as we continued to do more business with our core customers. Our average deposits were stable as our organic customer growth was offset by small branch divestitures as well as migrations to our Global Wealth and Investment Management area. +Our brokerage assets are at record levels within this business, up 6% from the second quarter and up 18% over the prior year's quarter. Average loans, as I mentioned, reflect stability in card balances as well as growth within our Dealer Financial Services area. +Card issuance during the quarter remained strong. We issued more than 1 million new cards in the third quarter, which is at the highest level going back to 2008. Consistent with our relationship strategy, 63% of this issuance was to people that we have existing relationships with. +And credit quality continues to be strong as delinquencies and net losses continued to improve during the quarter. Reduced expense levels in the segment reflect the benefits of our network optimization, partially offset by investments we continue to make as we build out our specialist salesforce in this area. +On slide 13, Commercial Real Estate Services, where we operate the production, origination, and servicing of consumer real estate loans. In our supplemental information we report the two separate components of this segment, one focused on loan origination and the other focused on servicing and legacy issues. +On originations this quarter, first mortgage retail originations were $22.6 billion, which was down 11% from the prior quarter and up 11% compared with originations in the year-ago period. We believe that the current-period decline in production is less than our industry peers, as we have been working through our existing pipeline. +Our current pipeline at the end of the third quarter is, however, down approximately 60% compared to the end of the second quarter of 2013, which reflects the significant reduction in market demand, particularly in the refinancing space. Since our production revenue is booked at the point in which you lock a loan, as opposed to funding, I should point out that our lock volume was down 23% from the second quarter of 2013. +In addition to those lower lock volumes, we saw a gain on sale margins decline compared to the second quarter of 2013. Our reduction was about 60 basis points during the quarter. +As a result of all these factors, core production revenue was down 46% to $465 million from the second quarter of 2013. +From a staffing point of view, just on the origination side, as we saw demand slow we reduced headcount by more than 1,000 employees toward the end of the quarter. We will continue to reduce these staffing levels, to be consistent with the lower volumes that we have seen. +The other primary component in this segment, servicing revenue, declined approximately $100 million versus the second quarter as our servicing portfolio declined as we continued to complete certain servicing transfers. +The other item that I want to highlight on this slide that is particularly important is the servicing costs that we see within the Legacy Assets and Servicing area. We have spoken a lot about reducing the number of 60-plus-day delinquencies in this portfolio, and we had a lot of success during the quarter as the number of 60-plus-day delinquent loans dropped below 400,000 units at the end of September, nearly 100,000 lower than what we had at the end of June. +Roughly half of the decline was driven by the transfers of servicing that I referenced in conjunction with the MSR sales agreements that we announced in the first quarter of 2013. Once again, as a result of this work we continue to believe that our LAS expenses, ex-litigation, will be below $2 billion during the fourth quarter of 2013. +On slide 14, our Global Wealth and Investment Management area had another strong quarter, generating solid earnings and solid returns. Within this segment, both Merrill Lynch and U.S. Trust maintained their leadership positions with a total of $2.3 trillion of client balances. +Revenue remains near record highs at $4.4 billion, up 8% over the third quarter of 2012. Relative to the third quarter of 2012, net income improved 26% and was the third consecutive quarter in which our pretax margin was above 25%. +Asset management fees achieved a new record during the quarter, while our brokerage income did decline from the second quarter due to reduced market activity. +Client engagement remains quite strong. Long-term AUM flows were $10.3 billion, near doubling last year's production. Ending deposits were up $6.5 billion or roughly 3% from the prior quarter; and our ending client loan balances of $117.2 billion reached record levels and are up 2% from the second quarter of 2013 and 11% over the third quarter of a year ago as we continue to provide more banking products to both our Merrill Lynch and U.S. Trust clients. +On slide 15, you can see Global Banking earnings were stable relative to the year-ago period. Revenue compared to a year ago includes the benefit of strong loan growth and stable investment banking fees. +Expenses this quarter include very good cost controls offset slightly by elevated litigation expense. Global fee pools did decline, but we maintained our strong second-place ranking of global net investment banking fees, recording $1.3 billion of fees and improving our market share to 7.7%. +In addition, if you look at it fees within the Americas, we ranked number 1 with an 11% market share. During 2013, we have advised on 7 of the top 15 announced M&A deals. +As we head into the last quarter of the year, the pipeline looks quite strong. But I do want to highlight that during the fourth quarter of last year we did see record levels of debt issuance during that period. +If we look at the balance sheet, average loans increased $4.4 billion from the second quarter, with more than half of that growth driven by commercial real estate lending, with the balance by C&I lending, particularly with our large corporate clients. Average deposits increased $12.2 billion from the second quarter of 2013, above our expectations, given certain timing considerations as well as customer liquidity that has been built around fiscal cliff concerns. +If we move to slide 16, Global Markets, we earned $531 million during the quarter after excluding the $1.1 billion UK tax charge as well as DVA losses of $291 million. On a comparable basis, this is a decrease of $341 million compared to the third quarter of 2012 and down $403 million from the second quarter of 2013 due to lower sales and trading revenue as well as higher expense from litigation. +Sales and trading revenue, ex-DVA, was $3 billion during the quarter, an 8% declined from the comparable year-ago period. FICC sales and trading revenue was down 20% versus the year-ago period, once again impacted by concerns regarding the Fed's position on its stimulus program as well as political uncertainty both domestically and abroad. +Our equity sales and trading area had another very strong quarter with revenues, ex-DVA, up 36% over the year-ago period as we experienced higher market volumes and continued to benefit from the repositioning of this business that has happened over the last 18 months. We are gaining market share and we are improving our performance in each of the product lines. +Expenses in the quarter compared to the third quarter of 2012 included higher litigation costs that were partially offset by a reduction in operating expenses. Average trading-related assets were down 4% from the year-ago period while our VaR was effectively flat. +On slide 17, we show you the results of All Other. Gains on the sale of debt securities were $347 million in the third quarter, down $105 million from the second quarter of 2013. You can also see the breakout of $1.1 billion of equity investment income, which reflects the CCB gains I mentioned earlier as well as an additional $368 million of gains. +The FVO that I mentioned earlier is also recorded in this segment. Expenses include roughly $350 million during this quarter for litigation. That compares to $100 million in the second quarter of 2013 and $950 million in the third quarter of 2012. +As we close on All Other, I would note that the effective tax rate for the quarter, ex-the impact of the UK tax reduction charge, was 25%. And as we look forward to the fourth quarter of 2013, we expect the effective rate to be in the high 20%s. +Before we take questions I would like to leave you with several thoughts about our results. Capital and liquidity both strengthened during the quarter. We had encouraging business results as we saw improvement in both activity and profitability within Consumer and Business Banking. +We saw continued strength in Global Wealth Management. We maintained our top position in Investment Banking and had another quarter of strong growth in our equity sales and trading business. +Credit continued to improve. Our cost initiative work remains on track. And to the extent that the steepened yield curve environment stays with us, it should allow us to move NII upward as we move forward. +We will continue to execute on our strategy and continue to deliver on the earnings power of the Company. With that we will go ahead and open it up for questions. + + + +================================================================================ +Questions and Answers +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) Moshe Orenbuch, Credit Suisse. + +-------------------------------------------------------------------------------- +Moshe Orenbuch, Credit Suisse - Analyst [2] +-------------------------------------------------------------------------------- + + Great, thanks. In addition, the slides have got a good breakdown of the rep and warrant reserving. Could you talk a little bit about the litigation and how to think about the litigation costs as we go forward? Because that is obviously still volatile. Maybe discuss what is still remaining that could get roped into that as we go forward. + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [3] +-------------------------------------------------------------------------------- + + Yes, I think, Moshe, what I would say is that if you look, as we referenced, it was roughly $1.6 billion a year ago. It was $500 million in the second quarter, and it was roughly $1 billion this quarter. +I'd go back to -- and I think we've been pretty consistent. If you go back to 2010 and look at the build over the course of four years from both a litigation and a rep and warrant perspective, I think you can see that we have had more of that over the course of a three-and-a-half year period than anyone else out there. +And as we look at the remaining pipeline we put it in really four different buckets. The first is the GSE bucket for rep and warrant, which with one exception we have got global settlements from the end of 2008 back with Freddie and Fannie. So as we look at that bucket we feel very good about that. +We then go to the second bucket which is mono-lines. You've got global settlements with three of the five mono-lines, and we have established the reserves for the remaining two based on that history of the three. +We then go to the rep and warrant. With respect to the private label securities, the $8.5 billion Gibbs & Bruns case, which represents half the exposure, continues to go through the court process and we'll be back in court on that I believe in November. And obviously we set up reserves at that point based on the Gibbs & Bruns history; and as we have said before, for that which we didn't have the basis to establish a reserve, we put out a range of possible loss for rep and warrant that continues to be up to $4 billion. +And then you move into the other piece that we have, that's the RMBS securities litigation. During the quarter, the Luther, Maine settlement received preliminary approval during the quarter, and we will look to get final approval by that sometime during the fourth quarter. And we obviously set up a reserve; and that settlement was for $500 million which represents in the ZIP Code of 65% to 70% of the Companywide exposure that we have for RMBS litigation. +And then the other two pieces that we continue to work through in that bucket are the HAFA litigation on behalf of Freddie and Fannie as well as AIG. And there is really nothing to report new on either of those fronts. +And what you saw during the quarter, as we said, was really an adjustment to the reserves based on as we get more information and to the extent that there are additional discussions with some of the people that we're in a party with those discussions, too. + +-------------------------------------------------------------------------------- +Moshe Orenbuch, Credit Suisse - Analyst [4] +-------------------------------------------------------------------------------- + + I guess just to follow up on that, because JPMorgan had indicated that they had expenses in this quarter that were substantially higher than what they would have anticipated as possible even three months ago because of a change of the regulatory environment. Do you feel like you have taken that fully into account? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [5] +-------------------------------------------------------------------------------- + + Yes, I think -- let me be a little bit more specific when we go back to it, because I think the one thing that has been overlooked a little bit -- and this is not a number we are particularly pleased with. But if you go back to the beginning of 2010 and look at the combined litigation and rep and warrant expense that we have had in this Company, it has been over $40 billion, which I think is quite a bit higher than the number that they quoted. +Obviously, those numbers are particular to each institution. But I think as you look at what we have tried to do, that those numbers have been significant and I think at this point relative to our peers we have tried to be out front and get through some of the larger settlements that we have. And we think that $40-billion-plus number reflects that. + +-------------------------------------------------------------------------------- +Moshe Orenbuch, Credit Suisse - Analyst [6] +-------------------------------------------------------------------------------- + + Just shifting gears on the mortgage business, you had a decline in rate locks that you identified; but the pipeline actually is down substantially more. Could you talk a little bit about how you see the fourth quarter and into 2014? +Because you have got both the potential for obviously a further decline as the pipeline moves through. But then again you also had a fairly high rep and warrant in the quarter. Like how should we think about that from a revenue perspective? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - CEO [7] +-------------------------------------------------------------------------------- + + I think let's talk about the production first. You remember that we had a lot of HAMP going on, and that has been dropping each quarter as we get through the volumes of that. And that had a pretty good impact; I think it was down roughly $3.5 billion or so linked quarter. +The rest of the production continues to move forward. But if you look at what is really going on as we speak, because during the third quarter you had significant changes July/August as we ran through pipeline, etc. The current pipeline stands at a level of 30,000-odd. The current application volumes today are 1,000 plus, around 1,000. +The purchased piece of that has maintained relatively constant, 300-ish a day. So if you think about that, we have sort of a month-and-a-half pipeline, and that has been pretty consistent as we got into September and to October. So if you extrapolate that out you should see production levels that will be down again in the fourth quarter, but will start to mitigate. +The issue on the revenue is the spreads come in and the refinancing volume is at a higher profit margin because the work is not as much. So we expect to see a lot like we are seeing now, spreads that have come in a couple hundred basis points or so, and we expect that to hold and the volumes will come down, and so I think the number will continue to work in that direction. +What you do mention is the other side, which is the rep and warrant exposure, and stuff that goes through there, and stuff that changes it. Bruce can touch on that. +But in terms of overall volumes, we have started taking the people down to match the volumes. You remember we had a lot of work to do here. If you look at our non-HAMP production it has continued to grow each quarter. +Our home equity loan production has doubled in the last few quarters and we'll continue to drive that forward. As we have told you many times it will never be a huge business for this Company, because it is a business which is very competitive out there and the profit margins will always be thin. But we need to do it for our customers and clients. + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [8] +-------------------------------------------------------------------------------- + + And on the rep and warrant front, you are right, the rep and warrant expense was just over $300 million a quarter. And we clearly would expect that the run rate of that expense is going to be much more in the $150 million a quarter type run rate as opposed to the $300 million-plus. + +-------------------------------------------------------------------------------- +Moshe Orenbuch, Credit Suisse - Analyst [9] +-------------------------------------------------------------------------------- + + Got it. The very last one for me is you had mentioned expected improvement in charge-offs. The provision obviously was substantially lower. How should we think about the provision relative to those charge-offs in Q4 and into 2014? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [10] +-------------------------------------------------------------------------------- + + Yes, I think once again our comments will be assuming that we don't see any slippage in the economy. During the quarter, if you look at the reserve release, roughly $250 million of it was from purchased credit-impaired, and roughly $1.150 billion from the core. +As we go forward I would think about the provision -- or excuse me, think about the reserve release much more consistent with what you saw in the first and second quarters of this year over the next couple quarters. And then ultimately as we get into the latter part of 2014 and beyond, you'd expect most of that to go away. +But I do think there are probably another couple quarters where it could be in line with what we saw in the first and second quarter. Clearly not at the third quarter of this year given the sharp improvement in credit we saw. + +-------------------------------------------------------------------------------- +Moshe Orenbuch, Credit Suisse - Analyst [11] +-------------------------------------------------------------------------------- + + Great. Thanks very much. + +-------------------------------------------------------------------------------- +Operator [12] +-------------------------------------------------------------------------------- + + Betsy Graseck, Morgan Stanley. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [13] +-------------------------------------------------------------------------------- + + Hi, good morning. Just one follow-up on the conversation that we just had regarding the reps and warranties and litigation. I heard you that the mono-line, three out of five are done; you established reserves for the other two based on the three out of five. +Is that part of the rep and warranty this quarter, the establishing reserves for the other two based on the three out of five done? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [14] +-------------------------------------------------------------------------------- + + No, it is not. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [15] +-------------------------------------------------------------------------------- + + Okay. Then on the litigation reserve, there's obviously a long list of stuff in your Q; so is it fair to say that litigation reserve was just all of the above of that long list? Or was there something specific that you saw in the quarter that drove the higher number? +I am just wondering; do we do the $1 billion quarterly in our model going forward? Or is it going to be more episodic than that? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [16] +-------------------------------------------------------------------------------- + + I think as we have said, that number tends to be lumpy. And I wouldn't say that there was any one specific item during the quarter that you could point to. It was really just a continued evaluation of the reserves as well as reflective of any current discussions that we are having with the different parties that we are trying to work through this with. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [17] +-------------------------------------------------------------------------------- + + Okay. Then on the LAS expenses, you indicated that next quarter is sub $2 billion. + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [18] +-------------------------------------------------------------------------------- + + That's correct. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [19] +-------------------------------------------------------------------------------- + + Okay. So you highlighted that your delinquents are down half from the asset sales and half from your own actions. So is it fair to say that the reduction, roughly $300 million or so -- well, $200 million to $300 million or so, that you are calling out for next quarter is also equally half and half? +And part of the question is trying to understand. You know the run rate of how those expenses are coming out associated with the asset sale. And I am wondering; is that front-end loaded in 4Q? Is that going to be 4Q through 2Q next year? +And are the organic actions you are taking likely to be equal in size in terms of the decline in the LAS expenses? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [20] +-------------------------------------------------------------------------------- + + Yes, I think I would say a couple things on that, Betsy. That once again we told you at the end of the second quarter that we would get the number of 60-plus-day units down below 375,000 units by the end of the year. And you can see during the third quarter alone we got them down below 400,000, so we feel particularly good with that guidance. +There is a lot of work that goes on in a quarter to move out and to get these servicing transfers done as it relates to both our own teammates as well as people that we use to help us with that. So that is why you saw some of the numbers Q2 to Q3 a little bit sticky. +But the point that you raise I think is the right one, which is -- now that you've got the loans out you have the ability to take the expense out. And that is why we would expect the expense reduction in the fourth quarter to be greater than what we had seen in the third quarter. +I think as you look out at and as you look through 2014, the guidance that we have given is very -- really remains the same. And we feel more comfortable with, given the delinquencies, that as you go through 2014 you should see that expense number go from below $2 billion in the fourth quarter of 2013 to below $1 billion by the end of 2014. +And it always can be a little bit lumpy, but you should see that occur generally consistently throughout the year. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [21] +-------------------------------------------------------------------------------- + + Okay, thanks. Then lastly, on page 7 you highlight the regulatory capital. Obviously it seems like you have set yourself up well for a bigger ask in CCAR from a buyback perspective. Is that a fair assumption to make? +Could you highlight how SLR factors into that? And are your SLR numbers that you present fully loaded in 3Q, or is it on a phased-in approach? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [22] +-------------------------------------------------------------------------------- + + Our SLR numbers are fully loaded at both the Bank Holding Company as well as at the subs. And as we look at CCAR what I would say is I think we have been consistent on this, that we have done it and done everything we can both in the way -- intrinsically the way we run the Company, which in many respects is not inconsistent with what you get tested in CCAR, in that we have built our Basel 1.5 ratio up significantly from last year. The Basel 3 ratios across the board are up. +As you look at both credit risk and market risk, those have obviously gotten better. And we have continued to put the legacy issues behind us. +So as we look at -- we obviously were able to return $5 billion to the common shareholders during this year as part of the CCAR process, and we will look to move forward from that, realizing that until we see the exact case that we are running and what the test is, I think it is probably premature to say anything more than that. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [23] +-------------------------------------------------------------------------------- + + Okay. Thanks a lot. + +-------------------------------------------------------------------------------- +Operator [24] +-------------------------------------------------------------------------------- + + John McDonald, Sanford Bernstein. + +-------------------------------------------------------------------------------- +John McDonald, Sanford C. Bernstein & Company - Analyst [25] +-------------------------------------------------------------------------------- + + Yes. Hi, good morning. Bruce, was wondering on the net interest income side; do you think that the core NII should grind higher at a similar pace that we saw this quarter? Looks like it was up $100 million, assuming no big change in rates. + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [26] +-------------------------------------------------------------------------------- + + I think that is fair, John. You are always a little bit subject to mix, loan pricing, as well as rate environment. But that is clearly the trajectory that we are on; so the answer would be yes. + +-------------------------------------------------------------------------------- +John McDonald, Sanford C. Bernstein & Company - Analyst [27] +-------------------------------------------------------------------------------- + + How should we think about the market-sensitive component? Do you still have the NII hedges on? Or is it really the FAS 91 that adds volatility from here? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [28] +-------------------------------------------------------------------------------- + + Yes, think it is important -- and the one thing that doesn't come out when you look at this slide is, it is not that we saw much variability in either FAS 91 or hedging effectiveness during the third quarter. It was that we had some benefit in the second quarter when you had the sharp increase in rate. +So as long as you are within a reasonable range where rates aren't bouncing around, you shouldn't see much of that. But keep in mind that what you saw in the first and second quarters was because of the largely unprecedented movement up in rates that we saw, that gave us the FAS 91 benefit. + +-------------------------------------------------------------------------------- +John McDonald, Sanford C. Bernstein & Company - Analyst [29] +-------------------------------------------------------------------------------- + + Okay. Over time does that FAS 91 affect dissipate, over time? Or is that always going to be with you? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [30] +-------------------------------------------------------------------------------- + + Well, it gets reset so that you don't have any aberration from quarter to quarter. The only time you have an aberration on a run rate basis is when the underlying rates move. + +-------------------------------------------------------------------------------- +John McDonald, Sanford C. Bernstein & Company - Analyst [31] +-------------------------------------------------------------------------------- + + Okay. Then just any update on your rate sensitivity relative to where you stood at the end of last quarter for a 100 basis point move in long rates? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [32] +-------------------------------------------------------------------------------- + + Yes, I want to think we are in the same ZIP Code both on a 100 basis point steepening as well as a 100 basis point parallel shift. The guidance that we have given was it takes us about three years to earn back any impact in OCI. +We are a touch better than that this quarter. If you look at the supplemental you will see that the level of debt securities is down modestly, as we are very sensitive to managing that OCI risk. + +-------------------------------------------------------------------------------- +John McDonald, Sanford C. Bernstein & Company - Analyst [33] +-------------------------------------------------------------------------------- + + Okay. Then just a follow-up on litigation expense. Back in July you were thinking perhaps $500 million per quarter and clearly came in much higher than that this quarter. Recognize things are fluid here, but should we be thinking of litigation expense more like this quarter or more like last? Are you able to say? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [34] +-------------------------------------------------------------------------------- + + John, that is really difficult to say. I think that the punchline is that it can be lumpy. And we obviously do and work hard each quarter -- to the extent that we can get things put behind us at reasonable levels for the shareholders, we do that. +It is an evolving process and it is something that we are working hard on. At the same time there is no question that the expense was elevated this quarter. + +-------------------------------------------------------------------------------- +John McDonald, Sanford C. Bernstein & Company - Analyst [35] +-------------------------------------------------------------------------------- + + Okay. Then one more clarification on the core expenses. How much did the expenses come down for mortgage so far and what do you see left on that? And then just any comment on the IB comp ratio, how we should think about that going forward. + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [36] +-------------------------------------------------------------------------------- + + Sure. I am not sure I understand your question on the mortgage expense -- + +-------------------------------------------------------------------------------- +John McDonald, Sanford C. Bernstein & Company - Analyst [37] +-------------------------------------------------------------------------------- + + Yes, any capacity reduction that you are doing as originations come down, have you gotten the benefit from that? And how much might we expect for you to do that going forward? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [38] +-------------------------------------------------------------------------------- + + No, as we referenced on the front -- on the legacy piece we talked about the 2.3 going to 2.2 and how we will have that below 2. As we talked about, we needed to get through the pipeline on the front end during the third quarter, which we did. The 1,000 people that we referenced on the front end happened late in the quarter. +As I mentioned we are 1going to continue to reduce t1hat, to size that for the volumes that we are seeing now. But we have not put out a specific number on that. + +-------------------------------------------------------------------------------- +John McDonald, Sanford C. Bernstein & Company - Analyst [39] +-------------------------------------------------------------------------------- + + Okay. In terms of IB comp, what we saw this quarter and how we should think about that? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [40] +-------------------------------------------------------------------------------- + + Yes, we typically -- if you look at combined Investment Banking and sales and trading you tend to be in the mid to high 30s, and I don't think you are going to see any significant variations in that Q3 to Q4. + +-------------------------------------------------------------------------------- +John McDonald, Sanford C. Bernstein & Company - Analyst [41] +-------------------------------------------------------------------------------- + + Okay, thanks. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - CEO [42] +-------------------------------------------------------------------------------- + + John, one thing on the -- both in the mortgage and otherwise, as Bruce talked about, the actions we've taken during the quarter to reduce headcount overall in the Company, a lot of it is in the second half of the quarter. So you always get a continuing-on effect of that. +And by the way, next quarter as we reduce further LAS and mortgage you will see it go into the first quarter. So it does lag; and it is just the nature of the severance accruals you take at the time plus as we move the headcounts out, paying them on, as you go on the severance also in certain cases. +So you should expect that those volume-related reductions will continue to move forward. And the economics of what we did in the third quarter is probably more in the fourth quarter than it is in the third quarter. + +-------------------------------------------------------------------------------- +John McDonald, Sanford C. Bernstein & Company - Analyst [43] +-------------------------------------------------------------------------------- + + Got it. Okay, thank you. + +-------------------------------------------------------------------------------- +Operator [44] +-------------------------------------------------------------------------------- + + Glenn Schorr, ISI. + +-------------------------------------------------------------------------------- +Glenn Schorr, ISI Group - Analyst [45] +-------------------------------------------------------------------------------- + + Hi, thank you. Question on FICC. I think the explanation on the down 20% was fair enough, and a lot of macro and political reasons, which I get. Just curious on if you had any early comments on swaps execution and clearing impact in the quarter and what you see going forward as clients migrate. + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [46] +-------------------------------------------------------------------------------- + + Yes, I wouldn't really note any specific change there, Glenn. It is something that we continue to look at. The one thing I would say that we are working hard on -- and this really flips more to some of the capital and central clearing type things -- that as we continue to have more and more of that migrated, that is going to benefit certain capital ratios as we look at counterparty. +So I think that the ongoing -- to the extent that there is an economic negative going forward, we are obviously continuing to spend a lot of time with that. The one piece that is a little bit more tangible that we worked through is that there will be some decent benefits over the course of 12 to 18 months as more and more of that gets migrated. + +-------------------------------------------------------------------------------- +Glenn Schorr, ISI Group - Analyst [47] +-------------------------------------------------------------------------------- + + Okay. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - CEO [48] +-------------------------------------------------------------------------------- + + I think as you think about the markets business, one of the things that Tom and team have done is got the -- as we talked about in various quarters -- has kept the breakeven point relatively low. So in a quarter which the equities business was very good for us, comparatively -- but the fixed income business, which is a lot bigger than the equity business, was obviously down -- we still made $0.5 billion. +So the goal there is to be able to serve our clients and customers well and keep the balance sheet in good shape, but also keep the expense base. So that when we get $2.5 billion to $3 billion we start making some decent money. And then in the good quarters we will make a good amount of money, and Tom and team have done a good job to keep that expense base in line. +And most of the expense increase here is with litigation and things that were not fundamental, just show up in line of business related to broader question. + +-------------------------------------------------------------------------------- +Glenn Schorr, ISI Group - Analyst [49] +-------------------------------------------------------------------------------- + + I appreciate that. Might be putting words in your mouth but it sounds like that there is a pretty good operating leverage built-in on the upside, then. In other words, it doesn't necessarily scale up and down with revenues to the same degree. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - CEO [50] +-------------------------------------------------------------------------------- + + Yes, if you just look across the last four quarters you see it. But the key was going from 11 to 12 we move the fundamental level, so there is good operating leverage. You get another $1 billion in revenues, a lot of it comes through net of -- with incremental compensation here. + +-------------------------------------------------------------------------------- +Glenn Schorr, ISI Group - Analyst [51] +-------------------------------------------------------------------------------- + + Okay. One other question just on cards. Looks like issuance and balances have been growing good. I am just curious how much of that is you turning up the heat on marketing, selling through the branches, and how you feel about the outlook. Because it has been a while since we saw the industry in general have decent balance growth. + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [52] +-------------------------------------------------------------------------------- + + Yes, I think a couple things and I'd just kind of reiterate a little bit, we touched on, is that we have made over the course of the last 12 to 18 months the investment of having more bankers in the branches and trying to do more things with our customers. And the two things that we feel best about as you look at that growth in cards to over 1 million cards in the quarter is that -- the first is that 63% of those people, once again, we already have an existing relationship with and obviously know something about and are trying to do more with. +And the second thing I would say is that as you look at the overall FICO and credit quality of those borrowers, they tend to be in the mid-700s on average. So it is the right customer; it is sold the right way; and it is part of an overall deepening strategy. +And now that we are starting to see some of the balances creep up, it is reflective of that activity, which I think, quite frankly, was overshadowed a little bit as we cleaned out some of the affinity and other programs, that the new stuff that you saw got overshadowed by things that were leaving the books. But now that we are largely through that, what we are doing on the front end is starting to come out. + +-------------------------------------------------------------------------------- +Glenn Schorr, ISI Group - Analyst [53] +-------------------------------------------------------------------------------- + + Okay, perfect. Thank you. + +-------------------------------------------------------------------------------- +Operator [54] +-------------------------------------------------------------------------------- + + Derek De Vries, UBS. + +-------------------------------------------------------------------------------- +Derek De Vries, UBS - Analyst [55] +-------------------------------------------------------------------------------- + + I just have a detailed question on the OCI. There was a $1.4 billion gain, I think from changes in pension. Could you just explain what that was about? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [56] +-------------------------------------------------------------------------------- + + Sure. What happens is that typically you mark your pension OCI once a year as you update the asset values and assumptions at year end. You typically do that on an annual basis. +Because we merged several pension plans at the end of August, we were required to remeasure those assets as of the end of August. And that $1.4 billion reflects the change in value from Jan. 1 to August 31; and then obviously we will remeasure those again at year end. + +-------------------------------------------------------------------------------- +Derek De Vries, UBS - Analyst [57] +-------------------------------------------------------------------------------- + + That's clear. Thanks. Then just on -- talking more generally, you obviously have a lot of corporate relationships, and I guess there is some unease about what is going on in Washington. But assuming we can get through that, do you get the sense that the corporates are looking to move from margin preservation to investment? Or are they just really worried about the macro environment? +I am trying to get a sense of where loan growth could go, going forward. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - CEO [58] +-------------------------------------------------------------------------------- + + Yes, I think if you look at our client base, which ranges from small businesses through the largest companies in the world, I would say all of them feel very good about their operating position. They are making money, have done a tremendous job of keeping a cost structure in line. +I had an example of a company that had 200 employees; their sales were going to grow by 25%; and they said we are only going to add five employees. So American business has gotten very efficient. +But when you put on top of them the uncertainties, because they are all engaged in global commerce, the macro uncertainties at the world level, the US level, I think there has been an uncertainty hold-back here that will come through as more and more clarity both in the economy -- i.e., final demand for their products -- and the macro situation comes clear. +So is it a sprint out of the blocks? No. They are running forward; it will probably be a speedup of the process. And you saw some of that this summer with some of the M&A activity and stuff in the larger companies has strengthened and you are seeing it go on. +So I think there is demand in the system, so to speak. There is money on the sidelines from the investor side. And the more clarity, you will see better activity. +Meanwhile, underneath it, you see the core economy continue to push forward even with all the things going on around the world. + +-------------------------------------------------------------------------------- +Derek De Vries, UBS - Analyst [59] +-------------------------------------------------------------------------------- + + That's very helpful. Thanks. + +-------------------------------------------------------------------------------- +Operator [60] +-------------------------------------------------------------------------------- + + Jim Mitchell, Buckingham Research. + +-------------------------------------------------------------------------------- +Jim Mitchell, Buckingham Research - Analyst [61] +-------------------------------------------------------------------------------- + + hey, good morning. Could you talk -- run me through the expense line a little bit on the compensation side? I guess I am just struggling a little bit with, on a year-over-year basis you guys were down around $100 million on the comp line but headcount is down 25,000 employees. Capital markets revenues are down. +Why are we seeing that stay elevated? How do we see that go down more significantly going forward? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [62] +-------------------------------------------------------------------------------- + + Sure. You have a couple things going on. The first thing I would say is that the expense number during the third quarter of last year -- and I'm going to speak to -- if you flip to slide 10 for a moment. That if you look at that All Other bucket, which is I think what you are referring to, that $13 billion in the third quarter last year was particularly low. If you look at where was in the fourth quarter it was at $13.4 billion; so that can bounce around by a couple hundred million dollars. So realize it was off a low base. +You did see a couple things, though, in the third quarter of this year that you wouldn't have had. The first is that the Wealth Management revenues, which there is a fair bit of formulaic compensation, are running at, as I mentioned, at higher levels in 2013 than 2012; so you have some compensation there. +The second thing that you had this quarter, as Brian referenced, is we took down headcount. We had roughly $100 million of severance that came through the P&L during the quarter. +The third thing that you had during the quarter that I referenced is you had some elevated marketing expense that will go down in the fourth quarter, that you also didn't have in the third quarter. So a combination of a variety of items. +But I think what we would say is as you look to go forward you should see that red bar come down based on our overall expense initiatives as well as New BAC. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - CEO [63] +-------------------------------------------------------------------------------- + + And remember also that when we give you these reduction numbers we are not giving you a reduction and saying that then we are growing elsewhere. This is a net number that you pointed out. So all the investments we're making and from the third quarter last year to the third quarter of this year, you are seeing the mortgage production costs go up, which will come back down. But all the investment we made in salespeople to do the cards that we talked about earlier, small business lending, investment services that you can see at the branch level, we can see the numbers growing there -- all those are in those numbers. +So all those investments are more commercial bankers that are helping our commercial loan growth. And yet we are overcoming them. +And then you have the natural salary increases and stuff like that are all absorbed in that. Then you have -- the nominal numbers are flat; and, frankly, if you back out a couple of the things that Bruce just mentioned are down. +So we are comfortable on course for New BAC. But remember these numbers are absorbing all the usual costs that we do plus the investments in the business, which we are making strong investments in the areas that we have growth opportunity. + +-------------------------------------------------------------------------------- +Jim Mitchell, Buckingham Research - Analyst [64] +-------------------------------------------------------------------------------- + + Okay. No, that's helpful on the severance. I guess I would assume that we would see some less of that going forward given the significant reductions in mortgage this quarter, right? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [65] +-------------------------------------------------------------------------------- + + That's correct. + +-------------------------------------------------------------------------------- +Jim Mitchell, Buckingham Research - Analyst [66] +-------------------------------------------------------------------------------- + + Okay, great. Thank you. + +-------------------------------------------------------------------------------- +Operator [67] +-------------------------------------------------------------------------------- + + Matt O'Connor, Deutsche Bank. + +-------------------------------------------------------------------------------- +Matt O'Connor, Deutsche Bank - Analyst [68] +-------------------------------------------------------------------------------- + + Hi, guys. Just as we think about the overall size of the balance sheet, you mentioned managing the securities book with OCI risk in mind; and obviously the securities did come down as you mentioned this quarter, while the loans are growing. How do we think about the net impact of those two, I guess looking out next several quarters? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [69] +-------------------------------------------------------------------------------- + + As far as just notional size of the balance sheet? + +-------------------------------------------------------------------------------- +Matt O'Connor, Deutsche Bank - Analyst [70] +-------------------------------------------------------------------------------- + + Yes, I am really focused on the loans plus the securities; because obviously liquidity levels can vary quarter to quarter and the trading book can vary quarter to quarter. So just -- I mean, loans are growing nicely, but it is being offset by securities coming down. So I am really just focused on those two components. + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [71] +-------------------------------------------------------------------------------- + + Yes, I think at this point what I would expect is that generally speaking the securities book should remain relatively consistent with where it is. And then if you look at the loan book I would say that you are going to see that the loan book as well as the shrinkage of the debt footprint will be absorbed through deposit growth, as well as a reduction to some extent in our parent Company liquidity as we are carrying an elevated level of parent Company liquidity to address the significant debt maturities in 2014. +The net of those, which I thought you were getting to initially, is that you should continue to see this balance sheet in the $2.125 billion to $2.15 billion type area. But as we go forward we should continue to get it to be more and more efficient. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - CEO [72] +-------------------------------------------------------------------------------- + + Yes, I think one of the things that we haven't talked about in a while is we still have significant runoff portfolios that we are replacing. We still have -- which gives us the ability to grow the core business without growing the balance sheet footings. +And I think that is something that will help us in our capital levels, that are already very strong today, going forward. Because effectively we don't need incremental capital to grow the balance sheet, even to have commercial loan growth and other types of growth that you are talking about. + +-------------------------------------------------------------------------------- +Matt O'Connor, Deutsche Bank - Analyst [73] +-------------------------------------------------------------------------------- + + Great. So flattish balance sheet, but optimizing the capital usage; and then obviously the NIM probably benefiting from the remix there. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - CEO [74] +-------------------------------------------------------------------------------- + + Yes, and you know, by the way everything is on the NIM is still -- the short rate move drives a lot of profit because the deposit franchise is an advantaged funding source, as you well know. + +-------------------------------------------------------------------------------- +Matt O'Connor, Deutsche Bank - Analyst [75] +-------------------------------------------------------------------------------- + + Then just separately, circling back on the core expenses of $13.1 billion. I guess it is $13 billion ex- the severance and there is some of the mortgage staff reductions, still some New BAC coming in, and then maybe some investments. Where does that -- on the revenue base that you have right now, where does that $13.1 billion go to, if you just fully loaded all the stuff that you can see? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [76] +-------------------------------------------------------------------------------- + + I think the best guidance that we'd give at this point is we have got roughly $600 million a quarter in New BAC to get done over the next five to six quarters. + +-------------------------------------------------------------------------------- +Matt O'Connor, Deutsche Bank - Analyst [77] +-------------------------------------------------------------------------------- + + Okay, that is a net number; so think about it $12.4 billion, $12.5 billion? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - CEO [78] +-------------------------------------------------------------------------------- + + Yes. But then you've got to remember, you've got to add back some of the LAS costs -- the subtract in there. But there is always -- LAS is a servicing business; it is always going to have some costs (inaudible) to. + +-------------------------------------------------------------------------------- +Matt O'Connor, Deutsche Bank - Analyst [79] +-------------------------------------------------------------------------------- + + Yes. I guess I was just breaking the -- you've got the litigation, which is a moving target; you've got the LAS which you have been pretty explicit; and then everything else is the $13.1 billion that -- + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - CEO [80] +-------------------------------------------------------------------------------- + + Sometimes people take that lower number and multiply it times 4, but you've got to remember parts of those other costs will also be in there. + +-------------------------------------------------------------------------------- +Matt O'Connor, Deutsche Bank - Analyst [81] +-------------------------------------------------------------------------------- + + Okay. Thank you very much. + +-------------------------------------------------------------------------------- +Operator [82] +-------------------------------------------------------------------------------- + + Vivek Juneja, JPMorgan. + +-------------------------------------------------------------------------------- +Vivek Juneja, JPMorgan - Analyst [83] +-------------------------------------------------------------------------------- + + My questions have been answered. Thanks. + +-------------------------------------------------------------------------------- +Operator [84] +-------------------------------------------------------------------------------- + + Mike Mayo, CLSA. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA - Analyst [85] +-------------------------------------------------------------------------------- + + Hi, I just wanted to clarify the New BAC benefits. How much of New BAC have you achieved? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [86] +-------------------------------------------------------------------------------- + + Roughly $1.4 billion a quarter, Mike, relative to $2 billion a quarter that we had previously announced. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA - Analyst [87] +-------------------------------------------------------------------------------- + + Originally I thought you were looking for mid-2015. So when you say $600 million more, that is what you mean, when you say over six or so quarters? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [88] +-------------------------------------------------------------------------------- + + That's correct. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA - Analyst [89] +-------------------------------------------------------------------------------- + + Just to clarify the last answer, so you expect all that to hit the bottom line? Or some of that will be offset by investments and salespeople and other investments? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [90] +-------------------------------------------------------------------------------- + + I think what we said was at the current run rate level you should be expecting that to hit the bottom line. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA - Analyst [91] +-------------------------------------------------------------------------------- + + Okay. Switching back to the legal questions, you said you had taken over $40 billion of charges. What is your legal reserve as of the end of the third quarter? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [92] +-------------------------------------------------------------------------------- + + We do not put out a litigation reserve on a standalone basis. The number that we do put out is where we are in rep and warrant, and that was just over $14 billion at the end of the third quarter. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA - Analyst [93] +-------------------------------------------------------------------------------- + + $14 billion rep and warranty? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [94] +-------------------------------------------------------------------------------- + + That's correct. $14.1 billion. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA - Analyst [95] +-------------------------------------------------------------------------------- + + Okay. Would that include anything other than the $8.5 billion settlement? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [96] +-------------------------------------------------------------------------------- + + That includes another $5.5 billion for a variety of matters. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA - Analyst [97] +-------------------------------------------------------------------------------- + + So for the Gibbs & Bruns settlement you have an $8.5 billion reserve for that settlement. I think I asked this on some other earnings calls; but if that agreement was not approved by the judge, what is the potential range for that $8.5 billion reserve? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [98] +-------------------------------------------------------------------------------- + + As we have said before we would need to look at that based on the circumstances that come out at the time. I don't think it is a foregone conclusion it goes one way or the other. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA - Analyst [99] +-------------------------------------------------------------------------------- + + Okay. Switching gears, in terms of loan growth, what is the loan utilization level? And what are you seeing as far as acceleration or deceleration in loan growth? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [100] +-------------------------------------------------------------------------------- + + I would say that the -- we really haven't -- and one of the things that we have tried to do and we will continue to optimize, particularly the way that the Basel 3 standardized ratio works, that we are focused more and more and for those places where we make credit commitments to have the loans be funded as opposed to unfunded, given the capital treatment that is out there. +So I would say generally as you look at line utilizations that there hasn't been much that has changed at all. Where you are seeing the loan growth has been more funded-type loan growth, in many cases for large, high-quality companies that are making acquisitions. A couple that we would have seen this quarter would have been Verizon Wireless as well as Amgen. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - CEO [101] +-------------------------------------------------------------------------------- + + Overall, Mike, the loan utilization rates, they haven't moved around a lot but they are at low levels historically across the board, whether it is our business banking segment, the middle-market segment. And the large corporates don't really use their lines other than as Bruce described, when they are doing something inorganic. +But they are very low, which gives you two things. One, it indicates that they have got lots of cash and have lots of room for investments. But secondly, as the economy picks up, moving back the 1,000 basis points or so we are from more normal levels, for lack of a better term, there is a lot of loan growth within the -- without new customer relationships or any more work. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA - Analyst [102] +-------------------------------------------------------------------------------- + + I understand you are picking and choosing your spots more. So would you say that demand really hasn't changed a whole lot over the past year or two? Or is it picking up in certain areas? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - CEO [103] +-------------------------------------------------------------------------------- + + I think demand has picked up over the last couple years. I think that if a company had a line of credit in their dynamics, they are using it at a lower level than they did, not necessarily two years ago but during the normal economic times. +And that is the second point. The demand has been picking up across consumer demand and things like that; but it is still not as strong as it would be because it's a 2% growth rate economy out there. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA - Analyst [104] +-------------------------------------------------------------------------------- + + All right, thank you. + +-------------------------------------------------------------------------------- +Operator [105] +-------------------------------------------------------------------------------- + + Guy Moszkowski, Autonomous Research. + +-------------------------------------------------------------------------------- +Guy Moszkowski, Autonomous Research - Analyst [106] +-------------------------------------------------------------------------------- + + Good morning. I just have a few cleanup questions. With respect to the long-term debt footprint then, have you talked about how much of the $40 billion that is coming due that you would expect to refi? Or are you going to let it all just go? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [107] +-------------------------------------------------------------------------------- + + It won't all just go, but I think it is safe to assume that less than half of it will be refinanced. + +-------------------------------------------------------------------------------- +Guy Moszkowski, Autonomous Research - Analyst [108] +-------------------------------------------------------------------------------- + + Okay, thanks. That's helpful. On the last question you were asked about the litigation reserve, which understandably you don't want to go there. But do you have an estimate of what your reasonable and possible beyond the litigation reserve will be this quarter? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [109] +-------------------------------------------------------------------------------- + + Yes, I believe, Guy, that at the end of the second quarter, I believe that we had said that the range of possible loss with respect to litigation was in the high $2 billions; and we will obviously need to freshen that up as we get the third quarter Q out. But I wouldn't expect to see anything significant one way or the other. + +-------------------------------------------------------------------------------- +Guy Moszkowski, Autonomous Research - Analyst [110] +-------------------------------------------------------------------------------- + + Got it. The $1.1 billion litigation expense and I guess reserve build this quarter, can you give us a sense of how it breaks down by business unit? Because it didn't seem like it all goes to All Other. + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [111] +-------------------------------------------------------------------------------- + + Yes, if you look at by business unit, I referenced that as you float through that you had -- you can see it in the Commercial Real Estate Service area, there was over $300 million of it there. There was roughly $300 million of it between banking and markets. And then the majority of the rest of it was in All Other. + +-------------------------------------------------------------------------------- +Guy Moszkowski, Autonomous Research - Analyst [112] +-------------------------------------------------------------------------------- + + Great. That's helpful. You mentioned that you had accelerated some marketing initiatives from the fourth quarter to the third. I was just wondering if you could give us a little color on specifically what they were, since everybody is looking for growth. + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [113] +-------------------------------------------------------------------------------- + + Yes, I think the only two things is that you have obviously seen a little bit more brand that is out there. And then with CCB there was the acceleration of what we do from a charitable perspective from the fourth to the third. Those were the two items. + +-------------------------------------------------------------------------------- +Guy Moszkowski, Autonomous Research - Analyst [114] +-------------------------------------------------------------------------------- + + Got it. Then the very final question is, you had a meaningful improvement in your Basel 3 capital above and beyond the earnings, and it looks like it is a pretty meaningful reduction in the threshold and other deductions. I was wondering if you could just give us a little more granularity on what was going on there. + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [115] +-------------------------------------------------------------------------------- + + Well, no, is a great question. Really two things going on. Keep in mind, as we have said, because we have a decent chunk of disallowed DTA from a Basel perspective, that ballpark we will accrete capital on a pretax basis generally speaking as opposed to a post-tax basis for a decent number of quarters going forward. So, when you look at that, think pretax not so much post-tax. +And then the second benefit that you had, which was an earlier question, was the benefit of OCI during the quarter of roughly $1 billion after-tax or $1.5 billion pretax. And that was the combination of pension to the positive; and then to the negative CCB coming out, as well as some of the debt securities gains. + +-------------------------------------------------------------------------------- +Guy Moszkowski, Autonomous Research - Analyst [116] +-------------------------------------------------------------------------------- + + Got it. Okay, that's great. Thanks so much for taking my questions. + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [117] +-------------------------------------------------------------------------------- + + Okay. I think that's all the questions that we have, so thanks for joining us this morning. + +-------------------------------------------------------------------------------- +Operator [118] +-------------------------------------------------------------------------------- + + This does conclude today's program. You may disconnect at any time. + + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/exam/original-files/Problem_1_Sample/2013-Oct-24-AMZN.OQ-139066299673-Transcript.txt b/exam/original-files/Problem_1_Sample/2013-Oct-24-AMZN.OQ-139066299673-Transcript.txt new file mode 100644 index 0000000..8d2caaf --- /dev/null +++ b/exam/original-files/Problem_1_Sample/2013-Oct-24-AMZN.OQ-139066299673-Transcript.txt @@ -0,0 +1,507 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q3 2013 Amazon.com Inc Earnings Conference Call +10/24/2013 02:00 PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Tom Szkutak + Amazon.com, Inc. - CFO + * Sean Boyle + Amazon.com, Inc. - VP of IR + +================================================================================ +Conference Call Participiants +================================================================================ + + * Scott Tilghman + B. Riley Caris - Analyst + * Jordan Rohan + Stifel Nicolaus - Analyst + * Tom Forte + Telsey Advisory Group - Analyst + * Scott Devitt + Morgan Stanley - Analyst + * Kerry Rice + Needham & Company - Analyst + * Greg Melich + ISI Group - Analyst + * Benjamin Schachter + Macquarie Research - Analyst + * Ron Josey + JMP Securities - Analyst + * Brian Pitz + Jefferies & Company - Analyst + * Victor Anthony + Topeka Capital Markets - Analyst + * Douglas Anmuth + JPMorgan - Analyst + * John Blackledge + JPMorgan - Analyst + * Heath Terry + Goldman Sachs - Analyst + * Mark Mahaney + RBC Capital Markets - Analyst + * Mark Miller + William Blair & Company - Analyst + * Mark May + Citi - Analyst + * Carlos Kirjner + Sanford C. Bernstein & Company, Inc. - Analyst + +================================================================================ +Presentation +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Good day, everyone, and welcome to the Amazon.com third-quarter 2013 financial results teleconference. +(Operator Instructions) +Today's call is being recorded. For opening remarks, I will be turning the call over to the Vice President of Investor Relations. Mr. Sean Boyle. Please go ahead, sir. + +-------------------------------------------------------------------------------- +Sean Boyle, Amazon.com, Inc. - VP of IR [2] +-------------------------------------------------------------------------------- + + Hello and welcome to our Q3 2013 financial results conference call. Joining us today is Tom Szkutak, our CFO. We will be available for questions after our prepared remarks. The following discussion and responses to your questions reflect management's views as of today, October 24, 2013, only, and will include forward-looking statements. Actual results may differ materially. Additional information about factors that could potentially impact our financial results is included in today's press release and our filings with the SEC, including our most recent annual report on Form 10-K. As you listen to today's conference call, we encourage you to have our press release in front of you, which includes our financial results as well as our metrics and commentary on the quarter. +During this call, we will discuss certain non-GAAP financial measures. In our press release, slides accompanying this webcast, and our filings with the SEC, each of which is posted on our IR website. You'll find additional disclosures regarding these non-GAAP measures, including reconciliations of these measures with comparable GAAP measures. Finally, unless otherwise stated, all comparisons in this call will be against our results for the comparable period of 2012. Now I will turn the call over to Tom. + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com, Inc. - CFO [3] +-------------------------------------------------------------------------------- + + Thanks, Sean. I will begin with comments on our third-quarter financial results. Trailing 12 month operating cash flow increased 48% to $4.98 billion. Trailing 12 month free cash flow decreased 63% to $388 million. Trailing 12 month capital expenditures were $4.59 billion. This amount includes $1.4 billion in purchases of our previously leased corporate office space as well as property for our development of additional corporate office space located in Seattle, Washington, which we purchased in the fourth quarter of 2012. The increase in capital expenditures reflects additional investments as part of our continued business growth, consisting of investments in technology infrastructure, including Amazon web services, and additional capacity to support our fulfillment operations. +Return on invested capital was 3% down from 10%. ROIC is TTM pre-cash flow divided by average total assets minus current liabilities excluding the current portion of long-term debt over five quarter ends. The combination of common stock and stock-based awards outstanding was 475 million shares compared with 469 million shares. Worldwide revenue grew 24% to $17.09 billion or 26% excluding the $332 million unfavorable impact from year-over-year changes in foreign exchange rates. We are grateful to our customers who continue to take it advantage of our low prices, vast selection, and shipping offers. Media revenue increased to $5.03 billion, up 9% or 13% excluding foreign exchange. +EGM revenue increased to $11.05 billion, up 29% or 31% excluding foreign exchange. Worldwide EGM increased to 65% of worldwide sales, up from 62%. Worldwide paid unit growth was 29%. Active customer accounts exceeded $224 million, worldwide active seller accounts more than $2 million. Seller units represented 40% of paid units. Now I will discuss operating expenses excluding stock-based compensation. Cost of sales was $12.37 billion or 72.3% of revenue compared with 74.7%. Fulfillment, marketing, technology, and content, and G&A combined was $4.46 billion or 26.1% of sales, up approximately 250 basis points year over year. Fulfillment was $1.96 billion or 11.5% of revenue compared with 10.5%. Technical content was $1.58 billion or 9.2% of revenue compared with 7.8%. Marketing was $671 million or 3.9% of revenue compared with 3.8%. +Now we will talk about our segment results and consistent with prior periods, we do not allocate to segments our stock-based compensation or other operating expense line item. In the North America segment, revenue grew 31% to $10.3 billion. Media revenue grew 18% to $2.61 billion. EGM revenue grew 33% to $6.73 billion representing 65% of North America, revenues up from 64%. North America segment operating income increased 1% to $295 million, a 2.9% operating margin. In the international segment, revenue grew 15% to $6.79 billion. Adjusting for the $327 million year-over-year unfavorable foreign exchange impact, revenue growth was 20%. Media revenue increased 2% to $2.42 billion or 9% excluding foreign exchange. EGM revenue grew 23% to $4.32 billion or 28% excluding foreign exchange. EGM now represents 64% of international revenues, up from 59%. +International segment operating loss was $28 million, compared to a $59 million loss in the prior period. Consolidated segment operating income increased 15% to $267 million or 1.6% of revenue, down approximately 10 basis points year over year. Excluding the unfavorable impact from foreign exchange, CSOI increased 18%. Unlike CSOI, our GAAP operating income or loss includes stock based compensation expense and other operating expense. GAAP operating loss was $25 million compared to a $28 million loss in the prior year period. Our income tax benefit was $12 million. GAAP net loss was $41 million or $0.09 per diluted share compared with net loss of $274 million or $0.60 per diluted share. The third quarter 2012 included a loss of $169 million or $0.37 per diluted share related to our equity method share of losses reported by LivingSocial primarily attributable to its impairment charge of certain assets including goodwill. Turning to the balance sheet, cash and marketable securities increased $2.44 billion year over year to $7.69 billion. Inventory increased 20% to $607 billion and inventory turns were 9.2, down from 9.7 turns a year ago, as we expanded selection, improved in stock globals, and introduced new product categories. Accounts payable increased 20% to $10.04 billion and accounts payable days was 75, consistent with the prior year. +I will conclude my portion of today's call with guidance. Incorporated into our guidance are the order trends that we have seen to date and what we believe today to be appropriately conservative assumptions. Our results are inherently unpredictable and may be materially affected by many factors including a high level of uncertainty surrounding exchange rate fluctuations as well as the global economy and consumer spending. It is not possible to accurately predict demand and therefore our actual results could differ materially from our guidance. As we describe in more detail in our public filings, issues such as settling intercompany balances from foreign currencies amongst our subsidiaries, unfavorable resolution of legal matters, and changes to our effective tax rates can all have a material effect on guidance. +Our guidance further assumes that we don't conclude any additional business acquisitions, investments, restructurings, or legal settlements, report any further revisions to stock based compensation estimates, and net foreign exchange rates remain approximately where they have been recently. For Q4 2013, we expect net sales of between $23.5 billion and $26.5 billion or growth between 10% and 25%. This guidance anticipates approximately 125 basis points of unfavorable impact from foreign exchange rates. GAAP operating income or loss could be between a $500 million loss and $500 million in income compared to $405 million income in the fourth quarter 2012. This includes approximately $350 million for stock-based compensation and amortization of intangible assets. +We anticipate consolidated segment operating income or loss which excludes stock-based composition and other expense to be between a $150 million loss and $850 million income compared to $678 million income in fourth quarter 2012. We remain headstrong focused on driving a better customer experience through price, selection, and convenience. We believe putting customers first is the only reliable way to create lasting value for shareholders. Thanks. And with that, Sean, let's move to questions. + +-------------------------------------------------------------------------------- +Sean Boyle, Amazon.com, Inc. - VP of IR [4] +-------------------------------------------------------------------------------- + + Great. Thanks, Tom. Let's move on to the Q&A portion of the call. Operator would you please remind our listeners how to initiate a question? + + + +================================================================================ +Questions and Answers +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) +Ben Schachter, Macquarie. + +-------------------------------------------------------------------------------- +Benjamin Schachter, Macquarie Research - Analyst [2] +-------------------------------------------------------------------------------- + + On the press release it says that you signed up millions of new Prime members. I believe if you read it, it says that it happened in the last 90 days. I wonder if you ever commented on a time period like that before. Is that a normal run rate to add millions of Prime users in 90 days or is it something special in this quarter that drove Prime? Thanks. + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com, Inc. - CFO [3] +-------------------------------------------------------------------------------- + + I do not recall if we've actually given a 90 period before. I do not believe that we have. In terms of beyond that, there's not a -- that I can add to that. We are very excited. Prime is growing very fast. I am very excited for the service that we offer customers both in terms of physical and digital goods. So it is exciting and that is why we put it in there today in the release. + +-------------------------------------------------------------------------------- +Operator [4] +-------------------------------------------------------------------------------- + + Scott Devitt, Morgan Stanley. + +-------------------------------------------------------------------------------- +Scott Devitt, Morgan Stanley - Analyst [5] +-------------------------------------------------------------------------------- + + Two if I could. First on the Kindle family. It seems like the timing of device launches, on the eBook library size, and local language content could be drivers of different levels of penetration in digital media in the US relative to what you've been able to obtain outside the US to date. I was wondering if there was anything else notable that you would highlight that helps explain the different dynamic that seems to be playing out within the media revenue line, domestically versus international. And whether you think any of those issues are structural or they just work themselves out with the benefit of time and your execution. And then secondly, if you could talk a bit about how you think about the lifetime value of a non-Prime customer versus a Prime customer and what the intended outcome may be as it relates to the increase in super saver pricing in the US market. Thanks. + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com, Inc. - CFO [6] +-------------------------------------------------------------------------------- + + In terms of the first question, certainly we have been launched devices in the US earlier in terms of content, both, you are really referring to mostly eBook content. And both are growing very fast. The base is different, as you mentioned. We have a higher base in the US just based on when we launched. So you're absolutely right. You do see that difference in the media line between North America and international. And so it is just again, both are growing very nicely right now in terms of digital Kindle books. In this case as you referenced, but it is just a different base. And so we're excited about the opportunity that we have in both segments there. But we are further ahead right now in North America. And then, I am sorry, can you repeat the second part of your question again? + +-------------------------------------------------------------------------------- +Scott Devitt, Morgan Stanley - Analyst [7] +-------------------------------------------------------------------------------- + + How do you think about lifetime value of those that are not Prime subs versus Prime subs given the increase you recently did with super saver shipping in the US from $25 to $35 threshold? + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com, Inc. - CFO [8] +-------------------------------------------------------------------------------- + + In terms of Prime customers, we have seen not only a very strong increase in Prime membership but we have seen a very good retention of Prime members. And so certainly, when you look at that, in terms of lifetime value, we have a customer base that is certainly staying with us longer. They are doing more cross shopping and they are getting the benefits of Prime that we are offering that we continue to add to. And then we still have a very good customer base that is non-Prime. You mentioned that the threshold changed. We did change. We have different thresholds in various geographies around the world for super saver, shipped with our super saver delivery in those geographies. +And in the case of the US, we have had the $25 threshold for over 10 years and we changed it to $35. And during this time frame, we have certainly increased our selection that is eligible for that by millions of items. And certainly as you would know, during this rather lengthy time frame, transportation costs and fuel prices have changed significantly over that time period. So we had to change it. So we just thought that was the right thing to do. + +-------------------------------------------------------------------------------- +Operator [9] +-------------------------------------------------------------------------------- + + Mark Mahaney, RBC Capital Markets. + +-------------------------------------------------------------------------------- +Mark Mahaney, RBC Capital Markets - Analyst [10] +-------------------------------------------------------------------------------- + + I want to ask about the North American EGM line. I guess it is the second quarter in a row you have had acceleration. When I asked about you about it last quarter, I think you singled out fashion apparel and consumer staples. But the acceleration really seems to be in line with using comps. Is there something in there that to you indicates that you are getting real critical mass with your customers in those two particular categories? And then just real quickly on the Kiva robots, is there a reason you would call that out? Should that have some sort of material impact over time on leverage in the fulfillment cost line? Thank you. + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com, Inc. - CFO [11] +-------------------------------------------------------------------------------- + + Sure. In terms of our growth in EGM, you highlighted a couple of categories that are growing very nicely that we mentioned last quarter as well. What you are seeing there, and actually the growth is very broad. We have added a lot of unique selections in both our hard lines and soft lines, categories including consumables and apparel, as you mentioned. The experience has gotten better on the site. Unique selection has increased dramatically over the past few years. So just a number of things are coming together in those categories so when I look at it, it just seems very broad, which we like. And there is just a lot of new selection with great category expansion too over the last several years. That is really what you are seeing there. +In terms of Kiva, we have launched in a few FCs. We think it is an interesting opportunity. I think as I mentioned, last quarter at this time we're ahead of the schedule that we had set forth at the time, that we joined with Kiva and we are excited what we see. Certainly, we will still be adding associates. Certainly over time in those FCs but this certainly will be productivity with Kiva. And we will have to stay tuned to see what that looks like but we are certainly excited about that opportunity and the roll out. + +-------------------------------------------------------------------------------- +Operator [12] +-------------------------------------------------------------------------------- + + Victor Anthony, Topeka Capital Markets. + +-------------------------------------------------------------------------------- +Victor Anthony, Topeka Capital Markets - Analyst [13] +-------------------------------------------------------------------------------- + + ROIC is the metric you highlighted each quarter. It has hovered around 20%, 30%, 40% range throughout the quarters of 2010, 2011. It is obviously been depressed over the past several year and a half due to investments. Maybe you can help us with the timing of when you expect ROIC to return to levels we saw in 2011. And second, you are investing a lot in video content for Prime Instant Video. Are there any hard numbers you can share in terms of conversions from the Kindle devices? And there -- in the past there has been talk about converting Prime Instant Video into standalone product. Maybe you can share your thoughts there. Thanks. + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com, Inc. - CFO [14] +-------------------------------------------------------------------------------- + + Sure. Keep in mind, when the -- as you mentioned, we are investing very heavily in the business. We think that is the right thing to do. We have a lot of good long-term opportunities which is why we are doing it. It is depressing ROIC. Just keep in mind from a pure metric standpoint, just as a reminder, the way we measure ROIC is free cash flow divided by average investor capital so total assets minus current liabilities. That is over a five point average and so when you do that first in the numerator, we do have, keep in mind, it's about $1.4 billion in our free cash flow number that relates to the purchase. It goes back to Q4 last year but it's in our TTM free cash flow that relates to the purchase of our campus here in Seattle and some nearby land, so it's $4.4 billion of that. So that is bringing the free cash flow down. +Also keep in mind in the invested capital, we do include cash and marketable securities which is certainly the largest piece of our invested capital. We think that is the right thing to do until we either deploy that capital or return it in some way. Just keep in mind that is included in the metric. In terms of Prime Instant Video, we are getting great usage from a broad set of customers on Kindle as well as other devices, and the adoption is going very well. I apologize. I can't share any specific metrics today but we like what we see. It certainly -- we think it is certainly helping the Prime numbers, you know, the Prime membership increases that you're seeing. It is -- we think it is interesting and we are investing there. We included in both our Q3 results as well as the Q4 guidance, our assumptions around additional content that we'll be acquiring including original content. So I am very excited about that opportunity. + +-------------------------------------------------------------------------------- +Operator [15] +-------------------------------------------------------------------------------- + + Mark May, Citi. + +-------------------------------------------------------------------------------- +Mark May, Citi - Analyst [16] +-------------------------------------------------------------------------------- + + The seasonal hiring is -- I think last year it grew about in line with growth rate in US revenue growth. But this year it looks like it's -- you are growing it about 10 percentage points above the midpoint of your range. Is there anything that is different this year that is driving that? And then second question on pricing. There have been numerous reports recently, and I think for a while now, that the multi-channel competitors are competing more fiercely with Amazon in terms of price parity, et cetera. What impact are you seeing or do you think you could see from that and how you are addressing it? Thanks. + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com, Inc. - CFO [17] +-------------------------------------------------------------------------------- + + In terms of the seasonal employees, unfortunately there is not a lot I can add to that. We are getting ready for an exciting holiday season. And that includes making sure that we have the right amount of employees as well as seasonal help during that period. It also includes making sure that we have the right capacity in place, making sure we have -- we have added a lot of selection over the past couple of years and particularly over the last 12 months in making sure that we have good in-stock levels related to that selection. We are making sure that we have people to help us with not only serving customers with our retail inventory but also Fulfilled by Amazon has grown, certainly very strongly over the past year. And that impacts the capacity and the number of employees that you see there. +So that is really what you are seeing in that number. In terms of pricing, we operate in a very competitive arena. That is not something that is new. That is something that we have been doing since our inception. We have many, many different competitors. You will pass those competitors on your way to work and on your way home. They are offline, they are offline. It's a very competitive marketplace. It is something -- pricing is something that we worked very hard at over the years. We want to make sure that we have great values for our customers. And it is something that we spent a lot of time on and worked very hard to make sure that we can offer that to customers. So I would not say that it is anything new. It is something that we have been dealing with since our inception. But it is a very competitive environment. + +-------------------------------------------------------------------------------- +Operator [18] +-------------------------------------------------------------------------------- + + Carlos Kirjner, Sanford Bernstein. + +-------------------------------------------------------------------------------- +Carlos Kirjner, Sanford C. Bernstein & Company, Inc. - Analyst [19] +-------------------------------------------------------------------------------- + + Two quick questions. First, how do you see your competitive position versus Alibaba in China and what gives you confidence that you have a chance of being a relevant player there, even in the long term? And secondly, in the US you have a service similar to subscription video-on-demand that is a feature of Prime which is Amazon Prime video, while in Europe you have a full-blown standalone service you offer them. Why is your strategy in Europe so different from your strategy in the US when it comes to video-on-demand? Thank you. + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com, Inc. - CFO [20] +-------------------------------------------------------------------------------- + + In terms of China, it is very early there. There is certainly room for many winners. It's a very large segment. We have seen -- we have a good business there in terms of top line that is growing, and we continue to look for ways to make sure that we satisfy customer demand. We work on a lot of the same inputs that we work on in our other geographies to make sure that we have great prices, good selection, speed of delivery. We've worked very hard in terms of putting in a lot of capacity close to customers. So those are the things that we're working on to try to ensure our success there. +In terms of the visual competitors, we have a long-standing practice of not talking about other companies, but again, there is room for a lot of winners. In terms of video content, there's not a lot that I can add to that question. I apologize. But certainly we have been ramping up our content in the US on Amazon.com as part of Amazon Prime. It is something that we have been looking at very carefully. We like what we see so far. We think it is interesting but beyond that, I can't speculate what we might do or might not do in another location. + +-------------------------------------------------------------------------------- +Operator [21] +-------------------------------------------------------------------------------- + + Mark Miller, William Blair. + +-------------------------------------------------------------------------------- +Mark Miller, William Blair & Company - Analyst [22] +-------------------------------------------------------------------------------- + + On AmazonFresh, can you comment on what you are seeing in LA versus the Seattle test? How important is the attachment rate with general merchandise? And then as you are making more frequent deliveries, are you finding that it is driving higher sales of general merchandise? + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com, Inc. - CFO [23] +-------------------------------------------------------------------------------- + + It is very, very early in LA, but we see so far we like. We are adding a lot of selection there on behalf of customers. It is a great opportunity for customers to get both a number of different items through AmazonFresh. So we are excited. We like the trials that we have done have been very good. The conversion has been good. We look forward to even improving the experience even more over time for customers but it is very early. We like what we see but you will have to stay tuned on that one. + +-------------------------------------------------------------------------------- +Mark Miller, William Blair & Company - Analyst [24] +-------------------------------------------------------------------------------- + + And with general merchandise? + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com, Inc. - CFO [25] +-------------------------------------------------------------------------------- + + Sorry? + +-------------------------------------------------------------------------------- +Mark Miller, William Blair & Company - Analyst [26] +-------------------------------------------------------------------------------- + + Are you selling more general merchandise as a result of more frequent deliveries in that market? + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com, Inc. - CFO [27] +-------------------------------------------------------------------------------- + + Yes. + +-------------------------------------------------------------------------------- +Operator [28] +-------------------------------------------------------------------------------- + + Kerry Rice, Needham & Company. + +-------------------------------------------------------------------------------- +Kerry Rice, Needham & Company - Analyst [29] +-------------------------------------------------------------------------------- + + I just wanted to ask a question on your acquisition of TenMarks which is really diving a little bit deeper into the Ed Tech market. I know you sell and rent the textbooks. Can you talk a little bit maybe what your strategy is there? + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com, Inc. - CFO [30] +-------------------------------------------------------------------------------- + + We though it was a company that is doing some interesting things about helping students and children learn math. We thought it was an interesting fit for us, and we look forward to exploring what opportunities we can do together there. And you'll have to stay tuned on that one but we think it is -- it's doing a very nice job and we are very excited to have them as part of the Amazon business. + +-------------------------------------------------------------------------------- +Operator [31] +-------------------------------------------------------------------------------- + + Scott Tilghman, B. Riley. + +-------------------------------------------------------------------------------- +Scott Tilghman, B. Riley Caris - Analyst [32] +-------------------------------------------------------------------------------- + + I just wanted to touch on the North American segment margins for a little bit. We have seen some pretty good progress there in terms of year-over-year improvement, a little bit of a back step last quarter but not too much. The category fell back this quarter. I am wondering if there is anything unusual there in terms of timing or investments that may be more called out and how we should think about it over the next few quarters. + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com, Inc. - CFO [33] +-------------------------------------------------------------------------------- + + Sure. In terms of Q3 specifically, Q3 just because of the, as I would call it the Q4 readiness, the seasonal readiness, you see this often in Q3 where both our total and our segment operating profit is lower than other quarters. That certainly is what you are seeing in Q3 in North America, so that is in terms of the investments we are making to get ready for the season. We talked about, you heard in Jeff's quote, the capacity that we are adding and certainly in multiple geographies but certainly in the North America is impacting that as well. You can see it in our fulfillment line item as a percentage of revenue being up. You can see it in our technical content. We are certainly investing. The other part too that I mentioned earlier is we are investing in video content for Prime in the US, and you see that certainly in this result as well. + +-------------------------------------------------------------------------------- +Operator [34] +-------------------------------------------------------------------------------- + + Tom Forte, Telsey. + +-------------------------------------------------------------------------------- +Tom Forte, Telsey Advisory Group - Analyst [35] +-------------------------------------------------------------------------------- + + I wanted to know where you stand. Last year, I think you added 20 fulfillment centers on a full-year basis. And the last time you gave us an update, I think this year it was five US and a handful of international. I wanted to know where you stood on that and why the change versus last year. And then also very quickly I wanted to see where you stood or how you felt about your Amazon locker initiative. Thank you. + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com, Inc. - CFO [36] +-------------------------------------------------------------------------------- + + Sure. In terms of fulfillment centers, the number is seven but it is a net number. And so included in that are several consolidations. We are building generally larger FCs and we are consolidating some of those. So that is a net seven. And so what that means is if you were to take that as a percentage of our total fulfillment centers, you would certainly get a number that is less than the square footage that we are actually adding. We are adding square footage that would be significantly higher than that. In terms of lockers, it is early. It is another way to get closer to customers to make it convenient for customers, and it is interesting. We have it in a few different geographies right now. It is limited. We do not have it probably across our full network. So that is something we are learning. It is an interesting experience. It is certainly something that over time we will continue to take a closer look at and certainly expand if it makes sense to do so on behalf of customers. + +-------------------------------------------------------------------------------- +Operator [37] +-------------------------------------------------------------------------------- + + Douglas Anmuth, JPMorgan. + +-------------------------------------------------------------------------------- +Douglas Anmuth, JPMorgan - Analyst [38] +-------------------------------------------------------------------------------- + + I just want to ask two things. First, Tom, can you give us some color on where you are in the shift from third party to first party eBooks and how much of a factor that has been in re-accelerating media revenue? We have seen re-acceleration in media the last three quarters I think in North America. And then secondly, it looks like there are six fewer shopping days this holiday season between Black Friday and Christmas. I am just curious what you do if anything differently to prepare for that and do you think that could actually drive more holiday shopping online. Thanks. + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com, Inc. - CFO [39] +-------------------------------------------------------------------------------- + + In terms of your second one, second question, there are fewer days. There is not a lot that we do different. We certainly see when that happens, there is some behavioral differences on behalf of customers just because of the shorter time period. We have certainly some more sizable days during that period. But there is not a lot to add to that. In terms of the transition for eBooks, in terms of our total growth across Amazon on both North America total or global total, it is not a significant or meaningful impact to the overall growth rate. And certainly this transition has been going on for some number of quarters now so there is not a lot I can help you with there. + +-------------------------------------------------------------------------------- +Operator [40] +-------------------------------------------------------------------------------- + + Greg Melich, ISI Group. + +-------------------------------------------------------------------------------- +Greg Melich, ISI Group - Analyst [41] +-------------------------------------------------------------------------------- + + I wanted to dig into the inventory a little bit. It looks like the growth slowed to 20% if the sale is accelerated. Tom, could you give us an insight as to why that is and maybe which categories out- performed in the quarter? + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com, Inc. - CFO [42] +-------------------------------------------------------------------------------- + + Sure, I would look at it more from a turns perspective. And if you look at it more over an average turns basis, it has gone down and the reason is unique selection. We keep adding a growth and unique selection so it certainly has increased over the past year, in stock levels have gotten better. And so those are the things that are really driving it. In terms of endpoints for any particular quarter, they can be a little bit lumpy, but I would look to the turns. + +-------------------------------------------------------------------------------- +Operator [43] +-------------------------------------------------------------------------------- + + John Blackledge, Cowan and Company. + +-------------------------------------------------------------------------------- +John Blackledge, JPMorgan - Analyst [44] +-------------------------------------------------------------------------------- + + Two questions. First, is it a priority to offer one day or same day delivery at some point as some competitors are offering same-day delivery in large markets for certain brick and mortar retailers? And then secondly, can you talk about the prospects for the log in and pay program? How many online merchants are signed up for it and what is Amazon getting out of it either economically and/or from getting data out of the purchases? Thank you. + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com, Inc. - CFO [45] +-------------------------------------------------------------------------------- + + In terms of speed of delivery, whether it be one day or same day, what has happened certainly over the past 10 plus years is we have added a lot of selection, we have added a lot of fulfillment centers. As a result of that, we have selection that is by default, increased in our selection that's closer and closer to customers. As a result of that, our speed of delivery has improved. And certainly for Prime customers, depending upon the geography in the case of the US, we have expressed two day shipping for free and then first of all fees so they get it faster than that. That is something that you have seen that improvement gradually over the past 10 plus years. You have seen it certainly getting even better the last few years as we have rapidly increased the number of fulfillment centers. +That is something that we think is important and we will continue to work on behalf of customers to give them those options and to make sure they get product when they want it. In terms of log in and pay, it is something that we think is interesting. Because of our large customer base and the credentials that we have and the secure payments that we have, we think it is an interesting opportunity. We think that there is -- it is certainly interesting ways to monetize that over time. But again, we think it is an interesting opportunity. + +-------------------------------------------------------------------------------- +Operator [46] +-------------------------------------------------------------------------------- + + Ron Josey, JMP Securities. + +-------------------------------------------------------------------------------- +Ron Josey, JMP Securities - Analyst [47] +-------------------------------------------------------------------------------- + + I want to talk about newer international markets. Specifically, I think Amazon India was called out given 10 new category launches in the past 120 days or so. My question is related to infrastructure in India and how good is it so that Amazon can continue to grow there. Specifically if other countries can follow a model like this, Brazil comes to mind. Thank you. + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com, Inc. - CFO [48] +-------------------------------------------------------------------------------- + + Sure. We have a few different models in India. And we -- from a -- we have a marketplace model which we offer Fulfilled by Amazon, which as you mentioned, certainly would be infrastructure is not as advanced as some geographies but we also we also view that as an opportunity. And we're happy to help sellers, we'll fulfill by Amazon. It is an interesting opportunity. It is very, very early. We are in investment mode there. It's a long-term opportunity but it is a very exciting opportunity. We are a very strong team that is working on that opportunity. So we're excited about it. + +-------------------------------------------------------------------------------- +Operator [49] +-------------------------------------------------------------------------------- + + Brian Pitz, Jefferies. + +-------------------------------------------------------------------------------- +Brian Pitz, Jefferies & Company - Analyst [50] +-------------------------------------------------------------------------------- + + Maybe you could comment on what you are seeing domestically and internationally in terms of eCommerce trends in the current quarter. Anything specific stand out, especially in North America, given some of the mixed commentary we have heard from some of your competitors? And then just some additional comments if you could on growth in the other revenue category, specifically on AWS and/or on your advertising business. Thanks. + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com, Inc. - CFO [51] +-------------------------------------------------------------------------------- + + Sure. I will take the second one first. In terms of AWS, it is growing very, very strong. It is an area that is very early for us. It is growing very, very strong. We have a great team that is working on it, servicing customers, and we are very excited about the long-term opportunity. In terms of you mentioned the trends in North America, what you have see is there are really a nice steady acceleration of growth since Q4 last year. If you look back to Q4 last year, for North America specifically, and you just trace that back over the past four quarters, you see a really nice sequential increase from quarter to quarter. Again, that gets back to it went from 23% in Q4 last year to 26% to 30% and 31%. Those are the year-over-year increases in by quarter for North America revenue And so a lot of it is what we talked about earlier. It is focused on a lot of the retail basics as well as also improving seller performance as well. Those are things that are driving it. + +-------------------------------------------------------------------------------- +Operator [52] +-------------------------------------------------------------------------------- + + Jordan Rohan, Stifel Nicolaus. + +-------------------------------------------------------------------------------- +Jordan Rohan, Stifel Nicolaus - Analyst [53] +-------------------------------------------------------------------------------- + + A follow-up to the last question on US in particular. Did you see any weakness or any discernible trends around the government shutdown and all of the politics going on in Washington in September and early October? And separately, can you talk about what you are learning from being an investor in LivingSocial? The accounting charges aside, can you talk about your own local business, how that may compete with other players in the space and all of the various initiatives you have with? What can be learned from what you know at this point? You are no longer a new investor in that company. Thank you. + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com, Inc. - CFO [54] +-------------------------------------------------------------------------------- + + In terms of North America growth, other than what I mentioned on the quarterly growth, Q3 was strong, 31% growth. Again, we see a nice steady increase over the past four quarters. That is overlapping a quarter from Q3 of last year that was 33%. So again, we like what we see from a growth perspective in Q3 for North America. In terms of total growth, giving a wide range for Q4 and that reflects our view for Q4 but we are excited about the quarter and about getting ready for customers during this heavy seasonal quarter. So we are excited about what we see there. In terms of LivingSocial, there is really not a lot that I can add to your question. I apologize. They are doing a good job in terms of local. We also have a local offering on Amazon. The team is very dedicated to make that work and it is an interesting area. We're learning but it is early. + +-------------------------------------------------------------------------------- +Operator [55] +-------------------------------------------------------------------------------- + + Heath Terry, Goldman Sachs. + +-------------------------------------------------------------------------------- +Heath Terry, Goldman Sachs - Analyst [56] +-------------------------------------------------------------------------------- + + When you look at the deceleration in growth in North America and other revenue and obviously it is still at a very high level. When we are thinking about the major components of that line, AWS, advertising, credit card relationship, is there anything relevant to the relative growth rates between those components that we should be thinking about? + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com, Inc. - CFO [57] +-------------------------------------------------------------------------------- + + I am not sure how to answer your question. The only part I would call out, you mentioned there is a number of different items that is in there. Certainly the largest and fastest growing largest area by far is AWS, and it is growing very nicely. That is certainly reflected in that line item. + +-------------------------------------------------------------------------------- +Sean Boyle, Amazon.com, Inc. - VP of IR [58] +-------------------------------------------------------------------------------- + + Thank you for joining us on the call today and for your questions. A replay will be available on our investor relations website at least through the end of the quarter. We appreciate your interest in Amazon.com and look forward to talking with you again next quarter. + +-------------------------------------------------------------------------------- +Operator [59] +-------------------------------------------------------------------------------- + + Thank you. That does conclude our conference. You may now disconnect. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/exam/original-files/Problem_1_Sample/2013-Oct-30-FB.OQ-138249704477-Transcript.txt b/exam/original-files/Problem_1_Sample/2013-Oct-30-FB.OQ-138249704477-Transcript.txt new file mode 100644 index 0000000..ee63f93 --- /dev/null +++ b/exam/original-files/Problem_1_Sample/2013-Oct-30-FB.OQ-138249704477-Transcript.txt @@ -0,0 +1,495 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q3 2013 Facebook Earnings Conference Call +10/30/2013 05:00 PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * David Ebersman + Facebook, Inc. - CFO + * Deborah Crawford + Facebook, Inc. - Director IR + * Mark Zuckerberg + Facebook, Inc. - CEO + * Sheryl Sandberg + Facebook, Inc. - COO + +================================================================================ +Conference Call Participiants +================================================================================ + + * Carlos Kirjner + Sanford C. Bernstein & Company, Inc. - Analyst + * Justin Post + BofA Merrill Lynch - Analyst + * Richard Greenfield + BTIG, LLC - Analyst + * Eric Sheridan + UBS - Analyst + * Ross Sandler + Deutsche Bank - Analyst + * Heather Bellini + Goldman Sachs - Analyst + * Jason Helfstein + Oppenheimer & Co. - Analyst + * Mark Mahaney + RBC Capital Markets - Analyst + * Brian Wieser + Pivotal Research Group - Analyst + * Scott Devitt + Morgan Stanley - Analyst + * Brian Nowak + Susquehanna Financial Group - Analyst + * Douglas Anmuth + JPMorgan - Analyst + * Mark May + Citigroup - Analyst + * Peter Stabler + Wells Fargo Securities - Analyst + +================================================================================ +Presentation +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Good afternoon. My name is Jay and I will be your conference operator today. At this time I would like to welcome everyone to the Facebook third-quarter earnings conference call. +(Operator Instructions) +Thank you very much. Miss Deborah Crawford, Facebook's Director of Investor Relations, you may begin. + +-------------------------------------------------------------------------------- +Deborah Crawford, Facebook, Inc. - Director IR [2] +-------------------------------------------------------------------------------- + + Thank you. Good afternoon and welcome to Facebook's third-quarter earnings conference call. Joining me today to talk about our results are Mark Zuckerberg, CEO; Sheryl Sandberg, CEO; and David Ebersman, CFO. +Before we get started, I would like to take this opportunity to remind you that our remarks today will include forward-looking statements. The actual results may differ materially from those contemplated by these forward-looking statements. Factors that could cause these results to differ materially are set forth in today's press release, our annual report on Form 10-K, and our most recent quarterly report on form 10-Q, filed with the SEC. Any forward-looking statements that we make on this call are based on assumptions as of today. And we undertake no obligation to update these demands as a result of new information or future events. +During this call we will present both GAAP and non-GAAP financial measures. A reconciliation of GAAP to non-GAAP measures is to included in today's earnings press release. The press release and an accompanying investor presentation are available on our website at investor.fb.com. +And now, I'd like to turn the call over to Mark. + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook, Inc. - CEO [3] +-------------------------------------------------------------------------------- + + Thanks, Deborah. And thanks, everyone, for joining today. This has been a busy quarter at Facebook where we planted the seeds to achieve our long-term goals with Internet.org, our AI group, and our efforts to build the knowledge economy. We continue to see strong overall engagement and are making good progress on our strategy, especially in mobile. This contributes to the results we reported today -- strong revenue growth, strong growth in daily actives and good growth in engagement, as our ratio of daily actives to monthly active continues to grow. +We've also reached new milestones as a mobile company. Now, 49% of our revenue comes from mobile. And 48% of the people who use Facebook on any given day are only accessing it from mobile. That's almost half of people only using Facebook from their phones. And it's a pretty incredible sign of how Facebook has evolved over the last year. +On our last earnings call I talked about our three big goals for the next phase of our Company -- connecting everyone, understanding the world, and helping to build the knowledge economy. Connecting everyone means giving everyone in the world the power to use the Internet and stay connected to the people and things that matter to them. Understanding the world means helping people not just share day-to-day updates but also building up long-term knowledge about the world, and being able to answer questions for you that no other service can. Building the knowledge economy is about helping people create growth in jobs, and supporting a larger economic shift in the world based on information and ideas. This framework is how I'll think about our progress as a company over the next few years. So I think it's a useful way to look at our progress over this quarter, as well. +Let's start with connecting the world. This quarter we took an important step. In August, we launched Internet.org, a global effort with Samsung, Ericsson, Qualcomm and other industry leaders to make affordable Internet access available to everyone in the world. Today, only about one-third of the world's population is online. And the Internet is growing more slowly than you'd probably expect, less than 9% a year. We want to change this. Our mission has always been to connect the world, and to us that means everyone. When the next 5 billion people have a chance to use these basic services and participate in the global economy, that's going to create huge benefits for everyone in the world. +By working together on technology and new business models, we think we can help accelerate the process of connecting everyone. We believe we're in a unique place to help encourage broader growth of the Internet because so much of what people do on the Internet is use Facebook. According to comScore, around 20% of the time that people spend in apps in the US alone is in Facebook services. And when you ask a lot of people in developing countries what service they care about using most, the answer is often Facebook. We're already trying to make access to Facebook cheaper. And we think that all the same tools and innovations that we're developing to do this can be applied to other basic Internet services, as well. Like messaging, search, weather, and Wikipedia, to make those services cheaper or free to deliver. +We also recently acquired Onavo. This is a team that builds world-class data compression technology in mobile analytics. And they'll play an important role in helping us build more efficient technologies and services that use less data. Of course no single company can do this alone, and we're working closely with our partners to develop our future plans. It's still very early for Internet.org, and we'll have more to say in the months ahead. But I'm very excited about this effort, and I'm grateful to our partners for being a part of that. +Next, let's talk about understanding the world. What I mean by this is that every day people post billions of pieces of content and connections into the graph. And in doing this, they're helping to build the clearest model of everything there is to know in the world. A big part of why this works is that people can share things with any audience they want. They don't have to share publicly with everyone at the same time. They can share with just their friends. So, this means that the model of the world that people are building in our systems includes things that people only want to share with just a few people. +This has the potential to be really powerful. But right now we actually do very little to utilize the knowledge that people have shared to benefit everyone in our community. The service we invest in the most is News Feed, which gives you a great sense of what's going on with your community today. News Feed has proved itself incredibly useful for people. And is the most used app on people's phones by far. But this is just the start of what's possible. And when we get to the point where anyone can easily ask any question to Facebook and get it answered by our community, that's going to be very powerful. +In the last quarter, there have been several important evolutions in our strategy of understanding the world. The first is around Graph Search. At the beginning of this year we announced the first beta version of the service on desktop, and indexed more than 1 trillion connections between people and things. In the last quarter we started testing what we call Post Search, which allows you to search all of the unstructured text and posts that people have ever made on Facebook -- about 1.2 trillion more posts. The folks on the team who have worked on web search engines in the past tell me that the Graph Search corpus is bigger than any other web search indexed out there. It's still early for Graph Search because it is still in beta, only in English, and we haven't launched our mobile version yet, but it's something I'm really excited about. +Another evolution in our progress to understand the world is around our approach to building mobile apps. Our goal has always been to help people share anything they want with anyone they want. Historically we've done this by building a lot of features into the core Facebook app. But we also have a few separate apps that are widely used, like Instagram and Messenger, our standalone messaging app. These are each large services that help people share in different ways. Instagram enables more than 150 monthly actives to share beautiful photos, often more publicly than people would want to share on Facebook. Messenger is part of how people send billions of private one-to-one and group messages everyday. And with the latest release of the app yesterday, we're continuing to add features and make this a better experience. In the future, we expect to develop more of these services to help people share different content with different groups of people. And we'll continue to build our Messenger as a better, distinct messaging experience. +There's one more evolution in our strategy to understand the world that I want to mention. In September we formed the Facebook AI group to do world-class artificial intelligence research using all the knowledge that people have shared on Facebook. The goal here is to use new approaches in AI to help make sense of all the content that people share so we can generate new insights about the world to answer people's questions. We started assembling a team of some of the best people in the field to work on these problems. We also announced the acquisition of Mobile Technologies, a speech recognition and machine translation company that will help expand our work in the field beyond just photo recognition to voice. Over time I think it's going to be possible to build services that are much more natural to interact with, and can help solve many more problems than any existing technology today. I'm excited that we're working on this problem and I'm looking forward to us doing a lot more here. +Finally, let's talk about the progress we've made towards building the knowledge economy. The key to building the knowledge economy is building tools for everyone to use information to do their jobs better. So, in addition to connecting everyone and understanding the world, we're also focused on building these services for businesses as a way to accelerate the growth of this new economy. The way businesses will experience this effort is that we'll keep building better services for them to reach their customers with higher quality ads, more efficiently, with better targeting, better analytics and using richer formats. The way people will experience this effort is that the ads they see will become more and more relevant to their lives. +Last quarter I started talking about how our approach going forward would be to grow our business through improving the quality of our ads rather than by just increasing the quantity. This quarter we continue to do this. And the results show our approach is working. We've been able to deliver better content and grow business for our customers and ourselves. We're finding that a lot more people are finding our ads useful and engaging with them. And the average daily actives is engaging with more than one ad per week. Most people probably wouldn't expect to engage with ads that often. So I think it's a great sign that people are finding ads useful, and they're adding value to the experience on Facebook. I think there's still a lot of room to improve the quality of our ads and grow our business over time. So, this is something that we're going to keep on investing in going forward. +So, that's my update on how we're thinking about the next big changes we want to make in the world -- connecting everyone, understanding the world, and building the knowledge economy. We made a lot of progress this quarter. And I want to take a moment to thank everyone who works at our Company and everyone who is part of our community for all that they do to make Facebook great. Looking ahead, you can expect us to keep preparing for the future, even as we keep on building momentum today. As I said in our original S-1 filing, we don't build services to make money, we make money to build better services. This approach has served people who use Facebook, marketers and entire Facebook community well. It's a different way of looking at the world. But it's how we're going to keep succeeding as a Company. Thank you for being with us today. And now I'm going to hand it over to Sheryl. + +-------------------------------------------------------------------------------- +Sheryl Sandberg, Facebook, Inc. - COO [4] +-------------------------------------------------------------------------------- + + Thanks, Mark. We continue to see strong growth in our ads business, especially mobile. Q3 total ad revenue grew 66% year over year to $1.8 billion. And mobile advertising grew to 49% of our total ad revenue. This is a remarkable milestone in the short time since we introduced mobile News Feed ads just last year. Similar to last quarter, our performance is very broad-based, with strong growth across all geographies and types of marketers. At the same time, our overall user engagement metrics remain strong. We think this validates the careful approach we're taking to building our ads business. +I'd like to highlight some of the key drivers of our performance this quarter. These are, to a large degree, the results of investments we've made over the past few years. And they will continue to be our priorities going forward. The first driver is the continued growth of mobile engagement around the world. In 2013, for the very first time, people will spend more time with digital media than watching TV. eMarketer estimates more than five-and-one-quarter a day on digital services, including mobile, compared with four-and-a-half hours watching TV in the US. Facebook is well-positioned to benefit from this shift. In the United States, Facebook, including Instagram, that's one in eight minutes people spend on the desktop but one in five minutes on mobile. +According to ComScore, Facebook and Instagram have more mobile time spent than many of the next largest services, including YouTube, Pandora, Yahoo, Twitter, Pinterest, Tumblr, AOL Snapchat, and LinkedIn combined. Along with this engagement, we believe that we have the best mobile ad products, with ads that are integrated unit into News Feed, where people spend most of their time on Facebook. +As people shift to where they spend their time, marketers are starting to follow. Our results today show that we're benefiting from this shift to mobile. And we believe this shift will continue, and will continue to benefit us. Today mobile represents 12% of consumer media time but it's still only 3% of ad budget. +The second driver of our performance is an increasing number of marketers spending their ad dollars on Facebook. From brands to direct response to local businesses to developers, more marketers are advertising on Facebook, which is a recognize that our ads work to drive sales. This growth is taking place globally. In the third quarter, the number of Facebook advertisers in EMEA nearly equaled the number in North America, reflecting global growth in our online advertising. +The third driver of our growth is product development. We're working in a number of areas to make the ads people see on Facebook better. More targeted ads are better, and we're improving our ad targeting to increase relevance. We're investing in features like custom audiences and partner categories to improve targeting. These are great tools that are still in their early days and we will continue to invest. We also want to make it easier for marketers of all sizes to buy ads and measure their impact. In late September we rolled out at ad format changes to make ads look more consistent across Facebook. And we reduced the number of ad units marketers have to choose from, to reduce complexity. And earlier this month we rolled out a full redesign of our ads buying tools to simplify the ads creation process. Advertisers now select from one of eight business objectives, such as website conversions or app installs. We think these product investments make it easier for marketers to achieve their goals. +We're also expanding our products for developers. We already have launched mobile app install ads and these are going very well. And we now launched mobile app install ads for engagement. These ads help developers and businesses reach people that have already installed there app, and directs them back to increased engagement. We believe these apps are a nice complement to our install ads, and represent a unique opportunity. +We also continue to invest in helping brands see that our campaigns increase in-store sales. We recently launched outcome measurement for the telecommunications industry. And initial tests showed that more than 90% of people who made a purchase after viewing a Facebook ad had never clicked on that ad. This shows that impressions matter, and focusing only on clicks does not tell the whole story. Similarly, a recent study by Kenshoo, one of our leading preferred marketer developer partners, proves this point. The Kenshoo study found that marketers who use multi-touch attribution to measure campaign ROI credited 12% to 30% more value from Facebook than marketers who use last click attribution. But, we still have work to do. Brand marketers aren't moving as quickly as we would like. And we believe measurement is key to influencing the advertisers. +Another important trend influencing our growth is our preferred marketing developer, or PMD, program. Over the past two years, we've invested in building an ecosystem that supports all types of marketers. And PMD has helped those marketers advertise effectively with us. Today, this program is a community of hundreds of technology and service companies spread across more than 45 countries. +In summary, we think our strong performance this quarter further validates that our ad strategy is working. Marketers are responding favorably, as we heard during Ad Week in New York. Our messages are on reach, targeting and measurement are resonating, and we'll continue to reinforce them. Our ads are getting better, and we still have a long way to go. Moving forward, our focus remains the same -- continuing to capitalize on the shift to mobile, increasing the number of marketers who advertise with us, and continuing to invest in our ad products. We believe that we're in the early stages of a major transitioning in advertising. And we're uniquely positioned to capitalize on that opportunity. +Now, David. + +-------------------------------------------------------------------------------- +David Ebersman, Facebook, Inc. - CFO [5] +-------------------------------------------------------------------------------- + + Thanks, Sheryl, and good afternoon, everyone. Q3 was a strong quarter for us in terms of our financial results. Our business grew rapidly around the world. And we're pleased with our performance across our key financial metrics, highlighted by the fact that Q3 was our first $2 billion quarter in terms of revenue. Let's start with the size and engagement of the Facebook community, which continues to grow. 728 million people used Facebook on an average day in September, up 25% from last year. Growth continues to be driven by mobile. In Q3, for the first time, daily actives on web declined year over year, albeit very modestly. Daily users represented 61% of the 1.19 billion people who accessed Facebook during the month of September. And our overall engagement data remains strong. Also, as we announced in September, Instagram now has over 150 million monthly actives. +I want to say a few word about youth engagement on Facebook. As we've said previously, this is a hard issue for us to measure because self-reported age data is unreliable for younger users. So, we've developed other analytical methods to help us estimate usage by age. Our best analysis on youth engagement in the US reveals that usage of Facebook among US teens overall was stable from Q2 to Q3. But, we did see a decrease in daily users, specifically among younger teens. We won't typically call out such granular data, especially when it's of questionable statistical significance, given the lack of precision of our age estimates for younger users. But we wanted to share this with you now since we get a lot of questions about teens. We're pleased that we remain close to fully penetrated among teens in the US. Our monthly user numbers remain steady. And overall engagement of Facebook remains strong. We'll continue to focus our development efforts to build products that drive engagement for people of all ages. +Turning to the financials. Total revenue in Q3 was $2 billion, up 60%. And ad revenue was $1.8 billion, up 66%. Exchange rates had no meaningful impact. Revenue growth was strong around the world, with each of the four geographic regions we report on growing by more than 50% versus last year. The primary drivers of ad revenue growth were an increase in the number of and the strong performance of News Feed ads, and increasing the number of marketers using Facebook, and increased demand in our system. In Q3, overall ad impressions were up 16%. And the average price per ad was up 42% compared to last year. The growth in ad impressions was primarily due to more people using our service, combined with the impact of a price floor reduction late in the third quarter last year. The growth in price per ad was primarily due to the increase in News Feed ads. +In the US and Canada, where last year's price floor change had a smaller impact, ad impressions decreased 8%, and average price per ad increased over 60% compared to last year. The decrease in ad impressions, despite an increase in the number of users in the US and Canada was due to the continued migration of usage to mobile devices where we show fewer ads per person compared to web. The greater than 60% increase in average price per ad in the US and Canada was primarily due to the increase in the number of News Feed ads shown on both mobile and web. Due to their high engagement levels, News Feed ads have a significantly higher price per ad then right-hand column ads. Therefore, the mix shift of our ads towards a higher percentage being in News Feed versus right-hand column is driving up our average price per ad. +Mobile ad revenue in Q3 was approximately 49% of our ad revenue, up from 41% in Q2. The sequential quarterly growth of mobile ad revenue was due to three factors -- an increase in the average price per mobile ad, an increase in the number of mobile users, and an increase in ads shown per mobile user. Looking now at web, ad revenue from web usage decreased both sequentially and year over year. Web ad revenue includes both News Feed ads on web and right-hand column ads on web. Revenue for News Feed ads on web increased significantly in Q3, sequentially and year over year, driven largely by an increase in the number of News Feed ads per web user. The increase was not enough to offset the revenue decline from right-hand column ads. Total payments and other fees revenue was up 24% year over year to $218 million, and roughly flat sequentially. Payments revenue from games was up 18% from last year. But we believe 12% represents the best apples-to-apples comparison, adjusting for accounting items such as the change in revenue recognition timing from late last year. Overall ARPU of $1.72 per user was up 33% compared to last year. We saw 43% increase in the US and Canada, and greater than 40% gains in each of the other three regions we report on. +Turning now to expenses, in Q3 our total GAAP expenses were $1.28 billion. On a non-GAAP basis, excluding stock compensation, total expenses increased 40% to $1.03 billion, driven by higher headcount and infrastructure spend. We ended Q3 with just under 5,800 employees, up 34% from last year. And we continue to be pleased with our success in attracting talent. Our Q3 GAAP operating income was $736 million, representing a 37% operating margin, up from 30% last year. And on a non-GAAP basis, operating income was $987 million, a 49% margin, up from 42% last year. Our GAAP and non-GAAP tax rates for Q3 were 41% and 36%, respectively. GAAP net income was $425 million or $0.17 per share. Non-GAAP net income was $621 million, or $0.25 per share, up around 100% from last year. In Q3 we spent $284 million on CapEx. And free cash flow was $666 million. +Looking at our balance sheet, we ended Q3 with $9.3 billion in cash and investments. During the third quarter we repaid our $1.5 billion term loan, and replaced it with a new $6.5 million line of credit, which is currently undrawn. We'll continue to manage our balance sheet to meet our liquidity needs, protect the business against risk, and provide us with flexibility to invest in new opportunities to grow the business. +Now, let's look forward. We continue to believe that improving the quality and relevance of News Feed ads provides us with a big, long-term opportunity. However, as we think about the future we do not expect it to significantly increase ads as a percentage of News Feed stories beyond where we were at the end of Q3. This is important because increasing ads in News Feed has been a meaningful driver of our revenue growth in 2013. So this should be factored into your expectations for next year. Turning to payments revenue, remember that in the fourth quarter of 2012 we recognized revenue from four months of payments transactions. So, for that reason, we expect payments revenue will be down this coming Q4 compared to last year. +Looking at expenses, we now expect that our 2013 totaled non-GAAP expenses, including cost of revenue but excluding stock compensation, will likely grow around 45%. In terms of our tax rate, we expect that our Q4 and full-year non-GAAP tax rates will be a few percentage points higher than our Q3 rate. Finally, we expect our 2013 CapEx to be in the neighborhood of $1.4 billion. This is down from our prior estimate of $1.6 billion due to a combination of efficiency gains and changes in timing of our planned purchases. +To sum up, in Q3 we made great progress against our key financial objectives -- growing revenue, investing for growth, and positioning the Company to maximize long-term returns for our shareholders. And, we remain excited about the opportunities ahead. +Now, we're ready to open the call for questions. + + +================================================================================ +Questions and Answers +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) +Heather Bellini, Goldman Sachs. + +-------------------------------------------------------------------------------- +Heather Bellini, Goldman Sachs - Analyst [2] +-------------------------------------------------------------------------------- + + Great, thank you for taking the question. I just had two -- one for Mark and then one for Sheryl or David. Mark, the first one, as Facebook's value proposition is connecting the world, how should we expect Facebook, in the future, to more specifically leverage deal location data to advertisers to make the ads even more useful for your users? And over what time frame should we expect that to play out in your mind? And then the second question for Sheryl or David would just be, you talked about brand advertisers taking a little bit more time, I think, that you might've liked. Just wondering if you could help share with us how your mix between DR and brand advertisers has played out over the course of the year, if you could just give us some rough ideas. Thank you. + +-------------------------------------------------------------------------------- +David Ebersman, Facebook, Inc. - CFO [3] +-------------------------------------------------------------------------------- + + The way we think -- I'll take both actually -- the way we think about using location data is that every time we use data we use it in accordance with the privacy controls we offer people. And we are working hard at making our ads better targeted. And over time I think you'll see the industry continue to evolve to get better at targeting more ads. We certainly see it's a significant upside for us to get better at targeting more dads, not just from geo-location data but from all kinds of different data we get based on what users do with our service. +On brand advertisers, we don't break out the different marketer segments. Our results this quarter are based on growth in all marketer segments, including brand. And we continue to make progress. We have every one of the Ad Age global 100 have advertised with us over the past year. My comment was based on the fact that marketing spend is just not keeping pace with the transition to time online and mobile in that segment of the market. And since that segment of the market is so big, helping that transition happen presents significant upside for us. +Our focus there is measurement. We have to show brand marketers that our ads drive in-store sales. And we work on that. We work on that client by client. To share a few examples from this quarter, Cadbury in the UK worked with us to sell their cream egg products the day before Halloween to talk about candy to 16 to 24 year olds. They used Facebook media for user-generated posts, along with TV. They reached 15 million people. 21% of those people they only reached on Facebook, not TV. And the combined impact of TV and Facebook where sales were up 9%. Another example, because it shows how we can move awareness, is the Alfa Romeo 4C launched in Portugal. And they did a pretty cool thing where a person could do a test drive with a Formula One driver. And they got the highest buzz they have ever had in Google trends for a product launch. So, for us, we think it's a big opportunity ahead of us. You have to work on these clients account by account, client by client. But we think as the shift to mobile and digital happens, it's a big opportunity, and we're focused on helping that shift happen. + +-------------------------------------------------------------------------------- +Operator [4] +-------------------------------------------------------------------------------- + + Scott Devitt, Morgan Stanley. + +-------------------------------------------------------------------------------- +Scott Devitt, Morgan Stanley - Analyst [5] +-------------------------------------------------------------------------------- + + Hi, thanks. Sheryl mentioned some of the tools that have been added to make it easier for advertisers to access and use the ad platform. One example was objective-based ad buying. I was just wondering how much you would attribute reduction in friction, like the examples that were referenced on the call leading to direct and immediate increases in inflow of ad dollars versus be more gradual in nature? And then, secondly, for Mark, the concept of the knowledge economy. I was wondering how you envision what the consumer will be doing on the site five years from now, if today is more about sharing, and sharing is more developed in search and product integrations? How you think about that relationship between those three activities on the site over a five-ish year time horizon? Thanks. + +-------------------------------------------------------------------------------- +Sheryl Sandberg, Facebook, Inc. - COO [6] +-------------------------------------------------------------------------------- + + On the first, our growth overall is based on the strong performance of News Feed ads, an increase in the number of News Feed ads per user, and also more marketers. And the simplification of products has actually been very important in attracting new marketers. If you look at the new advertisers we acquired in Q3, 62% of them started with either promoted posts or promoted page lives which are the most simple of our advertising formats. So, we think continuing to roll out very simple ways to become an advertiser is driving our growth, and will continue to. +The larger question you ask was based on our focus of business objective. And that's actually a really big deal for us. We are now getting to the point where our ad product support is really helping marketers achieve their core business objectives. So, before people used to buy via the product -- what product do you want to buy -- and now they're buying from us by identifying -- I want to get mobile app installed, I want to get mobile engagement, I want to get website conversion. I think the fact that we're pivoting to focus on those end business results and making everything else, including social, part of meeting those business results, is a really important part of our strategy. It's driving our growth and I think it's going to continue to. + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook, Inc. - CEO [7] +-------------------------------------------------------------------------------- + + I just want to answer the part of the question about the product experience over time. I move there are two pieces of this that we're thinking about related to the knowledge economy. The first is just helping our customers use information better to grow their businesses and create jobs. So, we're thinking about small businesses and making it so that they can have better insights into who their customers are, and better ability to reach them. Developers being able to use better analytics for being able to find new customers as well. And those are a lot of the inspiration and the strategy behind the ad products that we're delivering. +On the side of the product experiences that we're creating for people who use Facebook, right now I do think that the Facebook experience is very push-based, in that you go to Facebook and we're suggesting content to you through something like News Feed. And over time I think if we do a good job we should be able to create more value through all of the knowledge that has been shared over time that we're not really surfacing on a day-to-day basis right now in terms of helping people answer a lot of different questions that they have around the world. That's the direction we're starting to go in with Graph Search and a few other areas, as well. But, it's pretty early so I think around a five-year timeframe, like you were saying, hopefully we will have made pretty significant progress towards going in that direction. + +-------------------------------------------------------------------------------- +Operator [8] +-------------------------------------------------------------------------------- + + Mark May, Citigroup. + +-------------------------------------------------------------------------------- +Mark May, Citigroup - Analyst [9] +-------------------------------------------------------------------------------- + + Thanks for taking my questions. Maybe this first one for Sheryl and then David. It seems like a year-and-a-half ago, around the time of the IPO, the Company was very focused on top-of-the-funnel brand-related advertising. But over the last year or so it's been much more around direct response. But certainly get the sense that on the top-of-the-funnel brand is starting to move in a more meaningful way. What's the Company doing and what are some of the main projects that you're working on that you think will really start to move the dial on the top-of-the-funnel segment of the market? And what role does video maybe play into that? And then for David, regarding the ad load comment, had ad load not increased in North America, give us a sense of what the ad revenue growth would have been if you normalized for that? Thanks. + +-------------------------------------------------------------------------------- +Sheryl Sandberg, Facebook, Inc. - COO [10] +-------------------------------------------------------------------------------- + + So, top-of-the-funnel ads remain very important to us. And, again, our growth this quarter was very broad-based including top-of-the-funnel ads. The reason they're important is that Facebook is such a unique and powerful discovery place. When you're on Facebook you are open to discovery, you're open to getting messages. And that's what we're seeing with News Feed messages from friends and with ads, as well. The key for us is measurement. The way we're really going to make progress is better measurement. It's easier to understand and measure a click that goes through to an online sale. It's harder to measure households that see ads and don't see ads change their purchase, change their purchase behavior in stores. +The thing I think we've done a lot of over the last year, and we're continuing to do that, is put those measurements in place. So I talked in my opening remarks about measurement for telecom. We've also done a ton of work around CPG so that we can look at households that saw an ad, households that didn't see an ad, and what their difference is. To share one more example, Mondelez did a promotion with us for the Nilla Wafer in the US. They were targeting 35- to 44-year-old females and moms. Because we were able to do this type of measurement, that we couldn't have done a year ago, we were able to show that the got a 5 extra turn on their ad spend. We measured household spending who saw their ads versus households who didn't see their ads, and there was a 9% difference. They were also able to tell that a lot of the 9% was driven by new buyers of their products, which is what they want. So I do think we have a big opportunity. I do think the brands are going to continue to need to be convinced account by account that this moves products off shelves, and that's what we're doing. + +-------------------------------------------------------------------------------- +David Ebersman, Facebook, Inc. - CFO [11] +-------------------------------------------------------------------------------- + + Mark, thanks for your question. This is David. So, it's really not possible to tease out individual contributions because the way the auction works everything is interdependent. So if we have fewer ads, that's going to play out with different pricing and other sorts of things. So, I can give you our best feel for it but I can't quantify it precisely. If you look at overall ad revenue growth, for example, in the third quarter compared to the second quarter, there's probably three factors that contributed materially that are important to understand. One is just growth in users. Second is growth in demand which plays out into pricing. And then the third is an increase in the number of ads that we showed in News Feed per users. I'd probably order the ad load, probably third of the three, relative to the sequential. I think it plays out a little bit differently on mobile versus web. On mobile we really increased the number of ads as a percentage of the overall mobile experience quite modestly in the third quarter versus the second quarter. On web, the increase in the number of ads, or the percentage of ads, in the web News Feed experience went up more significantly than mobile did in the third quarter versus the second. + +-------------------------------------------------------------------------------- +Operator [12] +-------------------------------------------------------------------------------- + + Douglas Anmuth, JPMorgan. + +-------------------------------------------------------------------------------- +Douglas Anmuth, JPMorgan - Analyst [13] +-------------------------------------------------------------------------------- + + Great, thanks for taking the question. I just wanted to ask you about two things. First on video, can you talk about what you've learned from the recent launch of video on Instagram, and how that may have shaped your thinking on rolling out video ads on Facebook? And then, secondly, just following up on the ad volume, just to clarify, when you're saying the ad volume won't necessarily increase anymore beyond where it was at the end of 3Q, is that on average or in the more penetrated markets? And then can you comment relative to the 5% of stories in the News Feed that you mentioned last quarter? Thanks + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook, Inc. - CEO [14] +-------------------------------------------------------------------------------- + + The experience with video on Instagram has been very positive so far. And I think that we proved through that, that having clips that autoplay can be a good experience in line in a feed. And that people really feel like they're in control of the experience because they can just scroll away if they don't like the content. If it's good content then that can be really good. So we're heartened by that. This is an important launch for Facebook overall because the addition of video content to the stream could be one of the most positive things that we've done in a long time for making it more engaging. But if we do it poorly, then it could also be a negative thing. And we're trying to take our time to make sure that we do this in a very positive way, and I'm pretty confident that we will. But that's why you're seeing us take the process that we have on this + +-------------------------------------------------------------------------------- +Sheryl Sandberg, Facebook, Inc. - COO [15] +-------------------------------------------------------------------------------- + + I'll add on video ads, we do have a video ad product today because anyone can embed a video in page posts. And we're actually seeing very good results, particularly around entertainment and media. This is driving some of out ad spend. And the area remains pretty exciting because this is a very compelling way for marketers to tell their story. + +-------------------------------------------------------------------------------- +David Ebersman, Facebook, Inc. - CFO [16] +-------------------------------------------------------------------------------- + + Doug, you asked about what we mean when we say ad volume won't increase. The first thing I would say is I would frame that in the context of as a percentage of the News Feed experience. So, obviously, if we can drive more engagement, that provides more opportunity for us to show more ads. In general, I think your questions referenced whether this was geographic. The ad load in News Feed is reasonably consistent across the world. It's a little bit less in the least developed markets because we have less advertisers there. But it's not grossly different. So, I think that that comment holds generally across most of the markets where we make our advertising dollars. +In terms of relative to the 5%, what we said last quarter was that of the total volume of stories in News Feed, about 5% of those were ads. As I said on the last question, the mobile piece of that didn't change very substantially in the third quarter versus the second. The web percentage did go up. So, if you mix those two together, the Q3 number would be modestly higher than the 5% number from Q2. + +-------------------------------------------------------------------------------- +Operator [17] +-------------------------------------------------------------------------------- + + Mark Mahaney, RBC Capital Markets. + +-------------------------------------------------------------------------------- +Mark Mahaney, RBC Capital Markets - Analyst [18] +-------------------------------------------------------------------------------- + + Great, thanks. Two questions. First, David, can you just give us some color why the reduction in the OpEx growth for this year? Were there certain investment projects you decided to cut, and what were those, and why? And then, secondly, Mark, this five-year vision of moving towards, going from push-based to pull-based, that opens up a lot of opportunities. That's been the sauce, maybe, behind Google, and an interesting part of Twitter, et cetera. But could you talk about the challenges in order to get there? And maybe both in terms of the user experience, the advertiser opportunity, how difficult, substantial the technology challenges are to get there? It's a very different direction and there's a lot of opportunity but how do you get from point A to point B? Thanks + +-------------------------------------------------------------------------------- +David Ebersman, Facebook, Inc. - CFO [19] +-------------------------------------------------------------------------------- + + Hi, Mark. In terms of OpEx growth, we're continuing to invest aggressively in the business with particular emphasis on technical hiring and building out our infrastructure. At the same time, we're trying to do this in a disciplined fashion, making sure that all the investments we make and the dollars we spend are spent wisely in terms of furthering our mission and creating returns for the Company. I'm really quite pleased with how things are going in that regard in 2013. From an R&D standpoint, we're really on track or, if anything, ahead of where we expected to be in terms of hiring and spend. And that's really the most important area for us in terms of investing to drive future growth. +In other areas of the business such as cost of revenue, G&A, marketing and sales, I think we're ramping up spend less than we anticipated for a couple of reasons. One is better success than we expected in some of the efficiency projects that are helping to keep the Company small even as revenue ramps up. A second reason is some slower than expected ramp up in both hiring and new projects. And then the third contributing factor is just we have in the budget some expectations for the unplanned stuff that comes along that can drive spend, like an asset acquisition or something like that. And we really haven't spent as much money as we expected in the unplanned areas. + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook, Inc. - CEO [20] +-------------------------------------------------------------------------------- + + And for your question about how do we make the knowledge that's been shared in Facebook more useful, the first thing we needed to do is just index it all and build the infrastructure to start being able to use it in different ways. The first beta for Graph Search we'd indexed more than 1 trillion connections, friendship connections, group memberships, live connections. Then for post search we indexed more than 1 trillion of the posts that people had put into the system. The basic insight that we think we're operating on here is that right now a lot of the behavior and engagement on Facebook is very day-to-day. You're sharing something, and Facebook is the best place for you to share photos or an event that's going on in your life. And for you to go to News Feed and see what's going on with the people around you. But what's happened is that over the past almost ten years of this behavior, this amazing base of knowledge has been built up -- and it's trillions of pieces of content and information -- that now we're just trying to find different ways to expose that and basically make that more useful to people instead of just the stuff that has been shared in the last day or so. So, Graph Search is one way that you can see that coming to light in terms of people being able to do directed queries for different types of content. There are other kinds of services that we think we can build, as well, that just give people more utility from this corpus of knowledge that's been built up. And that's going to be a big focus for us over the next few years. + +-------------------------------------------------------------------------------- +Operator [21] +-------------------------------------------------------------------------------- + + Justin Post, Merrill Lynch. + +-------------------------------------------------------------------------------- +Justin Post, BofA Merrill Lynch - Analyst [22] +-------------------------------------------------------------------------------- + + Thank you. Mark, after a successful revenue year you start next year with a clean slate. And you highlighted some big ambitions in your prepared remarks about access and improving search. Just maybe remind us how you think about driving profit growth as you look at the Company relative to your long-term objectives for the Company. Thank you. + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook, Inc. - CEO [23] +-------------------------------------------------------------------------------- + + We care a lot about that, and in terms of the shareholder value that we're generating, as well. And I think the recent results -- and what I said at the end of my remarks there was that we're going to keep on planting seeds for future growth while continuing to build momentum now. And I admit that's a philosophy that we've taken in terms of building the Company. We generally want it to be profitable and such. But I don't think we're going to commit or have any specific guidance on this right now. + +-------------------------------------------------------------------------------- +Operator [24] +-------------------------------------------------------------------------------- + + Carlos Kirjner, Sanford Bernstein. + +-------------------------------------------------------------------------------- +Carlos Kirjner, Sanford C. Bernstein & Company, Inc. - Analyst [25] +-------------------------------------------------------------------------------- + + Thank you. Mark, can you talk a little bit more about how the knowledge and the Facebook graph compares with the knowledge in the overall web today qualitatively and quantitatively? And if you are planning to connect the World Wide Web graph to the Facebook graph when you think about the answers that you're going to give people in the future. Secondly, there's draft regulation in the European Commission, in Brazil at least, that may require Internet companies such as Facebook to store all their data locally. What do you think would be the impact on Facebook's CapEx and expenses if these regulations are indeed implemented? Thank you. + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook, Inc. - CEO [26] +-------------------------------------------------------------------------------- + + On your question about the graph, the graph that people share on Facebook versus the web overall, I think they're pretty different. So, in terms of quantity, they're getting to a pretty comparable size. So, engineers on the Graph Search team have told me, folks who have worked on other web search engines before, told me that the scale of things like post search are as big or bigger than any web search index that's out there. But I know they are just different use cases with different kinds of knowledge, and people are going to use them for different things. So, our approach with Graph Search is not to build something which is web search. We think that companies have done that and they're doing a good job at that. But there's different kinds of knowledge, things that you'd want more opinion on from people that you trust, that I think it's latent inside Facebook that we need to do a better job of surfacing that. So that's going to be the focus on that. Over time, there are a lot of possibilities for things that we can do. And I'm not really ready to talk about a lot of them today. But you can look at what we've launched in a couple of Graph Search launches that we've done so far. And we're pretty early in that journey. + +-------------------------------------------------------------------------------- +David Ebersman, Facebook, Inc. - CFO [27] +-------------------------------------------------------------------------------- + + And, Carlos, the second part of your question was about draft legislation or discussion about companies needing to store data locally in various countries. It's an interesting question and definitely something we're tracking. But the answer is really going to depend on the details of what that looks like. It's very hard to assess what kind of implications it would have for a company like Facebook without understanding what we would need to do. So, we'll continue to pay close attention to it but really hard to give you anything in the way of a specific answer at this point. + +-------------------------------------------------------------------------------- +Operator [28] +-------------------------------------------------------------------------------- + + Jason Helfstein, Oppenheimer & Co. + +-------------------------------------------------------------------------------- +Jason Helfstein, Oppenheimer & Co. - Analyst [29] +-------------------------------------------------------------------------------- + + Thanks. Can you give us some color on how many advertisers you guys ended the quarter, how that grew? And then if there's a way to think about how many advertisers have claimed pages, so we can get a sense of how deep the penetration is. Because it looks like you guys are more successful than other companies, and growing at a faster rate, particularly on the local penetration side. Thanks + +-------------------------------------------------------------------------------- +Sheryl Sandberg, Facebook, Inc. - COO [30] +-------------------------------------------------------------------------------- + + Last quarter we reported that we had 1 million active advertisers. And that number continues to grow, and continues to grow healthily. We believe globally we have 20 million small businesses and local businesses of some kind who have pages. So obviously just a fraction of those are advertisers. And I think it's one of the most exciting opportunities in front of Facebook. It's really hard to get small businesses to use technological products. And 20 million small businesses are using us. And we haven't gone out and done aggressive sales efforts to make that happen. Going from having a page that you're using for organic distribution to paid distribution is something we're very focused on. It's why we roll out these simple products. And I think our track record at doing that is good and we plan on getting better at it. + +-------------------------------------------------------------------------------- +Operator [31] +-------------------------------------------------------------------------------- + + Ross Sandler, Deutsche Bank. + +-------------------------------------------------------------------------------- +Ross Sandler, Deutsche Bank - Analyst [32] +-------------------------------------------------------------------------------- + + David, sorry to beat a dead horse but back to the ads per user comment. Can you just give us some color on, since you guys started the mobile News Feed ads a year-and-change ago, how much CPC and click-through rate improvement you've been able to drive? And should we think about it going forward, if mobile users are growing at 18% in the UK, 20% in the US, and I think 60% for ROW, should we think about revenue growth as a slight premium to that but somewhat correlated to that? Thanks. + +-------------------------------------------------------------------------------- +David Ebersman, Facebook, Inc. - CFO [33] +-------------------------------------------------------------------------------- + + Sure, Ross. I think if you look back over the last year, some of the metrics that I think been most positive for us have been, as we've ramped up from a very low volume, very few ads shown in News Feed to larger numbers, what one could reasonably have expected, given the way the auction dynamics work, is that the pricing would really come down as we were delivering more clicks, and as we were diving deeper into the pool of advertising demand. And the way pricing has really held up, and click-through rates have filled up, and CPCs have held up as we've progressed through this over the last year, I think, has really validated our confidence that News Feed ads were going to be a really important product, that could really drive the performance of the business. So, we remain really encouraged and pleased by that. +Going forward, clearly we will try to continue to grow the user base, as you described. And that's been an important part of our revenue growth since the Company started. And the other opportunity is for us to continue to improve the quality, the relevance and the performance of the ads, and to drive up pricing by bringing more demand into our system. We're certainly, I think, doing a good job of that right now, and we've got to continue to execute. + +-------------------------------------------------------------------------------- +Operator [34] +-------------------------------------------------------------------------------- + + Eric Sheridan, UBS. + +-------------------------------------------------------------------------------- +Eric Sheridan, UBS - Analyst [35] +-------------------------------------------------------------------------------- + + Thanks, guys. Two quick questions. One, following up on the last one with respect to ROI around advertising products going forward. I guess maybe more for Sheryl. But how do you guys think about the dialogue between advertisers and yourselves about ROI? And how much of that fits with measurement and attribution tools that you guys need to develop internally versus what they need to think about in terms of the ROI on your properties versus other online and off-line properties? And the second question on mobile app install ads, a question about the diversification of the advertiser base and how that's really developed since the product's been launched? Thanks + +-------------------------------------------------------------------------------- +Sheryl Sandberg, Facebook, Inc. - COO [36] +-------------------------------------------------------------------------------- + + To the first question, it's really both. In order to measure all the way from seeing a Facebook ad through to a purchase, particularly one that's off-line, that takes work and tools on our site, including the data systems. And it also takes thinking about measurement on their side. The industry overall is moving. We've been really pleased to see more embracing of multi-click over last-quick attribution. You can see that happening with a number of big players in the industry. The PMDs are really important here. The PMDs are good at helping people and helping marketers measure. But, really, the develop of measurement systems, take our measurement, take industry measurement. Particularly for brand advertisers, they also takes some rethinking of the ways they have measured ads and ads performance before. And we work very closely with our clients on that. +On mobile app install and mobile engagement ads, we are very focused on growing across the board. We want growth in all of our marketer segments, and we want growth that's broadly across the world. Developers are a really interesting place for us because we think not only do we have, we think, the best mobile ad product in general, because people spend a lot of their time in News Feed, they spend more time in News Feed than they spend in any other part of our service, that gives us an opportunity to sell ads broadly. But it also gives us a great opportunity for developers. Because what developers want people to do happens on their mobile phones and on the desktop. Mobile app install ads have been very successful for us. And they're interesting because the mobile app install market didn't even exist a few years ago. I think the move to roll out engagement ads further deepens our relationship with developers. And shows that we can help get them users, and then we can get those users to continually use their products. So we're pretty excited about this part of the market because we think it can grow so quickly. And we think our ad products and offering is so unique. + +-------------------------------------------------------------------------------- +Operator [37] +-------------------------------------------------------------------------------- + + Peter Stabler, Wells Fargo. + +-------------------------------------------------------------------------------- +Peter Stabler, Wells Fargo Securities - Analyst [38] +-------------------------------------------------------------------------------- + + Good afternoon. Thanks very much for taking the questions. You introduced hash tags in June and I'm just wondering if you could comment on usage trends, how strategically important hash tags are to indexing the knowledge graph going forward? And whether hash tags could become a meaningful part of an ad targeting opportunity in the future if usage catches on in a significant way? Thank you. + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook, Inc. - CEO [39] +-------------------------------------------------------------------------------- + + The launch of hash tag was more just following behavior that we see from people. All we really did was take hash tags that people were putting into the product and make them linked so that people could find other posts that had the same tag. The effort that I think you're latching onto is basically we are putting some more effort now into both public content on Facebook and more private content. So, there are a bunch of different sets of people that a person will want to share with. One is all of their friends. But a lot of the sharing and communication that's done is one-on-one in messaging, or with small groups, or with a community. And then there's a large set of content that's public, which is often very high-quality content, as well. And we have efforts in all of those areas to make it that people can share all of those different kinds of content on Facebook. And that's going to be something that we're going to continue to do. + +-------------------------------------------------------------------------------- +Operator [40] +-------------------------------------------------------------------------------- + + Brian Nowak, Susquehanna. + +-------------------------------------------------------------------------------- +Brian Nowak, Susquehanna Financial Group - Analyst [41] +-------------------------------------------------------------------------------- + + Thanks. I have two, please. You continue rolling out a lot of new products. I was wondering if you could speak to the traction and any of the user adoption of the early topical and interest trending that you've rolled out? And then last quarter you talked about strength in e-Commerce driving some of the advertising. Which kind of verticals would you speak to this quarter? Ad as we're adding into the holiday season, are you still seeing e-Commerce being a big driver again? Thanks. + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook, Inc. - CEO [42] +-------------------------------------------------------------------------------- + + You're asking about the effectiveness of some of the public content efforts that we've done. I think it's starting to do very well and we're very pleased with it. Some of the questions that we've gotten have asked if this is an area we've started focusing on recently, which actually it isn't. It's something we've been working on for a while. But I think the question is a sign that the results are starting to be quite good and folks are starting to notice the traffic that we're driving and the higher-quality content that's public that people are coming across on Facebook. So we're going to keep on focusing on this. It's not just about public content. It's about giving people the power to share with every different audience that they want, whether it's the most private, one-on-one communication and thread, up to the most public content that you want to get out for everyone in the world to be able to consume. We're just going to keep pushing on all of that + +-------------------------------------------------------------------------------- +Sheryl Sandberg, Facebook, Inc. - COO [43] +-------------------------------------------------------------------------------- + + To your second question, direct response, including e-Commerce, continues to perform well. We have high click-through rates, competitive CPCs, so we're attractive for marketers. When you think about verticals, I think we have really tremendous opportunity in basically all of them. Things that are performing particularly well right now -- financial services, media and entertainment, e-Commerce, professional services. But even if you look to a vertical like auto that we haven't historically been strong in, I think we're starting to make real inroads client by client, like the Alfa Romeo case study I showed, because we have such a great opportunity to engage the people they want to reach. Our targeting is also getting better. So with custom audiences and partner categories we're able to identify -- here are the people you want to show your ad to who we believe are in the market to buy a car, for example. So the combination of the measurement work we're doing and the ability to target, I think means we have a strong play in every vertical. + +-------------------------------------------------------------------------------- +Operator [44] +-------------------------------------------------------------------------------- + + Richard Greenfield, BTIG. + +-------------------------------------------------------------------------------- +Richard Greenfield, BTIG, LLC - Analyst [45] +-------------------------------------------------------------------------------- + + Hi. I really wanted to ask you about the Instagram blog post that you put up the other week where you stated specifically that -- I think the quote from the blog was you want ads to be creative and engaging. And that seems pretty different than most of the advertising that I've seen on Facebook, whether on mobile or on the desktop. And wanted to ask you how do you think, or is it possible that if this strategy of advertising works well on Instagram, could we actually see a new form of advertising appear on Facebook sometime in 2014 or 2015? + +-------------------------------------------------------------------------------- +Sheryl Sandberg, Facebook, Inc. - COO [46] +-------------------------------------------------------------------------------- + + What we announced last week is a small test with 10 advertisers to start showing ads in the Instagram feed. And we're excited about it because there's a lot of interest and a lot of excited brands. When you think about ads being exciting and engaging, I think we think about two things. We think about ads that fit the format of the product that they're part of. So, the Instagram ads right now are the pictures and videos, which are exactly what people post on Instagram. If you look at the progress we've made with our News Feed ads, those ads, those in the size, the shape, they got larger when they moved over from the right-hand side, right-hand column. But they're also meant to be as exciting, as engaging as the content. So, our goal is we want our ads to be as good as the user-shared content. Some of them are, a lot of them aren't. We have a lot of room to grow in improving that quality. But in terms of the excitement you'll see, or the interest, that is our goal. And we're just going to match the format of the product we're working with as we roll out ads. + +-------------------------------------------------------------------------------- +Operator [47] +-------------------------------------------------------------------------------- + + Brian Wieser, Pivotal Research. + +-------------------------------------------------------------------------------- +Brian Wieser, Pivotal Research Group - Analyst [48] +-------------------------------------------------------------------------------- + + Thanks for taking the question. I'll take another crack at the number of businesses advertising. I was wondering if you could quantify the number of new small businesses, perhaps, or number of advertisers going beyond that 1 million in the quarter. The reason I ask is I'm trying to understand to what degree that maybe the shift to spending mix towards smaller businesses may have contributed to margin expansion? And maybe you could talk about the margin profile, the different segments of marketers bring to your business. + +-------------------------------------------------------------------------------- +Sheryl Sandberg, Facebook, Inc. - COO [49] +-------------------------------------------------------------------------------- + + We don't break out our business by marketer segment and we don't give margins by marketer segment. But to help answer your question, we've seen strong growth across all of our marketer segments. All of them are growing. Brand's growing, direct response and eCommerce are growing, SMB and local businesses are growing, developers are growing. We definitely think there is a big opportunity, both to grow same-store sales of our large clients, particularly with the shift that's happening from TV to digital and mobile. We think that there's a really exciting opportunity. We also think SMBs are a big opportunity for us. And certainly in an advertiser base of over 1 million advertisers, the great majority of those are obviously the small- to medium-sized businesses. +We worked hard on our sales effort so that we have the right sales and support effort to meet our clients. We care about our margins. Certainly simplified products, such as we've rolled out over the last year, make it easier and cheaper for SMBs to use our products. Easier for them and cheaper for us. And we will continue to focus on the automated tools that help. +I think the most important thing we've done on this goes back to an earlier question about focusing on marketer objectives. Before, we were asking marketers to come in and choose what ad products they were buying. With our shift to focusing on marketer objectives, it's easier for everyone from the largest to the smallest. A small business owner can come in and say -- I want my app installed. Or -- I want web conversions. Or -- I want web click. And then we are doing the harder work of figuring out what products are there, figuring out which of those ads should have social context so that we can meet those objectives. I think that move of moving more towards using their language and focusing on their business needs is a simpler product for them. It will help gain us more marketers and it helps us work with them in a more efficient way. + +-------------------------------------------------------------------------------- +Deborah Crawford, Facebook, Inc. - Director IR [50] +-------------------------------------------------------------------------------- + + Great, that's it. Thank you for joining us today. We appreciate your time and we look forward to speaking with you again next quarter. + +-------------------------------------------------------------------------------- +Operator [51] +-------------------------------------------------------------------------------- + + This concludes today's conference call. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/exam/original-files/Problem_1_Sample/2014-Apr-16-BAC.N-139135830280-Transcript.txt b/exam/original-files/Problem_1_Sample/2014-Apr-16-BAC.N-139135830280-Transcript.txt new file mode 100644 index 0000000..6cfd067 --- /dev/null +++ b/exam/original-files/Problem_1_Sample/2014-Apr-16-BAC.N-139135830280-Transcript.txt @@ -0,0 +1,1093 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q1 2014 Bank of America Corporation Earnings Conference Call +04/16/2014 08:30 AM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Brian Moynihan + BofA Merrill Lynch - CEO + * Bruce Thompson + Bank of America Corporation - CFO + * Lee McEntire + Bank of America Corporation - SVP, IR + +================================================================================ +Conference Call Participiants +================================================================================ + + * Thomas LeTrent + FBR & Co. - Analyst + * Paul Miller + FBR & Co. - Analyst + * Jonathan McDonald + Sanford Bernstein - Analyst + * Mike Mayo + CLSA - Analyst + * Nancy Bush + NAB Research - Analyst + * Glenn Schorr + ISI Group - Analyst + * Ken Usdin + Jefferies & Company - Analyst + * Guy Moszkowski + Autonomous Research - Analyst + * Matt O'Connor + Deutsche Bank - Analyst + * Betsy Graseck + Morgan Stanley - Analyst + * Marty Mosby + Guggenheim Securities LLC - Analyst + * Jim Mitchell + Buckingham Research - Analyst + +================================================================================ +Presentation +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Good day, everyone, and welcome to today's program. (Operator Instructions). +It is now my pleasure to turn the conference over to Mr. Lee McEntire. Please go ahead. + +-------------------------------------------------------------------------------- +Lee McEntire, Bank of America Corporation - SVP, IR [2] +-------------------------------------------------------------------------------- + + Thank you. Good morning. Thanks for joining us on the web as well as the phone this morning. +Before I turn the call over to the CEO, Brian Moynihan, and CFO, Bruce Thompson, let me just say that we may make some forward-looking statements. For details on those, I will refer you to our -- page 24 and 25 in our earnings deck material, on either the website or our SEC filings. And with that I will turn it over to Brian. + +-------------------------------------------------------------------------------- +Brian Moynihan, BofA Merrill Lynch - CEO [3] +-------------------------------------------------------------------------------- + + Thank you, Lee. Good morning, everyone, and thank you for joining us to review the first-quarter results. +As you can see from our numbers we report a loss this quarter. That lost reflects the cost of resolving more of our legacy mortgage issues as well as adding reserves primarily for previously disclosed legacy mortgage related matters. +As disappointed as we are in the bottom line results, we are pleased to report that the businesses reported earnings at a level that allow us to substantially offset these losses. And also at the same time, we are able to still grow and improve our Basel III standardized regulatory capital ratio during the quarter. +Bruce will take you through the particulars of our results. But first I wanted to spend a couple of minutes looking at the progress we continue to make across the customer groups that we serve. +In particular, we added some slides to the appendix on pages 17 and 18, which highlight multiyear trends across our customer groups. Let me just touch on a few of those and connect them to our results. +When you think about our broad consumer franchise for mass-market consumers, affluent and wealthy consumers, as we think about the mass-market group, the strategy in our retail segment has been to lower the cost of service while we improve our customer experience. We do that by continuing to optimize our delivery networks of all types in response to customer behavior changes. +Banking centers and basic teller transactions continue to decline as customers move their business to mobile and online transactions. Yet we still have many millions of visits each week to our branches. +But in the aggregate, our self-service channels of ATM, online and mobile transactions continue to grow. This quarter, more than 10% of all the deposit transactions that consumers make in our Company are now done through mobile devices as people effectively carry a branch in their pocket. This, coupled with other measures, allowed us to reduce our costs in our consumer banking business, 4% from last year's first quarter and allows us to continue to invest in other areas to further improve customer satisfaction and grow sales. +On the preferred side of our consumer business where we serve mass affluent clients, we continue to invest in this group by adding sales specialists. We now have more than 6,500 sales specialists concentrated in the top banking centers. We also increased service associates to drive satisfaction to these clients as well. +The end result when you put all the consumer business together is the segment is organic deposit growth of $23 billion from last year to a total of $535 billion in deposits. On the investment side of this general consumer client base, our Merrill Edge assets grew 21% from last year and when we put the segment together, the earnings in our consumer and business banking business improved 15% year over year to nearly $1.7 billion this quarter. +As we move through the wealthy part of our consumer client base, in our wealth management business with US trust and Merrill Lynch, client balances again grew this quarter, now totaled over $2.4 trillion. This has driven record asset management fees in this segment and we are seeing growing demand from these customers for other banking products as loans and deposits continue to increase. This business made over $700 million after tax this quarter and had a pretax margin of more than 25% for the fifth consecutive quarter. +We'll move to our Company side of our house, our commercial and corporate client base, we continue to retain our leadership position in investment banking fees with $1.5 billion in fees received this quarter. We also saw solid loan and deposit flows this quarter in these -- from our commercial customers. These activities drove a 6% increase in revenue in our global banking business from last year. +In our global markets business, which serves investment clients, we earned $1.3 billion after tax as our top-tier sales and trading platforms generated over $4 billion in revenue this quarter. So we put it all together we have leadership positions that we continue to work on in each area and continue to see good momentum across the quarter. We are pleased also to be in a position to return capital to shareholders as we increase dividends in addition to our newly authorized share repurchase program. +As usual, as we see each day each quarter remain focused on executing this strategy that connects the capabilities of this Company with as customers and shareholders for your benefit. With that, I want to turn it over to Bruce to cover the earnings results. + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [4] +-------------------------------------------------------------------------------- + + Thanks, Brian, and good morning, everyone. I am going to start on slide 2 and work through the first-quarter results. +We did record a loss of $276 million, or $0.05 per diluted share this quarter. Driving the loss during the quarter was litigation expense of $6 billion, which cost us roughly $0.40 a share during the quarter. We recorded $3.6 billion in litigation expense for the previously announced FHFA settlement and we recorded another $2.4 billion primarily associated with the increase in reserves for previously disclosed legacy mortgage related matters. +Revenue during the quarter on an FTE basis was $22.8 billion, which was $1.1 billion higher than the fourth quarter of 2013, but below the $23.4 billion we saw in the first quarter of 2013. On a linked-quarter basis, our revenues benefited from improved sales and trading results and asset management fees and were offset by lower net interest income as well as lower mortgage banking revenue. +Compared to the prior-year period, revenue was down slightly on lower net interest income, mortgage revenue in sales and trading but did benefit from higher asset management fees. Total noninterest expense during the quarter was $22.2 billion, but did include $6 billion of litigation expense as well as $1 billion of retirement eligible incentive costs that we recognize during the first quarter of each year. If we exclude these items from both the first quarter periods for comparability of the underlying trends that we saw within the Company, expenses did improve by $1.2 billion, or 7% and were driven by lower LAS non-litigation costs as well as some of the new BAC improvements that we saw. +Versus the fourth-quarter 2013, the slight increase in noninterest expense reflects increased revenue related compensation in our market business and was partially offset by the decline that we saw in our LAS non-litigation expense reductions. Provision for credit losses was $1 billion during the quarter, an increased $673 million versus the fourth quarter of 2013. In the first quarter this year, we released $379 million from our loan-loss reserves and that compares to a release of $1.2 billion in the fourth quarter of 2013. +Before we move off of this slide, let me mention that we had a few other items in the quarter that in the aggregate benefited EPS by about $0.04 a share as higher equity and debt security gains, net DVA and the resolution of tax matters were positives and they were offset in part by the cost of retirement eligible incentives as well as the negative market-related impacts on our net interest income. +One last point on FVO and DVA, this quarter and moving forward, we report the net impact of these two items as one net DVA valuation number for our derivatives and structured liabilities within our global markets business. +On slide 3, you can see our period-end balance sheet increased from the end of 2013 as we grew both cash and securities in light of increasing liquidity requirements in our primary banking subsidiary. Ending loans declined $12 billion led by lower residential mortgages, principally within our discretionary loan portfolio as well as seasonal declines in credit card. +Loans were up in our global banking segment, which I will cover in a bit. Period-end deposits were up $14 billion from the fourth quarter and are up year-over-year by more than $38 billion. +Our tangible common equity ratio declined to 7% due to the increase in liquidity that I mentioned earlier. Tangible book value did increase slightly during the quarter and we repurchased 87 million shares for $1.4 billion, which completed our share repurchase program that we established at this time last year. Following our CCAR result, we announced a new $4 billion share repurchase plan as well as the intention to increase the quarterly common dividend to $0.05 a share in the second quarter of 2014. +We move to slide 4, we look at our capital ratios under Basel III. Recall this is the first period reporting under Basel III transition which became effective January 1 of this year. Under the transition roles, our common equity Tier 1 capital was $151.6 billion, while our risk-weighted assets were $1.28 trillion, which resulted in a ratio of 11.8%. +While there are no comparative reporting periods, we did provide pro forma fourth quarter of 2013 numbers to allow you to see the slight movement up in the ratio during the quarter. We do continue to provide our Basel III numbers on a fully phased-in basis as we have done in prior periods. The numbers in the chart reflect risk-weighted assets under the Standardized Approach with the common equity Tier 1 ratio improving to 9.3% and remaining above our 8.5% proposed minimum requirement in 2019. +If we move to the advanced method, our CET1 ratio was 9.9% and was impacted by an increased level of risk-weighted assets related to operational risk, which were largely offset by reductions in other risk-weighted assets as well as the increase in capital. We move to supplementary leverage ratios, we estimate at the end of the first quarter of 2014, we exceed the recently updated US rules that apply in 2018. Once again, that would mean our bank holding company is above the 5% minimum and our primary banking subsidiaries, BANA and FIA, are both in excess of their 6% minimums. +I also want to remind you that our Tier 1 capital and supplemental leverage ratios will benefit by approximately $2.9 billion in the second quarter of 2014, if we receive shareholder approval to amend our Series T preferred stock. One last item I want to note regarding capital in the first quarter of 2014, it includes the adjustment to capital allocations across our business line. +We included a slide in the appendix that notes that the new allocation. As you look at that, you will see that the primary adjustments were allocating more capital to our global banking business, given the loan growth we have seen in that segment and to a lesser extent, increases in both our global markets as well as our global wealth management business. As a result of these changes, the amount of unallocated capital that tell that the parent declined from $16 billion to $5 billion at the end of the first quarter of 2014. +If we move to slide 5, funding and liquidity, our global excess liquidity sources increased more than $50 billion to a record level of $427 billion as a result of seasonally strong deposit flows as well as some of the bank debt issuance that we did earlier in the quarter. Our total long-term debt of $255 billion was $5 billion higher than the fourth quarter of 2013. These figures do not include the $7.6 billion of debt issuance that settled on April 1 and was executed at more favorable spread than our existing debt footprint. +That issuance has enabled us to maintain our strong excess liquidity position at the parent, despite the cash flows required by both scheduled debt maturities as well as recent litigation settlement. Our time to required funding remain very strong at 35 months with parent company liquidity unchanged at $95 billion. +Moving forward, and as we consider the FHFA settlement, we would expect parent issuance to be below maturities as the focus evolves towards continued yield improvement following the past several years of sizable balance reductions within our debt footprint. +If we move to slide 6 on net interest income, net interest income on a reported FTE basis was $10.3 billion, which was a decline of $700 million from the fourth quarter of 2013. That decline was driven by a swing of roughly $500 million associated with our market-related adjustments, or FAS 91. FAS 91 was approximately $300 million negative in the first quarter of 2014 compared to the $200 million benefit that we saw in the fourth quarter of 2013. +The balance of the decline was largely due to two less interest accrual days in the first quarter of 2014 relative to the fourth quarter of 2013. Our net interest income, if we exclude those market-related adjustments, was $10.6 billion, once again down a little over $200 million from the fourth quarter of 2013. Other drivers in the quarter were lower average consumer balances and yields, which were largely offset by a reduction in long-term debt costs as well as continued declines in our deposit pricing. +As a result of these net interest income impacts, as well as the higher earning assets, the net interest yield, once again adjusting for FAS 91, declined 3 basis points, 2.36% in the first quarter of 2014. As it relates to asset sensitivity in the balance sheet, we continue to remain poised to benefit from higher rates, particularly when the short end of the curve moves up. As we continue to manage our OCI sensitivity, we are also mindful of both liquidity and leverage rules. +Our first-quarter 2014 increase in securities included shorter duration treasury securities instead of mortgage-backed securities and these treasury securities are much more LCR and OCI friendly, but do have lower yields. Given the continued growth that we have seen in our cash balances at central banks as we increase liquidity, we have adjusted our net interest yields to reflect the impact of adding these low yielding cash deposits once again at central banks into earning assets. This had no impact on net interest income but prior-period net interest yields have been adjusted to reflect the change. +Given the added liquidity during the quarter, coupled with the average balance impact of seasonally lower consumer balances, we expect net interest income in the second quarter of 2014 may be slightly lower compared to this quarter's $10.6 billion level, excluding market-related adjustments, before moving up modestly throughout the second half of 2014. +We move to our expense highlights on slide 7, noninterest expense was $22.2 billion in the first quarter of 2014 and once again included a $6 billion charge for litigation expense and a $1 billion cost for our retirement-eligible incentives. As previously mentioned, the $6 billion litigation expense did include the cost of the FHFA settlement as well as $2.4 billion in increased reserves associated with our previously disclosed the legacy mortgage-related matters. +If we exclude the litigation and retirement eligible incentive costs, our total expenses were $15.2 billion and declined $1.2 billion from the first quarter of 2013 driven by lower LAS costs but were up roughly $200 million from the fourth quarter of 2013 on incentives related to improved sales and trading revenue. Legacy assets and servicing costs, ex-litigation of $1.6 billion declined more than $250 million from the fourth quarter of 2013. As you look at that $1.6 billion number, the savings we generated during the quarter were 40% of our targeted quarterly reductions that we have communicated to you previously. +We continue to make progress on cost savings and as a result our expense program targets for both New BAC as well as LAS remain unchanged. +Turning to slide 8, you can see our credit quality continued to improve again. Net charge-offs declined $194 million to $1.4 billion, or a 62 basis points net loss ratio. Delinquencies, a leading indicator of charge-offs, showed improvement again as well, and our first quarter of 2014 provision expense was $1.0 billion and we released approximately $400 million of reserves during the quarter. +Looking forward, we would expect provision expense for the balance of the year to reflect both modest reductions in net charge-offs as well as reserve releases. Let's move to slide 9 and go through the different business segments, starting with consumer and business banking. Net income of nearly $1.7 billion in the first quarter of 2014 was up 15% from the first quarter of 2013. +Lower expenses, higher service charges, a portfolio divestiture gain and lower credit costs all drove that improvement in the first quarter of 2013. Return on allocated capital within the segment remains very strong at 23% this quarter. As we reflect on customer activity during the quarter, mobile banking customers grew 19% from the first quarter of 2013 to 15 million customers and customer deposit transactions using these devices now represent 10% of all transactions. +Average deposits of $535 billion are up organically $23 billion, or 5% compared to the first quarter of 2013 and our rates paid were reduced nearly in half to 7 basis points. Our brokerage assets surpassed $100 billion in the quarter and are up 21% year-over-year with the growth split fairly evenly between both increases in flows as well as valuations within the market. +Our card issuance remains strong at 1 million new accounts in the first quarter of 2014, but our end-of-period balances are down seasonally from the fourth quarter of 2013. Importantly, our risk-adjusted margin remained above 9%. Overall, our credit quality within the segment remains strong as our net charge-offs declined versus both the linked-quarter period as well as the year-ago period. +Provision expense was $812 million during the quarter. Net charge-offs improved $360 million from the year-ago quarter, and we released $69 million in reserves this quarter, which is $220 million less than the first quarter of last year and down $426 million from the fourth quarter of 2013. +One litigation item to note before we move off the consumer results is the resolution we reached last week with the CFTB and the OCC on issues related to the marketing, sale and billing of credit card debt cancellation and ID theft protection products. This settlement included cash payments to both regulators and provides for redress to customers and was covered by reserves that had been established in prior periods. +We move to slide 10, consumer real estate services, the higher loss in the quarter was driven by $5.8 billion of litigation within the segment. Let's first focus on the reported subsegment of home loans where we record the origination of consumer real estate. +Our first mortgage retail originations of $8.9 billion were down 24% from the fourth quarter of 2013, in line with overall market demand and drove a 32% reduction in core production revenue as margins held relatively steady compared to the fourth quarter of 2013. We continued to reduce production staffing levels in the quarter, consistent with the volumes that we are seeing, but those expenses don't flow through the P&L immediately. +Home equity originations of $2 billion were up from the fourth quarter of 2013 level. If we move to legacy assets and servicing subsegment, once again the driver here is the previously mentioned litigation costs. On litigation costs you saw the press release on March 26 regarding our settlement with FHFA, which identified the $6.3 billion payment and led to the $3.6 billion litigation charge this quarter. +We are obviously pleased to have this matter put behind us. Within our earnings release we also included information regarding a settlement with FGIC and related parties on involved securitization trusts which resolves all outstanding litigation in rep and warranty claims on second lien loans for approximately $900 million to $950 million, depending on the final outcome of two of the remaining trusts -- two of the nine remaining trusts, excuse me. +This settlement was covered by reserves that we had established in previous periods. The primary revenue component within the LAS subsegment, servicing revenue, declined $205 million versus the fourth quarter as the size of our servicing portfolio continues to decline as it aligns with our market share of production. And we also had less favorable MSR net hedge performance during the quarter. +Also impacting revenue during the quarter was rep and warrant expense of $178 million, which increased by roughly $100 million from the fourth quarter of 2013, given the settlement during the quarter with FHFA. From a cost of servicing perspective, our 60-plus day delinquent loans were reduced by 15% to 277,000 units at the end of the first quarter of 2014. And once again, our LAS expense, ex-litigation, declined $262 million to $1.6 billion. +We move to slide 11, global wealth and investment management, during the quarter, we achieved record revenue of $4.5 billion, which was up 3% from the first quarter of 2013 and 2% from the fourth quarter of 2013. The improvement was driven by record asset management fees during the quarter. +Net income of $729 million was slightly higher than the first quarter of 2013, but was down modestly from the fourth quarter of 2013 as expense was 3% higher than both periods. Expense increased compared to both periods on higher revenue-related incentives increased volume-related costs as well as certain investments in technology. Notwithstanding those increases, our pretax margin remains strong, north of 25% for the fifth consecutive quarter. +Our return on allocated capital was 25% but declined from prior period as the relative earnings stability was coupled with the increased capital allocations that I mentioned previously. Client engagement remains strong in the markets providing additional tailwind as our client balances increased $30 billion from the year-end 2013 to $2.4 trillion. +Long-term AUM flows of $17.4 billion for the quarter were the second highest in our Company's history. Ending client loan balances of $120 billion reached record levels and are up 9% year over year. +One other highlight I would like to mention is the core dated referral efforts that we are seeing across wealth management and the banking groups as we funded more than 300 Institutional Retirement plans worth more than $2.4 billion in client assets during the quarter. +On slide 12, global banking, earnings during the quarter were $1.24 billion. Earnings compared to the first quarter of 2013 show a 6% improvement in revenue that were offset by higher expense. +Investment banking fees for the quarter were $1.54 billion, consistent with what we saw during the first quarter of 2013, but 11% lower than the record level that we saw during the fourth quarter of 2013. We do believe for the second consecutive quarter this would rank us as a global leader in investment banking fees. +The remaining revenue drivers in this business, treasury services and business lending, show very positive trends year-over-year across both our commercial as well as our corporate client base. You can see some of these metrics on page 26 of the supplemental information that we provide to you. +Provision was up $116 million from the first quarter of 2013, driven by additions to our loan-loss reserves. The first quarter of 2014 included a build of $282 million versus a build of $81 million in the first quarter of 2013 and $434 million in the fourth quarter of 2013. +The expense increase in the quarter of $186 million on a year-over-year basis relates to investments in technology for our global treasury services and lending platforms, additional client facing personnel and to a lesser degree, some litigation that we saw during the quarter within this segment. We look at the balance sheet, average loans are up $27.4 billion, or 11% compared to the first quarter of 2013 and are up $2.6 billion compared to the fourth quarter of 2013. The overall pace of growth that we are seeing has slowed from the past few quarters as pricing for loans is quite competitive and we have chosen returns over growth in certain cases. +Return on allocated capital was 16% and is down from prior periods reflecting stable earnings that were more than offset by a 35% increase in allocated capital. +We switch to global markets on slide 13, excluding net DVA, we earned $1.24 billion in the first quarter, which is in line with the first quarter of 2013 and up $893 million from the fourth quarter of 2013. Ex-DVA, sales and trading revenue was $4.1 billion, 1% lower than the first quarter of 2013, but 37% higher than the fourth quarter of 2013. +Our FICC sales and trading revenue was down 2% compared to the first quarter of 2013, but we would note it would be down 15% after adjusting for a monoline write-down that we incurred in the first quarter of 2013. Our rates and currencies experienced declines for market volumes and lower volatility during the quarter. I would note that our FICC business did increase 42% over the fourth quarter of 2013. +Equity sales and trading flat with the first quarter of 2013 and up 28% from the fourth quarter of 2013. Expenses were stable compared to the first quarter of 2013 and when we compare expenses to the fourth quarter of 2013, they increased $453 million on higher revenue-related expenses, after excluding litigation of $655 million that we recorded in the fourth quarter of 2013 within this segment. +Our trading-related assets, on average, remain flat at $440 billion on a linked-quarter basis. Our return on allocated capital during the quarter was 16%, even after we consider a 13% increase in allocated capital. +On slide 14 we show all other. Revenue was down $193 million from the fourth quarter of 2013 on lower net interest income, which was driven by the swing in market-related adjustments that I discussed earlier and was partially offset by higher equity investment gains which were driven by the final monetization of an investment. First-quarter 2014 expense includes the retirement-eligible incentive costs which are in line with last year but still drive the expense variance compared to the fourth quarter of 2013, and was partially offset by lower litigation costs. +Provision benefit in the quarter was relatively flat to the fourth quarter of 2013 but did improve $385 million from the first quarter of 2013. Net charge-offs of $206 million improved $88 million from the fourth quarter of 2013, and $279 million in the first quarter of 2013. +Our first quarter of 2014 results in this segment included $341 million reserve release compared to a release of $482 million in the fourth quarter and $235 million in the first quarter of 2013. During the quarter, our effective tax rate was impacted by our loss position. For the rest of 2014, we would expect an effective tax rate of approximately 31% absent any unusual items. +We make a few comments before we open it up for questions. We obviously don't like to report a loss to shareholders but this quarter we achieved resolution of rulings around significant legacy matters -- FHFA, FGIC, CFTB and OCC as well as the positive court ruling on Bank of New York Mellon private-label securities matters, which is under appeal just to name a few. +We established additional reserves to help address previously disclosed mortgage-related issues and we did that and still built our already strong Basel III standardized capital ratio. Our supplemental leverage ratios at both parent and banks are compliant well in advance of their 2018 implementation dates under the more stringent new rules. +Our liquidity is at record levels and we are well positioned to meet the new LCR requirements. Asset quality is strong and improving. Our expense programs show good progress and most importantly, four of our five operating segments reported revenue and earnings that were essentially flat or higher than the prior year. +In our fifth segment, legacy assets & servicing, we made progress on legacy issues. We drove down 60 day plus delinquent loans and our costs, excluding litigation, declined $1 billion from last year's first quarter. +So as we move into the second quarter of this year, we feel that we are better positioned than we were coming into 2014. And with that, we will go ahead and open it up for questions. + + + +================================================================================ +Questions and Answers +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions). Betsy Graseck, Morgan Stanley. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [2] +-------------------------------------------------------------------------------- + + Hi, good morning. A couple of questions. One on the litigation reserve build that you did in the quarter, you mentioned that the FGIC and the trust settlement were fully reserved for. So that means that none of the $2.4 billion increase in reserves in 1Q that you called out was for that settlement? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [3] +-------------------------------------------------------------------------------- + + That's correct, Betsy. As we said, substantially all of the $2.4 billion related to a build in our litigation reserves for matters that we have disclosed previously. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [4] +-------------------------------------------------------------------------------- + + So I guess I am just wondering, if you could give us a sense or color as to what you are referring to there. It doesn't look like that went to the monolines or the PLS so is this something that is broadly mortgage related or is it something else? Given that it is such a large reserve build, does it suggest that there is another settlement on the near term? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [5] +-------------------------------------------------------------------------------- + + You bring up a good point. It does not relate to the previously announced Article 77. It does not relate to the remaining monoline exposure, given that we settled the FGIC closure within the context of our reserve level, so it relates to other mortgage-related matters outside of those that we have disclosed previously. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [6] +-------------------------------------------------------------------------------- + + Okay. + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [7] +-------------------------------------------------------------------------------- + + And I wouldn't interpret or necessarily assume that the build in the reserves suggest a settlement is eminent. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [8] +-------------------------------------------------------------------------------- + + Okay. Just moving to capital, on Basel III, you gave us some great information on the transitional to the fully phased in walk there in the appendix. +I guess I am just wondering, you did narrow the gap between standardized and advanced by 30 bps. Could you run through how you did that in the quarter? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [9] +-------------------------------------------------------------------------------- + + Sure, I think if you -- obviously, the numerator in both is the same and we saw during the quarter -- we saw improvements in OCI in the numerator and we saw some significant improvements in our threshold deductions. That numerator applies to both standardized as well as the advanced approaches. +If you look at the standardized risk-weighted assets, the big driver down there, related to the reductions in our consumer real estate, both first mortgage as well as home-equity, is those portfolios reduced from longer dated assets. In addition, you had the seasonal decline within the card portfolio that helped, and that was moderated a little bit by the growth that we saw in commercial loans. +So I think as you look at that Basel III standardized ratio, what was driving risk-weighted assets were actual reductions in exposure. There wasn't anything related to the models or assumptions that factored into that. +If you move over to the advanced approach, where we reported at 9.9%, which was down a touch, the biggest change and we continue to work with and look to refine and take guidance that we are getting with respect to operational risk, the operational risk-weighted assets during the quarter as we continue to refine that, we're up about $50 billion and now represents almost 25% of our overall Basel III advanced risk-weighted assets. And I think as you look at relative to our peers, brings us -- puts us in line with where our peers are with that and we'll continue to refine and work through that in the future. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [10] +-------------------------------------------------------------------------------- + + Okay, that's great. Thanks for the color. Just lastly on expenses. +You did show a nice reduction in core expenses. Could you speak to some of the things that have been hitting the headlines recently? Cuts in global markets, 5%, is this accurate? +Is it part of New BAC, or is it more a normal course expense management? And then the branches are down 10% over the last two years. How much more optimization is there? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [11] +-------------------------------------------------------------------------------- + + I'm sorry, Betsy, I missed the first part of your question on -- + +-------------------------------------------------------------------------------- +Brian Moynihan, BofA Merrill Lynch - CEO [12] +-------------------------------------------------------------------------------- + + On the global markets, the trimming that we did was announced as sort of the annual trimming that goes on. You remember we always are adding -- and we had, frankly, record hiring from schools this year coming in so we always are adjusting the head count to keep the expenses in line based on -- we are going to have a lot of new people joining us here as we get to the summer that we have already made offers to, and it is kind of the general vetting. +So I wouldn't put that as anything other than day-to-day expense management and also just the natural turnover in the business. The second part, Bruce? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [13] +-------------------------------------------------------------------------------- + + Yes, on branch optimization as we look at that, and I think you really get a sense for the progress within branch optimization when you flip to the Consumer and Business Banking segment. A chunk of that relates to new BAC, and you can see over the course of 12 months as we have taken the branches down by about 300 units, that has contributed to on a year-over-year basis the $180 million of expenses that we saw during the quarter. + +-------------------------------------------------------------------------------- +Brian Moynihan, BofA Merrill Lynch - CEO [14] +-------------------------------------------------------------------------------- + + Betsy, so this is a long-term strategy, so whether it is New BAC or not, we will continue to optimize the platform. And what we show you back in the appendix slide is the mobile banking growth is pretty strong. So at the end of the day, if you look at it across the last 5 or 6 years we have more customers, a lot more deposits and a lot less cost structure as we reposition to meet the customers' changing uses of first computers then phones and the enhanced effect of the ATMs. +So you should expect those techniques to continue. But be that as it may, we also still have 7, 7.5 million people come in our branches every week that are great opportunities to engage with customers that we also continue to see strong foot traffic. So we are manning this to meet those needs from both the people who come into the branch and the people who use the automated technique. And that is the challenge as we go forward. +I think we have done a pretty good job of bringing them down and keeping the expenses moving with the customer flow. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [15] +-------------------------------------------------------------------------------- + + Right, but from here this branch level you think holds or you still have more work to do on pulling it down? + +-------------------------------------------------------------------------------- +Brian Moynihan, BofA Merrill Lynch - CEO [16] +-------------------------------------------------------------------------------- + + We will adjust -- every month they keep looking at it and making adjustments as they look over multiple years in the future, but if you remember originally we said we would get around 5,000 out of New BAC. That was kind of a number we gave you and we are there. +But also remember that what you define as a branch will change. We have these express branch formats where there are salespeople plus what we call ATAs, which are ATM machines that you can actually pull up -- work with tellers directly. It allows you to cash checks to penny, authenticate without your card to stick into the machine, the same things you do with a regular teller, and so it is all important to us. +I think focusing on the numbers as opposed to the overall cost of the structure, all of the parts is and that is what I focus on. If you look at that, we continue to drive that down, taking all the costs of the whole infrastructure relative to the deposit base, that is down from -- it is down near 200 basis points. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [17] +-------------------------------------------------------------------------------- + + Got it. Thanks. + +-------------------------------------------------------------------------------- +Operator [18] +-------------------------------------------------------------------------------- + + Glenn Schorr, ISI. + +-------------------------------------------------------------------------------- +Glenn Schorr, ISI Group - Analyst [19] +-------------------------------------------------------------------------------- + + Thanks very much. Looking for a quick comment on the overall loan picture. +There is always a lot of puts and takes, so the commercial side grew by 8% year over year. The consumer shrunk by 4.7%. +A lot of that is run off. So can you just give a general comment on how you are feeling about loan growth, and then weave in there your commentary on the mortgage origination pipeline being up 23% in the first quarter. Thank you. + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [20] +-------------------------------------------------------------------------------- + + Sure. The first is -- why don't we start -- if you start with the -- within the global banking segment, you saw loans relative to year end up about $2.5 billion and up more significantly than on a year-over-year basis. +We say that we continue to see good loan demand within the commercial space. It is across both C&I as well as real estate, so we feel good about that. +But as I did note that during the quarter, there were certain opportunities and things that we looked at that we did not do in that we very much have a focus not just on growing the loans but the returns that is generated from those loans. And going forward, you should expect to see us grow loans but we are going to be prudent and it needs to be at returns that makes sense and for those customers that we have good relationships with. +If you move to the consumer side, as I did note, and you can see it when you look within the CSDB segment, that the majority of the loan reduction we saw in consumer was really three things. It was the payoff of first mortgage loans that were held for investment purpose within the investment portfolio; it was the continued reduction within the home equity business where we have about $3.5 billion of home equity loans that repay each quarter. Those tend to be older vintages, and we get back to the home equities that we are doing when I finish, and then the third was the overall card balances were down about $4 billion, which on a seasonal basis is what we would expect and we would look to see those card balances stabilize as we go throughout 2014. +As it relates to new activity, we did note that the pipeline is up about 23%. What we saw was not materially different than others in the first month, two months of the quarter. +Applications in volume were down with some of the weather, but we did see a pickup in that activity which led to, obviously, off of a low base, a 23% increase in the pipeline as we go into the second quarter. The other thing I would reference is if you look back, you can see that we have been able to increase and move up what we are doing on the home equity fronts where we have $2 billion of originations during the quarter. +And I would just note from a credit quality perspective and what we are seeing there, those loan to values tend to be in the sixties with FICO scores deep into the 700s. So that area is providing an opportunity for us as well. + +-------------------------------------------------------------------------------- +Glenn Schorr, ISI Group - Analyst [21] +-------------------------------------------------------------------------------- + + And summing it all up, I just -- I don't want to put words in your mouth but if you look at the net of up just 50 basis points for total loans year on year, it just sounds like it is better than that just because of the runoff and I just wanted to make sure that I get that specific comment. + +-------------------------------------------------------------------------------- +Brian Moynihan, BofA Merrill Lynch - CEO [22] +-------------------------------------------------------------------------------- + + Especially in the consumer business, the runoff affects the overall numbers. + +-------------------------------------------------------------------------------- +Glenn Schorr, ISI Group - Analyst [23] +-------------------------------------------------------------------------------- + + Okay. + +-------------------------------------------------------------------------------- +Brian Moynihan, BofA Merrill Lynch - CEO [24] +-------------------------------------------------------------------------------- + + Because remember, we have still got the portfolios that we inherited from acquisitions that they are still running through the system. + +-------------------------------------------------------------------------------- +Glenn Schorr, ISI Group - Analyst [25] +-------------------------------------------------------------------------------- + + Right. Follow up on the legal, you mentioned the first two were fully reserved for. +The 2.4 adds to the reserve, where are we now in terms of the estimated losses above and beyond what you reserve for? In other words, I would think it could go down as you continue to add for the reserve. + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [26] +-------------------------------------------------------------------------------- + + Are you referring to the range of possible loss that we disclose when we put the Q out? + +-------------------------------------------------------------------------------- +Glenn Schorr, ISI Group - Analyst [27] +-------------------------------------------------------------------------------- + + Correct. + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [28] +-------------------------------------------------------------------------------- + + Yes, I think we are working through and refining that. We don't put that out with earnings, we put it out when we file the 10-Q. +But to your point, I don't think there is -- we obviously made progress with getting FHFA put behind us as well as FGIC and some other related matters. And we are working through where exactly that range of possible loss comes out, but hear your point. + +-------------------------------------------------------------------------------- +Glenn Schorr, ISI Group - Analyst [29] +-------------------------------------------------------------------------------- + + Okay, appreciate it. And then last one on slide, I think it is 14. +Just curious, the equity investment income, what is driving that? It seems to have a nice steady and upward trending slope. + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [30] +-------------------------------------------------------------------------------- + + Yes, as we noted in the script, that we did complete the final monetization of an investment that was a decent chunk of that. So I would not expect to see those revenues at those levels going forward. + +-------------------------------------------------------------------------------- +Glenn Schorr, ISI Group - Analyst [31] +-------------------------------------------------------------------------------- + + Okay, that's good for me. Thank you. + +-------------------------------------------------------------------------------- +Operator [32] +-------------------------------------------------------------------------------- + + Jonathan McDonald, Sanford Bernstein. + +-------------------------------------------------------------------------------- +Jonathan McDonald, Sanford Bernstein - Analyst [33] +-------------------------------------------------------------------------------- + + Hi, Bruce, hi, I was wondering if -- just want to understand the dynamic of the net interest income outlook I guess in the second quarter. It is the increase in lower yielding liquidity on an average basis and that is going to push the NRI down a little bit. +That overwhelms the day count. Is that what is happening in the second quarter? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [34] +-------------------------------------------------------------------------------- + + Yes, keep in mind, you only pick up one day, Q1 to Q2, but I think you have a couple things, as I mentioned. You've got relative to the first quarter, you do have lower card balances given the seasonal bump that you see at year end that you carry a fair bit of during the first quarter. +We did build up throughout the first quarter a significant amount of liquidity anticipation of those rules. That will contribute a little bit to the decline in the second quarter, and then as we solve for that, you would expect to see that move up, so nothing structural. +We do have some seasonal stuff in the markets business that we do, that depresses things that touch in the second quarter. So as we said, it is obviously early in the quarter, but we are expecting a slight decline but then we would expect the trajectory to get back to the levels that we have previously talked about. + +-------------------------------------------------------------------------------- +Jonathan McDonald, Sanford Bernstein - Analyst [35] +-------------------------------------------------------------------------------- + + Okay, and what is helping it grind higher beyond the second quarter, Bruce? Just as a reminder, what helps it grow in the third and fourth quarter and beyond? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [36] +-------------------------------------------------------------------------------- + + Sure. I think, as you look at it, one of the things that we continue to work through is that the debt footprint will come down, although more modestly, but what we are seeing is as we look at the levels at which we raised debt going forward, the cost of that has come down significantly. So you have some pick up there. +You obviously have some pick up with some of the loan growth that we are seeing within the commercial space. And we continue to take deposit pricing down as well, although we are down to levels that are harder to get much lower. And I do just want to remind you, John, I know you know this that as we give this guidance, it backs out and it excludes market-related impacts that come out of FAS 91. + +-------------------------------------------------------------------------------- +Jonathan McDonald, Sanford Bernstein - Analyst [37] +-------------------------------------------------------------------------------- + + Okay, then on litigation expense, Bruce, with the big reserve build in the settlements this quarter, what is the outlook there? I know it is tough to forecast but should we assume that a few hundred million of litigation expense will persist for the next several quarters? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [38] +-------------------------------------------------------------------------------- + + I think, John, I think you have to split between -- we continue to -- and I'd just remind, as you look at the litigation pipeline and you look at where we are, we have obviously gotten through the base rep and warrant with respect to the GSEs. We were able to get through and reach an agreement with FGIC, which is the fourth monoline settlement that we have, and then we are working through and the Article 77 case is going through a judicial process. +So as we continued to reduce the number of outstanding litigation items that we have, that should obviously bode well for what I would characterize as the base litigation expense. That being said, I think we need to be realistic and you saw it this quarter that as it relates to the remaining couple of matters that we have disclosed, it can be lumpy and that it is just very hard to predict. +But as we talked about in the presentation, during the quarter, we did have a pretty significant build as we continued to evaluate those positions as well as the discussions that we have that are parties to the litigation. + +-------------------------------------------------------------------------------- +Brian Moynihan, BofA Merrill Lynch - CEO [39] +-------------------------------------------------------------------------------- + + John, I think the simple way -- if you think about things that -- litigation matters that sort of arrived after 2008/2009, the cost of those in the P&L is very modest. If anything it's sort of new -- these costs really relate to the stuff before the crisis and the [Bonner] cleanup. +So your point about what would be the ongoing litigation costs would be much, much lower. But the question is the lumpiness Bruce refers to the transition we have got left on a few of these matters. + +-------------------------------------------------------------------------------- +Jonathan McDonald, Sanford Bernstein - Analyst [40] +-------------------------------------------------------------------------------- + + Okay, and then, Bruce, just to clarify the provision commentary that you made, your outlook is for net charge-offs to grind lower modestly, and reserve release to continue, but probably at a smaller level than the 380 we saw this quarter. + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [41] +-------------------------------------------------------------------------------- + + I think that is fair, John. It can bounce around in any one quarter, but I think the provision number broadly speaking is in line with what we would expect over the next couple quarters. + +-------------------------------------------------------------------------------- +Brian Moynihan, BofA Merrill Lynch - CEO [42] +-------------------------------------------------------------------------------- + + So, John, one of the ways -- if you look at the supplemental material and the pages on the charge-off by product, you have got to remember that there is -- if you look at the credit card charge-offs, in US and domestic, they are down in the -- this quarter it was $700 million and a 3.75% charge-off rate. You're kind of hitting a place where the business is geared to have some amount of charge-offs and it is the way the business works, part of the cost of doing business through the credit costs. +If you look outside that number, that is -- card charge-offs are like 80% of the charge-offs -- or 60%, 70% of charge-offs. And so they are going to be hard to get down a lot more. So there is work to do on mortgage charge-offs, home equity charge-offs, but if you look across the rest of the board, they are in pretty good shape. + +-------------------------------------------------------------------------------- +Jonathan McDonald, Sanford Bernstein - Analyst [43] +-------------------------------------------------------------------------------- + + Okay, and last thing for me, just wondering if trading and fixed income in particular, do they have any notable sequential trends in the quarter? Did trading get better in March and early April as rate volatility started to pick up a little bit or anything like that? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [44] +-------------------------------------------------------------------------------- + + I wouldn't highlight any real seasonality of note as it relates to drastic ups or downs throughout the quarter. The one piece that I would say that -- I think generally, rates in foreign exchange given where the market was and the fact that there was not a lot of volatility in the quarter was clearly negatively affected. +And on the positive side, I would say that the overall credit trading businesses, whether it be loans, high-grade bond trading or high-yield bond trading, given market activity levels as well as our position from an underwriting perspective, were very strong during the quarter. + +-------------------------------------------------------------------------------- +Jonathan McDonald, Sanford Bernstein - Analyst [45] +-------------------------------------------------------------------------------- + + Okay, thank you. + +-------------------------------------------------------------------------------- +Operator [46] +-------------------------------------------------------------------------------- + + Paul Miller, FBR. + +-------------------------------------------------------------------------------- +Thomas LeTrent, FBR & Co. - Analyst [47] +-------------------------------------------------------------------------------- + + Morning. This is actually Thomas LeTrent on behalf of Paul. +Another sort of expense-themed question. There has obviously been an increased amount of regulatory scrutiny on MSR transfers. Can you [stretch] for me a little bit, whether if those transactions got delayed or pushed out if it would impact your ability to meet expense targets or just a little color there? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [48] +-------------------------------------------------------------------------------- + + It's a very good question. What I would point out is, and if you go back to the fourth quarter of 2012, that was when we announced our significant MSR transfers and so as you look at where we are, as it relates to just pure MSR transfers, we are through the significant majority of what we would expect. +We have got some cleanup in sparse smaller ones during the second, third and fourth quarters. We don't have any reason to believe, given they are small and who they are going to, that there will be a problem with the transfer. So we feel, and as it relates to getting to the expense targets with what is left to go, that will not be an issue for us. + +-------------------------------------------------------------------------------- +Thomas LeTrent, FBR & Co. - Analyst [49] +-------------------------------------------------------------------------------- + + Okay. That's very helpful. Thank you very much. + +-------------------------------------------------------------------------------- +Operator [50] +-------------------------------------------------------------------------------- + + Ken Usdin, Jefferies. + +-------------------------------------------------------------------------------- +Ken Usdin, Jefferies & Company - Analyst [51] +-------------------------------------------------------------------------------- + + Thanks. Good morning. I wanted to ask you about just operating leverage and, again, expense progress. +So year-over-year, revenues plus or minus are down $1 billion and if I am looking at slide 7, I am looking at the core expenses were down a few hundred million and that is net of all the New BAC benefits. So can you talk to us about just the push and pull between the net BofA, the new BofA, New BAC reductions and then what cost inflation you are seeing, if any, underneath the core? And then as you look forward, just how we should expect that core line to interject, you know, the $13.6 billion excluding the retirement eligible? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [52] +-------------------------------------------------------------------------------- + + Sure. Well, let me answer the last part of your question first, which is we would expect the core trajectory to trend down as we go throughout 2014. +When you look at the -- and if you are looking on slide 7 and we compare the $13.8 billion to $13.6 billion, let me just consider and give you a couple numbers that affected that core. During the first quarter of 2014, as we continue to reduce headcount, we incurred over $100 million in severance expense on both an absolute basis as well as a year-over-year basis within those numbers, so you had $100 million to the negative there. +The second thing is, and as we disclosed, we have been investing within corporate banking, cash management salespeople to a lesser extent, capital markets people and some of the technology that goes along with that. And we think as we look going forward we are through a lot of that investment but as I referenced in my comments, I would ask you to flip back up to page 26 because we are seeing the benefit from revenue growth from those investments and we would obviously expect those to moderate going forward. +The other couple things that I would note there is if you look at, within the wealth management business, you need to consider within that area that we did have a $200 million-plus increase in revenue from asset management fees. So there is obviously compensation that goes out with that as well as some of the technology dollars that were spent for our Merrill One project that we have rolled out within the wealth management area. +So I would just say as you look at that $200 million, the benefit from New BAC was clearly on a year-over-year, much more significant from that. But we are investing in the areas where we think and where we are seeing revenue growth. And we would obviously expect those investments, given that they have been made and are generating the revenues that you would expect those to moderate going forward. + +-------------------------------------------------------------------------------- +Ken Usdin, Jefferies & Company - Analyst [53] +-------------------------------------------------------------------------------- + + Thanks, Bruce. And as just a follow-up to that, then, we are going to continue to see improvements to get to that $2 billion New BAC level by mid next year, but given what you anticipate on the revenue side, do you feel that that is enough to get you where you want to go in terms of profitability improvement or is there anything you can contemplate or need to contemplate as far as finding other incremental ways to fund those investments or drive more to the bottom line? + +-------------------------------------------------------------------------------- +Brian Moynihan, BofA Merrill Lynch - CEO [54] +-------------------------------------------------------------------------------- + + Obviously we continue to look at that and we will continue -- we started after this -- as you know, in 2011, and so if you go back -- I think we had $80 billion-odd expenses when we started this thing and so we had been driving this down year after year after year but that doesn't mean it stops with New BAC. It's just the challenge inherent in the slow growth environment is how to manage the relative investment rate, expense growth rate versus revenue growth rate. +And so that is something we as management continue to have to focus on. But if you think about the $13.6 billion and think about continuing to make some improvement against it and annualize that, add back whatever the $1 billion to the one-time retirement costs and then some litigation, you start to get into levels that we think are consistent with the earnings -- sort of restoring the normalized earnings pool. +The question is -- and you are right, is that we have got to make sure that the investments we make are yielding the revenue benefits and we have got to keep the total expenses overall net. That is what we're up to. +And I think the way to think about that is look at 3,500 more employees, headcount reduction this quarter and you will continue to see that work its way down. That is a leading indicator what is going to happen next quarter because those employees -- that is a spot-to-spot number went out there in the quarter but they are still in the payroll for the quarter. + +-------------------------------------------------------------------------------- +Ken Usdin, Jefferies & Company - Analyst [55] +-------------------------------------------------------------------------------- + + Got it. One last one, just card income and service charges, a lot of other banks have been seeing weakness there, partially weather, partially regulatory, partial pricing changes. Anything that you guys are seeing or anticipate seeing on any of those fronts looking ahead? + +-------------------------------------------------------------------------------- +Brian Moynihan, BofA Merrill Lynch - CEO [56] +-------------------------------------------------------------------------------- + + If you think about the longer-term trend there as we had a big change in terms of fee structures in the consumer business broadly going back a few years ago and you kind of came through all that and that affected, what has happened now is if you just look at our card activity, our purchases on our cards are up by 5% or so quarter to -- last year to this quarter -- first quarter last year, fourth quarter this year. So we continue to see better than market growth in the activity levels that the general spending levels and things like that which helps on the interchange. +Once we got off sort of the reductions that were due to the change, interchange rule. And so I think it will keep grinding forward based on just general activity but most of the real downdraft came out in 2011/2012, early 2013 timeframe. + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [57] +-------------------------------------------------------------------------------- + + The other point, too, is if you look at within the consumer business we actually saw service charges during the quarter were up about 3% on a year-over-year basis. So some of the card income tends to be seasonally higher in the fourth quarter. It drops in the first quarter then builds backup, but within the consumer space we were pleased with what we saw on the service charge line during the quarter. + +-------------------------------------------------------------------------------- +Brian Moynihan, BofA Merrill Lynch - CEO [58] +-------------------------------------------------------------------------------- + + And so if you go back and look at 17, we have been producing from a sort of 700,000 to 800,000 run rate in new cards to 1 million-plus. And those cards are being used as a core card by the customers, and such driving up the pay rate's still high so the balances aren't moving much but the activity underneath is moving. +And we are still replacing some affinity portfolios that we sold and things like that. So our view is that the transactional behavior of our customers continues to grow and will benefit in some of the fee lines too. + +-------------------------------------------------------------------------------- +Ken Usdin, Jefferies & Company - Analyst [59] +-------------------------------------------------------------------------------- + + Okay. Thanks very much. + +-------------------------------------------------------------------------------- +Operator [60] +-------------------------------------------------------------------------------- + + Mike Mayo, CLSA. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA - Analyst [61] +-------------------------------------------------------------------------------- + + Good morning. First, just a couple follow-ups. How much of the New BAC savings were achieved by the end of the quarter? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [62] +-------------------------------------------------------------------------------- + + You should look at relative to the $2 billion a quarter, we are in the $1.7 billion area. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA - Analyst [63] +-------------------------------------------------------------------------------- + + All right, so you have $300 million per quarter to be achieved by mid-2015? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [64] +-------------------------------------------------------------------------------- + + That's correct. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA - Analyst [65] +-------------------------------------------------------------------------------- + + Okay, and then the LAS savings, you have another $500 million a quarter to be achieved by the end of the year? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [66] +-------------------------------------------------------------------------------- + + That's correct. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA - Analyst [67] +-------------------------------------------------------------------------------- + + All right, so $800 million total, quarterly expense savings we should expect over the next year or so. So should we expect all of that to hit the bottom line? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [68] +-------------------------------------------------------------------------------- + + You should expect it to hit the bottom line with just the one caveat that to the extent that there are revenue-related things that have costs attached to them, that could moderate that reduction. But ultimately, that would be a positive to the pretax income line. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA - Analyst [69] +-------------------------------------------------------------------------------- + + Okay. Do you have an efficiency target for the firm? I am just looking at page 3 of the supplement and the efficiency ratio is kind of thrown off by the charges and it has been in the 70%s the last few quarters. +97.68%, I don't think you consider that your core efficiency ratio. But, so what do you consider your core efficiency ratio and where should it be and where do you hope to get -- when do you hope to get there? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [70] +-------------------------------------------------------------------------------- + + I think if you go back and look at what we talked about in the fourth quarter, where we talked about where we would like to get to from an ROA, return on tangible common equity, and we talked about once rates starting to move up that as we looked out, if we look out at a couple years, that efficiency ratio should be in the high 50%s. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA - Analyst [71] +-------------------------------------------------------------------------------- + + Okay, so do you have a specific timeframe for that or just when rates go up? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [72] +-------------------------------------------------------------------------------- + + I think as we look at it, it is just the point in time that rates are up roughly 100 basis points across the curve. And, obviously, to the extent that we don't see rates move up, we are going to need to run harder on expenses to try to get it to the extent that the rate environment doesn't move up. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA - Analyst [73] +-------------------------------------------------------------------------------- + + Shifting gears, the tax rate excluding the mortgage charge for the first quarter was what? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [74] +-------------------------------------------------------------------------------- + + I believe it was roughly -- it was about 50% -- somewhere between 58% and 60%. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA - Analyst [75] +-------------------------------------------------------------------------------- + + I'm sorry, the tax rate? You said the tax rate going ahead will be 31%. I am just trying to figure out what was the core tax rate for this quarter, excluding the charge? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [76] +-------------------------------------------------------------------------------- + + It would be -- the core tax rate we project out and look out over the years, the core would have been 31%, but you always have a little bit of noise when you -- and obviously it was a pretax loss. But the discrete item always kind of overwhelm things in a low period, but the base rate from which you are starting from is a 31% and it was just a little bit skewed given what we saw from a pretax loss perspective. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA - Analyst [77] +-------------------------------------------------------------------------------- + + Okay. You had record wealth management for the quarter and one of the online brokers recently said that the big brokerage firms are doing better. Do you -- how much do you attribute the record wealth management to the environment versus what you are doing versus it is better to be a big broker? + +-------------------------------------------------------------------------------- +Brian Moynihan, BofA Merrill Lynch - CEO [78] +-------------------------------------------------------------------------------- + + I am not sure what the context of that is, Mike, but the net flows in the wealth management business were around $11 billion, $12 billion this quarter, which was $16 billion or $17 billion -- nearly $17 billion to $18 billion due to long-term flows and $6 billion of short-term liquidity flows out through net of around $12 billion. If you look in the Merrill Edge platform, which is more akin to the online type of thing, I think we had 80,000-plus new accounts this quarter. +The assets continue to grow; it topped 100 billion daily average trades. Darts are up I think 25% to 30% year-over-year, and so it continues to progress and we continue to see good asset flows there, too. So big, small, large, traditional, all that's sort of blended together, we operated the core consolidated franchise, you are seeing good momentum on both sides. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA - Analyst [79] +-------------------------------------------------------------------------------- + + You are allocating more capital to GWIM as well as global banking and global markets. Is that increased capital allocation due to regulatory capital changes or a deliberate move by you guys to invest more for growth in those segments? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [80] +-------------------------------------------------------------------------------- + + Well, let me just start -- the allocation of capital is how we take the capital that we have at the Company and push it out to the businesses. I think you need to go segment by segment within that, Mike, I think the first is that as you look at the global banking segment and look at the allocation and what we have done, the first is on a year-over-year basis you had average loans up about $30 billion so there were more loan balances against which you need to allocate capital. +The second thing that I would say is as you look at that segment and you consider Basel III standardized ratios, they tend to risk weight almost all commercial loans at 100%, regardless of what the models would suggest they should be risk-weighted at. So I think the combination of the loan growth, along with some of the impacts from regulatory capital led us to increase what we did with respect to global banking. +Within global wealth management, as you go back and refine operational loss models and assign operational risk capital, that was topped up as well as reflecting the fact that within the wealth management business that we have seen loan growth within that segment. So there was additional monies allocated there. +And then as we look at, and just continue to refine and look at both comparables as well as asset mix we thought it was prudent to increase modestly what we saw within global markets. And as I said in my comments, when you consider it in the aggregate and we look at where we are at relative to peers, we have got virtually all of our capital at this point pushed out to the different businesses which is the way it should be. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA - Analyst [81] +-------------------------------------------------------------------------------- + + I agree, so it sounds like it is partly business growth and partly regulatory related and partly a desire simply to have less unallocated capital? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [82] +-------------------------------------------------------------------------------- + + I think the last one is what you have got to keep focused on. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA - Analyst [83] +-------------------------------------------------------------------------------- + + Okay, and then lastly, the Bank of New York ruling was good; I did not expect that, but you still had a $6 billion charge this quarter and another $2.4 billion extra charge in the last 15 work days since the FHFA amount was announced. And I know you have had several questions on the call, but what is left as far as potential legal charges because it seems just so lumpy and within just a few weeks you could have another $2.4 billion charge, seemingly out of the blue for some of us. What is left? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [84] +-------------------------------------------------------------------------------- + + I think when you look at it, as I commented, I think we give fairly fulsome disclosure in the 10-K as it relates to the matters that are out there. And when you look at the matters and compare where we are now to what is out there, that obviously from the K that FHFA was resolved and that was the $3.6 billion number we mentioned. +You have seen resolutions during the quarter from an Allstate RMBS perspective. You saw resolution of force-placed insurance, you saw CFTB, OCC. And you saw the deal that we completed and announced with FGIC today. +So as you work through and look at those matters, it largely with what's disclosed leaves you with respect to one monoline. And then in addition to the monoline the other remaining legacy mortgage-related matters that we put out in our disclosure. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA - Analyst [85] +-------------------------------------------------------------------------------- + + All right, thank you. + +-------------------------------------------------------------------------------- +Operator [86] +-------------------------------------------------------------------------------- + + Guy Moszkowski, Autonomous Research. + +-------------------------------------------------------------------------------- +Guy Moszkowski, Autonomous Research - Analyst [87] +-------------------------------------------------------------------------------- + + Thanks very much. Good morning. +Let me just start out by saying on the litigation front I actually thought it was very good that you have provided now for a bunch of the issues that are actually still pretty visible out there, so that is just a thank you for having done that. I have a question for you on the control environment costs. +Some of your competitors, JPMorgan and Citi, have spoken to billion dollar type numbers for increased control environment cost in the wake of CCAR issues over the last few years and obviously all of the heightened scrutiny. I was wondering if you could give us a sense for what your control cost increase has been over the last year or two? + +-------------------------------------------------------------------------------- +Brian Moynihan, BofA Merrill Lynch - CEO [88] +-------------------------------------------------------------------------------- + + I didn't give you a number. Let me give you a way to think about it. +In our environment, coming out of the extreme issues in 2008 and 2009, we built a lot of personnel and headcount to get after this stuff and we are still finishing up the cleanup. And so if you look in the expense base, a lot of that has been in expense base for a couple of years. And then so if you think about something like our audit team, we doubled the size of our audit team in probably 2010 and it has been held fairly constant against that. +Against the backdrop we probably divested tens of businesses. And the rest of the headcount in the Company has come down fairly dramatically from a high of around 305,000, I think. +So the amount of control environment relative to the total cost structure has gone up. But the raw numbers haven't gone up as dramatically because, frankly, we've put them back, just a lot of men, in the 2010/2011 timeframe. +So, it is our duty to get it right, it is our duty to keep working on it and make sure that we get these things wrestled to the ground. But one of the key ways that we are doing this is by focusing the scope of the Company. +So the force-placed -- or excuse me, the products settlement this quarter, we quit offering those products a while ago, it just took a while with the OCC and the consumer bureau to finish up the negotiations and finish up the rebate. We have been sending money back to customers but we quit offering the product as an example. +And so the idea of narrowing the products set, narrowing the geographic scope of the Company, making the Company a lot less complex; we will always be big, but we make ourselves less complex. But against that, a growing -- a strong growth in the controlled cost in the 2009, 2010, 2011 timeframe and then a flattening of that but relative to a smaller company is actually an increase. + +-------------------------------------------------------------------------------- +Guy Moszkowski, Autonomous Research - Analyst [89] +-------------------------------------------------------------------------------- + + Thanks. That's helpful color, certainly in terms of thinking about the timing. You did allude to some increase in technology investment in GWIM and obviously the margin they are contracted a little bit. Maybe you can give us a little bit of a sense for what this -- I think you alluded to Merrill One? + +-------------------------------------------------------------------------------- +Brian Moynihan, BofA Merrill Lynch - CEO [90] +-------------------------------------------------------------------------------- + + Well, Merrill One is a new product they brought out and it has been successful. And like anything else, you put the product out there, you spend all the money to put the product together and then the assets come on it. +And so we are feeling good about that tens of billions of dollars of assets that moved to the platform. It is a good platform for customers and for the advisors. +I think more broadly, I talk about technology, if you look at the expenses we had going back after the crisis, we saw the Merrill transition expenses and all in we were spending around $3 billion on technology development a year. We now spend about $3.5 billion and obviously the transition expenses are out of there. +So everything we are spending is to better the platform, better the business, invest in the growth. And again, some of your questions about costs, that number I don't expect to change going forward because it takes that kind of technology investment to drive the product capabilities of our Company, Merrill One being one product this quarter, along with a new card system, and new trading platform Tom and his team are in the middle of putting in, a new backbone for the Company in terms of our general accounting systems, which has been a tail end to going in and across the board. +So across four- or five-year format, timeframe, we will replace almost every system in the Company but we would expect that to continue. So the GWIM, if we swung around off of last year we did more in other businesses, cash management, started building -- rebuilt the first -- the front end mortgage process and a lot of other things. This year we swung more to GWIM and it is really a decision of which business we invest in at which time and they asked for more investment this year. + +-------------------------------------------------------------------------------- +Guy Moszkowski, Autonomous Research - Analyst [91] +-------------------------------------------------------------------------------- + + Thanks, and then final one for me. You gave the leverage ratio as being above the 5% and the 6% requirements based on the most recent NPR. Subsequent to that, I guess Basel came out in March with some suggested changes to the netting on a standardized basis for counterparty credit and I was wondering if you have any sense at this point what the impact on the leverage ratio would be of those changes, if implemented? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [92] +-------------------------------------------------------------------------------- + + Well, I think the final supplementary leverage ratio rules that reflected that came out in April. And so the numbers that we have given you where we are above the 5% at the parent and the 6% at the bank reflects the impact of those rules with respect to netting and the other changes. So the numbers we have given you reflect that April release. + +-------------------------------------------------------------------------------- +Guy Moszkowski, Autonomous Research - Analyst [93] +-------------------------------------------------------------------------------- + + That is from the Fed, right? The April release from the Fed? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [94] +-------------------------------------------------------------------------------- + + Yes, that's correct. + +-------------------------------------------------------------------------------- +Guy Moszkowski, Autonomous Research - Analyst [95] +-------------------------------------------------------------------------------- + + Right, no, what I was referring to is that Basel had come out with something in March which one would assume that eventually the Fed will adopt for the standardized approach to counterparty credit. And I think JPM alluded on Friday to the idea that that could add, depending on whether you look at the holding company or the bank unit upwards of 20 basis points to the leverage ratio because it takes into account the netting to a greater extent. And I was wondering if you had any -- if you had done any preliminary work on that? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [96] +-------------------------------------------------------------------------------- + + I think I will say that our focus has been on wrapping up the work, given what the April pronouncement is. And I am not -- my understanding was that the Fed -- I think what came out in April is what we are assuming that we are going to need to operate in and if there is something else that changes where there is some benefit, that is great, but our assumption is we are going to be living with what came out on April 8. + +-------------------------------------------------------------------------------- +Guy Moszkowski, Autonomous Research - Analyst [97] +-------------------------------------------------------------------------------- + + Got it, okay, thanks very much. Appreciate that. + +-------------------------------------------------------------------------------- +Operator [98] +-------------------------------------------------------------------------------- + + Matt O'Connor, Deutsche Bank. + +-------------------------------------------------------------------------------- +Matt O'Connor, Deutsche Bank - Analyst [99] +-------------------------------------------------------------------------------- + + Good morning. If I could just follow up on the net interest income comments and thoughts. I guess just bigger picture, it seems like the outlook is a little bit lower than what you had previously thought, and I guess I think about building liquidity, it tends to be dilutive to NIM but not net interest income dollars. And some of the things you pointed to were seasonal. +So just like big picture I guess when you think about where you had thought net II might be a couple quarters ago, looking out. What is worse? +Is it more runoff than you thought? Less loan growth because you are tightening up versus what some others are doing or is it just the rates haven't moved at all, or some combination of all that? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [100] +-------------------------------------------------------------------------------- + + I would make a couple points here. If you go back, the guidance that we have given is that we would grind up from roughly a $10.5 billion number and as we look out to the third and fourth quarter, that is what we see in our numbers. +I do think there have been -- relative to if you go back two, three, four quarters ago, several things that have changed. The first is that as we have worked hard to get in the position that we are in from an LCR perspective, we have -- not only LCR but with the rate environment that we are managing the OCI risk that we have directed more of the investment portfolio to shorter dated treasuries and mortgage-backed securities. +And as you go out over a couple of quarters, that has a negative impact. The second thing, as you look at where we are and you look at the forward curve, our assumptions on what yields are going to be that we can reinvest in outside of the switch and mix, obviously those yields have not moved to the extent that the forward curves would have suggested at that point. +And I would say, generally with respect to the loan portfolio, I wouldn't say there is much changed. I do think the one thing to note that we have not talked about, if you look at within our global banking segment, this is the first quarter in a while where we have actually seen the loan pricing spreads stabilize and actually, in certain of the portfolios, move up a touch, so that is a positive. +I don't think there is anything to your question, that material that there are just some small things here and there. And we wanted to update and share our thoughts with what we thought the second quarter would be, but longer-term, I think we are still in the same place as far as the 10, 5 grinding up. + +-------------------------------------------------------------------------------- +Matt O'Connor, Deutsche Bank - Analyst [101] +-------------------------------------------------------------------------------- + + Okay, and then just switching topics, on the core LAS cost, so ex-all the litigation, you reiterated the target for year end, I think of about $1 billion or $1.1 billion. Still feel good about the $500 million per quarter late next year? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [102] +-------------------------------------------------------------------------------- + + Yes. + +-------------------------------------------------------------------------------- +Matt O'Connor, Deutsche Bank - Analyst [103] +-------------------------------------------------------------------------------- + + Okay, and is that something that we could see overshoot to the downside like we are seeing in charge-offs? Obviously like credit is getting much better than a lot of us would have thought a couple years ago? Do you think those core LAS costs end up just being much lower than expected once you work through all the issues? + +-------------------------------------------------------------------------------- +Brian Moynihan, BofA Merrill Lynch - CEO [104] +-------------------------------------------------------------------------------- + + I would just say, I hope so but I wouldn't -- let's just get it down to that level and we'll figure out what we can do from there. It's been an arduous task and there is still a lot of work ahead. + +-------------------------------------------------------------------------------- +Matt O'Connor, Deutsche Bank - Analyst [105] +-------------------------------------------------------------------------------- + + Okay. And then just lastly, on the SLR again, just care to provide any more details in terms of how much above 5%, how much of a 6%, roughly? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [106] +-------------------------------------------------------------------------------- + + I would say that we have said we are above 5%. We have said that assuming that the Buffett preferred amendment gets done that adds roughly another 10 basis points, which obviously helps move us up. +And you can assume that -- the only other guidance I would say is that the bank ratio relative to the limit is stronger than where we are with the parent today. But once again, the Buffett amendment will help. + +-------------------------------------------------------------------------------- +Matt O'Connor, Deutsche Bank - Analyst [107] +-------------------------------------------------------------------------------- + + Okay. All right, thank you. + +-------------------------------------------------------------------------------- +Operator [108] +-------------------------------------------------------------------------------- + + Marty Mosby, Guggenheim. + +-------------------------------------------------------------------------------- +Marty Mosby, Guggenheim Securities LLC - Analyst [109] +-------------------------------------------------------------------------------- + + Thank you. Three questions. +One is, operational risk, you talked about that now represents about 25% of your risk-weighted asset, so in doing that in the past, that is very sticky. How do you think you can manage around that amount of capital just being trapped and the fact of all these past settlements that you have had to kind of live through? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [110] +-------------------------------------------------------------------------------- + + Your point, Marty, is a good one, which is that the operational risk models are based on a fairly long time series as we look at it, and one of the things that we do continue to try to discuss and stress is that a lot of those operational risk losses are with respect to activities that we no longer engage and have no intention to engage. There are some of that dialog does continue, but your point, which is a fair one is that the time series are fairly long, and it will remain out there until the data runs out and I wish there was more that I could say but your point is a fair one. + +-------------------------------------------------------------------------------- +Marty Mosby, Guggenheim Securities LLC - Analyst [111] +-------------------------------------------------------------------------------- + + I mean is the only true way is just almost disembark from mortgage because there was so much in that particular area, the only way to clean it up is to say maybe if that is all related to those mortgage settlements, mortgage-related settlements it is just not worth caring that baggage going forward even though it wasn't really your fault, it was the Countrywide legacy more than it was your own operations. + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [112] +-------------------------------------------------------------------------------- + + Well, I think your point, Marty, is the one that we are working through. And in effect, we have done what you suggested that we have done in that if you look at those activities that led to those losses, we are no longer engaged in those activities. +If you look out at -- we are not doing business with monolines from a new rep perspective. You look at private label securitizations, that activity was rep and warrants, it is not continuing. +So we think we have largely done that and I think the question just going forward is if you have proven and you clearly are outside of the activity is there any relief to be had? Not the way that it works now and we will just have to work through and deal with it. + +-------------------------------------------------------------------------------- +Marty Mosby, Guggenheim Securities LLC - Analyst [113] +-------------------------------------------------------------------------------- + + Got you. Secondly, you called out that mortgage servicing hedging was unfavorable this quarter. If you kind of look at the environment, it seemed like I have seen in others that it was actually a positive, not a negative. What was in particular happening in your mortgage service hedging? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [114] +-------------------------------------------------------------------------------- + + There was really nothing. I think that the comment that we made was that the question of the hedging performance this quarter relative to a year ago. So the hedging was still a positive number, it was just less so on a year-over-year basis. + +-------------------------------------------------------------------------------- +Marty Mosby, Guggenheim Securities LLC - Analyst [115] +-------------------------------------------------------------------------------- + + Got you. And then lastly, when you think about moving from your mortgage-backed securities into agencies and treasuries that have shorter durations, that is kind of throwing you to become more asset sensitive. Are you thinking about because the liquidity rules are making the balance sheet become more asset sensitive employing more interest rate swaps or off-balance-sheet hedging to rebalance and not become so much more asset sensitive due to these other pressures? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [116] +-------------------------------------------------------------------------------- + + If you go back, we have been pretty consistent that the reason for the investment portfolio is to preserve the long-term value of the deposit. And as you look at that portfolio, it is very clear there are only three things that we do within that portfolio. +There is treasury securities, there is agency securities and there is AA and AAA super-sovereign type activities. And as it relates to becoming a little bit more asset sensitive, we just think given the first -- and you have seen a large portion of it happen that to drive and get to the point we have with LCR, the shift in the portfolio helped this quarter. +It has the same benefit, as I said, of shrinking and reducing your OCI risk as you go through this. And we are not interested in starting to try to do things from a derivative and other perspective to somehow change that. The investment portfolio needs to work with how we set it up and we are going to be prudent with respect to how we do it. + +-------------------------------------------------------------------------------- +Marty Mosby, Guggenheim Securities LLC - Analyst [117] +-------------------------------------------------------------------------------- + + All right, thanks. + +-------------------------------------------------------------------------------- +Operator [118] +-------------------------------------------------------------------------------- + + Nancy Bush, NAB Research, LLC. + +-------------------------------------------------------------------------------- +Nancy Bush, NAB Research - Analyst [119] +-------------------------------------------------------------------------------- + + Good morning, guys. Question on the mortgage business. +I think there was an article in the Wall Street Journal this morning or somewhere that the business is getting off to a slower start than we would have thought given the spring bounce back that was expected from the winter weather. Has there been any rethinking, Brian, on sort of the eventual size and direction of the mortgage business there? + +-------------------------------------------------------------------------------- +Brian Moynihan, BofA Merrill Lynch - CEO [120] +-------------------------------------------------------------------------------- + + Nancy, we kind of did that in 2011, we got out of all of the direct-to-consumer. So basically we have focused the business on really supporting the core customer base and not trying to drive standalone market shares in the scheme of things. +And so what has happened to that is as we sold off the non-core servicing we have gotten down to a significant less number of loans serviced and your originations, $10 billion just this quarter are all direct-to-consumer, which is the second highest total in the country, direct-to-consumer mortgages so I think we are comfortable where we are. Now the question is, with the LAS aside, the core business, what does it look like? +It will be a small business -- smaller business. It will generate customer, mortgages for our customers because it is a core product they need. But also that sales force, quite frankly, sells other products and does other things for us, refers people for other products. +So I think that the days of being a 20% market share and stuff are far behind us. The days of being a 4% market share direct-to-consumer and growing are there and we will make a little -- we will make some money in it and we will make some money servicing those four loans through the delinquency statistics in those and what we have been doing in that are far superior to even what we would have predicted and that is how we will run the business. +So effectively, we have done what you said. It is just that we are still sort of bound by the overhang of effectively the LAS portfolio still working through the system and the 300,000 delinquent mortgages of which only about -- the delinquency of the core portfolio is about 50,000, 60,000 of them. + +-------------------------------------------------------------------------------- +Nancy Bush, NAB Research - Analyst [121] +-------------------------------------------------------------------------------- + + Also, could you make sort of a similar pronouncement about the card business, where you stand in terms of share and growth right now and are you where you want to be? + +-------------------------------------------------------------------------------- +Brian Moynihan, BofA Merrill Lynch - CEO [122] +-------------------------------------------------------------------------------- + + That is different in the sense that, on the card side, we actually took it down unfortunately through charge-offs and (inaudible) more than not. But I think we have been relatively consistent on a domestic piece, around $90 billion-odd of outstandings and kind of grinding up and down from there and producing more cards that are coming out of the wallet first from our customer from 700,000 we showed you two years ago first quarter to 1 million plus this quarter and pretty consistently was 1 1/3 million plus the third quarter almost 1 million in the fourth quarter, another 1 million plus this quarter. +But the core of what we see there is actually usage of those cards. They are still 60%-plus to our primary customers, but also usage of the cards because of the core three or four card products is driving it. And we have to go some good affinity program. +So I think the card business is -- likewise, it is where we want it but it is a bit more of a payment stream business than it is a pure lending business as it was in some of the past. So the balances ought to be stable and ought to grow, but the high-quality portfolio of the payment rates in the 20%s now, means people pay us off because they are using a transaction card. + +-------------------------------------------------------------------------------- +Nancy Bush, NAB Research - Analyst [123] +-------------------------------------------------------------------------------- + + And just finally, Bruce, you've indicated that net interest income is going to decline somewhat due to liquidity issues, etc. Is that same going to be true of the NIM or is there anything in the mix change coming in the near term that can send the NIM up, or the adjusted NIM up, from this 236 level? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [124] +-------------------------------------------------------------------------------- + + Yes, I think -- I just want to be clear that we've said that we thought that the core MII ex-market-related impact would be down slightly in the second quarter and then build modestly through the rest of the year. What you will see in the second quarter, given that you have a full quarter of the liquidity, it is on the books, you would expect to see that the NIM in the second quarter moderate a little bit, given that you've got the full quarter of the liquidity and then, obviously, as it starts to grow during the latter half of the year, you would expect the NIM to follow that. + +-------------------------------------------------------------------------------- +Brian Moynihan, BofA Merrill Lynch - CEO [125] +-------------------------------------------------------------------------------- + + And Nancy, over all, now that we have a better insight as to what these rules are we then have to go back and -- we've got a 7% change of common equity ratio so we have very strong common equity ratio. We have to go back and sort of look at -- Bruce actually -- with the rules now in hand he can start to go work and say, okay, how do we optimize the next round because in terms of how we create maximum liquidity per dollar a balance sheet size, right? + +-------------------------------------------------------------------------------- +Nancy Bush, NAB Research - Analyst [126] +-------------------------------------------------------------------------------- + + Right. Okay, thank you. + +-------------------------------------------------------------------------------- +Operator [127] +-------------------------------------------------------------------------------- + + Jim Mitchell, Buckingham Research. + +-------------------------------------------------------------------------------- +Jim Mitchell, Buckingham Research - Analyst [128] +-------------------------------------------------------------------------------- + + Hey, good morning. Hopefully I will keep these two quick. +Just first on home-equity net charge-offs, I guess if you exclude the TDR impact last quarter, they were up and so were home equity NPLs. Could you just sort of talk through what is going on there? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [129] +-------------------------------------------------------------------------------- + + Sure, there were two things that come Jim, banged this up -- good question -- to the tune of about $50 million each. There were some home equity stuff that we just wrote off that was going to have foreclosure costs that were greater than what it was going to be worth to try to get repaid. +So that happened during the quarter. And then the second thing is there was some regulatory guidance that was given as it related it to second lien loans that were behind first lien that have been modified or charged-off, that we saw during the quarter. We think we got most of it in this quarter, there may be a little bit left in the second quarter, but a good question that those two items banged us up to the tune of about $100 million and that was the reason for the change. + +-------------------------------------------------------------------------------- +Jim Mitchell, Buckingham Research - Analyst [130] +-------------------------------------------------------------------------------- + + Okay, that's helpful. Then just on the investment banking pipeline, any commentary? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [131] +-------------------------------------------------------------------------------- + + I think what we have seen is the overall markets continue to be strong. The pipeline and the amount of activity and discussions from an M&A perspective is encouraging. And I would say as we go forward that we talked about, we felt the pipeline was strong at the end of the year. +And as we look at the pipelines, they have not changed materially one way or the other at the end of the first quarter versus the end of the year. And as we said, we feel very good about the quarter with the revenue side being north of $1.5 billion and the highest of any firm that has reported at this point. + +-------------------------------------------------------------------------------- +Jim Mitchell, Buckingham Research - Analyst [132] +-------------------------------------------------------------------------------- + + Okay. That's great. That's it for me. Thanks. + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [133] +-------------------------------------------------------------------------------- + + Super. Well thank you very much, everyone, for joining and we will talk to you next quarter. + +-------------------------------------------------------------------------------- +Operator [134] +-------------------------------------------------------------------------------- + + This does conclude today's conference. You may now disconnect. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/exam/original-files/Problem_1_Sample/2014-Apr-23-FB.OQ-137448671471-Transcript.txt b/exam/original-files/Problem_1_Sample/2014-Apr-23-FB.OQ-137448671471-Transcript.txt new file mode 100644 index 0000000..811d087 --- /dev/null +++ b/exam/original-files/Problem_1_Sample/2014-Apr-23-FB.OQ-137448671471-Transcript.txt @@ -0,0 +1,607 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q1 2014 Facebook Earnings Conference Call +04/23/2014 05:00 PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * David Ebersman + Facebook, Inc. - CFO + * Deborah Crawford + Facebook, Inc. - Director IR + * Mark Zuckerberg + Facebook, Inc. - CEO + * Sheryl Sandberg + Facebook, Inc. - COO + +================================================================================ +Conference Call Participiants +================================================================================ + + * Carlos Kirjner + Sanford C. Bernstein & Company, Inc. - Analyst + * Justin Post + BofA Merrill Lynch - Analyst + * Youssef Squali + Cantor Fitzgerald - Analyst + * Eric Sheridan + UBS - Analyst + * Ben Schachter + Macquarie Research - Analyst + * Colin Sebastian + Robert W. Baird & Co. - Analyst + * Ross Sandler + Deutsche Bank - Analyst + * Heather Bellini + Goldman Sachs - Analyst + * Mark Mahaney + RBC Capital Markets - Analyst + * Brian Wieser + Pivotal Research Group - Analyst + * Douglas Anmuth + JPMorgan - Analyst + * John Blackledge + Cowen and Company - Analyst + * Peter Stabler + Wells Fargo Securities - Analyst + * Evan Wilson + Pacific Crest Securities - Analyst + * Anthony DiClemente + Nomura Securities Intl - Analyst + +================================================================================ +Presentation +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Good afternoon. My name is Jay and I will be your conference operator today. At this time, I would like to welcome everyone to the Facebook first-quarter earnings conference call. +(Operator Instructions) +Ms. Deborah Crawford, Facebook's Director of Investor Relations, you may begin. + +-------------------------------------------------------------------------------- +Deborah Crawford, Facebook, Inc. - Director IR [2] +-------------------------------------------------------------------------------- + + Thank you. Good afternoon and welcome to Facebook's first-quarter earnings conference call. Joining me today to talk about our results are Mark Zuckerberg, CEO; Sheryl Sandberg, COO; and David Ebersman, CFO. +Before we get started I would like to take this opportunity to remind you that our remarks today will include forward-looking statements. And actual results may differ materially from those contemplated by these forward-looking statements. Factors that could cause these results to differ materially are set forth in today's press release and our annual report on Form 10-K filed with the SEC. +Any forward-looking statements that we make on this call are based on assumptions as of today. And we undertake no obligation to update these statements as a result of new information or future events. +During this call we will present both GAAP and non-GAAP financial measures. A reconciliation of GAAP to non-GAAP measures is included in today's earnings press release. +The press release and an accompanying investor presentation are available on our website at investors.FB.com. And, now, I would like to turn the call over to Mark. + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook, Inc. - CEO [3] +-------------------------------------------------------------------------------- + + Thanks, Deborah. And thanks, everyone, for joining today. This was a busy quarter and a strong start to 2014. We continued to grow our community in size of engagement, with nearly 1.28 billion people now using Facebook each month, and almost 63% visiting daily. We also reached new milestones as a mobile company, with more than 1 billion monthly actives on mobile, and almost 55% of our daily actives only connecting on mobile. +When you look at our business performance, we've also made some good progress. Our total revenue grew 72% year over year. Our advertising grew 82%, our strongest annual growth rate in nearly three years. And mobile accounted for 59% of our advertising revenue. These results show Facebook's business is strong and growing, and we are in a great position to continue making progress towards our mission. +This quarter we made a number of big investments in our future. We reached agreements to acquire WhatsApp and Oculus. And we announced our new connectivity lab that's focused on developing technologies to expand Internet access around the world. These are important efforts that we believe will help us continue making progress towards our mission over the long term. +But as this quarter shows, we are also staying focused on execution and carefully improving our core products and business. Execution gives us the strength to bet on the future. And our success over the long term depends on us serving our community today and delivering against our current strategy. +So, with that in mind, I'd like to run through our progress this quarter towards our three big Company goals -- connecting everyone, understanding the world, and building the knowledge economy. Connecting everyone is about making Internet services available to everyone in the world, and allowing everyone to connect to the people and things that they care about. +Our strategy for connecting everyone is based on two approaches. The first is about giving people new apps for sharing different kinds of content with different people. Today our apps are at different stages of maturity. +Our core Facebook app has an audience of over 1 billion people and has become an essential sharing infrastructure for the world. We are currently focused on building a great business around this, and our continuing revenue growth on mobile this quarter shows our strong momentum here. +For the next set of apps, like Messenger, Instagram and, hopefully soon, WhatsApp, the current priority is growth. Messenger and Instagram both reached 200 million monthly actives this quarter. We believe these apps have a lot of room to grow and will start to be important businesses in the future. But monetization isn't our near-term priority here. +And for the new apps that we're building as part is our Creative Labs effort we are still in the very early stages of development. We're working hard to develop the technical foundation for these services so we can rapidly launch new products and then refine them based on the initial feedback from our community. +For Creative Labs projects that demonstrate a lot of value, our next priority will be to grow them to reach 100 million people before we start developing them into significant businesses. We are pleased by the early reaction to Paper, our first app from Creative Labs. And we expect this to be a good test case for our strategy. +The longer-term part of our strategy for connecting everyone is focused on internet.org, our effort to make affordable basic Internet services available to the entire world. We recently reached 100 million monthly actives in India. And through internet.org we are looking to build on this kind of success. We've already started to deliver results. +By partnering with mobile operators in the Philippines and Paraguay, we've doubled the number of people using mobile data with our partners, and brought almost 3 million more people onto the Internet. Our early test and research into new technologies, such as drones and other infrastructure to connect people, are promising. +And over the long term, we also expect WhatsApp to play an important part in connecting everyone by offering a simple, fast and reliable messaging system that could be as ubiquitous as Facebook one day. We will have more to share after that deal closes. +Next, let's talk about understanding the world. Understanding the world is about using Facebook to build up long-term knowledge about the world, and helping to answer questions for people that no other service can. +Next week Facebook holds our fifth f8 conference, the main event for our developer community. We do this because even with all the experiences we are building, we understand that there will always be more social experiences that we can't build. So, we want to keep serving developers better, and to help them build, grow and monetize their apps. +We've made good progress here. On mobile, app installs have been one of our best-performing ad products, driving over 350 million installs to date. Over 60% of the top grossing apps on the Apple App Store and GooglePlay use mobile app ads, which is pretty impressive performance for a product that launched in January of last year. +On desktop, games continue to be popular on our platform. And over the last 12 months desktop game developers generated more than $3 billion in payments volume on Facebook. +It's worth noting that even though our mobile and desktop products seem completely different, they're both delivering the same value to developers -- the ability to reach a large targeted audience. That's what we provide. And regardless of the format, we will continue to improve this value. +We see a big opportunity to continue improving the relevancy of the ads people see on and off Facebook, to help mobile developers better monetize their apps, and to help provide greater reach for marketers. I look forward to sharing more details next week at f8. +Finally, let's talk about our efforts to build the knowledge economy. Building the knowledge economy is about building out the technology platforms the world needs for the future so everyone can use information to do their jobs better. Advertising and the ability to reach people more broadly is one of the most important technology platforms for achieving this. We are investing a lot to serve four major kinds of partners -- small businesses, brands, developers, and e-commerce partners. +After introducing News Feed ads, which increased the supply of ads in our system, our recent efforts have primarily focused on improving the relevance and quality of these ads. To do this, we've been working to improve the tools we provide for marketers so they have access to better targeting capabilities, simpler ad products, and more useful measurement tools. Our approach is less about developing new products for marketers, and more about improving existing ones and helping businesses use them efficiently. +Our goal is to make our ads as interesting and valuable as the organic content that you find on Facebook so that more people find ads useful, and businesses can engage effectively with our community and grow. Our most recent data shows that this approach is working well. And we continue to be really encouraged by the feedback we are seeing from people about our ads. There's still more work to be done here, but we've shown that we can continue to serve our community well while also growing a healthy business. +That's my update on how we've been executing against our strategy over the last quarter. It's been a busy quarter and a strong one. We are proud of our progress as a company and everything that we are accomplishing today. In large part this is due to the incredible quality of our team. And I'm very grateful for the support of everyone here at Facebook, as well as our stockholders and partners, as we continue working to achieve our mission. +In addition to thanking our employees, I also want to thank one person in particular, David Ebersman, who is stepping down as CFO after almost five years. David has been a great partner in building Facebook. He set the right tone about operating efficiently. He set us up to make the long-term investments we need. And, most importantly, he's built an incredibly strong team, including Dave Wehner, who will be our next CFO. I've learned a lot from Dave, both personally and professionally, and am grateful for everything he's done to help make the world more open and connected. +Thank you. And now here is Sheryl. + +-------------------------------------------------------------------------------- +Sheryl Sandberg, Facebook, Inc. - COO [4] +-------------------------------------------------------------------------------- + + Thanks, Mark. And hi, everyone. Before I start, I want to join Mark in thanking David for being an extraordinary partner and friend over these past five years. As Mark said, he's contributed so much to our Company, and I've learned so much personally working with them. +Great people build great teams, and that's what David has done. And, so, I'm also really excited to continue working with Dave Wehner as he steps into his new role as our CFO. +We are off to an outstanding start in 2014. Our total revenues were up 72% year over year. And our advertising revenue growth accelerated to 82%. That's our strongest year-over-year advertising growth rate in nearly three years. +We are really pleased with these results and the level of execution in our business. The team is staying focused on each element of our monetization strategy, capitalizing on the shift to mobile, growing the number of marketers who advertise with us, and investing in our ad products. +Mobile continues to be a big driver for us and a big opportunity. Mobile comprised 59% of our ad revenue in the quarter, up 6 percentage points from Q4. We continue to believe that this is because Facebook has the best mobile ad product in the market. +We also continued to grow the number of marketers using Facebook and saw growth from existing advertisers, as well. Our growth is very broad-based, coming from all types of marketers, with particular strength with SMB and direct response. We saw strong performance this quarter from verticals such as mobile gaming, e-commerce and consumer package goods. +I'm especially pleased with what we're seeing and hearing from clients around the world as they shift budgets to online, to mobile, and to Facebook. One recent powerful example is Sport Chek, Canada's largest sports retailer. They recently decided to pull their paper circulars, which their company had relied on as its primary ad vehicle for 92 years, for two weeks, and replace them completely with digital spend, a majority of which was on Facebook. +During those two weeks, national in-store sales grew 12% year over year. And in-store sales of the items they promoted on Facebook grew 23%. As a result, they're going to continue with their test. And their goal is to transition more than 25% of their print spend to digital and Facebook in the next year. +Last week I was in Europe meeting with clients, agencies, SMBs and developers. And what I heard from them was how Facebook was becoming increasingly important in driving their businesses. +Investing to improve and expand our ad products remains a very important priority for us. Our goal is to continue to develop new ways to help marketers reach their customers. We've done this over the last couple of years by enhancing our targeting capabilities, simplifying our ad products, and improving our measurement tools. I'll touch on each of these three areas. +First, targeting. Along with Facebook's reach and scale, marketers value our proprietary targeting to help them reach the right customers and create more personalized and therefore more efficient and effective ad campaigns. 10 times more marketers are now using our custom audiences targeting feature compared to last year. +To share just one recent example, Ben & Jerry's wanted to drive more sales from its classic flavors. They used a wide range of our targeting capabilities, including Custom Audiences and Partner Categories, to reach premium ice cream buyers. Their campaign reached 14 million people, roughly 90% on mobile, and drove an 8.1% sales lift from those consumers. As more marketers use our targeting tools, our ads become more relevant for our users and drive even better results for marketers. +Second, we're simplifying and enhancing our ad tools for the over 1 million advertisers on Facebook. The tools that were previously available to only the biggest and most sophisticated advertisers, like Custom Audiences and Partner Categories, are now available on our self-service ad creation process. By making these tools more accessible, we believe we can grow the number of advertisers on our platform and improve their results. Additionally, for direct response marketers, we've added more specific calls to action in our ads, including buy now or install now buttons that greatly improve the efficacy of these ads. +Finally, we are also really pleased with the results we're seeing from our investments in measurement tools. Our online conversion measurement tools enable our direct response advertisers to measure the impact their Facebook ad campaigns have on online sales. And we recently launched new off-line conversion tools to measure in-store sales, which have yielded positive initial results. +Our ongoing service will continue to be on improving the quality, relevance and performance of our ads, and demonstrating value to marketers. We believe we still have a lot of opportunity to generate future returns by continuing to focus in these areas. +We also have significant opportunities to develop newer products, like premium video, ads on Instagram, and our recently launched ad network test. Our initial efforts show a lot of promise and we've gotten good feedback from marketers in all of these areas. But it's still very early and we don't expect meaningful contributions from these projects this year. +To summarize, our ads business is performing very well. I want to take a minute to congratulate and thank our teams all around the world, and our ads engineering, product, and design teams on all the progress we have made. I also want to thank our clients, agencies, TMDs and over partners who work with us every day to use our platforms to build relationships with their customers to create personalized marketing at scale. +It's an exciting time for us as more marketers around the world gain conviction in the results they can achieve on Facebook. We have a great opportunity to build the world's first platform for personalized marketing at scale. It's early in that journey and we are going to stay focused on making the right investments in our ad business and executing against our plan. +Thanks, everyone. And now here's David. + +-------------------------------------------------------------------------------- +David Ebersman, Facebook, Inc. - CFO [5] +-------------------------------------------------------------------------------- + + Thanks, Sheryl. And good afternoon, everyone. Before I dive into the numbers I wanted to say a few words about my decision to step down as CFO. This was a hard decision for me because of how much I love Facebook and all the people I work with here. +In particular, I can't thank Mark and Sheryl enough for their friendship and support, and for letting me be a part of their team. I'm confident that Facebook's best days lie ad. And I'm excited about the path Mark and Sheryl are leading the Company on. +My decision is a personal one based on my desire to get back into healthcare where I spent my entire career before Facebook. And after 10 years as the CFO, half of them here, I'm ready for a different role and challenge. +Right now feels like a great time for this change. The Business is doing well, the foundation is solid. And in Dave Wehner we have a terrific successor who is up to speed and ready to go. I have complete confidence in Dave and the rest of the finance team. +Dave will formally take over for me in June and he'll take my place on the next earnings call. I plan to stay with the Company through September to ensure a smooth transition. I also want to thank our shareholders for your partnership and support. +Now, to the quarter. Q1 was a strong quarter for us across the business. We increased our revenue growth rate, expanded operating margins, delivered free cash flow of over $900 million, and continued to make investments to position the Company for near-term and long-term growth. +Let's start with some people metrics. The number of people using Facebook on an average day in March grew to 802 million, up 137 million from a year ago. As Mark mentioned, this daily number represents almost 63% of the 1.28 billion people who used Facebook during the month. And overall engagement remains strong. +Additionally, these stats don't include Instagram, which now has more than 200 million monthly active users, showing the remarkable progress by the team. Two years ago this month when the acquisition was announced Instagram had fewer than 22 million monthly actives. +Turning now to the financials. Q1 total revenue was $2.50 billion, up 72% versus Q1 last year. And total ad revenue was $2.27 billion, up 82%. Ad revenue growth was strong around the world, with each of our four geographic regions growing by over 70%. +Mobile ad revenue was approximately $1.3 billion compared to around $377 million in Q1 last year. And, notably, mobile ad revenue was up 7% sequentially despite the seasonal benefits in Q4. Desktop ad revenue in Q1 was up 8% compared to Q1 last year. +In Q1 the average effective price per ad displayed increased 118% year over year, while total ad impressions declined 17%. The decrease in ad impressions was due to factors including the continued shift towards mobile use, where people are shown fewer ads compared to desktop. The increase in average price per ad was primarily driven by a mix shift, with more ads being shown in News Feed. News Feed ads have significantly higher engagement, click through rates and price per ad compared to right-hand column ads, so a higher proportion of ads appearing in News Feeds drives up the overall average price per ad. +The price volume trends were pretty consistent across our four geographic regions. Total payments and other fees revenue was $237 million, up 11% versus Q1 last year. However, the more meaningful comparison that better reflects the organic growth we saw in the payments business comes from looking at payments volume from games specifically, which was up 1% in Q1 compared to Q1 last year, down from the 8% year-over-year growth rate we saw in Q4. +As we've discussed before, the shift to mobile is a significant headwind since our games payments revenue comes from desktop only where usage is flat or declining. So, growing this business going forward will be challenging. +Turning to expenses, our Q1 GAAP expenses were $1.4 billion, up 32%. And our non-GAAP expenses were $1.1 billion, up 26%. Our headcount increased 39% from a year ago. +Our Q1 GAAP operating income was $1.1 billion, representing a 43% operating margin. And our non-GAAP operating income was $1.4 billion, represented a 55% margin, up from 39% last year. While the margin improvement was helped by some nonrecurring items that drove up costs in Q1 last year, we're pleased that the increase in margins came mostly from cost of revenue and G&A. As planned, we've created efficiencies in infrastructure and administration, while continuing to aggressively grow our investment in R&D, along with marketing and sales, to drive future performance. +Our GAAP and non-GAAP tax rates were 40% and 36%, respectively. GAAP net income was $642 million, or $0.25 per share, and non-GAAP net income was $885 million, or $0.34 per share. In Q1 we spent $363 million on CapEx and generated $922 million in free cash flow. We ended Q1 with $12.6 billion in cash and investments. +Now, looking forward. First, I want to note that the forward-looking comments I will share today do not reflect any impact from the recently announced acquisitions of WhatsApp and Oculus, neither of which has closed. After the deals close, we will update our guidance, as appropriate. +In terms of expenses, consistent with what we've said previously, we're planning that our total 2014 GAAP expenses, including cost of revenue and stock comp, will likely grow in the neighborhood of 35% to 40%. And that non-GAAP expenses, including cost of revenue but excluding stock comp, will likely grow in the neighborhood of 40% to 45%. +For taxes, we expect GAAP and non-GAAP rates for the rest of 2014 to be similar to or a bit higher than our Q1 rates, although this could vary widely depending upon our international revenue and expense mix and other factors, including the impact from acquisitions. We continue to anticipate our 2014 CapEx will be approximately $2 billion to $2.5 billion. +We also continue to expect shares outstanding for calculating EPS to grow from around 2.6 billion at year-end 2013, by 2% to 2.5% in 2014, excluding the two large deals we've announced. Those deals, once closed, will add another 207 million shares, as well as additional unvested RSUs that will affect our share count over the subsequent four to five years. +Turning last to ad revenue. As you know, our year-over-year comparables will get more challenging going forward from here because of the timing of the ramp-up of News Feed ads in 2013. As the comps become more difficult, we continue to expect that over the rest of 2014, our year-over-year ad revenue growth rates will decline from the Q1 rate and be meaningfully lower by the end of the year. +That being said, we believe we are still in the early stages of building our ads business. And we remain as optimistic as ever about the long-term opportunity to grow revenue impressively by improving the quality and relevance of our ads and increasing the value we bring to marketers. +In summary, Q1 was a great start to the year. We are very pleased with how well our ads performed, the strong marketer interest in our ads platform, particularly on mobile, and the investments we're making to build long-term shareholder value. Now let's open for questions. + + +================================================================================ +Questions and Answers +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) +Heather Bellini with Goldman Sachs. + +-------------------------------------------------------------------------------- +Heather Bellini, Goldman Sachs - Analyst [2] +-------------------------------------------------------------------------------- + + I was just wondering, Mark or Sheryl, if you can share with us your vision of payments for Facebook, and how the Company might be able to play a role in reducing the friction that exists today when users are trying to engage in mobile e-commerce. And then the follow-up question was just going to be if you could share with us what inning do you think we are in, in terms of improving the relevancy of the ads that you are showing? Thank you. + +-------------------------------------------------------------------------------- +Sheryl Sandberg, Facebook, Inc. - COO [3] +-------------------------------------------------------------------------------- + + On payments, our payments business has been important in supporting some of the developer activity on Facebook, primarily games. And we continue to be interested in that. I think it's really important to know that our advertising business is very relevant for e-commerce. And that doesn't depend on taking payments, and it doesn't depend on a payment strategy, because we provide a really great opportunity for marketers to find customers who are then going to go ahead and buy their products both online and off-line. +In terms of relevance, I think we are in really early innings. I think people can see it from their own experience. Most people I talk to, and certainly the data we have across the base of people who use Facebook, suggest that the ads are getting more relevant. But, there's a long way to go. +Our goal is that every time you open News Feed, every time you look at Facebook, you see something, whether it's from consumers or whether it's from marketers, that really delights you, that you are genuinely happy to see. I think we hit that more than we used to with our ads. But I think the truth is we still have a long way to go to hit that bar, and that's the bar we are striving for. + +-------------------------------------------------------------------------------- +Operator [4] +-------------------------------------------------------------------------------- + + Douglas Anmuth with JPMorgan. + +-------------------------------------------------------------------------------- +Douglas Anmuth, JPMorgan - Analyst [5] +-------------------------------------------------------------------------------- + + David, just wanted to ask you a little bit more about margins, in particular. If we look at this quarter, it looks like the incremental margins here are 78% or so. So, I was hoping you could drill down a little more just on the drivers within cost of revenues and how you are thinking about the sustainability of that going forward. +And is the 40% to 45% growth that you mentioned in non-GAAP OpEx, is that taking into account the acquisitions at all? Just thinking about how you can get to that level of spend given what you are starting the year. Thanks. + +-------------------------------------------------------------------------------- +David Ebersman, Facebook, Inc. - CFO [6] +-------------------------------------------------------------------------------- + + Thanks for the question, Doug. I think Q1 is traditionally a light spending quarter for us because we budget with an annual cycle and often it take some time to ramp up the new programs. So, I don't think it's surprising that Q1 year-over-year increase would come in a little lighter than we expect for the full year. +Additionally, there were some one-time things that benefited the quarter that kept expenses down, particularly in cost of revenue as we continue to exit leased data centers and amend our supply chain. I think that, going forward, our expectation was and remains the 40% to 45% growth excluding the impact from the acquisitions. We will update that guidance once the integration plans are clearer and we have a better sense for what those spend patterns will look like. +In general, in terms of margins, the comments I would make are that we don't have a quarter-to-quarter target margin that we're managing closely to. To do so would require varying our spend patterns as revenue changes up and down over time. And I think that's the wrong way to focus on how you spend your money in the Company. +Our priority is really to try and make investments that are high quality, that drive the creation of value and make the business better. And since many of those investments take a longer period to mature, we want to be able to think about our spend increases over a longer-term horizon. As you can see, looking back at the last couple of years, and our plans for this year, there's been a pretty steady rate at which we've been growing spend, particularly in R&D and marketing and sales, where we really want to focus on making sure we are growing smartly and thoughtfully at a rate we can manage wisely, and doesn't get ahead of our ability to manage it. +On cost of revenue and G&A, what you can see in the Q1 numbers is the fruits of a lot of labor trying to manage those parts of the business really efficiently, and free up resources to invest elsewhere. So, I think we've always believed that Facebook has the opportunity to be a sustainably high-margin business, and we continue to believe that, noting that there were some individual items that helped us in Q1. + +-------------------------------------------------------------------------------- +Operator [7] +-------------------------------------------------------------------------------- + + Carlos Kirjner with Sanford Bernstein. + +-------------------------------------------------------------------------------- +Carlos Kirjner, Sanford C. Bernstein & Company, Inc. - Analyst [8] +-------------------------------------------------------------------------------- + + I think for Mark, how do you think about the evolution of browser technology, HTML5, and development tools versus native apps? If you look two to three years out, do you think native apps could finally become less important for many use cases? Or, in other words, maybe you guys were not wrong when you tried HTML5, you were just too early. Thank you. + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook, Inc. - CEO [9] +-------------------------------------------------------------------------------- + + Timing matters a lot. I do think that there's nothing wrong with the standard of HTML5 technically. I think a lot of what we see is what the main platform providers want to push as the standard for developing on their own platforms. What we've seen is that both Apple and Google have really favored and made it easier to build high-quality experiences in their own proprietary formats, rather than the open Web format. +So, while our bias, for a number of reasons, would have been to have really pushed on HTML5 -- and I don't want to sound like we've walked away from this because a large number of people access Facebook from the mobile web. I don't know if we break that out specifically but it's quite a large number of people. So, we are continuing to develop that. But for the foreseeable future, we see the best path to continuing to deliver great experiences be by working on the native app experience that we have now. + +-------------------------------------------------------------------------------- +Operator [10] +-------------------------------------------------------------------------------- + + Eric Sheridan with UBS. + +-------------------------------------------------------------------------------- +Eric Sheridan, UBS - Analyst [11] +-------------------------------------------------------------------------------- + + Congratulations, David, on your future endeavors, as well. Mark, maybe a quick question for you about the way in which you think Facebook, and the various applications Facebook is developing also, move towards a communication ecosystem longer term. A big picture question on where the various applications go, the ones that are in the process of being acquired and the ones you are developing organically. +And then second question, to use the baseball analogy again, as you continue to take ad impressions out of the Facebook platform, wonder if we should think about where you get to longer term on a level of ad impressions that you think are the perfect mix for balancing engagement and monetization, and what inning we are in that process. Thanks. + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook, Inc. - CEO [12] +-------------------------------------------------------------------------------- + + Sure. I think I can probably take both of those. In terms of building out a whole communication ecosystem, the way that we think about the new apps and products that we are building is that people want to share all kinds of different content with all kinds of different audiences. +Sometimes you want to have a one-on-one conversation or text or chat or voice call. Up to having a small group conversation, to communicating, updating all your friends on something at once. And sometimes there's really good public content, whether it's news or premium video, or things like that. +At the intersection of each type of content and each audience, we think that there's a really compelling experience to be built. Facebook, historically, has focused on friends and public content. Now, with Messenger and WhatsApp, we are taking a couple of different approaches towards more private content, as well. +You're going to see us do more things in more private content, I think. That's an ecosystem that's growing incredibly quickly. And, also, that speaks to why WhatsApp and Messenger are both growing independently, quickly is because they actually serve pretty different use cases within private sharing and private context. +In terms of our investments, I think you want to look at it as -- I outlined this in my remarks but I think it's important enough to say again -- there are different stages of maturity for the different things that we're doing. The Facebook app by itself is the furthest along. More than 1 billion people use it. And it's not only one of the most used apps, probably the most used app, it's also the core of our business. +Then the second set of apps that we have are Messenger, Instagram, and soon, WhatsApp. Messenger and Instagram are each now greater than 200 million active users. I think the WhatsApp folks independently announced, I think it was yesterday, that they just passed 500 million actives. +These are apps that are now at a pretty big scale. And the immediate priority is going to be getting them to 1 billion people. So we're continuing to focus on that before focusing on monetization in the way that we have with the core Facebook app. So, that's the second page. +The third set are the new Facebook Creative Labs apps that we're just getting started. So, things like Paper and a number of other things that we might announce at some point. Those are even further along than even Messenger, Instagram and WhatsApp, where it will probably take a few years for those to even get to the stage that Instagram, Messenger and WhatsApp are at. Which, by themselves, are probably a few years away from being big and important business. +So, that's the pipeline of things that we see. And there's a full ecosystem of different ways that people want to share with different people. +In terms of ads, going to your second question, I don't actually think we have a strategy to decrease ad impressions. I think what you are seeing, and what David mentioned, we have News Feed ads, which are higher quality and perform better, and then we have this legacy of right-hand column ads on desktop, which generally are just showing higher volume and they perform less well per ad unit. +As we shift more toward News Feed, what you are seeing is the total raw number of impressions is decreasing, but actually, the amount of value that we're delivering is increasing. That might continue to shift as we continue to shift towards mobile. +But I think, overall, what we're trying to do is make it so that the individual load on a per person basis isn't increasing at a dramatic rate. But instead we are driving most of the wins in user experience, advertiser performance, and our own revenue through increasing the quality, primarily around News Feeds adds. And we think that there's quite a lot to go there, as Sheryl said. +We want to get to a state where the ad content is as good as the organic content. And we see that we are getting pretty close to that in a few countries, but we want to get to that everywhere. + +-------------------------------------------------------------------------------- +Operator [13] +-------------------------------------------------------------------------------- + + Peter Stabler with Wells Fargo. + +-------------------------------------------------------------------------------- +Peter Stabler, Wells Fargo Securities - Analyst [14] +-------------------------------------------------------------------------------- + + I wanted to ask a question about engagement. By one measure, DAU over MAU, it's at an all-time high. But no doubt you always have a body of last users. I'm wondering if you could share any color on what types of algorithm or product tweaks that you've made have yielded the most return or the greatest return in terms of re-engaging last users. And then, secondly, just quickly, any color you could provide on your estimate of the overlap of Instagram and Facebook users, perhaps based on the linking of those accounts. Thank you very much. + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook, Inc. - CEO [15] +-------------------------------------------------------------------------------- + + Unfortunately, I don't think I'm going to have much color on either of those. We are constantly doing things to make it so that people can share the content that they want, that they have the tools that they need, and that we're showing the most relevant content to people. That is always going to be the way that people use the service, not through some kind of trick or something that we are using to reengage people. +One state that I think is pretty interesting is that you would expect naturally that, as the community continues to grow, and we are getting into later and later adopters, that the percent of people who are using Facebook, who use it every day, would decrease. And I've actually predicted for a long time that eventually that will flatten out, and I thought it would decrease. But actually, it continues to increase, much to our surprise and joy. And now this quarter, I think we are at almost 63% of people who use Facebook in a month will use it in a given day. +Another step that I think is actually quite interesting is we track how many people use Facebook not just every day. So, one day out of -- so, what percent of our monthly folks used it today. But what percent of people use it six out of seven days of the week. That number, for the first time in the last quarter, passed 50%. +So, that's pretty crazy, if you think about it. You have this really big engaged community, and not only are almost 63% of people touching it in a given day and using the service because it's really engaging content, but we've gone through a period where more than 50% of people have used it six out of seven days of the week, almost every single day of a week. That just speaks to, I think, the underlying fundamental strength in the content and the work that we're doing to serve the best content to the best people. + +-------------------------------------------------------------------------------- +Operator [16] +-------------------------------------------------------------------------------- + + Ben Schachter with Macquarie. + +-------------------------------------------------------------------------------- +Ben Schachter, Macquarie Research - Analyst [17] +-------------------------------------------------------------------------------- + + First, David, let me add my congratulations on your success. And good luck with the future role. Mark, beyond games, do you see other categories of apps that are ramping? And do you need to see that or can games continue to be the primary driver of app install and app engagement ads? +And then, separately, on Graph Search, do you see the potential for more partnerships for Graph Search in terms of additional data sets and distributions partners? Or is this more go-it-along? And then, finally, maybe for Sheryl or David, can you just give us a sense on pricing trends on app install ads? Thanks. + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook, Inc. - CEO [18] +-------------------------------------------------------------------------------- + + On app installs, I actually think we see more diversity in the customers and developers on mobile now than we saw on desktop with Canvas. Canvas, the business, was almost entirely games. And now we see that a lot of it is games, but a lot of it is other kinds of folks because everyone who is building apps on mobile needs installs, and we have the number one products out there for delivering that. So, we see that happening and we feel pretty good about that. + +-------------------------------------------------------------------------------- +Sheryl Sandberg, Facebook, Inc. - COO [19] +-------------------------------------------------------------------------------- + + On pricing, we don't break out pricing by type of ad. But overall in the ecosystem our prices are up. As Mark said, the effect of price per ad shown is driven up by more ads in News Feed. And that's because News Feed ads have significantly higher engagement and click-through rates. + +-------------------------------------------------------------------------------- +Operator [20] +-------------------------------------------------------------------------------- + + Evan Wilson with Pacific Crest. + +-------------------------------------------------------------------------------- +Evan Wilson, Pacific Crest Securities - Analyst [21] +-------------------------------------------------------------------------------- + + Just a small item. It looks like the Asia engagement metric, the MAU, was down sequentially, slightly. Was there something there that impacted that in Q1 or was there something competitive there you think might be impacting that part of the business, like the big mobile messaging services? Thanks. + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook, Inc. - CEO [22] +-------------------------------------------------------------------------------- + + I don't know that I would read anything into that yet. We haven't identified that as a trend that we are focused on at this point. The numbers do bounce around a little bit from quarter to quarter in various regions. + +-------------------------------------------------------------------------------- +Operator [23] +-------------------------------------------------------------------------------- + + Anthony DiClemente with Nomura. + +-------------------------------------------------------------------------------- +Anthony DiClemente, Nomura Securities Intl - Analyst [24] +-------------------------------------------------------------------------------- + + Congratulations, David. And best of luck in your new endeavors, as well. One question for David and one for Sheryl. +David, I just wondered if you could talk about your mix of impressions in terms of brand versus direct response. How has that changed this quarter versus prior quarters? And what else can be said about that split? +And then, secondly, for Sheryl, just wondered if you could give us a little more of an update on premium video ads. Specifically, I'm curious as to how those are sold. Are they sold on an impression basis or on a performance basis, or some hybrid of the two? +And then I know you don't give pricing by property, but is there a way to think about the premium or premium multiple of price that premium video ads would go for as compared to core News Feed ads? Thanks for any color on that. + +-------------------------------------------------------------------------------- +David Ebersman, Facebook, Inc. - CFO [25] +-------------------------------------------------------------------------------- + + Thanks, Anthony. I'm happy to take the first part of the question. In the first quarter, we delivered strong performance across all the advertiser segments that we focus on. So, I think they are all growing nicely. +We don't have a perfect measure for what kind of demand is brand versus DR, per se, because someone doesn't have to input that into the system when they come in. We have lots of things we do to try to find surrogates for that, and are happy to see that using some of that data we are seeing nice growth across the various segments. + +-------------------------------------------------------------------------------- +Sheryl Sandberg, Facebook, Inc. - COO [26] +-------------------------------------------------------------------------------- + + On video ads, video represents a really big opportunity, really driven by consumer behavior. Smartphones are getting better and faster, and more people have phones that can provide a great video experience. So, you are seeing consumers do a lot more on video. There's also a lot more video going through News Feed that consumers are putting in, and that creates an opportunity for us, both on the consumer side and the ad side. +We have a current product in the market. It's a click to play video ad. It's part of a page post. You can post a video. Those are sold both CPM and CPC. And those are going really well, and I think explains some of the growth we're seeing in our ads business. +We also have been in early conversations with some clients about what would be a CPM auto play video ad. In terms of the expectations for that, we really want to see auto play video ads be something that's pretty common in the News Feed experience based on consumer usage before we push very hard in the ads business. +So, we remain long term very excited. We do expect that product to demand a premium product. But as I said in my remarks, we won't see a material contribution from it this year. + +-------------------------------------------------------------------------------- +Operator [27] +-------------------------------------------------------------------------------- + + Mark Mahaney with RBC. + +-------------------------------------------------------------------------------- +Mark Mahaney, RBC Capital Markets - Analyst [28] +-------------------------------------------------------------------------------- + + On those autoplay videos, as an average Facebook user, I've noticed them more and more in my News Feed, and I think they're really neat. I think all my friends love watching videos of my kids play basketball. The question I'd have for you is what have you seen internally in terms of engagement. I assume that since I'm seeing more, other people are too, and that users like having them in. But is there any way you could quantify or maybe talk broadly about the impact that's having on usage? Thank you. + +-------------------------------------------------------------------------------- +Sheryl Sandberg, Facebook, Inc. - COO [29] +-------------------------------------------------------------------------------- + + Our goal is to make News Feed as engaging as possible. I think we look at the engagement we have on mobile, we are getting 20% of mobile time on Facebook in the US. And growing globally, as well. I think you see that that engagement is great. +I'm sure your friends love seeing your kids play basketball. I think they'd probably like to see more of those. And when and if we deliver a really great ad experience, and ads that you love, something you're interested in, I think you're going to like that just as much. We look forward to the growth. + +-------------------------------------------------------------------------------- +Operator [30] +-------------------------------------------------------------------------------- + + Justin Post with Merrill Lynch. + +-------------------------------------------------------------------------------- +Justin Post, BofA Merrill Lynch - Analyst [31] +-------------------------------------------------------------------------------- + + I have a couple questions. On the app installs, can you help us at all understand what -- I know you gave us the number of total apps, but maybe how that revenue as a percentage of total, how important it is to you? And then there's a lot of competitors targeting that market with new products. Maybe you could outline some of Facebook's competitive advantages in that market. +And then one for Dave. We will miss you. Maybe you could talk a little bit about maybe some things Facebook could do to offset some of the dilution from the acquisitions, if anything. Thank you. + +-------------------------------------------------------------------------------- +Sheryl Sandberg, Facebook, Inc. - COO [32] +-------------------------------------------------------------------------------- + + On mobile app ads, we've seen really strong adoption. And this is a very nascent but growing market. I think people sometimes think that a lot of our mobile ad revenue is coming from this one type of ad. And our mobile ad revenue is very broad-based. We know what you see in News Feed, and what we see, are ads from brand marketers, direct response, SMDs and developers. So, we are pretty distributed there and pretty happy about that. +I think it's not surprising that other people are entering this space. It's obviously growing. It's one that performs well. I think we continue to be excited by the results we are seeing for marketers and developers, the results we are seeing from consumers. And we think the fact that we've already been investing and learning and growing puts us in a great position to continue to have a very strong product offering, even in a more competitive space. + +-------------------------------------------------------------------------------- +David Ebersman, Facebook, Inc. - CFO [33] +-------------------------------------------------------------------------------- + + Justin, on the acquisitions, the most important thing we will do to, really, I would say, justify the dilution will be to make those acquisitions successful, and over time ensure that the unique assets that we are buying contribute to Facebook's success and to our cash flows over time. The business is obviously in healthy shape right now in terms of the cash it's generating. We look forward at the moment to really continuing to prioritize, where it's appropriate, investing that in the business to drive future growth. + +-------------------------------------------------------------------------------- +Operator [34] +-------------------------------------------------------------------------------- + + Youssef Squali, Cantor Fitzgerald. + +-------------------------------------------------------------------------------- +Youssef Squali, Cantor Fitzgerald - Analyst [35] +-------------------------------------------------------------------------------- + + David, can you talk a little bit about the ad load during the quarter? We saw noticeable increases here in the holidays and through Q1 versus that 5% or 6% you mentioned back on the Q3 call. Is the new ad load we are seeing sustainable, do you think, going forward? +And, second, maybe Mark or Sheryl, can you just talk a little bit about timing for monetization of Instagram? Are there any thresholds, either in terms of users, user engagement, whatnot, before you can ramp that advertising, or advertise on that platform? I think, David, you were talking earlier about maybe reaching 1 billion, but I think that was a general comment. Thanks. + +-------------------------------------------------------------------------------- +David Ebersman, Facebook, Inc. - CFO [36] +-------------------------------------------------------------------------------- + + As Mark alluded to earlier as it relates to ad load, what we're trying to do is optimize across multiple variables that really produce the best experience for people who use the network and help us to grow the business. Ad load is one of the variables that we look at. Of course, we also look at things like the size of the ads, the prominence of the ads, and, of course, the quality of the ads. What we are trying to do is continually really tweak all of those variables, and then measure what impacts we are having on engagement, on feedback from people, on revenue, and trying to optimize using that data and the changes that we've made. +I think the story there is a really good one. Things continue to go very well, obviously in terms of revenue which you see, but also in terms of engagement, in terms of feedback we get from people when we survey them. So we think we remain in a really very strong position in that way. +I actually would not validate the assertion that you gave that the ad load increased dramatically in the timeframe you described because that's not consistent in aggregate with our data. What I can say is that every person who uses Facebook has their own experience. The experience, including the ad experience, is personalized based on the other content we have available, based on how much they've engaged with ads we've shown in the past, et cetera. Ideally, we'd like to personalize not just the organic content that you see, but also your ad experience in a way that's really optimized for you and your interests. + +-------------------------------------------------------------------------------- +Sheryl Sandberg, Facebook, Inc. - COO [37] +-------------------------------------------------------------------------------- + + On Instagram, Instagram is a great product. I think that's why you see so much engagement from people who are using it, and the growth passing 200 million. It's also a great advertising product. And there's just tons of demand because the pictures themselves are so visually appealing, and also there's so much consumer engagement. +We are in really early days. We have seen some great results. Just to mention one, Levi's is running an ad which is basically pictures of people wearing denim in really beautiful outdoor spaces. They targeted people 18 to 34 in the United States, reached over 7 million people. And importantly, they drove a 24-point lift in ad recall, which was 3 times the control group. +I think that shows that just as people engage with the consumer pictures on Instagram, they're going to engage with the right pictures for marketers. That said, we are very focused on consumer growth and we move slowly and deliberately in monetization. So, we don't see the need or the urge to ramp this as quickly as we possibly could, but really want to grow it slowly, grow it deliberately, and continue the growth on the consumer side and the great returns for marketers. + +-------------------------------------------------------------------------------- +Operator [38] +-------------------------------------------------------------------------------- + + Colin Sebastian with Robert Baird. + +-------------------------------------------------------------------------------- +Colin Sebastian, Robert W. Baird & Co. - Analyst [39] +-------------------------------------------------------------------------------- + + The first one is, I wonder if there's any way we can generalize or correlate around the growth in mobile monetization with the shift to 4G LTE, and whether this could be a driver, as well, of improving monetization internationally, as those higher-speed networks are deployed in new markets. And then, secondly, regarding Nearby Friends, just wondering how you plan to tie that feature and data set into more of a commercialized local offering for businesses, whether that's geo targeting or other related services. Thank you. + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook, Inc. - CEO [40] +-------------------------------------------------------------------------------- + + A lot of what we are trying to do with internet.org is make it so that everyone has the cellular networks that they need to be able to get on the Internet and access basic services, which we think are text-based communication services, whether it's things like social networks or messaging or email or search. Whether it's stock prices. Basic stuff like that, that people use on a day-to-day basis but don't require a huge amount of data. +We are pretty happy with the early progress that we've made. We have a multi-year initiative to work with operators around the world to roll out a program where folks can have free basic services. As I mentioned before, a lot of the initial work, the initial partnerships were in the Philippines and Paraguay. +What we are really pleased with, even just a few months of work, we were able to help almost 3 million people get access to data for the first time. So, there's no doubt that going from having no access to data to having some access is a huge jump in terms of the activity in business that we see that's available from people. +Moving towards things like LTE later on in the funnel will be helpful as we move towards richer types of content, like higher resolution photos and videos, because that will be important, especially as the mix of content that people share moves towards richer media. But we are really focused on both. And we have a huge investment, as well, in the Internet.org, just making sure that everyone in the world gets connected. + +-------------------------------------------------------------------------------- +Sheryl Sandberg, Facebook, Inc. - COO [41] +-------------------------------------------------------------------------------- + + On Nearby Friends, it's a great new feature. It's an optional feature we just rolled out last week. I don't know if people have had a chance to try it yet. It's rolling out slowly but it's a great product experience, one we are excited to be able to offer. We use information like this to enhance all the services we provide, make things more relevant including relevant ads. + +-------------------------------------------------------------------------------- +Operator [42] +-------------------------------------------------------------------------------- + + Brian Wieser with Pivotal Research. + +-------------------------------------------------------------------------------- +Brian Wieser, Pivotal Research Group - Analyst [43] +-------------------------------------------------------------------------------- + + First of all, I was wondering, with regard to the WhatsApp acquisition, I was wondering if you could update us on the status, if the current situation with Russia poses any issues given the development team space there. And then, separately, I was wondering if you could talk Nielsen and the use of OCR with respect to advertisers' interest in using OCR tools. Do you find that that's making a difference at the present time in terms of brands spending money with you, in general? + +-------------------------------------------------------------------------------- +Sheryl Sandberg, Facebook, Inc. - COO [44] +-------------------------------------------------------------------------------- + + On the first, their development team is located in Mountain View, not in Russia. + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook, Inc. - CEO [45] +-------------------------------------------------------------------------------- + + They are doing extremely well. + +-------------------------------------------------------------------------------- +Sheryl Sandberg, Facebook, Inc. - COO [46] +-------------------------------------------------------------------------------- + + Yes, they're doing really well. + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook, Inc. - CEO [47] +-------------------------------------------------------------------------------- + + The deal hasn't closed so we don't have anything to share. But I would just point you to a blog post that Jan wrote, I think it was yesterday, announcing that they had just helped connect half a billion monthly actives. They are growing very quickly. +I think that's up to about 460 million monthlies just a couple of months ago when we announced the deal with them in the first place. And I think that Jan specifically called out a few countries, including Russia and Brazil, and I think India, as some of the fastest growing markets for WhatsApp. I'd just direct you to that statement, and you should probably go read that for more information on how they're doing. And we will update you more when the deal closes. + +-------------------------------------------------------------------------------- +Sheryl Sandberg, Facebook, Inc. - COO [48] +-------------------------------------------------------------------------------- + + On Nielsen OCR, anything that helps advertisers measure their spend is really important. I've talked on the call a bunch about how measuring online and in-store sales really matters. It also matters to marketers to be able to measure their spend compared to other investments they can make. +What OCR has done is given advertisers and marketers comparability between TV and digital and our spend. I think in those comparisons we do very well and I think that is part of the shift that's happening. And it's part of why we see growing interest from clients. + +-------------------------------------------------------------------------------- +Operator [49] +-------------------------------------------------------------------------------- + + Ross Sandler with Deutsche Bank. + +-------------------------------------------------------------------------------- +Ross Sandler, Deutsche Bank - Analyst [50] +-------------------------------------------------------------------------------- + + Just two quick questions. Facebook's on pace to represent around 20% of global display advertising or non search advertising in 2014. Do you view that as your addressable market? And, if so, what do you see as the potential market share you guys can capture relative to the -- I think, Sheryl, you said it is 23% mobile consumption, ex-China, globally today. +And then the second question is, there's been some press recently that Facebook is looking at building peer-to-peer money transfer services. Is that a market that you view as an opportunity? Would that fit into Messenger or potentially a standalone app? Thanks. + +-------------------------------------------------------------------------------- +Sheryl Sandberg, Facebook, Inc. - COO [51] +-------------------------------------------------------------------------------- + + We've had a payments business for a while and we continue to have one, and nothing new to announce there. On the first question, I think our addressable market is much bigger than digital. And you see that in the trends. +The big trend that's happening is the shift from consumer time. Last year was the very first time those lines crossed, and consumers spent more time in digital, which is mobile and desktop, than they did on TV. That continues to grow. So, where we are right now is, the average US consumer, as an example, spends 4.5 hours per day on TV, but 5.75 on digital. And that's largely being driven by mobile. +That means that as consumer time and attention shifts, we think ad budget shifts, as well, particularly if you have good mobile ad products and you can measure results. So, we definitely believe there will be, and continues to be, a shift happening. I talked about a print shift happening with the example of Sport Chek in Canada. +But we see this across the board, that marketers are looking for the highest ROI they can find. And they should be comparing us and everyone else across. And they do that not just across digital but across print, across radio, across TV, across any other vehicle they can. +I think our investments in measurement really pay off here. We say to our clients all around the world -- we want to earn your business because we want to be the best dollar and the best minute you spend. Because both their dollars and their time are so valuable. We want them to compare us to the other investments they could make, to see who can drive the most value to their bottom line. And that's what we are focused on, and that goes way beyond digital. + +-------------------------------------------------------------------------------- +Operator [52] +-------------------------------------------------------------------------------- + + John Blackledge with Cowen and Company. + +-------------------------------------------------------------------------------- +John Blackledge, Cowen and Company - Analyst [53] +-------------------------------------------------------------------------------- + + Just wondered if you could discuss how Facebook's potential mobile ad network would provide additional value to advertisers than other existing mobile ad networks. And then just a second question for David. I don't know if you could help quantify what meaningfully lower year-over-year ad revenue growth is, or just give us a sense of how to think about it for modeling purposes. Thank you. + +-------------------------------------------------------------------------------- +Sheryl Sandberg, Facebook, Inc. - COO [54] +-------------------------------------------------------------------------------- + + On the ad network, we are in very early testing for mobile ad network. We do see a big opportunity, here. We think because we are people-based we have an opportunity both to provide greater reach for marketers and developers who are working with Facebook across other platforms, but also improve the relevance of the ads people see, both on and off Facebook. +I think that has been our core advantage and will continue to be. That said, it's really early days and we're in the early testing phase. + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook, Inc. - CEO [55] +-------------------------------------------------------------------------------- + + John, obviously the Q1 ad revenue growth rate was 82%, which is fantastic and a real tribute to the team and the platform. One of the things that contributed to that growth rate is the ramp-up of News Feed ads, that in Q1 of last year we were still really early in that part of the journey. And, so, the comparison between the state of News Feed ads in the Q1 we are reporting now and a year ago is meaningfully different. +As you'll remember from last year, News Feed ads really ramped up in the second quarter, and revenue growth ramped up, as well. So, that's just going to impact the comparisons in the subsequent quarters of the year. +Having said that, there's lots of things that we are focused on that will continue to drive our ad revenue growth, including more users and critically more marketer demand. So, bringing more marketers into the system, improving our products and tools to increase their returns and their ability to measure those returns, and generally improving the quality and relevance and value of the ads. Those are the things that we will stay focused on. + +-------------------------------------------------------------------------------- +Deborah Crawford, Facebook, Inc. - Director IR [56] +-------------------------------------------------------------------------------- + + Great. Thank you for joining us today. We appreciate your time and we look forward to speaking with you again. + +-------------------------------------------------------------------------------- +Operator [57] +-------------------------------------------------------------------------------- + + This concludes today's conference call. You may now disconnect. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/exam/original-files/Problem_1_Sample/2014-Apr-24-AMZN.OQ-140443160996-Transcript.txt b/exam/original-files/Problem_1_Sample/2014-Apr-24-AMZN.OQ-140443160996-Transcript.txt new file mode 100644 index 0000000..0d918e6 --- /dev/null +++ b/exam/original-files/Problem_1_Sample/2014-Apr-24-AMZN.OQ-140443160996-Transcript.txt @@ -0,0 +1,674 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q1 2014 Amazon.com Inc Earnings Conference Call +04/24/2014 05:00 PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Tom Szkutak + Amazon.com Inc - CFO + * Dave Fildes + Amazon.com Inc - Senior Manager of IR + +================================================================================ +Conference Call Participiants +================================================================================ + + * Scott Tilghman + B. Riley Caris - Analyst + * Andrew Boone + JMP Securities - Analyst + * Ben Schachter + Macquarie Equities Research - Analyst + * Kerry Rice + Needham & Company - Analyst + * Justin Post + BofA Merrill Lynch - Analyst + * Greg Melich + ISI Group - Analyst + * Brian Pitz + Jefferies & Company - Analyst + * Douglas Anmuth + JPMorgan - Analyst + * Youssef Squali + Cantor Fitzgerald - Analyst + * Heath Terry + Goldman Sachs - Analyst + * Eric Sheridan + UBS - Analyst + * Colin Sebastian + Robert W. Baird & Company, Inc. - Analyst + * Mark Mahaney + RBC Capital Markets - Analyst + * Mark Miller + William Blair & Company - Analyst + * Aram Rubinson + Wolfe Research - Analyst + * Brian Nowak + SIG - Analyst + * Ross Sandler + Deutsche Bank - Analyst + * Carlos Kirjner + Sanford C. Bernstein & Company, Inc. - Analyst + * Mark May + Citi - Analyst + +================================================================================ +Presentation +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Good day ladies and gentlemen and welcome to the Amazon.com Q1 2014 financial results teleconference. At this time, all participants are in a listen-only mode. But following the presentation, we will conduct a question and answer session. In addition, today's conference is being recorded. And now for opening remarks I will turn the conference over to the Senior Manager of Investor Relations, Mr. Dave Fildes. Please go ahead sir. + +-------------------------------------------------------------------------------- +Dave Fildes, Amazon.com Inc - Senior Manager of IR [2] +-------------------------------------------------------------------------------- + + Hello and welcome to our Q1 2014 financial results conference call. Joining us is today is Tom Szkutak, our CFO. We will be available for questions after our prepared remarks. The following discussion and responses to your questions reflect Management's views as of today April 24, 2014 only, and will include forward-looking statements. Actual results may differ materially. +Additional information about factors that could potentially impact our financial results is included in today's press release and our filings with the SEC including our most recent annual report on Form 10-K. As you listen to today's conference call, we encourage you to have our press release in front of you, which includes our financial results as well as metrics and commentary on the quarter. +During this call we will discuss certain non-GAAP financial measures. In our press release, slides accompanying this webcast, and our filings with the SEC, each of which is posted on our IR website, you will find additional disclosures regarding these non-GAAP measures, including reconciliations of these measures with comparable GAAP measures. Finally, unless otherwise stated, all comparisons in this call will be against our results for the comparable period of 2013. Now I'll turn the call over to Tom. + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com Inc - CFO [3] +-------------------------------------------------------------------------------- + + Thanks, Dave. I'll begin with comments on our first-quarter financial results. Trailing 12 month operating cash flow increased 26% to $5.35 billion. Trailing 12 month free cash flow increased to $1.49 billion. Trailing 12 month capital expenditures were $3.85 billion. +We continue to make additional investments in support of business growth, consisting of investments in technology infrastructure, including Amazon Web Services and additional capacity to support our fulfillment operations. Return on invested capital is 9%, up from 1%. ROIC is TTM free cash flow divided by average total assets minus current liabilities excluding the current portion of long term debt over five quarter ends. The combination of common stock and stock based awards outstanding was 476 million shares compared with 471 million one year ago. +Worldwide revenue grew 23% to $19.74 billion, or 23% excluding the $10 million favorable impact from year-over-year changes in foreign exchange. Media revenue increased to $5.47 billion, up 8%, or 8% excluding foreign exchange. EGM revenue increased to $13.02 billion, up 27%, or 27% excluding foreign exchange. Worldwide EGM increased to 66% of worldwide sales, up from 64%. Worldwide paid unit growth was 23%. +Active customer accounts exceeded 244 million. Worldwide active seller accounts were more than 2 million. Seller units represented 40% of paid units. +Now I'll discuss operating expenses excluding stock based compensation. Cost of sales was $14.06 billion or 71.2% of revenue, compared with 73.4%. Fulfillment, Marketing, Tech and Content, and G&A combined was $5.18 billion, or 26.2% of sales, up approximately 240 basis points year-over-year. Fulfillment was $2.24 billion or 11.3% of revenue, compared with 10.8%. Tech and Content was $1.82 billion or 9.2% of revenue, compared with 7.9%. Marketing was $843 million or 4.3% of revenue, compared with 3.8%. +Now I'll talk about our segment results, and consistent with prior periods we do not allocate to segments our stock based compensation or other operating expense line item. In the North America segment, revenue grew 26% to $11.86 billion. Media revenue grew 12% to $2.82 billion, or 13% excluding foreign exchange. EGM revenue grew 28% to $7.83 billion, representing 66% of North America revenues, up from 65%. Other revenue grew 60% to $1.2 billion. North America segment operating income increased 23% to $562 million, a 4.7% operating margin. +In the International segment, revenue grew 18% to $7.88 billion; adjusting for the $24 million year-over-year favorable foreign exchange impact, revenue growth was 18%. Media revenue grew 4% to $2.64 billion or 4% excluding foreign exchange, and EGM revenue grew 27% to $5.19 billion, or 26% excluding foreign exchange. EGM now represents 66% of international revenues, up from 61%. International segment operating loss was $60 million, compared with $16 million loss in the prior period. +CSOI increased 14% to $502 million, or 2.5% of revenue, down approximately 20 basis points year-over-year. Excluding the favorable impact from foreign exchange, CSOI increased 10%. Unlike CSOI, our GAAP operating income includes stock based compensation expense and other operating expense. +GAAP operating income decreased 19% to $146 million, or 0.7% of net sales. Our income tax expense was $73 million. GAAP net income was $108 million or $0.23 per diluted share, compared with $82 million and $0.18 per diluted share. +Turning to the balance sheet. Cash and marketable securities increased $771 million year-over-year to $8.67 billion. Inventory increased 24% to $6.72 billion and inventory turns were 9.1, down from 9.5 turns a year ago as we expanded selection, improved in-stock levels, and introduced new product categories. Accounts payable increased 19% to $10.59 billion and accounts payable days were 68, consistent with the prior year. +I'll conclude my portion of today's call with guidance. Incorporated into our guidance are the order trends we've seen to date and what we believe to date to be appropriately conservative assumptions. Our results are inherently unpredictable and may be materially affected by many factors, including a high level of uncertainty surrounding exchange rate fluctuations, as well as the global economy and consumer spending. It's not possible to accurately predict demand, and therefore, our actual results could differ materially from our guidance. +As we describe in more detail in our public filings, issues such as settling intercompany balances and foreign currencies amongst our subsidiaries, unfavorable resolution of legal matters, and changes to our effective tax rates could all have a material effect on guidance. Our guidance further assumes that we don't conclude any additional business acquisitions, investments, restructurings, or legal settlements, record any further revisions to stock based compensation estimates, and that foreign exchange rates remain approximately where they've been recently. +For Q2 2014 we expect net sales of between $18.1 billion and $19.8 billion, or growth of between 15% and 26%. This guidance anticipates approximately 160 basis points of favorable impact from foreign exchange rates. GAAP operating income or loss to be between $455 million loss and $55 million loss, compared to $79 million in income in the second quarter of 2013. This includes approximately $455 million for stock based compensation and amortization of intangible assets. +We anticipate consolidated segment operating income, which excludes stock based compensation and other operating expense, to be between $0 million and $400 million, compared to $409 million in the second quarter of 2013. We remain heads down focused on driving a better customer experience through price, selection, and convenience. We believe putting customers first is the only reliable way to create lasting value for shareholders. Thanks, and with that Dave, let's move to questions. + +-------------------------------------------------------------------------------- +Dave Fildes, Amazon.com Inc - Senior Manager of IR [4] +-------------------------------------------------------------------------------- + + Thanks, Tom. Let's move on to the Q&A portion of the call. Operator, will you please remind our listeners how to initiate a question. + + + +================================================================================ +Questions and Answers +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Mark Miller, William Blair. + +-------------------------------------------------------------------------------- +Mark Miller, William Blair & Company - Analyst [2] +-------------------------------------------------------------------------------- + + Hi Tom, I was hoping you could maybe just lay out for us what do you think the main reasons are for the acceleration in growth here in the first quarter versus the fourth quarter. And then I have a specific question on Prime Pantry. Is one of the motivations to get the customer on that program, it might make it easier to convert them to AmazonFresh? And if so, would you want to run this operation as a breakeven like you do with Kindle to enable a bigger business? Thanks. + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com Inc - CFO [3] +-------------------------------------------------------------------------------- + + In terms of growth we did -- we saw very solid growth, good growth in Q1, up 23% on a local currency basis. North America we saw similar growth rates in Q1 as we saw in Q4 of last year, as well as Q1 of last year all at 26%. In International we saw the growth accelerate a little bit on an exchange adjusted basis from 15% to 18% from Q4 to Q1. +But what we're really seeing is we're pleased with the overall fundamentals. We continue to add new customers, in-stocks continue to be healthy. Third-party units as a percentage of units are about 40%, so still very strong. FBA adoption continues to be strong around the world, continue to add new selection. We saw strong growth in many different areas including Web Services, and so again a lot of different areas contributed to the growth rate that we saw in Q1. +In terms of Prime Pantry, we just think it's an exciting option for Prime members. It's available only to Prime members, so that they can get their everyday non-bulk items in one box, and we think that's interesting for customers. And again, it's a great way that we can add the selection and have the selection for those customers. + +-------------------------------------------------------------------------------- +Operator [4] +-------------------------------------------------------------------------------- + + Aram Rubinson, Wolfe Research. + +-------------------------------------------------------------------------------- +Aram Rubinson, Wolfe Research - Analyst [5] +-------------------------------------------------------------------------------- + + Thanks for taking the question. On the famous drone interview that Jeff had with Charlie Rose, he said something that caught my attention, which was that every elasticity study that you do says that Amazon should be raising prices. +I have two questions around that. The first is does that equation also work in reverse? Meaning that if higher questions don't dampen demand, does it also mean that lower prices don't stimulate demand like they used to? + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com Inc - CFO [6] +-------------------------------------------------------------------------------- + + In terms of pricing we've been very consistent. We want to offer great value to customers, and so we work very hard to make sure that we can offer and afford to offer great prices for customers. And so that's something that we've been working on very hard over the years. That's certainly one of the reasons why you've seen the growth rates that we've experienced along with getting closer to customers from a shipping perspective, making sure we have great in stocks and other service attributes. +In terms of price increases, we certainly have increased the price on Prime, but again that was after many years of not raising the price even though the cost of -- transportation costs certainly have gone up, and the fact that we have certainly added a lot of selection, going from a little over 1 million items in the first year to over 20 million items. So it's still an incredibly great value for customers, and that's why we did that. So again we're all about making sure we have great values for customers and we'll continue to do that. + +-------------------------------------------------------------------------------- +Aram Rubinson, Wolfe Research - Analyst [7] +-------------------------------------------------------------------------------- + + Okay, thanks for that. + +-------------------------------------------------------------------------------- +Operator [8] +-------------------------------------------------------------------------------- + + Carlos Kirjner, Sanford C Bernstein. + +-------------------------------------------------------------------------------- +Carlos Kirjner, Sanford C. Bernstein & Company, Inc. - Analyst [9] +-------------------------------------------------------------------------------- + + I have two quick questions about AWS. First I think everyone would agree that AWS is a vast opportunity. So given how large the opportunity is, why is it that you are not hiring more people, launching more products, and growing faster? What are the limiting factors for growth of AWS? +Second, you have a long history of cutting prices for a few specific AWS products, but you did something somewhat unusual in late March when you cut prices across EC2 and S3 products in one shot. Why did you only cut your prices after Google cut theirs? Thank you. + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com Inc - CFO [10] +-------------------------------------------------------------------------------- + + In terms of AWS, the team is doing a fantastic job. We are adding a lot of resources. We've grown our employee base there dramatically over the years and continue to add people there. And that's the way we've been able to launch all the new services that we've had over the past several years. And we continue the pace of acceleration in terms of new things that we're doing is increasing and we've published a lot of statistics around that. +In terms of pricing, we think this is our 42nd price increase that we've had in AWS, sorry price decrease in AWS, and we're very excited on behalf of our customers to be able to do that. The team works very hard to be able to afford those lower prices, and we're excited to do that. And so in terms of the timing of when we launch these price decreases that come at different times and it happened to come in a presentation that we were giving around that time. But again we're very excited about the opportunity and we continue to invest in that business given the big opportunity that we have there. + +-------------------------------------------------------------------------------- +Operator [11] +-------------------------------------------------------------------------------- + + Ben Schachter, Macquarie. + +-------------------------------------------------------------------------------- +Ben Schachter, Macquarie Equities Research - Analyst [12] +-------------------------------------------------------------------------------- + + Can you walk us through the process on how you think about and how you model how much you're willing to pay for exclusive content such as video or video game content? And then another question, is it fair for us to assume that the business model of the Kindle Fire TV is similar to what Bezos has said regarding selling other hardware at roughly breakeven, and then making money only if consumers use it? Thanks. + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com Inc - CFO [13] +-------------------------------------------------------------------------------- + + In terms of video content, the team does a very nice job of various modeling, certainly we're trying to estimate what the usage is of all the content that we launch, and we have a number of different ways that we do that. We do have certainly for some of the content that we've been selling, both in terms of physical format as well as selling on the transactional side, we certainly see what the -- what those sales are -- what those unit sales are, so we have that as a benchmark. +We also have other models to look at that could help us guide to what we think the usage will be of those. But again, the team has done a nice job looking at different ways to model that, and I expect that we'll continue to refine that over time as well. + +-------------------------------------------------------------------------------- +Ben Schachter, Macquarie Equities Research - Analyst [14] +-------------------------------------------------------------------------------- + + Then on Kindle Fire TV? + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com Inc - CFO [15] +-------------------------------------------------------------------------------- + + In terms of Fire TV, I can't talk about the economics of the device itself. But what I can say is it's very early and we're extremely pleased with what we see in just the few weeks here, and the team certainly made what we think is a killer product. And we're -- the team is very hard trying to keep in stock on that product. + +-------------------------------------------------------------------------------- +Operator [16] +-------------------------------------------------------------------------------- + + Mark May, Citi. + +-------------------------------------------------------------------------------- +Mark May, Citi - Analyst [17] +-------------------------------------------------------------------------------- + + Wondering if you noticed any change in signups or conversions in the few weeks here since you've rolled out the Prime price increase for new customers, and if you could maybe comment on what may have contributed to the deceleration in year-on-year growth in Media sales in North America. Thanks. + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com Inc - CFO [18] +-------------------------------------------------------------------------------- + + In terms of Prime, it's early but we're encouraged with what we see so far. Just over the last several weeks our Prime subscribers continue to grow week over week. New trials, the adoption of new trials again post the increase, are growing very nicely. So those customers accepting new trials is growing very fast. +We only have a few days of information related to conversion and we're encouraged by what we see there. So overall, we're very encouraged. The reason why is that customers we believe are responding to just a great service, and so we're continuously being reminded of that from customers in terms of the offering we have on the physical side, as well as the offerings that we have on the digital side as well, so very encouraged there. +In terms of the North American media, we did see a -- from a growth standpoint it's 13% year-over-year for North American Media. That compares to 14% in Q1 of last year. It is down a little bit sequentially from Q4, the Q4 keep in mind we do have video games and video consoles in that number in Q4, there's certainly a number of different factors. But that's certainly one that's impacting the Q4 numbers, and it's certainly seasonal as you would expect, but there's some great launches of consoles in Q4 that are impacting that number. + +-------------------------------------------------------------------------------- +Operator [19] +-------------------------------------------------------------------------------- + + Douglas Anmuth, JPMorgan. + +-------------------------------------------------------------------------------- +Douglas Anmuth, JPMorgan - Analyst [20] +-------------------------------------------------------------------------------- + + Thanks for taking the question. Tom, I was just hoping you could give us your view on units growth and how you think about that going forward. How important of a metrics it is, because we're seeing somewhat of a decoupling here as revenue and gross profit reaccelerated, but units obviously decelerated as media came down. Can you talk a little bit about that? Thank you. + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com Inc - CFO [21] +-------------------------------------------------------------------------------- + + Sure, as you mentioned unit growth was actually decelerated a little bit from Q4, and also from last year it was 23% year-over-year in Q1. +One thing to keep in mind is that our Web Services business is growing at a faster rate. We don't incorporate any units from AWS in that metric. But overall, you're right. We continue to from a growth standpoint we had a small acceleration of growth from Q4 to Q1 from a revenue standpoint, again on a local currency basis going from 22% to 23%. We're very pleased with a lot of the fundamentals that I talked about earlier that's impacting that growth rate. +Overall we're pleased and again, we think that we see a nice growth rate, and third-party units as a percentage of total units is 40%, which was consistent with what we saw last year. So third-party growth continues to be very strong as well. + +-------------------------------------------------------------------------------- +Operator [22] +-------------------------------------------------------------------------------- + + Brian Nowak, SIG. + +-------------------------------------------------------------------------------- +Brian Nowak, SIG - Analyst [23] +-------------------------------------------------------------------------------- + + I have two. The first one, just Tom to go back to the unit question, even if we exclude North America and International Other from gross profit. Gross profit held in there pretty steady at 28%. Just kind of curious, is there anything that we should think about of why gross profit growth and unit growth is decoupling? And is unit growth a really good way to measure the health of the business? +And then the second one is on International Media. One of the factors you guys have flagged in the past holding back International Media is more limited local language content. Can you just help us better quantify the difference in English language digital content compared to foreign language? And what steps are your taking to improve that? + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com Inc - CFO [24] +-------------------------------------------------------------------------------- + + In terms of -- I'll take the second part of the question first about International Media. The growth rate was 4% in the quarter, and as I've talked about in prior quarters, certainly one of the things that's happening is we see a conversion from physical to digital. +And for example in North America, we're now selling North America Media, we're now selling more digital units than physical units. So in the past 12 months we've sold more digital units than physical units. We're not at that point yet in International. And so certainly that's an opportunity for us as we look at growing International Media. It's again, it's certainly something that we're working very hard on and certainly a good opportunity for us. +In terms of unit growth, it's certainly just one measure that we thought has been helpful. And that's why we've continued to provide it. It is just one metric. We have many different metrics that we're sharing. But there's not much more I can add to that, but again it's a metric. Was there another -- was there a third part to the question? + +-------------------------------------------------------------------------------- +Brian Nowak, SIG - Analyst [25] +-------------------------------------------------------------------------------- + + Are there any other puts and takes we should think about in units as we go throughout the year where there are tough compares or easy compares of units from a digital unit perspective or anything? + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com Inc - CFO [26] +-------------------------------------------------------------------------------- + + There's not that I can think of at the minute. But just keep in mind when you think about our revenue growth, always be thinking about there's certainly a volume component. We have a third-party component. We have a mix component. We're continuously trying to lower prices for customers. All of those factor into the revenue growth rates that you see for each of the revenue metrics that we provide to you. + +-------------------------------------------------------------------------------- +Brian Nowak, SIG - Analyst [27] +-------------------------------------------------------------------------------- + + Okay, great. Thanks. + +-------------------------------------------------------------------------------- +Operator [28] +-------------------------------------------------------------------------------- + + Brian Pitz, Jefferies and Company. + +-------------------------------------------------------------------------------- +Brian Pitz, Jefferies & Company - Analyst [29] +-------------------------------------------------------------------------------- + + Regarding Fulfillment, does it make sense for you to bring some of the components in-house? We've been hearing talk of your own fulfillment network. Can you make any comments on this? And just to follow up on your digital units point, can you comment on any impact of recent shifts in music and video consumption to subscription based models, from download to own on your Media business? Is that having any impact? Thanks. + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com Inc - CFO [30] +-------------------------------------------------------------------------------- + + In terms of Fulfillment, there's not a lot I can comment on in terms of your specific question. What I would say though is we continue to work to be as we have over the years to become closer and closer to customers. And so we've certainly done that in a number of different ways, just the footprint we have from a fulfillment capacity standpoint enables us to be closer to customers and getting great selection even closer to customers. +So we continue to work. Certainly Prime was another way to get a faster delivery speed to customers, and so we'll continue to work on our capabilities there to make it even better over time. In terms of the digital units question, I apologize. There's not a lot I can comment in terms of your specific question there. + +-------------------------------------------------------------------------------- +Brian Pitz, Jefferies & Company - Analyst [31] +-------------------------------------------------------------------------------- + + All right. Thank you. + +-------------------------------------------------------------------------------- +Operator [32] +-------------------------------------------------------------------------------- + + Justin Post, BofA Merrill Lynch. + +-------------------------------------------------------------------------------- +Justin Post, BofA Merrill Lynch - Analyst [33] +-------------------------------------------------------------------------------- + + Tom, we look back at your model and we go back to '08 and '09 in the middle of a pretty bad global recession, you were able to put up 7.3% and 7.4% operating margins in Europe, I'm sorry International. And now it looks like you're losing money and maybe for the whole year. +Could you talk about some of the drivers that are driving the losses this quarter internationally? What the company's patience for losses are internationally. And when you come out of this, how your business will be different and what your margin outlook is for the International profits. Thank you. + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com Inc - CFO [34] +-------------------------------------------------------------------------------- + + Sure. In terms of what you're seeing in Q1 and you've been seeing this certainly for a few year period here is we're investing very heavily in International. And we're doing that in a number of different ways. Certainly from a geographic standpoint, we continue to invest in new geographies, and Italy and Spain were certainly the most recent. And you should assume we are investing in those geographies. +We continue to invest in China and certainly that's in investment mode. And then also as we've continued to grow in International, we've invested in terms of capacity, both fulfillment capacity as well as infrastructure capacity to support those. +What you saw, you will see some certainly variation over time in the period that you're talking about. We certainly had particularly coming out of -- going into late 2008 and also 2009 we had extra capacity globally. We still did continue to invest but not near the rates that we're investing now. And that's why you saw some of the results that you've seen. But again, one of the things that you see not only in International but in our total results is we continue to invest very heavily into the business because of the opportunities that we see. + +-------------------------------------------------------------------------------- +Justin Post, BofA Merrill Lynch - Analyst [35] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Operator [36] +-------------------------------------------------------------------------------- + + Greg Melich, ISI Group. + +-------------------------------------------------------------------------------- +Greg Melich, ISI Group - Analyst [37] +-------------------------------------------------------------------------------- + + Hi, thanks. I wanted to ask on the decision process that you went through when raising the Prime membership fee. I know you talked about potentially doing $20 to $40. What factors did you look at in deciding on the $20? And related to that, with the deleveraging of shipment costs happening a little bit, was weather an impact on that or is that just the business and how it's trending? + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com Inc - CFO [38] +-------------------------------------------------------------------------------- + + There was a number of different factors that we looked at in terms of when we looked at the price increase. But the biggest one is we had built -- we think we've built a great service, and we saw that just the particularly the transportation costs since inception had grown dramatically. We just hadn't done any price increase during that long time period, and that's really the big reason why we decided to do that. +We launched the program with over 1 million items and we have over 20 million items now. Customers are using that service in addition to having the transportation costs being higher, they're using that service more and that's really what led to it. And beyond that there's not a lot I can comment. + +-------------------------------------------------------------------------------- +Greg Melich, ISI Group - Analyst [39] +-------------------------------------------------------------------------------- + + Just on the shipment costs deleveraging in the first quarter a little bit. Did weather or something else have an impact, or is that just the trend of the business given the growth rate of shipments? + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com Inc - CFO [40] +-------------------------------------------------------------------------------- + + There's many different factors that go into that and certainly weather would have been one of those. + +-------------------------------------------------------------------------------- +Operator [41] +-------------------------------------------------------------------------------- + + Ronald Josey, JMP Securities. + +-------------------------------------------------------------------------------- +Andrew Boone, JMP Securities - Analyst [42] +-------------------------------------------------------------------------------- + + Hi, guys, thanks for taking the question. This is Andrew on for Ron. A quick question around streaming volumes in UK and Germany now that Lovefilm is bundled with Prime. Do you have any comment? + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com Inc - CFO [43] +-------------------------------------------------------------------------------- + + Unfortunately, it's probably a good question for future quarters, it's just so early. And again, what little data we have so far is very encouraging, but it's very early so I think that's a good question for future quarters. + +-------------------------------------------------------------------------------- +Operator [44] +-------------------------------------------------------------------------------- + + Heath Terry, Goldman Sachs. + +-------------------------------------------------------------------------------- +Heath Terry, Goldman Sachs - Analyst [45] +-------------------------------------------------------------------------------- + + Great, thanks. Obviously, a lot of focus on pricing in AWS. But you're clearly still seeing accelerating growth despite those cuts. Could you provide some context on the volume side of that equation? Whether it's just growth in customers or workloads or some way to sort of frame the other side of things outside of just pricing in AWS. + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com Inc - CFO [46] +-------------------------------------------------------------------------------- + + No, it's a good question and I think that's something we can certainly work on to try to be helpful. The price change, the most recent price change is certainly recent. And what we're commenting on is certainly the Q1 results. +But that's something that we'll think about and try to be helpful on that as we go forward, but certainly usage has been -- this is not something recent. Usage has been very, very strong. And as we've continued to lower prices over time, this is the 42nd price decrease that we've had and we've had great usage growth over time. + +-------------------------------------------------------------------------------- +Heath Terry, Goldman Sachs - Analyst [47] +-------------------------------------------------------------------------------- + + Great. And just on the AWS side with the sort of nationalistic concerns that we're seeing around stored data, does that change at all the way that the AWS team is thinking about infrastructure needs for that business or the way that you might be thinking about capex. + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com Inc - CFO [48] +-------------------------------------------------------------------------------- + + I think the best way to say it is, and hopefully this answers your question. The team focuses on many different aspects, but certainly the operational aspects of being up and running, being a very secure, reliable set of services, those are something the team is very focused on and spends a lot of time working on. And so beyond that, I'm not sure I can add to it. + +-------------------------------------------------------------------------------- +Heath Terry, Goldman Sachs - Analyst [49] +-------------------------------------------------------------------------------- + + Great. Thanks Tom. + +-------------------------------------------------------------------------------- +Operator [50] +-------------------------------------------------------------------------------- + + Youssef Squali, Cantor Fitzgerald. + +-------------------------------------------------------------------------------- +Youssef Squali, Cantor Fitzgerald - Analyst [51] +-------------------------------------------------------------------------------- + + Thank you very much. Two quick questions please. First, the HBO deal seems like a seminal event for Prime Video in terms of quality and probably the price bit as well. Is this the first of many potentially large deals you're intent on getting for the platform? Or was this more of an opportunistic transaction that just came your way. And second, just on the P&L can you just clarify where that $60 million in investment gains came from, please? + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com Inc - CFO [52] +-------------------------------------------------------------------------------- + + Sure. The answer to the second question which is down below in Other relates to a gain primarily from LivingSocial. They sold their Korean business and that's reflected in that line item. +In terms of the content question. The way I would think about it is this. We've continually since we launched the service, we've continually added -- tried to add great content, and I think we've been pretty successful in doing that. And this is just another contract that we've launched into that's multi-year to do that. And we think it's -- we think it's a great for customers. We're extremely excited to offer this to customers. And we'll try to keep making the service even better over time. + +-------------------------------------------------------------------------------- +Youssef Squali, Cantor Fitzgerald - Analyst [53] +-------------------------------------------------------------------------------- + + Is exclusivity an important consideration for you now? + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com Inc - CFO [54] +-------------------------------------------------------------------------------- + + There's a number of factors, certainly we have a number of different arrangements where we have exclusive content, and we think that's great for customers, and we've also supplemented with other content that's not exclusive. +And we're obviously as you know, we're working on original content as well that is exclusive. So those are the things that we're working on, and we see the customer response to all of those, and we're -- we like what we see. + +-------------------------------------------------------------------------------- +Youssef Squali, Cantor Fitzgerald - Analyst [55] +-------------------------------------------------------------------------------- + + Thanks. + +-------------------------------------------------------------------------------- +Operator [56] +-------------------------------------------------------------------------------- + + Scott Tilghman, B Riley. + +-------------------------------------------------------------------------------- +Scott Tilghman, B. Riley Caris - Analyst [57] +-------------------------------------------------------------------------------- + + Hi Tom, wanted to really ask two related questions. First following up on the international discussion from before. I was wondering if you could prioritize where the investments are going on the international side between fulfillment, media buildout, geography buildout, et cetera. And then related, I haven't seen any discussion on what's happening on the domestic fulfillment buildout this year. I was wondering if you could comment on that as well? + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com Inc - CFO [58] +-------------------------------------------------------------------------------- + + Yes, in terms of the priority, I'm not sure what to add there, but I would say that we're investing heavily in China and we have been for some time, and certainly that's a factor. We're investing in new geographies, most notably Italy and Spain. We're investing in as I mentioned in fulfillment centers and infrastructure to support that growth. So again, not a lot to add there. The other part of your question? + +-------------------------------------------------------------------------------- +Scott Tilghman, B. Riley Caris - Analyst [59] +-------------------------------------------------------------------------------- + + Let me ask it a different way, if you look at pricing, if you look at infrastructure, if you look at geography, is there one bucket that tends to trump the others? + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com Inc - CFO [60] +-------------------------------------------------------------------------------- + + Yes, and again we've been pretty consistent how we've talked about it. Again, China you should assume, China is a big investment. In all of our geographies, not just international we're investing on behalf of customers in terms of lowering prices, and so that's having an impact. Volume is having an impact. We continue to invest in a fulfillment capacity not only for our retail customers, but also for third parties on behalf of Fulfillment By Amazon, and so we're making investments there. And the others that I mentioned. + +-------------------------------------------------------------------------------- +Scott Tilghman, B. Riley Caris - Analyst [61] +-------------------------------------------------------------------------------- + + Fair enough. And on domestic fulfillment? + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com Inc - CFO [62] +-------------------------------------------------------------------------------- + + Domestic fulfillment, as we have in past years, we'll continue to update you as we go throughout the year. I don't have any comments today given that we're just coming out of Q1, but we will be adding fulfillment capacity given the growth rates we're experiencing, and we'll update you as we go. + +-------------------------------------------------------------------------------- +Scott Tilghman, B. Riley Caris - Analyst [63] +-------------------------------------------------------------------------------- + + Okay. Thank you. + +-------------------------------------------------------------------------------- +Operator [64] +-------------------------------------------------------------------------------- + + Eric Sheridan, UBS. + +-------------------------------------------------------------------------------- +Eric Sheridan, UBS - Analyst [65] +-------------------------------------------------------------------------------- + + Thanks for taking the question. A question about your advertising business. There's been a lot of movement by Google to push PLAs as a product to sellers. I want to know longer term as you guys think about on both advertising on Amazon, and also to give out advertising in a way that would allow sellers to bring traffic back to their own websites that might avail themselves of Amazon's advertising data and user data to help enable those sales. Thank you. + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com Inc - CFO [66] +-------------------------------------------------------------------------------- + + I can't comment on what we might or might not do in the future. But the team has done a nice job from an advertising perspective and you can see those prominently on our various websites. We view it as another way certainly to help be able to afford lower prices for customers, and again the team has done a very nice job of monetizing those detailed pages to allow us to be able to do that. + +-------------------------------------------------------------------------------- +Operator [67] +-------------------------------------------------------------------------------- + + Mark Mahaney, RBC Capital Markets. + +-------------------------------------------------------------------------------- +Mark Mahaney, RBC Capital Markets - Analyst [68] +-------------------------------------------------------------------------------- + + Thanks, Tom. Two questions, please. The International Media you talked about the I guess the digitization catchup or whatever of International Media. Could you break that down a little bit further? Are there certain categories, i.e., books versus videos, versus music, that one of those is dragging internationally. +What is it that needs to happen for that digital shift to occur? Do you need more rights, do you just need more devices in the market? What is the drag there? +And then in terms of the operating income guidance you're very consistent how you guided the last couple of years; it seems like you're guiding for more of a sequential decline in operating income in June quarter than you have the last two years. Is that just a different type of seasonality to the business, or are there new near-term investments that you're making in the June quarter? Thank you. + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com Inc - CFO [69] +-------------------------------------------------------------------------------- + + In terms of the second part of the question related to the guidance, what's reflected in the Q2 guidance has many different factors but we are investing. I mentioned a number of different investments that we're making in International, which related to Q1, also related to Q2. We're investing in content. We're investing in our Web Services business, both from a new services as well as pricing. +So again, we're investing in a lot of different areas across the company. I'm sure there's a number that I'm not mentioning, so again we're investing. So that's really what you're seeing in the range of guidance that we see in Q2. +In terms of International Media, we continue to make progress there on our conversion from physical to digital. But we're just not where we are in North America. And it's in many different categories and we'll continue to work on that. And certainly some of the things that you see related to video in Europe, certainly trying to address that part of that. So again we'll continue to work on the various pieces of that for our International business and look forward to doing that. + +-------------------------------------------------------------------------------- +Mark Mahaney, RBC Capital Markets - Analyst [70] +-------------------------------------------------------------------------------- + + Thanks, Tom. + +-------------------------------------------------------------------------------- +Operator [71] +-------------------------------------------------------------------------------- + + Ross Sandler, Deutsche Bank. + +-------------------------------------------------------------------------------- +Ross Sandler, Deutsche Bank - Analyst [72] +-------------------------------------------------------------------------------- + + Hey, guys. If you don't mind I'll beat the dead horse on the international question. But specifically around China, can you just give us an update on the overall strategy for China? Are the levels of investments going into the country accelerating or are they just stable? And then what kinds of milestones in terms of market share or customer adoption do you guys track to identify success or return on that investment? Thanks. + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com Inc - CFO [73] +-------------------------------------------------------------------------------- + + In China, we're investing a lot and trying to grow the business there. We're certainly investing in our fulfillment -- we have been investing in our fulfillment network to get even closer to customers. We're doing a lot on the retail basics as we've done in other geographies, making sure that we have great in-stock availability. We've making sure that we have had a unique selection. +So those are -- a lot of the things that we've done, making sure that we have the right pricing in place on behalf of customers. Making sure that our service levels are where we need them to be. +So those are the things we continue to work on in China. It's a very large opportunity. And we continue to work hard. Is it a large investment? Yes, it is. And that investment has certainly increased over the past several years. + +-------------------------------------------------------------------------------- +Operator [74] +-------------------------------------------------------------------------------- + + Colin Sebastian, Robert Baird and Company. + +-------------------------------------------------------------------------------- +Colin Sebastian, Robert W. Baird & Company, Inc. - Analyst [75] +-------------------------------------------------------------------------------- + + First just one clarification on the AWS question. Given the comments that customers would see hundreds of millions of dollars of savings in Q2 from the price cuts, I just want to understand or clarify if we should be expecting moderating growth rate in the other segments, at least temporarily? +And then lastly just Amazon's position on the ability of ISPs to add a toll for fastlane network access. Is this a scenario a situation that would change the company's approach or strategy with regards to video or is this more of a non-factor for you guys? Thanks. + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com Inc - CFO [76] +-------------------------------------------------------------------------------- + + In terms of the just clarification in Jeff's quote, he mentions that customers will be saving hundreds of millions of dollars over the next several months alone. He didn't say specifically to second quarter. So certainly that's impacting second quarter, and it's reflected in the guidance that you're seeing there. But again, we're very happy to do that on behalf of our AWS customers. +We've done many different price decreases over time and we think that's great on behalf of customers, and we think our team's and we're positioned very well in that business, and we'll continue to invest in that given the large opportunity that we have there. In terms of your other question, there's not really a lot I can comment there. + +-------------------------------------------------------------------------------- +Operator [77] +-------------------------------------------------------------------------------- + + And ladies and gentlemen, unfortunately we only have time for one more question which will come from Kerry Rice with Needham and Company. + +-------------------------------------------------------------------------------- +Kerry Rice, Needham & Company - Analyst [78] +-------------------------------------------------------------------------------- + + Just a couple questions. One on customer adds, you didn't add as many new customer accounts as you did in Q1 2013. And so I assume based on your comments that wasn't related to the price increase around Prime, and so I don't know if you can add any context there. +And then the second question is just around Mobile. Obviously, the mobilization throughout the world is an important trend and you guys haven't talked a lot about it. Wonder if you can give us any context around your strategy there or any metrics. + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com Inc - CFO [79] +-------------------------------------------------------------------------------- + + In terms of Prime, Prime again, over the year-over-year is growing very rapidly. And then also week over week as we look at the metrics over the last several weeks, continues to grow week-over-week. So we're very encouraged by what we're seeing there. +In terms of Mobile, it's certainly a tailwind for our business. We have a number of different things that we're working on for mobile. And we continue to make it easier and easier for customers to shop from a mobile perspective. Our traffic continues to increase from a mobile perspective, and we're excited about what we see there. And we continue trying to find ways to make that even better from an experience standpoint for our customers. + +-------------------------------------------------------------------------------- +Dave Fildes, Amazon.com Inc - Senior Manager of IR [80] +-------------------------------------------------------------------------------- + + Thank you for joining us on the call today and for your questions. A replay will be available on our Investor Relations website at least through the end of the quarter. We appreciate your interest in Amazon.com, and look forward to talking with you again next quarter. + +-------------------------------------------------------------------------------- +Operator [81] +-------------------------------------------------------------------------------- + + And again, ladies and gentlemen that does conclude our conference for today. Once again, we do thank you all for your participation. + + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/exam/original-files/Problem_1_Sample/2014-Jan-15-BAC.N-138523498996-Transcript.txt b/exam/original-files/Problem_1_Sample/2014-Jan-15-BAC.N-138523498996-Transcript.txt new file mode 100644 index 0000000..2c61b5a --- /dev/null +++ b/exam/original-files/Problem_1_Sample/2014-Jan-15-BAC.N-138523498996-Transcript.txt @@ -0,0 +1,1388 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q4 2013 Bank of America Corporation Earnings Conference Call +01/15/2014 08:30 AM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Brian Moynihan + Bank of America Corporation - CEO + * Bruce Thompson + Bank of America Corporation - CFO + * Lee McEntire + Bank of America Corporation - SVP, IR + +================================================================================ +Conference Call Participiants +================================================================================ + + * Andrew Marquardt + Evercore Partners - Analyst + * John McDonald + Sanford Bernstein - Analyst + * Paul Miller + FBR & Co. - Analyst + * Eric Wasserstrom + SunTrust Robinson Humphrey - Analyst + * Mike Mayo + CLSA - Analyst + * Matthew O'Connor + Deutsche Bank - Analyst + * Guy Moszkowski + Autonomous Research - Analyst + * Steven Chubak + Nomura Securities - Analyst + * Jim Mitchell + Buckingham Research - Analyst + * Matthew Burnell + Wells Fargo Securities - Analyst + * Derek De Vries + UBS - Analyst + * Chris Kotowski + Oppenheimer & Co. - Analyst + * Moshe Orenbuch + Credit Suisse - Analyst + * Nancy Bush + NAB Research - Analyst + * Glenn Schorr + ISI Group - Analyst + * Betsy Graseck + Morgan Stanley - Analyst + +================================================================================ +Presentation +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Good day, everyone, and welcome to today's program. (Operator Instructions) It is now my pleasure to turn the conference over to Lee McEntire. + +-------------------------------------------------------------------------------- +Lee McEntire, Bank of America Corporation - SVP, IR [2] +-------------------------------------------------------------------------------- + + Good morning everybody on the phone as well as the webcast. Thanks for joining us this morning. +Before I turn the call over to Brian and Bruce, let me just remind you we may make forward-looking statements today. For further information on those, please refer to the website and our SEC filings about our forward-looking statement information. +So without further ado let me turn it over to Brian, our CEO. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - CEO [3] +-------------------------------------------------------------------------------- + + Thanks, Lee, and good morning to all of you and thank you for joining us to review our fourth-quarter results. +As we talked over the last several quarters, we have been on a journey of simplifying our company and we talked to you about some consistent areas of focus: capital generation, reducing our cost, managing the risk down, addressing the legacy issues and driving business growth overall. Each quarter you have seen the progress our teammates have made and the momentum is becoming more evident. +On the first page, slide two, of the deck you can see the annual comparisons that will show you the progress over the last couple years. First, we have improved the balance sheet. Our Tier 1 common capital has grown 16% this year. +Liquidity and time to required funding have further strengthened. This strength in capital and liquidity allowed us to begin returning capital through share buybacks to shareholders in 2013. +Another area of our early focus has been rightsizing our expense base. We have been meeting the goals of our cost programs each year. While we make progress on this each quarter, there is still significant progress when you look across the last couple years. +After reporting expenses, excluding goodwill and impairment of $77 billion in 2011, we have worked that number down to $69 billion in 2013. As we have been clear with you, we expect additional cost savings in 2014 as we continue to execute on both our new BAC and our legacy assets and servicing initiatives. +We have also focused on addressing our legacy mortgage issues, and although we still have work to do, we have made progress. On our credit costs and our provision costs we see tremendous results as net loss rates in our portfolios are levels not seen in nearly a decade. As a result of all this work earnings have improved significantly, but we still have not approached the true earnings potential of Bank of America. +So as we move to slide two let's talk about recent results in the business on a business-by-business basis. We have been delivering solid growth and activity in relationships across all the groups of our customers and clients we serve. Let me highlight a few of those for you. +Deposit levels continue to reach records each quarter. While this growth has been occurring in balances, the rate paid has been declining to what we believe is low against our peers, that 8 basis points in our consumer business. Our operating costs, which we focus on heavily, of our deposit business has declined to just 200 basis points now. +Driving this improvement is the work we have done to optimize our delivery network, our stores, in response to customer behavior changes across time. Banking centers over-the-counter transactions continue to go down, but ATM, online, and mobile transactions continue to grow. We understand this and we observed this in our customers and we are working with them to capitalize on arguably the largest and best positioned branch network in banking. +However, branches do remain a critical component of everything we do. We have about 8 million customer visits a week, the kind of traffic that we really appreciate and most retailers would give their right arm for. Meanwhile, as that traffic comes in, the customer behavior continues to shift to ATMs, online, and mobile, and that is giving us the opportunity to be more efficient at the same time continuing to deliver innovative products to our customers. +When you move to our mass affluent customer base we have seen deepening across the customer relationships. Merrill Lynch brokerage assets continue their strong growth. We have invested heavily in the salesforce for what we call our specialist salesforce and that has grown to 6,700 people in 2013. Looking at what that salesforce has been able to do, this year we opened 350,000 new Merrill Edge accounts; 125,000 new small business deposit and card accounts as well during 2013. +As we move to our industry-leading global wealth investment management business, we continue to break records on top line and profitability. We just recorded the best year in the Company's history for wealth management results. We have more customers and clients doing more business with us and now we manage client assets of over $2.4 trillion. +In our global banking business loan flows have been very strong, now growing for six consecutive quarters. Investment banking is coming off a very strong year and a very strong fourth quarter where we have once again maintained our number two position overall, improved in fees overall, and grew market share year over year. +As we look at our trading business, or our global markets business, we have been really pleased with the success we have had in equities over the past year and that has helped offset some of the industry challenges facing the larger FIC business that we had. Now both remain very important customer-facing businesses for us. They face some tough regulatory changes as the rules have changed about what the scope of activities is over the past couple of years, but the team under Tom Montag has been managing those changes well. +Importantly, we rank for the third year as a top global research firm. All-in-all we believe, if you think back, 2013 was a significant year for the progress this company has made against all the focus areas I mentioned earlier. As we look to 2014, we are well positioned as a company to meet our customers' needs by delivering the whole company to every client and every customer and winning in the marketplace. +With that brief introduction I would like to turn it over to Bruce to cover the numbers for the quarter. Bruce? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [4] +-------------------------------------------------------------------------------- + + Great. Thanks, Brian, and good morning, everyone. I am going to start and go through the fourth-quarter results starting on slide number four. +We earned $3.4 billion, or $0.29 per diluted share, this quarter. Total revenues in the quarter on an FTE basis were in line with the third quarter of 2013 at $21.7 billion and were $22.3 billion if we exclude the negative impact of FVO and DVA as a result of the significant credit spread tightening we saw in our credit spreads during the quarter. +Our revenues benefited from increased net interest income, strong investment banking and wealth management fees during the quarter, and were partially offset by lower equity investment gains. Total noninterest expense of $17.3 billion increased from the third quarter of 2013 as a result of increased litigation costs, which were $2.3 billion during the quarter. +If we back those litigation costs out and back out $1.4 billion of the foreclosure look back expense that we saw in the fourth quarter of 2012, our expenses during the quarter declined $300 million from the third quarter of 2013 and $1.4 billion from the fourth quarter of 2012. Asset quality continued its improvement and resulted in provision expense of only $336 million. +I would also mentioned two additional items that impacted results during the quarter. As I mentioned, FVO and DVA $618 million and we also recorded discrete tax benefits of approximately $500 million during the quarter that were driven by tax items that were related to non-US operations as well as the resolution of certain global tax matters. +On slide five you can see that our period end balance sheet came in at $2.1 trillion, below the prior quarter on lower trading assets versus that third quarter of 2013. Ending loans declined $6 billion due to the decline in residential loans in our discretionary portfolio. Outside of residential mortgages, client and customer lending reflected good commercial and seasonal credit card growth that was offset by expected declines that we have within our runoff portfolios. +Period-end deposits grew $9 billion from the record levels that we saw during the third quarter of 2013. +Moving down the page tangible book value improved to $13.79 as the full benefit of earnings was partially offset by a negative move in AOCI as a result of higher rates. Tangible common equity increased to 7.2% during the quarter and during the quarter we repurchased 92 million common shares for roughly $1.4 billion. +The last thing that I would mention on this slide is, despite the earnings of $3.4 billion, our return on tangible common equity at 8.6% remains lower than we would like it to be, but we continue to make very good progress on this front. +On slide six, you can see our Basel I Tier 1 common ratio of 11.19% increased from the third quarter of 2013. If we look at Basel III on a fully phased-in basis, we remain above our 8.5% 2019 minimum requirement under both the standardized as well as the advanced approaches. +Let's first look at the advanced approach. Under that approach Tier 1 common capital increased from the third quarter of 2013 to more than $132 billion. Our Basel III risk-weighted assets remain steady at $1.3 trillion and our common ratio improved slightly from the third quarter of 2013 to 9.96%. +Under the standardized approach, our estimate of Basel III Tier 1 common ratio improved a touch from the third quarter of 2013 and remained slightly above 9%. If we turn to the supplementary leverage ratios, based on the proposed US requirements that are expected to take effect in 2018, as of the end of 2013 our bank holding company leverage ratio improved from the third quarter of 2013 and continues to exceed the proposed minimum of 5%. +Looking at our primary bank subsidiaries, BANA and FIA, they also continue to both be in excess of the 6% proposed minimums. The last point I would make on this topic the BCBS published final supplementary leverage rules over the weekend, and while we do note some improvements from the original proposal, we are still evaluating the exact impact to us. +If we turn to slide seven, funding and liquidity, our long-term debt ended the quarter $6 billion lower which further improved our funding cost. Global excess liquidity sources during the quarter increased $17 billion to $376 billion and was driven by our strong deposit flows. The time to required funding at the parent company increased to 38 months. As we look at 2014 we have $31 billion of parent company maturities during the year and once again we would expect the issuances to be below that number as we both reduce as well as smooth the maturity profile of that debt footprint. +The other thing I would mention is that we do expect to see some additional issuance within our banks this year, given the applicability of the new liquidity rules and how they apply to the bank subsidiaries. +If we turn to slide eight, net interest income, our net interest income on an FTE basis was $11 billion, which was $520 million over the third quarter of 2013. The fourth quarter of 2013 did include $210 million of positive benefits in market-related adjustments driven by lower premium amortization from slower prepay assumptions on mortgage-backed securities as long-term rates rose 30 basis points from the end of 2013 to the end of 2014. +Our net interest income excluding those adjustments was $10.8 billion, representing a $241 million increase from the third quarter of 2013. Roughly two-thirds of that improvement was driven by traded-related net income and the balance, once again excluding market-related adjustments, was driven by lower long-term debt levels and, to a lesser degree, higher deposit levels and lower rates paid. Net interest income in those benefits was partially offset by lower consumer loan balances and lower yields. +As a result of these different factors, our net interest yield, excluding market-related adjustments, improved from 2.44% in the third quarter of 2013 to 2.51% in the fourth quarter of 2013. +As we move into 2014, I do want to remind you that the first quarter includes two less interest accrual days so the Q4 2013 base of just below $10.8 billion, excluding the market-related adjustments, all else being equal would start at roughly $10.6 billion for the first quarter of 2014. Our asset sensitivity position remains positioned to benefit from higher rates, particularly from the short end of the curve. +If we move to expenses, as I mentioned earlier noninterest expense was $17.3 billion in the fourth quarter of 2013 and included a $2.3 billion charge for litigation expense. Litigation expenses increased $1.2 billion from the third quarter of 2013 as we continued to evaluate our legacy exposures, largely our MBS litigation, which led to additional reserves. Excluding litigation, total expenses were $15 billion during the quarter which compares favorably to the $15.3 billion in the prior quarter and $16.4 billion in the fourth quarter of 2012. +Our legacy assets and servicing costs, once again excluding litigation, declined nearly $400 million from the third quarter of 2013 and were below $2 billion this quarter as we previously guided. This drove the $300 million improvement in expenses adjusted for litigation in the quarter. As we continue to reduce the delinquent loans serviced over the course of 2014 and reduce operating costs, we expect the fourth quarter of 2014 LAS cost, excluding litigation, to be roughly $1.1 billion. +Move for a moment to new BAC, the benefits from new BAC in the most recent quarter were offset by a small seasonal uptick in costs when comparing to the third quarter of 2013. And when comparing to the fourth quarter of 2012 our new BAC savings are partially offset by roughly $300 million of increases from revenue-related costs on higher global banking in markets and GWIM revenues. We remain on track to achieve the expected $2 billion of new BAC cost savings in mid 2015 as these initiatives wind down near the end of 2014. +If we move to the number of full-time equivalent employees, we ended the quarter at 242,000 employees, a decline of more than 5,000, or 2.3%, from the third quarter of 2013. And that was split pretty evenly between staff reductions in LAS and the production side of the mortgage business as volumes declined and, to a lesser extent, we reduced staff associated with our branch optimization. +Before I leave expenses, I do want to remind you all that the first quarter typically includes the annual cost of incentives for retirement eligible associates. And once again we expect in the first quarter of 2014 that number to be approximately $900 million, which is consistent with what we saw in each of the first quarters of 2012 and 2013. +If we move to slide 10 on asset quality, you can see that credit quality once again improved nicely. Net charge-offs declined to a reported $1.6 billion or a net loss ratio of 68 basis points. The quarter did include $144 million of charge-offs related to clarification of regulatory guidance on accounting for TDRs in the home loans portfolios. If we exclude that change, net charge-offs were approximately $1.4 billion, or 62 basis point net loss ratio, and improved $250 million, or 15%, from the third quarter of 2013. +Delinquencies, which are obviously a leading indicator of net charge-offs, declined again as well. Our fourth quarter provision expense was $336 million on the back of this steadily improving consumer data, resulting in a reserve release of $1.1 billion excluding the regulatory guidance change. As we move into 2014 we continue to see credit quality improve. +Let's now move into a discussion of the businesses and I am going to start on slide 11 with consumer and business banking. Within this segment we delivered improved earnings from both the previous quarter as well as the prior year's quarter. Net income of nearly $2 billion in the fourth quarter of 2013 is up 11% from the prior quarter [and] 36% from the fourth quarter of 2012. +Stability in revenues, lower credit costs, as well as expense reductions driven by network optimization drove the improvement in both periods. If we take a step back and review customer activity during the quarter, we saw our average deposits grow steadily in rates paid down to 8 basis points. Our brokerage assets increased 7% from the third quarter of 2013 and are up 26% year over year on both improved market valuation as well as account flows. +Our consumer card loans show seasonal growth this quarter as well as continued strong issuance with 1 million cards issued during the quarter. +I would note that our fourth quarter of 2013 balances reflect the reclassification of roughly $1 billion of an affinity portfolio that was moved to loans held for sale and we would expect seasonality to move these balances lower in the first quarter of 2014. Our risk-adjusted margin on credit cards is now back above 9%, driven by seasonal spending and improved credit quality as net charge-offs and delinquencies continued to improve. +Our expense levels during the quarter do include approximately $112 million of litigation costs and that masked the benefit of our delivery network optimization as mobile banking usage continues to increase and we continue to consolidate banking centers. +Let's move to slide 12, consumer real estate services, which as you all know represents only 8% of the Company's revenues. In our supplemental information we report two separate components of this segment, one focused on loan origination and the other focused on servicing and legacy issues. +As we signaled last quarter, our first mortgage retail originations of $11.6 billion were down 49% from the third quarter as the amount and level of refinancing opportunities slowed given the rising rate environment. Locked volumes declined 37%, leading to lower core production revenue. We continue to reduce our production staffing levels to be consistent with these lower volumes that we are experiencing. +Our rep and warrant expense was $70 million during the quarter and declined by roughly $250 million from the third quarter of 2013, which benefited Mortgage Banking income. +One item I do want to mention from the appendix of our slide deck is on page 20 regarding rep and warrant exposure. We did receive increased levels of private-label claims, but it is important to note that the vast majority showed no evidence that the claimant reviewed the individual loan file ahead of the submission. That obviously impacts the overall claim quality and, therefore, the process for claims resolution. +The other primary revenue component in this segment, servicing revenue, declined $54 million from the third quarter of 2013 as a result of our smaller servicing portfolio. +From a cost of servicing perspective our number of 60-plus day delinquent loans dropped 73,000 to 325,000 units at the end of 2013. As a result of this once again, our LAS expense, ex litigation, declined nearly $400 million during the quarter to $1.8 billion. +Global wealth and investment management on slide 13, this represents 21% of our company's revenue and our wealth management business achieved records for net income in both the quarter as well as for the full year of 2013. Within this segment both Merrill Lynch as well as U.S. Trust maintain their strong leadership positions managing a total of $2.4 trillion in client balances. +Revenue approached $4.5 billion in the quarter, increasing 7% year over year and 2% on a linked-quarter basis. I would also note it is the fourth consecutive quarter in which the pretax margin was above 25%. +Our asset management fees once again achieved a new record during the quarter, driving the revenue improvement from the third quarter of 2013. Our client engagement remains strong and market levels are providing an additional tailwind. +Our long-term AUM flows for the quarter were $9.4 billion and $48 billion for the year, nearly doubling the 2012 production level. Ending deposits also grew nicely again and our ending client loan balances of almost $119 billion reached record levels as we continue to see very good activity in both consumer real estate as well as our security space lending. +Turning to slide 14, global banking, our fourth-quarter earnings of $1.3 billion show good growth over the third quarter of 2013 with strong investment banking results, but are down from the fourth quarter of 2012 due to higher provision expense. Provision in the year-ago quarter included reserve releases while we built reserves in the fourth quarter of 2013 associated with the commercial loan growth that we have seen. +While we are on credit quality, I would note that our net charge-offs within the banking segment for the quarter were only $7 million versus $132 million in the fourth quarter of 2012 and $35 million in the third quarter of 2013. +Our expenses reflect effective cost control, but also reflect increases related to revenue-related compensation for investment banking. Our investment banking fees this quarter across the Company were a record $1.74 billion, up 9% from the fourth quarter of 2012 and 34% from the third quarter of 2013. Based on deal logic we did maintain our number two position in fees with an 8% market share. In addition, during the quarter we ranked number one in America's investment banking fees with a 10.7% market share. +During 2013 we advised on 10 of the top 20 announced M&A deals. And as we move into 2014 the pipeline remains strong. +If we move to the balance sheet, average loans increased $8.8 billion from the third quarter with solid C&I growth, particularly in large corporate and healthcare, along with growth in commercial real estate. Our average growth did outstrip our $2.3 billion end-of-period growth as we funded several deals near the end of the third quarter of 2013 which benefited the overall average balances. We see solid customer demand for loans as we head into 2014, but would note that competition is particularly aggressive for middle market loans. +Lastly on banking, our average deposits increased almost $20 billion from the third quarter of 2013 as our customers continue to show strong liquidity. +We switched to global markets on slide 15. Ex-DVA we earned $341 million in the fourth quarter of 2013, consistent with the fourth quarter of 2012 but down $190 million compared to the third quarter of 2013 after we exclude the UK tax charge. Higher revenue in both comparisons was offset by litigation costs, mostly associated with RMBS securities litigation. +Our sales and trading revenue, once again ex-DVA was $3 billion, 19% above the fourth quarter of 2012 and in line with what we saw in the third quarter of 2013. Our fixed sales and trading revenue were up roughly $300 million, or 16%, compared to the fourth quarters of 2012 as the strength we saw in our credit and mortgage businesses more than offset slowness in both rates and commodities. Our fourth quarter of 2013 did include roughly a $200 million benefit from recoveries on certain legacy positions within the FIC business. +Our equity sales and trading area finished a very strong year. Revenues, although down 7% from the third quarter of 2013, were up 27% over the fourth quarter of 2012 as we continue to benefit from the repositioning of this business over the past 18 months. We gained market share and improved our performance in each of the different product lines. +Expenses excluding litigation showed very good cost controls and small increases in line with revenue improvement. Our average trading-related assets are down $54.3 billion, or 11%, from the year-ago period and are generally flat with the third quarter of 2013. +On slide 16 we show you the results of all other. Profitability this quarter compared to the third quarter of 2013 declined as the tax benefits this quarter that I described earlier were more than offset by lower revenue and less reserve release. +The revenue decline from the third quarter of 2013 was driven by lower equity investment gains -- if you recall we sold CCB shares during the third quarter of 2013 -- as well as more negative FVO valuations. The expense within all other includes $250 million of litigation in the fourth quarter of 2013. Lastly, I would note we expect an effective tax rate of approximately 30% in 2014 absent any unusual items. +Before we open it up for questions, let me make a few comments on the quarter. Capital and liquidity have never been stronger. On the revenue side customer activity drove stronger core business results. Our consumer banking saw a modest improvement on card income and service charges after troughing in early 2013. +Our global wealth and investment management business had a record year. Our global banking had a record year as well with higher investment banking fees and stronger lending activity. And our global markets business is performing well against the market opportunities that they are seeing. We kept our cost initiative work on track and credit improvement continues its track towards historic lows. +We also made significant progress in 2013 in continuing to resolve legacy mortgage matters with the more significant ones being settlements with Fannie Mae and Freddie Mac, on GSE rep and warranty issues, MBIA in the monoline space, and the Luther Maine State class-action suit in the private label area of RMBS litigation. With that let's go ahead and open it up for Q&A. + + +================================================================================ +Questions and Answers +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + John McDonald, Sanford Bernstein. + +-------------------------------------------------------------------------------- +John McDonald, Sanford Bernstein - Analyst [2] +-------------------------------------------------------------------------------- + + Good morning, Bruce. I was wondering in terms of the core net interest income you mentioned that the seasonally adjusted starting point for the first quarter would be 10.6, but it sounds like you expect that to keep grinding higher with the debt paydowns and rates being a little bit higher on the long end. Is $300 million that we saw this quarter, is that a good representation of the pace that core NII could grow at? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [3] +-------------------------------------------------------------------------------- + + I think, John, if you look at what we saw during the quarter, we had a series of benefits for the quarter. You can see that the -- if you look back at our tables, the margin that we saw within some of the repo and other global markets lending activity was up nicely. As you mentioned, we benefited from the continued reduction in the long-term debt footprint, which was clearly a positive. And we had a little bit of benefit, even if you back out FAS 91, on the debt securities line. +So I think that those three things were clearly favorable. We will have to see with respect to the markets margins, as well as just overall rates, where we go in the first quarter of 2014 relative to 2013. +I would be careful to assume that you are going to see $300 million type improvements in the NII as we go forward on a quarter-to-quarter basis. But over time, with the work that we are doing, we would expect that number to continue to grind upwards all other things being equal. + +-------------------------------------------------------------------------------- +John McDonald, Sanford Bernstein - Analyst [4] +-------------------------------------------------------------------------------- + + Okay. Any change, material change in your interest-rate sensitivity overall, Bruce, to long rates and/or short rates? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [5] +-------------------------------------------------------------------------------- + + I would say that whenever rates move up you tend to widen out a little bit as maturities extend in the mortgage space as rates move up. So you always have a little bit of that in a rising rate environment, although given where rates are, we think we are largely through that. +The only other thing from an asset liability management perspective I would note is that, as it relates to both managing OCI risk as well as managing to LCR, you saw it a little bit in the fourth quarter and you will see it a little bit more going forward, that we are purchasing on the margin some additional treasuries given the treatment that they have under LCR. + +-------------------------------------------------------------------------------- +John McDonald, Sanford Bernstein - Analyst [6] +-------------------------------------------------------------------------------- + + Okay. Then I was wondering if you or Brian could speak at a high level about how you approach this year's CCAR. Are you looking to grow your buybacks off of the $5 billion common request from last year? And do you feel that you have improved the earnings enough and consistency here to start moving the dividend up yet? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - CEO [7] +-------------------------------------------------------------------------------- + + We are not going to comment, John, on specific items with respect to the CCAR request. We have been pretty consistent as we came into 2013 that we would focus on increasing the core profitability of the Company. And as you look at the last couple of quarters from an EPS perspective, we think we have done a good job of that. +You can see the capital build that we have had and you can see the reduction in the legacy exposures that we have made. So we feel like we did a good job of preparing ourselves for CCAR this year and we are obviously working hard as we go through the rest of the process between now and mid-March. + +-------------------------------------------------------------------------------- +John McDonald, Sanford Bernstein - Analyst [8] +-------------------------------------------------------------------------------- + + Okay. Then last thing is you mentioned, Bruce, the 8.5% return on tangible and hope that that goes higher over time. Your ROA was 64 basis points. I guess what kind of goals do you have for ROA and ROE over the next few years, and any thoughts on timelines that you will hope to get there on? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - CEO [9] +-------------------------------------------------------------------------------- + + I think as we look out at, as we look out over the three years I would say it is more of the same for us that you can see a tangible common equity ratio that is just over 7%. The three metrics that we assume we stay at around that 7% level. We were about it in the fourth quarter, but if we stay at that level we are looking to get to the point where we are returning 1% on assets, which translates into a 14% return on tangible common equity. Those are the types of levels that we see ourselves looking to achieve over the course of the next three years. + +-------------------------------------------------------------------------------- +John McDonald, Sanford Bernstein - Analyst [10] +-------------------------------------------------------------------------------- + + Okay, thanks. + +-------------------------------------------------------------------------------- +Operator [11] +-------------------------------------------------------------------------------- + + Betsy Graseck, Morgan Stanley. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [12] +-------------------------------------------------------------------------------- + + Thanks, good morning. Couple of questions, one on the NIM discussion that we just were having. +When you look at what happened with the yield and the cost of funds it looks like you are getting a little bit more competitive on non-resi consumer. Just wondering how to think about how you are looking to shift either the loan growth going forward and how you are thinking about that loan yield relative to your cost of funds in an environment where NIB probably doesn't grow as much as it had been in the past, maybe your cost of funds is flattening out or potentially increasing a little bit. + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [13] +-------------------------------------------------------------------------------- + + I'm not sure exactly which piece you are looking at, Betsy, but if you go back to our earnings supplement, which is back on page 10, I think it is interesting that you can see from the third quarter of 2013 to the fourth quarter of 2013 that our yields on residential mortgages did increase about 6 basis points to 3.74%. The other interesting thing is that we have started to see and be able to do more home-equity type business with our core customers. +I think it is interesting; if you look at the yields on that portfolio, they were up 20 basis points to just under 4% for the quarter. So as we look at the yields and the rates that we are able to get, I think we are competitive in the market and we have been able to see some slight increases within the rates that we are able to earn. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [14] +-------------------------------------------------------------------------------- + + Sure. It is an interesting mix shift because you have got a little bit of shrinking going on obviously with the legacy resi still coming off, yet the yields there are increasing. And on the non-resi consumer you have got some yield compression happening, but your loan growth is at margin inflecting more positively. +At the same time, cost of funds looks like it is probably settling out here and potentially even going up a little bit. I mean NIB average balances were still up Q on Q, but end of period was down, so that is kind of the fuller context of the question. + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [15] +-------------------------------------------------------------------------------- + + The things is you have got the volume going through and then either the [receive] or the pay is on both sides of the rate question. And we continue to see deposit pricing. Liability pricing came down. The contribution from non-interest-bearing size in the balance sheet continues to go up. +But just focusing on the production, what has really been happening across the last several quarters that we are seeing stabilization in some of the balances and the runoff portfolio impact gets smaller and smaller from some of the non-core portfolios that we are getting rid of. But in the fourth quarter, for example, our direct auto, which is -- in 2013 our direct auto business, not our indirect but our direct-to-consumer auto, was up 55%. The home equities in the fourth quarter were up almost 100% over the prior year's fourth quarter. Year over year they are up 60%. +The card we had about 19% more production in the fourth quarter of 2013 versus 2012. So we are building -- in the business banking, small business area we are seeing production up, so we are building the basics that are producing the balanced growth. +The pricing spreads are holding. It's competitive as heck in the middle market and things like that. So I think it all serves us well largely having runoff stuff that may have yielded high but had a high credit cost content you got to remember. And we are replacing with stuff that is good and core and great credit quality and so we are seeing a shift a little bit from the commercial loan growth which was really more positive to where the consumer loan growth is starting to stabilize and come along. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [16] +-------------------------------------------------------------------------------- + + When do you think you get that inflection point in loan growth? Clearly, it is a function of legacy basically not weighing on the loan growth overall. When does that inflection point happen? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - CEO [17] +-------------------------------------------------------------------------------- + + If you look at the various portfolios, I think in card we have kind of seen it. As Bruce talked about, we have got a sale. I think it's home equity you still got a ways to go, Betsy, because remember we have got about 40% or so of our home equity is still in the non-core portfolio. And then I think in the commercial side you have seen the straight growth, whether it is large corporate or commercial middle market. +I think that would be the overall summary. So I think that sort of came through from the corporate activity. It moved faster to the smaller business activity and then consumer activity, but we are stabilizing both portfolios and growing. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [18] +-------------------------------------------------------------------------------- + + Okay. Then just turning to the mortgage for a moment. On LAS expenses, did I hear you right that you are looking for LAS expenses to be at about $1 billion at year-end? Is that correct on a quarterly basis for 2014? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [19] +-------------------------------------------------------------------------------- + + Yes, we quoted roughly $1.1 billion, Betsy. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [20] +-------------------------------------------------------------------------------- + + Okay, so that is an uptick, right, from what you had been saying before, sub $1 billion by year-end? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [21] +-------------------------------------------------------------------------------- + + Yes, that is correct. It is about $100 million higher than what we had said before. And I think the work that we are starting is -- take a step back that we got through roughly $400 million during this quarter, which was a little bit better than we would have expected to do, so we felt very good about that. +And if you look at the number of 60-plus day delinquent loans, it came all the way down to 325,000 loans. So what we are going to be working on over the course of the next 90 days is a little bit of a reset of that expense base so that we can continue to drive that number down. That $1.1 billion doesn't reflect that, but given the work and the activity levels we need to go back and do some more work on that. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [22] +-------------------------------------------------------------------------------- + + Okay. Then so $1.1 billion by year-end 2014; is there still runway in 2015 to bring that down further? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - CEO [23] +-------------------------------------------------------------------------------- + + We still think and we have been consistent that we would expect and look to end 2015 at roughly $500 million a quarter. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [24] +-------------------------------------------------------------------------------- + + Then just lastly on the litigation reserving, you called out the $2 billion litigation reserve for the mortgage business, highlighted that that reflects a lot of the litigation risk you think you have. The question we get from people is how many more quarters of this should we build in going forward, because you do still have some lumpiness in the lawsuits that you face. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - CEO [25] +-------------------------------------------------------------------------------- + + That is always a tough question. I think what I would say, Betsy, is that there was obviously a lot of new learning that we saw during the fourth quarter of this year and as a result of that we adjusted the reserves for the legacy exposures to reflect that which we learned. And as we have said, it was largely with respect to RMBS litigation and beyond that it is just a number that is difficult to predict. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [26] +-------------------------------------------------------------------------------- + + All right, thanks. + +-------------------------------------------------------------------------------- +Operator [27] +-------------------------------------------------------------------------------- + + Matthew O'Connor, Deutsche Bank. + +-------------------------------------------------------------------------------- +Matthew O'Connor, Deutsche Bank - Analyst [28] +-------------------------------------------------------------------------------- + + Good morning. We are seeing some peers that came out yesterday actually increasing liquidity and long-term debt levels to meet the LCR. I think you guys were starting at a higher point maybe than they were, but just give us a sense of maybe where you are for LCR with the current proposals. +And as we think about kind of the net impact of long-term debt running off at the holding company, increasing at the bank, how does that all shake out on the net basis this year? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - CEO [29] +-------------------------------------------------------------------------------- + + I will let Bruce talk you through it, but we got to remember how we got here which is with a legacy set of companies put together. They had debt structures that were built for their company and their industry without the core funding we had, so we are coming down to a level most of our peers were below and they may be coming up a little bit. +You got have to remember that whether it was Countrywide or Merrill Lynch the funding structure was so different. We had like $400 billion of long-term debt we have been bringing down and the size of the balance sheet shrank. We started off at about $2.5 trillion and we are down to $2.1 trillion, so I would be careful about comparing where they are going versus where we are going based on this just because what we had is different than what they started. +Then Bruce can talk about what we think from where we are now going forward. + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [30] +-------------------------------------------------------------------------------- + + As we look out, Matt, I think at the parent company as we look at and with our understanding of the LCR ratio we are in the 100% area as it relates to LCR. So at the parent you can look at us being where we need to be based on 2017 levels. +The one area that we will look to do more in and I highlighted is to further build and take out more term financing within the bank levels to look to build that. So I think we are in great shape at the parent, we are in great shape at the banks, but you will see us doing a little bit more bank financing activity to be able to meet those requirements. If you look at where we finance it at the banks, there is no incremental cost for that that is different than what we have communicated before. +The other thing that I would just point out on the overall debt footprint and the cost of it is with the work that we have done on the balance sheet and with where our credit spreads are now in the market, we will be refinancing our debt at lower rates than the debt that is coming off of the books as it matures. + +-------------------------------------------------------------------------------- +Matthew O'Connor, Deutsche Bank - Analyst [31] +-------------------------------------------------------------------------------- + + Then at the parent, being around 100% right now, any sense of how much cushion you want? I think some banks are running maybe like a 15% cushion. Some banks are still trying to get to where you are right. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - CEO [32] +-------------------------------------------------------------------------------- + + I think to project a cushion three years out I think we clearly are going to run at a cushion. We are going to run the Company so this is not an issue. But until we get out to 2016 and 2017 and understand the exact composition, as well as to any puts and takes that we are seeing, it is probably a little bit premature to talk about a cushion. +The focus has been to get to the 100% at the parent immediately, so it is not an issue to discuss. + +-------------------------------------------------------------------------------- +Matthew O'Connor, Deutsche Bank - Analyst [33] +-------------------------------------------------------------------------------- + + Okay. Then just separately, we saw out of JPMorgan yesterday a one-time valuation adjustment on certain derivatives. Just wondering is that applicable to you or have you been absorbing it over time or still to come? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [34] +-------------------------------------------------------------------------------- + + It is obviously applicable to anyone that has an uncollateralized derivative book, so it is applicable to us. I think that clearly the industry view and how you account for FBA is still very much evolving. JPMorgan, obviously, came out today with their adoption and as a company it is something that we continue to evaluate. +I think the important thing to remember when you look at this, and I'm sure you know this, is just that this is a question of do you take a reserve for something that you earn back over the average life of your uncollateralized balances. So it is not something that changes the core economics of the activities that we are doing. + +-------------------------------------------------------------------------------- +Matthew O'Connor, Deutsche Bank - Analyst [35] +-------------------------------------------------------------------------------- + + Okay. All right, thank you very much. + +-------------------------------------------------------------------------------- +Operator [36] +-------------------------------------------------------------------------------- + + Glenn Schorr, ISI. + +-------------------------------------------------------------------------------- +Glenn Schorr, ISI Group - Analyst [37] +-------------------------------------------------------------------------------- + + Thanks very much. So just kind of [wheezing] into some of the next questions, but on the balance sheet migration over the past year cash and equivalents up 19%; repo, trading assets, and derivative assets all down, say, 10% to 14%. Is that a function of some of the sluggishness on the trading side during the year in the market and just a reaction to what is out there, or is this your obviously intent to get on size for SLR and LCR? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - CEO [38] +-------------------------------------------------------------------------------- + + I would say that as we look at and what we have said is that from an LCR and an SLR basis, given that we are at the levels at the parent and then with respect to the supplementary leverage ratio at the bank, given we are at the levels that we need to be that phase in between 2015 and 2019, there is not anything directly related to those given that we are in great shape with respect to those. +What I would say is that as we move forward and as we look at the bank level and some of the rules, you will see us, on average, carrying a little bit more cash at those levels. And you saw that as you look at the year-end numbers. +As it relates to the different repo activity and the like within the global markets business, you continue to look to manage and balance what is the size of that book, how it affects the overall size of the Company, and the yield that you are able to achieve. I think that was one of the things as some of these different regs come out that we feel good that if you look at the repo book we were up 7 basis points from an average yield perspective Q3 to Q4. Those are numbers that are going to ebb and flow, but I would say directionally we feel very good about where the balances. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - CEO [39] +-------------------------------------------------------------------------------- + + Our approach has been as these rules come out to put ourselves in compliance, or whatever the right word would be, immediately and not wait so that we didn't have hanging over us could you get to the LCR, could you get to be supplemental leverage. So we just said position our balance sheet. +But I would say as you look at the company's sort of constitution in terms of business mix and balance sheet mix at the year-end 2013. We are very comfortable with that and so there will be ebbs and flows. Loans will grow here or maybe market will use a little more balance sheet on a given quarter. +But Tom and the team have done a good job to sort of be able to face against the customers and maintain our strong market position in all our businesses -- investment banking, sales trading, fixed income and equities both -- while at the same time bringing the balance sheet in year over year down. But we are completely comfortable with it being in the size range it is now and expect it to stay roughly in there. I don't think we see massive changes in how the Company looks to comply with rules because we are already complying. + +-------------------------------------------------------------------------------- +Glenn Schorr, ISI Group - Analyst [40] +-------------------------------------------------------------------------------- + + Okay, appreciate that. In global markets the trading in absolute numbers in relative to some peers is pretty good. The question I have is if you look at the return on capital or the return on average assets it is pretty low. +I am curious A) how much litigation costs dented that, because I know it dented it; we just can't see exactly how much. And are these metrics we should be looking at on a consistent basis? They are in the supplement and I am assuming that they mean something, I just don't know if the capital allocations and the asset allocations are fair things to judge on. + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [41] +-------------------------------------------------------------------------------- + + I think as it relates to the capital allocations they clearly are. One of the things that if you look back in the footnote that we highlighted is we will refresh those allocations in 2014 and continue to have more capital pushed out within the businesses. +As you look at the returns within the markets business, I think you need to adjust for two numbers when you look at those. The litigation number within markets business was north of $600 million for the quarter, and then you had another couple hundred million dollars during the quarter for DVAs. So when you look at the returns, you need to adjust for those two numbers and realize that, in the fourth quarter, you are looking at what is seasonally the slowest quarter. + +-------------------------------------------------------------------------------- +Glenn Schorr, ISI Group - Analyst [42] +-------------------------------------------------------------------------------- + + Okay, that is totally fair. Final one is in mortgage. I think there was a bit of a hiatus as you are getting things battened down. I think you picked up about 100 basis points market share since then on the retail side. Just curious for an update on, A, how the fourth quarter looked and then, B, your thoughts on going out in terms of intentions to continue to push that share higher. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - CEO [43] +-------------------------------------------------------------------------------- + + Well, I think if you look at it, you could calculate statistics, but we were down. We had two things going on during 2013 in the second half, especially as the HARP volume started to fall off because we sized our portfolio down in terms of total servicing size. So our HARP opportunity went down and then obviously as rates went up, sort of midyear out, the volumes dropped. And so the third quarter, the pipeline pull through helped us get $20 billion odd and in fourth quarter down to $11 billion. +But if we look at it non-HARP share, we are pleased with the progress we are making and we will continue to grind that direct-to-consumer, grind that forward from where we are now at about $9 billion this past quarter. +So I think we are fine. It is going to be a business which we shape to size -- to serve the customers and the wealth management business does a couple billion a quarter. It is a good solid position. +I would say in January with the rates moving down a little bit and stuff, you saw another kick up of about 20%, 25% in application volume in our book already. Now I don't know if that holds and how much seasonality because the way Christmas and New Year's fell this year and things like that as we move through the month, but it immediately kicked up over the last several days as rates moved a little bit in our favor. And the purchase volume has also moved up in January. +So we are looking for this business to start to grow again, but it obviously suffered a couple of different -- both the rate effect and also the HARP effect in the fourth quarter. + +-------------------------------------------------------------------------------- +Glenn Schorr, ISI Group - Analyst [44] +-------------------------------------------------------------------------------- + + Okay. Thanks both very much. + +-------------------------------------------------------------------------------- +Operator [45] +-------------------------------------------------------------------------------- + + Chris Kotowski, Oppenheimer & Co. + +-------------------------------------------------------------------------------- +Chris Kotowski, Oppenheimer & Co. - Analyst [46] +-------------------------------------------------------------------------------- + + Yes, I wanted to come back to the debt footprint discussion and just looking on page 11, you can see total average long-term debt down $27 billion year-over-year and at the same time, looking at page 7 of the presentation, the time to required funding expanded from 33 months to 38 months. +So I'm just curious, is there some other liability that is extending while you are bringing down the debt footprint and how can we gauge for the year ahead? What I'm getting at is how much further can you get, how can we triangulate on how much further room there might be in the debt reduction? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [47] +-------------------------------------------------------------------------------- + + I think that the important thing, and I understand your question, when you look at the time to required funding, one of the reasons why -- there are a couple components that go into that, the amount of liquidity that you have at the parent obviously and then what the debt footprint is over the course of the period of time that you are measuring it. +And if you look at what we have done, we basically -- if you looked at our Company at the end of 2012, we had $70 billion of debt maturities that we needed to work through over the course of 2013 and 2014. And you obviously need to carry significant amounts of liquidity to be able to basically meet your time to required funding when it is that lumpy. +What we have done is, between the debt that we repaid this year, as well as the activity you saw when we tendered for debt several times in 2013 for debt that was maturing in 2014, was to knock down those maturity profiles. +So you are asking a very good question, which is over time what you should expect us to be able to do is continue to move the parent company funding down and as we flatten out those debt maturities, we will be able to do that and not have nearly the impact on time to required funding because the maturity profile will be much flatter. + +-------------------------------------------------------------------------------- +Chris Kotowski, Oppenheimer & Co. - Analyst [48] +-------------------------------------------------------------------------------- + + Okay. Then as a follow-up, looking at your 10-K and 10-Q, you gave us a very nice breakdown of the debt by parent company versus Merrill versus BofA and A. And your parent company debt looks like, at least between year-end and September, like it was relatively flat and the declines in the long-term debt came primarily from Merrill Lynch going from like $90 billion to $60 billion. +Does Merrill Lynch as an entity need to continue to pay down debt or can that essentially be all squeezed into other subsidiaries and does that have an impact on the cost of funds? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [49] +-------------------------------------------------------------------------------- + + I think a couple things. Keep in mind we told you when we reported on the third-quarter earnings that the Merrill Lynch holding company that had previously issued debt before the merger of the two companies. That has been merged into the BAC holding company so when you look at that debt profile realize today it is one and the same. +I think the important thing I would look at is on page seven. What we do is that we do give you the actual what we consider parent company, and that parent company back in previous quarters prior to [ML and BAC] merging is a combined number. So if you look at those red bars on the bottom on page seven that is the combined debt footprint of the two companies that is now one and you can see it over the course of five quarters migrating down. + +-------------------------------------------------------------------------------- +Chris Kotowski, Oppenheimer & Co. - Analyst [50] +-------------------------------------------------------------------------------- + + Okay. All right, I will follow up, thanks. That is it for me. + +-------------------------------------------------------------------------------- +Operator [51] +-------------------------------------------------------------------------------- + + Jim Mitchell, Buckingham Research. + +-------------------------------------------------------------------------------- +Jim Mitchell, Buckingham Research - Analyst [52] +-------------------------------------------------------------------------------- + + Good morning. Just a couple of quick follow ups. On your Basel III Tier 1 common, the standardized versus advanced, you have I guess almost a 90 basis point difference. Some of your large bank peers are closer to a 10 basis point difference. Can you help us think about why you have such a large gap between the standardized and advanced? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - CEO [53] +-------------------------------------------------------------------------------- + + The first thing I would say is that generally we would expect that gap to narrow over time. But as you look at the actual content of it I think the biggest reason that you have is just given the percentage in some of our commercial loan balances that we have relative to our peers that under Basel III advanced get impacted significantly based on the actual credit quality, where when you go to standardized it is just 100%. +So I think you have got -- the first thing is you do have some of that activity or difference between the two metrics. Then I would say that the second thing is that we still do have some assets that under Basel III standardized do get some fairly heavy risk weightings that we will continue to work off over the next couple years. +So there is no question relative to what we have seen out there, we are a little bit wider. I think those are a couple of the differences. And as I say, I would expect over the course of the next 12 to 18 months you will see that gap tighten. + +-------------------------------------------------------------------------------- +Jim Mitchell, Buckingham Research - Analyst [54] +-------------------------------------------------------------------------------- + + So on the commercial side as credit gets better we should see that gap close for that reason? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - CEO [55] +-------------------------------------------------------------------------------- + + No, the commercial credit getting better really isn't going to -- that is not going to lead to it getting tighter, because under standardized a commercial loan is a commercial loan. There is no benefit of credit quality. It is going to be more the runoff of some of the different positions that we have within the Company as opposed to anything specific on commercial. + +-------------------------------------------------------------------------------- +Jim Mitchell, Buckingham Research - Analyst [56] +-------------------------------------------------------------------------------- + + Okay, got you. Then just a follow up on your eventual ROE target or a tangible ROE of 14%. When you are kind of discussing that target is that assuming some help from interest rates being higher, or is that without that help? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [57] +-------------------------------------------------------------------------------- + + As we look out at and as we look at 2015, 2016 we don't do anything besides just look out at the forward curve, so you do get a little bit of benefit at the very end of 2015 and a little bit more so in 2016. So there is embedded some of that. At the same time, to the extent that we are not in an environment and an economy that is growing and where we are seeing some of that movement up in short-term rates, if we are not seeing that there are other actions that we are going to need to take within the Company. + +-------------------------------------------------------------------------------- +Jim Mitchell, Buckingham Research - Analyst [58] +-------------------------------------------------------------------------------- + + Okay, great. That is very helpful, thanks. + +-------------------------------------------------------------------------------- +Operator [59] +-------------------------------------------------------------------------------- + + Steven Chubak, Nomura Securities. + +-------------------------------------------------------------------------------- +Steven Chubak, Nomura Securities - Analyst [60] +-------------------------------------------------------------------------------- + + Good morning. So one thing that we did see over the past year is a pretty robust pace of DTA consumption, which certainly helped boost your capital ratios. I know when contemplating DTA utilization the mechanics can be quite complicated, but how should we think about the potential level of progress as we enter 2014 as your earnings profile continues to improve? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - CEO [61] +-------------------------------------------------------------------------------- + + I would say on that that as we work through 2014 a fairly healthy percentage of what would show up in the tax provision line will not reduce our regulatory capital. And as we go out in 2015 and beyond how quickly the balance of that goes is going to be a function of profitability. +But what I would say is that as it relates to working through the DTA, and it is a complicated calculation, that we should get a very large amount of what we pay in taxes back in regulatory capital during 2014. + +-------------------------------------------------------------------------------- +Steven Chubak, Nomura Securities - Analyst [62] +-------------------------------------------------------------------------------- + + Okay, great. Then just thinking about some of the profitability targets you highlighted, such as the 14% tangible ROE, what are you guys assuming in terms of capital return over that potential horizon? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [63] +-------------------------------------------------------------------------------- + + Unfortunately, I can't answer a way around. We're not going to give any more guidance on CCAR than we have already given. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - CEO [64] +-------------------------------------------------------------------------------- + + It was a good attempt, though. + +-------------------------------------------------------------------------------- +Steven Chubak, Nomura Securities - Analyst [65] +-------------------------------------------------------------------------------- + + Fair enough. All right, that is it for me. Thank you for taking my questions. + +-------------------------------------------------------------------------------- +Operator [66] +-------------------------------------------------------------------------------- + + Paul Miller, FBR Capital Markets. + +-------------------------------------------------------------------------------- +Paul Miller, FBR & Co. - Analyst [67] +-------------------------------------------------------------------------------- + + Thank you very much. On the origination side, you did talk a little bit about that you are improving our retail side but the refis have gone down. You're down to like 4.5%; where do you see your market share and where do you think you can take your retail market share? +And also, what do you think about non-QMs? I know some banks have come out and said they will start doing some non-QMs. I didn't know where you stand on that. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - CEO [68] +-------------------------------------------------------------------------------- + + We think that, ultimately, if you look at our market share and other product capabilities, given the ebbs and flows of the rate environment, Paul -- fast refis, lower refis, whatever is going on. But if you look at it we should be able to better we should be able to -- we have a 10% or 13% deposit share we think in consumer deposits. We have a higher percent in cards, etc. Home equity is bigger. We should be pushing towards upper single-digit level in mortgage. +It just will take time because we are rebuilding that process, which was not geared to serving the core customers, and just doing it. The team has been doing a good job of building that fairly steadily. The purchase volume percent is in the 30%s this quarter and so we are getting there. That is our goal; it will just take us time and we will drive that. +But in terms of direct-to-consumer production, I think we are second largest now and we plan to keep driving. +On the non-QM and things like that we will meet the needs of our customers by using our balance sheet, because remember we do a lot of mortgages today through our wealth management business and stuff and so we will work through the rules. But for the standard products obviously, for the general consumer and the Fannie eligible and Freddie eligible, FHA type products we will be following all the rules and making sure they go through the standard process to get them off the balance sheet and into the securitization process. +But in terms of putting stuff on the balance sheet, I think we meet the needs of customers and we have been doing it for years. + +-------------------------------------------------------------------------------- +Paul Miller, FBR & Co. - Analyst [69] +-------------------------------------------------------------------------------- + + And on the jumbo loans I know a lot of the institutions are going after the jumbo product. You don't break out your jumbo product, but is that an area of focus for you guys? And if it is, what type of yields are you getting on that product? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - CEO [70] +-------------------------------------------------------------------------------- + + Inherently, when you have one of the largest wealth management businesses it is a focus. So of our production about 20-odd-percent comes from the wealth management business. And the yields are -- Bruce, I guess the yields on the product are competitive. We have to compete in the market, so it is a market-driven business. + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [71] +-------------------------------------------------------------------------------- + + I would say it obviously depends on the product, floating versus fixed, but you are clearly seeing credit spreads on a floating basis where some of those customers in the spreads of 100 to 150 basis points over from a floating rate perspective. + +-------------------------------------------------------------------------------- +Paul Miller, FBR & Co. - Analyst [72] +-------------------------------------------------------------------------------- + + And is there any update on the state of New York, where they stand with approving the Bank of New York settlement of $8.5 billion? Do we know when that is going to come to a conclusion? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [73] +-------------------------------------------------------------------------------- + + We do not. There is no update at all besides the fact that the trial is over. At this point you know what we know. + +-------------------------------------------------------------------------------- +Paul Miller, FBR & Co. - Analyst [74] +-------------------------------------------------------------------------------- + + Okay. Thank you very much. + +-------------------------------------------------------------------------------- +Operator [75] +-------------------------------------------------------------------------------- + + Moshe Orenbuch, Credit Suisse. + +-------------------------------------------------------------------------------- +Moshe Orenbuch, Credit Suisse - Analyst [76] +-------------------------------------------------------------------------------- + + Great, thanks. A couple of things. In the mortgage business I noticed that it looked like the revenue stream from the LAS servicing actually went up from the third quarter. Is that something that will remain at that level, or does that come down kind of with the servicing assets? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [77] +-------------------------------------------------------------------------------- + + The thing you need to look at within legacy assets and servicing, I know it is completely counterintuitive, but recall that the reps and warrants is a contra revenue line item. So we had the lower rep and warranty provision for the quarter was the big delta. + +-------------------------------------------------------------------------------- +Moshe Orenbuch, Credit Suisse - Analyst [78] +-------------------------------------------------------------------------------- + + In terms of the card business, I mean you had talked about the million-plus accounts and you have done that both third and fourth quarter. Just talk a little bit maybe more generally about the strategy there; are there any things that you are doing to kind of maintain or increase that? +Also, on the other side are there other affinity portfolios that your partners are going to ask for back as we go into 2014? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - CEO [79] +-------------------------------------------------------------------------------- + + I would say on the affinity side we identified the one -- I think we basically repositioned that business over the last three or four years and I think we are kind of where we are at this point. The strong affinity partners we have that have done well we continue to support them and continue to drive production there. +But the real story on the card business is think about the Cash 1-2-3 product, the Balance Rewards, and the Travel Rewards products, core products that we continue to drive. The production of those products continue to be up significantly year over year and that is what is driving us from a couple of years ago maybe 600,000, probably 700,000 cards a quarter up to 1 million-ish now per quarter. And so that is good because it is our core brand of product with a great product for the consumer and they use it. +So what you are seeing is if you look at some of the detail we give you in the supplement stuff you will see that the average spending is going up, the average spending per card is going up and so that obviously is more efficient and an indicator that you are becoming the primary card in the wallet for customers. With that though one of the drags is the spend rate. +We are in the low 20%s on payment rate. In other words, the people are paying us off and not caring balances because of the affluent customers. So that is a little bit of drag, but they charge enough that you make it through the interchange. +We are very comfortable with the business. We spent three or four years in positioning, but the good news is with the credit quality that we have seen from originations and things like that we are getting a 9% risk-adjusted margin. So we have ended up with the right spot where we are getting production growth, i.e., more cards, with our direct customers with a good, strong margin and we like that. +Then you might say: well, why don't you push it harder because it is returning so well? The issue is to do that you have to go to places where I think it is our core strength and so you should expect us just to grind forward on that. + +-------------------------------------------------------------------------------- +Moshe Orenbuch, Credit Suisse - Analyst [80] +-------------------------------------------------------------------------------- + + Got you. Following up on the DTA question, how do you think about and how do you believe the Fed thinks about that DTA consumption kind of as part of a CCAR submission? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [81] +-------------------------------------------------------------------------------- + + I think that the interesting thing is that as you move forward into -- as we move forward and you look to test under Basel III NOLs are not eligible as capital under Basel III. So there is good news and there is bad news. The bad news is you don't get to count it. The good news is that it eliminates the likelihood that you have a difference relative to the way somebody else looks at your deferred tax position. +Given that CCAR is based on the way regulatory capital works, that is how the deferred tax asset flows through. And once again under Basel III you don't get to count NOLs. + +-------------------------------------------------------------------------------- +Moshe Orenbuch, Credit Suisse - Analyst [82] +-------------------------------------------------------------------------------- + + So you are saying though they do consider the capital generation as opposed to just your earnings? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [83] +-------------------------------------------------------------------------------- + + I can't comment on the way the Federal Reserve looks at that, but our belief is that is correct. + +-------------------------------------------------------------------------------- +Moshe Orenbuch, Credit Suisse - Analyst [84] +-------------------------------------------------------------------------------- + + Thanks, Bruce. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - CEO [85] +-------------------------------------------------------------------------------- + + The point would be this year you are in transition, but as you go forward and the expectation is you move purely to Basel III, this becomes sort of a non-element in that it is out of the calculation already. + +-------------------------------------------------------------------------------- +Moshe Orenbuch, Credit Suisse - Analyst [86] +-------------------------------------------------------------------------------- + + Great, thanks. + +-------------------------------------------------------------------------------- +Operator [87] +-------------------------------------------------------------------------------- + + Guy Moszkowski, Autonomous Research. + +-------------------------------------------------------------------------------- +Guy Moszkowski, Autonomous Research - Analyst [88] +-------------------------------------------------------------------------------- + + Good morning. Question on how we should think about the fact that last year your capital return really included not just the buyback authorization of shares, but also the redemption of the preferreds. So you could add the two numbers together and say $10.5 billion out of last year's CCAR. Is there some conversion factor that we should think of for the preferreds in terms of saying what the 2013 baseline really was? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [89] +-------------------------------------------------------------------------------- + + I think as you look at the preferreds that we redeemed the yields on those preferreds were between 8% and 9%. Our belief, and once again I am not going to speak for the Federal Reserve, but I think most people looked at that and said -- at least the way we looked at it was that we look at the heavy content of Tier common that we have and you look at preferred that is 8% to 9% after tax. I think most people would look at that and say it makes good corporate finance sense and it is a good thing for Bank of America to retire those. +Given the work that we have done on the balance sheet, you can see that the majority of what we have left from a preferred stock perspective is priced at competitive rates. So I would be very careful to thinking of and including that preferred stock redemption and assuming that it was evaluated as common stock. + +-------------------------------------------------------------------------------- +Guy Moszkowski, Autonomous Research - Analyst [90] +-------------------------------------------------------------------------------- + + Right, but I mean is there a factor that you used in thinking about what it would convert into in terms of the capital return? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [91] +-------------------------------------------------------------------------------- + + No, because it was straight preferred stock. It had no conversion features whatsoever. + +-------------------------------------------------------------------------------- +Guy Moszkowski, Autonomous Research - Analyst [92] +-------------------------------------------------------------------------------- + + Okay, fair enough. I have had a number of clients ask me the question this morning about the significant increase in the yield on the securities portfolio just from the third quarter to the fourth. Obviously long rates are up a lot, but is it just that or can you link that to the couple hundred million dollar benefit that you were talking about in terms of the market-related impact? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [93] +-------------------------------------------------------------------------------- + + You are absolutely correct. If you adjust for the FAS 91 the delta Q3 to Q4 the increase was only 2 basis points. + +-------------------------------------------------------------------------------- +Guy Moszkowski, Autonomous Research - Analyst [94] +-------------------------------------------------------------------------------- + + Got it, that helps. I know you said that on the SLR with the Basel add-ons you are still evaluating that, but JPMorgan was out saying yesterday that their estimate was that it probably only increased above and -- beyond the NPR decreased their leverage ratio by about 10 basis points. Are you thinking similar order of magnitude or are you really not in a position to comment at all at this point? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [95] +-------------------------------------------------------------------------------- + + I would make a couple of comments on that, Guy. We have got teams, as you can imagine, culling data and spending a lot of time with it. The couple of comments I would make is that the changes that were made from prior BCBS rules to the new rules, as it relates to both the credit conversion factor as well as the netting for securities financing transactions, clearly are less punitive than what the original BCBS proposals were. +I would say on a very preliminary basis as we look at it I would say that we think the negative or the impact to us was a little bit more than what JPMorgan quoted. That being said, with our ratios above 5% at the parent and above 6% at each of the banks coming into this, we feel like we are in very good shape with respect to compliance with this supplementary leverage ratio. + +-------------------------------------------------------------------------------- +Guy Moszkowski, Autonomous Research - Analyst [96] +-------------------------------------------------------------------------------- + + Fair enough. That is very helpful. Then I guess the final question that I would have for you, and it is along the lines of some of the ones you have been asked about further reductions in the long-term debt footprint. +Obviously there has been some speechifying by members of the Fed about not seeing banks reduce their long-term debt levels much below where they are now. Is there some rule of thumb that you guys are using in the absence of any defined orderly liquidation or bail in capital definition yet as to what you would want your total sort of long-term debt plus Tier 1 capital to look like as a percentage of risk-weighted assets? That you are using as a guidepost to help you figure out how much long-term debt to bring down. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - CEO [97] +-------------------------------------------------------------------------------- + + I will let Bruce give you sort of his thoughts on that from his perspective, but before we get there you got to remember what I said earlier is we -- our company has shrunk and our equity has gone up. So when you think about that if you shrunk the Company by $300 billion to $400 billion in size across the last three or four years and your equity balance has gone up then your deposit balance has gone up. The only thing to do to balance the balance sheet is to take the long-term debt footprint down. +That is because we fundamentally got rid of businesses and assets and things that weren't necessary to do what we do today. There is just a difference between us and someone, our peers who have been more organic in how they came together in the last few years. +I would just be careful that -- obviously we work with the Fed and all this redemptions it's not like we can make capital plans and, as you said, liquidation authority and structure. But a lot of our reductions come by just shrinking the scope of the Company to $2.1-and-change-trillion from $2.4 trillion to $2.5 trillion and that is going to allow us to reshape the thing. And then getting rid of assets that were non-core, not yielding. +So I will let Bruce answer the rules, but remember we started from a different place because, as someone said earlier, Merrill had a lot of debt because they didn't have the deposit funding we did. Bruce? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [98] +-------------------------------------------------------------------------------- + + I think, Guy, we hear the same thing that you do where we hear the numbers quoted of very high teens that you need to be at from a common, plus your debt footprint that is greater than a year. If we look at where we are today from that metric, we are in the low 20%s today, which as we compare ourselves to our peers is higher than where our peers are. +I think what you are going to see as we go forward, and I referenced this earlier, that this is the last year of big debt maturities where we have got north of $30 billion at the parent that comes due. So I think what you will see for us going forward is you will see us issue less today at the parent than what matures at the parent. As you get out to 2015 and beyond it tends to be much more a $20 billion a year type maturity profile. +The impact in 2015 and beyond -- assuming we continue to do what we should with the balance sheet, the impact in 2015 and beyond is going to be more about the cost at which we are raising debt relative to the debt that we are retiring, whereas we do have one more year, which is this year, of shrink in the actual total amount. + +-------------------------------------------------------------------------------- +Guy Moszkowski, Autonomous Research - Analyst [99] +-------------------------------------------------------------------------------- + + Got it. That is really helpful perspective. Thanks so much for taking my questions. + +-------------------------------------------------------------------------------- +Operator [100] +-------------------------------------------------------------------------------- + + Matthew Burnell, Wells Fargo. + +-------------------------------------------------------------------------------- +Matthew Burnell, Wells Fargo Securities - Analyst [101] +-------------------------------------------------------------------------------- + + Good morning. First I guess a bigger picture question and then just a couple of administrative questions. +You have mentioned a couple of times your view about cards and the progress you are making not only in getting cards in the hands of your customers, but also the use that your customers are taking with the card in terms of charging more. I guess I'm just curious as to what your outlook is for actual balance growth over the course of 2014, presuming that we are in a somewhat better economic environment this year versus the last couple of years. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - CEO [102] +-------------------------------------------------------------------------------- + + If you look at the -- couple things that would drive that. If you look at the last three or four quarters you can see that we have kind of flattened out. Remember around the holidays you get a seasonal bump and it comes out, so Bruce said earlier that you should expect the card balances to come down in the first quarter just because of that. But if you look at it, it has been $90-odd-billion in the US business consistently. +What we did see in the latter part of last year is more usage on the credit side, which from a general economy perspective is actually good news in that people were using the credits versus debit when we look at our usage of the cards and what they are used for in a given quarter. So the credit spending was up better among all the customer bases in October and November and into December. So I would say we are set up to -- because we had gotten rid of the balances of the cards that we were running off, and that is really a very low percentage now, to have the thing stabilize. +I don't think it will have large balance growth because it will kind of work with our -- it will work with our customers and what they are doing and we have a substantial part of the people pay us off. But the good news is underlying it you have seen a little more credit usage fundamentally in the last couple quarters. + +-------------------------------------------------------------------------------- +Matthew Burnell, Wells Fargo Securities - Analyst [103] +-------------------------------------------------------------------------------- + + Okay. Bruce, I think you mentioned a couple of quarters ago that you were targeting a branch count for the Company, round numbers, around 5,000. You are basically there at the end of this year. Is there potentially a push to get that number materially below 5,000 or at this point do you think you are where you want to be? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [104] +-------------------------------------------------------------------------------- + + I would say when I reference the 5,000 that was in the context of starting at just under 6,000 branches and the work that we were doing with respect to new BAC. I would say that we continue to track towards that 5,000 number. +What is probably a little bit different from what we saw in new BAC is that we have been able to actually sell some of those branches that are, for us, out of market to local banks as they look to build up their local presence, which I think is a good thing for everyone. As we look forward, I think there will be a continued evaluation that we have at this point as to the opportunity and the cost versus the benefit of the branches. But I would directionally think of us being 5,000, maybe a few less than that by the end of 2014 and there will be a continued evaluation that we have beyond that. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - CEO [105] +-------------------------------------------------------------------------------- + + We would always focus people on the branch count. It was a fairly objective way to show how we were trying to do it. +The reality now is as you look at the different formats we are always putting new branches in the market. In other words, as leases run off, repositioning the branch, consolidating branches, and adding these express formats that we are testing and stuff. So the definition of a branch is changing in terms from what you would traditionally think. +After the period which Bruce talked about, you are really going to be where the customer is leading you, but the branches are critically important. You always use the example, in one market we were able to take four branches and put them in one larger one; have Merrill teammates, U.S. Trust teammates, and the core personal bankers and teammates in the branch. +So we don't know exactly where this goes because it will be dependent upon customer behavior, but what we do know is we have to dominate the physical side and the e-commerce, online, mobile side at the same time. And that is where we are investing heavily in both platforms. We have a fairly stated probably $0.5 billion we put in the online mobile platform across the last three or four years and we will continue to invest at that rate. You can see the future functionality return and the usage of the platform has grown tremendously. +For example, in the fourth quarter of 2013 9% of all the checks deposited by consumers went through the iPads and mobile phones. That was up from 7% the quarter before and didn't exist until basically the third quarter of 2012. So that is what we are driving, because of customer convenience and usage. At the same time we have 8 million customers coming to the branch and the engagement rate for those customers is going up. +And so the team is less about what number of branches and more about how the distribution process works between phones and ATMs and mobile in branches and express branches, ATAs which are tellers through the branch, and then we are deploying more people to sell in all those regards. And that is what we are trying to do. + +-------------------------------------------------------------------------------- +Matthew Burnell, Wells Fargo Securities - Analyst [106] +-------------------------------------------------------------------------------- + + Presumably over the next two to three years you could see the square footage of the total branch base come down potentially fairly dramatically given all the electronic delivery mechanisms that you just mentioned? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - CEO [107] +-------------------------------------------------------------------------------- + + Yes, dedicated to transactions, but the square footage dedicated to sales could increase. + +-------------------------------------------------------------------------------- +Matthew Burnell, Wells Fargo Securities - Analyst [108] +-------------------------------------------------------------------------------- + + Fair enough. Then just finally, what was your percentage of mortgage volume this quarter that was dedicated to purchase? And how does that compare to the third quarter? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [109] +-------------------------------------------------------------------------------- + + 32% was purchased this quarter. I think it was 21% in the previous quarter. + +-------------------------------------------------------------------------------- +Matthew Burnell, Wells Fargo Securities - Analyst [110] +-------------------------------------------------------------------------------- + + Okay, that is it for me. Thank you very much. + +-------------------------------------------------------------------------------- +Operator [111] +-------------------------------------------------------------------------------- + + Nancy Bush, NAB Research LLC. + +-------------------------------------------------------------------------------- +Nancy Bush, NAB Research - Analyst [112] +-------------------------------------------------------------------------------- + + Good morning, guys. I think we all appreciate the tremendous progress you have made on increasing profitability at the Company and getting things turned around, but there is a perception out there that you are going to have a gap up in profitability when short rates start to go up. Can you just give me your thoughts about that? Is that indeed a correct view? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [113] +-------------------------------------------------------------------------------- + + We look at -- in each quarter look at our asset sensitivity on the balance sheet. As we look out at and our constant metric that we look at is what does 100 basis points do to our net interest income. Obviously that flows directly to the bottom line and at the end of the year 100 basis point move up was worth between $3 billion and $3.1 billion to us from a net interest income perspective. +So we clearly will benefit from short-term rates. We obviously don't control that. And so I think the important thing, Nancy, is that as we look at near-term benefits that we have we continue to have a lot of work to do on expenses in both 2014 and 2015, because we have got another $0.5 billion a quarter of new BAC savings that will get implemented between end of 2013 and end of 2014. Then with the guidance that we gave today another $700 million a quarter to get out going into 2014 to where we end 2014. +So we do look forward to those days of higher rates, but in the meantime we have got a nice chunk of expenses to get out that we do not believe will impact the revenue-generating ability of the Company. + +-------------------------------------------------------------------------------- +Nancy Bush, NAB Research - Analyst [114] +-------------------------------------------------------------------------------- + + Just kind of to add on to that; do you have a sense at this point -- and this sort of goes back to the previous question. When rates do start up how much will the profitability of -- given everything you have done in the deposit-gathering network, how profitable will that be in the next cycle as opposed to, let's say, I don't know, three or four years ago? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - CEO [115] +-------------------------------------------------------------------------------- + + Nancy, if you look at page 11 where we give the profitability of the consumer business banking, and that is obviously the one that benefits the most by the short-term rate rise because they have a huge constitution of deposits that is non-interest-bearing and then picks it up. Then you can look at the returns there and in the supplement and you can see we are up to about $2 billion in after-tax income and the returns clearly exceed the cost of capital. +It will benefit, but in the meantime what we will be doing is driving the cost structure down in the deposit franchise for almost 300 basis points of cost to run the deposit franchise as a percentage of deposits down to 200 and opening that up. So it will absolutely help that business. But, meanwhile, it earned $2 billion this quarter, which is not a bad -- after tax, which is not bad either. + +-------------------------------------------------------------------------------- +Nancy Bush, NAB Research - Analyst [116] +-------------------------------------------------------------------------------- + + Okay, thank you. + +-------------------------------------------------------------------------------- +Operator [117] +-------------------------------------------------------------------------------- + + Eric Wasserstrom, SunTrust Robinson. + +-------------------------------------------------------------------------------- +Eric Wasserstrom, SunTrust Robinson Humphrey - Analyst [118] +-------------------------------------------------------------------------------- + + Thanks very much. Most of my questions have been answered, but just one small question also on the mortgage business. +Doing the simple gain on sale mathematics it looks like you had a rebound in your gain on sale sequentially, which is pretty consistent with what we have seen from others. But the magnitude looked much greater. It looked as if your gain on sale in the period was back to, more or less, year-ago levels, which doesn't seem intuitively right so I just wanted to get your view on that. + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [119] +-------------------------------------------------------------------------------- + + There was one piece internally between the LAS or, excuse me, the home loan space within LAS and what we have in all other. So if you adjusted that out you are not seeing material changes in the gain on sale. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - CEO [120] +-------------------------------------------------------------------------------- + + The core production margins that has come down and stayed pretty flat at the levels. Don't read into that is something we are doing, something different. + +-------------------------------------------------------------------------------- +Eric Wasserstrom, SunTrust Robinson Humphrey - Analyst [121] +-------------------------------------------------------------------------------- + + Got it. So just sequentially you would characterize the margins as largely flat, is that right? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - CEO [122] +-------------------------------------------------------------------------------- + + Yes. + +-------------------------------------------------------------------------------- +Eric Wasserstrom, SunTrust Robinson Humphrey - Analyst [123] +-------------------------------------------------------------------------------- + + Okay. Thank you very much. + +-------------------------------------------------------------------------------- +Operator [124] +-------------------------------------------------------------------------------- + + Mike Mayo, CLSA. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA - Analyst [125] +-------------------------------------------------------------------------------- + + You said the banking backlog was up. Was that versus the third quarter or year over year? And can you quantify that? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [126] +-------------------------------------------------------------------------------- + + I think I characterized the backlog as strong at this point, and I would say it is strong both relative to the third quarter as well as to the year-ago period. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA - Analyst [127] +-------------------------------------------------------------------------------- + + And which areas in particular? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [128] +-------------------------------------------------------------------------------- + + I think the interesting thing that we have seen coming into this is that the M&A business, and if you look at activity levels and just what has been announced over the course of the last week, that it does feel like that some of the -- the M&A deals that are being talked about are going to happen. Obviously there are a number of them that are still being negotiated and may or may not happen, but M&A activity clearly feels like it is beginning to pick up and ramp up from what we have seen. +You saw within the overall debt businesses very good growth, both year over year as well as linked quarter, and I would say that that business, as well as the market conditions, continue to be quite strong. You then move to the equity side. The fourth quarter was obviously a very good quarter from an IPO perspective. +Typically coming into the year you have a little bit less visibility on that, because a lot of that tends to happen after people wrap up their year-end numbers. But given overall valuations and what we are seeing, we are optimistic on the equity side as well. So I think there is not one piece that we look at within those pipelines that don't feel pretty good. +The only thing I would say as a brief cautionary note is that you are comping against a period that is the highest investment banking revenue period we have ever seen in the history of the Company. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA - Analyst [129] +-------------------------------------------------------------------------------- + + Then switching gears, the wealth management margin, 26.6%, can you give that to us excluding U.S. Trust? It just helps with apples to apples comparisons with peers. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - CEO [130] +-------------------------------------------------------------------------------- + + U.S. Trust adds maybe 150 to 200 basis points to it. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA - Analyst [131] +-------------------------------------------------------------------------------- + + Okay. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - CEO [132] +-------------------------------------------------------------------------------- + + Mike, so that gives you a sense of it. But be careful; what drives our margin is what I said before. It is the wholistic nature of the Merrill Lynch wealth management business. In there they have the wonderful classic investment business, but also they have a good deposit base and a good loan base and all the work the team does there under [John Thiel]. But it adds about 150, 200 basis points. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA - Analyst [133] +-------------------------------------------------------------------------------- + + Okay. Loan utilization in commercial and wholesale, where does that stand? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [134] +-------------------------------------------------------------------------------- + + Within commercial it continues to be in the very low 30%s. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA - Analyst [135] +-------------------------------------------------------------------------------- + + So no change? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [136] +-------------------------------------------------------------------------------- + + No change. The only thing that we are seeing that is a little bit of change, and we have talked about it before, is the -- if you look at the amount of funded commercial and corporate loans relative to our total commitments, that has been very much a focus of what Tom has looked at. And we have seen that migrate up to where it is just under 50%. +So while we are not seeing line utilization as much, we are seeing across our commercial and corporate books that the funded commitments relative to total commitments has increased. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA - Analyst [137] +-------------------------------------------------------------------------------- + + I wasn't sure; what is our net interest margin outlook for the next quarter or two? You mentioned FAS 91 for the debt security yield. To what degree, if the yield curve has flattened here a little bit here recently, do you give some of that back on the net interest margin? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [138] +-------------------------------------------------------------------------------- + + I think that we talked about that which drove the margin in the fourth quarter. I would say that across the board the margin was very strong in the fourth quarter. You have seen numbers in the low 240s; you have seen it at 251. I would think about that being generally range bound at this point in time with what we see. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA - Analyst [139] +-------------------------------------------------------------------------------- + + And with regard to new BAC, can you just repeat how much do you have left and how much do you think hits the bottom line this quarter? You spent a little bit more money for revenues, which I guess makes sense if you have the opportunity, but I just want to size that again. + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [140] +-------------------------------------------------------------------------------- + + We have said that we have got $500 million to get through over the course of the next four quarters and I would say that is going to generally be earned over time. So I wouldn't think of it being any more than 100, 125 is generally the way that you will see it phase in. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA - Analyst [141] +-------------------------------------------------------------------------------- + + I'm sorry, like $100 million to $125 million per quarter then and that should hit the bottom line, or you might look at reinvesting those gains? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [142] +-------------------------------------------------------------------------------- + + Well, we have committed to saying that our new BAC savings have to be net savings to the Company with the caveat that to the extent that businesses are doing more revenues from where we started that will pay out. And that is what we did see during the fourth quarter from both the global banking side as well as wealth management. +Keep in mind, and I think this is important as you look at the first quarter, is that we have got two things that generally happen in the first quarter. One that we know does and one historically that trend would suggest it does. I mentioned the FAS 123 that you have in the first quarter. We know that is going to be an incremental $900 million. +The other thing that historically has been true is that the sales and trading business the first quarter historically is the most significant quarter within that business. So the incentive compensation, given that we accrue based on revenues, tends to be seasonally highest in the first quarter. You add that plus the $900 million I mentioned and it is not an insignificant number. +We, once again, feel very good we will get the net new BAC savings on a net basis over the course of 2014. Just realize that the first quarter has those two components. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA - Analyst [143] +-------------------------------------------------------------------------------- + + Then lastly, you mentioned a goal for an ROA of 1% over three years and I just want to understand what you mean by that. Do you mean at the end of 2016 going into 2017 you look to have an ROA of 1%, or do you mean the average over these three years? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [144] +-------------------------------------------------------------------------------- + + What we are referencing is at the end of it -- as we look at over three years, at the end of the third year that is where we would look to get to which, given our current leverage profile, is around 14% on tangible common. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA - Analyst [145] +-------------------------------------------------------------------------------- + + So at the end of 2016 you look to have an ROA of 1%? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [146] +-------------------------------------------------------------------------------- + + That is correct. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA - Analyst [147] +-------------------------------------------------------------------------------- + + With the forward curve the way it stands. And with that, with those assumptions what sort of change do you expect with the certificates of deposits or CDs, which are historically low for you and others? Do you have money moving out of CDs at that point or not yet? You are around 15% of deposits; historically it is around 35%. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - CEO [148] +-------------------------------------------------------------------------------- + + I would say the general expectation should be that that number is going to be at or probably move down a touch from where we are today given the performance of the core deposit franchise. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA - Analyst [149] +-------------------------------------------------------------------------------- + + Then in your page 49 of the proxy it mentions PRSUs and they kick in with an ROA of only 0.5%, whereas you seem to be shooting for an ROA of 1%. How will your new expectations here for the next three years translate into kind of more formalized metrics or compensation? Is it more than simply a general target? How does it kind of sink into the organization? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - CEO [150] +-------------------------------------------------------------------------------- + + I think the targets that we have for performance we will put out in the proxy this year when the Board goes through the process over the next several weeks here, Mike. But I think in the past it has been based on getting us back to a level of profitability in the Company and that is what is reflected. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA - Analyst [151] +-------------------------------------------------------------------------------- + + Okay. In very simple terms, if you look for a 1% ROA on $2 trillion of assets, you hope to be at kind of a $2 annual run rate in the later 2016? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [152] +-------------------------------------------------------------------------------- + + The one piece, and once again we are not going to give it, is that if you are just doing that simple math you have not made any assumption with respect to the change in shares. Once again, given that we are in the middle of CCAR, we are not going to comment on that, but you do have some benefit over time through share count. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA - Analyst [153] +-------------------------------------------------------------------------------- + + All right, thank you. + +-------------------------------------------------------------------------------- +Operator [154] +-------------------------------------------------------------------------------- + + Derek De Vries, UBS. + +-------------------------------------------------------------------------------- +Derek De Vries, UBS - Analyst [155] +-------------------------------------------------------------------------------- + + Good morning, guys. I just have two questions. First, I think in the December conference you mentioned there has been a 70% increase in referrals to wealth management from other parts of BAC. I was just wondering if you could elaborate on that a little bit. +Is that environment driven or have you implemented some specific programs? And then maybe just give us a sense of how meaningful those referrals have been at the net income level? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - CEO [156] +-------------------------------------------------------------------------------- + + We have a very stringent program that is driven in each market by our marketing president and teammates where we count the referrals that go in, we count the close rate, and who participates in all of that. And then markets are stack ranked and we monitor it monthly to see how they are doing and reward the people doing well. +We set aggressive goals and this year for 2013 they hit all the goals. Every market was in good shape and so it is a fundamental way that our teams operate in the markets together. +When you get specifically into things that work well for wealth management, you have the connectivity when there are liquidity events, so-called business sales, IPOs, and things like that, where we bring in business. We will get through November and I haven't seen a final count yet. +We have about 675 401(k), retirement plan closed sales in 2013 and we had about 200 and some in 2012. That is driven through the Merrill institution of retirement planning business that [Andy Sieg] and John Thiel drive and delivered between national teams and the financial advisors in the market. +So that gives you the kind of sense of how this works. The dollars of that is in the $5 billion, $6 billion range, if I remember exactly so it is all those types of flows. +And then it is several tens of thousands of customers come from the consumer bank into the wealth management platform referred from the preferred team. But that goes on and those customers, they come into the branch, they have asset bases that are consistent with Merrill Lynch and U.S. Trust service models we move them in. So it is a whole bunch of things, but it is tracked, literally, person by person to make sure that it happens. +But, frankly, the teams like to work together and win in the market. And that is what you see when you go into our markets and talk to the teams that do it. + +-------------------------------------------------------------------------------- +Derek De Vries, UBS - Analyst [157] +-------------------------------------------------------------------------------- + + Okay. Then switching gears entirely and just talk about the leverage finance business. I think when you look at the industry you are seeing record (inaudible) issuance and you are seeing some pretty favorable pricing for issuers. How do you think about this business over the next few years, both from a revenue perspective but also from a risk management perspective? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [158] +-------------------------------------------------------------------------------- + + I would say the leverage finance business is a very good business for us. If you look at historically we are number one or number two in that business, and if you look at -- on an overall basis if you look at our debt origination, both investment grade as well as non-investment grade, it tends to be an $800 million to $1 billion a quarter type revenue stream. +As it relates to the risk -- and we believe, particularly given some of the new capital guidelines and the competitive landscape, that we are doing better in that business than we have. From the risk management perspective of it you have got two different components of it. +You have the underwrite to distribute component to it, which one of the most notable changes I think has been over the last couple years is the risk gets distributed from the underwriter to the investor generally much quicker, even in the context of deals that have a lag time from the time that they are committed to to where they are distributed. So that is a positive from a risk management perspective. +Then, with respect to the hold pieces, we continue to be very disciplined with respect to the hold levels that we have on those deals. The other thing I would say is, if you just look at mix of business now relative to what you saw 12 months ago, a lot more of the leverage finance business tends to be coming from corporate customers that are either privately held or public. And as valuations have gone up less of it tends to come from the private equity firms. +It is a business that we think that we are very good at. Our team has done a very good job of being mindful of the risk that is associated with it over the last couple years and it is a business that we are optimistic about. + +-------------------------------------------------------------------------------- +Derek De Vries, UBS - Analyst [159] +-------------------------------------------------------------------------------- + + Okay. Maybe just to follow up, so just to paraphrase what you said, you are very comfortable on the risk management side and you have taken market share it sounds like. But I don't think you gave an answer in terms of where you think the revenue outlook is for this business over the next couple of years. + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [160] +-------------------------------------------------------------------------------- + + The revenue outlook, I think in many respects, as we look out at the profitability we feel very good about the outlook. This is probably the business that most benefits from increased M&A activity, particularly on the corporate side. So to the extent that corporate M&A picks up, you would look to see this business continue to have favorable trends. +The word of caution would just be that it is a market-dependent business and, as you all know, periodically there are gaps in time where the new issue market, particularly on the high-yield side, does slow down, sometimes materially. But on balance we feel very good about the business going forward. + +-------------------------------------------------------------------------------- +Derek De Vries, UBS - Analyst [161] +-------------------------------------------------------------------------------- + + Great. Thank you very much. + +-------------------------------------------------------------------------------- +Operator [162] +-------------------------------------------------------------------------------- + + Andrew Marquardt, Evercore Partners. + +-------------------------------------------------------------------------------- +Andrew Marquardt, Evercore Partners - Analyst [163] +-------------------------------------------------------------------------------- + + Morning, guys. Just wanted to go back to the retail branch banking strategy shift and, Brian, you have been clear about this evolution of everyone having a branch in their pocket, so not totally surprised about targeting maybe shrinkage in branch count in 2014 and 2015. But, to frame it out a little bit more, does that provide additional expense leverage beyond what you have long been talking about on new BAC and LAS, or is there an investment spend component that we need to be mindful as well? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - CEO [164] +-------------------------------------------------------------------------------- + + The relative amount, obviously, you are getting more and more to the core franchise, so the relative amount of movement we can make -- and remember, couple that with we are investing in people and we are investing in technology to make it all work. And so I would be careful about assuming -- we are always going to be working this, that is our job, but I would be careful about assuming beyond the new BAC cost that Bruce talked about that there will be a lot net after that. Only because we are investing so heavily in the electronic space, which is still building in front of us. +But the theme is right; it is really how do you keep driving down the overall operating cost of all the platforms relative to the revenue stream and the deposit base obviously, because that drives a lot of the revenue stream in the business. And so I wouldn't hold the bottom line, but you should assume that we are going to be diligent in terms of managing that transition to help provide more investments, frankly, as we can. + +-------------------------------------------------------------------------------- +Andrew Marquardt, Evercore Partners - Analyst [165] +-------------------------------------------------------------------------------- + + And where do you think you are in terms of that investment cycle for mobile banking, other deliverables? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - CEO [166] +-------------------------------------------------------------------------------- + + We have got a great product and we just -- I think we are at a steady state. We spend just overall, we decide which business, about $3-billion-and-change in annual technology development, just development, and we expect that number to stay constant over time here. And as we take (multiple speakers) + +-------------------------------------------------------------------------------- +Andrew Marquardt, Evercore Partners - Analyst [167] +-------------------------------------------------------------------------------- + + On an annual basis? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - CEO [168] +-------------------------------------------------------------------------------- + + On an annual basis, yes. We are rebuilding a system, so I think that -- but that is all built into the dialogue we had about new BAC. + +-------------------------------------------------------------------------------- +Andrew Marquardt, Evercore Partners - Analyst [169] +-------------------------------------------------------------------------------- + + Got it, that is helpful. Then separate, but sort of related on expenses, so with new BAC that is left to realize in LAS how much of that should we have kind of a step function down on the absolute level of expenses off the core 4Q run rate of, call it, $15.5 billion type level? Should we see by the end of 2014 I guess heading into 2015 should we take out $1.5 billion or are there other costs related to maybe investment spend elsewhere that we need to be mindful of? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - CEO [170] +-------------------------------------------------------------------------------- + + I think if you look at the chart we gave you we try to isolate on the costs on page, the bar chart on page nine. You can see that the red bars are sort of the core if take out the litigation and LAS. You have to put some back because there will always be litigation. You have to put some back for just running the servicing portfolio, but we are shooting to drive into numbers that -- take those numbers and then you have to grow them and be careful of the FAS 123 type of thing and which quarter you are looking at. +But our job is to keep driving towards that core expense base. Then as you grow, if we are growing revenues -- the economy growth rate 100 basis points above that, we will grow expenses probably half of that. And that takes a lot of work to keep that expense down because the people content reaches 50%, 60% of our expense base. Our people do a great job and we will pay them. + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [171] +-------------------------------------------------------------------------------- + + I would just add that, Andrew, on the LAS piece we guided to roughly $1.1 billion at the end of the year. So with respect to the gray bar on page nine that Brian referenced, I would look at and think about $1.8 billion to $1.1 billion happening generally pro-rata over the course of the year. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - CEO [172] +-------------------------------------------------------------------------------- + + We still got a lot of clean up there. If you look at one of our peers announced yesterday, you can see that they are probably doing their mortgage servicing expenses maybe 30% to 40% of ours, and that is because we just are still getting through the higher delinquency content portfolio. And it lags a little bit getting the stuff done. + +-------------------------------------------------------------------------------- +Andrew Marquardt, Evercore Partners - Analyst [173] +-------------------------------------------------------------------------------- + + Got it, that is helpful. Then, Bruce, you have said I think in some of your prepared remarks that credit quality continues to improve into this year. Should we read into that that there is still meaningful credit leverage left to be realized in terms of reserve releases, or are we closer to the end here in magnitude? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [174] +-------------------------------------------------------------------------------- + + I think you are closer to the end on magnitude from a reserve release perspective. It always a little bit hard to predict obviously because the reserve releases are a function of what is happening in the underlying credit. But generally, Andrew, I would say that you expect to see charge-offs continue to decline. +And you are obviously going to see the reserve releases, given the magnitude that they have been, you are going to see those slowdown as well with the one delta just being what is the overall loan growth that you are seeing. + +-------------------------------------------------------------------------------- +Andrew Marquardt, Evercore Partners - Analyst [175] +-------------------------------------------------------------------------------- + + Got it, thanks. Then just lastly, just to wrap up some of the Q&A on the CCAR capital deployment. Just to be clear, it seems like one should not use kind of the $10 billion combined kind of preferred and common last year as a base. It really needs to be kind of a $5 billion as the baseline on common that you got approved for last year. +Hopefully we will make our own assumption, but it seems like it is fair to assume you could move upward in terms of deployment this year off that kind of base. Is that fair summarization? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [176] +-------------------------------------------------------------------------------- + + We agree with your characterization of the $10 billion number. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - CEO [177] +-------------------------------------------------------------------------------- + + You are trying to creatively ask the same question. You are doing a good job. + +-------------------------------------------------------------------------------- +Andrew Marquardt, Evercore Partners - Analyst [178] +-------------------------------------------------------------------------------- + + Okay. Thanks, guys. + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [179] +-------------------------------------------------------------------------------- + + That was our last question, so once again thanks, everyone, for joining us. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - CEO [180] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Operator [181] +-------------------------------------------------------------------------------- + + This concludes our conference call for today. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/exam/original-files/Problem_1_Sample/2014-Jan-29-FB.OQ-139655634314-Transcript.txt b/exam/original-files/Problem_1_Sample/2014-Jan-29-FB.OQ-139655634314-Transcript.txt new file mode 100644 index 0000000..be19331 --- /dev/null +++ b/exam/original-files/Problem_1_Sample/2014-Jan-29-FB.OQ-139655634314-Transcript.txt @@ -0,0 +1,585 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q4 2013 Facebook Earnings Conference Call +01/29/2014 02:00 PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * David Ebersman + Facebook, Inc. - CFO + * Deborah Crawford + Facebook, Inc. - Director, IR + * Mark Zuckerberg + Facebook, Inc. - CEO + * Sheryl Sandberg + Facebook, Inc. - COO + +================================================================================ +Conference Call Participiants +================================================================================ + + * Eric Sheridan + UBS - Analyst + * Ben Schachter + Macquarie Research - Analyst + * Brian Pitz + Jefferies & Company - Analyst + * Ross Sandler + Deutsche Bank - Analyst + * Colin Sebastian + Robert W. Baird & Co. - Analyst + * Heather Bellini + Goldman Sachs - Analyst + * Jordan Rohan + Stifel Nicolaus - Analyst + * Mark Mahaney + RBC Capital Markets - Analyst + * Scott Devitt + Morgan Stanley - Analyst + * Douglas Anmuth + JPMorgan - Analyst + * Mark May + Citigroup - Analyst + * John Blackledge + Cowen and Company - Analyst + * Tom Forte + Telsey Advisory Group - Analyst + * Anthony DiClemente + Nomura Securities - Analyst + +================================================================================ +Presentation +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Good afternoon. My name is Jay and I will be your conference operator today. At this time I would like to welcome everyone to the Facebook fourth-quarter and full-year 2013 earnings conference call. +(Operator Instructions) +Thank you very much. Ms. Deborah Crawford, Facebook's Director of Investor Relations, you may begin. + +-------------------------------------------------------------------------------- +Deborah Crawford, Facebook, Inc. - Director, IR [2] +-------------------------------------------------------------------------------- + + Thank you. Good afternoon and welcome to Facebook's fourth-quarter earnings conference call. Joining me today to talk about our results are Mark Zuckerberg, CEO; Sheryl Sandberg, COO; and David Ebersman, CFO. +Before we get started, I would like to take this opportunity to remind you that our remarks today will include forward-looking statements and actual results may differ materially from those contemplated by these forward-looking statements. Factors that could cause these results to differ materially are set forth in today's press release, our annual report on Form 10K, and our most recent quarterly report on Form 10-Q filed with the SEC. Any forward-looking statements that we make on this call are based on assumptions as of today and we undertake no obligation to update these statements as a result of new information or future events. +During this call we will present both GAAP and non-GAAP financial measures. A reconciliation of GAAP to non-GAAP measures is included in today's earnings press release. The press release and an accompanying investor presentation are available on our website at investor.fb.com. And now I'd like to turn the call over to Mark. + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook, Inc. - CEO [3] +-------------------------------------------------------------------------------- + + Thanks, Debra, and thanks, everyone, for joining today. This is a great quarter and a great way to end the year. We saw strong growth in engagement around the world and we are very pleased with the growth of our ad business, especially on mobile. +Overall 2013 was an important year for us. In 2012 was the year where we turned our core product into a mobile product, than 2013 was the year where we turned our business into a mobile business. I expect 2014 will be the year where begin to deliver new and engaging types of mobile experiences. As of the end of the year, more than 1.23 billion people now use Facebook each month. Last quarter was our first quarter were more than 50% of our ad revenue came from mobile. +Looking back at the year, we launched some important products and initiatives, Internet.org, Graph Search, Instagram Video and Messenger 3.0. We also made a lot of improvements to the performance and reliability of all our mobile apps. +One important trend from the last year is the continued growth and size and engagement of our community. In 2013, we added 172 million monthly actives and 139 million daily actives. That means that our daily engagement continues to increase. +In the last quarter more than 60% of our monthly actives visited Facebook daily. Given the size of our community we are very excited about this pace of growth. +We are also seeing people engaging more. On the average day in December, we saw more than 6 billion likes. That's up 59% from 3.8 billion likes a year ago. +These trends show that our strategy of improving the quality of our core experiences over the last year has paid off. And we are now in a good position to focus on our longer-term goals of connecting everyone, understanding the world, and building the knowledge economy. +Connecting everyone is about bringing the Internet to everyone and giving them the tools to stay connected with the people and things that matter to them. Today more than 750 million people use Facebook every day. +While that makes us by far the largest social network in the world we are still a small part of the world's population. Only one third of the world's population has access to the internet today, and for even many of those, their internet experience remains pretty weak. +Helping more people get connected is important to developing a global knowledge economy. Once people are connected, they can access tools like basic financial services, health information, and education tools to help them take care of the families and join the worldwide economy. That's why last summer we launched Internet.org, a partnership with industry leaders to make affordable internet access available to everyone in the world. +In 2014, we are going to focus on achieving Internet.org's mission by deepening our relationships with mobile operators around the world and working to develop new models for internet access. Our existing partnerships with operators are something we have already invested a lot in over the years and this is an area where we are really excited to build on going forward. +Connecting everyone also means giving people the power to share different kinds of content with different groups of people. This is something we focused on by building separate mobile apps beyond the main Facebook app, Messenger and Instagram are examples of this. +We launched a new version of Messenger to make the app even faster for mobile to mobile communication. Messenger was among the top most downloaded apps on iOS and Android in December and we see meaningful growth and engagement since launching. +The number of people using Messenger grew more than 70% in the past three months. We've seen a large increase in the number of messages sent. We have a lot more coming to Messenger in the first half of this year and I am excited to build on these early results. +Instagram also had a busy quarter bringing Instagram to Windows Phone, launching our first ads, and launching Instagram Direct, the new way to send private photo and video messages. We're pleased with the early reaction to all these products. With ads, the team has taken an especially careful approach working closely with a small number of brands that are already important members of the Instagram community to create a great early experience. +I'm also excited to report that there are now more than 500 million people using Facebook groups every month. Groups is one of our core products and it provides a private space for sharing with small groups like your family, close friends, or sports team, or for larger communities like schools or even companies. +One theme that should be clear from our work on product like Messenger, groups, and Instagram is that our vision for Facebook is to create a set of products that help you share any kind of content you want with any audience you want. We're not just focused on improving the experience of sharing with all of your friends at once, although that is growing quickly too. A lot of the new growth we see is coming from people -- from giving people the tools to share with different sized groups of people. +Now moving onto our business, last quarter I talked about our efforts to grow our business through improving the quality of our ads rather than just increasing the quantity. Our goal is to reach a point where the ads are as relevant and timely as the content your friends share with you. +To do this we've put a lot of effort into measuring people's sentiment around our ads and seeing how people engage with them. We do some of the broadest surveys in the world. We survey more than 35,000 people every day to see how we are doing and we use the results to drive our product development. Our approach is working. +In the second half of 2013, we saw an improvement in sentiment about ads on mobile, even as volume grew during that period. We also saw sentiment on desktop remain stable. Interestingly, even as the volume of newsfeed ads has grown, click through rates have also remained stable. We are very pleased with these results and they suggest our strategy of improving quality is working. +Our plan is to continue focusing on improving quality since we think this is the best way for us to improve the experience for people on Facebook, returns for advertisers, and our own revenue, as well as achieving our long-term goal of providing ads which are as relevant as organic content. +So that's my update on where we are focusing our efforts in the context of our longer-term goals. It's been a strong quarter and a great year for Facebook. +Next week Facebook turns 10 years old. It's been an amazing journey so far, for me personally and for all of us at the company. But what is ahead of us is even more exciting. +Many of the successes of the past 10 years have simply been steps on the path to achieving our long-term vision of connecting everyone and improving the world through sharing. Over the coming months and years you'll see us continue focusing on many of the same themes but now with greater scale, ambition, and resources. +Finally, I just want to thank everyone who works at Facebook for a great year in 2013 and over the past 10 years. What we've achieved together has been a result of all of your hard work and I'm grateful that so many talented people are a part of our team. Thank you, and now here is Sheryl. + +-------------------------------------------------------------------------------- +Sheryl Sandberg, Facebook, Inc. - COO [4] +-------------------------------------------------------------------------------- + + Thanks Mark, and hi everyone. I am really excited to report earnings this quarter and proud of the teams at Facebook who delivered these results. We ended 2013 with a terrific fourth quarter, continuing the strong momentum we saw throughout the year,. Our total revenue grew 63% year-over-year, led by 76% growth in advertising revenue. +Approximately 53% of our ad revenue came from mobile. This is not only the first time we crossed the 50% threshold in mobile but it's also our first $1 billion mobile quarter. In fact, our Q4 mobile ad revenue of $1.25 billion was nearly as large as our total ad revenue in Q4 of last year. +This growth continues to be very broad-based. The combination Mark spoke about of our growth in users and engagement, the effectiveness of our ads in newsfeed work together to provide marketers with a powerful way to reach people. It's impact is evident in our results. +This quarter we saw healthy increases in every region around the world and positive momentum in all four marketer segments. There are three key drivers propelling our business. First and foremost is strong mobile engagement. +Everyday more people around the world are spending more time on their mobile devices and marketers are starting to shift their budgets to reach them. This was especially clear during the holiday season where not surprisingly Black Friday was our single biggest mobile ad revenue day during the quarter. +When people are shopping in stores they are on their phones and when they are on their phones they are on Facebook. A recent study by Miller Brown Digital showed that while shopping in the store people who use Facebook do so at four times the rate of any other app or search. And for those people that use Facebook as a source before shopping, over half stated that it was a very influential source of information for them while they were shopping in the store. +The second driver of our ads business is a continued growth in the number of marketers using Facebook. Again, this growth is broad-based and diverse across marketers, verticals, geographies. +I'll update you briefly on each of our four marketing segments. Demand from direct response marketers was strong in the Q4 holiday shopping period, particularly in e-commerce. These marketers focus on short-term ROI, so the growth we're seeing speaks to our ability to efficiently drive sales for them. For example, online retailer NoMoreRack used Facebook to promote its holiday deals. They hit their aggressive ROI targets and they generated $8 million in revenue on Black Friday alone. +We are also making remarkable progress at SMBs, a segment that many in the industry have long considered the holy grail of online advertising, and a segment that I have been particularly focused on throughout my career. In November we reported that more than 25 million SMBs maintain an active page on Facebook. We've made a big investment in simplifying our ad products over the last year and that investment is working to convert these SMBs into advertisers. Of the new SMB advertisers we acquired in Q4, 72% started with our most simple ad products. +For developers, mobile apps are generating very healthy revenue growth. We launched mobile app install ads just over a year go and mobile app engagement ads last quarter based on a very simple idea that we can help people find and use great apps. +This is working even better than we hoped. We are helping developers attract new customers and keep them engaged. We remain excited about the opportunities in the small but quickly growing category. +In addition, last week we announced a small test to show Facebook ads in third-party mobile apps. We won't have meaningful results for a while, but it is an interesting area for us to explore. +Finally, we are making steady progress with our brand marketers, particularly in verticals like CPG. We are helping them connect with customers in more dynamic ways, starting a start test of our new video ad product, and measuring our impact on their sales, which is super important to driving their business. +The third quarter -- the third driver for both the quarter and the full year has been our investment in product development. We're especially pleased with the improvements we've made to our targeting capabilities and measurement tools. Our goal, as Mark said, is to make our ads as useful as possible for consumers and to generate greater returns for marketers. Eventually making all of our ads as valuable to users as our organic content. +Custom Audiences is our most important product in this effort. When we launched it over a year ago it allowed marketers to reach their current customers on Facebook. Since then we've built more targeting capabilities while maintaining user privacy. These include look-alike targeting that lets marketers reach people who are similar to the best customers, partner categories which use third-party data to improve our targeting. +Now marketers can reach exactly the people they are looking for, such as people who buy fashion apparel or are in the market for a new car. We have more than doubled the number of partner categories in the US and now offer more than 1,000. And we believe there is still significant opportunity ahead as we continue to improve our targeting capabilities. +We are also making major investments in measurement so that we can measure the impact of our advertising on in-store sales. In December we launched off-line conversion measurements. To date our results show that the average return on ad spend for newsfeed campaigns is eight times, a result that is really impressive when compared to other returns marketers have available. +As Mark noted, this is the beginning of a new year and our 10th anniversary, so I want to reflect really briefly on where our advertising business and we believe the marketing industry is heading. Before mass media all business was personal. Sales happened customer by customer at the local store or door to door. The evolution of mass media made it possible to sell at scale but business was no longer personal. +On Facebook, marketers can do both. We are building the world first global platform that lets marketers personalize their messages at unprecedented scale. This is marketing where you are for who you are. This shift to personalization represents the biggest shift in marketing in generations and it is one that we are uniquely positioned to lead. +Facebook is the only place where 750 million people visit every day increasingly on mobile to discover what matters to them. As we continue to leverage our understanding of people to make marketing more personal, and do it at massive scale, we will dramatically improve the quality of ads and drive more personal discovery. Facebook is making business personal again. +And like Mark, I want to thank the teams that we get to work with everyday at Facebook who are doing a great job to make this happen. Now I'd like to turn it over to David. + +-------------------------------------------------------------------------------- +David Ebersman, Facebook, Inc. - CFO [5] +-------------------------------------------------------------------------------- + + Okay. Thanks Sheryl. Overall 2013 was a great year for Facebook. We performed well against all at our key financial priorities, growing revenue to $7.9 billion, delivering operating profit and free cash flow each of over $2.8 billion, and making investments that position the Company for continued growth. Today's results strengthen our conviction that we're in the early days of capitalizing on a significant opportunity. +Let's start with some user and engagement highlights. During the year the population of people using Facebook on a daily basis increased by 139 million to 757 million, and the population of people using Facebook each month grew by 172 million to 1.23 billion. In December, 62% of our monthly users used Facebook on an average day. +Mobile continues to drive our growth. When we began 2013, we had more daily users on desktop than mobile. By the end of the year, our daily users on mobile outnumbered desktop by around 200 million. +We are also pleased that engagement per user continued to increase in 2013 based on measures such as time spent per user and feedback per user. And none of these stats include Instagram, which doubled its user base over the past year. The network of people who use our products remains the foundation for everything we do and they are the most important audience we are trying to serve and delight every day. +Turning now to the financials, in Q4, total revenue was $2.59 billion, up 63% and ad revenue was $2.34 billion, up 76%, for our highest year-over-year growth rate since mid-2011. Exchange rates had no meaningful impact. +We continued to experience strong revenue growth around the world. Ad revenue in each of our four reported geographic regions grew by more than 65% in Q4 compared to last year. The key driver of ad revenue growth continued to be the strong performance of newsfeed ads on mobile and desktop, which helped us attract more advertiser demand. Mobile ad revenue increase from approximately $881 million in Q3 to approximately $1.25 billion in Q4, a healthy increase that of course benefited from seasonal effects. +In Q4, total ad impressions declined 8% and the average effective price per ad was up 92% compared to last year. The decline in ad impressions was primarily due to the shift in usage towards mobile devices where people are shown fewer as compared to desktop since there's no right-hand column ads on mobile. +The significant increase in average price per ad was driven by the mix shift to more newsfeed ads that have much higher engagement and click through rates, increasing the average effective price per ad impression. The price volume trends were pretty similar across our four geographies. +Total payments and other fees revenue in Q4 was $241 million, down 6% versus last year, remembering that in Q4 last year we recognized revenue from four months of payments transactions. On a more apples to apples basis, payments revenue from games, which represents the substantial majority of our payments and other fees revenue, grew approximately 8% in Q4 versus last year despite the fact that our payments revenue from games is limited to our desktop users, a population that's declining. +Turning now to expenses, our Q4 GAAP expenses were $1.45 billion, up 37% and non-GAAP expenses were $1.13 billion, up 33%. For the full year, our non-GAAP expenses were up 44%, driven largely by growth in infrastructure expense and a 37% increase in headcount over the year. +As our revenue has grown we've worked hard to stay disciplined in terms of our expense growth. Focusing on investments where we are most confident of creating value and meaningful ROI. We are pleased with the returns we achieved from many of our investments that we made in 2013, including those to advance our ad products, improve mobile product quality, increase engagement, and drive efficiency improvements in our infrastructure. +Our Q4 GAAP operating income was $1.13 billion representing a 44% operating margin and our non-GAAP operating income was $1.46 billion representing a 56% margin, up from 46% last year. As you know, margins are typically the strongest in the fourth quarter given the seasonal strength in our advertising's business. +Our GAAP and non-GAAP tax rates for Q4 were 54% and 46% respectively, and for the full year 2013 our GAAP and non-GAAP tax rates were 46% and 41%. The tax rates in Q4 were higher than the rates for prior quarters in the year primarily because of intercompany payments that occurred in Q4 related to our international operations. Also at the end of 2013, we had a tax net operating loss or NOL carry forward of almost $8 billion. +In Q4 GAAP net income was $523 million or $0.20 per share and non-GAAP net income was $780 million or $0.31 per share, up approximately 80% compared to last year. CapEx was $483 million in Q4 and $1.37 billion for the full year. +Our efficiency investments including the open compute project on the hardware side and proprietary work on the software side has enabled us to significantly increase the amount of data and the number of users we can support with each server we buy, and these investments have saved us over $1 billion over the past three years. We wouldn't be able to deliver the profit and cash flow numbers we are reporting today without the success of these efficiency investments. Our Q4 free cash flow was $748 million and our full-year free cash flow was $2.8 billion, including the benefit from a $419 million tax refund in Q2. +Turning to the balance sheet, we ended the year with $11.4 billion in cash and investments. This number includes $1.5 billion from our secondary offering of 27 million shares in December at the time of our inclusion in the S&P 500 index. +Now I want to share a few thoughts on 2014. In terms of expenses, we are planning that our total 2014 GAAP expenses, including cost of revenue and including stock comp, will likely grow in the neighborhood of 35% to 40%. And non-GAAP expenses, including cost of revenue but excluding stock comp, will likely grow in the neighborhood of 40% to 45%. +We plan to invest with a continued emphasis on technical headcount and product development to take advantage of the opportunities we see to create new experiences and more value for our users, marketers, and developers. +On taxes we expect our GAAP and non-GAAP tax rates in 2014 to be roughly similar to our full-year tax rates in 2013, although this could vary widely depending upon acquisitions, our international revenue and expense mix, and other factors. Our tax rate in 2014 and over the next several years will continue to reflect the fact that we're in the early years of investing in our international operations. Longer-term we expect our tax rate to be in line with peer companies who have similar operations and international revenue mixes. +We ended 2013 with $2.6 billion diluted shares outstanding including the December stock offering, and we estimate that our diluted share count will increase roughly 2% to 2.5% by the end of 2014, although this may vary depending upon our stock price and new share issuances, for example to support M&A. We anticipate our 2014 CapEx will increase to be in the range of $2 billion to $2.5 billion. The significant year-over-year growth will be driven by an expansion of our Menlo Park headquarters, infrastructure related expenses such as the build out of our Iowa data center, and by our investment plans to support initiatives like Internet.org that are designed to increase internet penetration in the developing world. We'll also continue to make strategic investments to improve capital efficiency. +Last, in terms of revenue, in 2014 we hope to build on our success from last year. 2013's strong growth in ad revenue was driven by the rapid ramp-up of newsfeed ads, growth in users engagement and marketers using Facebook, and by the product investments we made that improved the quality, relevance, and performance of our ads. +As Sheryl described, we believe we're still early in the evolution of our advertising business and the mobile ad business in general. This makes for a difficult time to forecast near-term revenues with any precision, but it also makes for an exciting time and we're looking forward to capitalizing on this opportunity. +To sum up, Q4 was a strong end to a great year for Facebook. Thanks for joining us on the call today. And now let's open for questions. + + +================================================================================ +Questions and Answers +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) +Ben Schachter, Macquarie. + +-------------------------------------------------------------------------------- +Ben Schachter, Macquarie Research - Analyst [2] +-------------------------------------------------------------------------------- + + Congratulations on a fantastic year. Sheryl, I was wondering if you could rank order the four groups of marketers and discuss sort of how SMBs play out over time versus the larger enterprise companies? And then Mark, if you could talk a bit more, expand more on what you mean by standalone mobile apps and really what your vision is there, and I understand your speaking of Mobile World Congress so any update on what we should expect from that. Thanks. + +-------------------------------------------------------------------------------- +Sheryl Sandberg, Facebook, Inc. - COO [3] +-------------------------------------------------------------------------------- + + We don't break out by segment. But all four segments are growing and we are pleased with the growth there. I'm glad you asked about SMBs because it's a particular focus for us, and some where I'm really proud of our performance, our teams led by Dan Levy and others have just done a great job. +There are 25 million SMBs that have pages on Facebook and that's a really good first step, because it's just historically very hard to get small businesses online. What we've done over the last year is we've really worked at simplifying our ad product, and that's working because the way to convert our SMBs who are using our free product into being advertisers are with these really simple ad products. So rather than go to them and say do you want to become an advertiser, you say do you want to promote a post? And that's what's working and we are able to convert them to advertising, and then upsell them from there in large numbers and we are excited about it. + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook, Inc. - CEO [4] +-------------------------------------------------------------------------------- + + Yes. And in terms of the focus on building new and separate experiences, our theory is that there are all these different ways that people want to share and communicate. Almost any kind of content that you can imagine sharing, text, photos, videos, links, locations, events, games, anytime, a type of content with any type of audience, whether privately on a one-on-one situation or small groups, or with all of your friends or a larger community or publicly, there's an interesting intersection between most of these things. +And one of the things that we want to try to do over the next few years is build a handful of great new experiences that are separate from what you think of as Facebook today, that are just kind of helping to explore that place and give people new ways to share. And I you can see that that's something that people want from some of the mobile apps that exist out there today. +You can see it from our own offering with, not just Facebook, but also Instagram and Messenger already today. And were probably -- we're going to keep working on this over the next few years. + +-------------------------------------------------------------------------------- +Operator [5] +-------------------------------------------------------------------------------- + + Heather Bellini, Goldman Sachs. + +-------------------------------------------------------------------------------- +Heather Bellini, Goldman Sachs - Analyst [6] +-------------------------------------------------------------------------------- + + I have two questions. The first one, there's been a lot of talk about Messenger over the last couple of quarters. I'm just wondering if you could share with us how you see the competitive environment for Facebook in the area of messaging, in particular in regions like Asia, and how do you see Facebook differentiating itself, and maybe changing the user behavior from some of the newer companies that have aggregated a large number of users in the space? And then my second question is just for David in regards to seasonality of ad revenue, it obviously typically declines in Q1, I'm just wondering if we are at the point now where we should see seasonality of mobile ad revenue in Q1. Thanks so much. + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook, Inc. - CEO [7] +-------------------------------------------------------------------------------- + + So I can talk to Messenger, a bit. If you think about the overall space of sharing and communication, there's not just one thing that people are doing. People want to share, want to have the ability to share any kind of content with any audience. There are going to be a lot of different apps that exist, and Facebook has always had the mission of helping people share any kind of content with any audience, but historically we've done that through a single app. +And one of the stats that I shared today is that we now have more than 0.5 billion people using groups every month, and I think that's not something that I think a lot of people are paying attention to, because it was sort of seen as a feature of the Facebook app rather than its own product. So what we're doing with Messenger now, similarly a lot of people are using Messenger every day, but it's a feature of Facebook rather than its own network or standalone thing, and we are making it more of a standalone app. +We've actually, in the last quarter we've taken it out of the main app, so that way it gets room to breathe and blossom as its own great experience, and we're going to focus on making that really good and adding to it and adding a lot of new things, and some of the stats that I shared are incredibly promising. In the last few months, 70% more people are using it and a lot of message volume growth, so we are still focused on kind of general growth for Messenger rather than going country-specific at this point in its evolution. + +-------------------------------------------------------------------------------- +David Ebersman, Facebook, Inc. - CFO [8] +-------------------------------------------------------------------------------- + + And Heather, this is David. Thanks for your question on seasonality. Of course seasonality is an important factor in an advertising business, and affects Q4 and makes it a typically strong quarter. At this point, given how new we are with the mobile business, I think it's really difficult for us to quantify the impact of seasonality effects. I think I will take some more time before we can understand it better than we do. + +-------------------------------------------------------------------------------- +Operator [9] +-------------------------------------------------------------------------------- + + Mark May, Citibank. + +-------------------------------------------------------------------------------- +Mark May, Citigroup - Analyst [10] +-------------------------------------------------------------------------------- + + Thanks for taking my question. Just would love to get some updates on some of the efforts that you are making in terms of brand and real-time conversations. I think on the user side, we'd love to get some interest in terms of the usage and engagement with video content early on and real-time conversations, particularly around entertainment-related content. And then on the advertiser side, kind of early adoption by brand and TV-like advertisers, with some of the brand and video solutions that you have out there. +And then for David, given the significant transition that the business continues to go through that is affecting these ad impression and average price metrics, can you give us a sense of the breakdown between the ad impressions between desktop and mobile? Thanks. + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook, Inc. - CEO [11] +-------------------------------------------------------------------------------- + + I'll start here on the public content piece and then I think Sheryl will get into some of the specifics, but I just want to put this into the context of the overall strategy here. We were just talking about some of the standalone experiences and Messenger, and public content is part of this overall spectrum of content that people want to share and consume as well. In some ways it's on the opposite -- the complete opposite side of the spectrum from one-on-one messaging, but it's also an area where I think the medium of newsfeed and Facebook works really well. +So we've been focused on improving the tools for public discussion, and folks to be able to share public content, including premium content from videos and making it so they can autoplay in feed. And this is an area where just like messaging and some of the other things that we've talked about, and you should expect us to keep focusing on a lot, it's part of the overall space of sharing that we think is quite valuable. I think Sheryl is going to get into some specifics. + +-------------------------------------------------------------------------------- +Sheryl Sandberg, Facebook, Inc. - COO [12] +-------------------------------------------------------------------------------- + + Yes. I can start with video, and then go over to the overall brand question you started with. We have a video ads product, it works very well, it's part of what's driving our growth. +We also have recently started testing an auto play video ad test, it's a very small test. But overall, we are seeing what Mark has talked about, which is that marketers and users are using video more as they have the technology to do so, and we expect that to continue to grow. +In our overall brand effort we're making really good and steady progress as we are with all of our market segments. All of the AdAge Global 100 advertised with us over the past year, and the real key there is proving measurement to our clients. Our team led by Carolyn Iverson, and her people all around the world, really have to go client by client and show them that we can not just increase people's happiness or brand affiliation, but ring the cash register at the end of the door. +I think this is part of the big story for us in 2013, which is if you look back a year, we did not have that ability to look at the AB testers who saw our ads, and what the difference in sales is, and now we have that. And we still have a lot of hard work to do client by client ahead of us, but being able to prove that we have really strong ROI, and I think increasingly efficient ROI compared to the other marketing opportunities they have, is what is going to move the brand marketers to Facebook and to mobile. + +-------------------------------------------------------------------------------- +David Ebersman, Facebook, Inc. - CFO [13] +-------------------------------------------------------------------------------- + + Mark, yes, your second question about mobile and desktop impressions. As you know, per user, or per unit of time on the desktop, we show a higher number of ads because there's the right-hand column as in addition to newsfeed. But we are extremely pleased with how well the newsfeed ads continue to perform, and that's really what's driving up the average price per ad as I described. So these ads perform well from [others], are still continuing to contribute to the positive user experience that Mark described earlier. + +-------------------------------------------------------------------------------- +Operator [14] +-------------------------------------------------------------------------------- + + Anthony DiClemente, Nomura. + +-------------------------------------------------------------------------------- +Anthony DiClemente, Nomura Securities - Analyst [15] +-------------------------------------------------------------------------------- + + First for David, I wonder if you can comment on the ad load on Facebook. Do you expect it to continue to remain stable or is there a possibility that the ad load creeps up over time? And on Instagram, I know it's a new product, and you guys are taking it slowly at first, but I wondered if you could also talk about how long it might take for Instagram to get to a similar ad load to Facebook levels? +And then one last question for Sheryl, I wonder Sheryl, is there a way when you compare Facebook to television for brand marketers, to look at the disparity of ROI, or I should say the improved ROI for Facebook, and sort of extrapolate where you think pricing could go, obviously pricing doubling quite a bit? How much more upside to Facebook newsfeed pricing can we expect to see based on the ROI differential? Thanks. + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook, Inc. - CEO [16] +-------------------------------------------------------------------------------- + + I just want to start off here, and then David can get into some of the details on the number of ads and all that. But the strategy has been for the last period, and will continue to be, to primarily focus on increasing the quality of the ads and the experience. And I really think that -- it's easy to look at the model and say okay, well if we ran more ads then the business would grow faster in the short term. +But investing in quality is really actually the most important thing because it's what improves the experience for the people who use the products. It drives greater returns for advertisers, and over time it increases the potential size of our business. I think you could say that's a harder path for us to take, but I actually think that the results over the last couple of quarters have really shown that by focusing on improving quality instead of just increasing quantity, we can actually drive pretty incredible business results. So we think that there is more to do here, and that is what we are going to keep on doing. + +-------------------------------------------------------------------------------- +David Ebersman, Facebook, Inc. - CFO [17] +-------------------------------------------------------------------------------- + + And I think I can take most of the rest of this. So in terms of ad load, the one piece of context maybe to start with is that the variable we are really focused on optimizing is not ad load per se but it's the user experience, as you can measure that based on engagement or user feedback, et cetera. And ad load is one of the variables that impacts that, but there is relevant variables as well, such as the positioning of the ads, the size of the ads, and of course, critically, the quality of the ads, so ad load only gives a part of the picture. And we are really one or two years into this and we're still learning how to provide the best experience. +I think one of the most important pieces of positive news from 2013 was as we ramped up newsfeed ads, they performed as well as they did delivering great value for marketers, having a very minimal effect on the user experience, and enabling Facebook to deliver the kind of results that we reported today. So going forward we'll continue to tweak what we do in terms of trying to find the right balance and optimize the performance of the ads for marketers and for users, but generally, as Mark said, the most important place for us to invest is going to be in improving the quality and relevance of the ads. +You asked about Instagram and pricing, so let me just cover those quickly. Instagram, I would just say we're just really early with Instagram, so it's too early to talk about where we are going to be going. We're still trying to learn what the right way to approach that product is, and we're going to move slowly, because we think that's the right thing to do for Instagram. +In terms of pricing, it was our expectation that if ads in newsfeed worked well, that they would deliver more value for marketers, be more engaging, and that they would contribute to the average price per ad on Facebook going up. And we also believe looking forward, if we continue to improve the quality and relevance of the ads we show, that that's a critical way that we can drive pricing up in the future. + +-------------------------------------------------------------------------------- +Operator [18] +-------------------------------------------------------------------------------- + + Douglas Anmuth, JPMorgan. + +-------------------------------------------------------------------------------- +Douglas Anmuth, JPMorgan - Analyst [19] +-------------------------------------------------------------------------------- + + I just wanted to ask two things. First, you announced an initiative, or perhaps an algorithm tweak I think in early December to have more news stories in users' feeds, and I was just curious what the adoption has been thus far from users there, and what are the implications on usage and engagement, and then also ad load? And then secondly, can you give us an update on teen engagement trends? Thanks. + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook, Inc. - CEO [20] +-------------------------------------------------------------------------------- + + Sure. So to start with the public content, the change that we made is basically -- a lot of what our algorithm looks at is straight engagement, so the amount of content that people click, like, comment, and share, in feed. But what we found were that when we asked people qualitatively what they preferred getting, it did not often match up, because a lot of things like memes scored very high in terms of getting a lot of people to like them, but were not necessarily when you asked people what they wanted to see in feed or what they were happy seeing, didn't score that way. +So we ended up doing an adjustment to the algorithm which made it so that qualitatively things, and especially public content and news that people rated as higher quality, qualitatively scored more, and that was basically the adjustment to the algorithm. It had really no impact on ads, it was an organic content adjustment that we made to improve the quality of the experience. So I think David can talk about teens. + +-------------------------------------------------------------------------------- +David Ebersman, Facebook, Inc. - CFO [21] +-------------------------------------------------------------------------------- + + Sure Doug. In terms of teens, don't have any new data to report today. As you know we take engagement very seriously, and we are focused on building great products that all our users, including teens, will find useful and engaging, and that's the most important thing for us to stay focused on. + +-------------------------------------------------------------------------------- +Operator [22] +-------------------------------------------------------------------------------- + + Scott Devitt, Morgan Stanley. + +-------------------------------------------------------------------------------- +Scott Devitt, Morgan Stanley - Analyst [23] +-------------------------------------------------------------------------------- + + I had a couple product questions for Mark. The first one on Graph Search, just wondering how users are engaging with the product, how developed the product is in terms of the way, what we can see today relative to what your longer-term aspirations are for the product? +And just to follow-up on Doug's question, related to the news flow integration into newsfeed. Another feature that's been added more recently is trending, and attaching trending to news articles and newsfeed as well. So if you could talk more broadly about your interest in real time information and news as it relates to public content, that would be helpful. Thank you. + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook, Inc. - CEO [24] +-------------------------------------------------------------------------------- + + Graph Search. Starting with Graph Search, we are really early in the game on this. And I think you can see that, because we haven't even really rolled out our mobile version of Graph Search yet and we are a mobile company. We started on desktop, and the way that we are thinking about this is, there is just so much content that people have shared on Facebook that simply building the infrastructure to index all of it and start ranking it is a multi-year effort, which we are making our way through. +So the first release indexed more than 1 trillion connections between all the people and interests, and events and groups and things that everyone was connected to. The second release that we did recently was around all the updates. There are more than 1 trillion status updates and unstructured text posts and photos and pieces of content that people have shared over the past 10 years, and indexing that was a really big deal, because as the number of people on the team who have worked on web search engines in the past have told me, 1 trillion pieces of content is more than the index in any web search engine. +So we're kind of making our way through this. Pretty soon I think you should expect us to roll out the mobile version of this. I think that's going to be an important step because most of the usage and of Facebook overall is on mobile, so we expect that's where engagement will really start to come from on Graph Search over time. +But it's also only in English so far and we have to internationalize it, and there's a long road map of things that we need to do that I think is pretty clear, but it's just going to be incredibly useful when it's ready. So we look at this as an investment over a three to five-year period rather than a one to two or shorter kind of period. So that's how I think about that. +The other question was about trending topics, and that really ties into the public content push that we have, and we talked a bit about this before. But in terms of -- we're trying to build great experiences for all types of content that people want to share and consume with all audiences. +We think public content is great. Folks who are making news or making -- premium content on TV or movies or celebrities and different types of folks are extremely interesting, and produce great content. We want to be a great place for people to share the content, or for people to be able to learn about it and consume it, so trending topics is one step in what you will see is a pretty long road map of things that we're going to do to make Facebook great for public content. + +-------------------------------------------------------------------------------- +Operator [25] +-------------------------------------------------------------------------------- + + Eric Sheridan, UBS. + +-------------------------------------------------------------------------------- +Eric Sheridan, UBS - Analyst [26] +-------------------------------------------------------------------------------- + + First of all for Sheryl, I would like to get an update on how the company is thinking about mobile retargeting ads, you've seen a lot of success with retargeting on desktop, but how you can think about the evolution of retargeting in the mobile environment as a future product. And then second question for Mark, not a lot of talk on the payments business so far on the call, and just want to understand maybe an update around games or other areas of e-commerce that you think are opportunities for the payments business. Thanks. + +-------------------------------------------------------------------------------- +Sheryl Sandberg, Facebook, Inc. - COO [27] +-------------------------------------------------------------------------------- + + On retargeting, retargeting has been proven really valuable across all platforms. We've allowed it through FBX, and increasingly we are allowing it through our own products as well as part of our custom audiences suite of offerings. We are offering website custom audiences and mobile app custom audiences and allow -- and these all allow marketers to target ads in privacy safe ways that improve the relevance and improve results. I think when people think about targeting, what they are really thinking about is relevance, and taking the data and using it in a privacy-safe way to increase the relevance of ads to users, and that's something we're working on. + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook, Inc. - CEO [28] +-------------------------------------------------------------------------------- + + Yes, for payments -- I actually -- we don't think about our business so much as an advertising or a payments business, as much as a way for people to reach -- we build this network, and we help businesses reach people with relevant messages. And payments historically has been a great way for game developers, especially on desktop to -- an efficient way for us to monetize that business because instead of charging them up front for most of the ads, we can charge them only when their business grows because someone is paying for something. On mobile I think the natural evolution of this is for that to move towards app install ads, where we are not running the payment system on mobile, the operating systems are integrated with that. +But because a lot of the goods that people are buying in games are no marginal cost, a developer's economic incentive is to advertise to the point where, or to get more people to come into their flow to the point where -- for as many people as they can get to the buy the goods. So even though a game developer might be paying 30% to the operating system maker for payment, we're finding that people also really want to buy a lot of app install ads, and that has grown incredibly quickly and is one of the best parts of the ad work that we did over the last year. + +-------------------------------------------------------------------------------- +Operator [29] +-------------------------------------------------------------------------------- + + John Blackledge, Cowen and Company. + +-------------------------------------------------------------------------------- +John Blackledge, Cowen and Company - Analyst [30] +-------------------------------------------------------------------------------- + + Two questions. First, Mark, you referenced 2014 as a year of rolling out new, engaging mobile products. Maybe could you provide some color or highlight the types of products that users can expect, or maybe how you think about improving mobile engagement? And then just on Instagram, could you give us an update on the number of monthly active users ending 2013, and give us a sense of how the beta testing is going with advertisers and when it might be available for all advertisers? Thanks. + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook, Inc. - CEO [31] +-------------------------------------------------------------------------------- + + Sure. Before I get into some of the newer types of things, which we've actually touched on most of them already on the call, I also want to take a moment just to emphasize that we are going to start building new experiences, but they're going to start small compared to where the core of Facebook is, right? So most of the results that we are going to see in terms of increasing engagement and sharing in our business are going to come from that core Facebook experience, because mathematically it's just so much bigger than everything else that is out there that the numbers -- these have to be multi-year investments to add up to that. +You can look at, for example, comScore puts out these numbers every month or so that reference the amount of time that people spend in different mobile apps, and Facebook I think is almost 10 times bigger, 5 to 10 times bigger than the next app that is out there. So it's going to take a while for any of these things to turn into huge things, but that's -- so some of the things that we are thinking about are all of the different kinds of ways that people might want to share different kinds of content with different audiences. +So I mean I talked about groups earlier on the call, that's something that 0.5 billion people are using, it's currently a feature within the Facebook app. Giving experiences like that room to breathe and really develop to be their own brand I think is a huge and valuable thing. It's not necessarily the next thing that we're going to go do, but it's kind of an example of the type of audience and type of content that people might want to share. +Examples of things that we have done are Messenger, is a really big focus for us and we are focusing on that as a standalone experience. Instagram is a different kind of community than Facebook. We just launched Instagram Direct within Instagram, which is one-on-one or small group photo and video sharing, and you can kind of view that as the kind of experience that we're going to be rolling out, but there's a lot of space here for a lot of different kinds of things. +And what I think you should take away from this is that while the core business growth is going to come from the main app that exists, just because the numbers are so much bigger than everything else today that's just going to be where most of the momentum comes from, you should also expect us to start building a few of these other things that we'll focus on over a long period of time and hopefully build into meaningful things like Messenger and Instagram are today. + +-------------------------------------------------------------------------------- +Operator [32] +-------------------------------------------------------------------------------- + + Brian Pitz, Jefferies. + +-------------------------------------------------------------------------------- +Brian Pitz, Jefferies & Company - Analyst [33] +-------------------------------------------------------------------------------- + + Mark, last week on the Facebook developers blog there was an entry that noted you were testing placement of ads in third-party mobile apps. Just wondering if you could provide an update on how these tests may be going? And then separately, it appears that the growth on desktop ads reaccelerated during the quarter. Can you talk a bit about the drivers of that here? Thanks. + +-------------------------------------------------------------------------------- +Sheryl Sandberg, Facebook, Inc. - COO [34] +-------------------------------------------------------------------------------- + + On the Facebook ads in third-party mobile apps, it's a small test we just started that aims to show Facebook ads off of Facebook for mobile apps, so we don't have results yet. We are very excited about the mobile apps space in general. If you look at our mobile app installation ad, we've really done a great job working with developers to help users discover and download their apps. +,And the product we rolled out last quarter, which is the engagement ads, then help developers get people engaged or reengaged in their apps. And so it's a small, important and growing space and we feel really good about the progress we've made with those ads on Facebook. When you look at off Facebook, really early test. + +-------------------------------------------------------------------------------- +David Ebersman, Facebook, Inc. - CFO [35] +-------------------------------------------------------------------------------- + + This is David, in terms of desktop, I'd say the two trends that really benefited desktop in the fourth quarter were similar to what we described earlier. One was just the holiday strength that we saw the business, and the second was the strong performance of newsfeed ads, which we show on both mobile and desktop, so that worked well for us in the fourth quarter. Just recognizing still that the user numbers on desktop continue to sort of decline modestly overall, and that's obviously an important headwind for the revenue from that part of the business. + +-------------------------------------------------------------------------------- +Operator [36] +-------------------------------------------------------------------------------- + + Ross Sandler, Deutsche Bank. + +-------------------------------------------------------------------------------- +Ross Sandler, Deutsche Bank - Analyst [37] +-------------------------------------------------------------------------------- + + Mark, I had a follow from one of the previous questions on closing the loop in mobile. You guys have made a lot of progress improving the total mobile ad experience, yet there is still a lot of friction in downloading apps and making purchases today. You guys have recently rolled out some new ad formats, and you have some partnerships with the likes of Braintree and Stripe, and some of the other payment guys. +So what's your vision for removing some of this friction for marketers, and do you envision a scenario where users can buy physical or digital products within the Facebook mobile apps? Thanks. + +-------------------------------------------------------------------------------- +Sheryl Sandberg, Facebook, Inc. - COO [38] +-------------------------------------------------------------------------------- + + I can take this. Obviously the mobile app world is a new world and not just the functionality in ads are still developing, but the functionality of what then people can do. You can do a lot more on the desktop in many ways than you can on mobile. +I think the best role we play is to help connect consumers with marketers, and with companies and services, and I think reducing the friction there is really important. We don't have any plans to go into the direct e-commerce market, because the advertising products we provide I think are the best thing we can provide to help grow this market. + +-------------------------------------------------------------------------------- +Operator [39] +-------------------------------------------------------------------------------- + + Tom Forte, Telsey Advisory Group. + +-------------------------------------------------------------------------------- +Tom Forte, Telsey Advisory Group - Analyst [40] +-------------------------------------------------------------------------------- + + Congrats on a great quarter. On contextual advertising, this is essentially the holy grail for Facebook, and I think you understand this. Can you talk about where we are as far as innings are getting contextual ads, and can you talk about the role that Instagram plays with visually appealing ads, and the role that video plays? Thank you. + +-------------------------------------------------------------------------------- +Sheryl Sandberg, Facebook, Inc. - COO [41] +-------------------------------------------------------------------------------- + + As I said and I've talked about each quarter targeting is a huge issue for us, and a huge opportunity and challenge. Our goal is in a privacy-safe way to get information we can about what consumers want and then help connect marketers, so that the ad experience is great for users, we're serving relevant ads. Whether that information comes from the kind of things people like on Facebook or other websites they visit, or contextual statements they might make in their status updates, our goal is to use that information in a privacy-safe way to improve the targeting of the ads on Facebook. +To take one example, if you look at what's happening with our direct response business, which has been a very strong segment for us, if you look at people trying to find consumers, we offer the opportunity to get people before they search. We can judge interest based on other things, other things they are interested in, and give people the opportunity to find consumers before they search, so that they can then move them all the way down the funnel into purchase. + +-------------------------------------------------------------------------------- +Operator [42] +-------------------------------------------------------------------------------- + + Jordan Rohan, Stifel. + +-------------------------------------------------------------------------------- +Jordan Rohan, Stifel Nicolaus - Analyst [43] +-------------------------------------------------------------------------------- + + I'm curious if you could help me understand the international market development and monetization for Facebook's ad platform? Specifically can you speak to the build out of the international direct sales force, the channel partners, the number of international markets in which FBX is operational, and the extent of geographic rollout of the cost per install ad units in the newsfeed? Is that available everywhere? Where are we compared to the US? Thanks. + +-------------------------------------------------------------------------------- +Sheryl Sandberg, Facebook, Inc. - COO [44] +-------------------------------------------------------------------------------- + + The build out globally is going well. We've always been pretty conservative. We wait until we have a very strong user base in other countries, and we wait until there's a developed ad market, but we're growing. We have a PMD ecosystem which now covers 45 countries. +I was actually in Turkey at the beginning of last week, and had a chance to meet with our advertising partners there, and they are increasingly using our platform to reach consumers. We are growing our offices, we are growing our offices in Asia particularly this year, and we've rolled out offices across Europe as well. In terms of rolling out products, we tend to roll out products in our most developed markets first, and as we extend those products, we then extend them to the rest of the world. + +-------------------------------------------------------------------------------- +Operator [45] +-------------------------------------------------------------------------------- + + Colin Sebastian, Robert Baird and Company. + +-------------------------------------------------------------------------------- +Colin Sebastian, Robert W. Baird & Co. - Analyst [46] +-------------------------------------------------------------------------------- + + I just had a couple of questions. The first one on app install ads, if you could quantify how much those are driving growth in newsfeed advertising, and if not specifically, maybe on a relative basis to other mobile ad formats. And then second, Mark, the company has made some interesting hires in the area of machine learning, and I'm curious if you would characterize how important this initiative is for the Company, and how you think that AI will help Facebook over time? Thanks. + +-------------------------------------------------------------------------------- +Sheryl Sandberg, Facebook, Inc. - COO [47] +-------------------------------------------------------------------------------- + + On the first, we are excited about our mobile app install ads and our mobile app engagement ads. It's a small but growing category. We don't split out by segment. +But one thing that's really important to note is that our mobile ad strength is very broad-based. Our mobile ads are not just bought by people who are looking to drive engagement or usage of mobile apps, but is very broad-based. We're being used by SMBs, brand advertisers, and direct response advertisers as well. + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook, Inc. - CEO [48] +-------------------------------------------------------------------------------- + + Yes, and I can speak to some of the deep learning work. In the last quarter, Yann LeCun, one of the, really, the earliest folks, and one of the founders of deep learning and a professor at NYU, joined us to lead our AI Group. And this is a long-term research group that we have that -- it's going to fit into our strategy over a longer -- maybe a 5 or 10-year period. +And their goal is really just to try to understand how everything on Facebook is connected, right, by understanding what the posts that people write mean, and the content that is in the photos and videos that people are sharing, and help people with tasks. Like if you're sharing a voice clip in Messenger, being able to transcribe that for people so that they can receive it more easily. +So these are some pretty big tasks in AI that are things that we have teams that are working on that will need to be researched over time and will have obvious implications for the products that we do. But over time the real value will be if we can understand the meaning of all of the content that people are sharing; then we can just provide much more relevant experiences for people across everything that we do. +So I think you can kind of think about this, internally we talk about our strategy and if there's a 3-year strategy, a 5-year strategy, and a 10-year strategy, and the 3-year plan is really all about building new kinds of expenses for sharing like so many of the questions on this call have been about. The 5-year approach is really mostly about helping people use their network to answer interesting questions or solve problems that they have. And that's where all the Graph Search work, and the open graph work, and some of the early parts of the AI work that we're doing you're going to start to see over that period of time. +And then over a 10-year period I think you'll really start to see a lot of the impact of some of the Internet.org work that we're doing where, hopefully, we'll see some impact a lot sooner than that as well. But over a 10-year period, if we can get a lot more of the world on the internet, that's going to really mean a quite different world in terms of what folks in a lot of developing countries have access to, in terms of some of the things I've said in my opening remarks around basic financial services, and people can get credit to start businesses and buy homes, really life changing stuff, or get access to health information, or education materials, which I think are just a really big deal. And over the long-term we've always wanted to help out with that, and I think that's where we are going to go on that. + +-------------------------------------------------------------------------------- +Deborah Crawford, Facebook, Inc. - Director, IR [49] +-------------------------------------------------------------------------------- + + Operator, we have time for one last call -- one last question. + +-------------------------------------------------------------------------------- +Operator [50] +-------------------------------------------------------------------------------- + + Mark Mahaney, RBC. + +-------------------------------------------------------------------------------- +Mark Mahaney, RBC Capital Markets - Analyst [51] +-------------------------------------------------------------------------------- + + David, could you just talk about the sustainability of the gross margins that you had in the quarter, seemed pretty high? And then Mark, I know this question, hopefully this isn't redundant, when you think about the potential for ad quality at Facebook over the next three to five years, and you've gone through a lot of learnings over the last many years, or I guess two years on ads quality, how do you think about what the upside is? +I know that is a broad general question, but you think about all the different drivers, have there been certain moments when you've seen real gap opportunities? Are there any proxies out there that you see that you say well this is where Facebook could be, any thoughts on how much higher, how much better over the years ad quality could be on Facebook? Thank you. + +-------------------------------------------------------------------------------- +David Ebersman, Facebook, Inc. - CFO [52] +-------------------------------------------------------------------------------- + + So Mark, I'll start with the question on gross margins. I think in Q4, as you know, gross margins tend to be seasonally strong because revenue goes up in the fourth quarter, and the costs associated with operating our infrastructure don't go up accordingly with the seasonal strength in advertising revenue. So directionally, I think it's important to note we really had a great year in 2013 in terms of the efficiency investments that we made, but going forward, this is a compute-heavy service that we provide. It requires a lot of data centers and servers and infrastructure, we're going to continue to invest in those things, and we do expect to increase our infrastructure costs over time while trying to do that as efficiently as possible. + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook, Inc. - CEO [53] +-------------------------------------------------------------------------------- + + And in terms of quality, I just think that there is a lot of room to grow here. I said in my opening remarks that we have this long-term goal of making the advertising quality or content as good, and as relevant and timely, as the content that your friends are sharing with you. And at first blush, I think that seems kind of crazy, and that your friends' stuff will obviously always have the advantage of being immediately socially relevant to you, but at the same time, a lot of the folks who are advertising really invest in the quality of the content that they're producing and putting into their ads, and improving the targeting of their ads to deliver the right messages to the right people. And I don't think that there's a single step function that we're going to see here, although there are things like the video formats that really enable new kinds of rich experiences that folks who invest in building those can really benefit from. +But at the same time, I think a lot of this is going to be incremental. So as we make improvements, more advertisers come into the system, and as more advertisers come into the system, we have more options of relevant content to show to people, and that improves the quality as well. So this is just going to be something that we are going to focus on for a while, and there's a long way to go before we get to the quality level that we want, but I think over a multi-year period we can get there or at least very close. + +-------------------------------------------------------------------------------- +Sheryl Sandberg, Facebook, Inc. - COO [54] +-------------------------------------------------------------------------------- + + And it's a nice way to end the call because one of the really big opportunities we have is to make these ads at scale more personal. So just as we can have social context obviously from the user content, we put social context into ads. So we can take these ads that marketers can deliver at scale, improve the targeting, and give them social context, which will help drive the kind of opportunities Mark is talking about to make the ads as relevant as the user content. + +-------------------------------------------------------------------------------- +Deborah Crawford, Facebook, Inc. - Director, IR [55] +-------------------------------------------------------------------------------- + + Thank you for joining us today. We appreciate your time, and we look forward to speaking to you again next quarter. + +-------------------------------------------------------------------------------- +Operator [56] +-------------------------------------------------------------------------------- + + This concludes today's conference call. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/exam/original-files/Problem_1_Sample/2014-Jan-30-AMZN.OQ-141027717464-Transcript.txt b/exam/original-files/Problem_1_Sample/2014-Jan-30-AMZN.OQ-141027717464-Transcript.txt new file mode 100644 index 0000000..4b9a31f --- /dev/null +++ b/exam/original-files/Problem_1_Sample/2014-Jan-30-AMZN.OQ-141027717464-Transcript.txt @@ -0,0 +1,685 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q4 2013 Amazon.com Inc Earnings Conference Call +01/30/2014 02:00 PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Tom Szkutak + Amazon.com Inc - CFO + * Dave Fildes + Amazon.com Inc - Senior Manager, IR + +================================================================================ +Conference Call Participiants +================================================================================ + + * Robert Coolbrith + CRT Capital - Analyst + * Tom Forte + Telsey Advisory Group - Analyst + * Scott Devitt + Morgan Stanley - Analyst + * Justin Post + BofA Merrill Lynch - Analyst + * Greg Melich + ISI Group - Analyst + * Chad Bartley + Pacific Crest Securities - Analyst + * Brian Pitz + Jefferies & Company - Analyst + * Douglas Anmuth + JP Morgan - Analyst + * John Blackledge + Cowen and Company - Analyst + * Youssef Squali + Cantor Fitzgerald - Analyst + * Gene Munster + Piper Jaffray & Co. - Analyst + * Heath Terry + Goldman Sachs - Analyst + * Ronald Josey + JMP Securities - Analyst + * Mark Mahaney + RBC Capital Markets - Analyst + * Brian Nowak + Susquehanna Financial Group - Analyst + * Ross Sandler + Deutsche Bank - Analyst + * Mark May + Citi - Analyst + * Carlos Kirjner + Sanford C. Bernstein & Company, Inc. - Analyst + +================================================================================ +Presentation +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Thank you for standing by. Well, good day, ladies and gentlemen, and welcome to the Amazon.com Q4 2013 financial results teleconference. +(Operator Instructions) +Today's conference is also being recorded. +Now for opening remarks, I will turn the call over to the Senior Manager of Investor Relations, Dave Fildes. Please go ahead, sir. + +-------------------------------------------------------------------------------- +Dave Fildes, Amazon.com Inc - Senior Manager, IR [2] +-------------------------------------------------------------------------------- + + Hello, and welcome to our Q4 2013 financial results conference call. +Joining us today is Tom Szkutak, our CFO. We will be available for questions after our prepared remarks. +The following discussion and responses to your questions reflect management's views as of today, January 30, 2014 only, and will include forward-looking statements. Actual results may differ materially. Additional information about factors that could potentially impact our financial results is included in today's press release, and our filings with the SEC including our most recent annual report on Form 10-K. As you listen to today's conference call, we encourage you to have our press release in front of you, which includes our financial results, as well as metrics and commentary on the quarter. +During this call, we will discuss certain non-GAAP financial measures. In our press release, slides accompanying this webcast, and our filings with the SEC, each of which is posted on our IR website, you will find additional disclosures regarding these non-GAAP measures, including reconciliations of these measures with comparable GAAP measures. +Finally, unless otherwise stated, all comparisons in this call will be against our results for the comparable period of 2012. +Now I will turn the call over to Tom. + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com Inc - CFO [3] +-------------------------------------------------------------------------------- + + Thanks, Dave. +I will begin with comments on our fourth quarter financial results. Trailing 12-month operating cash flow increased 31% to $5.47 billion. Trailing 12-month free cash flow increased to $2.03 billion. Trailing 12-month capital expenditures were $3.44 billion. The increase in capital expenditures reflects additional investments in support of continued business growth, consisting of additional capacity to support our fulfillment operations, and investments in technology infrastructure, including Amazon Web Services. +Return on invested capital was 13%, up from 4%. ROIC is TTM free cash flow, divided by average total assets minus current liabilities, excluding the current portion of long term debt over five quarter ends. The combination of common stock, and stock-based awards outstanding was 476 million shares, compared with 470 million shares one year ago. +Worldwide revenue grew 20% to $25.59 billion, or 22% excluding the $258 million unfavorable impact from the year-over-year changes in foreign exchange. Media revenue increased to $7.23 billion, up 11% or 13% excluding foreign exchange. EGM revenue increased to $17.13 billion, up 23% or 24% excluding foreign exchange. +Worldwide EGM increased to 67% of worldwide sales, up from 65%. Worldwide paid unit growth was 25%. Active customer accounts exceeded 237 million. Worldwide active seller accounts were more than 2 million. Seller units represented 39% of paid units. +Now I will discuss operating expenses excluding stock-based compensation. Cost of sales was $18.81 billion, or 73.5% of revenue compared with 75.9%. Fulfillment, Marketing, Technology and Content and G&A combined were $5.9 billion or 23.1% of sales, up approximately 210 basis points year-over-year. Fulfillment was $2.84 billion or 11.1% of revenue, compared with 10.3%. Tech and Content was $1.69 billion, or 6.6% of revenue, compared with 5.7%. Marketing was $1.11 billion or 4.3% of revenue, compared with 3.9%. +Now I will talk about our segment results, and consistent with prior periods we do not allocate the segments or stock-based compensation, or other operating expense line item. In the North America segment revenue grew 26% to $15.33 billion. Media revenue grew 21% to $3.51 billion. EGM revenue grew 25% to $10.65 billion, representing 69% of North America revenues, down from 70%. Other revenue grew 52% to $1.17 billion. +North America segment operating income increased 19% to $725 million, a 4.7% operating margin. In the International segment, revenue grew 13% to $10.26 billion. Adjusting for the $244 million year-over-year unfavorable foreign exchange impact, revenue growth was 15%. Media revenue grew 3% to $3.71 billion, or 6% excluding foreign exchange, and EGM revenues grew 19% to $6.48 billion, or 21% excluding foreign exchange. EGM now represents 63% of International revenues, up from 60%. +International segment operating income increased 116% to $151 million, a 1.5% operating margin. Excluding the unfavorable impact from foreign exchange, International segment operating income increased 119%. +CSOI increased 29% to $876 million or 3.4% of revenue, up approximately 20 basis points year-over-year. Excluding the unfavorable impact of foreign exchange, CSOI increased 28%. Unlike CSOI, our GAAP operating income includes stock-based compensation expense and other operating expense. GAAP operating income increased 26% to $510 million, or 2% of net sales. Our income tax expense was $179 million, resulting in a 40% tax rate for the quarter, and a 32% rate for the full-year of 2013. GAAP net income was $239 million, or $0.51 per diluted share, compared with $97 million and $0.21 per diluted share. +Now I will discuss our full year results. Revenue grew 22% to $74.45 billion, or 24% excluding the impact of foreign exchange. North America revenue grew 28% to $44.52 billion, and International revenue grew 14% to $29.94 billion, or 19% growth excluding year-over-year changes in foreign exchange. Consolidated segment operating income, or CSOI, increased 20% to $1.99 billion, or 21% excluding the unfavorable year-over-year impact from foreign exchange, and the operating margin was 2.7%, consistent with the prior year. GAAP operating income increased 10% to $745 million or 1% of net sales. +Turning to the balance sheet, cash and marketable securities increased $1 billion year-over-year to $12.45 billion. Inventory increased 23% to $7.41 billion, and inventory turns were 8.9, down from 9.3 turns a year ago, as we expanded selection, improved in-stock levels, and introduced new product categories. Accounts payable increased 14% to $15.13 billion. Accounts payable days decreased to 74, from 76 in the prior year. +I will conclude my portion of today's call with guidance. Incorporated into our guidance, are the order trends that we have seen to date, and what we believe today to be appropriately conservative assumptions. Our results are inherently unpredictable, and may be materially affected many factors, including a high level of uncertainty surrounding exchange rate fluctuations, as well as the global economy, and consumer spending. It is not possible to accurately predict demand, and therefore our actual results could differ materially from our guidance. +As we have described in more detail in our public filings, issues such as settling intracompany balances, and foreign currencies amongst those subsidiaries, unfavorable resolution of legal matters, and changes to our effective tax rates can all have a material effect on guidance. Our guidance further assumes that we don't conclude any additional business acquisitions, investments, restructuring, or legal settlements, record any further revisions to stock-based compensation estimates, and that foreign exchange rates remain approximately where they been recently. +For Q1 2014, we expect net sales of between $18.2 billion and $19.9 billion, or growth of between 13% and 24%. This guidance anticipates approximately 30 basis points of unfavorable impact from foreign exchange rates. GAAP operating income or loss to be between a $200 million loss and $200 million income, compared with $181 million income in the first quarter of 2013. This includes approximately $350 million for stock-based compensation and amortization of intangible assets. We anticipate consolidated segment operating income which excludes stock-based compensation and other operating expense to be between $150 million and $550 million, compared with $441 million in the first quarter of 2013. +We launched Prime in the US nine years ago, with free, unlimited two-day shipping on 1 million items, and an annual membership price of $79. Today Prime selection has grown to over 19 million items. Even as fuel and transportation costs have increased, the $79 price has remained the same. We know that customers love Prime, as their usage of the shipping benefit has increased dramatically since launch. On a per customer basis, Prime members are ordering more items, across more categories, with free two-day shipping than ever before. +With the increased cost of fuel and transportation, as well as the increased usage among Prime members, we are considering increasing the price of Prime between $20 to $40 in the US. We remain heads down focused on driving a better customer experience through price, selection, and convenience. We believe putting customers first is the only reliable way to create lasting value for shareholders. +Thanks. And with that, Dave let's move to questions. + +-------------------------------------------------------------------------------- +Dave Fildes, Amazon.com Inc - Senior Manager, IR [4] +-------------------------------------------------------------------------------- + + Great. Thanks, Tom. Let's move on to the Q&A portion of the call. Operator, will you please remind our listeners how to initiate a question? + + + +================================================================================ +Questions and Answers +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Absolutely, Mr. Fildes. +(Operator Instructions) +Our first question will come from Mark May with Citi. + +-------------------------------------------------------------------------------- +Mark May, Citi - Analyst [2] +-------------------------------------------------------------------------------- + + Thanks for taking my questions. The unit growth in the quarter, I believe, was around 25%, which was a deceleration, notable versus the last couple of quarters, I believe the comp even got a little easier. Any -- can you give, provide any color as to the dynamics in the quarter that may have drove that? +And then, try to get a sense of how to think about the magnitude of the Prime price increase? Maybe if you could give us a sense of the base of subscribers that that would be applied to? And then lastly, on shipping demand, is there anything that Amazon will do differently next holiday season to try to smooth out the pace of demand late in the holiday shopping season? + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com Inc - CFO [3] +-------------------------------------------------------------------------------- + + First, the unit growth, you are right. It was 25% year-over-year, it is a deceleration, a small deceleration from the last couple quarters. Keep in mind, that it is our -- certainly, our biggest quarter, the most seasonal. And so, both from a revenue and from a unit standpoint, you saw a deceleration from Q3 to Q4 of 2012 also. And so, we saw a deceleration, not of the same magnitude we saw back in 2012, from Q3 to Q4. But if you take a look at the total growth, it is 25% on a unit basis, 22% ex exchange on a revenue basis. +We saw very good growth in North America, up 26%. This is again, on a revenue basis. It is down sequentially a little bit in the last couple quarters, but certainly up from Q4 last year where we grew 23%. In the International, the revenue was up about 15% ex exchange. If you look at the pieces, certainly one of the biggest things you are seeing is -- if you look at the Media growth, and our digital categories within Media and International it is growing very fast. +But as we have been talking about for quite some time, certainly a shift going from physical to digital. You see that reflected in our North America Media growth rates. The reason why you don't see it as much in our International is because we are at the very early stages of that. So that is what you are seeing, in terms of the differential up, certainly one of the key differentials between the International Media growth rate, and the North America growth rate. Also keep in mind, in other revenue, the AWS revenue which is growing very fast, is recorded in the North America segment. +In terms of the Prime -- in terms of impact, I am sorry, I can't help you with the impact on the US. What we have said is, globally, we have tens of millions of customers, and we certainly have been offering Prime in the US longer than International. And both segments are growing very fast from a Prime perspective, if that is helpful. And then, from a customer standpoint during Q4, we worked very hard on behalf of customers to make sure that we can service them. I think the team did a very nice job. We will continue to work on that to get even better in future quarters, and in future Q4's going forward. + +-------------------------------------------------------------------------------- +Operator [4] +-------------------------------------------------------------------------------- + + Our next question will come from Neil Doshi with CRT Capital. + +-------------------------------------------------------------------------------- +Robert Coolbrith, CRT Capital - Analyst [5] +-------------------------------------------------------------------------------- + + Good afternoon. This is actually Robert on the call for Neil. A couple questions. If you could maybe talk a little bit about the impact of refunds or incentives given to customers to make up for some of the goods that arrived late in the holiday season? Also on Prime, with respect to the increase, would you consider phasing that in, applying to perhaps just the new members at first? And also, would you consider giving an installment option to maybe soften the blow? Thank you. + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com Inc - CFO [6] +-------------------------------------------------------------------------------- + + Yes in terms of the refunds, we did give some in the form of gift certificates, as well as refunding some shipping fees where fees were incurred by customers -- for that subset of customers who were impacted. So that is reflected in the Q4 results that you see today. +And in terms of details of how we would roll out the Prime price increase that we are considering, you will have to wait on that. But certainly, it is, as I have mentioned it is something that we haven't had any increase in the nine years. Customers certainly love Prime. The available units for shipment have grown dramatically from 1 million to over 19 million. Over the last nine years, we haven't had any price increase. +Customer usage on a per customer basis has gone up pretty dramatically, given the selection and the convenience of the service. So that is why we are considering -- of course, during this nine year period, shipping costs have gone up a lot. Fuel costs have gone up a lot. So that is certainly the basis for us taking a look at it. But in terms of the details, we will be back when we make those decisions back to customers. + +-------------------------------------------------------------------------------- +Operator [7] +-------------------------------------------------------------------------------- + + Moving on to Douglas Anmuth with JP Morgan. + +-------------------------------------------------------------------------------- +Douglas Anmuth, JP Morgan - Analyst [8] +-------------------------------------------------------------------------------- + + Great, thanks for taking the question. Just want to follow-up on Prime as well, and was hoping, Tom, that you could give us some color on how newer Prime members -- you have obviously added a lot of them over the recent quarters, but how newer cohorts of Prime members act relative to older cohorts? And in particular, if they convert sort of as quickly, and if they are spending on a similar kind of early trajectory as your more tenured Prime members? And then also, can you just comment on the -- I believe the constrained sign-ups in 4Q on Prime? Thanks. + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com Inc - CFO [9] +-------------------------------------------------------------------------------- + + Sure. In terms of details, I can't really give you a lot of color on the more recent versus the Prime members who have been with us for a long time, except to say that there is a lot of similarities, in terms of what we are seeing. So in other words, customers, when we launched Prime nine years ago, one of the things that we hoped for, was customers would do a lot more cross-shopping, that they would buy more from us. And we are seeing that trend also in more recent Prime additions again. So we are -- the program is growing very fast. We are very, very pleased with it, and we think it is great for the business as we look forward as well. In terms of -- what was the second part of the question again? + +-------------------------------------------------------------------------------- +Douglas Anmuth, JP Morgan - Analyst [10] +-------------------------------------------------------------------------------- + + 4Q, I think you talked about sign-ups being constrained in the quarter? + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com Inc - CFO [11] +-------------------------------------------------------------------------------- + + Yes, it -- again, we had very fast growth. We put a couple statistics out in our holiday, our release on the 26th, that you can refer to. But we had very strong growth, and we -- it did constrain it a bit, and customers like it. And again, there is a lot of demand for the service, and we are going to continue to make sure that we can satisfy customers there. And we thought it was appropriate to do so, to do that during Q4. + +-------------------------------------------------------------------------------- +Douglas Anmuth, JP Morgan - Analyst [12] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Operator [13] +-------------------------------------------------------------------------------- + + We will move on to Scott Devitt with Morgan Stanley. + +-------------------------------------------------------------------------------- +Scott Devitt, Morgan Stanley - Analyst [14] +-------------------------------------------------------------------------------- + + Hi, Tom. A couple questions starting with -- I will continue the trend with Prime questions first. You mentioned higher shipping costs being a driver of potentially higher prices in the US. The US Prime service is also the only one that has Kindle Lending Library and video, and was just wondering if potentially those additional services have led you to think about increasing price as well, to potentially further bolster either or both? +And then secondly, International CSOI has been on a glide path lower over the last few years. And as has that happened, the organic International growth rate has moderated during the same period. And I am just wondering, going back to the decision to embark on the International investment cycle, if you anticipated the current revenue growth rate that you are experiencing? And if not, where are the areas in the business where you could point to, that we would begin to see growth that is not yet evident in International business? Thank you. + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com Inc - CFO [15] +-------------------------------------------------------------------------------- + + Sure. In terms of the first part, we have added a lot of new services to Prime, beyond our -- the shipping benefits. You mentioned Kindle Owners' Lending Library, certainly video, Prime Instant Video, we are investing very heavily, and so those are certainly costly. Those aren't the reasons for the price increase that we are contemplating. Those are -- that decision again is just based on, we haven't done a price increase in nine years. Shipping costs have gone up, if you look back very considerably over the nine-year period. Customers like the service. They are using it a lot more. We have a lot more selection. They are using it a lot more. And so, that is the reason why we are looking at the increase. +In terms of International growth -- we -- the growth was solid, with revenue ex exchange at 15%. The unit growth was considerably faster than that, primarily because third-party growth was very strong, and certainly FBA is a component of that. And when you think about the capacity that we built it for, not only for our retail, but also for our third-parties, and we are able to offer our FBA items through Prime as well. So we are very happy with the capacity that we have built across the world, including our International operations, and that is reflected in the results that you are seeing. Certainly, one of the reasons why you are seeing the growth of operating income, up over 100% in Q4 for International, is because of the mix of third-party, certainly helping that. So it is a combination of a number of factors, but certainly that is one that is a significant call out. + +-------------------------------------------------------------------------------- +Scott Devitt, Morgan Stanley - Analyst [16] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Operator [17] +-------------------------------------------------------------------------------- + + Our next question comes from Justin Post with Bank of America Merrill Lynch. + +-------------------------------------------------------------------------------- +Justin Post, BofA Merrill Lynch - Analyst [18] +-------------------------------------------------------------------------------- + + Great. A couple things, I was hoping you could talk about your initiatives with AmazonFresh, what you are seeing in the Bay Area, and Los Angeles so far? Are you seeing more units per customer? And then, maybe talk a little bit about the International Kindle Stores. Could you start to see better Media results, as you have built out that infrastructure? Thank you. + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com Inc - CFO [19] +-------------------------------------------------------------------------------- + + Sure. In terms of Fresh in LA and the Bay Area, it is very, very early. We like what we see. Customers like the service. There has been good adoption. There has been good conversion from the Prime trials. And so, we are very pleased with what we are seeing there. But it is still very early. And so, we will have to -- you will have to stay tuned on that one. But again, it is very early, but we like what we see. +In terms of International Kindle Stores, yes, absolutely -- we are, to be very clear, if you look at the Kindle content growth in Q4 in International, it is very strong. It is just again, we are at the early stages of this cycle, from physical to digital. So the growth rate is very strong, and we saw similar type things, when we look back at the US, in terms of trends. But it is, again, it is -- we are at the earlier part of the cycle on that conversion. + +-------------------------------------------------------------------------------- +Justin Post, BofA Merrill Lynch - Analyst [20] +-------------------------------------------------------------------------------- + + Great. Thank you. + +-------------------------------------------------------------------------------- +Operator [21] +-------------------------------------------------------------------------------- + + We will now hear from Brian Nowak with Susquehanna. + +-------------------------------------------------------------------------------- +Brian Nowak, Susquehanna Financial Group - Analyst [22] +-------------------------------------------------------------------------------- + + Thanks. It looks like 1P gross margins, ex shipping expanded nicely year-on-year again. I was wondering if you could talk to some of the margins of -- what some of the drivers of 1P gross profitability getting better? And how should we think about the sustainability of that over time? Thanks. + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com Inc - CFO [23] +-------------------------------------------------------------------------------- + + We are not breaking out the first party margins, if you will. So I can't talk to the specifics of that. But our retail business is very good, it -- the combination of our retail business and our third-party business on our platform works for us. We think it is very important have both offerings for a number of reasons. +One is, from a customer experience standpoint, we like the fact the customers come to our detail pages on our respective websites around the world, and they see competitive offerings. They know that we are very excited about making sure we get great values for customers, and we price our products appropriately, competitively low. And so, having third parties on our website certainly helps do that. It also adds additional selection that we don't have. +And so, it is a combination of being able to make sure we have a competitive marketplace, as well as add great, unique selection from both retail offerings and third-parties that make it work. And so, that is why we don't talk necessarily about first-party or third-party in terms of margins, but it is the combination of those working together on a platform that makes it work. + +-------------------------------------------------------------------------------- +Brian Nowak, Susquehanna Financial Group - Analyst [24] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Operator [25] +-------------------------------------------------------------------------------- + + We will now hear from John Blackledge with Cowen and Company. + +-------------------------------------------------------------------------------- +John Blackledge, Cowen and Company - Analyst [26] +-------------------------------------------------------------------------------- + + Great. Thank you. I have a couple questions, with the potential price change of Prime in US, would Amazon consider offering Prime Instant Video separately? And in terms of Prime Instant Video, can you discuss the change in marketing spend for the service on a year-over-year basis, 4Q 2013 versus 4Q 2012? And then, just in the North American electronics and other goods segment, could you call out any particular categories that drove the growth? Thank you. + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com Inc - CFO [27] +-------------------------------------------------------------------------------- + + In terms of Prime, there is not a lot I can help you with there. We certainly have -- it is a great offering for customers. I wouldn't speculate what we would do or not do, going forward. But we like the service that we have. We continue to invest in our Prime offering, and it comes in a number of different forms. We will continue to add unique selection that is Prime eligible. We have a great pattern of doing that over the nine-year period. +We have also offered other services as you mentioned, in terms of Prime Instant Video, as well as Kindle Owners' Lending Library. So it is a great value for customers, and we plan on keeping that a great value for customers, even with the price increase that we are considering in the US. + +-------------------------------------------------------------------------------- +John Blackledge, Cowen and Company - Analyst [28] +-------------------------------------------------------------------------------- + + Great, thanks. And the North American and electronics and other goods segment, just wondering if there are any particular categories that drove the growth? + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com Inc - CFO [29] +-------------------------------------------------------------------------------- + + Yes, it was very broad in terms of growth. We are very fortunate that we saw very good growth across many different categories. Certainly, if you call out the Softline categories, were very strong. Consumables were very strong, again a number of different areas, those certainly, a few call outs. + +-------------------------------------------------------------------------------- +Operator [30] +-------------------------------------------------------------------------------- + + Mark Mahaney with RBC Capital Markets has the next question. + +-------------------------------------------------------------------------------- +Mark Mahaney, RBC Capital Markets - Analyst [31] +-------------------------------------------------------------------------------- + + Yes. I will just stick with the EGM category in North America. It looked to us like it decelerated relatively sharply. I thought you were going to call out some areas of weakness there. Is there anything that caused that growth rate you would call out, that caused growth rate to decelerate on an easy comp? And then, Tom, did you want to call out anything related to weather or UPS, or did you think that those impacts were immaterial to the business in the quarter? Thank you. + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com Inc - CFO [32] +-------------------------------------------------------------------------------- + + Well, again, if you look at -- you were talking about -- I think your question was around EGM in North America? A good 25%, you are right, it did decelerate from Q3. Keep in mind that a number of the categories within EGM, there is certainly a seasonal impact. If you look back to last year, Q4, our growth rate in North America was 24%. So we actually saw an acceleration from Q4 last year to Q4 this year, up slightly. And so, that is -- and then, sorry, Mark, the second part of your question was related to? + +-------------------------------------------------------------------------------- +Mark Mahaney, RBC Capital Markets - Analyst [33] +-------------------------------------------------------------------------------- + + Did you want to call out anything related to weather and UPS? + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com Inc - CFO [34] +-------------------------------------------------------------------------------- + + No. I mean, I think certainly some of the UPS issues were documented in the press, and from our standpoint, our team did a very good job of serving customers. We did have the issue that you are describing. But again, we will continue to work on behalf of customers, to make sure we improve that experience over time, where we didn't serve them well. We certainly did give some GCs to customers. We also reimbursed them for shipping costs, where they incurred that, and we will continue to make that better and better for customers over time. + +-------------------------------------------------------------------------------- +Mark Mahaney, RBC Capital Markets - Analyst [35] +-------------------------------------------------------------------------------- + + Thanks, Tom. + +-------------------------------------------------------------------------------- +Operator [36] +-------------------------------------------------------------------------------- + + Moving on to Carlos Kirjner with Bernstein Capital + +-------------------------------------------------------------------------------- +Carlos Kirjner, Sanford C. Bernstein & Company, Inc. - Analyst [37] +-------------------------------------------------------------------------------- + + Thank you. Two quick questions. Your CapEx was just slightly higher than last year same period if you correct for the real estate purchase, even though the business overall grew 22%, and you said AWS grew very fast. Does this relative decrease in CapEx signal an expectation that AWS is going to grow slower? +And secondly on, again the Prime price increase, if you have tens of millions of Prime users that increasing price at least $20 with no incremental expense. That's quite a good chunk of money. Do have specific plans to reinvest that money? Thank you. + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com Inc - CFO [38] +-------------------------------------------------------------------------------- + + The first part of your question, do we expect -- is this is an indication that AWS is slowing down? No, it is not. Actually, we are very pleased with the AWS business. It is growing very fast. The team is doing a fantastic job, from a product and service standpoint, and we are very excited about that business. So I wouldn't form any opinions about what about what CapEx might be in the future, related to the growth rates in AWS. It is going very, very well. +And then, the price increase on Prime, anything that we would invest would be an independent decision from that again. I think in the in opening remarks, I talked about the rationale as to why, and that is really what is driving that decision. And then, our investment decisions would be independent of that. + +-------------------------------------------------------------------------------- +Operator [39] +-------------------------------------------------------------------------------- + + Greg Melich with the ISI Group has the next question. + +-------------------------------------------------------------------------------- +Greg Melich, ISI Group - Analyst [40] +-------------------------------------------------------------------------------- + + Thanks, Tom. Going back to Prime, as you consider the price increase, do you think the brand is such that you would be willing to price-tailor it or tier it, based on the value that is offered, and the sort of services you provide to certain customers? And then second, on the categories, I believe you called out a few quarters earlier, that Clothing in particular was one, and third-party Clothing had picked up a lot. Did you see that this holiday, just given the importance of that core category in the season? + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com Inc - CFO [41] +-------------------------------------------------------------------------------- + + I will take the second part first. Softlines was very strong in Q4, which Clothing is a piece of that. And in terms of tiers on Prime, I wouldn't speculate on what we might or might not do in the future. But we like the Prime program, where we have invested very heavily in it. We continue -- you should expect us to continue to make it even better over time. + +-------------------------------------------------------------------------------- +Greg Melich, ISI Group - Analyst [42] +-------------------------------------------------------------------------------- + + There is no prohibition to that, but you sort of like it the way it is? + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com Inc - CFO [43] +-------------------------------------------------------------------------------- + + Yes, we like it the way it is. But again, we are -- if you look back at what we have done -- can't speculate what we might do going forward. But certainly, we have had in the US Prime in place for nine years. We have added massive selection during that time period. +We have also added, this is on the physical side -- and we have also added digital content as well to the service in the US, with Kindle Owners' Lending Library, as well as Prime Instant Video. And so, it is a great value for our customers. We see the customers love it, and we are going to continue to try to make that even better for customers over time. + +-------------------------------------------------------------------------------- +Operator [44] +-------------------------------------------------------------------------------- + + Moving on to Ron Josey with JMP Securities. + +-------------------------------------------------------------------------------- +Ronald Josey, JMP Securities - Analyst [45] +-------------------------------------------------------------------------------- + + Great. Thanks for taking the question. So I wanted to follow-up on AWS, and talk a little bit on pricing. And while it is certainly coming down, and efficiency has improved. But I believe AWS is sold in hour increments. I think Google's complete solution is sold on a per minute of use. So I was wondering if you thought about maybe changing the way AWS is charged to maybe per minute? +And then a quick follow-up on just fulfillment centers. If you could just remind us what you ended the year with, and if you have any plans for this year? Thank you. + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com Inc - CFO [46] +-------------------------------------------------------------------------------- + + Sure. In terms -- I will take the second part first. The fulfillment centers, we opened seven on a net basis. So that is the net adds, and but on a -- if you take that as a percentage of our total fulfillment centers, you will get a number. But our square footage actually grew at quite a bit faster rate than that. Keep in mind that -- I think we have talked about in previous calls, we did have some smaller, older facilities that we consolidated into larger ones. And so, it is a net seven, and again the square footage growth is higher than that. +In terms of pricing on AWS, the team is doing a fantastic job, looking at the best way to run that part of our business. And I wouldn't want to speculate what they would or wouldn't do related pricing. But they are certainly making sure they are have -- offer great services to customers, and they are great values to customers as well, and we are very excited about that part of the business. + +-------------------------------------------------------------------------------- +Ronald Josey, JMP Securities - Analyst [47] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Operator [48] +-------------------------------------------------------------------------------- + + We will now hear from Chad Bartley with Pacific Crest. + +-------------------------------------------------------------------------------- +Chad Bartley, Pacific Crest Securities - Analyst [49] +-------------------------------------------------------------------------------- + + Hi, thank you. Two quick questions, how much of the slowdown in revenue and unit growth was a function of the shorter shopping season in Q4? And then in terms of raising the price on Prime, how much of that might be based on customers reaction behavior, after recently raising the threshold for free shipping to $35? + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com Inc - CFO [50] +-------------------------------------------------------------------------------- + + In terms of the shorter period for shopping, it is hard to tell. Honestly, it is hard to know. It definitely was a shorter period from post-Thanksgiving to the holiday, and but again, hard to know. And then in terms of your -- sorry, the other part of your question? + +-------------------------------------------------------------------------------- +Chad Bartley, Pacific Crest Securities - Analyst [51] +-------------------------------------------------------------------------------- + + I am curious if the potential price increase on Prime, and your confidence in doing that, and that it wouldn't impact the adoption of Prime, how much of that is tied to the early results of raising the shipper saving threshold to $35 from $25? + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com Inc - CFO [52] +-------------------------------------------------------------------------------- + + They were independent decisions. They weren't related. + +-------------------------------------------------------------------------------- +Chad Bartley, Pacific Crest Securities - Analyst [53] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Operator [54] +-------------------------------------------------------------------------------- + + Thomas Forte with Telsey Advisory Group has the next question. + +-------------------------------------------------------------------------------- +Tom Forte, Telsey Advisory Group - Analyst [55] +-------------------------------------------------------------------------------- + + Great. Thanks for taking my question. So when we think about shipping costs, I know you are talking about raising the rate on Prime. But you just indicated that you added seven fulfillment centers in 2013 on a net basis. As you get closer to the consumer, and you shorten the ship miles, how should we think about the benefit on shipping expenses, from just having more fulfillment centers closer to the consumer? + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com Inc - CFO [56] +-------------------------------------------------------------------------------- + + Yes. There is no question that we get -- as we grow our footprint, we get closer and closer to customers with additional selection. And that has certainly helped us not raise prices, or look at raising prices before this. And so, certainly we will continue to roll out our footprint. We will try to make -- we are trying to make our network as efficient as possible. +And that is -- even with this price increase that we are looking at, it still enables us to make sure we that have Prime at a great value to customers. And that is something that is very important to us, because we know it is very important to our customers. + +-------------------------------------------------------------------------------- +Tom Forte, Telsey Advisory Group - Analyst [57] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Operator [58] +-------------------------------------------------------------------------------- + + Moving on to Brian Pitz with Jefferies. + +-------------------------------------------------------------------------------- +Brian Pitz, Jefferies & Company - Analyst [59] +-------------------------------------------------------------------------------- + + Great, thanks. In terms of digital content, how are exclusive titles and original series driving user growth in Prime memberships? And any color on what kind of engagement dynamics you are seeing across the different platforms? Thank you. + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com Inc - CFO [60] +-------------------------------------------------------------------------------- + + Hello? Could you repeat the question, please? + +-------------------------------------------------------------------------------- +Brian Pitz, Jefferies & Company - Analyst [61] +-------------------------------------------------------------------------------- + + Sure. In terms of digital content, I am just trying to figure out how some of your exclusive content and titles are driving user growth in Prime memberships? And any color just on, what type of engagement you are seeing across the different platforms via PC, tablet, et cetera? + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com Inc - CFO [62] +-------------------------------------------------------------------------------- + + We are seeing customers like the digital content. We are seeing great engagement. We are not breaking out -- in terms of the form, but again, we are seeing great engagement. We do track very closely the Prime customers that come from free trials, for example, for -- that come through the pipeline for digital content from a free trials standpoint. We track those conversions, and we see that is growing very nicely. +We do look at customers that use our Prime Instant Video, how they -- what their shopping patterns look like outside of digital content? Do they buy, excuse me, beyond the free content that we have on there? Do they buy more digital content? And certainly, we are seen nice growth in digital content because of that, because they do. They also do a lot of shopping in physical categories as well. So those things we are tracking very closely. And it is a great pipeline for us, as customers look at the total value proposition for Prime, including digital content. + +-------------------------------------------------------------------------------- +Operator [63] +-------------------------------------------------------------------------------- + + Heath Terry with Goldman Sachs has the next question. + +-------------------------------------------------------------------------------- +Heath Terry, Goldman Sachs - Analyst [64] +-------------------------------------------------------------------------------- + + Great, thanks. Tom, you mentioned the strong growth in AWS. Looking at the deceleration in the North America and other line, how should investors think about the relative growth of AWS versus the advertising and financial partnership that are -- that make up the rest of that segment? And then, just on the Fresh with LA and San Francisco's fulfillment centers carrying a number of non-perishable SKUs, what does Fresh do for your same-day fulfillment capabilities in those markets? + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com Inc - CFO [65] +-------------------------------------------------------------------------------- + + In terms of AWS, I think the best way to think about it is, a number of things that are in other, other than AWS can be lumpy. And you should assume when you look at the North America growth for Q4, that our AWS revenue is growing at a faster rate than other. And then in terms of Fresh, it certainly, when you look at those two, look at the new offerings that we have in the Bay Area and in the LA area, it is certainly helping our same-day delivery, and they work hand-in-hand. So in other words, we have -- we have increased our capability, both for Fresh, as well as for our non-Fresh part of our business there in those locations. + +-------------------------------------------------------------------------------- +Brian Pitz, Jefferies & Company - Analyst [66] +-------------------------------------------------------------------------------- + + Great. Thank you. + +-------------------------------------------------------------------------------- +Operator [67] +-------------------------------------------------------------------------------- + + We will now hear from Yousef Squali with Cantor Fitzgerald. + +-------------------------------------------------------------------------------- +Youssef Squali, Cantor Fitzgerald - Analyst [68] +-------------------------------------------------------------------------------- + + Thank you very much. Two questions, please. First, have you seen any impacts from the use -- from the rise of the Google's PLA this quarter? And second, are you using Kiva's technology in the -- your food distribution centers, particularly for perishables -- for perishables, excuse me? Our understanding that it is not optimized for that, but is that true? And if not, are there any other solutions outside of Amazon that do that optimally? Thank you. + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com Inc - CFO [69] +-------------------------------------------------------------------------------- + + In terms of Kiva, it is very early, we have a -- we are early in our installations there. That is really all I can say. We have it in a few facilities. It is going very well, very pleased with having Kiva as part of the Amazon family, if you will, and we are excited about the opportunity that brings us going forward. + +-------------------------------------------------------------------------------- +Youssef Squali, Cantor Fitzgerald - Analyst [70] +-------------------------------------------------------------------------------- + + And on the PLAs? + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com Inc - CFO [71] +-------------------------------------------------------------------------------- + + I can't comment. + +-------------------------------------------------------------------------------- +Youssef Squali, Cantor Fitzgerald - Analyst [72] +-------------------------------------------------------------------------------- + + Okay, thank you. + +-------------------------------------------------------------------------------- +Operator [73] +-------------------------------------------------------------------------------- + + Our next question will come from Ross Sandler with Deutsche Bank. + +-------------------------------------------------------------------------------- +Ross Sandler, Deutsche Bank - Analyst [74] +-------------------------------------------------------------------------------- + + Thanks, Tom. Just a quick high-level question. So consumers in smartphone markets are spending about half their time on mobile these days, and a lot of that is coming off of PC. And I am sure that is a great kind of new customer acquisition channel for you. +But in terms of existing Amazon customers, are you seeing purchase frequency for physical products go up, because of having phones with you all day? Or is it just swapping off of PC and into these newer channels? Thanks. + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com Inc - CFO [75] +-------------------------------------------------------------------------------- + + I kind of view -- just having the more connected devices is just a tailwind for our business, and it is additive. It is certainly helping our business grow. So whether that is phones or tablets, it is just a tailwind for our business, and we think it will continue to be so. So it is -- customers will certainly still purchase from their desktop or their laptop. And so, the tablet and mobile will not be completely additive, but it will certainly be a tailwind for our business. It is just, anytime customers have easier access to be able to purchase, that is good for us. + +-------------------------------------------------------------------------------- +Operator [76] +-------------------------------------------------------------------------------- + + Now ladies and gentlemen, we have time for one additional question from Gene Munster with Piper Jaffray. + +-------------------------------------------------------------------------------- +Gene Munster, Piper Jaffray & Co. - Analyst [77] +-------------------------------------------------------------------------------- + + Good afternoon. Could you just remind us, on just -- from a kind of a high-level philosophy, the trade-off between revenue growth and earnings? We -- I think investors typically think that you see this as very -- all of your markets as nascent, and profitability is kind of a distant thought. Is that still the case? And any guidance in terms of how to think about that over the next 2, 5, 10 years? Thank you. + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com Inc - CFO [78] +-------------------------------------------------------------------------------- + + Sure. We track a lot of our investments on a discrete basis as best we can. We are looking to maximize -- can you hear me okay? + +-------------------------------------------------------------------------------- +Gene Munster, Piper Jaffray & Co. - Analyst [79] +-------------------------------------------------------------------------------- + + Yes. + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com Inc - CFO [80] +-------------------------------------------------------------------------------- + + We are looking to maximize free cash flow in those investments over time. And so, we have some investments that certainly start to pay off and become profitable in a three to five year period. We have others that have been a bit longer. But again, we are monitoring those investments very carefully. Our goal is to maximize free cash flow for investors over time. That is clearly our goal, and that is something that we are working towards. +All that being said, we are investing a lot of the business right now. You can see that when you look at our results. And the reason why we are doing that is because of the very large opportunities that we see. And we do go in cycles, as you have seen in our historical results. From time to time, we will pull back to make sure the model is working, and we have done that. And I am sure you will see that going forward at times as well. But again, we are focused on making sure that we have a great customer experience, and we maximize free cash flow over the long-term. + +-------------------------------------------------------------------------------- +Gene Munster, Piper Jaffray & Co. - Analyst [81] +-------------------------------------------------------------------------------- + + Got it. Thank you. + +-------------------------------------------------------------------------------- +Dave Fildes, Amazon.com Inc - Senior Manager, IR [82] +-------------------------------------------------------------------------------- + + Great, thanks, Tom. Thank you all for joining us on the call today, and for your questions. A replay will be available on our Investor Relations website at least through the end of the quarter. We appreciate your interest in Amazon.com, and look forward to talking with you again next quarter. + +-------------------------------------------------------------------------------- +Operator [83] +-------------------------------------------------------------------------------- + + And again, ladies and gentlemen, that does conclude our conference for today. We thank you all for your participation. + + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/exam/original-files/Problem_1_Sample/2014-Jul-16-BAC.N-137162730136-Transcript.txt b/exam/original-files/Problem_1_Sample/2014-Jul-16-BAC.N-137162730136-Transcript.txt new file mode 100644 index 0000000..41a4aa0 --- /dev/null +++ b/exam/original-files/Problem_1_Sample/2014-Jul-16-BAC.N-137162730136-Transcript.txt @@ -0,0 +1,1269 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q2 2014 Bank of America Corp Earnings Call +07/16/2014 08:30 AM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Brian Moynihan + Bank of America Corporation - CEO + * Bruce Thompson + Bank of America Corporation - CFO + * Lee McEntire + Bank of America Corporation - SVP IR + +================================================================================ +Conference Call Participiants +================================================================================ + + * Matt Burnell + Wells Fargo Securities - Analyst + * John McDonald + Sanford C. Bernstein & Co. - Analyst + * Paul Miller + FBR Capital Markets - Analyst + * Mike Mayo + CLSA - Analyst + * Guy Moszkowski + Autonomous Research - Analyst + * David Hilder + Drexel Hamilton - Analyst + * Steven Chubak + Nomura Securities - Analyst + * Jim Mitchell + Buckingham Research Group - Analyst + * Moshe Orenbuch + Credit Suisse - Analyst + * Glenn Schorr + ISI Group - Analyst + * Matt O'Connor + Deutsche Bank - Analyst + * Betsy Graseck + Morgan Stanley - Analyst + * Marty Mosby + Vining Sparks - Analyst + +================================================================================ +Presentation +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Good day, everyone, and welcome to today's program. (Operator Instructions) Please note, today's call is being recorded; and I will be standing by should you need any assistance. +It is now my pleasure to turn the conference over to Mr. Lee McEntire. Please go ahead, sir. + +-------------------------------------------------------------------------------- +Lee McEntire, Bank of America Corporation - SVP IR [2] +-------------------------------------------------------------------------------- + + Good morning. Thanks, everybody on the phone as well as the webcast for joining us this morning for our second-quarter results. +Before I turn the call over to Brian and Bruce, let me just remind you we may make some forward-looking statements today. For further information on those, please refer to either our earnings release documents, our website, or the other SEC filings. +So with that, I will turn it over to Brian Moynihan, our CEO, for some opening comments before he goes to Bruce. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - CEO [3] +-------------------------------------------------------------------------------- + + Thanks, Lee. Good morning, everyone, and thank you for joining us. +As you look at our results, you can see the storyline for this quarter is much the same as it was for last quarter. You can see that the revenue is showing stability in most of the core businesses; you can see the good core expense control, continued credit improvement, and solid business activity throughout the franchise. +You can also see, obviously, that the litigation expense from our legacy mortgage issues continue to affect our earnings this quarter. And you can also see that we have continued to build our strong balance sheet position and capital and liquidity. +In a minute Bruce will take you through the details and results, but I thought it would be good if we spent a couple minutes at the outset here talking about what our customer and client data is telling us about the economy and what we see in our franchise. +As we all know, the economy is off to a little bit of a slow start this year, but growth has picked up recently. The most recent jobs data shows nearly 1.4 million jobs were created in the first half of this year. +As we have strong positions, leadership positions, across consumer and commercial companies in America, we have a view into the key indicators of an improving economy which shows signs everywhere of improvement. Even in advance of the short-term interest rates changing, which would help our deposit-rich Consumer & Business Banking segment, our Consumer business had another good quarter. It performed well, growing earnings 29% from last year, including solid origination activities across the various products. +In addition, as we look at our underlying consumers, they have increased their spending. We can see in our data that the retail volumes on debit and credit cards were up 4% from last year's second quarter, but more importantly up 8% from the first quarter this year, showing increased momentum in spending among our card customers. +Consumers are growing card balances also; they are borrowing a little bit more. And they continue to add to their deposit balances. +As you know, home sales continue to improve across the industry, and we can see that in our own results as our originations and mortgages increased from first to second quarter. But importantly, our purchased mortgage origination continue to grow. Our home equity originations also were up almost 30% for the quarter. +When we look at the underlying transactional activity and volume activity in our stores, 7 million to 8 million visitors come in each week, showing continued strong activity. We could also see that in our online activity, where the 30 million online customers continue to grow their overall volumes, and importantly in our mobile activity, where our 15.5 million mobile customers continue to increase the use of technology, including depositing 10% of all the retail checks in our Company through their mobile phone and other devices. +The health of the consumer is also evident in our asset quality. Delinquencies continue to improve. Our consumer card loss rate ended the quarter at less than 3%. +We see on the Wealth Management side the markets growth has added to consumer wealth. We have nearly $2.5 trillion in client balances in our Global Wealth & Investment Management business, including $100 billion in the brokerage assets with our retail and preferred customer base in our Consumer business. +We also see encouraging signs throughout our Commercial customers. Commercial construction has improved, and manufacturing activity in our clients has accelerated. +The borrowing of our commercial customers remains healthy across the industry, and credit quality is very strong. Encouraging is that middle-market utilization rates are moving forward again this quarter, ever so slightly. +Industry sales and trading activity among our trading counterparties has been low, as many of our peers have talked about in this low volatility environment. However, our underlying business performed well. Tom Montag and his team, head of our Global Markets business, posted $1.1 billion in earnings for the quarter. +Our Investment Banking pipeline remains strong and the back half of 2014 looks healthy. +While the economy still faces challenges, progress is being made throughout the economy but also throughout our Company. We are seeing good business activity and its strengthening as we go throughout 2014. We are seeing improved financial health for our consumers and our customers and our corporate customers. +But the most important thing to think about is the signs of a gradually improving economy. This is how our business has continued to be positioned to take advantage of the activity and deliver for you, our shareholders. +With that, I will turn it over to Bruce. + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [4] +-------------------------------------------------------------------------------- + + Great. Thanks, Brian, and good morning, everyone. Let's start on slide 2 and work through the second-quarter results. +We reported earnings of $2.3 billion or $0.19 per diluted share this quarter, which included pretax litigation expense of $4 billion, which equated to roughly $0.22 a share after-tax. $3.8 billion of the litigation expense is associated with the build in reserves for previously disclosed legacy mortgage-related matters, which also included the AIG settlement that we announced this morning. +We're very pleased to reach a definitive agreement with AIG, which resolves all outstanding RMBS litigation between the parties for a settlement amount of $650 million. This agreement is important for two primary reasons. +First, we have now resolved 95% of the unpaid balance of all RMBS as to which securities litigation has either been filed or threatened for all Bank of America-related entities. It also includes AIG's agreement to withdraw as an objector to the Bank of New York Mellon private-label securities settlement, referred to as the Article 77 proceeding. +Revenues this quarter on an FTE basis were $22 billion. Relative to the second quarter of 2013, revenue was down $990 million, driven by lower net interest income and mortgage banking income. Relative to the first quarter of 2014 it was approximately $800 million lower, as higher investment banking fees, higher mortgage banking revenue was more than offset by seasonally lower sales and trading revenue as well as lower equity investment income. +Total noninterest expense for the quarter was $18.5 billion, but included $4 billion of litigation expense. If we back out that litigation expense and compare it to Q2 2013, expenses improved by $1 billion or 6%, which was driven by lower LAS non-litigation expenses and, to a lesser extent, our New BAC savings. +If we back out the $1 billion of retirement-eligible incentive comp from our first-quarter results as well, you can see expenses declined roughly $700 million from the first quarter as a result of lower revenue-related compensation within our Global Markets business; lower LAS expenses ex-litigation; and to a lesser degree, our New BAC savings. +Provision for credit losses was $411 million, with net charge-offs of $1.1 billion and a reserve release of $662 million during the quarter. +Our results from the quarter also benefited from the sale of $2.1 billion in nonperforming residential loans. The income statement benefit from that sale was approximately $350 million pretax, or $0.02 a share after-tax. And you saw roughly $150 million of that benefit flow through other income and the balance through the recovery of net charge-offs. +Lastly, the aggregate amount of a few other items, including debt securities gains, equity investment income, net DVA, as well as FAS 91, resulted in a benefit to EPS of approximately $0.04 a share. +If we move to slide 3 and look at our balance sheet highlights, you can see the balance sheet increased $21 billion from the first quarter of 2014. Our debt securities increased as a result of valuations and increases to highly liquid securities in our primary banking subsidiary. Our repo match book increased as well. +If we look at ending loans, they were down $4.3 billion, primarily due to lower residential mortgages, principally within our discretionary portfolios. And that also included the $2.1 billion bulk sale that I just mentioned. +If we exclude residential mortgage loans, our Consumer loans rose slightly as our US card balances grew $1.3 billion and our securities-based lending with our Wealth Management clients increased $1.8 billion. This was partially offset by paydowns within our home equity book. +If we move to the Commercial side, Commercial loans were up modestly as C&I growth was mostly offset by a few sizable loan paydowns as well as a focus on overall relationship returns. Period-end deposits were over $1.1 trillion and reached record levels. +Our tangible common equity ratio improved 14 basis points from the first quarter of 2014 to 7.14%. Tangible book value per share was $14.24, a 3% improvement from the first quarter, and was driven by both our earnings during the quarter as well as a $2.3 billion increase in the value of our debt securities, which you saw flow through OCI. +Lastly, to further enhance our Tier 1 capital structure, during the second quarter we received shareholder approval and amended the Series T preferred shares, which increased our Tier 1 capital by $2.9 billion, and we issued $1.5 billion in preferred stock during the quarter at a favorable rate. +On slide 4, we show our capital ratios under Basel 3. Under the transition rules our CET1 capital was $153.6 billion; risk-weighted assets, $1.28 trillion; and that resulted in a ratio of 12%. +If we look at our Basel 3 regulatory capital ratios on a fully phased-in basis, we saw very strong improvement from the first quarter of 2014. Our CET1 capital improved $7 billion, driven by earnings, OCI improvement, as well as lowered threshold deductions. The numbers in the chart reflect risk-weighted assets under the Standardized Approach, with our CET1 ratio improving from 9% to 9.5%, well above our 8.5% 2019 proposed minimum requirement. +Under the Advanced Approach, our CET1 ratio improved from 9.6% at the end of the first quarter of 2014 to 9.9%. That was driven by the improvement in our capital, partially offset by an increase in risk-weighted assets. +If we turn to the supplementary leverage ratios, we estimate that at the end of the second quarter of 2014 we exceeded the updated US rules that are applicable beginning in 2018. Our Bank Holding Company exceeds the 5% minimum, and our primary bank subsidiaries, BANA and FIA, are both in excess of the 6% minimum. +We turn to slide 5, on funding and liquidity, our long-term debt of $257 billion was up modestly during the quarter as our debt issuances were larger than maturities during the period. As we look forward at our debt issuance during the balance of the year, we will continue to be opportunistic; but we do expect our parent issuance to be below the $13 billion of contractual maturities in the second half of 2014. We will also likely to continue to issue term debt out of our primary bank subsidiaries. +Our second-quarter 2014 long-term debt yields improved 12 basis points from the first quarter of 2014 to 2.29%. We have realized significant improvement, given only 2 years ago this yield was over 3% and our average debt balances were nearly $75 billion higher. +Our total Global Excess Liquidity Sources during the quarter increased to a record $431 billion as bank liquidity continued to grow in the second quarter, and our time to required funding remains strong at 38 months. +If we turn to slide 6, our net interest income on a reported FTE basis was $10.2 billion, consistent with the first quarter of 2014, as a less negative impact from market-related adjustments was offset by an anticipated decline in the core net interest income. Negatively impacting our reported net interest income during the quarter were market-related adjustments $175 million, and that compares to $273 million negative in the first quarter of 2014. As you all know, long-term rates declined again during the quarter. +Our net interest income, if we exclude the market-related adjustments, declined as previously expected and communicated, due to seasonally lower average consumer loan balances and yields, offset by an extra day of interest. And all of that resulted in net interest income of $10.4 billion. +As a result of the increased liquidity in the first half of the year as well as lower loan balances and loan yields, the net interest yield excluding market-related adjustments declined 10 basis points to 2.26%. +We continue to thoughtfully manage our OCI sensitivity and are very mindful of the liquidity and leverage rules, as this quarter we invested more into shorter-duration Treasury securities. We continue to remain positioned to benefit if interest rates move higher, particularly from the shorter end of the curve. And as we head into the back half of 2014, we still expect modest improvement off of the second quarter of 2014 level of net interest income, which was $10.4 billion, excluding market-related adjustments. +Noninterest expense on slide 7 was $18.5 billion during the second quarter and once again included $4 billion of litigation expense. As we mentioned, $3.8 billion of the litigation expense relates to a build in reserves associated with previously disclosed legacy mortgage-related matters, including the AIG agreement. +If we exclude litigation, total expenses were $14.6 billion this quarter. If we compare those to the first quarter of 2014 and exclude retirement-eligible cost that we saw during the first quarter of 2014, our expenses declined $700 million on lower incentives related to sales and trading revenue, reduced LAS non-litigation expense, and to a lesser extent New BAC savings. +Our Legacy Assets & Servicing expenses during the quarter, ex-litigation, were $1.4 billion and declined approximately $150 million from the first quarter of 2014. +As we look forward, with respect to our two expense programs, New BAC, as well as our LAS expenses, ex-litigation, we have modified our expectation slightly. Our New BAC expense program is ahead of schedule, and we now expect to reach a quarterly level of $2 billion in expense savings in the fourth quarter of 2014 as opposed to mid-2015. +This means on an annualized basis we will have fully achieved the $8 billion target that we announced in 2011. In the second quarter of 2014, our quarterly savings rate that was achieved on New BAC was $1.8 billion plus. +Moving to our LAS expenses, ex-litigation, we continue to make very good progress. But our compliance with applicable mortgage programs as well as governance guidelines may delay the expected timing of achieving our $1.1 billion goal by one quarter. +If we turn to asset quality on slide 8, you can see credit quality once again improved on all fronts. Net charge-offs declined $315 million from the first quarter of 2014 to $1.1 billion, or a 48 basis point net loss ratio. +As I mentioned earlier, this quarter did include a $2.1 billion sale of bulk nonperforming loans, which included recoveries of $185 million on previously recorded net charge-offs. If we exclude the effect of the bulk sale net charge-offs, they declined $130 million or 9%; and the net loss ratio would have been at 56 basis points. These are decade-level loads. +Delinquencies, a leading indicator of net charge-offs, also showed improvement during the second quarter. Provision expense during the quarter was $411 million, and we released $662 million of reserves. +We would expect net charge-offs going forward to continue to show modest improvement from the second quarter of 2014 levels of $1.3 billion, which excludes the recoveries that we received on the nonperforming loan sales. We would also expect reserve releases to decline modestly through the balance of 2014. +Let's walk through the business segment results now starting on slide 9 with Consumer & Business Banking. We continue to make solid progress on the strategy in this business through deepening relationships and reducing our costs by optimizing the delivery network. +We are simplifying the product set as we reduce the number of offerings and focus the smaller product set on customer feedback, and offer greater rewards to customers who bring us more of their relationships. Some of the more significant operational activity during the quarter included the rollout of an advanced platform for mobile banking that had added functionality; rolling out the Safe Balance checking account; as well as an enhanced Preferred Rewards program that we launched after a successful pilot program. +We are pleased with the results again this quarter, as our earnings of $1.8 billion grew 29% from the second quarter of 2013 and were up 7% from the first quarter of 2014. This business generated a 24% return on allocated capital during the quarter. +Our revenue was relatively stable across the periods, as lower net interest income was partially offset by higher service charges. Our expenses are down 4% from the second quarter of 2013 on lower operating, litigation, and personnel costs. Our network delivery optimization benefits continued as we reduced another 72 Banking Centers through both sales as well as consolidations. +Our credit quality remains strong, as net charge-offs declined versus both periods. Our US credit card business exited the quarter with less than a 3% loss rate in June. +Second-quarter provision expense was $534 million. Our net charge-offs improved $313 million from the second quarter of 2013, and $36 million from the first quarter of 2014. We released $120 million more in reserves this quarter than the second quarter of 2013, and $242 million more than the first quarter of 2014. +From a customer activity perspective this quarter, we saw continued growth in our mobile banking customers, which reached 15.5 million customers. And our customer deposit transactions using mobile devices represented 10% of all transactions. +Our average deposits of $544 billion are up organically almost $11 billion or 2% compared to the first quarter of 2014, and up 5% or nearly $25 billion compared to the second quarter of 2013. And we did that as our rates paid on our deposits reached a new low of 6 basis points. +Our brokeraged assets surpassed $105 billion and are up 26% year-over-year based on both improved market valuation as well as customer flows. +Our card issuance remains strong at 1.1 million new accounts in the second quarter of 2014, with approximately two-thirds of those cards going to existing customers. We saw growth in ending US credit card balances this period, with ending balances up $1.3 billion relative to the first quarter of 2014; and our risk-adjusted margin remains strong at approximately 9%. +If you move to Consumer Real Estate Services, the loss in the quarter was driven by $3.8 billion of litigation expense. Overall, we saw higher originations, improved mortgage banking revenue, and lower cost in both the fulfillment as well as the servicing sides of the business. +Let's focus first on the reported subsegment of Home Loans, where we record the origination of Consumer Real Estate. Our home loans saw better leverage versus the first quarter of 2014 as both revenue and expenses improved. +Our first mortgage retail originations were $11.1 billion and were up 25% from the first quarter of 2014, leading to higher core production revenue. As Brian mentioned, our mix of originations continues to shift to purchased, as we are now at 47% purchased versus 17% in the year-ago quarter. At the end of the quarter, our origination pipeline was up 15% from the first quarter of 2014, but our applications per day are slowing a bit. +Our home equity originations were $2.6 billion and increased 31% from the first quarter of 2014. We continued to reduce production staffing levels; and the savings from several quarters of these reductions are beginning to show in our expense levels. +If we move to the Legacy Assets & Servicing subsegment, the driver here was the aforementioned litigation cost. From a cost of servicing perspective our LAS expenses, ex-litigation, did decline $141 million to $1.4 billion; and our number of 60-plus-day delinquent loans dropped 14,000 units to 263,000 units, or down 5% from the end of the first quarter of 2014. +The primary revenue component in our LAS subsegment, servicing fees, declined $40 million versus the first quarter as the size of our servicing portfolio declined. This was offset by a better net hedge performance on our MSR. Also during the quarter, we did benefit from lower rep and warrant provision, which was $87 million, or down nearly $100 million from the first quarter of 2014. +If we turn to slide 11, Global Wealth & Investment Management, this business turned in another record revenue quarter. Our pretax margins remained strong, north of 25% for the sixth consecutive quarter. +Our revenue of $4.6 billion was up 2% from the second quarter of 2013, and 1% over the first quarter of 2014. Record asset management fees offset the softness in transactional activity. Net income, $724 million, was slightly lower than both comparative periods, driven by increased expenses. +Our expense levels versus the second quarter of 2013 reflect higher revenue-related incentive comp, other volume-related costs, as well as continued investment in technology and other areas to support the growth that we are seeing within the business. Relative to the first quarter 2014, expenses were driven by higher revenue-related cost, litigation-related expenses, as well as marketing. +Our return on allocated capital during the quarter was 24%. The momentum we are seeing in flows continued and was quite strong during the quarter. +Client balances were up $72 billion from the end of the first quarter of 2014 to a record $2.5 trillion. Long-term AUM flows were nearly $12 billion for the quarter, marking the fifth straight year of positive quarterly AUM flows. Our ending client loan balances were up $3.9 billion to a record $123 billion, which is up 3% from the first quarter of 2014, as we saw growth in both our securities-based lending as well as our residential mortgage lending. +From a referral perspective, we continue to see coordinated efforts across Wealth Management and the banking groups, as our referrals resulted in the funding of more than 250 institutional retirement plans worth more than $2.4 billion in assets this quarter. And that compares to 156 wins in the year-ago quarter for $600 million in assets. +If we turn to slide 12, our Global Banking earnings for the quarter were $1.4 billion, up 4% from the second quarter of 2013, and up 9% over the first quarter of 2014. Our return on allocated capital was very strong at 18%. +Compared to the second quarter of 2013, our revenue showed modest improvement, while expenses increased and credit costs declined. Within the revenue category, our investment banking fees companywide this quarter were $1.6 billion, up 5% from the second quarter of 2013 and up 6% on a linked-quarter basis. We maintained a solid leadership position in investment banking fees, and we had particularly strong equity underwriting results during the quarter. +Our provision was $132 million during the quarter. It included a $156 million reserve build. Our provision costs were favorable to both comparative periods, as we added less reserves in the first quarter of 2014 and had less charge-offs compared to the second quarter of 2013. +Expenses increased $50 million versus the second quarter of 2013 on higher litigation, but improved $129 million from the first quarter of 2014 on lower personnel and back-office support costs. +If we look at the balance sheet, average loans were $271 billion during the quarter, up 6% compared to the second quarter of 2013, but flattish compared to the first quarter of 2014. Our loan balances relative to the first quarter of 2014 bear, I think, several comments that I would like to make. +The first is we saw sizable paydowns during the quarter as our customers accessed the capital markets. We had approximately $2 billion of such paydowns, where our customers chose to access the markets and refinance existing bank loans. +Within Commercial Real Estate, we continued to optimize the mix, with several small portfolio sales that took those balances down a little over $2 billion. And we are being sensitive with respect to pricing of commercial loans, as we are not going to chase loans at the expense of overall client relationship profitability goals. Lastly, within the Global Banking segment deposit flows remained solid and were stronger at the end of the quarter. +If we move to Global Markets on slide 13, we earned $1.1 billion in the second quarter of 2014. That is up 14% from the year-ago period and down seasonally 16% from the seasonally strong period of the first quarter. +Net DVA during the quarter was a gain of $69 million, versus gains of $49 million in the second quarter of 2013 and $112 million in the first quarter of 2014. +Despite the slowdown in FICC across the industry group, we were pleased with the results this quarter. Our revenue was up 9% from the second quarter of 2013, but down 9% from the seasonally high first quarter of 2014. +Our second-quarter of 2014 revenue did include an equity gain of roughly $240 million on the monetization of an equity investment. That is not reflected as part of our sales and trading revenue. +Our sales and trading revenue, net of DVA, was $3.4 billion, which was 1% lower than the second quarter of 2013 and 17% lower than the first quarter of 2014. Our FICC sales and trading revenue during the quarter increased 5% compared to the second quarter of 2013 and was down 20% from the seasonally higher first quarter of 2014 levels. +Driving the year-over-year improvement within FICC will result in both our mortgage business, our munis business, as trading conditions and our performance improved in both areas. Those improvements were partially offset by weaker financial performance in foreign exchange as well as commodities. +On the equity sales and trading side, we were down 14% from the second quarter 2013 and 11% from the first quarter of 2014, as lower market volatility depressed overall secondary market client activity. +Expenses were up from the second quarter of 2013 on higher technology and staff support investments and, to a lesser degree, incentives, but down from the first quarter of 2014, in line with the seasonal revenue decline that we saw. Trading-related assets on average increased $23 billion to $460 billion during the quarter, and our return on allocated capital was 13% during the second quarter. +On slide 14, we show All Other. Revenue was down $463 million from the first quarter of 2014 on lower equity investment gains of $618 million, which were partially offset by lower negative market-related adjustments to net interest income during the quarter. Our second-quarter 2014 expense in All Other is down $1.3 billion from the first quarter, as it included retirement-eligible incentive cost and some litigation expense. +The second quarter of 2014 provision benefit of $246 million was $111 million better than the first quarter of 2014, and $67 million better than the second quarter of 2013. Net charge-offs of $11 million improved $195 million from the first quarter of 2014, driven by the recoveries that I had mentioned associated with our bulk NPL sales. +During the quarter, our effective tax rate was relatively low, primarily as a result of the impact of tax preference items on a lower earnings base. For the back half of 2014, we would expect to see an effective tax rate of approximately 31%, ex- any unusual items. +I'm going to wrap up before we take questions with a couple closing comments. We feel like we made very strong progress during the quarter. We saw good business activity across the customer base. +We experienced year-over-year revenue growth in our Global Banking, Global Markets, and Global Wealth Management businesses. Our Consumer Business profitability grew 29% from last year. And in the mortgage business we are taking costs out of the fulfillment side as well as the cost to service our delinquent loans. +We reported $0.19 of earnings in absorbed cost, allowing us to resolve all outstanding RMBS issues with AIG and build substantial reserves for our remaining legacy mortgage issues. We did this while adding to our already-strong Basel 3 capital ratios and improving our liquidity measures to record levels. And our asset quality improved to decade-low loss ratios. +With that, we will go ahead and open it up for questions. + + +================================================================================ +Questions and Answers +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) Betsy Graseck, Morgan Stanley. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [2] +-------------------------------------------------------------------------------- + + Hey, thanks. Good morning. Hey, a couple questions. One, you had some callouts on some nice gains; and I know a couple of other banks reporting here this cycle have done the same thing. +I am wondering how much more in your pipeline do you think you have to extract some value from the mortgage-related portfolio here that you're in the process of selling down this quarter? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [3] +-------------------------------------------------------------------------------- + + Yes. We took, Betsy, a piece of our nonperforming loans out. And as nonperforming loans, and as you know, when you receive it -- to the extent that you receive income, you write down the basis to those loans. And we took those loans out and saw healthy gains. +We continue to look at the sale of nonperforming loans, but I would not expect anything near the magnitude from the sale of nonperforming loans that we saw this quarter. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [4] +-------------------------------------------------------------------------------- + + Okay. Separately, on just litigation-related stuff, you highlighted the AIG agreement; that looks like a great win for you guys. I guess the question is: Does them pulling out as a dissenter do anything to speed up the timing on that Article 77 case? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [5] +-------------------------------------------------------------------------------- + + I think the timing is going to progress on the schedule that it otherwise would have. I think you all know that from an objector perspective that they were probably the strongest and most vocal objector with respect to the case. And we'll just have to see as we move forward what the impact from them dropping their objection to the case is. +I think the other thing that's important is as it relates to holdings of the securities, or at least a basis to object. They were the largest holder that was out there from holding securities as a part of the settlement. And I think they noted that in their release this morning. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [6] +-------------------------------------------------------------------------------- + + Yes, thanks. Okay. Then just lastly, there's been a lot of debate recently about how the Fed could potentially start to exit. Obviously in the [F one two] minutes they talked about that, and it's been on some of the calls recently about how people are thinking about rate betas. +I know from the Q you have a relatively positive outlook for what rising rates does to your earnings stream. Could you just remind us what percentage of your deposits are consumer, and how you're thinking about rate betas in a rate rise environment relative to asset betas? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [7] +-------------------------------------------------------------------------------- + + Sure. A couple things. If you look at asset sensitivity, you will see that the exposure to a 100 basis point parallel shift in rates, that the benefit increased this quarter from about $3.2 billion in the first quarter to $3.4 billion. +As you look at the deposit base, a couple things of note. The first is, north of 70% of the overall deposits that we have throughout the Company are within our Consumer and Wealth Management business. As it relates to, I would say overall asset betas that through history, given the branch network and the relationships, those tend to be very stable. I think you get a sense for that as you look at the continued deposit growth that we have seen, while at the same time taking rates paid down pretty significantly. +If you move to the institutional side and look at where we are, roughly 75% of the deposits that we have within the institutional business are domiciled here in the US. And the predominant mix of that is with our core Corporate and Commercial customers. +If you look at the reason that they are holding those deposits with us, it is because we tend to be their core relationship bank. We do their cash management; we do their Treasury service revenue and have relationships that are beyond just a place for them to put their deposits. +So as we move forward, there is obviously a level of uncertainty to the extent of a Fed withdrawal. But as we look at the overall deposit base, the stability of it, and our outlook going forward, we feel like that we are very well positioned. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - CEO [8] +-------------------------------------------------------------------------------- + + I would add on the consumer side also, as you look at year-over-year dynamics in terms of deposit growth of $25 billion, also look at the -- we are still running off a CD portfolio that was more of a funding portfolio for some of the companies that we acquired. So that I think there is, round numbers, a $10 billion reduction in CDs over that time period. And we've also obviously sold some deposits; not a huge amount. +So that growth is over top of all that and net. So we feel good about the Consumer franchise, the ability to continue to grow deposits, even while being very disciplined on price. And as rates rise, that value will be recognized. +And we expect those deposits now are much more core. The average checking account deposits year-over-year I think are up 25%, 30% in terms of average balance. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [9] +-------------------------------------------------------------------------------- + + Okay. Thanks a lot. + +-------------------------------------------------------------------------------- +Operator [10] +-------------------------------------------------------------------------------- + + Jim Mitchell, Buckingham Research. + +-------------------------------------------------------------------------------- +Jim Mitchell, Buckingham Research Group - Analyst [11] +-------------------------------------------------------------------------------- + + Yes, hey. Good morning. Yes, I just wanted to follow up quickly, up on that deposit question. I noticed that noninterest-bearing was up 11%; interest-bearing up only 1%. So that speaks to your efforts. +Do you think there is more to go there? Or should we start to see deposit growth more in line with your peers at this point? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - CEO [12] +-------------------------------------------------------------------------------- + + I think if you look at the -- just on a Consumer business, the year-over-year growth was $25 billion and the linked-quarter growth was $10 billion. So obviously we're growing at a faster rate in the current environment -- at the spot, so to speak, Jim -- than we have been year-over-year. +So the growth rate of 2% was nominal in a quarter which would be annualized 8% and about high 5%s to 6% year-over-year. So it's accelerating still by the good core activity. + +-------------------------------------------------------------------------------- +Jim Mitchell, Buckingham Research Group - Analyst [13] +-------------------------------------------------------------------------------- + + Right. Okay, great. Then on loan growth you still have, as you mentioned, a couple of asset sales, still some legacy asset runoff. When do we start to see the inflection point, in your view? And maybe if you can give us a sense of underlying demand that you're seeing in your customer group. + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [14] +-------------------------------------------------------------------------------- + + Sure. Let's go -- it's a very good question, Jim, and I think we need to break out and discuss -- if you look at the declines that we saw in the residential mortgage area, those are largely due to whole loan repayments of loans that are held within our investment portfolio. So if you look at the Consumer Business, I think there are a couple key things that I would note. +The first is on a linked-quarter basis this is the first quarter in some time where we actually saw ending card balances within our domestic card balance increase. Those were up, as we mentioned, roughly $1.3 billion from the first quarter to the second quarter. So we saw growth there. +Then if you move to what we saw within the Wealth Management area, as I mentioned we saw very strong growth both in securities-based landing as well as within mortgage originations there. Once again, on the home equity front the progress that we're making on the origination front, where we saw about $2.6 billion, is really being masked by the runoff and the amortization of the home equity book that we had; that runs off to the extent of $3 billion to $4 billion a quarter. +So within the Consumer businesses, if you look at the core front-end, we are seeing some consumer loan growth. It just gets masked by the runoff of some of the Consumer Real Estate. +On the overall Commercial and Corporate side, I did reference the couple payoffs. As we look at -- one of the benchmarks that we look at is the revolver draws that we have within our Commercial Banking business. That number, which has gotten as low as in the low 30%s was up almost 100 basis points this quarter and is now in the high 30%s. So we are starting to see some greater activity on the revolver space within our Commercial Banking customers. +And overall activity with the corporate customers continues to be good, but we are seeing, as I referenced, customers taking advantage of favorable debt capital markets, which we obviously benefit from, from a debt underwriting perspective. + +-------------------------------------------------------------------------------- +Jim Mitchell, Buckingham Research Group - Analyst [15] +-------------------------------------------------------------------------------- + + Right, that's fair. Just one last question on the LCR. Maybe I missed it. Did you disclose where you are on that front? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [16] +-------------------------------------------------------------------------------- + + We did not. At the parent at this point we are above 100%, at the parent. So we're good from a 2017 compliance there. +If we look at the combined BANA/FIA LCR ratio, those two companies or two banks will be put together October 1. That LCR number is in the high 80%s at this point and we'll continue to build the LCR ratio at the banks to be at least a year ahead of where we need to be. + +-------------------------------------------------------------------------------- +Jim Mitchell, Buckingham Research Group - Analyst [17] +-------------------------------------------------------------------------------- + + Will that put any further pressure on NIM, if you're building more liquidity there? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [18] +-------------------------------------------------------------------------------- + + It should not. As we look at it, there has been a significant build at this point. And as we look at the funding and the balance of that between both core consumer deposit growth as well as where we are, that should not have an effect. +If you look at the build that we talked about in the first quarter and second quarter, at this point I would say we have eaten that expense. And we now need to get after it and optimize it to get the expense knocked back down. + +-------------------------------------------------------------------------------- +Jim Mitchell, Buckingham Research Group - Analyst [19] +-------------------------------------------------------------------------------- + + Okay, great. Thanks. + +-------------------------------------------------------------------------------- +Operator [20] +-------------------------------------------------------------------------------- + + Matt O'Connor, Deutsche Bank. + +-------------------------------------------------------------------------------- +Matt O'Connor, Deutsche Bank - Analyst [21] +-------------------------------------------------------------------------------- + + Hi, good morning. On expenses, it seems like most of the New BAC savings are in the run rate here. Yet we still read about various expense initiatives that you have underway in terms of branch rationalization and simplification and things like that. +So just wondering. Is there another New BAC, or just ongoing efforts to bring down costs, and how meaningful those might be? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - CEO [22] +-------------------------------------------------------------------------------- + + I think in the near-term, Matt, the number-one thing about costs is continuing to work down the LAS legacy costs, down to a more normalized level on a per-loan basis and also keep reducing the number of delinquent loans. So that's the real expense leverage. +And what Bruce talked about earlier is we've got to make sure we do it the right way, and especially in connection with finishing up some of the regulatory work there. So that is the real large dollar amount. +You're pointing out exactly the situation on the core. You're running about $13 billion a quarter on core expenses; not a bad number if you annualize it and think that through. But the real question is: How do you hold it there and keep investing in the businesses? +So when we started the New BAC, we never gave a target that said we're going to save all this money but we're going to reinvest it. We gave you sort of a net target, and now we're reaching that. +So what we're challenging our teams to do is how to maintain a good operating leverage going forward. So we're more about simplifying the Company and continuing to take out expenses; but a lot of that will offset the thousand people we have added in the branches to sell more products that you're seeing the benefits of, the continued adds we make in the Wealth Management business and the training programs. We hired 30% to 40% more people out of schools this year because we got to keep replenishing our talent base, commercial bankers, etc. +So as you look forward, the inflationary type things that go on, merit raises and healthcare expenses, and stuff like that, and investing in the business, including the $3-billion-plus we put in technology development every year, will need to be offset by hard expense work. So that's the plan we have, and we're putting those -- we keep driving those plans in place. +But it would be less bottom-line reduction on that core expense base and more how you hold it there in a relatively slow growth environment. + +-------------------------------------------------------------------------------- +Matt O'Connor, Deutsche Bank - Analyst [23] +-------------------------------------------------------------------------------- + + Okay. So just to try and summarize, even if there is some modest revenue growth, you would hope to keep that $13 billion relatively stable on a net basis, then? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - CEO [24] +-------------------------------------------------------------------------------- + + Yes, with one exception. When markets kicks up you are going to have more comp related to that, or Wealth Management comp, which is good. So you've got to be careful, because those things come and go, and you can see that just in the last couple quarters. +But on the -- like, if you think about what David Darnell and the team have done in the retail business, they are still rationalizing the branch structure, which will offset putting more people in the branches that are more personal bankers and FSAs. And they have done a pretty good job at offsetting that. +In addition, we are repatriating some jobs to help on the consumer credit, customer delight scores and stuff, from places that legacy enterprises had them in other places, and bringing them in. And that rationalization is going on, and that is adding to our job count in the near term but will rationalize back out. + +-------------------------------------------------------------------------------- +Matt O'Connor, Deutsche Bank - Analyst [25] +-------------------------------------------------------------------------------- + + Okay. Then on the LAS costs, obviously making good progress there. I am not sure there is too much concern if it gets pushed out one quarter. But is there still the goal of getting down to $500 million or below $500 million per quarter? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [26] +-------------------------------------------------------------------------------- + + Yes. And obviously that is going to trail and move with it as we drive down the 60-plus-day delinquent loans. But clearly the $1.1 billion that we'll either have in the fourth quarter or the first quarter of next year is still way too high given the number of 60-plus-day delinquent loans that we have, as well as the size of the servicing portfolio. + +-------------------------------------------------------------------------------- +Matt O'Connor, Deutsche Bank - Analyst [27] +-------------------------------------------------------------------------------- + + Okay. Then just lastly if I can squeeze in on the CCAR capital resubmission process, just remind us when you expect to get an update on that. + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [28] +-------------------------------------------------------------------------------- + + Sure. We recently -- we submitted our materials to the Fed on May 27. They have up to 75 days to respond. I believe the 75th day is August 10, and we continue to see where they come out. + +-------------------------------------------------------------------------------- +Matt O'Connor, Deutsche Bank - Analyst [29] +-------------------------------------------------------------------------------- + + Okay, thank you. + +-------------------------------------------------------------------------------- +Operator [30] +-------------------------------------------------------------------------------- + + Glenn Schorr, ISI. + +-------------------------------------------------------------------------------- +Glenn Schorr, ISI Group - Analyst [31] +-------------------------------------------------------------------------------- + + Thank you. Quick question. The match book was up, or at least the Fed funds sold and repurchased on the asset side was up 6.5% quarter-on-quarter. It's the opposite of what we're seeing at a lot of banks and trends in the market. So I am just curious. +Is there an opportunity to get closer to clients? Is this a function of the fact that your SLR is in great shape, so why not use it when you can? Just curious on what is underlying that trend. + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [32] +-------------------------------------------------------------------------------- + + Yes, I would say, Glenn, probably more than anything, if you go back and look at both the notional size of the balance sheet as well as the match book, we were probably a little bit lower at the end of the first quarter of 2014 than you would normally see. So that number will bounce around, but I wouldn't read anything into the fact that it was up, because it was much lower at both the end of 2013 as well as the first quarter of 2014. + +-------------------------------------------------------------------------------- +Glenn Schorr, ISI Group - Analyst [33] +-------------------------------------------------------------------------------- + + Anything different on the client usage front? It is bucking a trend, though I hear your comments on the year-end. It's just with the changes in SLR, it's changing pricing theoretically; I just don't know if it's more theoretical than actual. + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [34] +-------------------------------------------------------------------------------- + + I think the pricing is probably more theoretical. Because I think if you look across the industry, we continue to see both the banks in Europe as well as the banks in Asia provide it. So I'm not sure you are seeing any meaningful movement in what you are able to charge from a match book perspective. + +-------------------------------------------------------------------------------- +Glenn Schorr, ISI Group - Analyst [35] +-------------------------------------------------------------------------------- + + I get that, yes. Okay, switching gears. In Wealth Management, obviously everything is doing pretty darn good in Wealth Management. But I will pick a little bit and I will just ask. +Expense -- negative operating leverage in a quarter when the markets are doing well, meaning revenues were up or expenses are up more. I heard and saw your comments on the additional investments in technology. +Is it comp, or is it that additional investment technology? In other words, when markets are growing and flows are great you would expect margins to hold their ground, not give it up. Maybe a little more color on what investments to help that business grow would be helpful. + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [36] +-------------------------------------------------------------------------------- + + Sure. Well, you've got a couple things. The first is, as you look at the expense growth during the quarter and you look at the buckets, roughly half of it relates to incentive-related comp that is a result of increased revenues. +We do have a couple of initiatives that you would expect to roll off over the next couple quarters within the Wealth Management business. We obviously had the rollout of Merrill One over the last couple quarters, where you saw some expense there. +There has been some additional money spent as we invest in systems related to retirement systems and retirement programs, as we continue to see growth there. So you do have some of that activity as well as just making sure that the right investments within the various control and support functions are appropriate. +So at the same time, as we look forward you need to see positive operating leverage, not negative operating leverage. And that's what we will look to work for as we go through the next couple quarters of the year. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - CEO [37] +-------------------------------------------------------------------------------- + + You point out, it's an obvious point and we -- the team is focused on it. But we have made some near-term investments, including training programs and hiring people into the business, working in the branches and stuff, to help. +But it is something that we've got to monitor closely, and we think it will come back down and more in line with what you'd expect. + +-------------------------------------------------------------------------------- +Glenn Schorr, ISI Group - Analyst [38] +-------------------------------------------------------------------------------- + + Right. I appreciate that. Last one is, slide 20 shows that the private-label outstanding claims keep going up every quarter. Anything new there? +I am not sure what's driving that and if -- I know that we have most of this stuff accounted for in the settlements. But just curious. + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [39] +-------------------------------------------------------------------------------- + + Sure. I think the notable thing that I would call out is that when we get private-label claims that come in, there are two different types of claims that come in. There is the first that are claims where people have had the ability to look at loan files and submit a claim based on a loan file not being what they thought it could be. And the second is that you can have people that at points in time do what we call -- or throw in what we would characterize as a bulk claim, where they're just throwing it in without having done any work whatsoever on the loan file. +And what's important when you look at what we saw during the second quarter of 2014, we saw roughly $1.9 billion of original unpaid balance on the loans not lost, growth of that amount. The amount of bulk claims where no file reviews had been down was $1.9 billion. So I would not read too much into that number, because it's not for loan files where there has been any work done. +And I would just say generally, if you look at what we have seen regarding some of the recent decisions where there seems to be some stickiness at this point on different statutes of limitation, as well as a recent ruling that came out of California with respect to RMBS litigation, that we do feel like we're moving forward. And getting AIG behind us is significant in regards to putting the rest of this behind us. + +-------------------------------------------------------------------------------- +Glenn Schorr, ISI Group - Analyst [40] +-------------------------------------------------------------------------------- + + Okay. I appreciate it. That's it for me. Thanks. + +-------------------------------------------------------------------------------- +Operator [41] +-------------------------------------------------------------------------------- + + John McDonald, Sanford Bernstein. + +-------------------------------------------------------------------------------- +John McDonald, Sanford C. Bernstein & Co. - Analyst [42] +-------------------------------------------------------------------------------- + + Hi, good morning. Bruce, the increase in Tier 1 common of $7 billion was impressive relative to the net income in the quarter. Any more color on the drivers there? +You mentioned AOCI. What were the threshold deductions that helped drive the capital expansion so much more than that income? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [43] +-------------------------------------------------------------------------------- + + Sure. As we've said, given where we are from a disallowed DTA position, that we're at a point where broadly speaking we accrete capital on a pretax as opposed to an after-tax basis. So as you look at the results, we had roughly $3 billion of pretax income; we had roughly $3.5 billion of pretax OCI. That gets you to about $6.5 billion. +And then as you look at threshold deductions of roughly 10%, take 10% of that $6.5 billion; it gets you roughly $700 million. That gets you to roughly $7.2 billion of capital build. +You back out the common dividends of $100 million, and that get you to your $7.1 billion build. + +-------------------------------------------------------------------------------- +John McDonald, Sanford C. Bernstein & Co. - Analyst [44] +-------------------------------------------------------------------------------- + + Okay, and that building at a pretax due to the DTA, that is something that should continue on a steady pace, right? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [45] +-------------------------------------------------------------------------------- + + Clearly at least over the next, I would say, probably two to four quarters, it will be a function of the exact earnings. But for the near term, that's correct. + +-------------------------------------------------------------------------------- +John McDonald, Sanford C. Bernstein & Co. - Analyst [46] +-------------------------------------------------------------------------------- + + Okay. Can you give us the numbers on what the excluded DTA is today and what it changed in during the quarter? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [47] +-------------------------------------------------------------------------------- + + Yes. I believe that the excluded DTA was roughly $15 billion. And it was down a little over $1 billion. + +-------------------------------------------------------------------------------- +John McDonald, Sanford C. Bernstein & Co. - Analyst [48] +-------------------------------------------------------------------------------- + + Okay. On RWA, are there risks that the continued legal settlements would drive up your operational risk metrics? Or is there a forward-looking component to the op risk calc that already anticipates more settlements coming? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [49] +-------------------------------------------------------------------------------- + + Yes, we're mindful of the fact of settlements. There's obviously a lot of discussion and dialog around op risk RWA. +If you look at -- and when we noted that the reason risk-weighted assets went up during the quarter under the Advanced Approach it was for doing exactly what you referenced, was reflecting an increased amount of operational risk RWA. +We don't give the exact number, but you should assume that that amount is in the 26% to 27% of our total risk-weighted assets number and is in line with our largest peer. + +-------------------------------------------------------------------------------- +John McDonald, Sanford C. Bernstein & Co. - Analyst [50] +-------------------------------------------------------------------------------- + + Okay. On capital, on the last CCAR your binding constraint was the leverage ratio more than the risk-based Tier 1 minimum. I assume the recent preferred issuance and the Buffett conversions will help close that gap and position you better for next year's CCAR minimum. +Could you comment on that? Or are there more things you can do to close the gap and have a quantitative cushion that's bigger to that leverage ratio next year as well? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [51] +-------------------------------------------------------------------------------- + + Sure. Well, the first, John, is just to manage the notional size of the balance sheet, which we continue to do. The second thing that I would note is, when you look at the sale of the re-performing loans that we did, those are the types of assets that in the CCAR -- at least we believe; we don't have access to the Federal Reserve's models -- but those are the types of assets that tend to get hard. +So we continue to look hard and look to drive down the nonperforming Consumer Real Estate piece of what we have. And this quarter was a good example of it. +Then, you're exactly right with respect to the leverage ratio, that there is a benefit that preferred stock gives. We are north of $4 billion this quarter that we generated. We will continue to look to see if more preferred makes sense. +And then lastly, we will continue to look at and see if sub-debt makes sense from a total capital perspective as well. The incremental cost of those is very low, and we just want to make sure the balance sheet is optimized for those different buckets. + +-------------------------------------------------------------------------------- +John McDonald, Sanford C. Bernstein & Co. - Analyst [52] +-------------------------------------------------------------------------------- + + Okay, thanks. On sales and trading, just in terms of the dynamics of the quarter, did you see a pickup in June as the other banks did? And any sense of what drove that? Have you seen any follow-through on that? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [53] +-------------------------------------------------------------------------------- + + Yes, our activity levels -- and if you saw a P&L throughout the quarter, while June was marginally better, I would characterize the activity that we saw within the sales and trading business during the second quarter to be fairly consistent. And as we look out at the third quarter, typically with the summer the third quarter is a little bit seasonally slower than the second quarter. If you look at our results last year, you see that. +And as we come into the third quarter, there is nothing unusual in our third-quarter numbers of last year. And how we compare to those numbers is going to be a function of how well we perform this quarter, and that's obviously up to us. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - CEO [54] +-------------------------------------------------------------------------------- + + John, if you look at page 19, you can see the second quarter, second quarter, second quarter across the last 3 years. And it's remarkably stable in terms of markets revenue, on the lower part of that page. +So what Tom and the team did a few years ago was actually reduce the headcount almost 5,000 people and that's allowed us to make $1 billion in this kind of environment, as we did this quarter. So this will ebb and flow; and as you and I have talked about on various occasions, it is a core part of what we do. +But we show you the separate P&L to show that in the first quarter, have a good quarter; this quarter had $1 billion. And it may come down. Activity moves around for clients, but it is a relatively stable revenue base that we can make money on because of the expense adjustments we made last year -- in the last several years. + +-------------------------------------------------------------------------------- +John McDonald, Sanford C. Bernstein & Co. - Analyst [55] +-------------------------------------------------------------------------------- + + Okay. Last thing for me, Bruce, on the CRES page, in terms of mortgage servicing revenues, is this quarter's core mortgage servicing revenue a stable base as you see it? Or is there further shrinkage in the size of the servicing book from sales that are ongoing that would impact the servicing fees? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [56] +-------------------------------------------------------------------------------- + + Yes, there's -- we've got one more sale that we will look to wrap up this quarter that's got fairly high content of 60-plus-day delinquent loans. But beyond that one transfer this quarter, we are largely at the end of servicing sales. +And we're at a base of what you see should be what we have going forward, with the pluses and minuses being what runs off versus what we put on. + +-------------------------------------------------------------------------------- +John McDonald, Sanford C. Bernstein & Co. - Analyst [57] +-------------------------------------------------------------------------------- + + Okay. You're still taking rep and warranty provisions. What are those for? Is that for current originations, or is it still catch-up from past stuff? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [58] +-------------------------------------------------------------------------------- + + As you look at it, I think rep and warrant was less than $100 million this quarter. You're going to always have that as you go forward; but we're not seeing much rep and warrant at all on recent originations. It's going to be more legacy related. + +-------------------------------------------------------------------------------- +John McDonald, Sanford C. Bernstein & Co. - Analyst [59] +-------------------------------------------------------------------------------- + + Okay, thank you. + +-------------------------------------------------------------------------------- +Operator [60] +-------------------------------------------------------------------------------- + + Guy Moszkowski, Autonomous. + +-------------------------------------------------------------------------------- +Guy Moszkowski, Autonomous Research - Analyst [61] +-------------------------------------------------------------------------------- + + Thanks, good morning. The first question I had was just a follow-up on CRES. Is there any immediate benefit in terms of the ability to accelerate LAS legacy servicing cost reductions now because of the bulk sale? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [62] +-------------------------------------------------------------------------------- + + From a number of units perspective, as you look at the bulk sale there was a piece of it that we serviced, and there was also a piece that others serviced. So in the context of the number of 60-plus-day delinquent loans, it was not meaningful relative to the total. + +-------------------------------------------------------------------------------- +Guy Moszkowski, Autonomous Research - Analyst [63] +-------------------------------------------------------------------------------- + + Got it. So what we're really looking at is more what you were talking about in response to John's question a minute ago, which is the potential for one more sale this quarter and then just normal runoff. + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [64] +-------------------------------------------------------------------------------- + + That's correct. + +-------------------------------------------------------------------------------- +Guy Moszkowski, Autonomous Research - Analyst [65] +-------------------------------------------------------------------------------- + + Got it. Question for you, while we're on the topic of mortgage stuff. Obviously you had the $4 billion litigation reserve build essentially this quarter. +It appears, based on what you gave as an after-tax impact that you take a full tax benefit against that. Of course, what we find with a lot of these things, especially with like the DOJ settlements, is that a large amount is not deductible. Do you have any flexibility with respect to being able to use a lower tax rate? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [66] +-------------------------------------------------------------------------------- + + A couple things. We don't give the exact numbers; but if you go back, Guy, and look at the first quarter, we look at and try to understand what the tax treatment is for the different settlements. There was a piece of it in the first quarter that we would have assumed was not tax-deductible. +And, you're right, the piece that -- in the reserve that we took this quarter there was a presumption that it was tax-deductible. And the short answer is, until you get to the end, you don't know the exact mix. +But -- so we have tried to be thoughtful with that and just say, as it relates to the total number, as we said last quarter there was -- I think it was $2.4 billion of litigation expense over and above what was for settlements. In this quarter, you've got in the high $3 billions. And I think it gives you a sense as to the magnitude of the reserves that have been built over the last two quarters. + +-------------------------------------------------------------------------------- +Guy Moszkowski, Autonomous Research - Analyst [67] +-------------------------------------------------------------------------------- + + Got it. Switching topics, you did talk about pricing on commercial loans in the context of not seeing a meaningful increase in commercial loan balances this quarter, and I guess alluded to some discipline that you're exercising. Can you talk a little bit about the conditions that you're seeing in the commercial loan market and where you think there is froth? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [68] +-------------------------------------------------------------------------------- + + Sure. If you look at -- and embedded under the Global Banking segment we've got the loans that are down within our Corporate Investment Bank that tend to be for the larger companies. And as we looked at spreads and yields on a linked-quarter basis within our business we saw relative stability in the yields in those businesses. +And, as we look out at -- in the marketplace, given that those loans that are brought for those customers tend to be broadly syndicated, and there tends to be a relationship in the yield between that and where they can access capital in the capital market, that loan pricing over the last quarter has hung in there and, like I said, was generally flat Q1 to Q2. +I would say where you tend to see a little bit more of the competitive pressure tends to be within the base commercial bank, which is core middle-market companies, where they tend to be more one-, two-, or three-bank deals. And we have seen that area continues to be pretty competitive and we are just being disciplined with how we approach that market. +Given the footprint that we have, we do have the flexibility to not chase things within some of these regional markets. + +-------------------------------------------------------------------------------- +Guy Moszkowski, Autonomous Research - Analyst [69] +-------------------------------------------------------------------------------- + + Just to follow up on that, when you say banks competing for that business, are you using the word bank in a traditional sense? Or are you actually seeing a lot of the competition for those type of mid-market loans coming from outside of what we would think of as the traditional banking sector? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [70] +-------------------------------------------------------------------------------- + + No, I would -- for the core commercial customer, that's going to be the traditional banking customer as you'd think of it. + +-------------------------------------------------------------------------------- +Guy Moszkowski, Autonomous Research - Analyst [71] +-------------------------------------------------------------------------------- + + Okay. Then just a housekeeping question, just to make sure I understand what you were saying. You said there were maybe $250 million of gains in Global Markets, I guess. Probably -- not to put words in your mouth -- but things like market. +But I think you said that you did not include those numbers in the core equities or fixed income segment revenues. Is that right? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [72] +-------------------------------------------------------------------------------- + + Yes; that's correct. So we had a position that went public during the quarter. There was a gain, and it's reflected in the revenues of the Global Markets segment. But we did not think it was appropriate to include that in the core FICC and equity sales and trading. +So if you go to the table on page 13, when you look at that FICC and equity sales and trading number, ex-DVA, that does not include any benefit from the gain that we saw within the overall segment during the quarter. + +-------------------------------------------------------------------------------- +Guy Moszkowski, Autonomous Research - Analyst [73] +-------------------------------------------------------------------------------- + + Got it, perfect. Thanks for the clarification. + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [74] +-------------------------------------------------------------------------------- + + Sure. + +-------------------------------------------------------------------------------- +Operator [75] +-------------------------------------------------------------------------------- + + Moshe Orenbuch, Credit Suisse. + +-------------------------------------------------------------------------------- +Moshe Orenbuch, Credit Suisse - Analyst [76] +-------------------------------------------------------------------------------- + + Great, thanks. I was wondering; you've got a little less than $250 billion of residential real estate loans and $90 billion of home equity. How much do you think those decline before those stabilize? +Because I think you tried to talk about in terms of the overall loan growth. But that's really -- those are really the categories that are shrinking. Do you have a sense as to where those categories will level out? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [77] +-------------------------------------------------------------------------------- + + Well, if you start from a home equity perspective, I think the repayment and run off of those is a good thing and not a bad thing. So you will continue to see, I would expect, over the next couple years that the amortization of those is going to be greater than the new loans coming on the book. +We would not expect, though, as you look at net interest income, given the yields on those versus what you can do with other things, that the runoff of that book will have a negative impact from an overall net interest income perspective. +As it relates to the whole loans piece that we have, I would expect that over time that will continue to run down. We continue to look, as we've talked about before on the Home Loans business, to put and to originate mortgages for customers where we want to hold those loans. +During the quarter we put about $6 billion of home loans that were originated for our customers on our balance sheet. Roughly 75% to 80% of those would have been of the jumbo variety. +But I think to be realistic, over the next probably couple years you're likely to see a little bit more runoff of that than you will see new loans coming on. We obviously have the decision at that point of: Do you want to reinvest those proceeds in other whole loans that you can buy out in the market, or invest those in securities? +And I would say at this point, with LCR as well as what we're focused on from a customer perspective, they're much more likely to be invested in securities than new whole loans that are not for our customers. + +-------------------------------------------------------------------------------- +Moshe Orenbuch, Credit Suisse - Analyst [78] +-------------------------------------------------------------------------------- + + Got it. Secondly, the reserve build for legal, I guess, could you talk about how much you have in reserves in total? Or maybe address as to how you came up with that number? Given the fact that I think, if I'm reading the footnotes correctly, that your possible but not accrued losses have stayed flat from the first quarter. + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [79] +-------------------------------------------------------------------------------- + + Yes, a couple things. The range of possible loss that you quoted, of being flat from the first quarter to the second quarter, relates to our representation and warranty reserve, not our litigation RPL. So you're correct that the rep and warrant piece was flat quarter-over-quarter. +We do not update and provide our range of possible loss on litigation expense until we file the 10-Q. +As it relates to overall litigation reserves, we do not put out an exact -- or a level of our litigation reserve. What I do think is notable and probably most relevant is the information that I gave you as it relates to the litigation reserve that has been built over the last two quarters that relates to legacy mortgage-related matters. And I think you can see and people are aware of what the most significant of those matters are. +And obviously each quarter, as it relates to the reserving, we go through each quarter and assess where we are and what we think is appropriate from a reserving perspective. And we did that again in this quarter, just like we do in any quarter. + +-------------------------------------------------------------------------------- +Moshe Orenbuch, Credit Suisse - Analyst [80] +-------------------------------------------------------------------------------- + + Great. Just a quick follow-up to the first one. You had mentioned investing some of the runoff from the mortgage and home equity portfolio in securities. Is that in the context of keeping those balances stable? Or would you actually increase that portfolio? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [81] +-------------------------------------------------------------------------------- + + Yes, the first goal is obviously, as we've talked about, is to find and invest in loans that are for our core customers across the platform. And that is priority one. +To the extent that there is residual or excess, which there has been given the deposit growth that we've seen, the money does get invested. And it's been invested primarily in the most recent several quarters in securities. +I mentioned OCI risk. The notable thing is if you look at the OCI risk that we have as a Company, even though the securities book has increased significantly over the course of the last 12 months, the overall level of OCI risk based on the different metrics that we look at has not changed. And that is a result of us shortening the portfolio, investing it in shorter-duration Treasury securities. + +-------------------------------------------------------------------------------- +Moshe Orenbuch, Credit Suisse - Analyst [82] +-------------------------------------------------------------------------------- + + Okay, thanks. + +-------------------------------------------------------------------------------- +Operator [83] +-------------------------------------------------------------------------------- + + Steven Chubak, Nomura. + +-------------------------------------------------------------------------------- +Steven Chubak, Nomura Securities - Analyst [84] +-------------------------------------------------------------------------------- + + Hi, good morning. The first question I have pertains to capital and RWA specifically. Over the last five quarters, we have actually seen the RWAs on a flat to upward trajectory; and then effectively the growth has mirrored the balance sheet growth that we've seen over that same period. +I just wanted to get a sense as to whether there were any additional mitigation levers that you guys could potentially pull; or whether those types of opportunities have been largely exhausted, and thus the growth going forward will likely continue to mirror the balance sheet. + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [85] +-------------------------------------------------------------------------------- + + Yes, I think as it relates to the risk-weighted assets, you need to bifurcate risk-weighted assets under Basel 3 Standardized versus those under Basel 3 Advanced. As you look at the Basel 3 Standardized ratios, the benefits that we have there tend to come from the roll-off of the different consumer loan portfolios, both in first mortgage as well as in home equity. +And we would expect, as we've talked about throughout the call, that you will continue to see a runoff there. And given that a lot of the stuff that's running off is higher loan-to-value than the new stuff that's coming on, that there is incremental benefit there. +So if you look at over the last five quarters, I think in the way that the Standardized metric is set up, the Standardized metric is going to tend to mirror the overall loan growth that you have. I would just say, as I mentioned, going forward on average it will probably be a little bit lower mix coming on than what rolls off. +On the Advanced approach, at this point as we look forward there will continue to be opportunities on stuff that is Advanced but tends to be heavier risk-weighted that rolls off between now and 2017. It's not going to be anywhere near as material as what we've seen. And under the Advanced approach, the recent increases you've seen have largely been attributable to operational risk as opposed to what we're seeing within the core loan categories. + +-------------------------------------------------------------------------------- +Steven Chubak, Nomura Securities - Analyst [86] +-------------------------------------------------------------------------------- + + Okay, thanks. No, that's really helpful. Switching over to GWIM for a moment and actually taking a longer-term view on the earnings power within the segment, there is one area where we have struggled from a modeling perspective. It's trying to contemplate exactly how high the operating margin can get in a rising rate scenario. +Because the operating leverage improvement can be fairly dramatic, but presumably there is that peak margin level where competition is going to intensify to such a degree that effectively there's going to be no more room for improvement beyond, I don't know, let's call it 30%. I didn't know if that was something which you guys had evaluated at least in the context of a rising rate scenario. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - CEO [87] +-------------------------------------------------------------------------------- + + I think you've got -- one of the levers in the business that people often overlook is the lever towards rising rates. Because in the business itself the amount of total deposits and loans are significant, $250-billion-odd of deposits and significant loans. I think we said on the last call and have said many times, we can see this margin moving towards 30% in that dynamic, in that yield, in that environment. +But I think when you get to there, you start to top out a little bit, if you just understand the broad base of the revenue and the amount that goes through the grid and things like that, that become a governor on what you can do beyond that. +But the mix of our business of wealth management with the private banking business and the loans and deposits from the general client base and what we see [in Europe], that gives us leverage to the upside as you describe. + +-------------------------------------------------------------------------------- +Steven Chubak, Nomura Securities - Analyst [88] +-------------------------------------------------------------------------------- + + Okay, great. One final one on credit. At your Analyst Day a number of years ago, you had given some guidance on through the cycle charge-off rates. But clearly since that update your loan mix has changed fairly dramatically; and at the same time underwriting standards have tightened meaningfully. +From what I recall, I believe the through-the-cycle charge-off rate at that time that was implied was somewhere in the neighborhood of 120 bps. And clearly it's going to be lower than that going forward, but I was hoping you could give us an update, maybe some updated guidance on where you think that through-the-cycle and that charge-off rate will likely end up. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - CEO [89] +-------------------------------------------------------------------------------- + + I think if you look at the charge-offs, the key is that -- when you really think about the broad constitution of $1.3 billion, if you remove the recoveries, but some range -- you've got to look at the card business. And what changed since that time is we have changed our position in the card business fairly dramatically with the sale of some international portfolios and even how we have approached the US just based on the dynamics of the card business. +The good news is the card business is starting to grow in terms of balances. And going back to an earlier question, we got rid of the non-core aspects and now you're seeing the core start to come through. 1.1 million new cards; people are using the card more; and the balance is growing. +So I think that if you just think about that, that number is going to be -- is today and will be the dominant part of the charge-off question. And you should think that that $90 billion, $100-billion-ish in balances as you look forward you would expect that to grow, but not to change itself dramatically -- not for us to change it dramatically in terms of position on our balance sheet, because we need to keep that book balanced. Because it has higher charge-offs in a period of unemployment levels. +So I would say if you went back and looked at that, and that is the biggest core adjustment between the two items. And then -- but the core -- the counter to that is if you look at the appendix pages and see the charge-offs on the mortgage business, in the first mortgage business you had recoveries. But if you look at the home equity side you still have a charge-off rate which, based on the underwriting criteria, the stuff going on would be much higher. +So we had a couple hundred million dollars in quarterly charge-offs that you can see on page 21. So we would expect to see improvement in that from where we are. +But I would say the card business is about as good as -- is getting very strong. You ought to see a little bit of help in home equities. You're going to have a reversal from the recoveries on the first mortgage loans, but it is a fundamentally different level because we've mixed the balance sheet differently on purpose. + +-------------------------------------------------------------------------------- +Steven Chubak, Nomura Securities - Analyst [90] +-------------------------------------------------------------------------------- + + Okay, that's great. Thank you for taking my questions. + +-------------------------------------------------------------------------------- +Operator [91] +-------------------------------------------------------------------------------- + + Paul Miller, FBR. + +-------------------------------------------------------------------------------- +Paul Miller, FBR Capital Markets - Analyst [92] +-------------------------------------------------------------------------------- + + Yes, thank you very much. Going back to your LAS costs, excluding litigation, where you mentioned that it's probably -- to get to that $1.1 billion target is going to take another quarter or two. What should we be watching? +And how long do you think that LAS expenses are going to move to become nonmaterial, I guess is another way to say it? Can you give us things, what we should be tracking? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [93] +-------------------------------------------------------------------------------- + + Sure. The first thing -- I want to be clear, Paul -- that getting to the $1.1 billion is moved back -- may be moved back one quarter, not two. + +-------------------------------------------------------------------------------- +Paul Miller, FBR Capital Markets - Analyst [94] +-------------------------------------------------------------------------------- + + I'm sorry. + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [95] +-------------------------------------------------------------------------------- + + So we're looking at one quarter. The second, though, the biggest item that really relates to the trajectory of LAS expenses is your number of 60-plus-day delinquent loans. Because the cost to service that is many multiples what the cost of servicing a current loan is. +So as you go forward, we have full implementation of the national mortgage settlement effective September 30. That will be a big benchmark. +Then as you go beyond then, on a, as we've always said, a one- to two-quarter lag, you will see expenses trend down as your number of 60-plus-day delinquent loans trend down. And as those trend down you need less people as well as a variety of other expenses. So that is the key metric to watch. +And as it relates to just how long that's going to continue, I would not expect that we get down to the level of what should be a recurring number of 60-plus-day delinquents until probably the end of 2015 or the first part of 2016. So as it relates to continued expense leverage, we would expect to see upside in that business probably all the way through the end of 2016 as it relates to driving expense down. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - CEO [96] +-------------------------------------------------------------------------------- + + Paul, we've got work to do, in a sense. If you go back, I think, and if you looked at the fourth quarter of 2012, it was about $3.1 billion; the fourth quarter of 2013 I think it was $2.1 billion, Bruce; and then originally we said higher, then we brought it down to $1.1 billion, and now think that it's somewhere a little higher than that. +But that's the broad move, and the question is: How do you keep going on that? And that is really going to be, as Bruce said, the number of 60-plus delinquent loans, which allows you to release people. +But we are also getting a condition that we have now got the place stabilized enough behind us that we can start to invest in technology, what will add a level of improvement that we haven't been able to invest in, where we just had to get the work done. +So we expect there is systems deployment in that business as we move into the middle of 2015, into 2016, and we expect consolidations of physical plants and things like that, which will add to the expense leverage, but we haven't been able to do that as much yet just because of just the massive amount of work that had to take place. +So there is still a lot of work ahead of the team, but if you put it in a context of $2-billion-ish per quarter and expense reduction across eight quarters, a lot of work has been done, too. + +-------------------------------------------------------------------------------- +Paul Miller, FBR Capital Markets - Analyst [97] +-------------------------------------------------------------------------------- + + And just a follow-up. You talked about you do have another MSR sale. I don't know how material that is. But right now there has not been a lot of transfer of MSRs due to various -- well, Lawsky, up in New York, questioning a lot of the stuff that other companies are doing. +Is that -- can that interfere with the sale? Or you think you can sell the MSR without the headline risk of Lawsky? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [98] +-------------------------------------------------------------------------------- + + The MSR sale that I referenced that will happen in the second half of the year, in the context of what we've done is relatively small. It's just that the delinquency content associated with that sale is high, so it's material from that perspective. But from an overall size perspective it's not material. + +-------------------------------------------------------------------------------- +Paul Miller, FBR Capital Markets - Analyst [99] +-------------------------------------------------------------------------------- + + Okay, guys. Thank you very much. + +-------------------------------------------------------------------------------- +Operator [100] +-------------------------------------------------------------------------------- + + Marty Mosby, Vining Sparks. + +-------------------------------------------------------------------------------- +Marty Mosby, Vining Sparks - Analyst [101] +-------------------------------------------------------------------------------- + + Thanks. I wanted to ask you a couple questions. First off, you've been harvesting about $400 million worth of gains out of the debt portfolio. Is that in the sense of trying to minimize your AOCI risk when rates do go up, as you're shortening the portfolio? Or just wanted to think about your strategy; because that's been a pretty consistent flow through over the last year. + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [102] +-------------------------------------------------------------------------------- + + As you look at those gains, we are committed to not -- as we continue to see liquidity build, not taking incremental OCI risk, as I referenced. So over the last year, even as the securities portfolio has grown, we have managed to keep the OCI risk from an absolute dollar perspective relatively flat. +As you see markets move up and down, obviously selling longer-duration securities as you have growth in the securities portfolio is part of that strategy. + +-------------------------------------------------------------------------------- +Marty Mosby, Vining Sparks - Analyst [103] +-------------------------------------------------------------------------------- + + So I just want to make sure that the gains are just an outflow of that overall strategy that you had talked about. + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [104] +-------------------------------------------------------------------------------- + + Yes. You are exactly correct. + +-------------------------------------------------------------------------------- +Marty Mosby, Vining Sparks - Analyst [105] +-------------------------------------------------------------------------------- + + Okay. When you look at the Consumer and Business Bank, you have a considerable amount more in deposits than you really have in loans, which to me seems a little bit more skewed than what you would normally expect. How do you strategically think you can utilize that balance sheet funding over time? +Or what are some of the initiatives that you are doing? Because you should be able to penetrate that customer base with more lending. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - CEO [106] +-------------------------------------------------------------------------------- + + Yes. We should be able to penetrate them with more lending. So that's -- if you look on page 17 it is -- or 18, excuse me -- you can see the growth in card originations, the growth in home equity originations, which go on the balance sheet, that -- as Bruce talked about early, we're putting about half, broadly stated, of the originations and mortgages are going on the balance sheet. +In the Business Banking segment, which is a small part of our Commercial Banking segment geared to the $50 million and under revenue companies, we're actually starting to see net loan growth the first time in a lot of times, as we ran off some non-core portfolios. +So that's the core opportunity in the franchise, is to continue to originate credit to the core customer base. There's lots of opportunity there, but you can see us making progress against it each quarter. +I think on a broader context you've got to think about these businesses and how they mix together. So in every company's retail business it's an excess deposit generator, just by the very nature of it. And not only is it fund the loans of the consumer customers, but also provides the funding for the rest of the franchise. +So I think you have to keep that broader context. And that is why we invest -- going to your first question -- in mortgages in securities to, for lack of a better term, get the value out of those deposits for the shareholder. + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [107] +-------------------------------------------------------------------------------- + + The other point that I just want to mention is that historically, if you look at the front-end lending in Consumer Real Estate that we've done, from a segment perspective that Consumer Real Estate lending on a first mortgage basis, it shows up in the balance sheet in All Other. So you can't assume that those deposits that you see within page 9 -- a lot of the loans that they do for our customers are reflected in the All Other segment. + +-------------------------------------------------------------------------------- +Marty Mosby, Vining Sparks - Analyst [108] +-------------------------------------------------------------------------------- + + Then in the mortgage segment, the CRES, you're still, if you take out the litigation, generating about a $700 million negative loss in the sense of your just pretax pre-prevision between the revenues and expenses. You're talking about bringing down the Legacy Assets & Servicing expenses. But what is the timetable in your mind that would be reasonable to think of closing that $700 million gap? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [109] +-------------------------------------------------------------------------------- + + A couple things. The first is within Consumer Real Estate Services, if we look at the Home Loans business on the front end, we talked about how we saw during the quarter that we increased both front-end originations as well as took down expense. So Q1 to Q2 we saw about a $100 million improvement on the front end of the business that's reflected in Consumer Real Estate Services. +And as it relates to the $700 million number that you quoted, we obviously relative to the guidance have $300 million of expense to get out of that business over the next 90 days. And then as we have talked about earlier on the call, we've got work to do to continue to drive that down significantly in both 2015 and the first part of 2016. And that is clearly one of the highest priorities we have within the Company. + +-------------------------------------------------------------------------------- +Marty Mosby, Vining Sparks - Analyst [110] +-------------------------------------------------------------------------------- + + Just lastly -- and thanks for letting me ask you a few questions. Because if you're looking at valuation of your servicing portfolio, it dropped off to 82 basis points this quarter, which seems relatively low as the duration of that portfolio is extending. +I know interest rates came back, so the models force you to write it back down. But when you're looking at the prepayment speeds and the refinancing behavior, it seems like eventually that there is some value as that portfolio lasts a lot longer than the model assumes at this point. + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [111] +-------------------------------------------------------------------------------- + + I think your point -- the value and the fact that on a basis point basis it came down was reflective of the lower rates that we saw at the end of the second quarter relative to the end of the first quarter. And you're right; at a point in time when rates start to move out, you would expect that MSR to extend and for there to be value there. +But we do not -- I want to emphasize, we look to manage the MSR risk as part of the overall strategy and are managing that to have it be a flat book. + +-------------------------------------------------------------------------------- +Marty Mosby, Vining Sparks - Analyst [112] +-------------------------------------------------------------------------------- + + While from an interest rate standpoint I understand that, it just seems like the models have assumed a lot faster prepayments than we really actually experience, which eventually has to true up. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - CEO [113] +-------------------------------------------------------------------------------- + + At the end of the day, it comes down to what the customer does. You're exactly right. + +-------------------------------------------------------------------------------- +Marty Mosby, Vining Sparks - Analyst [114] +-------------------------------------------------------------------------------- + + All right, thanks. + +-------------------------------------------------------------------------------- +Operator [115] +-------------------------------------------------------------------------------- + + Matt Burnell, Wells Fargo. + +-------------------------------------------------------------------------------- +Matt Burnell, Wells Fargo Securities - Analyst [116] +-------------------------------------------------------------------------------- + + The questions have been asked and answered. Thanks very much. + +-------------------------------------------------------------------------------- +Operator [117] +-------------------------------------------------------------------------------- + + Mike Mayo, CLSA. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA - Analyst [118] +-------------------------------------------------------------------------------- + + Hi. A couple follow-ups. First on the deposit beta, I appreciate you giving us the color, for every 100 basis point increase it would help by $3.4 billion. You describe the deposit base. But what is the actual deposit beta that you use to come up with the $3.4 billion benefit? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [119] +-------------------------------------------------------------------------------- + + We do not quote, Mike, the actual deposit beta. We obviously go back and look at historical data. Our assumption is, as it relates to pass-through rates, as far as how much of the first 100 basis points that has to get passed along, we're in the 40% area, with respect to that. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA - Analyst [120] +-------------------------------------------------------------------------------- + + Okay, 40% for the first 100? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [121] +-------------------------------------------------------------------------------- + + Correct. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA - Analyst [122] +-------------------------------------------------------------------------------- + + All right. I think that's in the ballpark of one of your large peers, but below some others. Is the reason that would be below others just because it's a lot of branch-based deposits? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [123] +-------------------------------------------------------------------------------- + + You're exactly correct. If we go back and look at what it's been throughout time, at points where arguably we don't have the competitive position now, we look at a lot of historical data to come up with that number. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA - Analyst [124] +-------------------------------------------------------------------------------- + + As it relates to expenses, you've achieved 90% of the $8 billion New BAC savings. I see the branches are 5,023; and I think you said you wanted to be around 5,000 branches. So if I heard you right, I think you're going from a period of rightsizing to growth. Is that a fair characterization? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - CEO [125] +-------------------------------------------------------------------------------- + + We've been growing underlying activity, if you look at some of the statistics in the back [thing throughout], Mike. But you're right; if you go back a couple years ago, we started New BAC. We were running $15-and-odd-billion in core expenses; now we're running $13-odd-billion, and so we're largely getting there. +The question then is: Now, how do you hold it there in an economic environment which is lower growth than traditionally expected in the United States? And that is going to take constant vigilance on our part. +But during that whole time period we have invested literally thousands and thousands of people into the sales side and stuff to drive that growth. And we will continue to do that. The question is: How do you balance that investment rating? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [126] +-------------------------------------------------------------------------------- + + And I just, Mike, before -- I just want -- achieving the balance of the $2 billion in quarterly New BAC savings in the fourth quarter is not dependent on future branch sales. So I just want to make sure that that there is not an assumed linkage there. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA - Analyst [127] +-------------------------------------------------------------------------------- + + Are you reallocating some of the people assigned to New BAC to other areas? It seems like you could dismantle that project group, so to speak. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - CEO [128] +-------------------------------------------------------------------------------- + + It's not a big project. I mean this is done by the people running the businesses. It's just committed plans that we did. +This wasn't -- it's not a huge project group that actually accomplishes it. It's done by whoever runs each business, each function. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA - Analyst [129] +-------------------------------------------------------------------------------- + + Okay. As it relates to loan paydowns, Bruce, you mentioned that some bank loans declined as customers went to the capital markets. In a way, a type of disintermediation from the bank. +But can you elaborate on that? Are you still seeing that this quarter? Do you think that was a one-off event, or is that something we should watch out for? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [130] +-------------------------------------------------------------------------------- + + Our sense is, from what we saw during the quarter, it was more a one-off event. They were a couple loans that were for acquisition-related purposes, that people then went out and refinanced. So it was just a little bit of an anomaly that we saw in the second quarter. +And if you look at just the attractiveness that the capital markets have been, you would expect that to largely be over. But every now and then, when you deal with large, multinational companies where some of the loan holds are a little bit higher, you can have those one-time events where that happens. +And we had a little bit of that in the second quarter. It's not something we would expect to recur. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA - Analyst [131] +-------------------------------------------------------------------------------- + + What I'm getting to is, do you guys think this is an inflection point for loan growth? I can find one of your large peers who implied that it is; and I can find a large regional bank who says it's not. +Where do you fall out on the spectrum? You said, Brian, that middle-market utilization was up ever so slightly. Can you just give us that utilization number and where you stand? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [132] +-------------------------------------------------------------------------------- + + Sure. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - CEO [133] +-------------------------------------------------------------------------------- + + Bruce gave it to you earlier, but I'll have him do it again. + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [134] +-------------------------------------------------------------------------------- + + Sure. The middle-market utilization rate was 37%-plus at the end of the first quarter and was up about almost 1% to be mid-38%. Which I don't think in and of itself is not material, but it does seem that people are a little bit more willing to access their revolving credits. +At the same time, practically speaking you're not going to tend to see loan growth that is dramatically higher than the rate at which the overall economy is growing. So clearly, as Brian alluded to in his opening comments, we did see added an economy that improved in the second quarter relative to the first quarter. And on the Commercial side, our loan growth is going to tend to mirror or be a little bit above what we see in the macro-economy. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA - Analyst [135] +-------------------------------------------------------------------------------- + + So do you think this is an inflection point for loan growth? Or is that an answer you would rather not delve into? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [136] +-------------------------------------------------------------------------------- + + We have seen -- we are seeing signs of improvement. I'm not sure I'd go as far as saying it's an inflection point. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA - Analyst [137] +-------------------------------------------------------------------------------- + + Okay. At the Annual Meeting, the clock ran out on me before I could ask one question. Very simple. What are your financial targets with and without higher interest rates? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [138] +-------------------------------------------------------------------------------- + + We've been pretty consistent if we go back, I believe, Mike, to the third- or fourth-quarter earnings call, that as we look out to and as we look at and embedded in our models a 100 basis point parallel shift in the yield curve, that we're looking at that point with a tangible common equity ratio of 7%, a return on asset of 1%, to be at a 14% return on tangible common equity. +As you get into the -- and you don't see that rate environment until 2016. And if you look at those metrics and back out what we have said 100 basis points is worth to us on a parallel shift, you get a sense for what we need to get to, ex- the 100 basis point move. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA - Analyst [139] +-------------------------------------------------------------------------------- + + I'm sorry. So without the 100 basis point shift, the target for ROA and ROTCE is what? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [140] +-------------------------------------------------------------------------------- + + It's going to be roughly $3.3 billion or $3.4 billion pretax. +And at $0.63, it's $2 billion less, which on roughly $140 billion of tangible common equity is going to be about 20 basis points less on assets at that point. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA - Analyst [141] +-------------------------------------------------------------------------------- + + Okay. Then last question. As it relates to Citigroup's settlement with the DOJ for MBS securitizations and CDOs, you had quite a bit more in MBS securitizations and CDO structuring; and so how can we think about this number and the amount of reserves that you have? I read one press article that you were willing to offer $12 billion and the DOJ wanted $17 billion. +I know you can't go into too much detail on this. But can you just give us a framework for how you view resolving this? +I mean, on the one hand, you could argue maybe you shouldn't pay hardly anything because you bought a lot of these entities that created these deals, and you're just punishing the new shareholders. And on the other hand, if you say that you had 10 times the level of some of this MBS activity, it could be a huge number. So how should we think about that? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - CEO [142] +-------------------------------------------------------------------------------- + + As you said, Mike, I think we can't discuss that. You'd get a rendition of all the different criteria that people have written about. +But I think that this quarter we were able to put away the AIG case, which if you remember back in 2011 a lot of people said was worth a lot more money for $650 million. So we will continue to figure out what we can get put behind us at reasonable cost to our shareholders. We just can't talk about details that much. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA - Analyst [143] +-------------------------------------------------------------------------------- + + All right. Well, good job with the AIG. I was one of those people who thought it was going to be more, and it wasn't. But that's fine. +I will take any guidance I can get on the legal costs ahead. Thanks a lot. + +-------------------------------------------------------------------------------- +Operator [144] +-------------------------------------------------------------------------------- + + David Hilder, Drexel Hamilton. + +-------------------------------------------------------------------------------- +David Hilder, Drexel Hamilton - Analyst [145] +-------------------------------------------------------------------------------- + + Thanks. Most of my questions have been answered. Just on the AIG settlement, I actually thought AIG was the only remaining objector. Are there others? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [146] +-------------------------------------------------------------------------------- + + There are several other objectors that have not been as vocal. And as I said, we will have to see where it goes with them dropping out. + +-------------------------------------------------------------------------------- +David Hilder, Drexel Hamilton - Analyst [147] +-------------------------------------------------------------------------------- + + AIG has agreed to dismiss all its claims -- or its objections, I should say? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [148] +-------------------------------------------------------------------------------- + + That's correct. + +-------------------------------------------------------------------------------- +David Hilder, Drexel Hamilton - Analyst [149] +-------------------------------------------------------------------------------- + + Okay. Great. + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [150] +-------------------------------------------------------------------------------- + + It's part of the settlement agreement. + +-------------------------------------------------------------------------------- +David Hilder, Drexel Hamilton - Analyst [151] +-------------------------------------------------------------------------------- + + Great. Thanks very much. + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [152] +-------------------------------------------------------------------------------- + + Great. Super. Well, I think we're through all the questions, so thanks a lot for joining us and we will look forward to talking next quarter. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - CEO [153] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Operator [154] +-------------------------------------------------------------------------------- + + This does conclude today's conference. You may now disconnect and have a wonderful day. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/exam/original-files/Problem_1_Sample/2014-Jul-23-FB.OQ-137343825744-Transcript.txt b/exam/original-files/Problem_1_Sample/2014-Jul-23-FB.OQ-137343825744-Transcript.txt new file mode 100644 index 0000000..f971e1b --- /dev/null +++ b/exam/original-files/Problem_1_Sample/2014-Jul-23-FB.OQ-137343825744-Transcript.txt @@ -0,0 +1,536 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q2 2014 Facebook Inc Earnings Call +07/23/2014 05:00 PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Dave Wehner + Facebook, Inc. - CFO + * Deborah Crawford + Facebook, Inc. - Director of IR + * Sheryl Sandberg + Facebook, Inc. - COO + * Mark Zuckerberg + Facebook, Inc. - Chairman & CEO + +================================================================================ +Conference Call Participiants +================================================================================ + + * Ken Sena + Evercore Partners - Analyst + * Neil Doshi + CRT Capital - Analyst + * Ben Schachter + Macquarie Research - Analyst + * Justin Post + BofA Merrill Lynch - Analyst + * Arvind Bhatia + Sterne, Agee & Leach - Analyst + * Brian Pitz + Jefferies & Company - Analyst + * Douglas Anmuth + JPMorgan - Analyst + * Eric Sheridan + UBS - Analyst + * Colin Sebastian + Robert W. Baird & Co. - Analyst + * Mark Mahaney + RBC Capital Markets - Analyst + * Ross Sandler + Deutsche Bank - Analyst + * Brian Nowak + Susquehanna Financial Group - Analyst + * Heather Bellini + Goldman Sachs - Analyst + +================================================================================ +Presentation +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Good afternoon, my name is Jay and I will be your conference operator today. At this time, I would like to welcome everyone to the Facebook Second Quarter Earnings Conference Call. (Operator Instructions) Ms. Deborah Crawford, Facebook's Director of Investor Relations, you may begin. + +-------------------------------------------------------------------------------- +Deborah Crawford, Facebook, Inc. - Director of IR [2] +-------------------------------------------------------------------------------- + + Thank you. Good afternoon and welcome to Facebook's second quarter earnings conference call. Joining me today to talk about our results are Mark Zuckerberg, CEO; Sheryl Sandberg, COO; and Dave Wehner, CFO. Before we get started, I would like to take this opportunity to remind you that our remarks today will include forward-looking statements and actual results may differ materially from those contemplated by these forward-looking statements. +Factors that could cause these results to differ materially are set forth in today's press release and our quarterly report on Form 10-Q filed with the SEC. Any forward-looking statements that we make on this call are based on assumptions as of today and we undertake no obligation to update these statements as a result of new information or future events. During this call, we will present both GAAP and non-GAAP financial measures. +A reconciliation of GAAP to non-GAAP measures is included in today's earnings press release. The press release and an accompanying investor presentation are available on our website at investor.FB.com. Now, I'd like to turn the call over to Mark. + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook, Inc. - Chairman & CEO [3] +-------------------------------------------------------------------------------- + + Thanks, Deborah, and thanks, everyone, for joining today. This was a good quarter for us and a good end to the first half of the year. We've continued to grow our community in size and engagement with 1.32 billion people now connecting on Facebook each month and 63% of them visiting daily. Our momentum remains especially strong on mobile. +There are now 829 million people using Facebook everyday, with more than 650 million people using our services on mobile everyday. One thing that's exciting is that there's still so much room to grow. On average, people on Facebook in the US spend around 40 minutes each day using our service, including about one in five minutes on mobile. This is more than any other app by far, but overall, people in the US spend nine hours per day engaging with digital media on TVs, phones, and computers. +So, there's a big opportunity to improve the way that people connect and share across how we all engage with the rest of media as well. When it comes to our business, we continue to be pleased with our growth. This quarter, our total revenue grew to over $2.9 billion and advertising revenue grew by 67% from a year ago. Mobile now accounts for 62% of our advertising revenue, which is a good sign of how the growth of our community on mobile is also producing better business results for our partners. +The results this quarter show our continued focus on improving our core products and business. We're going to continue investing aggressively in areas that are important for our mission and long-term strategy, but we're also going to stay focused on our core products and business. This is the best way for us to continue creating value for our community. Now, let's talk about how we're making progress on our three big company goals: connecting everyone, understanding the world, and building the knowledge economy. +Our strategy for connective everyone has two basic approaches. Our first approach is internet.org, our effort to bring affordable internet access to every person in the world. Our second approach is about giving everyone more tools for connecting so they can share all of the different kinds of content they want with the right people. Instagram, Messenger, and our Creative Labs apps are a part of the second approach. +With internet.org this quarter, we've continued to deepen our partnerships with mobile operators and lay the foundation for running tests in more countries. Already, our initial partnerships in the Philippines, Paraguay, and Tanzania, have helped around 3 million people connect to the internet who had no access before. We're really proud of these early results. +In June, we acquired Pryte, which has a lot of expertise bringing affordable internet access to communities by partnering with mobile operators, app developers, and content providers. Later this year, we expect to launch a broader set of free basic internet services in a number of other countries, as well. In our app efforts, we're continuing to build momentum with messaging. +People now send more than 12 billion messages a day on Facebook, and in April, we reached 200 million monthly actives on Messenger. Last month, we announced that David Marcus will be joining us from PayPal to lead our messaging efforts. We expect David to continue growing Messenger, building out new experiences to serve our community, and ultimately, to build Messenger into an important business. +Instagram continues to make great progress in giving people new ways to share their stories through photos and videos. Last month, we made one of the biggest updates ever to Instagram, by adding new creative tools that allow people to refine exactly how their photos look and feel. This is an important part of building out Instagram's capabilities as a platform and serving the creativity of the Instagram community. +Next, let's talk about understanding the world. As of last month, on average, more than 1 billion search queries are made every day on Facebook. This is a great milestone and it shows we're in a unique position to answer a lot of questions for people. But this is just the start and over the next few years, as we make progress on building out search and our broader efforts in artificial intelligence, I expect us to deliver even greater utility for people. +Our progress on public content is also very promising. As part of helping people better understand the world, we want to help you connect around important public moments and personalities. Now, nearly 800 million people on Facebook are connected to public figures. These connections are driving conversations at a huge scale. During the World Cup, over 350 million people made over 3 billion interactions on Facebook. +To enable even more of these conversations, we've improved the ranking of videos and News Feed and launched new APIs to help TV and media organizations use Facebook content in their productions. Public content will continue to be a growing focus for us over the coming months and we plan to invest in building more great products and partnerships in this area. +Now, building great social experiences to serve our community isn't something we do alone. Supporting developers is a key part of our strategy and at our f8 conference in April, we announced new ways to help mobile developers build, grow, and monetize their apps. Over 1 billion people use Facebook on their phones every month and more than 80% of the top apps on iOS and Android now use Facebook log-ins. We think we're in a great position to be the cross-platform platform, that let's developers build great apps across every platform. +So far, we're very encouraged by the reaction from developers. App Links, our new method of deep linking to specific content in any app, is now being used by hundreds of apps across iOS, Android, and Windows phones, with links to more than 1 billion individual destinations in these apps. +We also launched our Audience Network, our first big effort to help developers monetize on mobile and we've received a lot of interest from developers. We're rolling out the Audience Network gradually, but we're going to continue to ramp this up over the coming months and are excited by the opportunities ahead. +Finally, let's talk about our efforts to build the knowledge economy. This has been a strong period for us and we've reached some new milestones as a business. Now, more than 30 million small businesses use Facebook pages to connect with their customers and more than 1.5 million of them are active marketers on Facebook. +To continue delivering the best returns for marketers, we've been very focused on improving the quality of the ad experiences for our community. Our goal here is to make ads as interesting and useful as your friends' content on Facebook. We're investing heavily in this area and this quarter, we launched a number of efforts to improve the quality and relevance of our ads, including new ads preferences tool, interest-based advertising, and improvements to News Feed designed to reduce low quality content. +In some countries, our surveys indicate that our ads get close to the quality level of organic content, but in most developed countries, we still have a lot to do. We expect to continue focusing on this for a long time. +That's my update on how we've been executing over the last quarter. It's been a quarter with good performance and continued momentum. I want to thank everyone who works at Facebook and is part of our community, including our shareholders and partners. +Because of your efforts, we're continuing to make progress towards our mission to help connect the world and we're improving hundreds of millions of people's lives everyday. I'm grateful for your support and to have the chance to work with all of you. Thanks. Now, here's Sheryl. + +-------------------------------------------------------------------------------- +Sheryl Sandberg, Facebook, Inc. - COO [4] +-------------------------------------------------------------------------------- + + Thanks, Mark, and hi, everyone. As Mark said, we had a strong second quarter. Ad revenue grew 67% year-over-year to more than $2.6 billion. Mobile ad revenue grew 151% year-over-year and now makes up 62% of our ad revenue. We continue to focus on three key areas in investment: capitalizing on the shift to mobile, growing the number of marketers using Facebook, and building our ad products. +These investments continue to generate broad-based growth. All geographies and all marketer segments performed well this quarter. Our team has a really strong belief in what we're building; the world's first ad platform that delivers personalized marketing upscale. While we believe it is still early days, we're pleased with the progress we're making and I want to join Mark in congratulating our global teams on their continued execution. +Today, I'm going to focus on two key marketer segments: small business and brand marketers, as well as cover some of the investments we're making on the product and ad tech fronts. We believe that personalized marketing of scale can drive results for all types of marketers. Just a few weeks ago, I was in India and I hosted our first India SMB round table. One of the entrepreneurs I met, Vivek Prabhakar, sold his house just a few years ago to raise the money to start his and his wife's dream business, Chumbak, a company that makes India-inspired products. +Facebook is Chumbak's leading marketing channel and is responsible for 35% of online revenue and 38% of their website traffic. Their Facebook ads deliver a 5x return on advertising spend and have helped the company grow to more than 150 employees in three offices. We have more than 30 million active small business pages and over 19 million of these are active on mobile. +We think we have a big opportunity to help SMBs like Chumbak grow their businesses. And I'm pleased to announce today that we have over 1.5 million active advertisers. We're also ramping up our engagement with this community. In the US, we're hosting Facebook Fit workshops in cities like New York, Chicago, and Miami to help small businesses and we're doing this globally, including forming our first European SMB council. +We're also making great strides in our work with larger brands who increasingly recognize how our scale, targeting, and measurement capabilities can drive great results. For example, P&G's Gillette works with us and agencies, IBS and MediaCom, to launch its Vector 3 razor to men in India. 80% of the 100 million Facebook users in India are on mobile and a majority of these are using feature phones. This was our first feature phone-only Facebook campaign in Asia. It reached 60% of Gillette's target audience and generated significant lift in both message and ad recall. +As we work with brand marketers around the world, we focus on how they can leverage our technology platforms to build their brands through creative storytelling. We saw many great examples of this at the recent Cannes Lions Festival. We were excited that campaigns that made Facebook a key part of their efforts took home prestigious awards. +The World Cup also provided a great opportunity for brand building on Facebook. Facebook was an important part of this global event, with 350 million people joining the conversation, generating 3 billion interactions. The final was the single-most talked about sporting event in Facebook history, generating 280 million interactions from 88 million people. Brands such as Visa, Nike, Ford, and McDonald's capitalized on this global conversation. +McDonald's worked with agencies, OMD, Framestore, and ARC sponsorship, as well as Facebook's Creative Shop, to produce 30 videos that used French fries as players. FryFutbol recreated the most spectacular World Cup moments and ran them as videos the very next day with the French fries acting as the players. This campaign reached 125 million people in 158 countries. +We also remain committed to investing in product development to drive higher returns for all of our marketers. Our custom audiences capabilities, which enable better targeting, are being adopted quickly and are now being used by 91 of the Ad Age 100. +Earlier this year, we launched website Custom Audiences, which enable marketers to target recent visitors to their websites. This is like retargeting, but it's even more effective because it works across both web and mobile. We're pleased with the early reaction from marketers. +We also introduced premium autoplay video ads this year. Video on Facebook helps brands extend their TV investments by combining traditional reach focus campaigns with our unparalleled targeting abilities. To date, we run about a dozen campaigns and the early data show promising results. We'll continue to roll this product out slowly and carefully. +Similarly, we're seeing positive early demand from marketers for ads on Instagram and we're rolling these ads out carefully as well. In all of this, we remain focused on the transition to mobile. Our recently launched Audience Network lets advertisers use Facebook targeting, while extending their campaigns beyond Facebook. This can improve the relevance of ads people see both on and off Facebook and we're encouraged by the early response. +Finally, earlier this summer, we announced the acquisition of LiveRail, a leading online video advertising platform that enables customers like MLB.com and A&E networks to monetize their video inventory efficiently. We have a lot to do here, but with LiveRail, we're investing in tools that can improve the relevance of video ads across the web. +In summary, we're pleased with our performance and the progress we're making. We're the first platform that can deliver personalized marketing at scale and marketers are increasingly recognizing the great results we can drive for them. Staying focused and executing will remain a major theme for us moving forward. Our teams know that our future success depends on our continued execution and our plan is to stay focused. Thanks and now, here's Dave. + +-------------------------------------------------------------------------------- +Dave Wehner, Facebook, Inc. - CFO [5] +-------------------------------------------------------------------------------- + + Thanks, Sheryl, and good afternoon, everyone. Q2 was a good quarter for us across our key operating and financial metrics. We generated strong revenue growth in operating margins and delivered $872 million of free cash flow. We continued to make investments to drive our core business, as well as to support our long-term strategic priorities. +Let's start with a review of our network. We are executing well on our ongoing mission to connect everyone. 829 million people used Facebook on an average day in June, up 130 million from a year ago. This represents 63% of the 1.32 billion people who used Facebook during June. Mobile continues to be a strong driver of our growth, with over 1 billion people using Facebook monthly on mobile. +At the same time, we're enabling more ways for people to connect and share beyond the core Facebook app. For instance, both Instagram and Messenger have each passed over 200 million MAU and continue to grow nicely. +Turning now to the financials, total revenue in the second quarter was $2.9 billion, up 61% or 59% on a constant currency basis. Total ad revenue was $2.7 billion, up 67% or 65% on a constant currency basis. Ad revenue growth was strong around the world, with each of our four geographic regions growing by over 60%. +Mobile ad revenue was approximately $1.66 billion or 62% of ad revenue compared to approximately $660 million or 41% of ad revenue last year. Desktop ad revenue was up 8% year over year. In Q2, the average effective price per ad increased 123% compared to last year, while total ad impressions declined 25%. The decrease in ad impressions continues to be driven by the shift towards mobile usage, where people are shown fewer ads compared to desktop. +The increase in the average price per ad was primarily driven by an increase in their percentage of our ads being served in News Feed. The price volume trends were generally consistent across all four reported geographic regions. Total payments and other fees revenue was $234 million, up 9% versus last year. +As we have noted in the past, we believe the more meaningful comparison that better reflects the organic growth rate of the payments business, comes from looking at payments volume from games specifically, which was up 1% in Q2 versus last year. Our current games payment revenue comes entirely from desktop usage and we are seeing declines in number of people using Facebook on desktop, a trend that will make this business challenging going forward. +Turning now to expenses, our Q2 GAAP expenses were $1.5 billion, up 22%, and our non-GAAP expenses were $1.2 billion, up 18%. Note that cost of revenue grew 2% on a GAAP basis and 1% on a non-GAAP basis, mainly driven by unusually high expenses in 2013 related to the transition out of certain lease data centers. This flatness in cost of revenue was the primary reason overall expenses grew relatively slowly. +Operating expenses, excluding cost of revenue, grew 33% on a GAAP basis and 31% on a non-GAAP basis. We ended Q2 with 7,185 employees, up 36% from last year. Our Q2 GAAP operating income was $1.4 billion, representing a 48% operating margin up from 31% last year. +Our non-GAAP operating income was $1.7 billion, representing a 59% non-GAAP operating margin up from 44% last year. Our GAAP and non-GAAP tax rates were 43% and 36%, respectively. GAAP net income was $791 million or $0.30 per share and non-GAAP net income was $1.1 billion or $0.42 per share. +In Q2, we spent $469 million on CapEx and generated $872 million of free cash flow. We ended Q2 with approximately $14 billion in cash and investments. This excludes the impact of the Oculus acquisition, which was closed earlier this week and included an approximately $400 million cash payment. +Now, looking forward, let me start by noting that the forward-looking comments I'll share today for 2014 include the impact from the recently closed acquisition of Oculus, but exclude, except where otherwise noted, the impact from WhatsApp, which we continue to expect will close later this year. In terms of expenses, we expect that our total 2014 GAAP expenses, including cost of revenue and stock compensation, will likely grow in the neighborhood of 30% to 35% and that our total non-GAAP expenses, including cost of revenue but excluding stock compensation, will grow at a similar rate. These rates are slightly lower than our prior expectations due to efficiencies in areas like cost of revenue and G&A. +However, we believe that we are still in the early days of building out all of the services to maximize Facebook's impact on the world and we intend to continue to invest aggressively in people, products, and infrastructure in the second half of 2014 and beyond. Though it is premature to give a specific outlook for 2015 expenses, I wanted to note that we expect significant stock-based compensation and amortization expenses, as well as substantial incremental operating costs related to the acquisitions of Oculus and WhatsApp. +These will add to our overall expenses in 2015 and subsequent periods. These costs will be incremental to core Facebook expenses, which will continue to grow significantly in 2015, as we ramp investments in people, products, and infrastructure. For taxes, we expect GAAP and non-GAAP rates for the rest of 2014 to be similar to our Q2 rates, although these could very widely depending upon our international revenue and expense mix and other factors; most notably, the impact from acquisitions, including the expected closing of WhatsApp later this year. +We continue to anticipate the 2014 CapEx will be approximately $2 billion to $2.5 billion. We expect shares outstanding to grow from around $2.6 billion at the end of 2013 to approximately $2.9 billion at the end of 2014; again, assuming WhatsApp closes by the end of the year. +Turning last to revenue, as we saw in Q2, our year-over-year growth rate declined from 72% in Q1 to 61% in Q2, or 59% on a constant currency basis. This is consistent with our comments on the Q1 call when we indicated that, over the course of 2014, the year-over-year growth rates in revenue would decline meaningfully as the comps became more difficult. We expect this trend to continue over the course of the second half of the year. +While we are excited about the long-term potential of our ads initiatives like Instagram, autoplay video, and the Audience Network, we are still in the early days of building these businesses and expect their revenue contribution to remain small in the near term. We remain optimistic as ever about the long-term opportunity to grow revenue by improving the quality and relevance of our ads and increasing the value we bring to marketers through our products, tools, and technologies. +In summary, we're very pleased with our overall performance in Q2 and in particular, the continued growth of our mobile audience, the strength of our apps business, and the investments we're making to build long-term shareholder value. With that, Jay, let's open up the call for questions. + + +================================================================================ +Questions and Answers +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) Eric Sheridan, UBS. + +-------------------------------------------------------------------------------- +Eric Sheridan, UBS - Analyst [2] +-------------------------------------------------------------------------------- + + Sheryl, one on Audience Network and LiveRail, maybe you can give us a little better sense of the depth of the conversations with advertisers and what that might do to the platform longer term, 2014 and beyond, in terms of broadening out Facebook's advertising effort? Second question, Dave, on the Oculus and WhatsApp, is there any way to get a sense of employee counts at the companies or the pressure that we might see from OpEx going forward? + +-------------------------------------------------------------------------------- +Sheryl Sandberg, Facebook, Inc. - COO [3] +-------------------------------------------------------------------------------- + + One of the goals we have talked about in all of these calls is to make ads more relevant for people and marketers and increasingly, with the Audience Network, we have a goal to do that for publishers, as well. Video is really important, it's one of the fastest ad mediums out there on both desktop and mobile. LiveRail has the leading online video advertising platform and we think we can use it to effectively expand video ads to marketers and to publishers outside of Facebook and offer greater audience reach and ability to sell to video advertisers. +When you look at the Audience Network, we're still in really early days and we only have some publishers in our network, but we see this as an opportunity to provide greater reach for Facebook marketers and developers, again, to improve relevance of the ads people see, both on and off Facebook. + +-------------------------------------------------------------------------------- +Dave Wehner, Facebook, Inc. - CFO [4] +-------------------------------------------------------------------------------- + + Thanks, Eric. On Oculus and WhatsApp, we're very much in investment mode on our overall business and we expect to continue to ramp investments in the core business through 2015. Like I said, we'll be layering on top of that costs related to Oculus and WhatsApp. But we're not getting into more specifics on the exact head counts on those, but we believe those are significant opportunities in the long run, and so we're going to be investing aggressively, accordingly. + +-------------------------------------------------------------------------------- +Operator [5] +-------------------------------------------------------------------------------- + + Heather Bellini, Goldman-Sachs. + +-------------------------------------------------------------------------------- +Heather Bellini, Goldman Sachs - Analyst [6] +-------------------------------------------------------------------------------- + + If you could share with us any qualitative commentary about the breadth of mobile ad revenue, there's always a lot of debate back and forth about how big mobile app installs are, and if there is anything you can share with us about how the breadth of these, the breadth of mobile has been changing over the last year or so. +The follow-up question would just be related to how your conversations with advertisers are changing as people start to think collectively about their TV and video budget together? I'm just wondering if you're starting to see your conversations with big TV advertisers start to change somewhat over the last six months or so? Thank you. + +-------------------------------------------------------------------------------- +Sheryl Sandberg, Facebook, Inc. - COO [7] +-------------------------------------------------------------------------------- + + When you think about mobile ads, and I'm really glad you asked this question, I do think sometimes people think that mobile app install ads are all of the revenue or a great majority of the revenue and they're not, they're only part of the mobile ads revenue. Our mobile ads revenue is broad-based. We have large brand advertisers, small SMBs, direct response advertisers, as well as developers using our mobile ads. +The mobile app install ads, which are run not only by developers, but also by large companies that want to get people to install apps, are growing. They remain a good part of our mobile ads revenue and we're excited about the opportunities there, but we see our opportunities in mobile ads as much broader than just installing apps. +To the second question, I do think one of the things that's happened in the last year, year and a half on Facebook is people understanding how strong the creative opportunity is. We've built out the technology platform and made our product investments, and we've really created, particularly with the move to mobile on our ads and News Feed, an opportunity to do great creative storytelling. +A great recent example is the Progressive baby ads, if you've seen them. They're really engaging and really fun, but they're making a really important point, which is people should be buying their own insurance. But the ability for them to do that ad is based on the technology we've created and also the great work they've done with Arnold Worldwide, their agency, on the creative part. +I think, for a long time, people have thought TV was for creative storytelling and online ads were for more targeted tech space results. I think we're seeing that change, which means that the way people approach TV, they'll also approach Facebook and are starting to, which makes those budgets work much better together. + +-------------------------------------------------------------------------------- +Operator [8] +-------------------------------------------------------------------------------- + + Douglas Anmuth, JPMorgan. + +-------------------------------------------------------------------------------- +Douglas Anmuth, JPMorgan - Analyst [9] +-------------------------------------------------------------------------------- + + Mark, there's been talk, and I know it was on your blog, about testing a buy button within the platform. I was hoping you could talk about how important you think commerce is to Facebook going forward and then perhaps also payments, as well. And then secondly, Sheryl, you mentioned some of the major brands that advertised during the World Cup. Can you talk about how you get the follow-through from those brands now that major event has passed and how you keep those ad dollars on Facebook? Thanks. + +-------------------------------------------------------------------------------- +Sheryl Sandberg, Facebook, Inc. - COO [10] +-------------------------------------------------------------------------------- + + On the buy button, we launched a small test in the US only, which enables people to hit a buy button and on pages or in page post ads on Facebook, it streamlines the process of buying from our clients. No one's buying from us, we're just streamlining the process of buying from our clients. I think commerce is really important and is a growing important part of our business, as all marketer segments are growing, but I don't think people should confuse that with Facebook selling things directly. +The more people buy online, the more people buy things they discover through their mobile phones, the more people discover things from a News Feed and go on to purchase, the more important we are in driving eCommerce and I think we are increasingly important. That doesn't mean we're going to or have to sell products. + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook, Inc. - Chairman & CEO [11] +-------------------------------------------------------------------------------- + + I'd just add to that, because some of the question was about payments, that we will clearly do work in payments to accept payments for advertising and on platform and other things that we do, but just because we'll do that doesn't -- we still basically view ourselves as a partner to other companies in the payment space, rather than trying to compete directly for that. Our main business is advertising and I think we're mostly, to the extent that we do payments, it's going to be supportive to that. +I wanted to make one more point related to that because I think some of the questions around payments are connected to what we're planning on doing in the other apps outside of Facebook, so things like Messenger and WhatsApp over time when that closes and Instagram. I really do just want to emphasize that there's a lot of work to set up the foundation for having a good business community and ecosystem in those that we think is going to be years of work before those are huge businesses for us. +I liken where we are now on something like Messenger to where we were on Facebook in like 2006 or 2007, where it was primarily a consumer product at the time where you really only communicated with friends and a bunch of people asked us and said that we should put ads in. But before we did that, we wanted to create really good organic consumer experiences for people to interact with different entities, so we created pages so people could interact with organic businesses. +In order to make it so that businesses and public figures and folks would create pages, we offered insights and different products. We gave all those away for free. Pages were free and continue to be free and that's partially why we have 30 million businesses today using pages on the platform and insights we gave away for free in order to enable more folks to use pages. But only after we had a good organic interaction that people could and would want to interact with these different businesses and entities, did we really layer ads on top of that and start to build the business that we have today. +I just think it's worth emphasizing this because we've said in a number of comments that we think that some of these newer initiatives are going to ramp over time. We really do mean that. We're serious about doing this the right way and building out these ecosystems. I think for some of these other apps, we're just going to build all the infrastructure that we need to make it be something that's scalable over time, rather than trying to have this be an impact that you'll notice in the next short-term period of time. + +-------------------------------------------------------------------------------- +Sheryl Sandberg, Facebook, Inc. - COO [12] +-------------------------------------------------------------------------------- + + To the World Cup part of your question, brands certainly use the World Cup and big events like this to launch things that they continue those ad campaigns. They also have other big events that come along, as well as their own events around product launches. We think, obviously not every day is a World Cup, but there are lots of opportunities throughout the year and through the product cycle to work with brand advertisers in big ways. + +-------------------------------------------------------------------------------- +Operator [13] +-------------------------------------------------------------------------------- + + Ross Sandler, Deutsche Bank. + +-------------------------------------------------------------------------------- +Ross Sandler, Deutsche Bank - Analyst [14] +-------------------------------------------------------------------------------- + + I had one question for Mark on the product side, and one for Dave. Mark, App Links just launched, but if you go out a few years, how much do you think something like deep linking could increase engagement or add effectiveness for Facebook? For those 1 billion links that you have up and running already, what are you seeing in those early tests? +Dave, we know you don't break out the price versus volume metrics for mobile, but just directionally, could you give us some color on how the ad impression growth in mobile compares with the 31% MAU growth in mobile? Thanks. + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook, Inc. - Chairman & CEO [15] +-------------------------------------------------------------------------------- + + Sure. I don't have much color that's useful to share here on App Links. It's still early. People have marked up a bunch of apps with this meta data that allows us to search for it, but Search for Facebook is going to be a multi-year voyage. There's just so much content that is unique to the Facebook ecosystem that we can answer questions for you that really no other service can. +The other day I was curious about finding out which of one of my friend's friends worked at a company. I don't know any other service where you can just go do that query, but on Facebook, you can. The secret to this is going to be basically just over a long period of time, indexing all of the different content that's on Facebook in every different way. We started off with people, because obviously you need to be able to find people in order to use the product and add friends and just have our core ecosystem work. +We're indexing more of the connection, and now we're getting into more of the content and it's a huge amount of content. There is more than a trillion posts, which some of the search engineers on the team like to remind me, is bigger than any web search corpus that is out there. But that's just one part of the data and we're going to keep on doing more and more. We're going to start off focusing on stuff that's unique to Facebook, that you couldn't really answer those questions elsewhere. +App Links, by definition being outside of Facebook, are not going to be unique to Facebook. We'll get to that over time. I think it will be a valuable part of the ecosystem, but honestly, we're mostly interested in that to enable value for other developers and pushing distribution to them than we are for our own search. +It's going to enable interesting ways for a developer to be able to make it so that people and their apps can share content on Facebook and link directly to the right part of the app, it'll enable some engagement ads, so that way a developer can say a person was using my app and they were going to buy something, but they dropped out of the check-out flow, so now we're going to have an ad that helps them link right back to the check-out flow so they can complete their conversion. You want deep linking to be able to enable things like that, but it's going to take a while to play out in the search. + +-------------------------------------------------------------------------------- +Dave Wehner, Facebook, Inc. - CFO [16] +-------------------------------------------------------------------------------- + + Ross, on your question on mobile ads, mobile DAU is ramping nicely at 39% growth and we're seeing it grow nicely across all of our geographic regions. Of course, mobile ads are ramping as well. In terms of pricing, we don't break it out, but on the reported pricing trend, as I think I made clear, the 123% increase in price was driven by mix shift with a higher percentage of News Feed ads. News Feed ads are really effective for marketers and that includes mobile News Feed ads as well. +They deliver a lot of value for marketers, that's why they're getting a higher price in the auction. The price of ads correlates to the value that they create. We continue to focus on making those ad units better and better, more relevant and targeted for the people who use Facebook, as well as for marketers. We're seeing good results. Marketers are getting good ROIs and they're coming back and spending more with us, so we're pleased about all of that. + +-------------------------------------------------------------------------------- +Operator [17] +-------------------------------------------------------------------------------- + + Justin Post, Merrill Lynch. + +-------------------------------------------------------------------------------- +Justin Post, BofA Merrill Lynch - Analyst [18] +-------------------------------------------------------------------------------- + + I'd like to follow a little bit on the ad pricing, obviously up 123%. Sheryl, maybe you can comment a little bit about the organic growth, like for like ads there, and do you see opportunities to continue to see nice pricing growth as you look out the next couple of years? And then, as you think about the new ad formats, video and other things, would you think that could continue to drive pricing higher, meaning new ad formats could drive even more value than the existing ads that you have on Facebook. Thank you. + +-------------------------------------------------------------------------------- +Dave Wehner, Facebook, Inc. - CFO [19] +-------------------------------------------------------------------------------- + + Justin, it is Dave. In terms of the pricing, as I said, it's really about the mix shift towards the News Feed ads is what's driving the overall reported pricing trend, but we are focused on making our ads all better and driving better returns for our marketers, and we see that reflected in the price. There's other things. For instance, we're making our right-hand column ads more effective by changing the format of those. +Those will be higher value to our marketers because they'll drive more engagement, but there will be fewer of them. That will impact pricing. But everything that we're doing is about trying to drive more value for our marketers, as well as trying to drive more relevant ad experiences for the people who use Facebook. If we're successful in doing that, we'll drive ROI for the marketers, we'll drive good experiences, and we'll get good pricing. + +-------------------------------------------------------------------------------- +Operator [20] +-------------------------------------------------------------------------------- + + Mark Mahaney, RBC Capital Markets. + +-------------------------------------------------------------------------------- +Mark Mahaney, RBC Capital Markets - Analyst [21] +-------------------------------------------------------------------------------- + + Anything you could share with us with regards to China and efforts to develop more of a presence there? On David Marcus coming over, somebody with a huge payments background running the Messaging product, it's kind of like hiring, signing Messi up to the Miami Heat, like it's a little of an odd transition. Are we looking at it wrong? Is there any particular reason why he wouldn't be more focused on payments? Thank you. + +-------------------------------------------------------------------------------- +Sheryl Sandberg, Facebook, Inc. - COO [22] +-------------------------------------------------------------------------------- + + I'll talk about China. Our mission is to enable everyone in the world to share and connect. We've been studying and learning about China for a number of years and we remain very interested. We are seeing Chinese-based companies use Facebook to reach a global audience and we think we have an important opportunity, just with their export market, and we're focused on that for now. + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook, Inc. - Chairman & CEO [23] +-------------------------------------------------------------------------------- + + On Messenger and David, I think he is just a real talented product generalist and he's done a number of different things, including in his past, he ran and built a messaging company. Most recently, clearly, he ran a very important company and I think it was pretty successful in helping get really good results there. Messenger will have, over time, there will be some overlap between that and payments. +But what I'm trying to say is two things. One is, the payments piece will be a part of what will help drive the overall success and help people share with each other and interact with businesses, but we're really focused on the interactions overall, rather than the mechanism and David shares that view. The second thing is just that there's so much groundwork that we need to do in order to make it so that people are communicating with businesses and public figures and entities in these other apps that we're building, which is part of the business ecosystem. +I really can't underscore this enough that we have a lot of work to do and we could take the cheap and easy approach and just try to put ads in or do payments and make some money in the short-term, but we're not going to do that. To the extent that any of your models or anything reflect that we might be doing that, I would strongly encourage you to adjust that, because we're not going to. We're going to take the time to do this in the way that we think that's going to be right over multiple years. + +-------------------------------------------------------------------------------- +Operator [24] +-------------------------------------------------------------------------------- + + Arvind Bhatia, Sterne Agee. + +-------------------------------------------------------------------------------- +Arvind Bhatia, Sterne, Agee & Leach - Analyst [25] +-------------------------------------------------------------------------------- + + On WhatsApp, I realize it hasn't closed yet, but can you give us any indications on the user trends and engagement, et cetera. Sheryl, you mentioned India where we see a lot of usage coming out of there for WhatsApp, in particular. Any comments there would be helpful. + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook, Inc. - Chairman & CEO [26] +-------------------------------------------------------------------------------- + + No, the deal hasn't closed. We have nothing to say. + +-------------------------------------------------------------------------------- +Operator [27] +-------------------------------------------------------------------------------- + + Neil Doshi, CRT Capital. + +-------------------------------------------------------------------------------- +Neil Doshi, CRT Capital - Analyst [28] +-------------------------------------------------------------------------------- + + Sheryl, I think attribution could be big opportunity, especially for local businesses to help them realize ROIs or if people are going from online to offline. With 30 million businesses now on Facebook, how are you helping those businesses realize the online to offline conversion through Facebook in order to drive more dollars going to local businesses? Thanks. + +-------------------------------------------------------------------------------- +Sheryl Sandberg, Facebook, Inc. - COO [29] +-------------------------------------------------------------------------------- + + I agree strongly that this is a huge opportunity. Our goal with all of our clients from the biggest to the smallest is to drive their business results and that's usually selling a product, sometimes online, but often in stores. We've done a lot of work over the last year or two on measurement. We talk about measurement in all of these calls and that's because investing in measurement and connecting, not just from online to online, but online to offline is super important. +Because if we can prove those results to our marketers large and small, they will continue to invest. We think we have a real advantage here that we have real identity, we have real identity across the desktop and across mobile and we have found ways in very privacy-protective ways to work with third parties, third party users of data to connect offline sales to online ads and those investments remain a very big focus for us. + +-------------------------------------------------------------------------------- +Operator [30] +-------------------------------------------------------------------------------- + + Ken Sena, Evercore. + +-------------------------------------------------------------------------------- +Ken Sena, Evercore Partners - Analyst [31] +-------------------------------------------------------------------------------- + + You mentioned over 1 billion users, 80% of app developers use the Facebook log-in on iOS and Android. When we think about Facebook as a platform, can you provide any stats on the number of developers who are starting to build their experience on Facebook? How integrated do they need to be to see things like app linking, data formats, autoplay video, or other? Thanks. + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook, Inc. - Chairman & CEO [32] +-------------------------------------------------------------------------------- + + We've shifted to this model on mobile where developers aren't really building their apps inside Facebook. We're not an operating system. We had a little bit more of this dynamic with Canvas on desktop, but now we've shifted the strategy to helping developers with three things: build, grow, and monetize their apps. We have a number of services that developers can plug into their apps to help out with all three of those. +For example, we have -- and for helping people build their app, we do things like log-in and we have services like parse that help developers build apps more easily, that stuff is all great for helping folks build social apps in a way that's faster than they could have otherwise. In terms of growth, we offer tools like sharing and messaging so that a developer can enable their users to be able to organically spread the app. +We have things like app installs and engagement ads to make it so that developers can pay to increase that. On the monetized side, we are rolling out the Audience Network and on Canvas, we have things like payments to help developers monetize and that's an increasing focus, as well. Audience Network is new and it's just getting started, so, again, it's one of these things that will be pretty slow for a while because we really want to do it right, but that's going to be an important part of this, as well. +That's how you want to think about developers and right now, we're really proud that 80% of the top developers see value in touching a part of our platform. We obviously want to get the last 20%, but we're excited about the progress so far. + +-------------------------------------------------------------------------------- +Sheryl Sandberg, Facebook, Inc. - COO [33] +-------------------------------------------------------------------------------- + + In terms of those developers using our different ad products, as we say, we roll out slowly and slowly usually means we pick a handful of advertisers to work with. That's certainly what we've been doing on autoplay video ads. Over time, our goal is to make our ad products available to all of our marketer segments and that's what we'll work on. Over the long run, any developer, any small or large business, whether they're using other parts of our platform or not, would be able to purchase any type of our ads. + +-------------------------------------------------------------------------------- +Operator [34] +-------------------------------------------------------------------------------- + + Brian Nowak, SIG. + +-------------------------------------------------------------------------------- +Brian Nowak, Susquehanna Financial Group - Analyst [35] +-------------------------------------------------------------------------------- + + The first one is on video ads. You mentioned it's the early days on video advertising. I was wondering if you could talk to some of your early learnings, what you're pleased with, and where you see areas for improvement and which metrics you're gauging to determine when to undergo a broader rollout. Secondly, I think you mentioned the larger, higher quality rail desktop ads. There's been some changes in experimentation around that inventory. +How has the advertiser receptivity been to those ad units compared to the old right rail? Where are those dollars coming from? Is that new dollars to the platform or are they shifting from old sponsor stories or old right rail? Thanks. + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook, Inc. - Chairman & CEO [36] +-------------------------------------------------------------------------------- + + I'll talk about video and then Sheryl can answer on the right hand column. The biggest thing that we want to make sure is that quality is really good as we roll this out and that's going to be the same on all of these different initiatives. One of the reasons why we're optimistic about autoplay specifically as a format for both organic and paid content, is that you're strolling through feeds and if the content catches your eye and you like it, then it's playing and it's loaded and you can just easily continue watching it. +Or otherwise the person has complete control and if they don't like it, they can just keep on going through it, so the content has to be really good and we think that's going to be a really high quality experience. There are still a number of things that we really want to prove and make sure that we're doing well here. We want to make sure that when people see an autoplay video, that's not only paid content, we want a lot of that to be organic content, as well. +We're trying to ramp up the amount of good public content and common content that people share at the same time as we're ramping up the autoplay video ads. We also want to make sure that this doesn't consume a lot of people's data. We're just being really careful about how we handle that and getting that really right across different markets. That's going to be a different thing that we want to be really sensitive to. +It really just, in a word, this all comes down to quality and we're more focused on just making sure that this is the right and best thing over time than something in the near term. That, I think, is a theme of the lot of the areas that we've talked about, whether it is the new apps that we're building, things like Messenger or Instagram and what we're doing there, or things like Audience Network, which we just announced, or video adds. +There are just a lot of things that we're super excited about. We, obviously, will talk about them publicly because we're working with partners and we're excited to talk about them here as well because we do really think that these are going to be great things to help build businesses over time. But we want to make sure that we don't want to get ahead of ourselves, because these things are early and quality is the most important thing for growing this the right way over time. + +-------------------------------------------------------------------------------- +Sheryl Sandberg, Facebook, Inc. - COO [37] +-------------------------------------------------------------------------------- + + On the right-hand column redesign, the redesign was driven by making the ads more consistent with News Feed, which results in fewer but larger ads. But they just don't come from any one place. When you think about Facebook's growing part in the ad ecosystem, you really have to think about ad dollars shifting online as the majority of the driver of budget shifting and ad dollars coming on to mobile. +We are pleased that we see higher engagement rates from the people who are shown the new ads compared to the old, which makes us optimistic that these are more valuable. + +-------------------------------------------------------------------------------- +Operator [38] +-------------------------------------------------------------------------------- + + Brian Pitz, Jefferies. + +-------------------------------------------------------------------------------- +Brian Pitz, Jefferies & Company - Analyst [39] +-------------------------------------------------------------------------------- + + Maybe a question in a different direction regarding privacy and maybe you could just walk us through your current thoughts? The reason I ask is because Facebook recently introduced the anonymous log-in product at f8 this year and new services like Save are hidden from friends unless users specifically opt-in. Can you just give us a sense, is this kind of a change of strategic shift in thinking or tone with regards to privacy? Thanks so much. + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook, Inc. - Chairman & CEO [40] +-------------------------------------------------------------------------------- + + It's a really important question, I think something that's misunderstood about Facebook. One of the things that we focused on the most is creating private spaces for people to share things and have interactions that they couldn't have had elsewhere. If you go back to the very beginning of Facebook, rewind 10 years, there were blogs and things where you could be completely public and there were email, so you could circulate something completely privately, but there was no space where you could share with just your friends. +It wasn't a completely private experience, but it's not completely public in that it's 100 or 150 of the people that you care about. Creating that space, which was a space that had the kind of privacy that no one had ever seen before, was what enabled and continues to enable the kind of interactions and the content that people feel comfortable sharing in this network that don't exist in other places in the world. +We're constantly looking for new opportunities to create new dynamics like that and open up new different private spaces for people where they can then feel comfortable sharing and having the freedom to express things that you otherwise wouldn't be able to. It's one of the reasons why I'm personally so excited about Messaging, because right now, at some level, there are only so many photos that you're going to want to share with all of your friends. +We still think that there's more to do there. The amount of messaging and how quickly we see that growing is crazy. There is just a lot more that people want to express and that they need the tools to express with smaller groups of people, not just one person at a time, but smaller groups, as well. Things like anonymous log-in totally unlock different behaviors. +How many times would you want to sign into an app, but you don't necessarily want to share a lot of information with that app, but if you can do it anonymously, we think that's going to unlock a lot of different interactions and experiences that people want to have. We view our jobs as very fundamentally providing people with these spaces and tools, which, I think, is very different from how a lot of people think about what Facebook is. But it's an important thing to think about how we do our product development. + +-------------------------------------------------------------------------------- +Operator [41] +-------------------------------------------------------------------------------- + + Colin Sebastian, Robert Baird. + +-------------------------------------------------------------------------------- +Colin Sebastian, Robert W. Baird & Co. - Analyst [42] +-------------------------------------------------------------------------------- + + On mobile advertising and ad loads, just curious what you're seeing in terms of the ad load thresholds is that you're at the point now where the relevancy and quality of ads means that you can tick that up, perhaps, a little bit. On Oculus and virtual reality applications, how should we think about the pace of development of this technology and the potential integration with Facebook's applications? Thank you. + +-------------------------------------------------------------------------------- +Dave Wehner, Facebook, Inc. - CFO [43] +-------------------------------------------------------------------------------- + + I can take care of the mobile ad load question. Ad load is really one of dozens of factors that we focus on. Others are, of course, the quality, the relevance, and then the prominence of the ads. +We monitor the sentiment and engagement of people engaging in News Feed. We're really pleased with the strength of sentiment and engagement as we've ramped up News Feed ads. We feel like we're in a good position, given where we are with that, to continue to grow the advertising business while driving good user experience. We're in a good place on that. + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook, Inc. - Chairman & CEO [44] +-------------------------------------------------------------------------------- + + Yes. I can talk about Oculus. We're really excited about this. The acquisition just closed earlier this week and we're real excited to welcome that team. They're extremely talented and have pulled off something that people had been talking about for a really long time and now it's possible, given the technology that this team has developed. +This hits on a different part of our strategy, which the way that I organize my remarks every quarter are around these 10-year goals and themes that we have for the Company: connecting everyone, understanding the world, helping to build the knowledge economy, and these future platforms. When I'm talking about how I think things like the businesses that we're talking about are further out than you think, I think that this stuff is actually even further out than that. +But there are huge opportunities to build the next generation of computing platforms. When mobile was getting defined, we were basically just getting founded; in 2004, the first SmartPhone came out in 2003. We've mostly been a company that has played on top of the different mobile foundations that other companies have built. One of the things I care really deeply about, on kind of a 10-year arc for the Company, is having a different relationship to whatever the next set of computing platforms are and investing accordingly now to make sure when the next set of computing platforms get defined, we can help define of what the next generation of computing is going to be. +I think virtual reality, augmented reality, vision, some of the AI work that we're doing is all going to play into this in an important way. I just think, while I was emphasizing that we're early on some of those businesses and we're not going to rush those, the flip side of the coin is to emphasize that we're also going to spend a lot and invest very heavily in a bunch of these things to do it right over the long term. +Dave pointed out that we expect to continue investing heavily and that our costs will increase and I just want to underscore that, as well, because I expect that to continue to be true. It's not that we're necessarily going to go out and have a lot more new strategic priorities, but we expect to go very deep on the priorities that we have to make sure that we completely nail them all, whether it's a 5-year or 10-year timeframe. + +-------------------------------------------------------------------------------- +Operator [45] +-------------------------------------------------------------------------------- + + Ben Schachter, Macquarie. + +-------------------------------------------------------------------------------- +Ben Schachter, Macquarie Research - Analyst [46] +-------------------------------------------------------------------------------- + + Mark, you talked about a focus on public content. Does that include a focus on exclusive content and should we expect that you'll pay for or have revenue share agreements with the content with some key public figures? Separately, on search, I think you still have quite a large team working on improving search, but from our vantage point, we haven't seen many changes since the original beta graph search product launch. +When should we expect to see those improvements and how would you rank search in terms of you priorities? Finally, just a quick housekeeping question, David, the D&A continues to trend down over the past few quarters. Why is that happening and should we expect that to continue? Thanks. + +-------------------------------------------------------------------------------- +Dave Wehner, Facebook, Inc. - CFO [47] +-------------------------------------------------------------------------------- + + I can take the D&A question first, if you'd like. Ultimately, depreciation is going to track more closely against the CapEx. In the first half of the year, we've been aggressively investing in the things we want to invest in and that includes infrastructure. CapEx is up 40% in the first half of the year. There are some investments that we're making, notably in the Iowa data center, also the new headquarters we're building where those facilities have not gone into service, so they're not hitting depreciation yet. +We're making the big investments in CapEx that will ultimately flow through in depreciation. In short, the answer to your question is we'll see depreciation come up as those things come online. + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook, Inc. - Chairman & CEO [48] +-------------------------------------------------------------------------------- + + I can answer the others. On public content, we actually do get a lot of exclusive content. We don't pay for it. This week, for example, I think Shakira hit her 100 million fans moment on Facebook. Part of the reason why some of these public figures and political leaders and folks have such big followings is because they're constantly providing insight into their lives and unique types of content that other folks -- that you can't get anywhere else. +There's a format that I think makes sense for Facebook. You're not going to come to Facebook to watch a movie or watch a full TV show, that's really long form stuff. But in the mode that we have today in our service, that kind of attraction is the best place for a number of types of content like this that we're starting to see that we get. +We're mostly focused on driving success for partners, whether they're news organizations that are publishing content that people share or public figures and individuals who are engaging directly on Facebook. Our view is that the more success from distribution and engagement we can drive for them, the better the content and the quality that they're going to invest in building for Facebook. +Type of search, I mentioned in my opening remarks that this quarter, I think for the first time, we are over, on average, 1 billion searches a day, which is awesome and it's something that we're really proud of and have worked a lot on, especially given that we generally found that people search a little bit less on average on mobile. We went through a period where in order to have that increased, we had to do some really good work and make it a lot faster and improve ranking and do a lot of the basic things that needed to get done. +There is just so much more content that needs to get indexed. If you want to go find that Shakira video that I was just talking about, I don't know if today the product fully delivers on that, but we will soon and in the next six months, we're going to be able to do that if we do well and then a year later, we're going to have more content in the system and be able to index that better. +It's an ongoing thing. There's huge potential. There are a lot of questions that only Facebook can answer that other services aren't going to be able to answer for you. +We're really committed to investing in that and building out this unique service over the long-term and I think at some point, there's going to be an inflection where it starts to just be useful for a lot of use cases. But that may still be years away, but we're just committed to doing this investment and making this right. + +-------------------------------------------------------------------------------- +Deborah Crawford, Facebook, Inc. - Director of IR [49] +-------------------------------------------------------------------------------- + + Thank you for joining us today. We appreciate your time and we look forward to speaking with you again. + +-------------------------------------------------------------------------------- +Operator [50] +-------------------------------------------------------------------------------- + + This concludes this conference call. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/exam/original-files/Problem_1_Sample/2014-Jul-24-AMZN.OQ-138703384359-Transcript.txt b/exam/original-files/Problem_1_Sample/2014-Jul-24-AMZN.OQ-138703384359-Transcript.txt new file mode 100644 index 0000000..5653424 --- /dev/null +++ b/exam/original-files/Problem_1_Sample/2014-Jul-24-AMZN.OQ-138703384359-Transcript.txt @@ -0,0 +1,555 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q2 2014 Amazon.com Inc Earnings Call +07/24/2014 05:00 PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Tom Szkutak + Amazon.com, Inc. - CFO + * Phil Hardin + Amazon.com, Inc. - Director of IR + +================================================================================ +Conference Call Participiants +================================================================================ + + * Neil Doshi + CRT Capital - Analyst + * Justin Post + BofA Merrill Lynch - Analyst + * Greg Melich + ISI Group - Analyst + * Benjamin Schachter + Macquarie Research - Analyst + * Brian Pitz + Jefferies & Company - Analyst + * John Blackledge + Cowen and Company - Analyst + * Youssef Squali + Cantor Fitzgerald - Analyst + * Heath Terry + Goldman Sachs - Analyst + * Eric Sheridan + UBS - Analyst + * Colin Sebastian + Robert W. Baird & Company, Inc. - Analyst + * Mark Mahaney + RBC Capital Markets - Analyst + * Mark Miller + William Blair & Company - Analyst + * Brian Nowak + SIG - Analyst + * Carlos Kirjner + Sanford C. Bernstein & Company, Inc. - Analyst + * Kaizad Gotla + JPMorgan - Analyst + * Mark May + Citigroup - Analyst + +================================================================================ +Presentation +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Good day and welcome to the Amazon.com Q2 2014 financial results teleconference. +(Operator Instructions) +Also, today's call is being recorded. For opening remarks, I'll be turning the conference over to the Director of Investor Relations, Phil Hardin. Please go ahead, sir. + +-------------------------------------------------------------------------------- +Phil Hardin, Amazon.com, Inc. - Director of IR [2] +-------------------------------------------------------------------------------- + + Hello, and welcome to our Q2 2014 financial results conference call. Joining us today is Tom Szkutak, our CFO. We will be available for questions after our prepared remarks. The following discussion and responses to your questions reflect Management's views as of today July 24, 2014, only and will include forward-looking statements. Actual results may differ materially. +Additional information about factors that could potentially impact our financial results is included in today's press release and our filings with the SEC, including our most recent annual report on Form 10-K. As you listen to today's conference call, we encourage you to have our press release in front of you, which includes our financial results, as well as metrics and commentary on the quarter. +During this call, we will discuss certain non-GAAP financial measures. In our press release, slides accompanying this webcast, and our filings with the SEC, each of which is posted on our IR website, you will find additional disclosures regarding these non-GAAP measures including reconciliations of these measures with comparable GAAP measures. +Finally unless otherwise stated, all comparisons in this call will be against our results for the comparable period of 2013. Now I'll turn the call over to Tom. + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com, Inc. - CFO [3] +-------------------------------------------------------------------------------- + + Thanks, Phil. I'll begin with comments on our second quarter financial results. Trailing 12-month operating cash flow increased 18% to $5.33 billion. Trailing 12-month free cash flow increased to $1.04 billion. Trailing 12-month capital expenditures were $4.29 billion. The increase in capital expenditures reflects additional investments in support of continued business growth consisting of additional capacity to support our fulfillment operations and investments in technology infrastructure including Amazon Web Services. +Return on invested capital was 6% up from 2%. ROIC TTM free cash flow divided by average total assets minus current liabilities, excluding the current portion of long-term debt over five quarter ends. The combination of common stock and stock-based awards outstanding was 480 million shares compared with 474 million one year ago. Worldwide revenue grew 23% to $19.34 billion or 22% excluding the $237 million favorable impact from year-over-year changes in foreign exchange rates. +Media revenue increased to $4.84 billion up 10% or 9% excluding foreign exchange. EGM revenue increased to $13.28 billion up 27% or 26% excluding foreign exchange. Worldwide EGM increased to 69% of worldwide sales up from 66%. Worldwide paid unit growth was 23%. Active customer accounts exceeded 250 million. Worldwide active seller accounts were more than 2 million. Seller units represented 41% of paid units. +Now I'll discuss operating expenses excluding stock-based compensation. Cost of sales was $13.4 billion or 69.3% of revenue compared with 71.4%. +Fulfillment, Marketing, Tech & Content, and G&A combined was $5.54 billion or 28.6% of sales up approximately 260 basis points year-over-year. Fulfillment was $2.28 billion or 11.8% of revenue compared with 11.2%. Tech and Content was $2.02 billion or 10.4% of revenue compared with 9.1%. Marketing was $911 million or 4.7% of revenue compared with 4.1%. +Now I'll talk about our segment results and consistent with prior periods, we do not allocate to segments our stock-based compensation or other operating expense line item. In the North America segment, revenue grew 26% to $12 million. Media revenue grew 13% to $2.46 billion or 14% excluding foreign exchange. EGM revenue grew 29% to $8.37 billion representing 70% of North America revenues, up from 68%. Other revenue grew 38% to $1.17 billion. North America segment operating income increased 7% to $438 million, a 3.7% operating margin. +In the International segment, revenue grew 18% to $7.34 billion excluding the $246 million year-over-year favorable foreign exchange impact, revenue growth was 14%. Media revenue grew 7% to $2.38 billion or 4% excluding foreign exchange. And EGM revenue grew 25% to $4.91 billion or 20% excluding foreign exchange. EGM now represents 67% of International revenues, up from 63%. International segment operating loss was $34 million compared to zero in the prior period. +CSOI decreased 1% to $404 million or 2.1% of revenue, down approximately 50 basis points year-over-year. Excluding the favorable impact from foreign exchange rates, CSOI decreased 9%. Unlike CSOI, our GAAP operating income or loss includes stock-based compensation expense and other operating expense. +GAAP operating loss was $15 million compared to operating income of $79 million in the prior-year period. Our income tax expense was $94 million and this includes approximately $90 million of discrete tax items primarily attributable to audit related developments. GAAP net loss was $126 million or $0.27 per diluted share compared with a net loss of $7 million and $0.02 per diluted share. +Turning to the balance sheet, cash and marketable securities increased $523 million year over year to $7.99 billion. Inventory increased 23% to $6.64 billion and inventory turns were 9.1, down from 9.4 turns a year ago as we expanded selection, improved in stock levels, and introduce new product categories. Accounts payable increased 16% to $10.46 billion and accounts payable days decreased to 71, from 73 in the prior year. +I'll conclude my portion of today's call with guidance. Incorporated into our guidance are the order trends that we've seen to date and what we believe to date to be appropriately conservative assumptions. Our results are inherently unpredictable and may be materially affected by many factors including a high level of uncertainty surrounding exchange rate fluctuations as well as the global economy and consumer spending. It's not possible to accurately predict demand and therefore our actual results could differ materially from our guidance. +As we describe in more detail in our public filings, issues such as settling intercompany balances and foreign currencies amongst our subsidiaries, unfavorable resolution of legal matters, and changes to our effective tax rates, can all have material effect on guidance. Our guidance further assumes that we don't conclude any additional business acquisitions, investments, restructurings, or legal settlements, record any further revisions to stock based compensation estimates, and that foreign exchange rates remain approximately where they have been recently. +For Q3 2014, we expect net sales of between $19.7 billion and $21.5 billion or growth between 15% and 26%. This guidance anticipates approximately 120 basis points of favorable impact from foreign exchange rates. GAAP operating loss to be between $810 million loss a $410 million loss compared to a $25 million loss in the third quarter of 2013. This includes approximately $410 million for stock-based compensation and amortization of intangible assets. +We anticipate consolidated segment operating income or loss, which excludes stock-based compensation and other operating expense, to be between a $400 million loss and $0 compared to $267 million of income in the third quarter of 2013. We remain heads down focused on driving a better customer experience through price, selection, and convenience. We believe putting customers first is the only reliable way to create lasting value for shareholders. Thanks, and with that, Phil, let's move to questions. + +-------------------------------------------------------------------------------- +Phil Hardin, Amazon.com, Inc. - Director of IR [4] +-------------------------------------------------------------------------------- + + Great. Thanks, Tom. Let's move on to the Q&A portion of the call. Operator, will you please remind our listeners how to initiate a question? + + +================================================================================ +Questions and Answers +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) +We'll hear first today from Carlos Kirjner with Bernstein. + +-------------------------------------------------------------------------------- +Carlos Kirjner, Sanford C. Bernstein & Company, Inc. - Analyst [2] +-------------------------------------------------------------------------------- + + Hi. Thanks for taking my question. Two if I may. Tom, you mentioned in the past that China is an area of investment. Can you say little bit about what are the main drivers of investment there, whether it's marketing pricing fulfillment? And how would you decide on any given year how much you invest in China just given the size of the potential market and opportunity? +And secondly, we saw a material deceleration in the North America Other revenues. Was this primarily driven by AWS deceleration, and is this deceleration a meaningful contributor to the losses implied in your next quarter guidance? Thank you. + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com, Inc. - CFO [3] +-------------------------------------------------------------------------------- + + Sure. I'll take the second part of the question first. Yes, North America Other includes a number of things including Amazon Web Services. Amazon Web Services is the largest part of North America other. You know, as we talked about on last call, we had very substantial price reductions for customers starting in second quarter. They range from 28% to 51% depending on the service. +But AWS continues to grow very strongly. In Q2, we had usage growth close to 90% year-over-year for the quarter. So the team's doing a fantastic job, and we put in some price reductions that were very substantial that are saving customers hundreds of millions of dollars over the next several months as we mentioned 90 days ago. But again, we love that business. It's doing great and we are very pleased to have the opportunity to invest in it. +The team is innovating very quickly, in fact so far year-to-date, they've released 250 significant services and features. And that's at a pace that's much, much faster than last year's pace which was faster than the year before. So again, they are continuing to innovate on behalf of customers, and so we're investing. So that's certainly impacting both the pricing decisions we've made. It's certainly impacting the guidance. +Also the large amount of CapEx and infrastructure for that business is certainly impacting the guidance, along with a number of other things across the business that we're investing in. But we're very pleased to do that. In terms of China, you know we are continuing to invest on behalf of customers there. Obviously trying to make the experience even better for customers in terms of improved in-stock levels. +We've spent -- certainly added a lot of fulfillment capacity over time in China. And we're doing a lot of interesting things to better serve customers in China. In terms of some of the other parts of your question, there's not much more I can add to that. + +-------------------------------------------------------------------------------- +Carlos Kirjner, Sanford C. Bernstein & Company, Inc. - Analyst [4] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Operator [5] +-------------------------------------------------------------------------------- + + We'll hear next from Neil Doshi with CRT Capital. + +-------------------------------------------------------------------------------- +Neil Doshi, CRT Capital - Analyst [6] +-------------------------------------------------------------------------------- + + Tom, can you talk a little bit about the deceleration in the units and then also in terms of the third-party dollar, it looks like you're kind of trending on 40% for a while. It ticked up a little bit to 41%. So if we adjust for Digital, how should that trend be looking? Thanks. + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com, Inc. - CFO [7] +-------------------------------------------------------------------------------- + + In terms of unit growth, we had 23% unit growth year over year. It is down from last year's growth rate but it's consistent with what we've seen recently, including last quarter. And in terms of the unit -- the third-party units as a percentage of total units, you're right, that's 41% this quarter. It's up about 100 basis points, you know, and we are not breaking out the Digital versus Physical on that. But again, very strong third-party growth. Number of factors but certainly FBA is helping third-party growth. + +-------------------------------------------------------------------------------- +Operator [8] +-------------------------------------------------------------------------------- + + And we'll go next to Eric Sheridan with UBS. + +-------------------------------------------------------------------------------- +Eric Sheridan, UBS - Analyst [9] +-------------------------------------------------------------------------------- + + Thanks for taking the question. When looking through the expense lines, Tech and Content seem to have an upward pressure in the quarter. Wanted to maybe get a little more granularity on what was driving that upward pressure and whether that's sort of a new run rate of expense as we saw in the first half of this year. Thanks. + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com, Inc. - CFO [10] +-------------------------------------------------------------------------------- + + There's a number of things that are going into the Tech and Content line. But you're right, we're one of the ones that I just mentioned. We are investing, you know, in various parts of the business but certainly for Amazon Web Services, that's both from an infrastructure standpoint to support the very fast usage growth that we are experiencing. +Again, we have usage growth close to 90% year-over-year in the second quarter for web services. In addition to that, we've -- over the past year, we've added thousands of people in web services. So again, ramping that up. And then across a number of different other investment areas, we continue to add great technical resources to do the things we're doing in Digital and many other parts of the company. +So again, we have a lot of opportunities to invest in as you can see from a lot of the releases that we've had over the past, you know, 12 months and you're certainly seeing that reflected in our actual results as well. + +-------------------------------------------------------------------------------- +Operator [11] +-------------------------------------------------------------------------------- + + And next from JPMorgan we will go to Douglas Anmuth. + +-------------------------------------------------------------------------------- +Kaizad Gotla, JPMorgan - Analyst [12] +-------------------------------------------------------------------------------- + + Thanks for taking the question. This is Kaizad Gotla in for Doug. I was wondering if you could just talk about the deceleration in your international EGM line. And then separately, now that you've had the Prime price increases in effect for about three months, wondering if you could just talk about any changes you have seen in sign-ups or conversions there. Thanks. + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com, Inc. - CFO [13] +-------------------------------------------------------------------------------- + + Sure. In terms of international EGM, and this would really relate to total international growth as well, we saw 18% growth on a dollar basis, 14% growth on a local currency growth basis, which is down a little bit sequentially from what we saw in Q1. You know, obviously, there's variability from quarter-to-quarter in each of the geographies that we operate in. +You know, one call out which impacted certainly EGM and our total international growth rate is Japan. We saw on April 1 the consumption taxes increased from 5% to 8%. Leading up to that in the latter part of Q1, we certainly saw accelerated growth in -- so that was reflected in the Q1 results. In Q2, we saw some corresponding softness in Q2 following that. +Hard to know how much was related to consumption growth but certainly as you've probably read elsewhere that others are seeing that too so it's not -- probably reflects the consumption tax increase. But if you take out Japan out of both Q1 and Q2, the growth rates on a local currency basis were very similar, within approximately 100 basis points of each other. +In terms of Prime, Prime subscribers are growing very nicely year-over-year. In fact, we added more Prime subscribers in Q2 of this year than in Q2 of last year. So we're very pleased and customers are responding to -- continue to -- we continue to get new subscribers as well as existing customers responding to the great value they're getting out of Prime. + +-------------------------------------------------------------------------------- +Kaizad Gotla, JPMorgan - Analyst [14] +-------------------------------------------------------------------------------- + + Helpful. Thanks. + +-------------------------------------------------------------------------------- +Operator [15] +-------------------------------------------------------------------------------- + + And from Citi we'll go to Mark May. + +-------------------------------------------------------------------------------- +Mark May, Citigroup - Analyst [16] +-------------------------------------------------------------------------------- + + Thanks for taking my question. Common sense based on sort of what you've talked about in the disclosures around the price -- the amount of the price decreases. But common sense would suggest that all, if not most, of the CSOI margin decline that you posted in Q2 year on year is related to the AWS price changes. +And common sense would also suggest that given the significant volume gains that you are seeing in that business that Q2 might be the most impacted quarter from that yet the third quarter guidance suggests that it's having an even greater impact on Q3. +Just wondering if you could help us think through that. Is there some timing issue related to the impact of that, or is there something else going on within the core retail business or maybe some other one-time items that might be impacting your Q3 outlook? Thanks. + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com, Inc. - CFO [17] +-------------------------------------------------------------------------------- + + Sure. In terms of we are not quantifying the impact of the price changes on our Q2 and Q3. But it is fair to say that the impact has certainly did impact our Q2 results in a meaningful way, and that's reflected in the actual results that you're seeing. +Another thing to keep in mind as you look out related to AWS is we're continuing to invest in that business. And with the great strong usage growth rates that we're seeing, we're also investing in CapEx and infrastructure to support that growth. So again, the team is doing a fantastic job innovating on behalf of customers, and as I mentioned earlier, the new releases both from a service and feature perspective was about 250 year to date which is at a pace that's much faster than we've seen over the last few years with very high bark given all the innovation that's happened from that team in that space. +So again, those are certainly things that are impacting Q3 guidance. There's a number of other things. When you look at Q3, keep in mind if you look back over the last several years, we're getting ready for our Q4 seasonal quarter. And when that happens, if you look back certainly, you've seen our CSOI usually has been at the lowest point for the year during Q3, particularly during these high-growth years. +And so we've added -- or announced that we are adding six net new fulfillment centers, and we've also announced that we'll have 15 or more sortation centers. The sortation centers helps us get closer to customers so that we can have fastest delivery speed as well as deliver on Sundays, which is the big deal for us in the US so we're very pleased to be able to do that. +On top of that, other investment areas that are certainly impacting our Q3 guidance is we like what we see on the content side, so video content, for example. We're ramping up the spend from Q2 to Q3 significantly. And then so be it also be a significant growth year over year. +Keep in mind we have two types of content. We have licensed content and we also have original content. A lot of you have probably seen a lot of the announcements that we've green lighted a number of pilots. We are going to be in heavy production on those pilots during -- sorry, in those series that a been green lit during Q3. We've also announced a number of pilots that we'll be in production on and so that original content, that's a portion of our total content, will be over $100 million in Q3. +Keep in mind that just as a reminder, that we do not capitalize that portion of our content -- of our original content. It's expenses incurred. So that's over $100 million in Q3, and again, that's ramped up considerably both on a sequential and on a year-over-year basis. Other areas that we're investing in, certainly with the launch of some new devices, more recently over the past couple quarters between Fire phone and Fire TV and others. +Over time, we've invested in devices so that's certainly an area we are investing in. We're investing in a lot of different areas including geographic expansion. We talked about China on one of the earlier questions, but certainly India we are investing very heavily. We are seeing some very positive results there. The team's doing a fantastic job. We're also investing in other geographies as well, like Italy and Spain and others. +So again, we're encouraged by just the sheer magnitude of opportunities we have and we're investing in those opportunities. + +-------------------------------------------------------------------------------- +Mark May, Citigroup - Analyst [18] +-------------------------------------------------------------------------------- + + Appreciate the added detail. + +-------------------------------------------------------------------------------- +Operator [19] +-------------------------------------------------------------------------------- + + We'll move next to Brian Pitz with Jefferies. + +-------------------------------------------------------------------------------- +Brian Pitz, Jefferies & Company - Analyst [20] +-------------------------------------------------------------------------------- + + Great. Thanks for the questions. First question on FBA. Any insights on the penetration of third-party sellers using FBA? Maybe you could comment just directionally. Is the number trending up or down? And separately, it's been less than a week but can you comment on early feedback to Kindle Unlimited by customers and publishers? Do you expect this to be the model for digital book consumption in the future? Thanks. + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com, Inc. - CFO [21] +-------------------------------------------------------------------------------- + + In terms of FBA, it's doing great. I can't provide any -- a specific percent. But it's continued really since the time we've launched, continued to increase as a percentage of total third-party units, and so the service has been -- has done very well. The team continues to work on making it even better on behalf of sellers and customers. In terms of Kindle Unlimited, it's very early but we're extremely pleased with what we see. There's been a great reaction to it, and we are pleased to offer that to customers. + +-------------------------------------------------------------------------------- +Operator [22] +-------------------------------------------------------------------------------- + + We go next to Heath Terry with Goldman Sachs. + +-------------------------------------------------------------------------------- +Heath Terry, Goldman Sachs - Analyst [23] +-------------------------------------------------------------------------------- + + Great. Thanks. I was just wondering, you mentioned that you were happy with the results that you are seeing from the video content. I was wondering if you could give us a sense of how that manifests itself, whether it's more Prime subscribers, whether it's more consumption of downloadable video content within the ecosystem. +And then, Tom, to the extent that you're talking about AWS volume increases on a year-over-year basis, can you give us a sense of how that may have trended over the course of the quarter as your AWS customers were able to sort of adapt to the price reduction in March? + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com, Inc. - CFO [24] +-------------------------------------------------------------------------------- + + Sure. In terms of content, we've seen just more and more customers are streaming, more and more Prime members are streaming free content. We're seeing through our pipeline as customers join Prime, we're seeing that we have more and more customers taking free trials and then converting. Those customers are great customers. +In addition to streaming free content, they have great purchasing patterns. Doing a lot of cross shopping on physical products as well as converting to paid digital video and other digital products as well. We are very pleased with what we are seeing there, and when you look at the service that we have today it's improved dramatically over the past 12 to 24 months. We really think it's a great service and that's why we are investing in it. +In terms of AWS, there's not much I can help you with on that. But again, just to reiterate we saw very strong growth during Q2. And with usage growth rates close to 90% year-over-year for the quarter. And we're extremely happy with what we see there and the team is doing fantastic job and continuing to innovate on behalf of customers. + +-------------------------------------------------------------------------------- +Heath Terry, Goldman Sachs - Analyst [25] +-------------------------------------------------------------------------------- + + Great. Thanks. + +-------------------------------------------------------------------------------- +Operator [26] +-------------------------------------------------------------------------------- + + We'll hear next from John Blackledge with Cowen and Company. + +-------------------------------------------------------------------------------- +John Blackledge, Cowen and Company - Analyst [27] +-------------------------------------------------------------------------------- + + Great. Thanks. Just a couple of questions. First on AWS. Just wondering your take on the competitive environment in public cloud. Has it intensified over the past 6 to 12 months and just given the investments in AWS, how do you view AWS's competitive positioning? +And then if you could just touch on the key drivers of EGM growth in North America and are those the same drivers of growth internationally or are there different drivers on North America versus International? Thank you. + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com, Inc. - CFO [28] +-------------------------------------------------------------------------------- + + In terms of AWS, there's not a lot in terms of talk to -- long-standing practice of not talking about other companies and what they're doing in environment. You know the team is certainly used to operating in a very competitive environment. They work hard to be able to afford lower prices for customers. That's something that is instilled in all of Amazon and it's something certainly that's instilled in our web services team. +And they're focused on what they do best which is innovating on behalf of customers, operating these services at the highest quality levels. And they'll continue to work on getting more efficient so that we can have great prices for customers. That's what the team's focused on and they're doing a great job. In terms of EGM growth, between North America and international, there's not a lot I can call out there. It has many different categories across many different geographies, many different ASINs, both first-party and third-party, so it's hard to comment. +The only thing I would call attention is the comment I made earlier around international growth rates related to EGM and that was the consumption tax increase in Japan that we saw a lead-in in Q1 were we saw very strong growth leading up to that point, and it softened after the rates went into effect. But other than that, there's not a lot to call out. + +-------------------------------------------------------------------------------- +John Blackledge, Cowen and Company - Analyst [29] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Operator [30] +-------------------------------------------------------------------------------- + + We'll now go to Macquarie's Ben Schachter. + +-------------------------------------------------------------------------------- +Benjamin Schachter, Macquarie Research - Analyst [31] +-------------------------------------------------------------------------------- + + When you mentioned that AWS is growing 90% year over year, what exactly is growing 90%? Is it storage? Is it something else? And then on the phone itself, are there any key differences in how we should be thinking about that piece of hardware versus other hardware you've done in the past where Jeff has discussed the notion of essentially wanting to break even. +And then just a follow-up on that, how are you modeling the impact of the phones on the P&L in 3Q? Is it going to be more or less than the original content initiative? Thanks. + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com, Inc. - CFO [32] +-------------------------------------------------------------------------------- + + In terms of AWS, it's really a aggregation of usage across all of our services year-over-year. I think that it's almost a proxy similar to unit growth on our retail business. It's a proxy to say how fast physical volume is growing, and so that's what it's a proxy for. In terms of the phone, there's not a lot I can help you with on that. We are extremely pleased to get it in customers' hands. +We think it's a premium product. And it also is -- it's also a great value too. You get a 32 gigabyte phone, premium product, one year free subscription to Prime, along with all the other features that I'm sure you've read about. So again, we're very pleased to get it to customers and start shipping, and customers have started to receive those today. + +-------------------------------------------------------------------------------- +Operator [33] +-------------------------------------------------------------------------------- + + And from William Blair, we'll go to Mark Miller. + +-------------------------------------------------------------------------------- +Mark Miller, William Blair & Company - Analyst [34] +-------------------------------------------------------------------------------- + + Good afternoon. Many investments one area looks like where you are getting a return is in the gross margin. If I take out AWS, it looks like you are up nearly 200 basis points. What are the drivers of that eCommerce margin increase? Are you seeing it primarily on the first-party margin expansion, and if so, why and how much is coming from third-party unit increase? Thanks. + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com, Inc. - CFO [35] +-------------------------------------------------------------------------------- + + Yes, we don't actually focus on total company gross margins because of the mix of the business, we focus more on operating profit and obviously, ultimately free cash flow dollars. But in terms of things that would be impacting, you know, COGS as a percentage of revenue and that change to be helpful. You mentioned AWS is certainly having an impact there. +Our third-party business continues to have an impact there. We have offsets as we lower prices to customers having an impact there. Just mix of products, our various products and geographies has an impact on those results. Again, a large number of items that are impacting that. + +-------------------------------------------------------------------------------- +Operator [36] +-------------------------------------------------------------------------------- + + And Justin Post with Bank of America Merrill Lynch has our next question. + +-------------------------------------------------------------------------------- +Justin Post, BofA Merrill Lynch - Analyst [37] +-------------------------------------------------------------------------------- + + Thank you. Tom, it might be a little bit of a disconnect when we've seen prior investment cycles such as distribution buildout or devices with say the Kindle reader, we did see the impact on units and accelerating growth in some of the categories. This time around, you've been investing for a couple years and I guess we are not really seeing the acceleration that some are looking for. +Maybe you could talk about what gives you confidence in investing in devices like the Fire TV and the phone and all the content you are doing and are seeing some underlying signs that say activity is picking up. Maybe you could walk through that. + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com, Inc. - CFO [38] +-------------------------------------------------------------------------------- + + Sure. Just a couple things to call out. One is when we look at our unit growth, you hear the 23% unit growth. Keep in mind that there are parts of our business that are not included in that unit growth. So when we talk about investing in web services and the usage growing close to 90%, that number is not included in the 23%, so that's obviously a large investment area for us that we are excited about that is not included in that. +The other is think about the base of business that we have versus where we were just a few years ago. And so you've seen very strong growth on the base that we have and we are excited to see that. And you know, so those of the things when we look at the opportunities that we're investing in, in terms of video you mentioned. We are seeing that certainly in the number of Prime members that are subscribing, and so that has some short-term impact but great long-term impact as we retain those Prime members. +And as they start to do more cross shopping over time, so it's more of a trailing -- we have a lot of investment in front of that demand, if you will. So those are some of the things that I would call out that maybe try to be helpful. + +-------------------------------------------------------------------------------- +Justin Post, BofA Merrill Lynch - Analyst [39] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Operator [40] +-------------------------------------------------------------------------------- + + We move now to Youssef Squali with Cantor Fitzgerald. + +-------------------------------------------------------------------------------- +Youssef Squali, Cantor Fitzgerald - Analyst [41] +-------------------------------------------------------------------------------- + + Okay, thank you very much. Going back to the $100 million in spend on the original content that you mentioned earlier, as the business -- as that part of the business grows, is there any reason to believe that the amount of spend on originals will go down? The assumption here is it will only go up. So is that $100 million a good level to work off of? +And then going back to the Fire phone, just trying to understand the strategy around the product longer term. Is it, again, just to try to further build the Amazon ecosystem with all its benefits or do you think this is a -- this could be a self-funded business? Thank you. + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com, Inc. - CFO [42] +-------------------------------------------------------------------------------- + + In terms of the original content, you know, we're not giving guidance on the numbers going forward beyond Q3. We are very excited about what we see in the pilots that we had and the series we had. And so, you know, we are happy to green light the series that we've released that we've talked about in releases over the past few months. We're also happy you'll be seeing many new pilots, and so that's reflected in the over $100 million that I mentioned earlier. +So we're extremely excited on behalf of customers to be able to do that, and we think that the right thing to do. But in terms of what we do, in terms of spend beyond Q3, I can't comment on today. In terms of the Fire phone, we're very excited about it. You mentioned two different areas. One is can it exist on its own and whether it's part of our family, if you will, to help drive other usage and the answer is we certainly think it can be both. +So we think it can be a great product on its own. We're very excited to offer it to customers. It's very integrated into our -- certainly our various video services -- various digital services including, you know, video and games at our app store and ebooks and certainly Prime Music. So those are all very interesting things on behalf of customers. +It's also a great way to do physical shopping as well. So again, it's certainly integrated into our business as well. + +-------------------------------------------------------------------------------- +Youssef Squali, Cantor Fitzgerald - Analyst [43] +-------------------------------------------------------------------------------- + + Thanks, Tom. + +-------------------------------------------------------------------------------- +Operator [44] +-------------------------------------------------------------------------------- + + And Brian Nowak with SIG has our next question. + +-------------------------------------------------------------------------------- +Brian Nowak, SIG - Analyst [45] +-------------------------------------------------------------------------------- + + Thanks for taking my questions. I have two. The first one is around CPG, consumer packaged goods. I was wondering, Tom, can you talk to some learnings in CPG so far of what's working and what you think is still holding back faster CPG adoption. Do you think you need a same day delivery offering at this point for CPG kind of given Google and given the traditional retailers push into that category? +And then the second one, the close to 90% AWS usage growth, just to help us understand a bit more. What did that number look like in 2013? Thanks. + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com, Inc. - CFO [46] +-------------------------------------------------------------------------------- + + In terms of the usage growth, that business is growing very, very fast. Beyond the data point, there's not a lot I can help you with. In terms of CPG, and this really relates to many of our categories. We are working on behalf of customers to provide fast delivery. It's something that we've improved on over the years and we're going to continue to work on. There's a number of different things we're working on. +One of the things that I mentioned earlier in the call is certainly sortation centers. That's an attempt on our side which we think we have in a small way and tested it and we've seen it the way to get product to customers even faster. So we're excited about that. It also helps us deliver on Sunday, which we think is great too, so those are the things that we're working on as well as others to help customers get product faster. We think that benefits CPG products as well as other products. + +-------------------------------------------------------------------------------- +Brian Nowak, SIG - Analyst [47] +-------------------------------------------------------------------------------- + + Thanks. + +-------------------------------------------------------------------------------- +Operator [48] +-------------------------------------------------------------------------------- + + We'll move next to Mark Mahaney with RBC Capital Markets. + +-------------------------------------------------------------------------------- +Mark Mahaney, RBC Capital Markets - Analyst [49] +-------------------------------------------------------------------------------- + + Thanks. I wanted to follow-up on that William Blair question about the gross margins, only because I know you don't focus on them and there's a lot of mixed factors that you correctly pointed out, but that's a record high gross margin for you, 30.7% ever. And it's in the context of a quarter in which AWS clearly came in because of the price cuts. And so there's something else that happened there that really caused that gross margin to gap up. Could you give us any color? +I understand a lot of puts and takes in there. But something must've happened that was unusual to have that kind of result with the slowing down AWS contribution. Thanks a lot, Tom. + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com, Inc. - CFO [50] +-------------------------------------------------------------------------------- + + I apologize Mark, again. We don't focus a lot on gross margin as a business. Obviously, individual product lines we would look at gross margin but across the business, we don't, for the very reason you mentioned. There's a large mix impact. You have our web services business. You have our third-party business. You have a retail business. You have categories within retail. +There's a whole host of things that would impact that. And so that's why we don't focus on a total company basis. Certainly, on individual SKUs or ASINs as we call them, we certainly would look at it, individual subcategories. We would certainly look at it internally, but from a total company perspective, given the mix effects, we think it's much more appropriate to look at operating profit and free cash flow. + +-------------------------------------------------------------------------------- +Mark Mahaney, RBC Capital Markets - Analyst [51] +-------------------------------------------------------------------------------- + + Okay. + +-------------------------------------------------------------------------------- +Operator [52] +-------------------------------------------------------------------------------- + + From ISI Group, we'll go to Greg Melich. + +-------------------------------------------------------------------------------- +Greg Melich, ISI Group - Analyst [53] +-------------------------------------------------------------------------------- + + Thanks. It looked like revenue per active customer accelerated again this quarter, I think over 5%. It was running closer to 2% to 3% last year. Could you help us understand what's driving that? Whether it's Prime particularly or anything -- any color on that. And when you gave the Prime numbers, second quarter more sign-ups, whether that was a gross or a net number. Thanks a lot. + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com, Inc. - CFO [54] +-------------------------------------------------------------------------------- + + The Prime was the net number so that's the net additions to total members. So again, we added net more Prime members in Q2 of this year versus Q2 last year, even with the price change. In terms of revenue per extra customer, there's not a lot I can say there. The one thing -- a few things to think about. One is certainly Prime customers buy more than non-Prime customers. +We're seeing great growth on Prime that's certainly having an impact on that number. Certainly, there'd be other factors to our web services business would be included in the numerator that you are talking about as well. And so those are factors you should be thinking about. But again, the biggest factor would certainly be in terms of looking at our retail business. +Prime is becoming much more meaningful. And that's also why we think about how do we make Prime better on behalf of those customers. We just like the long-term benefits that we see for those customers. + +-------------------------------------------------------------------------------- +Operator [55] +-------------------------------------------------------------------------------- + + Our final question today will be from Colin Sebastian with Robert Baird & Company. + +-------------------------------------------------------------------------------- +Colin Sebastian, Robert W. Baird & Company, Inc. - Analyst [56] +-------------------------------------------------------------------------------- + + Thanks Tom. One of your executives in the UK recently mentioned the Company's goal of reaching 1 billion different products available for sale on the site. I wonder if there is an expansion in selection beyond what we've seen recently that could help accelerate growth and related to that, are you still relatively agnostic in terms of the splits between first and third-party unit sales. Thanks. + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com, Inc. - CFO [57] +-------------------------------------------------------------------------------- + + In terms of selection, you know I would say nothing is new here. We are going to continue to add unique selection. That's something that we've been working extremely hard day in and day out over many years. We have a great team of people working on that and trying to make sure we get vast selection. So that is something we are pleased about. +In terms of the margins, you know, they do approximate each other. Obviously, there are some differences. Some of the third party will be used products so you shouldn't assume that a used product necessarily has the same contribution profit per unit as a new unit and things like that. But they're close approximates of those. + +-------------------------------------------------------------------------------- +Colin Sebastian, Robert W. Baird & Company, Inc. - Analyst [58] +-------------------------------------------------------------------------------- + + All right. Thanks very much. + +-------------------------------------------------------------------------------- +Phil Hardin, Amazon.com, Inc. - Director of IR [59] +-------------------------------------------------------------------------------- + + Thank you for joining us on the call today and for your questions. A replay will be available on our Investor Relations website at least through the end of the quarter. We appreciate your interest in Amazon.com and look forward to talking with you again next quarter. + +-------------------------------------------------------------------------------- +Operator [60] +-------------------------------------------------------------------------------- + + Again, that we conclude today's conference. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/exam/original-files/Problem_1_Sample/2014-Oct-15-BAC.N-137877397872-Transcript.txt b/exam/original-files/Problem_1_Sample/2014-Oct-15-BAC.N-137877397872-Transcript.txt new file mode 100644 index 0000000..d9db372 --- /dev/null +++ b/exam/original-files/Problem_1_Sample/2014-Oct-15-BAC.N-137877397872-Transcript.txt @@ -0,0 +1,1047 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q3 2014 Bank of America Corp Earnings Call +10/15/2014 08:30 AM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Brian Moynihan + Bank of America Corporation - Chairman & CEO + * Bruce Thompson + Bank of America Corporation - CFO + * Lee McEntire + Bank of America Corporation - IR + +================================================================================ +Conference Call Participiants +================================================================================ + + * John McDonald + Sanford Bernstein - Analyst + * Paul Miller + FBR Capital Markets - Analyst + * Mike Mayo + CLSA - Analyst + * Guy Moszkowski + Autonomous Research - Analyst + * Steven Chubak + Nomura Asset Management - Analyst + * Jim Mitchell + Buckingham Research Group - Analyst + * Matthew Burnell + Wells Fargo Securities - Analyst + * Chris Kotowski + Oppenheimer & Co. - Analyst + * Glenn Schorr + ISI Group - Analyst + * Ken Usdin + Jefferies & Co. - Analyst + * Matt O'Connor + Deutsche Bank - Analyst + * Brennan Hawken + UBS - Analyst + * Betsy Graseck + Morgan Stanley - Analyst + +================================================================================ +Presentation +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Good day, everyone and welcome to today's program. (Operator Instructions). Please note this call is being recorded and I'll be standing by should you need any assistance. It is now my pleasure to turn the conference over to Mr. Lee McEntire. Please go ahead, sir. + +-------------------------------------------------------------------------------- +Lee McEntire, Bank of America Corporation - IR [2] +-------------------------------------------------------------------------------- + + Good morning. Thanks to everybody on the phone, as well as the webcast for joining us this morning for our third-quarter results. Hopefully you've had a chance to review the earnings release documents available on our website. +Before I turn the call over to Brian and Bruce, let me just remind you we may make some forward-looking statements today. For further information on those, please refer to either our earnings release documents, our website or our other SEC filings. So with that, let me turn it over to Brian Moynihan, our CEO, for some opening comments before Bruce goes through the details. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman & CEO [3] +-------------------------------------------------------------------------------- + + Thanks, Lee and good morning, everyone. Thank you for joining us to review our third-quarter results. As you know, our bottom-line results were heavily impacted by a previously announced settlement with the Department of Justice. But given that, I'm still encouraged by what we accomplished this quarter. Our business has generated enough earnings to absorb the $5.3 billion charge and still reported positive net income before preferred dividends. +Now the themes we see are consistent with the past several quarters. You can see in our numbers a prudent balance sheet management. You can see in the numbers good core expense control. You can see in the numbers continued credit improvement and you can see in the numbers solid business activity. +Before Bruce takes you through the details of the quarter, I thought I would focus quickly on the profitability of our business segments and some of the key statistics that give rise thereto. If you look, we've included in the appendix to the materials on page 18 and 20 some information about net income, PPNR and business statistics. +So when you step back and look at that, you can see from our release the Company reported $2.9 billion in year-to-date pre-tax net income. That includes and overcomes $15.6 billion in pre-tax litigation costs to resolve primarily legacy mortgage issues. Now we're not suggesting that we want to incur litigation costs going forward, but what this demonstrates is how much progress we've made behind the noise of the significant legal settlements. +So as you step back and think about the businesses, you can see on appendix slide 18 a graphic showing year-to-date net income compared to the performance by the businesses. +Let's first focus on our Consumer & Business Banking segment. Year-to-date net income was $5.3 billion in 2014. That compares to $4.6 billion after-tax in 2013. The return on average allocated capital in Consumer & Business Banking was 24%. It is our largest business and has had a good year. Our Global Wealth & Investment Management business had net income of year-to-date of $2.3 billion in 2014. That is up 3% from 2013. Now this business, our GWIM business, has a pre-tax margin of 26% and its returns on allocated capital are 25%. +As we move to our Global Banking business, that's the business that provides lending, treasury services and investment banking activities to middle market and large corporate clients around the world. That business earned $4 billion after-tax so far this year, up 8% from 2013 and generated returns on allocated capital of 17%. Those three businesses together have great annuity streams and hold us in good stead as we look forward. +Our Global Markets business, which obviously is more affected by what's going on in the market on a given quarter, has earned $2.9 billion after-tax this year and for the first nine months versus $2.7 billion in 2013 when you adjust for DVA and in 2013, you exclude the UK tax changes. So in total, these four businesses generated $14.5 billion net income after-tax for the first nine months of 2014. That $14.5 billion is up 10% from last year. You can look on slide 19 and you can see on a pre-tax pre-provision basis, which some of you also focus on, we are up 4% year-over-year and you can see on pages 20 and 21 the business statistics over the last couple years, which give rise to these results. +We made real progress in the four businesses and we continue to work on the Consumer Real Estate segment and the losses therein. But that real progress shows in the operating leverage and profitability of these businesses and we expect that momentum to continue as we move to the other side of the mortgage issues. With that, I'll turn it over to Bruce. + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [4] +-------------------------------------------------------------------------------- + + Thanks, Brian and good morning, everyone. This quarter does reflect what we believe is very solid execution and a lot of what we have been consistently talking with all of you about. We maintained a strong balance sheet as a foundation to operate from. We continued to rationalize our balance sheet for liquidity, profitability, as well as evolving regulatory changes. Our revenue has shown relative stability and our non-litigation expenses continue to be reduced. Charge-offs have continued to come down and we resolved significant legacy mortgage exposures during the quarter. +Let's start on slide 2 and go through the details. We recorded $168 million of earnings in the third quarter and after preferred dividends, that resulted in a loss of $0.01 per share. Earnings included the $5.3 billion pre-tax impact of the settlement with the Department of Justice and various state Attorneys General that we announced in August. On an EPS basis, the impact was $0.43 a share as a portion of this charge was not tax-deductible. +As you can see on the right-hand side of slide 2, the $5.3 billion impact was split between $4.9 billion in litigation expense and $400 million in provision expense that relate to additional reserves that are associated with the consumer relief portion of the settlement. +Revenue during the quarter on an FTE basis was $21.4 billion versus $21.7 billion in the year-ago quarter. If we exclude the DVA impact from both periods, as well as the $1.2 billion of equity investment income that we recorded during the third quarter of 2013 that was driven by gains from our CCB investment, adjusted revenue of $21.2 billion was up slightly from the third quarter of 2013. +On a segment view, revenue was stable to modestly up in four of our five businesses from last year with CRES being the exception. Relative to the second quarter of 2014, revenue was 3% lower driven by the lack of equity investment gains, seasonally lower investment banking fees and lower mortgage banking revenue. Total non-interest expense was $19.7 billion, which included $5.6 billion in total litigation expense. If we back out litigation expense compared to the second quarter of 2014, expenses declined roughly $400 million from both our New BAC and our LAS cost initiatives, as well as lower revenue-related incentives. +On the same basis, looking back to the third quarter of 2013, expenses improved by $1.1 billion, or 7%, which were driven by reduced LAS costs and to a lesser degree our New BAC cost savings. Provision for credit losses during the quarter was $636 million and included $400 million, as I mentioned, for the DOJ settlement while our net charge-offs were $1 billion. Our results during the quarter did benefit from roughly $200 million in DVA or about $0.01 per share as our debt spreads widened during the end of the quarter. There was also approximately $0.04 of benefit to earnings that relate to certain discrete tax items. Lastly, the quarter also benefited by about $0.01 as our weighted average share count excluded the impact of diluted shares given the financial performance. +On slide 3, we show you all the usual balance sheet highlights that we do each quarter, but we did want to focus you specifically on our efforts to rationalize the balance sheet as our actions led to a $47 billion decrease from the second quarter of 2014. We took prudent actions to increase liquidity, as well as to reduce both credit and market risk. We shifted the mix of some of our discretionary assets out of less liquid loans into more liquid debt securities. For example, we converted $6.5 billion of residential mortgage loans that benefited from standby insurance agreements into agency securities. We also sold $2.5 billion of non-performing and delinquent loans during the quarter and had $4 billion of net paydowns in our legacy Consumer Real Estate loans. We reduced our Global Markets balance sheet and associated funding by $11.7 billion from the second quarter of 2014 and that included low-margin prime brokerage loans of approximately $3.3 billion. Our decline in quarter-end deposits was primarily driven by optimization efforts that included the reduction of approximately $15 billion of deposits that had little to no benefit to our LCR ratio. +From a capital perspective, I'll remind you that we did issue $3.1 billion of preferred stock during the quarter that improved our Basel III Tier 1 regulatory capital ratio. And lastly, as a reminder, we increased our quarterly common dividend to $0.05 a share during the quarter. +We move to slide 4 where we show our capital ratios under Basel III. Under the transition rules, our CET1 ratio was stable at 12%. If we look at our Basel III regulatory capital ratios on a fully phased-in basis, you can see CET1 capital declined $1.6 billion. That was driven by a $1 billion decline in OCI. Our operational risk-weighted assets did increase that negatively impacted our advanced levels, but not the standard levels. Other RWA balance sheet improvement benefited both approaches and that partially offset the increase in RWA under the advanced approach. +If we look at the ratios under the standardized approach, CET1 improved slightly to 9.6% during the third quarter of 2014 and under the advanced approach, the CET1 ratio was also at 9.6%, both well above our 8.5% 2019 proposed minimum requirements. If you look at our operational risk-weighted assets under the advanced approach, they now represent approximately 30% of our overall risk-weighted assets. +If we move to supplementary leverage, this is the first quarter that we've actually disclosed the actual ratios from a supplementary leverage perspective. The bank holding company during the third quarter was at 5.5% and if we look at our primary banking subsidiary, BANA, its ratio was 6.8%, which is pro forma for September 30 as we merged FIA, our card services unit, into BANA on October 1. We are obviously very pleased with the capital and supplementary leverage ratios in the context of the resolution of the DOJ matter during the quarter. +If we turn to slide 5, we feel very good about the work that the funding team did during the quarter. In addition to the $3.1 billion preferred stock issuance, we issued $3 billion of Tier 2 subordinated debt, which also adds to our total capital metrics. Lastly, we issued $4.5 billion of straight debt at the parent. Our goal is not only to build the Basel III non-CET1 component of the capital stock that we thought were levels that were appropriate, but also to build liquidity in advance of the payments that we'll make during the month of October for the DOJ and state AG settlement. +Total long-term debt for the quarter ended at $250 billion, which was down $7 billion from the end of the second quarter of 2014. If we look at the cost of our debt, our long-term debt yields improved 10 basis points from the second quarter of 2014 due primarily to maturities of higher-yielding debt, as well as issuances at more favorable levels. Global excess liquidity sources remain very strong at $429 billion and our time to required funding was stable at 38 months. +If we turn to slide 6, net interest income on a reported FTE basis was $10.4 billion, up from the second quarter of 2014, as we had a less negative impact from market-related adjustments and that was coupled with modest improvements in our adjusted net interest income. The market-related adjustments during the quarter were a negative $55 million in the third quarter of 2014. That compares to a negative $175 million in the second quarter of 2014. Net interest income of $10.5 billion, excluding the market-related adjustment, improved modestly as lower long-term debt balances and yields, as well as an extra day of interest accruals, were partially offset by lower loan balances, as well as lower loan yields. The net interest yield improved 4 basis points on an adjusted basis and 7 basis points on an actual basis. We continue to remain positioned to benefit as interest rates move higher, particularly from the short end of the curve. +Since we're largely done at this point with our debt footprint reductions, the direction, as well as the trajectory of our net interest income and net interest yield, we will be more dependent on rate, as well as balance sheet movements going forward. And given the volatility of the rates, should the opportunity present itself, we could decide to take actions to reduce OCI risk in preparation for what we will be in an eventual rising rate environment. Those actions could have a relatively small near-term impact to net interest income, but reduce our duration risk, as well as to provide additional liquidity to reinvest in a higher rate environment. +Non-interest expense on slide 7 was $19.7 billion in the third quarter of 2014 and included $5.6 billion of litigation expense. As I previously mentioned, $4.9 million of the expense related to the DOJ settlement while the remainder was associated with a number of smaller pre-existing cases. One of which caused us to book approximately $200 million in our Global Markets business. If we exclude litigation, total expenses were $14.2 billion this quarter, which declined $400 million from the second quarter of 2014 on both our New BAC, as well as our LAS initiatives, as well as lower revenue-related incentive costs. Compared to the third quarter of 2013, expenses our $1.1 billion lower driven by LAS cost savings. +Our legacy assets and servicing costs, once again ex-litigation, reduced by approximately $100 million in the quarter and remain on track to hit $1.1 billion in the first quarter of 2015. In the third quarter, we have now reached our New BAC savings initiatives with the targeted goal of $2 billion a quarter or $8 billion on an annualized basis. So as we move forward, we believe that expenses apart from litigation, as well as the continued reductions in legacy assets and servicing expenses, should move more directionally with the revenue streams that we see in the businesses. +Asset quality on slide 8, you can see credit quality continued to improve. Net charge-offs declined slightly from the second quarter of 2014 to $1 billion or a 46 basis point net loss ratio. A new decade low. NPL sales, which I mentioned, produced modest recovery in both the second quarter of 2014, as well as the third quarter of 2014 and if we normalize for those benefits, net charge-offs would have been $1.3 billion in the second quarter of 2014 and $1.2 billion in the third quarter of 2014 with the third quarter being about 8% lower. Delinquencies, a leading indicator of net charge-offs, remain very low. Our third-quarter provision expense was $636 million and we released $407 million of reserves given the continued pace of asset quality improvement. If we exclude the reserve that was associated with the DOJ settlement, we released $807 million from our reserves. +Let's now focus on the businesses starting on slide 9 with Consumer & Business Banking. Results again this quarter showed year-over-year improvement as our net income grew 4% to $1.9 billion and increased 3% from the second quarter of 2014. This business generated a 25% return on allocated capital during the third quarter. Revenue was relatively stable at $7.5 billion compared to the third quarter of 2013 and up from the second quarter of 2014 led by higher card income and service charges for both comparative periods. +As you can see on this slide, Q3 provision expense was lower than the third quarter of 2013 as net charge-offs improved and we also released less reserves. Expenses of $4 billion were stable compared to both periods as the benefits from our network delivery optimization were offset by investments that we made in our specialist salesforce. +With regard to the specialist salesforce, over the course of the last year, we've added nearly 500 financial solutions advisors and small business bankers. Growth in mobile, as well as other self-service customer touch points, has allowed us to continue to reduce our banking centers where we went below 5000 units during the quarter while at the same time our customer satisfaction scores continued to improve and customer activity continues to build. +If we look at customer activity during the quarter, we had good deposit growth and our rates paid remain very low. We experienced modest improvement in average loans on a linked-quarter basis driven by activity that we saw within the US consumer credit card business. Brokerage assets were up 21% year-over-year as we benefited from both improved account flows and market valuation. +Our mobile banking customers reached over 16 million during the quarter and 11% of all of our customer deposit transactions are now done through mobile devices. Card issuance remained strong at 1.2 million new accounts in the third quarter of 2014 with 64% of those cards going to existing customers of our Company. And lastly, credit quality continued to improve as our US credit card loss rate fell below 3% and where we continue to see north of a 9% risk-adjusted margin. +If we move to Consumer Real Estate Services, as I mentioned, the loss in the quarter was driven by the DOJ settlement, which impacted expense, provision, as well as income tax. Revenue was down about $300 million from the second quarter of 2014. The servicing income component of revenue was driven by an approximate $100 million charge to adjust our MSR for cost-of-service assumptions and a smaller amount as our level of servicing assets did decline. Our production revenue decline was driven by an approximate $80 million increase in rep and warrant expense. +First mortgage retail originations of $11.7 billion were up 6% from the second quarter of 2014. If we look at the pipeline at the end of the quarter, our first lien origination pipeline was down 12% from the second quarter of 2014. On the home equity front, we continue to see very good demand where originations during the quarter were $3.2 billion, which were up nicely on both a linked quarter and a year-over-year basis. Expenses once again included $5.3 billion of litigation costs during the quarter versus $3.8 billion in the second quarter of 2014. If we exclude that $1.5 billion increase in litigation costs, expenses declined $117 million. Our LAS expense for the quarter was just over $1.3 billion and once again remains on track to hit $1.1 billion in the first quarter of 2015. +Our number of 60 plus days delinquent loans of 221,000 that are serviced by LAS dropped 42,000, or 16%, from the end of the second quarter of 2014. In addition, we continue to reduce our production staffing levels in line with the market opportunity as we continue to lower our fulfillment costs. +On slide 11, Global Wealth & Investment Management delivered another strong quarter where we saw both record revenues, as well as record earnings. Pre-tax margins remained strong, north of 25% for the seventh consecutive quarter. Record asset management fees drove revenue higher, but were offset by some softness in transactional activity. Although I do want to mention that we did see transactional activity pick up during the month of September. +Net income of $813 million was up 12% on a linked-quarter basis as the business continues to focus on operating leverage and drop the revenue growth to the bottom line. We increased the number of financial advisors and year-to-date the retention of our more experienced advisors remains at record levels. Client balances were nearly $2.5 trillion with negative market valuation mostly offset by positive flows that we saw during the quarter. Long-term AUM flows were $11.2 billion during the quarter, the 21st consecutive quarter of positive flows. Ending client loan balances also increased to a record level from the second quarter of 2014 as we see good activity in both securities-based and residential mortgage lending. And return on allocated capital in this segment was 27% during the quarter. +If you turn to slide 12, Global Banking, earnings were $1.4 billion, which is up 24% from the third quarter of 2013 on lower credit costs and to a lesser degree higher revenue. Compared to the second quarter of 2014, earnings were up on lower credit costs, which were slightly offset by seasonally lower investment banking fees. Return on allocated capital during the quarter was strong at 18%. +Within the revenue line item, investment banking fees for the Company this quarter were $1.4 billion, which is up 4% from the year-ago quarter, but down seasonally from the second quarter of 2014. Our overall investment banking pipeline does remain very strong, but I do want to note that our fourth quarter of 2013 was a record quarter from an investment banking fee perspective. Provision during the quarter was a slight benefit, which reflected continued low loss rates and a small reserve release. +If we look at the balance sheet, average loans were $267 billion, which is up 3% compared to the year-ago period, but which has slowed over the past couple quarters as we continue to focus on client profitability. We've also seen some significant prepayments from some of our larger corporate banking clients during the last couple quarters. Although our average deposits during the quarter did increase, our end-of-period balances declined and that's due, as I mentioned earlier, that we intentionally managed down certain deposits, which have little LCR benefit. +If we move to Global Markets on slide 13, we earned $769 million during the third quarter of 2014. To put the third quarter of 2014 on a like basis to the third quarter of 2013, you should exclude a $1.1 billion impact from the UK tax rate change that we saw in the third quarter of 2013, as well as the impact of DVA for both periods. Once again, DVA this quarter was a benefit of $205 million versus a detriment of $444 million last year. If we make those adjustments, we saw very strong growth in earnings of 21% on a year-over-year basis. Earnings are down from the second quarter of 2014 as a result of the typical seasonal declines in sales and trading, as well as higher litigation expense during the third quarter of 2014 within this segment. +If we back out DVA, revenues up 7% from the year-ago period driven by strong sales in trading results. We're pleased to report both FICC and equity sales and trading revenues were up versus the year-ago period. FICC revenues were up 11%. The improvement was driven by results in currencies given the increased volatility that we saw during the month of September, as well as improved performance in both our mortgages and our commodities areas. Equity sales and trading was up as well, up 6% from the third quarter of 2013 driven by higher client financing revenues. +On the expense front, they were up 2% year-over-year driven by higher revenue-related incentives. Relative to the second quarter, expenses were up $70 million from the second quarter due to higher litigation expense. If we backed out the $200 million litigation expense during the quarter, expenses declined by about $130 million in line with the lower revenue levels on a linked-quarter basis. Average trading-related assets were down about $13 billion from the second quarter of 2014 and our overall VAR remains very low. Return on allocated capital during the quarter was 9%. +On slide 14, we show All Other. Our non-interest revenue during the quarter was down on a year-over-year basis as we had $1.1 billion of equity investment gains in the third quarter of 2013 and during the third quarter of 2014, we had a $300 million charge for UK payment protection insurance. Expenses on a year-over-year basis are down about $400 million due to lower litigation expense in All Other, as well as lower personnel cost. Income tax expense is included within All Other as the benefits related to discrete items that I mentioned earlier are largely reflected in this segment. As we look at the fourth quarter of this year, we'd expect the tax rate to be roughly 31% absent any unusual items during the quarter. +So before we open it up for questions, I'd like to summarize the quarter. We feel we made once again very good progress during the quarter. We saw good business activity across the customer footprint. This led to year-over-year earnings improvements in four out of the five businesses. And in our mortgage business, we're taking costs out of the legacy assets and servicing side and have taken costs out of the fulfillment side as well. We generated enough earnings during the quarter from the businesses to offset a significant charge to settle our RMBS issues with the DOJ and RMBS working group and at the same time maintain a very strong capital position. Asset quality continued its trend of improvement and we did take some deliberate balance sheet actions to improve liquidity, manage OCI risk and reduce both credit and market risk. And we'll go ahead now and open it up for questions. + + +================================================================================ +Questions and Answers +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions). Betsy Graseck, Morgan Stanley. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [2] +-------------------------------------------------------------------------------- + + Hi, thanks very much. Good morning. So just wanted to touch on a couple of things that you mentioned during your prepared remarks here. One is on the NII actions that you were talking about you might take with the securities portfolio as a way to protect OCI. But it might have a hit on the top line when you do that. Could you just talk through what kind of size you're thinking about and what the triggers for that action might be? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [3] +-------------------------------------------------------------------------------- + + Sure. A couple things, Betsy. I think the first thing, if you look at the balance sheet from the second quarter to the third quarter and you look at the securities portfolio, you can see that virtually the entire increase in the securities portfolio related to treasury securities that tend to have a maturity in the four to five-year life perspective as opposed to longer-dated agency securities. +The second thing that I mentioned is just, and references what we would look to do with respect to our buy ticket during the fourth quarter and I think at this point we're being very cautious in looking at that buy ticket given the overall rate environment that we see that's 30 to 35 basis points lower than what we saw during the second quarter of 2014. And there's also a little bit of roll to spot risk that you have as we look out and I'd say if we aggregate those two items and put it in the context of NII risk for the quarter, those two items could be roughly $100 million of risk relative to what we saw during the third quarter. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [4] +-------------------------------------------------------------------------------- + + Okay. And then obviously a question that a lot of people have is the current rate environment and what that impact is. So this is in addition to the typical negative impact on NII from the long end of the curve, I would assume, [coming down]? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [5] +-------------------------------------------------------------------------------- + + The $100 million risk that I referenced is relative to the actual net interest income in the third quarter once we back out for market-related items. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [6] +-------------------------------------------------------------------------------- + + Got it, got it. Okay. And then the other comment was on expenses where you indicated that you are obviously done with New BAC, which is fantastic and LAS is on track. So outside of the LAS expense reductions, more directionally expenses would move in line with revenue. Could you give us a sense as to what you think you could do on expenses in the event that the long end of the curve stays where it is right now, hovering at like [$2.01]? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [7] +-------------------------------------------------------------------------------- + + Sure. I think the biggest thing I'd point to, Betsy, is if you look at what we've done, if you look at the number of FTEs that we have, which tends to drive a lot of the expense, we're down 7% year-over-year and down 2% on a linked-quarter basis. And you see the flow-through of those benefits through a number of line items. I think one of the most important things to look at is if you go to our supplemental materials and flip to page 4, we show you nine different expense items and if you look at those line items and exclude the other category, which includes litigation expense, all eight line items are down both on a linked-quarter and a year-over-year basis. So as we continue to be efficient and continue to manage down overall headcount as a result of the various programs we've talked about, as well as just generally, you do continue to see grinddown expenses across all categories across the Company. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman & CEO [8] +-------------------------------------------------------------------------------- + + And Betsy, just to put it in a broader perspective, I think how would you manage the Company if a low rate environment continues is a lot like we've been managing it now, continuing to be careful in every expense item, every headcount, but at the same time investing in the business. And so if you think over the last year, we've added small business bankers and financial service advisors, the people who work in the branches for Merrill Edge and the Merrill Lynch teams. We've added sales of mortgage loan officers in the retail segment while we reduce the overall numbers. And so we've been able to accomplish a reduction in expenses at the same time we're making the investments, $3.5 billion in technology last year, probably $3.3 billion or so this year. So we'll continue to make those investments. So that means that the New BAC left to implement helps offset any kind of inflationary growth you get and on top of that, we continue to work on initiatives to continue to simplify the Company and eliminate non-core products, etc. to continue to keep the expenses where they are. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [9] +-------------------------------------------------------------------------------- + + So just to rephrase, you still have expense reduction coming through from the work that you've done so far; you're just not going to name it something new? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman & CEO [10] +-------------------------------------------------------------------------------- + + No, we're just doing the daily work that we need to do and remember, we're offsetting all the inflation and healthcare costs and wages and everything that goes on in a normal day. But we've made the raw reduction we talked about; now it's just business as usual and go to work. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [11] +-------------------------------------------------------------------------------- + + Okay, super. Thank you. + +-------------------------------------------------------------------------------- +Operator [12] +-------------------------------------------------------------------------------- + + Glenn Schorr, ISI. + +-------------------------------------------------------------------------------- +Glenn Schorr, ISI Group - Analyst [13] +-------------------------------------------------------------------------------- + + Hi, thanks very much. On slide 8 is this tiny uptick in consumer 30 day past due. It's a small number, but it's the first time I've seen it go up in a long time. Credit outlook is great. Just curious if that denotes like a bottoming and what you're seeing. And then in conjunction with that, how you feel about what appears to be a very large loan allowance as a percentage of charge-offs. + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [14] +-------------------------------------------------------------------------------- + + Sure. No, we went back and noticed the same thing, Glenn. There were a few items that were 10s, 20s, and 30s that rounded, but as we go out and look and as we have freshened up and look forward, I would say that the forward look on credit as we look forward relative to when we looked at it last quarter, we do continue to see continued improvements, albeit at a slower pace from a charge-off perspective once you adjust for the non-performing loan sales. + +-------------------------------------------------------------------------------- +Glenn Schorr, ISI Group - Analyst [15] +-------------------------------------------------------------------------------- + + That's good; that's comforting. You mentioned the $3 billion of sub debt that you issued during the quarter. Just curious if there's any thought process of is that getting ahead of OLA and do you feel that there's going to be a sub debt component? Is that just you being cautious and having some diversification in the debt structure? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [16] +-------------------------------------------------------------------------------- + + I think as we looked out and as you look to fill up the various non-CET1 buckets, you can see that we obviously had the Buffett Series T in May and we've issued about $4.6 billion to get where we're largely filled up on the preferred bucket and the sub debt issue of $3 billion was relative to approximately $5 billion to fill up that bucket from an overall capital perspective. And at this point, I would say from an OLA perspective we continue to read what you do. We feel like we've been very prudent in building up the significant debt stack at the parent and we'll just have to see where the regulation goes from here and we're obviously waiting to see exactly what that is. + +-------------------------------------------------------------------------------- +Glenn Schorr, ISI Group - Analyst [17] +-------------------------------------------------------------------------------- + + Okay, last one. On mortgage, just curious what percentage of current originations you're keeping on balance sheet and then related part two would be how much is the unfinished question around repurchase risk constraining any mortgage lending or is it really still a function of demand at this point? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [18] +-------------------------------------------------------------------------------- + + I'd say the first is, as it relates to the balance sheet, I believe it was roughly two-thirds of the production from a first lien perspective would have gone on the balance sheet during the quarter. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman & CEO [19] +-------------------------------------------------------------------------------- + + In terms of just the origination quality, we continue to focus as we have for quite a long time here on originating high-quality prime mortgages while still fulfilling our duties to get customers credit for home purchases. The originations continue to rise. The purchase component obviously is rising too, so we feel good about where we are and you can see that the new purchase requests from the agencies and stuff have come down dramatically. So we're not going to change course at the end of the day because we feel good about the credit quality that we're taking on producing for ourselves and for investors. + +-------------------------------------------------------------------------------- +Glenn Schorr, ISI Group - Analyst [20] +-------------------------------------------------------------------------------- + + Okay, thanks both. + +-------------------------------------------------------------------------------- +Operator [21] +-------------------------------------------------------------------------------- + + Jim Mitchell, Buckingham Research. + +-------------------------------------------------------------------------------- +Jim Mitchell, Buckingham Research Group - Analyst [22] +-------------------------------------------------------------------------------- + + Hey, good morning. Two questions. First on governance, can you just kind of talk through the reasoning on the Board's perspective to kind of change the Chairmanship and with a lead director how you think that dynamic may change, good or bad? And I guess secondly is this a vote of confidence in you, Brian, in terms of the leadership and current strategy? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman & CEO [23] +-------------------------------------------------------------------------------- + + Well, I think we have a strong Board. It's a team with various people with various skills and backgrounds and that diversity really helps us. So I think the Board's decision, as we put out a few weeks ago when the announcement was made, this is continued great governance, continued commitment to good governance. Jack Bovender, the lead director, takes over from Chad Holliday, who served as Chair for about 4.5 years and did a great job for us and the Board is very committed to continuing to have the strong governance, especially in the heightened expectations from the regulators and the enhanced supervisor prudential standards from the Fed. And so we feel good about the governance, but it's a team effort in how the Board works together and I think your points that Chad made in the announcement are that the Board feels very good about the accomplishments of the management team and this is part of the progression in that regard. + +-------------------------------------------------------------------------------- +Jim Mitchell, Buckingham Research Group - Analyst [24] +-------------------------------------------------------------------------------- + + And does the Fed take part in reviewing this decision in any way? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman & CEO [25] +-------------------------------------------------------------------------------- + + It's the Board's decision, but we consult with the regulators on all our major decisions in the Company, but I think the key is to how we operate as a Board and how we govern the Company and I think it will be for the benefit of the shareholders as it has been. + +-------------------------------------------------------------------------------- +Jim Mitchell, Buckingham Research Group - Analyst [26] +-------------------------------------------------------------------------------- + + Okay, great. And then second question on the balance sheet, with the $47 billion reduction, clearly it helps the LCR, but can you give us a sense on how it benefited -- I'm sorry, the SLR -- but can you give us a sense on how it might have improved your LCR, number one and if there's any additional benefits beyond leverage that helps the stress test? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [27] +-------------------------------------------------------------------------------- + + A couple questions. The first thing is we focus on the deposits. I wouldn't say it benefited LCR, but what it enabled us to do was continue to rationalize the balance sheet without hurting LCR. That relates to the deposit optimization. With respect to the mortgage loans, the $6.5 billion that we reference where we converted mortgage loans into agency securities, that's basically taking $6.5 billion of non-LCR benefit asset and converting them to $6.5 billion of LCR benefit. So that would have been the one pickup of the activities that we mentioned, as well as just the reinvestment of repayment of legacy loan proceeds into securities once again helps LCR. So the actions with respect to bullet one under the key balance sheet benefited LCR. The $15 billion of deposits just enable us to rationalize the overall size of the balance sheet. +As it relates to CCAR and the actions that are taken, as we look to manage the Company, we continue to look to manage out the higher risk categories of loans. And if you look at what we did in the second quarter with just over $2 billion of non-performing loan sales and $2.5 billion this quarter, we would clearly expect that, as you look at those from a CCAR perspective, they would be higher loss content loans relative to the rest of the portfolio. But the rationale and the goal to move those out was to reduce the risk in a market environment that was very favorable and we feel good about those actions that we took. + +-------------------------------------------------------------------------------- +Jim Mitchell, Buckingham Research Group - Analyst [28] +-------------------------------------------------------------------------------- + + So is it fair to assume that you guys are near or at the 100% LCR threshold? And I guess secondarily should we expect balance sheet growth to start -- loan deposit growth, balance sheet growth start to pick up from here or you still have more to do? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [29] +-------------------------------------------------------------------------------- + + Sure. So from an overall LCR perspective at the parent, we're at approximately 110% at the parent, so we're well in excess of where we need to ultimately be in 2017. Within the bank level, we're well above the 80% level and would look to drive that to be north of 100% during the first half of 2015, well in advance of the 2017 implementation. As we move forward and we look at the balance sheet, the goal as we go forward, and you saw a little bit, it's interesting, if you compare the loans in the three principal businesses where we make loans in the segments that we've laid out here and that would be in our Consumer business, in our Wealth Management business, as well as in our Global Banking business, that average loans within those segments are up about 2% on a year-over-year basis and we're clearly very focused on looking to drive out and push out and grow loans. We're obviously focused on growing deposits with our core customers, which will benefit LCR as well and I think as it relates to the overall size of the balance sheet, we want to continue to be more efficient, but I don't think you're going to see the magnitude of move in the balance sheet going forward that you saw during this quarter. + +-------------------------------------------------------------------------------- +Jim Mitchell, Buckingham Research Group - Analyst [30] +-------------------------------------------------------------------------------- + + Okay, great. That's helpful. Thanks. + +-------------------------------------------------------------------------------- +Operator [31] +-------------------------------------------------------------------------------- + + John McDonald, Sanford Bernstein. + +-------------------------------------------------------------------------------- +John McDonald, Sanford Bernstein - Analyst [32] +-------------------------------------------------------------------------------- + + Hi, Bruce. I wanted to follow up on the NII outlook and the potential strategic actions. Is the potential $100 million headwind on the core NII, does that reflect the possible strategic actions or is that just reflecting the fact that reinvestment rates for the maturing cash flows are lower today than they were in the second quarter? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [33] +-------------------------------------------------------------------------------- + + It would reflect two things, John. It's both the roll to spot risk, as well as the buy ticket during the fourth quarter. + +-------------------------------------------------------------------------------- +John McDonald, Sanford Bernstein - Analyst [34] +-------------------------------------------------------------------------------- + + Okay. And this buy ticket or these kind of actions that you might take, how might they impact your projections of rate sensitivity to rising short and long rates? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [35] +-------------------------------------------------------------------------------- + + Well, to the extent that we don't reinvest and build up cash, it will increase our asset sensitivity and the benefit to rising rates when that occurs. + +-------------------------------------------------------------------------------- +John McDonald, Sanford Bernstein - Analyst [36] +-------------------------------------------------------------------------------- + + Okay. So you're not talking about a major restructuring of the bond portfolio; it's just being patient in terms of investing? I think I might've misunderstood the actions. + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [37] +-------------------------------------------------------------------------------- + + This is much more, John, I think just realizing what we've seen during the quarter and being cautious on buy ticket during the fourth quarter to manage net interest income risk with OCI risk, but we're not talking about any kind of material shift. We're just flagging something for you given the magnitude of the rate move that we've seen so far this quarter. + +-------------------------------------------------------------------------------- +John McDonald, Sanford Bernstein - Analyst [38] +-------------------------------------------------------------------------------- + + Got it. Okay, totally understood. Thank you. And Bruce, just in terms of the FAS 91 or the premium amortization charges that move around with the 10 year, is that pretty proportional to how the 10 year moves up and down or are there levels where it stops kind of being a straight-line impact? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [39] +-------------------------------------------------------------------------------- + + I would say that the -- it tends to move -- the FAS 91 moves most and is most correlated to the 10 year and I would say that as you look at OCI risk, it tends to be more correlated to long-term mortgage rates. + +-------------------------------------------------------------------------------- +John McDonald, Sanford Bernstein - Analyst [40] +-------------------------------------------------------------------------------- + + Okay. And just a follow-up on the provision, just wondering how we should think about the jumping off point for the provision relative to the $600 million reported or the $200 million ex-DOJ this quarter? How should we think about where to start off with that? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [41] +-------------------------------------------------------------------------------- + + I think, John, I would look at the charge-offs adjusted for the portfolio sales that we said came down from $1.3 billion to $1.2 billion and assuming the overall economic environment doesn't change, we have continued to see improvements in the credit portfolios. And I think practically speaking, if you look at the reserve release during the quarter, once you adjust for the DOJ amount of $400 million, that you're not going to see reserve releases. I think clearly they will be a fair bit below the $800 million that we would have seen this quarter on an adjusted basis. + +-------------------------------------------------------------------------------- +John McDonald, Sanford Bernstein - Analyst [42] +-------------------------------------------------------------------------------- + + Okay. That's helpful. And then just on capital builds, Bruce, it seems like you're still able to grow the Tier 1 common at a multiple of the GAAP earnings. Is that primarily as DTA, and could you remind us what the status of the DTA balance is and how much is disallowed currently? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [43] +-------------------------------------------------------------------------------- + + Sure. The disallowed amount continues to be in the $15 billion to $16 billion type area. And as we look out between now and the end of 2015, we would expect that the CET1 should build generally consistent with pre-tax earnings all the way through the end of 2015. + +-------------------------------------------------------------------------------- +John McDonald, Sanford Bernstein - Analyst [44] +-------------------------------------------------------------------------------- + + Okay, thank you. + +-------------------------------------------------------------------------------- +Operator [45] +-------------------------------------------------------------------------------- + + Mike Mayo, CLSA. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA - Analyst [46] +-------------------------------------------------------------------------------- + + Hi, good morning. Were there any gains in the $2.5 billion of NPA sales? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [47] +-------------------------------------------------------------------------------- + + I believe between what came through in the charge-off line and the net, I think the NPAs were roughly $150 million, Mike. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA - Analyst [48] +-------------------------------------------------------------------------------- + + $150 million gain? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [49] +-------------------------------------------------------------------------------- + + Correct. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA - Analyst [50] +-------------------------------------------------------------------------------- + + Okay. As far as the outlook for rates, have you changed your rate assumption for the next year, given what the 10-year has done? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [51] +-------------------------------------------------------------------------------- + + As we look at rate assumptions, what we do is when we go through our internal forecasting process, we snap and manage the business just based on the forward curve of what the market is telling us. And clearly, I think if we look out at and look at the rate movement that we've seen over the course of the last couple weeks, people are obviously more cautious that rates may not be moving up at the level that they had had, but it's clearly been very volatile over the last 30 days. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA - Analyst [52] +-------------------------------------------------------------------------------- + + And is that changing the way you're managing the portfolio or the Company? In other words, at what point do you look at the low rate environment and say our prior assumptions might have been off a little bit; we need to revise the approach? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [53] +-------------------------------------------------------------------------------- + + Well, I think that as we look forward, Mike, I think it's a little bit of why we said what we did about a little bit of caution during the fourth quarter; that at this point as we look out and given the impact that OCI has to capital, until we see where rates settle out as they continue to move around, we continue to be very cautious with the buy ticket. And when we do it, we're investing clearly a little bit shorter than longer at this point, given the risk that OCI has to capital and being mindful of that. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA - Analyst [54] +-------------------------------------------------------------------------------- + + Sure. No, it's tough figuring out the rate environment right now. I'm just revisiting the comment you made. You said expenses should move more directionally with revenues. And if I look at the first nine months, I guess revenues are down but expenses are down more. Do you mean that instead of having positive operating leverage, it might be flat operating leverage looking ahead? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [55] +-------------------------------------------------------------------------------- + + No, I think it's a couple things, Mike. The first is that I want to make sure that we emphasize is that we still have a couple hundred million dollars of expenses to get out in the LAS area between now and the first quarter of 2015. And clearly, $1.1 billion of LAS expenses that we've set to get to in the first quarter of 2015 is not where we would expect to operate on a longer-term basis. And there's additional work that we need to do there. +The second area, just broadly speaking, that we highlighted is that clearly we'd expect, given what litigation has been, that that over time is going to come down. And then the third thing -- and when I said directionally expenses moving with revenues is just if we look at some of the areas, particularly within the wealth management area that we've seen, that there is a component of compensation and incentives that's very clearly tied to revenues, not unlike what you see within the Global Banking and the Global Markets space. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA - Analyst [56] +-------------------------------------------------------------------------------- + + Okay, and then two questions for Brian or perhaps it's for you, Bruce. I know I asked this before, but if rates do not go higher in 2015, what is Bank of America's ROE target? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman & CEO [57] +-------------------------------------------------------------------------------- + + I think if rates don't go higher, what you see in terms of earnings is what we've got to drive through this quarter. So, Mike, when you look at the charts Bruce showed you and I showed you, you can see that the core businesses have earned several billion dollars after-tax this quarter, and the CRES business took it away. And as that comes down, you'll see those earnings flow through. So you can compute the ROE based on that. +But basically we're earning -- you can see on page 18 the net income levels across the businesses each quarter. And our job is to take the commercial real estate business which is -- you see it for the year to date -- take the commercial real estate business which has lost money and get that back to breakeven. And that's the work we'll do. In absence of rate rising, it's not a lot different than it is right now. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA - Analyst [58] +-------------------------------------------------------------------------------- + + And then lastly, just following up on the other question relating to the separation of the CEO and the Chairman role, when you consult with regulators, do they care one way or another if the CEO and Chair position is split? There are several corporate governance experts who say it's better to have those two roles split and others say it doesn't matter. Do you know what the regulator view is on that because you're going from what some consider a preferred corporate governance approach, splitting the CEO and Chair role, to now combining them? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman & CEO [59] +-------------------------------------------------------------------------------- + + I think what they've been clear about in the published documents by the OCC and their heightened standards, their enhanced standards and recently in the Fed, they care about the engagement of the Board and the diversity of the Board and the experience of the Board and we have a good Board and it's experienced and has all the diversity and credible challenge and all the words that are used to describe that. And that's the core of the governance point that they make. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA - Analyst [60] +-------------------------------------------------------------------------------- + + All right. Thank you. + +-------------------------------------------------------------------------------- +Operator [61] +-------------------------------------------------------------------------------- + + Matt O'Connor, Deutsche Bank. + +-------------------------------------------------------------------------------- +Matt O'Connor, Deutsche Bank - Analyst [62] +-------------------------------------------------------------------------------- + + Good morning. If I could just follow up on some of the capital commentary you provided, especially in the deck here. It seems like there's a number of adjustments that were made this quarter and then just right after the quarter, you consolidated the bank subs. There's some increase in operational risk RWA. You commented on OCI, managing to that. Just as we think big picture on managing capital, what's left and is there opportunity to bring down some of the off-balance sheet exposures now that you have more final rules on the SLR? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [63] +-------------------------------------------------------------------------------- + + Sure. I think I would start and just reiterate as we look at capital on a go-forward basis, you basically have three items that are going to affect things. The first is your level of profitability and I just want to reiterate that we would expect once again on a go-forward basis to accrete capital on a pre-tax basis. And the second is the impact that OCI has to those capital ratios. We obviously saw during the quarter rates went up on the mortgage side. I believe it was about 5 basis points during the quarter and there were some security gains as well. That was what led to the change in overall OCI and as I said before, given the environment we're in where rates are down about 30 basis point so far quarter-to-date, that would have a benefit today to capital and we're just mindful of reinvesting so that we don't take on any greater OCI risk on a go-forward basis. +As it relates to what we're looking through and as you look at the overall risk-weighted asset work that's been done, I would say that clearly as we continue to work through the legacy home equity, as well as the first mortgage portfolios that do not benefit from a standby agreement, as we continue to work those assets down, that should enable us to grow the core and still keep risk-weighted assets generally constant. And I think more specific to your point, the other two things are that we continue to look to work through and we have the runoff of some of the structured credit and other portfolios that we're trying to accelerate that come off between now and 2017. +Then the last piece that we continue to work hard on and you saw it in the op risk, that is we updated the models for the time series. You do have the increase to risk-weighted assets and we're working hard to get to where we need to be from that model perspective as we would hope in 2015 if we're successful to go ahead and exit parallel run at that point. + +-------------------------------------------------------------------------------- +Matt O'Connor, Deutsche Bank - Analyst [64] +-------------------------------------------------------------------------------- + + Okay. And then as you think about -- I guess the adjustment on the operational risk RWA side, do you think that's about done or is it an ongoing process until you hopefully exit the parallel run? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [65] +-------------------------------------------------------------------------------- + + I think it's -- obviously as others have noted, it's an ongoing process. I think the important thing is if you compare our operational risk number relative to our peers, we're at roughly 30% and if you do the math against the risk-weighted assets, we're at the if not the top the upper end of where others are from that, but we obviously have work to do to get that finalized to be in a position to exit. + +-------------------------------------------------------------------------------- +Matt O'Connor, Deutsche Bank - Analyst [66] +-------------------------------------------------------------------------------- + + Okay. And then just separately within the C&I lending book, you talked about pricing pressure, as well as some paydowns, but I guess specifically on the pricing pressure, what are you seeing now versus a quarter or two ago when you were still trying to grow or growing the book in terms of not just the magnitude of pricing, but what types of products? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [67] +-------------------------------------------------------------------------------- + + Sure. I would say that the most competitive area that we continue to see is within the commercial banking space of our Global Banking segment, which are those middle-market type companies that tend to be loans that have one or two banks provide all of the credit and clearly the remaining services that go along with servicing those customers tends to go to those that provide the credit. And that's where you've seen the most competition. +I think it is interesting, if you look at and go back to our table on the international side as we've continued to shape the balance sheet and look for return, you've actually seen a step up in the yield in our international lending activity. And within the large corporate space of our Global Banking space, we have seen some stability in yields within that. So I'd really focus -- most importantly it's within the commercial -- the middle-market commercial space where we're seeing the most pressure on yields. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman & CEO [68] +-------------------------------------------------------------------------------- + + So just to add a little color there. Our view was along two dimensions. One, on the international side, we had strong loan growth a couple years ago into last year and now we have to materialize our structured management and other revenue streams under increasing our credit exposure and Tom and the team growing the business. So there was a growth of loans that then has to be a follow-through of growth of transactional revenue, etc. +And on the middle-market, I think the team went for optimization and we are going to continue to stress that they need to be able to manage both the optimization and the growth of the portfolio. So we're pushing on them to get the balance probably back a little bit more in skew than they had in the last couple quarters. + +-------------------------------------------------------------------------------- +Matt O'Connor, Deutsche Bank - Analyst [69] +-------------------------------------------------------------------------------- + + Okay, all right. Thank you very much. + +-------------------------------------------------------------------------------- +Operator [70] +-------------------------------------------------------------------------------- + + Guy Moszkowski, Autonomous Research. + +-------------------------------------------------------------------------------- +Guy Moszkowski, Autonomous Research - Analyst [71] +-------------------------------------------------------------------------------- + + Good morning, this is Guy. A question on, first of all, the optimization that you talked about with respect to commercial deposits around $15 billion and the, I think, roughly $12 billion in securities financing transactions. Should we look at those two things as directly related to each other? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [72] +-------------------------------------------------------------------------------- + + I think they're related to each other, that we think it's prudent balance sheet management, but they're independent actions that are part of prudent balance sheet management. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman & CEO [73] +-------------------------------------------------------------------------------- + + So Guy, I'd say thematically, but not necessarily directly. + +-------------------------------------------------------------------------------- +Guy Moszkowski, Autonomous Research - Analyst [74] +-------------------------------------------------------------------------------- + + Okay, so the $15 billion isn't all essentially prime brokerage-related as well like the asset reduction that you are talking about? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [75] +-------------------------------------------------------------------------------- + + No, it's not. + +-------------------------------------------------------------------------------- +Guy Moszkowski, Autonomous Research - Analyst [76] +-------------------------------------------------------------------------------- + + Okay, that's helpful. Another question is with respect to the provision related to the DOJ settlement. Should we look at this $400 million, which, as you said, offset what would have been an $800 million reserve release, should we look at that as essentially now a one-time true-up and going forward, you now feel that you have the provision that you'll need for multiple years to fulfill the settlement terms or is the settlement going to essentially be a pay-as-you-go thing through the provision? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [77] +-------------------------------------------------------------------------------- + + So to be clear, when we set up the $5 billion reserve or the $5.3 billion hit this quarter, that was to cover cash payments, as well as all expected costs associated with implementing our $7 billion of consumer relief. And the part of it that flows into the provision line item that's $400 million, that is a reserve to take care of the what would have been the P&L impact from the modifications that would happen within the different loans that we're modifying. So on a go-forward basis, assuming that we've got this set up the way that we do, there should not be any future P&L impact from DOJ. The only impact there will be on the balance sheet is you see the reserve number come down as we implement the consumer relief programs. + +-------------------------------------------------------------------------------- +Guy Moszkowski, Autonomous Research - Analyst [78] +-------------------------------------------------------------------------------- + + Got it. That's a very helpful explanation. Thanks. And finally, cyber security issues. Obviously you were not the bank that's been in the crosshairs here and yet I would imagine that this is something that has caused some consternation internally and some spending. JPMorgan has talked about a $250 million budget for cyber security issues, which is expected to double. Can you give us a sense for what you're spending there and how you would expect it to increase? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman & CEO [79] +-------------------------------------------------------------------------------- + + Obviously this is a matter that we take very seriously from the Board engagement, the talents that we have on the Board to help us with this all the way through management. Cathy Bessant and her team in tech and ops and we spend hundreds of million dollars on it a year and it's been growing and we expect it to continue to grow. It's the key to keep our customers and our teammates secure and we continue to work on it. So this is nothing but hard work and we continue to work with both the law enforcement authorities, the various government agencies and among our industry through the various trade groups and formal engagements to try to drive our competencies in industry up. So we're spending a lot of money on it, several hundreds of millions of dollars and we expect that to continue to increase. + +-------------------------------------------------------------------------------- +Guy Moszkowski, Autonomous Research - Analyst [80] +-------------------------------------------------------------------------------- + + Thanks. I actually do have one more if that's all right and it's with respect to the rep and warranty RPL, which in the footnote you say it's the same as it was last quarter at about $4 billion. Can you update us on where you are with any lawsuits related to the non-Countrywide originations, which add up to around $420 billion of UPB? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [81] +-------------------------------------------------------------------------------- + + So if you recall, Guy, what we've done and what we continue to refine each quarter is that as we continue to see rep and warrant claims, there was a reserve set up back in the second quarter of 2011. A piece of it was for Gibbs & Bruns. There was a piece of it that was for bank-issued rep and warrant and then there was a piece that was for third party and we obviously look at those reserves each quarter and adjust those reserves for the activity. In those cases where we have enough activity to have a reserve, we obviously have those and to those areas that are still uncertain, we provide the range of possible loss. As you referenced, the range of possible loss with respect to rep and warrant activity continues to be up to $4 billion. + +-------------------------------------------------------------------------------- +Guy Moszkowski, Autonomous Research - Analyst [82] +-------------------------------------------------------------------------------- + + Okay. So no movement there obviously this quarter? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [83] +-------------------------------------------------------------------------------- + + That's correct. + +-------------------------------------------------------------------------------- +Guy Moszkowski, Autonomous Research - Analyst [84] +-------------------------------------------------------------------------------- + + Thanks very much. + +-------------------------------------------------------------------------------- +Operator [85] +-------------------------------------------------------------------------------- + + Brennan Hawken, UBS. + +-------------------------------------------------------------------------------- +Brennan Hawken, UBS - Analyst [86] +-------------------------------------------------------------------------------- + + Yes, good morning, guys. A quick one on loan growth. So at first glance, it looked kind of weak. It seemed to be driven by Consumer. I just want to make sure I've got the right adjustments here that I think you guys have laid out. In mortgage, $12.5 billion decline sequentially, but should we be backing out the $2.5 billion of NPL sales and then the $6.5 billion of agency conversion from that decline so you know you get kind of like a normalized decline rate sequentially of more like $3.5 billion on the mortgage side? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [87] +-------------------------------------------------------------------------------- + + It's a good question. So the decision to move the $6.5 billion from loan to security form was based on LCR. It doesn't change the fact that when you move that that you still have the asset on the balance sheet. So I think that $6.5 billion is a fair adjustment to make and I would agree that the $2.5 billion where we sold the non-performing loans and quite frankly there's not much left there to attack is a fair adjustment, which gets you to the $9 billion. +The other thing when you look at those loans that I do think is important is that, on the home equity side, with those legacy home equity portfolios, which we want to get repaid, that repayments within those were roughly $3.5 billion, which were greater than the funded amount that came on from a new home equity origination perspective. So I come back to that, within those more discretionary portfolios, what's happening there is what we want to happen there, that they're repaying and we're converting them to more liquid instruments. And I think as we look at actual business activity and how we're doing, we'd focus you back within the segments and as we talked about within the Consumer business where average loans were up a little bit linked quarter on a card basis where we saw very strong continued growth within the home equity space, go back to the Wealth Management area where loans reached a record level and then I think we've already addressed the work that we need to do on the commercial front. + +-------------------------------------------------------------------------------- +Brennan Hawken, UBS - Analyst [88] +-------------------------------------------------------------------------------- + + Sure, sure. And maybe if you could, is it possible to give us an idea about the runoff portfolio, what's left in that at this stage and what your guys' expectations are for like a runoff headwind just so we can think about it for modeling purposes? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [89] +-------------------------------------------------------------------------------- + + Sure. I think I would look at, as you go forward given that we're not buying whole loans from third parties, that you're probably looking at a high single digit continued reduction for the next couple quarters with respect to whole loans that we hold for others. The second thing I'd say that you have is you've got roughly $3 billion a quarter in home equity payoffs, a portion of which will be mitigated by new originations, but you are looking at roughly $3 billion there. And then you have some other less than $1 billion type items, but I think it's fair to say that, as you go forward, outside of what we think is core, you're probably looking at in the Consumer businesses in the ZIP Code of $10 billion to $12 billion that will go away. We will either have the ability to reinvest and make new loans or otherwise reinvest. + +-------------------------------------------------------------------------------- +Brennan Hawken, UBS - Analyst [90] +-------------------------------------------------------------------------------- + + Okay. And that's on a quarterly headwind basis? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [91] +-------------------------------------------------------------------------------- + + Correct. + +-------------------------------------------------------------------------------- +Brennan Hawken, UBS - Analyst [92] +-------------------------------------------------------------------------------- + + Okay, terrific. And then thinking about Wealth Management, could you break down the expansion in the margins there this quarter? How much of it came from reduced spending? I know you guys have been investing there and so maybe could you help us understand how much of a contributing factor that was here this quarter and how much investment is left to wind down here? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [93] +-------------------------------------------------------------------------------- + + I'm sorry, when you referenced margin, margin in what area? + +-------------------------------------------------------------------------------- +Brennan Hawken, UBS - Analyst [94] +-------------------------------------------------------------------------------- + + Sorry, Wealth Management pre-tax. + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [95] +-------------------------------------------------------------------------------- + + Yes, if you look at it and you go through the different areas, you tend to have 40% type payouts with respect to the revenue piece. So when you look at the margin improvement of a couple hundred basis points, I would put it more in the context of just good core expense management. I do think there was a little bit less litigation within the quarter that benefited us, but it tends to be just across the board, whether it be a little bit lower support cost, a little bit lower licensing fee number, a little bit less litigation. There was no one number that was particularly dominant in driving the margin. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman & CEO [96] +-------------------------------------------------------------------------------- + + And last quarter, we had some startup costs for the Merrill One product that you can see has had strong success in terms of AUM. So that was sort of in the second-quarter technology expense and stuff to roll that out, but it comes back off [too]. + +-------------------------------------------------------------------------------- +Brennan Hawken, UBS - Analyst [97] +-------------------------------------------------------------------------------- + + Yes, so that technology spend also rolled off too, which probably helped, right? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman & CEO [98] +-------------------------------------------------------------------------------- + + Yes, exactly. If we remember last quarter when we talked about it, they had a decline. It was because some of the stuff was going in and this quarter, you saw it revert back to more where they had pretty consistently been over the last many quarters. + +-------------------------------------------------------------------------------- +Brennan Hawken, UBS - Analyst [99] +-------------------------------------------------------------------------------- + + Cool, cool. All right, I seem to remember that being somewhere in the ballpark of like $50 million to $100 million, is that right? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman & CEO [100] +-------------------------------------------------------------------------------- + + I think it was a little -- it was all in that much, but whether it was all in that one quarter or not, I don't remember. + +-------------------------------------------------------------------------------- +Brennan Hawken, UBS - Analyst [101] +-------------------------------------------------------------------------------- + + Okay, so a decline from that might be less so? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman & CEO [102] +-------------------------------------------------------------------------------- + + Yes. + +-------------------------------------------------------------------------------- +Brennan Hawken, UBS - Analyst [103] +-------------------------------------------------------------------------------- + + Cool. And then last one, I know you guys had talked about here the repositioning that you guys want to take as far as AOCI risk and such. When we think about the AOCI hit that you guys lay out versus other money centers and the interest rate shock, it's a little bit higher than where some of the other folks are. So hoping to maybe get a little bit of color on where the current duration is, where you expect the duration to go based upon the actions that you take and then maybe help us also square the circle of understanding, the larger AOCI hit and whether that's a result of a barbelling with the portfolio or what. + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [104] +-------------------------------------------------------------------------------- + + Sure. The first thing, I just want to clear up that there's, in the quarter, the only comment with respect to the quarter that we're referencing is just some caution on the buy ticket given where interest rates are at this point during the quarter. I think if you go back and you look at over the last couple quarters, it's been a very consistent message in that we've said we're going to direct more of the buy ticket to shorter-dated treasuries and you can see that there's been a buildup of those treasuries over the course of the last three to four quarters. So this quarter was a continuation of that and we were just calling out a note of caution given the rate environment. +I think as it relates to overall OCI sensitivity, if you look at what we've typically said is, in a 100 basis point parallel move up in rates, how long does it take back or take to earn back that OCI. Said consistently, it has been around three years. It peaked at about 3.5 years and at the end of September, it would have been less than three years. So we have on a consistent trend line continued to look to move down the overall OCI risk as it presents itself to capital. + +-------------------------------------------------------------------------------- +Brennan Hawken, UBS - Analyst [105] +-------------------------------------------------------------------------------- + + Okay. So is it right then to assume the duration on the AFS portfolio is a little under three years or is that not a correct inference? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [106] +-------------------------------------------------------------------------------- + + No, that's the period of time that it takes to earn it back. You're looking at the overall -- I think the overall duration it is going to be in the five plus years. + +-------------------------------------------------------------------------------- +Brennan Hawken, UBS - Analyst [107] +-------------------------------------------------------------------------------- + + Okay, thanks a lot. + +-------------------------------------------------------------------------------- +Operator [108] +-------------------------------------------------------------------------------- + + Ken Usdin, Jefferies. + +-------------------------------------------------------------------------------- +Ken Usdin, Jefferies & Co. - Analyst [109] +-------------------------------------------------------------------------------- + + Hi, thanks. Just a question just on the trading business. Obviously you guys and the other companies did well amidst the volatility in September and I'm just wondering with regard to the balance sheet changes you guys have been making and the optimization of RWAs and given what's happening in the environment right now, any changes in terms of how Tom's running that business as far as being able to capture the revenue opportunity out there or any inhibition given by your views around risk-taking and these capital balance sheet changes that you guys have talked about today? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman & CEO [110] +-------------------------------------------------------------------------------- + + I'd refer you to page 21 in the appendix in the lower left-hand corner and you can see this is the third quarter of 2012, 2013 and 2014 laid out side-by-side. And so I don't think this is a change in position if you look at it. The average trading-related assets of 460 to 440, the VAR is $55 million and $56 million, $50 million and you can see the revenues. What Tom and the team have done a good job is building a relatively stable -- this business is going to fluctuate in the market, but a relatively stable core amount of activity comes through this. And if you look at it over several quarters with the exception of seasonality in the first quarter that typically occurs each year, but we laid this out for you. The second quarter of 2012, 2013, 2014 last quarter, the third quarter, you see it's a relatively consistent $3 billion revenue type of number and we've maintained that. +So the adjustments we've made in the business on expenses, the scope of activities and stuff we actually made in 2010 and 2011 to bring the business in line, so we're very comfortable with where they are now. They are always moving around and paring risk and continuing to manage carefully the overall returns of the business. It's relative size to our Company. We think we've gotten a good place; we've simplified it. And so there's no change in strategy here and in fact, you can see there's a fairly consistent result from that activity. What's different this quarter versus last quarter obviously without the UK tax thing, you're seeing the bottom line come through to the third quarter, but we made $700 million odd after-tax and that's good performance. + +-------------------------------------------------------------------------------- +Ken Usdin, Jefferies & Co. - Analyst [111] +-------------------------------------------------------------------------------- + + Thanks, Brian. And to follow just on the mortgage business, the servicing line has continued to just trickle out. I'm just wondering have we seen the bottoming of the former sales and the related revenues moving away from that. + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [112] +-------------------------------------------------------------------------------- + + I think if you look at the servicing revenue, as I said, the biggest reason for the decline was the adjustment in the cost to serve. If you saw the actual servicing fee line that came through linked quarter, it was only down about $25 million on a linked-quarter basis. So what you're going to see on a go-forward basis is not so much the impact on the sale of MSRs, but just the servicing revenue that's derived based on the size of the MSR asset. So given that there aren't any more large-scale sales of that MSR, you're going to see that more vary on a core basis as opposed to a step function. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman & CEO [113] +-------------------------------------------------------------------------------- + + And the big advantage you'll see is that the number of 60 plus delinquents continues to normalize now and we have to continue to push that. That's where we think that we get the additional expense leverage in LAS going forward. And so it's $100 million this quarter and a couple hundred million dollars quarter four. It's just grinding through and working those loans for the customers and modifying or short-selling and going through foreclosure. So that number is still elevated as a percentage. You can see it. And if you look at our delinquency off of the things we produce really since after the crisis, the numbers are much smaller and imply a delinquency level ultimately of half that amount that you see now. So that's where the real work will come in unit reduction. The overall 3.9 million units was fluctuating around a little bit, but we're kind of getting to equilibrium where our production is nearly what runs off absent sales in the 60 plus bucket. + +-------------------------------------------------------------------------------- +Ken Usdin, Jefferies & Co. - Analyst [114] +-------------------------------------------------------------------------------- + + And my last follow-up just on that point, you had talked about $1.1 billion by 1Q 2015. You had previously talked about getting it down to about $500 million a year out from that. Is that still a reasonable expectation given that backdrop you just laid out? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [115] +-------------------------------------------------------------------------------- + + I think the first thing that we're focused on is getting it down to $1.1 billion and then longer term I think if you look at any metric with where we would see from a number of loans serviced, as well as the number of delinquent loans in the portfolio, we still have some significant work to do to drive that $1.1 billion down because given the size of the portfolio, it's way too high. + +-------------------------------------------------------------------------------- +Ken Usdin, Jefferies & Co. - Analyst [116] +-------------------------------------------------------------------------------- + + Okay, thanks, guys. + +-------------------------------------------------------------------------------- +Operator [117] +-------------------------------------------------------------------------------- + + Paul Miller, FBR Capital Markets. + +-------------------------------------------------------------------------------- +Paul Miller, FBR Capital Markets - Analyst [118] +-------------------------------------------------------------------------------- + + Yes, I just wanted to follow up on that. You talk about 60 day delinquent loans down 42,000 to 221,000. I don't think there's any sales of that. Is that just working through the portfolio and that seems like a very high pace? Can we expect that type of pace or what type of pace of loans do you think you can work out on a quarterly or annualized basis? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [119] +-------------------------------------------------------------------------------- + + Yes, there were some servicing transfers during the quarter. My recollection is it was between 20,000 and 25,000 units that were actually transferred during the quarter. So it was a very good quarter for us as far as MSR sales and driving that number down. But I think you're right that, on a go-forward basis, it's not going to be at that level. Although we do think we will make some significant progress between now and the end of 2015. + +-------------------------------------------------------------------------------- +Paul Miller, FBR Capital Markets - Analyst [120] +-------------------------------------------------------------------------------- + + Outside of the servicing trends, it was 20,000 to 25,000, so it was down roughly about 15,000 give or take, give or take 1,000 loans. Is that a pace that we could model going forward? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [121] +-------------------------------------------------------------------------------- + + There are obviously a lot of factors that can go into that that are going to have it [bump] around, but I don't think -- if you believe that with what we're seeing from the quality of the portfolio and you believe the foreclosure process continues along the same trend, you're probably looking at plus/minus 20,000 units a quarter on an organic basis, on a net basis. + +-------------------------------------------------------------------------------- +Paul Miller, FBR Capital Markets - Analyst [122] +-------------------------------------------------------------------------------- + + Okay. And then relative to the big Department of Justice settlement, where do you think you are on legal costs? I know it's hard to sit there and say, but we've seen a couple other competitors get the Department of Justice behind them, but there still tends to be this nagging $1 billion here and there in legal costs that just won't go away. Where do you think we are -- is Bank of America, since they've paid probably the most out than anybody, are you more through that than most other people? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman & CEO [123] +-------------------------------------------------------------------------------- + + Well, some of that stuff that people experience are pieces that we have already taken care of in prior quarters and some of it relates to completely different -- as it relates to mortgage matters, some relates to other matters. We will always have litigation expense in this Company, but in terms of the mortgage, we've talked to you in many quarters, but if you think just the last three quarters, three major pieces fell behind it and we're still waiting for the ultimate approval of the Gibbs & Bruns settlement. 95% of the RMBS by principal amount, we had settlements and settlements at this point are awaiting final approval. So a lot of the pieces we had settled up, FHA and things like that, along the way. So we've got -- in the monolines, four out of the five are settled, so we've been picking away at them. So without knowing all the ins and outs of the other competitors, from our standpoint, a lot of the smaller stuff was getting done as a lot of you focused on the larger things. A lot of the smaller stuff was coming in and out every quarter underneath that and we should see less of that going forward. + +-------------------------------------------------------------------------------- +Paul Miller, FBR Capital Markets - Analyst [124] +-------------------------------------------------------------------------------- + + Okay, hey, guys, thank you very much. + +-------------------------------------------------------------------------------- +Operator [125] +-------------------------------------------------------------------------------- + + Matthew Burnell, Wells Fargo. + +-------------------------------------------------------------------------------- +Matthew Burnell, Wells Fargo Securities - Analyst [126] +-------------------------------------------------------------------------------- + + Hi, Brian. Thanks for taking my question. I guess just a question in terms of the investment banking product rankings on page 32. Obviously most of the numbers are in the top three, particularly in the more important category. I guess just looking at the global rankings in terms of some of the numbers that aren't in the top three, are there further investments you all plan to make in that business that would have any effect on the operating expense ratios in Global Banking or is that pretty much steady-state in terms of the investments you all are putting into those businesses? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman & CEO [127] +-------------------------------------------------------------------------------- + + I think as a broad construct and I think you're asking more the strategic level, Christian Meissner and the team with Tom have done a good job of adding people in the markets where we needed to build our capabilities and while we're always looking to add more and more talent and more and more capabilities, I don't think there is any huge change in expenses or numbers. It's more of continuously upgrading our talent and adding incremental talent. But in the grand scheme of things, it's a pretty small expense base in the context of our Company with the level of expenses. +But you're point is exactly right. The global -- the US competitive franchise is obviously demonstrably stronger as you can see in the US rankings versus the global. The global has picked up honestly and as activity picked up in Europe and in Asia, we continue to drive forward. But we still are working hard to improve our positioning and across the board, but we've made a lot of the investments already. + +-------------------------------------------------------------------------------- +Matthew Burnell, Wells Fargo Securities - Analyst [128] +-------------------------------------------------------------------------------- + + And then if I could just ask a follow-up on the non-US commercial loans, a couple of competitors have mentioned that there's been some weakness in trade finance lending. And I'm just curious how much, if any, that has affected the loan growth within the non-US commercial side of the balance sheet? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [129] +-------------------------------------------------------------------------------- + + It has. It's affected it in two ways. So when you look at the declines that we saw within the loans outside of the US, a chunk of that decline was a decline in trade finance, but I think what's also notable is that trade finance tends to have the lowest spreads. So when you look at the yields within the international loan portfolio, they're up and that's because you've got more corporate type loans that have higher spreads than trade finance, which tends to have lower spreads. + +-------------------------------------------------------------------------------- +Matthew Burnell, Wells Fargo Securities - Analyst [130] +-------------------------------------------------------------------------------- + + Thanks very much, Bruce. + +-------------------------------------------------------------------------------- +Operator [131] +-------------------------------------------------------------------------------- + + Chris Kotowski, Oppenheimer. + +-------------------------------------------------------------------------------- +Chris Kotowski, Oppenheimer & Co. - Analyst [132] +-------------------------------------------------------------------------------- + + Mine were asked and answered. Thank you. + +-------------------------------------------------------------------------------- +Operator [133] +-------------------------------------------------------------------------------- + + Steven Chubak, Nomura. + +-------------------------------------------------------------------------------- +Steven Chubak, Nomura Asset Management - Analyst [134] +-------------------------------------------------------------------------------- + + Hi, good morning. Bruce, first question regards capital and profitability targets. I know at a recent investor conference you alluded to the fact that you believe that CCAR currently represents the binding capital constrained for the bank, which just presumably you'll need to manage to a higher core Tier 1, which I guess from my perspective could put at risk the 14% ROE T goal that you guys had established in the early part of this year and I suppose it's really a two-parter. First, what core Tier 1 target do you believe you'll need to manage over the cycle and then as a follow-up to that, how does that inform your outlook for meeting that goal? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [135] +-------------------------------------------------------------------------------- + + Well, a couple things. I go back to the first comment, which is that you have to break out a little bit what's going to happen for our Company over the next five quarters between the growth in tangible common equity versus the growth in regulatory capital that flows into the capital ratio because, as I said before, over the next five quarters, we will accrete capital on a pre-tax basis absent any other changes. That's the first thing I'd keep in mind. +The second thing is that as we look out, we do believe at this point that CCAR is the governor and we're obviously getting ready to go into the 2015 CCAR process and without instructions or assumptions or scenarios, I think it's premature to look at that. +The third thing is, as you look at return targets, and Mike touched on this a little bit in his earlier question, I think the thing that, as we look to getting to those 12%, 14% type targets, the thing I would encourage you to do because I do think that you start to get a bridge to that is if you take the earnings that we announced today and normalize them for the things that I touched on in my comments, you tend to be starting at a point that's in the 10% plus type return during the quarter from a tangible common equity perspective. And you've got really four things that are going to change that on a go-forward basis -- the continued reduction within our LAS expenses. We would expect obviously longer-term litigation expenses to go down. You have the benefit of rates and then you've got what we do within the core businesses. +So those are the four things that we're focused on and the last point I would say as it relates to just CCAR, we feel like getting ready for CCAR during this quarter and quite frankly throughout the year that we've made a lot of work between moving out of the Company those assets that tend to have high loss content in stress. We've augmented our CET1 ratios as we've gone forward and we think we've taken a lot of tail risk out. +So long-winded way of saying you can look at the bridge to more normalized returns. When you adjust what we saw this quarter, we feel very good about the progress that we've made as we prepare for CCAR. We'll look to see what the instructions are and we'll have to see if our assumption about that being the governor given the evolving regulatory landscape continues to be the case or if we need to update that assessment. + +-------------------------------------------------------------------------------- +Steven Chubak, Nomura Asset Management - Analyst [136] +-------------------------------------------------------------------------------- + + All right. Thanks for that, Bruce. That's really helpful. And then just switching gears to the liquidity side of the equation, one measure which hasn't garnered very much attention is the net stable funding ratio. And my understanding is that Basel's at least intended goal was to have the NSFR calibration completed by the end of this year. And I was hoping you could disclose where you currently stand on this metric. + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [137] +-------------------------------------------------------------------------------- + + So we do not have an exact number to disclose at this point. What I would say is we have worked through and we've done the work to get to where we need to be from an LCR perspective, that at this point there's not anything that gives us any concern that we're going to have to change in any material way what we're doing to satisfy NSFR. + +-------------------------------------------------------------------------------- +Steven Chubak, Nomura Asset Management - Analyst [138] +-------------------------------------------------------------------------------- + + All right, thanks. And maybe just one more quick modeling question. I was hoping you could clarify given all the preferred issuance that's been done, assuming nothing incremental is completed going forward in terms of issuance, what the preferred coupon should be on an annualized basis next year. + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [139] +-------------------------------------------------------------------------------- + + I've got an exact number for you. Bear with me one second. You should see during next year a preferred number of 1262. + +-------------------------------------------------------------------------------- +Steven Chubak, Nomura Asset Management - Analyst [140] +-------------------------------------------------------------------------------- + + All right, perfect. That's it for me. Thanks for taking my questions. + +-------------------------------------------------------------------------------- +Operator [141] +-------------------------------------------------------------------------------- + + And there are no further questions at this time. + +-------------------------------------------------------------------------------- +Lee McEntire, Bank of America Corporation - IR [142] +-------------------------------------------------------------------------------- + + Thank you, everyone. Look forward to seeing you next quarter. + +-------------------------------------------------------------------------------- +Operator [143] +-------------------------------------------------------------------------------- + + This does conclude today's conference. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/exam/original-files/Problem_1_Sample/2014-Oct-23-AMZN.OQ-140669099674-Transcript.txt b/exam/original-files/Problem_1_Sample/2014-Oct-23-AMZN.OQ-140669099674-Transcript.txt new file mode 100644 index 0000000..20a5b03 --- /dev/null +++ b/exam/original-files/Problem_1_Sample/2014-Oct-23-AMZN.OQ-140669099674-Transcript.txt @@ -0,0 +1,612 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q3 2014 Amazon.com Inc Earnings Call +10/23/2014 05:00 PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Tom Szkutak + Amazon.com, Inc. - SVP and CFO + * Phil Hardin + Amazon.com, Inc. - Director of IR + +================================================================================ +Conference Call Participiants +================================================================================ + + * Scott Devitt + Stifel Nicolaus - Analyst + * Ben Schachter + Macquarie Research - Analyst + * Justin Post + BofA Merrill Lynch - Analyst + * Ron Josey + JMP Securities - Analyst + * Brian Pitz + Jefferies & Company - Analyst + * John Blackledge + Cowen and Company - Analyst + * Heath Terry + Goldman Sachs - Analyst + * Eric Sheridan + UBS - Analyst + * Colin Sebastian + Robert W. Baird & Company, Inc. - Analyst + * Mark Mahaney + RBC Capital Markets - Analyst + * Aram Rubinson + Wolfe Research - Analyst + * Matt Nemer + Wells Fargo Securities, LLC - Analyst + * Aaron Kessler + Raymond James & Associates, Inc. - Analyst + * Brian Nowak + Susquehanna International Group - Analyst + * Carlos Kirjner + Sanford C. Bernstein & Company, Inc. - Analyst + * Colin Gillis + BGC Partners - Analyst + +================================================================================ +Presentation +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Thank you for standing by. Good day, everyone. Welcome to the Amazon.com Q3 2014 financial results teleconference. +(Operator Instructions) +Today's call is being recorded. For opening remarks I will be turning the call over to the Director of Investor Relations, Phil Hardin. Please go ahead. + +-------------------------------------------------------------------------------- +Phil Hardin, Amazon.com, Inc. - Director of IR [2] +-------------------------------------------------------------------------------- + + Hello and welcome to our Q3 2014 financial results conference call. Joining us today is Tom Szkutak, our CFO. We will be available for questions after our prepared remarks. The following discussion and responses to your questions reflects management's views as of today, October 23, 2014 only, and will include forward-looking statements. Actual results may differ materially. Additional information about factor that could potentially impact our financial results is included in today's press release and our filings with the SEC, including our most recent annual report on Form 10-K. +As you listen to today's conference call, we encourage you to have our press release in front of you, which includes our financial results as well as metrics and commentary on the quarter. During this call we will discuss certain non-GAAP financial measures, and our press releases, slides accompanying this website, and our filings with the SEC, each of which is posted on our IR website. You will find additional disclosures regarding these non-GAAP measures, including reconciliations of these measures with comparable GAAP measures. +Finally, unless otherwise stated, all comparisons in this call will be against our results for the comparable period of 2013. Now I'll turn the call over to Tom. + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com, Inc. - SVP and CFO [3] +-------------------------------------------------------------------------------- + + Thanks, Phil. I'll begin with comments on our third-quarter financial results. Trailing 12-month operating cash flow increased 15% to $5.71 billion. Trailing 12-month free cash flow increased to $1.08 billion. Trailing 12-month capital expenditures were $4.63 billion. +The increase in capital expenditures reflects additional investments in support of continued business growth due to investments in technology infrastructure, including Amazon Web Services, and additional capacity to support our fulfillment operations. Return on invested capital was 6%, up from 3%. +ROIC is trailing 12-month free cash flow divided by average total assets minus current liabilities excluding the current portion of long-term debt over five quarter ends. The combination of common stock and stock-based awards outstanding was 481 million shares compared with 475 million one year ago. +World-wide revenue grew 20% to $20.58 billion, or 20% excluding the $13 million favorable impact from year-over-year changes in foreign exchange. Media revenue increased to $5.24 billion, up 4%, or 4% excluding exchange. +EGM revenue increased to $13.95 billion, up 26%, or 26% excluding foreign exchange. Worldwide EGM increased to 68% of world-wide sales, up from 65%. World-wide paid unit growth was 21%, active customer accounts was approximately 260 million, world-wide active seller accounts were more than 2 million, seller units represented 42% of paid units. +Now I'll discuss operating expenses excluding stock-based compensation. Cost of sales was $14.63 billion or 71.1% of revenue compared with 72.3%. Fulfillment, marketing, tech and content and G&A combined was $6.09 billion, or 29.6% of sales, up approximately 350 basis points year over year. Fulfillment was $2.55 billion or 12.4% of revenue compared with 11.5%. Tech and content was $2.22 billion or 10.8% of revenue compared with 9.2%. Marketing was $961 million or 4.7% of revenue compared with 3.9%. +Now I'll talk about our segment results. And consistent with prior periods we do not allocate to segments our stock-based compensation or other operating expense line items. +In the North America segment revenue grew 25% to $12.87 billion. Media revenue grew 5% to $2.73 billion. EGM revenue grew 31% to $8.79 billion, representing 68% of North America revenues, up from 65%. Other revenue grew 40% to $1.34 billion. +North America segment operating income decreased 70% to $88 million, a 0.7% operating margin. In the international segment revenue grew 14% to $7.71 billion. Excluding the $21 million year-over-year favorable foreign exchange impact revenue growth was 13%. +Media revenue grew 4% to $2.51 billion or 3% excluding foreign exchange. And EGM revenue grew 20% to $5.16 billion or 19% excluding foreign exchange. EGM now represents 67% of international revenues, up from 64%. +International segment operating loss was $224 million compared to international segment operating loss of $28 million in the prior period. Consolidated segment operating loss was $136 million compared to consolidated segment operating income of $267 million in the prior period. Consolidated segment operating loss includes charges of approximately $170 million primarily related to the Fire Phone inventory evaluation and supplier commitment costs. +Unlike CSOI, GAAP operating income or loss includes stock-based compensation expense and other operating expense. GAAP operating loss was $544 million compared to operating loss of $25 million in the prior period. +Our income tax benefit was $205 million. GAAP net loss was $437 million or $0.95 per diluted share compared with a net loss of $41 million and $0.09 per diluted share. +Turning to the balance sheet, cash and marketable securities decreased $806 million year over year to $6.88 billion. Inventory increased 21% to $7.32 billion. And inventory turns were 8.9, down from 9.2 turns a year ago as we expanded selection, improved in-stock levels, and introduced new product categories. Accounts payable increased 18% to $11.81 billion. And accounts payable days decreased to 74 from 75 in the prior year. +I'll conclude my portion of today's call with guidance. Incorporated into our guidance are the order trends that we've seen to date and what we believe today to be appropriately conservative assumptions. Our results are inherently unpredictable and may be materially affected by many factors, including a high level of uncertainty surrounding exchange rate fluctuations, as well as the global economy and consumer spending. +It's not possible to accurately predict demand and therefore our actual results could differ materially from our guidance. As we describe in more detail in our public filings, issues such as settling inter-company balances and foreign currencies amongst our subsidiaries, unfavorable resolution of legal matters, and changes to our effective tax rates can all have a material effect on guidance. +Our guidance further assumes that we don't conclude any additional business acquisitions, investments, restructurings or legal settlements; record any further revisions to stock-based compensation estimates; and that foreign exchange rates remain approximately where they've been recently. +For Q4 2014, we expect net sales of between $27.3 billion and $30.3 billion, a growth between 7% and 18%. This guidance anticipates approximately 250 basis points of unfavorable impact from foreign exchange rates. GAAP operating income or loss to be between a $570 million loss and $430 million income compared to $510 million of income in the fourth quarter of 2013. This includes approximately $470 million for stock-based compensation and amortization of intangible assets. We anticipate consolidated segment operating income or loss, which excludes stock-based compensation expense and other operating expense, to be between $100 million loss and $900 million in income compared to $876 million in income in fourth-quarter 2013. +We remain heads-down focused on driving a better customer experience through price, selection and convenience. We believe putting customers first is the only reliable way to create lasting value for shareowners. Thanks. And with that, Phil, let's move to questions. + +-------------------------------------------------------------------------------- +Phil Hardin, Amazon.com, Inc. - Director of IR [4] +-------------------------------------------------------------------------------- + + Great, thanks, Tom. Let's move on to the Q&A portion of the call. Operator, will you please remind our listeners how to initiate a question. + + +================================================================================ +Questions and Answers +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) +Thank you. Our first question comes from analyst Brian Pitz with Jefferies & Company. + +-------------------------------------------------------------------------------- +Brian Pitz, Jefferies & Company - Analyst [2] +-------------------------------------------------------------------------------- + + Great, thanks. Two quick questions. Can you provide any color on the consumer over this year's back-to-school season? And how do you view the outlook for the consumer as we head into the holidays? +And then, separately, you recently closed the acquisition of Twitch last month. Can you help us understand where does Twitch fit into your overall digital content strategy? Thanks. + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com, Inc. - SVP and CFO [3] +-------------------------------------------------------------------------------- + + Sure. In terms of back-to-school, certainly the results are reflected in the Q3 results that you see today. There's a number of different impacts back-to-school has. One thing I would like to call out, as you look at our North American media growth rates, one thing that we are seeing is certainly a shift from a textbook standpoint from purchase to rental. And, so, we see a lot more customers renting, so you see that impacting the growth rate a bit in North America media. +But in terms of Q4, as in any Q4 when we look at it, there's a wide range of outcomes with giving a wide range of guidance. What we feel good about is we have a team that's been improving customer experience over the past 12 months. We're very excited to serve customers. We've had a lot of unique selection. We've got an inventory closer to customers, many different things we're doing on behalf of customers. We're very excited about the holiday season and look forward to serving customers. +In terms of Twitch, we're very excited to have Twitch as part of our overall team. We've been in video games for quite some time and we think that it's a very creative team. They're doing some very innovative things on behalf of their customers and our customers. And, so, we're excited to have them be part of Amazon, and look forward to working together with that team. + +-------------------------------------------------------------------------------- +Brian Pitz, Jefferies & Company - Analyst [4] +-------------------------------------------------------------------------------- + + Great, thanks. + +-------------------------------------------------------------------------------- +Operator [5] +-------------------------------------------------------------------------------- + + Thank you. Our next question will come from Carlos Kirjner, analyst, with Bernstein. + +-------------------------------------------------------------------------------- +Carlos Kirjner, Sanford C. Bernstein & Company, Inc. - Analyst [6] +-------------------------------------------------------------------------------- + + Thank you for taking my question. Two, if I may. International CSOI margin this quarter were the lowest they have been in years, maybe ever I don't know. We know you have been investing internationally but has something changed fundamentally? And if yes, what. +Secondly, I wanted to ask you about a vast difference in revenue growth rate between your international and domestic business. What is the fundamental difference between the US and your main international markets? And is this difference fundamental or temporary? Thank you. + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com, Inc. - SVP and CFO [7] +-------------------------------------------------------------------------------- + + Thanks for the questions. In terms of the consolidated segment or the segment operating for international, certainly versus what you would have seen last quarter, some notable changes. One is we're certainly getting ready for the holiday season. So, as we get ready for the holiday season, we are expanding from a capacity standpoint. +We do see we've gotten great penetration in Fulfilled by Amazon customers. So you'll see that actually our growth rate, our unit growth rate, is actually higher than our revenue growth rate. That's what we've been experiencing. So, certainly adding capacity from a fulfillment perspective, adding capacity from a infrastructure standpoint. +If you look at our overall operating expenses, we're certainly investing. With the slower growth rate, you're certainly not seeing as much leverage. We understand that we do have to get leverage over time, but we are investing right now. We're also investing in newer emerging geographies including India and Italy and Spain, and continue to invest in China. +And then one other call out. We had mentioned in my opening remarks there was approximately $170 million impact related to inventory evaluations and supplier commitment costs. The vast majority of that was in North America, but there was about $25 million in international, just to let you know that's there. +In terms of the growth rates, it has been softer across a number of geographies. If you look back over the past, really, four quarters, we've seen a little bit of volatility between the quarters, but it's been softer. We continue to focus on the inputs. We still think international is a very big opportunity for us in terms of growth. +More recently, if you look at the growth rate for Q3 and you see the 13% excluding foreign exchange, you may remember on the last call about 90 days ago I talked about Q2. What had happened was, in late Q1 we had seen a ramp up in Japan before the consumption tax increase happened on April 1. We saw a pretty sizeable drop off in Japan growth rates from Q1 to Q2, which brought that down. +The only update -- again, there's a number of different puts and takes in geographies -- but the only other comment I would say is that we really haven't seen Japan growth rates improving since Q2. So, that's something that's there. +But in terms of the fundamentals, long term we're very excited about international, as well as North America. We think that it's a big opportunity. We continue to focus on the inputs. Some of those inputs are certainly on the media side working on the conversion from physical media to digital media. We continue to work on that in a number of different ways. We continue to add new selection in those geographies and work on the retail basics. And so, again, we're very excited about the opportunity. + +-------------------------------------------------------------------------------- +Carlos Kirjner, Sanford C. Bernstein & Company, Inc. - Analyst [8] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Operator [9] +-------------------------------------------------------------------------------- + + Our next call will come from analyst Scott Devitt with Stifel. + +-------------------------------------------------------------------------------- +Scott Devitt, Stifel Nicolaus - Analyst [10] +-------------------------------------------------------------------------------- + + Hi, Tom. Thanks. I had a question just broadly. A lot of the capital that's been deployed in terms of planting seeds in new businesses have worked out very well. But given what's happening right now in terms of the deterioration in the margin structure as growth is slowing, I'm just wondering, I think a lot of investors have this question as well in terms of when things don't go as anticipated in some of the bigger projects where there's not a revenue stream, areas maybe like some of the hardware projects and China and other markets, what's the process for determining whether to plow ahead or turn back capital and redeploy it in other areas? Thanks. + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com, Inc. - SVP and CFO [11] +-------------------------------------------------------------------------------- + + Thanks for the question, Scott. With anything new that we do, and obviously we've done, as you mentioned we've done a lot of new things, there's certainly a wide range of outcome. And we certainly understand that. We try to learn from everything that we do as we launch new opportunities. That's something across things that go great and things that don't go as well as others. We try to learn from that. +And, so, the way that I would describe it is, from a looking-forward standpoint, we still think that we have a lot of opportunities. That said, we need to be very selective about what opportunities we pursue. So, that's, again, the way we're thinking about it. Probably not much more I can add to it than that. + +-------------------------------------------------------------------------------- +Scott Devitt, Stifel Nicolaus - Analyst [12] +-------------------------------------------------------------------------------- + + Okay, thank you. + +-------------------------------------------------------------------------------- +Operator [13] +-------------------------------------------------------------------------------- + + We'll continue on to analyst Mark Mahaney with RBC Capital Markets. + +-------------------------------------------------------------------------------- +Mark Mahaney, RBC Capital Markets - Analyst [14] +-------------------------------------------------------------------------------- + + Two questions, please. That $170 million in charges related to the Fire Phone, where was that put in the P&L, which of the OpEx lines, or was it a COGS? And then, secondly, in the media side you talked about maybe seeing a negative impact, or definitely seeing a negative impact from the switch towards owning to renting. Do you think that's a broader trend just beyond textbooks that affects all media retailers including Amazon? Could that be one of the issues behind the slow media growth in international markets? And if so, is there really a solution to that other than your own rental models? Thank you. + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com, Inc. - SVP and CFO [15] +-------------------------------------------------------------------------------- + + Sure. In terms of the first question, the $170 million, it's predominantly in COGS. The very vast majority is in COGS. And then in terms of the split about $25 million of that is in international and the remainder is in North America. +In terms of the growth, we certainly are seeing that in textbooks. We do see in other digital media, we're certainly seeing rentals being part for our portfolio, more than we had probably during certainly with physical. But in terms of some of the recent growth rates the one that I called out related to book rentals is certainly impacting North America media. +One of the other things that's really impacting it, too, is we just had some things last year Q3 that were overlapping, that were paused in Q3 last year from a demand standpoint. One was, certainly, in physical books we had very heavy discounting, which helped our growth in Q3 last year. We're overlapping that in Q3 this year. + +-------------------------------------------------------------------------------- +Mark Mahaney, RBC Capital Markets - Analyst [16] +-------------------------------------------------------------------------------- + + Thanks, Tom. + +-------------------------------------------------------------------------------- +Operator [17] +-------------------------------------------------------------------------------- + + Thank you. We'll now go to analyst Aram Rubinson with Wolfe Research. + +-------------------------------------------------------------------------------- +Aram Rubinson, Wolfe Research - Analyst [18] +-------------------------------------------------------------------------------- + + Hello, and thanks for taking my question. Hoping we can go back to square one here, if you don't mind. Can you tell us, or remind us, what financial measures are important to you, and which financial measures do you hold yourselves and the Board hold you accountable to? Because it's a little hard to see any of it making positive progress, so I just would love to get back to basics. + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com, Inc. - SVP and CFO [19] +-------------------------------------------------------------------------------- + + Sure. We're looking at a number of different metrics over a long period of time. And certainly our goal is to maximize free cash flow over the long term. We don't focus on individual margins, but we do focus on the inputs that are going to help drive free cash flow and operating income. +We certainly will look at making sure that we're using our capital wisely so that over time we get good returns on invested capital. And we certainly have been in several years now of what I would call an investment mode, because of the opportunities that we've had in front of us. As I mentioned earlier, there's still lots of opportunity in front of us, but we know that we have to be very selective about which opportunities we pursue. But we're encouraged by the opportunities that we have. + +-------------------------------------------------------------------------------- +Aram Rubinson, Wolfe Research - Analyst [20] +-------------------------------------------------------------------------------- + + So cash flow and return on invested capital is where we should keep our attention? + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com, Inc. - SVP and CFO [21] +-------------------------------------------------------------------------------- + + Yes. + +-------------------------------------------------------------------------------- +Aram Rubinson, Wolfe Research - Analyst [22] +-------------------------------------------------------------------------------- + + And are the employees on the recruiting side, is that becoming more difficult as the stock has faded a little bit, and those return characteristics have faded? How are you making sure that you're hiring the best people? + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com, Inc. - SVP and CFO [23] +-------------------------------------------------------------------------------- + + We have processes in place to make sure that we have a very high bar on the hiring that we do. The people that we're hiring are extraordinarily talented. We're very fortunate to get to work with so many talented people here. And we've been fortunate to be able to grow that employment base to work on the opportunities that we have. + +-------------------------------------------------------------------------------- +Aram Rubinson, Wolfe Research - Analyst [24] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Operator [25] +-------------------------------------------------------------------------------- + + Thank you. We'll go to analyst Colin Gillis with BGC Financial. + +-------------------------------------------------------------------------------- +Colin Gillis, BGC Partners - Analyst [26] +-------------------------------------------------------------------------------- + + Great. Thanks for taking my question. Just to get back to that North American media sales, it was the lowest growth rate in over 20 quarters. Are there other factors beyond the textbook shift and the Q3 strength last year? Are the digital media trends still intact? + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com, Inc. - SVP and CFO [27] +-------------------------------------------------------------------------------- + + In terms of the principal drivers, it's the two that I mentioned. It's the textbook rentals and also overlapping some of the strong discounting in strong titles that we had in some categories. So it's across a number of categories within the media. But those are the two principal drivers. + +-------------------------------------------------------------------------------- +Colin Gillis, BGC Partners - Analyst [28] +-------------------------------------------------------------------------------- + + You don't see this as a broader shift in that number? + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com, Inc. - SVP and CFO [29] +-------------------------------------------------------------------------------- + + No. Still, both in terms of North America and international, there is certainly a shift that's going on from physical to digital. And that's something that we're spending a lot of time on and trying to improve the experience for customers. And we've been able to do that certainly over a period of time. And so it's something that we'll continue to work on. + +-------------------------------------------------------------------------------- +Colin Gillis, BGC Partners - Analyst [30] +-------------------------------------------------------------------------------- + + Okay, thank you. + +-------------------------------------------------------------------------------- +Operator [31] +-------------------------------------------------------------------------------- + + Thank you. We'll continue on to analyst Ron Josey with JMP Securities. + +-------------------------------------------------------------------------------- +Ron Josey, JMP Securities - Analyst [32] +-------------------------------------------------------------------------------- + + Great. Thanks for taking the question. Two, please. If you could update us on this rotation center rollout. Are all 15 online? And I'd love to know maybe how they've helped bridge the last mile and improve overall speed delivery. +And then the second question, switching gears and just focusing on advertising, I believe a pilot was launched or beta was launched for Amazon's ad network called CPM Ads, I think maybe late August. I'm wondering if you could provide some commentary there. Thank you. + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com, Inc. - SVP and CFO [33] +-------------------------------------------------------------------------------- + + Sure. In terms of sort centers we'll have over 15 sort centers in the US by the end of the year. It's certainly helping us a lot. We have same day delivery in 12 cities. We'll have Sunday delivery in approximately 50% of the population. And, so, we're pleased to do that. +And in terms of the ad network there's not a lot I can say there. + +-------------------------------------------------------------------------------- +Ron Josey, JMP Securities - Analyst [34] +-------------------------------------------------------------------------------- + + Okay, thank you very much. + +-------------------------------------------------------------------------------- +Operator [35] +-------------------------------------------------------------------------------- + + Thank you. Our next question will come from analyst Aaron Kessler with Raymond James. + +-------------------------------------------------------------------------------- +Aaron Kessler, Raymond James & Associates, Inc. - Analyst [36] +-------------------------------------------------------------------------------- + + Great, thanks for taking my question. Can you just give us an update maybe on your views on original programming? It looked like Transparent's had some good success. +Also, just from an international standpoint, your views on the growth in China, India, as well as are you seeing signs of any increasing competition in the international, your key international markets today? + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com, Inc. - SVP and CFO [37] +-------------------------------------------------------------------------------- + + In terms of original content we're excited about it. We're investing as we talked about last quarter. We spent approximately $100 million in the quarter. Keep in mind that that's expensed in the quarter and so that's included in the results that you see in Q3. We're very excited about it. +We have a number of pilots, as well as a number of series launched. Transparent, you mentioned, is one of them. It's gotten very good reviews. The streaming on that series has been great. So, we're very excited about it and we think it's an interesting area for customers. +We continue to invest heavily in video content, including originals. There's a number of different metrics we're looking at certainly from a Prime standpoint. What we are seeing so far is those customers who are streaming are renewing at considerably higher rates, at a rate that's already high. So, we like what we see there. +When customers come in for new trials, free trials, and they engage from a video content standpoint, we see the conversion being higher. So, we see that we're adding new Prime members as a result of that. When those new Prime members become Prime members, the other thing we're seeing is they are buying physical product, which is a great impact for us. We see very similar patterns in terms of how much physical product that they're purchasing from us. +We're still certainly in investment mode there, but we like what we see. We have a long way to go there but we're concentrating on building a great service. And we see that customers are rewarding us with engagement on the content, both original and licensed. And they're buying more from us on the physical side and becoming Prime members when they do, and renewing at higher rates. +So, those are some of the early signs. We'll continue to monitor it very closely. But we're excited about what we're seeing there. +In terms of some of the international comments, and I would say this not just international but I'd say it for the US, as well. One thing that's not new is it's a very competitive environment. We have a lot of competitors both online and offline. That's not anything that's new. We are used to operating in that environment. We've been in that environment, really, for 19 years. But we are seeing a lot of competition. Again, that's not new. + +-------------------------------------------------------------------------------- +Aaron Kessler, Raymond James & Associates, Inc. - Analyst [38] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Operator [39] +-------------------------------------------------------------------------------- + + Thank you. Our next question will come from Heath Terry with Goldman Sachs. + +-------------------------------------------------------------------------------- +Heath Terry, Goldman Sachs - Analyst [40] +-------------------------------------------------------------------------------- + + Great, thanks. Last quarter you mentioned that the AWS business saw a 90% increase in volume. Was wondering if you could give us a sense of what you've seen so far this quarter. +And then in the highlight section of the release, the first six bullet points or so that you have there are all related to the hardware side of the business. If you can just give us, now that you have a little bit more time on the hardware side of the business behind you, if you can give us a sense of what you're learning in this category and where you think Amazon's long-term position in hardware is ultimately going to be. + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com, Inc. - SVP and CFO [41] +-------------------------------------------------------------------------------- + + In terms of AWS, we saw a very good growth in Q3, as well. From a usage standpoint, it's very similar to Q2, close to 90%. And, so, the team's doing just a fantastic job. +You can see our other revenue in North America went up a little bit sequentially. AWS is certainly the largest piece of that and it's the vast majority of it. They're growing at a faster rate than that other line item. So, again, the team is doing a fantastic job in not only serving customers, but launching many new features and services. And you can see some of the detail in that in the highlight section of our release today. So we're very excited about it. +In terms of devices, I can't speculate what we would do going forward. But we just launched a number of new tablets and E-readers that we're excited about. There's some really great price points for customers on the tablet side. We also launched a kids' tablet, which is the first time we've launched. +We've launched some new Kindles, including our premium Kindle. It's a terrific product. We think it's the best Kindle we've made to date, for sure, and so we're very excited about that. And we're excited to have these offerings for customers. + +-------------------------------------------------------------------------------- +Heath Terry, Goldman Sachs - Analyst [42] +-------------------------------------------------------------------------------- + + Great, thank you. + +-------------------------------------------------------------------------------- +Operator [43] +-------------------------------------------------------------------------------- + + Thank you. We'll continue on to analyst Ben Schachter with Macquarie. + +-------------------------------------------------------------------------------- +Ben Schachter, Macquarie Research - Analyst [44] +-------------------------------------------------------------------------------- + + Hi, Tom. You mentioned that you need to get leverage at some point, and last call you also said something similar. But can you help you quantify the timing? In your internal modeling, when do you expect to see more meaningful leverage? When you look at your three-to-five outlook, what does the leverage picture look like there? And then, also, can you remind us what your philosophy of stock buybacks is and what it would take to get you back in the market? Thanks. + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com, Inc. - SVP and CFO [45] +-------------------------------------------------------------------------------- + + In terms of leverage, beyond the guidance that we're giving today, there's not a lot of certainty I can give you. But, again, what I'd mentioned earlier is we do have a lot of opportunities, but our job is to be judicious and selective about which opportunities we pursue. And, so, that's the way we're thinking about it. I apologize I can't give you any more certainty in terms of timing, but certainly that's the way we're thinking about it. +In terms of buybacks, we have an open buyback right now. We have authorization to do that. I certainly can't comment on what price points we would or wouldn't do there. + +-------------------------------------------------------------------------------- +Operator [46] +-------------------------------------------------------------------------------- + + Thank you. We'll continue on to analyst Justin Post with Merrill Lynch. + +-------------------------------------------------------------------------------- +Justin Post, BofA Merrill Lynch - Analyst [47] +-------------------------------------------------------------------------------- + + Great, thank you. If you look at the phone impact in Q3, it seems to explain some of the difference versus the Street. But when you look forward to Q4 it looks like you're guiding to about 15% to 16% growth ex-FX, and again profits maybe below expectations. +Is the phone having an impact on profits in Q4, as well? And, also, when you think about the Q4 guidance, are there any events or things you want to call out? Are you being especially conservative in Q4 given recent trends? Anything different this year in the holiday? +Thank you. + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com, Inc. - SVP and CFO [48] +-------------------------------------------------------------------------------- + + Yes, in terms of the holiday season, Justin, if you look back the last several years, I've been giving wide ranges because it's, again, our most seasonal quarter, always challenging to predict precisely where we're going to be. In terms of a dollar range, I gave a $3 billion range last year, I'm giving a $3 billion range again this year from a revenue perspective. Again, wide range. At the higher end of the range, excluding foreign exchange it's approximately 21%, so it's a little bit higher than what we saw in Q3. And then you can see we were on the low end of the range. +In terms of the season itself, we're very excited about it in terms of to serve customers. We feel great about the selection that we have added and are continuing to add for the holiday season. We think from an operations standpoint each year we try to get better, and we believe that we'll be even better this year than we have in previous years. And so we're super excited to serve customers. +In terms of the phone, the only other thing that I can comment on is, at the end of Q3, we had approximately $83 million worth of inventory on hand. I can't comment on how that would impact guidance or not, but that's the amount of inventory we had on hand at the end of Q3. + +-------------------------------------------------------------------------------- +Justin Post, BofA Merrill Lynch - Analyst [49] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Operator [50] +-------------------------------------------------------------------------------- + + Thank you. Our next analyst will be John Blackledge with Cowen and Company. + +-------------------------------------------------------------------------------- +John Blackledge, Cowen and Company - Analyst [51] +-------------------------------------------------------------------------------- + + Great. Thanks, just a couple questions. We saw that Amazon Fresh expanded into Brooklyn recently. Just wondering if you can discuss the decision to expand into New York City and how we should think about timing for expansion into other markets. And then if you can update us on the number of fulfillment centers globally ending the year, that would be great. Thank you. + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com, Inc. - SVP and CFO [52] +-------------------------------------------------------------------------------- + + Sure. In terms of the number of fulfillment centers it's 13 net for the year. And then, as I mentioned earlier, in the US we'll have more than 15 sort centers by the end of the year. +In terms of -- sorry, the other part of the question was on Fresh? The team's doing a great job from a customer experience standpoint. As you can see we're in a few cities today. The team is just heads down focused on making sure that experience is great for customers. We continue -- customers like the service. So, we're seeing good pick up there. +And as you mentioned, we're expanding into Brooklyn. I can't speculate on what we do beyond the cities that we have launched to date, but we're excited about what we're seeing so far there. + +-------------------------------------------------------------------------------- +John Blackledge, Cowen and Company - Analyst [53] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Operator [54] +-------------------------------------------------------------------------------- + + Thank you. Our next question will come from analyst Eric Sheridan with UBS. + +-------------------------------------------------------------------------------- +Eric Sheridan, UBS - Analyst [55] +-------------------------------------------------------------------------------- + + Thanks for taking the question. Tom, you put through a price increase on the Prime service this year. Was curious what you were seeing in terms of the impact of that price increase on both the rate of adding people into Prime and the ability to control churn inside the Prime subscription base in general. And as you add additional functionality and layers into Prime, like you've done this year through the investments, whether you've thought about maybe putting in another price increase through next year. Thanks. + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com, Inc. - SVP and CFO [56] +-------------------------------------------------------------------------------- + + In terms of what we do going forward, I certainly wouldn't speculate. We had a price point since our initiation, since the launch of Prime at $79. So it took us a long time. And we were very careful with that to increase it to $99. +But since we've increased to $99 we've had great retention. We're very pleased with the retention we've had from customers. The program is growing very fast. We're very excited about it. And, so, we do think that it's really good for customers and it's really good for us and shareowners over the long term. +You're correct in that we're investing in Prime in a number of different ways, including video content, as I talked about earlier. That is certainly the way we will get a return on that investment principally, will be customers buying more, including, and especially, physical products. Again, we're very excited about Prime globally. + +-------------------------------------------------------------------------------- +Operator [57] +-------------------------------------------------------------------------------- + + Thank you. Our next analyst will be Brian Nowak with SIG. + +-------------------------------------------------------------------------------- +Brian Nowak, Susquehanna International Group - Analyst [58] +-------------------------------------------------------------------------------- + + Thanks for taking my questions. I have two, please. The first one, fulfillment ex stock-based comp was the highest it's ever been as a percentage of gross profit in the third quarter. Can you just talk about the drivers of that? Is that sortation centers or international growth? What's driving that? +And then as we think about the sortation centers what's the impact of those over next few quarters to fulfillment? Do they take awhile to get the inefficiencies out of the system like a standard DC would? + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com, Inc. - SVP and CFO [59] +-------------------------------------------------------------------------------- + + In terms of the fulfillment cost, you're right. Again, we are adding 13 net fulfillment centers. We'll have over 15 sort centers at the end of the year. Certainly one of the drivers for that is the growth that we're experiencing. +But in addition to that what we're seeing is the FBA adoption continues to get better. We get further penetrated with sellers adopting Fulfilled by Amazon. We think that's really good for sellers and for us and for customers over the long term. +What you're seeing is, several years ago in terms of fulfillment center planning, we were adding less of them and it was much closer to the holiday season. With the sheer amount of capacity that we're adding you're seeing more of that come in even before Q4. So, you're seeing that impacting us earlier. And the benefit of coming in earlier is we get to serve customer, get up to the productivity rates that we want to to serve customers in Q4 by having that capacity in a bit earlier than in past. So, we've seen that trend happen over the past few years where that's coming in earlier than certainly historically we've been able to do. + +-------------------------------------------------------------------------------- +Brian Nowak, Susquehanna International Group - Analyst [60] +-------------------------------------------------------------------------------- + + Okay, great, thanks. + +-------------------------------------------------------------------------------- +Operator [61] +-------------------------------------------------------------------------------- + + Thank you. Our next analyst will be Matt Nemer with Wells Fargo. + +-------------------------------------------------------------------------------- +Matt Nemer, Wells Fargo Securities, LLC - Analyst [62] +-------------------------------------------------------------------------------- + + Thanks so much for taking my questions. +First, Prime launched a referral fee recently and I'm wondering if we should take that as any indication that the membership growth has slowed or you're seeing some higher churn. And how does that referral fee get accounted for? +And then, secondly, Target launched free shipping with no hurdle for the holidays versus your $35 hurdle. Just wondering what your willingness is to leave that competitive gap during the holidays. Thanks. + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com, Inc. - SVP and CFO [63] +-------------------------------------------------------------------------------- + + I can't comment from a competitive standpoint what we might or might not do there. But in terms of the Prime referral fee, no, you should not read into that that Prime isn't growing well. In fact, just the opposite. We are seeing great growth. +We like the fact that enabling customers, because they like Prime, to be able to refer others, we think is great for us. I can't actually -- maybe offline you can follow-up with Phil or Dave on the accounting. Off the top of my head I can't remember how that's working. But I know they will be able to answer it for you. + +-------------------------------------------------------------------------------- +Matt Nemer, Wells Fargo Securities, LLC - Analyst [64] +-------------------------------------------------------------------------------- + + Okay, thanks so much. + +-------------------------------------------------------------------------------- +Operator [65] +-------------------------------------------------------------------------------- + + Thank you. Ladies and gentlemen, our final question will come from Colin Sebastian with Robert Baird. + +-------------------------------------------------------------------------------- +Colin Sebastian, Robert W. Baird & Company, Inc. - Analyst [66] +-------------------------------------------------------------------------------- + + Great, thanks. Good afternoon. +A couple of follow-ups. First off, in terms of the Q4 revenue guide, are you giving any consideration in that forecast to some of the shipping issues that happened last holiday, and the ability of your shipping partners to manage your growth? And then, secondly, on paid units, can you provide a split or color between physical and digital unit growth? +Thanks. + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com, Inc. - SVP and CFO [67] +-------------------------------------------------------------------------------- + + In terms of the guidance, it reflects all of the assumptions that we think could happen for the quarter. So, again, it's a wide range. To speak specifically to some of the issues last year, the team, again, we continually are trying to learn from everything that we do, and the team has done a great job learning from our experiences coming out of Q4 last year, as we do every year, and are excited to serve customers. +In terms of the unit growth, there's not a lot I can add in terms of splits, other than the overall growth rate. But we are pleased with -- certainly we're seeing good customer growth. Sellers are -- we're doing, we think, a great job for sellers. We continue to add a lot of unique selection throughout the year in terms of, we have customers, we see FBA for sellers getting further penetrated. +We've launched, we think, some interesting products for customers. We think our Web Services team is doing a great job. We realize that we have a lot of opportunities, but we need to be selective on which opportunities we pursue. And I think beyond that, we're just overall excited and getting ready for the holiday season. +Anyway, thanks, everybody, for calling in today. + +-------------------------------------------------------------------------------- +Phil Hardin, Amazon.com, Inc. - Director of IR [68] +-------------------------------------------------------------------------------- + + Thank you for joining us today on the call and for your questions. A replay will be available on our Investor Relations website at least through the end of the quarter. We appreciate your interest in Amazon.com and look forward to talking with you again next quarter. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/exam/original-files/Problem_1_Sample/2014-Oct-28-FB.OQ-140415619254-Transcript.txt b/exam/original-files/Problem_1_Sample/2014-Oct-28-FB.OQ-140415619254-Transcript.txt new file mode 100644 index 0000000..1a6b9e0 --- /dev/null +++ b/exam/original-files/Problem_1_Sample/2014-Oct-28-FB.OQ-140415619254-Transcript.txt @@ -0,0 +1,588 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q3 2014 Facebook Inc Earnings Call +10/28/2014 05:00 PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Deborah Crawford + Facebook, Inc. - VP of IR + * Dave Wehner + Facebook, Inc. - CFO + * Mark Zuckerberg + Facebook, Inc. - CEO + * Sheryl Sandberg + Facebook, Inc. - COO + +================================================================================ +Conference Call Participiants +================================================================================ + + * Justin Post + BofA Merrill Lynch - Analyst + * Youssef Squali + Cantor Fitzgerald - Analyst + * Eric Sheridan + UBS - Analyst + * Scott Davis + Stifel Nicolaus - Analyst + * Ben Schachter + Macquarie Research - Analyst + * Ross Sandler + Deutsche Bank - Analyst + * Paul Vogel + Barclays Capital - Analyst + * Heather Bellini + Goldman Sachs - Analyst + * Mark Mahaney + RBC Capital Markets - Analyst + * Stephen Ju + Credit Suisse - Analyst + * Douglas Anmuth + JPMorgan - Analyst + * Mark May + Citigroup - Analyst + * John Blackledge + Cowen and Company - Analyst + * Anthony DiClemente + Nomura Securities Intl - Analyst + +================================================================================ +Presentation +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Good afternoon. My name is Jay and I will be your conference operator today. At this time, I would like to welcome everyone to the Facebook third-quarter earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. +(Operator Instructions) +Thank you very much. Ms. Deborah Crawford, Facebook's Vice President of Investor Relations, you may begin. + +-------------------------------------------------------------------------------- +Deborah Crawford, Facebook, Inc. - VP of IR [2] +-------------------------------------------------------------------------------- + + Thank you. Good afternoon and welcome to Facebook's third-quarter earnings conference call. Joining me today to talk about our results are Mark Zuckerberg, CEO; Sheryl Sandberg, COO; and Dave Wehner, CFO. +Before we get started, I would like to take this opportunity to remind you that our remarks today will include forward-looking statements, and actual results may differ materially from those contemplated by these forward-looking statements. Factors that could cause these results to differ materially are set forth in today's press release and on our quarterly report on Form 10-Q filed with the SEC. Any forward-looking statements that we make on this call are based on assumptions as of today, and we undertake no obligation to update these statements as a result of new information or future events. +During this call, we will present both GAAP and non-GAAP financial measures. A reconciliation of GAAP to non-GAAP measures is included in today's earnings press release. The press release and an accompanying investor presentation are available on our website at Investor.FB.com. +And now, I would like to turn the call over to Mark. + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook, Inc. - CEO [3] +-------------------------------------------------------------------------------- + + Thanks, Deborah, and thanks, everyone for joining today. This has been a good quarter for Facebook, and we've achieved strong results across the board. We've continued to grow our community in both size and engagement, with 1.35 billion people now using Facebook each month and 64% using Facebook daily. On mobile, 1.122 billion people now use Facebook each month and 703 million people each day, nearly 40% growth from this time last year. +Looking at our business, we continue to do well. This quarter, total revenue reached $3.2 billion, and advertising revenue grew 64% year over year. Mobile now accounts for 66% of our advertising revenue. These results show that Facebook is getting stronger every day as a community, a partner for developers and marketers, and as the business. +One thing that I'm particularly pleased about is that while we are investing aggressively and making progress toward our big, long-term goals, we also continued to execute well against our near-term priorities. On previous calls, you've heard me talk about our big Company goals of connecting everyone, understanding the world, and building the next generation of platforms. +These goals are important for us and are the foundation of our strategy for the next decade. But achieving these will look involve many different efforts and steps along the way, some that will be achieved rapidly and others that are going to take longer. So with that in mind, I'd like to run through our progress this quarter on the different efforts that we expect to deliver a lot of impact over the next 3, 5, and 10 years. +Let's begin with our three-year goals: over the next three years, our main goals are around continuing to grow and serve our existing communities and businesses, and help them reach their full potential. When you look at the size and engagement of our community, our progress remains very strong. 864 million people use Facebook every day, and across our core products, we continue to see huge engagement. +For example, around 700 million people now use Facebook groups every month. Achieving this scale shows that we're delivering experiences for the way that people want to share and connect. +Another example is our progress on public content. Last quarter, I talked about how we're working to connect people around important public moments and personalities on Facebook. This quarter, we have continued to build on our results, and there are now more than 1 billion interactions every week between public figures and their fans on Facebook. +The investments we've made in video have also played a big part here. This quarter, we announced a new milestone for video on Facebook, achieving 1 billion video views a day of made [of] videos. During the summer's ice bucket challenge, there were more than 10 billion video views by 440 million people, which is a good sign of how far our video product has come. +Instagram has also made a lot of progress this quarter. In August, the Instagram team launched Hyperlapse, a standalone app for time-lapsed videos on iOS. The team has also invested heavily in improving the speed and performance of Instagram on Android. This has helped drive Instagram's strong international growth which, in some countries, has achieved more than 100% year-over-year growth. +Globally, people using Instagram now spend around 21 minutes a day, on average, using the app. This is a strong figure compared to the industry and a good sign that Instagram's strategy is on the right path. +Our other big focus over the next three years is to continue serving businesses well in creating a lot of value for marketers. As our results show, our approach here is working. To continue delivering value for businesses, we've work to improve the quality of ads and news feed by reducing low quality content and improving our targeting to show more timely and relevant content. +We've also made some big advances in our ad tech, most importantly, the launch of our Atlas platform. Atlas offers marketers a lot of new capabilities to help reach people across devices, platforms and publishers, as well as improving measurement of online campaigns. We're very excited for the future of Atlas, and Sheryl is going to talk more about this in a moment. +Next, let's talk about our strategy over the next five years. Over the next five years, our goals are around taking our next generation of services, Instagram, Messenger, WhatsApp, and Search, and helping them connect billions of people and become important businesses in their own right. One big priority for us here is messaging, and continuing to build and grow Messenger and now WhatsApp, as well, as great services. +This quarter, we made an important change to our mobile messaging efforts by transitioning people to Messenger on iOS Android and Windows phones. We believe that this change allows us to offer a better and faster messaging experience on mobile, and our data shows that people who use Messenger usually respond to messages about 20% faster. +This month, we also completed our acquisition of WhatsApp. I'm excited to be working with this team and for Jan to join our Board. WhatsApp continues to be on a path to connect more than 1 billion people around the world, and we are going to be working to accelerate their efforts here. +Another key part of our strategy is helping developers to build more great social experiences on our platform. Over the next few years, our goal is to make Facebook the cross-platform platform that allows developers to build, grow, and monetize their apps across every major mobile platform. +We've continued to make good progress here. This quarter, we opened our Audience Network to all developers and publishers, allowing over 1.5 million advertisers on Facebook to extend their campaigns across mobile, and for developers to begin monetizing their apps. +We're also excited by the continued adoption of App Links, our deep-linking technology for mobile apps. App Links is now used by hundreds of apps across iOS, Android, and Windows phones, and in just the past six months, developers have created links to more than 3 billion individual destinations in these apps. +Now let's talk about how we're approaching our goals over the next 10 years. For the next 10 years, our focus is on driving the fundamental changes in the world that we need to achieve our mission, connecting the whole world, understanding the world with big leaps in AI, and developing the next generation of platforms, especially in computing. +This is a very big -- very busy period for our efforts with Internet.org. In July, we worked with Airtel to launch the Internet.org app in Zambia. This provides free data access to a set of basic Internet services for health, education, employment, and communication. The results from this are very encouraging, and we've already heard a lot of amazing stories about how people are using the Internet to add value to their lives. We hope to bring the Internet.org app to many more countries soon. +Over the last few months, I've also traveled to several countries and met with policymakers, industry leaders, and people in communities that are coming online for the first time. Increasingly, industry and governments are seeing expanding Internet access as one of their core priorities. This is a positive development for our work with Internet.org and our long-term goal of connecting everyone in the world. +Finally, let's talk for a minute about our progress with Oculus. As I've said before, with Oculus, we're making a long-term bet on the future of computing. Every 10 to 15 years, a new major computing platform arrives, and we think that virtual and augmented reality are important parts of this upcoming next platform. +This quarter, Oculus continued to make progress towards this vision. In September, the first Oculus developer conference took place, where we announced a new prototype via our headset on the path to the consumer version of the Rift. We continue to see a lot of excitement in the developer committee, and we've now shipped more than 100,000 Rift developer kits to over 130 countries. It's still early for Oculus, but we're encouraged to see the variety of apps and games being developed for this platform. +Internet.org and Oculus are just two of the huge opportunities ahead. Our efforts here will take longer to achieve their full impact, but we're going to continue preparing for the future by investing aggressively. So that's how we're approaching our strategy over the next 3, 5, and 10 years, while focusing on our big goals of connecting everyone, understanding the world, and building the next generation of platforms. +This has been a quarter with strong results. I want to thank the entire Facebook community, our employees, our partners, and our stockholders for their continued support. Because of your contributions, Facebook continues to grow in strength and to create greater value in the world for people, partners, and businesses. We have a long journey ahead, we're on the right path, and I'm excited about the progress that we're making. +Thank you, and now, here's Sheryl. + +-------------------------------------------------------------------------------- +Sheryl Sandberg, Facebook, Inc. - COO [4] +-------------------------------------------------------------------------------- + + Thanks, Mark, and hi, everyone. We had another strong quarter, and we're continuing to execute well on our priorities, capitalizing on the shift to mobile, growing the number of Facebook marketers, and building products to make our ads more relevant. +Our growth this quarter was again very broad-based. We've had strong performance around the world, as well as across verticals and our four marketer segments: brand, direct marketers, developers, and small and medium businesses. I'd like to briefly highlight some of our progress on the product front, and then focus on important new investments we're making in ad-tech. +One of our main ad product goals is to make ads more relevant. Just like content and news feed, when ads are more relevant, they provide a better experience for people using Facebook and a better return for marketers. +One of the best ways to improve relevance is to help advertisers reach the right audience with their messages. Facebook's age and gender targeting is 45% more accurate than the digital industry average. Working with Facebook, advertisers can also target based on people's interests. +In addition, we're continuing to build out custom audiences, which enable marketers to use their own data to segment current and prospective customers. We are pleased with the response from clients, and we're focused on driving deeper penetration with both existing and new clients. +We also offer look-alike audiences, which help marketers find potential new customers who are similar to their current customers. To share one recent example, earlier this year, global financial services company MetLife wanted to find new customers for life insurance policies. +Working with its agency, [Merkel], they used look-alike audiences to find people more like their existing customers. MetLife ran ads that led people to their Get a Quote website page. Over the six-month campaign, the leads that came from Facebook resulted in new policies at a 2.4 times higher rate than MetLife's next best-performing channel and at 50% the cost of display ads. +We're also making steady progress with newer ads initiatives. Throughout this quarter, we continued to enable autoplay for more video ads. We're also continuing to roll out ads on Instagram. We think there's good opportunity with both video and Instagram ads, but we're going to remain deliberate and slow in our approach to scaling both businesses. +We're also making longer-term investments that we believe will be important for Facebook and the ad industry. In Q3, we relaunched Atlas, closed our acquisition of LiveRail, and rolled out our Audience Network, so I want to spend a few minutes discussing our longer-term ad-tech strategy. +We're investing in ad-tech for a simple reason: consumers are shifting quickly to mobile and the advertising industry is not keeping up. 2013 was the first year the average American adult spent more time on digital media than watching TV, and that gap has continued to grow. Today, the average adult in the US spends nearly 25% of their media time on mobile, but advertisers spend only about 11% of their budgets there. +One of the main reasons the budgets aren't moving as quickly as consumers is that advertisers haven't yet had an effective way to serve ads and measure their returns on mobile. Current solutions work well for one person with one device, especially a PC, and for sales that happen online, but today, people often have multiple devices and still make many purchases in physical stores. Nielsen OCR data shows that the digital industry is less than 60% accurate in demographic targeting of ads, which means that four in 10 people are seeing the wrong ads. +Similarly, marketers are not confident that they can measure mobile ad performance. Many of the most commonly-used measurement systems overemphasize the value of the last click. This does not make sense, given that studies of Facebook campaigns show that over 90% of ads -- of ad-driven in-store sales come from people who saw an ad but didn't click on it. +It's clear that marketers and publishers need better tools for the mobile world. This is an industry problem that we believe we are well-placed to solve. +Our relaunch of Atlas last month during Adweek was an important early step that builds on the advancements and measurements we have made over the past two years. The new Atlas is an ad-serving and measurement platform we completely rebuilt. By using Facebook data, Atlas can deliver highly relevant ads, regardless of device. +Atlas is also able to provide accurate measurement by connecting online marketing to in-store sales. Importantly, Atlas does all of this in a privacy-protected way; neither Atlas nor Facebook tells marketers who you are. +At Adweek, we had productive conversations about Atlas with many marketers and agencies. We are pleased with their interest. +We're also investing in additional pieces of our ad-tech platform. Our Audience Network improves the relevance of ads inside mobile apps. LiveRail provides tools for publishers to enable personalized marketing at scale, via their apps and websites. We believe LiveRail can build on their success in desktop video to become a great solution for mobile publishers. +I want to emphasize that the investments we're making in ad-tech are long-term; these are large and strategic investments. The payoff will take time, but we think they provide a necessary foundation for the advertising industry to make the shift to mobile and for Facebook's long-term growth. +We recognize that by staffing engineers in these strategic ad-tech areas, we forego shorter-term product improvements, which would generate revenue more quickly. We believe these are the right decisions. +As we look toward 2015, we're going to stay focused on the areas I've talked about today: capitalizing on the shift to mobile, growing the number of Facebook marketers, and building products that make ads more relevant. Our investors and ad-techs will be an increasingly important part of all of these efforts. Thanks, everyone, and now here's Dave. + +-------------------------------------------------------------------------------- +Dave Wehner, Facebook, Inc. - CFO [5] +-------------------------------------------------------------------------------- + + Thanks, Sheryl, and good afternoon, everyone. Q3 was a solid quarter across the board. We had strong revenue growth, generated $766 million in free cash flow, and continued to make investments to position us for long-term growth. +864 million people used Facebook on an average day in September, up 136 million from last year. This represents 64% of the 1.35 billion people that use Facebook during the month of September. +Mobile continues to be the core driver of our growth; over 1.1 billion people used Facebook on mobile during the month of September, up 250 million from last year. In addition, we have hundreds of millions of people on mobile using Instagram, Messenger, and WhatsApp. +Turning now to the financials, total revenue in Q3 was $3.2 billion, up 59% compared to last year, or 58% on a constant-currency basis. Total ad revenue was nearly $3 billion, up 64% compared to last year, or 63% on a constant-currency basis. Ad revenue growth was strong around the world, with each of our four reported geographic regions growing by 50% or more compared to last year. +Mobile ad revenue was approximately $1.9 billion, or 66% of ad revenue, compared to approximately $881 million, or 49% of ad revenue, last year. Desktop ad revenue was up 11% compared to last year, but was flat sequentially. +In Q3, the average price per ad increased 274% compared to last year, while total ad impressions declined 56%. The increase in the average effective price per ad was driven primarily by the redesign of our right-hand column ads, which resulted in larger, more engaging ads that delivered more value to marketers, and thus had higher effective prices. These right-hand column ads were also fewer in number, which drove the decrease of impressions in the quarter. +To a lesser degree, the shift of usage to mobile, where we don't have right-hand column ads, also continued to contribute to the reported price-volume trends. The price-volume trends were largely consistent across our four geographic regions. +Total payments and others fees revenue was $246 million, up 13% versus last year; however, payments volume from games, which represents the substantial majority of our payments and other fees revenue, declined 2% compared to last year, notably for the first time. And we expect this trend to continue, as desktop usage continues to decline. +Turning now to expenses, note that beginning in Q3, our definition of non-GAAP also excludes the amortization of intangible assets, and the historical non-GAAP measures discussed today have been updated accordingly. You can find our GAAP to non-GAAP reconciliations on page 10 of the Q3 press release. +Our Q3 total GAAP expenses were $1.8 billion, up 41% from last year, and non-GAAP expenses were $1.4 billion, up 39% from last year. Cost of revenue grew 11% on a GAAP basis and 7% on a non-GAAP basis. +We incurred expenses in the third quarter of 2013 related to the transition out of certain lease data centers. This mitigated our cost-of-revenue growth rate in Q3 2014, as it has done in the last two quarters. +Operating expenses, excluding cost of revenue, were up 61% on a GAAP basis and 72% on a non-GAAP basis versus last year, primarily due to an increase in headcount-related costs. We ended Q3 with 8,348 employees, up 44% from last year. Of the nearly 1,200 people we added sequentially, about one-quarter were from acquisition. +Organic growth was high, as the third quarter is our seasonally strongest new hire start period. Overall, we are pleased with our ability to attract and retain talented people who enable us to make strong progress against our mission. +Q3 operating income was $1.4 billion, representing a 44% operating margin, up from 37% last year. And our non-GAAP operating income was $1.8 billion, representing 57% operating margin, up from 51% last year. +Interest and other income and expense was a net expense of $61 million in the quarter, versus a net expense of $10 million last year. This increase in expense was primarily due to a foreign exchange losses resulting from the periodic remeasurement of our foreign currency balances, and largely resulted from the substantial reduction in the value of the euro relative to the dollar experienced from the beginning to the end of the quarter. +Our GAAP and non-GAAP tax rates for the quarter were 40% and 35%, respectively. GAAP net income was $806 million, or $0.30 per share, and our non-GAAP net income was $1.1 billion, or $0.43 per share. In Q3, we spent $482 million on CapEx and generated $766 million of free cash flow. +We ended Q3 with approximately $14.3 billion in cash and investments. This does not reflect the approximately $4.6 billion cash payment that we made in conjunction with the WhatsApp acquisition, which closed earlier this month. +Turning now to outlook, I'd like to start by noting that my forward-looking statements include the impact of both Oculus and WhatsApp. In addition, as part of the WhatsApp deal, we agreed to file a registration statement to register for resale the approximately 178 million shares issued to the WhatsApp stockholders. Nearly all of those shares will be fully registered and tradable during open trading windows in Q4 2014 and Q1 2015 under the Registration Statement we plan to file later this week. +In light of our recent acquisitions and our plans to file this Registration Statement, we are providing some additional guidance this quarter, including a more specific outlook on the current quarter revenue and a preliminary view on 2015 expenses. This is a more detailed outlook than we have historically provided, or plan to provide, on future earnings calls. +Let me start with 2014 expenses. We expect our full-year 2014 total GAAP expenses, including cost of revenue, stock compensation and the amortization of intangibles, will grow approximately 45% to 50% versus the full-year 2013. This increase from our prior range of 30% to 35% is primarily due to the impact of the WhatsApp acquisition on stock-based compensation charges in the fourth quarter. +We continue to expect that our full-year 2014 total non-GAAP expenses, including cost of revenue but excluding stock compensation and amortization of intangibles, will likely grow in the neighborhood of 30% to 35% versus the full-year 2013. +Turning now to revenue, we expect that total revenue in the fourth quarter will grow in the range of 40% to 47% versus the same quarter of last year. Please keep in mind that Q4 of 2013 was our first holiday season with the rollout of news feed ads at scale, which makes for a more difficult comparison. +For taxes, we anticipate the GAAP tax rate in the fourth quarter will be approximately 45% to 50%, which is higher than the current rate due to large, nondeductible stock-based compensation charges related to the closing of the WhatsApp transaction. Our Q4 non-GAAP tax rate should be similar to our Q3 rate. +For share count, we expect that our fourth-quarter fully diluted share count will be approximately 2.8 billion shares, taking into account the shares that we issued upon the closing of the WhatsApp deal. We expect that our 2014 CapEx will be at the low-end of our prior $2 billion to $2.5 billion CapEx guidance. +And lastly, while it is relatively early, I wanted to provide some preliminary color on our expense outlook for 2015. As Mark discussed in his remarks, we believe that we have very substantial growth opportunities in front of us, and we plan to invest aggressively to capitalize on those opportunities. As such, we plan on 2015 being a significant investment year. +Our current expectation is that total cost and expenses on a GAAP basis, inclusive of stock-based compensation charges related to the recent transactions, are likely to increase 55% to 75% compared to the full-year 2014. On a non-GAAP basis, we expect total cost to increase approximately 50% to 70% compared to 2014. Tax rates for 2015 should be similar to our fourth-quarter rates on both a GAAP and non-GAAP basis. +In summary, we're very pleased with the growth of our network, the great momentum we continue to see in our ads business, and the significant investments we're making to drive near-term and long-term growth. We have large opportunities ahead of us, and we're focused on capitalizing on those to achieve our mission and drive long-term shareholder value. +With that, operator, let's open up the call for questions. + + +================================================================================ +Questions and Answers +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) +Douglas Anmuth, JPMorgan. + +-------------------------------------------------------------------------------- +Douglas Anmuth, JPMorgan - Analyst [2] +-------------------------------------------------------------------------------- + + Thanks for taking the questions. Dave, just a follow-up on the comments that you just made on the outlook for expenses for 2015, could you help us understand more on the non-GAAP expenses, the 50% to [70%] and where we should be thinking about the incremental dollars being spent there, primarily? +And then secondly, can you talk, Sheryl, perhaps about what you're seeing in terms of branded advertising, whether you're seeing more of an inflection there as more bigger brands, CPG companies, auto OEMs are coming on board and how you're positioned there for the holidays? Thanks + +-------------------------------------------------------------------------------- +Dave Wehner, Facebook, Inc. - CFO [3] +-------------------------------------------------------------------------------- + + Sure, Doug. I'll take the first part. We're investing where we think there's a great opportunity for long-term growth. That's going to be really investing and continuing to grow the talent base at the Company, so we're investing in the people, and that's a big part of it. And we're also investing on the product side to grow the existing products, but also to invest in new areas like Oculus, WhatsApp, and then the ad-tech initiatives that Sheryl was talking about. +From an infrastructure side, we plan to invest to support the growth of the core business. That includes things like video; it also includes things like our global growth efforts with Internet.org, so we're really investing across the board on that. And in summary, we've got -- the strength of the business today is really putting us in a strong position to invest smartly for the future, and we're doing that. + +-------------------------------------------------------------------------------- +Sheryl Sandberg, Facebook, Inc. - COO [4] +-------------------------------------------------------------------------------- + + On brands, we're seeing very strong growth among our brand marketer segment. We're really excited about the engagement we're having right now with brand marketers and agencies. We think we're the first technology platform to offer the ability to do creativity and storytelling at scale in a personal way, and we talk a lot with our clients and partners about personal marketing at scale. +You'll find with our clients that they're in different parts of the adoption curve. We have clients who are very early on, and they don't launch any products or think about their ongoing messages without including Facebook. And there are some for whom we're not yet core, and we're working on that. +With all of this, we know we need to go client by client, and we're especially focused on measurement, because measurement is so key for this segment. A lot of the products the brand marketers are selling are bought in-store, and so showing that online and mobile ads lead to in-store purchases is a hugely important part of our strategy going forward, as I talked about, and video is really exciting as well. +When you think about the holiday season, Q4 is a really important time for our clients, and that makes it a really important time for us. And I think people are increasingly recognizing that mobile is important; 65% of people use their phones while they are out shopping and people are recognizing that opportunity. +From an earnings perspective, last Q4 was a great quarter, both because our business was growing but also because that was when we rolled out ads fully into news feeds. And so, it's worth keeping that in mind when you think about how you think about our business going forward. + +-------------------------------------------------------------------------------- +Operator [5] +-------------------------------------------------------------------------------- + + Ben Schachter, Macquarie. + +-------------------------------------------------------------------------------- +Ben Schachter, Macquarie Research - Analyst [6] +-------------------------------------------------------------------------------- + + A few questions: David, there was no mention of a 2015 revenue range, but I was wondering if you could give us any thoughts on how much margins should compress in 2015 versus 2014? +Then, a couple for Mark. Mark, now that you've spent more time with the Oculus team, can you update us on how your plans for Oculus have evolved since you first tried the device on? And then you mentioned it when you talked about your 10-year outlook. Does that mean we shouldn't expect any consumer Oculus product in the next one or two years? +And then similarly, on search, you mentioned that in your five-year plan, so does that mean we shouldn't expect anything on search for the next five years? Thanks. + +-------------------------------------------------------------------------------- +Dave Wehner, Facebook, Inc. - CFO [7] +-------------------------------------------------------------------------------- + + Hey, Ben. It's Dave. We're not really giving any guidance on 2015 revenue. We gave the growth range that we are expecting on Q4, which was 40% to 47% and that's down from 59% in Q3. But we're not providing any specific guidance on 2015. +Revenue sort of outlined the expense growth that we expect because of the substantial investments that we're making, also driven off some of the acquisitions that we've made. Hope that that is helpful for everybody. + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook, Inc. - CEO [8] +-------------------------------------------------------------------------------- + + Sure. And on your questions around Oculus and search and some of the other things that we're doing, the strategy for Oculus is to help accelerate their growth. They have these two products around Rift on PC, and they are supporting Gear VR and the Samsung team in building the mobile version. And I'm really excited about both of them. +I don't think that this is going to be -- it needs to reach a very large scale, 50 to 100 million units before it will really be a very meaningful thing as a computing platform. So I do think it's going to take a bunch of years to get there. +I don't know, it's hard to predict exactly, but I don't think it's going to get to 50 or 100 million units in the next few years. That will take a few cycles of the device to get there, and that's what I'm talking about. +When you get to that scale, that's when it starts to be interesting as a business in terms of developing out the ecosystems. So when I'm talking about that as a 10-year thing, it's building the first set of devices and building the audience and the ecosystem around that until it eventually becomes a business. +Some of the things like search and some of these other products -- this may sound a little ridiculous to say, but for us, products don't really get that interesting to turn into businesses until they have about 1 billion people using them. So for Facebook, we're there with news feed, and that's why, in the near term, our priority is really around continuing to grow and serve that community and making sure that the business around news feed and those mobile ads fully reach their potential. +Over a five-year time frame, we have a number of services which we think are well on their way to reaching 1 billion people: Messenger, WhatsApp Instagram, and search are a number of them. And once we get to that scale, then we think that they will start to become meaningful businesses in their own right. And I think that the right way to think about that, as I've tried to say repeatedly on these calls, is not that we're going to try to monetize them very aggressively in the next year or two, because I really think for each of those categories, the right strategy is to first focus on connecting 1 billion- plus people in reaching the full potential before very aggressively turning them into businesses. +But I do think that this is such a big opportunity ahead of us. I can't think of that many other companies or products that have multiple lines of products that are on track to reach and connect 1 billion people that have a clear path at how we can turn them into a business. So that will be a very fun and exciting challenge to work on over the next five years. + +-------------------------------------------------------------------------------- +Operator [9] +-------------------------------------------------------------------------------- + + Heather Bellini, Goldman Sachs. + +-------------------------------------------------------------------------------- +Heather Bellini, Goldman Sachs - Analyst [10] +-------------------------------------------------------------------------------- + + Great, thank you for taking the question. I just had two; one for Sheryl. If you could talk about the comments you made about giving advertisers a better feel for attribution, I was wondering, what percent of attribution do you find today is given to the left-click and how overstated do you think that is right now? +And then just a follow-up question for Dave, given your total expense range of 50% to 70% wider than what we've seen in the past, I'm wondering how should we think about the low-end versus the high-end? Under what scenarios are you thinking about those ranges? Thank you. + +-------------------------------------------------------------------------------- +Sheryl Sandberg, Facebook, Inc. - COO [11] +-------------------------------------------------------------------------------- + + Heather, to your first question, we think measurement is really -- really needs to evolve for the world we're in today in many ways. One of those is overemphasizing the last click. And the percentages by which that's done really vary, but we think substantially across the industry are overemphasized. +But there are also other problems: the current measurement systems don't work on mobile, because they are largely cookie-based. They are not accurate; we think they're only 59% accurate in even the most basic demographic targeting. They don't go off-line to online. +They really work well for one person with one device, usually a PC, that's making online purchases. The world we live in today, I bet you everyone on this phone call has multiple devices, and people look at ads online and then purchase off-line, as well as deserve more relevant ads and better targeting. +So as we relaunch Atlas, as we think about investing in ad techs, we're looking to solve all of these problems and we think our relaunch is the first step in doing that. + +-------------------------------------------------------------------------------- +Dave Wehner, Facebook, Inc. - CFO [12] +-------------------------------------------------------------------------------- + + Heather, yes, on the range of guidance, it is wider. It is obviously an early view into 2015, and so consequently, it is a wide range. It's -- giving you the best view that we have on it at this time, and we'll be updating that in the future, in terms of the expense guidance range as we have in the past on an annual basis each quarter. +The big drivers will be things like the pace of hiring and the success we have in building the great teams that we want to build at Facebook, but we will be updating that on an ongoing basis. + +-------------------------------------------------------------------------------- +Operator [13] +-------------------------------------------------------------------------------- + + Eric Sheridan, UBS. + +-------------------------------------------------------------------------------- +Eric Sheridan, UBS - Analyst [14] +-------------------------------------------------------------------------------- + + Great, thanks for taking the questions. Mark, you made comments about public content and the way that's evolved on Facebook. Would love to get deeper thoughts there about the way you think content distribution develops on Facebook over the longer term. +And then one for Sheryl. The ad-tech acquisitions and moves you've made over the last year to two, wanted to know when you think we should be looking at ad tech being fully deployed in the marketplace, and what sort of returns that might generate for Facebook? Thanks. + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook, Inc. - CEO [15] +-------------------------------------------------------------------------------- + + Sure, well, I can start off by talking about public content. So historically, a lot of people use Facebook for sharing moments in their lives with their friends and smaller sets of people, right? So we have Messenger for one-to-one communication; groups that just reached 700 million monthly actives this quarter; and then news feed, which is kind of the primary thing that people are using to share with all of their friends at once. +One of the big things that we, looking at this ecosystem, thought that there was a big opportunity in was public content, right? Where it's content that people are either comfortable sharing with everyone or want to consume that is public and shared with everyone. So we're looking at a few different areas. +Video is a very big priority. News is a very big priority, because a lot of people want to share that on Facebook already. And enabling public figures, whether they are celebrities or athletes or actors or politicians or leaders in different kind of communities, to get on Facebook and use the platform to distribute the content that they want. So those are the three areas that we're -- that you'll probably see us investing the most in over the next year or so. And we're making a lot of progress. I shared some of the stats before, but we're very proud of what we're doing, and we will have more to report soon. + +-------------------------------------------------------------------------------- +Sheryl Sandberg, Facebook, Inc. - COO [16] +-------------------------------------------------------------------------------- + + On ad tech, I think we're in the middle of what is a very fundamental shift from marketing that is cookie-based on a PC, one desktop, to people-based marketing on multiple devices, to marketing that is primarily for online sales, to marketing that affects both online and off-line sales on mobile. So I think we're right now in a pretty big shift and we're not [close to fully deployed] there. We have a lot of pieces to do. +Our Atlas relaunch is new. We're first growing our client base, and we're pleased with our progress there. And we're putting these other pieces in place on Audience Network or LiveRail. So I think we're pretty far from being fully deployed on even this big shift. +But I think in our industry, nothing is ever fully deployed. That as soon as we catch up here, there's going to be another movement and something else that happens that we have to react to and build the technology for. And so, we remain -- we're a long-term Company, run by a founder with a very long-run vision, and we want to keep our eyes ahead on these changes in technology and keep deploying against them. + +-------------------------------------------------------------------------------- +Operator [17] +-------------------------------------------------------------------------------- + + Ross Sandler, Deutsche Bank. + +-------------------------------------------------------------------------------- +Ross Sandler, Deutsche Bank - Analyst [18] +-------------------------------------------------------------------------------- + + Thanks, I just had two questions, one for Mark and then a quick one for Dave. Mark, I don't think I heard you mention payments in the three-, five-, 10-year plan. There's been some speculation of payment offerings within Messenger. Can you give us a sense at a high level of what you'd envision Facebook potentially doing in the payment space longer term across merchant payments, consumer products, like savings and lending or peer to peer? And then, how do you see social interaction tied in with payments evolving? Does Messenger make payments better than what's out there on the market? +And then Dave, just a clarification. So the high-end of the 4Q revenue guidance assumes a pretty sharp drop-off, even normalizing for some extra currency hit. So are you seeing anything out there that makes you concerned about pacing into the quarter? Or is that largely business as usual, and it's just a tougher law-of-large-numbers type situation? Thanks + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook, Inc. - CEO [19] +-------------------------------------------------------------------------------- + + I'll start on payments. So payments is an important part of the online business ecosystem. But we've traditionally thought about this as something that we're going to partner with other companies on to enable great solutions, rather than trying to compete and do it as a business ourselves. +And the reason why we've taken this approach is it's very important for all online businesses and our customers and partners that there's a good online payment system. People run ads to get customers and sell products, and at the end of that conversion, if there's a good payment system that is smooth, then people will buy more things, which ultimately makes the ads and all of the whole online flow more valuable for those partners and, therefore, more revenue and profit for our business as well. +We view the ad part of the business as a more efficient part of the business than payments itself. Payments tends to be fixed fee, whereas in ads because of the option model, there's really good price discrimination built in, right? So a partner or business who is willing to pay us 30% of their revenue can bid that, and someone who's willing to only pay 5% of their revenue can bid that. And the auction model inherently takes care of that. +We think that focusing on the ads part is going to end up being the more effective thing for us to do. But we realize that it's important for the ad system over time and for all of our partners for there to be a payment system, which is why we're excited about partnering with credit card companies and partnering with PayPal and all of the different folks in online payments to make their solutions as good as possible as well. + +-------------------------------------------------------------------------------- +Dave Wehner, Facebook, Inc. - CFO [20] +-------------------------------------------------------------------------------- + + And, hey, Ross, it's Dave. Our view now is that Q4 revenue will come in that 40% to 47% year-over-year growth range. As I mentioned, Q4 of 2013 was just an absolutely fantastic quarter for us. We had news feed rolled out at scale. It was our first $1 billion mobile quarter. So we're comping against a really outstanding quarter last year; that's really the largest issue. +You asked about currency; we did see the euro drop about 7% in value over the course of Q3. And that really didn't pick up, as you saw, it didn't pick up in an impact in Q3 at all, because it happened at the end of the quarter. So that will be a headwind that we see and that's factored into the guidance. + +-------------------------------------------------------------------------------- +Operator [21] +-------------------------------------------------------------------------------- + + Mark Mahaney, RBC Capital Markets. + +-------------------------------------------------------------------------------- +Mark Mahaney, RBC Capital Markets - Analyst [22] +-------------------------------------------------------------------------------- + + Great. Sheryl, you talked about being careful about and slow about rolling out video ads, autoplay video ads and Instagram monetization. Have you seen any pushback in terms of user experiences to date on videos or on video ads? Is that overall caution, or is there anything you've seen in the data that suggests that you want to keep it at a really slow pace? Thank you. + +-------------------------------------------------------------------------------- +Sheryl Sandberg, Facebook, Inc. - COO [23] +-------------------------------------------------------------------------------- + + We're pleased with the consumer response we've had on both fronts, and we remain really optimistic over the long run about Instagram and video, because there's a lot of interest. I spoke before about creative storytelling; images video can be such a big part of that and create a really resonant experience for brands and companies. +We really believe in going slow. That as we grow products, we pay attention to the consumer experience. We want the consumer experience always to come first. So although we're very optimistic about the opportunity here, we continue to grow slowly and pay a lot of attention to the quality of the advertising we see. +To share one example, we are seeing people using both Facebook and Instagram and also video and other ad products in combination. Mercedes-Benz launched the GLA, which was their first compact SUV, on Facebook and Instagram. They found that by doing Facebook and Instagram together, they got a 54% increase in their website visits. +So a lot of our products, as you do one, you also do more Facebook ads as well, and that's something we're paying a lot of attention to. + +-------------------------------------------------------------------------------- +Operator [24] +-------------------------------------------------------------------------------- + + Paul Vogel, Barclays. + +-------------------------------------------------------------------------------- +Paul Vogel, Barclays Capital - Analyst [25] +-------------------------------------------------------------------------------- + + Great, thanks so much. I was wondering if you could talk a little bit about on the engagement side. Your DAUs to MAUs continued to be very strong. If you could talk a little about your older cohorts versus your newer cohorts and how they are behaving. And then also geographically. And on top of that on the frequency side, obviously DAUs doesn't measure how often people come back more than once per day, so is there any update on increasing frequency of visits? Thanks + +-------------------------------------------------------------------------------- +Dave Wehner, Facebook, Inc. - CFO [26] +-------------------------------------------------------------------------------- + + I don't think anything to update on the latter front, Paul, but the DAU to MAU ratio, which we focus on on engagement, was strong across all geographic regions. So North America remains at the high end, and we're really pleased with what we're seeing there. +Nothing to update on cohorts. Obviously, we're really pleased overall what the mobile impact has on the DAU to MAU ratio, and really encourage what were seeing across the board on engagement. So I don't think anything other than that specifically to call out. + +-------------------------------------------------------------------------------- +Operator [27] +-------------------------------------------------------------------------------- + + Mark May, Citi. + +-------------------------------------------------------------------------------- +Mark May, Citigroup - Analyst [28] +-------------------------------------------------------------------------------- + + Thanks. For the last couple of years you've -- back on the OpEx for next year guidance, for the last couple of years, you've grown your cash OpEx by around $1 billion a year with some consistency. And I think that seems to be continuing into the second half of the year. But obviously, your midpoint of OpEx guidance for next year represents a very significant -- I think it's like 2.5% -- $2.5 billion increase at the midpoint. You obviously plan to change the level of investment in something quite significantly. +So I'm just wondering if you could talk a little bit more specifically about what are a couple of the projects, of the capital-intensive projects that you're planning for next year? And is it physically possible to accelerate your hiring by that much next year? + +-------------------------------------------------------------------------------- +Dave Wehner, Facebook, Inc. - CFO [29] +-------------------------------------------------------------------------------- + + Yes, thanks, Mark. The projects really that Mark and Sheryl both outlined, in terms of continuing to invest in the core Facebook experiences, growth engagement, and monetization there, building up the ad-tech side and the investments that we want to make there, as well as the recent -- continuing to invest against the recent acquisitions that we made in terms of WhatsApp and Oculus. So it's really the investments we're making there. We're also going to be supporting global growth with our Internet.org initiative, investing there. So it's a number of the key initiatives that Mark outlined in his comments that we're investing against. And again, we're giving a range on what we think is a reasonable range of guidance on that. +You saw headcount, we had a good growth headcount this quarter. And we're going to be continuing to invest, as we think that these will be good investments over the long run in terms of being able to drive our long-term growth. + +-------------------------------------------------------------------------------- +Operator [30] +-------------------------------------------------------------------------------- + + John Blackledge, Cowen & Company. + +-------------------------------------------------------------------------------- +John Blackledge, Cowen and Company - Analyst [31] +-------------------------------------------------------------------------------- + + Great, thanks; just a couple questions on video. How should we think about Facebook as a video platform? And how does the mix of video between user-generated versus public content versus professionally produced content evolve over time? For example, as the upcoming short film content produced by Lions Gate around the Twilight franchise that will be shown exclusively on Facebook, will that increasingly be the type of content Facebook users will see in the future? +And then if you could give an update on the Instagram multi-active user comp, that would be great. Thank you. + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook, Inc. - CEO [32] +-------------------------------------------------------------------------------- + + I can speak to the video point. I think it's going to be all of the above, in terms of what you said. Most of the content on Facebook is things that people are sharing with their friends and the people around them. So I think we'll continue to see that in video as well. +There's definitely been this trend over the last few years where, if you go back five years, most of the content was text. Now a lot of it is photos, and if you look in the future as networks get better and the ability to capture good video and share it in a good way improves, then I think that going forward, a lot of the content that people share will be video. It's just very compelling. +There's also a lot of great public content that's video, especially the shorter-form content that you were mentioning I think will fit very well into the feed form factor that people consume on Facebook. So I think we're going to see a lot of both of these things, and it's going to be an evolution over the next few years, but I think you can expect to see a ramp of all of this. + +-------------------------------------------------------------------------------- +Dave Wehner, Facebook, Inc. - CFO [33] +-------------------------------------------------------------------------------- + + And on Instagram MAU, we haven't updated the number; they continue to grow nicely, but we haven't announced a new public number on Instagram. + +-------------------------------------------------------------------------------- +Operator [34] +-------------------------------------------------------------------------------- + + Justin Post, Merrill Lynch. + +-------------------------------------------------------------------------------- +Justin Post, BofA Merrill Lynch - Analyst [35] +-------------------------------------------------------------------------------- + + Thanks. Mark, it seems like you're taking a portfolio approach to apps, and you've got several different experiences for people on mobile devices and other devices. Can you give us your philosophy around that? And as people use things like WhatsApp and Instagram, is it actually maybe possibly hurting Facebook's reported metrics? And how do you think about putting this all together and helping every app work? + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook, Inc. - CEO [36] +-------------------------------------------------------------------------------- + + Sure. One of the things that's happening on mobile is that there's an increased focus for apps to do one thing really well. So on desktop, a lot of the things that might have fit well into a single Facebook website, now (technical difficulty) people, you need to build multiple standalone different apps. So we are seeing that with Facebook and Messenger, and the work that we did to kind of split out Messenger from the Facebook app to give a dedicated experience around that that we think is a better experience. And we're going to do more of that in the future as well with the Facebook Creative Labs products that we are releasing. +Part of what we've seen is that the use cases for products like Instagram and WhatsApp are actually more different and nuanced from -- than the products that people compare them to that Facebook had already built. So for example, on the WhatsApp and Messenger side, Messenger is primarily used today for people to chat with their Facebook friends, within this context of maybe it's not a realtime text like you would send an SMS on your phone, but it's something that you're sending to one of your Facebook friends. Then if they happen to be there, and you can text back and forth or maybe they respond later. +SMS and WhatsApp are more for realtime activity. People have contacts on WhatsApp who they wouldn't want to make friends on Facebook. The graphs are somewhat different. +So one of the things that we found, interestingly, to us as well, was that Messenger and WhatsApp are actually growing quickly in a lot of the same countries. There's countries that they are growing in that are different, and there are countries that they are growing in that are the same, which to me suggests that they actually are in more different of markets than you probably intuitively would've thought. And that was definitely our understanding as we dug more into this. +Same with Instagram, and the type of sharing that happens on Instagram versus news feed. We've recently started doing more to help promote and accelerate the growth of Instagram from the Facebook app itself, because what we've found is that by doing that, we're net overall increasing the amount of sharing that people can do and connecting what they can do within our whole family of apps. +We're definitely seeing that this is all accretive and positive, and we think that in the future there will probably be room for more apps for sharing as well. + +-------------------------------------------------------------------------------- +Operator [37] +-------------------------------------------------------------------------------- + + Anthony DiClemente, Nomura Securities. + +-------------------------------------------------------------------------------- +Anthony DiClemente, Nomura Securities Intl - Analyst [38] +-------------------------------------------------------------------------------- + + Thanks a lot. First for Sheryl, I want to come back to the theme of media measurement. You gave us some good perspective. Can you help me with first-party data versus third-party data? Can you get where you need to go with brand marketers using your in-house tools like Atlas, or do you think you need the validity and integrity of a third-party measurement source, i.e., Nielsen, in order to get there? +And then second question for Mark. Mark, I was just wondering where do you see Facebook at this point, in terms of its place in the hardware ecosystem? And given so much time is spent on your apps, do you think it's possible that you could get more aggressive in devices in hardware in order to achieve some of your longer-term or 10-year goals that you laid out? Thank you. + +-------------------------------------------------------------------------------- +Sheryl Sandberg, Facebook, Inc. - COO [39] +-------------------------------------------------------------------------------- + + To your first question, data is really important for both measurement and targeting. And when you think about first-party and third-party data, you have to think about both of those usage. +Certainly with measurement, third-party verification of that data can be very important. A lot of our largest clients and agencies also build their own data systems, which are a very important part of measuring and certifying everything we do with them. So we're using a combination of first-party and third-party. +I think where this really gets interesting is around relevance. And as I spoke about, that's a major theme for us, because we think one of the best things we can do to drive more value for marketers and improve the consumer experience on Facebook is improve relevance. And data is a great way of doing that. +So, for example, with Custom Audiences. Custom Audiences is a combination of our clients using the data they have on their client base, combined with the data we have that we can target. Let's say target one ad to existing customers to get them to engage more and buy more, and one ad to brand-new customers. And you can see how having a different ad to people who have never bought your product and a different ad to people who are currently buying your product would make a lot of sense. +Then you look at something like look-alike audiences, where we're looking to map customers who share characteristics; age, demos, likes, interest, with current customers, and all of this takes a combination of first-party and third-party data, all of which we do in a very privacy-protected way. + +-------------------------------------------------------------------------------- +Operator [40] +-------------------------------------------------------------------------------- + + Stephen Ju, Credit Suisse. + +-------------------------------------------------------------------------------- +Stephen Ju, Credit Suisse - Analyst [41] +-------------------------------------------------------------------------------- + + Thanks. Sheryl, from a product-development perspective, it feels like from the outside looking in that you have accelerated the rollout and delivery of various products. So wondering how you were thinking about how your product delivery cadence will change, especially given the investments you have guided to for 2015? Thanks. + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook, Inc. - CEO [42] +-------------------------------------------------------------------------------- + + Before we go to that, I'll just quickly answer the hardware question that we didn't get a chance to answer on the last question. We actually probably do more with hardware already than is apparent, because we design and work with folks to build up all of our own data centers and the servers there. I do think that if that ever became the right thing for us to focus on from a product perspective, we have some of the skills there already. +And when we were thinking about working with Oculus, that's actually one of the areas where we think we can help out is because we've built up a supply chain team, and we've been, I think, pretty effective at delivering what we've needed to run Facebook as this large system at scale. +But that said, I think that there's a huge amount of value in delivering these network and software services, and that's where you should expect us to focus on the things that we've talked about. + +-------------------------------------------------------------------------------- +Sheryl Sandberg, Facebook, Inc. - COO [43] +-------------------------------------------------------------------------------- + + To the question about the rollout of products, I think the usual way we do things is that we roll out products slowly and then we iterate. So one example is Custom Audiences; we roll out Custom Audiences. Then we add on that website Custom Audiences to target ads to people visiting websites, and then mobile apps Custom Audiences adds to people who have visited mobile app. And one is building on the next, building on the next. +Similarly, this month -- earlier this month we launched local awareness targeting. It's a new option that allows local businesses to reach nearby customers, and when you saw that, it was in a massive launch; it was a small launch, fully enabled as targeting, get people to use it, and we will develop it. +Then there were the exceptions, such as Atlas. Atlas was one big launch that we're still in the process of doing, and that's really because it's a product we bought and needed to rebuild. But for the most part, our product development tends to be very iterative, and that's what you can expect from us going forward. + +-------------------------------------------------------------------------------- +Operator [44] +-------------------------------------------------------------------------------- + + Youssef Squali, Cantor. + +-------------------------------------------------------------------------------- +Youssef Squali, Cantor Fitzgerald - Analyst [45] +-------------------------------------------------------------------------------- + + Thank you very much. First question for Mark. Mark, you recently came back from China. How do you think about that opportunity and what gives you the confidence that you can actually be successful where so many have failed? +And then, second, on Instagram, we've seen some very complimentary data that shows that Instagram is actually becoming more popular than ever with some brand marketers. Just wondering, what are the best-performing ads formats on the platform right now, and where is the ad load versus where Facebook is? Thank you. + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook, Inc. - CEO [46] +-------------------------------------------------------------------------------- + + Sure. On China, we're already doing more in China on the business side than I think a lot of folks think about. A lot of Chinese businesses use Facebook to grow their export businesses and to help find customers around the rest of the world and grow the Chinese economy there. So that's actually a pretty meaningful thing for us already, and we always are looking to find ways to help businesses around the world to grow. And that will be just a long-term thing. +Our approach to China and every country is very long term. We're going to be here for decades, and we want to create good relationships with these countries and businesses around the world that will help and grow over the long term. +On the Instagram side, I think we're pretty early. There have been a number of good ads, both video and images, that I think have been pretty effective, but it's fairly early in the growth phase at this point. The top priority for Instagram is to grow from 200 to more and eventually connect 1 billion or more people, and I think that's something that should be possible. That's what I'm really focused on and excited about now, while we also start building out some of the parts of the business as well. + +-------------------------------------------------------------------------------- +Deborah Crawford, Facebook, Inc. - VP of IR [47] +-------------------------------------------------------------------------------- + + Operator, we have time for one last question. + +-------------------------------------------------------------------------------- +Operator [48] +-------------------------------------------------------------------------------- + + Scott Davis, Stifel. + +-------------------------------------------------------------------------------- +Scott Davis, Stifel Nicolaus - Analyst [49] +-------------------------------------------------------------------------------- + + Thanks. I think this question is for Sheryl; the app download business seems to have grown quickly and become a big contributor of the ad revenue total for Facebook, and just wondering how you think about app re-engagement relative to app downloads, and which of those you think is the larger long-term opportunity for the Company? Thanks. + +-------------------------------------------------------------------------------- +Sheryl Sandberg, Facebook, Inc. - COO [50] +-------------------------------------------------------------------------------- + + I'm glad you asked the question, because I think there has been some confusion around our mobile apps and our mobile app ads and our mobile app engagement ads. +On the engagement ads, it's still pretty early and we have rolled those out. We rolled those out after mobile app ads, so we definitely see less of them, but we do think there's an opportunity. +I think the broader point is that our growth in mobile ads is very broad-based. It's across all marketer segments, and it's across all of our different ad formats. When we talk about our mobile ad business growing, mobile app ads are a small part of that, that's growing in line with our total business. +The other thing that I think people get a little confused about is who is using mobile app ads. I think commonly when you think about mobile app, people often think about developers, and developers are using them and we're pleased we're able to help them grow. +But they're also being used by some of the largest branders and marketers in the world. So, for example, Burger King. Burger King just used our mobile app ads to do app installs for their apps. Excuse me, I'm about to sneeze. And the app was to find Burger Kings, look at their menu and nutritional options, use mobile coupons, and use virtual gift cards. That was one use of our mobile app ads, which is not what people typically think of. + +-------------------------------------------------------------------------------- +Deborah Crawford, Facebook, Inc. - VP of IR [51] +-------------------------------------------------------------------------------- + + Great. Thank you for joining us today. We appreciate your time, and we look forward to speaking with you again. + +-------------------------------------------------------------------------------- +Operator [52] +-------------------------------------------------------------------------------- + + This concludes today's conference call. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/exam/original-files/Problem_1_Sample/2015-Apr-15-BAC.N-138140128784-Transcript.txt b/exam/original-files/Problem_1_Sample/2015-Apr-15-BAC.N-138140128784-Transcript.txt new file mode 100644 index 0000000..15f0dfd --- /dev/null +++ b/exam/original-files/Problem_1_Sample/2015-Apr-15-BAC.N-138140128784-Transcript.txt @@ -0,0 +1,970 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q1 2015 Bank of America Corp Earnings Call +04/15/2015 08:30 AM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Brian Moynihan + Bank of America Corporation - Chairman, President and CEO + * Bruce Thompson + Bank of America Corporation - CFO + * Lee McEntire + Bank of America Corporation - SVP, IR + +================================================================================ +Conference Call Participiants +================================================================================ + + * Paul Miller + FBR & Co. - Analyst + * John McDonald + Sanford C. Bernstein & Co. - Analyst + * Eric Wasserstrom + Guggenheim Securities - Analyst + * Mike Mayo + CLSA Limited - Analyst + * Steven Chubak + Nomura Asset Management - Analyst + * Jim Mitchell + Buckingham Research - Analyst + * Jeff Harte + Sandler O'Neill & Partners - Analyst + * Nancy Bush + NAB Research - Analyst + * Glenn Schorr + Evercore ISI - Analyst + * Ken Usdin + Jeferies LLC - Analyst + * Matt O'Connor + Deutsche Bank - Analyst + * Brennan Hawken + UBS - Analyst + * Betsy Graseck + Morgan Stanley - Analyst + +================================================================================ +Presentation +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Good day, everyone, and welcome to the Bank of America earnings announcement conference call. At this time all participants are in a listen-only mode but later you will have the opportunity to ask questions during the question-and-answer session. Please note that this call is being recorded. +It is now my pleasure to turn the conference over to Lee McEntire. Please go ahead. + +-------------------------------------------------------------------------------- +Lee McEntire, Bank of America Corporation - SVP, IR [2] +-------------------------------------------------------------------------------- + + Good morning. Thanks to everyone on the phone as well as the webcast for joining us this morning for the first quarter results. Hopefully everybody had a chance to review the earnings release documents that are available on the website. +Before I turn the call over to Brian and Bruce, let me just remind you we may make forward-looking statements. For further information on those please refer to either our earnings release documents, our website or other SEC filings. +So with that, let me turn it over to Brian Moynihan, our CEO, for some opening comments before Bruce goes through the details. Brian? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman, President and CEO [3] +-------------------------------------------------------------------------------- + + Thank you, Lee, and good morning and welcome everyone to the earnings call for our first quarter of 2015. +I am going to start on slide two. So the highlights are there. We earned a $3.4 billion after tax in the quarter, which is up both on a linked quarter and year-over-year basis. We continue to work to drive growth in all our core businesses. We are beginning to see it overcome the run off with non-core portfolios in many areas. At the same time, we continue to focus on managing expenses carefully. As a result, we are beginning to see more predictable earnings with more improvement expected ahead. +Both capital and liquidity remain at record levels in our Company. We expect to return more capital to shareholders this year than we have in the past. +Revenue on an adjusted basis was $21.9 billion for the quarter. From the top of the house, revenue remains challenging in an environment with below trend economic growth and rate environment which comes from that. In addition, we remain faithful to our customer strategy with strong risk management and risk appetite to ensure we do not repeat the outsized credit losses of the past. With that said, we are seeing our core business stabilizing across the drivers of the revenue. +This quarter we saw continued growth in our wealth management revenues and a rebound from the fourth quarter in trading revenue. In our loan and deposit areas, we saw continued core growth albeit subject to continued spread contraction. +Our expense management efforts continue. The year-over-year expenses, excluding litigation costs, are down 6%. Including litigation costs, year-over-year expenses are down 30%. We continue to see our efficiency efforts drive forward beyond New BAC through our simplified and improved program. +We also continue to see progress on LAS expense. As proof of our efforts for the quarter we ended with our headcount at a little under 220,000 full-time employees, a reduction of 4000 employees for the quarter, about 2% and 19,000 employees year-over-year, or 8%. For the quarter this reduction came to about 35% from LAS and about 65% from the rest of the Company. To put it in a broad context, we are approaching employment levels where we were in early 2008 prior to bringing in over 100,000 people from Countrywide and Merrill acquisition. We are doing that to the investments we are making in technology to reduce costs and they continue to take hold. And we will continue to drive this effort even as the economy continues to improve and rates rise helping keep balance to our operating leverage. +During the last year even while we were reducing those costs and headcount, we continued to invest in the client facing growth capacity in this Company. We've added financial advisors in U.S. Trust and in Merrill Lynch, focused on building for the future. We have added commercial bankers in all our Global Banking areas to help fill in our franchise. We have added new financial centers in areas of opportunity and we continue to invest in products and innovation as well as efficiency. A simple example is our Consumer Mobile Banking space where we now have 17 million mobile banking customers, up over 2 million from last year. +Turning to slide three, you can see what we simply need to do. Each of the four core lines of businesses on the left-hand part of the slide earned above our cost of capital for this quarter. In addition, the aggregate earnings for all those businesses were $4.4 billion after tax. The LAS segment had a much smaller loss this quarter showing we are making progress. +The other area on the right-hand side of the slide has affected this quarter by the impacts of retirement eligible incentive costs and the market related NII adjustments which affect top of the house earnings. They are booked there in distributed business over the quarters. But this shows that we need to keep working LAS to get it to break even and the other will take care of itself in subsequent quarters. +Turning to slide four, with regard to CCAR, as previously disclosed, we received a conditional non-objection to our capital plan. We received the approval for our requested capital actions that we requested in the original submission, a dividend of $0.05 per share and $4 billion of stock repurchase on the relevant periods. As you can see, the cushion we have increased from about $2 billion last year under the tightest constraint to over $22 billion this year, in both of those cases under the tightest constraint after all capital actions. +These quantitative results bode well. However, the conditional approval is an area with which we are focusing. We are focusing our energy to the September resubmission and beyond. Our efforts are well underway. We are bringing additional resources to task. We simply have to be the best at CCAR to meet our shareholder objectives in our Company. To ensure that we achieve that success, I have asked Terry Laughlin to lead our efforts. As many of you know, Terry helped us clean up the mortgage issues over the last several years. +I can assure you that our Board and management are extremely focused on our resubmission and our core process improvement for CCAR 2016 next year. Terry has retained a team of external experts, increased the internal staffing to ensure we are successful. We have had in depth discussions with our regulators regarding the particular specified issues that we need to remediate with the resubmission and we are focused on getting that done by September. +With that, I will turn that over to Bruce. + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [4] +-------------------------------------------------------------------------------- + + Thanks, Brian, and good morning, everyone. I'm going to start on slide five. As Brian mentioned, we recorded $3.4 billion of earnings in the first quarter or $0.27 per diluted share. That compares to $0.25 a share in the fourth quarter of 2014 and a loss of $0.05 if we go back to the first quarter of 2014. I'd like to note a few items as you review these results. +Both first-quarter periods include $1 billion in expense for the annual cost of retirement eligible incentives awarded. This was $0.06 in EPS impact in each of the first-quarter periods. The first quarter of 2015 also includes a negative market related adjustment to net interest income of $484 million for the acceleration of bond premium amortization on our debt securities that is driven by lower long-term rates. That cost us $0.03 in EPS during the quarter. +The other large item that is worth noting as you look at the comparisons is the outsized litigation amount of $6 billion in the first quarter of 2014. +I'd like to spend just a moment on total revenue comparisons. Our first quarter of 2015 revenue on an FTE basis if we exclude the market related adjustment to NII and a small DVA adjustment, was $21.9 billion during the quarter. If we compare that to the fourth quarter of 2014 and adjust for the same items, revenue is up $1.7 billion or 8% and that 8% increase is attributable to a rebound in sales and trading results as well as higher mortgage banking income and is offset somewhat by lower net interest income mostly from two fewer days during the quarter. +If we compare back to the first quarter of 2014 and we further adjust for $800 million in equity investment gains as a result of monetizing a single strategic investment in the year-ago period, revenue is now a couple hundred million dollars or 1% and that is from lower net interest income and lower sales in trading results. +Total noninterest expense during the quarter was $15.7 billion and included the $1 billion in retirement eligible costs as well as $370 million in litigation expense. I will go through the comparisons from an expense perspective several slides back. +As we look at provision for credit losses during the quarter, they were $765 million and included $429 million in reserve release versus $660 million in the fourth quarter of 2014. Preferred dividends during the first quarter were $382 million and as you all look to update your models given the preferred issuances that we have had the majority of which pay semiannually as you look at preferred dividends, they should be roughly $330 million in the second and fourth quarters and $440 million in the first and third quarters going forward based on our existing preferred footprint. +Let's go ahead and move to slide six on the balance sheet. Our balance sheet was up slightly to $2.14 trillion and that was driven almost exclusively by cash balances associated with the deposit growth that we saw during the quarter. We continued our focus on balance sheet optimization for liquidity as we continued to ship some of our discretionary portfolio first lien loans into HQLA eligible securities. +Loans on a period end basis were down modestly reflecting good core loan activity in both our Global Banking as well as our Wealth Management segments. That was more than offset by seasonally lower card balances in our discretionary consumer real estate area as well as run-off portfolios. +Deposits were up $34 billion or 3% from the end of the year and some of that obviously has to do with seasonal tax activity. We issued $3 billion of preferred stock in the quarter that benefitted regulatory capital and as you look at common shareholders' equity, you can see it improved driven both by earnings growth as well as improved OCI. As a result of these factors, tangible book value increased to $14.79, 7% higher than 12 months ago and our tangible common equity ratio improved to 7.5%. +The last point that I would note is that we did add a slide in the appendix as we updated our capital allocations across the segments coming into 2015 and the returns that we show you are reflective of those updated capital allocations. +Let's go ahead and flip to slide seven and go through loans. From several calls, we are as frequently about the decline in reported loans which are down modestly again from the fourth quarter levels as you can see in the upper left-hand chart. I want to make a few points though as we go through this. +As we have discussed many times, much of the movement in loans has been driven by two pieces of non-core loans. The first relates to shifts in our discretionary mortgage loan levels that are used to manage interest rate risk and predominantly recorded in the all other unit. Many times based on the investment decisions that we make, these loans are replaced with debt securities on the balance sheet. +The other component as you look at loans to consider is the run-off that we have within our LAS unit, which are mostly home equity loans. As these home equity loans go away, it enables us to reduce our operating costs as we have less work to do. +As you can see over the past five quarters, these non-core loans have declined approximately $59 billion. If you adjust for that $59 billion though, and I'll go to the upper right-hand box, you can see that our loans have actually increased by $21 billion from the first quarter of 2014. The bottom chart on this slide provides the mix of this loan growth across our primary businesses. And you can see within our Wealth Management area, we have experienced strong demand in both consumer real estate as well as securities based lending and that has led to year-over-year loan growth within that segment of 10%. +Within Global Banking, we saw modest growth on a year-over-year basis but importantly we saw a significant pickup in activity in the first quarter of 2015 relative to the fourth quarter of 2014. Over that time frame, loans were up $6.7 billion or 8% on an annualized basis. +We move to slide eight and take a look at regulatory capital. This quarter the standardized transition reporting includes the switch from reporting RWA under the general risk-based approach to Basel III and the capital number includes another year of phase-in for capital deductions. With those changes, our CET1 ratio was 11.1% in 2015 under the new reporting. +If we go ahead and look at Basel III regulatory capital on a fully phased-in basis, our CET1 capital improved $6 billion during the quarter and was driven by earnings, lower DTA, lower threshold deductions as well as an improvement in OCI. That translated under (technical difficulty) approach to our CET1 ratio improving from 10% in the fourth quarter to 10.3% in the first quarter of 2015 while under the advanced approaches the CET1 ratio improved from 9.6% to 10.1%. +As you know from our 10-K disclosure, we are working with our banking regulators to obtain approval of our models in order to exit parallel run. Our regulators have requested modifications to certain commercial and other credit models in order to exit parallel run which we estimate would increase our advanced approaches RWA and negatively impact the CET1 ratio that we show here by approximately 100 basis points. +If we look at supplementary leverage, we estimate that at the end of the first quarter of 2015 we continue to exceed the US rules applicable in 2018. Our bank holding company SLR ratio was 6.3% and in our primary banking subsidiary, BANA, we were at 7%. +We turn to slide nine, long-term debt. At the end of the first quarter was $238 billion, down $5 billion from the fourth quarter of 2014. In the lower left box you can see that from a maturity profile perspective, we have $16 billion of parent company debt that matures during the balance of 2015 and we will be opportunistic as it relates to refinancing that indebtedness. +Our global excess liquidity sources reached a record level of $478 billion this quarter and now represents 22% of the overall balance sheet. The increase from the fourth quarter reflects the deposit inflows as well as the shift from discretionary loans into HQLA securities. +Within the liquidity, our parent company liquidity remains quite strong at $93 billion and our time to require funding is at 37 months. During the quarter, we did continue to increase our liquidity coverage ratios at both the parent as well as at the bank levels and at the end of the first quarter, we estimate that our consolidated company was well above the 100% fully phased in 2017 LCR requirement. +On slide 10, net interest income on a reported FTE basis was $9.7 billion, down a couple hundred million dollars from the fourth quarter of 2014 driven by two fewer interest accrual days during the quarter as well as some spread compression. If we exclude the previously mentioned market related adjustment, NII at $10.2 billion was largely in line with our expectations and lower than the fourth quarter of 2014 given two fewer interest accrual days. +Modest improvements in net interest income mostly from lower funding costs in the quarter were offset by some of the continued pressures that we saw in loan and securities yields as well as balances in new assets coming in at lower long-term rates. This drove the adjusted net interest yield to 2.28%. +If we look at the movement down in rates during the quarter, our balance sheet did become more asset sensitive compared to year-end such that 100 basis point parallel increase in rates from the end of the quarter would be expected to contribute roughly $4.6 billion in net interest income benefits over the next 12 months. Slightly more than half of that $4.6 billion is on the long end and just under half is based on the short end. +On slide 11, if we moved to expenses, non-interest expense was $15.7 billion in the first quarter of 2015 and included roughly $370 million in litigation expense. First quarter 2015 once again did include $1 billion in annual retirement eligible incentive costs consistent with what we saw in the first quarter of 2014. +Litigation expense during the quarter included FX and RMBS items and was significantly below what we saw a year ago, which included the cost of the [FHFA] settlement. +While we are on litigation, I do want to make sure that you notice this quarter that we did get one step closer on our Article 77 settlement as the Appellate Court approved the Bank of New York Mellon settlement in all respects and I would also note that the deadline for further appeal at this point has passed. +If we exclude litigation and retirement eligible costs, our total expenses were $14.3 billion this quarter, down nearly $1 billion from the first quarter of 2014 driven by three factors; continued progress on our LAS initiatives, our New BAC cost savings as well as lower revenue related incentives within Global Markets. +Relative to the fourth quarter of 2014, the expense level on an adjusted basis is up about $0.5 billion on higher revenue related incentives mostly for the improved sales and trading results on a linked-quarter basis. Our legacy assets and servicing costs, ex-litigation, were $1 billion. They improved approximately $100 million from the fourth quarter of 2014 and more than $500 million if we go back to the first quarter of 2014. And we remain on track to hit our Q14 target that we laid out for you of $800 million dollars in LAS costs, ex-litigation once again in the fourth quarter. +Beyond the LAS business, our teams continue to do very good work in optimizing our delivery network as well as our infrastructure and as you can see headcount was down 8% over the course of the last 12 months. +If we look at asset quality on slide 12, reported net charge-offs were $1.2 billion in the first quarter versus $900 million in the fourth quarter of 2014. I do want to note that the first quarter of 2015 included a net impact of approximately $200 million in losses associated with the DOJ settlement that was previously reserved for and that was offset in part by recoveries from certain NPL sales. +Our Q4 2014 included similar items but with the net adjustment positively benefiting net charge-offs to the tune of about $163 million. If we adjust for all these impacts, our net charge-offs during the quarter were $1 billion dollars, which is slightly lower than what we saw in the fourth quarter of 2014. +Our loss rates on the same adjusted basis were at about 47 basis points in the first quarter of 2015 consistent with what we saw in the fourth quarter of 2014. In both our consumer delinquencies as well as our NPLs declined from fourth-quarters levels. +On the commercial front we did see a slight pickup in reservable criticized exposure from the fourth quarter of 2014 as we bounce off comparatively low levels. +The first quarter of 2015 provision expense was $765 million. We released $429 million in reserves. Most of those reserve releases were in our consumer real estate portfolio, while we did see a modest increase in reserves in the commercial space that was associated with the strong loan growth that we saw during the first quarter. +We can flip to slide 13 on consumer banking. Hopefully last week you all saw and had a chance to review the filing of our recasted segment results. We mentioned to you during the last earnings call that we made changes in segment reporting where we moved the Home Loans into our Consumer Banking segment from CRES, which left our legacy assets and servicing as a standalone segment. We also moved the majority of business banking from Consumer Banking to the Global Banking segment which is how we manage the business. All of these changes have been made retroactively. +Let's go ahead and walk through then the business segment results starting on slide 13 with Consumer Banking. The results showed solid bottom-line performance with earnings of $1.5 billion, which is up slightly from the year-ago quarter and down seasonally from the fourth quarter of 2014, which tends to be a better consumer spending quarter. Business generated a solid 21% return on allocated capital. +Total revenue was lower compared to the first quarter of 2014 from a decline in net interest income. Two-thirds of that decline in NII was a result of pushing out in the allocation of a portion of the market-related NII adjustment to the deposits business. +Our non-interest income was stable compared to last year, reflecting good growth in both mortgage banking as well as higher card income, but was offset by a portfolio divestiture gain last year of roughly $100 million in the first quarter. Expenses were managed tightly and non-issue expense declined from the fourth quarter of 2014 as we continue to reduce our financial centers and the associated costs driven by consumer behavior patterns shifting to more digital. +The number of mobile banking customers continues to increase. We ended the quarter at roughly 17 million and these -- activity from these customers accounts for roughly 13% of all deposit transactions. +Page 14 we have added some additional slides here to give you a sense as to some of the trends that we are seeing in the business and key drivers. You can see we remain a leader in many aspects of our consumer bank, doing business with nearly half of all US households. +We look at fees compared to the first quarter of 2014, card income was up modestly despite some Affinity portfolio divestitures over the last year. Our card issuance remains very strong. Our balances did decline as our customers began to pay down holiday spend balance levels and our net charge-offs remain low at 2.8% and risk-adjusted margins remain high. +If we move to mortgage banking income, it was up 60% as originations for the Company ramped up during the quarter. Year-over-year first mortgage originations were up 55% to $13.7 billion while our home equity line and loan originations increased 62% to $3.2 billion. +The revenue improvement was driven by these increased volumes as well as the mix of first lien originations that was 76% weighted towards overall refinance activity. And looking forward, the pipeline remains strong, up 50% from the end of the year. +Moving to service charges, service charges were down versus the fourth quarter of 2014. This fee line continues to be muted as more of our customers take advantage of our reward plans and are opening accounts with higher balances. We also continue to reduce the number of less profitable accounts serviced and migrate customer activity to more self-service channels. As a result, we are getting the same or slightly better account fees and debit interchange from fewer accounts, which is allowing us to reduce our infrastructure. +Expense is declining and if you look at cost of deposits, it has dropped from just less than 2% in the first quarter of 2014 to 1.87% in the first quarter of 2015. +And lastly, as you can see while we are bringing down our overall headcount in this business, I want to note that we have been increasing our sales specialists in the financial centers and their sales are driving client balances higher. For example, our deposits are up 5% from the first quarter of 2014 and our brokerage assets are up 18%. +If we moved to slide 15, Wealth Management, it generated earnings of $651 million during the quarter. If we compare this to the first quarter of 2014, there's a $78 million decline as the solid fee growth that we saw during the quarter was offset by lower net interest income and higher expense. Once again, the allocation of the market-related NII adjustment drove the decline in NII, which more than offset the benefits that we saw from solid loan growth. +Our asset management fees continued to grow driven by strong client flows and higher market levels. Our non-interest expense increased from the first quarter of 2014 as a result of higher revenue related incentives as well as investments in client-facing professionals. +Our pretax margin was down 23%, down last year largely impacted by the decline in net interest income. Return on allocated capital remains strong at 22%. +If we look at the activity and drivers within Wealth Management on slide 16, you can see our management fees continue to grow and are up 10% from the first quarter of 2014 but this is partially offset by some of the sluggishness that we've seen in transactional revenue within the brokerage line. We do continue to be an employer of choice in this business increasing financial advisors by more than 850 individuals over the course of the last 12 months. +Our client balances climbed to over $2.5 trillion, up $12 billion from the fourth quarter of 2014 driven by strong client balance inflows. Long-term AUM flows at $15 billion for the quarter were positive for the 23rd consecutive quarter. +And as I mentioned earlier, when we discuss loans, we continue to experience strong demand in both our securities based and residential mortgage lending areas of the business reaching a new record level in loans during the quarter. +On slide 17, our Global Banking earnings during the quarter were $1.4 billion, which generating 16% return on allocated capital. Earnings were up 6% from the first quarter of 2014 as the decline in net interest income was more than offset by lower expense as well as improved provision expense. +As we look at NII, the year-over-year decline was driven by three things: the allocation of the market related to NII adjustment, which I have touched on in previous segments; the push-out of the firm-wide LCR requirements, a good chunk of which goes to Global Banking as well as some year-over-year compression in loan spreads. Our provision expense was lower than the first quarter of 2014 by $185 million as we did not build reserves to the same magnitude as we did in the first quarter of last year. +Non-interest expense was down 8% from the first quarter of 2014 driven by three factors, lower technology initiative spend, lower litigation as well as lower incentive costs. +Moving to the Global Banking metrics on page 18, we chart the components of revenue which show stability across the quarters with the exception of NII, as I just mentioned. Our investment banking fees companywide during the quarter were $1.5 billion, down 4% from the first quarter of 2014. I would highlight during the quarter we recorded the highest level of advisory fees since the Merrill merger, up 50% from the first quarter of 2014. This helped to offset the drop that we saw within our leverage finance business as a result of the regulatory guidance that was implemented during the first half of 2014. +Equity underwriting was also up nicely, up 10% from the first quarter of 2014. And as you look at the balance sheet, loans on average were $290 billion, up modestly on a year-over-year basis but if you look linked quarter, as I mentioned earlier, we had a fair bit of momentum ending the first quarter with balances up $7 billion on a spot basis from the fourth quarter of 2014. +The $7 billion improvement was broad-based. We saw middle-market utilization rates at levels that we have not seen for six years at this point so we feel good about that. And within commercial real estate, we saw linked quarter improvement as well. +On slide 19, Global Markets, we earned $945 million on revenues of $4.6 billion in the quarter. That was an 11% return on allocated capital during the quarter. Our earnings were up nicely from the fourth quarter of 2014 but down from the first quarter as our revenue was down 7% excluding net DVA and FVA. The decline from the first quarter of 2014 was driven by lower fixed sales and trading results. +On the expense front, non-interest expense was modestly higher year-over-year as we had $260 million in litigation expense in the quarter. Ex litigation, expenses were down 7% on reduced levels of revenue related incentives. +If we look at the Global Markets metrics on slide 20, sales and trading revenue of $3.9 billion ex-DVA and FVA as I mentioned was up nicely off fourth quarter of 2014 levels but down 5% from the first quarter of 2014. Fixed sales and trading was down 7% on a year-over-year basis while equities was effectively flat with the year-ago period. +Within the macro related product areas like FX and rates, there was a solid return in volatility and client trading activity in the quarter while the credit spread traded products area experienced lower activity in line with lower issuance levels during the quarter. And as you look at and we lay out a mix between macro and credit in the upper box, upper right-hand box and you can see that our activity tends to be more heavily weighted towards credit spread trading given the position that we occupy within the issuer market. +And the last point I would make on markets, our asset levels were fairly flat while VaR was below the level that we experienced last year. +Slide 21, Legacy Assets & Servicing, you can see we saw improvement in revenue and expense trends compared to both periods within Legacy Assets & Servicing. The loss in this segment narrowed to less than $240 million. Revenue improved as both rep and warrant was down $156 million from the year-ago period and we had a more favorable MSR hedge performance. Those two factors were partially offset by lower servicing fees as we continue to reduce the servicing portfolio. +Non-interest expense ex-litigation was $1 billion in the quarter once again improving approximately $100 million from the fourth quarter and more than $500 million since the first quarter of 2014. Importantly, our 60-plus days delinquent loans were 153,000 units but were down 36,000 units or 19% from the fourth quarter of 2014. +If we move to slide 22 All Other, All Other reflects a loss of $841 million and that includes once again the impact of the annual retirement eligible incentive costs as well as some of the market-related NII impact. If we compare this quarter to the first quarter of 2014, revenue is lower by about $683 million and that was driven by nearly $700 million in equity investment gains in the first quarter of 2014 compared to essentially nothing in the first quarter of 2015 and it was partially offset as well by the absence of payment protection costs this quarter compared to about $141 million in the prior-year quarter. +From a modeling perspective, the effective tax rate during the quarter was about 29% and as we look out during the balance of 2015, we would expect the tax rate to be roughly 30% absent any unusual items. +So I would just wrap up the prepared part of my comments that as we end the quarter, we end the quarter with record capital. We end the quarter with record liquidity. We will begin our $4 billion share repurchase program this quarter. The team is very focused on addressing our CCAR resubmission. Expense management remains a key focus across the Company. Our businesses are showing good activity including a pickup in lending across several businesses in the Company, credit quality remains strong and we remain well positioned to benefit in a rising interest rate environment. +And with that we will go ahead and open it up for questions. + + +================================================================================ +Questions and Answers +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions). Betsy Graseck, Morgan Stanley. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [2] +-------------------------------------------------------------------------------- + + So Brian, very impressive commentary in the beginning of the call on headcount getting back to 2008 levels before CFC and the Merrill Lynch acquisition. The one question we get continually from investors is what is left to do on the expenses and you've already got the core expense number coming into the $13 billion range, so can you give us some sense as to where you go from here on expense management and is it steady as she goes, or is there room to become even more efficient? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman, President and CEO [3] +-------------------------------------------------------------------------------- + + A couple of things. One is if you parse expenses, Betsy, into three basic buckets, the litigation expense bucket, which you are seeing come down to more reasonable levels and then there is a cost of that litigation, the external legal fees and stuff, which we will continue to see lift in which is in the expense numbers. Then you have a second bucket, LAS, we are at the $1 billion level and as Bruce said, we expect to get that down to $800 million and keep moving that to lower numbers over into 2016. +And then you get into the baseline and I think the thought on the baseline is even as we reduce the headcount we continue to reinvest in sales capacity. So just in our consumer business, headcount down year-over-year but we have 1000 more salespeople roughly out there selling. And then so the idea is to continue to drive salespeople into the businesses at the same time we are taking out wealth management, etc. +So when you think about the broad expense base, there is adjustments always in first quarter, second quarter just because of revenue and stuff in terms of the aggregate amount but we will continue to pare away. You can look linked -- year-over-year quarters over the last four years, we have continued to chip away. This year it was 300 on the core base. We will continue to work at that but I would say that a lot of it we are trying to make sure that we create the investment rate, continue to grow the franchise (inaudible) size. This is a matter of holding these expenses relatively flat as revenues start to pick up with the expected increase in rates and the economy continue to grow. If that changed we would have to go aggressively and push down the core also. + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [4] +-------------------------------------------------------------------------------- + + We manage it every day. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman, President and CEO [5] +-------------------------------------------------------------------------------- + + We manage it every day and you can see the headcount is a leading indicator because that headcount reduction in the quarter really benefits us in the second quarter. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [6] +-------------------------------------------------------------------------------- + + Got it. And then just separate topic on GWIM and maybe you could give us some commentary around how you are thinking about the impact of the fiduciary language that has been coming out if the Department of Labor and also how you deal with the competitive threats coming from Silicon Valley including some of the robo-advisor efforts? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman, President and CEO [7] +-------------------------------------------------------------------------------- + + On the first question, John Thiel, who runs Merrill Lynch for us, where largely we are affected by the discussion on fiduciary standards because remember U.S. Trust is actually a private bank and operates under the fiduciary standard in most of its activity. So John Thiel does the lead in our business, does a great job for us, has been clear. We believe that doing what is in the best interests for your customers is absolutely the right thing to do. And while this rule has just come out yesterday afternoon and frankly, Betsy, to get prepared for your questions this morning, I haven't spent a lot of time examining it in detail. But from a basic standpoint, we have been clear that we see the industry moving and we expect to help move it there. +On the robo-advisor I think that the clear segment match for us in that area in terms of what Schwab and other people are talking about is really in the Merrill Lynch business, which is below the Merrill Lynch cut off, for lack of a better term. So John and his team drive people $250,000 in investable assets free to invest, which is net worth $0.5 million/$1 million in [uprating] of the client. And then Dean Athanasia and his preferred team drive the business below that and if you look in our information, you will see that that business has got about $118 billion of brokerage assets. It is growing faster than the industry year-over-year. I think the assets are up 18%. The numbers of accounts are up, the sales levels are up and so that's really the automated rebalancing portfolios and stuff like that and we are driving that through as a core execution. +And by the way, they also refer tens of thousands of customers a year up to Merrill Lynch at the same time, so we are trying to have the best of both worlds. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [8] +-------------------------------------------------------------------------------- + + Okay, thanks. You have been a leader there, so appreciate that color. Thanks. + +-------------------------------------------------------------------------------- +Operator [9] +-------------------------------------------------------------------------------- + + Matt O'Connor, Deutsche Bank. + +-------------------------------------------------------------------------------- +Matt O'Connor, Deutsche Bank - Analyst [10] +-------------------------------------------------------------------------------- + + Any sense of when we get a clearer picture on the final impact of exiting parallel run? Should we just assume the 100 basis point hit that you mentioned is a done deal or is there a potential for it to be less than that? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [11] +-------------------------------------------------------------------------------- + + I think what we wanted to disclose, Matt, is that I think that we are coming out of the disclosure that we had in the K, there were a lot of questions and you are absolutely right that what we disclosed today was the requested amount from our banking regulators to exit parallel run. That was the ask on their behalf. Discussions continue but we did want to put out there what the ask was. + +-------------------------------------------------------------------------------- +Matt O'Connor, Deutsche Bank - Analyst [12] +-------------------------------------------------------------------------------- + + Okay. In terms of timing of a conclusion on that? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [13] +-------------------------------------------------------------------------------- + + I think that those things are always hard to predict but we are obviously working hard to get through it over the next quarter or so. + +-------------------------------------------------------------------------------- +Matt O'Connor, Deutsche Bank - Analyst [14] +-------------------------------------------------------------------------------- + + Okay. And then just related, obviously capital build was very good this quarter of 50 basis points, so you essentially got half that back already. But assuming that 100 basis point hit goes through, are there additional RWA levers to pull or model adjustments in the future that we can think about? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [15] +-------------------------------------------------------------------------------- + + You ask a very good question, which is that to the extent that there is an adjustment in the RWA, you obviously as you look to refine and improve your models, always have the ability to work hard to get that back. But there's obviously a lot of scrutiny with respect to models. But your point is spot on is that there would be the opportunity as we work through and look to refine, improve and become better with our models, to get some of that back over time. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman, President and CEO [16] +-------------------------------------------------------------------------------- + + And Matt, in a broader context, we have flipped the binding constraint in our Company to some degree with a move to advanced and so therefore, continue to look at the balance sheet what mix of businesses and how you approach the businesses changes again because standardize was a constraint we were focused on and was our binding constraint and now it's going to flip to advanced, as you can see in the numbers. And that then just -- expect us to be as aggressive and in depth at thinking through how we mix the businesses right to make sure that we are focused on that constraint now that it has become a binding one. + +-------------------------------------------------------------------------------- +Matt O'Connor, Deutsche Bank - Analyst [17] +-------------------------------------------------------------------------------- + + Okay. That is very hopeful, thank you. + +-------------------------------------------------------------------------------- +Operator [18] +-------------------------------------------------------------------------------- + + Paul Miller, FBR Capital Markets. + +-------------------------------------------------------------------------------- +Paul Miller, FBR & Co. - Analyst [19] +-------------------------------------------------------------------------------- + + On your legacy asset servicing in your discussions you said that the loans went down from 36,000 loans in the quarter. Did you sell any loans in the quarter? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [20] +-------------------------------------------------------------------------------- + + There was some servicing of loans that was moved as well as the outright sale of some nonperforming loans, so there was some inorganic activity but as you look at those reductions, it was very strong from both organic as well as inorganic. And I would say the other thing that we are seeing, Paul, is just less new delinquencies coming in than what we would've expected. So you've got the benefit of less coming in, you've got the benefit of working through some of what you have and then we are supplementing that with moving additional out. + +-------------------------------------------------------------------------------- +Paul Miller, FBR & Co. - Analyst [21] +-------------------------------------------------------------------------------- + + Yes, I know one of the things out there is what we are seeing or hearing is that there is a strong market right now for people wanting to buy either re-performing or nonperforming loans. Are you going to use that as an advantage to start moving this stuff off your books quicker? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [22] +-------------------------------------------------------------------------------- + + We have been using it as an advantage. If you go back and look at the results, Paul, I think we were one of the first out there that started to move those loans in the first half of 2014. We have been aggressively doing that both to take the risk of the loans off as well as to move the servicing. And I think if you look at the impact of that and how it flows through different things, you really get a good sense for it when you look at some of the CCAR results where the loss content that we have, particularly within both first mortgages as well as home equity, has come down. So we have been at that for some time at this point. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman, President and CEO [23] +-------------------------------------------------------------------------------- + + And Paul, I think overall remember as you get further and further removed from the crisis, what is left over even though at the time when we set up LAS or set up some of these non-core portfolios would have been a product or service you didn't want to continue. Seven years later, you are seeing the customers are left over and paid and so there's a good bit but also we want to make sure we measure the economics of the portfolios. Now that they are much smaller, the risk is way down and so we judge that really on the basis of who the customer is and whether we want to roll them into core loans in our Company and then also what the economics of the outside are. +So I wouldn't expect us to change our course there. We will just look at the opportunities we have to keep moving in the right direction. On both servicing and assets we own too because remember, Paul, there's also the servicing side of this even though we don't own the asset, the is a strong bid. Even the agencies are moving to move some portfolios. + +-------------------------------------------------------------------------------- +Paul Miller, FBR & Co. - Analyst [24] +-------------------------------------------------------------------------------- + + Okay, thank you guys. + +-------------------------------------------------------------------------------- +Operator [25] +-------------------------------------------------------------------------------- + + Jim Mitchell, Buckingham Research. + +-------------------------------------------------------------------------------- +Jim Mitchell, Buckingham Research - Analyst [26] +-------------------------------------------------------------------------------- + + Just want to follow up on the capital discussion. You guys had pretty good progress on the advanced approach, up 50 basis points quarter over quarter but the gap between standardized and advanced is still very large. And I guess if you have to go through with the full 100 basis points, I guess about 120 basis point gap versus your peers that are less than half that. I guess -- is the big difference operational risk because of the larger litigation you faced over the last couple of years and how do we think about that coming down and getting more in line with the peers? Is that just a time as you get further away from that, those op risks come down or how else do we think about the trajectory of the closing of the gap? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [27] +-------------------------------------------------------------------------------- + + No, your point is exactly right, which is that as we talked about last quarter that the op risk relative to the total advanced RWA was upwards of 30%. That's obviously higher than our peers. It is something that we are working hard on to be able to drive down. And to your point, the question is when are you able to get benefit from a declining litigation trend as we wrap up the legacy matters and that does take some time. Obviously the last two quarters from a litigation perspective have been much lighter than what we experienced going back several years. So it is up to us to continue to work that and to look to convince people that the level op risk capital should come down given the resolution of the matters. +And I would just highlight that we once again whether you look at Article 77, there was an Ocala litigation matter that was wrapped up as well as on the RMBS front with settlements that we got through this quarter were at roughly 99% of all threatened or filed litigation with respect to RMBS. So we continue to work through that and drive through that and ultimately the benefit from that should be lower op risk capital from an RWA perspective. + +-------------------------------------------------------------------------------- +Jim Mitchell, Buckingham Research - Analyst [28] +-------------------------------------------------------------------------------- + + Right and sorry, is that sort of a negotiation process on the models with regulators, so is it going to be sort of a step function or is it just really just time value as you move further away? I'm just trying to understand the process. + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [29] +-------------------------------------------------------------------------------- + + I think in all these cases clearly that we work closely with our supervisors on all model related activity and as you look to make changes that are to the good you obviously need to work through your regulators to get those put through. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman, President and CEO [30] +-------------------------------------------------------------------------------- + + As you think forward remember you saw a good capital build this quarter and we will continue to build. But remember that if we keep on the course of earnings that we expect -- and the issue wasn't CCAR last year when we went to the ask. You have to remember we came off a really low nominal earnings environment and so we retain a lot of capital between now and the next time we can ask to actually change the capital position of the Company and we have a big cushion. +So we will close this gap relatively quickly and then we have a longer-term question of what you are saying which is as op risk runs off, how do you get that reflected ultimately in your capital requirements and the same with the models and the other [side]. + +-------------------------------------------------------------------------------- +Jim Mitchell, Buckingham Research - Analyst [31] +-------------------------------------------------------------------------------- + + Right. And to your point, the stress test is based on standardized, not advanced. +But just one quick follow-up elsewhere, on the FICC revenues, can you talk about the trajectory over the quarter? Did it improve in March? It sounded like some of your peers have talked about a slow start. Did it get any better in March, or how do we think about the trajectory through the quarter? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [32] +-------------------------------------------------------------------------------- + + I am always hesitant to comment on results given that we are nine days into a new quarter but I think if you look at what we saw from both I would say both a sales and trading as well as an overall investment banking fee perspective, the January on the margin was a little bit slower than what we would've expected and we saw activity and momentum build up throughout the quarter to where if you had to grade which of the three months of the quarter did you feel best about, it was clearly March. And like I said, we are only nine trading days into the new quarter but we have not seen anything change directionally. Some of the activity that we saw in March, we have continued to see in April. + +-------------------------------------------------------------------------------- +Jim Mitchell, Buckingham Research - Analyst [33] +-------------------------------------------------------------------------------- + + Okay, great. That's very helpful. Thanks. + +-------------------------------------------------------------------------------- +Operator [34] +-------------------------------------------------------------------------------- + + Glenn Schorr, Evercore ISI. + +-------------------------------------------------------------------------------- +Glenn Schorr, Evercore ISI - Analyst [35] +-------------------------------------------------------------------------------- + + Quick question on Proposal 8 in the proxy. I don't think the regulators want it to happen. I don't think it should happen and I assume you have been doing a lot of the work on this along the way for the last couple of years. But curious why the Board is so against shareholders voting for it and what you actually have to do if it does get the yes vote? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman, President and CEO [36] +-------------------------------------------------------------------------------- + + As I think you read the response in the proxy, Glenn, you will see this is a core Board duty and they do look at it periodically and think about the optimal company structure, capital structure. So the idea to have a special element around it is really the whole Board looks at it and that is who should look at it. So then the technical terms of what the request is are a little hard to understand when you think about how a company really operates. But we do look at the question of do we have the optimal business mix? Is it optimal for shareholders? And the Board will look at it continuously and we will continue to look at it. + +-------------------------------------------------------------------------------- +Glenn Schorr, Evercore ISI - Analyst [37] +-------------------------------------------------------------------------------- + + Okay. I appreciate the comments you made on the increased asset sensitivity and if I remember the numbers correctly, it sounds like more of the increased sensitivity came out on the long end. So I guess my question is, it is great you make a lot more money if the curve shifts up 100 basis points. But I think a lot of people are more fearful of what happens if we get into a [flattener] environment. So is it is simple as you capture at least half by short rates going up and if we're in a flattener, that's where it ends? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [38] +-------------------------------------------------------------------------------- + + A couple of things, Glenn. The first is that in many respects we were at 3.5/3.6 at the end of the year and we went to 4.5/4.6 this quarter. Keep in mind that a chunk of what you see as far as becoming more asset sensitive is just the FAS 91 that we lost during the quarter. So I'd keep that in mind. +And to your point you are exactly right. If you looked at where we were at year end, I think we were just over in the 2.1 to 2.2 benefit from short rates moving and that has not changed materially. So to your point, the asset sensitivity is based almost solely on long-term rates and given the deltas that we saw change from the end of the year to the end of the first quarter. + +-------------------------------------------------------------------------------- +Glenn Schorr, Evercore ISI - Analyst [39] +-------------------------------------------------------------------------------- + + Okay. I appreciate it. Thank you. + +-------------------------------------------------------------------------------- +Operator [40] +-------------------------------------------------------------------------------- + + John McDonald, Sanford C. Bernstein. + +-------------------------------------------------------------------------------- +John McDonald, Sanford C. Bernstein & Co. - Analyst [41] +-------------------------------------------------------------------------------- + + Just a follow-up on in terms of if rates stay pretty flat, what kind of outlook would you have for the core NII if we take the 10.2 this quarter as a jumping off point? Do you have any room to lower the debt costs from here or how would you expect the core NII to trend if we don't see too much movement on rates? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [42] +-------------------------------------------------------------------------------- + + It is something we have spend a lot of time on, John. When we got to the end of the first quarter we looked at and said during the balance of 2015 what is the impact that we would see if in effect we rolled a spot throughout 2015, which just means that you don't get the benefit of the curve as we go through. And if you look at that, it is roughly a couple hundred million dollars a quarter relative to $10 billion of NII. +So we think that we've done between the debt footprint, deposits and if you actually look at the clean yields during the quarter Q4 to Q1 that we've done a pretty good job of managing this exposure in what has been a tough environment. But to your question, there is probably a couple hundred million dollars a quarter in risk if you roll the spot. + +-------------------------------------------------------------------------------- +John McDonald, Sanford C. Bernstein & Co. - Analyst [43] +-------------------------------------------------------------------------------- + + Got it. Okay and that's couple hundred million over a couple of quarters, Right? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [44] +-------------------------------------------------------------------------------- + + It would be about $200 million per quarter over the next three quarters. + +-------------------------------------------------------------------------------- +John McDonald, Sanford C. Bernstein & Co. - Analyst [45] +-------------------------------------------------------------------------------- + + Got it. And that's just kind of core leakage from new stuff coming on or lower yields and you not investing much in a low rate environment? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [46] +-------------------------------------------------------------------------------- + + That's correct. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman, President and CEO [47] +-------------------------------------------------------------------------------- + + Yes, and continuing to shorten the balance sheet every time we get a chance to. + +-------------------------------------------------------------------------------- +John McDonald, Sanford C. Bernstein & Co. - Analyst [48] +-------------------------------------------------------------------------------- + + Okay. And then just switching gears, Bruce, on the credit side, do you see the net charge offs kind of bouncing around the $1 billion per quarter level, or is there room for those to come down or is that kind of stabilizing? And how should we think about reserve releases from here relative to the 400 or so you did this quarter? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [49] +-------------------------------------------------------------------------------- + + A couple of things on that. I would say we continue to see, John, if you look at within the consumer space and overall consumer credit that the first quarter typically all of the things being equal is the toughest consumer quarter in the first quarter. So I think there's probably a little bit of room there if we continue to see what we see in the economy on the consumer side. +The tougher piece of it is probably to judge commercial because outside of what we see in the small business lending, there really haven't been many charge offs and we will just have to see how long that benign environment covers. +On the reserve release for the quarter, the one thing I want to make sure that we point out that while we release 400 plus of reserves, 200 of that was from the DOJ where with the mailings you had both charge-offs and reserve release, so as it relates to just from a -- as you look at the provision perspective, realize that which impacted the provisions is more like 200. + +-------------------------------------------------------------------------------- +John McDonald, Sanford C. Bernstein & Co. - Analyst [50] +-------------------------------------------------------------------------------- + + Okay. So that should be something -- the jumping off point is more like a 200 reserve release number? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [51] +-------------------------------------------------------------------------------- + + Yes. And I think we have said that we clearly expect reserve releases to moderate, so we will have to see as we roll into the quarters. But I think you are directionally right on your charge-off number and we will see if there's anything left in the reserve releases as we go through the second and third quarters. + +-------------------------------------------------------------------------------- +John McDonald, Sanford C. Bernstein & Co. - Analyst [52] +-------------------------------------------------------------------------------- + + Okay. Last quick thing for me. In terms of rep and warrants, the slide 26, not sure if you mentioned this already, Bruce, there was a pickup in the claims, the new claims this quarter showed a big increase. Just what is the driver of that? Why would those show up now? And any color you can provide on whether that is a concern or not. + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [53] +-------------------------------------------------------------------------------- + + Yes, I think you need to go down to and we lay it out in the footnote but if you start up in the new claim trends, if you recall there is a case going through where the statute of limitations on rep and warrant claims in the ACE case was found -- the statute was six years and if you look at the claims that you see up in the new claim trends, you can see virtually all of those claims were in the pre-2005 through 2006 area. So absent any tolling, a good chunk of those are going to be time barred. +The other part that -- the other point that I would mention is if you go down to the footnote you can see that the vast majority of these claims were put in with no file work done on whatsoever or no individual loan work that was done. +So I think there continues to be obviously activity on that front but there is not a lot of work being done as those claims are being filed. + +-------------------------------------------------------------------------------- +John McDonald, Sanford C. Bernstein & Co. - Analyst [54] +-------------------------------------------------------------------------------- + + Okay. Thank you. + +-------------------------------------------------------------------------------- +Operator [55] +-------------------------------------------------------------------------------- + + Steven Chubak, Nomura. + +-------------------------------------------------------------------------------- +Steven Chubak, Nomura Asset Management - Analyst [56] +-------------------------------------------------------------------------------- + + So Bruce, I just wanted to touch on the preferreds for a moment. So saw that you completed another $3 billion of issuance in the quarter. But seeing as you are already at the 150 basis point target contemplated under Basel III, whether it's fair to assume that you are now full on press at the moment and we shouldn't expect any additional issuance? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [57] +-------------------------------------------------------------------------------- + + Yes, I think you're absolutely right that we got the bucket filled up this quarter. I think the only thing that is out there is depending on exactly where we come out from an overall RWA perspective as we exit parallel run. That beyond 2015, could there be a couple billion dollars more preferred sometime during 2016? That's a possibility but you are absolutely right that based on where we are from an RWA perspective, the bucket is filled up, so we don't see much if any at all in 2015. Maybe a little bit in 2016 but not much. + +-------------------------------------------------------------------------------- +Steven Chubak, Nomura Asset Management - Analyst [58] +-------------------------------------------------------------------------------- + + Excellent. Thanks for clarifying that, Bruce. And I suppose since you mentioned RWA, one thing that I just wanted to clarify, I believe it was relating to your response to Jim where you noted that for CCAR it only contemplates a standardized approach. But I just wanted to know if that determination had been finalized since some are speculating that the advanced approach could be incorporated within the CCAR exam going forward? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [59] +-------------------------------------------------------------------------------- + + Yes, there is an open question out there that you are absolutely right that for the different CCAR submissions that went in in 2015, that those submissions are against the standard ratios. And as an industry, we just don't know the answer if we will test under just standardized in CCAR 2016 or if advanced will be brought in. That is an open question that is out there for the industry. + +-------------------------------------------------------------------------------- +Steven Chubak, Nomura Asset Management - Analyst [60] +-------------------------------------------------------------------------------- + + And do you have a sense at least for the moment as to what the impact would be on RWAs if they were to incorporate the advanced approach versus the standardized? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [61] +-------------------------------------------------------------------------------- + + I think if you look at the numbers you can see the difference that we have within our numbers. As to advanced, I think the open question that is out there as you look at moving to advanced in a CCAR scenario is that under advanced you hold capital for op risk and then that there's the open question if you go to stress test under advanced, what do you do with respect to CCAR in those op risk litigation type items? And like I said, that is an open question for the industry. + +-------------------------------------------------------------------------------- +Steven Chubak, Nomura Asset Management - Analyst [62] +-------------------------------------------------------------------------------- + + Right. But would it be fair to expect that because it is a -- the advance calculation is more procyclical in nature that the RWAs calculated under a period of stress would be higher versus the standardized? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [63] +-------------------------------------------------------------------------------- + + There is no question that there is a procyclical aspect of it that intuitively I think you are right but it is just until you understand exactly the completeness and the entire picture of what you are looking at, I just don't want to speculate. + +-------------------------------------------------------------------------------- +Steven Chubak, Nomura Asset Management - Analyst [64] +-------------------------------------------------------------------------------- + + Fair enough. That's it for me and thank you for taking my questions. + +-------------------------------------------------------------------------------- +Operator [65] +-------------------------------------------------------------------------------- + + Ken Usdin, Jefferies. + +-------------------------------------------------------------------------------- +Ken Usdin, Jeferies LLC - Analyst [66] +-------------------------------------------------------------------------------- + + I was wondering if you could talk a little bit about the investments in brokerage services business. The metrics continue to look very strong as far as assets gained but the growth rate on a year-over-year basis looks like it has slowed considerably. Any context you can provide around revenue generation and is there a potential catch up that we should see or expect going forward based on either markets or just activity levels? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman, President and CEO [67] +-------------------------------------------------------------------------------- + + From a high-level that team has continued to invest and grow and there is a couple of things driving that. One is they are adding more core advisors. So in the last 12 months I think we added 120 experienced advisors and we added almost 900 total. So there's a carry cost to bring those up but that is good for the future. +The second thing is there's a little bit of a business mix issue which is that the investment management side of the business continues to grow but we have seen weakness in the brokerage transactional side just as the business gets repositioned in that sort of year-over-year is enough to hit you. +And then third, frankly, is that the NII that Bruce pointed out earlier, just the way we allocate and we won't let businesses take an excuse for intercompany allocations but the way we allocate year-over-year, a big chunk of the NII loss is just due to the way we allocate out the impact on the market and less NII. + +-------------------------------------------------------------------------------- +Ken Usdin, Jeferies LLC - Analyst [68] +-------------------------------------------------------------------------------- + + Okay. And then secondly, just extending that to the other consumer fee lines, card income flattish and service charges down a bit. Is this customer behavior driven or additional repositioning in there and can you talk about growth expectations on the consumer side as well? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman, President and CEO [69] +-------------------------------------------------------------------------------- + + I think as Bruce talked about earlier, if you think about a couple of broad things. One is, as we continue to drive to be the core checking account for households, we are seeing higher sales. We are seeing higher primary sales but with that comes less fees in the sense but the average balances are higher. And so what you're seeing is a flattening of the fees charged on accounts, overdraft and other fees while you see an increase in the consumer balances, which in this environment are worth something but will be worth a lot more as rates rise because these are core checking account. +So there is some elements of how the business has been shifted based on our priority of making sure that we just don't have a lot of checking accounts, we have a lot of core checking accounts and that has caused it. So you are seeing a far faster growth and balances and actually a slight decline in total checking accounts out there. +When you put debit fees and other fees plus the interest rates together, which is core checking revenue, it's actually a little better picture. But that is kind of the story there. +On the credit card fees, it is basically we have absorbed most of the compression on the interchange at this point in the rebates we give. So really year-over-year you have a bit of loss there because we added a divestiture of a big Affinity program, two big Affinity programs that hurt us and you should expect to see that a little bit more in line with our spending growth going forward, which has been about 3%, 4%. + +-------------------------------------------------------------------------------- +Ken Usdin, Jeferies LLC - Analyst [70] +-------------------------------------------------------------------------------- + + Okay. And then last one, just Bruce, you mentioned on the discretionary portfolio on the switch out to HQLA. Can you give us a sense of just how much more of that mix shift we should expect or at some point do you get to a point where the loan portfolio finally starts to bottom out? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [71] +-------------------------------------------------------------------------------- + + I think a couple of things. So the shift to the discretionary portfolio, you probably have about $5 billion of that in each of the second quarter and the third quarter of this year and at that point that work is done. I would say as you look at just discretionary mortgage balances and what you are seeing from a payments for the old stuff that was put within the investment portfolio, you are probably looking at before what the new is that we put on within the business that you are in the $10 billion to $14 billion type run off in each of the next couple of quarters. Realize all of that net interest income doesn't go away because there is reinvestment of that and there is new loans coming in but you do have probably two more quarters where we will move stuff into securities and obviously there does continue to be a run-off of that portfolio as well. + +-------------------------------------------------------------------------------- +Ken Usdin, Jeferies LLC - Analyst [72] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Operator [73] +-------------------------------------------------------------------------------- + + Eric Wasserstrom, Guggenheim Securities. + +-------------------------------------------------------------------------------- +Eric Wasserstrom, Guggenheim Securities - Analyst [74] +-------------------------------------------------------------------------------- + + Just one quick question on the legal expense that was incurred in this period. Are those issues now the FX and the RMBS, are those issues now settled or are they ongoing? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [75] +-------------------------------------------------------------------------------- + + The RMBS piece I quoted, there were both amounts in litigation for things that were settled as well as accruals during the quarter. And once again, Eric, I would go back to that from an RMBS perspective at this point we are 98% or 99% of threatened or filed claims on original UPB that we're through, so that's where we are with the RMBS. +With respect to the FX piece, I think if you go back and look at where we said that we were in October, that we resolved the matter with the OCC, the top up that we saw in the quarter related to FX with respect to other banking regulators and there was also the resolution and we are working through the final documentation of the civil piece of the overall FX work. And that is all included within the litigation reserve during the quarter. + +-------------------------------------------------------------------------------- +Eric Wasserstrom, Guggenheim Securities - Analyst [76] +-------------------------------------------------------------------------------- + + Okay. And sorry, just so I understand that last point -- the civil component, is that with the DOJ or some other kind of authority? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [77] +-------------------------------------------------------------------------------- + + No, the civil piece with respect to a class-action type matter, not the DOJ. + +-------------------------------------------------------------------------------- +Eric Wasserstrom, Guggenheim Securities - Analyst [78] +-------------------------------------------------------------------------------- + + Oh, I see. Okay. But that was contained within the accrual in this period? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [79] +-------------------------------------------------------------------------------- + + That is correct. + +-------------------------------------------------------------------------------- +Eric Wasserstrom, Guggenheim Securities - Analyst [80] +-------------------------------------------------------------------------------- + + Okay, great. Thank you for the clarity. + +-------------------------------------------------------------------------------- +Operator [81] +-------------------------------------------------------------------------------- + + Mike Mayo, CLSA. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA Limited - Analyst [82] +-------------------------------------------------------------------------------- + + What are your financial targets for 2015 and 2016? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman, President and CEO [83] +-------------------------------------------------------------------------------- + + So, Mike, as we said, our goal is to continue to drive towards the 1% return on assets and depending on where we end up with capital between 7.5% and 8% tangible common equity ratio, that would translate into a 13 down to 12 return on tangible common equity. In this quarter we moved to up to where we have a return on tangible common equity is 8% and so -- and our return on assets was 64 basis points, so we are sort of two-thirds of the way to that goal. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA Limited - Analyst [84] +-------------------------------------------------------------------------------- + + And what timeframe do you expect to get then? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman, President and CEO [85] +-------------------------------------------------------------------------------- + + I think if you adjust our earnings this quarter for a couple of things, the FAS 123, the FAS 91 and then continue to think of LAS normalizing, you see us get close to that goal and that should happen between now and the end of 2016 because we just keep chunking away at LAS as we have described. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA Limited - Analyst [86] +-------------------------------------------------------------------------------- + + So is that your specific financial target -- what is your target for 2015 when it comes to your financial metrics? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman, President and CEO [87] +-------------------------------------------------------------------------------- + + I think the way you asked that, we basically have to give you our earnings estimates for 2015 and we just don't do that. But our targets long-term we told you each time you asked is the same, 1% return on assets and a 12%, 13% return on tangible common equity based on where we think our tangible common equity ratio will settle out. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA Limited - Analyst [88] +-------------------------------------------------------------------------------- + + Okay. I guess when I look back at 2014 I ask myself the question did Bank of America meet its financial targets? And I have trouble because I'm not sure if you had specific targets just for the year 2014 as opposed to your longer-term targets. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman, President and CEO [89] +-------------------------------------------------------------------------------- + + We made $4 billion in change last year against the expectation by you and your colleagues of $15 billion. So clearly we didn't meet the financial targets due to the litigation we took last year. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA Limited - Analyst [90] +-------------------------------------------------------------------------------- + + Okay. Let me just ask a separate question then. Glenn Schorr brought up Proposal 8 and the proxy and I guess my reaction is why not give more information on the trade-offs of the business model? One of your competitors gave three slides on this topic at their investor day. They weren't asked to do this and they have some higher ROE and ROA. So more information I think would be good and in the proxy it says that your Board believes that the proposal would not enhance stockholder value. If that is the conclusion of the Board, just why not share some of the insights of the Board to investors? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman, President and CEO [91] +-------------------------------------------------------------------------------- + + The insights we have when you look at the returns on page two or three of the material show that the core businesses return is above our cost of capital and that the mix between them and the revenue synergies and the diversity we get have been there. +But let's back up. What a lot of people are looking at here, Mike, is can you simplify your company to make it tighter? We started that in 2010 with about $2.4 trillion in assets. We are down to $2.1 trillion. We started with about $70 billion in capital or $80 billion in capital. We are up to $140 billion. And we started by getting rid of 60 operating businesses and so we have done a lot of simplification. +So what is really left and this is one of the reasons why our market business is more constrained in its growth prospects potentially than some other people's is because we keep it to about one-third of the franchise in terms of size. And that market business is really focused on driving the value of our issuer side customers going to market and then with our investor side customers providing sources of capital for that. So it's a very synergistic basis. +So we will continue to try to provide insight but if you look at it, the businesses return above their cost of capital and then if we put them out there the question would be what we would look like after and we would have capital we can't deploy and we would have less earnings power. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA Limited - Analyst [92] +-------------------------------------------------------------------------------- + + All right. Well if you can share additional insights into that conclusion in addition to what you just gave that would be great at least in the future. Thanks a lot. + +-------------------------------------------------------------------------------- +Operator [93] +-------------------------------------------------------------------------------- + + Nancy Bush, NAB Research. + +-------------------------------------------------------------------------------- +Nancy Bush, NAB Research - Analyst [94] +-------------------------------------------------------------------------------- + + I have one straightforward question and one that is more existential. I will ask the straightforward one first. Brian, could you just restate your position on paying or raising the dividend? I know the CCAR this year has distorted that a bit and if you could just state how you feel about dividends versus buybacks? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman, President and CEO [95] +-------------------------------------------------------------------------------- + + I think number one in terms of we received approval for what we had asked for which is a nickel a share of dividend and $4 billion of stock buyback in the CCAR. And we had to be conservative in that ask, leaving aside the modeling and other questions -- but this had to be conservative in base ask because if you think about it, our run rate of earnings was such that we were coming off a $4 billion plus earnings quarter. We had to keep our head on in terms of how we were accumulating capital and make sure we earned the capital before we paid it out. +The second thing is that the $22 billion cushion shows that based on all the works at CCAR we have a strong cushion going forward. So the key for us to be able to increase the dividend and continue to push forward is to get that normalized earnings stream in a couple of quarters, $3 billion plus in earnings we are getting. +Long-term we have said many times our ultimate goal is to take about 30% of our recurring earnings and pay it out in dividends and then to use the rest for capital management. At this price we would be buying stock back and if there's a different scenario where our multiple to book and earnings multiples are higher we might pay additional dividends but the goal would be about a 30% payout ratio of recurring earnings as we get there. + +-------------------------------------------------------------------------------- +Nancy Bush, NAB Research - Analyst [96] +-------------------------------------------------------------------------------- + + Okay, thank you. The second one is this and this is maybe a little bit more difficult to answer. You had a good trading quarter but we have seen one of your competitors have a much better trading quarter and I know that there is a mix issue there. But also as I kind of look at the composition of your businesses there, have you de-risked the trading desk to the point where you can't really take full advantage of the volatility in markets? And I'm wondering if you see that as the case? And secondly, if there will come a time when you are able to do some re-risking there? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman, President and CEO [97] +-------------------------------------------------------------------------------- + + Nancy, what you asked is really the core question, which is if you look a few years ago we put core capital Global Markets out as a separate reported segment to ensure that people saw that that was a less volatile earnings stream than people perceived and it was not the earnings stream of the Global Banking segment, high investment banking which you can see the fees move up or down and were relatively stable in clearly the loan book and the treasury services. So we tried to sort the businesses so people can see what we are doing with Global Markets. +Based on our capital and based on our view of how the franchise fits together, we keep that business to about one-third of our total size. So this total balance sheet deployed is under $600 billion and has been for years. That then requires Tom and the team to make a series of choices how they deploy that based on our appetite for risk expressed by VaR, our appetite for size expressed by the $600 billion, which other people have far bigger balance sheets deployed in the business. And that then does limit their ability to take risk and do certain things. +So there is a mix issue based on this quarter. In other quarters we have performed better relatively and that is this issue. But from a core standpoint, it's not an existential question at all. It's an actual determination we made to have our SIFI buffer lower, to have our overall risk lower to man demand the company, which is really customer focused on the core banking middle markets, franchise and the core investor, it would still be big enough to be a very impactful, number one research house in the world and have $3.5 billion, $4 billion of revenue in a given quarter. We had to basically optimize around size, capital, the capital deployed in the business and then the risk we were willing to put in the P&L and that's where we ended up and that's resulted in us having 100 basis points less SIFI buffer requirement than other people. +And we think that's balanced because with our book of business if we increased that, we've got to carry that 100 basis points across the whole franchise, not just the markets business and that extra capital in our balance would really increase the capital requirements that is really not needed for our core banking business. + +-------------------------------------------------------------------------------- +Nancy Bush, NAB Research - Analyst [98] +-------------------------------------------------------------------------------- + + So basically you are happy with the trading desk as it is? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman, President and CEO [99] +-------------------------------------------------------------------------------- + + No. We are always -- never happy because we always wanted to do better. But on the other hand, it is fair to say that we are not unsatisfied when we make almost $1 billion after tax in the quarter where they had a couple of big elements. This mix in the macro businesses, which we are positioned in on purpose. And then secondly, remember a core part of our business we are still adjusting to which was the leverage finance transaction business, which you can look at is down dramatically year-over-year as we adopted the guidance and what was acquired. That is through the numbers now and then we will build back based on that business doing it the way that meets the regulatory standards. +So happy -- we are never happy with any business. We are always pushing them to do better but given the constraints, there is an understanding I would say more than happiness of where we ended up. + +-------------------------------------------------------------------------------- +Nancy Bush, NAB Research - Analyst [100] +-------------------------------------------------------------------------------- + + Okay, thank you. + +-------------------------------------------------------------------------------- +Operator [101] +-------------------------------------------------------------------------------- + + Brennan Hawken, UBS. + +-------------------------------------------------------------------------------- +Brennan Hawken, UBS - Analyst [102] +-------------------------------------------------------------------------------- + + A quick follow-up on the op risk questions. So if we still have pending settlements out there on a few of the remaining large issues, could that lead to op risk at least sustaining at elevated levels and could it even potentially cause a little bit of an uplift there? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [103] +-------------------------------------------------------------------------------- + + I think at this point we have walked through and as we said on the last call that we are at the level that we need to be from an overall op risk perspective. And to your point, if we look at the last two quarters relative to when that op risk capital was set, we have seen fairly sizable declines in overall litigation expense. So you obviously work through that but our belief over time is that number should be less, not more but we need to deliver that to the shareholder. + +-------------------------------------------------------------------------------- +Brennan Hawken, UBS - Analyst [104] +-------------------------------------------------------------------------------- + + Yes, from your lips to God's ears, but if we still have some potential settlements my only point is that it might take a little while before we end up seeing that come down. Isn't that a similar reason? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman, President and CEO [105] +-------------------------------------------------------------------------------- + + (inaudible). Just as we said, there's a bid ask on the RWA related to commercial credit factors and models. There was a bid ask an operating risk. We closed that out and we have actually moved our RWAs to a number of those asks. And then from then you just look at it very simply, think about the last four quarters versus last year just picking up the third and fourth quarter, you have a complete change in the amount of litigation expense that is gone through the enterprise and you will see that keep rolling through. It will take a while for that to average out but basically assume that we've agreed to an amount which was requested to bring our op risk and we put that through last quarter. + +-------------------------------------------------------------------------------- +Brennan Hawken, UBS - Analyst [106] +-------------------------------------------------------------------------------- + + Okay, thanks. And then it seems some high-level turnover in your equities business. Can you comment maybe on what is driving some of those departures, any potential implications and what you are doing about it? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman, President and CEO [107] +-------------------------------------------------------------------------------- + + Yes, we have had some retirements of people worked in the business for 25 years, Henry and the team and it's just the ebb and flow of business. I don't think there's any major issues going on there. I think that (inaudible) and the team have done a good job and stabilized that business and brought it back. We continue to work on the prime brokerage side to make sure that we can be positioned to restart that engine of growth. Now we had to hold the business back where we got the operating platform in place to where we wanted (technical difficulty) not this past fall but the fall before. +So I think you should not read anything into that other than the usual ebb and flow of people deciding to do other things. + +-------------------------------------------------------------------------------- +Brennan Hawken, UBS - Analyst [108] +-------------------------------------------------------------------------------- + + Okay. Thanks for that color. And then the last one for me following up on Ken's question, it sounds like the FA headcount adds are sort of biased a little more to the junior side. So should we count on a bit of a headwind from that on your productivity metrics in GWIM? And maybe could you also comment on the recruiting environment currently and if you still think that comp may moderate as some of those deals with FAs from crisis level sunset? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman, President and CEO [109] +-------------------------------------------------------------------------------- + + The average deal last year I think was -- for the highest end producing FAs, which there were 100 of, 120 of, the average deal was like 1.27 times trailing 12 or something like that, or slightly less than that. Don't hold me to those exact numbers but think of it conceptually. So the rumors about these payouts are probably far in excess. The reality is only 120 people or so. So take whatever number. So let's broaden out the productivity question. The productivity per advisor in our business is extremely strong and has sort of structurally been strong for many years and continues to increase. +You wouldn't mind diluting that to get faster long-term growth prospects for the business and broaden out the business and that is what John and the team are doing. Whether it goes down or not is really going to be a factor. How fast the revenue stream grows -- it has been outgrowing that impact of investing in the lower-end business but we aren't -- I wouldn't say it is going to go down or up based on the added younger advisors but let's flip that and say that the way we think this business has to drive for our competitive advantage as a franchise is the linkage from preferred to Merrill Lynch Wealth Management and the interaction between the financial services centers and the people that come in there and the tens of thousands of people that get referred to Merrill is a competitive advantage for Merrill. And we will continue to drive that and part of that connectivity is we are now putting Merrill team-based brokers in the branches to work with clients and ultimately move physically onto the teams in the offices. +So we've got a lot of programs going. They seem to be working very well. It could dilute the productivity a little bit but it would be immaterial because of the strength of the core franchise is so strong. + +-------------------------------------------------------------------------------- +Brennan Hawken, UBS - Analyst [110] +-------------------------------------------------------------------------------- + + Thanks for the color. + +-------------------------------------------------------------------------------- +Operator [111] +-------------------------------------------------------------------------------- + + Jeff Harte, Sandler O'Neill. + +-------------------------------------------------------------------------------- +Jeff Harte, Sandler O'Neill & Partners - Analyst [112] +-------------------------------------------------------------------------------- + + A couple from me. First of all, you mentioned the commercial utilization rate being up a lot. Can you give me some or give us some idea of how much of that is energy complex driven versus maybe coming from other less stressed industries? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [113] +-------------------------------------------------------------------------------- + + Most all of that given that the number I quoted was within the commercial bank, that's almost exclusively outside of the energy space so it has nothing to do with anything distressed. It is just core commercial clients drawing more. Those numbers bottomed out in the low 30s and they are now up in the high 30s. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman, President and CEO [114] +-------------------------------------------------------------------------------- + + Think of that, when we say commercial, that is middle-market, general middle-market for us. Not the corporate bank where the energy exposure would be. So it is back to basically where it was not the highest point because it ran up right before the crisis but if you look back, it is higher than it was in say 2004 and 2005 at this point, or right on it. So you're starting to see a normalization of that borrowing, which is good news because that means that people are borrowing the money to do something. + +-------------------------------------------------------------------------------- +Jeff Harte, Sandler O'Neill & Partners - Analyst [115] +-------------------------------------------------------------------------------- + + Okay. And looking at the balance sheet, can you talk a little bit about the plans, the level of excess cash? 22% of assets in cash, a 7% plus SLR ratio. It would seem awfully tough to generate ROE or ROA with that much of the balance sheet sitting in cash. Is there something you can do there? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [116] +-------------------------------------------------------------------------------- + + I think the first thing as you look at that, you have to consider as we went through with the different regulatory metrics we needed to get to that the last metric that we needed to solve for and we wanted to get behind us was the satisfaction of where we needed to be from an LCR perspective in 2017 at both the bank level as well as the parent. And we are to the point where we've gotten to that point, so from an overall liquidity HQLA perspective, we feel very good about that progress. +As you look at on a go-forward basis, obviously the big focus and the reason as a company that we are looking to drive the loan growth that we have is to basically take the excess deposits today that are within the investment portfolio and release them from the investment portfolio into core loan activity to do more with our clients. +So as you look at the changes and mix in the balance sheet as far as the build that you've seen with cash, I think we are at the point where from an overall balance and where we need to be with the different metrics, that we have satisfied that at this point and it will be more of a normal course on a go-forward basis. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman, President and CEO [117] +-------------------------------------------------------------------------------- + + I think generally thematically if you think about, as we see roles come up we try to get in full compliance as fast as possible even though there is delay dates and then you can then work back on how to continuously improve the way you get there. But the first thing you've got to do is get over the hump because it affects every other aspect of the franchise. And so I think the LCR is another case that we got over the hump. 2017 is two years away still and we are in compliance and then the idea is that you keep -- to figure out how to work the dials to make it more and more shareholder friendly over time. But the first thing you want to do is show you can do it. + +-------------------------------------------------------------------------------- +Jeff Harte, Sandler O'Neill & Partners - Analyst [118] +-------------------------------------------------------------------------------- + + Okay, thank you. + +-------------------------------------------------------------------------------- +Lee McEntire, Bank of America Corporation - SVP, IR [119] +-------------------------------------------------------------------------------- + + I think that was the last question. Thanks for joining today and we will talk to you next quarter. + +-------------------------------------------------------------------------------- +Operator [120] +-------------------------------------------------------------------------------- + + This concludes the program for today. Thank you for your participation. You may now disconnect and have a nice day. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/exam/original-files/Problem_1_Sample/2015-Apr-22-FB.OQ-141043150939-Transcript.txt b/exam/original-files/Problem_1_Sample/2015-Apr-22-FB.OQ-141043150939-Transcript.txt new file mode 100644 index 0000000..698edc6 --- /dev/null +++ b/exam/original-files/Problem_1_Sample/2015-Apr-22-FB.OQ-141043150939-Transcript.txt @@ -0,0 +1,587 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q1 2015 Facebook Inc Earnings Call +04/22/2015 05:00 PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Deborah Crawford + Facebook Inc. - VP of IR + * Dave Wehner + Facebook Inc. - CFO + * Mark Zuckerberg + Facebook Inc. - Chairman & CEO + * Sheryl Sandberg + Facebook Inc. - COO + +================================================================================ +Conference Call Participiants +================================================================================ + + * Justin Post + BofA Merrill Lynch - Analyst + * Youssef Squali + Cantor Fitzgerald - Analyst + * Eric Sheridan + UBS - Analyst + * Ben Schachter + Macquarie Research - Analyst + * Brian Pitz + Jefferies LLC - Analyst + * Ross Sandler + Deutsche Bank - Analyst + * Paul Vogel + Barclays Capital - Analyst + * Heather Bellini + Goldman Sachs - Analyst + * Mark Mahaney + RBC Capital Markets - Analyst + * Brian Nowak + Morgan Stanley - Analyst + * Douglas Anmuth + JPMorgan - Analyst + * Mark May + Citigroup - Analyst + * John Blackledge + Cowen and Company - Analyst + * Peter Stabler + Wells Fargo Securities - Analyst + +================================================================================ +Presentation +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Good afternoon. My name is Chris and I will be your conference operator today. At this time, I would like to welcome, everyone to the Facebook first-quarter 2015 earnings conference call. +(Operator Instructions) +Thank you very much. Ms. Deborah Crawford, Facebook's Vice President of Investor Relations, you may begin. + +-------------------------------------------------------------------------------- +Deborah Crawford, Facebook Inc. - VP of IR [2] +-------------------------------------------------------------------------------- + + Thank you. Good afternoon and welcome to Facebook's first-quarter earnings conference call. Joining me today to talk about our results are Mark Zuckerberg, CEO; Sheryl Sandberg, COO; and Dave Wehner, CFO. Before we get started, I would like to take this opportunity to remind you that our remarks today will include forward-looking statements and actual results may differ materially from those contemplated by these forward-looking statements. +Factors that could cause these results to differ materially are set forth in today's press release and on our annual report on Form 10-K filed with the SEC. Any forward-looking statements that we make on this call are based on assumptions as of today, and we undertake no obligation to update these statements as a result of new information or future events. +During this call, we will present both GAAP and non-GAAP financial measures. A reconciliation of GAAP to non-GAAP measures is included in today's earnings press release. The press release and an accompanying investor presentation are available on our website at investor.fb.com. +And now I'd like to and the call over to Mark. + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook Inc. - Chairman & CEO [3] +-------------------------------------------------------------------------------- + + Thanks, Deborah, and thanks, everyone for joining us today. This was a good quarter and a good start to the year. We continued to grow the size and engagement of our community, now with 1.44 billion people using Facebook each month, and 936 million people daily. +We continue to see strong growth in daily engagement around the world, including in our most engaged markets. On mobile, nearly 1.25 billion people now use Facebook every month, 240 million more than a year ago, and we now we see more than 1 billion mobile searches every day. +Looking at our business, we continue to achieve impressive growth. Total revenue grew by 42% year-over-year, and advertising revenue grew by 46%. Mobile now accounts for 73% of our ads revenue. These results show that we're making progress on our mission to connect the world and we're executing well against our priorities, but this quarter also shows how Facebook is continuing to make progress for the years ahead. +Facebook has evolved from a single blue app on your phone into a family of apps. Now many of these apps are reaching a global scale. More than 1.4 billion people use the core Facebook service, 800 million also use WhatsApp, 700 million use our groups product, 600 million use Messenger, and on Instagram, there are more than 300 million active members of the community. +We're building this family of apps because we want people to be able to share whatever moments they want with all the different sets of people they care about. Over time, we expect people to share richer content with an increasing frequency, so we want to continue developing new and better tools to facilitate this expression. With that in mind, let's talk about our efforts over the quarter. +First, we are working to help people share and connect with all the things they care about today. An important part of our approach is helping our community connect around important public moments and personalities. Facebook is the largest community of sports fans in the world, with 650 million people connecting to sports pages. +For this year's Super Bowl, more than 65 million people generated more than 265 million interactions on Facebook, the highest level of conversation we've seen for a Super Bowl to date. For the Cricket World Cup, there were more than 700 million interactions by 53 million people, which shows the strength of the global reach of our community. +We are also making good progress with video. We're very pleased with our growth share, and this quarter we reached a new milestone of more than 4 billion daily video views. We also launched an embedded video player that allows people to watch Facebook videos across the web, and more than 80,000 videos have now been embedded on third-party websites. +Spherical videos are going to be supported in Newsfeed later this year, allowing you to change your viewing angle for a more immersive experience. Supporting new types of content like this is an important part of preparing for the future of how people want to share. +Another part of our strategy is helping people connect with businesses. This quarter, we announced that there were now 2 million advertisers on Facebook. This is an important milestone for our community and we're encouraged that so many businesses are finding value on Facebook. We continue to focus on innovation in our ads business and Sheryl is going to talk a bit more about that in a moment. +Now, here's how we're working to develop our family of apps so we can give more people more options for sharing in different ways. In the future, we expect that people are going to want to share content with their closest friends at an even greater frequency than they do today, so messaging is a big priority for us. +Across the Facebook family of apps, our efforts have a lot of momentum. On average, more than 45 billion messages are sent every day. With voice calling, we're also starting to make some good progress. This quarter, we started rolling out voice over IP calls on WhatsApp to let people call friends for free around the world; meanwhile, Messenger already accounts for more than 10% of mobile VoIP calls globally. With WhatsApp, we continue to be pleased with our growth and the team remains very focused on building new features to serve their community and expand. +For Messenger, this has been a particularly busy quarter. We launched the Messenger platform, which allows people to use creative new apps to have richer conversations. We also began rolling out payments on Messenger to give people an easy, secure way to send money to their friends. +And we announced a new way for people to communicate with businesses using Messenger. We're really excited by the potential to build Messenger into a service that helps people to express themselves in rich new ways and to access useful services. +With Instagram, our growth remains impressive and this quarter we reached a new milestone of more than 200 million daily actives. Growth in Asia, Europe, and Latin America is particularly strong, with our community growing in some countries by more than 100% year-over-year, including Japan, South Korea, and Indonesia. Combined with an average 21 minutes a day that people spend on Instagram, this is a good sign of this community's continuing and growing strengths. +Now let's talk about how we're working with developers. Last month, we held F8, our annual event for the global developer community. Creating the future of sharing isn't something that we can do on our own, but by supporting developers, we can deliver more apps and experiences for our community. +At F8, we presented new tools to help developers build, grow, and monetize their apps, including better sharing experiences from apps to Facebook and new analytics to help developers better understand how people are using their services. More than 30 million apps and sites have been built using Facebook developer tools, and last year we drove more than 3.5 billion app installs. We think these improvements are going to create a lot of value for our community. +All right. Finally, let's talk about some of our most long-term innovation efforts. Internet.org, our effort to connect everyone in the world to the Internet continues to gather momentum. We've now made free basic Internet services available to more than 800 million people in nine countries, including, just in this quarter, launching in India, Colombia, Ghana, Guatemala, and the Philippines. More than 7 million people who weren't connected to the Internet before now use Internet.org to get online, and this year we expect to connect even more people. +With our efforts in search, AI, and Oculus, we're also continuing to build a new generation of Internet services that are more useful, intuitive, and immersive and over the coming months we'll have more to share about these. So that's how we're thinking about innovation and the future of sharing. +It's been a busy quarter. In the last few months, I've visited countries in Asia, Europe, and Latin America. In many communities, I've gotten the chance to see how the Internet is changing lives and creating opportunities for people. I've heard from people who can't wait to get access to the same tools that so many of us take for granted. +We are making progress on our mission and working to accelerate towards the day when everyone in the world can be connected. Thanks to our entire community and all of our employees, partners, and shareholders for being a part of this journey and for helping to build something great. Now here's Sheryl. + +-------------------------------------------------------------------------------- +Sheryl Sandberg, Facebook Inc. - COO [4] +-------------------------------------------------------------------------------- + + Thanks, Mark, and hi, everyone. Q1 was a strong quarter and a great start to the year. Ad revenue was $3.3 billion, up 46%, or 55% on a constant currency basis. Mobile ad revenue grew 82% and is now 73% of total ad revenue. Our performance was strong across all marketer segments and we are pleased with the broad-based growth across our industry verticals. +From a regional perspective, we saw strong growth in North America and Asia-Pacific, while Latin America and Europe were affected by foreign exchange headwinds and macroeconomic factors. That said, we are pleased with advertiser adoption of our ad products across all regions. +Innovation drives our ads business. It's how we continually improve the quality of our ads, offer new tools to marketers, and build better experiences for the people use Facebook. We believe that this ability to innovate will continue to drive our Business, so today I want to focus on innovation across our three strategic priorities: capitalizing on the shift to mobile, growing the number of marketers using our ad products, and making our ads more relevant. +First, capitalizing on the shift to mobile, mobile continues to be a great opportunity for us. People continue to be highly engaged with our mobile apps. In the United States for example, Facebook and Instagram get more than one out of every five minutes spent on mobile. As consumers shift to mobile, businesses are following and we're focusing on helping them take advantage of this opportunity to use mobile to build their businesses. +Two new products we introduced this quarter are good examples of this. The mobile Ads Manager app gives marketers the ability to manage their ad campaigns from their mobile devices. It's early, but we are already seeing more marketers managing their activity on mobile. We also launched a page creation tool for feature phones, which has been a big driver of page adoption in high-growth emerging markets, where smartphones are less common. +Looking ahead, we believe video will play a significant role in bringing more marketers to mobile. More than 75% of global video views on Facebook occur on mobile, and we believe mobile video will become more important to marketers over time. +Lionsgate Age of Adaline premiere is a great example. To promote the film, Lionsgate targeted young women on Instagram with multiple video ads over the last few weeks. This week, since the film opens on Friday, they are retargeting the audience from the Instagram campaign on Facebook. We expect more marketers to put mobile video at the heart of their campaigns in the future and we are well-positioned to drive this shift. +Our second priority is growing the number of marketers using our ad products and we're making great progress. In Q2 of last year, we shared that we reached 30 million active business pages on Facebook. This number continues to grow as more and more small businesses are using our free Pages product and we remain focused on converting these page owners into advertisers. +One way we're doing this is by providing simple, easy-to-use products. Over 80% of our new advertisers start with entry-level tools like a promoted post or a page like. We are increasingly focused on making sure these tools work well on mobile. We are also educating marketers on how to use Facebook more effectively. +We recently launched to online training resources, Blueprint for large clients and agencies, and Learn How videos for small businesses. These efforts are paying off. In Q1, we announced that we now have over 2 million active advertisers. +Our third priority is making our ads more relevant. More relevant ads lead to better returns for marketers and better experiences for people. We are pleased with the increased adoption of our targeting tools like custom audiences and conversion tracking. +In Q1 we introduced dynamic product ads, which allow marketers to launch ads for different audiences. We also introduced carousel ads on Facebook and Instagram, which allow marketers to advertise for specific products. Adoption of our targeting tools and these new ad formats help make our ads more relevant. +We are also focused on insights and measurement. We want to help marketers accurately measure the performance of their campaign and then apply that learning to improve their returns. In Q1, we released an ads relevant score, a way for marketers to better understand how people respond to their ads. This helps marketers test different types of creative and optimize performance. +We also launch conversion lift, a tool that scientifically measures how much additional business is driven from Facebook ads. This is important because it shows that ads on mobile can drive sales in retail stores and via other channels. For example, Celbas is a woman's fashion retail in Europe. Using conversion lift, they proved that ads on Facebook mobile drove sales on desktop and via phone calls to sales reps at their call centers. +On the ad tech side, we are pleased with the results we're driving for advertisers and publishers. A good example of this is Cheetah Mobile. Using native ads from the audience network in its app, the Company is getting more than 2 times the CPMs compared to other ad networks. +We continue to invest in our ad tech platform. At our F8 developer conference last month, we made two important LiveRail announcements that will improve the relevance of ads people see across a sites, apps, and devices. We extended LiveRail's video ad platform into in-app mobile display, which will give publishers better ways to manage their ad inventory across devices. +We also announced that LiveRail will give publishers access to Facebook's anonymized demographic information, enabling us to serve more relevant ads to people. We've had a great start to the year and we're really optimistic about what's to come. Our teams are executing well, staying focused on our big priorities, and continuing to innovate. Now here's Dave. + +-------------------------------------------------------------------------------- +Dave Wehner, Facebook Inc. - CFO [5] +-------------------------------------------------------------------------------- + + Thanks, Sheryl, and good afternoon, everyone. +Q1 was a strong quarter for Facebook. We generated $3.5 billion in revenue and $1.2 billion in free cash flow, and continued making investments to position us for both near-term and long-term growth. +We are pleased with the growth and engagement of our community. In March, 936 million people used Facebook on an average day, an increase of 17% compared to last year. This daily number represents 65% of the 1.44 billion people who used Facebook during the month of March. +Mobile remains the key driver of our growth. In March, approximately 1.25 billion people accessed Facebook on mobile devices, up 24% from last year. In addition to Facebook, Instagram, Messenger, and WhatsApp continue to grow, exceeding 300 million, 600 million, and 800 million MAU, respectively. +Now turning to the financials. All of our comparisons on our on a year-over-year basis unless otherwise noted. Additionally, as a reminder, our non-GAAP measures exclude stock-based compensation and the amortization of intangibles. Total revenue was $3.5 billion, up 42%, or 49% on a constant currency basis. +Ad revenue was $3.3 billion, up 46%, or 55% on a constant currency basis. The general strengthening of the US dollar in the past year had an unfavorable impact on our revenue. Had foreign exchange rates remained constant with Q1 2014 levels, our total revenue this quarter would have been approximately $190 million higher. +Regionally, we saw strong North American ad revenue growth of 53% in the quarter, second only to APAC, which grew 57%. Europe and the Rest of World revenue grew more slowly at 35% and 32%, respectively, with currency impacts leading to a significant reduction in these regions' year-over-year growth rates. +Mobile ad revenue in Q1 was $2.4 billion, up from approximately $1.3 billion last year. Revenue from ads served on personal computers was down approximately 4%, and we continue to see overall usage on PCs decline. +In Q1, the average price per ad increased 285%, while total ad impressions declined 62%. Similar to last quarter, these price volume trends were primarily driven by the redesign of our right-hand column ads, which rolled out in the third quarter of last year. To a lesser degree, the shift of usage towards mobile, where we don't have right-hand column ads, also contributed to the reported price volume trends. +Total payments and other fees revenue was $226 million, down 5% compared to last year, a trend we expect to continue. The decline was driven by the year-over-year reduction in payments revenue related to games played on personal computers. +Turning now to expenses, our Q1 total GAAP expenses were $2.6 billion, up 83%, and non-GAAP expenses were $1.7 billion, up 57%. Similar to last quarter, stock-based compensation and amortization expenses related to the WhatsApp acquisition contributed significantly to the year-over-year growth in GAAP expenses. +Non-GAAP expense growth was primarily driven by increases in headcount-related costs, cost of revenue, and marketing expenses. We ended Q1 with 10,082 employees, up 48% compared to last year. We remain very pleased with our ability to attract and retain top-tier talent. +Q1 operating income was $933 million, representing a 26% operating margin. Non-GAAP operating income was $1.8 billion, representing a 52% margin. Our Q1 GAAP and non-GAAP tax rates were 45% and 35%, respectively. Q1 GAAP net income was $512 million, or $0.18 per share, and non-GAAP net income was $1.2 billion, or $0.42 per share. In Q1, capital expenditures were $502 million, and we generated $1.2 billion of free cash flow. We ended the quarter with $12.4 billion in cash and investments. +Turning now to the outlook, let's start with revenue. The strengthening of the US dollar in the past year reduced our Q1 total revenue growth rate by 7 percentage points, or approximately $190 million. The dollar strengthened over the course of the quarter, and in the month of March, our year-over-year total revenue growth rate was approximately 10% lower than it would have been in constant currency terms. +Based on this, we estimate that foreign exchange headwinds in Q2 will likely be greater than those we experienced in Q1. In addition, we expect our total payments and other fees revenue to decline on a year-over-year basis for the remainder of the year. +Turning to expense guidance, we are tightening our expense guidance range modestly based on better visibility into our annual spending. We expect that the year-over-year growth rate for total 2015 GAAP expenses will be in the range of 55% to 65% as compared to our prior guidance of 55% to 70%. +We expect that the year-over-year growth rate for total 2015 non-GAAP expenses will be in the range of 50% to 60% as compared to our prior guidance of 50% to 65%. Our expense outlook reflects the broad range of investments that we're making in both our services and infrastructure, as we continue to enhance the core experiences on Facebook and Instagram, grow our messaging products, strengthen our advertising business globally, and invest in long-term growth areas like Oculus and Internet.org. +The remainder of our guidance remains unchanged. We anticipate our 2015 capital expenditures will be in the neighborhood of $2.7 billion to $3.2 billion. We expect stock-based compensation in 2015 to be in the range of $3 billion to $3.3 billion, approximately half of which is related to our prior acquisitions, most notably WhatsApp. +We expect amortization expenses in 2015 to be approximately $700 million to $800 million. And lastly, we anticipate our Q2 and full-year 2015 GAAP and non-GAAP tax rates to be consistent with the rates in the first quarter. In summary, Q1 was a great start to the year for Facebook. We are very pleased with of the growth of our community, the strength of our business, and the investments we're making to build long-term shareholder value. +With that, Chris, let's open up the call for questions. + + +================================================================================ +Questions and Answers +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) +Brian Nowak, Morgan Stanley. + +-------------------------------------------------------------------------------- +Brian Nowak, Morgan Stanley - Analyst [2] +-------------------------------------------------------------------------------- + + I have two. The first one, can you talk a little about early advertiser and publisher feedback from the LiveRail in-app mobile product, and what are some areas where you see potential for improvements to drive faster adoption? And then on the OpEx side, appreciate your tightening the range, can you help us at all on expeditions for headcount growth this year and what are the biggest areas you see investing in incremental employees this year? + +-------------------------------------------------------------------------------- +Sheryl Sandberg, Facebook Inc. - COO [3] +-------------------------------------------------------------------------------- + + On LiveRail, we're pleased with the performance and the changes we've been able to make. Video is obviously super important, so having the ability to do work on video across the web has been really great. And then at F8, we made two more announcements that I mentioned. +What we're hearing from publishers is that this is a good opportunity and they're pleased with the extensions we're making because it can make their ad surveying and buying more efficient across the platforms they use. In terms of areas for improvement, I think there's a lot we can do. I think you have to look at our ad tech investments very holistically, from Atlas to LiveRail to the Audience Network. +These are all different pieces of the ad stack, but what they're all working on is taking the relevance and the ability to do people-based marketing and make that available to work on Facebook, but also off Facebook. We believe that because we can do marketing to people and then measure results across what people do in privacy-protective ways, we have an ability to improve the relevance of marketing, which will make it better for consumers, and increase returns for marketers. + +-------------------------------------------------------------------------------- +Dave Wehner, Facebook Inc. - CFO [4] +-------------------------------------------------------------------------------- + + Brian, it's Dave. Just on the OpEx question, I think the key is that we are investing in our near-, mid-term, and long-term priorities. In the near term, we're investing to grow the community, execute on the existing business, both on the product side and then the advertising sales force side. In the mid-term, we are building out those next generation of services to be great businesses that reach their full potential, so that's Instagram, WhatsApp, Messenger. Then in the long-term, we're investing in areas like the next-generation computing platform, Internet.org, AI. +In general, I would say our headcount growth has skewed towards the R&D side because a lot of these initiatives have long-term development needs, so we've been investing there, but we are investing across the board. In terms of a specific headcount guidance, I would just stick with our expense guidance, but I'd note that the 48% year-over-year does include some inorganic growth from the pickup of the three larger acquisitions, Oculus, LiveRail, and WhatsApp. We haven't lapped those at this point. + +-------------------------------------------------------------------------------- +Operator [5] +-------------------------------------------------------------------------------- + + Douglas Anmuth, JPMorgan. + +-------------------------------------------------------------------------------- +Douglas Anmuth, JPMorgan - Analyst [6] +-------------------------------------------------------------------------------- + + One for Sheryl and one for Mark. Sheryl, just wanted to ask you to talk a little bit more about big brands, give us a sense for what's working best in terms of products? And then also how penetrated do you think Facebook is now with some of the larger brands? And, Mark, what are the signals that you'll be looking for to tell you when it's the right time to ramp up the advertising on Instagram more? Thanks. + +-------------------------------------------------------------------------------- +Sheryl Sandberg, Facebook Inc. - COO [7] +-------------------------------------------------------------------------------- + + Our growth was really strong across all of our marketer segments, but we had a particularly good quarter in brands, I think driven by two things. The first is that we really have a great platform to do creative storytelling on mobile and I think we have that in a way that no one else does. Our mobile ad product is so integrated into the user experience and provides real creative flexibility that people have a way to reach people on mobile and that's becoming increasingly important in telling the stories that drive their business. +The second thing is video. Video is exploding on Facebook, as Mark talked about, and that gives us an opportunity to do a lot of work with marketers on video. This is the first time the technology in media vertical was one of our top four verticals, and that's largely because of the use of mobile, and so that's been really a great story for us. +In terms of penetration, we work with almost all the large marketers almost everywhere in the world, but even for the largest clients we have, we are a very small part of their budget. I don't think we have any large clients. If you look at 25% in the US of consumer media time is on mobile, and then 20% of mobile time goes to Facebook and Instagram. +That would be 5% of US consumer media time. With our largest clients, even our large ones, we are not close to 5% of their spend and so I think we have a considerable opportunity to grow. We also expect those underlying numbers, time on mobile, to continue to grow. + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook Inc. - Chairman & CEO [8] +-------------------------------------------------------------------------------- + + For your second question about Instagram and the ads opportunity there, we think about this the same way that we do ads on Facebook today. The primary goal is to increase the quality. That's our strategy for growing the business. There's more inventory that we can open up on Instagram over time because it's so early, but we are going to do that once we get to formats that are working well for businesses and that we feel really good about in the consumer experience. +This has been a theme for our ad strategy and product development for more than a year now, maybe two years, where folks have consistently asked us what we are going to do to increase the amount of ads that we are showing and our response has been that we're going to focus on improving the quality and relevance and that's both going to perform better for the people using our services and businesses who are buying ads. That strategy I think is bearing out and we'll continue to apply it to all the things that we do. + +-------------------------------------------------------------------------------- +Sheryl Sandberg, Facebook Inc. - COO [9] +-------------------------------------------------------------------------------- + + One clarification, I think I said tech and media as a vertical, I meant entertainment and media. This is the first quarter that entertainment and media is one of our top verticals. + +-------------------------------------------------------------------------------- +Operator [10] +-------------------------------------------------------------------------------- + + Heather Bellini, Goldman Sachs. + +-------------------------------------------------------------------------------- +Heather Bellini, Goldman Sachs - Analyst [11] +-------------------------------------------------------------------------------- + + I just had two quick ones. I was wondering, Mark, I think you mentioned you're seeing 1 billion searches per day on mobile. I was wondering if you could give us an update on your initiatives here. And also, when you think about Facebook as a microcosm of different applications, at some point is there a plan that we will be able to use this search functionality to go across all the different Facebook apps that we might have installed on our mobile devices? + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook Inc. - Chairman & CEO [12] +-------------------------------------------------------------------------------- + + We're pretty early in this whole thing and there's so much unique content that people share in Facebook that I think that that is the clear unique opportunity to go for first. Right? If you think about the overall web there's a lot of public content that's out there that any web search engine can go index and provide, but a lot of what we can get at are recommendations on products and travel and restaurants and things that your friends have shared they haven't shared publicly, and knowing different correlations or interesting things about what your friends are interested in. +That's the type of stuff -- those are questions that we can answer that no one else can answer and that's probably going to be what we continue to focus on doing first. And I think what you're seeing is that, as we enable more use cases and as we just get a lot of the basics right around performance and bringing the mobile features into parity and beyond, what we had been able to do on desktop, the volume is growing quickly. I think on a recent earnings call, we just announced that we'd passed 1 billion searches total, so now being more than 1 billion on mobile shows some progress that I'm pretty proud of for the search team. + +-------------------------------------------------------------------------------- +Operator [13] +-------------------------------------------------------------------------------- + + Eric Sheridan, UBS. + +-------------------------------------------------------------------------------- +Eric Sheridan, UBS - Analyst [14] +-------------------------------------------------------------------------------- + + Maybe one for Mark and one for Sheryl. Mark, you talked about the family of apps at Facebook. As more and more people are consuming professional content, different verticals like news, sports, and video format on Facebook, how do you think about the use case for the consumption of that content inside the main Facebook app versus maybe an even separate app for more professional content long-term for Facebook? +And then for Sheryl, appreciate the color you gave us on the evolution of targeting on Facebook. Wanted to know, either qualitatively or quantitatively, if you could talk a little bit about the way those ads are performing as you continue to evolve the product set around targeting on Facebook and off, in particular around dynamic product ads and what that might mean for closing the loop longer term? Thanks so much, guys. + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook Inc. - Chairman & CEO [15] +-------------------------------------------------------------------------------- + + Yes. In terms of news and different kinds of content, this has traditionally been something that we've delivered a really good experience for, in terms of people being able to share the content that they want, being able to get access to the content that they want, different recommendations from friends, and we have a lot more coming there, so I'm excited about that. +We definitely do see, in this family of apps strategy, that there's so many new ways that people want to share content, and so many different types of sets of people that people want to share with, ranging from one person at a time and that would be Messaging or small group sharing or sharing with interest-based communities or sharing with all your friends at once or sharing with public. +There are just a lot of different experiences that need to get built, and a lot of what we're trying to do is enable a number of those things through Facebook, while also building unique, world-class services to enable people to share all the things they care about with all the different sets of people that they care about. So we're going to keep on doing more there, but we're happy with where we are now. We have a number of services that are reaching pretty good scale and I think we'll keep on pushing that. + +-------------------------------------------------------------------------------- +Sheryl Sandberg, Facebook Inc. - COO [16] +-------------------------------------------------------------------------------- + + To your question on targeting and closing the loop, these are two really important pieces for what we want to do. Our goal, when we work with marketers, is to drive their business and that means their products off the shelves, their services into the hands of people. In order to do that well, we need to work on targeting and we need to work on measurement. +With targeting, a more relevant ad is just better. It's a better experience for consumers because they see something they like in their Newsfeed and it has a higher return for marketers. So we are very focused on getting more people to use our targeting tools from custom audiences, which lets people target ads differently to their current customers or people who they'd like to be their customers, to look like audiences, which enables us to identify the characteristics of your current customers and then find other people on Facebook who share those characteristics, so again, the ad is well targeted. +I think our targeting abilities are really second-to-none and I'll share a recent example. XFINITY put out a voice guide for visual disabilities. And they did this by doing an Oscar commercial with a girl who is blind imagining what Wizard of Oz characters look like. Now, by doing that at the Oscars, that's obviously TV, and it's a very broad ad and that's because they were both showing a product but also working on their brand. +On Facebook, they took that ad and showed it to movie fans, Wizard of Oz fans, and also people connected to accessibility causes. That's actually pretty specific targeting that lets them hit exactly the right audience and amplify what they were doing on TV. And I think that's the kind of thing that only we can do at scale and it shows how important targeting is. +When you think about closing the loop, you then have to add in the measurement piece because if we can connect people seeing ads on Facebook to what they buy in stores or in other ways, that's how you close the loop. That's why we've put so much investment and hopefully so much innovation behind measurement, so conversion tracking is increasingly used and we work with our marketers to use it even more. +We're also really excited about conversion lift, because that's the first product we've had which scientifically measures the additional business you get from Facebook ads. It compares test groups that see ads with control groups that don't, so whatever you're measuring in terms of conversions, whether it's sales or website clicks or registrations, we can A-B test and see exactly what the impact Facebook has. I think we're still at the beginning of this. I think there is so much more we can do to make ads more relevant on Facebook and so much more we can do to measure results and I think our future growth will depend on executing on that very well. + +-------------------------------------------------------------------------------- +Operator [17] +-------------------------------------------------------------------------------- + + Youssef Squali, Cantor Fitzgerald. + +-------------------------------------------------------------------------------- +Youssef Squali, Cantor Fitzgerald - Analyst [18] +-------------------------------------------------------------------------------- + + Question for Dave and then maybe one for Mark or Sheryl. FX-adjusted ARPU growth this past quarter was about 35%, which is, by our math, about one-half of what it was last year. Within mobile, it was about 45%; that's about one-third of what it was last year. Other than tough comps, what else is driving the decline? Is it just Q1 seasonality getting more pronounced? Is there anything else? Who would have thought that maybe video advertising would have actually have had the opposite effect. +And then, maybe Mark or Sheryl, what's your experience so far with voiceover IP? What is the strategy over time? Is that something you can start charging for or -- either through maybe a subscription or is there another way of monetizing it? Thanks, guys. + +-------------------------------------------------------------------------------- +Dave Wehner, Facebook Inc. - CFO [19] +-------------------------------------------------------------------------------- + + Youssef, it's Dave. On the FX-adjusted ARPU growth, I would really point to the overall revenue growth rates. That's what's driving it, so you're coming up against a bigger business last year than we had in the past, so you're seeing a declining rate on that basis. I don't think there's anything specific to ARPU. It's just a reflection of what we're seeing on the revenue front as we scale and it's as expected there. +So we're really pleased with the performance that we're seeing on the revenue front, certainly on the FX-adjusted basis. We are seeing strong growth in the face of really a tough currency environment, so we're really pleased with that. We think we've got the best mobile ad product out there in the market and it's just getting better, so we're really pleased with what we're doing on the revenue front. + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook Inc. - Chairman & CEO [20] +-------------------------------------------------------------------------------- + + And in terms of voice calling, no, we're not going to charge for it, just like we're not going to charge for messaging. What we're focused on doing is providing more -- higher-quality services for free than what you could otherwise get in paying for them. One thing that you may not know about voice calling is that, by using the Internet for calling rather than the relatively low bit rate voice networks, you can actually get higher-quality calls using VoIP. +One of our theories in this is that it's -- one of the reasons why voice calling has been a little slower to catch on is because you need the large established network of people who you know will have access to be able to receive a voice call before that behavior can really take on in a big global community. But now between Facebook Messenger and WhatsApp, which are two very broad communication networks, we're pretty confident that, because of the higher quality of calling that you can get through the services that we are providing, that this is going to continue growing very quickly. +A lot of people still -- we're just very early in rolling out and promoting it. Even in Facebook Messenger, it's been out for a little while where we are already more than 10% of the global VoIP market. I think that that's just going to continue growing and I'm really looking forward to getting the first stats on WhatsApp VoIP, as well, soon. + +-------------------------------------------------------------------------------- +Operator [21] +-------------------------------------------------------------------------------- + + Mark Mahaney, RBC Capital Markets. + +-------------------------------------------------------------------------------- +Mark Mahaney, RBC Capital Markets - Analyst [22] +-------------------------------------------------------------------------------- + + One question for Mark, one for Sheryl. Mark, there's just this explosion in these messaging platforms worldwide and you obviously bought into one. The growth has been greater than we would have expected and perhaps you, too. Has your thinking changed on the opportunity, or maybe the need, but really the opportunity to integrate WhatsApp and Facebook over the next couple of years because of the growth of WhatsApp to date? +And then, Sheryl, you mentioned some verticals that are doing well. I was wondering if I could ask about automotive and insurance, just a couple of verticals that have always been skewed very heavily towards TV advertising, and the question is whether they've really skewed up more now on Facebook given the autoplay video ad format? Thank you. + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook Inc. - Chairman & CEO [23] +-------------------------------------------------------------------------------- + + On the messaging question, yes. We're pretty happy with how it's all going. I think if we are going to pay $19 billion for a company, we should have pretty high expectations for how it's going to do. So I do feel good about how we're doing, but it needs to do a lot more, obviously, and we're very excited about the road map of things that we have ahead. +In terms of integrating them, no, we're not going to do that. One of the things that had been interesting while we were watching these different services grow was just how quickly multiple different messaging and communication services were growing at the same time. It seemed a little bit counterintuitive at first because it seemed like there should have been more overlap than it actually, now in retrospect, looking back, seems like there is. +So you can look at countries where both services, WhatsApp and Messenger, are growing very quickly, like Brazil, for example, and what you'll see is that basically people use them a little bit differently. WhatsApp is more of a clear text messaging replacement. Facebook Messenger people use to connect with people that they know on Facebook primarily. +Then there are differences in the feature sets where WhatsApp is extremely utilitarian and focused on texting and now voice calling, whereas Messenger is very focused on expression. And the whole set of things that fit into the tools around the Messenger platform that we rolled out at F8, communicating with businesses now, richer tools to communicate different ways. So I think that these are just going to keep on growing, is my expectation and hope, and we're excited to pursue both different products to serve the different communities. + +-------------------------------------------------------------------------------- +Sheryl Sandberg, Facebook Inc. - COO [24] +-------------------------------------------------------------------------------- + + On the auto and insurance verticals, they're both still small which makes them good opportunities to grow. We're seeing good progress on both of them, and interestingly, insurance companies have been pretty active, both on Facebook and Instagram, so we're optimistic about that. + +-------------------------------------------------------------------------------- +Operator [25] +-------------------------------------------------------------------------------- + + Paul Vogel, Barclays. + +-------------------------------------------------------------------------------- +Paul Vogel, Barclays Capital - Analyst [26] +-------------------------------------------------------------------------------- + + Two questions, one for Mark and one for Dave. Mark, just going back to the video question again real quick, I'm wondering, given all the noise around over-the-top and long-form content, and given your push in video, I'm just curious as to whether or not you think Facebook can or should be a player in more studio content or professionally driven content? And then, Dave, for you, just in terms of CapEx, you gave guidance for this year, but again, given the ramp-up in video and search, how should we think about CapEx longer term relative to, either in absolute terms or maybe relative to revenue growth? Thanks. + +-------------------------------------------------------------------------------- +Dave Wehner, Facebook Inc. - CFO [27] +-------------------------------------------------------------------------------- + + I can go first. On the CapEx growth for this year, Paul, yes, we are ramping CapEx, obviously, to support the initiatives that we have. 2015 is a big investment year for us, both in CapEx and OpEx. It's a little bit early to be talking about how that's going to scale going forward. +But clearly, we've got a lot of areas that we are investing in, including video, including the various other services on top of Facebook. So we're going to be investing to deliver the best quality services that we can for our users, so we'll continue to invest heavily on the data center and infrastructure side going forward, but 2015 is a big investment year for us across the board. + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook Inc. - Chairman & CEO [28] +-------------------------------------------------------------------------------- + + And on video, we're excited about people sharing all different kinds of content on Facebook. Right now, a lot of what people are sharing are their social videos and content. There are a lot of public figures who have pages, often with millions or tens of millions of followers, producing unique and really high-quality content that they are pushing out to all their fans on the network today. So, yes, we'll continue looking at ways to grow that and the product experience that we have right now is growing quite well, so we feel good about it. + +-------------------------------------------------------------------------------- +Operator [29] +-------------------------------------------------------------------------------- + + John Blackledge, Cowen and Company. + +-------------------------------------------------------------------------------- +John Blackledge, Cowen and Company - Analyst [30] +-------------------------------------------------------------------------------- + + Two questions. One more on video. With the explosive ramp in video views over the last six months, could you discuss the video advertising ramp this year and then maybe talk about the video versus static ads within the Newsfeed? And then the other question would be, you referenced Facebook hitting 2 million active advertisers in the first quarter, and with over 30 million company pages, how should we think about the advertiser TAM for Facebook next year and over time? Thank you. + +-------------------------------------------------------------------------------- +Sheryl Sandberg, Facebook Inc. - COO [31] +-------------------------------------------------------------------------------- + + To the first question, video is a big opportunity for us. Mark talked about how we have 4 billion video views on Facebook every day, and we've always believed that the format of our ads should follow the format of what consumers are doing on Facebook. So many years ago, when the homepage ticker was in vogue, we never did that. So the fact that there's so much consumer video, that gives us the opportunity to do more marketing video as well. +It's still early days and we are very focused on quality, and it's worth noting that not all of the revenue from video is incremental, because the video ads take the place of other ads that we would have served into Newsfeed. That said, we're really excited about the opportunity. I talked about increasing the entertainment and media vertical and brand marketers, particularly, but I think all marketers have the opportunity to do video. +And that's pretty exciting, including SMBs who would never be able to hire a film crew and buy a TV ad, we're seeing those put videos in. Over 1 million SMBs have posted videos and done really small ad buys around them and that's pretty cool, because I don't think there are probably 1 million advertisers who have bought TV ads in that same period of time. +When you think about our marketer growth, I think we have an ability to grow both the number of advertisers who use our platform, but also the percentage of their business that we get. So 30 million small business pages continuing to grow, we have an opportunity to turn those businesses into advertisers and marketers, and that's what we've done successfully and we are going to continue to focus on that. We do that by building very simple ad products. +Then when you think about the percentage of spend we have, what I said before on this call, which is we only have a small percentage of even our large customers, that's true of our small customers too. There are some who spend a large portion of their budget on Facebook, but that's actually very unusual. +For most people, even when they start spending with us, we are a small portion of their budget. When you look at the consumer time we get, we are not getting the equivalent amount of time or resources from our marketers, really of any size, and therein lies our opportunity to grow. + +-------------------------------------------------------------------------------- +Operator [32] +-------------------------------------------------------------------------------- + + Justin Post, Merrill Lynch. + +-------------------------------------------------------------------------------- +Justin Post, BofA Merrill Lynch - Analyst [33] +-------------------------------------------------------------------------------- + + Dave, maybe you could help us break down the 55% ad revenue growth a little bit between usage, are you increasing ad loads at all? Maybe you talk about the formats or is Instagram helping at all? Just a little granularity on that, or maybe it's just a format shift, but just help us understand what the key drivers are and how much room you still have to go on each of these things? Thank you. + +-------------------------------------------------------------------------------- +Dave Wehner, Facebook Inc. - CFO [34] +-------------------------------------------------------------------------------- + + Yes, Justin. In terms of the 55% revenue growth, obviously, it's mobile Newsfeed is what's driving it from a fundamental point of view. In terms of what the opportunity there is to drive it, it's really about increasing the relevance and quality of the ads. That's been a key part of what we've been doing and that will just continue to be the big driver in the near and medium term. +And we're doing that on a number of different fronts. Part of it's about finding the right format, so it's getting the video units there for the people for whom video ads are going to make sense. It's getting the dynamic product ads in front of people, for people who are going to find those ads interesting and engaging. And it's really just continuing to learn more and more about the people who are using Facebook and what types of as they interact with and like, and so that's part of what we're trying to do across the board. +And then at the same time, we're bringing more and more advertisers into the system and that's giving us a better selection of the ads that we can serve to the people using Facebook and that again improves the quality and the relevance. So the main thing that we're seeing drive this is just improving the quality and the relevance of the ads experience for the people using Facebook and I think that's going to continue to be the story. +The specific ads will be part of how we do that, but it won't be the only way. It will also be the targeting that we have and the targeting capabilities that we are doing with things like custom audiences and getting better and better at that. So there's a lot of different fronts that we're working on. +It's hard to tease out every individual component of it, but all in all we're really pleased with the revenue growth that we're seeing. And also, that's coupled with good engagement growth, so we are doing a nice balance of having an experience that's working well for our advertisers, but it's also working really well for the people who are using Facebook. + +-------------------------------------------------------------------------------- +Operator [35] +-------------------------------------------------------------------------------- + + Ross Sandler, Deutsche Bank. + +-------------------------------------------------------------------------------- +Ross Sandler, Deutsche Bank - Analyst [36] +-------------------------------------------------------------------------------- + + Just two quick questions. First, on the Newsfeed organic reach, and then Mark, one on Apple Watch and wearables. On the Newsfeed, you guys recently made tweaks to alter the algorithm in favor of friend-oriented content. And then, on the other hand, you're also moving towards hosting publisher content from New York Times and Buzzfeed and folks like that. So how are you balancing out organic reach between these algorithm changes and then whether or not professional content is hosted inside of Facebook versus coming from a third-party website? +And then the second question is, Mark, how do you view the shift to wearables with smaller screens and shorter interactions? It looks like you guys have got most of the apps on the Apple Watch. Just wondering what you're doing to adapt to these new smaller screens? Thanks. + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook Inc. - Chairman & CEO [37] +-------------------------------------------------------------------------------- + + Sure. I can speak to both of those. For the Newsfeed question, the North Star for us in Newsfeed is that we want to produce the best experience for everyone who is using the app and loading Newsfeed to see what is going on in the world around them. So when it comes to -- there are lots of businesses on Facebook, there are professional content producers, our main interest here is the people in the community who are using Newsfeed. Not those guys. +So of course, we want to build tools to enable them to share their content and all that, but we are constantly refining the algorithms in order to make it so the experience is the best for you, when you open up your phone, and look at Facebook and there are a bunch of things that are going on, we want to make sure that we're getting what you care about the most. And we go to a lot of lengths to make sure that we're getting signals from people in our community to make sure that we're doing this correctly. +In addition to the different signals that we would get from seeing people use the products, we also do a lot of qualitative surveys, to see what people what makes -- what people write in that they want to see from us, what people tell us is the most important thing that they saw on Facebook today or saw anywhere in the world today, what they would have wanted to have seen on Facebook. Our goal is just to constantly refine this and make it better, and we're going to keep on doing that, because we think that there's a lot of upside and there is a lot more that we can do. +At the same time, in order to make this experience good, there also needs to be good content in the system, so we need to make sure that people have the tools to be able to share the moments that they care about. If you're a professional publisher, you need to have the ability to share a version of the content that you're producing that you're proud of, that can load quickly, that can be as rich as the tools enable people to see. +And we're working on a lot of different tools for that. And you can imagine that as the tools for any of this content get better, people taking photos, newspapers writing news articles, advertisers putting out ads for content that they want to sell, the better that content gets, the more people are excited to see it, and then that informs the ranking and what the community qualitatively tells us that they want to see from us over time, as well. So it's just a constant cycle on that. What was the other question? + +-------------------------------------------------------------------------------- +Dave Wehner, Facebook Inc. - CFO [38] +-------------------------------------------------------------------------------- + + The watch. + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook Inc. - Chairman & CEO [39] +-------------------------------------------------------------------------------- + + Oh, the watch. + +-------------------------------------------------------------------------------- +Sheryl Sandberg, Facebook Inc. - COO [40] +-------------------------------------------------------------------------------- + + Wearables. + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook Inc. - Chairman & CEO [41] +-------------------------------------------------------------------------------- + + I haven't actually spent that much time with this so far, so I mostly just want to congratulate Apple on shipping something that seems like a pretty amazing piece of technology and work. We're proud to be supporting and I know that we have a bunch of apps. It's a space that's going to be really interesting and we're going to watch closely and build what our community wants us to. + +-------------------------------------------------------------------------------- +Operator [42] +-------------------------------------------------------------------------------- + + Brian Pitz, Jefferies. + +-------------------------------------------------------------------------------- +Brian Pitz, Jefferies LLC - Analyst [43] +-------------------------------------------------------------------------------- + + Two more quick questions on video. Roughly what percentage of videos are currently monetized via ads? And where do you see it headed over time? And as you look at the early video ads on the platform, how is pricing comparing to other ad formats? Thanks. + +-------------------------------------------------------------------------------- +Dave Wehner, Facebook Inc. - CFO [44] +-------------------------------------------------------------------------------- + + I can take this. In terms of what percentage of videos are ads, we're not breaking that out. I think what we said was that we are really pleased with the consumer adoption we're seeing. That's the fundamental table stakes that need to be there and that's the most important thing and we're really pleased with the 4 billion video views daily that we are getting. We know that marketers love video, so there's a great opportunity here. +It's still early. It's worth pointing out that, as Sheryl mentioned, video does displace other ads in Newsfeed and let me speak to how that plays into pricing as well. Video is just a format that is bid into the auction, so video is effectively winning in the auction if it's higher-priced. So if somebody's willing to pay more for a video, it's going to get served before another type of format ad, but there's not really a price differential. +You're paying for video. It's just what are you willing to pay into the system? So there's not differential pricing by product. It's just what are you willing to bid for the format that you want to show to the people that you want to show it to and that's how the system works. + +-------------------------------------------------------------------------------- +Operator [45] +-------------------------------------------------------------------------------- + + Ben Schachter, Macquarie. + +-------------------------------------------------------------------------------- +Ben Schachter, Macquarie Research - Analyst [46] +-------------------------------------------------------------------------------- + + Mark, does the OpEx guide assume an Oculus product for consumers this calendar year and will the initial products focus on gaming or more on some of the experiences that you showed at F8 around non-gaming, like that Saturday Night Live demo? And then separately, beyond searching within Facebook, should we expect to see Facebook leverage its 2 million advertiser relationships against third-party search queries? For example, when a user searches on, say, Yahoo or maybe soon an Apple device, Facebook might tap its advertisers to provide relevant sponsored results? Thanks. + +-------------------------------------------------------------------------------- +Dave Wehner, Facebook Inc. - CFO [47] +-------------------------------------------------------------------------------- + + Ben, let me take the OpEx guidance question. We have not announced any specific plans for shipment volumes in 2015 related to Oculus. I'd just note that Oculus is very much in the development stage, so it's early to be talking about large shipment volumes, and our expense guidance reflects any volumes that we might do in 2015. + +-------------------------------------------------------------------------------- +Sheryl Sandberg, Facebook Inc. - COO [48] +-------------------------------------------------------------------------------- + + And no plans to work with our marketers in the way you described. + +-------------------------------------------------------------------------------- +Operator [49] +-------------------------------------------------------------------------------- + + Peter Stabler, Wells Fargo Securities. + +-------------------------------------------------------------------------------- +Peter Stabler, Wells Fargo Securities - Analyst [50] +-------------------------------------------------------------------------------- + + Dave, I just wanted to return to I think Justin's question about the drivers behind ad growth. You mentioned gains made in relevance and quality and formats. Wondering if you could provide any quantitative color around ad engagement trends, clicks, shares, likes, or anything like that? And then, secondly, one quickly for Sheryl. In your SMB discussions, wondering if you are ever asked to help facilitate transactions in that space or if that's an area of small business that you are interested in? Thank you. + +-------------------------------------------------------------------------------- +Dave Wehner, Facebook Inc. - CFO [51] +-------------------------------------------------------------------------------- + + Peter, just on ads engagement, that's an area that we've obviously been very focused on and we're really pleased with the results that we're seeing there in terms of driving better engagement per ad. That's really the focus of a lot of our quality and relevance efforts. How do we find those ads that are going to be more engaging, that are going to get more clicks, that are going to get more views, that are going to get more installs? +We're working on focusing on all of those, on optimizing the relevance of the ads for all of those different potential actions that happen downstream and we are pleased with what we're doing there and the trends that we're seeing there. Again, that's a big part of what we are trying to do to drive the overall ads growth story, as well as providing a good experience for users with the ads that they're seeing. + +-------------------------------------------------------------------------------- +Sheryl Sandberg, Facebook Inc. - COO [52] +-------------------------------------------------------------------------------- + + On SMBs, we have a very small test in the US we started last quarter for Buy on Facebook and that enables people to buy products from merchants with a buy button on pages. It is a product that is used and aimed at SMBs. We are also very focused on helping SMBs have a presence, especially a mobile presence. +35% of SMBs in the United States, which is probably ahead of most other countries, don't have a web presence at all, and an even smaller percentage of SMBs have a mobile web presence or any kind of mobile presence that works. And so pages are a good and free and easy way to have a mobile web presence and that's something we are very focused on growing. +Operator, we have time for one final question. + +-------------------------------------------------------------------------------- +Operator [53] +-------------------------------------------------------------------------------- + + Mark May, Citi. + +-------------------------------------------------------------------------------- +Mark May, Citigroup - Analyst [54] +-------------------------------------------------------------------------------- + + I had two. You've recently announced plans to enable longer form video content, as well as to allow those videos to be syndicated or distributed on third-party publishers. What, if any, initiatives do you have to help with this content, contributors and the publishers, to generate revenue from those videos? And then, secondly, on public content, what, if anything, are you doing to try to secure more unique public content that's potentially unique to Facebook from personalities and other sources? Thanks. + +-------------------------------------------------------------------------------- +Sheryl Sandberg, Facebook Inc. - COO [55] +-------------------------------------------------------------------------------- + + On the video question, we're basically focused primarily on video on our own site [and] service. Video tends to be pretty short-form content right now on Facebook because it's playing in Newsfeed. We do see some pretty cool examples of people using it well. +So for example, in the election you saw Hillary Clinton announce her candidacy, very recently, obviously, and that video got 2.7 million views. Ted Cruz and others have done the same and they've gotten large numbers of video views. So we think it's a very attractive platform for people to reach people with video messages. + +-------------------------------------------------------------------------------- +Deborah Crawford, Facebook Inc. - VP of IR [56] +-------------------------------------------------------------------------------- + + Great. Thank you for joining us today. We appreciate your time and we look forward to speaking with you again. + +-------------------------------------------------------------------------------- +Operator [57] +-------------------------------------------------------------------------------- + + Ladies and gentlemen, this concludes today's conference call. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/exam/original-files/Problem_1_Sample/2015-Apr-23-AMZN.OQ-139804865882-Transcript.txt b/exam/original-files/Problem_1_Sample/2015-Apr-23-AMZN.OQ-139804865882-Transcript.txt new file mode 100644 index 0000000..82a813c --- /dev/null +++ b/exam/original-files/Problem_1_Sample/2015-Apr-23-AMZN.OQ-139804865882-Transcript.txt @@ -0,0 +1,623 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q1 2015 Amazon.com Inc Earnings Call +04/23/2015 02:30 PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Brian Olsavsky + Amazon.com, Inc. - Vice President & CFO, Global Consumer Business. + * Tom Szkutak + Amazon.com, Inc. - SVP & CFO + * Phil Hardin + Amazon.com, Inc. - Director of Investor Relations + +================================================================================ +Conference Call Participiants +================================================================================ + + * Justin Post + BofA Merrill Lynch - Analyst + * Jason Helfstein + Oppenheimer & Co. - Analyst + * Ron Josey + JMP Securities - Analyst + * Brian Pitz + Jefferies & Company - Analyst + * Douglas Anmuth + JPMorgan - Analyst + * Gene Munster + Piper Jaffray & Co. - Analyst + * Heath Terry + Goldman Sachs - Analyst + * Colin Sebastian + Robert W. Baird & Company, Inc. - Analyst + * Mark Mahaney + RBC Capital Markets - Analyst + * Mark Miller + William Blair & Company - Analyst + * Ross Sandler + Deutsche Bank - Analyst + * Brian Nowak + Morgan Stanley - Analyst + * Robert Peck + SunTrust Robinson Humphrey - Analyst + * Mark May + Citigroup - Analyst + * Carlos Kirjner + Sanford C. Bernstein & Company, Inc. - Analyst + +================================================================================ +Presentation +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Greetings. Thank you for standing by. Good day, everyone, and welcome to the Amazon.com Q1 2015 financial results teleconference. +(Operator Instructions) +Today's call is being recorded. For opening remarks, I will be turning the call over to do the Director of Investor Relations, Phil Hardin. Please go ahead. + +-------------------------------------------------------------------------------- +Phil Hardin, Amazon.com, Inc. - Director of Investor Relations [2] +-------------------------------------------------------------------------------- + + Hello and welcome to our Q1 2015 financial results conference call. Joining us today is Tom Szkutak, our CFO; and Brian Olsavsky, Vice President and CFO of our Global Consumer Business. We will be available for questions after our prepared remarks. +The following discussion and responses to your questions reflect management's views as of today, April 23, 2015, only, and will include forward-looking statements. Actual results may differ materially. Additional information about factors that could be potentially impact our financial results is included in today's press release and our filings with the SEC, including the most recent annual report on Form 10-K. +As you listen to today's conference call, we encourage you to have our press release in front of you, which includes our financial results, as well as metrics and commentary on the quarter. In addition, the release includes historical financial results of our North America, International, and Amazon Web Services reportable segments for 2014 and 2013. +During this call, we will discuss certain non-GAAP financial measures. In our press release, slides accompanying this webcast, and our filings with the SEC, each of which is posted on our IR website, you will find additional disclosures regarding these non-GAAP measures, including reconciliations of these measures with comparable GAAP measures. +Finally, unless otherwise stated, all comparisons in this call will be against our results for the comparable period of 2014. Now, I'll turn the call over to Brian. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com, Inc. - Vice President & CFO, Global Consumer Business. [3] +-------------------------------------------------------------------------------- + + Thanks, Phil. I'll begin with comments on our first-quarter financial results. Trailing 12-month operating cash flow increased 47%, to $7.84 billion. Trailing 12-month free cash flow increased to $3.16 billion. +In the supplemental financial information and business metrics portion of our earnings release, we include a few additional free cash flow measures. We believe these measures provide additional perspective on the impact of acquiring property and equipment with cash, and through capital and finance leases. Trailing 12-month capital expenditures were $4.68 billion. Capital expenditures do not include the impact of property and equipment acquired under capital and finance lease obligations. +Return on invested capital was 14%, up from 9%. ROIC is trailing 12-month free cash flow divided by averaged total assets, minus current liabilities, excluding the current portion of long-term debt over five quarter ends. The combination of common stock and stock-based awards outstanding was 483 million shares, compared with 476 million one year ago. +Worldwide revenue grew 15% to $22.72 billion, or 22%, excluding the $1.3 billion unfavorable impact from year-over-year changes in foreign exchange. Worldwide paid unit growth was 20%. +Active customer accounts was approximately $278 million. Excluding customers who only had free orders in the preceding 12-month period, worldwide active customers were approximately 260 million, up from approximately 230 million in the comparable prior-year period. Worldwide active seller accounts were more than 2 million. Seller units represented 44% of paid units. +Now, I'll discuss operating expenses, excluding stock-based compensation. Cost of sales was $15.4 billion, or 67.8% of revenue, compared with 71.2%. Fulfillment, marketing, technology and content, and G&A, combined was $6.62 billion, or 29.1% of sales, up approximately 290 basis points year over year. Fulfillment was $2.67 billion, or 11.7% of revenue, compared with 11.3%. Tech and content was $2.52 billion, or 11.1% of revenue, compared with 9.2%. Marketing was $1.05 billion, or 4.6% of revenue, compared with 4.3%. +Now, I'll talk about our segment results. Beginning in the first quarter, we changed our reportable segments to report North America, International, and Amazon Web Services. In addition, we have provided historical results for these segments, for 2014 and 2013, with our earnings release filing today. Consistent with prior periods, we do not allocate to segments, our stock-based compensation or the other operating expense line item. +In the North America segment, revenue grew 24% to $13.41 billion. Media revenue grew 5% to $2.97 billion. EGM revenue grew 31% to $10.25 billion, representing 76% of North America revenues. North America segment operating income increased 79% to $517 million, a 3.9% operating margin. Excluding the favorable impact from foreign exchange, North America segment operating income increased 77%. +In the International segment, revenue decreased 2% to $7.74 billion. Excluding the $1.3 billion year-over-year unfavorable foreign exchange impact, revenue growth was 14%. Media revenue decreased 12% to $2.32 billion, or increased 2%, excluding foreign exchange. +EGM revenue grew 4% to $5.38 billion, or 21%, excluding foreign exchange. EGM now represents 69% of international revenues. International segment operating loss was $76 million, compared to a loss of $33 million in the prior-year period. The unfavorable impact from foreign exchange to International segment operating loss was $78 million. +In the Amazon Web Services segment revenue grew 49% to $1.57 billion. Amazon Web Services segment operating income increased 8% to $265 million, a 16.9% operating margin. Excluding the favorable impact from foreign exchange, AWS segment operating income decreased 13%. +Consolidated segment operating income increased 41% to $706 million, or 3.1% of revenue, up approximately 60 basis points year over year. Excluding the unfavorable impact from foreign exchange, CSOI increased 45%. Unlike CSOI, our GAAP operating income includes stock-based compensation expense and other operating expense. GAAP operating income was $255 million compared to $146 million in the prior-year period. +Our income tax expense was $71 million. GAAP net loss was $57 million, or negative $0.12 per diluted share, compared with a net income of $108 million and $0.23 per diluted share. +Turning to the balance sheet, cash and marketable securities increased $5.12 billion year over year to $13.78 billion. Inventory increased 10% to $7.37 billion and inventory turns were 8.8. Down from 9.1 turns a year ago, as we expanded selection, improved in stock levels, and introduced new product categories. Accounts payable increased 13% to $11.92 billion and accounts payable days increased to 70 from 68 in the prior year. +I'll conclude my portion of today's call with guidance. Incorporated into our guidance are the order trends that we've seen to date, and what we believe, today, to be appropriately conservative assumptions. Our results are inherently unpredictable and may be materially affected by many factors, including a high level of uncertainty surrounding exchange rate fluctuations, as well as the global economy and consumer spending. It's not possible to accurately predict demand, and therefore, our actual results could differ materially from our guidance. +As we describe in more detail in our public filings, issues such as settling intercompany balances in foreign currencies among our subsidiaries, unfavorable resolution of legal matters, and changes to our effective tax rates, can all have a material effect on guidance. Our guidance further assumes that we don't conclude any additional business acquisitions, investments, restructurings, or legal settlements, record any further revisions to stock-based compensation estimates, and that foreign exchange rates remain approximately where they've been recently. +For Q2 2015, we expect net sales of between $20.6 billion and $22.8 billion for growth of between 7% and 18%. This guidance anticipates approximately 750 basis points of unfavorable impact from foreign exchange rates. GAAP operating income or loss to be between a $500 million loss and a positive $50 million of income, compared to a $15 million loss in second quarter 2014. This includes approximately $600 million for stock-based compensation and amortization of intangible assets. +We anticipate consolidated segment operating income, which excludes stock-based compensation and other operating expense, to be between $100 million and $650 million, compared to $404 million in the second quarter of 2014. We remain heads down, focused on driving a better customer experience through price, selection, and convenience. We believe putting customers first is the only reliable way to create lasting value for shareholders. +Thanks, and with that, Phil, let's move on to questions. + +-------------------------------------------------------------------------------- +Phil Hardin, Amazon.com, Inc. - Director of Investor Relations [4] +-------------------------------------------------------------------------------- + + Great. Thanks, Brian. Let's move on to the Q&A portion of the call. Operator, will you please remind our listeners how to initiate a question? + + +================================================================================ +Questions and Answers +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Thank you. +(Operator Instructions) +One moment while we poll for questions. Brian Pitz with Jefferies & Company. Please proceed. Your line is live. + +-------------------------------------------------------------------------------- +Brian Pitz, Jefferies & Company - Analyst [2] +-------------------------------------------------------------------------------- + + Thank you. Can you share with us any updated metrics for Prime Now? How sticky is it in terms of repeat customers, average order value, or other details? +And, also any update on your fulfillment center plans for the year? If you can't disclose specific numbers, maybe you could just qualitatively tell us your focus, either domestic versus international? Or, sortation versus traditional FC build out? Thanks. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com, Inc. - Vice President & CFO, Global Consumer Business. [3] +-------------------------------------------------------------------------------- + + Sure. On Prime Now, we're -- don't have specific metrics we want to share today. But, we have expanded to seven cities, with more on the way. Customers are really enjoying the one hour and two hour delivery of tens of thousands of daily essential products. So, the response has been great. +We'll point out that our operations network that we've been building for the last 20 years, helps make Prime Now a viable proposition for us. The scale makes a possible. So, really, so far customer response has been great. + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com, Inc. - SVP & CFO [4] +-------------------------------------------------------------------------------- + + And, Brian, on the FCs, as we've done in prior years, it's early in the year, and as we progress through the year, we'll give you some updates on how many. But, as a reminder, we ended the year with 109 fulfillment centers around the world and we'll update you as we go. + +-------------------------------------------------------------------------------- +Operator [5] +-------------------------------------------------------------------------------- + + Ross Sandler with Deutsche Bank. Please proceed. + +-------------------------------------------------------------------------------- +Ross Sandler, Deutsche Bank - Analyst [6] +-------------------------------------------------------------------------------- + + Great. Thanks for the new disclosure, guys. Really really helpful. I guess just digging in on that a little bit, we all understand the investments you guys are making on international retail. And, maybe why that margin's been declining. +But, can you give us some color on what's driving up the North America retail segment margin. And, I guess in the context of that, just talk about the impact that Prime is having on the retail margin for both North America and International. Thanks. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com, Inc. - Vice President & CFO, Global Consumer Business. [7] +-------------------------------------------------------------------------------- + + Yes, sure. So, North America operating margin up 120 basis points year over year to 3.9%. A lot of good cost efficiency. But, again, we're continuing to invest selectively as we build the Prime platform and invent on behalf of customers. +So, you'll see a lot of invention. Definitely to feed the Prime platform, which, things like video content, Prime music as we talk about Prime Now devices. And, we continue to build fulfillment centers for selection and expansion and FBA. So, that's -- it's generally what's driving the operating margin in North America. + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com, Inc. - SVP & CFO [8] +-------------------------------------------------------------------------------- + + And, just to add onto that, we're -- we gave the metrics last quarter about Prime. It's growing very fast. As Brian said, we're feeding the platform and certainly, the common thing with category expansion, new FCs, original content, Prime Instant Video devices, Prime Now; the common theme is they're all really intertwined with Prime. +And, they're inextricably linked to our consumer business in Prime. So, it's just -- we're happy to do it. And, the last quarter, we gave an indication of the growth rates after being added for 10 years. So, we're super excited to have the platform and to continue to invest in it. + +-------------------------------------------------------------------------------- +Ross Sandler, Deutsche Bank - Analyst [9] +-------------------------------------------------------------------------------- + + Great. Thanks, guys. + +-------------------------------------------------------------------------------- +Operator [10] +-------------------------------------------------------------------------------- + + Douglas Anmuth with JPMorgan. + +-------------------------------------------------------------------------------- +Douglas Anmuth, JPMorgan - Analyst [11] +-------------------------------------------------------------------------------- + + Thanks for taking the question. Could you guys talk a little bit more, just about the international business and, kind of, the key initiatives here in terms of getting the growth to reaccelerate from these levels? +And, then also perhaps, a little bit more on your strategy in China? How you're thinking about the cost structure there, relative to previous years? And, some of the key ways you might be able to rationalize things there? Thanks. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com, Inc. - Vice President & CFO, Global Consumer Business. [12] +-------------------------------------------------------------------------------- + + Yes, let me start with China. So, I think you see a lot of invention. You're seeing a lot of invention from us in China right now. Amazon is a trusted source of authentic international products. +And, that's really what we're doubling down on now, with the Amazon global store on our own site, which gives Chinese customers access to over a million Amazon products globally. And then, the team all flagship store for international brands, which you've heard about. Giving thousands of direct imported products access, or, customers, access to these products. And those happened to be stocked and ready to ship from our fulfillment centers in China. So, that's an added benefit. +25% of those are exclus -- or, over 25% of those are exclusives to Amazon. So, we continue to be selective in our investments there. But, we're taking the long-term view and we have hopes for the new initiatives along with the global store and the team all flagship store. + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com, Inc. - SVP & CFO [13] +-------------------------------------------------------------------------------- + + In terms of the growth for total international, just maybe, some comments first about the current quarter. And, then elaborate a little bit further. But, the growth was down 2% on a dollar basis. Up 14% on a local currency basis. +So, we did see a little bit of improvement in terms of growth rate acceleration versus the last couple quarters. And, in addition to the things that Brian mentioned earlier, about the Prime platform. That's something that we're doing globally. And so, we're certainly, all of those things we're working on globally. So, those are things that, at least in most geographies, we have today. +One thing to keep in mind also, as you look at the growth rate for Q1, is last year Q1 we talked about in April 1, there was a consumption tax increase in Japan. We had some, what we think some pre-buys in Q1 and we're overlapping that. And, in Q1 of this year. So, it's a headwind if you think about it for Q1. But, we're looking at -- we think there's still a big opportunity. +As we mentioned last call, a big opportunity with Prime. Prime's growing at a faster rate. We think there's still a great opportunity to add unique selection to -- for category expansion. And, again, so we're going to continue to feed the Prime platform as we talked about. Continue to add selection in a lot of categories. +We're also very excited about India. If you take a look at our results for -- from an operating profit standpoint, you see that it was approximately negative $76 million on a dollar basis. If you back out exchange, that's approximately breakeven. Included in there, we certainly have a sizable step up in investment in India. And, we're super excited from what we see there right now. +We think it's very big opportunity. And, we're investing appropriately for that big opportunity. So, those are some of the things that we're working on. And, we think they're -- we still have a lot of opportunity there moving forward. + +-------------------------------------------------------------------------------- +Operator [14] +-------------------------------------------------------------------------------- + + Brian Nowak with Morgan Stanley. + +-------------------------------------------------------------------------------- +Brian Nowak, Morgan Stanley - Analyst [15] +-------------------------------------------------------------------------------- + + Great. Thanks for taking my questions. I have two. The first one is on the new AWS disclosure. +Can you just help us on accounting question. The AWS data center costs related to the core e-commerce business. Are those being allocated to North America and International? Or, are those being fully embedded into the AWS segment? +And then, the second question goes back to China, I guess. Any early learnings from the team all partnership and whether you have new thoughts of, potentially, a lower capital intensive growth strategy in China? + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com, Inc. - Vice President & CFO, Global Consumer Business. [16] +-------------------------------------------------------------------------------- + + To answer your first question, yes, they are. The associated infrastructure costs to run our North America and International consumer business, those costs, those infrastructure costs are being allocated to those segments. +The second question, in terms of China, it's early. We're liking, certainly, some of the things that we're seeing there. But, there's not a lot I can add to that at this stage. + +-------------------------------------------------------------------------------- +Brian Nowak, Morgan Stanley - Analyst [17] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Operator [18] +-------------------------------------------------------------------------------- + + Colin Sebastian with Robert Baird. + +-------------------------------------------------------------------------------- +Colin Sebastian, Robert W. Baird & Company, Inc. - Analyst [19] +-------------------------------------------------------------------------------- + + Great thanks. Maybe, just another follow up on the new segment disclosure. Thanks for breaking that out. +If we assume that the advertising other segment is reasonably profitable, than the implication is then that the core retail business is very modestly profitable, close to breakeven. And, just wondering what the thought process is and strategy is behind that? If in a sense, there's some subsidy to the retail side being used as you build market share in the core business? Thanks. + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com, Inc. - SVP & CFO [20] +-------------------------------------------------------------------------------- + + Yes, I think the best way to think about it is, we certainly have an advertising part of our North American consumer segments. But, the way you should think about it is we are making some great investments for the long term. And, that's really what's reflected in the operating results that you're seeing in terms of -- so, it is certainly impacting the operating margins both for North America and International. +So, it's the things that we're -- both Brian and I talked about, that we're doing globally to support the Prime platform. All of those things that we mentioned. Video content, original content, Prime Now, category expansion, investing on behalf of FBA, which also helps Prime devices. Those are all intertwined and certainly part of that. +And, then some of the things outside of -- that are more specifically related to International in addition to those, are some of the geographic stuff that we talked about. So, I think you should think about it that way. That, certainly we think it's a big opportunity. +And, again, one of the reasons I wanted to give you an update last quarter on Prime growth and you can see that that's going very well, and so we're feeding that. And, that's what we have been doing and that's what you see also, in certainly, the results that you're seeing today. + +-------------------------------------------------------------------------------- +Colin Sebastian, Robert W. Baird & Company, Inc. - Analyst [21] +-------------------------------------------------------------------------------- + + All right, helpful. Thanks very much. + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com, Inc. - SVP & CFO [22] +-------------------------------------------------------------------------------- + + Sure. + +-------------------------------------------------------------------------------- +Operator [23] +-------------------------------------------------------------------------------- + + Mark May with Citi. + +-------------------------------------------------------------------------------- +Mark May, Citigroup - Analyst [24] +-------------------------------------------------------------------------------- + + Thanks for taking my questions. On the International revenue, I believe there's probably a -- there's a real distinction here between some of your more established countries and some of your more emerging countries. +I wonder if you could talk a little bit about, for Germany and the UK and Japan and some of the more established markets. What the profit profile of those markets look like? And, just how much of the International segment results are being -- losses being held back by a handful of the more emerging markets? +And, then a question on AWS pricing. That seemed like the pricing environment was pretty competitive last year. What are you seeing in the market this year and what your expectations going forward? Are you expecting a bit more of a stable pricing environment? Thanks. + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com, Inc. - SVP & CFO [25] +-------------------------------------------------------------------------------- + + Yes, in terms of International, we're not breaking out individual country results. The one thing that I did mention around from a country perspective, was India. In terms of, we've certainly stepped up our investment. And, if you look at it year over year. So, that's certainly reflected in the numbers that you're seeing. +In terms of AWS, we've had 48 price decreases since inception. The team is doing a terrific job in terms of working on behalf of customers to pass on savings as they see it. But, in terms of any comment on what to expect going forward, there's really not much to add there. + +-------------------------------------------------------------------------------- +Phil Hardin, Amazon.com, Inc. - Director of Investor Relations [26] +-------------------------------------------------------------------------------- + + It probably is worth adding, that although price is a factor, the primary factor for customers choosing to move to AWS is really around their ability to move quickly and to be nimble and agile. +And so, we're very pleased with the kind of continued adoption and usage growth we've seen and obviously the benefits of AWS around their ability, customers' ability to be nimble, as a primary factor there. + +-------------------------------------------------------------------------------- +Operator [27] +-------------------------------------------------------------------------------- + + Carlos Kirjner with Sanford Bernstein. + +-------------------------------------------------------------------------------- +Carlos Kirjner, Sanford C. Bernstein & Company, Inc. - Analyst [28] +-------------------------------------------------------------------------------- + + Hi. Thanks for taking my question. I have two. My first is, my first question is about the profitability of the North America segment. You mentioned a few moments ago, that investments in Prime were part of the, or, may -- most of the explanation for what is a relatively low 3.9% margin in North America. Which, are much lower than the 5 to 6% margin EBIT margin that the brick-and-mortar retailer books. Despite, a large benefit of booking 3P net. +Here's the question. Prime is not new in North America. You probably have tens of millions of Prime users in the US, now 30, 40, 50 million. Yet, margins are still low. What gives you confidence that the investments that you are making will pay off? +Second question on AWS. As you look at expenses like R&D, and perhaps, even the fixed component of marketing and sales, which presumably, one day will be really fixed. Are they still growing significantly? +In other words, is there room for significant margin expansion at some point in the future when AWS is, I don't know, three, five, or ten times its current size? Or, do you expect R&D to scale up at the same rate as revenues? Thank you. + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com, Inc. - SVP & CFO [29] +-------------------------------------------------------------------------------- + + In terms of your first question specifically related to North America. One of the comments we made last quarter, that we disclosed, was we disclosed the growth rate globally. As well as the growth rate in the US. And, the growth rate in the US after 10 years is up 50%. It was up 50% year over year. +And so, 2014 versus 2013, in terms of Prime membership. And, that's after a price increase on Prime from 79 to 99. So, it gives you a feel for the work that we've put into Prime to make that experience great for customers and the value that we're giving them. So again, given that growth. +So, that's what, that's certainly one of the things that gives us comfort. But, when we look at the individual pieces we like what we see. So, in other words, some of the investments we're making, I think as we've talked about the past. I'll give one example, would be, video content, both original and licensed content. +We mentioned last call that we spent approximately $1.3 billion on content globally for Prime customers. And, what we've seen to date, is it's certainly still an investment for us. It's certainly impacting our operating results, but we like what we see. We see customers who come in through our free trial pipeline, if you will, for video content. They convert at a higher rate. +We see -- we have a great retention of Prime members. But, those who stream, actually, we retain those at a higher rate. And, we bring in new customers through our video pipeline. The purchasing pattern that we have for those customers is very similar to those who come in from other pipelines. So, in other words, they're buying very good from a physical product standpoint, as well as digital. So, they're buying a diverse set of products. +So, in other words, the video content that we're spending is helping us. Customers will buy consumables from us. They'll buy clothing from us. They'll buy shoes from us. They'll buy electronics. They'll buy media items. +So, that's what we're seeing and so again, it's some of these things are very early. We'll have to see over time how efficient they are. But, each period we go, we keep the data that we see, we're encouraged. And so, that's just one example. +But, that's why we are investing a lot in Prime and we think it's a great -- the Prime platform, if you will. And, we think it's a great opportunity and as I mentioned earlier, all these things we're investing in are very intertwined. + +-------------------------------------------------------------------------------- +Phil Hardin, Amazon.com, Inc. - Director of Investor Relations [30] +-------------------------------------------------------------------------------- + + And, Carlos, I think you had a question about AWS. From our perspective, it's a business that's still really in day one. A lot of potential innovation in front of us, we believe. And so, you can see we're putting a lot of CapEx, obviously there, including capital leases. And, we think over time, we will be able to generate significant free cash flow at strong ROICs. + +-------------------------------------------------------------------------------- +Operator [31] +-------------------------------------------------------------------------------- + + Mark Mahaney with RBC Capital Markets. + +-------------------------------------------------------------------------------- +Mark Mahaney, RBC Capital Markets - Analyst [32] +-------------------------------------------------------------------------------- + + Thanks. I want to go back at this North America retail margins. And, I guess I want to try to figure out. I know you're not going to go out where they could go. +But, if we look in the past. I assume that if the base in 2014 and in full year 2013 was probably depressed for North American retail margins, North American segment margins. And, if we look back, five, six years, it's probable that that was running at, kind of, mid to high single digits, CSOI margins. Kind of similar to the incremental margins you just reported for that segment, 8.7%. +So, I guess the big question I want to ask is, is there a structural change in the North American retail business over the next -- this year and the next couple years? Versus what you had, call it in 2004 to 2009, when the margins were pretty clearly higher? And now, you're going to be recovering to the levels? +That's what I'm trying to get at. Any color would be great. Thanks. + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com, Inc. - SVP & CFO [33] +-------------------------------------------------------------------------------- + + The -- thanks for the question, Mark. Just in terms of going forward, we're not giving any specific guidance beyond the current quarter. So, I can't predict for you what could happen. +But, what you mentioned is, in some of the periods that you were describing, as you mentioned, what our business look like. Several years ago, when Prime was nascent or, and we were a bit earlier in the business. We go through different cycles. We're certainly still investing very heavily. +That being said, we, as I mentioned last quarter, we're spending time on making sure that we get productivity. So, we're working on both investing heavily in the business, while working on fixed and variable productivity in other areas. Putting a lot more energy into it. That's what's helping us with the improvement that Brian mentioned in terms of operating margins year over year. It's a number of different aspects, but certainly, a mix of business and some productivity is certainly impacting that. +But, again, we think this opportunity is to improve margins over time. You'll have to stay tuned on that to see what it looks like. But, we certainly, as you can see from, not only the results, but some of the data points that we've given over the last several quarters. We are investing heavily in the business again. +Because, we like what we see and the -- and Prime growing so dramatically globally after being in it for a long time. And, we think that that's a great platform to feed. + +-------------------------------------------------------------------------------- +Mark Mahaney, RBC Capital Markets - Analyst [34] +-------------------------------------------------------------------------------- + + Okay. Thanks, Tom. + +-------------------------------------------------------------------------------- +Operator [35] +-------------------------------------------------------------------------------- + + Justin Post with Merrill Lynch. + +-------------------------------------------------------------------------------- +Justin Post, BofA Merrill Lynch - Analyst [36] +-------------------------------------------------------------------------------- + + Hello, a couple questions on margins. First on AWS, I think those are higher than most of us were thinking. Appreciate the disclosure. +What is driving your margin versus your pricing decision? How do you think about passing through cost efficiencies or potential margin growth through to customers? +And then, secondly, on international margins. Clearly, below history, below the US, what kind of things need to happen to get those at least to where the US is today? Much less, back to where they were six or seven years ago? Thank you. + +-------------------------------------------------------------------------------- +Phil Hardin, Amazon.com, Inc. - Director of Investor Relations [37] +-------------------------------------------------------------------------------- + + Justin, I will take the AWS portion on the question first. So, our model over the long term really has been to innovate and to use our scale and position to be able to pass savings along to customers. And so, we've had 48 price decreases since we launched. +As I talked about earlier, that's one factor. Customers save a lot of money, but the primary motivator is really around the innovation that AWS enables and the ability for developers to move really quickly. + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com, Inc. - SVP & CFO [38] +-------------------------------------------------------------------------------- + + In terms of the International. Again, as you mentioned, Justin, we are investing a lot right now. At which, impacts the margins there. Again, X exchange. +Think of it as approximately breakeven for the quarter. And so, again we're continuing to invest. We're investing in all the things that we talked about related to the platform. We continue to invest in some emerging geographies. Most notably certainly, India, with the step up given the experience we have. +So, we are optimistic over time. We have a lot to do there. We think it's a great opportunity for us and so that's what we're doing. But, we're excited about the opportunity and that's why you see the results that you're seeing there. + +-------------------------------------------------------------------------------- +Operator [39] +-------------------------------------------------------------------------------- + + Heath Terry with Goldman Sachs. + +-------------------------------------------------------------------------------- +Heath Terry, Goldman Sachs - Analyst [40] +-------------------------------------------------------------------------------- + + Great. Thanks. I was wondering if you could give us a sense of how we should think about the run rate of CapEx and capital lease obligations in the quarter as any sort of indication for full year? And, the trajectory of investment in fulfillment and data centers? +And then, just on the question of Prime and Prime video. As we think about the way that media growth is trending now, is there a point where you start to think of allocating Prime, some of those Prime revenues to media to account for the -- as Prime video usage increases? + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com, Inc. - SVP & CFO [41] +-------------------------------------------------------------------------------- + + Yes, in terms of the CapEx question. You know there's certainly two pieces of that. There's the consumer, the North America and International piece. +There's a number of pieces, but certainly the two largest pieces would certainly be the CapEx associated with fulfillment and the second would be infrastructure. And, again, that's for AWS versus North America and International. +I'll take the North America and International first. We're seeing good growth and year over year, in terms of overall unit growth, in terms of revenue growth, certainly, X exchange. As I a mentioned earlier, it's early in the year. So, as we do every year, we'll continue to monitor the growth there. +We're making plans for the rest of the year. And we'll get back to you as we progress throughout the year in terms of what fulfillment capacity we'll need to support that growth this year. +In terms of web services, it's obviously growing extremely fast. We saw some acceleration of growth from a revenue perspective over the last few quarters here. Usage is growing faster than that, so we will be deploying more capital as we go there. In terms of the amounts, specific amounts, we're not giving guidance on that today. +And, one of the reasons is, it's just growing so fast, that we want to make sure we've put the right amount of capital in place and the team's doing a great job doing a lot of planning and the execution around that. So, that's what we're doing there. In terms of media, I'm not fully sure I understood the question. But, as it relates to, I think it's video, could you repeat the -- part of that, part of the question? + +-------------------------------------------------------------------------------- +Heath Terry, Goldman Sachs - Analyst [42] +-------------------------------------------------------------------------------- + + Right, was just getting a sense of, as video becomes such a, becomes a bigger part of the Prime value proposition. Do you start to allocate some of the annual revenues from Prime more directly into that media segment? Because of the level of usage associated with Prime video versus the shipping benefits of Prime? + +-------------------------------------------------------------------------------- +Phil Hardin, Amazon.com, Inc. - Director of Investor Relations [43] +-------------------------------------------------------------------------------- + + Heath, we do allocate some Prime to account for the video. + +-------------------------------------------------------------------------------- +Heath Terry, Goldman Sachs - Analyst [44] +-------------------------------------------------------------------------------- + + Okay. Great. Thank you. + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com, Inc. - SVP & CFO [45] +-------------------------------------------------------------------------------- + + Thanks for the question. + +-------------------------------------------------------------------------------- +Operator [46] +-------------------------------------------------------------------------------- + + Gene Munster with Piper Jaffray. + +-------------------------------------------------------------------------------- +Gene Munster, Piper Jaffray & Co. - Analyst [47] +-------------------------------------------------------------------------------- + + Good afternoon, could you talk a little bit about the focus on same day and same hour? And specifically, about the incremental investments? And, just some context to how big of those investments are? +And, separately is what the strategic advantage is? Is this something, ultimately, obviously, it's to improve the experience, but do you see in any of your data that this opens you up to be more competitive with traditional retailers? Thanks. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com, Inc. - Vice President & CFO, Global Consumer Business. [48] +-------------------------------------------------------------------------------- + + Yes, I'll take that one. We certainly, as I said earlier, we see this as a natural extension of our existing infrastructure investment. We've -- we have 109 fulfillment centers, again, very close to customers. It allows us and unlocks for us, same day and next day deliveries. +And, to its, extreme one hour and two hour deliveries, as you've seen with Prime Now. So, we're not forecasting or giving much more on that. But, we definitely see it as a valuable customer proposition and customers embraced it. +Again, a smaller number of ASINs, tens of thousands of ASINs, but available for one or two hour delivery. And, generally, in the category of essential products that you would need in a short time period. + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com, Inc. - SVP & CFO [49] +-------------------------------------------------------------------------------- + + And, the only thing I would add to that, as Brian mentioned earlier as well, we're in seven cities today and they'll be more to come. We haven't said how many, but, you should be definitely expecting more to come, and we're very excited to do that. + +-------------------------------------------------------------------------------- +Operator [50] +-------------------------------------------------------------------------------- + + Robert Peck with SunTrust Robinson. + +-------------------------------------------------------------------------------- +Robert Peck, SunTrust Robinson Humphrey - Analyst [51] +-------------------------------------------------------------------------------- + + Yes, thank you. I was wondering, Tom, could you give us an update on your retail store strategy? Should we expect stores to open up across the US or is that something you're just limited to trying out New York. And then number two, India's come up a couple of times on the call today. +China had several structural challenges based on the market there. I was curious if you could differentiate what you're seeing that's different in India versus the China challenges? Thank you. + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com, Inc. - SVP & CFO [52] +-------------------------------------------------------------------------------- + + Yes, in terms of our consumer business, we love the business that we have today. We love -- we think there's a great opportunity to do that. To continue to expand the existing business that we have. +In terms of other things, we have a longstanding practice of not talking about what we might or might not do there. In terms of the second part, India and China, could you repeat that part? Sorry. + +-------------------------------------------------------------------------------- +Robert Peck, SunTrust Robinson Humphrey - Analyst [53] +-------------------------------------------------------------------------------- + + Sure, so you've talked about India a couple of times today on the call. Obviously it's big area of investment and focus for the Company. China had some structural challenges based on how the marketplace is. +I was wondering if you could differentiate what you're seeing in India that makes you optimistic there versus some of the challenges you faced in China? + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com, Inc. - Vice President & CFO, Global Consumer Business. [54] +-------------------------------------------------------------------------------- + + Yes, thank you for the question. Yes, they are very different. You'll see the growth rate in India's very rapid. We talked about last year and it's increasing our investment. +I think the biggest difference is the focus on sellers and the connection of sellers. A big part of the challenge there is helping sellers all across India to succeed and grow their online businesses. You'll see from our press release, that we've launched some new apps for that. So, that helps them manage their inventory better and also respond to customer inquiries. +So, that's probably the biggest difference that we see between India and China. But, it's still very very early on in India. + +-------------------------------------------------------------------------------- +Operator [55] +-------------------------------------------------------------------------------- + + Jason Helfstein with Oppenheimer. + +-------------------------------------------------------------------------------- +Jason Helfstein, Oppenheimer & Co. - Analyst [56] +-------------------------------------------------------------------------------- + + Thanks. So, can you talk about how the impact on available third-party SKUs impacts the business particular to in Europe? +And, ultimately what you could do to drive more SKUs through the platform? Whether it's lowering third-party rates or is it -- are there are other factors to try to get more SKUs on there for third-party? Thanks. + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com, Inc. - SVP & CFO [57] +-------------------------------------------------------------------------------- + + We've spent a tremendous amount of time on our seller business over the years. And, trying to improve both the experience for sellers as well as customers. And, we've done a lot of interesting things to help sellers and that's why you see the results that we're seeing today. 44% of our units today, as of this quarter, are third-party units. That's up about 400 basis points from last year. +Certainly, one of the things that we've talked about that's most -- that's notable, is fulfillment by Amazon. And so, the benefit for sellers is they get to take advantage of our multi-node fulfillment network globally. We have 109 fulfillment centers globally. As well as our customers get to take advantage of that as Prime members where we offer it in those geographies. So, it's really a great benefit for sellers. +It's good for sellers. It's good for customers. And, we believe good for shareowners too. Again, we're very excited. A number of different things we're working on. But certainly, one of the drivers, along with all the things that I mentioned is certainly FBA is very helpful. + +-------------------------------------------------------------------------------- +Operator [58] +-------------------------------------------------------------------------------- + + Mark Miller with William Blair & Company. + +-------------------------------------------------------------------------------- +Mark Miller, William Blair & Company - Analyst [59] +-------------------------------------------------------------------------------- + + Hi, good afternoon. Looking at the service sales, less the AWS revenues, you've got about $4 billion in fees mostly coming from the marketplace off a strong mid-30%. +Can you help us think about the costs that go against those marketplace fees? And, specifically within fulfillment, if you could help us understand how much of the cost is going against 3P, or basically, FBA fulfillment? Perhaps, percent of units out of the FCs that are going to 3P? + +-------------------------------------------------------------------------------- +Phil Hardin, Amazon.com, Inc. - Director of Investor Relations [60] +-------------------------------------------------------------------------------- + + So, Mark, I can't comment on the derived number. But, I can say that FBA continues to grow really well. It's become a bigger and bigger part of our third-party mix over the years. +I think we gave you an update in Q4 that it was more than 40% of our third-party units. Obviously, in the fulfillment line there is cost associated with that. As well as our other third-party units as well, with things like payment processing and other costs that we incur. So, I don't know if there's much more that we can say about that. + +-------------------------------------------------------------------------------- +Mark Miller, William Blair & Company - Analyst [61] +-------------------------------------------------------------------------------- + + If I can insert a second question. Given the upside and profitability in the first quarter, the guidance for the second quarter quite a bit lower. What are the factors you see that are negatives? Or, I guess otherwise, people are going to think you are sand bagging. Thanks. + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com, Inc. - SVP & CFO [62] +-------------------------------------------------------------------------------- + + Well, if you take a look at the guidance that we gave. Again, we gave as we have in previous quarters, we give a wide range. And, from a consolidated segment operating income standpoint, we gave $100 to $650. +The implied margin at the lower end, the higher end, is approximately 50 basis points upwards to 2.9%. This quarter, in Q1, we were up 60 basis points year over year in total. At the upper end of the forecast, we implied we'd be up 80 basis points. So, again, you know that's the range that we think it's appropriate; range for Q2. + +-------------------------------------------------------------------------------- +Operator [63] +-------------------------------------------------------------------------------- + + Ron Josey with JMP Securities. + +-------------------------------------------------------------------------------- +Ron Josey, JMP Securities - Analyst [64] +-------------------------------------------------------------------------------- + + Great. Thanks for taking the question. Just going back to margins, and a little bit more on AWS. As I look at the seasonality. I wonder if there's any seasonality in margins? +Given, it looks like margins in 2Q and 3Q came in sub 10% versus maybe mid-teens in the -- in 4Q and 1Q. And then, sort of, looking at a different way, maybe given the dip in profitability in 2Q of last year. Did that have any impact from the pricing cuts in April? Thanks very much. + +-------------------------------------------------------------------------------- +Phil Hardin, Amazon.com, Inc. - Director of Investor Relations [65] +-------------------------------------------------------------------------------- + + So, let's start with the increase sequentially in margin from Q2, or Q3 to Q4 of 2014. So, revenue grew by about 21.5% sequentially and expense grew by around 10%. And, so obviously, we were growing faster on the top line than our expenses. +And, over the long term improvements in efficiency and innovation allow us to drive that kind of cost out of the business. I mean, there certainly was an impact with pricing changes and you probably saw some of that in Q2 as well. But, over the long term, that's the model we follow. Great, thank you. + +-------------------------------------------------------------------------------- +Phil Hardin, Amazon.com, Inc. - Director of Investor Relations [66] +-------------------------------------------------------------------------------- + + And, with that, thank you for joining us on the call today and for your questions. A replay will be available on our investor relations website at least through the end of the quarter. We appreciate your interest in Amazon.com and look forward to talking with you again next quarter. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/exam/original-files/Problem_1_Sample/2015-Jan-15-BAC.N-138737516690-Transcript.txt b/exam/original-files/Problem_1_Sample/2015-Jan-15-BAC.N-138737516690-Transcript.txt new file mode 100644 index 0000000..25f2de1 --- /dev/null +++ b/exam/original-files/Problem_1_Sample/2015-Jan-15-BAC.N-138737516690-Transcript.txt @@ -0,0 +1,948 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q4 2014 Bank of America Corp Earnings Call +01/15/2015 08:30 AM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Brian Moynihan + Bank of America Corporation - Chairman, President, CEO + * Bruce Thompson + Bank of America Corporation - CFO + * Lee McEntire + Bank of America Corporation - SVP IR + +================================================================================ +Conference Call Participiants +================================================================================ + + * John McDonald + Sanford C. Bernstein & Company - Analyst + * Paul Miller + FBR & Co. - Analyst + * Eric Wasserstrom + Guggenheim Securities - Analyst + * Mike Mayo + CLSA - Analyst + * Guy Moszkowski + Autonomous Research - Analyst + * Steven Chubak + Nomura Asset Management - Analyst + * Jim Mitchell + Buckingham Research Group - Analyst + * Nancy Bush + NAB Research - Analyst + * Glenn Schorr + Evercore ISI - Analyst + * Matt O'Connor + Deutsche Bank - Analyst + * Brennan Hawken + UBS - Analyst + * Betsy Graseck + Morgan Stanley - Analyst + * Marty Mosby + Vining Sparks - Analyst + +================================================================================ +Presentation +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- +Good day, everyone, and welcome to the Bank of America earnings announcement conference call. (Operator Instructions) Please note this call is being recorded. +It's now my pleasure to turn the conference over to Mr. Lee McEntire. Please go ahead. + +-------------------------------------------------------------------------------- +Lee McEntire, Bank of America Corporation - SVP IR [2] +-------------------------------------------------------------------------------- +Good morning. Thanks to everybody on the phone as well as the webcast for joining us this morning for the fourth-quarter results. Hopefully you guys have had a chance to review the earnings release documents available on the website. +Before I turn the call over to Brian and Bruce, let me just remind you we may make forward-looking statements. For further information on those, please refer to either our earnings release documents, our website, or our other SEC filings. +So with that let me turn it over to Brian Moynihan, our CEO, for some opening comments, before Bruce Thompson, the CFO, goes through the details. Thank you. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman, President, CEO [3] +-------------------------------------------------------------------------------- +Thank you, Lee. And good morning and thank all of you for joining us to review our fourth-quarter results for 2014. As we think about the year, we've accomplished a lot, including resolving many significant legacy issues that were overshadowing the underlying progress in our franchise. +Settling those issues obviously came at a cost and drove a decline in year-over-year net income. But importantly, the settlements removed uncertainty for all of us -- for investors, regulators, rating agencies, and others. Allows us to focus on the core business and operations of the Company going forward. +As we move to slide 2, you can see that we have a simplified and stronger Company. Today we reported earnings of $3.1 billion after-tax. +The Company is simpler and more straightforward, with improved risk profile. Everything we do now is focused on driving the Company forward and delivering for our customers and clients. +On this slide you can see some of the important results. This year we completed arguably the industry's largest-ever cost-savings program, which achieved $8 billion of annualized savings. +Let's think about that. We started that program in 2011 when we had around 290,000 FTE. Nevertheless, in the three years since then, driving it the right way, we completed 2014 ending the year with around 220,000 FTEs. +Noninterest expense, excluding litigation, declined $4.4 billion compared from 2013 to 2014, and is down more than $8 billion in the last couple years, and yet we have more work to do ahead of us. We further strengthened an already strong and liquid balance sheet and increased our common stock dividend during 2014 for the first time since 2007. +As you can see on this page, our credit costs are at a decade-low level. So not withstanding the headwinds our industry faces with rates and an ongoing global economic sluggishness, we have built our platform for growth, especially in the context of a continually improving US economy. +We have built a Company with leading market positions across every core customer base, and our task now is to continue to build on that foundation and the progress we've made. As you look at our results, you'll see that year-over-year earnings in our primary businesses, with the exception of the Consumer Real Estate business, made progress that shows stability in a volatile rate and geopolitical environment. +Importantly, as you think about our Company, we have been investing in growth while taking out expense. We reduced our overall headcount during 2014 by around 8%; but at the same time we invested. +We invested by reallocating resources to sales capacity from those savings, increasing in all our core businesses. We invested by reallocating expense reductions to product capabilities, our mobile capabilities, our cash management capabilities, and other capabilities around the world. +We've invested some of those savings and our technology, spending over $3 billion in 2014 to improve and protect our Company. Now you can see the results in the appendix pages, and Bruce will touch on them in the line-of-business presentations. +We expect to continue this effort going forward. We have teams working on it every day. They are working to reallocate nonproductive expense to drive towards growth, allowing us to maintain the good expense management you have come to expect from our Company. +At the same time we are laser focused on winning market share and growing with our customers, the economy continues to improve, and we look forward to reporting that progress during the year ahead. With that, I'll turn it over to Bruce to take you through the quarter's numbers. + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [4] +-------------------------------------------------------------------------------- +Great. Thanks, Brian, and good morning, everyone. Let's start on slide 3, and I'm going to go through the details. +During the fourth quarter, we recorded $3.1 billion of earnings, or $0.25 per diluted share. Let me give you a few thoughts on revenues. +There were two significant adjustments to revenue as well as negative DVA charges that in the aggregate reduced reported revenues this quarter by $1.2 billion pretax or roughly $0.07 a share after-tax. Of the components of the $1.2 billion impact, we recorded a roughly $578 million negative market-related adjustment which, as you all know we refer to as FAS 91, in net interest income for the acceleration of bond premium amortization on our debt securities that was driven by lower long-term rates. Otherwise, our core net interest income, which excludes this market-related adjustment, was pretty stable, with the fourth quarter coming in a little bit better than we signaled to you all during our third-quarter earnings call. +In addition, this quarter we adopted FVA, which is for funding valuation adjustment, and incurred a $497 million charge against our sales and trading results as a result of that adoption. And as we normally provide to you, our credit spreads tightened; and this tightening caused a negative charge for DVA in the trading account of approximately $130 million during the quarter. +Expenses during the quarter were well managed. Our total noninterest expense in the fourth quarter was $14.2 billion, which included approximately $400 million in litigation expense during the quarter. +This level of expense is the lowest level of expense that we've seen since the Merrill Lynch merger. And credit costs during the quarter improved, as our provision for credit losses was $219 million and included $660 million in the release of reserves. +On slide 4, reduced asset levels in our Global Markets business drove our balance sheet levels lower, coming down $19 billion from the third quarter of 2014. And we finished at just over $2.1 trillion in assets. We continued our focus on balance sheet optimization for liquidity as we continued to shift our discretionary portfolio into HQLA-eligible securities from non-HQLA loans and also improved our deposit composition. +As we signaled to you in the third-quarter earnings call, discretionary portfolio first-lien loans declined from the third quarter of 2014 levels; but we were very pleased with the loan growth we saw in our core businesses during the quarter. If we look in those core businesses, Global Banking loans increased $4 billion during the quarter; within Wealth Management, loan balances grew $3 billion; and our US consumer credit card receivables increased $2.9 billion during the quarter. +We did have a $2.7 billion decline in our direct and indirect portfolio as we transferred a portfolio of student loans to held-for-sale. Our deposits grew from the end of the third quarter while short-term funding declined. +We executed another successful issuance of $1.4 billion of preferred stock early in the third quarter, and that benefited regulatory capital. Shareholders equity improved with both the earnings growth as well as the improvements in AOCI. As a result of that, our tangible book value increased to $14.43 per share, and our tangible common equity ratio improved to 7.47%. +If we move to regulatory capital on slide 5, under the Transition rules our CET1 ratio was 12.3%. If we look at our Basel 3 regulatory capital metrics on a fully phased-in basis, CET1 capital improved $6.2 billion during the quarter; that was driven by earnings, deferred tax utilization, as well as the improvement in AOCI. +Our operational risk-weighted assets during the quarter increased again. They now represent 34% of total risk-weighted assets. But notwithstanding that increase, we were able to keep our Basel 3 Advanced ratio at levels consistent with what we saw at the end of the third quarter. +Under the Standardized Approach, our CET1 ratio improved from 9.5% in the third quarter of 2014 to 10% at the end of the year. +If we look at our supplementary leverage ratios, we've done a lot of work over the past year to improve those. Obviously, the fully phased-in kick in in 2018. We look at where we ended the quarter: at our Bank Holding Company, our SLR ratio was at 5.9%; and at our primary banking subsidiary, BANA, we were at approximately 7%. +We turn to slide 6, funding and liquidity, long-term debt ended the quarter at $243 billion, down $7 billion from the third quarter of 2014. We've done a lot of work over the past couple years to smooth out our Parent Company maturity profile; and as you can see, we have $22 billion scheduled to mature in 2015 and comparable amounts over the next four or five years. +Our Global Excess Liquidity Sources reached a record level during the quarter and closed at $439 billion. Within those Global Excess Liquidity Sources, our Parent Company liquidity improved $5 billion from the end of the third quarter to $98 billion at the end of the year. +Time to required funding increased to 39 months during the fourth quarter. And during the quarter we continued to increase our estimated liquidity coverage ratios at both the consolidated as well as at the Bank levels. At the end of the year, we are well ahead of the 100% fully phased-in 2017 requirement at the consolidated level, and at more than 90% at the Bank level, which is well ahead of the 80% phased-in 2015 requirement, and are well positioned to achieve the 2017 requirement. +If we turn to slide 7, on net interest income, our net interest income on an FTE basis was $9.9 billion, down from the third quarter of 2014 as a result of the more negative market-related adjustment I mentioned a moment ago, which also drove a reported net interest yield decline of 11 basis points. +Lower long-term rates coupled with a flattened yield curve resulted in adjustments to our assumptions to our bond premium amortization, which drove the $578 million of market-related adjustments in the fourth quarter versus the negative $55 million we saw during the third quarter of 2014. If we adjust this market-related adjustment, NII was $10.4 billion and declined less than $100 million from the third quarter of 2014, despite the challenging rate environment we saw during the fourth quarter. The adjusted NII decline was driven by the impacts of the lower discretionary loan balances within the Consumer Real Estate portfolio. +If we look at net interest yield on an adjusted basis, it was up a touch from the third quarter of 2014 to 2.3%. Given the movement lower in rates that we saw during the quarter, we did become more asset sensitive, such that a 100 basis point parallel increase in rates from what we saw at the end of the year would be expected to contribute roughly $3.7 billion in NII benefits over the course of the next 12 months. And given the movement in rates, the sensitivity is now more evenly weighted to both long-term as well as short-term rate moves. +Before we leave this slide I do want to remind you that during the first quarter of 2015 we have two fewer interest accrual days than the fourth quarter of 2014, which will negatively impact NII by a couple hundred million dollars. +Noninterest expense -- and I moving to slide 8 -- was $14.2 billion in the fourth quarter of 2014 and included approximately $400 million in litigation expense. As I said earlier, this is the lowest quarterly expense amount that we have reported since the Merrill Lynch merger. +If we exclude litigation, total expenses were $13.8 billion, which declined $300 million from the third quarter of 2014 and was driven by our LAS initiative cost savings as well as lower revenue-related incentive costs within our Global Markets business. If we compare these expenses to the fourth quarter of 2013, we were down $1.2 billion, driven by LAS cost savings, new BAC benefits, and, to a lesser degree, the lower revenue-related incentives. +Legacy Assets and Servicing costs, ex-litigation, were $1.1 billion in the quarter, $200 million lower than the third quarter and $700 million lower than the fourth quarter of 2013. As we continue to work through these delinquent loans, we expect these quarterly costs will come down a few hundred million dollars more by the end of 2015. +Headcount was down 5,800 during the quarter. And as we look at expense, a reminder that we will record our normal annual retirement-eligible incentive cost in the first quarter of 2015; and we expect that number to be roughly $1 billion, consistent with what we've seen the past couple years. +We turn to asset quality on slide 9. Credit quality continued to improve during the quarter. Q4 provision expense was $219 million, and we released a net $660 million of reserves, given the continued pace of asset quality improvement, particularly within our Consumer Real Estate portfolio. +Reported charge-offs were $879 million and declined from the third quarter of 2014. I would remind you both periods of net charge-offs included NPL sales and other recoveries, and the fourth quarter included approximately $150 million of costs related to actions that were taken in relation to our DOJ settlement, which were previously reserved for. +If we exclude the recoveries and the DOJ component, charge-offs in the fourth quarter were just over $1 billion versus a similarly adjusted net charge-off amount of $1.2 billion in the third quarter of 2014. Loss rates on this same adjusted basis were 47 basis points in the fourth quarter of 2014 versus 52 basis points that we saw in the third quarter of 2014. +Let's now move to the business segment results, which we start on slide 10 with Consumer and Business Banking. Our results within Consumer and Business Banking show solid bottom-line performance, with earnings of $1.8 billion. Those were down from the fourth quarter of 2014 due largely to lower release of loan loss reserves and, to a lesser degree, higher tax rates. +The business generated a solid 24% return on allocated capital during the quarter. Revenue was up slightly on a year-over-year basis despite net interest income being down, as our noninterest income grew more than 5%, with a strong improvement in card income. +We look at customer activity during the quarter, we had solid deposit growth; and our rates paid is now at 5 basis points. Loans on a linked-quarter basis increased seasonally, driven by US consumer credit card. +Our card issuance remains very strong, at 1.2 million new cards in the fourth quarter of 2014, of which approximately 67% of those were issued to existing customers. We look at all of 2014, we issued 16% more cards in 2014 than 2013 and increased the percentage of the issuance to our existing customers, which is consistent with the overall strategy. Credit quality improved again, as our US credit card loss rate fell to 2.7% and continues to have a very strong risk-adjusted margin at just below 10%. +Our Merrill Edge brokerage assets grew to $114 billion, which is up 18% year-over-year, on new accounts, strong account flows, as well as higher market levels. Our mobile banking customers reached 16.5 million in the fourth quarter, and now 12% of all customer deposit transactions are done through mobile devices. +If we adjust for portfolio divestitures, combined debit and credit purchase volume was up 4% relative to the fourth quarter of 2013 and, if we back fuel out, was up 5%. +Let's move to Consumer Real Estate Services on slide 11. The improvement in the results compared to the third quarter of 2014 was driven by the third quarter of 2014 DOJ settlement, which impacted expense, provision, as well as income tax. +Revenues did increase slightly over the third quarter of 2014 while expense, even after we exclude litigation, declined from the third quarter as both fulfillment costs on the production side and costs on the delinquent loan servicing side were down from the third quarter. Core production revenue and servicing fees were both stable compared to the third quarter of 2014, while servicing income did benefit from better MSR hedging results. +On the production front, first-mortgage retail originations were stable with the third quarter of 2014 at $11.6 billion, and the pipeline was consistent with the third quarter of 2014 as well, albeit up on a year-over-year basis. On home equity, we're the number-one lender; and line originations during the quarter were $3.4 billion, in line with the third quarter of 2014 and up north of 70% on a year-over-year basis. The credit quality of those second-lien originations remains very strong, with average FICO scores over 790 and combined loan-to-value ratios at less than 60%. +Expenses in the segment did include $262 million of litigation costs in the fourth quarter versus $5.3 billion that we saw in the third quarter of 2014. We continue to work through and resolve our MBS securities litigation matters, including this quarter the FHLB of San Francisco matter. With the resolution of that, we now estimate that we've resolved approximately 98% of the unpaid principal balance of all RMBS as to which RMBS securities litigation has been filed or threatened against all Bank of America related entities. +LAS expense, ex-litigation, this quarter was just over $1.1 billion as we achieved our first quarter of 2015 goal a quarter ahead of schedule. Importantly, the number of 60-plus-day delinquent loans that we have dropped to 189,000 units, which is down 32,000 or 14% from the third quarter of 2014. +If we turn to slide 12, Global Wealth and Investment Management delivered another strong quarter. Pretax margin was strong. Net income was just over $700 million, but was down from the fourth quarter of 2013 as solid fee-based growth was offset by lower net interest income and higher expense. +Record asset management speeds offset some weakness we saw in transactional activity and still drove a 7% increase in noninterest revenue relative to the fourth quarter of 2013. Our asset management fees now represent 45% of revenue within this segment, up from 40% a year ago. +Noninterest expense did increase from the fourth quarter of 2013 as a result of higher performance-based incentives as well as increased support costs. We increased the number of financial advisors; and year-to-date retention of our experienced financial advisors remains at record levels. +Return on allocated capital was 23%. Client balances were nearly $2.5 trillion, up $36 billion from the third quarter of 2014, and were driven by strong client balance inflows. +Long-term AUM flows were $9 billion for the quarter and represented the 22nd consecutive quarter of positive flows. Our record loan flows during the quarter reflect $3 billion in growth over the third quarter of 2014 in securities-based as well as residential mortgage lending. And our period-end deposits were up $7 billion or 3% from the third quarter of 2014. +If we turn to slide 13, Global Banking earnings for the quarter were $1.4 billion, up from the fourth quarter of 2013 on lower credit cost and, to a lesser degree, reduced expenses. +Results were partially -- the net income was partially offset during the quarter on a year-over-year basis by lower investment banking fees off of what was a record level in the fourth quarter of 2013. Return on allocated capital was strong at 18%. +If we look at the investment banking revenues of north of $1.5 billion, we feel very good about the results. They were up on a linked-quarter basis, and our investment banking team executed very well in a tough distribution environment, given the volatility of rates as well as energy prices. +Provision was a slight benefit in the quarter and reflected continued low loss rates and a small reserve release compared to the year-ago period, which included a reserve addition of $434 million. If we look at the balance sheet, we'd point you to average loans were $271 billion, up $3.7 billion from the third quarter of 2014 levels. +We switch to Global Markets on slide 14. The business reported a modest loss in the quarter, but that did include a $497 million charge to implement FVA. +For those unfamiliar with FVA, funding valuation adjustment is an adjustment to the fair value of uncollateralized derivative trades to account for the present value of funding cost. This is an accounting practice many of our peers have also adopted; and as you all know, this is a one-time transition cost for implementation. +Separately, net DVA for the quarter was a loss of $130 million versus a loss of $617 million during the fourth quarter of 2013. Earnings are down from the fourth quarter of 2013 as a result of a decline in sales and trading revenue that was mostly offset by a decline in expense. If you recall, on our fourth-quarter 2013 call, FICC sales and trading during that quarter included $220 million in recoveries on legacy positions in the fourth quarter of 2013. +Sales and trading, adjusting for net DVA and FVA, were $2.4 billion in the fourth quarter of 2014 versus $2.8 billion in the fourth quarter of 2013, after we adjust for the recoveries. On this same adjusted basis, FICC sales and trading revenues of $1.5 billion compare to $1.9 billion in the year-ago period. +December results were particularly challenging during the quarter, with the toughest areas of performance being the credit-sensitive businesses within FICC, most notably mortgages and credit trading, which are generally our largest trading revenue-related businesses. On the positive side, we saw increases in both FX and rates revenues versus the prior year that were driven by increased volatility, given global deflationary expectations leading to the US dollar strengthening. +Equity sales and trading was up modestly from the fourth quarter of 2013, as increased volatility was a positive for secondary flows across both our cash and derivative trading businesses. +On the expense front, the decline reflects litigation expense of $655 million in the fourth quarter of 2013. If we take that litigation expense out, expenses still declined 5% from the fourth quarter of 2013 as the incentives were reduced to align with the revenue performance that we saw. +On slide 15, All Other, the results in the fourth quarter of 2013 reflect lower revenue from NII, largely associated with the market-related adjustments that we've discussed, as well as lower securities gains and equity investment income, partially offset by gains on the sale of certain loans with long-term standby agreements that were converted to securities. Significant equity investment income is largely a thing of the past for us, as we've reduced the size of the principal investing positions in the business as well as strategic positions, and should be modeled accordingly. +You'll also notice we took additional reserves for the payment protection insurance, but at a lower level than we saw during the third quarter of 2014. Our fourth-quarter 2014 expense is down year-over-year on less nonmortgage litigation expense and lower infrastructure costs. +Our effective tax rate for the quarter was 29%, and I would expect the tax rate for the Company in 2015 to be in the low 30%s absent any unusual items. +One other thing I want to mention before wrapping up is some movement in our business lines that you'll see as we report them to you in 2015. In the first quarter of 2015, we expect to align Business Banking into our Global Banking business, which takes this more commercial business out of our core Consumer and Business Banking unit. In addition, we expect to move the home loans portion of our Consumer Real Estate Services business to Consumer Banking, as this product remains integral to their relationships with us. +So to conclude my comments, as we look at both 2014 and the fourth quarter of 2014, capital and liquidity reached record levels, which provides a solid base to support our businesses that hold leading or top-tier positions in the industry. We continue our focus on expense and operating leverage after reaching significant milestones this year on both New BAC as well as LAS cost-saving initiatives. +We reported a quarter of much lower legacy assets and servicing operating and litigation costs, which have been burdening our reported results. Asset quality continued its trend of improvement against a slowly improving US macroeconomic backdrop, and we continue to remain well positioned to benefit in an environment where rates start to increase. +With that, we'll go ahead and open it up for questions. + + +================================================================================ +Questions and Answers +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- +(Operator Instructions) Betsy Graseck, Morgan Stanley. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [2] +-------------------------------------------------------------------------------- +Hi, good morning. Hey, I just want to talk a little bit about the asset sensitivity and how we should be thinking about that from here. In particular, as you know, the long end of the curve has come down since the end of the quarter. +So just wanted to understand: is that FAS 91 effect Q-to-date given what the long end of the curve has done? And then maybe you could speak to what you are doing to try to minimize any further pressure. + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [3] +-------------------------------------------------------------------------------- +Sure. A couple things. If you recall, Betsy, we've historically been saying that the 100 basis points is in the $3.1 billion to $3.2 billion range. And think of the increase to $3.7 billion more or less just representing the recapturing of the FAS 91 that we saw this quarter. +That's why we referenced that there's been more asset sensitivity on the long side. The short-end side really hasn't changed at all. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [4] +-------------------------------------------------------------------------------- +Sure. Then given the fact that the 10-year is now yielding like 1.8% or so, should we assume -- like if we end the quarter in 1Q at 1.8%, that the same type of 10 basis points down draw is FAS 91-affected, the same in first quarter as it was in fourth quarter? Or is it, because you're more asset sensitive, there is a little bit higher impact? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [5] +-------------------------------------------------------------------------------- +Yes, it's a good question. I think when we looked at this last night, that the movement that we've seen so far in the first quarter of 2015 is almost identical to what we saw during the fourth quarter. So if you were to snap it off of what we saw last night, it would be a comparable-type number, realizing we still have two and a half months ago. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [6] +-------------------------------------------------------------------------------- +Okay. Is there any give-back in refi activity that you are expecting? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [7] +-------------------------------------------------------------------------------- +Yes, it's, say, if we look at -- we referenced in refi activity increased as a percentage of overall mortgage production in the fourth quarter. And as I said in my prepared remarks, if we look at the pipelines and compare the mortgage pipeline at year-end relative to the comparable period, it's up pretty significantly. +We'll just have to see how that plays out, realizing that the first quarter does tend to be a little bit seasonally slow. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman, President, CEO [8] +-------------------------------------------------------------------------------- +The other thing, Betsy, is that in January to date there's been a stark move in the amount of applications coming in -- a very stark upward move due to this last rate fall-off. So as those things close through we'd expect to see some pickup in production this quarter from the refi. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [9] +-------------------------------------------------------------------------------- +Got it. Okay. That's super. Thank you. + +-------------------------------------------------------------------------------- +Operator [10] +-------------------------------------------------------------------------------- +John McDonald, Sanford Bernstein. + +-------------------------------------------------------------------------------- +John McDonald, Sanford C. Bernstein & Company - Analyst [11] +-------------------------------------------------------------------------------- +Hi, Bruce. Just wanted to follow up on the NII. On the core side of NII, ex- the FAS 91, your core NII held up well despite what you'd indicated in October about being conservative with the buy ticket. +I guess, how did you hold the core in on NII? And how are you navigating that now in what feels like an even more difficult environment for reinvesting cash flows today, with the 10-year where it is? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [12] +-------------------------------------------------------------------------------- +Sure. That's a good question, John. I think there are a couple things. +The first is, if you look at in the quarter -- I think we did a good job with respect to the overall debt footprint, which was down $7 billion, which helped us out a little bit. Secondly, if you look at we were able to get another basis point out on the deposit front. And throughout the quarter we saw some loan growth that was a little bit better than what we would have seen when we spoke to you during the quarter. +The other thing that we did see during the quarter is we were able to invest and get some of the investments in the portfolio in -- I believe it was in mid-November when rates did back up. And as we go forward, we do have liquidity to invest in the second and third months of the quarter and will be prudent with how we invest it relative to OCI risk. +The other thing I would say just before we leave this, John, that I should've referenced with Betsy's point is that it's easy to focus on the FAS 91 because we're resetting the amortization of premium. I think the other thing you need to realize that we did see in the quarter is, with the rate movement up, while you do have a negative on FAS 91 you've got a significant positive from a capital perspective, where OCI in the quarter from the rate movement was north of $3 billion. + +-------------------------------------------------------------------------------- +John McDonald, Sanford C. Bernstein & Company - Analyst [13] +-------------------------------------------------------------------------------- +Got you, got you. So on the core piece, Bruce, do you expect it to be more challenging, to hold in to that $10.4 billion with the 10-year where it is? Does it make it more difficult? And what kind of -- how should we think about the risk to the $10.4 billion if rates stay low? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [14] +-------------------------------------------------------------------------------- +I think, as I said in my comments, the $10.4 billion you really need to start out with at about $10.2 billion because you've got two less days during the quarter. Then say there is a little bit of headwind to hold that on a core basis, and we are obviously doing everything we can to keep it as close to $10.2 billion as we can, realizing that we're not going to take outsized OCI risk. + +-------------------------------------------------------------------------------- +John McDonald, Sanford C. Bernstein & Company - Analyst [15] +-------------------------------------------------------------------------------- +Okay. Then shifting gears on expenses, you got the LAS target a quarter ahead of time. Do you have a year-end target? I think you said you expect to continue to reduce the LAS to $1.1 billion. Can you just clarify that? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [16] +-------------------------------------------------------------------------------- +Yes, I think as we look out and we look at the plans and actions along with the progress that we've made on the 60-plus-day delinquents, I think broadly speaking -- and as you know, this number can bounce around a little bit -- that we'd look to have the LAS expenses down to the $800 million type area by the end of the year. And we are obviously working through plans as we look out to 2016 to continue to drive that number south of $800 million as we go forward. + +-------------------------------------------------------------------------------- +John McDonald, Sanford C. Bernstein & Company - Analyst [17] +-------------------------------------------------------------------------------- +Okay. How should we think about the core rest of Bank of America expenses where you came in nicely at the $12.7 billion for the fourth quarter? Obviously, you mentioned the stock option expense stuff in the first quarter; but as we think about 2015, what are you hoping to do on the core expense base? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman, President, CEO [18] +-------------------------------------------------------------------------------- +You know, John, I think -- I will answer at a broad level and then Bruce can touch in. So if you think about it in the fourth quarter, a couple things happened. +One is, you've got to remember the market spread, that revenue, it was down. So be careful not to forget that as we see it coming back this quarter, expect it to rise as it traditionally does in first quarter: that would be an increased expense -- which you should want, obviously. +But from the rest of it, it's basically a continuous process of taking out expenses and then either bring in the bottom line or reinvest in the growth. So to give you a straightforward way, in the fourth quarter the reduction to headcount of approximately 5,000, 1,100 or so was LAS and the rest was core activity where we just keep drawing down the expense base. At the same time, we've added salespeople during that quarter. +So what we're trying to do is -- I wouldn't expect it to fall dramatically. But I'd expect you guys to be able to see us continue to make strong investment in sales capacity, technology, products while holding expenses relatively flat with a slight downward bias, irrespective of -- you just got to be careful of compensation related to revenue, because we'd all want that to be higher. + +-------------------------------------------------------------------------------- +John McDonald, Sanford C. Bernstein & Company - Analyst [19] +-------------------------------------------------------------------------------- +Okay, okay. Thank you. + +-------------------------------------------------------------------------------- +Operator [20] +-------------------------------------------------------------------------------- +Brennan Hawken, UBS. + +-------------------------------------------------------------------------------- +Brennan Hawken, UBS - Analyst [21] +-------------------------------------------------------------------------------- +Yes, hi; good morning. In FICC, seems a little bit below what certainly I was looking for. I know you highlighted some of the difficult markets that you are large in. Was there any specific positional pain, given what we saw in some of the credit spreads and some of the movements there? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [22] +-------------------------------------------------------------------------------- +No, not at all. You have to go back to the core premise that we talk about, which is that the Banking and Markets businesses are run as an integrated business. And a lot of the activity that we see within the Markets area is in market making and other things that are done off of the new issue platform from an underwriting perspective. +I think what we saw during the quarter, particularly in December, was that there was a significant slowdown as we saw overall volatility in the markets from both a new issue as well as a secondary market perspective that flowed through. But there were not any -- if you're looking, there were no losses or particular pain points within the Global Markets piece of the equation during the quarter. + +-------------------------------------------------------------------------------- +Brennan Hawken, UBS - Analyst [23] +-------------------------------------------------------------------------------- +Okay, thanks. That helps. Then can you guys add any comment to the press reports we've seen recently about you all rationalizing the PB business and cutting ties to 150 hedge fund clients? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman, President, CEO [24] +-------------------------------------------------------------------------------- +Well, I think this is a customer profitability exercise that -- as we look at driving the franchise, the way Tom and [Fab Gall] and the team have done a good job of repositioning the equities business, we have to constrain the prime brokerage a bit due to size, because it's lower balance sheet return, as you would be aware of. +But importantly, it's a customer profitability: we're looking for customers who will use us with multiple products and services, whether it's fixed income, equities, in all aspects of fixed income. So as we take the scarce resource, which is the GAAP balance sheet and the RWA balance sheet, and allocate it across customers, we've got to make sure we get the returns, and this was a natural reflection of it. + +-------------------------------------------------------------------------------- +Brennan Hawken, UBS - Analyst [25] +-------------------------------------------------------------------------------- +Should we expect to think about some revenue headwinds in your equities business as we model out 2015, as a result of some of those efforts? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman, President, CEO [26] +-------------------------------------------------------------------------------- +I would say no; it's all pretty much through it right now. As you look at the revenues quarter-to-quarter they run plus or minus $1 billion, and Fab and the team have done a good job of increasing the yield from the other clients at the same time. So that absent market forces, I wouldn't expect it to have much of an effect. + +-------------------------------------------------------------------------------- +Brennan Hawken, UBS - Analyst [27] +-------------------------------------------------------------------------------- +Terrific. Okay. Then helpful to hear about the target of around $800 million for LAS by year-end and then driving it lower in 2016. Can you help us think about how you think about that number to zero? +Because I mean, ultimately, that's -- given the title, the L in the LAS, right? That's got to go to zero eventually. How should we think about that? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman, President, CEO [28] +-------------------------------------------------------------------------------- +Well, you've got the (inaudible). There's and in there, so it is all the servicing expense in the Company is in that unit, for all good loans and bad loans. So it doesn't go to zero, but it's got to get a lot better. +Because if you start to noodle on the 4 million or so units we have in first-mortgage servicing, and think about the annualized cost, we've got to get it down significantly, make servicing mortgages make sense to us. But that's a project that we are working against doing it the right way for the customer, doing it the right way for the regulatory environment, and the consent orders and all the things that have gone on, as you're well aware of. So we've just got to keep peeling that away. +So when we say $800 million or so, that is the next way station on our train ride here. But it's got to go a lot further than that for the 3.5 million to 4 million of good units we have, so to (technical difficulty) + +-------------------------------------------------------------------------------- +Brennan Hawken, UBS - Analyst [29] +-------------------------------------------------------------------------------- +Okay. So no indication about where that settling-out level might ultimately be? Even if not a win, but kind of what the number would be? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman, President, CEO [30] +-------------------------------------------------------------------------------- +Well, I think -- yes, we've talked about $0.5 [million], but I'm not sure that's a great performance in that over time either. So just assume that there is nobody more interested in driving that number down to a normalized servicing cost than this Company. + +-------------------------------------------------------------------------------- +Brennan Hawken, UBS - Analyst [31] +-------------------------------------------------------------------------------- +Fair enough. And then, last one for me. You guys hit on in the Wealth Management business and the margin there, support costs and revenue-related comp. Could you maybe quantify how much each of those factors impacted the margin change quarter-over-quarter? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [32] +-------------------------------------------------------------------------------- +Yes. I think if you look at the -- a couple things. The first is that from a margin perspective, you had a little bit of a headwind with NII being lower than what it was. But as you look at the support costs during the quarter, I would think of that as being about 200 basis points on the margin during the quarter that we saw. + +-------------------------------------------------------------------------------- +Brennan Hawken, UBS - Analyst [33] +-------------------------------------------------------------------------------- +Great. Thanks a lot. + +-------------------------------------------------------------------------------- +Operator [34] +-------------------------------------------------------------------------------- +Glenn Schorr, Evercore ISI. + +-------------------------------------------------------------------------------- +Glenn Schorr, Evercore ISI - Analyst [35] +-------------------------------------------------------------------------------- +Hi. Thanks very much. I wonder if we could get your best comment that you can give us on energy-related exposures. In your Q you have a general comment on energy and $20 billion. But if you could break it down a little bit more, what's secured, what's not secured, what's investment grade, what's not, and just how overall you feel your position there -- it would be helpful. + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [36] +-------------------------------------------------------------------------------- +Sure. I think if we look at the amount of funded exposure across what we refer to as oil and gas, that the amount of funded exposure, which includes derivative exposure, was roughly $23 billion at the end of the year. As you look at that $23 billion, I would think of it generally as 60% that's directly reflected or affected by the price of oil. There are a lot of those that are not. +So you've got roughly $22 billion, $23 billion funded; 60% directly affected by oil. Well north of 80% of that are investment-grade borrowers. And for those noninvestment-grade borrowers, they are obviously secured facilities and in most cases have formulas upon which they can borrow based on the value of the assets that we are secured by. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman, President, CEO [37] +-------------------------------------------------------------------------------- +I think if you think overall, one of the things that give you a perspective that we see is in the consumer spending in January -- debit and credit cards basically. We've seen the spending go up by 3%. And if you look at the fuel side of that, it's about 5% of that total spending, and it is down 28% year-over-year. +So the people are getting a benefit. Our consumer customers are getting a benefit, but they are re-spending that benefit and the overall spending levels are growing through it. +So there is competing -- there is a technical risk to the oil-producing companies that Bruce just talked you through. But the overall economy, even in the first week or so of January, we're seeing the benefit to the consumer very starkly in the year-over-year comparison. + +-------------------------------------------------------------------------------- +Glenn Schorr, Evercore ISI - Analyst [38] +-------------------------------------------------------------------------------- +I definitely appreciate all that. You said that was the funded to oil and gas. Is commitments a larger number, I think, than that? And do you have the ability to pull back on the commitments? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [39] +-------------------------------------------------------------------------------- +Yes, well, I think on average the fundings are roughly 50% of what the commitments are. As it relates to the pulling back of commitments, I think what I would point to and what our teams did a very good job with is we obviously have commitments in the originate-to-distribute piece, which if we look at, we ended the year I believe with two commitments of investment-grade borrowers on an originate-to-distribute basis, one of which has had a significant positive event from a financing perspective already this year. The other is a single-A credit that will get done in the second quarter. +And outside of the investment-grade originate-to-distribute, I think there was a couple hundred million dollars that still needed to get done. So you're not pulling commitments from borrowers; but as it relates to commitments that needed to be distributed, the teams have done a very good job. + +-------------------------------------------------------------------------------- +Glenn Schorr, Evercore ISI - Analyst [40] +-------------------------------------------------------------------------------- +Okay. I don't want to put words in your mouth, but it sounds like you are semi-comfortable with the positioning. There will be some hits along the way, but this is not a major risk to the portfolio? Again, I don't want to put words in your mouth. + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [41] +-------------------------------------------------------------------------------- +We're comfortable with the positions. You should assume as we are making these commitments in environments where oil is higher, we're continually running and stressing those portfolios to be comfortable with the commitments. +And as Brian referenced, to the extent that we are in a prolonged period where these prices persist, to the extent that there are costs that run through because of difficulties that a commercial or corporate borrower may have, that as we look across the overall credit platform you'd expect there to be offsets, given what we're seeing with consumers and other people that are benefiting from lower energy prices. + +-------------------------------------------------------------------------------- +Glenn Schorr, Evercore ISI - Analyst [42] +-------------------------------------------------------------------------------- +Okay, that's helpful. Last one from me is I didn't hear anything on TLAC. If you could tell us where you think your ratio shook out, net of the conservation buffer and the SIFI buffer, that would be helpful. + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [43] +-------------------------------------------------------------------------------- +I think if you look at where we are from a TLAC perspective, we are generally in the 21% type area. And embedded in that 21% type area is the fact that structured notes -- we've assumed for that purpose that we would not benefit from structured note funding. And if we refinanced out those structured notes you'd pick up another 1% to 2% based on the current size of the debt footprint. + +-------------------------------------------------------------------------------- +Glenn Schorr, Evercore ISI - Analyst [44] +-------------------------------------------------------------------------------- +Okay. I just want to make sure: the 21% is net of the conservation buffer and your SIFI buffer, or gross of? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [45] +-------------------------------------------------------------------------------- +No, it's gross of. That is a gross of. So you're roughly 21%, call it, plus another 1% to 2% for structured notes; and then depending on the exact treatment of the buffers as we go through that, that number would be reduced by the buffers. + +-------------------------------------------------------------------------------- +Glenn Schorr, Evercore ISI - Analyst [46] +-------------------------------------------------------------------------------- +Got it, okay. Perfect. Thank you very much. + +-------------------------------------------------------------------------------- +Operator [47] +-------------------------------------------------------------------------------- +Jim Mitchell, Buckingham Research. + +-------------------------------------------------------------------------------- +Jim Mitchell, Buckingham Research Group - Analyst [48] +-------------------------------------------------------------------------------- +Good morning. Just a quick question on the balance sheet and NII. Appreciate the efforts to keep NIM flat; but to really get NII growing, we've got to start to see, I guess, the balance sheet on a net basis grow. +I think your balance sheet was down close to $25 billion this quarter. At what point do we start to see the net balance sheet -- the restructuring of the balance sheet start to give way to growth? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [49] +-------------------------------------------------------------------------------- +Yes, I think what you're going to see as we go forward is that, as we look out into our forecasted models, we would expect there to continue to be strong deposit growth throughout 2015. And as we referenced before, obviously the goal with that deposit growth is very much a focus to grow loans within our core customer segments. +As I referenced, we saw that within the Global Banking space this quarter. We saw it within Wealth Management. We are seeing pickups in overall mortgage activity. +So I think you're likely to see the balance sheet creep up as deposits come in and as we look to grow loans. I just want to make sure, though, that we remind you that we will continue to see the discretionary portfolio that has got whole loans in it, that in this rate environment they will continue to repay. So as you judge how we do on loan growth, you need to look at the core businesses. +As I said, we would expect to start to see the balance sheet move up. And at the same time, we're trying to get things that don't have a return and aren't core to what we do off. But to your point, I think we are largely through that. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman, President, CEO [50] +-------------------------------------------------------------------------------- +Yes, and I think if you think about it, say two years ago I think we cited about $100-odd-billion of noncore loans; that's down around to $30 billion. And a dominant part of that is still in the home equity area, quite frankly. +So in the card business and in the Business Banking area where we had some stuff that was put on by some predecessor company, we're largely through all that. And that's why you're seeing some growth there. +So the card you saw grow; it's seasonal, but it grew and it started to -- it's been stable for a number of quarters. The good home equity side is growing quite strongly. +The stuff we're running off in home equity starts is high charge-off contents, a better decision economic for the Company to run it. But the rest of the loan balances, we ought to see grow, with the exception of the discretionary residential mortgage holdings which will continue to run down, based on a better view of what we want to do for [ALCO] management going forward. + +-------------------------------------------------------------------------------- +Jim Mitchell, Buckingham Research Group - Analyst [51] +-------------------------------------------------------------------------------- +Okay. I think, Bruce, to your point, the deleveraging around trying to improve the leverage ratio is -- the impact of that should be easing going forward. Is that what you're saying? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [52] +-------------------------------------------------------------------------------- +That's correct. + +-------------------------------------------------------------------------------- +Jim Mitchell, Buckingham Research Group - Analyst [53] +-------------------------------------------------------------------------------- +Okay. Just one last, a follow-up on -- I don't know if you mentioned this: where you guys are in the NSFR. + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [54] +-------------------------------------------------------------------------------- +Yes, we've done a lot of work. We have not put anything out public on that, but as we've looked through it and sorted through it, we do not see that being a constraint as we go forward. + +-------------------------------------------------------------------------------- +Jim Mitchell, Buckingham Research Group - Analyst [55] +-------------------------------------------------------------------------------- +Okay, great. That's it for me. Thanks. + +-------------------------------------------------------------------------------- +Operator [56] +-------------------------------------------------------------------------------- +Matt O'Connor, Deutsche Bank. + +-------------------------------------------------------------------------------- +Matt O'Connor, Deutsche Bank - Analyst [57] +-------------------------------------------------------------------------------- +Good morning. The capital ratios grew more than expected. Obviously the decline in rates helped the positive earnings, and you mentioned the DTA consumption. +As we think about 2015 and the drivers of capital, is it more of the same? Or is there, call it, optimization overall? Not just the loan runoff that you address, but as we think about -- you've had Final Rules for the last few months; there are still some adjustments to the business throughout. +How should we think about the capital build? And if you have an estimate for 2015, that would be interesting as well. + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [58] +-------------------------------------------------------------------------------- +Sure. We're not going to provide an estimate, but what I would say is that, as you look at overall capital levels, if you start with the numerator, as we project out and look at the earnings stream we think that at least through 2015, and possibly into the first part of 2016, that on average -- and you can have some quarterly bounces around based on timing and payments -- but that generally we should accrete capital over the course of at least four and up to six quarters largely based on the pretax earnings of the Company, as opposed to the after-tax earnings. And that's what you saw during the fourth quarter. +The other thing on the numerator, as I referenced, that there is -- and if we were to snap a quarter today, there would be OCI benefit from the downward movement in rates. +As it relates to what we are seeing on the risk-weighted assets side, I would say generally we continue to benefit, although it declines a little bit each period. We continue to benefit from the runoff of some of the Global Markets positions that would have been put on in the 2005 to 2008 time frame that tended to have tenors of 7 to 10 years. +In addition to that, as we continue to have payoffs and as we continue to move out some of the tougher Consumer Real Estate assets and put higher-quality real estate assets on that are better credit borrowers, while the asset levels may stay comparable you do have an RWA pickup from that as well. + +-------------------------------------------------------------------------------- +Matt O'Connor, Deutsche Bank - Analyst [59] +-------------------------------------------------------------------------------- +On RWA, any numbers you can provide in terms of how much benefit you get from the -- I guess just priced on the credit correlation book and some of those contracts and the real estate running off, just those two pieces? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [60] +-------------------------------------------------------------------------------- +No, I mean I think as you look forward, these tend to be -- I think outside of op-risk quarter we had roughly $30 billion of risk-weighted asset benefit under the Advanced Approach. Roughly half of that was in the consumer books, half of it was in the wholesale books. I think you'll continue to see benefits, but I don't think you'll see the quarterly benefit of that magnitude on a go-forward basis. + +-------------------------------------------------------------------------------- +Matt O'Connor, Deutsche Bank - Analyst [61] +-------------------------------------------------------------------------------- +Okay. Then just separately, the home equity charge-offs increased a fair amount versus 3Q. Obviously, 3Q is a very low level. But remind me what's going on there. +I think there was an accounting or methodology change a year ago. Has that fully worked through? Or is there a seasonality or (multiple speakers)? What's going on? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [62] +-------------------------------------------------------------------------------- +The biggest thing you had in home equity this quarter is that I believe it was roughly $150 million that went through charge-off that was related to the DOJ settlement. So realize you have $150 million of charge-off, $150 million of reserve; so from a net P&L perspective, it was a push. +But you did have that during the quarter, and it's the reason that we wanted to give you the core charge-off number Q3 to Q4. Because as we implement the DOJ settlement you will see both charge-off and reserve release come out in each of probably the first and second quarter; then we should be largely through that. + +-------------------------------------------------------------------------------- +Matt O'Connor, Deutsche Bank - Analyst [63] +-------------------------------------------------------------------------------- +Okay. Thank you. + +-------------------------------------------------------------------------------- +Operator [64] +-------------------------------------------------------------------------------- +Steven Chubak, Nomura. + +-------------------------------------------------------------------------------- +Steven Chubak, Nomura Asset Management - Analyst [65] +-------------------------------------------------------------------------------- +Hi, good morning. Bruce, I was hoping you could maybe help explain what prompted the increase in operational risk RWA? The 34% I guess makes you an outlier relative to some of your peers, whereas previously you were more in line. +I know the process typically is you submit the models to the regulators and/or the Fed and then they give you feedback. I wanted to know: was the increase prompted by the feedback from the regulators themselves as part of the annual review? Or was it what you determined based on your own internal models? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [66] +-------------------------------------------------------------------------------- +Answer the question slightly differently, which is that as we work through an iterative process with our regulatory supervisors, we do believe at this point that, from an op-risk perspective, that we are adjusted and the amount of op-risk RWA that we have now is consistent with what you would need to exit parallel run. + +-------------------------------------------------------------------------------- +Steven Chubak, Nomura Asset Management - Analyst [67] +-------------------------------------------------------------------------------- +Okay, understood. So we shouldn't expect any further increases as a percentage of RWA going forward; or is it simply too early to make that determination? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [68] +-------------------------------------------------------------------------------- +We think with respect to op-risk RWA that we are there. We obviously need to get through those elements that are the rest of parallel run. But from an op-risk perspective we feel like we're there. + +-------------------------------------------------------------------------------- +Steven Chubak, Nomura Asset Management - Analyst [69] +-------------------------------------------------------------------------------- +Okay. That's really great. Then just one more quick one for me. I didn't hear in the prepared remarks any color on the investment banking backlog and didn't know if you can give us an update there as well. + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [70] +-------------------------------------------------------------------------------- +Yes, it's interesting, and we have to be a little bit careful. I would say as we looked at the backlog in the pipeline, particularly from an M&A perspective, that we feel very good about where the pipeline was at year-end. It's one of the stronger year-end pipelines that we have. +I think the only tone of caution I would say is that we've obviously seen a little bit more volatility in both the fixed income and equity new issue markets. But as it relates to the amount of business that we are winning, that's getting queued up and is in the pipeline, we feel very good about that. It was a good back backlog at year-end. + +-------------------------------------------------------------------------------- +Steven Chubak, Nomura Asset Management - Analyst [71] +-------------------------------------------------------------------------------- +Okay. Great. That's it for me. Thank you for taking my questions. + +-------------------------------------------------------------------------------- +Operator [72] +-------------------------------------------------------------------------------- +Eric Wasserstrom, Guggenheim. + +-------------------------------------------------------------------------------- +Eric Wasserstrom, Guggenheim Securities - Analyst [73] +-------------------------------------------------------------------------------- +Thanks. Good morning. I just wanted to follow up on a couple of topics that have been touched on already. Maybe just starting with the risk-weighted asset discussion once more, I just want to make sure I understand all the puts and takes of what's going into the risk-weighted asset calc. +It sounds like on the positive side, obviously, there is the benefit of a GAAP balance sheet reduction as well as the trade-off between lower-quality and higher-quality assets. And it sounds like the operating-risk component is now fully baked in. But are there any other components that could drive that up in a way that's different from what's going on, on the GAAP balance sheet? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [74] +-------------------------------------------------------------------------------- +I think the only thing that's out there is that, as part of exiting parallel run we are working through with our supervisors the different wholesale and other credit models that you need to exit parallel run. So we are working through that. +But I think absent that, you're largely at the point of looking at and you'd expect that the RWA is going to largely follow the GAAP balance sheet. The one thing, and I think you all know this, where you could possibly diverge from that is that there is a procyclicality to the extent that you have volatility in the Markets businesses as it relates to the stress VaR calculations that go into the risk-weighted asset. But outside of that, you would directionally expect it to follow the GAAP balance sheet. + +-------------------------------------------------------------------------------- +Eric Wasserstrom, Guggenheim Securities - Analyst [75] +-------------------------------------------------------------------------------- +Okay. And with respect to the GAAP balance sheet, what is your overall expectation about the net growth over 2015? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [76] +-------------------------------------------------------------------------------- +I think you're probably going to largely see it in the ZIP Code and probably be most correlated to the overall deposit balances. If you look at the range that we've been running at over the last 12 months, it's been in the 2.1 to 2.15, 2.175 type area. And I'd expect that area or that range to hold for 2015. + +-------------------------------------------------------------------------------- +Eric Wasserstrom, Guggenheim Securities - Analyst [77] +-------------------------------------------------------------------------------- +Great. Then just to talk about the asset quality for a moment, obviously it was the lowest provision that we've seen from you in some time; and many of your peers are inflecting from the point of asset quality improvements to some modest now deterioration and the rebuilding of reserves. I just want to get a sense from you about where you think you are in that spectrum. + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [78] +-------------------------------------------------------------------------------- +Sure. Well, I think if we go back -- and let's start with the fact that we saw during the quarter that if we back out any impact of loan sales as well as the DOJ settlement, charge-offs in the fourth quarter came down from $1.2 billion to just over $1 billion. I think as you look at charge-offs, when you're at virtually zero from a commercial perspective, it's hard to see getting much better than that. +I do think where we are probably a little bit different is that as we continue to work through -- and we had another solid improvement of a couple billion dollars from an NPL perspective within the Consumer Real Estate space -- that we continue to work through and reduce those tougher Consumer Real Estate credits. But I think that if you look at this $1 billion charge-off type level that we've seen, we're probably at areas where you're going to see that flatten out. +I think as we look forward there may be a little bit of reserve release on the front end -- on the first half of the year. And you'd probably expect that to flatten out and go away as we get through 2015. + +-------------------------------------------------------------------------------- +Eric Wasserstrom, Guggenheim Securities - Analyst [79] +-------------------------------------------------------------------------------- +Great. Then just finally on the LAS expense, which I know you've touched on several times, but I'm just wondering if the pace of that improvement changes at all as you are getting into the later stages of the delinquency and foreclosure inventory improvement. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman, President, CEO [80] +-------------------------------------------------------------------------------- +Yes, it did. It [does] that and the plus side is that you have an ability to push the numbers down faster as the economy continues to improve and the market continues to improve and the opportunities for borrowers and time passes, frankly. +The flip side of that, though, is in the states that -- in the areas where the process is slow, you're sort of boiling the beaker, and what's left is in the really slow areas. So we've sort of caught up in the states where the process goes through at a reasonable fashion; and we still have the laggards in places that the process is traditionally oriented. +So I think you're absolutely right. There is a bias that as you get better at it and get lower, it starts improving; but against that you get to some of the rocks that are harder to move because the process is so slow. +Secondly is, remember that we had -- we took it up to almost 58,000 employees in that business. And there is a lag to getting the real estate costs out and letting off the buildings and all the stuff that we have to do. So we've got to be a little careful we're getting ahead of ourselves. +The headcount comes out first; the facilities then come out second. And so we are working hard on that. +So you're right, that once you see the improve -- the pace of improvement continues almost nominally or even nominally better than the past, but there are obvious -- there are just some things that work against you in terms of assets left are harder, and then secondly there is a lag to the hard costs over and above the people costs. + +-------------------------------------------------------------------------------- +Eric Wasserstrom, Guggenheim Securities - Analyst [81] +-------------------------------------------------------------------------------- +Great. Wonderful. Thanks very much. + +-------------------------------------------------------------------------------- +Operator [82] +-------------------------------------------------------------------------------- +Guy Moszkowski, Autonomous Research. + +-------------------------------------------------------------------------------- +Guy Moszkowski, Autonomous Research - Analyst [83] +-------------------------------------------------------------------------------- +Good morning. I just want to go back to the net interest margin discussion a little bit. I thought that I heard you say in the prepared comments that there had been a shift in the balance of the asset sensitivity to more of a balance between long-term versus short-term rates. I was wondering if that is strictly a function of the FAS 91 issue in a falling long-rate environment. Or is there something more structural that you've been doing with the portfolio that has caused that to happen? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [84] +-------------------------------------------------------------------------------- +It's the FAS 91, Guy; you're absolutely correct. + +-------------------------------------------------------------------------------- +Guy Moszkowski, Autonomous Research - Analyst [85] +-------------------------------------------------------------------------------- +Okay. Then if we can just take a look at that one historically for a second, obviously over time that has caused quite a lot more volatility in your NIMs than it has for a lot of the peer group. I seem to remember that for regional banks, say, that have often had the same issue, there is a difference, I guess, in the way they accrue versus doing the constant resets that you do. And I was wondering why you do it in the way that you do, which seems to create more volatility. + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [86] +-------------------------------------------------------------------------------- +We probably wondered the same thing this quarter. All kidding aside, I think if you go back, you're right; there are two ways that you can do this. +The first is the way that we do it, which is: you have the premium; you look at the average life of the premium; and each quarter you reset it and basically retroactively make that adjustment from when it started. And that was the determination that we had made a number of years ago. +But you're right. The other way that that is allowed and provided for under GAAP is that you just basically adjust as you go, and take it through the P&L as you go. And you can do it either of two ways, and we obviously do it the way that we do. + +-------------------------------------------------------------------------------- +Guy Moszkowski, Autonomous Research - Analyst [87] +-------------------------------------------------------------------------------- +Would you ever consider changing that? And if you were to do so, would there be a significant one-time charge that would be associated with that? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [88] +-------------------------------------------------------------------------------- +No, I think it goes the other way. The reality is, is that we run through the P&L that amortization to catch up for, in effect, if rates ended up being lower than when the premium was set on. So I think the way that we do it is absolutely appropriate. +And keep in mind, the other thing -- and I referenced in my earlier comment -- is that as you do this from a balance sheet perspective, you're always adjusting the valuation of your AFS securities to be the fair market value at the time that you publish your financials. And obviously that flows through OCI. + +-------------------------------------------------------------------------------- +Guy Moszkowski, Autonomous Research - Analyst [89] +-------------------------------------------------------------------------------- +Yes, fair enough. You also talked about changing line items or lines of business, where certain things are booked, as we move into 2015. That was fairly clear, except I was wondering: will this also entail moving the very large investment portfolio of your mortgages from All Other into the Consumer category? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [90] +-------------------------------------------------------------------------------- +It will not result in a large portion of mortgages being moved. There may be a smaller amount or a percentage of it that we continue to evaluate, because the one thing that we want to make sure that we do is to have the geography of the financial statements motivate the behavior of the people that serve the client base that they do. +So there may be possibly a relatively small amount of home equity loans that could travel into the Consumer business. But it's not going to be anything that distorts things in any meaningful way. + +-------------------------------------------------------------------------------- +Guy Moszkowski, Autonomous Research - Analyst [91] +-------------------------------------------------------------------------------- +Got it. Thanks. Then final one for me. You talked a little bit about the Investment Banking backlog at the turn of the year. But more broadly for Global Markets and Global Banking taken together, can you give us a sense -- now that we're a couple weeks into the year -- how the, in particular say, trading activity has started off? +And given some of the increase in volatility, especially with big moves like what happened with the Swiss franc today, are you instructing the Global Markets business to pull back on risk? Or generally are you seeing that some of those volatility levels are in some way beneficial? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [92] +-------------------------------------------------------------------------------- +I think there's a couple parts of that. The first is, I think if you look at overall risk levels that we ran within the Global Markets business and if you look at our information that we put out at year-end, that even with a little bit of a pickup in volatility at year-end, VaR was at low levels and overall balance sheet levels were at low levels as we exited the year. +I think we are nine trading days into the quarter, so I think it's a little bit early to forecast what you would expect for the quarter for the overall sales and trading businesses. The only thing I would say is that clearly the activity levels that we've seen, that it's been more of a return to normal than what we experienced in the month of December, but I wouldn't want anyone to draw any conclusions when we are nine days through 62 trading days in a quarter. + +-------------------------------------------------------------------------------- +Guy Moszkowski, Autonomous Research - Analyst [93] +-------------------------------------------------------------------------------- +Sure, it's early. Thanks very much. I appreciate the color. + +-------------------------------------------------------------------------------- +Operator [94] +-------------------------------------------------------------------------------- +Paul Miller, FBR. + +-------------------------------------------------------------------------------- +Paul Miller, FBR & Co. - Analyst [95] +-------------------------------------------------------------------------------- +Thank you very much, and most of the questions has been answered. But on your legacy assets -- and you talked about this a little bit, where your default numbers have dropped roughly to 189,000 from roughly I think 220,000. Did you sell anything? Or is that all improvement in just credit in the quarter? +In other words, did you move the houses out, or did you also sell? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [96] +-------------------------------------------------------------------------------- +Yes, my recollection is there was -- roughly a third of that came from the sales of both servicing as well as the underlying loans themselves. Then in addition to that, we saw continued improvement in the net new 60-pluses. And then we obviously worked others through the normal foreclosure process, as well as for those borrowers that cured. + +-------------------------------------------------------------------------------- +Paul Miller, FBR & Co. - Analyst [97] +-------------------------------------------------------------------------------- +One of the things that -- because I -- on your -- you made a comment about that the lower oil prices has improved some of the consumer credit, consumer spending, and all that. Are you seeing any improvement in working through those 60-day defaults from that? Or those loans are just so old relatively speaking in the default bucket that the lower oil prices really doesn't help out? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman, President, CEO [98] +-------------------------------------------------------------------------------- +I'd say it is much too early to figure out what the oil price impact would have on mortgage defaults. What we are saying is you're actually seeing consumers spend the money they are getting; and you're seeing the consumer credit quality stay strong. +But as you project out a period of low prices, you would see a benefit on the consumer side offset by the commercial side. So I'm not sure, Paul, in the context of what's in that 60-day bucket that it will have a meaningful impact. +It hasn't had a meaningful impact so far. It's just pretty early days. +But the good news is if you look at our delinquencies in the first-mortgage portfolios they keep coming down. And that's what drives long-term reduction. + +-------------------------------------------------------------------------------- +Paul Miller, FBR & Co. - Analyst [99] +-------------------------------------------------------------------------------- +Brian, I missed -- I was writing it down as fast as I could, but you talked about how that you are seeing consumer balances increase over the last couple months, I guess, or last month. Can you go over those numbers again? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman, President, CEO [100] +-------------------------------------------------------------------------------- +Consumer spending increased. Is that what you're referencing, Paul? + +-------------------------------------------------------------------------------- +Paul Miller, FBR & Co. - Analyst [101] +-------------------------------------------------------------------------------- +Yes. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman, President, CEO [102] +-------------------------------------------------------------------------------- +So far, January of 2015 versus January of 2014, spending on credit and debit cards is up about 3% year-over-year. And that is overcoming a drag effect of about 1.5 percentage from lower fuel prices. + +-------------------------------------------------------------------------------- +Paul Miller, FBR & Co. - Analyst [103] +-------------------------------------------------------------------------------- +Okay. Hey, guys, thank you very much. + +-------------------------------------------------------------------------------- +Operator [104] +-------------------------------------------------------------------------------- +Marty Mosby, Vining Sparks. + +-------------------------------------------------------------------------------- +Marty Mosby, Vining Sparks - Analyst [105] +-------------------------------------------------------------------------------- +Thank you. I wanted to drill into the Markets business a little bit. In the sense that we've seen pressure on fixed income the last two quarters, is there anything in the drivers of that weakness that would jeopardize the seasonal uptick that we usually see in the first quarter? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman, President, CEO [106] +-------------------------------------------------------------------------------- +If I understand your question, I think that the answer to that is no. If you go back and look at -- with the exception of last year, the fourth quarter does tend to be the weakest quarter of the year seasonally. It was obviously a little bit more so this quarter. +But structurally, there's nothing that would lead you to that. I would just -- obviously, it's a market that ebbs and flows. But no, there is not anything structural that would lead you to believe that that should be different. + +-------------------------------------------------------------------------------- +Marty Mosby, Vining Sparks - Analyst [107] +-------------------------------------------------------------------------------- +Then there is a lot of noise in the Markets business, and I tried to take out as much as I could. What I'm trying to look at is expense elasticity relative to the revenues. +From third quarter to fourth quarter it looked very effective, was about 80% in relation to expenses to revenue reduction. But over the last year, when you take out the litigation expense, looks like operating expenses only declined about 20% of what revenues declined. +So I was just curious what you thought maybe the right elasticity number would be there. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman, President, CEO [108] +-------------------------------------------------------------------------------- +Well, I think largely what you saw in the fourth quarter was a reflection of the change in the incentive levels due to the lower revenue. And you'd expect that to happen. +But let me bring that up a little higher to a more broader point, which is about two, three years ago, Tom Montag and the team made a fundamental restructuring of that business to drop its expense base to where as long as we get $2.5 billion more revenues, more or less, we start making some money. And if you adjust the FVA charge, which is the one-time charge, they made somewhere around $300 million this quarter, to give you a sense. +So in its worst quarter, it earns $300 million; in its best quarter it earns over $1 billion. And that largely is really marginally profitable when you see the revenues go from the high $2 billions to the, say, $3 billion level up to the $4 billion level. Most of that comes through with a tariff on compensation of around 19%, 20% or something like that. +So there is elasticity, but as you get the lower level you start to hit the floor on the fixed cost structure. + +-------------------------------------------------------------------------------- +Marty Mosby, Vining Sparks - Analyst [109] +-------------------------------------------------------------------------------- +That's very helpful. Then Brian, lastly, you've talked several times about the core expenses and the investments you're making. A lot of the core businesses, really all except Banking, showed declines in net income sequentially and year-over-year. Do you feel like you're investing to try to reignite some of that growth going forward? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman, President, CEO [110] +-------------------------------------------------------------------------------- +Yes -- no, one of the things you've got to be careful of is they reflect -- all these charges that we talk about in NII get pushed out to all the businesses. So there's some elements that really aren't in the business's control, for lack of a better term. +And then secondly, you're still seeing -- as we move from a period where reserve releases were going on at the business level, you're seeing provision changes across-the-board that have it. But by and large, the rest, if you look at the fees and the direct expenses, which are the two things they control the most, you see a pretty good relationship going on and pretty good stability. +And I'd say as you look across the businesses, the Consumer Bank continues to make good progress on sales capabilities. And its actual sales, you can look at some of the later pages; you can see it. +I said Wealth Management, we've got to make sure the expenses and the revenue stay in line there. We talked about that last quarter, and John Thiel and the team, especially in Merrill Lynch, are doing a good job of getting after that. +Then in Banking, I think you've seen a pretty good relationship, if you back out the fundamental impacts of FAS 91 and the provision and things like that, which they -- those are adjustments we make at the top of the house and push through. + +-------------------------------------------------------------------------------- +Marty Mosby, Vining Sparks - Analyst [111] +-------------------------------------------------------------------------------- +Thanks. + +-------------------------------------------------------------------------------- +Operator [112] +-------------------------------------------------------------------------------- +Mike Mayo, CLSA. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA - Analyst [113] +-------------------------------------------------------------------------------- +Hi. You highlighted that the expenses are at the lowest levels since the Merrill merger, and we estimate that they are down almost one-fourth over five years so that's certainly good. But we also note that revenues are down quite a bit over that time frame too. +So how do you evaluate the trade-off between more aggressive restructuring and investing in the franchise? And specifically, you're pretty much done, I think, with New BAC. Would you have a program -- maybe Even Newer BAC, or a new restructuring plan? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman, President, CEO [114] +-------------------------------------------------------------------------------- +Yes, I'd say, Mike, the other piece of that is obviously the credit costs you've got to think about, in terms of if you look back and look at the higher revenue levels at the time. The charge-off run rate was $2 billion and $3 billion a quarter; at one quarter it was $10 billion if you remember, for cards especially. So be careful about that. +But I'd say your point really is: what do you do from now forward? And we see -- we talked about it in the core expense base, leave aside the LAS, the litigation, all that stuff, but just the core expense base. Basically what we continue to do is to take out nonproductive expenses and invest part of that back in the franchise and bring part of that to the ability to see that core line continue to move down -- nudge down. +Remember that when we are doing this we're absorbing health cost increases, wage and salary increases, incentive comp increases. So we are heavily focused on maintaining a rational balance between the core revenue and the core expense dynamic going forward. +So you should expect, assume, that there is a continuous program of looking at this, to continue to simplify our Company, continue to take out the vestiges of the cost of the crisis. And as we have downsized the Company, take out the overhead that was harder to shake out, as you're well aware. +So we are laser focused on it. But I think on the other hand, we continue to invest in sales capacity; and you see that reflected in things like card sales and home equity sales and auto loan sales, direct auto loan sales. All increased. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA - Analyst [115] +-------------------------------------------------------------------------------- +So don't expect another new program with expense targets, just more of a day-to-day perspective now? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman, President, CEO [116] +-------------------------------------------------------------------------------- +No. Remember, we absorb -- if you think of 60% of our costs being people costs, and you think of inflationary level of cost increases of 3% on those, basically to keep costs down and flattish you've got to work your tail off. Whether -- and that's the process going forward. +We had to drop the cost down to get into a reasonable level. We'll continue to make improvement relative to the revenues. +And if the world gets different, we will then have to revisit it. But right now in this revenue environment, even a slow growth environment, we can keep the costs flat as revenues start to rise. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA - Analyst [117] +-------------------------------------------------------------------------------- +Then a separate question: what are your key financial targets for 2015? I know you've expressed some of your targets, assuming interest rates increase. But if interest rates don't increase, what should investors evaluate you on at the end of 2015? +All I had to go on without the higher interest rates is page 42 of the proxy that talks about the PRSUs. It says as long as you get over a 50 basis point ROA you go in the money on the PRSUs. So I'm not sure if I should be looking at the 50 basis point number, or it's 80 basis points, 100% in the money, or the 1% number that you've talked about before. +But again, assuming rates don't go up, what's your ROA and ROE target for 2015? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman, President, CEO [118] +-------------------------------------------------------------------------------- +Mike, we don't give specific projections, but our goal is to continue to take the earnings from the $3 billion level this quarter and drive them forward. And our view is that, based on everything we see, as we see the impact of all the work we're doing plus the rollover of the cost saves, the reduction in LAS costs, the litigation falling back to the kinds of levels you saw this quarter, you'll see us move towards those long-term goals of 1% ROA and 12% return on tangible common equity. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA - Analyst [119] +-------------------------------------------------------------------------------- +One last try. That 1% and 12%, that assumes higher interest rates. If your forecasts do not expect higher interest rates as soon as they do right now, at what point would you take additional action with expenses? And how do you think about that? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman, President, CEO [120] +-------------------------------------------------------------------------------- +We take additional action on expenses every afternoon. In other words, we had 4,000 reduction in FTE in the fourth quarter of 2014, Mike, out of the core franchise to keep getting efficient. So we work on expenses every day, and we have teams of people working to do all the things that you expect us to do. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA - Analyst [121] +-------------------------------------------------------------------------------- +All right. Thank you. + +-------------------------------------------------------------------------------- +Operator [122] +-------------------------------------------------------------------------------- +Nancy Bush, NAB Research. + +-------------------------------------------------------------------------------- +Nancy Bush, NAB Research - Analyst [123] +-------------------------------------------------------------------------------- +Good morning, guys. Two questions. +Brian, I'm a little bit confused about the card growth. I think you said you got 1.2 million new cards out in the fourth quarter. Is that -- and didn't you mention something about it being seasonal? You've got lots of ground that you can gain in that business, and I just want to clarify whether this is something extraordinary going on here and what your projections are for the future for growth there. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman, President, CEO [124] +-------------------------------------------------------------------------------- +Yes, Nancy; sorry if we confused you. Let's talk about the production of new card units. +That's the 1.2 million -- 1.184 million, if you look on page 19 you can see that; and you can see it building from the fourth quarter of 2012, 830 million -- or 830,000. So the first is production of units, and the second was balances. +Balances in the card business were up in the fourth quarter almost $3 billion, $2.5 billion to $3 billion. That we've got to be careful, because it's Christmas season; people spend and borrow and then they pay down. +So the point there is that has a little seasonal help to it. But if you look back in prior quarters you've seen a stability in our card balances, which as we continue to sell more units and people continue to use the card, we ought to expect a positive growth there. +But it's units at 1.2 million. Balances grew at $2.5 billion to $3 billion, and the balances are common in seasonality. Units have been above 1 million new production units each quarter for the last several quarters. + +-------------------------------------------------------------------------------- +Nancy Bush, NAB Research - Analyst [125] +-------------------------------------------------------------------------------- +Is there one particular card that's proving to be very popular? I see your ads for the cash-back cards, etc. Is that the card of choice at this point? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman, President, CEO [126] +-------------------------------------------------------------------------------- +Yes, that is our core card offering. We've simplified our offering to three or four core products, and that's the biggest one. And it's contributing to card income being up year-over-year by about 7%. Bruce, come in. + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [127] +-------------------------------------------------------------------------------- +Yes. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman, President, CEO [128] +-------------------------------------------------------------------------------- +So that card is selling well. And the good news, as you can see, is 67% came through basically our web online sales process and our branch sales process in the core customer. So we continue to drive it. + +-------------------------------------------------------------------------------- +Nancy Bush, NAB Research - Analyst [129] +-------------------------------------------------------------------------------- +Okay. Secondly, the 25% margin in Wealth Management, I think back to the old days when you had much fatter margins in that business. What do you see as a normalized margin in Wealth Management? +Number two, to what impact is the Wealth Management margin being maybe impacted by high liquidity levels that customers are maintaining? And do you see that changing? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [130] +-------------------------------------------------------------------------------- +It's a couple things to that, Nancy. I think the first is that we've said that over the course of a couple years that we need that Wealth Management margin to get to 30%. I think you've got a couple things going on right now. +In the low rate environment, that business has an artificial drag because, as you know, you don't tend to pay out compensation, which is a significant portion of the expense, to those things that are net interest income related. So we would expect -- we also have in 2016 some deferred comp and other programs running off; so as we go through over the course of the next couple years, between the business growing, a normalization of rate environment, and some other things that that should be a 30% type pretax margin business. + +-------------------------------------------------------------------------------- +Nancy Bush, NAB Research - Analyst [131] +-------------------------------------------------------------------------------- +Okay, great. Thank you very much. + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [132] +-------------------------------------------------------------------------------- +I think we're through all the questions. So thank you very much for joining us and we'll look forward to speaking next quarter. + +-------------------------------------------------------------------------------- +Operator [133] +-------------------------------------------------------------------------------- +This concludes today's program. Thanks for your participation. You may now disconnect. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/exam/original-files/Problem_1_Sample/2015-Jan-28-FB.OQ-139431073452-Transcript.txt b/exam/original-files/Problem_1_Sample/2015-Jan-28-FB.OQ-139431073452-Transcript.txt new file mode 100644 index 0000000..8cc7f28 --- /dev/null +++ b/exam/original-files/Problem_1_Sample/2015-Jan-28-FB.OQ-139431073452-Transcript.txt @@ -0,0 +1,645 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q4 2014 Facebook Inc Earnings Call +01/28/2015 05:00 PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Deborah Crawford + Facebook, Inc. - VP of IR + * Dave Wehner + Facebook, Inc. - CFO + * Mark Zuckerberg + Facebook, Inc. - CEO + * Sheryl Sandberg + Facebook, Inc. - COO + +================================================================================ +Conference Call Participiants +================================================================================ + + * Carlos Kirjner + Sanford C. Bernstein & Company, Inc. - Analyst + * Justin Post + BofA Merrill Lynch - Analyst + * Eric Sheridan + UBS - Analyst + * Ben Swinburne + Morgan Stanley - Analyst + * Arvind Bhatia + Sterne, Agee & Leach - Analyst + * Ross Sandler + Deutsche Bank - Analyst + * Colin Sebastian + Robert W. Baird & Co. - Analyst + * Paul Vogel + Barclays Capital - Analyst + * Heather Bellini + Goldman Sachs - Analyst + * Brian Wieser + Pivotal Research Group - Analyst + * Mark Mahaney + RBC Capital Markets - Analyst + * John Blackledge + Cowen and Company - Analyst + * Robert Peck + SunTrust Robinson Humphrey - Analyst + * Peter Stabler + Wells Fargo Securities - Analyst + * Anthony DiClemente + Nomura Securities Intl - Analyst + +================================================================================ +Presentation +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Good afternoon. My name is Courtney and I will be your conference operator today. At this time, I would like to welcome everyone to the Facebook fourth-quarter and full-year 2014 earnings conference call. +(Operator Instructions) +Thank you very much. Ms. Deborah Crawford, Facebook's Vice President of Investor Relations, you may begin. + +-------------------------------------------------------------------------------- +Deborah Crawford, Facebook, Inc. - VP of IR [2] +-------------------------------------------------------------------------------- + + Thank you. Good afternoon and welcome to Facebook's fourth-quarter earnings conference call. Joining me today to talk about our results are Mark Zuckerberg, CEO; Sheryl Sandberg, COO; and Dave Wehner, CFO. +Before we get started, I would like to take this opportunity to remind you that our remarks today will include forward-looking statements and actual results may differ materially from those contemplated by these forward-looking. Factors that could cause these results to differ materially are set forth in today's press release, our annual report on Form 10-K and the most recent quarterly report on Form 10-Q filed with that SEC. Any forward-looking statements that we make on this call are based on assumptions as of today, and we undertake no obligation to update these statements as a result of new information or future events. +During this call we will present both GAAP and non-GAAP financial measures. A reconciliation of GAAP to non-GAAP measures is included in today's earnings press release. The press release and an accompanying investor presentation are available on our website at investor.fb.com. +And now I would like to turn the call over to Mark. + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook, Inc. - CEO [3] +-------------------------------------------------------------------------------- + + Thanks, Deborah. And thanks, everyone, for joining today. This has been a good quarter for Facebook and a great end to the year. Our community continued to grow in size and engagement, and we're very pleased with the growth of our business. +Overall, 2014 was a year of great progress for the Facebook community. 1.39 billion people now use Facebook each month and 890 million people daily, an increase of 165 million monthly actives and 133 million daily actives this year. +Time spent per person per day across our services continued to rise, growing this quarter by more than 10% compared to last year. And that doesn't even include WhatsApp which joined us late last year. These milestones show that our community continues to get stronger. +It's not just our community where we've made a lot of progress.2014 was also a year of big investments in our future. This year we made big bets on the next generation of communication and computng platforms by acquiring WhatsApp and Oculus. +We focused on serving our community better across all of our products, raising the quality and relevance of content and newsfeed, improving our search and video products, and improving the performance and efficiency of our mobile apps. And we continue to invest in our employees and infrastructure, furthering our headcount by 45% this year, and opening our newest data center in November, in Altoona, Iowa. +When you consider the progress of our community and our investments, 2014 was an important year for us and a good sign of how we're thinking about the future. In the next decade, Facebook is focused on our mission to connect the entire world, welcoming billions of people to our community, and connecting many more people to the Internet through Internet.org. +To serve the entire world, we need to build products that serve our community and allow people to share different types of content with different audiences. We need to offer new services and infrastructure at greater scale. And we need to create new tools and innovate to solve fundamental challenges in the places we want to connect. +Doing this will take a lot of effort over the coming years, and Facebook is going to have to evolve. Similar to our transition to mobile over the last couple of years, now we want to really focus on serving everyone in the world. +Our mission has always been to make the world more open and connected. This is something we've been preparing for over the last decade. +Everything we've achieved in 2014 and over the last 10 years has helped us to build a foundation for a future of greater scale. I'm excited for our progress in 2015. +Now, with that in mind, I want to talk about the things that we expect to execute on over the next 3, 5 and 10 years. Over the next 3 years, our main focus is to continue to serve and grow our community by delivering better services for people and businesses around the world. +One sign of our continued growth and engagement is our progress on visual and public content. More than two billion photos are now shared daily across Facebook, Instagram, Messenger and WhatsApp. +Video grew significantly this year to an average of more than three billion video views per day on Facebook. We now have more than two billion interactions every week on Facebook between public figures and their fans. +Instagram is also growing and helping people share and consume the most engaging content in different communities across world. Instagram reached 300 million monthly actives, with more than 70% outside of the US. Average time spent using the app continues to be very strong compared to other mobile services. +Across Facebook and Instagram we've done a very good job on engagement, especially when it comes to helping people find and consume content they like. In 2015 we will continue working on this as well as developing more ways for people to share even more of the moments they care about on Facebook. +Five years ago, most of the content shared on Facebook was text and some photos. Today, it's primarily photos with some text and video. Over the next five years, we want to keep developing new products and features to help people share the way they want. +When it comes to serving businesses, we've continue to help drive results for businesses of every size around the world. Last week a Deloitte report found that in 2014, Facebook created more than $225 billion of global economic impact and 4.5 million new jobs. This is an important reminder of the big opportunity we have to create value for businesses, and why we are committed to serving them well. +In 2014 we invested aggressively in improving our ad tech and measurement tools. We're going to continue working to provide new capabilities for marketers. Sheryl will talk about this more in a moment. +Next, let's talk about our efforts over the next five years to build the next generation of Facebook services. We expect WhatsApp and Messenger to connect hundreds of millions of more people, and become indispensable services for the world, as well as important contributors to our business. +Messenger and WhatsApp recently achieved impressive new milestones. In November, Messenger reached 500 million monthly actives. And at the beginning of January, WhatsApp reached 700 million monthly actives, with more than 30 billion messages sent each day. These numbers speak to the quality of both products and the size of the opportunity ahead to help billions of people communicate and collaborate. +Search at Facebook is another important efforts that we expect to create a lot of value over the next few years. In this quarter we launched updates to Facebook search to make it easier to find content and posts on mobile and desktop. +We're going to continue listening to feedback from our community and taking the time to build a really valuable product here. Were optimistic about our ability to deliver value that only Facebook is able to provide. +Working with developers is the other part of our strategy. In this quarter we continued to make progress with helping developers build, grow and monetize their apps. +In October we rolled out our Audience Network around the world. Since then, the number of apps in the network has nearly tripled, and impressions served by the network have more than quadrupled. +In 2015 we will continue to build upon our long-term goal of making Facebook a truly cross-platform that allows developers to share their work across every major mobile platform. And we look forward to sharing more details at our next F8 event in San Francisco this March. +Finally, let's talk about our plans over the next decade to connect everyone to the Internet through Internet.org, and to develop the next generation of computing platforms with Oculus. Internet.org now has a lot of momentum. And we've launched free basic Internet services in Zambia, Tanzania, Ghana, Kenya and Colombia. +More than 150 million people living in these countries now have the option to connect to the Internet using Internet.org. We've already connected 6 million of them to the Internet who didn't have access before. We're very excited about Internet.org's progress, and the level of interest we're seeing across industries, governments and our community. +2015 is going to be an important year for our long-term plans. And I expect us to share more updates about our progress here over the coming months. +Oculus continues to make progress towards the future of immersive VR experiences that are part of daily life for millions of people. This month the team had another good showing at ZS, and developer interest in Oculus platform continues to grow. +So, that's my update for this quarter. It's been a good quarter and a good end to an important year for us. I want to thank everyone in our Facebook community and our employees, our partners and our stockholders for their support. +Thanks to you, our community is growing stronger every day, and we are making progress toward making the entire world more open and connected. Thanks and now here's Sheryl. + +-------------------------------------------------------------------------------- +Sheryl Sandberg, Facebook, Inc. - COO [4] +-------------------------------------------------------------------------------- + + Thanks, Mark. And, hi, everyone. Q4 was strong across the board, capping a great year. +This is our first quarter with over $3 billion in ad revenue and over $2 billion in mobile ad revenue. Our Q4 ad revenue grew 53% year over year. Our mobile ad revenue was 69% of the total ad revenue, and doubled in the past year. +Our growth was strong across all verticals and marketer segments. We also saw healthy growth around the world, although growth rates outside the US were affected by exchange rates. +Looking back at 2014, our teams made great progress on our three main priorities -- capitalizing on the shift to mobile, growing the number of marketers using our ad products, and making our ads more relevant. We believe that the market increasingly understands that we have the leading mobile ad products and are the only platform that delivers people-based marketing at scale. +The shift to mobile is changing the way people consume video. As Mark said, video grew dramatically on Facebook in 2014, especially around global events like the World Cup and the ALS ice bucket took a challenge. +In just one year the number of videos posted per person on Facebook increased 75% globally and 94% in the US. Today, over 50% of people in the US who come to Facebook daily watch at least one video per day. +Globally, over 65% of Facebook video views occur on mobile. Marketers have followed this trend and are using video to help people discover and learn about their brands. +In Q4, we expanded autoplay video ads internationally. During the holiday season, we saw many clients telling their stories creatively through video. +2014 was also the year we began scaling Instagram ads. In Q4, we rolled out Instagram ads in Australia and Canada. Marketers are excited to have access to the 300 million people who use Instagram and the creativity it inspires. +We're seeing beautiful, creative and great results from brand marketers across verticals, from insurance and tax, to retail and entertainment. For example, as one of our first Instagram video advertisers, Banana Republic developed a series of videos to promote its new BR clothing line. The video showed fashion sketches from the new collection and drove a 23-point lift in ad recall. +While it's still early, and we are being deliberate in our rollout, we believe that Instagram will become core to advertisers' mobile brand-building efforts. We also made progress growing a number of marketers using our ad products. +Custom Audiences, our suite of proprietary targeting products, has become an essential tool for segmenting current and potential customers. Conversion tracking, a way from marketers to measure the impact of the campaigns online, is also seeing wider adoption. We've made it easier for businesses of all sizes to plan and manage their ad campaigns, and for small businesses to use our targeting tools. +Travel company Thomas Cook recently used Facebook in Belgium to reach a broad audience, and used Custom Audiences to send targeted messages to existing customers, based on the places they'd expressed interest in. They reached 30% of the Belgian population in just one day and achieved a 3.85 times return on investment. Results like these are attracting more marketers of all kinds to our platform. +Finally, we made great progress improving ad relevance and measurement. To do this, we made significant investments in both our core measurement and targeting tools, as well as Ad Tech. +Earlier in 2014, we introduced ad buying capabilities based on reach and frequency metrics, which is similar to how brand marketers buy TV ads, and therefore enables better cross comparison. We improved our Ads Manager product to give better insight into ad campaigns, audience and impact. +In the fall we relaunched Atlas to help marketers reach real people and measure results across multiple devices. Omnicom was our first global client. And this month we announced a partnership with Havas to further expand globally. +We also invested in Audience Network which helps marketers extend their campaigns off of Facebook, and LiveRail, which provides publishers with video tools to monetize their inventory more efficiently. +Heading into 2015, we are excited to build on the progress we've made with our core ad products, as well as with newer areas like video Instagram and Ad Tech. It's still early days in all of these efforts. There's a lot of hard work to do and we plan to invest aggressively. +Our ultimate goal is to be a critical business partner to our clients, providing people-based marketing at scale to build their brands and move their products off shelves. Over the past few weeks I've had a chance to meet with many of our largest global clients and agency partners and talk about how we can drive real business results for them, making every impression count and every dollar they spend improve their bottom line. +Our clients are excited by the opportunity to use video Instagram and ads on and off Facebook to reach the right people with the right message. In turn, as our ads become more relevant, we provide a better experience for the people who use Facebook. +Coming off our biggest year ever I want to say a special thank you to the Facebook teams around the world. To our global sales, engineering, product design and infrastructure teams, your accomplishments over this past year are the reason our business is in such a great place. +To our entire company, I feel lucky to work with you as we stay focused on our priorities and work together to help connect the world. And to our clients, thank you for your partnership and your trust in us. +Heading into 2015, we have big opportunities and a lot of work ahead. Thanks. And now here's Dave. + +-------------------------------------------------------------------------------- +Dave Wehner, Facebook, Inc. - CFO [5] +-------------------------------------------------------------------------------- + + Thanks, Sheryl. And good afternoon, everyone. Q4 wrapped up a strong year for Facebook. In 2014 our revenue growth 58% to approximately $12.5 billion and we generated over $3.6 billion in free cash flow. +We are very pleased with the continuing growth of our network. In December, the number of people using Facebook on an average day increased by 18% compared to last year, to 890 million. The daily number represents 64% of the 1.39 billion people who used Facebook during the month. +Mobile remains the primary driver of our growth. We ended the year with 1.19 billion people using Facebook on mobile in the month. We also continued to see solid growth with Instagram, Messenger and WhatsApp recently crossing 300 million, 500 million at 700 million MAUs, respectively. +Turning now to the financials, all of our comparisons are on a year-over-year basis unless otherwise noted. In addition, as a reminder, our non-GAAP measures exclude stock-based compensation and the amortization of intangibles. +Total revenue in Q4 was $3.9 billion, up 49%, or 53% on a constant currency basis. Given how significantly exchange rates have continued to move, we anticipate that this currency headwind will increase in 2015. I will give more color on this later in the call. +Ad revenue was $3.6 billion, up 53% or 58% on a constant currency basis. Mobile ad revenue in Q4 doubled to $2.5 billion or 69% of ad revenue, compared to approximately $1.2 billion or 53% of ad revenue last year. Desktop ad revenue was up approximately 1% despite the fact that overall desktop usage was down. +In Q4, the average price per ad increased 335%, while total ad impressions declined 65%. Similar to last quarter, these price-volume trends were primarily driven by the redesign of our right-hand column ads, which rolled out in the third quarter. +Total payments and other fees revenue was $257 million, up 7%. Note that the growth was driven by revenue from acquisitions made in the past year. +On an organic basis payments revenue from games, which represents the substantial majority of our payments and other fees revenue, declined 10% compared to last year. As previously noted, we expect this trend to continue as desktop usage declines. +Turning now to expenses, our Q4 total GAAP expenses were $2.7 billion, up 87%, and non-GAAP expenses were $1.6 billion, up 50%. GAAP expense growth was driven primarily by significant stock-based compensation and amortization expenses related to the WhatsApp acquisition. Non-GAAP expense growth was driven primarily by increases in headcount related costs, cost of revenue, and marketing expenses. +On a full-year basis, our 2014 GAAP expenses were $7.4 billion, up 47%, and our non-GAAP expenses were $5.3 billion, up 34%. We ended the year with roughly 9,200 employees, up 45%. Overall, we remain very pleased with our ability to attract and retain top-tier talent. +GAAP operating income was $1.1 billion in Q4, representing a 29% operating margin, down from 44% last year, again primarily due to expenses related to our recent large acquisitions. Non-GAAP operating income was $2.2 billion in Q4, representing a 58% operating margin, consistent with the margin last year. +Interest and other income and expense was a net expense of $19 million in Q4, versus a net expense of $3 million in Q4 last year. This increase in expense was primarily due to foreign exchange losses resulting from the periodic remeasurement of our foreign currency balances during the period. +In Q4, we benefited from the reinstatement of the R&D tax credit. Our GAAP tax rate was 37%, but would have been approximately 42% excluding the benefit of the tax credit. Our Q4 non-GAAP tax rate was 31%, and would have been approximately 32% excluding this benefit. +Q4 net income was $701 million, or $0.25 per share, and non-GAAP net income was $1.5 billion or $0.54 per share. In 2014, we spent $1.8 billion on CapEx and generated over $3.6 billion of free cash flow. We ended 2014 with $11.2 billion in cash and investments and a net operating loss carryforward of approximately $4.5 billion. +Turning now to the outlook, let me start with revenue. We are still in the early stages of building out many aspects of our ads business and we remain optimistic about our long-term opportunities. Looking at 2015, there are a couple of things I want to note. +The first involves how the recent movements in exchange rates might impact our 2015 revenue. Assuming exchange rates were to remain constant at today's level, we would expect that our total revenue in 2015 would be approximately 5% lower than it would be under 2014 exchange rates. Note this 5% represents the expected reduction in 2015 total revenue, not the reduction in the year-over-year growth rate. +And, second, we are reporting revenue from Atlas, LiveRail and the Audience Network on a net, not a gross, basis. So, the growth in those products will have less of an impact on our overall reported revenue growth in 2015. +Turning now to expenses, we are tightening our ranges modestly given the better visibility into 2015 spending. We expect that our full-year 2015 total GAAP expenses will increase 55% to 70% compared to 2014. We expect that our 2015 total non-GAAP expenses will increase 50% to 65%. +A simple way of thinking about our investments is across three categories -- people, product and infrastructure. On the people side, we enter 2015 with 45% more employees than we did a year ago. And we will continue to invest in and grow the talent base throughout the year. +In terms of product, we are investing to build great experiences for people, marketers and developers, ranging from our existing products and services to newer initiatives such as Ad Tech, Internet.org, Oculus, and WhatsApp. We'll also invest in marketing to support all of these initiatives which, as I noted, was a driver of expense growth in Q4. +Turning to infrastructure, we continue to build out our global infrastructure to enable billions of people around the world to connect, message and share with each other. We'll be investing in data centers, our network and servers to grow our existing services and support newer initiatives such as video and our global connectivity efforts through Internet.org. +We anticipate our 2015 CapEx will be in the neighborhood of $2.7 billion to $3.2 billion. We expect stock-based compensation for 2015 to be in the range of $3 billion to $3.3 billion, approximately half of which is related to our prior acquisitions, most notably WhatsApp. +We expect amortization expenses for 2015 to be approximately $700 million to $800 million. Finally, we anticipate our Q1 and full-year 2015 GAAP tax rates to be in the mid to high 40%s and non-GAAP rates to be in the mid to high 30%s. +In summary, Q4 caps off a great year for Facebook in which we executed well, and also made some very important investments for our future. In 2015 we are focused on continuing to execute on the business and investing in our long-term mission and success. +With that, Courtney, let's open up the call for questions. + + +================================================================================ +Questions and Answers +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) +Heather Bellini with Goldman Sachs. + +-------------------------------------------------------------------------------- +Heather Bellini, Goldman Sachs - Analyst [2] +-------------------------------------------------------------------------------- + + I just had two quick questions. Sheryl or Mark, I was just wondering, from a brand advertising perspective, is there a way you could share with us how your conversations with these advertisers have been trending over the past 12 months, how they've been evolving, and how they are thinking about the video opportunity? +And then, Dave, I just wanted to follow up on your question about total expense guidance, because in the past you've given a 5-point range, I believe, for total expenses and this year it's 15. Granted, you did tighten it, which we appreciate. And just wondering the parameters around how we think about the low end versus the high end? + +-------------------------------------------------------------------------------- +Sheryl Sandberg, Facebook, Inc. - COO [3] +-------------------------------------------------------------------------------- + + It's a great time for the brand question because over the past few weeks I've spent a lot of time kicking off 2015 with our largest agency partners and largest clients. I would say that people remain really excited about Facebook, but people are bigger believers, because we've had an opportunity to do more measurement over the past year. +So, I think there are two things about the Facebook platform that are really exciting for brand marketers. The first is the creativity and storytelling. And certainly, as you mentioned, video is a big part of that because video is a format that marketers have used for a long time to build emotional connection to brands. +The second is measurement. What clients want and what they should want is an ability to look at their ad spend and see how effective it is, not just in the brand lift metrics, even though those are important, but in moving products off shelves. Over the past year and a half, the investments we've made in building out that measurement have paid off. +So, when I sit down with clients at the beginning of this year compared to last year, we have more actual case studies of marketing we've done with them. We've been able to A-B test Facebook ads versus no Facebook ads, and what the effectiveness is on their sales. And I think across the board, we are showing very healthy, very competitive ROI. +The opportunity and the challenge, now, is to scale. Even for our largest clients globally we still represent a really small part of what they do. So, it's on us to prove to them that the results we're showing them in these smaller tests can happen in more brands, more countries with a larger part of their business. + +-------------------------------------------------------------------------------- +Dave Wehner, Facebook, Inc. - CFO [4] +-------------------------------------------------------------------------------- + + Heather, it's Dave. +Just following up on that, where we land in the range of guidance on expenses will depend on a number of different factors. It's going to depend on how successful we are at hitting our recruiting goals, how much we ramp in areas like marketing, how quickly we deploy our capital against our CapEx plan, and then how we execute against our plan of ramping investments in new areas like Oculus, WhatsApp, Internet.org, et cetera. +We feel good about where we are. We're going into 2015 on a high note. So, I feel like we're making these investments from a position of strength, and excited about the opportunities to put more capital to work in 2015. + +-------------------------------------------------------------------------------- +Operator [5] +-------------------------------------------------------------------------------- + + Eric Sheridan with UBS. + +-------------------------------------------------------------------------------- +Eric Sheridan, UBS - Analyst [6] +-------------------------------------------------------------------------------- + + Mark, I wanted to follow up on your comment around search. It's early days, but what the Company is seeing in terms of the way people are interacting with the new search functionality inside Facebook, broadly. And then maybe tying it back to advertising, what that might mean for closing the loop with some of your small- and medium-sized business advertises, and maybe even the Places initiative, long-term, thanks. + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook, Inc. - CEO [7] +-------------------------------------------------------------------------------- + + Sure. Our view on this is that there is a lot of unique content that people have shared in Facebook, a lot of personal content, recommendations from friends that you can get, that you just wouldn't be able to get through a traditional web search service or other app. We are on this multi-year voyage to basically index all the content and make it available to people and rank it well. +We started off by launching Graph Search, which I think included more than 1 trillion different connections in the first system. The second round of the search progress that we just started rolling out at the end of last year was Post Search, which now has indexed more than I think 1 trillion posts. The sizes of these corpuses are bigger than anything in a traditional web search corpus that you'd find. +It's an interesting and fun challenge to make this work. We're seeing that people immediately understand how they can use this and find content that they've seen in newsfeeds before or that they've posted with just a few keywords. We're excited about that but there's a lot more to do. +So, I'd say we're not really thinking about advertising in it yet. On the scale that our community operates, 1 billion searches per day is actually not that big compared to what we think the opportunity here should be. And we are just continuing to keep on working on it because there's just a lot of unique value that people should be able to get from their friends on Facebook through search. + +-------------------------------------------------------------------------------- +Operator [8] +-------------------------------------------------------------------------------- + + John Blackledge with Cowen. + +-------------------------------------------------------------------------------- +John Blackledge, Cowen and Company - Analyst [9] +-------------------------------------------------------------------------------- + + I just wondered if you could provide your view on Facebook as a video platform given that video views per day increased to 3 billion in December from 1 billion in September of 2014. And how we should think about video content mix over the next couple of years. +And same kind of topic, if you can give a sense of user and advertiser feedback on the autoplay video ads, that would be great. Thank you. + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook, Inc. - CEO [10] +-------------------------------------------------------------------------------- + + I'll talk about the consumer products and then Sheryl can jump in about ads. +What we're seeing, and I alluded to this a bit in my opening remarks, is that there's been this evolution of content on Facebook over the last 10 years towards richer format that conveys more of the moments that people care about. So, if you go back five years ago, a lot of Facebook was primarily text and a little bit of photos. +Now, I think the primary mode that people are using to share is photos. And I wouldn't be surprised if in the future that shifted more and more towards videos. +So, we're thinking about how to enable consumption first of the content that people were sharing. And this year an increased focus on new opportunities around production. That way it's easier for people to capture the moments that are important to them, create higher-quality moments and pieces of content out of those, and increase their experiences through that. +So, there's a lot more to do here. And I think that this is going to be one of the big trends over the next three to five years, is the growth in video and richer content in our service. + +-------------------------------------------------------------------------------- +Sheryl Sandberg, Facebook, Inc. - COO [11] +-------------------------------------------------------------------------------- + + From a consumer and marketer feedback on video ads point of view, those two things really go together. It's exciting that we've gotten to 3 billion video views per day because that means consumers are using video ads and enjoying them on Facebook and in newsfeed. +The way we think about our ads product is we want them to blend in with the consumer experience. So, the fact that we have this much consumer video on Facebook, means we have an opportunity to grow our ad business, and that's exciting for marketers. + +-------------------------------------------------------------------------------- +Operator [12] +-------------------------------------------------------------------------------- + + Justin Post with Merrill Lynch. + +-------------------------------------------------------------------------------- +Justin Post, BofA Merrill Lynch - Analyst [13] +-------------------------------------------------------------------------------- + + It looks like you did about $9 of revenue in the US per MAU, which is over a $30 run rate, which is impressive. +Sheryl, maybe first question to you. How do you grow that from here? Is it usage? Is it more higher ad load? Is it the mix of ads? Or is it targeting? Maybe some thoughts on how you grow from there. +And then, Mark, as you look at your other three platforms; WhatsApp, Instagram, Messenger, and other things you probably have in mind -- can they monetize anywhere as well as Facebook if you look out to your five-year plan? Thank you. + +-------------------------------------------------------------------------------- +Sheryl Sandberg, Facebook, Inc. - COO [14] +-------------------------------------------------------------------------------- + + Thanks for the question. When you think about what's happening, certainly the growth has been good. But it's still true that marketing dollars have not followed consumer time in the same percentages. +In the US, mobile gets 25% of consumer media time but only 10% of the ad budget. And to take one comparable example, that means that for every consumer hour spent on print, marketers spent $1, and they spend $0.07 per hour on mobile. Which means that we have an opportunity to grow. +One of the most important ways we grow is not just bring more marketers into Facebook, having them use more of our ad products, but, as you mentioned, better targeting. A more relevant ad is a better ad experience for consumers, but also drives a much higher return for marketers. And since we're running an auction, as our ads get more relevant and we provide higher ROI, we should be able to continue to grow. +I think we've done a good job over the last year making our ads more relevant. I think most people on this call would say that you see more relevant ads than you used to a year ago. But I still think some of the Facebook ads still have room for improvement in terms of relevance. And, so, we see a lot of room for improvement there, both in the ROI we deliver and in the experience we can provide consumers. + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook, Inc. - CEO [15] +-------------------------------------------------------------------------------- + + I'll add something to that just on the side of how we think about value through Facebook and then I will talk about the other apps. In terms of the product development that we do here, we have four major groups inside the Company. This is how our Company is organized. +We have one which is focused on growing the community; one which is focused on increasing content consumption and people's engagement; another which is focused on efficiency and helping people get the most value out of each moment that they're spending on Facebook; and then the fourth group is our core business which is focused on helping people to see the best ads and basically make the most money per moment that people are spending at the lowest cost and most efficiency in terms of serving people. +There is, I think, big upside in each of those four categories. Our community is growing. I mentioned in our comments up front that time spent across our services grew by 10% year over year per person, which is pretty meaningful. Utility and efficiency are increasing. And, of course, the ads business per person and the efficiency of our services are both increasing, as well. +So, I'm pretty excited about that and think we are organized in a way where we can continue executing against that. +That other opportunity is Instagram, Messenger and WhatsApp. I'm really excited about. And I do think that they're going to reach the level where they contribute to our business in a pretty big way. +But it's really important to get this right and not rush it. What I'd say around messaging is we're pretty early in that cycle. We are about where Facebook was in around 2006 or 2007, where, at that point, Facebook is really just a consumer product. There were no businesses in the ecosystem. +And a lot of people were telling us go put better ads in. And that felt wrong. I didn't think that that was going to be the right way to build the product or build the business. +So, instead, what we did was we built pages, which was a way for businesses to interact for free in the system and start creating organic interactions between people and businesses so we could figure out what the people using Facebook wanted from businesses within Facebook. And we build more tools for pages and businesses to engage. Our recent success with advertising is really just built on some of those organic interactions between people and businesses. +What you see in Messenger and WhatsApp now is we're still at the early end of that curve where the interaction is still primarily people to people, and businesses are starting to figure out, in the case of WhatsApp -- much less in Messenger, so far -- what the organic interaction is. But we're going to have to go through a whole cycle of figuring out how that works before it really makes sense to start monetizing them in a big way. But, yes, I'm a big fundamental believer that these are going to be very big contributors to our businesses over time, but we just have to do it right. + +-------------------------------------------------------------------------------- +Operator [16] +-------------------------------------------------------------------------------- + + Ben Swinburne, Morgan Stanley. + +-------------------------------------------------------------------------------- +Ben Swinburne, Morgan Stanley - Analyst [17] +-------------------------------------------------------------------------------- + + Two questions. Sheryl, can you talk about where we are in the North American market versus your other regions in terms of advertiser maturation and acceptance of the Facebook platform? The growth rates in North America continue to be really impressive despite it being your business when you look at the ARPU trends. And compared to the other regions those seem to be moderating a bit. +And then I was wondering, Dave, if you could talk about the pricing growth which actually accelerated from Q3 to Q4? Can you give us some color there? I know there were changes to right-hand rail but anything else you would add about why there was such a huge acceleration in pricing growth. Thanks. + +-------------------------------------------------------------------------------- +Sheryl Sandberg, Facebook, Inc. - COO [18] +-------------------------------------------------------------------------------- + + North America remains a really important market for us. And, as you said, we've had growth we are very happy with. It's still true that for any client, no matter how big they are for us, we represent a really tiny part of their ad spend. And we represent an under-investment in terms of where they can reach their consumers. +So we believe by continuing to make these investments we can really continue to grow. We get 20% of people's time on mobile phone in the US between Facebook and Instagram. We don't get close to that in terms of anyone's marketing spent or the time they spend. +What we say to our clients over and over again is that we want to drive their business. And that's probably the most important thing we're doing for these large North American spenders, is around the measurement work we've done. +Two years ago we were not able to measure all the way through to purchase off the shelves, and now we can. Yesterday, we rolled out a product we call Lift, which is really the next iteration of our measurement capabilities. It enables large customers to go in and set up ads with control test groups so that they can A-B test; this group of people saw a Facebook ad, this group of people didn't. And they can measure all the way through to conversion of whatever they are measuring, whether it's an online conversion to a sale. +We think the measurement out there online and digitally is not particularly accurate. People don't have real people-based measurement. Through our investments in Atlas and through our investments in the core Facebook measuring tools, we think if we can show the ROI marketers are getting, and we can increasingly do so, we can continue to penetrate the North America market. + +-------------------------------------------------------------------------------- +Dave Wehner, Facebook, Inc. - CFO [19] +-------------------------------------------------------------------------------- + + Ben, it's Dave. +Also just building on what Sheryl said, worth noting that the drop in the value of international currency is impacted by results outside the US. So, some of what you're seeing here is the result of that. +It reduced year-over-year revenue growth rates by 7% to 8% in the different international regions. That's a big reason why you see the US doing much better, as well as the fact that that's just a more advanced market in what we've done in terms of just building up the advertiser base and getting adoption of our best targeting products, as Sheryl was talking about. +Going to your question on pricing growth, I would just reiterate what I said in my comments. It's largely due to the right-hand column redesign and then also this shift to mobile where we don't show right-hand column ads. That's really what's causing the pricing shift. +Then, fundamentally, we just continue to get better at targeting. That drives better engagement. And as we get better engagement, that drives better ROI for our advertisers, which ultimately, I think as Sheryl commented on earlier, gets reflected in better pricing for our ads. And that's a big opportunity for us. +And we are seeing that we're getting better and better at driving engagement from the ad units that we have, and getting that right ad in front of the right person. So, that's a big factor, as well. + +-------------------------------------------------------------------------------- +Operator [20] +-------------------------------------------------------------------------------- + + Brian Wieser with Pivotal Research. + +-------------------------------------------------------------------------------- +Brian Wieser, Pivotal Research Group - Analyst [21] +-------------------------------------------------------------------------------- + + Thanks for taking the question. +First, I was wondering if you could talk about the degree to which you think premium video content, where it's not necessary to optimally capture budgets from advertiser that might otherwise have gone to TV? You have a couple of initiatives around ABC and NFL. So, I was curious to hear your thoughts on that. +Separately, among clients who are using Atlas, and especially those who are new to Atlas, do you get a sense that their spending on digital media is changing? Or, if so, how? And, alternately, are they just happier with their campaign management tools? Thanks very much. + +-------------------------------------------------------------------------------- +Sheryl Sandberg, Facebook, Inc. - COO [22] +-------------------------------------------------------------------------------- + + On video ads, what really matters is that consumers are using video on Facebook because that gives us an opportunity, one, to provide a great consumer experience, but, two, to have ads match that consumer experience. If there wasn't consumer video on Facebook, video ads in your newsfeed would be very jarring. As a percentage of the videos you're seeing, video ads fit nicely into that experience. +I don't think it matters as much what the video content is. So, while we're certainly exploring some premium content -- as you said, we have an NFL Verizon test out there in the public eye -- we're already seeing pretty explosive growth without that kind of premium content in the system in large numbers. And, so, we'll continue to figure out. +We are certainly open to increasing video content either way, but we haven't quite figured out what the mix needs to be. And right now the growth is very strong. +In terms of Atlas, we just relaunched this fall and we're just seeing those deals get done in broad adoption. So, I think it's too soon for us to report that Atlas drives an increase in digital spend or an increase in any particular kind of spend. +But here's what we believe really deeply, which is that Atlas is going to revitalize marketing by making the measurement more accurate. If you look at how digital ads are being measured, they are being measured based on a cookie-based world that assumes that people have one device, largely a PC, and that's just not true. +Consumers have phones, they have tablets, they have PCs, as well. And the ability to understand that that's one person to serve an ad and measure all the way through correctly, we think it's going to massively improve the efficiency in the system as it gets adopted. + +-------------------------------------------------------------------------------- +Operator [23] +-------------------------------------------------------------------------------- + + Peter Stabler with Wells Fargo. + +-------------------------------------------------------------------------------- +Peter Stabler, Wells Fargo Securities - Analyst [24] +-------------------------------------------------------------------------------- + + One for Sheryl. Sheryl, as you push further toward monetizing off-platform inventory, wondering if you could speak to the state of your relationships with premium publishers? There is a narrative out there we sometimes encounter that publishers are growing a bit concerned about the power you guys wheel, particularly as you push into monetizing off the platform. Thanks very much. + +-------------------------------------------------------------------------------- +Sheryl Sandberg, Facebook, Inc. - COO [25] +-------------------------------------------------------------------------------- + + Our audience network efforts are still pretty new. We have a goal of serving more relevant ads to people off Facebook, which will provide greater reach for Facebook marketers and also a better opportunity to monetize for publishers. +We're seeing some nice results. Shazam reported that using Audience Network increased their revenue from Ad Networks by 37%. We believe that working with publishers, if we can increase the value of their inventory by providing more relevant and targeted ads, they are going to be really happy with that opportunity. And we are in the early stages of finding those partners. + +-------------------------------------------------------------------------------- +Operator [26] +-------------------------------------------------------------------------------- + + Anthony DiClemente with Nomura. + +-------------------------------------------------------------------------------- +Anthony DiClemente, Nomura Securities Intl - Analyst [27] +-------------------------------------------------------------------------------- + + First for either Mark or Sheryl on the subject of public video content and what you guys are doing to increase the amount of video in the newsfeed. Are there things in terms of actors, celebrities, public figures that you can do to economically incentivize those creators of, let's say, the higher-quality user-generated content onto the Facebook platform, be it a revenue share, what have you, relative to the economics for those types of folks on competing online video platforms? +And then just one quick one for Dave. You mentioned -- I just had to ask -- you'd be the shifting the accounting for Facebook Audience Network and LiveRail for revenue to be net of TAC in 2015 versus gross in 2014. +I'm just wondering why do that? And is there anything you can help us with in terms of order of magnitude of that shift? Thanks. + +-------------------------------------------------------------------------------- +Sheryl Sandberg, Facebook, Inc. - COO [28] +-------------------------------------------------------------------------------- + + On premium video content, we haven't figured out exactly how important this is to the ecosystem or how much we're going to invest or what kind of monetization we're going to offer. Video is growing quite nicely through the ecosystem right now. +We have made a lot of investments in public content, working with public figures to use the Facebook platform. We are by far the largest social platform and increasingly you're seeing public figures, everything from news broadcasters to journalists to public figures, do a lot on Facebook. And that's important to us because it provides the kind of sharing people want. +People come to Facebook to share with their friends and family but they also come to Facebook to connect with everyone from politicians to journalists to celebrities they want to connect with, and get news. And we've definitely seen public content grow as a percentage of what people get. +We also had some nice wins with the Golden Globes this year. Other things we're doing to go deep, we're doing some partnerships. We did In Davos at CNBC to show how we can help content creators increase their distribution and reach people directly on Facebook. + +-------------------------------------------------------------------------------- +Dave Wehner, Facebook, Inc. - CFO [29] +-------------------------------------------------------------------------------- + + Anthony, it's Dave. +Just to be clear, the net revenue recognition for those products, that's how we did it in Q4, as well. Those are all small today. But there's not a change in accounting in 2015. That's how we accounted for those products in Q4. +As far as the net versus gross we just evaluated all the facts and circumstances and made the judgment that net revenue recognition was the most appropriate treatment here. + +-------------------------------------------------------------------------------- +Operator [30] +-------------------------------------------------------------------------------- + + Ross Sandler with Deutsche Bank. + +-------------------------------------------------------------------------------- +Ross Sandler, Deutsche Bank - Analyst [31] +-------------------------------------------------------------------------------- + + Just following up on the video concept, how important is it that Facebook host the videos versus sharing clips from third-party players in the feed? What percent of that 3 billion streams daily is Facebook-embedded versus from other players? And are you able to monetize videos from third-party players today or is there a way to work around that in the future? Thanks. + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook, Inc. - CEO [32] +-------------------------------------------------------------------------------- + + The stat that we shared of 3 billion a day is all native on Facebook. There are probably other shares from other video services, as well. But the way that those look in our services are if they're links to other sites. +The reason why I think native video is so valuable for people using our service is that, when someone uploads a video to Facebook directly, we can optimize how it's delivered. We can make it autoplay. We can find the right quality and bit rate to send down to the person based on their connection over time, and optimize all kinds of different things. +So, what I think people are finding from public figures to everyday videos that people are uploading is that the best experience that you can get is by uploading content native to Facebook, which is I think, a big part of the growth that we are seeing there. + +-------------------------------------------------------------------------------- +Operator [33] +-------------------------------------------------------------------------------- + + Colin Sebastian with Robert Baird. + +-------------------------------------------------------------------------------- +Colin Sebastian, Robert W. Baird & Co. - Analyst [34] +-------------------------------------------------------------------------------- + + I wonder if it's possible to distinguish how much of the growth in advertising revenues can be attributed to changes in organic compressions and how you balance the desire of business partners to contribute content to feeds versus monetization? Thank you. + +-------------------------------------------------------------------------------- +Dave Wehner, Facebook, Inc. - CFO [35] +-------------------------------------------------------------------------------- + + I'm not sure I exactly understand the question. But let me see if I can take a crack at it, Colin. +We're seeing, obviously, great growth in DAU which is up 18%. We're seeing growth in time spent across the network, up 10% per DAU. So, you've got those underlying drivers of engagement driving growth. +We're also monetizing at higher rates because we're able to get better targeting into the ads and get better conversion for advertisers. So, that's reflected in better pricing. +So, there's a number of different factors that are coming into play. But, clearly, driving organic growth and engagement is critical in the business and we're seeing good success there. + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook, Inc. - CEO [36] +-------------------------------------------------------------------------------- + + One theme that I'd just add to emphasize here, because I think there have been a couple of questions to this effect, is our primary strategy for growing the ad business is increasing the quality of the content, not increasing the number of ads per story that people are seeing on Facebook. There are impacts like, as people consume more content on Facebook, within the ratio of ads, the organic content that we will show, they might see more ads. +But overall, our strategy is much less about increasing the volume of ads and much more about increasing the quality of the content and the quality of the targeting to get the right content to the right people. This is a pretty controversial strategy internally and we weren't sure if that was going to work out. But for the last year it's really fueled our growth in a good way and we feel very confident that this is the right path going forward, as well. + +-------------------------------------------------------------------------------- +Operator [37] +-------------------------------------------------------------------------------- + + Carlos Kirjner with Bernstein. + +-------------------------------------------------------------------------------- +Carlos Kirjner, Sanford C. Bernstein & Company, Inc. - Analyst [38] +-------------------------------------------------------------------------------- + + I have two quick questions. +First, when you say that time spent increased 10% year on year, is this roughly uniform across your geographic regions? +And, secondly, Mark, I think during your remarks in every earnings call, you talk to your investors for a considerable amount of time about Facebook's efforts to connect the world, and specifically about Internet.org which suggest you think this is important to investors. Can you clarify why you think this matters to investors? And, importantly, why you think Facebook can make a significant difference at scale, given that your [ann over pupil] user in emerging markets is about $5, and to connect any user who has no device or coverage may be at risk in terms of dollars? Thank you. + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook, Inc. - CEO [39] +-------------------------------------------------------------------------------- + + It matters to the kind of investors that we want to have, because we are really a mission-focused company. We wake up every day and make decisions because we want to help connect the world. That's what we're doing here. +Part of the subtext of your question is that, yes, if we were only focused on making money, we might put all of our energy on just increasing ads to people in the US and the other most developed countries. But that's not the only thing that we care about here. +I do think that over the long term, that focusing on helping connect everyone will be a good business opportunity for us, as well. We may not be able to tell you exactly how many years that's going to happen in. But as these countries get more connected, the economies grow, the ad markets grow, and if Facebook and the other services in our community, or the number one, and number two, three, four, five services that people are using, then over time we will be compensated for some of the value that we've provided. +This is why we're here. We're here because our mission is to connect the world. I just think it's really important that investors know that. + +-------------------------------------------------------------------------------- +Colin Sebastian, Robert W. Baird & Co. - Analyst [40] +-------------------------------------------------------------------------------- + + And, Carlos, on the time spent per DAU, we're just giving the one point. We're not breaking anything out by region. + +-------------------------------------------------------------------------------- +Operator [41] +-------------------------------------------------------------------------------- + + Paul Vogel with Barclays. + +-------------------------------------------------------------------------------- +Paul Vogel, Barclays Capital - Analyst [42] +-------------------------------------------------------------------------------- + + I'm just curious, given the impact that currency had on the quarter on growth rates outside the US, is there any market you could call out, particularly, that were either better or worse that might be masked by the currency swings, number one? And, number two, I'm just curious if currency does stay where it is, does it all impact your spending plans or how and where and when you'll invest? Thanks. + +-------------------------------------------------------------------------------- +Dave Wehner, Facebook, Inc. - CFO [43] +-------------------------------------------------------------------------------- + + Paul, it's Dave. +Taking your second part first, we are really making investment decisions on short-term fluctuations in currency. So, I would say, in general, no, it's not affecting those decisions. +There are certainly big macro effects that are going on, and part of those are what's driving a lot of the currency fluctuation, as well. So, you have regions that are certainly growing more quickly and regions that are growing more slowly. +So, from a macro perspective, the United States is doing better in terms of growth versus Europe versus Latin America. You see those compounded in both currency and macroeconomic conditions in those regions. I'd say generally we've got more favorable market conditions in which to operate in the US. +Overall, I would say the business is driven by the fundamentals of us continuing to execute against our plan. Whether you're in a market that's suffering a little bit from a macroeconomic headwind, we still have the best mobile product in that market and we are growing. +So, I think, at the end of the day, it's the fundamentals of our business that are going to drive our success, and we're focused on that. But wanted to at least give some color around how the currencies might impact the 2015 results. + +-------------------------------------------------------------------------------- +Operator [44] +-------------------------------------------------------------------------------- + + Robert Peck with SunTrust. + +-------------------------------------------------------------------------------- +Robert Peck, SunTrust Robinson Humphrey - Analyst [45] +-------------------------------------------------------------------------------- + + I have two quick questions. Mark, you haven't spoken much yet today about the e-commerce opportunity in front of Facebook, particularly the buy button. Can you elaborate a little bit on plans around e-commerce and what you see that opportunity? +And then, Dave, I was wondering, for investors, could you maybe go through your view on how you look at capital efficiency and ROI, so that, whether it be acquisitions or CapEx or even OpEx, how you look and see you are getting a good return on that spend? Thanks so much. + +-------------------------------------------------------------------------------- +Sheryl Sandberg, Facebook, Inc. - COO [46] +-------------------------------------------------------------------------------- + + Q4 is a really important quarter in general, but it's a particularly important quarter for e-commerce. So, it's a timely question. +When you think about buy on Facebook, it's a small task in the US we started last quarter. It enables people to buy on pages. +To be clear, you're not buying from Facebook, you're buying directly from the merchant. And it's really an SMB product to give them capability they haven't had. +We'll see what happens in terms of where people convert, whether it's on Facebook. But we think the opportunity to connect consumers with the products that they then purchase is a really big one. Where we play in that most directly is the time and attention consumers have, as well as the information to do very relevant advertising, and we're going to stay focused there. + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook, Inc. - CEO [47] +-------------------------------------------------------------------------------- + + Robert, I think the bulk of the investment that we're doing is really focused on the capital and the OpEx to deliver against the core mission of enabling billions of people to connect and share. So, for the most part, we're looking at what do we need to deploy to deliver against the mission to deliver against our overall financial results. There are places where we can individually take out specific projects, whether it be M&A or specific capital investments, and then we'll look at those on an IRR basis for specific projects. +But you have to recognize that we're basically one large business, and we're operating against capital deployment against delivering, against the objectives of that business. That's the bulk of the spend that we do. But certainly we look at things on an ROI basis on an individual project basis, as well. + +-------------------------------------------------------------------------------- +Operator [48] +-------------------------------------------------------------------------------- + + Arvind Bhatia with Sterne Agee. + +-------------------------------------------------------------------------------- +Arvind Bhatia, Sterne, Agee & Leach - Analyst [49] +-------------------------------------------------------------------------------- + + Just quickly on WhatsApp, I know the focus will be user growth for a while. But in the future, as you do turn on the monetization engine, just curious what are some of the primary ways that you are assuming growth will come from advertising or games perhaps. +And also, on WhatsApp user growth, would you be able to call out where that's coming from? Is there any particular areas that are stronger? And curious how that's doing in the US? Thank you. + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook, Inc. - CEO [50] +-------------------------------------------------------------------------------- + + You are right that the focus for WhatsApp is on helping to connect a lot more people. When Jan and team joined us, one of the first things that we agreed on, and why I think it made sense for them to join, is that now they can focus for a few years on getting to 1 billion more than that and continuing to scale. +Beyond that, SMS is an incredibly global and universal product. And I think WhatsApp just has a huge opportunity to serve billions of people. +In terms of what the business looks like, at the end of the day, it's a distribution business, like Facebook and Instagram. How you most effectively convert that into business opportunity for customers, whether that's through payments or ads or other different kinds of structures, we'll figure that out, what the optimal thing will be. +But the first order thing to do is to help serve billions of people here, help continue to increase engagement. And if people are spending a lot of time in WhatsApp, sending more than 30 billion messages a day, which is really crazy when you think about the volume there compared to the global SMS volume overall. And I think if we do that, there will be a number of opportunities. +People asked me this question a while ago, about how we thought about games on Facebook, as well. I always thought about our canvass business on desktop, even though it was payment, as actually the same thing as our business on mobile around app install and engagement. +What developers tasked for is distribution. And whether they're doing that through payments or ads or whatever it is, it kind of is all the same. The most important thing is to help people connect, help people and businesses connect, create business opportunities. And then you get a small amount of the value that you are creating on top. +So, that will play out over the next set of years. It's one of the intellectual challenges that I'm really looking forward to tackling. + +-------------------------------------------------------------------------------- +Operator [51] +-------------------------------------------------------------------------------- + + Mark Mahaney with RBC Capital Markets. + +-------------------------------------------------------------------------------- +Mark Mahaney, RBC Capital Markets - Analyst [52] +-------------------------------------------------------------------------------- + + Sheryl, the size of the ad revenue that Facebook is generating and the growth, these are large budgets that are shifting over to Facebook. Any commentary on where you think those budgets are coming from? What are the source of funds? +And then I know, David, the engagement levels seem to be rising. This seemed to be a little slip in the engagement levels, that DAU over MAU ratio in Asia and the rest of world, at least sequentially. Is that just noise or is that a reason to panic? Thanks. + +-------------------------------------------------------------------------------- +Sheryl Sandberg, Facebook, Inc. - COO [53] +-------------------------------------------------------------------------------- + + I don't think there's any single source of where the dollars are coming from. Certainly as consumer time and attention is shifting to mobile, the marketer time and attention, we pay a lot of attention to the marketer segments we work with. So, we're seeing strong growth from brand, from direct response like e-commerce, from SMBs and developers. +We stay pretty focused, not really on the source of where the money is coming from but what are the objectives people are spending against on Facebook so that we can meet all the different objectives. We understand that in order to continue to grow -- and we want to continue to grow -- we're going to have to serve multiple objectives on the Facebook platform, and that's what we're focused on. + +-------------------------------------------------------------------------------- +Dave Wehner, Facebook, Inc. - CFO [54] +-------------------------------------------------------------------------------- + + Mark, I think the simple story is we're really pleased with how we're executing on the engagement front. 64% of people coming to Facebook monthly, coming on an average day, is, we think, a great stat. I think small changes are pretty much noise. We're really happy with it. +We talked about things like the video engagement. Mark shared some stats like how much photo sharing is going on across our properties. Overall, I think engagement is a great story for us and we are really happy with it. + +-------------------------------------------------------------------------------- +Deborah Crawford, Facebook, Inc. - VP of IR [55] +-------------------------------------------------------------------------------- + + Great. Thank you, everyone, for joining us today. We appreciate your time and we look forward to speaking with you again. + +-------------------------------------------------------------------------------- +Operator [56] +-------------------------------------------------------------------------------- + + This concludes today's conference call. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/exam/original-files/Problem_1_Sample/2015-Jan-29-AMZN.OQ-136951423128-Transcript.txt b/exam/original-files/Problem_1_Sample/2015-Jan-29-AMZN.OQ-136951423128-Transcript.txt new file mode 100644 index 0000000..3a05eda --- /dev/null +++ b/exam/original-files/Problem_1_Sample/2015-Jan-29-AMZN.OQ-136951423128-Transcript.txt @@ -0,0 +1,557 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q4 2014 Amazon.com Inc Earnings Call +01/29/2015 02:00 PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Brian Olsavsky + Amazon.com, Inc. - VP of Finance, Global Consumer Business + * Tom Szkutak + Amazon.com, Inc. - SVP and CFO + * Phil Hardin + Amazon.com, Inc. - Director of IR + +================================================================================ +Conference Call Participiants +================================================================================ + + * Ben Schachter + Macquarie Equity Research - Analyst + * Justin Post + BofA Merrill Lynch - Analyst + * Ron Josey + JMP Securities - Analyst + * Jason Helfstein + Oppenheimer & Co. - Analyst + * Brian Pitz + Jefferies & Company - Analyst + * Gene Munster + Piper Jaffray - Analyst + * John Blackledge + Cowen and Company - Analyst + * Katy Huberty + Morgan Stanley - Analyst + * Heath Terry + Goldman Sachs - Analyst + * Eric Sheridan + UBS - Analyst + * Colin Sebastian + Robert W. Baird & Company, Inc. - Analyst + * Mark Mahaney + RBC Capital Markets - Analyst + * Mark Miller + William Blair and Company - Analyst + * Ross Sandler + Deutsche Bank - Analyst + * Kaizad Gotla + JPMorgan - Analyst + * Carlos Kirjner + Sanford C. Bernstein - Analyst + * Mark May + Citigroup - Analyst + +================================================================================ +Presentation +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Good day, everyone, and welcome to the Amazon.com Q4 2014 financial results teleconference. (Operator Instructions). Today's call is being recorded. +For opening remarks, I will be turning the call over to the Director of Investor Relations, Phil Hardin. Please go ahead. + +-------------------------------------------------------------------------------- +Phil Hardin, Amazon.com, Inc. - Director of IR [2] +-------------------------------------------------------------------------------- + + Hello, and welcome to our Q4 2014 financial results conference call. Joining us today is Tom Szkutak, our Chief Financial Officer; and Brian Olsavsky, Vice President and CFO of our Global Consumer Business. We will be available for questions after our prepared remarks. +The following discussion and responses to your questions reflect management's views as of today, January 29, 2015, only, and will include forward-looking statements. Actual results may differ materially. +Additional information about factors that could potentially impact our financial results is included in today's press release and our filings with the SEC, including our most recent annual report on Form 10-K. As you listen to today's conference call, we encourage you to have our press release in front of you, which includes our financial results as well as metrics and commentary on the quarter. +During this call we will discuss certain non-GAAP financial measures. In our press release, slides accompanying this webcast, and our filings with the SEC -- each of which is posted on our IR website -- you will find additional disclosures regarding these non-GAAP measures, including reconciliations of these measures with comparable GAAP measures. +Finally, unless otherwise stated, all comparisons in this call will be against our results for the comparable period of 2013. +Now I will turn the call over to Tom. + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com, Inc. - SVP and CFO [3] +-------------------------------------------------------------------------------- + + Thanks, Phil. I will begin with comments on our fourth-quarter financial results. Trailing 12-month operating cash flow increased 25% to $6.84 billion. Trailing 12-month free cash flow decreased to $1.95 billion. In the supplemental financial information and business metrics portion of our earnings release, we include a few additional free cash flow measures. We believe these measures provide additional perspective on the impact of acquiring property and equipment with capital and finance leases. +Trailing 12-month capital expenditures were $4.89 billion. Capital expenditures does not include the impact of property and equipment acquired under capital and finance lease obligations. Return on invested capital is 9%, down from 13%. ROIC is TTM free cash flow divided by the average total assets, minus current liabilities, excluding the current portion of long-term debt over five quarter ends. The combination of common stock and stock-based awards outstanding was 483 million shares compared with 476 million one year ago. +I will turn the call over to Brian for additional financial highlights. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com, Inc. - VP of Finance, Global Consumer Business [4] +-------------------------------------------------------------------------------- + + Thanks, Tom. Worldwide revenue increased 15% to $29.33 billion, or 18% excluding the $895 million unfavorable impact from year-over-year changes in foreign exchange. Media revenue decreased to $6.95 billion, down 4%. Excluding FX, media revenue was flat year-over-year. EGM revenue increased to $20.64 billion, up 21%, or 24% excluding FX. Worldwide EGM increased to 70% of worldwide sales, up from 67%. Worldwide paid unit growth was 20%. Worldwide active customer accounts were approximately 270 million. Worldwide paid Prime members increased 53% year-over-year. +Worldwide active seller accounts were more than 2 million. Seller units represented 43% of paid units. Fulfillment by Amazon, or FBA, units represented more than 40% of seller units. Worldwide active Amazon Web Services customers exceeded 1 million. +Now I will discuss operating expenses, excluding stock-based compensation. Cost of sales was $20.67 billion or 70.5% of revenue compared with 73.5%. Fulfillment marketing, technology and content, and G&A combined was $7.62 billion or 25.9% of sales, up approximately 300 basis points year-over-year. Fulfillment was $3.33 billion or 11.3% of revenue compared with 11.1%. Tech and content was $2.41 billion or 8.2% of revenue compared with 6.6%. Marketing was $1.49 billion or 5.1% of revenue compared with 4.3%. +Now I will talk about our segment results. And consistent with prior periods, we do not allocate to segments our stock-based compensation or the Other Operating Expense line item. In the North America segment, revenue grew 22% to $18.75 billion. Media revenue grew 1% to $3.54 billion. EGM revenue grew 27% to $13.53 billion, representing 72% of North America revenues, up from 69%. Other revenue grew 43% to $1.67 billion. +North America segment operating income increased 40% to $1.02 billion, a 5.4% operating margin. In the international segment, revenue grew 3% to $10.58 billion. Excluding the $872 million year-over-year unfavorable foreign exchange impact, revenue growth was 12%. Media revenue decreased 8% to $3.41 billion, or a decrease of 1%, excluding foreign exchange. And EGM revenue grew 10% to $7.11 billion, or 19% excluding foreign exchange. EGM now represents 67% of international revenues, up from 63%. +International segment operating income was $20 million, down from $151 million in the prior year. Consolidated segment operating income increased 18% to $1.04 billion or 3.5% of revenue, up approximately 10 basis points year-over-year. Unlike CSOI, our GAAP operating income includes stock-based compensation expense and other operating expense. GAAP operating income was $591 million compared to operating income of $510 million in the prior year. +Our income tax expense was $205 million. GAAP net income was $214 million or $0.45 per diluted share compared with a net income of $239 million or $0.51 per diluted share. +Now I will discuss the full-year results. Revenue increased 20% to $88.99 billion or 20%, excluding year-over-year changes in foreign exchange. North America revenue grew 25% to $55.47 billion, and international revenue grew 12% to $33.52 billion or 14%, excluding year-over-year changes in foreign exchange. Consolidated segment operating income decreased 9% to $1.81 billion or 10%, excluding the favorable year-over-year impact from foreign exchange. And operating margin was 2% compared to 2.7% in the prior year. GAAP operating income decreased 76% to $178 million. +Turning to the balance sheet, cash and marketable securities increased $4.97 billion year-over-year to $17.42 billion. Inventory increased 12% to $8.30 billion, and inventory turns were 8.6, down from 8.9 turns a year ago as we expanded selection, improved in-stock levels, and introduced new product categories. Accounts payable increased 9% to $16.46 billion, and accounts payable days decreased to 73 from 74 in the prior year. +And now back to Tom with guidance. + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com, Inc. - SVP and CFO [5] +-------------------------------------------------------------------------------- + + Thanks, Brian. Incorporated into our guidance are the order trends that we've seen to date and what we believe today to be appropriately conservative assumptions. Our results are inherently unpredictable and may be materially affected by many factors, including the high level of uncertainty surrounding exchange rate fluctuations, as well as the global economy and consumer spending. It's not possible to accurately predict demand; and, therefore, our actual results could differ materially from our guidance. +As we describe in more detail in our public filings, issues such as settling intercompany balances in foreign currencies amongst our subsidiaries, unfavorable resolution of legal matters, and changes to our effective tax rate can all have a material effect on guidance. Our guidance further assumes that we don't conclude any additional business acquisitions, investments, restructurings, or legal settlements; record any further revisions to stock-based compensation estimates; and that foreign exchange rates remain approximately where they've been recently. +For Q1 2015, we expect net sales of between $20.9 billion and $22.9 billion, a growth of between 6% and 16%. This guidance anticipates approximately 460 basis points of unfavorable impact from foreign exchange rates. +GAAP operating income or loss to be between a $450 million loss and $50 million in income, compared to $146 million in income in the first quarter of 2014. This includes approximately $450 million for stock-based compensation and amortization of intangible assets. We anticipate consolidated segment operating income, which excludes stock-based compensation and other operating expense, to be between zero and $500 million in income compared to $502 million income in the first quarter of 2014. +I will conclude my portion of today's call with an update on our reportable segments. We expect to change our reportable segments to report North America, International, and Amazon Web Services, beginning with first-quarter 2015. We remain heads-down focused on driving a better customer experience through price, selection, and convenience. We believe putting customers first is the only reliable way to create lasting value for our shareholders. +Thanks. And with that, Phil, let's move to questions. + +-------------------------------------------------------------------------------- +Phil Hardin, Amazon.com, Inc. - Director of IR [6] +-------------------------------------------------------------------------------- + + Great. Thanks, Tom. Let's move on to the Q&A portion of the call. +Operator, will you please remind our listeners how to initiate a question? + + +================================================================================ +Questions and Answers +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions). Brian Pitz, Jefferies and Company. + +-------------------------------------------------------------------------------- +Brian Pitz, Jefferies & Company - Analyst [2] +-------------------------------------------------------------------------------- + + Just a quick question. You had a strong holiday season -- 100 million more items shipped for free this holiday -- while FBA units was up 50%, and fulfillment expense remained relatively flat. How did you manage that? Are the new sortation centers essentially the key to controlling shipping costs? And what percent of units sold are FBA? Thank you. + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com, Inc. - SVP and CFO [3] +-------------------------------------------------------------------------------- + + Sure. In terms of the last part of your question, the percentage of FBA units of third-party paid physical units are over 40%. And in terms of the fulfillment discussion, we certainly -- Q4 is our most seasonal quarter. You can see that we get a little bit better leverage, I should say, than we've gotten in other quarters; again, most seasonal quarter. Not a lot to add to that, but we continue to ship on behalf of obviously our retail offerings as well as FBA, that's included in that. + +-------------------------------------------------------------------------------- +Brian Pitz, Jefferies & Company - Analyst [4] +-------------------------------------------------------------------------------- + + Great, thanks. + +-------------------------------------------------------------------------------- +Operator [5] +-------------------------------------------------------------------------------- + + Katy Huberty, Morgan Stanley. + +-------------------------------------------------------------------------------- +Katy Huberty, Morgan Stanley - Analyst [6] +-------------------------------------------------------------------------------- + + There's a headline on the tape referencing improving productivity in 2015. So I just wondered if you could clarify what areas of the business you are focused on in terms of productivity. And then what are some of the projects or areas that we should be prepared to see a large uptick in investment in 2015? + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com, Inc. - SVP and CFO [7] +-------------------------------------------------------------------------------- + + Yes, I think what you are referring to, as I mentioned on the earlier call, that we do an annual planning process. We actually start it in the late summer, early fall. We go through that process; we take a break for the seasonal holidays, and then we get back to it. So we're in the process of finalizing it right now. And the teams are putting even more energy and attention on driving what we would call fixed expense and variable expense productivity, as well as other efficiency projects. So there's many, many different pieces that go into that. But certainly we've added a lot of people and structural over the last several years. And so we have been putting focus on that, but we're just putting even more focus on it as we finalize our plans for 2015. + +-------------------------------------------------------------------------------- +Katy Huberty, Morgan Stanley - Analyst [8] +-------------------------------------------------------------------------------- + + And what areas should we expect big upticks in, in investment, in 2015? + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com, Inc. - SVP and CFO [9] +-------------------------------------------------------------------------------- + + You'll have to -- in terms of investment, certainly we're going to continue to support the growth of the business. You should expect that we'll be spending more in terms of CapEx to support our Web Services business, which is growing very fast. You should expect us to add fulfillment capacity. As we've done in prior years, we have updated you a bit as we've gone along. And so we'll do that from time to time during the year, as well, in 2015. So stay tuned on that. + +-------------------------------------------------------------------------------- +Katy Huberty, Morgan Stanley - Analyst [10] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Operator [11] +-------------------------------------------------------------------------------- + + Ron Josey, JMP Securities. + +-------------------------------------------------------------------------------- +Ron Josey, JMP Securities - Analyst [12] +-------------------------------------------------------------------------------- + + Real quickly on fulfillment costs, it looks like overall costs accelerated quite a bit, to around 17% growth in 4Q from 30% in 3Q. I'm wondering if anything specific led to that improved overall growth from -- is it maybe the key of a rollout? And then, quickly, I think there was mentioning around breaking out AWS results. Wondering if any reason now? Perhaps it's getting to a level that you have to do it? Thank you. + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com, Inc. - SVP and CFO [13] +-------------------------------------------------------------------------------- + + Yes, in terms of the fulfillment piece, there's not a lot of callouts on that. We had unit growth of 20% year-over-year. Certainly, our FBA is growing at a faster rate; the sellers are up 65% over year. It's greater than 40% of our units. And, again, the teams continues to work on getting productivity there. In terms of AWS, yes, we just think it's an appropriate way to look at our business for 2015. And so our plan is to start breaking it out as of Q1 of this year. + +-------------------------------------------------------------------------------- +Operator [14] +-------------------------------------------------------------------------------- + + Douglas Anmuth, JPMorgan. + +-------------------------------------------------------------------------------- +Kaizad Gotla, JPMorgan - Analyst [15] +-------------------------------------------------------------------------------- + + Thanks. This is Kaizad Gotla in for Doug. I think you noted Prime is growing faster internationally than it is in North America. So can you help us reconcile that with the difference between your North America and international EGM growth rates? + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com, Inc. - SVP and CFO [16] +-------------------------------------------------------------------------------- + + If you take a look -- yes, what I had mentioned was Prime, worldwide, is up 53% year-over-year, so it's growing very fast globally. It's 50% growth in the US, and even higher in international. And so what I was -- the reason -- both are contributing to the growth rates that you're seeing, but we're certainly at an earlier stage in international. So it's an opportunity for us. But in terms of the number of Prime members relative to the US is smaller, so it's an earlier phase. So again, as we continue to grow that, it's an opportunity for us, and certainly something that we're focused on. + +-------------------------------------------------------------------------------- +Operator [17] +-------------------------------------------------------------------------------- + + Carlos Kirjner, Bernstein Research. + +-------------------------------------------------------------------------------- +Carlos Kirjner, Sanford C. Bernstein - Analyst [18] +-------------------------------------------------------------------------------- + + I have two questions. Can you comment on your view of the relative value proposition of Prime in European markets and Japan? Is it similar to the US? You know, two-day shipping and all the other benefits, or is it different because -- we think, for example, that penetration of Prime in the European markets is much lower. And you have told us that the number of Prime SKUs is much lower in the UK, for example. So, what's the fundamental cause of that? Why is it that Prime in the UK is not as developed as in the US? Is it timing or is it the proposition? +The second question is about AWS. You have a leadership position now, and it's a very large market. And it's easy to see from the outside that you are hiring aggressively, both in engineering and sales. Given the size of the opportunity and your position, what specifically prevents you from hiring faster, developing more products, investing more? How do you balance -- what prevents you from doing that? Why wouldn't you invest twice or three times as much in AWS? Thank you. + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com, Inc. - SVP and CFO [19] +-------------------------------------------------------------------------------- + + In terms of -- I'll take the AWS one first. We are expanding very rapidly. We are -- have been hiring a lot of great people over the past few years, and several years. We do think it's a big opportunity. We're making sure we keep the hiring bar really high to make sure we're bringing great resources, like we do across all of Amazon. And we're super-excited about the opportunity, so we are investing very heavily. +You see that certainly in our CapEx numbers. And the assets that we are acquiring with some of our capital leases, you see that represented. So again, we are investing very heavily, both in terms of people as well as capital for that business, and we share your excitement about the business. +In terms of the Prime piece, that proposition is a bit different by geography. And we continue to make it better in all of the geographies that we have Prime. That's something that we're focused on. The shipping speed is different by geography a bit, and so -- but the focus is all about how we make sure that we get a great experience for customers in those geographies. +But the one thing is different is -- you mentioned is that the proposition or the timing -- so the proposition is a little bit different. But we'll continue to work on making a better for all the geographies we have it in. But the timing is different. +We did launch in the US first, and we launched in other geographies following that; so, as a result, it's just earlier in these other geographies. So we still think it's a very good opportunity, and something that we're focused on. + +-------------------------------------------------------------------------------- +Operator [20] +-------------------------------------------------------------------------------- + + Mark May, Citigroup. + +-------------------------------------------------------------------------------- +Mark May, Citigroup - Analyst [21] +-------------------------------------------------------------------------------- + + One on -- I am sorry if I missed this. What's your thought or outlook for pricing in the AWS Cloud business for this year? It was obviously quite fierce last year. Do you think it will be quite as competitive in 2015? +And then in the media business, we've been hearing data points about a slowdown in the e-book space. Are you seeing that? And what's your outlook? Do you see any hope for the media segment to improve as a result of that? Thanks. + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com, Inc. - SVP and CFO [22] +-------------------------------------------------------------------------------- + + In terms of the first question, we have continued to lower prices for customers in Web services. Certainly that's something that we've been focused on since early launch. It's something that we continue to focus on. It's hard to predict what will happen going forward, so really can't comment on what we might or might not do there. But, certainly, it is something that we've had since launch. We've had many, many -- it's in the high 40s, in think, in terms of pricing actions there. So we're very excited to make sure that we have great prices for customers. +In terms of that media, you are seeing an overall media growth, globally. You are seeing some softness in the growth rate there. I just want to point out, certainly one of the larger factors, or largest factor, that's in that number is -- keep in mind that we have -- we do game consoles that are part of the media growth numbers or the media absolute numbers. And last year was a very strong year for new console launches. And so what happens is when you have those launches, you also have video games that are -- the video game sales themselves are also strong. So, for example, if you look at North American media growth rate in Q4 of this past year, you're seeing that impact. So that's what you're seeing there. + +-------------------------------------------------------------------------------- +Operator [23] +-------------------------------------------------------------------------------- + + Mark Mahaney, RBC Capital Markets. + +-------------------------------------------------------------------------------- +Mark Mahaney, RBC Capital Markets - Analyst [24] +-------------------------------------------------------------------------------- + + Tom, can ask you a high-level question? + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com, Inc. - SVP and CFO [25] +-------------------------------------------------------------------------------- + + Sure. Go for it, Mark. + +-------------------------------------------------------------------------------- +Mark Mahaney, RBC Capital Markets - Analyst [26] +-------------------------------------------------------------------------------- + + Okay. Amazon has always pitched itself in terms of price, selection, and convenience to customers. And I saw this great survey work that was done by Morgan Stanley in the last couple of weeks about this global survey that indicated a little bit of the shift in consumers' interest in online commerce, more towards convenience. You must have a pretty good feel at Amazon for whether that broad value proposition to consumers is shifting; if it's shifting to be slightly less sensitive to price over the last couple of years, and more towards convenience. +Are you seeing that kind of shift? There's a lot of implications if that is, in fact, what's happening. + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com, Inc. - SVP and CFO [27] +-------------------------------------------------------------------------------- + + I would say it this way. In terms of customer reaction, you see it really across the fundamental inputs that we've talked about for a long time. So in other words, in terms of speed of delivery and convenience, we see that with Prime members. Prime members are buying more. It's more convenient. They are getting their physical product to them faster versus being not a Prime member. So we certainly see that, so that certainly speed of delivery helps. +We also see -- we need to make sure, and it's something that we're always focused on, is making sure we have great prices. And that's every single item across categories, across geographies. So it's something we've focused on. We do think that's important for customers. And we need to be -- have the selection be in stock when a customer comes to our detail page. It matters. +So I don't view it as a shift. I view it as -- there's certainly a lot of visibility and transparency around all of these. That's what shopping and operating a business online does. There's just a tremendous amount of transparency. We think -- we like that world. And that's something that we continue to focus on those inputs so that we can be successful in that world. And that's not something new. That's something we've been focused on for a long time. + +-------------------------------------------------------------------------------- +Operator [28] +-------------------------------------------------------------------------------- + + Jason Helfstein, Oppenheimer. + +-------------------------------------------------------------------------------- +Jason Helfstein, Oppenheimer & Co. - Analyst [29] +-------------------------------------------------------------------------------- + + Two questions. One, just if you can clarify any impact of the Fire phone in the quarter. And then secondly, can you talk about how fuel prices impact your model? And I know the shippers, they use a trailing index to calculate fuel, how those savings would show up, or if you would pass those on to third parties, et cetera. Thanks. + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com, Inc. - SVP and CFO [30] +-------------------------------------------------------------------------------- + + Yes, there's not -- I don't have really any callout for the Fire phone. We continue to sell. I had mentioned we had a little bit over $80 million of inventory at the end of Q3, and it will continue to sell through that in Q4. +In terms of fuel prices, not a lot to call out there in terms of impact on the quarter. Certainly, over a long period of time, if it's sustainable, we should see some benefits there. + +-------------------------------------------------------------------------------- +Operator [31] +-------------------------------------------------------------------------------- + + Gene Munster, Piper Jaffray. + +-------------------------------------------------------------------------------- +Gene Munster, Piper Jaffray - Analyst [32] +-------------------------------------------------------------------------------- + + Over the past couple of years, it's just been a little bit of a roller coaster with margins for investors. There's points of optimism followed by points of frustration. And there's really some optimism here in this report. Is there anything that you can help investors with to understand just how you think about different cycles of investing, to try to smooth out some of this roller coaster mentality that happens with the stock? Thanks. + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com, Inc. - SVP and CFO [33] +-------------------------------------------------------------------------------- + + Well, in terms of -- I would describe it this way, Gene. We have a lot of opportunities in front of us that we've talked about. And we're also being selective with those opportunities. We have added a lot of resources over the past few years. We certainly have been in a heavy investment cycle. I mentioned earlier, we're in the process of finalizing our plan for 2015. We always put energy into various productivity measures. But we're putting even -- the team is putting even more focus on those efforts as we finalize our 2015 plans. +We'll have to see where that ends up, but putting more energy and focus around our various fixed productivity, variable expense productivity, efficiency projects. And again, a wide range of different activities. And so, that's what we're doing, and you'll have to stay tuned to see how that progresses as we go. + +-------------------------------------------------------------------------------- +Operator [34] +-------------------------------------------------------------------------------- + + Ross Sandler, Deutsche Bank. + +-------------------------------------------------------------------------------- +Ross Sandler, Deutsche Bank - Analyst [35] +-------------------------------------------------------------------------------- + + I had two questions. First on India, can you talk about the India opportunity broadly, and maybe some advantages you may have versus some of the local peers in terms of leveraging your scale? That market appears to be just on fire right now, so just a little bit of color on India. +And then on Prime, can you talk about the Prime member behavior in terms of purchasing frequency? How it looks today versus maybe a Prime member that joined two years ago? I know it looks a lot different from those very early Prime adopters from six, seven years ago. But just more recently, over the last couple of years, is the behavior consistent as you grow the base? Thanks. + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com, Inc. - SVP and CFO [36] +-------------------------------------------------------------------------------- + + Sure. In terms of India, we think it's very, very early. We are investing, certainly, in India and we think it's a very interesting opportunity. We have a very good team there, and we're excited to participate. And again, we think it is very early, so we like the opportunity there. +In terms of Prime, there's not a lot I can help you with on that, but I would say is this: certainly as you think about customers who are not Prime that become Prime, we see a very sizable step-up in their purchasing patterns. And so, the customers are certainly buying a lot more from us. +And one of the things that we're seeing -- another thing that we're seeing is certainly, as Jeff references in the quote, Prime has evolved. It is both a physical and digital offering. It's unique that way. We see, for example -- although it is still very early, and we're learning and investing in this area -- but I take video content, for example. What we see is customers that come in who come in through our Prime pipeline for video, for a free trial, those customers are converting at higher rates than other channels. We see that customers that are streamers, video streamers; even though we have high renewal rates, they are renewing at even higher rates than others. +We see those people who are customers who are streaming have a very similar purchase patterns on the physical product side as those who don't. And so we view that as a positive. So it's very integrated from a customer experience standpoint, which we think is great. +And so those are the things that we're seeing in Prime right now. And with Prime being almost 10 years old, growing at 53% year-over-year on a sizable base, tens of millions, we think is very interesting. And it's something that we're very focused on as we continue forward. + +-------------------------------------------------------------------------------- +Operator [37] +-------------------------------------------------------------------------------- + + Eric Sheridan, UBS Investment Research. + +-------------------------------------------------------------------------------- +Eric Sheridan, UBS - Analyst [38] +-------------------------------------------------------------------------------- + + On the topic of China, wanted to know if you could help us either qualitatively or quantitatively understand what that trajectory or the size of the business is in China. And then maybe the trajectory around investments needed to compete in China, and how you think about the opportunity there long-term, looking through the lens of the competitive landscape, and maybe Amazon's particular skill set on going to market in China. Thanks. + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com, Inc. - SVP and CFO [39] +-------------------------------------------------------------------------------- + + Sure. We haven't broken out the size of the business. I can't help you much there. But we continue to work on the customer experience there. The team has some interesting ideas that you'll have to stay tuned on of how to make that experience better, and we continue to work on it. So, there's not a lot more that I can add to that. + +-------------------------------------------------------------------------------- +Operator [40] +-------------------------------------------------------------------------------- + + John Blackledge, Cowen and Company. + +-------------------------------------------------------------------------------- +John Blackledge, Cowen and Company - Analyst [41] +-------------------------------------------------------------------------------- + + Just a couple questions. In North American media, aside from the video game impact, just wondering if there are any other factors driving the low or flattish growth year-over-year. And then, CapEx was up about 40% in 2014. It has kind of bounced around over the years. Just wondering if you can give us a sense of the level of growth in 2015. Thanks. + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com, Inc. - SVP and CFO [42] +-------------------------------------------------------------------------------- + + Sure. In terms of the North American media, a number of different, certainly, puts and takes there. But certainly, by far, the biggest one is the one I called out, which is the video game consoles. So if you look at the growth rate in Q4 last year, meaning 2013, and Q4 2014, you see a big difference. And the biggest, the most sizable difference there is certainly the video game consoles portion, and the video games associated with those. +So another way to say it is, the video game consoles and video games portion of that is down year-over-year. And obviously, years ago, we put the video game consoles as part of North American media to keep it with video games, and their kind of larger ASP items, as well, to go in there. So certainly having an impact on that when you look at the growth [row] and you compare 2013 growth -- Q4 2013 growth to Q4 2014 growth there. +In terms of CapEx, we're not giving guidance on the 2015 spend. But given the high usage rates that we've had in Web Services, you should expect that we'll be spending CapEx to support that growth. And we'll certainly be adding new fulfillment centers as we go. Also, keep in mind that we do also finance capital. So if you look at our capital lease activity, point to that -- that's also increased in activity over the last few years. +Certainly a number of different investments that are going -- different types of CapEx that go into that financing; but the biggest piece is certainly infrastructure to support our business, primarily on the AWS side. So, again, that's also included in that number. + +-------------------------------------------------------------------------------- +Operator [43] +-------------------------------------------------------------------------------- + + Heath Terry, Goldman Sachs. + +-------------------------------------------------------------------------------- +Heath Terry, Goldman Sachs - Analyst [44] +-------------------------------------------------------------------------------- + + Tom, I was hoping you could give us some kind of sense of the impact on delivery times and conversion rates that you saw during this holiday season from the investments that you made in fulfillment, particularly the sortation centers that were added before the holidays. And then also, to what degree you've seen some leverage, or some of the slower growth in fulfillment costs, from moving more of the fulfillment obligation to first-party-owned infrastructure? + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com, Inc. - SVP and CFO [45] +-------------------------------------------------------------------------------- + + Sure. In terms of the sort centers -- and I would say just in -- I would say, in addition to sort centers, what's happened over the course of the last several years is, with all the fulfillment centers that we've added, we've actually gotten selection closer to customers. And so, that's helped us from a delivery speed standpoint. It has helped us from a cost standpoint in terms of transportation cost, being closer to customers. And so, it's a natural result of the footprint that we've added. +In terms of sortation centers, there's a lot of different benefits to that. But certainly one of them is as you get closer and closer -- certainly throughout the year it's helped us with holiday deliveries; it's helped us with Sunday deliveries. And as we get closer to, in this case, December to the holiday -- end of the holidays, it has certainly helped us from a delivery to customer standpoint. So we're very pleased with the performance of those sortation centers. And really the global team, fulfillment team around the world, I think they did a terrific job during the holiday season, as they did throughout the year. + +-------------------------------------------------------------------------------- +Operator [46] +-------------------------------------------------------------------------------- + + Mark Miller, William Blair and Company. + +-------------------------------------------------------------------------------- +Mark Miller, William Blair and Company - Analyst [47] +-------------------------------------------------------------------------------- + + There's quite a disparate performance between North America and international, in terms of the profit change year-on-year, up nearly $300 million; North America down over $100 million. So could you just help us understand why the international performance is so much weaker? Perhaps give us some color on the established markets in Europe, relative to emerging markets. And in the past, you've also discussed Japan. And then is there an inflection point where international profits we could expect to head up again? + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com, Inc. - SVP and CFO [48] +-------------------------------------------------------------------------------- + + Sure. The first one is certainly the growth rates, the real growth rates, are slower in international versus North America; certainly would have an impact. The second is we continue to invest in international in terms of adding capacity for infrastructure, for fulfillment capacity. As our -- if you look at our international growth rates, the unit growth rates are actually growing at a higher rate than revenue. +And then emerging geographies; we talked about India earlier. Very excited about India. We are investing in India. We are also investing in China. So those are certainly impacting the results as well. + +-------------------------------------------------------------------------------- +Operator [49] +-------------------------------------------------------------------------------- + + Justin Post, Bank of America Merrill Lynch. + +-------------------------------------------------------------------------------- +Justin Post, BofA Merrill Lynch - Analyst [50] +-------------------------------------------------------------------------------- + + I wanted to ask about gross margins. They were up quite a bit year-over-year, and it looks like, in our numbers, EGM beat and media missed. So, any thoughts on the mix shift there helping or hurting gross margins? What are the key drivers for that line, and what are your -- can AWS continue to drive that in 2015? Thank you. + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com, Inc. - SVP and CFO [51] +-------------------------------------------------------------------------------- + + Certainly AWS -- mix of business is having an impact. AWS is certainly part of that, and impacting that. Also just to keep in mind, our third-party growth is growing at a faster rate than retail, and so certainly that's having an impact. And then obviously continuing to lower prices for customers, as well as working with our partners on the vendor side to support those activities from a pricing standpoint. So those are the dynamics. +And in terms of 2015, beyond the guidance that we're giving, there's not a lot of call-out there. But we've had a great success of being to grow our retail offerings. Our Marketplace side has grown very nicely over the years, including 2014. The team has done a great job there. Fulfilled by Amazon, in terms of number of sellers, continue to grow there. The percentage of paid physical units are approximately 40%, or a little over 40% of the total there. So that has become much more meaningful over the past several years; so, very happy about that. So all those contribute to the numbers that you just talked about. + +-------------------------------------------------------------------------------- +Operator [52] +-------------------------------------------------------------------------------- + + Colin Sebastian, Robert W. Baird. + +-------------------------------------------------------------------------------- +Colin Sebastian, Robert W. Baird & Company, Inc. - Analyst [53] +-------------------------------------------------------------------------------- + + One question, as a follow-up on AWS, and specifically some of the announcements related to WorkMail and WorkSpaces. This would signal that Amazon is moving up the stack towards a more of a SaaS offering. Is that the right interpretation? And, if so, should we expect a broadening of those SaaS product initiatives? Thank you. + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com, Inc. - SVP and CFO [54] +-------------------------------------------------------------------------------- + + You know, very happy to have the launch, make the launch that you mentioned. We think it's exciting. It's certainly -- we're excited overall about Web Services offerings. The team has done an incredible job in terms of innovation, as well as operating these large services at scale. So they're doing a terrific job. In terms of what we might or might not do in the future, we're not talking about what that roadmap is, so you'll have to stay tuned. + +-------------------------------------------------------------------------------- +Operator [55] +-------------------------------------------------------------------------------- + + Ben Schachter, Macquarie Equities Research. + +-------------------------------------------------------------------------------- +Ben Schachter, Macquarie Equity Research - Analyst [56] +-------------------------------------------------------------------------------- + + [Can you] just give any color on how you are evaluating the opportunities to show video advertising against the ever-increasing video content? Thanks. + +-------------------------------------------------------------------------------- +Tom Szkutak, Amazon.com, Inc. - SVP and CFO [57] +-------------------------------------------------------------------------------- + + Yes, we really aren't using advertising too much in that area. You've seen it a little bit on some of our original content. But beyond that, we really can't comment. We think the experience we have is great for customers. We get a lot of positive feedback on the content that we have there, and the uninterrupted content, if you will. And so wouldn't speculate on what we might or might not do there, but we're getting great feedback from customers. + +-------------------------------------------------------------------------------- +Operator [58] +-------------------------------------------------------------------------------- + + James Cakmak, Monness, Crespi & Hardt. +James, your line is live. Please proceed with your question. +James, if you have muted your line, please un-mute it. + +-------------------------------------------------------------------------------- +Phil Hardin, Amazon.com, Inc. - Director of IR [59] +-------------------------------------------------------------------------------- + + Thank you for joining us on the call today, and for your questions. A replay will be available on our Investor Relations website at least through the end of the quarter. We appreciate your interest in Amazon.com and look forward to talking with you again next quarter. + +-------------------------------------------------------------------------------- +Operator [60] +-------------------------------------------------------------------------------- + + Thank you, ladies and gentlemen. This concludes today's conference. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/exam/original-files/Problem_1_Sample/2015-Jul-15-BAC.N-137368163905-Transcript.txt b/exam/original-files/Problem_1_Sample/2015-Jul-15-BAC.N-137368163905-Transcript.txt new file mode 100644 index 0000000..6070c20 --- /dev/null +++ b/exam/original-files/Problem_1_Sample/2015-Jul-15-BAC.N-137368163905-Transcript.txt @@ -0,0 +1,1060 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q2 2015 Bank of America Corp Earnings Call +07/15/2015 08:30 AM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Brian Moynihan + Bank of America Corporation - Chairman & CEO + * Bruce Thompson + Bank of America Corporation - CFO + * Lee McEntire + Bank of America Corporation - SVP, IR + +================================================================================ +Conference Call Participiants +================================================================================ + + * John McDonald + Sanford Bernstein - Analyst + * Eric Wasserstrom + Guggenheim Securities - Analyst + * Mike Mayo + CLSA - Analyst + * Steven Chubak + Nomura Securities Co., Ltd. - Analyst + * Jim Mitchell + Buckingham Research - Analyst + * Christopher Wheeler + Atlantic Equity - Analyst + * Nancy Bush + NAB Research - Analyst + * Glenn Schorr + ISI Group - Analyst + * Ken Usdin + Jefferies & Company - Analyst + * Matt O'Connor + Deutsche Bank - Analyst + * Brennan Hawken + UBS - Analyst + * Betsy Graseck + Morgan Stanley - Analyst + * Marty Mosby + Vining Sparks - Analyst + +================================================================================ +Presentation +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Good day everyone and welcome to today's program. (Operator Instructions) +Please note this call may be recorded. (Operator Instructions) +It is now my pleasure to turn the conference over to Mr. Lee McEntire. You may begin, sir. + +-------------------------------------------------------------------------------- +Lee McEntire, Bank of America Corporation - SVP, IR [2] +-------------------------------------------------------------------------------- + + Good morning. Thanks to everybody on the phone as well as the webcast for joining us this morning for the second-quarter results. Hopefully everybody's had a chance to review the earnings release documents that are available on the website. +So before I turn the call over to Brian and Bruce let me just remind you we may make some forward-looking statements. And for further information on those please refer to either our earnings release documents, our website or our SEC filings. +So with that I'm pleased to turn it over to Brian Moynihan, our CEO, for some opening comments before Bruce Thompson, the CFO, goes through the details. Brian? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman & CEO [3] +-------------------------------------------------------------------------------- + + Thank you, Lee. And good morning everyone and thank you for joining us for our second-quarter results. +As you can see from our release we reported $5.3 billion in after-tax earnings this quarter which is up from last quarter as well as more than double what we made last year. Not only were we pleased with the bottom line but revenue was up and expenses were down comparatively against both periods. +Lots of things came together to achieve these results and we continue to work on all these also. On the expense side we told you that we achieved the new BAC cost savings back in the third quarter of last year. However, we didn't give up on our focus on expenses and you can see those in the results. +It's the lowest non-litigation expense base since 2008. At the same time we continue to invest in the future of this Company. Just to mention a few of these investments, we added sales specialists in our financial centers, up a 3% versus last year. +We added 3% to our financial advisors since last year. 4% to our commercial and business bankers. We've opened new financial centers in new markets that we previously didn't have coverage and we continue to upgrade those in other markets. +In addition we continue to invest in young new talent in our Company. We hired a record number of teammates from college, over 1,200, and we upped our intern program to over 1,800 this summer. +And we continue to invest as we have said in technology with over $3 billion we've spent this year to continue to improve and drive our products and our capabilities in the Company. As we are doing that we continue to focus on our process improvement. Our Simplify and Improve effort continues to take hold and you saw that and some of the effects of that this quarter. +The goal of the program is to hold the cost management well as the economy continues to recover and our revenues continue to recover. Away from the expenses, a few other highlights of the quarter, we saw our overall loan growth and balances from the first quarter, we saw a continued improvement in our net charge-offs in credit quality, our deposits and our consumer continue to grow even faster this quarter than prior quarters. +We also built capital and tangible book value despite the OCI impact of higher rates. We returned over $1.3 billion to our shareholders through share repurchase and common dividends. And looking at the results this quarter you can also see that we're making progress on our path to our long-term targets to return on assets and return on tangible common equity. +Bruce will take you through the business activity in the various pages in the slides but some highlights. This quarter again we averaged about 5,000 new customers a day to our mobile banking platform. But importantly the team continues to make progress in bringing that platform into the Company in multiple ways. +An example of that is this quarter our digital channel sales were up 30% from last year in the second quarter. In addition to that we continue to focus on our mortgage area; our direct-to-consumer mortgage and home equity originations improved 40% from a year ago. +In the mass affluent space our Merrill Edge product continues to have record assets and they're up 15% to over $122 billion. And that's on top of our investment brokerage services revenue teammates in US Trust and Merrill Lynch that continues to grow. +We also continue to drive our 401(k) business and this year we've added some of the industry's largest companies to our platform. So those are the trends in the business and Bruce will cover more later. +From a broad economic standpoint what do we see out there? Notwithstanding uncertainty in economies outside the United States we see the US economy continues to steadily improved. In our middle-market business, our commercial businesses, our Company's balance sheet is strong and they continue to draw loans at a higher rate than they did last quarter. +Our consumers continue to spend on our debit and credit cards, this quarter spending over $127 billion this quarter, up 3% from last year even with a downdraft in gas prices in the year-over-year comparison. Our industry-leading research team under Candace's leadership and Bank of America research expects US GDP growth for the second half of the year to be 3% for each of those quarters and we see that in our statistics. +Our Company is well-positioned to benefit from that continued health in the economy. And we continue to manage this Company to deliver for our customers, clients and for you as shareholders. With that I will turn it over to Bruce. + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [4] +-------------------------------------------------------------------------------- + + Thanks, Brian, and good morning everyone. I'm going to start on slide 3 and let's go through the results. +We recorded $5.3 billion of earnings in the second quarter or $0.45 per diluted share. This compares to $0.27 a share in the first quarter of 2015 and $0.19 in the second quarter of last year. +A few items to note as you review the results. In the second quarter we had $669 million of positive market-related adjustments in net interest income primarily driven by premium amortization on our debt securities from higher long-term rates. This provided a $0.04 benefit to EPS. +The quarter also included $373 million in benefits from consumer real estate loans which added $0.02 a share. One other item worth noting is the rep and warrant provision which is a net $205 million benefit this period. This was mostly associated with positive developments in legacy mortgage-related matters which +I'll discuss later in the presentation. +This added $0.01 to EPS. Revenue on an FTE basis was $22.3 billion in the second quarter and included the items that I just mentioned. Total non-interest expense in the quarter was $13.8 billion and reflects lower litigation costs, lower LAS cost and good core expense controls compared to both the first quarter of 2015 and the second quarter of 2014. +Provision for credit losses this quarter were $780 million and included improved net charge-offs on an adjusted basis as well as less reserve release compared to the first quarter of 2015. Return on tangible common equity this quarter was 12.8%, return on assets was 99 basis points and the efficiency ratio was 62%. If we adjust for those metrics for the few items I mentioned earlier return on tangible common equity was 10.9%, return on assets was 85 basis points and the efficiency ratio was 65%. +On slide 4, the balance sheet was up less than 1% versus the first quarter of 2015 as loan growth and higher securities balances were offset by a decline in the ending balances within our Global Markets business. Loans on a period-end basis were up reflecting good core loan activity. All of our loan categories showed growth from the first quarter of 2015 with the exception of Consumer Real Estate which declined from both discretionary activity as well as other one-offs. +Common shareholders' equity improved. This solid earnings growth was partially offset by a $2.2 billion decline in OCI and $1.3 billion in capital returns to common shareholders. +We repurchased 49 million shares for $775 million and paid approximately $500 million in common dividends this quarter. Tangible book value increased to $15.02 and tangible common equity improved to 7.6%. +If we look at lending activity on slide 5 our reported loans on an end-of-period basis increased for the first time since the third quarter of 2013, growing $8.5 billion from the first quarter or 4% on an annualized basis. Activity in our discretionary portfolio which is reflected in the LAS and All Other box where we use consumer real estate loans to manage interest rate risk in the LAS unit where we have a home equity run-off portfolio together showed a decline from the first quarter of 2015 of $15 billion. +The loan sales I mentioned earlier accounted for roughly half that amount and included certain loans with long-term standby arrangements that were converted into securities. After we exclude this activity, our core loans increased $23.5 billion, or 4% from the first quarter of 2015. Commercial lending was strong. +Among other initiatives the management team challenged our corporate and commercial lenders for the past several quarters to more fully utilize the credit limits to drive responsible growth. In that light, Global Banking showed a continuation of loan growth from the end of the first quarter of 2015 growing $11.4 billion, or 4% during the quarter from a mix of C&I across large corporate and middle market as well as growth in commercial real estate. +Our Wealth Management business continues to experience strong demand in both securities based lending as well as consumer real estate. And our Consumer Banking area grew both card and auto loans. +If we move to regulatory capital on slide 6, under the transition rules our CET1 ratio improved to 11.2% in the second quarter. If we look at our Basel III regulatory capital on a fully phased-in basis CET1 capital improved $1.1 billion driven by earnings, partially offset by the OCI decline, share repurchases and dividends. +Under the standardized approach, our CET1 ratio was steady at 10.3% as RWA was stable with the first quarter of 2015. Under the advanced approaches, CET1 ratio increased from 10.1% to 10.4% as RWA improved by approximately $34 billion. Lower counterparty RWA drove this decline and was equally split between three factors. +The first lower derivative exposures mainly driven by movements in both rates as well as FX. Second, optimization through better collateral management and reductions in certain positions. And third, an increase in the population of trades eligible for model treatment. +The balance of the improvement was driven by lower levels of market risk. In regards to the Fed's requested modifications to models in order to exit the parallel run that we have previously communicated to you, at the end of the quarter we estimate if we made the requested modifications that our advanced approach's CET1 ratio would be approximately 9.3% at June 30. +Moving to our supplementary leverage ratios we estimate that at the end of the second quarter we continue to exceed the US rules that are applicable in 2018. Our bank holding company SLR ratio was approximately 6.3% and our primary bank subsidiary BANA was approximately 7%. +If we turn to slide 7 on funding and liquidity, long-term debt of $243 billion was up $6 billion from the first quarter as issuances outpaced maturities. As you can see from the maturity profile we have $10 billion of parent company debt scheduled to mature in the rest of 2015 and we'll continue to be opportunistic in regards to issuance. +Our global excess liquidity sources reached a record level during the quarter at $484 billion and now represent 23% of the overall balance sheet. The increase from the first quarter of GELS reflects a continued shift from discretionary loans into HQLA securities as well as the increased step balances. +Our parent company liquidity increased to $96 billion and our time to required funding improved to 40 months. At the end of the second quarter we estimate that the consolidated Company was well above the 100% fully phased-in 2017 requirement for the liquidity ratio. +If we turn to slide 8 on net interest income, on a reported FTE basis was $10.7 billion, an increase of $1 billion from the first quarter of 2015. Volatility in long end rates over the past few quarters has clearly caused some variability in out reported NII. The market-related adjustment from our bond premium amortization this quarter was a benefit of $669 million as rates rose 40 basis points in the quarter while in the first quarter of 2015 we reported a negative $484 million adjustment from a decline in rates in the period. +If we adjust for those items our NII declined approximately $100 million from the first quarter of 2015 to just over $10 billion as the impact of lower discretionary balances and consumer loan yields more than offset the impact of one more day of interest. At the end of the second quarter an instantaneous 100 basis point parallel shift increase in rates would be expected to contribute roughly $3.9 billion in NII benefits over the following 12 months and that's split roughly 60% to short end rates and 40% to long end rates. Given the movement higher in long end rates our balance sheet did become less sensitive to long end rates compared to March 31 as we realized some of that sensitivity through FAS 91 in the second quarter. +As you can see on slide 9, non-interest expense was $13.8 billion in the second quarter and included $175 million in litigation expense. Litigation expense did decline significantly from the second quarter of 2014 levels. If we exclude litigation expenses were $13.6 billion in the quarter, a decline of $900 million, or 6% from the second quarter of 2014. +On balance we're quite pleased with our year-over-year expense improvement even while we continue to invest in the franchise. In the third quarter of 2014 we wrapped up the new BAC cost savings initiatives and several quarters later we continue to see good progress on operating cost reductions in LAS as well as in other areas. Our headcount is down 7% compared to the second quarter of 2014 and as a reminder we do expect to incur some costs associated with our CCAR resubmission through the balance of the year. +If we go ahead and switch to asset quality on slide 10, reported net charge-offs were $1.1 billion versus $1.2 billion in the first quarter 2015. Both periods include charge-offs associated with the August 2014 DOJ settlement which we had previously reserved for. If we exclude these impacts and a small impact from recoveries on NPL sales, our core net charge-offs declined $75 million from the first quarter of 2015 to $929 million. +Loss rates on the same adjusted basis improved to 43 basis points in the second quarter of 2015. US consumer credit card delinquencies improved as well and on the commercial front we saw an uptick in NPLs and reservable criticized exposure from the first quarter driven by downgrades in our oil and gas exposures. Despite these downgrades we feel good about our exposure in this area as they are well collateralized and most of these credits only had a one level migration on a risk rating scale. +The second-quarter provision expense was $780 million and we released a net $288 million in reserves which includes the utilization of previously accrued DOJ reserves. Releases in consumer card and consumer real estate were partially offset by reserve builds within the commercial loan growth area. +Let's go ahead and move to the businesses on slide 11, Consumer Banking. Consumer Banking had earnings of $1.7 billion which was 4% greater than the second quarter of 2014 and 16% above the first quarter of 2015 level. This in turn generated a strong 24% return on allocated capital. +Within revenue fees were up 2% from last year driven by higher card and higher mortgage banking revenue but this growth was more than offset by a decline in net interest income. The decline in net interest income is a result of the allocated impact of our ALM activities as well as some compression in card low yields. Provision decreased $44 million from the second quarter of 2014 driven by the continued improvement that we saw in both the credit card as well as the auto portfolios. +Our non-interest expense was down 4% from the second quarter of 2014 as we reduced the number of financial centers and associated costs and personnel. The cost of average deposits ratio is now less than 175 basis points and we have a 57% efficiency ratio within this segment. This business is a good representation of how the Company is doing more business while we continue to reduce expenses. +We also continue to experience a shift in consumer behavior patterns away from branches and towards more self-service. For example, the number of mobile banking customers continues to grow and increase to more than 17.6 million customers this quarter and these customers look to mobile devices for approximately 13% of all transactions or all deposit transactions. +If we look at some of the key drivers and trends within the consumer area on slide 12 we remain a leader in many aspects of Consumer Banking doing business with roughly half of all US households. Let's look at card activity. Card income increased 5% from the second quarter of 2014 on strong sales and solid spend levels. +Card issuance reached almost 1.3 million units in the quarter on increased sales efforts while the average book FICO score was also strong. Average loan balances were down slightly from the second quarter of 2014 as we do see customers paying down more of their balances. +Net charge-offs declined from very low levels and were 2.7% in the second quarter and risk adjusted margins remain high at roughly 9%. Mortgage banking income in this segment was up 8% from last year as originations had nice follow-through from the elevated pipeline at the end of the first quarter as well as higher production margins. +First-quarter mortgage -- first mortgage originations for the total Company were $16 billion, up 44% year over year and up 16% from the first quarter of 2015. Home equity line and loan originations increased 23% to $3.2 billion from the year-ago quarter and were stable with the first quarter. +Revenue improvement versus the second quarter of 2014 was driven by improved margins. Although the mortgage pipeline remains solid it is down 15% from the end of the first quarter driven in part by higher rates. +Service charges were down modestly versus the second quarter of 2014. This fee line item does continue to be somewhat muted as we continue to open higher quality accounts and those accounts are carrying higher balances. Compared to the second quarter of 2014 our average deposits of $545 billion are up $31 billion, or 6% even as we lowered the rates paid which now stands at 5 basis points. +Lastly, while we are bringing down our overall headcount in this business we continue to invest in the growth opportunity of our preferred client base. And we've been increasing sales specialists in the financial centers and that's resulted in increased activity. +If we turn to slide 13, Global Wealth and Investment Management produced earnings of $690 million which was up 6% from the first quarter of 2015 levels but down 5% from the second quarter of 2014. Compared to the second quarter of 2014, solid fee growth was offset by lower net interest income, higher credit cost and modestly higher expenses which resulted in a decline in year-over-year results. +The allocation of the impact of our Company's ALM activities more than offset the NII benefits that we had from solid loan growth within this space. Year-over-year non-interest income was up 4% on strong asset management results. Non-interest expense was modestly higher in the second quarter on the strength of our asset management fees as well as the continuing investment in client facing professionals. +The year-over-year increase in provision reflects larger reserve release in the prior periods. Pretax margin was 24% and the return on allocated capital remained strong at 23%. +If we look at activity and drivers on slide 14 asset management fees continue to grow and are up 9% from the second quarter of 2014. This was partially offset by sluggishness of transactional revenue in the brokerage business. We did increase our financial advisors by 6% over the last 12 months and we feel good about the number of advisors that are joining us from competitors. +Client balances are above $2.5 trillion, up almost $12 billion from the first quarter of 2015 driven by solid client balance in-flows as well as improved market valuations. Long-term AUM flows were $9 billion for the quarter and that's the 24th consecutive quarter where we've seen positive flows. As I mentioned earlier we continue to experience strong demand in both our securities based and residential mortgage lending areas and we reached a new record for loans within this space during the quarter. +If we turn to slide 15, Global Banking earnings were $1.3 billion which is 14% unallocated capital. Earnings did decline 13% from the second quarter of 2014 as lower non-interest expense was more than offset by lower net interest income, lower investment banking revenues and higher provision expense that was associated with a strong loan growth that we saw during the quarter. +The year-over-year decline in net interest income reflects the allocation of our ALM activity and liquidity cost as well as some compression in loan spreads. Non-interest expense did decline 3% from the second quarter of 2014 as lower litigation and other technology initiative cost were partially offset by investment in client facing personnel. +If we look at the trends on slide 16 we chart the components of revenue. Investment Banking fees for the Company were $1.5 billion, down 6% from the near record levels that we experienced during the second quarter of 2014. +Advisory fees were up 5% during the quarter. Debt underwriting was relatively stable as increased activity in the investment-grade and other products offset the declines that we saw within our leverage finance area. +Equity underwriting was down 19% from what was a record level for our Company in the second quarter of 2014. Outside of Investment Banking fees other banking revenue declined from lower leasing gains partially offset by modestly higher treasury fees and card income. If we look at the balance sheet loans on average were $301 billion, up 4% from both the year-over-year and linked quarter periods. +The growth was broad-based across both corporate and commercial borrowers. Although average deposits were relatively stable versus the second quarter of 2014 we did see a favorable shift in mix with our non-interest-bearing deposits up over $20 billion and our interest-bearing deposits down $17 billion versus the second quarter of 2014. This growth in non-interest-bearing balances was driven by a continuing focus on the growth within operating balances. +The decline in interest-bearing balances was driven by targeted reductions in these low liquidity value deposits. +Switching to Global Markets on slide 17, in the second quarter earnings were $1 billion on revenues of $4.3 billion. We generated 11% return on capital in this business during the quarter. Earnings were up modestly from the first quarter of 2015 levels which included higher litigation but down from the second quarter of 2014 is revenue declined. +Total revenue excluding net DVA declined from the second quarter driven by lower equity investment gains, lower FICC and sales and trading results and lower investment banking fees. If we exclude a $188 million difference between periods on the sale of an equity investment, revenue was down 4% from the second quarter. Non-interest expense was reduced 5% from that same period in line with the revenue reductions. +If we focus on the sales and trading performance components on slide 18, sales and trading revenue of $3.3 billion ex-net DVA is down 2% from the second quarter of 2014 levels. Compared to the same period a year ago, FICC sales and trading was down 9% and not unlike what we saw in the first quarter of 2015 strength within the macro-related products like FX, rates and commodities was offset by lower levels of activity within the credit products space. And to remind you, our mix does remain more heavily weighted to credit products based on the size of our new issue business. +Equities trading was up 13% year over year driven largely by increased client activity within the Asia-Pacific region as well as a strong performance within the derivative area. +Slide 19 shows our Legacy Assets and Servicing business where we were profitable during the quarter given the net benefit in our rep and warrant provision. Revenue excluding this benefit did decline from the first quarter of 2015 on less favorable MSR hedge performance as well as lower servicing revenue. Litigation expense declined significantly from the second quarter of 2014. +Non-interest expense ex-litigation was roughly $900 million this quarter, improving $122 million from the first quarter of 2015 and $526 million going back to the second quarter of 2014. We remain on track to hit our fourth-quarter goal of approximately $800 million in LAS cost ex-litigation. +We were also pleased that during the quarter our number of 60-plus day delinquent loans decreased to 132,000 units. That's down 14% from the first quarter and almost 50% from the prior period of last year. +Before I move away from the mortgage space let me mention an important development in our legacy mortgage exposures. This quarter there was a closely watched case in New York's highest court which confirmed that the New York six-year statute of limitation on filing rep and warrant claims begins to run at the time the reps and warranties are made and not at some later point in time. +Based on our review of the relevant documents we believe the vast majority of the bank's remaining PLS representation and warranty obligations are governed by New York law. As a result of the case ruling you can see on slide 20, a significant $7.6 billion reduction in our gross outstanding private label claims as a result of certain claims now being time barred. +This ruling also had positive implications on our rep and warrant provision as I mentioned as well as the range of possible loss above those reserves. You recall, the RPL had been a range of up to $4 billion for several years and so the top end of that range has now been reduced to up to $2 billion. +On slide 21 we show all other. The $637 million of earnings this quarter resulted in a swing in profitability as a result of the improvement in the NII market-related adjustment from quarter to quarter as well as the prior-period inclusion of the annual retirement eligible incentive cost. The loan sales I mentioned earlier also included in revenue. +Our effective tax rate for the quarter was 29% and I would expect the tax rate to be roughly 30% for the rest of 2015 absent unusual items like the recent UK tax reform proposals. Among the UK proposals were a reduction in the corporate tax rate, a surcharge tax on bank earnings and a reduction in the bank levy rate. Our preliminary read is that we could have a one-time charge of several hundred million dollars later in this year to reprice our UK deferred tax assets upon enactment. +At this time on an ongoing basis we expect a recurring tax impact to be modest. Before wrapping up on this slide let me remind you that our preferred dividends in the third quarter should be $440 million and $330 million in the fourth quarter of this year. +So to wrap up as Brian started the presentation with many things that our teams have been focused on for some time came together nicely this quarter and that enabled us to report more than $5 billion in earnings and move closer to our long-term targets. Revenue reflected relative stability, we lowered cost, we grew loans nicely, our credit quality remains very good and we're focused on operating leverage within the business. The foundation of the Company's balance sheet has never been stronger with record capital and record liquidity levels and we remain well-positioned to benefit from a rising rate environment. +With that let's go ahead and open it up for Q&A. + + +================================================================================ +Questions and Answers +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) Betsy Graseck, Morgan Stanley. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [2] +-------------------------------------------------------------------------------- + + Hi, good morning. The question I'm getting from people this morning is around the expenses. You showed some very nice improvement in core expenses coming down meaningfully Q on Q and year on year, and the question is have we reached the end state here or is there any further opportunity to bring down expenses from here? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman & CEO [3] +-------------------------------------------------------------------------------- + + I think, Betsy, in the broadest context we continue to work expenses. If we talk to all of you about each quarter, 18 straight quarter reduction in core operating expenses outside litigation, 15 straight quarters of 3,000 people or more reduction each quarter. So we just continue to apply technology to continue to over the long term reduce expenses. +So the goal we have in SIM is to keep the expenses flat as revenue increases. And if the world economic situation changes different what people are expecting we'd have to look at it differently. But as you can see this quarter that will result in a constant downward pressure given where we are in the economy. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [4] +-------------------------------------------------------------------------------- + + Okay. And then on the reps and warranty side you had what looks like a little bit of a true-up based on this litigation decision. Is that the right way of reading it or is there potential even in more to come in the future as you go through these cases? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [5] +-------------------------------------------------------------------------------- + + No, clearly what the case is significant is this, Betsy. We looked at and as we do every quarter look at the rep and warrant provision and you're right it was a net benefit of $200 million this quarter. +I think the important thing I think more than the $200 million is if you look back on our slide 20 in the earnings materials the effect of the decision led to two things that do reduce tail risk on a go-forward basis. The first is you can see the number of new claims that came in was just over $200 million which is a dramatic improvement from what we've seen historically. And second as a result of the time barring of certain claims that the outstanding claims that we have, and keep in mind these outstanding claims are based on original UPB, came down fairly significantly to just below $19 billion. +So while it was nice to have the modest benefit that we did in the quarter I think importantly on a go-forward basis it does reduce the tail risk that's out there. We saw some of the benefits from that in the activity levels this quarter. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [6] +-------------------------------------------------------------------------------- + + Okay, thanks. And then just one last question. +You indicated the upside that you have in the event of a rate rise $3.9 billion if the parallel shift is 100 basis points. The question is how you're thinking about dropping that to the bottom line? Is there reinvestments that would take up some of that or are you at sufficient run rate in investment spend that you would be able to drop more to the bottom line? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [7] +-------------------------------------------------------------------------------- + + There's no question, Betsy, as we look at and I'll just remind people that we were at $3.9 billion for a 100 basis point move. If you look at that roughly 60% of it is on the short end now. 40% of it is on the long end, and there's no question that we would expect to drop a significant portion of that to the bottom line if and when we see that 100 basis point move. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [8] +-------------------------------------------------------------------------------- + + Okay. And then just back to the expense side, the expense run rate that you've got right now is something you think you can hold at least if not improve from here, is that fair? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman & CEO [9] +-------------------------------------------------------------------------------- + + Yes, Betsy, really to your last question we've been investing in headcount to open up a customer facing capacity. So I'd rather give you some of the statistics earlier, so we're comfortable from a technology spend rate, from an investment and client facing capacity, marketing and everything we're at a good run rate. So there'd be downward pressure as headcount continues to come down through the application of technology across the platform with customers internally. +So we're comfortable that we can continue to drive it. And make no bones about it this is what we work on every day and we're reluctant to put out a dollar target because frankly that tells the team we've made a goal and stop as opposed to just get better at it every day. So we are constantly working to improve the dynamics of revenue versus expense in this Company. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [10] +-------------------------------------------------------------------------------- + + Thanks a lot. + +-------------------------------------------------------------------------------- +Operator [11] +-------------------------------------------------------------------------------- + + Matt O'Connor, Deutsche Bank. + +-------------------------------------------------------------------------------- +Matt O'Connor, Deutsche Bank - Analyst [12] +-------------------------------------------------------------------------------- + + If we look at the core net interest income ex- the market-related marks it was down a little bit versus last quarter but you're starting to see the loans inflect as you mentioned earlier. Do we start seeing stability in the core net interest income looking at next quarter or two or do we really need higher short-term rates for that? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [13] +-------------------------------------------------------------------------------- + + Thanks for the question. It's a good question. I think if you look at we typically have a little bit of seasonal pressure in the second quarter on NII so as we sit here today based on the curve we would expect to see the core net interest income which obviously excludes FAS 91 move up from Q2 to Q3 and we'd expect further growth from Q3 to Q4. + +-------------------------------------------------------------------------------- +Matt O'Connor, Deutsche Bank - Analyst [14] +-------------------------------------------------------------------------------- + + Okay. And that's without any benefit from rates? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [15] +-------------------------------------------------------------------------------- + + It's just based on the realization of what the existing curve is which quite frankly we don't look at and our models don't show Fed funds going up until January 2016. So there's not a lot of great benefit in that at all. + +-------------------------------------------------------------------------------- +Matt O'Connor, Deutsche Bank - Analyst [16] +-------------------------------------------------------------------------------- + + Okay. And then on the discretionary book you mentioned it came down a little bit when you look out on a combined securities mortgages basis and I guess just we saw long-term rates go up and some banks have been increasing the discretionary book with higher reinvestment rates or higher investment rates here. What's the thought on bringing that book down as rates have gone up? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [17] +-------------------------------------------------------------------------------- + + I have two comments. I think the first is that when we talked about the discretionary balances coming down that's basically the whole loan portfolio as well as certain pieces of the home equity portfolio. So we referenced that those came down about $15 billion quarter over quarter, half due to sales and half to paydowns. +We probably have one more quarter where you'll see some of the conversion of those loans to securities. But if you actually look at the amount of securities from a balanced perspective they went up a little bit Q1 to Q2 based on the conversion of those loans to securities. And as we continue to see the deposit footprint grow we will continue to invest and we're obviously mindful of the balance between increasing net interest income like I spoke about as well as being sensitive to OCI risk. + +-------------------------------------------------------------------------------- +Matt O'Connor, Deutsche Bank - Analyst [18] +-------------------------------------------------------------------------------- + + Okay, thank you very much. + +-------------------------------------------------------------------------------- +Operator [19] +-------------------------------------------------------------------------------- + + Jim Mitchell, Buckingham Research. + +-------------------------------------------------------------------------------- +Jim Mitchell, Buckingham Research - Analyst [20] +-------------------------------------------------------------------------------- + + Hey, good morning. Just a quick follow-up on the NIM outlook. +I think Bruce last quarter you mentioned that if the yield curve stayed where it was you'd have about $600 million of drag in NII over the next few quarters. Are you saying that that's pretty much changed with the steepening of the curve since April when you spoke last and not only NII is growing but NIM should stabilize or is it just sort of offsetting each other? +Are you getting a boost from that? How do we think about the yield curve versus your prior comment? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [21] +-------------------------------------------------------------------------------- + + As we look and snap forward there are a lot of things that influence that number. One is obviously the ability and how much we've put the increase in deposits to work through growing loans and clearly we've seen during the second quarter we saw that loan growth move up which is obviously a good thing which lessens some of that sensitivity. +And as we look at the amount and what we're doing from an investment portfolio there's less to do during the second half of the year. So all in all as we look at those different factors it's why we're comfortable saying that we'd expect the core to increase both Q2 to Q3 as well as from Q3 to Q4. + +-------------------------------------------------------------------------------- +Jim Mitchell, Buckingham Research - Analyst [22] +-------------------------------------------------------------------------------- + + Okay, fair enough. And just on the capital side, when do you think the modifications become official and you exit the parallel run? How long do we think we have to wait for that and is there anything that could change in terms of your expectation around I guess the 90 basis point hit to your CET1? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [23] +-------------------------------------------------------------------------------- + + I think I can say that we can't say too much about regulatory matters. I think given the updated disclosure we've given you can assume that we're getting closer to having that resolved. You never know until you're ultimately done but we feel very comfortable with the guidance of 9.3% factoring in the adjustments based on where we were at the end of the second quarter and we'll look to get that wrapped up sooner than later. + +-------------------------------------------------------------------------------- +Jim Mitchell, Buckingham Research - Analyst [24] +-------------------------------------------------------------------------------- + + Okay, that's helpful. And just one last quick one on the $3.9 billion of sensitivity to higher rates, how much is FAS 91 related versus core? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [25] +-------------------------------------------------------------------------------- + + Sure. As I mentioned roughly 40% of it's long end which is $1.5 billion of the amount and roughly half of that is FAS 91 and half of it is non-FAS 91 related. + +-------------------------------------------------------------------------------- +Jim Mitchell, Buckingham Research - Analyst [26] +-------------------------------------------------------------------------------- + + Okay, thanks a lot. + +-------------------------------------------------------------------------------- +Operator [27] +-------------------------------------------------------------------------------- + + John McDonald, Bernstein. + +-------------------------------------------------------------------------------- +John McDonald, Sanford Bernstein - Analyst [28] +-------------------------------------------------------------------------------- + + Hi, thanks. Bruce just one more question on the rate sensitivity, the $3.9 billion move for 100 basis point parallel move I assume that illustration is to a 100 basis point move that's a shock or an instantaneous move in rates? Can you give us any feel for how that number would change if the move in rates is more gradual? As the Fed is saying if I go gradually how does that change if it's not instantaneous? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [29] +-------------------------------------------------------------------------------- + + Well I mean ultimately over time if you get to the 100 basis point number you have that, I think your point is that if they move 25 basis points is it 25% or is it more than 25%? And I think the thing that you have to keep in mind and we've talked about it a lot with what we would expect from a deposit repricing perspective that clearly you'd expect the first 25 to 50 basis points move up that we would not have to do much from a deposit perspective. So net-net on a relative basis that should be a positive as you look at the numbers. + +-------------------------------------------------------------------------------- +John McDonald, Sanford Bernstein - Analyst [30] +-------------------------------------------------------------------------------- + + Okay. And a clarification, where it is the gain on consumer real estate loans? Is that in the Mortgage Banking line? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [31] +-------------------------------------------------------------------------------- + + No, it's in other income and it's reflected in the All Other segment. + +-------------------------------------------------------------------------------- +John McDonald, Sanford Bernstein - Analyst [32] +-------------------------------------------------------------------------------- + + Okay. The Mortgage Banking income was very strong on the fee income line, obviously you had the rep and warrant in there. Was there anything else in there that helped on the Mortgage Banking line? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [33] +-------------------------------------------------------------------------------- + + I would say that generally that the hedge results on the MSR were fairly decent in the quarter and then like we've said there just wasn't much litigation during the quarter as well. So all of those things led to the results being where they are. But you're right we've typically had 100 to 200 of rep and warranty provision and we had 200 benefits, so you get a sense of the magnitude of the swing on a comparable period basis. + +-------------------------------------------------------------------------------- +John McDonald, Sanford Bernstein - Analyst [34] +-------------------------------------------------------------------------------- + + Got it. Okay, and then last question for me on the credit, do you see the net charge-offs bouncing around the current level the $929 million and how do you see it playing out in terms of provision reserve release relative to what you just did this quarter? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [35] +-------------------------------------------------------------------------------- + + I think this quarter I think you're seeing a continuation of what we've been talking about and I want to be careful that I think we need to exclude DOJ both on the top as you did in your $929 million number as well as in the reserve release. So if you back out what we had for DOJ the reserve release was about 150, the charge-offs of $929 million were down roughly $75 million. +And while this can bounce around a little bit I think what you're likely to see over the next couple of quarters is probably a convergence where the charge-offs and the provision number become more closely aligned. And I would just say that particularly on the consumer side we continue to like what we see on credit and on the commercial side you can see that charge-offs are virtually nil within the large corporate space and there's nothing that we see out there that's going to change that materially. + +-------------------------------------------------------------------------------- +John McDonald, Sanford Bernstein - Analyst [36] +-------------------------------------------------------------------------------- + + Okay. And on top of that will the DOJ still be a factor for the next couple of quarters? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [37] +-------------------------------------------------------------------------------- + + As it relates to that I want to think, John, that it will be in the $100 million type area as it relates to both charge-off and reserve release and then by the time we get to the fourth quarter it should virtually go away. It can bounce around a little bit but it should largely be gone by the end of the third quarter. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman & CEO [38] +-------------------------------------------------------------------------------- + + But it pares off John so the way you subtract this quarter continue. So it's a number it's offset by a previously established reserve. + +-------------------------------------------------------------------------------- +John McDonald, Sanford Bernstein - Analyst [39] +-------------------------------------------------------------------------------- + + Got it. Okay, thank you. + +-------------------------------------------------------------------------------- +Operator [40] +-------------------------------------------------------------------------------- + + Glenn Schorr, Evercore ISI. + +-------------------------------------------------------------------------------- +Glenn Schorr, ISI Group - Analyst [41] +-------------------------------------------------------------------------------- + + Hi, thanks. Two quick ones on the average balance sheet. +When you look at the debt securities line, the yield went up some version of a lot from 2% to 3.2%. I'm assuming some of that is LAS loans converting, but could you give a little color on what drives that? Because the overall size of the book didn't change that much. + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [42] +-------------------------------------------------------------------------------- + + Yes, it's interesting, if you look year over year and you adjust for FAS 91 which shows up in the NII when you're looking back at the table that the yields were almost identical from the second quarter of 2014 to the second quarter of 2015 once you make that 91 adjustment. + +-------------------------------------------------------------------------------- +Glenn Schorr, ISI Group - Analyst [43] +-------------------------------------------------------------------------------- + + Okay. Similar but different question, inside the C&I book, the used commercial book it was just a 4 basis point drop quarter on quarter but there's growth there. So I'm just curious the trade-off between price and yield give up on the new loans you're putting on versus the responsible growth you talked about. +It doesn't seem that bad. I'm just curious on what kind of yield you're putting new loans on? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [44] +-------------------------------------------------------------------------------- + + Sure. I think when you look at commercial loan spreads there are two things that those numbers reflect. I think the first thing which just from a macro perspective that has been a little bit of compression although we're seeing it slow as it relates to just the competitive landscape and where loans are getting done. +As it relates to your question about the new loans, the responsible growth, if you looked at in particularly in the areas that picked up during the second quarter that on our risk rating scale they would translate to credits that tend to be in the strong BBB or a single 8 area so that they are largely investment-grade type credits where we're extending it and if you look at average spreads in that area they tend to be in the LIBOR plus 150 type area on average which is a little bit lower than the average across the commercial platform. But as you can see the credit is clearly at the upper end. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman & CEO [45] +-------------------------------------------------------------------------------- + + So Glenn it's probably say if you think about it we're not on credit structure we held our discipline, on price there's been pressure but then you have to look at that on a whole relationship basis with the other fees and revenues you get from cash management and stuff. And we try to have a client focused discipline to do it. But your observation is right, there is a little pressure on those spreads due to that. + +-------------------------------------------------------------------------------- +Glenn Schorr, ISI Group - Analyst [46] +-------------------------------------------------------------------------------- + + Okay, I definitely appreciate that. Last one is when you talk about the pushing for growth and you mentioned the different specialists in the branches, the Business Banking, the financial investment consultants, I'm curious what are you doing to incent and to encourage them? In other words are there actual incentives or do they get paid on their production? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman & CEO [47] +-------------------------------------------------------------------------------- + + In the sales context there is there are incentives for production but it has to be done the right way with the right customers in the right structure so it is not -- it doesn't drive their behavior. It's different than let's say the Wealth Management business in terms of the balance between incentives. +But yes they are paid to open, the mortgage loan officers are paid to produce mortgages and to open up checking accounts and other things. But it's really, it's actually deploying the people and building the capacity to sell, that's where we are reducing the need for services through all the automation that's going on and shifting that group of people. +So that it is really just having more of them than think of it as incentive driven behavior. And then really then having the information at the point of the sale through our technology of offers that have been made to people for credit cards, etc., so you can make the offer again that's already been made to them online or something. So it's a combination of sales practices, more people and then just the discipline of the team, Tom, Glenn and Dena (inaudible) then it would be incentive driven. + +-------------------------------------------------------------------------------- +Glenn Schorr, ISI Group - Analyst [48] +-------------------------------------------------------------------------------- + + All right. Thanks very much. + +-------------------------------------------------------------------------------- +Operator [49] +-------------------------------------------------------------------------------- + + Eric Wasserstrom, Guggenheim Securities. + +-------------------------------------------------------------------------------- +Eric Wasserstrom, Guggenheim Securities - Analyst [50] +-------------------------------------------------------------------------------- + + Thanks very much. Just to follow up a little bit on that last point, when I was trying to shift through the core loan growth numbers this morning it looked like the core loan growth coming out of the institutional bank and the Wealth Management looked strong but I'm still unclear what the core level of growth was inside the consumer organization and so I'm just trying to reconcile that with where the incremental hiring is occurring on the sales front. So can you just clarify what the core level of consumer growth was? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman & CEO [51] +-------------------------------------------------------------------------------- + + Well as you look at the consumer on page 5 you can see the balances and you can see the different pieces. We had change of practice of how we booked residential mortgages for our consumer customers that has an impact on that. But overall you remember they're still fighting a couple -- we're still fighting a couple of things on consumer. +One is the card balances are finally stabilize and you saw from first quarter to second quarter a slight uptick there. That's because we've been hitting increasingly record sales of credit cards so I think we did about $1.3 million this quarter, Bruce, that is again a record for us and since we changed the business model six, seven years ago. And if you look at -- but if you look at things like the home-equity balances and things like that those are under pressure just because we're still seeing significant repayments even though we're producing a lot in that area. +So if you look at that you can see it's across the board just a little bit upside tilt, in part the interplay between some of the runoff in the other category and the buildup in residential. But they do a lot more than sell loans in that place and so the investment sales levels that drives that Merrill Edge, in fact at the FSAs and the branches that we deploy do $4 million of notional on average a month of new investment products. In building $4 million to $5 million they sell obviously checking accounts, net checking accounts this quarter. +We're in a net checking account growth position even taking into account the runoff from divestitures and other things and then you have the loan side. So they are responsible for driving all that and so it shows up in the loans a little bit but also that's why the feed category is stable in other areas. + +-------------------------------------------------------------------------------- +Eric Wasserstrom, Guggenheim Securities - Analyst [52] +-------------------------------------------------------------------------------- + + And so do you have a sense or is there some sense maybe you can give us to how that investment in front office staff is contributing to growth outside of the segment? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman & CEO [53] +-------------------------------------------------------------------------------- + + Well, for example in the small-business arena in the first half of the year we did about $5 billion of originations and what the world would define as small business we have it across two divisions and they helped grow that. Merchant services growth, you know they sell that goes into the Business Banking -- Global Banking segment and they sent about 20,000 customers a year into Wealth Management that literally walk in a branch are wealthy and they get moved over and that helps our Wealth Management business. +So you can't think of -- you're right. That salesforce does what it does in the segment but it has the benefit across the board and then service is a lot for all customers. +Business Banking, Commercial Banking customers come into the branches obviously for the cash -- related to the cash management revenue. So it is across the board and contributes and so the good news is they are making more money than they made last year on their own but they are still providing that services and capabilities across the platform. + +-------------------------------------------------------------------------------- +Eric Wasserstrom, Guggenheim Securities - Analyst [54] +-------------------------------------------------------------------------------- + + And so when this is my final question on this if we divorce just the runoff from some of the legacy assets that are still occurring, would you expect the core consumer asset growth to accelerate as a consequence of this investment or do you think that it's currently run rating? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman & CEO [55] +-------------------------------------------------------------------------------- + + As the runoff subsides in the consumer categories this is Consumer Banking here and then you've got the LAS piece, the LAS home equities will continue to go down because frankly those are products we put in there because we decided not to do them. But on the consumer you should see as it stabilizes you'll see a little bit better loan growth. +But remember that focus on the responsive part of responsible growth we're not going to open up the credit card business in a way that will produce charge-off later down the road that we won't be happy with. So we are driving that growth into the core strong credit quality that we want to have in this Company. And so I'd be careful about assuming it will just leap to us because to do that you'd have to go into credit postures that we won't do. + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [56] +-------------------------------------------------------------------------------- + + And I would just add, Brian, if you look at home-equity it's a good example where if you look within the consumer banking space during the second quarter of this year the home equity originations of line amounts were about $3.2 billion. They were to loan to value less than 60%, FICOs deep into the 700s and so there were more than $3 billion of those booked. +It's number one market share, roughly $1.5 billion of that was funded, but you do have some of the legacy stuff that's running off. So I think when you wonder about activity levels and what's happening I think you need to realize that with that number one share in what we're doing it is growing. It's just that there is a runoff that mutes that effect. + +-------------------------------------------------------------------------------- +Eric Wasserstrom, Guggenheim Securities - Analyst [57] +-------------------------------------------------------------------------------- + + Great, thanks very much for the answers to all my questions. + +-------------------------------------------------------------------------------- +Operator [58] +-------------------------------------------------------------------------------- + + Ken Usdin, Jefferies. + +-------------------------------------------------------------------------------- +Ken Usdin, Jefferies & Company - Analyst [59] +-------------------------------------------------------------------------------- + + Thanks, good morning. First question just on the RWAs, looks like when you look at the reconciliation of the move to fully phased-in there is a little bit of a help on the advanced models this quarter and just in a general sense obviously we still have that finalization to come but what additional tweaks are you working on inside the models and what additional mitigation could we still see from here on the RWA side? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [60] +-------------------------------------------------------------------------------- + + I think there are couple of things. We're obviously working hard to move as many of the exposures from CEM treatment to IMM treatment which generally has favorable benefit there. +The second thing I talked about better collateral management as well as looking to work to do more compression and to net things out and we continued to see some benefit there. I think third is we continue to move out and we're largely through this but as we continue to move out some of the non-performing consumer real estate as well as the benefits of improved consumer credit quality, we're seeing benefits there. And there still are a few RMBS and other type positions that we'd expect to get benefit for over the next couple of quarters. +So I think this quarter was clearly a quarter between the activities that we undertook as well as what happened from a rates and FX perspective where we saw pretty good quarter-over-quarter improvement. And obviously that was not only in the markets business but also in the consumer businesses. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman & CEO [61] +-------------------------------------------------------------------------------- + + I'd say, Bruce, the other thing we have a healthy dose of operating capital due to the operating risk embedded from Countrywide and other things that we have to figure out over time how we can work through the system because we never did the activities in the Company but on the other hand we had to deal with the cost of them. And so both operating and general, so as you think about that longer term we had to get a more rational view of that operating risk relative to the Company we run today which is different but that will take time and working through the models there too. + +-------------------------------------------------------------------------------- +Ken Usdin, Jefferies & Company - Analyst [62] +-------------------------------------------------------------------------------- + + Okay. And then my second question relates to the Wealth Management business and Bruce you alluded to there being a little bit of a slowdown on the revenue. So if a look at the segment or the line item on the income statement there has been a deceleration, advisor productivity looks a little bit lower and you've added a lot of people. You've added a lot of assets. +So I'm just wondering what do we need to see to get a re-acceleration of the revenue side in brokerage and Wealth Management? And is it just a time lag relative to those additions? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [63] +-------------------------------------------------------------------------------- + + A couple of points on that. I think first there's clearly a building up of advisors particularly if we're bringing them in and training them, that there's a ramp up in productivity that occurs. I don't think there's any question. +The second thing that I do think is important is that when you look at the net interest income line that as I mentioned it looked a little bit muted, if you saw gross loan net interest income you would see this increasing. So some of the push out of the ALM activities has muted the NII line a little bit. +And then the third thing which you reference that I do think is a little bit more of a trend and I think is not only is somewhat consistent with some of the regulatory standards which we're seeing more and more of the assets that we manage being managed on a long-term basis where we're managing them. And so that's leading to growth in the asset management fees and the corollary to that is that you do have lower brokerage income but net-net you can see that we are growing in the segment and we feel good about the activity that we're seeing there. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman & CEO [64] +-------------------------------------------------------------------------------- + + And I'd say that the few quarters we saw the margin, the pretax margin come down and you're seeing it start to turn back and go up. And there's positive pressure out in the future on that at the end of this year because of some of the deal stuff runs off will add a couple of points to margin that it's in the numbers this year but won't be in the numbers next year. +And then your point is the maturity of the investment cycle so if you go back we're adding financial advisors, their books are coming in, they're building the books and as that maturity happens you'll see it match a little better. But the encouraging signs we're seeing the margin comeback up. +And remember this business also benefits a lot by the rate changes, too, ultimately. It is a big bank, it's got $250 billion deposits, round numbers, a lot of loans, and it has a lot of the same sensitivity our Consumer Bank does that people don't think of it in this context. +So as we think about the comp structure is in place but there's an added deal piece that runs off you're seeing the maturity cycle of the people coming up. And the team is just working hard on the revenue expense management and we started to see some better signs they've got some work to do still though. + +-------------------------------------------------------------------------------- +Ken Usdin, Jefferies & Company - Analyst [65] +-------------------------------------------------------------------------------- + + Understood. Okay, thanks, guys. + +-------------------------------------------------------------------------------- +Operator [66] +-------------------------------------------------------------------------------- + + Steven Chubak, Nomura. + +-------------------------------------------------------------------------------- +Steven Chubak, Nomura Securities Co., Ltd. - Analyst [67] +-------------------------------------------------------------------------------- + + Hi, good morning. So I have a couple of questions on the topic of capital. +The first is a follow-up to Ken's earlier question regarding RWA mitigation potential. And Bruce I do appreciate the color you cited relating to all the mitigation opportunities on the horizon. I'm just trying to get a better sense given your efforts to grow the core loan portfolio how we should be thinking about the trajectory in advanced RWAs, maybe excluding the upward adjustment tied to the regulatory guidance just to give us a sense as to what that trajectory should look like over the next couple of quarters? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [68] +-------------------------------------------------------------------------------- + + You make me the caveat that this assumes that we don't have a significant change one way in market conditions because obviously there's a part of Basel III that's somewhat pro cyclical. But I think net-net if we do a good job of managing this the way that we would expect to that absent any exogenous changes we should be able in the institutional business which is both Global Banking as well as sales and trading that we should be able to grow loans while at the same time have reductions in the overall risk-weighted assets that are attributed to that area. Now where you will probably see it be more dollar for dollar is obviously under standardized those loans tend to be every dollar of loan is a dollar of RWA so you have to be a little bit careful between which method you're looking at. + +-------------------------------------------------------------------------------- +Steven Chubak, Nomura Securities Co., Ltd. - Analyst [69] +-------------------------------------------------------------------------------- + + Okay. But presumably the focus at least on your part is going to be on mitigating the advanced RWAs given that that appears to be your longer-term binding constraint. + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [70] +-------------------------------------------------------------------------------- + + It's both because you're right, as it relates to a ratio pro forma for this it is the lower number. But keep in mind you have to keep the focus on standardized as well because at least based on last year's CCAR as well as guidance that's out there standardized is very important from a CCAR perspective. + +-------------------------------------------------------------------------------- +Steven Chubak, Nomura Securities Co., Ltd. - Analyst [71] +-------------------------------------------------------------------------------- + + No, understood. Okay and then actually it's a great transition to my next question on the topic of G-SIB surcharges where I'm sure you're aware there's been some discussion around the possibility of incorporating the surcharges within CCAR. And I was just hoping to get a better sense as to what contingency plans you might have in place if the surcharge were to be included and are there opportunities that you see to sufficiently mitigate the G-SIB indicators so that you could move into a lower bucket? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [72] +-------------------------------------------------------------------------------- + + A couple of things on that front. The first is as it relates to G-SIB, their application, where they may or may not be used, at this point while we participate in industry forums I think that the supervisory area has been very transparent and sharing much of the same things that they share with us you are also aware of. So I think that the information is fairly disseminated amongst everyone. +As it relates to contingency planning it's really an ongoing continuation of what we did from 2013 to 2014 which if you recall is related to our quantitative CCAR results in a timeframe where we didn't have significant levels of net income that our CCAR cushion grew significantly. So what are we doing to focus on that? On the investment portfolio we're mindful of managing OCI risk given that it flows through the overall CCAR process. +We continue to be very focused on moving out those loans and those assets that have higher loss content and at the same time making sure that the originations that we put on were of the highest quality. So we continue to focus on that. +If you look at the overall risk that's being taken within the markets business, we're managing that so that there's not a surprise as it relates to that. And clearly we continue to work hard to move out those exposures that have high loss content there. +So I think I would say it's really much more of a continuation of the work that we've been at for several years now. And we're mindful of making sure that we continue to push that stuff out at the same time that we're originating those things that we'll perform well as part of that overall exercise. + +-------------------------------------------------------------------------------- +Steven Chubak, Nomura Securities Co., Ltd. - Analyst [73] +-------------------------------------------------------------------------------- + + All right. Thanks Bruce. That detail is extremely helpful. +And then one more quick final one for me. I was hoping you can give us an update on where your TLAC ratio sit today? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [74] +-------------------------------------------------------------------------------- + + I think that the TLAC ratio as it relates to where we are and this assumes that we exclude stuff that's less than a year, I think the TLAC ratio is roughly 21% at this point, we'll have to see the deducts that come in and out of that based on G-SIB and other things. But I think we're just below 21% at the end of the quarter. + +-------------------------------------------------------------------------------- +Steven Chubak, Nomura Securities Co., Ltd. - Analyst [75] +-------------------------------------------------------------------------------- + + Okay, great. Thank you for taking my questions. + +-------------------------------------------------------------------------------- +Operator [76] +-------------------------------------------------------------------------------- + + Brennan Hawken, UBS. + +-------------------------------------------------------------------------------- +Brennan Hawken, UBS - Analyst [77] +-------------------------------------------------------------------------------- + + Good morning. Thanks for taking the question. +A quick one on Wealth Management. Is it possible for you to quantify for us how much of your total Wealth Management client assets are in retirement accounts and of that, what percentage are advisory? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman & CEO [78] +-------------------------------------------------------------------------------- + + We'll let Lee get back to you on that. I don't have that off the top of my head in terms of -- I just don't have that fact right in front of me. + +-------------------------------------------------------------------------------- +Brennan Hawken, UBS - Analyst [79] +-------------------------------------------------------------------------------- + + Okay. Just the whole idea there is trying to get at the DOL proposal and maybe what could be potential downside even based on how it all gets finalized understanding that it's preliminary at this point. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman & CEO [80] +-------------------------------------------------------------------------------- + + Yep, Lee can fill you in on that. + +-------------------------------------------------------------------------------- +Brennan Hawken, UBS - Analyst [81] +-------------------------------------------------------------------------------- + + Okay. And then looking at the branch declines that you guys referenced earlier should we count on the 5% year over year as a reasonable decline rate sustainable from here given the trends that you're seeing in your mobile platform? And could this potentially add additional juice to your expense declines beyond the business as usual type pushing that you've spent a lot of time talking about here on the call today? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman & CEO [82] +-------------------------------------------------------------------------------- + + So let's step back and make sure that we understand one thing is the idea here is we're moving because the customers are moving and how they conduct business. And so you've got to run your changes consistent with what they're doing. That's a baseline that you have to stick to because if you forget that you can overshoot or undershoot frankly and so that being said that's one point. +The second point is in the 6,100 branches that we had at the peak down to this level there were multiple things we were doing, customer behavior changes, change in the configuration of the markets we attack, etc., so there are lots of elements. So now we're now on a business as usual ongoing practice which will really be driven more by the customer behavior as opposed to some viewpoints we have about markets and arranging the franchise. +So I'd expect that they will continue to work themselves down and I wouldn't predict a steady rate because it's a very complex equation but then let's flip to what's really going on. As Bruce talked about earlier we have 17.6 million mobile users. We have 31 million bank computer banking users, that number is actually growing again. +For a while it was kind of flat, it's actually growing, so it's interesting that that's happening. 16% of all our sales are all digital now. About 6% of the sales of digital which is computers and mobile are mobile and that's growing at 300% so it's catching up. +And then you get things which are interesting because it goes to the efficiency of your branch. There are about 10,000 appointments scheduled in a mobile device a week at the branch which then allows us to have a more efficient branch structure. Even though we may have less we may have bigger branches because you have more sales going on in them. +So think about that, that's up from 2,000 last year, second quarter of 10,000 times a week now and growing at that rate implied there. People are scheduling appointments to come see us which is a lot better experience for us and then to help us to serve them. +So it allows us to have our staffing levels done. Bruce referenced the checks deposited are 13% of all the checks so the activity of all this is critical to that question. So I won't give you a 5% reduction or 4% reduction. +I think you can mathematically derive what we've done. But I'd be careful about assuming it will be that ratable but it will be more based in behavior change. But the key is our customer scores have gone up overall and even in the mobile channels we've gone up year over year 1,000 basis points in our mobile channel, top two box satisfaction. +So it will be a complex thing. It's an integrated pool of capabilities. Phones, online ATA and branches and you'd expect it to be pressure going down but remember we were early into this and if you think about 1,400 branches that's bigger than a lot of companies out there already out of the system. So we've been at this for a long time but we will do it the right way because if you push too hard you will upset the client. + +-------------------------------------------------------------------------------- +Brennan Hawken, UBS - Analyst [83] +-------------------------------------------------------------------------------- + + That's helpful color, Brian. Thanks. And then last one for me you made a reference earlier to a couple of points margin from the employee forgivable loan amortization dropping off next year. +Is next year a bump in the trend or is that indicative of potential further declines in forgivable loans as they continue to roll off? And does it assume some level of counter pressure offsetting pressure from continued recruiting? And maybe a little update on the recruiting environment for FAs would be helpful. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman & CEO [84] +-------------------------------------------------------------------------------- + + What I'm referencing is discrete away from the entire recruiting process. This is a -- was set up at the time of the transaction for a group of people at that time and it just came in over the years and it's not this last year it goes away. +The forgivable loan practice and all the other stuff in recruiting is a whole different thing. But for John in key banks and the teams they're successfully recruiting on the experience level the attritions for the top two quintile financial advisors is at an all-time low, I think again I think it's running at 2% or something like that. So we're retaining those and then we're recruiting at both the experienced level but importantly what is obvious to us is to drive the amount of client need here, drive against the client need which is huge and underserved in our belief. +We had to create more advisors than there are out there and so we've really worked hard on what they call the PMD program which is basically bringing people in the business who may have experience in other firms by bringing them into our firm and also other industries into our firm. And that is now reaping benefits to us given we've been working on it for two or three years to retool it and drive it. +So you should expect our advisor count to go up and our productivity may come down per advisor. But frankly there's a lot of business where remember our value predict is 1 million and so on so bringing it down a little bit to get a lot more growth, a lot more growth in advisors would not be -- would be a great trade for our Company. +So our recruiting is strong. We're net doing a decent job at the higher end that you hear a lot about, that is not a big part of the advisor count, several hundred a year, like in a couple 200, 300. +But what's going to drive our advisor and capabilities to serve our clients is the broader buildout of the teams which is the BFAs and the PMDs that work at the branches in some cases and work with people. And that should redound to our benefit over time although it will have a little drag on profitability right now because it's investment. + +-------------------------------------------------------------------------------- +Brennan Hawken, UBS - Analyst [85] +-------------------------------------------------------------------------------- + + Great, thanks for that. + +-------------------------------------------------------------------------------- +Operator [86] +-------------------------------------------------------------------------------- + + Marty Mosby, Vining Sparks. + +-------------------------------------------------------------------------------- +Marty Mosby, Vining Sparks - Analyst [87] +-------------------------------------------------------------------------------- + + Thank you. I wanted to ask about the asset liability management. +When you look at the market adjustments that you had of $669 million this quarter, as rates go up there is less and less impact from that. How much is remaining in the next 50 basis points in just the prepayment speed slowing down? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [88] +-------------------------------------------------------------------------------- + + I don't have 50 basis points, Marty, but the number we quoted was on a 100 basis point move the FAS 91 benefit would be $775 million. + +-------------------------------------------------------------------------------- +Marty Mosby, Vining Sparks - Analyst [89] +-------------------------------------------------------------------------------- + + Okay. Perfect. And then when you're talking about being able to see the margin go up in the back half of the year because of the current steepness of the yield curve does that include some utilization in the sense of increasing your securities portfolio while you invest some of the liquid assets you have on the balance sheet? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [90] +-------------------------------------------------------------------------------- + + There's clearly some of that because we would expect as we go forward with the composition of the balance sheet that there will be incremental cash that's generated. Obviously some of that goes into loan growth and some of it goes into the investment portfolio. So embedded in that those comments is an assumption that there will be a little bit more to be invested. + +-------------------------------------------------------------------------------- +Marty Mosby, Vining Sparks - Analyst [91] +-------------------------------------------------------------------------------- + + (multiple speakers) range $10 billion, $20 billion, $30 billion, any kind of rule of thumb there? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [92] +-------------------------------------------------------------------------------- + + I would think of it as on the low end of that during the third quarter and a comparable amount in the fourth. And there's one other thing that I did want to correct that I said earlier that if you look at the securities balances yield the stability that we saw once you adjust for FAS 91 was Q1 to Q2. + +-------------------------------------------------------------------------------- +Marty Mosby, Vining Sparks - Analyst [93] +-------------------------------------------------------------------------------- + + Got you. And lastly this is a nuance but when you look at the trading activity typically in the past when I had a trading activity in the bank that I was managing when you had a steepening of the yield curve you get some pickup because you're getting the current long-term yield funded by short-term rates. The rate on the trading activity account did not go up this quarter but averaging into the next quarter would you expect some benefit there? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [94] +-------------------------------------------------------------------------------- + + I think if you look at -- I think the important thing is that so that rate tends to manifest itself in the market based NII. There are a lot of things that drive that when rates move around as much as they have but I don't think there's any question that over time as you're in an increasing rate environment that there is a part of the yield component that flows through NII that you would expect to get a little bit better. + +-------------------------------------------------------------------------------- +Marty Mosby, Vining Sparks - Analyst [95] +-------------------------------------------------------------------------------- + + I'm just more focused on the steepness versus the flattening of the yield curve. A steeper yield curve typically brings a little better spread on the trading account? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman & CEO [96] +-------------------------------------------------------------------------------- + + It would but the question is it works its way through but if you look across long periods of time it's relatively constant. + +-------------------------------------------------------------------------------- +Marty Mosby, Vining Sparks - Analyst [97] +-------------------------------------------------------------------------------- + + Okay. Thanks. + +-------------------------------------------------------------------------------- +Operator [98] +-------------------------------------------------------------------------------- + + Nancy Bush, NAB Research. + +-------------------------------------------------------------------------------- +Nancy Bush, NAB Research - Analyst [99] +-------------------------------------------------------------------------------- + + Hi, good morning. Guys, just another liquidity issue. Could you just tell us what's on deposit, what excess deposits you've got with the Fed now and what your plans are for those going forward? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [100] +-------------------------------------------------------------------------------- + + At any one point in time it can move around but you should assume it's comfortably above $100 billion that's on the Fed in any one night during the quarter. And I think that when you look at where we are with LCR where we are at both the parent as well as the bank, that I think and $484 billion of overall liquidity which is a record that we feel we're in a reasonable place and I don't see significant changes going forward, Nancy. + +-------------------------------------------------------------------------------- +Nancy Bush, NAB Research - Analyst [101] +-------------------------------------------------------------------------------- + + Okay, you mean in overall liquidity or at liquidity on deposit with the Fed? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [102] +-------------------------------------------------------------------------------- + + Probably both. + +-------------------------------------------------------------------------------- +Nancy Bush, NAB Research - Analyst [103] +-------------------------------------------------------------------------------- + + Okay, that's a lot of liquidity. My second question, Brian is for you. +You've gone through a lot of change over the past few years and this transition to mobile, etc., etc., but one of the things I still get from talking to people are persistent gripes about service quality particularly in the mortgage company. Can you just tell us what your internal polling or whatever shows in terms of improvements in credit quality and how you feel about that entire subject? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman & CEO [104] +-------------------------------------------------------------------------------- + + In the mortgage business, for example the bank originators we're number one in JD Power survey and I think we're number two or three overall of all mortgage companies. So I think in terms of originating mortgage loans a guy name Steve Boland runs that for us has gotten that platform settled in and you'll get momentary spikes where the refis will bump up and things slow down. +From a get the loan done, from keeping our credit quality where we wanted that ends up with us having some noise around people who don't get mortgages. So we did $15 billion or whatever we did this quarter, 30% of those loans were moderate income so we're still serving that segment. But again we are not pushing for credit terms and mortgage and I think you'd understand why, Nancy. + +-------------------------------------------------------------------------------- +Nancy Bush, NAB Research - Analyst [105] +-------------------------------------------------------------------------------- + + But how about just more the issue of service quality at the branches, etc.? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman & CEO [106] +-------------------------------------------------------------------------------- + + Well, if you look at our customer scores continue to rise almost on a monthly basis and in the broadest context our brand and part of that is due to what happens at the branch. Part of it is also due to there's less stuff going on about the Company and that's gone from the low point in the fourth-quarter 2009 and has rose fairly steadily. So it's been in fact back to within 95% of where it was at it is highest point in 2005 and 2006. +So with that we're satisfied. And if you actually go to the customers who actually get served when we measure all the channels which we measure with tens of thousands of customers a week and a month you find that those scores continue to go up and the top two box score I think we're in the 70s to 80s of the various channels and including mortgage. +So because you just have a lot of customers you'll find out that once in a while we're bumping up in our jobs to fix something we do but if you think about it we've added mortgage production, checking accounts net new, credit cards and that's the ramification of good service and driving it and the team just continues to work on it. We're not perfect and we will always get better but I think if you look at it over the last three or four years it continues to get better. + +-------------------------------------------------------------------------------- +Nancy Bush, NAB Research - Analyst [107] +-------------------------------------------------------------------------------- + + All right. Thank you. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman & CEO [108] +-------------------------------------------------------------------------------- + + And by the way if you look at our deposit growth it continues to accelerate in over the top of the CDs continue to run off year over year of $10 billion. So we're up $31 billion in deposits and consumer year over year I think it has and CDs were probably down I don't know $10 billion or so. +So think about that if people didn't like us a lot they wouldn't be giving us their core checking account and that is happening more and more every quarter. And that will serve us well as rates change because we are a hugely primary focus checking account company in the broad mass-market business which is different than the past. + +-------------------------------------------------------------------------------- +Nancy Bush, NAB Research - Analyst [109] +-------------------------------------------------------------------------------- + + All right. Good to hear. Thank you. + +-------------------------------------------------------------------------------- +Operator [110] +-------------------------------------------------------------------------------- + + Mike Mayo, CLSA. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA - Analyst [111] +-------------------------------------------------------------------------------- + + Hi, I just wanted to follow up on Betsy's question at the start talking about expenses being at a run rate or maybe going lower. The expenses are down $400 million year over year but if you look at your four business lines the revenues are down twice that implying a lot of the rest is coming through the other line. So I guess I'm just wondering how much more there is to cut or should cut if the expenses are down again $400 million but the revenues in the four business lines are down $800 million? How do you balance that trade-off? + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [112] +-------------------------------------------------------------------------------- + + Yes, I think the first thing that you have to keep in mind, Mike, when you quote the numbers within the business is on a year-over-year basis you have two significant things happening. You've had FAS 91 in a significant movement in rates as it relates to push out of those charges as well as we push the LCR out to the businesses from a reported segment perspective that has a significant impact. +And so I think as we've gone through the presentation that the numbers that I would focus on are very much what's going on within the segments looking at the fee income line because there is activity from a net interest income perspective of greater activity within the businesses. So I'd be a little bit careful with that characterization and I think in that context I'd go back to Brian's initial comments which we continue to push hard, we're adding client facing personnel across the Company, at the same time we're reducing aggregate headcount and that's leading to declines in the expense numbers and we're very, very focused on continuing to keep that balance as we go forward. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA - Analyst [113] +-------------------------------------------------------------------------------- + + Okay. Just to understand because I'm just looking at your slides, slide 17 and the other slides in your presentation today, I looked at the four slides related to GWIM, Global Banking, Global Markets and Consumer Banking, I took second quarter of 2015 versus second quarter of 2014 and looked at the delta in revenues and that's how I got the $800 million decline. So you would say which adjustments should we make from that? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman & CEO [114] +-------------------------------------------------------------------------------- + + Don't take GWIM because I got that number off the top of my head Mike. I think year over year the difference in GWIM NII allocation due to sort of unfundamental things is Bruce how much of -- + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [115] +-------------------------------------------------------------------------------- + + Yes, let's just go through. Relative to the second quarter of 2014 you've got consumer from an overall NII impact was more than $200 million. GWIM was as Brian said roughly $130 million, overall Investment Bank, our Global Banking was a couple hundred million and then you have de minimis amounts within markets and LAS. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman & CEO [116] +-------------------------------------------------------------------------------- + + That is nothing more than us changing the allocation method, it's because of LCR and other things becoming important. So we pushed down the businesses to get the behavior of the businesses aligned with the parent. +So this is why you have to be a little careful about micro assessing these movements because things change in the methodology year over year and we don't go back and restate this. We didn't do it last year. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA - Analyst [117] +-------------------------------------------------------------------------------- + + Okay. I will follow up on that. So are you comfortable, are you satisfied with the revenue progression that you've had no matter how you take a look at it? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman & CEO [118] +-------------------------------------------------------------------------------- + + Mike, we are satisfied that we are starting to see the hard work of all our teammates come through but we're not satisfied in the sense that we expect better performance on both the revenue expense dynamic in the future. That's -- we'll keep working at it. +But if you look at it over the last several quarters what you've seen in stability in revenues but continue to work on expenses both in the dollars but also in the headcount. 15 straight quarters, 3,000 more personnel reductions per quarter is a pretty strong record to show that we're disciplined in workers. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA - Analyst [119] +-------------------------------------------------------------------------------- + + And then a separate question, I think it's the first time you've listed ROA and ROE on the first page of your press release. And should we read anything into that that we're more focused on achieving these targets with a specific timeframe or what changed? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman & CEO [120] +-------------------------------------------------------------------------------- + + It may be the pagination. It's been listed in our documents consistently. (Multiple speakers) focused on those goals and we've told you that each time you've asked the question. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA - Analyst [121] +-------------------------------------------------------------------------------- + + And then lastly just, I know I've asked this question before is there a specific timeframe that you can commit to to achieve your ROA and ROE goals? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman & CEO [122] +-------------------------------------------------------------------------------- + + Mike, as I told you at the Annual Meeting when you were there with a few other people and asking the questions on this question, we had the building blocks in place to get us to where we are and we can see the building blocks falling in place to get us to our goals. And there are external factors, the rate increase and stuff that you see in the market curve that's changed just in the last 15 days in this quarter and has moved around dramatically. But with our control of elements we continue to drive and we see the progression towards it over the next several quarters like we told you. + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [123] +-------------------------------------------------------------------------------- + + And I think, Mike, just to be clear we've talked about 100 basis points and 12% to 14% return on tangible common equity. Obviously at 99 basis points we're bumping right up against that. +And I think what's important is as you look to the path to what we've talked about we're basically there in the second quarter, you could say you had the $700 million in FAS 91, the $400 million of loan sale gains and a couple hundred million dollars from rep and warrant provisions. But what I think is interesting and as you look at the path there is if you look at and assume the 100 basis point parallel shift in the yield curve what that would mean in the quarter as well as if we ultimately get to where our LAS expense goals are you're basically back to all other things being equal where we were this quarter. So what was articulated is something where you couldn't see a path or a way to get there, I think it was a step forward this quarter as far as seeing how we can get there. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA - Analyst [124] +-------------------------------------------------------------------------------- + + All right. Thank you. + +-------------------------------------------------------------------------------- +Operator [125] +-------------------------------------------------------------------------------- + + Christopher Wheeler, Atlantic Equity. + +-------------------------------------------------------------------------------- +Christopher Wheeler, Atlantic Equity - Analyst [126] +-------------------------------------------------------------------------------- + + Yes, good morning gentlemen and I'm sorry to raise the subject of cost again. But I just want to square away what you said I think to Betsy's question at the very beginning to what you said at the conference back in May when you actually said that if trading revenues didn't pick up you'd have to adjust costs further. I just wondered where you were on that because obviously trading revenues were down about 2% year on year I think in the quarter and I'm having to assume that the start to the quarter has been pretty bumpy with Greece and China. +So could you just talk a little bit about how you see that? But perhaps also talk a little bit about how you might address that situation in global markets and global banking in respect of the US business and the international businesses? Because it is really clear that the US business seems to be offering more opportunities not just because they are more buoyant but also because you're seeing European banks play a lesser role. +And obviously seeing three of the big banks get new CEOs in the last few weeks I hardly imagine they are going to be allocating more capital to Investment Banking. Thank you. + +-------------------------------------------------------------------------------- +Bruce Thompson, Bank of America Corporation - CFO [127] +-------------------------------------------------------------------------------- + + Let me take a stab at a couple of parts of that question. The first is and I think you referenced that what would you do if global market expenses were lower on a go-forward basis? I think this quarter was reflective of the way you'd expect us to manage it which is the pure sales and trading number was down 2% and total expenses within the segment were down 5%. +So I think some of what Brian communicated inmate you saw evidence of that happening during the quarter. The second thing that I would say is that it's obviously earlier in the quarter but I wouldn't draw any conclusions as to overall performance based on the volatility that we've seen during the first couple of weeks to the negative. +And then third I think your question was and is just that with what's going on within some of the European banks as well as changes in management and questions around capital, how does that translate and what are you seeing in the US business? I think what I would say is that we obviously have significant share in the US business. We're looking to do a better job of that and I think that as you look at some of the loan growth that we've seen that it is reflective of the fact that we're deepening in the US but just as importantly that loan growth is not only in the US, it's throughout Europe. +There's been a little bit in Latin America and there's been growth in Asia-Pac. So we are looking to use some of these market opportunities as a basis to deepen and look to grow the overall global banking segment. + +-------------------------------------------------------------------------------- +Christopher Wheeler, Atlantic Equity - Analyst [128] +-------------------------------------------------------------------------------- + + Thanks very much. Thank you. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman & CEO [129] +-------------------------------------------------------------------------------- + + Well thank you everyone. That's the last question. We look forward to talking to you next quarter. + +-------------------------------------------------------------------------------- +Operator [130] +-------------------------------------------------------------------------------- + + This does conclude today's program. You may now disconnect at any time. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/exam/original-files/Problem_1_Sample/2015-Jul-23-AMZN.OQ-140462931809-Transcript.txt b/exam/original-files/Problem_1_Sample/2015-Jul-23-AMZN.OQ-140462931809-Transcript.txt new file mode 100644 index 0000000..49f9b01 --- /dev/null +++ b/exam/original-files/Problem_1_Sample/2015-Jul-23-AMZN.OQ-140462931809-Transcript.txt @@ -0,0 +1,676 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q2 2015 Amazon.com Inc Earnings Call +07/23/2015 05:00 PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Brian Olsavsky + Amazon.com, Inc. - CFO + * Phil Hardin + Amazon.com, Inc. - Director of IR + +================================================================================ +Conference Call Participiants +================================================================================ + + * Scott Tilghman + B. Riley Caris - Analyst + * Stephen Ju + Credit Suisse - Analyst + * Kerry Rice + Needham & Company - Analyst + * Justin Post + BofA Merrill Lynch - Analyst + * Ron Josey + JMP Securities - Analyst + * Brian Pitz + Jefferies LLC - Analyst + * Douglas Anmuth + JPMorgan - Analyst + * Youssef Squali + Cantor Fitzgerald - Analyst + * Gene Munster + Piper Jaffray & Co. - Analyst + * John Blackledge + Cowen and Company - Analyst + * Heath Terry + Goldman Sachs - Analyst + * Paul Vogel + Barclays Capital - Analyst + * Eric Sheridan + UBS - Analyst + * Colin Sebastian + Robert W. Baird & Company, Inc. - Analyst + * Mark Mahaney + RBC Capital Markets - Analyst + * Brian Nowak + Nomura Securities Intl - Analyst + * Ross Sandler + Deutsche Bank - Analyst + * Mark May + Citigroup - Analyst + * Carlos Kirjner + Bernstein - Analyst + +================================================================================ +Presentation +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Greetings. Thank you for standing by. Good day, everyone, and welcome to the Amazon.com Q2 2015 financial results teleconference. At this time, all participants are in a listen-only mode. +After the presentation, we will conduct a question-and-answer session. Today's call is being recorded. For opening remarks I will be turning the call over to the Director of Investor Relations, Phil Hardin. Please go ahead. + +-------------------------------------------------------------------------------- +Phil Hardin, Amazon.com, Inc. - Director of IR [2] +-------------------------------------------------------------------------------- + + Hello. And welcome to our Q2 2015 financial results conference call. Joining us today is Brian Olsavsky, our CFO. We will be available for questions after our prepared remarks. +The following discussion and responses to your questions reflect management's view as of today, July 23, 2015 only, and will include forward-looking statements. Actual results may differ materially. Additional information about factors that could potentially impact our financial results is included in today's press release and our filings with the SEC including our most recent annual report on Form 10-K. +As you listen to today's conference call, we encourage you to have our press release in front of you, which includes our financial results as well as metrics and commentary on the quarter. During this call we will discuss certain non-GAAP financial measures. In our press release, slides accompanying this webcast and our filings with the SEC, each of which is posted on our IR website, you will find additional disclosures regarding these non-GAAP measures including reconciliations of these measures with comparable GAAP measures. Finally, unless otherwise stated, all comparisons in this call will be against our results for the comparable period of 2014. +Now I'll turn the call over to Brian. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com, Inc. - CFO [3] +-------------------------------------------------------------------------------- + + Thanks, Phil. I'll begin with comments on our second quarter financial results. +Trailing 12 month operating cash flow increased 69% to $8.98 billion. Trailing 12 month free cash flow increased to $4.37 billion, up from $1.04 billion. In the supplemental financial information and business metrics portion of our earnings release, we include a few additional free cash flow measures. We believe these measures provide additional perspective on the impact of acquiring property and equipment with cash and through capital and finance leases. +Trailing 12 month capital expenditures were $4.61 billion. Capital expenditures do not include the impact of property and equipment acquired under capital and finance lease obligations. The increase in capital expenditures and capital leases reflects additional investments in support of continued business growth due to investments in technology infrastructure, the majority of which is to support AWS, and additional capacity to support our fulfillment operations. +Return on invested capital was 17%, up from 6%. ROIC is trailing 12 month free cash flow divided by average total assets, minus current liabilities, excluding the current portion of long-term debt over five quarter ends. +Combination of common stock and stock based awards outstanding was 488 million shares, compared with 480 million one year ago. Worldwide revenue grew 20% to $23.18 billion, or 27% excluding the $1.39 billion unfavorable impact from year-over-year changes in foreign exchange. Worldwide paid unit growth was 22%. +Worldwide active customer counts was approximately 285 million, excluding customers who only had free orders in the preceding 12 month period, worldwide active customers were approximately 265 million, up from approximately 237 million in the comparable prior year period. Worldwide seller units represented 45% of paid units, up from 41% in the comparable prior year period. +Now I'll discuss operating expenses excluding stock-based compensation. Cost of sales was $15.16 billion or 65.4% of revenue, compared with 69.3%. Fulfillment, marketing, technology and content and G&A combined was $6.95 billion or 29.9% of sales, up approximately 130 basis points year-over-year. Fulfillment was $2.74 billion or 11.8% of revenue compared with 11.8%. Tech and content was $2.70 billion or 11.7% of revenue compared with 10.4%. Marketing was $1.1 billion or 4.7% of revenue compared with 4.7%. +Now I'll talk about our segment results. As a reminder, in the first quarter we changed our reportable segments to report North America, International and Amazon Web Services. Consistent with prior periods, we do not allocate to segments our stock-based compensation or the other operating expense line item. +In the North America segment, revenue grew 26% to $13.8 billion. Media revenue grew 6% to $2.62 billion or 7% excluding foreign exchange. EGM revenue grew 31% to $10.99 billion or 32% excluding foreign exchange. EGM now represents 80% of North America revenues. North America segment operating income increased 113% to $703 million, a 5.1% operating margin. Excluding the $9 million favorable impact from foreign exchange, North America segment operating income increased 111%. +In the International segment, revenue increased 3% to $7.56 billion. Excluding the $1.37 billion year-over-year unfavorable impact from foreign exchange, revenue growth was 22%. Media revenue decreased 12% to $2.09 billion or increased 3% excluding foreign exchange. EGM revenue grew 10% to $5.43 billion or 31% excluding foreign exchange. EGM now represents 72% of International revenues. +International segment operating loss was $19 million compared to a loss of $2 million in the prior year period. International segment operating loss includes $89 million of unfavorable impact from foreign exchange. +In the Amazon Web Services segment, revenue increased 81% to $1.82 billion. Amazon Web Services segment operating income increased 407% to $391 million, a 21.4% operating margin. Excluding the $71 million favorable impact from foreign exchange, AWS segment operating income increased 314%. Consolidated segment operating income increased 166% to $1.07 billion or 4.6% of revenue, up approximately 250 basis points year-over-year. +Excluding the $9 million unfavorable impact from foreign exchange, CSOI increased 168%. Unlike CSOI, our GAAP operating income includes stock-based compensation expense and other operating expense. GAAP operating income was $464 million compared to a loss of $15 million in the prior year period. +Our income tax expense was $266 million. GAAP net income was $92 million or $0.19 per diluted share, compared with a net loss of $126 million or a loss of $0.27 per diluted share. +Turning to the balance sheet. Cash and marketable securities increased $6.02 billion year-over-year to $14 billion. Inventory increased 12% to $7.47 billion, and inventory turns were 8.9, down from 9.1 turns a year ago, as we expanded selection, improved in-stock levels and introduced new product categories. Accounts payable increased 18% to $12.39 billion, and accounts payable days increased to 74 from 71 in the prior year. +I'll conclude my portion of today's call with guidance. Incorporated into our guidance are the order trends that we've seen to date and what we believe today to be appropriately conservative assumptions. Our results are inherently unpredictable and may be materially affected by many factors including a high level of uncertainty surrounding exchange rate fluctuations as well as the global economy and customer spending. It's not possible to accurately predict demand and therefore our actual results could differ materially from our guidance. +As we describe in more detail in our public filings, issues such a settling intercompany balances and foreign currencies among our subsidiaries, unfavorable resolution of legal matters and changes to our effective tax rate can all have a material effect on guidance. Our guidance further assumes that we don't conclude any additional business acquisitions, investments, restructurings or legal settlements, record any further revisions to stock-based compensation estimates and if foreign exchange rates remain approximately where they've been recently. +For Q3 2015, we expect net sales of between $23.3 billion and $25.5 billion, or growth of between 13% and 24%. This guidance anticipates approximately 620 basis points of unfavorable impact from foreign exchange rates. GAAP operating income or loss to be between a $480 million loss and $70 million of income, compared to a $544 million loss in the third quarter of 2014. This includes approximately $580 million for stock-based compensation and amortization of intangible assets. +We anticipate consolidated segment operating income, which excludes stock-based compensation and other operating expense, to be between $100 million and $650 million, compared to a $136 million loss in the third quarter of 2014. We remain heads down focused on driving a better customer experience through price, selection and convenience. We believe putting customers first is the only reliable way to create lasting value for shareholders. +Thanks, and with that, Phil, let's move on to questions. + +-------------------------------------------------------------------------------- +Phil Hardin, Amazon.com, Inc. - Director of IR [4] +-------------------------------------------------------------------------------- + + Great. Thanks, Brian. Let's move on to the Q&A portion of the call. Operator, will you please remind our listeners how to initiate a question? + + +================================================================================ +Questions and Answers +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) +Our first question comes from Mark May with Citi. Please proceed. Your line is live. + +-------------------------------------------------------------------------------- +Mark May, Citigroup - Analyst [2] +-------------------------------------------------------------------------------- + + Thanks for taking my questions. Clearly a lot of things that were working well in the quarter, but maybe just focusing in on AWS which is -- seems to be quickly emerging as your largest contributor to operating income. Can you maybe provide a little more color on what drove the acceleration and just the overall growth in the business, if you could talk a little bit about the addition of new customers versus average spend per customer and I think in the past you've talked about what unit growth was for AWS? +And then in the press release you talked about expanding AWS into some new International markets. Can you give us a feel for how much of AWS's business today is domestic and what kind of opportunity you have there to expand AWS outside the US. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com, Inc. - CFO [3] +-------------------------------------------------------------------------------- + + Yes, Mark. Thanks for your question. +So we will not be providing the granular customer detail, unfortunately, but I will say the growth of 81% was up from 49% in Q1. You'll remember that we're lapping a number of large price decreases in Q2 of last year, so it was somewhat expected, but a very strong quarter in AWS. We did open a region in India + +-------------------------------------------------------------------------------- +Phil Hardin, Amazon.com, Inc. - Director of IR [4] +-------------------------------------------------------------------------------- + + We've announced a region in India. +The other thing to mention is just we continue to see really strong usage growth. It's outpacing the revenue growth of 81%, obviously. And so we're really excited about it. +From a distribution of customers, it is a global business. We have regions spread throughout the world. We've got 11 regions at this point and have announced plans to launch a region in India in the future. + +-------------------------------------------------------------------------------- +Operator [5] +-------------------------------------------------------------------------------- + + Our next question comes from Eric Sheridan with UBS. Please proceed. Your line is live. + +-------------------------------------------------------------------------------- +Eric Sheridan, UBS - Analyst [6] +-------------------------------------------------------------------------------- + + Great. Thank you for taking the question. There's been some recent press reports talking about investments in India. Wanted to know, you've talked a little bit about that market in the past, whether there was any update there in terms of how you're thinking about approaching that market and the level of investments that might be needed to compete in the market. Thank you. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com, Inc. - CFO [7] +-------------------------------------------------------------------------------- + + Certainly, Eric. What I could say about India is that when we say a positive surprise, we double down on it. That's kind of our policy. India is that kind of surprise. +We're very happy, very encouraged early on with what we've seen, the ramping of the business, the level of invention going on for both customers and sellers. We're over 25 million ASINs, which is the largest online store in India, and continue to improve pricing and fast delivery. +So we're super excited about India. I will not get into specific investment levels right now, but we continue to ramp up our investment there. + +-------------------------------------------------------------------------------- +Eric Sheridan, UBS - Analyst [8] +-------------------------------------------------------------------------------- + + Thanks so much. + +-------------------------------------------------------------------------------- +Operator [9] +-------------------------------------------------------------------------------- + + Our next question comes from Justin Post with Merrill Lynch. + +-------------------------------------------------------------------------------- +Justin Post, BofA Merrill Lynch - Analyst [10] +-------------------------------------------------------------------------------- + + Thank you. A couple questions. We follow this coming for a long time and profits seem to move around quite a bit year-over-year and year against year. Just wondering how you think about that? Is that just the nature of your big bets and that's just going to continue or is there a way to smooth that out? +And secondly, in AWS, it does seem like pricing competition has come down and we've been to a lot of your events and it seems like you're emphasizing pricing a little less to your customers. Can you talk at all about the pricing environment in cloud? Thank you. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com, Inc. - CFO [11] +-------------------------------------------------------------------------------- + + Sure. Let me start with that second question. So as Phil mentioned, we're seeing continued increases in usage, both sequentially and year-over-year. We're also seeing great efficiency in the business on a cost basis. Innovation is accelerating, not decelerating. We had over 350 significant new features and services and we believe that's what's resonates with customers. +Pricing is certainly a factor. We don't believe it's always the primary factor. In fact, what we hear from our customers is that the ability to move faster and more agilely is what they value. +I'm sorry, the first part of your question was? + +-------------------------------------------------------------------------------- +Justin Post, BofA Merrill Lynch - Analyst [12] +-------------------------------------------------------------------------------- + + I was asking about just how the profitability really moves, pretty big swings year-over-year. Is that the nature of your just big bets and that can continue or is there a way to smooth that out going forward? How do you think about that? + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com, Inc. - CFO [13] +-------------------------------------------------------------------------------- + + Sure. Well, here's how I think about it. We have two things, at least two things going on. We're continuing to drive operational improvement in every business that we're in. But we're also investing in large opportunities that are in front of us, particularly in Marketplace, Prime and AWS. +If you saw our shareholder letter this year, I think Jeff Bezos put it really well. He said we're going to look for things that are important to customers, customers love them, businesses that can grow to be a large size, that can generate a high return on invested capital and are durable and can last for decades. We will continue to invest in the businesses that we think fit that profile, and we're always looking for a fourth or fifth business that fits that profile. +As far as lumpiness, admittedly it is lumpy and we will continue to work on both those tracks going forward. + +-------------------------------------------------------------------------------- +Justin Post, BofA Merrill Lynch - Analyst [14] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Operator [15] +-------------------------------------------------------------------------------- + + Our next question comes from Mark Mahaney with RBC Capital Markets. + +-------------------------------------------------------------------------------- +Mark Mahaney, RBC Capital Markets - Analyst [16] +-------------------------------------------------------------------------------- + + Okay. Thanks. I don't know if Tom's listening in. That's a great exit on his part. +On International retail, you had nice acceleration there. Could you give us a little bit more of the why behind that? Why would international revenue growth, particularly in EGM, accelerate pretty materially? Is that the impact of the buildup of Prime in international markets, and also in the US, too, but more spend per Prime customer as they go through this evolution that's just layering on? Is that what it is? What is causing that acceleration? Thank you. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com, Inc. - CFO [17] +-------------------------------------------------------------------------------- + + Certainly. We saw good acceleration in both North America and international this quarter. North America was up 200 basis points sequentially and international was up 800 basis points. And half of that you'll remember we've spoken about the impact of the Japanese consumption tax that was instituted last April 1 of 2014. +It had a measurable impact on our run rate, our growth rate, last year, particularly in Q2. And so we're lapping that, which sequentially makes up half of the 800 basis point sequential gain. But independent of that, yes, you're right, Prime membership continues to grow. +Faster outside -- data we gave you at the end of the year, it's growing faster outside the US than it is in the US. We're happy with both growth rates, quite frankly. I would say the Prime membership to Prime Flywheel, the additional benefits we're adding to Prime, not only in North America but also internationally, and additional selection, both retail and FBA which feeds the Prime Flywheel. + +-------------------------------------------------------------------------------- +Mark Mahaney, RBC Capital Markets - Analyst [18] +-------------------------------------------------------------------------------- + + Okay. Thanks a lot. + +-------------------------------------------------------------------------------- +Operator [19] +-------------------------------------------------------------------------------- + + Our next question comes from Brian Nowak with Morgan Stanley. + +-------------------------------------------------------------------------------- +Brian Nowak, Nomura Securities Intl - Analyst [20] +-------------------------------------------------------------------------------- + + Great. Thanks for taking my questions. I have two. +The first one on the North America retail profitability was up nicely. Can you just talk to some of the drivers of that? Is it more top line and more Prime subs coming on, or is it more on the logistics side and what's driving the North America improving profitability? +And then the international profitability, is there any way you can help us understand the profitability of the more mature international markets like UK and Germany relative to the US at this point? + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com, Inc. - CFO [21] +-------------------------------------------------------------------------------- + + Sure. So let me start with North America. 5.1% operating margin was up from 3.9% in Q1 and 3% last Q2. You hit a nail on the head. A lot of it is the top line growth, but it's also a lot of the efficiency we're seeing, particularly on the fulfillment and marketing lines, which for the whole Company were flat year-over-year on a percent of revenue basis. +So we are getting very good top line growth, a lot of that is fueled by Prime, Prime adoption, and we are dropping a lot of it to the bottom line with many of the efficiency projects. In international we had not split countries out. What I can say is that if you adjust for foreign exchange, the operating margin is up slightly both sequentially and year-over-year. What you're seeing there is obviously colored by our investment, our increased investment in India based on the momentum and success we've been seeing there so far. + +-------------------------------------------------------------------------------- +Brian Nowak, Nomura Securities Intl - Analyst [22] +-------------------------------------------------------------------------------- + + Okay. Great. Thanks. + +-------------------------------------------------------------------------------- +Operator [23] +-------------------------------------------------------------------------------- + + Our next question comes from Douglas Anmuth with JPMorgan. + +-------------------------------------------------------------------------------- +Douglas Anmuth, JPMorgan - Analyst [24] +-------------------------------------------------------------------------------- + + Great. Thanks for taking the question. Just two things I wanted to ask. First on Prime Day, Brian, if you could give a little more color there on the early take-aways that you have, and also more importantly how you think that sets Amazon up for the back-to-school season and also the holidays later in the year? +And then also can you just comment on the headcount, which I believe is up 18,000 or so sequentially, which I believe is the biggest number that you've ever added in a quarter? Is there anything in particular that stands out there or just more fulfillment centers, more geography expansion as well? Thanks. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com, Inc. - CFO [25] +-------------------------------------------------------------------------------- + + Let me start with that second question first. Yes, headcount was up 38% year-over-year. The vast majority of that is in operations where we're adding people for our new FCs and call centers. We continue to look for smart, innovative people who want to build on behalf of customers and so we are -- but this particular quarter is colored a bit by the operations growth. +If you look at Prime Day, we're thrilled with the results of Prime Day. Surpassed all of our expectations. Any metric we look at, we think it was a huge success. Customers saved millions. New Prime members signed up at higher rates than we've ever seen. People bought more devices than on any other day. So it's a great success. +My hat's off to the operations team and all the people who worked on that because it was a Christmas in July, quite frankly. Bigger day than Black Friday as we've said and orders increased 266% year-over-year. I'll also point out that worldwide FBA unit order growth approached 300%. Not only was it a great day for Amazon, it was also a great day for our sellers, which was great. So while not breaking out the impact of Prime Day specifically, it's incorporated into our guidance. + +-------------------------------------------------------------------------------- +Operator [26] +-------------------------------------------------------------------------------- + + Our next question comes from Carlos Kirjner with Bernstein. + +-------------------------------------------------------------------------------- +Carlos Kirjner, Bernstein - Analyst [27] +-------------------------------------------------------------------------------- + + Hi. Thanks for taking my questions. I have two. I may be delusional, but if I add your capital leases and CapEx that suggests that AWS capital (inaudible) is at least 80% if not much higher. What gives you confidence that if AWS continues to grow so fast and consuming so much capital, two years out you'll be able to fund its growth from the retail business? And secondly, can you help me understand why you are not rolling out Prime Now and Fresh faster? What specifically are the bottlenecks there? Thank you. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com, Inc. - CFO [28] +-------------------------------------------------------------------------------- + + Let me start with that second one. Prime Now you said and Amazon Fresh. We are moving very quickly on Prime Now. We've now expanded to nine cities, three more in the quarter, including our first international city in London. So we're moving quick. But we would always like to move quicker, obviously. +On AWS, I think your question's more around the ability to fund AWS. No comments specifically on that. We do realize it's a capital intensive business and we have modeling that shows that it's going to be a very -- it is a very good business for us and that's what we aim for is long-term return on invested capital and free cash flow. +So we're certainly cognizant of the capital part of that calculation. So not much more I can add on that, Carlos. + +-------------------------------------------------------------------------------- +Carlos Kirjner, Bernstein - Analyst [29] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Operator [30] +-------------------------------------------------------------------------------- + + Our next question comes from Heath Terry with Goldman Sachs. Please proceed. + +-------------------------------------------------------------------------------- +Heath Terry, Goldman Sachs - Analyst [31] +-------------------------------------------------------------------------------- + + Great. Thanks, guys. Wondering if you can touch a little bit more on AWS margins? Is there a level, particularly when you've been able to maintain pricing strength the way that you have been, where you feel like margins start to become and the leverage that you have there starts to become a catalyst for lowering prices or is that purely a competitive decision? And as you think about AWS longer term, is there a framework or structure that you use to think about where margins in that business should be? + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com, Inc. - CFO [32] +-------------------------------------------------------------------------------- + + Sure. Thanks for your question, Heath. Yes, I'll point out that we have continued to lower prices. We've had multiple price cuts this year. We're now up to 49 since launch in 2006. So it is a fundamental part of our business model. So is innovation. And as I said, we have over 350 new features and services that have also significant features and services that have launched this year. +As we were just talking with Carlos, the capital investment is very large as well. So we continue to fund it and we're super excited with customer reception that we're getting and the feedback we get from large customers and so we're thrilled with the business and price reductions are part of that model. And again, as I said earlier, we're in the long haul, in this for the long haul. We are looking for return on invested capital, free cash flow and happy customers in this space. + +-------------------------------------------------------------------------------- +Heath Terry, Goldman Sachs - Analyst [33] +-------------------------------------------------------------------------------- + + Great. Thanks. Really appreciate it. + +-------------------------------------------------------------------------------- +Operator [34] +-------------------------------------------------------------------------------- + + Our next question comes from Youssef Squali with Cantor Fitzgerald. + +-------------------------------------------------------------------------------- +Youssef Squali, Cantor Fitzgerald - Analyst [35] +-------------------------------------------------------------------------------- + + Thank you. I guess another question on AWS, if I may? So want to go back to something that you said, Brian. You said that you've seen greater efficiency in that business from a cost standpoint. I was wondering if you could maybe parse that out a little more for us? Were you referring to OpEx or CapEx? +And if you're referring to CapEx as well, have you -- do you feel that you've reached that escape velocity that should allow CapEx as a percentage of revenues, pricing aside, to now allow you for constant decline in that metric? CapEx as a percentage of revenue for that particular business? Thanks. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com, Inc. - CFO [36] +-------------------------------------------------------------------------------- + + Yes, what I can tell you is we have seen great efficiency on the cost side. The cost to generate the capacity for AWS. I'll also say that Amazon is one of the primary large customers of AWS, so we see it on the consumer side of the business as well, although that's not included in AWS revenue. It's in intercompany relationship. So we get a double whammy there. We're getting great efficiency from our external AWS business, but also from our own use of AWS services. + +-------------------------------------------------------------------------------- +Youssef Squali, Cantor Fitzgerald - Analyst [37] +-------------------------------------------------------------------------------- + + Okay. Thanks. + +-------------------------------------------------------------------------------- +Operator [38] +-------------------------------------------------------------------------------- + + Your next question comes from Ron Josey with JMP Securities. + +-------------------------------------------------------------------------------- +Ron Josey, JMP Securities - Analyst [39] +-------------------------------------------------------------------------------- + + Thanks for taking the questions. Just a quick follow-up on Heath's question on the price reductions, Brian, you said earlier in the year. Can you just compare maybe the reductions earlier this year, versus the ones across the board from last year and 2Q 2014? +And a follow-up just on the third party units. I think you mentioned third party units are now 45% or maybe 47% of total units. Is there a natural limit there or does it matter as long as the customer experience through FBA is seamless. Thank you. + +-------------------------------------------------------------------------------- +Phil Hardin, Amazon.com, Inc. - Director of IR [40] +-------------------------------------------------------------------------------- + + I'll comment on the units first. We're really following the model of giving our customers as many choices as possible and letting them choose whether they want to buy first party or third party. I think we're working really hard to make sellers succeed on the platform. Brian touched on the success that our FBA sellers had with Prime Day. We see FBA as a tailwind for the third party business in general. +When we surveyed those sellers in the past, in 2014 about 71% of sellers saw a 20% or greater increase in sales when they entered the FBA program. So we're really happy with what that's doing for third party business. We're working really hard to give customers as many option as possible and allowing them to choose. We don't really have a specific target there. It all comes down to customer choice. +On the price reduction question, we've got a long track record of driving cost out of the business. And you can certainly see where we've even done that over the last several quarters if you look at the margins in AWS. We've also lowered prices for customers 49 times since launch and so it can be lumpy but over the long haul that's the model we followed. + +-------------------------------------------------------------------------------- +Ron Josey, JMP Securities - Analyst [41] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Operator [42] +-------------------------------------------------------------------------------- + + Our next question is from Paul Vogel with Barclays Capital. + +-------------------------------------------------------------------------------- +Paul Vogel, Barclays Capital - Analyst [43] +-------------------------------------------------------------------------------- + + Great. Thank you. Just a question on the content side. Any update on how engaged folks are, the video side of Prime, and their shopping behavior number one? Number two, any update on your plans for growth on the content cost side? Thank you. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com, Inc. - CFO [44] +-------------------------------------------------------------------------------- + + Sure. On the engagement of Prime customers, excuse me, PIV customers, we've seen buying habits that look like normal Prime customers or other Prime customers from the group that comes in through the digital pipelines. We also see a higher pick-up in retention rates and free trial conversions. So we're very happy with the linkage between our digital offerings and the Prime customer base. +On the content side, I will say that one of the factors in the sequential guidance, Q2 to Q3 being lower is two things. What we're talking about is the fulfillment center, additional fulfillment center cost we see this time every year as we get ready for Q4, but also additional step-up in content spend where we spend a lot of our content in Q3. You'll see extensions of a lot of the successful shows that we've had so far this year, a new pilot season including Man in the High Castle and Hand of God, so stay tuned for that. + +-------------------------------------------------------------------------------- +Phil Hardin, Amazon.com, Inc. - Director of IR [45] +-------------------------------------------------------------------------------- + + Or seasons of Man in the High Castle and Hand of God. + +-------------------------------------------------------------------------------- +Paul Vogel, Barclays Capital - Analyst [46] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Operator [47] +-------------------------------------------------------------------------------- + + Our next question comes from Gene Munster with Piper Jaffray. + +-------------------------------------------------------------------------------- +Gene Munster, Piper Jaffray & Co. - Analyst [48] +-------------------------------------------------------------------------------- + + Good afternoon and congratulations. Just want to follow up on a previous question. In past calls you talked about an increased focus on productivity. Is that still a focus of yours? And separately, any thoughts in terms of how robotics are impacting, any updates in terms of number of robots in fulfillment centers? Thanks. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com, Inc. - CFO [49] +-------------------------------------------------------------------------------- + + Sure. Thanks for your questions, Gene. On robotics first, we don't have any new numbers to share with you, but we're super excited with the progress of that business. We had very high expectations for Amazon robotics and its impact on our warehouse cost structure and we've been very pleasantly surprised by the job being done by that team. That's looking great. +Efficiency, yes, as we talked about in the last few calls we have more emphasis on variable and fixed productivity. I think that's evident in the Q2 results that you've just seen. To give you a little more color on that, I would say what does that look like. Defect reduction and process improvements are probably something we've always done and worked on, both to lower our cost but also improve the customer experience and also the seller and vendor experience. +We're using software and algorithms to make decisions rather than people which we think is more efficient and scales better and will be more accurate, especially as we insert machine learning into those decisions. As I said earlier, we benefit from the efficiency gains of the AWS business as on the Amazon side as well. We look to increase the leverage of our fixed assets, particularly our fulfillment centers and throughput of the fulfillment centers and just generally getting inventory closer to customers as we add and expand warehouses and the sort centers that we added primarily last year. All have helped our cost structure. +So just a little more color on maybe some specifics on the efficiency area. + +-------------------------------------------------------------------------------- +Gene Munster, Piper Jaffray & Co. - Analyst [50] +-------------------------------------------------------------------------------- + + Great. Thank you. + +-------------------------------------------------------------------------------- +Operator [51] +-------------------------------------------------------------------------------- + + Our next question comes from Brian Pitz with Jeffries & Company. + +-------------------------------------------------------------------------------- +Brian Pitz, Jefferies LLC - Analyst [52] +-------------------------------------------------------------------------------- + + Great. Thanks. You now halfway through 2015, any update or insights on your fulfillment center buildout plans for the year? If you can't disclose that, can you maybe just give us a general sense of focus and strategy, how should we be thinking about domestic versus international, as well as sortation versus traditional? What's kind of the path to build out over the next 6, 12, 18 months? Thanks. + +-------------------------------------------------------------------------------- +Phil Hardin, Amazon.com, Inc. - Director of IR [53] +-------------------------------------------------------------------------------- + + Sure. So we ended the year last year with 109 fulfillment centers around the world and 19 US sort centers. Typically, we're looking at what the demand would be for peak as we figure out what we need. Still a little early in the year to comment on that. +In the past we've given an update sometime around Q3 on that. Continuing to build as we have demand and like, Brian said, we like to be close to customers and benefit from having inventory close to customers as well. So like I said, a little early for the update at this point, but something that we're looking at and something the team's working really hard on. + +-------------------------------------------------------------------------------- +Brian Pitz, Jefferies LLC - Analyst [54] +-------------------------------------------------------------------------------- + + Great. Thanks. + +-------------------------------------------------------------------------------- +Operator [55] +-------------------------------------------------------------------------------- + + Our next question is from Colin Sebastian with Baird equity research. + +-------------------------------------------------------------------------------- +Colin Sebastian, Robert W. Baird & Company, Inc. - Analyst [56] +-------------------------------------------------------------------------------- + + Thanks. Congrats on the great quarter. In the retail business obviously a lot of variables driving growth there. You're seeing higher Prime membership levels for one, but I wonder how much of that growth you can also break down by some other factors, for example, we're seeing a notable increase in selection across longer-tail categories? +And then secondly, in the press release no mention of Fire phone. I think almost every other product was mentioned. Can we just chalk that one up now to a learning experience and an example of where Amazon is showing some discipline around investments, or how should we think about that? Thanks. + +-------------------------------------------------------------------------------- +Phil Hardin, Amazon.com, Inc. - Director of IR [57] +-------------------------------------------------------------------------------- + + So I'll start with the Fire phone question. We have a policy of not commenting on our roadmap, so can't give you anything there. We obviously do learn from everything we do and value the feedback we get from customers. But nothing to share at this point. +In terms of growth, we continue to see selection as a strong driver of growth. Prime is obviously very important as well. We really haven't teased those apart. FBA becomes very important as well. We've talked about some of the tailwinds we see there and sort of the linkage between Marketplace and Prime that FBA provides. +All those things are going on. As you see in EGM, strength across a lot of the categories there. There was no single category we're really calling out, but continue to see good selection growth and good Prime growth as well. + +-------------------------------------------------------------------------------- +Colin Sebastian, Robert W. Baird & Company, Inc. - Analyst [58] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Operator [59] +-------------------------------------------------------------------------------- + + Our next question is from Ross Sandler with Deutsche Bank. + +-------------------------------------------------------------------------------- +Ross Sandler, Deutsche Bank - Analyst [60] +-------------------------------------------------------------------------------- + + Thanks, guys. So Brian, I know you guys don't like to provide guidance beyond the next quarter, but philosophically if we go back a few quarters, you've characterized 2015 as a year where you believe that some of the heavier investments made in prior years should start to benefit and pay off and we're clearly seeing that in AWS and in North America retail. And it looks like you're still investing heavily on international retail. +If we look out 2016, 2017, is there any high level philosophical commentary about whether you see next year as another year of these types of trends that you're seeing now, or are there any bigger investment areas, particularly in the retail business that you might be looking to take advantage of? + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com, Inc. - CFO [61] +-------------------------------------------------------------------------------- + + Thanks for your question. I can't forecast into the future on that, but I will reiterate the investments we have going on right now, which, again, we're looking to invest to strengthen the Prime platform. That includes video content, including Amazon Originals, Prime Music, Prime Now, we have a robust device business, including a launch of a new Paperwhite Fire TV Echo with general availability and numerous other products that we're very excited about. That roadmap, we know those devices drive customer engagement and sales. We build fulfillment centers so we can add selection and we can add FBA partners and then we add things like same day delivery which we talked about. +On the AWS side, we continue to invest in that infrastructure. We talked about opening -- announcing the region in India, so there's expansion there's as well. Feature expansion, services expansion, internationally, very similar to the US on a number of the Prime fronts, but also the investment in India. +And then a few other things you may have seen in our press release today. The launch of Mexico, which we're very excited about, and Amazon Business, so lots of -- as I said, lots of investment in front of us but we operate in two paths. We're definitely working for operational efficiencies in the business that we're in. We're investing wisely in things that we think are big and important. And it's not a static activity. +We continue to evaluate those investments, take into account what customer response is and make changes. So I think you can look forward to continuation of that into the future. + +-------------------------------------------------------------------------------- +Operator [62] +-------------------------------------------------------------------------------- + + Our next question comes from Kerry Rice with Needham & Company. + +-------------------------------------------------------------------------------- +Kerry Rice, Needham & Company - Analyst [63] +-------------------------------------------------------------------------------- + + Thanks a lot. You've talked a lot about operational efficiencies. I know you guys have partnered with the post office and deliveries. +Can you talk a little bit about how that is potentially benefiting and maybe the longer term strategy with the post office? And then you guys haven't necessarily broken this out, but I think you do generate a fair amount of revenue from advertising. I think that's in the other category. Is there anything that you can provide on advertising revenue? Thank you. + +-------------------------------------------------------------------------------- +Phil Hardin, Amazon.com, Inc. - Director of IR [64] +-------------------------------------------------------------------------------- + + Sure. So I'll start with the first part of that question. We definitely are delivering a lot of packages with the post office. I think most notably they did a lot of the Sunday delivery that you saw when we started launching Sunday delivery. +We try lots of things for fulfillment. We're constantly working to provide the best experience to customers and be as efficient as possible. And so we're happy with all the partners we have and continue to work with them to provide the best experience possible. +For advertising, I would remind you that certain parts of the advertising roll up into other. Some actually roll up to EGM and media as well. So it's a business we're really excited about. We're taking a customer-centric approach as we build that to make sure we're providing engaging business, engaging ads to customers and making sure we keep the customer front of mind. +It's a business that the team is excited about and working hard on. + +-------------------------------------------------------------------------------- +Kerry Rice, Needham & Company - Analyst [65] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Operator [66] +-------------------------------------------------------------------------------- + + Our next question comes from Stephen Ju with Credit Suisse. + +-------------------------------------------------------------------------------- +Stephen Ju, Credit Suisse - Analyst [67] +-------------------------------------------------------------------------------- + + Thanks. Brian, just a follow up on the India question earlier. To my knowledge, foreign e-commerce operators such as yourself are not allowed to have first party retail operations. But given the fulfillment enhanced customer service has always been a high focus item for you guys, what steps have you taken in the country to make sure that the consumer experience there is as good if not better for the inventory on which you have no direct control? +And secondarily, similar to China you have a pretty large population base and internet penetration currently that's probably comparable to what was the case when you acquired Joyo. Can you provide any color on how the general operating environments are the same or different, and do you expect your growth trajectory there to be similar to what you saw in China? Thank you. + +-------------------------------------------------------------------------------- +Phil Hardin, Amazon.com, Inc. - Director of IR [68] +-------------------------------------------------------------------------------- + + Your first question was about the infrastructure and how we're managing the customer experience in India. So FBA, Easy Ship and some of those programs are important to us. They're very valuable for sellers to make it easy for the seller to get their goods to the customer. They're great from a customer experience standpoint because we can do what we do best with the logistics. And so there is a lot of investment, a lot of efforts going on in that front. +I would say that India and China are totally different and I think, as Brian mentioned, India is a country that we're doubling down on based on the success we've seen there so far. And so very happy with the trajectory we're on there and excited to be investing and have the opportunities we do at that point. + +-------------------------------------------------------------------------------- +Stephen Ju, Credit Suisse - Analyst [69] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Operator [70] +-------------------------------------------------------------------------------- + + Our next question comes from John Blackledge with Cowen & Company. + +-------------------------------------------------------------------------------- +John Blackledge, Cowen and Company - Analyst [71] +-------------------------------------------------------------------------------- + + Great. Thank you. So it appears that Amazon is growing its share of household budget driven by many factors, Prime growth and strong growth in large verticals like apparel among others. Specifically on apparel, just wondering how you view the breadth of Amazon's apparel offering? Any color on that segment's performance in the second quarter and how do you view Amazon's apparel opportunity going forward? Thank you. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com, Inc. - CFO [72] +-------------------------------------------------------------------------------- + + Yes, thanks for your question. We have not broken out specifically apparel, but we're super excited about that business. It's growing very well. We like our position in it. We think our website is very, very atune to selling online. So we're very happy with that. +It is a big business for us, not only in North America but also Internationally. So you mentioned a couple other consumables categories. I will say we are very happy in our consumables and hard line categories as well. We drive a lot of repeat business with things like Prime Pantry and subscribe and Save and others. So very happy with the EGM business as a whole. + +-------------------------------------------------------------------------------- +John Blackledge, Cowen and Company - Analyst [73] +-------------------------------------------------------------------------------- + + Thanks. + +-------------------------------------------------------------------------------- +Operator [74] +-------------------------------------------------------------------------------- + + Our final question comes from Scott Tilghman with B. Riley. + +-------------------------------------------------------------------------------- +Scott Tilghman, B. Riley Caris - Analyst [75] +-------------------------------------------------------------------------------- + + Thanks. Wanted to just follow up on a couple things. Three quick questions. +First off on international, I was wondering if you could compare and contrast relative performance of media and EGM, moving in different directions? Second, there have been a couple questions about shipping, but most notable is that we had a couple price increases from the majors hit at the beginning of the year and it seems like your costs are coming down. I was wondering if you could comment on that? +And then third just following up on Brian's question around the FCs. I was wondering how many of the facilities lend themselves to expansion rather than having to put up a new facility. Thanks. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com, Inc. - CFO [76] +-------------------------------------------------------------------------------- + + Sure. Let me start with the first question on international media and EGM. I think we're seeing similar trends in both geographies, both segments that EGM growth is much -- is very strong. Media growth has been consistent for the last four quarters. We do like the work being done by the media teams. +There's a lot of pipeline of invention, things like Prime Instant Video, Prime Music, all feed the Prime pipeline and Prime ecosystem, if you will. They work great with our devices, by the way. And they drive other non-media sales. So they're very tied together, although certainly the EGM is outpacing the media segment or excuse me, media businesses right now. +On transportation costs, not a lot to add there. Again, we are -- we have a combination of doing our own shipping and using third party carriers. So the rate increases are staged and we see those quite frequently, nothing to add there. +On the FCs and whether we would expand or build new, I think we're looking to always to get the most out of the fulfillment centers that we have. And as we need new facilities, we place them closer and closer to customers. So that can have its benefits as well. Not much more to add on that one. + +-------------------------------------------------------------------------------- +Phil Hardin, Amazon.com, Inc. - Director of IR [77] +-------------------------------------------------------------------------------- + + Thank you for joining us on the call today and for your questions. A replay will be available on our Investor Relations website at least through the end of the quarter. We appreciate your interest in Amazon.com and look forward to talking with you again next quarter. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/exam/original-files/Problem_1_Sample/2015-Jul-29-FB.OQ-141107486910-Transcript.txt b/exam/original-files/Problem_1_Sample/2015-Jul-29-FB.OQ-141107486910-Transcript.txt new file mode 100644 index 0000000..7ab1eff --- /dev/null +++ b/exam/original-files/Problem_1_Sample/2015-Jul-29-FB.OQ-141107486910-Transcript.txt @@ -0,0 +1,560 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q2 2015 Facebook Inc Earnings Call +07/29/2015 05:00 PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Deborah Crawford + Facebook, Inc. - VP of IR + * Dave Wehner + Facebook, Inc. - CFO + * Mark Zuckerberg + Facebook, Inc. - CEO + * Sheryl Sandberg + Facebook, Inc. - COO + +================================================================================ +Conference Call Participiants +================================================================================ + + * Justin Post + BofA Merrill Lynch - Analyst + * Eric Sheridan + UBS - Analyst + * Ben Schachter + Macquarie Research - Analyst + * Brian Pitz + Jefferies LLC - Analyst + * Ross Sandler + Deutsche Bank - Analyst + * Paul Vogel + Barclays Capital - Analyst + * Heather Bellini + Goldman Sachs - Analyst + * Mark Mahaney + RBC Capital Markets - Analyst + * Brian Wieser + Pivotal Research Group - Analyst + * Brian Nowak + Morgan Stanley - Analyst + * Douglas Anmuth + JPMorgan - Analyst + * Mark May + Citigroup - Analyst + * John Blackledge + Cowen and Company - Analyst + * Peter Stabler + Wells Fargo Securities - Analyst + * Anthony DiClemente + Nomura Securities - Analyst + +================================================================================ +Presentation +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Good afternoon. My name is Chris, and I will be your conference operator today. At this time, I would like to welcome everyone to the Facebook second-quarter 2015 earnings call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. +(Operator Instructions) +This call will be recorded. Thank you very much. Ms. Deborah Crawford, Facebook's Vice President of Investor Relations, you may begin. + +-------------------------------------------------------------------------------- +Deborah Crawford, Facebook, Inc. - VP of IR [2] +-------------------------------------------------------------------------------- + + Thank you. Good afternoon and welcome to Facebook's second-quarter earnings conference call. Joining me today to talk about our results are Mark Zuckerberg, CEO; Sheryl Sandberg, COO; and the Dave Wehner, CFO. +Before we get started, I would like to take this opportunity to remind you that our remarks today will include forward-looking statements, and actual results may differ materially from those contemplated by these forward-looking statements. Factors that could cause these results to differ materially are set forth in today's press release and in our quarterly report on Form 10-Q filed with the SEC. Any forward-looking statements that we make on this call are based on assumptions as of today, and we undertake no obligation to update these statements as a result of new information or future events. +During this call, we will present both GAAP and non-GAAP financial measures. A reconciliation of GAAP to non-GAAP measures is included in today's earnings press release. The press release and an accompanying investor presentation are available on our website at www.investor.fb.com. +And now, I'd like to turn the call over to Mark. + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook, Inc. - CEO [3] +-------------------------------------------------------------------------------- + + Thanks, Deborah, and thanks, everyone for joining today. This was a good quarter for us. We've continued to make good progress in the growth of our community with 1.49 billion people now using Facebook each month and more than 1.3 billion people using Facebook on mobile. We've also continued to make gains in engagement. More than 968 million people worldwide now use Facebook daily, and 65% of our monthly actives are daily actives. +Several products in the Facebook app are reaching global scale, too, now with more than 450 million people using events each month, and more than 850 million people using groups. And, when it comes to time spent across Facebook messenger and Instagram, people are now spending more than 50 -- sorry, 46 minutes per day on average and that doesn't include WhatsApp. +Our business performance has grown with our community. This quarter, our total revenue was more than $4 billion for the first time, and advertising revenue grew by 43% year over year. These results reflect the ongoing investments and improvements we've made and the quality, performance, and usefulness of our services. And, continuing to make progress here remains our biggest priority. +Now with that in mind, I'd like to talk about how we're working on this across our current products, our next-generation of apps, and our long-term innovation efforts. Over the next few years, our main focus is on helping our existing communities and businesses reach their full potential. An important part of our strategy is continuing to deliver great experiences across all our products. This means improving the speed and reliability of our apps and building new infrastructure to support our global scale like our new data center in Texas. +Over the last six months, we've improved the performance of our core app reducing crashes on iOS by more than 30% and some Android phones by more than 40%. On messenger, people can now send messages up to 20% faster, and it's twice as fast when you start the app. These are just a few examples of how our engineering focus is delivering better experiences for everyone in our community. Another part of delivering great experiences is helping people connect with the content they want. +This quarter, we've continued to focus on improving people's experience in newsfeed by making it easier to find more relevant and engaging content from friends and the entire community. Connecting people with more great video content is an important part. Video continues to be some of the richest and most engaging content for people and publishers, and since the start of the year, pages are also sharing more than 40% more videos. This quarter, we updated our newsfeed ranking to help people see more of the videos they care about and also began testing new options for video monetization to help our partners build their businesses. We're excited about the potential for continued work here. +The focus we've had on video also supports our efforts to connect more people around important public moments and events. From the 59 million people who generated more than 300 million interactions around the Copa America to the 26 million people who changed their profile photos for Pride, or the more than 150 million people who are notified that their friends were safe after the Nepal earthquake. Facebook has clearly become the home for global conversations about things that people care about. +And, when it comes to serving businesses on our platform, this quarter we continued to focus on delivering more useful tools and resources to help them achieve their goals. Helping marketers to tell more visually engaging stories through video and carousel ads is an important focus as well as supporting small businesses. There are now more than 40 million small businesses, small and medium-size businesses, using pages on Facebook. So, we have a big opportunity to create value for communities all over the world. And, Sheryl is going to talk more about this in a moment. +Next, let's talk about how we're building our next generation of services which we also expect to be important parts of our business over the next few years. With Instagram, the continued growth in the size and engagement of the community shows how this is becoming one of the best places to get a realtime snapshot of the world. For moments from the US presidential campaign trail to NASA's first photos from Pluto, people are using Instagram in a lot of interesting ways. This quarter, we made some big improvements to the app including upgrading our search and Explore functionality and introducing trending content which we expect will provide even more engaging experiences. +On messenger, this quarter we rolled out a number of new features including mobile video calling, a new way to share locations, and the option to sign up for messenger without using a Facebook account. We also continue to make good progress building out the messenger platform. We expect these improvements to continue making messenger a more useful and engaging experience for lots of people. More than 700 million people now use messenger, and we've reached more than 1 billion downloads on Android. These milestones are a good sign that we're on the right path here. +With WhatsApp, we're pleased with our continued growth, and the team is continuing to roll out new features to serve the whole community. We've continued to improve the web experience for WhatsApp as well as launching voice calling to more people and on more devices. With search, we are continuing to build a better experience for our whole community. We recently crossed 1.5 billion searches per day, and we've now indexed more than 2 trillion posts. This is a huge set of unique experiences and perspectives and by allowing people to unlock this knowledge, we have a huge opportunity to create value for the world in the coming years. +Finally, let's talk about our other efforts that we expect to deliver impact over the longer term. With Internet.org we have a lot of momentum with our goal of connecting everyone in the world to the Internet. A year ago, we launched the Internet.org app for the first time in Zambia. And, since then, we've made free basic Internet services available to more than 1 billion people in 17 countries. +Our results show that Internet.org is working. After launching free basic services, mobile operators are seeing people adopt mobile data 50% faster than before. And, more than one-half the new people coming online through Internet.org choose to pay for data and access more Internet services within their first 30 days. +We recently made changes to the Internet.org program for both developers and operators that will give people -- that will give more people access to even more free services. With the Internet.org platform, now it's easy for any developer to create services that integrate with Internet.org. And, just this week, we announced a portal for operators that makes it easy for them to quickly launch free basic services in new countries. +We're also making progress on our efforts to connect people living in some of the most remote communities on earth. Our connectivity lab is working on new technologies for connecting communities that include drones, satellites, and laser communication systems. And, we'll be sharing more of our progress here very soon. +And, with Oculus, we've announced that the Rift will ship to consumers in the first quarter of 2016. The team recently introduced details about the full hardware and software experience that people can expect including our new touch controllers. Oculus is going to be the best VR experience in the world when it launches, and I'm really excited for us to begin delivering on the promise of virtual reality. +So, that's how we focused our efforts over the last quarter. We're preparing for the future, but we're also working to deliver better experiences and value to our community today. And as usual, I want to thank our whole community including our employees, our shareholders, and our partners. Thanks to you, our community is getting stronger and stronger every day, and we're making progress on our mission to make the world more open and connected. +So, thank you. And now, here's Sheryl. + +-------------------------------------------------------------------------------- +Sheryl Sandberg, Facebook, Inc. - COO [4] +-------------------------------------------------------------------------------- + + Thanks, Mark, and hi, everyone. We had another strong quarter and a great first half of the year. Ad revenue grew 43% year over year, 55% on a constant currency basis. Mobile ad revenue grew 74% year over year, making it over three-quarters of total ad revenue. Our growth was broad-based across all marketer segments and industry verticals. Similar to Q1, we're pleased with the adoption of our ad products across all regions and we saw strong revenue growth in North America and Asia-Pacific in particular. We're staying focused on our three main priorities: capitalizing on the shift to mobile, growing the number of Facebook marketers, and making our ads more relevant and effective. +First, capitalizing on the shift to mobile. People are spending more time on their mobile devices and on Facebook apps. We continue to get more than one out of every five minutes on smartphones in the US, and mobile usage is driving our growth globally as well. We believe we have the best performing mobile ad product in the market, and video is making it even better. With so many consumer videos being watched on Facebook, video ads are a natural part of the newsfeed experience. +For marketers, video has always been a compelling format. Now Facebook enables mass reach and cross-device targeting and measurement abilities far superior to what other platforms offer. Mobile video was a major theme at the Cannes Lions Festival last month for some of the biggest winners like Under Armour's I will what I want, with Droga5; and Procter & Gamble's, like a girl with Leo Burnett; used mobile video on Facebook as part of their campaigns. +Our second priority is growing the number of marketers using our ad products. In Q2, we announced that 40 million small and medium businesses have active Facebook pages, and this number continues to grow. Earlier this month, I hosted SMB roundtables in Berlin and London. I got to hear firsthand how advertising on Facebook is helping SMBs sell their products, grow their businesses, hire new employees, and even expand to other cities and countries. +One of the business owners I met was Kelly Wright, a single mom who started selling dresses from her home. She began by shooting videos of her dresses on her mobile phone and promoting them on Facebook for just a few pounds. Using Facebook as her only marketing channel, Kelly grew her business, [Christalee] Fashions, to over GBP3 million annually, and she now has 10 employees. We're increasing our engagement with the global SMB community and have now held more than 80 local boost-your-business events around the world, meeting thousands of businesses and getting their feedback on how we can make our products work better for them. +We're also building out our leadership teams around the world. In recent weeks, we've added senior talent to our International teams including a new head of Latin America and new regional leadership in several countries in EMEA. We also opened an office in Johannesburg, our first in Africa. +Our third priority is making our ads more relevant and effective. Better, more engaging, and relevant ads are good for people and marketers. And, we're working hard to improve them. We continue to innovate at a rapid pace by introducing new ad formats and new tools for marketers. This quarter, we expanded carousel ads which show multiple images in one ad unit. We introduced dynamic product ads which allow marketers to upload their product catalog and show the right product to the right person at the right time. We also introduced a new ad format called lead ads, a simpler way for people to connect with companies they're interested in hearing from. +We continue to focus on providing world-class products and tools for direct response advertisers. Booking.com a Priceline Group Company, is using Facebook link ads featuring book now buttons to drive reservations. In Q2, Facebook ads drove a meaningful increase in room reservations for booking.com, helping them meet their ROI goals for the campaign. They are now expanding their use of Facebook ads across multiple markets. +We continue to make progress with ads on Instagram. In Q2, we launched Instagram ads in Brazil, Germany, and Japan. We also introduced additional capabilities for marketers including carousel ads on Instagram which brands are using in creative ways. For example, to showcase a spring fashion collection, gradually reveal a full panorama, or show different views of a location. +Over the coming months, Instagram ads will be available to more advertisers with new formats, better targeting, and the ability to buy online as well as through third-party planners. As we ramp Instagram ads, we remain focused on quality and relevance to ensure the best experience for people and the highest performance for marketers. And, as always, our highest focus is on the consumer experience with Instagram. +Measurement is a key priority as we work to expand our share of global marketing budgets. Since we introduced conversion lift, which measures the direct impact that Facebook ads have on sales, we've seen adoption from marketers across verticals. When Acura launched the TLX, the largest launch in their history, they used Facebook video to show the TLX in scenarios that quickly captured people's attention like imitating a roller coaster. They then used our retargeting technology to show more detailed ads only to the people who watched the videos. Using conversion lift, they proved that Facebook ads directly drove vehicle sales. +To help marketers target and measure campaigns both on and off Facebook, we're continuing to build out our ad tech platform with Atlas, LiveRail, and the Audience Network. Entertainment Company Live Nation knew that people browsed for concert tickets on mobile devices, but they were never able to measure whether they converted into sales. Using Atlas, Live Nation was able to link their mobile ads to 66% more ticket purchases for one of their largest artists. This shows the promise of Atlas to measure cross-device conversion. We're pleased with the progress we're making on all three of our main priorities, and we plan to stay focused. +Now, here's Dave. + +-------------------------------------------------------------------------------- +Dave Wehner, Facebook, Inc. - CFO [5] +-------------------------------------------------------------------------------- + + Thanks, Sheryl, and good afternoon, everyone. Q2 was another strong quarter for Facebook. We generated $4 billion in revenue and $1.3 billion in free cash flow. Strong community growth and engagement underpinned our financial performance. In June, approximately 968 million people used Facebook on an average day, an increase of 17% compared to last year. This daily number represents 65% of the 1.49 billion people who used Facebook during the month of June. That MAU number grew by 173 million year over year, and by this measure, the second quarter was our strongest in terms of community growth since 2013. +Mobile remains the key driver of our growth. In June, approximately 1.31 billion people accessed Facebook on mobile devices, up 23% from last year. We also saw strong growth in our next generation of services with Instagram, Messenger, and WhatsApp now exceeding 300 million, 700 million, and 800 million MAU, respectively. +Now, turning to the financials. All of our comparisons are on a year-over-year basis unless otherwise noted. Additionally, our non-GAAP measures exclude stock-based compensation and the amortization of intangibles. Total revenue was $4 billion, up 39%, or 50% on a constant currency basis. Ad revenue was $3.8 billion, up 43%, or 55% on a constant currency basis. The strengthening of the US dollar has continued to have an unfavorable impact on our revenue. Had foreign exchange rates remained constant with Q2 2014 levels, our total revenue this quarter would have been approximately $330 million higher. +Regionally, we saw strong North American ad revenue growth of 55% in the quarter, and APAC growth also remained strong at 48%. Europe and the rest of the world ad revenue grew more slowly at 30% and 22%, respectively, as currency had a significant negative impact on each of those regions' year-over-year growth rates. +Mobile was the engine of our revenue growth. Mobile ad revenue in Q2 was $2.9 billion, up 74% from last year, and represents 76% of our advertising revenue. Revenue from ads served on personal computers was down approximately 8%. +In Q2, the average price per ad increased 220% while total ad impressions declined 55%. Similar to last quarter, these price volume trends were primarily driven by the redesign of our right-hand column ads which rolled out in the third quarter of last year. To a lesser degree the shift of usage towards mobile where we don't have right-hand column ads also contributed to the reported price volume trends. +Total payments and other fees revenue was $215 million, down 8% compared to last year. The decline was driven by a 19% year-over-year reduction in payments revenue related to games played on personal computers, offset primarily by the addition of other revenue related to acquisitions closed in the second half of 2014. +Turning now to expenses. Our Q2 total GAAP expenses were $2.8 billion, up 82%, and non-GAAP expenses were $1.8 billion, up 57%. Similar to last quarter, stock-based compensation and amortization expenses related to the WhatsApp acquisition contributed significantly to the year-over-year growth in GAAP expenses. Non-GAAP expenses growth was primarily driven by increases in headcount-related costs, cost of revenue, and marketing expenses. +We ended the quarter with 10,955 employees, up 52% compared to last year. With 873 additional employees, Q2 was one of our strongest quarters in terms of hiring, and the majority of the new employees were added in R&D. Our Q2 GAAP operating income was $1.3 billion, representing a 31% operating margin. Non-GAAP operating income was $2.2 billion, representing a 55% margin. Our Q2 GAAP and non-GAAP tax rates were 44% and 36%, respectively. Q2 GAAP net income was $719 million, or $0.25 per share, and non-GAAP net income was $1.4 billion, or $0.50 per share. In Q2, capital expenditures were $549 million, and we generated $1.3 billion of free cash flow. We ended the quarter with $14.1 billion in cash and investments. +Turning now to the outlook. Let's start with revenue. Since the first quarter of 2014, we have seen year-over-year advertising revenue growth rates decline each subsequent quarter. We expect this trend to continue in Q3 and Q4 as we continue to grow off a much larger base and face currency headwinds due to the strong dollar. In addition, we expect our total payments and other fees revenues to decline on a year-over-year basis for the remainder of the year. The decline in the second half of the year should be closer to the 19% year-over-year decline we experienced in the payments business alone, as we will be lapping periods in which we added other fees revenue from acquisitions closed in the second half of 2014. +Turning to expense guidance. Based on our second-quarter results, we are narrowing the expense guidance range for 2015. We now expect the year-over-year growth rate for total 2015 GAAP expenses to be between 55% and 60%, narrowed from the prior range of 55% to 65%. And, we expect the year-over-year growth rate for total 2015 non-GAAP expenses to be between 50% and 55%, narrowed from the prior range of 50% to 60%. We anticipate our 2015 capital expenditures will be in the neighborhood of $2.5 billion to $3 billion, down slightly from the prior range of $2.7 billion to $3.2 billion. +We continue to expect stock-based compensation in 2015 to be in the range of $3 billion to $3.3 billion, approximately one-half of which is related to our prior acquisitions, most notably, WhatsApp. We expect amortization expenses in 2015 to be approximately $700 million to $800 million. And, lastly, we anticipate our Q3 and full-year 2015 GAAP and non-GAAP tax rates to be consistent with the rates in the second quarter. +We have had a great first half of the year with solid revenue performance underpinned by healthy community growth across all of our services and regions. We have many exciting opportunities ahead, and we are investing in the talent and resources to capitalize on them as we seek to build long-term shareholder value. +With that, Operator, let's open up the call for questions. + + +================================================================================ +Questions and Answers +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) +Anthony DiClemente, Nomura Securities. + +-------------------------------------------------------------------------------- +Anthony DiClemente, Nomura Securities - Analyst [2] +-------------------------------------------------------------------------------- + + I have one for Mark and one for Dave. Mark, Facebook has had so much success in terms of the engagement -- the growth of the engagement. I'm just wondering if there's a framework that you use to think about how much of that success is due to the core value proposition of Facebook itself continuing to resonate with people at its most basic level as opposed to the product innovation that you detailed in your prepared remarks or new use cases, which are more of a driver in your mind? +And then, second one for Dave, CapEx being down as a percentage of revenue in the 2Q and you lowered the guidance, it doesn't feel like you are in the midst of ramping investment in the infrastructure. I wonder as you look at the assets, you have so much growth, you have the shift to bandwidth-intensive content, and applications. Do you feel like you have been more efficient in terms of your CapEx spend? Or, at some point, should we anticipate a reacceleration to CapEx? Thanks. + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook, Inc. - CEO [3] +-------------------------------------------------------------------------------- + + I can talk to the first part. So, at some level, I do think that the core mission and promise of helping to connect people with their friends and family is very fundamental. And, everyone has friends and family and wants to stay connected. And, uses a variety of tools and ways to do that in the world today, which are often very inefficient, and the Internet offers new opportunities to make that a lot better. +When you look at the specific products that -- and the work that we're doing -- there is this process that we've followed that we basically will look at an area of our products that people are using. So, for example, going back a few years, newsfeed was -- it has always been since we rolled it out a very central part of the product. But, we're looking at the stuff with increasing rigor now where we organize the Company into these product groups. And, each product group leader will not just look at the product as one thing but what are the key three or four or five use cases which often can really be their own product lines on their own, and we go through and build those out to be world-class. +I think a lot of the success that we've seen has been because of some of the work that we've done a few years back at this point in products like newsfeed. That team has executed really well. But, when I look forward, I'm very excited about doing the same thing for messaging and groups and video. There's many different use cases. You don't want to just look at these as one thing. There are a bunch of different use cases, and we want to be the best at each of them. And, if you have good people leading those teams, then I think you can deliver that over time. So, I think, yes, is the answer to your question. The mission is fundamentally, deeply important to people, but that has to be coupled with good thorough execution of each of the available opportunities. + +-------------------------------------------------------------------------------- +Dave Wehner, Facebook, Inc. - CFO [4] +-------------------------------------------------------------------------------- + + Yes. Anthony, it's Dave. So, on CapEx, we are absolutely investing in the infrastructure, and 2015 is an investment year. So, we are ramping CapEx versus 2014. The guidance is $2.5 billion to $3 billion, and that's up from $1.8 billion last year. We've got a lot of infrastructure investment that we're making across data centers, servers, network, we are clearly investing for the growth of both Facebook at its core, and then also the additional services that we're bringing on. So, we're proud about the efficiencies that we've had. +The infrastructure team has done an outstanding job in driving good efficiencies through things like the open compute project which allows us to leverage an open source strategy to lower our costs on server and other expensive hardware. So, it has been a great strategy for us. But, given the growth we have in the business, given the opportunity we have before us, we are very much in investment mode in terms of the infrastructure. + +-------------------------------------------------------------------------------- +Operator [5] +-------------------------------------------------------------------------------- + + Douglas Anmuth, JPMorgan. + +-------------------------------------------------------------------------------- +Douglas Anmuth, JPMorgan - Analyst [6] +-------------------------------------------------------------------------------- + + Mark, you talked about Oculus Rift shipping in 1Q 2016. Can you talk more about what you're most excited about in terms of the primary applications when it's into the mainstream? And then, Dave, can you also help us understand the cost structure more here as that product ramps? And then, Sheryl, if you could help us understand how broadly Instagram will open up to advertisers by year-end? Thank you. + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook, Inc. - CEO [7] +-------------------------------------------------------------------------------- + + I can talk about Oculus. So, the reason why Facebook is excited in this space is I can give you two reasons for this. One is there's this continued progression of people getting richer and richer ways to share what's on their mind. So, if you go back 10 years, most of how people communicated and shared was text. We are going through a period where now it's mostly visual and photos. We are entering into a period where that's going to increasingly be primarily video. And, we're seeing huge growth there. But, that's not the end of the line. There's always a richer way that people want to share and consume thoughts and ideas, and I think that immersive 3-D content is the obvious next thing after video. +So, if you look at what the initial use cases are going to be around that, I think it's a lot of the stuff that you hear people talking about. Video, I think, will be huge. So, just taking that to be 3-D and immersive. Gaming will be huge. Those are both areas that Facebook has been involved with. Once you start to get more of a critical mass, I think you can start to get social applications which is what we as a Company are more interested in over the long term. And, think have a huge amount of potential. In addition to the video and gaming stuff which I just think is going to be awesome in the next few years as well. + +-------------------------------------------------------------------------------- +Dave Wehner, Facebook, Inc. - CFO [8] +-------------------------------------------------------------------------------- + + Doug, it's Dave. Just on the question of how Oculus would affect the cost structure, it's premature for us to be giving guidance on the cost structure in 2016. But, I think one of the things to recognize here is that we're still early with Oculus. We haven't announced any specific plans as it relates to shipment volumes for the consumer for Rift. But, VR is still early and in the development stage so it would be early to be talking about large volume shipments. Obviously, we're investing on the research and development side on Oculus in 2015, and that's factored into our expense guidance for this year. + +-------------------------------------------------------------------------------- +Sheryl Sandberg, Facebook, Inc. - COO [9] +-------------------------------------------------------------------------------- + + On Instagram, we are opening up to more advertisers. I talked about some of our global rollouts in the past quarter. We're also opening up more capabilities, which means more formats like direct response, more ways to buy like self-serve. That said, and it's important to understand this, while we think there's a lot of interest and a great opportunity, we're going to be really thoughtful and strategic about how we ramp revenue. Instagram remains small relative to Facebook, and it's going to really take time to have significant impact on our growth. + +-------------------------------------------------------------------------------- +Operator [10] +-------------------------------------------------------------------------------- + + Heather Bellini, Goldman Sachs. + +-------------------------------------------------------------------------------- +Heather Bellini, Goldman Sachs - Analyst [11] +-------------------------------------------------------------------------------- + + I wanted to ask a little bit more about as you start to speak with more advertisers on the Instagram opportunity, how are you and they thinking about the differences in how they'll engage with their customers across both platforms? And, I guess what I'm getting at is do you see Instagram targeting a different type of advertiser? Or, do you expect people to leverage both platforms and almost think of them as separate areas to budget for? + +-------------------------------------------------------------------------------- +Sheryl Sandberg, Facebook, Inc. - COO [12] +-------------------------------------------------------------------------------- + + I think one of the things that's interesting about Instagram is while the ads are really visually appealing and that brings to mind certain verticals like fashion or autos -- things where the visual really matters. What we're seeing is that lots of different verticals can use the platform really well. So, a recent example, HTC working with their agency, Swift, did Instagram videos to raise awareness of their mobile device warranty program. So, they targeted 18 to 34-year-olds. They did five short videos with these funny moments of where you're about to break your phone, and they got a 6-point lift in awareness of what is a warranty program. I think that's not something you would think of typically as Instagram. +In terms of Instagram and Facebook, we believe that marketers are looking to connect with people in a really deep way, connect with the right people, and our targeting we think is really strong compared to other any other platform at the right time. And, that really means mobile. We see such engagement on both Facebook and Instagram along with the different targeting and ad formats. We believe we'll be able to have and are already starting to have relationships with marketers which grow across both platforms. +Our focus with our marketing partners is their business results. I talked about in my remarks how we're looking for conversions. We're trying to help them measure if you do a car ad for us, how many vehicles were driven off the lot? We see what products you use within Facebook or Instagram or Facebook and Instagram as less important as the best product for the right marketer at the right time to drive their business results. And, we like having more abilities, more products, more apps to work with so that we can drive this business results. + +-------------------------------------------------------------------------------- +Operator [13] +-------------------------------------------------------------------------------- + + Brian Nowak, Morgan Stanley. + +-------------------------------------------------------------------------------- +Brian Nowak, Morgan Stanley - Analyst [14] +-------------------------------------------------------------------------------- + + In early June, you rolled out some new CPC measurement methods about how the changes and the clicks and the CPCs are measured. I'd be curious about early findings you see in ad engagement growth, average price per ad? And then, the advertiser feedback or change in budgeting since you've rolled out these CPC measurement changes. +And then, the second one -- on the North American advertising results were really strong. I think you have accelerating growth. Sheryl, could you call out any specific ad products that are driving this faster North American ad growth? Thanks. + +-------------------------------------------------------------------------------- +Sheryl Sandberg, Facebook, Inc. - COO [15] +-------------------------------------------------------------------------------- + + On the first, we're always trying to improve our ad products so marketers can buy what they want and pay as they want to pay. We recently announced that we're updating the definition of CPC so that includes only websites and apps. But, you can also buy on a cost per engagement basis, and that includes likes, comments, and shares. It's too early to see any direct impact, but I think it's part of the innovation that you'll see from us as we continue to roll out different ways that marketers can use our tools, different ways they can pay, different results they can target. +When you look at our overall growth, our growth is very broad-based. We're broad-based against all of our segments of marketers so brand and direct response, SMBs and developers. Definitely, a part of the story here is video. Our video demand is very deep. People love the format of video. It has long been used to reach people in a compelling way, and we can do targeting in a way that's really unique. +So, I'll share another example. Wendy is working with their agency, VML, launched their jalapeno fresco spicy chicken product, and they were trying to reach millennials and spicy food lovers. Working with us, they did five video ads, and on our platform they could not just do the video format, but they could target millennials and people who like spicy food which is very specific targeting. They got an 8-point lift in ad recall and a 4-point lift in purchase attempts among their millennial target, and so what that shows is our growth is being driven by the ability of us to do this broad-based consumer media advertising but do it in a more targeted way. + +-------------------------------------------------------------------------------- +Dave Wehner, Facebook, Inc. - CFO [16] +-------------------------------------------------------------------------------- + + I think, Brian, you were also commenting on North America. Obviously, it's probably -- everybody realizes this. But, that the big disparity between the US-Canada growth rates versus the other regions like Europe and the Rest of World are the currency headwinds which had a very significant impact to the year-over-year advertising growth rates in those regions. + +-------------------------------------------------------------------------------- +Operator [17] +-------------------------------------------------------------------------------- + + John Blackledge, Cowen and Company. + +-------------------------------------------------------------------------------- +John Blackledge, Cowen and Company - Analyst [18] +-------------------------------------------------------------------------------- + + Couple questions on video. Mark, I think you mentioned potentially some new options for video monetization. Maybe could you discuss some of the new options that we may see implemented? More broadly, how does video content evolve on Facebook from what we see today? Thank you. + +-------------------------------------------------------------------------------- +Dave Wehner, Facebook, Inc. - CFO [19] +-------------------------------------------------------------------------------- + + On the options on video monetization, it's going to be -- still our focus is going to be on continuing to grow autoplay and continuing to leverage the video unit in newsfeed. That's going to be the primary driver of video growth for us. So, that's really the main focus. We've got other areas that we're experimenting with like suggested videos which are going to be very much like those ads in a feed of suggested videos. Which are also an opportunity for us, but essentially the focus is going to be on monetizing through feed ads for video. + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook, Inc. - CEO [20] +-------------------------------------------------------------------------------- + + I think you got it. + +-------------------------------------------------------------------------------- +Operator [21] +-------------------------------------------------------------------------------- + + Justin Post, Merrill Lynch. + +-------------------------------------------------------------------------------- +Justin Post, BofA Merrill Lynch - Analyst [22] +-------------------------------------------------------------------------------- + + I think on the call you said time spent was 46 minutes per day. Any comparable metric from past quarters? And then, how would you -- if you can't give us that -- how would you gauge the overall engagement of Facebook? Just for the core site? Maybe some help about what you're seeing there? And, what products are really having an impact? Thank you. + +-------------------------------------------------------------------------------- +Dave Wehner, Facebook, Inc. - CFO [23] +-------------------------------------------------------------------------------- + + I think in terms of engagement the product is having the biggest impact is newsfeed continuing to do very well. So, newsfeed at the core is proving to be just a great experience for users. It's getting better. We continue to invest in that. As people spend more time with newsfeed, we get better about understanding what they like and getting the content that they care about in front of them. So, we're investing on that front. We're also doing more with public content. That's having an impact. So, we're seeing across the board, good improvements to newsfeed videos -- another contributor there as well. So, that's what we're seeing in terms of driving engagement. +Engagement across the different regions as we think about it from a DAU to MAU perspective was at record levels in the quarter so we're pleased with that. And, we continue to see time spent growth across the platform. So, on all those measures, we really like what we're seeing, and we like the investments that we're making to make that newsfeed experience even better. + +-------------------------------------------------------------------------------- +Operator [24] +-------------------------------------------------------------------------------- + + Ross Sandler, Deutsche Bank. + +-------------------------------------------------------------------------------- +Ross Sandler, Deutsche Bank - Analyst [25] +-------------------------------------------------------------------------------- + + I just had two questions. One for Mark and then one clarification for Dave. Mark, question on the messaging app. So, the vibe at F8 from the first-day keynote at the end of the day, Brian Acton and David Marcus were basically presenting different strategies in terms of their long-term philosophy around monetization of those two platforms. So, if you look out three to five years, do you see the opportunity with Messenger and WhatsApp as being similar? Or, can you talk about the strategy there? +And, is the engagement for the messaging apps similar, higher, lower than the average for the core Facebook app in terms of daily visits? And then, Dave, you mentioned that you expect ad revenue to decelerate. I'm guessing that's a function of some of the FX headwinds. Can you talk about that on a currency-neutral basis? Relative to the 55% in the second quarter? Thanks. + +-------------------------------------------------------------------------------- +Dave Wehner, Facebook, Inc. - CFO [26] +-------------------------------------------------------------------------------- + + I can take the second part first. So, in terms of the -- also you had asked about the growth rate in the back half of the year. I'd reiterate what I said in my comments, the business continues to perform very well driven off the strength of our mobile newsfeed ads business. And, really consistent with the trend we've seen in the last several quarters, we would expect that year-over-year ads growth rate to decline modestly in Q3 and Q4. It's really because we're delivering growth against a much larger scale newsfeed business in the prior-year period, and also of course, headwinds are an impact as well as you mentioned. + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook, Inc. - CEO [27] +-------------------------------------------------------------------------------- + + And, I can talk to the messaging strategy questions. So, the playbook that we're going to run with Messenger and WhatsApp is kind of similar to how we thought about building a business in Facebook and newsfeed. Where if you go back to 2006 and 2007, there were a lot of people who were encouraging us to just put Banner ads and inorganic content into the experience. And, what we decided was that over the long term, the ads and monetization would perform better if there was an organic interaction between people using the product and businesses. So, instead of focusing on ads first, what we did was we built pages, and we made that free. That way as many businesses as possible could get into the network. And, we built insights to make it so that businesses knew how they were driving business when they used pages for free and could post into newsfeed. And then, on top of that whole ecosystem, we then had the opportunity to build what has turned into a newsfeed business that we're really proud of, right. That we think is driving a lot of value and good content for people are using the platform and helping a lot of businesses find customers and sell their products and grow overall. +Messaging, I think, is going to be pretty similar. We're right now -- some people in WhatsApp use the service in order to message businesses. Messenger is, I think, more people to people today. We're working on a lot of different things that make it so that people can get value from interacting with businesses. We launched some of them at F8. We have a number of other things that we're working on across Messenger and WhatsApp. +But, the long-term bet is that by enabling people to have good organic interactions with businesses, that will end up being a massive multiplier on the value of the monetization down the road when we work on that and really focus on that in a bigger way. So, we would ask for some patience on this to do this correctly. And, the game plan will be more similar to what we did in Facebook with newsfeed. + +-------------------------------------------------------------------------------- +Dave Wehner, Facebook, Inc. - CFO [28] +-------------------------------------------------------------------------------- + + And, Ross, you also asked about I think the impact of Messenger on our user statistics and the daily users. The vast, vast majority virtually -- all of Messenger users are using newsfeed as well. So, Messenger-only usage is not having a material impact on our overall usage stats. + +-------------------------------------------------------------------------------- +Operator [29] +-------------------------------------------------------------------------------- + + Mark May, Citi. + +-------------------------------------------------------------------------------- +Mark May, Citigroup - Analyst [30] +-------------------------------------------------------------------------------- + + I had one on search. I think you mentioned 1.5 billion daily searches. Just kind of curious, what portion of those our commercial, if you will? Not so much lookups for friends and family, but more commercial-oriented? And, can you give us an update of where you are in the process of building out an even more robust search experience on Facebook and across the other family of apps? +And then, on Instagram, just a question on how we should be thinking about the ramp as well as the long-term opportunity? I guess the question would be in your tests, have you noticed any meaningful difference in Instagram users' willingness to see or interact with ads in their newsfeed as compared with an average Facebook user? Recognizing that probably Instagram's audience is more geared towards some of the developing markets in the US relative to the Facebook? Thanks. + +-------------------------------------------------------------------------------- +Dave Wehner, Facebook, Inc. - CFO [31] +-------------------------------------------------------------------------------- + + Sure. On the search experience, and Mark can add anything if he'd like. But, on the search experience from a monetization perspective the vast majority of the searches are for people or posts, and there can be -- there's the potential for there to be commercially-relevant content in people's posts, people searches. Which is the largest part of searching is not something that we think is really a monetizing category, but there is certainly great content that people are finding using post-search. But, it's really the focus is really to try and allow people to discover content that's been shared on Facebook that's relevant to them. And, that's going to be the focus in the near term. And, as people consume more content on Facebook, there's opportunities to show them ads in feeds. There's an opportunity there, but it's really around engaging with content that you want to find on Facebook. + +-------------------------------------------------------------------------------- +Sheryl Sandberg, Facebook, Inc. - COO [32] +-------------------------------------------------------------------------------- + + On Instagram, we haven't noticed any difference in willingness to engage with ads between the platforms for Instagram and Facebook. But, we've ramped really slowly, and we're very, very cautious. And, again, we're going to continue to focus on the user experience, focus on the community growth, and monetization will follow. + +-------------------------------------------------------------------------------- +Operator [33] +-------------------------------------------------------------------------------- + + Ben Schachter, Macquarie. + +-------------------------------------------------------------------------------- +Ben Schachter, Macquarie Research - Analyst [34] +-------------------------------------------------------------------------------- + + A couple questions. One, given your success with standalone apps, should we expect to see more apps in the future? And, could one of those focus specifically on video? And then, on Oculus. The monetization for that? Should we expect an app store-like model where you'll be sharing revenue with the content partners? Thanks. + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook, Inc. - CEO [35] +-------------------------------------------------------------------------------- + + We work on a lot of different things. I don't think we'd rule out the things that you just mentioned, but we don't have anything specific to talk about today on either of them, I think. + +-------------------------------------------------------------------------------- +Dave Wehner, Facebook, Inc. - CFO [36] +-------------------------------------------------------------------------------- + + Obviously, a big part of our investment strategy is investing in this next generation of apps, and the focus there is on growing the communities around Messenger, WhatsApp, and of course, Instagram. That's all going really well, and that's a big focus of our investments. + +-------------------------------------------------------------------------------- +Operator [37] +-------------------------------------------------------------------------------- + + Mark Mahaney, RBC Capital Markets. + +-------------------------------------------------------------------------------- +Mark Mahaney, RBC Capital Markets - Analyst [38] +-------------------------------------------------------------------------------- + + Two questions. David, the sales and marketing expenses this quarter were almost flattish sequentially. You don't normally see that in your business. Was there anything -- any particular reason behind that, and why you didn't have that area grow? I assume it will continue to grow going forward. +And then, Mark, you had made a comment about -- I think you were referring to Instagram becoming one of the best places to get a realtime snapshot of the world. And, it reminds me or makes me think about some other leading platforms on the Internet, and I wonder how does that happen with Instagram? Is that something that you're already seeing users use Instagram to make that happen? Or, is that something that you have to tweak the user interface and change the product a little bit in order to try to have people think about it that way? How does it become that realtime snapshot of the world? Thanks. + +-------------------------------------------------------------------------------- +Dave Wehner, Facebook, Inc. - CFO [39] +-------------------------------------------------------------------------------- + + So, on the sales and marketing expenses, Mark, I think you're going to see that be lumpy. That's just due to product marketing. And, that's just not going to necessarily be a steady quarter-to-quarter trend so you're going to see that be lumpy. But, yes, we are investing more in general in sales and marketing over time so you'd expect to see that line grow in line with the expense guidance that we're giving. So, it's definitely an area that we'll be investing in on an ongoing basis, and I wouldn't read too much into the quarterly trend there. + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook, Inc. - CEO [40] +-------------------------------------------------------------------------------- + + Yes. In terms of Instagram, I just think Kevin and the team are doing amazing work. The clarity of focus and clarity of the vision that Kevin and Mike have has been exceptional. And, this is something that they've always focused on. They've cared deeply about it since the first conversations I've had with Kevin. And, I think it takes real composure as a leader to scale something from to [many X] where it was just a few years ago and build up the organization and be able to continue pushing the products forward every day to be able to do that. I think it's rare that you get someone who's as talented as the folks who are leading this, and they're just doing an amazing job. + +-------------------------------------------------------------------------------- +Operator [41] +-------------------------------------------------------------------------------- + + Paul Vogel, Barclays. + +-------------------------------------------------------------------------------- +Paul Vogel, Barclays Capital - Analyst [42] +-------------------------------------------------------------------------------- + + Similar follow-up question to Mark's. Your DAU to MAU number has been exceptionally strong and moving up. I'm going to guess a lot of that is mobile-related so I guess that would be question number one. Is it a lot mobile? And, the second question would be around this realtime issue? Are you seeing more realtime usage of Facebook? And, are you developing more products specifically around realtime usage of Facebook as a platform? Thank you. + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook, Inc. - CEO [43] +-------------------------------------------------------------------------------- + + I think a lot of it is that we're getting better and better at ranking and showing people the content they want. So, part of it is that there's of course a bigger opportunity when people have their phones with them all the time. But, I think that there are plenty of other worlds that we could be living in where we wouldn't have necessarily executed on that opportunity. The execution is hard. And, just having something that's appealing universally to people wanting to stay connected with their friends -- that's an important piece of it. But, the team has just done really good work in terms of ranking the content and making the experience faster and building out better ways to get feedback from our community on what kinds of content they want to see in newsfeed. And, helping people have the tools that they need to share the social content and news and video content that they want. That way it exists in the corpus of content that can be shown. I just think the team is doing really good work on all of these, and I'm really proud of them. + +-------------------------------------------------------------------------------- +Dave Wehner, Facebook, Inc. - CFO [44] +-------------------------------------------------------------------------------- + + Paul, there's no doubt that mobile has the beneficial effect on our engagement. In the US, two out of three smartphone users check their phone as soon as they wake up in the morning. It's just having that experience readily available in your pocket is tremendous, and we just see that being helpful across the business as it relates to mobile engagement. + +-------------------------------------------------------------------------------- +Operator [45] +-------------------------------------------------------------------------------- + + Brian Weiser, Pivotal Research. + +-------------------------------------------------------------------------------- +Brian Wieser, Pivotal Research Group - Analyst [46] +-------------------------------------------------------------------------------- + + You mentioned 40 million small businesses have active pages. I'm wondering if you can update us on how many individual small businesses -- or businesses in total [are] buying ads right now. And, separately, I was curious about current thoughts on how ad-type businesses will evolve? If you see an integrated marketplace evolving? Or, if you see a discrete demand by side businesses -- sorry, demand and supply-side businesses evolving? + +-------------------------------------------------------------------------------- +Sheryl Sandberg, Facebook, Inc. - COO [47] +-------------------------------------------------------------------------------- + + On the first, we announced that we have over 2 million advertisers who are buying ads on Facebook. And, the process for that is often that small businesses become organic users. So, those 40 million small business pages that are using it once a month. And then, we're able to move them on to being advertisers. The best way we've done that is by simplified ad products. 82% of the people who start advertising with us, start with our really simple ad products. Do you want to pay a few dollars or a few pounds or a few euro to sponsor this post -- is a really easy on-ramp for a small business. +In terms of the overall ad tech world, I think a lot is happening and there is a lot that's going to evolve in the whole ecosystem. Our focus is on bringing people-based marketing and the effectiveness and relevance of Facebook ads off of Facebook. So, we can give marketers and publishers the tools to reach people across all of their devices, and importantly for our business, is connect the dots between online marketing and business outcomes. You heard on this call me give a few examples of where we're already able to connect what happens in terms of ads with real sales of real products. For us, this is an important investment, and it's a very strategic. We are going to put the time in to make this work rather than look for any short-run, specific return. + +-------------------------------------------------------------------------------- +Operator [48] +-------------------------------------------------------------------------------- + + Peter Stabler, Wells Fargo Securities. + +-------------------------------------------------------------------------------- +Peter Stabler, Wells Fargo Securities - Analyst [49] +-------------------------------------------------------------------------------- + + Drafting off that, Sheryl, wondering if you could update us on Atlas? We understand Atlas in and of itself is not likely to be a major revenue driver, but we do see it as a strategically important piece of your tool set. Wondering if you could comment on agency adoption? Is it going according to plan? Are you happy with it? +Secondly, on SMB, just wondering -- the 80 events that you've held around the world. In terms of learning coming out of those, you talked a little bit about how folks get introduced as users and that makes sense. Is the tool set simple enough today for SMBs to grasp? Or, are there significant additions that you need to make to the tool set to accelerate the growth of SMB advertisers? Thanks very much. + +-------------------------------------------------------------------------------- +Sheryl Sandberg, Facebook, Inc. - COO [50] +-------------------------------------------------------------------------------- + + On the first, Atlas is really important because it's solving a measurement problem which is that the current systems for serving and measuring ads are really flawed. They basically assume that you are one person on one device, and we know that's not true. They're only about 65% accurate in demographic targeting. They don't work on mobile because they are cookie-based. They don't work on multiple devices. They don't go off-line to online, and they overemphasize the last click and reach. +And so, our focus with Atlas is helping people really understand the results they get with ads. You heard my Live Nation example earlier where we are able to connect Facebook ads and our platform directly to ticket sales. We never could have done that without Atlas measurement. +In terms of the migration process, this is an enterprise sale. We have to work client by client, then they have to choose us. Then, they have to migrate their systems. And so, it's going to take time. What really matters is that when we get that migration and we are seeing it, we are able to show them the value because it makes their buying much more effective because they understand real results in a new way. +In [tune] with SMBs I would say two things. One, our products aren't simple enough yet because they can never be simple enough for SMBs. But, two, our products are probably the simplest ones out there. And so, I think we're leading, and I think we have a lot more to do. If you look at even in the United States, which is a very advanced market, I think it's something like 35% of SMBs don't have a web presence of any kind. But, a great majority of those do have a Facebook page, and that's because setting up a web presence for an SMB is complicated and expensive. You can't just start a webpage, but it is easier and free to start a Facebook page until you see broad adoption. +We also make a lot of things that they couldn't do in other platforms available on us. So, over 1 million SMBs have posted a video on Facebook. Which is pretty amazing because I doubt 1 million SMBs have ever run what is a video or TV ad. That's because you can shoot it on your mobile device, you can upload it. You can do that for free, or you can pay us for the ad. And so, I think our tools are the simplest. But, I think we still need to do better because what we hear from SMBs is simple, fast, inexpensive, showing them real return, and we're going to continue to focus on all of those things. + +-------------------------------------------------------------------------------- +Operator [51] +-------------------------------------------------------------------------------- + + Eric Sheridan, UBS. Your line is open. + +-------------------------------------------------------------------------------- +Eric Sheridan, UBS - Analyst [52] +-------------------------------------------------------------------------------- + + I wonder if I could get an update on the e-commerce initiatives including the partnership with Shopify? And, how we should be thinking longer-term about e-commerce becoming a bigger and bigger part of the platform. Sheryl you called out Priceline.com and the booking relationship during your prepared remarks. Curious how far that might go longer term? Thanks. + +-------------------------------------------------------------------------------- +Sheryl Sandberg, Facebook, Inc. - COO [53] +-------------------------------------------------------------------------------- + + E-commerce is one of our top categories of advertisers, and we are already driving a lot of product sales through Facebook. But, importantly, our e-commerce initiatives are really about connecting consumers with marketers so that they can buy from companies. They are not buying through us. We are testing a buy button in the new shops section on pages, but again that buy button is letting people buy directly from their advertisers not from us. It's pretty early days. We're excited by what we see in the e-commerce vertical, and we're going to continue to invest in growing that vertical as part of our ads business. + +-------------------------------------------------------------------------------- +Operator [54] +-------------------------------------------------------------------------------- + + Brian Pitz, Jefferies. + +-------------------------------------------------------------------------------- +Brian Pitz, Jefferies LLC - Analyst [55] +-------------------------------------------------------------------------------- + + Questions on audience network. Any updates here including a sense for the level of adoption you're seeing from developers? Also, any synergies with the mobile app install product? And, finally, any comments on ad price comparisons to traditional newsfeed ads? + +-------------------------------------------------------------------------------- +Sheryl Sandberg, Facebook, Inc. - COO [56] +-------------------------------------------------------------------------------- + + We're seeing investment. We're investing in the audience network, and we think it's important because it takes -- it makes the ads more relevant. It's part of our overall Ad Tech push to bring the effectiveness and relevance of our ads off of. We're growing the number of advertisers and publishers, and we're continuing to see growth and we'll continue to invest. +When you think about mobile app install ads, those are an important, but relatively small, part of our revenue. The important thing to understand here is that they're not only used by developers, they're used by all four marketer segments. So, for example, HBO used our video retargeting mobile app install ads on Facebook to drive downloads at HBO now, and Facebook is now the number one channel driving subscribers. I think when people think about our mobile app install ads, they often think this only applies to developers and small companies. And really, it's them as well, but it's also companies like HBO which are using those ads to drive adoption and downloads. + +-------------------------------------------------------------------------------- +Deborah Crawford, Facebook, Inc. - VP of IR [57] +-------------------------------------------------------------------------------- + + Thank you for joining us today. We appreciate your time, and we look forward to speaking with you all again. + +-------------------------------------------------------------------------------- +Operator [58] +-------------------------------------------------------------------------------- + + Ladies and gentlemen, this concludes today's conference call. Thank you for joining us. You may now disconnect your lines. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/exam/original-files/Problem_1_Sample/2015-Nov-04-FB.OQ-139744337761-Transcript.txt b/exam/original-files/Problem_1_Sample/2015-Nov-04-FB.OQ-139744337761-Transcript.txt new file mode 100644 index 0000000..b5133c4 --- /dev/null +++ b/exam/original-files/Problem_1_Sample/2015-Nov-04-FB.OQ-139744337761-Transcript.txt @@ -0,0 +1,511 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q3 2015 Facebook Inc Earnings Call +11/04/2015 05:00 PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Deborah Crawford + Facebook, Inc. - VP of IR + * Dave Wehner + Facebook, Inc. - CFO + * Mark Zuckerberg + Facebook, Inc. - CEO + * Sheryl Sandberg + Facebook, Inc. - COO + +================================================================================ +Conference Call Participiants +================================================================================ + + * Justin Post + BofA Merrill Lynch - Analyst + * Ross Sandler + Deutsche Bank - Analyst + * Paul Vogel + Barclays Capital - Analyst + * Heather Bellini + Goldman Sachs - Analyst + * Mark Mahaney + RBC Capital Markets - Analyst + * Brian Nowak + Morgan Stanley - Analyst + * Eric Sheridan + UBS - Analyst + * Rich Greenfield + BTIG - Analyst + * Douglas Anmuth + JPMorgan - Analyst + * Mark May + Citigroup - Analyst + * John Blackledge + Cowen and Company - Analyst + * Anthony DiClemente + Nomura Securities Intl - Analyst + +================================================================================ +Presentation +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Good afternoon. My name is Chris and I'll be your conference operator today. At this time, I would like to welcome everyone to the Facebook third-quarter 2015 earnings call. +(Operator Instructions) +This call will be recorded. Thank you very much. +Ms. Deborah Crawford, Facebook's Vice President of Investor Relations, you may begin. + +-------------------------------------------------------------------------------- +Deborah Crawford, Facebook, Inc. - VP of IR [2] +-------------------------------------------------------------------------------- + + Thank you. Good afternoon and welcome to Facebook's third-quarter earnings conference call. Joining me today to talk about our results are Mark Zuckerberg, CEO; Sheryl Sandberg, COO; and Dave Wehner, CFO. +Before we get started, I would like to take this opportunity to remind you that our remarks today will include forward-looking statements and actual results may differ materially from those contemplated by these forward-looking statements. Factors that could cause these results to differ materially are set forth in today's press release and in our quarterly report on Form 10-Q filed with the SEC. Any forward-looking statements that we make on this call are based on assumptions as of today, and we undertake no obligation to update these statements as a result of new information or future events. +During this call, we may present both GAAP and non-GAAP financial measures. A reconciliation of GAAP to non-GAAP measures is included in today's earnings press release. The press release and an accompanying investor presentation are available on our website, at investor.FB.com. +And now I'd like to turn the call over to Mark. + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook, Inc. - CEO [3] +-------------------------------------------------------------------------------- + + Thanks, Deborah. And thanks, everyone, for joining us today. +This was another good quarter, and we continue to grow the size and engagement of our community. 1.55 billion people now use Facebook every month. And more than 1 billion people use Facebook every day. On mobile, we continue to have a lot of momentum. 1.39 billion people now use Facebook on mobile devices, including more than 1 billion on Android. 50 million people also use Facebook Lite, our app for people on low bandwidth connections and one of our fastest-growing interfaces. This is a great sign for how our mobile strategy continues to make progress across markets, devices, and platforms. +When it comes to our business, we're also pleased with our results. This quarter, total revenue reached $4.5 billion and advertising revenue grew by 45% from a year ago. We've already accomplished a lot this year, and these results show how we're getting stronger as a community and as a business. But we want to serve the entire global community, not just the people who are on Facebook today. Connecting everyone is one of the fundamental challenges of our time; and to achieve this, we need to continue innovating faster and investing for the long term. That means continuing to invest in our core products and services, as well as technologies and strategies that allow us to achieve a truly global reach over time. +Let's talk about how we're doing this. And let's start with how we're improving our core products to better serve our existing communities and businesses. This quarter, we introduced some big updates on Facebook to give people more options for expressing themselves. We began rolling out an improved mobile profile design, including the ability to add a profile video instead of just a photo. We also started testing Reactions, a new version of the Like button that provides more ways of expressing love, awe, and sympathy. We think this going to provide a much more engaging experience. +Another way we're working to improve people's experiences on Facebook is by helping them to share many different types of content with different groups of people they care about. One example is our progress with Groups on Facebook. More than 925 million people now use Groups each month; and in some countries, more than half of the population is participating. From a youth organization in Chicago to aid workers dealing with the refugee crisis in Europe, we've seen many inspiring examples of people using Groups to collaborate. +Video is another area where we continue to make progress. On average, there are now more than 8 billion daily video views on Facebook and more than 500 million people who are watching daily. To offer even more engaging video experiences, we've added live video to our Mentions app for public figures and we now support interactive 360 videos and news feed. We've also rolled out new video tools for Pages and begun testing a dedicated video section on Facebook. Over the next few years, video is going to be some of the most engaging content online. And by continuing to innovate here, we have a chance to build the best place to watch and share videos. +When it comes to serving businesses, we continue to create a lot of value. We now have more than 2.5 million active advertisers on Facebook, and more than 45 million small- and medium-sized businesses actively using Facebook pages. This quarter, we continued to focus on helping marketers achieve results while using our ad products, including video and carousel ads, as well as on Instagram. And, as usual, Sheryl can talk more about this in a moment. +Now let's talk about how we're working to develop our next generation of apps and services. For Instagram, this was a busy quarter. The community celebrated its five-year anniversary and reached a new milestone of 400 million monthly actives. More than 80 million photos are now shared on Instagram every day; and the pace of adoption among public figures, organizations, and people around the world continues to grow really well. When President Obama visited Alaska in September, he used Instagram to document his trip. And this is a great example of how Instagram is changing the way that people see the world. +With our efforts in messaging, we're also making progress at building WhatsApp and Messenger both into great platforms with global scale. Last quarter, WhatsApp reached 900 million monthly actives and continues to be on a path to reach 1 billion people and beyond. Messenger has over 700 million monthly actives and we continue to focus on improving the core messaging experience. A good sign of our progress is the more than 9.5 billion photos now sent monthly on Messenger. We're also building many different tools that can offer useful experiences to people beyond just traditional messaging. One example is M, a digital assistant we introduced this quarter that, over time, will use AI to help people complete tasks. +Finally, let's talk about some of our longer-term efforts in innovation to help connect the world. With Internet.org, we have a lot of momentum. We've now rolled out free basic internet services to people in 29 countries and overall brought more than 15 million people online. As we've rolled out the program, we've made a number of improvements based on feedback from communities and partners, including opening up our platform for free basic services to all developers who want to build. Meanwhile, our work on new technologies to connect people in the most remote regions continues to make progress. This quarter we revealed Aquila, our first aircraft designed to beam internet into communities down from the sky. And we also announced a partnership to bring internet to large parts of Sub-Saharan Africa, using a satellite which is launching next year. +And with Oculus, we're in a great position to begin delivering a new generation of shared immersive experiences. We plan to ship the Rift headset early next year; and Gear VR, our mobile product with Samsung, is going to have its first consumer release this holiday season, retailing for $99. And we also announced new partnerships with Minecraft, Netflix, and Twitch, and many other content partners. Virtual reality has the potential to be next computing platform that changes all of our lives. It's important also to recognize that this is going to grow slowly, like computers and mobile phones when they first arrived. So we're committed to Oculus and virtual reality for the long term. +So that's how we've continued to make progress on our strategy this quarter. The results we've achieved show that our investments are creating a lot of value for our community and the world. I just want to thank the entire Facebook community -- our employees, our partners and our shareholders -- for helping us to continue moving forward. We've done a lot, but there's always more to do. +And now I'm going to hand it off to Sheryl. + +-------------------------------------------------------------------------------- +Sheryl Sandberg, Facebook, Inc. - COO [4] +-------------------------------------------------------------------------------- + + Thanks, Mark, and hello, everyone. +We had an excellent third quarter. Results were strong across the board. Ad revenue grew 45% year over year, or 57% on a constant currency basis. Mobile ad revenue was $3.4 billion and grew 73% year over year. Mobile now makes up 78% of our total advertising revenue. Our business grew across all regions and marketer segments. Like last quarter, we saw especially strong growth in our North America and Asia-Pacific regions. Overall, we're really pleased with marketer adoption of our ad products around the world. +Our results show that we continue to make progress on our three priorities: capitalizing on the shift to mobile; growing the number of marketers using our ad products; and making our ads more relevant and effective. First, capitalizing on the shift to mobile. People have already shifted to mobile and this shift is driving engagement on Facebook. The average American adult spends 25% of their media time on mobile, and Facebook and Instagram together continue to account for over 1 in 5 minutes on mobile in the US. Businesses are lagging behind consumers in making this shift to mobile and we believe we're well-positioned to help them catch up. Facebook pages are already the mobile solution for millions of businesses. Pages now offer better messaging capabilities, call to action buttons, and new sections that enable businesses to highlight important information. +We're also capitalizing on the shift to mobile by expanding ads on Instagram. This quarter on Instagram, we introduced new ad formats and objectives, opened up our API, and launched self-serve ad capabilities. Instagram ads are now available in all countries where we offer Facebook ads, and marketers can manage campaigns across both platforms with the same targeting. We're really pleased with the marketer demand for Instagram ads. +Our second priority is growing the number of marketers using our ad products. In September at Ad Week, we announced that we have over 2.5 million active advertisers on Facebook. With more than 45 million active SMB pages on Facebook, we think there's a lot of opportunity to turn even more of these businesses into a marketers. Marketers come to Facebook and Instagram because we have the best performing mobile ad products, and video is making them even better. Marketers have always loved using videos to tell stories. +As Mark discussed, video is a natural and growing part of our mobile news feed experience. Video on Facebook gives marketers not just mass reach, but better cross-device targeting and measurement than we believe is available on any other platform. We're especially pleased with the breadth of marketers using video on Facebook, from brands to direct response to SMBs. Over 1.5 million small businesses posted video, which includes organic video posts and video ads on Facebook in the month of September alone. +Video ads complement TV ads. According to a recent study with Nielsen Research, marketers using Facebook ads with TV ads saw higher reach, ad recall, brand linkage, and likeability. To share one example, GMC used video and other ads on Facebook to extend the reach of their TV brand campaign highlighting their premium trucks and SUVs. The Facebook campaign drove a 13 point lift in ad recall and a 6 point lift in brand favorability. We recently introduced Target Rating Point, TRP buying, so that marketers can plan, buy, and measure video ads on Facebook the same way they do on TV. We're pleased with the feedback we're receiving on this from marketers and agencies. +Our third priority is making our ads more relevant and effective. We know relevant ads are more engaging for people and therefore drive better results for businesses. Products like carousel ads and dynamic product ads help improve effectiveness for marketers. Carousel ads show multiple images, and now videos, and drive 30% to 50% lower cost per conversion than single-image link ads. Dynamic product ads, which allow marketers to upload their product catalog, are driving ROI comparable to search. For example, Marriott uses DPA to retarget travelers based on their travel search habits, and they are now scaling globally across their portfolio of brands. LatAm e-commerce company Mercado Libre uses DPA to remarket over 38 million products in over 13 countries. Both are seeing high ROI and continuing to invest. +On the measurement side, Conversion Lift is helping clients see the real business results from their campaigns. Boost Mobile, a Sprint brand, showed ads to people eligible for device upgrades. Using Conversion Lifts, they were able to attribute a 4% lift in in-store sales to their Facebook campaign. +Finally, we're continuing to invest in ad tech across Atlas, LiveRail, and the Audience Network. This quarter, we expanded the ad format so publishers in the Audience Network can add to their mobile apps. On LiveRail this quarter, we began testing age and gender targeting. LiveRail can now deliver over 90% accuracy on age and gender segments across desktop, mobile web, and mobile apps versus a non-target rate of only 31% to 55% when not using LiveRail technology. +I want to take a moment to thank our clients around the world for their continued partnership and congratulate our global Facebook teams on great execution. Looking forward, we're going to stay focused on our priorities to continue to build a solid foundation for our long-term business. +Now here's Dave. + +-------------------------------------------------------------------------------- +Dave Wehner, Facebook, Inc. - CFO [5] +-------------------------------------------------------------------------------- + + Thanks, Sheryl, and good afternoon, everyone. +Echoing Mark and Sheryl's comments, Q3 was another strong quarter for Facebook. We generated $4.5 billion in revenue and over $1.4 billion in free cash flow. Growth in engagement of our community again provided a great platform for our strong financial performance this quarter. In September, we reached a new milestone, with over 1 billion people using Facebook on an average day, an increase of 17% compared to last year. This daily number represents 65% of the 1.55 billion people who used Facebook during the month of September. +Mobile continued to drive our growth. In September, approximately 1.39 billion people accessed Facebook on mobile devices, up 23% from last year. Additionally, our next generation of services continued to grow, with Instagram, Messenger, and WhatsApp now exceeding 400 million, 700 million, and 900 million monthly actives, respectively. +Now turning to the financials. All of our comparisons are on a year-over-year basis, unless otherwise noted. Additionally, our non-GAAP measures exclude stock-based compensation and the amortization of intangibles. Total revenue was $4.5 billion, up 41%, or 51% on a constant currency basis. Ad revenue was $4.3 billion, up 45%, or 57% on a constant currency basis. The strengthening of the US dollar continued to have an unfavorable impact on our revenue in Q3. Had foreign exchange rates remained constant with Q3 2014 levels, our total revenue would have been approximately $340 million higher. Regionally, US and Canada and Asia-Pacific were our strongest markets, producing ad revenue growth of 56% and 48%, respectively. Europe and Rest of World grew more slowly, at 33% and 29%, respectively, impacted by our currency exposure in both of those regions. +As Sheryl mentioned, mobile continued to drive our revenue growth. Mobile ad revenue was $3.4 billion, up 73% from last year, representing 78% of our advertising revenue. Revenue from ads served on personal computers was down approximately 8%. We have been very pleased with the sustained high growth of mobile advertising revenue. There are a number of important factors contributing to that growth, both from the supply and demand sides. +The drivers of year-over-year mobile revenue growth fell into three main categories. First, as Sheryl covered, we've continued to have success driving strong advertiser demand. Second, we've grown both the number of people using Facebook and the time that they spend with us. And third, the growth in advertiser demand and ad quality has enabled us to increase ad load over time. As we have grown mobile advertising, we have remained very pleased with overall engagement levels, user satisfaction with news feed, and the overall quality of the ads themselves. +Turning now to our overall price-volume metrics. In Q3, the average price per ad increased 61%, while total ad impressions declined 10% on a year-over-year basis. As I've indicated on prior calls, the changes in our reported price-volume metrics have been driven recently by the change in the number of right-hand column ads and the shift to mobile. These factors will have a less significant impact on the reported price-volume metrics going forward, now that a full year has elapsed since the redesign of right-hand column ads and now that mobile impressions have grown to become the majority of impressions. In fact, the quarter-over-quarter trends already point to that. In Q3, total ad impressions increased 7% sequentially and average price per ad increased 5%. +Total payments and other fees revenue was $202 million, down 18% compared to last year. The decline was expected and was driven by a reduction in payments revenue related to games played on personal computers. +Turning now to expenses. Our Q3 total GAAP expenses were $3 billion, up 68%, and non-GAAP expenses were $2.1 billion, up 51%. Similar to last quarter, stock-based compensation and amortization expenses related to the WhatsApp acquisition contributed significantly to the year-over-year growth in GAAP expenses. Non-GAAP expenses were driven by increases in headcount-related costs, cost of revenue, and marketing expenses. We ended Q3 with nearly 12,000 employees, up 44% compared to last year. We added over 1,000 employees to Facebook in the quarter and we are pleased with the continued strength in our recruiting efforts. +Our Q3 GAAP operating income was approximately $1.5 billion, representing a 32% operating margin. Our non-GAAP operating income was $2.4 billion, representing a 54% margin. Our Q3 GAAP and non-GAAP tax rates were 37% and 32%, respectively. Our Q3 GAAP net income was $896 million, or $0.31 per share, and our non-GAAP net income was $1.6 billion, or $0.57 per share. In Q3, capital expenditures were $780 million, as we continued to invest in servers, network infrastructure, and the buildout of data centers and other facilities to support the rapid growth of the business. We generated $1.4 billion of free cash flow and ended the quarter with over $15.8 billion in cash and investments. +Turning now to the revenue outlook. We remain focused on growing the number of people who use our services, increasing advertiser demand, and improving the quality and relevance of our ads. Across these dimensions, we continue to see healthy growth opportunities ahead for Facebook and Instagram. Given the strengthening of the US dollar over the past year, we will continue to face currency headwinds next quarter, particularly in Europe and Latin America. In addition, we expect our total payments and other fees revenues to decline sequentially from Q3 to Q4, similar to the trends that we have experienced over the last couple quarters. +Now turning to the expense outlook. We expect the year-over-year growth rate for total full-year 2015 GAAP expenses to be approximately 55% and for total full-year non-GAAP expenses to be approximately 50%. We anticipate our 2015 capital expenditures will be in the range of $2.5 billion to $2.7 billion. We continue to expect our 2015 stock-based compensation to be in the range of $3 billion to $3.2 billion, approximately half of which is related to our prior acquisitions, most notably WhatsApp. We expect amortization expenses for the full year 2015 to be approximately $700 million to $800 million. And lastly, we anticipate our Q4 and full-year 2015 GAAP and non-GAAP tax rates to be several percentage points above their respective Q3 rates. +In summary, Q3 was another strong quarter for Facebook. We are pleased with the growth and engagement of our community and the momentum in our business, which together support our ability to continue investing to build our next generation of services and execute on our mission of connecting the world. +With that, Operator, let's open up the call for questions. + + +================================================================================ +Questions and Answers +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Thank you. +(Operator Instructions) +Your first question comes from Eric Sheridan with UBS. Your line is open. + +-------------------------------------------------------------------------------- +Eric Sheridan, UBS - Analyst [2] +-------------------------------------------------------------------------------- + + Thanks for taking the questions. Mark, maybe one for you and one for Sheryl. For Mark, on virtual reality and Oculus, how do you see the development of the entertainment and content ecosystem around virtual reality playing out in 2016 and beyond? And what's the role Facebook's going to have to play in maybe seeding some of the content and entertainment side of VR. +And then for Sheryl, any color you can give us on Instagram? We've obviously seen a ramp-up now in advertising on the property. How the Company's thinking about ad load monetization, some of the opportunities and how those will be balanced against engagement. Thank you. + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook, Inc. - CEO [3] +-------------------------------------------------------------------------------- + + I can start off talking about Oculus and virtual reality. So the first thing that I want to stress here is that these kind of new platforms take a long time to develop. So we've said often that we think that virtual reality and augmented reality could be the next big computing platform. But just to put that in perspective and compare it to the development of previous computing platforms, like phones and computers, I think the first smartphones came out in 2003. And in the first year, I think BlackBerry and Palm Treo were the initial smartphones that came out. I think they each sold in the hundreds of thousands of units. So just to kind of give a sense of the time frame that we're thinking about this and how we expect this to develop, that's how we're thinking about that. +In terms of the actual content, first, we think gaming is going to be the most obvious market. There are around, I think, more than 200 million, almost 250 million people who have either an X-Box, a PlayStation or a Wii. And we think that that audience is going to the type of people who are going to be very excited about the type of experiences initially that you can have with virtual reality. And the advantage of that is also that some of those can be single player experiences. They don't require a big network effect or a lot of people having the technology or large installed base. +Once we start getting a bit further along with that, then the next thing that we think is going to be huge is video and immersive experiences, both things that people can create, like the social content that they share on Facebook today, and more professional and premium content, both short form and longer form. But we'll start to see some experimentation with that. There already is some very good content. But until there are millions of units out in the market, I don't expect that to be a big industry for folks to be investing a huge amount in in 2016. +Then when they're starting to get to be more units, just like every other major computing platform before that, what we expect is that a large portion of what people do in it will be communication and social behavior, and that's where Facebook really has the DNA and experience to, I think, build the best experiences. And we're investing in trying to figure out what that's going to look like. That's ultimately a lot of what we're extremely excited about for a number of years down the road. + +-------------------------------------------------------------------------------- +Sheryl Sandberg, Facebook, Inc. - COO [4] +-------------------------------------------------------------------------------- + + On Instagram, we think that with Facebook and Instagram, we now have the two most important mobile platforms out there. And what we bring to this is a common ads infrastructure. So Instagram ads, now that we've rolled out as we have this past quarter and gotten to a really good product offering, combine the creative format of Instagram, which is very visually compelling and has a lot of engagement from people, with the back-end infrastructure and marketer base that Facebook has. +So now we have self-service ads rolled out. We've rolled out in all countries where we offer Facebook ads. We have new ad formats for Instagram, all of which can use the same targeting as we have on Facebook and all of which are increasingly tapping into our measurement capabilities. On ad load, we have a lot of experience rolling out ads into feed-based products and we monitor it very carefully and we're going to continue to monitor really carefully. +We're also excited about how they work together. To share one example, American Express, working with Digitas, rolled out carousel ads on Instagram that targeted travel-related interest groups for people who are 18 years and older. They then retargeted those same people on Facebook. And what they created was a really visual journey, using both the format that is Instagram, the format that is Facebook and combining the two platforms with their targeting. We've think we're at the very beginning of what's possible when we combine these two. + +-------------------------------------------------------------------------------- +Operator [5] +-------------------------------------------------------------------------------- + + The next question is from Heather Bellini with Goldman Sachs. Your line is open. + +-------------------------------------------------------------------------------- +Heather Bellini, Goldman Sachs - Analyst [6] +-------------------------------------------------------------------------------- + + Great. Thank you. I had two quick questions, as well. One, Sheryl, just to follow up on what you mentioned about Instagram, obviously, it's a very visual experience. I'm just wondering, when you're talking to advertisers, are they viewing this as a separate channel? So I think there's been some questions as to the incremental nature of Instagram. It would seem like it could be extremely incremental, given these are the two top platforms in mobile. I was wondering if you could talk a little about what the advertisers say about blending the experiences. +And also, a question for Mark. I was just wondering if you could share with us how we might see your content strategy evolve over time and, in particular, just wondering what your view is on longer form content on the video side? Thank you. + +-------------------------------------------------------------------------------- +Sheryl Sandberg, Facebook, Inc. - COO [7] +-------------------------------------------------------------------------------- + + To the Instagram question, what we see in the short run is that some of the spend on Instagram is incremental to Facebook and some isn't. Some clients are comfortable with Instagram and bringing a new budget to bear. Some clients are shifting some of their Facebook budget. For us in the medium to long run, we believe that we're not competing between Facebook and Instagram. We're competing with other forms of media. And if you want the most eyeballs, and we think the highest ROI, over time we think that will benefit Facebook and Instagram. +So for us, what we really want is people to experiment and learn and get to experience Instagram as they have on Facebook so that we can make the case and prove the ROI. And then we believe if you look at the consumer metrics of where people were spending their time, we will be able to gain share compared to almost anything else you can buy out there. + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook, Inc. - CEO [8] +-------------------------------------------------------------------------------- + + And to your question about long form content, the more natural starting point for us is shorter form content, which can either be social content or premium short form content. But the vast majority of the content that's consumed on Facebook, just talking about video right now, is people browsing through feed, they discover something interesting that they weren't necessarily looking for previously. That's very powerful, because that's a behavior that there isn't really anywhere else to do at scale on the internet today in a great way. And then people watch it there or they bookmark it to watch later. +But if you're talking about watching inline and feed, that's not the place where you're necessarily going to see a TV show and then watch an hour-long clip right there. So what we're actually seeing is that a lot of the best -- or at least from my perspective -- TV shows that we see folks like Jimmy Fallon breaking up their show into clips that they can now share to be consumed over social media and on the internet in three- to five- or seven-minute segments, which are more of what people want when browsing through news feed. +I do think over time we will get to more different types of content and we'll build products that serve that. The current market of trying to help people share and experience all these shorter form clips is massive. We are nowhere near serving that as well as we want to. I actually think in a lot of ways, though, the more interesting question is not in the near term what we're going to do to develop ways to consume long form content, but what traditional media and content producers who have traditionally produced long form content are going to do to chunk their stuff up better, so that way it can be more easily consumed by this big community online. + +-------------------------------------------------------------------------------- +Operator [9] +-------------------------------------------------------------------------------- + + The next question is Douglas Anmuth with JPMorgan. Your line is open. + +-------------------------------------------------------------------------------- +Douglas Anmuth, JPMorgan - Analyst [10] +-------------------------------------------------------------------------------- + + Thank you for taking the question. One for Mark and then one for Dave. Mark, you recently spent time in China and India. I was hoping to get some of your key takeaways, both in terms of Internet.org and also about Facebook's potential in China. +And then secondly, Dave, was hoping to get some early thoughts on OpEx for 2016, at least perhaps qualitatively, if you could walk us through some of the puts and takes for next year, Oculus in particular. Thanks. + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook, Inc. - CEO [11] +-------------------------------------------------------------------------------- + + Sure, I can start off with the India and China question. They're very different situations. So India is a unique country where there are 1.25 billion people, more than 1 billion of them are not on the internet. It is the country in the world that benefits the most from connectivity. And there's a lot of research that we've seen and reports that third parties have put out that show that when you connect to places like India, it makes a very big difference socially and for the economy there. +A lot of us here, everyone we know is on the internet and we think about the internet as an entertainment and basic communication. But if you don't have access to a good school, then getting basic internet access could be your best educational information. Or if you don't have access to a good doctor, then getting access to the internet could be the only way that you can learn about how to avoid certain diseases or how to raise your kids and help them avoid certain diseases and find jobs and a lot of stuff. +What we find through the research is that for every 10 people that get connected to the internet, a little less than, or right around one person gets lifted out of poverty and one new job gets created. We're very focused on this. It's a huge priority for the Indian government. And anything that we can do to help there, we think is very good for the world and we're invested in that and we're happy to support. +And Internet.org in India now, there are already more than 1 million people who now have access to the internet who didn't otherwise, because of our efforts. So we're proud of that. But obviously, that's still very early on. We're only working with one operator currently and part of the country, so there's a lot of room to expand that. And that's just a big opportunity for the internet overall and for India over the next decade, and we hope to play a role in that. +On China, that is a more complex situation. Obviously, you can't have a mission of wanting to connect everyone in the world and leave out the biggest country. So over the long term, that is a situation that we will need to try to figure out a way forward on. For now, the thing that I would leave you with is that people think that Facebook isn't in China at all, and that's actually not true. +Our consumer service isn't active there, but it actually is already one of the biggest advertising markets that we have. Because there are a lot of really big and important Chinese companies who sell a lot of products to people outside of China. And they use Facebook as one of their primary tools, in a lot of cases, to spread information about what they're doing and grow their customer base. So we're happy to do whatever we can to help develop the economies in both of those countries and they're both long-term efforts for us. + +-------------------------------------------------------------------------------- +Dave Wehner, Facebook, Inc. - CFO [12] +-------------------------------------------------------------------------------- + + Doug, on your question on 2016, yes, we're not going to, obviously, give specific guidance at this time. That will be coming with our Q4 call. But we're focused on continuing to invest heavily in the business across our near-, mid- and long-term opportunities, and we see a bunch of great opportunities to invest there. So in the near-term, we're focused on growing the community and executing on our existing business. In the medium term, we're focused on those next generation of services, Instagram, Messenger and WhatsApp. And in the long term, we've got the investments we're making in things like artificial intelligence, VR, and obviously, the Internet.org efforts that Mark just spoke about. +Specifically with regards to Oculus and how that could impact the plan for next year, we're, as Mark said, very bullish about the long-term opportunity for VR and excited about the launch for Rift next year. But VR is still very much in the development stage, so it would be early to be talking about large shipment volumes. + +-------------------------------------------------------------------------------- +Operator [13] +-------------------------------------------------------------------------------- + + The next question is from Brian Nowak with Morgan Stanley. Your line is open. + +-------------------------------------------------------------------------------- +Brian Nowak, Morgan Stanley - Analyst [14] +-------------------------------------------------------------------------------- + + Thanks for taking my questions. I have two, one for Mark and one for Sheryl. Mark, can you talk a little about what factors and metrics you consider when you're thinking about a multi-app strategy versus rolling out more products and offerings on Facebook? There's a difference in Facebook Paper, Messenger, the video viewer on the platform. Just be curious how you think about multi-app versus adding more functionality to the mother ship. +And then for Sheryl, it sounds like there's still a lot of SMBs on the platform that are not yet paying advertisers. Can you talk about some of the biggest hurdles you need to overcome to get more SMBs paying and initiatives you have in place? Thanks. + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook, Inc. - CEO [15] +-------------------------------------------------------------------------------- + + So I can talk to the multi-app question first. So we view the social space as almost this matrix. You can think about it as a two dimensional grid, where there's one axis is the richness of the content that people want to share. Then the other axis is the size of the audience, or intimacy of how people want to share. So on the first axis, you get everything ranging from text to links to photos to videos to immersive 360 videos and virtual reality content, and this progression. And on the other axis, you get everything ranging from one-to-one messaging to small group communication to communicating with all your friends at once to big interest groups to completely public. +And what we believe is that you can intersect at any point on that, and there will be something interesting to build. So a small group product for sharing video, that's like -- that's going to be a thing. A one-on-one product for sharing text or calling, that's clearly a thing. A public sharing and consumption product for video, that's a thing. And what we've tried to do is basically figure out the areas that we think are open and are not currently served by the set of products that the industry has built and figure out a way to offer those. +So one of the big opportunities that I'm really excited about right now is I think that there's a pretty big opening between very private messaging, kind of the one-on-one messaging products like Messenger and WhatsApp, and products like Facebook, where you share with all your friends at once, or Instagram, and in between there, what we're seeing is this huge growth of private groups. And Groups remains one of the, I think, least talked about products on Facebook. But I just said earlier that we have more than 900 million people are using that every month. It's a huge thing and it's a big area that we can develop going forward. +So we experiment with all these things in terms of some of them make sense to naturally have inside the Facebook app because you're using the same set of friends and network and connections. Some of them get clear value by being separate, like Messenger, for example, where we can make sure that everyone has their push notifications turned on, which is extremely important for our messaging app. But overall, there's just a lot of stuff in this space and the amount that people want to share and communicate is boundless. And that's I think partially why we're seeing the growth that we are with so many of these products. + +-------------------------------------------------------------------------------- +Sheryl Sandberg, Facebook, Inc. - COO [16] +-------------------------------------------------------------------------------- + + On SMBs, I think it's one of the most compelling opportunities we have for Facebook. And that's because I think we solve a really big problem for SMBs, which is how are they going to reach customers. In the United States, which is usually the most advanced market, 35% of small businesses have no web presence at all. And building a mobile presence is even harder than a web presence, because most people don't use the mobile web, and mobile apps are expensive to build and hard to get people to use, especially if you're a small business. +That's why there are 45 million SMB pages on Facebook. These are people who are using Facebook and this free product to create an online and increasingly, a mobile presence. And then our job is to make sure that free product works for them and then over time, bring them into our paid products. +We have 2.5 million advertisers and over 80% of them started on Pages and then started with simplified ad products; and that's what we've done over time and will continue to do that. And what you see is that it's as easy for them to use it as profile and we can give them opportunities to do things they otherwise couldn't do. So to what I said in my transcript before, 1.5 million SMBs posting videos in one month alone. 1.5 million SMBs have not posted or created video on any other platform. But with us, it's cheap, it's very easy to use, and that gives us a way to continue to work with SMBs and increasingly grow our business with them. + +-------------------------------------------------------------------------------- +Operator [17] +-------------------------------------------------------------------------------- + + The next question is from Justin Post with Bank of America Merrill Lynch. Your line is open. + +-------------------------------------------------------------------------------- +Justin Post, BofA Merrill Lynch - Analyst [18] +-------------------------------------------------------------------------------- + + First one, Mark, could you talk a little about how much activity you see around Events on Facebook and maybe your views on whether Facebook could benefit from political activity or advertising? And then Sheryl, could you talk a little bit about where ad loads are today? Is there still room there? And also just what your feedback you're getting on advertiser ROIs, is there still more room there? Thank you. + +-------------------------------------------------------------------------------- +Dave Wehner, Facebook, Inc. - CFO [19] +-------------------------------------------------------------------------------- + + I'll start with the question on ad load. It's Dave. And then Sheryl can follow up on the political question. So Justin, over time, ad load has been one of the factors driving year-over-year growth. It's just worth noting that it is up significantly from where we were two years ago. Looking forward, we continue to feel like there are good opportunities to grow the business. I talked about the three factors that contributed to growth this quarter, ad demand, users and engagement, and ad load. And we see all of those continuing to be factors for growth going forward. And then Sheryl, did you want to take the question on the political? + +-------------------------------------------------------------------------------- +Sheryl Sandberg, Facebook, Inc. - COO [20] +-------------------------------------------------------------------------------- + + And I'll take Events, too. Just as Mark said with Groups, Events are growing quickly on Facebook. We don't break out by product, but we're pleased with the growth. +On the elections and political activity and political advertising, we're excited about the elections, because we think we give politicians and people a really compelling way to interact. If you wanted to feel like you were interacting with someone running for office before, you had to go to a town hall meeting. And increasingly, that's happening on Facebook. Between January 1 and October 7 of this year, over 68 million people on Facebook in the US made over 1 billion interactions about the campaign alone. And every candidate and every member of Congress is on Facebook now. +In terms of the revenue impact, no one vertical drives our business. We have a very large and diversified business. But we think we offer something pretty compelling, which is the reach of Facebook with very unique targeting. So on Facebook, you can target an ad by district, by interest. Ben Carson ran 240 different ads targeted at different audiences. And so we're starting to see candidates use our platform to communicate, to advertise and to share. + +-------------------------------------------------------------------------------- +Operator [21] +-------------------------------------------------------------------------------- + + Next question is from Anthony DiClemente with Nomura. Your line is open. + +-------------------------------------------------------------------------------- +Anthony DiClemente, Nomura Securities Intl - Analyst [22] +-------------------------------------------------------------------------------- + + Thank you very much. Mark, on the subject of media content on Facebook, it seems like the big opportunity is for Facebook to be the portal with which to access the short form video content that you mentioned earlier, and maybe the idea is to keep the consumption of that content in line or inside the Facebook wall, the garden. So the follow-up question that I would have is how do you think you could best partner with the media providers and convince them the merits of bringing their valuable, in some cases expensive, content into the Facebook world, particularly at a time in media when they're really trying hard to guard their own existing ecosystems? +And then a question for Sheryl. I wonder if you could just touch on the relative growth of branded advertising versus direct response ads. You mentioned Total Ratings Point buying. Can you help us think about the mix of branded versus DR? And for you, do you think that DRP buying and video is going to shift your ad mix more towards branded over time? Thanks. + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook, Inc. - CEO [23] +-------------------------------------------------------------------------------- + + I can talk about video and the business model around that. So you're definitely right that there's a certain class of content which is only going to come onto Facebook if there's a good way to compensate the content owners for that. And we've recently rolled out the business model for this, which is for premium content, we'll give a revenue share on a portion of the views to the content owners. And we've got good feedback so far on that. We're working with a small set of partners to start, and we'll roll it out beyond that as that keeps on going. +But it's important to keep in mind that there are a few different reasons why people share content on Facebook, and that's just one of the use cases. So there are a lot of people who are sharing content socially, because they want to get a message out. That may not be business motivated. +There are a lot of folks who are business motivated, but who primarily post content in order to promote something or gain distribution for something and that, you can gain value without some kind of rev share. And that's why the video ecosystem has grown so quickly, even before we rolled out a revenue share. +And now the third class of content, which I think is going to be important, and increasingly important over time, is the one that you basically want to essentially trade the content for money. And that is one where you need the rev share to unlock that. But we're getting good feedback on that upfront. So we're looking forward to seeing how that trends. + +-------------------------------------------------------------------------------- +Sheryl Sandberg, Facebook, Inc. - COO [24] +-------------------------------------------------------------------------------- + + On to our marketer segments. We don't break out by segment, but all of our marketer segments are growing. We're seeing strong growth in brand. And we believe that's because we're delivering on the promise of personalized marketing at scale. We've worked hard on things that will help brand purchasers feel comfortable on the platform and measure their ROI. So that's where TRP buying comes in, allowing people who usually buy TV ads to plan, buy, measure Facebook ads the same way enables an apples-to-apples comparison that we believe is very strong for our ROI. We've also worked on brand awareness optimization, mobile polling to measure campaign effectiveness, and we're working client by client. +Our other segments are growing, as well. We're working hard in the direct response area, rolling out things like carousel ads and dynamic product ads. And one thing that's worth understanding is that all of these different marketer segments often work together. To share one example, Ikea wanted to boost their online sales when their stores were closed. So in Norway, most retailers are closed Saturday to Sunday night. So they invested in carousel ads and only showed them when their stores were closed. And they turned a $35,000 investment in carousel ads into $2 million in sales, which happened precisely when they want it to happen. That's a direct response ad buy, because it's very specific, carousel ads product. But it's also a brand play for them, as they strengthen their brand and get people to interact with them as they want them to. + +-------------------------------------------------------------------------------- +Operator [25] +-------------------------------------------------------------------------------- + + The next question is from John Blackledge with Cowen and Company. Your line is open. + +-------------------------------------------------------------------------------- +John Blackledge, Cowen and Company - Analyst [26] +-------------------------------------------------------------------------------- + + Great. Thank you. Two questions. With the explosive video consumption growth and growth in public content being consumed in the news feed, could engagement perhaps materially increase from current levels over the next couple years? +And then on WhatsApp, as it heads towards 1 billion [miles], and/or greater, could you give us a sense of how you're thinking about monetization of that platform and perhaps timing of the monetization? Thank you. + +-------------------------------------------------------------------------------- +Dave Wehner, Facebook, Inc. - CFO [27] +-------------------------------------------------------------------------------- + + On engagement, John, I think we're obviously focused across a number of different dimensions to drive engagement. Videos had a big contribution there. So that's certainly been helpful in terms of making news feed even more engaging and we'll continue to be focusing on a number of initiatives, public content and just sharing with your friends. So there's lots that we are working on engagement to continue to derive time spent. +On WhatsApp, I don't think there's a particular magical number with 1 billion users. The focus really for our messaging products is to continue to drive user growth and continue to build great products that are fast, useful, engaging and fun. And on that front, they're both doing great. Messenger has over 700 million users and WhatsApp, obviously, has over 900 million users. So the business side is not the main focus right now. We believe there are going to be opportunities as we further scale those properties. + +-------------------------------------------------------------------------------- +Operator [28] +-------------------------------------------------------------------------------- + + The next question is from Paul Vogel with Barclays. Your line is open. + +-------------------------------------------------------------------------------- +Paul Vogel, Barclays Capital - Analyst [29] +-------------------------------------------------------------------------------- + + Great. Thanks. Two questions. One, big picture, Mark, there's a lot of debate around what content is appropriate for Facebook to block and not block. I'm wondering if you could talk a little about how you decide what to censor and not censor in terms of on the content side. And then less big picture, but just in terms of fourth quarter, given it's a big retail quarter, any increased testing around direct retail on the platform? Thanks. + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook, Inc. - CEO [30] +-------------------------------------------------------------------------------- + + I can answer the policy question, and then I guess Sheryl will take the other one. The guiding principle for us on this is that we want to give the most voice to the most people. And the idea is that there are all these different barriers that any given person has to being able to share and express everything that they want, from technical barriers -- it's really hard to communicate with someone if you're not on the internet and they're far away -- to product barriers -- it's hard to share videos if we don't have a good product for sharing videos -- to legal barriers -- it's hard to share content that your government says is illegal for you to share. And at the end of the day, there's also policy, and you're in a community and we have community standards for how we think people should communicate in order to be safe. +Because even if you have all of the internet connectivity and the products and the legal framework that you need, if you don't feel safe saying what you want to express, then you're probably not going to share it. And we see a lot of that online and that's a pretty big issue. Everything from bullying to terrorism, there are lots of reasons why people might otherwise have the tools to share what they would want, but feel silenced. And that isn't giving the most voice to the most people. So we feel a responsibility to have policies for our community which limit hate speech and limit things which are going to create just an overwhelmingly uncomfortable environment for people that is going to silence other people's speech, in order to make sure that over the long term we are enabling the most people to be able to express as much as possible as they can. And that's the philosophy that we have. + +-------------------------------------------------------------------------------- +Sheryl Sandberg, Facebook, Inc. - COO [31] +-------------------------------------------------------------------------------- + + On commerce going into the holiday season, commerce is a really important vertical for us and we're working hard to make our ads more effective. So what we're seeing from DPA ads and carousel ads, we're really happy with. We're seeing lower cost per conversion when people do multiple objectives and video. We're seeing lower post per click than single image link ads. And importantly, we're also creating better experiences for people. +Because when an ad is more targeted, more relevant, when you see a product you're interested in or a service you're interested in, that's a better experience. So we go into the holidays feeling that we have a really strong product offering, certainly the best product offering we've ever had, to connect people to the products they're going to buy this holiday. + +-------------------------------------------------------------------------------- +Operator [32] +-------------------------------------------------------------------------------- + + The next question is from Rich Greenfield with BTIG. Your line is open. + +-------------------------------------------------------------------------------- +Rich Greenfield, BTIG - Analyst [33] +-------------------------------------------------------------------------------- + + Hello. Thanks for taking the question. When you look at ad quality, I think when Facebook started, Sheryl, you were really adamant that you were focused on improving the ad quality and really making sure you were serving the highest quality ad to the right person. When you look at Instagram, I felt like you took incredible care to make sure that the advertising, like every ad was of the highest quality. As you've opened up the API, there's a tremendous amount of ads, some of them incredibly good quality, but some of them of lesser quality. How do you work to make sure that Instagram maintains what you started it with, which is incredibly beautiful ads that fit the platform, and so that you don't get criticized by users for pushing, not so much the amount of ads, but the type of ads? + +-------------------------------------------------------------------------------- +Sheryl Sandberg, Facebook, Inc. - COO [34] +-------------------------------------------------------------------------------- + + You're right that quality is really important to us. Because your experience on Facebook or Instagram is about the quality of what you see, both in terms of the organic posts you see from your friends or public people you're following and the ads, as well. And what we do is we monitor it carefully. We ramp slowly. We monitor engagement sentiment, quality of ads. We get a lot of feedback directly from people who use Facebook. They can X out the ads. If they do, we ask them why they're X'ing out the ads. And we just continue to monitor the metrics. +We're pleased with what's happened with quality on our platform overall. And a lot of the product innovations and investments I've been talking about on this call feed into quality. The carousel ads, they're not just that they're showing multiple products, it's that they're showing products that are more specifically directed at the person. And so a lot of the underlying things we do to build our ad systems don't just feed into revenue, they feed into quality. And that's important, because over the long run, our quality today is our revenue tomorrow. + +-------------------------------------------------------------------------------- +Operator [35] +-------------------------------------------------------------------------------- + + The next question is from Mark May with Citi. Your line is open. + +-------------------------------------------------------------------------------- +Mark May, Citigroup - Analyst [36] +-------------------------------------------------------------------------------- + + Thanks. I had two, if I could. We noticed a very impressive acceleration in user MAU growth, I'm focused on in the quarter. It seemed like it was pretty much in every region of the world. What, if anything, can you attribute that to? I know that you seem to be running more TV ads, at least where I live. But wonder if anything you could attribute that to. +Secondly, again on video, as more and more people and businesses are uploading video, I assume that there's a lot of good video content on Facebook, but I don't see all of it. Question is really around video discovery. What strategies do you have going forward to improve video discovery from what is today more of a push based model to something that may be akin to a pull based model where I can enjoy all the great video content that's on Facebook? Thanks. + +-------------------------------------------------------------------------------- +Dave Wehner, Facebook, Inc. - CFO [37] +-------------------------------------------------------------------------------- + + Hello, Mark, it's Dave. Just on the user growth point, we're obviously pleased with the growth we're seeing across the globe. In terms of DAU growth, the three largest countries were India, the US and Brazil. So we're seeing good, diversified growth. +Specifically, we've made a lot of initiatives to help improve and invest in the Facebook experience in emerging markets, and that has helped drive some of the acceleration and growth. So we've made a number of product and performance investments there, with Facebook Lite being a good example of that. The question then was on video and discovery. + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook, Inc. - CEO [38] +-------------------------------------------------------------------------------- + + And also just on the growth point, I just think the team that's working on that is executing extremely well. Sometimes it's not that you came up with some brilliant strategy, it's just like really good work consistently over a long period of time. And I think they are. +On video, yes, right now the strength in our system is definitely through helping people discover content that they hadn't really asked for through news feed. And a lot of I think what we need to do is give people a way to see all of the videos that page that they like or follow is interested in sharing on Facebook. And that's -- there's a pretty clear road map of stuff we're going to do over the next couple of years that I'm quite excited about to add some more dimensions to the video experience on Facebook. But we're just so early in this right now. It's pretty amazing how quickly it's growing, but there's a lot more to do. + +-------------------------------------------------------------------------------- +Operator [39] +-------------------------------------------------------------------------------- + + The next question is from Ross Sandler with Deutsche Bank. Your line is open. + +-------------------------------------------------------------------------------- +Ross Sandler, Deutsche Bank - Analyst [40] +-------------------------------------------------------------------------------- + + Great. I just have one for Sheryl. Sheryl, you mentioned that Marriott and Mercado Libre are both using DPA and seeing comparable ROI to paid search. That's a pretty incredible data point. So I guess the question is, what kind of lift in ROI and overall budget do you see as e-commerce or travel marketers migrate from your first few products, like custom audiences and other, to DPA? And are the yields that you're getting from DPA ads higher than other formats, like video and app downloads and those types of things? Thank you. + +-------------------------------------------------------------------------------- +Sheryl Sandberg, Facebook, Inc. - COO [41] +-------------------------------------------------------------------------------- + + Our goal is to give marketers the highest return they can and over time, to capture the amount of budget that's equivalent to the percentage of media time we capture. And we're not there. Consumers have shifted to mobile and consumers have moved to Facebook and Instagram more quickly than ad budgets, and that's the opportunity we have in front of us. +What product you use really depends upon what you're trying to do. If you're trying to tell a brand story, then you want to do a video ad. If you're trying to sell a direct product, then you want to use DPA ads. And all of these products and all of the underlying targeting, like custom audiences, are designed to help people meet different objectives. And we're trying to be really clear on that. If you're trying to move a brand objective, if you want to move favorability or brand sentiment, we can do that. And that's often a video ad or one of our branded ads or you optimize for brand awareness. If you're trying to sell a product, you might want to use carousel ads or dynamic product ads. And the targeting that is custom audiences underlies all of our product offerings. So our goal is to have lots of different things we can do for our marketers and measure them really deeply all the way through to business results. + +-------------------------------------------------------------------------------- +Dave Wehner, Facebook, Inc. - CFO [42] +-------------------------------------------------------------------------------- + + And Ross, you just asked about yields. The way the auction system works, it's going to be just be whatever is the ad that is going to necessarily have the best return is going to win in the auction. So it doesn't necessarily mean you're paying a premium for a given product. And so if we've got a good DPA ad, that might win in the auction for a given user. + +-------------------------------------------------------------------------------- +Deborah Crawford, Facebook, Inc. - VP of IR [43] +-------------------------------------------------------------------------------- + + Operator, we have time for one last question. + +-------------------------------------------------------------------------------- +Operator [44] +-------------------------------------------------------------------------------- + + Certainly. The final question is from Mark Mahaney with RBC Capital Markets. Your line is open. + +-------------------------------------------------------------------------------- +Mark Mahaney, RBC Capital Markets - Analyst [45] +-------------------------------------------------------------------------------- + + Okay. Let me try going back to future use cases, and Mark, I think this was touched on a couple times. Can you talk about whether you're seeing greater attempts to do search, the search functionality on the site and how that could change over the next three to five years, and also comment on news and to the extent to which you're seeing a rising utilization by regular users of Facebook as a way to get news and what you can do to make that even easier for people, if that's something, a behavior you want to facilitate? Thank you. + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook, Inc. - CEO [46] +-------------------------------------------------------------------------------- + + Sure. So on search, we already have one very big use case, which is people basically using our search engine to look up pages and people who are on Facebook. And that by itself is already one of the biggest search engines in the world. +The next big use case that we've really been working on for a couple of years now and I think is going to -- is starting to roll out and is growing quickly is people finding content on Facebook. So that's Trending. It's people finding posts that their friends or others had posted on news feed that they saw but might want to go check out later. And I think this is going to be a very important part of the video experience, as well, because one half is push, going to news feed and not asking for content, but just coming across and discovering it. And then the other half is pull and going to some experience where you're asking for some type of content. And getting to a point where we can do that very well is just going to add a whole new dimension to the service. +So that's something I remain very excited about. In some ways, it's taken a little bit longer than I'd expected to get to a point where it's growing quickly. The people and page look up part is doing very well. The post part has taken a bit longer, but I'm very excited about that going forward. +In terms of news, the biggest issue with news today in Facebook is that it is the slowest part of the experience. You go to load a video and it loads quickly. We made it auto play to load even quicker. You tap on a photo, you expect it to expand immediately. But you tap on a link and often, it can take 10 seconds to load. And if you're on a 2G connection somewhere in the developing world, it could take 30 seconds to load. +The big initiative that we have here, which I'm really excited about, is Instant Articles. And the big thing that that does is just it lets publishers basically put the content on our servers ahead of time, and that way, when people tap on it, it loads instantaneously, and it can be a much more immersive experience. And we've already found, from the initial experiments that we've done, that the engagement is positive, and we're starting to roll that out more broadly. I think that's going to be a really big deal for improving the experience of reading news on Facebook, and it's something that we've been working on for a while and I'm very excited about it. +So yes, I would expect that we will see an expansion of sharing and consumption of all of the different types of things that you asked about, news, video, search and the different experiences there. And these are some of the big areas that we're investing in. And they're long-term investments and they're big investments and we're going to keep on pushing on them. But I think that's what we need to do to serve our community well and ultimately connect everyone in the world. So thank you, guys. + +-------------------------------------------------------------------------------- +Deborah Crawford, Facebook, Inc. - VP of IR [47] +-------------------------------------------------------------------------------- + + Great. Thank you for joining us today. We appreciate your time and we look forward to speaking with you again. + +-------------------------------------------------------------------------------- +Operator [48] +-------------------------------------------------------------------------------- + + Ladies and gentlemen, this concludes today's conference call. Thank you for joining us. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/exam/original-files/Problem_1_Sample/2015-Oct-14-BAC.N-139658820022-Transcript.txt b/exam/original-files/Problem_1_Sample/2015-Oct-14-BAC.N-139658820022-Transcript.txt new file mode 100644 index 0000000..16766d4 --- /dev/null +++ b/exam/original-files/Problem_1_Sample/2015-Oct-14-BAC.N-139658820022-Transcript.txt @@ -0,0 +1,883 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q3 2015 Bank of America Corp Earnings Call +10/14/2015 08:30 AM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Brian Moynihan + Bank of America Corporation - Chairman of the Board and Chief Executive Officer + * Lee McEntire + Bank of America Corporation - SVP of IR + * Paul Donofrio + Bank of America Corporation - CFO + +================================================================================ +Conference Call Participiants +================================================================================ + + * Thomas LeTrent + FBR Capital Markets - Analyst + * John McDonald + Bernstein - Analyst + * Eric Wasserstrom + Guggenheim Securities LLC - Analyst + * Nancy Bush + NAB Research - Analyst + * Mike Mayo + CLSA Limited - Analyst + * Glenn Schorr + Evercore ISI - Analyst + * Ken Usdin + Jefferies LLC - Analyst + * Matt O'Connor + Deutsche Bank - Analyst + * Steven Chubak + Nomura Securities - Anayst + * Betsy Graseck + Morgan Stanley - Analyst + * Jim Mitchell + Buckingham Research Group - Analyst + +================================================================================ +Presentation +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Good day everyone and welcome to today's program. (Operator Instructions). Please note this call is being recorded. +It is now my pleasure to turn the conference over to Mr. Lee McEntire. Please go ahead, sir. + +-------------------------------------------------------------------------------- +Lee McEntire, Bank of America Corporation - SVP of IR [2] +-------------------------------------------------------------------------------- + + Good morning. Thanks to everybody on the phone; thanks on the webcast for joining us as well. Welcome to our third-quarter results. Hopefully everybody has had a chance to review the earnings release. It is only available on the Bank of America investor relations website. +So before I turn over the call to Brian, let me just remind you we have our new CFO that will be going through the results this morning, Mr. Paul Donofrio. And so we will -- we may make some forward-looking statements. For further information on those please refer to either our earnings release documents on our website or our SEC filings. +So with that I will turn it over to Brian. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman of the Board and Chief Executive Officer [3] +-------------------------------------------------------------------------------- + + Thank you, Lee, and good morning everyone and thank you for joining us to review our third-quarter results. +Today we reported $4.5 billion in after-tax earnings or $0.37 per diluted share. When we think about the quarter, the key messages we continue to make good progress in a tough revenue environment due to low interest rates and a sluggish economic recovery. In addition with the late summer's volatility especially in the fixed income trading markets, are remaining challenging but with that we produced another good quarter of progress in all of the businesses. +Before Paul takes you through the details of the quarter, I want to provide a little context from my vantage point. We have continued to make progress toward our full earnings capacity here at Bank of America and this quarter represents the fourth consecutive quarter of solid results following the resolution of our large legacy exposures in the third quarter of last year. When you think about it over the last four quarters we have reported over $16 billion in after-tax income. That compares to the previous four quarters leading up to the third quarter of 2014 of about $5.2 billion, including the significant litigation cost. +Returns over the last four quarters in aggregate have generated an ROA of about 76 basis points and a 10% return on tangible common equity. This quarter we were able to keep the absolute level of our balance sheet flat to the second quarter. But by doing that we continue to replace discretionary assets with good core customer loans and we believe that is a very good trend. We continue to build record liquidity and we believe we are well positioned against the 2017 LCR requirements. +Our capital is again at record levels and we returned over $3 billion back to shareholders so far this year through common share repurchases and dividends. +Our tangible book value per share improved this quarter to $15.50. It is the highest level in many, many years. +So I want to spend a couple more minutes focusing on a few drivers in our business. Our teams here at Bank of America are focused on the everyday engagement with our customers, deepening relationships by growing the core of things we do with them deposits, loans, managing their risks, helping them invest their assets all while keeping our costs down and you can see that in our results. +When you think about our deposit franchise, we grew $50 billion in deposits over the last year on an all organic basis. That in and of itself is a large bank. As a reminder, our Consumer franchise is the largest retail bank in the United States. In our Consumer Banking business as you can see, we grew revenue and earnings year-over-year despite the low interest rate environment. +We have been restructuring our branch structure selling some branches, closing some branches and changing account structures and with that this quarter our core consumer checking accounts continue to grow. We grew those accounts and improved the percentage of those customers who use us as a primary bank and importantly the average balance per account continues to grow. +On cards, on credit cards, we issued another 1.3 million credit cards this quarter and active accounts continue to grow. The good news is we are doing it through the lowest cost possible through our core franchise, much lower than other means of growth. +When you go to the change in our financial services business for mobile and digital banking, we now have 18.4 million active mobile customers and 31 million active online customers. Digital sales this quarter were up 30% over last year. More customers are using mobile device to deposit checks and access their accounts and now are starting to buy products as well as book appointments. To get a sense of that, we are now looking 15,000 appointments a week off of our mobile devices. +Our Merrill Lynch teammates who work within our Consumer business helped push us through a new standard of 2 million accounts this quarter. +When we go to our Wealth Management business, this business is showing the effects of lower market valuations pressuring revenue but activity here has reflected good long-term flows, good deposit flows and good loan growth. In addition, we continue to invest in long-term growth in this business, more advisors, better products and better advice in building and preserving wealth for our clients and these clients continue to use the full range of our products including banking products. +As we have switched to our commercial banking business, the business we call Global Banking, loans to commercial and corporate clients around the globe grew nicely from last quarter and the year ago quarter. Although investment banking fees were down year-over-year, the industry fee pools appear to be down as much or more. We maintained our leadership across many of the products. +In our Global Markets business despite the challenging market conditions in the late August and September timeframe, we reported $1 billion in after-tax earnings in that business. Excluding DDA impacts, this is the best third quarter in earnings for this business we have seen in recent memory. +Our net interest income in the Company is benefiting from loan and deposit growth showing momentum this quarter after you exclude the impact of FAS 91. +Focusing on expenses which we've talked to you much about, we continue to hold our costs in check. Expense less litigation LAS costs remain well below the $13 billion threshold of $12.7 billion and that was in line with our second quarter despite the additional cost of CCAR and additional investments in the business. +We are taking the benefits of our simplify and improve program which keeps our costs flat while we continue to invest in customer facing client people to grow our businesses. This ability to invest in growth is key to driving our franchise forward. +When you go to the risk side of the house, credit risk remains very strong, market risk remains subdued and we get a great return on that VAR as you look at it across the competitors. We continue to feel good about our legacy exposure risk and LAS business continues to work itself down. +So in the context of the environment we faced, we are operating what we feel is a solid quarter and as evidenced the continuing progress on our strategy, our strategy of responsible growth with our customers. +With that, let me hand it over to Paul. + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [4] +-------------------------------------------------------------------------------- + + Thanks, Brian. Good morning, everybody. Starting on slide three, we present the summary of our income statement and returns for this quarter as well as Q2 and Q3 last year. As Brian said, we earned $4.5 billion in the quarter compared to a loss of a couple hundred million dollars last year and earnings of $5.3 billion in Q2. Earnings per share this quarter were $0.37. +Let me mention a few larger items that in aggregate, benefited diluted EPS this quarter by a penny. +First, a negative $597 million market related NII adjustment, primarily FAS 91, cost us about $0.03. More than offsetting this was a $0.02 benefit from DVA of $313 million and a $0.02 benefit from a collective impact of three other items, gains from selling some Consumer Real Estate loans, tax benefits from restructuring some non-US subsidiaries, and a provision for payment protection insurance in the UK. +Revenues were $20.9 billion this quarter; expenses were $13.8 billion, significantly lower than a year ago because of litigation costs and compared to Q2, expenses were flat as we managed cost well while investing in our franchise. Return on assets was 82 basis points this quarter and return on tangible common equity was 10%. +Turning to slide four, the balance sheet ended basically flat relative to Q2 with assets of $2.15 trillion. However, we grew deposits $12 billion from Q2 while long-term debt declined by approximately $6 billion. Liquidity rose to nearly $500 billion, a record level and the time required for funding is now 3.5 years. Tangible common equity of $162 billion improved because of earnings supplemented by $1.5 billion in OTI. This was partially offset by $1.3 billion in capital return to common shareholders through share repurchases and dividends. +Tangible book value increased 10% from Q3 last year and our tangible common equity ratio grew to 7.8% as equity improvements outpaced asset growth. +With regard to regulatory capital, I want to start by pointing out that our transition ratios under Basel III increased with CET1 ending the quarter at 11.6%. However, I will focus my comments on Basel III fully phased in regulatory capital ratios. CET1 capital improved $4.8 billion to $153 million driven by net income, positive OTI and DTA utilization. This was partially offset by capital return to shareholders. +Under the standardized approach, our CET1 ratio improved to 10.8% as risk-weighted assets decreased modestly even as loans grew. Under the standardized approaches, the CET1 ratio increased from 10.4% to 11% as RWA improved by roughly $30 billion largely due to reductions in risk. During the quarter we announced that we exited the parallel run and we will begin reporting under the advanced approaches beginning in 4Q. +So we have also presented our CET1 ratio for 9-30 on a pro forma basis which includes the addition of approximately $170 billion in RWA primarily for wholesale credit under the advanced approaches. The pro forma CET1 ratio at 9-30 was 9.7%, an increase of approximately 40 basis points from Q2 on the same pro forma basis. +In terms of the supplementary leverage ratio, we estimate that as of 9-30, we continue to exceed US rules applicable at the beginning of 2018 at both bank and parent. +Turning to slide five, we grew loans and deposits both of which are key drivers to our financial performance. Reported loans on an inter-period basis increased $1.2 billion from Q2. However underneath the consolidated number, there was significant activity I want to take a moment to point out. +With that in mind, let's review why loans in All Other and LAS are declining. First, the portion of our mortgages that we report in All Other continue to run off due to paydowns. This runoff is being replaced by new loans which are now recorded in business segments like GWIM and Consumer where they are originated. +Second, also in All Other, we converted $6.2 billion of mortgages with long-term standby agreements into securities thereby improving HQLA. These types of conversions are largely complete. +Third, we sold roughly $3.6 billion of other mortgages and NPLs as we continue to clean up and optimize the balance sheet. Lastly, in LAS where we report our legacy home equity portfolio, second lien loans continue to run off. +Now if one excludes the above activities in LAS and other, ending loans in our primary lending segments increased $19 billion or 3% from Q2. +Turning to deposits on an ending basis, they reached $1.16 trillion this quarter growing $50 billion or 4% over Q3 last year. We produced solid growth across the franchise, Global Banking grew deposits 6% year-over-year. GWIM grew 3% and Consumer grew 7%. However as you can see at the bottom right, if one includes CD runoff, Consumer deposits grew 10%. We have also included two other tables to give you a sense of the composition of our deposits. +Turning to asset quality on slide six, I won't spend a lot of time here as asset quality continues to be strong and mostly consistent with Q2. Net charge-offs were flat around $930 million versus adjusted Q2, Q3 provision expense of $806 million and we released a net $126 million in reserves. Releases in Consumer real estate and credit card were partially offset by reserve builds in commercial. In commercial we saw small increases in reserve over criticized exposure from Q2 driven by downgrades in oil and gas that were partially offset by some improvements in the rest of the commercial portfolio. +Also noteworthy, the increase in oil and gas reserve over criticized in Q3 was less than half the size of the increase from Q1 to Q2. +Turning to slide seven, net interest income on a reported FTE basis was $9.7 billion, declining $1 billion from Q2. The decline in long end rates in the quarter caused adjustments in our bond premium amortization which resulted in a linked quarter decline in NII of $1.3 billion partially offset by good growth in NII otherwise. The Q2 adjustment increased NII by $669 million while the Q3 adjustment decreased NII by $597 million. +NII excluding these adjustments improved $292 million from Q2 to $10.3 billion. Three factors drove this increase. First, we grew core commercial loans. Second, we improved the composition of the balance sheet and our Global Markets business which improved trading related NII. Third, we benefited from one extra day in the quarter. +With regard to asset sensitivity, at the end of the third quarter our overall asset sensitivity increased as a result of the decline in long end rates which drove the FAS 91 adjustment. As of 9-30, an instantaneous 100 basis point parallel increase in rates is estimated to increase NII by approximately $4.5 billion over the subsequent year with a little more than half of that improvement caused by increases in short end rates. +Turning to slide eight, noninterest expense was $13.8 billion in Q3 matching the level of expense reported in Q2. The $20.1 billion expense in Q3 last year included $6 billion in litigation costs. Litigation this quarter and in Q2 was less than $250 million. Excluding litigation, expenses were $13.6 billion in the quarter, a decline of $600 million or 4% from last year and consistent with Q2 despite additional costs related to our CCAR submission. +Headcount continues to trend lower, down 6% compared to Q3 last year. LAS costs excluding litigation were relatively stable compared to Q2. However, we still expect to lower that number to roughly $800 million in Q4 and move lower in 2016. As a reminder, in fourth quarters we tend to experience some seasonal increase in expenses as we close out the year. +Let's walk through the business segments starting on slide nine with Consumer Banking. Consumer $1.8 billion, 5% greater than Q3 last year. The business segment generated a strong 24% return on allocated capital. Revenue increased over last year as increases in noninterest income outpaced a decline in NII. +With respect to NII compared to last year, the benefit of higher deposit levels was more than offset by the allocation of ALM activity and lower car deals. Noninterest income benefited from divestiture gains as well as higher card income driven by increased customer activity while service charges declined. Expenses declined from Q3 last year despite a 5% increase in sales specialist and higher fraud costs in advance of ruling changes regarding EMV chip implementation. Those increases were offset by savings from the continued optimization of our delivery network. The cost of operating our deposit franchise remains low at 180 basis points and the consumer bank reported an efficiency ratio of 57%. +We continue to experience shifts in consumer activity away from branches towards self-service options. Self-service trends are driven by mobile banking, online banking and ATM usage. Mobile banking customers increased to 18.4 million and deposits via mobile devices now represent 14% of consumer deposit transactions. Mobile processing is better for us and it is better for our customers. It is one-tenth the cost relative to processing and financial centers and more convenient for customers. +On slide 10, we present key drivers and trends. Average loans grew across mortgages, card and vehicle lending. Deposits, as Brian mentioned, continue to increase particularly if one excludes the impact of CD declining. On this basis, deposits are up 10% from the year ago. +Regarding brokerage assets, Merrill Lynch accounts crossed the $2 million mark and are up 2% while asset levels are up 8% from last year even with declines in equity markets this year. +Mortgage production although up from 3Q last year was down from 2Q as refinances declined. In the future, mortgage banking income in the Consumer segment will be lower by approximately $30 million per quarter given the Q3 sale of a small appraisal business. A similar amount of expense should reduce quarterly as well. +Looking at card activity, card issuance was strong at 1.3 million. Combined credit and debit spending volumes were up 3% from last year despite the decline in fuel prices. Average outstandings were down slightly from Q3 last year as customers paid off more of their balances. However, average balances showed modest growth over Q2. +US card credit quality was strong as net charge-offs declined this quarter to a decade low of 2.5% driving risk-adjusted margins higher to 9.3% excluding divestitures. +Turning to service charges, they were down moderately versus Q2 last year -- excuse me -- versus Q3 last year as we continued to open higher quality accounts that carry higher balances. These higher quality accounts tend to have fewer account fees. +Turning to slide 11, Global Wealth and Investment Management produced earnings of $656 million. Results were down from Q3 last year driven by lower market values and lower related client activity. Compared to Q3 last year, Asset Management fees were up 2% but more than offset by declines in transactional revenues. +The trend of lower transactional revenues continued this quarter as clients migrated from brokerage to managed relationships which was compounded by lower markets and muted new issuance. On NII, the benefits of higher loan and deposit flows was more than offset by the Company's ALM activities driving NII down from Q3 last year. +Noninterest expense was modestly higher than the year-ago period as litigation cost were higher and wealth advisors grew 6%. Pretax margin was 23%, down from a strong Q3 last year. Margins were pressured this quarter by a few factors. +First, markets declined pressuring revenue across many products especially those in which we record transactional revenues. Second, operating leverage was challenged as areas of revenue where incentives are high like asset management grew while NII where incentives are much lower, declined. +Moving to slide 12, despite the lower market levels, business drivers improved. Wealth advisors were up almost 1000 or 6% from Q3 last year. Long-term AUM flows were more than $4 billion. Deposits increased more than $7 billion. Average loans were up 10% from last year, our 22nd consecutive quarter of loan growth in this segment. +The last thing I would note that is not shown here is referral rates across the Company remained strong. For example, our retirement solutions business continues to win in the marketplace. We have won more than 1200 retirement plans year to date, many of which were referred from global banking. On a year-to-date basis, this is up more than 40% from 2014. +Turning to slide 13, Global Banking's earnings were $1.3 billion, generating a 14% return on allocated capital. Earnings declined from Q3 last year but were up modestly versus Q2. The comparison to Q3 last year reflects higher provision expense and lower NII driven by the Company's ALM activities as well as increased liquidity costs. Additionally, we saw year-over-year compression in loan spreads. However, loan growth was a positive contributor to NII. Growth from Q2 reflects improved NII from loan and deposit growth. +Regarding provision expense while flat to Q2, it is up $243 million from last year. We added $125 million to reserves in Q3 compared to a release of $116 million in the year-ago quarter. +Looking at trends on slide 14, let's first focus on fees relative to the same period last year given seasonality. Despite a lower level of IBCs this quarter, we maintained our number three global fee position and believe we increased our market share as industry fees pools declined. Investment banking fees for the Company this quarter were $1.3 billion, down 5% from Q3 last year. Advisory fees were up 24%, debt underwriting was down modestly, equity underwriting was down from Q3 last year, in line with industry volume declines. +Outside of IB, our Treasury fees improved from Q2 on increased activity. Looking at the balance sheet, loans on average were $310 billion, up 9% year-over-year and a similar percent relative to Q2 on an annualized basis. The growth was broad across both corporate and commercial borrowers and asset quality was consistent with our overall portfolio. +Importantly, the decline in spreads year-over-year flattened as the decline from Q2 was relatively small. On deposits, we saw good performance with average deposits increasing by $8 billion over Q2 and we continue to optimize the portfolio, improving the composition towards higher quality deposits from an overall LCR perspective. +Switching to Global Markets on slide 15, earnings were $1 billion on revenue of $4.1 billion despite challenging markets. We generated an 11% return this quarter. Earnings were up from Q3 last year which included litigation costs of roughly $600 million most of which was nondeductible for tax purposes. As you can see, we have a net DVA gain this quarter which was higher than last year. Total revenues excluding that DVA declined from Q3 last year driven by lower fixed sales and trading and to a lesser extent IBCs, offset partially by improved equity sales and trading. Noninterest expense excluding litigation improved $102 million versus Q3 last year, a 4% improvement. +Moving to trends on slide 16 and focusing on the components of our sales and trading performance, sales and trading revenue of $3.2 billion excluding net DVA is down 4% from Q3 last year. Comparing to the same period a year ago, fixed sales and trading revenue declined 11%. Similar to the first half of this year, the year-over-year comparisons reflect good activity in macro related products like rates and after tax. Conversely, market activity remained muted in credit products driving lower client activity this quarter than Q3 last year. +As a reminder, our mix remains more heavily weighted toward credit products driven by the strength of our new issues capability and market share. +Equity rose 12% driven by strong performance in equity derivatives reflecting favorable market conditions. Asset levels were down modestly from Q3 last year. +Turning to Legacy Asset & Servicing on slide 17, this segment lost roughly $200 million. I want to focus on three things here, the reduction in delinquent loans, mortgage banking income and expenses and compare each to Q2. +First, the number of delinquent first mortgage loans continued to decline, down 14% this quarter as the teams continue to work through solutions for customers. +Second, mortgage banking income declined by more than $400 million. This decline was driven primarily by three factors: servicing fees declined about $50 million as the units we service declined; net MSR and hedge performance declined $100 million driven by gains on MSR sales in Q2; reps and warranty provisions swung nearly $300 million from a benefit of $204 million in Q2 to a revision of $77 million this quarter. +Lastly, I want to focus on expenses which excluding litigation were flat compared to Q2 as increased professional fees offset improved operating costs from the decline in delinquent loans. We believe we are on track to achieve our goal of reducing expenses excluding litigation to approximately $800 million in Q4. +On slide 18, we show All Other which primarily includes our ALM actions and the operations of our UK card business and other smaller activities. All Other reported a $503 million pretax loss more than offset by certain tax benefits. The pretax loss was a result of a negative NII market-related adjustment and an increase in provisioning for UK credit, UK credit card payment protection insurance. This was partially offset by gains from securities and loan sales. +Regarding the change in PPI liability, we increased it because of a notice of future regulatory guidance regarding treatment of claims and a case ruling. +A comment or two on taxes before we wrap up. The Company's effective tax rate for the quarter was 26%. It was lower than Q2 due to the tax benefits I mentioned earlier. I would expect the tax rate to be roughly 30% next quarter excluding unusual items and specifically the recent UK tax proposals. +In terms of 2016, I would expect it to be in the low 30s. As a reminder from last quarter's announcement, we expect that the UK tax proposal announced in July will result in a one-time tax charge of approximately $300 million upon enactment from revaluing our UK DTAs. +Let me conclude our prepared comments by offering these takeaways. Although the US economy is improving slowly, revenue growth remains challenging in this interest rate environment. We are focused on those things we can control and drive. These include delivering for our clients and customers within our risk framework and driving those things we know will result in sustainable profits and returns. Our results reflect this focus. +We grew both loans and deposits across our business. We delivered to our corporate and institutional clients in a challenging market environment. We stayed focused on managing risk and we kept costs in check while investing in the business. We are getting better positioned each quarter for the current business environment and we remain well-positioned to benefit when rates rise. +With that, let's open it up to Q&A. + + +================================================================================ +Questions and Answers +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Eric Wasserstrom, Guggenheim Securities. + +-------------------------------------------------------------------------------- +Eric Wasserstrom, Guggenheim Securities LLC - Analyst [2] +-------------------------------------------------------------------------------- + + Thanks, good morning. Just wondering if we could maybe just speak a little bit at the NII outlook given the dynamics about the stable balance sheet, shifts within the balance sheet and how we should think about both the GAAP and adjusted NIM if the interest rate environment continues to look more or less like it does today? Can you just help us think through what all of those dynamics mean for NII? + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [3] +-------------------------------------------------------------------------------- + + Sure. So assuming some loan growth and adjusting for day count, we would expect normalized NII excluding market related adjustments to be flat to grind up as long as rates don't decline in the future. In the fourth quarter, we think they will grind up slightly based upon the realization of the expected forward curve and some loan growth. + +-------------------------------------------------------------------------------- +Eric Wasserstrom, Guggenheim Securities LLC - Analyst [4] +-------------------------------------------------------------------------------- + + Okay. And with respect to the loan growth, is that in the context of growth in the overall balance sheet or continued stability given mix shift? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman of the Board and Chief Executive Officer [5] +-------------------------------------------------------------------------------- + + If you just look at commercial loans year-over-year up 10%, last quarter up 3%, so you've got to annualize that out and what we are looking at is that we replaced discretionary assets with actually good core assets so whether the balance sheet grows a little bit or not is not as critical as the assets. So it is probably driven in the near-term more by mix than aggregate size growth on a GAAP basis. + +-------------------------------------------------------------------------------- +Eric Wasserstrom, Guggenheim Securities LLC - Analyst [6] +-------------------------------------------------------------------------------- + + Thanks very much. + +-------------------------------------------------------------------------------- +Operator [7] +-------------------------------------------------------------------------------- + + John McDonald, Bernstein. + +-------------------------------------------------------------------------------- +John McDonald, Bernstein - Analyst [8] +-------------------------------------------------------------------------------- + + Wondering on expenses, you kept the core expenses flat to last quarter. Did you digest additional CCAR expenses and also some costs related to the proxy vote? What are the puts and takes on keeping that flat and what is your outlook on the core expenses going from here in this kind of environment? + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [9] +-------------------------------------------------------------------------------- + + Sure, so the short answer to your question but then I would like to elaborate a little more is yes, we kept core expenses flat and we absorbed CCAR and other CCAR expenses and other investments in the business in the quarter. +To take a step back, I think the way we would ask you to think about expenses is we are seeing good expense progress within our business importantly as we continue to invest in the future. So core expenses which for everybody excludes litigation and LAS are expected to remain relatively flat at call it a little less than $13 billion per quarter in a moderately improving business environment as we invest in growth and use SIM and other initiatives to offset inflationary pressures. +If the business environment slows, we would have to adjust. If the business environment gets better, we are going to use SIM and other efforts to improve the operating leverage of this Company even as incentives and other expenses increase. + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [10] +-------------------------------------------------------------------------------- + + So, John, I would remind everybody that we did guide you that we would have increased CCAR expenses in the second half of the year so we do have a little bit of that in the fourth quarter as well. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman of the Board and Chief Executive Officer [11] +-------------------------------------------------------------------------------- + + So, John, just so you think about it from a headcount perspective because that is what is going to drive our 60% people cost down. For the quarter we were down about 1.5. In that, we actually had an increase in client facing headcount in the quarter up 1.6 so basically we were able to achieve a reduction while we continued to invest. On top of that, the risk in CCAR FTE count was up about 400 for the quarter and other business hiring especially the new kids from school were up about 1000. So through attrition and then through other reductions we got that down to net 1.5. +So if you follow that course, last quarter we were down 3000 or so and that was 15 quarters in a row or something like that. We are down a little less this quarter which is expected to be a similar pickup next quarter. So the 12.7 we did in the second quarter remember was a surprise to all of you. We called it flat this quarter which I think exceeds what our expectations were. We are laser focused on keeping it at that kind of level while we continue to invest in 1000+ people to go generate the business growth you are starting to see. + +-------------------------------------------------------------------------------- +John McDonald, Bernstein - Analyst [12] +-------------------------------------------------------------------------------- + + Okay. Paul, in terms of the credit outlook, do you expect to kind of bounce around here, you've got charge-offs in the low 900s and you did about $100 million in reserve release. So charge-offs 900, provisions 800, is that the kind of ballpark you expect to stay in near-term? + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [13] +-------------------------------------------------------------------------------- + + I would expect to see provision in 2016 roughly where it is today. + +-------------------------------------------------------------------------------- +John McDonald, Bernstein - Analyst [14] +-------------------------------------------------------------------------------- + + So that is around 800 a quarter, something like that, ballpark? + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [15] +-------------------------------------------------------------------------------- + + Yes, because we are going to get a little help. John, if you look at it, you've still got a little excess mortgage charge-offs going through card continues to work its way down because of this period of credit quality and the question on the commercial side is bouncing around, gets lumpy. But you look at the reserve release, we are down to 100 so think of that sort of 800 to 900 range a quarter and I think that is a way to think about it over the next several quarters. + +-------------------------------------------------------------------------------- +John McDonald, Bernstein - Analyst [16] +-------------------------------------------------------------------------------- + + Okay, thank you. + +-------------------------------------------------------------------------------- +Operator [17] +-------------------------------------------------------------------------------- + + Betsy Graseck, Morgan Stanley. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [18] +-------------------------------------------------------------------------------- + + Good morning. Paul, I just wanted to just you to elaborate a little bit on the comment you made during prepared remarks regarding the composition of the balance sheet improving that being a benefit for trading related NII. Could you just talk through what you did and is that sustainable? The benefit to NII? + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [19] +-------------------------------------------------------------------------------- + + Sure. I think the answer is we just sold for lack of a better word, sold some lower yielding assets that we used to grow our business end markets and we positioned them to higher yielding assets. So as an example, we would do a little bit less in prime brokerage and a little bit more in fixed income where some (inaudible) worths and yields are higher. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [20] +-------------------------------------------------------------------------------- + + Okay. And then on the conversion of the loan to securities for HQLA given the fact that you mentioned that is done, what kind of core loan growth are we looking for as we move forward here? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman of the Board and Chief Executive Officer [21] +-------------------------------------------------------------------------------- + + By core do you mean loan growth in the business segments or for the consolidated Company? + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [22] +-------------------------------------------------------------------------------- + + I guess I will take consolidated more than anything. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman of the Board and Chief Executive Officer [23] +-------------------------------------------------------------------------------- + + So we grew loans as a consolidated company year-over-year by 1%. It was up slightly quarter over quarter. I would expect that we would be able to continue to grow the whole Company in the sort of, in that range. You are going to see faster growth in the core lending businesses, we grew that year-over-year 9%. I am not going to stand here and tell you that we are going to do that every quarter but we would expect to see more robust growth in our lending segments. +You have to remember that in LAS home-equity loans are still coming down and in the discretionary portfolio even though we are not going to have $6 billion as much as $6 billion in LTSE conversions, we still are going to see first mortgages run off there. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [24] +-------------------------------------------------------------------------------- + + And then just lastly on this topic when you are thinking about reinvesting deposit growth etc. in securities, where are you relative to your new investments in securities versus what the portfolio yields are? Are you close to breakeven there? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman of the Board and Chief Executive Officer [25] +-------------------------------------------------------------------------------- + + In terms of running off yields, Betsy, versus the coming on yield? + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [26] +-------------------------------------------------------------------------------- + + Correct. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman of the Board and Chief Executive Officer [27] +-------------------------------------------------------------------------------- + + It is relatively stable. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [28] +-------------------------------------------------------------------------------- + + Okay. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman of the Board and Chief Executive Officer [29] +-------------------------------------------------------------------------------- + + Our portfolio has been priced down over the years and so it is relatively stable. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [30] +-------------------------------------------------------------------------------- + + Okay, thanks. + +-------------------------------------------------------------------------------- +Operator [31] +-------------------------------------------------------------------------------- + + Matt O'Connor, Deutsche Bank. + +-------------------------------------------------------------------------------- +Matt O'Connor, Deutsche Bank - Analyst [32] +-------------------------------------------------------------------------------- + + Good morning. Can you give us an update on the CCAR resubmission and then also comment on some of the management changes that occurred there as we think about the 2016 process just how you might approach it differently or similar to what you have done in the past? + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [33] +-------------------------------------------------------------------------------- + + Why don't I start with CCAR and then maybe Brian will speak to some management. So in terms of CCAR, we submitted our resubmission on September 30 as planned. That has the involvement of the leadership of the Company and the Board, significantly involved within the line of business we tried to keep the regulators involved and up to speed every step of the way and they have until 75 days after that submission to get back to us. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman of the Board and Chief Executive Officer [34] +-------------------------------------------------------------------------------- + + In terms of the change three months ago we told you that we were making the changes, nothing has changed in that Terry continues to work on the CCAR process, Terry Laughlin and Andrea has moved over as Chief Administrative Officer and been heavy in the process from the day that we announced it and that transition will continue to take place over the period of time between now and the next CCAR submission in 2016. + +-------------------------------------------------------------------------------- +Matt O'Connor, Deutsche Bank - Analyst [35] +-------------------------------------------------------------------------------- + + Okay, and then just separately in terms of the credit quality comments that you provided for the next several quarters, how are you thinking about energy as part of that? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman of the Board and Chief Executive Officer [36] +-------------------------------------------------------------------------------- + + I think we mentioned in the prepared remarks that our criticized assets were up modestly if you sort of dive into the oil and gas segment. And remember last quarter we increased criticized assets about $1 billion because of oil and gas. This quarter we saw that increase decline significantly to about 40% of that level and then be offset by improvements in the rest of the portfolio. So we saw a modest increase in criticized assets. We feel pretty good right now where we are with oil and gas. As you know, clients are going through the redetermination process. + +-------------------------------------------------------------------------------- +Matt O'Connor, Deutsche Bank - Analyst [37] +-------------------------------------------------------------------------------- + + Just a big picture question following up on that, there is a lot of concern I think among credit folks that energy defaults have increased a lot and will continue to increase from here but we are not really seeing all that much pressure either at you guys or the banks. Are you guys higher in the structure, different customer base, why do think there is less pressure maybe with you guys than we are seeing from the industry as a whole outside of banks? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman of the Board and Chief Executive Officer [38] +-------------------------------------------------------------------------------- + + I think the answer is yes, higher in the structure and a lot of the risk is distributed out to investors and things like that. The Company has had reserve base methodologies have hedges involved and it is more complex I think than oil price changes. So I think as you look at it, our lending portfolio is done consistent with our credit quality standards and had held pretty well under the significant change in revenue from oil price changes. + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [39] +-------------------------------------------------------------------------------- + + And large corporates, we are just dealing with larger companies that have a lot of different options and in middle-market as Brian said, a lot of that lending is secure. +If you look at our overall energy portfolio, we are at about 22-ish and really only about 40% of that really isn't tied. Of course everything in that sector is tied in some way to oil and gas but 40% of that is not really directly tied to the price of oil and gas. So when you start just working through the numbers and you whittle that down and then you whittle it down for the number of loans that we have where we have reserves, it gets to something I think that is manageable. + +-------------------------------------------------------------------------------- +Matt O'Connor, Deutsche Bank - Analyst [40] +-------------------------------------------------------------------------------- + + Okay, thank you very much. + +-------------------------------------------------------------------------------- +Operator [41] +-------------------------------------------------------------------------------- + + Jim Mitchell, Buckingham Research. + +-------------------------------------------------------------------------------- +Jim Mitchell, Buckingham Research Group - Analyst [42] +-------------------------------------------------------------------------------- + + Good morning, Paul. Just a quick question on the liability side of the balance sheet. You had highlighted that long-term debt was down $6 billion or so in the quarter. I noticed that long-term debt costs were down about 11 basis points quarter over quarter. Is that sustainable in the context of TLAC? Is there just some movement underneath the hood or is it timing? Just kind of help me think about where that footprint and cost go from here. + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [43] +-------------------------------------------------------------------------------- + + We generally don't comment on our issuance plans. I guess the only guidance I would give you is we are going to try to have preferred that is roughly 1.5% of Tier 1 capital and sub debt that is roughly 2%. And in terms of TLAC, we don't know what the rules are yet. We may have to issue a little bit more debt. But based upon what we are hearing at least from a sort of rumor perspective, it looks to be quite manageable. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman of the Board and Chief Executive Officer [44] +-------------------------------------------------------------------------------- + + Technically quarter to quarter there were some hedges that went from a deduct to a benefit or the other way around that changed that rate. So I wouldn't think that the underlying rates haven't changed much is the way to think about it. There is just a hedge cost and a hedge benefit that came through that increased the spread. + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [45] +-------------------------------------------------------------------------------- + + Or you were referring to the decline to the yield, sorry. + +-------------------------------------------------------------------------------- +Jim Mitchell, Buckingham Research Group - Analyst [46] +-------------------------------------------------------------------------------- + + No, that is all helpful. Maybe just on the loan growth side, what are you seeing on the demand side as Consumer has begun to pick up for you guys? Where are you seeing the most strength and do you think the environment still is pretty positive from the loan demand perspective in the US? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman of the Board and Chief Executive Officer [47] +-------------------------------------------------------------------------------- + + Remember we are focused on -- in the Consumer business on two things that we have been consistently focused on. We are making loans to our customers in connection with the whole franchise. And then secondly, we are staying in the very prime orientation. So as you think about this quarter, home equity production was $3 billion-ish which was kind of consistent with other quarters. It has grown from $1 billion up to $3 billion across the last couple of years and been very consistent. +As Paul said earlier, mortgages tipped down a little bit but year-over-year they are up strong, a little bit of seasonality in there and a little bit of refi runoff. Our auto lending business is still was strong. The direct to consumer piece of that we didn't have two, three years ago. We are up to $0.5 billion a quarter production so we are seeing good demand but part of it is just capturing that inherent client share, wallet share that we have been after and you are seeing that materialize. +The other key honestly in terms of nominal growth for us is the runoff non-core part that has gotten small enough over the last couple of years that we can overcome it. So the only place we still have that hole from a corporate perspective is really the home equity business. So we have resized the card business and you are seeing all the hard work, the 1.3 million cards producing some loans even though it is a huge payment rate on that. +You are seeing the auto lending business, both direct to consumer and then what we do with dealers and stuff strong and stable, and you saw the car sales numbers strong. And you are seeing the Consumer Real Estate strong from the home-equity production and I think solid. +When you go over to GWIN, you saw loan growth there between US Trust and what we call structured lending, but don't think of it that way. It is lending -- as well as assets and then also in the margin lending was fairly stable. I talked to John (inaudible). We haven't seen a big change in our margin lending. A lot of people think investors have lowered their risk and stakes have been relatively stable across the last few months. + +-------------------------------------------------------------------------------- +Jim Mitchell, Buckingham Research Group - Analyst [48] +-------------------------------------------------------------------------------- + + Okay, great. That is helpful. Thanks. + +-------------------------------------------------------------------------------- +Operator [49] +-------------------------------------------------------------------------------- + + Steven Chubak, Nomura. + +-------------------------------------------------------------------------------- +Steven Chubak, Nomura Securities - Anayst [50] +-------------------------------------------------------------------------------- + + So one of your competitors revealed that their efforts to mitigate some of the GSIF indicators had actually helped push them into a lower GSIF bucket and looking at the metrics that have been published as of year-end, it looks like you are actually closer to the lower end of that 3% threshold. And we have seen some progress in terms of reduction in Level III assets at year end. And just wanted to see if you actually see opportunities to manage that bucket lower somewhere closer to 2.5%? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman of the Board and Chief Executive Officer [51] +-------------------------------------------------------------------------------- + + We always manage the balance sheet against all the different constraints whether you can see the improvement in pro forma advanced ratio by 40 basis points this quarter, closing down the gap. So we are always looking to manage the balance sheet. I wouldn't put a lot of stake in the us moving ourselves fundamentally in buckets at this point because we have been working at that for the last three years to make sure as this rule was going to come out, that we had ourselves positioned as well as we could. So we will continue to work on it but I wouldn't expect us to change. +If you look about the risk assets and Level III assets and things like that and our Company continue to trend down and we just worked the balance sheet back. But I wouldn't say that we expect to move a bucket. We could but we don't expect to. + +-------------------------------------------------------------------------------- +Steven Chubak, Nomura Securities - Anayst [52] +-------------------------------------------------------------------------------- + + Okay. That is really helpful. Thanks, Brian. Maybe just digging into some of the GWIN guidance that, Paul, you had given earlier, the negative operating leverage has been fairly pronounced which you acknowledged and I did appreciate the detail at least on some of the specific factors that weighed on the margin such as litigation and maybe some remixing in terms of revenue. +But just wanted to get a sense as to how we should be thinking about that margin trajectory going forward assuming no elevated litigation and without any rate boost, just to get a sense as to how we should be thinking about that profitability trajectory? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman of the Board and Chief Executive Officer [53] +-------------------------------------------------------------------------------- + + If you remember the last quarter we talked a bit about this. There are some things that will help us which are that some of the deal stuff runs off this year relative to next year which will give us some positive help but round numbers nearly $100 million a quarter of expense help. That is just amortization that finally runs off so that is positive. +And I think Paul cited and you cited back the examples of some nonrecurring things. I think you have to be careful in the year-over-year comparisons on the margin because this business, there is a big bank inside our GWIN business, that $250 billion deposit franchise, big-money franchise so all of the dynamics that we talk about from the corporate obviously hit them also. And so they will benefit more by stability in that as we compare quarters and hopefully grow out of that as they grow loans and deposits. +But I think that is the thing. The question then comes down to more philosophically would you quit investing in new advisors to get a point on margin or so and in the context of that business earn $600 million to $700 million after-tax for us in the context of needing to drive it to another level. We still believe the right trade is to continue to invest in growth. And if the world changed and those people weren't becoming successful which they are, we would change that. +And the thought is that we are adding advisors, you don't see that in other people's franchises and we are doing it in connection with Consumer Bank which is a critical increased success factor for our advisors. In other words, we hire people in what they call BFAs without -- that work within the Consumer franchise but on Merrill teams and we are seeing them get up to speed fast. We think that is a competitive advantage for people we during this business and we will continue to invest in that. +So if we can't seen the success we will pull back on that but right now it is worth it for our shareholders and our customers. + +-------------------------------------------------------------------------------- +Steven Chubak, Nomura Securities - Anayst [54] +-------------------------------------------------------------------------------- + + Okay, thanks for that detail, Brian. Maybe just one more for me on the investment banking side. One of your competitors was talking about a pause in activity that they have experienced so far in 4Q. I recognize it is early days but just wanted to get a sense as to what you are seeing within the global banking and markets businesses and also if you could provide just some additional color or detail on what you are seeing in the backlogs by channel, that would be really helpful too. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman of the Board and Chief Executive Officer [55] +-------------------------------------------------------------------------------- + + I will let Paul hit that but in terms of that. Just want to make sure you are talking about trading or investment banking fees or both? +Steven Chubak +Both. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman of the Board and Chief Executive Officer [56] +-------------------------------------------------------------------------------- + + Okay, Paul? + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [57] +-------------------------------------------------------------------------------- + + So I guess in terms of the pipeline, the pipeline right now looks quite -- this is investment banking fees -- the pipeline right now looks quite strong. There is a decent amount of M&A in it, the timing of which can move around a lot. Some of the pipeline increase I guess can be attributed to transactions that were in our pipeline in the third quarter didn't it come out in the third quarter and are rolling over into the fourth quarter. We saw that type of activity in ECM and as markets improve, we hope that pipeline activity will come out. +In terms of sales and trading, we talked a little bit about that in the prepared remarks. We saw I think good activity in equity sales and trading as clients needed to rebalance risk or take advantage of opportunities particularly in Asia. We were getting some of that flow and feel good about it. On the other hand, we do have a strong FICC business that is tied to new issuance and the new issuance market in the third quarter wasn't as strong so some of those flows just weren't there. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman of the Board and Chief Executive Officer [58] +-------------------------------------------------------------------------------- + + Year-over-year, last year's fourth quarter was pretty tough so I think being better than that wouldn't be great performance in sales and trading. But Tom and the team have got the business pretty well positioned in terms of effectiveness and that is why even with the slowdown in the latter part of the quarter we still made $1 billion and you subtract out DVAs, $800 million or so and that is good performance in that business. + +-------------------------------------------------------------------------------- +Steven Chubak, Nomura Securities - Anayst [59] +-------------------------------------------------------------------------------- + + All right, great. That is it for me. Thank you for taking my questions. + +-------------------------------------------------------------------------------- +Operator [60] +-------------------------------------------------------------------------------- + + Glenn Schorr, Evercore ISI. + +-------------------------------------------------------------------------------- +Glenn Schorr, Evercore ISI - Analyst [61] +-------------------------------------------------------------------------------- + + Thanks. A couple of quick follow-ups. I hear all o your comments so no need to repeat them on the feeling decent about credit quality and energy specifically. Just looking for two pieces of info if you are willing to share either reserve as a percentage of loans for energy specifically or maybe what percentage of the criticized exposure is energy related? Just looking for more detail behind the comfort. Thanks. + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [62] +-------------------------------------------------------------------------------- + + I don't think we have any of that perspective with us handy and I am not sure we disclose that but we will follow up with you if we do. + +-------------------------------------------------------------------------------- +Glenn Schorr, Evercore ISI - Analyst [63] +-------------------------------------------------------------------------------- + + Okay, worth trying. In terms of what is going on in terms of the mix shift on balance sheet out of some of the discretionary assets and into the core loan growth, I think everybody will take that all day long. And I am curious on if there are RWA implications that we need to think about, is that a heavier RWA mix even though we will take it -- I am just curious on how that plays on the capital side? + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [64] +-------------------------------------------------------------------------------- + + Yes, I think that as we grow loans, obviously our RWA is going to increase particularly on a standardized basis. It is less of an increase on an advanced basis but they are completely tied. And as you said, we are comfortable with that given the interaction with our clients and the opportunity that brings to increase our margins relative to other investment opportunities. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman of the Board and Chief Executive Officer [65] +-------------------------------------------------------------------------------- + + As you think about it, remember that if you look at page five and you look at the content of what is leading coming on especially in the Consumer business and then think about running that through all kinds of models including the CCAR process and think about getting rid of $5 billion of home equity loans which were basically nonperforming and putting on $3 billion of good home equity loans, that dynamic is pretty favorable to the overall calculations. And so it is not only within categories -- not only in categories it is also within categories that we are seeing improvement in credit quality on what is coming on especially when we run through models and things like that. + +-------------------------------------------------------------------------------- +Glenn Schorr, Evercore ISI - Analyst [66] +-------------------------------------------------------------------------------- + + Okay, I appreciate that. One last one. You commented earlier about the strength in equities partially driven by the good performance in the derivatives business during the quarter. I guess the question is it ebbs and flows but maybe over the last 12 months, not just the last quarter, is derivatives 40%, 50% of overall equities, is that a number you are willing to share? + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [67] +-------------------------------------------------------------------------------- + + Are you talking about the percentage of equities as a function of what? + +-------------------------------------------------------------------------------- +Glenn Schorr, Evercore ISI - Analyst [68] +-------------------------------------------------------------------------------- + + I'm saying in any given period, your equity markets revenues, how much of that is driven via the derivatives business? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman of the Board and Chief Executive Officer [69] +-------------------------------------------------------------------------------- + + I think it is less than half but I don't have the number off the top of my head but I think you can look at it in various pieces. We are checking it now but remember it is an integrated business, it is between 30% and 40%. We just found a number but remember it is an integrated business so you can't say growth or derivatives but cash -- the clients do all things with us including fixed income and equities so we are growing it together. So think 30%, 40%. + +-------------------------------------------------------------------------------- +Glenn Schorr, Evercore ISI - Analyst [70] +-------------------------------------------------------------------------------- + + Okay, thank you. + +-------------------------------------------------------------------------------- +Operator [71] +-------------------------------------------------------------------------------- + + Ken Usdin, Jefferies. + +-------------------------------------------------------------------------------- +Ken Usdin, Jefferies LLC - Analyst [72] +-------------------------------------------------------------------------------- + + Good morning. Brian, just one question follow-up on the loan side. You talked about the demand and where you are seeing it but I'm just wondering in terms of like the no excuses growth mentality from a supply side, where are the lending officers now in terms of like using the excess capacity to continue to grow the balance sheet? Is there still room from the Bank of America supply side to extend that growth on top of what the economy and the market place is giving you broadly? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman of the Board and Chief Executive Officer [73] +-------------------------------------------------------------------------------- + + Yes, if you look at the different segments, if you think about on the Consumer side using -- it is more sales force growth and effectiveness and so in building that team and then also the digital sales coming up whether it is autos, whether it is credit card are up dramatically. So think of that engine as being both people and machine for lack of a better term. But don't think of it as changing credit quality or taking any kind of more risks. So [Tom and Dean] that run that business for us has done a good job and so I would say these supply is there more from a delivery capacity than it is from an expanding the box or anything like that. We've really kept it to where we want it and we think that holds us in good stead as you think through all the different dynamics in our Company. +When you go to the commercial side, it is simply a couple of things. In the very small business which is reporting, we have actually seen that business stabilize and start to make its way out of a run-off position and that is again a more automated scored approach. We sped up approval times and done a lot of work to make ourselves more competitive more on delivery than credit. But if you go into business making, commercial banking, global corporate investment banking segment are three versions. (inaudible) and the team, they have actually hired over 100 people, loan officers this year so think of that as 10% to 15% growth in loan officers. Got them hired, they are in working. It takes time for them to get up to speed. Al (inaudible) in our middle-market business, I think is up 60 this your, something like that, 70 people delivering lending and products and things behind that also as treasury services people. +So again capacity expansion in the global corporate investment banking a little differently but as we look at middle market, I think that is an area where we are -- we used to think if we were going to take 10, let's only take eight, that is better, we are now telling our teams you need to -- we to understand why you are not taking 10 if that is our whole limit and our capacity in a given transaction as an example and they are doing that. So I think we are probably creating a little more not risk weighting type of supply but just we are taking a little bit more loans because we are twice the equity we used to be and therefore we can absorb it and the team does a great job in credit quality there. +So I would say if you looked at it across the board, Consumer, it is more delivery capacity and in commercial it is more both delivery capacity and then as you cite, sort of take a little more risk in terms of dollar denomination but not in terms of unwanted credit quality. + +-------------------------------------------------------------------------------- +Ken Usdin, Jefferies LLC - Analyst [74] +-------------------------------------------------------------------------------- + + Okay, got it. Paul, one quick follow-up on GWIM, can you just remind us how that business kind of marks itself in terms of asset level pricing versus the transactions? It seems like those kind of went different directions this quarter and the result was kind of flattish on a revenue perspective. So what do we need to think about in terms of where the markets have come and where we are looking ahead in terms of asset level versus transaction type revenue activity? + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [75] +-------------------------------------------------------------------------------- + + AUM? So we continue to grow AUM and that is all good. I mean it was a little bit slow this quarter but in a bad market environment we continue to grow AUM, we continue to grow deposits, we continue to grow loans so I think everybody is doing their job. You are right that when market activity is lower, we tend to see less activity in the transactional side of that business. There is a lot of new issuance there, mutual funds, other products that just don't come to market and so that sort of exacerbates things when the markets are bad. Does that answer your question? + +-------------------------------------------------------------------------------- +Operator [76] +-------------------------------------------------------------------------------- + + Nancy Bush, NAB Research. + +-------------------------------------------------------------------------------- +Nancy Bush, NAB Research - Analyst [77] +-------------------------------------------------------------------------------- + + Good morning, guys. Two questions. One, there is an issue out there I think supposed to happen in 2018 on credit quality. It is this current expected credit loss. Can you just tell us where the argument is about that right now and whether you have been able to do any preliminary work about how that would impact you? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman of the Board and Chief Executive Officer [78] +-------------------------------------------------------------------------------- + + I don't think, Nancy, the idea of a loan type of reserving on the commercial -- all loans it is out there, the FASB is working on it. I think there has been voluminous comments and questions about it. But when it comes out, we well make it -- it will be basically a one-time adjustment type of thing and then it would be over with and so over the course of time, it should come out the same because you think about it this is just putting it all up front as you put the loans on and the commercial side especially would be a change. +So we will get to that when we get to that but it hasn't been clarified what the rule is. Lots of people have commented on it and it would be a one-time thing and as you say somewhere around 2018 is what people currently think. + +-------------------------------------------------------------------------------- +Nancy Bush, NAB Research - Analyst [79] +-------------------------------------------------------------------------------- + + Okay. Secondly, another credit quality question. There was a lot of speculation before the quarter and I think this is probably based on the energy outlook that this would be the quote inflection point quarter and beginning to build reserves. But what you are saying and what J.P. Morgan said yesterday was that the credit quality outlook remains pretty stable. Can you just comment on this inflection point issue and when you think we will get there? + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [80] +-------------------------------------------------------------------------------- + + Well, we are still seeing reserve releases on the Consumer side of a bank. They are certainly starting to moderate and consistent with loan growth, we are seeing some reserve additions on the commercial side of the bank. And as I said earlier, if you are looking for when those lines are going to sort of cross, we think provision as Brian and I both said is going to be roughly sort of 800 to 900 in 2016. That is kind of where the conversion is going to happen someplace per quarter that is someplace in 2016. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman of the Board and Chief Executive Officer [81] +-------------------------------------------------------------------------------- + + Nancy, remember, we still have massive risk coming off in Consumer that we are not -- reserves are going over to the commercial side and some is coming out net of that 100 plus million this quarter. We expect that to probably mitigate and then if you get loan growth, you will build reserves at some point but I think that is still a bit out there. + +-------------------------------------------------------------------------------- +Nancy Bush, NAB Research - Analyst [82] +-------------------------------------------------------------------------------- + + So sometime in 2016 probably? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman of the Board and Chief Executive Officer [83] +-------------------------------------------------------------------------------- + + Well, it depends on what the loan growth is and it depend on the best economic scenario. But I think we still we are still repositioning reserves on the Consumer side that are [excessive]. You can see in the credit statistics we are carrying a healthy reserve for areas that are continuing to come down in terms of risk. + +-------------------------------------------------------------------------------- +Nancy Bush, NAB Research - Analyst [84] +-------------------------------------------------------------------------------- + + Okay, thank you. + +-------------------------------------------------------------------------------- +Operator [85] +-------------------------------------------------------------------------------- + + Paul Miller, FBR Capital Markets. + +-------------------------------------------------------------------------------- +Thomas LeTrent, FBR Capital Markets - Analyst [86] +-------------------------------------------------------------------------------- + + Good morning, guys. It is actually Thomas LeTrent on behalf of Paul. Most have been asked and answered but one quick question on the servicing side. The servicing income has been coming down at a faster rate than the portfolio and I know you guys have sort of exited most of the sales on the portfolio side. So at what point can we sort of expect the fees to level off and is that just a function of the legacy stuff continuing to run off? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman of the Board and Chief Executive Officer [87] +-------------------------------------------------------------------------------- + + If you go to page 17, you can see that the rate of reduction will come down, will slow down but it will still come down on the theory of the units doing. But remember the other issue we have is we are holding more of the loans so that from a corporate perspective that also -- comes in yield and not in servicing fee. So expect it to work its way down to 345 this quarter I would think 300-ish is where it ought to sort of flatten out. + +-------------------------------------------------------------------------------- +Thomas LeTrent, FBR Capital Markets - Analyst [88] +-------------------------------------------------------------------------------- + + And then also on slide 17 if I may on the 60 days delinquent, how much of that is the quarterly change, how much of that is from sales or is that mostly just runoff? + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [89] +-------------------------------------------------------------------------------- + + I would say most of it is just runoff. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman of the Board and Chief Executive Officer [90] +-------------------------------------------------------------------------------- + + We are just working it out contemptuously and so we've still got room to go to get it normalized but there is nothing big material going on in terms of sales and stuff this quarter. + +-------------------------------------------------------------------------------- +Thomas LeTrent, FBR Capital Markets - Analyst [91] +-------------------------------------------------------------------------------- + + Okay, that is all. Thank you. + +-------------------------------------------------------------------------------- +Operator [92] +-------------------------------------------------------------------------------- + + Mike Mayo, CLSA. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA Limited - Analyst [93] +-------------------------------------------------------------------------------- + + I had three small questions. First, you sold $3.6 billion of assets, mortgages and NPLs. What was the gain or sale on those sales? I'm sorry, the gain or loss? + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [94] +-------------------------------------------------------------------------------- + + In total on our gains, on all our sort of loan sales in the quarter, it was $400 million. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA Limited - Analyst [95] +-------------------------------------------------------------------------------- + + I am sorry, $400 million? + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [96] +-------------------------------------------------------------------------------- + + $400 million. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA Limited - Analyst [97] +-------------------------------------------------------------------------------- + + That added a little bit. Can we assume that repeats or this is kind of a one-off? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman of the Board and Chief Executive Officer [98] +-------------------------------------------------------------------------------- + + If you look, Mike, it is in the puts and takes we put on the first slide there. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA Limited - Analyst [99] +-------------------------------------------------------------------------------- + + Okay, that is fine. Higher rates, you are more asset sensitive now I guess $4.5 billion to 100 basis points. You were $3.9 billion last quarter. Are you intentionally -- I mean how do you think about that, are you leaving money on the table by being so asset sensitive? Do you want to be this asset sensitive? Maybe give the answer in the context of the last jobs report which seems to imply rates will increase later than previously expected. + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [100] +-------------------------------------------------------------------------------- + + We have not changed how we manage the interest rates of the Company. All that happened was long end rates went down from Q2 to Q3 increasing the (technical difficulty) that number. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman of the Board and Chief Executive Officer [101] +-------------------------------------------------------------------------------- + + The FAS 91 is really the major difference. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA Limited - Analyst [102] +-------------------------------------------------------------------------------- + + And then lastly, Paul, you are new in the job as CFO. Actually Brian, this is the first call where we can ask the question, why did the old CFO leave? We have heard a lot of different reports so why did the last CFO leave? +And, Paul, as you are new in the job as CFO, what changes might you want to make? And Paul or Brian, if rates don't go up for a lot longer than you expected, what is your Plan B to deal with the tougher environment? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman of the Board and Chief Executive Officer [103] +-------------------------------------------------------------------------------- + + So let me answer that and then I will let Paul talk. As we talked about three months ago, Bruce had served as Chief Risk Officer and CFO for a combined six years and wanted to get back and run a business or do something different so we announced that and Paul became CFO. There is nothing new to add. +In terms of how we will deal with the environment as we said most times to earlier questions, we continue to be able to hold the core expenses flat while we make the investments, pay the increased CCAR expenses, pay for the cost to reposition the franchise, severance and everything and we will continue to work that. If the environment changed and we didn't think we were getting returns on that, we will just go to the long-term interest of our shareholders, we would reduce the investment rate. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA Limited - Analyst [104] +-------------------------------------------------------------------------------- + + And Paul's philosophy on being CFO, any changes with your predecessor? + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [105] +-------------------------------------------------------------------------------- + + I think it is a little early for me to have developed a plan in terms of radical change. Bruce did a tremendous job of cleaning up the balance sheet and positioning our Company for growth and we have a great team that he built and I'm getting to know all of that and we will see how it goes. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA Limited - Analyst [106] +-------------------------------------------------------------------------------- + + All right, thank you. + +-------------------------------------------------------------------------------- +Operator [107] +-------------------------------------------------------------------------------- + + As it appears we have no further questions, I would like to return the program to Mr. Lee McEntire for closing remarks. + +-------------------------------------------------------------------------------- +Lee McEntire, Bank of America Corporation - SVP of IR [108] +-------------------------------------------------------------------------------- + + Thanks for joining, everybody. We will talk to you next quarter. + +-------------------------------------------------------------------------------- +Operator [109] +-------------------------------------------------------------------------------- + + This does conclude today's program. Thanks for your participation. You may now disconnect. Have a great day. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/exam/original-files/Problem_1_Sample/2015-Oct-22-AMZN.OQ-137384537916-Transcript.txt b/exam/original-files/Problem_1_Sample/2015-Oct-22-AMZN.OQ-137384537916-Transcript.txt new file mode 100644 index 0000000..b3515a5 --- /dev/null +++ b/exam/original-files/Problem_1_Sample/2015-Oct-22-AMZN.OQ-137384537916-Transcript.txt @@ -0,0 +1,580 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q3 2015 Amazon.com Inc Earnings Call +10/22/2015 05:00 PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Brian Olsavsky + Amazon.com Inc. - CFO + * Phil Hardin + Amazon.com Inc. - Director of IR + +================================================================================ +Conference Call Participiants +================================================================================ + + * Neil Doshi + Mizuho Securities - Analyst + * Stephen Ju + Credit Suisse - Analyst + * Scott Devitt + Stifel Nicolaus - Analyst + * Ben Schachter + Macquarie Research Equities - Analyst + * Justin Post + BofA Merrill Lynch - Analyst + * Ron Josey + JMP Securities - Analyst + * Brian Pitz + Jefferies LLC - Analyst + * Douglas Anmuth + JPMorgan - Analyst + * Youssef Squali + Cantor Fitzgerald - Analyst + * John Blackledge + Cowen and Company - Analyst + * Kunal Madhukar + SunTrust - Analyst + * Heath Terry + Goldman Sachs - Analyst + * Eric Sheridan + UBS - Analyst + * Mark Mahaney + RBC Capital Markets - Analyst + * Aaron Kessler + Raymond James & Associates, Inc. - Analyst + * Brian Nowak + Nomura Securities Intl - Analyst + * Mark May + Citigroup - Analyst + * Carlos Kirjner + Bernstein - Analyst + +================================================================================ +Presentation +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Good day, everyone, and welcome to the Amazon.com Q3 2015 financial results teleconference. +(Operator Instructions) +Today's call is being recorded. For opening remarks, I will be turning the call over to the Director of Investor Relations, Phil Hardin. Please go ahead. + +-------------------------------------------------------------------------------- +Phil Hardin, Amazon.com Inc. - Director of IR [2] +-------------------------------------------------------------------------------- + + Hello, and welcome to our Q3 2015 financial results conference call. Joining us today is Brian Olsavsky, our CFO. We will be available for questions after our prepared remarks. +The following discussion and responses to your questions reflect Management's views as of today, October 22, 2015 only and will include forward-looking statements. Actual results may differ materially. Additional information about factors that could potentially impact our financial results is included in today's press release and our filings with the SEC, including our most recent annual report on Form 10-K. As you listen to today's conference call, we encourage you to have our press release in front of you which includes our financial results as well as metrics and commentary on the quarter. +During this call, we will discuss certain non-GAAP financial measures. In our press release, slides accompanying this webcast and our filings with the SEC, each of which is posted on our IR website. You will find additional disclosures regarding these non-GAAP measures including reconciliations of these measures with comparable GAAP measures. Finally, unless otherwise stated, all comparisons in this call will be against our results for the comparable period of 2014. Now, I'll turn the call over to Brian. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com Inc. - CFO [3] +-------------------------------------------------------------------------------- + + Thanks, Phil. I'll begin with comments on our third quarter financial results. Trailing 12-month operating cash flow increased 72% to $9.8 billion. Trailing 12-month free cash flow increased to $5.4 billion, up from $1.1 billion. Trailing 12-months free cash flow less lease principal repayments was $3.1 billion, up from an outflow of $99 million. Trailing 12-months free cash flow less finance lease principal repayments and capital acquired under capital leases was $637 million, up from an outflow of $2.3 billion. Trailing 12-month capital expenditures were $4.4 billion. Capital expenditures does not include the impact of property and equipment acquired under capital and finance lease obligations. These capital expenditures and capital leases reflect additional investments in support of continued business growth due to investments in technology infrastructure, the majority of which is to support AWS, and additional capacity to support our fulfillment operations. +Combination of common stock and stock-based awards outstanding was 489 million shares compared with 481 million one year ago. Worldwide revenue grew 23% to $25.4 billion or 30% excluding the $1.3 billion unfavorable impact from year-over-year changes in foreign exchange. Worldwide paid unit growth was 26%. Worldwide active customer counts was approximately 294 million, excluding customers who only had free orders in the preceding 12-month period, worldwide active customers were approximately 272 million, up from approximately 244 million in the comparable prior-year period. Worldwide seller units represented 46% of paid units, up from 42% in the comparable prior-year period. +Now, I will discuss operating expenses excluding stock-based compensation. Cost of sales was $16.8 billion or 66.1% of revenue compared with 71.1%. Fulfillment, marketing, technology and content and G&A combined was $7.6 billion or 30.1% of sales, up approximately 50 basis points year-over-year. Fulfillment was $3.1 billion or 12.3% of revenue, compared with 12.4%. Tech and content was $2.9 billion or 11.4% of revenue compared with 10.8%. Marketing was $1.2 billion or 4.8% of revenue compared with 4.7%. +Now, I will talk about our segment results. As a reminder, in the first quarter we changed our reportable segments to report North America, International and Amazon Web Services. Consistent with prior periods, we do not allocate to segments our stock-based compensation or the other operating expense line item. +In the North America segment, revenue grew 28% to $15 billion or 29% excluding foreign exchange. Media revenue grew 8% to $3 billion or 9% excluding foreign exchange. EGM revenue grew 35% to $11.8 billion. EGM now represents 79% of North America revenues. North America segment operating income was $528 million, a 3.5% operating margin compared to a loss of $60 million in the prior-year period. North America segment operating income includes $11 million of favorable impact from foreign exchange. +In the International segment, revenue increased 7% to $8.3 billion. Excluding the $1.3 billion year-over-year unfavorable foreign exchange impact, revenue growth was 24%. Media revenue decreased 8% to $2.3 billion or increased 6% excluding foreign exchange. EGM revenue grew 14% to $5.9 billion or 32% excluding foreign exchange. EGM now represents 71% of International revenues. International segment operating loss was $56 million compared to a loss of $174 million in the prior-year period. International segment operating loss includes $64 million of unfavorable impact from foreign exchange. +In the Amazon Web Services segment, revenue grew 78% to $2.1 billion. Amazon Web Services segment operating income was $521 million, a 25% operating margin compared to $98 million in the prior-year period. AWS segment operating income includes $78 million of favorable impact from foreign exchange. +Consolidated segment operating income was $993 million or 3.9% of revenue, up approximately 460 basis points year-over-year. CSOI includes $25 million of favorable impact from foreign exchange. Unlike CSOI, our GAAP operating income includes stock-based compensation expense and other operating expense. GAAP operating income was $406 million compared to a loss of $544 million in the prior-year period. Our income tax expense was $161 million. GAAP net income was $79 million or $0.17 per diluted share, compared with a net loss of $437 million or a loss of $0.95 per diluted share. +Turning to the balance sheet. Cash and marketable securities increased $7.5 billion year-over-year to $14.4 billion. Inventory increased 23% to $9 billion and inventory turns were 8.6, down from 8.9 turns a year ago as we expanded selection, improved in stock levels and introduced new product categories. Accounts payable increased 22% to $14.4 billion and accounts payable days increased to 79 from 74 in the prior year. +I'll conclude my portion of today's call with guidance. Incorporated into our guidance are the order trends that we've seen to date and what we believe today to be appropriately conservative assumptions. Our results are inherently unpredictable and may be materially affected by many factors including a high level of uncertainty surrounding exchange rate fluctuations as well as the global economy and customer spending. It is not possible to accurately predict demand and therefore, our actual results could differ materially from our guidance. +As we describe in more detail in our public filings, issues such a settling intercompany balances in foreign currencies among our subsidiaries, unfavorable resolution of legal matters and changes to our effective tax rate can all have material effects on guidance. Our guidance further assumes that we don't conclude any additional business acquisitions, investments, restructurings or legal settlements, record any further revisions to stock-based compensation estimates and that foreign exchange rates remain approximately where the have been recently. +For Q4 2015, we expect net sales of between $33.5 billion and $36.75 billion, or growth of between 14% and 25%. This guidance anticipates approximately 340 basis points of unfavorable impact from foreign exchange rates. GAAP operating income to be between $80 million and $1.28 billion, compared to $591 million in the fourth quarter of 2014. This includes approximately $620 million for stock-based compensation and amortization of intangible assets. We anticipate consolidated segment operating income, which excludes stock-based compensation and other operating expense, to be between $700 million and $1.9 billion, compared to $1.04 billion in the fourth quarter of 2014. +We remain heads down focused on driving a better customer experience through price, selection and convenience. We believe putting customers first is the only reliable way to create lasting value for shareholders. Thanks and with that, Phil, let's move on to questions. + +-------------------------------------------------------------------------------- +Phil Hardin, Amazon.com Inc. - Director of IR [4] +-------------------------------------------------------------------------------- + + Great. Thanks, Brian. Let's move onto the Q&A portion of the call. Operator, will you please remind our listeners how to initiate a question? + + +================================================================================ +Questions and Answers +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) +Scott Devitt, Stifel Nicolaus. + +-------------------------------------------------------------------------------- +Scott Devitt, Stifel Nicolaus - Analyst [2] +-------------------------------------------------------------------------------- + + Hi, thanks for taking my questions. The first question Brian, International retail growth continues to improve and I was wondering if you can just talk through some of the dynamics there understand the consumption tax in Japan comp? You have some real markets where you have physical infrastructure now in Europe and then also the dynamics in India and China as contributors. And then secondly, maybe if you could just given how profitable AWS has become, if you could framework for thinking about the long-term profitability of that business? Thank you. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com Inc. - CFO [3] +-------------------------------------------------------------------------------- + + On International yes, you are right, first of all, the FX neutral growth of 24% year-over-year is up 200 basis points versus Q2 and up 1,100 basis points year-over-year. Some of that is due to the comping of the JP consumption tax increase in April of last year which we said last year, impacted Q2 and Q3 and not really impact in Q4. We are seeing the last of that on the comp. +But the impact of Prime Day globally we estimated about 200 basis points and we saw a pickup in both. I'll remind you that Prime Day was a global event, so we saw that as International as well. That was great event for -- a great day for customers, Amazon and sellers alike. The base International growth is really being driven by Prime adoption, greater selection, greater Prime selection including FBA. So it is essentially the same playbook as the US. The additional Prime features, we launched a Prime Now location in the UK this quarter. Not materially going to impact the entire continent but it is a good start. So we like the trends in International and they mirror many of the same things we see in North America. +On AWS, the business model there, let me talk about margin which was up sequentially from Q2 from 21.4% to 25%. We're continuing to see great acceleration in the pace of innovation. We've launched 530 new significant features this year which is more than last year already. We continue to lower prices. We've lowered prices eight times since a rather large price cut in April of 2014 -- excuse me, April of 2014. And we like the customers are really responding. They like the speed and agility that AWS provides them. They like the new features that we launched, many of which are also enable them to lower their cost of infrastructure. +Amazon Aurora, one-tenth the price of other high-end commercial databases, a new storage class of Amazon S3 QuickSight also very effective and cost-effective products for our customers. So like AWS, the model remains in early days and we enjoy leading this business and customers have responded well and we believe we are adding new services and features at a rate faster than many others. But the growth rates and margins will certainly remain lumpy and bumpy as we go forward. But we are very encouraged by the business and so are customers. + +-------------------------------------------------------------------------------- +Operator [4] +-------------------------------------------------------------------------------- + + Mark May, Citi. + +-------------------------------------------------------------------------------- +Mark May, Citigroup - Analyst [5] +-------------------------------------------------------------------------------- + + Hello? Can you hear me? + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com Inc. - CFO [6] +-------------------------------------------------------------------------------- + + Yes. + +-------------------------------------------------------------------------------- +Mark May, Citigroup - Analyst [7] +-------------------------------------------------------------------------------- + + Okay. Thanks. Question hopefully it hasn't been asked already is around AWS margins were obviously quite strong in the quarter. Can you speak to the sustainability of the margin improvement that we've seen there and what is your long-term expectations for profit margins for this business? And if you give us a sense of what CapEx for this segment of the business look like in the quarter and the rate of growth that would be helpful. And then secondly, your employee adds were fairly strong in the quarter as well. Wonder if you could call out any particular areas within the business where you are strengthening your hiring efforts? Thanks. + +-------------------------------------------------------------------------------- +Phil Hardin, Amazon.com Inc. - Director of IR [8] +-------------------------------------------------------------------------------- + + So this is Phil. I will take the AWS portion. I'll echo what Brian said earlier. This is a young and rapidly growing business and as you've seen looking backwards, certainly growth rates and margins and capital expenditure timing can be bumpy. We are taking a very long-term view on this business. We are excited about the potential there and really the team's focused on just keeping their heads down and continue to accelerate the pace of innovation to try to continue to grow the functionality gap we think we offer. A lot of hard work going on there. But again, we're take a long-term view on the business and interested in helping customers as much as possible in that space. +On the CapEx, again, we are focused on the ability to drive efficiencies across all of Amazon but we are also certainly investing in growth. On the AWS side, we've got investment going on around the world. Certainly additional servers to support the strong growth we have and some of the expense for things like data centers or new regions can be a little lumpy and we've mentioned a couple of new regions we are working on throughout the world. So that's going on as well. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com Inc. - CFO [9] +-------------------------------------------------------------------------------- + + Mark, on your headcount question, you are right, the headcount was up 49% year-over-year which is higher than Q2 -- we saw in Q2. This is going to be primarily our Ops area. If you exclude Ops related employees, our headcount's growing actually slower than our FX neutral growth rate of 30%. So what's going on in Ops is we've added 14 net fulfillment centers this year bringing the total to 123 globally. We've added four sort centers in the US bringing the US footprint to 23. We're staffing earlier in those locations. We are in good shape for the holidays and ready to go. The other issue -- is there any other reason is that we are also doing a live conversion of temp workers to full-time workers purposefully. This a metric of employment of full-time hires so it is a little bit higher due to that program. + +-------------------------------------------------------------------------------- +Operator [10] +-------------------------------------------------------------------------------- + + Mark Mahaney, RBC Capital Markets. + +-------------------------------------------------------------------------------- +Mark Mahaney, RBC Capital Markets - Analyst [11] +-------------------------------------------------------------------------------- + + I'm tempted to ask about the long-term margins for AWS but I won't. Can you talk about two areas? One, the EGM growth in North America, it is accelerated really strongly. Any color behind what's in particular categories that are driving that? And secondly, there's been -- you've made some public comments in the last eight months about some on the retail side about investments internationally. Particularly in India. Could you refresh us on what kind of levels suspend you're interested in targeting in that market? And then, maybe as part of that, any comments on China and how well you think you're doing there now? Thanks a lot. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com Inc. - CFO [12] +-------------------------------------------------------------------------------- + + Sure. On a EGM growth, I won't call out any particular categories but it is a direct reflection of our efforts to grow selection both our retail selection and also our third-party, particularly FBA which is also Prime eligible. And then just the responsiveness of our customers, especially our Prime customers to the EGM product line. We are very encouraged with the EGM growth. +And on India, I will not -- excuse me. I won't give specific dollar numbers on investment but I can give you an update on India. We are really encouraged with what we are seeing both on the customer side and the seller side. On the customer side, active customer accounts were up 230% year-over-year. We're in the middle of the Dewali season. That is going really well. Sales are 4X what they were last year. So customers are responding greatly this year. We continue to invest. We've been adding products at the rate of 40,000 products per day so far this year. +And just as big is the number of sellers, the sellers -- the number of sellers has grown more than 250% year-over-year. 90% of those sellers are using our logistics and warehouse services. As a result, we have tripled our fulfillment capacity year-over-year. We are very encouraged, as I said last quarter, in India, and continue to invest there very heavily. + +-------------------------------------------------------------------------------- +Phil Hardin, Amazon.com Inc. - Director of IR [13] +-------------------------------------------------------------------------------- + + Mark, I think you asked about China as well. This is Phil. We're continuing to work on some of the items we've been talking about for a couple quarters now. So the team has some interesting ideas. Really focused on making Amazon a trusted conduit for Chinese customers to access authentic International branded products and things that customers cannot get. +I think Amazon Global Store continues to expand the selection there. We added about another 400,000 items to that store this quarter and continue to focus on using our global network of vendors to be able to get those products to customers. We continue to test the store on TMall as well. And the team has some other ideas but that's what we are talking about so far. + +-------------------------------------------------------------------------------- +Operator [14] +-------------------------------------------------------------------------------- + + Eric Sheridan, UBS Investment Research + +-------------------------------------------------------------------------------- +Eric Sheridan, UBS - Analyst [15] +-------------------------------------------------------------------------------- + + Thanks for taking the question. Can you call out in terms of the 3P business what you are seeing in terms of third-party sellers maybe needing to make more and more of their goods Prime eligible? What the economics of that might be in terms of creating a tailwind for the business and how we should think about that evolving over the next couple of years? Thanks. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com Inc. - CFO [16] +-------------------------------------------------------------------------------- + + Sure, Eric. What I can tell you is the 3P percent of revenue continues to grow for now up to 46% of paid units, which is up 400 basis points year-over-year and 100 basis points sequentially off Q2. We feel that Prime and FBA are reinforce each other, they are inextricably linked. FBA adds Prime selection and Prime growth attracts more FBA sellers. So we have seen growth in FBA. It increases our Prime fast-track eligible selection, which we like and customers like, so we like what we see in the third-party side. + +-------------------------------------------------------------------------------- +Operator [17] +-------------------------------------------------------------------------------- + + Justin Post, Bank of America Merrill Lynch. + +-------------------------------------------------------------------------------- +Justin Post, BofA Merrill Lynch - Analyst [18] +-------------------------------------------------------------------------------- + + Thank you. We did see the acceleration in EGM. I was just wondering if some of the local delivery and Prime Now is driving that acceleration? Is that having a big impact on your business? And down the road, do you think the delivery infrastructure will be valuable in maybe delivering third-party and other units? Thank you. + +-------------------------------------------------------------------------------- +Phil Hardin, Amazon.com Inc. - Director of IR [19] +-------------------------------------------------------------------------------- + + This is Phil. It still pretty early for a lot of the really expedited delivery options. We've been working on our network for about 20 years to be able to enable some of the really fast delivery with things like Prime Now. But at this point, we are in a relatively small list of cities but it is expanding pretty fast. I think we launched it a couple more Prime Now cities just today. So that brings us up to about 17 across the globe. +On the same day, here in the US, we continue to expand that as well. But we think that those fast options add us to the consideration set of a customer's purchase on some purchases that we might not otherwise be included in. But at this point, we are still working on that and getting it up to speed. So nothing specific to call out on that. On the other part of your question, we continue to work on the network around the world but cannot respond to any of the rumors and speculation. + +-------------------------------------------------------------------------------- +Operator [20] +-------------------------------------------------------------------------------- + + Robert Peck, SunTrust. + +-------------------------------------------------------------------------------- +Kunal Madhukar, SunTrust - Analyst [21] +-------------------------------------------------------------------------------- + + Thanks for letting me ask a question. This is Kunal for Bob. Quick question on India, is there any change or any indication that there might be a change in the regulatory framework that would allow you to go direct? + +-------------------------------------------------------------------------------- +Phil Hardin, Amazon.com Inc. - Director of IR [22] +-------------------------------------------------------------------------------- + + This is Phil. I don't know that we have anything to comment on all of that. + +-------------------------------------------------------------------------------- +Kunal Madhukar, SunTrust - Analyst [23] +-------------------------------------------------------------------------------- + + Thanks. + +-------------------------------------------------------------------------------- +Operator [24] +-------------------------------------------------------------------------------- + + Douglas Anmuth, JPMorgan. + +-------------------------------------------------------------------------------- +Douglas Anmuth, JPMorgan - Analyst [25] +-------------------------------------------------------------------------------- + + Thanks for taking the question. I just wanted to ask the most frequent investor question and concern that we get is when will Amazon flip back to its heavier spending and investment ways from 2014 and earlier? So I wanted to ask, is that a legitimate question do you think or are you now at a point of scale and market share and maturity that you could sustainably manage the heavy invest and while still delivering material profit? Thanks. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com Inc. - CFO [26] +-------------------------------------------------------------------------------- + + Yes, thanks, Doug. I will point out that this quarter showed a lot of innovation, a lot of new products and features and a lot of investment. We've already talked about India, but domestically, we're -- excuse me, globally we are investing very heavily in our Prime platform both in North America and International. And that includes video content and original content, Prime Music, as Phil just said, the Prime Now has been expanded to 14 Metro areas, we have had same day delivery in now in 16 metro areas, we've built 14 new fulfillment centers, we've launched multiple devices including e-readers, tablets that are priced under $50, Echo, Dash Button. +So there's a lot of investment going on and there will be continue especially related to Prime. And on the AWS side, as I said, we have 530 new features so far this year. So innovation and investment will continue and can be lumpy. I hate to use that word again, but could be lumpy over time. The other dynamic in our Company though is definitely working on cost reductions and efficiency. I think you see a lot of that in this quarter's P&L and in our capital efficiency, both in the warehouse world and also in infrastructure. +So we will continue to work on costs. The good thing about 30% revenue growth is it gives you a lot more cost to work on as well. So we will -- I would say it is not as much as a pendulum as maybe it's been portrayed, it is more of a constant. The investment will, it sometimes ebbs and flows but the cost reductions will be a constant presence and the increase in customer experience and shortening the time to delivery in making the customer experience better. + +-------------------------------------------------------------------------------- +Operator [27] +-------------------------------------------------------------------------------- + + Brian Nowak, Morgan Stanley. + +-------------------------------------------------------------------------------- +Brian Nowak, Nomura Securities Intl - Analyst [28] +-------------------------------------------------------------------------------- + + Thanks for taking my questions. You guys had the Kindle store in Brazil since December of 2012. Just curious about the learnings around that and what benchmarks are you analyzing as you try to determine whether or not to invest further in a larger Brazil store? +The second one, just curious for comments on International Prime sub growth. It sounds like Prime subs are growing really well. I think a couple quarters ago, you mentioned how they are growing over 50%. Is that still the case and if so, what is driving that faster International Prime sub growth? + +-------------------------------------------------------------------------------- +Phil Hardin, Amazon.com Inc. - Director of IR [29] +-------------------------------------------------------------------------------- + + On the Brazil side, this is Phil, we've had the Kindle store in Brazil for a while. I think we look at all of our investments within an eye towards trying to maximize long-term free cash flow at strong returns on invested capital. That's across the Board. That's the criteria we are using, making sure we're building things that customers love that can have attractive financial returns over time and can persist for a long time and if they work, can be big. That's the metrics we are using. There's nothing specific to call out to Brazil though. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com Inc. - CFO [30] +-------------------------------------------------------------------------------- + + This is Brian. We are not going to update our Prime subscription growth beyond what we said last year or the end of last year, which last year in the year when we raised prices early in 2014, the global growth rate was 53% and North America growth rate was 50%. So by default, the International growth rate was higher. We like the adoption of Prime internationally, it is helped by additional selection that's available for fast-track shipment including FBA. So that fly wheel is working. +We've also launched video benefits, most recently in Japan, but we have them in UK and Germany. We continue to launch other Prime benefits, Amazon Pantry in Japan and Germany this quarter. We launched Prime Now in the UK. So it is very similar to the US story potentially time lagged a bit but we are seeing the same customer adoption and impact on growth rates. + +-------------------------------------------------------------------------------- +Operator [31] +-------------------------------------------------------------------------------- + + Carlos Kirjner, Bernstein. + +-------------------------------------------------------------------------------- +Carlos Kirjner, Bernstein - Analyst [32] +-------------------------------------------------------------------------------- + + Thank you. I have two questions. You have told us that you have tens of millions of Prime users, that you are investing heavily in Prime. Now at this scale and the 50% plus growth rates that you just mentioned, if you roll the clock two or three years, one can see Prime penetration in markets like the US starting to saturate as judges so many homes in the country. How should we think about the level of investment in Prime once you reached full penetration? Are there components that are given primarily to customer acquisition and what's the right way to think about that? +And secondly, what are the economic drivers that justify the business case for Prime Now? I don't expect you to give us any numbers, I've learned that lesson in the last few years, but what are the components of the customer lifecycle value calculation or what type of calculation that you make to justify someone dropping a box with that $15 order to a customer? Thank you. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com Inc. - CFO [33] +-------------------------------------------------------------------------------- + + Sure, thank you, Carlos. First, what I will classify as Prime demographics. So yes, we still think there's a lot of people in the country who are not Prime members and we are anxious to have them try it and sign up and join. The other thing that we see is that with our vast offering of selection and faster and faster shipping programs, we have a more competitive offering for many things that they buy. So there's a share of wallet element to it as well over time that we are looking to be more useful to customers all the time. +On your comment about the economic drivers of Prime Now. You know what I will say is, customers really value it. It is not our entire selection, it is tens of thousands of items that they may need on a daily basis. We think it is an interesting part of the selection offer for Prime and it's in many ways something that we can do that others cannot because it is a natural evolution of our 20-year effort to grow our fulfillment center network and our scale, quite frankly, makes it possible to even offer this to customers. + +-------------------------------------------------------------------------------- +Operator [34] +-------------------------------------------------------------------------------- + + Neil Doshi, Mizuho Securities. + +-------------------------------------------------------------------------------- +Neil Doshi, Mizuho Securities - Analyst [35] +-------------------------------------------------------------------------------- + + Great. Thanks, guys. Can you talk a little bit more about India and what is the opportunity there that you see? There's a tremendous amount of -- tremendous middle-class there but the distribution can be very challenging. So is that an area where we could see Amazon really building out the last mile? And then there's been some reports of an Amazon potentially trying to close the GAAP in terms of delivery and deliver sooner. On the grocery side, what is the impetus there and can we see how is the recent market's been trending on the grocery side that you've launched recently? Thank you. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com Inc. - CFO [36] +-------------------------------------------------------------------------------- + + I will take the India question. So again, India is a different market and does not have a lot of the same ready fulfillment options that some other countries did. We see that as an opportunity, an opportunity that we can build and we can bring to sellers. And as I believe I already mentioned, we like what we see, we are very encouraged, customer accounts, active customer counts are up 230% year-over-year and sellers, number of sellers is up 250% year-over-year. 90% of those sellers use our logistics and warehouse services, as you mentioned, which has caused us to triple our fulfilment capacity. We are happy to do so. We like what we see in India. We think we have, we're attractive both to customers and to sellers and we like our position. + +-------------------------------------------------------------------------------- +Phil Hardin, Amazon.com Inc. - Director of IR [37] +-------------------------------------------------------------------------------- + + This is Phil. On the grocery side, for Fresh we are in a handful of metropolitan areas here in the US. It is been a relatively measured rollout by Amazon standards. We continue to work on the customer experience and making sure we are really delivering a quality experience for shoppers. We are also working on the economics. And so, we've continued to work on that, but not much new to add right now. + +-------------------------------------------------------------------------------- +Operator [38] +-------------------------------------------------------------------------------- + + Heath Terry, Goldman Sachs. + +-------------------------------------------------------------------------------- +Heath Terry, Goldman Sachs - Analyst [39] +-------------------------------------------------------------------------------- + + Great. Thanks. I'm just wondering if you could give us a sense how some of the recent announcements from FedEx and UPS about pricing during the holidays and the structure of some of the third-party relationships might impact you? And given the investments that you've made in your own fulfillment infrastructure, how much of a competitive advantage you feel like you've got during the holiday season as other retailers have -- that are more directly exposed to these changes have to deal with it? + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com Inc. - CFO [40] +-------------------------------------------------------------------------------- + + No comment on the pricing. I would say that we have 23 sort centers which allows us to control a lot more of our shipments for longer but we certainly value our relationships with USPS, FedEx, UPS and other global carriers. And we are looking forward to a great holiday season. + +-------------------------------------------------------------------------------- +Operator [41] +-------------------------------------------------------------------------------- + + Aaron Kessler, Raymond James. + +-------------------------------------------------------------------------------- +Aaron Kessler, Raymond James & Associates, Inc. - Analyst [42] +-------------------------------------------------------------------------------- + + Yes, hi guys. Can you quickly, if you can talk about some of the more experimental projects you work on? I guess the travel business, you're in again for a few months and then got out of. Also, maybe with just restaurant, providing restaurant delivery. How do you view these services? They're not necessarily core to what you do, obviously you can provide those services. But how should we think about these types of investments longer-term? Thanks. + +-------------------------------------------------------------------------------- +Phil Hardin, Amazon.com Inc. - Director of IR [43] +-------------------------------------------------------------------------------- + + On destinations, we're constantly trying new things and testing and measuring and iterating here at Amazon and we learned a lot but we've discontinued that. On the restaurant delivery, we've had it for a couple months here in Seattle and recently announced it in Portland, and it fits very well with Prime Now. At this point, it is pretty small but something we are excited to do for customers. We think it will be helpful for them and we are happy to take advantage of some of the competencies we've built with Prime Now with our fulfillment network so far. + +-------------------------------------------------------------------------------- +Operator [44] +-------------------------------------------------------------------------------- + + Brian Pitz, Jefferies and Company. + +-------------------------------------------------------------------------------- +Brian Pitz, Jefferies LLC - Analyst [45] +-------------------------------------------------------------------------------- + + Thanks, some questions on video. Any color such as engagement on the recent launch of video products in Japan including the Fire TV, the Fire TV stick and Prime Video? And also, any general updates on your video content strategy or view on standalone streaming separate from Prime? Thanks. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com Inc. - CFO [46] +-------------------------------------------------------------------------------- + + Yes, I will take that one, this is Brian. No specific call outs in Japan. I would say that we are still very bullish on our Prime Instant Video, especially our new original content we've created. We think it is been critically acclaimed and also a big hit with customers. Man in the High Castle is coming out shortly as is the second season of Transparent which won Emmys this year. So we are really excited about the creative team we've assembled and the products that they have been able to bring to Prime customers. And we still like the customer reaction. Free trial conversion rates are higher when Prime members stream and they also renew at a higher rate their annual subscription. So again, that's very important to us as well and are very happy with the results. + +-------------------------------------------------------------------------------- +Operator [47] +-------------------------------------------------------------------------------- + + Ben Schachter, Macquarie Equities Research. + +-------------------------------------------------------------------------------- +Ben Schachter, Macquarie Research Equities - Analyst [48] +-------------------------------------------------------------------------------- + + So Prime has done remarkably well with folks willing to pay $99 up front. But do you expect to have different offerings for different cohorts? In other words, right now, Prime is a one-size-fits-all model. Could we see different pricing models for different demographics in the future? And then separately, can you also talk about how shipping leverage changes during the holiday season when shoppers tend to want more items per transaction? Thanks. + +-------------------------------------------------------------------------------- +Phil Hardin, Amazon.com Inc. - Director of IR [49] +-------------------------------------------------------------------------------- + + Sure. So this is Phil. On the Prime pricing, we do have a few different programs for different demographics today with programs like Prime Student or Prime Family, which we're very excited about. I can't speculate as to what we'd do in the future but Prime is a program that is really important for us and we are working hard everyday to continue to build selection there and to continue to make Prime better. +Hopefully you see that in the list of things we've launched recently and the continued cadence of making the services we have better. We just added a lot of new music in our Prime Music program. And as Brian mentioned, some of the upcoming programming should be pretty good in the fall. The Man in the High Castle is actually our most watched pilot, so we are excited about that one as well. So, continue to work on Prime. + +-------------------------------------------------------------------------------- +Phil Hardin, Amazon.com Inc. - Director of IR [50] +-------------------------------------------------------------------------------- + + On the shipping side -- + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com Inc. - CFO [51] +-------------------------------------------------------------------------------- + + I would say it is difficult equation. Yes, order size can go up but we ship a lot of toys and bigger items so it is hard to predict what that looks like. But having the density, having the sort centers has certainly helped our cost structure in that area and having inventory closer to our customers. + +-------------------------------------------------------------------------------- +Operator [52] +-------------------------------------------------------------------------------- + + Stephen Ju, Credit Suisse. + +-------------------------------------------------------------------------------- +Stephen Ju, Credit Suisse - Analyst [53] +-------------------------------------------------------------------------------- + + Thanks. Brian, it seems like you guys are rolling out Prime Now as well as product verticals internationally, fairly quickly especially if you measure it versus the pace of the rollout for Fresh or your other International older territories. Am I reading too much into this or have you guys put in place different processes to iterate more quickly? +And second, I think you've disclosed that as of the end of 2014, a little less than 10% of your fulfillment centers are outfitted with Kiva. So I guess, are all of your other fulfillment centers on a go forward basis going to have Kiva? If not, why not? And given the pickup in presumably the volume through-put there, does this mean you can slow down the pacing of your buildout there? Thanks. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com Inc. - CFO [54] +-------------------------------------------------------------------------------- + + Yes, sure. On Prime Now, it is our intent to rollout benefits and functionality globally as quickly as possible. I think we were able to do that with Prime Now and get to the UK faster. We are happy with that, it is not necessarily a comment on Amazon Fresh, it's just they are different businesses. So we're happy with the launch in the UK and the team did a great job to get that launch in a timely manner. +On Kiva, we are up to 30,000 bots at the end of Q3, which is -- and then they're in 13 for fulfillment centers. At the end of 2014, we had 15,000 bots. So we've doubled that amount and they were in 10 warehouses. Our intent is to use that more widely. And stay tuned. + +-------------------------------------------------------------------------------- +Operator [55] +-------------------------------------------------------------------------------- + + Ron Josey, JMP Securities. + +-------------------------------------------------------------------------------- +Ron Josey, JMP Securities - Analyst [56] +-------------------------------------------------------------------------------- + + Great. Thanks for taking the question. Just real quickly on pay unit growth accelerated 26% this year. I realize that these are comps but anything significantly higher or anything that happened this quarter? I know Prime Day could be it, but wondering if that was the reason? And then on AWS usage, just wondering if you could update on usage? I believe last quarter you mentioned usage was growing faster than revenue. I wonder if that's the same case this quarter? Thank you. + +-------------------------------------------------------------------------------- +Phil Hardin, Amazon.com Inc. - Director of IR [57] +-------------------------------------------------------------------------------- + + So this is Phil. On the unit side, you did see units move in a rate that's highly correlated with revenue there. Keep in mind AWS and some of the other rental type offerings don't generate units so we don't count those. But we did see, certainly saw some additional units as result of Prime Day. And on a longer-term, bigger basis, the continued growth of Prime, the continued selection expansion is helping with the units growth there. Was there a second part of your question? + +-------------------------------------------------------------------------------- +Ron Josey, JMP Securities - Analyst [58] +-------------------------------------------------------------------------------- + + It was just on AWS unit growth. I think last quarter you said it was growing faster than revenue. I'm wondering if that's still the case here? + +-------------------------------------------------------------------------------- +Phil Hardin, Amazon.com Inc. - Director of IR [59] +-------------------------------------------------------------------------------- + + We continue to see really strong usage growth across the board and it's coming from customers of all sizes. We also have recently announced that Aurora, which is our new database software, is our fastest growing service ever. For a long time we talked about red shift and Aurora has now outpaced that. So we're very excited about what we are seeing there. + +-------------------------------------------------------------------------------- +Operator [60] +-------------------------------------------------------------------------------- + + Youssef Squali, Cantor Fitzgerald. + +-------------------------------------------------------------------------------- +Youssef Squali, Cantor Fitzgerald - Analyst [61] +-------------------------------------------------------------------------------- + + Thank you very much. Two questions. First, with the courts striking down the Safe Harbor Provision between the US and the EU, how do you see the changes to European data storage requirement affecting AWS potentially? And on the Kiva, a question asked earlier, can you maybe help us understand the capital intensity of ace and actually using Kiva versus one that is not? Thank you. + +-------------------------------------------------------------------------------- +Phil Hardin, Amazon.com Inc. - Director of IR [62] +-------------------------------------------------------------------------------- + + This is Phil, I will take the Safe Harbor question with AWS. With our EU approved, AWS data protection agreement and model clauses we have in place, AWS customers can keep running their global operations using AWS and be in compliance with E-law. I think your second question was about the capital intensity? (Multiple speakers). + +-------------------------------------------------------------------------------- +Youssef Squali, Cantor Fitzgerald - Analyst [63] +-------------------------------------------------------------------------------- + + Yes, right. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com Inc. - CFO [64] +-------------------------------------------------------------------------------- + + I'm going to be vague on the scale of it but their capital intensity is offset by their density and throughput. So it is a bit of an investment that has implications for a lot of elements to your cost structure but we are very happy with Kiva. We think it is a great pairing our associates with Kiva robots to do some of the hauling of products within the warehouse has been a great innovation for us. And we think it makes the warehouse jobs better and I think it makes our warehouses more productive. + +-------------------------------------------------------------------------------- +Operator [65] +-------------------------------------------------------------------------------- + + John Blackledge, Cowen and Company. + +-------------------------------------------------------------------------------- +John Blackledge, Cowen and Company - Analyst [66] +-------------------------------------------------------------------------------- + + Great. Thanks. Two questions. So first, our data suggests that the US Prime sub growth is growing very rapidly at scale. Just wondering where you think the US Prime sub base is right now on the adoption curve? The second question is North American EGM growth accelerating again this quarter, we're assuming growth is being driven in part by categories like apparel and consumables versus perhaps a more mature category like electronics. So the questions are, with the vertical mix changing, how should we think about the impact to margins or are some of the newer and faster growing categories structurally higher margin for Amazon than the more mature categories? Thank you. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com Inc. - CFO [67] +-------------------------------------------------------------------------------- + + Yes, I cannot get into too much detail on the components of EGM profitability. I would say that we are seeing strong growth across all of our EGM categories. We have great teams that are chasing a lot of different product lines and working with vendors to get more selection on the site, both retail and also third-party. So still a lot of room there. +On the Prime sub growth, we are not updating the statistics. We are very happy with the growth not only in participation but also purchases and retention and we had a very successful Prime Day in July that we are really happy. It was a great event for customers and sellers. That's about all I have on that. + +-------------------------------------------------------------------------------- +Phil Hardin, Amazon.com Inc. - Director of IR [68] +-------------------------------------------------------------------------------- + + Thank you for joining us on the call today and for your questions. A replay will be available on our Investor Relations website at least through the end of the quarter. We appreciate your interest in Amazon.com and look forward to talking with you again next quarter. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/exam/original-files/Problem_1_Sample/2016-Apr-14-BAC.N-138757977086-Transcript.txt b/exam/original-files/Problem_1_Sample/2016-Apr-14-BAC.N-138757977086-Transcript.txt new file mode 100644 index 0000000..5debc4c --- /dev/null +++ b/exam/original-files/Problem_1_Sample/2016-Apr-14-BAC.N-138757977086-Transcript.txt @@ -0,0 +1,1078 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q1 2016 Bank of America Corp Earnings Call +04/14/2016 08:30 AM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Brian Moynihan + Bank of America Corp. - Chairman, President & CEO + * Lee McEntire + Bank of America Corp. - SVP of IR + * Paul Donofrio + Bank of America Corp. - CFO + +================================================================================ +Conference Call Participiants +================================================================================ + + * Steven Chubak + Nomura Securities - Analyst + * John McDonald + Berstein - Analyst + * Paul Miller + FBR & Company - Analyst + * Eric Wasserstrom + Guggenheim Securities - Analyst + * Mike Mayo + CLSA Limited - Analyst + * Nancy Bush + NAB Research - Analyst + * Glenn Schorr + Evercore ISI - Analyst + * Ken Usdin + Jefferies LLC - Analyst + * Matt O'Connor + Deutsche Bank - Analyst + * Jim Mitchell + Buckingham Research - Analyst + * Betsy Graseck + Morgan Stanley - Analyst + * Marty Mosby + Vining Sparks - Analyst + +================================================================================ +Presentation +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Good day and welcome to today's program. (Operator Instructions). Please note this call is being recorded. It is now my pleasure to turn the conference over to Mr. Lee McEntire. Please go ahead, sir. + +-------------------------------------------------------------------------------- +Lee McEntire, Bank of America Corp. - SVP of IR [2] +-------------------------------------------------------------------------------- + + Good morning. Thanks to everyone on the phone, as well as the webcast, for joining us this morning for the first-quarter 2016 results. Hopefully everybody has had a chance to review the earnings release. The documents are available on our website. +Before I turn the call over to Brian and Paul, let me remind you we may make some forward-looking statements. For further information on those, please refer to either our earnings release docs or our website or the SEC filings. +Let me just remind you, please limit the number of questions so that we can get to everyone's -- so we can get through all the questions that everyone has. And with that I'm pleased to now turn it over to Brian Moynihan, our Chairman, CEO, for some opening comments before Paul Donofrio, our CFO, goes through the details. Brian? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corp. - Chairman, President & CEO [3] +-------------------------------------------------------------------------------- + + Thank you, Lee, and good morning to everyone. We want to thank you for joining us to review our first-quarter results. Today we reported $2.7 billion in earnings this quarter, or $0.21 per diluted share. +As you can see in the results, two large items impacted this quarter's results. We recorded negative market-related NII adjustments for bond premium amortization. That adjustment alone cost us $0.07 per diluted share. And we also recorded a $0.05 per share diluted share cost of seasonal retirement eligible incentives. +When you think about revenue, net interest income, excluding that bond premium adjustment, was $10.6 billion this quarter. This is improvement linked quarter and year-over-year. Our loans are growing across the franchise and, compared to the prior year, are up 11% in our business segments. +In addition, deposit growth remains very strong. Our deposits were up $64 billion from last year or 6% to over $1.2 trillion. This growth reflects our progress to grow responsibly and deepen relationships with all of our core customers. +Moving to noninterest income, it declined year-over-year. Of note, the downdraft in that was driven by Capital Markets and related activities and, to a lesser degree, mortgage servicing and other fees as we continue to wind down our third-party servicing book. However, the other banking sources of noninterest income were relatively stable. +Switching to costs, we continue to drive costs down in this Company. Costs year-over-year in the first quarter were down 6%. FTEs were down 3%. That is $1 billion per quarter, $4 billion on an annualized basis. And if you focus just on the core costs excluding our LAS and litigation, those were down $600 million quarter -- from first quarter of last year or $2.4 billion annualized. We're going to keep driving those costs down as we continue to move forward through 2016. +Turning to slide 3 and looking at the business segment earnings, you can see the good year-over-year results because of the operating leverage in those businesses. The only exception is the results in Global Banking, which were negatively impacted by the increased [energy] reserves. +The combination of business segments outside the All Other group earned $4.5 billion in quarter one this year compared to $3.9 billion in quarter one of 2015. Offsetting those earnings were the $1.9 billion loss in All Other. That loss primarily reflects the two large adjustments I mentioned earlier and some legacy litigation costs. +You can also see the returns and efficiency ratios for each of our segments and note, with the exception of LAS, which came close to breaking even this quarter, they earned above their cost of capital. +Moving to slide 4, during the period of -- during the first quarter, there was a lot of talk with the market volatility, the Company buying surrounding the question about global growth and the forward-looking economic picture. However, we don't see any evidence of our customer base changing. +Spending by consumers remains strong and is up year-over-year over 4%. Loan demand remains solid throughout the franchise. And we continue to position our Company to face any potential economic outcome. +When you think about this, it's important to remember the work we've done over the past years to simplify and strengthen our foundation. We remain a different Company today than that which had entered the last downturn. We start with a clear strategy to serve the core financial needs of the customers. +We've gotten out of businesses, portfolios, products and client relationships that don't meet those strategic goals. We simplified the Company in every area. We cut the number of legal entities in half and we also reduced costs through programs like New BAC that produced [a loan] more than $8 billion in annual savings and our SIM program which continues to operate today. +At the same time we've continued to invest in the areas we can grow. $3 billion in technology-related growth initiatives, especially in areas of digital practice, whether it's in Consumer Banking, Commercial Banking, where we lead the industry with mobile and online platforms. We've also invested more in client facing teammates, funding that investment through elimination of bureaucracy and simplification and elimination of management jobs. +We believe that we have to continue to drive the productivity and will continue to do so in 2016. In the end, when you think about all this, it makes our Company more resolvable. As you all know, we received the latest input from our regulators on our resolution plans yesterday. Those plans were filed nine months ago and we've been busy at work since the day they were filed to continue to remedy the deficiencies and shortcomings stated in those plans and we will do so by the October submission date. +As you move to slide 5 you can also see the financial foundation that we've built in this Company. Liquidity and capital at record levels. Tangible book value per share, the marker of what we as shareholders own in our Company now stands at $16.17 and has improved over $5.00 a share over the last few years even as we've taken the hits that are now largely behind us. +Our funding structure continues to improve. Long-term debt has been cut dramatically; deposits have increased over 20% and most of that growth is coming through our Consumer Banking and Wealth Management segments. Our loan book is now well-balanced, half consumer, half commercial. And importantly, the consumer piece is much more secured lending than it was before the last crisis. +As we look in Global Markets, whether it's our Level 3 assets which are more risky, the total trading assets or VaR, they are all down significantly over the last few years. So as you can see we've simplified our Company and our operating structure. +As we look ahead to 2016, we remain focused on what we can control. We intend to keep driving the core customer activity you see on the loan and deposit and customer flow growth in each and every business, focusing intently on the Wealth Management and Global Markets businesses to take advantage as markets have stabilized. +We'll continue to drive on focusing on costs and drive those costs down and we'll continue to drive to deliver more capital to you as we did in the first quarter as investors. With that, let me hand it over to Paul. + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corp. - CFO [4] +-------------------------------------------------------------------------------- + + Thanks, Brian. Good morning, everybody, and thanks for joining us. Starting on slide 6, we present a summary of the income statement returns for this quarter, highlighting comparisons to Q4 2015 as well as Q1 2015. Earnings this quarter were $2.7 billion or $0.21 per share. +These earnings include the negative impact of the FAS 91 market-related adjustment which reduced EPS by $0.07. They also include $850 million of FAS 123 retirement eligible incentive expense which reduced EPS by $0.05. +For comparative purposes, the aggregate impact of these two same items in Q1 2015 reduced EPS by $0.08. Revenue on an FTE basis was $19.7 billion this quarter. Adjusted for FAS 91, revenue was $20.9 billion, a decline of $700 million from Q1 2015 on a similarly adjusted basis. +This decline was driven by the reduction in sales and trading revenue and IB fees as well as mortgage banking income offset by improvement in adjusted NII. Expenses were $14.8 billion, approximately $1 billion or 6% lower than a year ago, driven by good discipline across the entire Company. +Before moving to the balance sheet I want to note an adjustment to the financial statements this quarter, reclassifying some operating leases. We moved $6 billion of leases to other assets and we made conforming reclassifications to prior periods to improve comparability. +This reclassification had no effect on net income. However, as a result of this reclassification, quarterly NII is lower by approximately $50 million, other income is higher by approximately $180 billion and depreciation expense is higher by about $130 million. While these changes are small and don't affect profits, I wanted to note them so that you can more easily adjust your models. +Turning to slide 7 and the balance sheet. Total assets increased $41 billion from Q4 driven by higher Global Markets repo activity as well as increased cash. Deposits rose $20 billion from Q4 while loans increased $4 billion. Driven by deposit inflows, liquidity rose to $525 billion. +Time to required funding, while down, remains strong at three years. And note that the first quarter included the $8.5 billion settlement payment to Bank of New York Mellon as trustee in the article 77 suit which was reserved for over four years ago. Tangible common equity of $167 billion improved $4.7 billion from Q4. On a per-share basis, tangible book value increased to $16.17, up 9% from Q1 2015. +Turning to regulatory metrics: as a reminder, we report regulatory capital under the advanced approaches. Our CET1 transition ratio under Basel III ended the quarter at 10.3% and really is only comparable to Q4 as prior periods were reported under the standardized approach prior to our exit from parallel run. +On a fully phased-in basis, CET1 capital improved $3.4 billion to $158 billion as improvements from earnings and OCI were partially offset by dividends and repurchases. Under the advanced approaches, compared to Q4 2015, the CET1 ratio increased 30 basis points to 10.1% and is now above our fully phased-in 2019 requirement. RWA decreased roughly $18 billion driven by reductions related to retail exposures as credit quality improved. +We also provide our capital metrics under the standardized approach. Here our CET1 ratio improved to 11% with the same capital improvement as advanced but less of an RWA improvement given standardized is less risk sensitive. Supplemental leverage ratios for both the Parent and the Bank continue to exceed US regulatory minimums that take effect in 2018. +Turning to slide 8, we had solid loan and deposit growth in the quarter. Reported loans of $901 billion on an end of period basis increased $4 billion from Q4 and are up $28 billion or 3% from Q1 2015. Loans in our primary lending segments were up $14 billion or 2% from Q4 which is 8% on an annualized basis. +We continued to see solid commercial loan growth in Global Banking. In Consumer Banking we continue to see strong growth in consumer real estate and vehicle lending. Lastly, in Wealth Management we also saw continued growth in consumer real estate. +Loans outside the primary lending segments in LAS and All Other were down $10 billion from Q4 driven by continued pay downs of first and second lien mortgages as well as loan sales. During the quarter, we sold FHA loans totaling $2.7 billion and NPLs and other delinquent loans of roughly $1 billion, recording a small gain on sales and other income. +Turning to deposits, on an ending basis they reached $1.2 trillion this quarter, growing $64 billion or 6% from Q1 2015. Growth was led by our consumer businesses. Consumer Banking grew $43 billion or 8% year-over-year. GWIM grew nearly $17 billion, a 7% pace, and Global Banking grew at a 3% pace. +Turning to asset quality on slide 9. Outside the energy sector, credit quality is strong. Total net charge-offs were $1.1 billion in Q1 and Q4. We had some immaterial movements this quarter from minor adjustments but overall very little change in consumer losses. +Commercial losses declined slightly from Q4 despite a slight increase in energy charge-offs. Provision of $1 billion in Q1 was up $187 million from Q4. While net charge-offs were flat, total reserve release declined as reserve releases in Consumer were mostly offset by reserve increases in commercial driven by energy exposures. +On slide 10, we provide credit quality data on our Consumer portfolio. Net charge-offs declined $41 million from Q4. Consumer real estate charge-offs benefited from continued portfolio improvement and fewer one-time items, primarily collateral valuation adjustments on consumer real estate. Adjusting for those items, consumer net charge-offs were relatively flat versus Q4. Delinquency levels and NPLs improved and reserve coverage remains strong. +Moving to commercial credit on slide 11, net charge-offs improved $35 million. A decline in non-energy net charge-offs from Q4 more than offset a modest increase in energy losses. Energy charge-offs increased $17 million from Q4 to roughly $100 million in the quarter. +Given that asset quality outside energy remains relatively stable, let's focus on energy. We continue to support our energy clients while managing lending limits and actively engaging with stressed borrowers. Our overall committed energy exposures declined slightly from Q4 while utilized exposures were up by $500 million. +As discussed last quarter, within energy, we believe two subsectors, refining and marketing, as well as vertically integrated, which by the way tend to be large market cap and/or sovereign supported. These two subsectors are less dependent on oil prices and therefore carry less risk than our exposures in E&P and oilfield services. +Looking at our $7.7 billion utilized exposure to the higher risk E&P and oilfield services clients, we saw a decline of $600 million from Q4 as payoffs and charge-offs more than offset draw downs. +In addition, this quarter we moved $1.6 billion of our energy exposure to reservable criticized, and we added $525 million to our energy reserves. We made these adjustments based upon another quarter of not only low oil prices but also volatile prices. This moves our energy reserve to just over $1 billion. +And while these reserves cover also energy portfolio, they would represent 13% of our $7.7 billion E&P and oilfield services exposures. We believe that percentage is probably more relevant as you compare exposures across the industry. +Turning to slide 12, net interest income on an FTE basis was $9.4 billion. Included in NII this quarter was a FAS 91 negative $1.2 billion market-related adjustment for bond premium amortization. This adjustment in Q1 2015 was a negative $500 million. And including TruPS-related charges, Q4 was also negative $500 million. +Adjusted NII of $10.6 billion improved approximately $500 million compared to Q1 2015, excluding FAS 91, and improved $100 million from Q4 after also excluding the TruPS charge. +Several factors contributed to the improvement from Q4. We had good commercial loan growth funded by deposits. We also had about $100 million in seasonal benefits in Q1. Offsetting these factors we had one last day of interest and lower dividends on our Federal Reserve stock as required to contribute to the Highway Trust Fund. Lower long-term rates also offset some of the benefits of the Fed rate hike in December pressuring NII. +Lower long-term rates was also the driver of increased asset sensitivity in the quarter. As of 3/31, and instantaneous 100 basis point parallel increase in rates is estimated to increase NII by approximately $6 billion over the subsequent year. About 40% of this estimated $6 billion increase comes from short end rate improvement and the rest is from long end rate improvement split equally between FAS 91 and reinvestment at higher rates. +Turning to slide 13, noninterest expense was $14.8 billion in the quarter. That is $1 billion or 6% lower than Q1 2015 driven by good expense discipline across the Company. Legacy asset costs excluding litigation -- excuse me, Legacy Assets Servicing costs excluding litigation were $729 million this quarter, declining $292 million from Q1 2015 and $64 million from Q4. +Litigation expense of $388 million was in line with Q1 2015 as we work to resolve remaining legacy issues. First-quarter expense also included FAS 123 annual retirement costs of $850 million, slightly below Q1 2015. First quarter of both years also included about $300 million of seasonally elevated payroll tax expense. +Adjusting for all these items, i.e. the litigation, LAS, FAS 123 and the elevated payroll tax, expenses were $12.5 billion. This decline of $600 million from Q1 2015 was driven by: lower revenue-related costs associated with sales and trading in investment banking, as well as revenue in our Wealth Management business; the roll off of advisory retention awards put in place after the combination with Merrill Lynch; and lastly, SIM initiatives that are improving productivity and helping us lower costs so that we can continue to invest in growth. +Our employee base is down 3% from Q1 2015 and increases in client facing professionals were more than offset by reductions in LAS and other operations staff. +Lastly, before leaving expense highlights I want to remind you that quarterly FDIC insurance expense is set to increase at the large banks until the deposit insurance fund reaches 1.35%. For us, this will increase expense by approximately $100 million pretax starting in Q3 2016. +Okay, turning to the business segments, starting with Consumer Banking on slide 14. Consumer earned $1.8 billion, 22% better than Q1 last year. These earnings reflect continued core customer growth coupled with strong expense management. Lower provision expense from continued improvement in asset quality also benefited the bottom line. +This work generated a strong 24% return on allocated capital. Note that allocated capital increased slightly for 2016 pursuant to our normal capital allocation reviews completed in Q1. +On slide 15 we focus on some important trends. First, in the upper left, we continue to lead the industry in a number of ways, as you can see from the stats. Revenue increased $242 million or 3% from Q1 2015 as NII growth more than offset lower noninterest income. +Net interest income benefited from higher client balances. Noninterest income was down due to lower mortgage banking income offset by increases in card income and service charges. We continue to see mortgage banking income come down given our strategy to book more of our originations on the balance sheet. Expenses declined 2% from Q1 2015. +On the bottom left, you can see the year-over-year decline in FTEs as Mobile Banking growth continues to help us optimize our delivery network. Note, while overall FTEs are down year-over-year, sales specialists are up almost [900] from Q1 2015. +Lastly, our deposit franchise continues to drive operating leverage. Our cost of deposits as a percent of average deposits continues to improve and now stands at 171 basis points which we believe is best-in-class in the industry. +Focusing on Mobile Banking users in the upper right for a minute, we added 910,000 net new mobile users this quarter. We now have nearly 20 million active users and deposit transactions from mobile devices now represents 16% of deposit transactions. +Interestingly, this quarter we added more net new users than any quarter in the last three years and we continue to add new features and capabilities, improving convenience and satisfaction. +One way we are promoting adoption is by deploying digital ambassadors in our financial centers. Digital ambassadors engage with customers who come to our branches to transact. They educate these customers on alternatives to branch banking which are not only more convenient for them but also less expensive for us. Digital sales, digital appointments, digital satisfaction all continue to achieve new highs. +Focusing on client balances, you can see Merrill Edge brokerage assets are up 7% from Q1 2015 on strong flows offset by lower valuations. Moving to the bottom right of the page, note that loans were up 8% in Q1 2015 on strong mortgage and auto growth. +Okay, moving to slide 16, this is a new page that presents some statistics around loan growth and the quality of originations in our Consumer segment. Starting with card we issued 1.2 million cards in the quarter, which is a bit lower than the past few quarters. Average balances were impacted by the sale of a $1.7 billion nonstrategic card portfolio late in Q4. +Adjusting for that divestiture, loans were up from Q4. Spending on credit card, adjusted for divestitures, was up 8% compared to Q1 2015. +As we've discussed many times and shown here, we are originating high FICO loans that have produced very low loss rates and strong risk-adjusted margins currently exceeding 9%. Moving to vehicle lending, one sees similar high-quality, low risk lending stats. Average book FICOs are around 780 and loss rates are low. +Also, the tenor of these loans is relatively conservative compared to the industry as nearly 90% of our loans are less than 73 months. Margins obviously aren't as high as credit card, but average balances are growing well across multiple channels within the business. +Our underwriting standards are producing similar results in consumer real estate lending which is presented on the bottom of the page. Net loss rates on first lien mortgages have been negligible. Remember, we began booking these loans in the Consumer segment in the first quarter of 2014 and the macro consumer environment has been healthy, particularly for high FICO borrowers. +Turning to slide 17, Global Wealth & Investment Management produced earnings of $740 million, up 13% from Q1 2015. Year every year revenue was down but expenses declined more, improving pretax margin to 26%. Overall, revenue declined 2% from Q1 2015 as strong NII growth was more than offset by lower market sensitive revenue. +Asset management revenue declined on lower market values. Transactional revenue was also down and continues to be impacted by the shifting of activity from brokerage to managed relationships as well as market uncertainty. NII benefited from solid deposit and loan growth. +Noninterest expense in the first quarter of 2016 benefited from the fully amortized advisory retention awards given at the time of the Merrill Lynch merger. We have not seen a noticeable attrition as a result of this. Lower revenue-related incentives also contributed to lower expense versus Q1 2015. +Moving to slide 18, despite lower market levels, we continued to see overall solid client engagement and we continue to invest in the business, growing client facing professionals year-over-year. Client balances are $2.5 trillion. Long-term AUM flows were down this quarter as a result of market volatility which impacted client behavior. Average deposits grew $9 billion from Q4 and average loans also grew this quarter concentrated in consumer real estate lending. +Turning to slide 19, Global Banking earned $1.1 billion, down from both comparative periods as energy reserves weighed on results. Despite this increased provision expense, Global Banking was able to deliver a 12% return on allocated capital. And note that we allocated $2 billion more in capital to Global Banking for 2016, pursuant to our annual evaluation of allocated capital. +Global Banking continues to drive solid loan growth within its risk and client frameworks and this drove a nice increase year-over-year in NII, mitigated to some degree by spread compression. That NII improvement, combined with revenue growth from credit cards and treasury fees, partially offset a decline in investment banking and other marks on loans and hedges. Noninterest expense, compared to Q1 2015, reflects a decline in revenue-related expense offset by the cost of adding sales professionals over the past 12 months. +Looking at trends on slide 20 and comparing to Q1 last year, it was obviously a tough quarter for the capital markets with spikes in volatility causing declines in client activity. However, clients still have financing needs and here is where the diversity and strength of our franchise allows us to continue to deliver for them even when capital markets are less attractive. +You can see that trend in our average loans and lease balances, which increased again this quarter and are up 14% year-over-year. Growth in loans was broad-based across C&I, CRE and leasing, although recently we have slow growth in CRE. Spread compression on average across all our customer sizes has moderated relative to a year ago. +Average deposits also increased from Q1 2015, up $11 billion or 4%. We remain focused on our deposit mix which is strong with only 3% classified as 100% runoff balances. On the other hand, total firm-wide IB fees of $1.2 billion were down 22% from Q1 2015 with declines broad-based across M&A, DCM and ECM. +Switching to Global Markets on slide 21 and comparing Q1 last year, again the challenging market condition caused revenue compared to Q1 2015 to be down. The quarter included a benefit from the resolution of a litigation matter and we also had lower revenue-related costs compared to Q1 2015. +All of this resulted in Global Markets reporting earnings just under $1 billion. Reported revenue was down year-over-year, but note that last year DVA negatively impacted revenue versus added to revenue this quarter. Total revenue, excluding DVA, while up from Q4, was down 17% from Q1 last year on lower sales and trading revenue as well as Global Markets share of lower IB fees. +Noninterest expense declined 23% from Q1 2015 driven by lower litigation. Adjusting for litigation, expenses were down 9% as a result of lower revenue-related expenses demonstrating a disciplined approach to compensation. +Moving to trends on the next slide and focusing on the components of our sales and trading performance, sales and trading revenue of $13.3 billion excluding net DVA is up 25% from Q4 with improvement in both FICC and equity, but down 16% from Q1 last year. +Versus Q1 2015, FICC sales and trading of $2.3 billion fell 17% reflecting a tough environment for credit-related products as well as a tough comparison to a strong Q1 2015 in currencies. Equity trading was $1 billion, declining 11% reflecting weaker trading performance in a challenging market environment. Average trading assets continued to trend down as did VaR which remains at historically low levels. +Turning to Legacy Assets & Servicing on slide 23. This segment lost $40 million this quarter. I'm not going to spend a lot of time here as trends are consistent with past quarters. Revenue was down a bit from lower servicing fees as the portfolio of service loans declines. Revenue was also impacted by lower net [hedge results]. +As the portfolio shrinks, we continue to lower servicing costs particularly with respect to delinquent loans. The number of 60 plus day delinquent first mortgage loans serviced continue to decline and is now only 88,000 units. Excluding litigation expense this quarter was $729 million, dropping nearly $300 million from Q1 2015 and down $64 million from Q4. +On slide 24 we show All Other which reported a loss of $1.9 billion. Results were impacted by the $1.2 billion FAS 91 market-related adjustment, the FAS 123 seasonal retirement eligible incentive costs and litigation costs. The loss here is higher than Q1 2015 for a number of reasons. +First, the market-related adjustment is more negative this year than last. Second, we had higher gains on sales of loans in Q1 2015 than this period. Third, provision expense is higher as both periods had a benefit from provision but this quarter that benefit was smaller than Q1 2015. Lastly, litigation costs were higher this quarter versus Q1 2015 as we worked down legacy issues. +The effective tax rate for the quarter was about 28%, which is better than we expect for the full year absent any unusual items. One expected item that we want to bring to your attention is another UK tax rate reduction recently proposed in the Chancellor's budget. We expect this to be signed into law in Q3 and will result in a tax charge of about $350 million to reduce the carrying value of our UK DTA. The vast majority of this charge will not impact regulatory capital. +Okay, so let me offer a few takeaways as I finish. Given the market volatility, revenue growth was challenging this quarter. However, we compensated for this by managing expenses well. If one adjusts this period's reported results for the noncash FAS 91 market-related NII amount and the FAS 123 costs, earnings are largely in line with recent quarters. You can see progress most clearly in our business segments which don't include these adjustments. +Taken as a whole, the segments, not including All Other, improved earnings by 16% versus Q1 2015. The drivers of this improvement were solid loan and deposit growth across our customer groups. Net charge-offs were largely unchanged as modest increases in energy were mitigated by other improvements. We strengthened our capital liquidity and we returned $1.5 billion in common dividends repurchased to shareholders. +To Brian's earlier point, we have done years of work to simplify the Company and reduce risk. With $167 billion in tangible common equity, $12 billion in credit reserves and twice the amount of liquidity of a few years ago, we believe we are well prepared to help customers and clients in good and bad times and we are focused on growing earnings in many different economic scenarios. With that let's open it up to Q&A. + + +================================================================================ +Questions and Answers +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions). Jim Mitchell, Buckingham Research. + +-------------------------------------------------------------------------------- +Jim Mitchell, Buckingham Research - Analyst [2] +-------------------------------------------------------------------------------- + + Hey, good morning. Just maybe let's focus -- I'll focus my question on expenses and then I'll get back in the queue. But I think outside of incentive comp expenses generally were better than I was expecting and how much of that is to simplify and improve and how much more do you think there is to do on some of these core expenses I guess is number one? + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corp. - CFO [3] +-------------------------------------------------------------------------------- + + Look about from Q4 to Q1, $300 million in core expense decline. $100 million of that is the roll off of the amortization of the awards we gave to advisors around the Merrill Lynch acquisition. $200 million of it is just good, solid expense discipline being driven by SIM and other initiatives. If you look at the supplement you're going to see expenses came down in nearly every category. + +-------------------------------------------------------------------------------- +Jim Mitchell, Buckingham Research - Analyst [4] +-------------------------------------------------------------------------------- + + And you think there's more to do there? I guess maybe in the context of your discussion around digitization and Consumer, that seems like that could be a longer-term tailwind. Do you guys agree? And do you think that's a material mover or just more incremental? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corp. - Chairman, President & CEO [5] +-------------------------------------------------------------------------------- + + Jim, I think there's a lot more to do here because at the end of the day adjusting the efficiency ratio for the two major adjustments, which won't reoccur next quarter, you get in the mid-6 -- 66, 67 and we need to drive that down in the low 60s even with the realities of the wealth management business not being as profitable and a big part of our revenue stream but very return on capital beneficial. +So then if you flip and say how are we going to get down there? You're exactly right. If you look, we drifted down even further this quarter. Numbers of branches, smaller numbers of customers, but deposits are up. If you look at headcount in Consumer we continue to reposition it towards the sales and relationship management side and away from the transactional side. +And so that digitization, which is -- we're at $19.6 million, Mobile Banking consumer customers. And interesting enough we're growing on the online customer base, meaning computer-based customers grew over 1 million customers from last year's first quarter. So all that just drives more and more transactions, more and more cost structure of the day-to-day transactional stuff into those environments and saves us money overall. +And at 170 -- 170 basis points, there was a time when that was 300 basis points five, six, seven years ago. We thought we'd got it into the low 2s -- 220, 240, and thought that was pretty good and now we're at 170, and my guess is we continue to push it down. + +-------------------------------------------------------------------------------- +Jim Mitchell, Buckingham Research - Analyst [6] +-------------------------------------------------------------------------------- + + That's helpful. And maybe just one ticky tack question on the FDIC charge. It wasn't clear. Is that an annual expense or is that going to be quarterly at $100 million? + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corp. - CFO [7] +-------------------------------------------------------------------------------- + + It's going to be quarterly $100 million beginning in Q3 until the fund gets up to its adequate level and then it will come down. + +-------------------------------------------------------------------------------- +Jim Mitchell, Buckingham Research - Analyst [8] +-------------------------------------------------------------------------------- + + Okay, all right. Great. Thank you very much. + +-------------------------------------------------------------------------------- +Operator [9] +-------------------------------------------------------------------------------- + + Matt O'Connor, Deutsche Bank. + +-------------------------------------------------------------------------------- +Matt O'Connor, Deutsche Bank - Analyst [10] +-------------------------------------------------------------------------------- + + Good morning. Any outlook you can provide in terms of the potential for additional reserve boosts related to energy? We heard one bank yesterday talk about maybe another [$]500 million, although a lot of variability around that number they pointed to. And obviously their book is different than yours, but any thoughts if conditions stay where they are now on additional reserve boosts? +And then just related to that, the outlook for additional reserve release in the rest of the portfolio given, as you mentioned, trends continue to be strong or even improve in some areas. + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corp. - CFO [11] +-------------------------------------------------------------------------------- + + Sure. Look, in terms of reserve build, we think the reserves we have right now are the right reserves for our portfolio. Built in releases in the future of going to be based upon how companies adapt to the level and duration of low oil prices as well as our net charge-offs and we think companies are adapting. +In terms of reserve releases, we would expect releases in Consumer, but at a slower pace than we've seen in the past as we run off the legacy portfolio and dependent upon the real estate market. Consumer releases would likely go to offset any builds in commercial. + +-------------------------------------------------------------------------------- +Matt O'Connor, Deutsche Bank - Analyst [12] +-------------------------------------------------------------------------------- + + Okay. That's helpful. And then just separately, kind of big picture from a regulatory point of view if I look back to last year, you've had some steps forward, some steps backwards. Obviously had to resubmit on CCAR. That was a net positive once you got the results back. You got the approval for the extra 1% buyback which I think symbolically a lot of investors view and I view as positive. +You've got the living will issue that came up yesterday for you and a number of others. Just at a very high level, maybe give us an update on how you are feeling from the regulatory point of view and where the areas are that you feel like you still need to improve. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corp. - Chairman, President & CEO [13] +-------------------------------------------------------------------------------- + + I think from a global perspective we continue to implement all the rules and regulations of change over the last few years. And importantly, Volcker was an implementation mid-this year. And all lot of the hard work has been done if you think about LCR, SLR, the core Basel rules and the changes. +We absorbed the advanced increases over the last year and now we're above the 10% advanced including the $100 billion or more of RWA for the commercial assets and the off risk of capital of $40-billion-odd. And so, we've absorbed a lot of that into the run rate and I think we're now to the point of fine-tuning the Company around the rules and regulations and continue optimizing it. +And I think that -- we've obviously submitted the CCAR work. We did a tremendous amount of work just on the expense side. That was another $40 million of incremental expense this quarter in the first quarter to continue to get us using third parties to continue to make sure we kept our run rate at best-in-class. And so that's in and being reviewed as we speak. +And then we've got obviously, as you spoke about, the continuation of finishing up the resolution plan, which we -- has probably spent at least $0.25 billion on external parties to help us with and a lot of internal work. And that's all been in the run rate as we speak and ultimately provide relief as we get through it. +So I think overall you've seen us implement most of the rules and optimize the Company. We need to continue to do that. That ought to provide some RWA opportunities in the future, but it continues to take time. But we've -- I think we're in pretty good shape and now the question is just to finish up a couple of these key tasks on the resolution plan that you can see. Unprecedented transparency -- you've got the same letter I got, so you know exactly what we have to do, and we'll get it done. + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corp. - CFO [14] +-------------------------------------------------------------------------------- + + If I could just have maybe two thoughts. One, this is not an episodic activity for us. This is being (technical difficulty) and meeting the standards under the regulations. That's one. +Two is it's not a group of people who are doing this. It's everybody in the Company. It's -- we have a significant -- it's really being led in many ways by the line of business. We've got involvement from all of the support functions, so it's become part of the culture of the Company to get to the right standards across all the regulations. + +-------------------------------------------------------------------------------- +Operator [15] +-------------------------------------------------------------------------------- + + Betsy Graseck, Morgan Stanley. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [16] +-------------------------------------------------------------------------------- + + Hi, good morning. Hey, couple of questions. One is on the quality of the book. You went through and reminded us how much you've improved the quality of book in the Consumer. Could you speak to that in the commercial as well, ex-energy? +And then give us a sense as to whether or not you think that's embedded in the CCAR results. I'm just trying to get an understanding of whether or not you think that RWA hit that you had to take could potentially come down as commercial rolls through? + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corp. - CFO [17] +-------------------------------------------------------------------------------- + + So outside of -- on the commercial side, outside of energy and metals and mining, we don't see issues with credit quality. We're obviously watching very carefully, but it feels very good outside of those two sectors. What was the second part of your question? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corp. - Chairman, President & CEO [18] +-------------------------------------------------------------------------------- + + It's on the CCAR results. + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corp. - CFO [19] +-------------------------------------------------------------------------------- + + Oh, yes, yes, absolutely. Look, if you look at our CCAR results, either on an absolute basis or on a comparative basis, you can see what a third-party, the Fed, thinks our losses would be. You're going to see that again in a few months. And I think you can really see, when you look at those results, how much we've improved the credit quality of the Company of both -- across both Consumer and Commercial. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [20] +-------------------------------------------------------------------------------- + + Do you think that can help in the buyback ask as you go through -- it's not just a question about this year but just over time? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corp. - Chairman, President & CEO [21] +-------------------------------------------------------------------------------- + + Over time, Betsy, our view is that we can grow the Company and grow it responsibly as we talk about. So there's opportunities for growth and that's -- on the Consumer segment a lot of questions we get is how can you grow and keep your credit discipline? You must be changing. +You can see that this stuff coming on today is as strong as anything we put on and the Commercial you should assume is the same. And so there is still plenty of opportunity for us to grow, which is just good for earnings and prospects. +When you flip it to the other side of it, yes, our job from the management team was to set this Company up to -- it would never have the kind of risk embedded in it that would lead us to difficult times and a real recession, leave alone the CCAR analysis. And as you see the CCAR analysis over time, you see our loss content continue to come down and that should serve us in good stead to be able to take out capital over time, as you said. +And if you think about in the Commercial book, it's -- things like commercial real estate, we have been very disciplined and what we inherited through all the deals and development loans -- all that stuff is really nonexistent at any consequence, so we feel very good about the Commercial book. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [22] +-------------------------------------------------------------------------------- + + Okay, and then just separately, you talked a bit about the mobile user increase. And I just wanted to get your sense as to the opportunity from here. You recently launched the new app with mobile pay, which you've been doing internally but now you can do externally. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corp. - Chairman, President & CEO [23] +-------------------------------------------------------------------------------- + + Right. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [24] +-------------------------------------------------------------------------------- + + Could you give us a sense as to how that's resonating with clients? Is there an opportunity set here for you and are you going to market it a little bit more aggressively going forward? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corp. - Chairman, President & CEO [25] +-------------------------------------------------------------------------------- + + So let's -- just framing from the overall top. Last year this quarter we had 17 million mobile users; this year we have 19.5 million. And as Paul said, there was an interesting point that the nominal rate of growth this quarter was one of the highest we've ever had. So even though smart phones have penetrated, you think you've kind of penetrated the customer base, it's still growing fast, so that's number one. +And then as I said earlier, Betsy, and you've followed our Company for a long time, you might -- you would've seen a plateauing in the online -- the computer-based banking, for lack of a better term, people coming in through BankofAmerica.com. And that now is growing as fast [nominally] or faster mobile which means people are also using both sides. And so that's one thing. So the core activity is growing. +And if you look at the activity in the core customer base from card usage -- both debit and credit card usage up 4% plus year-over-year, and that's good. The online mobile part of the spend is now up to 20% of the spend and it's growing 15% per year versus the 4%, 4.5% growth on the total. So that's tremendous. +Then if you get in the wallet categories, just to give you a sense, just in the last week the growth rates in enrolled cards was 12% week to week growth in terms of volume enrolled, 100,000-odd cards came on. The payment usage was up 3% week over week, so you see this phenomenal growth rate. If you annualized that out, that's a weekly growth rate and it ebbs and flows with holidays and everything else, but think about that. +And you see that usage going up, but the mobile wallet payments are still less than 0.2% of the total payments made with plastic at Bank of America. So you still have lots of opportunity to convert activity to a platform which is more convenient for the customer. +And then the other thing we've -- and then a part of that you talk about is the new consortium to build a new P2P deployment for the banking system. We're up and operating that. We still have a few more months before the rest of the colleagues in the consortium get up and then we'll start to push that out in the market heavily. +I think it's a tremendous improvement over what we have today, even though we have a fair amount of volume on it today through clearXchange and that was an effort to get us all together so we could have a very interoperable payment network. +We've got the Visa Checkout work that's going on where we're preloading customers' cards in their wallet. We're about, as best we can tell, 13%, 14% of all the spend in Visa Checkout today and we've got 1 million-plus cards; we'll drive that forward. +And if you put that altogether you're seeing tremendous volume off of all these mechanisms. And in the month of March, to give you an example, we had almost $60 billion of payments off the computer-based platform and about $20 billion off the mobile-based platform. So think about the size of that. +Now given all that, we still sent out about $8 billion of cash out of our ATMs in the month of March on -- that's $0.25 billion a day or more. So it's still -- you have to have all the capabilities and that's what we're building towards. And going back to I think Jim's question earlier, the cost structure keeps moving in your favor as you keep driving this activity through. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [26] +-------------------------------------------------------------------------------- + + I mean eventually you've got an elimination of checks and some of your bill pay costs potentially go down as well, I would assume? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corp. - Chairman, President & CEO [27] +-------------------------------------------------------------------------------- + + Yes, eventually is always an operative word. Even today I think there's about a quarter million checks a day, people take a picture of them and send them in on their mobile phones and that didn't exist three years ago. But there's still a quarter million of them that would have to go way, so it will be a while. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [28] +-------------------------------------------------------------------------------- + + Okay, but that's in line with expectations to bring down the consumer expense ratio? I mean, is that really the driver of getting the consumer expense ratio down is the backend on the payments piece? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corp. - Chairman, President & CEO [29] +-------------------------------------------------------------------------------- + + Yes, it's everything about payments: processing payments, fraud losses, discussions with the customers about the payment -- the multiple payment faculties that they could use and how they interface. And so, it has been a huge driver. Remember we went from 6,100 branches down to 4,600 or whatever today. +And the customer base has increased by 10% and the volume of deposits is up by I think 30% to 40% and checking deposits are up dramatically. So I think year-over-year checking deposits were up 8% over 10% I think, Lee, right? Something like that. So the activity is level is growing up on a smaller and smaller base. +And that cost structure in retail is driven by two things, the people, which we're increasing sales in relationship management content, and the physical plant. And you're absolutely right, driving all that out -- near as we can tell, we spend about $1 billion a year just moving cash around in our Company. So less cash moving around saves us money. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [30] +-------------------------------------------------------------------------------- + + Okay. And just remind us what your goal is to get the consumer expense ratio to? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corp. - Chairman, President & CEO [31] +-------------------------------------------------------------------------------- + + The goal is to have it keep going down every day, week, month, quarter. And I think, Betsy, with all these things you've got to be careful about letting my consumer colleagues think they are doing too good a job. So I keep putting pressure on them, so I'm not going to give them a goal that they think they've achieved something. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [32] +-------------------------------------------------------------------------------- + + All right. Thank you. + +-------------------------------------------------------------------------------- +Operator [33] +-------------------------------------------------------------------------------- + + John McDonald, Bernstein. + +-------------------------------------------------------------------------------- +John McDonald, Berstein - Analyst [34] +-------------------------------------------------------------------------------- + + Hi, good morning. I was wondering about -- on the net interest income side if you could talk a little bit about, Paul, what kind of outlook we should think about for the core net interest income. That was [$10.6 billion] this quarter. If rates are relatively stable and we don't see any hike for a while, how should that trend with all the puts and takes? + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corp. - CFO [35] +-------------------------------------------------------------------------------- + + Sure. So look, we're hesitant to give guidance. Given the volatility rate that we've experienced, guidance has not been that helpful, in my opinion, but I'll give you a couple of thoughts. $10.6 billion, if you think about maybe as a launching off point, given some of the seasonal NII gains we had in Q1 I think a more reasonable launch point would be more like $10.5 billion. +Then you go to the second quarter, we've obviously got to deal with lower long-term rates. Second quarter is always a little bit seasonally lower for us. So there's some -- progress there is going to be challenged. But I think as you head to the third quarter and fourth quarter, when you consider what we're -- think we can do on deposit growth and loan growth, and if rates follow the path along the forward curve, we would expect to make progress in the latter half of the year. + +-------------------------------------------------------------------------------- +John McDonald, Berstein - Analyst [36] +-------------------------------------------------------------------------------- + + Okay, and you do get a day count [help] modest in the second quarter from the first, right? Doesn't that help? + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corp. - CFO [37] +-------------------------------------------------------------------------------- + + It's a leap year, so I think it's normally down 2, but now it's down 1, or -- (multiple speakers) flat, yes. + +-------------------------------------------------------------------------------- +John McDonald, Berstein - Analyst [38] +-------------------------------------------------------------------------------- + + Going into the second. Okay. And then just on trading, there was a quote in the media from you this morning, Paul, saying March felt better in certain areas. Could you just give us a little color on what changed in March on the trading front? What got better? Has that carried over a little bit into April? And how are you thinking about the Brexit vote from a risk and revenue impact potentially as that comes up this spring? + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corp. - CFO [39] +-------------------------------------------------------------------------------- + + Sure. So March felt, I think, a lot better than certainly January and February. And April it's really too early, but April feels, at least is starting out, like it's more like March than it is like January and February. +In terms of Brexit, we are focused on our clients and customers. They are going to need -- there's going to be volatility potentially around the vote and around any changes after the vote. And we're working very closely with our customers to address how they need to manage their risk. +From our own Company perspective, we are -- we're going to listen. It's a UK -- it's the UK's decision. We're going to -- after we find out what the decision is and understand it, then I think we will react to it and do what we think is in the best interest of our customers and clients and shareholders and other constituencies. + +-------------------------------------------------------------------------------- +John McDonald, Berstein - Analyst [40] +-------------------------------------------------------------------------------- + + Okay, thank you. And in terms of March, what -- could you just -- any color on what got better? What felt better? Which areas of the business? Could you help on that? + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corp. - CFO [41] +-------------------------------------------------------------------------------- + + No, I wouldn't say -- look, I think you heard from competitors that Asia was a little better in March. We're stronger in the US than we are in Asia. We have a significant business there, but -- so there was some improvement out there. But, no, I wouldn't have any more specifics than that. + +-------------------------------------------------------------------------------- +John McDonald, Berstein - Analyst [42] +-------------------------------------------------------------------------------- + + Okay, thanks. + +-------------------------------------------------------------------------------- +Operator [43] +-------------------------------------------------------------------------------- + + Glenn Schorr, Evercore ISI. + +-------------------------------------------------------------------------------- +Glenn Schorr, Evercore ISI - Analyst [44] +-------------------------------------------------------------------------------- + + Hi, thanks very much. On slide 12 you noted your asset sensitivity increased a bunch from the prior quarter. You mentioned driven by the drop in long end rates. Could you talk through how that actually works. And then how much of the $6 billion is short end versus long end? + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corp. - CFO [45] +-------------------------------------------------------------------------------- + + Sure. 40% of the $6 billion is going to come from an increase in short end rates and then the other 60% is split equally between FAS 91 and reinvesting at longer-term rates. The FAS 91 piece is relatively straightforward. I mean we had a $1.2 billion decline in Q1 because interest rates went down 50 basis points. We're going to retrace that if they go back up. + +-------------------------------------------------------------------------------- +Glenn Schorr, Evercore ISI - Analyst [46] +-------------------------------------------------------------------------------- + + Separate one. If you look at the ROA [full] year on year, it's a large amount on a percentage basis from 59% down to 50%. I'm just curious, I wouldn't think weak capital markets in the quarter was the big driver, but I guess the question is what's the big driver of it. And are the new business you are putting on coming in at higher ROA so we should expect that to rise from here, assuming not so crazy markets? + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corp. - CFO [47] +-------------------------------------------------------------------------------- + + Look, if you think about our ROA and you adjust for FAS 91 market-related NII adjustments and retirement-eligible expenses, you're going to get into the mid-70s. And then if you give us some credit for the progress we've made in LAS over the last few years and continue with that progress, you're going to get even higher. +From there it's about growing loans -- growing deposits, growing loans, putting on, like you said, assets that are accretive to what we have on the books right now. And, importantly, continuing to grind and work on expenses. And so, that's what we've got to do. + +-------------------------------------------------------------------------------- +Glenn Schorr, Evercore ISI - Analyst [48] +-------------------------------------------------------------------------------- + + Okay. One last tiny one is Wealth Management margins increased a couple hundred basis points quarter on quarter. 500 year on year without the help of revenues. Expenses were down a bunch. You mentioned the $100 million roll off of the previous amortized retention awards. What's the rest of the expense saves inside Wealth Management? It's pretty good in a world that didn't have much revenue. + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corp. - CFO [49] +-------------------------------------------------------------------------------- + + It's compensation related given the fact that revenue was a little weak because of the volatile markets. That's not to say we're not working on bringing down costs in that segment as well, but specifically to answer your question in Q1, that's what drove it. + +-------------------------------------------------------------------------------- +Glenn Schorr, Evercore ISI - Analyst [50] +-------------------------------------------------------------------------------- + + Is that nonproduction expenses, meaning usually the comp stuff goes hand-in-hand with revenues? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corp. - Chairman, President & CEO [51] +-------------------------------------------------------------------------------- + + Yes, it's -- they are working on all the elements expense, so you've got that right. But also remember as the NII increases there's not as much expense attached to that. So that's one of the operating leverage points in wealth management that we were losing a lot last year that we're going to get back as short-term rates rise because they are a heavy deposit business. +Remember, they alone are $260 billion of deposits in Wealth Management, which those deposits and loans continue to grow which continues to produce more core NII. As well as what everybody thinks of as being a large Investment Management trust fee type company. But they are a big bank and the loans grow and that's going to drive that up and that is marginally more profitable for the shareholder. + +-------------------------------------------------------------------------------- +Glenn Schorr, Evercore ISI - Analyst [52] +-------------------------------------------------------------------------------- + + Okay, perfect. Thank you. + +-------------------------------------------------------------------------------- +Operator [53] +-------------------------------------------------------------------------------- + + Paul Miller, FBR & Company. + +-------------------------------------------------------------------------------- +Paul Miller, FBR & Company - Analyst [54] +-------------------------------------------------------------------------------- + + Hey, thank you very much, guys. On the legacy asset, on the -- you lowered your loans from 103,000 to 88,000 on the high touch servicing or default servicing. How much of that was sold or are you guys just working through the book? + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corp. - CFO [55] +-------------------------------------------------------------------------------- + + I would classify it as little to very little sold this quarter. It's just working service loans -- delinquent service loans down. + +-------------------------------------------------------------------------------- +Paul Miller, FBR & Company - Analyst [56] +-------------------------------------------------------------------------------- + + Just working it down? And has -- the new stuff coming in, is that still a material amount or it has that been -- is that mainly done? Like you're not really getting a lot of new stuff coming into this bucket? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corp. - Chairman, President & CEO [57] +-------------------------------------------------------------------------------- + + Very little from any production that was done after the crisis, Paul, as you could expect. So they're delinquency statistics. So really you still have modifications that -- the re-modification work going on because people have had modifications for years. Some portion of them go back in the situation and then you have just the normal flow. +But that number keeps working itself down and, based on the quality of our portfolio, should come down even significant to where it is. This is a grind now. This is just working through -- if some were involved in litigation take time. It's just a grind to work them out now. + +-------------------------------------------------------------------------------- +Paul Miller, FBR & Company - Analyst [58] +-------------------------------------------------------------------------------- + + And then you said in the quarter -- and you disclosed this a very, very clearly -- that it was about $700 million on this. Where can we -- can this be cut in half by the end of the year? When does this really become immaterial do you think? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corp. - Chairman, President & CEO [59] +-------------------------------------------------------------------------------- + + Well, as we've told you, our target -- our next weigh station on improving this thing is $500 million at the end of the year and we're well on our way to get there, Paul. But your experienced in this business. That is not an acceptable number, but I just need to keep them tracking it down. +What's interesting, and if you look at the headcount we show you and stuff, what is changing is they're headcount down is at 9,800 or something like that, 9,900 at the end of the quarter so it's come down from a high of 58,000 internal people plus external contractors dramatically. +Now we've got to get some of the harder costs out, meaning the systems and technology that was overbuilt for $12 million servicing portfolio, the real estate, and that takes a little harder work. So we're grinding all that out. So say $700 million and change to $500 million and change and ultimately we've got to get it down to significantly below that $500 million to make it makes sense as a servicing. +I think it's okay, but to actually be an effective servicing platform we should drive it down. Your point about immateriality is something -- this is becoming less and less of an event to us. And so what we've got to execute on -- it's not going to have the impact of when we had $3.1 billion of quarterly costs a few years ago. + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corp. - CFO [60] +-------------------------------------------------------------------------------- + + $1.4 million of 60 plus day delinquent loan service. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corp. - Chairman, President & CEO [61] +-------------------------------------------------------------------------------- + + So $500 million by year end, that's our next goal, and then when we get there we'll give you another one. But we're just -- like I said earlier to Betsy on the Consumer side, we've got to keep moving this in the right direction and we have an idea where we'll get to, but we want to make sure we get the first piece out, it's $1 billion a year. + +-------------------------------------------------------------------------------- +Paul Miller, FBR & Company - Analyst [62] +-------------------------------------------------------------------------------- + + Okay, guys. Guys, thank you very much. + +-------------------------------------------------------------------------------- +Operator [63] +-------------------------------------------------------------------------------- + + Eric Wasserstrom, Guggenheim. + +-------------------------------------------------------------------------------- +Eric Wasserstrom, Guggenheim Securities - Analyst [64] +-------------------------------------------------------------------------------- + + Thanks very much. If I could just refer back to slide 16 for a moment. There's been a lot of debate about the dynamics in the auto lending market, about deterioration in underwriting and the risks of large amounts of used cars coming off of lease. Could you give us any granularity about what you are seeing in lending across the FICO spectrum and how you are anticipating that residual issue to play out? + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corp. - CFO [65] +-------------------------------------------------------------------------------- + + Sure. Look, this is some perspective. We're maintaining our market share in auto lending, but we're very focused on originating prime and super prime loans. Average FICO score, as you can see on the page, of 778 and debt to income ratios are at all-time lows. +Again, we're not following the market from a structuring standpoint to the longer tenors. 90% of our loans are 73 months or lower, so that's our strategy. And I think if we stick to that, we'll be fine. We did pull forward from -- we had an opportunity this quarter to get more flow. We had planned to do that in later quarters. We pulled that volume to this quarter and we'll evaluate it in future quarters. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corp. - Chairman, President & CEO [66] +-------------------------------------------------------------------------------- + + And you asked a question about residual values and the volume of cars sold and what happens. We also, as part of our stress testing of our -- stress testing our portfolios, internal stress testing and also for the CCAR DFAST work, we stress the collection -- the recognized collection value of cars down 40% and it's not -- it'd obviously have more losses, why wouldn't you? +But what really controls your losses is the quality portfolio and what runs through that calculation. And that number is, because of the high quality is very low. So we test that question you're asking which is what happens if residual values or used car values continue to -- fell dramatically in a recessionary environment or something and that's one of the things we test, and it's not a big number. + +-------------------------------------------------------------------------------- +Eric Wasserstrom, Guggenheim Securities - Analyst [67] +-------------------------------------------------------------------------------- + + Right, and when you say that you pulled forward some flow, what do you mean by that? + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corp. - CFO [68] +-------------------------------------------------------------------------------- + + We had the opportunity -- we have relationships where -- on the flow side and when we see opportunities we can pull some of that in. Originations come through the branch, they come online and they come through our relationships with financial institutions who have relationships with dealers. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corp. - Chairman, President & CEO [69] +-------------------------------------------------------------------------------- + + And our relationship with dealers also. + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corp. - CFO [70] +-------------------------------------------------------------------------------- + + Yes, our relationship with dealers. So every once in a while we'll see an opportunity to add some balances and if it's within our underwriting standards we'll consider it. + +-------------------------------------------------------------------------------- +Eric Wasserstrom, Guggenheim Securities - Analyst [71] +-------------------------------------------------------------------------------- + + And that was primarily on the indirect side? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corp. - Chairman, President & CEO [72] +-------------------------------------------------------------------------------- + + Yes. + +-------------------------------------------------------------------------------- +Eric Wasserstrom, Guggenheim Securities - Analyst [73] +-------------------------------------------------------------------------------- + + Okay. Thanks very much for the clarity. + +-------------------------------------------------------------------------------- +Operator [74] +-------------------------------------------------------------------------------- + + Mike Mayo, CLSA. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA Limited - Analyst [75] +-------------------------------------------------------------------------------- + + Hi, my short question is when will the return on equity go into the double-digit range? Look, you have a good franchise and balance sheet. You're showing growth in loans, deposits, online banking, other areas. And you're showing lower, better expenses, branches, headcount, risk but it's not adding up. I mean your stock is 15% below tangible book value and this was yet one more quarter of mid-single-digit ROEs and worse than peer efficiency. +So my question is why is Bank of America less efficient than peer? And it's tough on the outside to know because you have $2 billion of expenses in Other that's not allocated to the business lines. What is your Plan B if rates don't go up and when will the ROE go into the double-digits? + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corp. - CFO [76] +-------------------------------------------------------------------------------- + + Well, hi, Mike. Thank you. So I guess I would start by again -- just so everybody understands the facts -- we -- if you adjust for FAS 91 and FAS 123, our return on tangible common equity would be roughly 8.5%. And again, as I said before, we've made a lot of progress in LAS. And if you give us any credit for the progress for the progress we think we're going to make in the future, we're going to be able to take that 8.5% even further. +We've made, I think -- so the key is we've got to continue to make progress on expenses. I'll get to revenue in a second, but we've got to continue to make progress on expenses and, again, I think we've demonstrated that we can do that. If you look just year-over-year, expenses are down $1 billion or 6%. If you go back to Q1, Q1 2011, we've taken quarterly expenses down, core quarterly expenses down $3.5 billion, so that's a $14 billion run rate. We've got to continue to do that. +If you look this quarter at our Consumer and GWIM segments, you can see the operating leverage. If you look at the whole Company and you back off FAS 91, you can see the operating leverage. So we've just got to continue to work on expenses. We're not sitting around waiting for rates to go up. It would help if they did, and that's what we're focused on. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA Limited - Analyst [77] +-------------------------------------------------------------------------------- + + All right, if I can follow-up. Despite all the progress that you've made -- and you talked about the LAS expenses, you can talk about New BAC, you can talk about the quarterly expense rate since 2011. But your core EPS is still $0.33 this quarter, and it was a weak -- tough quarter, tough environment, but it still in that $0.35 range. +So despite all those expense savings we're not seeing it in the core EPS number that's still around $0.35. So where did all those expense savings go or is this going to come through in future quarters? +And I know I've asked this question on many earnings calls and also thank you, Bank of America, for having that -- and Brian for having that opening letter from the lead director in the annual report. Jack Bovender says that he wants to engage more with investors. +And so I do hope that he takes my questions at the annual meeting to engage a little bit more because I've asked this so many times. I still don't feel like I have an answer that I understand, so just one more try at it, Paul. Just where are these expense savings going if EPS is still in the same range? + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corp. - CFO [78] +-------------------------------------------------------------------------------- + + So, they're going -- you sort of have identified the opportunity that we have in a different market environment. It's a judgment I think we have to make. But a portion of these savings are going to increase growth in the future. A portion are going to the bottom line. +That's the lever we can pull over an extended period of time to adjust for the market environment. We've proven we can get the expenses out. If we wanted them all to drop to the bottom line we could do that, but we need to invest in growth at the same time and we've got to balance that. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA Limited - Analyst [79] +-------------------------------------------------------------------------------- + + So, no new New BAC coming up or anything like that? It's just -- as I guess, Brian, you've said, you grind it out. It's just -- it would be nice to see more of the progression. Is it -- do you think it's a 2016 event? A 2017 event? Or we just -- when rates go up we'll see more of it? + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corp. - CFO [80] +-------------------------------------------------------------------------------- + + Look, in terms -- we are focused on driving down expenses every day, every quarter, every week. You can call it anything you want. We've got a lot of focus on this and I think you're going to continue to see progress. +Our operating leverage on an adjusted basis this quarter was meaningful. You can see it. If you adjust for FAS 91, revenue down 3%, expenses down 6%. We're getting the operating leverage. Look at the GWIM segment, look at the Consumer segment. We are focused on it. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA Limited - Analyst [81] +-------------------------------------------------------------------------------- + + All right. Thank you, Paul. + +-------------------------------------------------------------------------------- +Operator [82] +-------------------------------------------------------------------------------- + + Steven Chubak, Nomura. + +-------------------------------------------------------------------------------- +Steven Chubak, Nomura Securities - Analyst [83] +-------------------------------------------------------------------------------- + + Hi, good morning. So, I had a follow-up to Glenn's earlier question on the Wealth Management margin. I just want to get a sense as to whether we should be thinking about that 26% margin that we saw in the quarter as a good jumping off point, just given some of the tailwinds you had spoken to, whether it be the higher-margin NII growth and the absence of the legacy Merrill awards. And I suppose as it relates to that, are preparation efforts for things such as DoL compliance potentially going to weigh on the margin in future quarters? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corp. - Chairman, President & CEO [84] +-------------------------------------------------------------------------------- + + A couple things with that. The 26% -- if you think back across the last year when we discussed this, we had the ATP piece. And so a chunk of that is that, the other chunk is good expense management. I said earlier the margin net interest income stabilizing, improving. They been growing the balances now. It's more stable. So I think it is a good starting point. +It will -- in some cases you would hope that it wouldn't go up a lot because that would mean asset management fees and other things are growing, which attach more compensation, less marginal profit, which will be good news, because the overall profit will grow better. But you should assume that that's a level we should hold onto if -- in a relatively stable environment as we see this quarter starting out at. +When you go to the fiduciary, we've been working on that, obviously. Just because it's the final rule and it came out recently we've been working on it. So I don't think -- I think to the extent there's cost embedded in that, a lot of it's in the run rate and it will be marginally in the run rate for the next few quarters. It's not a hugely substantial cost and if you even -- look, we've spent a lot of time educating our teammates about doing it. There are operational costs but I don't think it's material in the grand scheme of things. + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corp. - CFO [85] +-------------------------------------------------------------------------------- + + I'll just add a little bit to that. I think from the very beginning we supported the fundamental objectives of the Department of Labor. And if you look at our goals-based strategy, it delivers a lot of what they are getting at with that rule in terms of the best interest standard. +Our Merrill Lynch One advisory platform, which we successfully completed the transition of a lot of clients this quarter. That's a great example of how we've been up front to create an experience that is really transparent, single fee schedule, etc. That's a significant investment. And we're guessing that that investment is really going to pay off here in terms of implementing this rule. +If you look at the roughly $2 trillion of [GUM] client assets we have outside of deposits and loans, we think the Department of Labor will probably impact less than 10% of that. And certainly given the implementation schedule we wouldn't expect to see much of an impact, if any impact, in 2016 and as we digest the rules we'll just have to evaluate how it's going to affect out years. + +-------------------------------------------------------------------------------- +Steven Chubak, Nomura Securities - Analyst [86] +-------------------------------------------------------------------------------- + + Okay. So it sounds as though a lot of the incremental expense is already in the run rate and that you don't anticipate much revenue disruption based on the final rule as written? + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corp. - CFO [87] +-------------------------------------------------------------------------------- + + That's correct. + +-------------------------------------------------------------------------------- +Steven Chubak, Nomura Securities - Analyst [88] +-------------------------------------------------------------------------------- + + Okay. Got it. And maybe just focusing on the expense base within Global Markets. Was certainly pleased to see the absolute level of dollar expense was, from what I could tell, the lowest level that we've seen over the last five years. So clearly some of the efforts that you highlighted to right size the cost base have borne fruit. +And as we think about the expense trajectory for this business, what should we expect in an environment where the trading revenues are relatively stable or consistent with what we saw in the most recent quarter? Is that [$2.4 billion] a reasonable run rate expectation? + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corp. - CFO [89] +-------------------------------------------------------------------------------- + + We're going to continue -- like every other segment, we're going to continue to work on bringing our costs down in this segment as well. I think there's lots of things we can do from an operational standpoint to improve profitability over the medium and long term and we're focused on that. +You're right, here compensation expenses are significant and they are going to be consistent with the revenue performance. I think we were disciplined this quarter in terms of our compensation expense and you saw that in the numbers. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corp. - Chairman, President & CEO [90] +-------------------------------------------------------------------------------- + + They've been adjusting -- as you read about in the press, there is a -- it's not in the run rate yet, it comes in next quarter because it happened mid-March. They made major adjustments in the size of the platform in mid-March. I'll give you an example. +We have equity sales people year-over-year down 60 or 70 on a base of -- that's probably down 15% or 20% at least. So fab in that business continues to reposition. Bernie and Jim continue on the fixed income side so they've made some major adjustments in headcount. So we'll hold it down here. +You want this expense to go up because that means the revenue has gone back up. So you've got to be careful. But the fundamental operating platform has embedded in the run rate cost actually continue to develop a systems architecture, continue to drive the compliance of Volcker and all that stuff as you go in the run rate. So the chances of the non-compensation related expenses moving a lot is not the big deal and the question is just how do you incrementally keep management down. + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corp. - CFO [91] +-------------------------------------------------------------------------------- + + The other thing to remember just in this quarter, I would just point out again, that we did have a little bit of help from litigation. We had a reversal of a prior matter. It helped on the expense line. + +-------------------------------------------------------------------------------- +Steven Chubak, Nomura Securities - Analyst [92] +-------------------------------------------------------------------------------- + + Okay. And can you quantify how much of a benefit that provided, Paul? + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corp. - CFO [93] +-------------------------------------------------------------------------------- + + We don't generally comment on those sorts of things. It was -- look, it was north of $100 million. + +-------------------------------------------------------------------------------- +Steven Chubak, Nomura Securities - Analyst [94] +-------------------------------------------------------------------------------- + + Okay, got it. And then just one more final one for me, just on the investment banking side. You talked about stability in March continuing into April on the trading business. One of your competitors talked about actually seeing some improving trends in the capital raising environment in April versus what was clearly a challenging quarter in 1Q. +I didn't know if you were seeing some improvement on the capital raising side as well. And if you can give us an update just in terms of backlogs in some of the other pockets like M&A, that would be helpful. + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corp. - CFO [95] +-------------------------------------------------------------------------------- + + As you might imagine, the pipeline is -- looks great because everybody -- people need to transact, they just haven't -- they just didn't do it in the first quarter, so it's building up. In periods where there's volatility like this, the best thing our bankers can do is to be in front of CEOs, Boards and CFOs. They are doing that. +There is going to be -- have to be financing activity at some point because clients need to finance. And so our pipeline looks good. I wouldn't necessarily say we've seen any -- in the first few days of April we've seen any dramatic increase in capital markets activity, but there is certainly lots of dialogue. The pipeline looks good again because I think there's a lot of pent-up demand there. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corp. - Chairman, President & CEO [96] +-------------------------------------------------------------------------------- + + I think the simple thing to think about in the investment banking Capital Market side is the work is ready to go, we just -- if we continue to see the stability, you will see it come through. And that's -- our comments are really based on still -- they're still stabilizing as we speak. +And so, if that happens, you expect to see it start pulling through and it would be up from the quarter, quarter over quarter. But there are still a few more weeks of stability that you have to see for people to actually pull the trigger on financings and stuff. + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corp. - CFO [97] +-------------------------------------------------------------------------------- + + Obvious, the markets right now are stable. People can finance if they want to. I think it's just a question, as Brian said, of CEOs and Boards just making sure that the stability we're seeing right now is something that they can count on as they go to market. + +-------------------------------------------------------------------------------- +Operator [98] +-------------------------------------------------------------------------------- + + Ken Usdin, Jefferies. + +-------------------------------------------------------------------------------- +Ken Usdin, Jefferies LLC - Analyst [99] +-------------------------------------------------------------------------------- + + Thanks. Good morning. Brian, right at the outset you said that there has really been no meaningful change in the customer base activity. And then the following on your comments about stable capital markets, you are growing the core loan book now double-digits still, 11%. I'm just wondering how much of that is the environment holding up. How much of that is still the spigot opening from reasonable growth? And just your outlook in terms of customer behavior on the lending side? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corp. - Chairman, President & CEO [100] +-------------------------------------------------------------------------------- + + The other thing, Ken, is that you have to remember that for a long period of time we were fighting the runoff of the noncore assets, which are now small enough that we could actually overcome them. So there are a lot of quarters where the core activity was growing but you couldn't find it because -- if you look at the slide you can see the All Other, which is the investment portfolio, really mortgages and then the LAS assets are now small enough so that the quarter-to-quarter runoff. +But I think it's solid across-the-board. I think that in the segments we focus in on the Consumer side, prime, super prime, there's strong activity. Mortgages, you could see the origination volumes this quarter were solid. I think if you think of home equity has kicked back up a little bit again because people see home equity in their house. +The auto businesses strong, but it will ebb and flow with how many units get sold ultimately because that's the nature of the business. Although I think we can gain share there because our share on our direct-to-consumer business was very low. We didn't even do it two years ago and now we're up to, I don't know, $0.5 billion or more a quarter. +So I think from a consumer side, the card business, because we've now sold through all the portfolios we have to sell, I think you should see stable and start to see better year-over-year comparables than we've had the last several years. Obviously the last big portfolio went out in the fourth quarter, and so I think we feel good. +If you look at the online customers, the creditworthy customers that we deal with are there to borrow and we're lending to them. And if you go on the Commercial side, as Paul said earlier, I think you would expect us the CRE -- we slowed -- we want to be careful in CRE, so we are doing very fundamentally structured loans. But in C&I, and a nice -- business banking, not a huge business for us, frankly, but they finally are making it through their runoff and that's good. +And so I think across all those businesses you should see -- it may not grow as fast as [normally] it has. Two years ago we had the international book grow and corporate -- we slowed that down based on our judgments about risk. And so I think it's a pretty balanced growth. And so the question always is do you have to compromise your credit standards to grow? No, we don't because you can see that. And then secondly, is there opportunity to actually get growth? And the answer is yes. But -- and that's just good, hard work. + +-------------------------------------------------------------------------------- +Ken Usdin, Jefferies LLC - Analyst [101] +-------------------------------------------------------------------------------- + + Yes, Brian, to that last point, how much opportunity actually, without pointing to compromising, but how much more spigot opening can you still do, to your point about the post crisis, the tightening up internally? Are you still under lent, if at all. Or you still have to be somewhat careful about where we are in this stage of the economic cycle being that we are seven-plus years into an expansion? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corp. - Chairman, President & CEO [102] +-------------------------------------------------------------------------------- + + We have to be careful and that's what I think we wanted to show you some of the -- there are two -- three basic principles that you have to follow. One is, we had to balance the portfolios between Commercial and Consumer. +Second, we had to get the Consumer to secure portfolios, dominating versus unsecured both credit card -- now the loans really put us behind -- in a tough situation last time. And then, third, you've got to maintain your individual quality of underwriting. Consumer is more formulaic and Commercial more deal selection and customer selection. +But if you look at it -- I'll just give you the simplest way to think about this. We have moved probably from 8 out of 10 mortgage holders who are absolutely within our credit box, absolutely we do business with, getting their mortgage somewhere else to maybe 7. So we've still got 7 more to go without talking about expanding the credit parameters in our mortgage business one iota. +So think of that as a demonstration point that you can go over and over again. So there is plenty of market share out there. And then one of the things, Ken, we're looking at is we look across our 90-odd markets in the United States. There are areas where we have tremendous opportunity to expand our market share where the franchise just wasn't balanced. +Some areas of franchise, the wealth management business is a high percentage; in some places, it's low. The middle-market business is very high market -- very strong, good market shares in certain markets and a third of that in other markets. And so, where we're deploying these people is also based on our view of which market. So it's going into that market, hiring talent, using this massive customer capability we have to go drive it. Again, target the exact customers we want. +So, even on a geographic basis, whether it's the deposit business and expanding in some of those markets, but also in the commercial lending business and -- otherwise there's opportunities without compromising credit. + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corp. - CFO [103] +-------------------------------------------------------------------------------- + + As Brian said, that's where those added sales professionals are going. They're going to markets where we think we have synergies across commercial, GWIM and Consumer. + +-------------------------------------------------------------------------------- +Ken Usdin, Jefferies LLC - Analyst [104] +-------------------------------------------------------------------------------- + + Okay, got it. so in some -- you think this 10% plus primary lending is still achievable? That's what it sounds like from what you're saying. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corp. - Chairman, President & CEO [105] +-------------------------------------------------------------------------------- + + Well, I think we've been telling people to focus more on mid-single-digits type of numbers in a given 2% growth -- 1.5%, 2% growth economy as opposed to 10%. So -- but the core business is growing faster and then we're still running off, but we've told people to focus in at that level. + +-------------------------------------------------------------------------------- +Ken Usdin, Jefferies LLC - Analyst [106] +-------------------------------------------------------------------------------- + + Okay. Understood. Thanks, guys. + +-------------------------------------------------------------------------------- +Operator [107] +-------------------------------------------------------------------------------- + + Nancy Bush, NAB Research. + +-------------------------------------------------------------------------------- +Nancy Bush, NAB Research - Analyst [108] +-------------------------------------------------------------------------------- + + Good morning. Brian, I think we've all over the last few years been trying to find banking normal and it's proving hard to find. And it kind of has begun to strike some of us that maybe first quarter -- what we saw in the first quarter in terms of volatility and continued low rates, etc., etc., is banking normal, at least for the foreseeable future. +And under that scenario, if you believe that, would you -- have you begun to look at -- take a second look at your businesses again? And will there be any sort of reallocation of capital going forward and are there businesses you might want to exit? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corp. - Chairman, President & CEO [109] +-------------------------------------------------------------------------------- + + I'm not sure you can consider first-quarter banking normal in the sense that we still have extra costs we've got a get out of here, Nancy, that we continue to work down. Litigation was elevated in the quarter from more the normalized level that we feel we can achieve and things like that. But leave that aside. +The basic principle is we continuously look at the franchise to see about optimization. So generally when people ask that question they are thinking about a couple different areas. One is the markets area. We show you the markets. Profitability returns in this business. But if you get into the supplement you'll see you can never call a markets business an annuity business. +But what drives our business is really a connection between the issuer clients, the commercial borrowers and commercial clients and the investor clients that we serve. And to do that -- in our Wealth Management business, because that's a group of people that rely on the research platform. If you look, the interconnectedness of that is massive and -- whether it's by us getting out of proprietary trading and Volcker and things like that, the whole -- the real business is driven at that. +And so, if you -- we've taken the balance sheet from implying at the time of Merrill, probably nearly to $800 billion or more, maybe closer to $1 trillion down to $500 billion and the revenues have stabilized and I think that's a good place for us to be. Number one research plant in the world. Number one in the US this year. The ability to use it in wealth management, the ability to use it to inform our corporate customers. +So, we look at how we pare away things and look at it -- so in the international business we've pared back -- there was 1,200 -- I don't know, 800 to 1,200 people that were downsized in markets and banking in the first quarter. So we keep -- it's not in or out, it's more how do you keep paring it back. +And so, if you look across there, we always look at that question. We continue to look at it, but right now we really like the franchise and the connectivity between the franchise of all the different elements, focused on markets, focused on wealth management, focused on the core business. +And I think now the question is with low rates, we just have to grind the cost down and that's going to come out of really all the pieces and -- well, for a while, it was -- you could go at it at a fairly high level and drive it. Now it's really incrementally idea by idea and taking it out and that's why you see that constant improvement. +Improvement of core costs of $2 billion run rate first quarter last year to first quarter this year is not -- is working at it. It just takes more time because 130 million square feet of real estate down to 80 million going to 70 million. There's a lot of work to get out of that real estate. + +-------------------------------------------------------------------------------- +Nancy Bush, NAB Research - Analyst [110] +-------------------------------------------------------------------------------- + + Right. Just as an add-on and looking at costs in the consumer bank, and you look at your mobile penetration and how it's going up, etc., etc. Is there a magic number in terms of -- mobile transactions, mobile penetration, just the whole use of mobile in your Company where I think you've been a leader that will lead to sort of a step down in branches. Are we sort of on this threshold of being able to take branches down yet another however many? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corp. - Chairman, President & CEO [111] +-------------------------------------------------------------------------------- + + Well, I think if you think of branches and think about it as offices as opposed to the historical notion of a place where you transact, the question of how many you have is going to be how many relationship managers you need and how many places they have to sit. And so, what we've done is consolidated the branches to be even bigger. +So the sheer number -- so we added 6,100, or 4,600. Each year we've repositioned 200 or 300 of them. But what we're doing is getting out of smaller branches and building into bigger branches. So we consolidated three into one and build up -- that branch has in it US trust people, Wealth Management people, small business salespeople. +So what we're actually -- if you think about it as a real estate question, the number is not as important as they are full and that they are marginally driving the profit. And you can get a lot of salespeople per square inch, a lot of customer activity per square inch, and that's where we're going. +And so, you're going to see some of the new prototypes that we've deployed. You can see in places like Denver where we're now on our third branch and we'll continue to build out that are much -- look much more like a sales office than what people's vision of a traditional branch. +But going to your earlier question, Nancy, I don't know where this stops and I'm not -- that's not saying I'm trying to hide an answer that I have, it's just that if you and I were here last year, and we were, and you said 17 million mobile users, that's good penetration, it's 2 million more a year later. +And as computer-based banking is up 1.5 million or something like that, which is kind of remarkable on top of that. So we don't know where this goes, but we're going to be pushing ahead, following our clients and making sure we stay with them. At the same time, our customer satisfaction scores are now reaching an all-time high, which means the way we're doing it works for them. +And you've given me your feedback about our customer focus and capabilities over the years, but they are back to the highest they've ever been and that's, importantly, managing that transition carefully and that's what we've got to keep doing. + +-------------------------------------------------------------------------------- +Nancy Bush, NAB Research - Analyst [112] +-------------------------------------------------------------------------------- + + Okay. Thank you. + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corp. - CFO [113] +-------------------------------------------------------------------------------- + + I just want to echo a couple of thoughts the Brian said. I think the branches are going to become not a destination where people come to transact but a destination where people come because they need a product or service because of something changing in their lives. They need to start saving for their kids' college or they need a new -- they need a mortgage or they need a credit card. +It's more about they are coming there because of some life event or because of some product or [service] they need, not for every day transaction banking. We'll still have the branches that can do that for people who prefer that, but I think over time people will recognize the convenience and safety of doing these things online, doing them electronic not from paper. And the branches will become -- we're organizing our branches so that they become destinations for people who need help with their financial lives. + +-------------------------------------------------------------------------------- +Nancy Bush, NAB Research - Analyst [114] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Operator [115] +-------------------------------------------------------------------------------- + + Marty Mosby, Vining Sparks. + +-------------------------------------------------------------------------------- +Marty Mosby, Vining Sparks - Analyst [116] +-------------------------------------------------------------------------------- + + Thanks. I wanted to focus on mortgage banking and the retention of those loans, more on the balance sheet than continuing to push them to the GSIBs. Is that regulatory driven or are you really looking for that higher retention rate because you're looking for some assets that have duration, so is that one of the better maybe option adjusted yields that you can get at this point? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corp. - Chairman, President & CEO [117] +-------------------------------------------------------------------------------- + + Marty, you can come at this a fairly straightforward way which is we have $1.2 trillion in deposits and we have $900 billion in loans. And if we put our own mortgages on the balance sheet we know the quality, we know the customer and we know that the servicing cost ultimately will be a lot less of how we're doing it. +If we buy third-party loans -- so to extract the value of those deposits we've got to invest in something. We invested substantially in treasuries. We have to -- back to mortgages and mortgage-backed securities. And so the question is why by someone else's when you are producing your own? +So it's really a very pragmatic view of -- we want to control our destiny in mortgage going forward so that the customer we look in the eye and originate the mortgage with is the customers we service for, is the customer we have the asset quality with and there is no third party involved. So it's more driven by us just getting to our own, controlling our own destiny. + +-------------------------------------------------------------------------------- +Marty Mosby, Vining Sparks - Analyst [118] +-------------------------------------------------------------------------------- + + And a follow-up to that is if you look at the impact of that on the business segments you actually are increasing the portfolio by about 30%, which is showing that retention. However, if you look at All Other, it's more than overkill swamping that growth. +You had about a $45 billion reduction, and kind of getting back to Mike's question about where is the benefits going, just the reduction in All Other, that almost $50 billion of loans is over $1 billion worth of NII that is going away, whereas you are having to do and invest and spend money to generate the 30% growth in the business. +So is the runoff still part of where some of the leakage is that we are hoping to get in all the improvements in growth that you're showing in the core? And when does that -- what's left is about $100 billion, when is that finally done so that you wouldn't have that leakage anymore? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corp. - Chairman, President & CEO [119] +-------------------------------------------------------------------------------- + + Well, the -- we used to -- there is an element that's just as -- we used to book that retained piece in the central area. We stopped doing that. That's showing the changeover, so you've got to think of it a little bit together. But -- and it's consistent with our peers. Most people have their consumer businesses booked to loans they retain. We just didn't do that for years. +But remember, those -- you've got to remember that you've got to think of the whole balance sheet. You're looking at the loan category. The money comes out of center because of liquidity demands in the rules. It goes into treasuries and other securities which are not in that chart because they are not loans, mortgage-backed securities and treasuries and that still has a yield to it. Not as dollar-denominated as much as mortgages but has a yield to it. +That has been driven more by the liquidity demands in LCR than it is by anything else, which is the centralized portfolio. We've gone from $100 billion in liquidity four or five years ago to $500 billion, so that has a cost to it in that -- in prior years that could have been invested in high-yielding assets, but not -- mortgages don't count for liquidity. + +-------------------------------------------------------------------------------- +Marty Mosby, Vining Sparks - Analyst [120] +-------------------------------------------------------------------------------- + + Got you. Thanks. + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corp. - CFO [121] +-------------------------------------------------------------------------------- + + And again, look -- the facts are we've been growing overall, so year-over-year including those segments which, as you point off by our strategy are running off faster. We're still growing the overall balance sheet. + +-------------------------------------------------------------------------------- +Operator [122] +-------------------------------------------------------------------------------- + + Betsy Graseck, Morgan Stanley. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [123] +-------------------------------------------------------------------------------- + + Hi, it's a follow-up on mortgage. So I think one of your suppliers or one of your partners, PHH, mentioned that you were going to be pulling back some of the servicing to yourself. And I just wanted to understand did you have to do anything to build for that book of business or is this already something that's in your run rate on the expense side and we're going to be bringing in incremental revenues on the mortgage servicing side? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corp. - Chairman, President & CEO [124] +-------------------------------------------------------------------------------- + + It's marginally -- will be absorbed. If you think about it, the total number of loans is relatively small. The total -- it will go on the platform of very little change. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [125] +-------------------------------------------------------------------------------- + + Okay, and is this the beginning of pulling it all over? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corp. - Chairman, President & CEO [126] +-------------------------------------------------------------------------------- + + I think -- I would just say that we're trying to be consistent with our strategy of controlling our own destiny. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [127] +-------------------------------------------------------------------------------- + + okay. All right. That's great. Thank you. + +-------------------------------------------------------------------------------- +Operator [128] +-------------------------------------------------------------------------------- + + And it appears we have no further questions. Ladies and gentlemen, this will conclude today's Bank of America earnings announcement call. We thank you for your participation. You may now disconnect and have a great day. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corp. - Chairman, President & CEO [129] +-------------------------------------------------------------------------------- + + Thank you. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/exam/original-files/Problem_1_Sample/2016-Apr-27-FB.OQ-137612530009-Transcript.txt b/exam/original-files/Problem_1_Sample/2016-Apr-27-FB.OQ-137612530009-Transcript.txt new file mode 100644 index 0000000..80af57d --- /dev/null +++ b/exam/original-files/Problem_1_Sample/2016-Apr-27-FB.OQ-137612530009-Transcript.txt @@ -0,0 +1,509 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q1 2016 Facebook Inc Earnings Call +04/27/2016 02:00 PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Deborah Crawford + Facebook Inc. - Director of IR + * Dave Wehner + Facebook Inc. - CFO + * Sheryl Sandberg + Facebook Inc. - COO + * Mark Zuckerberg + Facebook Inc. - Chairman & CEO + +================================================================================ +Conference Call Participiants +================================================================================ + + * John Blackledge + Cowen and Company - Analyst + * Ken Sena + Evercore ISI - Analyst + * Heather Bellini + Goldman Sachs - Analyst + * Anthony DiClemente + Nomura Securities Intl - Analyst + * Eric Sheridan + UBS - Analyst + * Douglas Anmuth + JPMorgan - Analyst + * Ben Schachter + Macquarie Research - Analyst + * Justin Post + BofA Merrill Lynch - Analyst + * Brian Nowak + Morgan Stanley - Analyst + * Ross Sandler + Deutsche Bank - Analyst + * Mark May + Citi - Analyst + +================================================================================ +Presentation +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Good afternoon. My name is Chris, and I'll be your conference operator today. At this time I'd like to welcome everyone to the Facebook first-quarter 2016 earnings call. +(Operator Instructions). +This call will be recorded. Thank you very much. Ms. Deborah Crawford, Facebook's Vice President of Investor Relations, you may begin. + +-------------------------------------------------------------------------------- +Deborah Crawford, Facebook Inc. - Director of IR [2] +-------------------------------------------------------------------------------- + + Thank you. Good afternoon and welcome to Facebook's first quarter 2016 earnings conference call. Joining me today to discuss our results are Mark Zuckerberg, CEO; Sheryl Sandberg, COO; and Dave Wehner, CFO. +Before we get started I would like to take this opportunity to remind you that our remarks today will include forward-looking statements. Actual results may differ materially from those contemplated by these forward-looking statements. Factors that could cause these results to differ materially are set forth in today's press release, our annual report on Form 10-K filed with the SEC. +Any forward-looking statements that we make on this call are based on assumption as of today, and we undertake no obligation to update these statements as a result of new information or future events. During this call we may present both GAAP and non-GAAP financial measures. A reconciliation of GAAP to non-GAAP measures is included in today's earnings press release. +The press release and an accompanying investor presentation are available on our website at investor.fb.com. And you now I'd like to turn the call over to Mark. + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook Inc. - Chairman & CEO [3] +-------------------------------------------------------------------------------- + + Thanks, Deborah, and thanks, everyone, for joining today. We started 2016 off well. 1.65 billion people now use Facebook every month, and 1.09 billion people use Facebook every day. In recent weeks we're also consistently seeing more than 1 billion people using Facebook on mobile everyday. +We're also pleased with our business results. Total revenue this quarter grew by 52% year-on-year to $5.4 billion. And advertising revenue grew by 57% to $5.2 billion. I'll have more to say about these results in a minute, but first I want to talk about a proposal by our Board of Directors to reclassify Facebook stock. +At F8, I talked about our mission and how the work we're doing to connect the world is more important today than it's ever been. I walked through our 10 year road map, focused on building the technology to give everyone in the world the power to share anything with anyone. Bringing people together and giving everyone a voice takes long-term commitment. Not just over the next few years, but over the next few decades. +We're focused on the long-term, and that's the main reason for today's proposal. Facebook has always been a foundry-like Company, so we can focus on our mission and build long-term value. This structure has served our shareholders well. Early on we received some generous offers for companies trying to buy Facebook and our structure helped us resist that pressure. +More recently, we navigated a challenging transition to mobile but because we were a controlled Company we were able to focus on improving the user and product experience of our apps first and then build a strong mobile business over time, rather than being forced to do something short-sighted. And over the years, our structure has helped us make big bets on acquisitions like Instagram that were very controversial initially but were good decisions for our community and our business. +Facebook has been built by a series of bold moves. And when I look out at the future, I see more bold moves ahead of us than behind us. We're focused not on what Facebook is but on what it can be and on what it needs to be, and that means doing bold things. A lot of what we're building today in the areas like connectivity, artificial intelligence, and virtual and augmented reality, may not pay off for years, but they're important to our mission of connecting the world, and I'm committed to seeing this mission through and to leading Facebook there over the long term. +Personally, there's another element to this. While helping to connect the world will always be the most important thing that I do, there are more global challenges that I also feel a responsibility to help solve to create a better world for my daughter and all future generations. Things like helping to cure all disease by the end of the century. Upgrading our education system so it's personalized for each student and protecting our environment from climate change. +That's why Priscilla and I created the Chan Zuckerberg Initiative and committed to give 99% of our Facebook shares to advance human potential and promote equality. Today's Board proposal will allow us to maintain and improve the voting structure that has served us well and allow me to fund the Chan Zuckerberg Initiative. +In December, I also announced that I won't sell more than $1 billion worth of stock -- Facebook shares -- per year over the next three years. That's still my commitment and I'll update our shareholders on future plans beyond that. Dave will talk more about the mechanics of this proposal in his comments in just a few minutes. +But before we get there I want to also share a few more thoughts on the progress we've made this quarter. As I said before, our road map has three horizons. Over the next three years we're going to keep investing in our most developed ecosystem, the Facebook app and platform. Today, people around the world spend on average more than 50 minutes a day using Facebook, Instagram and Messenger, and that doesn't even include WhatsApp yet. +This growth isn't happening because we came up with just one or two big changes. Our team has just worked day after day on lots of improvements over a long period of time, and that progress continued in the first quarter. We launched reactions to help people express themselves in more ways, and we improved how our products work on different mobile networks and devices all over the world. +Sheryl will talk more about this in a minute, but now more than 3 million businesses are using our advertising products every month. We've expanded our measurement capabilities so more businesses can see the results they get from ads. We've made it easier for small and medium businesses to use the same targeting tools and ad formats that our larger advertisers use. +Over the next five years we're going to build ecosystems around our products that are already being used by a lot of people. We're at the beginning of a golden age of online video. Video isn't just a single kind of content. We think it's a medium that allows people to interact in a lot of new ways. So that's why in addition to normal internet video, we're also focusing on more interactive video experiences, like live and 360 video. +I'm a big Game of Thrones fan, and the other week HBO and our Oculus team came out with a 360 video of the opening sequence of the show, and it's now the most watched 360 video on Facebook in any 24 hour period with more than 12 million total views. +Earlier this month we opened up live to everyone. Live is just one part of our overall video effort. But we think it has a lot of potential. Friends go live because it's unfiltered and personal. Actors and news anchors go live because they can reach bigger audiences, in some cases, than they can on even their own shows. If we do a good job, we think it's something that people will associate with Facebook. With interacting with people and not just watching content. +But it's also a very new and small part of all of the videos that we see on Facebook today. I'm also really excited about what we're building around messaging. Right now we have two of the top messaging apps in the world. 900 million people use Messenger every month, and 1 billion people use WhatsApp every month. Between Messenger and WhatsApp, People send around 60 billion messages every day. That's almost three times as many message as SMS handled at its peak. +Over the past couple of weeks we've talked about steps we're taking to build messaging into a platform that developers and business can build on. We announced bots for Messenger that let you do things like order flowers or get news without leaving your Messenger thread. But this is all very early and we're rolling these experiences out carefully and slowly over time. +We're also very happy with the way that Instagram is growing with more than 400 million actives and more than 200,000 businesses advertising every month. Now we're focused on making the user experience even more engaging. With more content on Instagram all the time, people are currently missing about 70% of what's in their feed. So that's why in the first quarter we started rolling out feed ranking to help you see more of the posts that you care about. +And this is a long-term effort, but news feed shows that ranking creates the best and most engaging experiences for our community. Over the next 10 years we're going to keep investing in new technology to help everyone connect. As part of Internet.org we're building an open source Telco infrastructure, a project called TIP, to make it cheaper to operate mobile networks. Free Basics, which helps people access tools for education, health information and communication for free, now features more than 600 services and it has brought more than 25 million people online. That makes it one of the most successful connectivity initiatives in the world. +We're also working to help people connect and share in a more natural and intuitive way. Artificial intelligence is a long-term effort for us, but we're already using it in lots of ways. Right now our Moments app is using face recognition to help you share pictures with your friends. We're using AI to show the most relevant content in news feeds, filter Spam and messaging and even help blind people understand what's in their friends' photos by reading explanations of them allowed. +Finally, we're building technology and virtual and augmented reality that can change the way that we all experience the world. Gear VR started shipping late last year and the response so far has been great. There are now hundreds of apps built specifically for Gear, and people have watched more than 2 million hours of video on it. +In Q1 we also started shipping Oculus Rift. We've got a lot of great content with more than 50 games and apps built Rift. And again, this is very early and we don't expect VR to take off as a mainstream success right away. I Really want to emphasize that. Most Rift early adopters are gamers and developers, but eventually we believe that VR is going to be the next big computing platform and we're making the investments necessary to lead the way there. +So that's our update for the quarter. As always, everything we do is focused on our mission to make the world more open and connected. And to get there, we're building technology that brings people together and that helps everyone in the world share anything they want with anyone. +It takes a long-term commitment and it won't happen overnight, but we're in a strong position and I'm excited about what's next. So thank you to everyone in our community, to all of our teams, all of our partners, and all of our shareholders for everything you're doing to help connect the world. And now here's Sheryl. + +-------------------------------------------------------------------------------- +Sheryl Sandberg, Facebook Inc. - COO [4] +-------------------------------------------------------------------------------- + + Thanks, Mark, and hello everyone. We had a great first quarter and a strong start to the year. Q1 ad revenue grew 57% or 63% on a constant currency basis. Mobile ad revenue reached $4.2 billion, up 75% year-over-year and is now approximately 82% of total ad revenue. Our growth was strong across all verticals, marketer segments and regions, particularly North America and AIPAC. +We remain focused on driving our clients' businesses, moving their products off shelves, both in stores and online. A big focus for us in 2016 is helping our clients understand the true business impact of their ads, especially on digital. We're pleased with the progress we made in Q1 across our three priorities. Capitalizing on the shift to mobile, growing the number of marketers using our ad products, and making our ads more relevant and effective. +First, capitalizing on the shift to mobile. Consumers have shifted to mobile and businesses know they need to catch up. We hear from marketers that figuring out mobile today is like figuring out TV in its early days, but given where consumers spend their time the question now is not t if they should market on mobile but how. One of the drivers of the consumer shift to mobile is video. People are sharing and creating nearly three times more video on Facebook than they were a year ago, and as of February, the time people spend watching videos on Instagram increased by more than 40% over the preceding six months. +This presents a big opportunity for marketers. The best marketers understand that people watch video differently in mobile feed than on TV. They create ads that grab attention in the first few seconds, sometimes even without sound. What we now thumb-stopping creative. For example, Nestle took their TV ad for Natural Bliss coffee creamer and in less than a day edited for mobile feed by creating a new opening and adding text overlays to relay their message without sound. +They showed both the original TV ad and the mobile ad on Facebook. The original TV ad drove a 4 point increase in ad recall. The mobile optimized version, however, drove an even stronger 10 point increase in ad recall and a 7 point increase in product awareness. We want to help marketers optimize their video ads. For example, we know that on average captioned videos increase view time by 12% so we introduced auto captions to generate captions for video ads. +In Q1 we introduced new ad formats like Canvas Ads. Canvas Ads showcase products by combining video images and call-to-action buttons. While it's still early, we're pleased with the results and are seeing adoption across many verticals. To motivate millennials to take on do it yourself projects, Lowe's and DVDO targeted 25 to 34-year-old homeowners with Canvas Ads that let them see bathroom designs, discover the products in each design, and tap to purchase. The ads were so engaging that people spent an average of 28 seconds interacting with them and Lowe's saw a 6.7 times return on ad spend. +Our second priority is growing the number of marketers using our ad products. This quarter we announced that we have over 3 million active advertisers on Facebook and over 200,000 on Instagram. A significant number of these advertisers are small and medium businesses. These businesses use our platform because it's easy and affordable for them to connect with their consumers on mobile. +We're also making it easier for SMBs to use the same targeting tools and ad formats that our most sophisticated advertisers use. We're seeing even small businesses use products like Lead Ads, Slide Show and Dynamic Product Ads. Our third priority is improving the relevance and effectiveness of our ads. +Last year we introduced conversion lists to measure how Facebook and Instagram campaigns drive business objectives like sales. We've seen clients across verticals from retail to auto use conversion lift to measure and improve the return on their ad investment. Chase Bank used conversion lift to measure how effectively their Super Bowl ad drove credit card applications. They found that combining Facebook video adds with their TV ads drove 1.5 times more conversions than TV ads alone. +In Q1 we expanded or list capabilities by testing list API, enabling more partners to measure the effectiveness of more of their campaign. We're pleased with the value we're driving for our partners and the progress we're making across our three priorities. Helping marketers make the shift to mobile will take time. We have a lot of hard work ahead and we'll continue to invest. +I want to thank our clients around the world for their partnership and congratulate our global teams on the results of their hard work. Thanks, everyone. And now here's Dave. + +-------------------------------------------------------------------------------- +Dave Wehner, Facebook Inc. - CFO [5] +-------------------------------------------------------------------------------- + + Thanks, Sheryl, and good afternoon, everyone. We're off to a great start in 2016 led by the ongoing growth and engagement in our community and continued momentum in our ads business. In Q1 we generated $5.4 billion in total revenue and delivered over $1.8 billion in free cash flow. +Let's begin with our community metrics. In March 1.09 billion people used Facebook on an average day, up 16% compared to last year. This daily number represents 66% of the 1.65 billion people who visited Facebook in the month of March. Mobile continues to drive our growth. Over 1.5 billion people accessed Facebook from mobile devices in March, up 21% from last year. +Before diving into our quarterly financial results, I wanted to highlight that beginning this quarter I will focus my prepared remarks on our GAAP results and our all financial metrics are GAAP unless otherwise noted. The primary difference between our GAAP and non-GAAP metrics is stock-based compensation. Stock-based compensation plays an important role in how we compensate our employees, and therefore we view it as a real expense for the business. We will continue to provide a reconciliation of GAAP to non-GAAP financial metrics in our press release and earnings slide. All of our comparisons are on a year-over-year basis unless otherwise noted. +Q1 total revenue was $5.4 billion, up 52% or 58% on a constant currency basis. Ad revenue in Q1 was $5.2 billion, up 57% or 63% on a constant currency basis. This marked a slight decline from the 66% constant currency ad growth rate we experienced in Q4. In Q1 this year we benefited from an additional day due to the leap year which contributed approximately 2% to our year-over-year ad revenue growth rate. +North America and Asia-Pacific were our fastest growing regions with advertising revenue growth of 64% and 62% respectively. Europe and Rest of World grew advertising revenue more slowly at 49% and 35% respectively, with the latter particularly impacted by foreign exchange headwinds. Setting aside currency headwinds all regions exceeded 50% constant currency ad revenue growth. +Mobile ad revenue was $4.2 billion, representing approximately 82% of total ad revenue. Mobile ad revenue grew 75%, driven by strength from Facebook's news feed. Our mobile ads business continues to be driven by the combination of both supply-side and demand-side factors. On the supply-side, we continue to see healthy growth in the number of people using Facebook, time spent across our products and app load. +On the demand-side, we believe the investments we have made to improve our mobile advertising solutions are helping drive value for both people and marketers. We are seeing growth in both new customers as well as existing customers who are spending more with us on average compared to last year. In Q1 the average price per ad increased 5% while total ad impressions increased 50%. +The recorded increase in price is being driven by the continued mix shift towards mobile, which contains higher price news feed ads rather than the mix we have on PCs of both news feed ads and lower price right hand column ads. The increase in impressions was driven by strong growth in mobile add impressions and was offset partially by a decline in ad impressions delivered on personal computers consistent with the ongoing declines in PC usage. +The increase in -- total payments and other fees revenue was $181 million, down 20% compared to last year. This decline was mainly driven by a reduction in payments revenue related to games played on personal computers. Q1 total costs and expenses were $3.4 billion, up 29%. We ended the quarter with approximately 13,600 employees, up 35% compared to last year. +Q1 operating income was $2 billion, representing a 37% operating margin. Our Q1 tax rate was 27%, down from our full year 2015 tax rate of 40%. Our Q1 net income was approximately $1.5 billion or $0.52 per share. In Q1 capital expenditures were $1.1 billion, more than double compared to Q1 of last year. Server purchases and data center construction were the largest contributors to year-over-year growth. +New builds in Texas and Ireland along with the expansion of existing facilities will nearly double our current data center footprint when completed. In addition to servers and data centers, investments in office facilities also contributed to the year-over-year growth. We ended the quarter with $20.6 billion in cash and investments. +Turning now to the outlook. First, some color on revenue. We remain focused on creating value for the people and marketers who use our services. We expect that the main drivers of advertising revenue growth will continue throughout 2016, but we will face tougher comparables as the year progresses given the accelerating ad revenue growth we experienced throughout 2015. +Payments and other fees revenues will continue to face headwinds throughout the year, given that the substantial majority of that revenue relates to payments from games played on personal computers. Even with the expected contribution from Oculus, we anticipate that our payments and other fees revenue for the full year 2016 will come in lower than the level in 2015. +Next, onto the expense outlook. Our expense guidance remains unchanged. We expect that full year 2016 total GAAP expense growth will be approximately 30% to 40%. We expect full year 2016 amortization expenses to be approximately $700 million to $800 million and full year 2016 stock based compensation expenses to be approximately $3.1 billion to $3.3 billion. +If you take into account our GAAP expense guidance as well as our amortization and SBC guidance, you'll see that our full year 2016 total non-GAAP expense growth guidance range remains unchanged at 45% to 55%. We anticipate full year 2016 capital expenditures to be at the high end of the $4 billion to $4.5 billion range we gave last quarter as we invest to support the rapid growth of the business. We expect our Q2 and full year 2016 tax rates to be similar to our Q1 rates. +In summary, 2016 is off to a great start for Facebook. Our results reflect healthy growth and engagement in our community, strength in our ads business, and investments we're making to capitalize on the long-term opportunities we see ahead. Before going to questions, I wanted to touch briefly on the share reclassification that Mark discussed at the beginning of the call. As we disclosed in the proxy statement we filed today, our Board of Directors has approved a proposal for the reclassification of our capital stock that would involve the creation of a new class of publicly listed non-voting Class C capital stock. +Pending stockholder approval, we intend to issue two Class C shares as a one-time stock dividend for each outstanding Class A and Class B share, resulting in a tripling of the pre-reclassification total shares outstanding. All stockholders would be treated equally. The net effect of this transaction would be to establish two publicly traded classes of Facebook stock, one representing the current Class A shares, and the other representing the non-voting Class C shares. +Since the Class C shares would have the same economic rights as the Class A and Class B shares, we would expect that after the payment of the stock dividend, the share price of the Class A common stock would generally reflect a three-for-one stock split. This will have no effect on the voting interests related to shares that investors currently hold. As Mark mentioned, this structure will allow for the preservation of the voting structure that has served the Company well to date, while allowing for Mark to fund the Chan Zuckerberg Initiative over the course of his lifetime. +Importantly, as part of this proposal, the preservation of the multi-class capital structure would be generally predicated on Mark continuing to maintain an active leadership role at Facebook. Let me talk about next steps. +The reclassification would be conditioned on approval by a majority of outstanding votes held by Company stockholders, and we anticipate a vote on the matter at our annual meeting to be held on June 20th this year. A record date for this dividend would be determined at a later date. With that, Chris, let's open up the call for questions. + + +================================================================================ +Questions and Answers +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + We will now open the lines for a question-and-answer session. +(Operator Instructions). +Your first question comes from the line of Eric Sheridan with UBS. Your line is open. + +-------------------------------------------------------------------------------- +Eric Sheridan, UBS - Analyst [2] +-------------------------------------------------------------------------------- + + Thank you so much. Wanted to come back to your comments on the small and medium size business opportunity at Facebook. Maybe direct a few points to Sheryl to get some comment. +Wanted to understand what some of the opportunities are to continue to demonstrate to those advertisers what the potential is for both Facebook, and maybe even Instagram and Facebook Messenger, long term as platforms to grow their businesses, and sort of also pointing out what some of the measurement tools and operating challenges are to bring people onto the platform. Thank you. + +-------------------------------------------------------------------------------- +Sheryl Sandberg, Facebook Inc. - COO [3] +-------------------------------------------------------------------------------- + + Thank you for the question. SMBs or SMUs, as they're called in different places around the world, we think are a very core competitive advantage for us. It's prohibitively expensive for most small businesses to reach people digitally. 35% of small businesses in the United States, which is often the most advanced market, don't have a web presence at all, and setting up a mobile app, getting people to find and download a mobile app, can be more expensive. +And so what's happening is that SMBs are turning to Facebook page as their mobile solution. They're free. They're easy to set up, and they already know how to do them because almost all of them are already Facebook users in the first place. And so the on-boarding has been incredibly important and incredibly effective. +We announced last year that we have over 50 million small business pages active on a monthly basis. 80% of those are active on mobile. We then work on helping them use our ad products and upsell them to our paid ad products as well, and we announced this quarter that we hit 3 million active advertisers on Facebook and 200,000 on Instagram. +What's interesting is that what you see is SMBs able to use the tools of some of the biggest brands in the world. So over 2 million SMBs have posted a video both paid and organic in the last month, and that has to be many times the number of SMBs that have shot or played a TV commercial. In terms of measurement, your question's important because it's not just getting them to use our platforms to connect to consumers, it's getting them to be able to measure a result. +And so we've worked hard to build measurement tools into the product, so that when you buy an ad, SMBs in a very easy interface, and decide what their goals are. Are their goals measuring sales, are their goals to visit a website, are their goals a mobile app download, and then measuring all the way through from showing that ad to the purchase. +I continue and we continue to be very bullish on this channel, because we have such a broad base of usage because that usage is so active, and because we're very focused on investing and simplifying our products so that all SMBs can use them. + +-------------------------------------------------------------------------------- +Operator [4] +-------------------------------------------------------------------------------- + + The next question is from Brian Nowak with Morgan Stanley. Your line is open. + +-------------------------------------------------------------------------------- +Brian Nowak, Morgan Stanley - Analyst [5] +-------------------------------------------------------------------------------- + + Thanks for taking my questions. I have two. The first one, Sheryl, you talked about video and kind of increasing the overall video consumption. Could you just talk about where you are in traction with video advertising and kind of the adoption of video ad units and the impact of video in the quarter? +And then secondly, just kind of breaking down the advertising by cohort, could you talk to the strengths of, points of strength or weakness across direct response versus branded advertisers in the quarter? Thanks. + +-------------------------------------------------------------------------------- +Sheryl Sandberg, Facebook Inc. - COO [6] +-------------------------------------------------------------------------------- + + Sure, I'll take the second one first. Our growth was really broad based, and we grew across all of our marketer presence this quarter. That's direct response, brands, SMBs and developers. Our direct response business continues to be very strong. It's very ROI focused, and we continue to invest and roll out products that help people. +So for example, lead ads, where people can fill out forms on a mobile device, take their contacts and throw it on Facebook. We rolled that out fully this quarter. And that enabled people to use Facebook in a very direct-to-response way and we'll continue to invest there. +Video ads are really exciting. It's worth noting that video ads take place of another avenue. These are not all of the revenue (Inaudible), but as consumer engagement with video has continued to grow that creates more and more of an opportunity for video ads. Marketers have always loved video because it's a really compelling way to reach people. And this now you can reach them on mobile all day with those kind of messages. +Importantly, marketers have to adjust sometimes. While the 30 second ad does perform well in news feed, we also have people understanding that some of the formats are different creating shorter ads, creating ads that can work even without sound, more personal ads, has really mattered. One example is Toyota used Facebook for the launch of the Rav4 Hybrid. This was actually in Los Angeles. They used a very broad video to drive brand awareness. They reached over 36 million people in their target demo within three days. +Then, and this is where it gets even more interesting, they retargeted people who watched the video with over 500 personalized video ads which were optimized for Facebook and Instagram. So they were creating a direct response campaign to get people to take specific actions, like requesting a quote and finding a specific dealer. We saw a 14-point lift in ad recall, a 7-point lift in message association. And right now we're using a lift roll to continue to measure their sales for the 30 and 60 days beyond the campaign to see what happens, and we're pretty excited about what that shows in terms of you how video can be used in a really broad based way but also a more personal way. + +-------------------------------------------------------------------------------- +Operator [7] +-------------------------------------------------------------------------------- + + The next question is from Douglas Anmuth with JPMorgan. Your line is open. + +-------------------------------------------------------------------------------- +Douglas Anmuth, JPMorgan - Analyst [8] +-------------------------------------------------------------------------------- + + Thanks for taking the questions. I had a couple for Mark around Messenger. Mark, I was hoping you could talk to us about how you expect to shift user behavior within Messenger to get you users to focus more on businesses versus more personal communications and how you'll make users aware of the capabilities within the platform? And then just secondly, as more bots come on board here and businesses are engaging with Messenger, how do you envision kind of bots and humans working together in terms of providing more customer service? Thanks. + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook Inc. - Chairman & CEO [9] +-------------------------------------------------------------------------------- + + Sure. So part of our playbook for building out these ecosystems to scale is we start with the person-to-person use case, right? So whether that's in Messaging, and people messaging their friends or groups, in news feed before that, it was people posting updates and seeing what was going on with their friends and the people that they care about. +And then the next step is to create organic activity around public entities, right? So whether that's businesses, public figures, like athletes and celebrities and types of folks that people want to interact with, these different platforms, we did that on Facebook and news feeds or pages, and we're working on a number of different ways to do that in messenger. One of those is bots. And one of the good things about bots that we've seen is that it can increase or, sorry, decrease the amount of time that you have to wait before you get a reply back from interacting with a message. +So what we've seen, we've done some research on this. A lot of people everyday in Facebook today are already messaging pages and businesses directly. And the businesses respond. But what we've actually also found is that through some of our AI research, we can look at the responses that businesses give to common questions and can confidently provide the right reply a lot of the time. And when we can do that, then that decreases the latency, and predictably people want to do more of that activity. +So that's one way that I think you're going to see bots work, between people who are actually driving the businesses directly will need to in some way train or answer questions for people, but we can build artificial intelligence that can learn from people how to automate a lot of that and make that experience a lot faster for people who want to interact with businesses and public figures. And of course then after you start building out that segment of businesses and public figures on the platform, then on top of that you have just a good amount of intent in these platforms to build a good business on top of that, that kind of stage-through. + +-------------------------------------------------------------------------------- +Operator [10] +-------------------------------------------------------------------------------- + + The next question is from John Blackledge with Cowen and Company. Your line is open. + +-------------------------------------------------------------------------------- +John Blackledge, Cowen and Company - Analyst [11] +-------------------------------------------------------------------------------- + + Great. Thank you. Two questions. So Facebook just opened up instant articles globally to all publishers. Just wondering what you see as a publisher's benefits of joining instant articles and how should we think about the monetization impact in 2016. And then second question, the ad revenue in AIPAC was much better than we thought, just any more color on the drivers there. Thank you. + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook Inc. - Chairman & CEO [12] +-------------------------------------------------------------------------------- + + So instant articles is all about the quality of the consumer experience. I mean right now for links that are not instant articles, it can be one of the slowest parts of the Facebook app. You're browsing through a news feed, you tap on a link, if you're not on a good connection the content doesn't cache, and it can take 10 or 20 seconds in some cases for that content to load. +And, you know, people in our community, they don't know the difference about whether that content is coming from Facebook or a different place. And they hold us accountable for making their experience quick and we want to do everything we can to do that. So instant articles makes it so that any publisher around the world now can deliver a really great native experience instantly with no latency in loading it, and we're just seeing that people like to engage with that a lot more. So that's what we're most excited about there. + +-------------------------------------------------------------------------------- +Sheryl Sandberg, Facebook Inc. - COO [13] +-------------------------------------------------------------------------------- + + The AIPAC question. AIPAC's been growing really well for several quarters now and we're seeing a lot of great adoption as people learn to use the products. One part of the business that I think has been really strong and is worth noting is we're working with marketers in China to help with their export business. So Air China is a good example. They're a popular airline in China. But they don't really have -- they're not really as well-known overseas, and before working with us they really only invested in traditional media. +They had a goal of promoting their new flight routes including one from Mumbai to Beijing and their new aircraft. So they launched a campaign with us in 15 countries globally. They used Regent Frequency and Carousel and video ad targeting and for example, they would target in the US age 18 and above, frequent international travelers, living in cities where they had routes. Or Indian ex-pats living in the US to promote new routes to Mumbai. +They reached 30 million people globally, more than 95% on global. And here's the best part. They had a 73% sales lift in the United States. So our AIPAC business is robust, and I think the global nature of our business is part of driving that. + +-------------------------------------------------------------------------------- +Operator [14] +-------------------------------------------------------------------------------- + + The next question is from Heather Bellini with Goldman Sachs. Your line is open. + +-------------------------------------------------------------------------------- +Heather Bellini, Goldman Sachs - Analyst [15] +-------------------------------------------------------------------------------- + + Great. Thank you. I was just wondering if you could share with us, how do you see Instagram's ramp impacting Facebook's ad growth in 2016 or if there's any color you could share with us about kind of how that's been ramping. And also, if you could share with us how advertisers are viewing the platform, are you finding that it's typically more additive to their Facebook spending, or are they funding it with existing Facebook budgets? Thank you. + +-------------------------------------------------------------------------------- +Sheryl Sandberg, Facebook Inc. - COO [16] +-------------------------------------------------------------------------------- + + Facebook and Instagram are the two most important mobile ad platforms out there. In the short run, some of the spend is incremental and some isn't. There are people who will have a social budget or a digital budget, and as they move to Instagram some of that will come from Facebook. +In the medium to long run, we believe we can compare very favorably with any other spend we can do because we have this very broad reach on both platforms, plus the ability to target very specifically. So what you're seeing in our results right now, very strong growth for Facebook and very strong growth for Instagram. We hit 3 million advertisers for Facebook. We hit 200,000 for Instagram. And often the platforms really work together. + +-------------------------------------------------------------------------------- +Operator [17] +-------------------------------------------------------------------------------- + + The next question is from Justin Post with Merrill Lynch. Your line is open. + +-------------------------------------------------------------------------------- +Justin Post, BofA Merrill Lynch - Analyst [18] +-------------------------------------------------------------------------------- + + Question for Mark. There's been some concerns about traffic to publishers and sharing levels on Facebook. I was just wonder if you could talk about core Facebook engagement, what's really working, are you concerned at all about that, and then when you think about the ad loads, are you comfortable with where they're at? Is there still a lot of room to go? And then maybe last one, if you were to ever leave Facebook, what would happen to your voting shares? Thank you. + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook Inc. - Chairman & CEO [19] +-------------------------------------------------------------------------------- + + All right. Let's talk about engagement first. So overall sharing is up across Facebook and people are spending more time on Facebook and the whole family of apps, and that is not just the case for the aggregate of the growing community but it's actually also the case on a per person basis as well, in terms of people sharing more and spending more time individually. Now, one of the things that we see is that the way that we are sharing is always changing. And some of this is because of underlying technical transition. +So on desktop, for example, it was easier to type so we saw more text posts. On mobile it's easier to take videos so we see more videos. On desktop people would have more commonly uploaded an album of photos that they took from their digital camera and downloaded onto their computer, whereas on mobile the more common behavior is to take a single photo or a couple and just post those. +There are all these transitions and that's our job, right, is to make it so that we build great tools that people, everyone around the world can share anything that they want with everyone. Now, the other thing that's also true is that people want to share with lots of different kinds of audiences. So Facebook gives you the ability to share with all of your friends and publicly if you want and with groups, but we're also investing in things like Messenger and WhatsApp, because a lot of people want to share increasingly messages, privately, one on one, their with very small groups. +So in addition to Messenger, which is at 900 million people a month and WhatsApp just at more than 1 billion people a month. Facebook groups is also at more than 1 billion people a month, which I think represents the increasing diversity of the different types of audiences that people want to share with. +But you know, ultimately, I think that humans have such a deep desire to express themselves and want to connect with the people around them that I think that all of these audiences and all of these different types of media should grow over time, and it's our job to basically make sure that we build good products and get rid of all of the bugs and make it so the performance is fast, and all the basic stuff works. That way we get there. But in general, right now all the high level trends look pretty positive on that. I think I'll kick it off to Dave to go through your questions about some of the technical pieces about the reclassification. + +-------------------------------------------------------------------------------- +Dave Wehner, Facebook Inc. - CFO [20] +-------------------------------------------------------------------------------- + + Sure. I guess also, Justin, you had a question on ad load, so I'll do both the ad load and the question on the reclassification. So on ad load it's definitely up from where we were a couple of years ago. I think it's really worth emphasizing that what's enabled us to do that is just improving the quality and the relevance of the ads that we have, and then that's enabled us to show more of them without harming the user experience at all. So that's been really key. +Over time we would expect that ad load growth would be a less significant factor driving overall revenue growth, but we remain confident that we've got opportunities to continue to grow supply through the continued growth in people and engagement on Facebook as well as on our other apps such as Instagram. On the question regarding what would happen to Mark's shares if he were to leave Facebook, I would just kind of refer that the new multi-class capital structure is generally dependent on Mark continuing to maintain an active leadership role at Facebook. +And if you go into the proxy materials, it goes into more detail on how different things would play out under various other scenarios, so I would just refer you to those. + +-------------------------------------------------------------------------------- +Operator [21] +-------------------------------------------------------------------------------- + + The next question is from Ben Schachter with Macquarie. + +-------------------------------------------------------------------------------- +Ben Schachter, Macquarie Research - Analyst [22] +-------------------------------------------------------------------------------- + + Mark, when you're thinking about acquisitions broadly, in what area do you think Facebook needs to buy versus build? So basically where do you need external help? And then on VR, just a few quick questions. Any update on the shipping delay, how many units shipped in the quarter and expectations for the year, and then also on VR, understanding I know it's very, very early but beyond games and entertainment, what verticals do you expect to be first to utilize VR and AR? Thanks. + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook Inc. - Chairman & CEO [23] +-------------------------------------------------------------------------------- + + So on the acquisition philosophy, I mean, I talked about how I think the social ecosystem will play out an a number of these calls. The basic theory that we have is that there are a small number of services that are going to be ubiquitous utilities that1 billion or 2 billion or more people are going to want to use. That's core, basic messaging, the core functionality around having your real identity and connecting with all of your real friends and family online. Those are things that we just think are going to be ubiquitous. +So we want to build those. At the same time, we also think that there are going to be many, many good businesses and different other social use cases where there are people doing good work and building different companies. We feel no need to own those things. So I think people come up from time to time and suggest, should we buy this company or that and what we look at are what are things that we think are going to be ubiquitous tools and who are the most talented people in the world to build this. +And so when you think about something like virtual and augmented reality, that's how we thought about that. This is -- those are going to be important platforms over time. It's very early, obviously, it's going to take a long time to get there. And a lot of what we felt like we were buying there was a critical mass of the best people and the best technology to go do all the things that we needed to go do over the next 10 years to drive that home and turn that into a big platform. +And then you asked a question about virtual and augmented reality, what are going to be the big use cases. I mean, you know for the first few years of virtual reality I think gaming and video are going to be the big ones. The initial market that we look at are all the people who have X-Boxes, PlayStations and Wii U's use, right? The people who are excited to have an immerse media experience sitting in their living room for a long period of time, and that's a pretty big market. +And even though that's not all of what we hope to eventually serve, and that's not the full potential of these new platforms, I think that is one case where you can obviously deliver better and richer experiences than what you can with the current generation of technology. Video is going really well. I shared a stat before in some of my comments that on Gear VR alone we're now at more than 2 million hours of video, have been watched in the platform. So that's really exciting. +And that of course will be bolstered by the fact that these new kind of 360 videos cannot only be watched in VR, so in the headsets, but we're building tools so you can share them on news feed and through our products elsewhere as well. So I think that's exciting. Over time there will be even more. But that I think should be enough to have some initial use. +But again, I do want to really emphasize this is early and it's going to take a long time. And I know there's a lot of hype around this, and we're just focused on building this to be very good over the long term. + +-------------------------------------------------------------------------------- +Dave Wehner, Facebook Inc. - CFO [24] +-------------------------------------------------------------------------------- + + And then you asked about shipping units. We did begin shipping units in the quarter. This is a very, you know, very small still. VR is still very early. It's not going to have a material impact on revenue in 2016. And I gave more color on that in my prepared remarks. + +-------------------------------------------------------------------------------- +Operator [25] +-------------------------------------------------------------------------------- + + The next question is from Mark May with Citi. Your line is open. + +-------------------------------------------------------------------------------- +Mark May, Citi - Analyst [26] +-------------------------------------------------------------------------------- + + Thanks a lot. First one for Sheryl, I think. Wondering if you could update us on the progress you're seeing with Fan. You gave some metrics in Q4. It seemed like that advertisers were really adopting that platform and seeing a lot of additional reach, maybe you if you could tell us how that's going, and then I think a couple more on the tax rate. We saw it step down quite a bit in Q1, but you're guiding for flat sequentially. +Should we think about that as a run rate or are you still attempting to manage your tax rate down even further than where you saw in Q1 and we were expecting for Q2? And then on the OpEx guide, 41% non-GAAP growth in Q1, obviously below your range but you maintain the range. Why is that? Is that just purely a function of the comps as you head into the year, or are there some specific kind of investment plans that you have? Thanks. + +-------------------------------------------------------------------------------- +Dave Wehner, Facebook Inc. - CFO [27] +-------------------------------------------------------------------------------- + + Sure, Mark. I can start with the detailed one, the tax rate and the OpEx guide. So on the tax rate, yes, the rate came in better than guidance in terms of the tax rate, but it's consistent with the long-term trend that I've indicated. We do expect that that rate will be the approximately the rate that will continue for the rest of the year. So for purposes of 2016 modeling, I would use the Q1 rate. +On the OpEx guide, Q1 came in slightly below our annual expense growth guidance, but we do expect that investments in areas like video and Oculus will impact the remainder of the year more substantially. So that's why we're maintaining the annual OpEx growth guidance that we have. And then Sheryl, did you want to speak about Audience Network? + +-------------------------------------------------------------------------------- +Sheryl Sandberg, Facebook Inc. - COO [28] +-------------------------------------------------------------------------------- + + Yes, Audience Network is important to us because we're making a strategic investment in ad pack, helping advertisers and publishers grow both on and off Facebook. We think we're uniquely placed to bring people based marketing to scale and solve the measurement problem, and the Audience Network is a place we're really focused, because we feel like we're delivering value for advertisers and publishers so we're investing behind the growth we've seen. +We've seen a growth of native ads, 83% of the overall inventory on the platform is native, and over 50% of our publishers are only using native ads. We have some great examples of Audience Network really improving people's results. Our recent one is Ebay Vivanuceous, which is an online real estate destination working in Latin America and Mexico. When they were using a combination of Facebook, Instagram and the Audience Network, they saw 57% lower cost per install with placement optimization and 69% more volume versus running on Facebook alone, which led to 6% incremental revenue. +So compared to November a year before, the number of their app installs increased by 115%. So what we're seeing is the results we're able to deliver on Facebook and Instagram, a lot of our marketing partners want more, and our ability to do that is why we're investing in the Audience Network. + +-------------------------------------------------------------------------------- +Operator [29] +-------------------------------------------------------------------------------- + + The next question is from Colin Sebastian with Robert W. Baird. Your line is open. + +-------------------------------------------------------------------------------- +Unidentified Audience Member [30] +-------------------------------------------------------------------------------- + + Hello, this is actually Ben on for Collin. This one's for Mark. You had already talked about the AI and machine learning applications with respect to Messenger and bots, but was wondering what are some of the more nascent initiatives where you're applying machine learning or maybe where we might see those investments manifest themselves in the user experience over the next few years? + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook Inc. - Chairman & CEO [31] +-------------------------------------------------------------------------------- + + So the biggest thing that we're focused on with artificial intelligence is building computer services that have better perception than people. So the basic human senses like seeing, hearing, language, kind of core things that we do, I think it's possible to get to the point in the next five to 10 years where we have computer systems that are better than people at each of those things. That doesn't mean that the computers will be thinking or be generally better. But that is useful for a number of things. +So for example, I talked about earlier we are building this moments app. So that way you can take photos on your phone and if you use this app, our face recognition can look at the photos that you take and suggest that you might want to share photos that you took with a friend in them, with that person. So that way all the photos that might be of you in your friend's camera rolls, they can share with you. +Another example is just Spam filtering and just making sure we can actually read the content and understand what's interesting to you or not and not show that. One obvious thing I think over time is if you just look at the way that we rank news feeds, today we use some basic signals like who you're friends with and what pages you like as some of the most important things for figuring out what out of all of the millions and millions of pieces of content that are on Facebook, what we're going to show, and then what are going to be the most interesting things to you. +That's because today our systems can't actually understand what the content means. We don't actually look at the photo and deeply understand what's in or look at the videos and understand what's in it, or read the links that people share and understand what's in them. +But in the future we'll be able to, I think on a five or 10 year period. So all of these millions and millions of pieces of content that are out there, whether or not you've added someone as a friend or have liked a page, we'll be able to know a lot better what types of things are going to be interesting to you to produce some much better feed of content. So that's just a basic example of where having human level perception broadly is going to yield better experiences and a lot of the things that people care about today. + +-------------------------------------------------------------------------------- +Operator [32] +-------------------------------------------------------------------------------- + + The next question is from Ken Sena with Evercore. Your line is open. + +-------------------------------------------------------------------------------- +Ken Sena, Evercore ISI - Analyst [33] +-------------------------------------------------------------------------------- + + Hello. I have kind of a high level longer term question. But for brands, we're seeing where promotion, transaction and support capabilities for businesses are all deepening within Facebook. +Therefore, should we be thinking about a longer term transition from the platform that's basically all ad to something where more marketplace capability is offered, given that buyers and both sellers are so known and so connected. And if so can we think about Facebook starting to monetize maybe on a transaction basis or even through various customer support capabilities, via the Messaging tools, AI, et cetera, that you're beginning to offer businesses? So maybe you could just kind of provide a little bit of color on how you how you see that evolution, that would be great. Thank you. + +-------------------------------------------------------------------------------- +Sheryl Sandberg, Facebook Inc. - COO [34] +-------------------------------------------------------------------------------- + + You're right that people are increasingly using Facebook to discover products and services. And we're testing some ways like marketplace to make this easier. We're also testing some incremental featured pages, which enable businesses to drive purchases on a page or direct people directly to their website. These are really early but we've had some positive feedback. +Our focus, however, continues to be on our ad products, because we think we can take people all the way from the top of the funnel where they can really get a brand awareness or a product awareness and go all the way down to purchase, not necessarily because the purchase is happening on Facebook, but because we can work on the measurement systems to understand how the advertising both at the top and lower down in the funnel is influencing those purchases. We've been really excited by what we've seen in the commerce vertical of our ad products. +So products like Dynamic Product Ads, Carousel Ads, are working really well for us. This quarter we launched Canvas Ads, which are very fast loading immerse I've mobile ads. They're easy to build. You can use the self-service tool. You don't have to write any code. They are native format so they had decrease that initial dropoff you see when people click off to another site. +Very early days but the average viewing time is over 30 seconds, which shows you how immersive that is. I'll share one example of how ads are driving a small business on Facebook through ads, which is a company called Sparkle and Paint. They're a Utah-based SMP. They're selling girls' clothing. They did a Slide show ad that included a shop now, button which enabled you to take action on their site. +They were able to increase sales by 9% per month, and more exciting for us, this was 6 times more efficient in terms of acquisitions than any other digital media channel. And that shows how you can use our ad products to go all the way from awareness, measuring through to a sale and show how important our ads can be to commerce on our platform. + +-------------------------------------------------------------------------------- +Operator [35] +-------------------------------------------------------------------------------- + + The next question is from Ross Sandler with Deutsche Bank. Your line is open. + +-------------------------------------------------------------------------------- +Ross Sandler, Deutsche Bank - Analyst [36] +-------------------------------------------------------------------------------- + + Great. So I guess a question for Mark or Sheryl. So at F8, you showcased a bunch of new features for Messenger, including ads to promote your business inside of Messenger. So how should we think about the timing of those ad units coming on in Messenger, and can you use the same ad stack and the Facebook power editor that's used on core Facebook and Instagram to get ads up on messenger, can you just walk us through that? +And then the second question on messaging, so with WhatsApp crossing 1 billion users recently, how do you view the product road map today on WhatsApp versus what you showcased recently with messenger? Is it a year behind or is it further back than that? Any color there would be helpful. Thanks. + +-------------------------------------------------------------------------------- +Sheryl Sandberg, Facebook Inc. - COO [37] +-------------------------------------------------------------------------------- + + For messenger and WhatsApp our focus right now continues to be on growth and engagement. We are not rolling out any monetization products on WhatsApp right now. But we did start that process at F8 on Messenger. +And what we're doing is following the organic activity that's happening on the Messenger platform. Businesses and consumers are using Messenger to connect to each other in a more personal, more immediate way. And we rolled out a platform beta which gives new opportunities to build compelling experiences. +Bots, very early but giving the opportunity for more personal interactions between businesses and mobile which then received API, so that businesses could send immediate responses to common questions, including engaging images and call to action as well as text. In terms of the timing this is really early. We have a lot of opportunity to invest in advertising across our different platforms, and so we want to make sure we get this right as we focus on continued engagement. +You're right that over time when we make these investments we are going to be able to rely on some of the core aspects of the ad's infrastructure, certainly our long ad, our base of advertisers, some of the things we understand about how ads perform and the functionality will be an important part of the product offerings in the future, but those are not immediate by any stretch of the imagination. + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook Inc. - Chairman & CEO [38] +-------------------------------------------------------------------------------- + + Operator, we have time for one last question. + +-------------------------------------------------------------------------------- +Operator [39] +-------------------------------------------------------------------------------- + + The last question is from Anthony DiClemente with Nomura. Your line is open. + +-------------------------------------------------------------------------------- +Anthony DiClemente, Nomura Securities Intl - Analyst [40] +-------------------------------------------------------------------------------- + + Thanks a lot. I have one for Sheryl and one for Mark. Sheryl, there are many out there who might have assumed that this leg of excellent growth that Facebook is realizing might have come at the expense of TV advertising, but the TV ad world seems to be quite resilient here and you actually talked a lot in your prepared remarks about how marketers benefit from running digital and TV campaigns in parallel. +So I wonder if you could just comment on where your share gains are coming from in your view. And then Mark on live video, I realize this is a small part of overall video, but I wonder do you think multiple platforms can succeed in live streaming over time, given the size of the market longer term, or do you think it's more of a network effect business where a vast majority of the traffic and economics will ultimately accrue to the leader in the live streaming space? Thank you. + +-------------------------------------------------------------------------------- +Sheryl Sandberg, Facebook Inc. - COO [41] +-------------------------------------------------------------------------------- + + We think our growth has been very broad based, but dollars are shifting from all types of media formats to where consumers are spending their time. We tell our clients that we want to be the best dollar and the best minute they spend and we want them to measure value. I don't think this means that all of our expense comes in -- all of our growth comes at the expense of any one channel, but it's broad based and often TV and Facebook and Instagram can work really well together. +I'll give a fun example from the Super Bowl. T-Mobile wanted to use their Super Bowl campaign to increase their brand awareness and increase their reach. So before the game they targeted their 30 second Super Bowl ad that featured Drake to NFL and people with NFL and celebrity interests. It performed so well that they decided to run the 60 second version on Facebook and Instagram. +That ad was so successful on Facebook and Instagram that they then ran the 60 second ad on TV instead of their 30 second ad. So as people invest they can use these different platforms together and we're pretty excited to see that progress. + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook Inc. - Chairman & CEO [42] +-------------------------------------------------------------------------------- + + And on live video, the theme that I think is most important is just that there's so much that people want to express and share with the people around them that they don't have the tools to do today. And I think that's a huge opportunity not just in live video but in a lot of the things that we're talking about. +One interesting example recently that I touched on earlier is between Messenger and WhatsApp, we're around 60 billion messages a day, and SMS at its peak we think was around 20 billion messages a day. Just unlocking some of the friction that existed in SMS and improving the product a little bit and removing the small fee that was there has just unlocked a huge amount of expression. And we think that this is going to be the case in all different types of media and with all different audiences that a person would share it with. +So in video, there are billions and billions of videos that are viewed every day on Facebook. Live is a very small part of it. The reason why we give disproportionate attention to it is because we're trying to help push forward new formats that are not just about consuming content but are really about interacting, so live 360 video, and there will be others in the future. And so, yes, to answer your question, I do think that multiple products and companies can succeed in building these things. +I also think that there are go going to be a lot more interactive forms of video than just live and 360, like we're talking about now. And I think that this extends not just to video but for all of the different types of media and audiences that we're serving. So we're very excited about continuing to do our work to help unlock all the expression and connection that people want to do. + +-------------------------------------------------------------------------------- +Sheryl Sandberg, Facebook Inc. - COO [43] +-------------------------------------------------------------------------------- + + Thank you for joining us today. We appreciate your time, and we look forward to speaking with you again. + +-------------------------------------------------------------------------------- +Operator [44] +-------------------------------------------------------------------------------- + + Ladies and gentlemen, this concludes today's conference call. Thank you for joining us. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/exam/original-files/Problem_1_Sample/2016-Apr-28-AMZN.OQ-137577237096-Transcript.txt b/exam/original-files/Problem_1_Sample/2016-Apr-28-AMZN.OQ-137577237096-Transcript.txt new file mode 100644 index 0000000..7dbdd5c --- /dev/null +++ b/exam/original-files/Problem_1_Sample/2016-Apr-28-AMZN.OQ-137577237096-Transcript.txt @@ -0,0 +1,541 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q1 2016 Amazon.com Inc Earnings Call +04/28/2016 05:00 PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Brian Olsavsky + Amazon.com, Inc. - CFO + * Phil Hardin + Amazon.com, Inc. - Director of IR + +================================================================================ +Conference Call Participiants +================================================================================ + + * Douglas Anmuth + JPMorgan - Analyst + * Carlos Kirjner + Bernstein - Analyst + * Justin Post + BofA Merrill Lynch - Analyst + * Ron Josey + JMP Securities - Analyst + * Brian Pitz + Jefferies LLC - Analyst + * John Blackledge + Cowen and Company - Analyst + * Stephen Ju + Credit Suisse - Analyst + * Heath Terry + Goldman Sachs - Analyst + * Bob Peck + SunTrust Robinson Humphrey - Analyst + * Eric Sheridan + UBS - Analyst + * Mark Mahaney + RBC Capital Markets - Analyst + * Aaron Kessler + Raymond James & Associates, Inc. - Analyst + * Benjamin Schachter + Macquarie Research - Analyst + * Brian Nowak + Morgan Stanley - Analyst + * Ross Sandler + Deutsche Bank - Analyst + * Mark May + Citigroup - Analyst + +================================================================================ +Presentation +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Good day, everyone, and welcome to the Amazon.com Q1 2016 financial results teleconference. At this time, all participants are in a listen-only mode. After the presentation, we will conduct a question-and-answer session. Today's call is being recorded. For opening remarks, I will be turning the call over to the Director of Investor Relations, Phil Hardin. Please go ahead. + +-------------------------------------------------------------------------------- +Phil Hardin, Amazon.com, Inc. - Director of IR [2] +-------------------------------------------------------------------------------- + + Hello and welcome to our Q1 2016 financial results conference call. Joining us today is Brian Olsavsky, our CFO. We will be available for questions after our prepared remarks. The following discussion and responses to your questions reflect management's view as of today, April 28, 2016 only, and will include forward-looking statements. Actual results may differ materially. Additional information about factors that could potentially impact our financial results is included in today's press release and our filings with the SEC, including our most recent annual report on Form 10-K and subsequent filings. +As you listen to today's conference call, we encourage you to have our press release in front of you, which includes our financial results, as well as metrics and commentary on the quarter. During this call, we will discuss certain non-GAAP financial measures. In our press release, slides accompanying this webcast, and our filings with the SEC, each of which is posted on our IR website, you will find additional disclosures regarding these non-GAAP measures including reconciliations of these measures with comparable GAAP measures. Finally, unless otherwise stated, all comparisons in this call will be against our results for the comparable period of 2015. Now, I'll turn the call over to Brian. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com, Inc. - CFO [3] +-------------------------------------------------------------------------------- + + Thanks, Phil. I'll begin with comments on our first-quarter financial results. Trailing 12-month operating cash flow increased 44% to $11.3 billion. Trailing 12-month free cash flow increased to $6.4 billion, up from $3.2 billion. Trailing 12-month free cash flow less lease principal repayments increased to $3.5 billion up from $1.5 billion. Trailing 12-month free cash flow less financed lease principal repayments and assets required under capital leases increased to $1.6 billion, up from an outflow of $1.2 billion. +Trailing 12-month capital expenditures were $4.9 billion. Capital expenditures do not include the impact of property and equipment acquired under capital and finance and lease obligations. These capital expenditures and capital leases reflect additional investments in support of continued business growth due to investments in technology infrastructure, the majority of which is to support AWS and additional capacity to support our fulfillment operations. +The combination of common stock and stock-based awards outstanding was 490 million shares compared with 483 million one year ago. Worldwide revenue increased 28% to $29.1 billion, or 29% excluding the $210 million unfavorable impact from year-over-year changes in foreign exchange. Worldwide active customer accounts, excluding customers who only had pre-orders in the preceding 12-month period, exceeded 285 million. Worldwide paid unit growth was 27%. Worldwide seller units represented 48% of paid units. +Now, I'll talk about our segment results. In the first quarter of 2016, we began to allocate stock-based compensation and other operating expense net to our segment results. These amounts are combined and titled stock-based compensation and other in our segment results and reflect the way we now evaluate our business performance and manage our operations. For reference this quarter, I'll also mention segment operating income excluding stock-based compensation and other. +In the North America segment, revenue grew 27% to $17 billion. Media revenue grew 8% to $3.2 billion. EGM revenue grew 32% to $13.5 billion. North America segment operating income including stock-based compensation and other was $588 million, a 3.5% operating margin compared with $254 million in the prior year. This includes $5 million of favorable impact from foreign exchange. North America's segment operating income before stock-based compensation and other was $924 million, a 5.4% operating margin compared with $517 million in the prior year. +In the international segment, revenue grew 24% to $9.6 billion. Excluding the $177 million year-over-year unfavorable foreign exchange impact, revenue growth was 26%. Media revenue increased 7% to $2.5 billion, or 9% excluding foreign exchange. EGM revenue grew 31% to $7 billion, or 33% excluding foreign exchange. International segment operating loss including stock-based compensation and other was $121 million compared with a loss of $194 million in the prior year. This includes $21 million of favorable impact from foreign exchange. International segment operating income before stock-based compensation and other was $20 million compared with a loss of $76 million in the prior year. +In the Amazon Web Services segment, revenue grew 64% to $2.6 billion. Amazon Web Services segment operating income including stock-based compensation and other was $604 million, a 23.5% operating margin compared with $195 million in the prior year. This includes $24 million of favorable impact from foreign exchange. Amazon Web Services segment operating income before stock-based compensation and other was $716 million, a 27.9% operating margin compared with $265 million in the prior year. +Our operating income includes stock-based compensation expense and other operating expense. Operating income was $1.1 billion, or 3.7% of revenue, up approximately 260 basis points year-over-year. This includes $50 million of favorable impact from foreign exchange. Consolidated segment operating income before stock-based compensation and other was $1.7 billion, or 5.7% of revenue compared to $706 million in the prior year. Our income tax expense was $475 million. Net income was $513 million, or $1.07 per diluted share compared with a net loss of $57 million, or loss of $0.12 per diluted share. +Turning to the balance sheet, cash and marketable securities increased $2.1 billion year-over-year to $15.9 billion. Inventory increased 30% to $9.6 billion, and inventory turns were 8.6 down from 8.8 turns a year ago as we expand selection, improved in-stock levels, and introduced new product categories. Accounts payable increased 26% to $15 billion, and accounts payable days increased to 72 from 70 in the prior year. +I'll conclude my portion of today's call with guidance. Incorporated into our guidance are the order trends that we've seen to date and what we believe today to be appropriately conservative assumptions. Our results are inherently unpredictable, and may be materially affected by many factors, including a high level of uncertainty surrounding exchange rate fluctuations, as well as changes in global economic conditions and customer spending, world events, the rate of growth of the internet, online commerce and cloud services, and the various factors detailed in our filings with the SEC. It is not possible to accurately predict demand, and therefore, our actual results could differ materially from our guidance. +As we describe in more detail on our public filings, issues such as settling inter-Company balances in foreign currencies among our subsidiaries, unfavorable resolution of legal matters, and changes to our effective tax rate can all have a material effect on our results. Our guidance further assumes that we don't conclude any additional business acquisitions, investments, restructurings, or legal settlements, record any further revisions to stock-based compensation estimates, and that foreign exchange rates remain approximately where they've been recently. +For Q2 2016, we expect net sales of between $28 billion and $30.5 billion, or growth of between 21% and 32%. This guidance anticipates approximately 70 basis points of favorable impact from foreign exchange rates. Operating income to be between $375 million and $975 million compared with $464 million in second-quarter 2015. This includes approximately $825 million for stock-based compensation and other operating expense net. +We are grateful to our customers and remain heads-down focused on driving a better customer experience. We believe putting customers first is the only reliable way to create lasting value for shareholders. Thanks. And, with that, Phil, let's move on to questions. + +-------------------------------------------------------------------------------- +Phil Hardin, Amazon.com, Inc. - Director of IR [4] +-------------------------------------------------------------------------------- + + Great. Thanks, Brian. Let's move on to the Q&A portion of the call. Operator, will you please remind our listeners how to initiate a question? + + +================================================================================ +Questions and Answers +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) +Our first question is from Mark May of Citi. + +-------------------------------------------------------------------------------- +Mark May, Citigroup - Analyst [2] +-------------------------------------------------------------------------------- + + Thanks a lot. Lots here, but international retail revenue -- the international retail segment really stood out. Revenue accelerated. Seemed like a bit of a milestone also that the CSOI turned positive in a non-Q4 quarter. Can you shed any more light in what the key driver there was? And, how sustainable it is? And, AWS just mathematically, the comps get tougher starting in Q2, just given what happened in 2014. Is that something that we should be taking into account in terms of thinking about how the rest of the year may progress? Thanks. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com, Inc. - CFO [3] +-------------------------------------------------------------------------------- + + Sure. Your first question on international. Yes, all three segments had very strong growth in the quarter. International's 26% for FX-neutral growth rate was actually the strongest we've seen in 3.5 years. I would attribute it to the Prime Fly Wheel. As we may have mentioned in the past -- feel that Europe and the large countries in Europe and Japan are a few years behind the US on a lot of the key Prime metrics, but we also said last year that Prime subscriptions were up 51% year-over-year in 2015. 47% of that was in the US and a higher rate than that internationally. +So, certainly a lot going on in the international. A lot that's really good adding Prime subscribers at a high clip. Continuing to add selection at FBA sellers. So, you'll see devices, you see video content. It's the whole array of Prime offering. Prime Now, Same-day, everything is in Europe. Maybe getting there a little slower than starting point at the US. We see it really showing up in customer engagement and customer purchases. +On the AWS side, I think the 2016 to 2015 comparison probably stands on its own and 2014 falls by the wayside so I would encourage you to look at recent trends. We don't forecast, obviously, by segment. + +-------------------------------------------------------------------------------- +Operator [4] +-------------------------------------------------------------------------------- + + Our next question comes from Douglas Anmuth, JPMorgan. + +-------------------------------------------------------------------------------- +Douglas Anmuth, JPMorgan - Analyst [5] +-------------------------------------------------------------------------------- + + Thanks for taking the question. Just wanted to ask you about unit growth overall and if we look back over the last three quarters, you've accelerated it now to a materially higher level than what we saw in 2014 and the first half of 2015, and I realize in 3Q last year you had Prime Day. I was hoping you could comment on the overall acceleration we've seen here and key drivers behind that? And, if there's something different perhaps than what you talked about on international? +Also, on AWS, can you talk about the underlying drivers here of margins and thinking about that a little bit going forward primary sources of leverage? As you open up six new regions in coming months, should we expect this to be constant build-out? Or, something that's more lumpy over time and more in waves? Thanks. + +-------------------------------------------------------------------------------- +Phil Hardin, Amazon.com, Inc. - Director of IR [6] +-------------------------------------------------------------------------------- + + This is Phil Hardin. I'll take the units question. Really the units are driven by very similar trends to what Brian described. When we look at the bridges for revenue, and obviously, units is our key driver of revenue. Things like Prime are key in that bridge. I would also call out selection growth. That has been a big area of focus for us. +One important way we drive selection is through FBA. We continue to be very pleased with the progress we're making in FBA. What that means for our Prime customers is there's more for them to choose from. Obviously, that gives them more they can purchase. It makes Prime more valuable. For sellers, it means they sell more. I would say that FBA is helping drive some of the selection growth we're seeing here. Selection growth and Prime though are two very key drivers of our growth. On the second part, I think Brian -- . + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com, Inc. - CFO [7] +-------------------------------------------------------------------------------- + + One other comment I didn't say earlier, I do want to point out that because of the leap year there was an extra day in Q1. Every Company would have seen this obviously. But, we estimate it was worth about 150 basis points to our growth rate in revenue. That would be consistent North America and international. +Your other comment -- question was on AWS and a bit about margins and margin outlook. We're very pleased with the quarter. We came in at 23.5% operating margin on the new basis including stock-based compensation and other. We're very pleased. But, stepping back with the 64% growth in AWS which is now a $10 billion business. On the margin side, I would caution you that we're pleased, but it is very early to start drawing too many conclusions on the long-term margins in this business. They'll be bumpy over time. At any point in time, they are going to reflect the balance of investing including global expansion that he's talked about. Price reductions we may offer and also driving cost efficiency which for us is a very important driver in not only this business but also the North American and international segments. + +-------------------------------------------------------------------------------- +Operator [8] +-------------------------------------------------------------------------------- + + Our next question is from Heath Terry with Goldman Sachs. + +-------------------------------------------------------------------------------- +Heath Terry, Goldman Sachs - Analyst [9] +-------------------------------------------------------------------------------- + + Great. Thanks. Looking at the active customer account number, it looks like growth slowed pretty significantly, about 10 percentage points. Just curious if you can give us a sense of anything that might be throwing that number off, assuming we're reading it the right way? And then, as you roll out on AWS -- as you roll out the fixed new availability zones over the course of the year, is there a way to quantify what kind of an impact that's going to have on the capacity at AWS? + +-------------------------------------------------------------------------------- +Phil Hardin, Amazon.com, Inc. - Director of IR [10] +-------------------------------------------------------------------------------- + + I'll take the first part of your question about active customers. As we look at our metrics and what information we provide each year, we often make some changes. So, this quarter we only gave the active customers with a paid purchase in the trailing 12 months. So, that number was more than 285 million. I think that's pretty similar to the trend that we've seen in that metric. +In the past, sometimes we had also given a total active customers count. That number for this quarter was over 310 million so that may be where you're making the statement about the slowdown in growth. The trajectory was very similar from prior quarters for both of those numbers. But, we opted just to give the other one, but you now have the number for the total number of customers as well. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com, Inc. - CFO [11] +-------------------------------------------------------------------------------- + + And, on your AWS footprint question so we ended the quarter with 33 availability zones and 12 geographic regions, and we have 11 more availability zones opening in the next year. The impact on capital, yes, there will be additional capital investment as we build out those zones. Some of it has already taken place. But, I'll also say that by and large, the largest increases in capital leases is to support the growth of incremental usage of customers we have now and agreements we have now. You should expect to see us continue to invest to support this business. We have a leadership position. We intend to maintain it, and we're very excited about where we are. + +-------------------------------------------------------------------------------- +Operator [12] +-------------------------------------------------------------------------------- + + Our next question is from Brian Nowak with Morgan Stanley. + +-------------------------------------------------------------------------------- +Brian Nowak, Morgan Stanley - Analyst [13] +-------------------------------------------------------------------------------- + + The first one is on Prime. You've had two straight years of around 50% Prime subscriber growth. Curious about how you think about keys to driving Prime sub-growth going forward? And, the thought process behind the reported monthly Prime subscription? And, the second one on the logistics investments, there's been a lot about truck investments and logistics investments. Any comments at all about learnings, and what you're seeing from some of the investments in your truck fleet and your own delivery network? Thanks. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com, Inc. - CFO [14] +-------------------------------------------------------------------------------- + + Let me start with the Prime. Yes, we have had very strong growth the last two years and earlier obviously on Prime growth of members. I would say it's a culmination of a lot of separate investments that we're making. If you look at the success of our devices, we are seeing tablets sell twice the volume in Q1 year-over-year. Fire TV stick, you may have read in our press release that it has greater than 100,000 customer reviews, the most reviewed product ever. Over 62,000 of those reviews are 5-star reviews. We've not only had the Echo, but we have the Echo Dot and Tap. We're branching off that product line and having trouble keeping those in stock. And, of course, we launched the new Kindle Oasis, our e-reader. +That is an important part of the series as is the digital content. You may have seen the recent announcements that we're working on a great amount of new content for Prime members. Customers love the content, and we like the results we see particularly around Prime free trial conversion and renewal rates for subscribers who use and take advantage of Prime. So, beyond the awards that the content is winning and the success we're having with Amazon particularly Amazon Originals, we feel that program is working. We're going to significantly increase our spend in that area. Some of that is in Q2. You'll see that more in the next few quarters. But, we think that's working and look forward to bringing a lot of new content to our Prime subscriber base. Both to our normal Prime subscription and also the monthly plan that you alluded to. + +-------------------------------------------------------------------------------- +Phil Hardin, Amazon.com, Inc. - Director of IR [15] +-------------------------------------------------------------------------------- + + This is Phil Hardin. I'll jump in on the second part of your question. For the trucks, really it's trailers. The typical use case is running a lag between a fulfillment center and a sort center. So, we're running enough volume there that we were using trucks already. We thought it made sense to go ahead and buy some trailers. We're actually still contracting out for the truck part, and it gives us flexibility. We think the economics will make sense over time. Similarly, we've announced an agreement to lease some airplanes with air transport services group, agreement to lease up to 20 Boeing 767s there. And, similar use case, it's products that are already boxed, and we think again this is activities we've been doing already which means we grow at a very rapid rate. This gives us extra capacity, and we think it's good to be able to deliver to customers. We think it makes sense over the long-term. + +-------------------------------------------------------------------------------- +Operator [16] +-------------------------------------------------------------------------------- + + Your next question comes from Mark Mahaney of RBC Capital Markets. + +-------------------------------------------------------------------------------- +Mark Mahaney, RBC Capital Markets - Analyst [17] +-------------------------------------------------------------------------------- + + Great. Two questions related to Prime overseas. Could you talk about the status of Prime in international markets? How far rolled out it is in most of your major markets? Then, you talk about Prime Fly Wheels, and you did last year. But, it seems likes those Fly Wheels spun faster than you expected in the fourth quarter of last year that caused some near-term expense issues for you? Can you talk about how you're thinking about planning against that as the Prime Fly Wheels are getting broader for you, how do you try to get ahead of that into the peak season later this year? Thank you. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com, Inc. - CFO [18] +-------------------------------------------------------------------------------- + + Sure. This is Brian. Let me start with the second question first. It wasn't necessarily the Prime Fly Wheel that was the issue. It was more the FBA demand that we had from FBA sellers for space in our warehouses. We were very full. It was a high-class problem to have. +But, as I mentioned last quarter, it did result in higher fulfillment costs in the fourth quarter as a result. I think you'll see some of that dissipated now in Q1. You can tell it was a Q4 issue. +We learn from every Q4. This one was no exception. We are already making plans for a smoother Q4 next year. We will continue to add fulfillment capacity. We'll work with FBA sellers on inventory stocking and timing, and we think that there's things that we can do better as we do every year, come out of the fourth quarter with immense learnings. + +-------------------------------------------------------------------------------- +Phil Hardin, Amazon.com, Inc. - Director of IR [19] +-------------------------------------------------------------------------------- + + This is Phil. On the Prime question, we launched Prime in the US in 2005. Followed that in 2007 with UK, Germany, and Japan. And then, other countries after. We have Prime in all the countries where we have marketplaces with the exception of Mexico, China, and India. +And, Prime is really in varying stages in those countries. We have some kind of an expedited shipping offer in all of them. Here in the US, we've been talking quite a bit about Prime Now. That's also in Italy and Japan and the UK at this point and not others. Also, varying levels of digital benefits as well. +Generally, the international countries are not as far along with selection or the fullness of the digital offers. We've got Prime Video in the UK, in Germany, and Japan. Music is not fully rolled out yet all together. That's where we are with Prime. + +-------------------------------------------------------------------------------- +Operator [20] +-------------------------------------------------------------------------------- + + Our next question comes from Carlos Kirjner with Bernstein. + +-------------------------------------------------------------------------------- +Carlos Kirjner, Bernstein - Analyst [21] +-------------------------------------------------------------------------------- + + Thank you. I have two. I think it's the first time 1Q 2011 that we see tech and content counted as a percentage of revenue declining or flat. Is it just a sign of your inability to increase investment in line with revenue growth? Or, is there something going on, if yes, what? +Secondly, Brian, you said that the growth of Prime has been driven by investments you have made or are making. You gave the examples of devices that you are selling. I think it's a mathematical certainty that Prime subscribers would accelerate in North America at some point from 50% growth. As penetration increases and growth slows, will we see a deceleration in the investment levels? In other words, how do we think about the effect of deceleration in Prime on the North American margin structure in the future? Thank you. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com, Inc. - CFO [22] +-------------------------------------------------------------------------------- + + Sure. Let me start with that second one. We think there's a lot of room to grow not only in our international countries but also in the US. We plan on continuing to build the benefits of the Prime program from music to video to two-day shipping to same-day shipping to Prime Now. I don't see that dissipating, and it remains the best deal in retail so hopefully everyone signs up for that. +On the tech and content question, I don't have a lot to call out in the quarter. I would say there's no letup in the pace of invention here particularly on the AWS side. We used quote the number of new features and services to you each quarter. We had 214 in Q1 up from the 170 this first quarter of last year. Over 26% growth in this quarter alone coming off a year where I believe the number was 722 significant new features and services delivered for AWS customers last year. + +-------------------------------------------------------------------------------- +Operator [23] +-------------------------------------------------------------------------------- + + Our next question comes from Brian Pitz of Jefferies. + +-------------------------------------------------------------------------------- +Brian Pitz, Jefferies LLC - Analyst [24] +-------------------------------------------------------------------------------- + + Thanks for the question. Any comments on your business in India? How is that market ramping up? On the competitive front there, any sense of where the local incumbents may actually have some advantage in the region? Thanks. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com, Inc. - CFO [25] +-------------------------------------------------------------------------------- + + Thanks. I actually just returned from India where I spent a week with our teams in Bangalore and Hyderabad. We're breaking ground on a new 10-acre campus there. So, we are solidifying and increasing our investment in India on all fronts. +I had a chance to see firsthand the level of invention going on with both customers and sellers making deliveries to customers, seeing the I have space program we have with merchants. It's a very exciting time in India, and again, the invention is off the charts. We're inventing things in India that do not exist in other parts of the world. And, the team there is one of our best. You can see it in some of the external commentary as well. For the second year in a row, customers selected Amazon India as Amazon's most trusted online shopping brand. +During the quarter we rolled out a feature called Tatkal which is a studio on wheels that we go to the sellers to help them sign up. We let them do registration, imaging, catalog, uploads, and basic seller training. We're taking it to the sellers -- taking the business to the sellers. We've already reached sellers in 25 cities, and we're really helping them expand their business. Not only within their home region, throughout the whole country. + +-------------------------------------------------------------------------------- +Operator [26] +-------------------------------------------------------------------------------- + + Our next question comes from Justin Post of Merrill Lynch. + +-------------------------------------------------------------------------------- +Justin Post, BofA Merrill Lynch - Analyst [27] +-------------------------------------------------------------------------------- + + Thanks. My question is on the international margins. They're quite a bit below where they were many years ago and trailing the US. Maybe talk about the dynamics there and what is it going to take to catch up over time? Thanks. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com, Inc. - CFO [28] +-------------------------------------------------------------------------------- + + Sure. On the op margin side, although there was improvement year-over-year, you're right, it is still on an FX-neutral basis negative. We have, as I said earlier, fulfillment network and digital content. We continue to build the underpinnings of the Prime program in our international countries. You also have to keep in mind that we're making large investments in India. We're very excited about what we see. And, we will continue to invest heavily in India. + +-------------------------------------------------------------------------------- +Operator [29] +-------------------------------------------------------------------------------- + + Our next question comes from Ross Sandler with Deutsche Bank. + +-------------------------------------------------------------------------------- +Ross Sandler, Deutsche Bank - Analyst [30] +-------------------------------------------------------------------------------- + + Great. I just had two questions on AWS. First, last fall at re:Invent, you disclosed that data management revenue was at a $1 billion run rate. Can you provide an update on that figure? And, maybe talk about how much of AWS revenue today is outside of the storage and compute layers. +And then, the second question is on the AWS margin. I think everybody is trying to learn more about the structural long-term margin, and it was down a tad quarter-on-quarter. Is that solely from FX impact? Or, was there some seasonality of expenses? Any color on what's driving the AWS margin, and how we should think about that over the longer term? Thank you. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com, Inc. - CFO [31] +-------------------------------------------------------------------------------- + + I'll take your second question first. So, again, we had margin expansion year-over-year that was quite significant from 12.4% to 23.5%. But, again, it's very early in this business. We're very pleased with the results we're seeing on the top and bottom line. But, margins are going to be bumpy and affected by levels of investing, price reductions, and also cost efficiency that we're driving. So, quarter to quarter, it will very. We are concerned at this point about capital efficiency, returning price to customers periodically with price reductions, and adding feature sets for them to make the business more valuable. + +-------------------------------------------------------------------------------- +Phil Hardin, Amazon.com, Inc. - Director of IR [32] +-------------------------------------------------------------------------------- + + This is Phil. For your other part of the question, we're not providing an update on the $1 billion stat. What I would say is that the AWS team has strong revenue growth across their suite of products. The fastest growing product in their history is actually Aurora, the new database. We're very excited by what we're seeing in that space, but we're not breaking out the revenue for those various components today. + +-------------------------------------------------------------------------------- +Operator [33] +-------------------------------------------------------------------------------- + + Our next question comes from Eric Sheridan of UBS Investment Research. + +-------------------------------------------------------------------------------- +Eric Sheridan, UBS - Analyst [34] +-------------------------------------------------------------------------------- + + Thanks for taking the question. Looking at the gross margin, impressive performance in Q1. There were a few headwinds it looked like in gross margin in Q4. Wanted to understand how we should think about the puts and takes in gross margin. It has evolved to be a much higher number in the last few years. What some of the puts and takes are going forward especially with respect to content costs? Thanks. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com, Inc. - CFO [35] +-------------------------------------------------------------------------------- + + Sure. I don't have a forecast for you on content cost in isolation or really forward looks on anything besides the guidance I've given you. Yes, it hits in the gross margin. Content costs do show up there. I think the bigger issues that you should look at in gross margin, and again, starting with the comment that we expanded by 300 basis points year-over-year. That is really driven by, first of all, the AWS growth. And again, $10 billion business growing 64%. We're very pleased with that, and that affects gross margin as well. +The other bigger element though is the third-party contribution. Third-party units are now up to 48% of paid units, and that's up 400 basis points year-over-year. That continues to be a factor in gross margin. We book that on a net basis. The third-party revenue. It's a positive factor in gross margin. It can be a negative factor in fulfillment costs and some of the other metrics. + +-------------------------------------------------------------------------------- +Phil Hardin, Amazon.com, Inc. - Director of IR [36] +-------------------------------------------------------------------------------- + + This is Phil. Also, just to jump in, gross margin is not the primary metric we use to measure the business. We're much more focused on free cash flow dollars and operating profit dollars. So, there are a whole lot of moving parts in gross margin, and Brian mentioned a lot of them. But, it's not a primary metric for us. + +-------------------------------------------------------------------------------- +Operator [37] +-------------------------------------------------------------------------------- + + Our next question comes from Aaron Kessler of Raymond James. + +-------------------------------------------------------------------------------- +Aaron Kessler, Raymond James & Associates, Inc. - Analyst [38] +-------------------------------------------------------------------------------- + + Thanks. Couple of questions. First, if you can update us on your new advertising initiatives in terms of how the sponsored links are performing? Additionally, if you can give us an update on Prime Now. Seems like you've rolled out a number of cities for that. How that's involving and the traction with Prime Now? Thank you. + +-------------------------------------------------------------------------------- +Phil Hardin, Amazon.com, Inc. - Director of IR [39] +-------------------------------------------------------------------------------- + + We're very excited about the advertising business, and we think it's still very early days for this opportunity. So, it's an offering we've been working on. We're trying to take a very customer-centric approach. You've probably noticed some changes in the treatment on the website, and we did move away from text ads and product ads in favor of some of the other, newer products. We're really excited about the opportunity there is for third-party sellers and for other vendors on the site. But, we're not breaking out numbers today. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com, Inc. - CFO [40] +-------------------------------------------------------------------------------- + + On Prime Now, we're now in 30 metro areas. Really from a standing start 16 months ago when we opened our first Prime Now location, and it's now a worldwide business in the US, UK, Italy, and Japan. The five cities we added in the first quarter were Raleigh, North Carolina, Cincinnati, Tampa, Liverpool, England, and Osaka, Japan. +How do we feel about that business? Again, it offers tens of thousands of daily essential products. We think it's a service that customers like. Certainly is hard for companies to do. We think the natural evolution of our operations network and our scale gives us a chance to do this, and we are happy to invest in it as a service for our customers. We're taking a long-term approach on this one though. + +-------------------------------------------------------------------------------- +Operator [41] +-------------------------------------------------------------------------------- + + Our next question comes from Stephen Ju of Credit Suisse. + +-------------------------------------------------------------------------------- +Stephen Ju, Credit Suisse - Analyst [42] +-------------------------------------------------------------------------------- + + Thanks. Your capital lease-driven property and equipment acquisitions is down again year-over-year. So, will you help tie this to perhaps the overall usage growth at AWS? Or, maybe the changing nature of how your enterprise customers may be using the platform to be more compute versus storage or database-heavy? I think historically on the e-commerce side, you have been price followers as opposed to price leaders. AWS, you have been price leaders for the most part for actively taking down price. Now, given your leadership position, do you think you'll continue to be price leaders? Or, do you think it's now time for you to follow instead? Thanks. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com, Inc. - CFO [43] +-------------------------------------------------------------------------------- + + Let me start with your CapEx question. We like to look at both capital expenditures and capital leases because they're both essentially our level of investment. Those totaled $9.5 billion in the trailing 12 months, and it was up 7% from the 12-month period ending this quarter last year. I will point out that the prior year was $6.1 billion. We have stepped up investment. Although it did not go up as much year-over-year this quarter, we are still spending almost $10 billion on what essentially is fulfillment capacity in support of really strong growth -- unit growth in FBA and global expansion and then also on AWS. Additional capacity for existing customers as they grow their business and also in new regions. We've been working and continue to work very hard on capital productivity. It's very important to us and I attribute a good piece of the ability to keep that at a modest growth rate year-over-year to our capital efficiency and better purchasing across all capital and capital leases quite frankly. But, again, we are spending almost $10 billion. + +-------------------------------------------------------------------------------- +Phil Hardin, Amazon.com, Inc. - Director of IR [44] +-------------------------------------------------------------------------------- + + Stephen, this is Phil. Just to jump on the usage growth comment, we continue to see really strong usage growth. We're not in the business of raising prices. We lower prices for AWS. There can be mix for products, but by and large, if you see our revenue growth, we're also lowering prices which means that by math we're typically going to be growing usage at a very strong rate. Just wanted to jump on that. + +-------------------------------------------------------------------------------- +Operator [45] +-------------------------------------------------------------------------------- + + Our next question comes from John Blackledge of Cowen and Company. + +-------------------------------------------------------------------------------- +John Blackledge, Cowen and Company - Analyst [46] +-------------------------------------------------------------------------------- + + Great. Thanks. The North American EGM segment outperformed our expectations of growth accelerating on a year-over-year basis. Given you don't break out GMV by vertical within the EGM segment and given the strong growth at massive scale, can you cite any key verticals that were particularly strong? +Second question is just an update on Fresh. Rollout has obviously been much slower than Prime Now. How should we think about the Fresh rollout and the impact over the long-term? Thank you. + +-------------------------------------------------------------------------------- +Phil Hardin, Amazon.com, Inc. - Director of IR [47] +-------------------------------------------------------------------------------- + + This is Phil. I'll take the EGM question first. So, just to put numbers on that, the year-over-year in the US, or North in America, was 32% growth which was up from 28% in Q4. There's not any single categories we're calling out there. To grow on a base that big, that kind of rate, you need pretty strong performance across the board. A lot of categories are selling a lot. It's a lot of the drivers we talked about. As Brian mentioned on the revenue growth side -- Prime, selection growth. We also benefited from the extra day in quarter due to the leap year. Strong performance from many of the categories. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com, Inc. - CFO [48] +-------------------------------------------------------------------------------- + + On Amazon Fresh, we continue to have a strong Fresh business in a number of cities in the US. We know customers love it. We're making good progress on the economics. You'll also notice we have other ways for people to buy consumable products. We have Prime Pantry. We have Prime Now. We're playing with a lot of different models to see what resonates with consumers, and it will guide our investment decisions going forward. + +-------------------------------------------------------------------------------- +Operator [49] +-------------------------------------------------------------------------------- + + Our next question comes from Ben Schachter of Macquarie Equities Research. + +-------------------------------------------------------------------------------- +Benjamin Schachter, Macquarie Research - Analyst [50] +-------------------------------------------------------------------------------- + + First, congratulations on the great quarter. Couple on Prime and one on China. First, a point of clarification. You answered a previous question by saying that you will significantly increase investment in Prime. Was that specifically in reference to video? Or, should we expect new types of offerings beyond video and music? +And, secondly on Prime, membership is likely hitting some saturation levels for certain demographics in the US? Do you intend to focus on more lower income households for growth there? Then finally, on China, anything notable to call out there that's been different over the recent past driving results? The free trade zone, et cetera? + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com, Inc. - CFO [51] +-------------------------------------------------------------------------------- + + I'll take the first question on content. Yes, my comment on Prime benefits was essentially one about video content and our investment there. Not saying other investments may not go up as well, but that is the one we're focusing on that I called out. +On the comment about Prime -- I guess what I'll call availability or saturation. I think that's one of the thoughts behind our monthly plan. We want to create flexibility for consumers to try Prime in a low cost way if that's how they choose. We've always had our free trial program, but it is a hurdle for many people, or there's a hesitancy to put up a full year's payment for a year of Prime. Annual is still going to be a better deal. But, we know customers may try it more frequently if it's a monthly plan. And, that's what we're looking for. We know that once customers try it, generally they'll really like it. So, we think that will purge some other demographic groups as well. + +-------------------------------------------------------------------------------- +Phil Hardin, Amazon.com, Inc. - Director of IR [52] +-------------------------------------------------------------------------------- + + This is Phil. Another comment on the Prime. Your saturation question. Keep in mind, even in the US, which is our most mature by years of launch, we still grew last year at 47% year-over-year membership growth, and we continue to make the program better and better. I think the monthly offers are great for flexibility. Give people a chance to try new ways, and we continue to add content. We continue to add selection. Prime Now is a huge benefit that didn't even exist two years ago. We're still out trying to meet as many customers as possible. We're very committed to driving Prime and it's part of the Company. +Your question on China, probably the biggest thing to point to is more progress and selection on the Amazon global store. This is our website -- this is the offer that allows Chinese customers to shop from the US website, Amazon.com with prices in RMB and with Chinese language pages. It's focused on items that may be hard to get. And, Amazon is really trying to become the trusted source for many of these goods. So, really that's a big part of the focus. If you've been tracking that number over time, we're now up over $10 million which is good progress on that front. + +-------------------------------------------------------------------------------- +Operator [53] +-------------------------------------------------------------------------------- + + Our next question comes from Ron Josey of JMP Securities. + +-------------------------------------------------------------------------------- +Ron Josey, JMP Securities - Analyst [54] +-------------------------------------------------------------------------------- + + Thanks for taking the question. I want to go back to North America but focus on margins. 5.5%, 5.4% margins, I think that's the highest level since maybe Q2 2010 and resumes the margin expansion we saw for most of last year. Just hoping we can understand -- help us understand a little more what's driving that? I'm sure the more mature Prime Fly Wheel you mentioned that's happening in Europe. Is there anything else that's going on besides Prime Fly Wheel, maybe more efficient shipping or things along those lines? Thanks. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com, Inc. - CFO [55] +-------------------------------------------------------------------------------- + + I'll start. You see the growth rate of the segment at 27%. It's showing the success we're having with customers. When we grow at that clip, we can do a lot of good things with it. We can on the cost side run our facilities more efficiently. We can buy better. We can look to in-source some things that we may have paid externally for. There's a number of things that we can do that I think will show up on the bottom line. But, principally, what we're trying to do now is make the Prime experience as strong as possible for consumers. + +-------------------------------------------------------------------------------- +Phil Hardin, Amazon.com, Inc. - Director of IR [56] +-------------------------------------------------------------------------------- + + This is Phil. The other thing I would add to that is that the margin you see in any quarter is the output of our rate of investment in some places and drive for efficiencies in others. We're not really trying to optimize for any particular number in a given quarter. We're just trying to make the best decisions we can to grow long-term free cash flow per share. We're juggling the investment in the places where we feel like we have long-term opportunities where we need to invest with making sure we're getting continuously better in all our other processes at the same time. + +-------------------------------------------------------------------------------- +Operator [57] +-------------------------------------------------------------------------------- + + Our final question will come from Bob Peck of SunTrust. + +-------------------------------------------------------------------------------- +Bob Peck, SunTrust Robinson Humphrey - Analyst [58] +-------------------------------------------------------------------------------- + + Thank you. Two quick ones. Back to India for a second, I was wondering if you could talk about the regulatory environment there, particularly how it pertains to Amazon cloud tail? Two, on logistics, could you talk about excess capacity in logistics as you build out air, freight, sea, et cetera. Would you ever entertain delivering other Companies' items, i.e., like a FedEx or UPS? + +-------------------------------------------------------------------------------- +Phil Hardin, Amazon.com, Inc. - Director of IR [59] +-------------------------------------------------------------------------------- + + This is Phil. I'll take the India question. We're happy to see the recent clarifications. Then, we're happy to operate in any regime. Frankly, the more clarity the better. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com, Inc. - CFO [60] +-------------------------------------------------------------------------------- + + Then, on the logistics question. Stepping back, the reason we add logistics capability and transportation capability is so we can serve our customers faster and faster delivery speeds, and we've needed to add more of our own capacity to supplement our carriers and partners. They're still, again, great partners, have been, and will continue to be for the future. But, we see opportunities where we need to add additional capacity, and we're filling those voids. + +-------------------------------------------------------------------------------- +Phil Hardin, Amazon.com, Inc. - Director of IR [61] +-------------------------------------------------------------------------------- + + Thank you for joining us on the call today and for your questions. A replay will be available on our Investor Relations website at least through the end of the quarter. We appreciate your interest in Amazon.com and look forward to talking with you again next quarter. + +-------------------------------------------------------------------------------- +Operator [62] +-------------------------------------------------------------------------------- + + This concludes today's teleconference. Thank you for your participation. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/exam/original-files/Problem_1_Sample/2016-Jan-19-BAC.N-137516735613-Transcript.txt b/exam/original-files/Problem_1_Sample/2016-Jan-19-BAC.N-137516735613-Transcript.txt new file mode 100644 index 0000000..7b9165d --- /dev/null +++ b/exam/original-files/Problem_1_Sample/2016-Jan-19-BAC.N-137516735613-Transcript.txt @@ -0,0 +1,1135 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q4 2015 Bank of America Corp Earnings Call +01/19/2016 08:30 AM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Brian Moynihan + Bank of America Corporation - Chairman & CEO + * Lee McEntire + Bank of America Corporation - SVP, IR + * Paul Donofrio + Bank of America Corporation - CFO + +================================================================================ +Conference Call Participiants +================================================================================ + + * Steven Chubak + Nomura Securities Co., Ltd. - Analyst + * John McDonald + Sanford Bernstein - Analyst + * Paul Miller + FBR & Co. - Analyst + * Brian Foran + Autonomous Research LLP - Analyst + * Eric Wasserstrom + Guggenheim Securities - Analyst + * Mike Mayo + CLSA - Analyst + * Glenn Schorr + Evercore ISI - Analyst + * Ken Usdin + Jefferies & Company - Analyst + * Matt O'Connor + Deutsche Bank - Analyst + * Betsy Graseck + Morgan Stanley - Analyst + * Jim Mitchell + Buckingham Research - Analyst + +================================================================================ +Presentation +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + + Good day everyone and welcome to today's Bank of America earnings announcement. +(Operator Instructions) +Please note that this call may be recorded. I will be standing by if you should need any assistance. It is now my pleasure to turn the conference over to Mr. Lee McEntire. + +-------------------------------------------------------------------------------- +Lee McEntire, Bank of America Corporation - SVP, IR [2] +-------------------------------------------------------------------------------- + + + Good morning. Thanks to everybody on the phone. Thanks for those that are joining us on the webcast as well. +Welcome to the fourth-quarter earnings results presentation. Hopefully everyone's had a chance to review the earnings that we released. It's available on the Bank of America investor relations website. +And so before I turn the call over to Brian and Paul let me remind you we may make some forward-looking statements. For further information on those please refer to either our earnings release documents on our website or our SEC filings. So with that I will turn it over to our CEO, Brian Moynihan. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman & CEO [3] +-------------------------------------------------------------------------------- + + + Thank you, Lee, and good morning. Thanks to all of you for joining us this morning to discuss our fourth-quarter results. +Before Paul Donofrio takes you through the details of the quarter I just wanted to provide some overall context on our progress in 2015 and the opportunities and challenges ahead. As you know for the fourth quarter we reported $3.3 billion in earnings or $0.28 per diluted share. +For 2015 we had net income of $15.9 billion. That's the highest net income we've had in a long time. +Full-year return metrics are 74 basis points for ROA and 9% for return on tangible common equity. During 2015 we continued to drive our eight lines of business forward. We focused on driving responsible growth across all our businesses and as you look at the annual earnings of the Company and see how they fell you can see how they came through. +Our consumer and wealth management business serving mass-market customers all the way to the wealthiest Americans delivered $9.3 billion net income this year. Our global banking business, which provides services to small, medium and large companies around the world, produced $5.3 billion in net income this year. +Our institutional investor clients, our markets business, with its market leading research capabilities and top-tier platform across the globe delivered $3 billion in earnings after adjusting for DVA in a very challenging market. What's clear in these earnings despite the gyrations in the markets especially at the end of the year last year is the annuity nature that we get from our franchise by driving customer and client flows. That's the power of the Company, its balance and its scope and its strong customer base. +We aim to continue to improve it every day for our clients and customers and our shareholders. These results reflect the work we've done over the past several years to develop a more straightforward simplified operating model and focus on responsible growth. +As you can see on slide 2 across a variety of measures, loan growth, business activity, capital, liquidity, credit losses and cost management, we've made meaningful progress and believe we're positioned for a variety of economic cycles. At the foundation of all of this is a strong capital liquidity base. We added to our record liquidity levels in 2015 and we believe we're well positioned against the 2017 LCR requirements with total global excess liquidity resources now over $500 billion. +This amount represents nearly a quarter of our balance sheet. We have enough parent liquidity to last more than three years before we need to tap the market for funding. +Now our liquidity levels were driven by strong growth in deposits this year. And we were able to put that funding to work to grow loans on an absolute basis for the first time in several years. +Loan growth was all driven by organic activity and consistent with our risk posture. Our tangible common equity of $162 billion is at record levels as well. We returned $4.5 billion to shareholders this year in common dividends and share repurchases. +Our tangible book value per share improved 8% in the past 12 months to a new high of $15.62. Our responsible lending focus also shows in our underwriting results. Our net charge-offs were down to $4.3 billion this year, consistent with 2014 but much lower than previous years. +Commercial charge-offs increased off a very low base, mostly from oil-related charge-offs, while consumer losses as a core continue to improve. This reflects both our responsible underwriting and continued improvement in our legacy portfolios. +Finally, we get to the cost management side. At the heart of our work has been improving expenses which you can see are down sequentially from last year, mostly on lower litigation costs but also on improved LAS and other operating costs. +These have improved steadily across the last several years. We began new BAC in 2011 and completed it in 2014. Since then we have been using our simplify and improve initiatives to find savings that more than offset increased compliance, merit and other inflationary cost. +But most importantly those savings fund investments in our business whether it's in technology, our salesforce growth or other infrastructure costs. +As we move to slide 3 we include a few examples of trends of business activity in our consumer side of the house and wealth management side of the house. As you can see we grew average deposits in consumer banking wealth management business $52 billion or 7% comparing year-over-year fourth-quarter periods. +These deposits were up over $105 billion in core deposits since the end of 2012. This is strong organic growth as a result of hard work and improving the customer satisfaction our franchise by making it easier for customers to do business with our bank and strong product management simplifying the product set. All this has been done, we've optimized our delivery network reducing our financial centers, divesting certain markets and also expanding our award-winning mobile capabilities and the customer base that uses that. +As you can see this work also extends to our wealth management business. We've had long-term net flows for every quarter for a 6.5 years in wealth management. We have record low levels and significant higher deposit levels. +Good products and advice, a growing sales force and two of the leading brands in the business position us well here. When you move to our global banking markets area you can see in the institutional side of the house set forth on slide 4 we saw solid activity in 2015. Loans to commercial and corporate clients around the globe have grown nicely. +Client demand has been good and our bankers have met our challenge to capture market share responsibly. This focus allows us to demonstrate a strong 12% growth in loans and global banking in the past 12 months. And you can see the deposit growth has been strong here over the last year as well. +If you look at the markets business Tom Montag and his team have done a good job reducing assets and lower their risk and still generating relatively stable revenue. Despite the recent market challenge we remain quite profitable in this business and well-positioned around the globe with both a strong FICC and equity platform. +As we step back we remain focused on our core customer strategy. We continue to invest in the future even as we continue to address the legacy issues of the past. We have been able to grow even as the operating and economic environment remains in a low growth mode. +Our model is solid but there is still plenty of work to do but also there's plenty of opportunity ahead for us. Overall I'm pleased with the progress we made in 2015 and we have more to do in 2016. +In 2016 you should expect us to continue to focus on responsible growth. We'll continue to drive the investments made in the franchise to deliver the value to you as shareholders. We'll continue our sharp focus on risk management and we'll continue our cost discipline as we look to continue to improve return on capital metrics of our Company. +With that let me hand it over to Paul. + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [4] +-------------------------------------------------------------------------------- + + + Thanks, Brian, good morning everyone. Starting on slide 5 we present a summary of the income statement returns for this quarter as well as the fourth quarter of last year which had similar seasonal aspects. +We earned $3.3 billion in the quarter compared to earnings of $3.1 billion in 4Q 2014. Earnings per diluted share this quarter were $0.28, up 12% versus a year ago. Results include two significant charges that were previously announced and impacted EPS by $0.06. +First, we recorded a pretax charge of $612 million associated with trust preferred securities which phased out of Tier 2 capital at the end of 2015. Second, we had a tax charge of $290 million associated with the UK tax changes that were enacted during the quarter. Lastly, we had a few other items that benefited EPS this quarter by a penny on a net basis. +These included a negative net DVA impact in sales and trading that was more than offset by positive impacts of market-related adjustments in net interest income and some one-off tax benefits. Revenue on an FTE basis was $19.8 billion this quarter, up 4% from Q4 2014. Expenses were $13.9 billion, approximately $300 million or 2% lower than a year ago driven by good expense discipline across the Company. +We also provide returns of a few other metrics on this page. I would remind you that client activity and revenue in our global market segment tend to be lower or lowest in the fourth quarter, affecting returns and other statistics. +Lastly, as many of you are aware there was a recent accounting change that requires certain unrealized debit valuation adjustments to be recorded directly to OCI rather than through the P&L. We early adopted this change, effective as of the beginning of 2015. The slides and the supplemental earnings material that present 2015 results have been adjusted. +Turning to slide 6 and focusing on the balance sheet, we grew deposits by $35 billion from Q3 and we used these increased deposits to fund responsible loan growth. In total assets declined $9 billion as increases in loans and security balances of $30 billion were more than offset by reductions in trading-related assets and cash. +Liquidity rose to just over $500 billion, a record level and time to required funding remains over three years. Tangible common equity of $162 billion improved modestly from Q3 as earnings were offset by both the return of $1.3 billion in capital to common shareholders and negative OCI driven by security values. Tangible book value per share increased to $15.62, another new record high. +Turning to regulatory metrics, we began reporting regulatory capital under the advanced approaches for the first time this quarter. On a CET1 transition ratio under Basel III, ended the quarter at 10.2% and really has no comparable metric as transition ratios in prior periods were reported under the standardized approach with lower RWA levels. +On a fully phased-in basis, CET1 capital improved modestly to $154.1 billion. Under the advanced approaches compared to Q3 2015 pro forma estimate the CET1 ratio increased slightly to 9.8%. RWA was essentially flat as growth from commercial exposures was mostly offset by lower activity and balance sheet levels in our global market segment. +We also provide our capital metrics under the standardized approach. Here our CET1 ratio was flat at 10.8% with modest improvements in capital, offset by modest increase in RWA. In terms of the supplementary leverage ratios we estimate that as of 12/31 we continue to exceed US rules applicable beginning in 2018 at both parent and bank. +Turning to slide 7, we had strong loan and deposit growth this quarter. Recorded loans on an end-of-period basis increased $15 billion from Q3. This is the third consecutive quarter of recorded increases in total loan balances. +We continue to see solid loan demand in our primary lending businesses, partially offset by runoff in LAS and all other. Excluding declines in LAS and all other, ending loans in our primary lending segments increased $22 billion from Q3. +$8 billion of this increase was in consumer loans as GWIM increased mortgages and security-based lending. Consumer banking also saw good loan growth in mortgages as well as vehicle loans. +We also had some seasonal growth in credit card partially offset by selling $1.7 billion of card receivables at the end of the quarter. Commercial loans were $15 billion spread across multiple industry groups. +Turning to deposits on many basis they reached nearly $1.2 trillion this quarter, growing $78 billion, or 7% in Q4 2014. Growth was solid across the franchise. Consumer led the way, growing 9% year over year while both global banking and GWIM each grew at a 6% pace. +Turning to asset quality on slide 8, while still strong we did see net charge-offs increase modestly from recent levels. Total net charge-offs increased $212 million versus Q3. $144 million was from consumer items previously reserved for and lower recoveries on the sale of NPLs in the fourth quarter versus Q3. +We also saw a $73 million increase in net charge-offs from our energy portfolio. Outside of these two areas net charge-offs were stable compared to Q3. Provision of $810 million in Q4 was relatively flat with Q3. +Reserve releases in consumer real estate and credit card were partially offset by reserve builds in commercial which were driven by increases in criticized exposures as well as loan growth. Reserve releases excluding the previously reserved items I mentioned earlier were roughly $200 million. +On slide 9 we provide credit quality data on our consumer portfolio. Net charge-offs increased $137 million. +The two items of note that make up this increase were reserved for in prior periods and did not impact provision expense in the quarter. $119 million was the result of collateral valuation adjustments. +In addition we had some small charge-offs associated with our 2014 DOJ settlement. We expect to complete our commitments under this settlement in the first half of 2016. +Adjusting for these two items consumer net charge-offs were relatively flat versus Q3. Delinquency levels and NPLs continued to decline and reserve coverage remains strong. +Moving to the commercial side, on slide 10, net charge-offs increased $75 million primarily from losses in our energy portfolio. Outside of the energy portfolio, commercial losses remain very low. +Given the focus on the impacts of low oil prices on companies in the energy sector we want to spend a minute to describe our energy portfolio and provide some perspective. The pie chart breakdown our $21 billion of utilized exposure to the energy sector. This represents a little more than 2% of our total loan balances. +Within that $21 billion, $8.3 billion or less than 1% of total loans is loans to borrowers in two subsectors, exploration and production as well as oilfield services. We consider these two subsectors to have significantly higher risk than the rest of the energy portfolio. +Of our $8.3 billion utilized exposure to these two higher risk subsectors $2.9 billion has already been downgraded to criticized. So 35% of the higher risk subsectors has already been downgraded to reservable criticized exposure, thereby driving a portion of the reserves. And allowances for loan losses for the entire energy portfolio is approximately $500 million, or 6% of the funded exposure of these two subsectors. +Companies in the vertically integrated subsector represent $5.8 billion of the energy portfolio. We believe this subsector has a better ability to withstand lower oil prices. Nearly 100% of the companies have a market cap of $10 billion or more or they are sovereign owned and the average company has a market cap greater than $60 billion. +We believe the remaining exposure in refining and marketing as well as other is also less dependent on oil prices. As part of our standard risk management process we stress test our credit portfolios including our pension portfolio. Our stress analysis of the energy portfolio includes various sustained low oil prices over extended periods. +As an example, if we held oil prices at $30 per barrel for nine quarters we estimate our potential losses on the energy portfolio would be roughly $700 million. In energy and across our commercial sector we continue to support clients while managing lending limits and actively engaging with stressed borrowers. +Before moving from asset quality I want to refocus on total provision expense and how one should think about it over the next couple of quarters. As we continue to assess and react to future changes in the energy sector we could see lumpiness that could potentially drive provision expense over $900 million. +Turning to net interest income on slide 11, on an FTE basis NII was $10 billion increasing roughly $300 million from Q3. NII included a negative $612 million charge associated with three trust preferred securities. These securities were scheduled to be completely phased out of Tier 2 capital as of Jan 1 and with 7% to 8% coupons became expensive debt. +NII also included $116 million of positive market-related adjustments to the amortization of bond premiums under FAS 91. NII excluding market-led adjustments and the charge on the trust preferred improved $188 million from Q3 to $10.5 billion. This improvement was driven by increased deposit balances which we used to fund growth in loans and securities. +As we move into the first quarter, please note the following. First, we will have one less day of interest. Second, recent changes by Congress will lower the amount of dividends we receive from the FRB by approximately $50 million a quarter. +Having said that, if the forward curve is realized and if we have some modest deposit and loan growth we still expect to show some growth in NII in Q1 2016 relative to our adjusted NII of $10.5 billion. +With regard to asset sensitivity, at the end of the fourth quarter out overall asset sensitivity decreased slightly as a result of increases in long-end rates as well as security balances. As of 12/31 and instantaneous 100 basis point parallel increase in rates is estimated to increase NII by approximately $4.3 billion over the subsequent year. A little more than half of that improvement comes from the increases in short-end rates and a little less than one-quarter of the benefit comes from market-related adjustments. +Turning to expenses on slide 12 non-interest expense was $13.9 billion in Q4, $300 million lower than Q4 2014. This was driven by good expense discipline across the Company. +Litigation expense was a little higher this quarter at $428 million, exhibiting some lumpiness as we work to resolve legacy issues. Keep in mind that annual litigation expense decreased from $16.4 billion in 2014 to $1.2 billion in 2015. Legacy asset servicing costs excluding litigation finished Q4 a little better than our target of $800 million. +As we have said our net goal is $500 million per quarter. Expenses excluding litigation and LAS were $12.6 billion and represents the fifth quarter out of the past six below $12.8 billion. We continue to look for ways to streamline and simplify how we do business. +This is important because it allows us to invest in growth while maintaining relatively flat core expenses in a sluggish revenue environment. Importantly, this relative flatness continued even as we invested in additional sales professionals and improved technology. +Looking towards expenses in 2016 let me remind you in the first quarter we will record as normal approximately $1 billion in cost for retirement eligible incentives. In addition, the first quarter typically includes seasonally higher payroll taxes of roughly $300 million. And if we experience additional rebound in Q1 sales and trading revenue this would also increase incentives and other associated costs. +Turning to the business segments and starting with consumer banking on slide 13. Consumer earned $1.8 billion, 9% greater than Q4 last year. These results reflect good operating leverage on increased customer activity. The segment generated a strong 25% return on allocated capital. +Revenue of $7.8 billion was up modestly from Q4 2014. Net interest income benefited from higher deposit and loan levels. Non-interest income was down slightly from lower mortgage banking. +The decline in mortgage revenue reflects selling fewer nonperforming loans as we hold more on our balance sheet, in addition with the absence of $30 million in quarterly revenue from the Q3 sale of the small noncore appraisal business. Expenses declined 2% from Q4 2014 as the savings from reduction in financial centers and personnel more than offset higher product cost and investment in increased sales specialists. +The cost of operating deposit franchise remains low at 177 basis points. Operating leverage drove improvements in the efficiency ratio to 56% as we continue to experience shifts in customer activity away from branches towards self-serve options. Mobile banking users increased to 18.7 million which is up 13% from Q4 2014 and deposit transactions from these devices now represent 15% of deposit transactions. +Slide 14 presents consumers progress across a number of customer activities. I would highlight activities in three areas: loans, deposits and brokerage assets where we continue to grow responsibly. These three products are at the core of our rewards program where we share benefits with customers who deepen relationships with us. +Average loans grew $12 billion from Q4 2014 in mortgages and vehicle lending. Ending deposit growth was strong at $48 million or 9% from Q4 while the rate paid decline to 4 basis points. +Regarding brokerage assets, Merrill Edge asset levels of $123 billion are up 8% from last year even with declines in equity markets this year. Total mortgage production was up 13% from Q4 last year and stable with Q3. Looking at card activity which includes GWIM card issuance was strong at 1.3 million. +Average US card balances of $89 billion were down modestly from last year but up seasonally from Q3 2015. US card credit quality was strong as net charge-offs remained at decade-low levels of 2.5% with a risk-adjusted margin of 9.4%. Credit spending volumes finished on a high note as Q4 spending was 5% higher than last year, outpacing what we believe to be total market spend levels. +Debit spending was strong as well. For example, on Christmas Eve day we saw record debit card spending of more than $1 billion. +In our consumer segment we expect technology adoption by customers to continue to be a cornerstone of not only improved customer satisfaction but also efficiency gains and operating leverage. The latest examples of this are around digital selling and appointment setting. +Digital sales in the fourth quarter were up more than 31% from last year. Digital appointments reached more than 16,000 in a recent week. We expect these adoption trends to play an increasing role in future performance and customer satisfaction as we continue to advance online and mobile capabilities. +Turning to slide 15, global wealth and investment management produced earnings of $614 million. Results were down from Q4 last year driven by lower transactional revenue and the impact of the market decline on asset management fees. Transactional revenue continues to be impacted by the shifting of activity from brokerage to managed relationships as well as market uncertainty. +NII benefit followed loan growth and solid deposit growth but was offset by the Company's ALM activities, leaving NII relatively flat with Q4 2014. Non-interest expense was modestly higher than the year-ago period. Investment in client facing professionals continues while lower revenue caused a decline in incentive compensation that was more than offset by amortization of stock awards issued in prior periods. +Pretax margin was 21%, down from Q4 2014. Beginning in the first quarter of 2016, we will benefit from lower expense resulting from the completion of amortization related to advisor retention awards given at the time of the Merrill Lynch merger. +Moving to slide 16, despite the volatility in market levels we continue to see solid client activity and we continue to invest in the business growing wealth advisors 5% from Q4 last year. Long-term AUM flows were $7 billion and remain positive for the 26th consecutive quarter. Deposit flows were strong growing end-of-period balances $15 billion from Q3. +By the way, this may have been driven in part by client concerns with market volatility. Loans continue to grow, improving 10% from last year. This is the 23rd consecutive quarter of average loan growth in this segment. +Turning to slide 17, global banking earned $1.4 million, down 9% from Q4 2014 but still generating a 60% return on allocated capital. The earnings decline from Q4 was driven by higher provision expense. Provision expense was up $264 million from Q4 last year driven by higher energy-related charge-offs and reserve build to loan growth and energy-related risk. +Revenue increased modestly from Q4 2014 while expense declined modestly. Driven by higher loan balances NII improved despite spread compression and the allocation of the Company's ALM activities including higher liquidity cost. Non-interest income benefited from higher treasury services revenue, higher leasing revenue and a small gain from the sale of a foreclosed property, partially offset by lower IB fees. +Looking at trends on slide 18, in comparing to Q4 2014 IB fees of $1.3 billion were down 17% as leveraged finance and equity issuance was partially offset by advisory fees that were at second-highest level since the Merrill merger. From a marketshare perspective we maintained our number three global fee ranking. +Looking at the balance sheet loans on average were $320 billion, up 12% year over year. The growth was broad-based across C&I, real estate and leasing. We continue to experience some spread compression although it has moderated relative to a year ago. +Asset quality of new loans was consistent with the overall portfolio. On deposits we saw good performance with average deposits increasing by $16 billion or 5% over Q4 2014. The mix of these deposits remains very good with less than 5% classified as 100% runoff balances. +Switching to global markets on slide 19 and comparing to Q4 last year we are pleased with the results here given challenging market conditions as the teams increase revenue while using lower asset levels and less VAR. Global markets earned approximately $200 million but we think one should consider results excluding DVA. On that basis adjusted earnings were $308 million which was relatively flat to Q4 2014 on the similarly adjusted basis. +Note that our net deviated loss this quarter was $198 and compared to a loss of $626 million in Q4 2014 which included an initial FTE adjustment. Total revenue excluding DVA improved $313 million, or 10% from the fourth quarter last year on improved FICC sales and trading. +Outside of sales and trading global market share of lower investment banking fees was offset by a gain on the sale of an equity investment. Non-interest expense increased 9% in line with revenue improvement. +Moving to trends on the next slide and focusing on the components of our sales and trading performance, sales and trading revenue up $2.6 billion excluding net DVA was up 11.5% in Q4 2014. Compared to Q4 last year FICC sales and trading of $1.8 billion improved 20%, reflecting improvements across most products notably in rates and credit-related products. +Equity trading of $882 million declined 3%, reflecting lower client activity. Average trading-related asset levels were down 9% in Q4 2014 while VAR was down 14%. +Turning to legacy assets and servicing on slide 21, this segment lost roughly $350 million in line with the prior year. Focus areas here are mortgage banking income, the number of delinquent loans and expenses all compared to Q4 2014. +First, mortgage banking income which improved slightly was driven by three factors. Rep and warranty provisioning improved $237 million to a provision of $9 million this quarter. That favorability was offset by a decline in servicing fees of $108 million as the units serviced declined as well as a decline in net MSR hedge performance of $152 million. +Next, the number of first mortgage loans that we service that are 60 days delinquent continued to decline and are now at 103,000 units. And last, the team did an excellent job lowering expenses. Excluding litigation we achieved our goal of $800 million, moving costs down $309 million or 28%. +On slide 22 we show all other which reported a loss of $289 million. This was an improvement of $86 million from Q4 2014. This loss was driven by the $612 million pretax charge associated with our trust preferred as well as the impact on the UK tax law changes. +This was partially offset by gains on debt security sales as well as reserve releases on consumer real estate loans booked in all other. +A comment or two on taxes before wrapping up. The Company's effective tax rate for the quarter excluding the UK tax charge was 25%, reflecting reoccurring tax benefits plus a few small one-off benefits. We would expect the tax rate to be in the low 30s for 2016 excluding unusual items. +Before closing I want to cover our early adoption of DVA accounting in more detail. In January of this year the Financial Accounting Standards Board issued an update to allow early adoption of a new rule regarding recognition of DVA on financial liabilities from changes in our own credit spreads. +The update means these types of debit valuation adjustments will now flow through OCI instead of the income statement. We believe this change makes our earnings comparisons more meaningful and easier to understand, therefore we adopted early. +We restated all prior years, excuse me, we restated all propose this year per the FASB rules and those numbers are contained in the supplemental package. This has no impact on capital as it moved dollars between retained earnings and OCI but it did impact revenue earnings taxes and EPS in the first three quarters of 2015. +The changes reduced previously reported EPS by approximately $0.02 each in Q1, Q2 and Q3. This accounting standard adoption did not impact DVA on derivatives which continued to flow through trading account profits. +Okay, let me conclude by offering a few takeaways. Although the US economy is improving slowly revenue growth remains challenging. This quarter we continued our progress on those things we can control and drive. +These include delivering for clients and customers within our risk framework and driving client and customer activity that will result in sustainable profits and returns. Our results reflect this focus. We maintained a strong foundation of capital and liquidity. +We grew loans, deposits and investment flows. We continue to invest in our franchise by adding sales professionals and improved technology. Our strength, global capability and experience allowed us to deliver for clients in a challenging market environment. +And we did all this while closely managing expenses. With that we will open it up to Q&A. + + +================================================================================ +Questions and Answers +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + + (Operator Instructions) Matt O'Connor, Deutsche Bank. + +-------------------------------------------------------------------------------- +Matt O'Connor, Deutsche Bank - Analyst [2] +-------------------------------------------------------------------------------- + + + Good morning. Can you talk about the outlook for the core costs beyond some of the lumpy items in 1Q? +And then specifically maybe comment on how you feel like your markets business is sized. We've obviously seen some cost savings announcements at your US and non-US peers. I want to get a sense of how you feel you're positioned for the markets? + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [3] +-------------------------------------------------------------------------------- + + + This quarter, the fourth quarter I think represents as I said in the comments the fifth quarter out of six that we've been below $12.8 billion. As you know I think we've been talking about maintaining core expenses below $13 billion, so we feel really good about our progress. +I have to remind everybody that we're maintaining those core expenses at those levels while we're investing in front office professionals while we're investing in technology, while we're absorbing the natural increase in pay for our employees and fraud cost and CCAR costs and other things. So I think we feel good about the work we're doing there. In terms of global markets what was the question? + +-------------------------------------------------------------------------------- +Matt O'Connor, Deutsche Bank - Analyst [4] +-------------------------------------------------------------------------------- + + + Just in terms of the staffing and the positioning there how you feel for I don't know about the current environment but just not bouncing back in a big, big way. And obviously we're seeing reductions being announced at some of your US and non-US peers. So how are you feeling about the sizing of your business for the environment you expect? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman & CEO [5] +-------------------------------------------------------------------------------- + + + Matt, in the fourth quarter we did reduce headcount in the business, the markets businesses and the related capital markets business. We didn't make a big announcement but that led to the $130 million in severance in the fourth-quarter numbers that you see. So we will continue to adjust that headcount. Tom and his team will continue to adjust it but they made an adjustment in headcount in the fourth quarter, just didn't make quite the press other people's did. + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [6] +-------------------------------------------------------------------------------- + + + The only thing I'd add, Matt, is my focus was on core expenses. We're going to see total expenses I think continue to come down as we work on LAS and continue to hopefully see some moderation on legal expense. + +-------------------------------------------------------------------------------- +Matt O'Connor, Deutsche Bank - Analyst [7] +-------------------------------------------------------------------------------- + + + And just on the timing of the LAS getting to that below $500 million you did disclose a big drop in the headcount if we look year over year and obviously there's delay in terms of costing [self] coming to down but what's the timing of getting to that $500 million or below? + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [8] +-------------------------------------------------------------------------------- + + + I think we've made great progress in terms of getting expenses down. I think we started at what, $3.1 billion quarters ago but we've made great progress getting down to $800 million. +Our net milestone is $500 million per quarter. That's going to be a little bit harder, as you get lower and lower it's a little bit more unpredictable. And so we're not really giving a target at this time but we're going to get there as soon as we can. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman & CEO [9] +-------------------------------------------------------------------------------- + + + You should expect us to make good progress, Matt, towards this year. And so as you look towards the end of the year we should be getting there. + +-------------------------------------------------------------------------------- +Matt O'Connor, Deutsche Bank - Analyst [10] +-------------------------------------------------------------------------------- + + + Okay, thank you. + +-------------------------------------------------------------------------------- +Operator [11] +-------------------------------------------------------------------------------- + + + Betsy Graseck, Morgan Stanley. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [12] +-------------------------------------------------------------------------------- + + + Hi, good morning. I just want to dig in on a couple of things, one was on energy since it's the flavor of the day. +You know you gave a lot of color there and you indicated that those $30 holds for nine quarters, that's a loss of $700 million. I just wanted to understand is that already reserved for or that's over and above what you've reserved for? +And then maybe you could give us an even more bearish case, if we go below $30 what you've got baked in? Because I don't think it's linear, I just want to understand how you're thinking about it. + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [13] +-------------------------------------------------------------------------------- + + + Sure. Well as we said in the comments we've got reserves against that energy portfolio of $500 million. That's 6% of the high risk subsectors and we develop reserves on an incurred basis. +We develop them by looking at loss given default, probability of default, exposure to default. We go loan by loan. We have a lot of imprecision, other factors that we look at for imprecision and we put judgment on all that. +One of the things we look at when we come up with our judgment of what we should be is our stress testing. And so that's how that gets factored in to our reserve which again has to be on an incurred basis. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [14] +-------------------------------------------------------------------------------- + + + Right. So when you indicated that if $30 holds for nine quarters your model suggests a loss of $700 million. That's already reserved for or that's on top of what you already have reserved? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman & CEO [15] +-------------------------------------------------------------------------------- + + + In part, Betsy, because the idea is you can only incur for what you see through today. In terms of the operating structure of these companies and the asset-based lending, these are asset-based loans, derivative-based loans. So they've ratcheted down based on price but at year-end you're only reserving for what you see today. +If you're nine quarters from now and oil is still at that price you'd have to have it reserved for what's left of the portfolio of the exposures. But coming down it would come down during those nine quarters by the losses you took at least in resolving those credits. So it's in part covered but not fully because that's an estimate of a future that as Paul said it's an incurred view of the portfolio. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [16] +-------------------------------------------------------------------------------- + + + Okay, I get that. + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [17] +-------------------------------------------------------------------------------- + + + The other way to think about it is we've got a $500 million. As we go, theoretically you go through the nine quarters if that $700 million were to come true if our model was perfect it would go against that model $500 million but you'd be building reserves as you went through that process. +So if you told me what you wanted to end the nine quarters at, if you wanted to end at $500 million you can do the math. If you wanted to end at more or less it's going to be more or less in terms of you kind of have to build. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [18] +-------------------------------------------------------------------------------- + + + And then could you talk a little bit about the reserve release that's still possible from the other portfolios? You had a $200 million reserve release this past quarter. Just wondering what the legs are on that? +We've seen other institutions essentially finish up their reserve release. I know you had a big legacy book, so maybe there's a little more legs there. Just wanted to understand how you're thinking about the trajectory there. + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [19] +-------------------------------------------------------------------------------- + + + I think you've got it. I think we have a legacy, we have a large legacy portfolio on the consumer side. As we continue to work through that and if home prices continue to stay where there or improve, the economy stays where it are or improve, I think you're going to continue to see reserves from us in 2016 or reserve releases I should say from us in 2016 but they are going to moderate from what they have been in the past. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [20] +-------------------------------------------------------------------------------- + + + Okay. So there's still some legs but at a decelerating pace? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman & CEO [21] +-------------------------------------------------------------------------------- + + + Yes, some of that swings over to the commercial book as you saw this quarter. So we have come down from a lot of reserve releases last year, I think it's 800 million or so in the fourth quarter, 700 million or 800 million or something down to 200 million, a couple of hundred million. And you'd expect that to mitigate during the course of 2016. + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [22] +-------------------------------------------------------------------------------- + + + Yes, and we've built reserve in commercial. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [23] +-------------------------------------------------------------------------------- + + + Okay, thanks. + +-------------------------------------------------------------------------------- +Operator [24] +-------------------------------------------------------------------------------- + + + John McDonald, Bernstein. + +-------------------------------------------------------------------------------- +John McDonald, Sanford Bernstein - Analyst [25] +-------------------------------------------------------------------------------- + + + Hi, good morning, Paul. I was recalling I think you had for a goal this year to generate positive operating leverage. I was wondering how you feel about the ability to achieve that, what kind of revenue environment are you planning for and how will you manage expenses to try to get some positive operating leverage this year? + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [26] +-------------------------------------------------------------------------------- + + + I think we feel good about the operating leverage we achieved in 2015. You can see that with the revenue growth relative to the EPS growth and I think we're looking to continue that trend. +We got hopefully a little bit of a tailwind here on rates. We're going to continue to manage expenses carefully. +So in terms of our EPS growth in 2016 we don't give estimates but in terms of our EPS growth in 2016, I think it will be more of the same. Revenue growth with some hopefully expense discipline that will get us some operating leverage. + +-------------------------------------------------------------------------------- +John McDonald, Sanford Bernstein - Analyst [27] +-------------------------------------------------------------------------------- + + + Okay. And then Brian, could you talk a little bit about what your goals will be with your 2016 CCAR submission? Are you looking to make some progress on both the dividend and buyback potentially and if you maybe could share some thoughts about that? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman & CEO [28] +-------------------------------------------------------------------------------- + + + John, we haven't seen the scenarios yet and stuff like that so I think it's probably premature to discuss that. Our goal is long term is to return more and more capital to shareholders through dividends and stock buybacks. +At this price obviously stock buybacks are favored. But when we see the scenario and play that out it would be getting ahead of the process to talk about it today. + +-------------------------------------------------------------------------------- +John McDonald, Sanford Bernstein - Analyst [29] +-------------------------------------------------------------------------------- + + + Okay, and Paul, one quick follow-up on the NII, is there a benefit from the paydown of trust preferreds that you're get in 2016? And is that why you're able to grow the core NII a little bit in 2016? + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [30] +-------------------------------------------------------------------------------- + + + I wouldn't say that's why but obviously there's a benefit from paying off those trust preferreds. They had I think it was $175 million per quarter -- I've got that right? Yes. +And so there's a benefit there. The way I would think about those is we're not going to, quote, replace them because they don't count toward our regulatory capital, so why would we replace them? +We're going to have a capital structure that meets our regulatory requirements which requires us to have a certain amount of CET1. We're going to have the appropriate amount of preferred and subject and of course we have to meet the TLAC requirements. So that's how I would think about it. + +-------------------------------------------------------------------------------- +John McDonald, Sanford Bernstein - Analyst [31] +-------------------------------------------------------------------------------- + + + Okay. And so it's really just the loan growth and pretty stable rates driving some core NII growth? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman & CEO [32] +-------------------------------------------------------------------------------- + + + John, if you look at it what global is affecting us 2013, 2014 was we're continuing to run off portfolios that have yield to them. And obviously the reinvestment rates on the investment side of the house as we ran those off were flattish. That's kind of all run through the system. +So now what you're seeing is $80 billion a period deposit growth from fourth quarter last year to this year. And the overall pay rate for that is in the low single-digit basis points. All core, all in consumer, wealth management and driven by middle-market and the banking business. +So that's the deposit funding side. And the asset build is now good core loans that have reasonable yields to them and you start to see it and then pick up just a hair from that. And we expect it to drive in our core as long as the economy continues to grow a couple percent. + +-------------------------------------------------------------------------------- +John McDonald, Sanford Bernstein - Analyst [33] +-------------------------------------------------------------------------------- + + + Okay, thank you. + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [34] +-------------------------------------------------------------------------------- + + + Hey, John, just real quick I want to correct one thing I said. The $175 million is full-year. + +-------------------------------------------------------------------------------- +John McDonald, Sanford Bernstein - Analyst [35] +-------------------------------------------------------------------------------- + + + Okay. + +-------------------------------------------------------------------------------- +Operator [36] +-------------------------------------------------------------------------------- + + + Paul Miller, FBR & Company. + +-------------------------------------------------------------------------------- +Paul Miller, FBR & Co. - Analyst [37] +-------------------------------------------------------------------------------- + + + Thank you very much. On your NPAs you have really good disclosure, you're getting it down to 103,000. Did you sell any this quarter or was that all workouts through your servicing? + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [38] +-------------------------------------------------------------------------------- + + + We sold a little bit but not as much as we had in the past. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman & CEO [39] +-------------------------------------------------------------------------------- + + + Largely Paul, that's been, it's very incremental at this point on the sales side. + +-------------------------------------------------------------------------------- +Paul Miller, FBR & Co. - Analyst [40] +-------------------------------------------------------------------------------- + + + And then, at this point when do you think you can get that down to I guess it's not a normal level because you're just going to run this whole portfolio off. Could you have any idea when that would be over with? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman & CEO [41] +-------------------------------------------------------------------------------- + + + Well, Paul, the 103,000 is of the total portfolio. So there's a normal piece in that and an abnormal piece in it. But we should be driving it down to the 60 days, 103,000 is across both portfolios. +But that number should come in I don't know pick a percent, percent and a half of the service loan units. So it's still got some room to go. +And that's the key that I think Matt pointed out earlier is the FTE headcount in LAS we had a 2,000 person headcount drop in the Company overall in the fourth quarter, about half LAS, half the rest of the Company. The LAS percentage rate was 8 percentage points not annualized for the quarter at 30%. It's still dropping its headcount but it's getting flatter and now we've got all the old cost to drive out of the portfolio. +So in terms of thinking about real estate and old systems and stuff and so that's what takes a little more time now than just the people cost. + +-------------------------------------------------------------------------------- +Paul Miller, FBR & Co. - Analyst [42] +-------------------------------------------------------------------------------- + + + Okay, guys, thank you very much. + +-------------------------------------------------------------------------------- +Operator [43] +-------------------------------------------------------------------------------- + + + Jim Mitchell, Buckingham Research. + +-------------------------------------------------------------------------------- +Jim Mitchell, Buckingham Research - Analyst [44] +-------------------------------------------------------------------------------- + + + Hey, good morning. Maybe just a quick question on deposit behavior. Since the rate hike have you seen anything unusual? I would assume it would be more on the institutional side where you would see movement at this point. +And then maybe you can give some update on how you're thinking about the deposit betas this year. + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [45] +-------------------------------------------------------------------------------- + + + Sure. The short answer is that we have seen no real movement. +Of course we're very focused on making sure that we pay an appropriate deposit rate but so far there's been no movement. We have been modeling deposit betas on our interest-bearing deposits in the high 40s. + +-------------------------------------------------------------------------------- +Jim Mitchell, Buckingham Research - Analyst [46] +-------------------------------------------------------------------------------- + + + And do you still think that make sense or do you think that's relatively conservative? + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [47] +-------------------------------------------------------------------------------- + + + We think that makes sense. And given the quality of our deposit base as Brian walked through already the portion we have in our consumer and GWIM franchises, the number of primary checking accounts, even on the wholesale side if you look at our deposits less than 5% of them are 100% runoff deposits. +So we feel good about our $1.2 trillion in deposits. We took this year the deposit rating came down another basis point to 4 basis points for all deposit. So we feel good about that modeling. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman & CEO [48] +-------------------------------------------------------------------------------- + + + And Jim, remember that modeling is not 40% of everything, it's a lot nothing and a lot less for the first couple of bumps. So I think that's what you're thinking about. So if we continue along with one or two rate rises there will be a lot more capture then as it gets into the higher -- + +-------------------------------------------------------------------------------- +Jim Mitchell, Buckingham Research - Analyst [49] +-------------------------------------------------------------------------------- + + + Right, it will be more back-end weighted. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman & CEO [50] +-------------------------------------------------------------------------------- + + + Exactly. I think that's what you're asking. + +-------------------------------------------------------------------------------- +Jim Mitchell, Buckingham Research - Analyst [51] +-------------------------------------------------------------------------------- + + + Okay and just one last question, maybe on the expense side, if we look at, I mean you guys have done a good job, but if you look at your core expenses normalized for all the puts and takes it still seems like your efficiency ratio would be sort of in the 63%, 64% range and a lot of your peers are well below 60%. Is this sort of you grow into the improving efficiency ratio with the revenues as you reinvest or is there do you think you can get there more quickly? Just trying to get a sense of how you get the trajectory into more in line with the peer group on the efficiency ratio side? + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [52] +-------------------------------------------------------------------------------- + + + If you look at the full-year 2015 and you do those puts and takes with the things that we've talked about through the year and you make any sort of a reasonable guess as to the progress we're going to make around LAS, we're in the 65%-ish range, we're going to continue to focus on growing responsibly and working on our total expenses as we talked earlier. And so with a little help from growth and some more work on expenses we think we're in shooting range. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman & CEO [53] +-------------------------------------------------------------------------------- + + + As we model ourselves and look at sort of the peers, so the average efficiency by business units and model against our business mix we're going to be a little higher because the high-level wealth management in our business relative to the total. But look, three things on expenses. +Number one, we'll continue to drive it them and funding all the growth and FTE for the sales side we have 6% growth in consumer FTE sales side, 3% wealth management, maybe 8% in global banking year over year. So we're paying for all that, paying for all the incentives attached to it, paying for all the infrastructure attached to it. So we're going to continue to drive it down. +So just rest assured that is. And then we are not satisfied in the mid-60s efficiency ratio of the Company and we should be able to drive that down and it will come from both just hard work and as you say with a rate lift and stuff which affects -- we're still affected a little bit more by low rate structure than other people we should pick it back up. But don't think we're complacent on this. + +-------------------------------------------------------------------------------- +Jim Mitchell, Buckingham Research - Analyst [54] +-------------------------------------------------------------------------------- + + + Okay, I appreciate it. Thanks. + +-------------------------------------------------------------------------------- +Operator [55] +-------------------------------------------------------------------------------- + + + Glenn Schorr, Evercore. + +-------------------------------------------------------------------------------- +Glenn Schorr, Evercore ISI - Analyst [56] +-------------------------------------------------------------------------------- + + + Hi, thanks. So I think you put the heat on a little bit on loan growth over the last couple of quarters. And if you look at lending in your primary lending segments it's picked up and I think that's good. +The question I have is with new information that we have, I mean the markets digesting and anticipating I don't know if I'll call it a recession but a lot of fear around recession on lower oil and China-related fears. The question I have is if you look at the core loan growth are you still okay running it at this level? Do you feel like your customer base that you're making these new loans to are a little more insulated to the world that the market is fearful of? + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [57] +-------------------------------------------------------------------------------- + + + Outside of energy we are not seeing asset quality change nor are we seeing a reduction in appetite for credit. I would remind everybody that we were very, very focused on our customer framework and our risk framework. But within that framework we continue to see a lot of opportunities to help our customers grow their businesses. +If you look at this quarter and you just focus on the core we had 3% quarter-over-quarter growth or an annualized growth rate of a little over 12% or $22 billion. I'm not going to sit here and tell you that's what it's going to be next quarter. But we're not seeing material decline in conversations with our clients about how to help them grow. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman & CEO [58] +-------------------------------------------------------------------------------- + + + I think to give a additional color if you think about it if you go back a couple of years we grew the international business because we had to round out that franchise. We sort of slowed that down, 24 months ago that started to drop in terms of growth rate. And so because of the client selection criteria there is very high in clients, multinational clients, etc. +But we slowed it down just to keep the Company in balance and that's been our watchword. If you think about on the consumer no subprime, no lowering FICO scores. If you look at the coming on FICOs they are higher in the portfolio still which is almost hard to believe, the charge-offs, delinquencies in both home-equity, delinquencies across the last four years and continue to get lower every year. +This year was the lowest they've been all the way back a long time in both credit card and home-equities. And if you look at the client selection in the US a couple of things. One is we're adding officers in the middle-market business but they are going after our target clients and this is not go find new industries, etc. +So whether it's the way we lend to commercial real estate which is very high-end real estate developers, etc., the way we lead in middle-market is very strong. So as you look across this client selection in the middle-market business has been strong. +The best (technical difficulty) that we're seeing is things in our business banking, small business portfolios. We're actually starting to see growth there, again sticking to our credit risk which is the first time in many years because we had to run off some stuff that came in through LaSalle, Merrill and everything else that we're finally seeing nominal growth. +And so I think this client selection we slowed down international, it sort of always watching and in fact using your stress test to make sure you stay balanced. And if you look at us we feel we're pretty balanced between the consumer and commercial sort of 50/50. And then within the consumer we're really sticking to our knitting which is very strong, high-quality, both creditworthy borrowers. + +-------------------------------------------------------------------------------- +Glenn Schorr, Evercore ISI - Analyst [59] +-------------------------------------------------------------------------------- + + + Great. One follow-up on the FA growth you noted a 5% year on year, I'm just curious there's not a heck of a lot of core growth in that business. I'm just curious how much is coming from your training programs versus recruiting both traditional and nontraditional sources? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman & CEO [60] +-------------------------------------------------------------------------------- + + + It's coming from both. The reality is that the number one issue they face in the wealth investment and brokerage services revenue line is the decline in transactional revenue. +And it has gone from two years ago probably $600 million a quarter even in non-robust market times down to I don't know $300 million, $400 million. That is hard to make up on the annuity piece. Even though they are having record net flows it's just the revenue rate on that is less. +So that's the factor. So it's not to do with really recruiting. The production per FA continues to be solid at 1 million-plus. +It's really that core fundamental issue that they are facing. And that transition is what we're all going through. It's getting to the point where it's becoming less material and i.e., less material to the total revenue line from the transaction side. + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [61] +-------------------------------------------------------------------------------- + + + On the other hand I would just remind everybody that we've got significant positive loan base in that business. And so again if rates rise we're going to see some benefit there. + +-------------------------------------------------------------------------------- +Glenn Schorr, Evercore ISI - Analyst [62] +-------------------------------------------------------------------------------- + + + All right, thank you very much. + +-------------------------------------------------------------------------------- +Operator [63] +-------------------------------------------------------------------------------- + + + Steven Chubak, Nomura. + +-------------------------------------------------------------------------------- +Steven Chubak, Nomura Securities Co., Ltd. - Analyst [64] +-------------------------------------------------------------------------------- + + + Hi, good morning. So actually I had a quick follow-up to the topic Glenn was just addressing. +Relating to GWIM and just some of the margin pressures that we've been seeing over the last couple of quarters I wanted to get a better sense as to how much of that do you think is cyclical versus secular, whether it be DoL-related pressures or just intensifying competition for advisors? And along those same lines whether a 30% margin target is still achievable once we get to a more favorable rate backdrop? + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [65] +-------------------------------------------------------------------------------- + + + Let me start with the last one and pick up on just some comments Brian made again. The decline in the margin has been because of decline in transactional revenues. +In addition over the last couple of quarters there's been a lot of market volatility. Markets have ended down in certain months and that affects what we make on asset management. +We would hope in a better market environment we would see some improvement in some aspects of the transactional business because there's a lot of selling of mutual fund products and other products there. And then again as I point out we've got a business here with close to $140 billion in loans and $240 billion to $260 billion-ish of deposits and as rates move we're going to start seeing some benefit from that on which the payout ratio is quite different than on the more traditional asset management products. +So that really I do think is the revenue story that will affect margins. And again in the first quarter of this year we're going to see $100 million reduction in expenses because of the runoff of the compensation programs we've put in place around the Merrill merger. +So I think that's what I would say about the margins. What was the second part of the question? + +-------------------------------------------------------------------------------- +Steven Chubak, Nomura Securities Co., Ltd. - Analyst [66] +-------------------------------------------------------------------------------- + + + Just about to what extent if you could at least segregate the secular versus cyclical headwind components on the revenue side? But I think that you adequately addressed that in your response. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman & CEO [67] +-------------------------------------------------------------------------------- + + + So I think people ought to think about GWIM, the margin has come down, we think it's flooring out here and it will start to pick back up in part because of some of the unfundamental changes in the ATP program running off and stuff. But we've invested in a PMD program. It cost a few hundred million dollars of drag to do that. +That's the right thing to actually build the advisor base over time and service the clients. And the team if you look at it underneath the US the flows and stuff are strong and the US trust business is having some of its best quarters ever just because of the difference that it didn't have the secular runoff you referred to in terms of the fee-based business. +So it's a good business, it does a good job with its clients. We expect more out of it. And that's the job for John and Keith and Andy and Terry going forward. + +-------------------------------------------------------------------------------- +Steven Chubak, Nomura Securities Co., Ltd. - Analyst [68] +-------------------------------------------------------------------------------- + + + All right. Thanks, Brian. And maybe just switching over to the credit side, I appreciate the detailed disclosure you guys have been giving on the energy book and was just hoping you could provide both exposure and reserve levels, maybe some other areas of the commodities complex, specifically metals and mining. + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [69] +-------------------------------------------------------------------------------- + + + We feel good about our metals and mining exposure. It's about $8 billion but most of that exposure is much more short dated and much more collateral. So we feel good about that exposure. + +-------------------------------------------------------------------------------- +Steven Chubak, Nomura Securities Co., Ltd. - Analyst [70] +-------------------------------------------------------------------------------- + + + Okay. And then just as a follow-up to the initial provision guidance you had given, thinking about it from a modeling perspective is the right way for us to be thinking about the provision rate for 2016 taking that $800 million to $900 million quarterly run rate plus whatever additional energy driven reserve building we should be contemplating which presumably is incremental. + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [71] +-------------------------------------------------------------------------------- + + + Yes, that's not a bad way to think about it. Again if you remember our guidance from last quarter we said $800 million to $900 million for the first two quarters of 2016. And the way I would think about those two quarters would be yes, we could see some lumpiness. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman & CEO [72] +-------------------------------------------------------------------------------- + + + But I think the one thing overall is that as you look at the question on the exposure that we're also paying close attention to is it sort of a demand or supply issue for oil prices. And if it's a supply issue that affects these companies and related companies and demand from. +But if it's a demand in the broadest context i.e., economies continue to slow down and that's the broader concern. So we're looking at not only the impact on all the portfolios thinking about who gets the benefits in our portfolio basis from low energy cost which are serious benefits to the consumers and to companies that consume energy versus those producing it. +So there's a balance here that we've got to think through. Right now it's pretty isolated the energy companies and even if you look at consumers who work for them in our basis by ZIP Code and unemployment levels and stuff we've seen relatively modest deterioration or none in the consumer side people employed in these businesses. +So I think as you think about it the real question is going to come down to for 2016 in terms of all our industry is are we in a demand-driven issue i.e., a general economic issue or is the United States going to plug along and if it does then I think Paul's guidance is the right one. If you're in the supply it's all going to be localized on these industries. + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [73] +-------------------------------------------------------------------------------- + + + It's not demand, it's again worth emphasizing there are a lot of people who are helped by low prices. That helps our asset quality not only on the consumer side but also in places like India and manufacturers all around the world. + +-------------------------------------------------------------------------------- +Steven Chubak, Nomura Securities Co., Ltd. - Analyst [74] +-------------------------------------------------------------------------------- + + + All right, got it, guys. Very helpful. Thanks for taking my questions. + +-------------------------------------------------------------------------------- +Operator [75] +-------------------------------------------------------------------------------- + + + Eric Wasserstrom, Guggenheim. + +-------------------------------------------------------------------------------- +Eric Wasserstrom, Guggenheim Securities - Analyst [76] +-------------------------------------------------------------------------------- + + + Thanks very much. I was just wondering if you could help me think through a little bit your GAAP and risk-weighted assets over the first half of the year given the growth dynamics that are pretty robust and some of the runoff and then also some of the changes that are going through on the RWA calculations. + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [77] +-------------------------------------------------------------------------------- + + + So you're talking about going with the first half of 2016? + +-------------------------------------------------------------------------------- +Eric Wasserstrom, Guggenheim Securities - Analyst [78] +-------------------------------------------------------------------------------- + + + Correct. + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [79] +-------------------------------------------------------------------------------- + + + Well, on a standardized basis I think you're going to see RWA trend up if it we're able to grow deposits and loans. On an advanced basis there's all sorts of puts and takes there. +I don't think you'll see as much growth as you would on a standardized basis -- on an advanced basis, yes, as you would on a standardized basis as we continue to work on our RWA. + +-------------------------------------------------------------------------------- +Eric Wasserstrom, Guggenheim Securities - Analyst [80] +-------------------------------------------------------------------------------- + + + And so what are the implications of that then for your regulatory capital ratios? + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [81] +-------------------------------------------------------------------------------- + + + Well we need to get to more inventory target. From a CET1 under an advanced basis our goal is to get to 10%-plus a buffer by 2019. +So we're at 9.8%. I feel like we have the time to do that. +We're certainly not going to need to take all that time. We would expect to get there soon. But it is impacted by changes in rates, changes in OCI. +We're hopefully returning capital. But we're not -- we feel like we're on track to get to 10% plus an appropriate buffer. +The only other thing I would add is we still have some opportunity to optimize RWA from an advanced perspective. That's in two fundamental areas. It's always stuff you can do in markets and other areas. +But in two fundamental areas, one is the extra RWA we got on the wholesale side when we exited parallel run. That's not a permanent thing. We need to work on our models, work with our regulators and hopefully over time we can make some improvements there. +The other one is operational risk. We have $500 billion of RWA for operational risk under the advanced approach. That is 25% more than the net highest bank and that operational risk is for businesses that we are no longer in. +It's for products we no longer sell. It's for a risk profile that we no longer tolerate. So again that will take time but that's another opportunity for us to lower RWA from an advanced perspective. + +-------------------------------------------------------------------------------- +Eric Wasserstrom, Guggenheim Securities - Analyst [82] +-------------------------------------------------------------------------------- + + + Thanks. Maybe if I can just sneak in one more. When you talk about an appropriate buffer are you thinking a method 1 or a method 2 as a baseline? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman & CEO [83] +-------------------------------------------------------------------------------- + + + I think -- the buffer to the capital? + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [84] +-------------------------------------------------------------------------------- + + + Yes, B3A. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman & CEO [85] +-------------------------------------------------------------------------------- + + + We're basically thinking the buffer we need to be above the requirements, the 10%. We'd say 25 to 50 basis points would be where we're at. + +-------------------------------------------------------------------------------- +Eric Wasserstrom, Guggenheim Securities - Analyst [86] +-------------------------------------------------------------------------------- + + + Okay, thanks very much. + +-------------------------------------------------------------------------------- +Operator [87] +-------------------------------------------------------------------------------- + + + Ken Usdin, Jefferies. + +-------------------------------------------------------------------------------- +Ken Usdin, Jefferies & Company - Analyst [88] +-------------------------------------------------------------------------------- + + + Thanks, good morning. Just a quick follow-up on the loan growth side, you talked about the credit quality underneath the commercial side. But after 13%, 14% loan growth year do you think you can maintain that type of pace of growth given some of the concerns we've seen underlying even if quality is holding up? +So just I guess your general outlook for loan growth rates. And can you match or maintain what you did last year? Thanks. + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [89] +-------------------------------------------------------------------------------- + + + Look, I'm not sure we're in the business of giving guidance on loan growth we think we can grow. If you were looking for some perspective from us I wouldn't even call it guidance. Mid-single digit is what we hope we can accomplish. + +-------------------------------------------------------------------------------- +Ken Usdin, Jefferies & Company - Analyst [90] +-------------------------------------------------------------------------------- + + + Okay. Continue to be driven by commercial would you say? + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [91] +-------------------------------------------------------------------------------- + + + I think it's going to continue to be driven by commercial but you're going to see growth in consumer as well. + +-------------------------------------------------------------------------------- +Ken Usdin, Jefferies & Company - Analyst [92] +-------------------------------------------------------------------------------- + + + Just a quick second one. You've been growing the mortgage business again. What's your outlook for continuing to take share in the mortgage business and have we seen the bottoming of results on the fee side of mortgage? + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [93] +-------------------------------------------------------------------------------- + + + In our mortgage business I think we are focused on originating prime and sort of non-conforming loans. There's been good progress here I think if you look over the last year. +The number of non-conforming loans that we are originating has increased meaningfully and a reminder a that those loans we book on our balance sheet. So that's NBI when you're booking, when you're selling less loans it's going to affect your NBI income but it's going to come through the NIM on a more annualized basis. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman & CEO [94] +-------------------------------------------------------------------------------- + + + From a broader -- we decide the fees because of the geography and how the accounting works when you put I think 60%, 70% of loans on balance sheet. In terms of overall production we expect to continue to make progress because, and you can see that in the numbers, that we're going to as other people are flattening out we continue to have lots of opportunity with our core of customers. +A set amount of 10 still that are creditworthy in our customer base are still getting a mortgage elsewhere and that's what the team is chipping away at. And it's never going to be the hugest business of Bank of America compared to things like the Merrill Edge business in consumer, the credit card business and consumer. But we expect to get broader market share from each of the segments. + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [95] +-------------------------------------------------------------------------------- + + + I think it's interesting I'm not going to sit here and tell you that it's directly 100% correlated, we've done all the work but we've added sales professionals in our branches. They are focused on originating mortgages that are more prime-oriented. We've got them working with our GWIM specialists. +That client group is generally more prime-oriented and we see progress. We see the prime loans growing. + +-------------------------------------------------------------------------------- +Ken Usdin, Jefferies & Company - Analyst [96] +-------------------------------------------------------------------------------- + + + Thanks, guys. + +-------------------------------------------------------------------------------- +Operator [97] +-------------------------------------------------------------------------------- + + + Brian Foran, Autonomous Research. + +-------------------------------------------------------------------------------- +Brian Foran, Autonomous Research LLP - Analyst [98] +-------------------------------------------------------------------------------- + + + Hi, good morning. I guess on commercial if you could follow up on the ex-energy comments, you know in your experience what are some of the best leading indicators for the commercial credit cycle and what kind of trends have you seen again ex-energy and those leading indicators over the past couple of months that gives you confidence that things are stable? + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [99] +-------------------------------------------------------------------------------- + + + Well, I have to think about that. We spend a lot of time, our credit people do spend a lot of time just combing through that portfolio and looking at cash flows from the Company and making sure we understand the collateral, making sure we fully understand our structures. So I think it's a lot of blocking and tackling and talking to clients and making sure we understand what's going on with their businesses in terms of the energy portfolio. +I would emphasize again that outside of the energy portfolio we are not seeing movement in NPL and criticized assets. Our NPLs continue to come down. + +-------------------------------------------------------------------------------- +Brian Foran, Autonomous Research LLP - Analyst [100] +-------------------------------------------------------------------------------- + + + And then if I could ask a follow-up along the same lines on the consumer side. I just two parts, one you made the point that even in energy-heavy geographies you're not seeing any adverse change in the consumer. +In part specifically just since it's such a big credit line are early delinquencies still coming in better-than-expected or are they stable or how would you characterize the current early delinquency trends? And then on home equity since again that's another big outsized portion of the reserve is there any update you can give us on how the first wave of HELOC recasts or switches to amortization schedules have performed versus what you had modeled? + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [101] +-------------------------------------------------------------------------------- + + + Sure. So in terms of card when we look at our credit losses they are at low points, historic low points and they've been bumping around at that level. We've seen a little bit of increase the last couple of quarters but that again I think is just a reflection of things just bumping around at really low levels. +In terms of the home equity and of draw based on the volume we've seen to date which we've seen a lot of volume the portfolio is performing in line with our expectations. And we continue to monitor the end of draw portfolio and continue to work with our customers to manage the risk. +I just would remind everybody that these borrowers have paid through the downturn and this portfolio continues to improve as home prices improved. The risk is an ongoing part of our reserve process and we think we're well-reserved. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman & CEO [102] +-------------------------------------------------------------------------------- + + + Just on card and those 30 days delinquency or 90 they came down during the course of from the end of 2014 all the way through 2015 and in both cases is running at multiple-year lows in both percentage-wise and nominal amounts. So we're seeing no deterioration of credit in either of those, and the same with the home equities. It's just in home equities just have a little more cleanup because of the legacy portfolio in there. + +-------------------------------------------------------------------------------- +Operator [103] +-------------------------------------------------------------------------------- + + + Brennan Hawken, UBS. + +-------------------------------------------------------------------------------- +Operator [104] +-------------------------------------------------------------------------------- + + + And pardon the interruption. We lost Mr. Hawken. +(Operator Instructions) Mike Mayo, CLSA. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA - Analyst [105] +-------------------------------------------------------------------------------- + + + Hi, I have one question for Paul, one for Brian. Paul, lower energy prices you said can help certain segments such as consumers. +Can you give any examples of that? And also on the energy topic, if oil stays at $30 then your provisions for energy would go up by how much? I didn't understand the answer from before. + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [106] +-------------------------------------------------------------------------------- + + + Oil, let me take the last one first. So we've got a reserve on our energy portfolio of $500 million. That is 6% of those two subsectors that we think are high-risk and we have done modeling stress test modeling at various oil prices. +The one we've been talking about on this call has been at $30 and that's over nine quarters. And so if oil stayed at $30 for nine quarters we would think that our losses over those nine quarters would be $700 million. +Again that would go against the $500 million we already have reserved. And one would presume we would be building reserves during that time period to make up the difference. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman & CEO [107] +-------------------------------------------------------------------------------- + + + So Mike, when you look at consumer benefits from the oil and gas just to give you a simple thing, if you look at our card base in the fourth quarter of 2015 the spending on debit and credit cards rose 4% from the fourth quarter of 2014. And if gas prices would have been stable it would have grown at 5.7%. +So what that means is consumers had effectively on that base of 1.7% that they received the benefit of year over year. If you translate that to dollars round numbers that's $20 million a day of less spending on gasoline by our consumers in our portfolios per day and from like $90 million down to $70 million-ish or something like that. +That is the benefit they get. So for a large number of consumers median income the cash flow increases and that gives them more money to spend. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA - Analyst [108] +-------------------------------------------------------------------------------- + + + Do you think people are being too negative on the decline in oil prices? You're implying it has a nice stimulative effect. But people sure aren't thinking that these days. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman & CEO [109] +-------------------------------------------------------------------------------- + + + I think Mike it comes down to the question of whether you think this is a (inaudible) price is a reflection of our broader issue of growth in the economies or we're going to get slow growth 2.5% in the US and I guess 3.5% in the world. If you're going to get that in 2016 it's going to be isolated, the negative is going to be isolated to the oil companies and related commodity producers just because of a slow growth environment. +If you're saying there's going to be a much different economic scenario than so-called consensus predicts that's a broader based problem. But right now it's really an oversupply of oil driving prices down and that's impacting the people in the industry. And the rest of the consumers, I mean corporate customers and consumers that use oil and energy are getting a good benefit. + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [110] +-------------------------------------------------------------------------------- + + + And Mike, the only thing I would say, Brian is spot on, if it's a demand issue we're going to see it in other parts of the economy. However, we have not seen that yet. We have not seen a change in our asset quality outside of energy. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA - Analyst [111] +-------------------------------------------------------------------------------- + + + And then if I can shift gears, Brian, I know I've asked this question in other years but I know you're not satisfied with the mid-60s core efficiency ratio and I know you're not satisfied with a single-digit ROE. So what is your specific financial target for efficiency in ROE and what is your timeframe to get there? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman & CEO [112] +-------------------------------------------------------------------------------- + + + As we've said we've ran about 9, adjusting for everything about 9.5 for the year. And return on tangible common equity we believe we have a path to get that to 12. Rates get us part of it and hard work on expenses and core revenue growth and driving gets us the rest of it and so an LAS expense drop-in. +We're chipping away at that and if you look from 2014 to 2015 we made a substantial step and we'll continue to drive away. We haven't put a specific timeframe on it. It's just a goal to keep driving and we'll drive beyond that. +On the efficiency it follows that as efficiency it follows that sort of map that right now we're operating 66%, 67%, 67% probably normalized for 2015. And between LAS we can drop that down to 65% and that's just hard work and we're grinding away at it every day. You're seeing loans grow, you're seeing deposits grow and so you should see an improvement in 2016. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA - Analyst [113] +-------------------------------------------------------------------------------- + + + Any expense initiative plan, Paul, since you've had a couple of quarters now to take a look at that? Are we looking for like an extra $1 billion or I know kind of like a new BAC program or what are you thinking about there? + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [114] +-------------------------------------------------------------------------------- + + + Expenses are on our mind every day at Bank of America. We have everybody focused on expense discipline. That's translating through our culture under our simplify and improve program where the teams are always coming up with ideas to make it simpler for our customers, make it simpler for our employees and improve the expenses of the Company. +That's how we're going to achieve our objectives around core expenses that we've talked about on this call. We're all very focused on expenses. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA - Analyst [115] +-------------------------------------------------------------------------------- + + + All right. Thank you. + +-------------------------------------------------------------------------------- +Operator [116] +-------------------------------------------------------------------------------- + + + It appears that we have no further questions at this time. I would like to return the program back to our hosts for any concluding remarks. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman & CEO [117] +-------------------------------------------------------------------------------- + + + Thank you, everyone. We look forward to talk to you next quarter. + +-------------------------------------------------------------------------------- +Operator [118] +-------------------------------------------------------------------------------- + + + This does conclude today's program. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/exam/original-files/Problem_1_Sample/2016-Jan-27-FB.OQ-137249190020-Transcript.txt b/exam/original-files/Problem_1_Sample/2016-Jan-27-FB.OQ-137249190020-Transcript.txt new file mode 100644 index 0000000..9beb764 --- /dev/null +++ b/exam/original-files/Problem_1_Sample/2016-Jan-27-FB.OQ-137249190020-Transcript.txt @@ -0,0 +1,516 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q4 2015 Facebook Inc Earnings Call +01/27/2016 05:00 PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Deborah Crawford + Facebook, Inc. - Director IR + * Dave Wehner + Facebook, Inc. - CFO + * Mark Zuckerberg + Facebook, Inc. - CEO + * Sheryl Sandberg + Facebook, Inc. - COO + +================================================================================ +Conference Call Participiants +================================================================================ + + * Carlos Kirjner + Bernstein - Analyst + * Justin Post + BofA Merrill Lynch - Analyst + * Paul Vogel + Barclays Capital - Analyst + * Heather Bellini + Goldman Sachs - Analyst + * Mark Mahaney + RBC Capital Markets - Analyst + * Brian Nowak + Morgan Stanley - Analyst + * Eric Sheridan + UBS - Analyst + * Douglas Anmuth + JPMorgan - Analyst + * Michael Nathanson + Moffett Nathanson - Analyst + * John Blackledge + Cowen and Company - Analyst + * Ben Schachter + Macquarie Research - Analyst + * Anthony DiClemente + Nomura Securities Intl - Analyst + +================================================================================ +Presentation +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Good afternoon. My name is Chris, and I'll be your conference operator today. At this time, I would like to welcome everyone to the Facebook fourth-quarter and full-year 2015 earnings call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. +(Operator Instructions) +This call will be recorded. Thank you very much. Ms. Deborah Crawford, Facebook's Vice President of Investor Relations, you may begin. + +-------------------------------------------------------------------------------- +Deborah Crawford, Facebook, Inc. - Director IR [2] +-------------------------------------------------------------------------------- + + Thank you. Good afternoon, and welcome to Facebook's fourth-quarter and full-year 2015 earnings conference call. Joining me today to discuss our results are Mark Zuckerberg, CEO, Sheryl Sandberg, COO, and Dave Wehner, CFO. +Before we get started, I would like to take this opportunity to remind you that our remarks today will include forward-looking statements. Actual results may differ materially from those contemplated by these forward-looking statements. Factors that could cause these results to differ materially are set forth in today's press release, our annual report on Form 10-K, and our most recent quarterly report on Form 10-Q filed with the SEC. Any forward-looking statements that we make on this call are based on assumptions as of today, and we undertake no obligation to update these statements as a result of new information or future events. +During this call, we may present both GAAP and non-GAAP financial measures. A reconciliation of GAAP to non-GAAP measures is included in today's earnings press release. The press release and an accompanying investor presentation are available on our website at investor.SB.com. Now, I would like to turn the call over to Mark. + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook, Inc. - CEO [3] +-------------------------------------------------------------------------------- + + Thanks, Deborah. And, thanks, everyone, for joining us today. Overall, Q4 was a strong quarter and a great end to the year. More than 1.59 billion people now use Facebook each month and 1.04 billion every day. Our growth of nearly 200 million people monthly and 148 million people daily this year. More than 1.44 billion people use Facebook on mobile devices. +And, when it comes to our business, we're also pleased with our continued growth. Total revenue grew by 52% year-over-year to more than $5.8 billion, and advertising revenues grew by 57% to reach more than $5.6 billion. But, it's important to consider not just our business results, but also how we're improving the lives of people and communities around the world. +Next week, Facebook celebrates its 12th birthday, and as I think about our progress and where we go from here, I have reflected on the diverse global moments that Facebook was involved in in 2015. More than 950 million people received a notification that a friend or a loved one was safe in a crisis. Millions of people supported the people of Nepal after the earthquake and the people of France after the Paris attacks. More than 8 million people used 35,000 groups and pages on Facebook to support refugees. And, people from all over the world connected around moments from Star Wars to the US presidential election, from the Indian super league to the Cricket World Cup. +Seeing our global community connecting in all of these ways shows the opportunities ahead as we connect the world, but also the challenges. Even as the world has tended towards greater openness over time, in many communities we also see greater fear over what a connected world and more technological progress means for them. +Addressing these concerns is essential for making progress on our mission, and we're going to keep working to give as much voice as we can and advance the benefits of connectivity and bringing the world together. In 2016 and beyond, we're going to continue doing that by serving our community, working to bring connectivity to billions of the people who are not yet connected, and building new technologies that give people more ways to express themselves. +Now, let's talk about how we've continued working to do that, and let's start with how we're improving our existing products and businesses. Our strategy here is to deliver better, more engaging experiences for our community and to give people better tools for sharing different types of content with the different groups of people that they care about. +Video is an important part of the Facebook experience and continuing to invest here is important for allowing people to share and consume some of the most engaging content. We've continued to make progress, and now 100 million hours of video are watched daily on Facebook. We've been testing new experiences, like suggested videos, which enables people to discover more videos they might be interested in. We're also exploring ways to give people a dedicated place on Facebook for when they just want to watch videos. +With other parts of our core, we've continued to focus on improving the performance and quality of our products to better serve different communities on Facebook. And, these efforts are paying off with growth and engagement for different products reaching an impressive scale. +Now, more than 500 million people use events each month, and more than 123 million events were created on Facebook in 2015. For the first time, more than 1 billion people used groups in a single month on Facebook. It's inspiring to see all the different communities using groups from the small family and classroom and church groups, to the large ones, like the running challenge group that I started a few weeks ago that now has about 100,000 members. +To serve our entire global community, we're optimizing our services for people in developing countries. We've improved Facebook Light to offer a better experience in low bandwidth environments, improving load times, and adding features like video. More than 80 million people now use Facebook Light as of December. +And, when it comes to serving businesses, we've continued to focus on creating better ads and tools for our more than 2.5 million active advertisers. More than 50 million small businesses now use pages on Facebook, and people post more than 2.5 billion comments on these pages each month. This is a good example of how the strength and engagement of our community is making Facebook more valuable for businesses every day. And, Sheryl is going to talk more about this in a minute. +Next, let's talk about how we're building our next generation of services. With Instagram, we've continued to drive the shift towards more visual content online. The community continues to grow, and back in September, we announced a new milestone of 400 million monthly actives. +Over the last year as the community has grown, we've focused on building engaging new experiences for the community, including by improving search and by introducing trending content. We've also worked to develop new experiences to give people more options for creating and sharing different types of content. In March, we launched the layout app, allowing people to easily combine images. In October, the team also launched Boomerang, an app for making looping videos which reached number one in the app store in more than 70 countries. +We also introduced a new video channel on Instagram for people to watch moments from big events, like New Year's or the college football championship as they happen. With messenger and WhatsApp, we've continued to make progress with building these into valuable communication services for everyone in the world. +More than 800 million people now use messenger monthly. In 2015, we grew that number by almost 0.25 billion, while also increasing engagement. We continued to give people new ways to communicate by introducing video calling and new options for customizing conversations with fun things like colors and emojis and by using apps through the messenger platform. +We also worked to expand messenger's utility by adding payments, a new way to connect with businesses, and by testing M, a digital assistant powered by AI. In this quarter, we also began testing a transportation platform allowing people to request an Uber ride through messenger. More services will be coming to the platform soon, including airlines. +WhatsApp ended the year with nearly one billion monthly actives. As WhatsApp has grown, we've worked to keep it fast, simple, and reliable. And, we've seen many communities come to depend on this as their main communication service. +To serve these communities well, this month we announced that WhatsApp will now be free to everyone, and we will no longer charge the subscription fees that many people were charged after their first year. We think this is an important step towards creating an even more ubiquitous product without affecting our plans for building WhatsApp into an important business in the coming years. Later this year, we'll be testing new ways for people to use WhatsApp to communicate with businesses and organizations that they want to hear from. +Finally, let's talk about our work on new breakthrough technologies that can help connect more people to the Internet and create transformative new experiences. In 2015, we made significant progress on our efforts to connect more people to the Internet. We've launched the first trials of express Wi-Fi, a product designed to help entrepreneurs bring their communities online. We launched free basics in 33 more countries. And, we've now connected 19 million people. +This year, we expect to hold our first test flight of Aquila, our First Solar-powered aircraft designed to beam internet into communities from the sky. We're also working on new advances in lasers that can transfer large amounts of data faster and more efficiently than anything today. +With our work in AI, we continue to make progress towards a new generation of computers that can see and understand. Over the last year, we've published dozens of research papers including some of the leading work on image recognition and language understanding. +To drive the entire AI community forward, we've also opened source software and a lot of new AI hardware platforms. Achieving the scientific breakthroughs to build AI that makes a dramatic, visible difference in people's lives -- it's going to take a long time. But, already, we're seeing opportunities to serve our community. +We recently built a prototype AI system that combines language and vision comprehension, so you can show it an image that it's never seen before and it can answer questions about that image. And, we've even used AI to help blind people experience their friends' photos and newsfeed by describing the scenes. +With virtual reality, we've reached some important milestones. The Samsung gear VR shipped over the holidays with our Oculus software, and we're pleased with the initial reaction. +This month, we also opened pre-orders for Oculus headsets. This will be the world's best VR experience, and we're excited to begin shipping to people in more than 20 countries before the end of March. More than 100 VR games and experiences are coming to Oculus this year. And, later this year, we'll also be shipping our Oculus touch controllers to get your hands into virtual reality. These controllers will enhance the VR experience and allow people to communicate more naturally in VR through intuitive hand movements and gestures. +This Oculus launch is shaping up to be a big moment for the gaming community. But over the long term, VR has the potential to change the way that we live, work, and communicate as well. The launch is an important step towards the future, and we're really looking forward to seeing how people use it. +So, that's how we've continued to make progress on our strategy. It's been a strong quarter, and we ended 2015 with a great foundation for our efforts going into 2016. Our strategy is working, and we have many more opportunities ahead. So, we're going to continue investing to deliver more great results over the long term. +On a more personal note, over the last few months with the new addition in my family, I've been reflecting a lot on the legacy that we want to pass on to the next generation. I'm excited about our progress and the chance to build something great for the future. If we continue to focus on solving the fundamental challenges facing the world and bringing the world closer together, we can leave a better world for the whole next generation. And, that's what I think about every day as we continue building Facebook. I want to thank everyone in our community, our employees, our shareholders, our partners who are helping us on this journey. Thanks. And, here's Sheryl. + +-------------------------------------------------------------------------------- +Sheryl Sandberg, Facebook, Inc. - COO [4] +-------------------------------------------------------------------------------- + + Thanks, Mark, and hi, everyone. We had a terrific fourth quarter capping off a great 2015. Q4 ad revenue grew 57%, or 66% on a constant currency basis. Mobile ad revenue reached $4.5 billion, up 81% year-over-year, and is now 80% of total ad revenue. +Facebook and Instagram drive business results for our partners, helping move products off shelves, online and off. As a result, we're growing spend from our current clients and attracting new marketers to our platform. +We saw strong growth across all verticals, marketer segments, and regions. We're also pleased with the growth we're seeing in emerging markets in countries like China, where businesses are advertising on Facebook and Instagram to reach people internationally. +We continue to make progress on our three priorities. Capitalizing on the shift to mobile, growing the number of marketers using our ad products, and making our ads more relevant and effective. +First, capitalizing on the shift to mobile. Heading into 2016, it's clear that consumers have shifted to mobile, and businesses know they need to catch up. Marketers now realize that if they want to reach their customers where they are, mobile is essential. Our conversations with clients have shifted from if they should market on mobile to how. +With over 1.44 billion people using Facebook on mobile monthly and over 400 million monthly actives on Instagram, Facebook and Instagram have become the two most important mobile advertising platforms. We provide a creative canvas powered by technology, a unique combination of art and science that marketers can use to deliver great creative with the highest quality targeting at unparalleled scale. +The 2015 holiday season was a defining moment for mobile marketing and demonstrated the power of our mobile platform. According to comScore, total US consumer spending on mobile in November and December was up 59% year-over-year. This holiday season, marketers turned to mobile more than ever before. +To reach a large global audience for the launch of Halo 5, Microsoft Xbox used video optimized for Facebook and Instagram. Working with their agencies and power media team from Dentsu Aegis network, Eisenberg group, and 215 McCann, they understood that people watch video differently in mobile newsfeed than on TV, so they created videos to capture audience attention in the first 3 seconds even without sound. They drove over 380 million impressions and 49 million video views in key markets and increased purchase intent by 10 points in the US. +Our second priority is growing the number of marketers using our ad products. Last quarter, we announced that we had over 2.5 million active advertisers, and since then, our growth has remained strong. This represents a small fraction of the over 50 million small businesses now actively using pages. So, we see a big opportunity to continue to grow the number of Facebook advertisers going forward. +We're also very pleased with the growth in advertiser adoption of Instagram, and the positive results advertisers are seeing from their investments. 98 of the top 100 advertisers on Facebook also advertised on Instagram in Q4. +Our third priority is improving the relevance and effectiveness of our ads. We shipped a lot of new ad products this past year. These products help deliver personalized marketing at scale and drive business for our clients. +Leading up to Black Friday, Shop Direct, the UK's second largest online retailer, teased upcoming sales with a cinemagraph video to build awareness. They then retargeted people who saw the video with one-day-only deals. On Black Friday, they used our carousel and DPA ads to promote products people had shown interest in. They saw a 20 times return on ad spend from this campaign, helping them achieve their biggest Black Friday and their most successful sales day ever. +To share just a few other product examples -- in emerging markets, we launched slide show, a video-like ad experience that works with lower connection speeds and feature [phones]. We introduced local awareness ads globally to help brick-and-mortar businesses reach people near their stores and started testing canvas ads to help marketers showcase their products in a more immersive way. We continue to invest in ad tech and are especially pleased with the growth of audience network. +Measurement also remains a critical area of focus. Our measurement tools like conversion lift and the Facebook pixel prove to marketers that we're driving business results and help make our ads more relevant. This year, we saw more advertisers shift from proxy metrics like clicks to business results, like digital and in-store sales. +Our results show that the investments we've made over the past few years are paying off, and we see a lot of exciting opportunities ahead. We know we still have a lot of hard work to do and heading into the new year, we will remain very focused on our top three priorities. +I want to take this opportunity to thank our clients around the world for their partnership. Your investment and feedback is critical to making our products better. I also really want to thank the global Facebook teams for your extraordinary dedication to our partners' success. Your hard work and execution is critical to helping us to sell our mission. Thanks, everyone. And, now, here's Dave. + +-------------------------------------------------------------------------------- +Dave Wehner, Facebook, Inc. - CFO [5] +-------------------------------------------------------------------------------- + + Thanks, Sheryl, and good afternoon, everyone. Q4 was a strong quarter and wrapped up a phenomenal year for Facebook. Full-year 2015 revenue was $17.9 billion, up 44% year-over-year, or 53% on a constant currency basis. In 2015, we generated over $6 billion in free cash flow, including $2.1 billion in Q4, while continuing to fund important investments for the future growth of the business. +The strong growth and engagement of our community was a consistent theme throughout 2015 and that continued in the fourth quarter. In December, 1.04 billion people used Facebook on an average day, an increase of 17% compared to last year. This daily number represented 65% of the 1.59 billion people who visited Facebook during the month of December. +Mobile continued to drive the growth of our community. In December, 1.44 billion people accessed Facebook on mobile devices, an increase of 21% compared to last year. And, 90% of the people who used Facebook on both a monthly and daily basis accessed us via mobile devices. +Now, turning to the financials. All of our comparisons are on a year-over-year basis unless otherwise noted. Additionally, our non-GAAP measures exclude stock-based compensation and the amortization of intangibles. +In Q4, total revenue was $5.8 billion, up 52%, or 60% on a constant currency basis. Q4 ad revenue was $5.6 billion, up over $2 billion from last year. Year-over-year growth was 57%, or 66% on a constant currency basis. +The strengthening of the US dollar continued to have an unfavorable impact on our revenue in the fourth quarter. Had exchange rates remained constant with Q4 2014 levels, our total revenue would have been approximately $320 million higher. +US and Canada and Asia-Pacific continued to be our two strongest regions, with ad revenue growth of 64% and 57%, respectively. Our rest of world and Europe regions grew at 53% and 45%, respectively, as they were more heavily impacted by currency headwinds. +Mobile ad revenue was $4.5 billion, up 81% from last year, and represented 80% of our advertising revenue. For perspective, three years ago, the mobile percentage was just over 20%. +Q4 capped off a remarkably successful year for our mobile advertising business, where we were able to combine strong growth in ad inventory supply with strong growth in advertiser demand. On the supply side, we grew the number of people using Facebook on mobile, time spent, and ad load. Our ongoing focus on ad quality and relevance enabled us to deliver a better overall mobile ads experience for our users while increasing the number of ads that they see. In Q4, we also benefited to a lesser extent from increases in ad inventory from Instagram and the audience network. +On the demand side, we believe our efforts on targeting and measurement solution enabled marketers to achieve better business results at better values. This helped us drive strong growth from a broad array of advertisers, including direct response in brand advertisers, large companies and SMBs, and both existing and new advertisers. +Turning now to the overall price [volume metrics]. In Q4, the average price per ad increased 21%, while total ad impressions increased 29% on a year-over-year basis. It's worth noting that this was the first quarter since Q3 2013 that total ad impressions increased on a year-over-year basis. This was driven by an increase in mobile ad impressions and was partially offset by a decline in ad impressions delivered on personal computers, consistent with the ongoing declines in PC usage. +The reported increase in price is being driven by the continued mix shift towards mobile, which contains higher-priced newsfeed ads, rather than the mix we have on PCs, of both newsfeed ads and lower-priced right-hand column ads. Total payments and other fees revenue was $204 million, down 21% compared to last year. The decline was driven by a reduction in payments revenue related to games played on personal computers. +Turning now to expenses. Q4 total GAAP expenses were $3.3 billion, up 21%, and non-GAAP expenses were $2.3 billion, up 42%. Our year-over-year GAAP expense growth rates slowed this quarter, as we lapped the introduction of stock-based compensation charges associated with the WhatsApp transaction. Non-GAAP expenses were driven by increases in head count-related costs, cost of revenue, and marketing expenses. We ended the year with nearly 12,700 employees, up 38% compared to last year. +Our GAAP operating margin was -- I'm sorry. GAAP operating income was approximately $2.6 billion, representing a 44% operating margin. Our non-GAAP operating income was $3.5 billion, representing a 60% operating margin. Our Q4 GAAP and non-GAAP tax rates were 39% and 36%, respectively. +Our Q4 GAAP net income was approximately $1.6 billion, or $0.54 per share, and our non-GAAP net income was $2.3 billion, or $0.79 per share. In the full-year 2015, capital expenditures were $2.5 billion, as we continued to invest in servers, data centers, network infrastructure, and office facilities to support the rapid growth of the business. We ended the year with over $18.4 billion in cash and investments. +Turning now to the outlook. First, some color on revenue. We expect the factors that drove the strong growth of our advertising business in 2015 will continue into 2016. However, we expect to continue to face foreign exchange headwinds, especially early in the year, as we will be lapping periods where the dollar was relatively weaker than it is today. +More importantly -- sorry. More broadly, the overall macro environment introduces a level of uncertainty around global growth and exchange rates that could impact our business in 2016. And, we do expect to face tougher comparables as the year progresses, given the remarkably strong advertising performance in 2015. +Turning now to expense guidance. 2016 will be another significant investment year for Facebook. In 2015, we continued investing heavily in the core. At the same time, we doubled our investment levels in our next generation services, which includes WhatsApp, Instagram, and messenger, and we tripled our investment levels in our long-term areas of focus, which includes our connectivity efforts, Oculus, and our AI investments. We will continue investing significantly in all of these areas in 2016. +We expect the year-over-year growth rate for full-year 2016 total GAAP expenses to be approximately 30% to 40%, and for full-year 2016 total non-GAAP expenses to be approximately 45% to 55%. Note these ranges represent total operating expenses, including cost of revenue. These ranges also include the cost of revenue impact of the expected shipments of Oculus Rift that we expect that impact to be immaterial to our overall total expenses for the year. +We anticipate our 2016 capital expenditures will be in the range of $4 billion to $4.5 billion. We recently announced that we will begin building a new data center in Clonee, Ireland, and that project is on top of the new data center being built in Fort Worth, Texas. We expect our 2016 stock-based compensation to be in the range of $3.1 billion to $3.3 billion, approximately 50% of which is related to our prior acquisitions, most notably WhatsApp. We expect 2016 amortization expenses to be approximately $700 million to $800 million. +And, lastly, we anticipate that our Q1 and full-year 2016 GAAP and non-GAAP tax rates to be in the low 30% on a percentage basis, down from our 2015 rates. We expect our tax rates will decline further over time and resemble those of our global peers over the next several years. In addition, in 2016, we expect for the first time to pay a significant amount of US income tax on a cash basis. +To conclude, 2015 was an outstanding year for Facebook. Our performance reflects the strong growth and engagement of our community, the momentum we're seeing in our ads business, and the significant progress we're making on our mission to connect the world. With that, Chris, we would like to open up the call for questions. + + +================================================================================ +Questions and Answers +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) +Your first question comes from the line of Douglas Anmuth with JPMorgan. Your line is open. + +-------------------------------------------------------------------------------- +Douglas Anmuth, JPMorgan - Analyst [2] +-------------------------------------------------------------------------------- + + Thanks for taking my question. Two things I wanted to ask. First, Mark, on messenger and WhatsApp, can you talk more about the takeaway on the messenger platform now that it's been open for nearly a year to developers, and how that's informed your view on what you're going to do with WhatsApp going forward? +Then, secondly, perhaps Dave or Sheryl, on the ad load, a few years ago you had talked about ad load at mid-single-digit levels and then more recently as up significantly since then. Do you still feel like there is still significant room to increase ad load here? And, how do you think about the theoretical ceiling there? Thanks. + +-------------------------------------------------------------------------------- +Dave Wehner, Facebook, Inc. - CFO [3] +-------------------------------------------------------------------------------- + + I can start with the ad load question, Doug. So, ad load is definitely up significantly from where we were a couple of years ago. And, as I mentioned, it's one of the factors driving an increase in inventory. Really, one thing to think about here is that improving the quality and the relevance of the ads has enabled us to show more of them, without harming the experience. And, our focus really remains on the experience. So, we'll continue to monitor engagement and sentiment very carefully. I mentioned that we expect the factors that drove the performance in 2015 to continue to drive the performance in 2016. So, yes, I think that's the color I can give on ad load. + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook, Inc. - CEO [4] +-------------------------------------------------------------------------------- + + On messenger, the platform efforts in 2015 focused on two things. One was expanding the different types of content that people can share in messenger. And, that diversity is going really well. We see continued increase in video sharing and photos and stickers and a lot of stuff that you would just call fun, but that people really enjoy as different ways to express themselves. +But, in terms of the business, the more important piece is how people can interact with businesses through messenger. And, we started some early small tests around F8 last year, where with some eCommerce services made it so that people who were buying things could follow up with the business and get customer support and buy more things, and we went through this process of integrating that and making sure that it integrated with all of these systems well. And, I think everyone is really happy with that so far. We started off pretty slowly, but that's going to be some of the basis for how we look to make messenger a business going forward. We're happy with the initial results. There's obviously a lot more there that we need to do, and we'll have more to talk about this year and beyond. + +-------------------------------------------------------------------------------- +Operator [5] +-------------------------------------------------------------------------------- + + The next question is from John Blackledge with Cowen and Company. Your line is open. + +-------------------------------------------------------------------------------- +John Blackledge, Cowen and Company - Analyst [6] +-------------------------------------------------------------------------------- + + Great, thanks. So, it was a phenomenal quarter and year for Facebook. And, given we're about a month into 2016, there's a lot of discussion around the global macro headwinds. Just wondering how the business is trending thus far in the quarter? Maybe by market, US, Europe, Asia-Pac and rest of world. And, generally, just how Facebook is positioned if the global macro environment softens a bit. Thank you. + +-------------------------------------------------------------------------------- +Dave Wehner, Facebook, Inc. - CFO [7] +-------------------------------------------------------------------------------- + + John, it's Dave. Just on that question, we're not commenting specifically on Q1. We didn't see anything in Q4 that indicated broad-based macro weakness, beyond, of course, the impact that FX was having, which was pretty significant. We saw the impact in places like Brazil where you've got a currency headwind of over 30%. So, you're certainly seeing that impact it. And, obviously, those sort of global macroeconomic and currency factors will continue to impact us. +We're obviously benefiting from a strong secular shift to usage of mobile, and we feel we're very well positioned in that. We're seeing more and more advertisers move to mobile. They realize that it's no longer a question of whether they need to be on mobile, but it's really how they are going to be on mobile. And, we think we've got the best solution for that, and we're investing to make it even better. So, I think from a secular trend point of view, we're very well positioned. But, obviously, we'll continue to monitor the macro conditions in currency. + +-------------------------------------------------------------------------------- +Operator [8] +-------------------------------------------------------------------------------- + + The next question is from Eric Sheridan with UBS. Your line is open. + +-------------------------------------------------------------------------------- +Eric Sheridan, UBS - Analyst [9] +-------------------------------------------------------------------------------- + + Thanks for taking the question. Maybe just asking for more color on Instagram. It's obviously still very early days on Instagram, but what are you seeing in terms of user engagement as you continue to move ad load up on the product? What advertiser adoption of the product is? I know you gave us a little bit of color during the prepared comments. And also, pricing on the environment inside the platform as you continue to roll out deeper with the advertising products. Thank you so much. + +-------------------------------------------------------------------------------- +Sheryl Sandberg, Facebook, Inc. - COO [10] +-------------------------------------------------------------------------------- + + When we introduce ads into feed and continue to increase the ad load, we monitor really carefully. We're looking at user engagement on the platform. We also look at the quality of ads. And, our basic belief is that if we have high-quality ads, those create a good consumer experience, and we can look at what consumers are doing because we can understand how actively engaged they are on the platform. +For Instagram, we don't break out revenue. Instagram -- and we're pleased with the growth on Instagram. And, as I mentioned, 98 of our top 100 advertisers on Facebook are now advertising on Instagram. It's also the case that Facebook had remarkably strong growth as well. So, we're seeing strong growth across those platforms. I think what's exciting about both platforms is that they combine the art and the science of both a creative canvas that marketers are excited about and targeting. So, to share another example from the holiday, Shutterfly did a Facebook and Instagram -- both a brand and direct response holiday campaign on mobile. And, what they did was just beautiful pictures, but also targeting very specifically to women with specific interests, such as things like weddings and babies. They saw a 6.4 times return on ad spend. We think that's what's possible when you combine the creative canvas we have, using the technology and using the platform that we've created. + +-------------------------------------------------------------------------------- +Operator [11] +-------------------------------------------------------------------------------- + + The next question is from Heather Bellini with Goldman Sachs. Your line is open. + +-------------------------------------------------------------------------------- +Heather Bellini, Goldman Sachs - Analyst [12] +-------------------------------------------------------------------------------- + + I just had two quick questions. One, Sheryl, I just wanted to follow up on what you said about Facebook and Instagram and the overlap in the advertisers. And, I was wondering if you could share with us how you feel those advertisers view it? Do they view it as an incremental platform? Or, there's been some question about whether or not some advertisers might take their spending and just move it over to Instagram. I'm wondering if you see incremental spending as a result of opening up both platforms? +And then, the second question would just be to Mark. Just was wondering, I know you've mentioned Oculus and the pre-orders. I was just wondering if you could give us your take on whether or not you're happy with the initial launch of Oculus pre-orders? And also, we obviously all know the big gaming impact. I'm just wondering from your perspective, as you look out, what industries do you think where this could be the most disruptive, outside of gaming? Thank you. + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook, Inc. - CEO [13] +-------------------------------------------------------------------------------- + + I'll take the Oculus one first. Yes, I am happy. I don't show much joy, but I'm happy. Sorry. It's going to be gaming for the beginning. That's the initial market. There are about -- I think it's around 250 million people who have Xboxes, PlayStations, or Wiis. That's the initial market of folks who we think are going to be most interested in the early VR experiences, especially at some of the higher price points. But, overall, the reason why we're interested in this as a social company is that we think that this is going to be a new way that people interact, right? And, if you've tried out the toy box demo with the hands, Oculus Touch, what you see is when you're in virtual reality with another person and you can interact with the environment and use your hands, you can -- it's not just about where you are and the fact that you can instantaneously teleport to another place. You can interact with people in all of these different ways that would be very difficult in the rest of the world. So, we're very excited about that. That's going to be a big area of investment for us, and is ultimately, I think, going to change the way that we communicate and live and work in addition to how we play games. But, I think we're off to a good start. + +-------------------------------------------------------------------------------- +Sheryl Sandberg, Facebook, Inc. - COO [14] +-------------------------------------------------------------------------------- + + On the Instagram question. Certainly in the short run, some of the spend is incremental, and some of it isn't. Some of our clients approach this where they have a social budget or a Facebook budget, and some of that moves to Instagram. And, some people, it's incremental spend. +In the medium to long run, however, we believe that we are really well positioned to take share from other platforms out there. We believe both Facebook and Instagram have this combination of an ability to do great creative with the best targeting and the most sophisticated measurement, which shows businesses how we help them move products off shelves. And, we want -- and we tell our clients we want to be the best dollar, the best euro, the best pound, and the best minute you spend. We really encourage them to measure their ROI and compare us to other platforms. We think that comparison bodes very well for our growth. +We also think the continued consumer shift to mobile devices bodes well for our growth as well. That said, we have to continue to execute. We know this won't be easy. We have to continue to build the right products. We have to continue to measure all the way through from seeing an ad impression to sale. So, it's up to us to stay focused in the coming year and years. + +-------------------------------------------------------------------------------- +Operator [15] +-------------------------------------------------------------------------------- + + The next question is from Ben Schachter with Macquarie. Your line is open. + +-------------------------------------------------------------------------------- +Ben Schachter, Macquarie Research - Analyst [16] +-------------------------------------------------------------------------------- + + Congratulations on a great year. You've had a lot of success with standalone apps. Should we expect to see you launching more such apps? And, could a standalone video app be a part of that, particularly for people who want to just watch video. +On the virtual reality, another question. Can you just discuss the supply constraints in terms of how many units you can ship per month? And, should we expect those shipments to accelerate into the holiday? Then, also related to that, how are you going to work with retailers to show consumers the power of Oculus in-store and in person? Thanks. + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook, Inc. - CEO [17] +-------------------------------------------------------------------------------- + + So, on the apps question, the ones that have done the best are things that augment the core Facebook functionality for large subsets of the community. For example, we have this pages manager app. There are 50 million businesses that have pages on Facebook, and while that is not a huge number compared to the size of the overall community of people, it's a very large number of people and businesses. And, giving a focused experience for the person who wants to run their business through Facebook and be communicating with their customers all day long, that's just proven to be an incredibly engaging experience that drives content into the system and is good overall. We have introduced a number of things like that for public figures, for groups. Messenger has probably been the most successful as something that's connected to the Facebook experience that now has more than 800 million people using it. So, I do think that there are additional opportunities for this. And, we'll continue looking at them. + +-------------------------------------------------------------------------------- +Dave Wehner, Facebook, Inc. - CFO [18] +-------------------------------------------------------------------------------- + + So, Ben, just following up on VR and supply constraints. We have two products -- the [you've got gear] VR, and Samsung is really handling all of that from a hardware perspective, and obviously, they are well prepared on that front. With rift, it's really -- it's early in the evolution of VR. It's early to be talking about large volume, so at this point, I don't think we're giving a lot of color around supply chain and that sort of thing. It's not going to be material to our financials this year. + +-------------------------------------------------------------------------------- +Operator [19] +-------------------------------------------------------------------------------- + + The next question is from Brian Nowak with Morgan Stanley. Your line is open. + +-------------------------------------------------------------------------------- +Brian Nowak, Morgan Stanley - Analyst [20] +-------------------------------------------------------------------------------- + + Thanks for taking my questions. I have two. The first one is to go back to some of the core Facebook advertising success. I wonder if you could talk about some of the Facebook video ad learnings and kind of positives that you've encountered and hurdles that you still encounter that could be holding back advertisers from moving further video budgets out of the platform. +And then, the second one, we always see this gap between Asia and rest of world monetization versus North America and Europe. I was wondering if you could talk through some strategies and qualitative drivers you see over the next couple of years that are going to increase the overall Asia and rest-of-world monetization even further. Thanks. + +-------------------------------------------------------------------------------- +Sheryl Sandberg, Facebook, Inc. - COO [21] +-------------------------------------------------------------------------------- + + I think our approach in increasing monetization around the world is really the same. We need to build really compelling ad products with great formats that let marketers be creative and be convincing. I'll share an example of something we did for an emerging market. I mentioned briefly in my remarks slide show. The slide show product is enabled a video-like experience with phones with lower connection speeds than feature phones by a series of photos. So, Coca-Cola used that in Kenya and Nigeria. They took screen shots of a video ad they had produced for other markets. They uploaded them with texts. They reached 2 million people with a 10-point lift in ad awareness. The way we need to drive sales around the world is by understanding markets, launching things like click to missed call ads in India and making sure our products work for markets, but also being able to connect to both advertising metrics and business metrics around the world. +Video ads are important on our platform and the most important thing that's growing well there is consumer engagement with videos growing. We have 500 million people watching video a day. And, the fact that so much video is being consumed on our platform gives us room for an ads business to grow because we want the formats to match. Marketers also really love video, and it's a really compelling way to reach people. +And, videos contributing to our growth -- it's important to note that it's not just large brand advertisers that are doing video, but all of our market segments. Direct response, [SMBs] who have uploaded 1.5 million videos, and that's both organic and paid in the last month, and developers. The video ad spend is not all incremental, of course, because every time we put an ad in a newsfeed, if it's a video ad, it's taking the place of an ad with another format. +In terms of learnings, one of the most important learnings we have is that video formats are different on Facebook. There are certainly people that are watching the whole 30-second video ad with sound, but there are some people that are doing less. They are watching shorter formats, and they are watching with sound. And, one of the challenges we have in the market is convincing marketers and agencies and people that make the video to experiment with different formats. +The good news is that we're getting great results, like the Halo 5 example I shared in my remarks. That when people are willing to experiment, this is a pretty unique, creative canvas. You can do short form with sound off. You can do longer form with sound on, and everything in between. And, our ability to persuade marketers to experiment is going to be a major driver of how much we can do here. + +-------------------------------------------------------------------------------- +Operator [22] +-------------------------------------------------------------------------------- + + The next question is from Justin Post with Bank of America Merrill Lynch. Your line is open. + +-------------------------------------------------------------------------------- +Justin Post, BofA Merrill Lynch - Analyst [23] +-------------------------------------------------------------------------------- + + Thanks. I'll ask a couple of longer-term questions. First, I know a year ago you gave us a usage update on time spent. Wondering if video or any other products are having a big impact on usage? And, if you can give us any metrics there. +And then, maybe one for Sheryl, we have you at 8% of all media time spent. Just wondering if you think Facebook could monetize better than other forms of media based on time spent or maybe a little bit below? +And then, maybe one for Dave. 60% margins last quarter, obviously very strong. Just wondering, what you think about the long term, and any comments on long-term margins. Thank you. + +-------------------------------------------------------------------------------- +Sheryl Sandberg, Facebook, Inc. - COO [24] +-------------------------------------------------------------------------------- + + In terms of monetizing time spent, it's certainly the case that consumers have shifted to mobile, and businesses need to catch up. The exact percentage we can monetize that, we'll see. But, we certainly think that we will continue to benefit from the consumer shift to mobile because businesses are behind. If you ask even our largest clients, our largest clients if they drew a pie chart of where their consumers spend their time and money and [whether] they spend their time and money, we are still underindexed. +That said, I'll say it again, we have a lot of hard work to do. We really need to prove to clients, particularly as they scale and we become a bigger part of their spend, that we're driving results. Other platforms, other forms of advertising, like TV and other, have very established metrics that people have believed for a very long time. We think our targeting can be better than any other platform. We also believe our ability to measure results can be deeper. But, it's up to us to prove that and to prove that client-to-client. +It's also worth noting that we work really well with TV. It's not always a choice of TV or Facebook, but often, we can be a complement. We've done a bunch of work with Nielsen to measure what happens when marketers do big TV campaigns and do campaigns that are broadly targeted on Facebook. And, we are able to increase the reach and increase brand favorability. So for the most part, when people are doing big campaigns, they are doing them across multiple platforms, and we think that will continue. + +-------------------------------------------------------------------------------- +Dave Wehner, Facebook, Inc. - CFO [25] +-------------------------------------------------------------------------------- + + Justin, on time spent, there's no question that video is helping us on time spent and engagement. We're not -- you won't have any specific stats other than the hours per day -- sorry, time spent per day that Mark mentioned on video. So, no updates on stats there other than that. +In terms of our long-term margins, we're not managing the business to a specific margin target in any year. We still think we're early in investing in the business. And, we're really investing in new areas today where we see a long-term opportunity for revenue growth. That being said, there -- we do think there's a lot of margin potential in this business, given the focus on advertising. But, no target at this point. + +-------------------------------------------------------------------------------- +Operator [26] +-------------------------------------------------------------------------------- + + The next question is from Anthony DiClemente with Nomura. Your line is open. + +-------------------------------------------------------------------------------- +Anthony DiClemente, Nomura Securities Intl - Analyst [27] +-------------------------------------------------------------------------------- + + Thanks for the questions, and good afternoon. Just for Mark or Sheryl, wondering what is your strategy for professional video content going forward? You talked a lot about video. Would bringing more professional content to Facebook accelerate video engagement and adoption? +And then, for Dave, just kind of back to the quarter. You don't break out Instagram revenue or financials, but wondering if the acceleration in the quarter -- would you say was that driven more by the step-up in Instagram given the opening up of the API, the incremental Instagram ad load? Or, was there a commensurate acceleration in the core Facebook revenue? Thanks. + +-------------------------------------------------------------------------------- +Sheryl Sandberg, Facebook, Inc. - COO [28] +-------------------------------------------------------------------------------- + + In terms of video content, newsfeed is as interesting as the quality of the content in it. What we're seeing is that users are generating a lot of really high-quality content, often pretty short form that people are really happy to consume. And, we believe that trend will continue because we're at the very beginning with people really understanding the power of the smartphones that a lot of people are walking around with, particularly in developed markets. +We are working with publishers to try to make the content experience better inside of newsfeed. The best example of that is probably news with instant articles where we figured out that it was the slowest upload experience you could have in newsfeed to link off to an outside articles. So, we've worked with publishers to upload more news articles natively to Facebook, and we're seeing great engagement from that. +Similarly, we've had conversations with makers of premium content. I think they are excited by the work they already do with us to use Facebook to distribute their content. And, we're interested in doing more. It's probably worth noting that much of the engagement and consumption we have is short form, not long form. + +-------------------------------------------------------------------------------- +Dave Wehner, Facebook, Inc. - CFO [29] +-------------------------------------------------------------------------------- + + Anthony, it's Dave. Instagram -- we're certainly very pleased with the performance of Instagram, and it's certainly made a contribution this quarter. Make no mistake, core Facebook is really driving the top line. We're very pleased with the strong performance that we had with Facebook itself in the quarter. + +-------------------------------------------------------------------------------- +Operator [30] +-------------------------------------------------------------------------------- + + The next question is from Carlos Kirjner with Bernstein. Your line is open. + +-------------------------------------------------------------------------------- +Carlos Kirjner, Bernstein - Analyst [31] +-------------------------------------------------------------------------------- + + I have two quick questions. I am interested in the plans to allow users to do other things beyond liking content. I think you call it reactions. I call it adding more words to the Facebook graph. Can you talk about the rollout of this capability? And, whether this is something that you only see at Facebook.com? Or, whether it's going to be widespread across the web and other sites, much like the like button. +And, secondly, can you talk about your thinking of the role of different Facebook platforms in payments? Are there things that you will not do because you don't have or do not want to acquire these [key one] assets? What's the boundary for what you could do with payments? Thank you. + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook, Inc. - CEO [32] +-------------------------------------------------------------------------------- + + Sure. So, reactions is going to roll out on every platform. We're testing it in a handful of countries to start, just to make sure that we have the UI and interaction simple enough that people could express more of what they wanted without getting in their way. It is adding a little bit of complexity to something that is very simple today, just a one-tap like button. +But, the philosophy behind it is that when you only have a like button, if you share a sad piece of content or something that makes you angry, people may not have the tool to react to it and therefore over time the community feels less comfortable sharing that kind of content on Facebook. And, we want people to be able to share all of the things that are meaningful to them, not just the things that are happy and that people are going to like when they see it. We think that that's just really important to the mission of the Company and will increase engagement and sharing and openness and all of the things that we care about. And, so far, I think there are a few tweaks that we needed to make to reactions since initially testing it, but it's going well. I think we plan to roll it out everywhere pretty soon. So, that's the game plan there. +On payments, the basic strategy that we have is to make it, especially in products like messenger, that where the business interaction may be a bit more transactional, to take all the friction out of making the transactions that you need. So, we don't view ourselves as a payments business. That's not the type of Company that we are. We'll partner with everyone who does payments. We look at the stuff that Apple is doing with Apple Pay, for example, which is a really neat innovation in the space that takes a lot of friction out of transactions as well. And, our view is that the less friction, the better the user experience. The more people can easily interact with the businesses that they care about. Ultimately for our business, that will drive up the amount that businesses are willing to pay to advertise to send people into those kind of interactions because they perform well. So, it's good for everyone, but that's kind of how we think about that. + +-------------------------------------------------------------------------------- +Operator [33] +-------------------------------------------------------------------------------- + + The next question is from Michael Nathanson with Moffett Nathanson. Your line is open. + +-------------------------------------------------------------------------------- +Michael Nathanson, Moffett Nathanson - Analyst [34] +-------------------------------------------------------------------------------- + + Thanks. I have two. Following on Mark's answer to the question about payments. I wondered, Sheryl, if you look at the fourth quarter as you said as a defining moment for marketers and with the friction of transactions getting easier, was there any type of shift in the marketers or verticals that moved money to Facebook in the quarter? Do you see more retail, let's say, or anything different in terms of the composition of who was buying in the fourth quarter? + +-------------------------------------------------------------------------------- +Sheryl Sandberg, Facebook, Inc. - COO [35] +-------------------------------------------------------------------------------- + + Fourth quarter is a holiday quarter, so our top verticals were eCommerce, CPG, and retail. Our growth is really broad-based. And, I think it really shows how important the targeting can be. What we've definitely done over the last year and plan to invest even more in over the next year is worked hard on vertical-specific targeting. So, for example, for the telecom industry, being able to target existing consumers with new consumers with people who are -- their voice plan or data plan is about to expire. With the auto industry, really important industry for growth for us, helping them figure out who their current customers are, who their potential customers are, and where are the audience segments out there who have similar likes, interests, backgrounds, demographics to their current customers so that they can serve the right ad to the right people. The kind of things we're able to do with targeting and measurement apply across industries and obviously have to be industry and vertical-specific, and we're working hard at that. + +-------------------------------------------------------------------------------- +Operator [36] +-------------------------------------------------------------------------------- + + The next question is from Mark Mahaney with RBC Capital Markets. Your line is open. + +-------------------------------------------------------------------------------- +Mark Mahaney, RBC Capital Markets - Analyst [37] +-------------------------------------------------------------------------------- + + Great, thanks. Two questions. Sheryl, could you talk about political advertising? And, how you think about the attractiveness of -- and any anecdotes you have on Facebook as a platform for political campaigns? +And then, Mark, the story is in 2012 at the beginning of that year, you realized just how powerful the movement was towards mobile devices, and you turned to your engineers and said we need to generate $1 billion in revenue off of mobile devices. I wonder if you've had that same conversation with your engineers when you think about these two messaging platforms that you have. They have got a large number of users, and clearly globally, we've seen this massive shift over towards messaging. The Internet has changed, and how people have engaged with it. Do you feel like you had -- or do you need to have that kind of $1 billion conversation with your engineers about those two messaging platforms? Thanks. + +-------------------------------------------------------------------------------- +Sheryl Sandberg, Facebook, Inc. - COO [38] +-------------------------------------------------------------------------------- + + In terms of the elections, it's important to note that we're large and diversified, so no one vertical drives our business. Yes, the 2016 election is a big deal in terms of ad spend. But, so is the World Cup. So, is Super Bowl every year. So are events like the Olympics. +We are excited about the kind of targeting we're able to offer for our ads platform. We believe we have precision that doesn't exist on any other platforms. So, for example, using Facebook and Instagram ads, you can target by congressional district, you can target by interest, you can target by demographics, or any combination of those. And, we're seeing politicians at all levels really take advantage of that targeting. +It's also probably worth saying that we're pretty excited about what's happening with the elections organically on Facebook. Facebook is really the new town hall and connecting the people who are running for office, both at the national and the local level with people directly has been really important. Every member of congress in the United States is now on Facebook. We're seeing some of them post every vote and explain why they are doing votes. We're seeing a bunch of the candidates for president get on Facebook themselves and interact, taking questions from their potential voters directly. And, we think that kind of direct engagement where people can hold their elected officials accountable, and elected officials can speak directly to constituents is a really important part of our mission, and we're excited about the 2016 election and what's happening there. + +-------------------------------------------------------------------------------- +Operator [39] +-------------------------------------------------------------------------------- + + The next question -- . + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook, Inc. - CEO [40] +-------------------------------------------------------------------------------- + + I'll answer the other one. In terms of the story that you said, I think you have it wrong. I don't know where you got that story from. I never had a conversation with the team where we were behind on mobile, and then I said we need to do this to make money. That's not really how we operate. What happened is we realized that mobile was growing faster than desktop and that people were shifting their usage. And, it was the more important thing for people's consumer experience. That's when we made the shift, not in our business first, but in how we developed products. And, I told all of our product teams when they come in for reviews, really just come in with mobile. If you come in and you try to show me a desktop product, then I'm going to kick you out. You have to come in and show me a mobile product. +And that, I think, was just as a crude leadership tactic, somewhat effective in helping to motivate the organization to shift its energy towards focusing on mobile. But, it was -- if you remember, we actually went through a pretty tough period because we went through this period where our mobile experience was not as good as we wanted it to be. And, we had no ads on mobile, and we actually prioritized making the mobile experience good before putting ads in. So, there was a long time where people thought that our business might not be as good because we had no ads on mobile. And, that was because we always prioritized the experience for people above, even if it's going to be a painful thing for the Company. +That's how I think about messaging. We know that messaging is going to be increasingly important. That's why we went out and hired David Marcus, who is one of the best product leaders in the field to run messenger, and why we bought WhatsApp, which is the leading messaging product worldwide. And, we have a formula for how we build these businesses. +First, you build a great consumer experience, right, that helps people share in a new way that's really important. Then, after that, you can start to introduce organic ways that people can interact with businesses. So that -- and Facebook is pages. The businesses that people want to interact with, the public figures, the politicians. Not necessarily ads, but organic interactions around not necessarily just your friends and families, but more public figures and businesses. And then, only once you have that ramped up to a good scale can you really start dialing up advertising, having that feel good and be a good part of the experience with good content because all of those public figures and businesses are already participating in the platform at scale. +So, you can expect to see that playbook in Instagram where we're pretty far along in terms of having quite a mature public content ecosystem, and ads are ramping well with good, high-quality ads because a lot of public figures and businesses are already investing and creating that kind of good content that goes on Instagram. And, you're going to see the same playbook in messenger and WhatsApp, in terms of making it so there are organic businesses and public figures. There's a bit more of that on WhatsApp already in terms of businesses using it than on messenger. We are catching up on messenger, but we'll do that on both. Once we have those ecosystems built out, we'll build businesses around them. And, that's how we think about stuff. We'll do that in all of our products and the different things that we do going forward. + +-------------------------------------------------------------------------------- +Deborah Crawford, Facebook, Inc. - Director IR [41] +-------------------------------------------------------------------------------- + + Operator, looks like we have time for one last question. + +-------------------------------------------------------------------------------- +Operator [42] +-------------------------------------------------------------------------------- + + Certainly. The final question is from Paul Vogel with Barclays. Your line is open. + +-------------------------------------------------------------------------------- +Paul Vogel, Barclays Capital - Analyst [43] +-------------------------------------------------------------------------------- + + Great, thanks. Just two questions. One, on the Facebook sports stadium? Just wondering how you think about that in terms of how is it going to be different from other offerings? What's the big differentiating factor? And, how do you get folks to participate in that? And the second side, just on the margin side again. Do your revenue and costs line up geographically, so there's obviously a translation impact to the numbers. But, is there any operating mismatch between revenue and costs that would either benefit or hurt margins? + +-------------------------------------------------------------------------------- +Sheryl Sandberg, Facebook, Inc. - COO [44] +-------------------------------------------------------------------------------- + + On the sport stadium, this is an early test, but we're pretty excited about it. We are the largest community of sports fans in the world. We have 650 million sports fans on our platform. And, people are already using Facebook to share during realtime events. It's an increasingly important use case for us. This gives people a place to share that one event and participate in it. I think what you'll see from us is always a focus on driving users and driving engagement. This is one way to do it. We'll see how it works. We're pretty open to experimentation. So, we feel -- but we feel pretty confident that realtime sharing is an increasingly important part of the platform, and one we'll continue to invest in. + +-------------------------------------------------------------------------------- +Dave Wehner, Facebook, Inc. - CFO [45] +-------------------------------------------------------------------------------- + + And, Paul, it's Dave. I think that question is really around FX and how it relates on the revenue side versus the costs side. And, on that front, we're -- substantial majority of our expenses are US dollar-based, so certainly we see an impact to margins with FX headwinds. So, that's just the reality of having most of our development resources, for instance, in the US. Beyond that, we don't do geographic cost breakouts and allocations. It's not how we run the business. But, certainly from an FX point of view, FX headwinds have a dampening effect on margins. + +-------------------------------------------------------------------------------- +Deborah Crawford, Facebook, Inc. - Director IR [46] +-------------------------------------------------------------------------------- + + All right. Thank you for joining us today. We appreciate your time. And, we look forward to speaking with you again. + +-------------------------------------------------------------------------------- +Operator [47] +-------------------------------------------------------------------------------- + + Ladies and gentlemen, this concludes today's conference call. Thank you for joining us. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/exam/original-files/Problem_1_Sample/2016-Jan-28-AMZN.OQ-139696494446-Transcript.txt b/exam/original-files/Problem_1_Sample/2016-Jan-28-AMZN.OQ-139696494446-Transcript.txt new file mode 100644 index 0000000..3a4f05e --- /dev/null +++ b/exam/original-files/Problem_1_Sample/2016-Jan-28-AMZN.OQ-139696494446-Transcript.txt @@ -0,0 +1,712 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q4 2015 Amazon.com Inc Earnings Call +01/28/2016 05:00 PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Brian Olsavsky + Amazon.com Inc - CFO + * Phil Hardin + Amazon.com Inc - Director of IR + +================================================================================ +Conference Call Participiants +================================================================================ + + * Ken Sena + Evercore ISI - Analyst + * Ronald Josey + JMP Securities - Analyst + * Neil Doshi + Mizuho Securities Co., Ltd. - Analyst + * Douglas Anmuth + JPMorgan - Analyst + * Kerry Rice + Needham & Company - Analyst + * Carlos Kirjner + Bernstein - Analyst + * Justin Post + BofA Merrill Lynch - Analyst + * Jason Helfstein + Oppenheimer & Co. - Analyst + * Brian Pitz + Jefferies LLC - Analyst + * Gene Munster + Piper Jaffray & Co. - Analyst + * John Blackledge + Cowen and Company - Analyst + * Stephen Ju + Credit Suisse - Analyst + * Heath Terry + Goldman Sachs - Analyst + * Paul Vogel + Barclays Capital - Analyst + * Colin Sebastian + Robert W. Baird & Company, Inc. - Analyst + * Mark Mahaney + RBC Capital Markets - Analyst + * Aram Rubinson + Wolfe Research - Analyst + * Brian Nowak + Morgan Stanley - Analyst + * Mark May + Citigroup - Analyst + +================================================================================ +Presentation +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + + Thank you for standing by. Good day, everyone, and welcome to the Amazon.com Q4 2015 financial results teleconference. +(Operator Instructions) +Today's call is being recorded. For opening remarks, I will be turning the call over to the Director of Investor Relations, Phil Hardin. Please, go ahead. + +-------------------------------------------------------------------------------- +Phil Hardin, Amazon.com Inc - Director of IR [2] +-------------------------------------------------------------------------------- + + + Hello, and welcome to our Q4 2015 financial results conference call. Joining us today is Brian Olsavsky, our CFO. We will be available for questions after our prepared remarks. +The following discussion and responses to your questions reflect management's views as of today, January 28, 2016 only, and will include forward-looking statements. Actual results may differ materially. Additional information about factors that could potentially impact our financial results is included in today's press release and our filings with the SEC, including our most recent annual report on Form 10-K. As you listen to today's conference call, we encourage you to have our press release in front of you, which includes our financial results, as well as metrics and commentary on the quarter. +During this call, we will discuss certain non-GAAP financial measures. In our press release, slides accompanying this webcast, and our filings with the SEC, each of which is posted on our IR website, you will find additional disclosures regarding these non-GAAP measures, including reconciliations of these measures with comparable GAAP measures. Finally, unless otherwise stated, all comparisons in this call will be against our results for the comparable period of 2014. Now I will turn the call over to Brian. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com Inc - CFO [3] +-------------------------------------------------------------------------------- + + + Thanks, Phil. I'll begin with comments on our fourth quarter financial results. Trailing 12-month operating cash flow increased 74% to $11.9 billion. Trailing 12-month free cash flow increased to $7.3 billion, up from $1.9 billion. +Trailing 12-month free cash flow less lease principle repayments increased to $4.7 billion, up from $529 million. Trailing 12-month free cash flow less finance lease principle repayments and assets acquired under capital leases increased to $2.5 billion, up from an outflow of $2.2 billion. Trailing 12-month capital expenditures were $4.6 billion. +Capital expenditures does not include the impact of property and equipment acquired under capital and finance lease obligations. These capital expenditures and capital leases reflect additional investments in support of continued business growth, due to investments in technology infrastructure, the majority of which is to support AWS, and additional capacity to support our fulfillment operations. The combination of common stock and stock-based awards outstanding was 490 million shares, compared with 483 million one year ago. +Worldwide revenue increased 22% to $35.7 billion, or 26% excluding the $1.2 billion unfavorable impact from year-over-year changes in foreign exchange. Worldwide paid unit growth was 26%. Worldwide active customer accounts were approximately 304 million. Excluding customers who only had free orders in the preceding 12-month period, worldwide active customers accounts were approximately 280 million, up from approximately 254 million in the comparable prior year period. +Worldwide paid Prime members increased 51% year-over-year. Worldwide seller units represented 47% of paid units. Fulfillment by Amazon or FBA units represented nearly 50% of seller units. Worldwide active Amazon web services customers exceeded 1 million. +Now I'll discuss operating expenses, excluding stock-based compensation. Cost of sales was $24.3 billion or 68.1% of revenue, compared with 70.5%. Fulfillment, marketing, technology and content and G&A combined was $9.7 billion or 27.1% of sales, up approximately 100 basis points year-over-year. Fulfillment was $4.4 billion or 12.3% of revenue, compared with 11.3%. Tech and content was $3.2 billion or 9% of revenue, compared with 8.2%. Marketing was $1.7 billion or 4.8% of revenue, compared with 5.1%. +Now I'll talk about our segment results. As a reminder, in the first quarter we changed our reportable segments to report North America, international, and Amazon web services. Consistent with prior periods, we do not allocate segments, our stock-based compensation, or the other operating expense line item. +In the North America segment, revenue grew 24% to $21.5 billion. Media revenue grew 11% to $3.9 billion, or 12% excluding foreign exchange. EGM revenue grew 28% to $17.3 billion. North America segment operating income was $1 billion, a 4.7% operating margin, compared with $733 million in the prior year period. North America segment operating income includes $6 million of favorable impact from foreign exchange. +In the international segment, revenue grew 12% to $11.8 billion. Excluding the $1.1 billion year-over-year unfavorable foreign exchange impact, revenue growth was 22%. Media revenue decreased 3% to $3.3 billion, or increased 5% excluding foreign exchange. +EGM revenue grew 19% to $8.5 billion, or 31% excluding foreign exchange. International segment operating income was $60 million, compared with $65 million in the prior year. International segment operating income includes $47 million of unfavorable impact from foreign exchange. +In the Amazon web services segment, revenue grew 69% to $2.4 billion. Amazon web services segment operating income was $687 million, a 28.5% operating margin, compared with $240 million in the prior year period. AWS segment operating income includes $60 million of favorable impact from foreign exchange. Consolidated segment operating income was $1.8 billion or 4.9% of revenue, up approximately 140 basis points year-over-year. CSOI includes $20 million of favorable impact from foreign exchange. +Unlike CSOI, our GAAP operating income includes stock-based compensation expense and other operating expense. GAAP operating income grew 88% to $1.1 billion. Our income tax expense was $453 million. GAAP net income was $482 million or $1 per diluted share, compared with a net income of $214 million and $0.45 per diluted share. +Now I'll discuss the full year results. Revenue increased 20% to $107 billion, or 26% excluding year-over-year changes in foreign exchange. North America revenue grew 25% to $63.7 billion, or 26% excluding year-over-year changes in foreign exchange. International revenue grew 6% to $35.4 billion, or 21% excluding year-over-year changes in foreign exchange. +Excluding year-over-year changes in foreign exchange, Germany revenue grew 18%. Japan revenue grew 19%, and UK revenue grew 16%. AWS revenue grew 70% to $7.9 billion. +Consolidated segment operating income was $4.5 billion or 4.2% of revenue, up approximately 220 basis points year-over-year. CSOI includes $16 million of favorable impact from foreign exchange. GAAP operating income was $2.2 billion, compared with $178 million in the prior year. +Turning to the balance sheet, cash and marketable securities increased $2.4 billion year-over-year to $19.8 billion. Inventory increased 23% to $10.2 billion. And inventory turns were 8.5, down from 8.6 turns a year ago, as we expanded selection, improved in-stock levels, and introduced new product categories. Accounts payable increased 24% to $20.4 billion, and accounts payable days increased to 77 from 73 in the prior year. +I'll conclude my portion of today's call with guidance. Incorporated into our guidance are the order trends that we've seen to date, and what we believe today to be appropriately conservative assumptions. Our results are inherently unpredictable, and may be materially affected by many factors, including a high level of uncertainty surrounding exchange rate fluctuations, as well as the global economy, and customer spending. It's not possible to accurately predict demand, and therefore our actual results could differ materially from our guidance. +As we describe in more detail in our public filings, issues such as settling intercompany balances in foreign currencies among our subsidiaries, unfavorable resolution of legal matters, and changes to our effective tax rate can all have a material effect on guidance. Our guidance further assumes that we don't conclude any additional business acquisitions, investments, restructurings, or legal settlements, recording further revisions to stock-based compensation estimates, and that foreign exchange rates remain approximately where they have been recently. +For Q1 2016, we expect net sales of between $26.5 billion and $29 billion, or growth of between 17% and 28%. This guidance anticipates approximately 130 basis points of unfavorable impact from foreign exchange rates. GAAP operating income to be between $100 million and $700 million, compared with $255 million in first quarter of 2015. +This includes approximately $600 million for stock-based compensation and other operating expenses net. We anticipate consolidated segment operating income, which excludes stock-based compensation and other operating expense net, to be between $700 million and $1.3 billion, compared with $706 million in the first quarter of 2015. +We are grateful to our customers, and remain heads-down focused on driving a better customer experience. We believe putting customers first, is the only reliable way to create lasting value for shareholders. Thanks. And with that, Phil, let's move on to questions. + +-------------------------------------------------------------------------------- +Phil Hardin, Amazon.com Inc - Director of IR [4] +-------------------------------------------------------------------------------- + + + Great. Thanks, Brian. Let's move onto the Q&A portion of the call. Operator, will you please remind our listeners how to initiate a question? + + +================================================================================ +Questions and Answers +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + + (Operator Instructions) +Thank you. Our first question is coming from analyst, Stephen Ju with Credit Suisse. Please proceed with your question. + +-------------------------------------------------------------------------------- +Stephen Ju, Credit Suisse - Analyst [2] +-------------------------------------------------------------------------------- + + + Okay, thanks. So Brian, I think in the past, you've given some indication as to what usage growth may be at AWS. I was wondering if you have an update for that in the fourth quarter? And secondarily, is there any way to characterize what the pricing environment is right now for AWS as well? Thank you. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com Inc - CFO [3] +-------------------------------------------------------------------------------- + + + Yes, thanks, Stephen. No, I don't have a usage growth number for you. We'll say we're -- it's been very strong. AWS revenue is on a -- just short of a $10 billion run rate at the end of Q4. +As far as pricing is concerned, we had a price reduction in January for our EC2 services. It was our 51st price reduction since we launched AWS years ago. And generally, what we find is that price is important, but so is speed and agility for customers, and the ability to deliver services and features that are beneficial to them. I will point out that we added 722 new features and services in 2015, and that was up 40% year-over-year. So we feel we have a lead in this space. And we don't take it for granted, and we want to serve customers better each year. + +-------------------------------------------------------------------------------- +Stephen Ju, Credit Suisse - Analyst [4] +-------------------------------------------------------------------------------- + + + Thank you. + +-------------------------------------------------------------------------------- +Operator [5] +-------------------------------------------------------------------------------- + + + Thank you. Our next question is from analyst, Jason Helfstein with Oppenheimer. Please proceed with your question. + +-------------------------------------------------------------------------------- +Jason Helfstein, Oppenheimer & Co. - Analyst [6] +-------------------------------------------------------------------------------- + + + Thank you. Can you talk a little bit about the dynamics in fourth quarter, eCommerce, particularly in the US? Did we see more aggressive promotional activity? And maybe talk about how you tried to work that to continue to drive the Prime number of members going forward? Thanks. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com Inc - CFO [7] +-------------------------------------------------------------------------------- + + + Sure. Well, what I can say is our approach to pricing has not changed. And through Q4, we did everything we could to have the best prices available for customers, and in-stock in time for the holiday. Another dynamic of Q4 was that, it was a huge FBA quarter. Nearly 50% of our third-party units were FBA, and our third-party units were also up to 47% of our paid units, so up 400 basis points year-over-year. +So a really strong quarter for our FBA sellers, using our FBA services. It did put a lot of demands on our warehouses, and we were full. It was a very busy quarter, and it did increase some of our variable costs as a result, primarily in the US. But a very strong quarter for FBA. It exceeded our -- even our expectations. + +-------------------------------------------------------------------------------- +Jason Helfstein, Oppenheimer & Co. - Analyst [8] +-------------------------------------------------------------------------------- + + + Perhaps how are you able to integrate that into holiday promotions? + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com Inc - CFO [9] +-------------------------------------------------------------------------------- + + + I'm sorry. You cut off there. Could you repeat your question? + +-------------------------------------------------------------------------------- +Jason Helfstein, Oppenheimer & Co. - Analyst [10] +-------------------------------------------------------------------------------- + + + Sure. Just any additional color around Prime, and how you were able to integrate that into holiday promotions? + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com Inc - CFO [11] +-------------------------------------------------------------------------------- + + + Nothing specific. I will say, one interesting enhancement this year was our Prime Now service, which allowed people to order in selected markets up until 11:59 on New Year -- or excuse me, Christmas Eve. So that was a valuable service to many late shoppers, last-minute shoppers. + +-------------------------------------------------------------------------------- +Operator [12] +-------------------------------------------------------------------------------- + + + Thank you. Our next question is from Aram Rubinson with Wolfe Research. Please proceed with your question. + +-------------------------------------------------------------------------------- +Aram Rubinson, Wolfe Research - Analyst [13] +-------------------------------------------------------------------------------- + + + Hey, thanks very much. Two questions, both on the logistics side. It seems pretty clear that you guys are trafficking in some old world assets, like truck trailers, and ship lanes, and air fields. Can you help, give us a sense as to maybe what we're trying to accomplish with that? If it's defensive to protect your service to your existing customers, or if you're looking to maybe start new businesses with those assets? + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com Inc - CFO [14] +-------------------------------------------------------------------------------- + + + Sure, Aram. Thanks for your question. I would say that -- what we've found, is in order to properly serve our customers at peak, we've needed to add more of our own logistics to supplement our existing partners. That's not meant to replace them, and those carriers are just not -- no longer able to handle all of our capacity that we need at peak. They have been, and continue to be great partners, and we look forward to working with them in the future. +It's just we've had to add some resources on our own. You mentioned trucks. The Amazon trucks, we did invest in those this past year. We use those primarily for movement between our warehouses and our sort centers. + +-------------------------------------------------------------------------------- +Operator [15] +-------------------------------------------------------------------------------- + + + Thank you. Our next question comes from the line of Brian Nowak with Morgan Stanley. Please proceed with your question. + +-------------------------------------------------------------------------------- +Brian Nowak, Morgan Stanley - Analyst [16] +-------------------------------------------------------------------------------- + + + Thanks for taking my questions. I've got two. The first one is just on gross margins. I think they were down about 200 basis points sequentially. It's the biggest fall in the fourth quarter in quite sometime. Anything you would call out there? Is it devices, or more sortation centers? Is there anything pressuring gross margins we should think about in the fourth quarter? +And then on the fulfillment line, you mentioned FBA being a big driver of the growth in the fulfillment costs. Anything else you would call out, leading to incremental fulfillment costs? Maybe India or something else? Thanks. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com Inc - CFO [17] +-------------------------------------------------------------------------------- + + + No. And again, keep in mind, that the fulfillment as a percent of revenue is impacted by the calculation of FBA revenue being a net number, as opposed to a full revenue number. But our fulfillment costs per unit actually decreased year-over-year. It's just that we are now shipping more and more of our -- other than demand, out of our warehouses because of the strength in retail and FBA. +On gross margin, I -- first, I'll caution you and say, we would encourage you to look at free cash flow which was -- it grew at a minimum $4 billion on each of the metrics that we point out. And Op profit, which was up 88% year-over-year. If you look sequentially, also keep in mind that in Q3, when it was up about 500 basis points year-over-year, that was lapping the write-down of our Amazon phone inventory the prior year. So there was a little bit of noise in the Q3 number. But generally, again, we're happy with the ability to service customers, the reaction of customers in Q4, and the bottom line results that we had. + +-------------------------------------------------------------------------------- +Operator [18] +-------------------------------------------------------------------------------- + + + Thank you. Our next question comes from the line of Colin Sebastian with Baird Equity Research. Please proceed with your question. + +-------------------------------------------------------------------------------- +Colin Sebastian, Robert W. Baird & Company, Inc. - Analyst [19] +-------------------------------------------------------------------------------- + + + Great, thanks. One follow-up, and then another question. On the logistics and transportation side, I was curious if that's to date, just to supplement some of the other carriers? But more broadly or longer term, is there an ambition from the services side, to perhaps provide capacity to other companies? +And then on AWS margins, was just wondering if we should expect more leverage there going forward? And whether Q1, whether that should demonstrate some seasonality, versus what we've seen in terms of sequential growth in prior years? Thank you. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com Inc - CFO [20] +-------------------------------------------------------------------------------- + + + Sure. Let me work backwards -- don't give guidance by segment, so cannot really comment on AWS specifically in Q1. The -- and the operational improvements -- excuse me, the gross margin -- the operating margin year-over-year that we've seen in the AWS business has been heavily driven by operating efficiencies, both purchase reductions and purchase prices, and also efficiency in driving greater utilization of the assets that we have. So we're very happy with that. +Keep in mind that we did have -- although the year-over-year increase in capital expenditures and capital leases was not as great as we saw in 2013 to 2014, we did spend over $9 billion on those -- on capital, and expenditures and capital lease obligations, up from prior year was -- excuse me -- (multiple speakers) + +-------------------------------------------------------------------------------- +Operator [21] +-------------------------------------------------------------------------------- + + + Thank you. Our next question come -- (multiple speakers) + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com Inc - CFO [22] +-------------------------------------------------------------------------------- + + + Sorry, let me finish my answer to him, please? We grew up, we grew from in the $5 billion range in 2013, to $8.9 billion in 2014, and now over $9 billion in 2015. + +-------------------------------------------------------------------------------- +Operator [23] +-------------------------------------------------------------------------------- + + + Thank you. Our next question comes from the line of Ken Sena with Evercore ISI. Please proceed with your question. + +-------------------------------------------------------------------------------- +Ken Sena, Evercore ISI - Analyst [24] +-------------------------------------------------------------------------------- + + + Hi. So a lot of headlines around Amazon's activity at SunDance. I was hoping maybe you could expand once more on the video strategy, and specifically are you seeing an inflection in Prime Video usage? And maybe, just also on your streaming partners program, what the general reception is like? Thank you. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com Inc - CFO [25] +-------------------------------------------------------------------------------- + + + Sure. We're very thrilled with the customer response to Prime Video. Again, when Prime Video is used by our Prime members, it drives adoption and retention, higher free trial conversion rates, and higher renewal rates for subscribers. So what we were encouraged by in Q4 was that globally, we doubled the number of -- our Prime members doubled the number of viewing hours of the Prime Video year-over-year. And internationally, we had twice as member Prime members streaming year-over-year. So very encouraged by the pick up, and the response of customers. +The other comment I would say about video is, we're very happy with the Amazon studios content, in particular. We've had some great success in 2014 and 2015. As you probably know, Transparent has won multiple Golden Globes and Emmys, both for actors and for the show itself. Mozart in the Jungle just won two Golden Globe Awards. +So very pleased with the critical acclaim to the Amazon Studios content, and we've got a lot of new content coming out this year. Catastrophe Season 2, Bosch Season 2, we're all looking forward to. And in February, we will have Chi-Raq, our first original movie that we got to work with Spike Lee on, which won many critical -- made many critics' Best Films list in 2015. That will be coming to Prime Video in February. + +-------------------------------------------------------------------------------- +Phil Hardin, Amazon.com Inc - Director of IR [26] +-------------------------------------------------------------------------------- + + + Just to add to that, this is Phil. On your question about the streaming partners program, so that's our new over-the-top streaming subscription program for Prime members. We think it's a really convenient way for them to access additional content, content from sources like ShowTime and Starz. And it's really early, so it's just out of the gate, but we've been very pleased with what we've seen so far. + +-------------------------------------------------------------------------------- +Operator [27] +-------------------------------------------------------------------------------- + + + Thank you. Our next question comes from the line of Mark Mahaney with RBC Capital Markets. Please proceed with your question. + +-------------------------------------------------------------------------------- +Mark Mahaney, RBC Capital Markets - Analyst [28] +-------------------------------------------------------------------------------- + + + Two things, please. Any call outs on the macro side? Occasionally, you called anything -- you've called things out, anything this time? And then, could you talk a little bit about Amazon business? +I know that there is a little bit of a line in the press release on it. I know you've had this for a couple of years. But any indications to the materiality of that, the kind of momentum it's gaining, the kind of traction it's gaining? Thank you. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com Inc - CFO [29] +-------------------------------------------------------------------------------- + + + Sure, Mark. Thanks for your questions. No macroeconomic comments. Again, we feel we're very encouraged by the customer response to our offerings in Q4. +Amazon business, yes, in April, you may remember we launched it as a marketplace, with specific features and benefits for businesses. That -- Amazon business now serves more than 200,000 businesses, from small organizations to Fortune 500 companies. So it's still early, but we're encouraged, and we think we're creating some value, a lot of value for our business customers. + +-------------------------------------------------------------------------------- +Operator [30] +-------------------------------------------------------------------------------- + + + Thank you. Our next question comes from the line of Mark May with Citi. Please proceed with your question. + +-------------------------------------------------------------------------------- +Mark May, Citigroup - Analyst [31] +-------------------------------------------------------------------------------- + + + Thanks. Brian, question on the international retail business. I think you added well over $1 billion in revenue year-on-year in the quarter, but from a CSOI perspective, you really didn't see any improvement there. I'm sure there is -- there are a lot of different things going on. +I just wonder if you could unpack that a little bit, and give us a sense of what profitability looks like maybe in some of your more mature, established countries and regions, relative to the investments you're making in other countries? So that we can kind of get a better picture of what's actually going on under the hood there? Thanks. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com Inc - CFO [32] +-------------------------------------------------------------------------------- + + + Yes. Sure, Mark. Thanks for your question. We are very pleased by the international growth, 22% FX neutral, was up 1,000 basis points year-over-year. We saw that the -- we told you that the Prime growth, Prime membership growth, 50% in -- excuse me, 51% globally. 47% in the US means that the international Prime programs grew at a faster clip than that. So very, very pleased with the uptick. +We rolled out a lot of additional Prime features internationally as well this year, from free same-day, to Prime Now, to Prime Music, and Prime Video in Japan, to name a few. So very happy with that. But in general, if I step back, our investments in national are twofold. +First, there's the Prime platform and all the features I just mentioned, including the fulfillment, adding more fulfillment resources to handle higher and higher retail volumes, and a very strong FBA program as well. And then, the remainder -- the biggest other investment area is obviously India. And we like -- we continue to see, like what we see in India. In Q4, Amazon India was the top e-commerce site in India, throughout the very busy -- Diwali shopping season, including the shopping season, according to comScore. +And sales by sellers in Q4 were greater than all of 2014 combined, in Q4. So seeing great progress with downloads, innovations for sellers and customers alike. And we like the ramp there, and we're continuing to invest in India. + +-------------------------------------------------------------------------------- +Operator [33] +-------------------------------------------------------------------------------- + + + Thank you. Our next question comes from the line of Douglas Anmuth with JPMorgan. Please proceed with your question. + +-------------------------------------------------------------------------------- +Douglas Anmuth, JPMorgan - Analyst [34] +-------------------------------------------------------------------------------- + + + Thanks for taking the question. Two things. Just first, on the North America EGM growth, if you could just talk about the 28% there? And the decel on an easier comp, and whether there's any particular factors within that we should be thinking about? And perhaps, if there was any weather and apparel impact there? +And then second, last quarter, and I don't want to misquote you, but you said something along the lines of, being able to invest as you would like, and also deliver good profit, and that the pendulum wouldn't swing as far perhaps as it has in the past. Is that statement and thought still hold, as you head into 2016? Thanks. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com Inc - CFO [35] +-------------------------------------------------------------------------------- + + + Sure. Let me start with EGM. So EGM growth, North America EGM growth of 28% was actually also the highest in the last four years. So we're happy with that. +The deceleration you're seeing of 700 basis points is more a function of the Prime Day that we had in Q3, if you remember. We didn't break it out by segment, but we said that Prime Day contributed 200 basis points to our Q3 run rate, revenue growth rate. So sequentially last year, in North America EGM, we dropped from 31% to 27%. +This year, it's 35% to 28%. So there is always a -- generally, a sequential drop in Q4. But certainly very happy with that business and its role in Prime as well, in total customer satisfaction. +Your other question, investments. Yes, we continue to have healthy investments as we've stated across the globe. To step back again on that, our general philosophy is, we want to find things, businesses that customers love, that can grow to be large, will provide strong financial returns, and are durable. They can last for decades. We think Prime is that, we think Marketplace is that, we think AWS is that, and we are constantly looking for a fourth or fifth business that fits that criteria. +But as we continue to invest primarily in, as I said in Prime, the Prime platform, Prime features for customers, expansion for fulfillment capacity, as we build out to support 26% unit growth in Q4, for instance, and much greater FBA share, and not to mention all the investments in AWS, we are constantly looking for cost efficiencies, in fixing variable productivity. I think a thing to think about is, the investments will ebb and flow over time, but our focus on cost reductions and improvement on customer experience will be constant. + +-------------------------------------------------------------------------------- +Operator [36] +-------------------------------------------------------------------------------- + + + Thank you. Our next question comes from the line of Heath Terry with Goldman Sachs. Please proceed with your question. + +-------------------------------------------------------------------------------- +Heath Terry, Goldman Sachs - Analyst [37] +-------------------------------------------------------------------------------- + + + Great, thanks. I was wondering if you could give us a sense, as we look at the slowing growth in AWS, obviously, still from an incredibly high level, and still very strong growth there. But try and take that into context, with the growth in margins that you keep seeing in that business, to levels that certainly seem a lot higher than you would anticipate for an Amazon business. Is there any capacity constraint or management that, that's driving pricing strategy in AWS? +We've heard the comments about the number of availability zones that are being launched this year, which is obviously about a big part of driving incremental capacity in that business. I'm just trying to balance those, think about how we should balance those three things? + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com Inc - CFO [38] +-------------------------------------------------------------------------------- + + + Sure. Let me work backwards from your footprint question or comment. We have -- we just announced Korea as a region. And we'll be adding five more regions in the next, in the future, in the near future as we mentioned. CapEx, let me start with that first. CapEx, we've seen great efficiencies in capital expenditures, in particularly in AWS. And we continue to work on better purchase efficiencies and driving utilization rates in our data centers. +CapEx, as I mentioned, grew quite a bit in 2014. It grew even more to over $9 billion, across all of our capital expenditures and capital leases in 2015. From the new regions, they are not the major driver in any way. Most of our capacity, and capital and capital leases in AWS is to service existing regions, and existing customers' demand growth. But there's certainly expenditures when we open up new regions. Some of that is not always in the year that we open the region, so we spent a good bit on those new regions already in 2015. +But as far as pricing, there's no capacity constraint. And I would a little bit dispute the deceleration comment on the -- yes, on a percentage basis, 69% is lower than Q3. But as I've said before, we're approaching a $10 billion run rate in this business. On a dollar basis, we continue to grow. We saw the greatest growth year-over-year and quarter-over-quarter. And again, we continue to invent, it's not all about price-- we continue to innovate on behalf of customers, and see great customer response. + +-------------------------------------------------------------------------------- +Heath Terry, Goldman Sachs - Analyst [39] +-------------------------------------------------------------------------------- + + + Sure, sure. Got it. Thank you. + +-------------------------------------------------------------------------------- +Operator [40] +-------------------------------------------------------------------------------- + + + Thank you. Our next question comes from the line of Kerry Rice with Needham & Company. Please proceed with your question. + +-------------------------------------------------------------------------------- +Kerry Rice, Needham & Company - Analyst [41] +-------------------------------------------------------------------------------- + + + Thanks a lot. First question is, if you can provide maybe some context around linearity within Q4, more as a -- compared to your expectations? Obviously, you have a ramp-up into the holiday season, but was -- did December tail off faster than you expected, or did the ramp-up, did it spike higher than you expected? And then, just on the follow-up, maybe can you add some context about how the mobile played a role in the holiday season for Amazon? Thanks. + +-------------------------------------------------------------------------------- +Phil Hardin, Amazon.com Inc - Director of IR [42] +-------------------------------------------------------------------------------- + + + So in terms of -- this is Phil. In terms of expectations, I think we were pleased with what we saw this Q4. And if you look at what we gave for guidance, we were in the upper half of the range there for revenue. So no real call outs there. I think, what was your second part of your question? +Oh, and mobile, we said for a long time continues to be a tail wind for the business. We're working very hard to make sure that it's very easy for customers to buy the things they want to buy, and access a lot of the features they have grown accustomed to on the website. And so, we're very focused on the convenience factor. And if you look at some of our new offerings like Prime Now that's available through a mobile app, and very, very convenient for customers. And as Brian has mentioned, allowed them to shop even up to Christmas Eve, and then have their items delivered in two hours. + +-------------------------------------------------------------------------------- +Operator [43] +-------------------------------------------------------------------------------- + + + Thank you. Our next question comes from Carlos Kirjner with Bernstein. Please proceed with your question. + +-------------------------------------------------------------------------------- +Carlos Kirjner, Bernstein - Analyst [44] +-------------------------------------------------------------------------------- + + + Thank you. I have two. I want to go back to AWS margins. You talked briefly about purchasing an asset utilization. But do this explain the 800 bps or so, on your year-on-year margin expansion? +And are you seeing anything else? Like is there any impact of scale driving leverage over fixed costs? Is there some benefit from revenue mix shift, like services, like Aurora and RedShift growing faster than EC2, or is all the margin expansion due to purchasing and asset utilization? So that's the first question. +And the second, I have a question about your streaming content expenses or cost of revenues to be more precise. Last year, you told us they were $1.3 billion, but if you didn't give us a figure for 2015. In lieu of that, can you comment on whether 4Q saw higher than usual costs for streaming content, compared to other quarters in the year? Thank you. + +-------------------------------------------------------------------------------- +Phil Hardin, Amazon.com Inc - Director of IR [45] +-------------------------------------------------------------------------------- + + + Carlos, this is Phil. So your question about the AWS margins, that business as they continued to learn, and as we continue to invent and get better at designing and operating the infrastructure and assets, we have been able to drive costs out of that business. And so, that's one of the primary drivers of the improvements that you've seen in margin year-over-year. +There is also an FX tail wind in there as well, which I think was about $60 million this quarter, which would contribute on a year-over-year basis, which really arises, because we're largely priced in dollars, but have assets with local currency costs throughout the world. As for the streaming content, we haven't given another update this year, and haven't given any commentary on the profile quarter to quarter. + +-------------------------------------------------------------------------------- +Operator [46] +-------------------------------------------------------------------------------- + + + Thank you. The next question comes from Brian Pitz with Jefferies. Please proceed with your question. + +-------------------------------------------------------------------------------- +Brian Pitz, Jefferies LLC - Analyst [47] +-------------------------------------------------------------------------------- + + + Thank you. You mentioned Amazon Dash in the press release. Can you give us some color around how you're viewing the traction there, both with customers, and with brands and devices? And then, maybe any update on Twitch? How is traffic and user engagement been trending on that site? Thanks. + +-------------------------------------------------------------------------------- +Phil Hardin, Amazon.com Inc - Director of IR [48] +-------------------------------------------------------------------------------- + + + This is Phil. So on the Dash buttons, we're really excited about what we're delivering there. I think, as you saw in the release, there are some new devices that take advantage of the underlying service, that we think will be really convenient for sellers, and interesting for device makers. We're excited about what we're building there. I don't have any stats for you today. +On the Twitch side, we continue to let Twitch do what Twitch does best. And so, don't have any updates on numbers there, but they continue to really engage customers, and offer a really unique experience, which was one of the reasons we were attracted to them to start with. + +-------------------------------------------------------------------------------- +Brian Pitz, Jefferies LLC - Analyst [49] +-------------------------------------------------------------------------------- + + + And maybe just quickly, end of year fulfillment and sortation centers? + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com Inc - CFO [50] +-------------------------------------------------------------------------------- + + + Yes, I'll take that. So we ended the year at 123 fulfillment centers, up a net 14, and we have 20 -- excuse me, 23 sortation centers in the US, up 4 year-over-year. + +-------------------------------------------------------------------------------- +Operator [51] +-------------------------------------------------------------------------------- + + + Our next question comes from the line of Gene Munster with Piper Jaffray. Please proceed with your questions. + +-------------------------------------------------------------------------------- +Gene Munster, Piper Jaffray & Co. - Analyst [52] +-------------------------------------------------------------------------------- + + + Hey, good afternoon. I want to just quickly revisit the margin pendulum question in some of your comments, as you mentioned that to kind of expect it to ebb and flow. Could you tell us if you expect it to ebb and flow, but moving higher? Or is ebb and flow just mean that, that it's kind of undetermined in 2016? And then, a second follow-up, is the robotics. Any update in terms of number of robots, or how you see that expansion going forward? Thank you. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com Inc - CFO [53] +-------------------------------------------------------------------------------- + + + Yes, my comment on ebb and flow was more about the investment, and also including capital expenditures and capital leases. So not around gross margins. And merely, I was pointing out that again, we've laid out all the invested areas, where we're seeing heavy investment. We continue -- we see the continuation of that certainly, into 2016 and beyond. +There are quarter-to-quarter and even year-to-year fluctuations in some accounts, and some investment areas. But generally, we're pretty transparent on where we're investing our dollars. And against that backdrop, we are always looking for efficiency. And the nice thing about growing the top line at such a high clip, is we have a lot more areas for opportunity to save money year-over-year. And we always look to do that. + +-------------------------------------------------------------------------------- +Phil Hardin, Amazon.com Inc - Director of IR [54] +-------------------------------------------------------------------------------- + + + And this is Phil. On the Kiva question, the last update we've given is more than 30,000 robots. We continue to be really pleased with the program, and like what it does in the warehouse, both from a density of storage, as well as from making the jobs easier for the associates who are picking packages, by bringing the packages actually to the associates. But no new numbers on that. + +-------------------------------------------------------------------------------- +Operator [55] +-------------------------------------------------------------------------------- + + + Our next question comes from the line of Justin Post with Bank of America Merrill Lynch. Please proceed with your question. + +-------------------------------------------------------------------------------- +Justin Post, BofA Merrill Lynch - Analyst [56] +-------------------------------------------------------------------------------- + + + Thank you. Two questions. Was there any category mix impacts in the quarter on gross margins? That's just a quick one. +And then secondly, as you look back at last year, you had some quarters where you really exceeded your guidance on the CSOI line. Maybe looking back, or just looking forward, what are the types of things that causes you to come in at the high end, versus maybe the low end, when you look back, or when you look forward? Thank you. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com Inc - CFO [57] +-------------------------------------------------------------------------------- + + + Sure. First, on guidance, we keep it pretty, a consistent process on how we look at guidance, and how we estimate the near-term view of the business. I will point out that Q4 is obviously, a very large quarter, the largest revenue quarter by far of the year. There's a lot of demand that comes in the last six weeks of the year as well. +So very, very little visibility at the time of guidance when we do the call. So we are using are best projections on a lot of fronts. We think it's a similar -- we know it's a consistent process. And there are times, when we under-run and sometimes we over run it. + +-------------------------------------------------------------------------------- +Phil Hardin, Amazon.com Inc - Director of IR [58] +-------------------------------------------------------------------------------- + + + On the -- this is Phil. On the category mix question, obviously, category mix does play a role in gross margin. I would say though, that we're much more focused on operating profit dollars, and free cash flow dollars, as we've probably talked about before. +The gross margins are impacted by first-party versus third-party mix, as well as AWS mix, if you're looking at the total for the Company. So we're much more focused on the dollars. And no specific categories we're calling out, as a driver for gross margin, because, again, we're much more focused on the profit dollars. + +-------------------------------------------------------------------------------- +Operator [59] +-------------------------------------------------------------------------------- + + + Thank you. Our next question comes from the line of Paul Vogel with Barclays. Please proceed with your question. + +-------------------------------------------------------------------------------- +Paul Vogel, Barclays Capital - Analyst [60] +-------------------------------------------------------------------------------- + + + Great. Thanks. Just wonder if you could give an update on the strategy around same-day shipping? How we should think about kind of further expansion of that? And kind of what parameters do you guys use to determine what markets to go in? Is it density of the market? Is it proximity of your distribution facilities? Just some color on that would be great. + +-------------------------------------------------------------------------------- +Phil Hardin, Amazon.com Inc - Director of IR [61] +-------------------------------------------------------------------------------- + + + So we deliver, really quickly, a couple of ways. One is the free same-day, that you've seen us roll out in a number of markets in the US. The other is Prime Now. And we're now in more than 25 metropolitan areas for Prime Now. Delivering for free in two hours is difficult and expensive, but customers love it. +So we feel like this is the natural evolution of our delivery, and we're happy to invest in that service. We like what it does for Prime members. We like the convenience factor. And so, we're taking a long-term approach, and doing what we normally do, which is really focus on continuing to drive greater and greater efficiency. + +-------------------------------------------------------------------------------- +Operator [62] +-------------------------------------------------------------------------------- + + + Thank you. Our next question comes from the line of Ron Josey with JMP Securities. Please proceed with your question. + +-------------------------------------------------------------------------------- +Ronald Josey, JMP Securities - Analyst [63] +-------------------------------------------------------------------------------- + + + Great. Thanks for taking the questions. I wanted to ask more about North American operating margins, because I think they expanded just under 50 bps this quarter to 4.7%. And that compares to an average of 200 basis points thereabouts, expansion in the prior three quarters. +So I'm just wondering, if in 4Q maybe higher FPA costs or something else in there that led to, maybe an expansion not as great as we saw in prior quarters. And then, following up on the Prime Now question just now, I'm wondering how an hour delivery or two-hour delivery has changed a consumer's perception of just delivery overall? Thank you. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com Inc - CFO [64] +-------------------------------------------------------------------------------- + + + Sure. Yes, again, I'll point out that the demand for FBA services was very high, nearly 50% of our third-party units, again were FBA. And the demand for space and services was very large by our seller base, which was great from a lot of standpoints, and it did exceed our expectations. But did make our warehouses rather full, and did cause us to incur some additional variable costs in the US. And there is also the dynamic that we were fulfilling more of these units ourselves, at our warehouses because of the FBA growth, and the retail growth. + +-------------------------------------------------------------------------------- +Phil Hardin, Amazon.com Inc - Director of IR [65] +-------------------------------------------------------------------------------- + + + On the speed of delivery, this is Phil. All I can say is, the customers love the service. It's very convenient, and it gives them flexibility, and the ability to get products really quickly. I don't know that there's any big trends we are ready to call out at this point, but they seem to really, really like it. So we're encouraged by that. We're excited to invest in it, and excited what we can do for our Prime members. + +-------------------------------------------------------------------------------- +Operator [66] +-------------------------------------------------------------------------------- + + + Thank you. Our next question comes from the line of Neil Doshi with Mizuho. Please proceed with your question. + +-------------------------------------------------------------------------------- +Neil Doshi, Mizuho Securities Co., Ltd. - Analyst [67] +-------------------------------------------------------------------------------- + + + Great. Two questions, please. One, it seems like the Echo did perform well. Can you talk more broadly about your Internet of Things ambitions, and kind of how Echo plays into that strategy? +And then, secondly, just wanted to know a little bit more about restaurant delivery? It seems a little bit outside of the wheelhouse. What's the impetus behind doing more in terms of food delivery, and what are your ambitions there? Thanks. + +-------------------------------------------------------------------------------- +Phil Hardin, Amazon.com Inc - Director of IR [68] +-------------------------------------------------------------------------------- + + + So on the Echo, we like what -- how Echo has done. We're really excited about the ecosystem, and some of the skills that are being added to Echo, as well as some of the other devices that are taking advantage of Alexa, which is the brains behind Echo. So we like our device business in general. +As you probably saw from the press release, we had a good Q4, where we did almost double the, or double what we did last year, so very excited about the devices. We like that they pump more energy into Prime, and really the whole ecosystem. Not sure on the Internet of Things, but it's very exciting for devices standpoint. And the brains of Echo are in the AWS cloud. And so, Echo gets new capabilities all the time, as Alexa gets better and better. +On the restaurant delivery, it's just another great service we can offer for our Prime members. This is tied in with the Prime Now offering in a handful of cities at this point. And so, we have the delivery people going out and making the deliveries in the neighborhoods. And so, this is one more really valuable convenient service we can offer for our Prime customers. + +-------------------------------------------------------------------------------- +Operator [69] +-------------------------------------------------------------------------------- + + + Thank you. Our final question will come from John Blackledge with Cowen and Company. Please proceed with your question. + +-------------------------------------------------------------------------------- +John Blackledge, Cowen and Company - Analyst [70] +-------------------------------------------------------------------------------- + + + Great, thanks. Two questions. First one, shipping costs were higher than we expected. I think it was 12.5% of net revenue, versus 11% last year. +Just any color on the higher shipping costs? And is that percentage of net revenue a new normal, as we are in 2016 now, and as we look out? And then the second question on Prime Now, in 25 markets globally, how should we think about the total number of markets that, additional markets you can enter with the Prime Now offering in 2016? Thanks. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com Inc - CFO [71] +-------------------------------------------------------------------------------- + + + Sure. Yes, as you say, the net shipping margin was up 70 basis points year-over-year. Again, this is all tied in with the increase in FBA growth, and the demand from Prime members. We're shipping more units -- more of our units, so this ripples through our ship cost per unit. And, again, the calculation of ship costs, as margin is a percent of revenue, and that is impacted by the denominator effect on the FBA sales, being booked at a net revenue. + +-------------------------------------------------------------------------------- +Phil Hardin, Amazon.com Inc - Director of IR [72] +-------------------------------------------------------------------------------- + + + Related to your Prime Now question, this is Phil. We're in more than 25 metropolitan locations. It's -- if you've been watching, this roll out has really happened in the last year, so it's been a pretty rapid rollout. We're excited to bring it to more places. +We don't have a target for you today, but we are working hard to bring it to more and more places. We're outside the US now in a handful of countries, in the UK and Japan and Italy, and working to expand. So it's a program we're really excited about, and we're happy to bring it to more customers. +Thank you for joining us on the call today, and for your questions. A replay will be available on our Investor Relations website, at least through the end of the quarter. We appreciate your interest in Amazon.com, and look forward to talking with you again next quarter. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/exam/original-files/Problem_1_Sample/2016-Jul-18-BAC.N-138282004512-Transcript.txt b/exam/original-files/Problem_1_Sample/2016-Jul-18-BAC.N-138282004512-Transcript.txt new file mode 100644 index 0000000..5216054 --- /dev/null +++ b/exam/original-files/Problem_1_Sample/2016-Jul-18-BAC.N-138282004512-Transcript.txt @@ -0,0 +1,833 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q2 2016 Bank of America Corp Earnings Call +07/18/2016 08:30 AM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Brian Moynihan + Bank of America Corporation - Chairman & CEO + * Lee McEntire + Bank of America Corporation - SVP of IR + * Paul Donofrio + Bank of America Corporation - CFO + +================================================================================ +Conference Call Participiants +================================================================================ + + * Steven Chubak + Nomura Securities - Analyst + * Brennan Hawken + UBS - Analyst + * Paul Miller + FBR Capital Markets - Analyst + * Eric Wasserstrom + Guggenheim Securities - Analyst + * Mike Mayo + CLSA - Analyst + * Glenn Schorr + Evercore ISI - Analyst + * Ken Usdin + Jefferies LLC - Analyst + * Matthew Burnell + Wells Fargo Securities - Analyst + * Matt O'Connor + Deutsche Bank - Analyst + * Vivek Juneja + JPMorgan - Analyst + * Jim Mitchell + Buckingham Research - Analyst + * Richard Bove + Rafferty Capital - Analyst + +================================================================================ +Presentation +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- +Good day, everyone, and welcome to today's program. (Operator Instructions). Please note this call is being recorded. It is now my pleasure to turn the conference over to Mr. Lee McEntire. Please go ahead. + +-------------------------------------------------------------------------------- +Lee McEntire, Bank of America Corporation - SVP of IR [2] +-------------------------------------------------------------------------------- +Good morning. Thanks, everybody, on the phone as well as the webcast, for joining us this morning for the second-quarter 2016 results. Hopefully everybody's had a chance to review the earnings release documents that were available on our website. +Before I turn the call over to Brian and Paul, let me remind you we may make some forward-looking statements. For further information on those, please refer to either our earnings release documents, our website or our SEC filings. +So before Brian and Paul get into the results, just let me mention one housekeeping item. Please limit your questions to one per caller so that we can get to everyone and you can circle back. +With that, I'll turn the call over to Brian Moynihan, our Chairman and CEO, for some opening comments, before Paul Donofrio, our CFO, goes through the details. Brian? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman & CEO [3] +-------------------------------------------------------------------------------- +Thank you, Lee, and good morning, everyone, and thank you for joining us to review our second-quarter results. I'm beginning on slide 2 of the materials we sent to you. +We reported solid earnings of $4.2 billion after-tax, or $0.36 per diluted share, in what was certainly an eventful quarter for the markets from an overall macro perspective. This compares to $5.1 billion or $0.43 per share in the year ago quarter. +This quarter included negative market-related NII adjustments that cost $0.05 per share, and negative DVA that cost us another $0.01 for a total of $0.06. That compares to a $0.03 benefit to EPS for both those items in the second quarter 2015. +Earnings neutralizing for the FAS 91 DVA for both periods improved from $0.40 per share to $0.42 per share on a year-over-year basis. Our results represent another quarter of solid progress in the strategies we have been executing. Those strategies are delivering more of the Company's capabilities to each and every client we serve. +At BAC, we focus on what we can control and, despite low rates and other macro events; we continue to focus on managing our risk, our costs and our delivery of quality products and customer service. +In Q2, we grew loans $22 billion, or approximately 2.5% versus last year, even as we sold a few portfolios during the year. All this growth was organic and consistent with our risk appetite. We also grew deposits more than $66 billion or 6% over that same time period. And we did so while maintaining disciplined deposit pricing. +We also continue to transform our Company in a digital way in all things and all businesses. For example, this quarter we crossed over 20 million active mobile users and continue to increase their use of digital channels for book transactions and buying more bank products. +Active Mobile Banking customers logged into their accounts over 900 million times this quarter, depositing more than 25 million checks, or more than $20 billion via mobile check deposits. They made over 25 million mobile bill payments, up 30% year-over-year, and made nearly 80 million transfers. +Person-to-person, or P2P payments, continue to ramp up as well. While still a small component of the overall consumer payments this quarter, we had $6.7 billion in P2P payments this quarter. That is more than $13 billion year-to-date and is up 28% from last year. This channel is a value channel for all our customers and made possible by the continuing investment we make. +As we move to slide 3, we have talked to a lot of you over the last several months, including many of you on the phone today. I thought I'd try to address some of the more common questions we get from those conversations by looking at our results, by looking at the income statement and the items there in. +First, one of the core questions is what if rates stay lower for longer? Well, for bank management and for you as investors, it would be easier if rates were to rise, but that hasn't happened. So the question is, can would grow earnings without rates improving? We believe we surely can. +We can do that by continued success on things like expense management, by keeping NII stable to growing, stable and growing fees and continue to manage risk well and hold down our credit costs. +As you can see, revenue this quarter was $20.6 billion on an FTE basis. Adjusted for the negative impacts of market-related NII adjustments and DVA, that number is $21.8 billion. Adjusted for the same items in the year ago quarter, the total was comparable. +Now as we focus in on NII, Paul will take you through some of the changes this quarter later in the presentation. However, in summary, adjusted for market-related changes in both last year's second quarter and this year's second quarter, we grew NII by $400 million or 4% year-over-year. And that took place while the 10-year treasury yield fell 86 basis points from last year on a spot basis. +Going forward in a stable interest rate environment, we believe we can maintain NII around the second-quarter 2016 level based on the current loan and deposit growth we see. And if rates rise, we would expect NII to grow. +Another question relates to the Global Markets business. That question is often asked how we need to change this business, especially the FICC area, as many of our customers have. I want to hit this head on. +First of all, fixed income is a good business for us here at Bank of America. It is a business which benefits not only by its core activities but by being coupled with our massive Global Banking franchise that has leadership positions across the globe. +Combined together they generate a pretty steady $1 billion or so quarterly investment banking fees. It's also an important part of our overall Global Markets platform, the platform which sits on top of the number one global research team for the past five years. +In the second quarter, this business did well. Global Markets generated $3.7 billion in sales and trading revenue excluding DVA. Compared to the same period last year, that is up 12%. This year-over-year improvement is driven by FICC sales and trading, which is up 22%. +Now think about that, sales and trading revenue including DVA for this quarter was the highest second quarter we've experienced in five years and it led to one of the most profitable quarters for Global Markets we've seen in the past five years. +Also, the team served clients well during a period of difficult volatility, so it clearly remains a profitable important business for us to serve clients. We're proud of how the team supported their clients through the Brexit vote and the periods of volatility related thereto. +Another question is getting clarity on how we're transforming the business on the fee lines. Noninterest revenue was $11.2 billion this quarter; although modestly down from second quarter 2015, it was up nicely from the first quarter. There are a lot of items that run through the various lines of fees. +First, with regard to consumer fees, we are largely done with the big card portfolio divestitures and branch divestitures. Both those impacted both card fees and banking service charges and you can see them coming off the bottom as you look at the linked quarters. Fees now will grow with the volume of cards and accounts that are now net growing in our Company. +Our mortgage business is now sized appropriately for our franchise and the fee line there, Paul will talk about later, but will be -- is at near where it's going to be in the future. +With regard to revenue more closely tied to markets businesses, the ups and downs in volumes of activity in sales and trading, investment banking and brokerage will move back and forth through the market. But the important thing is we have strong businesses -- strong client facing businesses in these areas and we're getting our share of these revenue streams even while the market ebbs and flows. +So if we look about -- move from the fee line to the expense line, many of you give us credit for having managed expenses from $70 billion five years ago to the mid $50 billion today. But the question is can we do more? If you look at this quarter we continue to manage expenses well. +Non-interest expense this quarter was $13.5 billion, improving more than 3.5% -- 3% from 2015's second quarter. This continues a trend of performance that has shown expense declining significantly on a quarterly basis quarter after quarter over the past several years. This is the lowest level that we have reported since the fourth quarter 2008, and that's prior to the Merrill Lynch merger. +If you look at our efficiency ratio and normalize it to the NII adjustments stated above, it would be about 62% this quarter. That's an improvement of 200 basis points from last year's second quarter. +Cost control and cost-effectiveness is a focus for our management team here at Bank of America. So the question is how much more can we do on expenses? So if you think about this, let's start by looking at the cost of the most recent four quarters. +In the trailing four quarters, the total expense base was $56.3 billion. As we look out from the third quarter of 2016 through the next six quarters into 2018, we believe that with our SIM efforts and the continued work we're doing across the board in expenses, we are targeting an annual expense number of around $53 billion in total expenses for the year 2018. +So over six quarters, we continued to absorbed investment, merit increases, rising healthcare costs and bringing expenses down a nominal amount. +Our continued work in driving down costs to service delinquent loans will help with this, but the other reductions are generally coming from the core work in Simplify & Improve, work we continue to do to simplify those work processes, but also the core work we do to allow us to self fund our growth initiatives, and our continued investments in technology and salespeople. +While I'm on the topic of expenses, I want to point out another important milestone for our Company this quarter. This quarter we changed our reporting to eliminate the Legacy Assets & Servicing segment. This completes the transformation -- this segment was the last place where product orientation was reported, [not] customer orientation. And more importantly, it also reflects the last of Legacy is really behind us from an operational basis. +We added a couple slides in the appendix today to go along with our 8-K we filed a few days ago to explain the methodology of the realignment of LAS and the highlights that impact this segment where those loans and associated P&L are reported now. +But what I want to get to -- across to you is LAS was [not] as an operational segment successfully did what it was tasked to do, to clean up one of the largest mortgage servicing businesses in the US. +Consider that progress. From 1.4 million delinquent loans mortgage loans, we're down to 80,000 today. At one point we had 58,000 teammates and 20,000 contractors working on this task, and now we're down to 10,000 teammates. From one peak quarter of $3 billion plus in expenses, we're down to $600 million this quarter. +That phase of the work is complete and we need to move that operating business in with the rest of the Company to do the further consolidation and further work to improve our servicing costs. We are pleased with the accomplishments of this group, but there is still more to be done. +And that brings us to our provision. Simply put, the question we often get is, is credit deteriorating? As you can see, we remain very pleased with both consumer and commercial credit performance. Not only net charge-offs not gotten worse, but they've improved in the most recent quarter, moving back below $1 billion. +Provision expense is and will remain roughly equivalent to net charge-offs. Even in our energy portfolio we've seen lower exposures [improved] losses. +And that brings us to our returns. In this operating environment, can we get our returns above our cost of capital? Well, as you can see, we made solid progress on our returns this quarter. Our return on tangible common equity adjusted for the market-related and DVA impacts was 10.9%. On a similarly adjusted basis, ROA has moved to 90 basis points. +We still have work to do, but you can see the improvement coming through. +As we move to slide 4, you can see our business segment results. You see strong year-over-year results in every business driven by the generation of operating leverage. Consumer Banking continued its momentum around client activity and operating leverage. Consumer satisfaction continues to improve as does adoption and use of digital capabilities and functionality. +In our wealth management business, they grew earnings as costs declined more than revenue while we continue to invest in this business. Revenue was impacted by AUM valuations from market variability. +Our Global Banking team drove results with continued solid loan growth, operating leverage of 9%, and strong credit results. Global Markets executed well for its clients, as I stated earlier, in a very difficult period and used operating leverage to grow its earnings year over year as well. +So on a combined basis, those four business segments improved 16% from last year's second quarter, earning about $5 billion this quarter. Partially offsetting this was a loss in All Other and that primarily reflects the market-related NII adjustments I spoke about earlier. +You can also see the returns and efficiency ratios for each of these segments and note that each segment is earning well above our cost of capital. With that, I'm going to turn it over to Paul to take you through the numbers. + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [4] +-------------------------------------------------------------------------------- +Thanks, Brian. Good morning, everyone. Since Brian covered the income statement, I will start with the balance sheet on page 5. +As you know, when general deposit flows drive the size of our balance sheet and they, on an ending basis, were relatively flat this quarter as inflows were partially offset by outflows to fund seasonal tax payments. +So total assets were stable compared to Q1 with loans increasing modestly, security balances rising and cash down a corresponding amount. Liquidity also saw a small decline; however, we remain well compliant with LCR requirements. +Tangible common equity of $170 billion improved by $3.6 billion from Q1 driven by earnings in OCI. This was partially offset by [$1.4 billion] (corrected by company after the call) in share repurchases and roughly $500 million in common dividends. +As a reminder, following the CCAR results, we announced an increase in both our share repurchase authorization as well as a planned increase of 50% in our quarterly dividend. On a per share basis, tangible book value per share increased to $16.68, up 11% from Q2 2015. +Turning to regulatory metrics, as a reminder we report capital under the advanced approaches. Our CET1 transition ratio under Basel III ended the quarter at 10.6%. On a fully phased in basis, CET1 capital improved $4.3 billion to $161.8 billion. +Under the advanced approaches compared to Q1 2016, the CET1 ratio increased 37 basis points to 10.5% and is above our current 2019 requirement. Our [risk-weighted assets] (corrected by company after the call) declined roughly $13 billion driven by reductions related to retail exposures, primarily from credit improvement. +We also provide our capital metrics under the standardized approach. Here our CET1 ratio improved to 11.4%. Supplementary leverage ratio for both parent and Bank continue to exceed US regulatory minimums that took effect in 2018. +Turning to slide 6 and on an average basis, total loans were up $7 billion from Q1 and $23 billion or 3% from Q2 2015. On an ending period basis, loan growth this quarter was impacted by pay downs near the end of the quarter in the non-US corporate loan facilities and about $1.6 billion in FX translations across international loans including UK card. +Note on the slide there is a breakdown of the loans in our business segments and All Other. Again on an average basis year-over-year, loans in All Other were down $42 billion driven by continued run off of first and second lien mortgages, while loans in our business segments were up $65 billion or 9%. +In Consumer Banking, we continue to see strong growth in consumer real estate and vehicle lending offset somewhat by runoff in home equity outpacing originations. In Wealth Management, we saw growth in consumer real estate and structured lending. +Global Banking loans were up $35 billion or 12% year-over-year and up 7% annualized from Q1. Deposits were stable with Q1 at $1.2 trillion but grew $67 billion or 6% from Q2 2015. +Broad-based growth was led by Consumer increasing more than $44 billion or 8% year-over-year, while Wealth Management deposits rose 6% and deposits with corporate clients and Global Banking improved nearly 4%. +Turning to asset quality on slide 7, we saw improvement from Q1. Total net charge-offs improved $83 million from Q1 to less than $1 billion in Q2. Consumer losses declined modestly across a number of products and while slight commercial losses also declined from Q1 as a result of lower energy losses. Provision of $976 million in Q2 was down $21 million from Q1. +Finally, we had a small overall net reserve release in the quarter as consumer releases were modestly offset by builds in commercial. +On slide 8, we provide credit quality data on our Consumer portfolio. Net charge-offs declined $68 million from Q1. While driven by the real estate losses, the improvement, as I mentioned, was broad-based. +Over half of the losses in this book are US credit card with a loss rate improved 5 basis points from Q1 to 2.66%. Delinquency levels and NPLs improved and reserve coverage remains strong. +Moving to the commercial credits on slide 9, net charge-offs improved $15 million from Q1 as energy losses declined. Energy charge-offs decreased $23 million from Q1 to $79 million this quarter. +There isn't a lot of new news on the commercial asset quality front other than the modest improvement in our energy-related exposure. As you all know, the price of oil and gas was more stable in Q2. +Within this backdrop, we experienced some improvement in both energy losses and exposure. A few clients refinanced with equity issuances and other financing solutions which also helped improve exposures. +Overall, ever committed energy exposure declined $3 billion from Q1 with utilized exposure declining more modestly and exposure to exploration production as well as oilfield services, which we believe are the two higher risk subsectors, declined 1% from Q1. +Outside of energy, commercial asset quality continues to perform well. Let me share with you a few metrics that exhibit the quality of this book and its performance. +The reservable criticized exposure ratio is 3.8% and, excluding energy, metals and mining, exposure is 2.4%, which is near prerecession levels. +The commercial net charge-off ratio, excluding small business, has been below 15 basis points for 14 consecutive quarters, even with the elevated levels of energy charge-offs we experienced over the past three quarters. +The NPL ratio, which today is at 37 basis points, has been below 40 basis points for 11 consecutive quarters. +Turning to slide 10, net interest income on a reported non-FTE basis was $9.2 billion. Included in NII this quarter was a negative $974 million market-related adjustment to true up (inaudible) premium amortization. This follows Q1's more negative adjustment of $1.2 billion and it's important to note that the adjustment in Q2 2015 was a benefit of $669 million. +NII on an FTE basis, excluding market-related adjustments, was $10.4 billion. This was lower than Q1 primarily due to lower long-end rates and Q1's seasonal impacts. Compared to Q2 2015, results were up nearly $400 million or 4% as higher [shorten] rates, combined with loan growth funded by deposits, offset the negative impact of lower long-end rates. +Looking forward to Q3, we will benefit from an extra day which will be offset by the impact of declines in long-end rates over the past two quarters and put pressure on our MBS bond yields and reinvestment yields more generally. +As we get into Q4 and the next year, we get more optimistic about NII, assuming both the current forward curve and the current pace of loan and deposit growth. +With respect to asset sensitivity, as of 6/30, an instantaneous 100 basis point parallel increase in rates is estimated to increase NII by $7.5 billion over the subsequent 12 months, driven by the increase in long-end rates. +Now we think it's also important to understand what we expect to happen to NII if rates don't rise. Referring to the bottom left of the slide; the adjusted NII has been fairly stable averaging between $10.3 billion and $10.4 billion over the past five quarters. +If we have stability in long-end rates, we would expect to maintain that level in the near-term, again assuming modest loan and deposit growth. Rates moving up or down from here would obviously impact that perspective slightly in the near-term, but building as we extend that scenario into future quarters and years. +Turning to slide 11, noninterest expense was $13.5 billion in the quarter. That is $0.5 billion or 3% lower than Q2 2015, driven by good expense discipline across the Company. +As you can see, we are presenting expenses a little bit differently now that we have eliminated the LAS segment. Having said that, we made steady progress on reducing legacy loan servicing costs this quarter and we still expect to achieve our original goal of lowering the former LAS segment costs, ex-litigation, to $500 million in Q4. +Q2 litigation expense was $270 million, which was higher by $95 million in Q1 2015. So year-over-year, expense improvement, ex-litigation was actually $600 million. +Nearly every category of cost was lower year-over-year. It was led by personnel, including the expiration of the fully amortized advisor awards, and the revenue-related incentive mostly in Wealth Management. While the rest of the improvement I would characterize as just good hard work, grinding expenses lower through SIM and other initiatives. +While the rate of decline has been slowing, our employee base is down 3% from Q2 2015. As the employee base continues to grind lower, we think it's important to point out that the reductions on a percentage basis now include more highly paid managerial associates. +So while the rate of FTE reduction has slowed, the relationship to expense reductions is not linear. Also, we continue to increase the number of client facing associates to drive growth, while at the same time, through SIM and other efforts, simplify and streamline activities and thereby reduce non-client facing positions. +Lastly, as I said last quarter, we expect our quarterly FDIC expense to increase approximately $100 million for a number of quarters, starting in Q3 2016. +Turning to the business segments and starting with Consumer Banking on slide 12, Consumer earned $1.7 billion, continuing its trend of solid improvement and reporting a robust 20% return on allocated capital. +Revenue and earnings were driven by deposit and loan growth, coupled with continued expense improvement, driving operating leverage. As a result of this operating leverage, the efficiency ratio improved roughly 360 basis points year-over-year. +Note that the lack of reserve releases this quarter versus a meaningful release last year mitigated some of the improvement in operating leverage. So while earnings were up 3% year-over-year, pre-tax pre-provision earnings rose 11%. +On slide 13 we focus on additional key Consumer Banking trends. First in the upper left, the stats are a reminder of our strong competitive position. Revenue increased by $107 million as NII growth more than offset lower noninterest income. +Net interest income continued to improve as we drove deposits and loans higher. Noninterest income was down due mostly to lower mortgage banking income. This decline is in part a result of selling fewer loans and instead holding more on our balance sheet thereby shifting mortgage banking income to NII. +Expense declined 5% from Q2 2015. The positive expense trend is a result of a number of initiatives. As an example, I would note that our growth in Mobile Banking continues to play an important role in helping us optimize our delivery network while improving customer satisfaction. Our cost of deposits as a percent of average deposits also continued to improve and now stands at 162 basis points. +Focusing on client balances on the bottom of the page, Merrill Edge brokerage assets at $132 billion are up 8% versus Q2 2015 on strong account flows partially offset by lower market valuations. We increased the number of Merrill Edge customers by 10% from Q2 2015. We now have more than 1.6 million households using our platform for self-directed trading. +Moving across the bottom right of the page, note that loans are up 5% from Q2 2015 on strong mortgage and vehicle lending growth. Average vehicle loans are up 20% from Q2 2015 with average book FICO scores remaining well above the 770 level and net losses remaining below 30 basis points and improving on a linked quarter basis. +Mortgage loan growth was aided by solid mortgage production of $16 billion, up modestly from Q2 2015, as customers took advantage of historically low interest rates. +On consumer card -- or I should say on US consumer card, we issued more than 1.3 million cards in the quarter which is the highest level since 2008. Average balances were modestly down. However, adjusting for divestitures, average card balances grew $1.4 billion compared to Q2 2015. Spending on credit cards adjusted for divestitures was up 7.5% compared to Q2 2015. +As we viewed in previous quarters, we continue to focus on originating high FICO loans which generally produce low loss rates and strong risk-adjusted margins. +Last quarter we highlighted the quality of our underwriting in the Consumer business. This quarter, we are highlighting our leading position in digital banking. This technology continues to reshape how our customers bank. +Importantly, as adoption rises, particularly around transaction processing and self-service, we see improved efficiency and customer satisfaction. We added more than 2.5 million new mobile customers in the past 12 months. With more than 20 million active users, deposits from mobile devices now represent 17% of deposit transactions. +Mobile customers, on average, process 280,000 deposits per day, an increase of 28% year-over-year and the equivalent to volume of 800 financial centers. Mobile sales are up nearly 50% from last year. We are promoting mobile sales and electronic adoption by deploying digital ambassadors in our financial centers. +We now have more than 3,500 digital ambassadors in our branches engaging with customers who come into the branch to transact. They educate these customers on alternatives to branch banking which are not only more convenient for them but also more efficient for us. Digital sales, appointments and satisfaction all continue to achieve new highs. +Also, as you know, we are a leader in person-to-person and person-to-business money movement through digital transfers and bill payment capabilities. The adoption and popularity of these capabilities continues to drive growth with record volume of $246 billion this quarter, up nearly 5% year-over-year. +Turning to slide 15, Global Wealth & Investment Management produced earnings of $722 million, up 8% from Q2 2015. Year-over-year, revenue was down modestly but expenses were down even more, improving pretax margin to 26%, up meaningfully from Q2 2015. +This quarter included a modest gain from the previously announced sale of Bank of America Global Capital Management. This reduced AUM comprised of short-term liquid assets by approximately $80 billion. Overall, revenue declined 2% from Q2 2015 as strong NII growth and the gain were more than offset by lower market sensitive revenue. +Asset management revenues decline from Q2 2015 on lower market values while improving modestly on a linked quarter basis. Transactional revenue was down and continues to be impacted by market uncertainty as well is the migration of activity from brokerage to managed relationships. NII benefited from solid deposit and loan growth. +Noninterest expense declined nearly $200 million or 6% from Q2 2015 with half of that benefit derived from the expiration of the amortization of advisor retention awards that were put in place at the time of the Merrill Lynch merger. The rest of the improvement was a result of lower revenue-related incentives and other support costs. +Moving to slide 16, despite volatile markets, we continue to see overall solid client engagement. Client balances at $2.4 trillion were down from Q1 but, excluding the sale I mentioned earlier, were up from Q1 as higher market valuation levels, $10 billion of long-term AUM flows and loan growth more than offset tax-related deposit outflows. +Driven by the expected seasonality, average deposits were down from Q1 as clients paid income taxes. Importantly, average deposits are up 6% from Q2 2015 driven by growth in the second half of 2015. +Average loans also grew this quarter. Growth was concentrated in consumer real estate and structured lending as well. +Turning to slide 17, Global Banking earned $1.5 billion producing solid improvement over both Q1 and year-over-year. Returns on allocated capital was 16%, a 200 basis point improvement from Q2 2015, despite adding $2 billion in allocated capital. +Double-digit percent revenue growth year-over-year offset a low-single-digit expense growth creating strong operating leverage that improved the efficiency ratio to 45%. Global Banking continues to drive solid loan growth within its risk and client frameworks producing solid year-over-year improvement in NII. +Revenue benefited this quarter from mark-to-market gains on our [FEO] loan portfolio due to recovery in certain energy and mining exposures. Higher treasury fees and leasing gains also aided the improvement from Q2 2015. While total investment banking fees for the Firm were down from Q2 2015, Global Banking gained a little share supported by M&A fees which were up on an absolute basis. +A modest increase in noninterest expense compared to Q2 2015 reflects the cost of adding sales professionals over the past 12 months, and a modest increase in incentive related due to the higher revenue. +Looking at trends on page 18, and comparing Q2 last year, clients were confronted with increased volatility once again this quarter with concerns around both global growth as well as the outcome of the UK referendum. +However, despite concerns, companies still need to finance as well as store their -- move their money and this is when the strength and diversity of our franchise is most appreciated by our clients. +Average loans on a year-over-year basis grew $35 billion or 12%. Growth was broad-based across large corporates as well as middle-market borrowers and spread across most products. +Having said that, we slowed our construction led commercial real estate lending a few quarters ago. Average deposits increased from Q2 2015 up $11 billion or 4% from both new and existing clients. +Switching to Global Markets on slide 19. The past couple of quarters are great examples of the importance of this segment to not only its clients around the world, but also to our customers and clients in all our business segments. +Customers and clients were able to live their financial lives better in Q2 because Global Markets delivered for them under challenging market conditions helping them raise capital, buy and sell securities as well as manage risk. +We believe we increased our relevance with clients during Q2 and, more specifically, during the market volatility after the UK referendum. We did this by showing them that we will be there for them when they need us most. +That we are there for them with consistent set of products and services at terms that makes sense for our clients and our shareholders. And there for them with thoughtful advice as well as the capabilities, strength and confidence to make markets and execute. +All of this results in Global Markets reporting earnings of $1.1 billion and a return on capital of 12% -- 13% excluding net DVA impact. +Revenue was up appreciably year-over-year as well as linked quarter. Total revenue, excluding DVA, was up 8% year-over-year on solid sales and trading results and up 18% over a Q1 that saw challenging market conditions. strong expense management drove expenses 6% lower year-over-year even while revenue was higher. +Moving to trends on the next slide and focusing on the components of our sales and trading performance, sales and trading revenue of $3.7 billion excluding net DVA was up 12% from Q2 2015 driven by FICC. +In terms of revenue, this was the best second quarter we have had in the past five years. Excluding DVA and versus Q2 2015, FICC sales and trading of $2.6 billion increased 22% as the improvement which begun in late Q1 continued through Q2 as global concerns abated and central banks took further monetary policy actions. +Improvement was across both macro and Credit Products driven by stronger rates in currency, client activity as well as improved credit market conditions. +Tighter spreads benefited mortgage trading and municipal bonds outperformed treasuries with strong retail demand. Equity sales and trading was $1.1 billion, declining 8% versus Q2 2015 which saw significant client activity in Asia driven by stock market rallies in the region. +On slide 21, we show All Other which reported a loss of $815 million. This loss was driven by the current quarter's $974 million market-related NII adjustment. The loss is lower than Q1 due to both a lower market-related NII adjustment as well as the absence of retirement eligible incentive costs. +Compared to Q2 2015, the difference is driven by a number of factors. First, the negative NII market-related adjustment in this quarter versus a large positive adjustment in Q2 2015. Second, we had reps and warranty recoveries in Q2 2015 related to a court ruling and gains on the sale of consumer real estate loans. Third, provision expense declined from Q2 2015 driven by continued portfolio improvement. +The effective tax rate for the quarter was about 29%, which is in line with what we expect for the remainder of the year absent any unusual items. +And, as a reminder, we still expect to record a tax charge of about $350 million, most likely in 3Q, that reduces the carrying value of our UK DTAs as a result of UK tax reform announced last year. The vast majority of this charge will not impact regulatory capital. +Okay, so let me offer a few takeaways as I finish. Q2 was another quarter of solid progress in a challenging global environment. While growth concerns persist in many countries, the US economy continues to steadily improve, albeit at a less than optimum pace. +The diversity and strength of our franchise makes us more relevant to clients and customers during times such as these and you can see that in our results. +Clearly interest rates affected our financial performance this quarter. Still, while we cannot control interest rates, we are not waiting for them to rise. We grew in this environment by focusing on the things that we can control and drive. We grew deposits, we grew loans, we managed risk well reflected in reduced charge-offs. +We delivered for customer clients in another challenging quarter, especially around the UK referendum. We invested in our future by adding sales professionals and continuing to deploy technology that improves customer satisfaction. +We returned capital to shareholders and we announced plans to return increasing amounts. And we did all of this while we lowered expenses and drove operating leverage. Thank you. With that, let's open it up for questions. + + +================================================================================ +Questions and Answers +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- +(Operator Instructions). Matt O'Connor, Deutsche Bank. + +-------------------------------------------------------------------------------- +Matt O'Connor, Deutsche Bank - Analyst [2] +-------------------------------------------------------------------------------- +Good morning. I had a few follow-ups on the expense commentary. I guess first, though, just maybe what drove the timing of -- given a three-year expense outlook, is it acknowledging lower for longer rates? Is it finding more opportunities? Or what was the motivation to give expense outlook for 2018 at this point? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman & CEO [3] +-------------------------------------------------------------------------------- +Well, Matt, as we looked at it, this is our current plan, so there's no new news for us in terms of how we operate the Company. But what we saw is that people were not getting the expenses right in the out years thinking that we could not continue the rate of investment and continue to bring down expenses. +Secondly, to make sure people understood it in terms of blending in LAS and putting it into the base, it's now become less of the contribution; now it's more the general expense base we're working on. +So, I think it was consistent with the way we were running the Company, but we wanted to make sure people had clarity over the next six quarters and going into 2018 of where we think the expense base goes versus what we saw in some of your guy's estimates and stuff. + +-------------------------------------------------------------------------------- +Matt O'Connor, Deutsche Bank - Analyst [4] +-------------------------------------------------------------------------------- +Okay, and then I guess specifically, the $53 billion that you pointed to, does that include the first-quarter stock expense of around $1 billion and some, I assume, nominal amount for legal? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman & CEO [5] +-------------------------------------------------------------------------------- +Yes, it includes an estimate based on current views of both. That's all in expenses for the year. Now they come in different quarters. +You just pointed out we have a frontloaded of that, but -- so this quarter did not include that -- think about it as $0.25 billion, plus [a quarter] when you think about the $13.5 billion this quarter. But overall, it includes the estimate for that out there plus the litigation estimate. + +-------------------------------------------------------------------------------- +Matt O'Connor, Deutsche Bank - Analyst [6] +-------------------------------------------------------------------------------- +Okay, and just separately if I can ask, we've had a couple other banks talk about loosening standards a bit on the consumer side. I feel like you've held your standards quite high especially in credit card. +But just any thoughts on appetite for loosening standards a little bit here given the challenging rate environment and the economy is still hanging in there? + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [7] +-------------------------------------------------------------------------------- +Look, we've worked, I think, extraordinarily hard to transform the Company, its balance sheet, its ability to produce earnings. We've got a customer and risk framework on the Consumer side that is focused on prime and super prime. That strategy, I think, works for our shareholders and our customers and we're sticking to it. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman & CEO [8] +-------------------------------------------------------------------------------- +And just to give you a simple view of that, Matt, this quarter we did the highest number of new credit card originations we've done for a long time and all of them are consistent with that risk appetite. So there's plenty of market share to gain there by just concentrating on current customers and deepening. +And while people always ask the question you asked, the answer is there still about 7 out of 10 mortgage customers at Bank of America get their mortgage somewhere else that fit within our credit customers. +There is plenty of cardholders that fit our credit parameters that are out there that don't have our card or aren't using our card as their primary card. And so, just giving those couple of examples, there's plenty of market share to get there so we don't need to change the standards to grow, and you've seen that come through. + +-------------------------------------------------------------------------------- +Matt O'Connor, Deutsche Bank - Analyst [9] +-------------------------------------------------------------------------------- +Okay. Thank you very much. + +-------------------------------------------------------------------------------- +Operator [10] +-------------------------------------------------------------------------------- +Jim Mitchell, Buckingham Research. + +-------------------------------------------------------------------------------- +Jim Mitchell, Buckingham Research - Analyst [11] +-------------------------------------------------------------------------------- +Hey, good morning. Maybe I could follow up a little bit on the NII discussion. Maybe if you could help us think through -- you talked about near-term kind of flattish, but as we think a little bit longer-term, if the forward curve is realized and/or maybe give some color -- you've had good deposit growth, core loan growth of 9%, but net loan growth has only been about 2.5%. +Do we start to see that inflect more? And does that start to help the out years as well? So, just any color on NII beyond the next quarter or two would be helpful. + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [12] +-------------------------------------------------------------------------------- +Sure, look, as I said in my comments, if rates follow the current path of the forward curve, we would expect, with the extra day and the decline in long-term rates, to be at around the $10.4 billion range in the next quarter. +So -- but as you get out to 4Q and next year, I think we get more optimistic about being able to grow. Given just our current pace of deposit and loan growth, we're obviously experiencing good deposit growth. +We've got, as we talked about, a strong risk and client framework, so we'd like to put all of that deposit growth into loan growth, but we're going to only do so if it meets our criteria. Whatever deposit growth doesn't get absorbed by good loans with our clients obviously goes into the investment portfolio and we get a return there. +So, I think -- look, it's just a question of the further you get out the more that wave of deposits and asset growth kind of overwhelms the change in interest rates and we see growth. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman & CEO [13] +-------------------------------------------------------------------------------- +Also, if you look at page 6, you'll see -- you can see that the point you made is that the inflection point was hit a few quarters ago where the noncore loans and leases were running down and not being made up by growth. +We passed that and so as we think about it going forward in the upper right-hand part of page 6 you can see that other loan leases balance is coming down. They'll continue to come down, but there's just less of them. +And then if you look at the lower left you see the core loans are growing at a good rate -- have been growing at a good rate, now can come through. +So I think your point about what gives us encouragement because you saw last year's second quarter, this year's second quarter, about how even in a lower for longer rate environment we can grow NII is that you actually are growing the net loan book pretty consistently now each quarter. + +-------------------------------------------------------------------------------- +Jim Mitchell, Buckingham Research - Analyst [14] +-------------------------------------------------------------------------------- +So if -- I guess you don't want to put too many numbers around it, but should we think that maybe starting in 4Q or 1Q we might start to see some incremental NII growth and maybe that accelerates, as you point out, the loan growth overwhelms the rate picture? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman & CEO [15] +-------------------------------------------------------------------------------- +I think we'd say that you've got to be careful about your rate scenario even on a spot basis because it can move around and move that around. But if you think about it as second quarter next year you'd start to see this breakthrough again based on absolutely no change in rates from the low point they were. + +-------------------------------------------------------------------------------- +Jim Mitchell, Buckingham Research - Analyst [16] +-------------------------------------------------------------------------------- +Right. Okay, great. Thanks. + +-------------------------------------------------------------------------------- +Operator [17] +-------------------------------------------------------------------------------- +Ken Usdin, Jefferies. + +-------------------------------------------------------------------------------- +Ken Usdin, Jefferies LLC - Analyst [18] +-------------------------------------------------------------------------------- +Hey, good morning, guys. Just one, on the fee side you mentioned all the great metrics in terms of the growth of activity and account growth and whatnot, but we're continuing to see declines year-over-year in card income, service charges and the brokerage business. +So, I was wondering if you can walk us through when you anticipate some of the building blocks turning into revenue. Or are there still some of the spending or competitive pressures building in underneath? So just the outlook for some of those core consumer and brokerage-related fee areas would be great. Thanks. + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [19] +-------------------------------------------------------------------------------- +Okay. Well, let's start with card. I think card actually is up on a linked quarter basis, down year-over-year, but you have to remember, again, we had portfolio divestitures. So I think we're at the point now where we're not going to be seeing those sorts of divestitures in the future and we start feeling better about more consistent growth around card. +If you look at brokerage income, we've been in a multi-quarter trend of people shifting from brokerage to more managed accounts. That trend has obviously put pressure on the revenue line because at the same time that was going on we had a lot of volatility in the marketplace, lower overall capital markets, lower overall activity. +But I think over time as -- if capital markets continue to rise, we will get -- we will offset the decline in transactional revenue. + +-------------------------------------------------------------------------------- +Operator [20] +-------------------------------------------------------------------------------- +Glenn Schorr, Evercore ISI. + +-------------------------------------------------------------------------------- +Glenn Schorr, Evercore ISI - Analyst [21] +-------------------------------------------------------------------------------- +A quick two parter on Wealth Management. One, I wanted to see if you saw any difference, post the retention lock-ups of a few months back in terms of [FA] attrition? And then the second part is in wealth management. What specifically -- product or behavioral changes are you putting in place ahead of the DoL rules kicking in in April? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman & CEO [22] +-------------------------------------------------------------------------------- +So on the first question; we haven't seen any change in attrition after retention. And most of the retention -- most of the attrition of experienced financial advisors have been more due to our change in the way we do the international business which has been going on for about a year. But in terms of aggregate numbers, it's been relatively stable. +In terms of -- and the attrition we see is actually in the lower production levels, mainly due to people not being able to build a book of business and we're trying to fix that through the integrated business system with our consumer and preferred teams. +In terms of department -- DoJ and the fiduciary standard, we're busily implementing this. It's consistent with where we're going with the business. It's consistent with the move from an old view of what Financial Advisory was versus a managed money fee-based loaded with a financial planning driven business. +Admittedly, it's a little tricky because the actual rules only apply to the $200 billion-odd of 401(k) in retirement assets we have, but it's consistent with where we've taken the business and the teams [drawing] it. We don't see meaningful revenue or changes due to that. We will see meaningful changes to implement it, but not meaningful revenue changes. + +-------------------------------------------------------------------------------- +Glenn Schorr, Evercore ISI - Analyst [23] +-------------------------------------------------------------------------------- +Okay, appreciate that. And just a follow-up on the 2018 expense target which everyone appreciates. It might be a silly question, but should we -- is it safe to assume that 2017 will be somewhere between 2016 actual and 2018's target? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman & CEO [24] +-------------------------------------------------------------------------------- +Well, we've got -- yes, it's a safe assumption. It's not a silly question, but you've got six quarters between now and then and you can see what we are running at it now to get it down to that level. We'll take work every quarter. + +-------------------------------------------------------------------------------- +Glenn Schorr, Evercore ISI - Analyst [25] +-------------------------------------------------------------------------------- +Okay. Thanks, Brian. + +-------------------------------------------------------------------------------- +Operator [26] +-------------------------------------------------------------------------------- +Steven Chubak, Nomura. + +-------------------------------------------------------------------------------- +Steven Chubak, Nomura Securities - Analyst [27] +-------------------------------------------------------------------------------- +Hi, good morning. So I hate to beat a dead horse on the expense question, but Brian or Paul, I was hoping you could provide some more detail as to what specific expense leverage you can pull to really drive that figure to $53 billion. +It is a pretty meaningful delta versus the $56 billion run rate over the last four quarters. I'm just trying to gauge how those expense initiatives might impact revenues and whether we should expect any revenue attrition as those additional initiatives take hold? + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [28] +-------------------------------------------------------------------------------- +Sure. So let me just back up a little bit -- I will definitely answer your question, but I want to emphasize again we're talking about LTM $56 billion going to $53 billion and absorbing in that merit, healthcare, inflation and other investment. +And the first thing I would point out as you think about the credibility of that -- look at what we accomplished over the last five years. From Q2 2011 to Q2 2016, we reduced quarterly expenses by $4.8 billion; that's a $19 billion annualized run rate. +And we did this by not only reducing legacy mortgage-related expenses, which were only -- make up about $2 billion of that $4.8 billion, but just through good expense management in every major category across the Company. +So, from here it's about -- a number of things -- a lot of those things are been identified through our Simplify & Improve initiative. We're investing in technology and capabilities to improve efficiency. The most obvious example of that you can see is in the increasing adoption of customers for digital channels. +But I do want to emphasize that it is about making progress across the entire Company, from our leaders and our teams. So if you look in Consumer, there are examples -- the digital adoption, we've got mobile users up 15% to over (technical difficulty). When they make a deposit that's 1/10 the cost. +We've got digital sales up 12% year-over-year. We've got more customers using digital statements, a lot more work to do there as we transition from paper to electronic. We are optimizing the coverage model in both consumer and GUM and they all have goals. We all have goals and initiatives around controllable expenses, including travel, supplies, support costs. +If you look at Global Banking and Global Markets, we're simplifying our legal entities structure and business model. We're integrating wholesale credit origination and processing across the lines of businesses. We're centralizing data platforms. We're expanding electronic capabilities and we're optimizing the coverage model. So there's a lot going on and we're going to need all of it to get to our goals. + +-------------------------------------------------------------------------------- +Steven Chubak, Nomura Securities - Analyst [29] +-------------------------------------------------------------------------------- +Got it. Okay. So, Paul, based on your comments it sounds like it's really going to be driven by technology and other efficiency initiatives. So there shouldn't be any expectation that we could see any meaningful revenue drop off or attrition in light of those actions that you are taking? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman & CEO [30] +-------------------------------------------------------------------------------- +I think -- yes, Paul gave you a lot of different places it comes from, but I think you've got to back up and say it comes from reducing the expense base and -- by people -- and you can see that even in markets year-over-year we're down 7% and people where revenue went up. +So, it's electronification to the fixed income platform and the equities platform continuing down that road. So every single area is moving here. +And then you also have to think about the stability of the platform. This Company has now been operating with a consistent strategy and a consistent ability to execute for many years. And what's gone with the legacy and stuff, that just allows us to keep operating on ourselves. +And we always have performed best in history when we had that period of time, no acquisitions, no divestitures, no legacy asset servicing. So we're very confident that it will happen. +On revenue, I'd say look at it year-over-year, look at it linked quarter. So last three or four quarters you've seen revenue stable and -- well, it bounces around with market activity in a given quarter. The core revenue continues to go forward and the expenses keep coming down on a core basis. +So we're comfortable that there is nothing -- we won't allow our people under our responsible growth to give us cost saves and not grow the business. So it has to be sustainable. It has to be actually taking out real work and yet still investing in more client facing teammates, more salespeople and more technology capabilities for customers. + +-------------------------------------------------------------------------------- +Steven Chubak, Nomura Securities - Analyst [31] +-------------------------------------------------------------------------------- +Thanks very much. + +-------------------------------------------------------------------------------- +Operator [32] +-------------------------------------------------------------------------------- +Eric Wasserstrom, Guggenheim Securities. + +-------------------------------------------------------------------------------- +Eric Wasserstrom, Guggenheim Securities - Analyst [33] +-------------------------------------------------------------------------------- +Thanks. Just a couple of questions on auto and then one clarification on the OpEx guidance. I'm sorry to come back to that, but on the OpEx, is it -- is the 2018 figure where you expect to begin 2018 or end 2018? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman & CEO [34] +-------------------------------------------------------------------------------- +It's for the full year. + +-------------------------------------------------------------------------------- +Eric Wasserstrom, Guggenheim Securities - Analyst [35] +-------------------------------------------------------------------------------- +For the full year? On auto, you underscored the origination quality and the high end of the FICO range, but one of the things that we are hearing from dealers is about the compression in pricing that's occurring in the high end ranges. +Some other lenders move up out of the mid-FICO range and I wanted to see if that's something that you think you're experiencing or if you're in fact seeing some stabilization in the competitive area around high FICO auto lending? + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [36] +-------------------------------------------------------------------------------- +I would say we haven't experienced that. We can check and get back to you. I would just make a couple more comments about auto. We are maintaining our share but we are very focused on the prime and super prime. +And as we pointed out last quarter, we are booking these loans at FICO scores of around 774 and we've got debt to income at all time lows. And importantly, we are not, from restructuring standpoint, extending tender the way we see in the marketplace. + +-------------------------------------------------------------------------------- +Eric Wasserstrom, Guggenheim Securities - Analyst [37] +-------------------------------------------------------------------------------- +Thanks very much. + +-------------------------------------------------------------------------------- +Operator [38] +-------------------------------------------------------------------------------- +Mike Mayo, CLSA. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA - Analyst [39] +-------------------------------------------------------------------------------- +Hi, still more on expenses. This might be good news/bad news. I guess the good news is your expenses over the last year, branches are down 2%, FTE down 3%, almost every expense line is lower, so that's good, and for efficiency ratio is down to 62%. +But the bad news the way I look at it is over the last five years your expenses are down a lot but your core revenues are down even more. So what might resolve at least the issue in my mind? Do you have a specific efficiency target for 2018? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman & CEO [40] +-------------------------------------------------------------------------------- +Well, Mike, the -- if you look at the risk-adjusted revenue, you would come to a different conclusion. So yes, we had a lot of revenue in 2011 or 2012, but the charge-offs were running tens of billions dollars more a year than we have now. So, a lot of that revenue is just going off the backend. +So, if you look at it from a risk-adjusted base, I think we grew from the low 60[%]s to the low 80[%]s over the last five or six years. So that is actually the work that gets done. +So we could -- going back to point, we focus on very high credit quality, so we keep that credit cost moving in the right direction or stable when the world has gone a different way. +We don't have a target efficiency ratio. You can calculate one of that out in 2018, because, as we talked about earlier, the NII differences will be driven by where rates go to some degree. +But the idea is we are going to take expenses from $56 billion in the last four quarters to $53 billion. We think that's where we'll get them to. And if rates stay stable or go up a little bit, you'll see a lower efficiency ratio. Right now we're running about 62% this quarter, fairly stated, and we think we can push it down from there. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA - Analyst [41] +-------------------------------------------------------------------------------- +And I don't want to take away -- I think we collectively appreciate having a 2018 expense target. But if you just take the second quarter annualized, you are at $54 billion. And then if you reduce your LAS expenses you get down to a $53 billion number. So is this (multiple speakers)? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman & CEO [42] +-------------------------------------------------------------------------------- +Mike, you're missing the FAS 123 in Social Security which is $1.2 billion in the first quarter that doesn't occur this quarter, but will -- you've got to add that back, too. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA - Analyst [43] +-------------------------------------------------------------------------------- +Okay, well that's helpful. And you said a lot is going on and I think some other analysts tried to restate what you're saying. But what are the three biggest drivers then of that reduction and what you might term a core expense base? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman & CEO [44] +-------------------------------------------------------------------------------- +It's been people -- we're down 2,600 people quarter over quarter; it's a constant reduction in personnel through hard work and automation, while we're continuing to increase the investment in salespeople. And so that helps on the revenue side and the revenue equation versus expense. +It's things like our data center configuration. We've been in a program, take about $1 billion, $1.5 billion out of all the data work, all the data centers and configuration that we're partway through. +And in part, just -- like Paul said, every line item is just grinding that -- as we continue to bring down people, we have less occupancy, less telecommunications and everything else, so it really comes across-the-board. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA - Analyst [45] +-------------------------------------------------------------------------------- +And then lastly, should we expect a restructuring charge or do you pay as you go? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman & CEO [46] +-------------------------------------------------------------------------------- +We have consistently paid as we've gone, as you well know, and even in every quarter we have between $50 million and $100 million of severance expense that we don't even talk about. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA - Analyst [47] +-------------------------------------------------------------------------------- +All right, thank you. + +-------------------------------------------------------------------------------- +Operator [48] +-------------------------------------------------------------------------------- +Vivek Juneja, JPMorgan. + +-------------------------------------------------------------------------------- +Vivek Juneja, JPMorgan - Analyst [49] +-------------------------------------------------------------------------------- +Hi. I won't beat the dead horse on expenses. Just a quick question on the card business. If I look at purchase volumes year on year, it slowed further from last quarter. Any color on what's going on there? + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [50] +-------------------------------------------------------------------------------- +Yes, I think purchase volumes are up 7% if you normalize for the divestitures. + +-------------------------------------------------------------------------------- +Vivek Juneja, JPMorgan - Analyst [51] +-------------------------------------------------------------------------------- +Okay, but the divestiture happened in 4Q; it slowed from where it was. It was up 2% year on year in the first quarter and it slowed to 1% year-on-year in the second quarter. So it seems to me a little bit of a weakening trend. + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [52] +-------------------------------------------------------------------------------- +I think we've had divestitures in 2Q last year and in the fourth quarter. + +-------------------------------------------------------------------------------- +Vivek Juneja, JPMorgan - Analyst [53] +-------------------------------------------------------------------------------- +I know, I am -- in fact, those were both reflected in 1Q 2016 year-on-year growth rates and I'm comparing (multiple speakers) --. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman & CEO [54] +-------------------------------------------------------------------------------- +Vivek, let me just -- let me make it simple for you. The year to date through July is up -- taking divestitures up about 4% on debit and credit both and up 7% in credit card purchases, normalized for divestitures year-to-year -- the first six months plus this part of July, so it's growing fine. + +-------------------------------------------------------------------------------- +Vivek Juneja, JPMorgan - Analyst [55] +-------------------------------------------------------------------------------- +Okay. Got it. Thanks. + +-------------------------------------------------------------------------------- +Operator [56] +-------------------------------------------------------------------------------- +Paul Miller, FBR & Company. + +-------------------------------------------------------------------------------- +Paul Miller, FBR Capital Markets - Analyst [57] +-------------------------------------------------------------------------------- +Yes, thank you very much. On the LAS, so you now consolidate the LAS segment into pretty much the Consumer segment. You still -- last on the appendix you said you had about 11,000 workers in that area -- I guess continuing to work through about 88,000 loans. +Should that number continue to move down? Will we continue to see that move down or what's the thoughts behind that? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman & CEO [58] +-------------------------------------------------------------------------------- +Be careful because those 10,000 people work on the 88,000 loans plus the 3 million good loans. They service both good and not good loans, to make it simple. And so, that's one of the reasons why we're separating. +And in All Other going forward is loans that we are actually only -- loans we'd never do again and that we're running off 600,000, 700,000 units. Moved into the segments whether it's Consumer, US Trust or Merrill Lynch are the loans that relate to their businesses in terms of servicing costs, too. +So, that was one of the confusions, as this thing got down you got to the point where the good servicing costs are becoming a more meaningful part of the total. And they'll continue on because that portfolio, whether it's direct servicing costs for third parties or even the stuff on our balance sheet, will continue. +But to give you a sense, from first quarter to second quarter, when we were down -- the total headcount of about 2,600, about 900 and change came from LAS, from the servicing side. So it still contributes but it's contribution is going down each quarter because the amount left to service the good stuff and just generally service our portfolio will be a higher percentage of what's left. + +-------------------------------------------------------------------------------- +Paul Miller, FBR Capital Markets - Analyst [59] +-------------------------------------------------------------------------------- +Okay, and then you gave some guidance on where you think LAS expenses will be by the fourth quarter. And I'm not sure I wrote it down correctly and I might have misinterpreted it. But was it close to $500 million, you said, or am I off somewhere? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman & CEO [60] +-------------------------------------------------------------------------------- +Yes, so this quarter we ran about $600 million and we said we would get -- a long time ago we said it would get to $500 million by the fourth quarter this year, so we're almost there, and the idea is that that will be completed. + +-------------------------------------------------------------------------------- +Paul Miller, FBR Capital Markets - Analyst [61] +-------------------------------------------------------------------------------- +So, is $500 million the run rate to service the good loans? I'm confused. Or is that still servicing the bad loans? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman & CEO [62] +-------------------------------------------------------------------------------- +Both. + +-------------------------------------------------------------------------------- +Paul Miller, FBR Capital Markets - Analyst [63] +-------------------------------------------------------------------------------- +Both? Okay. Thank you very much, guys. + +-------------------------------------------------------------------------------- +Operator [64] +-------------------------------------------------------------------------------- +Brennan Hawken, UBS. + +-------------------------------------------------------------------------------- +Brennan Hawken, UBS - Analyst [65] +-------------------------------------------------------------------------------- +Good morning. Sorry to come back here, but I just hate horses, so I'm going to take another whack at this thing. On expenses, what should we think about as far as your assumptions for legal and then some of your market-related businesses, market sensitive businesses? GWIM end markets? Just because the expense line items in those businesses do have a pretty big impact from market conditions. + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [66] +-------------------------------------------------------------------------------- +I'll start with legal. From a legal perspective, if you look over the last four, five, six, seven quarters we've been running around $300 million per quarter. We did $270 million this quarter. That I feel like is a reasonable range if you're building a model for the near-term. +In terms of the capital markets businesses, not quite sure I get your question. Obviously, they are -- that line is tied to the performance of the business. +The total performance of the business, returns, earnings and revenue and we have programs in place that we think are competitive with what's on Wall Street, so that we can attract the best of talent and retain the best of talent. +We're constantly benchmarking against those programs and we feel like we're where we should be for the quality and the market presence we have in those areas. + +-------------------------------------------------------------------------------- +Brennan Hawken, UBS - Analyst [67] +-------------------------------------------------------------------------------- +So overall (multiple speakers) --. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman & CEO [68] +-------------------------------------------------------------------------------- +So you should think of the environment we're talking about as an environment consistent where we are now from growth of 1.5%, 2% of US GDP and stuff. So it doesn't contemplate any change to the current environment from just a general operating principle. + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [69] +-------------------------------------------------------------------------------- +And again, remember what I think Brian said and what I emphasized again, that $53 billion is absorbing increases in merit, absorbing increases in healthcare, investment that are just -- inflation that are just natural in the business. + +-------------------------------------------------------------------------------- +Brennan Hawken, UBS - Analyst [70] +-------------------------------------------------------------------------------- +Right. I guess I was just -- so you're saying that first of all on legal, the $53 billion includes a roughly $300 million per quarter rate, and that your operating assumption for the GWIM and other market business would assume a revenue inflation and corresponding payout inflation from those businesses from here? + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [71] +-------------------------------------------------------------------------------- +Yes, based upon our current plan. + +-------------------------------------------------------------------------------- +Brennan Hawken, UBS - Analyst [72] +-------------------------------------------------------------------------------- +Got it. + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [73] +-------------------------------------------------------------------------------- +What's in our current plan. And in terms of legal, I hope it's going to be less than $300 million When we get out there. I'm not telling you to stick that in your model, but that's a good range to be thinking about. + +-------------------------------------------------------------------------------- +Brennan Hawken, UBS - Analyst [74] +-------------------------------------------------------------------------------- +Okay, that's really helpful. Thank you. And then one quick follow-up on GWIM. You guys highlighted a gain on sale, but could you talk about how much that impacted the margins in that business and then whether or not there was any EPS tailwind there? + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [75] +-------------------------------------------------------------------------------- +Yes, it was $80 billion of AUM again. That was all short-term. It had a minimal impact on margins. Minimal. + +-------------------------------------------------------------------------------- +Brennan Hawken, UBS - Analyst [76] +-------------------------------------------------------------------------------- +Okay, thanks. + +-------------------------------------------------------------------------------- +Operator [77] +-------------------------------------------------------------------------------- +Matthew Burnell, Wells Fargo Securities. + +-------------------------------------------------------------------------------- +Matthew Burnell, Wells Fargo Securities - Analyst [78] +-------------------------------------------------------------------------------- +Good morning. Thanks for taking my question. Paul, I wanted to follow-up on the mortgage banking side of things. That was one of the areas you highlighted in terms of potential growth. Year-over-year, the mortgage banking revenue was down fairly substantially. It seems like a lot of that was hedging gains and losses and things like that. +But you also mentioned that you're planning on keeping more mortgages that you originate on the balance sheet. Could you give us a little more color in terms of how you are thinking about that going forward both in terms of the mortgage originations being kept on the balance sheet and how you are thinking about mortgage banking fees? + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [79] +-------------------------------------------------------------------------------- +Sure. Let me -- you're right. The MBI line was down year-over-year; that was planned for. We knew that was coming. I just want to walk -- so for everybody else -- I just want to walk through why it's down and then we can talk a little bit about going forward. +So four items. First, we sold an appraisal business last year, so there was revenue in last year's second quarter that isn't in this quarter. Second, we had some servicing sales in the second quarter of last year for a game that we didn't have this quarter. Third and probably most significant from a revenue perspective is that we had the Ace decision in the second quarter last year. So we released last year some reps and warranties and that was a significant amount of benefit last year. +And then fourth, and probably strategically most important and the point you're getting too, is we are selling less mortgages, choosing instead to hold them on our balance sheet. And, obviously, this decreases MBI but increases NII over time. +So -- plus you have to note that, as we just talked about, servicing -- bad servicing is going to continue to run off. So if servicing is running off and not being replaced as fast, if we're holding more mortgages on the balance sheet as we transition from MBI to NII, you could see that line continues to trend lower. +In terms of the mortgages, I think in the short-term it's going to be fairly stable and that trend is going to -- it's a good base this quarter. It was a good base to start from. +I think that trend lower is going to be in some quarters very slow because, as you point out, other line items are a little bit messy and bounce around there depending on what happens in interest rates, but that's the trend. +In terms of what we're trying to accomplish, all of the loans we originate that are nonconforming, we would like to keep on our balance sheet. And even the conforming loans that have a certain characteristic we're going to be holding on our balance sheet. So right now let's around 75%-ish of the loans we're originating are going on our balance sheet. Is that helpful? + +-------------------------------------------------------------------------------- +Matthew Burnell, Wells Fargo Securities - Analyst [80] +-------------------------------------------------------------------------------- +Yes, thanks very much. + +-------------------------------------------------------------------------------- +Operator [81] +-------------------------------------------------------------------------------- +Richard Bove, Rafferty Capital. + +-------------------------------------------------------------------------------- +Richard Bove, Rafferty Capital - Analyst [82] +-------------------------------------------------------------------------------- +Hi. I apologize for going back to the net interest income issue, but obviously the reason why central banks keep interest rates down is because they expect it to increase lending. And I'm wondering if you've done any elasticity studies which show what happens to loans when interest rates go down or up. +And as part of that, there are multiple examples of what happens to earnings if interest rates go up 100 basis points or down. And I'm wondering if you've done anything to show if interest rates remain flat and loans go up 2%, 5%, 6%, 8%, what the impact on earnings would be. + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [83] +-------------------------------------------------------------------------------- +Yes, absolutely. On that last part of your question is precisely what I think we've been talking about today in the Q&A and in the remarks. We've got interest rates -- we talked about interest rates following the forward curve. We talked about interest rates being flat. +And despite both of those circumstances we think in the out years we can grow NII, or in the out quarters we can grow NII because we're growing deposits and we're putting them to work where we can within our risk and client frameworks to grow well priced loans. +Any amount of deposits that doesn't go to our clients and customers we're sticking in the securities portfolio and getting as much yield as we can get there within the constraints of liquidity and capital risk and interest rate risk. +So, we think we can grow in even a flat interest rate environment, grow the NII line, not necessarily in the next quarter, but as we again move out into the future. +Brian has already pointed out all the work we're doing around expenses, so when you combine what we think we can do from a fee base, from an NII perspective and then lowering expenses, we think we can grow earnings in the Company even if interest rates are flat. + +-------------------------------------------------------------------------------- +Richard Bove, Rafferty Capital - Analyst [84] +-------------------------------------------------------------------------------- +What I'm asking to get a lot more specific in the sense that you do this with interest rate changes, right? In other words, there's these bubble charts which show what will happen to net interest income if interest rates go up 100 basis points. There is nothing which says what happens to earnings if you see a 5% increase in loans. +In other words, what is more important? In the old days people would show these charts, if you hold interest rate flat and volume goes up, what happens to earnings if you get a 5% increase in lending as a result of interest rates staying so low? + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [85] +-------------------------------------------------------------------------------- +Again, Dick, you're right, we tend to talk in our disclosures about interest rates moving 100 basis points, 50 basis points as the -- and holding all else equal what's in our plans. We could just as easily do the opposite. We could hold interest rates flat and then you could see the effect of deposit and loan growth. +We certainly have that analysis. That's how we arrived at our perspective on the future. And I think if that's something that interests you, maybe after the call we can share with you some of that work; it's just math. + +-------------------------------------------------------------------------------- +Richard Bove, Rafferty Capital - Analyst [86] +-------------------------------------------------------------------------------- +Yes, but the reason why I'm interested is because the whole discussion that we now have is that interest rates are staying flat and therefore bank earnings cannot go up because the other side of the equation, which is what happens to volume when interest rates go down, is just not discussed at all. So I'd love to talk to you more about it. + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [87] +-------------------------------------------------------------------------------- +Yes, okay. That'd be great. + +-------------------------------------------------------------------------------- +Operator [88] +-------------------------------------------------------------------------------- +Jim Mitchell, Buckingham Research. + +-------------------------------------------------------------------------------- +Jim Mitchell, Buckingham Research - Analyst [89] +-------------------------------------------------------------------------------- +Oh, thanks. Thanks. Just a quick follow-up on the capital ratios. Paul, we saw a pretty big improvement across you and your peers in PP&R on seemingly lower op risk hits, particularly legal. Do we start to see that factor into the advanced approach calculation? +You guys get punished pretty hard on op risk in the advanced approach. Do you start to see some -- I guess some light at the end of the tunnel of being able to reduce that given all the reductions in legacy risk assets that you've seen? + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [90] +-------------------------------------------------------------------------------- +Thanks for noticing. So let me start with saying that we are very pleased with our results in CCAR this year and we believe they really do reflect all the hard work we've been putting into that process and improving capital planning. +Operational risk, we have a third of our advanced RWA roughly is operational risk and we would characterize most of that, or I might say all of it, as for businesses we're no longer in, products that we no longer sell and risks that I don't think we ever took as a basic Bank of America. So there's a lot of RWA sitting there and we have to work overtime to show the regulators that we can get that down. + +-------------------------------------------------------------------------------- +Jim Mitchell, Buckingham Research - Analyst [91] +-------------------------------------------------------------------------------- +But you're not -- nothing to read into the results in CCAR yet anyway? + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [92] +-------------------------------------------------------------------------------- +No, I don't think so. Obviously, CCAR is on a standardized basis, so it doesn't incorporate operational risk. + +-------------------------------------------------------------------------------- +Jim Mitchell, Buckingham Research - Analyst [93] +-------------------------------------------------------------------------------- +No, no, but in the PP&R they obviously made that point, that --. + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [94] +-------------------------------------------------------------------------------- +Yes, you're right. + +-------------------------------------------------------------------------------- +Jim Mitchell, Buckingham Research - Analyst [95] +-------------------------------------------------------------------------------- +Okay. + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [96] +-------------------------------------------------------------------------------- +You're right. I think they improved their models. I don't know, but I think we're all looking at what they've done in trying to understand it. And I think they probably improved their models a little bit around op risk and there was a little bit less across all the banks. +I think the banks that have the most maybe benefited -- because it was more of an average type of thing. So maybe we get a little extra benefit in that, but I don't know, to tell you the truth. We don't know what's in their models. + +-------------------------------------------------------------------------------- +Jim Mitchell, Buckingham Research - Analyst [97] +-------------------------------------------------------------------------------- +Right, so it's just a little too early to see any kind of spillover benefits yet? + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [98] +-------------------------------------------------------------------------------- +Yes. + +-------------------------------------------------------------------------------- +Jim Mitchell, Buckingham Research - Analyst [99] +-------------------------------------------------------------------------------- +Okay, thanks. + +-------------------------------------------------------------------------------- +Operator [100] +-------------------------------------------------------------------------------- +It appears we have no further questions at this time. I'll turn the program back over to our presenters for closing remarks. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman & CEO [101] +-------------------------------------------------------------------------------- +Thank you very much and we look forward to talking to you next quarter. Thank you. + +-------------------------------------------------------------------------------- +Operator [102] +-------------------------------------------------------------------------------- +This will conclude today's program. Thanks for your participation. You may now disconnect. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/exam/original-files/Problem_1_Sample/2016-Jul-27-FB.OQ-139115186913-Transcript.txt b/exam/original-files/Problem_1_Sample/2016-Jul-27-FB.OQ-139115186913-Transcript.txt new file mode 100644 index 0000000..3c89970 --- /dev/null +++ b/exam/original-files/Problem_1_Sample/2016-Jul-27-FB.OQ-139115186913-Transcript.txt @@ -0,0 +1,434 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q2 2016 Facebook Inc Earnings Call +07/27/2016 05:00 PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Deborah Crawford + Facebook, Inc. - VP of IR + * Dave Wehner + Facebook, Inc. - CFO + * Mark Zuckerberg + Facebook, Inc. - CEO + * Sheryl Sandberg + Facebook, Inc. - COO + +================================================================================ +Conference Call Participiants +================================================================================ + + * Carlos Kirjner + Bernstein - Analyst + * Justin Post + BofA Merrill Lynch - Analyst + * Ross Sandler + Deutsche Bank - Analyst + * Heather Bellini + Goldman Sachs - Analyst + * Mark Mahaney + RBC Capital Markets - Analyst + * Brian Nowak + Morgan Stanley - Analyst + * Eric Sheridan + UBS - Analyst + * Douglas Anmuth + JPMorgan - Analyst + * Mark May + Citigroup - Analyst + * Benjamin Schachter + Macquarie Research - Analyst + * John Blackledge + Cowen and Company - Analyst + * Anthony DiClemente + Nomura Securities Intl - Analyst + +================================================================================ +Presentation +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- +Good afternoon. My name is Chris and I will be your conference operator today. At this time, I'd like to welcome everyone to the Facebook second-quarter 2016 earnings call. +(Operator Instructions) +This call will be recorded. Thank you very much. Ms. Deborah Crawford, Facebook's Vice President of Investor Relations, you may begin. + +-------------------------------------------------------------------------------- +Deborah Crawford, Facebook, Inc. - VP of IR [2] +-------------------------------------------------------------------------------- +Thank you. Good afternoon, and welcome to Facebook's second-quarter 2016 earnings conference call. Joining me today to discuss our results are Mark Zuckerberg, CEO; Sheryl Sandberg, COO; and Dave Wehner, CFO. Before we get started, I would like to take this opportunity to remind you that our remarks today will include forward-looking statements. Actual results may differ materially from those contemplated by these forward-looking statements. Factors that could cause these results to differ materially are set forth in today's press release and in our quarterly report on Form 10-Q filed with the SEC. +Any forward-looking statements that we make on this call are based on assumptions as of today, and we undertake no obligation to update these statements as a result of new information or future events. During this call, we may present both GAAP and non-GAAP financial measures. A reconciliation of GAAP to non-GAAP measures is included in today's earnings press release. The press release and the accompanying investor presentation are available on our website at investor.FB.com. And now, I'd like to turn the call over to Mark. + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook, Inc. - CEO [3] +-------------------------------------------------------------------------------- +Thanks, Deborah. And thanks, everyone, for joining today. We had another good quarter and first half of the year. Our community continues to grow around the world. 1.7 billion people now use Facebook every month, and 1.1 billion people use it every day. Our business is growing at a healthy rate as well. Total revenue grew by 59% year over year to $6.4 billion. And advertising revenue was up 63% to $6.2 billion. Our results show our progress as we work to make the world more open and connected across our 3, 5 and 10 year horizon. Over the next three years, we're focused on continuing to build our community and help people share more of what matters to them. +The next five years are about building our newer products into full ecosystems for developers and businesses. Over the next 10 years, we're working to build new technologies to help everyone connect in new ways. I'll give an update on our progress across each of these areas, starting with how we're working to deliver better experiences for our community and more ways for people to share more of what they care about with anyone they want. We continue to see excellent growth in our community. Over the past year, we've added over 200 million people using Facebook on a monthly basis. And in the second quarter, time spent per person increased double-digit percentages year over year across Facebook, Instagram, and Messenger, and that doesn't even include WhatsApp yet. +One of the biggest opportunities to grow our community is in developing countries where connectivity is less advanced than what we take for granted here at home. Over the past couple of years, we've been making steady improvements to our apps to make them work regardless of the device or connection that people are using. We've also built a lightweight version of our Android app called Facebook Light that's tuned to work on 2G networks and is now used by more than 100 million people. We're also working on new tools to help people express themselves and understand what's going on with the people they care about. 10 years ago, most of what we shared and consumed online was text. Now it's photos. Soon, most of it will be video. We see a world that is video first, with video as the heart of all of our apps and services. +Over the past six months, we've been particularly focused on live videos. Live represents a new way to share what's happening in more immediate and creative ways. This quarter, Candace Payne's Chewbacca mask video was viewed almost 160 million times. Live is also changing the way we see politics as news organizations and delegates go live from the Republican and Democratic conventions. We've seen in Minnesota and Dallas how live can shine a light on important moments as they happen. This quarter, we also launched 360 photos. You don't need a special camera to take them. You just take a panorama or use the 360 camera app on your phone and post it. Since we launched, more than 4,000,360 photos have been shared on Facebook with a million more being shared every week. +We're making good progress on core services within the Facebook app like search. The growing way that people use search has defined what people are saying about a topic across the more than 2.5 trillion posts in our network. Now people are doing more than 2 billion searches a day between looking up people, businesses, and other things that they care about. Continuous steady improvement to services like search are an important part of helping people connect and realizing our mission. We're also improving the experience for our community by building our business with more engaging ads. We've always emphasized the importance of measurement and value in driving real results for the businesses that use Facebook and that means helping them create more relevant and engaging ads. +Over the next five years, we are working hard to build ecosystems around some of our newer products. Instagram now has more than 500 million monthly actives with more than 300 million daily. Now, we're working to make that experience even more engaging. Recently, Instagram began to rank its feed because we know that people have a better experience when they see more of the stories they care about. We're already seeing a positive impact in terms of time spent and the amount of content that people are sharing. We've also introduced our advertising tools on Instagram, and we're seeing marketers engage with people in creative and innovative ways. +In the two years since we separated Messenger from the main Facebook app, which was a pretty controversial decision at the time, we've improved performance and given people new ways to express themselves. And now for the first time, more than 1 billion people are using Messenger every month. I'm also happy with the updates we're making to WhatsApp, which also has a community of more than 1 billion people. This quarter, we launched new desktop apps and end-to-end encryption and millions of people are using WhatsApp's voice calling features. The scale we've achieved with our messaging services makes it clear that they are more than just a way to chat with friends. That's why we're also making it easier for people to connect groups and businesses as well. We're going to keep focusing on this over the next several years. +I'm also excited about the early progress we're making on our 10-year initiative. We're investing in new technologies to give more people a voice including, of course, the 4 billion people around the world who aren't yet online. And we're helping more people take advantage of the opportunities that come with the internet. We're still early in our journey with lots of hard work ahead, but we're making good progress like the first successful flight of Aquila, our solar powered aircraft that will beam internet to places that have never been connected. Eventually, we're going to work with telecom operators and governments around the world to connect people on the outskirts of cities, rural areas, and disaster zones where you can't get traditional connectivity today. +We've also been making progress with our initiatives around artificial intelligence and virtual reality. This quarter we announced DeepText, a deep learning-based engine that can understand the context of several thousand posts per second across 20 different languages. This is a long-term project but it also has some near-term benefits like helping show people more of what they want to see and filtering out less of what they don't want to see. We're also investing in new platforms to help people connect and share. We believe that virtual reality can help people share richer experiences and help everyone understand what's going on around the world. +It's really early for us in VR, but we're hitting some important milestones. As of the second quarter, more than 1 million people a month are you now using Oculus on mobile phones through our Gear VR partnership with Samsung. More than 300 apps are already available at the Oculus store for Gear VR. We filled all of our preorders for Oculus Rift, and we are seeing increasing demand from retail as stores plan for the holidays. While it's still early for augmented reality, we're doing AR research and are seeing light weight versions of AR technology in mobile apps like MSQRD. +That's a recap of the progress that we're making in our 10-year plan. We have a saying at Facebook that our journey is only 1% done. And while I'm happy with our progress, we have a lot more work to do to grow our community and connect the whole world. That means making big investments and taking risks focusing not just on what Facebook is, but on what it can be. I want to thank everyone in our community, all of our teams, our partners, and our shareholders, for being a part of this journey with us. And now, here's Sheryl. + +-------------------------------------------------------------------------------- +Sheryl Sandberg, Facebook, Inc. - COO [4] +-------------------------------------------------------------------------------- +Thanks, Mark, and hi, everyone. We had a great second quarter. Q2 ad revenue grew 63%. Mobile ad revenue reached $5.2 billion, up 81% year over year and was approximately 84% of total ad revenue. Our growth was broad based across verticals, marketer segments, and regions. We're excited to announce that we now have 60 million monthly active business pages on Facebook. We also continue to grow the number of active advertisers on our platform. This shows that both our free and paid products are providing value to marketers of all sizes around the world. We continue to focus on our three priorities. Capitalizing on the shift to mobile, growing the number of marketers using our ad products, and making our ads more relevant and effective. +First, capitalizing on the shift to mobile. For 32 years, the advertising industry has gathered in Cannes to celebrate creativity. People have shifted to mobile and marketers know they need to catch up. Mobile is no longer a nice to do, it's a must do, and we're working closely with marketers to help them make this transition. The best marketers understand that people watch video differently in mobile feed. The goal is to create what we think of as thumb stopping creative, videos that grab attention in the first few seconds even without sound. For example, to drive awareness for Sour Patch Kids gum, Mondelez has targeted teens with non-chocolate candy interest. Working with VaynerMedia, O'Harra, and the Facebook creative shop, they created punchy 10 second looping videos tailored for Facebook and Instagram. The campaign helped the Sour Patch Kids portfolio detailed benchmarks for the entire candy industry. +We're excited to bring more relevant video ads to people both on and off Facebook. In May, we expanded Audience Network to include video for brand objectives. This means that advertisers can place brand video ads not just on Facebook and Instagram but across a network of apps and sites. Our second priority is growing the number of marketers using our ad products. Over a third of small and medium businesses in the US don't have a website and having a mobile presence is even more difficult and expensive. Creating a business page on Facebook is as easy as setting up a personal profile. This is why Facebook pages are the mobile solution for many of the 60 million businesses using our products each month in the US and around the world. We've made it easy for business owners to manage their Facebook page from their mobile device. Over 85% of active business pages use mobile, and 40% of active advertisers have created a Facebook ad on their mobile device. +In Q2, we rolled out new tools to make it easier for businesses to promote posts and track performance directly from the Instagram app. We've worked hard to make becoming an advertiser as easy as possible for these businesses. With just a few steps and for as little as a few dollars, businesses can boost their posts to reach more people. Simplifying our ad products is key to advertiser acquisition. Over 80% of new advertisers in Q2 started with simplified products like boosted post. Once these businesses begin advertising with us, we make it easy for them to take advantage of even our most sophisticated capabilities. +For example, Lighting Etc., a third-generation family-owned business, used Facebook and Instagram ads to drive in-store sales. They targeted 25 to 45-year-old homeowners interested in interior design living within 35 miles of their showroom in Fort Worth, Texas. It was striking to them that on Facebook, the size of our community meant that they could reach over 300,000 people even with such specific targeting. They've seen a 40% increase in revenue in 2016, and they attribute this increase to their ads on Facebook and Instagram. +Our third priority is making our ads more effective and relevant. Our goal is to help our clients grow their businesses whether it be moving products off shelves, driving online sales, or building their brands. Our system constantly looks for the most efficient and effective way to drive these objectives. Businesses that want to build their brands need to reach a large audience with a compelling story, and they're seeing strong results from immersive formats like video and canvas ads. Businesses working to acquire new customers need to reach high-quality leads and convert them to action. We introduced Lead Ads in Q1 to make it easy for people to fill out forms on mobile devices right from news feed. +In Q2, we made it possible for advertisers to retarget people who opened or completed a lead ad form. For example, Nissan Turkey and the SEM agency used Lead Ads to collect over 20,000 high-quality leads from people interested in buying a new car. They then used retargeting to show relevant ads to people who had completed these Lead Ads and ultimately drove vehicle sales. The cost of a high-quality lead was 9.3 times lower on Facebook than all other online media. Businesses selling products are getting search like ROI from dynamic ads. Dynamic ads allow advertisers to upload their product catalog and target people with specific products in real time. Over 300 million people see dynamic ads each month, and over 2.5 billion unique products have been uploaded by marketers. +In Q2, we expanded dynamic ads to Instagram and also launched dynamic ads for travel. For example, you can now advertise specific destinations and dates for hotel rooms. We're pleased with the value we're driving for our partners and the progress we're making across our three priorities. With only a small fraction of our 60 million business pages advertising, we have a lot of opportunity ahead. We also have a lot of hard work to do to help businesses make the shift to mobile and to drive results for our clients. I want to thank our clients around the world for their partnership and their ongoing input which informs our product development. I also want to congratulate our global teams on the results of their hard work and thank them for their dedication to our mission. Thanks, everyone. And now here's Dave. + +-------------------------------------------------------------------------------- +Dave Wehner, Facebook, Inc. - CFO [5] +-------------------------------------------------------------------------------- +Thanks, Sheryl, and good afternoon, everyone. Q2 was another strong quarter for Facebook. Total revenue grew 59% to $6.4 billion, and we generated over $2 billion in free cash flow. These results highlight the continued growth and engagement of our global community and the strength of our ads business as advertisers benefit from our increasingly broad and deep portfolio of targeting creative and measurement schools. +Let's start with our community metrics. This past quarter was our strongest in over three years in terms of absolute year-over-year growth of monthly and daily actives on Facebook. In June, 1.13 billion people used Facebook on an average day, up 17% compared to last year. This daily number represents 66% of the 1.71 billion people who visited Facebook in the month of June. Mobile continues to drive our growth with over 1 billion people accessing Facebook via mobile devices on an average day in June, up 22% compared to last year. The growth of our other services also continues to be strong. WhatsApp and Messenger now each have over 1 billion monthly actives, and Instagram surpassed 500 million. +Turning now to the financials. My comments today will focus on our GAAP financial metrics, and all of our comparisons are on a year-over-year basis, unless otherwise noted. A reconciliation of our GAAP to non-GAAP financial metrics is included in our press release and earnings slides. Total Q2 revenue was $6.4 billion, up 59%. Q2 ad revenue was $6.2 billion, up 63%. Exchange rates did not impact our overall revenue growth rates this quarter as headwinds in certain currencies were offset by tailwinds in others. US and Canada and Asia-Pacific were our fastest growing regions with advertising growth rates of 69% and 67% respectively. Mobile ad revenue was $5.2 billion, up 81% and representing approximately 84% of total ad revenue. +Let's turn to the supply and demand factors that continue to drive our growth. Advertiser demand was particularly strong in Q2 across a broad range of verticals and advertiser objectives. Additionally, supply side factors including growth in users, time spent, and ad load, all contributed to our Q2 revenue growth. In Q2, the average price per ad increased 9% while total ad impressions increased 49%. The reported increase in price was again driven by the continued mix shift towards mobile where we only show higher-priced news feed ads compared to the mix of news feed ads and lower price right hand column ads on personal computers. The 49% increase in total ad impressions was driven primarily by growth in ad impressions served in Facebook's mobile news feed where the majority of our ads are shown. +Payments and other fees revenue was $197 million, down 8%. Remember that payments and other fees revenue is largely generated from games played on personal computers, which has declined as people spend less time on their PCs. Q2 total expenses were $3.7 billion, up 33% inclusive of $825 million of share based compensation related expenses as well as $193 million of amortization of intangible assets. Q2 operating income was $2.7 billion, representing a 43% operating margin. We continue to be pleased with the profitable growth of the business while we invest for the long term. We ended Q2 with approximately 14,500 employees, up 32% year over year. We added about 900 employees in the quarter, with the majority of those in technical functions. We are seeing continued success with our efforts to hire top talent in a market that remains very competitive. +Our Q2 tax rate was 26%. GAAP net income was approximately $2.1 billion or $0.71 per share. Q2 capital expenditures were $1 billion. Year to date, capital expenditures totaled $2.1 billion driven by investments in data centers, servers, office buildings, and network infrastructure. Facebook generated over $4 billion in free cash flow in the first half of 2016, and as of June 30, we had over $23 billion in cash and investments. +Turning now to the outlook. First, some color on revenue. We have been pleased with the strength of our advertising revenue in the first half of 2016. As I discussed on our last call, while we expect the main drivers of our advertising revenue growth will continue throughout 2016, we will face tougher comparables as the year progresses given the accelerating revenue growth rates we experienced in the second half of 2015. Consequently, we anticipate lower advertising revenue growth rates in each successive quarter in 2016. Additionally, we anticipate ad load on Facebook will continue to grow modestly over the next 12 months and then will be a less significant factor driving revenue growth after mid-2017. Since ad load has been one of the important factors in our recent strong period of revenue growth, we expect the rate at which we are able to grow revenue will be impacted accordingly. +Turning now to expenses. Based on our updated view of the remainder of the year, we are tightening our expense guidance range. We expect that full-year 2016 total GAAP expense growth will be approximately 30% to 35%, narrowed from our prior range of 30% to 40%. We expect full-year 2016 amortization expenses to be approximately $700 million to $800 million and full-year 2016 stock-based compensation related expenses to be approximately $3.1 billion to $3.3 billion. Accordingly, we anticipate that our total non-GAAP expenses, which exclude stock-based compensation and amortization, will grow in the range of 45% to 50%, narrowed from our prior range of 45% to 55%. +We anticipate full-year 2016 capital expenditures will be approximately $4.5 billion as we invest to support the rapid growth of our business. Finally, we expect that our Q3 and full-year 2016 tax rates will be similar to our Q2 rates. In summary, Q2 was another great quarter for Facebook, illustrated by the strong growth and engagement of our global community and continued broad-based strength of our ads business. We're pleased with the results, and we will continue to invest in order to best position Facebook for our long-term growth opportunities. With that, Chris, let's open up the call for questions. + + +================================================================================ +Questions and Answers +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- +Thank you. We will now open the lines for a question-and-answer session. +(Operator Instructions) +Your first question comes from the line of Eric Sheridan with UBS. Your line is open. + +-------------------------------------------------------------------------------- +Eric Sheridan, UBS - Analyst [2] +-------------------------------------------------------------------------------- +Thanks for taking the questions. Maybe two. One on the video platform going forward and you how you think about video as a distribution mechanism. How should we think about investments that need to with made in video on both technical infrastructure side as well as the sourcing of content side sort of broadened out the video offering over the next couple of years? And then maybe on the last comment on ad load, just wanted to go back to that for a minute in terms of what you're seeing on ad load by region. Because we are seeing a widening gap in revenue per user between the US and Canada and the rest of the world. How much of that might be driven by ad load or ad product? Thank you so much. + +-------------------------------------------------------------------------------- +Dave Wehner, Facebook, Inc. - CFO [3] +-------------------------------------------------------------------------------- +Sure. I can take the question on video distribution as it relates to CapEx and the ad load question and then maybe on the sourcing of content, I'll pass it back to Sheryl. So on the video platform, clearly from an investment perspective, you've seen us step up our CapEx this year pretty substantially, and that's baked into the guidance of $4.5 billion of CapEx, which if you recall is the high end of our prior range. We are investing across our infrastructure to prepare ourself for growth across all of our different services and a part of that investment is really to support video. That is definitely more taxing on the network, and we're investing heavily on the network side. And as well, it does also impact our overall needs within the data center, servers, and the like. So it's certainly an area that we're investing in heavily and we expect to be investing in heavily going forward, Eric. +And then on the ad load question, ad load is not -- it's not something that varies that dramatically by region. You're really looking at a number of factors. Really what's driving that is just the dispersion of overall ad demand across region. We're seeing really good strength across the globe on that front but ad load is not a big driver of discrepancies in ARPU that you see. That's really something that maps very closely to the size of the mobile ad markets per population in those countries. So it's not an ad load question. And then I'll hand it over to Sheryl to talk about video from a content perspective. + +-------------------------------------------------------------------------------- +Sheryl Sandberg, Facebook, Inc. - COO [4] +-------------------------------------------------------------------------------- +When you think about what's happening on video on our platform, we're really excited by the production and consumption of video, and we're seeing the full range from people posting the things in their personal lives. The power of what a mobile phone can produce and distribute now is pretty incredible when you compare it to just a few years ago to some of the most sophisticated content producers in the world producing for us. We're experimenting across a wide variety of things. We're doing a partnership with the NBA to stream some US men's Olympic team games in the next couple of weeks. That said, our primary focus is on short-form content, not long-form content and we're pretty excited to see the different forms of content people will create both to share messages to create new content and to engage audiences around the world. + +-------------------------------------------------------------------------------- +Operator [5] +-------------------------------------------------------------------------------- +The next question is from Douglas Anmuth of JPMorgan. Your line is open. + +-------------------------------------------------------------------------------- +Douglas Anmuth, JPMorgan - Analyst [6] +-------------------------------------------------------------------------------- +Thanks for taking the questions. I just have two. First on engagement, obviously the DAU and NAU numbers were strong and you gave the increase in the daily activity as well in the double digits. Can you just give us some color on the user trends underneath that a little bit, and more specifically perhaps what you might be seeing in terms of younger users and different age demographics. And then secondly, just going back to the ad load, we have in the past heard some caution from you guys before in that area. Granted, it was a few years ago and at a much earlier stage. I guess my question is, if targeting continues to improve along with click-through rate and then ultimately ROI, why does ad load have to become less of a factor going forward? Thanks. + +-------------------------------------------------------------------------------- +Dave Wehner, Facebook, Inc. - CFO [7] +-------------------------------------------------------------------------------- +Thanks, Doug. On the DAU and NAU front, a couple things. One is DAU and MAU are up sequentially and year over year in all regions and with trends that are largely consistent with past quarters. So really good, strong growth across the globe on a DAU to MAU ratio. We don't do specific breakdowns of those metrics by demographic. We're obviously pleased with our overall level of growth and engagement. On the teen front, younger users, we continue to be the best way to reach the largest global audience of teens and millennials. Teens remain engaged on Facebook. Clearly, how they've used our service has evolved over the years, and in addition to Facebook they're using Instagram, Messenger, and WhatsApp. So from a teen perspective, that's some color there. +On the ad load front, ad load is definitely up from where we were a few years ago. It's been an important driver of inventory growth, and really I think one of the things that's enabled us to grow ad load has been improving the quality and the relevance of the ads as you mentioned. And we've been able to do that without negatively impacting the user experience. We do expect that ad load will be a less significant factor driving overall growth, especially after mid-2017. The optimal ad load is really a mix of art and science. We've carefully tracked the impact of ads on the user experience over the last several years. We aren't seeing a cause for concern. +We also want to be thoughtful about making sure that each person's overall feed experience has the right balance of organic and ad content. And that factors into you how we think about ad load and where that might ultimately be. And that's really why we're talking our expectation that as you get into mid-2017, ad load will not be a big factor in driving overall inventory growth. We still see the opportunity to grow inventory from the growth of people and engagement on Facebook as well as our other services like Instagram. Instagram does have a lower ad load than Facebook. + +-------------------------------------------------------------------------------- +Operator [8] +-------------------------------------------------------------------------------- +The next question is from Brian Nowak from Morgan Stanley. Your line is open. + +-------------------------------------------------------------------------------- +Brian Nowak, Morgan Stanley - Analyst [9] +-------------------------------------------------------------------------------- +Thanks for taking my questions. I have two. The first one on the US advertising, was up particularly strong. Any specific ad category, branded, direct response, et cetera, or ad unit like video that's driving this growth in the US? And then the second one just on live video. Recognizing it's very early with live video, but any help at all on what percentage of your users are engaging with live video and the type of uplift you're seeing on engagement. Thanks. + +-------------------------------------------------------------------------------- +Sheryl Sandberg, Facebook, Inc. - COO [10] +-------------------------------------------------------------------------------- +Our growth this quarter was very broad-based across all of the regions. We had especially strong growth in APAC and the US and Canada, so that was part of the growth. In terms of our marketer segments from brands to direct response to SMBs to developers, the growth is really strong there as well. We're really excited today to announce that we have 60 million small business pages that are using Facebook on a monthly basis. And we're very focused on the opportunity to upsell them to advertising products. We think we have a good track record there. +We're also seeing a lot of strength in brand, and I think that's because we have a combination of the creative and the storytelling, so the art with the science of the targeting. And when people do that well together, you see great opportunities. So to share one example. Jack in the Box used our canvas ads, which are very immersive ads. They are really good for a brand experience to roll out a new menu item, their Double Jack burger. They worked with agencies, Horizon, David and Goliath, and Adaptly, and they targeted millennials on Facebook to create two different custom audience groups. One group was customers who had visited the restaurant web page or engaged with previous video ads. +And the second group were people that hadn't engaged with them directly but were quick service restaurant purchasers. They had an average view rate of 23 seconds across those canvas ads, so clearly people were really engaged in the planned experience of the ad, and they had a 13 point lift in ad recall and 9 point lift in purchase intent. I think what you're seeing is that across all of the objectives people have from brands, marketers to direct response to SMBs to developers, as our ad products get more sophisticated, our targeting and measurement get better. They have an increased opportunity to grow. And that's why we think our growth to date continues to be broad based. + +-------------------------------------------------------------------------------- +Dave Wehner, Facebook, Inc. - CFO [11] +-------------------------------------------------------------------------------- +Brian, I'll take the live video question. It's hard to compete with the Double Jack burger. In terms of live video, it's really early. We're really excited about it in terms of it providing an authentic and real form of sharing for people, and we're really trying to give people the full range of tools to share what they care about with anyone that they want, and live is really effective there. We've seen experiences both in terms of the light hearted like Candace Payne and also more serious issues around the US and around the globe. +So it's really an important part of what we're offering for people to share real experiences. Video as a whole is making a significant contribution to time spent growth. When we talk about the time spent per DAU growing worldwide across our family in double-digit percentages, video is making a contribution there more broadly. + +-------------------------------------------------------------------------------- +Operator [12] +-------------------------------------------------------------------------------- +The next question is from Justin Post with Merrill Lynch. Your line is open. + +-------------------------------------------------------------------------------- +Justin Post, BofA Merrill Lynch - Analyst [13] +-------------------------------------------------------------------------------- +Yes, a couple. First, Mark, just maybe on core Facebook, there's been commentary out there that maybe there's less personal sharing. Just maybe comments on the direction of Facebook, what the activities are going on, how you feel about that. And then just about the ad loads, how are you deciding how much ads to show? Could you hold back a bit and drive higher pricing? How are you balancing that and why not hold back a little bit more now for longevity there? Thank you. + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook, Inc. - CEO [14] +-------------------------------------------------------------------------------- +Sure, so I'll talk about sharing, and then I think Dave can probably talk about ad load and pricing. So the overall level of sharing is up on Facebook, and what we're seeing is that how people share is evolving as we move from desktop to mobile. So you can imagine more photos on people's mobile cameras, fewer long full photo albums, more ability to capture video, probably a little bit harder to type on mobile. So there's this evolution. The other thing that we see is that now people have tools to share more privately as well. So when you think about sharing on Facebook, you shouldn't just think about the kind of sharing that you see in news feed. So sharing with all your friends, sharing in groups on Facebook and public sharing, which are the trends that I was just talking about. +But another area that's growing incredibly quickly is private messaging. Between Messenger and WhatsApp, I think we're around 60 billion messages a day, which I think is something like 3 times more than the peak of global SMS traffic. That is something that is growing pretty quickly and that we're really excited about as well, and we're just going to continue working on giving people the best tools across the spectrum from private to public and across the spectrum from text-based and simple communication to richer type of media like photos, videos, and then eventually more immersive forms like VR. + +-------------------------------------------------------------------------------- +Dave Wehner, Facebook, Inc. - CFO [15] +-------------------------------------------------------------------------------- +Justin, in terms of ad load, we talked about the different factors that go into it. Obviously, just in driving the overall business, advertiser demand, that was particularly strong this period. And then also we matched that with supply. The supply, the two big drivers are user and time spent and then ad load. And getting the balance and mix right is important and clearly how the pricing plays out is via the auction. And we've had a good balance of demand growth and supply growth, and that's led to our good, strong financial results and our ability to deliver very strong ROI to advertisers. +So we think we're in a good zone on the right ad load, and we do think there's opportunities to grow that modestly. But as we look forward into 2017, we think it will be a less significant factor driving inventory growth. We still think there's opportunities to drive inventory through user growth and time spent. I don't think we would think about necessarily dropping ad load to drive pricing. We're also very cognizant of providing good value to advertisers and getting that balance right is important to driving overall ROI as well as obviously providing better targeting and measurement tools for our advertisers. + +-------------------------------------------------------------------------------- +Operator [16] +-------------------------------------------------------------------------------- +The next question is from Anthony DiClemente with Nomura. Your line is open. + +-------------------------------------------------------------------------------- +Anthony DiClemente, Nomura Securities Intl - Analyst [17] +-------------------------------------------------------------------------------- +Great. Thank you for taking my questions. I have one for Mark and one for Sheryl. Mark, you mentioned search in your prepared remarks, 2 billion searches a day on Facebook. I also noticed you said you're making it easier for users to connect to businesses. How far away are you from commercial search on Facebook being viable? Why can't you do that today? And how big of an opportunity could commercial search be? +And then Sheryl, you mentioned the expansion of the Facebook Audience Network. Can you talk more about the revenue opportunity of bringing Facebook's targeting tools to other video publishers? How fast is Audience Network monetization growing? Is it accelerating, for example, and how you see the revenue opportunity of expanding the Audience Network across the mobile web as well? Thank you. + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook, Inc. - CEO [18] +-------------------------------------------------------------------------------- +I can take search. So when we talk about our strategy, I often talk about how when we develop new products, we think about it in three phases. First, building a consumer use case. Then, second, making it so that people can organically interact with businesses. And then third, on top of that, once there's a large volume of people interacting with businesses, give businesses tools to reach more people and pay. And that's ultimately the business opportunity. So I'd say we're around the second phase of that in search now. +We have a pretty big navigational use case where people look up people and pages and groups that they want to get to and look at and search. One of the big growing use cases that we're investing a lot in is looking up the content in the ecosystem and that is an area that we're very excited about which helps people find more content. But certainly, there's a reasonable amount of behavior in there, which is looking for things that over time could be monetizable or commercial intense, and at some point, we will probably want to work on that but we're still in the phase of just making it easier for people to find all the content they want and connect with businesses organically. + +-------------------------------------------------------------------------------- +Sheryl Sandberg, Facebook, Inc. - COO [19] +-------------------------------------------------------------------------------- +On the Audience Network, we continue to invest in ad tech, and the Audience Network is a key part of our focus there. We don't break out revenue by our different platforms, but the opportunity to take not just video ads but other ad formats we have, bring them to the rest of the web and other apps with our ability to target and measure, we think is a big one. And what we're starting to see is that people are using Facebook, Instagram, and Audience Networks to drive their objectives in a cohesive way. +So to share an example. Garmin launched the Fenix3 Sapphire watch, and they did it with video ads on Facebook that worked without sound. They targeted outdoor enthusiasts then retargeted people who viewed the Instagram videos with carousel ads on Facebook that highlighted the product features. Then they extended those ads on Audience Networks to maximize reach and they used the Facebook pixel to measure the incremental sales and got to a 9.7 times return on ad sales. That's a really good example of how you can take targeting and the ability to target across Audience Network, Facebook, and Instagram and drive people all the way down the funnel and we think more and more people will do that particularly as we do a better job of combining the interfaces. For example, you can buy now in one interface on Facebook, Instagram, and Audience Network. + +-------------------------------------------------------------------------------- +Dave Wehner, Facebook, Inc. - CFO [20] +-------------------------------------------------------------------------------- +And then Anthony, just one thing to add on top of that. We recognize the majority of our third-party advertising revenue through the Audience Network on a net rather than gross basis. That will also minimize the impact that will have on the top line. + +-------------------------------------------------------------------------------- +Operator [21] +-------------------------------------------------------------------------------- +The next question is from Mark Mahaney with RBC Capital Markets. Your line is open. + +-------------------------------------------------------------------------------- +Mark Mahaney, RBC Capital Markets - Analyst [22] +-------------------------------------------------------------------------------- +Mark, when you see what seems like phenomenal success of Pokemon Go, what are your reactions to that? And then David, could you talk about the monetization ramp that you've seen on the messaging platforms? I know it's still very early days. Anything in there that strike you as being particularly substantive for material yet? Thank you. + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook, Inc. - CEO [23] +-------------------------------------------------------------------------------- +I, like everyone else, am enjoying Pokemon Go. The biggest thing that I think we can take away from this as we invest in augmented reality in addition to virtual reality is that the phone is probably going to be the mainstream consumer platform that a lot of these AR features first become mainstream, rather than form factor that people will wear on their face. I think we're seeing this in a number of places, whether it's location through Pokemon or some of the face filter activity. I reference the MSQRD app that we acquired earlier in my remarks. That's kind of a fun way to augment social experience that you're having with someone. I think that there's a big opportunity to build out that platform and a lot more functionality around that. +And one of the big themes that we're talking about here is becoming video first. And as people look for richer and richer ways to express themselves, just like people in the past have shared a lot of text and photos on Facebook, we think that in the future more of that is going to be video and more of these augmented reality tools I think are going to be an important part of delivering that experience and making that fun to use and expressive as it can be. + +-------------------------------------------------------------------------------- +Dave Wehner, Facebook, Inc. - CFO [24] +-------------------------------------------------------------------------------- +And Mark, we've talked about our strategy on how we go about monetizing the different apps in our portfolio, and we usually talk about it in terms of three phases. Phase one is really growing the user base and engagement, and we're really pleased with where we are with Messenger and WhatsApp from that perspective, with both over 1 billion monthly actives. The second phase is really working on building organic interactions between businesses and consumers. And then finally, the third phase is about building those commercial opportunities. With Messenger, we're really at the beginning of phase two. Messenger today has 1 billion organic interactions between businesses and consumers each month. But in terms of where we are in having in terms of actual monetization, incredibly early on that front. We're really in that phase two where we're really talking about building those organic interaction. + +-------------------------------------------------------------------------------- +Operator [25] +-------------------------------------------------------------------------------- +The next question is from Heather Bellini with Goldman Sachs. Your line is open. + +-------------------------------------------------------------------------------- +Heather Bellini, Goldman Sachs - Analyst [26] +-------------------------------------------------------------------------------- +Great. Thank you very much. I was wondering, I guess this is a follow-up on Anthony's question, is there a way to think about maybe the percentage of your kind of top 100 customers or however you want to define it that might be using FAN as an add-on to their Facebook spending? And I guess I'm wondering if you're seeing increasing leverage of FAN? And then the other question would just be, political spending obviously wasn't a big driver for you guys in 2012, but it does seem like it is potentially a great opportunity in the back half of the year. Was just wondering if you could comment on that at all. Thank you. + +-------------------------------------------------------------------------------- +Sheryl Sandberg, Facebook, Inc. - COO [27] +-------------------------------------------------------------------------------- +On the political spending, our business is broad based enough that no one event drives our business. We're pretty large and diversified. While the political campaign, obviously a lot of money is spent in ads. That's also true of an Olympics. It's also true of a World Cup. It's also true of a Superbowl. With all of these events taking place around the world, there's no one event that we think drives a huge portion of revenue. That said, we are pleased by what's happened on Facebook for the election cycle. Not just on the paid side but actually on the organic side as well. +We really see Facebook being embraced by politicians all over the world to get in touch with their constituents, and we're pleased with that. Every member of Congress right now has a Facebook presence, and we're seeing people like one example is Elise Stefanik, who is the youngest person in the Congress. She made a pledge when she was elected that she would explain every vote she takes, and she explains every vote she takes on Facebook with shorter explanations if they're not controversial but longer explanations. That's the kind of mission-based work we're happy about because it brings people closer to the people who are representing them. +We don't break out how many advertisers are advertising on the Audience Network but we're seeing solid and growing adoption of the Audience Network across the board as we are with Instagram. And we think all of these platforms together really help give us the ability to serve our clients in a very leveraged way and use the targeting and measurement capabilities we've invested in across multiple platforms. + +-------------------------------------------------------------------------------- +Operator [28] +-------------------------------------------------------------------------------- +The next question is from Carlos Kirjner with Bernstein. Your line is open. + +-------------------------------------------------------------------------------- +Carlos Kirjner, Bernstein - Analyst [29] +-------------------------------------------------------------------------------- +Hi. Thanks for taking my question. First, some people believe that much of what users see in the news feed is driven by their behavior and preferences, and as a consequence, the stories they end up seeing are almost always in line with their existing views and preferences. Does this phenomenon in the end increase -- does this phenomenon lead to increased adoption in use of Facebook creating more polarization of views and less effective communication at least in some areas of people's lives? Mark, how do you think about this line of thought that because people see things that are already in line with what they believe, communication is hindered. Second, when it comes to video ad formats, are you philosophically opposed to pre-rolls and if yes, why? And if not, what is missing for you to adopt them? Thank you. + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook, Inc. - CEO [30] +-------------------------------------------------------------------------------- +So we have studied the effect that you're talking about and published the results of our research that show that Facebook is actually and social media in general are the most diverse forms of media that are out there. And basically what -- the way to think about this is that even if a lot of your friends come from the same kind of background or have the same political or religious beliefs, if you know a couple hundred people, there's a good chance that even maybe a small percent, maybe 5% or 10% or 15% of them will have different viewpoints which means that their perspectives are now going to be shown in your news feed. +If you compare that to traditional media, where people will typically pick a newspaper or a TV station that they want to watch, and just get 100% of the view from that, people are actually getting exposed to much more different kinds of content through social media than they would have otherwise or have been in the past. So it's a good sounding theory, and I can get why people repeat it, but it's not true. So I think that that's something that if folks read the research that we put out there, then they'll see that. What was the other question? + +-------------------------------------------------------------------------------- +Dave Wehner, Facebook, Inc. - CFO [31] +-------------------------------------------------------------------------------- +Pre-roll. + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook, Inc. - CEO [32] +-------------------------------------------------------------------------------- +Pre-roll. I can take that one too. So we don't think it would be a good experience in news feeds because a lot of when people are finding videos on Facebook is you're scrolling through news feed, you're looking at what stories seem interesting to you, which is why we did the auto play videos so that rather than having to take an action, you can start experiencing the video automatically and continue watching if it's something that you're interested in. If we started playing an ad in the middle of feed before you got to the video then that would really go against that. I think people would just watch a lot less of the organic videos that were posted because of that. But the important thing to keep in mind on this is we don't need to do pre-rolls because our model is not one where you come to Facebook to watch one piece of content. You come to look at a feed and putting the ads in between the stories is a much more effective way to do it and better for the user experience. + +-------------------------------------------------------------------------------- +Operator [33] +-------------------------------------------------------------------------------- +The next question is from Ross Sandler with Deutsche Bank. Your line is open. + +-------------------------------------------------------------------------------- +Ross Sandler, Deutsche Bank - Analyst [34] +-------------------------------------------------------------------------------- +Great. I had two product-related questions for Mark. Mark, you guys mentioned when you released the latest Instagram MAU crossing the 500 million mark, you give out the breakdown of US, international. Looks like US has been around 100 million for about the past nine months. Is that just a pause along the growth path or is there something else that you're seeing that's causing that growth to stall out a bit in light of what you just said about engagement being up since you did the algorithmic reranking. Any color there would be helpful. Second question is just any update on Messenger M and how do you see that product potentially impacting engagement monetization on Messenger? Thanks. + +-------------------------------------------------------------------------------- +Dave Wehner, Facebook, Inc. - CFO [35] +-------------------------------------------------------------------------------- +On any update on M, I can start with that one. + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook, Inc. - CEO [36] +-------------------------------------------------------------------------------- +I was going to take that one. + +-------------------------------------------------------------------------------- +Dave Wehner, Facebook, Inc. - CFO [37] +-------------------------------------------------------------------------------- +You're going to take that one. On the Instagram MAU question, I don't think we're breaking out by region Instagram MAU. So no, I don't think there's any update there that I'm aware of. + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook, Inc. - CEO [38] +-------------------------------------------------------------------------------- +Okay. Yes, so we just haven't updated the stat. Yes. So for M, we've released the Messenger platform and in bots in the last six months. F8 was the big announcement there. I think since then, I think we've announced we have more than 10,000 bots in the system which are basically making it so that different businesses can build automated ways to communicate with people. The way we think about this experience is that qualitatively, I don't know a single person really who wants to call a business to get support or interact with it, whether that's trying to get a reservation for a restaurant or getting customer support or calling to buy something. Those are slow interactions. They're synchronous. They consume your whole attention while you're doing them. +If we can make it so that you can have some of those interactions in an automated way where you fire off a text and then just get a response that quickly but asynchronously so it doesn't take up your full attention. I think that that's going to be a much better experience that people really enjoy and like. So we're in the experimentation phase I think with the platform. We're seeing a lot of good ideas getting tried out, and I'm -- I personally enjoy a lot of the different bots set that people are using or making, especially the news ones where you get these digests at the end of the day of different kinds of content. And between that and M, which is kind of our own internal bot that we're building, I think this is going to be an interesting area to watch and encourage more interaction between people and businesses and texting. + +-------------------------------------------------------------------------------- +Operator [39] +-------------------------------------------------------------------------------- +The next question is from Ben Schachter with Macquarie. Your line is open. + +-------------------------------------------------------------------------------- +Benjamin Schachter, Macquarie Research - Analyst [40] +-------------------------------------------------------------------------------- +Couple questions for Mark. The first one, what are the lessons you're learning from seeing the growth of Snapchat and some of the other newer networks, particularly among young people. Obviously Facebook continuing to do well but these things are growing. Second, related to video, what are the key problems that you really think you need to solve for consumers and for video producers and how is Facebook going to evolve to help solve those problems? Thanks. + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook, Inc. - CEO [41] +-------------------------------------------------------------------------------- +Sure. And they're related. So overall, people are spending more and more time on mobile and that means that there are always more services that people use, whether it's YouTube or there's some really interesting ones with younger folks, especially like Musical.ly and Live.ly that I think are pretty interesting as well. Snapchat, which you mentioned. Part of why I think you see this is that there are just so many different ways that people want to share, so many different kinds of content ranging from text to photo to video to just richer and richer more immersive content. And also there's a range from private one-on-one type sharing to small groups, all your friends at once, large interspace communities, and then ultimately fully public. +There are different apps that explore different regions of that space and do a good job with it and offer ideas that I think the whole market needs to learn from. Right now, the big theme and strategy that we're executing is we're going to become the video first, and what I mean by that is that there's this trend where 10 years back, most of what you saw and shared online was text. And then we went through a phase where most of it is photos. We really believe that in call it five years, whatever the period of time that it takes to get there, I think most of what people consume online is going to be video. And that means that there need to be a whole range of new production tools and consumption experiences for enabling that. +For production, I think that means that you need to get the camera experience, the experience for capturing and uploading videos that you captured to be much better and a more central part of the experience. On consumption, there are innovations that we've had like auto play and feed but what's the next version of that that makes it so that people can have an even more native and default video experience when they're in news feed as well as private areas like Messenger and WhatsApp. I think you're going to see this across all of our apps, more focus on producing this kind of content and making it first class to consume as well, both in private and public context. And I think that's just a big trend across the market and one of the big things that if we get right, I think it's going to unlock a lot of sharing and opportunity. + +-------------------------------------------------------------------------------- +Dave Wehner, Facebook, Inc. - CFO [42] +-------------------------------------------------------------------------------- +And then just following up on Ross' question on Instagram and US because I think Ross you were asking, we've provided some rough percentages around international and US and I just wouldn't -- I wouldn't -- those were very approximate and I wouldn't base any trending on that, on those percentages. + +-------------------------------------------------------------------------------- +Operator [43] +-------------------------------------------------------------------------------- +The next question is from John Blackledge with Cowen and Company. Your line is open. + +-------------------------------------------------------------------------------- +John Blackledge, Cowen and Company - Analyst [44] +-------------------------------------------------------------------------------- +Great. Thanks. For Instant Articles, I think it went live globally for all publishers around the time of F8 in April. Just wondering if you can provide an update on the progress and how you see Instant Articles evolving over the next couple years. And then maybe Dave on the 49% year-over-year impression growth, how much of that was driven by ad loads? Thank you. + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook, Inc. - CEO [45] +-------------------------------------------------------------------------------- +I can take Instant Articles quickly. I think it's going well. It's a good user experience. People like it. The hypothesis when we rolled it out was that if we removed the latency, which is often 10 to 15 seconds of opening up a web view for news feeds that more people would read news. I think the initial data suggests that that's probably true. So that's good. We're getting more partners on and over the long term, I think one of the big things that we need to do is see if we can not only make this good for engagement for our partners but also a really positive business driver for them, too. That's something I'm excited about and we'll hopefully have more news on that coming up. + +-------------------------------------------------------------------------------- +Dave Wehner, Facebook, Inc. - CFO [46] +-------------------------------------------------------------------------------- +On the 49% year-over-year growth in impressions, we're not providing a specific breakdown there. I would say that it's primarily driven by growth in Facebook mobile news feed. We've talked about the drivers of supply being growth in DAU, growth in time spent per DAU and ad load. And obviously, we've given stats around -- rough stats around -- we've given specific stats around DAU. We've talked about time spent per DAU being up double digit. I think you can make some assumptions around that. So that's probably the way to triangulate on that. I think we have time for one more question, Chris. + +-------------------------------------------------------------------------------- +Operator [47] +-------------------------------------------------------------------------------- +Certainly. The final question is from Mark May with Citi. Your line is open. + +-------------------------------------------------------------------------------- +Mark May, Citigroup - Analyst [48] +-------------------------------------------------------------------------------- +Thanks a lot. I had two as well. You probably won't give specific revenue numbers, but just if you kind of in aggregate look at some of the non-Facebook app revenue streams, if it's FAN, Instagram, et cetera, curious to get a sense of the traction and materiality of those. Would you expect, Dave, that in aggregate that those would become kind of material meaning that sort of 10% plus threshold some time this year? Just trying to get a ballpark sense of the level of traction and diversification of revenue outside the core Facebook app. And then along the lines of your commentary around ad load, how should we be thinking about -- your MAUs are obviously very significant. DAU to MAU quite high. Do you continue to see that as being a primary driver of ad impression and ad revenue growth going forward as well? Thanks. + +-------------------------------------------------------------------------------- +Dave Wehner, Facebook, Inc. - CFO [49] +-------------------------------------------------------------------------------- +Yes, thanks, Mark. Like you said, we're not specifically breaking out revenue numbers. One thing to just keep in mind is Instagram is known and operated, property is represented gross in our revenue. Where as I mentioned the Audience Network by and large is going to be recognized net rather than gross. That is going to make it smaller in how it's going to appear in the revenue numbers. +The overall growth is still being driven predominantly by Facebook. Instagram is clearly making a contribution, and then as is the Audience Network. In terms of ad load, as I said, it's been one of the factors driving supply. It's certainly been helpful. But there's also DAU growth and time spent per DAU growth to time spent per person and we continue to feel that there are opportunities to execute on those and continue to grow inventory in that way. So that's where we would focus. As we drive DAU faster than MAU, then that's going to increase that ratio but we're really focused on driving DAU and time spent per person. + +-------------------------------------------------------------------------------- +Deborah Crawford, Facebook, Inc. - VP of IR [50] +-------------------------------------------------------------------------------- +Great. Thank you for joining us today. We appreciate your time and we look forward to speaking with you again. + +-------------------------------------------------------------------------------- +Operator [51] +-------------------------------------------------------------------------------- +Ladies and gentlemen, this concludes today's conference call. Thank you for joining us. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/exam/original-files/Problem_1_Sample/2016-Jul-28-AMZN.OQ-138879486315-Transcript.txt b/exam/original-files/Problem_1_Sample/2016-Jul-28-AMZN.OQ-138879486315-Transcript.txt new file mode 100644 index 0000000..7ea48ed --- /dev/null +++ b/exam/original-files/Problem_1_Sample/2016-Jul-28-AMZN.OQ-138879486315-Transcript.txt @@ -0,0 +1,436 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q2 2016 Amazon.com Inc Earnings Call +07/28/2016 05:30 PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Brian Olsavsky + Amazon.com, Inc. - CFO + * Darin Manney + Amazon.com, Inc. - Director of IR + +================================================================================ +Conference Call Participiants +================================================================================ + + * Victor Anthony + Axiom Capital - Analyst + * Douglas Anmuth + JPMorgan - Analyst + * Ray McDonough + Oppenheimer & Co. - Analyst + * Carlos Kirjner + Bernstein - Analyst + * Justin Post + BofA Merrill Lynch - Analyst + * Brian Pitz + Jefferies LLC - Analyst + * Gene Munster + Piper Jaffray & Co. - Analyst + * Youssef Squali + Cantor Fitzgerald - Analyst + * Heath Terry + Goldman Sachs - Analyst + * Colin Sebastian + Robert W. Baird & Company, Inc. - Analyst + * Eric Sheridan + UBS - Analyst + * Mark Mahaney + RBC Capital Markets - Analyst + * Brian Nowak + Morgan Stanley - Analyst + * Ross Sandler + Deutsche Bank - Analyst + * Mark May + Citigroup - Analyst + +================================================================================ +Presentation +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- +Thank you for standing by. Good day, everyone, and welcome to the Amazon.com Q2 2016 financial results teleconference. At this time all participants are in a listen only mode. After the presentation we will conduct a question-and-answer session. Today's call is being recorded. For opening remarks, I will be turning the call over to the Director of Investor Relations, Darin Manney. Please go ahead. + +-------------------------------------------------------------------------------- +Darin Manney, Amazon.com, Inc. - Director of IR [2] +-------------------------------------------------------------------------------- +Hello and welcome to our Q2 2016 financial results conference call. Joining us today is Brian Olsavsky, our CFO. We will be available for questions after our prepared remarks. +The following discussion and the responses to your questions reflect management's views as of today July 28, 2016, only, and will include forward-looking statements. Actual results may differ materially. Additional information about factors that could potentially impact our financial results is included in today's press release and our filings with the SEC, including our most recent annual report on form 10K and subsequent filings. +As you listen to today's conference call, we encourage you to have our press release in front of you, which includes our financial results as well as metrics and commentary on the quarter. During this call we will discuss certain non-GAAP financial measures. In our press release, slides accompanying this webcast and our filings with the SEC, each of which is posted on our IR website, you will find additional disclosures regarding these non-GAAP measures including reconciliations of these measures with comparable GAAP measures. +Please note, unless otherwise stated, all comparisons in this call will be against our results for the comparable period of 2015. Now I will turn the call over to Brian. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com, Inc. - CFO [3] +-------------------------------------------------------------------------------- +Thanks, Darin. I'll begin with comments on our second-quarter financial results. +Trailing 12-month operating cash flow increased 42% to $12.7 billion. Trailing 12-month free cash flow increased to $7.3 billion, up from $4.4 billion. Trailing 12-month free cash flow, less lease principal repayments, increased to $3.9 billion, up from $2.4 billion. Trailing 12-month free cash flow, less financed lease principal repayments and assets acquired under capital leases, increased to $2.5 billion, up from an outflow of $492 million. +Worldwide revenue increased 31% to $30.4 billion or 30% excluding the $166 million favorable impact from year-over-year changes in foreign exchange. Worldwide paid unit growth was 28%. Worldwide seller units represented 49% of paid units. +Now I will talk about our segment results. North America revenue grew 28% to $17.7 billion. North America operating income was $702 million, a 4% operating margin, compared with $348 million in the prior year. This includes $5 million of favorable impact from foreign exchange. +International revenue grew 30% to $9.8 billion. Excluding the $184 million year-over-year favorable foreign exchange impact, revenue growth was 28%. International operating loss was $135 million, compared with a loss of $189 million in the prior year. This includes $40 million of favorable impact from foreign exchange. +Amazon Web Services revenue grew 58% to $2.9 billion. Amazon Web Services operating income was $718 million, a 24.9% operating margin, compared with $305 million in the prior year. Our operating income was $1.3 billion, or 4.2% of revenue, up approximately 220 basis points year over year. This includes $45 million of favorable impact from foreign exchange. Net income was $857 million, or $1.78 per diluted share, compared with the net income of $92 million, or $0.19 per diluted share. +I'll conclude my portion of today's call with guidance. For Q3 2016, we expect net sales of between $31 billion and $33.5 billion, or growth of between 22% and 32%. This guidance anticipates approximately 30 basis points of favorable impact from foreign exchange rates. Operating income to be between $50 million and $650 million, compared with $406 million in third quarter 2015. +We are grateful to our customers and remain heads-down focused on driving a better customer experience. We believe putting customers first is the only reliable way to create lasting value for shareholders. Thanks, and with that I will hand it back to Darin. +Thank you, Brian. Before we move to questions I need to remind you that our guidance incorporates the order trend that we've seen to date, and what we believe to be appropriate assumptions. +Our results are inherently unpredictable and may be materially affected by many factors including fluctuations in foreign exchange rates, changes in global economic conditions and customer spending, world events, the rate of growth of the Internet, online commerce and cloud services and the various factors detailed in our filings with the SEC. +Our guidance also assumes that we do not conclude any additional business acquisitions, investments, restructurings or legal settlements and that foreign exchange rates remain approximately where they have been recently. It is not possible to accurately predict demand for our goods and services, and therefore, our actual results could differ materially from our guidance. +With that let's move to the Q&A portion of the call. Operator, please remind our listeners how to initiate a question. + + +================================================================================ +Questions and Answers +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com, Inc. - CFO [1] +-------------------------------------------------------------------------------- +At this time, we will now open the call up for questions. In the interest of time, we ask that you limit yourself to one question. +(Operation Instructions) +Thank you. Our first question is from Mark May of Citi. Please proceed. + +-------------------------------------------------------------------------------- +Mark May, Citigroup - Analyst [2] +-------------------------------------------------------------------------------- +Thanks for taking my question. We've noticed some data points out there that suggest that you're accelerating your build-out of fulfillment capacity in North America and obviously also in India. Can you give us a sense of what sort of impact that, that might have in the near to mid-term on your CapEx, depreciation and ultimately CSOI? Especially as it relates to your Q3 guidance? And then just a maintenance question, how much is FX impacting your Q3 guidance? Thanks. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com, Inc. - CFO [3] +-------------------------------------------------------------------------------- +Okay. Thanks, Mark. Yes, let me talk a little bit about guidance, and I'll incorporate the answer to the fulfillment question. So, you'll notice on the top line guidance of $31 billion to $33.5 billion or 22% to 32% growth incorporates the Prime Day results and I can talk more about that later. But Prime Day was very successful for us. It was up 60% on a worldwide basis over the prior year, and it was also a record day for our Amazon devices, as well as sellers and customers alike. +In the bottom line, you'll need to remember that Q3 is a typically a lower operating income quarter as we prepare for Q4, the holiday peak. It's a little bit more exaggerated this year in that we're opening 18 fulfillment centers this quarter. To put that in perspective, we launched six in Q3 of last year. This will bring us up to 21 net FCs for the year by the end of Q3, and that compares with 10 fulfillment centers for the first three quarters of last year on a net basis. So, why are we expanding so much? If you remember back to Q4 and the capacity constraints we had in Q4, primarily due to really strong FBA growth, we talked a lot in the Q4 call about the operational cost of that in Q4. Customers are well taken care of, but we had additional fulfillment costs from being so tight on capacity. +This year, with that in mind and then knowing that our growth rate is actually accelerating on a unit basis, we are - Q2 was 28% unit growth for paid units, but fulfilled by - units fulfilled by Amazon is much higher than that due to the growth of Prime and FBA. That compares with last year in Q2 when we saw 22% unit growth. So we're 600 basis points faster growth in Q2 this year than last year and that 22% last year turned into 26% in Q4. So it ramped up in the back end of the year. +So a lot of data points there, but the bottom line is that there's a large step up in the amount of fulfillment capacity in Q2 - excuse me, Q3 versus Q2. There's a couple of other factors while I'm at it for guidance. We are also nearly doubling our content spend in the second half of this year versus the second half of 2015. We have a great slate of new Amazon Originals coming out later this year, both in the US and internationally, and we're nearly tripling our number of new Amazon Original shows - TV shows and movies compared with the second half of last year. There are other investments, certainly, that are increasing sequentially. I'd point to India and AWS, but primarily the two biggest issues in Q3 guidance I would say are the operational ramp and also the increase in digital content spend. + +-------------------------------------------------------------------------------- +Darin Manney, Amazon.com, Inc. - Director of IR [4] +-------------------------------------------------------------------------------- +And, Mark, to follow up on the other question, our net sales guidance anticipates approximately 30 basis points of favorable impact from foreign exchange rates. + +-------------------------------------------------------------------------------- +Mark May, Citigroup - Analyst [5] +-------------------------------------------------------------------------------- +And, Brian, where does that bring your video content spend to with the doubling in the second half if we look at it on an annualized basis? + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com, Inc. - CFO [6] +-------------------------------------------------------------------------------- +We're not disclosing that at this time. + +-------------------------------------------------------------------------------- +Mark May, Citigroup - Analyst [7] +-------------------------------------------------------------------------------- +Thanks. + +-------------------------------------------------------------------------------- +Operator [8] +-------------------------------------------------------------------------------- +Our next question comes from Douglas Anmuth from JPMorgan. Please state your question. + +-------------------------------------------------------------------------------- +Douglas Anmuth, JPMorgan - Analyst [9] +-------------------------------------------------------------------------------- +Thanks for taking the questions. I just want to go back to Prime Day for a minute. I didn't hear any commentary around new Prime members in particular. Obviously a lot of other metrics that you gave but hoping you could provide a little bit more color around that. +And then also, is there anything else that stood out in terms of what you learned around operations and systems ahead of the holiday season? And then just going back to the 3Q guide, what's the right way for us to think about stock-based comp in the third quarter and if we looked at your 2Q numbers, is that a fair assumption for what you're thinking about? Thanks. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com, Inc. - CFO [10] +-------------------------------------------------------------------------------- +Sure. Let me circle back on Prime Day. So again, it was the biggest global day ever for Amazon and was up 60% on a order product sales basis versus Prime Day 2015. It was a record day for Amazon devices. It was a great day for small businesses and sellers who saw great year-over improvement in their sales. And more importantly, it was a great day for customers. Globally they saved over double what they had saved in Prime Day 2015. +So we're very pleased with the results of Prime Day, and the impact of Prime Day is factored into this guidance. As far as new customers and new Prime members, we're not disclosing that, but suffice to say that it was a great day for both existing Prime members and also new customers who were trying us out for the first time. + +-------------------------------------------------------------------------------- +Darin Manney, Amazon.com, Inc. - Director of IR [11] +-------------------------------------------------------------------------------- +And on the stock-based compensation, you'll recall beginning in Q1 this year, we began allocating stock-based compensation and other operating expense to our North America, international and AWS segments. So we're including that in our guidance on operating income and have not separately guided to stock-based comp and other income expense this quarter. + +-------------------------------------------------------------------------------- +Operator [12] +-------------------------------------------------------------------------------- +Our next question comes from Gene Munster from Piper Jaffray. + +-------------------------------------------------------------------------------- +Gene Munster, Piper Jaffray & Co. - Analyst [13] +-------------------------------------------------------------------------------- +Hello, good afternoon. First, love the conference call format here. Get right to it. In terms of questions, the customer count, can you give us a little bit of guidance on that? And then also talk about the theme of automated consumption and separately, the importance of Prime Now and how you can grow those SKUs. Thanks. + +-------------------------------------------------------------------------------- +Darin Manney, Amazon.com, Inc. - Director of IR [14] +-------------------------------------------------------------------------------- +Hi, Gene. This is Darin. I'll start with the customer accounts. As we noted again in our Q1 release, our active customer accounts exceeded 300 million. However, today we're not going to update that number. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com, Inc. - CFO [15] +-------------------------------------------------------------------------------- +To your question on Prime Now, so I will point out Prime Now is now in more than 40 metro areas worldwide. In the past quarter we expanded further internationally to Germany, Spain and France, so it's a global program, again, offering free two-hour delivery on tens of thousands of items. We also have in the same vein of, I think what you called maybe automated consumption, the same day has expanded. Now we've added 11 metro areas, bringing the total to 27 metro areas that are qualified for same day. +So, yes, we think this is an important part of our Prime offering. We know customers love it. We're very happy with their order patterns from Prime Now, and very happy with it. Of course, we do always talk about - we always usually get asked about profitability, and it is a very hard service to deliver and make money on. But we know customers love it and we're in a great position to do this because of our long-term approach, our drive of greater efficiencies and our proximity to the customer with our vast global FC network. + +-------------------------------------------------------------------------------- +Operator [16] +-------------------------------------------------------------------------------- +Our next question comes from Heath Terry from Goldman Sachs. + +-------------------------------------------------------------------------------- +Heath Terry, Goldman Sachs - Analyst [17] +-------------------------------------------------------------------------------- +Great, thanks. I was wondering as it relates to the Q3 guidance, can you give us a bit of a sense of just how we should think about margins in the AWS business, especially as the next eight availability zones roll out? Presumably that kind of increase in capacity likely has an impact on margins, but would appreciate any direction you can share on how to think about that. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com, Inc. - CFO [18] +-------------------------------------------------------------------------------- +Sure. We don't give - obviously we don't give segment-based guidance. But to your question about AWS, we actually see nine availability zones in four regions coming out in the next - in the coming year. The impact on short-term is pretty much indistinguishable from the growth that we're seeing in our expansion of our base customers in our existing regions, so we don't see a large step-up from the addition of new regions relative to the large and rapid growth in the business itself. +We do think that it does pay benefits both for ourselves and for our customers because of the expansion, and we're happy to have added the region in Mumbai this past quarter. We think when we expand geographically, existing customers will run more of their workloads on AWS. Sometimes they have local latency concerns or security issues that require them to run things in their country, so that helps. And we also open up to new customers when we add these regions. So not a large impact on Q3 guidance, but certainly an exciting investment for our customer base. + +-------------------------------------------------------------------------------- +Operator [19] +-------------------------------------------------------------------------------- +Our next question comes from Carlos Kirjner with Bernstein. + +-------------------------------------------------------------------------------- +Carlos Kirjner, Bernstein - Analyst [20] +-------------------------------------------------------------------------------- +Thank you. Two questions if I may. As I look at your tech and content expense as a percentage of revenues, we see year-on-year decline for the last two quarters, which is something we hadn't seen since mid-2010, and of course it's reflected in the AWS margins. Can you help us understand what has driven this significant change in relative trajectory in tech and content expenses? And the second question is, why is it that the rate at which you are deploying Prime Now is so much greater or faster than the rate at which you are deploying Fresh? What's different between them and how is it that you are deploying Fresh in new markets but not as fast as Prime Now, and what drives the difference? Thank you. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com, Inc. - CFO [21] +-------------------------------------------------------------------------------- +Sure. On tech and content, that's going to be a combination of our people cost related to many areas of the website and also the infrastructure cost to run it, at both the Amazon Web Services and also the Amazon site. We've been seeing some great efficiencies in our infrastructure, both internally as Amazon and also as part of AWS. We have great people working on not only better efficiency, but also driving cost out of our acquisition prices. So, there's a lot of great work going on there and I think that's what you're seeing reflected in the tech and content line. Again, this can fluctuate quarter-to-quarter, but we're happy with the current trend and you see it in the AWS margins. +On Prime Now versus Fresh, they are separate - sorry. The - we'll point out in Q2 that we added London and Boston as two new sites in London for AmazonFresh, and that was the first international location. But we've been running AmazonFresh for seven years, or excuse me, since 2007 in Seattle. And what you've seen as we've been testing the model, we've been expanding in North America and more so we've been expanding within the cities that we're in, adding zip codes, adding additional customers. So, the move into Boston and also now into London give us some really good data points and as - it's a great customer feature for the Prime offering. +Prime Now is a little bit easier to build up from scratch, I would say. The - it has a different purpose, although some of the products overlap. Again, this is more about immediacy of one-hour and two-hour delivery of a curated list of important products that people need in a short period of time. So, they have different roles. Some of the products overlap, of course, but we're happy with both, and we think that customers like both of them. + +-------------------------------------------------------------------------------- +Operator [22] +-------------------------------------------------------------------------------- +Our next question is from Brian Nowak from Morgan Stanley. + +-------------------------------------------------------------------------------- +Brian Nowak, Morgan Stanley - Analyst [23] +-------------------------------------------------------------------------------- +Thanks for taking my questions. I have two. The first one is on the Echo. Anything you could share at all on some of the most commonly used searches? How are consumers using the Echo as of now most commonly, and then anything on uplift in purchase behavior from Echo households? And the second one on Prime, on AWS margins, can you just walk us through some of the puts and takes that have been driving the AWS margin expansion we've seen in the first half of this year? Is it utilization, product mixes? What's been driving the margin expansion? Thanks. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com, Inc. - CFO [24] +-------------------------------------------------------------------------------- +Sure. Well, in Echo, again, we continue to build out the list of devices, launching the Dot and Tap and Fire TV skills this past year. And now we have 1,900 third-party skills for the Alexa, including new skills from Kayak, Lyft, NBC, Honeywell and more. So there's a lot of uses that we're seeing for Echo. A lot ties into our Prime Music offering. It's just a great way to access Prime Music and more and more the Amazon site. We don't have anything to disclose on physical orders from - through - excuse me, orders through Echo. +On Amazon Web Services margin, again, this is primarily due to efficiencies gained on our infrastructure, better utilization, better cost out. There is a - certainly a mix of products and services. I don't have a bridge for you on whether that's helpful or hurtful, but the - these margins in AWS will fluctuate from quarter to quarter, and that's what you're seeing. But we're very happy with the year-over-year improvement. + +-------------------------------------------------------------------------------- +Operator [25] +-------------------------------------------------------------------------------- +Next question is from Mark Mahaney from RBC Capital Markets. + +-------------------------------------------------------------------------------- +Mark Mahaney, RBC Capital Markets - Analyst [26] +-------------------------------------------------------------------------------- +Okay. Brian, could you give us some whys as to the revenue growth acceleration that you're seeing, a little more color about the revenue growth acceleration in North American retail and in international retail? I remember last quarter you called out really starting to see, I don't know, critical mass, tipping point, whatever the buzzword is, from Prime and from FBA in international markets. Is that what's continuing, I assume, to drive that re-acceleration in any geographic country comments behind that? Thanks a lot. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com, Inc. - CFO [27] +-------------------------------------------------------------------------------- +Sure. Yes, I have the same buzzwords for you, Mark. It's really -- the flywheel of Prime is definitely working. It's as simple as that. The low prices, vast selection and convenience continue to resonate with customers. Prime membership increases and selection through FBA makes Prime more valuable. So it's a bit as simple as that in the consumer business in North America and international, we are seeing great acceptance of Prime and usage of Prime benefits. We continue to expand the list of Prime benefits for customers to make it more valuable, and none is more valuable than FBA, which we've talked a lot about the value of Prime to FBA and vice-versa. +FBA is bringing more Prime-eligible selection to Prime and then the growth of Prime and the type of customers that utilize Prime and their buying behavior is a great traction for other FBA sellers. So that is essentially what we're seeing, and we're certainly pleased with the customer response to those offers globally. + +-------------------------------------------------------------------------------- +Operator [28] +-------------------------------------------------------------------------------- +Our next question comes from Youssef Squali from Cantor Fitzgerald. + +-------------------------------------------------------------------------------- +Youssef Squali, Cantor Fitzgerald - Analyst [29] +-------------------------------------------------------------------------------- +Thank you. Two questions, please. Brian, your operating income has been come in stronger than expectations, but more importantly, stronger than your own guidance, at least in the last couple of quarters. I was just wondering as you look back at where you guided relative to actual, where do you think that delta was most pronounced? Why wouldn't we assume that maybe, at least on the margin, the investment intensity in the business has maybe decelerated a bit? +And second, on Prime Video, just was wondering, considering what the main competitor there is doing, i.e., expanding aggressively around the world, you guys have been growing in a more measured manner, is that still the plan or are you guys interested in maybe instead of moving into a few countries, expand globally in one fell swoop? That's it. Thanks. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com, Inc. - CFO [30] +-------------------------------------------------------------------------------- +Sure. Let me start with the second question first. So on Prime Video, again, we're very happy with the customer adoption of Prime Video, and we know the customers love it. We like the results that we see, particularly with the free trial conversion, the renewal rates for subscriptions. So it's clearly working. I mentioned earlier how we're doubling the investment rate in the second half of the year versus last year's second half, and we're tripling the Amazon Originals content. +That Originals content for TV and movies, that content can be used globally. We've talked a bit about our Prime launch in India, and alluded to the fact that we'll be having video soon in India, but local content and also Amazon Originals. So, stay tuned for that. I don't have any more to announce on that today. On the variance to guidance, what I'll say is, we came in the very high end of our revenue guidance. I would say that our business model usually reacts well to high volume as we get a really good leverage on our fixed expenses. So that's part of what we saw, very strong operating efficiencies as we hit essentially the highest end of our revenue guidance. +But we do have a lot of diverse profit streams here at Amazon and a lot of investments going on at any point in time. I think I heard a question there about level of investment. We continue to invest heavily. In fact, I just called out a few things that are going to be stepping up in investment levels in Q3, mostly ops and digital content. So we continue to invest on behalf of customers. But we also work very hard at efficiencies and scaling the businesses that we have. So we take both roles very seriously around here, investing on the right - in the right things, seeing results on behalf of customers, and also driving efficiencies. And there can be timing, quarter-to-quarter, the operating margin and levels of investment can fluctuate, but certainly continue to expand. + +-------------------------------------------------------------------------------- +Operator [31] +-------------------------------------------------------------------------------- +Our next question comes from Jason Helfstein from Oppenheimer. Mr. Helfstein, your line is live. + +-------------------------------------------------------------------------------- +Ray McDonough, Oppenheimer & Co. - Analyst [32] +-------------------------------------------------------------------------------- +Hi. Sorry about that. This is Ray McDonough on for Jason Helfstein. Just on the AWS side, we've been hearing a lot of talk and especially a lot of media reports that larger customers tend to use AWS, they might use Google and Microsoft Azure in tandem in a multi-cloud kind of architecture. Just wondering your thoughts on how you see AWS fitting in the overall ecosystem and kind of your place longer term in the ecosystem. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com, Inc. - CFO [33] +-------------------------------------------------------------------------------- +Sure. Well, first of all, we believe customers will choose AWS primarily for three factors, the functionality and pace of innovation that we bring to the table, our partner and customer ecosystem and our experience. We've been in this business longer than anyone. Having said that, there's plenty of room for multiple winners in this business. What we focus on is innovating on behalf of customers and expanding the geographic footprint to make our services more widely available. +You can see us continue to invest in things like new application services, higher up the stack, additional technologies that will make integrating with AWS seamless for those companies that have a hybrid IT environment and then continuing to add functionality for data analytics, mobile, Internet of things, machine learning offerings, things like that, that will add greater and greater value for AWS customers. And I would say the rapid pace of innovation continues to stretch our lead in that dimension. We have had 422 new significant services and features added in the first half of this year. That's a faster pace than last year when we added 722 services and features. So we feel good about the business position we're in and our position with customers. + +-------------------------------------------------------------------------------- +Operator [34] +-------------------------------------------------------------------------------- +Our next question comes from Colin Sebastian from Robert W. Baird. + +-------------------------------------------------------------------------------- +Colin Sebastian, Robert W. Baird & Company, Inc. - Analyst [35] +-------------------------------------------------------------------------------- +Okay. Thanks, guys. As another follow up on the margins, I was hoping you could comment on any impact from the investments and build out of enhanced transportation capabilities including the air cargo leases. And then secondly, was hoping you could identify any categories within EGM that are becoming more meaningful drivers of growth or at least are an increasing focus on the retail side? Thank you. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com, Inc. - CFO [36] +-------------------------------------------------------------------------------- +Yes, sure. First, on EGM, I'll just say the growth is across a lot of different products, none to exactly call out here, and we think that a lot of it is, of course, driven by the growth of Prime itself. EGM in North America grew 32%, which was higher than the revenue growth rate, and also grew 36% internationally. So when people join Prime, they are certainly buying EGM in strong quantity. So that continues to grow with the growth of the Prime program. +On transportation, I think your question was about whether that's impacting our short-term results. No, the answer is no. We are certainly expanding our service offerings in the transportation side and we have been for many years, things like sortation centers and delivery methods. The plane deal that we were talking about is essentially planes that we're going to be leasing from other companies, and you'll hear more about that as we go forward, but that is to essentially take on the demand for internal flights as we move product around. It certainly will be well utilized. + +-------------------------------------------------------------------------------- +Operator [37] +-------------------------------------------------------------------------------- +Our next question comes from Brian Pitz from Jefferies. + +-------------------------------------------------------------------------------- +Brian Pitz, Jefferies LLC - Analyst [38] +-------------------------------------------------------------------------------- +Thanks for the questions. First, on FC build out, is the cost of building centers scaling over time given the use of Kiva, other technologies or general learnings, or are those costs still relatively consistent? And also, we noticed some device sellout in the next four to five weeks, post-Prime Day. Was this a bit of a planned inventory reduction for some of the devices or did volumes take you by surprise here? + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com, Inc. - CFO [39] +-------------------------------------------------------------------------------- +I will start with the second question. So I would just say Prime Day had enormous impact on the device business and devices were well featured and also well adopted by customers. So it was the largest device sales day that we've ever had and essentially pretty much across all of our device types, E-readers, tablets, Fire TV and Echo. +And I'm sorry, your first question was around - the cost of fulfillment centers. Not disclosing that we do continue to change our fulfillment centers. We've changed, again, the automation, the size, the scale many times and we continue to learn and grow there. So no general trends I can point to on cost per fulfillment center to start up, but because they do vary in size and mission and some have fully outfitted in using Amazon Robotics, others - some don't for economic reasons. Maybe the volume is not perfect for robot volume. But, yes, so I can't give you any real distinct trends there. + +-------------------------------------------------------------------------------- +Operator [40] +-------------------------------------------------------------------------------- +Our next question is from Justin Post from Merrill Lynch. + +-------------------------------------------------------------------------------- +Justin Post, BofA Merrill Lynch - Analyst [41] +-------------------------------------------------------------------------------- +Great. Thank you. First on the customers, I'm guessing - I'm wondering why you aren't giving the number, a lot of people use it for their models. And then second thing, when you look at the US Prime penetration versus total US customers, how do you feel about that and do you think there's still a lot of room for Prime growth in the US? Thank you. + +-------------------------------------------------------------------------------- +Darin Manney, Amazon.com, Inc. - Director of IR [42] +-------------------------------------------------------------------------------- +Hi, Justin. This is Darin. I'll comment on the customer accounts again. We may consider updating that in the future, but really we encourage you and our investors to look at our free cash flow measures, our revenue and our GAAP operating profit since our customer purchasing behavior can vary. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com, Inc. - CFO [43] +-------------------------------------------------------------------------------- +And on Prime penetration, of course, we haven't released Prime subscription levels. We have talked about growth certainly globally and in North America. What I can tell you there is we still think there's a lot of room in Prime. We've tailored programs to students, we've tailored video programs, we've rolled out monthly plans, we have plans with grocery delivery. +So there's a lot of different flavors of Prime and we are aggressively looking for a perfect Prime for everybody. We know that, again, when customers try Prime, they like it. So it's really just about getting them to try Prime and continuing to deliver great Prime benefits and great low prices and selection. + +-------------------------------------------------------------------------------- +Operator [44] +-------------------------------------------------------------------------------- +Our next question comes from Ross Sandler from Deutsche Bank. + +-------------------------------------------------------------------------------- +Ross Sandler, Deutsche Bank - Analyst [45] +-------------------------------------------------------------------------------- +Thanks, guys. I just had two. First as a follow up on the logistics topic. So, in addition to the cargo planes you just mentioned for in-network moving products around, you guys have registered and received a US maritime license to operate as a freight forwarder and you recently announced this partnership with the UK for drone delivery that you've been working for a couple years. At a high level, can you just talk about how the overall logistics strategy is evolving from trucks and fulfillment centers to incorporate some of these new methods and how that might impact your unit costs going forward? +And then the second question's on AWS. So you continue to put up really strong results, and you guys obviously talk to a lot of customers across lots of different verticals. Just a high level, what percent of enterprise workloads do you think have shifted to the public cloud at this stage? Is it low-single digit to mid-single-digit? And any color there on where we are in terms of penetration in the space. Thank you. + +-------------------------------------------------------------------------------- +Darin Manney, Amazon.com, Inc. - Director of IR [46] +-------------------------------------------------------------------------------- +So thank you, Ross. This is Darin. Let me take that first question. On Prime Air in the UK, we've been working with and developing Prime Air for some time to develop a rapid delivery system that is safe, environmentally sound and it really enhances the services that we provide for millions of customers. And we're extremely happy to partner with the UK government to advance the safe use of drones for small parcel delivery. This is providing us with permission to trial new methods in the space, including beyond line-of-sight operation, sense-and-avoid technologies and flights where one person operates multiple drones. +So we definitely appreciate the pragmatic and forward-looking approach on this topic with the UK, and we're going to continue to work with regulators and policymakers in many countries, including the US, so we're excited about there. As for the ocean-going licenses, we have no comment on that today. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com, Inc. - CFO [47] +-------------------------------------------------------------------------------- +As far as AWS, essentially penetration question you asked. We think still very early. Again, we like our position, our industry leading position in the cloud space, and we're working on things that would incent more and more customers to accelerate their cloud conversion. The lower prices and services that we offer, and as I said, we'll work on things that will make it easier and easier for customers to work with us with their hybrid data centers or transfer their volume to us. + +-------------------------------------------------------------------------------- +Operator [48] +-------------------------------------------------------------------------------- +Our next question comes from Eric Sheridan from UBS. + +-------------------------------------------------------------------------------- +Eric Sheridan, UBS - Analyst [49] +-------------------------------------------------------------------------------- +Thanks for taking the questions. Maybe one clarification and one big picture topic. On the clarification, appreciate the disclosure on content and how that'll double year-on-year in the second half. For purposes of just making sure we can understand the trajectory, is there any way to frame it within second half of this year versus first half of this year, just so we can try to triangulate on a gross margin basis from the content spend? And the bigger picture topic would be China, hasn't come up yet on the call. I wanted to understand your latest thoughts there on either the competitive landscape, relative positioning in China and how you think about investments in China. Thank you. + +-------------------------------------------------------------------------------- +Darin Manney, Amazon.com, Inc. - Director of IR [50] +-------------------------------------------------------------------------------- +So, hi, Eric. This is Darin. I'll take the second question on China. So we continue to operate well in China. We see China as a - and the way we're approaching China as a way to - a trusted avenue for our Chinese customers to access authentic international brands and we'll focus on those global brands and bringing those to Chinese customers. Offerings like the Amazon Global Store where Chinese customers can access those international brands on the China website and have them shipped directly to their houses is something we're focused on. So, yes, it's still early days and some of those experiments that we're doing, but we're seeing good traction on those things and we like that. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com, Inc. - CFO [51] +-------------------------------------------------------------------------------- +Yes, and on the content spend, I think the only other data point I can give you is probably a dated one at this point, but we spent $1.3 billion in 2014, that's the last number that we disclosed and we continue to add content. The best I can give you at this point is that it will be double, nearly double what we spent in the second half of 2015. + +-------------------------------------------------------------------------------- +Operator [52] +-------------------------------------------------------------------------------- +Our final question will come from Victor Anthony from Axiom. + +-------------------------------------------------------------------------------- +Victor Anthony, Axiom Capital - Analyst [53] +-------------------------------------------------------------------------------- +Thanks for putting me on. Maybe I'll just ask a question about India. You called out India was - you had the most visited e-commerce site as well as the most downloaded mobile app, and you also launched Prime. So maybe you could just talk about the opportunities and the challenges that you see in that market. And second, there was some press reports that you invested about $500 million of incremental capital in Italy. I was wondering, what are you seeing in that market that justifies that level of investment? + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com, Inc. - CFO [54] +-------------------------------------------------------------------------------- +Sure. So India, we're very encouraged by what we've seen so far in India, both with customers and also sellers; that's a third-party seller market. You heard that we launched the Prime program this week, which will be a whole new experience for Indian customers. In hundreds of cities we'll now have unlimited free one-day and two-day delivery, and we also mentioned that Prime Video is coming there, both Indian and global content. +We're also starting to see exclusive online sales partnerships. Recently, we've had partnerships with Motorola, Samsung, Lenovo on select phones. But more importantly, again, we really like the opportunity in India. We like the initial results that we see from customers and also sellers. We really like our team there. We have a great team of Amazonians who've been very inventive in India. +Every time there's an obstacle or something that's different from the US or another major business, they'll invent around it, whether it's a shipping method or a payment method or whatever. So, very creative and the customer response has been really strong. So we are very excited about the Prime program. We think it'll enter into a new chapter in India, and we've seen great success in every country in the world that we've launched Prime, and we feel India is going to be no different. So we're looking forward to seeing what we can do on behalf of the Indian customer. + +-------------------------------------------------------------------------------- +Darin Manney, Amazon.com, Inc. - Director of IR [55] +-------------------------------------------------------------------------------- +And hi, Victor, this is Darin. On Italy, yes, we continue to invest in Italy and really throughout Europe to keep pace with the strong customer demand we see. Since opening Italy in 2010, we've invested over EUR450 million and created 1,700 jobs in Italy, and this increased investment will be to add future FC near Rome and other infrastructure assets. So, yes, this is really to support both the customers that we have there in Italy and throughout Europe, and we'll continue to invest in the coming years. +So thank you for joining the call today and for your questions. A replay will be available on our investor website at least through the end of the quarter. We appreciate your interest in Amazon.com and look forward to talking with you again next quarter. Thank you. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/exam/original-files/Problem_1_Sample/2016-Nov-02-FB.OQ-137048274923-Transcript.txt b/exam/original-files/Problem_1_Sample/2016-Nov-02-FB.OQ-137048274923-Transcript.txt new file mode 100644 index 0000000..d5c9963 --- /dev/null +++ b/exam/original-files/Problem_1_Sample/2016-Nov-02-FB.OQ-137048274923-Transcript.txt @@ -0,0 +1,420 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q3 2016 Facebook Inc Earnings Call +11/02/2016 05:00 PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Deborah Crawford + Facebook, Inc. - VP of IR + * Dave Wehner + Facebook, Inc. - CFO + * Mark Zuckerberg + Facebook, Inc. - CEO + * Sheryl Sandberg + Facebook, Inc. - COO + +================================================================================ +Conference Call Participiants +================================================================================ + + * Justin Post + BofA Merrill Lynch - Analyst + * Youssef Squali + Cantor Fitzgerald - Analyst + * Eric Sheridan + UBS - Analyst + * Brian Fitzgerald + Jefferies & Co. - Analyst + * Ross Sandler + Deutsche Bank - Analyst + * Heather Bellini + Goldman Sachs - Analyst + * Mark Mahaney + RBC Capital Markets - Analyst + * Brian Nowak + Morgan Stanley - Analyst + * Douglas Anmuth + JPMorgan - Analyst + * Mark May + Citigroup - Analyst + * John Blackledge + Cowen and Company - Analyst + * Peter Stabler + Wells Fargo Securities - Analyst + * Anthony DiClemente + Nomura Securities Intl - Analyst + +================================================================================ +Presentation +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- +Good afternoon. My name is Chris, and I'll be your conference operator today. At this time I'd like to welcome everyone to the Facebook third-quarter 2016 earnings call. +(Operator Instructions) +This call will be recorded. Thank you very much. Ms. Deborah Crawford, Facebook's Vice President of Investor Relations, you may begin. + +-------------------------------------------------------------------------------- +Deborah Crawford, Facebook, Inc. - VP of IR [2] +-------------------------------------------------------------------------------- +Thank you. Good afternoon, and welcome to Facebook's third-quarter 2016 earnings conference call. Joining me today to discuss our results are Mark Zuckerberg, CEO; Sheryl Sandberg, COO; and Dave Wehner, CFO. Before we get started I would like to take this opportunity to remind you that our remarks today will include forward-looking statements. Actual results may differ materially from those statements contemplated by these forward-looking statements. Factors that could cause these results to differ materially are set forth in today's press release and in our quarterly report on Form 10-Q filed with the SEC. Any forward-looking statements that we make on this call are based on assumptions as of today, and we undertake no obligation to update these statements as a result of new information or future events. +During this call we may present both GAAP and non-GAAP financial measures. A reconciliation of GAAP to non-GAAP measures is included in today's earnings press release. The press release and an accompanying investor presentation are available on our website at investor.FB.com. Now I'd like to turn the call over to Mark. + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook, Inc. - CEO [3] +-------------------------------------------------------------------------------- +Thanks Deborah, and thanks everyone for joining today. We had another good quarter. Our community continues to grow around the world. We're pleased to see nearly 1.8 billion people now use Facebook every month, and nearly 1.2 billion people use it every day. It's also great to see the continued growth and strength of engagement on our platform. And our ads growth is growing at a healthy rate as well. Total revenue grew by 56% year over year to $7 billion. And advertising revenue is up 59% to $6.8 billion. +I want to start by talking about our work around putting video first across our app. People are creating and sharing more video. And we think it's pretty clear that video is only going to become more important. So that's why we're prioritizing putting video first across our family of apps and taking steps to make it even easier for people to express themselves in richer ways. One way we're putting video first is through live video on Facebook. Since May the number of people going live at any given moment has grown by 4 times. People have gone live from all seven continents, and also from outer space. +Another recent example is Instagram Stories, which we launched in August. Instagram Stories is a lightweight way for people to share moments of their day through photos and videos that appear in a slideshow format and disappear after 24 hours. Stories now has more than 100 million daily actives. We also improved the explore tab in Instagram to include more videos in stories, and it has 100 million daily actives now as well. In addition to making it easy to share video, we also want to make it easier to capture video. In most social apps today, a text box is still the default way we share. Soon, we believe a camera will be the main way that we share. We're already testing this in our main Facebook app with a version that has a camera directly just one swipe away from newsfeed with creative effects for your photos and videos. And in Messenger we're testing new camera and video features. We'll be experimenting with even more visual messaging tools over the next few months, as well. So those are a few examples of some of the things that we're doing to put video first across our family of apps. +Now I'll give you an update on our progress over our 3-, 5-, and 10-year time horizon. Over the next three years we're focusing on making our core services more useful and engaging. The 2016 Summer Olympics were huge on Facebook, with more than 270 million people creating 1.5 billion interactions. Facebook helped bring the world together. And athletes, fans, media went live throughout the Games, including athletes who went live from the Olympic Village, and Michael Phelps who even announced his retirement on our platform. +This election season has also driven a lot of conversations, including on Facebook where we've made it easier for voters and candidates to communicate with each other. In the first nine months of this year 109 million people on Facebook in the US generated over 5.3 billion posts, comments and likes ands shares related to the election. During the primaries and in September, we also added a register-to-vote link at the top of our Facebook app that we estimate helped more than 2 million people register to vote, some who were registering for the first time. Facebook really is the new townhall. And we're proud of the role that we've played in enabling dialogue and increasing civic engagement. That's the three-year update. +Over the next five years we're going to keep building ecosystems around products that a lot of people already use every day. Instagram, Messenger and WhatsApp each have large communities. But we have a lot more work to do on all of them. I think about our progress here in three phases. The first phase is building a great consumer experience and getting it to scale. The second phase is about enabling people to organically interact with businesses. And then the third phase is to give businesses tools to reach more people. That's where we build our business. +Right now Instagram has moved into that third phase. Instagram has more than 500 million monthly actives and more than 300 million daily actives. We're making good progress helping businesses and marketers use Instagram in new ways. And Sheryl will talk more about that in a few minutes. Messenger is early in the second phase. We're helping businesses and consumers increasingly interact in richer ways. To date there are 33,000 bots live on Messenger. We also launched Messenger Light, which is designed to make messaging fast and easy with a wide variety of Android phones and for people who are slower networks as well. A lot of businesses use WhatsApp already. But we're going to really start working on the second phase in the next. Right now we're testing new camera features and we're continuing to keep features fast and reliable on multiple devices in every network condition. +Finally, we're starting to build communities around completely new apps. This quarter we launched Workplace to help make organizations more connected and productive. Workplace is a communications platform that uses features that people know, like newsfeed, groups and messages to help them collaborate and share at work the same way that they do ever else. Already more than 1,000 organizations are using Workplace including Starbucks, Royal Bank of Scotland, and (inaudible), and we're adding more all the time. +We're also getting new services to scale in the core app. In October we also launched the Marketplace tab to help people discover, buy and sell things with people in their community. While we just launched Marketplace, many millions of people have been buying and selling things in Facebook for sale groups for a while. We think this is going to be an important tool going forward. +Over the next 10 years we're going to continue to invest in the platforms and technologies that will connect more people in more places and allow everyone in the world to have a voice. We focused our long-term innovation road map around three areas: connectivity initiatives that bring more people online, artificial intelligence, and virtual and augmented reality. On connectivity, through our efforts with Internet.org, we've connected 40 million people, based on our best estimates. And we're making good progress with our Express Wi-Fi program which empowers entrepreneurs to build a business by providing their community with access to the internet. On artificial intelligence we're starting to see the impact that AI can have on enhancing people's experiences on Facebook and showing them more of what they care about. More than 40 teams at Facebook and more than 25% of our engineers are already using AI to power the products and services they build. We've made changes to and improvements to our AI in order to filter out misleading clickbait stories from newsfeed. And we're using AI to help find terrorist propaganda on Facebook. It's still early, but we think that AI will help improve the quality of what people see and can share on our platform. +We also took some important steps forward on virtual reality to help people experience the world in richer and more immersive ways. At Oculus Connect we announced that touch controllers for Rift will ship in early December with 35 games and experiences exclusively built for touch. Since we believe the next phase of VR is great software experiences, we're investing another $250 million in virtual reality content on top of the money that we've already invested. +So this was a very busy third quarter. And 2016 is shaping up to be a year of important progress for Facebook. Our business is performing well. And while I'm happy about what we've accomplished, we're really just getting started. We want to continue to invest aggressively to accomplish our goals, which is why we're hiring, especially in engineering, which is going to be one of our top priorities going into 2017. Dave will say more about this in his remarks. Everything we do is about opening the world to everyone and helping more people to connect and share. So I want to thank our entire community, all of our teams, our partners, and our shareholders for being a part of this journey with us. Now here's Sheryl. + +-------------------------------------------------------------------------------- +Sheryl Sandberg, Facebook, Inc. - COO [4] +-------------------------------------------------------------------------------- +Thanks Mark, and hi everyone. We had a great third quarter. Q2 (sic) ad revenue grew 59%. Mobile ad revenue reached $5.7 billion, up 70% year over year, and was approximately 84% of total ad revenue. Our growth was broad based across all regions, marketer segments, and verticals. In Q3 we announced that we have over 4 million active advertisers on Facebook and over 500,000 active advertisers on Instagram. The number of advertisers on both platforms continues to grow quickly. And we're pleased to see more and more of them using the full range of our ad products. +We continue to focus on our three priorities: capitalizing on the shift to mobile, growing the number of marketers using our ads products, and making our ads more relevant and effective. First, capitalizing on the shift to mobile. People have shifted to mobile, and we remain focused on helping businesses catch up. We know that marketing shifts take time. The first TV ads showed people standing in front of microphones reading their radio ads. Similarly, many of the first mobile video ads were TV ads dropped into mobile. Ads optimized for each platform often perform better. So marketers are increasingly tailoring their creative for mobile. +We're excited to see the world's largest advertisers realize that the small screen is big. In September P&G Chief Brand Officer Mark Pritchard, GM CEO Mary Barra, and I addressed the Ad Week audience together. Mark described how P&G is creating mobile video ads designed to grab attention in the first few seconds. He shared the example of Tide. In a typical TV ad they start with a clean dress or shirt, show it getting stains, and then cleaned with Tide. On mobile they need to communicate the product value more quickly. So they start by showing Tide cleaning a stained garment. +Mary shared GM's success with Facebook Mobile video ad. In Q3 GM subsidiary Holden used Carousel Ads with video to maximize its sponsorship of Australia's Premier Rugby Tournament. Holden created a video series about their support of youth rugby. The ads generated an 8-point lift in brand favorability for the overall audience and a 15-point lift amongst their target audience of women over 35. For many small businesses a shift to mobile means leveraging video for the very first time. Rather than needing a camera crew and production budget, anyone with a smartphone can shoot a video and share it on Facebook. In the past month alone over 3 million small businesses have posted a video on Facebook, including organic posts and ads. +Our second priority is growing the number of marketers using our ad products. We continue to focus on our advertiser pipeline. In Q2 we announce that over 60 million businesses use our free Facebook pages product each month. And we introduced the Instagram equivalent, Business Profiles, which are being used by 1.5 million businesses. On past calls I've talked about product simplification as a driver of advertiser growth on Facebook. Now with the launch of promoted posts, we're seeing that on Instagram too. Like boosted posts on Facebook, promoted posts on Instagram are an easy way to start advertising. And we're pleased with adoption. Over 85% of business pages are active on mobile. We're making it easier for advertisers to manage campaigns from their phones. +In Q3 we added a feature that shows marketers a preview of a potential ad in newsfeed just as our customers would see it. They can then run the ad with just a few taps from their mobile device. Making it easy to advertise from a mobile phone is especially important in emerging markets. For businesses operating in areas with weak network connections, we continue to build advertising tools into Facebook Light, our low bandwidth app, and are making more of them available offline. +Our third priority is making our ads more relevant and effective. Our goal is to be the number one driver of growth (inaudible) for our clients. In Q3 we introduced tools to help businesses find people around the world who look like their current customers and target the ones most likely to convert. For example, SA Company, an outdoor gear and apparel business started by a young man out of his parents' home, used international look-alike targeting to reach customers in 32 countries and increase sales by 37%. We're focused on driving purchases online and in stores. In Q2 we launched estimated store visits, which show advertisers how many people came to their store after seeing an ad. And this quarter we made it possible for advertisers to optimize campaigns for in-store visits. We also expanded dynamic ads, a proven way to drive online sales for in-store retail objectives. Businesses can use dynamic ads for retail to show people the products available at their closest location in real time and reach people likely to visit their stores. To prove the value we're driving for our partners we continue to invest in measurement. This quarter we announced new third-party partnerships with Nielsen Datalogix, Visual IQ and Marketshare to help our clients measure how Facebook ads drive business results. +We're pleased with the value we're driving for our partners. And we remain focused on helping them make the shift to mobile. With only a small fraction of businesses on Facebook and Instagram advertising, we have a lot of opportunity in front of us. We also have a lot of hard work to do to help our partners around the world use mobile to drive their businesses. I want to thank our clients around the world for their partnership, and congratulate our global teams on the results of their continued focus and dedication. Thanks. And now here's Dave. + +-------------------------------------------------------------------------------- +Dave Wehner, Facebook, Inc. - CFO [5] +-------------------------------------------------------------------------------- +Thanks Sheryl, and good afternoon everyone. Q3 was another strong quarter for Facebook. Total revenue grew 56% and exceeded $7 billion for the first time. And we delivered $2.4 billion in GAAP net income, up 166%. We saw healthy growth and engagement in our community, as well as broad-based strength in our mobile apps business. Let's start with our community metric. In September 1.18 billion people used Facebook on an average day, up 172 million, or 17% compared to last year. This daily number represents 66% of the 1.79 billion people that used Facebook in the month of September. Mobile continues to drive our growth, with 1.09 billion people accessing Facebook on mobile on an average day in September, up approximately 197 million, or 22% compared to last year. +Turning now to the financials. My comments today will focus on our GAAP financial metrics. And all of our comparisons are on a year-over-year basis, unless otherwise noted. A reconciliation of our GAAP to non-GAAP financial metrics is included in our press release and earnings slide. Q3 total revenue was approximately $7 billion, up 56%. Q3 ad revenue was $6.8 billion, up 59%. Exchange rates did not impact our overall growth this quarter, as headwinds in certain currencies were offset by tailwinds in others. Asia Pacific and North America were our fastest growing regions, with ad revenue growth rates of 64% and 62% respectively. Ad revenue grew at a rate of 50% or more in all regions in Q3. Mobile ad revenue was $5.7 billion, up 70% and representing approximately 84% of total ad revenue. On prior calls we have discussed the supply and demand factors that drive our mobile ads business. As Sheryl noted earlier, advertiser demand remained strong in Q3 across all geographies, verticals, and marketer segments. We also benefited from growth in users, time spent, and ad load. It is worth noting that desktop ad revenue grew 18%, which is higher than growth rates in recent quarters and was aided by our efforts to limit the impact of ad blockers on advertising served via web browsers. +Our price volume trends were similar to those we reported last quarter. The average price per ad increased 6% in Q3, while total ad impressions increased 50%. The reported increase in price continues to be driven by the ongoing mix shift towards mobile, where we show only higher priced feed ads. Impression growth was primarily driven by mobile's feed ads on Facebook and Instagram. +Payments and other fees revenue was $195 million, down 3%. Payments and other fees revenue is largely generated from being played on personal computers, which has declined as people spend less time on their PCs. Q3 total expenses were $3.9 billion, up 28%. This includes $839 million of share-based compensation expenses and related payroll taxes, as well as $195 million of amortization of intangible assets. In Q3 we hired over 1,200 people and ended the quarter with approximately 15,700 employees, up 31% compared to last year. We remain committed to investing aggressively in hiring, including expanding our technical and recruiting teams globally. +Q3 operating income was $3.1 billion, representing a 45% margin. Our tax rate was 25%. GAAP net income was $2.4 billion, or $0.82 per share. Q3 capital expenditures were $1.1 billion. Year to date through September capital expenditures were $3.2 billion, up 76%, driven by investments in data centers, servers, office buildings, and network infrastructure. In addition to our new data center projects in Texas and Ireland, we recently broke ground on our seventh data center facility in New Mexico, which we anticipate will come online in late 2018. We generated approximately $2.5 billion of free cash flow. And ended the quarter with $26.1 billion in cash and investments. +Turning now to the outlook for the remainder of 2016. First, some color on revenue. We continue to expect that revenue growth rates will decline in Q4 as we lap a strong fourth quarter in 2015. We also continued to expect that our total payments and other fees revenue in Q4 will be lower than it was in the fourth quarter of last year. +Turning now to the 2016 expense outlook. Based on our year-to-date results and our updated view of the remainder of the year, we are adjusting our expense guidance ranges. We now expect that full-year 2016 GAAP expense growth will be at the lower end of our prior range of 30% to 35%. We expect full-year 2016 amortization expenses to be approximately $700 million to $800 million, and that full-year 2016 share-based compensation expenses to be approximately $3.2 billion to $3.3 billion. Accordingly, we anticipate that our total non-GAAP expenses, which exclude those share-based compensation and amortization expenses, will grow in the range of 40% to 45%, down from our prior range of 45% to 50%. We anticipate full-year capital expenditures to be approximately $4.5 billion as we invest aggressively to support the rapid growth of the business. We expect that our Q4 and full-year 2016 tax rates will be in line with the year-to-date tax rates. +I also wanted to provide some brief comments on 2017. First on revenue. As I mentioned last quarter, we continue to expect that ad load will play a less significant factor driving revenue growth after mid-2017. Over the of past two years we have averaged about 50% revenue growth in advertising. Ad load has been one of the three primary factors fueling that growth. With a much smaller contribution from this important factor going forward, we expect to see ad revenue growth rates come down meaningfully. Secondly, on expenses. Although it is premature to provide specific expense guidance, as Mark mentioned, we anticipate 2017 will be an aggressive investment year. Adding top engineering talent remains one of our key investment priorities as we continue to execute on our 3-, 5-, and 10-year road map. We will continue to invest in our ability to recruit top technology talent, both in the Bay area and beyond. In addition, we expect to grow capital expenditures substantially as we continue to fund the ongoing data center expansion efforts that we have under way. +Finally, I wanted to share some plans on the use of cash starting in 2017. Beginning in January, we intend to fund withholding taxes due on employee equity awards via net share settlement rather than our current approach of requiring employees to sell our shares of common stock to cover taxes upon vesting of such awards. We expect this change will increase our cash flows and correspondingly result in less dilution -- our cash outflows, and correspondingly result in less dilution. If we had used this approach in 2016, our cash outflows would have increased by approximately $1.8 billion in the year through September. +To wrap things up, Q3 was another strong quarter for Facebook. Our results reflected the continued growth and engagement of our community around the world and the strength of our mobile apps business. With that, operator, let's open up the call for questions. + + +================================================================================ +Questions and Answers +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- +Thank you. +(Operator Instructions) +Your first question comes from the line of Brian Nowak with Morgan Stanley. Your line is open. + +-------------------------------------------------------------------------------- +Brian Nowak, Morgan Stanley - Analyst [2] +-------------------------------------------------------------------------------- +Thanks for taking my questions. I have two. Just the first one. The past couple quarters you've given us a metric on the growth and time spent per user across the three big platforms. Any update at all on that around this quarter and what you're seeing? The second on the Instagram Stories, 100 million daily views. Any help at all on what the demographics or the age of those people look like? And how do you think about engagement of those users? Thanks. + +-------------------------------------------------------------------------------- +Dave Wehner, Facebook, Inc. - CFO [3] +-------------------------------------------------------------------------------- +I can take the first one, Brian, on the time spent metric. We're pleased with the growth in time spent per DAU that we're seeing across the Facebook family of apps. And that includes the Facebook mobile app where we saw good year-over-year growth in time spent per DAU. There video is making a big contribution to time spent growth. We are not providing a specific stat on time spent growth on an ongoing basis. + +-------------------------------------------------------------------------------- +Sheryl Sandberg, Facebook, Inc. - COO [4] +-------------------------------------------------------------------------------- +We're also not providing a specific breakdown of the DAU growth in Instagram Stories. But we're really excited about the engagement with the product and how it's growing across the board. + +-------------------------------------------------------------------------------- +Operator [5] +-------------------------------------------------------------------------------- +The next question is from Eric Sheridan with UBS. Your line is open. + +-------------------------------------------------------------------------------- +Eric Sheridan, UBS - Analyst [6] +-------------------------------------------------------------------------------- +Thanks for taking the questions. Maybe one for Sheryl and one for Dave. Sheryl, on local business and small business as you continue to see success there, wonder if we could get increased color on what you're seeing from an adoption curve on business pages? What are people looking for in terms of measurement attribution? What's Facebook delivering for those advertisers? Any color there would be very, very helpful. Dave, as we try to digest some of the comments you made about ad load and revenue as we exit 2016, go to 2017, how should we also be thinking about the mix of ad units as you continue to see more e-commerce and video in the platform? And how should we be thinking about the pricing of ad units as that mix changes over time? Thanks so much, guys. + +-------------------------------------------------------------------------------- +Sheryl Sandberg, Facebook, Inc. - COO [7] +-------------------------------------------------------------------------------- +On local, we think this is a really big opportunity and you see this in the large base of existing businesses using Facebook and Instagram increasingly. There's 60 million small business pages up on Facebook and 1.5 million Instagram business profiles, which are the similar -- the equivalent for Instagram. And the reason we think people are so active is, it's just really expensive and hard to have your own mobile site or your own, even, web page. 35% of small businesses in the United States, which is the most developed market, in many cases don't even have a web page of any kind. And it's cheaper and easier to build a web page than it is to build a mobile app and get distribution or downloads. So what's happening is that people are really using the Facebook business pages, and increasingly the Instagram business profiles, as their mobile presence. And we think that's what's working. And then we're working hard to build products that work in-store visits and then use simplified ad products that convert them over to advertising. + +-------------------------------------------------------------------------------- +Dave Wehner, Facebook, Inc. - CFO [8] +-------------------------------------------------------------------------------- +And Eric, it's Dave. Just really reiterating what I said last quarter about our expectations on ad load going into mid-2017. It's been one of the key factors in terms of driving growth, along with time spent -- user growth and time spent growth and advertiser demand. So we continue to see good opportunities to grow time spent, continue to see good opportunities to grow users, and we continue to see good opportunities to grow advertiser demand. On that latter point, really the mix of ad units is part of what we're doing, I think, really well. We're developing a number of new ad products as well as enhancing the ad products that we have out in the market today. So we're taking what is a great mobile ad product on Facebook and Instagram and making it even better. And I think the investments that we're doing there will continue to enable us to drive advertiser demand. Those key factors will continue, we believe, to drive growth next year. So what I'm specifically talking about is ad load and our anticipation that it's going to be a less significant factor as we get into mid-2017. + +-------------------------------------------------------------------------------- +Operator [9] +-------------------------------------------------------------------------------- +The next question is from Anthony DiClemente with Nomura. Your line is open. + +-------------------------------------------------------------------------------- +Anthony DiClemente, Nomura Securities Intl - Analyst [10] +-------------------------------------------------------------------------------- +Good afternoon. Thanks for taking my questions. For Mark, in terms of video and your broader media content strategy, just trying to think about your investment in Facebook Live. And then trying to frame that against investments in, I guess, non-live forms of video, such as maybe short form, prerecorded professional content. How do you weigh investing in live versus, let's call it, on-demand content? And maybe a related question would be, Fox Sports and Sports Illustrated are co-producing some original content for Facebook Live. I think they're doing a pregame show ahead of the big game tonight. That seems like in some ways it's an entree into sports, perhaps, for Facebook. Could you give us an update on whether or not you see any advantage or any benefit in licensing sports content over time versus having one of the publishers do it on the Facebook platform? Thanks. + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook, Inc. - CEO [11] +-------------------------------------------------------------------------------- +Sure. So there was a lot in there. I'll address most of it. The video on demand content is the vast majority of video that is both shared and consumed on Facebook, not live video. But live is growing very quickly. Part of the reason why we're investing in it is we see that video as a medium is not only in the future going to be about people producing content that looks like traditional content and then consuming it in a static rectangle video screen. Live video we think represents an example of something new, which is video which is a medium for doing something that's really interacting with other people. Whether you're a public figure that is using it to hold a townhall or interact with a lot of people at the same time, or you're hanging out with your friends by going live and you have 10 people who are just there with you, chatting with you while you're doing something, going about throughout your day. It's not the kind of traditional video experience. It's actually a more social experience. +I think 360 videos in another way are another example of this kind of interactive video experience. And my guess will be that we will see more different kinds of video media as time goes on. I think Stories is another example of this, that we're seeing it with Instagram Stories and with Messenger and the initial test that we have with Messenger Day where that is another interesting format for how you can put videos together. I think that's going to be more and more. To put that all in context, the majority of the consumption today is video on demand. We are very interested in making sure that the business model that we have works for folks who produce content as their business, to make sure that they can make money from it, so that their best content comes on Facebook. It's going to be a lot of growth in all of these things across all of our family of apps. + +-------------------------------------------------------------------------------- +Operator [12] +-------------------------------------------------------------------------------- +The next question is from Mark May with Citi. Your line is open. + +-------------------------------------------------------------------------------- +Mark May, Citigroup - Analyst [13] +-------------------------------------------------------------------------------- +Thanks a lot. I think the first one's for Mark. When you went mobile only, or started this concept, you had to tweak the app because it wasn't necessarily optimized for mobile. As now you move to more of a video first approach, what needs to happen to the Facebook app, both from a consumer-facing and from an ad tools perspective, to make sure that you're optimized for video? What needs to change? +I think the next question's for Dave. As the rate of growth in ad load slows and as -- and also as you continue to enhance targeting and as more video advertisers come onto Facebook, would you expect that ACPMs will rise and offset part, if not all of this, impact of the ad load slowing? Thanks. + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook, Inc. - CEO [14] +-------------------------------------------------------------------------------- +I can talk about shifting to put video first across our whole family. There are two broad sets of improvements that I think we need to make. One are to the capture and sharing tools that we offer. So the example of that is the new camera that we're working on and all the creative tools around that. And then on the other hand, we also need to improve the infrastructure to deliver the best videos to people and do that quickly. So if you think about what is enabling video to become huge right now, it's that fundamentally the mobile networks are getting to a point where a large enough people around the world can have a good experience watching a video. If you go back a few years and you tried to load a video in newsfeed, it might have to buffer for 30 seconds before you watched it, which wasn't a good enough experience for that to be the primary way that people shared. But now you can -- it loads instantly. You can take a video and upload it without having to take five minutes to do that. So it's a good experience. +So we're very focused on creative tools. You can see that a little bit in the announcement and launch of Instagram Stories and what we're doing with Messenger, and some of the initial tests in Facebook, and the camera work that we're doing in WhatsApp. This is across the whole family of apps. This is a big part of the product experience that we want to deliver. Then the actual delivery of video side, it's just much more intensive technically. There aren't that many companies that can do this at the scale that we're talking about. This has been a big advantage for us in rolling out things like Live, we've had this infrastructure that we've been building out for a decade all around the world. And that allowed us to build a product like live where someone has to stream something live from their phone to potentially hundreds of thousands of people around the world from a phone. That's a difficult scaling problem. So we've been able to build that up, not just because of the ongoing investment in technology and infrastructure here, but because we're building on the strong base. That goes not only for just being able to deliver the content, but being able to understand what it is so we can rank it in newsfeed better and show people the right content. But all of these things are going to be part of a cohesive experience to get behind our community. And when people are ready and want video to be the primary way that they're sharing and consuming content, we're going to be there ready. + +-------------------------------------------------------------------------------- +Dave Wehner, Facebook, Inc. - CFO [15] +-------------------------------------------------------------------------------- +Mark, yes, and on ad load growth slowing and the impact on effective CPMs, I think when you think -- when you look at our business, demand has been one of the key factors driving growth. So we've built up a large base of advertiser demand. We've got 4 million advertisers on Facebook, 0.5 million advertisers on Instagram. We continue to innovate on the products, make this more effective and make this a great gateway for businesses to come onto Facebook and come into mobile and spend. And we expect we've got a lot of great opportunities to continue to innovate on that front. +We've also been innovating over the past several years. Demand has been a big factor and what's been driving our growth to date. On top of that we've grown users and time spent. And then we've also grown ad load. So I do think as we look into 2017, we do expect that as you get to mid-2017 ad load will be less significant factor contributing. We'll continue to get benefits of being able to grow our revenue with advertiser demand, and continuing to innovate there. But I do think that as we slow ad load growth, we're going to have a slowing in revenue as well. So that's our expectation. But obviously we're going to continue to work hard to innovate in the ad product space. + +-------------------------------------------------------------------------------- +Operator [16] +-------------------------------------------------------------------------------- +The next question is from Mark Mahaney with RBC Capital Markets. Your line is open. + +-------------------------------------------------------------------------------- +Mark Mahaney, RBC Capital Markets - Analyst [17] +-------------------------------------------------------------------------------- +Two questions. A product question for Mark. You talk about some of these features and making the camera more of a central way of communicating on Facebook. How long do you think the iterations, or the testing is going to go, until as an average user I would notice that in my newsfeed? Like I do see much more prevalence of live video, and it doesn't seem to me yet a perfect experience. But just in terms of other features and out putting the camera at centerpiece? Do you think this is something that's going to be obvious to people in the next year, couple of months? Just what's the timing of the innovations? And then real quickly, MAU growth seemed to accelerate in both Asia and Rest of World. Any color on what would have caused that, or any particular markets? Thank you. + +-------------------------------------------------------------------------------- +Dave Wehner, Facebook, Inc. - CFO [18] +-------------------------------------------------------------------------------- +I can take the MAU growth first. And then Mark can talk about camera. On the MAU front, we're seeing very strong overall growth in terms of the 240 million-plus MAUs that we added. If I was to point to -- there's really no single driver, but I'll point to a few that contributed. It also plays into the fact that we're seeing good growth in places like India, Mexico, Brazil, and others. First, we're improving our Android experiences. And we've talked about the impact that Facebook Light has had on that, just making easier registration processes, just making Android -- our Lightweight Android app easier to use. Secondly, Mark talked about the Internet.org efforts that we have. That's been a contributing factor to MAU growth. And then finally, we're seeing the introduction of low price data plans in markets like India and Mexico contributing. So there's no single factor. But those are all contributing factors in terms of MAU growth. And then Mark, do you want to talk about the camera? + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook, Inc. - CEO [19] +-------------------------------------------------------------------------------- +Sure. So we already rolled out the first test of the new camera in Ireland. We're a Company that believes in testing things and getting feedback from our community before we roll it out broadly. We think we have a lot to learn. And the methodology of how we develop is we try to build things quickly. And rather than just relying on our own intuition, although we do rely on that a lot, we will try to put it out in the market and get feedback and then roll it out from there. So we rolled out what we believe is a good experience in Ireland. They're the first part of the community to get access to these new features. From there we'll start to roll it out broadly across the world, hopefully sooner rather than later. +Same thing on the Messenger side, as I mentioned these products around My Day. It's a similar video medium to Instagram Stories and a similar camera to what we're building in the Facebook apps as well. And that we've rolled out in a few countries as well. And similarly based on the feedback that we're getting, I would expect that we'll be rolling that out pretty widely across the world soon, as well. + +-------------------------------------------------------------------------------- +Operator [20] +-------------------------------------------------------------------------------- +The next question is from Douglas Anmuth with JPMorgan. Your line is open. + +-------------------------------------------------------------------------------- +Douglas Anmuth, JPMorgan - Analyst [21] +-------------------------------------------------------------------------------- +Thanks for taking the questions. We're going to stick with video. One for Mark and then one for Sheryl. Mark, how do you think about whether, with video in terms of doing it on core Facebook itself or on a separate video app, some of the puts and takes there between those two? And then Sheryl, can you just talk about with video how you see marketers using Facebook more to complement TV? And what it would take to shift dollars over in a bigger way going forward? Thanks. + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook, Inc. - CEO [22] +-------------------------------------------------------------------------------- +So in the main Facebook app we're doing a number of different things. One is that video is naturally becoming a larger share of the content in newsfeed because both people and pages are sharing more videos in the mix. And people want to consume that content. So there's not really a question of whether that should be a separate app. This is what people want newsfeed to be increasingly. So this is what it will become. There is a second experience called Video Home which we start talking about earlier in the year. And we've rolled out, again, in a few markets, and those tests have gone well. So we're also hoping to roll that out pretty soon widely. +And that's the new experience, which if you come to Facebook and you specifically want to watch some different kinds of videos or you want to see what videos a recent page that you follow has posted. Or the Presidential debate is on and you want to find a good place to go online to get that, you can go to Video Home and see that. That is the new experience that we're building. And building that is part of Facebook, is a great way for people to see it and get exposure to it. And we'll see where that goes over time. I think it's a good experience inside Facebook. But we also have had examples over time, like Messenger for example, where we started them on Facebook and decided that in order to fulfill their potential it needed to be its own experience over time. We'll look at all those options. But for now I really think that video home is going to be a great experience. And I'm excited to roll that out. + +-------------------------------------------------------------------------------- +Sheryl Sandberg, Facebook, Inc. - COO [23] +-------------------------------------------------------------------------------- +When we think about video ads and what platform they run on, we really believe that over time the dollars will shift with eyeballs. And our goal is to be the best dollar and the best minute people spend measured across channels. It's definitely true that most of our advertisers are advertising on TV and advertising with us on mobile. And they should be. We've done studies that show with Nielsen that our ads can be a really big complement to TV, particularly enabling you to reach people who really aren't on TV and you can't reach. I think the power of what we're able to do really goes to the targeting. And what we're seeing is big brand advertisers, and this is actually a particularly strong growth -- this quarter was particularly strong for brand, are really recognizing that they can do big brand buys on our platform like they would do on TV, but make them much more targeted. +So for example, Nestle Purina Petcare did an ad campaign with Germany -- in Germany with ZenithOptimedia. And they defined five distinct cat owner personality times. And created different creatives for each group. So that's kind of a big brand thing. There's -- the cat food category is big and they want brand awareness. But rather than just run one ad, they were able to run five based on the kind of interest space and personality targeting that really only we can do. And the results were amazing. They got an 89% increase in brand awareness and a 20% lift in sales. And so we think what we offer is the power of the broad reach of TV, but an ability to target much more efficiently. + +-------------------------------------------------------------------------------- +Operator [24] +-------------------------------------------------------------------------------- +The next question is from Ross Sandler with Deutsche Bank. Your line is open. + +-------------------------------------------------------------------------------- +Ross Sandler, Deutsche Bank - Analyst [25] +-------------------------------------------------------------------------------- +Great. I just had one for Mark. Any update on the revenue ideas for Messenger that might be getting traction? I know it's still early days, but any kind of early indications there? And based on the three phases you laid out earlier in the call, when can we expect Messenger to move into phase three? Thank you. + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook, Inc. - CEO [26] +-------------------------------------------------------------------------------- +So I'd say we're pretty early in phase two. Just to recap the framework that we have here. The strategy is there are three phases that we build, and then build businesses around these apps. The first is build an experience and get it to scale. Build a community that can get to hundreds of millions or 1 billion people or more. The second phase is help people not only interact with the people they care about, but also the businesses and other public entities that they care about as well. Then the third phase is once there's good organic interaction between people and those businesses, give those businesses tools that they can pay for to reach more people and amplify those interactions. +So I mentioned this stat earlier. That we have about 33,000 bots live in Messenger, including experiences across a range of verticals from news to e-commerce to local businesses and all kinds of different things. And where we're seeing some early progress, I'd say we're still pretty early on in getting this to be widely rolled out. I think we're going to need many more than 33,000. And the number of people using them, I think, is still pretty early in terms of there are more than 1 billion people using Messenger. So we need to get that rolled out pretty widely. +So I'm not sure that I have an answer for you just yet on exactly when we're going to move to the third phase. The one thing that I would say in terms of making money through Messenger is we're already driving results for businesses by letting them advertise in newsfeed to open up threads in Messenger, which is different from the long-term vision that we have here around creating interactions that start in Messenger. I think that that ultimately will be most of the value that's generated. But in the near term what we found is that a lot of businesses are creating ads in newsfeed that then they can [call] off and do transactions with people in Messenger. That's going to be pretty meaningful over the next few years. + +-------------------------------------------------------------------------------- +Operator [27] +-------------------------------------------------------------------------------- +The next question is from Heather Bellini with Goldman Sachs. Your line is open. + +-------------------------------------------------------------------------------- +Heather Bellini, Goldman Sachs - Analyst [28] +-------------------------------------------------------------------------------- +Great. Thank you. I just had a couple questions left. One, I was just wondering, given your comments on the local and small business opportunity, I'm wondering what your view is on Facebook's potential role in the payment ecosystem and how that might evolve over time? And also if you could share with us how the rollout of Instagram Shopping, which people have started to talk about, how that might evolve over time as well? Thank you. + +-------------------------------------------------------------------------------- +Sheryl Sandberg, Facebook, Inc. - COO [29] +-------------------------------------------------------------------------------- +In terms of payments, we really see payments as primarily a way to enforce the other activities we want to see on Facebook and Instagram. Payments enable advertisers to pay us. We are using payments in some of our other products in ways that enable some of the interactions we want to see. When we think about Instagram Shopping, it's very early tests. But it really follows the kinds of things we do in other areas of our products and services like Messenger. What we see is that people in Instagram are using Instagram to browse for products and make those connections. And so we then make the product investment to make those a little bit easier, similarly to some of things we've done in Messenger, some of the things we've done in Marketplace. We're watching for what is the organic activity between businesses and consumers. And then we're building products to enhance and enable that organic activity. + +-------------------------------------------------------------------------------- +Operator [30] +-------------------------------------------------------------------------------- +The next question is from Peter Stabler with Wells Fargo Securities. Your line is open. + +-------------------------------------------------------------------------------- +Peter Stabler, Wells Fargo Securities - Analyst [31] +-------------------------------------------------------------------------------- +Good afternoon. Thanks for taking the question. One for Sheryl. Sheryl, you guys have talked about your top verticals as being e-com, CPG, entertainment media, and gaming. And despite your really significant growth I can think of some categories where you've got more considered purchases where you're probably punching below your weight in terms of share. So auto, telecom, travel, financial services. Wondering if you could talk a little about some of the unique challenges with those verticals and how you guys are attacking them? Thanks so much. + +-------------------------------------------------------------------------------- +Sheryl Sandberg, Facebook, Inc. - COO [32] +-------------------------------------------------------------------------------- +Those are -- you have our top verticals correct. And we see a lot of strong growth in those verticals. Our top verticals this time were e-commerce, CPG, retail, and entertainment media. We do see growth in the other verticals as well. You're right that historically it took us a longer time to break into some these, particularly travel and auto were things that took us longer. But we are seeing some really nice traction. I talked about Mary Barra and what she and I did together in New York at Ad Week. And we're seeing them not just use the platform for advertising, but really use the platform. So earlier this year they rolled out a car at CES on Facebook Video rather than at a car show. And that was a big moment for us, I think, in the auto vertical. And we continue to work with them and lots of other partners. +Measurement's really key there. The better we can do with dealers and with auto manufacturers of measuring all the way through to purchase, the better off we are. And I think they know that people are doing the research for autos and the purchases they make, which is a very long sales cycle, on their mobile phone. And they want us to be part of that. Similarly with travel, this is a vertical that we are really investing in. We have rolled out different types of product ads that we think will help. So in Q2 we rolled out dynamic ads that were specifically focused on the travel vertical. And I'll share one example. +Celebrity Cruises used these dynamic ads for travel on both Facebook and Instagram to increase their online bookings. They worked with one of our F&Ts, Sticher Ads. And they created custom audiences who viewed specific itineraries by state. So they looked for people that at a certain date had viewed specific itineraries. And then created dynamic ads which showed the available cruises and pricing, and had a book-now button. They saw a 3 times increase in their online bookings. And I think those kind of results are made possible by more vertical-specific products. And we're going to continue to invest there. + +-------------------------------------------------------------------------------- +Operator [33] +-------------------------------------------------------------------------------- +The next question is from Justin Post with Bank of America Merrill Lynch. Your line is open. + +-------------------------------------------------------------------------------- +Justin Post, BofA Merrill Lynch - Analyst [34] +-------------------------------------------------------------------------------- +Hi. Thanks for taking my call. Dave, could you clarify a bit on investment year, what that means? Does that mean expenses growing faster than revenues? I think Mark mentioned $250 million on content for VR. Anything else in there that we should be thinking about? And then maybe one housekeeping, ad blocking. Could you quantify how much that might have helped desktop revenues? Thank you. + +-------------------------------------------------------------------------------- +Dave Wehner, Facebook, Inc. - CFO [35] +-------------------------------------------------------------------------------- +Justin, just on investment year, and not giving specific commentary around revenue growth versus expense growth. What I wanted to provide was just some color around our thinking about investments going into 2017. Obviously on the CapEx side we've got a number of projects underway on the data center front. So clearly on that front we've got a lot of projects that are going to need ongoing funding going into 2017. So that we've got good visibility on. +In addition, it's too early to give specifics, I wanted to give some directional color around expense growth. We've already invested in accelerating our recruiting efforts. I wanted to highlight that. That's primarily around technology, technical recruiting, software engineering. And we have a lot of opportunities that we see to invest in the long-term growth of the business. And so that's our plan going into 2017. +On ad blocking. In terms of the impact, I would just point out that this quarter we had 18% year-over-year desktop revenue growth. If you look at recent quarters, it was about half of that growth rate on a year-over-year basis. So that increment, that acceleration in desktop revenue growth is largely due to our efforts on reducing the impact of ad blocking. So that's what led to the acceleration of desktop revenue growth. + +-------------------------------------------------------------------------------- +Operator [36] +-------------------------------------------------------------------------------- +The next question is from Brian Fitzgerald with Jefferies. Your line is open. + +-------------------------------------------------------------------------------- +Brian Fitzgerald, Jefferies & Co. - Analyst [37] +-------------------------------------------------------------------------------- +Thanks. You've been tweaking the newsfeed algorithm to prioritize friends and family original content. We're curious what kind of impacts you're seeing there? And is it driving more engagement and more sharing of originals? Thanks. + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook, Inc. - CEO [38] +-------------------------------------------------------------------------------- +Sure. So newsfeed is an ongoing work that we're always improving. What we basically are trying to do is work on, over time, adding more and more signals to the newsfeed model to help us fully value what people in the community value about the different content that we show them. So what we realized was that the model that we had previously didn't fully capture the nuance and how people preferred certain content from friends and family. So we ran a bunch of qualitative studies and talked to a bunch of people, and incorporated those signals into the model. And that has had the result that people in our community who gave us that feedback and who we worked with on this, what we'd expected, in terms of both increasing the quality of the content that people see and, therefore, also enabling people to share more with their friends and the people that they want. One thing that I would clarify is that I think sometimes people -- in your framing of your question you asked if we'd tweaked newsfeed to do this or that. This is an ongoing iterative process. We're constantly learning about what our community wants. We will constantly be trying to incorporate new information and signals into the model to help value all of the content in the system as accurately as possible. The biggest job that we have is to show people in the community what's going to be meaningful and important to them. And that is our goal in all of these changes. + +-------------------------------------------------------------------------------- +Operator [39] +-------------------------------------------------------------------------------- +The next question is from Youssef Squali with Cantor. Your line is open. + +-------------------------------------------------------------------------------- +Youssef Squali, Cantor Fitzgerald - Analyst [40] +-------------------------------------------------------------------------------- +Yes, thank you. Two questions. About AI, can you help us understand your ambitions for (inaudible) its current form? Does it have a place in the workplace or internally maybe to enhance productivity, et cetera? About the additional functionality of additive pages with the delivery and a few others, can you just help us understand what you're doing around discoverability? How will people actually find these services? And do you need tools for that, and maybe timing? How quickly can we see these tools being rolled out? Thank you. + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook, Inc. - CEO [41] +-------------------------------------------------------------------------------- +I did not fully understand the first question so I'm going to talk about our AI work overall. In general what we want to do is try to understand the content that people are sharing and that's out there for them to see as best as possible. So for example, that means being able to read and understand news articles or posts that people make or messages that a person might send to a business so we can help that business auto reply to them and get information back to the person really quickly. Or understand the content so we can better understand what might be interesting to a person and show in a newsfeed. Similarly, aside from the conversational linguistic understanding, there's a whole thread of the work that we're doing on visual understanding. So understanding photos, what's in photos, what's in videos, what people are doing. That allows us to not only do things around accessibility to show someone who is visually impaired to be able to read to them what might be in a video or a photo, but it also helps us rank newsfeed better so that way we can help understand what is in the content and show people more of what is going to be meaningful to them. It helps us identify content that might be offensive or graphic that might violate the policies of Facebook so we can flag that and review that better. +That's the main thread of the AI work that we're doing, is trying to understand conversational and linguistic context and computer vision, photographic and video signals, to understand what's going on there. And that will apply across basically every product that we build at the Company. Of course, there's some deeper AI research that we're doing that feeds into those applications as well that can apply to things like ranking for newsfeed and search and ads and all of our systems more broadly. + +-------------------------------------------------------------------------------- +Dave Wehner, Facebook, Inc. - CFO [42] +-------------------------------------------------------------------------------- +On the discoverability of pages, a couple of things that I would point out there. First, we continue to invest in search. So obviously that's a good way for people to discover interesting pages, interesting businesses around them. So search is one angle there. And then, of course, ads. We've got 60 million businesses with pages. They manage those pages. And then they can promote those pages via our easy to use ad products. We try to make it very easy for businesses to promote pages, promote posts, and the like. That's an important on-ramp to mobile advertising for a number of businesses around the world. So those are the two ways that I think of from enhancing discoverability of pages on Facebook. + +-------------------------------------------------------------------------------- +Deborah Crawford, Facebook, Inc. - VP of IR [43] +-------------------------------------------------------------------------------- +Operator, I think we have time for one last question. + +-------------------------------------------------------------------------------- +Operator [44] +-------------------------------------------------------------------------------- +Okay. The last question is from John Blackledge with Cowen and Company. Your line is open. + +-------------------------------------------------------------------------------- +John Blackledge, Cowen and Company - Analyst [45] +-------------------------------------------------------------------------------- +Great. Thanks. Just as relates to video search, do you think that Facebook has the video content depth at this point for users to search for video content and be pleased with the experience? And then second for Mark, while Facebook embarks on its video first strategy, how should we think about Facebook also evolving into a transactional platform with the recent introduction of the Marketplace? Thank you. + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook, Inc. - CEO [46] +-------------------------------------------------------------------------------- +Sure. So search is an area that we've been working on for a while to improve. I don't know what the most recent public stat is on that, so I'm not going to say a stat. But it's grown a lot. So we're happy with that. And we think that that reflects that people are getting value from the search experience, which a lot of the growth comes from people searching for posts and content in the system, not just looking up people and pages in the system. So yes, on search, there's that. And then of course I think that search is often driven by what unique content is in a system and not just the ability to find it. I think what people are going to search Facebook for are finding people and content that they know is on Facebook and that isn't in other places. That I think is driving most of the volume today. And I think can get us to be -- we're already one of the largest search engines in the world, but to be even bigger on that front. +You asked about transactions as well. And we spent a lot of time on this call talking about putting video first. That has certainly been the biggest theme of the last quarter. And is the biggest part of the product strategy for Facebook and Instagram, and is a big part of the product strategy for Messenger and WhatsApp as well. In terms of transactions, one of the big things that we see happening in messaging long term is that it's a great channel for people to interact with a business one on one, and either do transactions in a private space or get support, or for businesses to reach out with very personally tailored messages and have an ongoing engagement with a person. That's something that we're very excited about building. And that is going to be the business that we hope to build on Messenger and WhatsApp over time. So we're looking forward to that. +Marketplace I think is going to be a great example of this, too. What we're seeing in pages and marketers on Facebook is they want to both get awareness and drive all the way down to generating transactions. And Marketplace I think is going to help people do that. We're starting with people being able to sell things to -- and connect to other people who want to buy them, just like they've been doing in for-sale groups for many years. But we're excited to evolve this and grow it over time as well. + +-------------------------------------------------------------------------------- +Deborah Crawford, Facebook, Inc. - VP of IR [47] +-------------------------------------------------------------------------------- +Thank you for joining us today. We appreciate your time, and we look forward to speaking with you again. + +-------------------------------------------------------------------------------- +Operator [48] +-------------------------------------------------------------------------------- +Ladies and gentlemen, this concludes today's conference call. Thank you for joining us. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/exam/original-files/Problem_1_Sample/2016-Oct-17-BAC.N-139667176127-Transcript.txt b/exam/original-files/Problem_1_Sample/2016-Oct-17-BAC.N-139667176127-Transcript.txt new file mode 100644 index 0000000..8eb2b5b --- /dev/null +++ b/exam/original-files/Problem_1_Sample/2016-Oct-17-BAC.N-139667176127-Transcript.txt @@ -0,0 +1,1112 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q3 2016 Bank of America Corp Earnings Call +10/17/2016 08:30 AM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Brian Moynihan + Bank of America Corporation - Chairman & CEO + * Lee McEntire + Bank of America Corporation - SVP, IR + * Paul Donofrio + Bank of America Corporation - CFO + +================================================================================ +Conference Call Participiants +================================================================================ + + * Steven Chubak + Nomura Securities Co., Ltd. - Analyst + * Gerard Cassidy + RBC - Analyst + * Brennan Hawken + UBS - Analyst + * Brian Kleinhanzl + Keefe, Bruyette & Woods, Inc. - Analyst + * John McDonald + Sanford Bernstein - Analyst + * Paul Miller + FBR & Co. - Analyst + * Brian Foran + Autonomous Research LLP - Analyst + * Mike Mayo + CLSA - Analyst + * Eric Wasserstrom + Guggenheim Securities - Analyst + * Matthew Burnell + Wells Fargo Securities - Analyst + * Vivek Juneja + JPMorgan - Analyst + * Jim Mitchell + Buckingham Research - Analyst + * Nancy Bush + NAB Research - Analyst + * Glenn Schorr + Evercore ISI - Analyst + * Ken Usdin + Jefferies & Company - Analyst + * Matt O'Connor + Deutsche Bank - Analyst + * Betsy Graseck + Morgan Stanley - Analyst + * Marty Mosby + Vining Sparks - Analyst + +================================================================================ +Presentation +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- +Good day everyone and welcome to today's program. +(Operator Instructions) +Please note this call is being recorded. It is now my pleasure to turn the conference over to Mr. Lee McEntire. Please go ahead. + +-------------------------------------------------------------------------------- +Lee McEntire, Bank of America Corporation - SVP, IR [2] +-------------------------------------------------------------------------------- +Good morning. Thanks to everyone on the phone as well as the webcast for joining us this morning for the third-quarter 2016 results. Hopefully everybody has had a chance to review the earnings release documents that are available on the website. +Before I turn the call over to Brian and Paul let me remind you we may make some forward-looking statements. For further information on these please refer to either our earnings release documents, our website or our SEC filings. +One thing before Brian and Paul get into the results I just want to remind you we filed an 8-K on October 4 giving notification the Company changed our method of accounting for the amortization of premium and accretion of discounts related to certain debt securities known by the investment community as FAS-91. Our change to the contractual method which is used by the majority of our peers will provide better comparability of our results. As a result of that change we restated our historical results and provided the historically restated information in the 8-K and our earnings materials today naturally reflect those restatements. +With that let me turn it over to Brian Moynihan, our Chairman and CEO, for some opening comments before Paul Donofrio, our CFO, goes through the details. Brian? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman & CEO [3] +-------------------------------------------------------------------------------- +Thank you, Lee. Good morning everyone and thank you for joining us today to review our third-quarter results. +Our results this quarter continue our progress on our long-term strategy. We continue to drive responsible growth and deliver more of the Company's capabilities to our customers and clients. This progress is becoming clearer with each successive quarter and you can see the highlights of that on slide 2. +We reported earnings of $5 billion or $0.41 per diluted share, an EPS improvement of 8% from the year-ago quarter. We improved operating leverage across the businesses, utilizing technology to lower cost and improve our processes. +Our pretax earnings improved 17% compared to third-quarter 2015. This pretax earnings comparison is important as it eliminates the unusual movements in the tax line like this quarter's tax charge and the UK corporate tax rate change. +Like last quarter I thought I would address a few topics we are hearing from all of you. To do that let's look at slide 3 and 4 of the earnings material. +A first question is, are we making progress driving our responsible growth strategy? Yes, we continue to show progress throughout all the businesses. Our revenue growth has more clarity as we move past the periods of significant impacts from implementing regulations, running off non-core portfolios and divesting non-core businesses. +Revenue grew 3% over the third quarter of last year. Behind that improvement is our continued investment in this great franchise, in our sales teams, in our technology across the board. These sales teams and the buildup we have been doing there helps us to increase our capacity to serve our customers and clients. +An example of that is in our Consumer business. There our focus is on being the core bank to all our households. This has resulted in fewer checking accounts than we had years ago, but the average balance of the checking accounts we have has doubled and they are now roughly $6,500 per account. +You can also see this in the growth of our Merrill Edge brokerage balances which now total over $138 billion, adding investment relationships to the mass-market customer base. In general, consumers are deepening their relationships with us as they use our straightforward investing tools to get them started on the path to investing. +For our affluent and wealthy customers our customer progress also continues. Our Global Wealth & Investment Management teams, US Trust and Merrill Lynch, not only managed $2 trillion-plus in investment balances but also manage nearly $150 billion in loans at more than $250 billion in deposits. And we continue to see net flows of core assets in that business. +On the commercial side clients continue to respond to our universal banking model for a simplified stop for financing investing advisory services. We will continue to operate within our established risk framework in defined customer groups and we aren't reaching for growth. This will drive more sustainable results over a longer period of time for our shareholders. +With our global peers restructuring, including in the Markets business, I think this quarter is another great example of our Global Markets business' importance to our investing and issuing clients. We saw better client activity driving the best third-quarter results we have had in five years in Investment Banking and in sales and trading. We are doing that with a smaller balance sheet, fewer people and lower value at risk or VAR. +So growth in deepening all consistent with our responsible growth strategy continues across all the customer bases. Paul will talk to you more about the statistics and these successes. +Another question that we get asked is can credit remain this strong? Well, many of you asked that last quarter and the quarter before that and the quarter before that and this quarter it still got better again with our charge-off ratio declined to 40 basis points this quarter at an historic low. This is driven by changes we made right after the crisis, think in 2008 and 2009, and the long-term benefits of that effort continue to come through. +And, by the way, sticking to our responsible growth strategy even as times have been relatively better. US consumer health is generally good. Over the past few quarters, exposures in our oil and gas that were causing industry concerns for commercial losses have improved and charge-offs have receded. Other commercial credit remains very strong, and Paul will touch on these topics later. +Another question we get asked is what can we do to drive earnings even if we stay in this low rate, low growth environment? We aren't waiting for interest rates to rise here at Bank of America. We are driving our earnings growth now. +We work on the things that we can control: expenses, loan and deposit growth and fee growth. Long-term rates are down compared to last year yet earnings have grown. Despite that net interest income is up 3% from third-quarter 2015 while net interest yield has been stable because we grew core loans and deposits. +Paul will take you through the loan growth details later but I want to pause a moment and talk about our deposit growth. Deposits are a core part of what drives our franchise earnings. We have $1.2 trillion in deposits. +That's proof that customers entrust us to safeguard their money. We are heavily weighted in the mix of those deposits towards consumers whether the general consumers or wealthy consumers. This, in turn, provides a very stable base of funding for the Company and allows us to be less reliant on the markets for funding. +Nearly $450 billion or 36% of our deposits are noninterest-bearing, a very strong mix. Deposits on average grew $68 billion year over year or 6%. The teams have done tremendous work here and this quarter wasn't an anomaly. +This is the fourth consecutive quarter where we have grown deposits more than $50 billion over the previous year. Our commercial teams remain focused on growing deposits also. They are growing deposits that are LCR friendly and doing great work with our industry-leading cash management capabilities. +As a result year-over-year Global Banking grew deposits 3% to $300 billion. Our Consumer and Wealth Management teams combined have $860 billion in deposits. They grew this large base by 8% in the past 12 months. +For the first time Consumer topped $600 billion in deposits. These deposits are growing because our capabilities in the business are the best in the industry and our customers and clients see that. Whether t is our 21 million plus mobile banking customers, or 34 million plus online customers or the more than 5 million customers that come into our financial centers every week, these customers show that they appreciate the capabilities and integration of our networks. +So when we look at what else can we do to control and drive earnings in a low growth environment we get asked a lot about expenses and can those expenses keep being driven down and go lower. Well, the answer is yes. Last quarter we gave you a 2018 expense target and we continue to make progress towards that. +Our expenses declined 3% from the third quarter of 2015 to 2016. Our efficiency ratio improved to 62% this quarter. That is a 400 basis point improvement from last year's third quarter. +We continue to deliver on expense reductions while continuing to invest in technology and sales teams and other matters that are important for the future of this franchise. After you take into account the additional large bank FDIC assessment that started this quarter, expense is also down on a linked-quarter basis even as we continue to invest and absorb all the severance, regulatory, resolution planning and other repositioning cost to continue to reduce our operating costs. +We have been innovating in technology and we will continue to do so to improve processes and eliminate the need for paper and humans handling that paper. Our Simplify and Improve initiatives continue to help drive those costs are down. +And that leads to the question we also get asked, can we deliver and sustain returns above our cost of capital? As Lee talked about earlier we restate our results to change under FAS-91 and reduce the variability and make us more comparable to peers. As you can see, that makes it a little easier to see the longer-term return on tangible common equity trends. +This quarter we reported 10.3%. It has now stabilized above the cost of capital, even given our larger and larger capital base. +We still have work to do here to drive it to our ultimate goals. But this quarter is another strong step in that direction. +Importantly, on slide 4 you can see that each business has improved its leverage. They grew their earnings, had strong efficiency and returned far above the cost of capital. And all that continues to bode well as we look ahead. +So as we look forward we are driving responsible growth and maintaining discipline on cost. And this has allowed us to deliver more capital back to you. And we will keep on doing that. +Now let me turn it over to Paul to cover the numbers. Paul? + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [4] +-------------------------------------------------------------------------------- +Thanks, Brian. Good morning everybody. Since Brian covered the income statement highlights I will start with the balance sheet on page 5. +Strong deposit growth drove a small increase in the size of our balance sheet versus Q2. Deposits rose $17 billion or 6% on an annualized basis. During the quarter long-term debt fell by $5 billion. +We put cash to work growing securities in our investment portfolio and more modestly through loan growth. Global liquidity sources rose driven by deposit growth and we remain well compliant with LCR requirements. Tangible common equity of $174 billion improved by $2.8 billion from Q2, driven by earnings. +In the process we returned $2.2 billion to common shareholders through a combination of dividends and $1.4 billion in share repurchases. On a per share basis tangible book value increased to $17.14 of $1.60 or 11% from Q3 2015. I would note that this increase was driven by both retained earnings as well as share repurchases below tangible book value as we reduced shares 3% from Q3 2015. +Turning to regulatory metrics, as a reminder we report capital under the advanced approaches. RCET1 transition ratio under Basel III ended the quarter at 11%. +On a fully phased-in basis, CET1 capital improved $4 billion to $166 billion. Under the advanced approaches compared to Q2 2016 our CET1 ratio increased 40 basis points to 10.9% and is well above our 10% 2019 requirement. +RWA declined roughly $20 billion, driven by reductions in global markets exposures and improvements in credit quality driven by runoff of non-core legacy exposure. We also improved our capital metrics under the standardized approach. Here our CET1 ratio improved to 11.8%. Supplemental leverage ratios for both parent and bank continue to exceed US regulatory minimums that take effect in 2018. +Turning to slide 6, on an average basis total loans were up $23 billion or 3% from Q3 2015 and while up from Q2 2016 growth was at a slower pace. Consistent with past periods, we break out loans in our business segments and in All Other. Year over year, loans in All Other were down $30 billion, driven by continued runoff of first and second lien mortgages while loans in our business segments were up $53 billion, or 7%. +In Consumer Banking we continue to see growth in residential real estate and vehicle lending, offset somewhat by home-equity paydowns which continued to outpace originations. In Wealth Management we saw growth in residential real estate and structured lending. Global Banking loans were up $26 billion or 8% year over year. On the bottom right of the chart, note the growth of $68 billion average deposits that Brian mentioned. +Turning to asset quality on slide 7, we believe a number of factors including our strategy of responsible growth, enhanced underwriting standards since 2008 and a healthier economy have transformed the risk profile of Bank of America as we look forward to future economic cycles. Total net charge-offs of $888 million improved $97 million from Q2. Consumer losses declined across a number of products and commercial losses also declined, driven by lower energy losses. +Driven by these improvements, provision expense of $850 million declined $126 million from Q2. We had a small overall net reserve release in the quarter as consumer real estate releases more than offset builds in other products. +On slide 8 we provide credit quality data on our Consumer portfolio. We remain focused on originating consumer loans with borrowers with high FICO scores and our asset quality remains strong. +Net charge-offs declined $71 million from Q2. This improvement was broad-based across consumer real estate as well as credit card. +Note that credit cards accounts for more than two-thirds of losses in our Consumer portfolio and within our US credit card book the loss rate improved to 2.45%. NPLs improved and reserve coverage remains strong. +Moving to Commercial credit on slide 9, net charge-offs of $110 million improved $26 million from Q2. With respect to energy, exposures are down, losses improved, oil prices have stabilized and we have $1 billion of reserves. More specifically, energy charge-offs of $45 billion decreased $34 billion from Q2. +While reservable criticized declined from Q2 we did experience an increase in NPLs this quarter which was concentrated with two clients, one in metals and mining and one in energy. Overall, our commercial portfolio continues to perform well. As I shared with you last quarter, the metrics in the commercial portfolio speak for themselves in terms of quality and performance. +The reservable criticized exposure declined and as a percentage of loans remains low. The Commercial net charge-off ratio is 10 basis points. Excluding small business it is 5 basis points and has been around 15 basis points or better for 15 consecutive quarters and the NPL ratio remains low at 45 basis points. +Turning to slide 10, net interest income on a GAAP non-FTE basis was $10.2 billion, $10.4 billion on an FTE basis. As Lee mentioned earlier, we changed our accounting method for the amortization of premium or discount paid on certain of our debt securities from the prepayment method to the contractual method. The contractual method is used by our peers and should make it easier for investors to make comparisons. +Compared to Q3 2015, NII is up $300 million or 3% as loan growth, higher short-end rates and higher security balances funded by deposits more than offset the negative impact of generally lower long-end rates over the past several quarters. +Okay, with respect to asset sensitivity as of 9/30, an instantaneous 100 basis point parallel increase in rates is estimated to increase NII by $5.3 billion over the subsequent 12 months. This is lower than the sensitivity we reported at June 30. +The reduction was mostly on the long end, driven by the change to the contractual method and slower prepaid speeds based upon recent trends and customer behavior. Note that this sensitivity on the short end at $3.3 billion has not changed significantly. +Turning to slide 11, noninterest expense was $13.5 billion. That's $0.5 billion lower or 3% lower than Q3 2015, driven by cost reductions across the Company. This is the initial quarter of the increased FDIC assessment to shore up the deposit insurance fund. +The increase in expense for us is roughly $100 million per quarter. Compared to Q2 2016, expenses were stable as good core expense control was offset by the higher FDIC cost and modestly higher incentives. +Q3 litigation expense was $250 million, which is fairly consistent with both Q3 2015 as well as Q2 2016. Most expense categories were lower year over year. This trend was led by personnel expense, which includes the Q4 2015 expiration of the fully amortized advisor awards in Wealth Management. The rest of the improvement was driven by reduced cost of mortgage servicing coupled with same efforts and other initiatives. +Our employee base is down 3% from Q3 2015. While the overall headcount is down it is important to note that year over year we added over 1,000 primary sales associates across Consumer, Wealth Management and Global Banking. +Turning to the business segments and starting with Consumer Banking on slide 12. Consumer earned $1.8 billion, continuing its trend of solid results and reporting a robust 21% return on allocated capital. I would note that pretax pre-provision earnings rose $377 million or 10%. +Expense and NII improvement were both notable and together enough to more than offset higher provision expense and prior-year divestiture gains. Revenue was relatively flat on a reported basis compared to Q3 2015 as 4% in NII was offset, as I said, by the absence of approximately $200 million of divestiture gains in 2015. As a reminder, these gains in Q3 2015 result from divestitures of an ancillary appraisal business, a card portfolio and some financial centers. +Excluding those prior-period gains, revenue improved year over year and growth in pretax pre-provision earnings was even more substantial. Falling 400 basis points, Consumer Banking's efficiency ratio of 55% improved meaningfully year over year. +Okay, turning to slide 13 and key trends, first on the upper left the stats are a reminder of our strong competitive position. Looking a little closer at revenue drivers compared to Q3 2015, net interest income continued to improve as we drove deposits higher. Average deposits continued their strong growth, up $50 billion or 9% year over year, outpacing the industry. +With respect to noninterest income service charges were up modestly while card income was down. Spending levels and issuance were strong but revenue growth was muted by customer rewards. We are attracting relatively higher quality card customers that, on the one hand, have higher spending habits but, on the other hand, receive more rewards. +This has two important benefits to note. First, rewards deepen relationships, helping to grow deposits and make them more sticky, for example. Second, in our experience these customers have lower loss rates and a reduced need to interact with call centers, thereby allowing us to lower costs. +Turning to expenses, in the upper right they climbed 7% from Q3 2015 despite, excuse me, turning to expenses they declined 7% from Q3 2015 despite the higher FDIC assessment charges in the quarter. Expense reductions are the result of a number of initiatives. For example, mobile banking penetration helps to optimize our delivery network while improving customer satisfaction, more chip cards help us lower fraud costs and digitalization of processes and statements helps us eliminate paper and related handling costs. +One can observe the impacts of these types of initiatives on the cost of deposits which continued its march lower, dropping below 1.6% this quarter. Focusing on client balances on the left, in addition to deposit growth Merrill Edge brokers assets at $138 billion are up 18% versus Q3 2015 on strong account flows and market valuations. We also increased the number of Merrill Edge accounts by 11% from Q3 2015. +We now have nearly 1.7 million households that leverage our financial solution advisors and self-directed investing platform. +Moving across the bottom right of the page, note that loans are up 7% from Q3 2015 on strong mortgage and vehicle lending growth. As reviewed in previous quarters we continue to focus on originating high FICO score loans which have generally produced low loss rates and strong risk-adjusted returns. Loan growth included consumer real estate production of $20.4 billion, up 21% from Q3 2015 and in line with Q2 2016 as customers continue to take advantage of historically low interest rates. +We retained about three-quarters of first mortgage production on the balance sheet this quarter. Average vehicle loans were up 17% from Q3 2015 with average booked FICO scores remaining well above 750 and net losses remaining below 30 basis points. +With respect to US card -- excuse me, US consumer card, average balances grew 7% from Q2 on an annualized basis, aided by seasonal back-to-school lending. We issued more than 1.3 million cards in the quarter and spending on credit cards, adjusted for divestitures, was up 8% compared to Q3 2015. +Turning to slide 14 and digital banking trends, as I mentioned earlier, we continue to see strong momentum in digital banking adoption with use across service, appointments and sales. Mobile banking is transforming how our customers bank and reshaping our Consumer segment. Importantly, as adoption rises, particularly around transaction processing and self-service, we see improved efficiency and customer satisfaction. +We continue to improve capabilities with the latest example being the launch of our Spanish mobile app which attracted over 800,000 active users in the first 10 weeks. We added roughly 1.1 million new mobile users in the quarter. The pace of user growth has increased despite an already impressive penetration rate of our checking account holders. +With more than 21.3 million active users, deposits from mobile devices now represents 18% of deposit transactions and 26 million checks were deposited via mobile devices this quarter. That is an average of 280,000 deposits per day, an increase of 27% year over year and the equivalent to volume of 830 financial centers. +Digital sales now represents 18% of total sales. And we now have more than 3,500 digital ambassadors in our financial centers driving further adoption. +Also, as you know, we are a leader in person-to-person and person-to-business money movement through digital transfers and bill payment capabilities. Consumers moved $243 billion in Q3, up 6% from last year. +And while all this is transformative, I would just remind you that we still have a little less than 1 million people per day walking into our centers across the US. This in-person interaction is important in terms of deepening and retaining personal relationships, providing more complex financial help and creating opportunities for further engagement. +Turning to slide 15, Global Wealth & Investment Management produced earnings of $697 million, up 10% from Q3 2015. Now it's no secret that this segment operates in an industry undergoing meaningful change as firms and clients adapt to the new fiduciary rules and other market dynamics. The good news is we start from a position of strength with a $2.5 trillion in client balances. +We have market-leading brands and a wide range of investment service offers from self-service to fully managed. Plus we have the resources to continue to invest in market-leading capabilities that address the changing needs of our clients. Year over year, revenue was down modestly but expenses were down even more, improving pretax margin to 25%, up meaningfully from Q3 2015. +Overall revenue declined 2% from Q3 2015 as NII growth was more than offset by lower transactional revenues. NII benefited from solid loan and deposit growth, noninterest income declined from Q3 2015 driven by lower transactional revenue that continues to be impacted by market factors as well as migration of activities from brokerage to managed relationships. +Noninterest expense declined nearly $313 million or 6% from Q3 2015 with half of that benefit derived from the expiration of the amortization of advisory retention awards that were put in place at the time of the Merrill Lynch merger. The rest of the improvement was a result of work across many categories of expense more than offsetting higher FDIC cost. +Moving to slide 16, we continue to see overall solid client engagement. Client balances approached $2.5 trillion and are up from Q2, including higher market valuations, $10 billion of long-term AUM flows and continued loan and deposit growth. +Average deposits compared against Q3 2015 are up 4%, driven by growth in the second half of 2015. Compared to Q2 average deposits were impacted by seasonal tax payments. +Average loans were up 7% year over year. Growth remained concentrated in consumer real estate and structured lending. +Lastly, earlier this month we announced some innovations to our IRA products and services which we believe positions us to better serve our clients given new fiduciary rules. These innovations are industry-leading and address not only the new fiduciary rules for time and accounts but also client preference for more choice and new ways to invest. First, we announced the rollout of a new offering called Merrill Edge Guided Investing. +This solution offers clients online investing enhanced with professional portfolio management. With the addition of this solution, clients have three fundamental choices which they can mix and match to best meet their needs. Clients can invest online completely self-directed through Merrill Edge or if they are interested in enhanced professional portfolio management they will be able to use Merrill Edge Guided Investing or they can choose fully advised, working one-on-one with a financial advisor via brokerage or fee-based advisory platforms. +We also announced that beginning in April 2017 for clients that choose to have a financial advisor provide advice with respect to their IRA accounts, we will provide this service to our fee-based advisory platform, Merrill Lynch One as we believe this is the best way for us to deliver for our IRA clients who choose to have this level of service and advice. Clients will also have the option to invest their retirement through Merrill Edge either completely self-directed or through Merrill Edge Guided Investing. +Turning to slide 17, Global Banking earned $1.6 billion which is up 22% year over year. Q3 reflects good revenue growth, solid cost control and solid client activity. The efficiency ratio improved to 45% in Q3. +Compared to previous third quarters, investment banking fees this quarter were the highest since the merger with Merrill in 2009. Return on allocated capital was 17%, a 300 basis point improvement from Q3 2015 despite adding a couple of billion dollars of allocated capital this year. Global Banking continues to drive loan growth within its risk and client frameworks, producing solid year-over-year improvement in NII. +Revenue growth also benefited from roughly $175 million from gains on FVO loans this quarter versus losses in Q3 2015. Higher treasury fees also added to revenue growth. The decrease in noninterest expense compared to Q3 2015 reflects good expense control that offset modestly higher revenue-related compensation and higher FDIC costs. +Looking at the trends on slide 18 and comparing to Q3 last year, average loans on a year-over-year basis grew $26 billion or 8%. Growth was broad-based across large corporates as well as middle-market borrowers and diversified across most products. +Having said that, as we noted last quarter the pace of commercial loan growth has slowed over the past couple of quarters. Demand across the industry appears to have slowed as well. We remain diligent in certain sectors such as commercial real estate and energy and we are also closely monitoring certain international regions. +Average deposits increased from Q3 2015, up $10 billion of 3% from both new and existing clients. As we grow treasury services we remain focused on quality deposits with respect to LCR. +Switching to Global Markets on slide 19, let me start by reviewing what I said last quarter regarding this segment. The past few quarters are examples of the importance of this segment to not only its clients around the world but also to the customers and clients of all our business segments. Again this quarter, Global Markets delivered for clients by helping them raise capital, buy and sell securities as well as manage risk. +We continue to invest in and enjoy leadership positions across a broad range of products. We believe this improves our sustainability -- we believe this improves the sustainability of our revenue and makes us more relevant to clients across the globe. We've been there for clients when they needed us across all these products. +Our results this quarter reflect this strategy and continued commitment to clients. Global Markets earned $1.1 billion and returned 12% on allocated capital. Revenue was up appreciably year over year and even outpaced typical seasonality by posting modest improvement over Q2 2016. +Total revenue excluding DVA was up 20% year over year on solid sales and trading results which rose 18%. It's worth noting we achieved these results with slightly less balance sheet, lower VAR and 7% fewer people. Continued expense discipline drove cost 1% lower year over year as increases in revenue-related incentives were more than offset by reductions in operating and support costs. +Moving to trends on slide 20 and focusing on the components of our sales and trading performance, sales and trading revenue of $3.7 billion excluding DVA was up 18% from Q3 2015 driven by FICC. In terms of revenue this was the best third quarter in five years. Excluding DVA and versus Q3 2015, FICC sales and trading of $2.8 billion increased 39% as we built momentum as the quarter progressed across a host of credit products and continued gains in rates products. +Mortgages showed particular strength among credit products as investors sought yield. Equity sales and trading was solid at $1 billion in revenue but declined 17% versus Q3 2015 which benefited from higher levels of market volatility and client activity. +On slide 21 we present All Other which recorded a net loss of $118 million. This loss includes a previously disclosed tax charge of $350 million due to the third-quarter UK enactment of a tax rate reduction which reduced the value of our UK DTA. The loss in the current period compares to earnings of $152 million in Q3 2015 as lower security gains and higher expense litigation offset higher mortgage banking revenue. NBI revenue this quarter includes $280 million benefit from higher valuations on our MSR driven by slower expected prepaid speeds based upon recent observed trends in customer behavior. +Okay, let me offer a few takeaways as I finish. We reported solid results this quarter that were consistent with our strategy of responsible growth. We remain focused on delivering responsible growth as well as strengthening and simplifying Bank of America. +Capital and liquidity strengthened. Asset quality remains strong. We grew revenue. +We grew deposits. We grew loans. We delivered for clients in capital markets. +We lowered costs. We invested in our future by adding sales professionals and deploying technology that helps customers better live their financial lives and improves satisfaction. And, importantly, we returned more capital to our shareholders. +With that let's open it up to questions. + + +================================================================================ +Questions and Answers +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- +(Operator Instructions) John McDonald, Bernstein. + +-------------------------------------------------------------------------------- +John McDonald, Sanford Bernstein - Analyst [2] +-------------------------------------------------------------------------------- +Hi, good morning guys. I wanted to ask about expenses. +Could you talk about what kind of timing expectations you have on the various projects helping to drive down your expenses further in 2017 and 2018? Maybe just remind us what are some of the big items that you are working on? And should we still think about $53 billion in 2018 as your hard target that you are shooting for? + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [3] +-------------------------------------------------------------------------------- +Well let me start with the last part first. Nothing has changed at all for our thoughts regarding the 2018 target that we discussed in the second-quarter call. Again I would note that year over year we reduced expenses by $0.5 billion. +And I would also just point out to remind everybody that if you look at expenses over a longer term we reduced quarterly expenses ex-litigation by $4.8 billion from Q3 2011. That's a $19 billion run rate. +So if you think about what we have to do between now and 2018, I think we've talked about this before, roughly a third of that is going to come from continued progress on the (technical difficulty) loan servicing. The other two-thirds is going to come from a lot of different initiatives across the Company. +We've talked about SIM, our Simplify and Improve initiative. We are going to be utilizing technology to digitize processes, eliminating handling costs. We are going to get technology efficiencies from our data centers consolidation and for more efficient servers. +As I said, we are going to continue to make progress on delinquent loan servicing costs, hopefully see some modest improvement in litigation. Very important part of this is the shift to self-serve digital channels: mobile, online, ATM. So that's what the list sounds like and it goes on and on. +I would emphasize this shift to self-serve. We're seeing good momentum with more than 21 million mobile banking active users. And that's growing every week, every month. +18% of our deposit transactions are now completed through mobile devices. That's better for customers. +It's also better for our shareholders. It's 1/10 the cost of walking into a branch. +So it's all these things put together. It's initiatives across the whole Company. It's going to come a lot from support and operations, but there's a little bit in the front office, as well, as we get more efficient. + +-------------------------------------------------------------------------------- +John McDonald, Sanford Bernstein - Analyst [4] +-------------------------------------------------------------------------------- +In terms of the timing, Paul, is it something that we should think of is ramping throughout 2017? And is it have a longer tail at the end? Can you give us a sense there? + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [5] +-------------------------------------------------------------------------------- +Yes, I would say it's going to be fairly spread out throughout the whole process. However, as you think about one quarter over a next, it's not going to be straight down every quarter. Not every quarter is the same, there's going to be some lumpiness. +If you look at the fourth quarter, for example, we traditionally have some seasonality in the fourth quarter. So generally we will make progress but don't expect that you are going to see it in every single quarter. + +-------------------------------------------------------------------------------- +John McDonald, Sanford Bernstein - Analyst [6] +-------------------------------------------------------------------------------- +Okay, thanks. And then a second question just quickly on net interest income. +Can you help us try to translate your 100 basis point rate sensitivity into something closer to what one Fed hike might do for your net interest income? And what would be the trajectory of NII and NIM if we did get a Fed hike this quarter? What would you expect more in the near term next quarter, too, on NII and NIM? + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [7] +-------------------------------------------------------------------------------- +Sure. So let me I can help you through that. So if you look about a 25 basis point, that would be one quarter of our $5.3 billion in sensitivity. +If you want to assume that 25 basis points increases the long end by 25 basis points you know the answer. you can roughly take a quarter of it, perhaps even a little bit more, because we're probably more asset sensitive on the first 25 than the last 25 of that 100. +But if you don't want to increase on the long end just look at the short end. We've disclosed its $3.3 billion. You can divide that by four and get a pretty good sense of what 25 basis points would do over the subsequent 12 months. + +-------------------------------------------------------------------------------- +John McDonald, Sanford Bernstein - Analyst [8] +-------------------------------------------------------------------------------- +Great, thanks. + +-------------------------------------------------------------------------------- +Operator [9] +-------------------------------------------------------------------------------- +Glenn Schorr, Evercore ISI. + +-------------------------------------------------------------------------------- +Glenn Schorr, Evercore ISI - Analyst [10] +-------------------------------------------------------------------------------- +Hi, thanks very much. Just curious for a point of clarification, Brian had mentioned Global Markets. It feels like it's taking a little share, alluded to global peers restructuring. +Completely get it, believe it's going to happen. Just curious if you can give a little color on where you might see some of that evidence taking shape. Product, geography, whatever? + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [11] +-------------------------------------------------------------------------------- +Yes, I will try to do that but let me just start with a couple of thoughts. First of all, I think it's difficult to see share shifts in Global Markets in any given quarter. The fee pools are just not as transparent as they are in, let's say, investment banking fees or other areas. +What we know is client activity was up in the third quarter and that's what drives our short-term results. Over the longer term it is easier just to assess what's going on with fee pools and share. So I just want to point out from 2014 to 2015 on declining fee pools we're pretty sure we improved our share. +Third parties tell us that. And I think that share has come from a number of regions and a number of firms and a number of products as competitors adjust their strategies and capabilities. +More specifically, we've been investing in rates for a number of years. I think we're making some progress there. We have a very strong credit platform, as you know. +I think we are making progress there relative to competitors around the world. And I think we are investing in equities. And I think equities revenue is down, but we are seeing an improvement relative to the fee pool in equities as well. +I do want to emphasize, very importantly, that our strategy is to have a diversified product portfolio across both FICC and equities and globally. That's what our clients need and want from us. And so you could see gains one quarter in one place and see something lower in another place, and that's okay with us. +That's our strategy. It's about what the client needs in any given quarter. If we are doing a little bit worse in one place we are probably doing better in another place. + +-------------------------------------------------------------------------------- +Glenn Schorr, Evercore ISI - Analyst [12] +-------------------------------------------------------------------------------- +Fair enough. Nature of the business, I guess. One other, one in GWIM I appreciate all the color on the different products and what you are doing in Wealth Management. +The curious move in the quarter was the move away from the commission-based IRAs. And I'm curious, is that move specifically done to avoid the best interest contract? +I'm just curious, based on how we roll forward if the SEC comes in what that might mean. You talked about giving customer choice, but this sounds like less choice for the FA. + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [13] +-------------------------------------------------------------------------------- +Clients are going to have three ways to invest in their IRAs: they are going to continue to do it completely self-directed through Merrill Edge, they are going to be able to do it online but enhanced with professional portfolio managed through Merrill Edge Guided Investing and, again, for those clients who want one-on-one advice and service from their FA they are going to be able to do that on a fee-based advisory platform. What we've decided not to do is use the best interest exemption to allow IRA accounts to be added to our brokerage platform where clients pay on a transaction basis. +After reviewing all her options, let's say, if a client chooses one-on-one advice and service on her IRA we believe the best way to provide that advice is through Merrill Lynch One on our fee-based advisory platform. We took a lot of time to make this decision. +We took months thinking about this. We did research. We believe this is the best interest of our clients and our advisors. + +-------------------------------------------------------------------------------- +Glenn Schorr, Evercore ISI - Analyst [14] +-------------------------------------------------------------------------------- +I don't doubt that. I worry about just the execution of it. I'm assuming that it means that the advisor has to talk to the client and explain this whole thing and just -- + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [15] +-------------------------------------------------------------------------------- +That's right but the advisor is going to have to talk to their clients and explain the best interest exemption. That's going to be much harder a conversation than the one we are going to have. + +-------------------------------------------------------------------------------- +Glenn Schorr, Evercore ISI - Analyst [16] +-------------------------------------------------------------------------------- +Fair enough. All right, thanks, Paul. + +-------------------------------------------------------------------------------- +Operator [17] +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [18] +-------------------------------------------------------------------------------- +Hey, good morning. A couple of questions. Just one on loan growth. +Could you give us a sense as to how you think you are trajecting there? We talked a little bit about market share and trading, could we talk a little bit about how you think you are doing in the lending side of the equation and if there's any legs there? + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [19] +-------------------------------------------------------------------------------- +We feel good about loan growth. The economy feels good, so we are confident we can grow. But, of course, there's going to be some uncertainty and as I said in certain sectors in certain regions around the world. +I would remind you that we are focused on responsible growth. So we are going to look a little bit different than some of our competitors in some places but we feel good. Year over year if you look at our business segments we had 7% loan growth. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [20] +-------------------------------------------------------------------------------- +So one of the areas that I just want to dig in a little bit more to is on the mortgage side where you have had some good loan growth. But I'm just wondering if there's more opportunity there as it relates to either taking some duration exposures or on credit as you've moved into some wider credit boxes with my first home which is insured by Fannie, Freddie but just want to get some color on that. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman & CEO [21] +-------------------------------------------------------------------------------- +Betsy, if you go to page 6 of the materials you can see that we are continuing in the mortgage area overall. So I think both in the home equity and first mortgage loans. +You can see that we continue to run off some of the non-core portfolios and overall the balances grow in the business segments. And we expect that to continue. We are doing about 2,000 applications a day, about 1,000 each plus in each of the products that has continued to grow. And so we will continue to drive that core capability to the customer. +In terms of expansion of product sets we have a limited product for that we've built for similar to 3% down payment for $0.5 billion a year of production just to give us a more competitive product there but limited the size. And we will do some other things, but we are going to stick with the core credit. +Remember who you are talking to here, Betsy, and our experience in mortgage is probably deeper than most people. So we will stick with what our customers need and what we think the right business for the Company is. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [22] +-------------------------------------------------------------------------------- +Okay, so as you are thinking about your revenue growth from here, which are the three key legs that you expect are going to keep that revenue growth going? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman & CEO [23] +-------------------------------------------------------------------------------- +Well, I think if you think about the growth you've got the interest side and you've got the fee side. And if you look at the interest side it's going to be driven by balanced growth between loans and deposits. And I think we keep growing deposits year over year $60 billion, we are paying 4 basis points in Consumer and think about that dynamic and putting that to work in anything we can is important. +And we continue to grow loans at less rate than we grow deposits. That's going to drive our NIM is just a bigger and bigger, lower lower cost deposit base. +And on the loan side I think Consumer is growing better now than commercial linked quarter but overall we expect commercial will kick back in a little bit as the economy continues and some of the uncertainty lifts in the political season here. So on loans and deposits it will just be growing and now as you've seen year over year core growth of 7% on loans and growth on deposits. +On the fee side what you are seeing is the dynamic in especially consumer fee areas finally turn a little bit stable and then turning for us in the card revenue and things like that, which we've hit sort of the inflection point where the run down and relative interchange due to selling some portfolios and getting out of non-core portfolios and putting on the core portfolios with rewards attached to it which helps us generates deposits and things like that has stabilized and you are starting to see in the last few quarters card income start to move up a bit. +And on service charges it's been relatively stable. So the fee side will be driven more by Wealth Management markets and things like that. And Consumer is stable, which is good because it had been a drag for a long time. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [24] +-------------------------------------------------------------------------------- +And then on the expense side you indicated all the various technology efforts that you've got underway but is there more that you can do on the comp side as well? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman & CEO [25] +-------------------------------------------------------------------------------- +We continued -- when we have less people going through our bonus pools and stuff you can see that comp continues to drift down. A large part of a comp, obviously, is the financial, in the Wealth Management business which there is no meaningful changes there. But in the other business we continue, as we have less people we continue to reduce that as a percentage of revenues. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [26] +-------------------------------------------------------------------------------- +Okay, thanks. + +-------------------------------------------------------------------------------- +Operator [27] +-------------------------------------------------------------------------------- +Jim Mitchell, Buckingham Research. + +-------------------------------------------------------------------------------- +Jim Mitchell, Buckingham Research - Analyst [28] +-------------------------------------------------------------------------------- +Hey, good morning. Maybe you could talk a little bit about the credit cycle. +I think one of the major pushback from investors is that we are going to start to see credit get worse but I think you guys have been pretty clear that you are not lowering standards to drive growth. So how do you think about the cycle from here, I guess that's the start? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman & CEO [29] +-------------------------------------------------------------------------------- +I said earlier if you think about the last several quarters of earnings calls it's been getting better than this and every quarter it gets slightly better. And that in part is because we are still getting the benefits of the changes made six, seven, eight years ago coming through the Consumer business i.e., that what we call back book portfolios or legacy portfolios or whatever word you want to use continue to run off with higher credit risk. And we keep putting on and have put on and continue to put on higher credit quality. +So I think if you think about overall charge-offs of 880 this quarter that's a driven by the Consumer business and that's driven by the card and the legacy home equities. So keeping the card business where we want it is critical and you are seeing this continue even as we start to grow that portfolio, both nominally and rate the charge-off picture is strong. And so when you go back and look at what happened during the crisis the charge-offs came normally from the edges of credit and we've kept ourselves out of it. + +-------------------------------------------------------------------------------- +Jim Mitchell, Buckingham Research - Analyst [30] +-------------------------------------------------------------------------------- +So you feel like you can keep your lease ratios as you grow pretty stable? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman & CEO [31] +-------------------------------------------------------------------------------- +We have done that. + +-------------------------------------------------------------------------------- +Jim Mitchell, Buckingham Research - Analyst [32] +-------------------------------------------------------------------------------- +Okay. And maybe a follow-up on the capital ratios. Paul, I saw that the RWAs dropped while the balance sheet grew a little bit, so it seems like you've reduced risk. I guess where was that and can that continue? + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [33] +-------------------------------------------------------------------------------- +Yes, you are speaking under the advanced approaches we had a drop. We had it under standardized as well just a little bit less. And that drop came, again, from legacy portfolios running off and from continued work by our Global Markets teams to better manage their balance sheet relative to those ratios. + +-------------------------------------------------------------------------------- +Jim Mitchell, Buckingham Research - Analyst [34] +-------------------------------------------------------------------------------- +Is there any more detail or can you get a little more from here? + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [35] +-------------------------------------------------------------------------------- +Yes, look there's always more to do and we are focused on a lot of different regulatory metrics. We are looking at all of them. There are some that may be a little bit more important than others. +Right now we are focused on all of them. And I think there is more to come there. +Obviously, as we do grow the balance sheet, as we grow loans and deposits we are going to continue to see some increase particularly on the standardized side. But I think we can, relative to that growth I think we can continue to make a little bit of progress incrementally. + +-------------------------------------------------------------------------------- +Jim Mitchell, Buckingham Research - Analyst [36] +-------------------------------------------------------------------------------- +Okay, great. Thanks. + +-------------------------------------------------------------------------------- +Operator [37] +-------------------------------------------------------------------------------- +Matt O'Connor, Deutsche Bank. + +-------------------------------------------------------------------------------- +Matt O'Connor, Deutsche Bank - Analyst [38] +-------------------------------------------------------------------------------- +Good morning. Can you talk about the strategy within the securities book? +You did mention that you added some later in the quarter and, obviously, deposit growth has been exceeding loan growth to justify that. But maybe just some color in terms of what you are buying, the duration and how to make sure it doesn't get too big relative to the size of the balance sheet. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman & CEO [39] +-------------------------------------------------------------------------------- +You pick up on the core thing that drives. We have a securities portfolio because we have more deposits coming in, then we have loans. So our view of that portfolio is we don't take credit risk there and so we have two alternatives, treasuries and mortgage-backed securities, or cash I guess is a third. +And so that's how we invest it. And Paul can take you through his earlier comments a little bit and give you some color on that. But I think people always have to remember the reason why we have more is because our deposits grew at $60 billion year over year and that's more than our loans grew by quite a bit. +So, Paul, do you want to answer, give some color on that? + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [40] +-------------------------------------------------------------------------------- +Just one step back. Obviously what we are doing every day is managing earnings, capital liquidity and interest rate risk when we think about that portfolio and where we want to invest things. This quarter as you noted our deposit growth exceeded loan growth and so we did add significantly to the investment portfolio. +Most of that incremental amount we devoted to treasuries. Just as we think about the balance in that portfolio we wanted to just add a little bit more treasuries. That's really kind of it. + +-------------------------------------------------------------------------------- +Matt O'Connor, Deutsche Bank - Analyst [41] +-------------------------------------------------------------------------------- +Okay. And then a little bit related but on the deposit side, obviously, very strong growth year over year. You mentioned $60 billion and really little to no repricing despite the one bump in Fed rates that should impact the year-over-year comps. +So I guess the question is if we do get a rate increase, do you think you've got more flexibility to limit deposit repricing given it's basically worked so far and the loan growth is, obviously, not enough to absorb the deposit growth you have? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman & CEO [42] +-------------------------------------------------------------------------------- +Remember that the reason why you don't see much repricing is really two or three dynamics. One is a full $450 billion of our deposits are noninterest-bearing. So they aren't going to reprice. +The great debate is about how sticky are those? And if you think about that, those are dominated by our Consumer business and our noninterest-bearing accounts in Consumer have doubled in size over the last five or six years due to focusing on primary accounts, grew up to 90% primary accounts in the household where they run their household finances through our account and, therefore, they direct deposit their check and things like that. +So the first thing to remember is that $1.2 trillion, $450 million noninterest-bearing and a dominant and part of that Consumer and also in the Wealth Management and the transactional account of both Consumers. And then on the business side similarly we have a driven our deposits to be really LCR friendly into core operating accounts. +And so those aren't going to move, they are noninterest-bearing and they aren't going to move much and the big debate is how much balance will be in there and we feel confident the balances will stay just because of the nature of the accounts. And then when you go to the second dynamic, remember that even with all this deposit growth one of the things we continue to do and the impact is less and less is we are expecting Consumer business running off CDs still at a fairly decent clip that were historically used to fund prior companies' balance sheets that we don't need the funding that cost. So we have some rollover but that continues to decline. +That weighted average cost drops off -- that cost drops off and drives down or hold steady the average weighted cost. And then if you look at money markets and other interest-bearing they really haven't moved much. +So we feel good about the consumer -- we feel good about the deposit base overall. We feel very good about the consumer deposit base, just crossed $600 billion for the first time in the Company's history in Consumers generally. +And with that, I think if rates rise we think that it's substantial value for the Company. And Paul gave you a way to think about that earlier with a quarter of $3.3 billion -- 25% of $3.3 billion. + +-------------------------------------------------------------------------------- +Matt O'Connor, Deutsche Bank - Analyst [43] +-------------------------------------------------------------------------------- +Okay, thank you very much. + +-------------------------------------------------------------------------------- +Operator [44] +-------------------------------------------------------------------------------- +Ken Usdin, Jefferies. + +-------------------------------------------------------------------------------- +Ken Usdin, Jefferies & Company - Analyst [45] +-------------------------------------------------------------------------------- +Thanks, good morning. I want to ask about the card business a little bit. I saw in the deck that you grew card issuance at the fastest level since 2008, but we are not really -- and there is a burden on the fee side, with reward stuff, balances are still flat. +I was wondering if you could walk us forward and help us understand a little bit better just the ROA and income direction of the card business? When do we start to see that show up in both balances? And when do expect to see that fee growth come along for the ride given the good underlying growth that we haven't quite seen yet in the financials? + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [46] +-------------------------------------------------------------------------------- +So look, I think you are noticing some modest card balance growth in the quarter, which we think will continue as we add new accounts. And, again, we are very focused on adding high-quality accounts there. +I think you probably also noticed that while combined debit and credit card spend was good in the quarter at 5%, 6% if you include fuel, I'm adjusting for divestitures last year, that the growth in the card income was impacted by, as you noted, customer reward programs. However, I think just focusing on the fee income misses some really key benefits of our strategy which is to attract relatively higher-quality card customers and reward them for deepening their overall relationship with us. +This strategy really drives deposit growth and makes deposits stickier, plus we believe these customers have lower loss rates. They use the call center less which helps us lower costs. I think when you want to see the effect of this you have to look at the overall Consumer segment and what's going on there in terms of growth of profits and improvement in expenses. +And just lastly I would just point out, look, our risk adjusted margins on card are strong at over 9%. This is in no way a signaling that we are not going to be able to grow the card income line. I just want you to get a better sense of how we think about it. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman & CEO [47] +-------------------------------------------------------------------------------- +I think if you think about that more broadly, we had the last divestitures of size we made in this card business were the fourth quarter of last year and they are through the P&L, so they are through the balances and through the thing. So what you are starting to see if you look at the trend this year is you are starting to see movement, positive movement both in card income and in balances as we move across the year. And we expect that to continue. +It will be strong, responsible growth. And one of the great debates we have in the Company is people say, why can't you grow this faster? Or why can't, we are giving up too much in the interchange for the preferred balance or preferred rewards, the interesting question is are you giving up something you'd never have in the preferred rewards i.e., we are bringing more customer relationships in depth and that gets us something. +So incrementally the net interchange is actually there as opposed to what theoretically you get gross interchange with a non-customer in an affinity program. So we focus on the entire customer relationship. It is very valuable, it is very profitable and believe me if we could grow it faster responsibly we would. +But the idea is just to grind out the slow, steady growth and we are starting to see that come through. And largely it was masked in 2014, 2015 and behind that 2013, those areas because we were divesting a lot of non-core relationships and now we have the core affinities we want and we have the core card businesses we want. + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [48] +-------------------------------------------------------------------------------- +And, again, I think you can see it if you look at the whole segment. I don't want to start comparing us to peers, but just take a look at our PPNR year over year. It's up 10%. + +-------------------------------------------------------------------------------- +Ken Usdin, Jefferies & Company - Analyst [49] +-------------------------------------------------------------------------------- +Understood. Second quick question is you mentioned that you are now achieving the cost of capital in an ROE above 10% and capital is still building. +Do you think you can continue to hold if not improve the ROE as capital will likely continue to grow, presuming that you still will get those benefits going forward and you are not at the point of returning more than 100% of your earnings yet? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman & CEO [50] +-------------------------------------------------------------------------------- +Well, I think embedded in that is the future return of capital. And we now have a significant buffer above the requirements. And as Paul said we continue to try to optimize our core. +So I think you are a little bit of a horse race between increasing earnings and increasing capital. And as we return more you expect that the horse race of increasing earnings would stay ahead of it. But we've got room to go and we are driving at it. +But if we don't hit -- if the issue is that our capital continues to grow, that capital is also yours as an investor and continues to go into our book value. And so it's not going anywhere. It's there to be returned when we can get through the process of getting from where we are to higher percentages of capital return and ultimately returning excess capital. + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [51] +-------------------------------------------------------------------------------- +And we have a goal to return more. + +-------------------------------------------------------------------------------- +Ken Usdin, Jefferies & Company - Analyst [52] +-------------------------------------------------------------------------------- +Understood. Thanks, guys. + +-------------------------------------------------------------------------------- +Operator [53] +-------------------------------------------------------------------------------- +Mike Mayo, CLSA. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA - Analyst [54] +-------------------------------------------------------------------------------- +Hi, you've reduced your branch count from 6,000 to 4,600. Where do you think that count can go? And on the one hand we heard you say almost 1 million customers walk into branches each day but on the other hand you have grown deposits $1.2 trillion. +You did mention more self-service digital channels. You did mention mobile banking is 18% of the deposit transactions. And less reliance on the branches might ease any extra pressure to sell more products in this low rate environment. +So where do you think you might take the branch count to? And I don't think you mentioned the impact of the cross-selling issues on Bank of America or if we wake up one day and find out that Bank of America did something inappropriate. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman & CEO [55] +-------------------------------------------------------------------------------- +Well, let's go to how we run our Consumer business. So we run our Consumer business consistent with responsible growth for the Company. And what that means is that you focus on deepening relationships, what we call a stairstep where the core deposit account, the quarter credit card and getting it used in the core mortgage, in the core home-equity and the core auto loans. +That's what's been driving it and we'll continue to drive that. That is the backbone of what we did and how we repositioned this Company over many years. +In terms of the branches, Mike, you rattled off all the statistics which Paul talked about earlier. But it is a complex optimization, but it all starts with the consumer. What is the consumer going to do? +And so while 18% of deposits are made by mobile deposits, 82% by their nature aren't and where do they go, about 50 percentage points of that go through the ATM machines and about another 30% odd go through the teller line still today. And so you have to be ready and able to serve in all dynamics. +And so what we continue to do is optimize the branch structure, the call structure, the ATM structure, the mobile structure and the online structure altogether. And the way to think about that optimization and why it's an extremely important business to this Company is that we've gone from 300 basis points of the cost of all that to deposits to about 150 over the last six, seven years. And that's by continuing to optimize the physical plant as well as all these other means. +And so if you ask me your question is how far can go? You have to also then think about what we want to go on at a branch. +And so if you look back at some of the statistics that Paul had in the deck for Consumer where you see things like appointments set up or 340,000 in the third quarter, so just think about that. 340,000 times a customer went on a mobile phone and asked to come to a branch. +And so we need those branches to receive those mobile phone customers and why are they coming? Usually for a much more important financial transaction to them than handing us a check for deposit. So it's a quality versus quantity and making sure we understand that. +So we are optimizing all those and you can see on page 14 on the lower right you can see the different moves. I'd say we went from 7 million visits probably four or five years ago to 6 million to 5 million. But those five are of a higher quality and we think that's important. +And there certain transactions and certain capabilities that you just have to have at your branch, you just have to do face-to-face. Very difficult things like how to get a power of attorney for a parent that's sick or I want to do a mortgage, it's still difficult to do through the phone and things like that. So we will have all aspects, we will drive it down and you can see that we continue to make that progress. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA - Analyst [56] +-------------------------------------------------------------------------------- +I mean just as a follow-up, on slide 14 it's kind of thing Bank of America we're a FinTech Company, and look how well we are doing. And you are showing some good growth rates, that chart on the upper right. +So at what point does that lead to a greater number of branch reductions? Is this do you have the answer and you don't want to say for competitive reasons? Or you don't know yet, it's kind of a give-and-take based on the customer experience? +Some of your competitors talk about closing 100 to 200 branches per year. You've reduced 112 over the last year but it seems to be slowing. So I'm trying to get a sense of that. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman & CEO [57] +-------------------------------------------------------------------------------- +I'd say that the point is that we run this business and we start with the consumer and their activities and their behaviors, and so what they want to do. And the key is not to get ahead of them because that can cause you problems and not to be behind them because that can be cost issues and empty branches. +So even in the 112 we are down we've added branches. And places like Denver, the Denver branch that we added are in the top 10% of performing branches today on relationship building. We've added branches in Manhattan, we've added branches in Minneapolis. +So we are in a sea change in terms of what the branches look like individually. The new branches are different. We are adding branches we didn't have and we are closing branches where the utilization isn't there. +The nature of how far a customer will travel is also different now than it was 10, 15 years ago. So I think you said what all the different reasons? The answer is I think you said is we will follow the customer. +And I don't know the exact number because I can tell you eight years ago when we had 6,100 there were people that said there was never going to be less branches in our system and maybe we should add more. And guess what? We are 4,600 -- 4,500. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA - Analyst [58] +-------------------------------------------------------------------------------- +All right, thank you. + +-------------------------------------------------------------------------------- +Operator [59] +-------------------------------------------------------------------------------- +Paul Miller, FBR & Company. + +-------------------------------------------------------------------------------- +Paul Miller, FBR & Co. - Analyst [60] +-------------------------------------------------------------------------------- +Yes, thank you very much. You guys took an MSR write-up or hedging benefit, I can't really which one it is, about $360 million. But you did write up the MSR from 51 basis points to 60 basis points. +Was that all rate driven? The 10-year did go up a little bit. Or was that also some better credit metrics out of the servicing portfolio? + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [61] +-------------------------------------------------------------------------------- +You are right, we had a $280 million benefit this quarter and that was from a higher valuation of the MSR, which was due to slower observed prepayment speeds. So we are just updating our -- the way we value that. +We have to monitor -- it's a level III assets, so there's a lot of things that go into that. It's hard to value and you've got to continually be looking at that valuation. And we thought it was time based upon observations of prepayment speeds to make a change in some key assumptions. + +-------------------------------------------------------------------------------- +Paul Miller, FBR & Co. - Analyst [62] +-------------------------------------------------------------------------------- +Okay, guys. Thank you very much. + +-------------------------------------------------------------------------------- +Operator [63] +-------------------------------------------------------------------------------- +Eric Wasserstrom, Guggenheim Securities. + +-------------------------------------------------------------------------------- +Eric Wasserstrom, Guggenheim Securities - Analyst [64] +-------------------------------------------------------------------------------- +Thanks. I just wanted to follow up on a couple of questions related to the various consumer lending businesses. +First, Paul, just from your response to Ken's question a moment ago on card, I heard everything you said about the risk-adjusted margin and the credit quality of the portfolio, etc. But just to be clear, are you expecting improving, stable or deteriorating ROA based on the current competitive environment? Because it seems like many peers are underscoring the near-term risks to profitability from rewards and customer acquisition costs. + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [65] +-------------------------------------------------------------------------------- +Based upon how we are growing the business, how we are running the business we expect stability. + +-------------------------------------------------------------------------------- +Eric Wasserstrom, Guggenheim Securities - Analyst [66] +-------------------------------------------------------------------------------- +Stability, okay great. And with respect to mortgage I saw there was about $100 million benefit from rep and warrant release. How much of that research still exists and what would be your expectations about potentially realizing it at this stage given where we are with respect to that issue? + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [67] +-------------------------------------------------------------------------------- +I think the rep and warranty is a contra-revenue. So is that what you are referring to? + +-------------------------------------------------------------------------------- +Eric Wasserstrom, Guggenheim Securities - Analyst [68] +-------------------------------------------------------------------------------- +Yes, correct. It's the provision line item. You had a negative provision. + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [69] +-------------------------------------------------------------------------------- +So that's going to bump around. That bumps around because -- + +-------------------------------------------------------------------------------- +Lee McEntire, Bank of America Corporation - SVP, IR [70] +-------------------------------------------------------------------------------- +Hey, Eric, it's Lee. I think what you are looking at, what Paul is referring to is the contra-revenue item. So it's a negative revenue item when it's a provision expense on the provision, okay? + +-------------------------------------------------------------------------------- +Eric Wasserstrom, Guggenheim Securities - Analyst [71] +-------------------------------------------------------------------------------- +Okay, maybe I will come back to you in a bit. Just finally on auto, it seemed that some peers were signaling that competitive conditions in auto underwriting were easing a bit after intensifying over the past several quarters. Are you seeing anything like that across any particular segment of the FICO strata? + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [72] +-------------------------------------------------------------------------------- +We are continuing to see good growth in consumer vehicle lending the way that we run the business. We are up roughly 7% or $7 billion or 17% year over year. Again, though, we are focused on prime and super prime. +So originations were down modestly Q3 versus the prior quarter as we accepted a little bit less dealer flow but we still feel good about that product offering. The third-quarter average book FICO scores remained at approximately 770. Debt to income was at all-time lows. +We are not following the market expansion to 84 months in terms of tenor. We have got a maximum tenor of 75 and I think in the third quarter we were averaging around 67. So we are getting the growth within our responsible growth framework and we feel good about it. + +-------------------------------------------------------------------------------- +Eric Wasserstrom, Guggenheim Securities - Analyst [73] +-------------------------------------------------------------------------------- +Thanks very much. + +-------------------------------------------------------------------------------- +Operator [74] +-------------------------------------------------------------------------------- +Steven Chubak, Nomura. + +-------------------------------------------------------------------------------- +Steven Chubak, Nomura Securities Co., Ltd. - Analyst [75] +-------------------------------------------------------------------------------- +Hi, good morning. So I want to kick things off with a follow-up to an earlier question on the DOL. +Paul, you had noted that Merrill FAs will no longer be permitted to engage in brokerage activities in retirement accounts. And I was hoping you can give us an update as to what portion of Merrill client assets are currently in brokerage IRA? +And maybe more specifically, how should we think about the net economic impact from transitioning some of those retirement assets into some of the other offerings that you highlighted, whether it be fee-based which should generate higher fees versus robo or self-directed Merrill Edge? + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [76] +-------------------------------------------------------------------------------- +Sure. So the primary affected portion of our business is in the transactional brokerage retirement accounts. +And if you look at our roughly $2 trillion of GWIM client assets outside of loans and deposits we would see the DOL rule having an impact on significantly less than 10% of those balances. And, again, that's as the industry works towards the full implementation of the rule in January 2018. +So as you noted we are going to see some geography movement on the P&L. There's going to be some shifts. +And if I had to guess today we might see some modest revenue impact in 2017. But it's really way too early to know how it's all going to shake out. But we would expect to mitigate that in subsequent years. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman & CEO [77] +-------------------------------------------------------------------------------- +People, Steve, when you talk about backing up to the fuller trends on Wealth Management and there's been a constant decline in brokerage revenue over the years largely because the industry and we have been moving more to a financial device to manage the account execution. And so in, obviously, a limited portion of that is IRA-related in both counts. But the reality is this is against the backdrop that you will see, that brokerage number has the number has been tough to chase for five years now. + +-------------------------------------------------------------------------------- +Steven Chubak, Nomura Securities Co., Ltd. - Analyst [78] +-------------------------------------------------------------------------------- +Got it. Okay. And just one other quick follow-up on the same topic, the press article have highlighted some of the changes that you've made indicated that some clients that would transition to the, quote, higher touch advisory offerings will be rebated some incremental fees. +And I was wondering how are you planning to apply changes to the fee structure for those brokerage assets that do, in fact, transition? I'm just struggling to see how a two-tiered structure might work in practice across the hundreds of billions of assets that would be affected here? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman & CEO [79] +-------------------------------------------------------------------------------- +I think the implementation has to be very carefully handled. And the team, Andy and John, have been leaders in trying to figure this out the right way for the client. And we start with what's best for the client. +So what you are reading about is there will be adjustments made clients by clients based on their circumstances and what they want from us. And the FAs will engage in a lot of conversations about that as we go through the next several months. + +-------------------------------------------------------------------------------- +Steven Chubak, Nomura Securities Co., Ltd. - Analyst [80] +-------------------------------------------------------------------------------- +Got it. Okay, thanks Brian. Then just one more on the topic of capital, just switching gears for a moment. +Following Tarullo's recent remarks, there's one area of debate has been whether the Collins Floor would, in fact, apply to this new capital framework, i.e. whether you will be forced to manage to capital minimums under both the standardized and advanced approaches. And now that you've had some time to digest the initial release or guidance I was wondering if you can give us any insights into how you are thinking about that potential change? + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [81] +-------------------------------------------------------------------------------- +Okay, well, look that's, obviously, a pretty technical question. And it's not that we haven't thought about it, but to be frank it's just a speech at this point and he didn't really address that in his speech. So we don't know the answer. +That's one of the questions we have. I think once we get the Fed's proposal we will have a better idea. But all I can tell you is based upon our current reading of the speech, in particular some of the changes you mentioned in CCAR around asset growth, we think that the substitution of the capital conversion, conservation buffer, sorry, capital conservation buffer with the stress capital buffer would not be a material change for Bank of America given our risk profile and given how we run the Company. + +-------------------------------------------------------------------------------- +Steven Chubak, Nomura Securities Co., Ltd. - Analyst [82] +-------------------------------------------------------------------------------- +Got it. I recognize it's early days, Paul, so I appreciate you taking, making the effort to answer the question. And that's it for me. + +-------------------------------------------------------------------------------- +Operator [83] +-------------------------------------------------------------------------------- +Brian Foran, Autonomous Research. + +-------------------------------------------------------------------------------- +Brian Foran, Autonomous Research LLP - Analyst [84] +-------------------------------------------------------------------------------- +Good morning. I guess we've had a couple of good quarters in FICC both for you and the industry and I know volatile business not really looking for quarterly expectations. +But just more broadly there is an investor debate, is it just a couple of good quarters or has the business absorbed all the changes in regulation, absorbed low rates, absorbed all the restructuring required and the cycles inflecting FICCs at the bottom and has upward pressure from here? So where do you come in on the debate? Is it a couple of good quarters at this point or has FICC bottomed? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman & CEO [85] +-------------------------------------------------------------------------------- +Well, the way I come at that debate is to go back along many years ago and think through the repositioning that was done in our Company and so the key was to make FICC work. You are talking more revenue, but we look at profit. +And so to get the profit we needed to out of the fixed income and equities business we had to take the cost structure down which we did in 2010 and 2011. Tom Montag and the team worked very hard at that and got breakeven down over $1 billion a quarter. +And then we ran along a number of years and then they've actually had taken out, year over year you can see the costs continue to be managed well despite higher revenue. So I would say taking the discussion I'd say the way our fixed income business generates revenue a lot of it is around our capabilities, underwriting capabilities in all the different variations from high-grade leverage to everything that goes on. And that's a relatively stable pool of revenue that you see repeated. +What goes up or down is really the activity around that based on the market seizing up in certain quarters in terms of issuance and things like that. When you think about the other thing that Tom and the team had to really go after which is to broaden our capabilities in the macro segment a little bit because that was something that traditionally the Bank of America Merrill Lynch teams came together. And he has done that so that's added some more volume to us. +So we think we've been gaining share, as Paul said earlier. When you look at revenue comparison among the top 10 banks without all the leak charge for just revenue, and we think it's driven by our fixed income capabilities and it's driven by our connectivity from the issuer of the bonds in debt to the investor. And we will continue to drive that. +And so the team has done a good job. And I'd say we are at a fundamental level. +This quarter feels better than last year's quarter. It's not a quarter that when you look across four or five years that we haven't come close to on many cases and have done better than a few times. + +-------------------------------------------------------------------------------- +Brian Foran, Autonomous Research LLP - Analyst [86] +-------------------------------------------------------------------------------- +Thank you for that. I guess a similar question on commercial lending. +You referenced some of the strategies you have in place driving responsible growth and how you felt good about the business going forward. But we saw this pause across the industry in the third quarter in commercial growth, the Fed numbers, your numbers, other banks reporting so far. Have you seen signs of customer demands coming back, I guess, late in 3Q and early in 4Q, do you have visibility and confidence that the commercial loan growth cycle more broadly is still in gear? + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [87] +-------------------------------------------------------------------------------- +We feel -- I think let me start with what we noticed in commercial in the quarter was lower industry growth this quarter I think that really reflected a slowdown in closed, actually booked closed acquisition financing for us, which is probably maybe could be different for peers depending on the timing of transactions and then uncertainty around the election and then I think some lingering concerns around certain countries or regions. That's what I think impacted the third quarter. +When you look at the US, when you look around the globe, when you look at GDP growth we are optimistic. We think the economy feels good. So in a good economy we should be able to grow commercial loans. +We will have to stay focused on some sectors in some regions but we think we can grow commercial loans. Utilization rates and revolvers, they came off their highs but they are at the higher end of the range which also suggests or reflects good commercial activity. +We are adding bankers in the US in commercial banking and small business. We are adding them to regions where we know we have some synergies or some capabilities, some big MSAs. So there's no reason why we can't grow within our responsible growth framework assuming the economy continues to chug along here. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman & CEO [88] +-------------------------------------------------------------------------------- +Also if you think about by sub asset class, in real estate we modulate our growth there based on our view of wanting a diverse portfolio and then how we lend in the business. And if you see that number it was growing and it has flattened out a little bit and that relative to others that was the difference. But I think to Paul's last point is a key point. +There are creditworthy customers that we can do more with and the only way to do that is because we have a talented world-class commercial banking team is to add more capacity. And that capacity is starting to build, and it takes a while because you hire a commercial banker and we sometimes give them some of the undercovered names in our portfolio or else then they go after the prospects that we have, then it takes a while to build those up. People don't change their commercial banking relationships in an afternoon. +So in our business banking and our middle market, especially across America, we have been adding commercial bankers and we expect that to redound to our benefit. Given an environment which may be solid but okay we'd expect to gain share in those markets as those bankers come on stream and become more productive and Alastair Borthwick and Katy Knox, the team that's driving that, has proven that those bankers do get share and you will see that come through. + +-------------------------------------------------------------------------------- +Brian Foran, Autonomous Research LLP - Analyst [89] +-------------------------------------------------------------------------------- +Thank you both. + +-------------------------------------------------------------------------------- +Operator [90] +-------------------------------------------------------------------------------- +Nancy Bush, NAB Research. + +-------------------------------------------------------------------------------- +Nancy Bush, NAB Research - Analyst [91] +-------------------------------------------------------------------------------- +Good morning guys. We are all, of course, very attuned to the issue of fraud after the recent news at Wells Fargo, both on the customer side and on the employee side. +I guess my question to you would be as you move more to digital methods of attracting customers and keeping customers, etc., is fraud on either side becoming a bigger issue? Or if you could just speak to the whole issue of how you prevent fraud as you become a more electronic bank. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman & CEO [92] +-------------------------------------------------------------------------------- +I think when you think about fraud most people think about in terms of the electronic side most people think about credit card fraud and fraud as a broad worded, arguments about whether the charge was valid, whether a merchant and things like that. So there's a long history of adjudicating that. +So more and more sales go online by the consumer the techniques for online are continuing to develop. At face to face or point-of-sale, the chip card when we are largely through our customers having chip cards, merchants, what we call chip-on-chip, i.e. our chip card used with a merchant chip machine is rising a percent or so a quarter and is now as best we judge it in the 30s, the high 20s or something like that, Nancy. +So all that being said, we expect to get leverage in our fraud losses in a Consumer business year over year and we expect that to continue to come down. So yes, that is a major initiative for us to continue to drive that down. +Part of it is education to consumers, part of it is getting the chip cards in the hands and getting the machine, merchants using the chip machines. Part of it is the tokenization and the wallets and things that go on in Visa Checkout and all the variations of MasterCard and getting, because that's a tokenized better execution and is more secure. +So our view as a provider has been to adopt all these wallets and technologies that have this tokenization capabilities and that then drives down the cost of losses due to merchant complaints and other types of things. So you are absolutely right: cyber security, theft of cards from other people and sold on the Internet, all that stuff is important to us. And so we spend, as we said, $0.5 billion a year protecting ourselves but also part of it is making sure we understand who our consumers are in terms of lost cards and things like that. + +-------------------------------------------------------------------------------- +Nancy Bush, NAB Research - Analyst [93] +-------------------------------------------------------------------------------- +Well how about on the other side, the employee side, opening false accounts. If you could just speak to how you think your methodology is different from what produced the problems at Wells Fargo. + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [94] +-------------------------------------------------------------------------------- +Maybe I will take that one. Look, I want to take just one step back because to really answer that question you just have to have a better appreciation for how we run Bank of America. And it truly really does start with our purpose, which is to help customers better live their financial lives and then from there you have to understand what we mean by responsible growth. +So if you ask anybody in the Company, responsible growth, it's about developing relationships so that we can grow with our customers over time based upon their needs and goals. It's not about the number of products that we open. It's whether customers want or need the products and services we are offering them and use them. +That's how we measure ourselves. We've spent years building controls and governance and escalation around this. We are always monitoring them. +It's just how we run the Company. So that's probably the best answer I can give you in terms of how we think about this issue. + +-------------------------------------------------------------------------------- +Nancy Bush, NAB Research - Analyst [95] +-------------------------------------------------------------------------------- +And Brian, I have what is going to be a difficult question for you. But in response to the problems at Wells Fargo we have seen them separate the chairman and the CEO roles. And while that may have been due to exigent circumstances, do you foresee another push now either by regulators or by shareholders to separate those roles? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman & CEO [96] +-------------------------------------------------------------------------------- +Nancy, I'd say this, we have dialogue with all our shareholders often and Jack Bovender, our Lead Independent Director. Obviously, we went through this a year or so ago. And last year the shareholders they voted on it, but the key is how we run the Company and how we govern ourselves. +So, again, Paul's view of what he talked about responsible growth, one of the tenets is to be sustainable and sustainable, all growth has to be sustainable and it involves things like you've got to invest in the future. But it also involves how we govern the Company. +And our Board, the independence of our Board, the experience on our Board, how they approach their responsibilities I think is very strong. And I think our shareholders have understood that and agreed with that. +So I think we govern ourselves in a very tough fashion i.e., the Board's demanding on us and understands the strategy and has helped support the strategy through some times when people would challenge it. And I think it's proven to be the right strategy at this point. +So if you get to the technicalities our Lead Independent Director duties are as strong as anybody's in the industry. If you look at all the new governance surveys that have come out, all the words about proper governance and all the different things you've seen recently, we meet or exceed everything anybody says to go to. So I feel comfortable with that. + +-------------------------------------------------------------------------------- +Nancy Bush, NAB Research - Analyst [97] +-------------------------------------------------------------------------------- +All right. Thank you. + +-------------------------------------------------------------------------------- +Operator [98] +-------------------------------------------------------------------------------- +Brennan Hawken, UBS. + +-------------------------------------------------------------------------------- +Brennan Hawken, UBS - Analyst [99] +-------------------------------------------------------------------------------- +Good morning. I just wanted to follow-up on the fiduciary rule questions before. So I appreciate retirement assets are less than 10% of your balances as you've highlighted before. +But I think what a lot of folks are thinking about here is that SEC has been pretty clear that they are working on their own version of this applying to taxable. And so when people watch what you are doing here on the fiduciary rule for retirement people it's sort logic to assume you would apply the same policy in the event we see a similar rule come out more broadly. +So isn't that the message that you are basically sending to FAs? And aren't you concerned that FAs might look at your platform versus some of your competitors that will offer the BIC and think that they might have greater amount of flexibility as some of those other platforms? + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [100] +-------------------------------------------------------------------------------- +Okay, so look. When you look at advisor attrition today it's at all-times lows. And we don't expect significant attrition for the same reasons that attrition is low today. Merrill Lynch is a great place to work and serve your clients. +So if you are an FA you are looking at a platform, we have market-leading capabilities, we have breadth of products across banking and wealth management, we have lots of options in terms of servicing clients. We have got great technology that we are investing in, tremendous transparency that provided through Merrill Lynch One award-winning research and incredible global execution through global markets. So there's a lot of reasons to be here. +This is a great place to serve your clients. We are implementing a strategy that creates significant flexibility for our advisors. And we are delivering fiduciary best interest advice to clients. +I said it before. When we came to this decision not to use the best interest exemption after a lot of months of thinking and research, and this is better for our advisors and it's better for our clients. The best interest exemption is going to create confusion, it's got operational pain for clients, it's going to be inefficient and cumbersome for advisors. This is the best solution we believe for our clients and advisors. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman & CEO [101] +-------------------------------------------------------------------------------- +And if you look at the brass tacks financials in the third quarter of 2016 we had $4.4 billion of revenue in our Wealth Management business. Of the $4.4 billion, $500 million of it in total was brokerage. And so this part of the business has been declining in favor of financial advice to the client and to managed portfolios that meet the needs of the client and have investment framers and decisions based on the client's goals. +So the goals-based method is the dominant method in our business. And so you've seen a constant growth in asset management fees, net interest income and other sources of revenue and, frankly, a constant decline in the brokerage business across many years. And so the SEC has an obligation in the rules to issue a rule on this at some point, and they will and we will adjust to that there, but it's consistent with where we have been taking the business for five or seven years. + +-------------------------------------------------------------------------------- +Brennan Hawken, UBS - Analyst [102] +-------------------------------------------------------------------------------- +Sure, sure. I get it and there's no question that commissions have been declining. +It is just that when you look at some of the asset classes like alternatives and such it's hard to get everything to fit into a fee-based approach. So that was the gist of my question. Maybe going a different direction -- + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [103] +-------------------------------------------------------------------------------- +Well, again, just to be clear we are not doing away with brokerage. Brokerage is going to be -- unless something changes in the industry, and that's going to affect everybody, we are not doing away with brokerage. Brokerage is a very important part of our advisory relationship and FAs will work that out with their clients what's best for them. + +-------------------------------------------------------------------------------- +Brennan Hawken, UBS - Analyst [104] +-------------------------------------------------------------------------------- +Right. But if we take the logical conclusion that your approach here with retirement would be similar to taxable under the assumption and, look, all of this, I am making assumptions with all of this, but we all have to, that the SEC comes out with a similar rule, then your option within to maintain brokerage is self-direct. And I could see how FAs might dislike the idea of having a component of their relationship move effectively away from them. +So what has been the response from FAs of this idea that if we want to maintain brokerage it has to go the self-directed route? And has that tapped in on any of the worries that some of these brokers have seen much of their book shift over to discount brokers that would fit in that type of an approach? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman & CEO [105] +-------------------------------------------------------------------------------- +I think you've stated yourself that you are making a lot of assumptions. Let's let it play out. +We have the biggest and most capable business in the world making more money and having better margins than anybody else. I think we will figure it out. + +-------------------------------------------------------------------------------- +Brennan Hawken, UBS - Analyst [106] +-------------------------------------------------------------------------------- +Okay, thanks. + +-------------------------------------------------------------------------------- +Operator [107] +-------------------------------------------------------------------------------- +Matthew Burnell, Wells Fargo Securities. + +-------------------------------------------------------------------------------- +Matthew Burnell, Wells Fargo Securities - Analyst [108] +-------------------------------------------------------------------------------- +Thanks for taking my question. Perhaps a bigger picture question. On your media call you were, I guess, asked a question on Brexit, and it sounds like you do have plans in place for that which certainly makes sense. +I guess given relative to your $53 billion cost target for 2018 and the fact that the negotiations seem to be starting to gear up early next year, how are you thinking about the costs in the Global Markets and Global Banking businesses from Brexit if it ends up being a harder Brexit than a softer Brexit? + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [109] +-------------------------------------------------------------------------------- +Look, I think it's just too early to tell at this point. We don't know how it's all going to unfold in the UK and in Europe. We don't know what the effect is going to be on our clients on the new rules. +So as I said on the press call we've developed plans based upon various scenarios and we are going to have to wait and see how everything unfolds to know what we are going to do. But as I emphasized on that call, today we are focused on our clients. And as I alluded to, this impacts them, too. +So for now we are just working with them, providing them loans, helping them raise capital, store and move their money, manage risk. That's what we are focused on. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman & CEO [110] +-------------------------------------------------------------------------------- +Just remember materiality here. So the markets business is about 20% of our expense base today. +That's the entire business. So I don't think the impact of Brexit in the overall Company, we would manage it without having any impact of any great magnitude. As it relates to the European business itself, it will have an impact if it costs us more but not to the whole Company. + +-------------------------------------------------------------------------------- +Matthew Burnell, Wells Fargo Securities - Analyst [111] +-------------------------------------------------------------------------------- +Okay. And then just a quick administrative question. +You mentioned on slide 9 that the nonperforming loans in the commercial portfolio were increased by $340 million quarter over quarter. It seems like it's mostly in the energy and related space. Is that a US or are those US credits and what's your outlook for those balances going forward? + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [112] +-------------------------------------------------------------------------------- +Yes, it was to credits, one in metals and mining, one in the US. And if you look at the ratio it's at a very comfortable level. +So that doesn't concern us. If you note criticized assets were down in the quarter. That's because these two credits that went NPL were already in reservable criticized. + +-------------------------------------------------------------------------------- +Matthew Burnell, Wells Fargo Securities - Analyst [113] +-------------------------------------------------------------------------------- +Okay, thanks very much. + +-------------------------------------------------------------------------------- +Operator [114] +-------------------------------------------------------------------------------- +Vivek Juneja, JPMorgan. + +-------------------------------------------------------------------------------- +Vivek Juneja, JPMorgan - Analyst [115] +-------------------------------------------------------------------------------- +Hi, thanks for taking my question. Couple of questions. +Paul, your deposits at the Fed declined pretty sharply, almost 20% linked quarter even though you had deposit growth and given that long-term rates are still very low. Can you talk a little bit about what drove that thinking? + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [116] +-------------------------------------------------------------------------------- +Yes, we moved some cash into securities. Again, we are always managing the trade-off between liquidity capital in terms of interest rate movements and returns. And we just deployed some of that as I said in U.S. Treasury, so you can think about it going from one part of the government to the other. +We just moved them to get a little bit more yield. We feel good about that move and we will continue to optimize our cash and investment securities. + +-------------------------------------------------------------------------------- +Vivek Juneja, JPMorgan - Analyst [117] +-------------------------------------------------------------------------------- +Is that saying that you don't expect rates to go up that much given that you move credit a chunk at a time and long-term rates are pretty low? + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [118] +-------------------------------------------------------------------------------- +I'm not sure we're making any -- we are not projecting any view of rates . When we make that move we are just balancing liquidity capital and earnings. +It's a big portfolio. We are always looking at it to make sure that we feel good about where we are at any point in time. + +-------------------------------------------------------------------------------- +Vivek Juneja, JPMorgan - Analyst [119] +-------------------------------------------------------------------------------- +One more question. Earlier you mentioned that global, in response to a question that Global Markets was doing a better job managing the balance sheet. Could you give us some more color about what specifically they are doing? + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [120] +-------------------------------------------------------------------------------- +I'm not sure I really want to give much more color than that. They are doing the standard things you might do to optimize RWA, create compression, looking at returns on various assets and just optimizing. + +-------------------------------------------------------------------------------- +Vivek Juneja, JPMorgan - Analyst [121] +-------------------------------------------------------------------------------- +All right. Thanks. + +-------------------------------------------------------------------------------- +Operator [122] +-------------------------------------------------------------------------------- +Marty Mosby, Vining Sparks. + +-------------------------------------------------------------------------------- +Marty Mosby, Vining Sparks - Analyst [123] +-------------------------------------------------------------------------------- +Thanks. I wanted to ask you about two strategic balance sheet decisions. +One is that there seems to be a lot more retention mortgages. So when we have these surges we are not picking up as much mortgage fees but growing mortgage loans maybe a little bit faster. That is a shift, and do you think that will hold mortgage fees down and trade-off for further net interest income down the road? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman & CEO [124] +-------------------------------------------------------------------------------- +Yes, you've got the dynamic. But the reality is as Paul was just answering the last question we continue to build cash that we need to put to work. These are our core customers, very high credit quality mortgages and pipeline has grown quarter over quarter and continues to grow and production capacity and capabilities. +So you've got it right. The technical differences instead of recognizing the upfront gain on sale of the mortgage and capitalizing the servicing you see that come through NII over time. And so and the other dynamic, remember, is the MSR asset will continue to drift down because we have less and less third-party servicing. + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [125] +-------------------------------------------------------------------------------- +And, again, I want to point out we've done a lot of thinking about that. And we think maybe there's a near-term impact on earnings. But long term we think that's a better strategy for our shareholders given the risk profile of the mortgages that we are originating and putting on the balance sheet. + +-------------------------------------------------------------------------------- +Marty Mosby, Vining Sparks - Analyst [126] +-------------------------------------------------------------------------------- +And kind of in connection with that you talked about the big question on asset sensitivity which is duration expectation on your deposits. As you've gone through this cycle, and initially we all assumed that there was going to be a lot more volume runoff than the volumes that keep going higher, have you adjusted that duration and is that part of why you are also comfortable putting on more mortgages that have that longer duration feel to it? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman & CEO [127] +-------------------------------------------------------------------------------- +In terms of the technical modeling for NII we still use the same assumptions we've used. You could have great debate in our Company whether we think those assumptions are conservative or not. But so in terms of the NII modeling we've been very consistent in terms of what, Marty, a deposit beta and what would change and how it would work. +I think the pragmatic answer is that we are 90% of our customer consumer checking accounts are core transaction accounts, the primary checking account. Those balances are touching $250 billion-plus. +They've been doubled over the last seven, eight years. Those balances are the daily cash flow of a household, and I don't think they are going to change much. But until you've got experience, a model has to look backwards as we'd say. +And so we will see what happens. But so far those of us that take the side that this will be less sensitive of one, let's just say that. + +-------------------------------------------------------------------------------- +Marty Mosby, Vining Sparks - Analyst [128] +-------------------------------------------------------------------------------- +All right. And, lastly, just a strategic utilization of capital, if you look at your allocation of capital and returns by business segment you do a weighted average, you come up with close to an 18% return. +As profitability is getting higher that is getting further away from the overall return which is still around 10%. How do you envision trying to clean up either the capital positions or the overhang from overhead expenses that brings those two numbers maybe a little bit closer together? Thanks. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman & CEO [129] +-------------------------------------------------------------------------------- +So, Marty, moving expenses down, we talked about that earlier, that helps the returns. But we always have to remember that there is basically, leave aside how the allocation works, to the businesses works differently, but when you think about the 10% capital requirements for us 300 basis points or 3 percentage points of that cannot be put to use, it cannot take risk. +And so we are earning all our money on the 7%. And so when you think about the weighted average of that it comes out over 10, that means you are in a lot more on the 7 even across the whole Company. And so that's one of the difficulties. +So how do we optimize that? We make that 10% less dollar volume, if we can keep moving dollar volume down and keep increasing earnings you get that that's by all the discussion Paul had in response to earlier questions about optimizing the balance sheet or we get expenses down or we grow less risky earnings that can generate income, but it's a constant optimization. But the basic that people, that we sometimes forget is that when you think about 10% only a 30% of capital can take no risk, and so basically earns your cost of debt. + +-------------------------------------------------------------------------------- +Marty Mosby, Vining Sparks - Analyst [130] +-------------------------------------------------------------------------------- +Got it, thanks. + +-------------------------------------------------------------------------------- +Operator [131] +-------------------------------------------------------------------------------- +Gerard Cassidy, RBC. + +-------------------------------------------------------------------------------- +Gerard Cassidy, RBC - Analyst [132] +-------------------------------------------------------------------------------- +Thank you and good morning. A question on your digital sales. +Obviously, you've had 18% of total sales coming through digital channels and 25% through the mobile. Can you share with us what products you are having the most success with selling through these channels and which products proved to be more challenging? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman & CEO [133] +-------------------------------------------------------------------------------- +Well, generally you should think that the products which are more straightforward, like a card application, we build a nice auto loan execution that's unique because those things are fairly straightforward applications mortgage and things like that really take a lot more process around them. So I'd say cards and autos are the dominant part of it. + +-------------------------------------------------------------------------------- +Gerard Cassidy, RBC - Analyst [134] +-------------------------------------------------------------------------------- +Is there any target of where you can get these sales to as a percentage of total sales? Can eventually 50% of sales come through the digital channel? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman & CEO [135] +-------------------------------------------------------------------------------- +I think it will continue to rise in terms of dollar amount, probably rise in terms of percentage. But remember as sales grow overall in the Company, getting it to 50 means they have to win the mix race in the growth overall. But we are becoming more and more capable in delivering this, and that's why you've seen the nice growth, and so we are applying it deeply where it can really be the primary method and things like cards and autos are the easier play. + +-------------------------------------------------------------------------------- +Gerard Cassidy, RBC - Analyst [136] +-------------------------------------------------------------------------------- +And then, finally, sticking with digital, is there any application in the digital channel where you can have success like you are having in the consumer bank in the Merrill Lynch brokerage channel? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman & CEO [137] +-------------------------------------------------------------------------------- +Yes, well, Merrill Edge is, obviously, an across-the-board execution. There are clients that utilize that in Merrill and in US Trust and the broad Consumer business. So it's a broad execution and well-recognized as being one of the leaders by the various authorities. +We believe, and one of the things Terry Laughlin and Keith Banks and Andy Sieg and John and others are working on is to increase our capabilities for both the advisor and the customer in digital more or less stated in that GWIM business. So we think there's upside for us. Again, less customers, so the leverage is not quite the same, and that's why we spend a lot of our time around the consumer and there's just less leverage. +In the advisor you have to think about that business because the advisor is the core strength that we have to the customer that we have to have an execution which is universal between the advisor to the customers they can all see the same thing. And so we've got some great capabilities now in My Merrill and things like that. +But we plan to continue to enhance them and continue to integrate them so when they get the loans and deposits and things like that they are much more integrated over time. You can still see it all, but it's not where we want it to be. + +-------------------------------------------------------------------------------- +Gerard Cassidy, RBC - Analyst [138] +-------------------------------------------------------------------------------- +Great, thank you, Brian. + +-------------------------------------------------------------------------------- +Operator [139] +-------------------------------------------------------------------------------- +Brian Kleinhanzl, KBW. + +-------------------------------------------------------------------------------- +Brian Kleinhanzl, Keefe, Bruyette & Woods, Inc. - Analyst [140] +-------------------------------------------------------------------------------- +Yes, thanks. I just had one quick question and it is on the $53 billion expense target. +If we got into an environment where you saw revenues come back more robustly near term, could you still commit to that $53 billion target, meaning you have enough levers to pull? Or would you see yourself switching to maybe an efficiency ratio target if all of a sudden these revenues came back stronger? Thanks. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman & CEO [141] +-------------------------------------------------------------------------------- +Yes, if you remember when we made that target it was in the context of a 1.5%, 2% GDP growth economy much like we have now and a rate environment incremental from where we have now. So I think the shareholders and this management team would be happy if we were having a discussion about revenue-related incentives going up faster than that. That would be good news for the Company. + +-------------------------------------------------------------------------------- +Brian Kleinhanzl, Keefe, Bruyette & Woods, Inc. - Analyst [142] +-------------------------------------------------------------------------------- +Thanks. + +-------------------------------------------------------------------------------- +Operator [143] +-------------------------------------------------------------------------------- +It appears we have no further questions at this time I will return the floor to our presenters for closing remarks. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman & CEO [144] +-------------------------------------------------------------------------------- +Thank you very much. And we look forward to speaking to you next quarter. + +-------------------------------------------------------------------------------- +Operator [145] +-------------------------------------------------------------------------------- +This will conclude today's program. Thanks for your participation. You may now disconnect. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/exam/original-files/Problem_1_Sample/2016-Oct-27-AMZN.OQ-139909051245-Transcript.txt b/exam/original-files/Problem_1_Sample/2016-Oct-27-AMZN.OQ-139909051245-Transcript.txt new file mode 100644 index 0000000..59bddb9 --- /dev/null +++ b/exam/original-files/Problem_1_Sample/2016-Oct-27-AMZN.OQ-139909051245-Transcript.txt @@ -0,0 +1,370 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q3 2016 Amazon.com Inc Earnings Call +10/27/2016 05:30 PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Brian Olsavsky + Amazon.com, Inc. - CFO + * Darin Manney + Amazon.com, Inc. - Director of IR + +================================================================================ +Conference Call Participiants +================================================================================ + + * Gene Munster + Piper Jaffray & Co. - Analyst + * John Blackledge + Cowen and Company - Analyst + * Neil Doshi + Mizuho Securities - Analyst + * Youssef Squali + Cantor Fitzgerald - Analyst + * Heath Terry + Goldman Sachs - Analyst + * Colin Sebastian + Baird Equity Research - Analyst + * Douglas Anmuth + JPMorgan - Analyst + * Ben Schachter + Macquarie Research - Analyst + * Mark Mahaney + RBC Capital Markets - Analyst + * Justin Post + BofA Merrill Lynch - Analyst + * Brian Nowak + Morgan Stanley - Analyst + * Mark May + Citigroup - Analyst + +================================================================================ +Presentation +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- +Thank you for standing by. Good day, everyone and welcome to the Amazon.com Q3 2016 financial results teleconference. +(Operator Instructions) +Today's call is being recorded. For opening remarks, I will be turning the call over to the Director of Investor Relations, Darin Manney. Please go ahead. + +-------------------------------------------------------------------------------- +Darin Manney, Amazon.com, Inc. - Director of IR [2] +-------------------------------------------------------------------------------- +Hello and welcome to our Q3 2016 financial results conference call. Joining us today to answer your questions is Brian Olsavsky, our CFO. As you listen to today's conference call, we encourage you to have our press release in front of you which includes our financial result as well as metric and commentary on the quarter. Please note, unless otherwise stated, all comparisons in this call will be against our results for the comparable period of 2015. +Our comments and responses to your questions reflect Management's view as of today, October 27th, 2016, only and will include forward-looking statements. Actual results may differ materially. Additional information about factors that could potentially impact our financial result is included in today's press release and our filings with the SEC, including our most recent annual report on Form 10-K and subsequent filing. +During this call, we may discuss certain non-GAAP financial measures. In the press release, slides accompanying this webcast and our filings with the SEC, each of which are posted on our IR website, you will find additional disclosures regarding these non-GAAP measures, including reconciliations of these measures with comparable GAAP measures. +Our guidance incorporates the order trends that we have seen to date and what we believe today to be appropriate assumptions. Our results are inherently unpredictable and may be materially affected by many factors, including fluctuations in foreign exchange rates, changes in global economic conditions and customer spending, world event, the rate of growth of the Internet, online commerce and cloud services and the various factors detailed in our filings with the SEC. Our guidance also assumes, among other things, that we don't conclude any additional business acquisitions, investment restructurings or legal settlements. It is not possible to accurately predict demand for our goods and services and therefore our actual results could differ materially from our guidance. +With that, we will move to Q&A. Operator, please remind our listeners how to initiate a question. + + +================================================================================ +Questions and Answers +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- +(Operator Instructions) +Our first question comes from Douglas Anmuth with JPMorgan. Please state your question. + +-------------------------------------------------------------------------------- +Douglas Anmuth, JPMorgan - Analyst [2] +-------------------------------------------------------------------------------- +Thanks for taking the question. The international retail segment margin was the lowest we have seen in quite a while. I was hoping that you could provide some of the key drivers there in terms of the drag and any color on how to think about the incremental international investment that might be impacting the 4Q guide. Thanks. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com, Inc. - CFO [3] +-------------------------------------------------------------------------------- +Sure. Thanks, Doug. Specifically to international, we are seeing expansion to support selection expansion fulfillment network increases. We're also investing in digital content and additional prime benefits, Fresh location and Prime Now. By far the biggest individual thing is the investment in India that we continue to make. Very excited about the initial reaction in India from both customers and also sellers. That is essentially the international margin guidance in Q4. + +-------------------------------------------------------------------------------- +Douglas Anmuth, JPMorgan - Analyst [4] +-------------------------------------------------------------------------------- +Thank you. + +-------------------------------------------------------------------------------- +Operator [5] +-------------------------------------------------------------------------------- +Thank you. Our next question comes from Gene Munster with Piper Jaffray. Please proceed with your question. + +-------------------------------------------------------------------------------- +Gene Munster, Piper Jaffray & Co. - Analyst [6] +-------------------------------------------------------------------------------- +Great. Thanks. I guess when we think about the progression in margins in the second half versus the second half of 2015 and kind of the flat lining of overall margin at this point, excluding AWS, should we think about this as a temporary plateau that will at some point will resume once you start leveraging your fulfillment build-out or is there something structural that is philosophically changing with the way that you operate your business. Thanks. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com, Inc. - CFO [7] +-------------------------------------------------------------------------------- +Yes. Thanks, Gene. We will continue to invest in the business where we are seeing significant customer traction. The things that I'm about to mention fall into that category. The largest individual reasons for the ramp-up in investment between the first half and second half of this year and also second half of this year versus second half of last year are the things that I mentioned on the call last quarter. +First, video content and marketing associated with that is nearly doubling year over year in the second half of the year. It continues to be a large increase for both Q3 and Q4. In the quarter in Q3, we added 18 fulfillment centers and we have added 5 more in October. For the year, we will add 26. Most of those are in North America. +That compares to 14 last year and I would -- looking back, there is -- the last time we had double-digit increase in fulfillment centers was 2012 when we added 11 in the third quarter. There was a rare aggregation of startups in Q3 and into Q4. It is helping us position better for Q4 volumes, because paid unit growth continues to be strong and Amazon fulfilled unit growth, which includes what we ship, includes FBA is significantly higher than even that. We are continuing to build for high AFN, or Amazon fulfilled network demand, including both retail and FBA. +The number of warehouses that we added represent the 30% increase in square footage year over year. Last year we increased square footage by just under 20%. The definition of square footage in this case is all of our warehouses, plus our sortation and delivery centers, so it's pretty much our end-customer service centers. It's pretty much our square footage that support operations. +Those will dissipate as we -- as they burn in. We've talked about fulfillment centers initial startup costs include increase in fixed cost but also variable cost as we train workers and also bring in inventory. There's a number of transportation costs also related to the startup of a new fulfillment center, both inbound and outbound. They are inherently less efficient than more established, mature buildings. There will be a cycle where those will be more productive next year than they are this year and more productive in 2018 than they are in 2017. +What you are seeing, essentially, in the second half of this year is a step-up investment, primarily around digital content and also the fulfillment center investment, but also things like Echo and Alexa which we're adding a lot of resources to, India and AWS as we add people there to support additional service rapid growth in that business. + +-------------------------------------------------------------------------------- +Operator [8] +-------------------------------------------------------------------------------- +Thank you. Our next question comes from the line of Brian Nowak with Morgan Stanley. Please proceed with your question. + +-------------------------------------------------------------------------------- +Brian Nowak, Morgan Stanley - Analyst [9] +-------------------------------------------------------------------------------- +Thanks for taking my question. I have two. The first one, just to go back, Brian, to the fulfillment build. In the past you talked about how it takes time to kind of get the fulfillment centers to peak efficiencies. With these new FCs opening, can you talk about if you become more efficient, so if you get into a lower volume quarter next year, there's less risk of deleverage or should we still think about it's going to take time to get up to peak efficiency? +The second one at AWS, Amazon the Company is good in removing friction in the purchase process. Can you talk about some of the main hurdles you have to overcome for large enterprises to start using AWS more? Thanks. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com, Inc. - CFO [10] +-------------------------------------------------------------------------------- +Sure. In the fulfillment network, as we build it yes, they will be more productive next year than this holiday peak and probably even more productive in 2018. I can't forecast it for you into next year quite yet, but we certainly had productivity and additional costs in Q3 and even into Q4 of this year as we built the additional capacity. Again, the underlying reason for that capacity build is the strength in paid units and even more so in the units that we're fulfilling, driven by our FBA program. +The FBA program is the key pillar of our Prime offering. It adds selection. It makes Prime stronger. That's a self-reinforcing loop where Prime -- the Prime success attracts more sellers. We're glad to have that problem. We are just working very hard to get capacity in place and productive use for Q4 and beyond. + +-------------------------------------------------------------------------------- +Darin Manney, Amazon.com, Inc. - Director of IR [11] +-------------------------------------------------------------------------------- +Hi, Brian. This is Darin. On the AWS question, we continue to invest in AWS on behalf of our customers. In addition to the technologies that make integrations easier and it helps companies move from an on-prem or a hybrid IT environment into AWS if we're going to continue to do that. Specifically, the database migration tool that are helpful for customers when they move production databases from on premises to the cloud with virtually no downtime. +Also, many of our AWS customers are beginning to choose and continue to choose the AWS schema conversion tool which really switches database engines to get out of old-guard proprietary databases and on to AWS. We will continue to react to customer needs and that will include opening up new regions. We have opened up Ohio this past quarter. We've highlighted that we will have a number of regions coming online in a few months. Yes, we're doing a lot of things to help make it easier for all customers to migrate to AWS. + +-------------------------------------------------------------------------------- +Operator [12] +-------------------------------------------------------------------------------- +Thank you. Our next question comes from the line of Mark Mahaney with RBC Capital Markets. Please proceed with your question. + +-------------------------------------------------------------------------------- +Mark Mahaney, RBC Capital Markets - Analyst [13] +-------------------------------------------------------------------------------- +Okay. Hey, Brian, would you give us any commentary on two categories in particular, groceries and fashion and apparel? Particularly on groceries, I know in the release there was a couple of data points about Fresh rolling out into newer areas like Maryland. Great to see that. Can you just talk about that in the investment horizon? Is that moving the needle for you and how big that -- any way to help us quantify how big that already is to your -- to the revenue growth that you're seeing, particularly on groceries and any particular comment on fashion and apparel. Same line of thinking. Thanks. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com, Inc. - CFO [14] +-------------------------------------------------------------------------------- +Sure. Thanks, Mark. I will start with Fresh and groceries in general. Yes, this quarter we launched in Northern Virginia, Maryland, Dallas and Chicago. We also launched a new pricing plan, which is a monthly $14.99 add-on to Prime in the US. We have expanded, as you know, previously into London. +We're very happy with the progression both in the geographies that we have been in for a long time where we are at, continuing to add zip codes and additional neighborhoods and also in these new cities. Certainly a business where we continue to work on costs and profitability. We are finding at the very attractive service to our customers, which is what we're after. +Similarly, but not exactly the same, is the Prime Now business which has similar overlap on things besides groceries. It is a slightly different model, obviously, where we're more about immediacy and smaller list items available in one to two hours. There's certainly a lot of people who are using that for groceries and consumable items. That is now up to 40 cities across 7 countries versus 17 this time last year. We're also adding Amazon Restaurant Delivery to the Prime Now offer in 19 metropolitan cities in the US. That is up from two last year. +We continue to believe consumables, groceries are a key part of the offer to customers. We are playing with very different models to see which works and for what needs. We're very happy with the Amazon Fresh and we have now expanded quite a bit as you see in this year. Prime Now we're also very happy with, although obviously the economics in that business are even tougher, but we do feel that our scale makes that possible because of our geographic footprint and how close we already are to customers. + +-------------------------------------------------------------------------------- +Darin Manney, Amazon.com, Inc. - Director of IR [15] +-------------------------------------------------------------------------------- +Hi, Mark, this is Darin. On fashion, fashion and apparel continue to be a large part of our EGM business and one that we're very excited about. We continue to make it easier for brands and manufacturers to come on board in that category. We continue to work with brands to come on board. We're happy with the traction that we're seeing with those brands. As we get more and more selection, we're really pleased with the customer engagement that we have there, both from the discoverability, the technology that goes behind making it easier to shop fashion on our site, as well as the (inaudible) selection by adding the brand. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com, Inc. - CFO [16] +-------------------------------------------------------------------------------- +Sorry. To answer your question about whether that is part of investment. Yes, it certainly is part of our investment. The larger ramp, if you will, in investment that we're seeing from the back end of last year and also the first half of this year is more related to digital content and the building our fulfillment network, which I already discussed. + +-------------------------------------------------------------------------------- +Operator [17] +-------------------------------------------------------------------------------- +Thank you. Our next question comes from the line of Mark May with Citi. Please proceed with your question. + +-------------------------------------------------------------------------------- +Mark May, Citigroup - Analyst [18] +-------------------------------------------------------------------------------- +Thanks a lot. In some of these incremental investment areas like warehouses, logistics and also content, I know in some cases you expense up front. In some cases you amortized over time. Wondering if you can give us a sense of how much of the recent step-up is being expensed. I'm particularly looking at your COGS as a percent of retail revenues that was up year over year for the first time in quite a while. How much of that was because of content that expensed in the period? Just trying to better understand that. +I think also you have been changing around, and this is happening here shortly, FBA pricing, including increasing your storage fees but also reducing your handling fees. I guess the question is, are these changes designed to just pass through kind of increasing shipping costs or is this more of a net neutral change where really the goal is to try to free up capacity in some of your facilities? Thanks. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com, Inc. - CFO [19] +-------------------------------------------------------------------------------- +Let me start with your second question on FBA. Yes, we did make some changes to the pricing formula for this holiday season. They're essentially meant to incent the right behavior among sellers around holiday. The biggest issue you're trying to get at is having the most valuable products for holiday in the warehouse, in the Prime space and not having the warehouse filled with things that may not sell until after the New Year. We are trying to incentivize that behavior. We're also trying to incentivize getting inventory into the warehouse quicker. Yes, the formulas were -- the changes to the pricing formulas were really with that in mind, to help the flow and the space utilization in Q4. + +-------------------------------------------------------------------------------- +Darin Manney, Amazon.com, Inc. - Director of IR [20] +-------------------------------------------------------------------------------- +Yes. Hi, Mark. This is Darin. On the capitalization point, I'd say the things that get capitalized are the core buildings and the leasehold improvements in the buildings. The things that we're seeing hit the P&L are the fixed and variable expenses that it takes to run the building. I think that is what Brian is pointing out most pointedly in terms of what is impacting our profitability of second half. Yes, the capitalization is relatively small in terms of -- other than the building itself. + +-------------------------------------------------------------------------------- +Operator [21] +-------------------------------------------------------------------------------- +Thank you. Our next question comes from the line of Youssef Squali with Cantor Fitzgerald. Please proceed with your question. + +-------------------------------------------------------------------------------- +Youssef Squali, Cantor Fitzgerald - Analyst [22] +-------------------------------------------------------------------------------- +Yes. Two quick questions. With the step-up in investments and content from Prime Video as you mentioned before, you would also be stepping up the international expansion? Maybe you can just remind us how many countries you're in with Prime Video and whether there is a potential chance of stripping Prime Video from Prime to allow it to be extended to other countries. Do you -- I know you're not guiding to 2017, but just looking at the capacity increase that you had for FCs for 2016, should we expect that kind of as an ongoing expense going forward or is the current build-up enough to give you spare capacity to cool that down for 2017? Thanks. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com, Inc. - CFO [23] +-------------------------------------------------------------------------------- +Sure. First on your video comment, we're in four countries right now, the US, UK, Germany and Japan and we have stated that we will be in India soon. The content that we are creating, through Amazon studios, we are generally holding the worldwide rights to and can use that in other countries as well. The cost of that then get amortized to the country and becomes part of the international segment results. Yes, we consider that to be very valuable as opposed to versus licensing many times, by country the third-party rights to content that we don't create ourselves. +Your question on fulfillment expenses, I can't extend the guidance into next year. We will do that, obviously, at the end of next quarter. I would say we are -- this was in extraordinary step-up as I mentioned in Q3 that is tied to very rapid growth in not only paid units but Amazon fulfilled units. Really our forecast for additional capacity additions and the rate of addition will be tied to those growth factors as well. +We will have to see. We right now are working on getting the capacity in. It was very lumpy this time, with 18 warehouses in one quarter and another 5 in the first three weeks of the next quarter. Obviously we will be working on the efficiencies of all of the warehouse we have, including the ones that we just started up this year. + +-------------------------------------------------------------------------------- +Operator [24] +-------------------------------------------------------------------------------- +Thank you. Our next question comes from the line of Colin Sebastian with Baird Equity Research. Please proceed with your question. + +-------------------------------------------------------------------------------- +Colin Sebastian, Baird Equity Research - Analyst [25] +-------------------------------------------------------------------------------- +Thanks. A follow-up on the FC question. I guess more specifically, it sounds like you have enough capacity in terms of fulfillment centers for the holidays. Also wondering what your comfort level is in terms of your shipping partners to manage those deliveries. Secondly, was wondering how you would characterize the pricing environment for AWS, in particular with more deep pocketed competitors in the space now. Google in fact highlighted this on their conference call today. Thank you. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com, Inc. - CFO [26] +-------------------------------------------------------------------------------- +Sure. Let me start with transportation. Yes, we are looking forward to a great holiday. That includes working with our shipping partners, both in the US and globally. We have worked very closely with them to line up capacity, share capacity plans. We certainly have additional delivery capability of our own, but with all of our partners, we work well in advance of the holiday to get our plans in place. We feel very confident we're looking forward to a great holiday not only for customers but also for sellers. +On your question on AWS, I didn't listen to the Google call. You will have to fill me in on that later. The thing that I can tell you about pricing is that our pricing is -- price reductions are a core part of our philosophy, of course. We had a price decrease in Q3. That was our 52nd since we started this business. It's -- we are comfortable with price decreases. Not only did we lower the prices of our products but we also create new services that are cheaper that customers can switch to. They can also benefit from that as well. +If you step back and say, why do people choose AWS? I'll give you the points I said last quarter. Basically what we hear are the functionality and pace of innovation. It is greater than our competition. We have added new -- more new significant features and services this year already than we had all of last year when we added 722. We have a partner and customer ecosystem. You've read about the VMware deal that we signed this quarter. We continue to extend with partners and build ecosystems that better can support customers. +Finally, experience. We have been in this business a long time, longer than anyone else. We've used that time to make our product and services better. There's going to be a lot of winners in the space, as we said, but we are very happy with our position and the customer reception to our products. + +-------------------------------------------------------------------------------- +Operator [27] +-------------------------------------------------------------------------------- +Thank you. Our next question comes from the line of Justin Post with Merrill Lynch. Please proceed with your question. + +-------------------------------------------------------------------------------- +Justin Post, BofA Merrill Lynch - Analyst [28] +-------------------------------------------------------------------------------- +Great. Thank you. I guess when you look at fourth-quarter guidance and you back out AWS, it suggests that margins are -- on the core business are going to be pretty down versus last year. Do you view this as an abnormal investment cycle or just part of the overall kind of ebbs and flows of the business? Long term, I know several years ago you talked about maybe high-single-digit, low-double-digit margins long term. I wonder if you could refresh us on that and also let us know if you think international has structural marginal differences than the US, the core retail business. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com, Inc. - CFO [29] +-------------------------------------------------------------------------------- +Sure. Yes. As far as the continuation of the investment and into next year, I cannot give you as much color on that today. What I can tell you again is that we have ramped up considerably. We have been investing quite openly in a lot of areas and continue to do so. We are experiencing a ramp-up, if you will, in the second half of this year, particularly tied again to the fulfillment center and expanded also the video content spend. +We will continue to invest in video content. We will continue to invest in fulfillment space to handle higher and higher paid unit volumes than shipped unit volumes. We will continue to invest in things that we believe enhance the customer experience, particularly the Prime experience. Devices we will invest in, particularly Alexa and the Echo products. We will continue to invest in getting faster and faster shipping methods for our consumers. We believe that is working. We are very happy with the results. We're very happy with all of the customers we have but particularly the Prime customers that we have. +As far as long-term operating margins, I can't forecast that right now. I can't forecast that for our AWS business, either. We are, again, working on two fronts. We are honing the businesses that we're in and making them as efficient, as profitable as possible while also investing very pointedly and very wisely, we believe in things that will enhance customer experience and create lasting businesses for us down the line. +We have said we want things that customers will love, can grow to be large, will have strong financial returns and durable and can last for decades. That is still our mission. We have pillars of the business right now with Marketplace, AWS and Prime and we're actively looking for a fourth and fifth pillar. + +-------------------------------------------------------------------------------- +Operator [30] +-------------------------------------------------------------------------------- +Thank you. Our next question comes from the line of Heath Terry with Goldman Sachs. Please proceed with your question. + +-------------------------------------------------------------------------------- +Heath Terry, Goldman Sachs - Analyst [31] +-------------------------------------------------------------------------------- +Great. I'm wondering, there obviously have been some headlines since the call that you did earlier with the press on the scale of this investment cycle relative to other investment cycles that you have been through. With the 2014 cycle sort of being the most recent, could you quantify a little bit more how you would compare this investment cycle to that most recent one? To the extent that we're in the midst of this investment cycle, would you say we're in sort of the earlier or later stages? Any sort of clarity around that would be useful. Thank you. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com, Inc. - CFO [32] +-------------------------------------------------------------------------------- +Sure. Yes. The word cycle, if I mentioned that, was an omission. It was a misspeak. The investment that we are seeing is a step-up versus what we have experienced in particularly the first half of this year and the last half, the second half of last year, which I mentioned. +We have said investments are going to be lumpy. They are going to be high sometimes and they will be moderate at other times. We are right now, the second half of this year looks like a big step-up compared to the first half, and it is. But, again, it is all areas that we will continue to investment in, some of which I just actually went through the laundry list. +I would not characterize it as the cycle. I would characterize it as continued investments. We make investments with the idea that they are going to pay off and they pay off in either directly in the business they're in or in their contribution to the total business, many times as a part of the Prime program. + +-------------------------------------------------------------------------------- +Operator [33] +-------------------------------------------------------------------------------- +Thank you. Our next question comes from the line of John Blackledge with Cowen and Company. Please proceed with your question. + +-------------------------------------------------------------------------------- +John Blackledge, Cowen and Company - Analyst [34] +-------------------------------------------------------------------------------- +Great. Thanks. Two questions. It seems that you're increasing your efforts in the auto vertical with the recent launch of Amazon Vehicles. Just wondering if you can discuss some of the dynamics of the auto industry that make it attractive and maybe how it aligns with the Prime value prop. Also wondering if you had any plans to work directly with auto shops, just given your ability to service most areas in one to two days. +The second question, on grocery, would you consider physical locations in an effort to kind of expand and/or accelerate growth in that vertical? Thank you. + +-------------------------------------------------------------------------------- +Darin Manney, Amazon.com, Inc. - Director of IR [35] +-------------------------------------------------------------------------------- +Hi, John. This is Darin. On vehicle, Amazon Vehicles is really a car research destination and built the automotive community for customers. Gets information that they need when shopping for vehicles offsite or shopping for parts and accessories on-site. The features include research tools, community engagement, where you can talk to other customers. Certainly we try to build a one-stop shop for vehicles as an extension to the automotive store, which engages customers to add information about their cars in the garage which makes it actually easier to shop for parts and accessories for your particular vehicle. +We think there's a lot of opportunity there to add convenience for customers. On the b2b side, certainly we do have an Amazon business offering. Businesses of all shapes and sizes can sign up to be a b2b customer. The selection that we have in our parts and automotive categories are certainly open to that channel. I wouldn't speculate on anything that we might do in a particular vertical for those business customers. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com, Inc. - CFO [36] +-------------------------------------------------------------------------------- +Sure. Your comment on -- your question on grocery and physical stores, I can't comment on any rumors or speculations there might be regarding that. What I will tell you is that we have experimented with physical stores. As you may know, we have three physical bookstores, one in Seattle, one in San Diego and one in Portland and two more coming, one in Boston and one in Chicago. +What we're finding is they're great places for customers to browse what ends up being a curated selection of books and they also get to try out our devices, which is very beneficial. They get to touch and try our e-readers, tablets, Fire TV and Echo. We like what we see with that connection. We also have pop-up stores that you may see and also college pick-up points. We will try different delivery methods or pick-up points or ways of getting product to customers, but nothing specific to point out on the grocery side right now. + +-------------------------------------------------------------------------------- +Operator [37] +-------------------------------------------------------------------------------- +Thank you. Our next question comes from the line of Ben Schachter with Macquarie. Please proceed with your question. + +-------------------------------------------------------------------------------- +Ben Schachter, Macquarie Research - Analyst [38] +-------------------------------------------------------------------------------- +Given the low unemployment rates that you are seeing in the US, do you expect any unusual impact on wages for seasonal workers this year? Are you seeing overall wage pressure in the fulfillment centers? Separately, if you could talk about trend lines you are seeing in paid units versus shipping units. Are they diverging meaningfully versus the past? Thanks. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com, Inc. - CFO [39] +-------------------------------------------------------------------------------- +Yes. On wages, nothing to point out for this holiday. Our challenge generally is the volume of head count that we're looking to hire. We work well in advance with agencies to help to get seasonal employees and many of them turn into full-time employees after the holiday. Nothing specific on the wage pressure front. As you probably saw, head count is up 38% year over year in Q3 and that is continuation of a lot of ops roles that are supporting this high demand, the opening the fulfillment centers we talked about, new Fresh locations, Prime Now, but also and a lot of hiring in our tech areas, strictly around AWS and also the Echo/Alexa areas. + +-------------------------------------------------------------------------------- +Operator [40] +-------------------------------------------------------------------------------- +Thank you. + +-------------------------------------------------------------------------------- +Darin Manney, Amazon.com, Inc. - Director of IR [41] +-------------------------------------------------------------------------------- +I'm sorry. The second question? + +-------------------------------------------------------------------------------- +Operator [42] +-------------------------------------------------------------------------------- +Sorry, go ahead. Okay. Our final question will come from the line of Neil Doshi with Mizuho. Please proceed with your question. + +-------------------------------------------------------------------------------- +Neil Doshi, Mizuho Securities - Analyst [43] +-------------------------------------------------------------------------------- +Thanks. Can you provide a little more color into the investments that you're making in India? What is driving that growth and what stage is India in today relative to some of the other large international markets that you have launched in the past? + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com, Inc. - CFO [44] +-------------------------------------------------------------------------------- +Yes, sure. We are very encouraged by what we're seeing in India, but it is certainly very early on still. Most recent highlights would be the launch of the Prime program in India this past quarter. It's now one of the top-selling units on Amazon.India. It has been well received by customers. +It is hard to compare India to any other country. It is very different in its stage and structure. Being a third-party market has caused a lot of invention on our side. We're being creative. The team there in India has been very creative on whenever they find a roadblock or something that has not existed in another country, they create it themselves, whether that's from delivery stations to working with small merchants to you name it. We're very happy with both the customer engagement that we're seeing and also the seller engagement, which is very important in India. Very pleased with the team that brought that over there and the way they work with teams throughout the world. + +-------------------------------------------------------------------------------- +Darin Manney, Amazon.com, Inc. - Director of IR [45] +-------------------------------------------------------------------------------- +Brian, to step back to Ben's other question on units. Ben, this is Darin. Paid units grew at 28% again this year, as it did in the prior quarter. As Brian pointed out earlier, our AFN units, our Amazon Fulfilled Units, which includes our first-party units as well as FBA unit that's that go through our warehouses, are continuing -- are certainly higher than that 28%. That is a result of the traction we're getting with our FBA sellers. +Thank you for joining us on the call today and for your questions. A replay will be available on our investor relations website at least through the end of the quarter. We appreciate your interest in Amazon.com and look forward to talking with you again next quarter. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/exam/original-files/Problem_1_Sample/2017-Apr-18-BAC.N-141158160180-Transcript.txt b/exam/original-files/Problem_1_Sample/2017-Apr-18-BAC.N-141158160180-Transcript.txt new file mode 100644 index 0000000..9c30203 --- /dev/null +++ b/exam/original-files/Problem_1_Sample/2017-Apr-18-BAC.N-141158160180-Transcript.txt @@ -0,0 +1,748 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q1 2017 Bank of America Corp Earnings Call +04/18/2017 08:30 AM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Brian T. Moynihan + Bank of America Corporation - Chairman, CEO and President + * Paul M. Donofrio + Bank of America Corporation - CFO + * Lee McEntire + Bank of America Corporation - SVP of IR + +================================================================================ +Conference Call Participiants +================================================================================ + + * Betsy Lynn Graseck + Morgan Stanley, Research Division - MD + * Glenn Paul Schorr + Evercore ISI, Research Division - Senior MD, Senior Research Analyst and Fundamental Research Analyst + * John Eamon McDonald + Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst + * Brian Kleinhanzl + Keefe, Bruyette, & Woods, Inc., Research Division - Director + * Marlin Lacey Mosby + Vining Sparks IBG, LP, Research Division - Director of Banking and Equity Strategies + * Saul Martinez + UBS Investment Bank, Research Division - MD and Analyst + * Steven Joseph Chubak + Nomura Securities Co. Ltd., Research Division - VP + * Kenneth Michael Usdin + Jefferies LLC, Research Division - MD and Senior Equity Research Analyst + * Gerard S. Cassidy + RBC Capital Markets, LLC, Research Division - Analyst + * Andrew Lim + Societe Generale Cross Asset Research - Equity Analyst + * Matthew D. O'Connor + Deutsche Bank AG, Research Division - MD in Equity Research + +================================================================================ +Presentation +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Good day, everyone, and welcome to today's Bank of America First Quarter Earnings Announcement Conference Call. (Operator Instructions) Please note this call may be recorded. (Operator Instructions) +It is now my pleasure to turn today's program over to Mr. Lee McEntire. Please go ahead, sir. + +-------------------------------------------------------------------------------- +Lee McEntire, Bank of America Corporation - SVP of IR [2] +-------------------------------------------------------------------------------- + + Thank you. Good morning. Thanks to everybody for joining us this morning for the first quarter 2017 results. Hopefully, everybody's had a chance to review our earnings release documents that were available on our website. +Before I turn the call over to Brian and Paul, let me remind you we may make some forward-looking statements. For further information on those, please refer to either our earnings release documents, our website or our SEC filings. +With that, I'm pleased to turn it over to Brian Moynihan, our Chairman and CEO, for some opening comments before Paul Donofrio, our CFO, goes through the details. Take it away, Brian. + +-------------------------------------------------------------------------------- +Brian T. Moynihan, Bank of America Corporation - Chairman, CEO and President [3] +-------------------------------------------------------------------------------- + + Thank you, Lee, and good morning, everyone, and thank you for joining our first quarter results. +I'm going to begin on Slide 2, and first, this quarter is another solid example of driving responsible growth at Bank of America. My teammates continue to deliver for customers around the world, and not many companies have the resources we have to help our clients drive the global economy. +But with that, we understand responsibility comes with doing this, and we do it in a responsible way. Responsible growth is driving more sustainable returns for you as shareholders, also. This quarter, we produced strong revenue growth. We drove cost savings that offset higher revenue-related cost, and we managed risk well, and we returned more capital to you, our shareholders, through dividends and increased repurchase of shares, than any period since the crisis. +Turning to Slide 3. Our company produced earnings of $4.9 billion after tax in the first quarter of 2017. Those earnings were up 40% compared to the first quarter of last year, driven by 700 basis points of operating leverage. Revenue rose 7%, and we managed to keep overall expenses flat. +Our earnings per share were $0.41 per share. On a diluted basis, that was up 46%. This is the fourth quarter in a row we've exceeded $0.40 of EPS per share. We did that in quarter 1 despite $1.4 billion of annual retirement-eligible incentives and seasonally elevated payroll tax costs. And importantly, we have done this in a responsible manner, not reaching for growth outside of our established risk and customer framework, and we achieved this in an economy which continues to grow in the 1.5% to 2% range. +On a year-over-year basis, our average deposits were up over $58 billion. Average loans were up $21 billion, and sales and traded revenues, excluding DVA, were up 23% with better client activity. We saw $29 billion in long-term asset under management flows this quarter within our wealth management business. Asset quality remains strong with a provision expense of $835 million. Net charge-offs were down 13% from the first quarter of 2016 but were modestly up from the fourth quarter of '16 as expected from the normal seasonality, especially in consumer credit cards. +Regarding progress against long-term metrics, the first task the company had many years ago was to become stabilized, then it was to reduce our legacy costs and simplify the place, and then we drove towards sustainability of our results. Once results became more sustainable, we pushed towards generating return on tangible common equity above our cost of capital. We've now shown that we have a return on tangible common equity in the double digits the last 4 quarters. And keep in mind that we have been doing this while our capital continues to build. The next step is to push that towards our 12% target. +This quarter, our return on tangible common equity was 10%, where our return on assets was 88 basis points. These are reported numbers. The efficiency ratio was 67%. These figures reflect solid progress in this quarter against our long-term targets but are even closer if you were to allocate the seasonal aspects of the retirement-eligible compensation costs and elevated payroll tax expenses across the years as just opposed to putting it all in the first quarter. +And even though quarter 1 is typically a good capital markets quarter for us, if you just spread those costs, you'll see that across all the quarters, the metrics this quarter would have been reflecting an efficiency ratio of nearer 62%, a return on assets nearly 100 basis points and a return on tangible common equity of 12%. So simply put, we're getting there. +On Slide 4, as I mentioned, the key to profit building in this environment is to drive good core customer growth and revenue while controlling our costs to drive operating leverage. We have established record for the past -- we have an established record for the past several years of producing quarterly operating leverage on a year-over-year basis. +This quarter, you can see on the Slide 4, that our revenue growth on a year-over-year basis across each of our business segments. We're also able to hold the expenses overall in the company flat through the careful management of cost. As you can see in this slide, that's 700 basis points of operate leverage for the total company. +Some of our businesses, like our consumer business, have been driving operating leverage consistently for many years in a row now. Some, like our Global Banking business, are using operating leverage to drive the company to the best line of business efficiency ratio among our businesses. Other businesses continue to have leverage opportunities that are becoming more clear. This is the case in our wealth management or our Global Markets businesses. +As we turn to Slide 5, you can see the line of business results. Each business improved their efficiency ratios. Each line of business reported returns well above the firm's cost of capital. +Consumer Banking continued its strong performance and transformation, produced $1.9 billion in after-tax earnings this quarter, growing 7%. And on a pretax, pre-provision basis, PPNR, which excludes the prior year's sizable reserve release, the PPNR was up 17% year-over-year. The efficiency ratio in this business was down 500 basis points to 53%. +Global Wealth and Investment Management improved earnings 4%, earning $770 million after tax, improving its profit margin to 27%. This is a new record for the business. +Our Global Banking business produced a record revenue quarter led by strong Investment Banking results, and that generated $1.7 billion in after-tax earnings. It remains our most efficient operating business at 44%. +Lastly, our Global Markets business earned $1.3 billion in after-tax earnings, generating a 15% return on its allocated capital. Improved performance in sales and trading revenue combined with strong expense discipline that drove those results. +Our Other category shows a loss, driven mostly by the $1 billion in first quarter FAS 123 costs and related personnel taxes, which gets allocated across the business segments throughout the year. But the reduction in losses year-over-year was driven by improved operating costs in the company and lower litigation expense. +As you'll see from the slides Paul will walk you through later, our businesses have important leadership positions across the board. We believe they have room to grow both market share by deepening relationships with existing customers and by winning customers from the competition. +Overall, I'm pleased with the results this quarter. We grew the top line, we grew the bottom line, and we did it the right way, all while making significant investments in people, technology and more capabilities for our customers. And all that will bode well for future growth. +While many of you might focus on rates and our leverage to rising rates, note that the $1.5 billion in year-over-year revenue growth is split 40% for NII, which is driven by rates and by also the growth in loan and deposit balances, and the other 60% was driven through noninterest revenue. +As you know, we remain focused on things we know we can control and drive. We maintained our discipline on both expenses and pricing. Our rates paid has remained steady at 9 basis points on deposits while, at the same time, we have grown those deposits 5% year-over-year or $58 billion. +On lending activity, there's been a lot of discussion regarding a slowdown. In our core middle market business, representing a broad base of American companies, our business loans grew 7% year-over-year. In our smallest -- smaller business segments, business banking and small business, we were up 3%. And small business had the best production quarter in its history. +We assisted our markets clients with their financing needs, which also put capital in the system for economic growth. All this growth occurred in a sub-2% GDP growth environment. Our clients stand ready, they're engaged, and they're ready to grow faster as the economy continues to grow and improve. +Now let me turn it over to Paul to talk -- go through the other details about the quarter. Paul? + +-------------------------------------------------------------------------------- +Paul M. Donofrio, Bank of America Corporation - CFO [4] +-------------------------------------------------------------------------------- + + Thanks, Brian. I will start with the balance sheet on Page 6. Overall, end-of-period assets increased $60 billion from Q4. The growth was fairly evenly split between 2 elements: First, we saw higher trading-related assets in Global Markets business with incremental customer activity following a seasonal slowdown at the end of Q4; secondly, we had higher cash levels driven by seasonal deposit growth, primarily from tax refunds. +Deposits rose $55 billion or 5% from Q1 '16 and are up $11 billion from Q4. Q1 deposit growth was primarily driven by customer tax refunds in our consumer business. Loans on an end-of-period basis were steady with Q4 as solid commercial growth was offset by seasonal declines in credit card and runoff of legacy noncore loans. +Lastly, common equity increased $1.3 billion compared to Q4 as $4.4 billion in net income available to common was reduced by $3 billion and capital returned to shareholders through dividends and net share repurchases. +Global liquidity sources increased in the quarter, driven by higher deposit flows and bank funding. We remain well compliant with fully phased-in U.S. LCR requirements. Book value per share rose 5% from Q1 '16 to $24.36. +Turning to regulatory metrics and focusing on the advanced approach. Our CET1 transition ratio under Basel III ended the quarter at 11%. On a fully phased-in basis compared to Q4 the CET1 ratio improved 20 basis points to 11% and remains well above our 2019 requirement of 9.5%. +CET1 capital increased $1.6 billion to $164 billion, driven by earnings and the utilization of deferred tax assets offset by return of capital. The ratio also benefited from an $11 billion -- excuse me, a $14 billion decline in RWA, driven by lower exposure in our Global Markets business, lower card exposure and legacy asset runoff. +We also provide our capital metrics under the standardized approach, which remains relevant for CCAR comparison purposes. Here, our CET1 ratio is 10 basis points higher at 11.6%. Supplementing leverage ratios both for parent and bank continued to exceed U.S. regulatory minimums that take effect in 2018. +Turning to Slide 7 and on an average basis. Total loans were up $21 billion or 2% from Q1 '16. Loan growth in our business segments was primarily offset by continued runoff in noncore Consumer Real Estate loans in All Other. Year-over-year loans in All Other were down $23 billion. On the other hand, loans in our business segments were up $44 billion or 6%. +Consumer Banking led with 8% growth. We continue to see good growth in residential mortgages although our originations slowed in Q1 '17, given the increase in mortgage rates in Q4 and Q1. We saw growth in credit card and vehicle loans. Home equity pay-downs continue to outpace originations. +In wealth management, we saw a year-over-year growth of 7%, driven by residential mortgages. Global Banking loans were up 4% year-over-year. Loans in our commercial business grew 6% year-over-year despite a slight reduction in commercial real estate. We think these growth rates are responsible, given the economy grew around 2% year-over-year. +Middle market revolver utilization rates have now climbed back to record levels. On the bottom of the chart, note the $58 billion, 5% year-over-year growth in average deposits, which is driven by 10% growth in Consumer Banking. +Turning to asset quality on Slide 8. The stability of our asset quality and loss trends reflects many years now of disciplined client selection and strong underwriting practices that are foundational to our responsible growth and through-the-cycle performance. +Credit quality remains strong. Total net charge-offs of $934 million or 42 basis points on average loans increased slightly from Q4 due to expected seasonality in our credit card products but were down 13% from Q1 '16. Provision expense of $835 million rose $61 million from Q4 but was down $162 million from Q1 '16. +Net reserve releases in the quarter of $99 million was fairly consistent with Q4 and the year-ago quarter. Note that Q1 '16 included a significant increase in reserves in Global Banking for energy exposures. That was mostly offset by releases in consumer reserves in that quarter. +Our reserve coverage ratios -- excuse me, our reserve coverage remains strong with an allowance-to-loan ratio of 125 basis points and a coverage level 3x our annualized charge-offs. NPLs and reservable criticized exposure both declined notably. +On Slide 9, we break out credit quality metrics for both our consumer and commercial portfolios. On the consumer chart, you can see the impact of the seasonal increase in credit card losses. Note that delinquency trends remain low and improved modestly from Q4. Commercial losses continue to be low. +Turning to Slide 10. Net interest income on a GAAP non-FTE basis was $11.1 billion, $11.3 billion on an FTE basis. NII improved $730 million from Q4, primarily due to higher rates. The net interest yield increased 16 basis points to 2.39% from Q4 as loan yields improved 17% while the rates we paid on deposits was flat at 9 basis points. +Q4 and Q1 increases in long-end interest rates resulted in slower prepaids and less premium amortization on our securities portfolio this quarter. Increases in the short end in terms of interest rates caused our variable rate assets to reprice higher while we maintain good pricing discipline on deposits. We also benefited from normal seasonality in Q1 in our leasing business. +And in addition, we benefited from less unfavorable hedge ineffectiveness as compared to Q4. But one can think of the reduction in the hedge ineffectiveness as roughly offset by 2 fewer days in the quarter. +Now as Brian mentioned, we remain disciplined around deposit pricing given the investment we have made in customer relationships through Preferred Rewards and other deepening activities. +So your natural next question is what should shareholders expect for Q2 with respect to NII given the March rate hike by the Fed? Based on our models and assumptions, we believe NII should continue to improve, but the improvement is expected to be much more modest than Q4 to Q1 driven by a number of factors, most notably, the increase in long-term rates in Q1 -- in Q4 and Q1 drove a significant portion of the Q1 improvement. +In terms of Q2, think about it this way. Given where we are today, with the Fed funds rate hike in March and the long end down since the end of the first quarter, I would focus you on our asset sensitivity disclosures. +As of 3/31, an instantaneous 100 basis point parallel increase in rates is estimated to increase NII by $3.3 billion over the subsequent 12 months, which is consistent with our position at year end. Nearly 3/4 or $2.5 billion of this modeling is driven by our sensitivity to short-end rates. Given a 1-month LIBOR rise of about 25 basis points with the March hike and the long end down, we should focus on the $2.5 billion short-end benefit. Dividing that by 4 gets you a quarterly run rate of roughly $600 million for a 100 basis point shock. Assuming it's only 25 basis points instead of 100 would get you to approximately $150 million benefit in the quarter. +From there, we would expect continued modest growth in NII in the second half of 2017 assuming modest growth in loans and deposits and rates at least above where they are today. +Turning to Slide 11. Noninterest expense was $14.8 billion. We were able to hold expense flat compared to Q1 '16 despite 9% growth in noninterest income and several other expense headwinds. The efficiency ratio improved 400 basis points year-over-year. And if you allocate Q1's $1.4 billion of incentive for retirement-eligible employees and the seasonally elevated payroll tax across all 4 quarters, then the efficiency ratio would be 62%. +Our company-wide simplification efforts and the $110 million in lower litigation costs offset a number of higher expenses year-over-year, including: $150 million of higher incentives for annual retirement-eligible employees and seasonally elevated payroll taxes; $190 million of higher incentives associated with the revenue growth across wealth management, Global Banking and Global Markets; and $160 million of higher expenses due to changes in our share price with respect to accounting for employee stock-based awards. The year-over-year swing is caused by the share price decline in Q1 '16 compared to an increase in Q1 '17. We also had $100 million in higher quarterly costs for FDIC assessments. Finally, note that employees are down 2% from Q1 '16, and we continue to add client-facing associates. +Turning to the business segments and starting with Consumer Banking on Slide 12. Consumer Banking had another solid quarter. This segment produced $1.9 billion in earnings, growing 7% year-over-year and returning 21% on allocated capital. Note that, that 21% return is on $37 billion of allocated capital, which is an increase of $3 billion this quarter given growth in their loans and deposits. +On a pretax pre-provision basis, which adjusts for the sizable release of reserves in Q1 '16, earnings rose $559 million or 17%. Year-over-year, average loans grew 8%, average deposits grew 10% and Merrill Edge brokerage assets grew 21%. That drove revenue growth of 5% led by a 9% increase in NII from Q1 '16. +Note that the rate paid on deposits in this business declined 1% -- excuse me, declined 1 basis point year-over-year to 3 basis points as a result of disciplined pricing. Noninterest income included improvements in service charges and a small increase in card income that was more than offset by a decline in mortgage banking income. The decline in mortgage banking income was due to both lower volumes from less refinancings as well as our strategy of holding more of our production on our balance sheet versus selling it to the agencies. +Through continued efforts to drive down costs, the efficiency ratio improved nearly 500 basis points to 53%. Cost reductions also helped drive the cost of deposits down 10 basis points from Q1 '16. Consumer Banking credit quality remains solid, with the net charge-off ratio declining 4 basis points to 121 basis points. +Turning to Slide 13 and looking at key trends. First, as usual, in the upper left, the stats are a reminder of our strong competitive position; second, as we point out each quarter, while we report NII and noninterest income separately, our strategy remains focused on relationship deepening and growing total revenue while improving operating leverage through expense discipline. +So as you review the top boxes on this page, note that we drove 8% operating leverage this quarter. Also, note that our relationship deepening is improving NII and balance growth while holding the fee lines flat as we reward customers for doing more business with us. +Average deposits continued their strong growth, up $57 billion or 10% year-over-year, outpacing the industry. Importantly, 50% of these deposits are checking accounts, and we estimate that 89% of these checking accounts are the primary accounts of households. This means these are operational accounts used to pay mortgages and car payments and other bills. So outflows chasing rates is less likely in our view. We also believe these deposit accounts offer clients significant value in terms of transparency, convenience and safety, which also means they are less likely to move their relationships. +With respect to card, spending levels and new issuances were solid. However, the industry's trend of increasing rewards continues to mitigate our overall card revenue growth. Digitalization and other productivity improvements, as well as lower fraud costs, continue to lead expenses lower. +Expenses declined 3% from Q1 '16 despite increases in the FDIC assessment rate and charges. Focusing on client balances on the bottom left, you can see the success we continue to have growing deposits, loans and brokerage assets. +Merrill Edge continues to attract customers who want a self-service investment option as accounts are up 11% from Q1 '16. We now have more than 1.7 million households that leverage our financial solution advisers and self-directed investment platform. This quarter also included the successful rollout of Merrill Edge Guided Investing for clients who want some advice from our CAO office but don't desire a fully advised relationship. +With respect to loans, residential mortgages continued to lead our growth. As expected, the sudden rise in long-term rates in late 2016 caused a noticeable decline in mortgage production from Q1. While mortgage originations was down, we continue to hold more of our loans on the balance sheet. In Q1, we retained about 80% of first-mortgage production on the balance sheet. We believe retaining these mortgages will provide better economics over time, plus retention deepens our relationship with these customers. +Consumer vehicle lending remains solid, up 12% year-over-year, and we continue to remain focused on prime and superprime borrowers. Our net charge-offs at 38 basis points remain not only low, but also lowest among peers. U.S. consumer card average balances grew 3% year-over-year, and spending on our credit cards was up 8% compared to Q1 '16. +Turning to Slide 14. We remain a leader in digital banking and we continue to see momentum in digital banking adoption. Given the rollout of Zelle this quarter, Bank of America customers can now use their online app to transfer money, request money and split bills person-to-person with more ease than before. While still in its infancy, customers sent $8 billion in payments through our person-to-person apps in Q1, which is up 25% year-over-year. +Importantly, as digital banking adoption rises, particularly around transaction processing and self-service, we expect to see continued improved efficiency and customer satisfaction. Mobile devices now account for 1 out of every 5 deposit transactions and represent the volume of nearly 1,000 financial centers. Sales on digital devices continue to grow and now represent 22% of total sales. +Still, with all the digital activity, we have not forgotten and remain focused on the 800,000 people walking into our financial centers across the U.S. on a daily basis. Many of these customers still use our branches to transact, but many others use our branches as financial destinations, where they can learn more about products and services, work face to face with a specialized professional and generally improve their financial lives. We want to encourage that, and that's why we have an extensive branch refurbishing underway. By the way, that's also helping increase customer satisfaction. +We're also building new centers in markets where we have never had financial centers but where we have presence across Global Banking, wealth management or both. These markets include MSAs like Denver, Minneapolis and Indianapolis. +In addition, we are testing smart centers, which utilize video-assist -- video-assisted ATMs and other very [ useful ] conferencing capabilities in regions where it makes sense. +Turning to Slide 15. Let's review Global Wealth and Investment Management, which produced earnings of $770 million and record pretax operating margin of 27% while returning 22% on allocated capital. These solid results were produced in a period of change for the industry as firms and clients anticipate new fiduciary standards and other market dynamics, such as the shift between active and passive investing. +Net interest income rose 3%, driven by loan growth. Year-over-year, noninterest income also rose 3% as 8% higher asset management fees were partially offset by lower transactional revenue. Year-over-year, while total revenue grew 3%, expenses grew 2%, creating an important but modest operating leverage. Also note the $29 billion of long-term AUM flows this quarter, reflecting strong client activity as well as the continuing shift from IRA brokerage to AUM. +Moving to Slide 16. We continue to see overall solid client engagement. Client balances climbed to nearly $2.6 trillion, driven by higher market values, solid long-term AUM flows and continued loan growth. Average deposits of $257 billion were flat compared to Q4 while ending deposits were down, primarily reflecting some movement to investment assets. Average loans of $148 billion were up 7% year-over-year. Loan growth remains concentrated in Consumer Real Estate. +Turning to Slide 17. Global Banking had record revenue this quarter, up 11% year-over-year led by Investment Banking activity. Revenue growth, coupled with expense management, improved the efficiency ratio 500 basis points to 44%. +In addition, provision expense of $17 million in Q1 '17 was more closely aligned with charge-offs while Q1 '16 included approximately $500 million in reserve increases for energy exposure. This resulted in a 58% year-over-year improvement in earnings to $1.7 billion. +Global Banking continues to drive loan growth within its risk and client frameworks, albeit at a slower pace. Total Investment Banking fees for the company were $1.6 billion, which was up 37% from Q1 '16. By comparison, overall industry fee pools were up 19% year-over-year. +A number of items to note given the strong performance. First, this was a record Q1 in terms of revenue from IB fees. Client underwriting activity in the capital markets was quite strong. We also earned record M&A fees this quarter with involvement in 6 of the top 10 completed transactions. +Debt underwriting was up 38% year-over-year led by strong performance in leveraged finance. Equity underwriting was up 65% year-over-year. Expenses decreased from Q1 '16 despite higher revenue-related incentives, higher FDIC insurance costs and costs associated with adding 340 new relationship managers over the past couple of years. +Return on allocated capital increased 18% -- excuse me, increased to 18% despite adding $3 billion of allocated capital this quarter. +Looking at trends on Slide 18 and comparing to Q1 last year. Average loans were up $14 billion or 4%. Growth was driven by our commercial bank, where lending was up 6% despite subdued real estate lending. As Brian said, we feel good about this growth rate given 2% GDP environment. We stand ready to support clients who want to borrow directly from us or tap the capital markets. One of the benefits of our universal banking model is our ability to deliver for clients across a complete product set and geographies. +Average deposits increased 2% from Q1 '16. As expected, we saw a seasonal decline in deposits from Q4. We remain mindful of the LCR rules as we grow deposits. +Switching to Global Markets on Slide 19. The business had a strong quarter, which once again benefited from the breadth of our product and geographic footprint with leadership positions in a number of areas. This quarter saw strong issuer activity and tighter spreads across credit products, which played well to our strength in mortgage and corporate credit. The business improved operating leverage with revenue, excluding DVA, growing 27%, while expenses increased modestly after adjusting for litigation recovery in Q1 '16. +Global Markets earned $1.3 billion and returned 15% on allocated capital. This includes a reduction of capital of $2 billion given the great work the team has done optimizing the balance sheet and reducing RWA in the past year. It is worth noting that we achieved these results with a lower VaR and 6% fewer people than last year. With respect to expenses, Q1 '16 litigation included a sizable litigation recovery. Excluding litigation, year-over-year expenses were up 2% while revenue grew 19%. +Moving to trends on Slide 20 and focusing on the components of our sales and trading performance. Sales and trading revenue of $4 billion, excluding net DVA, was up 23% from Q1 '16. Excluding net DVA and versus Q1 '16, FICC sales and trading of $2.9 billion increased 29%. Within FICC, the year-over-year improvement was driven by improved client activity in corporate credit and mortgage products. Equity sales and trading was up 7% year-over-year to $1.1 billion despite weaker cash equity volumes. We saw increased activity in Europe and Asia across all products. We also are beginning to see the benefits of deploying additional balance sheet to meet the financing needs of clients. +On Slide 21, we show All Other, which reported a net loss of $834 million. This was an improvement from Q1 '16, driven by lower litigation and mortgage servicing costs. The only other thing worth pointing out here is a reminder that this is where we book the annual retirement-eligible incentive and elevated Q1 payroll tax before they get allocated out to the line of business throughout the year. +The effective tax rate for the quarter was 26% and included approximately $200 million of tax benefit from the deductions on deliveries of share-based awards exceeding the related compensation costs. A recent change in accounting rules requires booking this difference to the tax income expense instead of directly to equity. The effective tax rate would have been 29.4% excluding this benefit, which is in line with our expectation of approximately 30% for the rest of the year. +Okay. A few points -- a few summary points as I wrap up. This quarter shows the value of our businesses as rates begin to rise and as we experience increased capital markets activity. For years, we have stayed focused on growing responsibly, including staying within our risk and client frameworks and making our growth more sustainable by simplifying the company and improving efficiency. +In Q1, consistent with this strategy, we stuck to our strong underwriting standards while growing loans and trading assets. Asset quality remains strong and net charge-offs low. We grew deposits while managing deposit rate paid. We grew AUM while helping clients adapt to a changing industry. When client activity picked up, we were ready with a breadth of capabilities to raise capital and manage risk in major markets all around the world. We continue to invest in new technology and capabilities while adding sales professionals in certain businesses. We lowered non-personnel expenses, offsetting some seasonal and other expense headwinds this quarter. We created operating leverage in each of our business segments. And we returned more capital to shareholders than in any quarter since the financial crisis. +These results tell us that responsible growth is working, with more to come as the economy continues to improve. Many of you have been waiting patiently for us to approach our long-term targets. I hope you noted that if one allocates annual retirement-eligible incentives and seasonally elevated payroll tax throughout the year, we are basically at our return targets this quarter. We know we have more work to do to be consistently achieving all our targets, but we have more confidence than ever that responsible growth will get us there. +With that, we'll open it up to Q&A. + + +================================================================================ +Questions and Answers +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) And we'll take our first question from Glenn Schorr with Evercore ISI. + +-------------------------------------------------------------------------------- +Glenn Paul Schorr, Evercore ISI, Research Division - Senior MD, Senior Research Analyst and Fundamental Research Analyst [2] +-------------------------------------------------------------------------------- + + First, a very quickie. Did you mention what NPLs you sold during the quarter? And if there was any P&L impact? + +-------------------------------------------------------------------------------- +Paul M. Donofrio, Bank of America Corporation - CFO [3] +-------------------------------------------------------------------------------- + + Small and small. Small sell, small impact. + +-------------------------------------------------------------------------------- +Glenn Paul Schorr, Evercore ISI, Research Division - Senior MD, Senior Research Analyst and Fundamental Research Analyst [4] +-------------------------------------------------------------------------------- + + No problem. I'm curious, I think we've all taken note of the responsible growth, what you've done, heard your comments on it relative to the economy. I'm curious, as we watch the industry loan growth come down for a bunch of different reasons, can B of A continue on this path? I don't want to say irregardless of what the industry backdrop is, but can it buck the trend of the declining loan growth that we're seeing in most other places? + +-------------------------------------------------------------------------------- +Brian T. Moynihan, Bank of America Corporation - Chairman, CEO and President [5] +-------------------------------------------------------------------------------- + + Glenn, it's Brian. I think at the end of the day, banks reflect the economy and help make the economy happen. So we've been able to grow loans 5%, 6% in the core, so the middle market segment, 7% actually year-over-year. Credit card's been picking up a little bit, home equity is strong, residential mortgage down. So if you look at it overall, we've been out -- able to outgrow the economy, but we're going to be dependent upon the economy keep growing. But what we've shown you across the last couple of years, with the discipline we have, are driving deeper penetration in our customers, working hard on our relationships even with repositioning portfolios that you can see in some of the slides and/or making sure that we maintain great discipline, we've been able to grow the mid-single digits, as we've told you, against the backdrop of an economy growing at 1.5% to 2%. If that grows faster, we'll grow faster. If that stays in that range, we should be able to continue to grow at that level. + +-------------------------------------------------------------------------------- +Glenn Paul Schorr, Evercore ISI, Research Division - Senior MD, Senior Research Analyst and Fundamental Research Analyst [6] +-------------------------------------------------------------------------------- + + Okay. Maybe on the credit front. As you've mentioned, credit's awesome in most places, and I saw criticized credit came down with energy improving. Are there any areas that are criticized credits increasing, like something like retail? + +-------------------------------------------------------------------------------- +Paul M. Donofrio, Bank of America Corporation - CFO [7] +-------------------------------------------------------------------------------- + + No. Credit looks good across the board, and it's performing as we model and expect. + +-------------------------------------------------------------------------------- +Glenn Paul Schorr, Evercore ISI, Research Division - Senior MD, Senior Research Analyst and Fundamental Research Analyst [8] +-------------------------------------------------------------------------------- + + Okay, last little one. Zelle -- you mentioned the increase in Zelle activity. Do you make money on that? Or is that mostly a customer retention tool? + +-------------------------------------------------------------------------------- +Brian T. Moynihan, Bank of America Corporation - Chairman, CEO and President [9] +-------------------------------------------------------------------------------- + + I think, Glenn, think about it this way, is the way people pay each other. So you -- we don't charge for it. It's just a service as part of a core DDA account, just like checks or just like an ATM card would be to withdraw. It's just more efficient for the customer, more efficient for the -- for us, too, ultimately, because the payback will be taking cash out of the system. And so year-to-date, we're up about -- even before Zelle is announced, for the first quarter, P-to-P payments at Bank of America are up 25% first quarter of '17 versus first quarter of '16. So this is growing fast and will continue to grow. And what we'll do, we'll swap out other payment forms which cost us more to execute, but it's free to the customer. + +-------------------------------------------------------------------------------- +Operator [10] +-------------------------------------------------------------------------------- + + And we'll take our next question from John McDonald from Bernstein. + +-------------------------------------------------------------------------------- +John Eamon McDonald, Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst [11] +-------------------------------------------------------------------------------- + + Paul, just a clarification regarding the second quarter framework you provided for net interest income. Does the $150 million potential bump, based on the disclosures, include the benefit of loan growth? Or was that just the rate impact? And could it be a little better if loan growth continues? + +-------------------------------------------------------------------------------- +Paul M. Donofrio, Bank of America Corporation - CFO [12] +-------------------------------------------------------------------------------- + + Well, the loan growth is embedded in our 100 basis point shock. So theoretically, it includes it. But if loan growth's a little bit better than we think, it could be better; if it's a little lower, it would be less. That's one of the variables that we have to think about when we think about NII growth. + +-------------------------------------------------------------------------------- +Brian T. Moynihan, Bank of America Corporation - Chairman, CEO and President [13] +-------------------------------------------------------------------------------- + + John, just one of the things to keep in mind there is remember, we just capitalized or put in the run rate, for lack of a better term, $600 million-plus, fourth quarter to first quarter, and this is on top of that, too. That first benefit as you think for the year, that benefit is now locked in and moves its way through the system. + +-------------------------------------------------------------------------------- +John Eamon McDonald, Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst [14] +-------------------------------------------------------------------------------- + + Got it, got it. So that's incremental to the 1Q print. Okay. And then can you remind us what kind of deposit repricing beta you assume in the disclosures, Paul? + +-------------------------------------------------------------------------------- +Paul M. Donofrio, Bank of America Corporation - CFO [15] +-------------------------------------------------------------------------------- + + Sure. So in a 100 basis point rise on interest-bearing deposits, and remember, we have a large amount of noninterest-bearing deposits, but on interest-bearing deposits, we're kind of low 50-ish for that full 100 basis point rise. As you can expect, the first 25, 50 of the 100 is going to be a little bit different than the second 25 or 50, and that's about as much that I'd want to give you given the competitiveness around this topic. + +-------------------------------------------------------------------------------- +John Eamon McDonald, Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst [16] +-------------------------------------------------------------------------------- + + Okay, and a separate question on capital. With the CET1 at 11% now versus the 2019 requirement of 9.5%, what kind of buffers are you thinking of holding? And what level of CET1 feels right -- like, the right target for you, longer term? + +-------------------------------------------------------------------------------- +Paul M. Donofrio, Bank of America Corporation - CFO [17] +-------------------------------------------------------------------------------- + + So with respect to buffers, I wouldn't want to give an exact number for all sorts of reasons. We put a lot of thought into how we manage our capital and liability structure, including buffers. Having said that, we have 150 basis points of cushion right now on fully phased-in minimums and a lot of time between now and 2019. So maybe we'll talk more about it as we get a little closer. But right now, we feel good where we are. + +-------------------------------------------------------------------------------- +Operator [18] +-------------------------------------------------------------------------------- + + And we'll take our next question from Steven Chubak with Nomura Instinet. + +-------------------------------------------------------------------------------- +Steven Joseph Chubak, Nomura Securities Co. Ltd., Research Division - VP [19] +-------------------------------------------------------------------------------- + + So just wanted to kick things off with a question on the 2018 expense target of $53 billion that you guys had outlined on previous calls. Can you just remind us what the revenue growth assumptions were underlying that target? And just given some of the acceleration that we've seen in fee income growth and the higher incentive comp, is that still an achievable target in your view? + +-------------------------------------------------------------------------------- +Brian T. Moynihan, Bank of America Corporation - Chairman, CEO and President [20] +-------------------------------------------------------------------------------- + + The revenue growth assumptions were like we said. If long term, we believe we can grow faster than GDP growth and that's embedded in those assumptions. I think a way for you, Steve, to think about it is look at the Global Markets year-over-year. And what you see there is with that substantial rise in revenue, the expense growth absent -- last year, we had a credit and litigation, this year we had an expense. So you had a pretty good reversal there. Absent that, it was 2% growth. And as Paul said, it had 6% less people. Comp expenses were up a bit even though revenue was up quite a bit. So we can manage against that with the inevitable thing that if revenue grows faster, we might have a little bit more expense pressure. But I think you and I will be very happy to see that happen. + +-------------------------------------------------------------------------------- +Paul M. Donofrio, Bank of America Corporation - CFO [21] +-------------------------------------------------------------------------------- + + Look, the only thing I would add, just for the record, is when we gave that guidance around this time last year, we specifically said it was based upon the economic environment at that time, and that if things got better, we'd have to adjust. If things got worse, we'd have to adjust. Having said all that -- that's just for the record, having said all that, we're still focused and comfortable we can get to the $53 billion, approximately $53 billion for full year 2018. That's what we said. + +-------------------------------------------------------------------------------- +Steven Joseph Chubak, Nomura Securities Co. Ltd., Research Division - VP [22] +-------------------------------------------------------------------------------- + + Got it, and then just one question on the provision outlook. Just given the continued favorable credit and delinquency trends, how should we be thinking about the trajectory in the near term? Is a run rate of, I guess, around $850 million, plus or minus, a reasonable target? + +-------------------------------------------------------------------------------- +Paul M. Donofrio, Bank of America Corporation - CFO [23] +-------------------------------------------------------------------------------- + + The way I would think about it in Q2, provisions should roughly match net charge-offs. But remember, we're bouncing around the bottom with respect to net charge-offs in commercial. So a material credit can move the needle one way or the other. Absent that caution, we will build as we grow loan balances. But we should expect to see that offset, perhaps, by further runoff of noncore Consumer Real Estate, and we have a high energy reserve. + +-------------------------------------------------------------------------------- +Steven Joseph Chubak, Nomura Securities Co. Ltd., Research Division - VP [24] +-------------------------------------------------------------------------------- + + And just one final question on capital return, just touching on John's last question. How should we be thinking about the capital return trajectory given the 150 basis points of excess? And I'm also wondering whether some of the recent rhetoric from the regulators suggesting a disinclination of sorts to have a qualitative CCAR failure, whether that informs your approach at all in terms of future payouts. + +-------------------------------------------------------------------------------- +Brian T. Moynihan, Bank of America Corporation - Chairman, CEO and President [25] +-------------------------------------------------------------------------------- + + I think we have been building our capital [ ask ] year-over-year, and you should expect us continue to do that since we have both a strong cushion under CCAR. We'll see with this year's results, we don't know yet obviously. But from last year, just extrapolating. And also, our start point is higher and our run rate of earnings is now very consistent. So capital return's part of our story, and we'll continue to pursue it. + +-------------------------------------------------------------------------------- +Paul M. Donofrio, Bank of America Corporation - CFO [26] +-------------------------------------------------------------------------------- + + We've made progress every year, you've seen that. And I would remind everybody that we tapped the de minimis last year as well. So with the stability of our earnings, with the progress we're making on CCAR, as Brian said, we hope to continue to make progress. + +-------------------------------------------------------------------------------- +Operator [27] +-------------------------------------------------------------------------------- + + And we'll take our next question from Ken Usdin with Jefferies. + +-------------------------------------------------------------------------------- +Kenneth Michael Usdin, Jefferies LLC, Research Division - MD and Senior Equity Research Analyst [28] +-------------------------------------------------------------------------------- + + Just first clarification, just coming back to the NII commentary, does the $150 million also incorporate the extra day you get in the second quarter? Because that's usually pretty meaningful for you guys. + +-------------------------------------------------------------------------------- +Paul M. Donofrio, Bank of America Corporation - CFO [29] +-------------------------------------------------------------------------------- + + Yes, I would think about the extra day as kind of being offset by the seasonality we have in Q1 for leasing. + +-------------------------------------------------------------------------------- +Kenneth Michael Usdin, Jefferies LLC, Research Division - MD and Senior Equity Research Analyst [30] +-------------------------------------------------------------------------------- + + Okay. So you've got -- you're saying you got a benefit in the first and that kind of washes to the second. So really, your net is the $150 million? + +-------------------------------------------------------------------------------- +Paul M. Donofrio, Bank of America Corporation - CFO [31] +-------------------------------------------------------------------------------- + + Yes, approximately $150 million. And as you know, there's a lot of things that go into that modeling. + +-------------------------------------------------------------------------------- +Kenneth Michael Usdin, Jefferies LLC, Research Division - MD and Senior Equity Research Analyst [32] +-------------------------------------------------------------------------------- + + Understood. Okay, great. So on the consumer fee side, I wanted to just ask, we saw kind of a little bit of a positive turn in both card income and also in the brokerage line, which is the first time in a while we've seen both of those move the right way. Any better line of sight at this point on just the trends getting better underneath the surface? Whether it's the rewards competition or the fee capture pressures in brokerage kind of starting to get into the run rate, and we can kind of expect to see growth from here? + +-------------------------------------------------------------------------------- +Paul M. Donofrio, Bank of America Corporation - CFO [33] +-------------------------------------------------------------------------------- + + Look, we've seen modest growth in card balances. We think that should continue. We're adding new accounts. We added 1.2 million cards this quarter. Combined debit, credit spend was good year-over-year and really good recently. But as you point out, the card income line remains -- I think in terms of growth, remains muted by competition around customer rewards. I guess what I would point out and just remind everybody is that just focusing on the fee income line sort of ignores some of the key benefits of our strategy, which is to attract relatively higher-quality card customers and reward them for deepening their relationship with us. The strategy, we think, is driving incremental deposit growth and making them stickier, and that helps NII. And by the way, these customers have lower loss rates as well as reduced need to interact with call centers, so that helps us lower costs. In terms of the service line or service charges, they've shown some modest growth, driven by growth in new accounts, and we expect that probably to continue here. + +-------------------------------------------------------------------------------- +Kenneth Michael Usdin, Jefferies LLC, Research Division - MD and Senior Equity Research Analyst [34] +-------------------------------------------------------------------------------- + + And can you just touch on brokerage? + +-------------------------------------------------------------------------------- +Paul M. Donofrio, Bank of America Corporation - CFO [35] +-------------------------------------------------------------------------------- + + You mean brokerage... + +-------------------------------------------------------------------------------- +Kenneth Michael Usdin, Jefferies LLC, Research Division - MD and Senior Equity Research Analyst [36] +-------------------------------------------------------------------------------- + + Wealth and brokerage. + +-------------------------------------------------------------------------------- +Paul M. Donofrio, Bank of America Corporation - CFO [37] +-------------------------------------------------------------------------------- + + Yes. Well, wealth and brokerage is being driven by the long-term trend that we've been seeing with growth in AUM as transactional brokerage continues to decline. We saw that again this quarter. This quarter, we had significant growth in AUM, which offset that sort of continuing decline in brokerage. I think AUM fees were up 8% this quarter. + +-------------------------------------------------------------------------------- +Operator [38] +-------------------------------------------------------------------------------- + + And we'll take our next question from Betsy Graseck with Morgan Stanley. + +-------------------------------------------------------------------------------- +Betsy Lynn Graseck, Morgan Stanley, Research Division - MD [39] +-------------------------------------------------------------------------------- + + A couple of questions. One on the expense discussion earlier. On Page 4, you highlighted very clearly the strong operating leverage that you've got year-over-year from the various industries, various segments that you run. The question I have is, where should we expect the next leg of improvement on expenses could come from? Because one of the questions I've gotten from people today is this is fantastic operating leverage, but where are the levers to take it further? + +-------------------------------------------------------------------------------- +Brian T. Moynihan, Bank of America Corporation - Chairman, CEO and President [40] +-------------------------------------------------------------------------------- + + Right. I think when we started a few years ago at $70 billion operating expenses, to bring it down to this level, it was more obvious. Betsy, now it's everywhere. It's everywhere, a little bit everywhere and a lot of hard work. So headcount generally is drifting down year-over-year at around 4,000 or 5,000 people. That gets harder, but what we're doing is taking out people and putting them into the front line in the client-facing roles, and so we're seeing that shift go on. [ You're ] continuing to work our real estate portfolio down, again, through colocations in cities. So you'll see us take 3 buildings in an area and put them in 1, and you've seen some announcement in that regard. In our data centers, we're accelerating the process that you'll -- that -- to consolidate data centers, and that helps continue to knock down the number of data centers. It takes $0.5 billion investment to -- or a $0.25 billion investment to build one, to bring it in. And so you'll see that go on. And then it's everywhere we turn, every place we look, just keep working at the pieces. But at the end of the day, continue to watch the FTE headcount numbers drift down and also how we move those around from less managers to more client-facing people and less layers in the company, which we've been after. And so it is just hard work across the board using our simplify and improve and what we call organizational health going on in our company, and we're seeing the aspects of that. That -- by the way, I think last -- in '16, to give you an example, I think we invested -- got about $400 million, $500 million in savings from some ideas, but it took us an investment of a couple hundred million dollars to get that. And so even that investment rate is important to getting the sales out. And so we're not asking you to exclude, but there's severance cost in here, there's real estate repositioning costs, all of that which actually comes down as you get further and further towards the optimization level. + +-------------------------------------------------------------------------------- +Betsy Lynn Graseck, Morgan Stanley, Research Division - MD [41] +-------------------------------------------------------------------------------- + + Okay. So that speaks to why you can continue the revenue growth but yet still bring these expenses down. Got it. Two other quick ones. One on fixed income. You mentioned that credit was a source of strength this quarter. Others have highlighted credit as a weakness. So maybe you could speak to what you're seeing in your client base that drove such a strong credit quarter in FICC. + +-------------------------------------------------------------------------------- +Paul M. Donofrio, Bank of America Corporation - CFO [42] +-------------------------------------------------------------------------------- + + Well, first I would say, look, we've been making a lot of investments in our Global Markets business across equity, across macro. Credit has always been a traditional strength of Bank of America Merrill Lynch, a lot of very strong bankers combined with strong sales and trading effort. Corporates raised money this quarter in the capital markets. We have a strong relationship. So we saw a lot of increased activity on the primary side, which helps your sales and trading on the secondary side. That's one. Two, with spreads tightening a little bit and with clients' activity picking up as they were repositioning given the change in markets, the change in spreads, again, we have strong corporate credit trading desk. We have strong special situations in credit. We have strong mortgage. And they just saw a lot of client activity given what happened in the quarter. So when -- we've often said, when client activity picks up, you're going to see this business perform. And for us, client activity was more this quarter and it showed up in our results. And again lastly, it's a breadth of products. It's significant presence and scale in every major market around the world. So it's not just the U.S. We saw activity in emerging markets around the globe. We were there for -- when our clients needed us. + +-------------------------------------------------------------------------------- +Betsy Lynn Graseck, Morgan Stanley, Research Division - MD [43] +-------------------------------------------------------------------------------- + + Okay. And then lastly, you mentioned on the call during the prepared remarks that you "remain mindful of the LCR rules as we grow deposits". Could you elaborate on your thoughts behind that? + +-------------------------------------------------------------------------------- +Paul M. Donofrio, Bank of America Corporation - CFO [44] +-------------------------------------------------------------------------------- + + Sure. Particularly on the wholesale side, there are 3 types of deposits fundamentally, 25%, 40% and 100% runoff. And as we think about serving our customers and clients, we're mindful -- very mindful of their needs, but we're also focused on maintaining those -- having deposits that are of the highest quality in terms of being able to use, to lend out to customers. So that means you've got to focus on the 25% and 40% or the more of -- the deposits that are much more operational in nature, the deposits that we know our corporate and FI clients are using to run their businesses. We're focused on growing those deposits and we're focused on helping them use those deposits to pay bills and to move their money around, to do FX, all the things you might think an individual does but just on the corporate side. Those are the types of the deposits we're focused on. We're not -- we're respectful of clients who want to give us other types of deposits, but we're having conversations about them, about the value of those and therefore what they should expect in terms of the pricing. + +-------------------------------------------------------------------------------- +Operator [45] +-------------------------------------------------------------------------------- + + And we'll take our next question from Gerard Cassidy with RBC. + +-------------------------------------------------------------------------------- +Gerard S. Cassidy, RBC Capital Markets, LLC, Research Division - Analyst [46] +-------------------------------------------------------------------------------- + + Brian, when you look out longer term, I mean, if you turn back the clock when the industry, before the financial crisis, typically earned 120 on assets -- or 130 basis points on assets, kind of a more normal interest rate environment, what do you see for the long -- and I know ROE is what you focus on, and we all do. But from an ROA standpoint, when everything's going right for Bank of America, your expenses are where you want them to be, the margins are where you want them to be, what kind of ROA do you think this company is capable of producing? + +-------------------------------------------------------------------------------- +Brian T. Moynihan, Bank of America Corporation - Chairman, CEO and President [47] +-------------------------------------------------------------------------------- + + Well, I think, Gerard, just to focus, we've talked to you about getting at above 100 basis points, and then with the adjustments of sort of smoothing out the first quarter a little bit from the onetime or the annual expenses that occur in the first quarter, you're getting close to that. That is not a aspirational goal which we'll stop at. I mean, I think it'll improve if the rate structure continues to move up and the economy continues to grow, we'll get above that. But the first order of business is to get above -- to get to that so that we get the returns on tangible common equity and returns on equity where we want them to be. As you're thinking about that just more broadly, remember that we have, I don't know, a balance sheet of $2.3 trillion or so. And think about $500 billion basically being completely liquid assets. That is a far different cry than we were when our balance sheet sort of the high point was $2.7 trillion and we had -- probably had $200 billion or $100 billion to $200 billion of high-quality assets or whatever the moniker we'd use back then was. And that's going to knock around your yields on your balance sheet. And so we do focus on ROA in our company, we also -- because it basically is the thing that ultimately would drive ROE. But as equity builds, that ROE can be under pressure just from increases in equity. But if you think about it, the real driver of the yield on the balance sheet has more to do with the amount of assets you're carrying which are underleveraged for purposes of liquidity and safety and soundness. + +-------------------------------------------------------------------------------- +Gerard S. Cassidy, RBC Capital Markets, LLC, Research Division - Analyst [48] +-------------------------------------------------------------------------------- + + Right. Okay. And speaking of the lever on the equity, can you remind us what the risk-weighted assets are now for the operational risk for you guys? + +-------------------------------------------------------------------------------- +Paul M. Donofrio, Bank of America Corporation - CFO [49] +-------------------------------------------------------------------------------- + + Sure. We have $500 billion in RWA for operational risk, which is -- if I can go on a little bit, which is 1/3 approximately of the RWA of the company under the advanced approach and more RWA than we have for our credit. + +-------------------------------------------------------------------------------- +Gerard S. Cassidy, RBC Capital Markets, LLC, Research Division - Analyst [50] +-------------------------------------------------------------------------------- + + Very good. And then coming back to the combined payout ratio that you guys are striving for, within that, what should we envision for -- once you get your capital levels to the point where you're very comfortable with, is the dividend payout ratio of 30% to 40% a reasonable expectation down the road when things more normalize? + +-------------------------------------------------------------------------------- +Brian T. Moynihan, Bank of America Corporation - Chairman, CEO and President [51] +-------------------------------------------------------------------------------- + + A couple of things. One is our capital is more than sufficient. We're very comfortable with it, with the tangible common equity ratio, Gerard. Thinking about before the crisis of 7.9% and a CET1 of 11% with a minimum of 9.5%, we're more -- we have more capital than the company needs by the different measures, whether it's a traditional market-based measure or a regulatory measure. So we're completely comfortable with that. That leads us to return more capital. You should expect our dividend payout ratio will, for the bigger companies, I think they'll be more focus of keeping that to the 30% level that's been talked about in the various rules and regulations. And if you go back 3 or 4 or 5 years ago, I spoke to that at one of our industry conferences, I think if you look across time, that level of -- if you think about that level of payout against your earnings stream, there's very low probability that you'll have real danger in the dividend -- continuing that dividend even in tough times. So our goal is never -- to keep the dividend stable and then use the excess capital to buy the stock back at around book value. We think it's a great trade. + +-------------------------------------------------------------------------------- +Gerard S. Cassidy, RBC Capital Markets, LLC, Research Division - Analyst [52] +-------------------------------------------------------------------------------- + + Got it. But something, Paul, just circling back to your comments about the FICC -- the strength in FICC, the client activity was strong, can you give us some color on the clients? Was it primarily investment clients or hedge -- or pension funds, hedge funds? What type of clients did you see that strength in the activity? + +-------------------------------------------------------------------------------- +Paul M. Donofrio, Bank of America Corporation - CFO [53] +-------------------------------------------------------------------------------- + + I think it was -- the only way to really classify it is really across the board. I think we have strength in all of those client sets. It was just a lot of good sales and trading activity driven by client interest in repositioning their investments, but also again, driven by (inaudible) of our clients. We just have a very broad and diverse product set in FICC, both from a product perspective and a geographic perspective. And that kind of footprint and that kind of diversity, when clients want to make changes, we're a natural call. + +-------------------------------------------------------------------------------- +Gerard S. Cassidy, RBC Capital Markets, LLC, Research Division - Analyst [54] +-------------------------------------------------------------------------------- + + Brian, thank you for batting clean-up and not Lead-off. It made it a lot easier for all of us today. + +-------------------------------------------------------------------------------- +Brian T. Moynihan, Bank of America Corporation - Chairman, CEO and President [55] +-------------------------------------------------------------------------------- + + Okay. + +-------------------------------------------------------------------------------- +Operator [56] +-------------------------------------------------------------------------------- + + And we'll take our next question from Saul Martinez with UBS. + +-------------------------------------------------------------------------------- +Saul Martinez, UBS Investment Bank, Research Division - MD and Analyst [57] +-------------------------------------------------------------------------------- + + A couple of questions. First, can you comment on the sustainability, broadly, of your returns in your markets and banking businesses? 15% return on allocated equity in markets, 18% banking despite the fact that you increased your capital allocation there. Obviously, if you can sustain those kinds of returns, it goes a long way towards helping you hit your 12% ROTCE targets on a sustainable basis. So just can you comment broadly on how confident you are to -- in your ability to, say, hit sort of mid-teen returns in those businesses? + +-------------------------------------------------------------------------------- +Paul M. Donofrio, Bank of America Corporation - CFO [58] +-------------------------------------------------------------------------------- + + We have been getting, in Global Markets, a double-digit return now for a number of quarters. It's been in the 10-ish, 11% range for a number of quarters. So we feel like, in Global Markets, we've made a tremendous amount of progress in improving returns. In Global Banking -- and remember, this quarter where they did 15%. But this quarter, I think we had a very strong quarter in sales and trading. Our performance in Global Markets is going to be a direct result of client activity, as we say every quarter. So when client activity is lower, our results will be lower, but through a number of different quarters now with varying amounts of client activity, I think we've been able to get at 10% or more return on equity. So that's how I'd answer it from that perspective. In Global Banking, again, those returns are somewhat dependent on client activity in Investment Banking, but there, I think the Global Banking segment is less volatile with respect to returns tied to the Investment Banking fee pool in any given quarter. We have a diverse product set across treasury service, traditional corporate banking products and Investment Banking products. And then from a client perspective, we're the full spectrum: Small, medium-sized and large global companies. So there, I would expect us to be able to main those -- maintain that return level. + +-------------------------------------------------------------------------------- +Saul Martinez, UBS Investment Bank, Research Division - MD and Analyst [59] +-------------------------------------------------------------------------------- + + Okay, that's helpful. Yes? + +-------------------------------------------------------------------------------- +Brian T. Moynihan, Bank of America Corporation - Chairman, CEO and President [60] +-------------------------------------------------------------------------------- + + The thing I'd add to that is if you think about what we did, we took Global Banking because we think that is an integrated business, whether it's corporate Investment Banking with both the corporate side and Investment Banking side or middle market banking, what we call Global Commercial Banking, again, with Investment Banking capital markets behind obviously less than GCIB. We split that out to show you that, that business -- many years ago, we broke Global Banking away from Global Markets to show that the [ distinctness ] in the business at Global Banking was more of an annuity stream driven by treasury services revenue, lending revenue and then Investment Banking fees, which ebb and flow based on client activity and the returns are fairly consistent, et cetera. The flip side was we also wanted to show -- I think doing this 5, 6 years ago when we first did it, and have been doing it at ever since. And we're were one of the few companies that does it. On the Global Markets side, you can see that there's actually more stability in that business than a lot of people thought. So if you look on the low end, we might make $600 million, $700 million after tax. On the high end, we made $1.3 billion this quarter, but you'll see this range. And if you look across years of quarters and look at the comparative quarters year-over-year because there's some seasonality, you'll see it's relatively stable. And so we've sort of hit that double-digit level in the worst of quarters during a year and then in the best of quarters, it will kick above it. That was, again, how Tom and the team -- Tom Montag and the team run the business. The stability we put in. And then most importantly was bringing the expense structure down dramatically 5 or 6 years ago, Tom and the team did by almost $1 billion in a quarter in operating expenses just in this markets business alone, and then maintaining it there and continuing to push it down while revenues have stabilized and come back up. + +-------------------------------------------------------------------------------- +Saul Martinez, UBS Investment Bank, Research Division - MD and Analyst [61] +-------------------------------------------------------------------------------- + + Yes, no. That's helpful. So I mean, obviously one of the things that's been helpful for returns in banking is a very benign credit environment. Commercial charge-offs were 10 basis points this quarter, it hasn't really moved much in recent quarters. But how do you -- how should we think about more of a sustainable level? And is there anything there that makes you think that you could start to see some sort of inflection or some sort of an uptick in terms of credit costs? + +-------------------------------------------------------------------------------- +Paul M. Donofrio, Bank of America Corporation - CFO [62] +-------------------------------------------------------------------------------- + + Are you referring to more sustainable on the net charge-off side? + +-------------------------------------------------------------------------------- +Saul Martinez, UBS Investment Bank, Research Division - MD and Analyst [63] +-------------------------------------------------------------------------------- + + Yes, exactly. On commercial. + +-------------------------------------------------------------------------------- +Paul M. Donofrio, Bank of America Corporation - CFO [64] +-------------------------------------------------------------------------------- + + I guess what I would -- how I would answer the question is we have been -- we changed our underwriting standards years ago. We've been focused on responsible growth now for a number of years. We've been sticking with that improved client selection, heightened credit standards. So the answer is we can't compare to a previous period in the company's history. We're just going to have to see how this develops. But we're very confident. We don't see anything today, as we look at what's going on in the marketplace, that would suggest that we're at an inflection point. It doesn't mean that I won't be talking to you about -- next quarter about having lived through an inflection point, but we're not seeing anything right now that would tell us that we should expect net charge-offs to rise in the near term. In the long term, there is some seasoning going on in the credit card portfolio that we expect and we've talked about before. But outside of that, we feel good about where our credit card quality is. + +-------------------------------------------------------------------------------- +Operator [65] +-------------------------------------------------------------------------------- + + And we'll take our next question from Brian Kleinhanzl with KBW. + +-------------------------------------------------------------------------------- +Brian Kleinhanzl, Keefe, Bruyette, & Woods, Inc., Research Division - Director [66] +-------------------------------------------------------------------------------- + + Great. Yes, I just had a quick question. I remember you saying that both the business -- or the commercial customers and consumer customers were optimistic still. But did you see a change in that optimism over the course of the quarter? I mean, did it end lower at the end of the quarter given what was going on with D.C. and everything else? Or was it fairly consistent? + +-------------------------------------------------------------------------------- +Brian T. Moynihan, Bank of America Corporation - Chairman, CEO and President [67] +-------------------------------------------------------------------------------- + + I'd say -- I could say consistent. And if you looked at spending, I think it actually maintains its pace through the quarter. As an indicator of their behavior, March was a stronger month than the first 2 months of the quarter. Now you can get into day counts and movements around which weekends fall, but just we didn't see any fall-off in terms of their behavior in spending, which I think is a good indicator of how they're feeling. + +-------------------------------------------------------------------------------- +Operator [68] +-------------------------------------------------------------------------------- + + And we'll take our next question from Matt O'Connor with Deutsche Bank. + +-------------------------------------------------------------------------------- +Matthew D. O'Connor, Deutsche Bank AG, Research Division - MD in Equity Research [69] +-------------------------------------------------------------------------------- + + I just wanted to follow-up on the net interest income one more time. I mean, it feels like the 2Q expectation is a little bit less, certainly versus what I would have thought. And I guess I'm trying to figure out if it's just some conservatism on the deposit repricing assumption. You talk about 50%, but it's been really insignificant so far for the Fed hikes. So I'm trying to gauge, is it conservatism on that? Is it the fact that 10-year has obviously come in a fair amount? Or some combination of both, maybe? + +-------------------------------------------------------------------------------- +Paul M. Donofrio, Bank of America Corporation - CFO [70] +-------------------------------------------------------------------------------- + + So I'm not going to take you through the math again because the math is fairly self-explanatory, but you've -- there are a lot of assumptions, or I should -- I'll call them assumptions, but there's a lot of things that go into the modeling of NII. You hit upon one of them. Obviously, we could have deposit betas that are different than what we're expecting as we're doing our modeling. The 50 basis points, obviously, is for a full 100% shock. We're talking about a 25% shock. So it's reasonable to expect that we would be lower than 50% for that first 25%. I think the question is how should we be? And we're just going to have to wait and see. We're very focused on the competitive environment. We're focused on the needs and wants of our clients. And we're focused -- we're balancing all of that against what our shareholders would want us to do. So we're just going to have to see how it develops, but there's a lot of things that go into the modeling of expected NII. + +-------------------------------------------------------------------------------- +Matthew D. O'Connor, Deutsche Bank AG, Research Division - MD in Equity Research [71] +-------------------------------------------------------------------------------- + + Okay, understood. And then just the impact of long-term rates. I mean, obviously, the comment you made on rate leverages for higher rates and your 75% lever on the short end, as we think about the decline here in long rates, if it holds, how [ frame ] kind of the drag on that. And I think it bleeds in over time, obviously, not all at once. + +-------------------------------------------------------------------------------- +Paul M. Donofrio, Bank of America Corporation - CFO [72] +-------------------------------------------------------------------------------- + + Yes. The sensitivity on the long end is a function of being able to reinvest as assets mature at higher or lower rates than the average we have now and what it does to the amortization of our premium on our securities portfolio. The latter is a bigger driver in the short term, the former is a bigger driver in the long term. If you think about the company right now, where long-term rates are, we've said this on other calls, we're kind of -- we used to be at equilibrium where an asset rolling off the balance sheet was being replaced by assets rolling on the balance sheet at roughly the same yield. I would say we're in a little bit more positive place right now where even where our rates are, having long-term rates have gone up here over the last 2 quarters, we're sort of in a position where an asset rolling off the balance sheet, on average, is being replaced by an asset coming on at slightly higher yield. So I don't know if that helps you. + +-------------------------------------------------------------------------------- +Matthew D. O'Connor, Deutsche Bank AG, Research Division - MD in Equity Research [73] +-------------------------------------------------------------------------------- + + Yes, no. That's very clear and very helpful. + +-------------------------------------------------------------------------------- +Operator [74] +-------------------------------------------------------------------------------- + + And we'll take our next question from Marty Mosby with Vining Sparks. + +-------------------------------------------------------------------------------- +Marlin Lacey Mosby, Vining Sparks IBG, LP, Research Division - Director of Banking and Equity Strategies [75] +-------------------------------------------------------------------------------- + + Two technical issues on the kind of net interest margin, NII. When you look at the big benefit in net interest margin, it seems like you had several things, like the hedge ineffectiveness and leasing, that pushed the margin up. And even though you can have NII growth, your margin may even kind of just flatten out. Was there kind of a bias towards the margin just being a little bit higher, given some of those moving pieces this particular quarter? + +-------------------------------------------------------------------------------- +Paul M. Donofrio, Bank of America Corporation - CFO [76] +-------------------------------------------------------------------------------- + + Look, the bulk of the increase from Q4 to Q1, the $700 million, the bulk of it was due to rates. We just would highlight that there was meaningful improvement that was driven by the leasing seasonality. Think about that as roughly the kind of improvement we get with an extra day in a quarter. And then there was, I think, significant improvement driven by the lack of hedge ineffectiveness in the first quarter relative to what we experienced in the first quarter. But the bulk of it was driven by rates. And if you think about the rate impact, more than half of the rate impact was driven by the long end as opposed to the short end. + +-------------------------------------------------------------------------------- +Marlin Lacey Mosby, Vining Sparks IBG, LP, Research Division - Director of Banking and Equity Strategies [77] +-------------------------------------------------------------------------------- + + And I was just focusing on the margin in the sense that just like it was rounded up because the things that are going to help next quarter are going to help NII, which may not help the margin. But then the second question was when you look at your transfer pricing mechanism, was curious because it doesn't seem like a lot of banks would have the benefit from rates showing up in corporate other. Is your mechanism, where it's still spreads some of that -- because that will matter on operating leverage for the business segments. So are the segments going to benefit as rates go up more than corporate? It does seem like it's spread out more than other banks. + +-------------------------------------------------------------------------------- +Paul M. Donofrio, Bank of America Corporation - CFO [78] +-------------------------------------------------------------------------------- + + I think over the longer -- in any one quarter, it could be a little bit lumpy on what -- how company overall benefits versus the segments. But I think over time, over multiple quarters, the segments will benefit. It's just basically a function of how residual flows back to the -- to our segments. + +-------------------------------------------------------------------------------- +Marlin Lacey Mosby, Vining Sparks IBG, LP, Research Division - Director of Banking and Equity Strategies [79] +-------------------------------------------------------------------------------- + + It is. It just seems like you've got a good methodology to push it to the segments, which is helping operating leverage in each of those segments as you're getting that benefit + +-------------------------------------------------------------------------------- +Operator [80] +-------------------------------------------------------------------------------- + + And we'll take our next question from Andrew Lim with Societe Generale. + +-------------------------------------------------------------------------------- +Andrew Lim, Societe Generale Cross Asset Research - Equity Analyst [81] +-------------------------------------------------------------------------------- + + Another NII question, actually. I'm just trying to understand the mechanics of how your guidance in 4Q for a $6 billion uplift in NII, a 400 basis point shock, has come down to about $3.3 billion there. If I understand correctly, the long end has increased, so that reduces your guidance going forward. Is that the way to think about it? + +-------------------------------------------------------------------------------- +Paul M. Donofrio, Bank of America Corporation - CFO [82] +-------------------------------------------------------------------------------- + + Yes. I think if you look at our disclosures, you'll see that the 100 basis point rate shock at the end of the year was basically the same as rates it is right now. You're referring to what we reported at the end of Q3 being 4-point-something. And that decline in benefit we experienced as rates rose, and that went into our run rate of NII that, as Brian mentioned earlier. + +-------------------------------------------------------------------------------- +Andrew Lim, Societe Generale Cross Asset Research - Equity Analyst [83] +-------------------------------------------------------------------------------- + + What I've got difficulty understanding is why a past movement in your long rates should affect your future guidance going forward. So if I think about it hypothetically, let's say the yield curve did actually go up by 100 basis point shock in the fourth quarter, then your guidance going forward would actually be 0, based on the way you view it. Is that the way to think about it? Or am I missing it? + +-------------------------------------------------------------------------------- +Brian T. Moynihan, Bank of America Corporation - Chairman, CEO and President [84] +-------------------------------------------------------------------------------- + + No, I think you have to go back. If you look -- you can follow up with Lee afterwards, but if we think about what we told you in the fourth quarter, from the third to the fourth quarter, I think you may be off a quarter. From the third to the fourth quarter, what we said is you basically capitalize into the earnings run rate that $2 billion difference, is now in the earnings run rate. And that's what you're actually seeing. And that's a benefit of the lift in rates, the special on the short-term side. And so that is relatively stable now because the -- that piece went through it. So Lee can follow up with you and take you through sort of the calculation. But it's because -- the good news is it showed up in earnings this quarter as we said it would. + +-------------------------------------------------------------------------------- +Andrew Lim, Societe Generale Cross Asset Research - Equity Analyst [85] +-------------------------------------------------------------------------------- + + No, absolutely. I can see that. Just trying to see how that moves depending on the shape of the -- the shift in the curve. + +-------------------------------------------------------------------------------- +Brian T. Moynihan, Bank of America Corporation - Chairman, CEO and President [86] +-------------------------------------------------------------------------------- + + Well, because the future investment rate on the long-term rates as it comes down, as the earlier caller talked about, affects our yields on our securities portfolio going forward as we reinvest $20 billion-plus a quarter. So let's -- I'll get Lee to call you afterwards, he can take you through that. + +-------------------------------------------------------------------------------- +Operator [87] +-------------------------------------------------------------------------------- + + And we have no further questions at this time. I'd like to turn it over to Mr. Moynihan for any closing remarks. + +-------------------------------------------------------------------------------- +Brian T. Moynihan, Bank of America Corporation - Chairman, CEO and President [88] +-------------------------------------------------------------------------------- + + Well, thank you, all of you, for your time. Just to remind you, this is a quarter where we showed our responsible growth coming through. Revenue growth of 7%, flat expenses, 700 basis points of operating leverage across our franchise, good client growth in each of the business. And our asset quality remains strong. So we look forward to talking to you next quarter. Thank you for your time and attention. + +-------------------------------------------------------------------------------- +Operator [89] +-------------------------------------------------------------------------------- + + This conclude today's call. You may disconnect at any time and have a wonderful day. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/exam/original-files/Problem_1_Sample/2017-Apr-27-AMZN.OQ-139668306179-Transcript.txt b/exam/original-files/Problem_1_Sample/2017-Apr-27-AMZN.OQ-139668306179-Transcript.txt new file mode 100644 index 0000000..e25e7f6 --- /dev/null +++ b/exam/original-files/Problem_1_Sample/2017-Apr-27-AMZN.OQ-139668306179-Transcript.txt @@ -0,0 +1,418 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q1 2017 Amazon.com Inc Earnings Call +04/27/2017 05:30 PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Brian T. Olsavsky + Amazon.com, Inc. - CFO and SVP + * Darin Manney + Amazon.com, Inc. - Head of IR + +================================================================================ +Conference Call Participiants +================================================================================ + + * Heath P. Terry + Goldman Sachs Group Inc., Research Division - MD + * Ronald V. Josey + JMP Securities LLC, Research Division - MD and Senior Research Analyst + * Stephen D. Ju + Credit Suisse AG, Research Division - Director + * Eric James Sheridan + UBS Investment Bank, Research Division - MD and Equity Research Internet Analyst + * Gregory Scott Melich + Evercore ISI, Research Division - Senior MD, Head of Consumer Research Team and Senior Equity Research Analyst + * Jason Stuart Helfstein + Oppenheimer & Co. Inc., Research Division - MD and Senior Internet Analyst + * Daniel Salmon + BMO Capital Markets Equity Research - Media and Internet Analyst + * Justin Post + BofA Merrill Lynch, Research Division - MD + * Brian Thomas Nowak + Morgan Stanley, Research Division - Research Analyst + * Douglas Till Anmuth + JP Morgan Chase & Co, Research Division - MD + * Mark S. Mahaney + RBC Capital Markets, LLC, Research Division - MD and Analyst + * Colin Alan Sebastian + Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst + * Mark Alan May + Citigroup Inc, Research Division - Director and Senior Analyst + * Scott W. Devitt + Stifel, Nicolaus & Company, Incorporated, Research Division - MD + +================================================================================ +Presentation +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Thank you for standing by. Good day, everyone, and welcome to the Amazon.com Q1 2017 Financial Results Teleconference. (Operator Instructions) Today's call is being recorded. For opening remarks, I'll be turning the call over to the Director of Investor Relations, Darin Manney. Please go ahead. + +-------------------------------------------------------------------------------- +Darin Manney, Amazon.com, Inc. - Head of IR [2] +-------------------------------------------------------------------------------- + + Hello, and welcome to our Q1 2017 financial results conference call. Joining us today to answer your questions is Brian Olsavsky, our CFO. +As you listen to today's conference call, we encourage you to have our press release in front of you, which includes our financial results as well as metrics and commentary on the quarter. Please note, unless otherwise stated, all comparisons in this call will be against our results for the comparable period of 2016. +Our comments and responses to your questions reflect management's views as of today, April 27, 2017, only and will include forward-looking statements. Actual results may differ materially. Additional information about factors that could potentially impact our financial results is included in today's press release and our filings with the SEC, including in our most recent annual report on Form 10-K and subsequent filings. +During this call, we may discuss certain non-GAAP financial measures. In our press release, slides accompanying this webcast and our filings with the SEC, each of which is posted on our IR website, you will find additional disclosures regarding these non-GAAP measures, including reconciliations of these measures with comparable GAAP measures. +Our guidance incorporates the order trends that we've seen to date and what we believe today to be appropriate assumptions. Our results are inherently unpredictable and may be materially affected by many factors, including fluctuations in foreign exchange rates; changes in global economic conditions and customer spending; world event; the rate of growth of the Internet, online commerce and cloud services; and the various factors detailed in our filings with the SEC. Our guidance also assumes, among other things, that we don't conclude any additional business acquisitions, investments, restructurings or legal settlements. It's not possible to accurately predict demand for our goods and services, and therefore our actual results could differ materially from our guidance. +Before moving to Q&A, I would like to draw attention to a new accounting rule that we implemented in Q1. The new rule requires excess tax benefits from stock-based compensation to be presented as an operating activity in the consolidated statements of cash flows. We retrospectively adjusted our consolidated statements of cash flows to reclassify excess tax benefits from financing activities to operating activities. And as a result, you will see an increase in our free cash flow measures for prior periods. +Additionally, beginning January 1, 2017, the excess tax benefit or deficiency for stock-based compensation is recognized as a component of tax expense rather than equity. This change resulted in a decrease to our tax expense for the quarter and a corresponding increase to our net income and earnings per share. Specific changes are presented in the footnotes to the consolidated statement of cash flows and related metrics provided in our press release. Further disclosure of the impact of the adoption of this accounting change can be found in our Form 10-Q. +With that, we'll move to Q&A. Operator, please remind our listeners how to initiate a question. + + +================================================================================ +Questions and Answers +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) Our first question comes from Justin Post with Merrill Lynch. + +-------------------------------------------------------------------------------- +Justin Post, BofA Merrill Lynch, Research Division - MD [2] +-------------------------------------------------------------------------------- + + Got it. Saw on the front pages of release you're really focused on India. Can you give us a progress update on how you're doing? Any thoughts on how far you're willing to take the investment levels there? And what are your thoughts on maybe when international margins can start to make progress? + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - CFO and SVP [3] +-------------------------------------------------------------------------------- + + Sure, Justin. Thank you. Yes, I think Jeff's comments were pretty dead on. The launch of Prime last year was a big turning point. We've increased Prime selection by 75% since launching that 9 months ago in India, also increased the fulfillment capacity for sellers by 26% this year. On the content side, we've announced 18 Indian Original TV series, and we're customizing the content. So it's a really vast selection of local and global movies and TV shows that are available to the Indian public. You'll also notice that the Fire TV Stick was -- the new version of it was launched in India with some important features there, such as the ability to search in Hindi and in English, free data usage for 3 months and also data monitoring, which is important there. So we're -- again, we continue to be encouraged by both the response from customers and sellers. As far as level of investment is concerned, it is certainly one of our important investment areas. We see a lot of potential for the country and our business there. + +-------------------------------------------------------------------------------- +Justin Post, BofA Merrill Lynch, Research Division - MD [4] +-------------------------------------------------------------------------------- + + Any thoughts on how much this is impacting your international profitability? + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - CFO and SVP [5] +-------------------------------------------------------------------------------- + + Sure. I can't quantify it, but -- or break out specifically, but I will say it's a large factor as well as a couple other things in the international segment. So keep in mind that we launched Prime Video in the fourth quarter, and now we have that in over 200 countries and territories. We're spreading a lot of the Prime benefits that we've seen in North America to other countries. We just opened up AmazonFresh in Tokyo last weekend, but also Prime Now. You saw other things like our business -- B2B business just opened up in the U.K. We have Amazon devices. So there's a lot of moving parts here. The other big influence is the same trends are happening in international with respect to FBA growth and the fact that our Amazon fulfilled network or the units we shipped are growing at much faster clip than our paid unit growth. Last year, we said that was a 40% -- nearly 40% growth worldwide, so we're making the investments in warehouses, fulfillment capacity and delivery capacity to handle that. So there's a lot going on in international. We are very encouraged with the growth of the Prime program, and we're hopeful for the Prime Video that we launched in the fall. + +-------------------------------------------------------------------------------- +Operator [6] +-------------------------------------------------------------------------------- + + Our next question comes from Mark Mahaney with RBC Capital Markets. + +-------------------------------------------------------------------------------- +Mark S. Mahaney, RBC Capital Markets, LLC, Research Division - MD and Analyst [7] +-------------------------------------------------------------------------------- + + Okay. 2 questions. The North American operating margins seem to come down like 70 bps year-over-year, and I know it's not a big focus of you, the margins. I get that, but it's sort of a change. You've had margins be flat or up year-over-year for quite some time and now they dip down. Just could you explain that? And then secondly, on these -- on the Echo devices, the Echo family, Alexa devices that are coming out, could you comment at all about what kind of impact you're seeing in terms of increased wallet or per share within household? Are you seeing that have an impact in terms of Amazon customers more likely to spend more once they have these devices in particular categories like groceries or household products, Pantry, products that they're more likely to spend because they have these devices in their houses, in their kitchens, in their living rooms? + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - CFO and SVP [8] +-------------------------------------------------------------------------------- + + Sure, Mark. Let me start with the Echo question first. So yes, we're very encouraged by the customer response to the Echo products. Not only the Echo products, but the ability to use tablets -- our tablets now as Echo devices since we've spread the Alexa technology to many of those devices. And we're also happy with the success we've had with developers. There's over now over 12,000 Alexa skills. So we think that's all foundational. The monetization, as you might call it, is -- the theme of your questions, that's not our primary issue right now. It's about building great products and delighting customers. We think as engagement -- as we pick up engagement with the devices, it helps the engagement with Amazon as a whole. So whether someone is ordering off their Alexa device or whether they're going to their phone or going to their computer, it all has the same effect for us. So very, very pleased with the initial progress. We see a lot of momentum there, and we continue to invest. And that's one of the answers to your second question on North America operating margin. So if I step back, let me just talk generally about investment. So right now we're just seeing a lot of great opportunities before us, and we're continuing to ramp up the investments in pursuit of those opportunities. And the big picture is, again, as we've said, customers -- we want the things that customers love, can grow to be large, will have strong financial returns and they're durable and can last for decades. So in that category and some of the things that we are investing the most in are, as you say, the Echo and Alexa devices. We're doubling down on that investment, video content and marketing, not only in the U.S. but globally with the launch of our Prime Video in the fall. So we're building global scale in that business in both content and marketing. As I said earlier, we're expanding Prime benefits in the U.S. and also globally, things like Prime Music, Prime Now, AmazonFresh, all expanding globally. And we've launched Prime in India, China and Mexico. I know I'm drifting a bit from North America, but it's all part of the same theme. We also have this trend going on in our fulfillment networks where strong FBA growth and high growth in Amazon fulfilled units is resulting in a large increase in fulfillment capacity. We're also investing in new technologies, such as artificial intelligence, machine learning. You're starting to see some of that show up in things like Amazon Go, our beta store that we've developed in Seattle; drones. We use those technologies a lot in our internal businesses, and we're also developing services for AWS customers. So -- and that's -- of course, another area as AWS continues to grow and add services and features and doing so at an accelerating rate. So there's a long list and I can keep going, but I think the general theme is we're -- there's a lot of investment in front of us that we're optimistic about and we continue to ramp those investments. In North America, that manifests itself mostly in the device area, the content area and also the expansion of the fulfillment networks. + +-------------------------------------------------------------------------------- +Operator [9] +-------------------------------------------------------------------------------- + + Our next question comes from Brian Nowak with Morgan Stanley. + +-------------------------------------------------------------------------------- +Brian Thomas Nowak, Morgan Stanley, Research Division - Research Analyst [10] +-------------------------------------------------------------------------------- + + I have 2. Just the first one, Amazon always has a pretty big focus on efficiency. So I'd be curious to talk -- if you could talk about examples or areas where you've been able to iron out inefficiencies in the fulfillment process. And there's -- any still existing examples where you see low-hanging fruit to really improve fulfillment efficiency? And then just back to the point on investment, you didn't mention brick-and-mortar at all, yet there's been a lot of mention in the press about Amazon brick-and-mortar. I guess I'd be curious to hear how you think about the importance of an Amazon brick-and-mortar presence and how that fits into the long-term strategy. + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - CFO and SVP [11] +-------------------------------------------------------------------------------- + + Sure thing. So particularly as it pertains to our fulfillment center networks, I think the biggest areas of efficiency right now are in our Amazon robotics areas. That technology continues to improve, and we've -- we're now multiple generations down. We just launched a Amazon robotics fulfillment center in the Tokyo area recently. And so toward that last month, and it's just amazing to see the strides that the Amazon robotics has taken and the efficiency we're getting in our warehouse as a result. The other efficiencies we're seeing are network efficiencies, especially as we had things like sort centers. It's a collaboration and a movement between warehouses and sort centers and then to the end customer. The ability to have control through our sort centers has allowed us over the last few years to cut off our -- to extend our cut off times from 3 p.m., in most cases, till midnight. So greater control of our processes. If we do it cost-effectively, it can also have favorable benefits both for our warehouse flow and also for our customers and their ordering pattern. So there's a lot of efficiencies that are going on day-to-day around here. One of the benefits of rapid growth and -- is the ability to create leverage on purchases and a lot of the processes that we run. So your second question was on stores. Yes, yes, I think you're seeing the expansion of our bookstores. We have 6 bookstores right now, and we've announced another 6. The Amazon Go is in beta in Seattle. And while that's not large and it's only one site, we're excited about the potential there and the use of the technologies of computer vision, sensor fusion and deep learning. We think that has a lot of potential. Again, it's only one location. That's still in beta. But along with the bookstores, we also have -- you'll see us in pop-up stores and college pickup points. So for us, it's another way to reach the customer and test what resonates with them, and we're pleased with the results. + +-------------------------------------------------------------------------------- +Operator [12] +-------------------------------------------------------------------------------- + + Our next question comes from Ron Josey with JMP Securities. + +-------------------------------------------------------------------------------- +Ronald V. Josey, JMP Securities LLC, Research Division - MD and Senior Research Analyst [13] +-------------------------------------------------------------------------------- + + Brian, I think you mentioned accelerating growth within AWS on new products, and last year you added about 1,000. Can you just talk about maybe the plans for AWS and product growth going forward here in 2017 and the focus on innovation? + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - CFO and SVP [14] +-------------------------------------------------------------------------------- + + Sure. Yes, we haven't updated that number, but suffice to say, the innovation pace continues to accelerate. We are very proud of the launches in Q4: the Amazon Connect, which we think will provide customer service-like capability to customers; and Amazon Chime, which we also believe will resonate with customers. We've had a lot of adoption of our new services. We've got customers migrated more than 23,000 databases using the AWS data -- database migration service since that launched last year. And just generally, we continue to expand geographically. We've announced additional Availability Zones and regions worldwide. So again, we signed a number of big customers. I guess I would point out in the quarter Liberty Mutual, Snap and Live Nation, all starting relationships with us or expanding their current relationship. We're now over $14 billion run rate, but we're happy with the business and the team. And again, for us innovation is going to be key as we move forward. + +-------------------------------------------------------------------------------- +Operator [15] +-------------------------------------------------------------------------------- + + Our next question comes from Dan Salmon with BMO Capital Markets. + +-------------------------------------------------------------------------------- +Daniel Salmon, BMO Capital Markets Equity Research - Media and Internet Analyst [16] +-------------------------------------------------------------------------------- + + Brian, a couple questions about your growing advertising business. We see more and more of it appearing on the site, and I was interested to hear a little bit more about how you expect that business to roll out internationally. I think it's largely U.S.-based today, but be curious to hear about that. And then second, I think it's fairly obvious what someone selling within the Amazon ecosystem would be interested in promoting on the platform. But maybe tell us a little bit about maybe over the long term, there are opportunities for sort of non-endemic advertisers within your platform. + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - CFO and SVP [17] +-------------------------------------------------------------------------------- + + Sure. Yes, we're -- it's pretty early in the days with advertising, but we're very pleased with the team we have and the results. Our goal is to help -- is to be helpful to consumers and enhance their shopping or their viewing experience with targeted recommendations, and we think a lot of the information we have and preferences of customers and recommendations help us do that for customers. We have -- Sponsored Products is off to a great start, and it's a very effective way for advertisers to reach those especially interested customers. While you're on the topic of advertising, I thought I'd point out that in other revenue -- advertising is in other revenue, as is co-branded credit card agreements and also some other advertising services. That decelerated from 99% to -- in Q4 to 58% in Q1, but the fluctuation and the volatility was essentially in the co-branded credit card agreements and the other services, which can fluctuate quarter-to-quarter based on contract terms and that's what happened. Advertising was -- remains strong and was consistent growth with Q4. + +-------------------------------------------------------------------------------- +Operator [18] +-------------------------------------------------------------------------------- + + Our next question comes from Stephen Ju with Credit Suisse. + +-------------------------------------------------------------------------------- +Stephen D. Ju, Credit Suisse AG, Research Division - Director [19] +-------------------------------------------------------------------------------- + + So you periodically disclosed usage growth for AWS, but it has been some time since we saw one. So we're wondering if you can update us in terms of where you are now. If not, I mean, should we think about the growth in your cash deployment as an indicator of the ongoing growth? + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - CFO and SVP [20] +-------------------------------------------------------------------------------- + + Yes, sorry, I don't have a usage number to share with you today. If it'll help, I will tell you that, again, we're now over $14 billion run rate. You clearly see our -- we break out very clearly our AWS segment revenue and operating income. And you'll also keep in mind that there's price decreases that are part of the business, and we're pretty public when we do those. And if you remember last call, I mentioned that we had 7 price increase -- or excuse me, price decreases that were timed for December 1. So about 1/3 of the impact of those was seen in Q4 and then, again, that's one element of the sequential operating margin. But in general, we're very happy with that team and the progress they're making. And we're deploying more capital, as you can see, to support the usage growth. + +-------------------------------------------------------------------------------- +Operator [21] +-------------------------------------------------------------------------------- + + Our next question comes from Douglas Anmuth with JPMorgan. + +-------------------------------------------------------------------------------- +Douglas Till Anmuth, JP Morgan Chase & Co, Research Division - MD [22] +-------------------------------------------------------------------------------- + + I just want to ask you about CapEx. It looks like CapEx, including leases, more than doubled year-over-year. So I know you listed kind of a long list of the many investment opportunities here, but can you just point out anything else in particular that drove the pretty substantial increase there? + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - CFO and SVP [23] +-------------------------------------------------------------------------------- + + Sure. Yes, CapEx, which is principally the fulfillment centers, was -- grew 51% year-over-year. As you'll remember, we added 26 warehouses last -- fulfillment centers last year, 23 in the second half of the year. Some of that cost of startup is before the startup. Some comes in a quarter afterwards. So there was some carryover from that. But generally, the biggest trend here is that the difference -- differential between Amazon fulfilled network unit growth and paid unit growth. So that nearly 40% growth in Amazon fulfilled units last year and the continuation of the strong growth higher than the paid unit growth that we see in 2017 is resulting in a lot of fulfillment center capacity. And the fulfillment centers, I will also say, with the robotics technology tend to be more capital intensive than prior versions of warehouses and then they're -- generally have much better operating efficiencies and variable costs following their start up. On the capital leases, as grew 45%. A good deal of that is tied to the AWS business. As I just mentioned, a lot of that's tied to unit -- excuse me -- usage growth. But I'll caution, CapEx can fluctuate quarter-to-quarter. And if you look back to last year, the trailing 12 months was only 7% growth from the quarters through Q1 of last year. So certainly, there was a bigger step up in 2016, now carrying into 2017. + +-------------------------------------------------------------------------------- +Operator [24] +-------------------------------------------------------------------------------- + + Our next question comes from Mark May with Citi. + +-------------------------------------------------------------------------------- +Mark Alan May, Citigroup Inc, Research Division - Director and Senior Analyst [25] +-------------------------------------------------------------------------------- + + I know that we talked about over the last couple quarters that part of the step up in CapEx was to catch up from the underinvestment in '15. Just curious if you'd say -- have you made a lot of progress in terms of catching up with some of the fulfillment needs that you saw necessary in the business at the beginning of last year? And then I know you just said that you're -- it still is early days in terms of advertising. But there's a perception out there that over the last year or so, that the company has sort of really begun to focus more on this business opportunity. Has something really changed at the business in the last year? And do you see advertising becoming a more meaningful part of the business over the near to midterm, I guess? + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - CFO and SVP [26] +-------------------------------------------------------------------------------- + + Sure. Let me start with advertising. So yes, I think scale is helping. We have great teams working on advertising for a while now. Our scale in number of customers, number of clicks, number of eyeballs and new content -- or excuse me, video content and other opportunities for advertising has really helped create some scale in that business. So we're very happy. I can't project it forward, but we're happy with the growth there. I think the Sponsored Products was a very inventive move for us, and I think that is having some really good impact on advertising growth. On your second point about fulfillment capacity, here's how I'd generally -- I'd generalize it. We -- in Q4 of 2015, we were pretty vocal, or pretty transparent anyway, that we ran out of space in Q4, especially due to some very strong demand for FBA space and services. Last year, we changed some of our incentives to -- and worked with FBA merchants to try and have their throughput to our FCs, particularly in Q4. That, combined with the step up in fulfillment centers that I mentioned, the 26 new ones, left us in a really good position. We had a very clean holiday, and we think it worked well for both customers, Amazon and also for sellers, especially for FBA sellers. So yes, that leaves us now continuing to grow internationally as well because we continue to see strong FBA adoption, and it's a big part of our business, and it's a big part of our value with the additional Prime eligible ASINs that FBA provides. So again, it's -- they're self-reinforcing, the FBA program and also our Prime program. Prime program attracts more people to Amazon, and they buy more, including FBA products. And conversely, more FBA products in our warehouses helps our in stock of things that people want to buy, Prime eligible in stock, and that helps reinforce the Prime program. + +-------------------------------------------------------------------------------- +Operator [27] +-------------------------------------------------------------------------------- + + Our next question comes from Heath Terry with Goldman Sachs. + +-------------------------------------------------------------------------------- +Heath P. Terry, Goldman Sachs Group Inc., Research Division - MD [28] +-------------------------------------------------------------------------------- + + Wondering if you could give us a sense of how we should think about the increase in unearned revenue. Obviously this quarter, the biggest increase that you've seen from at least from a dollar perspective. What does that say about the way customers are changing in the behavior in the AWS business? How should we think about the way that, that might be impacting pricing mix, near-term growth? + +-------------------------------------------------------------------------------- +Darin Manney, Amazon.com, Inc. - Head of IR [29] +-------------------------------------------------------------------------------- + + Heath, this is Darin. Yes, on the deferred revenue balances, as we've said in the past, the primary drivers of that increase are both the activity that we're seeing with our AWS customers and the purchase of Reserved Instances and prepaid credits for their account as well as Prime member purchases. We're not breaking out the specific growth rates for Prime. But certainly, we like what we see in terms of the growth, and it's been consistent with what we've seen over the last quarter or so. Certainly, part of that increase in deferred balances is related to Reserved Instances as customers get more comfortable and begin to put more sustained workloads into the AWS services. Through buying RIs, they're able to get fairly significant discounts on their usage. And so we like that model, customers certainly like that model and collecting that through deferred revenue and then letting customers use that over time is very helpful. + +-------------------------------------------------------------------------------- +Operator [30] +-------------------------------------------------------------------------------- + + Our next question comes from Colin Sebastian with Robert W. Baird. + +-------------------------------------------------------------------------------- +Colin Alan Sebastian, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [31] +-------------------------------------------------------------------------------- + + Question on the transportation and logistics initiatives and, in particular, if you could share any of the facts or learnings thus far with air cargo. In particular, what kind of performance or cost efficiencies that you may be realizing or expect to realize from this effort. + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - CFO and SVP [32] +-------------------------------------------------------------------------------- + + Sure, Colin. As you pointed out, we're -- we've expanded our own fleet. We now have 18 planes in service for Amazon, and we've announced rights to lease up to 40 planes. So it's gone very well. The ability to control shipments within our network has gone up, and we think the cost is very good. So on that front, it's better control -- better capacity control and especially search capacity and also good costs. So we have great relationships with third-party carriers. We will continue to, and we value all of our partner relationships as we develop our own capability, particularly in intra-network. We're putting it to good use, as I mentioned before, with the sortation center example. + +-------------------------------------------------------------------------------- +Operator [33] +-------------------------------------------------------------------------------- + + Our next question comes from Scott Devitt with Stifel. + +-------------------------------------------------------------------------------- +Scott W. Devitt, Stifel, Nicolaus & Company, Incorporated, Research Division - MD [34] +-------------------------------------------------------------------------------- + + I was wondering if you could talk a little bit about where you are in terms of investment and capabilities in India at this point and how you think about that market longer term. And then secondly, also if you could just comment on the limitations and your willingness to invest more throughout LatAm, the way you have more recently in markets like China and India. And if I could, just finally, you've previously discussed satisfaction with the measurements of success for the video product in terms of consumer engagement and the effects on Prime. I was just wondering if you could comment on whether these metrics are continuing to improve as spending continues to rise on video and consumer awareness is seemingly growing as well. + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - CFO and SVP [35] +-------------------------------------------------------------------------------- + + Let me start with your middle question. I think it was about Latin America growth. Let me step back and talk about international growth in general. So it -- our approach varies by country. If you look historically, we've taken multiple approaches. So in China, we bought an existing business, Joyo.com, and built off that base. In India, we started from scratch and have built a lot of things ourselves. And it's always going to depend on the country, the dynamics in that country both for retail, for online and for foreign investment. But a real key factor in all of this generally is management bandwidth as well. So we pick our spots carefully. You'll see -- you heard in the quarter that we've announced the intention to buy Souq in the Middle East. Where does that fit into the strategy? Well, Souq is a pioneered e-commerce in the Middle East, and they're creating great shipping experience for the customers and their multiple countries and they're doing a great job. So we see this as an example where we can learn from them and also support their efforts with our Amazon technology and global resources. So we -- we are in Mexico, but we're not in other parts of Latin America. We're -- we have a business in Brazil, but other countries will take on a case-by-case basis, again, bounded by what our management bandwidth can support and prioritization versus other things. You obviously heard my long list of investments. All of those are pretty much gated by the need for people and software engineers and strong teams to approach them. So international expansion gets played off in the same prioritization that other efforts do. + +-------------------------------------------------------------------------------- +Operator [36] +-------------------------------------------------------------------------------- + + Our next question comes from Jason Helfstein with Oppenheimer & Co. + +-------------------------------------------------------------------------------- +Jason Stuart Helfstein, Oppenheimer & Co. Inc., Research Division - MD and Senior Internet Analyst [37] +-------------------------------------------------------------------------------- + + So is there -- just an accounting housekeeping, a way to think about stock-based comp. You guys aren't providing that by segment anymore, but the rates of growth kind of differed by the businesses. And so is there just a way to think about, a, will that be in the Q, or are you not disclosing anymore? And is there a way to think about would, I guess, the patterns be consistent with historical patterns by segment? + +-------------------------------------------------------------------------------- +Darin Manney, Amazon.com, Inc. - Head of IR [38] +-------------------------------------------------------------------------------- + + Jason, this is Darin. We, a number of quarters back, started breaking out stock-based compensation by segment, and now we've collapsed that in our op income by segment. So it's definitely in there. We do provide some disclosure by P&L line item on a consolidated basis that helps you identify that stock-based compensation expense in total, and you'll see the trend analysis in the metrics at the back of the press release. + +-------------------------------------------------------------------------------- +Operator [39] +-------------------------------------------------------------------------------- + + Our next question comes from Eric Sheridan with UBS. + +-------------------------------------------------------------------------------- +Eric James Sheridan, UBS Investment Bank, Research Division - MD and Equity Research Internet Analyst [40] +-------------------------------------------------------------------------------- + + Maybe I could take 2 away from the press release just to understand a little bit of the quarter-over-quarter cadence. The retail subscription services, that's a pretty big jump up in the growth rate year-on-year in Q1 versus Q4. I think that might be Prime memberships had come on to paid from trial, but just want to understand what maybe what some of the driver was of that quarter-over-quarter in terms of the growth rate. And net shipping costs actually grew at the slowest rate by our count in a couple years. It looks like you're starting to get some improvements there in terms of revenue over costs on the shipping line. I just wanted to know what that was in terms of what's driving that, and can we expect that to possibly continue. + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - CFO and SVP [41] +-------------------------------------------------------------------------------- + + Sure. Let me start with the retail subscription services revenue. So there's multiple things in that category, the largest is Prime membership fees, but also other subscription services like audiobooks, e-books, digital video, digital music and other subscription services. So you're right, there was an acceleration. Much like the comment I had on advertising and the other revenue category, the Prime membership growth rates for Q1 and Q4 last year are relatively consistent. So the volatility is in those other items. So I'm not quantifying the Prime membership or commenting on the growth rates other than to say it's been very strong and Q4 strength has continued into Q1. Your comment on shipping costs, yes, that is going to -- that was a lower unit volume as well. But generally, costs are going to be a combination of the tailwind -- the headwinds obviously are going to be FBA growth and shipping more products ourselves and this expansion of our Prime program and the demand for products from our Prime customers. And demand's been great. Again, there's over 50 million items that people can get delivered to their doorstep within 2 days or, in some cases, next day or same day. So it's going to be a big part of our cost structure, but it's an investment we work hard to reduce as far as rates and we're glad to spend it to support our Prime program. + +-------------------------------------------------------------------------------- +Operator [42] +-------------------------------------------------------------------------------- + + And our final question will come from Greg Melich with Evercore ISI. + +-------------------------------------------------------------------------------- +Gregory Scott Melich, Evercore ISI, Research Division - Senior MD, Head of Consumer Research Team and Senior Equity Research Analyst [43] +-------------------------------------------------------------------------------- + + I have a follow-up and then a new question. The follow-up is would love an update. You talked about the fulfillment centers, but could you update us on where we are in terms of rolling out Prime Now facilities and sorting centers -- just a count? And if you feel that's an area to really ramp-up investment this year, or what you got last year is sort of what you need. + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - CFO and SVP [44] +-------------------------------------------------------------------------------- + + Sure. I'm sorry, you said Prime Now. And what was the other thing? + +-------------------------------------------------------------------------------- +Gregory Scott Melich, Evercore ISI, Research Division - Senior MD, Head of Consumer Research Team and Senior Equity Research Analyst [45] +-------------------------------------------------------------------------------- + + And the sorting centers. + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - CFO and SVP [46] +-------------------------------------------------------------------------------- + + Sort centers, right. Well, I don't have updated numbers for you, but the Prime Now is available in more than 45 cities across 8 countries. The same day is available in 30 cities in the U.S. So that's a bit on the quantification of those. I can't tell you much more on sort centers. + +-------------------------------------------------------------------------------- +Gregory Scott Melich, Evercore ISI, Research Division - Senior MD, Head of Consumer Research Team and Senior Equity Research Analyst [47] +-------------------------------------------------------------------------------- + + But when you think about building out the capacity, it sounds like last year you had that big surge in fulfillment centers. There isn't a similar surge about to happen this year on some of those other areas? + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - CFO and SVP [48] +-------------------------------------------------------------------------------- + + Yes, I can't project that. We're still growing that, and we're happy with the progress in Prime Now and the service that -- the value it creates for Prime customers. And as I said, we've expanded internationally, which is a big goal of ours as well. So we will continue to grow that. I can't quantify it for you right now. The other similar-like facility metric you might want is AmazonFresh is now in 21 metro areas in the U.S. as well as London and Tokyo. + +-------------------------------------------------------------------------------- +Darin Manney, Amazon.com, Inc. - Head of IR [49] +-------------------------------------------------------------------------------- + + Thank you for joining us on our call today and for your questions. A replay will be available on our Investor Relations website at least through the end of the quarter. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/exam/original-files/Problem_1_Sample/2017-Feb-01-FB.OQ-140831484304-Transcript.txt b/exam/original-files/Problem_1_Sample/2017-Feb-01-FB.OQ-140831484304-Transcript.txt new file mode 100644 index 0000000..6c2dbcf --- /dev/null +++ b/exam/original-files/Problem_1_Sample/2017-Feb-01-FB.OQ-140831484304-Transcript.txt @@ -0,0 +1,611 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q4 2016 Facebook Inc Earnings Call +02/01/2017 05:00 PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Deborah Crawford + Facebook Inc. - VP of IR + * Dave Wehner + Facebook Inc. - CFO + * Sheryl Sandberg + Facebook Inc. - COO + * Mark Zuckerberg + Facebook Inc. - CEO + +================================================================================ +Conference Call Participiants +================================================================================ + + * Ken Sena + Evercore ISI - Analyst + * Heather Bellini + Goldman Sachs - Analyst + * Anthony DiClemente + Nomura Instinet - Analyst + * Brian Fitzgerald + Jefferies LLC - Analyst + * Scott Devitt + Stifel Nicolaus - Analyst + * Justin Post + BofA Merrill Lynch - Analyst + * Peter Stabler + Wells Fargo Securities - Analyst + * Doug Anmuth + JPMorgan - Analyst + * John Blackledge + Cowen and Company - Analyst + * Eric Sheridan + UBS - Analyst + * Mark Mahaney + RBC Capital Markets - Analyst + * Brian Nowak + Morgan Stanley - Analyst + * Mark May + Citigroup - Analyst + +================================================================================ +Presentation +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Good afternoon. My name is Mike, and I will be your conference operator today. At this time, I would like to welcome everyone to the Facebook fourth quarter and full year 2016 earnings call. +(Operator Instructions) +This call will be recorded. Thank you very much. Ms. Deborah Crawford, Facebook's Vice President of Investor Relations, you may begin. + +-------------------------------------------------------------------------------- +Deborah Crawford, Facebook Inc. - VP of IR [2] +-------------------------------------------------------------------------------- + + Thank you. Good afternoon, and welcome to Facebook's fourth quarter and full year 2016 earnings conference call. Joining me today to discuss our results are Mark Zuckerberg, CEO, Sheryl Sandberg, COO, and Dave Wehner, CFO. +Before we get started, I would like to take this opportunity to remind you that our remarks today will include forward-looking statements. Actual results may differ materially from those contemplated by these forward-looking statements. Factors that could cause these results to differ materially are set forth in today's press release, and in our quarterly report on Form 10-Q filed with the SEC. Any forward-looking statements that we make on this call are based on assumptions as of today, and we undertake no obligation to update these statements as a result of new information or future events. +During this call, we may present both GAAP and non-GAAP financial measures. A reconciliation of GAAP to non-GAAP measures is included in today's earnings press release. The press release and an accompanying investor presentation are available on our website at investor.fb.com. And now I'd like to turn the call over to Mark. + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook Inc. - CEO [3] +-------------------------------------------------------------------------------- + + Thanks, Deborah, and thanks everyone for joining today. This was another good quarter, and a good end to 2016. Our community continues to grow, and now with nearly 1.9 billion people using Facebook every month, and more than 1.2 billion people using it every day. We've seen continued growth in engagement on our platform, and our ad business is doing well too. Total revenue grew by 51% year-over-year to $8.8 billion, and advertising revenue is up 53% to $8.6 billion. +Facebook stands for connecting people, and creating a global community, [in] 2016, more people than ever made their voices heard. We saw billions of conversations about everything from important elections, to the Olympics, to breaking news stories around the world. And more people are taking advantage of new tools to connect and share on our family of apps, especially with video. +2016 was also a year that reinforced the importance of connecting the world. Today is the five year anniversary of the day we filed to go public. In our letter to potential shareholders I wrote that, there's a huge need and a huge opportunity to get everyone in the world connected, to give everyone a voice, and to help transform society for the future. I believe that now more than ever, and as the largest global community, I see our responsibility as very important, and we'll continue to focus on doing everything we can to bring the world closer together. +I want to give you an update on our progress over our 3, 5 and 10 year time horizon, with a particular focus on what we're going to be doing over the next few years. I said before that I see video as a mega trend, on the same order as mobile. That's why we're going to keep putting video first, across our family of apps, and making it easier for people to capture and share video in new ways. To make it easier to find and watch videos, we've added a tab at the bottom of the Facebook app, with top videos and recommendations. We've already rolled the tab out to everyone in the US, and we're planning to bring it to more countries soon. +We're also improving live video as more people use it. New Year's Eve was our biggest live moment ever, with more people going live than at any other time since we launched the product. We're experimenting with live 360 video, audio-only live for people with slower connections, and live face masks and more camera effects. And we'll have more updates. +Finally, we're looking for ways to grow the ecosystem of video content on Facebook. We want people to think of Facebook as a place for interesting and relevant video content, from professional creators as well as their friends. Last year, we started to invest in more original video content to help the seed ecosystem, and we're planning to do more in 2017. +We're also focused on building a more informed community. We see Facebook as a community, and ourselves, our role is supporting that community. We don't write the news that you read, but we want to be a place where people can access information, have meaningful conversations, and this is a responsibility that we take very seriously. +In the past, we've taken steps to reduce spam and click-bait, and now we're approaching misinformation and hoaxes the same way. In Q4, we started working with third-party fact checkers in the US to flag disputed stories, and make them less likely to appear in news. We made it easier to report and identify misinformation, and we're working to build stronger ties between Facebook and the news industry. +Our primary goal here is to do the right thing for our community. If we can help people stay informed, and make Facebook a better place to understand what's going on in the world, then we think that's going to make our community stronger, and a more positive force for good for the world. So that's the three year update. +Over the next five years, we're going to keep building ecosystems around our apps, that a lot of people are already using. Growth and engagement on Instagram has been strong. We announced in December, that Instagram now has over 600 million monthly actives, and recently passed 400 million daily active. Instagram Stories reached 150 million daily active, just five months after the launch. And we've added new features like Boomerang and Live into Stories, and I'm excited to see that continue to grow. +Our messaging services are making good progress as well. In Q4, Messenger launched a new camera, a group video chat for up to 50 people, and games. 400 million people now use voice and video chat on Messenger every month. +WhatsApp is growing quickly too. We recently reached 1.2 billion monthly active, and more than 50 billion messages are sent through WhatsApp every day. In the last quarter, we also added the ability to make video calls in the app. +Over the next 10 years, we're going to continue to invest in these platforms and technologies that give more people a voice, and make sharing even more [immersive]. Through our efforts with internet.org, we have now connected more than 50 million people to the internet. And in November, our Connectivity Lab set a world record by transmitting 20 gigabits per second over 13 kilometers using the same amount of power that it takes to light a single light bulb. +Ultimately, this technology is going to make it into the solar-powered planes that we're building to beam internet to parts of the world that aren't connected. On artificial intelligence, we developed a new technique called style transfer that uses AI to study a painting and then can take your photos and videos, and draw them in that style in real-time on your phone. And if you post on Facebook, looking for a place to eat or suggestions for where to go, we can now use AI to understand the text of your post, and understand what you're asking, and [surface] recommendations from the comment. +We're still early in our 10 year plans for virtual reality, but we've made some good progress. In December, we shipped our touch controllers, and the community response has been very positive. Samsung announced that they've now shipped more than 5 million Gear VRs, and we're bringing more social experiences to VR with apps like Oculus Rift for Gear VR. We're going to keep making big investments in VR content, and I'm excited about what's coming in 2017, from new games to more immersive educational experience. +As I said in our call last quarter, we're going to continue to invest in hire and aggressively, to help improve our product, but also to build the infrastructure that will help us grow in the future. A few weeks ago, I visited our newest data center in Fort Worth, Texas. It's going to be the biggest data center we built, powered by 100% renewable energy. And it's a great example of the investments that we're making to help us serve our community even better. +So we've made some good progress, but we have a lot more to do to help bring the world together. I want to thank our community, our teams, our partners, and all you for being a part of this journey with us. Now here's Sheryl. + +-------------------------------------------------------------------------------- +Sheryl Sandberg, Facebook Inc. - COO [4] +-------------------------------------------------------------------------------- + + Thanks, Mark, and hi, everyone. We had a strong fourth quarter, capping off a great 2016. Q4 ad revenue grew 53%. Mobile ad revenue reached $7.2 billion, up [61]% year-over-year, and was approximately 84% of total ad revenue. +Our growth this quarter was broad-based across all regions, marketer segments and verticals. We're really excited to announce today that [65] million businesses are using our free pages products, and 5 million are using Instagram business profiles. More and more of these businesses are becoming advertisers, with over 4 million advertising on Facebook, and over 500,000 on Instagram. As a result, our revenue base is becoming more diverse. +In Q4, our top 100 advertisers represented less than a quarter of our ad revenue, which is a decline from Q4 last year. We continue to focus on our three priorities, capitalizing on the shift to mobile, growing the number of marketers using our ad products, and making our ads more relevant and effective. +First, capitalizing on the shift to mobile. In Q4, we saw consumers use mobile for more of their holiday shopping. [Contour] found that mobile drove over $1 billion in total Cyber Monday sales for the first time ever. +Marketers are increasingly seeing mobile as the opportunity it is. In 2016, we saw more marketers prioritizing mobile, and especially mobile video. People consume video differently on mobile, so the best marketers are optimizing their creative. +For example, Hershey's used Facebook Live and video ads for the launch of their Cookie Layer Crunch. They optimized their video ads to grab attention in the few seconds, and used captions for people who were viewing without sound. Nielsen Brand effects measured an 11 point lift in brand awareness, and a 20 point lift in ad recall. +We are helping more businesses connect with more people on mobile, both on Facebook and off. Last month, we announced that advertisers can reach over 1 billion people a month on the audience network. +Our second priority is growing the number of marketers using our ad products. It's clear that businesses of all sizes are using our platforms to reach customers. Two weeks ago, I visited Holzconnection, a family-run furniture-maker in Berlin. +When competition increased several years ago, the owner worried that he might have to close stores. His son joined the family business, and convinced his father to market on Facebook. Holzconnection didn't change anything about their traditional craft, just the way they reached customers. +Since then, they've opened five new locations both domestic and internationally. We want to help more small businesses grow. So we invited companies including Holzonnection to participate in small business councils around the world. +We continue to invest in making our free and paid products easier to use, expanding our online tutorials, and offering creative tools for businesses of all sizes. For example, the owners of Distinctive Gardens, a gardening center in Illinois, watched one of our online tutorials, and then used their mobile phone to shoot a holiday-themed video ad, sorry, a holiday themed video. They sold out their holiday inventory. +Our third priority is making our ads more relevant and effective. Our goal is to drive value for our clients. As we grow the diversity of businesses on our platform, we've invested in building ad products that meet a broad set of objectives, from building brands, to moving product off shelves, online and in stores. To make our ad products as relevant and effective as possible, we're increasingly tailoring them by vertical. +In 2016, we invested in dynamic ads, which allow advertisers to automatically promote products from their entire catalog. We expanded dynamic ads across Facebook, Instagram, and the audience network and tailored them for verticals like travel and retail. Dynamic ads for travel enables businesses to show ads based on dates and destinations people are interested in, while dynamic ads for retail show people the products available at nearby locations in real time. +Last month we introduced dynamic ads for broad audiences to help businesses reach new customers based on their interest on Facebook and online behavior. We're going to continue to work on building effective ad products, improving the value they drive. +We know that measurement is important to building advertiser trust. Last year, we discovered several metric issues, and while no billable metrics were affected, we took action to fix the errors, and reviewed all of our metrics. We also expanded our partnership with third-parties, given the important role they play in verification. We're going to continue to invest in measurement, including third-party partnerships in the upcoming year. +We believe our strong 2016 is because of the value we drove for businesses on our platform. We're inspired by the entrepreneurs we work with, like the owners of Holzconnection and Distinctive Gardens, and we're grateful for the opportunity to help them reach customers, grow their businesses, and hire more people. +With only a small fraction of the businesses on Facebook and Instagram advertising, we know we have a lot of opportunity and hard work ahead. In 2017, we'll stay focused on helping businesses of all sizes reach customers around the world and grow. Thanks. And now here's Dave. + +-------------------------------------------------------------------------------- +Dave Wehner, Facebook Inc. - CFO [5] +-------------------------------------------------------------------------------- + + Thanks, Sheryl, and good afternoon, everyone. 2016 was another year of strong, profitable growth, and we continued to invest in building our business for the long-term. Full year 2016 revenue was $27.6 billion and grew 54%, or 56% on a constant currency basis, and we generated over $10 billion in GAAP net income. +Let's start with our community metrics. In December, 1.23 billion people used Facebook on an average day, up 189 million or 18% compared to last year. 1.86 billion people used Facebook during the month of December, up 269 million or 17% compared to last year. In addition to our ongoing internet.org and Android product efforts, we benefited from an increase in third-party promotional free data plans in Asia and the rest of world. +Mobile continues to drive our growth, with 1.15 billion people accessing Facebook on mobile on an average day in December, up 212 million or 23% compared to last year. Given that the vast majority of monthly and daily usage now occurs on mobile devices, my comments will focus on total MAU and DAU beginning next quarter, and we do not plan to include mobile and mobile-only usage breakdowns in our supplemental investor materials after this quarter. +Turning now to the financials. My prepared remarks will focus on our GAAP results unless otherwise noted. As I have noted before, we focus on GAAP results because stock-based compensation plays an important role in how employees are compensated in our business and industry more broadly, and we view it as a real expense. +Q4 total revenue was $8.8 billion, up 51%. Q4 ad revenue was $8.6 billion, up 53%, or 54% on a constant currency basis. Mobile ad revenue was $7.2 billion, up [61]% and represented approximately 84% of total ad revenue. Desktop ad revenue grew 22% despite a decline in desktop usage, helped by our efforts to limit the impact of ad blockers on advertisements served on personal computers. +The same supply and demand factors we have discussed in the past continue to drive our mobile ads revenue. On the demand side, we continued to improve our targeting, measurement and ad formats to drive strong results for marketers. As Sheryl mentioned, these efforts are working for an increasingly broad set of advertisers. +On the supply side, growth in users, time spent in ad load also contributed to our strong results. In Q4, the average price per ad increased 3%, and the total number of ad impressions served increased 49%, driven primarily by mobile feed ads on Facebook and Instagram. +Payments and other fees revenue was $180 million, down 12%. Q4 total expenses were $4.2 billion, up 29%. We ended the year with approximately 17,000 employees, up 34% compared to last year, and an increase from the 31% growth rate last quarter. Q4 operating income was $4.6 billion, representing a 52% margin. Our tax rate was 21%. +Note that our tax rate reflects our early adoption of a new accounting standard, ASU 2016-9. Under this standard, the tax benefit related to the difference between the vesting price and the grant price of our RSU is now reflected in our income tax provision, whereas previously it was reflected as an adjustment to equity. This is purely an accounting convention change, and does not change the cash taxes we pay. Excluding the impact of this new standard, our Q4 GAAP tax rate would have been approximately 26%, and in line with the guidance we provided on the Q3 call. +Net income was $3.6 billion or $1.21 per share. Full year 2016 capital expenditures were approximately $4.5 billion, up 78%, as we continue to invest to support the rapid growth of the business around the world. Over the course of 2016, we expanded four of our existing data centers, and began construction of four new data centers. +In 2016, we generated over $11.6 billion in free cash flow, and ended the year with $29.4 billion in cash and investments. Also note, that the new accounting standard changed how we present operating cash flow, and free cash flow, and the free cash flow calculation. In the past we treated the excess tax benefit as a financing cash flow item, and thus was not included in either cash flow metric. +Adoption of this standard also resulted in a retrospective adjustment to certain 2016 quarterly financial line items. For more detail on these adjustments, please refer to the supplemental earnings slide available on our investor website. +Turning now to the outlook. First, on revenue, the outlook is unchanged. Consistent with my comments on the Q3 call, we continue to expect that our ad revenue growth rate will come down meaningfully in 2017. The factors driving this expectation remain the same. We also expect that our full year 2017 payments and other fees revenue will decline, compared to full year 2016. +Second, on expenses. Consistent with what I said last quarter, we expect that 2017 will be an aggressive investment year. We saw hiring growth accelerate in Q4, and we plan to accelerate hiring further in 2017 from the 34% growth rate. In addition to headcount, we expect to increase investments in R&D, content, sales and marketing, and other areas as we execute on our near-, medium- and long-term priorities. +We expect that full year 2017 total GAAP expenses will grow 40% to 50% compared to the full year 2016. We anticipate that full year 2017 share-based compensation expenses will be in the range of $3.9 billion to $4.1 billion, approximately $1.3 billion of which is related to acquisitions, most notably WhatsApp. We also expect full year 2017 amortization expenses to be approximately $700 million to $800 million. +Accordingly, on a non-GAAP basis, we would expect total expenses to grow approximately 47% to 57% compared to the full year 2016. We anticipate our expense growth rates will increase over the course of the year. We expect our full year 2017 capital expenditures will be in the range of $7 billion to $7.5 billion, as we fund the expansion of data center capacity, and office facilities to support the continued rapid growth of our business. +Turning now to tax. At current stock prices, we expect that our full year 2017 GAAP and non-GAAP tax rates will be 1 to 2 percentage points lower than our respective 2016 tax rates. Let me note two additional factors with the new standard. First, our tax rate will vary based on stock price. And secondly, we anticipate the tax rate will start lower in Q1, and then trend up throughout the year. +Before wrapping up, as a reminder, in the fourth quarter our Board of Directors authorized a $6 billion stock repurchase program beginning in 2017, with no fixed expiration date. Our main priority is to invest aggressively to grow the business, while maintaining a strong cash position. At this time, the Company's strong balance sheet and financial performance puts us in a position to make opportunistic repurchases of our common stock from time to time, to help offset the dilution incurred through equity issuance. +To conclude, 2016 was a strong year for Facebook in terms of community growth, engagement, product innovation and the growth of our advertising business. We believe we have significant opportunities ahead of us as we invest in our mission to make the world more open and connected. With that, operator, let's open up the call for questions. + + +================================================================================ +Questions and Answers +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) +Your first question comes from the line of Doug Anmuth from JPMorgan. + +-------------------------------------------------------------------------------- +Doug Anmuth, JPMorgan - Analyst [2] +-------------------------------------------------------------------------------- + + Thanks for taking the question. Mark, it's been a couple quarters that you've talked about video first. Can you just talk about the strategic importance of longer form content? And then, also how do you think about that, in terms of distribution platforms both on the Facebook Mobile app, and then through other distribution formats as well? Thanks. + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook Inc. - CEO [3] +-------------------------------------------------------------------------------- + + We're focusing more on shorter form content to start. So the thesis that we have now, is that there are different parts of short-term content. There is the type of content that people produce socially for friends. There's promotional content that businesses and celebrities and folks will produce. +But there's also a whole class of premium content, that the creators need to get paid a good amount, in order to support the creation of that content. And we need to be able to support that with a business model which we're working on through ads to fund that. So the biggest change that I think that we're going to see, on the consumption and news feed, and in the tab over the next year or two, is going to be much more video inventory and content coming in, as we work through and make that business model start to really click for a lot of folks. +Over the longer term, I think as that works, people will experiment with longer forms of video as well, and all kinds of different things. But that I think is the primary focus for the foreseeable future. + +-------------------------------------------------------------------------------- +Dave Wehner, Facebook Inc. - CFO [4] +-------------------------------------------------------------------------------- + + Yes, Doug, I think you asked about platforms. I mean, we've always been focused on a variety of getting our services on a variety of platforms, but the main focus is obviously on mobile. + +-------------------------------------------------------------------------------- +Operator [5] +-------------------------------------------------------------------------------- + + Your next question comes from the line of Brian Nowak from Morgan Stanley. + +-------------------------------------------------------------------------------- +Brian Nowak, Morgan Stanley - Analyst [6] +-------------------------------------------------------------------------------- + + Thanks for taking my questions. I have two. The first one, Mark, is on Instagram, 400 million daily active users. Curious to be, [interesting] how you think about the core use of Instagram now, and how it differs from core Facebook? And how do you think about that evolving over time, and the monetization of Instagram evolving over time? +And then, the second one, just to go back to Doug's question on the content. I know, Dave, you mentioned content spend as being part of the investment. Should we think about the content investment being more driven on rev share, or do you see yourselves going out and writing, and doing licensing deals? Thanks so much. + +-------------------------------------------------------------------------------- +Dave Wehner, Facebook Inc. - CFO [7] +-------------------------------------------------------------------------------- + + I can start on that latter question. Our goal really is to kick start an ecosystem of partner content in the video tab, for example, and our model is really oriented towards revenue share with creators. We are funding some seed content to get the ecosystem going, but the focus is on rev share. And then, I think your question was on, how the core use case between Facebook and Instagram differs? + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook Inc. - CEO [8] +-------------------------------------------------------------------------------- + + Yes, I can take that one. There are a number of differences. I think a lot of this comes down to the graphs and the community that you have, and the different places. Instagram is a follow model, right? So it's -- they're not all bidirectional friendships. A larger portion of the content is public content. +More of the content is visual, where Facebook has a mix of text and news and links, and visual content like photos and videos. Instagram creates a pure experience, that's focused on photos and videos. So all of those good and subtle decisions that Kevin has made over the years, add up to creating a different kind of community that, what we're finding -- and that's great -- is that it's really complementary to what people are doing on Facebook. +And some of what we found is that, as we encourage people to use both Facebook and Instagram, engagement on both can increase. So that is great. And that I think speaks to how you can build these different kinds of communities, with different connections, in a way that really is creating new value in people's lives. + +-------------------------------------------------------------------------------- +Operator [9] +-------------------------------------------------------------------------------- + + Your next question comes from the line of Eric Sheridan from UBS. + +-------------------------------------------------------------------------------- +Eric Sheridan, UBS - Analyst [10] +-------------------------------------------------------------------------------- + + Thanks for taking the question. Maybe two, sticking on the same theme as what Doug and Brian just talked about. Sheryl, for you, would love to get a sense of how you think about some of the opportunities and challenges sitting ahead of the business now, on monetizing all of the video that's being consumed on Facebook? +And then maybe, Dave, for you, when we think about the P&L impacts of both monetizing video and investing in video, is there anything we should be thinking about, or you want to call out, in terms of gross versus net on either the revenue side or the revenue share side, that could be leading to mix shift to incremental revenue growth, but possibly lower margin revenue coming into the business? Thanks so much. + +-------------------------------------------------------------------------------- +Sheryl Sandberg, Facebook Inc. - COO [11] +-------------------------------------------------------------------------------- + + On the video ad opportunity, we're seeing consumer video exploding on our platform, as Mark has talked about, and that really creates the opportunity for video ads in the feed. And a lot of this happens within the current news feed product. People post videos, people consume news feed stories. Those stories include video stories from consumers, and then we have an opportunity to serve ads. As consumer video has grown in news feed, it's given us that opportunity for video ads, because the format of the ads fit the format of what consumers are doing. And we're seeing a lot of great examples of people using ads in the feed across Instagram and news feed. +In terms of monetizing some of our newer attempts at products and news feeds such as ad breaks, those are really in early experimental stages. And for now, we're really focused primarily on our core business, our core ad products of which video is one. +One of the things that's really important in this, is helping marketers understand that they need to optimize those video ads. That an ad that works really well 30 seconds in other platforms, in more traditional platforms, can work on ours, but the ones that are optimized, and use our targeting really perform better. And we're working hard with advertisers to help them see that. +So to share one example, Motorola working with Ogilvy and [Modomento] launched the Moto Z phone. And they did awareness boosting before they launched, targeting Android users, and Verizon subscribers, and they optimized their video for the Facebook and Instagram mobile feed. And then, after they launched, they did purchasing ads, and retargeted people who had viewed those initial ads. That's just a great example of someone using video ads, optimizing a format, but also using the pretty unique targeting we can offer to drive sales. +They measured that they had over 3.5% lift in sales, driven by the Facebook and Instagram video ads. And so, we're pretty excited about the opportunity we have in our current business, and we're going to work client by client, to get the video format of those ads right, get the targeting to be as good and as deep as it can be, and make sure we're measuring all the way through to sales. + +-------------------------------------------------------------------------------- +Dave Wehner, Facebook Inc. - CFO [12] +-------------------------------------------------------------------------------- + + And Eric, you were asking about content, and where that's going to get picked up in the P&L. There's no real simple answer in that. I would say, in general, where we're going to be rev sharing with creators, that's going to be picked up in cost of revenue. So that's probably the simplest answer. +But as we do arrangements to get the ecosystem going, some of that could get picked up in the sales and marketing. And then, we have content as well that's getting picked up in R&D for the efforts we're making with Oculus. So you're seeing some of those get spread across several different lines in the P&L. So it's not going to be a clean, one spot where you're going to find it. + +-------------------------------------------------------------------------------- +Eric Sheridan, UBS - Analyst [13] +-------------------------------------------------------------------------------- + + Great. Thank you. + +-------------------------------------------------------------------------------- +Operator [14] +-------------------------------------------------------------------------------- + + Your next question comes from the line of John Blackledge from Cowen. + +-------------------------------------------------------------------------------- +John Blackledge, Cowen and Company - Analyst [15] +-------------------------------------------------------------------------------- + + Great. Thanks. Just a couple questions. With the strategic shift to video, how do you view the state of the digital flash mobile video measurement? Any call out on improvements being done industry-wide, and within Facebook? And then, just on video search, could you just comment on improvements in video search capabilities for users? Thank you. + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook Inc. - CEO [16] +-------------------------------------------------------------------------------- + + Sheryl, do you want to take the question on video measurement, and how that's evolving? + +-------------------------------------------------------------------------------- +Sheryl Sandberg, Facebook Inc. - COO [17] +-------------------------------------------------------------------------------- + + Yes. So new platforms demand new measurement. And so people are measuring all kinds of different things, from viewability, to how many people see the ad, to how long they run the ad. We're focused on all of these metrics, and working hard with third-parties, and with our advertiser to get those metrics right. +We really believe that at the end of the day, what matters the most is, all the way through the sale. What matters the most is the [AB] test, that these people saw ads on Facebook and Instagram, these people didn't, and here's the sales lift. And all the other metrics, although important and we're working hard, are proxy metrics. And those metrics are going through a platform shift that we need to work on. + +-------------------------------------------------------------------------------- +Dave Wehner, Facebook Inc. - CFO [18] +-------------------------------------------------------------------------------- + + And then Mark. + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook Inc. - CEO [19] +-------------------------------------------------------------------------------- + + And for video search, search is a big priority, and the thing that we're working on across all of the different verticals, not just video, but also all the posts on Facebook, all of the content that people are selling in marketplace, the groups that people are joining and sharing, and all the news content. And it's an area that we've been working on for a while. It's growing steadily, and doing well, and we hope to have more updates on that soon. + +-------------------------------------------------------------------------------- +Operator [20] +-------------------------------------------------------------------------------- + + Your next question comes from the line of Mark May from Citi. + +-------------------------------------------------------------------------------- +Mark May, Citigroup - Analyst [21] +-------------------------------------------------------------------------------- + + Thanks for taking my questions. I think the first one might be directed at Sheryl. Your reported pricing metric, I realize there's typically been noise in that. I think it's up 3% year-on-year. +First of all, is that sort of representative for general pricing changes in the marketplace, and do you think that there's still room for upside in pricing? And if so, where are some of the key areas that you -- where you see that coming from? +And then, another question on video. As you've begun to push more video content to users within the Facebook app itself, are you witnessing any meaningful changes in engagement time spent, with a typical Facebook app user? Thank you. + +-------------------------------------------------------------------------------- +Dave Wehner, Facebook Inc. - CFO [22] +-------------------------------------------------------------------------------- + + Mark, it's Dave. I can take those, on the metrics. From the price volume perspective, yes, the price per ad increased modestly 3%. +There's lots of different underlying metrics, but the overall kind of reported metric is really, continues to be driven by the mix shift away from right-hand column ads, which are lower price and lower value. And then, obviously impression growth is driven by the user's time spent in ad load. +In terms of the opportunities for price, it's really just continuing to focus on making our ads better targeted, more relevant, improving all the different ways in which we can drive better outcomes for our advertisers, and sort of meeting them with the results that they care about, and delivering those results. We think there continues to be great opportunities to do that, and how the supply demand dynamics play out, will kind of impact the overall direction of price. And it's going to depend obviously, also on regional mixes too, because some regions are -- have obviously lower prices. +I think the other question was on video. Video is one of the big drivers of engagement growth on Facebook. It's also helpful on Instagram, where we're also seeing the benefit of ranking changes. So we continue to see good engagement, and time spent growth across the Facebook family, and on just Facebook, and video is a part of that story. So it's an important part of that story. + +-------------------------------------------------------------------------------- +Operator [23] +-------------------------------------------------------------------------------- + + Your next question comes from the line of Justin Post from Bank of America Merrill Lynch. + +-------------------------------------------------------------------------------- +Justin Post, BofA Merrill Lynch - Analyst [24] +-------------------------------------------------------------------------------- + + Great. A couple things. First, we know a lot of political activity, obviously in Q4. Did that contribute anything abnormally to revenues or users? +Second question, and I know you'll be getting a lot of this over the next two or three months, but just any difference on trends, millennials on the platform, versus other cohorts or groups, just thinking about how those are trending versus the other groups? And then finally, I think we've seen some ads on Messenger being tested in certain regions of the world. Any commentary on that would be helpful? Thank you. + +-------------------------------------------------------------------------------- +Sheryl Sandberg, Facebook Inc. - COO [25] +-------------------------------------------------------------------------------- + + Yes, I'll take a few of those. So on elections, we run a very large and diversified business. So there are these events that are obviously, big like the US elections, the World Cup, Super Bowl, but there are enough of these all around the world, that no one event is that big for our business. Even last quarter, political spending, even within the US alone, was not a top 10 vertical for us. +When you think about ads in Messenger, we right now are really focused on consumer growth and engagement, because we know that over time that creates a monetization opportunity. We're seeing a lot of organic connections between businesses and consumers. We're now, per month at 1 billion messages sent between people and businesses, and we think that's very promising for our ability for people to use this platform, to make those connections that will ultimately drive the business opportunities. +We're in the very early stages, some of those ads you're seeing are [exploring] how to build more of these connections. But right now, we're going to remain focused on the user experience, and the experimentation we're doing. + +-------------------------------------------------------------------------------- +Dave Wehner, Facebook Inc. - CFO [26] +-------------------------------------------------------------------------------- + + Yes, Justin, just adding to the question on elections, I'd also point out that our reported daily active and monthly active numbers reflect usage in December. So even for the US, that doesn't really pick up the election period, just because the way that we tabulates those results. +On millennials, we were really pleased. This was a fantastic quarter for overall growth of the Facebook community, our strongest absolute MAU and DAU additions year-over-year since being a public Company. So we're really pleased with that. So within that context, we're not breaking out specific cohorts. But we remain a great place for advertisers to reach millennials, and Instagram is obviously another great place to reach millennials. And we continue to build our products to serve a wide variety of audiences, including millennials as well. + +-------------------------------------------------------------------------------- +Operator [27] +-------------------------------------------------------------------------------- + + Your next question comes from the line of Mark Mahaney from RBC Capital Markets. + +-------------------------------------------------------------------------------- +Mark Mahaney, RBC Capital Markets - Analyst [28] +-------------------------------------------------------------------------------- + + David, I think you just talked about this, a pretty material increase in MAUs. Can I ask two questions? The Asia area MAU growth in particular, I think it was something like 44 million sequentially, that's the biggest that I think you've ever had. So could you just talk about, was there some particular markets, some particular region there that added to it? +And then, since we're talking Asia, can you just comment, Mark, on China? And how you think about it, long-term as a market opportunity, and your level of optimism that Facebook can have a material presence in that market in 5 to 10 years? Thank you. + +-------------------------------------------------------------------------------- +Dave Wehner, Facebook Inc. - CFO [29] +-------------------------------------------------------------------------------- + + Sure. So Mark, Asia benefits probably more than any other region, around the sort of three factors that I called out in my prepared remarks. And those are internet.org efforts, Android product improvements that we've continued to make a big area like Android, our Facebook Light platform on Android has been a great grower for us. +But then particularly, in the fourth quarter, wanted to call out that we've seen an increase in third-party promotional free data plans in places like India. So that clearly, is having an impact in APAC, and India was our strongest growth market. So that would be something that I would say, was a little bit more unique this past quarter. + +-------------------------------------------------------------------------------- +Operator [30] +-------------------------------------------------------------------------------- + + Your next question -- (multiple speakers) + +-------------------------------------------------------------------------------- +Mark Mahaney, RBC Capital Markets - Analyst [31] +-------------------------------------------------------------------------------- + + The China question. + +-------------------------------------------------------------------------------- +Dave Wehner, Facebook Inc. - CFO [32] +-------------------------------------------------------------------------------- + + Yes, sorry. Mark's going to take China question. + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook Inc. - CEO [33] +-------------------------------------------------------------------------------- + + Sure. So as I've said a number of times before, our mission is to connect everyone in the world. And it's hard to do that over the long-term, if we don't find a way to serve the more than 1 billion people who live in China. So that's certainly a thing that we're going to look out -- at over the long-term. And the specific time horizon that you mentioned, I think it's really hard to predict how this will play out, or what we will end up doing. +But one of the big things that we need to think about here is, of course, we're only going to do this in a way, that we're comfortable with over the long-term. So obviously, something that we're going to continue engaging in, and thinking about, how to move forward on. And long-term, it's very important, but no news at all in the near-term. + +-------------------------------------------------------------------------------- +Operator [34] +-------------------------------------------------------------------------------- + + Your next question comes from the line of Heather Bellini from Goldman Sachs. + +-------------------------------------------------------------------------------- +Heather Bellini, Goldman Sachs - Analyst [35] +-------------------------------------------------------------------------------- + + Great. Thank you for taking the questions. I had two. I was just wondering, Mark, you mentioned -- similar to how you referenced Facebook and Instagram being complementary, how do you think about WhatsApp and Messenger? And I'm wondering if there's different paths to monetization over time for each of these? +And then, my second question, I guess, might be for any of you, just you, Dave, have mentioned expectations for slower growth in ad load on core Facebook in the second half of this year. How should we think about the potential for ad load growth on Instagram? Thank you. + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook Inc. - CEO [36] +-------------------------------------------------------------------------------- + + I'll take Messenger and WhatsApp, then you can take ad load. So yes, is the basic answer that Messenger and WhatsApp serve somewhat different utilities for people. WhatsApp really takes the place of SMS in a lot of the markets where it operates. +The graph is based on phone numbers. You're as likely to text your barber, or somebody that you're going to transact with, you would have a phone number with, as you would be a friend. Whereas on Facebook Messenger, the graph is your friends. And you're more likely to say, wish an acquaintance happy birthday on Facebook Messenger than on WhatsApp, where you might not have their phone number in the first place. So you can think about some overlap in the core use case, as you might message your close friends and family on either. +But what we found in general, is that if you look at some of the markets that are strongest for both of them, they could each grow in those markets. And as messaging has become more affordable and more reliable for people, the volumes of messaging have just gone through the roof, in terms of what people want to do. +Looking at -- my understanding from looking at a bunch of analytics is that the peak of global SMS reached somewhere in the low 20 billion messages per day. And we already have many times more than that, three times or more than that, across WhatsApp and Messenger. And of course, there are other messaging products in the world, besides these as well. So we're pretty confident that this is going to keep on growing. +I do think to your point that the monetization paths are going to be somewhat different, reflecting the difference in product philosophy. So Messenger is much more focused on being an expressive and rich environment, that has lots of different types of content. Kind of more like Facebook to the Instagram example that we used before, whereas WhatsApp I think is a much more utilitarian experience, with a much more stark UI, where there's just not as much emphasis on having a lot of different ways to engage. +So we did the experiment that you asked about before, around ads in Messenger and different ways that businesses can interact. And there is a lot of flexibility on how we can explore there, which is why I think you'll see some more of that on the Messenger side, than on the WhatsApp side in the near-term. But giving businesses the opportunity to connect in WhatsApp, and reach the people that they want, and eventually have increasingly, hopefully transactional interactions, I think will be a really useful thing on that platform as well. + +-------------------------------------------------------------------------------- +Dave Wehner, Facebook Inc. - CFO [37] +-------------------------------------------------------------------------------- + + Heather, it's Dave. Just on Instagram versus Facebook and ad load, clearly the biggest driver of our business is core Facebook, just in terms of sheer size, and even sheer contribution to growth. Instagram is growing quicker on a percentage basis, but it's much smaller. +The ad load opportunities are higher on Instagram, because Instagram is at a lower ad load than Facebook. So there is an opportunity for us to continue to grow ad load on Instagram probably beyond -- in a longer time frame than there is on Facebook, because of that disparity in terms of where they are today. +But given the scale of Facebook and the importance driving overall revenue, that's why I continue to express what our expectations are for advertising growth in 2017, and the reduction in the growth rate that we expect, given the potential to grow ad load on Facebook, that we expect come down in 2017. + +-------------------------------------------------------------------------------- +Operator [38] +-------------------------------------------------------------------------------- + + Your next question comes from the line of Peter Stabler from Wells Fargo Securities. + +-------------------------------------------------------------------------------- +Peter Stabler, Wells Fargo Securities - Analyst [39] +-------------------------------------------------------------------------------- + + Thanks very much. Two for Sheryl, if I could. First of all, Sheryl, when it comes to measurement, I'm curious if you could comment on what appear to be the really successful efforts you've had in linking on Facebook ad exposure to both offline and online sales of your customers. +And I guess, if we think across, maybe your 1,000 largest clients, any chance you could give us a sense of what percentage are utilizing this level of kind of advanced measurement, in terms of measuring actual sales lift, and share gains? And then, secondly, just wondering if there's any color around the pretty recent roll out of buy buttons on Instagram? Thank you very much. + +-------------------------------------------------------------------------------- +Sheryl Sandberg, Facebook Inc. - COO [40] +-------------------------------------------------------------------------------- + + Yes. So when you think on measurement, your question gets to the heart of the matter, which is there's a lot of conversations on what we measure. And when you see platform shifts, as you are in the ad market for more traditional forms of media, to display, to now mobile, we're seeing those metrics change. And there's obviously, a lot of conversation, and a lot of concern out there about what we're measuring. +We think the answer to all of this, is to remember that what really matters is going all the way through, from the ad itself to the sale, whether that sale is online or offline. And we are working hard, to work on the data in a privacy-protected way to be able to do that. And we're making progress across verticals, across our large customers. I don't have the percentage of exactly how many customers are working on this type of measurement with us. +It's certainly growing. It's certainly something we're working on vertical by vertical. But it has really important impacts, not just in their ability to serve the right ad, to the right person, at the right time, but also their ability to optimize their ad for our format. That once they understand what's really moving their products off shelves, online and off, that's where we get to the real work we need to do, to optimize the ad, and really work on the targeting. +And so, I remain very optimistic. We have a lot of hard work to do, to get to all of our ad campaigns having that kind of measurement. That's going to take a long time. But the more we can do it, even in studies with each client, the better our ads get. + +-------------------------------------------------------------------------------- +Operator [41] +-------------------------------------------------------------------------------- + + Your next question -- (multiple speakers) + +-------------------------------------------------------------------------------- +Sheryl Sandberg, Facebook Inc. - COO [42] +-------------------------------------------------------------------------------- + + Oh, buy button. Yes, sorry, just to address the buy button. The core of our business is really connecting people with what they care about. And so, we're looking at getting the right message, the right time. +We've worked hard on product ads that get to products. So you've seen us work on dynamic ads, carousel ads, estimated store visits, things that help our ads business sell products. You are seeing us take other steps, like a buy button, like the marketplace launch, which are really aimed at improving some of the experiences we think people are trying to have, and already having in organic ways on Facebook. But the core of our focus is, still very much focused on ads, and how we can do ads at the product level. + +-------------------------------------------------------------------------------- +Operator [43] +-------------------------------------------------------------------------------- + + Your next question comes from the line of Ken Sena from Evercore ISI. + +-------------------------------------------------------------------------------- +Ken Sena, Evercore ISI - Analyst [44] +-------------------------------------------------------------------------------- + + Thanks. Just on the OpEx for 2017, you mentioned R&D content, sales, marketing. As we think about R&D, and also the talent shortages that are in data science and engineering, not to mention the potentially, it getting worse around immigration, et cetera. How should we think about that potentially factoring in, as we look out through 2017, and maybe a little bit further out? + +-------------------------------------------------------------------------------- +Dave Wehner, Facebook Inc. - CFO [45] +-------------------------------------------------------------------------------- + + Sure, Ken. I mean, we obviously are focused on hiring top engineering talent. It's key to our 2017 goals, and executing on our 3, 5 and 10 year road map, the one that Mark outlined. One thing that we're optimistic about is, our ability to hire technical talent outside of the Bay area, as well as in the Bay area. And that's because we built up engineering locations in key areas like Seattle, London, New York, Boston, Tel Aviv. +So we've got other markets in which we can recruit, and grow engineering and other technical teams. And that's really different from where we were a couple years ago. So that's an important part of the infrastructure that we put in place in the last two years that we're pleased with. + +-------------------------------------------------------------------------------- +Operator [46] +-------------------------------------------------------------------------------- + + Your next question comes from the line of Brian Fitzgerald from Jefferies. + +-------------------------------------------------------------------------------- +Brian Fitzgerald, Jefferies LLC - Analyst [47] +-------------------------------------------------------------------------------- + + Thanks. Mark, on AI maybe, you mentioned improved recommendations, and we've interacted with chat bots on Messenger. Maybe curious overall, how you see artificial intelligence and machine learning processes impacting your business over time? + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook Inc. - CEO [48] +-------------------------------------------------------------------------------- + + Well, I think AI is going to be great for the experience that people have in our community. So there are a few types of systems here that we're working on, around understanding content. One is around visual content, and the other is about language. +So for visual content, we want to be able to look at a photo, and understand what's in it, right? And whether that's something that you're going to be interested in, right? And similarly, we went to be able to look at a video, and watch it, and understand whether that's something that you're going to be interested in. And you can imagine that, today we consider putting things in your news feed that you're connected to in some way, right? That are from a friend, or a page that you're following, or that one of your friends liked. +But there's no reason that we shouldn't be able to match you up, with any of the millions of pieces of content that you might be interested in, that get shared on Facebook every day, except for the fact that we don't have the AI technology to know what those are about, and if they match your interest today. So but a combination of being able to understand the texts that people message, read the articles that people would want to look at, watch the videos, look at the photos, are going to be great too. +Another area where I'm really excited about this, is our ability to keep the community safe, right? So there's an increasing focus on objectionable content, right, and a lot of unfortunate things, right, that people share on Facebook. And it's a minority of the content, but I'm really focused on making sure that our Company gets faster at taking the bad stuff down. +And we can do better with people. But ultimately the best thing we can do is build AI systems that can watch a video, and understand that it's going to be problematic, and violate the policies of our community, and that people aren't going to want to see it. And then, just not show it to people, before bad experiences happen -- and things like violence get spread through -- violent content gets spread through the network. So I think it's -- both going to be -- AI is both going to be great on showing people content -- that's really good, and helping us enforce the community standards that we have, to make sure that everyone has a good and fair experience. + +-------------------------------------------------------------------------------- +Operator [49] +-------------------------------------------------------------------------------- + + Your next question comes from the line of Scott Devitt from Stifel. + +-------------------------------------------------------------------------------- +Scott Devitt, Stifel Nicolaus - Analyst [50] +-------------------------------------------------------------------------------- + + Hi, thanks. I had two questions for Mark. Wondering, Mark, if you could talk a bit more about the new video tab, just early engagement trends, user feedback? And really just how the product works in terms of categorization of content, user preference targeting, and maybe how the content flows into the tab, versus being in the news feed, and to the extent that there's duplication there? +And then separately, VR and AR continues to be in the 10 year vision for the business. Mark, was wondering if you could provide some detail on what you think the friction points are, that are keeping that from being on a more accelerated commercialization path? Thank you. + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook Inc. - CEO [51] +-------------------------------------------------------------------------------- + + So I'll take video first, and then I can talk about VR as well. So for the video tab, the goal that we have for the product experience, is to make it so that when people want to watch videos, where they want to keep up to date on what's going on with their favorite show, or what's going on with a public figure that they want to follow, that they can come to Facebook, and go to a place, knowing that that's going to show them all the content that they're interested in. +So that's a pretty different intent, than how people come to Facebook today. Today for the most part, people pull Facebook out when they have a few minutes, when they want to catch up, and see what's going on in the world, with their friends and in the news, and everything that's going on. So that's very different from saying, hey, I want to watch video content now. And that's what I think we're going to unlock with this tab. +So all of the content that is on Facebook is eligible to go in the tab. I mean, we're showing video content, not all the rest of it. But there isn't a concrete difference between what can be a news feed, and what could be here. It's just that the experience is designed to deliver on that promise of, you want to watch videos, you want to keep up with the content that you watch episodically, week over week. This is going to be the place where you go to do that. +I do think that it's going to get a lot stronger, once the business model really starts to click here, right, because a lot of the best episodic content is professionally created. And those folks needed to make a good amount of money in order to support their business model. So having mid-roll ads, we're committed to doing this in a way, that's very good on the user experience. +But that is going to enable the kind of content that I think is going to take this to the next level. The early trends are good, but I think this is really going to be an area, that is proportional to the amount of quality content that is in the system, and the business model is really going to be the thing that enables that. + +-------------------------------------------------------------------------------- +Operator [52] +-------------------------------------------------------------------------------- + + Your next -- (multiple speakers) + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook Inc. - CEO [53] +-------------------------------------------------------------------------------- + + All right, sorry, I forgot about that for a second. All right, so VR and AR, what can accelerate that? I think that there are parts of this that are on a good trajectory, and parts where we're a little behind where we would want to be. +I think, Samsung shipping 5 million Gear VRs -- I mean, that's their product, not ours, but we build technology that powers it. I think that's quite a good result, right, and one that we're very happy with, and just shows how strong of a company Samsung is, at being able to build these products, and sell them through into the world. +On the side of the products that we built, Rift and Touch were both a little delayed. That was obviously somewhat of a disappointment. And if you want to accelerate development, obviously we need to get our products in the market at a good pace. +But in terms of the content development, I actually think that's coming at a reasonable clip. Early on, there is this issue which is that if you're a [AAA] game developer, until there's a certain volume of units in the field, you're not going to be able to make enough money to fund your game development, just based off of people buying your content. So that's why we're investing so much capital in content, to seed the ecosystem, and solve this chicken and egg problem of, you need the content in order to create the ecosystem. +But I don't think that there is really a strategy to pull this in from 10 years to 5, I just think it's going to be a 10 year thing. I mean, the analogy that I always use is, the first smartphone came out in -- sorry, 2003, right, the Blackberry and Palm Trio, and it took 10 years to get to 1 billion units. And I don't know, if there was something that folks could have done to make that happen fast, but I think that was pretty good. +And if we can be on a similar trajectory, of anywhere near 10 years for VR and AR, then I would feel very good about that. And I feel like we're making the right bets now to plant the seeds for that. But I would ask for the patience of the investor community in doing that, because we're going to invest a lot in this, and it's not going to return, or be really profitable for us for quite a while. + +-------------------------------------------------------------------------------- +Deborah Crawford, Facebook Inc. - VP of IR [54] +-------------------------------------------------------------------------------- + + Operator, we have time for one last question. + +-------------------------------------------------------------------------------- +Operator [55] +-------------------------------------------------------------------------------- + + Your last question comes from the line of Anthony DiClemente from Nomura Instinet. + +-------------------------------------------------------------------------------- +Anthony DiClemente, Nomura Instinet - Analyst [56] +-------------------------------------------------------------------------------- + + Thanks a lot for fitting me in. A couple for Mark. Mark, just on the theme of video, given the strong cash position that Facebook has, the cash on the balance sheet, the free cash flow generation of the Company, are there any possible acquisitions out there, that you think would or could super-charge your growth in the video space, in the original content space, given this evolution? +And maybe, along those lines, what do you think about live sports in terms of the video use case? Is that working on Facebook? You've experimented, you experimented with NBA games on Facebook outside the US, NBA D-League on Facebook. So just wanted to get your thoughts on how those have gone? Thanks a lot. + +-------------------------------------------------------------------------------- +Dave Wehner, Facebook Inc. - CFO [57] +-------------------------------------------------------------------------------- + + So Anthony, I can just take the first part of that at least, which is look, our focus was on kick-starting the ecosystem here, for the video tab that Mark talked about. We're looking at a wide range of content, and we're really working towards a revenue share model with creators. We're certainly going to be seeding content to get the ecosystem going, but that's not about doing big deals. So we'll -- we're certainly looking at a variety of different types of content to look at. + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook Inc. - CEO [58] +-------------------------------------------------------------------------------- + + I think you got it. + +-------------------------------------------------------------------------------- +Dave Wehner, Facebook Inc. - CFO [59] +-------------------------------------------------------------------------------- + + Great. + +-------------------------------------------------------------------------------- +Deborah Crawford, Facebook Inc. - VP of IR [60] +-------------------------------------------------------------------------------- + + Great. Super. Thank you for joining us today. We appreciate your time, and we look forward to speaking with you again. + +-------------------------------------------------------------------------------- +Operator [61] +-------------------------------------------------------------------------------- + + Ladies and gentlemen, this concludes today's conference call. Thank you for joining us. You may now disconnect your lines. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/exam/original-files/Problem_1_Sample/2017-Feb-02-AMZN.OQ-139452463844-Transcript.txt b/exam/original-files/Problem_1_Sample/2017-Feb-02-AMZN.OQ-139452463844-Transcript.txt new file mode 100644 index 0000000..433c5c1 --- /dev/null +++ b/exam/original-files/Problem_1_Sample/2017-Feb-02-AMZN.OQ-139452463844-Transcript.txt @@ -0,0 +1,458 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q4 2016 Amazon.com Inc Earnings Call +02/02/2017 05:30 PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Brian Olsavsky + Amazon.com Inc. - CFO + * Darin Manney + Amazon.com Inc. - Director of IR + +================================================================================ +Conference Call Participiants +================================================================================ + + * Anthony DiClemente + Nomura Instinet - Analyst + * Scott Devitt + Stifel Nicolaus - Analyst + * Ben Schachter + Macquarie Research - Analyst + * Douglas Anmuth + JPMorgan - Analyst + * Justin Post + BofA Merrill Lynch - Analyst + * Jason Helfstein + Oppenheimer & Co. - Analyst + * John Blackledge + Cowen and Company - Analyst + * Heath Terry + Goldman Sachs - Analyst + * Colin Sebastian + Robert W. Baird & Company, Inc. - Analyst + * Eric Sheridan + UBS - Analyst + * Mark Mahaney + RBC Capital Markets - Analyst + * Brian Nowak + Morgan Stanley - Analyst + * Mark May + Citigroup - Analyst + +================================================================================ +Presentation +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Good day, everyone, and welcome to the Amazon.com Q4 2016 financial results teleconference. +(Operator Instructions) +Today's call is being recorded. For opening remarks, I will be turning the call over to the Director of Investor Relations, Darin Manney. Please go ahead. + +-------------------------------------------------------------------------------- +Darin Manney, Amazon.com Inc. - Director of IR [2] +-------------------------------------------------------------------------------- + + Hello and welcome to our Q4 2016 financial results conference call. Joining us today to answer your questions is Brian Olsavsky, our CFO. +As you listen to today's conference call, we encourage you to have our press release in front of you, which includes our financial results as well as metrics and commentary on the quarter. Please note, unless otherwise stated, all comparisons in this call will be against our results for the comparable period of 2015. +Our comments and responses to your questions reflect management's views as of today, February 2, 2017 only, and will include forward-looking statements. Actual results may differ materially. Additional information about factors that could potentially impact our financial results is included in today's press release and our filings with the SEC, including our most recent annual report on Form 10-K and subsequent filings. +During this call, we may discuss certain non-GAAP financial measures. In our press release, slides accompanying this webcast and our filings with the SEC, each of which is posted on our IR website. You will find additional disclosures regarding these non-GAAP measures, including reconciliations of these measures with comparable GAAP measures. +Our guidance incorporates the order trends that we have seen to date, and what we believe today to be appropriate assumptions. Our results are inherently unpredictable, and may be materially affected by many factors. Including fluctuations in foreign exchange rates, changes in global economic conditions and customer spending, world events, the rate of growth of the internet, online commerce and cloud services, and the various factors detailed in our filings with the SEC. +Our guidance also assumes, among other things, that we don't conclude additional business acquisitions, investments, restructurings or legal settlements. It is not possible to accurately predict demand for our goods and services, and therefore, our actual results could differ materially from our guidance. +And just briefly before we move to questions, I would like to address our Form 10-K that we will be filing with the SEC. We received a comment letter from the SEC's Division of Corporate Finance regarding our 2015 Form 10-K, and have subsequently been engaged with the SEC staff regarding our disclosures. +We will be revising the disclosures of net, product and service sales in our Form 10-K. As a result, we expect to file our 2016 Form 10-K later than we typically have, but before the SEC's due date of March 1. These changes relate to our entity-wide disclosures and do not impact the financial results that we report for the Company or our segments. +With that, we will move to Q&A. Operator, please remind our listeners how to initiate a question. + + +================================================================================ +Questions and Answers +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) +John Blackledge, Cowen. + +-------------------------------------------------------------------------------- +John Blackledge, Cowen and Company - Analyst [2] +-------------------------------------------------------------------------------- + + Great, thanks for the question. So the first quarter GAAP operating income guide essentially implies negative incremental margins at the low, mid and high end of guidance. So just wondering if you can frame in order of possible the investment areas that are driving the negative incremental margins, and then just generally how should we think about the margin profile in 2017? Thank you. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com Inc. - CFO [3] +-------------------------------------------------------------------------------- + + Thank you, John. First, let me talk about revenue just to get that out there as well. +We are guiding to 17% to 25% growth on an FX-neutral basis. That includes approximately -- on top of that is approximately 250 basis points or $730 million of FX negative impact, which brings the non-FX adjusted range down to 14% to 23%. +I will also point out we that had the Leap Year comp from last year. Last year, the extra day of Leap Year was worth 150 basis points to us in our Q1 revenue. This year that reverses, so we have 150 basis point headwind to growth and it's been factored into our guidance range. +But your question was on bottom line. So yes, what you are seeing, John, is the continuation of the step-up investment that we saw in the second half of last year. I talked about in prior calls about the fulfillment center step up. +We had 26 warehouses we added last year, 23 of them were in the second half of the year. Digital content, digital video content, end marketing stepped up quite a bit in the second half of the year. +We continue to invest heavily in those two areas. We also have investments in other Prime benefits from Prime Now to Amazon Fresh, and of course we're continuing to invest in Alexa in our Echo devices. And finally I'd point out India which continues to be a rather large investment for us. + +-------------------------------------------------------------------------------- +Operator [4] +-------------------------------------------------------------------------------- + + Scott Devitt, Stifel. + +-------------------------------------------------------------------------------- +Scott Devitt, Stifel Nicolaus - Analyst [5] +-------------------------------------------------------------------------------- + + Hello, thank you. The question is on video. I was wondering if you could just give any quantification in terms of the magnitude of video spend in 2017, as well as the lumpiness from an expensing standpoint quarterly? +And then separately as it relates to just the video service. From a positioning standpoint in the market, how do you think about the unique aspects of the product that Amazon has relative to others in the market in terms of is the aggregation tools that are being provided now where some of the value is being perceived longer term? +Is it the uniqueness of the content or is it other things? If you could provide a little bit of color on that, that would be helpful. Thank you. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com Inc. - CFO [6] +-------------------------------------------------------------------------------- + + Well ultimately, I will step back and say one of the main things we look at on Prime Video is customer usage patterns. And in 2016, we had a doubling of Prime hours for video, music and reading. So we are happy with the engagement that customers have. +We're also happy with the -- especially on the studio side, the people we have been able to work with. Some of the most talented people in the entertainment industry. And our customers have responded really well to the shows that we have created. We have garnered awards of course, but mainly what we were focused on is good content that is attractive to customers. +I will also point out that we rolled out the global Prime Video offer in the second half of last -- in Q4, and what we see there is again original content is a fixed cost expense. The more we can amortize it over a large base, the better off we will be. But more importantly, we have great content that we want to share with people outside of our primary retail countries and this takes us to over 200 more countries. +So we are very happy with the results in video. Yes, the investment did step up in the second half of last year, including marketing and that will continue in 2017 and likely beyond. + +-------------------------------------------------------------------------------- +Operator [7] +-------------------------------------------------------------------------------- + + Ben Schachter, Macquarie. + +-------------------------------------------------------------------------------- +Ben Schachter, Macquarie Research - Analyst [8] +-------------------------------------------------------------------------------- + + Can you discuss what you're doing to help merchants in China sell and ship directly to consumers in the US and other developed economies, and how the business has been evolving over time? Thanks. + +-------------------------------------------------------------------------------- +Darin Manney, Amazon.com Inc. - Director of IR [9] +-------------------------------------------------------------------------------- + + Hello, Ben. This is Darin. We are very pleased with our FBA offering, and that's really helpful to sellers around the world. Certainly, our international sellers have access to more and more customers through that offering, and that doesn't exclude sellers in China as well. +The offering in China that we have for consumers is also a great trusted customer engagement. We have a very strong and trusted venue for Chinese customers to access international brands there, as we continue to focus on great offerings through the Amazon global store which offers great brands from outside of China to customers. And so there is a mix of things going on in China, and we're happy with what we are seeing in both of those. + +-------------------------------------------------------------------------------- +Operator [10] +-------------------------------------------------------------------------------- + + Justin Post, Bank of America/Merrill Lynch. + +-------------------------------------------------------------------------------- +Justin Post, BofA Merrill Lynch - Analyst [11] +-------------------------------------------------------------------------------- + + Thank you. A follow up on India and China. I know you are investing a lot, I'd love to hear how much but you probably won't tell us. +But can you tell us why you think the market is worth investment, and what really attracts you to the market as you think out longer term? And then China, can you give us any updates there on how financial performance is doing, and if you have changed your strategy and if anything has gotten better there this year? Thank you + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com Inc. - CFO [12] +-------------------------------------------------------------------------------- + + Let me start with India. So it's still very early. We continue to say that, but we're very encouraged with what we have created with customers and sellers alike in India over the last few years. +We continue to develop new functionality for that country, whether it's delivery, whether it's seller features. We rolled out Prime last summer, if you'll remember, and we recently launched Prime Video there. +So we've had success with Prime in every country we've been in, we don't expect India to be any different. We will continue to build our business there, and continue to do a great job for both customers and sellers. We are bullish on India longer term, and it's early but we like the initial engagement we are seeing and the response again from both customers and sellers. + +-------------------------------------------------------------------------------- +Darin Manney, Amazon.com Inc. - Director of IR [13] +-------------------------------------------------------------------------------- + + And this is Darin. On China, like I said, we are very pleased with our offering in China. Our strategy there has been one of bringing a trusted and authentic product to customers in China, both domestically and from international offers. +So we will continue to focus on the global store there. As you may know, we've launched the Prime program that's focused around the availability of international goods in China, and we are pleased with what we are seeing there. + +-------------------------------------------------------------------------------- +Operator [14] +-------------------------------------------------------------------------------- + + Heath Terry, Goldman Sachs. + +-------------------------------------------------------------------------------- +Heath Terry, Goldman Sachs - Analyst [15] +-------------------------------------------------------------------------------- + + Great. Two primary questions. Can you give us a sense of what the best way to think about the impact that the shift to third-party? And within that the growth in FBA is having on these sequential growth rates? +To the extent that there is 150 basis point impact from Leap Year on a year-over-year basis, is there a way to quantify the impact that that shift to third party is having on the growth rate for the first quarter or for what you have reported in the fourth? And then on the AWS side of the business, with the price cut in November can you give us some sense of what impact the price cut had on the deceleration in growth compared to the impact that presumably it had in driving incremental volume to the platform? + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com Inc. - CFO [16] +-------------------------------------------------------------------------------- + + Let me start with that second question first. So more basically on AWS, very happy with the response from customers. We feel we've got a very broad base of customers from startups, to small medium businesses, to large enterprises, to the public sector, and we are continuing to see strong growth across all those sectors. +The business is now a $14 billion annualized -- running at a $14 billion run rate. You are right that we had seven price cuts in Q4 essentially timed for December 1, so about a third of the impact was seen in Q4. But that's going to be constant in this business. +We have been pretty clear that this business is all about creating new functionality for customers, giving price cuts, and then working on the operating efficiency. So very pleased with Q4 and the pace of the business. +The new services and features last year were over 1,000 versus 700 or so in 2015. So we continue to innovate on behalf of customers. We are working with some very large customers in each industry. +You have seen probably press releases on companies like Capital One, Workday, salesforce and others. So again, widespread usage and new customer adoption which is great. +Your second question on FBA, I can't break out the year-over-year difference there. What I will say the impact of FBA on our business is, and first that's -- one of the things that we look at is how well are we attracting new FBA sellers. Because again, FBA reinforces Prime, Prime reinforces FBA. It's a good flywheel. +We added active sellers in FBA grew 70% year over year in 2016. So we are very happy with the continued adoption of FBA and what that does to Prime eligible selection for Prime members. +The other data point I will give you that affects our cost structure is our Amazon fulfilled units, which is the combination of retail plus FBA, grew nearly 40% last year. That compares to our paid unit growth of 24% in Q4. I'm giving you Q4 and a full-year number, but they are similar in relative proportion. +The fulfillment center expenses and a lot of our shipping costs are tied to the increase in that FBA percentage, and that growth of Amazon fulfilled units. So that is certainly a factor that we consider a positive from a customer standpoint, and it's one from a cost standpoint that we certainly continue to work on every day. But I think that's the most I can give you on FBA at this point. + +-------------------------------------------------------------------------------- +Operator [17] +-------------------------------------------------------------------------------- + + Colin Sebastian, Robert W. Baird. + +-------------------------------------------------------------------------------- +Colin Sebastian, Robert W. Baird & Company, Inc. - Analyst [18] +-------------------------------------------------------------------------------- + + Thanks very much. Maybe as a quick follow up on the quarter, we have heard from other e-commerce companies and retailers about a higher degree of promotional activity during Q4. So I wonder if there was any conscious decision on your part to pull back from some of the more aggressive discounting? +And then my other question is whether you can shed any more light on the motivation to build out the air cargo hub in Cincinnati, understanding the need to support the growth of the core retail business? But also if this gives you more of an opportunity to build out direct connections to suppliers, for example, or longer-term offer excess capacity or logistics as a service? Thank you very much. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com Inc. - CFO [19] +-------------------------------------------------------------------------------- + + Sure, Colin. On your first question, holidays are always a very promotional period, so we don't see -- I can't really comment on the year-over-year differential in promotional activity to us. We are always looking to not be beat on price. We want to offer the best options to customers, and we saw a lot of great response from customers this holiday season. I think we'd be a very trusted holiday partner, particularly as you get closer to the holiday. +So on the promotion side, we don't consider it a huge factor either way. It's pretty much a cost of doing business 12 months a year for us. +Sorry, the second question was on the hub in Cincinnati or Kentucky. Yes, that is -- I saw the announcement on that, that is a partnership we have to build out a facility at the Hebron, Kentucky airport. We think it will create thousands of jobs over time. +What it does for us is it this gives us a base for future growth. It's all about supplementing our existing capacity, both our Partners and ourselves, and essentially building capacity that can handle this top line growth and also the growth in AFN, or Amazon fulfilled network units which as I just mentioned is even higher than our paid unit growth. +So same as some of the investments you saw in airplanes last year or partnerships with companies that do air cargo, this is about supplying our need for our customers and our sellers. We value the partnership with the external providers as well, and I think we're all dealing with the problem of having lots of incremental volume year over year. + +-------------------------------------------------------------------------------- +Operator [20] +-------------------------------------------------------------------------------- + + Mark May, Citi. + +-------------------------------------------------------------------------------- +Mark May, Citigroup - Analyst [21] +-------------------------------------------------------------------------------- + + Thank you. Just a question on paid unit growth. For the last several quarters here it's been accelerating on a year-on-year basis, and I think this quarter 24% was below the 26% that you reported in Q4 of 2015. Just curious what had been driving the acceleration over the past few quarters, and what may be changed this quarter? +And then in terms of the Q1 revenue guidance, wondering if you could provide a little bit of color in terms of the impact that maybe the recent AWS price adjustments are having on your Q1 guidance? Thanks. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com Inc. - CFO [22] +-------------------------------------------------------------------------------- + + Let me start with the second one. We factored it in, and obviously into the numbers I gave through guidance the timing of it was again closer to December 1. So there will be a incremental differential in Q1 on those price cuts, but this is something that we again have quite frequently and I don't think it's a large factor in Q1. +The bigger one is more mechanical that Leap Day comp I would say. And if you are looking on a non-FX adjusted basis, the foreign exchange exposure which I mentioned was $730 million or 250 basis points expected in this guidance. + +-------------------------------------------------------------------------------- +Darin Manney, Amazon.com Inc. - Director of IR [23] +-------------------------------------------------------------------------------- + + Hello, Mark. This is Darin. On that unit growth, we're very happy with the 24% unit growth that we saw in Q4, like you mentioned. Our unit growth has been strong, it's primarily attributable to our Prime program and the customers and members that enjoy that program. +As Brian mentioned, that 28% is only part of the story. Our Amazon fulfilled units, the amount going through our fulfillment centers which essentially includes our first-party retail and our FBA sales, grew nearly 40% over 2016. So we are very pleased with those results, and happy with the fundamentals of the business from that perspective. +Customers continue to respond very well to the low prices, the vast selection, which is helped by the FBA sellers, and the strong convenience that we can offer through free two-day shipping and the multitude of other faster shipping options. Such as same day, next day, and in some cases with Prime Now the 1 to 2 hour delivery. Prime membership and selection continues to drive growth, and you'll see that in our unit growth numbers. + +-------------------------------------------------------------------------------- +Operator [24] +-------------------------------------------------------------------------------- + + Douglas Anmuth, JPMorgan. + +-------------------------------------------------------------------------------- +Douglas Anmuth, JPMorgan - Analyst [25] +-------------------------------------------------------------------------------- + + Thanks for taking the question. A lot of talk obviously about border tax. I was hoping that you could give us some of your initial thoughts there and how you might think about some of the key considerations around a potential border tax. +And then secondly, can you talk a little bit about fulfillment centers? You mentioned the 26 fulfillment center build out in 2016. Any color that you can give us in terms of how you're thinking about that for 2017? Thanks. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com Inc. - CFO [26] +-------------------------------------------------------------------------------- + + On the first one, we have a long-standing practice of not commenting on regulatory or tax matters. So I am not going to comment on any proposed issues out there. We certainly keep an eye on external issues and weigh in when we think it's going to impact our business. +But the -- sorry, your second question was on FCs. We will continue to invest in FCs. The comparable I will give you is that I won't forecast 2017, but the 20% growth in square footage that we saw in 2015 was followed by 30% square footage increase in 2016 that generally went to service that 40% growth in units in AFN units. +It also included some of the additional logistics delivery stations and all too, so it's not all FC capacity that's square footage. But I would say that we're going to continue to invest in fulfillment centers as long as our AFN growth rate maintains high, and we certainly want to keep that high and growing. + +-------------------------------------------------------------------------------- +Operator [27] +-------------------------------------------------------------------------------- + + Mark Mahaney, RBC Capital Markets. + +-------------------------------------------------------------------------------- +Mark Mahaney, RBC Capital Markets - Analyst [28] +-------------------------------------------------------------------------------- + + Thanks, two questions please. First, any comment on customer growth qualitatively how that trended throughout the year, accelerated, consistent, decelerated? And then would you be willing to give any commentary on the engagement impact you're seeing from all of these Echo devices that are getting into households? +Are you seeing people shop more? Are they engaging more with other parts of Amazon? Just any impact on what people with these Echo devices do that's different than Amazon customers that don't have them? Thank you. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com Inc. - CFO [29] +-------------------------------------------------------------------------------- + + Let me start with the Echo. I don't think I'm going to answer your exact question there on quantifying the retail sales through Echo devices. It's still very early days on that, so that's not material. +But the engagement is just like any other Prime benefit or investment that we have. We do look at engagement, and we like the engagement of customers who have Echos. But let me step back and give some highlights on that, Alexa and Echo together. +As we mentioned in our press release, the unit sales of Echos grew nine times 9x year over year during the holiday period. So great customer adoption. We are really glad to see that, and that creates a great base of Echo and Alexa fans out there. +We've added 4,000 skills to Alexa since I last spoke to you in October, and we are working with a lot of major companies as they add abilities for our customer base to use the Alexa or the Echo to reach them. Tens of thousands of developers are building new skills for Alexa, so the skills addition should continue. And just as importantly, tens of thousands of developers are also using the Alexa voice service to help integrate Alexa into their products which then creates a great network effect. +We're doing that ourselves. If you've seen in the quarter, we added Alexa capabilities to our tablets and Fire TV devices, making them better. So it's a great part of the flywheel in that Echo and Alexa make the devices better, and it builds the engagement, not only with Echo and Alexa but also with Amazon. + +-------------------------------------------------------------------------------- +Darin Manney, Amazon.com Inc. - Director of IR [30] +-------------------------------------------------------------------------------- + + Hello, Mark. This is Darin. On the customer account, no absolute number to give this quarter. As you know, back in Q1 we gave an active customer account that exceeded $300 million. I can see it's still growing, and we're pleased with the number there. +What we do like is the engagement with Prime. We continue to add Prime members, and similar to the flywheel that Brian was just mentioning the FBA selection helps us with engaging customers, and in particular the Prime program. So we are very pleased with our customer engagement this year. + +-------------------------------------------------------------------------------- +Operator [31] +-------------------------------------------------------------------------------- + + Brian Nowak, Morgan Stanley. + +-------------------------------------------------------------------------------- +Brian Nowak, Morgan Stanley - Analyst [32] +-------------------------------------------------------------------------------- + + Thanks for taking my questions, I have two. The first one is on the last mile on the Logistics build. Can you help us at all on what you are seeing in some of these markets, like the UK where you have more of the last mile build out done on your own? Is there anything you're seeing about Prime behavior? +What are the advantages and even the challenges you are facing as you're building out a last mile? And secondly, on the brick-and-mortar stores, any learnings and strategically just talk to the strategic advantage of having a bigger Amazon storefront? Thanks. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com Inc. - CFO [33] +-------------------------------------------------------------------------------- + + Let me start with your first question. So as you point out, we have had Amazon Logistics deliveries in the UK for more years than some of our other countries, and what we see is it gives us control of the shipment for a lot longer. We can shift order cutoff times out, and time is valuable to us because again we can avoid split shipments, we can avoid other costs of acceleration. +So having control later in the process is very valuable to us, especially as we're working across multiple nodes in a network. But I have driven with drivers in downtown London, and it's a very interesting experience. I think it's a great value to our customers. +It's interesting to see the route density that we see in high cities or in some cities, and the challenges and the upside of that. But I would say essentially in a nutshell, our logistics deliveries allow us to have better control of the end delivery in markets where we use it. The challenge is always going to be cost, and as we get better at this and get economies of scale we lower those costs over time. So that's essentially my overview of Amazon Logistics. +Sorry, your second question was on the stores. You probably noticed we opened the Amazon Go store in Seattle in the fourth quarter. We think that is very interesting. +It's only one store at this time, but it's using some of the same technologies you would see in self-driving cars, computer vision, sensor, fusion, deep learning. So it's a great accomplishment by that team. It's in beta right now and we like the promise of that. +Probably more advanced and further along are the Amazon Bookstores. We have three physical stores Seattle, San Diego and Portland right now. We see adding five more this year. So we are still in that phase where we are testing and learning and getting better, even on the bookstore. +I would say there's other things that are physical in nature, the pop-up stores and college pickup points that we learn from as well, and think creates a great value particularly at the college pickup points. So not much projection beyond where we are today, except for the fact that we will be adding more bookstores. +But we test, we innovate. We think the bookstores, for instance, are a really great way for customers to engage with our devices and see them, touch them and play with them and become fans. So we see a lot of value in that as well. + +-------------------------------------------------------------------------------- +Operator [34] +-------------------------------------------------------------------------------- + + Jason Helfstein, Oppenheimer. + +-------------------------------------------------------------------------------- +Jason Helfstein, Oppenheimer & Co. - Analyst [35] +-------------------------------------------------------------------------------- + + Thanks, two questions. As we think about investment in the first quarter in 2017, any color how to think about domestic versus international? You did give some comments about India, but any other color or how to think about it. +And then on AWS, you announced both new products at re:Invent at the low end and at the high end. Any commentary on if that impacted the types of customers who you have been adding on AWS with those new products? Thank you. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com Inc. - CFO [36] +-------------------------------------------------------------------------------- + + I can't give an exact split of the investments by geography, but I would say most of the fulfillment expansion was in North America last year, most of those 26 warehouses we talked about. We see that being more balanced over time, and being more global as we move forward. +Video content is with the new global program. Global Prime Video is becoming more global with the launch in India as well, and of course we had Prime Video in some of our existing countries prior to that. So that is going more global, and will be more balanced as you see devices rollout to other countries same thing. +So I would say over time, it will become more balanced and probably what you have seen in the short run tended to be more North America focused. But I can't give you a great split of -- I'm not giving you absolutes anyway, so I can't give you a great split of the two. +And I will also say that not all of our investments are on the consumer side. AWS continues to expand their global footprint. Last year, we added regions in the UK and Canada, we now have 42 availability zones in 16 geographic regions and will continue to grow that business globally. And India again, we've mentioned, but that is obviously an international investment. + +-------------------------------------------------------------------------------- +Darin Manney, Amazon.com Inc. - Director of IR [37] +-------------------------------------------------------------------------------- + + On the customer split, we serve, in AWS, we serve millions of active customers along the spectrum of large enterprise companies, as well as small startups and the public company or public environment as well. The multitude of launches that we had in re:Invent was great for all sizes of customers really, both large and small. +Both companies just getting there start with AWS, but also companies that have been engaged with AWS for many years. So we're really happy about the engagement of re:Invent and the participation in that conference, as well as the engagement of the new services that we have launched in Q4 and all of 2016 really. + +-------------------------------------------------------------------------------- +Operator [38] +-------------------------------------------------------------------------------- + + Eric Sheridan, UBS. + +-------------------------------------------------------------------------------- +Eric Sheridan, UBS - Analyst [39] +-------------------------------------------------------------------------------- + + Thanks for taking the question, maybe two if I can ask. One, the other North America revenue line in our view has a lot of advertising revenue in it, and that line continues to show a lot of momentum, come in better than expected. Can you talk holistically short, medium, long term about how you think you are approaching an advertising business across your broad properties? +What that might become longer term, and how that might impact the P&L? And then one housekeeping item, anything to call out as an impact from demonetization efforts India in either Q4 or Q1? Thanks so much. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com Inc. - CFO [40] +-------------------------------------------------------------------------------- + + Yes, I will take the advertising question. Yes, it's very early in the advertising space, but what our goals there are to be helpful to customers and enhance their shopping and viewing experiences. Mostly with targeted recommendations. We think that is a good strategy rather than invasive things that take away from the shopping experience. +I would sponsored products is off to a great start. They're finding a very effective way for advertisers to reach interested customers. +We also on Video have not added much in the way of advertising yet. There is some pre-roll as we call it, but for the most part we like to the progression. We are balancing customer experience with advertising at all times, and we like the team that's working on it. + +-------------------------------------------------------------------------------- +Darin Manney, Amazon.com Inc. - Director of IR [41] +-------------------------------------------------------------------------------- + + And on other revenue, I just want to call out. There's a number of things going into that particular line. These things include revenue from our co-branded credit card arrangements and certain advertising, particularly display advertising. +We have other types of advertising that spread out throughout the P&L, whether that's a shared marketing investment from our vendors which goes into contra COGS and lowers the cost of sales or its related to other seller advertising which is generally within the EGM and media categories. I would say other revenue incorporates a number of things, not just advertising. And on India demonetization, nothing particular to call out today on that. + +-------------------------------------------------------------------------------- +Operator [42] +-------------------------------------------------------------------------------- + + Anthony DiClemente, Nomura Instinet. + +-------------------------------------------------------------------------------- +Anthony DiClemente, Nomura Instinet - Analyst [43] +-------------------------------------------------------------------------------- + + Thanks for taking my questions. It's about Prime Video, you said you were pleased with the hours of engagement. My question is do you think that the hours of video stream need to accelerate from here to get to an adequate return on the invested capital in video, or are you happy with those returns with the current levels of engagement? +And then relatedly on Prime Video, could you just talk about your ambitions to potentially extend the video offering beyond on demand and into possibly a virtual cable bundle? And then finally, just a question of do you need to aggressively partner with distributors, whether they be cable distributors or hardware device companies, in order to get better distribution of the Amazon Prime Instant Video app and content to your customers? Thanks. + +-------------------------------------------------------------------------------- +Brian Olsavsky, Amazon.com Inc. - CFO [44] +-------------------------------------------------------------------------------- + + I can't add too much or won't add too much on the last two questions, but I will say on -- you're talking about the levels of engagement now that we are seeing versus what would be the long-term model over time. We're certainly spending ahead of the value of the engagement right now. But it's a good sign that it's building, an important step was that global Prime program that we launched in the fall, excuse me, in Q4. +As I said, it's very much a fixed expense game, especially with original content. The fixed amount can go up or down, but the ability to amortize it over large population is what we are looking for. So we see a double benefit of the global Prime Video program, again, both to amortize the investment in original content but also to show that original content to more and more people. +Because we think it's done really well. We think it's won a lot of awards, and we have worked with some great talented people. It's our ability to scale that and to amortize it over a much larger customer base, which will help us in the future. + +-------------------------------------------------------------------------------- +Darin Manney, Amazon.com Inc. - Director of IR [45] +-------------------------------------------------------------------------------- + + Thank you for joining us on the call today and for your questions. A replay will be available on our Investor Relations website at least through the end of the quarter. We appreciate your interest in Amazon.com, and look forward to talking to you again next quarter. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/exam/original-files/Problem_1_Sample/2017-Jan-13-BAC.N-137706007374-Transcript.txt b/exam/original-files/Problem_1_Sample/2017-Jan-13-BAC.N-137706007374-Transcript.txt new file mode 100644 index 0000000..9292206 --- /dev/null +++ b/exam/original-files/Problem_1_Sample/2017-Jan-13-BAC.N-137706007374-Transcript.txt @@ -0,0 +1,950 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q4 2016 Bank of America Corp Earnings Call +01/13/2017 08:30 AM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Brian Moynihan + Bank of America Corporation - Chairman, President and CEO + * Lee McEntire + Bank of America Corporation - SVP, IR + * Paul Donofrio + Bank of America Corporation - CFO + +================================================================================ +Conference Call Participiants +================================================================================ + + * Steven Chubak + Instinet - Analyst + * Matt Burnell + Wells Fargo - Analyst + * Gerard Cassidy + RBC - Analyst + * John McDonald + Bernstein - Analyst + * Paul Miller + FBR Capital Markets - Analyst + * Mike Mayo + CLSA - Analyst + * Eric Wasserstrom + Guggenheim - Analyst + * Jim Mitchell + Buckingham Research - Analyst + * Nancy Bush + NAB Research - Analyst + * Glenn Schorr + Evercore ISI - Analyst + * Matt O'Connor + Deutsche Bank - Analyst + * Betsy Graseck + Morgan Stanley - Analyst + * Marty Mosby + Vining Sparks - Analyst + +================================================================================ +Presentation +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Good day, everyone and welcome to the Bank of America earnings announcement call. (Operator Instructions). Please note this call is being recorded. It is now my pleasure to turn the conference over to Mr. Lee McEntire. Please go ahead, sir. + +-------------------------------------------------------------------------------- +Lee McEntire, Bank of America Corporation - SVP, IR [2] +-------------------------------------------------------------------------------- + + Good morning. Thanks to everybody for joining us. I know it's a busy morning for all of you for the fourth-quarter 2016 results. Hopefully, everybody has had a chance to review the earnings release documents that are available on our website. Before I turn the call over to Brian and Paul, let me remind you we may make some forward-looking statements. For further information on those, please refer to our earnings release documents, our website or SEC filings. With that, let me turn it over to Brian Moynihan, our Chairman and CEO, for some opening comments before Paul Donofrio, our CFO, goes through the details. Brian? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman, President and CEO [3] +-------------------------------------------------------------------------------- + + Good morning. Thank you, Lee and thank all of you for joining us to review our results today. Results this year in the fourth quarter complete a solid year of execution and driving our responsible growth strategy. We produced earnings of $17.9 billion in 2016. That is a 13% growth over 2015. In a year in which we had a series of unexpected and sizable events around the world and a rough start in the capital markets, we were able to achieve 1% growth in revenue against the backdrop of a slow growth US economy. +Important, we focused on driving what we could control -- cost, production and risk. So how did we do on all that? We lowered our cost, improved productivity with a result in reduction of expenses by almost 5% compared to 2015. That's nearly $3 billion in expense reductions continuing a long-term trend. From the peak in 2011 of $77 billion, expenses are now down $22 billion or 29%. And the reductions coupled with the revenue growth drove 6% in operating leverage. +An improving economy, a relentless focus on client selection and growth through responsible lending combined to result in a historical low charge-off rate of 39 basis points for our Company this quarter. We also returned more capital to shareholders through higher dividends and more share repurchases during 2016. As you may have seen in the news release this morning, we announced an additional $1.8 billion expansion to our share buyback program. So adding the $1.8 billion to the $2.5 billion left, that brings us to $4.3 billion for the first six months of 2017. +Our repurchase resulted in a 2% reduction in share count at the end of 2016, which added to the earnings growth to produce a 15% growth in earnings per share. For the year, our return on tangible common equity was 9.5% while return on assets was 82 basis points and the efficiency ratio improved from 70% to 66%. +From a balance sheet perspective, let me mention a few things that are noteworthy as the items continue to grow with the business while optimizing the balance sheet at the same time. Our average deposits grew $64 billion or 5% compared to fourth quarter of 2015. Our average loans grew $22 billion, or 3%, as the lending segments outgrew the legacy runoff and Paul will show you that later on. +On regulatory capital, we ended the year at 10.8% on a fully phased in CET1 advanced basis. Importantly, after reviewing our year-end calculation and through the hard work of our teams, we are pleased to report that our method 2 GSIB capital ratio requirement has dropped 50 basis points, so our total 2019 CET1 requirement is now 9.5% instead of 10%. +Turning to slide 3, on these charts, you can see that each business segment played a role in driving our earnings growth in 2016. The businesses are producing good efficiency ratios and returns above the firm's cost of capital. And on this page, you can see that each business is driving hard to create operating leverage in the upper right-hand corner. +Consumer Banking, our biggest earning business, continued its strong performance through its transformation; produced more than $7 billion in after-tax earnings, growing 8%. Our Global Wealth and Investment Management business improved its earnings 8% as well, earning $2.8 billion. Our Global Banking business serving our commercial customers continues to produce strong revenue and generated $5.7 billion of earnings. And lastly, but not leastly, our Global Markets business earned $3.8 billion, the most it's earned in the past five years with a rebound in sales and trading revenue and strong expense discipline on the part of the team. +As you know, and you can see from the slides Paul will walk through later, our business has important leadership positions across the board in the industry and we believe that they have room to grow their marketshares by focusing on deepening relationships with their existing customers, as well as winning customers from the competition. +Turning to slide 4, let me cover a few highlights on the fourth quarter before I turn it over to Paul. Reported earnings of $4.7 billion after tax of $0.40 per diluted share, an EPS improvement of 48% from the year-ago quarter on a reported basis. We had a couple pennies of net benefit this quarter from resolution of some tax matters that were partially offset by the combination of smaller charges for revenue for debt hedge ineffectiveness, additions to our UK card PPI reserves to be prepared for sale and DBA. This improvement in year-over-year results was driven by expense reductions as we lowered costs by 6% from fourth quarter 2015 to fourth quarter 2016. Revenue from the fourth quarter 2015 to the fourth quarter of 2016 was up 2% on a reported basis. Note that this quarter had lower levels of noncore gains from equity, debt and asset sales than in past years. So it is effectively more core earnings. Provision expense was modestly lower in the aggregate from fourth quarter 2015. Our responsible growth strategy resulted in a 23% improvement in net charge-offs and we also had a lower amount of net reserves released from last year's fourth quarter. +So overall, I am pleased with the results. The Company has produced another quarter of solid results with strong operating leverage. We reported year-over-year earnings growth in every quarter 2016 with expenses declining in every quarter and revenue growing in three out of four. Our focus on operating leverage, expense management and operating excellence continues. The fourth quarter of 2016 represents the 20th successive quarter of year-over-year non-litigation expenses going down. +The expense reduction has been an important ability to grow earnings without the benefit of significant rate increases, but now we see rate increases in the fourth quarter of 2016, the latter part of the quarter, on both the long end and the short end. As these rate increases were late in the quarter, they didn't benefit the fourth quarter NII number that significantly, but we look forward to first quarter 2017 when we expect NII to increase, all things remaining equal, by approximately $600 million per quarter despite having two less days in that first quarter. And with loan and deposit growth, we'd expect NII to continue to improve from there throughout 2017 and beyond. And Paul will take you through these numbers in a minute. +This dynamic bodes well as we expect growth in earnings from productivity improvements will now get the added benefits of rate increases. This quarter, investors have asked a lot of questions that they usually ask, but importantly questions about the incoming new Presidential administration. Their questions have ranged from corporate tax reform and what do we think about that, regulatory changes, economic growth and the impacts of these things and interest rate changes. +The optimism for positive change here at Bank of America and among our customers is palpable and has driven bank stock prices higher. We will have to see how these topics play out, but that we are optimistic. But, in the interim, we will continue to operate the Company by controlling and driving what we can. We are going to drive responsible growth. In prior calls, I answered the questions you asked about the fundamentals. First, can we continue to stay this disciplined on risk? Yes, we are making progress growing our loans, growing our deposits, growing our market business and keeping the risk in check in all areas and our credit is among the best it has ever been in history. +Can we get earnings growth in a low rate environment? Yes, the answer is yes; you are seeing our earnings growth even without a significant rise in rates and now we look forward to those rises in rates. And the question is can you keep driving expenses lower? Again, the 20th consecutive quarter of year-over-year lower operating expenses and we have room to move them lower even as we continue healthy investment across all our businesses. And can we continue to drive our returns up above our cost of capital and you are seeing that happen. +So while we are very optimistic about the future, optimistic about new policies which could spur growth, we, at Bank of America, will continue to drive what we can control and that's a culture of what we have and we will keep doing that. With that, I will turn it over to Paul for the fourth quarter results. Paul? + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [4] +-------------------------------------------------------------------------------- + + Thanks, Brian. Good morning, everybody. Since Brian covered the income statement highlights, I'm going to start with the balance sheet on page 5. Overall, the end-of-period assets declined $8 billion from Q3 as solid loan growth across our business segments was more than offset by lower levels of trading assets in our Global Markets business. On an ending basis, loans grew $10.9 billion from Q3 2016. This includes adding back $9.2 billion in UK card balances that were moved from loans and leases to assets of businesses held for sale pursuant to the announcement of the sale of our UK card business. Loans on a reported basis showed growth of $1.7 billion as a result of that movement. We expect to close the sale around the middle of the year subject to regulatory approvals. +On the funding side, deposits rose $28 billion from Q3, or 9% on an annualized basis. At the same time, long-term debt fell by $8.3 billion driven by hedge and FX valuations. Global Markets trading liabilities declined in tandem with Global Markets assets. Lastly, common equity declined $3.2 billion compared to Q3 as additions from earnings were offset by a decline in AOCI and capital returned to shareholders. AOCI declined by $5.6 billion. Driving the decline was a $4.7 billion reduction in the value of AFS securities held in our investment portfolio, which reduced in value as long-term rates rose significantly during the quarter. Reflecting this, global liquidity sources declined a bit in the quarter, ending the year just below $0.5 trillion. However, we remain well compliant with fully phased-in US LCR requirements. +We returned a total of $2.1 billion to common shareholders through a combination of dividends and share repurchases in the quarter.. Return of capital, plus the decline in AOCI, drove a 1% decline relative to Q3 2016 intangible book value per share to $16.95. However, it's up $1.33, or 9% from Q4 2015. +Turning to regulatory metrics and focusing on the advanced approach, our CET1 transition ratio under Basel III ended the quarter at 11%. On a fully phased-in basis compared to Q3 2016, the CET1 ratio decreased 12 basis points to 10.8% and remains well above our new 2019 requirement of 9.5%. CET1 capital declined $3 billion to $163 billion driven by the negative OCI valuations. Benefit (inaudible) ratio was a $12 billion decline in RWA driven by lower exposures in our Global Markets business partially offset by loan growth. We also provided our capital metrics under the standardized approach, which remained relevant for CCAR comparison. Here, our CET1 ratio is higher at 11.5%. Supplementary leverage ratios were both the parent and the bank continue to exceed US regulatory minimums that take effect in 2018. +Turning to slide 6, on an average basis, total loans were up $22 billion, or 3% from Q4 2015. Versus Q3 2016, we saw a pickup in growth driven by holiday spending on credit cards and some late quarter growth in commercial activity. Looking at loans by business segment and in all other, year-over-year, loans in all other were down $26 billion driven by continued runoff of first and second lien mortgages while loans in our business segments were up $48 billion or 6%. +Consumer Banking led with 8% growth. We continue to see growth in residential real estate. As the pipeline from Q3 2016 flowed through, vehicle lending was solid, home equity paydowns and runoff continued to outpace originations. In Wealth Management, we saw year-over-year growth of 7% driven by residential real estate. Global Banking loans were up 6% year-over-year and on the bottom right chart, note the $64 billion in year-over-year growth in average deposits that Brian mentioned. +Turning to asset quality on slide 7, one can see clear evidence of our responsible growth strategy. Credit quality metrics remain strong, perhaps best symbolized by our net charge-off ratio, which hit a record low of 39 basis points this quarter. Our strong credit quality metrics are a manifestation of our overall risk management, which has been transformed since 2008 and we expect our performance to bode well as we move through economic cycles. +Total net charge-offs of $880 million improved slightly from Q3 and are down $264 million from Q4 2015. Provision expense of $774 million declined $76 million from Q3 and $36 million from Q4 2015. A net reserve release in the quarter of $106 million was slightly higher than Q3 2016 as we released $75 million of energy reserves given improvement in asset quality and current stability in energy prices. +The Q4 2016 total net reserve release was roughly a third the amount released in Q4 2015 as consumer real estate releases continue to moderate lower. Our allowance to loan ratio this quarter was 1.26% with a current coverage level 3 times our annual net charge-offs. +On slide 8, we break out credit quality metrics for both our consumer and commercial portfolios. As you can see, charge-offs improved in both periods with consumer real estate driving consumer improvement and reduced energy losses driving commercial improvement. We saw improvement in most of our other credit metrics. +Turning quickly to slide 9, net interest income on a GAAP non-FTE basis was $10.3 billion, $10.5 billion on an FTE basis. Compared to Q4 2015, NII this quarter was relatively stable after adding back the $612 million charge we incurred last year when we called some TruPS securities. Compared to Q3 2016, NII was up $91 million. NII benefited in the quarter from solid loan and deposit growth. We also saw some modest benefit in NII from higher interest rates. Partially offsetting these benefits was market-based hedge ineffectiveness totaling $169 million related to the accounting for our long-term debt and associated swaps where we have swapped interest payments from fixed to floating. This ineffectiveness is recorded in NII and will revert to zero over the remaining life of the debt. It is just a timing issue caused by accounting rules. +While I'm not likely to give specific NII guidance in most quarters, the move in Q1 2017 is expected to be significant, so we wanted to provide some near-term perspective. As you think about Q1 2017 versus Q4 2016, the benefit from the absence of negative market-related ineffectiveness will be offset by two less days in the quarter, so you can effectively take this quarter's NII as a starting point. +Now assuming interest rates remain at current levels and we see modest loan and deposit growth, we believe we will earn approximately $600 million in additional NII in Q1, primarily driven by the Q4 rate increases in both the long and short end. From there, we would expect continued growth in 2017 assuming modest loan and deposit growth and stable short and long-term interest rates. With respect to asset sensitivity as of 12/31, an instantaneous 100 basis point parallel increase in rates is estimated to increase NII by $3.4 billion over the subsequent 12 months. +Turning to slide 10, non-interest expense was $13.2 billion. That's an improvement of more than $800 million or 6% from Q4 2015 and as you can see, the reductions are across the Company in virtually all line items of expense. Our productivity projects and efforts to simplify how we get our work done and how we deliver for our clients are driving these reductions. +Q4 litigation expense was $246 million, which is fairly consistent with Q3 2016, but lower than the $400 million recorded in Q4 2015. Our employee base declined 2% from Q4 2015. However, we continue to invest in growth by adding primary sales associates across Consumer, across Wealth Management and across Global Banking. As a reminder, in Q1, similar to past years, we expect to incur roughly $1.3 billion for retirement-eligible incentives and seasonally elevated payroll tax expense. Additionally, if we were to see a normal seasonal rebound in capital markets-based activity, we would most likely see an associated increase in expense. +Turning to the business segments and starting with Consumer Banking on slide 11, this business is generating above-average deposit growth, solid loan growth, improving customer satisfaction and strong growth in earnings. Consumer Banking earned $1.9 billion and produced a 22% return on allocated capital this quarter. I would note that pre-tax, pre-provision earnings rose more than $400 million or 12%. 7% expense and 5% NII improvement were both notable and enough to more than offset higher provision expense and prior-year divestiture gains. Revenue was up 1% compared to Q4 2015 as NII growth was partially offset by the absence of approximately $100 million of divestiture gains in Q4 2015 as we sold the last of our larger, non-core affiliate portfolios in that quarter. +Credit quality remains good and provision was higher primarily as a result of reserve releases in the year-ago quarter. Consumer continued to lower expenses and the efficiency ratio dropped nearly 500 basis points to 53% from Q4 2015 with good pricing discipline, rate paid on the deposits remained a steady 4 basis points and the operating cost of deposits was also steady at 160 basis points. +Turning to slide 12 and looking at key trends, first, in the upper left, the stats are a reminder of our strong competitive position. Looking a little closer at the revenue drivers compared to Q4 2015, while we report NII and noninterest revenue separately, it's important to emphasize again that our strategy is to focus on relationship deepening and growing total revenue while improving operating leverage through expense discipline. Our relationship deepening is improving NII and balance growth while holding the fee line flat as we reward customers for doing more business with us. +We believe the overall result is more satisfied customers whose balances are more sticky over time. We continue to see strong client enrollment in our preferred rewards programs. For the year, we enrolled 1.2 million clients in preferred rewards and that's up 42% from 2015. We are seeing a 99% retention rate for customers enrolled in preferred reward. Average deposits continue their strong growth, up $54 billion, or 10% year-over-year, outpacing the industry. +With respect to card, spending levels and new issuances were strong; however, the industry trend of increasing reward costs continues to mitigate our overall card revenue growth. By the way, this makes it even more important to hold down acquisition costs for the use of our branch network to source and fulfill customer demand. I would also emphasize that our underwriting standards in card result in a relatively higher quality new card customers that, on the one hand, have higher spending habits, but, on the other hand, receive more rewards. +Turning to expenses, in the upper right, they declined 7% in Q4 2015 despite higher FDIC assessment charges between the two periods. Digitalization and other productivity improvements continue to help us drive down costs in our delivery network. Focusing on client balances on the left, in addition to deposit growth, client brokerage assets at $145 billion are up 18% versus Q4 2015 on strong account flows and market valuations. We also increased the number of Merrill Edge accounts by 11% versus Q4 2015. We now have more than 1.7 million households that leverage our financial solution advisors and self-directed investing platforms. +Moving across the bottom of the page, note that the average loans are up 8% from Q4 2015 on strong mortgage and vehicle lending growth. Loan growth reflected total consumer real estate production of $22 billion, up 29% from Q4 2015 and 7% higher than Q3 2016 as the prior quarter's pipeline came through. We retained about three quarters of first mortgage production on the balance sheet this quarter. As you might imagine, the sudden rise in long-term rates caused a noticeable decline in applications to refinance, driving the overall mortgage pipeline down 43% from the end of Q3. Auto lending was up 15% from Q4 2015 with average book FICO scores remaining well above 750 and net losses of 35 basis points. +On US consumer card, average balances grew from Q3 aided by seasonal holiday spending. And spending on our credit cards adjusted for divestitures was up 10% compared to Q4 2015. +Okay, turning to slide 13. We remain an established leader in digital banking. With improvements like our Spanish app and contactless sign-in, we continue to see momentum in digital banking adoption. Mobile banking continues to transform how our customers bank and we expect to introduce our artificial intelligence application, Erica, this year. She will add to both the functionality and excitement around digital banking. Importantly, as adoption rises, particularly around transaction processing and self-service, we expect to see efficiency and customer satisfaction improve. +I won't go through all the details on this slide, but mobile devices now represent 19% of all deposit transactions and represent the volume of more than 880 financial centers. Sales on digital devices continue to grow and now represent 20% of total sales. While these trends are important, and continue to transform how consumers interact with us, I would remind you that we still have nearly a million people a day walking into our financial centers across US. Many of these customers still use our branches to transact, but many also use the branch as a financial destination where they can learn more about products and services, work face-to-face with a specialized professional and generally improve their financial lives. +Turning to slide 14, Global Wealth & Investment Management produced earnings of $634 million, which is up modestly from Q4 2015 on solid operating leverage. The business continues to undergo meaningful change as firms and clients adapt to the new fiduciary rules and other market dynamics. We remain well-positioned with market-leading brands and a wide range of investment service options ranging from fully advised to self-directed with guided investing for those who want something in between. We also have strong margins and returns, as well as resources to help us manage through market dynamics and customer trends. +Year-over-year noninterest income declined $104 million as higher asset management fees were more than offset by lower transactional revenue. A 4% decline year-over-year in expenses drove a 170 basis point improvement in operating leverage from Q4 2015. The decline was driven by the expiration of the amortization of advisor retention rewards that were put in place at the time of the Merrill Lynch merger. Other declines were the result of work across many categories of expense more than offsetting higher litigation and FDIC costs compared to last year. +Moving to slide 15, we continue to see overall solid client engagement. Client balances climbed to $2.5 trillion driven by market values, solid long-term AUM flows and continued loan and deposit growth. $19 billion of long-term AUM flows include clients transferring assets from AUM, clients transferring assets to AUM from IRA brokerage. Average deposits of $257 billion were up 2% from Q4 2015. Average loans of $146 billion were up 7% year-over-year. Growth remained concentrated in consumer real estate. +Turning to slide 16, Global Banking (inaudible) $1.6 billion, which was up 11% year-over-year. Global Banking continues to drive loan growth within its risk and client frameworks, continued stabilization in oil prices and improvement in exposures drove provision expense lower in Q4 2016. Investment banking fees were down 4% from Q4 2015 as strong debt underwriting activity was more than offset by lower advisory and equity issuance fees. Expenses decreased from Q4 2015 despite the addition of new commercial and business bankers and increased FDIC costs. The efficiency ratio improved to 45% in Q4. Return on allocated capital increased to 17% despite adding a couple billion dollars of allocated capital this year. +Looking at trends on slide 17 and comparing Q4 last year, relative to Q3 2016, we saw a pickup in lending with average loans on a year-over-year basis up $19 billion, or 6%. Growth was broad-based across large corporates and middle-market borrowers and it was diversified across industries. Average deposits increased from Q4 2015, up $6 billion or 2% from both new and existing clients. +Switching to Global Markets on slide 18, the business had another solid quarter. Given our broad product and geographic footprint, we were well-positioned to help clients address volatility around the elections and central bank policy uncertainty both in the US and abroad. We continue to invest in and enjoy leadership positions across a broad range of products. This business is another great example of our focus on improving operating leverage. Revenue grew 8% excluding net DVA while expenses declined 10%. Global Markets earned $658 million and returned 7% on allocated capital in what is typically the most seasonally challenged quarter of the year. +For the year, the return on allocated capital was 10% as sales and trading revenue ex-DVA grew 5% while expense declined. It is worth noting that we achieved these results with a stable balance sheet, lower VAR and 7% fewer people. Continued expense discipline drove cost 10% lower year-over-year led by reductions in operating and support costs. +Moving to trends on slide 19 and focusing on the components of our sales and trading performance, sales and trading revenue of $2.9 billion, excluding DVA, was up 11% from Q4 2015 driven by FICC. In terms of revenue, while we experienced a normal seasonal decline versus Q3, this Q4 was our second best fourth quarter in five years. Excluding net DVA and versus Q4 2015, FICC sales and trading of $2 billion increased 12%. Mortgages showed particular strength among the credit products as investors sought yield. It was a challenging market for municipals. With the exception of rates, we saw an improvement in trading of macro products, equity sales and trading was solid at $948 million, up 7% versus Q4 2015. Flows were strong in the second half of the quarter driven by changing investor sentiment after the US elections, which drove a favorable environment for derivatives as clients repositioned across industries. We were able to help many clients who were underweight equities leading up to the election add exposure. +On slide 20, we show all other, which reported a net loss of $95 million. This quarter includes a $132 million charge to add to our PPI reserve. You will also note that this quarter includes no debt security gains. Equity investment income was only $56 million and there was little to no gains from asset sales. Given the increase in rates and our progress with respect to reducing non-core assets, this quarter's results are more reflective of future trends with respect to these two line items. All others Q4 2016 loss includes a net benefit from some tax matters of roughly $500 million, which reduced our tax rate in the quarter to 22%. Excluding those matters, the effective tax rate would have been about 31%. I would expect a similar tax rate of 31% for the average for 2017, excluding unusual items. +Okay, let me editorialize a little bit as I finish here. We reported solid results this quarter that capped a year filled with improvement. These results show that our strategy of responsible growth is working. One can see responsible growth in our deposit growth while maintaining good pricing discipline. You can see it in the reduction in our expenses even as we continue to invest in the future of the franchise. And you can see it in the deepening of relationships with our customers and clients. Our focus on responsible growth is helping us return more capital to shareholders and today's announcement of an increase in our share repurchase authorization is another example of that. +Responsible growth has also driven the transformation of our risk profile, which is evident in our credit risk metrics and something we believe will differentiate us through future economic cycles. And responsible growth is driving operating leverage, which is visible in each of our lines of business. Lastly, responsible growth has put us in a solid position to benefit in 2017 from higher interest rates. With that, I will open it up to Q&A. + + +================================================================================ +Questions and Answers +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions). John McDonald, Bernstein. + +-------------------------------------------------------------------------------- +John McDonald, Bernstein - Analyst [2] +-------------------------------------------------------------------------------- + + Hi, good morning. Paul, I was wondering if you could give us a little more split on some of the drivers of the net interest income increase that you are expecting to occur between the fourth and first quarter, the $600 million. How much of that is driven by the Fed hike we saw on the short end and how much of it might be the long end in rates versus loan growth? + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [3] +-------------------------------------------------------------------------------- + + Sure. Maybe the simplest way to answer that question would be to take you back to 9/30 when the interest sensitivity on the long end was $2.1 billion. We saw a 75 basis point increase in long end rates since then, so 75 basis points times $2.1 billion is $1.6 billion. At that time, the short-end sensitivity was $3.3 billion. We saw 25% of 1%, 25 basis points, so 3.3 times 25%, that's another $600 million. So together, that's $2.4 billion that you can see just in the change in the interest sensitivity. If you divide that by four, you get your $600 million. +Again, I would emphasize that we see NII growing from there as we move through 2017 assuming again we have modest loan growth, modest deposit growth and a stable short and long-term interest rate environment. + +-------------------------------------------------------------------------------- +John McDonald, Bernstein - Analyst [4] +-------------------------------------------------------------------------------- + + Okay. And then the reason the 5.3 future sensitivity has now moved to 3.4 is you've rolled $2 billion into your base case outlook? + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [5] +-------------------------------------------------------------------------------- + + Yes, conceptually, we've captured the decline in sensitivity -- we are going to capture the decline in sensitivity that you've just experienced in our NII over the next 12 months. You can see that under the calculation I just did for you. + +-------------------------------------------------------------------------------- +John McDonald, Bernstein - Analyst [6] +-------------------------------------------------------------------------------- + + Yes, okay, got it. That's helpful. And then a question for Brian on capital return and CCAR. Some of the other banks have used the de minimis exception to top off their 2016 CCAR authorizations. That leaves Bank of America standing out quite a bit on the low end of payouts versus peers. So I'm kind of wondering -- two questions -- one, how do you guys think about that de minimis -- you did well in 2016. Any reason that Bank of America couldn't think about the de minimis top-off? Are there restrictions on that or could you do that at some point this year on the de minimis? +And then second, as you move into 2017, what are your goals to get your capital distributions closer to peer payouts and why wouldn't you be able to do that? Thanks. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman, President and CEO [7] +-------------------------------------------------------------------------------- + + Yes, John. So this morning, as part of our release, we announced that we got approval for a de minimis of $1.8 billion to add to the $2.5 billion we have for the first half of this year to bring the repurchase volume to $4.3 billion for the first half here. So we applied for that obviously in December and got the approval and our Board has approved it and that went out with the release this morning. +In terms of next year, we will see what the scenarios are with all the caveats, but you've seen us constantly move our numbers up and we will continue to do that. Our cushions and stuff are strong on the earnings. The most important thing for us was to make sure the earnings power of the Company kept coming back and now with $17 billion of earnings, we feel confident we ought to be able to push forward. + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [8] +-------------------------------------------------------------------------------- + + And John, that $1.8 billion was the full 1%. + +-------------------------------------------------------------------------------- +John McDonald, Bernstein - Analyst [9] +-------------------------------------------------------------------------------- + + Great. And that will take you through -- just as a reminder, Paul, that will take you through the end of this CCAR period, right? + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [10] +-------------------------------------------------------------------------------- + + Right. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman, President and CEO [11] +-------------------------------------------------------------------------------- + + Right, the first two quarters all in the first half here. + +-------------------------------------------------------------------------------- +John McDonald, Bernstein - Analyst [12] +-------------------------------------------------------------------------------- + + Great, thank you. + +-------------------------------------------------------------------------------- +Operator [13] +-------------------------------------------------------------------------------- + + Jim Mitchell, Buckingham Research. + +-------------------------------------------------------------------------------- +Jim Mitchell, Buckingham Research - Analyst [14] +-------------------------------------------------------------------------------- + + Hey, good morning. Maybe I'll just follow up on the NII question a little bit. Does that guidance that you provided include the sale of the UK card business and what's the impact from that? + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [15] +-------------------------------------------------------------------------------- + + Yes, the guidance includes the sale of the UK card business, but just to be clear, that's not going to close until probably mid this year. So that NII will be with us until it closes. + +-------------------------------------------------------------------------------- +Jim Mitchell, Buckingham Research - Analyst [16] +-------------------------------------------------------------------------------- + + Sure. So when we think about going forward, what kind of deposit betas are you assuming in that $600 million per quarter and how do we think about the next rate hike? Say we get one in June, which seems to be consensus, do you still expect to have very low deposit betas there? + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [17] +-------------------------------------------------------------------------------- + + Yes, so, again, if you go back to 9/30, I think we told you we were using deposit betas in our modeling on interest-bearing deposits in the high 40s. And we said, hey, the first few rate hikes is going to be less and the later rate hikes, it's going to be more and that's what we are experiencing. So if you looked at our deposit betas right now, you would probably see it inching into the 50s. It's definitely moving up as we get more short-term rate hikes. + +-------------------------------------------------------------------------------- +Jim Mitchell, Buckingham Research - Analyst [18] +-------------------------------------------------------------------------------- + + And you think that can continue into the third, the next rate hike? + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [19] +-------------------------------------------------------------------------------- + + Well, again -- we will see what happens here. We had a rate hike a year ago and I think a number of people would have said that we would have had a pass-through, and I don't think there was a significant pass-through in the industry. We just had a rate hike in December and we are going to see how much pass-through we actually had. From a modeling perspective, in that guidance I gave you, from a modeling perspective, the pass-through rate on the next 100 basis points would be in the 50s. And again, it would be the same story. Less in the beginning, more at the end. + +-------------------------------------------------------------------------------- +Jim Mitchell, Buckingham Research - Analyst [20] +-------------------------------------------------------------------------------- + + Yes, understood. Okay, that's very helpful. Thanks. + +-------------------------------------------------------------------------------- +Operator [21] +-------------------------------------------------------------------------------- + + Glenn Schorr, Evercore ISI. + +-------------------------------------------------------------------------------- +Glenn Schorr, Evercore ISI - Analyst [22] +-------------------------------------------------------------------------------- + + Hello there. Two quickies. One on card, one on mortgage. On cards, you had some pretty good growth and we're seeing really big growth at some of the other big banks and some of the economics of the business are being given way to support that growth. I'm just curious on how you are balancing that of customer growth versus giving up some of the economics to capture that growth. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman, President and CEO [23] +-------------------------------------------------------------------------------- + + Well, I think the way to think about it, Glenn, overall is that we are doing on a customer basis. So when we -- Paul gave you the statistics earlier for the preferred rewards enrollments and things like that, so we are driving -- our priorities are to get our card used by our core customers and reward them for that who have other deeper relationships with the Company. So in a broad sense, we are getting paid through the NII line, as well as any other relationship they have, as well as the card income fee line that you see on deposit balances and other things, plus obviously the card balances. +We've been pleased that we now have gotten through all the sales when you think about this quarter versus last year and so active accounts are moving up I think 2% or 3% or so. Year-over-year the active accounts are up, which shows the strategy is working. So while we make that investment you're talking about and that is part of the competitive dynamics, we feel good about the balances growing, so we are getting more NII from it, but importantly with our customers these are the best customers we have and so we're seeing their other aspects of relationship grow. + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [24] +-------------------------------------------------------------------------------- + + And again, strong risk-adjusted margins in that business, stable for us above 9%, charge-offs look great and as Brian said, we are standing at the higher end of the market. + +-------------------------------------------------------------------------------- +Glenn Schorr, Evercore ISI - Analyst [25] +-------------------------------------------------------------------------------- + + I guess the super ROA and ROE support it anyway for the overall Company. And then the question on mortgage was production was good, but the pipeline fell a lot. Obviously a function of what happened in rate, but can you help us think about what to expect say next year if say rates go up along the forward yield curve? How do you model that? How can you manage the expense along the way? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman, President and CEO [26] +-------------------------------------------------------------------------------- + + Well, I think if you look at the page that showed the quarterly production in the Consumer section there, you can see I think it was three quarters -- last three quarters all over $20 billion in home mortgage loans and home equity loans. What you wouldn't know from the outside is, during the last year, we made a series of major changes in that business. We've consolidated internal platforms so we have one group, a fellow named Steve Boland who does a terrific job for us, delivering the product across all the businesses whether it's US trust, Merrill Lynch or the consumer business. +In addition, we brought in servicing from third parties of our customers and we continue to do that. So even in a year where we've made tremendous transformations, you saw [$320 billion] plus. And so our view -- the team would tell me that the pipeline will be down because refinances are down and therefore expect less, but I think my view is that they should be able to continue to grow marketshare frankly because of the capacity that they were able to develop this year given those changes and still produce flow. +That being said, it's a rate-sensitive product. So we've told you to think about the mortgage banking line as $300 million odd. It was a little higher this quarter just because of some of the dynamics, so it's a relatively modest line, but the production will be strong. + +-------------------------------------------------------------------------------- +Glenn Schorr, Evercore ISI - Analyst [27] +-------------------------------------------------------------------------------- + + Okay, thanks very much. + +-------------------------------------------------------------------------------- +Operator [28] +-------------------------------------------------------------------------------- + + Steven Chubak, Instinet. + +-------------------------------------------------------------------------------- +Steven Chubak, Instinet - Analyst [29] +-------------------------------------------------------------------------------- + + Hi, good morning. So Paul, I wanted to start off with a question on the FICC business. The revenues have been remarkably resilient over the last couple of years really helped by some of the factors that you cited, whether it be strong risk discipline, balance sheet management and the reduction in VAR. But as we look ahead, what we've been hearing from a lot of folks is growing optimism around the FICC business in the coming year and what I'm wondering is whether your strong risk discipline actually precludes you from participating in a significant recovery if that materializes to the same extent as some of your peers. + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [30] +-------------------------------------------------------------------------------- + + Look, we feel, as you point out, look, we feel really great about that business. It is performing very well. I would note the operating leverage we are getting, I would note, as you said, our discipline on risk and the reduction of VAR. So we have no complaints. We have a diversified product set that has a global geographic footprint. We have scale in every major market around the world and when you look at Global Banking and Global Markets together, I would argue that only three companies in the world can deliver what we can deliver for our clients and customers in every major market around the world. +So there is tremendous opportunity there. We are not going to look exactly like every competitor every quarter. We have often said that when things are great, we might not be as high, but when things aren't so good, we are not going to be as low. So we feel great about it, but we think there's lots of opportunity and we would expect continued performance in that business. + +-------------------------------------------------------------------------------- +Steven Chubak, Instinet - Analyst [31] +-------------------------------------------------------------------------------- + + Got it. And switching over to just the capital side for a moment, you highlighted the progress you made in reducing the GSIB surcharge to 2.5. I'm wondering, as you think about how you're going to allocate capital across the different businesses, whether that positions you to reduce your firmwide targets and maybe more specifically how are you thinking about your spot capital requirement today for the firm overall? + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [32] +-------------------------------------------------------------------------------- + + Well, I'm not sure I understand the question. In terms of -- so let's just talk about it a bit. In terms of the allocation of capital, that's a process we go through once a year. We look at a number of different metrics, advanced approach, standardized approach, SLR. We look at internal models, economic capital and we arrive at what we think is the right amount of capital to give to our businesses based upon their business operations and risk. Remember, we've got $500 billion of operational risk capital that was assigned to us by the regulators. From my perspective, personal perspective, most of that is for businesses that we're no longer in, products that we no longer sell, risk that we no longer take. So a big chunk of that sits in all other and wouldn't really be appropriate to push it from a segment standpoint out to the businesses because they are not really using that risk capital. +So is that what you are looking for or was there some other element of that question that I missed? + +-------------------------------------------------------------------------------- +Steven Chubak, Instinet - Analyst [33] +-------------------------------------------------------------------------------- + + Well, I think the tricky part there and admittedly, it's a complex topic is thinking about how much capital you need to get through the CCAR process unscathed or maybe under the new SEB framework, like what's the minimum capital requirement that you would need over which the remainder is considered to be excess and can be returned to shareholders over time? + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [34] +-------------------------------------------------------------------------------- + + Look, we've made a lot of progress on CCAR. We've made -- the progress you are really seeing in the Company is lots of technical things we've done to be much better in CCAR in terms of improving how we do it, involving everybody in the Company, the qualitative aspects of it. I think from a quantitative standpoint, we've always looked like we've had enough capital. I think if you look at our stress losses relative to competitors, you can see responsible growth coming out in the Fed's models, not our models. +So I think we feel really good quantitatively. I think we feel really good qualitatively. If you look at the stress capital buffer, that's not going to impact capital for us. We are probably -- we'd have to see how it all -- the rules -- this was a speech, so we don't really know what all the rules are going to say, but my guess is our stress capital buffer is below the minimum that would be required. So we feel like we are in a good position for CCAR 2017. We don't know what the scenario is yet. We don't know what the rules are, so there's a lot still changing, but we feel really good about the progress we've made and certainly our cushion from a quantitative standpoint. + +-------------------------------------------------------------------------------- +Steven Chubak, Instinet - Analyst [35] +-------------------------------------------------------------------------------- + + All right. Thanks for taking my questions. + +-------------------------------------------------------------------------------- +Operator [36] +-------------------------------------------------------------------------------- + + Betsy Graseck, Morgan Stanley. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [37] +-------------------------------------------------------------------------------- + + Hi, good morning. A couple of questions. One is on just the balance sheet and as you think about your cash duration, just the profile that you have today in a rising rate environment over time. Do you expect to stay more static where you are today or any changes that we should be anticipating? + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [38] +-------------------------------------------------------------------------------- + + I don't think you should anticipate any changes. We haven't changed since rates started rising. We feel good about the way we are. We are very focused on (inaudible) our balance sheet deposits come in. That's what really drives the size of the balance sheet, deposits come in and the question is, within our risk framework, can we put those deposits to work with our customers and clients around the world. If we can, we put it to work within our risk framework. If we can't, it goes into some other place, either cash or the investment portfolio. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [39] +-------------------------------------------------------------------------------- + + Okay, and then on --. + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [40] +-------------------------------------------------------------------------------- + + We are always balancing liquidity, earnings and capital, but we are not really sitting there every quarter figuring out what the most optimum duration is for us. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [41] +-------------------------------------------------------------------------------- + + And then just from the cash perspective, the LCR, could you just give us a little color as to where you stand there? + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [42] +-------------------------------------------------------------------------------- + + We are in very good shape. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [43] +-------------------------------------------------------------------------------- + + So I hear you on that and it sounds like, okay, we have some excess cash and I guess that's part of the reason I asked the question. Is there any interest in moving some of that cash into [that]? + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [44] +-------------------------------------------------------------------------------- + + Yes, but LCR isn't just cash. LCR includes highly -- lots of different securities go into the LCR calculation. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [45] +-------------------------------------------------------------------------------- + + Sure, no, I get that. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman, President and CEO [46] +-------------------------------------------------------------------------------- + + Betsy, to make it simple, the excess of cash coming in over loan growth goes half into mortgage-backed securities and half into treasuries at this point and the duration of what we do on the treasuries will be a little bit based on where we think rates are going and stuff like that. But it's driven -- just it goes into those two things because we have -- once we fund the loan balances, that's where it goes. + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [47] +-------------------------------------------------------------------------------- + + We are not trying to hold more cash than we need. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [48] +-------------------------------------------------------------------------------- + + Yes, that's good to hear. Other question was just on the improvement in the minimum capital ratio and the RWA reduction that drove that. Could you just give us a little more color on the drivers there and do you feel like you are optimized now for what you want to take in terms of risk relative to total size balance sheet? + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [49] +-------------------------------------------------------------------------------- + + Yes, sure. So as I think Brian mentioned and I mentioned, we took the GSIB buffer down 50 basis points. It's at 9.5%, again compared to 10.8% on a fully phased-in basis. So that's 130 basis points of cushion at this point. We got there through things like reducing derivative notionals through riskless trade compressions. We got there by lowering level three assets, as well as overall optimization as the rules became a little bit more clear. So we've been working at this for some time. You've asked on other calls, I think other people have asked, we haven't really wanted to declare where we were, but now we've got to the end of the year. This is when the calculation really matters so we thought it was important to disclose that progress. +I would also say that Global Markets, it's going to be up and down in any given quarter. The ending balances in the third quarter were up. They were a little bit less than the end of the fourth quarter just on client activity. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [50] +-------------------------------------------------------------------------------- + + Right. Okay, thank you. + +-------------------------------------------------------------------------------- +Operator [51] +-------------------------------------------------------------------------------- + + Marty Mosby, Vining Sparks. + +-------------------------------------------------------------------------------- +Marty Mosby, Vining Sparks - Analyst [52] +-------------------------------------------------------------------------------- + + Thank you. When you think about rate sensitivity and deposit betas, you get back to really deposit flows. We continue to see increases in deposit balances and until we see any pressure of those balances being deployed back into the economy, there really shouldn't be much impact on pricing. What is -- you are looking at the core deposit balances and what are the flows you are seeing and where is the growth coming from and are you seeing any pressure in the sense of thinking of those balances being deployed back into the economy? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman, President and CEO [53] +-------------------------------------------------------------------------------- + + Well, Marty, we saw $50 billion odd of deposit growth year-over-year. Consumer business was the lion's share of that. To give you a sense, fourth quarter 2015 to fourth quarter 2016, checking balance in the Consumer business grew 12%. So the growth is strong and as you said, we expect to maintain pricing discipline in the Company. Obviously those are not interest-bearing, but on the interest-bearing side and you have seen that so far as the first rate move happened last year. +In terms of deploying the economy, we made $20 billion more loans and we will continue to drive the economy and if we can't, we'll invest in mortgage-backed securities and things like that. So we are able to fund easily all the loan demand that we think is responsible to take on. In the fourth quarter, we saw loan growth and our commercial business picked up draws online stated at a high level and loan growth in the middle-market business was strong in the fourth quarter and we are looking for more of that in our small business. So you are exactly right. We are deploying it in the economy. There is not a lot of -- they are growing faster than loans and we believe that we can price with discipline. + +-------------------------------------------------------------------------------- +Marty Mosby, Vining Sparks - Analyst [54] +-------------------------------------------------------------------------------- + + And then just two unusual things out there. The hedge ineffectiveness, can you give us the actual dollar amount? It looks like the day count will typically impact you about $150 million to (technical difficulty) and then other fee income looks artificially low. If you could just give us some color on that line item as well. + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [55] +-------------------------------------------------------------------------------- + + Sure. So the hedge ineffectiveness was $168 million in the quarter, a negative obviously. And in terms of the other -- you are talking about the other income line, so --. + +-------------------------------------------------------------------------------- +Marty Mosby, Vining Sparks - Analyst [56] +-------------------------------------------------------------------------------- + + Other fee income. + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [57] +-------------------------------------------------------------------------------- + + The other fee income. So that last quarter -- let me give you a sense. Last quarter, we had I think some -- that line is going to bounce around a little bit. Let me start with that. But the last quarter, we had some positive impacts in that line from loans related to our FEO portfolio. This quarter, it was negatively impacted by the UK PPI provision. That was $132 million and that's non-tax-deductible. So if you adjust for those two items, we would be around $300 million and I would say that's probably a good base for you to think about if you are modeling. + +-------------------------------------------------------------------------------- +Marty Mosby, Vining Sparks - Analyst [58] +-------------------------------------------------------------------------------- + + Perfect. We were right in that range, so that got us right back to the normal level. Thank you. + +-------------------------------------------------------------------------------- +Operator [59] +-------------------------------------------------------------------------------- + + Mike Mayo, CLSA. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA - Analyst [60] +-------------------------------------------------------------------------------- + + Hi, so there's certainly a lot of positives on this call, whether it's deposits, loans, expenses, etc. But the end result is still a single digit return on equity or return on tangible common equity. And I know you want it to be higher. I know it's improved, but it's still below your peers today of 13% and below your target of 10%. So can you give us a target metric for ROTCE for 2017 or when do you think you get to that double-digit range where some of your peers are? + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [61] +-------------------------------------------------------------------------------- + + So thank you, Mike, for noticing the improvement because we feel really good about all the progress we've made. As you point out, earnings are up year-over-year on 15% and that's on a very significant earning base of $18 billion. We need to get our capital down. We are returning more capital to shareholders. That's going to help. We need to continue to grow. So we feel really good about the progress that we have made. +Our return on assets metric is tracking in the right direction. Our return on tangible common equity metric is tracking in the right direction. So we will just have to wait and see. I think we get there even without a rate rise eventually, but certainly a rate rise is going to help. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA - Analyst [62] +-------------------------------------------------------------------------------- + + As a follow-up, I know I ask this each year, but you just said wait and see and that's kind of been the answer. It just seems like, from an investor standpoint, you get a free pass. Like you will get to the double-digit ROTCE when you get there and as investors, we're just going to have to wait and see. It would be nice to have that metric or more color or -- or anything else you can give along those lines. +And maybe just for some more of that color, the efficiency ratio, I get it, you've gotten better, but it's still not where I think you want to be. It's 66% and your peers today that report it are under 60% for last year. What else can you do with efficiency, which might help improve that ROTCE to the double-digit range? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman, President and CEO [63] +-------------------------------------------------------------------------------- + + Mike, a couple things. One is, if you look across the last three quarters, the return on tangible common equity was 10.5%, 10.28% and 9.92% and you have a fourth-quarter seasonal decline in trading. So it will pick back up in the first quarter and we look forward to that going back up. And on the efficiency, we've set the goal for $53 billion in expenses and with the rate increases, we will continue to drive that down and if you look through the year-over-year, it was down from 70 into 66 and the last couple of quarters have grown sub 65, around 65 and we will continue to move from there. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA - Analyst [64] +-------------------------------------------------------------------------------- + + You've come a long way with branches from 6,000 down to 4,600. Where do you think you ultimately could take that branch count and why all of a sudden are you reducing the level of ATMs? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman, President and CEO [65] +-------------------------------------------------------------------------------- + + Well, the ATMs are coming down largely because, as you reduce branches, there's one or two and then third-party ATMs in places that aren't very efficient, so they will continue to wind down. So I wouldn't necessarily focus on that as being a separate question as we build them out. But if you think about -- on the branch, we're down -- for the year, we had 179 that closed, but we also renovated 205, put out 34 new ones. So we are continuing to invest; yet there is a steady downdraft in the total branch count. So we ended the year at 4,500, almost 4,579 so we will continue to work that count down again based on how the customer flows go. These are critical to serve the customers and so we end up as larger branches and smaller branches that are being folded in and we will continue to do that. + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [66] +-------------------------------------------------------------------------------- + + I think as you think about that number, Mike, focus on the active mobile users because that's going to be the interplay here. Active mobile users are up 16% year-over-year. On a big base, we grew active mobile users more than we grew in 2015 and deposit transactions are now 19% -- mobile deposit transactions are now 19% of all deposit transactions. That's the equivalent of 880 financial centers. +So on the one hand, that says maybe you can optimize a little more, but, on the other hand, as I said in the lead-in, we still have a million people, almost a million people coming into the branch every day and they need that channel, they need it to transact, some of them, but a lot of them come in for advice and we want them to do that. So we need a certain footprint of financial centers. +I think Brian alluded to the fact that we are adding financial centers all around the country, in certain markets around the country. So it's going to ebb and flow. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA - Analyst [67] +-------------------------------------------------------------------------------- + + All right, thank you. + +-------------------------------------------------------------------------------- +Operator [68] +-------------------------------------------------------------------------------- + + Matt Burnell, Wells Fargo. + +-------------------------------------------------------------------------------- +Matt Burnell, Wells Fargo - Analyst [69] +-------------------------------------------------------------------------------- + + Good morning. Thanks for taking my question. Brian, maybe a question for you. I noticed on slide 19 of the breakout of the Global Markets revenue mix, 40% of the revenue in the past year coming from outside the US and Canada. As we look towards what appears to be a potentially more volatile market condition in Europe relative to the Brexit negotiations, which are set to start early in 2017, how are you thinking about that and what the effect could be on your sales and trading revenue in 2017? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman, President and CEO [70] +-------------------------------------------------------------------------------- + + I think there was volatility this year around it just on the announced vote and things like earlier in the year. That was one of the events that I referenced. The nice thing is the balance in this business when you think about it. So it's balanced by product, it's balanced by geography. So when one thing goes -- if something else is going [well], we pick it up. So I'm not overly worried about -- we've got to get Brexit right as our Company and the industry and everything and there's a lot of discussion about that, but in terms of an impact on the trading revenue on a given day, it will ebb and flow and we will get through it. But the good news is, is the United States strengthens in the first part of the year. We have seen a good normal first quarter developing and we've seen customer activity strong, all of which bodes well. So we will get through it. + +-------------------------------------------------------------------------------- +Matt Burnell, Wells Fargo - Analyst [71] +-------------------------------------------------------------------------------- + + Okay. And then if I can just follow up on your earlier comments about the post-election positive sentiment. Can you give a little more color as to what your borrowers and what your corporate clients are saying in terms of what their demand -- the increase in their demand could be or are they holding back a little bit waiting to see what comes out of the Beltway over the next six to nine months?? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman, President and CEO [72] +-------------------------------------------------------------------------------- + + What I'd reflect on is that, as you came through the summer into the fall through the election, you saw -- both on the consumer side and on the commercial side, you saw increasing optimism. On the consumer side, you saw a bit of an acceleration and spending coming into the fall. So just if you think about the middle-market business, as I said earlier, the revolver utilization is on the high end of where it has been the past several years at 40% plus and that group, which is our middle-market business, our commercial real estate business, etc., added about $4 billion worth of loans in quarter four. So all that really relates to greater business confidence. So I think we feel very good where business is staying and you get the same reports from the small business side. +So as I go out and visit these clients, they are very optimistic. They think policies will be supportive of growth in their businesses and they are facing all the things that we face. Can they find the good employees, can they find the final demand, but I think overall the optimism is very strong. And we are seeing it translate into some loan balances. I think it still will play out into early next year. + +-------------------------------------------------------------------------------- +Matt Burnell, Wells Fargo - Analyst [73] +-------------------------------------------------------------------------------- + + Okay, thank you. + +-------------------------------------------------------------------------------- +Operator [74] +-------------------------------------------------------------------------------- + + Eric Wasserstrom, Guggenheim. + +-------------------------------------------------------------------------------- +Eric Wasserstrom, Guggenheim - Analyst [75] +-------------------------------------------------------------------------------- + + Thanks. Two quick questions please. One is on the -- can you just perhaps update us on your outlook for auto credit? It's been an issue that's been a bit of a battleground, particularly on the mid and low FICO range and I know that's not where you are concentrated, but I'd love to get your perspective there. + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [76] +-------------------------------------------------------------------------------- + + So we've got marketshare of around 3.5% and we are originating in prime and super prime with average FICO scores at 771 and debt to income ratio is at all-time lows. And I know this isn't necessarily completely responsive to your question, but credit statistics here are phenomenal. I think in the quarter, our net charge-off ratio was 19 basis points. So we are able to grow that. We did grow it in the quarter well and we are able to grow it within our risk tolerance. +Now the fourth quarter was a great quarter in auto. I think we have all seen the numbers and we are expecting that growth to continue. Assuming a modestly improving economy, we are expecting that growth to continue in the first and second quarter. I guess as guidance I would give you auto growth in mid to low single digits. By the way, I've just been corrected here. Our net charge-off ratio in the fourth quarter was 35 basis points, not 19, but still well, well within our risk tolerance for that product. + +-------------------------------------------------------------------------------- +Eric Wasserstrom, Guggenheim - Analyst [77] +-------------------------------------------------------------------------------- + + And does the potential decline in collateral values present any particular concern to you guys? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman, President and CEO [78] +-------------------------------------------------------------------------------- + + It presents a concern and you watch it carefully, but where we keep our business, how we view this business is it's a very high credit quality business. It hasn't affected us, as Paul just said, but we see it in the industry and it's obviously a concern, but there's always some seasonality to those recoveries and those statistics reported, but overall with our high -- our FICOs are 770-ish range, so it's not really -- it doesn't really affect us. + +-------------------------------------------------------------------------------- +Eric Wasserstrom, Guggenheim - Analyst [79] +-------------------------------------------------------------------------------- + + And just one quick follow-up on capital return. I just want to make sure I understand all the dynamics. It seems like there's two trends that are coinciding. One, of course, is the continued increase in targeted payout ratio as a percent of your earnings and then, of course, there is the expansion in earnings themselves. Is that the right way to think about it? Is there any other dynamic to consider? + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [80] +-------------------------------------------------------------------------------- + + You have it right. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman, President and CEO [81] +-------------------------------------------------------------------------------- + + You have it right. Well, actually the only thing I would add is the process itself in terms of the scenarios and things like that, but we've had plenty of cushion, so unless they change grammatically, you've got it right. + +-------------------------------------------------------------------------------- +Eric Wasserstrom, Guggenheim - Analyst [82] +-------------------------------------------------------------------------------- + + Great. Thanks very much. + +-------------------------------------------------------------------------------- +Operator [83] +-------------------------------------------------------------------------------- + + Paul Miller, FBR Capital Markets. + +-------------------------------------------------------------------------------- +Paul Miller, FBR Capital Markets - Analyst [84] +-------------------------------------------------------------------------------- + + Thank you very much and good quarter, guys. Talking about mortgage banking a little bit, you talked about that you did about $22 billion originations in the quarter. And correct me if I'm wrong, Brian, but did you mention that you portfolioed three quarters of that onto the portfolio? And if you did, what was the breakout between jumbos, just a rough estimate between jumbos and regular conforming or were they all jumbos? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman, President and CEO [85] +-------------------------------------------------------------------------------- + + Yes, so we balance sheet, I think to be precise, 78% this quarter and we generally balance sheet all of the jumbos. So then the question is, for conforming, how much do we do. I don't really have that in front of me. We are starting to do more conforming, but we are certainly not doing all of it. Maybe a good guess would be around half. + +-------------------------------------------------------------------------------- +Paul Miller, FBR Capital Markets - Analyst [86] +-------------------------------------------------------------------------------- + + Okay. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman, President and CEO [87] +-------------------------------------------------------------------------------- + + Hey, Paul, just to think about that a second, that credit quality as mortgages is so strong that frankly it's not worth getting the guarantees and things like that. We have the liquidity to fund them and it's obviously jumbos, but even on the conforming, the credit quality of ours is at the top end and I think the charge-off ratio was 3 basis points in the fourth quarter. So economic gets better at keeping the pace for the guarantee. + +-------------------------------------------------------------------------------- +Paul Miller, FBR Capital Markets - Analyst [88] +-------------------------------------------------------------------------------- + + We are seeing a lot more people portfolio before -- what you just said because the guarantees are so expensive. Is the PHH, is that all now consolidated down into your operations? The PHH stuff from Merrill Lynch that you brought over? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman, President and CEO [89] +-------------------------------------------------------------------------------- + + Yes, it's finished up and we're still working through the last part of the conversion, but it's basically in-house. + +-------------------------------------------------------------------------------- +Paul Miller, FBR Capital Markets - Analyst [90] +-------------------------------------------------------------------------------- + + Hey, guys, thank you very much. + +-------------------------------------------------------------------------------- +Operator [91] +-------------------------------------------------------------------------------- + + Matt O'Connor, Deutsche Bank. + +-------------------------------------------------------------------------------- +Matt O'Connor, Deutsche Bank - Analyst [92] +-------------------------------------------------------------------------------- + + Good morning. Sorry if I missed it, but did you guys comment on the $53 billion expense target that you put out there? I think it's exiting 2018 is what you said. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman, President and CEO [93] +-------------------------------------------------------------------------------- + + It's still good. + +-------------------------------------------------------------------------------- +Matt O'Connor, Deutsche Bank - Analyst [94] +-------------------------------------------------------------------------------- + + Okay, so even if revenue is better than expected, but it's rate-driven, that's not going to impact expenses materially? + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [95] +-------------------------------------------------------------------------------- + + It's still good and we still target that and you are exactly right. Rate increases will go to the bottom line. + +-------------------------------------------------------------------------------- +Matt O'Connor, Deutsche Bank - Analyst [96] +-------------------------------------------------------------------------------- + + Okay. And then separately credit quality overall was very good. The charge-offs and non-performers. You did flag I think it's the nonguaranteed consumer early delinquencies. I think it was about 15% Q2 and a little bit year-over-year. Just anything to flag there, especially given how quality the consumer book is? + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [97] +-------------------------------------------------------------------------------- + + That was the transfer of servicing that we just talked about on the previous question. + +-------------------------------------------------------------------------------- +Matt O'Connor, Deutsche Bank - Analyst [98] +-------------------------------------------------------------------------------- + + Oh, I apologize about that. Okay. + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [99] +-------------------------------------------------------------------------------- + + It's a good question, but we transferred servicing at the end of the quarter. When you transfer servicing, you've got to redo all the bill pay and that's just a result of not getting all those bill pays done over the quarter. By now, we are probably 90% of the way through that problem. It's just a timing issue. + +-------------------------------------------------------------------------------- +Paul Miller, FBR Capital Markets - Analyst [100] +-------------------------------------------------------------------------------- + + Okay. Then ex that impact, I assume the early stage delinquencies -- what would the early stage delinquencies look like? + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [101] +-------------------------------------------------------------------------------- + + I think 30 plus day in mortgage was actually down $40 million I think. + +-------------------------------------------------------------------------------- +Paul Miller, FBR Capital Markets - Analyst [102] +-------------------------------------------------------------------------------- + + Absent that. + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [103] +-------------------------------------------------------------------------------- + + Absent that issue. + +-------------------------------------------------------------------------------- +Paul Miller, FBR Capital Markets - Analyst [104] +-------------------------------------------------------------------------------- + + Okay, all right, that makes sense. Thank you. + +-------------------------------------------------------------------------------- +Operator [105] +-------------------------------------------------------------------------------- + + Nancy Bush, NAB Research. + +-------------------------------------------------------------------------------- +Nancy Bush, NAB Research - Analyst [106] +-------------------------------------------------------------------------------- + + Good morning. Brian, could you just talk a little bit about your deposit marketshare? You are up the street or around the corner from a company that showed us this morning that they are getting a lot of churn in their deposit base. So are you able to track whether you are benefiting from that? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman, President and CEO [107] +-------------------------------------------------------------------------------- + + I don't think we have specific guidance on that. Our marketshare -- we are growing our deposits faster than the market, therefore your marketshare is growing. Where it's coming from exactly, Nancy, just for historical perspective, because you've been around this Company, this industry for a long time, I had them check something, but from 2007 to today, effectively, the deposits per branch have doubled and the checking account numbers are basically flattish and up maybe a percent or something like that. So think about the dynamics of that in terms of profitability. So we feel very good about the growth in deposits year-over-year, 12% in checking and 10% overall. So it's coming from somewhere. I just don't know where exactly. + +-------------------------------------------------------------------------------- +Nancy Bush, NAB Research - Analyst [108] +-------------------------------------------------------------------------------- + + Can you just give us an idea of -- where are you gaining more marketshare through digital, mobile? Are you gaining more through people still coming in the branch? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman, President and CEO [109] +-------------------------------------------------------------------------------- + + The answer would be yes because --. + +-------------------------------------------------------------------------------- +Nancy Bush, NAB Research - Analyst [110] +-------------------------------------------------------------------------------- + + All of the above? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman, President and CEO [111] +-------------------------------------------------------------------------------- + + Think about it, I think Paul said earlier that mobile sales are 20%-ish, but that means 80% are not mobile, therefore they are coming through other call centers and branches. So it's an integrated business system and [Tong] and [Dean] and the team working there have done a great job of optimizing that if you look at the chart and watch the cost per deposit continues to work its way down while there's growth and then additional salespeople. So it's coming. The year-over-year rise in mobile sales is actually faster obviously, but it's still only 20% of the contribution. + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [112] +-------------------------------------------------------------------------------- + + The other thing interesting, by the way, we are using -- a statistic I really like is we have digital appointments. So people come into the branch, but they don't just walk in now. They are coming in for an appointment that they've made over their smartphone. So that really helps us from an efficiency standpoint as well. If we can get people to do that, it's better for them and it's better for us. + +-------------------------------------------------------------------------------- +Nancy Bush, NAB Research - Analyst [113] +-------------------------------------------------------------------------------- + + Okay. My follow-up question is this. We have experienced or we experienced on November 8 a sea change in the thinking about bank regulation going forward. And everybody that I've talked to seems to think, even if there are not significant changes in what's on the books, that there will be, quote, a lighter touch in regulation. And I guess I would ask if you are thinking in those terms and if so, do you think that that will have an impact on your expense numbers, number of people you need to add in compliance, etc. etc. ongoing? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman, President and CEO [114] +-------------------------------------------------------------------------------- + + I think if you think about it, there are a couple of dimensions. Obviously that dimension is well spoken about out there. You saw yesterday I think the House passed a couple cost benefit analysis type requirements for the SEC and the commodities things. So I think there will be a body of work that will go on to balance, let's make sure we understand the pluses and minuses of a lot of this stuff. +But, in reality, if you think about our Company, we have maintained -- we invest a lot of talent and capabilities in people, in compliance and risk in 2010, 2011 and 2012 and it's been relatively flat, but the Company has shrunk around it, so it's become a higher percentage, but it's not -- we are able to now start to optimize that and make it better and so I think if we get that, that's terrific. That will help us even do more potentially, but even if we don't, there's optimization to come now that we've crested -- all the different things that have gone on in the industry. +So first it was the work of just collecting the bad mortgage and stuff went up, but now you are optimizing more the way we manage risk in a systems environment and stuff like that. So I look forward -- that's what helps us give confidence for the future path on costs overall. + +-------------------------------------------------------------------------------- +Nancy Bush, NAB Research - Analyst [115] +-------------------------------------------------------------------------------- + + All right, thank you. + +-------------------------------------------------------------------------------- +Operator [116] +-------------------------------------------------------------------------------- + + Gerard Cassidy, RBC. + +-------------------------------------------------------------------------------- +Gerard Cassidy, RBC - Analyst [117] +-------------------------------------------------------------------------------- + + I've got a question for Paul. You made a comment about that the end of the quarter you saw some commercial activity. I know Brian referenced already some pickup in middle markets and commercial real estate, but can you give any further color of that commercial activity that you saw in the lending side at the end of the quarter? + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [118] +-------------------------------------------------------------------------------- + + Yes, sure. That's a little earnings prep talking to our head of our middle markets business, our GCB business and our small business banking. They are telling me that they are definitely seeing more interest from CEOs to have meetings. A lot of engagement around 2017 and what the environment might be. Things are feeling a lot more optimistic to those bankers and it's not just talk. Late in the quarter, we actually did see an increase in loan balances that was I wouldn't call it a spike, but there was definitely an acceleration late in the quarter, particularly in middle market and to a lesser extent in business banking. + +-------------------------------------------------------------------------------- +Gerard Cassidy, RBC - Analyst [119] +-------------------------------------------------------------------------------- + + Great. And another question actually, Paul, obviously the banking industry has to live by a number of regulations that are dictated by the regulators on capital, liquidity, etc. Coming back to that operational risk capital number you gave us for businesses that you have exited and no longer are operating in, is that an opinion that the Fed has just laid upon all the banks or is that actually in statutes where to change it would require a lot of work versus if it's just the Fed wants to do that to make it extra conservative, maybe a new change in the Fed could maybe give you guys some relief there? + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [120] +-------------------------------------------------------------------------------- + + Yes, so we have $500 billion of operational RWA. I think our closest competitor has 400 and then I think Citi is probably at 3 something. So we were given more by the regulators based upon the history of the bank, the acquisitions we did and the losses that were historical. But, as you know, we've exited a lot of those products. Bank of America never had a risk profile. It was more the companies that we acquired. So it's a little bit arbitrary. There are models out there for calculating operational risk capital. Those models, they are the subject of a lot of debate if you follow the Basel committee process. +So we are focused on trying to get that number down, but it's going to take a little while and we are going to need more clarity from the regulators on how they want to calculate a company's operational risk capital, but that's something that would be very helpful to us if new models were approved that were a little bit more rational in terms of looking at historical losses versus the current operations of a company. + +-------------------------------------------------------------------------------- +Gerard Cassidy, RBC - Analyst [121] +-------------------------------------------------------------------------------- + + And then just finally I think in your K you put your DTA from last year. It might have been around $25 billion for the deferred tax asset. Do you have an estimate yet for where it will stand at the end of 2016? + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [122] +-------------------------------------------------------------------------------- + + Yes, I do. The total DTA -- guys, keep me honest here -- but I think will be $19 billion, but let me give you the number that matters probably if you are thinking about the future. We are not here sitting, predicting any tax change, but what really matters, if there is US tax change in the US, is I will use 2015. In 2015, we had over $20 billion of US profits, pretax profits. That's an important number. And then the other number that's important is, at year-end, our DTAs that would be repriced if the tax rate changed equaled approximately $7 billion. + +-------------------------------------------------------------------------------- +Gerard Cassidy, RBC - Analyst [123] +-------------------------------------------------------------------------------- + + Thank you very much. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman, President and CEO [124] +-------------------------------------------------------------------------------- + + So that was the last question. Let me close by closing up 2016. We had a 13% increase in net income for the year, 15% EPS. We had a good operating leverage with 1% revenue growth and 5% expense growth and we announced today that we increased our stock repurchase program another $1.8 billion. So that closes off a good year. +As we look forward to 2017, we will just continue to do what we told you we are doing -- focus on responsible growth and we look forward to the benefits of a faster growing economy potentially and increasing rate. So thank you for your time and we look forward to next time. + +-------------------------------------------------------------------------------- +Operator [125] +-------------------------------------------------------------------------------- + + This will conclude today's program. Thanks for your participation. You may now disconnect. Have a great weekend. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. While the Preliminary Transcript is highly +accurate, it has not been edited to ensure the entire transcription +represents a verbatim report of the call. + +EDITED TRANSCRIPT: "Edited Transcript" indicates that a team of professional +editors have listened to the event a second time to confirm that the +content of the call has been transcribed accurately and in full. + +-------------------------------------------------------------------------------- +Disclaimer +-------------------------------------------------------------------------------- +Thomson Reuters reserves the right to make changes to documents, content, or other +information on this web site without obligation to notify any person of +such changes. + +In the conference calls upon which Event Transcripts are based, companies +may make projections or other forward-looking statements regarding a variety +of items. Such forward-looking statements are based upon current +expectations and involve risks and uncertainties. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/exam/original-files/Problem_1_Sample/2017-Jul-18-BAC.N-138882471971-Transcript.txt b/exam/original-files/Problem_1_Sample/2017-Jul-18-BAC.N-138882471971-Transcript.txt new file mode 100644 index 0000000..51c0e0f --- /dev/null +++ b/exam/original-files/Problem_1_Sample/2017-Jul-18-BAC.N-138882471971-Transcript.txt @@ -0,0 +1,824 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q2 2017 Bank of America Corp Earnings Call +07/18/2017 08:30 AM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Brian Moynihan + Bank of America Corporation - Chairman, President & CEO + * Lee McEntire + Bank of America Corporation - SVP of IR + * Paul Donofrio + Bank of America Corporation - CFO + +================================================================================ +Conference Call Participiants +================================================================================ + + * Gerard Cassidy + RBC Capital Markets - Analyst + * Steven Chubak + Nomura Securities - Analyst + * Brian Kleinhanzl + KBW - Analyst + * John McDonald + Bernstein - Analyst + * Glenn Schorr + Evercore ISI - Analyst + * Saul Martinez + UBS - Analyst + * Ken Usdin + Jefferies LLC - Analyst + * Matt O'Connor + Deutsche Bank - Analyst + * Jim Mitchell + Buckingham Research - Analyst + * Betsy Graseck + Morgan Stanley - Analyst + * Marty Mosby + Vining Sparks - Analyst + +================================================================================ +Presentation +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Good day, everyone, and welcome to today's Bank of America 2017 second-quarter earnings announcement. (Operator Instructions). It is now my pleasure to turn today's program over to Mr. Lee McEntire. Please go ahead, sir. + +-------------------------------------------------------------------------------- +Lee McEntire, Bank of America Corporation - SVP of IR [2] +-------------------------------------------------------------------------------- + + Good morning. Thanks for joining us this morning to discuss the second-quarter 2017 results. Hopefully everybody has had a chance to review the earnings release documents that are available on the Bank of America website. +Before I turn the call over to Brian and Paul let me remind you that we may make some forward-looking statements. For further information on those, please refer to either our earnings release documents, our website or our SEC filings. +With that I am pleased to turn it over to Brian Moynihan, our Chairman and CEO, for some opening comments before Paul Donofrio, our CFO, goes through the details. Over to you, Brian. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman, President & CEO [3] +-------------------------------------------------------------------------------- + + Good morning and thank you for joining us for our second-quarter results. This quarter represents another solid example of driving responsible growth here at Bank of America, where staying the course and executing against our responsible growth mantra has allowed us to market share and grow revenue. +That mantra drives the way we manage our cost effectively while at the same time making continuing large investments in people and technology for the long-term value of this franchise. That mantra allows us to manage risk well whether its credit, market, operational or reputational risk. That mantra also drives an appropriate pace of growth in a modest GDP environment while holding credit costs down. +All this has resulted in significant operating leverage leading to strong earnings growth and supports our plan to deliver more capital back to shareholders. Through the first six months of 2017, we have more than doubled the amount of net share repurchases and dividends to shareholders compared to the first half of 2016. +As a reminder, with successful CCAR results behind us, we announced plans on June 28 to deliver $17 billion in capital back to shareholders over the next 12 months through higher dividends and net share repurchases. For the quarter we produced net income of $5.3 billion after tax, growing 10% compared to last year's second quarter. Now that was driven by continued strong operating leverage across the franchise. +Our efficiency ratio touched 60% this quarter. In addition to the net income improvement, a 2% reduction in diluted shares resulted in a 12% improvement in diluted EPS. Year-over-year net interest income improvement of nearly $900 million drove revenue growth proving the value of this deposit rich franchise. We continue to also make progress on our returns and our return on tangible common equity moved above 11% for the first time despite increasing capital levels. +As we look at the next slide on first-half line of business results, I'm going to let Paul talk about the details of the quarter in a minute, but I wanted to highlight basically two things. First, the momentum the businesses have comparing the first half of this year versus the first half of last year. And second, to focus a bit on our consumer business as it reached $2 billion in after-tax earnings this quarter. +So as a broad statement, each business segment grew earnings and capital and it had its reported returns well above our cost capital. Consumer Banking produced $3.9 billion in after-tax earnings for the first half of the year, growing 14% from 2016. This was achieved with good revenue improvement in controlling costs and driving operating leverage while maintaining great credit quality. +Our Global Wealth & Investment Management business recorded first-half earnings of $1.6 billion, up 9% year over year with a 27% profit margin. Both of these are records for this business. Our GWIM business has seen assets under management flows of $57 billion for the first six months of the year. This is strong performance considering the industry is navigating many changes both from the customer side and the regulatory side. +While we have been growing and having strong margins we've been investing. The Merrill Lynch One platform, our Merrill Edge platform and other many investments are providing great transparency for clients allowing us to lower our cost. +Our Global Banking business serving commercial customers in commercial lending and treasury services and investment banking has produced first-half profits of $3.5 billion after-tax. Earnings are up 36% from last year with strong operating leverage on an operating basis and lower credit costs. And even though this is our most efficient business at 43%, we continue to make investments in both technology and people. +This quarter, for example -- this year we have rolled out our cash pro customer interface for mobile devices making that -- cash management services more convenient for our clients. And over the last few years we have embarked to increase our local market coverage by just simply hiring more bankers. We have hired nearly 400 bankers over the last couple years and we continue to hire more and we will hire 200 more by the end of next year. +And finally, when you look at our Global Markets business, it earned $2.1 billion in the first half and generated 12% return on its capital. We grew our sales and trading revenue, excluding DVA, in the first half of 2017 versus the first half of the prior year, in this case 2016 -- for the first time in five years the first half grew faster than the previous year's first half. This growth combined with continued expense discipline drove that improvement. +So in general, all our businesses continue to improve. And now I want to focus a second on our consumer business and you can see that on slide 4. So given the $2 billion in earnings milestone, I want to talk about and focus on the multi-year effort this business has gone through. +This change really began around 2009 when we had more than 6,000 financial centers, 100,000 associates and about one-third less deposits. And at the time we had some digital banking capabilities but nothing near what we have now. The team has worked hard over an extended period to produce the results you see today. +Not only have they significantly reduced headcount, we've done that while adding more and more sales and relationship teammates. We have not only reduced financial centers but we invested and refurbished many and added others in markets we didn't previously serve. And we've continuously invested heavily in technology to drive innovation to keep up with customer behavior changes. And all during this our customer experience continues to improve. +As you go to slide 4 you can see some of the trended results just for the last four years. In 2014, due to all the changes that you're all familiar with, the revenue had declined in this business because of regulatory changes and to focusing more on our direct business to our consumers as opposed to some of the indirect businesses. +As you can see also from the crisis forward, we had focused on underwriting prime and super prime customers. And you can see that in the change in total net charge-offs that occurred prior to 2014 and remains in good stead over the last four years. At the same time, while those credit costs have come down, our risk-adjusted revenue has been improving. +Also you can see our expenses on the lower right hand side continue to drive tremendous operating leverage leading to that net income growth. Today's business operates at a 52% efficiency ratio and, with continuing to drive the customer behavior changes, continued investments for further cost improvements, we expect that to go lower. +Continuing on slide 5, you can see some of the other changes in the business that have enabled us to make this change happen. How do we make this happen? We do it by optimizing and driving technology enhancements for our customers, for our teammates and ultimately for the benefit of you, our shareholders. +This sustained level of investments is also validated by the top-tier rankings by third parties, whether it is in digital banking or mortgage banking fulfillment operations of Merrill Edge, and we continue to enhance these offerings. This quarter we launched new capabilities for car shopping and financing those cars through mobile and added new person-to-person features through our partnership with Zelle. We have also rolled out small business capabilities to respond faster to the needs of the small businesses we serve across America. +We can't emphasize enough the positive impacts all these investments, especially mobile and digital, have made in our improvement as mobile banking users you can see have grown to 23 million at the end of the second quarter. Rapid adoption in digital is shown in the charts you can see on the interactions in the lower part of the page. This quarter we broke through the 1 billion interactions digitally with our customers. That is 1 billion in a single quarter. +When you look at deposit transactions you can see that 21% of all the deposits are made through mobile devices today. That's equivalent of what 1,000 financial centers does. That's important for client satisfaction, but it's also important because those cost 1/10 of what it costs to do it over the counter. +Once customer got used to transacting we're now using devices in a broader sense. You can see in the quarter 370,000 appointments were set up on a mobile device to come to the branch. When they come to the financial center we are in better shape to serve them because we know what they are coming for we know what they need. In addition, sales on digital devices are up to 22% of all our account and loan sales. +So then we switch to the payment side. Payment volumes have been increasing over this time period, but electronification of those payments shows increased adoption of mobile banking and other digital payment methods. You can see in the lower part of the page on the left-hand side while payments have grown 4% overall, digital has grown at an 8% pace while non-digital is relatively flat. +Our latest push that we made a lot of discussion about with all of you has been person-to-person. This is an important payment stream that we are driving. It's already sizable, but it still only accounts for 3% of the total payments in our consumer business this quarter. It's still in early adoption but P2P customers sent $18 billion in payments through our platform in quarter two. This is up 20% year over year. +So people focus on all the digital activity, but at the same time we have 800,000 customers a day come into our financial centers. These financial centers serve those customers well, not only helping them transact when they need to, but more importantly to help answer their financial needs and by serving them with the products and capabilities that we have with a face-to-face specialized professional. +We will continue to invest in that branch structure and it's all in the run rate you see today. We have now built or refurbished 290 centers over the past 12 months and expect to have completed more than 1,500 by the year-end 2019. In addition, we have upgraded all our ATMs or plan to upgrade all ATMs and will finish that by the end of 2019 as well. That's 16,000 new ATMs over three or four years. All that has led to customer satisfaction levels which have reached the highest level in our history. +So at the end of the day our consumer business is an sample of driving responsible growth, growing with no excuses, doing it [in] the right way [with] the customer, doing it [while] managing risk well, and importantly doing it on a sustainable and best basis, investing in the future while producing great returns in the current. With that I want to turn it over to Paul for some more details about the quarter. + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [4] +-------------------------------------------------------------------------------- + + Thanks, Brian. Good morning, everybody. I am starting on slide 6. As Brian said, we earned $5.3 billion or $0.46 per diluted share with EPS increasing 12% versus Q2 2016. Revenue of $22.8 billion in 7% higher than Q2 2016 and expenses of $13.7 billion was 2% higher than Q2 2016. +The quarter included a few noteworthy items. First, we completed the sale of our UK consumer card business during the quarter resulting in a small after-tax gain. The transaction added roughly 12 basis points to our advanced CET1 ratio through both additions to CET1 and reductions in RWA. +A pretax gain of roughly $800 million recorded in All Other reflects a number of factors ,including a premium on credit card receivables sold and the monetization of goodwill. It also reflects the recognition in other income of currency hedging gains and transaction losses from currency fluctuations that were previously recorded in OCI. +Lastly, we recorded tax expense associated with the currency hedging gains which drove our effective tax rate higher in Q2. After-tax the gain added about $100 million to earnings. The sale completes the transformation of our consumer credit card business from a multi-country multi-brand business to a single brand business serving core retail customers in the United States. As usual we also note DVA for you; this quarter net DVA was a negative $159 million which was similar to Q2 2016. +We also recorded a couple of charges in expense that are worth mentioning. The first is a $300 million impairment charge related to a few data centers we are in the process of selling. The second is severance costs which were approximately $100 million higher than Q2 2016. Provision expense was $726 million compared to $976 million in Q2 2016 as net charge-offs of $908 million improved versus Q1 and year over year. And as Brian mentioned, ROA and ROTC approached our financial targets, improving both on a year-over-year basis and on a linked-quarter basis. +Turning to the balance sheet on slide 7, overall end of period assets increased a modest $7 billion from Q1 despite the sale of assets totaling $11 billion associated with the UK card business. We increased assets associated with our trading business as we continue to invest in our clients, particularly in our equities business. These increases in assets were offset by a decline in cash driven by seasonal deposit outflows associated with tax payments and a shift from deposits to AUM and brokerage in our Wealth Management business. +When looking at deposits on the year-over-year basis, they are up $47 billion 4% from Q2 2016 driven entirely by our Consumer Banking business. Loans on an end of period basis were up $11 million from Q1 as broad-based growth across consumer and commercial loans was modestly offset by the runoff of legacy noncore loans. It's worth noting that this loan growth excludes UK card. These card loans were moved from assets of business held for sale when we announced the transaction in Q4 2016. +On the liability side, long-term debt increased $2.5 billion during the quarter to $224 billion (corrected by company after the call) as we increased issuance to meet TLAC requirements. Given our progress in the first half towards the requirements, we currently expect to issue less debt in the second half of 2017 as compared to the first half. Global liquidity sources were $514 billion (corrected by company after the call) this quarter and we remain compliant with fully phased in US LCR requirements. +The asset composition of our global liquidity sources is materially the same as high quality liquid assets as defined under the US LCR rule. However, HQLA for the purposes of calculating LCR are reported not at their fair market value, but at a lower value which incorporates regulatory haircuts and exclusion of excess liquidity held in certain subsidiaries. Therefore the HQLA on a net basis when reported will be lower than our current GLS number. +Common equity increased $2.8 billion compared to Q1. This increase was driven by $4.9 billion of net income available to common and improved OCI of $700 million offset by common dividends and net share repurchases totaling $2.8 billion in the quarter. Tangible book value per share of $17.78 increased 6% versus Q2 2016. +Turning to regulatory metrics and focusing on the advanced approach, our CET1 transition ratio under Basel III ended the quarter at 11.6%. On a fully phased in basis compared to Q1, the CET1 ratio improved 50 basis points to 11.5% and remains well above our 2019 requirement of 9.5%. +CET1 increased $4.4 billion to $168.7 billion driven by earnings, utilization of deferred tax assets and less goodwill deductions given the UK card sale. These improvements in CET1 were partially offset by return of capital. The CET1 ratio also benefitted from a $34 billion decline in RWA driven by continued optimization work, including model improvements, as well as the sale of UK card. +We also provide our capital metrics under the standardized approach. While our RWA reduction was lower under the standardized approach our CET1 ratio still improved 40 basis points to 12%. Supplementary leverage ratios for both parent and bank continue to exceed US regulatory minimums that take effect in 2018. +Turning to slide 8, on an average basis total loans were up $15 billion or 2% from Q2 2016. Note that the sale of UK card lowered average loans by $2.9 billion, so you may want to adjust for that when studying growth trends. As usual, loan growth was reduced by the continued runoff of noncore consumer real estate loans in All Other. +Year-over-year loans in All Other were down $24 billion. On the other hand, loans in our business segments were up $39 billion, or 5%. Consumer Banking led with 8% growth. We continue to see good growth in residential mortgages; we also saw good growth in credit card and vehicle loans. Home equity originations are up nicely but continue to be outpaced by pay downs. +In Wealth Management we saw year-over-year growth of 7% driven by residential mortgages as well as structured lending. Global Banking loans were up 3% year over year. There was a lot of capital markets activity this quarter and this may have impacted more than usual loan growth among larger corporates as a number of funded bridge loans were paid off and as borrowers substituted bonds for loans in a flattening curve environment. +On the bottom right note that we grew average deposits by $44 billion, or 4% year over year. This growth was driven by our consumer segment which grew deposits by 9% year over year. +Turning to asset quality on slide 9. As I have emphasized before, the stability of our asset quality and loss trends reflects years of disciplined client selection and strengthened underwriting standards along with an improving economy. While there is room in the industry for other strategies, we remain focused on responsible growth. Credit quality continues to be solid with net charge-offs, NPLs, delinquencies and reservable criticized exposure all improving from Q1. +Total net charge-offs were $908 million or 40 basis points of average loans, decreasing $26 million from Q1. Provision expense of $726 million declined $109 million from Q1 and was down $250 million from Q2 2016, driven by lower losses in consumer real estate and improvements across most of our commercial portfolio, particularly energy. Our reserve coverage remains strong with an allowance to loans coverage ratio of 120 basis points and a coverage level three times our annual net charge-offs. +Turning to slide 10, we break out credit quality metrics for both our consumer and commercial portfolios. Asset quality metrics in consumer real estate continue to improve. While net charge-offs were down overall, there are a few small items to bring to your attention. +Within consumer we had a small recovery on the sale of a legacy consumer portfolio. And note that one-third of the quarterly UK card losses went away with the June 1 sale. While US card losses increased from seasoning, they remain low. Consumer NPLs of $5.3 billion are at the lowest level since Q2 2008. NPLs came down from Q1 levels and keep in mind that 43% of our consumer NPLs are current on their payments. Commercial losses were up modestly from Q1 driven by a couple of names. +Turning to slide 11, net interest income on a GAAP non-FTE basis was $11 billion, $11.2 billion on an FTE basis. Compared to Q2 2016, which has the same day count and seasonal factors, NII is up $868 million or 9% driven by an improving spread between our asset yields and deposit pricing in an environment where both short end rates and long end rates increased. +We also benefited from loan growth and excess deposits deployed in security balances. Compared to Q1 2017, NII was relatively flat as the benefit from an increase in short end rates was offset by a number of factors, including lower long end rates in the quarter. +First, we increased client financing activities and balances in our equities business to support clients and drive growth. Some of the products we used to accomplish this created interest expense with no interest income. Instead they drove trading account profits recorded in non-interest income. +Second, the UK card sale closed June 1. That was earlier than we expected and so the quarter's comparisons to previous ones are negatively impacted by one-third of UK cards interest income. +Third, we saw a decline in leasing interest from the seasonality we see in Q1, but that was offset by one additional day in interest in Q2 versus Q1. +And then lastly, we experienced some negative debt hedging effectiveness. As a reminder, accounting rules require us to measure changes in the value of our debt differently than changes in the value of swaps we use to hedge, creating temporary ineffectiveness that will revert to zero over the remaining life. +As a general comment on deposit pricing, overall we held pricing relatively stable in Q2; however, we did increase pricing for some commercial and wealth management clients late in the quarter and this will impact Q3 NII. While holding pricing relatively steady we were able to grow deposits 9% year over year in our consumer segment. +Looking forward to Q3, please keep three additional things in mind. First, with respect to rates, the most recent June short end rate hike should benefit Q3 NII subject to continued stability in industry deposit pricing. But, the Q2 decline in long end rates will have a negative lag effect in Q3 with respect to the write-off of premium associated with prepayment of mortgage-backed securities. +Second, we will benefit from one additional day of interest. And third, going forward we will also feel the effects of the full quarter loss of interest income from UK card equating to about $225 million. Having said all that, we would expect NII to be up compared to Q2 if the forward curve is realized and if we have some loan and deposit growth. +With respect to asset sensitivity, as of 6/30 an instantaneous 100 basis point parallel increase in rates is estimated to increase NII by $3.2 billion over the subsequent 12 months, which is broadly in line with our position at the end of the first quarter and continues to be predominantly driven by our sensitivity to short end rates. +Turning to slide 12, non-interest expense was $13.7 billion. As I mentioned earlier, Q2 included roughly $400 million in higher costs from the combination of impairment costs associated with the sale of a few data centers and higher severance costs. Otherwise litigation and other operating costs were lower. +We feel good about our expense progress this quarter especially in light of our continued investments in sales professionals and new technology. Also remember we have $100 million in higher quarterly costs from FDIC assessments compared to Q2 2016. The efficiency ratio hit our 60% target this quarter, improving 300 basis points year over year. +With respect to associate levels, on a full-time equivalent basis, we are down modestly from the prior quarter. Please note that we have changed our disclosure on employees from FTE to headcount this quarter. By the way, that was a SIM idea from one of our associates. FTE is much more complicated to calculate and less relevant today given our shift from part-time associates. +As you can see, the headcount is down more than 4,000 from Q2 2016. Half of that decrease is driven by UK card and half by Consumer Banking optimization. Note the continuing shift from non-client facing associates to primary sales professionals which now make up 21% of our headcount. Compared to Q1 2017 the release of associates from the sale of UK card was offset by bringing on 1,500 summer interns and hiring 1,000 primary sales professionals. +Just a quick observation on these interns. We selected these 1,500 students from 133,000 applications as we continue to be an employer of choice. From a diversity perspective, 42% of these interns are female and 53% are ethnically diverse. +Turning to the business segments and starting with Consumer Banking on slide 13. Consumer Banking recorded their highest earnings in a decade. Earnings were $2 billion growing 21% year over year and returning 22% on allocated capital. The business created 900 basis points of operating leverage, holding expenses flat while growing revenue 9%. +Year over year average loans grew 8%, average deposits grew 9%, and Merrill Edge brokerage assets grew 21%. An improvement in NII drove the 9% revenue growth which was driven by an increase in the value of deposits given the rise in short end rates as well as solid loan growth. +Note that the rate paid on deposits in this business remains low at 4 basis points as we remain very disciplined on pricing. Non-interest income included improvement in service charges and a small increase in card income that was more than offset by a decline in mortgage banking income. +Through combined efforts to drive costs down, the efficiency ratio improved nearly 500 basis points to 52%. Cost of deposits fell below 160 basis points in the quarter. Consumer Banking credit quality remains strong with a net charge-off ratio of 121 basis points. +Turning to slide 14 and looking at key trends, our strategy remains focused on relationship deepening and growing total revenue while improving operating leverage through expense discipline. The concept of total revenue is important as you evaluate NII and fee movements. +Mortgage banking income was lower driven by our strategy of holding more of our originations on our balance sheet instead of selling to the agencies. We believe retaining these mortgages on our balance sheet provides better economics over time. In Q2 we retained about 90% of our mortgage production on balance sheet. +Also note that our relationship deepening preferred rewards program is improving NII and balance growth while holding fee lines flat as we reward customers for doing more business with us. Spending levels on debit and credit cards were up 6% year over year and new issuance of credit cards was solid at $1.3 million. Spending levels on cards drives revenue but are largely offset by rewards given back to customers. +Focusing on client balances on the bottom left, you can see that the success -- we continue to have growing deposits, loans and brokerage assets. At the bottom right you can see deposits broken out. Our 9% year-over-year average deposit growth continues to outpace the industry while the rate paid remains low and stable. Importantly 50% of these deposits are checking accounts and we estimate 90% of these checking accounts are the primary accounts of households. +With respect to loans, residential mortgage continues to lead our growth while we also saw growth in card and auto. Client brokered assets are up 21% year over year driven by strong client flows as well as market performance, new accounts grew 10% from Q2 2016. +The digitalization efforts that Brian discussed earlier and other productivity improvements continue to drive expenses lower. Expenses were stable compared to Q2 2016 despite strong revenue growth and increases in the FDIC assessment rate and charges. We continue to remain focused on prime and super prime borrowers with average book FICO scores of at least 760. +Turning to slide 15, let's review Global Wealth & Investment Management which produced record earnings of $804 million, a pretax margin of 28% and a return on allocated capital of 23%. The industry continues to evolve as firms and clients anticipate new fiduciary requirements and other market dynamics such as the shift between active and passive investing. At the same time the financial markets continue to provide a tailwind to client activity and balances. +We saw $28 billion of AUM flow this quarter continuing the strength of $29 billion in Q1. Net interest income rose 14% driven by an increase in the value of deposits given the rise in short end rates as well as an increase in loans. Year-over-year noninterest income improved 3%. However, note that in Q2 2016, non-interest income included a $60 million gain from the sale of cash management capabilities as we transition from proprietary products to open architecture. +Adjusting for that prior period gain noninterest income improved 5% -- as 10% higher asset management fees were partially offset by lower transactional revenue. Year-over-year expenses were up 3% from revenue-related incentives as well as higher FDIC costs. Revenue growth outpaced revenue-related expense producing solid operating leverage. +Moving to slide 16, we continue to see overall solid client engagement. Client balances now exceed $2.6 trillion driven by higher market values, solid AUM flows and continued loan growth. Average deposits of $295 billion (corrected by company after the call) were down $12 billion from Q1 reflecting both normal seasonality from tax payments as well as client shifts to investment in AUM and brokerage. Average loans of $151 billion were up 7% year over year. Loan growth remained concentrated in consumer real estate as well as structured lending. +Turning to slide 17, Global Banking earned $1.8 billion in Q2. Earnings increased 19% from Q2 2016 driven by good results across investment banking and treasury services. Return on allocated capital was up year over year to 18% despite an increase in capital allocated to this business. +A number of results to note given the strong performance: record revenue in the quarter, record advisory fees, record first-half revenue and net income and year to date we remain ranked number three in investment banking with fees of $3.1 billion. Year-over-year revenue growth of 7% coupled with flat expenses drove operating leverage of 600 basis points. +Provision expense of $15 million in Q2 2017 is down $184 million driven by improvements across most of the portfolio, particularly energy. Global Banking loan growth was 3% year over year. The pace of loan growth remains good, but has slowed driven by both capital markets disintermediation as well as reduced demand from clients as they look for more certainty of economic growth. +With respect to disintermediation, clients are using bond issuance to pay down loans and pay off funded bridges. Global Banking held expenses relatively flat compared to Q2 2016 as savings offset higher technology investment. +Looking at trends on slide 18 and comparing to Q2 last year, average loans were up $11 billion or 3%. With the exception of CRE, loan growth was fairly broad-based with C&I loans up 5% in middle-market lending. Average deposits were stable relative to Q2 2016. NII growth drove the 7% year-over-year revenue increase. +NII increased $286 million from Q2 2016 driven by an increase in the value of deposits, given the rise in short-term rates as well as increase in loans partially offset by modest spread compression on loans. Total investment banking fees of $1.5 billion were up 9% from Q2 2016, finishing strong in the last few weeks of the quarter. As I mentioned, record M&A fees drove the increase. Within debt capital markets we saw a solid increase in investment grade fees while leverage finance declined. +Switching to Global Markets on slide 19, the business had a solid quarter earning $830 million or $928 million if one excludes net DVA. Global Markets generated a 10% return on allocated capital. Earnings were down relative to Q2 2016 which, if you remember, was uncharacteristically strong given a rebound from a weak Q1 2016 and the Brexit vote. +Just to complete the picture, remember Q3 last year was also atypically stronger than Q2 2016. 2017 has followed a more typical seasonal pattern so far this year. While Q2 was solid, sales and trading, excluding DVA, declined 9% from Q2 2016. But comparing the first-half results of 2017 to 2016, sales and trading ex-DVA increased 6%. This is the first time in the past five years that first-half performance is up year over year. With respect to expenses, Q2 2017 was 3% higher than Q2 2016 driven by increased technology investment. +Moving to trends on slide 20 and focusing on the components of our sales and trading performance, sales and trading revenue of $3.4 billion, excluding net DVA, was down 9% from Q2 2016, finishing ahead of our mid-quarter expectations. Excluding net DVA and versus Q2 2016, fixed sales and trading of $2.3 billion decreased 14%. +Within FICC, the year-over-year decline was driven by stronger rates in emerging markets. In Q2 2016 equity sales and trading was up 3% year over year to $1.1 billion benefiting from growth in client financing activity offset by slower secondary market revenue. +On slide 21 we show All Other, which reported a net loss of $183 million. This includes the $100 million after-tax gain associated with the sale of UK card. Revenue here also includes a roughly $800 million pretax gain from the UK card transaction which was almost entirely offset by related tax expense recorded here as well. +Non-interest expense includes the data center impairment charge I mentioned earlier, which was mostly offset by lower personnel and other operating costs. When comparing expenses and earnings to Q1 2017, remember Q1 2017 includes seasonal retirement eligible incentives and elevated payroll tax expense of $1.4 billion. +The effective tax rate for the quarter was 37.1%, which includes approximately $700 million of tax expense recorded in conjunction with the sale of UK card. We continue to expect an effective tax rate of approximately 30% for the rest of the year absent unusual items. +Okay, a few summary points to wrap up. Again this quarter, we created operating leverage by managing expenses while improving revenue. For years we have been focused on growing responsibly including staying within our risk and client frameworks as well as simplifying the Company to improve operational efficiency, all aimed at making our growth more sustainable. +In Q2 consistent with this strategy, we stuck to our strong underwriting standards while growing loans and investing in our clients in global markets. Asset quality remains strong as net charge-offs, NPLs, delinquencies and commercial reservable criticized exposure all declined. +Several of the businesses set new records for revenue or earnings as we grow with our clients and manage costs well. Importantly, we continue to invest in new technology and capabilities while adding sales professionals in certain businesses. And we significantly increased the amount of capital we returned to shareholders and announced plans to increase that even more. +These results tell us that responsible growth is working and that we are well-positioned to continue to invest in and grow with our customers and clients as the economy continues to improve. With that, we will open it up to Q&A. + + +================================================================================ +Questions and Answers +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions). Glenn Schorr, Evercore ISI. + +-------------------------------------------------------------------------------- +Glenn Schorr, Evercore ISI - Analyst [2] +-------------------------------------------------------------------------------- + + Hi, thanks. I appreciate all the detail on the net interest income discussion. One piece of it on the repo borrowings part of it, financing -- the equity financing side. I'm curious if you think of that as a little episodic and you just go with the flow. Or is it more a permanent part of the strategy where you are using your strong balance sheet to help grow? The tag along to that is if it is more permanent why do it through repo? Is that more expensive? + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [3] +-------------------------------------------------------------------------------- + + I think it's a little bit of both. So we did make a decision to invest more on our equities business this quarter. That's going to go up and down depending on client activity in every quarter. We could always change our mind, but generally we made a decision to add more balance sheet [to] equities because we see an opportunity there and because our customers would like us to do that. +In terms of how we add that balance sheet, that definitely can change one quarter to another. This quarter it was a lot of synthetic which tends to happen when you have clients overseas who have some demand. Next quarter it could be more plain old PB and that does change the mix of NII when that happens. But it's based upon client demand, not necessarily how we want to manage one part of our P&L versus another. + +-------------------------------------------------------------------------------- +Glenn Schorr, Evercore ISI - Analyst [4] +-------------------------------------------------------------------------------- + + Got it. I appreciate that. And the tagalong for net interest income guidance is, as you mentioned, very low deposit beta on the consumer side, just 2 basis points up in the quarter. Is there a point in time where you expect that to accelerate over the next couple hikes? I know we all kind of ask the same thing each quarter, but it's amazingly low. + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [5] +-------------------------------------------------------------------------------- + + Yeah, look, you're -- we are watching it closely. I guess I would point out that Bank of America and the industry really haven't increased, as you point, out deposit rates on traditional bank accounts. I think we believe we deliver a lot of value to depositors: transparency, convenience, safety, mobile banking, online banking, nationwide network, rewards, advice and counsel. There's some real value to having a relationship with us. +And I think this value plus the fact that there has been a lack of market pressure so far has allowed us on traditional accounts to leave rates relatively flat. We are starting to see some rate increases on some account types in GWIM and in Global Banking. And if you look at our models they anticipate that we are going to have to start raising eventually based upon historical experience. +But the bottom line is we are going to balance our customer needs and the competitive environment with our shareholder interest and do the right thing. So we will just have to wait and see. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman, President & CEO [6] +-------------------------------------------------------------------------------- + + Glenn, I would just that when you dig into the supplement and other materials and look at the consumer business, even the GWIM business, you have to focus on the core checking balances in consumer on a $650 billion deposit base or $320 billion. +And so, that is 10 years of hard work of driving core operating accounts to the consumer with our core checking balances in and the primary account as we call it running near 90% up from the 60%s and 70%s many years ago. And those are zero interest and they will remain zero interest because that's the nature of the beast. +So where you will see other areas like CDs year over year down again 10%, and so we have been driving this business to be core, core and core and that's what's happening. In GWIM you are seeing the pieces that we are functionally investment equivalent move faster. But we feel good about it and we feel good about how we are driving both the value to the consumer for the total of our services relative to interest rate paid on certain types of deposits and frankly relative to non-interest-bearing deposits. + +-------------------------------------------------------------------------------- +Glenn Schorr, Evercore ISI - Analyst [7] +-------------------------------------------------------------------------------- + + Great, thanks both. I appreciate it. + +-------------------------------------------------------------------------------- +Operator [8] +-------------------------------------------------------------------------------- + + John McDonald, Bernstein. + +-------------------------------------------------------------------------------- +John McDonald, Bernstein - Analyst [9] +-------------------------------------------------------------------------------- + + Hi, good morning, guys. Just to follow up on the NII, Paul, it sounds like when you net a few positives and negatives in terms of your NII outlook for next quarter you are expecting a modest increase in the third quarter as of now. Could you put any size parameters on that? + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [10] +-------------------------------------------------------------------------------- + + No, I think we want to get out of the game of putting size parameters on it. I have given you all the inputs; I can run through them again if you like. But look, we feel good about where we are, that we had some transient things this quarter. There are a lot of variables that go into this. One of the biggest ones is, by the way, predicting people's behaviors, predicting customers. So I wouldn't want to give you a number. Again, if you want I would be happy to go through all the different ins and outs again if you want, but (multiple speakers). + +-------------------------------------------------------------------------------- +John McDonald, Bernstein - Analyst [11] +-------------------------------------------------------------------------------- + + No, that's fine. Maybe you could just remind us how much the Fed hike itself -- what your estimate of how much that helps the June hike. And then also just how much the lower 10-year hurt in the second quarter? How should we think about the 10-year impact going forward? So the short and the long end impacts would be helpful. Thanks. + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [12] +-------------------------------------------------------------------------------- + + Look, again, I won't give you a number, but we had a significant improvement in NII from the short end. But the long end also did significantly impact us relative to what we were expecting. Because, as you know, we have a securities portfolio and as rates change there, customer behavior changes and we can amortize more or less of that premium. + +-------------------------------------------------------------------------------- +John McDonald, Bernstein - Analyst [13] +-------------------------------------------------------------------------------- + + Okay. And then just on expenses could you help us think through the expense trajectory for the back half of the year? And more importantly, your current thoughts on the target for the $53 billion next year. And how some of the -- maybe the tech consolidation you did this quarter, how does that impact either the timing or just confidence level on delivering expense saves? + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [14] +-------------------------------------------------------------------------------- + + Sure. We feel good about our goal. I will remind everybody that some time ago now we said that our full-year 2018 expense would be approximately $53 billion. A lot has changed since then, good, bad or whatever, a lot of things have changed. But we are still very confident in that goal. To get there we feel like we need to run in a normal quarter at around kind of $13 billion and then you have got the first quarter that has $1 billion or so more in retirement eligible and FICA. +If you look at our expenses this quarter we reported [$13.7 billion]. Last year we reported [$13.5 billion]. If you back out the data center and the elevated severance we would be at [$13.3 billion]. So we think we've made pretty good progress year over year and we just have to continue to make that type of progress over the next few quarters and we will get there. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman, President & CEO [15] +-------------------------------------------------------------------------------- + + Effectively, John, it's about a $100 million step down over the next couple quarters, which has been very consistent with what we've been doing over the past several quarters. We used to have the major drops as we got it position, but it's going to be a $100 million-ish year-over-year step down from the prior year and so you will see that kind of play out we think. + +-------------------------------------------------------------------------------- +John McDonald, Bernstein - Analyst [16] +-------------------------------------------------------------------------------- + + Okay thanks, guys. + +-------------------------------------------------------------------------------- +Operator [17] +-------------------------------------------------------------------------------- + + Jim Mitchell, Buckingham Research. + +-------------------------------------------------------------------------------- +Jim Mitchell, Buckingham Research - Analyst [18] +-------------------------------------------------------------------------------- + + Great, thanks. Good morning. Maybe getting back to the deposit question. You guys are growing 9% in the consumer book better than the industry, despite holding low obviously reflecting your mix. How far do you think -- A, I guess can you give your sense of what you think is driving that market share? And is this something where you are willing to test the patience of your customers to lag deposit rates until growth slows more materially? How do we think about what your decision-making process is in terms of rates in the consumer book? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman, President & CEO [19] +-------------------------------------------------------------------------------- + + I would make it -- Jim, I'd look more to the broader aspects of your question. Some of the statistics that I talked about earlier. What has been driving this has been, at the end of the day, to get ourselves positioned as the core transaction -- on the transaction side of the consumer business there's a core transaction provider to every household. +And we have -- our checking account numbers are growing now slightly -- couple hundred thousand net new checking accounts this quarter type of numbers -- but have been falling from 37 million and small business consumer combined down to about 34 million-ish. And so, we had run off a lot of stuff that were extra checking accounts and things like that starting 10 years ago frankly. +And so, that's what plays to your benefit here because, at the end of the day, as rates continue to rise, if they continue to rise, the value of the consumer deposit franchise, as you know being around this industry for a long time, is going to be driven by the advantage in the checking balances. And then from the other balances will help but they will be more rate sensitive. +So it comes more from the operating business than it does from any strategy on actual pricing. Because those are free balances and will remain free. So the question is how do you gain share? And what you see is, if you think about it year over year, our consumer business grew about $60 billion in deposits, round number, half of that was in checking account balances, one half of that. +And that is driven by the innovation I talked about, 1 billion digital interactions this quarter, 22.9 million active digital mobile customers, 30 million odd active digital customers, more and more capabilities there and becoming more and more embedded in everything the consumer does. And that then means you are gaining share against people who don't have all those capabilities in our minds. +And so, as you think about it, that's what's going to drive a lot of deposit value. And if you look at some of the rates and volumes charts, even if you get to the interesting things when you look about the Corporation overall, year over year our deposit costs on interest-bearing, [not on] interest-bearing, we are up $100 million. $60 million of that was in the US and $40 million of it is on 10% of the interest-bearing deposits outside the US. So there is not even that much movement on the interest-bearing part. +So we feel good about the franchise and where we need to price because it's more investment oriented say in the GWIM business, we've priced to maintain those balances. Half of what went out of GWIM this quarter was us putting people into the market based on our allocation methodology. So irrespective of the rate that went into the market as opposed to into other cash equivalent. So it really comes from all the different advantages we've been driving at to drive this franchise for 10 years. + +-------------------------------------------------------------------------------- +Jim Mitchell, Buckingham Research - Analyst [20] +-------------------------------------------------------------------------------- + + All right, well, thanks for that. Maybe, Brian, a follow-up on regulation. Obviously the treasury report seemed pretty favorable for the industry. You are not really leverage constrained. Is there any aspect of the recommendations that you would find most helpful to your business? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman, President & CEO [21] +-------------------------------------------------------------------------------- + + All of them would be helpful in the sense that there's a good amount of work that's gone in by all the industry groups, all the individual companies and the administration to come up with a list of things that -- our belief is we want responsible, clear, transparent and regulation that helps maintain the safety and soundness and capabilities of this industry, there is no question. +But in areas where things have gotten too far you've got to bring them back a little bit and that laundry list is really there to provide it. So while some are more important to our franchise than maybe other people's franchises and vice versa, at the end of the day a careful revisiting of some of these things to ensure that we maintain the safety and soundness while getting good regulation is critical. And I think hopefully the ball is moving forward on that. + +-------------------------------------------------------------------------------- +Jim Mitchell, Buckingham Research - Analyst [22] +-------------------------------------------------------------------------------- + + Okay, thanks. + +-------------------------------------------------------------------------------- +Operator [23] +-------------------------------------------------------------------------------- + + Ken Usdin, Jefferies. + +-------------------------------------------------------------------------------- +Ken Usdin, Jefferies LLC - Analyst [24] +-------------------------------------------------------------------------------- + + Thanks, good morning. If I can ask questions on the card business, first of all I noticed that the card losses were up first to second. They are typically down. I am just wondering if you can help us understand just where we are in the seasoning of the portfolio, also noting that the risk-adjusted margin continues to slip as well. So what do you think about card losses going forward and when do we see that bottoming of the card margin? Thanks. + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [25] +-------------------------------------------------------------------------------- + + Sure. So let's start with NCOs. Charge-offs this quarter were 2.87%. They were at 2.66% last quarter -- last year I should say. Both of those numbers -- and that delta is completely within our expectation and modeling for the portfolio, well within our risk parameters. +As you think about what's going on here we've got a portfolio, we've got a back book that is in great shape that's getting smaller every day and we've got a front book that we are growing that is seasoning. So that's what's driving up the NCOs in a natural way very gradually. +We also have a little different phenomenon going on this year. Obviously there is some seasonality as you go throughout the year. So as you think about the future next couple of quarters we have got seasonality, which is going to be -- all else equal if the year is normal it is going to be lowering the net charge-off rate, but you've got some seasoning that's going to be increasing it. So we will just have to see how that plays out over the next couple quarters. What was the second part of your question? + +-------------------------------------------------------------------------------- +Ken Usdin, Jefferies LLC - Analyst [26] +-------------------------------------------------------------------------------- + + Just on the risk-adjusted -- the card risk-adjusted margin. + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [27] +-------------------------------------------------------------------------------- + + Sure. I mean a couple of things. One, tend to think of it as opposed to the margin as put just the dollars that we are producing there and we've got modest growth in the number of cards outstanding. We have got good growth in debit and credit card spend. +And just focusing on the margin I think overlooks some key benefits of our strategy to attract relatively higher quality card customers and reward them for deepening their overall relationship with us. That strategy is driving incremental deposit growth and making those deposits a little bit stickier, so that helps NII. It also, if you think about these customers, they have lower loss rates and they tend to reduce their interaction with the call center. +We also have a model that has lower acquisition costs in terms of those new cards. So that's how we think about it. If you just want to focus in on the risk-adjusted margin, that's going to, I think, perform well in line with the industry and probably drift a little bit lower. But we are more focused on total revenue. + +-------------------------------------------------------------------------------- +Ken Usdin, Jefferies LLC - Analyst [28] +-------------------------------------------------------------------------------- + + Understood. And if I can just ask one big picture one, all the points you made earlier, all the credit metrics are going the right way otherwise, NPAs, inflows, etc. Coming back into this point about where card is going and then just not seeing anything else, you guys have been at 40 basis points of losses. Any reason to see that changing really? And then do you still have some room for release as well given that? + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [29] +-------------------------------------------------------------------------------- + + Look, absent some change in the world and the economic situation, we don't see a reason why that necessarily changes materially. I don't want to give you guidance, but that's kind of our view. +In terms of releases, we are building -- I just pointed out we are growing loans, we are growing card. Things are seasoning, that's seasoning. So, we may have some releases, but I would more think of those releases as potentially offsetting some of that growth. + +-------------------------------------------------------------------------------- +Ken Usdin, Jefferies LLC - Analyst [30] +-------------------------------------------------------------------------------- + + Understood. Thanks a lot. + +-------------------------------------------------------------------------------- +Operator [31] +-------------------------------------------------------------------------------- + + Betsy Graseck, Morgan Stanley. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [32] +-------------------------------------------------------------------------------- + + Hi, good morning. Brian, two questions. One on the consumer banking efficiency ratio. You mentioned that there still is room for that to fall from the 52%, which is obviously very efficient as it stands right now today. And you indicated all various opportunities to drive incremental revenues at a much improved expense ratio with all the digital that you outlined earlier. +But could you speak to how the branch network could also impact those numbers? I mean, your branch has been coming down about 3% the last couple of years. Is that the kind of pace that you think you are going to continue? Or does the digital improvements enable you to move even faster there? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman, President & CEO [33] +-------------------------------------------------------------------------------- + + Well, I think, Betsy, to be careful there, you have to go back to the broadest context which is the 6,100 to 45. We got after this relatively early and so we've got it down a level. We don't know where it goes from here because it will be based on customer behavior demand. +But if you go back, if you think about it, over the last several years we've been adding branches in places like Denver and we will continue to build out there. We have been refurbishing branches heavily across the whole franchise. That's all in this run rate you see. And that will continue and in the expectation I'm talking about. +So we'll -- I think we drifted down 15, 17 branches linked quarter, 100 odd year over year. That will continue to happen. But I think what you would expect is the efficiency of that system continues to improve dramatically. So let me give you an example. +In Chicago we had one of these old big branches, and what we have done is created a call center in there and we have 70 teammates going to work in the call environment just to use up the physical space to keep the branch open as opposed to closing the branch. So if you think about it from the scheme, because the telephony capabilities that exist today you could actually distribute phone calls down to individual people based on the number coming in and things like that local calls. +So we have done that in three or four markets. We continue to use up the excess capacity. So you wouldn't see a branch decline there, but you would see 80% of its real estate goes for a different purpose. So it's a very complex thing and I don't like to get caught by numbers. I'd say that you've seen us manage it well and we'd expect to continue to manage it well in the future. But we are not good to get ahead of the customer and create any disruption to the growth we are seeing in the core channel. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [34] +-------------------------------------------------------------------------------- + + Okay, thanks for that. And then separately, you've spoken before about the op risk RWA burden that you guys have. We had some questions come in on how you are thinking improvements there could help you given that it's not directly in the CCAR stress test. But maybe you could give us a sense as to how you think any changes could help you given that it's not a constraining factor. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman, President & CEO [35] +-------------------------------------------------------------------------------- + + I think you've seen us start to make improvements and changes have gone through and the overall advanced RWA op risk being a portion of that, the change has been more in other areas quite frankly. We will expect to see further. But you have to be careful. +At some point standardized then backs into your constraint. And so this will be a toggle between -- for a long time advanced was our need and over the years now it's coming down and so standardized at some point will counter veil the improvement overall and then we will go to work on standardized quite frankly. +So expect us to continue to work on optimization of the balance sheet. Really at the end of the day opening up the difference between our GAAP capital levels for lack of a better term and our regulatory capital levels. So we are down -- RWA on an advanced base down $30 billion odd this quarter. Expect that to continue to improve, but be careful that at some point it hits the other side. +And then where we have so much excess capital is just kind of an interesting exercise. But in a world where we actually start returning that capital through our earnings we are going to have to continue to optimize both sides of that equation. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [36] +-------------------------------------------------------------------------------- + + And then just lastly, you had a nice increase in the dividend. Could you just speak to how you are thinking about dividend payout ratios? Do you feel like you are where you should be given the business model? Or is there more room and if there is more room what the drivers are to affect that change? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman, President & CEO [37] +-------------------------------------------------------------------------------- + + We've always been clear that -- in the guidance still relative to large banks is out there sort of 30% of earnings to dividends and 70% to share buybacks. We think that the shares are a tremendous value and we will continue to do that. And with $17 billion over the next 12 months we can make some headway. So think about 30/70 split for us and in the large bank category I think that's a responsible place to be. Right now we are moving up towards that but we are not quite there. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [38] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Operator [39] +-------------------------------------------------------------------------------- + + Gerard Cassidy, RBC. + +-------------------------------------------------------------------------------- +Gerard Cassidy, RBC Capital Markets - Analyst [40] +-------------------------------------------------------------------------------- + + Thank you, good morning, guys. In looking at your ROE, your returns on allocated capital in the Consumer and the Wealth Management businesses are very strong, well over 20%. Global Bank is 18%, Global Markets about 10%. Can you share with us how you are going to get the 8% ROE up let's say above your cost of capital let's say 10%? Is it going to be more coming from the Global Markets area or management of the capital or somewhere else? + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [41] +-------------------------------------------------------------------------------- + + Well, the first thing I would point out is that we have a goal to get our ROA up, we have a goal on our return on tangible common equity -- 1% on ROA, we are making a lot of progress. Return on tangible common equity we want to get to 12%, we are at 11.2% this quarter. And we have been making steady progress and if we stay focused on operating leverage and doing the right things for our customers we know we are going to get there. +I would make a point to what Brian was talking about earlier about our excess capital. So if you just look at the 11.2% return on tangible common equity we had this quarter, and you -- if we ran the Company at 10% capital instead of 11.5%, that would still be above our regulatory minimum, we would have a 50 basis point buffer. That would have increased that return on tangible common equity to 12.6%. +So we are at our goal right now from an operating standpoint if we could just continue to make progress on the amount of excess capital we have at the Company. In terms of ROE, look, we've got a lot of goodwill. We could tomorrow just write off all that goodwill -- nothing would change at the Company. Your ROE would just go up to your return on tangible common equity. + +-------------------------------------------------------------------------------- +Gerard Cassidy, RBC Capital Markets - Analyst [42] +-------------------------------------------------------------------------------- + + Very good. And then coming back to the mobile users, I think you guys pointed out you had just shy of 23 million mobile users. What percentage of your customer base are mobile users? And where do you see that number going to in the next two to three years? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman, President & CEO [43] +-------------------------------------------------------------------------------- + + I think -- every time I say this can't go up because we are starting some inflection point where you have got penetration, it continues to go up. So I think we ask 30 million odd checking holders, so think about the delta between those two being available, for lack of a better term. You've got 34 million digital users and so you still have some digital only users who don't use the mobile phone just because they do it which means they come through the website instead of an app, for example. +And so, each year we think it's not going to -- you are starting to hit a possible inflection point it goes up 10% or 15% year over year. And so I think there's headroom ahead of us. So I think of us having 30% more that we could get just easily and we are growing the customer base and we will drive it. And as you see norms change you will see that penetration continue to increase. +The important thing isn't necessarily only the 22.9 million users. The important thing is how people use it. And so, just take the P2P payments, even though we do 18 billion this quarter, even though it's been a product we've had for a while, even though we are going to re-launch it and we will see [whether the sale of that] will drive it, it's still 3%. +And even though all the wallets, whether it's Apple or Samsung or Android, etc., all those are out there, they are still 1.5% of payments. And so at the end of the day we've got a lot of work within the customer base in how they use all the form factors to get more efficient and more effective for them on top of what you think is more penetration so to speak. +So, we've got a long way to go on penetration, only 22% of the sales are done, so we will continue to drive that. But importantly for the team -- [Tom] and Dean and the team is to drive that usage up. And that's where we are starting to see some good pickup, but there's a lot of room to go there. + +-------------------------------------------------------------------------------- +Gerard Cassidy, RBC Capital Markets - Analyst [44] +-------------------------------------------------------------------------------- + + Brian, you mentioned Gazelle. Any early read on what you are seeing there and when do you expect to have a broad launch of that product if you haven't done it already? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman, President & CEO [45] +-------------------------------------------------------------------------------- + + It's Zelle, not Gazelle, but -- I don't want to violate anybody else's trademark here, but it's still pretty early. The nice thing is that the industry has built a network among all of us that allows us to operate very easily among us all the companies. And so I think the better time to talk about it would be in six months or so after we've gotten everybody up and operating and driving it through. +But previous to this we were already driving it and it was up double-digits year over year. And so, this ought to -- just awareness and with the students signing up for accounts from now to the fall you will see a lot of embedding this in our marketing and our capabilities. So maybe next quarter we will have a better read. + +-------------------------------------------------------------------------------- +Gerard Cassidy, RBC Capital Markets - Analyst [46] +-------------------------------------------------------------------------------- + + Very good. Thank you. + +-------------------------------------------------------------------------------- +Operator [47] +-------------------------------------------------------------------------------- + + Matt O'Connor, Deutsche Bank. + +-------------------------------------------------------------------------------- +Matt O'Connor, Deutsche Bank - Analyst [48] +-------------------------------------------------------------------------------- + + Good morning, just a couple of quick follow-ups. Did you guys disclose the debt hedge ineffectiveness drag that was in net interest income this quarter? + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [49] +-------------------------------------------------------------------------------- + + We didn't disclose the amount. It was meaningful, not a huge amount but it was meaningful. And again I would remind everybody that over time it's just going to reverse itself. + +-------------------------------------------------------------------------------- +Matt O'Connor, Deutsche Bank - Analyst [50] +-------------------------------------------------------------------------------- + + Okay, does that show up in the 10-Q or -- I can't remember where we got that from. + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [51] +-------------------------------------------------------------------------------- + + No, I don't think so. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman, President & CEO [52] +-------------------------------------------------------------------------------- + + Matt, at the highest level, remember -- if we go back and think about where we started the quarter, where we ended it, we took out about half of what we thought the increase was going to be due to the card. The rest of it, all the factors, Paul has talked about ins and outs chewed up the other half of the projected increase. So that will give you a sense of dimension. + +-------------------------------------------------------------------------------- +Matt O'Connor, Deutsche Bank - Analyst [53] +-------------------------------------------------------------------------------- + + Okay, and then just separately the expenses related to the UK card business that go away, how much is that? + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [54] +-------------------------------------------------------------------------------- + + Sure. Let me just run you through the whole picture, okay, if you want to build any models. On the revenue side it's primarily interest income, think about $10 billion of receivables at 9%. Plus you've got a little small amount of card income, I think that was around $30 million in the second quarter. The efficiency ratio for that business is around 40%. +If you look in our supplement you can see I think the net charge-off ratio has been running a little bit less than 2%, call it $40 million, $45 million per quarter. I think that probably gives you just about everything you need to model it. I would remind you that when we sold it we did get a 12 and 15 basis point improvement in our CET ratio on an advanced and standardized perspective respectively. + +-------------------------------------------------------------------------------- +Matt O'Connor, Deutsche Bank - Analyst [55] +-------------------------------------------------------------------------------- + + Okay, that's helpful. Thank you. + +-------------------------------------------------------------------------------- +Operator [56] +-------------------------------------------------------------------------------- + + Steven Chubak, Nomura Instinet. + +-------------------------------------------------------------------------------- +Steven Chubak, Nomura Securities - Analyst [57] +-------------------------------------------------------------------------------- + + Hi, good morning. So Brian, I appreciate the helpful commentary you've given on capital ratios and the continued effort to optimize your RWAs. And just given the significant capital cushion that you are operating with today, I'm just wondering how you are thinking about the payout trajectory over the next couple of years. +And maybe just to help us frame it from an ROE perspective, because you did note that your excess capital continues to be a drag on returns, what do you believe is a reasonable spot capital target for you to manage to through the cycle? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman, President & CEO [58] +-------------------------------------------------------------------------------- + + Well, if you take that the 9.5% is the place we are at, we have 50 basis points or so of cushion on that at all times. And so, that gives you a sense where we are and we are running at 11.5% and that difference is available. So you would expect more. Assuming that we have a 2% growth environment and continue to grow and there is no big recession that comes, we continue to ask for more capital return. +I think to keep you focused in the near-term, we've got $17 billion plus that we've got to take out in the next four quarters, which is a pretty healthy chunk. And then we will go through next year's CCAR process and you'd expect us, like the industry, to keep stepping that up to start to work against that excess. +Against that, when Paul talked about the last question, the UK card, remember the thing that people have to think about is not only does it give you current capital benefit, but also in the stress the losses and stuff are out of the system. So you can also pick that up. So I would say simply pointing to the next 12 months we are going to return more capital we earned in 2016, to give you a framework, and we would expect to ask -- as we earn more in 2017 we would expect to ask more for the next ask and keep driving that forward. +And everything contributes -- [it's] better asset quality, better earnings and better modeling and everything else. So, our CCAR losses continue to come down and we continue to drive to responsible growth. So just think about that as a framework to say more in the future, but we've got a nice pickup just coming in the next four quarters. + +-------------------------------------------------------------------------------- +Steven Chubak, Nomura Securities - Analyst [59] +-------------------------------------------------------------------------------- + + Got it. And then just on some of the expense initiatives, Brian, that you outlined. I'm getting quite a few questions on how we should think about it from a timing perspective. I know that you have the $53 billion expense target that's out there, but just given some of the efficiency opportunities that you identified, should we expect that progress to continue beyond 2018? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman, President & CEO [60] +-------------------------------------------------------------------------------- + + You are asking me what have you done for me lately. We are getting to $53 billion first, Steven, and then we will move from there. But the idea is if you think about an expense base of a financial services firm, and Bank of America in particular, about two-thirds of the costs are people costs. The cost of salaries and wages, incentives, etc., healthcare costs rising at 6%, 7%, 8%, 9% a year. +And so, our job is to figure out how to pay our teammates fairly and more for more productivity and what they do to drive for you US shareholders. And if you just lock in a growth rate on just that part of the expense base, you are locking 2% growth. So what we do through all these initiatives is figure out a way we can turn that into being on a core basis year over year sort of flattish. +And so, whether the $53 billion keeps coming down or stays flat while revenue keeps going up, that will produce further operating leverage. And so, we haven't told -- we haven't made projections past the $53 billion. More just because we've got a lot of initiatives coming in. +But you should expect that we will be just as disciplined and thoughtful about how we both invest and invest to take out expense that we have been so far. And I think that will redound to our benefit in terms of keeping those expenses relatively flat as revenues grow in the future. + +-------------------------------------------------------------------------------- +Steven Chubak, Nomura Securities - Analyst [61] +-------------------------------------------------------------------------------- + + Thanks, Brian. And just one more quick one for me just on the DoL fiduciary rule. You had outlined your strategy previously for stopping or no longer engaging in retirement brokerage activities. But just given the potential for that rule to be repealed, I'm wondering if your thinking has evolved around that? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman, President & CEO [62] +-------------------------------------------------------------------------------- + + I would say -- let's see what happens. I don't think it will change our thinking. We have accommodated customers' larger balances in some of the areas and some cash IRAs and things that get a little bit different, but just out of necessity. +But the overall trend of driving towards the model products and driving towards the effectiveness and offsetting demands for lower and lower cost structure the customer pays in fees to get higher and higher service and the capabilities from us is what's driving this. The fiduciary rule is only a part of it. And so, I don't expect to change our course. + +-------------------------------------------------------------------------------- +Steven Chubak, Nomura Securities - Analyst [63] +-------------------------------------------------------------------------------- + + Thanks for taking my questions. + +-------------------------------------------------------------------------------- +Operator [64] +-------------------------------------------------------------------------------- + + Saul Martinez, UBS. + +-------------------------------------------------------------------------------- +Saul Martinez, UBS - Analyst [65] +-------------------------------------------------------------------------------- + + Hi, good morning. First wanted to follow-up on the net interest income. The 100 basis point -- the benefit of $3.2 billion you get from a 100 basis point parallel shift in the yield curve, you mentioned it's primarily sensitive to the short end. I think last quarter you gave sort of a 75/25 split between short and long and is that still a good rule of thumb to use? + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [66] +-------------------------------------------------------------------------------- + + It's changed a little bit. We are a little bit more sensitive on the long end now that -- since rates went down. The asset sensitivity on the short end hasn't changed that much. + +-------------------------------------------------------------------------------- +Saul Martinez, UBS - Analyst [67] +-------------------------------------------------------------------------------- + + Okay, so a little bit more skewed to the long end than the disclosure in 1Q? + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [68] +-------------------------------------------------------------------------------- + + It's like -- it's actually -- it's like two-thirds/one-third. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman, President & CEO [69] +-------------------------------------------------------------------------------- + + Just to back up, the first half of the year when you think about the rate environment it's really changed on the short end. Just to give a sense how it works, we got a $1.5 billion -- $1.4 billion to $1.5 billion pickup in first-half NII versus last year and so that gives you a sense. It really is driven 60%-70%, depending on the quarter, by the short end. + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [70] +-------------------------------------------------------------------------------- + + I think that's an important point. Again, we picked up that $1.5 billion and you haven't seen the sensitivity change much. So that tells you what is embedded in the pass-throughs in the first half of the year. + +-------------------------------------------------------------------------------- +Saul Martinez, UBS - Analyst [71] +-------------------------------------------------------------------------------- + + Okay, got it. Moving on -- just to discuss capital deployment strategies a little bit. You've talked about your excess capital position, obviously you upped your returns in the CCAR cycle and you will keep going forward with that. +But is it too early to talk about acquisitions as part of the capital strategy? And how would you think about M&A in terms of opportunities whether from a product strategy, geographic segmentation standpoint? How do you think about M&A in the context of your capital strategy? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman, President & CEO [72] +-------------------------------------------------------------------------------- + + We don't think about M&A in the context of our capital strategy. We are organically growing this Company, including open up in markets, investing in bankers, investing in branches, investing in things. And the capability -- and investing in cash management capabilities. We've built out the lot in Asia, Tom Montag and the team driving our global franchise -- we just don't need the distraction. + +-------------------------------------------------------------------------------- +Saul Martinez, UBS - Analyst [73] +-------------------------------------------------------------------------------- + + Okay, all right, fair enough. Thanks a lot. + +-------------------------------------------------------------------------------- +Operator [74] +-------------------------------------------------------------------------------- + + Marty Mosby, Vining Sparks. + +-------------------------------------------------------------------------------- +Marty Mosby, Vining Sparks - Analyst [75] +-------------------------------------------------------------------------------- + + Thanks, I've got three bigger picture kind of questions. First, Brian, you've turned the corner on the customer growth and business growth. That was one of my main concerns after so many years of having to deal with the overhang issues to be able to re-energize and get that -- business segments growing again. What are the couple of things that you could say have helped go through that inflection point as quick as you've been able to do that? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman, President & CEO [76] +-------------------------------------------------------------------------------- + + I think, depending on the business, at the end of the day, if you go across eight businesses -- in the relationship business it's been just deploying more and more relationship management teammates and being able to pay for that while bringing expenses down across the board. +So that's whether it's US trust or Merrill Lynch, the preferred business in Consumer, the business banking, global commercial bank, [global] corporate investment banking and driving that -- always had great products, we just literally had to add more sales teams. Behind that has also been the deployment in technology to help those sales teams. We are using artificial intelligence to prioritize their work in terms of targeting their efforts. +And then if you look in both the markets business separate from the commercial side of it in the true markets business and you look in the mass-market consumer business, what we call retail, you see the nice thing about the retail business and mass-market is we are now growing and making money in a business which it was a little bit tricky. And that's largely because the electronification, digitization has been driving it. +And if you go to markets, the team in equities and fixed income has done a great job of repositioning that business and it's gaining share. So in each case it's investments in people, technology, better customer experience. And that all sounds like you say it all the time, but it has been a relentless focus in just driving that and investing behind that at all times taking out some of the extraneous costs including credit costs through very disciplined client selection and credit underwriting capability. + +-------------------------------------------------------------------------------- +Marty Mosby, Vining Sparks - Analyst [77] +-------------------------------------------------------------------------------- + + Paul, one of the -- sort of the second question to look at, we've talked about the core, core, core and that the Company has taken actions to try to drive that. But really we've had an historical shift in the liquidity premium coming out of the financial crisis and just having rates at zero. +So hasn't a lot of this shift been related to just the environment more than really Company actions? And what we are seeing has been the derisking. Now that GWIM deposits are starting to move out, is that the first sign of the rerisking or are the customers willing to take a little bit more risk and drop that liquidity premium? So I'm kind of watching for that first sign of the customer behavior beginning to change. + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [78] +-------------------------------------------------------------------------------- + + I think, Marty, across all the years since the crisis there has been ebbs and flows in customers' views about where they want to invest and the cash portion of our balance has come up and down. But I think the consumer and the investor are very bullish on America and they continue to invest in it. +Consumers through their spending and activity do and investors on the personal side through their investments. And you've seen those investments in equities and risk products continue to rise almost without fail. And then when there's real market disruption concern you see it pull back a little bit. But basically without fail there has been a steady investment and that's why we've hit assets under management levels of record levels at this point. + +-------------------------------------------------------------------------------- +Marty Mosby, Vining Sparks - Analyst [79] +-------------------------------------------------------------------------------- + + It just seemed like there's a little bit of a change sitting there. You will see it ripple into some of the other business maybe later. But a third question was with what's going on in the mortgage business, you are retaining 90% of loans. In the past, I don't know the number, but I bet you were securitizing before the financial crisis probably 90% of the loans. +How do you look at that business different? That is such a paradigm shift that you really are now a portfolio lender much more than you are a securitization. Are there any other dynamics that we should look at separately? + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman, President & CEO [80] +-------------------------------------------------------------------------------- + + Well, the business pre-crisis that came out of some of the other firms, and etc., was driven by a basic view of generating more and more mortgages as opposed to customers and penetration of customers and giving mortgages to the customers. And so one of the ways -- the major way it did it, 75% of its production was bought from third parties, either its correspondence or brokers or brokers or whatever the methodology. All that is gone. +And so, if you had that size of production that was bought in the secondary market through wholesale trades of the production you would have to go off balance sheet because you wouldn't have the capacity. During 2004 to 2008 we generated $2 trillion of mortgages or something like that. So you had to go off balance sheet. +Now where we are now where quarterly production runs $13 billion, $15 billion, and this huge deposit franchise that needs to be invested, you can put those mortgages on the balance sheet. The odd thing would be in the past we were sending them off and then buying back mortgage-backed securities. The answer is we just retain the mortgages and frankly the credit quality in ours, it's not worth paying the insurance. +But it really came to focusing on what we call direct to consumer where our market share continues to be solid and really saying we are in this business. It's always been a tough business, it's priced on a commodity basis, it's on your screen every day, and the MSR assets always had interesting issues of how you could hedge them and make them work. +Our goal as a Company was to take all that volatility and up and down out and just focus then on getting mortgages to historic customers of high credit quality. And then why wouldn't we keep them, because, at the end of the day, we've got to invest our deposits somewhere and these are great investments. + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [81] +-------------------------------------------------------------------------------- + + They're our customers; it's not like we're -- as Brian said, we are not buying somebody else's underwriting. These are our customers. We know these customers. We have [been underwriting] these loans and why pay the insurance? + +-------------------------------------------------------------------------------- +Marty Mosby, Vining Sparks - Analyst [82] +-------------------------------------------------------------------------------- + + And it's not just you all, I mean it has been across the industry where you are seeing much more in retention than you are seeing in securitization. So I just didn't know if there was any operational or other issues that gives you more flexibility on pricing or product development. It's a very different market than what it used to be when we were in it before. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman, President & CEO [83] +-------------------------------------------------------------------------------- + + I agree, it's a different market and I think a better one because of it. + +-------------------------------------------------------------------------------- +Operator [84] +-------------------------------------------------------------------------------- + + Brian Kleinhanzl, KBW. + +-------------------------------------------------------------------------------- +Brian Kleinhanzl, KBW - Analyst [85] +-------------------------------------------------------------------------------- + + Great, thanks. I just had a question first on the lending environment overall. Could you give an update of the pipelines? And I know last quarter you said middle market revolver, you were at record levels there. Were you able to increase utilization rates there? Just give a sense of where your clients are if optimism is waning? + +-------------------------------------------------------------------------------- +Paul Donofrio, Bank of America Corporation - CFO [86] +-------------------------------------------------------------------------------- + + We feel good about loan growth. Unless the economy changes significantly we wouldn't expect much change from the past few quarters. We did see a little bit of disintermediation this quarter in commercial. That could slow growth in the future. But having said that, we haven't changed our medium-term outlook on our ability to grow loans. +We expect total loan growth at the Company to be low-single-digits and we expect to grow mid-single-digits in our lines of business once -- that obviously excludes the headwind from loans in All Other, the mortgage runoff and now UK card is gone. +So with respect to each segment, we are anticipating modest growth in consumer led by mortgage. We would also expect to grow card and auto, although auto growth has probably slowed a little bit. But we still expect a little bit of growth. That growth is going to be partially offset by continued runoff of home equity loans. +In commercial, again, while things have slowed a little bit, our outlook still remains favorable led by middle market. You saw middle-market loans grow 5% year over year. And I would note that growth in any quarter in commercial can bounce around a bit because you've got acquisition financing thrown into the mix. All of that I think is consistent with responsible growth. + +-------------------------------------------------------------------------------- +Brian Kleinhanzl, KBW - Analyst [87] +-------------------------------------------------------------------------------- + + Okay great. And then just a question on wealth and investment management. You did see the financial advisors increase 2 percentage points quarter on quarter. Is that a trend now that you think you can -- or back into a hiring phase where you can actually grow the number of financial advisors? Because productivity also increased as well. So there was no drag from hiring those advisors. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman, President & CEO [88] +-------------------------------------------------------------------------------- + + We have a tremendous customer base that is underserved in the investment management area. And so, we are going to continue to grow our financial advisor team to serve that customer base, whether it is the teams that work in the branches, the teams that work in the Merrill office, the team that work in US trust and we have been after that and growing that. And so, you should expect that number to continue to go up with Terry Laughlin, Andy Sieg, Keith Banks and the team are driving it. +And so, that's -- it's through unit of production for lack of a better term. It's your team that really has the core customer interface and will drive that. Meanwhile on the nonfinancial advisor side you saw the assets in Edge up 21%, so that means that we are also facing off against the customers who choose to go about it a different way. + +-------------------------------------------------------------------------------- +Brian Kleinhanzl, KBW - Analyst [89] +-------------------------------------------------------------------------------- + + Okay great. Thanks for taking my questions. + +-------------------------------------------------------------------------------- +Brian Moynihan, Bank of America Corporation - Chairman, President & CEO [90] +-------------------------------------------------------------------------------- + + All right, I think, operator, that's all the calls. So I want to thank everyone for joining us again this quarter. I think if you think about this quarter it's a quarter which shows you what responsible growth is all about: solid earnings growth, very solid operating leverage. +Each business grew first half of this year versus first half of last year and did it the right way, did it while maintaining great risk and did it while we invested heavily in technology and invested in our people. So we look forward to next quarter and talk to you soon. + +-------------------------------------------------------------------------------- +Operator [91] +-------------------------------------------------------------------------------- + + This does conclude today's call. You may disconnect at any time and have a wonderful day. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/exam/original-files/Problem_1_Sample/2017-Jul-26-FB.OQ-136950829491-Transcript.txt b/exam/original-files/Problem_1_Sample/2017-Jul-26-FB.OQ-136950829491-Transcript.txt new file mode 100644 index 0000000..4120ccd --- /dev/null +++ b/exam/original-files/Problem_1_Sample/2017-Jul-26-FB.OQ-136950829491-Transcript.txt @@ -0,0 +1,574 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q2 2017 Facebook Inc Earnings Call +07/26/2017 05:00 PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Deborah T. Crawford + Facebook, Inc. - VP of IR + * Sheryl K. Sandberg + Facebook, Inc. - COO and Director + * David M. Wehner + Facebook, Inc. - CFO + * Mark Zuckerberg + Facebook, Inc. - Founder, Chairman of the Board and CEO + +================================================================================ +Conference Call Participiants +================================================================================ + + * Peter Coleman Stabler + Wells Fargo Securities, LLC, Research Division - Director & Senior Analyst + * John Ryan Blackledge + Cowen and Company, LLC, Research Division - Head of Internet Research, MD and Senior Research Analyst + * Richard Scott Greenfield + BTIG, LLC, Research Division - Co-Head of Research, MD and Media and Technology Analyst + * Justin Post + BofA Merrill Lynch, Research Division - MD + * Brian Thomas Nowak + Morgan Stanley, Research Division - Research Analyst + * Brian W. Wieser + Pivotal Research Group LLC - Senior Analyst of Advertising, Media, and Internet + * Heather Anne Bellini + Goldman Sachs Group Inc., Research Division - Research Analyst + * Douglas Till Anmuth + JP Morgan Chase & Co, Research Division - MD + * Ralph Edward Schackart + William Blair & Company L.L.C., Research Division - Partner and Technology Analyst + * Ross Adam Sandler + Barclays PLC, Research Division - MD of the Americas Equity Research and Senior Internet Analyst + * Mark Stephen F. Mahaney + RBC Capital Markets, LLC, Research Division - MD and Analyst + * Benjamin Ari Schachter + Macquarie Research - Head of TMET Research + * Michael Brian Nathanson + MoffettNathanson LLC - Co-Founder, Partner and Senior Research Analyst + * Colin Alan Sebastian + Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst + * Mark Alan May + Citigroup Inc, Research Division - Director and Senior Analyst + * Lloyd Wharton Walmsley + Deutsche Bank AG, Research Division - Research Analyst + * Robert Jason Sanderson + MKM Partners LLC, Research Division - MD & Senior Internet Analyst + +================================================================================ +Presentation +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Good afternoon. My name is Mike, and I will be your conference operator today. At this time, I would like to welcome everyone to the Facebook Second Quarter 2017 Earnings Call. (Operator Instructions) This call will be recorded. Thank you very much. +Ms. Deborah Crawford, Facebook's Vice President of Investor Relations, you may begin. + +-------------------------------------------------------------------------------- +Deborah T. Crawford, Facebook, Inc. - VP of IR [2] +-------------------------------------------------------------------------------- + + Thank you. Good afternoon, and welcome to Facebook's Second Quarter 2017 Earnings Conference Call. Joining me today to discuss our results are Mark Zuckerberg, CEO; Sheryl Sandberg, COO; and Dave Wehner, CFO. +Before we get started, I would like to take this opportunity to remind you that our remarks today will include forward-looking statements. Actual results may differ materially from those contemplated by these forward-looking statements. +Factors that could cause these results to differ materially are set forth in today's press release and in our quarterly report on Form 10-Q filed with the SEC. Any forward-looking statements that we make on this call are based on assumptions as of today, and we undertake no obligation to update these statements as a result of new information or future events. +During this call, we may present both GAAP and non-GAAP financial measures. A reconciliation of GAAP to non-GAAP measures is included in today's earnings press release. The press release and an accompanying investor presentation are available on our website at investor.fb.com. +And now I'd like to turn the call over to Mark. + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook, Inc. - Founder, Chairman of the Board and CEO [3] +-------------------------------------------------------------------------------- + + Thanks, Deborah, and thanks, everyone, for joining today. +This quarter, we reached an important milestone for our community. 2 billion people now use Facebook every month, and more than 1.3 billion people use it daily. We also saw good results on the business with total revenue growing by 45% year-over-year to $9.3 billion and advertising revenue up 47% to $9.2 billion. +We're proud of the progress we're making, and it also comes with a responsibility to make sure that we have the most positive impact on the world that we can. That's why, last month, we updated Facebook's mission. For the past decade, we focused on making the world more open and connected. We have a lot more to do here to give people a voice and help everyone stay connected with their family and friends, but now I believe we have a responsibility to do even more. Our new mission is to bring the world closer together. +A big part of this mission is building community. Communities give us a sense that we're part of something bigger than ourselves, that we're not alone and that we have something better ahead to work toward. Last month, we had our first ever Facebook Communities Summit to talk about our product road map focused on building what we call meaningful communities. +Meaningful communities on Facebook are groups that quickly become an important part of your social network experience and your real-world support structure. And right now, over 100 million people are members of these groups, from new parents to people suffering from rare diseases. So these groups often span online and offline and bring people together physically as well as over the Internet. +Our goal is to help more than 1 billion people join meaningful communities, and part of this involves helping people discover the right groups, which is why we're building technology like AI to better understand people's interests and suggest groups that might be meaningful to them. And in the 6 months after we started working on this, we've already helped more than 50% more people join meaningful communities than had before that. So we have a lot more to do here. +We also want to make it easier for people to build and lead communities. Last month, we launched new tools for group admins, making it easier for them to get insights into who their members are, filter member requests and remove bad actors and their content quickly to keep a positive and safe environment. +Next, I want to give a quick update on what we're building over our 3 time horizons: making our existing services more useful now; building new ecosystems over the next 5 years around our products that a lot of people already use; and creating foundational technologies to achieve our mission over the next 10 years. +So we're pleased with the growth that we're seeing with Stories. Instagram Stories now has more than 250 million people using it daily, and WhatsApp Stories also now has more than 250 million people using it daily. We're always working to improve and give people more ways to share, and this quarter, we added the ability to reply to stories with a photo or video and share a replay of live video on Instagram. +I'm excited about how AI will improve people's experiences across our products. We're finding AI is both delivering consistent improvements to many of our systems like News Feed, search ads, security and spam filtering and more. But more than just improving these existing experiences, I expect AI to change the way that we do business in some important ways. +So for example, today, to keep our community safe, we rely on people flagging content that might violate our community standards for us to review. In the future, AI will be able to help flag more of this content faster and before people have even seen it. +Now we've started using AI to fight terrorism and keep propaganda and extremist accounts off Facebook. We've even started experimenting with using AI to understand text that might be being used to promote terrorism. +When it comes to News Feed, we currently mostly show you content from people and pages you're connected to. And we can rank this better with algorithm improvement, but the really big improvement from AI will be when we can understand all the other content that's out there, so we can help you discover much more of what matters to you beyond just what your friends are up to. +On the business side, we're seeing a large shift in the way that marketing works. In the first wave of marketing, people would buy ads in media they thought their customers might watch, like a TV show that had similar demographics, but they wouldn't know who saw their ad. Now the Internet gave people the power to target their messages to people who actually might be interested and to measure results much more precisely. And that was a big improvement. And now AI is taking this a step further. Now you can put a creative message out there, and AI can help you figure out who will be most interested. A lot of the time, you don't even need to target now because AI can do it more precisely and better than we can manually. This makes the ads that you see more relevant for you and more efficient for businesses. +Those are just a few of the reasons why I'm optimistic about how AI is going to improve our core services over the next few years. Over the next 5 years, we're going to build ecosystems around products that a lot of our -- a lot of people are already using. +We've talked about how video will continue to be a big focus and area of investment for us. It's growing quickly, and we're introducing new features to make the video experience even better. For example, in May, we made the option to go live with someone else available to all profiles and Pages on iOS, and we also launched closed captions to make Live more accessible. +We're also working to build a business ecosystem around Messenger and WhatsApp. Messenger and WhatsApp both have large communities and are growing quickly with 1 billion people now using WhatsApp daily. It is still early on the monetization side here, although we have started showing ads to a small number of people on Messenger. I want to see us move a little faster here, but I'm confident that we're going to get this right over the long term. +Now finally, over the next 10 years, we're working on foundational technologies that are necessary to achieve our mission. In VR, we launched Live from Spaces, so you can go live with friends in different places. And we think that this has the potential to be a powerful tool to bring people together and help build community in some new ways. +We're also working to help everyone in the world access the opportunities that come with the Internet. In May, we successfully flew Aquila, the solar-powered plane that we're building to beam Internet to parts of the world that currently don't have access, and that was the second successful flight. +These initiatives and other projects require a lot of ongoing aggressive investment in the infrastructure to serve our community. Last quarter, our Fort Worth data center went live and is now serving traffic using 100% renewable energy. And we're also extending our data centers in Los Lunas, New Mexico and Altoona, Iowa. +This first half of 2017 has been an important period for Facebook. We've achieved some major milestones, delivered good business results and set clear goals around building strong communities and bringing people and the world closer together. But we have a long way to go. So thanks to our community, our teams and our partners for all being a part of this mission. I'm looking forward to making more progress together. +And now here's Sheryl. + +-------------------------------------------------------------------------------- +Sheryl K. Sandberg, Facebook, Inc. - COO and Director [4] +-------------------------------------------------------------------------------- + + Thanks, Mark, and hi, everyone. +We had a strong second quarter and a great first half of the year. Our business continues to deliver terrific results. Q2 ad revenue grew 47% year-over-year. Mobile ad revenue grew 53% year-over-year to $8 billion and is now 87% of total ad revenue. Our growth continues to be broad-based across regions, marketer segments and verticals. +Our goal is to build meaningful connections between people and businesses by focusing on our 3 key priorities: helping businesses leverage the power of mobile; developing innovative ad products; and making our ads more relevant and effective. +Our first priority is helping businesses leverage the power of mobile. People are rapidly increasing the time they spend on mobile, and businesses know they need to be where consumers are. Given the size and engagement of our audiences, Facebook and Instagram are the best platforms to reach people and drive business results. We have over 70 million businesses on Facebook, and I'm excited to announce today that we now have more than 15 million business profiles on Instagram. +Video is an important part of our mobile strategy. More video is being shared and watched on Facebook than ever before and it's increasingly helping people and businesses connect. That's because video on Facebook is personal, built around connections, conversations and communities. This is why it creates opportunities for businesses to reach people in new and creative ways. +People consume content faster on their phones, and marketers are increasingly recognizing that this behavior is different than on other media. This means that developing short-form snackable content is a big opportunity on mobile. We're working hard to help marketers adopt mobile-first video ad strategies for Facebook and Instagram. +In a mobile environment, native mobile video ads typically outperform more traditional ads. For example, when Tropicana launched its probiotic juice, the company tested 6-second video ads against 15- and 30-second ads. The shorter ads resulted in higher brand metrics across the board, including a 16-point lift in brand awareness compared to a 6-point lift for the longer ads. +Our second priority is developing innovative ad products. We're listening closely to feedback from marketers around the world to develop new ad formats and innovate on existing ones. Last quarter, I talked about how our Dynamic Ads help retailers and e-commerce companies promote their products across devices. Dynamic Ads show people the products that are most relevant to them based on actions they've taken, such as viewing items on a company's website. +This quarter, we continued to improve Dynamic Ads and extended them to new verticals and categories. Delta Air Lines used our new flight format to reach people who had searched for a flight but not yet booked one. Delta was able to run personalized ads based on the routes people viewed on their site and then bring people back to their booking page. This resulted in a 12.7x return on ad spend. +This quarter, we also rolled out ads in Instagram Stories for all types of marketer objectives. As Mark described, Instagram Stories are growing incredibly well and are therefore a big opportunity for marketers. From driving brand awareness to increasing sales, businesses can now use full-screen Instagram Story ads for any goal. For example, Ben & Jerry's created a brand awareness campaign using vertical video in Instagram Stories and saw a 14-point lift in ad recalls and a 2-point lift in purchase intent for its new Pint Slices ice cream. +Our third priority is making our ads more relevant and effective. This means better targeting and better measurement across Facebook, Instagram and Audience Network. Marketers of all sizes are increasingly following our best practices, like optimizing your ads to drive real-world outcomes rather than focusing on proxy metrics such as Page likes and video views. 53% of our revenue from SMBs is from campaigns that use these tools and strategies, up from 23% in the beginning of last year. +This quarter, we also added new ways for marketers to improve their targeting and spend more efficiently. For example, we introduced Value Optimization, which helps businesses show ads to people who are most likely to spend based on previous purchase behavior. We also introduced value-based Lookalike Audiences, which use machine learning to help marketers reach people who are similar to their most valuable current customers. +For example, California-based accessory company, Nomad, built a custom audience of people in the U.S. who bought something on their site and then created a multi-country Lookalike Audience of people with similar characteristics. They targeted ads to their international audience across Facebook, Instagram and Audience Network, resulting in a 2.7x return on ad spend. +We know that many marketers want to verify and compare results across platforms, and that's why we're focused on giving our clients more options for third-party measurement and verification. We now have 24 partners in our measurement system, including 3 partners measuring viewability, and we're in the process of adding 2 more viewability partners, DoubleVerify and Meetrics. +As the first half of 2017 comes to a close, we feel good about the progress we're making. As marketers build more meaningful connections with people on mobile, we help them grow their businesses, which in turn grows ours. +I continue to be grateful to our clients and partners all around the world and to our global teams who make all of this possible. Thanks, and now here's Dave. + +-------------------------------------------------------------------------------- +David M. Wehner, Facebook, Inc. - CFO [5] +-------------------------------------------------------------------------------- + + Thanks, Sheryl, and good afternoon, everyone. +Echoing Mark and Sheryl's comments, Q2 was another strong quarter for Facebook. We continue to see strong growth and engagement in our global community as well as momentum in our mobile ads business. +Let's begin with our community metrics. In June, 1.32 billion people visited Facebook on an average day, up 17% compared to last year. This number represents 66% of the 2.01 billion people that visited Facebook during the month of June, which was up 294 million or 17% compared to last year. Our community growth was again driven by product improvements on Android, our Internet.org efforts and ongoing third-party promotional data plans in markets like India. We will begin lapping the impact of these promotions in Q3 of this year. +We're also pleased to see strong adoption and community growth across video, Instagram Stories, Messenger and WhatsApp. While these products do not monetize at the same level as News Feed, they are providing new ways to build global community. +Turning now to the financials. All of our comparisons are on a year-over-year basis unless otherwise noted. Q2 total revenue was $9.3 billion, up 45%. Had foreign exchange rates remained constant with last year, total revenue would have been approximately $140 million greater or up 47%. Q2 total ad revenue was $9.2 billion, up 47% or 49% on a constant currency basis. +Ad revenue growth was strong globally. Rest of World and Asia Pacific grew at 56% and 54%, respectively, while U.S. and Canada and Europe grew at 45% and 43%, respectively. +Mobile ad revenue was $8 billion, up 53% and represented approximately 87% of ad revenue. Desktop ad revenue grew 17% despite an ongoing decline in desktop usage. Note that our Q2 desktop ad revenue benefited from our efforts to limit the impacts of ad blocking technologies. +In Q2, the average price per ad increased 24%, and the ads -- number of ad impressions increased 19%, primarily driven by mobile feed ads on Facebook and Instagram. +Payments and other fees revenue was $157 million, down 20%. Total expenses were $4.9 billion, up 33%. +We ended Q2 with over 20,000 employees, up 43% compared to last year. Our hiring growth rate increased for the third consecutive quarter as we continued to invest in the many opportunities ahead. +Q2 operating income was $4.4 billion, representing a 47% operating margin. +Our tax rate was 13%. In the quarter, excess tax benefits recognized from share-based compensation decreased our effective tax rate by 6 percentage points. +Net income was $3.9 billion or $1.32 per share. +Q2 capital expenditures were $1.4 billion, driven by investments in servers, data centers, office facilities and network infrastructure. +We generated over $3.9 billion in free cash flow and ended the quarter with over $35 billion in cash and investments. +Turning now to the outlook. Growth, engagement and advertising demand remain healthy, but there are certain factors that will impact revenue growth that are worth mentioning. As we have discussed before, we continue to expect that Facebook ad load will play a less significant factor driving advertising revenue growth going forward and that desktop ad revenue growth rates will slow in the second half of 2017 when we begin to lap efforts to limit the impact of ad blockers. +In addition, we expect that our strategic focus on driving engagement with mobile video may slow advertising impression growth given the relatively fewer ad impressions in video relative to News Feed. I would also note that we do not see our early efforts in Messenger monetization offsetting the factors that I just mentioned. For these reasons, we continue to expect that our ad revenue growth rates will come down as the year progresses. +We continue to expect full year 2017 payments and other fees revenue to decline compared to full year 2016. +Turning now to the expense outlook. Based on our updated view of the remainder of the year, we are tightening our initial expense guidance range. We expect that full year 2017 total GAAP expense growth will be approximately 40% to 45%, narrowed from our previous range of 40% to 50%. I would note that we expect to accelerate our headcount growth rates in the second half of the year as we remain solidly in investment mode. We also expect that our video content investments will contribute to operating expense growth in the second half of 2017. +In terms of capital expenditures, we expect that full year 2017 CapEx will be in the lower end of the prior range of $7 billion to $7.5 billion. We are ramping our infrastructure investments to support global growth and anticipate more data center building activity in the second half of this year. For example, we recently broke ground on new buildings at our New Mexico and Iowa data centers. +Turning now to tax. As I have previously noted, our tax rate will vary based on our stock price. At the current stock price, we would expect that our Q3 and full year 2017 tax rates will both be similar to our Q2 rate. +In summary, the first half of 2017 was a strong period for Facebook, both financially and in terms of growth and engagement of our community. We will continue to invest aggressively in the many opportunities we see ahead as we make progress on our mission to give people the power to build community and bring the world closer together. +With that, Mike, let's open up the call for questions. + + +================================================================================ +Questions and Answers +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) Your first question comes from the line of Brian Nowak from Morgan Stanley. + +-------------------------------------------------------------------------------- +Brian Thomas Nowak, Morgan Stanley, Research Division - Research Analyst [2] +-------------------------------------------------------------------------------- + + I have one for Mark. Mark, the offerings on the core Facebook app have improved and changed a lot over the years from groups, live video, search, et cetera. I'd be curious to hear how you've noticed consumer behavior on the core product, the core Facebook app change as Instagram has grown. And how do you think about that evolving over the next 3 to 5 years? + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook, Inc. - Founder, Chairman of the Board and CEO [3] +-------------------------------------------------------------------------------- + + So the main value proposition for the Facebook app is helping people share any type of content that they want with any audience that matters to them, right? So you can go from text to photo to video, from small groups to larger groups, from your friends to everyone in the world, and that's always been where the Facebook app has excelled. There have been different experiences that are more focused on specific things, but with a strong technological foundation supporting all of these different use cases, the Facebook app has always supported people using all of them. Now the biggest trend that we see in consumer behavior is definitely video, right? And there's a strong technological underpinning for that, which is that if you go back 5 years, you try to watch a video on your phone, it would probably have to buffer for a minute or so before you'd actually get to watch it, which wasn't a good experience. And if you wanted to upload a video, like whether it's a longer video like what you post to News Feed or a 10-second story like what you'd post on any of the apps, I mean, even that might take 30 seconds to upload, so it wasn't a good experience. So now as the technology on the network level improves to support that, what we're seeing is the ability to serve what is a large amount of demand for what's a very engaging type of content. And that demand flows across social content like we're seeing in Stories and feed to clearly a huge amount of public content. I mean, Pages are engaging in this and some of the trends that Dave just talked about for just a lot of video behavior across the platform. + +-------------------------------------------------------------------------------- +Operator [4] +-------------------------------------------------------------------------------- + + Your next question comes from the line of Ralph Schackart from William Blair. + +-------------------------------------------------------------------------------- +Ralph Edward Schackart, William Blair & Company L.L.C., Research Division - Partner and Technology Analyst [5] +-------------------------------------------------------------------------------- + + Mark, in the prepared remarks, you talked about Messenger and WhatsApp being on the early innings of the monetization. And then you also talked about your desire to move faster on Messenger. Just curious what are the factors sort of driving your willingness to move faster. And then how should we think about that both from a consumer and monetization experience? + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook, Inc. - Founder, Chairman of the Board and CEO [6] +-------------------------------------------------------------------------------- + + Well, on Messenger, there are 2 basic things that we're doing. One is we're starting to put some ads into the product just to see the basic parameters around how that performs, how people like the ads or don't, how they work for businesses and just try to get an understanding of that. So we're starting to run that across the world. But as Dave said, even though we're starting to roll that out in a lot of places, the volume starts off pretty small. The biggest strategic thing that we really need to do in messaging right now is make it so that people organically interact with businesses, and that that is a good interaction both for people and for the businesses. So here's one way to think about this. If you're a business and you have a higher ROI for interacting with a person in your messaging thread than you do on the mobile web or trying to get them to install an app, then that creates this positive feedback loop where you're going to point your ads towards the Messenger thread, you're going to invest more of your engineering resources in building out the content and experience around the Messenger thread. So we're currently working on making it so that, that is the highest ROI thing. I think we're making progress there. It's not that we're going to crack every market at once, but in some, I think we're definitely getting there. We're getting some positive feedback from the market. But once we start to achieve that in more and more verticals, I think that that's going to start unlocking a lot of behavior, and a lot of businesses are going to want to push more interactions to happen there, which I think will really be the foundation for building that into a big business. + +-------------------------------------------------------------------------------- +David M. Wehner, Facebook, Inc. - CFO [7] +-------------------------------------------------------------------------------- + + Yes. And, Ralph, it's Dave. I would just add that with messaging monetization, this is early, and it's not a near-term overall Facebook growth driver. And much like Instagram in its early days, we're going to be cautious. But unlike Instagram, this isn't a feed product, so there are just -- there are more unknowns here. + +-------------------------------------------------------------------------------- +Operator [8] +-------------------------------------------------------------------------------- + + Your next question comes from the line of Heather Bellini from Goldman Sachs. + +-------------------------------------------------------------------------------- +Heather Anne Bellini, Goldman Sachs Group Inc., Research Division - Research Analyst [9] +-------------------------------------------------------------------------------- + + I was wondering -- Sheryl talked a little bit about Instagram Stories. I was wondering if you could share with us kind of the initial feedback from advertisers. Did they see it as similar to advertising in the IG feed? Or are they using it to reach people in a different way if you've noticed anything over the period that you've been doing it? + +-------------------------------------------------------------------------------- +Sheryl K. Sandberg, Facebook, Inc. - COO and Director [10] +-------------------------------------------------------------------------------- + + So it's pretty early for ads in Stories. And I think the way people largely think about this is this is another way of using the Facebook ad system, including our targeting and measurement capabilities, to create ads that are great creatives that can reach people. So the fully immersive format with the targeting and optimization of Facebook ads is a pretty unmatched opportunity. We also have a huge opportunity within Instagram, and obviously, the use of ads in Instagram is much, much bigger than the use of ads in Stories. The way we think about this is we're trying to help marketers reach their customers, both their existing and their new customers effectively, and we think it's the combination of all these offerings that really are the strength of our business and explains why we can continue to grow. So within one interface, we're working with one sales rep. If you're a large company or a small company, you can buy Facebook. You can buy Instagram. You can buy Audience Network. You can buy the different ad formats within Facebook and Instagram. And that means that you have multiple targeting opportunities, multiple opportunities and even opportunities to see who engages in an ad in one place and then reinvest to continue the conversation with those customers. So we think all of these things work together, and these new formats fit in really nicely with the ad system we built, which underlies all of the opportunity. + +-------------------------------------------------------------------------------- +Operator [11] +-------------------------------------------------------------------------------- + + Your next question comes from the line of Peter Stabler from Wells Fargo. + +-------------------------------------------------------------------------------- +Peter Coleman Stabler, Wells Fargo Securities, LLC, Research Division - Director & Senior Analyst [12] +-------------------------------------------------------------------------------- + + One for Sheryl if I could. Sheryl, you guys have rolled out some initiatives designed to address specific advertising categories like dynamic travel ads. Could we anticipate more efforts going forward to address categories that may be relatively underpenetrated by Facebook, Instagram and Audience Network? So I'm thinking about categories like financial services, auto, for example. + +-------------------------------------------------------------------------------- +Sheryl K. Sandberg, Facebook, Inc. - COO and Director [13] +-------------------------------------------------------------------------------- + + So we're really happy that our growth has been really strong across our verticals, and that continues to be the case. Our top verticals are pretty consistent in e-commerce, CPG, entertainment, media, retail and gaming. For the most part, when we build products, we build them to work for all verticals and you see us do that. So being able to upload your catalog of products can be used no matter what your product lists are. We do build vertical-specific ad products when they are necessary, so dynamic ads for travel, for example, as you mentioned, being an example. I think the heaviest lifting of the work we do is really helping marketers in different verticals focus on the right metrics, which are the sales metrics. Because, for too long, our industry has been focused on proxy metrics, how long someone viewed a video, even brand lift, measurements we care about. But these are all proxy metrics. What really matters is you see an ad and you buy a product. You see an ad, and you drive a car off a lot. You see an ad, and you order a service. And so there's very different processes with these different verticals in terms of helping them understand their own purchasing data so that we can connect our ads to their ultimate purchases. We believe that's one of the most important things that we've been very, very focused on, and we have a long way to go. And part of the results you see from us in different verticals are actually explained by the ability of us to help those marketers measure sales at the end of the day. The more that we can tie ad viewing to sales, the stronger our case is with our clients. And so we need to do a lot of work around the measurement with different verticals. + +-------------------------------------------------------------------------------- +Operator [14] +-------------------------------------------------------------------------------- + + Your next question comes from the line of Doug Anmuth from JP Morgan. + +-------------------------------------------------------------------------------- +Douglas Till Anmuth, JP Morgan Chase & Co, Research Division - MD [15] +-------------------------------------------------------------------------------- + + Two if I could. Mark, you visited many different parts of the country over the last several months. Just curious how you're applying what you've learned to Facebook and the broader platform. And then, Dave, can you just give any -- some more color on, I guess, how things have changed in terms of OpEx and CapEx just given that we're coming down toward the lower end of the ranges? + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook, Inc. - Founder, Chairman of the Board and CEO [16] +-------------------------------------------------------------------------------- + + So a lot of the themes around building community and bringing people closer together have been underscored by a lot of experiences that I've had traveling around. And I've tried to write about them. I don't write about each visit that I make on Facebook, but it's been really striking to me, when you talk to folks in a lot of different communities, how important local institutions and their local communities are for supporting people there. And there's been a clearly documented trend across the world of declining membership in a lot of different kinds of communities, and I think that that's an important problem that is eating at the social fabric not only of our country but around the world that I hope that we can play a role in addressing. And that's not something that we can do directly, but I believe that we can empower people who want to build local communities and want to play a leadership role in their local community to have the tools that they need. And I think if we can do that, then you start bringing people together at a local level. And when people feel more comfortable in their lives at a local level, then I also think that, that helps bring people and bring the world closer together at a global level, too. So that all has been underscored by a lot of the visits and what I've seen as well as a lot of the research that we've done at Facebook, and it's all reflected in the new mission. + +-------------------------------------------------------------------------------- +David M. Wehner, Facebook, Inc. - CFO [17] +-------------------------------------------------------------------------------- + + Doug, it's Dave. I don't think there's anything that's really fundamentally changed. We're tightening the range to 40% to 45% expense growth due to better visibility. We remain solidly in investment mode, and if anything, we're finding new opportunities to invest in. From the perspective of hiring growth, I'd really point to the fact that we've been consistently accelerating hiring so far in 2017, and I pointed to the fact that we expect to accelerate hiring in the back half of the year as well. And this quarter was the biggest recruiting quarter in terms of net hires ever for Facebook. We're continuing to invest in a number of key areas, hiring engineers to drive the 3-, 5- and 10-year priorities. We're going to be investing in content to help build a platform for content producers to find an audience and monetize. We are also continuing to invest in areas like community operations and other areas. So we remain solidly in investment mode from a total expense point of view. On CapEx, we still expect to be within the range of $7 billion to $7.5 billion, and we're investing aggressively in our data center footprint to support the global growth that we see. So I think across-the-board, we're investing heavily. On headcount, I would just point out that our payroll growth tends to lag headcount growth because headcount is an end-of-period number, so the acceleration that we're seeing in 2017 will obviously play out in 2018 as well. + +-------------------------------------------------------------------------------- +Operator [18] +-------------------------------------------------------------------------------- + + Your next question comes from the line of Ross Sandler from Barclays. + +-------------------------------------------------------------------------------- +Ross Adam Sandler, Barclays PLC, Research Division - MD of the Americas Equity Research and Senior Internet Analyst [19] +-------------------------------------------------------------------------------- + + Good. Got couple of questions on the messaging apps. I think 2 years ago at F8, you talked about WhatsApp user base about a little north of 1 billion sending out 50 billion messages a day, and Messenger was about 1 billion and 20 billion messages a day, so implying kind of like 2.5x the engagement on WhatsApp compared to Messenger. Is that accurate? And where does that stand today? And then both of these messaging apps kind of started in different geographies around the world. So how does that impact your thinking around monetization ideas between Messenger and WhatsApp? + +-------------------------------------------------------------------------------- +David M. Wehner, Facebook, Inc. - CFO [20] +-------------------------------------------------------------------------------- + + Yes. I don't think we're sharing detailed stats on engagement by messaging platform. They're obviously both critical platforms. Both have over 1.2 million monthly actives, and WhatsApp has demonstrated significant engagement with crossing 1 billion daily actives. So I think that indicates the engagements that you have on that platform. There are different geographies where the messaging platforms are stronger, and depending on that, that shifts our priorities in different ways. But overall, from a monetization perspective, I think the strategy there is clear. We're focused on growing the user base first and foremost, and then secondly, it's about building organic connections between businesses to -- and consumers. And then third, it's about how do we build monetization around those relationships. And I think, there, we're further along with Messenger than we are with WhatsApp. And so I think you see us rolling out the global data there with ads. So I think we'll watch and learn from that, and as we learn things, we can apply them in other areas. + +-------------------------------------------------------------------------------- +Operator [21] +-------------------------------------------------------------------------------- + + Your next question comes from the line of Justin Post from Bank of America Merrill Lynch. + +-------------------------------------------------------------------------------- +Justin Post, BofA Merrill Lynch, Research Division - MD [22] +-------------------------------------------------------------------------------- + + Maybe a question for Mark. I know video is a priority for the company. To start with, any change in user trends or engagement as you've added video to Facebook? And then secondly, just how do you think about semiprofessional or professional video for Facebook? Is that a good business given all the content sharing costs and the production costs when you compare it to kind of your existing social business? And do you see it as cannibalistic or additive as far as usage? + +-------------------------------------------------------------------------------- +David M. Wehner, Facebook, Inc. - CFO [23] +-------------------------------------------------------------------------------- + + I can share a little bit about it. Then, Mark would want to jump in on any other color. I mean, I would say, as I mentioned, Justin, in my commentary, as people spend more time with video and more time is going to video, that is going to have a limiting factor to how much time they spend in News Feed. And so that's going to have an impact on impression rate growth. So there is, in that sense, a cannibalistic effect of sorts that happens there. But what Mark alluded to is video is where people -- as networks improve and devices improve and our products improve, video is the most engaging experience that we can offer. And so we're seeing consumers adopting that, and we're building products for them. In terms of the types of content, I think we're looking at a wide variety of content from -- of course, at the core is people sharing experiences in their lives as that's at the base of what we offer in terms of bringing the world closer together. It's just it's that community content. But then there's opportunities for semiprofessional and professional content, and we're exploring things around the platform of making sure that we're a platform where professional content providers can come find an audience and then also monetize that audience. + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook, Inc. - Founder, Chairman of the Board and CEO [24] +-------------------------------------------------------------------------------- + + I think (inaudible) got it. + +-------------------------------------------------------------------------------- +Operator [25] +-------------------------------------------------------------------------------- + + Your next question comes from the line of Colin Sebastian from Robert Baird. + +-------------------------------------------------------------------------------- +Colin Alan Sebastian, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [26] +-------------------------------------------------------------------------------- + + Mark, I wanted to ask a question on conversational interfaces and specifically, if we should think of Facebook becoming integrated as a skill app or feature on platforms such as Alexa. Or should we think of things like Oculus, Messenger and perhaps even a dedicated device as part of Facebook's own alternative platform? And then, Dave, just hoping you could put a finer point on the timing around the reduction in ad load growth. + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook, Inc. - Founder, Chairman of the Board and CEO [27] +-------------------------------------------------------------------------------- + + I mean, to the first question, we're going to build the services that we think are useful. Some of them are going to be platforms, and some of them are going to be apps and different things on top of platforms that other folks build. But fundamentally, we're trying to serve our community the best we can, and we'll do that across all these platforms. + +-------------------------------------------------------------------------------- +David M. Wehner, Facebook, Inc. - CFO [28] +-------------------------------------------------------------------------------- + + Yes. And in terms of ad load growth, I pointed to the fact that we continue to expect that ad load will be a less significant factor in the remainder of 2017. And that's certainly the case. That starts in Q3 but there's a number of other factors that I also pointed to, including the desktop, lapping some of the efforts we made on desktop in terms of unblocking or working against the ad blocking technologies. And so that has a factor on desktop growth. And then, of course, I talked about video and our focus on driving and serving the consumer demand for video. And that's also leading to a potentially lower impression growth as well. + +-------------------------------------------------------------------------------- +Operator [29] +-------------------------------------------------------------------------------- + + Your next question comes from the line of Rich Greenfield from BTIG. + +-------------------------------------------------------------------------------- +Richard Scott Greenfield, BTIG, LLC, Research Division - Co-Head of Research, MD and Media and Technology Analyst [30] +-------------------------------------------------------------------------------- + + On one of your blogs, you put a post up basically detailing basically what people were doing during TV, and you showed kind of a control group where Facebook usage was really constant. And then you did a group that was watching the TV show, and you saw huge spikes of Facebook usage during the television -- during the ad breaks during the show. Wondering like, as you go talk to marketers, obviously, TV ratings are down a lot. How does that type of study -- I realize it's just one TV show. But as you make the pitch of like why are you not shifting dollars faster to Facebook, how does that type of research start to play into their thinking? And what's holding them back? Is it just the creative doing or the embracing of 6-second ads? Like, what's the block to getting more of that $70 billion of TV ad dollars to shift over faster? + +-------------------------------------------------------------------------------- +Sheryl K. Sandberg, Facebook, Inc. - COO and Director [31] +-------------------------------------------------------------------------------- + + Well, that is just one study, and I don't want to overstate its importance in how we sell ads. We make the case to our clients that consumers are moving to mobile and that they need to move to mobile. And not that mobile should replace all of their other advertising, but responsible marketers with great companies large and small, they'll advertise on TV and they advertise on mobile and they advertise in other places. Our goal is to be the best dollar and the best minute anyone spends. And the case we make is that we want them to take advantage of the opportunity that is mobile and the opportunity for the targeting we offer and the measurement we offer. I think what has taken us time and continues to take us time is we need to convince marketers to make mobile-first video, video and other ad formats. We talk a lot about how the first TV ads were people reading their radio ads in front of microphones. And we're still in the case that when people go to put an ad on mobile, they often will take an ad that's really produced for TV and put it on mobile. And those work, and they can work well. But they do not work as well as ads that are natively mobile like the Tropicana example I shared in my earlier comment. Mobile ads, when they're video, are shorter. The brand comes in faster. They tell a story that doesn't evolve but really gets you to understand the brand and the offering really quickly. We talk about it as Thumb-Stopping Creative. And so the work we have cut out for us is to help marketers and working with their agencies evolve the format of the ads so that they're optimized for mobile, optimized for Facebook, optimized for Instagram. I think we're making progress, but we have a long way to go there. + +-------------------------------------------------------------------------------- +Operator [32] +-------------------------------------------------------------------------------- + + Your next question comes from the line of Mark Mahaney from RBC Capital Markets. + +-------------------------------------------------------------------------------- +Mark Stephen F. Mahaney, RBC Capital Markets, LLC, Research Division - MD and Analyst [33] +-------------------------------------------------------------------------------- + + Mark, you talked about maybe trying to accelerate a little bit the messaging monetization, and I'm wondering if there's anything more behind that statement. Is it that you were frustrated with the level that you'd seen to date or that you saw some opportunity that you thought we -- you could accelerate the push towards, I guess, monetizing? And maybe big picture, I want to ask just, as you think about -- I know the monetization is very early stage or it's barely even begun. There's very few platforms around the world have got 1 billion users that are unmonetized. So you would think that there's a lot of opportunity there but maybe not, and maybe people are making a mistake in trying to look at Asian assets and seeing what they've done there and thinking that you can do that with your assets. So what's the upside? Like when you think about the real opportunity, like what gets you excited about the ability to monetize those assets 5 years from now? + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook, Inc. - Founder, Chairman of the Board and CEO [34] +-------------------------------------------------------------------------------- + + Sure. So we're currently going through the process of figuring out what we want to invest in over the next year and doing our long-range planning. And this is certainly one of the areas where I think we want to be investing a lot more in and believe that there's a big opportunity and can accelerate all the effort. I do think, as you say, this is one of the rare times in business where you can look at messaging platforms that exist and see how they've successfully monetized in other parts of the world and have that be a floor. I mean, I think that, over time, we should be able to do better, but that at least provides this existence proof that despite -- regardless of what our internal logic is of what we're doing, that someone has done it. So that gives us some degree of confidence there in addition to our own execution on other things. But I think there's a pretty clear playbook that we have here of, first, building up the consumer usage, then building up the organic person-to-business interaction, making sure it works for both people and businesses, and then once you have that, the quality of those interactions is really what contributes the scale of how much you can grow it. We've seen this in News Feed, too. One of the factors that's contributed to ad load over time is the quality of the ads, where if ad quality was low, we wouldn't be able to put as many ads in because people wouldn't want them. But in a lot of markets around the world, we see that ad quality is increasing at a very fast rate, and that makes it so that, in a lot of times, people ask for the content, which, of course, creates a very different dynamic. So we need to get to that in messaging, and there's -- because messaging really started from this place of people communicating one to one with each other and now adding all these other uses, it's just a lot of investment and a lot of different functionality that needs to get at it. But for all the reasons that I've said here around our own experience doing this in other context with Facebook and Instagram proof points in the market of how it's worked, I think, over the long term, I'm pretty confident that we will get there. And we -- it's our job to just go do that. + +-------------------------------------------------------------------------------- +David M. Wehner, Facebook, Inc. - CFO [35] +-------------------------------------------------------------------------------- + + Yes. And I would just add, we don't know at what level that is, right? So we're more -- we had more experience with fee-based product, so we kind of know how those play out. And so we're -- this is in very much early days mode. + +-------------------------------------------------------------------------------- +Operator [36] +-------------------------------------------------------------------------------- + + Your next question comes from the line of John Blackledge from Cowen. + +-------------------------------------------------------------------------------- +John Ryan Blackledge, Cowen and Company, LLC, Research Division - Head of Internet Research, MD and Senior Research Analyst [37] +-------------------------------------------------------------------------------- + + Two questions. On the Messenger ads, recognize that it's early days, but just wondering if you think there'll be more -- those ads will be more complementary for core Facebook and Instagram advertisers or perhaps serve a different advertiser base or different use cases versus core Facebook and Instagram. And then second question would be, at the high end of the OpEx guide, it implies 53% year-over-year OpEx growth in the back half of the year versus plus 36% in the first half. Just wondering if you can discuss other key drivers of OpEx growth in the back half of the year aside from headcount. Like should we consider investment in video content the #2 driver of OpEx growth in the back half of the year? + +-------------------------------------------------------------------------------- +Sheryl K. Sandberg, Facebook, Inc. - COO and Director [38] +-------------------------------------------------------------------------------- + + On the Messenger ads, I think the way we think about it is, as Mark said, we have a lot of work to do to work on the format that. This is not a fee-based product. And this is a messaging product, so it's a different consumer format. And we believe that the ad format should follow the consumer format, so it's really integrated as part of the experience. And that's where we have a lot of work to do. We do think that the advertiser base and the targeting measurement we offer, once we figure out the format, will be a very considerable advantage. We already have 5 million advertisers on Facebook, 1 million advertisers on Instagram, and one of the reasons we were able to scale into Instagram ads more quickly is because we were building off of the Facebook advertiser base. And similarly, the work we've done in Facebook and Instagram and Audience Network will help us expand to Messenger. What we really want to emphasize, especially since there are so many questions on Messenger monetization on this call, that we're going to be slow and deliberate. We are always looking at the long run. We do not manage this company quarter to quarter. We protect the consumer product and the consumer engagement. Messaging is really strategically important for the company, and the long-term engagement with our users and the organic feel of the engagement with businesses and consumers is where we'll be focused. So it's early days this year, and it's going to continue to be early days for a while. + +-------------------------------------------------------------------------------- +David M. Wehner, Facebook, Inc. - CFO [39] +-------------------------------------------------------------------------------- + + So yes, on the OpEx guide, clearly, the biggest driver there is going to be the accelerating headcount growth. In addition, I mentioned video content as being a driver. And then also, we're just supporting the global growth of the platform. We continue to see growth in users. We continue to see growth in time spent per DAU across the Facebook family of apps and Facebook, and we're bringing more data centers online and the like towards that growth. So those will start hitting cost of revenue with depreciation. So there's going to be a variety of contributions to that growth, but like you mentioned, I would point to both headcount specifically in R&D. R&D headcount grew 48% year-over-year in Q2, and that's going to be a key driver along with the content layering in. + +-------------------------------------------------------------------------------- +Operator [40] +-------------------------------------------------------------------------------- + + Your next question comes from the line of Mark May from Citi. + +-------------------------------------------------------------------------------- +Mark Alan May, Citigroup Inc, Research Division - Director and Senior Analyst [41] +-------------------------------------------------------------------------------- + + Sheryl, in your prepared remarks about a case study, you discussed the benefits of shorter video ads, but I was hoping you could provide an update on the mid-roll ad breaks that you've now been testing for a few months and maybe what kind of progress that you're seeing in terms of completion rates. Are you at a point where those -- where ad breaks could start to roll out more broadly? And then, Dave, you mentioned that a greater focus on video could impact growth in ad impressions. But would you also assume that a greater focus on video ads could also drive improved ad pricing and yield on your available inventory? + +-------------------------------------------------------------------------------- +Sheryl K. Sandberg, Facebook, Inc. - COO and Director [42] +-------------------------------------------------------------------------------- + + On ad breaks, we're currently really just testing the ability to put a short ad break in uploaded videos. We do it if a video is longer than 90 seconds or live videos are longer than 4 minutes. We're just in the process right now of expanding to more publishers in the United States, so it's really early. In terms of the metrics we're looking for, it's a great question. And obviously, we care that people view the ads, but the most important thing is tying those ads impressions, even if they're short views, all the way through to that same purchase data that we keep talking about. And so as we work on rolling out more ad breaks, and we are rolling out slowly, we're really focused on finding ways to help marketers measure the right things, and that's a very important focus for the company going forward. + +-------------------------------------------------------------------------------- +David M. Wehner, Facebook, Inc. - CFO [43] +-------------------------------------------------------------------------------- + + And then, Mark, you were asking about video and its impacts on pricing growth. I would probably step back and look at it from an overall system perspective. And so starting with the supply side, there's a variety of factors that'll impact impression growth, and I mentioned slower ad growth and then increasing video watch time as being 2 of them. And given there's an auction that drives the pricing in how we run the business, there's always an interplay between supply growth and pricing growth. And to the extent -- and so what we're really focused on, right, is driving better ROI for our advertisers. And Sheryl alluded to it in her earlier commentary about if we get better at converting our impressions into things that are valuable for advertisers, we get more efficient in doing that, we'll be rewarded with better pricing and higher demand at better pricing as a result of that hard work. That doesn't necessarily specifically pertain just to video. It really is across-the-board. So if we're effective at continuing to do that, then that should benefit pricing growth. And if we can grow demand faster than we grow supply, then we're going to see that play through in price. And that's really the goal of a lot of the hard work that the ads team does to make our products better and more effective for advertisers. + +-------------------------------------------------------------------------------- +Operator [44] +-------------------------------------------------------------------------------- + + Your next question comes from the line of Michael Nathanson from MoffettNathanson. + +-------------------------------------------------------------------------------- +Michael Brian Nathanson, MoffettNathanson LLC - Co-Founder, Partner and Senior Research Analyst [45] +-------------------------------------------------------------------------------- + + I have one for Dave, one for Sheryl. Dave, going back to your prepared comments, I think you mentioned there was a 24% growth in pricing this quarter on unit pricing. Can you help us explain or understand underlying that growth which products you're seeing the greatest inflation maybe quarter-over-quarter or year-over-year? + +-------------------------------------------------------------------------------- +David M. Wehner, Facebook, Inc. - CFO [46] +-------------------------------------------------------------------------------- + + Yes. I don't think there's any -- I would really just kind of point to the overall dynamics of the system. And again, what we're seeing is, with slower supply growth, that's going to play out to higher pricing and again, are we effective? And we've been effective at delivering good return on investment for our advertisers and getting better at converting what we have as inventory into what they care about as outcome. And that, from a systemic point of view, is what's playing through there. From a product perspective, as we get things like Dynamic Product Ads rolled out, those are incredibly valuable as we connect more advertisers with those and bring more data into the system, and we can get more of the impressions that are very highly targeted and very relevant, then we'll be rewarded with better pricing. As we can expand that out into things like Lookalike, we've talked a lot about on this call, that basically takes some of that really good targeting and extends that into a much bigger audience. And then we can get more impressions at better value because we're really connecting that with end results that the advertisers value. So it's really those types of -- all that type of work that we do to get the system better and better. And so we're constantly working to get better penetration of these key ad products. In terms of the supply side, obviously, News Feed is incredibly valuable because it's very present for the consumer. And we've improved the quality of the ads in News Feed, and so that's another driver from the supply side. + +-------------------------------------------------------------------------------- +Operator [47] +-------------------------------------------------------------------------------- + + Your next question comes from the line of Rob Sanderson from MKM Partners. + +-------------------------------------------------------------------------------- +Robert Jason Sanderson, MKM Partners LLC, Research Division - MD & Senior Internet Analyst [48] +-------------------------------------------------------------------------------- + + Already feel like a call about Messenger monetization, so I'm almost reluctant to ask another. But just 2 things. Compared to what you saw in the early phases of testing News Feed ads, what can you say so far about users' responsiveness to ads in Messenger? And then second, obviously, there's a lot of momentum in the development of bots on the platform. And do you see this enabling of a great organic interaction, as Mark put it, as a way to ultimately make Messenger a great ad platform? Or do you think that enabling these other business services can lead to other monetization opportunities down the road independent of advertising? + +-------------------------------------------------------------------------------- +Sheryl K. Sandberg, Facebook, Inc. - COO and Director [49] +-------------------------------------------------------------------------------- + + It's really too early to understand the impact of the ads on consumers because there aren't enough of them and they haven't been rolled out for long enough. In terms of the bots, what we really think about is our business is in people making useful connections on both sides, on Messenger or any platform. If the connection is useful for marketers' businesses and useful for people, then it will grow. And we're open to automated bots being useful. We're open to other forms of things being useful. I think when you think about what bucket of spend that is in, which is a question we get, it really is both marketing spend and any other spend companies have where they're reaching their customers of which, if you think about marketing spend and customer service spend, marketing spend is way bigger because marketing spend grows as you can grow sales, and customer service spend is something that people generally try to minimize. So the way we think about it is we want to grow the organic connections, whether they're automated or whether they're personalized, and make sure that, that is growing the business of our customers. + +-------------------------------------------------------------------------------- +Operator [50] +-------------------------------------------------------------------------------- + + Your next question comes from the line of Brian Wieser from Pivotal Research. + +-------------------------------------------------------------------------------- +Brian W. Wieser, Pivotal Research Group LLC - Senior Analyst of Advertising, Media, and Internet [51] +-------------------------------------------------------------------------------- + + I was wondering if you'd comment on how you think the European Commission's GDPR and related privacy initiatives will impact the business, either -- generally either positively, negatively and whether or not those policies around privacy might yet become global standards. Curious how you think that impacts both the consumer product as well as the advertising business. And maybe separately, I'm just curious if -- among those advertisers who've expressed particular concern around third-party tool access, we certainly heard from some who've said very publicly that they're going to reduce their spending. Obviously, others clearly are increasing their spending. But curious how far you've gone towards allaying those concerns and possibly regaining any loss spent. + +-------------------------------------------------------------------------------- +Sheryl K. Sandberg, Facebook, Inc. - COO and Director [52] +-------------------------------------------------------------------------------- + + Well, when we think about any regulatory issues, GDPR or anything else, we respect local laws and regulations, and we have to work really closely with regulators to make sure they understand our business practices, understand how we contribute to economic growth in their countries and understand the steps we take and continue to take to protect privacy. Certainly, regulation is always an area of focus that we work hard to make sure that we are explaining our business clearly and making sure regulators know the steps we take to protect privacy as well as making sure that we're in compliance. When you think about the metrics question you asked, how we think about what is I think -- what I think you're asking about is third-party verification. We're very interested in making sure that marketers can verify or measure outcomes through third parties, and that's why we're working to actively expand those partnerships. + +-------------------------------------------------------------------------------- +Operator [53] +-------------------------------------------------------------------------------- + + The next question is from the line of Lloyd Walmsley from Deutsche Bank. + +-------------------------------------------------------------------------------- +Lloyd Wharton Walmsley, Deutsche Bank AG, Research Division - Research Analyst [54] +-------------------------------------------------------------------------------- + + Another one on Messenger. So you guys have talked up building -- the importance of building organic consumer-to-business interaction here. So wondering if you can share kind of what sort of adoption you are seeing in those kind of interactions. And are there certain verticals or geos where it's really taking off? And then a second if I can. We've talked a lot obviously already about ad impression growth and how it's set to slow in the second half. You're already seeing a big slowdown in impression growth in the first half, and yet, as you've noted with supply growth slowing, pricing has gone up as you've added a lot of ROA as to your customers. So wondering why should this phenomenon not continue to carry ad revenue growth in the second half. + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook, Inc. - Founder, Chairman of the Board and CEO [55] +-------------------------------------------------------------------------------- + + I'll take this. So there have been a number of questions about Messenger, and in general, we're seeing a -- I'm happy with the rate of growth in the experiences of -- that we're seeing on Messenger. But if there's one message here that I think is actually important to say, it's that we're trying to communicate that the pace of growing the Messenger business, it's a longer-term thing. I actually think in the -- over the next couple of years or a few years, the much bigger driver of the business and determinant of how we do is going to be video, not Messenger. Messenger, I think, is a really important thing and WhatsApp over a 3- to 5-year period, and we're investing a lot in it. I think it's a huge opportunity. But as has been noted on the call, video is both at large scale and the economics are quite different from what the current fee-based businesses that we have today, especially around how -- with mid-roll ads and rev share around that, the margin structure will be different. So I mean, one of the big questions that we're focused on as we build this out, we're very committed to building it out because it's what people in the community want. But one of the big things that we're really very focused on is making sure that we get this right so that even though this business will likely be -- not likely, I think, almost certainly will be a lower-margin source of revenue than the current thing that we do, there's this big question of how incremental is that behavior going to be. And I mean just -- I just want to -- I'm just throwing this context out there because so many of the questions here today have been about Messenger. And I want to make sure on these calls that we do an accurate and a full job of conveying what we're actually thinking about as a business and what we think the outlook is going to be. And I think that those questions around video, which, I mean, I'm optimistic about, but there are real questions there that we need to manage well, is going to be a much bigger driver of the business over the next 2 to 3 years likely even than the trajectory of what we're doing on Messenger and WhatsApp. + +-------------------------------------------------------------------------------- +David M. Wehner, Facebook, Inc. - CFO [56] +-------------------------------------------------------------------------------- + + And, Lloyd, you asked about why the good work that we've done so far in basically providing value for advertisers, that's playing through into price. Look, that's not just happening. That's a bunch of hard work that goes into making our ads more targeted, that makes the outcomes that advertisers get more valuable. We're going to continue to work to do that, and we're going to continue to invest in making improvements in the ad products. But yes, there's -- and we think there are great opportunities to continue to make improvements to ROI. But obviously, if you have rising prices, it's going to make that work against an upstream trend, so we need to continue to work hard to deliver more value for advertisers in the face of that. So we've got our work cut out for us, and we think we've got a great team working on that -- on those challenges. + +-------------------------------------------------------------------------------- +Operator [57] +-------------------------------------------------------------------------------- + + The last question comes from Ben Schachter from Macquarie. + +-------------------------------------------------------------------------------- +Benjamin Ari Schachter, Macquarie Research - Head of TMET Research [58] +-------------------------------------------------------------------------------- + + Mark, you stated that AR-mixed reality could be the next computing platform, and obviously, this is way out in the future. But if that implies something so large, how do you think about allocating resources for that? I mean, how much are you willing to spend on it and how you think -- any new thoughts on how this all evolves? Then related to that, the next iPhone is coming out soon. Do you think that there'll be capabilities there that will impact the AR evolution meaningfully? + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook, Inc. - Founder, Chairman of the Board and CEO [59] +-------------------------------------------------------------------------------- + + Well, this is certainly something that I'm really excited about longer term. I think it not only does it have the possibility of being the next major computing platform, AR and VR together, but I think it has the possibility of being much more social and intuitive and natural than some of the devices that we have today, whether they're computers or phones. So that's why I'm really excited about that. When you think about AR glasses, the technology and science to build an experience that would be both comfortable to wear and something that people would actually want to wear out in public, that doesn't exist yet, right? So there's a lot of foundational work that needs to get done there. That's partially why I'm excited about doing the VR work because it doesn't have that constraint. You're not wearing VR out in public. But also recently, I think one of the things that we've seen is that there are a lot of AR experiences on mobile, right? So the work that we started talking about at F8 that we are releasing slowly over the course of the year is certainly one of the precursors for building up that ecosystem that I'm excited about. But I mean, look, if I was just saying that video is going to be the primary driver or one of the big drivers over the next few years and Messenger maybe after that, I think AR is quite far down the road. But when you're running an operation and serving people of this scale, I think you have a responsibility to invest in all these things that are downstream that could help shape and improve people's lives because I don't think that there are that many other folks in the world who will. So I think that that's a thing that we take seriously, whether it's connectivity and making sure that people actually all around the world get to enjoy and benefit from the opportunities that the Internet has or the improvements that come from AI, or eventually upgrading the computing platforms that we all get to use. This stuff just doesn't happen automatically. And someone in the world needs to focus on building it, and we want to play a role in that. + +-------------------------------------------------------------------------------- +Deborah T. Crawford, Facebook, Inc. - VP of IR [60] +-------------------------------------------------------------------------------- + + Great. Thank you. Thank you for joining us today. We appreciate your time, and we look forward to speaking with you again. + +-------------------------------------------------------------------------------- +Operator [61] +-------------------------------------------------------------------------------- + + Ladies and gentlemen, this concludes today's conference call. Thank you for joining us. You may now disconnect your lines. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/exam/original-files/Problem_1_Sample/2017-Jul-27-AMZN.OQ-137040257613-Transcript.txt b/exam/original-files/Problem_1_Sample/2017-Jul-27-AMZN.OQ-137040257613-Transcript.txt new file mode 100644 index 0000000..3e6566b --- /dev/null +++ b/exam/original-files/Problem_1_Sample/2017-Jul-27-AMZN.OQ-137040257613-Transcript.txt @@ -0,0 +1,331 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q2 2017 Amazon.com Inc Earnings Call +07/27/2017 05:30 PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Brian T. Olsavsky + Amazon.com, Inc. - CFO and SVP + * Darin Manney + Amazon.com, Inc. - Head of IR + +================================================================================ +Conference Call Participiants +================================================================================ + + * Heath P. Terry + Goldman Sachs Group Inc., Research Division - MD + * Brian Patrick Fitzgerald + Jefferies LLC, Research Division - MD and Senior Equity Research Analyst + * Eric James Sheridan + UBS Investment Bank, Research Division - MD and Equity Research Internet Analyst + * Jason Stuart Helfstein + Oppenheimer & Co. Inc., Research Division - MD and Senior Internet Analyst + * Daniel Salmon + BMO Capital Markets Equity Research - Media and Internet Analyst + * Justin Post + BofA Merrill Lynch, Research Division - MD + * Mark Stephen F. Mahaney + RBC Capital Markets, LLC, Research Division - MD and Analyst + * Brian Thomas Nowak + Morgan Stanley, Research Division - Research Analyst + * Colin Alan Sebastian + Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst + * Mark Alan May + Citigroup Inc, Research Division - Director and Senior Analyst + * Douglas Till Anmuth + JP Morgan Chase & Co, Research Division - MD + +================================================================================ +Presentation +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Thank you for standing by. Good day, everyone, and welcome to the Amazon.com Q2 2017 Financial Results Teleconference. (Operator Instructions) Today's call is being recorded. For opening remarks, I'll be turning the call over to the Director of Investor Relations, Darin Manney. Please go ahead. + +-------------------------------------------------------------------------------- +Darin Manney, Amazon.com, Inc. - Head of IR [2] +-------------------------------------------------------------------------------- + + Hello, and welcome to our Q2 2017 financial results conference call. Joining us today to answer your questions is Brian Olsavsky, our CFO. +As you listen to today's conference call, we encourage you to have our press release in front of you, which includes our financial results as well as metrics and commentary on the quarter. Please note, unless otherwise stated, all comparisons in this call will be against our results for the comparable period of 2016. +Our comments and responses to your questions reflect management's views as of today, July 27, 2017, only and will include forward-looking statements. Actual results may differ materially. Additional information about factors that could potentially impact our financial results is included in today's press release and our filings with the SEC, including our most recent annual report on Form 10-K and subsequent filings. During this call, we may discuss certain non-GAAP financial measures. In our press release, slides accompanying this webcast and our filings with the SEC, each of which is posted on our IR website, you will find additional disclosures regarding these non-GAAP measures, including reconciliations of these measures with comparable GAAP measures. +Our guidance incorporates the order trends that we've seen to date and what we believe today to be appropriate assumptions. Our results are inherently unpredictable and may be materially affected by many factors, including fluctuations in foreign exchange rates, changes in global economic conditions and customer spending, world events, the rate of growth of the Internet, online commerce and cloud services and the various factors detailed in our filings with the SEC. Our guidance also assumes, among other things, that we don't conclude any additional business acquisitions, investments, restructurings or legal settlements and excludes the impact of our proposed acquisition of Whole Foods Market. It is not possible to accurately predict demand for our goods and services, and therefore our actual results could differ materially from our guidance. +With that, we will move to Q&A. Operator, please remind our listeners how to initiate a question. + + +================================================================================ +Questions and Answers +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) Our first question comes from the line of Heath Terry with Goldman Sachs. + +-------------------------------------------------------------------------------- +Heath P. Terry, Goldman Sachs Group Inc., Research Division - MD [2] +-------------------------------------------------------------------------------- + + I was just wondering if you could give us a sense on the investments that are planned in Q3. Previously, you've been willing to provide sort of some qualitative guidance around how you're rank ordering those in terms of the ones that are -- the largest areas of investment in the quarter. Just wondering if you could update us on that just given the guidance for Q3 and what we saw in investment in Q2. + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - CFO and SVP [3] +-------------------------------------------------------------------------------- + + Sure. Let me see what I can tell you on that. First of all, I want to remind you that Q3 is typically a lower operating income quarter as we're preparing for the Q4 holiday peak. The other dynamic is that similar to last year, a large percentage of our new fulfillment centers are coming online in the second half of the year, a lot of them in Q3. So to give that some perspective, the Amazon-Fulfilled Network or the combination of retail and FBA shipments coming out of our warehouses has been nearly 40%. It was that last year and it's continued through this year. Last year, we added 30% additional square footage to handle that additional shipping volume, and about 80% of that went in to service in the back end of last year. That's what I mentioned about this time last year. The -- similar dynamic this year. We're going to have about 80% of our increase in square footage for fulfillment and shipping coming online in the back end of the year. So that's a major increase. The other comment I would make is on the content -- video content. Video content, last year I highlighted the fact that it was going to be a significant step up between first half -- second half of 2016 and the second half of 2015. We are still -- we lapped that most of the first half of this year, and we'll also be increasing video spend on a sequential and year-over-year basis in Q3 and that's included in this guidance. Other than that, I can't give much more specifics except to say that the large investment areas remain increasing fulfillment capacity to service the strong growth of the FBA business. I'll also point out that the strong usage growth at AWS has led us to a step up in infrastructure in the form of capital leases. We've built capital leases in the trailing 12 months. They've increased 71% through the end of Q2 versus last year. That is servicing -- accelerating usage in our largest AWS services as well as geographic expansion. So that's additional factor sequentially in the quarter year-over-year. + +-------------------------------------------------------------------------------- +Operator [4] +-------------------------------------------------------------------------------- + + Our next question comes from Colin Sebastian with Robert W. Baird. + +-------------------------------------------------------------------------------- +Colin Alan Sebastian, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [5] +-------------------------------------------------------------------------------- + + A question on the grocery category and the announcement that we have -- that we heard recently. Specifically, does that imply that the strategy has changed around Fresh, which was presumably replacing the trip to the grocery store? Or should we think about adding different modes, such as pickup points and bricks-and-mortar, as serving a distinct customer base or geared to reduce the cost bottleneck around home delivery? Any comments would be helpful. + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - CFO and SVP [6] +-------------------------------------------------------------------------------- + + Sure, Colin. First, as far as Whole Foods is concerned, as Darin mentioned, it's not included in this guidance since it hasn't closed yet, but we are excited about that acquisition and looking forward to working with the team at Whole Foods. We think they're very customer-centric just like us. They've built a great business focused around quality and customers. So we're really glad to join up with them. On your larger question about with the place of AmazonFresh, that include Prime Now and some of our other efforts, I would say we believe there will be no one solution. So we're experimenting with a number of the formats, from physical pickup points in Amazon Go to online ordering and delivery to your door through Prime Now and AmazonFresh. And we'll see how customers respond. We like the response that we've seen so far. We think they're valuable. All those are valuable services. Amazon Go is not out of beta, but the other ones are. On top of that, we're looking forward to adding the Whole Foods team and their great reputation for quality and customer service to this offering. + +-------------------------------------------------------------------------------- +Operator [7] +-------------------------------------------------------------------------------- + + Our next question comes from Justin Post with Merrill Lynch. + +-------------------------------------------------------------------------------- +Justin Post, BofA Merrill Lynch, Research Division - MD [8] +-------------------------------------------------------------------------------- + + A couple of questions. It definitely seems relative to your guidance, you may have stepped up spending in the second quarter. Anything in particular to call out, India or anything like that? And then just thinking bigger picture, I'm wondering why physical locations might make sense for Amazon. Why is that a positive use of capital going forward? + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - CFO and SVP [9] +-------------------------------------------------------------------------------- + + Sure. As far as Q2 is concerned, we were very encouraged by the revenue and unit growth acceleration, particularly in North America. We see that as tied to the Prime growth and the adoption of Prime and success of that program. Also point out that AWS stepped up its run rate from a $14 billion run rate last quarter to $16 billion. So we saw the largest quarter-over-quarter and year-over-year increase in revenue in that businesses as well, and gross margin expanded 130 basis points. So as you point out, the year-over-year difference is primarily driven by investments. The -- we're within the guidance range, and we continue to invest in, as I said, fulfillment capacity and logistic services, digital video, our Echo and Alexa -- Echo devices and Alexa platform, India, the buildup at AWS infrastructure, all the things I mentioned, not to mention Prime Now and AmazonFresh and Prime benefits. We did see a big jump in headcount in year-over-year. You'll see it's 42%, and in the past I've said most of that is driven by operations hiring. And I've even said that headquarters office hiring many times in the past was below the level of revenue growth. Right now what we're seeing is an accelerated growth rate in software engineers and also sales teams to support primarily AWS and advertising. So yes, those -- the growth rate of those 2 job categories actually exceeded the company growth rates. So we are adding -- having success hiring a lot of people and pointing them at some very important programs and customer-facing efforts. On the place of physical, again, as I mentioned in the earlier question, we are experimenting with a number of formats. You've seen the physical bookstores, and I would say that the benefit there is -- again, we have a curated selection of titles and it's also a great opportunity for people to touch and feel our devices and see them, especially the new Echo devices. I went into the store in Seattle last week and I saw about 1/3 of the people were standing around the device table, learning how they work, how they interact with the devices. So I saw firsthand the customer experience. I think that's where we're seeing the benefit to the physical stores right now. + +-------------------------------------------------------------------------------- +Operator [10] +-------------------------------------------------------------------------------- + + Our next question comes from Mark May with Citi. + +-------------------------------------------------------------------------------- +Mark Alan May, Citigroup Inc, Research Division - Director and Senior Analyst [11] +-------------------------------------------------------------------------------- + + Question on the comments around the fulfillment investments. Could you characterize or maybe even quantify how much of the fulfillment infrastructure investment that you're making is going to incrementally gear towards handling growth in sort of the existing business and infrastructure versus expanding your capabilities in fulfillment, like adding more inbound or last mile and/or from entering new international markets where you need to invest ahead of growth versus just sort of keeping up and maintaining growth within sort of your existing footprint? And then AWS, you had some price adjustments in May, yet the Q2 growth was quite good. Can you just comment about the impact that those cuts may have had in Q2? And if you're modeling those also in your Q3 guidance, maybe the impact there. + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - CFO and SVP [12] +-------------------------------------------------------------------------------- + + Yes, let me start with the second one. So yes, we've had numerous price increase -- or decrease, excuse me, and we continue to have that in the AWS business, both absolute decreases in service costs and also rolling out new services that may be cannibalizing more expensive, other services that we provide. So nothing really to note on Q2 or Q3 from that standpoint. The fulfillment investments, I can't split it out for you between Amazon Logistics support sort centers and fulfillment centers. What I can say, the biggest dynamic going on, again, is that Amazon-Fulfilled unit growth of nearly 40%, which was last year and carrying it to this year. It's a global number, and we are very glad of the success of the FBA program. We're matching that with just over 30% increase in square footage. And yes, you're right, that does include some shipping sort centers and things that are incremental and new functions for us, if you will. But that's about all I can say on that right now. I think we're very happy -- we're very happy with the FBA program, its impact on Prime and we think Prime and FBA are self-reinforcing. We know customers really like it, the additional selection that FBA provides. So we like those combined, and we are working very hard to match that with capacity in an efficient manner. + +-------------------------------------------------------------------------------- +Operator [13] +-------------------------------------------------------------------------------- + + Our next question is from Douglas Anmuth with JPMorgan. + +-------------------------------------------------------------------------------- +Douglas Till Anmuth, JP Morgan Chase & Co, Research Division - MD [14] +-------------------------------------------------------------------------------- + + I just wanted to follow up on AWS and just on the back of the price cut, obviously 1Q being the first full quarter, but it looks like 2Q, as Mark said, things did stabilize some. Can you just talk about whether you're seeing more of a volume pickup response here and companies kind of more actively moving volume into the cloud at these lower prices? And then just secondly on Prime, the value of the Prime subscription for the consumer seems to continue to increase as you add more features in there. Can you just talk about your view around the flexibility of the price of an annual Prime subscription? + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - CFO and SVP [15] +-------------------------------------------------------------------------------- + + Sure. On the price of Prime, I have nothing to add at this time. We think that the -- we're increasing the value of the Prime program every day. So it becomes more and more valuable and again, as we've said, it's the best deal in retail. On AWS, yes, the -- we are seeing great customer adoption. The -- again, as I've said earlier, the run rate's gone up from $14 billion to $16 billion in Q2. And also, we had the largest sequential and year-over-year dollar rise in revenues. Our usage in all of our large services are actually accelerating, so -- and they're growing at a rate higher than our revenue growth. So we're seeing great adoption. We are seeing AWS customers migrate more than 30,000 databases over the last 1.5 years. We've signed some very big customer wins like Ancestry, Hightail, California Polytechnic State University and others that we're very proud to have. So yes, the momentum in the businesses is very strong. We continue to open new regions. We'll be opening 5 regions in the near future in France, China, Sweden, Hong Kong and a second government cloud region in the east. So yes, we like the momentum in that business. Stepping back, I would say that where pricing is important, again, we're generally being selected because of our functionality and pace of innovation. The innovation keeps accelerating. It did in the first half of this year, the pace of new services and features. We also know that customers value our partner and customer ecosystem, and really the experience we've had. We've been at this longer than anybody else. + +-------------------------------------------------------------------------------- +Operator [16] +-------------------------------------------------------------------------------- + + Our next question comes from Mark Mahaney with RBC Capital Markets. + +-------------------------------------------------------------------------------- +Mark Stephen F. Mahaney, RBC Capital Markets, LLC, Research Division - MD and Analyst [17] +-------------------------------------------------------------------------------- + + I want to stick with AWS, please. So the AWS revenue growth showed almost no change, but the AWS operating margin was lower, I guess, than we've seen in, I don't know, 6 quarters or something like that. I find that a little surprising, but then I also saw that the tech and content came in materially heavy, I think, versus our and, I assume, other expectations. So could you just talk about that a little bit, the profitability, if there's anything that's changed in the profitability of AWS? + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - CFO and SVP [18] +-------------------------------------------------------------------------------- + + Sure. Those margins, as we say frequently, are going to fluctuate quarter-to-quarter and always going to be a net of investments, price reductions and cost efficiencies that we drive. So I would say the biggest impact in the margin that you're seeing in Q2 is really around the 71% increase in assets acquired under capital leases. Most of that is for the AWS business. So we've really stepped up the infrastructure to match the large usage growth and also the geographic expansion, and that is showing up in tech and content. On the marketing, if you look under the marketing expenses, they are also up and that is driven by the increases we're seeing in the sales team, both in AWS and advertising. So I would point to those 2 as probably larger-than-normal impacts on Q2 operating margin. + +-------------------------------------------------------------------------------- +Operator [19] +-------------------------------------------------------------------------------- + + Our next question comes from Brian Nowak with Morgan Stanley. + +-------------------------------------------------------------------------------- +Brian Thomas Nowak, Morgan Stanley, Research Division - Research Analyst [20] +-------------------------------------------------------------------------------- + + I have 2. The first one, as you continue to add more Prime Now markets with 1- to 2-hour shipping, can you just talk to some of the logistical challenges you've already encountered and worked through? And talk to kind of -- if you really do see 1- to 2-hour shipping become a larger piece of the business over the next year, what's the biggest challenge to make sure that you manage? And the second one on the subscription revenue. Looks like subscription revenue growth was strong again, over 50%. Can you just talk to what drove that acceleration? Was it Prime, or was there something else in there? + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - CFO and SVP [21] +-------------------------------------------------------------------------------- + + Sure. Let me start with your second question. On the subscription revenue, grew 53% year-over-year versus 52% in Q1. So yes, we continue to see strong Prime membership growth. That is the main thing. There's also, in that line item, are also other monthly fees associated with some of our other subscription services like audiobooks, eBooks, digital video and digital music. But again, I would say that we're very happy with the Prime membership growth, and it remained pretty consistent both in Q4 and then through Q1 and Q2 of this year. On your second question on Prime Now, so Prime Now is now available in 50 cities across 8 countries. We do learn something new in every city and have different -- slightly different shapes and sizes of those buildings and different density profiles. And so we are learning as we go. We learn as we grow internationally as well. That is a service that customers love. That's not an inexpensive service though, and we also have -- so we're constantly working on our cost of delivery and our route densities. And again, we like what we see, and we'll continue to expand that and we'll be working very hard on making that not only a valuable Prime offering, Prime benefit, but also lower-cost operation as well. + +-------------------------------------------------------------------------------- +Operator [22] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Dan Salmon with BMO Capital Markets. + +-------------------------------------------------------------------------------- +Daniel Salmon, BMO Capital Markets Equity Research - Media and Internet Analyst [23] +-------------------------------------------------------------------------------- + + Brian, I think I heard you earlier say that your headcount for advertising salespeople is growing faster than the company as a whole -- or company's headcount growth rate as a whole. I'd just like to use that maybe as a springboard to talk a little bit about what you think the right mix is for how you sell in terms of the self-service versus salespeople. And then a second one would just be a quick one. I know it's early, but I'd be curious to see what you're seeing with users of the Echo Show with the screen on it and if you're seeing any particularly different type of user behavior there versus the original devices without one. + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - CFO and SVP [24] +-------------------------------------------------------------------------------- + + Sure. Yes, it's early on the Echo Show. As you know, we just started shipping those in late June, but we're very excited about the potential and the additional -- the addition of the video screen and the messaging capability and video capability. So it's -- I've used mine and it's awesome. It's a big step up, in my mind, but we'll get more customer feedback as we go along. On advertising, technically, what I said is the sales force has grown higher than the rate of growth in the business itself, which was 42% regular headcount, and that sales force is primarily AWS and advertising. So we build self-service tools and obviously that we want to make those as efficient as possible for customers and advertisers, but we realize it will need actual sales contact with accounts as well. So it's a mix. I can't get into the split really, but I would see both growing. + +-------------------------------------------------------------------------------- +Operator [25] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Eric Sheridan with UBS. + +-------------------------------------------------------------------------------- +Eric James Sheridan, UBS Investment Bank, Research Division - MD and Equity Research Internet Analyst [26] +-------------------------------------------------------------------------------- + + Maybe 2. One, with respect to international margins, is there anything there you can give us in terms of rank order or color, whether it'd be geographies or category expansion that we should be thinking about that are driving some of the cost curve in the international side of the business? That would be number one. Number two, stock-based comp stepped up a lot both quarter-over-quarter and year-on-year. Wanted to know if there was anything either organic or inorganic that was driving that step up in stock-based compensation. + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - CFO and SVP [27] +-------------------------------------------------------------------------------- + + Sure. I'll start with the second one. Yes, as you noted in the press release or the 8-K, we had an absolute step up from Q1 of $792 million to Q2 of $1.2 billion. So it increased 51% year-over-year in Q2 versus a headcount increase of 42%. I'll also say that we generally see a step up from Q1 to Q2 because we do our employee RSU grants in Q2 of each year. So that's a normal trend. But the 51% year-over-year is also -- is a combination of the hiring we've done, but also an adjustment we've made to our estimated forfeiture rate. We're seeing less forfeitures, which is a great sign for our employee retention, but you have to make adjustments to your reserves as you see that. So that was another influence in Q2. On operating margins internationally, I'd step back and say, we -- a lot of the investments we're making in North America, we're also making in international: Prime benefits, including Prime Video and remember, we launched global video in Q4 of last year to 200 countries; Prime Now; AmazonFresh; the general rise of FBA and added selection, both retail and FBA, to make Prime more attractive and the fulfillment and logistics costs that go with that, any additional constant effort to reduce prices and accelerate shipping. So that all impacts both North America segment and international. The North America segment is a little further along in the Prime -- or excuse me, yes, the Prime membership growth curve. And so in some respects, we are giving benefits earlier in the life cycle to international Prime customers than we did in North America just because it launched later. And then there's also India. As I mentioned, we continue to invest in India. We're very hopeful with the progress we've made with sellers and customers alike in India, and we see great momentum and success there. So we'll continue to invest, and we have some of our best people in that business. + +-------------------------------------------------------------------------------- +Operator [28] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Brian Fitzgerald with Jefferies. + +-------------------------------------------------------------------------------- +Brian Patrick Fitzgerald, Jefferies LLC, Research Division - MD and Senior Equity Research Analyst [29] +-------------------------------------------------------------------------------- + + You mentioned before as you stand up new fulfillment centers, it takes a bit of time for them to ramp up optimization. How should we think about that path optimization over a year or so as you continue to scale operations and you bring data to bear in robotics, in Kivas and AI machine learning? Are you finding that kind of new fulfillment center optimization curve is accelerating? + +-------------------------------------------------------------------------------- +Darin Manney, Amazon.com, Inc. - Head of IR [30] +-------------------------------------------------------------------------------- + + Brian, this is Darin. Yes, we're getting more efficient every time we put new capacity into the network, whether that's through automation or just through the experience that we've gained over the years. We still say it takes up to 3 years or 3 peaks to get to kind of network efficiency for a new particular facility. And that's about staying the same, although the whole network gets efficient over time. So there's a big mix going on, and we like the new innovation that we're bringing to the capabilities, but that ramp stills stays about consistent as it was. + +-------------------------------------------------------------------------------- +Operator [31] +-------------------------------------------------------------------------------- + + And our final question comes from the line of Jason Helfstein with Oppenheimer & Co. + +-------------------------------------------------------------------------------- +Jason Stuart Helfstein, Oppenheimer & Co. Inc., Research Division - MD and Senior Internet Analyst [32] +-------------------------------------------------------------------------------- + + Just one. Other slowed from 58% in the first quarter to 53% year-over-year. Anything to call out? And then you made a comment about the physical stores in reaction to one of the other questions that was really about showcasing new devices. Is it fair to say that probably means locations would have small footprints versus the large footprints if you were thinking about that? + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - CFO and SVP [33] +-------------------------------------------------------------------------------- + + I'm sorry, what was the first part of your question? + +-------------------------------------------------------------------------------- +Jason Stuart Helfstein, Oppenheimer & Co. Inc., Research Division - MD and Senior Internet Analyst [34] +-------------------------------------------------------------------------------- + + Other revenue slowed from 58% in the first quarter to 53%. Is there anything to call out around that? + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - CFO and SVP [35] +-------------------------------------------------------------------------------- + + No, nothing. In that other line item is advertising and also other things like co-branded credit card agreements. I would say that the main -- excuse me, advertising revenue growth has been strong and fairly consistent over the past 3 quarters. So that number will move around, but there's other things that more the variance in the volatility as in the other line items. Your question on stores. We are -- again, I personally think that new devices -- the ability to see new devices is a great asset, but I don't want to shortchange our -- the rest of the bookstore and the ability to have curated selection and the creativity we've had in taking a new look at the bookstore. So we are experimenting with different formats, and we look at different sizes and we look at revenue and cost per square foot just like any other physical retailer. So we haven't essentially nailed the model yet, and we continue to experiment and see what works and how it differs by city or more suburban locations. + +-------------------------------------------------------------------------------- +Darin Manney, Amazon.com, Inc. - Head of IR [36] +-------------------------------------------------------------------------------- + + So thank you, Brian, and thank you all for joining us on the call today and for your questions. A replay will be available on our Investor Relations website through at least the end of the quarter. We appreciate your interest in Amazon.com and look forward to talking to you again next quarter. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/exam/original-files/Problem_1_Sample/2017-May-03-FB.OQ-137850824087-Transcript.txt b/exam/original-files/Problem_1_Sample/2017-May-03-FB.OQ-137850824087-Transcript.txt new file mode 100644 index 0000000..d224f58 --- /dev/null +++ b/exam/original-files/Problem_1_Sample/2017-May-03-FB.OQ-137850824087-Transcript.txt @@ -0,0 +1,515 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q1 2017 Facebook Inc Earnings Call +05/03/2017 05:00 PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Deborah T. Crawford + Facebook, Inc. - VP of IR + * Sheryl K. Sandberg + Facebook, Inc. - COO and Director + * David M. Wehner + Facebook, Inc. - CFO + * Mark Zuckerberg + Facebook, Inc. - Founder, Chairman of the Board and CEO + +================================================================================ +Conference Call Participiants +================================================================================ + + * Eric James Sheridan + UBS Investment Bank, Research Division - MD and Equity Research Internet Analyst + * John Ryan Blackledge + Cowen and Company, LLC, Research Division - Head of Internet Research, MD and Senior Research Analyst + * Justin Post + BofA Merrill Lynch, Research Division - MD + * Peter Stabler + Wells Fargo Securities, LLC, Research Division - Director and Senior Analyst + * Brian Thomas Nowak + Morgan Stanley, Research Division - Research Analyst + * Heather Anne Bellini + Goldman Sachs Group Inc., Research Division - Research Analyst + * Douglas Till Anmuth + JP Morgan Chase & Co, Research Division - MD + * Ross Adam Sandler + Barclays PLC, Research Division - MD of the Americas Equity Research and Senior Internet Analyst + * Michael Brian Nathanson + MoffettNathanson LLC - Co-Founder, Partner and Senior Research Analyst + * Mark S. Mahaney + RBC Capital Markets, LLC, Research Division - MD and Analyst + * Colin Alan Sebastian + Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst + * Mark Alan May + Citigroup Inc, Research Division - Director and Senior Analyst + * Anthony Joseph DiClemente + Instinet, LLC, Research Division - Media Analyst + +================================================================================ +Presentation +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Good afternoon. My name is Mike, and I will be your conference operator today. At this time, I would like to welcome everyone to the Facebook First Quarter 2017 Earnings Call. (Operator Instructions) This call will be recorded. Thank you very much. +Ms. Deborah Crawford, Facebook's Vice President of Investor Relations, you may begin. + +-------------------------------------------------------------------------------- +Deborah T. Crawford, Facebook, Inc. - VP of IR [2] +-------------------------------------------------------------------------------- + + Thank you. Good afternoon, and welcome to Facebook's First Quarter 2017 Earnings Conference Call. Joining me today to discuss our results are Mark Zuckerberg, CEO; Sheryl Sandberg, COO; and Dave Wehner, CFO. +Before we get started, I would like to take this opportunity to remind you that our remarks today will include forward-looking statements. Actual results may differ materially from those contemplated by these forward-looking statements. +Factors that could cause these results to differ materially are set forth in today's press release and in our annual report on Form 10-K filed with the SEC. Any forward-looking statements that we make on this call are based on assumptions as of today, and we undertake no obligation to update these statements as a result of new information or future events. +During this call, we may present both GAAP and non-GAAP financial measures. A reconciliation of GAAP to non-GAAP measures is included in today's earnings press release. The press release and an accompanying investor presentation are available on our website at investor.fb.com. +And now I'd like to turn the call over to Mark. + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook, Inc. - Founder, Chairman of the Board and CEO [3] +-------------------------------------------------------------------------------- + + Thanks, Deborah, and thanks, everyone, for joining today. We started the year off with a good quarter. Our community continues to grow with more than 1.9 billion people now using Facebook every month and almost 1.3 billion people using it every day. Our ads business is doing well too. Total revenue grew by 49% year-over-year to $8 billion, and advertising revenue was up 51% to $7.9 billion. +In my letter to our community back in February, I talked about how, for the past decade, Facebook has focused on connecting friends and families. Now with that foundation, our next focus will be building community. There's a lot to do here. Building global community is bigger than any one organization, but we can help by developing social infrastructure for the community: for supporting us, for keeping us safe, for informing us, for civic engagements and for including everyone. +Building a global community that works for everyone starts with building millions of smaller supportive communities. This is especially important since membership in many physical communities is declining. We recently found that more than 100 million people on Facebook are members of what we call very meaningful groups, like parenting or rare disease support groups that are an important part of their support structure. My hope is to help more than 1 billion people join meaningful groups to strengthen our social fabric over the next few years. +To help build a safe community, we launched Community Help, a tool that allows people to give and get things like food, shelter or transportation in the wake of a natural disaster. We also launched a new fundraising tool that allows people to raise money for themselves, a friend or a cause that isn't already on Facebook. +But it's clear we have more to do here. We're going to continue building new tools to keep people safe on our platform. Over the next year, we'll be adding 3,000 people to our community operations team around the world, on top of the 4,500 we already have today, to review the millions of reports we get every week and to improve the process for doing that quickly. +To help build a more informed community, we make changes to our News Feed ranking to reduce the financial motivation to spread hoaxes. We're working with independent fact checkers to give people more information on whether an article has been disputed. We launched an educational tool at the top of News Feed in 14 countries to help people spot false news. And we're beginning to test related articles that appear before you read an article, giving you easier access to more perspectives and information. +We're also helping to build a more civically-engaged community. In March, we launched Town Hall to help people find and connect with their government representatives on a local, state and federal level in the U.S. And in just this, the first month, we created more than 1 million new connections between people and their representatives. We also rolled out a tool in France ahead of their election that allows candidates to share statements about where they stand on different policy issues. +So these are some of the changes we've made to help people build stronger communities. +Next, I want to give a quick update on what we're building over our 3 time horizons: how we're making our core services more useful and engaging right now; how we're building ecosystems around product that a lot of people are already using over the next 5 years; and how we're investing in the technologies that will give more people a voice and make sharing more immersive over the next 10 years. +This quarter, we launched a set of new cameras. Photos and video are becoming more common than text, so the camera is becoming more central than the text box in all of our apps. +In the Facebook app, you can now swipe right from News Feed to access our new camera with masks, frames and filters. We've developed new computer vision tools that can apply the style of a painting to a photo or a video, and we can do that in real time on your phone for the first time. +This is part of making the camera the first augmented reality platform. We want to give developers the power to build all kinds of AR tools in the camera so more people can experience augmented reality on their phone. Creating the first open camera platform is a huge step forward, and we're excited to keep pushing augmented reality forward. +We also expanded the Stories format to give people more new ways to share. Instagram Stories now has more than 200 million daily active people using it. And just a couple months after we launched it, WhatsApp status has more than 175 million daily active people using it. More recently, we also rolled out Messenger Day and Facebook Stories, and we're going to keep putting video at the center of all these services. +Over the next 5 years, we're going to build ecosystems around our products that a lot of people are already using. I put Live video in this category. Last month, we announced that 1 in every 5 Facebook videos is a live broadcast. And over the past year, daily watch time for Facebook Live broadcasts has grown by more than 4x. This year, we also gave people the ability to go Live in 360. +Messenger is in this category too. And we just announced that 1.2 billion people use Messenger every month. At F8, we launched the second generation of our Messenger platform and introduced a Discover tab to make it easier to find the best experiences quickly. +Finally, over the next 10 years, we're developing consumer use cases around technologies that are a big part of our future but won't be a part of our business, a big part of the business for a while. +On the connectivity side in April, we successfully simultaneously beamed 16 gigabits of data in each direction between a location on the ground and a Cessna aircraft circling more than 7 kilometers away. Eventually, we're going to use this technology along with Aquila, our solar-powered plane that we're building, to beam Internet to parts of the world that currently don't have access. +In virtual reality, we launched Facebook Spaces, the first social VR platform that lets you create your own avatar and hang out with your friends. And we also released the Facebook 360 app for Gear VR that makes it easier to discover and experience 360 photos and videos. And we continue to ship Rift and Touch to people everywhere and deliver a strong content ecosystem across both Rift and Gear VR. +As people share more video, as we explore more things like augmented reality and as we build more tools to keep our community safe, we're going to keep investing aggressively in the infrastructure that we need to grow and serve our community. That's why we announced that our next 2 data centers will be built in Odense, Denmark and Papillion, Nebraska. +We've made some good progress but we have a lot more to do to help build community and connect the world. So I want to thank everyone in our community, our teams, our partners and all of you for being a part of this journey with us. +And now here's Sheryl. + +-------------------------------------------------------------------------------- +Sheryl K. Sandberg, Facebook, Inc. - COO and Director [4] +-------------------------------------------------------------------------------- + + Thanks, Mark, and hi, everyone. We had a strong first quarter and a great start to the year. Q1 ad revenue grew 51% year-over-year. Mobile ad revenue was $6.7 billion, up 58% year-over-year and was approximately 85% of total ad revenue. Growth again this quarter was broad-based across regions, marketer segments and verticals. +Our goal is to build meaningful connections between businesses and people. We're doing this by focusing on 3 key priorities: helping businesses leverage the power of mobile; developing innovative ad products; and making our ads more relevant and effective. +Our first priority is helping businesses leverage the power of mobile. More businesses around the world are shifting to marketing on mobile. Over 70 million businesses are now using Facebook Pages around the world on a monthly basis, and more and more of them are becoming advertisers. We also recently announced that over 5 million businesses are actively advertising on Facebook, including more than 1 million in emerging markets. Most of these advertisers start by using our free Pages product because it's easy to use. +People are increasingly recognizing that the small screen is big. Our Creative Hub is providing tools that make it easier to create ads optimized for mobile, what we talk about as thumb-stopping creative. Marketers can see previews of their ads across Facebook and Instagram before rolling them out and get tips to help drive business results. +Our second priority is developing innovative ad products that help businesses make the most out of their campaigns. We continue to improve Dynamic Ads, which enable advertisers to promote their full range of products across all devices. Advertisers can now target Dynamic Ads to broad audiences and are seeing great results. +Last week, I visited home retailer Wayfair in Boston. They use Dynamic Ads to reach a large audience with personalized recommendations from their catalog of over 8 million items. By finding higher revenue customers at a lower cost, the campaign beat Wayfair's return on ad spend goal by more than 20%. +We're also helping marketers use video to capture shoppers' attention. People are watching more video on Facebook than ever before, and it's changing how they connect with businesses. In a recent study Facebook commissioned with Kantar, 30% of mobile shoppers said video is the best way to discover new products. +This quarter, we introduced a new ad format called Collection. Collection helps marketers tell stories on mobile by combining creative videos or photos of product images. Clicking on the products leads to an immersive shopping experience, driving purchase consideration and ultimately sales. +For example, adidas, which is how you pronounce them at their headquarters, and its agency, iProspect, created a video highlighting the innovative features of a Z.N.E. Road Trip Hoodie. Using our Collection ad format, adidas featured 4 more items from their product catalog below the video. They saw a 5.3x return on ad spend and a 1.8x decrease in cost per conversion. It's still early for this new format but it's a great example of how we can deliver innovative mobile experiences that work for advertisers and work for people. +This quarter, we also launched full-screen sound-on ads in Instagram Stories. Advertisers can now reach over 200 million daily actives on Stories to do everything from building brands to selling products. +Our third priority is making our ads more relevant and effective. Measurement is critical. We recently introduced new and expanded verification partnership and committed to audits with the Media Rating Council. Whether marketers are trying to get people to buy something on their website or in their store, we now have systems in place to help them measure results and third-party partnerships to verify those results. These are important steps as we continue to build the advertiser trust. +Bud Light's NFL campaign is a great example. To promote the designs of their new team-specific cans, Bud Light took a national and regional approach. They ran video ads featuring the new cans to people ages 21 to 49 in the U.S. Then they also ran more targeted ads in each region, featuring the 2 cans of the teams playing each other. Using Facebook polling and Oracle's data cloud, they saw a 24-point lift in ad recall and a 4.4x return on ad sales. +We know marketers want to compare results across platforms and placements. Historically, we've enabled larger marketers to do this. In Q1, we started testing a set of advanced measurement tools that make it easier for marketers of all sizes to compare the effectiveness of Facebook, Instagram and Audience Network alongside other publishers. +We're off to a strong start in 2017. We're helping marketers leverage the power of mobile, developing innovative ad products and delivering proven and measurable results. We're excited about the growing adoption of our platforms, and we're going to continue to invest in helping businesses and people connect. +Thanks, and now here's Dave. + +-------------------------------------------------------------------------------- +David M. Wehner, Facebook, Inc. - CFO [5] +-------------------------------------------------------------------------------- + + Thanks, Sheryl, and good afternoon, everyone. Q1 was a strong quarter for Facebook. We continued to see healthy growth and engagement trends across our community as well as broad-based growth in our ads business. +Let's start with our community metrics. In March, 1.28 billion people visited Facebook on an average day, up 18% compared to last year. This daily number represented 66% of the 1.94 billion people that visited Facebook during the month of March, which was up 282 million or 17% compared to last year. Our community growth in Q1 was driven by product improvement, Internet.org and ongoing third-party promotional data plans in markets like India. Note that we do not control the timing or terms of these promotions. +Before diving into the financials, I want to highlight that we are no longer reporting non-GAAP expenses, income, tax rate or EPS. Given that stock is an important part of our compensation structure, we believe that investors should focus on our financial performance with stock-based compensation included. +Turning now to the financials. All of our comparisons are on a year-over-year basis, unless otherwise noted. Q1 total revenue was $8 billion, up 49%. Ad revenue was $7.9 billion, up 51%. Exchange rates did not affect our overall growth rate this quarter as headwinds in certain currencies were offset by tailwinds in others. +In terms of regional advertising growth, Rest of World and Asia Pacific were our strongest growers in percentage terms at 66% and 60%, respectively. Both regions benefited from particularly strong advertiser demand. Europe and North America both grew at 47%. +Mobile ad revenue was $6.7 billion, up 58% and represented approximately 85% of ad revenue. Desktop ad revenue grew 22% despite a decline in desktop usage and was aided by our recent effort to limit the impact of ad blocking technology, which we began in Q3 of last year. +Our mobile ads business continued to be driven by healthy supply and demand dynamics. In Q1, the average price per ad increased 14%, and the total number of ad impressions served increased 32%, primarily driven by mobile feed ads. +Payments and other fees revenue was $175 million, down 3%. Q1 total expenses were $4.7 billion, up 40%. +In 2017, we have continued to accelerate our hiring efforts. We added over 1,700 employees in Q1, predominantly in technical and recruiting functions, and ended the quarter with approximately 18,800 employees, up 38% compared to last year. This marked an acceleration from the 34% growth rate in Q4. +Q1 operating income was $3.3 billion, representing a 41% margin. Our tax rate was 10%, which reflects the adoption of ASU 2016-09 in the fourth quarter. Excluding this adoption, our tax rate would have been approximately 9 percentage points higher. +Note that the new accounting guidance does not impact the cash taxes we pay but merely how the tax provision is presented under GAAP, whereby now excess tax benefits are flowing through the P&L and in this quarter positively impacted EPS. +Net income was $3.1 billion or $1.04 per share. +Q1 capital expenditures were approximately $1.3 billion, driven by investments in data centers, server, office facilities and network infrastructure. In Q1, we also broke ground on our ninth data center in Nebraska. +We generated approximately $3.8 billion in free cash flow. +In the first quarter, we repurchased $228 million of our Class A common stock and used $771 million in cash for taxes paid related to the net share settlement of equity awards. We ended the quarter with $32.3 billion in cash and investments. +Turning now to the outlook. With regards to revenue, we continue to expect that our ad revenue growth rates will come down meaningfully over the course of 2017. We expect that ad load will play a less significant factor in driving revenue growth after mid-2017. We also expect desktop ad revenue growth rates to slow in the fourth -- in the third quarter when we begin to lap our efforts to limit the impact of ad blockers. +We continue to expect that our full year 2017 Payments and other fees revenue will decline compared to full year 2016. As a reminder, Payments and other fees revenue is primarily generated from payments related to games played on personal computers. +Turning to the expense outlook. We continue to expect that full year 2017 GAAP expenses will grow 40% to 50% compared to full year 2016. I would note that as we look into 2017 and beyond, there are going to be a number of initiatives we believe are valuable to the community and to the company in the long term that are going to be net negative on our operating margin. +We are embarking on a significant ramp-up in infrastructure supporting global growth, and we continue to expect that full year 2017 capital expenditures will be in the range of $7 billion to $7.5 billion, which is up over 50% compared to last year. +Turning now to tax. As we noted in the last call, under the new accounting guidance, our tax rate will vary based on our stock price. At current stock prices, we expect that our Q2 and full year 2017 tax rates will both be in the mid-teens, so up from the first quarter rate. +In summary, Q1 was a strong quarter and a great start to the year. Growth in the Facebook community remains strong. Engagement across our family of apps is healthy and growing, and advertiser demand from our growing base of marketers is robust. Importantly, we continue to invest aggressively to build our business and drive value for our community over the long term. +With that, operator, let's open up the call for questions. + + +================================================================================ +Questions and Answers +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) Your first question comes from the line of Eric Sheridan from UBS. + +-------------------------------------------------------------------------------- +Eric James Sheridan, UBS Investment Bank, Research Division - MD and Equity Research Internet Analyst [2] +-------------------------------------------------------------------------------- + + Maybe one thematic question on Instagram for Mark and Sheryl. I wanted to understand what you're seeing in terms of the development of the community on the user growth side, the engagement side as well as on the monetization side with respect to breadth of advertisers and ad product evolution, what that means for Instagram's future and how it compares to maybe what you've learned growing the business on the Facebook side over the last couple of years. + +-------------------------------------------------------------------------------- +David M. Wehner, Facebook, Inc. - CFO [3] +-------------------------------------------------------------------------------- + + Eric, why don't I take the beginning of that and then Sheryl can augment with some additional color? So when you think about Instagram, we're seeing great growth there with the community. So this past quarter, we announced 700 million daily -- sorry, monthly actives, so that was a big announcement. And that's broad-based growth across the globe so we're pleased with that. In terms of the development on the advertising side, we're not specifically breaking out Instagram revenue, as you know, because that's sold through the same Facebook ad interfaces. But we're seeing really good contribution and good growth there. And we're developing it across a wide variety of ad products. So VR is becoming a more significant part of the Instagram story, whereas it was originally more brand-focused, but we've expanded the product offerings on the direct response front. And we're continuing to bring more ad products to Instagram. + +-------------------------------------------------------------------------------- +Sheryl K. Sandberg, Facebook, Inc. - COO and Director [4] +-------------------------------------------------------------------------------- + + We're pretty excited about what's happening in the Instagram ad space because Facebook and Instagram are the 2 most important mobile ad platforms. And there's a special property with Instagram, which is that the increasing visualization of ads and the creative canvas it offers with the science behind the Facebook targeting and measurement systems is really a pretty unusual combination. We're also seeing very broad adoption including small customers. We're pretty excited to have 1 million advertisers and 8 million Instagram business profiles on the platform. To share 1 example, an online store in Brazil called [Lohanama], they sell decorative items and accessories. Their business owner, [Joanna], took photos of her products on her phone and then created ads with our Shop Now button. She targeted young audiences in Brazil who are interested in fashion, decoration, movies and architecture. And during the period of her campaign, Instagram accounted for 78% -- 79% of her sales. And I think what that shows is the power of the very sophisticated targeting we offer across our platforms, along with really the ability to use a very simple tools like a phone to create very sophisticated but visually compelling ads. + +-------------------------------------------------------------------------------- +Operator [5] +-------------------------------------------------------------------------------- + + Your next question comes from the line of Douglas Anmuth of JP Morgan. + +-------------------------------------------------------------------------------- +Douglas Till Anmuth, JP Morgan Chase & Co, Research Division - MD [6] +-------------------------------------------------------------------------------- + + One for Mark and then perhaps one for Sheryl or Dave. Mark, first, just on the video strategy, I was hoping you could talk a little bit about how that's evolving in terms of the type of content that you're licensing and featuring within the Facebook video tab. And then if you have any more clarity just on how the economics are going to work there around revenue share and gross margins. And then on ad revenue, the U.S. and Canada was very strong at 47% growth, but at the same time, it also did decel a little bit more than we've seen in recent quarters. I was just wondering if there was anything else to call out there. + +-------------------------------------------------------------------------------- +David M. Wehner, Facebook, Inc. - CFO [7] +-------------------------------------------------------------------------------- + + Yes, Doug, why don't I take the decel question on the U.S. and Canada. I don't think there was anything particularly surprising about the deceleration in the growth in U.S. and Canada. We've been talking about expecting a deceleration in ad revenue growth, and we saw that play out U.S., Canada modestly. Obviously, we're particularly pleased that there was really strong demand that benefited regions like APAC and Rest of World so really broad-based strength in APAC. And then Rest of World, we saw a rebound in Latin America. So especially, Brazil so we're seeing some particular strength there. So I think that, sort of, I think, was a big highlight. On the content front, we're looking at investing in kickstarting an ecosystem for longer-form content on Facebook. And that involves us working with content providers to develop that content. In the long run, we expect it to be a revenue share model on the platform. And obviously, we're going to be -- we're going to be in an area where we're sharing revenue with content providers so it's going to have a different margin profile than core Facebook News Feed from an expense profile perspective. + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook, Inc. - Founder, Chairman of the Board and CEO [8] +-------------------------------------------------------------------------------- + + I think you pretty much got that. + +-------------------------------------------------------------------------------- +Operator [9] +-------------------------------------------------------------------------------- + + Your next question comes from the line of Brian Nowak from Morgan Stanley. + +-------------------------------------------------------------------------------- +Brian Thomas Nowak, Morgan Stanley, Research Division - Research Analyst [10] +-------------------------------------------------------------------------------- + + I have one for Mark on Messenger monetization. Can you just talk about some of the biggest trends you're monitoring and what you're most excited about as you think about ways to monetize Messenger over the next 2 or 3 years? And then on engagement, you continue to grow Instagram and Messenger user bases really helpfully. I guess, I'd be curious to hear, do you still continue to see rising time spent per user across all 3 of those platforms even as the DAU base gets bigger? + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook, Inc. - Founder, Chairman of the Board and CEO [11] +-------------------------------------------------------------------------------- + + You can start with the stats, Wehner? + +-------------------------------------------------------------------------------- +David M. Wehner, Facebook, Inc. - CFO [12] +-------------------------------------------------------------------------------- + + Yes, I can start with the stats. So on -- yes, Mark, on the engagement front, we're seeing time spent growth per DAU across the Facebook family of apps and that includes Facebook itself. Instagram has been strong, especially with feed ranking and Stories. We're not breaking out specific time spent stats on a quarterly basis on those. And then on the Messenger monetization front... + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook, Inc. - Founder, Chairman of the Board and CEO [13] +-------------------------------------------------------------------------------- + + I can talk about the strategy. Yes, so the first thing that we need to do on Messenger and WhatsApp is get a lot of businesses using it organically and build the behavior for people that they reach out to businesses for different things, like customer support or for getting news content, things that may not eventually be the big business use cases but establish the behavior of people interacting not only with their close friends but also with businesses. In terms of making money on that, once we have that behavior, I think that there are going to be a number of ways that we can amplify that. We're already experimenting with a couple. One is ads that actually display in News Feed, not in Messenger or WhatsApp, but that link to the ability to communicate with a business directly in Messenger or eventually WhatsApp. And that's great. I mean, it converts better for the businesses. They can have a better dialogue with the person, a persistent relationship. So that's one way that I think that this will be valuable. The other way is, of course, eventually showing paid content in Messenger whether that's in the inbox or in relevant ways throughout the product. But the top priority right now is just building up the base of organic interactions between people and businesses that they want to interact with. And once we get that to a big base, I think there are going to be a lot of opportunities to build the business. And the business will be proportional to the amount of that activity that people want to do organically. + +-------------------------------------------------------------------------------- +Operator [14] +-------------------------------------------------------------------------------- + + Your next question comes from the line of Justin Post from Bank of America Merrill Lynch. + +-------------------------------------------------------------------------------- +Justin Post, BofA Merrill Lynch, Research Division - MD [15] +-------------------------------------------------------------------------------- + + A couple of things on advertising and modeling. When we think about Q1, can you help us at all think about how much the ad load growth is contributing? And what drove the improvement in pricing in the quarter? And then, Dave, when you look out to the third quarter and you kind of lap the ad blocking on desktop, are there more ad blocking you can do to help maintain that growth? Or are there other drivers there for desktop that we could think about? + +-------------------------------------------------------------------------------- +David M. Wehner, Facebook, Inc. - CFO [16] +-------------------------------------------------------------------------------- + + Sure, Justin. Not breaking out specific drivers on the supply side, supply growth was healthy and we had contributions from users, time spent and ad load in the quarter. In terms of what drove the improvement in the pricing, it's strong demand. So that's playing through in the face of a little bit slower supply growth. And so you're seeing, of course, the auction drives the pricing and there's interplay between the supply growth and the pricing growth, and we're seeing the strong demand play through on the pricing side. When we get to lapping our efforts on desktop, I do think you're going to -- just you have a secular trend away from desktop, so that's going to be an overall factor in desktop -- our ability to grow and maintain the desktop business, so I think that's an underlying factor. We're always going to be in a back and forth with ad blockers on the desktop side, so I think that's going to constantly be a thing that plays into the desktop revenue. + +-------------------------------------------------------------------------------- +Operator [17] +-------------------------------------------------------------------------------- + + Your next question comes from the line of Colin Sebastian from Baird. + +-------------------------------------------------------------------------------- +Colin Alan Sebastian, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [18] +-------------------------------------------------------------------------------- + + First off, I guess, as a follow-up on the earlier video question from Doug. Could you add some perspective on engagement trends with video content and video ads, such as average viewing time and whether those mix is what is impacting impression growth? And then more broadly, if you can offer some perspective on how much of the video ad spending on Facebook applications are incremental to television budgets or if there's any evidence you're seeing of a share shift? + +-------------------------------------------------------------------------------- +David M. Wehner, Facebook, Inc. - CFO [19] +-------------------------------------------------------------------------------- + + Sure, Colin. I'll take that first one. So yes, impression growth was 32% in Q1, as I noted. And that was a bit slower than in previous quarters. Those of you who have been following us for a while know that periodically, we make changes to the product that it's going to impact some of the metrics. One of the things that I would call out in Q1 as a contributing factor on the impression growth side was our decision to rank longer-form video higher in News Feed. That means more time in video. And that does come at the expense of some impression growth in News Feed. So I think you do see some interplay there on the impression growth side due to our focus on video. And then Sheryl was going to follow-up on the video ad spending. + +-------------------------------------------------------------------------------- +Sheryl K. Sandberg, Facebook, Inc. - COO and Director [20] +-------------------------------------------------------------------------------- + + On TV, we are definitely seeing people continue to advertise on TV and use us as a complement. Over time, we believe that the dollars shift with eyeballs, and we want to earn it from our clients and be the best dollar and the best minute they spend and help them measure across channels. I think increasingly, the question is not you can do without TV but if you can do without mobile. And we're working hard to help advertisers develop the video creative that really works for mobile because that makes a really big difference. And we think the combination of the creative working for mobile but also the measurement and targeting we can do is a very powerful offer. To share one of my favorite new examples, Subway working with their agency, 360i, developed video ads and images for Facebook and Instagram to promote their limited-time offer Reuben sandwich. And they used Audience Insights, targeting people aged 18 to 49 who purchase meat and cheese. And that's just pretty incredible targeting. Nowhere else I don't think you could actually target that way and people interested in fast food and encourage them to visit Subways. They then used Nielsen Brand Effect and were able to measure a 16-point lift in ad recall and a 5-point lift in intent to visit Subway. So it's a really unique combination of the power of creative that was designed for video for mobile with very specific targeting and very specific measurement. + +-------------------------------------------------------------------------------- +Operator [21] +-------------------------------------------------------------------------------- + + Your next question comes from the line of John Blackledge from Cowen. + +-------------------------------------------------------------------------------- +John Ryan Blackledge, Cowen and Company, LLC, Research Division - Head of Internet Research, MD and Senior Research Analyst [22] +-------------------------------------------------------------------------------- + + Two questions. Mark, you mentioned adding 3,000 reviewers to content at Facebook. Could artificial intelligence be used over time to help solve some of the monitoring? And then just more broadly, how is AI being employed in processes at the company now versus a couple of years ago? And then second item would be, could newer ad units like mid-roll video help mitigate the decel from the lower ad load growth contribution in second half '17? + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook, Inc. - Founder, Chairman of the Board and CEO [23] +-------------------------------------------------------------------------------- + + I'll talk to the content and AI questions and then someone else can talk about the ad piece. The short answer is yes. AI tools over time will be able to do a better job of flagging things for the set of people who are in the community ops teams that we can prioritize what we look at. A lot of what we're trying to do here, it's not just about getting content off Facebook. Last week, there was this case where someone was using Facebook Live to broadcast -- or was thinking about suicide. And we saw that video and actually didn't take it down and helped getting in touch with law enforcement, who used that Live Video to communicate with that person and help save their life. So a lot of what we're trying to do is not just about taking the content down but also about helping people when they're in need on the platform, and we take that very, very seriously. Over time, the AI tools will get better. Right now, there are certain things that AI can do in terms of understanding text and understanding what's in a photo and what's in a video. That will get better over time. That will take a period of years, though, to really reach the quality level that we want. So for a while, our strategy has been to just continue building intuitive tools as we can because no matter how many people we have on the team, we're never going to be able to look at everything, right? So that's going to be a big challenge. But given the importance of this and how quickly Live Video is growing, we wanted to make sure that we double down on this and made sure that we provide as safe of an experience for the community as we can, which is why we're almost doubling the size of the community ops team to focus on some of these issues around safety on Live Video. But over time for sure, more AI will do this, but this is over a period of time. + +-------------------------------------------------------------------------------- +David M. Wehner, Facebook, Inc. - CFO [24] +-------------------------------------------------------------------------------- + + John, I think your question then was on ad breaks and the mid-roll type of format. I think there, we're testing the ability and are putting short ad breaks into longer-form live and on-demand videos. Tests are going well, but it's really early days to talk about that being a significant contributor. So we're working to continue to make those products better and continuing those tests. But it's early. We are -- on that front, we're focused on building out the best video experiences for our community and growing longer-form content as a priority. And ad break is going to allow us to have a monetization strategy with that longer-form content. So like I said, it's early. + +-------------------------------------------------------------------------------- +Operator [25] +-------------------------------------------------------------------------------- + + Your next question comes from the line of Heather Bellini from Goldman Sachs. + +-------------------------------------------------------------------------------- +Heather Anne Bellini, Goldman Sachs Group Inc., Research Division - Research Analyst [26] +-------------------------------------------------------------------------------- + + I guess I had a question just related to Instagram and Facebook Stories. I mean, we've talked a lot about ad load growth over the last year, and Dave's been talking about the pending slowdown, which I think we're all expecting. But how do we think about these new applications or new ways to engage with the apps at the top of the -- at the top of your phone where you're starting to see ad insertion show up as well? Is that thought of as a -- is that thought of different than the general ad load comment that, Dave, you're making? And I'm sorry to split hairs here, but I'm just trying to get a sense of how to think about when they're starting to show up in new places. And then, I guess, I just had a follow-up for Sheryl. And one question in particular was if there's any measurement metrics that advertisers are asking for now that if you could help them with, it would make them even more eager to shift their budgets over from TV and follow their eyeballs. + +-------------------------------------------------------------------------------- +David M. Wehner, Facebook, Inc. - CFO [27] +-------------------------------------------------------------------------------- + + So yes, Heather, on the -- on Stories, again, it's a pretty similar answer, I think, to ad break in the sense that it's early in terms of using -- putting -- using the ads format in Stories. We certainly rolled those out. They are not in the ad load calculation per se. So it is different, as you said, from the ad load commentary that I've given. But obviously, it's very early on those products. And then, Sheryl, you had the question about measurement metric. + +-------------------------------------------------------------------------------- +Sheryl K. Sandberg, Facebook, Inc. - COO and Director [28] +-------------------------------------------------------------------------------- + + Yes, we know that measurement is so critical. And we really want to measure core business results and focus on becoming the #1 growth driver for our clients. We are continuing to constantly review our metrics. When we find bugs or errors, we're reporting them to our clients and addressing the issue and continuing with that analysis as we work through all of our metrics. We're also very focused on extending measurement partnerships and third-party verification. This last quarter, we extended viewability measurement to the Audience Network, add another verification partner, double verify for video and display measurement and introduced our MMM portal so that we can help people measure across all of the different platforms and compare the effectiveness of their ad spend no matter what their end goal is. + +-------------------------------------------------------------------------------- +Operator [29] +-------------------------------------------------------------------------------- + + Your next question comes from the line of Anthony DiClemente from Nomura Instinet. + +-------------------------------------------------------------------------------- +Anthony Joseph DiClemente, Instinet, LLC, Research Division - Media Analyst [30] +-------------------------------------------------------------------------------- + + I have one for Mark and one for Sheryl. Mark, at F8 and in your comments today, you talked about making the camera central to the app being the camera, the first augmented reality platform. I know it's early but can you maybe share with us your thoughts about the potential commercial application of augmented reality as you see it today? And then, Sheryl, there's been more lately about the use and effectiveness of influencer marketing on both Facebook and Instagram. How is Facebook thinking about sharing in the economics of when brands use celebrities or influencers to market their products using their Facebook posts? Is it by bringing more transactions onto the platform, building on the shopping experience on Facebook. How is Facebook going to share in those economics? + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook, Inc. - Founder, Chairman of the Board and CEO [31] +-------------------------------------------------------------------------------- + + All right. Well, I can start by talking about augmented reality. The big step forward that we announced at F8 is that there are lots of different apps that have cameras in them right? Or that independent developers just build an app that has a single camera effect. But what we're basically seeing is that there's so much innovation and so many different types of effects that people are creating that we didn't want developers to have to build their own separate app and get to a huge scale in order to build some new kind of visual tool. So we built -- we're making the cameras inside the whole family of apps into the first augmented reality platform, into an open platform, which is different from what any other apps that has a camera has done before. It's going to open up a much greater diversity of use cases, not only making it so that use cases like face masks, the style transfers that we already have, you're now going to have thousands of options instead of just 10 or 20 at a time. But there are also going to be all these new kinds of things that we're not even building today that developers will be able to experiment with. One of the examples I showed at F8 was around using object recognition and computer vision to be able to point your camera at something and then tap on it and get a card of information and maybe even a buy button, right? So there are lots of different ways that, over time, this kind of content is going to both augment existing real-world objects and eventually replace them, which I think is going to be an interesting opportunity, maybe not on augmented reality on the phone but on glasses eventually when you have that. I think we're going to get to a point where things like TV, you no longer need a physical TV. You'll get a $1 app that you can watch a screen on. And it will just be an interesting exercise to see how many of the things that we have that are physical things don't actually need to be physical in that world and how much innovation that opens up for independent developers all around the world. And a lot of people don't have a factory, right, where they can build a TV. But think about how many kids and different developers around the world, kids sitting in dorm rooms and all these different places, they're going to be able to create things that today they couldn't. So I know this is going to create a pretty interesting economy, but a lot of that stuff is pretty far out, 5, 10 years. But we want to be pushing this forward. And we -- I think we're a little bit late to the trend initially around making cameras the center of how sharing works. But I do think at this point, we're pretty much ahead in terms of the technology that we're building and making it an open platform, I think, is a big step forward. A lot of people are using these products across our family of apps, and I would expect us to continue leading the way forward on this from this point on. + +-------------------------------------------------------------------------------- +Sheryl K. Sandberg, Facebook, Inc. - COO and Director [32] +-------------------------------------------------------------------------------- + + When you think about influencer marketing, we definitely see publishers interested in it, brands interested in it. And so we've worked on branded content, the ability to tag a sponsor and share posts and insights. And the financial arrangement remains between a sponsor and a publisher. It's early, but we're seeing some positive results with publishers of many different types bringing branded content to Facebook. In Q1, we opened this up to unverified pages, so we could enable more people to take advantage of this kind of targeting. We see this in a broader context of better targeting. When you think about what really drives great performance for both people who are using Facebook but for marketers, it's well-targeted ads. And so influencer marketing is one way to get there, but we're focused on a very full range of ability to target well. We've been really pleased with the adoption of our targeting products from Custom Audiences to Lookalike to Dynamic Ads. And we think all of these can improve the relevance of the ad by making ads more targeted because when they're more targeted, they have higher returns for marketers and they're more enjoyable and relevant for people. + +-------------------------------------------------------------------------------- +Operator [33] +-------------------------------------------------------------------------------- + + Your next question comes from the line of Mark Mahaney from RBC. + +-------------------------------------------------------------------------------- +Mark S. Mahaney, RBC Capital Markets, LLC, Research Division - MD and Analyst [34] +-------------------------------------------------------------------------------- + + First thing, it's a great move to go all in GAAP in terms of reporting. Second, David, when you talked about the ad, your ad load commentary, I couldn't tell if there was a subtle shift there when you're saying that the ad load pressure would occur after the end of the year rather than in the second half year. And then third, this is for Sheryl and Mark. The recent stories about gender bias amongst the engineers at Facebook, and I know you quickly responded to that and said that, if anything, there may be a rank bias. But in my mind, it kind of creates the opportunity potentially for Facebook to better tap into what is probably underappreciated female engineering talent in the Valley and across technology. How do you think about that as an opportunity for the company? + +-------------------------------------------------------------------------------- +David M. Wehner, Facebook, Inc. - CFO [35] +-------------------------------------------------------------------------------- + + And I'll just real quickly address the ad load issue, Mark. Sorry if it wasn't clear. Really no change in outlook there. We continue to expect that we'll see deceleration in ad revenue growth. And that's going to be particularly pronounced as we get into the second half of 2017 because ad load will be a less significant factor driving growth starting in the second half. + +-------------------------------------------------------------------------------- +Sheryl K. Sandberg, Facebook, Inc. - COO and Director [36] +-------------------------------------------------------------------------------- + + On the issue you raised at the Facebook female engineers, I'm really glad to have a chance to address this because this is an issue I take very seriously. On the specific report on this study, the study was conducted by a former employee with very incomplete data. When that study was shared with people internally, and we have that culture where people do studies and share things, and we're really glad because that helps surface issues, we immediately conducted our own research using the full data. And what we found is that the main reason code was sent back at different rates was not correlated with gender. It was correlated with level, and the fact that we have more male senior engineers was explaining it. If you compared now and female engineers at the same level, there was not the discrepancy. Well then, that leads to the obvious question is, are you promoting men and women at the same rate? And the broader question of are you paying men and women fairly? And we do a comprehensive look at that every single promotion and pay and performance cycle we have, which is 6 months. And we know that we're promoting men and women at the same rate as men. Now, that said, our industry still has issues and we still have issues. We don't have enough senior female engineers. We don't have enough women going into computer science. And we take this very seriously from the work we've done with LinkedIn to get CS&E lean in circles all over college campuses to encourage more women and underrepresented minorities to come into our field. We've had a really nice program in extra internship, where we're taking people who are not yet majoring in computer science but we think have the ability and teaching them for summer and seeing them return to the work we're doing with our female engineers to make sure that all forms of bias are surfaced and eliminated and we can continue to use the full talent of the population. Nothing is more important to us. + +-------------------------------------------------------------------------------- +Operator [37] +-------------------------------------------------------------------------------- + + Your next question comes from the line of Ross Sandler from Barclays. + +-------------------------------------------------------------------------------- +Ross Adam Sandler, Barclays PLC, Research Division - MD of the Americas Equity Research and Senior Internet Analyst [38] +-------------------------------------------------------------------------------- + + Just had 2 questions on video. We know it's kind of early, but what kind of traction do you see with the video tab that's in beta? And do you think longer term, the video consumption is going to be in that dedicated tab or will it stay in the News Feed based on what you're seeing right now? And then, Dave, just a follow-up on one of your previous answers. So on the cost related to video ad rev share or licensing of video content, is that baked into your OpEx guidance for '17? Or is that something that will step up after this year? + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook, Inc. - Founder, Chairman of the Board and CEO [39] +-------------------------------------------------------------------------------- + + I don't know if we have any public stats on the video tab. Probably not. But in terms of the strategy, I can talk about that quickly. There are 2 basic use cases for checking in with Facebook and seeing what's going on in the world. What people do with News Feed a lot of the time is they have a few free minutes or you want to sit down for maybe a longer session to see everything that's going on in the world. You don't have a specific intention to watch a specific type of content. You kind of just want to check in and see what's going on in the world. There's this whole other use case around content, which is going because -- going to the app or sitting down at TV because there's some content that you want to watch and you want to go directly to it. And that's what we're trying to do with the video tab, to make it so that all the different folks whether they're pages that you follow or creators that you like, who you want to subscribe to and kind of -- and get the updates to what they're doing that you have a place that you can go to with more intent to consume that content. The reason why it needs to be a different tab or at least a different service from News Feed is because people come to it with a different intent. I think you're going to start in the future getting people coming to Facebook for the News Feed use case of checking in and people coming with an intent to go to the video tab to watch specific video. So that's what we're doing there. That's the strategy. And I guess we'll update on stats when we have them. + +-------------------------------------------------------------------------------- +David M. Wehner, Facebook, Inc. - CFO [40] +-------------------------------------------------------------------------------- + + And, Ross, on the costs related to the video ad rev share, yes, our guidance on total cost is all inclusive, so it includes all the R&D investments we're making. It includes the content. It includes things like community operations investments that we talked about today in the announcement. But I would say that the nature of the types of video content deals that we're doing, will make them more likely to show up after 2017. So there'll be some content expense in 2017, but I think it'll be something you will see step up after 2017. + +-------------------------------------------------------------------------------- +Operator [41] +-------------------------------------------------------------------------------- + + Your next question comes from the line of Mark May from Citi. + +-------------------------------------------------------------------------------- +Mark Alan May, Citigroup Inc, Research Division - Director and Senior Analyst [42] +-------------------------------------------------------------------------------- + + Mark, in your prepared remarks, you talked about doing more to foster local communities and groups. And it would seem like one of the more interesting test cases here already is in local marketplaces. Just wondering if you could talk to us a little bit about the kind of adoption and engagement that you've seen with local marketplaces and maybe anything that you've learned that you can apply to some of the newer initiatives that you're looking at. And then secondly, probably for Sheryl, for ad breaks to scale, it appears that content creators need to adapt their programming for this. And, of course, users need to engage with the ads. So I guess the question is how are kind of completion rates for ad breaks? I know it's early but kind of what's your -- what are you seeing so far? And how would you characterize the willingness of content creators to adapt? + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook, Inc. - Founder, Chairman of the Board and CEO [43] +-------------------------------------------------------------------------------- + + I can talk about marketplaces first. So I think your basic point is right that the reason why we started working on marketplace and the tab around that is because when we were exploring what the biggest use cases were of Groups, we uncovered that a very large number of people, hundreds of millions, use Groups to buy and sell different things. And so these whole communities that have formed, which was somewhat surprising to us honestly because we hadn't developed that product specifically for buying and selling. It was for group communication, and that's what people are using it for. So we decided, "Hey, we're going to put together a team that's going to invest in making this actually good for buying and selling and see how much we can grow that economy." So I don't know that have any public stats on that yet, but that's an area that I'm certainly very excited about. And then in terms of local communities, one of the big trends in the world that we've seen is just that participation in all kinds of different physical communities, whether they're sports teams or some religious groups or different kinds of different things, have been declining a lot over the past several decades. And that, I think, is a big social issue that is eroding the social fabric of the whole society, not just our country but around the world. And that's one where I look at that and I wonder if Facebook can play a role in helping to strengthen that. And we look at -- there are more than 1 billion people every month who use our Groups product. But if you think about your own use of the Groups product, you probably are a member of a bunch of different groups that you may be checking on very infrequently. So that's very different from there's a handful of people, around 100 million or a bit more, who are a member of what we call a very meaningful group. So it's -- that could be a parenting group or you're diagnosed with a rare disease and you can now connect with people all around the world to share stories around that. These are groups that upon joining may become one of the things they spend the most time with on Facebook, one of the most important parts of your experience and a really fundamental part of your real-world support structure. So we looked at that and we asked the question of, "Hey, if 100 million people are in those very meaningful groups today, can we get that to be 1 billion people over the next several years?" And if so, then that can help reverse some of the decline in community membership and help strengthen the social fabric not only in our country but around the world. So that's a big part of what we're focused on across a number of different initiatives. + +-------------------------------------------------------------------------------- +Sheryl K. Sandberg, Facebook, Inc. - COO and Director [44] +-------------------------------------------------------------------------------- + + And I'll talk a little bit about the ad break, what we're seeing. It's really early both in terms of testing the ads and getting any feedback from users so people who use Facebook, so we don't have that data to share. But we're pleased that the test is active. We're pleased that it's going well and that we can do both Live and uploaded videos. We think over time that marketers will follow where people are spending their time. And if the ads can be well targeted, we think we'll be able to see engagement and we already see that. When ads are really well targeted in taking full advantage of the kind of targeting we offer, that you're showing people something they want to see, we see engagement that we think is really critical. It's also worth noting that the metrics that really matter at the end are driving sales. And so any of the engagement with ad metrics, whether it's remembering an ad, going back to, say, people have been measuring that for a long time to how long a video ad is viewed, our only proxy metrics, what matters is the impact on sales. And so we think the better we can do at getting the measurement to what actually matters, which is the end behavior marketers are trying to drive, the more people will shift their focus to business metrics, the better it will be for the return they get and ultimately our business. + +-------------------------------------------------------------------------------- +Operator [45] +-------------------------------------------------------------------------------- + + Your next question comes from the line of Michael Nathanson from MoffettNathanson. + +-------------------------------------------------------------------------------- +Michael Brian Nathanson, MoffettNathanson LLC - Co-Founder, Partner and Senior Research Analyst [46] +-------------------------------------------------------------------------------- + + I have 3 philosophical questions on video for you guys and (inaudible). The first is, it was interesting to see the NFL games go from Twitter and Amazon. I wondered, do the NFL games fit with your video strategy? Why or why not? That's one. Two is, I know the model is revenue share, but a lot of the more traditional companies would like license fee or the ability to sell their own inventory on your platform. Is that something you'd consider? And last but not least, the question about monetization. Why is mid-roll optimal to pre-roll? And could you share anything about the testing of that concept? + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook, Inc. - Founder, Chairman of the Board and CEO [47] +-------------------------------------------------------------------------------- + + I can talk about sports. So in terms of experimenting with different content, I think we'll try a number of different things here in terms of working with folks to produce all kinds of content. Sports is probably something that we'll want to try at some point. But again, like Dave said before, the goal is going to be creating some anchor content initially that helps people learn that going to the video tab, that they -- that that's a great destination where they can explore and come to Facebook with the intent to watch the video that they want. And then the long-term goal is actually not to be paying for a specific content like that but doing a revenue share model once the whole economy around video on Facebook is built up. But we're working on that. And I think we'll probably look at different pieces of content like this around the world, but, at this point, don't feel like any specific one of them is a must-have for us. + +-------------------------------------------------------------------------------- +David M. Wehner, Facebook, Inc. - CFO [48] +-------------------------------------------------------------------------------- + + And I think Mark touched on the question of a business model here, and our focus really is on revenue share. We'll be investing to kickstart the ecosystem with content, so derisking it for some of our content partners to start off with. But the focus is really to build a rev share model over time that's sustainable. That's the focus as opposed to other models. In terms of why mid-roll is preferable to pre-roll, Facebook is well suited for shorter form content where we're ranking things to be longer-form as well so we're ranking longer-form video. But that's still relatively short video views. And for that reason, we think mid-roll is a good -- is a better user experience. + +-------------------------------------------------------------------------------- +Operator [49] +-------------------------------------------------------------------------------- + + Your last question comes from the line of Peter Stabler from Wells Fargo. + +-------------------------------------------------------------------------------- +Peter Stabler, Wells Fargo Securities, LLC, Research Division - Director and Senior Analyst [50] +-------------------------------------------------------------------------------- + + One for Sheryl. Sheryl, you've talked a lot about the targeting advantage of Facebook. And you have a number of data signals and sources informing that. Wondering if you could talk about the relative importance of collecting signals on the platform versus off the platform. For instance, the behavior of Facebook users interacting with third-party websites. Is this the depth of your off-platform collection? Is this a significant competitive advantage for you? + +-------------------------------------------------------------------------------- +Sheryl K. Sandberg, Facebook, Inc. - COO and Director [51] +-------------------------------------------------------------------------------- + + We think that targeting and measurement are significant competitive advantages for us. We're very focused on the privacy of what people do, wherever they do it and using the information we have in a very responsible way. We believe that because people are sharing interests, because people are themselves their real identity on the Facebook platform, we have a significant advantage. Just in basic targeting itself, just age and gender, we're 38% more accurate than broad-based targeting according to Nielsen in the U.S. And that's just age and gender. And then if you think about some of the case studies I shared, targeting people who purchase a certain item, targeting people who are interested in a certain item, we think that's very substantial. We also think that there's a real competitive advantage in focusing on business results as we have. We're really working on shifting people to understanding what their real objectives are so that they can focus on driving businesses. At the end of the day, when you show an ad, you want to move a product off a shelf into a shopping cart, whether it's online and off-line. And that's where our focus is and will continue to be. + +-------------------------------------------------------------------------------- +Deborah T. Crawford, Facebook, Inc. - VP of IR [52] +-------------------------------------------------------------------------------- + + Great. Thank you again, everybody for joining us today. We appreciate your time, and we look forward to speaking with you again. + +-------------------------------------------------------------------------------- +Operator [53] +-------------------------------------------------------------------------------- + + Ladies and gentlemen, this concludes today's conference call. Thank you for joining us. You may now disconnect your lines. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/exam/original-files/Problem_1_Sample/2017-Nov-01-FB.OQ-137641444844-Transcript.txt b/exam/original-files/Problem_1_Sample/2017-Nov-01-FB.OQ-137641444844-Transcript.txt new file mode 100644 index 0000000..9cbff1e --- /dev/null +++ b/exam/original-files/Problem_1_Sample/2017-Nov-01-FB.OQ-137641444844-Transcript.txt @@ -0,0 +1,435 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q3 2017 Facebook Inc Earnings Call +11/01/2017 05:00 PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Deborah T. Crawford + Facebook, Inc. - VP of IR + * Sheryl K. Sandberg + Facebook, Inc. - COO and Director + * David M. Wehner + Facebook, Inc. - CFO + * Mark Zuckerberg + Facebook, Inc. - Founder, Chairman of the Board and CEO + +================================================================================ +Conference Call Participiants +================================================================================ + + * Kenneth Michael Sena + Wells Fargo Securities, LLC, Research Division - MD, Head of Internet Equity Research & Senior Analyst + * Eric James Sheridan + UBS Investment Bank, Research Division - MD and Equity Research Internet Analyst + * Brent John Thill + Jefferies LLC, Research Division - Equity Analyst + * Richard Scott Greenfield + BTIG, LLC, Research Division - Co-Head of Research, MD and Media and Technology Analyst + * Justin Post + BofA Merrill Lynch, Research Division - MD + * Brian Thomas Nowak + Morgan Stanley, Research Division - Research Analyst + * Heather Anne Bellini + Goldman Sachs Group Inc., Research Division - Research Analyst + * Douglas Till Anmuth + JP Morgan Chase & Co, Research Division - MD + * Youssef Houssaini Squali + SunTrust Robinson Humphrey, Inc., Research Division - MD & Senior Analyst + * Ross Adam Sandler + Barclays PLC, Research Division - MD of the Americas Equity Research and Senior Internet Analyst + * Mark Stephen F. Mahaney + RBC Capital Markets, LLC, Research Division - MD and Analyst + * Colin Alan Sebastian + Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst + * Mark Alan May + Citigroup Inc, Research Division - Director and Senior Analyst + +================================================================================ +Presentation +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- +Good afternoon. My name is Mike, and I will be your conference operator today. At this time, I would like to welcome everyone to the Facebook Third Quarter 2017 Earnings Call. (Operator Instructions) This call will be recorded. Thank you very much. +Ms. Deborah Crawford, Facebook's Vice President of Investor Relations, you may begin. + +-------------------------------------------------------------------------------- +Deborah T. Crawford, Facebook, Inc. - VP of IR [2] +-------------------------------------------------------------------------------- +Thank you. Good afternoon, and welcome to Facebook's Third Quarter 2017 Earnings Conference Call. Joining me today to discuss our results are Mark Zuckerberg, CEO; Sheryl Sandberg, COO; and Dave Wehner, CFO. +Before we get started, I would like to take this opportunity to remind you that our remarks today will include forward-looking statements. Actual results may differ materially from those contemplated by these forward-looking statements. Factors that could cause these results to differ materially are set forth in today's press release and in our quarterly report on Form 10-Q filed with the SEC. Any forward-looking statements that we make on this call are based on assumptions as of today, and we undertake no obligation to update these statements as a result of new information or future events. +During this call, we may present both GAAP and non-GAAP financial measures. A reconciliation of GAAP to non-GAAP measures is included in today's earnings press release. The press release and an accompanying investor presentation are available on our website at investor.fb.com. +And now I'd like to turn the call over to Mark. + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook, Inc. - Founder, Chairman of the Board and CEO [3] +-------------------------------------------------------------------------------- +Thanks, Deborah, and thanks, everyone, for joining us today. Our community continues to grow, now with nearly 2.1 billion people using Facebook every month and nearly 1.4 billion people using it daily. Instagram also hit a big milestone this quarter, now with 500 million daily actives. And we saw good results in the business where total revenue grew 47% year-over-year, and we had our first-ever quarter with more than $10 billion in revenue. +But none of that matters if our services are used in a way that doesn't bring people closer together or the foundation of our society is undermined by foreign interference. I've expressed how upset I am that the Russians tried to use our tools to sow mistrust. We built these tools to help people connect and to bring us closer together, and they used them to try to undermine our values. What they did is wrong, and we are not going to stand for it. +Now for those who followed Facebook, you know that when we set our minds to something, we're going to do it. It may be harder than we realized up-front and may take longer and we won't be perfect, but we will get it done. We're bringing the same intensity to these security issues that we brought to any adversary or challenge that we have faced. +The first step is doing everything we can to help the U.S. government get a complete picture of what happened. We've testified in Congress over the past couple of days about the activity we found in last year's election. We're working with Congress on legislation to make advertising more transparent. I think this would be very good if it's done well. +And even without legislation, we're already moving forward on our own to bring advertising on Facebook to an even higher standard of transparency than ads on TV or other media. That's because in traditional media, there's no way to see all of the messages an advertiser is showing to different audiences. We're about to start rolling out a tool that lets you see all of the ads a page is running and also an archive of ads political advertisers have run in the past. +We're also working with other tech companies to help identify and respond to new threats because as we've now seen, if there's a national security threat involving the Internet, it will affect many of the major tech companies. And we've announced a number of steps to help keep this kind of interference off our platform. +This is part of a much bigger focus on protecting the security and integrity of our platform and the safety of our community. It goes beyond elections, and it means strengthening all of our systems to prevent abuse and harmful content. +We're doing a lot here with investments both in people and technology. Some of this is focused on finding bad actors and bad behavior. Some is focused on removing false news, hate speech, bullying and other problematic content that we don't want in our community. We already have about 10,000 people working on safety and security, and we're planning to double that to 20,000 in the next year to better enforce our community standards and review ads. +In many places, we're doubling or more our engineering efforts focused on security. And we're also building new AI to detect bad content and bad actors just like we've done with terrorist propaganda. I am dead serious about this. And the reason I'm talking about this on our earnings call is that I've directed our teams to invest so much in security on top of the other investments we're making that it will significantly impact our profitability going forward. And I wanted our investors to hear that directly from me. I believe this will make our society stronger and, in doing so, will be good for all of us over the long term. But I want to be clear about what our priority is: protecting our community is more important than maximizing our profit. +So security and the integrity of our services will be a major focus. Beyond this, our focus is on building community. I talked about this last quarter when we changed our mission to focus on building community to bring the world closer together. And that's more important now than ever. And this gets into our road map for the next 3, 5 and 10 years. +Over the next 3 years, the biggest trend in our products will be the growth of video. This goes both for sharing where we've seen Stories in Instagram and status in WhatsApp grow very quickly, each with more than 300 million daily actives. And also for consuming video content. We recently launched the Watch tab where you can discover shows, follow creators, connect with people watching an episode and join groups with people with similar interests to build a community. +But as video grows, it's important to remember that Facebook is about bringing people closer together and enabling meaningful social interaction. It's not primarily about consuming content passively. Research shows that interacting with friends and family on social media tends to be more meaningful and can be good for our well-being, and that's time well spent. But when we just passively consume content, that may be less true. +When done well, video brings us closer together. We found that communities formed around video, like TV shows or sports, create a greater sense of belonging than many other kinds of communities. We found that live videos generate 10x the number of interactions and comments as other videos. +But too often right now, watching a video is just a passive consumption experience. Time spent is not a goal by itself. We want the time people spend on Facebook to encourage meaningful social interaction. So we're going to focus our products on all the ways to build community around video that people share and watch. That's something Facebook can uniquely do. +Moving along, over the next 5 years, I expect us to make some good progress on several newer initiatives. In messaging, today, already more than 20 million businesses are communicating with customers through Messenger. Now we're starting to test business features that make it easier for people to make the same kinds of connections with businesses through WhatsApp. +We rolled out Marketplace to Canada and 17 countries across Europe, giving people the ability to discover, buy and sell things in their local communities. Today, more than 550 million people are using Marketplace and buy and sell groups on Facebook to connect with other people for transactions. +We're also seeing good progress with Workplace, helping companies connect their own teams internally through their own versions of Facebook. It's been less than a year since we launched Workplace, and today, more than 30,000 companies are using it. This quarter, we welcomed on Walmart, the largest employer in the U.S. +Over the next 10 years, we are working on the foundational technologies needed to bring the world closer together. I'm proud of the work we're doing with AI. We're now using machine learning in most of our integrity work to keep our communities safe. When Hurricane Maria hit Puerto Rico, we used AI to look at satellite imagery and identify where people might live and need connectivity and other resources. Progress in AI can unlock a lot of opportunity. So this quarter, we opened a new AI research lab in Montreal, and we're building another lab in Paris as well. +This quarter, we held Oculus Connect and we announced Oculus Go, our first-ever all-in-one headset that's great for feeling like you're present with someone when you can't physically be together in person. It's great for playing games, watching movies or hanging out with friends. And at $199, we think it's going to help us bring great virtual reality experiences to more people. It ships next year. +At Connect, I also showed off our new Santa Cruz prototype, which is the first time any company has shown the full experience of positional tracking with stand-alone headset and controllers. It's a major technical achievement, and I'm looking forward to getting this into developers' hands next year. +In order to support our communities' growth, we need to keep investing in our infrastructure. This quarter, we broke ground on our New Albany data center, and we announced that we'll build our 11th major data center in Henrico County, Virginia. As always, all our new data centers are powered by 100% renewable energy. +These long-term investments are important for our community's future. We can do a lot to help people connect through phones and computers, but so much more will be possible in a world where everyone has Internet access, where AI improves all our services and where we -- where we can basically teleport anywhere or be within -- with anyone anytime we want. +With all the issues we face, it would be a lot to just invest in addressing those. But we know that we also have a responsibility to deliver these fundamental technical and scientific advances to fulfill the promise of bringing people closer together. So we're going to keep making significant investments looking ahead towards the future, too. +We've made some real progress this year. Across the board, we have a lot of work to deliver on our mission of bringing the world closer together, but we're committed to rising to the challenge and doing what we need to for our community. Thanks to all of you for being a part of this journey, and I'm looking forward to the road ahead. +And now here is Sheryl to discuss our business. + +-------------------------------------------------------------------------------- +Sheryl K. Sandberg, Facebook, Inc. - COO and Director [4] +-------------------------------------------------------------------------------- +Thanks, Mark, and hi, everyone. We had a strong third quarter with growth across all regions, marketer segments and verticals. Ad revenue grew 49% year-over-year. Mobile ad revenue was $8.9 billion, a 57% year-over-year increase, making up approximately 88% of total ad revenue. +We're continuing to build our business by focusing on our same 3 priorities: helping businesses leverage the power of mobile; developing new ad products; and making our ads more relevant and effective. +Today, we're announcing that Facebook has over 6 million active advertisers, and we recently announced that Instagram had over 2 million advertisers. The vast majority of these are small- and medium-sized businesses, which are a major source of innovation and create more than half of all new jobs globally. These businesses often have small ad budgets, so the ability to reach people more effectively is really valuable to them. +A great example is LoveBook, a small business in Michigan, which lets you make personalized books to people you love. During a recent campaign, they used Facebook ads to reach people getting ready to celebrate their first anniversary. They have grown so much for marketing on Facebook that they've been able to hire 10 new employees this year alone. We're proud of the role we are playing in enabling businesses like LoveBook to reach people on mobile to grow and to create jobs. +One of our strongest areas this quarter was SMBs in Europe, with revenue growing more than 60% year-over-year. When I was in Germany 2 months ago, I had a chance to meet Victor, one of the cofounders of Brooklyn Soap Company, which, despite its name, is based in Hamburg. Victor and his friends came up with the idea for their business while staying in a hostel in Brooklyn. Now they sell their grooming products in 38 countries using mobile video ads on Facebook and Instagram. As a result, their sales increased 62% over the last year. They're one of many small businesses using mobile to find new customers and grow across borders. +Our second priority is developing innovative ad products. Video is exploding, and mobile video advertising is a big opportunity. Until recently, ads were only eligible for ad breaks if they also ran in News Feeds. But in Q3, we gave advertisers the option to run ads in videos alone. We're seeing good early results, with more than 70% of ad breaks up to 15 seconds in length on Facebook and Audience Network viewed to completion, most with the sound on. +As Mark said, Instagram Stories are growing well, too. People and businesses are finding creative new ways to use full screen vertical video in Stories. This quarter, we gave advertisers even more flexibility in the content, format and reach of their ads in Stories. +We're also seeing how immersive video and images can help people discover new products on Facebook. We added a new creative template to Collection ads, which helps retailers bring their catalogs online. west elm, a home decor company, recently used this template to promote its furniture and home accessories. They targeted people who already got their physical catalog and saw a 5.5% lift in purchases in-store. +Our third priority is making our ads more relevant and effective. In Q3, we introduced new tools powered by machine learning and automation to help businesses reach people more likely to spend with them. We also simplified the tools for creating ads, making it easier for businesses of all sizes to advertise with us. +It's important for all businesses to reach the right audience, but it's especially important for small businesses that have limited budgets. Targeting allows them to show ads only to the people they want to reach. Neon Retro Arcade in L.A. is a great sample. They advertise to people within 10 miles of their location who are interested in video games and comic books. Last year, they moved their entire ad budget to Facebook and Instagram, and their revenue was up 25%. +Relevance and effectiveness are also about giving businesses more control over where their ads run. In Q3, we clarified which publishers and creators can include ads next to their content. This is good for creators who want guidance on how to earn money from their content on Facebook, and it's good for advertisers who want transparency and control to make the right decisions for their brands. We're also working to give advertisers more clarity on where their ads were shown so they can make informed choices about where to run them in the future. +I want to close by talking about what we're doing to protect our platform and help ensure that the ads and content people see on Facebook and Instagram are legitimate and authentic. When I was in Washington a few weeks ago, I made clear that we are determined to do everything we can do to minimize abuse going forward. +As Mark said, we're investing heavily in new technology and people to review ads and posts. This will enable us to look more closely at the content of the ads, targeting and the advertiser who submits them as well as tighten our ad policies, particularly for ads directed at social and political issues. We believe that ads are important to free expression, and we will continue to accept ads on issues, but we will also do our part to elevate the quality of that discourse. +Transparency helps keep -- helps everyone keep advertisers accountable for their messages. We're working with Congress on new requirements for online political advertising, but we are not waiting for legislation. We're building a tool now that will allow anyone to see the ads a page is running even if those ads are not targeted to them. We will test it soon in Canada and then in the U.S. in the coming months. +For ads related to U.S. federal elections, we'll start sharing even more information, including an archive of past ads with total amount spent and demographics about the people the ad reached. We're also going to require more thorough documentation from these advertisers, and we'll label their ads so it's clear who paid for them. We believe these actions will set a new standard for transparency in online ads. +Because the interference on our platform went beyond ads, we're also increasing transparency around organic content from pages. We're looking at ways to provide more information about who's behind a political- or issue-based Facebook page. We believe this will make it harder for deceptive pages to gain large followings and make it easier for us to identify malicious activity. +We are all committed to getting this right and to investing in strengthening our platform so we can better serve our community. We are also committed to continuing to help businesses all over the world attract customers, sell their products and create jobs. +As always, I'm grateful to all of our clients for their partnership and to our global Facebook teams for their hard work. +Thank you, and now here's Dave. + +-------------------------------------------------------------------------------- +David M. Wehner, Facebook, Inc. - CFO [5] +-------------------------------------------------------------------------------- +Thanks, Sheryl, and good afternoon, everyone. Q3 was another great quarter for Facebook. We saw continued growth in engagement in our community as well as strong performance in our ads business. +Let's begin with our community metrics. Daily active users in Q3 reached 1.37 billion, up 16% compared to last year. This number represents 66% of our 2.07 billion monthly active users in Q3. MAUs were up 284 million year-over-year or 16%. Our community growth was again driven by product improvement, promotional data plans and Internet.org. Note that in Q3, we began to lap the introduction of promotional data plans for mobile operators in markets like India. +Before going to the financials, let me touch briefly on our ongoing effort to improve our user estimate. This quarter, we implemented a new methodology to help identify duplicate accounts. As a result, we increased our estimates for duplicate accounts to approximately 10% of worldwide MAUs from our previously disclosed estimate of 6%. Duplicate accounts are those that we believe are used by the same person and represent real activity and engagement on Facebook. +We have also increased our estimate for inauthentic accounts to approximately 2% to 3% of worldwide MAUs. Inauthentic accounts are largely those that are used for spam and other policy-violating reasons. We continuously monitor and aggressively take down those accounts. These accounts tend to be less active and thus, we believe, impact DAU less than MAU. +Now turning to the financials. All comparisons are on a year-over-year basis unless otherwise noted. Q3 total revenue was $10.3 billion, up 47% or 45% on a constant currency basis. Foreign exchange tailwinds contributed $128 million of revenue in Q3. Q3 total ad revenue was $10.1 billion, up 49%. On a constant currency basis, our ad revenue growth rate was 47%, down 2 percentage points compared to the growth in Q2. Ad revenue growth was strong globally, led by Europe and APAC with 56% and 54% growth, respectively. Mobile ad revenue was $8.9 billion, up 57%. +In Q3, the average price per ad increased 35%, and the number of ad impressions served increased 10%, driven primarily by feed ads on Facebook and Instagram. I would note that compared to a year ago, price is a much more important driver of our ads revenue growth. Payments and other fees revenue was $186 million, down 5%. Total expenses were $5.2 billion, up 34%. +Q3 was our biggest hiring quarter ever. We added over 2,500 people and ended the quarter with over 23,000 employees, up 47% compared to last year. +Operating income was $5.1 billion, representing a 50% operating margin. Our tax rate in the third quarter was 10%. Excess tax benefits recognized from share-based compensation decreased our effective tax rate by 6 percentage points, a level that was driven by appreciation in our stock price. +Net income was $4.7 billion or $1.59 per share. Year-to-date, capital expenditures were approximately $4.5 billion, driven by investments in servers, data centers, office facilities and network infrastructure. In Q3, we generated over $4.3 billion in free cash flow and ended the quarter with over $38 billion in cash and investments. Year-to-date, we have brought back over $1 billion of our Class A common stock. +Turning now to the revenue outlook. Our ads business remained strong. But it's worth noting that in Q3, our year-over-year ads revenue growth rates decelerated for the fifth consecutive quarter on a constant currency basis, and we expect this trend to continue for the foreseeable future. Going forward, we also expect the growth in advertising revenue will increasingly be driven by price. This is a shift from prior years when growth was primarily driven by increases in supply. +Turning now to expenses. We anticipate that our full year 2017 total expenses will grow approximately 35% to 40% versus our prior range of 40% to 45%. We anticipate that full year 2017 capital expenditures will be approximately $7 billion. +As mentioned previously, our tax rate will vary based on our stock price. At the current stock price, we would expect that the Q4 rate will be in the low teens. +I also wanted to provide some comments on 2018 expenses and capital expenditures. Please recognize that these are preliminary estimates as we have not yet finalized our 2018 budget. That said, it is shaping up to be a significant investment year, and I wanted to provide initial guidance to align investors with our most current thinking. +We expect full year 2018 total expenses will grow approximately 45% to 60% compared to full year 2017. We continue to invest aggressively across the business, but there are 3 important factors driving an acceleration in our expense growth rates from 2017 levels. +First, as Mark outlined in his earlier comments, we are making sizable security investments in people and technology to strengthen our systems and prevent abuse. Secondly, we are investing aggressively in video content to support the Watch tab. Finally, we continue to invest in our long-term initiatives around augmented and virtual reality, AI and connectivity. +Given our expectation of continued deceleration in revenue growth rates, we expect these significant investments will be net negative on our operating margins. In addition, we expect to make substantial investments in our infrastructure to support growth and improve our products. As such, we expect full year 2018 capital expenditures will roughly double from 2017 levels. We would also anticipate that the full year 2018 tax rate will be in the mid-teens. +In summary, Q3 was another strong quarter for Facebook across the board. We are excited about the opportunities we see ahead and will continue to make significant investments to support our growth and our mission. +With that, Mike, let's open up the call for questions. + + +================================================================================ +Questions and Answers +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- +(Operator Instructions) Your first question comes from the line of Eric Sheridan, UBS. + +-------------------------------------------------------------------------------- +Eric James Sheridan, UBS Investment Bank, Research Division - MD and Equity Research Internet Analyst [2] +-------------------------------------------------------------------------------- +Maybe revisiting Mark's comments at the beginning of the call. Would love to get a better sense or granularity about what sort of video content you'd like to see on the platform that could drive a more active or interactive experience than passive. And then the second question will be what does that mean in terms of the business model? Will there be licensing content, funding content that you have to do to build the sort of business you're aiming for, for the medium to long term? + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook, Inc. - Founder, Chairman of the Board and CEO [3] +-------------------------------------------------------------------------------- +So the strategy here around helping people connect reflects more on what we do around the videos than some of the content itself, right? So hopefully, the experience on Facebook will not just be that you come and watch a video, and you get informed, you feel entertained, and that's it. We think that the most valuable thing that people do are help build relationships with other people on the platform. So to the extent that the -- that video can serve as a touchstone for building community and helping facilitate interaction, then that's the thing that we feel like we can uniquely do. So we're going to continue investing heavily in video content for Watch that is centered around people, that is centered around things that people want to talk and connect around, that give people a sense of pride and bring people together. We're going to invest as much and just build -- making sure that we build out the community features around that. And that, I think, is going to be the thing that differentiates us over time. + +-------------------------------------------------------------------------------- +Operator [4] +-------------------------------------------------------------------------------- +Your next question comes from Brian Nowak, Morgan Stanley. + +-------------------------------------------------------------------------------- +Brian Thomas Nowak, Morgan Stanley, Research Division - Research Analyst [5] +-------------------------------------------------------------------------------- +I have 2. Just -- Mark, to go back on your focus on community and video. I was wondering if you could show us or kind of help us understand what you're seeing in engagement trends or in time spent per user on the core Facebook platform as you've had so many efforts focused on community and video. And then secondly, for Sheryl. You've made such good progress growing the advertising business across SMB and a lot of verticals. I wonder if you -- can you step back -- could you talk to any areas or any verticals where you really see the potential for material improvements or verticals where you're having a hard time cracking into? Do you think it will really be bigger drivers of ad revenue growth going forward? + +-------------------------------------------------------------------------------- +David M. Wehner, Facebook, Inc. - CFO [6] +-------------------------------------------------------------------------------- +So Brian, on -- just on engagement metrics. I mean, we're -- we continue to see good growth in DAU, as you saw, in the 16% growth that we posted this quarter. In addition, we do continue to see time spent growth per DAU on the Facebook family and on Facebook. + +-------------------------------------------------------------------------------- +Sheryl K. Sandberg, Facebook, Inc. - COO and Director [7] +-------------------------------------------------------------------------------- +For my part, when I think about our marketer segments, we have SMBs, we have brand direct response and developers, we're seeing strong growth across. I think if you think about where the growth remains, it really is in increasing the relevance of the ad because the ads, I think, are getting better in terms of reaching the right people at the right time. But I think there's still a lot more we can do. And as people really use our Custom Audiences, our targeting tools, the quality of the ads improve, and the returns improve. And the more we -- the better we get at measuring those returns, the better the ads get. And so I'll share just one example, but one I really love, which is the Alameda County Fair, which is a local fairground in Pleasanton, California. I happened to meet this woman, [Angel], who's running their marketing this year. And they used Facebook to target people within 25 miles of their fairgrounds aged 20 to 51 who had specific interest in concerts, music festivals and theme parks. And what they saw for season pass ticket sales for 2017 was a 50% increase compared to 2016, and they attribute that to Facebook. And that's really about finding the people that are interested. And if you look at the percentage of our ads business where people are using our most sophisticated approaches to finding the right audience, I think we still have a lot of opportunity for growth there. And that will improve both the quality of the ads people see but also the returns to marketers. And I think that will hit all of the verticals and all of the segments. + +-------------------------------------------------------------------------------- +Operator [8] +-------------------------------------------------------------------------------- +Your next question comes from Mark May, Citi. + +-------------------------------------------------------------------------------- +Mark Alan May, Citigroup Inc, Research Division - Director and Senior Analyst [9] +-------------------------------------------------------------------------------- +I had 2 related questions on video. First, on the OpEx guidance. One of the real consistencies of the business is OpEx growth. You've been growing that at $4 billion to $5 billion incremental spend per year. But the midpoint of your guidance is looking like a $14 billion increase next year. Is the differential there the additional $6 billion, $7 billion, is that -- should we be thinking of that as the video content spend that you're kind of setting aside possibly to spend next year? Just trying to understand where the significant increase would be coming from. And then related, the 35% increase in ad prices. Would you say that, that's predominantly being driven, the acceleration there, by the mix towards video ad breaks and other longer-form video ads? + +-------------------------------------------------------------------------------- +David M. Wehner, Facebook, Inc. - CFO [10] +-------------------------------------------------------------------------------- +Sure, Mark. So on the acceleration of the growth rate in expenses from 2017 to 2018, I would really look at this sort of the growth rate that we grew at in 2017, apply that to the total expense base and look at that growth in 2018. And then I would say the additional expense that leads to the acceleration is driven by 3 factors, not just one factor. And those 3 factors are the ones that I outlined in my commentary: number one, the substantial investments that Mark highlighted that we're making to just improve the security on our platform; two, the video content investments we're making for Watch Tab; and then, three, additional investments we're making in the long-term initiatives like AR/VR, AI and connectivity. And each of those are significant. So it's really the combination of those 3 factors that's driving the expense growth acceleration. And then on the 35% increases in ad prices, this is really being driven off of a couple of things. One is just the auction dynamic, which as supply growth has slowed, then there's more competition, and you're seeing prices increase as demand continues to grow. But I think what is important here is we've been getting better and better at targeting as we optimize for real business results for advertisers, and we're better at converting the signals that we get from those advertisers and to finding the right ad spots for them. And I think that's really what's allowing us to improve yield and effectively driving higher effective CPMs for us while still delivering business outcomes to them at attractive ROIs. So that's really what's driving it, not a shift to a different format like video. It's really about us getting better at targeting and working with especially people where we get those downstream signals like direct-response advertisers. + +-------------------------------------------------------------------------------- +Operator [11] +-------------------------------------------------------------------------------- +Your next question comes from the line of Douglas Anmuth, JPMorgan. + +-------------------------------------------------------------------------------- +Douglas Till Anmuth, JP Morgan Chase & Co, Research Division - MD [12] +-------------------------------------------------------------------------------- +I wanted to hit on 2 topics. First, just on the security comments. You talked about headcount increasing from 10,000 to 20,000. I was hoping you could just help us understand. Is that 10,000 fully in the 23,000 headcount that you have today? Or is there a part of it that's not included in there perhaps because it's not full-time? And then just secondly, just going back to the ad pricing changes. Dave, just to clarify on that. I mean, it sounds like what you're saying, it's not that advertisers across the board are seeing that substantial of an increase in pricing, but that's just more an output in your eCPM. Is that the right way to think about it? + +-------------------------------------------------------------------------------- +David M. Wehner, Facebook, Inc. - CFO [13] +-------------------------------------------------------------------------------- +Right, Doug. So on the first one, yes, the 10,000 number, that encompasses both employees at Facebook and also employees at partners. So it's not all Facebook employees. So that's a fully loaded number. So that's also in the OpEx guidance as well. So it's -- but yes, you can't compare the 10,000 with the 23,000 directly. On the ad pricing, what you're seeing is that most of the advertising we get isn't necessarily bid on an impression basis. You're getting people bidding for other actions and optimizing against other actions like a click to a website or a downstream e-commerce transaction and app install. And our ability to optimize the inventory that we have against those downstream activities allows us to deliver those at still good prices while seeing effective CPMs go up. You do have, obviously, people who are bidding on impressions if they're looking for, like, a brand campaign or a reach campaign. But those aren't necessarily a part of the business that's driving up prices. It's more around just us doing a better job at being able to optimize campaigns for people who have downstream activities that we can do that for. + +-------------------------------------------------------------------------------- +Operator [14] +-------------------------------------------------------------------------------- +Your next question comes from the line of Heather Bellini, Goldman Sachs. + +-------------------------------------------------------------------------------- +Heather Anne Bellini, Goldman Sachs Group Inc., Research Division - Research Analyst [15] +-------------------------------------------------------------------------------- +I wanted to just ask a question about your content strategy. And I was wondering, how do you think about Facebook Watch in terms of Facebook-produced content versus the licensing of content that you might engage in? And I was wondering if there's a certain type of content that you think will be best suited to optimize the watch experience. + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook, Inc. - Founder, Chairman of the Board and CEO [16] +-------------------------------------------------------------------------------- +I think it might be useful to take a step back and first talk about why we're funding lighthouse content and Watch overall. So video is growing incredibly quickly on Facebook. And today, most of that is in News Feed. But most people who come to News Feed and who come to Facebook today in general are trying to figure out -- they are trying to see what's going on with their friends, see what's happening in the world. They're not coming necessarily to engage in a specific type of video or a specific community around video. So the Watch Tab is mainly -- it's a way to give people a tool to do that. When they want to specifically come and engage around video or communities around that, they can go to the Watch Tab. So the intent there is different. Now in order to build that up, we think it makes sense to first invest in a bunch of lighthouse content, some that we may produce or some that we may license. To get to your question, we're pretty agnostic on how that goes. We just want to start the flywheel going. So there's content and communities that are there that support this use cases of people coming to Facebook specifically to engage in that. Long term, our hope is that the business here will primarily be through revenue shares of videos that normal creators and businesses put into the system rather than ones that we proactively go out and license ourselves. So that's a look at where we're trying to get on this. But first, we need to build this behavior where people want to come intentionally to engage with this content. + +-------------------------------------------------------------------------------- +Operator [17] +-------------------------------------------------------------------------------- +Your next question comes from the line of Ken Senna, Wells Fargo Securities. + +-------------------------------------------------------------------------------- +Kenneth Michael Sena, Wells Fargo Securities, LLC, Research Division - MD, Head of Internet Equity Research & Senior Analyst [18] +-------------------------------------------------------------------------------- +Just going back maybe to the investment in security comments. Maybe could you provide a little more detail just on what that investment could look like and how we could think about that showing up in R&D, cost of revs, G&A or maybe a combination? And then maybe any early thoughts on GDPR and potential impact there and maybe some of this transparency efforts if they could have possible benefit? + +-------------------------------------------------------------------------------- +David M. Wehner, Facebook, Inc. - CFO [19] +-------------------------------------------------------------------------------- +Yes. So on the first part, Ken, you're going to see that show up in a variety of different line items, but we don't have it specifically broken out. We're making substantial product and engineering investments. So as part of the overall hiring on R&D headcount, that -- there's going to be a pretty significant allocation of that to some of the product-related security initiatives that we're doing. So that's going to show up in R&D. You're going to have some of the ads work that we're doing, the ads quality work showing up in the sales and marketing line. So you're going to see some there. And then you're going to also just have overall impact on G&A as well for things like policy-related expenses and the like. So I think you're going to see it kind of impacting across the spectrum of our lines. But overall, one of the significant factors driving the acceleration in growth rate. + +-------------------------------------------------------------------------------- +Sheryl K. Sandberg, Facebook, Inc. - COO and Director [20] +-------------------------------------------------------------------------------- +On GDPR, the Facebook family of apps already applies the core principles in the framework because we built our services around transparency and control, and we're building on this to ensure that we comply in May of next year. It's too soon to tell whether this will impact the extent to which EU users opt out of certain services, but we're going to continue to give people personalized experience and be clear about how we're using the data. We believe that we'll be able to obtain consent for uses of the data across Europe and that people still expect the content and their ads to be relevant. And so we expect a good result here, and we're going to do it very carefully and very seriously as we always do. + +-------------------------------------------------------------------------------- +Operator [21] +-------------------------------------------------------------------------------- +Your next question comes from the line of Justin Post, Bank of America, Merrill Lynch. + +-------------------------------------------------------------------------------- +Justin Post, BofA Merrill Lynch, Research Division - MD [22] +-------------------------------------------------------------------------------- +I had 2 things. First, as you've integrated more video content into Facebook, are you seeing better time spent per user? Is that really showing up in more engagement on the site? And then secondly, it looks like you're running around $80 a year per user now in the U.S. Quite good improvement over the last couple of years. Just think about benchmarking that versus other media categories or other things in traditional media. Do you still think you have a lot of room ahead to grow that $80 over time? + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook, Inc. - Founder, Chairman of the Board and CEO [23] +-------------------------------------------------------------------------------- +I'll talk about video engagement, and then Dave can jump in on some of the stats. So one of the important points here that I tried to communicate in my comments up-front is that connecting with friends and family and having those meaningful interactions is more important than just consuming content, right? So video is growing incredibly quickly, and that goes across both social content and kind of more passive public consumption of content. Then they create different dynamics in the system, and I think that's an important thing to understand. When your friend posts something and you get to engage with it, it might inform you and entertain you but you also -- if you interact with -- you're building a relationship with that person, right? You feel closer to that person. And that is a really important part of what social networking is supposed to do. Whereas when you engage with public content, you might get informed or be entertained, but it's not necessarily increasing social capital in the same way or relationships between people. So we really differentiate what the core thing is that we're trying to do, which is help people connect with each other and build meaningful relationships. And that's why on a lot of these calls, I emphasize products like Instagram Stories or WhatsApp status, which are very video-based products, but they're improving social interactions. And we're going to focus a lot more on helping people share videos of their moments in their lives because in a lot of ways, I think if -- when you take a video of yourself and your family out trick-or-treating, that's more engaging than a photo and a better representation of that than writing it out in text. But overall, I would say not all time spent is created equal. That's why I tried to stress up-front that time spent is not a goal by itself here. What we really want to go for is time well spent. And what the research of that we found shows is that when you're actually engaging with people and having meaningful connection, that's time well spent, and that's the thing that we want to focus on. So out of this big video thing that's growing very quickly, I think that is the real opportunity and product area that we should be focused on more. And to the extent that there is going to be a lot of public content, which there will be, a big part of the focus is going to be around building community and interactions around that content. + +-------------------------------------------------------------------------------- +David M. Wehner, Facebook, Inc. - CFO [24] +-------------------------------------------------------------------------------- +Justin, on your question on ARPU in the U.S. We do think that there are opportunities to continue to grow the business in the U.S. on a lot of different fronts. So we can continue to grow engagement on core Facebook as well as there's opportunities with Instagram and the other services that we have that are not monetizing significantly today. So there's opportunities there. But most importantly, kind of I would go back to the fact that we're getting better at -- on the ad product side of being able to optimize our inventory for the advertisers in a way that will, we think, drive good pricing in the system for us and good outcomes for the advertisers. So we do think that, that will lead to the potential for additional revenue growth in the U.S. + +-------------------------------------------------------------------------------- +Operator [25] +-------------------------------------------------------------------------------- +Your next question comes from the line of Ross Sandler, Barclays. + +-------------------------------------------------------------------------------- +Ross Adam Sandler, Barclays PLC, Research Division - MD of the Americas Equity Research and Senior Internet Analyst [26] +-------------------------------------------------------------------------------- +I had 2 questions for Mark. One, Mark, as you move to make changes around safety and security and kind of (inaudible), do you think that this will have any adverse impact on engagement? Or is it just too small to even be material? And then a follow-up on the video consumption comment happening mostly in the feed. Is the deceleration you guys are seeing around impression growth right now a function of promoting video in the feed versus, what else, other things that might be in there? And I guess, asked a different way, should we see impression growth kind of revert back to be at your growth at some point? And then is that likely the next year? Or is that further off in the future? + +-------------------------------------------------------------------------------- +David M. Wehner, Facebook, Inc. - CFO [27] +-------------------------------------------------------------------------------- +So I can take the second one, which is the question about impression growth. So there's a couple of factors there. Certainly this quarter, we saw that ad load is predicted -- had a much less significant impact on impression growth. So overall, that story has played out sort of as we thought, and that's one of the reasons you're seeing the impression growth come down. And then yes, I do think that there are less impressions when people are consuming video. So that also is a factor as more time is spent on video. So I think you have both of those factors coming into play. In terms of how those play out going forward, hard to say. We just kind of point to our overall comments on just continued revenue growth deceleration. And I believe the first question was whether the security investments would have an adverse impact on engagement. + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook, Inc. - Founder, Chairman of the Board and CEO [28] +-------------------------------------------------------------------------------- +Yes, and I can speak to that. Let me be clear on this that people do not want false news or hate speech or bullying or any of the bad content that we're talking about. So to the extent that we can eradicate that from the platform, that will create a better product, which will also create a stronger long-term community and better business as well. So the reason why we haven't been able to get these things to the level that we want today is not because we somehow want them on the platform; it's that it's a really hard problem. And we're going to invest both in people and technology because we think that both are really important parts of the solution here to go after all different parts of these problems. And that was what I tried to stress earlier on. We're going from 10,000 people working on safety and security to more than doubling that to 20,000. We're building -- we're doubling, in some cases, more our engineering teams focused on security. We're building AI to go after more different areas of harmful content and finding fake accounts and other bad actors in the system. And I expect that all of these things will make our product better over the long term, but we will incur the expenses a lot sooner as we ramp up these efforts. And I also just think that going forward, we're going to be investing at these things at a much higher level because we realized that this is important not only for our community and this company, but it's a part of our responsibility to the society overall. + +-------------------------------------------------------------------------------- +Operator [29] +-------------------------------------------------------------------------------- +Your next question comes from the line of Rich Greenfield, BTIG. + +-------------------------------------------------------------------------------- +Richard Scott Greenfield, BTIG, LLC, Research Division - Co-Head of Research, MD and Media and Technology Analyst [30] +-------------------------------------------------------------------------------- +A couple of things. You talked about creators, I think, Mark, creating for the platform on their own without you having to invest. But just trying to frame it in the sense of Hollywood, like I look at what Apple is doing now and going -- hiring a couple of Sony executives and doing a $5 million an episode buy of a Steven Spielberg show. And I guess, what I'm trying to understand or I think a lot of investors are trying to understand is, what type of content do you ultimately want? Because I don't think, like, someone like Spielberg is going to work for an ad revenue share no matter how good that advertising is like. So how do you balance what type of content business you ultimately want to build? And then when you look at sports, which I also think about as being kind of really relevant content that has a huge community around it, something like the NFL Mobile rights, I think, come up next year. Wondering how important are those types of -- how important is that type of content? I know you were bidding on cricket rights overseas. But how important is sports in this mix? + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook, Inc. - Founder, Chairman of the Board and CEO [31] +-------------------------------------------------------------------------------- +Well, I think that the answer to that is we don't know all the answers around what kinds of content are going to work and are not. So we will probably experiment with a number of different things. I do think your point is right, that not all kinds of content can be supported by ads no matter how effective we make that. That said, the current model that we have for at least getting some of the lighthouse content onto the platform is to pay up-front. And what we would like to transition that more to over time and what an increasing amount of the content is revenue shares for ads shown in the video. And as we do better and better on the monetization there, that will support people with higher production costs than doing more premium production and bringing their content to the platform. And we've certainly found on the Internet and YouTube and in other places that there are whole industries around creators with different cost structures than traditional Hollywood folks who can produce very informative and engaging content that a lot of people like and enjoy and that builds communities. And that helps people connect together in a way that definitely can be supported by this ad model. So I think the answer is we're going to try a bunch of things. That's a bunch of what the budget is. I'm very optimistic that a lot of the stuff will be able to be supported long term. But you're certainly right that not all that will be able to be supported by ad models alone. + +-------------------------------------------------------------------------------- +Operator [32] +-------------------------------------------------------------------------------- +Your next question comes from the line of Brent Thill, Jefferies. + +-------------------------------------------------------------------------------- +Brent John Thill, Jefferies LLC, Research Division - Equity Analyst [33] +-------------------------------------------------------------------------------- +On video, there's been a lot of questions about the ultimate profitability of this going forward. I was just curious if you could share your view. I know it's early, but what your thoughts are there. + +-------------------------------------------------------------------------------- +David M. Wehner, Facebook, Inc. - CFO [34] +-------------------------------------------------------------------------------- +Yes. I mean, I think -- look, today, we're talking about the additional investments we're making in terms of the lighthouse content on the Watch Tab. So we are putting a substantial investment behind that. That clearly is going to have implications for margins along with the other big investments that we're making next year. And then even after the -- after we establish a flywheel here and get content being produced for ad revenue share, that's going to have a different margin structure than core News Feed. So even going forward, there's going to be revenue share back to the content creators, so it's going to have a different margin structure than the core business. + +-------------------------------------------------------------------------------- +Sheryl K. Sandberg, Facebook, Inc. - COO and Director [35] +-------------------------------------------------------------------------------- +I think it's worth adding that the ad inventory itself is really valuable for marketers and our clients and also works very well with our other ad products. So I'll share a recent one. Visa, with [SocioCode] and BBDO, created 10-second videos with text overlays, showing people making digital payments, and they targeted millennials and early tech adopters. And they ran ads one group for Facebook News Feed only, one group for ad breaks only and one group for News Feed and ad breaks combined. And the best results combined the ad breaks and the News Feed, they had a 7x lower cost per video view compared to News Feed alone. And so one of the opportunities we have here is increasing inventory. And it's particularly good inventory for marketers because we're seeing nice adoption of video views and really nice impact from those sales. And it's also the case that our ad products work together. The ability to show something in News Feed and then show a video in Watch and then show something on Instagram and measure results across the full funnel, we think, are very worthy investments for the long-term health of the business. + +-------------------------------------------------------------------------------- +Operator [36] +-------------------------------------------------------------------------------- +Your next question comes from the line of Mark Mahaney, RBC Capital Markets. + +-------------------------------------------------------------------------------- +Mark Stephen F. Mahaney, RBC Capital Markets, LLC, Research Division - MD and Analyst [37] +-------------------------------------------------------------------------------- +A comment and 2 questions. I think this incremental spend or this materially increased spend on security is highly unfortunate, but I think it makes eminent sense. I think most long-term investors realize the community maximization, including security, would lead to long-term profit maximization. So I think makes eminent sense. 2 quick questions. The Watch tab, is there any evidence or any data points you can give us to -- what kind of traction you're seeing with that so far? I was surprised by how many people are on Marketplace. Any relevant data like that for Watch Tab? And then secondly, of all the regions, Europe really stuck out to us as one that showed surprising acceleration. And I know you talked a little bit about that, Sheryl did, about the SMB pickup and traction there. Any other color for why Europe would have accelerated so much in terms of its revenue growth? + +-------------------------------------------------------------------------------- +David M. Wehner, Facebook, Inc. - CFO [38] +-------------------------------------------------------------------------------- +Sure. Let me, I guess, hit both of those, and then Sheryl can add any color if she'd like. On the Watch Tab, I think it's just early. So I think it's too early to be talking about any stats there. In terms of Europe, one thing to note is that we did pick up currency advantages there. So it was 56% on a reported basis but 51% on a constant currency basis. Still a healthy growth rate. I think it's a strong economy there. I think the team is executing well there, so I think you've got a variety of factors. And then as Sheryl commented in her prepared remarks, SMB has been particularly strong in Europe. And so I think that's the -- that's one of the key drivers and one of the things we're really happy with. + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook, Inc. - Founder, Chairman of the Board and CEO [39] +-------------------------------------------------------------------------------- +One clarification on your question, too, is that the 550 million people is across both Marketplace and buy and sell groups, not just the Marketplace tab. So that's the total amount of activity that we're seeing there across both of those things. + +-------------------------------------------------------------------------------- +Operator [40] +-------------------------------------------------------------------------------- +Your next question comes from the line of Colin Sebastian, Baird. + +-------------------------------------------------------------------------------- +Colin Alan Sebastian, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [41] +-------------------------------------------------------------------------------- +First, a quick follow-up on safety and security. I guess, I'm wondering why more of the AI machine learning that you've built for product and the ad platform can't be utilized or cross-utilized to help mitigate some of the costs of adding people in technology to handle those issues. And then secondly, related to how much time younger people are spending or not spending on the Facebook app. I wonder if you've looked at over the course of time the trend in usages younger people hit different milestones in life such as graduating from college or getting a job and how their usage of the app changes over that time frame? For example, if you're seeing a steady stream of the users coming to Facebook once they hit those milestones. Any color around that would be interesting. + +-------------------------------------------------------------------------------- +Mark Zuckerberg, Facebook, Inc. - Founder, Chairman of the Board and CEO [42] +-------------------------------------------------------------------------------- +Sure. I'll speak to the safety and security investments, and then Dave can speak to the other questions. So we need both technology and people for this. And the best articulation of this that I can make is that today, AI has different strengths than people do, right? So the AI tools that we've built can enable a system to look at millions of pieces of content and make rough assessments on them and figure out what to flag for people. But ultimately, if you want to get those high-quality judgments today on sensitive content and you want to do it quickly when the stakes are pretty high in terms of taking down content or leaving things up, I mean, we take that extremely seriously. You want people to be looking at that. So earlier in the year, when we were working on problems like seeing issues when people were going live, right? There was this really serious issue around people with self-harm and, in some cases, suicide on live. And we made an investment in AI tools and in dramatically increasing the staffing of the team that was working on that and brought the amount of time to review those live videos down through a combination of those things to under 10 minutes now. That might still be a conservative estimate. But -- and we're continuing to work on that. So now what we're trying to do is just increase the SLAs that we have across all of these different types of content and security threats that we might see. So that way, through a combination of the AI tooling that we build and having people to look at these things, we can get it right faster for more of the types of content. And you're definitely right that a lot of the AI research that we do is applicable to multiple areas, but we still need to build those tools. So it takes a lot of engineering investment, and we will be prioritizing that, in some cases, by adding people to teams and, in other cases, by trading off and doing more security work instead of other product work that we might have done. But this is really important and this is our priority. + +-------------------------------------------------------------------------------- +David M. Wehner, Facebook, Inc. - CFO [43] +-------------------------------------------------------------------------------- +Yes. I think on sort of how people use our products in life stages, I would just sort of -- I would say, generally, what we're trying to do is build a variety of different types of social products that can help in a variety of different use cases. So it could be one-on-one messaging with WhatsApp and Messenger. It could be sharing to Groups with the Facebook. It could be the friends that you have on Instagram. So it's -- we're trying to kind of make sure that we flesh out the full range of sharing experiences. And we think that, that has applicability across all the different life stages and depending on the ages people use the products differently, but would not -- we're not showing any specific breakouts on that. + +-------------------------------------------------------------------------------- +Operator [44] +-------------------------------------------------------------------------------- +Your last question comes from the line of Youssef Squali, SunTrust. + +-------------------------------------------------------------------------------- +Youssef Houssaini Squali, SunTrust Robinson Humphrey, Inc., Research Division - MD & Senior Analyst [45] +-------------------------------------------------------------------------------- +Just one question. You guys unbundled the video buy. Can you speak to pricing relative to that 35% average increase in ad pricing? Can you maybe just help us understand the disparity that exists today between pricing on the new video platform and the legacy platform? + +-------------------------------------------------------------------------------- +David M. Wehner, Facebook, Inc. - CFO [46] +-------------------------------------------------------------------------------- +So I'm not totally clear on what you mean by the new video platform and the legacy video platform. But I would just say that this is primarily driven by News Feed pricing, and then you have right-hand column pricing as well. So you have impressions on Facebook News Feed, Instagram feed as well as Facebook right-hand column. Ad breaks are really a relatively small -- a very small factor today. So the pricing is really about what are the -- what is the pricing that you're seeing in the overall system primarily given on the feed-based product. So that's really what the driver is. And again, there I would point to the comments that I made about getting better at targeting and driving towards good outcomes for our advertisers as being kind of the reason that we've been able to support higher prices. + +-------------------------------------------------------------------------------- +Deborah T. Crawford, Facebook, Inc. - VP of IR [47] +-------------------------------------------------------------------------------- +Great. Thank you for joining us today. We appreciate your time, and we look forward to speaking with you again. + +-------------------------------------------------------------------------------- +Operator [48] +-------------------------------------------------------------------------------- +Ladies and gentlemen, this concludes today's conference call. Thank you for joining us. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/exam/original-files/Problem_1_Sample/2017-Oct-13-BAC.N-136999269367-Transcript.txt b/exam/original-files/Problem_1_Sample/2017-Oct-13-BAC.N-136999269367-Transcript.txt new file mode 100644 index 0000000..57090a5 --- /dev/null +++ b/exam/original-files/Problem_1_Sample/2017-Oct-13-BAC.N-136999269367-Transcript.txt @@ -0,0 +1,813 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q3 2017 Bank of America Corp Earnings Call +10/13/2017 08:30 AM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Brian T. Moynihan + Bank of America Corporation - Chairman, CEO & President + * Paul M. Donofrio + Bank of America Corporation - CFO + * Lee McEntire + Bank of America Corporation - SVP of IR + +================================================================================ +Conference Call Participiants +================================================================================ + + * Betsy Lynn Graseck + Morgan Stanley, Research Division - MD + * Glenn Paul Schorr + Evercore ISI, Research Division - Senior MD, Senior Research Analyst and Fundamental Research Analyst + * John Eamon McDonald + Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst + * Nancy Avans Bush + NAB Research, LLC, Research Division - Research Analyst + * Michael Lawrence Mayo + Wells Fargo Securities, LLC, Research Division - MD, Head of U.S. Large-Cap Bank Research & Senior Analyst + * Saul Martinez + UBS Investment Bank, Research Division - MD & Analyst + * Steven Joseph Chubak + Nomura Securities Co. Ltd., Research Division - VP + * Brian Matthew Kleinhanzl + Keefe, Bruyette, & Woods, Inc., Research Division - Director + * Kenneth Michael Usdin + Jefferies LLC, Research Division - MD and Senior Equity Research Analyst + * Gerard S. Cassidy + RBC Capital Markets, LLC, Research Division - Analyst + * Matthew D. O'Connor + Deutsche Bank AG, Research Division - MD + * James Francis Mitchell + The Buckingham Research Group Incorporated - Research Analyst + +================================================================================ +Presentation +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Good day, and welcome to the Bank of America earnings announcement. (Operator Instructions) Please note today's call may be recorded. (Operator Instructions) +It is now my pleasure to turn the conference over to Mr. Lee McEntire. Please go ahead, sir. + +-------------------------------------------------------------------------------- +Lee McEntire, Bank of America Corporation - SVP of IR [2] +-------------------------------------------------------------------------------- + + Good morning. Thanks for joining us this morning for our third quarter 2017 results. Hopefully, everybody's got a chance to review the earnings release documents that are available on the Bank of America website. +Before I turn the call over to Brian and Paul, let me remind you we may make some forward-looking statements. And for further information on those, please refer to either our earnings release documents, our website or our SEC filings. +With that, let me turn the call over to Brian Moynihan, our Chairman and CEO, for some opening comments before Paul Donofrio, our CFO, goes through the details. Over to you, Brian. + +-------------------------------------------------------------------------------- +Brian T. Moynihan, Bank of America Corporation - Chairman, CEO & President [3] +-------------------------------------------------------------------------------- + + Thank you, Lee. And good morning, everyone, and thank you for joining us. This was another strong quarter across the board for Bank of America. Responsible growth is delivering for our customers and for you, our shareholders, with strong operating leverage, strong credit results and strong expense management. We earned $5.6 billion or diluted EPS of $0.48 per share this quarter. That is up 17% from the third quarter of '16. +So thinking back and talking to a lot of you over the last year or so, as we met with you, you asked 3 basic questions: Can Bank of America actually grow while sticking to its responsible growth principles? Can we achieve the $53 billion 2018 expense goal? And can you meaningfully invest in the company at the same time you're reducing the costs? +So what I thought I would do is use the summary on Page 2 to answer a few of those questions. So on the first question, you can see on Page 2, will responsible growth work? I'd point to several of the metrics there. We've been operating on this model for some time. +First, if you look at this quarter compared to a year ago, revenue grew 1% on a reported basis. And looking at the core lines of business without other, we grew revenue 4% despite the tough comparison for Global Markets. If you remove the Global Markets, you can see that the core annuity-oriented businesses of Consumer Banking, wealth management and Global Banking grew revenue at 7%. +If you look at what drives that revenue growth, average loans in business segments grew 6% year-over-year. Average deposits grew 4% year-over-year, led by our consumer business, which grew its deposits 9% year-over-year. The assets under management -- our wealth management business reached $1 trillion this quarter, and flows into the assets under management were $21 billion in the quarter, bringing year-to-date flows to almost -- to $75-plus billion. +Our mobile usage continues to grow. We had 1.2 billion mobile interactions this quarter alone, up nearly 20% from last year and it's doubled in the last 3 years. Our investment banking fees were up 14% through the 9 months this year. And we did this the right way. With net charge-off ratio still bouncing along decade lows, we are growing with our risk framework and driving a strong risk culture. Nonperforming loans, at the lowest level since first quarter of '08, and our market risk remains low. So we are growing responsibly. +The second question we get asked is: Can you get to your expense target? In the second quarter of '16, we committed to achieving a goal of approximately $53 billion in total expenses by 2018, and that's all-in reported expense. At that time, our 12 months leading up to that point was running around $56 billion in expense, so that means we had to take out $3 billion in costs. This reduction meant we also had to overcome a couple of years of normal merit increases, revenue-based incentive compensation increases, health care cost increases and other inflationary costs such as lease renewals, et cetera, and we had to do all this while our volume increased because we're doing more with our customers and have more clients and customers to do business with. +And we remain on track. This quarter, you can see we reported a little more than $13.1 billion in expenses. Our efficiency ratio moved below 60% on an FTE basis. By the way, that is the lowest level of expense since the fourth quarter of '08. That was the last quarter before we bought Merrill Lynch. So we've reduced the costs in our company equivalent to the entire cost structure of Merrill Lynch over those years. Headcount is now down to 210,000 (corrected by company after the call) and is down again this quarter. +So the third question is: Can you continue to invest in the franchise while reducing those costs? So the first thing to think about there is, for the first 9 months of the year, we spent nearly $2.25 billion on technology initiatives. That's on pure initiatives. Look no further than the branch in your pocket for evidence of that. Customers using our mobile have increased 47% in the past 12 months. Mobile deposits account for 21% of all check deposit transactions. Digital sales account for 22% of all consumer sales. +In this quarter, Zelle came forward, the latest offering we have in mobile area. Bank of America's volumes alone, our volumes through Zelle this quarter were $4 billion in the third quarter. We processed nearly 14 million transactions, and the growth continues. We recently processed $0.5 billion in a single week. Our customers are using Zelle, and we look forward to further growth in that area. +We're also continuing to innovate. This -- we're rolling out auto shopping across the country. Home Loans mobile deployment is following that. And as we roll through the next couple of quarters, our AI, our artificial intelligence offering, Erica, will come out. +We continue also to invest in our physical network by refurbishing nearly all our existing financial centers, which is well underway and will complete over the next couple of years. We have been and we'll continue to open centers in markets where we a have strong commercial banking, wealth management client base but lack financial centers due to historical issues. We continue to enhance our online brokerage offering, benefiting consumer and wealth management clients. +For our Global Banking customers, we have added the availability of CashPro on our mobile devices. We're using artificial intelligence to efficiently prospect business clients and offer clients receivables -- client receivables management alternatives to our clients. We're investing also in enhanced wholesale credit underwriting operating model. And in our markets business, we are redoing the trading platforms in total. +In addition to the technology investments, we have added 2,000 primary sales professionals over the past 12 months, whether relationship bankers, financial advisers, commercial and business leaders. So yes, we're doing both, investing and finding ways to be more efficient to pay for it and, therefore, lowering our overall expense. +Now we did all this in an economic environment that still feels very constructive -- consistent, with growth at 2% plus. We expect moderate economic growth to continue this year, expect to grow -- the U.S. to grow a little faster next year, above 2%; and outside the U.S. as growing a little -- in the mid-3s. +For the year-to-date, interesting, in our consumer payments, we're seeing consumer activity pickup. Consumers are spending, whether it's checks written, cash taken out of the ATMs, P2P payments and all the different debit and credit cards, 5% more through the first 9 months of 2017 than they did in the first 9 months of 2016. That's a faster growth rate than it has been in prior years. Debit and credit card spending were up 7% for the first 9 months of the year, showing the strong consumer activity. +Our commercial clients continue to perform well. They continue to remain optimistic. They continue to look forward to continued implementation of a pro-growth agenda, particularly focused on meaningful tax reform. Housing starts, home prices continue to remain on positive trends. Employment is strong, and employers continue to search for skilled workers. So that leaves a solid atmosphere, and we see no near-term indications of any change to it. +As we move to Slide 3, we show that growing responsibly is not new, and it's showing sustained progress. As you can see on Slide 3, we have delivered positive operating leverage on a year-over-year basis every quarter for the past 3 years. And by the way, not every quarter had revenue growth. In those quarters, we reduced expenses more than revenue decline. +So that remains our focus, continue to drive growth. But on occasions where capital markets might be slower and there might be less growth in revenue, we have to manage our expenses well, and we have to do all that while we continue to make the investments. That consistent operating leverage shows up in our businesses. All totaled, we earned $15.7 billion for the first 9 months of 2017, up 19% from the first 9 months of 2016. +On Slide 4, you can see how the businesses contribute to those results. The businesses are driving earnings improvement and returns above the firm's cost of capital, and they continue to drive their efficiency ratios lower. As you can see, Global Market results are actually down year-over-year for the 9 months on a reported basis, but excluding some DVA and a prior-year recovery, earnings would be up modestly on consistent revenue growth despite low volatility and low activity. +But as you look at the other businesses, beginning with the consumer bank, the years of hard work the team has put in is now clearly showing. The business is driving operating leverage as we optimize our delivery network, continue to digitize the business and follow the customers' behavior as it changes over time. +In our wealth management business, they -- the teams continue to do a good job, and you see earnings were up 10% on a year-to-date basis. We have industry-leading margins in the business at 27% and the leading brands of Merrill Lynch and U.S. Trust. And ahead of us, we have a lot of work to continue to deal with the industry-wide dynamics and margin pressures. Global Banking has had a record-setting $15 billion in revenue year-to-date and has the company's best efficiency ratio, as you can see. +So as you think about that, all that sums up in allowing us to return more capital to you, the shareholders. For the first 9 months of 2017, we have repurchased $7.9 billion in common shares and paid $2.8 billion in common dividends. This totals $10.7 billion, comparing to $5.6 billion for the same period in 2016. +So with that, let me turn it over to Paul to give you some other details on the quarter. + +-------------------------------------------------------------------------------- +Paul M. Donofrio, Bank of America Corporation - CFO [4] +-------------------------------------------------------------------------------- + + Okay. Thank you, Brian. I'm starting on Slide 5. +As Brian said, we earned $5.6 billion in Q3, up 13% from Q3 '16; EPS of $0.48 per share, up 17% year-over-year as we reduced diluted shares by 3% over the past 12 months. Revenue of $21.8 billion was 1% higher than Q3 '16 as NII improvement and higher asset management fees outpaced decline in sales and trading and mortgage banking income. +Expenses of $13.1 billion were 3% lower than Q3 '16. We generated more than 3% of operating leverage; the efficiency ratio of 60% for the second consecutive quarter now, 59% on an FTE basis. Provision expense was $834 million, down modestly compared to Q3 '16, and continued improvement -- we see continued improvement in Consumer Real Estate and energy. Return on assets this quarter was 98 basis points and return on tangible common equity was 11.3%, improving both on a year-over-year and a linked-quarter basis. +Turning to the balance sheet on Slide 6. Overall, compared to June 30, end-of-period assets increased $29 billion, driven by strong deposit growth that funded an increase in loans to customers, with the remainder invested in securities and cash. Loans on an end-of-period basis were up $10.5 billion from Q2, led by commercial activity, while consumer loan growth was mitigated by the continued runoff of legacy noncore loans. +On the liability side, long-term debt increased $4.7 billion during the quarter as we took advantage of favorable credit spreads to prefund upcoming maturities. Given that we are now compliant with TLAC requirements, our debt issuance over the next few quarters will likely be more opportunistic. Liquidity remains strong, with $517 billion in global liquidity sources, and our liquidity coverage ratio was 126%. +Common equity increased more than $4 billion compared to Q2. During the quarter, Berkshire Hathaway converted its Series T preferred stock into 700 million shares of common stock per the terms of their 2011 investment. As a result of this conversion, common equity increased and preferred stock decreased by the $2.9 billion book value of their Series T preferred stock. This issuance does not impact diluted EPS in this or subsequent quarters as the effect of this conversion was already accounted for in diluted EPS. +The remaining increase in common equity reflects $5.1 billion in net income available to common, partially offset by the return of capital totaling $4.2 billion for both common dividends and share repurchases. Tangible book value per share of $17.23 was modestly higher than Q3 '16 but decreased 3% versus Q2 '17 as a result of the Series T conversion. +Turning to regulatory metrics and focusing on the advanced approach. Our CET1 transition ratio under Basel III ended the quarter at 11.9%. On a fully phased-in basis, compared to Q2, the CET1 ratio improved 40 basis points to 11.9% and remains well above our 2019 requirement of 9.5%. CET1 increased $4.9 billion to $173.6 billion, driven by earnings and the Berkshire Hathaway conversion. The CET1 ratio also benefited from a modest $3 billion decline in RWA as growth in loans and low RWA density assets was offset by continuing optimization of the balance sheet. +We also provide our capital metrics under the standardized approach. RWA increased $15 billion from Q2, driven by loan growth, but increases in capital more than offset asset growth, resulting in a CET1 ratio improvement of 20 basis points to 12.2%. Supplementary leverage ratios for both the parent and bank continue to exceed U.S. regulatory minimums that don't take effect until 2018. +Turning to Slide 7. On an average basis, total loans increased to $918 billion. Note that the sale of U.K. card, which was recorded in All Other, impacted year-over-year comparison of average loans by $9.3 billion. Adjusting for the sale, average loans were up $26.8 billion or 3% year-over-year. Loan growth continue to be dampened by the runoff of noncore Consumer Real Estate loans in All Other. Year-over-year, loans in All Other, including the sale of U.K. card, were down $28 billion. +On the other hand, loans in our business segments were up $47 billion or 6%. Consumer Banking and wealth management both experienced solid loan growth of 8%. Both businesses continue to see good growth in residential mortgages. Consumer Banking also saw growth in credit card and vehicle loans. Originations of new home equity loans was solid, but overall loan growth continues to be outpaced by pay-downs. In wealth management, growth was also aided by structured lending. Global Banking loans were up 4% year-over-year, led by C&I growth in the U.S. and abroad. +On the bottom right, note that we grew average deposits by $45 billion or nearly 4% year-over-year. This growth was driven by consumer segments' deposits increasing by $53 billion or nearly 9% year-over-year. Average deposits declined year-over-year in our wealth management segment as clients sought alternatives for their cash within brokerage or AUM. Deposit outflows here largely abated in Q3, and ending deposits were slightly up from the end of Q2. Deposits in Global Banking experienced strong growth in Q3, driven by rate actions taken in the quarter to win and defend relationship deposits. +Turning to asset quality on Slide 8. Credit quality continues to be solid, with net charge-offs, NPLs and reservable criticized exposure all showing improvement from Q2. Total net charge-offs were $900 million or 39 basis points of average loans, decreasing modestly from Q2. Provision expense of $834 million included a $66 million net reserve release. Provision expense was in line with the prior year but increased $108 million from Q2 as a result of less net reserve releases. Our reserve coverage remains strong, with an allowance-to-loan ratio of 116 basis points and a coverage level 3x our annual charge-offs. +On Slide 9, we break out credit quality metrics for both our consumer and commercial portfolios. With respect to consumer, net charge-offs were down from Q2. Included in the quarter were recoveries on the sale of some Consumer Real Estate loans. Partially offsetting this recovery benefit was the negative impact of clarifying guidance from the regulators on bankruptcies, which increased our consumer losses this quarter. The net effect of all these pluses and minuses was minimal. +Consumer NPLs of $5.3 billion were the lowest they have been since Q2 '08. NPLs came down from Q2 levels, and keep in mind, 45% of our consumer NPLs are current on their payments. Commercial losses were up modestly from Q2, driven by a couple of names while reservable criticized exposures and NPLs declined. +With respect to the impact of hurricanes, first, let me say that our focus has been on those impacted by the storms, including our employees and customers. One decision we made early was to provide a payment deferral to many of our customers in the impacted areas, delaying some potential net charge-offs in Q3. Since then, we have and we will continue to engage with consumers and businesses in the impacted areas to better understand how we can assist them. +As it relates to credit, we have not seen any material impact. Our overall net reserve release for the quarter did include a modest build related to the storms for losses that are probable, and it goes without saying that we believe we are adequately reserved today. +Turning to Slide 10. Net interest income on a GAAP non-FTE basis was $11.2 billion, $11.4 billion on an FTE basis. Compared to Q3 '16, which has the same day count and seasonal factors, NII is up $960 million or more than 9%, driven by an improving spread between our asset yields and deposit pricing. The year-over-year comparison also benefited from loan growth and excess deposits deployed in security balances. An additional benefit was higher long-end rates from Q3 '16, which drove lower prepayments and, therefore, lower bond premium write-offs. The full quarter effect of the sale of U.K. card negatively impacted the comparison. +Focusing on net interest yield. It improved 18 basis points from Q3 '16 to 2.36% after adjusting for the impact of U.K. card. Compared to Q2 '17, NII increased $175 million as the benefits from an increase in short-end rates and an extra day of interest as well as loan deposit growth was mitigated by a number of factors. +First, we lost the 2 months of interest income associated with the U.K. card book. Second, we raised rates broadly across our wealth management business to offer clients a competitive deposit alternative to cash alternatives within brokerage and AUM. Third, we experienced a decline in long-end rates in Q2 and early in Q3, which impacted reinvestment rates as well as increased the write-off of bond premium as mortgage prepayment speeds accelerated. +I would note that we also increased deposit pricing for some commercial clients, which had a modest impact on NII in the quarter. Looking ahead to Q4, assuming no change in interest rates, NII growth will be dependent on loan and deposit growth and pricing. If we get a late 4Q hike, as expected by the market, this should mostly benefit NII in Q1 '18. With respect to asset sensitivity, as of 9/30, an instantaneous 100 basis point parallel increase in rates is estimated to increase NII by $3.2 billion over the subsequent 12 months. This is largely unchanged from June 30 and continues to be predominantly driven by our sensitivity to short-end rates. +Turning to Slide 11. Our teams continued to deliver on cost management. Net interest expense of $13.1 billion is down more than $300 million or 3% from Q3 '16. Productivity improvements were driven by our focus on digitizing processes and lowering our costs to deliver for our customers. Keep in mind that we are seeing these expense declines while investment in technology and new sales professionals remains robust. +Compared to Q3 '16, in addition to overall operating cost improvements, we reduced personnel expense, which included costs associated with our U.K. card business, as well as non-personnel expense, which included lower litigation expense. Compared to Q2 '17, expense declined by $600 million, with half of that decline driven by a Q2 '17 charge in anticipation of the sale of several data centers. Q3 also included modest declines from lower severance as well as revenue-related incentives. The remaining reduction reflects broad-based improvement as we drive operational excellence. The efficiency ratio hit our 60% target again this quarter. +With respect to headcount, we are down from the prior quarter and continue to see a shift from non-client-facing associates to primary sales professionals, which now make up more than 21% of our headcount. We have added more than 2,000 primary sales professionals over the past 12 months -- excuse me, over the past, yes, 12 months. +Okay. Turning to the business segments and starting with Consumer Banking on Slide 12. Earnings were $2.1 billion, growing 15% year-over-year and returning 22% on allocated capital. The business created over 800 basis points of operating leverage on revenue growth of 10%, which outpaced expense growth of 2%. Year-over-year, average loans grew 8%. Average deposits grew 9%, and Merrill Edge brokerage assets grew 21%. +Revenue growth was led by NII, driven by increases in client balances. Revenue was modestly impacted this quarter by the hurricanes as we took steps to help customers in the impacted areas. We expect the dip in fees and interchange weakness to be temporary as impacted communities begin to recover and rebuild. +With respect to expenses, through continued efforts to drive operating leverage, the efficiency ratio improved over 400 basis points to 51%. Cost of deposits and rate paid, which when combined represents cost of goods sold from a deposit perspective, remains steady at a combined rate of 163 basis points in the quarter. Consumer Banking credit quality reflected moderate seasoning and portfolio growth, which drove reserve build of $168 million in addition to the $800 million in net charge-offs. The net charge-off ratio declined modestly from Q2 to 1.18% of loans. +Turning to Slide 13 and looking at key trends. As I said earlier, revenue increased 10% year-over-year. Within revenue, mortgage banking income was the only major category that was lower year-over-year, driven by our strategy of holding more originations on balance sheet instead of selling to the agencies as we like the economics of holding these high-quality originations. In Q3, we retained about 80% of first mortgage production on balance sheet. +Looking at revenue more broadly. We believe our relationship-deepening Preferred Reward program is improving NII and balance growth while mitigating industry pressures on fees as we reward customers for doing more business with us. This is why we continue to emphasize total revenue as opposed to fees and NII separately. Having said that, spending levels on debit and credit cards were up 7% year-over-year, and new issuance of credit cards was solid at 1.3 million. Spending levels on credit card -- on cards drove revenue increases but were, again, largely offset by the rewards to customers. We saw modest year-over-year improvement in card fees as well as service charges. +Focusing on client balances on the bottom left. You can see the success we continue to have growing deposits, loans and brokerage assets. With respect to loans, residential mortgage continue to lead our growth, but we also saw good growth in auto as well as better growth in card than we've experienced in quite some time. We remain focused on prime and super-prime borrowers with average booked FICO scores of at least 760. Client brokerage assets were up 21% year-over-year, driven by strong client flows as well as market performance. Net new accounts grew 6% from Q3 '16. +At the bottom right, you can see deposits broken out. Our 9% year-over-year average deposit growth continue to outpace the industry while the rate paid remained low and stable. Importantly, 50% of these deposits are checking accounts, and we estimate that 90% of these checking accounts are the primary accounts of households. Expenses were up modestly compared to Q3 '16 despite strong revenue growth as optimization and digitalization savings were more than offset by investments in refurbishing branches and technology initiatives. +Turning to Slide 14. Let's look again this quarter at digital banking highlights as they continue to shape the way we do business with our customers. As you can see, the year-over-year growth in these metric is impressive. We remain the leader in digital banking. We now have nearly 24 million mobile users and another 11 million online with us. +Within the $639 billion in total payments shown here, note how digital continues to grow as customers move away from cash and check. This migration is helping us lower expenses and reduce operational risk. Further, digital growth of credit and debit card usage is accelerating as e-commerce grows and more payments are taking place within merchant applications like Uber and Starbucks. +Within total payments, this person-to-person -- and I want to spend a moment on Zelle as Bank of America has been one of the lead banks introducing this P2P capability for customers. Note the steady adoption by Bank of America customers of this online app, which makes it easier to spend, request and even split person-to-person money transfers. Also, note, on the bottom left, the growth in mobile channel usage. This quarter, we saw nearly 1.2 billion log-ins, which is up 19% versus Q3 '16. +And more than 21% of all check deposit transactions are now done on mobile devices. This represents the volume of 1,100 financial centers. And while important in terms of how we transact with customers, mobile has also become important in terms of how we connect with our customers. One example of that is the reduction in our call center volumes, which are down 13% over the past 3 years. +And we continue to innovate. This quarter, we rolled out an app in several states for mobile auto shopping, which will soon be followed by a mortgage shopping and fulfillment app -- excuse me, I meant mobile auto shopping, which will soon be followed by a mortgage shopping and fulfillment app that we call Home Loan Navigator. +Still, even with all this digital activity, it is important to note that we still have 775,000 people a day walking into our financial centers across the U.S. Many of these customers still use our centers to transact, but many use the centers as financial destinations where they can learn more about products and services, work face to face with a specialized professional and generally improve their financial lives. That's why we continue our multiyear branch refurbishment program, and it is also why we continue to add new financial centers in markets where we have never had a Bank of America center but we have a strong presence in other lines of business. This quarter, for example, we opened centers in Denver, Minneapolis and Indianapolis. In addition, we are testing advanced centers which utilize video-assisted ATMs and other videoconferencing capabilities in areas where it makes sense to do that. +Turning to Slide 15. Let's review Global Wealth and Investment Management. We have produced earnings of $769 million, up 10% from Q3 '16; a pretax profit margin of 27%; and return on allocated capital of 22%. The market and client activity once again provided a tailwind for asset management fees while, at the same time, transaction revenue continues to face headwinds in the industry evolves -- as the industry evolves and adapts to new fiduciary requirements and the increasing adoption of passive investing. +In all, revenue grew 6% year-over-year, led by NII and a 13% increase in asset management fees, partially offset by lower transactional revenue. We saw nearly $21 billion of AUM flows this quarter, continuing the strength of $57 billion in the first half of the year. Year-over-year, expenses were up 4%, driven by revenue-related incentives. Other expenses were managed well, creating modest operating leverage in this segment. +Moving to Slide 16. We continue to see overall solid client engagement. Capital balances rose to nearly $2.7 trillion, driven by higher market values, solid AUM flows and continued loan growth. Average deposits of $240 billion were down $5 billion from Q2. The increase in deposit rates at the end of the second quarter helped mitigate the movement of client balances from deposits to other cash investment alternatives within AUM and brokerage. +The decline in NII from Q2 to Q3 reflects the cost of this rate increase. Average loans of $154 billion grew 8% year-over-year and reflect the continued trend of investment clients deepening their relationship with us. Loan growth remained concentrated in Consumer Real Estate as well as structured lending. +Okay. Turning to Slide 17. Global Banking earned $1.8 billion. This was a 13% increase from Q3 '16. Return on allocated capital was 17% and stable with last year despite a $3 billion increase in allocated capital. Year-over-year, revenue growth of 5% was driven by improved NII, reflecting solid loan and deposit growth, compounded by rising short-term interest rates. We also grew IB fees modestly year-over-year, led by debt and advisory fees. +Revenue improvement coupled with lower expenses created operating leverage of 650 basis points and an efficiency ratio of 43%. This expense comparison versus Q3 '16 reflects savings offset by continued technology investment. We also added new bankers while keeping overall headcount relatively flat over the year. We're also deploying more AI capabilities in this business. The focus so far has been on improving client prospecting and more intelligent receivable processing for clients. +Provision expense of $48 million remains low and is down from Q3 '16 on improvement across most of the portfolio, particularly energy. Global Banking grew loans 4% year-over-year. As Brian mentioned, our loan growth in Global Banking has been pretty consistent over the past 3 or 4 quarters at 4% to 6% on a year-over-year basis. When compared to Q2, I would note an increase in loans near the end of the quarter drove end-of-period balances meaningfully above the average. +Looking at the trends on Slide 18 and comparing to Q3 last year. Average loans of $346 billion were up nearly $12 billion. With the exception of CRE, loan growth was fairly broad-based, with slightly elevated growth in Asia. Loan spreads were stable compared to Q2 '17 but compressed compared to the year-over-year period. +Average deposits rose 3% compared to Q3 '16, with most of it concentrated in Q3 given the rate action this quarter. Total investment banking fees of $1.5 billion were up modestly from a strong Q3 '16. Debt underwriting remained strong while equity underwriting was down from a year ago. Growth in advisory fees also benefited the year-over-year comparison. Year-to-date, we remain rank #3 in investment banking fees, with fees of $4.6 billion, which is up 14% from 2016. +Switching to Global Markets on Slide 19. The business had a solid quarter although it's a tough comparison against a strong Q3 '16 for the reasons you all know. Global Markets generated $3.9 billion in revenue and earned $770 million after adjusting for a modest impact from DVA. Given the tough comparison, we view this quarter as solid despite the fact that sales and trading revenue of $3.2 billion, excluding DVA, declined 15% from Q3 '16. +Excluding net DVA and versus Q3 '16, FICC sales and trading of $2.2 billion decreased 22%. Within FICC, the decrease was driven by less favorable market conditions across credit products, especially mortgages, combined with lower volatility in rates products in the current quarter. Equity sales and trading was up 2% year-over-year to a little less than $1 billion, benefiting from growth in client-financing activity. Lower volatility also drove lower secondary market activity in equities. +With respect to expenses, Q3 '17 was 2% higher than Q3 '16, driven by increased technology investment in our trading platform as well as numerous regulatory requirements such as MiFID II, Volcker and UMR, among others. +Moving to trends on Slide 20 and focusing our attention -- or your attention on the components of our sales and trading performance on a year-to-date basis for just a moment. While the quarter is down from Q3 '16, as you can see in the lower left box, sales and trading revenue has been fairly consistent on a year-to-date basis for the last 3 years at roughly $10.5 billion. And note that we have achieved this stability while reducing VaR and RWA. And just as important, if not more important, this revenue consistency reflects the value to our clients of our diverse product set and sales and trading capabilities in every major market across the globe. Without this strength and diversity, one would have seen a lot more revenue volatility as client activity shifted from a product and market perspective over the last 3 years. +On Slide 21, we show All Other, which reported a net profit of $217 million. This is an improvement of roughly $400 million compared to Q3 '16. This quarter included lower litigation expense while reps and warranty expense increased a little more than $100 million over Q3 '16. Reps and warranty provision is recorded as contra revenue in mortgage banking income and was a result of advanced negotiations with certain counterparties to resolve several outstanding legacy issues. Also note that mortgage banking income in Q3 '16 included a benefit of roughly $300 million in net MSR hedge results. +And also remember that this is the first quarter without the U.K. card business, which was sold in June. So in addition to 2 months of approximately $250 million in normal-quality revenue generated from U.K. card, Q2 also included a $795 million benefit from the sale of U.K. card that was mostly offset by tax expense in that quarter. And when making expense comparisons, remember, in addition to lower litigation, Q2 also included a $295 million impairment charge on 3 data centers that we are in the process of selling. Lastly, note that the effective tax rate for the quarter was 29%. +Okay. Just a few summary points to wrap up. Again, this quarter, we created positive operating leverage by growing revenue while lowering expenses. And as Brian pointed out, this continued the trend of many quarters of positive operating leverage. For years, we have been focused on growing responsibly while improving operating efficiency and making our growth more sustainable. And importantly, we have stuck to and not compromised our clients and risk frameworks while doing so. +NII growth is benefiting from the value of our deposit franchise and continued loan growth in a modestly improving world economy. Asset quality remains strong as net charge-offs, NPLs and commercial reservable criticized exposure all declined. We continue to invest in new technologies and capabilities while adding sales professionals in certain businesses, and we did all this while nearly doubling the amount of capital we returned to shareholders this year versus last year. This tells us that responsible growth is working and that we are well positioned to continue to invest in and grow with our customers and clients as the economy continues to improve. +Thank you. And with that, we will open it up to questions. + + +================================================================================ +Questions and Answers +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) And we'll go first to the line of Nancy Bush with NAB Research. + +-------------------------------------------------------------------------------- +Nancy Avans Bush, NAB Research, LLC, Research Division - Research Analyst [2] +-------------------------------------------------------------------------------- + + Brian, I have a question on digital banking. I guess, right after the crash, when you guys sort of first began to emphasize digital and mobile banking, you were sort of the leader in the industry in that regard. And do you still feel that you have that leadership position? Is it important that you keep it? And what are your thoughts about what you need to do to do that? + +-------------------------------------------------------------------------------- +Brian T. Moynihan, Bank of America Corporation - Chairman, CEO & President [3] +-------------------------------------------------------------------------------- + + I think we have leadership position as told to us by the people and how they rate people in terms of activities and capabilities and things like that. But most importantly, it's how your customers use you and what you see going on. So if you look at the Page 14 that Paul took you through, you can see the growth in transactions and trends in activity. And well, you mentioned the drive after the crisis, but the reality is the drive started before the crisis. And we were one of the first apps available on smartphones, way back to the start of the iPhone, and so that helped us grow quickly. But it is a core platform for us. The question is how do we drive all its feature functionality. The deposits that go through on a daily basis are equivalent to 1,000 branch activity and deposits, to give you an example, so it's moved major amounts of activity. We're excited about the Zelle payment levels because, at the end of the day, we have $5 billion that we spend a year on cash currency, checks moving around our company and the system, that the way we're going to get there is by coming -- digitizing those and eliminating cash and driving that. And so things like Zelle, while they are small numbers compared to all the other payment forms today, the pace that they're growing at with the digital wallets and other things will help drive it there. So we feel we're a leader. We expect to be a leader. The activity grows faster. And I think you put it against any kind of mobile, digital person out there, 1.2 billion customer interactions in the quarter shows you that people believe that this must be pretty good. + +-------------------------------------------------------------------------------- +Nancy Avans Bush, NAB Research, LLC, Research Division - Research Analyst [4] +-------------------------------------------------------------------------------- + + Is there a direct relationship? Or is there any kind of quantification that you've done of X mobile transactions means Y fewer branches? Is there that direct a relationship? + +-------------------------------------------------------------------------------- +Brian T. Moynihan, Bank of America Corporation - Chairman, CEO & President [5] +-------------------------------------------------------------------------------- + + No, yes, and no. Yes, in the sense that we know the cost of the various things and branch transaction for deposits 10x more than a mobile transaction. But remember, at the same time, we're investing heavily in the high touch side of our house, 2,000 more salespeople, a lot of those in consumer refurbishing all the branches, building out branches and things like that because at the end of the day, 20-odd percent of sales are on digital and mobile, but 80% aren't. And because of nature of the intimate customer discussions, because of nature of what customers want to discuss and have face-to-face help on, the branches are critically important to that. So the real question is you have to have both to be successful. The model doesn't work solely one or the other and the model of having both works in that where you can see the activity growth. Think about the deposit growth year-over-year in consumer $50-odd billion and start to think about that in the context of activity. + +-------------------------------------------------------------------------------- +Nancy Avans Bush, NAB Research, LLC, Research Division - Research Analyst [6] +-------------------------------------------------------------------------------- + + Okay. And just one quick follow-up for Paul. Paul, you mentioned in Global Banking that all categories of loans grew except CRE. Is that a [self-selection] or could you just expand on that a bit? + +-------------------------------------------------------------------------------- +Paul M. Donofrio, Bank of America Corporation - CFO [7] +-------------------------------------------------------------------------------- + + Yes, sure. We instituted hopefully a year ago now, if not longer, we pulled back a little bit on CRE. So we're still servicing customers there. We're still making loans, but we're not -- we're just being a little bit more cautious, and so you're not seeing a lot of growth in our CRE balances. And I would point out that, that kind of makes a 4% growth all that more kind of interesting given our stance there. + +-------------------------------------------------------------------------------- +Operator [8] +-------------------------------------------------------------------------------- + + We'll go next to the line of Glenn Schorr from Evercore ISI. + +-------------------------------------------------------------------------------- +Glenn Paul Schorr, Evercore ISI, Research Division - Senior MD, Senior Research Analyst and Fundamental Research Analyst [9] +-------------------------------------------------------------------------------- + + A little drilling down on your comments on deposit cost drive. So we go from, I guess, 8 basis points last year to 24 this or 11 to 24 over the last quarter. How much of that increase is what you mentioned in wealth management? I heard your comment on bringing them a competitive cash alternative. I'm just curious is it CD versus money market? Is it all coming from current clients? + +-------------------------------------------------------------------------------- +Paul M. Donofrio, Bank of America Corporation - CFO [10] +-------------------------------------------------------------------------------- + + Mostly in wealth management, and it's -- I wouldn't say it's in 1 place or another. It's cut across a lot of the different deposit products we offer to that community of investors and depositors. + +-------------------------------------------------------------------------------- +Brian T. Moynihan, Bank of America Corporation - Chairman, CEO & President [11] +-------------------------------------------------------------------------------- + + Glenn, if you go to Page 10 of the supplement package, you can see the comparison of the third quarter last year to this year. And you start to think about some of the numbers you were citing. But if you look at the different categories, you're going to see that most of move is in now money market, which is -- that's where the wealth management business is and the $240 billion-odd number in there, about $140 billion of it is really people's invested cash. And so if we make an allocation like we did in the second quarter to less cash and more equities, that actually brings deposits out, and then people are obviously thinking as investment cash. These are accounts that might have $5 million in securities in it and $500,000 of cash. So, obviously, rate structure moves in that. But if you think about it across a year, there's been a 75 basis point increase in Fed funds, and you start to put these numbers against an even wealth management, it's relatively modest in terms of change in the overall. The other thing that drives our profitability is if you look at that page, go down and you remember that's an noninterest-bearing account. The deposits are still 0, and they grew -- there are $436 billion of noninterest-bearing accounts. If you look in the consumer side of that, you know that drives the profitability and that's where it comes from. + +-------------------------------------------------------------------------------- +Glenn Paul Schorr, Evercore ISI, Research Division - Senior MD, Senior Research Analyst and Fundamental Research Analyst [12] +-------------------------------------------------------------------------------- + + Got you, and so there's a competitor too, who had put out some high priced or high rate CDs in an effort to gather new client money. This is more of just compensating clients for being good clients, giving and sharing a little bit of the love with... + +-------------------------------------------------------------------------------- +Paul M. Donofrio, Bank of America Corporation - CFO [13] +-------------------------------------------------------------------------------- + + I would not say we're... + +-------------------------------------------------------------------------------- +Brian T. Moynihan, Bank of America Corporation - Chairman, CEO & President [14] +-------------------------------------------------------------------------------- + + CDs are down $4 billion at Bank of America year-over-year. + +-------------------------------------------------------------------------------- +Glenn Paul Schorr, Evercore ISI, Research Division - Senior MD, Senior Research Analyst and Fundamental Research Analyst [15] +-------------------------------------------------------------------------------- + + I appreciate that. + +-------------------------------------------------------------------------------- +Paul M. Donofrio, Bank of America Corporation - CFO [16] +-------------------------------------------------------------------------------- + + This is about providing our GWIM clients with an alternative, a deposit alternative if they want to take it since they have options of AUM and brokerage for some of their excess cash. + +-------------------------------------------------------------------------------- +Glenn Paul Schorr, Evercore ISI, Research Division - Senior MD, Senior Research Analyst and Fundamental Research Analyst [17] +-------------------------------------------------------------------------------- + + Okay, cool. And just a curious follow-up on the comment you guys have in the slides on targeted growth and client-financing activities and equities. Is that just growing PB with clients? + +-------------------------------------------------------------------------------- +Paul M. Donofrio, Bank of America Corporation - CFO [18] +-------------------------------------------------------------------------------- + + We talked about that last quarter where we made a decision to add some balance sheet to our equities business. We see an opportunity there. We've made a lot of investments in technology. We've got great relationships, and there's an opportunity to add a little bit more leverage to that business. We provide some balance sheet. So we did that last quarter, and we continued that this quarter and see now it's having an effect. It's, like I said, it's PB, but it's also synthetic PB in Europe. So it's both synthetic and physical. + +-------------------------------------------------------------------------------- +Operator [19] +-------------------------------------------------------------------------------- + + We'll go next to the line of John McDonald with Bernstein. + +-------------------------------------------------------------------------------- +John Eamon McDonald, Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst [20] +-------------------------------------------------------------------------------- + + Wanted to ask about expenses. The magnitude of improvement was nice surprise this quarter. I think you were targeting kind of a $100 million year-over-year improvement. You got something closer to $300 million or more. Just wondering where did you kind of outperform your own expectations on expenses this quarter? And is this run rate ballpark kind of a good jumping off point, Paul? + +-------------------------------------------------------------------------------- +Paul M. Donofrio, Bank of America Corporation - CFO [21] +-------------------------------------------------------------------------------- + + Yes. I would say we feel great about the work we did. We've always talked about expenses not being a straight line, the same line every quarter. This quarter, we did maybe a little bit better than other quarters. You're right. It was down about $300 million year-over-year. And those expense reductions were broad based across personnel and nonpersonnel. + +-------------------------------------------------------------------------------- +John Eamon McDonald, Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst [22] +-------------------------------------------------------------------------------- + + And in terms of next year when you think about the $53 billion target, it doesn't look like you might need it, but do you have any expectations that the roll-off of the FDIC special assessment kind of will help you can get to that target? And just maybe a reminder of how much that expense stepped up for you. + +-------------------------------------------------------------------------------- +Paul M. Donofrio, Bank of America Corporation - CFO [23] +-------------------------------------------------------------------------------- + + Yes. Look, we -- it's a good question. We -- I think the industry was assuming that, that would end at around -- in the second quarter. It looks like it may extend to the third quarter because we're not going to get to the level they need to get to. So that actually hurts us, and that's why we always say we're going to get to approximately $53 billion for full year '18. There's a lot of things that can happen. I don't know the exact amount is. Is it roughly around $100 million quarterly? + +-------------------------------------------------------------------------------- +Brian T. Moynihan, Bank of America Corporation - Chairman, CEO & President [24] +-------------------------------------------------------------------------------- + + Yes. + +-------------------------------------------------------------------------------- +Paul M. Donofrio, Bank of America Corporation - CFO [25] +-------------------------------------------------------------------------------- + + It's around $100 million quarterly. So it's a material number. + +-------------------------------------------------------------------------------- +John Eamon McDonald, Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst [26] +-------------------------------------------------------------------------------- + + Okay. + +-------------------------------------------------------------------------------- +Paul M. Donofrio, Bank of America Corporation - CFO [27] +-------------------------------------------------------------------------------- + + I think a little more than $100 million, frankly, but I can get back to you on that. + +-------------------------------------------------------------------------------- +John Eamon McDonald, Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst [28] +-------------------------------------------------------------------------------- + + Okay. And then, I guess, just on capital return, Brian. With that CET1 growing nicely, anything that you could see now that would stop you from approaching more of a peer capital payout next year? And then can you just remind us what kind of CET1 ratio would be good target for you, knowing what you know now about regulatory minimums? + +-------------------------------------------------------------------------------- +Brian T. Moynihan, Bank of America Corporation - Chairman, CEO & President [29] +-------------------------------------------------------------------------------- + + A couple of things. One, we would expect to keep moving up the ladder in terms of capital management. This year, 88%, I think, is a number and you expect us to keep pushing forward. And, two, on the levels where 9.5, you'd add 50, 75 basis points on top of that. SIFI buffer levels can bounce around on you, but we think about somewhere around 10-10.5%. And if you subtract that from the 12%, that's a pretty good amount of excess capital. + +-------------------------------------------------------------------------------- +John Eamon McDonald, Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst [30] +-------------------------------------------------------------------------------- + + Okay. And just one quick follow-up, Paul, on that FDIC expense roll-off. Is that's in the numbers now? You kind of running close to almost the $13 billion per quarter, it's almost at $53 billion annualized. Are you just saying that if you didn't get that step down, it gets a little tougher to get to the target? + +-------------------------------------------------------------------------------- +Paul M. Donofrio, Bank of America Corporation - CFO [31] +-------------------------------------------------------------------------------- + + Yes. I'm just -- look, the target now goes back to the middle of '16. We said at that time, we would achieve approximately $53 billion for full year '18. So obviously, it's just a little harder if FDIC doesn't roll-off in the second quarter and extends in the third quarter, but we're going to get there either way. + +-------------------------------------------------------------------------------- +Operator [32] +-------------------------------------------------------------------------------- + + We'll go next to the line of Betsy Graseck from Morgan Stanley. + +-------------------------------------------------------------------------------- +Betsy Lynn Graseck, Morgan Stanley, Research Division - MD [33] +-------------------------------------------------------------------------------- + + A couple of questions. One, as we go towards the $53 billion, can you just give us a sense as to the source of the improvement, consumer versus corporate? + +-------------------------------------------------------------------------------- +Brian T. Moynihan, Bank of America Corporation - Chairman, CEO & President [34] +-------------------------------------------------------------------------------- + + Betsy, I think if you look at the quarterly progression across all expense category, it comes from everywhere. And so it comes from the data center configurations that we took a charge and move a lot of stuff last quarter. It comes from continuing to shed real estate occupancy costs. It comes from lower headcount. That was down 1,000 this quarter. It comes from taking out the spans and layers for things we called organizational health. But if you think of it more strategically, it comes from basically applying technology in digitizing processes, and so across the -- our wholesale banking and credit underwriting initiative, I talked about, we've been able to save about 20% of the headcount thereby consolidating our activities and bringing their activities together. We'll have another big chunk as we go to apply the technology that we are developing that's not yet deployed. And so it's 1,000 ideas, it's little -- I mean, thousands of ideas. It's literally across the board and the team does a great job of just going after piece by piece by piece and then we can manage the sort of repositioning cost by getting ahead of it and doing it on a rational basis, so that attrition -- we'll hire 8,000 people this quarter to maintain our headcount sort of neutral or down a bit. So we have lots of chances not to hire people and continue to shrink the company when we apply this technology. + +-------------------------------------------------------------------------------- +Betsy Lynn Graseck, Morgan Stanley, Research Division - MD [35] +-------------------------------------------------------------------------------- + + I'm just thinking about the digital efforts. Obviously, you put a lot of time in the call on the consumer side. Just wondering rate of change on corporate is that where you think the digital efforts are picking up. + +-------------------------------------------------------------------------------- +Brian T. Moynihan, Bank of America Corporation - Chairman, CEO & President [36] +-------------------------------------------------------------------------------- + + Yes, there'll be more -- there will be more there because of like trade finance, we started digitizing more processors. And if those process improve out, we'll drive it. There's a lot in the back-office of the securities clearance capabilities that is going on. So there are -- the numbers are -- consumer always dominates in terms of the numbers in a lot of ways just if you think about it, but GWIM has a bunch of digitization efforts, a bunch that saves statements and we send up 12 statements. If we can get people take e-statements that saves 12 times a year times whatever it costs for that particular statement. So these things are never -- if there's some silver bullet, you could shoot and take care of it all at once, we had a shot at it already, this is just hard work. + +-------------------------------------------------------------------------------- +Betsy Lynn Graseck, Morgan Stanley, Research Division - MD [37] +-------------------------------------------------------------------------------- + + So then the follow-up is a question I get from people a lot of times, which is we get the expense improvements. Are there any pressures that we should also be making in here when you talk about cash management, fee rate, some of the fintech disruptors, look at these fee pools and say, oh, this is too high. I'm going to go after that. I'm assuming that you're staying ahead of that threat. I'm just wondering is there a fee rate that we should be making sure that we're including when we give you the expense side? + +-------------------------------------------------------------------------------- +Brian T. Moynihan, Bank of America Corporation - Chairman, CEO & President [38] +-------------------------------------------------------------------------------- + + Yes. I mean, I think we've given the guidance on the expense side. If you think about something like in a global transaction services platform, cash management, as people call it, there has always been a loss in revenue that you're fighting against when paper, which people pay us, mode of process turns to digital. We lose revenue, but we save expenses at a faster rate. That has been going through the numbers for last several years. So the revenue growth we see in cash management takes that all into account. So it's more customers, more activity fighting off with the customers are converting cash to digital. So, yes, that's a part of it, but you're seeing in our run rate. There's not -- there's nothing sort of ahead of us that's unusual compared to the quarter-to-quarter sort of picking away at us that goes on in that regard. + +-------------------------------------------------------------------------------- +Betsy Lynn Graseck, Morgan Stanley, Research Division - MD [39] +-------------------------------------------------------------------------------- + + And then consumer expense ratio of 51%, that as you're getting more people onto your Zelle platform, et cetera, is there a line of sight to that going sub-50 at some point? + +-------------------------------------------------------------------------------- +Brian T. Moynihan, Bank of America Corporation - Chairman, CEO & President [40] +-------------------------------------------------------------------------------- + + I think through both the revenue lift they get as the rate structure rises and good expense management, we'd expect that it should move down below 50 at some point, but we never say to people where do we think it can get to some big target. The consumer teams has set some targets. I said, don't give people targets because then they'll think that that's success. We don't know where it goes. In other words, over -- I'm not talking about next quarter, but over multiple years when you continue to drive the revenue expense play here because the accumulating core transaction deposit account and getting it from $2,000 over the last 8, 10 years to $6,000 per account is a tremendous revenue lift by focusing primary counts as the number of accounts actually fell by 10%. And so that dynamic is what we're after. So, yes, it will move down, but I wouldn't -- we never put that success because then people quit working. + +-------------------------------------------------------------------------------- +Operator [41] +-------------------------------------------------------------------------------- + + We'll go next to the line of Mike Mayo with Wells Fargo Securities. + +-------------------------------------------------------------------------------- +Michael Lawrence Mayo, Wells Fargo Securities, LLC, Research Division - MD, Head of U.S. Large-Cap Bank Research & Senior Analyst [42] +-------------------------------------------------------------------------------- + + Your branch count continues to go down, I guess, down 3% year-over-year, but deposits are up 4% year-over-year. And I'm trying to get a distinction between retention of deposits when you close branches, a retention of customers because according to your 10-K in 2015 and 2016, the number of accounts declined by about 2% but at the same time, deposits continue to grow just like the entire decade. So my question is what is your retention rate of deposits? And what is your retention rate of customers when you close a branch today and why the difference? + +-------------------------------------------------------------------------------- +Brian T. Moynihan, Bank of America Corporation - Chairman, CEO & President [43] +-------------------------------------------------------------------------------- + + The deposits to consumer just, Mike, which are more -- and small business, which are more related to your thing, are actually up 9% year-over-year and up 4%. That's the all-in corporate level, including GWIM and commercial. But if you look at it across time, it really depends on where you're closing the branch, obviously, and what's nearby, but the retention rates continue to go up. The -- over time because the physical plant becomes less dominant and relevant to the customer, and so what we're doing is fine-tuning the branch count and often consolidating into a bigger branch, and we've invested heavily into the quality of the branch itself with the numbers of people there. So our branches are getting bigger in terms of numbers of people in them and smaller in terms of count. When you think about it, the customer fall off in terms of numbers of accounts, was really continuing to focus on that primary account. So as we do that, the balances are up twice in the accounts, I think, over the last 7 years or something like that and account numbers are down from 34 million to 31 million. That was all given by our view that we had to get to the primary account because that's where the profit can be made and the core transaction capabilities are there. So we closed a lot of people -- people runoff who were using us as a secondary or third bank just because they loved our distribution of ATMs and things like that and basically we have emphasized primary account sales. + +-------------------------------------------------------------------------------- +Michael Lawrence Mayo, Wells Fargo Securities, LLC, Research Division - MD, Head of U.S. Large-Cap Bank Research & Senior Analyst [44] +-------------------------------------------------------------------------------- + + I'm not sure if you disclosed this. So what is the retention of deposits when you close a branch today? And what was it a few years ago? + +-------------------------------------------------------------------------------- +Brian T. Moynihan, Bank of America Corporation - Chairman, CEO & President [45] +-------------------------------------------------------------------------------- + + We don't disclose it separately, Mike. That's all in there. So in that 9% growth is every thing we did so... + +-------------------------------------------------------------------------------- +Michael Lawrence Mayo, Wells Fargo Securities, LLC, Research Division - MD, Head of U.S. Large-Cap Bank Research & Senior Analyst [46] +-------------------------------------------------------------------------------- + + Okay. And just last question. You've mentioned -- I mean, digital banking is up. Global Banking is up. You mentioned 1,100 branches that's equivalent of it. That's good. So have you reached the [chipping form] where you can go from 4,500 branches down to 3,500 branches or 4,000. How far can you go? + +-------------------------------------------------------------------------------- +Brian T. Moynihan, Bank of America Corporation - Chairman, CEO & President [47] +-------------------------------------------------------------------------------- + + That always depends on the customer behavior and other factors. We are deploying new branches, hundreds of them over a multiyear period into places we didn't have branches before, located more strategically given circa 2017 and beyond banking. So we don't put -- again it's not another number, we target a number. What we target is a more and more efficient system. And so each day, 3/4 of 1 million people come into our branches and our teammate serves them well, and our scores of those branches are all times high in terms of satisfaction, and 80% of sales go on in that space. So I wouldn't want to cut them back at one branch more than the customer wants us to do it by evidence by their behavior. + +-------------------------------------------------------------------------------- +Operator [48] +-------------------------------------------------------------------------------- + + We'll go next to the line of Steven Chubak from Nomura Instinet. + +-------------------------------------------------------------------------------- +Steven Joseph Chubak, Nomura Securities Co. Ltd., Research Division - VP [49] +-------------------------------------------------------------------------------- + + I had a follow-up question regarding the discussion earlier about GWIM deposit competition and just some of the efforts that you cited to compete with other cash alternatives. I was hoping you could qualify the actual magnitude of deposit price increase that we saw in the quarter and maybe just give a little bit more context as to what prompted the action. And, Paul, I know you gave some color here. I'm just trying to get a better understanding as to whether this is really driven by increased competitive pressures or is it more a function of the DOL, which actually requires that some clients receive reasonable compensation on some of their assets, including cash. + +-------------------------------------------------------------------------------- +Paul M. Donofrio, Bank of America Corporation - CFO [50] +-------------------------------------------------------------------------------- + + I don't think it's -- it's not a function of the DOL. It's function of our desire to give our customers an alternative to leave their money in a deposit account at Bank of America as opposed to seeking other alternatives within our AUM and brokerage platforms. So that's what's driving this. It's a meaningful increase, but it's nothing when you think about the 100 basis points that we've seen here. It's not a significant amount. + +-------------------------------------------------------------------------------- +Brian T. Moynihan, Bank of America Corporation - Chairman, CEO & President [51] +-------------------------------------------------------------------------------- + + Just philosophically, we said our team, "You got to maintain the operating leverage given relative pricing against the rate curve because the rate curve, we got to zero fullers for so long." And so they have to grow faster than the market 4% or 5%, at least you've got to grow deposits, then you've got to maintain the pricing discipline. What happens at GWIM, frankly, is they got a little behind the curve and they had to move in a single quarter, and they did. And so what you see in the period-end deposits, even though the average I think is down. Period end actually is up, and so they were able to shut down some of the runoff as Paul just described, but it's really localized in the GWIM business, and it's really driven by a subset of those deposits, which are in asset management accounts and in brokerage accounts that are a part of an investment strategy that is different than transactional checking accounts and things that are driving both in our commercial business in our consumer business. And so that's why you see if you go look at Page 10 and kind of sort throughly, you'll see there's differences and it's really narrowly in the area that has to do with really investment cash rather than transitional and transactional cash. + +-------------------------------------------------------------------------------- +Steven Joseph Chubak, Nomura Securities Co. Ltd., Research Division - VP [52] +-------------------------------------------------------------------------------- + + And so my understanding then is that if we do see rate hikes from here because much of this increase was a function of your efforts to catch up with the competition, that should we see the NIM trajectory increase? Or how should we think about the outlook from here? If we get additional rate hikes? + +-------------------------------------------------------------------------------- +Paul M. Donofrio, Bank of America Corporation - CFO [53] +-------------------------------------------------------------------------------- + + Well, first, let me say that our outlook on NII absent to any change of rates is going to be dependent on loan and deposit growth offset by deposit rate pay, which is mostly going to be driven here by competitive factors. So if we get a 25 basis point rate hike in December, again, most of that will see in the first quarter, the benefit, and it's going to depend on what our customers need and want and what the competitive dynamic is. I mean, that I don't know how else to answer that question. We don't know yet what we're going to do. We have to see how the market develops. + +-------------------------------------------------------------------------------- +Brian T. Moynihan, Bank of America Corporation - Chairman, CEO & President [54] +-------------------------------------------------------------------------------- + + But secondly, in the $3.2 billion for 100 basis points is modeled in a rate of change relative to that interest rate change for deposit pricing. We have better that and because of the power of the franchise and other things, and we'd expect to continue to maintain that discipline. + +-------------------------------------------------------------------------------- +Steven Joseph Chubak, Nomura Securities Co. Ltd., Research Division - VP [55] +-------------------------------------------------------------------------------- + + Got it. And just one more for me on the credit side. The trends there continue to be quite positive. You appear to be doing a lot better than many of your peers in that regard. I know the guidance that you've given previously at least in the near term was that provision should approximate net charge-offs. We did begin to see those in healthier building consumer. I'm just wondering how we should think about the near-term provision trajectory from here? + +-------------------------------------------------------------------------------- +Paul M. Donofrio, Bank of America Corporation - CFO [56] +-------------------------------------------------------------------------------- + + We still think provision is expected to roughly match net charge-offs. You could see some modest increase as we bounce around the bottom with respect to net charge-offs in commercial and as we build allowance in support of loan growth, however, these factors may be offset by the release of noncore consumer real estate and energy as we sort of have been experiencing here over the last few quarters. So no change there. + +-------------------------------------------------------------------------------- +Steven Joseph Chubak, Nomura Securities Co. Ltd., Research Division - VP [57] +-------------------------------------------------------------------------------- + + Okay. It means, this $900 million as like a charge-off run rate at least in the near term a reasonable expectation? + +-------------------------------------------------------------------------------- +Brian T. Moynihan, Bank of America Corporation - Chairman, CEO & President [58] +-------------------------------------------------------------------------------- + + Over the last 5 quarters, the average has been $900 million. + +-------------------------------------------------------------------------------- +Operator [59] +-------------------------------------------------------------------------------- + + We'll go next to the line of Matt O'Connor from Deutsche Bank. + +-------------------------------------------------------------------------------- +Matthew D. O'Connor, Deutsche Bank AG, Research Division - MD [60] +-------------------------------------------------------------------------------- + + I was wondering if you could just elaborate a bit in terms of what you're seeing on the loan demand side, both on the commercial corporate as well as the consumer and, obviously, the industry has slowed down overall. Would you make some comment about seeing more activity in pockets of consumer? And then along with that, just your outlook for loan growth in the near term here. + +-------------------------------------------------------------------------------- +Paul M. Donofrio, Bank of America Corporation - CFO [61] +-------------------------------------------------------------------------------- + + Look, we've been experiencing a solid loan growth in consumer and GWIM and in -- on the wholesale side in Global Banking. You saw that again this quarter. We don't -- so we talk about loan growth for the whole company being driven by deposit growth, and so if you think about our deposit growth and the size of our deposits relative to our loans, every quarter we grow deposits, and we put as much of that to work as we can in loan growth and whatever doesn't go to loans and client growth goes into the investment portfolio or cash. So if you're growing deposit sort of mid-single digit, that means you're going to grow total loans low single digits. We don't think that's going to change given the current economic environment. But as you've seen, because we have a significant runoff portfolio in All Other, that has translated into mid-single digit loan growth in our business segments, and that's what we're comfortable with. + +-------------------------------------------------------------------------------- +Matthew D. O'Connor, Deutsche Bank AG, Research Division - MD [62] +-------------------------------------------------------------------------------- + + And then as we think about the deposit growths driving the balance sheet growth, you've got this side of yield curve and some people -- my personal view is if we get additional increase in the short end, you might have further flattening. I'm just wondering about the thought process to keep building the securities book and the mortgage book. You're seeing some banks shrinking the securities book and building cash instead. And obviously, there's a cost of doing that, but just a thought process to keep building securities here as the curve has flattened pretty meaningfully. + +-------------------------------------------------------------------------------- +Paul M. Donofrio, Bank of America Corporation - CFO [63] +-------------------------------------------------------------------------------- + + Yes, look, we are always, always thinking about the trade-off between earnings liquidity and capital where we have a risk framework that we operate in with respect to the securities portfolio. But remember, when you're growing deposits in consumer 8%, those are, we believe, high-quality deposits. So they have a meaningful duration. And you've got to find investments on the asset side to match what you believe the duration of those deposits are. So we're very thoughtful about it, and we think about it all the time. We haven't made a lot of changes into how we're operating. We're operating within our risk framework, and we feel good about kind of what we're doing there. + +-------------------------------------------------------------------------------- +Brian T. Moynihan, Bank of America Corporation - Chairman, CEO & President [64] +-------------------------------------------------------------------------------- + + I think one of the things to remember is that as you think about deposits, in our $1 trillion plus of deposits, we have significant more consumer personal deposits than anybody else does, which then if you think through the resolution planning and how those are treated and all that stuff, those deposits are extremely valuable. If you think of the consumers, it was 4 basis points last year and 4 basis points this year. You're going to continue to grow those because unless the curve flattens in the way that would be below 4 basis points plus the FDIC, you'd start to think of -- which no one thinks it is going to do. It's still a very valuable idea to generate more customers and generate more deposits. But we continue to really push that with -- its almost $900 billion in deposits in our GWIM and consumer businesses, which are tremendously valuable in terms of what drives this franchise's profit. So there's no way we're turning down more customers with good core deposits. + +-------------------------------------------------------------------------------- +Matthew D. O'Connor, Deutsche Bank AG, Research Division - MD [65] +-------------------------------------------------------------------------------- + + Yes, just a point I was getting at is, you're paying up a little bit on the deposit side in the wealth management business, you're paying up a little bit on the Global Banking side, and on the one hand, you can afford to pay up to help out the customers and keep them in your products, but at the same time, with the flattened yield curve, just makes it less economical to do so I think. + +-------------------------------------------------------------------------------- +Brian T. Moynihan, Bank of America Corporation - Chairman, CEO & President [66] +-------------------------------------------------------------------------------- + + Yes. But we -- I mean, if you think about the all-in cost, then it's still much -- it's still very advantage cost of $600 million a quarter for the $1.2 trillion in deposits in total. These numbers -- think about that a second, and you think that there's a lot of advantage in any yield curve. + +-------------------------------------------------------------------------------- +Paul M. Donofrio, Bank of America Corporation - CFO [67] +-------------------------------------------------------------------------------- + + Portion is, obviously, focused on the right thing, is focused on the economics, but remember these are our customers and we want to make sure that they have the right alternatives for them to make good decisions about whether they want to keep the deposit or whether they want some other alternative. + +-------------------------------------------------------------------------------- +Operator [68] +-------------------------------------------------------------------------------- + + We'll go next to the line of Brian Kleinhanzl from KBW. + +-------------------------------------------------------------------------------- +Brian Matthew Kleinhanzl, Keefe, Bruyette, & Woods, Inc., Research Division - Director [69] +-------------------------------------------------------------------------------- + + Yes. First question was on the first mortgage production that you mentioned. You said that you're putting most of that on the balance sheet. Can you just give kind of a description of the type of paper that it is? Is it just 3-year conforming? And then what does that do to the duration of the loan book for the consumer? + +-------------------------------------------------------------------------------- +Paul M. Donofrio, Bank of America Corporation - CFO [70] +-------------------------------------------------------------------------------- + + These are our customers who are originating mortgage either through purchase or refinancing, and we like the risk profile. We know them. We're focused on primes and superprime, and we -- so it's mostly nonconforming, but there is some conforming in there. We still are selling some through the agencies and, obviously, that would -- that adds duration to the asset side to the extent that it starts getting a lot, but we'll manage that, and remember we're adding deposits. + +-------------------------------------------------------------------------------- +Brian T. Moynihan, Bank of America Corporation - Chairman, CEO & President [71] +-------------------------------------------------------------------------------- + + Also don't think that we don't manage -- we manage that rate risk through a whole bunch of things, including derivatives and stuff, too. So it's not like we just sit there and throw the long assets on and leave them there. + +-------------------------------------------------------------------------------- +Brian Matthew Kleinhanzl, Keefe, Bruyette, & Woods, Inc., Research Division - Director [72] +-------------------------------------------------------------------------------- + + Okay. And then you didn't call out the hiring of the sales staff of about 2,000 year-on-year. I mean, how do we measure the success of those hires? Is -- how much of that is already in the run rate? I mean, was it an opportunity to take market share? Or were you understaffed in certain areas? I mean, how should we think about the increase in sales staff? + +-------------------------------------------------------------------------------- +Brian T. Moynihan, Bank of America Corporation - Chairman, CEO & President [73] +-------------------------------------------------------------------------------- + + Well, we have a -- how you should think about is that you can't grow in a business which is largely driven by face-to-face interaction for the wealth management business and the commercial business in total and a large part of the consumer business. If you don't grow in your sales force, you can't grow your production. If you don't grow your production, you can't grow your balances. And so all those balances were growing loan balances and deposit balances and are all driven by having more sales capabilities. And so unless you assume your team isn't working hard, which is absolutely not the truth. The Bank of America team works very hard. You got to add more capacity and to serve the customers, we have tremendous opportunities. So whatever metric and you can stun yourself with the opportunity. The number of customers who have their banking accounts that are in a wealth management business with other banks, hundreds of billions of dollars of bank deposit balances and loan balances, the amount of middle market Investment Banking goes to competitors from our middle market clients is 70%, 80% of their activity, which we should be capturing a lot more of. So we added middle market investment banker. So that capacity is a requirement. If we look at all the markets, 92 markets in the U.S., we look at the relative market shares, we look at what we should be able to do, we look at how our team works together and we deploy those people in units and between 6 -- 5 or 6 core business of operating markets to make sure building markets so they can play off each other and then they work to get business together and refer business back and forth. So without that sales force build, you won't have growth in the future. + +-------------------------------------------------------------------------------- +Operator [74] +-------------------------------------------------------------------------------- + + We'll go next to the line of Ken Usdin from Jefferies. + +-------------------------------------------------------------------------------- +Kenneth Michael Usdin, Jefferies LLC, Research Division - MD and Senior Equity Research Analyst [75] +-------------------------------------------------------------------------------- + + Paul, I wanted to follow up on the customer credit. There's been last day or so a lot of concern about card. Your card losses have been up a little bit, but very manageable, but I did notice you did -- and you mentioned you built a card reserve to now 3.5%. I'm just wondering what kind of normalization are you expecting on the card losses to follow -- to start, sorry. + +-------------------------------------------------------------------------------- +Paul M. Donofrio, Bank of America Corporation - CFO [76] +-------------------------------------------------------------------------------- + + Yes. So we've been growing our card book. We have a back book that is well seasoned. We have a front book that we're growing and that is seasoning like any other normal portfolio card. And you're seeing, I think, that across the industry. So we feel really very good about our card portfolio. We're focused on again prime and super prime. We're focused on our customers. We did see a modest pickup in NCOs year-over-year, but that was fully expected and planned for. So nothing here from our perspective unusual. + +-------------------------------------------------------------------------------- +Kenneth Michael Usdin, Jefferies LLC, Research Division - MD and Senior Equity Research Analyst [77] +-------------------------------------------------------------------------------- + + Okay. So just expected gradual seasoning, and you're not expecting any kind of vintage major shift in the recent growth? + +-------------------------------------------------------------------------------- +Brian T. Moynihan, Bank of America Corporation - Chairman, CEO & President [78] +-------------------------------------------------------------------------------- + + No. If you think about the whole card business, we reshaped it over the last 10 years, quite frankly, has been a move to more and more relationship customers whose credit statistics are relatively consistent over time. And so while we have a year-over-year increase in card charge-offs, linked quarter, it fell back down. And so you should expect this thing to bounce around in these rates, but it's because of the nature of the way we originate the cards to its core relationship customers and then our focus is not necessarily getting a lot more cards out there. It's really get people to use their card as the primary card out of their wallet, the Bank of America customer, the Bank of America card and using it and that's where we're driving the business. So I don't think you expect the strategy is responsible growth. So the balances grew $1 billion or $1.2 billion, a couple of billion here over the last year, but we do -- it's going to be steady to go and drive it. So you shouldn't see major changes in terms of nominal dollars of charge-offs. + +-------------------------------------------------------------------------------- +Kenneth Michael Usdin, Jefferies LLC, Research Division - MD and Senior Equity Research Analyst [79] +-------------------------------------------------------------------------------- + + Understood. And then as a follow-up to that in terms of the new Preferred Rewards card, how will that work through? Will there be any type of amortization of rewards cost, et cetera, that we should think about in terms of the card fees line? How -- or is that just also kind of already been as part of the spending you've been doing? + +-------------------------------------------------------------------------------- +Paul M. Donofrio, Bank of America Corporation - CFO [80] +-------------------------------------------------------------------------------- + + Yes. So let me just take a step back as lot of people are in the call and just review what we did. So we did launch it last month. It's a card that we launched because we're listening to our customers, and we want to design a card that rewarded them. We rewarded those customers who wanted to deepen their relationship with us even further, and importantly, we also wanted to give them the flexibility to use their rewards the way they wanted to use them. Similar to all our other cards, we are very careful to balance the customer value with the shareholder value rewards that are very clear and transparent. We've got enough from fee in this card that we're not waiving. So we've been very mindful of the profitability of the product, and we don't expect any significant impact at this point anyways. We'll see how it goes, but at this point, any significant impact to card income from existing upfront. + +-------------------------------------------------------------------------------- +Operator [81] +-------------------------------------------------------------------------------- + + We'll go next to the line of Jim Mitchell with Buckingham Research. + +-------------------------------------------------------------------------------- +James Francis Mitchell, The Buckingham Research Group Incorporated - Research Analyst [82] +-------------------------------------------------------------------------------- + + Maybe quick question on rate sensitivity. It looks like it didn't change despite absorbing another rate hike this past quarter. Is that sort of indication that you've gotten slightly more asset sensitivity -- asset sensitive as the quarter went on? Or how do we think about your -- the flat rate sensitivity? + +-------------------------------------------------------------------------------- +Paul M. Donofrio, Bank of America Corporation - CFO [83] +-------------------------------------------------------------------------------- + + I mean, if you look at rates at the end of last quarter, you look at rates where they are now. There really wasn't -- hasn't been a lot of change. So that's -- it's the rate structure both existing at the end of the quarter versus existing then plus what the forward path look like at both those points that drives that asset sensitivity disclosure, and they were kind of similar at both points. + +-------------------------------------------------------------------------------- +James Francis Mitchell, The Buckingham Research Group Incorporated - Research Analyst [84] +-------------------------------------------------------------------------------- + + Was there any change in the short versus long-end sensitivity? + +-------------------------------------------------------------------------------- +Paul M. Donofrio, Bank of America Corporation - CFO [85] +-------------------------------------------------------------------------------- + + Not really. It's still around 2/3 short end. + +-------------------------------------------------------------------------------- +James Francis Mitchell, The Buckingham Research Group Incorporated - Research Analyst [86] +-------------------------------------------------------------------------------- + + Okay. I mean, maybe just a broader question on consumer credit. I mean, I think this has been a big issue. I heard your comment in cards, but maybe just taking -- looking at the consumer as a whole, do you feel like there's any stress points out there that gives you some pause. I think that's really what's going on in the industry or at least in a lot of investors' minds worrying about is this the start of a new upward cycle in consumer credit costs? And how do you think about that? + +-------------------------------------------------------------------------------- +Paul M. Donofrio, Bank of America Corporation - CFO [87] +-------------------------------------------------------------------------------- + + Look, we -- again, we're focused on prime, superprime. We're focused on our customers, and we're just not seeing it in that group. I'm looking at a page here, it's (inaudible) on it. And after you adjust for the OCC bankruptcy and the repossession if you look at card, if you look at auto, if you look at consumer vehicle lending and you make an appropriate adjustment net charge-offs, they haven't really gone up, linked quarter or versus Q1. So we're just not seeing it yet in our net charge-offs. + +-------------------------------------------------------------------------------- +Brian T. Moynihan, Bank of America Corporation - Chairman, CEO & President [88] +-------------------------------------------------------------------------------- + + That's been a multiyear discipline. This is not something that happened this quarter. This is multiyears of changing the underwriting standards and sticking to it and not varying those standards as we move through time. So we changed the mortgage underwriting standards in '07 and '08. We changed the card standards about the same time. The auto standards have always been high. We've always made that a business that we took very little credit risk in, and so when you think about it, we just don't see it, but it's -- a lot of it is just sticking to the knitting over the years into the responsible growth strategy and the team finding the growth in the customers. And so the debate has always been, "can you grow?" and answer is yes. But you've got to grow in a rationale, responsible basis. So -- and that's what's playing out, and that's this quarter relative to other people, I think. + +-------------------------------------------------------------------------------- +Operator [89] +-------------------------------------------------------------------------------- + + We'll go next to the line of Gerard Cassidy with RBC. + +-------------------------------------------------------------------------------- +Gerard S. Cassidy, RBC Capital Markets, LLC, Research Division - Analyst [90] +-------------------------------------------------------------------------------- + + You'd mentioned, Brian, on the call about going into different markets with de novo expansion of your retail branches. Can you give us some color on how long it takes to get to those branches to break even? And then second, how long does it take to get them to a level of profitability that's similar to your legacy branches? + +-------------------------------------------------------------------------------- +Brian T. Moynihan, Bank of America Corporation - Chairman, CEO & President [91] +-------------------------------------------------------------------------------- + + Well, I think the -- it takes a lot to build them up to the level of deposits, obviously, but what we've seen so far, and that's going to be one of the things you test every quarter is that some of the branches will be opened in Denver, quickly moved into the top 10% of sales and a lot of stuff. Now why is that different than the de novo branching? A, we have a nationwide brand; B, we have wealth management and commercial businesses in all these markets; C, we have card customers and mortgage customers in these markets that were -- that we had for years. And so a lot of times, you're converting a deepening proposition as opposed to I'm opening a store and seeing what comes in. And the fourth is, we strategically locate them near where the rest of our teammates are and drive it. So they're getting up to speed faster. I won't give you the exact date that we target and things like that because it's proprietary, but you should assume they're getting up to speed faster. You should assume that we're smart enough that we're not going to build them if they don't work. + +-------------------------------------------------------------------------------- +Gerard S. Cassidy, RBC Capital Markets, LLC, Research Division - Analyst [92] +-------------------------------------------------------------------------------- + + Very good, and then second, we're all familiar with the treasury white papers that have come out about where they think regulation as you go through the banks. When you guys review what has come out? What are the top 1, 2 or 3 items that when you sit down with the new Vice Chairman of the Fed, Quarles, what are you going to talk to him about? And as part of that answer, can you share with us your thinking on where is your operational RWA? And is that a big issue for you to talk to the regulators about changing in the future? + +-------------------------------------------------------------------------------- +Paul M. Donofrio, Bank of America Corporation - CFO [93] +-------------------------------------------------------------------------------- + + Sure. So on the first point on the white papers and all the other stuff, that you've been seeing, it looked -- as an industry, I think it goes without saying that we really have a vested interest in regional regulation that also promotes safety and soundness. So we are very focused on that. I would say that we are for regulatory refinement that promotes economic growth while protecting your financial stability. There's been a lot of discussion out there, a lot of white papers, a lots of great points that are being made in those papers, but we would be in favor sort of generally in the type of refinement that allows us more access and control over our capital liquidity in support of responsible growth that we've been talking about all throughout this call in support of the economy and the communities where we live and work and for lending and for capital return. We've talked about how large our buffer is. We'd also like to see a little bit more efficient regulation driven by harmonization across the regulatory bodies. So we're going to work with whatever parties we can to see some of this get refined in a responsible way. On your second question was on RWA -- oh, on operational risk capital, yes, one of our favorite subjects. Yes, look, we have -- 1/3 of our advanced RWA is operational risk RWA. It's a floor that's been given to us by regulators. That $500 billion is 33% more than our next closest competitor has in operational risk RWA. That $500 billion is more RWA than just about all the European banks have in total RWA. So we'd like to make progress on that. The advanced approach is something we used to manage risk of the company. So it's important to have an accurate amount of RWA as we think about how we're managing the company. Having said all that, I would point out that at least in the United States with the Collins amendment, we have to have an amount of RWA that is the higher of standardized and advanced. And as we continue to make progress on optimizing how we deliver for customers and clients, we are optimizing our advanced RWA, and it's getting closer and closer to standardize. So at some point, standardize will likely become our binding constraint. That doesn't mean that the operational risk capital is not -- operational risk RWA is not important, it is. But standardize, at some point, will become our binding constraint and make that a little bit move. + +-------------------------------------------------------------------------------- +Gerard S. Cassidy, RBC Capital Markets, LLC, Research Division - Analyst [94] +-------------------------------------------------------------------------------- + + Very good, and then just finally, Paul, you mentioned that, I think, on the call about the higher rep and warranty expense. Can you guys kind of frame for us what's left there? And, obviously, I'm assuming we're towards the tail end. But do you guys know about what's left? + +-------------------------------------------------------------------------------- +Paul M. Donofrio, Bank of America Corporation - CFO [95] +-------------------------------------------------------------------------------- + + Look, we don't really go through them line by line. I think, you guys know all the big ones. I'd be happy to sort of list a couple of those if you want. What I would say is if you look at our disclosures, we still have $2 billion in reserves for reps and warranties, and we've got another $2 billion at least as of the end of the second quarter in the RPL for reps and warranties. So we're going to work through these things, and we're going to see over time how all of that plays out. + +-------------------------------------------------------------------------------- +Operator [96] +-------------------------------------------------------------------------------- + + We'll take our final question from the line of Saul Martinez from UBS. + +-------------------------------------------------------------------------------- +Saul Martinez, UBS Investment Bank, Research Division - MD & Analyst [97] +-------------------------------------------------------------------------------- + + I want to ask about a follow-up on efficiency in cost performance beyond 2018. And where you think your efficiency ratio can go to? So you've, obviously -- you've brought down your efficiency ratio to 60%. If you get to the $53 billion, whenever that is, '18 or whenever you get there, around '18, can you drive down your efficiency ratio even further to $57 billion, $58 billion? So you're pretty close to sort of your competitors, despite the fact that your business mix is one that has more wealth management and which has a higher efficiency ratio. So how should we think about your ability, the opportunity set to continue to drive positive operating leverage over a multiyear period and get your efficiency ratio down even further to the mid- to low 50% range? And I know it's a difficult question to answer, and it depends on a lot of things. But with technology and AI and cognitive computing and digitization and mobile banking, can we see efficiency ratios that maybe a few years ago we wouldn't have even thought about for a bank like Bank of America? + +-------------------------------------------------------------------------------- +Brian T. Moynihan, Bank of America Corporation - Chairman, CEO & President [98] +-------------------------------------------------------------------------------- + + Well, I think a number of things. Number one, you've got the general picture, right, which is we're getting it down to $53 billion. That puts us in a level we have a higher position of wealth management, which has revenue-related compensation that obviously is a 27% pretax margin. You flip that around 83% efficiency ratio, and it's a meaningful amount of dollars, but it's a great return on capital business. And last thing you want to do is not grow it. So that creates a dynamic around the aggregation of all these numbers, and you look at the other ones in there, 50-ish type of numbers across the board. So we're going to drive that. When you think about in the future, the way we talk about is the $53 billion is the '18 target. We try to hold it flattish after that, fighting to apply technology, all things you talked about more digitization and the early callers -- the early questioners talked about and using that to offset the fact that medical care premiums go up 6%, 7%. Something else goes up, rents go up and things like that and pay for all that and merit increases and bigger bonus pools because our teammates are doing a good job. So all that, you're fighting that and if you keep it flattish and then the question of what scenario you're playing into, your rates rise a little bit that, of course, is the bottom line and that's we told you guys before, and that's what we'll tell you in the future there's no additional cost to that. If it comes through wealth management fee generation, it's going to have more expense attached to it. So there's a little bit of a debate -- little bit of what's your scenario you're playing into. But we don't target -- the efficiency ratio is a result of all the hard work that goes in to keep expenses flat down to $53 billion and flattish after that. That will then produce the efficiency ratio based a little bit on the revenue scenario, which will be good on the economics and what's going on out there. But you should rest assured after $20 billion of expenses in the last 5 years taken out of this company that there's no team that is more focused on this than the team that works for me. + +-------------------------------------------------------------------------------- +Operator [99] +-------------------------------------------------------------------------------- + + We would like to turn back over to Mr. Moynihan for closing remarks. + +-------------------------------------------------------------------------------- +Brian T. Moynihan, Bank of America Corporation - Chairman, CEO & President [100] +-------------------------------------------------------------------------------- + + Thank you, operator. Let me just wrap up quickly. Thank you all for being on the call today, and thank you and look forward to talking to you next quarter. As you think about Bank of America over the quarter 3 of 2017, it's pretty straightforward: responsible growth. It's evidenced across the company in all different fashions, whether it's -- we've got to grow no excuses. You saw that in balances and revenue. We've got to do with the right customer focus, we've got to do with the right risk and we've got to do it and be sustainable. When we say sustainable, that means we've got to do it and keep investing in the future, and you saw us do that also. When we do that right, we can take more capital and deliver back to you through dividend and share buybacks. And as we told you earlier, we'll nearly double that year-over-year. So thank you. We look forward to talking to you next quarter. + +-------------------------------------------------------------------------------- +Operator [101] +-------------------------------------------------------------------------------- + + I'd like to thank everybody for their participation. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/exam/original-files/Problem_1_Sample/2017-Oct-26-AMZN.OQ-140695336667-Transcript.txt b/exam/original-files/Problem_1_Sample/2017-Oct-26-AMZN.OQ-140695336667-Transcript.txt new file mode 100644 index 0000000..df1aff3 --- /dev/null +++ b/exam/original-files/Problem_1_Sample/2017-Oct-26-AMZN.OQ-140695336667-Transcript.txt @@ -0,0 +1,376 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q3 2017 Amazon.com Inc Earnings Call +10/26/2017 05:30 PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Brian T. Olsavsky + Amazon.com, Inc. - Senior VP & CFO + * Dave Fildes + - + +================================================================================ +Conference Call Participiants +================================================================================ + + * Heath P. Terry + Goldman Sachs Group Inc., Research Division - MD + * Eric James Sheridan + UBS Investment Bank, Research Division - MD and Equity Research Internet Analyst + * Jason Stuart Helfstein + Oppenheimer & Co. Inc., Research Division - MD and Senior Internet Analyst + * Ross Adam Sandler + Barclays PLC, Research Division - MD of the Americas Equity Research and Senior Internet Analyst + * Justin Post + BofA Merrill Lynch, Research Division - MD + * Mark Stephen F. Mahaney + RBC Capital Markets, LLC, Research Division - MD and Analyst + * Brian Thomas Nowak + Morgan Stanley, Research Division - Research Analyst + * Ronald Victor Josey + JMP Securities LLC, Research Division - MD and Senior Research Analyst + * Mark Alan May + Citigroup Inc, Research Division - Director and Senior Analyst + * Scott W. Devitt + Stifel, Nicolaus & Company, Incorporated, Research Division - MD + * Douglas Till Anmuth + JP Morgan Chase & Co, Research Division - MD + +================================================================================ +Presentation +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Thank you for standing by. Good day, everyone, and welcome to the Amazon.com Q3 2017 Financial Results Teleconference. (Operator Instructions) Today's call is being recorded. For opening remarks, I'll be turning the call over to the Director of Investor Relations, Dave Fildes. Please go ahead. + +-------------------------------------------------------------------------------- +Dave Fildes, - [2] +-------------------------------------------------------------------------------- + + Hello, and welcome to our Q3 2017 financial results conference call. Joining us today to answer your questions is Brian Olsavsky, our CFO. +As you listen to today's conference call, we encourage you to have our press release in front of you, which includes our financial results as well as metrics and commentary on the quarter. Please note, unless otherwise stated, all comparisons in this call will be against our results for the comparable period of 2016. +Our comments and responses to your questions reflect management's views as of today, October 26, 2017, only and will include forward-looking statements. Actual results may differ materially. Additional information about factors that could potentially impact our financial results is included in today's press release and our filings with the SEC, including our most recent annual report on Form 10-K and subsequent filings. During this call, we may discuss certain non-GAAP financial measures. In our press release, slides accompanying this webcast and our filings with the SEC, each of which is posted on our IR website, you will find additional disclosures regarding these non-GAAP measures, including reconciliations of these measures with comparable GAAP measures. +Our guidance incorporates the order trends that we've seen to date and what we believe today to be appropriate assumptions. Our results are inherently unpredictable and may be materially affected by many factors, including fluctuations in foreign exchange rates, changes in global economic conditions and customer spending, world events, the rate of growth of the Internet, online commerce and cloud services and the various factors detailed in our filings with the SEC. +Our guidance also assumes, among other things, that we don't conclude any additional business acquisitions, investments, restructurings or legal settlements. It's not possible to accurately predict the demand for our goods and services, and therefore, our actual results could differ materially from our guidance. +With that, we will move to Q&A. Operator, please remind our listeners how to initiate a question. + + +================================================================================ +Questions and Answers +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) Our first question comes from the line of Justin Post with Merrill Lynch. + +-------------------------------------------------------------------------------- +Justin Post, BofA Merrill Lynch, Research Division - MD [2] +-------------------------------------------------------------------------------- + + Great. I guess I'll just start with, can you give us your thoughts on the Whole Foods integration? How you see that contributing to the bottom line over time? And then on a quick balance sheet note, we obviously saw the strong AWS results, but unearned revenue doesn't seem to be growing at the rate it was in the past. Maybe comment a little bit on the unearned revenue growth on the balance sheet, why it might be slower than the past? + +-------------------------------------------------------------------------------- +Dave Fildes, - [3] +-------------------------------------------------------------------------------- + + Yes, thanks, Justin. This is Dave. I'd also point you to beyond the balance sheet. There's some disclosure around additions to unearned revenue as part of the cash flow statement. So when you look at that, for the 3 months ended, you'll see that up around 34%, 35% versus the same time last year. +And historically, what we've seen with unearned revenue is big and leading contributor to that is Prime memberships. The example is a customer signing up, paying $99 upfront and having that amortize over the 12 month period. That continues to be the biggest absolute contributor to what you see there. The other one area that's been growing over the past few years is Amazon Web Services, features like reserved instances where those customers can pay for services upfront, in some cases and receive discounts over a multiyear period. What we're seeing and more recently, I think, is on the Prime piece, we launched month-to-month Prime last year, and if you think about how that works, customers are paying $10.99 per month as they go. So there's less that's deferred. So, that's I think one of a number of factors. There's obviously other mix factors going in there besides the pieces that I just mentioned. But we've seen monthly Prime has been a good driver of getting more members into the program. So that's part of what you're seeing. + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - Senior VP & CFO [4] +-------------------------------------------------------------------------------- + + And your question about Whole Foods, yes, we're really excited to have them as part of the team now after the acquisition in late August. What you see in the financial results for this quarter is a -- it's shown actually in the new physical stores, revenue component $1.3 billion of revenue, $21 million of operating income. And that's where you'll be seeing Whole Foods revenue showing up. In addition, that is -- that class of revenue, physical store's revenue is going to be where we are going to book any sales that where a customer physically select an item in a store. So it also -- it does include our Amazon Books. If you step back on Whole Foods, again, I think we've had busy months since we've joined forces, offering lower prices on a range of key grocery items in the stores. Launching the private-label -- Whole Foods private-label products on Amazon, we've got technical work to make Prime the Whole Foods customer rewards program, and we'll have that coming out in the future. We've added Amazon Lockers to select Whole Foods stores. So lots of activity, lots of energy and we're real excited to show customers what's possible when we join forces here. + +-------------------------------------------------------------------------------- +Operator [5] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Mark Mahaney with RBC Capital Markets. + +-------------------------------------------------------------------------------- +Mark Stephen F. Mahaney, RBC Capital Markets, LLC, Research Division - MD and Analyst [6] +-------------------------------------------------------------------------------- + + Guess I'll ask 2 as well. The first one is, that was a bit of a usual upside to your guidance, even stripping out Whole Foods. Is there -- what would you -- what's most surprised you in the quarter? You've been pretty consistent to how you reported versus your guide. So something unusual happened or somewhat unusual happen? What would you attribute that to? + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - Senior VP & CFO [7] +-------------------------------------------------------------------------------- + + Sure. In Q3, yes, I would say we had a very strong Prime Day. As you know, we talked about that on the last call, but it really carried into the quarter. We had a record day for sign-ups for free trials for Prime and Prime Day globally. Had a very strong Prime Day in particular internationally. So it really got a lot more traction in this, the third year that we've had it. So I would point mostly to those factors. There's also very strong quarter for AWS, revenue growth was the same as Q2 and now we're at an $18 billion run rate. Whereas last quarter, when I had this call, we were at $16 billion. So very pleased with the customer response in the AWS business as well. And usage growth is actually growing a lot higher than revenue growth. So particularly pleased with the new customers that we've added and the additional workloads that we've picked up from existing customers. + +-------------------------------------------------------------------------------- +Mark Stephen F. Mahaney, RBC Capital Markets, LLC, Research Division - MD and Analyst [8] +-------------------------------------------------------------------------------- + + And then briefly on the international retail, that growth also by itself was intrinsically stronger than you've seen in a while. Any particular markets geographic markets, you would call out there? + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - Senior VP & CFO [9] +-------------------------------------------------------------------------------- + + Yes, it was pretty strong across the board. We had the impact of Souq, obviously this quarter internationally and the Diwali holiday in India was a few days earlier, which maybe pushed some sales into Q3 versus Q4. But generally, it was the strength of Prime Day internationally and it carried through the quarter. So it's -- but generally, I would point to the increase selection, a lot of the building blocks we've been working on. All the Prime benefits, advancement and free shipping offers or faster shipping offers, the Prime benefits that drive engagement, of course, adding selection, adding Fulfilled by Amazon partners and the selection that they bring. So again, I wouldn't point to anything other than the Prime Day pickup, but stronger than -- it was stronger than probably I anticipated. + +-------------------------------------------------------------------------------- +Operator [10] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Brian Nowak with Morgan Stanley. + +-------------------------------------------------------------------------------- +Brian Thomas Nowak, Morgan Stanley, Research Division - Research Analyst [11] +-------------------------------------------------------------------------------- + + I have 2. Just on Whole Foods again, I was wondering, could you talk about 1 or 2 of the biggest surprises you've seen so far? And then maybe just a strategic opportunity, as you see, of having a brick-and-mortar presence as you look to continue to grow your overall business? And the second one on the subscriptions revenue, you accelerated to 59%, could you just talk about which countries or which regions are driving that? And maybe talk a little bit about the growth or the cadence of what's happening in the U.S., your oldest market? + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - Senior VP & CFO [12] +-------------------------------------------------------------------------------- + + Sure. On Whole Foods, I would say it is early. August 28 was the close date and -- what I could tell you is, I've been in meetings with John Mackey and his team and they're very like-minded with us, customer-obsessed, ready to work together to continue their mission then expand on their offerings that we can offer customers. The other things I mentioned, price reductions early on, selling products on -- their products on Amazon.com and also installing Amazon Lockers. I think over time, you'll see more cooperation and working together between AmazonFresh, Prime Now and Whole Foods, as we can explore different ways to serve the customer. So that's kind of the earlier report on Whole Foods. So far so good, and we're thrilled to finally be working together after the summer of closing the deal. On subscription revenue, let me just remember your question there. We had essentially 59% growth, you said, 600 basis points higher than Q2. In this line item is certainly the fees associated with Amazon Prime and also it's where a lot of our subscription services from digital music, digital video, audio books, eBooks. So there's some moving parts in there. The growth in Prime has been fairly consistent over the last recent quarters in Prime memberships. And as I said, we had a great -- the largest new Prime -- new sign-ups on Prime Day for the Prime program. The monthly program is gaining traction. It's an attractive option for a lot of people. And again, on this -- on the other subscription services, music especially, it works just so well with our Echo device that we're seeing a lot of growth in that area as we increase the number of Echo devices and customers using the Echo devices. + +-------------------------------------------------------------------------------- +Operator [13] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Eric Sheridan with UBS. + +-------------------------------------------------------------------------------- +Eric James Sheridan, UBS Investment Bank, Research Division - MD and Equity Research Internet Analyst [14] +-------------------------------------------------------------------------------- + + In the comment in the release on seasonal workers, that looks roughly flat year-on-year. I wanted to know if you could understand a little bit more about the trajectory around the workers needed to fulfill seasonal holiday demand and what that might also mean for automation or efficiency benefits you're getting inside your fulfillment centers. + +-------------------------------------------------------------------------------- +Dave Fildes, - [15] +-------------------------------------------------------------------------------- + + Yes, Eric. This is Dave. I think we put out a release saying earlier this quarter talking about 120,000 operations folks to bring into our fulfillment centers this year. So we're continuing to hire and hire across a number of locations. We talked earlier this year about expecting to see a greater than -- roughly greater than 30% square footage growth in an operations, so we're certainly hiring to support that. More of these facilities do have Amazon Robotics and certainly that helps with the efficiencies there, but it requires tremendous effort from a number of our folks as well. And so we'll continue to hire there. + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - Senior VP & CFO [16] +-------------------------------------------------------------------------------- + + While we're on this subject of headcount. Headcount grew 77% year-over-year in the quarter. That includes the impact of the Whole Foods and Souq acquisitions. Without those -- without that headcount, the base Amazon grew 47%, which is still up from 42% in Q2. So a lot of the additional pickup in Q3 was tied to our ramp for the holidays. We continue to hire a lot of software engineers. We continue to hire a lot of sales reps, and it's tied directly to our major investment areas of AWS, Prime Video and devices. + +-------------------------------------------------------------------------------- +Operator [17] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Douglas Anmuth with JPMorgan. + +-------------------------------------------------------------------------------- +Douglas Till Anmuth, JP Morgan Chase & Co, Research Division - MD [18] +-------------------------------------------------------------------------------- + + Brian, I was hoping you could help us understand how at this point you're prioritizing expansion into new product categories. In particular, there's a lot of talk now about potentially using Whole Foods stores for physical pharmacy presence and also that you've perhaps got an approvals across multiple states in that category. Can you just help us understand the approach in general to new categories and pharmacy, in particular? + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - Senior VP & CFO [19] +-------------------------------------------------------------------------------- + + Yes, I can't confirm or deny any of the rumors related to pharmacy or anything else. I will say we do see a lot of opportunity with Whole Foods. As I said, there will be a lot of work together between Prime Now, AmazonFresh, Whole Foods, Whole Foods products on the Amazon site, Lockers at the Amazon -- excuse me, Amazon Lockers at the Whole Foods stores. So there'll be a lot of integration, a lot of touch points and a lot of working together as we go forward. And we think we'll also be developing new store formats and everything else just as we've talked about in the past with before Whole Foods, amazon Bookstores, Amazon Go and the opportunity that technology presents. We have campus -- on-campus bookstores. So we're experimenting with a lot of formats. I think that Whole Foods really gives us a vast head start on that and a great base and a great team to work with who has a lot of history, and a lot of -- they probably have 10 to 20 years of learnings that we don't have and wouldn't have. So we're really excited about that. And I think working together will bring our different strengths to the table and really be able to build on behalf of customers. + +-------------------------------------------------------------------------------- +Operator [20] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Mark May with Citi. + +-------------------------------------------------------------------------------- +Mark Alan May, Citigroup Inc, Research Division - Director and Senior Analyst [21] +-------------------------------------------------------------------------------- + + The other category which includes advertising accelerated 58% in the quarter. I think the common view there is that's a fairly high-margin business, certainly higher than corporate average. Is there any reason why that isn't the right assumption to make? Essentially what impact is the growth in the ad business having on the company's overall profitability? And in terms of the increased losses in the international retail segment of the business, can you provide some color around how much of that's being driven by Amazon launching into new markets, which I know you continue to do, versus investing more heavily in existing markets? + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - Senior VP & CFO [22] +-------------------------------------------------------------------------------- + + Sure. Let me start with the revenue. So you're right. Other revenue grew 58% in the quarter, and that includes advertising services and other things such as our cobranded credit card agreements. Advertising revenue continues to grow very quickly, and its year-over-year growth rate is actually faster than the other revenue line item that you see there. But I would say generally, we're very pleased with the advertising business. Our goal here is to be helpful to consumers and help them make better shopping and selection choices. We'll also provide in giving them targeted recommendations. So making it helpful for customers rather than intrusive. And then we believe that by creating that (inaudible) and engaging advertising experience with the customers, it will also maximize success for our advertisers. So it's an important part of the flywheel and the -- so it's -- the traffic and the customers, especially the Prime customers that come to the site, are really the ones that we can use to help them select items and use advertising to help make their decisions more informed when they're picking products. +On the international, yes, I can't split it, the effects. But I'll tell you again, it is international expansion in -- primarily in India where we're continuing to add benefits, and we launched Prime there a year ago, if you remember, and we've had more Prime members joined in India than in any other country in the first 12 months. We have free shipping on 10 million items there, and we're continuing to add benefits: Prime Video, Amazon Family, we've had a first Prime Day there this year, Prime Music. Amazon business is also expanding in India. So a lot of positive momentum and investment going on in India. Very pleased with that. We also recently announced Echo and Alexa are available in India. So that -- that should be well received by the Indian consumer base. But excluding India and Souq, the rest is the Prime benefits and the continued growth in the other countries that we've been in for a while, continue to roll out Prime Now and AmazonFresh. In Video, we launched -if you remember in Q4 of last year, we launched Prime Video in 200 -- over 200 countries globally, continue to build up not only the offerings but also the engagement that we see from those Prime customers. So becoming more engaged, and we're also doing the basic blocking, tackling of adding selection, especially FBA selection, increasing free shipping offers and also speed of shipping offers. So there's a lot of -- a lot of different influences there. You saw the growth rate. It's, we believe, it's resonating with customers. So we will continue to invest and think that we have a good path forward. + +-------------------------------------------------------------------------------- +Operator [23] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Ross Sandler with Barclays. + +-------------------------------------------------------------------------------- +Ross Adam Sandler, Barclays PLC, Research Division - MD of the Americas Equity Research and Senior Internet Analyst [24] +-------------------------------------------------------------------------------- + + Two questions. There's been some news flow recently about Brazil expansion. Can you just talk about how Brazil compares to maybe some of the other international markets that you're investing in? What level of investment should we expect in Brazil maybe relative to like in Australia or in India? And then the follow-up on the Whole Foods. So do you feel like the store footprint at 460-odd stores is adequate? Or any color on plans to expand either the Whole Foods store footprint or the Amazon bookstores or those other ones you mentioned? + +-------------------------------------------------------------------------------- +Dave Fildes, - [25] +-------------------------------------------------------------------------------- + + Yes, Ross. Thanks for the question. This is Dave. On Brazil, just briefly, yes, we did recently expand and add an electronics category there in Brazil. It's a third-party marketplace offering. You may recall we've been in Brazil for a number of years now, initially launched with really a Kindle and eBooks offering without the sort of physical categories and more recently added physical books again, a third-party marketplace offering. So I think we're excited about the electronics that are getting out there. There's a wide variety of products included in that category: Smartphones, tablets, cameras, TVs, what have you. So I think, really excited to get that technology out there for Brazilians. And I think beyond that, really just focus on those categories and growing selection there, but I can't speculate on what we might do in the future there. + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - Senior VP & CFO [26] +-------------------------------------------------------------------------------- + + And on Whole Foods, yes, I believe the total is 465 stores or thereabouts. And we have 12 bookstores now. We are adding a few more in the near future in California, Washington D.C. and Austin. So yes, you will see more expansion from us. We're not ready to announce any, what that will look like, and we're working with the Whole Foods team on what maybe what they will -- how many more stores we might have in that area. But still early. So, those plans will develop over time. + +-------------------------------------------------------------------------------- +Operator [27] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Heath Terry with Goldman Sachs. + +-------------------------------------------------------------------------------- +Heath P. Terry, Goldman Sachs Group Inc., Research Division - MD [28] +-------------------------------------------------------------------------------- + + I understand you can't comment on rumors one way or the other, but curious as you think about categories like health care and obviously you guys are already in health care to some degree through Amazon Business, can you give us a bit of a status update on what you do have out there now? And particularly how the company and management thinks about entering more regulated businesses over time? How you would approach that versus a standard category that you might go into? Or maybe again, I know you can't comment on rumors, how you have approached to that in the past or in other market? And then to the extent that we are thinking about AWS growth in the fourth quarter, you guys are lapping the price cuts from last year and obviously have about an 800 basis point easier comp Q3 to Q4, taking those 2 things into consideration, how should we think about AWS growth through the end of the year? + +-------------------------------------------------------------------------------- +Dave Fildes, - [29] +-------------------------------------------------------------------------------- + + Yes, Heath, this is Dave. I'll take that first question in relation to health care. I think where you're seeing us do some work on that, I think is in the areas of Amazon Business, and that's really just from the standpoint of there are many different types of businesses that we can serve with that offering, and we're in our third year now. And so there's a lot of different sectors, whether they're hospitals, educational institutions, labs, government agencies. I mean there's a lot of different shapes and sizes across industries that we can serve with that. And so I think what you're seeing us do is really focus on services that meet those businesses, multiuser accounts, improving approval workflow tools, and just more recently, we introduced Amazon Business for Business Prime shipping, which we think will be a great way for our businesses use multiuser -- Business customers that have multiuser accounts, and that's in the U.S. and in Germany. So I think it's part of that offering, and we really have to see how that evolves. And the other side, too, is certainly health care is one of many sectors as part of Amazon Web Services that are important customers that we're focusing on and building tools for. So probably nothing specific to call out on that one, but that's a lot of what you're seeing from us today. + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - Senior VP & CFO [30] +-------------------------------------------------------------------------------- + + Yes, on AWS, we don't provide segment level estimates, but we did consider in our guidance the impact of the price cuts last year. You're right, we had a number of price cuts on (inaudible) time to -- about around December 1 of last year that certainly had an impact on Q4 of last year. But again, price cuts and not only price cuts, but new products that have lower average costs and can cannibalize more expensive products is pretty much a part of our business all the time in AWS. So we're looking forward to a strong Q4 and re:Invent is in December, so that's -- the end of November, early December, so that is also an exciting time of year for the AWS business. + +-------------------------------------------------------------------------------- +Operator [31] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Scott Devitt with Stifel. + +-------------------------------------------------------------------------------- +Scott W. Devitt, Stifel, Nicolaus & Company, Incorporated, Research Division - MD [32] +-------------------------------------------------------------------------------- + + I had 2, please. The first, Prime Now, Fresh Prime Pantry and Whole Foods, they're all distinct offerings, but it does seem like there's natural overlap with the potential to be further connected. And I was just wondering if you could just speak to how we should think about those 4 as distinct product offerings in the future versus being more integrated and possibly even, in some cases, eliminated to remove overlap from a customer experience standpoint? And then secondly, given the recent management changes in video, Brian, I was just wondering if you could speak to any strategic shifts in Video or changes in the pace of content portfolio build in coming years? + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - Senior VP & CFO [33] +-------------------------------------------------------------------------------- + + Sure, let me start with Video, and I just want to be clear, we are going to continue to invest in video and increase that investment in 2018. And why are we going to do that? It's because the Video business is having great results with our most important customer base, which is our Prime customers. They continue to -- it continues to drive better conversion of free trials, higher membership renewal rates for existing subscribers and higher overall engagement. We're seeing engagement go up year after year in video and also music and a lot of the other Prime benefits. We also know Prime members who watch video also spend more on Amazon. And we have a lot of data. We're -- that's the advantage we have is that we see the viewing patterns and we also see the sales patterns, so we can tie the 2 together and understand which video resonates with Prime members, which video doesn't, and make midcourse corrections. So we always do that, the -- we're always changing the emphasis and looking for those more impactful shows, more shows that resonate better with our customer base and things they want to see. And -- so that will always be an important part of our Prime offer, and we'll continue to use the data that we have to make better and better decisions about where to invest our dollars in Prime Video. So we're very -- we remain very bullish on the Video business, and we're looking forward to a lot of interesting new projects back end of this year and also lined up into next year. On the -- sorry, the second comment was, the overlap. Yes, so Whole Foods, I think I mentioned this earlier, but we definitely see commonality and overlap with the Whole Foods business as well as Amazon in total, but specifically, Prime Now, and also, AmazonFresh. And we're going to work to see how we expand those offerings, and in some cases, combine them. We're not sure how it will play out, but we're going to cooperate across those different customer touch points and trying to make them better for customers. We know customers are going to buy just like in the physical world, sometimes you go to a convenience store, sometimes you go to a supermarket, sometimes you go to a superstore. Sometimes you need things within an hour, sometimes you can wait days for shipment. So there's no one paradigm for all customer engagement, and we're looking for the ones that resonate best with customers, and we're going to continue to work on those. + +-------------------------------------------------------------------------------- +Operator [34] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Jason Helfstein with Oppenheimer. + +-------------------------------------------------------------------------------- +Jason Stuart Helfstein, Oppenheimer & Co. Inc., Research Division - MD and Senior Internet Analyst [35] +-------------------------------------------------------------------------------- + + I'll actually ask 2 if I can. Just any way you can comment on the increase in Whole Foods traffic after the close? And then second, talk about your desire to have an ad-supported business on Fire TV or through Prime Video? + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - Senior VP & CFO [36] +-------------------------------------------------------------------------------- + + I think I'll start on traffic. So we're not disclosing traffic figures. Whole Foods will be issuing a final 10-K at the end of the -- early next month, so you'll see a better perspective on the entire quarter. The quarter -- the 4-week period that you see running through the Amazon P&L this quarter is pretty hard to draw conclusions on other than revenue at this point. But Dave, do you have more on the... + +-------------------------------------------------------------------------------- +Dave Fildes, - [37] +-------------------------------------------------------------------------------- + + Yes, Jason, this is Dave. On the ad-supported question, I think what you've seen to date is really particularly as you're looking as a customer as a Prime Video member and watching content, we view that as you paid into that service and able to watch those shows ad-free. There may be instances where you're viewing a first episode and there's an ad leading into that if it's the first free episode, but generally like to have that as customers have paid into that program and they'll be able to enjoy that without interruption. + +-------------------------------------------------------------------------------- +Operator [38] +-------------------------------------------------------------------------------- + + Our final question comes from the line of Ron Josey with JMP Securities. + +-------------------------------------------------------------------------------- +Ronald Victor Josey, JMP Securities LLC, Research Division - MD and Senior Research Analyst [39] +-------------------------------------------------------------------------------- + + Just wanted to ask about delivery, in just over the last several months, we've seen a lot of announcements in products around delivery options between Lockers, testing the Kohl's partnership, Whole Foods, obviously, Amazon Key came out recently. I just wanted to better understand this investment. Is this a result of -- or the thesis that more options could drive, obviously, more sales on the flip side? Do you think you're losing some sales by not having those options? + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - Senior VP & CFO [40] +-------------------------------------------------------------------------------- + + Probably a little of both. We think that, especially as we get into more and more Amazon Logistics deliveries, we're going to experiment with different ways to deliver things that make it easier on consumers, things that cut down on potential theft on doorsteps, but really it's mostly about increasing convenience for them. + +-------------------------------------------------------------------------------- +Dave Fildes, - [41] +-------------------------------------------------------------------------------- + + Yes, I think that's right, in terms of overall investments there. + +-------------------------------------------------------------------------------- +Brian T. Olsavsky, Amazon.com, Inc. - Senior VP & CFO [42] +-------------------------------------------------------------------------------- + + And the other investments, obviously, are maybe the bigger-ish things are like planes and transportation capacity in general. And there our philosophy is, again, we're going to watch out for our customers, we're going to build capacity that gives them great service 12 months a year but particularly at holidays, by investing in those transportation options, we do so at same costs or cost parity, I would say, at the very minimum, but it also allows us to do interesting things like extend cutoff times for customers, enable Sunday delivery, enable better weekend delivery. So we're seeing a lot of benefits, just the ability to stretch the order cut off from what once was 3 p.m. in the afternoon to midnight, has huge benefits both for the customer and also for Amazon. It results in incremental sales, it also builds that trust that when you need something, Amazon's going to be there for you. And I need to remind you that the Thursday Night Football game will start in 2 hours and 20 minutes so. + +-------------------------------------------------------------------------------- +Dave Fildes, - [43] +-------------------------------------------------------------------------------- + + On that, thanks for joining us on the call today and for your questions. A replay will be available on our Investor Relations website at least through the end of the quarter. We appreciate your interest in Amazon and look forward to talking with you again next quarter. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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Actual results may differ +materially from those stated in any forward-looking statement based on a +number of important factors and risks, which are more specifically +identified in the companies' most recent SEC filings. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/exam/original-files/Problem_1_template.py b/exam/original-files/Problem_1_template.py new file mode 100644 index 0000000..2603728 --- /dev/null +++ b/exam/original-files/Problem_1_template.py @@ -0,0 +1,371 @@ +# -*- coding: utf-8 -*- +""" +Created on Sat Jul 30 15:20:32 2022 + +@author: Alexander Hillert, Goethe University +""" + +# import packages +import re + +# define working directory +# adjust it to your computer +directory = "YOUR DIRECTORY" + + +# ============================================================================= +# Part A: Creating an Overview File on the Call Participants +# ============================================================================= + +# Create output file +output_csv_file=open(directory+'Problem_1_Overview_Calls.csv','w',encoding="utf-8") +# Write variable names to the first line of the output file +# 1) Call-ID +# 2) Filename +# 3) Fiscal Quarter +# 4) Fiscal Year +# 5) Date of the call in the format YYYYMMDD +# 6) Time of the call, e.g., 05:00 PM GMT +# 7) number of non-corporate call participants +# 8) the names of all corporate participants and their positions -> each item +# should be written in a seperate column +output_csv_file.write('ID;Filename;Fiscal_Quarter;Fiscal_Year;Date;Time;\ +#Analysts') +# There can be up to 4 corporate particiapnts +for i in range(1,5): + output_csv_file.write(';Name_'+str(i)+';Position_'+str(i)) +output_csv_file.write('\n') + +# Open the overfiew file "Overview_File_Problem_1.csv" to call the earnings calls +overview_file=open(directory+'Overview_File_Problem_1.csv','r',encoding="utf-8") +overview_text=overview_file.read() +list_earnings_calls=overview_text.split("\n") +# The last line is empty -> drop it +while list_earnings_calls.count("")>0: + list_earnings_calls.remove("") + + + +# iterate all earnings conference calls +for i in range(1, len(list_earnings_calls)): + + # reset the variables + fiscal_quarter="" + fiscal_year="" + date="" + time="" + + # we split the entire transcripts into three parts + # its header + header_text="" + # the list of non-corporate participants + participants_text="" + # the list of corporate participants + corporates_text="" + + # the number of analysts joining the call + number_analysts=0 + + # variables for manager name and position + manager_name="" + manager_position="" + manager_position_edited="" + + # a list of manager names for part b) + manager_name_list=[] + + # get the filename of each earnings call + call_information=list_earnings_calls[i].split(";") + call_id=call_information[0] + filename=call_information[1] + + # open the call transcript + call_file=open(directory+'Problem_1_Sample/'+filename,'r',encoding="utf-8") + call_text=call_file.read() + + # Get information on the call + # FOr example: + # Q1 2013 Bank of America Corporation Earnings Conference Call + # 04/17/2013 08:30 AM GMT + + # the header ends where the list of corporate particpants starts + match_corporates=re.search(TO BE COMPLETED,call_text) + if match_corporates: + header_text=call_text[TO BE COMPLETED] + + + # get the fiscal quarter and year from the header text + match_fiscal_quarter=re.search(TO BE COMPLETED,header_text) + if match_fiscal_quarter: + fiscal_quarter=match_fiscal_quarter.group(0) + match_fiscal_year=re.search(TO BE COMPLETED,header_text) + if match_fiscal_year: + fiscal_year=match_fiscal_year.group(0) + + # get date and time of the call + # date + match_date=re.search(TO BE COMPLETED,header_text) + if match_date: + date=match_date.group(0) + # the date in the output file should be formatted as YYYYMMDD + # so, you need to rearrange the date text + year=date[TO BE COMPLETED] + month=date[TO BE COMPLETED] + day=date[TO BE COMPLETED] + date_formatted=year+month+day + # time + match_time=re.search(TO BE COMPLETED,header_text) + if match_time: + time=match_time.group(0) + + + # count the number of analysts + # the relevant text part starts with, for example, + # ================================================================================ + # Conference Call Participiants + # ================================================================================ + # + # * Chris Mutascio + # Keefe, Bruyette & Woods - Analyst + # * Thomas Laturneau + # FBR - Analyst + + # and ends with the beginning of the presentation + # ================================================================================ + # Presentation + # -------------------------------------------------------------------------------- + + match_participants=re.search(TO BE COMPLETED,call_text) + match_presentation=re.search(TO BE COMPLETED,call_text) + # if you find both boundaries + if match_participants and match_presentation: + # get the text in between + participants_text=call_text[TO BE COMPLETED] + + # split the text of the participants that you have just identified + # in a way that each element refers to one analyst. + analyst_list=participants_text.split(TO BE COMPLETED) + # depending on how you split, you might need re.split() + + # check whether you get empty elements and/or elements that do not refer + # to analysts -> remove them + while TO BE COMPLETED>0: + TO BE COMPLETED + + # after these steps and checks, the number of analysts is the length of your analyst list + number_analysts=TO BE COMPLETED + + + # get the names of the corporate participants and their position + # remember that you already have the beginning of corporate participants + # see above at around line 90 + # the corporate participants come before the list of non-corporate participants + corporates_text=call_text[TO BE COMPLETED] + # like before, split this text such that one element refers to one corporate participant + corporates_list=corporates_text.split(TO BE COMPLETED) + # check whether you get empty elements and/or elements that do not refer + # to corporate participants -> remove them + while TO BE COMPLETED>0: + TO BE COMPLETED + + + # write the call information to the output file + output_csv_file.write(str(call_id)+";"+filename+";"+fiscal_quarter+";"+fiscal_year+";"\ + +date_formatted+";"+time+";"+str(number_analysts)) + + # now, we need to add the information on the corporate participants + # go over all corporate participants + for j in range(len(corporates_list)): + # depending on how you split the text of corporate participants, + # one element of your list could contain the name of the mangager in the first + # line and their position in the second line. + # ADJUST THE FOLLOWING COMMANDS IF YOU USED A DIFFERENT SPLIT. + + # split each element of the list of corporate participants further + # into name and position + manager_entry=corporates_list[j] + manager_entry_parts=manager_entry.split(TO BE COMPLETED) + manager_name=manager_entry_parts[TO BE COMPLETED] + + # for part b) of the problem it is helpful to have a list of all + # manager names. With this list, we can identify whether a statement + # comes from a managers (-> answer) or from an analyst (-> question) + manager_name_list.append(manager_name) + + + manager_position=manager_entry_parts[TO BE COMPLETED] + # Like before, the template assumes a very specific type of split here + # So depending on your approach, you might need to change the commands below. + # the position is just the text part after " - " + # For example + # Bank of America Corporation - CEO + # the position is "CEO" + manager_position_edited=re.TO BE COMPLETED + + # write the manager names and positions to the output file + output_csv_file.write(";"+manager_name+";"+manager_position_edited) + + output_csv_file.write("\n") + + + print("For earnings call "+str(i)+" part a) has been completed.") + + # ========================================================================= + # Part B: Extracting the Call Segments + # ========================================================================= + + # set variables + presentation_text="" + qanda_text="" + qanda_list=[] + question_text="" + answer_text="" + + + # identify the presentation + # the begin of the presentation has already been identified above + # see at around line 140 + # + # the presentation ends where the Q and A part begins + # ================================================================================ + # Questions and Answers + # -------------------------------------------------------------------------------- + match_qanda=re.search(TO BE COMPLETED,call_text) + presentation_text=call_text[TO BE COMPLETED] + + # drop operator statements + # search for the beginning of an operator statement + match_operator=re.search(TO BE COMPLETED,presentation_text) + while match_operator: + match_operator_start=match_operator.start() + # search for the end of the operator statement + # Hint: search only after the beginning of the operator statement + # Hint 2: remember to keep track of your coordinates (.start() and .end()) + match_operator_end=re.search(TO BE COMPLETED,TO BE COMPLETED) + + # keep the text before the operator statement and the text after + # the approach is similar to removing tables (see Problem 4 and 5 from class) + presentation_text=presentation_text[TO BE COMPLETED] + + # check whether there is another match + match_operator=re.search(TO BE COMPLETED,presentation_text) + + # sometimes there are technical remarks like "(inaudible)", "(corrected by company after the call)", + # or "(technical difficulty)" -> drop those + TO BE COMPLETED + # there are several ways to approach this editing step (e.g., re.sub()) + + + # drop information on the speakers, e.g., + # ------------------------------------------------------------------------- + # Deborah Crawford, Facebook, Inc. - Director of IR [2] + # ------------------------------------------------------------------------- + match_speaker=re.search(TO BE COMPLETED,presentation_text) + while match_speaker: + # the task is similar to the Operator statement but be careful + # to only remove the speaker name but NOT the text of the speaker. + presentation_text=presentation_text TO BE COMPLETED + # check whether there is another speaker name + match_speaker=re.search(TO BE COMPLETED,presentation_text) + + + # write the text of the presentation to an output file + # make sure that the folder "Problem_1_Conference_Call_Segments" exists. + output_file_presentation=open(directory+'Problem_1_Conference_Call_Segments/call_'+str(call_id)+'_presentation.txt',"w",encoding='utf-8') + output_file_presentation.write(presentation_text) + + # Close file + output_file_presentation.close() + + + # ------------------------------------------------------------------------- + # identify questions and answers + # ------------------------------------------------------------------------- + # you already have the start of the Q&A section (see at around lines 235) + qanda_text=call_text[match_qanda.end():] + + # the earnings call transcript ends with definitions + # remove these/keep the text before the definitions + match_definitions=re.search("\n-{1,}\nDefinitions\n-{1,}\n",qanda_text) + if match_definitions: + # keep the text before + qanda_text=qanda_text[TO BE COMPLETED] + + # split the Q and A part by speaker + qanda_list=re.split(TO BE COMPLETED,qanda_text) + + # variables to count the number of answers + answer_counter=1 + # and questions + question_counter=1 + + # go over all speakers/statements that you obtained from the previous split + # you now have to decide whether the speaker is an analyst (-> question) + # or a corporate participant (-> answer) + for k in range(TO BE COMPLETED): + + # identify the speaker name to check whether it is a corporate participant. + # For example + # -------------------------------------------------------------------------------- + # Bruce Thompson, Bank of America Corporation - CFO [3] + # -------------------------------------------------------------------------------- + # + speaker_text_part=qanda_list[k] + # split the text part of the kth speaker + # into his*her name and the rest + # NOTE: re.search() and re.sub() are also nice ways to accomplish the goal + speaker_text_sub_parts=re.split(TO BE COMPLETED,qanda_list[k]) + # get the name of the speaker from the previous split + # in the example above, we need to get "Bruce Thompson" + speaker_name=speaker_text_sub_parts[TO BE COMPLETED] + # depending on your split, you might need some further editing to + # get onyl the name ("Bruce Thompson") without any additional information. + + + # the second part of speaker_text_sub_parts is (probably) the statement + # of the speaker (again, it depends on your split) + text=speaker_text_sub_parts[TO BE COMPLETED] + + # sometimes there are technical remarks like "(inaudible)", "(corrected by company after the call)", + # or "(technical difficulty)" -> drop those + text=TO BE COMPLETED + # there are several ways to approach this editing step (e.g., re.sub()) + + # check whether the speaker name is in the manager list from part a) (see at around line 195) + if speaker_name in manager_name_list: + # the name of the speaker is in the list of corporate participants + # -> it is a management answer + + answer_text=answer_text+"Answer_"+str(answer_counter)+":\n"+text+"\n" + answer_counter=answer_counter+1 + + else: + # it is either an analyst question or an operator statement + # be careful to check the condition below. depending on how your + # speaker names look like, you may need .count() and/or re.search() instead of .startswith() + if speaker_name.startswith("Operator") or TO BE COMPLETED: + pass + + else: + # it is an analyst question + question_text=question_text+"Question_"+str(question_counter)+":\n"+text+"\n" + question_counter=question_counter+1 + + # write the texts to output files + # make sure that the subfolder exists. + output_file_answers=open(directory+'Problem_1_Conference_Call_Segments/call_'+str(call_id)+'_answers.txt',"w",encoding='utf-8') + output_file_questions=open(directory+'Problem_1_Conference_Call_Segments/call_'+str(call_id)+'_questions.txt',"w",encoding='utf-8') + output_file_answers.write(answer_text) + output_file_questions.write(question_text) + + # Close files + output_file_answers.close() + output_file_questions.close() + call_file.close() + + +# Close files +overview_file.close() +output_csv_file.close() + +print("Problem 1 completed.") diff --git a/exam/original-files/Problem_2_3_Sample_QandA/10_answers.txt b/exam/original-files/Problem_2_3_Sample_QandA/10_answers.txt new file mode 100644 index 0000000..c3dc18b --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_QandA/10_answers.txt @@ -0,0 +1,148 @@ +Answer_1: + + There wasn't anything particularly noteworthy in terms of one-time events. It was really quite broad particularly in derivatives. +In cash the performance was I would say solid year over year because we saw strength in the Americas this year but we had strength in Europe last year. And I think the first-quarter 2014 wasn't particularly strong, so I think we were flatter a little bit with a relative comparison but it was a really strong absolute and we think probably strong relative performance. + +Answer_2: + + Yes, this is where it would be. I wouldn't say it's a driver, but we are as you said and the whole industry is looking to work with clients to optimize the use of the balance sheet and improve returns. +So we've seen some of that. But I wouldn't say it was a key driver. + +Answer_3: + + It is more of the same. Obviously G-SIB took on a slightly heightened focus when we had some doubling happen in the proposal in December. +So we've always been measuring and monitoring and tracking G-SIB at a very granular level. But we are obviously on a path now to aggressively manage it which means that we are going to be just a little bit more focused on that constraint, not uniquely also with advanced capital, standardized limits, balance sheet caps, the like. So it's more of the same, honestly, than just a heightened focus on this given the US proposal and given the impact of at least at this point FX translations. + + + And different than RWA it affects certain products more than others. And we pointed out nonoperating deposits, stuff like that. Certain businesses more than others we've pointed out clearing and certain clients more than others we've pointed out financial institutions. +So it's just kind of a multi-variant theme. It's not mystical and we're actually already starting to reprice some of these businesses to get an adequate return on G-SIB capital. And we're seeing other people do that too. + + + That's right. We may be in a different position with G-SIB but others are leverage constrained. And just generally speaking we are starting to see a lot more discipline around balance sheet and pricing is following somewhat generally. + +Answer_4: + + So again assuming for a second that rates don't rise until the backend if not the end of the year and we can come back to that if you like we would expect our NII dollars to be stable to slightly up because we're still seeing growth in our interest-earning assets. Obviously this quarter we were down some on day count, it was a big chunk of the quarter-on-quarter reduction. +So we're really going to see the biggest lift in NII when we do see interest rates rise and we'll see when that is. And similarly on our NIM we would expect NIM to be stable particularly given as we talked about what we've seen dilute our NIM more particularly over the course of the last year or two has been this significant increase in cash and we're going to see some of that at least stabilize and turn as we start to reduce nonoperating deposits. So we should see our NIM relatively stable and again start to rise when rates rise. + +Answer_5: + + Okay, so taking your first point, Erika, obviously I don't know the next time we're going to in all likelihood get CCAR instructions including the rules and the minimums is likely to be some time towards the end of this year for the next CCAR cycle as we get prepared to deliver that. So all I can say is what you know which is clearly the door was left open for the minimum to be increased or potentially to include some element of the surcharge. +We're hopeful that that won't be the case because we would say the surcharge should be carried in baseline times to be used in stress and to have all firms end up well-capitalized afterwards. But I have no more insight than that for you. +With respect to the dialogue with the Fed look, it's definitely much, much further progressed than it was two years and three years ago and every year it gets better in terms of the bilateral conversations and it's constructive. I don't think, however, you could today or will likely ever be able to characterize it as transparent and clear, maybe potentially by design in terms of understanding or being able to reconcile exactly what their models do and what their results are driven by. So I won't be able to clarify for you what changed in their results or what differs between ours and theirs but the dialogue itself is definitely more constructive and more bilateral and more continuous. + +Answer_6: + + Look, I think that the best way to answer that is that we are still firmly with our guidance of adjusted expenses being $57 billion plus or minus by the end of the year or for the year, sorry. Obviously we will always try and outperform that but I wouldn't characterize one quarter as a change in that guidance at this point. + +Answer_7: + + So look the most important thing obviously in all of that is that we were delighted to be able to partner with the large company on their strategic transformation and that's the most important thing about that transaction for us. I'm not going to comment specifically on whether or what JPMorgan would be interested in in terms of asset purchases. We're much more focused on partnering strategically with the company. + +Answer_8: + + No, we haven't given any specific guidance, Chris. + +Answer_9: + + In the context of the CCAR we just had? + + + We expect our -- it's a little complicated this year and we sort of articulated it at Investor Day because we're going to move at some point whether it's the third of the fourth quarter to have standardized RWA be our binding constraint. So 11% plus or minus is our target on CET1 and that's all we've said. + +Answer_10: + + There's a couple of different things. One was a little specific. +We had a portfolio of loans that we held for sale and have subsequently exited from the balance sheet which drives some of it. But in addition just generally a competitive environment and lower demand particularly in Asia. + +Answer_11: + + Not specifically, no. I will tell you that while we are obviously delighted with the performance it was a relatively strong market and there were some larger transactions so we're happy with the gains. I can't specifically comment on where it came from. + +Answer_12: + + Yes, it's definitely more the latter. So basically if you think about our E&P portfolio in particular when we think about the redetermination somewhat semiannually of the borrowing base and looked at those companies on a client-specific name by name basis there was some contraction in the borrowing base and therefore some downgrades that drive our reserving methodology. +It doesn't mean that we feel that those companies are necessarily in significant difficulty but that's the way the reserving methodology works. And as I said we do this on a client by client basis, we're comfortable with our exposures and clients are looking to manage their own defensive position. So it's not clear that they will necessarily be realized in losses; in fact, if the implied curve rather than flat to long oil prices is in fact how things play out it's possible that there will be very little in the way of credit loss we'd experience. + +Answer_13: + + Both. Both. + +Answer_14: + + Yes, so first of all just on the contraction in spend driven by oil prices it's pretty typical in this part of the cycle that you would see lower energy prices in the first instance drive savings rates up and you see consumer spend for the energy dividend so to speak lag back. So the fact that we saw that happen in the first quarter is not atypical and it doesn't mean that we don't expect the spend to grow and for that energy dividend to ultimately translate into higher spend going forward. So it's more of a normal timing phenomenon is our expectation but with respect to other activity, yes we saw active equity capital markets with some defensive issuance and generally I think it's a positive overall for the businesses and for the economy. + +Answer_15: + + Not readily but we can get back to you. + +Answer_16: + + Yes, nothing specific to call out in the second half of the year. And we should hit 11% if not a little better, yes. + +Answer_17: + + Look, I would say seven weeks or six weeks or whatever it is after Investor Day that the messaging hasn't really changed which is we have every intention of aggressively managing the score, doing it as we talked about earlier in a very granular way. And we're already working on that and you see that in the most obvious place which is in the reduction already to date in nonoperating deposits. +But we continue to work on all of the things so derivative notional compression, level III assets, financing, obviously we're still thinking about what the response should be in terms of risk intermediation and clearing. And so I think six weeks on from Investor Day the story is the same, we feel we are fully committed to ensuring that we are safely within the 4.5% bucket and we may not stop there but we're only a few months into this. + +Answer_18: + + Yes, I was obviously you noted it from a small base so that's notable. There are two specific transactions or two specific exposures that were moved to nonaccrual. +One of them was moved on a somewhat of a technicality, a sovereign downgrade which we fully expect to recover on. But that is just the way we have to present it and the other smaller piece was one other isolated exposure. +So I wouldn't overthink it right now. It's two exposures and it's $200 million in total. + +Answer_19: + + The first the sovereign downgrade was did have oil and gas underlying exposure but again it was on a technicality rather than on the fundamentals of the Company. And we fully expect to recover on that. + + + Focus on the very, very small number. + +Answer_20: + + No, I would just say that overall our sense is that the market is neutral relative to the event. We happen to be able to benefit a little from it. Some others will be more neutral and some may have lost. +As these happen regular way in trading businesses and it just happens to be the case that that event and the volatility it drove is good for our client franchise. And I think it really just goes to show you that we're in a business where expertise matters and risk discipline matters and we were able to capitalize on both of those not just for the Swiss franc but also for the other macro events in the quarter. + +Answer_21: + + No, I wouldn't even characterize them as one-time gains. I would characterize them as one of a number of items that drove our performance in the business. + +Answer_22: + + Yes, so overall the total firm the reserve build that we took was a little over $100 billion, 4/5 of which was in the Commercial Bank. So we did experience -- we do all of this on a name-by-name basis, so we did it across our portfolios but the majority was in the CB E&P portfolio. + +Answer_23: + + It was $100 billion. + + + $100 billion. + + + No worries. $100 billion, I mean look at the end of the day you can see that over the course of the last since whatever the third quarter of 2012 our cash balances grew by a couple hundred billion dollars and that has been a very large contributor to the compression in our NIM, not the only one. +So as we push out the nonoperating deposits we would expect to see that help but remember we're still growing retail deposits. So if you look at this quarter in particular even though we reduced our nonop deposits related to client actions by about $20 billion, the majority of that $24 billion, we have flat deposits so we're continuing to grow the good retail deposits. So I would say it would be a tailwind but it would be a tailwind to a stabilizing and slightly improving NIM outside of rate rises. + +Answer_24: + + No, I'm sorry of the top of my head can't remember the number you're saying. But no, our legal expenses, forget the legal expense that relates to reserves that we've taken and settlements that we reached, our regular way expense for third parties in legal isn't down substantially quarter on quarter or year on year at this point, although at some point it will be. + +Answer_25: + + So specifically with respect to the quarter I would say that the wholesale parameter update -- wholesale credit parameter updates model benefits is about half of the RWA reduction with the other half coming from regular way portfolio run off as well as some reductions in market risk associated with market risk positions, reductions in private equity, reductions in commitment. So some position reductions rather than driven specifically by FX. +Look, we're running above $1.5 trillion now and we said we're going to manage both the advance and standardize to that number over the course of the next couple of years. So if FX or if the currency translation is a tailwind then we would hope to do better but at this point let's get there. + +Answer_26: + + So at the moment our CET1 ratio launching into CCAR was below 10%, not the 12% that we expect to run at once we have built our capital to our target level. And so you are right that right now under CCAR Tier 1 leverage was our binding constraint both last year and this year. +And so a combination of our capital strategy around how we think about the issuance of preferred together with balance sheet actions will be how we think about mitigating that limitation in the short to medium term. But ultimately it doesn't change the fact that once we get to our target assuming that is the 12% that we articulated at Investor Day that again we don't think we should be leverage constrained, so yes we're going to work on that obviously and we are continuing to build capital but when we launched into CCAR we weren't at that level. + +Answer_27: + + To give you a little perspective I also spoke in that the banking system is much stronger to start with and every bank in the system is much stronger. So just trying to think through what are the effects of some of these things and we look at it is kind of a warning shot across the bow. What I worry about more is what happens in a stress environment and I think people are paying attention to what's going on in the markets and if there has to be changes down the road there might be some changes that are relevant to that. + +Answer_28: + + I think the best way to think about it is through the cycle target that Doug Petno put out at Investor Day which is 18%. So that doesn't mean to say that we will benefit when rates rise in this business and it is very competitive and spreads are compressing and there's a lot of factors going on but through the cycle 18% so we're some years below and some above. +Just the question on core growth and security services outside of presentation changes and client exits is currently in the low single digits. So obviously a little bit muted because we're working on the balance sheet optimization but certainly growing and in the low single digits and in terms of looking at advisory and who we are gaining share from principally European banks. +Okay, no more questions? + diff --git a/exam/original-files/Problem_2_3_Sample_QandA/10_questions.txt b/exam/original-files/Problem_2_3_Sample_QandA/10_questions.txt new file mode 100644 index 0000000..0fb6512 --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_QandA/10_questions.txt @@ -0,0 +1,119 @@ +Question_1: + + Hello there. Just one quick clarification question on the performance in equities was great. You mentioned pretty much across the board, do you think there's any seasonality, any one-time events, block trades, anything like that that would lift such good performance in the quarter? + +Question_2: + + And maybe this is a related question but I'm not sure which line it would flow through. From what I understand you guys and others have been pushing or talking with your prime brokerage clients to help improve ROAs in the business. Is part of that flowing through and just better equity performance, more business with clients? + +Question_3: + + Okay, switching gears in Jamie's letter he talked about mentioning the need to push the new G-SIB rules to the product and the client level. And it piqued my curiosity. +I'm just curious, how different is that from what you've already done? In other words each step of the way you've been early in adopting and pushing out to the desk level higher capital charges. Does this just mean more of the same meaning, higher capital charge, higher capital charge or is there something different there that you need to do? + +Question_4: + + Hi, good morning Marianne. I was wondering on net interest income, do you have an outlet for how the net interest income dollars could trend from here? Assuming that you don't get much help from higher rates what are the key drivers and what's your outlook for NIM and NII dollars for the year? + +Question_5: + + Good morning. On the CCAR do you expect any potential surcharges on the CCAR to come out when the US final rules on SIFI buffers come out? +And in addition to that have you learned anything from the CCAR in terms of the transparency of the process? Is there progression in terms of the back-and-forth with the regulators as you go through the CCAR process and their expectations? + +Question_6: + + Good morning. The drop in the adjusted expenses I think about 3% year over year came in a little bit better than we were thinking while revenues were also a little bit better. Obviously you've got a lot of cost-saving programs underway that you mentioned earlier in the call and at Investor Day but should we think that maybe you're running ahead of schedule or that the cost saves could be more or is it just lumpiness as we go quarter to quarter? + +Question_7: + + Okay, and then just separately obviously a big company out there announced it's exiting most of its banking assets and just wondering if there's any interest or appetite within your Commercial Bank to bulk up the acquisition there in terms of asset purchases versus a complete company? + +Question_8: + + Hi, this is Chris Spahr on behalf of Mike Mayo. I just have a question relating to your CET1 ratio guidance. Do you give any kind of guidance on the Tier 1 leverage ratio by the end of this year given your CET1 of 11%? + +Question_9: + + Do you think there is any way you will be able to kind of manage that ratio higher in the context of this year's CCAR? + +Question_10: + + Thank you and good morning. Marianne you mentioned that Treasury Service revenues were down due to the trade finance revenue area. And I noticed on the balance sheet the trade finance outstandings have dropped meaningfully on a year-over-year basis. Can you share with us what's going on in that line of business? + +Question_11: + + And then second you mentioned that you obviously had a very strong advisory business in the quarter and you gained marketshare of 150 basis points. Do you have a sense of who you took the marketshare from? Was it European investment banks or US? + +Question_12: + + Thanks and good morning. I just wanted to follow-up on your energy comments. +Could you help us understand what events it was that led to the reserve building? Was it company-specific events in the form of bankruptcies or just something else in your internal ratings migration? + +Question_13: + + And just on that last point your view on that is because of a recovery in prices rather than restructuring actions or things that your clients are undertaking. Is that fair or is it a bit of both? + +Question_14: + + Hi, good morning. I just wanted to see if I could just follow-up on the energy point. +Obviously you have the reserving and then you mentioned the 200 basis point impact on spend. I'm wondering if you'd just expand the discussion of energy, are there positive offsets that you're starting to see in the businesses elsewhere, either in terms of whether it's credit or borrowing or investment banking opportunities that may be popping up? Can you summarize the benefit if at this point you can see any positive offsets? + +Question_15: + + And my follow-up question is just with respect to the security services business you mentioned the change in presentation and then there was the client loss. Is there a way you can help us understand just what the organic growth rate of the business is adjusted for the reclassifications whether it's on a sequential-quarter or a year-over-year basis? + +Question_16: + + Good morning. Maybe just go back to the capital ratio issue for a second. You noted that standardized you're at 10.8% and that you still feel that will be your constraining factor by the end of this year. +So if you're already at 10.8% and your target is 11%, I know it's plus or minus, but it does seem like you got three quarters you hit 20 basis points. So is there anything unusual that you're expecting in the coming quarters or is it just you can never know quarter to quarter but all else being equal it looks like you can probably hit 11% if not better. Is that a fair way to think about it? + +Question_17: + + And as you've looked at the surcharge, at the G-SIB surcharge more the proposal is do you feel better or worse, you feel is there any areas where you think you can pull the lever more significantly to improve that ratio or lower the charge? + +Question_18: + + Thank you. Marianne, going back to the reserve build which obviously was done for the oil and gas as you mentioned can you share with us in the Corporate & Investment Bank I know on a total dollar amount relative to the corporation it's not significant but there was a big increase in the nonaccrual loans from 110 to 251 in the quarter. Can you give us some color on what drove that? + +Question_19: + + And again that was not oil and gas related obviously, it's in the CIB area that was in the Commercial Bank? + +Question_20: + + Good morning. You highlighted the Swiss franc is a tailwind for FICC. Could you may be size that for us? + +Question_21: + + Sure. I know that the higher volatility of course would drive higher volumes, I was just talking about the event specifically and if there was some one-time gains involved in that so that we can adjust for a core figure here? + +Question_22: + + Okay, fair enough. And then on the energy front a lot of the focus was on the CB and the energy exposure there but you all mentioned that there's exposures in CIB, too. Can you give us may be an update if there was any changes in any of those exposures or loans this quarter? + +Question_23: + + Yes, thank you very much. On your deposit discussion about pushing out I think you said during your Investor Day that you would like to get about $3 billion of noncore deposits off the balance sheet and I know you said you hope to make progress in the second quarter. How should we model that out and what type of benefit have you modeled out to the NIM with that $3 billion of deposits? + +Question_24: + + And then real quick on your professional services, professional services was down from $2 billion to $1.6 billion. Is that mainly due to some of that legal cost maybe starting to go away from the crisis? + +Question_25: + + Hi, good morning. So Marianne I was hoping that we could dig into the RWA progress that we saw in the quarter and specifically was hoping that you could disaggregate how much of the sequential decline that we saw was a function of the planned mitigation actions and model benefits that you've cited versus actual FX driven declines? +Because assuming that the US dollar strength persists all else equal one could surmise that we should expect RWAs in a long-term context actually coming out below that $1.5 trillion target that you've cited in the past. + +Question_26: + + Okay, fair enough. And another question on capital but relating to CCAR. Marianne you've noted on this call and in the past that you don't expect CCAR to be JPMorgan's binding constraint longer term but just given the reduction that we saw in the ask or the need to use the Mulligan in the last exam I was just hoping you could cite some of the planned mitigation actions that you expect to take so that we could see you guys get on the path towards delivering on that 55% to 75% net payout target. + +Question_27: + + Good morning. Jamie you warned in your annual letter about the possibility of another flash crash. Yesterday I think Simon Potter at the Fed warned about it and cited HFT as one of the issues. +Larry Summers warned about it about a week ago. Are these warnings going anywhere, are they being translated into action anywhere in the system? + +Question_28: + + Secondly, Marianne a question about Commercial Banking. The returns in Commercial Banking have remained in sort of the high teens over the last number of quarters and it's certainly respectable sort of 17% to 19%. Is there any way those returns improve materially or as rates go up or does that get offset by competitive factors and are we at a normalized level for that business? + diff --git a/exam/original-files/Problem_2_3_Sample_QandA/11_answers.txt b/exam/original-files/Problem_2_3_Sample_QandA/11_answers.txt new file mode 100644 index 0000000..41ac0a4 --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_QandA/11_answers.txt @@ -0,0 +1,284 @@ +Answer_1: + + So to -- obviously we don't have any particular insight. I think the comments you're referring to were comments about the support for evaluating the possible inclusion of some or all [of it]. And so really it hasn't changed relative to previous comments and the door has clearly been left open for that, but we have no further information. And so far it's evaluating the possible inclusion of some or all of the surcharge, so we're just going to have to I suppose and see. +Meanwhile, as you know, we are -- and by the way, if it happens for us it would happen for everyone. We have shown you before -- not that that's a good outcome, but we've shown you before that we think that regardless the competitive peers set that we have is going to cluster at or around similar capital levels. And so if everybody has to increase their minimum, it is going to be a similar position for everyone. +Meanwhile, we are continuing to execute on everything that we've already told you we are going to do to optimize our capital. Our commitment is to go to firmly within the 4.5% bucket for the surcharge, and if we believe we can do it and it's economic and it's not going to hurt our clients, we may go further. So we will respond when we see the rules and we are not going to stop continuing to do the best we can to optimize our returns based on scarce resources. + +Answer_2: + + We actually haven't really changed our point of view since the investor day and previously about the fact that we are expecting retail deposit -- and there are other people who have slightly differing views. But we are expecting retail deposits to reprice higher and faster in this cycle than in previous rising rate cycles, given the competition for good, high-quality, LCR-compliant retail deposits; given the advancements in mobile banking; given the awareness in the general environment around low rates and the desire to participate in rising rates. So when we think about our sensitivity and our reprice, we model it in assumption that it's going to be higher, somewhat higher. + +Answer_3: + + Obviously, when you talk about trading, when you have two months to go in a quarter you don't know the exact number and repricing is a complex issue. I'll give you some very specific things and then I'll tell you why it's hard to figure out exactly what shows up. +Clearing, we've definitely seen people start to charge for clearing and effectively charge the balance sheet 25, 50 basis points. It's a small business so I don't think it's going to dramatically affect those lines. Prime broker, we've seen similar type of thing. +Repo, it seems that people are charging pretty much for repo. We need to get a return on it. Exotic derivatives, which are again very small, are being repriced to, I would say, full capital and liquidity. Muni credit has probably been repriced a little bit. Again, it's a small market. +If you go to credit and trading, so credit we've really not seen any repricing effectively in commercial credit. You've seen a little bit in mortgage to make up for the extra costs in mortgage. You've seen a little bit in auto; it got more aggressive, not less aggressive. So trade finance you've seen a little bit of repricing, and I know these are not all trading numbers. +What you don't see, Mike, is that in a lot of cases, while you may have repriced a little bit, you're also shedding business so that you have -- as you are protecting your margins by -- because of AML costs you are going to not do certain types of business anymore. In FHA the lifetime cost of servicing, you cut back on FHA volumes, etc. So you're protecting your margins, but you're actually shrinking your revenues in some cases. That's happening a little bit in clearing and prime broker and stuff like that; you want your best clients. +In other categories clients are -- like deposits, we haven't seen repricing effectively, I don't think, in non-operating deposits. On the other hand, some clients are saying let's restructure our relationship; it makes more sense for you, JPMorgan. I'm willing to give you other business which is not credit sensitive, etc. +It's kind of a whole of the amount of things taking place in there, but the goal is to get a proper return on your capital, not necessarily to show revenue growth in that line item. It's very easy to show revenue growth. + +Answer_4: + + Mostly what you see in trading is just volume related and spread related, etc. Even in trading, spreads are narrow but breadth is also very low, which means spreads get gap out pretty quickly, which eventually could be good for trading. So it's unclear (multiple speakers). + +Answer_5: + + I'm talking about basis points, 20 basis points, 15 basis points, 10 basis points. That's all you need in some of these things to get an adequate return on capital as we currently look at capital. + +Answer_6: + + So what I said, and hopefully it was clear, is that we actually exceeded our commitment. We actually shrunk our non-operating deposits by more than $100 billion and not just through our consumer deposits, but we are also able to grow wholesale operating deposits. So we had a good mix shift both in consumer versus wholesale, but also within wholesale and so we feel really great about that. +There are two priorities after that. The first is protecting that position and making sure that we are able to not have inflows of those deposits as the industry continues to absorb them. But the second is we will likely look to potentially push a little farther, but it gets harder and harder each margin, the next $5 billion or $10 billion, as you get more and more closely aligned to operating accounts and operating business. And we've always said that we want to do this for the right reasons, for capital efficiency, but not do it in a way that's going to materially harm our clients. So that's the lens. + + + The [product] has also been made in the Level III assets: derivative receivables, certain balance sheet items, RWA. So the effort to optimize the balance sheet for G-SIFI, etc., is not going to stop; that we are going to continue to do. + + + But you know what, I don't anticipate us launching another and announcing another program. We've already done a little better. We will continue to try and do a little better. +In terms of revenue impact, not very much right now, as you might very well know, because you can see that the balance is much more on a spot basis that on an average basis. But the equation looking forward will be much the same math we said at investor day, approximately 25 basis points revenue on approximately $100 billion average for a half a year, but there would be some expense benefits on FDIC costs, etc. So not a very big number. +I think that was the question? + +Answer_7: + + A little bit, yes. + +Answer_8: + + Yes, so let me do this in two parts, and I'm going to start with the consumer businesses, where the commitment is actually a couple of years old and we are sort of well, well on our way to delivering against that -- the commitment $2 billion dollars in 2017 versus 2014. It's not exactly linear, but you can consider it to flow through time. +And if you look at the CCB page on whatever page that is, I think we show that for the first half of the year our expenses are down over the first half of last year by $0.5 billion. So that gives you a sense for how we are tracking. On the CIB, obviously the commitment is somewhat newer; at investor day this year $2.8 billion in 2017 versus 2014. +I would characterize that in two parts. $1.5 billion is business simplification. The majority of business simplification -- not all, but the majority -- will come out of our run rate in 2015. And you've already seen that in the first and second quarter when you've seen the $300 million, $400 million expense reductions in each of the quarters on business simplification. +The other $1.3 billion, which is all the reductions in technology and operations and headcount, is going to be things. We are working on it actively -- we have programs, we have people -- but it's going to be more of a 2016 and 2017 benefit. If I was to look at the first half of 2015 versus the first half of 2014, take the $500 billion in consumer and business simplification in the CIB space -- that's probably the right way to size it, about a quarter so far this year. + +Answer_9: + + Yes. + +Answer_10: + + RWA, advance RWA is down $36 billion, $37 billion; [one five three six]. We said a little greater than $1.5 trillion. We are still on track to be $1.5 trillion or a little greater, $1.5 trillion advanced at the end of the year. Standardized right now is at $1.5 trillion, $1.5 trillion, so pretty close to $1.5 trillion against the target at the end of the year of $1.55 trillion. +That's a little better, but obviously on the standardized you have some upward pressure as we continue to grow those really great loans that we are growing. If you look to our investor day targets, we are still hoping to maintain the discipline around both of those at approximately $1.5 trillion through time. + +Answer_11: + + Of course. I'll do it in three parts. First of all, it is growing pretty solidly or strongly, so either in-line or in many cases better than the industry across most of the product categories. The one that's growing the most strongly because of the way we are portfolioing loans is mortgage, so that's driving some of that outperformance. And the one that is most challenging, but still growing, is middle market. Fiercely competitive; everybody is chasing that sector. +But you can go through the businesses. We had 6% loan growth, 8% loan and lease growth in auto; 6% business banking; 19% core in consumer; 4% in commercial, so 3% core in card. So it's solid to strong pretty much across the board; most competitive in middle-market and flattered by portfolio and mortgages. + +Answer_12: + + What I said earlier is not inconsistent; it's entirely consistent with what we said last quarter. We built reserves modestly for oil and gas last quarter on the back of the spring redetermination of borrowing base. We feel another modest reserve this quarter. +And we said we don't -- we might expect more reserves in the second half of the year. There's another redetermination cycle in the fall and it's I'm not going to say likely, but it's possible we will be selectively downgrading some clients. If none of that is out of our expectations, it's completely normal levels considering the cycle and how we think about the credits, we are still very happy. +And we are not going to make any comments on regulators. + + + Those reserves do not mean we're going to have losses. + + + Correct. We are reserving for downgrades; doesn't necessarily mean that they are going to be cash losses. + +Answer_13: + + So credit, like charge-offs, have been very benign across the whole sales base. They have reverted to somewhat more normal levels in auto, so I'm not expecting there to be a big step changes in the underlying charge-offs in the wholesale space. We continue to see improvements at a slower pace in mortgage, but at 21 basis points we are sort of getting down there. +And card, while it is slightly above -- 2.6% above our 2.5% is also pretty much getting there. It's one of the reasons why we've said expect the second half to look like the first half in terms of order of magnitude and expect net-net low for long. + +Answer_14: + + I would say in the non-credit -- sorry, just to clarify the comment on oil and gas; we said they will not necessarily translate into losses. We are not going to predict which ones will or won't. +On the reserves, for non-credit-impaired portfolio we are continuing to see improvements in charge-offs as well as home prices, albeit a little bit more gradually. So I would still expect there to be more reserve releases over the course of the next 18 months in hundreds of millions of dollars in total; not billions any longer, of course. We have $1.8 billion reserved right now. +In the post-credit-impaired space clearly that's life-of-loan model and so we will continue to evaluate that model against parameters that we have in it and expectations, so that will be what it is at the time. And in card we're not expecting any significant reserve actions. + +Answer_15: + + So you are absolutely right; all the underlying phenomenon are still there. We are still seeing spread compression, but we are seeing very strong growth in spend. We aren't quite lapped yet on new accounts going through the revenue rate. We will eventually be, but it's a good thing to be adding these new accounts that will drive strong spend in the future. +So I would say our near-term guidance is that we are expecting our revenue rate to be at the lower end of that 12%, 12.5% range. And, yes, over time as spread compression abates and we continue to drive strong growth with the quality of our products and our partnerships we would expect that to start to edge up. + +Answer_16: + + Yes. We told you we would hope to drive core loan growth in the card space low single digits and this quarter it was 3%. + + + I just want to emphasize -- Marianne mentioned it, but emphasize; Chase Paymentech, which is seeing really good growth, probably 50% faster than the industry, but we are also signing people with Chase Paymentech combined with ChaseNet. We are running real volume across it and we are signing up a lot of folks for that and ChasePay. So the strategy of ours is kind of coming to fruition and we hope it will be a good driver; happy customers and good growth for the next 10 years. + +Answer_17: + + Obviously we don't give you lots of details on our issuance plans. You are right; one of the drivers for us to issue in part, not exclusively, was it's not -- as you know, we were Tier 1 leverage constrained in CCAR and so as a result of issuing this we not only helped TLAP, but we help our CCAR stress capacity. And we are about 164 RWA. So we are not going to talk about forward issuance but we've made progress. + +Answer_18: + + So to start with Volcker, we aren't expecting Volcker to have an impact in the near-term trading outlook. We've been talking very consistently over an extended period of time about the fact that we've reshaped our business through time to be compliant in substance and in form with Volcker. And so while that was real reshaping of the business, the last 18 months have been really focused on getting operationally ready around the reporting and the metrics; it's been hard work and we are ready. +So I don't expect it to have a direct impact on our near-term trading. Clearly over time we need to continue to evolve the feedback loop with regulators, but that will be entirely gradual. +With respect to the trading, it is too early for us to say anything specific about the second quarter -- sorry, the third quarter -- except to say we are -- all other things equal, we would expect to see normal seasonality from the market. Nothing has changed that fundamentally wouldn't have us expecting normal seasonality in the third quarter. + + + I just want to point out that trading, if you look at it over a long period of time, has been -- we've become very consistent. I think in 2014 we had no trading loss days and even this year there were only a handful of trading loss days. Obviously some areas are up and some are down, but our shares are high. I think we are doing a great job servicing clients. +We are adopting all the new rules. Like [50%] of interest-rate swaps are on SEF today and I think it's 95% of FX trading by transaction is electronic. You can do a lot on your mobile phone or iPad now, so the business is actually doing fine. The returns on risk are very good. We used to report that, but kind of return on VAR are very good. It's become a much more stable business that clients need overtime. + + + Right. And just to add to that, I would say that we also talked about, in the period of transition towards a more normal economy and rising rates, you might see some shocks like this. We've weathered both the EMEA bond sell off and China well, and it just speaks to the strength of our risk management discipline. And we generally do pretty well in more difficult markets. + +Answer_19: + + So with respect to -- we saw a stronger seasonal purchase market. We actually gained a little share in the purchase market in the quarter and refi held up pretty well because of pipelines coming into the quarter. But we are expecting that to grow seasonally in purchase and in refi to pull that down to smaller levels in the third seasonally. And no direct impact from the disclosure requirements. + + + Part of the quarter is the reserve takedown, so don't double count that. That may not be there next quarter. + + + Right. + +Answer_20: + + The way I would think about it is normal tax rate for the year is 30%, plus or minus. Just given the way tax reserving is it's usually biased to being fairly conservative and so, as you know, we have seen discrete tax gains periodically, some of them not insignificant, resulting from completion of settlements and audits with tax authorities. Not to say that you should necessarily model in directly 30%, but we don't predict or forecast the tax benefits. + +Answer_21: + + It's definitely the latter and I think it's perhaps a little too early to tell on the former. + +Answer_22: + + Jumbo. + + + Yes. So over half are jumbo, the other are conventional performing fee plus. + +Answer_23: + + We have a fairly large securities portfolio and our decisions around that are in part driven by our overall interest-rate risk positioning, but with respect to the mortgages it's fundamentally a better execution decision for us. We will portfolio or loan where it makes economic sense to do it relative to distributing it, other than jumbo where, clearly, they will always go on our balance sheet. + + + If you can put a jumbo on a higher ROE than a Fannie/Freddie, you would do that. And part of the investment portfolio is for liquidity and obviously, because non-operating deposits are down, proportions of that will come down too. + +Answer_24: + + There's been a lot of press and reports, including recently, on market liquidity and there are a number of factors playing into it. It's true that liquidity, in some cases, has dried up quite quickly when there's been extreme volatility and it fed on itself. But the reality is that we've talked about the fact that that was likely to be a phenomenon that happened more frequently as we transition to a more normal environment. +We are very disciplined about how we trade and support our clients and generally we've been able to weather them very well, as has generally the community. Not that we know, but we haven't got any stories or horror stories around (inaudible) a bond sell-off or other things this quarter. So I think it's definitely an issue; one that we need to watch, one that has multiple root causes, and one that we are generally taking in our stride. + + + And look at the big picture and we pointed it out, the financial system -- like in the United States banks are much more sound. Trading books have more capital liquidity. The whole system is better off. So you can't look at one piece and say what will that do. +The second is that these -- obviously there's less liquidity in the marketplace and it's a whole bunch of factors. It's hard to tease out exactly which one, but trading books have more capital and more liquidity. I think people are a little worried about potential Volcker rule violations, so they are being a little more cautious. +There are obviously structural changes in electronic trading, HFT, and each business is slightly different. So not every -- I wouldn't say everyone is affected exactly the same. It's also true that the system is pretty resilient to what happened with the currencies and treasury, and that's a good sign. +I think what we are going to be really cautious about is when markets aren't that good. JPMorgan is fine. We are not talking about whether or not JPMorgan is going to have a hard time with liquidity. We are not. The question I really would have is, when markets are tough, will there be a feedback from -- these violent markets, will there be more volume or less volume. +Someone was quoted the other day saying markets always pull back when there are tough times; that is true. The question is will be harder and worse, will it feed back into the real economy. It's not will there be lack of liquidity. +During the crisis they were two market makers out there and we were one of them and so you need them a little bit, but it doesn't stop markets from gapping out. We are not saying this is a terrible thing, just being very cautious about it. And we are always trying to be very cautious. + +Answer_25: + + So I can tell you that obviously we took the feedback from the regulators as the industry did exactly as you would expect, entirely seriously; put loads of resources and effort to bear in making as much progress as we thought was humanly possible over the course of the period. And we feel that we made very, very -- I would agree with you; the industry, but JPMorgan specifically, made very, very significant progress in addressing the feedback between getting it and the July submission date. And obviously we feel like we have a credible plan. +That's not to say that we won't continue and some of our plans, and you saw it in some other disclosures. We are going to continue to work very hard at simplifying our legal entity structure over the next few years and interconnectedness and operational resiliency and all the things -- and reporting readiness, all the things that are going to make it even better. +So we think we made very, very significant progress. We think our plan is credible. We don't know exactly when we will get feedback, probably in the fall. + + + And we respond to every single thing regulators raise with the huge resources to meet their needs. It will probably be iterative over time about they'll make more demands this year, etc. and --. By the way, I think there is a 50-page public part that you can actually read and it shows you. That's a 50-page summary of I think a 200,000 page detailed report. + +Answer_26: + + It's very broadly competitive and we compete obviously with big banks, regional banks, and non-banks. It's not that we are losing loans and deals most often on price. It's normally on size of holds or non-bank taking whole deals or on structures, but it's very, very competitive. Everybody likes the sector for growth and everybody likes -- so everybody is trying to make progress. +We are being very, very disciplined, and as a result of that, slightly lower growth than the industry average. And you might not always want us to always grow at the industry average. You want us to hold true to discipline. + + + Remember, we looked at the whole relationship. I forgot the exact number, but if you look at the middle market relationship, I think something like half, maybe even a little bit less, of the revenues are from the lending. + +Answer_27: + + The way I would characterize it is we had a period of time following the Wampum merger where we were in new markets and we didn't have the right distribution footprint where we were building. We said about a year and a half ago that we felt like we had the right footprint as a macro matter, about 5,600, and that now we are around perfecting that, which is about consolidating certain branches where it makes sense but building new ones where makes sense. Consolidating them together where it makes sense. +You will see I think Gordon said approximately 150 net down in each of the next couple of years and that's probably still the right way to look at it, but it's really perfecting the network. Moving branches to the areas we like where there's a high density of affluence. And then, as you know, really looking at the nature of branches: so the footprint, the way we are using them, the way we are staffing them, importantly, moving them to more advice and less transaction, more automation. +Definitely responsive to the evolution in customer preferences. And mobile and online is not only a fantastic customer experience evidenced in our experience stat, but it's also a lower cost to serve, so we are also improving the profitability of the very highly transactional customers. I think Gordon used the word omnichannel. We have a place for everything in our suite and branches are very important. We're just going to be evolving them to continue to meet customer needs. + + + One add is that we are thinking about attacking a new city for the first time, like in a major way, because we want to see how that works out. + +Answer_28: + + In the non-operating deposits within the wholesale deposits, the majority is the CIB, but not quite two-thirds. And then you've got the commercial bank and you've got a little bit in asset management. So it is the majority of the number, but there are still sizable numbers, particularly in the commercial bank in the financial (inaudible) space. +And then, when you look at our overall balance sheet, you see cash going down because of the deposits. You see securities going down, but strong loan growth offsetting, and then small reductions in trading and secured financing. + +Answer_29: + + Are you doing year-over-year? + + + You're starting in the wrong time period. + + + Are you starting at the year-end or year over year? + +Answer_30: + + Well, we are getting more operating deposits, too. + + + We talked about the deposit reduction is overachieving in non-op and improving mix in operating. So, trust me -- and I'm not looking at what you're looking at, so I do trust you -- but trust me that 60%-ish of it is CIB. + +Answer_31: + + We will clarify off this line because (multiple speakers). + +Answer_32: + + The M&A -- we don't think Greece has affected the M&A dialogue very much, because it's been very active pretty much around the world. And when I say around the world, it's also like European companies coming to America and American companies going to Europe, etc., and those conversations continue. + + + A lot to Europe, yes. + + + A lot to Europe, yes. So Greece had no real effect on that. Greece is a very, very small percent of the Eurozone in total, so economically it's not a driving factor for most of the companies there. Psychologically maybe it's going to affect some people, but I don't see why a company that has its own ambitions is going to change them because of Greece. + + + And would just -- with respect to the backlog, I would say it's very good. + + + We did see a tremendous amount of something that we've almost never seen before, of American companies financing in euro because it was cheaper to do that, even if you swap back to dollars. So you saw a lot of American companies going to Europe to do that. + +Answer_33: + + I think if you go back to last quarter, Brennan, and take a look at the remarks from last quarter, we talked about the change in presentation of some expenses versus revenues for the ADR business that drove a reduction, but just a classification issue. And then in addition we did lose a large client at the end of last year and that is having an impact. I think if you go back and look at the second quarter, hopefully that will make it clear. +And so the guidance, when we did those -- when we made that presentational change and obviously we talked about the client exit a few quarters ago, the guidance was, given those, we would expect the revenues to run between $950 million seasonally. And this is obviously a strong season and, therefore, it at through $950 million and $1 billion seasonally and, therefore, it's at the $1 billion. + + + So Marianne gave you all very specific guidelines, which we don't normally do, on treasury services, investor services, and expenses in the commercial bank because a lot of you have your models wrong. And Sarah finds it very frustrating that you can't get it corrected quarter after quarter, so we've said here is the number that is actually our best guess. So, please, put it in your third- and fourth-quarter models. +And mortgage revenue was another one which has been ongoing to us. And what's the other one so we can just get it on the table whatever it is? + +Answer_34: + + Nancy, it's really important -- when we talk about these numbers, by the way, RWA and branches, we are not making commitments to anybody. That's our best guess knowing what we know today, but we reserve the right to change that on a moment's notice for whatever reason that makes sense for the Company and the clients. +And so branches -- it is very important that you look at branches city by city until you have the right footprint. So if you remember, the old A&P which never changed its locations and it never changed sizes and it failed. Any retail business should always be adding in new communities, subtracting in some; having the branches to adjust to a new reality, whether it's getting bigger or getting smaller. +In our case it's getting smaller, but again we are not getting smaller because we are guessing at this stuff. We are getting smaller because of the less need for operations and branches now. People are doing far more on mobile phones like that. +So we actually do it city by city. You don't set an overall guideline and say you have to do X, Y, or Z. It's city by city. And so, for the most part, in the WaMu footprint, I think Florida and California for the most part, city by city we went in and added what we thought we should have. +Wampum -- remember we also added on top of that small business, private banking, some middle-market, other businesses that WaMu wasn't even in. It was part of the expansion of those businesses, too. And so when I said a new city, I'm talking about what we've never really done -- I was talking about this way back to BankOne and the stocks when we did the merger with JPMorgan -- is going into a city de novo that we never been in. There you've got to look at how many branches you are going to open, how long is it going to take. And so we do want to do one of those and that will have nothing to do with WaMu because they are also places that WaMu wasn't. + +Answer_35: + + No. I don't think there's been a retreat from open markets there either. +Remember, we've always said about China is you got to look and plan for the long run, which we do in all businesses. McKinsey has a report that shows that they are going to have 25% or so of some of the Fortune 1000 in I think it was 10 or 12 years. Enormous growth in their companies. Their companies are going overseas. Their companies are doing more M&A. +We did that one unique transaction where ChemChina bought Pirelli in Italy. Obviously, when we have a unique network, we can help a Chinese company and an Italian company at the same time, so we are building there for the long run. +As a risk management tool we've always said that the way we treat that is we will be prepared for very tough times and I think it's a mistake not to grow because you're going to have tough times. I have never seen an economy that didn't have tough times. If you went back to the United States, when J.P. Morgan was building JPMorgan back in 1850 and 1860, look every single time that you panic because America had a recession there would be no JPMorgan. So we are not going to change. +What we've seen with the officials in China is that they are very responsive to changes, and you can argue whether they should have gotten that involved in the stock market. You can't manipulate stock markets. But they are very responsive to lending. +They've changed their reserve policies, their RMB policies, the QFII policies, the Hong Kong Shanghai Connect. Not everything they do is going to work, but they still seem very committed to more and more market reform, more and more of taking SOE -- rationalization of SOEs and taking them public, so some market discipline there. Creating more of a consumer society. +And what we've always said -- and I think they have the wherewithal to meet their short-term objectives of growth, but we expect that they will have bumps in the road. We expect that and we are going to look right through that. The fact that their -- I also remember their market went from $4 trillion value -- so it's a $10 trillion economy. It went from $4 trillion market value to $10 trillion; now it's back to $6 trillion. I think those are the numbers. +The American stock market has done that roundtrip a couple times itself and so the American economy is $18 trillion. I think our stock market is $25 trillion, so there will still be huge opportunities there. If they ever completely reverse what they are talking about doing, you will see it in far more significant ways than them getting involved in the stock market. + +Answer_36: + + Marianne, you showed a NIM thing that NIM would go back to 265 to 275. And, remember, when we say deposit beta it is by product, by --and it's got gamma, so the first 25 basis points, the second are a different 25 basis points, they are different than the third 25 basis points. It's a pretty intensive analysis to try to get accurate; that's what we're trying to do. And it's all in that number that was presented and we don't think that's changed dramatically. +As Marianne said, we are assuming that whatever happened in the last cycle, this one will be worse. In other words, you will gather less of the benefit from rates going up than we have in the past. + +Answer_37: + + Listen, there's a unique --. + + + Yes, (multiple speakers). + + + It is a unique circumstance when you're at zero. There are a lot of things that happen when rates grow to 25 basis points that there will be -- you will pass very little of that also. And we also see that -- we will see that in money market funds. We will see that in some forms of deposits, etc. +The beta gets much higher as rates go up. If I had to guess, I would say we are conservative, not aggressive. + +Answer_38: + + Yes, the credit downgrades included oil and gas and we called it out just because in total oil and gas was $140 million of our total net $250 million reserve build. But also I said that there were select names, it's like a dozen names, so it's not really like there's another sector, just very discrete names. + +Answer_39: + + No, we are not going to give you that. We disclose -- when you say mortgage duration, obviously we build into all of our models mortgage duration. You guys can calculate that yourself by looking at disclosures in the 10-K that show mortgages at 3%, 3.5%, 4%, 4.5%, etc. And obviously we can change that at will with our investment portfolio and things like that. +It's all in the NIM already. So obviously we have negative convexity in our portfolio. + diff --git a/exam/original-files/Problem_2_3_Sample_QandA/11_questions.txt b/exam/original-files/Problem_2_3_Sample_QandA/11_questions.txt new file mode 100644 index 0000000..163c0ee --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_QandA/11_questions.txt @@ -0,0 +1,160 @@ +Question_1: + + My first question is the capital progress has currently been solid this quarter; last week, however, there seems to have been more support in the Fed in terms of including the SIFI surcharge in the CCAR test. And I guess the question is in two parts: one, what do you think the chances are of the -- any or all of the CCAR surcharge or the CET1 surcharge to be included in CCAR; and two, what are the next steps in terms of business model adjustments, if that did pass? + +Question_2: + + Got it. And just the second question is you've clearly made also progress in terms of your deposit mix. As we potentially anticipate a rising rate environment for the back half of the year, given what the regulators have done in terms of saying, okay, here are the good deposits, here are the not-so-good deposits, how should we expect the pace and magnitude of retail deposit repricing or pass-through if the Fed does raise rates in the second half of this year? + +Question_3: + + I see your markets revenue are down 1% year over year the way you look at this, but I'm trying to reconcile that with Jamie's comments two months ago at a New York conference where you said there is repricing in rates derivatives, prime brokerage, clearing, and trade finance. I'm guessing it's just risk off. +Can you shed more light on what type of repricing you are seeing with any specific examples, because the transparency for us on the outside is pretty weak? + +Question_4: + + And just one follow-up. When you say (multiple speakers)? + +Question_5: + + When you say a little repricing, is it bigger than a breadbox? Are we talking about basis points or 1% or 5%? What are you talking about here? + +Question_6: + + Question on the deposit shrinkage. You obviously finished the program you announced at investor day. Just wondering if you're going to take it further; what the impact on revenues has been. And do you expect that the full benefit to NIM is already in 2Q or -- in the 2Q numbers or we are going to see more benefit in 3Q from the actions you took? + +Question_7: + + Yes, and the NIM benefit should flow into 3Q as well? + +Question_8: + + Marianne, was wondering if could remind us about the timing of your expense reduction targets in the consumer and investment bank. Specifically, if you hit the $57 billion in adjusted expenses for 2015, how much of the ultimate cost saves does that $57 billion target for this year incorporate? How much would you have achieved already in 2015 and any thoughts on the trajectory for remaining saves after this year? + +Question_9: + + A quarter of the total? + +Question_10: + + Okay, great. Then a quick follow-up is on RWA. Any update to your year-end RWA targets and thoughts about how we should think about potential RWA levels longer term? + +Question_11: + + I'm just curious in terms of your core loan growth; you mentioned that that's up about 12% year over year. Can you give us a sense as to where that's growing the strongest and where you're seeing a bit more weakness? Within the core loan growth, specifically. + +Question_12: + + Okay, Marianne, and for my follow-up I noticed I guess you were quoted in an earlier meeting today suggesting that there could be further provisions for the oil and gas portfolio. There's been some media reports prior to this week about regulators potentially looking a bit more carefully at your portfolio as well as a number of other banks. +Can you give us a little more color as to how you are thinking about the potential trends there and any comment you might want to give in terms of where the regulators are focusing? + +Question_13: + + Marianne, just wanted to follow up on that last point. Your commentary about credit, for the second half, is in line, you're $4 billion plus and you've got $1 billion of charge-offs this quarter again. So on that point just one question about where you continue to see underling improvements. Card obviously is still above your guidance, but can you give us some of the thoughts about where any existing improvement can come from? + +Question_14: + + And then to your point about not expecting to be much loss from the energy provisioning and that we could see energy provisioning, plus this quarter you had a nice $300 million release from the NCI portfolio, is this kind of it for reserve release and can you talk about your outlook there? + +Question_15: + + Maybe we could just ask a question on card fees? That's been an area where growth in card fees have been pretty flat for a while as you ramp up reward spending. We saw a pretty nice jump quarter over quarter; some of that is seasonal, but it was a little stronger than what we saw the last couple of years. +Are we getting to a point where you are lapping some of these higher reward costs and growth in new accounts and we should start to see that revenue line track more closely with spending, or is this something unusual this quarter? + +Question_16: + + Okay. And on the card loan side it seemed like you saw a decent uptick this quarter. You are starting to get past some of the runoff and it seemed more of a core driver. + +Question_17: + + So first question on capital. I just want to get a sense as to how we should be thinking about preferred issuance plans going forward now that you've met the 150 basis point RWA target. + +Question_18: + + Okay. And then just a follow-up regarding, Marianne, your comments about the trading outlook for at least in the near term, recognizing it's still very early days in the quarter. Since the very start we've seen, or at least we've experienced, a number of global shocks and on the regulatory front we do have the Volcker implementation deadline, which is looming. So taking all those factors into consideration, how should we be thinking about the near-term trading outlook? + +Question_19: + + You guys had a very decent mortgage banking quarter in the second quarter with rates going up. We know that the refis have started to come down, but the purchase market has been stronger I think than people expected in the second quarter. What do you see going into the third and fourth quarter, especially with the new regulations coming out with the disclosures with (inaudible)? + +Question_20: + + (multiple speakers) Can you talk a little bit about the tax --? My follow-up question on the tax rate. Should we be modeling in 28% to 30% going forward; is that 25% just an outlier? + +Question_21: + + The equity trading has been very strong the last couple quarters, both for you and for others, assuming it continues the rest of this earnings season. As you step back and think about some of the drivers there, you mentioned some repricing; we've obviously seen some deepening of some markets, increased volatility. Can we think about there being potentially a long-term secular recovery in the equities trading, or do you think it's more just stocks are going up, just global QE, or too early to tell? + +Question_22: + + Okay. And then just separately, what type of mortgage loans are you adding? Are these jumbo? Are they fixed rate? + +Question_23: + + Okay. And I guess are you choosing to add some mortgage loans instead of securities? Because you've got a smaller securities book than a lot of peers and it seems like there's capacity to add there. + +Question_24: + + I just want to follow up on the conversation in fixed income, and I agree with you; it seems like you weathered the whole Greece and China storm pretty well. The thought on the lack of liquidity in the fixed income markets gets a lot of attention. You guys have the most market share; have the lowest standard deviation in the business. As a liquidity provider that's a good thing for you. +But curious on how you are thinking about preparing for what seems to be a pretty serious issue and how serious of an issue do you think it is in terms of the potential disruption? + +Question_25: + + Speaking of cautious, the last one I have is on living wills. I know we have a little bit of time before we hear anything, but if you look at the comments from the previous year, what they wanted you all to address, it seems like there was a massive amount of progress made. I'm not sure what you can tell us, but curious your thoughts on progress made and then maybe timing on when we might hear regulators thoughts. + +Question_26: + + Marianne, you mentioned a couple of times about the competitiveness in the middle-market lending space. Can you give us some color on what you are seeing, whether it's underwriting standards, and what kind of product type in the middle market that is most competitive? + +Question_27: + + You guys have made great progress with the penetration of the mobile banking app that you've created as well as online banking. You showed us that your branch count is down over 100 branches on year-over-year basis. What do you see for the branches as you go forward? Is that trend line likely to continue as you continue with the increased penetration from the mobile app? + +Question_28: + + I was just curious about the reduction of the non-operating deposits and I would have expected that to come mainly out of the corporate and investment bank. But when you look at the disclosures on your average asset level, it's essentially been $850 billion plus/minus each of the last five quarters. Where is the shrink really happening, or how do we see it? + +Question_29: + + But when I look at total assets in the CIB, it's 845 this quarter versus 846 last year. It just doesn't look like a whole bunch came out of there. It looks like it all came out of the --. + +Question_30: + + Well, if you go linked quarter it's 865 to 845. I'm just curious; it doesn't seem to mesh up to --. + +Question_31: + + Okay. When you see it in your public disclosures it all looks like it's coming out of corporate and other, which is down more than 100 linked quarter, so I was just kind of curious how it all works. Because if --. + +Question_32: + + Just following up on the markets discussion. Curious whether or not you have seen some of the drama around Greece impact M&A discussions in Europe this quarter and maybe an update on the IB backlog at this point. + +Question_33: + + Okay. Thanks for that. And then on security services, I know that you all highlighted that it's up quarter over quarter on the seasonal strength for the dividend season, but it was down year over year. Can you help us reconcile the year-over-year decline? + +Question_34: + + Jamie, you made a comment about attacking new markets and that sort of tags on to what I was going to ask, which is whether there are any of the old WaMu markets where you've not been able to expand as aggressively as you've wanted to and that you might be thinking about exiting. So I'm just wondering, can you just tell us how you feel about individual markets right now? + +Question_35: + + Okay. Another geographic question. I get that Greece is not that important to the Eurozone and the events of the past couple weeks seem to have been a lot of theater, frankly. But the events in China in the last couple of weeks have been somewhat worrisome. Have your plans for China changed at all, given what seems to be a retreat from open markets there? + +Question_36: + + Just a quick follow-up. Marianne, earlier on you were talking about deposit betas and, for a lot of very good reasons, expecting that deposit betas will be a little bit faster this time around. But could you round out the conversation as to how you are thinking about how your NIM is going to traject in a rising rate scenario? Because I got a few questions on whether the deposit betas being a little faster means that the NIM trajectory is likely to be different from last time rates rose for you guys. + +Question_37: + + Okay, because the last time rates rose your NIM didn't move up that much. + +Question_38: + + This is actually Steve dialing in for Gerard. Just two follow-ups. You had mentioned the credit downgrades; I believe you said oil and gas. Were there any other sectors, and if there were, just some figures on them? + +Question_39: + + Okay, great. Thank you. And just a second follow-up. Can you just give us your mortgage duration and how far you are willing to take it? + diff --git a/exam/original-files/Problem_2_3_Sample_QandA/12_answers.txt b/exam/original-files/Problem_2_3_Sample_QandA/12_answers.txt new file mode 100644 index 0000000..33047dd --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_QandA/12_answers.txt @@ -0,0 +1,175 @@ +Answer_1: + + Yes. + +Answer_2: + + There are a couple of different questions in there and maybe I'll try and separate them. My comments about the seasonality in the fourth quarter were most particularly towards Markets revenues and less so towards the IB revenue space. With IB revenues, it's a mixed story. Talking now about the sort of Banking revenues rather than Markets revenues. So the pipeline for M&A remains very constructive and really pretty good, so we're expecting to continue to have strength in M&A in the fourth quarter. +With ECM you saw obviously a pretty sharp falloff in activity in the third quarter. We have seen the pipeline in ECM to the degree that that shows you visibility into the fourth quarter which is somewhat limited. We have seen that build up and so there is possibility that we'll be able to pull through some of that into the fourth quarter. But that will depend upon how the markets behave. +With respect to DCM, our sort of guidance there was a commentary really mainly to the strength of the fourth quarter last year and on relative basis, the pipeline is down. And it's really to do with normal refinances are slowing and the maturity wall is smaller but it's still healthy. It's just not going to be at the same levels that we saw last year. + +Answer_3: + + Look, the situation for us in markets was one where there was volatility, regardless of you how you want to characterize it, and people were acting -- our clients were acting on the back of that. We were able to capitalize on that flow. We were able to intermediate for our clients, put our capital [at risk and make] some money. We did pretty well where there was volatility. Where there wasn't, it was more about, to your point, more about low levels of activity, people on the sidelines. It was tougher to make money because less was happening rather than anything else more significant than that. So far in the fourth quarter we're two weeks in, it's too early to say, but there's not been a tremendous change in the landscape. + +Answer_4: + + Looking at the revenue rate, the guidance, remember our guidance previously had been you should expect our revenue rate to be at the low end of the 12% to 12.5% range. The most important thing we want you to take away from talking about our co-brand partners is that we feel great about having signed up United Airlines and Southwest Airlines and partnering with them again for the medium term. +And the economics of those deals on a standalone basis are still really very good. But the co-brand space is very competitive and when any of those contracts are going to be renegotiated at this point, they're going to be renegotiated to competitive levels. And so, it's really the fact that we're seeing that is going to come through in our revenue rate in the fourth quarter which is going to push it down to below 12%. It doesn't change the fact that the ROE target for the business is still 20% and that the economics of those partnerships are still good. Remember, these -- + + + Just given the numbers, it's $200 million a quarter for four quarters until it lapse. + +Answer_5: + + So I would say, first of all, we gave some expense goals in Investor Day for both Consumer Businesses as well as for the CIB. And those were I think pretty sizable goals, $2 billion in 2017 versus 2014 for the Consumer Businesses and $2.8 billion in 2017 versus 2014 for the CIB. And we are working through that. We are on track in both of them. I think I said earlier that adjusted, the Consumer Businesses in the three quarters so far are $700 million down year-over-year in expenses. So against the $2 billion target, we're certainly getting there. +And on the CIB, we expected 2015 to be mainly about forcing out those business simplification expenses and we've essentially done that too. So we're on track. We're pushing hard. We still have work to do. We are always going to be diligent on our expenses and generally speaking at Investor Day we also said we're going to be on or down which is actually pushing hard to keep them down but not at the expense of good investments in the business. So obviously we are going to respond appropriately to the revenue pressure but not overreact. + + + I've spoken my whole life about good expenses and bad expenses. Bad expenses are waste, things you don't need. You don't have [to trade through] processing, things like that. We want certain expenses to go up. When we find marketing opportunities in Card, we're going to spend it. If the Investment Bank does better, the comp accrual is going to go up. That's how we run the Company. That's not ever going to change. + +Answer_6: + + So Mike, thanks for that. So $700 million, if you adjust for legal expense in the Consumer Businesses year-to-date, we'll do some more in the fourth quarter. And year-to-date on business simplification, which I think for in total was about $1.5 billion, we've done $1.3 billion. In total, that's $2 billion so far. Obviously more work to do in 2016. With respect to the adjusted overhead ratio, it speaks a bit more to seasonality of revenues than anything else. + +Answer_7: + + I'll start. Jamie, you can yes or no at the end. Mike, we would say that the US economy is doing pretty well there. We're seeing good demand for loans in the Consumer space and reasonably good sentiment in the Business Banking space and our core loan growth numbers do show that. There's nothing particularly funky in the loan growth numbers. We do our very best to show them in the right light. +I would take a slightly different perspective on the jobs report on the non-farm payrolls. And not to sort of over think it, but while I know it was somewhat lower than people were expecting or possibly hoping for, it's still at around 140,000, almost two times what would be required to have stable unemployment. So it's only one report too. You can't overreact to it. It's not that we're seeing anything that's causing us any concern and our outlook for the fourth quarter is pretty solid I think. Jamie, anything? + + + Nothing to add. + +Answer_8: + + We did better than we had targeted on our non-op deposits. We worked very, very hard but we told you we would on derivative notionals, compressionals, so our level 3 assets. It is absolutely the case, not to diminish the amount of work we've done and the progress we've made, that we obviously went after the most impactful -- least impactful to the client franchise, most impactful to the ratio with a less revenue [give-up] first. We made great progress. It becomes increasingly, not exponentially, but increasingly more difficult for every net basis point. +That's not to say, by the way, that we aren't continuing to work very hard at it and optimize and that we won't push further. But we're not at a place right now where we're going to target anything structurally below this, except for over the longer term just continuing to work through it. And our overall capital target, we're at 11.4% now. Our overall capital target still in the short to medium term is still 12%. + + + I just want to add, in the new world we have to obviously monitor and push down to all the business levels, GSIB, CCAR, Basel, LCR and SLR, and we want to optimize all of them. So we're only living with this for a couple years now. As we embed it in our systems, we'll have a better way to track it and monitor it. Over time, I would expect the GSIB will come down a little bit. It only comes down in lumps. You got to make a big difference to go from 4% to 3.5% but imagine over time, I'm talking about years. I'm not talking about anything you'd see this quarter. We are very comfortable where we are today. Over years, you might have to change some of your business strategies but I think it's a better thing not to be an outlier in GSIB. + +Answer_9: + + It has nothing to do with next year, Betsy. When I say over time, it just happens that JPMorgan built a global corporate investment bank. 70% of it is financial institutions, 30% corporate. We easily could have been built the other way around, we focused on it over time. When I say over time, it might be quite easy for us to say that over five to six years let's focus more on corporates and less on financials and that will affect your GSIB fairly substantially. That's what I'm talking about. It has nothing to do with CCAR for next year or anything like that. + + + A couple of really small points on CCAR for next year for what it's worth is we were constrained in CCAR by leverage. We have issued $6 billion of preferreds in the year. We are reacting to try and make sure that we are managing our binding constraints or our most binding constraints. So we're working on that. +The other thing to note is that we're at 11.4% as we sit here now. So we're not gliding a long way from where we need to get to. Both of those things together, with obviously our profitability, should mean that we have incremental opportunity. But our range is 55% to 75% and we hope to be in that range. + +Answer_10: + + So just a couple of things. First of all, I think the [FSB] thing was a sort of leak. So it's as good as it is. I will tell you that the news on structured notes was not strongly positive but we hadn't banked on it being. So not entirely pleasing but not disappointing relative to our models and expectations. +Other things to pay attention to anyway are there's no change to the internal TLAC assumptions. The clean holding Company rule is one that we're watching out for. But fundamentally -- and then there was the timing. Is there going to be a substantially elongated transition period? I would call it all fairly marginal. It hasn't changed the overall picture for us. We're at around 16% and we'll figure out the FSB proposal that's leaked out wasn't shockingly different and we'll see how the Fed responds. + +Answer_11: + + So with respect to the fourth quarter, we are expecting our loans to grow and overall net-net [rotation out], cash and securities to loans would be supportive of NII. But remember, the biggest boost to our NIM was associated -- or was a big boost to our NIM was associated with changing the mix, reducing our overall cash balances. So, a few things going on. +The outlook for the fourth quarter being relatively flat was associated with market implied rates which are relatively flat. And so in the law of big numbers, that plus or minus a few basis points is what we're expecting. With respect to looking out to 2016, obviously we don't know what's going to happen with the rate curve. If rates stay very flat we should still have upward pressure on our NII associated with the change in mix of our balance sheet. +So the fact that we've got a smaller interest earning asset base and more loans and less cash and less securities should be supportive even on flat rates. We don't know when rates will rise but if market [implies] are followed or if the Fed [dots] or anything like realistic, then that will be even more constructive. Remember in the first year, we get the biggest benefit from short end rates and the first 50 basis points of them. + + + No, unfortunately not. + +Answer_12: + + So I would say that first of all, with respect to purchased credit impaired, with this release we did on the $375 million, that's our baseline expectation for that portfolio. Our baseline expectation is no material incremental reserves. Obviously if things improve and they're sustained, then there may be more reserve releases. But I wouldn't try and model those. +With respect to the noncredit impaired portfolio we talked about, you've seen our charge-offs at normalized 14 basis points. Our portfolio quality is really getting quite high. We're cycling through most of the significant risks. Reserve releases will be more modest and a little bit more periodic and several hundred million dollars next year, maybe $300 million plus or minus but not significantly more than that. + +Answer_13: + + Look, our efficiency target at 55% was over three years or so and we still will be driving to get to around that level. But it does, as you quite rightly mention, include not just rates rising but a fair degree of normalization in rates. We'll see what happens in 2016. Obviously it's possible but we're not going to call an outlook on rates next year. + +Answer_14: + + Okay. So we've taken some large reserves in the last few quarters and our overall reserve number obviously is consistent with our expectations based upon the outlook for oil prices. There was a redetermination cycle that we reserved for in the first quarter and so there will be another one in the fall. We've been as forward leaning on that as we can be. Obviously I'm not saying that there may not be any net incremental reserve build but we're not expecting them to be significant. A lot of companies have tried to adjust their expense bases and otherwise help their position. So if energy prices stay around these levels and recover slowly, we're expecting, net, not to have material incremental reserves in the next quarter. We may see some. + +Answer_15: + + Let me deal first of all with production quarter-over-quarter revenues. Margins are down. Margins are down for two principal reasons. Remember, quarter-over-quarter, at least on a closed loan volume, we were at a consistent level. Margins are down because we moved a mix shift towards correspondent from retail towards purchase from re-fi as well as capacity in the industry, more capacity in the industry and therefore less constraints. So the production quarter-over-quarter revenue is more of a margin number than anything. +With respect to year-over-year, I do want to make this clear. With respect to the guidance year-over-year that we should expect non-interest revenue for the mortgage Company in totality to be down $250 million. That brings our total year-over-year NIR down around $1 billion, maybe a little more, which is what we guided to at Investor Day. And it's more off the back of lower repurchase reserve releases, lower gains on Ginnie Mae sales and [XI] gains, non fee-based revenues that are to do with our third party UPB as well as run off in the UPB. So it's consistent with our guidance. It wasn't fully reflected in everyone's models. +I think there was a third part to your question but I have to say I've -- oh, expenses, yes. Thank you. On expenses -- we continue to work very hard on our expense equation, both in terms of managing down the -- particularly in the servicing space by the way, managing down the default inventory in a number of different ways but also investing in our operating model. So in technology, to improve the production operations cycle process, also in our site strategy. So no, we are not done. We continue to work very hard at it. We have made great progress but we continue to work hard at it. + +Answer_16: + + Obviously, we're not going to comment on anything specific. We would be willing to take and we do take a look at things when they come up and if we are able to price for the risk and it's in a client segment or an entry we like we might be interested. But there's no -- we have no special comments on it. What we're really interested in is growing our underlying core loans with our customers that we can continue to do business with. + +Answer_17: + + Not as defaults happen. It's to do -- depends on whether it's reserve based lending or whether it's not. But as companies are either downgraded or as they are experiencing financial -- change in financial condition or the borrowing base is redetermined, we will act accordingly. We try to be as forward-leaning on that as is possible. We don't have perfect insight until some of that information becomes clear. That's the process. + + + And the reserve base lending, you basically take essentially current prices, you discount at a discount rate, you assume expenses, you [active real engineer] your force and things like that, and you see if you can make rollover the loan at a sound -- I'm going to call it 65% LTV and we think it's pretty good. That's what we're here for is to lend to clients particularly in tough times. You can't be a bank that every time something goes wrong you run away from your client. +We also do things like stress test down to $30 oil, maintain $30 for 18 months and say, how much more reserve do you have to put up? I think I said somewhere, you can correct this number, Marianne, we're not in the same room, that if that happened, we think we're going to have to put up another $500 million or $750 million in reserves. Which is just not something we worry a lot about. + +Answer_18: + + Good evening. + +Answer_19: + + So it's obviously a really great question. Unfortunately we really don't guide to our forward-looking issuance. You're right, we are above 150 basis points right now and we're also working on our leverage balance sheet. So we're working the dials exactly what you would expect us to, but we're not going to make any comments about forward issuance. + + + Yep, I got it. + +Answer_20: + + The pipeline for 2016 is building up, so we don't have perfect visibility yet. We think obviously the deals that were being done in 2015 were skewed toward larger deals and we think there may be more flow in 2016 but it looks pretty healthy to us so far, but it's building up. + + + Thank you. + +Answer_21: + + I think over the last several quarters, forgive me if I'm slightly wrong but I don't think I'm entirely wrong, our sort of C&I growth has been broadly in line with the industry. Remember that over the course of 2013 and 2014, we did a lot of work on simplifying our businesses and that had an impact on the pace of our loan growth. But our mature markets are performing well. We're seeing growth in our expansion markets. We're adding new clients. We're culling our prospects. So everything is set to continue to see growth more going forward than we have in the past. + +Answer_22: + + There was about -- in CIB, there was about $47 million of metals and mining, about net-net $20 million of BAU growth and then just a few other normal BAU puts and takes, downgrades, upgrades. Other than those three things there was no one specific call out. + +Answer_23: + + Thanks, Chris. + +Answer_24: + + Of the $19 billion that we put on our balance sheet, around $10 billion, just a little over $10 billion was jumbo. The rest was conventional conforming. + +Answer_25: + + We'll have to get you the split. + + + I think the jumbo's like a third ARM. Counting the conforming, I think it's all fixed. That's what I remember. + + + We'll confirm for you. + +Answer_26: + + You are right that at these kind of 2.5%, 250 basis point levels in Card, it does speak to the quality of the loans we're originating and the engagement with the customers. Which is much more now about driving, yes, some NII but really, really good spend and therefore lower credit quality. It's an integrated equation. We're expecting, given our originations and the runoff portfolio, the work loans running off in the portfolio that we're building is really very, very clean. +We're expecting that those charge-off rates to be low for the short to medium term, to read out for the next year for sure. And there will be a combination of things that would drive that. But largely it would be environmental. We don't expect at this point, we have made changes to our credit box but they aren't material changes and we'll continue to test our appetite to want to do that and that may have an impact. But we're originating the vast majority of our cards in the super prime sector. + +Answer_27: + + Similar, yes. Compared to the industry, our originations are skewed to the prime space. + + + And our LTVs are lower and our durations are in line or lower. + +Answer_28: + + The biggest comment I would make is that there was a lot of volatility, particularly in China, in the second part of or the last part of the second quarter. We were -- we did pretty well. We helped our clients. We didn't have significant open risk positions. We weren't very directional. We were able to do well in that situation. Also in the reversal, also on currency moves. It really is a comment I made about we're here to serve our clients, they were transacting, we were able to do risk intermediation in today for them and so we made money on both ends. + +Answer_29: + + Let me just talk qualitatively for a second and we'll get you some numbers. But we're focused on mobile and digital primarily because it's going to be great for the customer experience, it's what our customers want. And also because it's a significant enabler for reducing cost to serve and improving efficiency. So we've been very focused on whether it's quick deposit, whether it's quick pay, whether it's our mobile wallet, whether it's our mobile app and we've been seeing great results. I'm off the top of my head not going to be able to tell you the penetration rates but we can get back to you. + +Answer_30: + + I can tell you that we are growing our deposits nearly twice the industry. That we know. I think that's a reasonable indication for a bunch of different reasons and that we have a very highly rated app. I think the most highly rated bank app but we'll check that too. + +Answer_31: + + On the Fed funds and reverse repos, we had moved toward higher yielding, for example, emerging markets assets there. So we got some high yield there. We saw some yield on our trading book moving out of emerging markets. Just a bit of puts and takes. On securities, was it significant? I'm sorry, I'll come back to you. Operator, any more? + diff --git a/exam/original-files/Problem_2_3_Sample_QandA/12_questions.txt b/exam/original-files/Problem_2_3_Sample_QandA/12_questions.txt new file mode 100644 index 0000000..ffdc7b9 --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_QandA/12_questions.txt @@ -0,0 +1,124 @@ +Question_1: + + Thanks very much. So I'm curious, the capital markets related commentary, I get there could be a hangover effect into fourth quarter and I'm guessing that's the primary driver behind your analyst estimates appear high on fourth quarter. But could we talk about what you're actually seeing in terms of where the financing markets are maybe drawing the line? Meaning, are the deals that underwriting you expect to fall off in the fourth quarter based on your pipeline, is that a function of timing that you think could come back next year? Are these marginal deals where markets are drawing the line? I'm trying to get at -- + +Question_2: + + The ultimate question of is this the first time that FICC could actually grow in 2016 just because of the beat down it took in the back half of this year? + +Question_3: + + Maybe just a follow-up in FICC in general, I know none of us have a crystal ball. The slowdown in activity that we see, some of it's clients sitting on hands. Maybe you could separate that between any providing of liquidity [and marks] along the way. Because we did see a really wide credit spread widening in the quarter. + +Question_4: + + Thanks. Marianne, can you talk a little bit more about the Card business and try to help us understand the Card revenue pressure that we saw this quarter into the fourth? How much of that is the NII side of things and how much of that is the partner repricing? And how far past the fourth quarter do those resets continue before growth can overcome it? + +Question_5: + + Got it. Okay. Second question, just on -- in this tough revenue environment, first of all, can you give us a quick update on the progress on the expense plans? And then, any -- does anything change given how tough this revenue environment has changed as far as either accelerating or digging in again? I know your prior comments have focused on obviously always needing to invest. But in terms just of your focus as you think about next year and building the expense budget against the environment that we're seeing. + +Question_6: + + Hi. Just a follow-up to that last question. So of the total $4.8 billion of expense savings, how much have you achieved? And if you're on track, why did the adjusted overhead ratio go backwards? It's 60% in the third quarter versus 58% in the second and 59% last year. + +Question_7: + + All right. And one follow-up. Clearly it's due to revenues. So the question Jamie, if you could answer this, a simple yes or no question. Is the economy getting stronger or weaker? And the reason I ask that, the jobs report from a couple weeks ago seems to imply the economy's getting softer. Yet, your loan growth actually -- your core loan growth accelerated and you're guiding for faster loan growth in the fourth quarter. So is there noise in that loan growth figure or is the economy, based on what you're seeing, getting stronger and the jobs number is misleading? + +Question_8: + + Hi, Marianne. You saw some very good improvement in the GSIB surcharge from the 4.5% to 4%, probably came a little faster than some of us expected. Do you have good momentum there to do more there and how are you thinking about the tradeoff, the cost benefit tradeoff, of pushing further down on that GSIB bucket? + +Question_9: + + Hi, thanks. So just a question on the capital, getting to 4% now with a goal over time to get to something lower, 3.5%, 3%. Does it also give you more room for capital return requests next year, Jamie? + +Question_10: + + Okay. And then just on TLAC, I know we're still waiting for the Fed decision but we did get FSA recently. Anything in there that you can respond to as to how you're prepared for TLAC? + +Question_11: + + Good afternoon. Just maybe a question on NII and NIM. I think Marianne you said it would be relatively flat in the fourth quarter yet you're still expecting some pretty strong loan growth. Just wondering if you could maybe discuss why you think it would remain flat in that scenario? And maybe a bit longer term in an environment where we're looking at lower for longer potentially in the rates, how do we think about the NIM a little bit over the intermediate term? + +Question_12: + + Yes, good afternoon. My question is on the Credit outlook. The consumer reserve release has continued to offset the wholesale reserve build and I'm just wondering, how should we think about how much is left on the Consumer side over the next several quarters, especially given the 23% loan growth that we saw this quarter and your note saying that this momentum should continue? + +Question_13: + + And just my follow-up question, following on Ken and Mike's question on expenses, maybe I'll ask it another way. Over the past two quarters your adjusted overhead ratio was 58% to 60%. You noted that you think that net interest income could grow next year even if rates stay low. Could you potentially slide below the 58% to 60% band that you reported over the past two quarters relative to -- you mentioned an efficiency target of 55% if rates actually normalize? + +Question_14: + + Good afternoon. Thanks for taking my call. First of all, Marianne, if I could in terms of some of the credit numbers that you mentioned in terms of the Oil & Gas provisions? They seemed pretty modest in the scheme of your more than $20 billion of exposure to that industry. How are you thinking about the redetermination process that started this quarter and how would you guide us in terms of thinking about what the provisions could be in the fourth quarter following the redetermination this quarter? + +Question_15: + + Okay. And then in terms of Mortgage Banking, you noted that production -- the production amount was actually up quite nicely year-over-year but the revenues in terms of production and also in servicing were a bit weaker, certainly on a quarter-over-quarter basis. But the expenses were relatively stable on a quarter-over-quarter basis. Is there something going on there that we might see further improvement in the expense base on the Mortgage side of the business in the fourth quarter? Or are we sort of -- are you at where you need to be in terms of the $1 billion to $1.1 billion a quarter in that business? + +Question_16: + + We've seen some assets change hands and you guys have been mentioned as a buyer for some of the other assets that are out there. Just wondering on what the ability and appetite is out there to buy loans. + +Question_17: + + Just separately, following up on energy, how exactly do you re-evaluate the portfolio? Is it as the defaults happen, that's where there's a big boost to reserves or you get in front of that? + +Question_18: + + Good evening. + +Question_19: + + Marianne, I appreciate your commentary on the preferred issuance that you guys have done so far throughout the year. Looks like you're now above the 150 basis point target. You alluded to that being a function of efforts to manage to your binding constraint under CCAR. Just wanted to get a sense as to what -- how you guys are thinking about issuance plans going forward? + +Question_20: + + So just moving over to the Investment Banking side and maybe trying to dig a little bit deeper into some of the guidance you've given on M&A. Looks like the backlogs and expected completions for the fourth quarter are quite healthy but at the same time, post the August volatility, some of the historically strong M&A indicators like market cap, CEO confidence, those measures appear to be deteriorating. I just wanted to get a sense as to how you're thinking about the M&A outlook beyond the fourth quarter, just given some of the weakness that we've seen in some of those measures. + +Question_21: + + Thank you. Good afternoon. Marianne, can you share with us -- you mentioned that you've built out 400 new relationships in the middle market area of the Commercial bank. But when we look at the loans outstanding, they're essentially flat on a year-over-year basis whereas the Corporate Client business has grown very rapidly. Can you give us some more color behind what's driving those numbers? + +Question_22: + + Okay. And then you talked about the reserve build in the CIB, about $128 million was for Oil & Gas and the total number was $232 million. What was the other areas that required reserve building this quarter? + +Question_23: + + Mine were asked and answered. Thank you. + +Question_24: + + Yes. On the Mortgage Banking side, I noticed that your jumbo loans -- not your jumbo loans -- that your residential loans on your balance sheet's grown. Are they mostly jumbos and are they coming out of your normal production, that $29 billion and you're selling less to the government? Can you add some color around those numbers? + +Question_25: + + And are they mainly ARM loans or are they fixed rate loans? + +Question_26: + + Thanks very much. Marianne, if I can just follow up on some of the consumer credit quality metrics. At the Investor Day and subsequently Gordon was indicating unsurprisingly just given the very low levels that the expectation should probably be for some moderate rate of deterioration. And yet, we haven't seen it and I'm guessing that's partly because of the underwriting that's occurred over the past few years. My question is, what are the circumstances in which we should expect more significant deterioration there? Is it only macro or is there something else competitively that could influence that at this stage? + +Question_27: + + And are the dynamics similar in Auto as well? + +Question_28: + + Yes, hi. Just a quick one at this point. Equities, Marianne, you highlighted strength in Asia which I think probably was better than maybe some had expected given some of the volatility. So could you give some color on the trends you saw in that region in your Equities business? + +Question_29: + + Thank you. Hi, Marianne. Quick question on your Consumer business. You guys have shown very strong steady growth in the mobile users. I think it's over $22 million in this quarter. That's up from $18 million a year ago. Can you share with us what percentage of your customers are actually mobile users and how does that compare to a year ago? And what does Gordon think? What's the penetration rate that you think you can finally get to there? + +Question_30: + + Is there any evidence that you guys can point to where you're actually taking market share from other banks because your mobile products are just more superior than some of the smaller regional banks and community banks? + +Question_31: + + Okay. And then finally, your asset yields jumped this quarter which was good to see of course. Can you share with us how the Fed funds rate went up as much as it did sequentially? And also your securities yield went up in the quarter sequentially, can you give us some color behind both those numbers? Thank you. + diff --git a/exam/original-files/Problem_2_3_Sample_QandA/13_answers.txt b/exam/original-files/Problem_2_3_Sample_QandA/13_answers.txt new file mode 100644 index 0000000..dc7b92e --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_QandA/13_answers.txt @@ -0,0 +1,264 @@ +Answer_1: + + Good morning. + +Answer_2: + + So, again, I would say that the pipeline coming into 2016 in M&A was good, solid, up, in fact. Obviously, volatility can dampen the confidence of Boards and CEOs. Dialogues are pretty active, and we think the types of deals that we'll see in 2016 will look different. But I think, in the first couple of weeks, it's not been particularly strong, and we do need to see some of the stability come back, I think, for us to really see that conversion start to pick up. + +Answer_3: + + Yes, less mega-deals, more mid-sized deals, more cross border. It's a little different. Actually, more deal count, less big mega-deals, could be very constructive for revenue, but we're likely to see it be a little bit different in 2016. But honestly, the pipeline is good, and -- yes. + +Answer_4: + + North America will be a tough comp. It was very strong in 2015, but Europe could be very constructive. + +Answer_5: + + Yes. So, the way we do our reserves, just for context, because I think it's important is, obviously the oil price outlook is important and instructive. And it's very clearly going to drive how we think about probabilities of default and loss, given [default for] certain of our customers. +But I think it's also the case, just for context, to know that it is very name-by-name specific. Specific conditions at clients matter greatly. And so when we do these estimates, they are directionally correct, and order of magnitude correct. But that's just for context. +Oil -- we said last quarter, if oil reached $30 a barrel, and here we are, and stayed there for, call it, 18 months, you could expect to see reserve builds of up to $750 million. And that assessment hasn't fundamentally changed. +So, it is not the current market expectation that oil will flatline. It is the expectation, right now, that there will be a modest recovery. Based upon that, we would expect to take some additional reserves, but for them to be more modest, less significant. But that's the range; if oil's at $30 and stays here for a long time, up to $750 million. + +Answer_6: + + I think, first, I'd say we try to be very conservative, always, and so we're not trying to put up as little as possible. You know me, I'd put up more if I could. But accounting rules dictate what you can do. +And these are baskets of -- the real risk is in producing wells, cash flows are down. Surprisingly, the cost of getting the oil out of the ground has also dropped dramatically, and probably much more than most of us would have expected. +So, you take these producing wells, you take the cash flow, you discount it at 8% or 9%, you lend against it. And so these are our forecasts. +And our energy book isn't that large, relative to JPMorgan Chase. We're not worried about the big oil companies. These are mostly the smaller ones that you're talking about these reserve increases on. + + + I also think, Mike, just -- + + + And the forward curve is -- the end of the year, for 2016, I think is more like [$41] or [$42], or something like that. + + + Yes, it's [$48]. So, hey, Mike, the other thing to know about the profile of reserves -- three things. The first is, it's not linear. +So, just the oil price decline, and the decline in the forward curve that we saw into December and to the end of the year, that's the impact it had on our reserves. It's fallen significantly in the first two quarters. That was not a knowable condition, and we can't reserve for that at the end of the year. That's why we said we would expect to take some more reserve increases in the next couple of quarters. +But again, it's a name-specific thing. And lots of other conditions at clients matter, including their hedging, their cash flows, the level of security, all those things. + +Answer_7: + + We don't. + +Answer_8: + + First of all, the oil folks have been surprisingly resilient. And remember, these are asset-backed loans, so a bankruptcy doesn't necessarily mean your loan is bad. +So, you have to be a little bit careful in -- and it's also, Mike, a philosophical thing. A bank is supposed to be there for clients in good times and bad times. So, it's not a trading market, where you try to support clients. +So, to the extent we can responsibly support clients, we're going to. And if we lose a little bit more money because of it, so be it. +And we've done that around the world. We did it in 2007 and 2008 and 2009. We try to do it responsibly. If banks just completely pull out of markets every time something gets volatile and scary, you'll be sinking companies left and right. + +Answer_9: + + Yes, so, let me just deal with where we are against our targets. So, the most notable targets were $2 billion in the Consumer businesses in 2017 versus 2014, and $2.8 billion in the CIB in 2017 versus 2014. +You probably heard my comment, but to clarify, on an apples-to-apples basis, we're halfway through on Consumer. We've done $1 billion this year. You don't see that 100% translate into the results, partly because of legal expense, which is not something that we particularly can predict, and hopefully won't be there forever. Also, because we intentionally decisioned in 2015, in the fourth quarter in particular, or mostly, to increase our investments in the Consumer businesses by $150 million. +So, we've achieved the $1 billion. We chose to reinvest a portion of it. Another $1 billion we're on track for. We will potentially reinvest some of that, too. And Gordon and we will talk to you about the basis for that at Investor Day. +On the $2.8 billion in the CIB, we're $1.3 billion through at the end of the year. And we talked before about the fact that the first $1.3 billion is largely on business simplification. We've had the revenue decline. We need to have the expense decline, and we've worked hard to deliver that, and we have. +The next chunk is to do with technology and operations and infrastructure and organization, and it's harder. And so, we will continue with them on track to deliver it, but it's going to be a job through 2016 and into 2017. + +Answer_10: + + Yes, I can give you some thoughts that won't totally satisfy you, which is our core expenses will continue to trend down, on the back of delivering against them. But we will make investment decisions that we think are good for the Company, accretive for shareholders, that will re-spend some of that money. And so we'll give you that shrink and grow at Investor Day. + +Answer_11: + + So, just on NII, yes, we are seeing, embedded in that NII, flat to up slightly. We are seeing a nice lift associated with the rate hike in December across businesses, as well as the continued benefit of the mix towards loans in our balance sheet. But we were flatted in our NII this quarter by $178 million on securities gains in CIO. So, that's going to mean the comparison is challenging, and then day count is obviously seasonal. +So, that's the dynamic. We are seeing the rate benefit. We do expect to see it, as I said in my remarks, for the full year. +Look, we think we are appropriately conservative on deposit [beta's]. It is not -- it is way too early to have any idea. There's -- virtually nothing has moved yet. And so, our job, and what we are doing, is paying very close attention to the competitive landscape. +These deposits that we're talking about, that have the high beta's, are valuable deposits with valuable clients for us, and we want to be competitive and pay fair rates. But it's so early in the movie that we haven't changed much in our modeling assumptions. + +Answer_12: + + So, energy, Metals & Mining, we're watching very closely, industries that could have knock-on effects like industrials and transportation. But we're not seeing anything broadly, in our portfolio, right now. +We're just watching very closely, which is why -- now, obviously, you can take our reserve build number, and you can say it's almost substantially all made up of Oil & Gas and Metals & Mining. And behind the scenes, we've had upgrades and downgrades of a number of other different companies, across sectors, but nothing particularly thematic yet. But we're watching. + + + I would just point our that Credit Card, Commercial Bank, middle market, large corporate credit is as good as it's ever been. So obviously, it's going to get a little bit worse. I wouldn't call it a cycle, per se. +If you have a recession, yes, you will see a normal cyclical increase in all those losses. We're not forecasting a recession. We think that the US economy looks pretty good at this point. + +Answer_13: + + Yes, so, look, we talked about achieving 4% last quarter, I think; and for disclosure, we were quite close to 3.5%. At that point, it becomes increasingly compelling to want to look at the margin, for what you could do to get within the bucket. And so that is what we did in the fourth quarter, is spend time really focusing on getting to that achievable boundary, which we thought at that point it was. +And remember, it's not nothing, in the year, that we started the year thinking we would exit $100 billion of non-operating deposits. And while there still could be some volatility in that number, of course, we've almost doubled that -- or doubled that, in fact. +So, we got some wind to our backs in doing it. It's also the case that, when you get the entire Business and Company attuned to the sense of urgency and desire to want to be increasingly efficient in this way, that, at the margin, in a 100 different things, little benefits accrue. +So, look, we're at about 3.5% -- we're just inside the 3.5% bucket, as best we estimate it. It's not as much important whether we're basis points or surcharge points below or above. It's much more what we do now to get safely in the bucket. And that's going to still take work. So that's why -- we'll obviously talk to you more about this at Investor Day. +In terms of the give-up, from an economics perspective, we wouldn't have done it at any cost. We have done it because we think it is important to do, because we think it's going to be constructive for the Company, and because the revenue give-ups were not significant. But they weren't zero, either. But to be able to reduce a constraint that is, in one way or another, likely to bind us -- or in multiple ways, in fact, likely to bind us, it was a, I think, very good trade. + + + It was done, effectively, client by client. + + + Yes. + + + To make sure we were trying to do the right things for our clients; not just jamming our balance sheet down and hurting people. + +Answer_14: + + The US economy has been chugging along at 2% to 2.5% growth for the better part of five years now. In the last two years, it has created 5 million jobs. If you look at the actual household formation -- car sales, wage, people working -- it still looks okay. +Corporate credit is quite good. Small business formation -- it's not back to where it was, but it's quite good. Household formation's going up. +So obviously, market turmoil, we all look at it every day. But I'm not sure most of the 143 million Americans look at it that much, who have jobs; and you have a big change in the world out there. People are getting adjusted to China slowing down. When you have commodity prices go down like that, there are big winners and losers. +The oil companies are the losers; consumer is a benefit. Brazil gets hurt. India benefits. South Korea benefits. Japan benefits. And those cause troubling waters. And hopefully, this will all settle down, and it's not the beginning of something really bad. + +Answer_15: + + Okay. So our total reserves, on balance sheet, for Metals & Mining, or notwithstanding we built $60 million-odd this year, is over $200 million. So the coverage ratio is pretty good. +The exposure is about -- I haven't got the precise numbers in front of me. They're [about] a third the size of our exposure to Oil & Gas, so about 2% of our overall wholesale credit exposure; so, considerably more modest. Which is why, if energy prices and general commodities weakness and stress stayed where it is right now, even for an extended period, we would think that the incremental reserves would be considerably more modest. + + + And it's also -- that one is mostly name by name. + + + Yes, for sure. + + + It's not big asset-based reserves. It's just -- they're big corporate credits, name by name. + + + And for both Oil & Gas and Metals & Mining in our portfolio, Oil & Gas is close to 60% investment grade, and Metals & Mining about half. + +Answer_16: + + Yes, so, with respect to home equity [re-class], remember, the majority of the problematic home equity underwriting was 2005 through 2008. So here we are, at the beginning of 2016, with [pig filling the python]. But we're monitoring it closely, and we have some re-class that have happened. +Obviously, interest rates are low. Home price appreciation, on the other hand, is your friend. So there are puts and takes. +We've been monitoring it, I would say, at the margin, or more than at the margin, at the early stages, coming in better than we had modeled. And remember, from an incurred loss perspective, we would consider these re-class risks to be largely incurred, so we've tried to reserve them, to the best of our ability. So we feel good about our reserve. I don't think we've disclosed them. But so far, from a performance perspective, I would say slightly better than our models. But we continue to monitor it, because it's still relatively early. + +Answer_17: + + Good morning. + +Answer_18: + + So obviously, you'll forgive me because we've been on calls since it came out. But, yes, we have been working on this for years. +The problem with this particular rule is that, as you stated, based upon the four QIS's that were done, there were some, I would characterize, significant challenges, with respect to the rules as written. And we were expecting there to be a number of meaningful changes, and there have been; in many cases, meaningful improvements. +But it's very technical, and there's been a lot of changes, so we need to sift through it to figure out, net-net everything. Although it is clear that net-net, despite the fact of the stated intention of the committee wasn't necessary to increase market risk capital across the industry, it will be higher. But by how much, it's really going to need to be sifted through. +And for that same reason -- for both those same reasons, I'm sorry -- for the reason that the rule has not been stable and there have been significant questions, many of which have been either addressed or partially addressed, and many, I guess, that have not, it would have been premature to have taken any actions in advance of figuring out where this has landed. And, as you know, the period to comply is three years. So it's more of a start from here, to figure out how to manage with this, after we've sifted through the details. +So, I wish I were able to give you a little bit more of a detailed answer, but we're going to need to take the time to go through it. + +Answer_19: + + There are always actions that we can take to reduce the impact. And so, we have to think about them in the context of our overall capital optimization program. +And, again, if there are -- if some of the things that we hoped -- and I -- honestly, I've been on calls since it came out. So, if some of the things that we hoped were going to be addressed have not, they could have had, or may have, meaningful impact on specific types of activity. And we will have to react accordingly. And, yes, we will take actions, if that's the right answer. I wish I could give you more details, but we just need to go through it. + +Answer_20: + + Good morning. + +Answer_21: + + Yes, so, I would say that, based upon our fourth-quarter balance sheet, given that market risk was a driver, given that balance sheet levels was a driver, particularly on standardized, we could give back, on standardized, as much as 10 to 20 bps of capital, of the 10.7% capital accretion. But the bigger point, on the RWA outlook, is that we expect to be bound, over the medium term, by standardized. And standardized is going to always have a neutral to upwards pressure, as we continue to grow these high-quality loans. +So, even though the RWA, being at the $1.5 trillion-ish sooner than we expected, is obviously good news. Regardless of how much of that may, in the short term, revert, our job is going to be to continue to become more efficient, to try and keep it there, just given the natural upward pressure of the standardized calculations. We can become more efficient in advance, but we're unlikely to be bound by it in the medium term. So, that's what we're focused on. +So, I wouldn't take the $1.5 trillion, and read through that we'll be continuing to decline from here on standardized. We'll be continuing to work hard to make sure that we can grow those loans that we love, but that have (inaudible) [risk weights] under a standardized basis. + +Answer_22: + + Okay. If I miss something at the end, remind me. +In terms of how we think about buffers, just really conceptually, the Firm manages, and the Board has set for the Firm, a risk appetite. That risk appetite has a number of features, and capital depletion in a stressed environment is one of them. And so, when we think about setting buffers, we think about it just broadly in the context of allowing ourselves enough room to absorb losses that are within our risk appetite, and not have to take premature actions, from a capital perspective. +So -- but having said that, our buffer has been pretty consistent, at the 50-basis-point level, for a reasonable period of time. And we'll update you on all of that at Investor Day. +With respect to our targets, it's a little bit more complicated than minimum regulatory capital, because as you say, we're bound, potentially, by multiple constraints, and one of them may be CCAR. Plus -- it is CCAR, I should say. Because as you know, the first two quarters of this year, our capital distribution plans have already been approved. And we haven't done CCAR, so this is not any kind of prediction, but it wouldn't surprise you to know that it's unlikely that we will pay out 100% of our earnings in CCAR, going forward. +So, we are on a path to continue to accrete capital, though we would like to move up in our pay-out range. So, given that we're still moving towards our 12% target, and we will update you if any of that changes at Investor Day. We're also, as you know, potentially going to understand whether or not the Fed changes any of the CCAR parameters, and whether that has an impact. +So, at the moment, the best we know is that we're going to continue to accrete capital, albeit more slowly, as we hope to move up in the pay-out range, but we haven't done CCAR yet. And that's if the rules don't change. So, 12% it is for now. + +Answer_23: + + It's both. So, think about -- in a [rate-sat] scenario, when you can pick whether you believe the market -- whether you think the market is -- or whether you believe the [FONC docs]. And I think it's going to be data dependent, so we're not going to have a stated opinion on that. +But because of the mix in our balance sheet in 2015, as well as our expectation of continued loan growth, we would expect mix to contribute about half of that. And defer 25 basis points about the next half because we are more sensitive to the front end of rates in the first 25 basis points. And you can see that in our earnings and risk disclosures. So -- even if we see nothing else. +Now, obviously, we believe, and the market believes that you're going to see a couple more hikes. That would be, on average, another 25 basis points, and that would be incremental NII again. + +Answer_24: + + I would say I would think about them in a somewhat similar directional way, given that our balance sheet ended below $2.4 trillion, a little bit of it market delivered, a lot of it purposeful. But we do intend to continue to gather deposits and extend loans, and while you're -- and portfolio loans, as well. So, while you will see some securities balances decline and the like, I would say again, net modest growth, but modest, and very lending driven. + +Answer_25: + + Okay. So, in terms of the impact of rates, obviously there was a lot of monetary policy confusion. Broadly, in the fourth quarter, the ECB underwhelmed the Fed, was (inaudible). So there was a lot of confusion. But by the time the rate hike happened, it was obviously pretty well understood. We did see strong activity, or strong client activity, relatively speaking, on the back of that in the rates business, more so than necessarily about spreads. +With respect to the Fixed Income business, we've always been very disciplined about how we think about the staffing levels and the expenses in that business. We've managed it very carefully. The compensation has come down across the trading businesses, and it wouldn't surprise you that some of that -- a lot of that has been in Fixed Income. And our business is at scale and productive. So -- + +Answer_26: + + You've seen, in Fixed Income -- we have a very good Fixed Income operation globally, around the world. Rates themselves don't filter through FICC trading directly. I think what Danny was talking about is, if you have healthy economies and confident investors, you have more volume in things like that. +We do see a little bit of repricing taking place, in prime broker, repo, conduit, and some of those things run through FICC. So, that is going to take place as the world adjusts to all the new capital requirements. And obviously, there's a lot of seasonality in the business, which we've experienced for the last decade. + +Answer_27: + + Thanks, Erika. + +Answer_28: + + No, we've seen no real repricing in loans on the balance sheet. You have seen a little bit of -- people are getting other revenues to make up for their credit exposure. + + + Yes. Think about the bank loans as being relationship loans that need to be in the context of [broader] relationship, and everybody is competing for them. + + + They barely repriced in 2008 and 2009. Banks were continuing to lend at the existing price. But that was because they -- these were long-term relationships. The bank loan market does not reprice like the markets do. + +Answer_29: + + We haven't seen it. + + + Also, it's very, very competitive. Everybody has been chasing these loans, and so that's a factor, too. So, we haven't seen it yet. + + + And then, if you -- the number in middle market lending, if I remember correctly, if you look at it by client, 60% of the revenues are not loan related. So, clients -- they also know what their relationship is to the bank. And while we need to make a good return on capital, the capital applied to the client is only partially loan related. And that capital, on its own, doesn't earn an adequate return. Simple lending, on its own, is generally not an adequate return business. + +Answer_30: + + I think the better way to look at it is that people seem, in certain of our businesses -- and I mentioned those, and there are some other ones -- capital has been deployed, people have adjusted to the new rules, and you've seen pricing go up. Whether it goes up a lot -- I wouldn't count on it going up a lot more from there. +The markets are going to be competitive at that point. But use of balance sheet, the cost has gone up; not loans, but most of the other stuff. + + + And remember, we think about our prime brokerage business going hand in glove with equity. + + + That's correct. + + + And so, while the repricing is helpful, and does -- at the margin, everybody is going to continue to always observe their pricing. We've built our platform internationally; Europe, we are seeing strong demand for our [synthetic pull-outs]. In Asia, we're adding clients -- we've got the wind to our backs. +So, it's an important business to our clients. You're right, there are some other people, potentially, not going to be as aggressive. And if we can take share, we certainly will. + +Answer_31: + + Obviously, we expect any transition adjustment to go through equity. If we are able to adopt it early, we might do that. I'm not aware that we are. But I could be wrong about that. + +Answer_32: + + So, yes, obviously, it was -- I think if you add up [cleared plus] other servicing rules, print them out, put them on the floor and stand them next to me, they're a foot taller. So they are very complicated. There's a lot of operational complexity to complying, and we're working very hard at doing that. +I will say, in the quarter, we did -- as part of being cautious about making sure that we're complying, our cycle times were a couple days -- a few days worsened. And so, volumes, our origination volumes, are a little lower than we would have otherwise seen; not a lot. And that's just timing, and it's just days. But not really from a financial results perspective, because of the way we recognize the revenue. +So, I would call it a little bit of teething problems -- across the industry, by the way, not just us -- nothing significant. We are going to get the work finished, and so it's tough, but it is what it is. + +Answer_33: + + Yes, so, it's about 60% jumbo, 40% agency or conventional conforming, and it's a better execution decision. So, when we look at the better economics between selling or portfolio-ing the mortgage, we'll generally choose the better economics. But we also prefer the annuity nature of the NII -- the lower servicing risk, and the better capital efficiency. +So, it has been the case, over the course of the last several quarters, that it has been the best execution to portfolio these mortgages. And actually, they are generating a nice return on equity. + +Answer_34: + + So we have had pretty big tax gains over the course of the last -- most notably, obviously, last quarter, over the course of the last couple of years. Most of those related to the, call it, 2003 through 2008 tax periods, when we were going through the financial crisis. And so, some of the matters were more complex, and we took appropriate reserving decisions on that. +There are many less of those very complicated matters ahead of us, and so we wouldn't expect to see the same sort of size of tax benefits going forward as we've seen in the past. But we had some this quarter. So, we'll have a few. And generally speaking, they are, because of the nature of the reserving for tax, generally speaking, we take a conservative approach and the bias to the positive. But it could be much more plus or minus zero, at this point. + +Answer_35: + + 30%. + +Answer_36: + + So, do I think it's plateaued? I think it remains incredibly competitive in card generally, in particular in the co-brand space. So, plateaued at a very competitive level, I suppose. +But in terms of -- I'm not going to talk about any specific names, actually, Brian, in terms of the potential for repricing. It's an important part of our Business, and we're going to defend our Business. + +Answer_37: + + It's a Board decision, and so, neither have we received that guidance from the regulators, nor have we done CCAR, and had that discussion yet with the Board. But we have generally said that the Board likes to have the flexibility to increase dividends over time, and we have had our dividend most recently at or close to that soft cap. +So, we would love that capacity, and I would imagine that, over time, it may be used. But again, it is a Board decision, not a management decision. + +Answer_38: + + From -- we do everything pro forma. So, first of all, I would say the following. Right now, my understanding -- and if I'm wrong, forgive me -- is that it's your spot balance sheet two years prior that would drive your G-SIB two years forward. But the reality, if you ask my opinion, given that we're going to be reporting quarterly going forward, and because of the likelihood that G-SIB may or may not feature into CCAR, I think it's going to be less important, necessarily, what you are at any one moment in time, but where you are projecting to be or stay. +So, I suspect that we will get the benefit, potentially, of this, not today. We just closed our balance sheet. But I think that it's going to need to be a little bit more dynamic going forward, as it gets potentially introduced into stress test. + + + But I don't know that. + diff --git a/exam/original-files/Problem_2_3_Sample_QandA/13_questions.txt b/exam/original-files/Problem_2_3_Sample_QandA/13_questions.txt new file mode 100644 index 0000000..af2f673 --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_QandA/13_questions.txt @@ -0,0 +1,164 @@ +Question_1: + + Good morning, Marianne. + +Question_2: + + So, curious about whether or not you all have seen the stress we've seen in some of the credit and equity markets, and some of the volatility impacting M&A velocity appetite, amongst Boards and C-suites, broadly, in your conversations and throughout the IB? + +Question_3: + + And just by different, is that a reference to size, or can you be a bit more specific on what you mean? + +Question_4: + + Okay. (multiple speakers) That's helpful. + +Question_5: + + Terrific. Helpful. And then, you referenced energy prices staying this low would lead to a significant reserve build, you expect, in your energy book. Can you maybe give a little bit more color around that? How would you define significant? And how long would oil need to stay down here, in order to see some of that reserve action? + +Question_6: + + Hi. I wanted to follow up on the Oil & Gas question. It just seems as though $124 million in additional provisions for Oil & Gas could be low, at least based on the one-year forward prices for oil, which are still in the $30s. And so, my question is for Jamie. As you look back, how does the Oil & Gas situation today compare to prior periods of stress? We have 2002; we had the TMT meltdown. +When you were at Bank One, you reduced the lines of credit. You got ahead of that early. In 2007, you weren't exactly at the start, but then you adjusted and you said -- hey, this is a big issue. +And now we have Oil & Gas, which could be another industry-specific stress, and you're only taking additional provisions of $124 million. Is that going to be enough? And one year from now, are you going to look back and say -- whoops, we didn't get ahead of this enough. + +Question_7: + + And how do you use CDS to help protect yourself on that portfolio? + +Question_8: + + Okay, you don't. And then, the last follow-up: Do you intend to keep lending to the Oil & Gas companies, as they run into problems? On the one hand, you have the risk of throwing good money after bad. On the other hand, if you stop lending as much, and you have the high-yield market retreating, and you have private equity firms retreating, maybe it becomes a liquidity crisis for some of the oil companies. +So, which is it? Do you lend more or less to the Oil & Gas sector? + +Question_9: + + Hi, good morning. Marianne, was wondering if you could remind us where you are on your expense reduction targets in the Consumer and the Investment Bank? And how does that translate to some thoughts about the expected trajectory of total Firm-wide expenses for this year? + +Question_10: + + And how does that all net in to an outlook for this year, if you're willing to give us some thoughts on that? + +Question_11: + + Thanks. Good morning. I was wondering if you could talk to us a little bit about the benefits from rates, as they come through? Obviously, your commentary that NII will be even flattish in the first quarter, adjusted for day count, and even with some securities gains in the numbers this quarter, presumes a nice helper from that first move. +And you guys were really conservative on your deposit beta thoughts, when you talked about them previously. I know, probably you haven't seen much change yet. But how are you expecting the deposit behavior to act? And has there been any change to your modeling expectations about what might come through, as we get through the first couple of hikes? + +Question_12: + + Okay. And my second question -- if I can ask an ex-energy credit question? A lot of concerns are that we're going to get into some type of broader deterioration, of which your numbers showed no signs of heading towards. What are you looking for? Are you seeing any signals of ex-energy changes in either delinquencies or watch trends? And are you still comfortable with that low [4%s] type of charge-off expectation that you guys had talked about previously? Thanks. + +Question_13: + + Hi, thank you. So, I think you talked about some of this, Marianne, in terms of the Method 2 G-SIB surcharge now estimated at 3.5%. I'm just curious -- I think, if the numbers are right, you took down notionals, and that there's booked $3.4 trillion, $21 billion in level 3 assets, $50 billion in non-op deposits. +You've said that you don't want to be an outlier, so you're whittling that down. I'm curious of the driving force behind it. What kind of revenue give-up there is, in such a move like this, because we like it. And thoughts on the go-forward? + +Question_14: + + Fair enough. I just have one quick follow-up, on Ken's last question: If two-thirds of the economy is consumer-led, you look at all your early-stage delinquencies, like Ken said. And, Jamie, to your comments, things look okay. I hate putting words in your mouth, but what do you think the disconnect, then, is, between what's going on in the markets versus what's going on in the trends in your Business, both in terms of growth and forward-looking credit looks? + +Question_15: + + Hi. The disclosure around the Oil & Gas is really helpful. And I was wondering if you could just walk through something similar on Metals & Mining? So, you gave us the -- I think you said $68 million of full-year reserve build, and you gave us the not-significant, if things stay where they are. Can you give us the balance? +And then, is there a comparable $500 million to $750 million stress test for Oil & Gas, or stress case? Is there a comparable -- what is the stress case, if broader Commodities, and Metals & Mining, comes in worse? + +Question_16: + + And then on -- I guess staying with credit -- on home equities and the whole issue of free cash from interest [home-made] amortizing, can you lay out how it's progressed, relative to your expectations so far? And also remind us how big the allocation of the reserve is against that? +And I guess, not to lead the witness, but is that an area where things are trending, early days, better than expected, and could provide some buffer against, maybe, anything else that happens on the C&I side? + +Question_17: + + Hi, good morning. + +Question_18: + + Marianne, I know that the Basel Committee put our their fundamental review of the trading book proposal this morning. So, clearly, no one's had time to really go through it in detail. However, I'm sure you have already gone through the prior proposals, and done the QIS for the last couple of years. The proposal is better than what had been -- the ruling is better than what the proposal -- the most recent one had been. +Just wanted to get a sense from you, as to how you can manage to this 2019 implementation time frame? Are there things set in motion already? Or is this something that you would start from here? And if you could just give us some broad strokes on how you think about overall impact, that would be helpful. + +Question_19: + + Right, I totally understand that. And I guess my basic question is: There's -- you can take action, as opposed to just deal with what the current decision would be for you. There are actions that you can take to reduce the impact? + +Question_20: + + Good morning. + +Question_21: + + I had a couple of questions on capital. The first relates to the RWA progress, which did surprise positively in the year, by about $50 billion ahead of expectations. And I was just hoping you can give a better sense, Marianne, just given some of your prepared remarks, as to how much of that incremental $50 billion reduction was a function of more proactive mitigation efforts? Maybe even tied to the G-SIB mitigation efforts that you guys had talked about, which should presumably remain in the run rate, versus balance sheet shrinkage that may be due to the risk loss environment that we're experiencing today? + +Question_22: + + Understood, Marianne. That's very helpful. +And then, maybe just switching gears to the G-SIB surcharge, clearly the progress surprised positively, getting down to that 3.5%. I was just wondering how you guys are thinking about establishing minimum capital targets? I recognize you'll likely lay that out at Investor Day. +Just want to get a better sense as to what methodology are you employing, in terms of thinking about a management buffer? And all the different binding constraints that you have to manage to day-to-day? And thinking about through-the-cycle target that you guys would like to manage to? + +Question_23: + + Thanks. Marianne, if I could just clarify your NII comment from the very beginning of the call, do I understand correctly that the $2 billion of incremental NII that you've cited is just a function of the repricing dynamics, as they move through your balance sheet, rather -- or is there also, I guess, a contribution from loan growth? + +Question_24: + + Great. Thank you. And so, I know we just touched on RWAs, but how do you suggest we think about GAAP assets for this year? + +Question_25: + + Good morning. I just wanted to -- I had a follow-up question on Fixed Income trading. I think Dan Pinto has talked about benefits from higher rates. And so, I guess number one, I wanted to see if you had any thoughts on that? Have you seen any initial benefits to spreads in the FICC trading market, with the first rate hike? +And in contrast, you've had a couple of competitors announce -- or at least it's reported -- that they're cutting headcount. That seems to be a little bit in contrast to the expectation that Fixed Income could pick up with higher rates. So, if you could talk through your thoughts on Fixed Income? +I do notice that you did mention 1Q is off to performing well, so maybe that's part of it, too. But if you could help on that, that would be great. + +Question_26: + + All right. So, you still feel pretty comfortable with your outlook that things could improve, and market share gain potential, as competitors pull back? + +Question_27: + + Hi, good morning. My questions have been asked and answered. + +Question_28: + + Hi. If we look at credit spreads in the bond market, even ex-energy, they've widened considerably. And I'm wondering if this has resulted in wholesale credit being repriced at all? I realize the bond market doesn't set bank loan pricing, but just wondering if you've been able to reprice some of the wholesale customers, or expect being able to do so? + +Question_29: + + I guess I wonder why. We saw pricing in the debt markets come in considerably over the last several years. C&I pricing came in. I realize it might take some time. But I would think there's the opportunity for at least some repricing around the edges; no? + +Question_30: + + Thank you. Good morning. Jamie, to follow up on your comments about maybe some better pricing in prime brokerage and repo because of the capital requirements, or requiring you guys to raise prices, can you expand upon that? Do you see it growing, where you could get even better pricing going forward, because of less competition? Can you give just more color there? + +Question_31: + + Great. And then the follow-up question is: Obviously, the FASB is coming out this quarter with the new loan loss reserve methodology -- the current expected credit loss versus what we're using today -- obviously, the incurred loss model. There's going to be a true-up for everybody. Have you guys given any thought that, when this goes into place, when you may take that true-up? Assuming they say you have to implement it by 2019, or something like that, would you do it much before that, or can you give us some thoughts on your thinking about what's going to happen? + +Question_32: + + Thank you very much. We know that you implemented a new disclosure form in the Mortgage Banking space tread. Did that have any -- you guys had very good Mortgage Banking results. Did that have any impact whatsoever on your operations in the Mortgage Bank? + +Question_33: + + And then a follow-up question on your portfolio: You look like you grew your residential loans by about $11 billion. Last quarter, you said it was a mix between agency and jumbo. If a big chunk of it's agency, can you give us your thoughts on portfolio of that agency product? + +Question_34: + + One quick follow-up, Marianne: You've had some pretty big tax gains the last couple quarters, running below 30% of your tax rate. At some point, do you pull forward future benefits, and run with a higher tax rate in the future? + +Question_35: + + So, what's your natural tax rate, if you don't have those? Is it around 30%? Or is it closer to -- + +Question_36: + + I was wondering if I could just sneak in on credit cards. Do you think the competitive environment has hit a plateau? And on co-brands, are there any large upcoming repricing events? And is there any bigger than a bread box size you can give on [Marriott]? + +Question_37: + + Thank you. Hi, Marianne. If the regulators lift the dividend pay-out ratio in this year's CCAR to 40%, would you guys consider lifting your dividend pay-out ratio something closer to that? + +Question_38: + + Thank you. And then just one last follow-up: On the G-SIB buffer, obviously you guys have done an incredible job in bringing it down to where it is today. When do you expect the regulators to put you into that bucket, assuming you guys are obviously looking at the same types of numbers? + diff --git a/exam/original-files/Problem_2_3_Sample_QandA/14_answers.txt b/exam/original-files/Problem_2_3_Sample_QandA/14_answers.txt new file mode 100644 index 0000000..fdbfed2 --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_QandA/14_answers.txt @@ -0,0 +1,247 @@ +Answer_1: + + So the first thing I'd say is with respect to oil and gas, obviously I think $529 million is pretty close to $500 million, plus or minus. So that was pretty much in line. But you are saying it'll be a little bit higher with metals and mining. We were expecting close to $100 million and there were a couple of extra downgrades that came through in the quarter, and that kind of timing is going to happen. It doesn't change the overall sort of perspective for us. +With respect to draws, when I gave some sort of indicative guidance about what you might expect to see potentially in the rest of the year in terms of reserve build, we do try to take into consideration the likelihood that we will see incremental draws. And clearly we will work with borrowers to try and help them such that that may not be necessary, and in other cases we can reduce our exposure in redetermination cases. But we will expect to see draws and that's contemplated in our guidance. + And I want to make sure that everyone understood that we tried to be very complete. So this is not just oil and gas and metals and mining, as the [Mace] Code would suggest. We've looked at very closely related companies in shipping and marine transportation and the like. So we're trying to be very complete. + + + We've yet to take a loss. + + + We have taken a couple. Not very much. + +Answer_2: + + So of the $1.2 billion, $1 billion was a combination of oil and gas and metal and mining, so the vast majority and outside of that, consistent with my comments on contagion, there's not any sort of thematic other noteworthy thing to mention to you. And obviously as we continue to watch the cycle play out over the next several quarters and reevaluate some clients that may be experiencing stress, it's likely that we will see some more MPLs. But I gave you context around what we're expecting to see in terms of reserve. So they will go up, but not to numbers I would consider to be large in the context of our wholesale portfolio. + +Answer_3: + + The draws are about $1.3 billion in the quarter. So some but not excessive. And after the reserves that we put up in the first quarter the coverage ratio is 6.3%. + + + What is it on balance and stuff? + + + That is the on balance sheet. + +Answer_4: + + Sorry Glenn, just on that 6.3%, that's the Firm. If you look in the Commercial Bank, obviously it's higher. So you've got a sort of a different portfolio mix in the Commercial Bank versus the CIB. So if it's some parts of our portfolio it's closer to 9% or 10% and in other parts it's lower. Sorry. Your second question? + +Answer_5: + + It's a perfectly reasonable question. And obviously when we look at growth in CRE, or the commercial real estate business, of 18% it's an obvious question, are you doing something different? And the answer is, no we're not. We haven't changed our geographies, we haven't changed our risk appetite. It just simply is the case that we have a good process and we are continuing to focus on our sort of core capabilities and our core risk segments. But we've been able to take advantage of the opportunity because our process is better, and to a lesser degree, but nonetheless to a degree, given that the CMBS market has been somewhat disrupted. + +Answer_6: + + Hi. + +Answer_7: + + So Betsy obviously, with having only received the specific feedback less than 24 hours ago we still have to get into the analysis phase about what it all means. +I would start with your opening comment that considering our liquidity you were surprised. This doesn't appear to be a statement about the adequacy obviously of JPMorgan's liquidity, which is very significant, as you know. But it really about how we analyze and think about that at the material legal entity level and the inter-affiliate nature of how we formed our entity. So I can't tell you with any clarity exactly what will be required as we get into the analysis. It wouldn't be my core expectation that it would require us to do a meaningful overall new liquidity actions, but we have to do the work. + +Answer_8: + + Again, just based on our preliminary read, I think there's going to be significant work to meet the expectation of the regulators. And our plan already had us doing a lot of work around actual real simplification of legal entities and other things. So I don't know that there are going to be significant changes. It's not my primary expectation that there would be, but we do need to have a moment to go through the details. + + + The liquidity of the Company is extraordinary. We have $400 billion in central banks around the world, $300 billion of AA-plus short duration securities, just about $300 billion of very short-term secure -- really top quality repo or type of stuff like that. The trading book is $300 billion, which is mostly very liquid kind of stuff. So the liquidity of the Company is extraordinary. + + + I would say, just again, we need to do the work and we need to figure out obviously what the response to that will be. But it is encouraging that sometimes we're found to be credible for large systemic financial institutions. And if they have been able to adequately show their preparedness, we're confident we should be able to do the same. We just need to make sure that we understand the details of what it is that we don't have in our plan today that we need to change, and we're committed to doing it. + +Answer_9: + + Yes, absolutely. So I just wanted -- if you used the industry codes the way that you could if you want to expand your thinking to just what is technically considered to be an oil and gas company, you'd miss out on, for example, a marine shipping company that all they do is ship oil and therefore their financial and their performance is going to be directly related to the health of the energy sector. +Those companies we have identified them specifically, they are managed within our energy risk team. They are not managed by a different team. So I was simply saying that some of the companies that we are watching, and in one or two small cases that have experienced some stress, are not traditional energy companies. But their condition is directly related to oil and gas. + +Answer_10: + + So obviously not for us. I would say that it's competitive, as the C&I space is very competitive. Commercial real estate is also competitive, but it's not irrational. And we aren't seeing, or at least we are not seeing very rational proposals on structure and risk. +Meanwhile we haven't changed our risk appetite, we haven't changed our underwriting standards. We continue to have lower LTVs and higher debt coverage ratios, pretty consistent geography. So speaking for JPMorgan specifically, there's been no change in our underwriting standards. In fact if anything since the last crisis, obviously the last recession, we tightened our underwriting standards and we've moved away from some of the riskier types of that business, so home builders and a lot of construction loan business. + +Answer_11: + + Hey, Mike. I'll start and then Jamie can add to it. +So on the interest rate point, the colors are pretty consistent with what we said over time, which is we have the belief that the US economy is continuing to move in the right direction, that the consumer is on solid footing, and that despite the noise in the data and some of the volatility in the market, global growth will continue albeit at a moderate pace. And obviously stability in the markets in March has continued to help us with that thesis. So that coupled with the fact that the Fed themselves, while they are dovish in their narratives in the minutes and also they are [dots] are continuing to talk about gradual increases, and the debate around negative rates has kind of quieted. +So we don't particularly run the Company with a day-to-day view on what's going to happen with interest rates, we are positioned for rising rates, as you know, and have been. But we also understand what the performance of the Company looks like if there are no more rate rises, or when we stress our portfolios in lots of different ways. +So we are positioned for rising rates, it is our central case that will happen. The market is pricing less than one hike in this year. The Fed dot says two. Our research says two. We're just going to have to wait and see. +I'll also start and then Jamie can jump in on the living will thing. We have to take it at face value in discussions with our regulators that we need to meet their requirements, whatever they may be, all of the rules whether it's capital, whether it's liquidity, whether it's stress testing, whether it's resolution plans. And if we do that and satisfy them, then we can continue to operate the Company the way that we think it is best for our clients and communities around the world. + So at this point we need to remediate and address the issues and the feedback they've given us and resubmit a plan for assessment that we hope will be credible. And that's certainly what we will commit to do. And that's what we are focused on. + +Answer_12: + + Well I don't think it's inconsistent. We're trying to meet all the regulations, all the rules and all the requirements. We've been doing that now for five or six years. What is it, six years since Dodd-Frank was passed. They had their job to do and we have to conform to it. + + + I know it's easy to sort of overlook the quite a few statements where there's an acknowledgment that progress has been made. And none of the feedback in the letter negates the significant progress across the industry on capital liquidity stress testing. So it is consistent, but we have more work to do and we'll do it. + + + On the interest rate stuff, I wasn't predicting it. I'm simply saying I think there's a chance it will be different than what people expect, and it will be a little -- I said it'll gradual until it's sudden. + +Answer_13: + + Good morning. + +Answer_14: + + So obviously we're the first to read out, and it's very difficult when you think about performance because you also have to think about the relative performance in the comparable periods and prior years and the like. So I would say that down mid-single digits adjusted for what we would consider to have been outperformance last year is really quite good performance. So I don't know that we gained share, but I certainly think we protected share, and it may differ across the different product sets. But I think in general we feel pretty good about our performance and we don't know anything to the contrary. + + + I'd just add that $5 billion-plus of sales and trading in a quarter like this look as good, earning decent returns. We have good margins. We're not quite sure about share, but it was -- I would look as quite a good performance. And trading losses, while we, was it six days you said to me? + + + Six days, yes. + + + Six days, there was -- like $40,000. So that the actual results were just -- that's really good. I look at that as a very healthy business. + + + And then with respect to the restructuring and whether that presents opportunities for us broadly [define], including in compensation for -- we pay for performance and we pay risk (inaudible) returns, and we're not looking to try and make changes to what we've been very consistent about over time. And you can see our comp-to-revenue ratio of 32% this quarter is in line with the ratio in the first quarter of last year, and in fact the first quarter of the year before. So lower -- obviously on lower revenues, but a fair pay for the performance. And obviously we intend to insure that we are competitive, but we're not going to take any direct actions as a result of that in terms of (multiple speakers) -- + + + We've also got some big deals done near the end of the quarter in Western Digital and [Newmar] Cable, which is part of sales and trading. We also got -- we did this, I thought, a very creative Chase, [what I would call], a Chase Trust in order to secure the first real securitization in a long time in the mortgage business, we do revenue risk-sharing, and I think it's quite good. + +Answer_15: + + On legal, the number is [circ] $0. Pretax is actually slightly positive. After-tax we did some true-ups, assessments on penalty. So actually net/net about $0 this quarter, which I'll take it for the quarter but it doesn't necessarily predict the future. +In terms of expenses, so we talked at Investor Day, Gordon in particular but also Daniel, that we are continuing to invest in our businesses. And across the board in fact adding bankers and technology and digital, digitizing, et cetera. So we continue to do that across the businesses and I mentioned in the CCB page that the net expenses, albeit down, includes self-funding $200 million of incremental investments year over year and growth. + But you did notice the headcount in the Consumer businesses is up slightly. And that's a combination of the investments we're making in technology and digital, that's about 500 of the heads and other 1500 is increasing part-time staffing in the branches so that we have flexibility to make sure that we have loading at the right times of day for making sure the customer experience is good. So I would characterize it all as very consistent and yes, we continue to invest. And that is in part what you're seeing in the headcount in CCB. + + + And you saw new credit card Freedom Unlimited 1.5% back. We're doing a lot of stuff in Chase Pay. So the Starbucks thing, we apply the top digital side, and we continue to win awards in the Consumer Bank. So we'll always be investing there. + +Answer_16: + + So it is our expectation across both the consumer and the wholesale businesses outside of energy that the credit trends will remain favorable, or credit will be relatively benign. We're not expecting to see material increases, except for the fact that we are growing our loan portfolio. +So when we did Investor Day we talked about charge-offs this year will go up year on year, and they will go up to potentially as high as $4.75 billion. But half of that would be on the back of the fact that we are growing our portfolios. So you'd just have natural sort of BAU levels of charge-off from that and then the other half would be on energy. So we're not expecting or seeing at this point anything, other than good credit quality for the rest of 2016, outside of the obvious. + +Answer_17: + + So I will start by saying that as you know our regulators have extraordinary powers over a wide range of requirements for us regardless, and many ways of influencing those and you're familiar with most of them. It is absolutely the case that as you look at the resolution process that there are provisions that talk about if remediation is not satisfactory with, or cured within a two-year period, there are - there's a possibility that the regulators could jointly decide, may jointly decide, to take other actions that could include capital or liquidity or leverage or operating model discussions. So obviously they do have those powers. +October is not that far away. We're going to do our very, very best to make sure that we put our best foot forward and remediate the issues and then we have another submission in July 2017. So not to suggest that we won't fully remediate them to the very best of our ability, but the living will process I expect to continue to be somewhat iterative over the next several cycles, and we continue to push ourselves to raise the bar. And I'm certain that the bar will continue to be raised on us, as it should. + +Answer_18: + + Good morning, Matt. + +Answer_19: + + Okay. So we talked about the fact that if there's no change in rates and if we continue to grow our loans, we would expect our NII to go up by $2 billion. So you're right, if you look at the run rate right now that would be relatively flat from here. +I think in our favor, because of the easing that's still going on around the rest of the world and the sort of the dovish Fed comments, there's been a lower re-price just in the industry generally. So that's in our favor and we're much more sensitive to the front end of rates. So we're not suggesting that the long end of the curve has no impact, it's relatively modest. So $2 billion, maybe a little more. The biggest driver of significantly higher NII above that guidance would be if we had another hike earlier than December. + +Answer_20: + + So not going to talk specifically about the Treasuries' actions, other than saying that we would support Fed tax reform in general. With respect to the impact on our business, either historically or going forward, it wouldn't be zero and it wouldn't be significant. + +Answer_21: + + Okay. So obviously I'm not going to be able to talk specifically about our plans that we've submitted because we just submitted them and we haven't had any feedback and they are confidential, but I will tell you that obviously negative rates, it was the first time this has been in the scenario. It's not the first time we have thought about it, and it is not the first time that we've experienced it, and at least in other parts of the world in Europe, Japan and elsewhere. So we have had strategic discussions, we understand broadly what we think we would do and what would happen to our balance sheet. We can model it and we can effect it. So in that sense, now I mean obviously, we'll continue to work that process through if it continues to be a feature of CCAR. +You're absolutely right that year over year our launch point is a higher level of capital and our balance sheet and our credit quality continues to improve, and our risk levels have not materially changed. So as a general matter we would hope, and we've also added [press]. So as a general matter we would hope to have incremental capacity but nothing inconsistent with what we have said externally, which is that the Board would like over time to continue to have the capacity to potentially increase dividends and that we would likely the capacity to, within a reasonable range, repurchase our stock. And that's the framework that we have used to submit our plan. + +Answer_22: + + Good morning. + +Answer_23: + + So if I do the -- I don't want to use the word call, if I adjust for the full impact of the asset sale that was in the quarter not just the $150 million in this quarter but also the revenues that were present with respect to that in the first quarter of last year, my adjusted revenues are down about 4% to a market that on average, while I appreciate that it recovered in March, but the market on average for the quarter was down around 5%. So we would characterize that as generally in line. And similarly if you do adjustments on the balance sheet side, the Assets Under Management and client assets. So certainly you can speak to Jason afterwards and reconcile our numbers so that we're not confusing each other. +I'm sorry what was the second part of your question? + + + Retail engagement. So retail engagement picked up in March, as you would expect. We saw positive flows. We obviously saw negative flows for the quarter in equities, that's not surprising. And then we saw positive flows, particularly in multi-asset. So we did see some reasonably healthier retail flows in the quarter, but primarily in March, and some were offset by outflows in equities. + + + Thank you. + +Answer_24: + + As luck would have it, in this quarter there is nothing one-time that you need to adjust for. Last quarter there obviously was. So we would expect that our NIM should be stable to improving over the course of 2016. The extent to which it would improve, obviously depending upon what happens in term of gradual rising rates. + +Answer_25: + + Okay. So with respect to equity capital raises, I mean obviously to a degree that would be true, although those companies that were able to access the equity markets are not those that are experiencing the most stress. So obviously all other things equal it's a positive, but I'm not necessarily thinking it's going to take significant steam or the pressure off. With respect to second part of your question I'm so sorry? + + + The C&C. + + + Jason will get back to you. I'm sorry, I don't have the answer. + +Answer_26: + + Okay. So no, nothing has changed in the card competitive landscape, including in co-brands. It's still very competitive, albeit that we saw a little bit of deceleration in sales growth year over year last year and we've seen that trend back positively for us this year. So we feel good about that and we've been increasing our marketing spend and as Jamie did say, we launched Freedom Unlimited quite recently and it has been quite recent, but early feedback is very positive. With respect to Freedom with a 50% increases in activity and interest, there's going to be a degree of cannibalization of other products, we would expect that. But so far, so good. And we just like to give our customers choices. And its been favorably received. + +Answer_27: + + So the Manheim is down slightly. We continue to believe and expect that it will continue to trend downwards and so [also seeing] it will continue to trend upwards, just given where it is today and also the amount of leased inventory that will ultimately go into the used car space over the course of the next several years. However the fundamentals are still good, the market is still solid. + We have pulled back on subprime a while ago. It's a small part of our originations. So other than seeing some delinquencies tick up, as expected, in some of the energy-related states but not very significantly, there's nothing at the moment that's on the burner. + + + For us. I do think you'll see issues in the market. + +Answer_28: + + So the MSR P&L for the quarter was a positive $124 million, and they are a combination of BAU and material factors that added up to that, and probably about half of it was a combination of hedge performance and the market. + +Answer_29: + + Yes, yes. So purchase applications are up 30%, I think, year on year. We continue to be positive momentum in that space, and we are seeing Spring activity continue to be robust, as expected. + +Answer_30: + + Okay. So in terms of run rated, the two biggest drivers of the walk that we gave at Investor Day were the card co-brand renegotiations and the mortgage banking non-interest revenue. I would just point out that while we are seeing some of the incremental impact of card renegotiation, that will play out over the course of the year. But on the positive side -- and on the positive side mortgage banking, just given where rates were over the quarter, has been positive relative to central expectations when we did Investor Day. So those two things are worth noting. +But we are seeing really quite good drivers in non-interest revenue drivers across the consumer space generally, in debit investments, in fees and accounts, in the sort of 4%, 5% range, and sometimes in the range higher than that. So we are continuing to see exactly what we expected, which is the majority of our businesses will continue to deliver mid- to high single digit growth, and they seem set to do that. The card impact will be what it will be, and mortgage NII will end up down year over year, whether it's $700 million or $600 million we'll see. And so the biggest driver of what the end result will be is going to be markets. + +Answer_31: + + Yes. Look, the business is not immune to markets either. So obviously as you look at the performance for the quarter our fees have been impacted by low asset levels. And we also have got the tail impact of some business simplification, just getting the tail of that out of the performance. We are also seeing the benefit of higher rates. +So I'd characterize the majority of those negatives on lower fees and simplification as being behind us. So the trajectory, if rates continue to rise, would be upwards. But that's why we said market dependence. We were not expecting our performance to go down from here. Flat to up, but depending on rates. + +Answer_32: + + So -- + + + I'd just use 32%. + + + We've given a range 30% to 35%. We've been at the lower end of that range. When we performed very strongly we could drift up. If we perform less strongly, we pay for performance and I think we did a good job in the first quarter. + + + We have among the lowest ratio. + + + We're paying our people properly and well. + + + And consistently. + +Answer_33: + + That's very fair. And we've talked about it pretty often, that people when they restructure, they restructure out of the things that they were less strong at, less comfortable at, and in many cases they double down where they continue to have strength. And we are seeing that. And that's what we mean when we say there's always someone left to fiercely compete in every part of our business, and equities is no exception. It's not the poster child for that. + However, the equities business here at JPMorgan, we've rebuilt our technology platform. We have rebuilt the prime -- we've built the prime brokerage, international capabilities. The two of those work hand in glove. And we have every opportunity to continue to gain share and win. + + + And we've done very well gaining share in electronic trading and the prime broker has been built in Asia and Europe where we had weaknesses. So you've seen our share go up and we intend to win it. We have topnotch research, which obviously helps drive the equity business too. + +Answer_34: + + That's correct. + + + Give or take, and that's right. Obvious are there's a high degree of variability around it. If we had complete ability to understand it we would lean into those reserves. But it's name specific and situation specific, it would evolve over time. We just wanted to give you an indication that there's likely to be some more costs. It could be plus or minus quite a bit from that because we've had to make stress assumptions in there. But $500 million for nine months, yes. + +Answer_35: + + Yes. No Gerard, I'm not going to make any comments about SNC, except to say that everything that we know and aware of is reflected in our results. + +Answer_36: + + Correct. Yes. + +Answer_37: + + They changed by a couple of billion dollars on a single name that we like, up. + diff --git a/exam/original-files/Problem_2_3_Sample_QandA/14_questions.txt b/exam/original-files/Problem_2_3_Sample_QandA/14_questions.txt new file mode 100644 index 0000000..feb696a --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_QandA/14_questions.txt @@ -0,0 +1,158 @@ +Question_1: + + Good morning. Thanks for taking my questions. Marianne, maybe a couple of questions on energy. You noted that the provision was slightly above your guidance this quarter relative to what you mentioned you thought it might be in late February. +Guess I'm curious in terms of what your expectations are in terms of your guidance relative to potential draw-downs, particularly in the $10 billion of high yield loans that you have undrawn? And what your ability is to potentially mitigate potential draw-downs based on the financial condition of your borrowers? + +Question_2: + + Fair enough, that makes sense. But that dovetails nicely actually into my follow-up. In terms of the wholesale non-accrual balances, those are up about $1.2 billion quarter over quarter. +Can you give us a sense as to how much of that was energy and metals and mining? And were there other areas of the portfolio that added to that? And what's your outlook for wholesale non-accruals over the course of the next couple of quarters? + +Question_3: + + Hi. Just one follow-up. What was the drawn-on energy facilities this quarter? It doesn't seem to be too big, but -- and then related to that, what's the reserve as a percentage of drawn credit right now? + +Question_4: + + And then maybe a little bit of different question. + +Question_5: + + I appreciate that, and I thank you. +The other question is on growth. We've been waiting for a long time, but you've been seeing great growth across a lot of different products. CRE up 18% and the commercial bank C&I up 9%. +At this stage of the cycle, I appreciate the consumer's showing a lot of strength. Is there any growth where we scratch our heads and said, wow is that growing too much? It sounds funny for me to be asking for less growth, but just curious to get your thoughts. + +Question_6: + + Hi, good morning. + +Question_7: + + I have a question on the living wills. The indication today was that there were four areas that you needed to enhance. Liquidity was one of those and I was a little surprised to see that, given the strength of your liquidity book. I guess what I'm wondering is, does the living will submission and the changes that you have to make have an impact on your current business at all? In other words, do you need to build liquidity to meet the requirements that the regulators have, or this is in a obviously worse case scenario you'd build at that time? + +Question_8: + + As we think about the implications of this morning's announcement, it's around your planning and procedures as opposed to a likely impact on the business operations today and the results that you can generate, is that a reasonable conclusion? + +Question_9: + + Thank you. Good morning. Marianne, can you expand upon your comments in your opening dialogue about the energy exposure? You're not too worried about the contagion risk, but you did say there are a couple of specific issues relating to some very closely related companies. Can you give us more color on what you're referring to? + +Question_10: + + Thank you. And then on the loan growth, which is obviously very strong, what are your people on the front lines saying about commercial real estate? Are there any changes in terms of underwriting metrics that your front line people are seeing since we are starting to see in certain markets, like multifamily, which you guys have already identified as some weak spots? Are there any other underwriting issues that are cropping up now that you didn't see three months ago or six months ago? + +Question_11: + + Hi. That was a very serious CEO letter you had in the Annual Report. But two questions related to that. +One would be you, Jamie, indicate the potential for higher interest rates, and just looking for some more color into why you think that's the case and if you're preparing the bank for a scenario of higher rates or if you're just trying to set a tone at the top, or perhaps be a contrarian. I know you gave some technical factors in the CEO letter. +And then the second thing is just the contrast between what you have in the CEO letter, liquidity trading governance oversight with the living will letter that came out today. And just a follow-up on the earlier question, do you simply have to write a better resolution plan or might you have to change a little bit the way you do business? And does this make you have a more conservative CCAR ask? + +Question_12: + + Was there anything else from Jamie on that, because if you compare and contrast the CEO letter to what the regulators just said about you guys, it's not completely consistent? + +Question_13: + + Hi, good morning. + +Question_14: + + I wonder on trading, you appreciate that you reported first so you haven't seen the market yet. But two questions around the whole thesis, the last man standing versus restructures. +One, do you have any sense of whether your performance overall and really thick represented market share gains or not this quarter? And then two, with some of the guidance coming out of the European banks in particular being very poor and some of the restructurings maybe accelerating steam, is there any thought around comp and maybe using that as a lever to improve returns over the remainder of the year and into next? + +Question_15: + + Hi. Just a question on expenses. First, was there any legal expense in the quarter? And then just a broader question, Marianne. +Are the incremental expense saves you're getting from your programs flowing through the bottom line, or is it some of it getting reinvesting, like in CCB I noticed the headcount is up a little bit on page 11, just the last couple quarters? Is that reflect like reinvestment of the cost saves? And then just on the legal side, if you had anything this quarter? Thanks. + +Question_16: + + Yes, good morning. You're fielding a lot of questions on energy credit quality. But taking a step back, given that the delinquency statistics outside of energy still remain fairly stable, could you give us an outlook for how you think credit quality trends will play out for the rest of the year if the base case is slow growth in the US? + +Question_17: + + Great. And just one more follow-up question on the living will. Could you help us understand what you think the regulators meant in terms of if the remediation is not met by October 1 of this year that there could be more stringent prudential requirements? Could that possibly mean higher capital or liquidity standards if the expectations aren't met by October? I guess we always thought of the living will as more of a cost issue rather than a further tax on regulatory ratios. + +Question_18: + + Good morning. + +Question_19: + + If I look at the first-quarter net interest income, which was at least better than what I had, good NIM, and think about your full-year outlook. If I take it literally it implies flattish net interest income dollars from here. And I'm just wondering if that's too literal of an interpretation, or if maybe there are some offsets to the loan growth from, say, lower long-term rates as we think about the rest of the year? + +Question_20: + + And then just separately, any comments on the Treasuries ruling on inversion as you think about M&A, kind of broadly speaking for the industry and for you guys specifically? And if you can frame how much that driven your M&A revenues in the past, or the industry? Any color around that would be helpful. + +Question_21: + + Good morning. Maybe we could talk a little bit about CCAR. I've had some investors express concern about the Fed's inclusion of negative rates. Have you found that to be difficult in terms of modeling? And overall, I guess given the improvement -- on the flip side, given the improvement in your capital ratios, do you think that there's -- you should be able to see some improvement or increase in CCAR into -- now that you've looked at it for a few months? + +Question_22: + + Hi, good morning. + +Question_23: + + So Marianne, within the Asset Management segment you noted that the revenues were down in line with the market. But if we isolate the fee income components to exclude some of the gains you highlighted as well as other income, the revenues declined by double digit both quarter on quarter and year on year, which is a bit more pronounced than what we had expected. And I was hoping you could speak to maybe some of the factors outside of the market declines that may be impacting revenues in that business, specifically what you're seeing in terms of retail engagement and maybe whether you've seen improvement in sentiment now that the markets have recovered pretty nicely off the February trough? + +Question_24: + + Good morning, Marianne. Quick question on NIM here. Can you talk about how sustainable you think the NIM expansion might be and whether or not there's anything one-time in the numbers we should adjust for? + +Question_25: + + Okay, great. Thank you. And then on the energy exposures in the loan book, can you comment on maybe whether or not some of the equity capital raising that we've seen in the energy space has perhaps taken some of the tail risk away from that book? And then is it possible also to update us on the criticized exposures in oil and gas? I believe in the 10K it was somewhere around $4.5 billion at year end? + +Question_26: + + Thanks. Marianne, can you comment on what competitive conditions are like in the credit card market currently and if there's been any change around the intensity of competition for co-brands and awards? And I think Jamie you alluded to the launch of a new product. I'd love to get an update on your initial thoughts about how it's going. + +Question_27: + + Great, thank you. And on the -- auto has been a big area of focus, and you touched on it certainly during your Investor Day. But on the mid-FICO range is there anything going on, on a macro level, that would suggest some significant likelihood of credit quality deterioration? + +Question_28: + + Thank you very much. In the mortgage banking segment you wrote down the MSR by almost as like $0.9 billion. Was there any hedging gains? I couldn't find them in the documents, any hedging gains to offset that? + +Question_29: + + And the other. And then on the mortgage banking side, have you been seeing -- you saw the MBA today release that the purchase applications are the high since 2010 or something in that order. Are you seeing the Spring buying season, especially on the purchase side, starting to pick up? + +Question_30: + + Hi, thanks. Good morning. Just two quick follow-ups on the fee side. Understanding that market dependence is built into the outlook to get the $50 billion of fees for the year. I'm just wondering, have we now run-rated the combination of the business repositioning, the card revenue run rate, and so -- and the toughness of this first quarter? I guess the question is really, what are the things that you expect to get better from the first quarter on the fee side upside of normal seasonality? + +Question_31: + + Yes, okay. And I know it's a smaller line item, but just noticing in the guide for security services to be flat from here, there's always some seasonality in there too. But I'm just wondering if you could just give a comment about what you're seeing in that business and are there any incremental challenges that leave you with a flat outlook? + +Question_32: + + Yes, good morning. The question is already on the compensation ratio. You've obviously done a fantastic job on the cost base. But one of the issues that strikes me is clearly with the reduced revenues, particularly in the capital markets business. Your comp down about $400 million in the --compared to the first quarter of last year. +Obviously what we've experienced generally is you holding the ratio steady for the second or third quarter and then tooling up with a lower ratio in the fourth quarter. So I'm looking at the estimates we have for revenues on a well-known provider of data. We've got pretty flat revenues being forecast by people like me, whether we're right or wrong. Should we be thinking about how you're going to build a bonus pool on the -- against this background and whether we should be looking at thinking -- or thinking that you're going to have to [retain] the comp ratio at a pretty similar level through the year, if indeed we don't see any uptick in revenues and they remain reasonably flat? + +Question_33: + + But I'm not [be] talking about the quality of the ratio. I'm interested in (inaudible) because clearly what we're seeing are mostly this, and indeed in Europe, is the difficulty of building a pool when you have been so used to having a very strong first quarter, obviously makes it quite difficult. Maybe just as a follow-up which is vaguely related, could I just ask, you talked earlier about where there's question about competition and picking up market share, which indeed you clearly have. But one of the questions I perhaps just wanted to ask is, I know that you've been pushing hard on these equities, cash equities in particular. +My sense is that actually a lot of the players, including the Europeans who are doing massively structural, are putting more capital into equities on the back of the fact that it's a lower capital business and therefore they think they can get higher returns. And just maybe that's why [Nomura] pulled out of European equities yesterday. What are you seeing in the equity space in particular, because I'm not seeing as much sort of withdrawal as we have done in the fixed space? + +Question_34: + + Thank you. Marianne, just as a follow-up I just want to make sure I understood you correctly. On the $500 million of incremental reserve build for energy for the remainder of the year, that's for the total of the following nine months is that correct? + +Question_35: + + Okay, thank you. And then I know there was the energy specific shared national credit exam that the first quarter results for the industry will reflect similar to your own. But we also have the traditional shared national credit exam that's been done for 20-plus years. Any color on how that's going, the normal shared national credit exam? + +Question_36: + + Hi. Two quick follow-ups, Marianne. Getting a couple questions about just the math on the energy reserve ratio. I think you mentioned 6.3%. Just to be clear, is that the reserve for loans, over-funded loans, and then there's an additional reserve for unfunded commitments? + +Question_37: + + Okay, got it. And then did you tell us the size of your energy commitments and whether they changed at all this quarter? + diff --git a/exam/original-files/Problem_2_3_Sample_QandA/15_answers.txt b/exam/original-files/Problem_2_3_Sample_QandA/15_answers.txt new file mode 100644 index 0000000..6899d90 --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_QandA/15_answers.txt @@ -0,0 +1,176 @@ +Answer_1: +Good morning, Brian. + +Answer_2: +Brian, I know that everybody is keenly interested to hear what we have to say, but the truth of the matter is it's very, very early days. The new government is just forming as we speak. Negotiations need to be given some time to unfold and take shape. So it's really too early to hypothesize. +We would hope that we can continue to operate the way we are right now. But we will just continue to evaluate the landscape, as I'm sure you will, over the coming weeks, months and quarters, and plan accordingly. The most important thing is that we intend to continue to support our European franchise and clients throughout. + +Answer_3: +So, on the card space, as you know, we have loans running off. We're replacing them all of the time. Over the course of the last couple years, since the end of 2013, we made some changes to our credit box and our credit risk policies very, very thoughtfully. And we've been monitoring them very closely. +And what we're seeing in terms of the loss rates and the seasoning of them is fully in line with our expectations. And these loans are coming on at higher risk-adjusted margins. So, the ROEs are at or above the portfolio ROEs. So, nothing that would speak to anything other than our full expectations for our credit risk appetite. +And with respect to Auto, not to speak for others, but obviously when you look at lower FICO scores and high LTVs and longer terms on top of each other in an environment where you've already seen used car prices soften some and they're likely to continue to do so, it's something to watch. And so we've been very, very thoughtful about that, not just today but as we've been going through the cycle. And not only on an absolute basis do we compare favorably in terms of LTVs and FICO scores and even terms to the industry, but we've been very, very careful in -- and low percentage of subprime origination -- very, very careful about looking at those layered risks. +So nothing in our -- and remember, for Auto this year, I think the charge-off rate's going to be 40-ish basis points compared to a long-run average of more like 60. We're sort of reverting to a more normal level, if nothing else. And used car prices will ultimately come down, and we're being thoughtful about that. + +Answer_4: +Good morning, Jim. + +Answer_5: +At the risk of not getting like overly complicated, the long-term debt expense -- our NII was flat with loan growth. And NII on loan growth being offset by long-term debt expense, which was largely to do with the hedging of non-dollar debt and just relative quarter-over-quarter small moves in currency levels and currency basis. So, I would honestly characterize it, not to sort of underplay it, as quarter-over-quarter noise. +Looking forward -- so when you look at our NIM, you have NII flat. You have the balance sheet growing, as we expected, both on loans and trading assets. So, NIM just naturally is down a few basis points. But we would be looking for NII to be up slightly in the third and fourth quarter, and for our NIM to be relatively stable. + +Answer_6: +So, I would say there's going to be two things. First of all, obviously when you talk about Consumer, it kind of gets dwarfed by Card. So let's start with Card. +We are growing the portfolio. We added 4% core loans year over year in Card. So naturally, as the portfolio grows over time, you would expect to add to reserves. So there will be some of that, but I would characterize it as modest. +And then, as these vintages continue to season, we've been experiencing very, very low loss rates at circa 2.5%. They will trend up slightly. So there will be a little bit of rates impact, too, but again, as I say, with very accretive ROEs. +I would look forward and expect there to be some reserve adds over the course of the next several quarters on a combination of those factors, but for all the right reasons. And similarly, volume-wise in Auto we should see some adds, but again, in comparison to Card, modest. + +Answer_7: +So, as you know, Erika, everything that we do, we do with a view to, first of all, the client franchise and making sure that we're supporting our clients. And then secondarily, with a view to all of our binding constraints. We will provide capital and access to the CIB. But also take into consideration our overall objective of making sure that we stay in the 3.5% G-SIB bucket. So we will continue to try and find capacity to be able to recycle it and grow high-ROE/high-ROA business. + +Answer_8: +Not anything significant, no. I think you've got to compare it to the prior year, which was stronger, particularly this time last year in Asia. And that's less true today -- stronger in Europe, less strong in Asia. It's more of a regional story than any particularly significant items. + +Answer_9: +Good morning, Betsy. + +Answer_10: +Yes. So let me -- two pieces to the story. Yes, the guidance is $2 billion-plus year on year. You'll recall when we came in to Investor Day, we said we would expect $2 billion, rates flat. It looks like rates will be flat, at least in the front end at this point, at least for the majority of the year, if not the whole year. +You've seen already in the first two quarters that year over year we're up $1.4 billion. We were doing better than that on a combination of lower deposit bases reprices and also on strong loan growth. +But if you annualize that, that would be too high. We are going to have some impact in NII of the lower 10-year. It's not significant. But it will offset that to a degree. We would expect our NII to be between $2 billion and $2.5 billion up year on year -- largely strong loan growth, low reprice. + +Answer_11: +I would say we've been doing a combination. We've been growing our deposits more strongly than the industry. So we continue to be net-net attracting more deposits than the industry, and also, as you say, a mix shift out of securities and into loans. +Our outlook for loan growth through the remainder of the year is to be at the higher end of our range. We said 10% to 15% core loan growth, and at this point, demand still seems robust. So we would expect to be at the higher end of that range. We certainly have been this quarter. +So at this point I would say that it's a combination of factors. And remember that the way we think about our investment securities portfolio also takes into consideration how we think about positioning the Firm's duration of equities. So all of those factors will contribute. + +Answer_12: +If I get this wrong, I apologize. But I think it was actually we make $3.5 billion on the rates implied and $6 billion on normalized rates. But in any case, let me just talk about rates flat versus implied right now. And just because things can change so quickly, let's just focus on 2017. +Rates flat from here. So, with the 10-year at about 1.5% and IOER at 50 basis points, because of the loan growth, notwithstanding any sort of long-end pressure, we would still expect year over year our NII next year to be up between $1 billion and $1.5 billion, implied, which is actually not that much different from that. So it does have about 20 basis points better long-end rates by the end of 2017, but otherwise relatively flat through the end of 2017 would be about $0.5 billion more than that. + +Answer_13: +Growing like a sunflower, not like a weed. + +Look, I'll say a couple of things. The first is, a lot of that growth is commercial term lending. And it is the case that we have the technology and a process that has speed and certainty of execution, and competitive funding costs. So it is the case that it's a value proposition that we're able to bring to clients, I think, that differentiates us. We're able to close in times that are a fraction of what the industry is. +Secondarily, we're really concentrated on identified, supply-constrained markets, low-rent stabilized. So these are not the same properties that had problems in the past. We have -- since the previous cycle, we have looked carefully at our underwriting, and there are some things and some regions and some products that we either don't do or do significantly less of. So we're very, very careful. But we're looking at some really good credit quality in our commercial real estate portfolio right now. + +Answer_14: +So I would say in the CIB, it's also a revenue story. So you need to consider both factors (multiple speakers). +So let me talk about where we are on the expense commitments. And you'll recall that -- whether you remember a $4.8 billion number or a $5.5 billion number in total, we're about 70% of the way through delivering against that across the CIB and the CCB at the end of the second quarter, and we continue to make progress. +In the CCB, obviously, it is generally more progressive. And in the CIB, it's a bit more about technology and operations, and it takes some time to deliver that. +But fundamentally we continue to chug through that. And we will get there over the course of the next several quarters. So I would say in line with our expectations, and is a contributing factor. + +Answer_15: +So I would say the comp-to-revenue ratio is an outcome, just for what it's worth. Obviously we try to give the range to give people an idea. We pay competitively and we pay for risk-adjusted performance. +But there's nothing notable going on. We've been actually at the lower end of our range for a little while now. + +Answer_16: +So it's always a little tricky. The share thing is going to become clearer with a rear-view mirror than it is necessarily at a moment in time. It does feel like we are doing fairly well competitively, not just against European banks, but just generally. And not just in Europe, but generally, because we, as you say, have continued to be there for clients across products, across the globe. +So I would say that we feel like we are doing fairly well. We'll know whether that is share gains when we are able to actually look at that in the rear-view mirror. +But there's still plenty of competition out there. So we're just focused on serving our clients the right way. But it does feel a little bit like we're doing well. + +Answer_17: +I'm going to try to tell you as best I can, if you can hear me. So, number one, we do think it will reduce the GDP, the UK and the EU, a little bit. And obviously that's not going to affect our business plans. That will affect the economies a little bit. +Number two, we know it's going to create uncertainty for an extended time period. So we don't think we can answer or make certain all these things you want to know because there are a lot of parties involved. We are hoping that the political leaders are very sensible. It makes sense for both the EU and for Britain to think through the process to make it sensible, whatever changes they make, to give businesses time. I'm talking about years -- time to adjust to the new reality, which we don't know what it is. +I think the most important thing is that we will continue in every single country to serve our clients day in and day out. If it adds extra cost, so be it. I'm not really worried about it. It would be nice if it doesn't create huge turmoil. +I'm hoping the EU is sensible, but we're going to be prepared. As Marianne mentioned, there's a range of outcomes. Any one (inaudible) we'll try to be prepared for each one of them. +We're not going to, like, pull back on serving people in Italy, Germany, France, UK or Spain because it might lead to higher costs. I would accept the higher cost, as opposed to disrupt our clients. + +I would also point out, Mike, that competitively we are not in this situation alone. And so we're going to take our time to work out what the right course of action is. And obviously we'll update you as and when that becomes clearer. +We're not going to be at a competitive disadvantage. If anything, as we talked about earlier, we feel like we're in a position of strength. + +Answer_18: +The truth of the matter is, it's a bit early to say for that, too. I hate to continue to repeat that. +I will tell you that, generally speaking, uncertainty is not particularly conducive or constructive for M&A. But in this case, I think there are some offsets. So I would start with, in terms of the actual strategic dialogue with CEOs and at the boardrooms, it is as good as it's ever been. +If you think about the other factors that would be supportive of M&A, like cheap financing globally, low organic growth, good multiples, solid economy in the US and globally notwithstanding a bit of the steam taken out in Europe or the UK, all of that should continue to be supportive for strategic M&A. At the end of the day -- and currency could be supportive of cross-border activities. So there are puts and takes. +I'm certain that there will be some people who think carefully through the right timing and what to do. At the end of the day, the strategic proposition should ultimately win out in most cases. And similarly, volatility, generally speaking, is not particularly conducive in terms of ECM, but investor appetite is still there, and there have been deals priced post-Brexit. +It's a little early. There's still activity. Volatility is reasonably subdued at this point. And I think, because there are no event calendars out there right now, there's still quite a lot of opportunity in the space. Obviously, DCM, low rates would be a tailwind, notwithstanding the M&A and ECM landscape. + +Answer_19: +So I'm going to start with the second part of the question. So we are still very much concentrated in the prime and near-prime space, but we have a higher percentage of our origination in the near-prime space, reasonably meaningfully higher over the course of the last couple years. +So where we may have previously been, I think 40%, above 760. Now that's less than that, and there's more like 20% or 30% below 700. By the end of the day, still pristine credit, relatively speaking. +With respect to delinquencies, is it a cure rate issue? Not specifically, no. + +Answer_20: +We're not really doing much in the way of 2017 guidance right now. It will ultimately honestly depend on the opportunities we see in front of us to continue to invest and to add customers. +I think we're at a very good run rate of investments. We've increased reasonably significantly in terms of marketing dollars and also lease growth. That will drive profitability in the medium to longer term. +So it's possible, if we see the opportunity to continue to do that, we would do it. But we have no specific guidance yet. + +Revenue environment can change reasonably quickly, particularly, as you know, with rates, and to a lesser degree, markets. We're not going to overreact to a short-term phenomenon. + +Answer_21: +Yes, taxes much -- generally speaking, the reserve changes are somewhat episodic. Outside of those, yes, 36% is a good central case for our managed tax rate. + +Answer_22: +Good morning. + +Answer_23: +So starting with the qualification that obviously, as you suggested, it's going to be market dependent, but also remembering that we knew when we gave the guidance that we would expect the second half to be seasonally lower. So here's what I would say -- first half, market challenged; second half, markets better. Net-net, first quarter markets challenged; second quarter better. Net-net, first half relatively flat year over year. So, call it a wash, with the acknowledgement that we knew we would expect seasonal declines in the second half of the year. +Mortgage better -- so you may recall that we said we would expect mortgage revenues to be down year on year, actually by a reasonably significant amount. Given obviously where the rate environment is, as well as some positive MSR results in the first half of the year, we would expect mortgage revenues to be more like flat. And against that, to your point, lower IB fees and lower Asset Management revenues, given the environment. +The way I would characterize it is there are puts and takes, but net-net it's still a reasonable central case. So we are not changing it. But it's market dependent. + +Answer_24: +So I would say if you look at the last three years of PPNR, notwithstanding that there have been obviously differences in the scenarios, 2015 CCAR results, so not this year's but last year's, were low. Not to say that means that these results are more normal. I would say if you look at the three years and look at the PPNR results now, it's more consistent with the sort of portfolio risks, revenue generation we would expect. And you can see that because it's much more consistent with our results. +So I don't have insights that I can share with you specifically to try and reconcile the Fed's results year on year, nor do we really try to do that. You're right -- operational risk is likely a piece of it. And that was disclosed in that information. So I would just say, there can be volatility but I feel like this is not an unreasonable place to think the PPNR would start, and it's consistent as you can see, relatively speaking with what we calculated. +In respect to what that means for what's most binding, what it does mean is if you look at the analysis that we've done a couple of years in a row now, where we've said using the CCAR results from the Fed, what would that imply a CET1 ratio would need to be to pass, it had previously been a little less than 11%. With the improved PPNR and, therefore, the improved result, at this point, it would be a little less than 10%. +So in that context, as we sort of look forward, sometime in the near future, maybe in the third quarter, to getting the sort of 2017 CCAR changes in proposed form hopefully, it will alleviate to a degree a little bit of that pressure. But I still would suggest to you, as we said at Investor Day, that CCAR may, depending on how the G-SIB surcharge is included in the minimum, may become binding, if not likely will become binding. And so we'll continue to take that into consideration as we go forward. And we are already taking it into consideration as we think about optimizing against the multiple binding constraints we have. + +Answer_25: +We think about using all of our channels based upon obviously the demand, and our capacity and our appetite to want to continue to close strongly for our customers. We've obviously also been focused in the anticipation of it becoming a more purchase-oriented market very much on building out the retail channel and the retail distribution channel, and that's been very successful. +So there's less correspondent contribution this quarter. It is a lever we will likely use going forward. + +Answer_26: +At this point, I'd still say -- at this point, we would still say it will be episodic. And while we are hopeful that the overall structural costs will start coming down, or has come down, and that's a good thing, there will still be potentially some puts and takes in the legal space. +There's no real way obviously of forecasting a run rate. I would just do what many of you have done, I think, and go back and look at what the legal expense looked like in the years preceding the crisis, and make your own determination whether it's going to be structurally a little higher. But it probably wouldn't be multiples of that. + +Answer_27: +Okay. So it was particularly strong in rates, but nevertheless also very strong year over year in currencies, emerging markets, credit trading, [SPG]. So it was pretty broad-based. +But remember, you also have to think about it relative to the equivalent course of last year, and we didn't have a particularly strong second quarter last year. So on a relative basis, that is an important factor, but it was pretty broad-based -- more volume than anything. +And then seasonality, I'm sorry -- look, it's anyone's guess. I think you can go back and look over time. But last year we saw -- we had a weak second quarter, as I said. So we didn't see as much seasonality. But if you look at the last quarter's run rate, I don't know that would be a bad place to start -- last year's third quarter run rate would not be a bad place to start. + +Answer_28: +I'm going to start with a couple of general comments, which is, we talked about the fact that the charge-offs that we've experienced in the quarter were credits that we had previously reserved for. So we're at the point now where at least as a sort of basic matter as we're experiencing charge-offs, we feel like we're in a reasonably good reserve position, notwithstanding that idiosyncratically there may be additional adds. +What we would need to see is continued firming of sentiment in the sector, continued access to capital markets to allow companies to repair their balance sheets, and continued stabilization if not improvement in oil and gas prices. And so everything is constructive on that path, but it needs to continue along the same path. +And yes, we are growing our portfolio. And so even if it were not for energy, we would, all other things equal, be adding to reserves, but there are also time to (inaudible) pay down -- a lot of puts and takes, too. + +Answer_29: +So, I mean, just to say -- we obviously have our own spend data to look at, and it continues -- the Card spend is up 8% year on year. Energy continues to be a tailwind for consumers. The labor market continues to be solid and improving. And sentiment is still good. Housing, still improving. +So I mean, really just looking at the same things you're looking at, and we obviously have a slightly different lens to it. But all other things equal, consumers are in very good shape, and demand is there for the product. And we've been investing outside of consumer in new products -- inside Consumer, sorry -- in the Freedom Unlimited space and also in marketing. We're growing, not only because the demand is there but also because we're investing. + +Answer_30: +Our second-quarter results reflect everything that we have and we know of at the end of the quarter. And we're not going to make any specific comments on regulatory exams. + +Answer_31: +Not specifically. I'm not sure; I haven't polled the dealers myself. We continue to have very high FICO scores. I'm not aware of that, but I can't comment. + +Answer_32: +In our portfolio at this point, no. + +Answer_33: +So we are expecting refi to be stronger in the coming quarters; and the mortgage market, as best we can tell, will be at around $1.7 trillion, $1.8 trillion this year. + +Answer_34: +So we've done one, and we're looking at more securitizations in the mortgage space. And we are keeping a vertical stripe. We're retaining the loans on our balance sheet -- or the securities on our balance sheet, I should say. And in doing that we've been able to get private capital to take the majority of the lower credit risk and get better capital treatment for ourselves, in terms of the RWA that it attracts. + +Answer_35: +New originations. + +Answer_36: +I'll just start by sort of orientating you on why that would be the impact for us. If you look at our balance sheet and you look at what we have in fixed rate loans versus what we have in either IOER or in LIBOR loans, it's about $650 billion. So we're much more sensitive to the front end of the rate curve. +If you look at our earnings at risk disclosures, a 100-basis-point parallel shift would be around $800 million. And so obviously we haven't seen, and won't hopefully see, anything of that order of magnitude. That kind of gives you an ability to size up, notwithstanding compounding, why you've only seen our NII relative to prior expectations come down by that much. + +Answer_37: +So I think earlier on the call somebody else asked the question, and I made the comment that it's really more related to the results from our hedges of non-dollar debt, long-term debt. And so in the first quarter, the dollar weakened. In the second quarter, it strengthened. And with some currency basis in the first quarter that we didn't see in the second quarter, it really is, not to dismiss it, but it really is accounting and nothing really else than that. + +Answer_38: +No shift from our desire to want to be with engaged customers and our rewards programs. Our products are all geared towards that. So it's really just a credit decision. And, yes, we do have relationships with many, many customers in that still near-prime space. + +Answer_39: +Yes. So look, obviously P2P real-time payments is very important to our customers, so therefore it's important to us. It's also important for us on the industry that it's done in a safe and secure way. +And so early warning, the fraud protection that they are able to provide, as well as bank-level cyber security and the absence of a need to provide your bank credentials we think is very strongly positive for our customers. And we expect to see volume go across that. +As you know, we have QuickPay already, and we saw reasonably significant volume, $21 billion, on QuickPay last year and growing. So I would expect to see more and more P2P payments. And it's good for our customers, it's good for us. + +If you look at the whole payment space, Chase Paymentech is gaining share. Chase Net is doing very well. Chase Pay, we've signed up lots of different people. One piece of that is the P2P. +Today, right now, if you use Chase QuickPay, it's very easy within Chase to Chase. It's now just as easy to go from Chase to a bunch of other banks, who I won't name now. We've just started rolling out -- it's soon to be rolled out to 60% of American banking accounts. +And then we're going to make it available to all banks. So you will be able to go P2P, real time, through Chase QuickPay, there will be a special app for Chase QuickPay. It'll also be branded under another name, which we haven't rolled out yet, which I think will be rolled out shortly. +I think it's a great success that the banks can get together and do this. This will be great service, which I think shows you the banks making progress on what you would have called prior fintech. + diff --git a/exam/original-files/Problem_2_3_Sample_QandA/15_questions.txt b/exam/original-files/Problem_2_3_Sample_QandA/15_questions.txt new file mode 100644 index 0000000..7ae7886 --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_QandA/15_questions.txt @@ -0,0 +1,129 @@ +Question_1: +Good morning. + +Question_2: +I know it's very early, and it's probably limited in what you can say because you mentioned it depends on the timeline of Brexit and how passporting works, but is there any qualitative thoughts you can give us around the operational and/or legal issues we should be watching as this develops -- legal entity restructuring, net impacts of moving people versus lower-cost geographies and things like that? + +Question_3: +I appreciate that. Maybe switching gears, you mentioned the Consumer business was firing on all cylinders. Clearly, there's some nervousness in the market that the credit cycle is turning. +I wonder if you could touch on two things, which are -- maybe a little bit more detail on the seasoning impact you saw -- you mentioned in Card. Is it just seasoning or is there any like-for-like deterioration? And then in auto, you mentioned risk layering. What particular factors are you seeing layered in the underwriting box that make you concerned right now? + +Question_4: +Hello, good morning. + +Question_5: +Maybe just talk a little bit about the net interest margin and the outlook there. It was down 5 basis points. It looked like it was mostly in the funding costs. I just wanted to get a sense of what was driving -- I think long-term debt was an up-trading. Liability costs were up. Can you give us a sense of what's going on there and how to think about that going forward? + +Question_6: +Okay, that's helpful. +And maybe just one follow-up on the prior question of credit -- how should we think about the provisioning going forward in Consumer? Is that going to be a consistent build or is that a catch-up that we saw this quarter? + +Question_7: +Hi. Good morning. So my first question is -- given how well JPMorgan did on the CCAR relative to last year's results, and it seems like RWA and SLR exposure have stabilized over the past few quarters, how comfortable are you perhaps allocating more balance sheet to the investment bank, given that you seem to be very well positioned to continue to gain market share, especially in markets? + +Question_8: +Great. And was there anything to call out on the equities, the $1.6 billion equities number, that could be a little bit more one-time in nature for the quarter? + +Question_9: +Hi, good morning. + +Question_10: +Okay, two questions -- one on the outlook page. I see on the printed page it's the same as what you had last quarter for the Company overall, obviously. But I heard the emphasis on NII was on the plus side, right, $2 billion year on year plus. Is that the right nuance that you were trying to communicate? + +Question_11: +And then on the loan growth side, you've been funding this in part from just a mix shift, right, where your loan-to-deposit ratios moved up very nicely. It's still very low at 66%, but up 2 percentage points Q on Q, and up from 61% year on year. I'm just wondering how far do you think you can take that before you might want to look to fund loan growth with deposit growth more ratably? + +Question_12: +Good morning. One more rate question -- as you mentioned, you're super sensitive on the front end of the curve, and you just alluded to the curve is flatter. I'm curious about that great chart that you roll out on Investor Day that talks about -- we make $3 billion more through 2018 if rates stay flat, and $6 billion more if the curve goes down the implied path. The implied path is now lower. Just curious how much those numbers change if the current curve holds? + +Question_13: +That is perfect, thank you. +Other question was -- there's some regulators chirping a little bit about concerns in commercial real estate. Some of the other banks have mentioned that you're growing like a weed, and your credit is great. So can we just talk a little bit about what you think you're doing differently to both get that growth and then what you're doing to avoid mistakes of the past? And that'll be good. + +Question_14: +Hi, Marianne. Thanks for taking my question. +Wanted to ask a couple -- wanted to ask a question on the cost side of things where the overhead ratios, both in the CIB and the Consumer Bank, dropped fairly materially quarter over quarter. I guess I'm just looking for some guidance here in terms of how much of the expense initiatives that you've already been talking about, both in the CIB and the CCB, how much progress did you make in this quarter on that, and was that an outsized contributor to the improvement in the overhead ratios? + +Question_15: +Okay. And then just in the CIB specifically, you mentioned the comp ratio there was 30%. That's sort of at the low end of your -- of the range that you typically talk about, which is 30% to 35%. +I'm presuming that's largely driven by the better-than-expected revenues. Was there anything else going on there, or was that just pretty much a result of a benign revenue -- a relatively benign revenue environment? + +Question_16: +Hi. How is CIB doing in Europe and against European bank competitors in terms of revenue growth, share, the degree of competition? Some competitors are pulling back and you guys have stayed the course. Are you seeing the benefit from that? + +Question_17: +And I know you were asked already about Brexit. Maybe if we could hear from you, Jamie, about the implications of Brexit. Marianne, you said, quote, minimize friction costs. If you can just give us some sense of what that means? +You've given us a lot of guidance about the recent quarter and the year ahead. But you have what could be a monumental event, and you haven't really talked to investors about that since Brexit's occurred. How do you think about the currency risk, the cost, the revenues? And are you delaying any investments, given the increased uncertainty? + +Question_18: +Good morning. Thanks for taking the question. I just, first off, had a follow-up. So on Brexit, post this development, have you seen any impact on your banking pipelines? Has this had any impact on appetite for M&A, particularly if there is a component that involves either the continent or the UK? + +Question_19: +Great. Thank you for that. +And then one more on credit here -- so it seems as though we had 30-day delinquency rate actually go down quarter over quarter. So it seems like maybe -- in the Card, sorry, business. So it seems like maybe it's a cure rate issue. Is that the right assumption? And then, could you give maybe a little color on how much the non-prime growth has been -- has driven in recent vintages versus prior? + +Question_20: +Hi, Marianne. I'm not sure if this is too early, but when you think about expenses longer term beyond this year, if you think about 2017, if we find ourselves in a similar revenue environment next year, when you wrap in your cost save objectives and where you want to be on investment spend, do you think you'll be shooting for expenses to be kind of in the same range of that $56 billion next year, if things don't change on the revenue front? + +Question_21: +Sure. Just more near term, you talked at a recent conference about the tax rate going forward. Just with the kind of issues you had this quarter with the tax rate, looking at 39%, you said it would 36%. What should we think about going forward? Is it like in that 36%? + +Question_22: +Hi. Good morning. + +Question_23: +Marianne, I had a question on the outlook. You reaffirmed the fee income guidance of $50 billion, plus or minus, for the full year. I'm trying to gauge, just given the tough start to the year in trading in 1Q, the subdued second-half M&A commentary, and second-half trading seasonality that we would typically expect, the $50 billion target does appear somewhat ambitious. I didn't know if you felt like that was a fair assessment, or just given what you're seeing across the businesses, that the $50 billion is still ready achievable? + +Question_24: +Thanks, Marianne. One more for me on CCAR -- given that you've had some time to digest the latest set of results, the improvement in PNR was probably the most impressive aspect of the release, at least based on our own findings. From what you can gather, based on your own internal assessment, what were the primary drivers of the increase where maybe we have some limited visibility, such as areas like op risk? And does a favorable CCAR outcome inform your view in terms of which constraint is currently most binding and maybe how you might change your deployment tact across the different businesses? + +Question_25: +A quick question on the mortgage originations -- the correspondent channel didn't change all that much quarter on quarter, although I would have thought with seasonality and a pick-up in refis, that would have increased in the second quarter. Could you talk about how you're thinking about correspondent mortgage originations? And given that refi volume looks strong at the start of the third quarter, should we expect a pick-up in correspondent in the third quarter? + +Question_26: +Okay. And I know you can't really discuss too much on the legal side, but is there a right way to think about legal expenses going forward, like an ordinary cost of doing business for a bank your size? Is it 1% of revenues as kind of an ongoing run rate for expected legal expenses going forward, or is there not the right way to think about it and it's just episodic? + +Question_27: +Thanks. Good morning. +Marianne, I was wondering just if you could -- I know it's a little backward-looking now and you've made your points already about what normal trading seasonality could be, but could you help us understand the products that drove the really strong [FIC trading] and kind of what happened in June? Was it volumes? Was it spreads widening? And then I guess I would actually ask what you typically consider what normal JPMorgan seasonality is, as you mentioned? + +Question_28: +Understood, okay. +The second question just is -- on the wholesale reserve, you mentioned -- it's been nice to see the energy prices start to stabilize, and it seems like you're able to stabilize the amount of reserve build outstanding, aside from that one credit. What needs to happen for you to get even more comfortable, where you could see some of that reserve start to come out, underneath the context of that you're also growing the wholesale business extremely fast as well? + +Question_29: +Hi, Marianne. Thank you. +Marianne, can you give us some color -- obviously your consumer loan growth has picked up quite nicely. You pointed to, it's going to be at the higher end of the range for the year. What are you guys seeing on consumer behavior? Has it improved and they feel stronger about their own job prospects, which is enabling them to borrow more? Are there any metrics that you guys are looking at from that end? + +Question_30: +I see. And coming back to credit, obviously your first-quarter results had the results of the targeted shared national credit exam for oil. Traditionally obviously we have the shared national credit exam every year. Second-quarter results normally reflect that exam. +Do your second-quarter results reflect the shared national credit exam? Or is that going to -- ? + +Question_31: +Great, thanks. Marianne, just a couple of quick follow-ups on the auto lending business -- the originations came down a bit. And you talked about the dynamics around that previously in the quarter and at the Investor Day. +When I poll auto lender or auto dealers, they say that where they had primarily seen you retreat was from very high FICO, sort of super-prime new lending and leasing, but that their experience with Chase remained very consistent in the mid-FICO range. I just wanted to see if that was consistent with your view internally? + +Question_32: +Okay. Just one follow-up on auto credit -- obviously the Manheim issue points to perhaps some rising severity, given default. But at this stage, is there anything that suggests to you that we should see a higher frequency of default? + +Question_33: +Yes, thank you very much. One of the things about what we saw as mortgage rates -- I mean, the 10-year dropping down to record levels and mortgage rates probably following right behind it -- can you give us a little outlook? Are you seeing an uptick in refi's? We've seen the refi indexes go up very high. Any outlook on where you think the mortgage market's going to be in the next quarter or two? + +Question_34: +And the other follow-up question is -- there's some news articles out there about JPMorgan securitizing conforming loans. This hasn't really been done a lot by anybody. I don't know if you can address that, the economics behind that, or what's the thought behind that, instead of getting Fannie and Freddie wraps, you're securitizing them yourself? + +Question_35: +Thank you. Most of my questions actually have been answered. Just a quick follow-up on the credit card originations in terms of dipping down to the lower prime or below. You said something like 20% to 30% had FICO scores below 700. I didn't know if that was for new originations or for the portfolio overall that you were referring to. + +Question_36: +Thanks. Wanted to ask you a little bit about the focus everybody has on the flattening of the Treasury curve, but yet earlier you were able to say that going into next year you would see 2016 NII growth of $2 billion to $2.5 billion, only really fall to $1.5 billion to $2 billion, which means that flattening of the yield curve is very manageable. Just talk about asset yields as your earning asset yield actually went up 1 basis point -- what you've been able to see in the market versus what's happening in the Treasury curve. + +Question_37: +In this particular quarter, your funding costs went up. Is that a lag effect from what the rate hike in December still just now coming through, or was there something else maybe more unusual about the funding cost that we saw that drove the margin down this particular quarter? + +Question_38: +Hi, again. Just a follow-up on the Card new originations -- I know one of the key things that you've done for many years is to focus on relationship lending, relationship offerings. And so when I hear that 20% of the new originations are below a FICO of 700, is that a shift from the relationship strategy that you have or does it reflect the fact that you do have significant relationships on deposits, et cetera, with folks in that FICO band? + +Question_39: +Thank you. As a follow-up, Marianne, your consumer business obviously has been very, very strong. Can you share with us the update on clearXchange? It's expected to be rolled out later this year, and what that might do to even grow the mobile business even more than it's growing now? + diff --git a/exam/original-files/Problem_2_3_Sample_QandA/16_answers.txt b/exam/original-files/Problem_2_3_Sample_QandA/16_answers.txt new file mode 100644 index 0000000..a3a7f47 --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_QandA/16_answers.txt @@ -0,0 +1,108 @@ +Answer_1: +So I think there's three or four things to mention. The first is that I would say that the industry generally had a pretty weak third quarter last year. And so when you think about the year-over-year comparison we are a little flattered by last year's performance. +Not necessarily more so than our peers, but nevertheless we are. Then we talked about the fact that this quarter the conditions were relatively favorable broadly and compare and contrast that to last year where there were pockets of activity and client flow but there were also pockets where people were really sitting on their hands and not transacting. So I think client flow quite broadly across the environment would characterize the quarter. +In terms of the competitive performance I would say it feels like we did well. Obviously, we're the first to report, apart from Citi this morning. It feels like we did relatively well, so we may have gained some share. +Certainly, hopefully the momentum in terms of the business we've been building and the way we are serving our clients will service in that capacity, not just this quarter but through time. But, obviously, there can be a bit of volatility in the market share space. So we prefer to look at it more through time and we feel pretty good about the performance. + +Answer_2: +So I would say we don't specifically target a competitive set. But I will tell you that our balance sheet, we talked about it many times on this call before that we do have the capacity to put our balance sheet and our resources to work for our clients, for our best clients. +And we think about using those resources in the context of overall relationships. So if any period is more leverage constrained and has less access we may have competitive advantage. And certainly we will continue to make those resources available to our clients. + +Answer_3: +So I don't know, Glenn, if you recall that we had a bit of discussion about this last quarter and guided to the fact that we would expect to see our loss rates go up slowly, partly because, obviously, at 250-ish basis points I think we could call that pretty low historically. But also because over the course of the last couple of years we have been changing the mix of our originations a bit to the prime, near prime space, still completely within our credit risk appetite and at risk-adjusted margins that are better than the portfolio average. +So we are getting paid for that. So we are doing it within our risk appetite, doing it judiciously. But as a result, as those vintages become a higher percentage of our overall population they will have a gentle upward pressure on the charge-off rate. +So what we are seeing in terms of the delinquency uptick and the charge-offs, gradual increases completely in line with how we underwrote those loans and our expectations. And so as you look forward for us over the course of the next several quarters and we would expect those phenomena to generally continue, again, slowly. We are growing our portfolio, we are going to see the seasoning of those vintages as the mix increases and as they become more seasoned cause us to build a reserve but for the right reasons. + +Answer_4: +No, nothing significant, Glenn. No significant changes to our sensitivity. + +Answer_5: +So I would say that all of the things that you mentioned, whether it's closed loop network, whether it's our new proprietary products, whether it's our investments in the technology platform and the business in merchant services are all at good returns that ultimately will drive the business to be profitable in the future as it has been in the past. So we haven't given specific guidance for ROE targets for this business but nothing has changed over the medium term for what we think that the performance of the business would be. + +Answer_6: +Yes, it's a very competitive business and it's very profitable. So all other things being equal, we would like to continue to gain share. + +Answer_7: +So we haven't given specific cost guidance going out beyond this year at this point. But our objective will remain consistent with those that we stated previously which is we continue to try and become more efficient across our businesses. +As you know, we are at the tail end but not finished on a couple of large expense programs in our largest businesses so that we create capacity to be able to invest in the businesses broadly, whether that's in products, in marketing, in investment, in innovation, all of which we're doing as much as we can as long as we do it well. So it's going to come down to if we think we have investment opportunities that we can execute well that have an appropriate return we would like to keep doing that and in order to have the right to do it we would like to become more and more efficient in our core business operation. +So we haven't actually given guidance. I think I would characterize it as expenses under control creating capacity to invest. But we will decision investments based upon their merits and, obviously, explain them to you in the future at Investor Day, if not another venue. + +Answer_8: +So, first of all, I would say that based upon the speech and, obviously, you know that there are still some unanswered questions with respect to specific parts of the proposal which I will come back to, but based upon the speech moving to a baseline minimum standard is more consistent with how we think about our capital management policy. And using the capital stack add-up using, our G-SIB score and our stress drawdown actually you would come out with a capital constraint under CCAR that's pretty much on top of our regulatory capital minimum. +So in that sense because of the offset, because of the lack of balance sheet growth, lack of RWA growth and the curtailment of capital distributions, we've actually ended up in a place where we look to be approximately equally bound based on last year's test by both of those two measures, which is a space we've played in for a while. We've been, as we talked about before, we've been bound by many constraints, somewhat equally over a period of time and striving to operate within that constraint and maximize shareholder value. +I think the things we don't know are, obviously, how funding or liquidity shock will be incorporated. And in any case this is not for the 2017 CCAR cycle, so it's a whole cycle away from now. +So we will be operating in 2017 under the same basic test construct as we have previously. And so I don't think it's a clear and present danger necessarily that we will be able to look at payout ratios that are above the top end of our range. Meanwhile, we are at the top end of our range now. + +Answer_9: +Yes, so I would just generally speaking with respect to our rate sensitivity, as I think you know we are most sensitive to the front end of the curve but to IOER and prime. So we do have LIBOR-based assets but also liabilities. +A good example would be commercial loans on the asset side or long-term debt on the liability side. But our notional mismatch is not particularly big. And so as a consequence, the impact of LIBOR curve moves has been not very significant on our P&L, we wouldn't expect it to be. +I will say that the LIBOR moves were one of the features that our rates business had a perspective around. And they got good client flow in and around that trade. +And so it was one of the catalysts, one of many, but one of the catalysts that we point to in terms of the ability for rates to monetize flow as we had a lot of client flow around that conviction. But I wouldn't be able to put a number on it for you. + +Answer_10: +I think we, obviously, did get some good inflows, liquidity flows in terms of money market reform into our government fund. But we also have been very focused in our other wholesale businesses on continuing to attract operating deposits. +And so as I look at our overall strong deposit growth I wouldn't say it was equally but it was pretty much equally wholesale operating and retail deposit growth. So we feel good about both of those. + +Answer_11: +I might just give for context remind you all, or maybe you recall, that for a number of years now, for a fairly long time we've been standing up at Investor Day and other venues saying that customer experience is the central tenet for how we think about engaging with all of our clients but certainly our retail clients in the branches. And we have been very, very focused on investing in customer experience broadly defined and have made great progress, I think, in doing that. +And also we had talked about the fact that what we are looking for very, very clearly is deep customer relationships, engaged customers. We want to be primary bank. We want to gather deeper share of wallet. +So balance is not necessarily products. And so, again, remember saying that cross-sell is an outcome, it's not an objective. And that certainly is a philosophy with which we have designed our compensation and performance structures for the branches. +We review them regularly, at least annually to make sure that they continue to be aligned with our objectives and, again, objectives about the engaged relationship with customers, good customer experience in the right products, all the right reasons the right way. So as we think about those objectives and how we've designed our plan and as we look inwardly not just, obviously, because of the news now but also regularly in our BAU capacity we feel like our plans are designed to incent those behaviors. + +Answer_12: +So I would say, first of all, I would say we, I will tell you, we are on track with respect to the commitments Daniel made to you to deliver over time the $2.8 billion of expense saves. While we are not finished yet we are substantially through that program. So it's moved from being a plan through execution to being in the later stages of execution. +So we feel very good about that, which means that all other things equal that $19 billion is still a reasonable level of expense target. However, obviously we pay for performance. And so clearly if we have significant out-performance next year relative to our expectations at the time of setting those plans, there would be some variable cost associated with it. +But for every dollar of out-performance the variable cost may not always be the same. So, obviously, it also depends upon the mix and payout ratios and all those sorts of things. But a large, large portion of it would be, it would be, obviously, as you know incredibly accretive because we would be leveraging all of our scale, so the only variable cost would really be comp, largely. + +Answer_13: +So first of all based upon last year's results for us we are at the floor for the stress capital buffer. Not to suggest, by the way, that we wouldn't continue to want to properly understand and better understand how we can through time make sure that we are performing the best we can under stress within our risk appetite. But we are at that floor right now. +So within those constraints what we are trying to do is be within our risk appetite, manage risk properly but also add shareholder value. We have to carry that capital anyway, so we would want to use it well. + +Answer_14: +So for your purposes I'm going to talk about NII. We don't really manage to NIM. But you can, obviously, back into it. +So if we ended up in a situation right now where rates were flat throughout all of 2017 which for what it's worth I don't think is pretty much anyone's central expectation right now, but if we were rate flat you've seen us grow our core loans and our loan balances pretty strongly, pretty consistently across businesses. And while we may not be able to replicate our 15% core loan growth forever, certainly we can continue to grow our loans. +So on that plus mix shift away from securities over time we should be able to deliver $1.5 billion of incremental NII next year rate flat. You know that if rates are -- if we are fortunate enough for the right reasons that we see a hike this year, at the end of this year and get the full benefit of that next year, it will be higher than that. And you've seen our earnings and risk disclosures, they've been pretty close to a $3 billion number on a 100 basis point move for a while, most of which is front end. + +Answer_15: +So look, we are aware, obviously, of the riskier types of CRE lending, the types of lending that attract scrutiny for reasonable reasons considering how they've performed in past cycles. We are also mindful of where we are in the cycle and take that into consideration in our underwriting. +So we have and continue to avoid what I would characterize as the riskier segments and those segments that performed poorly in previous cycles. And we really stick to our knitting, if that's an American expression, in terms of continuing to do what we are good at within our risk appetite. +And so if you think about our commercial real estate growth, Commercial Term Lending is about three-quarters of our portfolio. And you know that we are very focused on smaller loan size, term B -- sorry, class B, class C properties with low vacancy rates. So rent stabilized, supply constrained markets, underwrite to low LTVs, good debt service coverage. +We look at forward rates and current rents. And so we really have an expertise in a specific niche and we compete on speed and certainty of execution, not on credit and structure. +So we feel pretty good about our exposures and even in our more traditional real estate banking space we have avoided the riskier segments with limited construction lending exposure, homebuilders minimal exposure. We are pretty disciplined about it. + +Answer_16: +So we are a primarily prime lender in Auto. We are the number one prime lender. +We actually have the lowest share in subprime among the national banks. So it is less than 5% of our origination. So I wouldn't speak specifically to underwriting in the lower FICO sectors, not where we play at this point. + +Answer_17: +So not that I would comment on except for we have recently decided to pull back on 84-month plus term loans on all FICO bands, just as where we are in the cycle as we see the risks of that type of lending. So we continue to calibrate our underwriting. But I wouldn't comment on seeing anything specifically. + +Answer_18: +Auto? + +We've built $25 million of reserves this quarter for Auto and we expect to continue. We think the Auto opportunity is still strong and we have a great franchise. +We have great manufacturing partnerships that are growing strongly, too. So as we grow that portfolio I would expect us to continue to grow reserves modestly in 2017. However, we are expecting charge-offs to stay under control. + +Answer_19: +Yes, so you are right. And, obviously, even specifically for JPMorgan if you look at our stress results that [handicapped] by the Fed over the course of the last three years has been reasonable volatility. And clearly it's not the case that we will expect it to be completely stable. +I would not expect to see the same levels of volatility going forward as we've seen historically as the test has, as you know, over time occasionally included new not insignificant features. And while that may continue to be the case I would think that there would be a bit more stability. But we haven't actually gone through and finalized our thinking about what the buffers would look like. + +Answer_20: +Yes, before I talk about the prioritization of capital distributions I would just start by saying our capital management policies prior to this year's CCAR and this year's resolution had us making those actions regardless of whether they were allowed to be reflected in a test. And, obviously, as part of the resolution planning we have revised our policies to include more granular triggers. +So our policies do with some specificity run pretty granularly through time through a stress speak to the sorts of actions that we would be leaning into and taking, even if they don't get reflected in the test. +With respect to the prioritization, look, the soft cap on dividends has been lifted. Dividends are ultimately still a part of the baseline minimum standard, so there will be possibly some natural constraint there. It hasn't changed, at this point anyway, the Board's determination or management's determination about the order of priority. +We would like to continue to have the capacity to grow our dividend. And I think even though there may be some natural constraints I think it would be above 30. + +Answer_21: +So we are very focused across the spectrum of our businesses on developing better digital capabilities to allow seamless engagement with customers and acquisition through digital channels. There are complexities associated with documentation and standards for know your customer and anti-money laundering that we're continuing to work through. But ultimately it should be achievable, and we are working on it. +So one of the things that we have previously mentioned is that the majority of our Consumer accounts are opened in branches. One of the reasons among others why branches are [still] important to us as well as advice centers. And we will continue to work on trying to see how far and how fast we can move people to be able to have a better digital experience opening accounts with us. + +Answer_22: +Well, I will just start by pointing out that all of the businesses, all of our businesses, not just the ones that I talked about at the high level, not just macro spreads equities, but even if you go a level below that quite granular, all of our businesses did really quite well this quarter. So not to overuse the phrase firing on all cylinders but it really was pretty consistent. And normally you might see pockets of more strength and less strength. +So I think it would be hard to imagine replicating this kind of strength through time consistently. But the fourth quarter is seasonally low and we have no reason to expect that it would not be. + +Answer_23: +So there isn't a whole lot of really clear new news. So as we think about all of the -- FRTB we've talked about before, modest and manageable, nothing about that has changed for us. But, obviously, there's the advanced and standardized credit operational proposals out there. +The most important thing that we've yet to really, and there are pluses and minuses in it and different for us than others maybe. But the one thing that we haven't really heard about yet, Betsy, is how it will all be calibrated and calibration will be very important. +So we are expecting to hear over the course of the next short while, and maybe that will be delayed some just given some of the discussion. And we will update you when we hear a bit more about how it's all going to come together. But right now it's still a little unclear. + diff --git a/exam/original-files/Problem_2_3_Sample_QandA/16_questions.txt b/exam/original-files/Problem_2_3_Sample_QandA/16_questions.txt new file mode 100644 index 0000000..a6c3ee6 --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_QandA/16_questions.txt @@ -0,0 +1,80 @@ +Question_1: +Hi, can you talk about the competitive environment in capital markets? You had a strong growth. Is that due to better markets, better share or both? + +Question_2: +Specifically versus the European banks, are you looking to use your balance sheet more to gain share? + +Question_3: +Hi, thanks very much. Curious on Card delinquencies ticking up. I know you've been guiding towards that but when you see it it's the only part of credit that has anything but great trends. +You mentioned on your comments newer vintages will have a higher loss rate than the portfolio average. Do you mind just drilling down a little bit more color on what exactly is driving that? Is that going down credit a little bit or is that just expected season as you'd thought? + +Question_4: +Fair enough. Fair enough. Just one follow-up. +If I could get just a high-level comment on has anything materially changed in terms of rate or curve sensitivity as you remix the portfolio? And as you are getting all this great loan growth I'm just curious on the current positioning. + +Question_5: +Hey, good morning. I had a question on the Card strategy, and I know we all know that you've created the closed loop and you are using that in part it seems to drive really efficient pricing in the marketplace on the credit card products. +What I'm obviously seeing is an increase in share on card issuance. You are taking some nice share in the merchant space, as well. I just want to understand what the goal is and how far you are willing to push this, market share versus ROA, ROE. + +Question_6: +But is it fair to suggest that part of the market share improvement here is coming from some give-up of profitability and the underlying question is really how much market share do you want in this business? You are already at 18% to 22% market share of the credit card space depending on which numbers you want to use. + +Question_7: +Thanks, good morning. Marianne, you mentioned that part of the increase in Consumer cost this quarter was planned investments and that you are continuing to self-fund. +I'm just wondering as you think forward and we get past this good gear that you've had, will that be an underlying expectation for you guys, again with the understanding that the revenue environment will always take things up or down? But do you have an aspiration that you can continue to keep costs flat? + +Question_8: +Understood. And if I can come back to another investment day point from earlier this year, you had mentioned that you felt comfortable with an 11% CET1. You plan to get to your CET1 to 12%. You are at 12.1% now already. +Just within the construct of Governor Tarullo's recent commentary, does 11% still feel like the right time? Did you sense anything from the commentary that would change your philosophy around where you'd like to live in that potential comment you made at February to potentially go above 100 if, in fact, this was the right mechanism? + +Question_9: +Good morning. Maybe just a quick follow-up on FICC in your commentary and maybe you can have a broader commentary around how the widening LIBOR or rising LIBOR yields helped your businesses across the board in FICC or anywhere else? Just help us understand how that's playing through the income statement. + +Question_10: +Fair enough and maybe just a follow-up on deposits. You guys have had very good trends in retail but on the institutional side there was quite a bit of flow looked like, as well. Any particular drivers there, was it money market performed helping the flows in institutional or something else? + +Question_11: +Good morning. In light of some of the selling issues over at Wells Fargo, I was just wondering if you've thought about reevaluating how you approach the consumer, how you compensate staff. And this was, obviously, not a JPMorgan-specific question, but just for the overall industry I think it's something folks are wondering about. +There's clearly some stuff that's black-and-white that you shouldn't do. But I think we also worry that there might be some gray areas that are somewhat less known. So just how are you thinking about the way you conduct business and compensate staff in light of what's going on? + +Question_12: +Hi, good morning. Just a question you, back to CIB, you had a slide during Investor Day that showed a walk to $19 billion of expenses by 2017. +If some of the factors that you mentioned that drove revenues into CIB higher repeat for 2017 is that $19 billion number still achievable? Or I guess a better way to ask it, will any incremental revenue uplift from here fall to the bottom line? + +Question_13: +Got it. And just as a follow-up to that, a follow-up to Ken's question actually, he mentioned the stress capital buffer. Outside of the static balance sheet and capital distribution offset, is there an element to this in terms of just getting better at the test that you could do to reduce that stress capital buffer without actually taking risk down significantly? + +Question_14: +Hi, this is Tim Hayes for Paul Miller. Can you give any color on your outlook for margin throughout 2017? +To me, Fed commentary suggests that rates could remain low and potentially hover around these levels over the next 12 months. So how can we think about your NIM in that type of scenario? And then what would a December rate hike do for your outlook? + +Question_15: +Okay, thank you. And then switching gears, your CRE and C&I lending was pretty strong this quarter and regulators have, obviously, grown a little bit more cautious on those segments. So I was just if you could give any color for your outlook on lending to those segments going forward. + +Question_16: +Thanks very much. Marianne, at a conference just before the end of the quarter another bank talked about improving underwriting conditions in the auto lending space, particularly in the mid to lower FICO range. Are you seeing anything similar? + +Question_17: +Sure, sure. I think the reference was to below 700 which includes the bottom end of the prime segment, which has been an area of intense competitive focus. I'm just wondering if you've seen anything in that segment? + +Question_18: +Got it. And is that influencing your reserve expectations for Consumer at all? + +Question_19: +Hi, good morning. So, Marianne, I appreciated your remarks on the latest guidance from Tarullo relating to G-SIB capital. +One of the questions we've been getting from a lot of folks is because this SEB is calculated based on stress losses year-to-year and historically CCAR results have been pretty volatile, I'm wondering how you are thinking about the appropriate management cushion or buffer above the minimum? Historically it had been about 50 bps just for AOCI volatility and maybe operational risk losses, but do you now have to also handicap CCAR volatility when thinking about that cushion? + +Question_20: +Understood. One more question, just thinking about capital management priorities, given that the new proposal as you noted allows for curtailment of the buyback or termination of the buyback and then curtailment of the dividend halfway through the test, do these changes as well as the softening of the 30% dividend cap alter your thinking about how you prioritize buybacks versus dividends? + +Question_21: +Thank you. Good morning, Marianne. +I had a question, you pointed out that about three quarters of your credit card acquisitions organic growth were coming through mobile channels or digital channels I should say. Can that be moved over to other Consumer products or is it just unique to credit cards that you are going to be able to generate that much growth through the digital channel? + +Question_22: +Okay, thank you. And then as a follow-up, obviously third-quarter results in Investment Banking were very strong. +Fourth quarter seasonally is weaker than third quarter as you pointed out. Are there any other reasons why you think the fourth-quarter numbers may be weaker than the third quarter, other than the traditional seasonality? + +Question_23: +I just wanted to follow up on FRTB and Basel IV and how you are thinking about the implications for JPM at this stage? + diff --git a/exam/original-files/Problem_2_3_Sample_QandA/17_answers.txt b/exam/original-files/Problem_2_3_Sample_QandA/17_answers.txt new file mode 100644 index 0000000..4f7d783 --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_QandA/17_answers.txt @@ -0,0 +1,219 @@ +Answer_1: + + Yes. So hey, Ken, you guys have a busy day today. So I would say that, the first quarter is always a quarter in which we have a bunch of different factors. And most notably, you also have day count issues in the first quarter. So I can go through that, but I would say most of the benefit which we expect to be up modestly will be driven by the rate increase, with growth being offset by day count. That's sort of fundamentally how to think about it. +It's probably more instructive to think about the full year. And so, if you recall back to the third quarter, just to kind of reorient everyone, at that point when we didn't have the December hike, we said rates flat. So on growth alone, we would expect NII for the full year to be up about $1.5 billion. Obviously, we have had the 25 basis point hike in December. And based upon that alone, so now the new rate flat, that $1.5 billion would be about $3 billion, a little over $3 billon. So for the full year, we're expecting on the December hike alone, that it would be about half volume, and about half rate. + +Answer_2: + + Yes. So I think the way to think about it, and again, I think we talked a little bit about it last quarter, and you maybe see it in the fourth quarter. So we've been growing our loans in the -- we said it was going to be a 10% to15%. We revised that, to be at the top end of that range. So we've been growing at around 15% core loan growth, the fourth quarter was 12%. So I wouldn't call it a deceleration per se, but it is a little bit lower. So I think going into 2017, our expectation is that we would continue to grow loans strongly, but possibly at the lower end of that range, rather than the higher. And of course, to a degree, it will depend upon our mortgage portfolio, but we intend to continue to add to that too. So sitting here today, I'd say more high single 10% plus or minus, and we'll give you more updates at Investor Day. + +Answer_3: + + Good morning. + +Answer_4: + + So just taking the two things separately, Betsy, I would say the NII, up 5% is dropping to the bottom line. But as we, you saw all of our underlying drivers, across all of the businesses and volumes, transactions, everything is growing very strongly. And although we still have some work to do to finish the large expense programs, we're near the end of that. So just generally speaking, we're continuing to invest in the businesses, and we'll see the improvement in our expenses flatten out, and start to grow with volumes. And that would also support growth in non-interest revenue, outside obviously of the card phenomenon we talked to you about. + +Answer_5: + + Sorry, carry on. + + + Right. So when we think about our investment securities portfolio, we think about it as responding to structural changes in our balance sheet, which predominantly is driven by loans and deposits. And it's always important I think, to remember, because we focus a lot on structural interest rate risk, but it also is liquidity and liquidity risk. In this quarter, there was a combination of things. You saw that we grew deposits more strongly than loans this quarter, so we had some excess cash, as well as the fact that rates rose. +So two things happened in our investment securities portfolio, mortgages extended, and we did add to duration. But we have a very disciplined risk management framework that's based -- that's been consistent through time, based on our expectations of normal rates in the future, and we just executed on that strategy. + +Answer_6: + + Yes, we added to duration, in accordance with our framework. + +Answer_7: + + Great. So obviously, the Sapphire Reserve card is still quite young, or still quite new. But relative to our modeled expectations even at the intro promo premium, things are coming in, in line or better than our expectations. Now obviously, we need to continue to [back test] that [three] times. But we're very encouraged by, not only the excitement in our customer base, but also the way that the trends are performing in terms of spend and engagement. But when we introduce a new product, we intentionally introduce a very exciting premium promo, and it's intended to generate excitement. And I think you would agree it did. So we're delighted with the response that we've had. +And we've actually kept it up for longer than we initially expected, but it's normal for us to come down from those intro rates, as the product becomes more mature, and that's what we are doing. But to be very clear about our expectations of the performance of the card, even at 100,000 points, we still expected the card to be a strong return and very accretive. So obviously, at a lower premium, it would be more so. But one last thing I would say, is everybody gets very interested the up front points. It's our opinion that the real value to consumers of that card happens over time with their spend behavior, and to take the points down from 100,000 to 50,000 has less than a 10% reduction in the overall value through the lifetime of an engaged customer on average. + +Answer_8: + + So the charge-offs came in for the year at 2.63%, which is in line with the guidance that we gave, I think in November that Kevin Watters gave. He's given guidance for 2017, as we continue to see the newer vintages seasoned, are 2.75% plus or minus. And that's still our expectation, so the newer vintages are performing in line with our expectations. + +Answer_9: + + Yes. So I'll give you a couple of things, and hopefully that will help. So I think a year or so ago, we talked about the fact that -- I'm going to now talk about cost of controls more broadly than just regulatory, that the cost of controls had increased for the Company by about $3 billion over several years. But that we expected they would peak and start bending down, and that is indeed what we have been seeing. Now I'm not saying that bend down is a sharp bend, as we continue to be held to very sort of hard compliance burdens. But nevertheless, we are seeing some efficiencies as we mature our processes and automate them. +Offsetting against that, and one of the reasons why it may be less obvious, is that we've continued to increase our spend in cyber security, as we want to protect the bank and the customer's data. So naturally, that is happening. We are not going to continue at this point, carving out the costs of regulatory or control because that is our operating model, it's our new normal. And until we understand whether or not the forward-looking landscape is changed, we won't be able to give you any kind of idea about how and when that will impact our expenses. But we will continue to be more and more efficient. +And certainly, if we are able to take a step back, and look at the rules and regulations, and the way that they are being implemented, and make rational changes to it, if that is something that is -- allows us to become more efficient, then we will certainly do that, and keep you informed. + +Answer_10: + + So I think in the conference in November, Kevin Watters said that as we look at the new products, and we look at them growing, coming out in 2016 and into 2017, we would expect the card revenue rate for the year next year to be about 10.5%, after which as the cards and the accounts season and drive revenue growth, we should see that continue to trend back up to a level in the past. + +Answer_11: + + Yes. + +Answer_12: + + Yes. + +Answer_13: + + I mean, I think that it's actual detail of retail spend, auto sales, house prices, household formation, confidence numbers. So I'm not basing it on the market, I'm just basing it -- if you look at a broad range of things, it looks like growth may have gotten a little bit better in the fourth quarter. Plus if you take a walk around the world, Japan is doing a little better, Europe is doing better. In fact, one of the IMF [or someone else] came out yesterday, and [said] the global growth is going to tick up next year. So it's just those factors. + +Answer_14: + + We're not going to change our plans very much, because we don't really react that much to the weather, because we grow to add bankers and stuff. You know you have to do it through a cycle. I do think of it as some regulatory relief. You will see banks be more aggressive and growing, opening branches in new cities, adding to loan portfolios, seeking out clients they don't have. So I'm hoping to see a little bit of that too, but that will wait for regulatory relief. + +Answer_15: + + Well, I'm saying we don't react to the small change in the economy to how we grow and expand our business. But I just that it looks to us, if you look across the broad spectrum, capital expenditures, business confidence, consumer confidence, household building, household formation, wage income, wages going up, unemployment going down, auto sales going up, retail sales going up, it looks like it's getting stronger, not weaker. That's what it looks like to me. That's just my own personal belief. + + + And maybe just if we give you a bit of insight into the philosophy about how we do our investment and expense budgeting. When we talk to our businesses, regardless to Jamie's point about necessarily whether the external factors are moving, the question is, what do we want to do in terms of products and services and technology and bankers and offices that we can execute on well and responsibly? And that is typically what defines us, not our appetite to invest the dollars. +So I think we've told you pretty consistently that, and you've seen it. We added 130 net new bankers, we opened eight offices in the commercial bank. We're investing in technology very, very broadly, payments, digital across the Company. So I would say that, we don't feel like we've been held back in terms of our appetite to invest, because of concern around the economy. And in the same way, a more confident outlook in the economy won't step change that. But we will continue to look for great investments everywhere we can and make them. + +Answer_16: + + So I would say, just if we separate the two, and just talk for one second about banking. The fundamentals for a solid M&A year are there, and obviously there will be puts and takes depending on what happens in the policy and reforms space. But we're optimistic about a solid M&A market, but with the continuing trend of fewer mega deals, but nevertheless good flow. At ECM, looks set to be quite active, and the IPO market continuing to recover, and debt capital markets have a solid pipeline in terms of the refinance arena, but having said that, interest rates may have an impact. So I think pretty solid pipeline coming into the year, but lots of factors will ultimately affect the full year. +With respect to trading, Jamie said, that we don't look at the first couple of weeks, but so far, so good. And what I would tell you is, we said this before, we're a client flow oriented business. And there will be a lot of micro and event-driven activity, and as long as it's not discontinuous, we should be able to intermediate transactions with our clients. And so far, generally there's been more risk appetite in the investor space, but that can change very quickly as we saw in previous quarters. So we will be there to support our clients. And if they are active, everything should be good, but it can change quickly. + +Answer_17: + + So just reminding you about our sort of philosophy on comp to revenue, we pay -- or our comp to revenue is just a calculation, obviously we pay for shareholder value-added. So you need to take into consideration the fact that we've had overtime increased capital levels and liquidity levels, and that's reflected in a declining overall comp to revenue ratio. I would say that there are three factors to it being lower. +The first is the strength in performance, and the pay outs aren't linear. And as you have stronger performance, you would expect to see a lower ultimate outcome. But importantly, we were -- some tail winds in the numbers this year included a stronger dollar. So as we pay -- remember comp to revenue isn't just on the front office compensation, it all supports our salaries, benefits and compensation. And we have a large number of people that we pay not in dollars. So that was a bit of a tail wind. Some of that will carry on, but maybe not at the same level. And we also just did our normal regular hygiene and productivity, in terms of the -- how we think about the workforce and pay. At the end of the day, we pay for performance, we pay, we think very competitively, to retain the best team on the street, and make sure that our shareholders are getting a fair share of any outperformance. + +Answer_18: + + Simplifying the securitization rules, because we've done some securitizations. We think they're excellent, but that would open up the market a little bit, clarifying the Safe Harbors on certain types of underwriting. For example, it's very hard and risky for a bank to make a loan to first time buyers, former bankruptcies, even though it could be very good people with brand new jobs, self-employed, it's hard to necessarily do all of the income verification, stuff like that. Simplifying servicing, the services standards now have, I think nationwide, we have 3,000 different standards. It's very costly. +It's very expensive. It's kind of risky. If you make a mistake, the punishment is pretty high. And all those things, that should be done for the good of the United States of America, not for the good of JPMorgan Chase. And so, I do think it's too tight and there's one thing, that if you get around too quickly, it will help the housing market a little bit, it will help the housing formation, it will reduce the cost of mortgages, and make it available to more people. + +Answer_19: + + Hi, Glenn. + +Answer_20: + + So starting off with sort of interest rates. And obviously, we've talked for an extended period of time about the fact we've positioned the Company to benefit when rates rise, we built the branches, we acquired the accounts, we've built the technology and the services. So we've been growing our deposits very strongly, and we're going to enjoy the benefits of that. With respect to how much will go to the bottom line, we have been we think appropriately conservative, when we've given you guidance about ultimately how much incremental NII we would expect in a more normal rate environment. +I mean, if you go back to Investor Days of past, you would see that we said when normalized, we would expect $10 billion-plus, and embedded in that are assumptions obviously around rate paid. We think that rate paid will be higher this time in this cycle, than in previous cycles for a bunch of reasons including as you said, competition for high quality liquidity balances. But also that we are coming off of zero rates and the improvement in technology. So we've been, we think appropriately conservative, but we'll find out in the fullness of time. +So far two rate hikes, absolute rates at 50 basis points, it's too early. And so far, you would expect there to be (inaudible) in there, and it's not linear, and everything is behaving quite rationally right now. So we, in fact, if anything a little better than we had modeled. So we'll keep watching it, and we think we've been thoughtful. We don't know the right answer, and we'll keep you updated as we see how things progress. + + + And just on the tax side, so other people understand, generally, yes, if you reduce the tax rates all things being equal to 20% of something, eventually that increased return will be competed away. That is a good thing. Okay, so it's not a good thing for JPMorgan Chase per se, but it's a good thing for the world, it's a good thing for growth. And a lot of studies actually show the beneficiary of that is wages. And so, it's important for people to understand that good tax policy is good for growth and the country in general. It's not just good for companies, it will eventually be competed away. + +Answer_21: + + Listen, you aren't going to really know for probably nine months to a year exactly what it is, so I wouldn't worry too much about it. And I also, just remember the most efficient companies do benefit from things like this, more than others. + +Answer_22: + + I think if you look at -- I mean, again, there's a lot of wood to be chopped and sausage to be made before tax reform gets done. And some of these things are brand new, they've never been talked about or done before, so you can read a lot of studies in the next six months. Obviously, interest deductibility, for banks, from a net interest income, so it doesn't directly change how you look at it. For everybody else, it affects complete industries differently. How you leverage differently, and utilities will be in a different position, and unleveraged companies. And plus, I think people will be able to convert what would have been interest expense to some other kind of expense. So let the work get done, before we spend too much time guessing about it. + + + I also think that while interest deductibility is one point, the repatriation of cash is another point. And there are puts and takes, and you have to think, you have to see the whole package, before you can see what the net impact is. But ultimately if these things get done rationally and grow the economy, then it's good for our franchise just broadly. So don't focus on DCM, focus on the whole thing. And I think when you get the whole package, if it's done well which we hope will happen, then it will be good for the economy, good for our clients, and good for our whole franchise. + +Answer_23: + + Yes, okay. So yes, Matt, it does include the benefit of higher long end rates. And if you get the Q, and get our disclosure on net income risk, and do some math, you'll get pretty close to numbers that looks similar to that $1.5 billion or more. And then, with respect to rate sensitivity from here, clearly it's not linear. So you can see, if we just look at the third quarter, the first 100 basis points -- this is an illustration of $2.8 billion, 200 basis points is $4.5 billion. So as we clip away, 25 basis points a time, our $2.8 billion will start to come down. And so, that's broadly the outlook. + + + And the next 10-Q will show the next -- (multiple speakers). + + + And the next 10-Q will show the next. + + + But obviously, it's less and less as rates go up. It's not linear. + + + Unless we actively change the ratio, which we may also do at one point. + +Answer_24: + + Yes. So I mean, what you saw happen in 2016 was not only obviously a rotation from securities and deploying deposits into loans, but also we took a very large amount of non-operating deposits out of the balance sheet in 2016. So that is having an impact. But we would expect to continue to grow our loans, to grow our deposits strongly to manage the overall balance sheet through our investment securities portfolio. And from here, if everything continues to be as the market implies, we should see margin expansion. + +Answer_25: + + Good morning. + +Answer_26: + + Yes. So answer is across the metals and mining and energy, we have a little over $1.5 billion of reserves. I mean, there is a normal level of reserves that we will have, that would be a large chunk of that. And as you saw in 2016, we did take charge-offs of a little less than $300 million. So we will continue to likely see on a name specific basis, as people work through their business models, that there will be more charge-offs. But ultimately, if energy stays stable or improves, and of course, we have to see that be somewhat sustained, and find its way flowing through the financial statements of our clients. Then as we upgrade them, God willing, then we will see more reserve releases. But it's going to take some time. +We'll start to see some of that -- and think about the large reserves we took. We took them at the tail end of 2015 and into 2016, we'll start to see new financial data from our clients. We'll start to do the borrowing base redeterminations, and look at the impact of prices on reserves in the spring. And so, we'll start getting some data this year, and so we may see some more releases, but it's going to come through over time. + +Answer_27: + + Yes, I mean, I would say that when I talk about the overall core loan growth going down, still being strong, it does reflect the fact that we've been seeing very strong outperformance in our growth over the course of the last couple of years, particularly in commercial term lending. And while we continue to believe there's great opportunities there, they will be lower. So we've been printing in the teens pretty consistently, and I would say, it will be less red hot, and maybe more in the high single-digits, but we're going to keep you updated. + + + There's still plenty of opportunity. + +Answer_28: + + Well, I don't know that I would ever try to decide what moment in time, is the pinnacle. But I would say, you saw us invest heavily in the business in 2015 and 2016 across a number of different fronts. You saw us proactively renegotiating the card program deals for the vast majority of our portfolio, and investing very heavily in exciting new products. And in both cases, while it has had an impact on our revenues, in one case in the short-term, and another case more structurally, in both cases these are still very attractive returns. And so, card is still a very attractive ROE business, very important to our customers. We are after deep engaged relationships through time with them. And so, we are going to continue to invest in growth. + +Answer_29: + + At this point, yes. + +Answer_30: + + We did try to actually analyze it, because we got asked a lot about what was secular. So you could break apart your exotic derivatives, certain types of CDOs. Of course, across the whole spectrum, there are things that disappeared and won't be done no more, for better or worse. In some cases, by the way, like a CDOs it didn't go away, because the person is still a credit buyer. So they just went to another product, but that was our best estimate. I don't want to over do it or anything like that. +I also said that the actual market making requirements are going to be going up over time, I'm talking about over 20 years, I'm not talking about the next quarter or next month. And remember, we don't run the business next quarter, next month, because assets under management are going up, and needs of corporations are going up. The fixed income mortgage is going to go up, the needs for FX is going up, the needs for hedging is going up. So over time, we know there's going to be a cyclical increase. And we just try to estimate how much of the [downturn] is cyclical, and so, there will be a flip side of that. And I think you might have gotten to the end of the secular, end of cyclical decline. + +Answer_31: + + So I will obviously, give you a lot more detail about all of this at Investor Day, but really quick, because I knew the $19 billion would get some excitement. If you go back, and talk to yourself to look at the specifics on the slide, you should see that the $19 billion that he guided to did have some assumptions about some legal costs in there. The CIB didn't have legal costs in the year. And as a result, it's still a little higher on an apples-to-apples basis than that would imply. Additionally, I talked about the tail winds in terms of a stronger dollar. +Now for full disclosure we have intentionally reinvested some of that, but it was a tail wind that meant that apples-to-apples, it would still be a little higher. I'd tell you that compared to the targets that they set, we still have a few hundred million dollars to deliver on, and Daniel will go through that at Investor Day. + +Answer_32: + + Okay, so just to talk about rate trading for a second. You're right, that it was a part of the strength story in the fourth quarter this year. It was also a strong fourth quarter last year, which is pretty much the only reason why we didn't call it out as a bigger driver of the year-over-year growth, but it was a strong performance in the quarter. And we would expect that to continue. It's much more interesting to -- for our clients to trade around a moving yield curve and rates above zero. So as we see rates normalize, we would fully expect that to be ultimately a beneficiary to the franchise in terms of clients trading, and positioning, and hedging around that over time. And so, [wonderful] if that would be the case. +In terms of the excitement and the enthusiasm of our businesses, lending versus we're enthusiastic about all of our businesses, and would want to defend share and grow them all. I mean, the reality of the CIB revenue performance in markets, and in general, it was very strong in 2016. So we will try our hardest to replicate that. But it will be a challenging comparison, but we're proud of it. So we gained share competitively over the course of the last couple years, and so I don't think you should necessarily expect that we can continue to gain share at that pace; but defend it we will. + +Answer_33: + + I think the better way to look at CIB lending, is it's kind of episodic, and goes in and out. Corporations, a lot of corporations don't need to borrow, and when they do, it may be inconsistent. It might be because of M&A or something like that. Our [bridge] book will always be driven by certain types of activity, so the loan book isn't something -- the CIB loan book isn't something you're going to say, that you're growing. That is more serving clients in the way they need. +One of the things I just want to point out which is, of course, all of our businesses, but just take trading in particular is, we're always creating efficiencies. Part of what we're investing is big data, is [trade] through processing, electronic exchanges, online services. I think 97% of FX -- I think it's 50% to 60% of US interest rate swaps, all these things have become electronic and digitized, as trade through for clients. So that's where some of the investments are going. And you're going to see more of that not less, but it also creates another round of efficiencies every time we do that. + +Answer_34: + + Good morning. How are you? + +Answer_35: + + Yes, so we talked before about -- we had in certain markets already pulled back, not necessarily because we had a crystal ball, but because we saw them getting soft before the energy decline. Dallas and Houston would be examples, parts of Brooklyn would be examples of that. I would say, watching more carefully -- you've seen us, we have that there is some supply coming through in markets, Seattle, Denver, D.C., San Francisco. We're still very active there, but just keeping an eye on those markets. But the supply pipeline, while it's real does not look like it did when we saw the real pressure on the term lending business, the real estate business back in the 1980s and 1990s. So we're keeping an eye on it. + +Answer_36: + + (Inaudible) I'll add, we don't want to give you all of our secrets in that business, but we do (inaudible). But we're very disciplined about where we see supply, and supply and demand and pricing, and we would have no problem, not growing at all. We don't sit at meetings here and say, can you grow at 10%, can you grow to [12%]? No, if we can't meet what we think is proper risk return, we're not going to grow at all. We'll shrink. We have no problem doing that. And so, the other thing I want to point out about CTLs, the exceptional performance of the CTLs through the last Great Recession. I mean, we were really pleased with how that happened. So we try to look at all these things through the cycle, not just what are they doing in good times. + +Answer_37: + + We don't disclose that. + + + Thank you. + +Answer_38: + + So, there's a couple different things. First of all, we, about a little more than half of our originations are jumbo. We retain all of those. And then, when you look at the conforming space, it's really, honestly, consistently the best execution decision. And so in particularly in this quarter, it speaks a bit more to our correspondent conforming volume, it's the lowest margin product. And it does somewhat frequently toggle backwards and forwards in terms of better execution, whether we would retain or sell it. +But we intend to keep adding to our portfolio, we like the mortgage asset classes. Even those spreads have compressed in the fourth quarter, OAS and ROEs are holding up. And so, I would expect us to continue to grow it strongly. And from quarter to quarter, it may go up or down a few percent, but over a year, we'll continue to add to the portfolio. + +Answer_39: + + No. + +Answer_40: + + I think there was a little bit of that in the fourth quarter, particularly around actively managed product. I think you're accurate. But we haven't seen everybody else yet, but I think you will be true, when we see everybody. + +Answer_41: + + That's a really hard question to answer. I'd have to think about that a little bit. + +Answer_42: + + I think that -- I mean, everything is going to end up being reasonably named specific, so I mean, that may be true in some cases. But for some companies in industries, where deregulation and that would be more helpful. But generally as I said the trend is towards lower -- I'm sorry, less mega deals, more flow, and the fundamentals are in pretty good shape, and then there will possibly be tail winds, in terms of tax reform and other things. So I think net-net, we think the underlying flow in the M&A market, and the fundamentals are set to have a pretty positive year. + +Answer_43: + + We'll see. No more questions, operator? + diff --git a/exam/original-files/Problem_2_3_Sample_QandA/17_questions.txt b/exam/original-files/Problem_2_3_Sample_QandA/17_questions.txt new file mode 100644 index 0000000..cece7f7 --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_QandA/17_questions.txt @@ -0,0 +1,173 @@ +Question_1: + + Hi, thanks. Good morning. Marianne, I was just wondering -- I know you'll give us more at Investor Day, but just in terms of that first quarter starting point for NII, and just how it translates between growth in the balance sheet? And then, you mentioned the benefit from the roll over in rates, can you help us just try to think about -- just you parse those views out, and think about volume versus rate? + +Question_2: + + Understood, great. And if I could ask a follow-up? Just on the volume side, you had another great year of double-digit loan growth. And obviously, we're at this intersection between kind of the what was, and then the what will be. Any change to that expectation you could just grow the loan [bit] book, a core loan book that is, as strongly as you have in the past few years? + +Question_3: + + Hi, good morning. + +Question_4: + + I just wanted to dig in a little bit on the forward look. NII up a bit, but also expense is up a bit. And I just wanted to understand is that because you've got the opportunity to reinvest in things that you haven't been able to? And if you could just speak to what kind of time frame the reinvestment will yield returns, because the question I've gotten from people is, why aren't you dropping the NII benefit to the bottom line here? + +Question_5: + + And then related follow-up has to do with, how you're thinking about the excess cash you've got, and the balance sheet duration? And if there's anything in this new interest rate environment that you would be seeking to do -- (multiple speakers) to optimize -- + +Question_6: + + Okay. So no change to the duration? + +Question_7: + + Hi, good morning. Marianne, I was wondering if you could comment a little bit about some more color in card trends? You have exciting new products out there. How are the economics of the Sapphire Reserve card been coming in relative to your expectations, and what factors drove the decision to cut the original promotion award back, and should that affect your account acquisition costs? Thanks. + +Question_8: + + Okay. And just as a follow-up on that, in terms of the card, credit quality, it's been very good. Would you still expect to see though some seasoning as the book matures? What kind of outlook would you have on the card charge-offs? + +Question_9: + + Hi, good morning. I know that you've said previously that regulatory reform or regulatory relief will unlikely have any fundamental change in terms of how you're thinking about budgeting. But I'm wondering if you could help us understand, sort of over the past few years, how much has regulatory costs grown, and has that peaked anyway? And can you give us a sense of how that could trend over the next few years, either the natural trend of it, or what the impact would be of regulatory reform? + +Question_10: + + Great. And just as a follow-up to John's question on card trends, when you look at the card revenue rate declining about 200 basis points or so year-over-year, is your response to this question essentially implying that we've potentially hit peak promotion in 2016, and perhaps the revenue rate will have some stability to it in 2017? + +Question_11: + + Hi. Is Jamie on the call? + +Question_12: + + So Jamie, your comment said that the US economy may be gaining momentum. + +Question_13: + + If you can give some of the basis for that comment, is it more risk borne by investors, or more CapEx by companies, or is this more hope? + +Question_14: + + Is that enough for you to say you're going to invest a little bit more, or hire more people, or expand a little bit more? And along those lines, how do you see market share gains potentially from now? + +Question_15: + + Why are you saying this might be a little bit more than just weather, that this might be more sustainable, when you say the economy might be turning? + +Question_16: + + Hey, good morning. Maybe we could talk a little bit about the investment bank? Obviously, your peers and a lot of investors have been growing in their optimism for this year, in terms of animal spirits and everything else, and just want to get a sense of how you're thinking about it? Do you share that optimism, and any commentary on how we can think about both banking and trading into the New Year, with all of the moving parts that we have around policy, et cetera? Thanks. + +Question_17: + + Okay, that's helpful. And maybe as a follow-up. On the expense side, the comp ratio in the investment bank, I think dropped around 240 basis points this year or last year. Do you think that's sustainable into 2017, assuming flat to up revenues, or was there anything unusual in there? + +Question_18: + + Yes, thank you very much. Hey, Jamie, one of the things that we're seeing, some of the new politicians, coming in talking about opening up to credit box, especially in the mortgage world that has been really shut down over the last years, mainly due to the rules coming from all of the things, Fannie, Freddie, [UB]. What type of things do you need to see or do you think they can do to open up that credit box, where banks can take more risk and be protected? + +Question_19: + + Hi, thanks. + +Question_20: + + Hello, there. So I guess the question for either one of you is, if we do get some lower taxes and/or a better rate environment, I'm curious on your confidence on how much of that can fall to the bottom line? Because there's a lot of optimism about what can happen if stocks have moved well, we're expecting that to move to the bottom line. There's the big concern that people have is, that it gets competed away by irrational behavior. So curious to get your thoughts on that, just big picture in general, if things go well how much of that are you repaying? + +Question_21: + + So when should I take that lower tax rate out of my model? I'm kidding (laughter). + +Question_22: + + The real follow-up I had was, that the concept of interest deductibility, if that is the means that they use to pay for the tax hikes, it feels tough, like a bad thing. I'm just curious on how you think it impacts your franchise, from anything from debt underwriting to anything else? + +Question_23: + + If I could circle back to the discussion on net interest income and the rate leverage. I think the outlook for net interest income to grow over $3 billion versus $1.5 billion before the rate increase. That's obviously a nice lift for just a 25 basis point bump on the short end. So I guess, one, does that include the benefit of longer term rates since they've moved up as well since 9/30, which I assume it does, but just to confirm that? And secondly, what's the leverage to rising rates from here, as we think about movements in both the short and long end? + +Question_24: + + And that is actually -- getting to my follow-up question. I mean, on the size of the balance sheet, you did talk about loan growth of about 10% this year. If you look full year 2016 versus 2015, the balance sheet or the earning assets only rose 1%. So maybe tie that into, as you think about duration, the fact that you're sitting on a lot of liquidity and cash, and how we should think about both overall growth in the balance sheet, and then potentially some more remixing? + +Question_25: + + Hi, good morning. + +Question_26: + + Just a quick question on the credit and reserve releases, as it relates to the energy and metals and mining portfolio. Now that you've actually seen some better credit in there, how much of the reserves are left in that portfolio, and can you still see reserve releases going forward? + +Question_27: + + Okay, thanks. And then, also on CRE, again strong loan growth year over year. I mean, I understand that you're focusing in these housing-constrained markets, but is there a limit to how much you can grow in those markets? + +Question_28: + + Thanks very much. Marianne, just to follow-up, a couple more questions on card. I know you've talked quite a bit about it already. But one of the sort of conventional wisdoms at the moment is that 2016 represented the pinnacle of the intensification of the competitive environment. And I just wanted to get your thoughts on whether that's an accurate assessment or not? + +Question_29: + + Great. And just on that point, the ROA expectations that you have as a consequence of the trends that you just underscored, do you consider these to be, sustainable as you get back to that 11% kind of revenue yield? + +Question_30: + + Hi, Jamie. I wanted to start off with a big picture question on the trading side. You made some recent remarks talking about the outlook for the [FICC] business, and alluded to roughly half of the declines versus the peak being attributable to cyclical as well as secular factors, and a lot of FICC optimism in particular that we've spoken with have really latched on to your remarks. And I was hoping you could provide context as to how you determine the 50/50 split. Should we be taking those comments so literally? And how you're thinking about the FICC fee [portfolio] trajectory overall, as some of those cyclical headwinds abate? + +Question_31: + + Thanks, Jamie. That's extremely helpful color. And Marianne, maybe just switching over to the expense side for a moment. You also provided very helpful detail on some of the drivers of the strong expense progress that you're seeing in CIB in particular. And from what I recall, last year's update, Daniel actually guided to an expense target of about $19 billion by 2017. It looks like you've gotten there essentially a year early. And I'm wondering whether there are more savings initiatives that have not yet been filtered through, and could potentially accrete in the coming year? + +Question_32: + + Hi, good morning. Was just wondering if we could talk a bit about rate of trading. I mean, to my mind, that was a product that's done particularly well this quarter. But I was wondering looking forward, how you see that performing, whether it's supported by what's going on in the yield curve? Or whether do you see that supported more by sort of like one-off euphoria around the election, so maybe that might tail off a little bit? +And then just moving on from that, how do you view the opportunities for growth in your capital markets businesses, your CIB versus say, your lending businesses? Are you equally enthusiastic about both, and given the opportunity sets going forward, or do you see some being more positive than others? + +Question_33: + + I mean, it sounds maybe that you'll (laughter) the pressures of year-on-year growth, in the CIB business but you're not really highlighting that in terms of your lending businesses, which obviously you'd expect further margins to grow, the loan books to grow. + +Question_34: + + Good morning, Marianne. + +Question_35: + + Good. Can you give us some color, in the past you've talked about -- in the multifamily, I know you commented on that in your prepared remarks, on your multifamily book, some of the markets that you continue to be a little leary of, can you give us an update to those types of thoughts? + +Question_36: + + Okay, great. And I know you talked about the duration of the securities portfolio, it's in line with -- (multiple speakers) + +Question_37: + + Certainly. And Marianne, coming back to the investment portfolio, obviously you talked a little bit about the duration. Do you have the actual duration of it in years, this quarter versus the third quarter? + +Question_38: + + Good morning. Just a quick question for you, Marianne. In terms of the mortgage, in the overall picture, I understand why you're talking about maybe 10% core loan growth rather than 15% more recently. But just within the residential mortgage portfolio, it looks like that slowed in the fourth quarter, third and fourth quarter from a mid teens year-over-year rate, to a low single-digit quarter-over-quarter rate. Can you give us a little more color as to what's going on there? Are you buying -- or are slowing your purchases of your own originations, or is that -- is there something else going on there? + +Question_39: + + Okay. So no real change in your thinking there? + +Question_40: + + Thanks for taking my questions. The thing that jumped out at me was, if you looked at the asset management group, you had $21 billion of long-term product outflows, and you had $35 billion of liquidity products inflows. And it seems like now that we're getting past the financial crisis, when everybody was looking at liquidity, that combining that with continued deposit growth, we're not seeing a change in that perspective, but there's still a premium for increasing liquidity still? + +Question_41: + + Do you foresee that premium for liquidity lessening, as we kind of go into the rerisking of a better economy, and some things that improve the outlook? + +Question_42: + + And then my last thought was, when you look at M&A, we had M&A kind of suppressed when things were more regulatory constrained, and the outlook was a negative on the overall economy and that uncertainty. Now we have this positive uncertainty. Wouldn't that delay some activity for at least a couple quarters, for people to kind of see where we're going to end up, and see where tax rates are, and see what we might get in deregulation that may change perspective on their long-term opportunities? So just thought there might be a little pause here. + +Question_43: + + I just thought maybe in the second half versus the first half, but thanks for your response. + diff --git a/exam/original-files/Problem_2_3_Sample_QandA/18_answers.txt b/exam/original-files/Problem_2_3_Sample_QandA/18_answers.txt new file mode 100644 index 0000000..8e5d773 --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_QandA/18_answers.txt @@ -0,0 +1,171 @@ +Answer_1: + + So in the retail space, the answer is no, not really. And to be completely honest, we've been pretty consistent that we would not really have expected there to be much in terms of deposit reprice at absolute levels of rates that are still quite low. And so with IOER at 100 basis points, we're still in that sort of realm of the atmosphere, and so we would expect that to start happening a couple of rate hikes from here maybe. We'll have to wait and see. We've obviously never really been through exactly this before. On the other side of the equation, in the Wholesale space, we are in the process of seeing a reprice happen. + +Answer_2: + + No. + +Answer_3: + + Yes, so I don't have all those numbers directly in front of me. I know that in the Commercial Bank, our exposure to mortgage is really pretty modest, it's around about a total of $3 billion in the commercial real estate space. And I would tell you that while there obviously is a lot of discussion around retail, and with some merit, it's very case-by-case, location-by-location-specific. And I kind of liken the discussions a lot to discussions we have around our bricks-and-mortar banking businesses, which is consumer -- the way consumers engage with retail isn't changing, it doesn't mean they will stop engaging with retailers. And so it will be very specific with respect to location and tenants. And it doesn't necessarily mean that retail is going to be in as much potential trouble as I think people are talking about. So we remain cautiously watching it but also cautiously optimistic that it's not -- that it's a bit overblown. + + + And you should assume that we've looked at not just direct retail or retail-related real estate, and all the vendors to any potentially covered retailers. When you put it all together, it's a little bit like there'll be something there, but it's nothing that will be dramatic when it's happening. + +Answer_4: + + Are you talking about real estate related to retail? Or are you talking about retailers? + +Answer_5: + + No, you're way out of line. I mean, direct retail exposure, we're very careful. The retail business has always been violent and volatile. You can look back through our history, and half of them are gone after 10 years. That's the normal course. So we're usually senior, we're very careful with stuff like that. And then you go to real estate, okay, most of our real estate has nothing to do with retail. So we do have some shopping centers and malls and buildings and stuff like that. But those are generally high on the stack, well-secured and not relying on single retailers, et cetera. + +Answer_6: + + It will be like oil and gas for us, it won't be a big deal. + +Answer_7: + + Yes. So look, I know that -- so one of the things that we want to remind everybody before we talk about the trend is that the credit card losses are still at absolutely very, very low levels. And notwithstanding whatever we would have done or have done or continue to do with our credit books, we would ultimately have expected them to normalize to higher rates regardless, so -- and then for -- obviously, the first quarter hasn't been that... + + + It's probably just the previous cycle stuff. + + + Yes, exactly. And obviously, first quarter has some seasonality. So I would just start by saying that the charge-off rates we're seeing are completely in line with our expectations and guidance that we gave you at Investor Day both in terms of 2017 being below 3% and over the medium term being between 3% and 3.25% for all of the reasons we articulated. A combination of positive credit expansion that took place over the last couple of years and the performance of those newer vintages is in line with our expectations and with high risk-adjusted margins. So it's not really about tolerating the charge-offs as long as we're getting paid properly for the risk, which is the case. And obviously, as we see those charge-off rates both normalize and reflect those newer vintages, they will go up modestly over time. And we expanded our credit in a targeted way, but it wasn't a significant expansion. And we will respond in our credit and risk appetite to whatever we're seeing in the environment. But it won't necessarily be predicated by charge-offs rates as long as (inaudible). + +Answer_8: + + So I would say if you look back over 2016 and even 2015 and '16, it's true and clear that we gained share, not just in fixed income -- reasonable share not just in fixed income but also in equities. And our business performed well last year. And I would suggest to you that we will defend that share. But the competition is back and healthy. And you can't expect us to continue to gain share at those kinds of levels. We want to defend it, but it's a healthy competitive market right now. So I would say not really. + +Answer_9: + + We have a ways to go before we're concerned. + +Answer_10: + + For merchant processing, there's a lot of share you can gain. And that's not even close, because you give products and services and a change in technology. And I think we're way, way in credit card when you say, "Well, that's too big for JPMorgan Chase." There is a point where it's going to be a good question, but it's not even remotely close to this one. + + + And I would also say that Cards continue to be a very competitive space. So we will continue to try and provide our customers with significant value and have deep, engaged relationships. But I don't think you're going to see material shifts in share in the short term. + + + And we also look strategically at credit card, debit card, online bill pay, P2P as all one big thing to do a great job for the client. + +Answer_11: + + Not particularly at this point. I think we're very happy with the performance of the portfolios, with the growth rates we're getting. You saw that our core card loans were up 9% year-on-year. We're getting a lot of NII benefit from that. So I think we're pretty well positioned at this point. + +Answer_12: + + Yes, I would say loan growth should be in the mid- to higher single digits. + +Answer_13: + + So obviously, when we give you guidance, we give you sort of reasonably rounded numbers. So actually, the impact of current implied is a bit more than $500 million more than it was at Investor Day. But in the law of big numbers, that's a pretty reasonable amount. Yes, there is an element, of course, as we talked about, in the Wholesale space, where we are seeing reprice happen, and it does reflect our estimates of what we expect to see over the course of the year in cumulative deposit bases. And with respect to if there was -- and you know that the implied has priced in 1.5 more hikes, so it's -- obviously, March is earlier, so longer, there's a little bit more rate benefit. But it's sort of in line with our expectations. And if we had another rate hike, it would likely be later in the year, and ultimately have a relatively modest impact on this year but obviously be important going forward. + +Answer_14: + + You should be able to extrapolate those numbers on your own. + +Answer_15: + + I think it's important to put that slowdown into context. I mean, we did have 8% growth year-on-year in C&I. We're just saying sequentially, things are a bit quieter, and there's a whole bunch of reasons that could be driving that. And importantly, you mentioned it, when we're in dialogue with our clients, they are optimistic and they are thinking about growing their businesses and hiring, and all of those things are true. And so putting aside those that have access to capital markets for a variety of reasons in newer bank loans, it's completely understandable that optimism would lead actions. And so as to what that lag will look like, we'll wait and see. But fundamentally, a pro-growth series of policies will be constructive to the economy, to our clients, and ultimately, will end up in them hiring, spending, and they already are, and we'll see that translate into loan growth. Whether that's in the second half of this year, we'll see. + + + I would just add that I wouldn't overreact to the short term in the loan growth because there are so many things that affect it. When you go through the episodic part, if you look at CIB, I wouldn't look at loan growth at all, because companies have a choice of doing loans and deals and -- or bonds, something like that. Look at credit card looks okay. Mortgage is obviously affected by interest rates. Autos is obviously affected by auto sales. And middle market was okay. It was like it was slow, but it was okay. So I wouldn't overreact to that. And the second thing is you all should expect as a given that when you have a new president and they get going, that the 9 months after the 100 days is going to be a sausage-making period. There will be ups and downs, wins and loss, stuff like that, okay? But it is a pro-growth agenda, tax, infrastructure, regulatory reform. And that is a good thing, all things being equal. And we think that if that took place, it would be helpful to Americans. But to not -- to expect it to be smooth sailing, that would just be silly. + +Answer_16: + + It looks fine. And of course, it's episodic. + + + Yes. And I would also say that while, of course, people's dialogues include a degree of discussion around regulatory reform and tax reform and the like, it isn't stopping the strategic dialogue and it isn't stopping people from -- or boards from considering strategic deals partly because of what you said, partly because there is a recognition that these things will take some time to ultimately get finalized, and that they don't want to put their strategic agenda on hold. So in some ways, you get both sides of the equation. People aren't going to wait indefinitely to get certainty on issues when there are good strategic deals that can be done, and that's past the dialogue. So not to say it has no impact, but it's still quite healthy. + +Answer_17: + + Can I just answer that? Marianne has given you guys some very specific guidance on interest rates. When interest rates got to 0, remember that when it floored, those -- no one expected the first 25 to 50 basis point to necessarily be paid out, because of the cost. Marianne also gave you at Investor Day a very forward-looking view of that, where it kind of normalizes, okay? And it's different for every different type of deposit. For wholesale deposits, commercial credit deposits, company deposits, treasury deposits. They're all different. So it's hard summarize it all. But at one point, you're going to go back to kind of a normalized spread, and in terms of just retail, I would say that's like 3%. + + + Maybe a little less than that. + + + Maybe a little less. + + + And I would also just say, I am glad that you brought up one point because it's something that I'd like -- a point that I'd like to make, which is when people think about the benefit we get from NII on rising rates, there's an element of people making it sound very passive. Yes, you're correct, we did build those branches, we acquired those customers, we built the product, we invested in the customer service to be able to enjoy the industry-leading deposit growth that we're having. But I would also make the -- and so as margins improve, then, we will obviously enjoy the benefit of that. And to your point, we invested to be able to. But I will say that if you -- we look at the performance of our branches every single week, month, individually, put together by market, and the very, very, very vast majority of them, meaning that only a handful do not, are profitable in their own right today at these spreads on a marginal basis. So the branches are doing very well. + + + There's another number we give you all that you should look at. We give you what we expect normalized margins and normalized returns to be in Consumer, Card, all these businesses. Those numbers include normalized credit card charge-offs, like the credit card, the number we now use is for in a quarter, something like that, and in retail, going back to normal spreads. That's what those numbers include. And of course, it all bounces around. But we kind of look at them to be priced for normalized results. We don't price for them to be overearning or underearning or to have too much credit or too little. And that's kind of how we run the business. + +Answer_18: + + We've built that into every number we've given you. We've always told you the beta and gamma. + + + Yes, I can point you to a presentation in May of 2014 where we showed exactly what we expected the complexity of deposit reprice to look like based upon historical moves. So what we have actually seen to date looks incredibly similar in terms of realized reprice. You're absolutely right. I will tell you though that history may not be a precise predictor of the future because we've never really been in this exact position before and other things play into the equation, including the fact that the industry, but us specifically, have significantly invested in other customer service products, items like digital and the like, which will change the dynamic one way or another on reprice. So you're right, historically, 100, 150 basis points should dot [ph] see some movement, we'll see. + +Answer_19: + + Yes, but I'd be a little cautious there, too. I mean, we feel great about the deposit growth and the account growth. So you have new accounts that are growing and existing accounts are growing. Remember, there you also -- history -- you've got to be very careful, because if rates were higher, people do different things with their money, like CDs. And then how they view the stock market, that money -- some of that attracts lenders to the market. So we're always conscious of the fact those flows kind of ebb and flow, and history is only somewhat of a guide to that. + +Answer_20: + + So I picked that category out precisely because it didn't take legislation and it was very important. And my point isn't about banks versus nonbanks. My point is about the United States of America and what these things did to the availability of credit to a certain class of people. I was very specific, and we actually published a research report in mortgage land, which you can go get, by Mr. Jozoff, that really breaks it out. But because of the cost of servicing delinquent accounts, $2,000 a year, because of the additional cost of origination, because of the potential litigation, because of the not clarity around the QM, because of the forward claims that the consumer's both paying more and the credit box is wider than it would otherwise be. And that we actually believe that credit box is hurting first-time buyers, younger, self-employed, prior defaults, someone who when they defaulted passed his reserve, who always say deserves a second chance. So that policy has restricted that. And the shocking thing to me is the absolute size of that, which we think could be $300 billion to $500 billion a year. That one thing alone could have added -- because of a secular stagnation, could have added 0.3% or 0.4% a year to growth. So if you'd changed it 5 years ago, you're talking about a lot of growth, a lot of jobs, a lot of new homes, a lot of young families into homes and a very positive thing without taking a lot of extra credit risk. It's not -- it was about America, is why I wrote it. I could care less whether the banks and nonbanks do it. My point about that was how it's hurting the growth of America and hurting that class of citizens. And I really think some of you should be writing about that more because that's how important it is. That was one example. + +Answer_21: + + Okay. So I would just start by saying we've been consistent that our operating model, including the diversification of our businesses, has been and was a source of strength not just for us but also for the financial markets during the crisis. And there is strength in the way the company operates that can't be discounted. I would also say that the commentary feels unnecessary given where the industry stands on capital liquidity and regulatory reform broadly. And I would just point, as I'm sure you all read, to most recently, Governor Tarullo making comments about this but historically, other thought leaders in the financial stability space talking about it. And I would further say that it doesn't feel, for the reasons that you just articulated in terms of structural reform or structural change in the model of banks, that, that would be consistent with a level playing field and pro-growth agenda in the U.S. So that's kind of how we feel about it. I can't give you specific reasons to not continue to monitor the situation. But it doesn't feel consistent with the rest of the objectives of the administration. And with respect to Investor Day a couple of years ago, lots of things have fundamentally changed since then, but the ultimate conclusion hasn't, which is that we believe that there's significantly more value for our shareholders, and as I said before, for the economy with this company the way it is today than in some other form. + +Answer_22: + + First of all, we don't overthink the shape of the curve or the process of normalization in any one period. We think about the reason for the actions. And ultimately, as long as they're kind of growing, you'll see both of the short and the long end of rates ultimately go up. And even though I know that it's lower than what we've broken down, broken below a little bit of the lower bounds, it's been in the kind of 2.30%, 2.60% range for a while, so we're still within -- largely speaking, within the range. And our central case is that we're going to see the 10-year higher by the end of the year. And if you look at our earnings and risk disclosures, we're much more sensitive to -- as a pure NII, NIM matter, to the front end of rates. And so not to say it would not have an impact, but it would take a while for that to have an impact that would meaningfully offset any of the benefit of higher short-end rates. + +Answer_23: + + Well, I mean, ultimately, sort of any actions by central banks, any change in the shape of the yield curve, anything that is presenting an opportunity for clients to transact and trade is an opportunity for our businesses. So as long as it happens in a reasonably rational fashion and there are no significant events, it should create an opportunity for clients and an opportunity therefore for us. + + + Always keep in mind that why they do something probably is more important than the what they do. So if they are doing it because the American economy is getting stronger, that is more important than the direct effect of adding -- letting securities mature, et cetera. + +Answer_24: + + It could, I just wouldn't put that in your models. + +Answer_25: + + So well, I mean -- so in terms of rates, obviously, the loan balances are seasonally low in the first quarter and charge-off rates are higher in the first quarter. But overall, we're not expecting to see abnormal patterns in our charge-offs. + +Answer_26: + + Because it happens every 5 to 10 years, so why would anyone be surprised? And we've always been very conscious of this and very careful about how we do leases, we do them conservatively, we've got... + + + But we only do them to our strategic manufacturing businesses. + + + And only to strategic manufacturers, and we properly account for it. And we have loss mitigation. That's pretty important. So no, we're not surprised, it's going to happen every now and then. + +Answer_27: + + I have no idea. + +Answer_28: + + So it's actually got somewhat less to do with our marketing strategy than it has to do with the fantastic success we've had with the new products, particularly Sapphire Reserve, in the fourth quarter and in the first quarter of this year. But fundamentally, if you go back, I think, to a conference that Kevin Watters spoke at last year sometime in, I think, September, he said, look, we're going to see the revenue rate be lower about 10% and some for the couple of quarters while we acquire all of these accounts. Once we've hit a pace, we should see it middle out at 10.5% the full year of 2017, so the first quarter lower and subsequent quarters continuing to now start rising back up towards the 11.25%, which was our ultimate run rate target. And that's still fundamentally what we're expecting to see, which is we're at a -- assuming that our expectations of what we're going to see in account growth over the future period continues to hold, we would expect to see an increase from here in the second quarter, the overall year, to be sort of finish the mid-10s and the year 11-ish, and then go back to 11.25% over the course of the next couple of years. + + + (inaudible) + + + And we have great new products. + +Answer_29: + + I said I'm not interested. I'm kidding. + +Answer_30: + + Look, I've been clear. I think that Gary Cohn and Steve Mnuchin are doing the right thing. They want to find the right people for those jobs. They're talking about -- I gather they're talking to lots of people. But even after they announce it, remember, they need to be vetted and confirmed, and that's -- that normally could take 90 days. Well, the sooner, the better, but I think getting the right people is as equally important. + diff --git a/exam/original-files/Problem_2_3_Sample_QandA/18_questions.txt b/exam/original-files/Problem_2_3_Sample_QandA/18_questions.txt new file mode 100644 index 0000000..b6a290b --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_QandA/18_questions.txt @@ -0,0 +1,120 @@ +Question_1: + + So I had a question about any early signs of deposit beta and elasticity. I guess, on the consumer side, in your retail banking area, are you seeing customers increasingly ask for higher rates in their deposit accounts or any activity where they're moving from kind of checking to savings and kind of early signs of pressure on deposit pricing? + +Question_2: + + Got it, okay. And in terms of customers, they're not really asking yet or behaving in a way that they're looking price-sensitive, you're not seeing early signs of it yet? + +Question_3: + + I wanted to maybe get out in front of what could be some brewing issues in retail land. And the perspective I'm looking for is you have plenty of gross exposure to retail and retail-related. However, there seems to be plenty of collateral, and you're typically at the top of the capital structure, too. So can you talk about both direct exposure in some of the problem retail areas and the related exposure in, like, commercial real estate and on the mall side? + +Question_4: + + Is the main reason you're positioned in the stack, meaning I notice you have a lot of collateral against your exposure, and like I said, you tend to be at the top of the stack. Is that the main issue? I remember doing this with you guys 2 years ago in oil, while oil was dropping, and it turned out you barely came out with a few cuts and bruises. There seems to be more collateral here, but I don't want to put words into your mouth. + +Question_5: + + I'm talking both because you do have hundreds of billions of direct retail exposure plus the commercial real estate exposed to it. I'm just thinking you have... + +Question_6: + + Okay, I was just looking at taking a temperature. + +Question_7: + + Can you give us some color on the credit card area in terms of -- I know you upped your credit card losses earlier in the year at the Investor Day in the fall of last year. What's your guys outlook for the credit losses in the credit card portfolio? Where would you tolerate it to? And at what point do you really change the underwriting standards if you need to? + +Question_8: + + Got you. And as a follow-up, obviously you had very strong investment banking on the FICC trading side, very strong capital market numbers. Are you guys seeing further evidence of taking more market share from your competitors in any of the product lines, whether it's investment banking or FICC trading or equity trading, et cetera? + +Question_9: + + A couple of questions, one on Card. How large are you willing to be in Card? I think on various metrics, you're between 15% and 22%, depending on if you're looking at things like merchant acquiring or the balances in Card in general as a percentage of total outstandings in the country? + +Question_10: + + I'm asking because in the last cycle, you were really nimble. And do you still feel that you can be nimble at this market share? + +Question_11: + + And then when you're thinking about the credit box, I know a while back, you mentioned, okay, we widened the box to 680. Is there any interest in widening it further? + +Question_12: + + So loan growth should probably stay in line with where it is or slow down, is that how should we be thinking about it? + +Question_13: + + I'm going to follow up on the NII question. I think your implied guidance of $4.5 billion higher than 2016 is now $500 million from where you were at the Investor Day. Is that the lower deposit beta experience? What's driving, I guess, the modest increase? And then just as a follow-up on that, in terms of if we do -- the implied curve, I think, has about one more rate hike in June. If we were to get another one realized, a dot plot, say we get another one in September, would that be a material increase in that expectation or just incremental or just how do we think about that? + +Question_14: + + Okay. So anything in September would be sort of incremental? + +Question_15: + + Marianne, you had noted the obvious slowdown we've seen in C&I, and Jamie, in the press release, you talk about the consumers and businesses being healthy and the pro-growth initiatives. Since the Analyst Day, we obviously had Obamacare not go through, and then there's been some doubts on tax reform. So just wondering, can you help us understand just where you're seeing that slowdown in C&I? And how would -- where are we in terms of that confidence turning into real results? And how much is just the wait and see versus where the economy actually is? + +Question_16: + + Yes, fair points. And just one quick follow-up, just on the deal making side. M&A has slowed a little bit, but I'm assuming it's the same point, Jamie, just in terms of just pipelines and expectations that corporates have about transacting. Does that fit into that same vein? Or is there anything different in terms of just companies getting -- strategics getting more aggressive in terms of acquiring and adding to their businesses? + +Question_17: + + I wanted to focus on deposit pricing in the sense that before the Feds started moving up, deposit rates and the Fed funds rates were right on top of each other, around 15 basis points. Now the effective Fed funds rates is around 90 basis points and deposit costs are only 20. So that 70 basis points on your $1 trillion of deposits basically gives you about $7 billion worth of incremental revenue that's needed to cover the cost of branches and other things for those deposit franchise. At what point do you hit a targeted kind of spread? And where is that where you begin to at least breakeven on those costs versus revenues? + +Question_18: + + A follow-up to that is really what I'm getting at is last year, everybody was assuming through the cycle kind of betas, and we were saying that they were going to be much lower early on. We do think once you get to a certain target, usually about 100 basis points of spread, you start to see a little bit more pricing pressure starting to kick in, just like you were saying, Jamie, in the sense of different products... + +Question_19: + + And the last component of this is the balances continue to grow. So as long as we're seeing double-digit kind of sequential, annualized and year-over-year growth in deposits, that provides a little bit cover in a sense of what you're talking about as well. We may see a little bit more lag just because we're still continuing to get deposit growth. + +Question_20: + + I had a few questions on deregulation. Jamie, in your shareholder letter, you dedicated a lot of time on mortgage and having -- opening that up for banks to originate more of the percentage of mortgage in the United States. As we look forward, do we need legislative change for the banks to gain more market share from nonbanks and mortgage, like clarity in QM or the CFPB? Or would a change in supervisory attitudes be enough for that to shift on the mortgage side? + +Question_21: + + That's clear. And the follow-up to that is a couple of -- a week ago or so, there was a lot of talk from Washington about the current administration potentially supporting Glass-Steagall. And of course, a lot of your investors called in concerned. And Jamie and Marianne, a 2-part question, I'm wondering if that's a real worry for JPMorgan's shareholders? And second, Marianne, maybe at an Investor Day 2 years ago, you mentioned that the capital and the cost that a breakup would save was not that much. And I'm wondering if you could also, if you remember, refresh us on that analysis. + +Question_22: + + We've obviously seen quite a bit of flattening of the yield curves. And it could reverse pretty quickly if there is progress made on the pro-growth agenda. But just talk about at what point does the flatter yield curve start to impact NIM. And I guess I'm thinking specifically if we get a couple of more hikes on the short end, but the long end either doesn't move or the long end comes down more, how do we think about the breakpoint in terms of NIM benefiting the short end being offset by the flatter yield curve? + +Question_23: + + Okay. And then separately, as we think about central banks winding down, some of the QE and the Fed actually shrinking their holdings, how do you think about that impacting your businesses? And obviously, there might be a rate impact. I think you talked about your rate expectations quite a bit. But just how do you think it might impact, say, the markets business with potentially more assets kind of out there to be purchased and sold? + +Question_24: + + I guess there's 2 thoughts on -- there's the impact of QE on the economy, and then the impact of QE on some of the markets businesses that maybe there's been a crowding out from all the QE, so as they unwind, that it could actually boost activity levels. + +Question_25: + + Just a couple of questions on consumer. We've talked a lot about card losses. But one thing that seems to be a little bit unusual is that a lot of the commentary across many of the card issuers is for the expectations of losses to be higher in the first half than the second half. And I just wanted to get your perspective on the likelihood of that trajectory. + +Question_26: + + Got it. And then just to follow up on auto, your release alluded a little bit to the impact of declining residual values, which has been, of course, a focus for the past couple of years. Was there anything unusual in your view about the pace of decline in resid values in this first quarter? + +Question_27: + + But in terms of the pace of resid values from here, similar or different in your view? + +Question_28: + + Marianne, let me start with a question on the net revenue rate in the Card Services business. That's been relatively steady, a little over 10%, for the last couple of quarters. I presume, given your outlook, that, that would stay pretty close to the 10.1% level that you reported for the last couple of quarters? Or are you thinking about a change there as you slightly change your marketing strategy? + +Question_29: + + Fair enough. Jamie, a question for you, just another one on the regulatory landscape. There are a number of open positions inside the Beltway at a number of the primary bank regulators, and I'm just curious in terms... + +Question_30: + + Well, somebody should fill those spots if it's not you. And I'm just curious what you're thinking is of the timing of those appointments and how quickly those could get filled and what benefit that might provide to the banking industry. + diff --git a/exam/original-files/Problem_2_3_Sample_QandA/19_answers.txt b/exam/original-files/Problem_2_3_Sample_QandA/19_answers.txt new file mode 100644 index 0000000..e0d0843 --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_QandA/19_answers.txt @@ -0,0 +1,150 @@ +Answer_1: + + Yes. I would just stop for a second to just point out that what Jamie actually said was, "This is uncharted territory. It's not something that we've seen before." And so while it is the case that the Fed is communicating clearly and has every intention to make this gradual and predictable, things can change, and we should just be prepared for that. Not to say that, that would have a particularly significant impact necessarily on JPMorgan but that, that would just be a downside risk, not a probability. So on the balance sheet, it's still the case that we expect to start seeing normalization in the balance sheet in September; if not in September, by the end of this year. And we're still actually calling for the next rate hike in December; the market is calling for March of next year. And as we said, the communication has been pretty consistent and pretty clear across the Fed space, which is to say that it's mostly priced into the market at this point as far as we can tell. And so based upon what we've understood, all things equal, we would see the balance sheet shrink about $1.5 trillion over about the next 4 years. So that would ultimately slow growth, not stop growth. And if we saw $1 billion -- sorry, $1.5 trillion come out of the Fed's balance sheet, empirical evidence would suggest that we don't see dollar-for-dollar reduction in deposits. So if you just pick a point between $500 billion and $1 trillion of deposit outflows, at our 10% market share, that would be about $75 billion over 4 years. So it would slow growth. It would not stop growth. And it is what we've been expecting and what we've been talking about now for an extended period, and gradual is good in that sense. In respect of which deposits we would like to see, so that's the sort of growth scenario. In terms of liquidity, again, evidence would suggest, and we've been communicating this quite clearly, that we think the preponderance of that deposit outflow would be wholesale deposits and that would -- it would be nonoperating deposits. And those are deposits we ascribe little to no liquidity value to. So assuming that we're close to right, we would see those deposits ultimately leave the system, but it wouldn't affect materially, if at all, our liquidity position. So ultimately, the yield curve has priced, I think, all of this in. What I think the Fed had been clear about is that they expect the balance sheet or hope the balance sheet to be in the background and to use short rates as their primary monetary policy tool. And so as a result, we would ultimately expect to see perhaps a flattening yield curve, but with the front end ultimately pulling the long end up. And you heard Yellen -- Chair Yellen talk about being conscious of the shape of the curve as they go about normalization. I think you may have asked something else. Did I miss anything? + +Answer_2: + + No, we -- that's correct. If you saw the -- compared to a $400 million expectation, we were up $150 million. So it would be fair to say that most of it was in this quarter. We had also -- when we gave the last set of guidance at $4.5 billion, we pointed out that the 10-year was low and that, that was ultimately pressuring that $4.5 billion. So it really isn't that significant of a change. The only thing I would caution you to remember is that when we think about asset sensitivity and we think about NII, market NII, which we wouldn't consider to be, in a traditional sense, core, can exhibit volatility geographically with NIR. If you think about a market-making business where we can have assets that are throwing off NII hedged by derivatives that ultimately have an offset in NIR, we actually think about that in total revenue numbers. So there could be a little noise in there, but no, I'm not expecting there to be significant changes. But I think what this makes me realize acutely is that no good deed ever goes unpunished. And chasing our tails, reforecasting the full year NII every 3 quarters isn't as important -- or every quarter isn't as important as keeping our eye on the long term, which is nothing has changed. We are absolutely realizing the benefits we expected in the banking book assets and liabilities, and that means that our long-term projections will be good and the path is a little bit less important. + +Answer_3: + + Yes. So I understand why you're asking. As you look at the loan yields, they look relatively flat or even slightly down. If you adjust for the mortgage, it would be flat. If you decompose them into wholesale versus retail, we are absolutely seeing all of the yield improvement on the wholesale side, about 10-ish basis points. And on the consumer side, at this -- with respect to this quarter, there were some mix impacts in the Card business as we saw a higher level of transactors and saw a few other things. So it's not to say that the loan yields aren't moving in line with our expectations, and they are, but mix will matter for any one quarter. + +Answer_4: + + Yes, that's right. And if you look back last quarter, they did, too. It's just that we've had a couple of opposing things going on this quarter. + +Answer_5: + + Yes. So obviously, one of the biggest drivers over the last recent while in card revenues has been the extraordinary success we've had in capturing new Chase Sapphire Reserve accounts. And so the end of the third quarter both -- importantly, both the fourth quarter and the first quarter were extraordinary in terms of the number of accounts we acquired. And of course, we amortize or contra revenue out those expenses over 1 year. So at 10.5% revenue rate right now and with those -- having adjusted the premium with those originations stabilizing out into the second quarter, we will see ultimately -- we'll lap that impact a year from now. And we'll see our revenue rate start improving from here towards the 11.25% that we sort of guided to in the medium term. And we expect to get to that point, all other things equal, kind of mid-next year. And of course, that's just one facet. We're also seeing significant momentum on the sales front. Obviously, as a result of those accounts, we're growing our core loans, up 8%. And so we're having higher NII on those balances. So there's a lot of dry powder. We just need to get past these account acquisition costs, which we will. And I always feel compelled to point out that these are extraordinarily good customers. Their characteristics, their engagement, their spend, these are the customers that everybody wants to acquire. We now have them, and we intend to deepen relationships with them. + +Answer_6: + + So I would characterize our strategy as unchanged. We've always been pretty consistent over an extended period that we would prioritize, first and foremost, strategic investments for growth in our businesses, be that organic or otherwise. And obviously, you've seen us be investing, whether it's in growing loans or introducing new product, hiring bankers, opening offices in our expansion markets and the like. But yes, it's been heavily skewed to being organic over the most recent while. We've also been pretty clear and active, I would say, in terms of partnering with, investing in, collaborating with partners that can accelerate our growth potential. So we would always be interested, whether that's fintech or otherwise, in getting capabilities that allow us to accelerate our growth potential. We don't have big gaps, but we would always be interested in that. Having said that, I'm not going to comment on the state of the regulatory environment except to say you should expect, for any of these events or transactions, that we would have the appropriate regulators at the -- conversation with regulators at the appropriate time. + +Answer_7: + + Yes. So obviously, we are supportive of the new hedge accounting rules, and it will allow us to consider taking advantage of hedge accounting for a wiser set of products than we currently do. But we actually have reasonably limited hedge ineffectiveness in our (inaudible) right now. So from a practical perspective, it won't make a big difference to the business, but it is more flexibility in terms of the scope. And we're looking at that. + + + I would just add, as a policy matter, we make economic decisions, not accounting decisions. Accounting is a fiction. And Marianne spoke about the credit card. You expense the acquisition costs over 12 months. The benefit comes over 7 years. So we make huge investments all the time based on economics. We will never make a decision based upon accounting. And then we'll describe it to our shareholders to understand why we're doing what we're doing. + +Answer_8: + + Yes, it's seasonality. So you've seen the first half at or around that guidance level. We would expect that to go down slightly just from seasonality in the second half for a full year a bit below 3%. + +Answer_9: + + So I would say, obviously anytime you reach an inflection point, you need to be cautious about understanding the pace of change. For -- at least for 2018, 3% to 3.25% feels right. I think as -- when you get beyond that, we'll be updating you with our views as we experience a bit more in reality. It doesn't feel significantly different from that, but I think 2018 is a good number. And 2019, we'll update you. + +Answer_10: + + Yes. Okay, so just talk about what we've seen so far, I think the industry has been really quite disciplined, which is what we would have expected at this early stage of a normalization in terms of the rate cycle. It is a tale of 2 cities. We've said that (inaudible) the wholesale space necessarily experiences higher reprice more quickly, and we are seeing that pretty much in line with our expectations. It matters, you need to get granular. The type of deposit, that client segmentation, it matters. So in the wholesale space, we're seeing it. We're on that journey. In the retail space, we haven't seen that yet. So while there have been small changes in the industry in CDs, there's been nothing in checking or savings. But again, I'd just point out to you that we wouldn't have expected there to be at this point yet in the cycle. And I would say, with respect to deposit betas and the Fed's balance sheet, if we are right, and we believe we'll be close to right, and that we see the wholesale nonoperating deposit flowing out of the system, assuming everybody else has reached that same conclusion, then it really shouldn't materially impact the liquidity position of financial institutions. And if you couple that with the expectation of a very gradual and measured pace, which gives people a lot of time and opportunity to plan accordingly, we wouldn't expect there to be a significant impact on betas, if any. + +Answer_11: + + Yes. I would say -- first of all, I would say, focusing on any one -- so we would be very supportive of changes to how operational the capital is treated under [reg] capital rules. But I think focusing on one facet and not the whole thing -- it's unlikely to be that only one thing changes. So we'd like to see changes made over time. But for the foreseeable future, as we're growing our loans quite strongly, and these are extraordinarily high-quality loans where the differential between advanced and standardized is quite big, we still expect standardized to bind us. + + + And as you pointed out, the standardized were 100% in the United States. In Europe, they're talking about 75%. So there are -- will be some changes over time in how all these capital ratios get calculated for international competitiveness reasons. + + + Yes. So whether it's because the operational risk rules change or whether it's because the standardized rules become at least somewhat more risk sensitive, there should be changes over time, but I think for the foreseeable future, this is what we expect. + +Answer_12: + + Yes. So I would start with, if you go back a couple of years ago, 2013, '14, '15, when we were doing our business simplification agenda and derisking and uplifting the controlled environment, the Commercial Bank was blocking and tackling and doing a lot of inwardly focused work. And we talked, I think, all the way back in 2016, that there were outbound calls, opening offices, hiring bankers, and that if you waited a minute, you'd see that come to our results. And this is the sort of fruits of that labor. So I do think it is sustainable. There's nothing in these results that is particularly noisy outside of reserve releases, which I'll come back to. And I would also say the partnership between the Commercial Bank and the IB in terms of covering our clients, the introduction of 16 specialized industries, which is an advantage we can bring to our clients nationally and, in fact, globally, that other competitors can't bring, all of those things set us up for continued solid growth. With respect to loan growth, I would say, if you look at our C&I loans, this quarter, as an example, was pretty broad based. There wasn't a specific -- in the Middle Market, there wasn't a specific industry or market segment that was strong. But over the last -- stronger, I should say. But over the last few years, a lot of our growth has been driven by the investments we've been making in the expansion markets. So we got into some new markets with the WaMu acquisition. We continued to build out those markets, add bankers, open offices. And that has been a source of growth for us that perhaps others haven't been able to enjoy. And also, as I said, specialized industries. And then... + + + And I would just add, we -- I think we're in all major 50 markets now, unlike retail, where, one day, we'll embark on an expansion in cities we're not in. And the product set is just fabulous. We're adding more and more online things. We're adding simpler and faster credit approvals. We're adding -- making it easier to do merchant processing when you sign up for Middle Market loans. The online systems are great. So all that stuff, I think is -- this is going to grow for a long period of time. + + + All right. And then... + + + And thanks for pointing out how well it did. And Doug Petno, if you're listening, congratulations. + + + And then the only thing I would say on commercial real estate, just because I think it's really important, is commercial real estate, it depends what you do. And more than half of our commercial real estate exposure is Commercial Term Lending. It's a very specific strategy. We don't deviate from that strategy. And I would just point to you, because it was interesting to me, if you look at the Fed's CCAR stress results for commercial real estate across the industry and look at how our results compared to others, I think you can hopefully get somewhat more comfortable, and we are very comfortable with what we have right now. Now that said, the performance this quarter did benefit from reserve releases and benign credit, and at some point, there will be a cycle. But the risk appetite we have and the way we've managed with discipline, we're very happy with that. + + + And the IB, bringing JPMorgan Investment Banking to Chase corporate clients, we still think has a long way to go. + +Answer_13: + + I would look at it the other way around. So we've, for -- since the Great Recession, okay, which is now 8 years old, we've been growing at 1.5% to 2% in spite of stupidity and political gridlock because the American business sector is powerful and strong and is going to grow regardless -- when they wake up in the morning, they want to feed their kids, they want to buy a home, and they want to do things. It's the same with American businesses. My -- what I'm saying is that it would be much stronger growth had we made intelligent decisions and were there not gridlock. And thank you for pointing it out because I'm going to be a broken record until this gets done. We are unable to build bridges. We're unable to build airports. Our inner city schoolkids and are not graduating. I was just in France. I was recently in Argentina. I was in Israel. I was in Ireland. We met with the Prime Minister of India and China. It's amazing to me that every single one of those countries understands that practical policies that promote business and growth is good for the average citizens of those countries, for jobs and wages, and that somehow this great American free enterprise system, we no longer get it. And so my view is it -- and corporate taxation is critical to that, by the way. We've been driving capital and bringing it overseas, which is why there's $2 trillion sitting overseas, benefiting all these other countries and stuff like that. So if we don't get our act together, we can still grow. I would say it's unfortunate, but it's hurting us. It's hurting the body politic. It's hurting the average American that we don't have these right policies. And so no, in spite of gridlock, we'll grow at -- we can grow at 1.5% or 2%. I don't buy the argument that we're relegated to this forever; we're not. And if this administration can make breakthroughs in taxes and infrastructure, regulatory reform -- we have become the most -- one of the most bureaucratic, confusing, litigious societies on the planet. It's almost an embarrassment being an American citizen traveling around the world and listening to the stupid (expletive) we have to deal with in this country. And at one point, we all have to get our act together or we won't do what we're supposed to do for the average Americans. And unfortunately, people write about the thing like it's for corporations. It's not for corporations. Competitive taxes are important for business and business growth, which is important for jobs and wage growth. And honestly, we should be ringing that alarm bell, every single one of you, every time you talk to a client. + + + And then I would just say that in terms of how our clients are behaving and how the (inaudible) going, whether you look at Middle Markets, Corporate Client Banking, M&A, it's not to say that the possibilities of reform and the impact that, that could have isn't a part of the dialogue, but they're fundamentally really just getting on with things. And so if there's a client that has a compelling strategic deal to be done or some spending or hiring or growth, then they're pretty much getting on with it, which is why we're seeing solid growth. + +Answer_14: + + Yes. So look, obviously, you know the deal with CCAR approvals, which is it is capacity. It's not necessarily a commitment to utilize it, although we are -- as we fairly clearly articulated at Investor Day and as you see in the numbers here, we are at 12.5% in terms of our CET1. And we believe we ought to be able to, over time, operate the company lower than that, within the range of 11% to 12.5%, albeit that we would take time to do that. So we're in the market buying our stock every day. We're at 1.8x tangible book value. So in Jamie's shareholder letter, we still think that there's significant value in the stock. We believe in the earnings power in the franchise that we have here. And so I'm not to say that we will utilize all the capacity because other things can come up, but we put in the request based upon our desire to want to ultimately move lower. + + + Yes. And there's a very important policy issue here, too. So our preference is always to build organically, to not buy back stock but to build branches and grow and lend more. But there's an argument that people are making that banks can't lend it, and even if there is excess lending capability, they wouldn't have done it. And that is not true. The counterfactual would have been, had banks been free to use their capital and their liquidity 5 years ago, there would have been a lot more lending in the system. And we've pointed out 2 areas where it would have taken place. One is mortgages, where regulations have held back lending to first-time buyers, immigrants, self-employed, prior defaults, et cetera. And the second is small business, where it's not existing small businesses, think of it as start-up small businesses and that they are having a hard time getting capital maybe at the community bank level, et cetera. The counterfactual would have been that $1 trillion or $2 trillion would have been lent out had these rules been changed 5 years ago. That's the counterfactual. It's not that, well, the banks wouldn't have lent the money. And so again, there's a false notion that all this stuff didn't hold back the economy. Yes, it did. + +Answer_15: + + Yes. So obviously, they haven't been specific. Although the Treasury report had some ideas, they haven't been specific about what the calibration would look like and whether there would be recalibration to the numerator and the denominator or one or the other. Clearly, we've been pretty clear that we think cash at central banks shouldn't necessarily be included, and there are other things. Different people have different opinions. So we've done the calculations. I would just point you back to the fact that we have some 20 potentially binding constraints right now, of which leverage in a variety of forms is part of that. So to the degree that we get the opportunity to recalibrate that, it could have impact at the margin. But we take all of those things into consideration when we think about the direction of travel of the company. So we're being as thoughtful as we can. We are not specifically leverage constrained right now. That doesn't mean we're not supportive of making those changes and we will obviously model it out. But we take the potential for those changes into consideration when we think about the direction we grow our businesses. + +Answer_16: + + So I think -- I want to point out something because I know that Sapphire Reserve gets a significant amount of attention for obvious and good reasons. But it is only one product in a platform of successful products, both proprietary and co-brand. And so in reality, while we obviously do all the modeling and the math, it's not about what the cost of any one individual card acquired is or the NPV of that, it's how the portfolios ultimately together perform over time. And it's still very early on Sapphire Reserve. I mean, it's not even a year old yet. And these are portfolios and products that develop and season over time. And as I said, these are extraordinarily good customer relationships. So you know we've done a bunch of things in the card business over the last few years. We've renegotiated our co-brands. That was ultimately with lower economics but still very good economics. We've been out on the front foot issuing new products, not just Sapphire Reserve but Freedom Unlimited, the Amazon Prime card, Ink. And so we think about everything in the total portfolio and its collective performance over time, and it's still generating very good returns. + + + Let me just mention about the regulatory SLR. So looking at it very broadly, if you look at -- it's not just capital liquidity but mortgage rules, requirements, capital liquidity, collateral rules, what collateral can be used and not used, if these things were just calibrated differently, the cost of credit would go down, swap spreads would go down, mortgage would become more available, the cost of mortgage will come down. And those are kind of important in total if they're done right without changing at all the risk to the system. In fact, the system is healthier if the economy is healthier. + +Answer_17: + + So when we think about the sort of liquidity position of this company, we're obviously managing not just to regulatory requirements but also to what we want the ultimate sort of duration of equity and position of our balance sheet to be through the cycle. So we take into consideration not just the amount of liquidity we have and how that could be utilized but also the mortgage portfolio we have, agency MBS. So all of that goes into our determinations. And we will continue to add to duration opportunistically when it makes sense to do it and manage our balance sheet with discipline. + +Answer_18: + + Yes. So I would start by saying that a lot can change between now and the next cycle of CCAR or the next 2 cycles of CCAR. And so we never did actually say that we necessarily wanted to get the low end of the range but just to operate for the short and medium term within the range while we let all of the potential changes to the sort of regulatory environment at large play out. And so as to whether or not, over time, there's a sort of recalibration of whether 11% is our minimum, that will play out over time. So for the next 1 or 2 cycles of CCAR, this cycle and the next one, I would just expect that we want to be on a measured pace to be within the range to allow us to better understand all of the changes that will take place over time and make appropriate decisions. I wouldn't start imagining necessarily how low that goes. I think we would want to operate with a sufficiency of capital and liquidity. + +Answer_19: + + So I would say, of course, it's possible. We've seen a number of situations where implementing global standards in the U.S. have differed in meaningful ways from how they've been implemented elsewhere. You have rarely seen that be to the advantage of the U.S., and the SLR is no exception. So while there may be recalibrations of either the numerator or denominator, know that to the Europeans, 3% standard. Our current depository institutions are held to a 6% standard. So there's plenty of room for there to be adjustments before it would create an unlevel playing field. And my suspicion is there will also be adjustments elsewhere. And it's supposed to be, as I think Chairman -- Chairwoman Yellen said, a backstop, not binding in the way that perhaps it has become. So I think the answer is yes, but we'll see. + + + So -- and the key point Marianne said is almost every single thing that's been done in America added to Basel requirements, the gold plating, SLR, calculation of LCR, calculation of stress, G-SIB, almost every single thing. And remember, America doesn't have to listen to Basel either. And you may -- we may have noticed that basically France, Germany, India, China are all telling Basel they better take a deep breath and stop doing more of what they're doing. + +Answer_20: + + And so -- sorry, go ahead. + + + Go ahead, go ahead. + + + No. So look, there are a number of different people talking about the forward-looking standard for operational risk, Basel -- under Basel III.5 or IV or whatever is talking about it, there were some proposals in the CHOICE Act. So there's no question that there should be a revisitation of the mechanism to calculate operational risk. And then you're right, the way that all of these rules ultimately interplay with each other matters. And so from a pure stress test perspective, at the margin, we had a little bit more binding constraint on leverage than CET1. But if you look at just what we could run the company at if CCAR was the only constraint, it would be lower than where we are. So it's a complicated dynamic of trying to make sure that we're maximizing against all of these constraints and not just the mathematical ones but also the operational and practical ones. So I mean, it's necessary to go back and rethink the calculation of operational risk just because it's the right thing to do. Ultimately, how that plays out into how we optimize against our constraints is less of what we're focused on. + +Answer_21: + + I wouldn't imagine -- it's not going to change our risk management strategy in a meaningful way, so I wouldn't imagine it would be... + + + Just the (inaudible) corporations, though. The new hedging rules would affect other corporations are nonbanks. + +Answer_22: + + We haven't looked at whether it creates more demand from the other -- from the corporate side. So we'll look at that and see. + +Answer_23: + + No. It is still this quarter. There are requirements to make public disclosures in August. So depending on whether you make them in your Q, in your Pillar 3 or not will determine whether it's the beginning or middle or end of August. We, as you know, have -- as an industry, are being quite public about the fact that we think -- by the way, we provide an extraordinary amount of real-time granular -- same-day granular information on liquidity to our regulators in order for them to be able to properly supervise not just us but the system. And so we believe the regulators do have and can have anything they need when they need it. It's just a question about whether there is any added benefit of those informations being made public near real time. While it wouldn't matter today when everyone's running very significant liquidity surpluses, it could have unintended consequences if we were in an environment that was more stressful than we are today. So right now, the requirement is that we have to disclose. I suspect, although we've asked for a delay, as an industry, that we might have to disclose. We will continue to debate, I think, with regulators the merits of those public disclosures over time. + +Answer_24: + + Yes. And we -- I mean, I would suggest, although it's not something we show you every quarter, that we've been pretty forthcoming about showing you the level of our deposits and the split, at least in Investor Day now and then, between operating and nonoperating deposits. And as we start to see the impacts of the Fed balance sheet unwind and the like, we will be very forthcoming. We try to be incredibly transparent, and we'll take that under advisement, regardless of what the regulatory disclosures are about the quality of our deposit franchise. But we have, I think, periodically, been more disclosive than most in terms of the quality of our deposits. + + + And knowing that, you could see that we have $500 billion of cash, $300 billion of securities, $300 billion of repo. I mean, it's a pretty liquid company, as liquid as any bank I've ever seen on this planet. And... + + + And we removed $200 billion of nonoperating deposits proactively. So we manage it very carefully. + + + Yes. There's nothing that would happen because of all this that would affect JPMorgan that much. And the very important thing about LCR, it's not -- we -- it doesn't affect us, okay? We're fine disclosing whatever they want us to disclose. It's an issue of whether the monetary -- whether it's good for monetary policy. And would it -- will it cause a problem, not for us, for the system when there's a crisis. Like do they want banks to use their liquidity or not? Very simple. Because if the answer is you've got to maintain over 100%, then you can't use your liquidity. That's what it means. And then so they -- and they've said publicly -- some of have said publically that, "Well, if there's a crisis, we'll let you go below 100%." And we're saying, "Well, what bank is going to be the first to go below 100%?" And so it's kind of a policy issue. Whatever happens, we're completely fine at JPMorgan. If I were the regulators, I wouldn't want to put myself in that kind of position. + diff --git a/exam/original-files/Problem_2_3_Sample_QandA/19_questions.txt b/exam/original-files/Problem_2_3_Sample_QandA/19_questions.txt new file mode 100644 index 0000000..6eaf8b2 --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_QandA/19_questions.txt @@ -0,0 +1,96 @@ +Question_1: + + During the quarter, Jamie had made a comment on potential disruptions related to the unwinding of the U.S. balance sheet. And I'm just curious, it's supposed to be slow and deliberate, but I'm curious how you think that impacts liquidity, the yield curve, trading, deposit betas and is there anything you can do to protect JPMorgan against those disruptions? + +Question_2: + + No, that was absolutely awesome. I do have one tiny follow-up. You always get a little more than you wanted. The one tiny follow-up, Marianne, is I just want to make clear, the whole $4 billion versus $4.5 billion, and you spelled out what happened in the quarter, it sounded like most of that full year guidance happened in this second quarter. But I'm just -- I just want to clarify that in terms of the second half NII, do you think it's overly different from where we were a quarter ago? + +Question_3: + + I want to follow up on the loan yield side, which were not much moved. You mentioned the $75 million in mortgage. Can you just help us walk through the loan portfolio and whether you're seeing the assets move, whether there's a lag or whether there's any spread compression underneath that? + +Question_4: + + Okay. So that -- would that naturally say that, as we go forward, that should -- if they're moving the right way, mix adjusted, they should kind of move the right way from here? + +Question_5: + + Understood, okay. And then my second question is, it was nice to see the card revenues on the fee side and the revenue capture rate move towards the way you've been saying. It actually eclipsed the 10.5% you'd said for the year already. Can you just help us understand like have we turned the corner then on card income and your expectations for that going forward? + +Question_6: + + Two questions. One on M&A strategy. There was discussion that maybe you were interested in acquiring something. That's not really the question, to comment on that specific rumor. But more in this regulatory environment and the changes that we've had already, do you feel like there's a little more flexibility for your strategic actions or outlook than maybe a year ago? + +Question_7: + + Second question is on -- a little bit of a ticky-tacky, but on FASB. They're working on changing some of the hedge accounting rules. And I wondered how you're thinking about areas in your balance sheet you might be able to utilize that in a way that makes your business more efficient. I don't know if that's something that you're thinking about. + +Question_8: + + Marianne, wanted to ask about credit cards. The outlook for charge-offs remains the same at about -- below 3% for the year, and you're about 3% now in the first half. So maybe you're expecting a little bit of improvement in the back half of the year. Is that seasonal? + +Question_9: + + And then at Investor Day, the outlook for the medium term was not much higher, 3% to 3.25%. Does that allow for the seasoning over the next year or 2 of all the growth that you've had and allow for some normalization, too? Is that enough cushion to get all that in there? + +Question_10: + + I just wanted to follow up to the questions that Glenn and Ken had on margin. Marianne, could you give us a little bit of insight on how deposit betas trended wholesale versus retail during the quarter? And also, just back -- going back to your comments. If the Fed balance sheet reduction drives wholesale deposits out of the system, can we assume that, that should not affect deposit betas negatively for JPMorgan? + +Question_11: + + And my second question, you mentioned in the beginning of the call that standardized will ultimately be your CET1 binding constraint. And I'm wondering, if you were allowed to float off your op -- current op risk floor, and I think it's still $400 billion, does that mean, if standardized is your constraint, that being able to float off the floor and model out your op risk may not be an incremental source of capital because standardized is binding? + +Question_12: + + First question is on Commercial Banking. Can you just comment a bit on the sustainability of the growth in profitability you've had there? Your earnings are up 30% year-on-year; loan growth, C&I, 9%; CRE, up 15%. And we're not talking about small numbers anymore. I think your loan book now is about $200 billion in Commercial Banking. And can you just talk about some of the initiatives that you've discussed of the Middle Market, the IB and how sustainable that is and whether you're comfortable with the risk profile of the books you -- of the book you have there? Because you are growing quickly, it is a big book now, and you're certainly growing faster than the industry. + +Question_13: + + That's great. If I can follow up with a bigger-picture question. And Jamie, you've been -- and correct me if I'm wrong, you've been pretty vocal about believing that the underpinnings of our economy are healthy and strong and not buying into this whole secular stagnation argument. But at what point does political dysfunction and political paralysis really start to dent that confidence? And because you've also indicated that we do need structural reform to lift trend growth, whether it's infrastructure, tax reform, whatever it is. And can you just comment on that? And I guess as an adjunct to that, what are your conversations with clients like? And is there a risk that is materializing that clients are also starting to become more frustrated with the lack of progress politically? + +Question_14: + + You guys obviously had a very big approval for share buybacks on the latest CCAR here. And I just wanted your thoughts on terms of using it all, given where your stock price is, given loan growth has slowed a tad and given the flatter yield curve makes buying securities a little less interesting. How do you put that all together? + +Question_15: + + Marianne, can you give us some color -- Federal Reserve Chairwoman Yellen indicated that she sees that there could be some relief on the horizon for the banks. And one of the areas that's been talked about is changing the calculation of the SLR. Have you guys modeled out what that could do to your SLR and then how that may change your view on capital going forward, if there are changes where, for example, they take the cash that's sitting at the central banks out of the equation? + +Question_16: + + Very good. And then as a follow-up and coming back to credit cards, obviously the Sapphire has been a huge success in growing your business there. Are the acquisition costs higher today than when you compare them to maybe 2 or 3 years ago? And in that vein, when you guys look at the economics of putting on new cards, is the net present value or whatever measure you use to determine the economics, has that improved, stayed the same or weakened from maybe a year or 2 ago? + +Question_17: + + So Marianne, I wanted to start off with a question on liquidity. You spoke of how the Fed balance sheet unwind should have little impact on your LCR. But just given the strength of your liquidity position and the significant excess reserves that you have at the Fed, how should we be thinking about the current capacity to deploy some of that excess into higher-yielding MBS? And maybe what's your appetite to redeploy, just given some of the tougher liquidity treatment for agency MBS in particular? + +Question_18: + + Okay, understood. And then just one more question from me, just on capital targets, and I appreciate all the detail, Marianne, you provided indicating that, over time, there could be a path or trajectory towards getting to the lower end of that 11% to 12.5% range. And I'm just wondering, given some -- the very favorable CCAR results we saw this year, coupled with some of the Treasury reforms that have been outlined, is there the potential for you to actually manage to a target even below that 11%, especially if gold plating of G-SIB surcharges, in fact, goes away? + +Question_19: + + Just coming back to the Treasury's proposals for the new calculation of the SLR. Can you give any color as to whether that's actually even possible within the glib context as to how the Basel Committee wouldn't want harmonization across the whole world? Of course, if it did happen, then you would have a massive advantage along with other U.S. banks versus other European investment banks. + +Question_20: + + Great. And just a follow-up question also on the reduction in the op risk. I mean, you talked about advances for standardized, but I mean, looking at CCAR, your SLR is a binding constraint there. So isn't it really a moot argument, a non-argument really, as to whether that happens or not, i.e., if you reduce your op risk, it doesn't really change your excess capital? + +Question_21: + + Just 2 other quick things. One, on the accounting with hedge, just to get back on that a little sec, the question also was, was there any opportunity for your clients, too, because if there is an opportunity for, say, institutions to hedge their books of business more, that could feed into your revenues? + +Question_22: + + Yes. In the sense that you can potentially hedge your commodity risk, so wouldn't that be something? + +Question_23: + + Yes, okay. And then is there a time frame here where you have to start telling us what your LCR is? I wasn't sure if that was coming up soon. Was that this quarter or next quarter? Has that just been put on hold? + +Question_24: + + I get that. I'm just thinking that there's the opportunity to show us the nonoperating deposits going away, which would help people understand the strength of the deposit franchise. + diff --git a/exam/original-files/Problem_2_3_Sample_QandA/1_answers.txt b/exam/original-files/Problem_2_3_Sample_QandA/1_answers.txt new file mode 100644 index 0000000..acd86bb --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_QandA/1_answers.txt @@ -0,0 +1,348 @@ +Answer_1: + + Yes, we obviously have to make some assumptions going forward in house prices and they are not that different than the assumptions you would see in most other that get published by Case-Shiller, etc. Right now, they have a modest increase in home prices in 2013 and '14. I will stick with just those two years. But if it was 5% better than that, which is possible, that would run through our books in lower charge-offs and lower reserves. And just as a rule of thumb, $500 million for one year. + + + It's a very rough rule of thumb. + +Answer_2: + + Yes, no, we are required under Dodd-Frank to disclose our stress tests. Remember, we do -- in March. We do it almost immediately after the Fed's report. And remember, we do hundreds. The Fed is four. So we look at multiple kind of stress tests and we are going to try to give you a full view of how we look at the Company under stress. I should point out that a lot of you did it yourselves in the past. You were pretty accurate some of you. + +Answer_3: + + Just to give you a view, we have $200 billion of equity and $250 billion of unsecured debt. That is $450 billion. That is a lot of capital before anyone else bears a loss. It is not clear to me that subordinated versus just unsecured, and it would take time to develop those markets. If a bank has 50/50 or -- obviously it changes the nature a little bit over time, so it will take time to develop. But I think we're working with the authorities to get it right, to do the analysis right, to have the right numbers. I think you have a little time before someone says it has to be this amount. +Remember, we have got Basel I, Basel II, Basel III, OLA, LCR NSF and the new one and we are going to be able to accommodate all of them. It will take a little bit of time. I do want to point out that we fully intend in 2013, late 2013, to be a 9.5% Basel III and to be fully compliant with LCR. + +Answer_4: + + Well, we had done giving you some numbers in our annual report last year about where it is a no-brainer to buy back stock, which I said is tangible book value. Tangible book value is now $38 or $39, which has gone up, what is it, $4 this year, almost $5 this year. So we still think if you haircut earnings and buy stuck at these prices, it's probably still a good deal. We got permission to buy back $3 billion in the first quarter. Obviously, it is going to be a little price-sensitive and then CCAR will set what we can buy back for the next four quarters after that. I hope that answers your -- yes. + +Answer_5: + + You can do the same numbers at today's prices. Discount, if you want to be conservative, discount earnings, buy back stock. At the end of a two or three-year period, you will apply earnings per share and higher tangible book value per share even at these prices. It seems like a pretty good deal to me. Typically, you have a good company. + + + And you are not going to need the capital down the road. I am not talking about for one year, but down the road. + +Answer_6: + + Think about it as all in and we are expecting our run rate in the future to be I think $300 million to $350 million, as I said, excluding the items we talked about. Including IFR, we are at $725 million. We have got a ways to go, but it is coming down. Think about it in there. + +Answer_7: + + Well, I think let me just put out first off that our comp ratio was 33%. If you, by the way, if you added back some of the bonuses paid in corporate that don't show up as comp in the IB, it would be like 35%. We think that the roundest number is kind of an ongoing run rate. We have formulas. We don't pay out necessarily by the formula, but we have formulas that are capital-adjusted, risk-adjusted, etc., etc. that -- that is what really guides it and it is not -- so it is really done at a much more detailed level than it will bounce around that 35%. +I should point out that again we feel good that our ROE in the investment bank was 17% this year. It was 16% or 17% last year and the year before and we are paying our people fair and well. I feel good about that. That is a good thing. That is a good business model to have something like that. + +Answer_8: + + Yes, I think that is probably true, but other firms have ratios of 50%, 55%. Ours is already fairly low. We want to win in the business. We are going to be competitive in compensation and obviously that will adjust over time as competition changes. + +Answer_9: + + At Investor Day, we will try to give you a better view of that. So there are clearly some negatives and we don't know all the rules, also some positives. So we are in a position between custody and clearing and our brokers businesses to provide some of those services for investors so they can allocate capital properly, transform the collateral and serve them better. So let the rules come out. Obviously, this is going to affect our revenues a bit, but there will be opportunities there too. + +Answer_10: + + No, here is my caveat. We are going to meet LCR this year whatever it is. It doesn't matter to us whether we like it or not. Now to answer your question, there were some changes in LCR; I think they were good, but they still capped the benefit like mortgages and we have like almost $90 billion of MBS. So government-guaranteed MBS is in what they call level 2 and therefore, you are restricted in how much [capital] liquidity. +Now personally I think that is wrong, but it is okay. We will live with it, we are moving on. I don't know why the American regulators would agree to that. Government-guaranteed MBS in a market you want where they treated liquid and remember, they already have a 15% haircut. I could argue they don't need any haircut, but look, whether changes are made or not, we are going to be compliant. It is not going to affect our earnings that much. + +Answer_11: + + Yes, so hey, Betsy, we talked about the third quarter being -- peaking at over 200 basis points before the margins compress in some 40 or so basis points in the quarter and we do expect that to continue into 2013, not at that level. If you go back in time, you would see gain-on-sale margins more in the 65 basis points. I don't know if that is where it will end, but certainly we expect for that to be seen through 2013, but with gaining marketshare. We hope to keep our volumes up. + + + Obviously, it will normalize over time, but it may not go that low because our expenses could also be permanently higher. To be in the business is going to cost more money and obviously that will be part of your -- what you have to earn back. + +Answer_12: + + Yes, so we -- the number that Marianne showed you is the Basel III Tier 1 common 8.7. If you look at what I call for the next two years passive mitigation, that is run-off and what I call normal models, so we still have to get certain models in there and there is not arguing with anybody, it's just models that should be put in place, that would add almost 1% to Basel right off the bat. About I am going to say $100 billion of that would be models, $80 billion to $100 billion would be models. Part of that is the runoff to synthetic credit, which is obviously coming down over time. +And the other thing, which I think you're going to see, is we are pushing Basel III down, we have, but we are pushing it down at a very detailed level. I think over time you're going to see (inaudible) down capital Basel RWA even more. And there are things in Basel, which I don't know what the future portends. We have $200 billion plus of operational RWA in there now. That is driven very -- that is like $16 billion of capital. That is driven very high by obviously the mortgage litigation and stuff like that, some of which will go away. So one day, a lot -- that $200 million should come down a lot too. I just don't know the timetable for that. + +Answer_13: + + No, I didn't mention -- we are going to get there late in 2013 whatever it takes. + +Answer_14: + + We will answer -- to give you more feedback -- maybe we have to have a buffer. We don't know what the final rules are for capital. So you already have a conservation buffer. You go below what happens. Obviously, OCI could be a big swing. Like if you model -- I forgot -- we had modeled it. Like 300 basis points would be $20 billion after tax or something like that. But you could handle that too because it is going to come in over time and you can manage your balance sheet going forward, your stock buyback going forward. So we really need to see the future rules to make that determination. If we need a buffer, we will have a buffer. + + + Whatever that is, we will go there right away too, but we just don't know what it is yet. And we don't know whether CCAR is going to drive capital or the conservation buffer is going to drive capital or whatever. And we don't know how the G-SIFI exactly works, even though we know it's a 2.5%. We will probably find ways to reduce that over time. So we have plenty of capital. Right now, I am -- far more than I personally think we need, but we have plenty of capital. + +Answer_15: + + Well, unfortunately, that is a one-year thing, okay and I should point out that before you ask is that when we started the dividends, we said that the intent would be to increase them a little bit every year, so you should expect to see that. We are going to ask for less capital return from stock buyback than we have in the past so where I can do $3 billion in the first quarter. We are going to do less because we have determined, and this is a Board-level determination too, that we want to get to 9.5% quicker and we don't exactly know how these stress tests work. So we think under severe stress, we would have plenty of capital, but the last time the Fed's numbers were very different. We don't understand that and the way CCAR has done this year has even more volatility. Basel 2.5 is far more volatile in how you calculate RWA, OCI and all that than the old Basel I test. So we are a little cautious, which I think is what obviously the Fed expected people to do. + +Answer_16: + + Yes, let me just separate the two. In Consumer, credit card is near the end. There could be more, but it is near the end. It's really mortgage. Mortgage reserves are going to have to come down as charge-offs come down and charge-offs are going to come down. We are not trying to manipulate our earnings or anything like that. They are going to come down. The portfolios are smaller; housing prices are going up. We just don't know exactly the pace they are going to come down, but remember they are half what they were a year and a half ago and my guess is, in a year and a half to two from now, they will be half of what they are today, which implies the reserves will come down. We have $5 billion left; that implied would be $2.5 billion. So nothing magical there. That is what is in the numbers. It is really a matter of timing, etc. +On the CIB side, it was really -- we had one or two big recoveries, so we did have, what was it, $400 million, but Marianne also pointed out there were some other negatives that got booked in CIB too. So you are right; we are not going to have much reserve takedown in CIB, but the other negatives won't be there either. So it is a little bit of a wash in CIB too from other non-reserve-related stuff. + +Answer_17: + + I wouldn't call it a strong fourth-quarter showing. We kind of made an assumption that the last two weeks of the year are pretty dead in terms of activity and we were a little bit wrong about that. But here is what I would say. Activity now is continuing; it is usually strong in the first part of the year. We don't know. But I personally believe that this has been, and I have been consistent about this, a cyclical, a secular change. We deal with 16,000 investors. Investable assets are going up; they are not going down. Global trade is going up; it is not going down. High net worth assets, I'm talking over 10 years and so there is a need that people have to buy and sell securities, etc. So I think the underlying trend is up and obviously spreads will compress over time. They have by the way for 20 years. That will continue. +And now we have got a bunch of model changes, not models, but like business model changes from swaps and derivatives and regulations. We will adjust all that, but there is a chance you're going to wake up one day and it will be a boomer year and no one is going to predict that either. There is a chance we happen to go into recession that it will get worse, but my attitude is I think we are very well-positioned in the business. It is very broad-based between FX rates, credits, securitized products, commodities. It is very global, emerging markets driven by research, which Marianne mentioned we are number one. So over time, it will grow. I just can't predict what it is going to do next quarter. + +Answer_18: + + Yes. Look, I think the American economy -- I've said the table is rather well set. Consumers, businesses, housing, small business they are all in pretty good shape and I think we need good policy and good fiscal policy, but yes, so we expect to see -- we have had, which I think you mentioned, we have had run-off in consumer too. Remember, in Card, from (inaudible) and some other stuff and we are running off sort of businesses and certain things we got out of, but you could start to see a little bit of growth now going forward in outstandings. Good growth in spending, a little bit of growth in outstandings. + +Answer_19: + + Yes, so, hey, John, we will do that for you at our Investor Day in a lot of detail. I think the way to think about our adjusted expenses going forward, you should think about them being flat to down in terms of direction and we will go through all of that for you in February. + +Answer_20: + + Yes, around $50 billion. + +Answer_21: + + One day we hope. + + + (multiple speakers). So we don't -- yes, we won't -- we can't predict the litigation expense, I'm sorry. + + + I think the one part, which I just want to reiterate, is that obviously that one is going to be lumpy and be ongoing except the part relating to mortgages. We have done a lot of work on and we are hoping that we are properly reserved there and they are not going to see duplication of that. In the last couple of years of litigation, a lot of it related to mortgages. Not all of it, but a lot of it. + +Answer_22: + + You have got me there. I think if we buy back $3 billion and what we issue -- I think we issue -- + + + 2.5. + + + -- amortizes in over time as we issue it -- + + + Right. + + + -- so my guess is it will go down a little bit in the first quarter. When you issue restricted stock, it doesn't immediately go into fully diluted. That goes in as it amortizes. Remember this stuff amortizes over three years generally. + +Answer_23: + + If we spend the whole $3 billion, my guess is it will go down, yes. + +Answer_24: + + Yes. + +Answer_25: + + Yes, I think, John, in part, that is it. I can get back to you with more specific details. It did come down slightly in the quarter. It does reflect the combination of our full understanding of all of the rules, plus some model changes and everything else in the quarter and BAU activity, but we can get you more detail. + +Answer_26: + + Yes, well, so we are continuing to grow our deposits very strongly. We are continuing to grow our loans very strongly, so core loan growth up 9%. So all in all, we are generally holding pace with NIM compression and hope to see the same next year plus or minus. + +Answer_27: + + It was better by over $100 million versus the fourth quarter last year. + + + Of course, last year wasn't particularly good by the way. + +Answer_28: + + Completely off. Let me tell you where - you raised a lot of subjects; let me do them one by one. Obviously, when you have a problem like the whale, you have mistakes, which you should acknowledge and then fix. So we obviously fixed CIO totally 100%. People in it, reporting, risk, controls, committees, guidelines and we don't do synthetic credit there at all. But some of those mistakes obviously scared us and we went and checked everywhere in the Company. So we are fixing certain things across the Company. Not that they are bad, they are not disasters, but they require fixing. And so when you have an accident like that, you want to say we are going to use this to get stronger, better, smarter, tougher. And we have to and we are going to. Obviously you can't meet every demand of the regulators. So we have got real resources doing it. We have already done a lot of it. We are going to continue to do more. So yes, they were changes from the whale. +Number two, we are in business to build the business over time by serving clients. That is what we do. We do it every -- we take risk. When you take risks, you make loans; you take risks when you invest money; you take risk when you build systems and branches. But that is what we have been doing consistently and I hope you see in the underlying numbers more branches, more bankers, more custody, more trading, more products, more services, more countries, happier clients in every business. Record results in Commercial Banking, Asset Management, a lot of cross-sell in that and we are going to do a lot more to describe to you the competitive benefits that we get in this Company because the different business units work together and things like that. +So that part of the business hasn't changed. That is why we are here. Even CIO has always been doing that, investing assets conservatively because I was watching something on TV today -- you have to earn a return on your assets. The book -- you are not going to try to earn a return on your assets is ludicrous to me and to manage asset liability exposure generally conservatively. We obviously made a mistake. +And the third thing, the reorganization, that was around -- and I (inaudible) do a lot of this for you, around the client. If you said rebuild the Company from the ground up, you probably would have organized it around the clients, not necessarily by product. It is not that we were bad or banks were bad or anything like that; it is that companies acquired mortgage companies, they acquired credit card companies, they acquired retail branches. The power of that franchise is extraordinary. 40% of our retail branches own credit cards -- are credit cards today. A big chunk of our mortgage sales come out of the branches. Most of our small businesses serve out of the branches. Middle-market is served out of the branches. The branches are becoming an enormous competitive advantage for asset management. The commercial bank couldn't survive without them. +So all we did is say put together those businesses under one roof where you want to have -- you want to treat the client the way they want to be treated when they come in the front door. Same thing for CIB, the same client set in the investor side and the issuer side, the corporate side. So we go to any country. We serve the big companies, we serve the sovereign wealth funds, we serve the governments. We serve them out of TSS and we serve them out of the investment bank. +All we are doing here is better coordination, which we think will have more cross-sell and believe it or not lower expenses. Plus it will help us deal with the new regulatory environment. So both of these things are going to help us deal with the new regulatory environment to have consistent standards across all the businesses, etc. So that is why we had the reorg. +And management changes, you went through the litany of changes, but just remember Daniel Pinto has been in that business his whole life. Mike Cavanagh has been here for many years and was already running TS&S. Doug Petno has been running the Commercial Bank for several years now. Gordon Smith and Todd Maclin, we did it a little bit faster than we told people. We told people we were going to put that under one roof. Marianne Lake has been the Controller of the IB and the CFO of the consumer bank. All the people in these jobs have been here a long time and they are very good. I mean I think it is an exceptional management team. +It is too much turnover, but again the way I look at the turnover, if I have 15 people in the operating committee, you should assume that 15% to 20% every year will turn over. Some years will be zero and some years will be more. When you have reorgs and stuff like that, it is a little bit more. Hopefully, you're going to have stability. We have got a great management team. They are working a lot of different things. Most have been here a long time. And part of it, part of it relates to -- remember if you were on my Board of Directors, you would be asking me, in fact instructing me to make sure you were putting in place in big jobs the people who have to be tested to see if they can do my job. That is -- I mentioned this many years ago, that is job number one. That takes precedence over all other things. And sometimes it leads to turnover. I'm sorry. + +Answer_29: + + Well, look, you should get to know them, but you could evaluate their quality, their integrity, their brains. Mary Erdoes has been here a long time. Matt Zames, who is now Co-Chief Operating -- Frank Bisignano both been here a long time. So these are long tenured, very good, respected employees. And so I know it is going to work. Obviously, you have to make that evaluation yourself. + +Answer_30: + + Not really, but the CCAR does have this qualitative aspect, which I don't exactly know what that means, but not really. It really related more to the desire -- the stock price is higher and the desire to get to 9.5% quicker. Everyone's being doing it and obviously we shouldn't lag. That's all. + +Answer_31: + + Also, Mike (inaudible) because you had me do a little work after one of your reports came out about stock price. So do this yourself. Take Bank One's stock price from the day before I got there to today, and take JPMorgan's stock price from the day we announced the deal to today, compare it to the S&P, the bank, the bank index or all other major firms and it's actually rather good. It outperformed in both cases, the bank by a long shot. In both cases, the S&P not by a long shot but by a significant margin and almost most other financial companies. So obviously something has been working a little bit here. +Opportunity, I think the opportunities are fabulous. So next year, we are going to focus a tremendous amount of regulatory requirements, these consent orders getting things done, but also just organic growth. Small business, Marianne mentioned, is up almost everywhere, partially in Florida and California where WaMu gave us the opportunity to do that. We opened our 1000th branch in California. We are still going to open net over 100 branches this year. Our credit card has been growing. The Chase Private Client, we have got 250 branches to 1200 Chase Private Client. That number is going to go up -- and I don't know if we've -- I don't know if that is public -- okay, now it's public -- to something like 2000 end of next year. It is really working. So it is growing dramatically. +Our mutual fund complex has been growing. TS&S, actually not TS&S, the Global Corporate Bank has opened multiple branches overseas. We have gone from 120 Global Corp bankers to 286 or something. It is going to be north of 300 and it is working. +If you look at Investment Banking revenues out of the commercial bank, when we first got here, I think it was like $450 million. This year, it hit almost $2 billion and we think the opportunity to continue to grow is large. So in almost every single business, we see very good opportunities to grow and obviously, we operate in a difficult world, the financial services, but in the Investment Bank, it was -- it has been -- Marianne went through the numbers, but we don't see why we can't continue to grow that around the world and serve more clients in more places like Colombia or in some of the emerging markets. +In Commercial Banking, we opened branches in non -- states we don't have branches, which have been focused on kind of larger clients and international. That is working well. International commercial bank is working well and all these numbers are in here. You guys should go through it soon. They are all pretty good and you are going to see us continue to focus on growing those businesses in a quality way. + +Answer_32: + + Well, I think you should look at it -- we are already fully engaged in meeting all of those concents and other regulatory demands. Remember, we have changing rules and requirements. We also have a lot of items that the regulators have asked us to focus on, their consent orders. So yes, it is a tremendous amount of resource, but it is not going to change the numbers you see. It is just the people involved -- a lot of people involved in risk credit, legal compliance, audit, HR all are really involved in getting a lot of this stuff right and we have to do that. Of course and people in the business too of course. + +Answer_33: + + Yes, so, Matt, you would have seen that we pretty much portfolio all the jumbos we originate right now. We price them to great returns and we would continue to do that. We like that asset. I think overall across the firm, we did $5 billion of jumbos this quarter and so you should expect to see that continue. + + + I would just add that one of the things you learn to live with a little bit is that you could put a mortgage on your balance sheet and earn or 3.75% or 4% if it is a jumbo or something like that. It doesn't have OCI. It holds more capital, but it might be a wiser thing to do than taking the gain on sale and then buying an MBS at 2.25%. So there are all these opportunities to think through how to manage in the new world properly both for the client and for the shareholder. (multiple speakers). Go ahead. + +Answer_34: + + It may be -- and that may change over time and get bigger. So we are doing a little bit more and right now, it is the jumbos. We have done a little bit like C pluses and stuff like that, but there may be others. + +Answer_35: + + We would much prefer loans than securities like in commercial bank, credit card, etc. So the reason we have securities is because we can't generate that kind of loan right now. + +Answer_36: + + I think the QM was a really big start and kind of well thought through, but it also needs to be coordinated with Basel III, some of these NPR rules, this whole thing about OCI. So all these things are going to affect mortgage a little bit and a lot of players involved in that who have to coordinate it. But I do think over time they will open up the mortgage markets. How rep and warranty is going to be handled, etc. + + + TRN, skin in the game. I think securitization will be important. So if I was the government, I would want to get QRM and securitization rules fixed as quickly as I can to allow people to start. + +Answer_37: + + I would say that is probably in line with that. We have excess cash and excess capacity at central banks and that is what that reflects. + + + They are two different numbers, but they move in the same direction. And we will probably disclose more about that at the Investor Day too. + + + We will. + +Answer_38: + + Probably not much. + + + Yes, not much. + + + The average yield in the investment portfolio is coming down a little bit every quarter and that will continue for a while. + +Answer_39: + + No. + + + We do break it out. + + + We disclosed it. We haven't disclosed it in the fourth quarter. + + + What was it last time? + + + Probably like 3. + + + Interest duration. So it is probably about the same. + +Answer_40: + + The other thing -- right, but the important -- I think the way to look at (inaudible), we would benefit from rising rates. So I've always said that that portfolio is subordinated to the interest of the Company. It is very short. You can extend that duration or a lot more income, but then we would be hurt by rising rates and we break out the earnings and risk from rising rates -- if the whole curve goes up 100 basis points, it is about a $2 billion plus pretax. And that comes through the investment portfolio and loan repricing, etc. + +Answer_41: + + I can't -- offhand, it is hard for me to say that, but I think I am going to guess, but like 30 or 40 basis points. It's not a lot to neutralize it -- + + + -- to eliminate -- right, something like that. + +Answer_42: + + The margin? + + + So I think it is in the supplement. I am afraid I --. + + + It's in the production revenue. + + + Yes, it's in production revenue, which I think was close to $800 million. + +Answer_43: + + Revenue was 3%, 3.5% and net was -- (multiple speakers). + + + So it's like 3.5 times 50, actually is on closed, not --. + + + We will do the math for you. + +Answer_44: + + First of all, it is a Board-level decision and in some ways, it is a nice problem to have, but the way you set the question up you almost have no option. You can't buy back stock and you can't raise your dividend. All you have left is something like that. So we will get there when we get there. Again, we need to see all the new rules and how they are going to apply like this conservation buffer and we may know more by Investor Day, but when we know more, we will let you know. + +Answer_45: + + So the first one is obviously we do budgets and stuff. We put targets in place, things we would like to accomplish. So that is in how we look at -- we are not going to disclose it to you. But I did say that we do think it is going to enhance revenues and reduce expenses a little bit. So a little bit is in there for the CIB and a little bit in there for consumer. And we are going to disclose more at Investor Day about kind of cross-sell and how we look at it and where we think we can benefit, etc. +And if you look at risk-weighted assets, we are up to -- our balance sheet is $2.4 trillion. We have got $200 billion of money deposited in central banks around the world or in repo, very short-term investments, $350 billion in AA securities and $400 billion in securities borrowed or resales. We have a really, really liquid balance sheet. I just mentioned $750 billion, almost $1 trillion of very short-term stuff that is sitting there on our balance sheet in the asset side and our risk-weighted assets are now $1.65 trillion. They have gone up dramatically because of Basel 2.5, the fact that we don't have certain models in place that will be accepted. +So some of the benefit arguably is going to be just -- I am going to call it run-off. Some is from models that regulators expect people to design and put in place that we don't have yet. We just don't have the history or we haven't done the modeling and that is -- a lot of it is around credit-related, synthetic credit type stuff, securitizations and things like that. So we are going to put those in place. And that is not arguing with regulators; they would expect us to do that over time. Obviously, regulators -- I know they are going to look at how people do models around the world and they want this done fairly, etc. + +Answer_46: + + Sure. So think about repurchase. So both sides of that we do them separately. So repurchase losses, I told you you will see demand down significantly, you will see the outstanding pipeline down significantly. We have seen cure rates improve and so our realized losses were sub $200 million and it is what it is and it is a factor, a feature of activity obviously and it can vary a little. +On the repurchase reserve side, it is obviously model-driven and we use inputs, including things like cure rates. So it is not going to be a perfect offset in this quarter. It happened to be slightly more and over time, over the next few quarters, we think they could largely offset that you might see some small pluses and minuses. + +Answer_47: + + Yes, and I would say we are in constant dialogue with the agencies and obviously people ask about behavior and we are in constant dialogue, we think we understand the direction it is going and we feel good about where we are right now and we will continue to monitor that. + +Answer_48: + + I don't know how to respond to that. I think -- maybe you can call later and get some more feedback on some of the stuff you said. You can call Sarah Youngwood at investor relations. But you went through a lot of the stuff that is accurate. Obviously we are in an environment -- the environment changes all the time, but we have growth plans everywhere. So it isn't like we are sitting on our laurels and just looking at what is going to -- NIM compression, stuff like that. So we expect to grow earnings next year. I may be wrong, but that is what we expect. + +Answer_49: + + Yes, okay. + + + You're welcome. + +Answer_50: + + I think we had said earlier, on July 13, we hope it is almost a nonissue by the end of the year. I think we are getting there. I think from the day that -- and we are not going to give you more detail than what I am about to tell you so don't ask. We had modest losses in the fourth quarter. There is no reason to have any losses going forward. The risk from the date of the investment bank got and they have done a good job continuing to derisk it are down, I am going to say, another 50%. +So obviously, there is still risk. It is still a portfolio which has got -- the average duration I am going to say is 2, 2.5 years left. So if you did nothing, it is going to diminish dramatically over time, but I think we have got it well-controlled at this point. There could be some volatility because of the nature of it. It has got some idiosyncratic exposures in there, but we think we are fine. We don't think there's anything that anyone needs to worry about anymore. + +Answer_51: + + You have got to do it a little bit by business because I think in consumer mostly sticky, but it is probably a little bit of TAG -- like you guys had an estimate for that. + + + Yes, like (inaudible) plus or minus. Mostly those deposits we would consider core and sticky. + + + Right. And then TS&S is a lot of seasonal year-end deposits, so it bounces all over the place. Asset management I put in the sticky category. Commercial Bank has been kind of flat, but it is sticky. + + + It is flat because the loans are starting to grow and it is huge. Commercial has $190 billion of deposits. I think that number was $100 billion 3.5 years ago. So they have a lot of money there. We actually expect that might have come down one day as companies start to grow and expand more aggressively, which would be a good thing. + +Answer_52: + + That's a woulda', shoulda', coulda'. I don't know, Guy, the answer to that question. I think if they had been put in place -- it depends how they would have ultimately been put in place. So they were delayed to get more work and how it gets done. I think if they had been put in place for JPMorgan where the rules constrained us overseas, but didn't constrain other companies overseas, we would be down from what we might now have. If the rules were put in place as we can compete freely in Frankfurt, London, Singapore and Shanghai, my guess is our US revenues would have been down a little bit, our international revenues would have been up a little bit. + +Answer_53: + + No, so private equity is $8 billion invested. We expect to earn a return on that. We are obviously getting a great return on it, so that is lumpy, but it should be more than $50 million on average. Treasury -- think of treasury as NII. It is very predictable. The NII (inaudible) by quarter. That number will go down a little bit. That is just how we allocate capital and funds between all the business units. And then how we invest the assets. +So we can change that tomorrow by having longer duration in our investment portfolio. The lumpier part of treasury and CIO is when we have mark-to-market gains and securities gains. That bounces around a little bit and again some of that is discretionary. So we don't look at that -- we should almost call it a net loss, and that number -- I think the $300 million will come down over time, not go up for a whole bunch of different reasons, which I won't go through right now. +And then the other corporate -- that has net allocations, BOLI, COLI, taxes, all these lumpy items and we will just try to tell you it should be plus 100 -- it could be on average 100, plus or minus a couple hundred because of lumpiness of those items. Like corporate taxes are lumpy for a whole bunch of different reasons and so our numbers would be 100 on average. And we always explain the difference if there is ever a big difference there. + +Answer_54: + + It has got not a damned thing to do with exotic investment strategies, zero, nada, nothing, okay? The bulk of those assets are always invested conservatively, AA plus. We had to do it around the world, so deposits around the world, etc., nothing to do with that. It has all got to do with some of the NIM compression that shows up there because obviously investment portfolio yield has gone down a little over 2%. It was 4% three years ago and how we allocate capital and things like that. +The changes you have seen. Some of them are the differences due to the regulatory changes of B3, RWA and stuff like that. So we will try to make this a little bit clearer going forward. But on average, that number will come down, not go up over time. + +Answer_55: + + Yes, when we allocate the new Basel III operational capital debt, the capital allocations will go up mostly to the CIB by I am going to say 20% or so and to the commercial bank by 20% or so or maybe a little bit more than that. And that will obviously change the return targets for those units. It will also be very healthy, so it will just come down. The Company will be exactly the same. +I mean so we just have -- I think when we allocate all this stuff intelligently, it will actually probably end up driving better returns over time as people learn how to manage it a little bit differently. So we will be allocating -- again, it eventually will show more. We will be allocating out -- think of it as everything at one point, LCR, G-SIFI, Basel III, Basel II, whatever comes down the pike will be allocated out so our managers can manage through it. + + + And the other thing we haven't decided permanently is how you look at each business because my feeling has been, this is open for debate, is that the business should be capitalized the way its competitors are going to be capitalized so they would feel free -- they are free to compete in that category. I think the people lump their capital ratios around their competitors. That could be very hard for someone for example to be -- run with 7.5% capital and all their competitors are at 10% or vice versa. + +Answer_56: + + No, cost is cost. It has nothing to do with that. I am talking about capital -- saying we may capitalize the commercial bank at 8.5% and the investment bank at 10%. It may not be 9.5% for everybody because they have to operate, they have to compete in different environments. So that is where you just -- we just haven't figured out exactly how to do that yet. + diff --git a/exam/original-files/Problem_2_3_Sample_QandA/1_questions.txt b/exam/original-files/Problem_2_3_Sample_QandA/1_questions.txt new file mode 100644 index 0000000..e8d9b96 --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_QandA/1_questions.txt @@ -0,0 +1,227 @@ +Question_1: + + Hi there. Thanks. So over time, we have talked back and forth about housing improving and you were right and it is improving. But curious if you have any metrics for us on say what is built into the reserve models and how -- what kind of sensitivity we could have on say -- let's just say hypothetically housing improves 5% in 2013 and again in '14. Just -- I don't know if you can put metrics around it, but -- (multiple speakers). + +Question_2: + + I appreciate that. From what I understand on CCAR this year, the Fed is going to be taking a closer look at internal stress testing and all the procedures that go around that. And I think we are going to get to see -- you are going to be disclosing some of those results. I am not front-running what we are going to see. I am just curious. In general, are we going to see that at the same time, are we going to see that on a lag basis and what you plan on disclosing? + +Question_3: + + Jamie, maybe the last one, on things related to part of the liquidation authority. I know we haven't seen the white paper yet, but there has been a lot of back-and-forth and I am not a believer that we are going to get the worst-case scenario that some of the people at the FDIC had thought about, but long story short is, as ironic as it is, every bank has spent the last couple of years reducing their subdebt because Basel III doesn't count it. Now, shocker, we are going to have to (inaudible) some more because the OLA is going to want it. Just curious on how much prep you can do ahead of that and what your expectations are in terms of a phase-in if that is going to be impactful in the near term. + +Question_4: + + Good morning. Thanks for taking the question. So you all are about to start buying back stock here in the first quarter and the share price is at about $45. Ironically, this is the price point historically where there has been an indication of some price sensitivity. So maybe I was hoping for an update on your thinking on that front. + +Question_5: + + Yes, no, I think so. So basically we can look at the tangible book value growth versus the last comments and imply from there? + +Question_6: + + Fair enough. And then the $100 million to $150 million that is coming out of your legacy costs, is that part of that $500 million per quarter that you all have highlighted in the past or is that in addition to that? + +Question_7: + + Okay. Good deal. And then the comp ratio in CIB is down this year or I should say maybe full-year 2012 about 2.5 percentage points from year prior. How should we think about the comp ratio in the IB on a going-forward basis? Have we hit a structural shift here? + +Question_8: + + Sure, but probably, on the whole, upward comp pressure across the street competitively is probably nowhere near as it had been. So in improvements and increased cost leverage is probably decently sustainable wouldn't you say? + +Question_9: + + Okay. And then last one from me, as we start to move forward towards the central clearing of swaps here late in the first quarter of '13, do you maybe have an updated view of what this transition might mean for JPMorgan's FICC business or your capital markets revenues for 2013? + +Question_10: + + Hey, good morning. A question on LCR. Jamie, you mentioned that you were going to be -- looking to be 100% compliant by the end of 2013 and I wanted to understand did the Basel release on LCR align with your sense of how it is going to shake out in the US? And I ask because the RMBS looks like it was very tightly worded, so I wonder if there is any caveats to your comment that you will hit the 100% by -- (multiple speakers). + +Question_11: + + Okay. And then just separately, a small item, but on mortgages, you talked about the gain on sale that came down on the quarter and that you are looking forward to that normalizing over the course of the next year or so. Could you just give us a sense of how much we are talking about normalizing because we could go back to precrisis and it is a much bigger implication on mortgage revenues than if you are talking about just before the long end of the curve started to come down dramatically. + +Question_12: + + Yes, good morning. Jamie, a quick question. Any update with respect to how quickly you expect your Basel III risk-weighted assets to decline? We saw a little bit of a decline this quarter, expecting more decline, but is there sort of any change in the outlook for the pace of that decline or how you are thinking about it? + +Question_13: + + Okay. And then just a quick follow-up to that, you mentioned wanting to get to 9.5% by the end of 2013. + +Question_14: + + Okay. Along with that, we see a number of companies sort of building a little bit, 50 basis points or something like that, of sort of a buffer on the buffer to account for AOCI fluctuation and things like that. For you guys maybe getting up to 10% or wherever the ultimate endpoint in, is that more of a '14 event or is that also something that you would like to get done this year? + +Question_15: + + Well, I think everyone is trying to sort of do math on how much capital you might return this year. So all of those are questions -- (multiple speakers). + +Question_16: + + Good morning. Some of the pushback that I have gotten from some investors on your strong quarter is on the provisionals overall. So I guess I want to follow on Glenn's question because clearly CIB is unsustainable from a provision basis, but it seems like there is still a lot of leverage left on the provision side from CCB. So Jamie, was your comment that if house prices were up 5% over what is in your model, the additional leverage provision is $500 million per year? + +Question_17: + + Got it. And in terms of CIB activity levels, I think that the investor base did expect some strength this quarter more than seasonal. I guess could you give us a sense of whether or not the strong fourth-quarter showing is sort of a harbinger for activity levels finally picking up in 2013? + +Question_18: + + Okay. And just I wanted to sneak one more in on Card. We appreciate the color on sales volume in Card and I think there is a thesis out there that if the US consumer is taking home less because taxes are higher, but the underlying economy is okay, then that could potentially translate into receivables growth finally. Is that a reasonable leap to make as we look at receivables growth for next year? + +Question_19: + + Yes, hi. Marianne, it looks like your adjusted expenses ex-litigation IB comp came in around $49 billion or so for the year. Do you have an outlook for this number in 2013? Are you looking for some improvement in that above and beyond what you save from the foreclosure settlement? + +Question_20: + + Is that the right number like flat to down from around that $49 billion or so level? + +Question_21: + + Okay, okay. And then that excludes litigation. It looks like litigation for the full year came in at about $3.7 billion. That is down from $4.5 billion the year before. Do you expect that trend of declining litigation expense in '13? + +Question_22: + + And then on the buybacks, the first quarter is usually a big issuance quarter for you on shares, but knowing you have approval for $3 billion of gross repurchases, do you expect to have a net reduction in your share count by the end of the first quarter? + +Question_23: + + Okay. Like for 2012, your share count didn't go down. That is because you suspended the buybacks and it didn't do enough in the first quarter to take the share count down. I assume you would like to see it decrease at some level. + +Question_24: + + And then when you say you are going to ask for less, just to clarify, you mean you will ask for less than $3 billion per quarter? + +Question_25: + + Okay. Last thing, on risk-weighted assets, it looks like your assets were up 2%, but Basel III RWA came down. What drove that delta? Are we starting to see the mitigation take effect? + +Question_26: + + Okay. And one more thing. Your net interest income grew in the fourth quarter despite the NIM headwinds and the runoff. And I understand your NIM percentage outlook, but I guess what helped you grow NII dollars this quarter and do you think you can grow NII dollars in 2013? + +Question_27: + + Good morning. Just first a factual question. How much were fourth-quarter performance fees in asset management? + +Question_28: + + Okay. My main question is does the CIO incident change how JPMorgan is run? And as you said, you have had record net income, 15% return on tangible equity. I think you said in the past -- someone at JPMorgan at least implied that the CIO incident shouldn't change things. On the other hand, you have the new cease-and-desist orders, regulatory actions by the Fed and the OCC and this change in reporting format is the most radical that has ever been put in place since, Jamie, you have been CEO and then all the changes in management. You have a new head of consumer, commercial, investment bank, international, CFO, CIO. +So on the one hand, you highlighted the record net income. I guess my question goes to sustainability of the results over the next several years given how many people have changed, the change in reporting format and the regulatory action. Maybe it is like if you are driving on the Long Island Expressway and you get a ticket for going 80 miles per hour, then you drive 50 miles an hour. Is that just completely off? + +Question_29: + + I guess we will hear more at Investor Day next month, but what are you watching for since there is so much rotation among top managers around the same time? What are you looking for to make -- ensure that this current team will work? + +Question_30: + + Then last follow-up, does your positioning to ask for less than $3 billion per quarter in buybacks have anything to do with the regulatory actions that recently came about? + +Question_31: + + Great. Jamie, I was wondering if you could kind of talk just a little bit about given the strong results that you've got and kind of the hopes of continuing to drive them, which areas you think are the best in terms of where you can see investment in either share gains or growth into 2013. + +Question_32: + + Just as a separate issue, you have obviously responded to the orders from both the OCC and the Fed. Are there any kind of impacts while those are out there until they have kind of deemed them to be kind of fully dealt with and what is the timeframe for that? + +Question_33: + + Good morning. A couple questions in the mortgage banking business and as we think about the mortgage asset, I guess the first one is what is your appetite either now or as you look forward to actually portfolioing some of the mortgages you originate? + +Question_34: + + That is really what I was getting to because I think you have one of the shorter MBS books out there. Obviously has a strong mortgage origination platform. And as we strip out kind of the legacy residential mortgages, what you are left with is not a huge number. So just trying to gauge what the appetite might be to --. + +Question_35: + + Okay. And then maybe somewhat related, as we think about just the underwriting standards in the mortgage business -- + +Question_36: + + As we think about underwriting standards in the mortgage business -- I mean we can see the average FICO scores that the banks do collectively that Fannie and Freddie backed still quite high. There has been some good progress with dealing with the legacy issues, not just for JPMorgan, but for the industry as a whole. Got the new guidance from the CFPB, home prices going up. What else do we need to see for banks to loosen underwriting standards of mortgage a bit? + +Question_37: + + Good morning. Maybe a question for Marianne. Marianne, I noticed that the global liquidity balance was up about $50 billion quarter-over-quarter to just a little bit under $500 billion. Is that in line with your guidance that you are going to meet the LCR requirements by the end of the year or is there something else going on there? + +Question_38: + + Okay. And how much of an effect, if any, was that on the margin in the quarter? + +Question_39: + + Thank you. Good morning. Could you tell us what the duration of the securities portfolio is? + +Question_40: + + Okay. And I may have missed this, so I apologize if you -- (multiple speakers). + +Question_41: + + How much would you estimate at the long end of the curve would you need to see the long end of the curve go up to mitigate the margin pressures so that you could actually see maybe margins not go down? + +Question_42: + + Yep. The other question, and I apologize if you guys already gave this answer, but what was the gain on sale of mortgages this quarter? + +Question_43: + + And what was the spread, like 3%, the revenue spread? + +Question_44: + + Okay. And then coming back to the return of capital, Jamie, I know this at a stock price you are not going to want to buy back your stock. I am not asking for that stock price, but let's assume for a moment bank stocks do well this year, your stock gets to that level where you are not real comfortable in buying it back. Would you guys consider, as the excess capital builds up on the balance sheet and the Fed limits your regular dividend to maybe 30% of earnings, would you consider special dividends as an avenue to give back that excess capital if you feel it is not -- you are not comfortable buying back the stock at the price at some future level? + +Question_45: + + Yes, good morning. A couple of questions. The first one, on the latest reorganization, I guess that comes with you in the light of having completed the integration of both Bear Stearns and Washington Mutual. It makes complete sense, but have you actually set any targets in terms of both the revenue and cost synergies you think you might achieve in the medium term? That is the first question. +And the second one was on the $80 billion to $100 billion of RWA you think you could shed by reworking your models. Something ironically you have been pretty critical about in the past in terms of the Europeans' view on that. But can you just tell me is it getting more difficult to do that in the market (inaudible) at the moment? We are getting some pushback from (inaudible) on some of the risk-weighted asset calculations or are you finding it pretty straightforward to actually negotiate that? + +Question_46: + + I wanted to ask a detailed question about the mortgage rate purchase expense. You were able to show this quarter that you had a reduction in the reserve of $249 million and only experienced $196 million of losses. So you actually net brought down the impact there. And in your outlook, you talked about being able to offset future losses with release of reserves. So I wanted to ask that question first and then I had one more follow-up after that. + +Question_47: + + So we should see a -- we have gone through an inflection point here where you think the demands are coming down and improvement of what you are seeing overall but that drain should be somewhat mitigating going forward? + +Question_48: + + And then as we look into 2013, I was trying to take a little bit of your outlook and just kind of create a net progression. If you look at the $1 million that you basically highlighted in margin compression, you have a natural offset that you have explained in the servicing expenses for about $400 million. So if you take your current run rate of operating of $1.35, annualize that to $5.40, you have probably got somewhere between $0.07 and $0.10 worth of negative that comes out of that from netting out the positive that you have in the servicing expenses from margin compression. +If you then move incrementally for growth, if you offset a lot of the margin compression with loan and deposit growth, then you are being able to generate about $1 billion of incremental by just growth and overall balance sheet. If you look at expense savings and then some reduction in shares, you can kind of look at how you would layer in towards something like 10% kind of growth next year as you kind of mirror those kind of big moving pieces. So I just want to make sure we were tracking those and if you had any other thoughts about incremental opportunities to create EPS next year? + +Question_49: + + And I guess, Jamie, the bottom line is that you have product growth to offset margin compression, but then you have got share repurchase and some efficiencies that create incremental growth. I guess that is the bottom line. + +Question_50: + + Good morning. Can you just give us an update on where you are on the synthetic portfolio? I know you probably don't want to give a dollar amount, but is it mostly gone and what the timeframe is of that -- even if it is a modest drag, just having that off the books completely? + +Question_51: + + Okay, that's helpful. And then maybe just on the deposit growth, I think you were up on a period-end basis $54 billion. Is there any way to kind of get a sense of how much of that is stickier? Was that just sort of fiscal cliff concerns or was it the TAG-related deposits? Do you have any sense on what was driving that and if it is just more sustainable organic growth that would be helpful? + +Question_52: + + Yes, good morning. This first question is a little bit short term, so forgive me, but the CFTC, as somebody mentioned earlier, did push back the timing of some of the OTC reforms with respect to central clearing. And I guess my question is, from your point of view, all other things being equal, should we expect stronger fixed income revenues as a result of that in the first half than we otherwise might have? + +Question_53: + + Okay, that is actually real helpful. Thanks. My other couple of questions have to do with your outlook slide. First of all, on corporate private equity, I just want to make sure that there is no distinction that I should read. When you talk about treasury and CIO, you talk about the net loss of $300 million plus or minus specifically in the first quarter. When you talk about the other corporate $100 million, you don't mention a timeframe. So does that mean that you expect more potential variability over say the course of this year in the treasury and CIO number than the other number, which is more of a run rate? + +Question_54: + + So if I add the two together, and obviously we know there is lumpiness, but just adding those two numbers together at face value, we are talking about a quarterly loss of a couple hundred million. You used to guide to quarterly earnings of I think it was $100 million to $200 million on that kind of combined line. So if I was trying to assess what the swing had been relative to a few years ago, how much of it would you say is just the compression of net interest margins and how much of it is moving away from some of the, pardon the word, but exotic investment strategies that CIO used to --? + +Question_55: + + Okay, that's fair. And then the final question I have is just on the [firmwide] right below that. You talked about capital allocations a moment ago. It sounds like your LOB return on equity targets are, like you say here, are going to come down for some units and therefore overall but the corporate guidance is the same. So does that mean that basically all this change just is because you're allocating more capital out to the business units and you will have less at the corporate parent? That is the only real change? + +Question_56: + + So you are going to try to move both capital and cost allocations more to each unit being on a stand-alone basis, is that right? + diff --git a/exam/original-files/Problem_2_3_Sample_QandA/20_answers.txt b/exam/original-files/Problem_2_3_Sample_QandA/20_answers.txt new file mode 100644 index 0000000..290c184 --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_QandA/20_answers.txt @@ -0,0 +1,166 @@ +Answer_1: + + So Betsy, there's no change in our transfer pricing methodology or even the way we compute it. It's to do, as you appreciate, with, obviously, higher rates and the fact that we are in a very disciplined environment at this point on deposit reprice. We would expect to continue to see the margin expand over the course of the next several quarters, but we would also expect to continue to drive higher NII as we're growing our deposits. [And those remain] in FTP. + +Answer_2: + + Yes, yes. + +Answer_3: + + Yes. So I mean, I think the way to think about it, not to sort of diminish the importance of any individual breach or situation, is that we are, honestly, under constant attack both in a more general side, but also from a fraud perspective. And so while we will always react and learn lessons from every individual situation, this is not the first breach, nor will it be the last breach. And so as a result, we have been constantly evolving and refining the way we think about fraud prevention, detection, underwriting, continuing to move to multifactor protocols around customer identification, looking to leverage all of our data to sort of better inform our underwriting decisions. So the reality is that, as important as it is and as much as we -- as each individual breach could impact the overall equation, we have had to evolve over an extended period to the position that we're in now. And so as a direct result of this, there won't be specific, meaningful changes, but a continuous evolution. And so when we are looking whether it's at sending out preapprovals or marketing offers or receiving inbound applications, we are increasingly looking at a number of different data points and facts to be able to identify the customer and understand the application. + + + And just -- let me add. As part of a breach -- so if your name was taken, and we know that as Social Security, a driver's license, we can put in a lot of enhanced controls that we do about your name specifically. We don't have to rely on those things. We can reduce reliance. We can greatly, dramatically include antifraud on your account. So we do, do that to dramatically diminish any effect on our customers. + + + And the reality, Betsy, is that we kind of operated over an extended period now on the presumption that while we happen to know about this breach, there will be others either right now that we don't know about or over time. And so we have to be proactive, not reactive. And we'll obviously look to learn anything we can, but we continue to evolve so that we can use all of the information at our fingertips. And as a practical matter, we are not seeing a specific increase in fraud. + +Answer_4: + + Correct, correct. As a result, we're already spending the money that we need to spend to keep, hopefully, ahead of the curve on all of these things. Our operating losses are -- I will say, the combination of all of the information that has been compromised over the course of the last several years has put pressure on fraud costs, but nothing incremental from this. And so no impact on expenses or loan growth that would be measurable. + +Answer_5: + + Yes. So look, we -- obviously, apart from the rate hike in June, nothing has really happened much since last quarter. And so the landscape is looking pretty similar, and -- not because that's surprising, so I'll come back to that in a second, which is to say that there's been very little to no movement in the repricing of deposit accounts. There's been some incremental movements in certain savings and CDs, but nothing systematic in the consumer space. But that's pretty much as we would have expected with rates at these absolute levels. And so at some point in time, and that may be a couple, 3 more rate hikes from now, the dynamic may start to change, and so we haven't changed our perspective about what we think the ultimate reprice will look like. In Asset & Wealth Management, the story on deposit pricing is somewhat similar. A little bit more movement, but nothing particularly meaningful or dramatic. The story there is very much, again, as expected. At these levels of rates, you are seeing customers start to make choices to move certain of their deposit balances into investment assets. That's normal migration, migration that we expected and that we've modeled, and we are retaining those balances. So we are starting to see some of the dynamics we expected play out. That started happening at the beginning of the year and has continued to progress. And then in the wholesale space, there is a spectrum as well. So I would start with we're firmly on a reprice journey in wholesale, no doubt. And depending on where you are in the spectrum, it ranges from the smaller and lower middle market companies, where the reprice is modest, but present to the higher end, where it's reasonably high. And so overall, if I step back, that's where we are. If I step back and say, "Have we learned something new in this cycle that we didn't know?" The answer is, "No, not really." If you look at the first 4 rate hikes of the previous normalization cycle, the overall cumulative deposit reprice was pretty much the same as it is now. So we continue to believe that the dynamics that we've been talking about over the last several years and that we've expected will play out. They may not play out exactly as we have them modeled, but they will ultimately play out that way and that we have appropriately conservative reprice assumptions. + +Answer_6: + + So at the risk of sort of hedging, it's actually a bit of both. The reality is there's always been 2 different camps on the reprice theories for consumer. There's been the camp of acute market awareness, low for long, technology enhancements allow movement of money to be easier, competition for retail deposits and good liquidity deposit is high. Therefore, reprice higher. And the counter to that, which has merit and which we are seeing to a degree, is customers feel that they're weighing a more balanced scorecard of things when they choose where to keep their deposits. And customer satisfaction, the suite of products and simplicity, the digital and online offerings as well as the safety, security and brand all matter and that price is a factor, but not the only one. So I would say we certainly feel that having a leading digital capability is critical to, overall, our customer franchise, and it will, in all likelihood, have an impact on the stickiness of deposits because customers value that kind of convenience very highly. I would also say one other thing about where we are right now, is that, as you know, as much as you're right about the sort of potential demand for these sort of high-liquidity value deposits, there's a lot of excess liquidity in the banking system. And although loan growth is solid, it's solid. So we aren't seeing a frenzy, albeit that we're very proud of our deposit growth. + +Answer_7: + + Yes, welcome back. + +Answer_8: + + I don't have that off the top of my head, but we can get back to you. + +Answer_9: + + I fear -- here's what we'll do. I fear if I give you a ballpark, I'll get it wrong. While we're on the call, we'll get someone to send the details and let you know. + +Answer_10: + + So we're doing a bit of all of the above. So I'll start with the comment which you heard from us before, but which we still strongly defend, which is that branches still matter. That 75% of our growth in deposits came from customers who have been using our branches. That, on average, a customer comes into our branches multiple times in a quarter. So I know that all sounds like old news, but it's still new news at -- or current news. So the branch distribution network matters. Customer preferences are changing, and we are not being complacent to that. So we are, underneath the overall 5,000-plus branches, continuing to consolidate, close, move, grow, change all of our branches in line with the opportunity in the market that we're in. So net for the year, we'll be down about 125 branches. We've closed more than that, consolidated some and added some. So we're not being complacent to the consumer preference story. But branches still matter a lot, and we're building out all of the other sort of omni-channel pieces, as you know, so that we have the complete offering. And if the customer behaviors start changing in a more accelerated fashion, we will respond accordingly. + +Answer_11: + + Yes. So I would characterize this as -- over the 2 quarters of normal. So you may recall last quarter, there were a couple of things that we talked about. First was that there was a $75 million sort of onetime interest adjustment in mortgage, which artificially reduced loan yields for the quarter. And secondly, that seasonality and mix in Card similarly. So we would normally, in the law of extraordinarily big numbers, expect for a 25 basis point rate hike that we'd see about 10-ish basis points of improvement in loan yields across the whole portfolio. We didn't see that last quarter. What you're seeing this quarter is the reversal of those factors and the normal benefit of the June rate hike. + +Answer_12: + + Yes. So as we look at the loss rates for this year, they're coming in, as we expected, at less than 3%. And as we look out to next year, based on what we know today, it's still in that 3% to 3.25% range, albeit maybe at the higher end of that range. So it's broadly in line with our expectations. So the reserve build -- and we -- in the consumer space, we move our reserves in -- not in dollar increments. But the reserve build is about a little less than 1/3 on the growth and a little more than 2/3 on normalization of rate. + +Answer_13: + + I think that was about... + +Answer_14: + + Yes. So -- yes, NII, so a couple of things. The first is just to sort of repeat the standard. Just as a sort of macro matter, we're more sensitive to the front end of rates than to the long end of rates, particularly over any short period of time. And so intra-quarter volatility in the 10-year, while it's not nothing, it's not like it would have a material impact on the run rate. We're -- clearly, an overall generally flatter long end of the curve, in general, on average, through the year, all other things being equal, will have had a dampening pressure on our expectations. And it's part of the reason why they went from 4.5% to 4%, not the only one, as we progress through the year. But generally speaking, intra-quarter volatility is not something that would have a meaningful impact on our run rate. + +Answer_15: + + Okay. So on the first, I think it's quite important to, like, not look at the average and to kind of decompose it into constituent parts. Because we've talked before about the fact that we use our balance sheet strategically in CIB, but loan growth is not really a thing there. And so this quarter, we saw no loan growth in CIB. So no big deal, but it means that, that 7.5% core growth for the whole portfolio would have been, outside of CIB, closer to 9%. So start with that. Consumer has been pretty consistent. So across the consumer space, whether it's our jumbo mortgages, whether it's the Business Banking, Card, Auto loans and leases, they've been growing at reasonably solid and consistent high single-digit territory or even low double digit for mortgage over the last several quarters. And at this point, we don't really see anything that is suggesting that, that will moderate meaningfully. So where you're seeing -- and similarly, in Asset & Wealth Management on the banking side. So really, where you're seeing the growth moderate is in commercial, and it's in both the C&I loans and the commercial real estate loans. And they each have a story. With the commercial -- with the C&I loans, for us, the story is about moving from meaningfully outperforming the industry to being more in line with the industry. So over the course of the last couple of years, as we've added expansion market, opened new offices, added a couple hundred bankers, developed our specialized industry coverage models, we've been growing meaningfully better than the industry. And so you see that even in this quarter in our year-on-year growth, 8%, as compared to the quarter-on-quarter growth, where it is flatter. And that, to me, is really a factor of the fact that in this stage of the cycle, our clients have strong balance sheets. They have a lot of liquidity. They have had access to the capital market. And so GDP-plus growth is not unlikely to be a level for the foreseeable future. With commercial real estate, it's slightly different. We're still outpacing the industry, but we've kind of gone from very strong to strong, and we would continue to expect that to slowly moderate. And that's a number of things. It's some higher rates. It's actually a lot of competition. And then it's a lot also about client selectivity given where we are in the cycle. So we are being very cautious about new deals that we add to the pipeline and the client selection that we have. So all of those factors, I think, weigh into the commercial real estate space. Just -- tax reform, so fiscal stimulus. The reality right now is, although I think everyone and ourselves included are hopeful, obviously, that tax reform is done for the right reasons and that the economy responds accordingly, at this point, it's not front and center in the dialogue we're having with our clients about whether they should or shouldn't do a strategic deal or take an action. So I would say it's neither holding up business, nor spurring business, but that could change. So at this point, I'd say it's a factor, but not a driving factor, and that could change. + +Answer_16: + + Well, so -- I mean, we'll just deal with the fourth quarter because I think the landscape of rate hikes for 2018 is an open question. But no, we would expect loan yields to hold relatively flat, all other things being equal. It's a very competitive environment. We aren't seeing -- we're seeing some pressure in commercial real estate spreads. We're seeing, generally, spreads holding up. But I would expect competitive pressures to keep loan yields relatively flat. + +Answer_17: + + Yes. So we are -- at this point, we are, at that 3% charge-off rate, rising to 3% to 3.25% next year and growing, so you should continue to expect that we'll be adding to reserves. Our outlook for reserve adds next quarter is below this quarter. But obviously, we will continue to observe that. And with respect to the hurricanes, right now, in this quarter's results, in the credit lines, in mortgage particularly, and to a much lesser degree, in wholesale, we built -- effectively built $55 million of reserves. To sort of contextualize that, we have used our unfortunate experiences of Sandy and Andrew and other natural disasters to calibrate the assumptions we're using. At this point, it's early to be able to say how the losses will actually manifest themselves. It could be that it's lower than that, but that's also the central case right now, $50 million in mortgage and just a handful of million in the wholesale space. + +Answer_18: + + Yes. So I'll just start with a bit of a philosophical discussion, which is it is our opinion that now, as much, if not more so than ever, the investments we're making in technology will effectively breed and deliver the efficiency. So to the degree that we are able to find incremental investments or accelerate them, we'll be willing to do that. And our expense numbers, our outlook has never -- have never been target. So that's just a sort of mental -- philosophical point of view that we would deliver any technology innovation and investments that we could execute well, that we think would be either accretive to our returns through revenues or efficiency. Specifically, when you look at the simulation, this is a point of technicality. In 2018, middle -- probably middle to third quarter of 2018, we are expecting that the FDIC DIF fund will reach its level at which the surcharge will be able to be reduced. That's a meaningful positive for us. And so if you look at the implied growth in expenses from '17 through the medium term, they are larger than is implied. But if we found the opportunity to do more or to accelerate more, we would do it and explain it to you. So we'll come back to that at Investor Day. + +Answer_19: + + Yes. I think I'm -- so when we did some conferences at the end of the last year, I think that we said that we'd expect the revenue rates for the full year this year to be 10.5%, and it will be a little better than that. And the revenue rate increase in the quarter speaks to a little bit of spread and a little bit of lower premium. It will go down the next quarter because of the fourth quarter effect of the Sapphire Reserve travel credit for overall, call it, 10.6% for the year. But yes, we do expect to hit the 11.25% in the first half of next year. And we've reached the inflection point end of the third -- second quarter and into the third quarter, where growth is offsetting the impacts of the significant upfront investments in Sapphire Reserve. Then we'll see revenues grew from here. + +Answer_20: + + Yes. So I'll just start with credit for a second because although we absolutely expect at some point that we're going to see normalization of credit -- we haven't seen that yet, I just want to make that clear, that we are appropriately cautious in sharing everything, but we're not seeing any deterioration or any thematic fragility in our portfolio that we're concerned about at this point. With respect to the revenue side of the story and the efficiency side, I mean, it really is a story of all of the things you mentioned sort of all coming together at the same time. So we have been adding to -- we have our expansion markets from the Walmart acquisition. We've been adding new markets and opening offices. We've been adding bankers. And as you know... + + + We're in all 50 of the top MSA now. + + + Yes. We are in all 50 of our top MSAs now. And we've been adding bankers. And as you know, when you add all of these investments, for a period of time, when they are still in the buildup mode, you don't see that drop to the bottom line or to the top line. And now we're starting to see our bankers hit their stride, become very productive, the balances are building. And then I would also say that this is a -- the epicenter of delivering the whole platform to our clients. So if you think about what we're able to offer our clients in terms of international capabilities, banking coverage across industries, core cash, global payments, we have a platform offering, I think, that is -- well, it's certainly complete, and it's somewhat differentiated. And then the third thing I would say is that it's a buttoned-up business. We have been looking at efficiency and expenses and really working on making sure that due to simplification processes that we went through in 2013, '14 and '15, that we are focusing all of our efforts on our core strategic clients, and it's paying off. + +Answer_21: + + Yes. So I would say it's almost -- like you said, there are so many uncertainties that it's almost talking about hypothetical at this point, as encouraged as we are with the ongoing dialogue. My view is sentiment is relatively high. In fact, it's ticked up slightly over the course of the last short while. So from that vantage point, we're in a position of strength. And there would necessarily be some lag, so whether that is a couple of quarters or longer. So certainly, in the foreseeable future, you would hope to be able to see increased demand and confidence leading to action. + +Answer_22: + + Yes. So I'll start with the excess liquidity question because while we feel very, very good about our liquidity position, and you will have seen in the recent disclosures where everyone is positioned and necessarily, even if LCR was the only consideration, people would want to be running a Basel II LCR. So -- but LCR is not the only consideration. And the other most notable one I would point out to you would be resolution planning. So know that when we have our overall liquidity position, we're taking into consideration a combination of constraints. And so what may look excess in one -- on one lever may not be as excess on another. The second I would say is that when we look at the deployment of our HQLA, we look at it in the context of our sort of target for what we want the duration of equity for the company to be over the course of the normalization in rates. And obviously, it's not just about liquidity. It's also about duration. So we're comfortable with our liquidity position. We have a framework for deploying it and for thinking about the spot and forward-looking duration of the company. That's not to say that we are not opportunistic in taking advantage of moves that are technical in the long end of rates to either deploy or to undeploy dry powder, and we still have some. So it's more than just liquidity. It's also duration, and we've taken the overall balance sheet and our expectations and our target into consideration, albeit that we still have some dry powder. + + + And we maximize for between loans, securities. + + + Yes, yes. + +Answer_23: + + So it will be over the short while, and our full expectation outside of any other, like, stimulation is that as the front end of rates goes up and as gradual QE unwind happens, that you're going to see the long end of rates go up, albeit more slowly. So it's pretty typical at this point in the normalization cycle to have a curve flattened. That's what we're seeing. That's what we would expect. I would expect to continue to see the long end rise. And yes, it should be NIM-accretive. + +Answer_24: + + So I would say it's wallet share. It's blocking and tackling. We did pretty well in Europe, and -- but there is still a lot of competition. So I would say it's less about the specifics of any one competitor because the environment is pretty competitive and just about sort of reasonably broad strength. Two things that I would also point out is, the first, in equity underwriting, similar to -- in FICC, we gained a couple hundred basis points a share in the third quarter of last year. So on an apples-to-apples basis to where we would normally expect our shares to be, we're still doing very well. + + + I would just say, I think the competition is fundamentally fully back. + + + Yes. + + + It's not that they're -- or most of these players are all out there. Some specialize in certain areas, but it's fully competitive. And you have new entrants soon, like the Chinese banks, et cetera. + +Answer_25: + + Okay, that was a lot. So look, first of all, we welcomed the report. And it's a long report, a couple hundred pages. There's a lot of recommendations, very comprehensive. So kudos to the Treasury for delivering it. And we are supportive of those recommendations kind of at large. And I think the most important thing to remind you is that this is not about materially changing the legislative landscape. It's about recalibrating -- sensibly recalibrating the specifics of individual rules over time. And so we're still digesting the report, but we are supportive. It is very comprehensive, and it could be very beneficial to the liquidity and depth of the capital market, which is what we should all hope for and not contrary to safety and soundness. So in that sense, very supportive, all good. It's going to be complicated, and it will take time, but the will is there. And so whether it's the administration or the regulators, there's a general recognition that there's the ability and the appetite to want to make rational change. And so if that helps to grow the economy and all the things that come with that, we're working as constructively as we can on that. + +Answer_26: + + Yes, so we're building, obviously, kind of beta platforms for trading and investing and things like that. And also, the P2P, Zelle which is doing quite well. We look at all those things as things you want to -- from the client standpoint, we want to offer to a client. And at one point, we'll be talking about a more -- testing what we think might or might not work, and then we'll give you more of a strategic view of that probably around Investor Day. + +Answer_27: + + So we have a fairly large mortgage loan portfolio in addition to having a large portfolio in our investment securities in MBS. So we are already reasonably equivalently mixed in terms of our percentage of mortgage exposure to our total assets or loans to the competitive landscape. And so trust me when I tell you that you talk about excess liquidity because of LCR and we are thinking about more than just LCR. And we do -- as I said, while we do maintain a short position and the cost of being short is relatively cheap, we don't have the kind of capacity to invest $100-plus billion in MBS right now or anything that's meaningful like that to generate higher returns without blowing through our duration target. + +Answer_28: + + No, no, no. We haven't. We -- as we talked about before -- a while ago, we made some surgical changes to our credit box in the Card space, but that's, if anything, I would say, incredibly granular, incredibly surgically tightening, not the reverse. Whether that's in Card, in certain micro sales or whether that's in Auto, I would say we've been pretty conservative. And we're probably doing, at the very margin, a little bit of tightening. + +Answer_29: + + No. So I mean, congratulations to them if they have a high degree of confidence on what 2018 CCAR is going to look like. So I will tell you this. We said very clearly that we feel that the company should operate within the range of 11% to 12.5%. We feel like it should be lower in that range. And having a capital plan approved of $19.4 billion of share buybacks over the next 4 quarters and over 100% payout based on analyst estimates is a start. So nothing has changed about that objective, but we would want to be measured about the pace at which we do it until we have a bit more final clarity on what the new generation of capital rules will look like. So we hopefully will know more as we go into the next cycle of capital planning. We haven't changed our point of view that we should be able to continue that journey down into the range, and that would be our objective. To tell you that we can give you the road map for that today, I think, is not accurate. So -- but you can do your -- you can and you have done your own math. You can -- your base -- look at our earning outlook in your earnings models and payouts of over 100%, and you can see that we can move down in that same time frame to something much lower than we are now. It's not towards the bottom, but that's not to say that we will be able to do that. We need to go through tests. + +Answer_30: + + Yes. So I think I got that. So the compliance burden and the readiness and the work to be ready is a significant heavy lift not just for us, but, as you say, for all market participants. And so there is the possibility that effective at the beginning of the year, there will be ongoing work that needs to get done. We feel like we're reasonably well positioned and -- to defend our position. But there's no doubt that over the course of the year and beyond that people get clearer and clearer on transparency and cost to execute versus advice versus content that there may be competitive dynamics to change. And we feel like we've been building for the last several years to be ready for those dynamics. So there could be some bumps. I don't think it's anything that we're concerned about at this point, and we will all learn a little more as we go through 2018. + +Answer_31: + + So I would say that, for sure, has to be part of it. And even with the auto situation, what you're seeing is, I think, a marketplace that is much more responsive. So while we felt like we got ahead of the issues and tightened early, you've seen the sort of industry generally move in that direction. So I think there's no doubt that the environment, in totality, sort of capital liquidity controls regulation has led to higher-quality loan books. And so yes, we have been pressure-tested. Energy was a 1 in 100-year flood. And I think the industry, and specifically our portfolio, performed really quite well. And that's not to say that there isn't a point of pain out there somewhere we just -- that we won't see. We just feel like we'll be in a good position to get through that. + +Answer_32: + + Yes. + + + Yes, but no. Yes, (inaudible). So I would tell you that we are seeing that rotation start. If you go back even 3 years ago, we kind of gave you an outline of what we thought would happen. We said we're going to see rotations from the high wealth segment into investment assets, followed ultimately by the consumer space. We'll see retail deposits move into money funds. We'll see outflows of wholesale, not deposits, as the Fed shrinks its balance sheet. But those things are going to play out over the course of the next -- depending on the rate cut, over the course of the next 2 to 4 years. So we've begun to see it. It should be expected. I don't think it tells us anything new or different necessarily at this point. + +Answer_33: + + Yes. So look, our card spend growth at 13% up year-on-year is still very strong. So when we say moderated, it's from very strong to very strong. And it is in part due to the number of new products we've had. So we would continue -- the Sapphire Reserve card spend engagement is very strong, and we're very pleased with it. So it's not -- I wouldn't say it's a moderation necessarily. It's just, at these very high levels, from a slightly higher to very strong is still a great story. + +Answer_34: + + So if you think about -- our first acquisitions were in August and September. So we're kind of at the early stages. So far, very encouraging. So far, better than our expectations. But a little early to sort of draw firm conclusions on it, but very encouraging. + diff --git a/exam/original-files/Problem_2_3_Sample_QandA/20_questions.txt b/exam/original-files/Problem_2_3_Sample_QandA/20_questions.txt new file mode 100644 index 0000000..62a608c --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_QandA/20_questions.txt @@ -0,0 +1,136 @@ +Question_1: + + Two questions. One, on the revenue lift in the Consumer & Community Bank. I know on Slide 4 you highlighted that the 6% up year-on-year is driven by the higher NII and deposit margin expansion. Could you just describe a little bit if this is just the start of an improvement in transfer pricing that the Consumer Banking division is benefiting from? And is there a lag that, we should expect, would continue to drive up this revenue lift over the next several quarters? + +Question_2: + + And then -- right, but that FTP methodology should continue to drive up margin -- deposit margin over the next couple of quarters. + +Question_3: + + Okay. And then the second question is just how you're dealing with the Equifax fallout. The real -- the question here is, does the breach that occurred drive any changes to how you are assessing credit requests that come in, how you're filtering for what you perceive as fraud risk and how you're managing the book of outbound credit requests that you're looking for from a proactive perspective on your loan book? + +Question_4: + + And as a result, expense impact, loan growth impact, de minimis from your perspective? + +Question_5: + + I wanted to follow up to your responses, Marianne, on no pressure on deposit pricing. I'm wondering if you could -- especially in light of your deposit growth strength, and especially in the Consumer, give us a sense on how repricing trends are today in terms of the consumer wealth management versus wholesale deposits. + +Question_6: + + Got it. And my follow-up question on that is you're one of the few firms that have been really talking about anticipating the impact from a Fed balance sheet reduction over the next several years. And the question I often get from investors is, obviously, in particular, retail is valuable not just for the price of it today, but on an LCR basis. And how would you respond to the question, given the 6% growth in digital in the consumer bank and 12% growth in mobile, does technology help with the stickiness of the consumer deposits? Or does it potentially aid in the velocity of switching? + +Question_7: + + Can you hear me? + +Question_8: + + My question is on the consumer and the community bank, a 3-part question. First, what percent of your customers have online bill pay? I'm trying to get back to that stickiness of the deposits. + +Question_9: + + Okay. Can you give a ballpark? I don't think you've disclosed that before. Is it, like, to the nearest quarter or... + +Question_10: + + Okay. And then the second part is -- I mean, you're talking -- the deposit beta has been lower. You gave your caveat. But mobile bank customers are up 12% year-over-year. Why do you still need 5,200 branches? Isn't this a good time to close branches when deposit competition isn't as tough as it might be in the future? + +Question_11: + + A question first on the loan side, on the yields. So last quarter, they held flat. And this quarter, they're up 16 basis points. I just wonder if you could help us understand, was that more just the mechanics of timing of hikes moving through your variable rates? Was -- is it any element of pricing? Or any other things you could just help us understand why we saw that great, nice improvement there? + +Question_12: + + Got it, okay. And my second question, with the Card build, you took the reserve for Card to around 3.3%. I know you had talked about staying below a 3% Card loss rate for this year. But I'm just wondering, as we get into next year, you kind of had a medium-term idea of 3% to 3.25%. How are you feeling about that in terms of the seasoning of the Card book and loss rates? + +Question_13: + + I don't know. Maybe it's a little nitty-gritty, but you're definitely the person for this. Point to point, the yield curve was about the same. 10-year was about the same. + +Question_14: + + 10-year was about the same, point to point. However, throughout the quarter, the curve was much flatter. I'm just curious if that has any dampening effect in any given quarter. And maybe the better way to ask it is, could it have a little bit more of a positive run rate as we go forward? + +Question_15: + + Okay, cool. And in terms of the loan growth, I think it's completely normal to see some moderation, and you're still doing reasonably better than the industry. I'm curious on the main source of maybe the moderation ticking down a little bit. And then more importantly, is it too soon to ask if any of this talk on tax reform and decent economic data is having a pickup in the conversations on the loans growth side? + +Question_16: + + Maybe just a quick question on the outlook on the net interest margin, if -- should we still expect some grinding higher of asset yields even without rate hikes? How do we think about that trajectory, assuming we don't get any more rate hikes from here? + +Question_17: + + Okay. And just maybe on the reserve build outlook. Should we still expect it to kind of track with growth and keep the reserve ratio kind of similar in Cards where we are now? Or do you still anticipate some additional building? How do we think about that? And if you could size the hurricane impact, that would be great this quarter. + +Question_18: + + Marianne, I was wondering if you could discuss how you're balancing all the investments you're doing in IT and business growth with the efficiency mindset that you guys always have. I guess one of the frameworks is if I look at the 3-year simulation you provided in February, a lot of the expense growth seemed to happen this year. We have kind of a $2 billion increase in adjusted expense. And post-2017, the expense growth looks very modest. So maybe just talk about -- a little bit about the leverage you're using to keep expenses in check as you're doing all the investments. + +Question_19: + + Okay, and then just a follow-up. You mentioned the Card revenue run rate has moved up again nicely this quarter. It seems like you might be able to get to your target by the early half of next year. Is there upside to that revenue run rate target? Is that -- are things coming in better than expected in terms of the moderation of promo rates and things like that? Or maybe could you just give a little color there? + +Question_20: + + Just following up on, Marianne, on the Commercial Banking business. You've had -- you've obviously -- you've had very good momentum there over the last couple years, and you did talk about credit dynamics in moderation in credit growth and sort of a normalization back towards industry trends. But can you just comment a little bit more broadly about some of the initiatives you've had there from a revenue standpoint, whether it be the middle markets initiative, BI -- the growth in IB, international and whatnot? The earnings growth has obviously been very, very strong in this business, and it's starting to move the needle a little bit. But if you can just give us a little bit of color on the opportunity set you see there. + +Question_21: + + No, that's great. I guess sort of a related question on the Commercial Banking business that's a little bit of a follow-up as well on tax reform. Obviously, the Congress -- or the administration and House Ways and Congress released a blueprint so Congress can now start to flesh out a tax plan. And obviously, there's a lot of uncertainty as to the content, the timing, heck, whether it even happens or not. But how -- if we do see something that is sensible, however you want to define it, how quickly do you think that we could start to see that beating through into better sentiment and ultimately, into better demand or increased demand for credit? + +Question_22: + + Can you talk about how your -- can you just talk a bit about how you're managing the excess liquidity? You've obviously continued to build cash. The securities book has shrunk. It makes sense given the flatter yield curve, but you combine that with still good deposit trends and a strong loan growth and obviously, a challenge as you think about protecting them going forward. So maybe you just talk about the dynamics there and how you're thinking about the yield curve, how to manage that. + +Question_23: + + And then just a follow-up on the rate sensitivity. I mean, you mentioned before -- or you reiterated before you're more leveraged through the short end of the curve. If we get continued increases on the short end of the curve but the 10-year doesn't go anywhere, is that still NIM-accretive as it's been thus far? + +Question_24: + + You touched on this a little bit, but maybe you can give us a little more color. You mentioned in your opening remarks you increased your market share in investment banking. Can you share with us, is it -- are you getting a bigger wallet share? Or are you winning more customers? And also, are -- some of your competitors are still struggling. Is that also a factor? + +Question_25: + + Very good. And then possibly, Jamie, if you want to weigh in on this, what's your guys read of the new Treasury report on changes coming in the capital markets that was released in early October? Any specific items in there that you guys looked at that would be specifically beneficial that you'd like to see change? And what's the probability of it happening? And could it happen sometime next year? + +Question_26: + + Jamie, I was actually hoping you could update us on your efforts to launch your online brokerage offering, it's something that you had mentioned in your last letter, and was curious, since it comes up with investors quite often, how you view the opportunity set in that business for JP, whether it's an effort to just build a moat around your current client cash balances and maybe fill a void. Or is your intention to become a bit more disruptive in the space and actually attract many more customers and potentially even offer more aggressive pricing and terms? + +Question_27: + + Got it, okay. And Marianne, just wanted to follow up on some of the discussion around excess liquidity management. And I appreciate the fact that you guys certainly want to be conservative in thinking about duration and maybe taking a more holistic view of the asset side of the balance sheet. But looking at the LCR disclosures and just given the stark contrast in terms of how much you have parked in the way of excess reserves and relatively low levels of MBS compared with your peers, how you're thinking about duration management and whether you do have additional capacity to actually remix some of that cash of the Fed into higher-yielding MBS, especially as we think about the Fed balance sheet unwind dynamics. + +Question_28: + + Just a quick question on loan growth. You just had another decent quarter of the growth in residential mortgage. Maybe looking across Consumer, is there anywhere where you've had to kind of open up a credit box in order to growth there? I know you mentioned that loan yields are expected to be tight on competition, probably not increase as much, but have you had to go down market at all for loan growth? + +Question_29: + + I was wondering if you could talk a bit more about the quantum and timing of return of excess capital. Of course, one of your notable competitors has given a very detailed strategy of how to do this by the end of 2019. Are you in a situation to adopt a similar strategy? + +Question_30: + + Okay, fair enough. And I have a different question. MiFID II is high on everybody's minds. I think everyone's focused on the impact on equity research and FICC research. But I mean, there's broader implications possibly for how that might impact trading, not just from your own point of view but also from the point of view of clients who might not be compliant by the end of the year. How does that weigh on your mind? And what impacts could we expect there? + +Question_31: + + I was going to ask you about the credit. You pulled out and highlighted auto after we went through kind of an episode of possible deterioration. You put that together with energy and what we experienced last year, those are our first 2 pressure points on the credit cycle. And really, we've come through without any real heartburn from either. Does that tell us something about the derisking and underwriting discipline that the banks in particular have adopted since the financial crisis? + +Question_32: + + And then flipping over to deposit growth. What we saw -- as you kind of layer deposits and institutional deposits, corporate deposits, retail deposits, we're starting to see a little bit of a pressure in the sense of institutional deposits and wealth management began to decline. Corporate and retail still show a lot of strength. Just kind of think about that dynamic because that's really where you begin to see pressure on betas as typically when you see pressure on volumes, we just haven't seen it in the core deposit base yet. So a premium for liquidity that's been kind of pushed into those core customers from corporate and retail seems to be pretty persistent, which will mean the duration and the length and the growth of deposits will be much longer than what we probably anticipated before. + +Question_33: + + A follow-up question. So Card revenues are tracking well per your other comment, but the year-over-year Card spend growth has moderated some. Can you talk about the trend with the Sapphire Reserve card? + +Question_34: + + And with such a great deal a year ago, are you -- what's the attrition like with the customers? + diff --git a/exam/original-files/Problem_2_3_Sample_QandA/21_answers.txt b/exam/original-files/Problem_2_3_Sample_QandA/21_answers.txt new file mode 100644 index 0000000..420acf8 --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_QandA/21_answers.txt @@ -0,0 +1,105 @@ +Answer_1: + + Yes, Bill, I think -- I've recently been to Korea, to Australia, in the last 10 days to also southern Russia and Sochi, but I think essentially in Europe, there is a sentiment there that people are beginning to feel that it's not going to get any worse, that there will be some expansion happening as we move forward instead of just purely fiscal restraint and monetary restraint. So there is that feeling beginning to emerge, but I think it's going to be a long recovery. +Certainly in China, we are seeing the transition happen from a purely export-led economy to one that is more balanced with consumer spending and a combination of consumer spending, as well as export-led a balanced economy. I think there were some challenges in that transition initially where there was a divergence between GDP growth and pure disposable incomes for a while. But I think long-term, that's going to be very beneficial for everyone, this transition in China. I think in general, Japan is going to also -- I think the consumer sentiment will continue to be modeled and volatile there and subdued. +The rest of the world, whether it's Africa, the youngest billion, Latin America, Eurasia, Middle East, we see -- and of course Asia, Southeast Asia and other parts of Asia, Indian subcontinent, we see growth. We see very disciplined monetary policy, balanced budgets, good banking system, and the consumer is more positive. And so it's modeled and it's mixed. +And here in the United States, we see some signs of improvement. We need to wait and evaluate the impact of the payroll taxes, as well as the higher gasoline prices. It's too early to say, but it's a recovery that is at best lukewarm, but we feel that it could get better. That's how we see the world. And based on that, we continue to invest for opportunity. We continue to invest based on our long-term models and plans with our bottling partners, to continue to generate both volume, top line, and income growth. + +Answer_2: + + Are you just -- sorry. Are you talking about just the restructuring? + +Answer_3: + + Yes, it's got nothing to do with that at all. Think of it as last year we announced a new productivity and reinvestment program that includes continued synergies from our North America CCR, Coca-Cola Refreshment operations, to be able to enable us to continue to invest in our brands to grow in North America. 11 quarters of consecutive quarters of growth. When we first talked about growth in North America back in '09, people thought that we were trying to go to the moon with a glider. And now, it's reality. +11 quarters of consecutive growth. And we intend to continue that. We see this as a growth market. And therefore, to enable us to continue to invest in our brands, this is just ordinary course of business. Think about it exactly like that. It's not a big deal, ordinary course of business, and therefore, it's got nothing to do with the United States bottling structure. It's just part of ongoing business and I'll have -- Steve Cahillane is here with me on this call, as well as Ahmet Bozer and Irial Fanin, so I can ask Steve to also comment. + + + Muhtar, you said it very well. This is very much an effectiveness play. Two years ago when we put these businesses together, we had a simple mantra. First, we were going to make it work. Then we were going to make it better. Then we were going to make it best. +We've learned a lot over the course of the last 2.5 years. One of our most successful organizations is our food service organization, which is aligned around three geographic units. We're moving our national retail sales and our field sales organizations also around the same three units, which will really build our total efficiency and effectiveness, our ability to work together, our ability to continue to invest in this market, invest against our brands, put more feet on the street. So we're very excited about the new organization and think it will get us from making it better to making it best. + +Answer_4: + + Thanks, Bill. Yes, and I was trying to be pretty clear, but let me be very clear. We expect to hit our long-term growth targets both in 2013 and in long-term. But that applies to 2013 as well. So we're comfortable with that and would expect to be able to deliver that. +The second thing is we have always had a mantra that you invest through a crisis. We've been in a global crisis for a number of years now. But we've got history and we've seen what happens when you invest through the crisis, when you come out the other end. As Muhtar says, we think -- see things slowly improving across the world, but we expect to come out at the other end much stronger than we were even going in. So we're going to continue to drive efficiencies, productivity, and then reinvest that back to grow the business and growing the brands. The brands are stronger than they have ever been, but we think we can drive it even further so. We're going to continue to invest behind the brands. + + + And just one point to add on that, Bill. I always say, as you go up, the air gets thinner. Always remember, we're adding on top of significant increases from prior year all the time. Just on sparkling beverages alone, we've added 500, over 0.5 billion cases each year. So we are cycling that every year and we're continuing to grow. I think that is really important. +And in three years, the worst, I guess, probably macroeconomic environment, we've seen for a long time. We're able to generate volume growth in line with our growth expectations, revenue growth in line with our growth expectations and income growth. Generating record revenues of $48 billion, record income, as well as record cash growth. It needs to be taken into that context, continue to crack the calculus for growth. + +Answer_5: + + I think in the United States, we are -- as you have heard, we've gained -- continued to gain both volume and value share. And in all over the world, our share is at an all-time high, everywhere across the world, in NARTD, as well as in the different categories that we're operating in and competing in. We choose to compete in. And therefore, and similarly in China in sparkling, we've widened our gap to our nearest international competitor in sparkling. In Europe, I think there have been a month or two where we've had some challenges. But overall for the whole year, we've, again, gained share across the whole of broader Europe, in Western Europe, as well as Eastern Europe, and in Southeast Europe, across the whole continent in both volume and value share. +And to be -- I think to be frank, we see competition is healthy, and it keeps us on our toes, it keeps us executing better and being better, becoming more efficient and more productive, and that's all we strive every single day as a business system, together with our 275 bottlers around the world, is that we strive to get better. Better at making decisions quicker, so that we can be more nimble and more innovative and, as you know, we've launched more than 800 different products over the last four or five years. Many of them are new, innovative products that are gaining great traction, as they are in the United States. +Look at the still -- performance of our still business. Look at the relative performance of our sparkling business. I mentioned that between 2009 and 2012, spend per person on our brands went up from $56 to $60. So transactions are up in the United States. Our brand price pack channel location architecture is working in the United States. So both in China, transactions are ahead of our volume, as well as in the United States immediate consumption business. +So judge us not only by pure volume. Judge us by the quality of our volume and transaction growth. We sell -- in the end, consumers buy packages and products, combination of packages and products, each one at a time. They don't buy liters. That is really important, I think, to understand and how we think about our business. + +Answer_6: + + Judy, we're actually fully hedged on the Yen, Euro and Sterling, and in fact, the Yen positions that we have are actually in the money. They are in good play. That's not an issue. When you look at the first quarter, it was actually -- I said 4%, it was 3% pre-Venezuela. It is 4% now. The Venezuela devaluation obviously is a big one, when you devalue 50%. So that's number one. +But number two, the real impact is not what you would expect, is not the Yen. The impact are the rates that we're cycling in the emerging markets, particularly Latin America. If you look at Brazil, look at Mexico, those -- look at the rates at early last year, and then they started devaluing South Africa as well. If you look at those, you'll see there's an improving trend. So towards the latter part of 2013, based on where spot is today, we actually turned positive with kind of even to minus one for the full year. But it is front end loaded negative and then improving throughout the year. + +Answer_7: + + We've got a loss on monetary assets. That was the 100 to 125. And so if you look in the Wall Street Journal article this morning, we just joined a list of other companies that have the same issue. So that's kind of a one-time item that I'm just telling you has occurred and will occur. And then the translation impact of the revenues will be about a 1% drag in the first quarter. + + + Thank you. + +Answer_8: + + John, let me see if I can get the first half of your question. First, below operating income growth, you're right, because we will see net interest flip from interest income to interest expense. There are a couple of things going on in there. Primarily, it's rates. And just rates are down, particularly in some of the emerging markets where we've got some cash which was generating a lot of the interest income. You saw that happening during the latter part of this year. +And the reason that interest income was actually a lot better than in the fourth quarter than I told you to expect it to be was actually we put on some interest rate swap hedges a couple years ago. There's a small ineffectiveness piece to that hedge and the ineffective piece has to go through the P&L. That was actually pretty large this quarter positive, and it gave us a lot of interest income. So that's part of what you're seeing. So -- but then equity income, you're going to get some leverage. It's going to be up because of the structural items that I talked about from some of the transactions that have occurred. +Then if we go to, all right, the second half of your question was -- tell me again. + +Answer_9: + + Well, I think there are a couple of different things. There, I think we're going to see improving and slowly improving trends in many of the markets around the world. Europe, I think will improve. My expectation is that Europe will improve in 2013 from well -- pretty good improvement form the fourth quarter of 2012, so I would say you're actually going to see sequential improvement in Europe. You're going to see sequential improvement in China for sure. I think the US is poised now also in a pretty good place. +So I think number one, I think volumes in 2012 dipped a little bit in the fourth quarter. Our view is that is not the start of a trend, that we think that's just -- it happened, but it's not the start of a trend. And we would expect volume actually to be okay in 2013 and we think it will sequentially start coming back and be better, be okay in 2013. + + + John, just, just to add on that, I think very little is always said about the 120 or so countries which have a per capita of around 125 in our business, where volume growth for 2012 was, again, 7%. These countries represent about a little more than one third of our total global volume, countries that we never talk about, whether it's Sub-Sahara, or whether it's in Asia or Middle East or central Asia and so forth. But -- and we grew in these countries 9% in 2010, 7% in 2011, 7% in 2012, and we keep on growing. This is the beauty of our portfolio impact. +So while you may have a quarter where China doesn't grow or where Europe doesn't grow, we still continue to be able to deliver on our long-term growth model for volume and also for revenues, and I think that is -- imagine what would have happened to our volume if Europe did grow this past quarter and China. So this is the benefit of having this portfolio, which is getting stronger and bigger, as we continue to invest with our bottling partners in alignment. + +Answer_10: + + Yes, John, that's exactly right. When I said hit the target, we hit the target before structural, but then you would have to adjust for structural. But with pretax or net income being the same, it's just what is the geography within the P&L. + + + Perfect. Thank you. + +Answer_11: + + Ali, I've always said the fact we are total believers in the franchise system. It is a beautiful system when you can get it to work as we have aligned towards the vision, aligned with its goals and aligned in its ownership objectives and goals. That's what we have. And therefore, we will continue to drive this bottling system towards an aligned vision, which we have. And as I said, we've got three years that we've accomplished that and seven years to go and we're confident that we can continue to accomplish it. +As we move through the system, you've already heard us talk about what we see, envisage for the US system, where we have a role again for bottling partners. We are on -- we still have the same time table for that. I won't repeat what the time table was. We said about four to five years since the time we closed the transaction. And you can figure we're still -- we still believe that is doable. And as we move along different parts of the world, you see us creating stronger systems, like Brazil, stronger systems like Kanto. That is a huge milestone in the 55-year history of our Japanese business, getting the four Kanto bottlers to unite and to take costs out of the system to be able to continue to invest to drive top line growth for our system. +And you will see us doing more of those as we move forward. And again, refranchising Philippines is another example. So don't think of this as seismic changes in our bottling system. We will continue to fine tune and evolve as needed, as necessary to drive the goals that we have outlined. + +Answer_12: + + First, let me just say that everything we're doing, none of it is reactionary. It's proactive, whether it's Brazil, whether it's Philippines, whether it's Japan, and we've got more to talk about that we're not in a position to talk about right now. All of that is actually proactive. And the US is all about proactive. +And I can tell you very clearly, once again, that as I mentioned in Judy's question, judge us not only by the leaders, judge us also by the transactions, judge us by how we are doing in terms of the value of the business that we are creating and the consumer spend that's coming into our business, into our brand and the health of our brands. This is ultimately a brand business. Our brands are healthier than they have ever been, both in sparkling, as well as in still beverages. So I think that we see -- I repeat, we see opportunities in the United States for it to keep growing and also for us to keep generating value in both sparkling and in still beverages. And that's how we see it and whatever it takes for us to be able -- investment, proactive long-term investment is the key. Whatever it takes for us to be able to continue our targeted, thoughtful, purposeful investments, you will see us continuing to do that so that our brands remain healthy, our system remains nimble, and flexible, as far as throughout the market, as far as production and as far as distribution and sales. + +Answer_13: + + Brian, this is Gary. No, no changes at all. We -- you're exactly right. What we announced the beginning of last year in productivity and reinvestment was $550 million to $650 million for total company, including North America. We are still on track. In fact, well on track on that program. It was a 2012 through 2015 program and we are continuing to execute against that. +We're on track. We are taking the savings and from the supply chain optimization, the marketing effectiveness, operational excellence, data and IT systems standardization were the areas of that whole program, in addition to what we're doing in CCR, and we're taking that and reinvesting behind innovation, as well as marketing of our brands and that's still working well. What we talked about in North America today is just a normal part and evolution of that program and we'll continue to do that around the world to drive effectiveness, because it really helps us in several different ways. It's not only about saving money. It's about operating more effectively so we can operate faster. Being more productive means we can make decisions quicker, and those are the things we are driving for. We want to be fast, flexible and very big. + +Answer_14: + + Outside of North America, we probably had about $40 million to $50 million in savings in 2012, and then North America continues to drive synergies and did fairly well against their part of their targets as well. + +Answer_15: + + Yes, it will be. It will be. + +Answer_16: + + Let me, Brian, answer it this way, because as we continue -- I'll continue to update you on where we are and how big the plan is. So let's call it $550 million to $650 million today, but as you know, a few years ago, we had another program as well that we kind of concluded and then started this one. So we continue to look for efficiencies and effectiveness. But everything we look at when we evaluate it, we would expect that the one-time costs ought to be in a ratio no more than 1 to 1.5 to 1 payback. So you're talking about a 12 to 18-month payback on something that's then continuous benefit to the P&L going forward. + + + Okay, great. Thanks, Brian. + + + Thank you, Gary, Ahmet, Steve, Irial and Jackson. In closing, we had a strong 2012 and have once again delivered quality full-year performance results. Our business continues to grow, even in the midst of ongoing global economic challenges. Our system is aligned. And it's on track to achieve our 2020 vision. +Together, we are consistently investing in our brands on a global scale through world class marketing and commercial strategy. And as we get closer to the midpoint of our 2020 vision, our system remains resolutely focused on refreshing our consumers, creating value for our customers, maintaining strong partnerships with our bottling partners, strategically investing for the future, and expanding shareholder value. As always, we thank you for your interest and your investment in our company and for joining us this morning. + diff --git a/exam/original-files/Problem_2_3_Sample_QandA/21_questions.txt b/exam/original-files/Problem_2_3_Sample_QandA/21_questions.txt new file mode 100644 index 0000000..60e6d8e --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_QandA/21_questions.txt @@ -0,0 +1,67 @@ +Question_1: + + Hi, guys. Good morning. Muhtar, I know you have been doing a lot of globe-hopping lately, so could you talk about the global macro, maybe some granularity about regional growth rates? I know you were at [sohishina dobos], just to give us some color on how you think things are going to trend over the next year. I know you kind of covered it big picture, but maybe some more granularity. + +Question_2: + + Great. Thanks very much. And can I follow up with the change in the structure of CCR North America? Does this change your sort of philosophy on sort of how long you're going to own the asset and maybe how it's going to be operated going forward? + +Question_3: + + Yes, exactly. Like for the three different regions. There were seven different businesses before and now there's three. Does that sort of change your view on how long that asset stays with TCC? + +Question_4: + + Good morning, everybody. I just wanted to clarify one thing first, Gary. When you are hitting the long-term FX neutral operating target, you expect to do that in 2013, as well as in the long run? Then with close to zero operating expense leverage guidance of '13, despite the savings, you're signaling stepped-up spending. Wanted to get an idea of where you're focusing that incremental spending on. Thanks. + +Question_5: + + Thanks. Good morning. So Muhtar, I know you spoke a lot about the macro environment, but maybe you could speak a little bit about the competitive environment, particularly around US sparkling, China, and parts of Western Europe where you have seen some step-up in competitive pressure and how that's affected your volume performance and how you see that sort of trending in 2013. + +Question_6: + + Okay, and then Gary, following up on currency guidance for the full year. It seems like the first quarter guidance is actually a little bit worse than I thought. Can you help us understand, is it based on your hedge position and with the Yen moving pretty sharply, how much are you hedged on the Yen? + +Question_7: + + And in Venezuela, Gary, just the impact you're purely looking at transitional impact or some sort of margin impact as you have the pricing control in place? + +Question_8: + + Thank you. Just two questions here. Gary, just sort of more of a housekeeping type of thing. As you look at the commentary on the net interest line, seems as though that's going to create a situation where there's probably not much leverage, if any, below the operating lines. If you could just sort of confirm that. +And then secondly, as we look at the organic top line growth in terms of just simply the bottler case sales volume plus price mix, it decelerated looks like to me at least every quarter this year. So can you talk about how you see that trending up as we go through the course of 2012? You've got difficult comparisons in the first half of the year and sort of how that's going to play into your comfort level of hitting that 6% to 8% currency neutral operating profit target. Thanks. + +Question_9: + + Just looking at the deceleration in the organic top line growth and how that maps out over the course of the year and the comfort on let's say the 6% there. + +Question_10: + + Okay, and then finally, one housekeeping question. Gary, you mentioned the equity income line. That's coming out of the operating profit line. So is it -- as you look at hitting your target, I'm assuming that's before the bottler deconsolidation, right? So that's 6 to 8, sort of minus 1 for the bottler, minus 1 for the FX is how we should look at it? + +Question_11: + + Hi, guys. Can you give us a little bit more of a sense of the go-forward evolution of the bottling system globally and in the US? And you look at Germany that shrank this quarter and you want to do some system changes there. Japan certainly has seen some system changes and that's had some struggles. China is struggling a little bit and there were competitive system changes there. US sparkling volumes are still a little bit tough and you bought TCC about two years ago. +And whether, to Gary's point, these volume trends are a trend or not, it just seems to us that given all of that, you might actually see the next few years with very large changes to the Coca-Cola system and the industry overall. So if you were to kind of close your eyes and see with us, how would you see the structure of the system, of the future looking versus what it is today? + +Question_12: + + So it's helpful, and I'm still struggling with what's -- what can we look forward to changes in terms of not being as reactionary, but maybe thinking going forward. Maybe if you can help me, you mentioned the US and Steve mentioned it a little while ago, so it's been about two years since you closed the CC North America transaction. +Can you give us a sense of where you think you are ahead of plan and where you are behind plan? Certainly for many investors, this quarter was probably pleasing, because operating margins start in reflect positively, but is this sustainable without any more meaningful restructuring, bigger things? And how do you think about the volume trends we've been seeing so far in sparkling and whether that changes anything about how you think -- not reactionary -- but going forward about the structure here, as just another example of what you're describing, Muhtar? + +Question_13: + + Hi, good morning. I've got a question on the, just the productivity program, just really looking for an update. First, I think if you took the two elements of it, both what was initially announced last year plus the extension of the CCR integration, your expectation was $550 million to $650 million of annualized savings by the end of 2015. So is that still the same size or has there been any change to what you're expecting in terms of total savings? + +Question_14: + + How much did it drive -- how much savings did you drive in 2012? + +Question_15: + + Fair to say you think '13 will be a bigger aggregate pull to savings to spend back than you had in '12? + +Question_16: + + Okay, and then just one last one. How much in terms of charges are you expecting to take over the life of the plan relative to the savings? + diff --git a/exam/original-files/Problem_2_3_Sample_QandA/22_answers.txt b/exam/original-files/Problem_2_3_Sample_QandA/22_answers.txt new file mode 100644 index 0000000..4d4990d --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_QandA/22_answers.txt @@ -0,0 +1,100 @@ +Answer_1: + + Hi, John. Good morning. This is Muhtar. First, I think it's important to realize that there's not one model for the world. There's many different models for the world, as you can see. What's happening, this has been an exciting last several months with respect to the evolution, actually continuous evolution, of our franchise system. We manage our business to create sustainable long-term value, and evolution of our franchise system continues to play an absolutely critical role in that process. +And so what you have seen recently, the [Contal] merger in Japan, the Brazil merger of three bottling partners creating a large Brazilian-led bottling business, the Iberian merger of seven bottling partners in Iberia, the sale of the Philippines -- of the majority shares of the Philippines and the control to FEMSA, and now the US process, the journey starting in the United States, are all part of our vision, our plan, and to ensure that we can continue to deliver on the commitments we've made for our vision. +They use, in some cases, they use partially our capital. In some cases, where there's a sale, obviously, we bring back capital back into The Coca-Cola Company, but all the time ensuring that our bottling business is fully suited for the needs of the 21st century, delivering what is necessary ahead of consumer expectations, customer expectations, and so not one size fits all. And in the case of the United States, again I'm pleased to report, we are pleased to report today, that we've reached agreement in principle to start this journey. All along, since the first day we've closed the transaction with Coca-Cola Refreshments, I've always said there will be a meaningful role to invite partners back into the business. +When I was -- when we were asked about the timing, we've always said around the four- to five-year timeframe from the time we've closed, the close of the Coca-Cola Refreshments was, as you will recall, back in the latter part of 2010, and we are well within that timeline. And it's a continuous evolution. And sometimes it will necessitate for us to use our own capital, sometimes a mix, and sometimes no capital. And again, not one size fits all. The US model is very different, but it is, again, a model that invites partners to serve with us passionately the communities that we operate in. + +Answer_2: + + Yes. I think from -- we can't comment on the timing for the end game, but all I can tell you is that we are intent on creating the evolution necessary for us to be able to serve both our large customers and small, independent customers in the best possible way with our bottling partners. Again, we've always said that, right from the beginning, and we're consistent to that, that the US will be slightly different. We want to create the best-in-class production, optimum cost production system, coast-to-coast, from the East to the West. That will be nationally managed. +We also want to create a nationally managed large customer -- customer management system that will essentially have the responsibility to put together a 21st century customer plans with our large partners in the United States, and at the same time invite partners to come in and be part of this new evolution in the United States. It will take as long as it is necessary. And that is not our focus. It's going to be about doing the right thing as quickly as possible, as efficiently as possible, and as effectively as possible, and that's what we are going to be doing. + +Answer_3: + + Bryan, thanks. There are a couple of things to consider. First is, as I mentioned previously in the prepared remarks, that we reversed some compensation accruals in the first quarter. So that gave you more leverage in the quarter, but you will not see that. That's more of a one-time impact, if you will. So it's more leverage in the quarter. +The other significant piece is you're going -- the currencies had an impact as well, and currencies moderate going out. But the biggest thing will be geographic mix. And we would expect to see geographic mix changing throughout the year as we go through the year. And as that happens, it will have an impact on gross margin and operating leverage. + +Answer_4: + + Yes, that's exactly right. And think about North America, actually. I would expect North America, actually in the first quarter of this year, North America's operating income on a recurring kind of comparable basis, was down 3%, and it's down 3% primarily because of two fewer selling days. So if you adjusted for those selling days, it would have been positive. But I would expect North America to actually improve versus where they were, the minus 3%, but as they improved, because it's a finished product business, it's going to have negative gross margin impact, and it'll be reduced leverage. + +Answer_5: + + Yes. Yes, that's what I was trying to say more in code in the prepared remarks. + + + We normally don't think North America, but that's what it was. + + + Thanks, Bryan. + +Answer_6: + + Yes, I think, Dara, I think -- this is Muhtar, I think that we haven't seen anything markedly different from previous quarters as far as the competitive environment is concerned. China remains a very competitive environment. Actually the whole world, and again, this is a competitive environment that is a mix of large international companies, but also very much local companies, very much local companies in Asia, in parts of Africa, in the Middle East. We also see a somewhat more rational pricing, particularly in Europe, as well as parts of -- other parts of the world, in Latin America, too. +And I think -- so the way we see the environment is, it will continue to be challenged from a consumer perspective. Whether you're talking about Asia coming back, or whether you're talking about Europe, consumer sentiment in Europe, will continue to be volatile and mixed at best. And therefore, pricing is going to be critical, and therefore also ensuring leverage and ensuring productivity can be generated out of operations for us to be able to continue to invest, is going to be critical. But we are intent on continuing to invest in this environment. I'll let Steve Cahillane talk a little bit about how we manage the pricing environment in the United States (technical difficulties) price mix of 3% in terms of leverage in pricing for sparkling beverages in the past quarter. + + + Yes, thanks, Muhtar. We would -- we have seen a rational pricing environment in the United States over the course of a good period of time right now. We would expect that to continue, and I've said many times that if commodities go down, don't look for us to reinvest that in price. We've worked very hard to earn the price that we take in the marketplace. We don't have an affordability problem in the United States with our sparkling beverages, and we would look to continue to invest behind our brands. +We've got a terrific summer program for the Coca-Cola brand. We've got an exciting new partnership with Taylor Swift around Diet Coke. We'll invest around activating those types of program to continue to focus on our most important objective, which is to continue to support, develop, and drive the sparkling, our sparkling category, inside the United States business. + +Answer_7: + + Hi, Bill. This is Muhtar. Good morning. + + + I would say to you that this is, again, we're at the beginning of this journey. We have reached agreement in principle with these five US bottling partners. It is very important that we did reach that agreement in principle, and now we can actually ensure that we put all the details into motion, and we can implement effectively. We have always said production is, in the United States, is critical to our success in achieving a optimum cost, 21st century production system, nationally managed coast-to-coast. That is going to take place. +We've also said that managing large, 30 or so, of our largest customers in the United States is going to be done nationally. That's also going to take place. In terms of who else would be coming in, we can't comment on that. In terms of what will happen, in what form an architecture production is going to take place in terms of what our current bottlers own, I can't comment on that. All I can tell you, and I can assure you, that we are intent on ensuring that we make the necessary changes in the format and architecture of production to achieve what I just said, which is a coast-to-coast, nationally run production system that generates the efficiencies, synergies, productivities that allow us to continue to win in the marketplace. And again, there may be a future where our partners in the United States take certain ownership in the national production. I wouldn't rule that out also, but it will be managed nationally from one point, single point. + +Answer_8: + + Okay, Judy. I'll have Steve answer the first part of your question before Gary comes in and sheds some light on the question on profitability. Steve? + + + Yes. Thanks, Judy. First quarter clearly had a lot of noise in it. We expected a benefit from Easter being in the first quarter. It's never as big a benefit when it comes that early in the year. Easter's always better when it comes later in April because of the warmer weather. But obviously you reference the weather. +We saw some very dramatic changes. Last year we benefited from one of the hottest summers -- sorry, hottest winters, warmest winters in the United States, and we cycled that with one of the coldest winters in the United States. So clearly that had an effect. And we saw any benefit from Easter really being washed away, if you like, by the poor weather. +There was clearly an effect in the payroll tax. It's a little bit of art and science, trying to pick apart what's weather and what's payroll tax. We would figure about two-thirds is probably weather-related and one-third of the slowdown is based on the economy. We are, though, optimistic, guardedly optimistic, that the consumer is coming back, that the payroll tax and the economy is kind of a short-term, need to get used to the discretionary impact that that has had. So we remain optimistic that we've got the right programs in place, that the economy is on the mend, and we would expect continued good performance as we go out into the next three quarters. +In terms of, I guess, questions around profitability, I'll turn that over to Gary. + + + Yes. Judy, I would say a couple of things on profitability. It's really kind of repeating what Steve just said. If you take the first quarter and you throw in lousy weather, payroll tax, actually the price of gasoline, what that then does to your immediate consumption versus future consumption business, it's going to have an impact on your profitability. Now, if I go back to the answer I gave to Bryan earlier, though, when I was talking about geographic mix and it's North America, I would expect North America to be improving, actually, from the first quarter and from where we were. And then North America also has this two fewer days. +Now, I can tell you, Steve's got a number from minus 3%. I said it would have been positive. Steve's got a number, but you can calculate it several different ways as to what would the impact of the two days be. We would all agree, I think, it is positive. They would have been positive at the operating income line. But you put all that together, the weather, by the way, as lousy as it's been, and the impact on Steve's business, has been given a lot of moisture to the Midwest for the drought for the corn crops. So you look for commodities, and we'll see what happens there. +Payroll tax, consumers hopefully are starting to get used to it. Gasoline prices, looks like they are starting to trend downward somewhat. So I think there are some reasons to be cautiously optimistic. CCR continues to execute with excellence, continuing to improve capability. So I think there are lots of reasons to be optimistic on North America. + +Answer_9: + + Judy, I would actually say the biggest impact on the first quarter for North America was two less selling days, by far, as a whole company as well. But by far, the biggest impact was the two selling days. + + + Judy, I didn't answer this part. A secondary impact is clearly weather-impacted food service and immediate consumption more than the take-home channel. So we would expect as weather moderates, those profitable parts of our business will start to normalize as well. But, as Gary said, two less selling days, when you've got the fixed cost assets that we have in the North American business is really quite significant. Those extra two days are golden cases that are going out. And when you lose those two days, it obviously has a big impact. + + + Thanks, Judy. + +Answer_10: + + Yes. Caroline, I think first in terms of our capability in our system in the United States is I would say the best in the consumer products world in terms of how we go to market and how we can get the product from production facilities. I would like to comment on how we can improve that. If there is a way for us to even improve and generate more productivity, we'll certainly look at it. I think the most important thing, though, is that there is room to generate significant further synergies in production. I think today I wouldn't say that the United States production system, after three years of having integrated Coca-Cola Refreshments, it is where we need it to be. And we need to achieve that -- continue on that road map to proceed towards a modern and best-in-class optimum cost production system coast-to-coast. +That will mean, obviously, a lot of changes. That will mean building new plants. That will mean combining some facilities, but I would like to also comment, in terms of hot-fill and aseptic versus sparkling beverage plants, we will look at ensuring that we have the most modern, most productive facilities in place. I don't believe the answer is to combine all under one roof. I think the answer is to combine many that are scattered across the country, both in terms of still and sparkling separately, into some consolidation process, and I can't comment any further. +What I can tell you is that there is room for costs to come down. There is room for efficiencies to increase, and we will achieve all of those. This is all in line with our 2020 Vision. We laid out a plan when we took over the business of Coca-Cola Enterprises. We laid out a plan when I took over as the CEO back 4.5 years ago, and we are executing it meticulously, and we are doing what we have said we will do, and we're doing it ahead of time. + +Answer_11: + + Absolutely. I think we can improve service levels. I think we can improve execution inside the point of sale. I think we can improve availability. I think we can improve availability of cold drink. I think we can improve how we serve independents, and all of those things are going to be played out as we implement, execute this new strategy in the United States. And I don't know, Steve, do you want to comment? + + + I agree completely. Part of what we're doing with this new bottler arrangement focuses on that up and down the street, where bottlers and CCR add the most value, which is not only big customer sales, but up and down the street execution. And we've got also our venture and emerging brands unit, which you're familiar with, which brings brands like ZICO Coconut Water, it brought Honest Tea. So in those spaces that you're talking about, we are very much innovating. We've got glaceau fruitwater, which we just launched to great success a couple of weeks ago. That's being executed, not only in the large stores, but importantly in the up and down the street, food service on-premise accounts as well. We see that as a very important capability. We see ourselves as having a competitive advantage there when it comes to not just shelf space, but cold drink space and overall availability. + + + Yes, and just to finally add on to that point, Caroline. Rest assured, we are in a mode of evolution, rapid evolution, not just in the United States, across the whole world. But, and you will see us adapting, reinventing how we go to market, how we serve customers, and also how we communicate with consumers, very importantly. Our brand's at an all time high in terms of health and we will continue, again, to evolve and bring out the best modes of communication with our consumers as well. + +Answer_12: + + Yes, I think, Mark, it's -- I can't -- we can't comment on the details. What we can say is that it will be a model that will align us fully with our bottling partners to do what is right in the marketplace, and to focus on what is right in the marketplace, with full alignment model, and I think I can't just comment any further than that. But you will see us executing better, serving the customers better, with a better production template, as well as a customer service template. + +Answer_13: + + I think all of that will come into play, best practices, everywhere around the world. And I am certain that in four or five years time, many people will come into the United States to see the best practices, and as it used to be back in the 1980s when I used to bring bottlers, new bottlers, from Eastern Europe to see best practice in the United States at that time. + + + In closing, I would like to thank Gary, Ahmet, Steve, Irial, and Jackson, and to again say that we're pleased with our solid first quarter. We are working as a system to unlock real value, further strengthen execution, and to win at the point of sale. We are confident that a focus, a relentless focus on growth, will enable us to build capable, resilient, optimized, advantaged, and sustainable systems that are well positioned to deliver results in 2013 and achieve our 2020 Vision. As always, we thank you for your interest and your investment in our Company, and for joining us this morning. + diff --git a/exam/original-files/Problem_2_3_Sample_QandA/22_questions.txt b/exam/original-files/Problem_2_3_Sample_QandA/22_questions.txt new file mode 100644 index 0000000..e9add76 --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_QandA/22_questions.txt @@ -0,0 +1,53 @@ +Question_1: + + Sorry. There's a lot of static. As you look at the bottle consolidation piece, is Spanish or Japanese bottler consolidation just sort of the beginning of the next wave of, let's say, a bottler-driven consolidation? And how much are you pushing this, as opposed to letting the bottlers lead where the system's going? + +Question_2: + + Great, and if I could just ask a follow-up on that, which would be as you look at the different options you gave for the US pieces here, in terms of sub-bottler agreements, asset sales, swaps, things like that. Is there some way to think about the financial impact as you do this? I mean, this is a small piece of it. How long does this timeframe take out, as you sort of push these US pieces out? Thanks. + +Question_3: + + Hi, good morning. A question for you, Gary, just on the operating leverage in the first quarter, and maybe more specifically, the gross margins. If I understood it right, this quarter would have been one of the highest in terms of the impact from commodity inflation? We also really had no positive benefit from price mix, and as we kind of look out going forward, right, we should get some benefit from price mix later in the year, and maybe some relief on commodity inflation. So why wouldn't there be maybe more leverage going through the year than we originally expected, given the leverage you had in the first quarter? + +Question_4: + + So the geographic mix would be more negative going through the back half, the rest of the year, is that --? + +Question_5: + + Okay. So more growth from lower margin geographies going forward, and that's what will affect sort of that margin impact? + +Question_6: + + Good morning. I was hoping to get an update on the competitive environment around the world, both in China and Western Europe, which have been hot spots recently. And also just your thoughts around how you manage the pricing environment in the US sparkling business in 2013 and beyond, in light of the moderate commodity pressure, and if that solid 3% sparkling growth we saw in Q1 could continue in the balance of the year? + +Question_7: + + Morning, everybody. I wanted to follow up on the US bottling announcement. Coke held onto the production assets for the territories the five bottlers picked up. Do you see these bottlers eventually contributing their manufacturing assets into a national production company to get at the cost savings opportunity that you've talked about on the manufacturing side? And also, would Coke be willing to let new partners bring in outside capital to help finance some of the additional territory sales, given the size of the territory that Coke still holds onto in the US? Thanks. + +Question_8: + + Thanks, good morning. I just had a couple of questions on North America. First, in terms of volume performance, I think the macro data points and consumer data points have been a little bit choppy more recently. So maybe if you could give us a little bit color just in terms of category of your performance, immediate consumption versus take-home. And sort of the expectation as you get out into the back half of the year, lapping of some of the transitory headwinds, whether it's payroll taxes or weather-related, if you expect volume performance to improve. +And then, Gary, just on the profitability in North America, I know you talked about this a little bit, but I look at first quarter. You had 1% volume growth, 2% price mix, and you did say profitability was up a little bit, but just why aren't we seeing the profitability really improve more meaningfully and what drives the sequential acceleration in North America profitability going forward? + +Question_9: + + Okay. But from a profitability perspective, though, the bigger delta is really the mix shifting towards more immediate consumption as weather normalizes, or is there step-up in cost savings or timing of marketing investments that help the profitability? + +Question_10: + + Good morning, Muhtar, Gary, and team. I would like to just understand, Muhtar, your vision, again, going back to the United States. You talked a little bit about how manufacturing is going to evolve. A little bit of understanding the benefits of merging the operations of food service, your non-carbs, and your CSDs into one production facility. Just can that actually be done? And are there synergies there? And then secondly, do you feel strongly that your own people have to get the product to market from the plant, or could you use a third party, such as a Sysco? + +Question_11: + + That's excellent. I was just wondering, in terms of getting shelf space, you see a big opportunity up and down the street, and to get better pricing, much as you've done in LatAm. I'm often asked how you compete with all the new things that come in, be it coconut water, energy drinks. I know you have some, but are you convinced you can keep or improve shelf space for your carbonated soft drinks? + +Question_12: + + Yes, thanks. Good morning, everyone. Also a question on the US re-franchising, Muhtar or Gary. You talk about this new beverage agreement being ultimately what's at play here. Could you speak a little bit to how you're thinking about that, and the role of incidence-based pricing in that? Is it right to think that continues to have prominence in this new agreement, and any distinction you might draw between how stills and carbonateds are treated as you move production more squarely to staying, if you will, at least for a little while inside Coca-Cola? + +Question_13: + + Is it fair to think that other markets, there's a sort of a fact pattern, an experience set, to draw on as you implement this new form of agreement here in the US? + diff --git a/exam/original-files/Problem_2_3_Sample_QandA/23_answers.txt b/exam/original-files/Problem_2_3_Sample_QandA/23_answers.txt new file mode 100644 index 0000000..5b17e17 --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_QandA/23_answers.txt @@ -0,0 +1,123 @@ +Answer_1: + + Yes, hello, Bill, thanks. Overall both from -- in Europe, United States, India, some other parts, we did have a pretty significant impact from weather -- unusual weather, monsoons coming very early in India as you probably all read, many thousands missing in flooding, worst flooding since the tsunami back 10 years ago. So -- and then Europe -- also Central Europe, Germany, all the issues around the river beds rising and flooding and very heavy, wet conditions. So we did, yes, have impact both from a consumer sentiment, both from a mobility sentiment in the United States also, and both also from just the pure, in some cases, distribution issues that hindered our performance and as you know, when we lose a sale that doesn't recur any more, we lost it that day and so. And also in some cases we were cycling very unusually warm and favorable weather conditions from prior year in some cases like India last year the monsoons actually started later, that gave us a 20% growth in India, unusual for the second quarter in India. Usually the first half in India is always less than the second half in India because of the anomalies of the weather. So, yes. +And then macro conditions, we all have felt it in social issues in Southeast Europe, demonstrations across the Middle East, and then more recently in Brazil, but we feel confident both in terms of looking at our plans in place, looking at current dynamics, that both Brazil will have a better second half, China will have a better second half, Russia will have a better second half, and certainly a better quarter than this last quarter where we grew volume 3%. Overall, Mexico as well as India. So while we have -- we continue to invest in our brands, our brands are stronger than ever before, we have taken market share, our system is stronger and so all these key markets we believe will perform better in the second half. In fact, as I've said, we have seen this -- we always know that the second half in a country like India is significantly better than the first half. In any case, if you look back at our performance over last few years. So -- and then in the United States, we've got very robust plans to return back to growth. +So we feel pretty confident that this was a confluence of events that happened all at the same time. The portfolio effect of our global business did not work in our favor in this particular case in the second quarter and I feel and my colleagues feel and our bottlers feel very confident. I have been across many markets recently. I've traveled to China, Japan, Thailand, Myanmar, many other parts of Asia, I have been in Southeast Europe, I've been in France, and all in the last four, five weeks and I feel that we will look towards a definitely a better quarter volumetrically, and again, we can talk to you about how we feel about the financial numbers too later in the call and I can ask Gary to reflect on that too in terms of the second half. You want to -- Gary? + + + Sure. Well, let me continue on [then] versus the volume. On the second half on the P&L, we had a very solid first half, we would expect to have a solid second half of the year as well. We have said there would be bumps along the road, the industry had one, obviously and it slowed. But we continued to take share and we feel very confident about the second half. As we look at the second half financial results, we will be very close to our long-term growth targets, particularly in volume and earnings per share should be coming back in line with what we would all have been expecting at the first of this year. + + + Yes, I would just add, Bill, that this is more an anomaly. We should not see this as a trend or a systemic issue and that is simply how I believe one should think about it and again I can ask Steve and Ahmet to reflect upon how they see the second half from their vantage point in both Americas and International. Maybe Steve, you can start? + + + Sure. Thanks, Muhtar. Starting with Latin America, Muhtar said it well. We saw things in Brazil that we hadn't seen before the economy slowed. There was social unrest. It didn't last very long, things are slowly getting back to normal, and we expect a better performance sequentially as we progress through the year in Brazil and in Mexico. In Latin Center and in South Latin, we have seen very good results. High single-digit results continue so there's a lot still going very well that continue to go well in Latin America and Brazil and Mexico, getting back to what we would expect to see on a normal basis. In North America, Muhtar said it, it's -- we don't like to talk about the weather, but the first half of last year saw unusually good weather conditions. We had warm weather, we had dry weather coming out of winter and going into spring. This year in North America we had some of the worst weather and you've all seen it. It's been very wet, it's been very cold, it's been historically wet and cold, which obviously impacts our business. +On top of that, we had the payroll tax effect which started at the beginning of the year, which affects lower income households, obviously much more, affects their disposable income, their ability to spend. We saw late payroll tax -- late payroll -- or tax refunds coming into the marketplace. But as we look forward we expect the weather pattern to obviously normalize. The weather will not continue to be a factor in a country as big as the United States like it's been and from an economic standpoint, people are used to the payroll tax now. They have had four to five months to moderate their household budgets, to get used to it. The refunds, obviously, have been back in the marketplace and we are already starting to see better trends in QSR, better trends in Convenience Retail, better trends across our business. So we look forward to the second half of the year across the Americas, much more favorably than the first half. Muhtar used the word anomaly -- especially an anomaly in North America and we see ourselves coming out of that. + + + Ahmet? + + + Thanks, Steve. Thanks, Muhtar. Yes, just to build further on Muhtar's comments, I'll start with India, that's definitely completely weather-related. All our investments in the route to markets coolers and capabilities will continue to deliver the kind of levels that we are used to having from India in the rest of the year. So we are quite comfortable on that. On China, there were probably impacts of -- as you hear, the continuing slowdown in macro levels, as well as there was some weather impact, but we do expect volume to return for a number of reasons. First of all, China is a country with very, very low per capitas. I have been there a number of times in the last three, four months and we have been working on evolving our strategy with better OBPPC, more price points, and more packs, as well as improving our capability. +As Muhtar mentioned, we have recently strengthened our Management team there, and I'm very confident that in the second half of the year we are going to start returning to growth in China, maybe not at the levels of double-digits that you might have been seeing but we will certainly be looking to returning to growth in China. Now, the other anomaly in the International results was Europe. I could comfortably say that a very, very big part of that 4% decline was driven by unseasonable weather, as it has already been mentioned. It shows the strength of our system that we were able to gain volume and value share in both sparkling and NARTD and as we see weather normalizing we again look forward to coming back to our normal range of growth in Europe. The rest of International territory, such as EAG continued to deliver at historical growth rates. + + + And Bill, this is Gary. Just add one or two other quick data points as well. When we talk about 1% volume, you have to wonder, is that a weak 1% or a strong 1%. Let me just assure you, it's as strong as it can be and still be 1%. So that's number one. The other thing is we talk about some of these anomalies on some of these markets. One of the things that gives me some confidence as well because there's been a lot of discussion about what's happening with the emerging markets and all around the world with the slowdown from China, et cetera, but we have always talked about the markets where the per capita consumption is less than 150 and has always been a real strength of ours. Well again even in the second quarter, if you looked at those markets under 150 and exclude China and India, which we have just discussed separately, if you excluded those, our volume in those markets was plus 7% in the second quarter, so it still shows underlying strength of the markets in those emerging markets. + +Answer_2: + + Yes, John. Thanks for the question. Here's how I would say it. We are actually very close in the first half of the year, year-to-date, if you look at operating income, I think year-to-date ex structural, currency neutral is plus 5% and our volume is plus 3% so we are not that far away. So our view would be that we should be and in fact year-to-date earnings per share ex currency is 8%, rounds up to 8%. So we are not that far away in the first half. That's why I was saying, solid results, and when I say it's solid -- you've followed us long enough, we like to be at the top end of ranges and not at the bottom end of ranges. Unfortunately, we are at the bottom end right now but that's the world we are dealing with but we feel very good about the second half. + + + John, this is Muhtar. Just one point that I can add to that is the following. It's customary sometimes that when in the kind of businesses that we are in, when you have a blip in your volume because of a confluence of events, some of which are not in your control, the first thing you do is go out and cut marketing and if you look at our numbers, we have continued to invest aggressively in our brands through the second quarter, through -- in the first half and, as you know, every investment in marketing does not pay back in that quarter. It pays back in future quarters and therefore we are confident that with the share gains, we are confident with the strength of our brands, we are confident about the metrics on our brands both in sparkling and stills across the world and we are confident in our bottling partners' investment plans that are taking place in the second quarter that we can continue our momentum going into the second half of the year and also improve on it, volumetrically, but also continue with our mission to achieve our 2020 Vision through the next -- the years ahead. + +Answer_3: + + Okay, John, first I want to compliment you on your creativity with that first question and then here's the real question. But anyway. Great question, actually. And the first thing I would say around pricing is we believe strongly that we have premium brands and our brands should command a premium in the market. And they do command a premium across the world. Number one, we are seeing pricing across -- rational and within the industry we think pricing is rational, particularly in the United States. But if you look at price mix and I'm going to go year-to-date, but the second quarter is essentially the same thing. If you look at price mix, price mix year-to-date is even. But within that you've got positive pricing and you've got negative geographic mix. +So year-to-date consolidated, we actually have positive 1% pricing. If you look at it by region, year-to-date North America has positive pricing up 1%. Eurasia and Africa has positive pricing up 8%. Europe has -- looks like positive pricing up 2%, although I'll tell you a lot of that is because of Innocent and our acquisition of Innocent so absent Innocent, I think Europe is closer to flat. Latin America is positive 8 points of pricing year-to-date. The Pacific is even. And Bottling Investments Group is plus 2% as well. So we are actually getting very nice, positive pricing as well as category mix, brand mix, channel mix, all of those things are working. +What's happening to us and where the ding comes in, if you will, is that we've got negative geographic mix so we've got significant negative geographic mix across many of those regions, which brings us back to even when you put price and geography together overall at the consolidated level. As I've often said, geographic mix would -- is always going to be probably negative because you're going to expect those emerging market countries to be growing faster than the developed market countries and you've got better pricing in the developed market countries. What's amplified it a little bit this quarter particularly was the result in Europe that we talked about and North America being -- coming out even where they were. So, you put all that together, we are actually getting the kind of pricing we would expect to be getting in the market. + +Answer_4: + + Should I take this? + + + Yes. Judy, let me just reflect on that and I'll ask Ahmet also to comment. But what we have said again is there was a coming together of many events that usually don't come together all the time. We have performed overall globally at rates that are much more commensurate to what you've been used to in the last three, four years despite the fact that we've had issues, some of these issues happening to us from quarter to quarter, but you haven't felt them because of the fact that the portfolio worked. And this time, you have the issues around in Latin America and the two key markets -- Brazil and Mexico -- on slowing down and on also consumer spending being impacted because of the Brazilian crunch in consumer credit that was taken away from the consumers and generally the consumer spending went away. And then you also had China, the issues in China that was consumer spending is actually much below GDP levels and that is documented across the macro numbers in China and as well as the weather issues related to India and also other issues coming together in North America where it went for the first time in 12 quarters from a plus to a negative, which we don't expect. +All of these things we don't expect to continue at the same time. Some of these things may still continue to impact us. Therefore, the portfolio will work. Now, related specifically to China, we are participating in two great categories in China and we are the leaders, which is sparkling and juices, those categories we have grown in and they are adding tremendous value to our portfolio and to our business in China. We have also, as we said, retargeting all our efforts in China, refocusing all our efforts. Yes, there's a different competitive landscape. We feel that actually that is not -- has not been the issue for us. The main issue for us is to ensure that we can continue to distribute in outlying areas in China that we have had some issues and we are correcting those and also that our marketing is working, which we feel definitely our brands are stronger, our innovation pipeline is working in terms of what we are providing to the consumer, also in terms of packaging. +And we feel confident that those two categories -- playing in those two categories -- and then also innovating across some other categories like dairy is going to create the growth and the value for us starting in the second quarter but also continuing and we also feel confident that the Chinese leadership -- the new Chinese leadership -- are going to ensure that they take the right actions and we are seeing that to reposition and transform the economy without creating a major bump as they transform the economy from a purely export-led economy to a more balanced economy with also consumer spending and both Deputy Vice Premier Yang in charge of the economy, as well as the new team, we feel confident and have the plans in place to ensure that that takes place. So again, Ahmet, you can reflect more on that, as well as any other markets you want to. + + + Yes. Thanks, Muhtar. Thanks, Judy, for the question. A couple of messages here, Judy. Message number one is that the economy may be down but the growth prospects in China, even in the short term, is there simply because of the very low level of per capitas and strength of our system. Point number two, if you look at all the competitors in China, nobody really participated in all the categories. All the players have one or two categories that they are strong in and then they drive their businesses through those categories and maybe extend them to others. Our position is the same so our strategy is basically first of all, we definitely can do better in the categories that we already exist, such as sparkling. So to give you some specific actions we are taking to do that, I have highlighted the OBPPC and that's actually accelerated, we have pilots running on various multi-serve and single-serve packages for different price points in different parts of China. And as those things roll out of the pilot, we will be rolling some of them nationally, so those are already in a way in the market and they will be accelerated into the second quarter. We have also relooked at our communication strategies and we are going to be communicating more intensely on the intrinsics of our products as well as extrinsics. +You might have heard about our nickname promotion, that's the similar promotion to the Share a Coke promotion around the world elsewhere, which is getting incredibly positive reaction from the consumer, and all the other things of improving our route-to-markets, et cetera, those are all underway and we are very confident that that's going to give us our strength in sparkling. Now we also play in juices as you know, and we, as Muhtar mentioned, we are the number one player there. We are refocusing our efforts back around Pulpy and we are just looking at an extension of that into Mango, which is getting very strong consumer reaction. So as we consolidate our efforts behind that you would see a continued increase. +Now, obviously we are not only focused on just our existing categories. We have a pretty successful brand in Super Milky Pulpy, which is a value-added dairy, and we are beginning to increase our focus on that and we are getting high single-digit growth of that brand and we are building our innovation pipeline for the future. So it's a fairly robust strategy and, yes, under lower economic environments we might have lower growth rates than what you're used to, but we are ever strengthening our position in China to capitalize on this market for not just immediate future but the very long term. + + + And we have Irial also, which oversees Bottling Investments Group and, as you know, we are one of the three system players in China in terms of bottling. Maybe, Irial, you can comment on what you're seeing down on -- very close to the ground? + + + Yes, Judy, good morning. Just to build on something Muhtar said earlier, which is around investment and I would say from a bottling perspective, we continue to invest heavily in the market and particularly in our execution capability, route-to-market capability, and critically in developing the talent to be successful in the next years ahead. So when you add those to the revitalized marketing strategies, OBPPC, I actually feel very confident about the future. Yes, we have bumps along the way but our Business is growing, our challenge is to grow a healthy long-term Business and I think, from a bottling perspective, we are really putting in place the infrastructure and the capability to really drive a success for the future and that's basically where I would leave it. + + + Judy, what I would just say finally is I wouldn't read anything more into this than what it is. As Gary said earlier, we were fractionally away from rounding up to 2% and we could -- it would not have been hard for us to do something which would not be right for this Business and take the volume up to 3% and selling low, cheap product. That is not what we are about. We are about investing. We are about doing the right thing for this Business and we are about -- and I've always said there may be a bump along the road, the one bump along -- we have grown this business consistently in line every year on an annual basis since 2008 on our way to our 2020 Vision in the range -- in the upper range of our long-term growth plan despite very, very challenging macroeconomic conditions and that is going to happen in 2013 also. + +Answer_5: + + Yes, let me just comment on what you just said. We are not -- this is not about managing on a day -- yes, we manage this business on an hourly basis but it's not healthy to comment on what has happened in the last two weeks. Yes, of course, we expect the weather to normalize. As you know, whoever is in the Northeast now and whoever was in the West Coast of the United States in the last 10 days, you know that weather has -- it does normalize. That's probability and statistics, so it just happened all in a very short period of time where everything was negative in many major markets, it's -- and it will turn -- it will normalize and that's what we are saying, part of what we are saying, so I have every confidence that with the normalized conditions, as I've said, we will again, 2013 will be another year when volume will grow at the range of the long-term growth model. As far as the margins are concerned, I will turn it over to Gary in terms of what -- the margin of what you mentioned in terms of the margin numbers in Europe. + + + Yes, in Europe it's a structural anomaly. It's actually Innocent. So when the juice business, juice having lower margin, when it came in, that's what changed the margins. It's nothing more than that. + +Answer_6: + + Yes. + + + And that's actually the flip side, if you will, of what I said when I was answering John's question, that if you looked at price, the price inside of price mix in Europe is actually plus 2%, but it's really Innocent giving us a lift on price but it gives the opposite effect on the margin. + +Answer_7: + + Yes, exactly right. + +Answer_8: + + Yes, great question, Bryan. Well, first, you will see that we did accelerate purchases in the first half of the year. As I said, if our annual target was in the $3 billion to $3.5 billion range and we actually have repurchased $2 billion in the first half, we did exactly what you said and we accelerated in the first half of the year. Where we are right now is we are sticking with the annual target, which we originally set at $3 billion to $3.5 billion and I'd just tell you, we will give you an update on that at the end of the third quarter. + +Answer_9: + + I've learned to never say never to anything. + +Answer_10: + + Perhaps, Mark, let me take the margin question and then we can come back to the innovation question. But this is actually -- let me get back into actually what I talked about, price mix and margins when I was talking about Innocent. The same thing applies actually at a higher level for the total Company. So what you've got is very positive pricing and you're seeing that and that being offset by geographic mix. But what you're seeing is when an operation like North America is minus 1% in the quarter, that actually -- this is counterintuitive -- but it actually improves margins, okay, because North America having the finished product business has lower margins. So in our expectation is, number one, to continue to get positive pricing and we are going to be rational in pricing and we intend to stay premium as I said earlier. But in addition to that, we expect North America's performance to improve in the second half of the year, which will actually put pressure on margins, which is why we said earlier that we would expect gross margins to moderate over the second half of the year and it's really the geographic mix of where the income is coming from. Does that make sense? + +Answer_11: + + Yes. + + + Yes, also on innovation, as we have said before, we don't look at innovation only as ingredients, we look at it as packaging, ingredients, equipment, even in terms of the marketing, social media, the brand price pack channel, architecture, occasion architecture, all of that is working for us and also our -- in terms of our new campaign to be part of the solution around the world, working closely with local governments, national governments, working with the government of Mexico, working with mayors in Chicago, in San Antonio, other parts of the United States, in different states, in Atlanta, and you can look at the patents that we have been filing of recent. So we are working and freestyle and the next generation of what is behind -- what's coming next after that, we are working on a host of new innovations. +Also ingredients. Continue to work with our partnerships across the world in different incubators around the world. The best -- we always believe here in The Coca-Cola Company, the best ideas are outside. So the plant bottle came from the outside from one of the incubators in India. Many new ideas are coming from different incubators in Israel or in China or in Japan or in Latin America. We have many -- we have substantial partnerships from here in -- with the University of Georgia to across many institutions around the world in techno parks. So, yes, we are very, very active and we are content that we have the right pipeline and maybe I can ask Steve to reflect on -- from just a North America and Americas perspective. + + + Yes, thanks, Muhtar. From a -- starting with the Latin America perspective, we've got Coca-Cola Light, which we are kicking off in Argentina. Which we are excited about watching the prospects of that. We are doing terrific innovation around our Jugos Del Valle platform in juices in Latin America, as well as in North America we have launched Fruitwater, a brand new product off to a very good start. Powerade Zero Drops have joined Dasani Drops as a very exciting innovation. NOS Active, with is a fusion between sports drinks and energy, kicked off in April, again off to a very good start. From a packaging perspective, we continue to innovate around our price package architecture. We've just launched 16-ounce sparkling icy cans in our major packages. We've got Taylor Swift Slim cans coming into the marketplace. We've got 19.2 ounce sparkling cans coming into the marketplace. Again, lots of excitement around the packaging innovation. +In terms of some marketing innovations, we've got Coke Zero, which is going to be launching College GameDay this fall, which we are very excited about. We've got Caffeine-Free Coke Zero coming into the marketplace. We feel very good about that. Really building out the Coke Zero platform as an all-day brand, so we've got lots in the marketplace and lots more coming into the marketplace and it builds on one of Muhtar's earlier points that throughout this rough period of time, we have continued our marketing pressure, we have continued our marketing investment. We have not cut it. We have increased it and it allows us to continue to innovate and bring new innovations into the marketplace. + +Answer_12: + + Yes, I would just comment on that that it's all about ensuring that you provide the right choices at the right time for the right consumers in the right environment and that you shouldn't read that we have an increased resolve to use any specific ingredient. It's all about ensuring that we do have viable lights and no-calorie versions for every one of our major brands available to the consumer, ensure that we [front the pack] label transparently, ensure that we have active lifestyle programs, as per all our global commitments, and ensure that we have responsible marketing. That's our -- those are our four commitments and our Business, we've said many times, is about brands. Today, we have $16 billion brands, that are growing. We have in the pipeline another 19 brands that are bigger than $750 million in revenue and less than $1 billion. Those are all going to become $1 billion brands in the next increment of time because they are growing and we are confident that we will have multiple -- more $1 billion brands than we have today and I think that's what this Business is all about, adding value through brands to our system and I'm confident that you will see us add many more $1 billion brands to our [rostrum] in the near future. + +Answer_13: + + Steve, you want to go? + + + Yes, thanks, Ali. I will start. In terms of pricing, we have always said that our pricing strategy in North America is consumer-based and it continues to be consumer-based. We captured, if you look at Nielsen, we captured very good pricing across our portfolio in North America and we think it was an appropriate amount of pricing by channel. The unfortunate 4% volume decline was, as we said, had a lot more to do with weather and the economy, at least 60% to 70% having to do with a one-time, really poor weather event, so we didn't put more price in the marketplace to try and chase volume that wasn't there. We put appropriate price increases in the marketplace and we maintained our margins and we maintained our price strategy going forward and we continue to bring new products and new packages into the marketplace to help our whole architecture achieve the type of pricing that we deserve. +And we have given some examples of this in the past and a good one is our 1.25 liter, which continues to be very successful. One-third of the 1.25 liter volume is in fact incremental volume, so it is good in and of itself but it has also allowed it -- so if you look at our 2-liter pricing over the course of the past 12, 15 months, we are out of the $0.99 price promotion for 2-liter and have been for quite some time. So we are not going to put too much price in the marketplace. We take appropriate price, based on what the consumer and what's right for the consumer and what's right for the customer and we fully expect that based on the price plans we have in place for the back half of the year, based on the innovations we have on the back half of the year, that sparkling volume will in fact improve from what happened in the second quarter. + + + Ali, I would move onto your question on China. The answer is there's absolutely no plans for increased price promotion. In fact, the reason for having a evolving OBBPC is to have more sustained volume at the right price point and the right packs for all the consumers. Now, to give you an example, you might be familiar that there's been a lot of upsizing going on in China and we have launched our 300 mL package last year. Now, we will tactically respond to such upsizing to be able to balance our volume and share performance but that's a -- those are limited tactical moves rather than a strategy to have increased price promotion so that's not really in the cards. Now, to maybe build on this a little bit and also to address some of the innovation questions that I didn't have a chance to share, is that we have small cans -- either slim can or sleek can -- and small PET launches all across the International territory, all across Europe, all across Eurasia Africa Group, and some of the Pacific markets. +That I believe is an important innovation in a way and also allows us to drive revenue and gross margin. In addition to that, let's also keep in mind that we had some very successful products such as Pulpy that hasn't been fully launched in all of our International territories. Eurasia Africa Group, for example, have taken that and they have launched it in Morocco. In a very short period of time, we were able to achieve a 20% plus market share with that launch. We've just had a recent launch of extensions of coffee into PET in Japan. In the CVS channel, the recruiting female consumers were quite happy and pleased with the results of that. We have been innovating in energy drinks in Russia and Turkey by extending them into PET packages, resealable PET packages that the consumers want so we continue to innovate in different packages, different categories across our International territory as well as using successful innovations from the previous years. + + + Thank you, Jackson, Irial, Steve, Amit, and Gary. Our Business continues to grow and to capture global volume and value share even in the midst of ongoing global economic challenges and importantly we do not manage our Business for the short term but rather for the medium and long-term and, as I mentioned earlier, our focus on achieving our 2020 Vision is unwavering with current dynamics leading us to believe that our performance will be better in the back half of this year and beyond. As always, we thank you for your interest, your investment in our Company, and for joining us this morning. + diff --git a/exam/original-files/Problem_2_3_Sample_QandA/23_questions.txt b/exam/original-files/Problem_2_3_Sample_QandA/23_questions.txt new file mode 100644 index 0000000..2c65dda --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_QandA/23_questions.txt @@ -0,0 +1,52 @@ +Question_1: + + Muhtar, I was hoping you could step around the world and dive a little bit deeper into certain markets and regions to help us separate out the impact of nonrecurring factors that hit your second quarter. First is any macro related factors that can continue to pressure the business in the second half. You had mentioned macro factors in Brazil, Mexico, Europe, and China. Will those continue to be as big an impact in the second half as the second quarter and if not why? And then maybe if you could help quantify maybe what you think the weather-related impact was in the second quarter? + +Question_2: + + Gary, I just wanted to ask a clarification about the back half of the year. Your commentary on the financials, it sounds like you're saying you're going to get to that level in the back half of the year and not the back half of the year will get you to the long-term algorithm for the full year. At least that's how I interpreted it. Can you just clarify that? + +Question_3: + + Got it. Okay. Thanks. Then my actual question here was, Gary, you got positive price mix in the vast -- in every region this quarter with the exception of Pacific. And yet it's not going up to full positive price mix here. How do we view the regional price mix versus the geographic offset and how does this fit into your long-term algorithm? Because it seems like this is something that's most likely going to continue to be a notable overhang? + +Question_4: + + I just wanted to go back to the second half expectations and clearly you can't control the macros and the weather, but I would just like to hear a little bit more specifically on some of the actions that you're doing to improve the volume performance, particularly in markets like China where there's a macro issue but there's also competitive issue, there's also portfolio issue just in terms of not participating in some of the fast growth segments. So can you just talk about how you're thinking about marketing investments, how you're thinking about your portfolio? Can you accelerate price tag architecture strategy more aggressively to really get the volume performance even if the macros don't come back and/or the weather continues to be challenging? + +Question_5: + + Just two quick questions. What are the trends like recently? It seems like you're pretty bullish in the back half. So as you exited June and got into July, it looks like some of the weather normalized, so what are you seeing more recently? And then minutia but the big margin decline percentage year-over-year in Europe, what's the primary driver of that? + +Question_6: + + Got you but so they should be down going forward though because of that because Innocent is now fully consolidated? + +Question_7: + + Got you. So from a dollar margin perspective it's almost neutral but the percentages change because of the price component? + +Question_8: + + Gary, just a question for you related to share repurchases. With the stock the way it's performed in the second quarter, did you accelerate or do anything different in terms of timing of maybe pulling forward share repurchases? And then the business right now is bouncing around the low end of your algorithm and the stock has bounced around in a pretty tight range here recently. So is there any consideration to maybe even buying back more stock than you originally planned just because you've got an opportunity to buy it here at the -- around the $40 level? + +Question_9: + + Okay. But not out of the realm of possibility that you could go higher if you chose to? + +Question_10: + + Muhtar or Gary, question on the gross margin evolution. I don't want to put words in your mouth but it seems like one of the silver linings here is that the price pack architecture work you've been doing over several years has allowed you to put up a pretty decent gross margin number and offset some of the corresponding earnings disappointment that comes from the revenues being what they were in the quarter. If that is a fair assessment, can you give us a bit of an update on what's going on in terms of innovation, not in terms of the price, the pack but in terms of what's really in the bottle because that seems to be one of the problems you're facing from a larger share performance absolute NARTD performance perspective? + +Question_11: + + It does, yes. Absolutely. The geographic headwind is what it is. + +Question_12: + + That's helpful. And if I could simply follow up on this subject of a stevia-based sweetener in the brand -- on the door, so to speak. Coca-Cola, we have seen what you've said recently about globally taking down the portion of your volume that is in the full-cal portion of your business. Should we infer here that there's an increased resolve to use organic sweeteners against the main brand here and there's some optimism globally for that potential? + +Question_13: + + So the general theme of my couple questions is really what we are all trying to figure out, which is, what's going to get better from here and why, and not only in terms of volume but also in terms of some of the other key drivers of profitability. So if I may, my first question is around North America and although you say in the press release, you remain committed to rational pricing, price mix was only up 1% and do you think volumes would have been down more than negative 4% if you had taken more than 1% pricing so taken 2% to 3% pricing or can we hope for that part of the business, the pricing in North America improving going forward? And as a follow-up to that, in a completely different per cap market like China, following up to Ahmet's point a second ago, I just want to get a better sense of if evolving a strategy has anything to do with increased price promotion as well, as it sometimes does with some companies? + diff --git a/exam/original-files/Problem_2_3_Sample_QandA/24_answers.txt b/exam/original-files/Problem_2_3_Sample_QandA/24_answers.txt new file mode 100644 index 0000000..31761a0 --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_QandA/24_answers.txt @@ -0,0 +1,154 @@ +Answer_1: + + Good morning. + +Answer_2: + + Yes, Dara, good morning. I think first it's important to realize that there is different timing across the world to some of the volatility and macroeconomics, and particularly what's interesting for us which is disposable incomes. So I think China has already had a slowdown and is beginning to recover. We see that. And there's always also a lag between the GDP per capitas and disposable income. So also important to realize that they don't all happen at the same time. The numbers don't correspond to each other one-to-one. +And so we do see an improvement in Southeast Asia and parts of certainly China, where things have stabilized and things, people are beginning to normalize their habits. And in the last three, four months we've seen a flight of currency from emerging markets, market stock exchanges in countries back into North America. That's had impact on disposable incomes in Latin America, in Eurasia, in countries like Turkey, and other countries, in certain other countries in North Africa. So, yes, those -- and you can track stock exchange indexes and you can track disposable income growth or slowdowns. They are all very related and we do see that the world is not just one city or one element of volatility. There's different pockets of volatility happening at the same time. And what is, what we are fortunate with is the great portfolio, a wonderful portfolio where India slowed down maybe seven, eight, nine months ago. +We see some comeback in terms of disposable income I'm talking about, and China is the same. Southeast Asia I would say are similar. Philippines also pretty much in that camp. And then we certainly also see that we've still got some headwinds maybe in other parts of the world. So there's some tailwinds coming and some headwinds coming. And we continue to invest in our brands and when you look at our performance, we have sequential improvement in many parts of the world, particularly when you look at places like India, places like China, Atayan, even also developed markets such as Australia and also South Africa. And our African continent, I haven't mentioned that, countries that are some sub-South Africa that are usually south of 80 per capita, again, grew in a very healthy manner this past quarter, about 5% up. And we expect Africa to continue to generate good results and economies in Africa seem to be pretty buoyant and seem not to be too impacted. But of course they are very slow level of their per capita development as well. I hope that helps. + +Answer_3: + + I thinks it's pretty -- as I said, different pockets showing different results, but we have a very, very sharp focus on -- I was down in Latin America recently a month ago. I visited many countries in Africa recently as well as in Asia. We have an incredibly sharp focus on brand price pack channel architecture, new price points, lower price points, more focus on affordability, more focus on returnable packs and smaller packs. Individual packs that help continue to keep the drinkers' base growing, which is key and essential to when economies also start turning up and when disposable income starts heading north. + +Answer_4: + + Good morning. + +Answer_5: + + Yes, thanks, Bill. First, philosophically, from a strategic vantage point, the whole story of balanced growth we believe is still very impact. Balance being growth in western markets, growth in emerging markets, balance being growth in sparkling and growth in still beverages. And you see that happening in this past quarter as well. So we've grown in markets like the United States, which we believe is a long-term growth market. When you think about it, 14 of the last -- of the last 14 consecutive quarters, we've grown in all but one of them. And now we've generated, again, 2% growth, with 2% growth of brand Coca-Cola. +So we -- Australia grew. Many important markets in Western Europe grew. Germany grew again 3%. Countries in Northwest Europe generated good healthy growth for us. And then emerging markets. Yes, there's some headwinds that are happening in emerging markets but we believe they are very temporary. The whole demographic, the whole investment, the whole story of 1 billion new middle class still holds very strong in our opinion by 2020. Over this past decade that we're in, this decade that we're in, a billion new middle class. +That bodes very well for the industry we're in and we believe we can continue to generate very healthy good growth. We believe we can continue to generate very healthy price earnings. I mean, I'm sorry, price mix. And we believe that, therefore, in this, like in this past quarter which was where we did see a lot of headwinds, we generated 4% revenue growth and 8% currency-neutral operating income growth. And we believe that we had a lot of headwinds. So as economies begin to move, I think we'll see a lot of improvement. And I'll ask Ahmet as well to make some comments on this and if need be also ask Steve to add his commentary. + + + Thank you, Muhtar. Bill, you mentioned a few items. I'll just focus on a couple of them. Emerging markets, as you know, if you look at the history that it goes through cycles. So it has a cycle of years and years of growth and every now and then you have economic headwind, and you manage through that. But emerging growth, emerging markets growth economically certainly isn't over, and we have a formula which pretty much closely shows that as personal consumption grows, we actually grow with it. +Now, having said that, in some of the emerging markets where there might be personal consumption and macro headwinds, we could still grow, like India, because we have very low per caps and we have significant investments in feet on the street, infrastructure, brands. We're just really building our business. And India showed that again this year. So that's what I would say about your comment of emerging markets. The growth story there is far from over for a long time to come. And I guess the rest were about US pricing and decline in soft drinks. So maybe I should just pass that on to Steve. + + + Yes. Thanks, Ahmet. First, I would just underscore on the broader question, what Muhtar said in his prepared remarks, that in this quarter we delivered the highest number of servings ever reported in the third quarter. So I think that bodes well for our growth story going forward. But with regards to North America pricing, which I heard you ask, Bill, and in particular, sparkling price. We feel good about delivering positive price mix in the quarter of plus 1%, in line with our strategy to consistently earn at least 1 to 2 points of sparkling with consumers. And in the US Coke system remains committed to taking rational pricing and we've done this very well over the past several years. In fact, we achieved 2 to 3 points of price mix in sparkling beverages and across our total portfolio in both 2011 and 2012. Year-to-date, we're 2% sparkling price mix, which we feel good about. +But I think it's important to remember, we've always said that we're going to focus on consumer-centric pricing. And if I can give you an example of that, the average price today of an 8-ounce serving of Coca-Cola is $0.25, exactly $0.25. This is up over 5% versus two years ago and it's up nearly 10% versus three years ago, which compares very favorably to the US inflation market. And this tells me really three things. First, at $0.25 we do not have an affordability issue. Coca-Cola remains a very affordable indulgence. Two, we've been able to earn price above inflation in the United States. And three, we still have plenty of room to continue to take price. +But now addressing the third quarter in particular, we acknowledge we did strategically invest in select promotional activity in the back half of the summer through the Labor Day holiday. Given that we essentially didn't have much of a Fourth of July holiday and Memorial Day holiday, this Labor Day acted much more like a Fourth of July holiday. But these investments were tied to specific occasion-based brands and packages to help drive incremental household penetration, which they did, attract more consumers into the category, which happened, and is very much in line with our long-standing North American strategy. And all of these activities that we did, all of them, to take price in the marketplace, I think set us up very well to take more price in this quarter and going into 2014. So we're very confident that the pricing environment in North America remains very rational and that we'll be able to continue to earn price in the marketplace in this quarter and going forward in the next year. + + + Yes, just let me round out that question with one final remark, Bill, and that is that once again if you take our world average per capita of around 90, just under 90, and you take the most populous nations of the world that are less than half of that per capita, India, China, Indonesia. Way below that number, way below half of that number, we believe there's -- and many other parts of the world as well in Africa, the youngest billion, we believe the critics, whoever they are, are wrong. I don't understand that sentiment. We're growing while others are not at the moment. And our business and balanced portfolio is built for times like these. So we see this as a time of opportunity. + +Answer_6: + + Good morning. + +Answer_7: + + Yes. Look, Bryan, firstly let me just address that by saying regressive taxes do not work, period. And wherever we have seen them being implemented in some cases, they have been taken away by the government after two, three years, basically like in Denmark. They are not working wherever else they have been implemented, and so the consumer suffers in them. It's proven time and time after again. We've made our case to the government. We have tremendous respect for the government of President Pena Niento. And we need to understand that, and we've made our case that this really does not have anything to do with health policy. In order to address the health policy properly, we have to come and work together with government and with civil society to raise the awareness and to create programs that really work. That really drive physical activity and, therefore, just a regressive discriminatory tax on one part of the food industry just is not going to work and apparently that's all I would really like to say, because its discussions are in progress and I don't want to comment any further. + +Answer_8: + + I just don't want to comment on it at this moment. As I said, there are a lot of discussions going on and it would be wrong for me to publicly comment on any of those discussions and, therefore, we'll deal with whatever the result is in the most effective way. I can assure you that we will continue to prosper the business. We're one of the largest, we are the largest consumer goods business in the country. We are one of the largest contributors to the GDP in that country by a big margin, and we support millions of retailers in the country effectively for their livelihood and, therefore, I think that we will certainly find the right way forward, whatever happens. + +Answer_9: + + Okay, John. Let me see how well I can do on this and then you can come back and ask. But first, going to price mix, and just as a reprise in general on price mix, generally what we see, and I'm going to take this in steps, generally what we see is you see pricing. So you see rate and mix, positive rate and mix, would be positive across almost all of the groups. You would then see negative, generally, you would see negative geographic mix and it's basically a function of higher growth in emerging market countries than developed market countries, which would give you a negative geographic mix. Then on top of that, and you're absolutely right, then where we own bottlers and they're growing, and that gives you then a positive price mix because they're finished products versus concentrate. +So a couple things. So if you go back to the second quarter, I talked about margins and I thought margins would moderate and because of geographic mix. And the follow-up to questions I remember, I said because we expect North America to actually perform better and that will actually hurt margins because it's a finished product business where margins are lower. But it helps price mix. And what you're seeing today is while price mix in North America was even for the quarter, we are getting positive price mix from our finished product businesses. +Going forward, and not talking specifically about 2014 because we're still in the midst of planning 2014 and we'll give you a full review on our views on next year in the February call, we are planning to take appropriate pricing and Steve referred to taking pricing in North America as well. So we are expecting to take pricing. So going forward, what I would expect to see is that we should have a positive in rate going forward. We should have a positive in mix going forward. We should have a positive from finished products going forward. And we should have a negative from geographic mix. So that's the kind of -- and if you add all of that up, it should be a positive price mix. That's what we would expect and it's what we would expect as what's in our long-term earnings road model, is positive price mix long term. +Now, let me see if I can turn to operating income. When I was talking about operating income, it was definitely currency-neutral. It was -- and ex structural. So let's be very clear on both of those, currency-neutral and ex structural So operating income was 8% currency-neutral ex structural for the quarter, and 6% year-to-date currency-neutral ex structural. And what I said was we now expect the full year to be generally in line with the first half of the year. So somewhere in that ball park and that is net of currency-neutral and net of the structural impact because I can tell you with the structural impact, it's a point of negative structural impact and so that would take our year-to-date from 6% to 5%, for example. So just to be clear, ex structural, currency-neutral. + +Answer_10: + + Yes, without giving guidance, what we're basically saying is that the full year we think ex structural and ex currency, it ought to be in line pretty much with where we are year-to-date. + + + Yes. + + + Okay. + +Answer_11: + + Yes, Steve, you want to address that? + + + Yes, thanks, Judy. First, I did talk specifically about diets. I would underscore that we have a very wide portfolio in North America led by brand Coca-Cola, which is twice the size of Diet Coke, and brand Coca-Cola, as you know, grew 2% in the quarter which we're very pleased with. Diet Coke is like a lot of diet products in the United States, and not just beverages but across the whole array of food, are under a bit of pressure as people are questioning ingredients, ingredient safety, and so forth. But we believe very strongly in the future of Diet Coke, the number two sparkling brand in the United States. We've got terrific programs against it. We're actually seeing increased incidents in the past quarter, between 19- and 24-year olds. We think a lot of that has to do with the exciting new promotions with Taylor Swift, some of the new packaging we're bringing into the marketplace, an increased focus on Diet Coke. +But there are headwinds. There are headwinds that we're facing. And we face headwinds in a lot of different areas, a lot of different places, and this is just one of them. But last year it became the second best selling sparkling in the United States and we're continuing to focus on it. Coke Zero, also a part of our zero-calorie portfolio, grew mid-single digits in the quarter. So we're very happy about that. We've got a great program around Coke Zero, College GameDay just kicked off, it's really becoming ever-more relevant with young males. So we're confident that throughout our whole portfolio, we're offering consumers exactly what they want, when they want it, how they want it, at the right prices that they want it, and we'll continue to focus on any of the headwinds around Diet Coke. And we're confident that it has a bright future in this country. + +Answer_12: + + Well, Judy this, is Muhtar. First, I think it's important to understand that, and I've said this in the past, that economies that are performing at a different pace in the continent of Europe, not everywhere is really bad, not everywhere is really good. And so you still have very challenging consumer sentiments in Spain and Italy and Greece and Portugal and the South, in Southeast Europe, in what used to be termed as the Balkans, Romania, Bulgaria, former Yugoslavia. It's very challenging environment. And then you've got a better environment in Northwest Europe and then certainly the best environment still in Germany. And so based on those, our business also reflects some of those conditions and so it's a pretty good mirror actually. And I'll ask Irial to comment on Germany and why we've been consistently performing in Germany and growing our business and, again, there is tremendous sequential improvement versus the first half in many countries of Northwest Europe, in Scandinavia and also Northwest European countries. Irial? + + + Thanks, Muhtar. And this actually goes back to one of the earlier questions. I think in Germany we've got an economy that's doing okay. We have got actually really good marketing married up with continued excellent execution. And you bring all of that together and you get great results. And for me in Germany, it gives me great confidence about the future of our business, quite frankly, because we are seeing where we put in the hard work, where we do the right things in the business, we do get good results. And Germany is just an example of what can happen, quite frankly, in many markets around the world as the economies turn and improve. + + + Ahmet, do you want to comment? + + + Yes, I just wanted to -- hello, Judy. I just wanted to add to the others that we had a very, very strong Share a Coke campaign across Europe this summer that worked extremely well. We are ever-more closely aligned with our bottling partners, really driving growth. And just on the macro, I would like to add that there's a clear divergence between North and South. So North continues to do better and South continues to do worse. So our business in the North certainly is reflective of that. + +Answer_13: + + Good morning. + +Answer_14: + + Yes, I think it's on target, as we have said, reported previously, where we make very sound significant good progress with, in discussions with some of our existing partners, as well as discussions ongoing with some other prospective partners. So we are on target, if not a little bit ahead. And I think you'll hear more about it in the coming period ahead of us, and I'll ask Steve just to maybe shed some more light on it. + + + Yes, thanks, Muhtar. Bill, the one thing I would really underscore is we absolutely have not hit a lull. Don't take the absence of public commentary to mean that we are not making very good, very constructive progress. All our bottling partners, both current and prospective, are extremely excited about this business in the United States, about the opportunity to continue to be franchise partners in the United States, to grow the business in the United States, and we're making very exciting progress and we'll have more to report in the coming months. + +Answer_15: + + Talking about productivity, Bill? + + + I'll ask Gary, do you want --? + + + Sure, Bill. Within the quarter, we continue to invest in marketing, so marketing is actually up in the quarter and up year-to-date. We had significant productivity savings in the quarter. We have some previously announced productivity programs that we announced back in 2012. Those 2012 programs will go through 2015, and really focus around productivity and then reinvesting those back into the business. They were focused on information systems, marketing, supply chain, innovation, operational excellence, that sort of thing. +I can tell you, we'll give you a full update on it at the year-end call, so I can give you the full year. But we are making very good progress against the goals and you'll see that on the February call when we go through a full update. And we've got hard savings and soft savings. So let me give you some examples of what's happening and it's adding into the productivity and some of the leverage that you're seeing. +So in things like supply chain, if you buy things cheaper, hard savings. And we're doing a lot around supply chain and actually getting a lot of hard savings. And those you're seeing being reflected. In marketing, if you can buy media cheaper, then we just buy more media basically is what we're doing. So we're reinvesting back into marketing and being able to buy more media for the same price, if you will. So we, as I say, we'll give you a full update on all the productivity programs in February at our year-end call. But we're making excellent progress and you're seeing a lot of that just what's coming through the G&A line with, as I say, within that marketing, SG&A marketing, being up for the quarter and year-to-date. + +Answer_16: + + Very, very little. There's a huge cycling of last year in the fourth quarter, as I've mentioned earlier. But there's very little. I mean, there's a little bit but nothing of significance in the quarter this year. + + + Thank you. + +Answer_17: + + Yes, thanks, Ali. I think that's a fair interpretation of what I said. This was a very different summer. It's been a difficult year starting with the fiscal cliff and sequestration and payroll taxes and so forth. And then the summer was very sluggish and it's very important in our business to keep consumers engaged with our brands, to make sure that we're in the households, to make sure that teens are being recruited. And so Labor Day acted very much like a Fourth of July or Memorial Day, whereas typically it would not. It would be the end of summer. +And Labor Day acted like the only summer, so it was more promotional than you would have seen. It would be more promotional than what we would expect going forward. But those things happen from time to time. And we think that the pricing environment will continue to be very strong, very rational, and because of all the investments we're making in our brands, we feel that we have the opportunity to earn even more price going forward in the marketplace. And that would be absolutely our intention to do that. + + + And I just want to add one thing. In terms of the Nielsen data, yes, that's exactly the reflection. But don't underestimate. We took very healthy pricing and I see also in the quarter. And so, overall, that's how you get to the one price mix positive on sparkling. And so, don't let that point go unnoticed at the moment. + +Answer_18: + + I would say that first, we believe that our long-term growth model, with appropriate mix which we believe we can take and we can generate, it would definitely get us to our 2020 vision of, from a system revenue point of view, of doubling our business with the base of 2010. So that's the sort of trajectory, if you like, and we're on track in terms of moving ahead to doing, achieving our goal. The second piece is we'll always be looking for any kind of bolt-on acquisitions that may make sense, but that's the extent of what I would say that right now we would be looking at. Bolt-on acquisitions and if there's an opportunity, we will look at it seriously. + +Answer_19: + + Sorry, say that again? + +Answer_20: + + I don't think materially. You know, if you look at our long-term growth of corridor of volume plus what we've been achieving, I think the balance is still there the same as it used to be. + +Answer_21: + + Yes, I'll have Ahmet just comment on China. Then maybe Gary can finish off the second part of the question. Sure. + + + Thanks, Wendy. You might remember that in our last call, we talked about the fact that we were evolving both our organization and our strategy in China. And what we see in the third quarter really encourages us that we had not only 9% growth in total, but also 8% growth in sparkling. And that's pretty much delivers on the expectation that we've said that we would expect sequential improvement from the first half results, in the second half of this year, and we expect that sequential improvement from the first half results to continue into 2014. +To your question of pricing promotion, we did not have any significant marked pricing promotions in the marketplace. It was basically a combination of, A, beginning to implement parts of our new strategy in the marketplace, B, the same Share a Coke promotion as we're scaling up these wonderful global assets in all parts of the world. And then our new team beginning to gel together, connecting with our bottling system and really improving execution. So we are encouraged by those results and we expect to continue to, as I said, improve sequentially from the first half results. + + + Okay, Gary. + + + Yes, Wendy, relative to share repurchase, let me first, let me just start with a preface that don't particularly agree with you on saying our share price is relatively underperformed for the last two years. But absent that, a couple of thoughts on share repurchase. Our view on share repurchase is that share repurchase is value neutral. It is not something that grows value. It does for the short-term holder. Because maybe you can get a bump in the share price. But for the long-term holder, it is not something that is value-enhancing. It is much more like a cash-efficient dividend, which is the way we treat it in that our priorities for cash are number one, to reinvest in the business, to grow the business that would include bolt-on acquisitions, et cetera. +Number two would be dividends which we have increased for the last 51 years, 10% this year. And third, excess cash would be put into share repurchase and just because we don't need that cash in the business. So it's a return of cash to shareholders. But leveraging the balance sheet to do something that we would view as value-neutral, we don't think is the right thing to do so we continue to just perform exactly in line with the targets that we set at the beginning of the year. Thanks. + + + Thank you Gary, Ahmet, Steve, Irial, and Jackson. We delivered sound third-quarter results within an ongoing challenged macroeconomic environment. While we saw sequential improvement in the business, we remain constructively discontent and resolutely focused on further advancing our growth trajectory. Our 2020 vision and long-term strategies remain firmly intact. And together with our global bottling partners, we're investing in our brands and our capabilities to further strengthen our system and to drive sustainable growth and value. As always, we thank you for your interest, your investment in our Company, and for joining us this morning. + diff --git a/exam/original-files/Problem_2_3_Sample_QandA/24_questions.txt b/exam/original-files/Problem_2_3_Sample_QandA/24_questions.txt new file mode 100644 index 0000000..1d6743c --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_QandA/24_questions.txt @@ -0,0 +1,86 @@ +Question_1: + + Good morning. + +Question_2: + + Muhtar, I was hoping for more granularity on emerging markets given the Q3 slowdown, particularly in Latin America, which was in contrast to some improvement we saw in China and India. So can you give us an update on the macro environment as you look around the world? And also, some of the strategies you mention you were implementing, are you gaining traction at this point from a market share standpoint? And should we expect to see volume performance in emerging markets improve as we look out going forward from here? + +Question_3: + + Yes, that's helpful. And then some of the strategies you're implementing, do you think it's helping to drive an improvement in market growth at all or drive market share gains? And do you feel comfortable that emerging markets trends have bottomed in general at this point and we should see some improvement going forward, or is it still too volatile to call right now? + +Question_4: + + Good morning, everybody. + +Question_5: + + Muhtar, critics have said that Coke's growth story is over, reflected in the stock price, pointing to the slowing emerging market growth you were just talking about, declines in diet soft drinks. Some say the pricing in the US is irrational, and an inability to grow in big markets like US and Mexico. Can you explain why you still see solid growth ahead for the Company? And what the Company is doing in terms of innovation, productivity, you mentioned price pack earlier, to drive that growth and why the critics who have declared the growth story is over are wrong? Thanks. + +Question_6: + + Hello, good morning. + +Question_7: + + Question about Mexico and excise taxes. It's been in the press over the last, especially more so over the last couple of weeks, and in speaking to some of your bottling partners in Mexico specifically, it seems like they are more resigned to the potential that it's going to be a reality. So if you could talk a little bit about just how you see the situation unfolding in Mexico and to the extent you'll get an excise tax increase, how you plan -- or do you plan to do anything differently in Mexico in response to it? Maybe some thoughts about elasticity? And then finally, just any concern that there's spill-over into other markets would also be helpful? + +Question_8: + + Are there any preparations for -- I guess, just trying to understand if it does become a reality, do you have plans in place to deal with it if it does occur? + +Question_9: + + Thank you very much. Muhtar and Gary, you guys talked about the price mix number improving sequentially, which was good to see. So Gary, can you talk a little bit about how you see this playing out over the next 12 to 24 months? Where you have the negative geographic mix offset by the positive mix on a per case basis is the bottler territories, where you own the bottler gets better like North America, versus the absolute level of pricing. How should we look at those factors competing against each other to try and map something out? +And then one other housekeeping question, which was your comments on operating profit for the year, could you just revise those and, or restate those, just because there's some confusion about whether it was currency-neutral or non-currency-neutral, what have you? Thanks. + +Question_10: + + Okay. So, and I'm not trying to trick you into guidance or anything here, but it basically sounds like you're saying currency-neutral, ex structural, mid-single digits year-to-date. So, therefore, that implies the Q4 but then you talked about the currency impact. So as we're looking at those, should basically offset to get you to slight operating profit growth for the quarter? + +Question_11: + + Thanks, good morning. I had one follow-up question on North America and then a question about Europe. So in North America, there's been a lot written about the declines that we've seen in diet sodas. And, Steve, I'm not sure if you went through that and whether you shared some of the similar concerns that people have written about the decline in diets and your perspective on whether the artificial sweetener issue is impacting that category at all and from your strategy in dealing with that situation? + +Question_12: + + Okay. And then just on Europe, the improvement that we saw in Northwest Europe and Germany as well, to what do you attribute that to? Perhaps weather getting much better in the quarter as opposed to the macros in consumers and what you guys are doing to really rejuvenate growth in those markets? + +Question_13: + + Hello, good morning. + +Question_14: + + Hey, can you just talk about the timing of some of the refranchise in the US? Because I think we talked a lot about it earlier in the year and it's kind of hit a lull recently? And then I have a follow-up, if I may. + +Question_15: + + Great. Thanks so much. And then just on the SG&A costs, can you just give us a little bit more color on what drove some pretty significant efficiencies, which is obviously great, but with the advertising ratio flat or up and then maybe what drove some of the other improvements on that line item? + +Question_16: + + Got you. Was there any benefits from the incentive compensation accruals either this quarter, maybe into the fourth quarter as well? + +Question_17: + + Hello, guys, thanks. Just one quick thing and then a real question. So I just want to underscore something again, because it's a key controversy and, look, I'll be fair. I think what Steve said a moment ago is music to a lot of investors' ears. And I want to just replay to make sure I understand. So did you say that the past couple months in North America from a price promo investment perspective, we're a little bit more of a blip and that we should expect something like higher pricing that we saw in 2011 and 2012 going forward in North America? + +Question_18: + + I appreciate that. That makes a lot of sense. And then a broader question, and I don't know how often you revisit this, but what do you think the Company has to grow volumes between now and 2020 to deliver on the 2020 vision, given some of the recent slowdown in volumes? And I guess in that context, do you think as a Company you have to acquire more to reach that vision? + +Question_19: + + And from a difference of volume versus price mix to reach the system doubling goal, has it shifted at all between the two? + +Question_20: + + Well, so to double the system sales by 2020, there is perhaps an ingoing assumption of what would be from volume and what would be from price mix. Has the recent global slowdown shifted that mix at all between volume growth and price mix growth to reach the doubling of sales? + +Question_21: + + Hello, thanks, good morning. First question on China, can you talk about the acceleration, the pickup in volumes there, whether that was driven by any change in pricing or promotional levels? And what your outlook of a normalized run rate, because that region's just been so lumpy in terms of volume growth as we go into 2014, where's a base case of volume growth? +And then my second question is looking at the buyback program, the stock's on track for two years of relative under-performance, and we haven't seen that for a while and yet your target for buybacks hasn't changed since the beginning of the year. So I'm kind of surprised with the balance sheet you have, with the weakness in the stock, and certainly, Muhtar, with your resounding confidence about the long-term outlook, you're not getting more aggressive on the buyback here? Thanks. + diff --git a/exam/original-files/Problem_2_3_Sample_QandA/25_answers.txt b/exam/original-files/Problem_2_3_Sample_QandA/25_answers.txt new file mode 100644 index 0000000..be83aa6 --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_QandA/25_answers.txt @@ -0,0 +1,121 @@ +Answer_1: + + Sure, Bill. Good morning. This is Muhtar. +Let me first just take a step back and just say that, in a way, we've had a speed bump. We know it would have come on our road to 2020. We dealt with commodities and in 2011 and 2012. Volatility in weather has become a norm. +Uncertain economies -- internal, also execution issues caused us to under-perform versus our expectations in 2013. I'll start by saying that. +We have looked at everything. We have looked at our people, priorities, marketing, selling, and innovation, and we have refreshed our plans with a simple but scaled up set of priorities on marketing our brands, system execution by our franchisees and bottling partners and Company-owned bottlers, and on innovation of all kinds. Business models like the one that we recently announced with Green Mountain, brands, equipment, packaging, the lot. +Our long-term outlook is our performance algorithm which we have and will deliver going forward. And 2014 will be a year of steady improvement as we get back up to speed. +But make no mistake, our leadership team is confident, accountable. Our system will market well. We will sell well and we are going to achieve our 2020 Vision. +Now let me just take you through a quick tour of the world and I'll ask Ahmet also to comment. Starting with Asia, China is going to sustain its growth, India in terms of its macroeconomic outlook, and we will continue to benefit from that. +In India, there is elections coming up and usually when there are elections, there is a little bit of easing of fiscal discipline. That will play into a little bit of added disposable incomes. +In Southeast Asia, certainly we've seen quite a lot of political turmoil, especially in Thailand. That will -- as we go into 2014, my expectation is that, that will ease a little bit. +Indonesia, also there's an election coming up. But Indonesia is certainly having some macroeconomic issues that will probably continue into 2014. Philippines, we'll see a slightly improved outlook in the Philippines versus 2013. +In Japan, obviously everyone is looking very closely at the new policies of Prime Minister Abe's government. There's a new tax coming up. We'll see how that impacts but certainly we all feel -- that our operating in Japan -- feel that there is some hope for a little bit of more inflation in the economy that will benefit also businesses like ours. Although recently, the last economic numbers from Japan were a little bit below expectations. +Africa, youngest continent, we're very well-positioned. We feel that we will continue to grow well in the years to come in the African continent and benefit from also improvements in governance across the whole continent. +In Eurasia, there's elections coming up in Turkey. Lots of again political issues in the Middle East will continue. +Russia, all Russians can be very proud of the Olympics that are taking place. We will as we move forward -- and I was there in Russia, looking at some of the great activations that we've had in our Business -- and Russia, our Business will continue to grow in Russia with all the investments that we're making with our bottling partners. +Europe is a continued tale of two cities. If you take the southern zone, the high unemployment and low growth is going to continue but it's not going to get worse. +As far as northern Europe, Britain is certainly ahead of all the other economies in terms of the growth outlook. Germany also is in that area. We will continue to benefit from the robustness of policies in those two economies and the rest of the continent is somewhat behind Germany and England. +In Latin America, again, 2014 is going to be a year leading into an election in early 2015. We'll have also the benefit of the World Cup and our biggest ever activation globally on the World Cup. Southern Cone -- Argentina, Chile -- we should continue to see the benefit of all the programs we have in place and also continued inflationary environment in those two areas. +Mexico, President Pena Nieto's programs are taking effect, all the reforms. Long-term, that is a benefit to our Business, to the economy, to the people of Mexico. Again, as I said in my commentary, it's too early to say about the impact of the price increase we've had there. +So I hope that gives you a good tour of the world. Then finally, in terms of our flagship market in the United States, clearly the best right now, as far as we can see -- the best Western developed economy in the world, we think we will see slightly improved mobility in the United States in 2014 versus 2013. We hope that, that will also mean a little bit of increased spending for consumer products as we go into 2014. +So -- and again, we will benefit from all the robustness in our marketing programs and our increased expenditure and quality of marketing as we move into 2014 for our flagship market. +Ahmet, do you want to add some commentary? + + + Yes, I'll add a few things to really compare some of these issues that have existed even last year, how they are different now. So for example emerging market currencies, when the first news on discontinuation of tapering came out last year around May or June, there was a bit of a shock in emerging markets. +We see that over the last seven or eight months, these emerging markets are finding ways to deal with it -- by no means it's certain, by no means it's perfect -- but it certainly feels a little bit more under control compared to when it first came up, and the interest rate and things like that have been baked into those expectations. So the message there is countries and our Business, we are finding ways to deal with that new reality of less liquidity coming out of the United States. +I would just add, Muhtar, to your comment on Europe north-south divide, that is very much true but we are beginning to see different shades of gray in the south as well. There are some encouraging signs in Spain; less so in Italy at this point in time, although there's a new prime minister there and we're hopeful with the new programs to be announced if they are. +And Eastern Europe -- it continues to struggle in terms of consumer confidence and economics. So North continues to do well and South is even showing different performance now. +The other point that, Muhtar, you mentioned, is political uncertainty. It's another common theme to many of our emerging markets. They eventually could impact the economic realities, but again, so far, in countries like Turkey and Thailand, it's been fine. +And let me, just, in the interest of giving time to other questions, let me just stop it here. + + + Sandy, do you want to add any commentary to North America? It's important to say in North America that we believe in the North American market; we believe in the demographics; we believe this is a growth market. +We have grown in all but 2 quarters of the last 15 quarters in the United States. We believe we can do better and we're intent and resolutely focused on achieving that. Sandy? + + + Thanks, Muhtar. We have a great Business in North America. Our focus in accelerating the Business is on our brands, on our customers, and on our capability. +I'm really happy to be working with Irial and Paul and all of our US bottlers. Irial Finan and Paul bring a tremendous amount of selling and executional energy that will help us build on our momentum. +On my end, over the last 6 to 7 weeks, Paul and I have met with our major customers, we've met with our bottlers, and we've gone through the brand plans in detail looking at opportunities to focus and strengthen them and to move resources to emphasize advertising and brand-building on our largest brands. With the plan in place, our focus as a system -- Irial, Paul, and I, and our bottlers -- is to improve all aspects of our execution whether it's marketing or sales or in the marketplace. +We believe as a result of that, that we will improve steadily over time, and we share the confidence that Muhtar expressed in the long-term health of North America. It's a great market, it will grow, and I think we can be confident about our long-term future there. + +Answer_2: + + Bryan, thanks, and let me see if I can go through all of those. Let me start at the top. +When you're the industry leader, you have to believe in rational pricing and we believe we should get pricing for our brands because our brands are worth it and we would expect to have positive price mix this year to go with the volume that we will have this year. When you look at commodities, they're fairly benign from what we're seeing for 2014 so not a big deal. +Now let's say currency, among the worst we've seen in years. There's not a whole lot you can do about it when all the emerging market currencies melt down as they did earlier at the end of December, early January. With that said, let me be very clear. Ours is a growth business, is a business model that is built on growth, and we know that we cannot save our way to prosperity. +We will have productivity, but that productivity will be reinvested for growth. While we are reinvesting for growth in our marketing, we have -- our goals are also, in addition, while we're increasing the marketing, we will also have a goal and it is the goal for this year of hitting our long-term growth models this year. So we're going to significantly increase our marketing but at the same time the goal is we will hit long-term growth model this year. + + + Right. Thank you. + +Answer_3: + + John, this is Gary. Thanks for the question. +First, as Muhtar said in the prepared remarks, it's too early to tell what's going to happen in Mexico. We have planned around Mexico of what we believe is the most likely case, but we have a portfolio of brands that are marketed and sold across 200 countries, and our job is to manage that portfolio. +So unless something unforeseen should happen, the answer has to be yes. It includes what could happen in Mexico. If that changes, we'll update you obviously, but we're going on what we believe would happened today. + + + And just to add to Gary's answer and to the second part of your question, John, I'll just tell you very simply that the Coca-Cola way is to grow our way to success. We invest for growth together with our bottling partners and we have the greatest system in the world. +We have a tremendous amount of experience to say that good marketing, good selling works for our Business. And it will work for our business. We have numerous cases to prove that. +We're going to continue to build on our marketing in both quantity and quality. This is a global increase in marketing. +In every country that we operate in, large or small, we know it works. When we invest in marketing, our global partners invest in feet-on-the-street, in more coolers, in more trucks, in more [lines], and that's what we see happening. That's what we will see, we believe, happening to our Business as we restore steady momentum in through 2014 and beyond. + +Answer_4: + + Judy, it's Gary. Let me take the first part of that question on the fourth-quarter operating profit declined was down 12% in the fourth quarter. By the way, I know the answer to this one specifically because I asked the same question some time back and got into the minute detail on it. +100% of that change is because it's in all in OpEx, or primarily all in OpEx and it's what we're cycling from 2012. There were some incentive compensation accrual reversals in the fourth quarter of 2012 that did not happen in 2013. That cycling caused a significant change in OpEx swing year-on-year in the fourth quarter only and it's what swung North America to that 12% operating income loss. +So it's much more reasonable to actually look at North America, look at it for the full year, and you'll get a better picture of actual performance versus the fourth quarter. When you look at the full year, then you will see that is where we've got some challenges, as Muhtar said, around volume and particularly in sparkling -- around diets and lights. But that's what we're specifically on. + + + Yes, just let me add to in terms of the outlook, and that is that, as I said, we are confident about and excited about, first, our performance our algorithm worldwide. But also in terms of steady improvement as we get back up to speed in the United States and that will -- when we start restoring the momentum in the United States, which we believe is going to happen, that will also bring the financial results that we will be happier with as we move into 2014 and beyond. +It's going to take a while. This is not an immediate fix but we know that it's going to be a steady improvement. + +Answer_5: + + Can't give you the specifics on the geographic mix, Judy, but as we announced, it's about $1 billion by 2016. And it is a global number. +Again, there will be a good distribution. We will be again also looking and tracking through franchise leadership, resulting also system increase in investment in all the key markets. + + + Yes. See you Friday. Thanks. + +Answer_6: + + Thanks, Dara. Sandy, you want to take the (multiple speakers) and then, Irial, you want to comment? + + + The key to the North America growth algorithm is investing in our brands and our feet-on-the-street. A key element to that is getting our pricing so that we can have the revenue to be able to reinvest in sustainable growth. +Where we've had issues over the years, in my experience, in North America, is when we did not get the price we needed, when our marketing execution was not what it need to be, and therefore the feet-on-the-street started to get reduced and ultimately it hurt sustainable growth. Our plan going forward, and it's going to take some time, and we're focused on improving it, is to make sure that we get the price and that we execute the marketing well and feed the feet-on-the-street, which creates the virtuous cycle in the United States just like it does around the world. Irial, do you want to add to that? + + + The only comment I'd say -- Muhtar already mentioned that we are an industry leader. And industry leaders have to set the tone in terms of price, in terms of how to market the brand in any given markets. +Actually less than 50 days in to my new involvement in North America, I'm really excited about the future. I'm excited about the enthusiasm, the passion of our people, our job -- mine, Paul's, Sandy's -- is really to make sure that excitement translates into performance and to results. +As Sandy said, it's not going to happen overnight. I feel we've already started on the journey, and over the next quarters and next couple of years, you will see very positive momentum in our market in North America. + +Answer_7: + + Yes. Nothing different than before. So no change. +We're obviously very excited with our new opportunities for consumption as will be brought to us by the partnership with Green Mountain over time. The key is to fuel the power of partnerships. +The Coca-Cola Company and system is an incredible integration of power of partnerships in every respect. And therefore, this is yet another one. So think about -- if you look at household consumption, in particular the Western markets, there's a tremendous opportunity to gain incremental consumption occasions for our brands through these kind of partnerships. +This is what the Green Mountain partnership is all about. When you look at how beverages are consumed at home and when you look at trends in the next 10 years, people are going to spend more time at home. +They're going to work more from home. Home is going to be an even more important place for people, for consumers. And we need to be present there with different technologies, different packaging, different ways to serve our brands, and that's why this is important and partnerships like these are going to be important for us over time going forward. +Our thinking has not really evolved or changed in terms of bolt-on acquisitions. If we see opportunities, we will get them, like Innocent, like [Oshan] and so forth. And we will continue to seek new power partnerships -- to leverage new power partnerships also going into the remaining part of our 2020 Vision for the next six years. + +Answer_8: + + First, Ali, I disagree with you. We have a great portfolio of brands; we have a great system, the best consumer product system in the world; and I believe that our programs will work and have worked. +We've significantly outperformed and grown since 2010. Yes, we've had a speed bump and certainly that makes us even more focused and more resolute to continue on our road to 2020. +We have -- I will share at CAGNY on Friday, the real reasons why we believe in our future. And so that's all I would say. + +Answer_9: + + I understand. I understand it's easy for people to have very short memories. But we have the experience and we know what we are doing and we will continue to do what we believe and we are focused and we will execute the best and we will achieve our 2020 Vision. +That's what this is all about. So that's what I will say. +And we have talked about pricing. You've heard my colleagues also talk about pricing. And we don't want to repeat ourselves. + + + Thank you, Gary, Ahmet, Sandy, Irial, and Jackson. We've delivered sound full-year financial results. We're implementing the strategic actions that will enable us to restore momentum in 2014 and we see many reasons to believe that we can accelerate our growth over time, achieve our long-term growth model targets, and realize our 2020 Vision. +Our global beverage industry is healthy. The trends that have historically fueled it continue to be strong, and our global systems' commitment and reach are unparalleled. This commitment has never wavered and the strategic decisions that we have made over recent years have not only enabled us to deliver solid financial results, they've also advanced our competitive position, enhanced our capabilities, and strengthened our resolve as a global system to achieve our 2020 Vision. +That is our promise to our investors, to our customers, to our consumers, and the daily objective of the more than 700,000 associates of the Coca-Cola system all around the world. As always, we thank you for your interest, your investment in our Company, and for joining us this morning. + diff --git a/exam/original-files/Problem_2_3_Sample_QandA/25_questions.txt b/exam/original-files/Problem_2_3_Sample_QandA/25_questions.txt new file mode 100644 index 0000000..4633d9f --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_QandA/25_questions.txt @@ -0,0 +1,40 @@ +Question_1: + + Can you please talk about the outlook geography-by-geography and then maybe how the pace of growth is going to differ between volume and pricing given some of the big currency moves and also obviously the tax in Mexico? I have a follow-up if I could? + +Question_2: + + Just a follow-up to Bill's question, if we think about 2014 there's a lot of moving parts, with exchange rates and some of the volatility in emerging markets. Gary, could you talk a little bit about how we should think about currency-neutral and also maybe neutral of the effects of structural change? +Are you still looking at a currency-neutral on-algorithm year in operating profits? And also just some of the other major drivers behind volume that might influence that cost of goods sold inflation, price mix, country mix, that sort of thing? That would be helpful? + +Question_3: + + Just one quick follow-up to Gary's question and then a question for Muhtar or Gary to answer, rather. Gary, does that include a Mexico impact in hitting your long-term algorithm program in 2014? +Then Muhtar, responding to Gary's question about ramping up the marketing, how do we view -- there's a sense out there in the market that given the headwinds for the category, that adding more marketing could be pushing on a string, so to speak. So what is it that you're seeing that says these headwinds that you are facing can be offset with higher marketing? Thanks. + +Question_4: + + A few questions. First, just the North America, Gary, the profitability decline in fourth quarter was pretty surprising. So maybe you could give us a little bit color in terms of the components of the profit decline in North America? +Just broadly in North America from a profitability perspective, the Business hasn't really grown since the acquisition of the bottlers. So as you think about the next couple of years, thinking about the refranchising opportunities, and all the productivity savings, are we at a point where we can actually see growth in this Business from a profitability perspective in 2014, or is this more of a transition year still with the investment that's going on? + +Question_5: + + And just in terms of the media investments, is there any color you can give us in terms of the breakdown by regions, by categories? Is North America likely to get a disproportionate amount in terms of the media spending increase in 2014? + +Question_6: + + I also wanted to touch on profit in North America. It sounds like, in 2013, you view the profit challenges as more driven from a volume perspective, but given that diet soft drinks worries seem to be more secular around longer-term health concerns, I'm just wondering if going forward, you may manage more for profitability and lean more on pricing than driving volume growth. Is there any change as you look at the algorithm between pricing and volume and which metric you'll focus on going forward? + +Question_7: + + Okay, and then Muhtar, post the investment in Green Mountain, I was just hoping to get an update on how important a role acquisitions might play in meeting your 2020 Vision goals. You mentioned the focus on partnerships earlier in the call -- I was hoping you could elaborate there? And if acquisitions are a greater priority here given some of the difficult macro conditions and a somewhat favorable environment with your healthy balance sheet and still low rates here? + +Question_8: + + The frustration I'm hearing from many investors and a lot of questions on this call is just that there's a feeling that the Company isn't doing enough to change itself, despite that the world around it has clearly changed and many, like us, believe secularly. There is continued emphasis on the Coca-Cola way and history, which is respectable in volumes, market share, spending even more on marketing, blaming some short-term externalities. But it's been a little while now that we've seen tougher volumes, North America profit pool continues to shrink, there's only $1 billion cost savings, when some of your competitors are doing more [only] from a pro rata basis. There is limited movement on refranchising your health innovations so far. +So might the Company ever believe that it needs to focus on new levers of shareholder value creation, like pricing up even more, lower promotions, massive cost cutting, big portfolio or innovation change, and indeed returning more cash to shareholders? I know there's lots there, but should investors expect bigger, bolder change at KO to meet this truly different world and if so what should specifically should we be looking forward to, to just sharing in your confidence about the story, or should we just expect the same status quo, going forward? + +Question_9: + + But I don't disagree with you about the strength of the brands at all actually, Muhtar. And I don't disagree with you about the strength of the system. I'm just looking at the results and I'm trying to figure out whether enough is changing, enough is different and whether you guys actually do you the world as different enough and so you're taking action but I actually don't disagree with you--? + diff --git a/exam/original-files/Problem_2_3_Sample_QandA/26_answers.txt b/exam/original-files/Problem_2_3_Sample_QandA/26_answers.txt new file mode 100644 index 0000000..a6b5eb9 --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_QandA/26_answers.txt @@ -0,0 +1,120 @@ +Answer_1: + + Thank you, Bill. + + + Thank you, Bill. + +Answer_2: + + Thanks, Bill. Good morning. First let me say again, that I am pleased to report that our growth momentum is improving in line with our expectations. And in the midst of still -- continued volatility headwinds, achieving sequentially stronger 2% volume growth, that means delivering an incremental 100 million unit cases in the past 90 days or so. That means incrementally, every single day, an additional 27 million actual servings per each day. As the base grows, we are still very proud that we can continue to drive growth. +This is a quarter that is where Easter has shifted, where we were cycling 4% from prior year, whereas I said macro volatility continued, and where we had the harshest winter in northern hemisphere particularly in the US. We don't think this is a great result, but satisfying, as one step in the right direction to restore momentum. Germany, US was flat. In the past quarter, we think, given where -- what we went through and what economies and consumer and climate. Turkey was up 2%, Japan was up 3%. France was up 4%, Brazil was up 4%, India and Russia was up 6%. China was up 12%. These are -- these show, and give us the proof points that our actions are working. +And I think this is a quarter again where only a small fraction of our incremental marketing went -- was deployed. I would say probably around -- so 5% of our total incremental marketing for the year was deployed in this quarter. As we ramp up the quality and also quantity of our marketing, I believe that certainly we are going to drive better alignment. We have really good plans in place, fully aligned with our bottling partners. And I would be disappointed, as would be all my colleagues and associates, if we don't go back into the corridor of our long-term growth algorithm for volume growth. +But also importantly, we are driving not just volume growth, but we are driving immediate consumption growth. When you look -- which is really important for our business. When you look at -- say in this past quarter, of top five countries growing as -- China up 18% in IC growth. Indonesia up 9% in IC growth. Vietnam up 8%, Brazil up 5%. +These are really important numbers, because it is sustainable growth. It is profitable growth, and it is growth in transactions, which is directly married to the health of the brands, and the health of our portfolio. So from that perspective again, I want to just register cautious optimism that I feel we would be disappointed if we do not fall back into the corridor of our long-term growth algorithm for the remainder of the year, in terms of the volume growth picture, and also the other key metrics that follow on from there. + +Answer_3: + + Thanks, Bryan. + +Answer_4: + + Bryan, good morning. Last question first on Brazil, I think Brazil was out the gate first, in terms of the FIFA World Cup activation, a lot of noise around that, a lot of activation in stores. And I think that certainly, we also see a little less malaise in terms of the macroeconomic environment. So and again, in terms of also the relationship between durables and nondurable consumer goods was a little bit more in favor for us. +So we feel that is going to continue, and that Brazil will have a better year. And I think the government is also aware of what they need to do, as they lead into one of the biggest events in their history, which is hosting a memorable event like the World Cup. +As far as Mexico is concerned, I think sparkling volume for us was sort of in the mid single-digits decline for the first quarter. The important thing here is that, because of the strength of our brand, because of also the incredible richness of our packaged portfolio, and our occasion brand price pack channel architecture, the strength of that in Mexico, we are seeing that we are gaining market share, versus both local competitors and our international competitor in Mexico as well. And that -- and again, we -- it is too early days related to Mexico. But I would say that we are again, executing with great precision and passion in Mexico with our great bottling partners. +And then, in terms of price mix, including a favorable geographic mix, other points came as the result of high inflation in local markets. And again, I will ask Gary to comment related to the Venezuela piece. + + + Yes, Bryan, Venezuela definitely contributed positively in the quarter to positive price mix. Now with going forward, that will no longer really be the case, because we have adjusted the -- as of the end of the quarter, we have adjusted the exchange rate and we will be using the [VEF]10.8 exchange rate going forward for most of the revenues, a large part of the revenues in Venezuela. So that will come down. But that impact is included in the latest currency forecast that I gave you. So again, some of the other currencies actually have improved from what we talked about in the February call, that offset now by Venezuela. So still at the same 7% impact. + +Answer_5: + + Oh, yes. (Multiple Speakers). Definitely positive price mix going in there. And I think the other thing to point out, and Muhtar said it, I said it. But I think it is really important as you look at this quarter how we drove value share ahead of volume share. So we are definitely focused on rational pricing across the world, and getting -- earning price. + + + Thanks. + +Answer_6: + + Thanks, John. + +Answer_7: + + Yes. Well, I will try John, and we will see how this goes. But basically, they are -- let's go to marketing first, and let's talk about it in two different ways. One is, how much of the marketing is actually in the market. And that is what Muhtar was referring to, how much is -- of the marketing is actually hitting the consumer, and a lot of our incremental spend actually has not hit the consumer yet. It will -- it is much more weighted, starting in the second quarter going through Q4. A lot of the first quarter really focused on getting the quality of our marketing up, and that sort of thing. +That is different from the way we account for marketing, and marketing as you referenced is on the sales curve. So on the sales curve, that incremental marketing is included in what we expensed in the first quarter. Now, then we get into the marketing that we are cycling quarter by quarter from last year. And so, it was an increase in marketing. In the first quarter, the increase will significantly grow during the year based on what we are cycling. That is part of why I said, that 4 points of operating leverage will go to even to slightly positive, and we are also benefiting from some other timing in the first quarter in just some of the OpEx expenses as well. + +Answer_8: + + Yes. I would say the mood is positive, in terms of their willingness to invest, their appetite for new territories. I have always -- you have heard me say this before in terms of litmus test for the health of the business. There is a lot of appetite for growing in -- horizontally in territory, and trying to get -- expand. And I think in terms of the quality of our marketing, in terms of the quantity of our marketing, I feel that based on all the bottlers that I have [priced] in this past quarter, I feel good. +I feel positive about the sentiment, both here in the United States, as we start our path to franchising, and as we look at how we expand and how we hasten the pace of franchising, but also across the world. I have recently have been with many bottling leaders, and talked to many of them. We have a global system meeting next month. Also, about 50 of the top bottlers get together with their CEOs and Chairmen, and we are there to further align our plans for 2015 and beyond. But I feel good related to the plans in place, related to everyone's desire to execute better and to invest more into the future. +And again, based on the investments that have gone into the marketplace, in the third and fourth quarter of last year. I feel -- that is why I feel confident that you are going to see us back into the corridor of the 3% to 4% long-term growth algorithm for the balance of the year, as we keep restoring momentum. So that is what I would say. +Do we have some pockets of challenges? You mentioned Coca-Cola Amatil. I feel, again, very cautiously optimistic as Alison Watkins assumes her new role there, and we are working very closely with her and her team. And again, we are very much aligned as to how we move forward with SAB Miller and their management team related to their nonalcoholic beverage business. + +Answer_9: + + Thank you, Judy. + + + Thank you. + +Answer_10: + + Thanks, Judy. I will ask Ahmet to give you a response onto your question. Ahmet? + + + Yes, thanks, Judy. Yes, the results obviously for Europe for the first quarter was less than what we would have desired, with the minus 4%. A lot of things came into play with that. You mentioned that Easter obviously, that was definitely a factor. And Muhtar has mentioned the transition into a new future consumption pack in GB. +I would add to that, that there was sort of a pricing activity in the marketplace on future consumption packs that had also had some impact. And we are in very close discussion and alignment with our bottlers to make sure that we actually sort of respond in a way that we maintain rational pricing in the marketplace, but also balance volume growth and value growth at the same time. So that was one. +You mentioned southern Europe. The slight improvement that everybody sees in Iberia and Spain, that we see as well. Our numbers had a bit of noise in it, with regards to the strike in our Iberian bottling partners that you all have heard about before. We have had great mitigation plans in place and executed them. And the negotiations -- or sorry, the restructuring is expected to end in May, and we continue to see improvements in our Iberian business as well. So we expect, as we move into Quarter 2, remove the effect of Easter, fully implement our OBPPC in GB and continue to finish our restructuring in Spain, we expect to see improvements in Europe over the next quarter and the rest of the year. + +Answer_11: + + Yes, Judy, this is Muhtar. Let me frame again, just a couple important takeaways. For Britain, rational pricing was really the theme for us in Q1. And the very -- the strength of our marketing program, the strength of our commercial program leads us to believe that we will see improvement as we go into Q2 and Q3 and Q4 in Britain. That is the takeaway, I would say. +Again, the same phrase and motto for our US business, rational pricing. That is the takeaway. And we had 2% to 3% price mix in our sparkling portfolio in the US, and you will see that continuing. And I will ask Sandy to and Irial to reflect on further details on that for the year. + + + Thanks, Muhtar. Pricing, we expect pricing for the full year in sparkling to actually improve from the first quarter. Our plans are in place with our customers. The market is rational. Our focus on immediate consumption growth will drive mix, and our rate should continue to be healthy, and even improve as we move through the second quarter and into the third quarter where we are lapping some promotional activity. So that is point one, +Point two is, on stills, the case pack water business continues to grow, so it pulls down mix. We see opportunities, however, on a targeted basis in our bottle can stills to improve pricing, and we will take action to do that. Paul, Irial and I see opportunities on a category by category basis. +And then finally, in our chilled juice business, we have just fielded a significant price increase to respond to the commodity issues with our orange juice in Florida, and that is taking root. And our juice business continues to be advantaged from a share perspective. +And I think all of that wraps up, from a pricing standpoint to a much more favorable profit outlook for the full-year. I mean, we saw some timing related issues, and obviously we have talked about having 1 less selling day in the first quarter. But all of that is going to come to do with our price and volume plan for the year to produce profit growth for the full year. Irial? + + + Yes. The only add I would give is, we are about building a long-term sustainable profitable business in the US. And to do that, we must have a balance of pricing and volume growth. And pricing is a really critical part of that, and we will in this year end up with sparkling in the 2% to 3% range in pricing, or price mix, I should say. +And that is really it, and that is what we are focused on. That is what Sandy, and the team, Paul and the team, all of us together are focused on delivering that -- delivering a healthy business that is going back to growth as well. + +Answer_12: + + Yes. Michael, this is Muhtar I will say, just a couple of top line, and then ask again, Ahmet to contribute. But I will repeat what I said about IC, particularly pleasing was China, IC was up 18%. Indonesia, IC was up 9%, Vietnam up 8%. These are really important for us when -- as we drive profitable growth in our business. And again, our newly architected packaging portfolio in China is really working with the smaller packs and the new price points. +And I think also, the new team certainly is really delivering what we expect of them, as well as our bottlers with renewed focus. Both the Bottling Investments Group but also Swire as well as COFCO are really doing a good job in the first quarter. And I think a lot of really good investments and activity and commercial leadership is in place to continue to drive that momentum, both in the stills as well as in the sparkling portfolio in China. And so, again Ahmet, if you want to just -- (Multiple Speakers). + + + Yes. Thanks, Muhtar. Yes, I think, Michael, you have listed a lot of reasons. But my headline would be, it is all of the above. But let me color it a little bit. +Certainly, the new team and the new strategy that we covered with you last year is really coming together nicely, and we are happy with the quality of the growth. Sparkling is growing. Juices are growing and those are the categories that we have told you that we were betting on for our growth in China. +You might see us -- growth in waters. That is an important category. But we just had some recent launches into a [RMB2] water, which improves the profitability of that. Very, very early days, and it is doing well. Also, we are quite encouraged with, again very early results on some of our innovations with Schweppes and plus. And just a couple weeks out, the plans is our isotonic. So we are getting that good mix of sparkling juices and innovation that is beginning to work for us. +I would just caution us though, you did mention the easier cycle rates from last year. That is definitely the case, and 12% growth we are very happy with. But we would expect to see growth in China, continued growth in China, probably in the range of mid to high single-digits that we could expect over time. So that is basically -- I think covers everything. + + + And just one other point I would highlight, Michael, is Japan, very pleasing that it grew 3%, 3% in sparkling and stills grew 4% in Japan in the quarter. And again, despite the longest monsoon that I have ever experienced in terms of seasons and how long it took, India grew 6% and should do much better going forward. So and again, I am certainly very proud that this is the 31st consecutive quarter of growth in India for us, including continued share gains. + +Answer_13: + + Yes, and again, Michael, that is very important market for us, and we have been focused on aligning with our bottling partner, Amatil, there on a new plan. Or let's say, an evolved plan as was the case in China with the revised OBPCC investments in sparkling and still beverages. There has been a recent change in management in -- on the ground. And all of that again, we are cautiously optimistic about the progress we are making in Indonesia, are beginning to deliver good results. And certainly, that market has a -- has so much more opportunity to grow in the coming years. + +Answer_14: + + Thank you. + +Answer_15: + + Now -- no changes as far as my perspective is concerned. And I can confirm that both our entire team, as well as our bottling partners feel the same way as a system. We are blessed to be in a great business, both in the sparkling area, as well as in the stills. We continue to innovate. I believe that we have a great future, where so many hundreds of millions of people in so many large markets haven't tasted a Coca-Cola in the last month, or in the last six months, or in the last year. +We have tremendous opportunity going forward. And I believe that innovation, packaging, equipment and great marketing will continue to grow our business going forward, both in sparkling and in stills. And I feel confident that we will go back into the corridors of our long-term growth algorithm this year and years to follow. +And with new innovations, like creating new paths to consumption, creating new consumption occasions like the Keurig Green Mountain innovation, like Freestyle that is driving, we know everywhere, every time, it is actually installed in an outlet, it drives traffic, it drives incidence, it drives increased sales, and it drives excitement for the consumer. +And at the same time, our contour packages, you will see us being focused much more on the contour. Next year is the 100th anniversary of the contour bottle, the iconic contour bottle. You will see a lot of activity around that also. So we feel we have a lot of work to do. But we feel that, isn't that a great place, where you have a lot of work to do, and you believe in your future. + +Answer_16: + + I think they will -- I am certain innovation is going to be impactful, and I can't give you any more details on timing. + + + Yes. Sure. So just thank you again, Gary, Kathy, Ahmet, Sandy, Irial, Jackson, we are just once again, firmly committed to advancing our growth trajectory in 2014. Our strategic priorities are yielding tangible and measurable results, and they are consistent with our long-term goals, and our overarching business strategy. Increased marketing investments and a focus, a relentless focus on execution underscore the confidence we have in our systems alignment, as we seek to execute these strategies, while we further strengthen the foundation for profitable and sustainable long-term growth. +Our 2020 vision calls for a well-balanced growth, that is growth in sparkling beverages, and also growth in still beverages across more than 200 markets, countries, and in revenues and margins. And thanks to this balanced growth in both portfolio, as well as geographic mix, we see a path that leads to global volume, revenue and profit growth in line with our long-term targets. Our focus is unwavering, and our execution of our five strategic priorities is going to enable us to restore momentum for growth to our business. Thank you for your time this morning, and for your continued interest and trust in our Company. + diff --git a/exam/original-files/Problem_2_3_Sample_QandA/26_questions.txt b/exam/original-files/Problem_2_3_Sample_QandA/26_questions.txt new file mode 100644 index 0000000..fe3b49f --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_QandA/26_questions.txt @@ -0,0 +1,70 @@ +Question_1: + + Good morning, and congratulations again, Gary and Kathy. + +Question_2: + + Muhtar, if you could talk about what gives you the confidence that Coke can hit its long-term growth algorithm in 2014 specifically? And also, when you look at the improving momentum here in the first quarter, how much would you attribute to any relief you are seeing in external headwinds versus the impact of the internal actions that you are taking? Thanks. + +Question_3: + + Hello, good morning, and Gary and Kathy both, congratulations to both of you. + +Question_4: + + So just wanted to drill in a little bit further on Latin America, and I guess, sort of three topics. One, in Mexico with volumes, the volume decline was a little bit less than we thought. So if you could talk about whether what we are seeing now is sort of the expected elasticity? Or if there is something else in the future that might change the elasticity, so has the consumer really seen the full effect of the pricing? +And then second, if you could talk a little bit about some of the drivers of price mix in the Latin America segment in the quarter, how much of it was driven by Venezuela? And then finally, just in terms of the Brazil comp being better sequentially, how much of that do you think is just that -- maybe the consumer is a little bit better? Was there anything specific that Coke did in the first quarter to drive that better performance in Brazil? + +Question_5: + + As we're modeling price mix in Latin America, just going forward, there is some price mix in there that is positive excluding Venezuela? I guess, that is what I was after. + +Question_6: + + Thank you very much, and Gary, it has been great over the last 14 years. So best of luck, as you move forward, and Kathy, looking forward to working with you as well. + +Question_7: + + Gary, I had to finish off with sort of one accounting question here. So you drove tremendous SG&A leverage in the quarter, and you talked a little bit about sort of how you haven't put a whole lot of marketing spend to work yet. +So can you walk us through maybe how we should think about the sales curve over the next couple of quarters, and what we should look for on the SG&A line as we look to model out the balance of the year? Thanks. + +Question_8: + + Okay. And then, Muhtar, if I could ask you a follow-up question on -- you talked about the strength of the bottling system. And obviously, the equity income line is getting hit by FX, but we have seen some comments from Amatil, in terms of what is going on there. And then, also SAB talked about cutting some positions in their soft drink business. +Can you just talk a little bit about the mood of the bottlers and what they are seeing now? And how we should look at some of the headwinds they are facing in the shorter-term? And how that maybe will differ with what happens in the longer-term there? Thank you. + +Question_9: + + Thank you. Good morning, everyone, and I also echo my congratulations to Kathy. And Gary, it has been great. We will miss you. + +Question_10: + + So just wanted to maybe delve a little bit into Europe in the quarter. And the question, number one, just relating to Great Britain. Obviously, sparkling being down double-digits, if you can give us some context of trends that you have seen throughout the quarter? And sort of strip out some of the one-off factors with respect to the Easter timing, as well as some of the transition into the 1.75-liter packaging, and whether you are seeing some improvement there? +And then, just in terms of southern Europe, we are hearing more from some of the consumer companies that things are trending a little bit better in markets like Spain and Portugal. So maybe you can also just give us whether we are seeing a similar improvement for your business in that part of Europe? + +Question_11: + + Okay. Great. And then, if I can follow-up on North America, just on the pricing side. So sparkling up 2% seems encouraging, but the broader North American pricing kind of being flattish. How should we think about that going forward? Do you expect to see the still pricing being a little bit more pressured, or do we see improvement there going forward, for the broader North American pricing turning positive? + +Question_12: + + Good morning. I was wondering if you could comment on the performance of your key markets in Asia, and particularly China and Indonesia. The China volumes have rebounded quite strongly now for two or three quarters, and I was just hoping you could shed some light on what has been driving that? Was it the new strategies and the new team that has been put in place there, whether that is all paying off, or whether it is really mostly due to relatively low comparison basis still? +And then, a similar question on Indonesia, volumes continue to be strong there. I am just wondering what is driving that? + +Question_13: + + And in Indonesia, could you just comment similarly? + +Question_14: + + Good morning. First, Gary, congrats on a great run, and best wishes on the farm, and congrats to Kathy also. + +Question_15: + + And Muhtar, I was hoping to discuss if your expectations have changed at all here over the last year, just regarding the long-term growth potential of the sparkling category? Not necessarily from a market share front, but more just in terms of category growth? +And if one looks at industry data, it looks like sparkling trends slowed more in 2013 than we have seen in other CPG categories. So I was just hoping for some perspective on that, the drivers behind it, and expectations going forward? + +Question_16: + + Okay. And on the innovation front in the US, can you give us a bit more detail in terms of maybe potential timing of sweetener innovation? And how impactful you think natural sweeteners could be to your top line results eventually? + diff --git a/exam/original-files/Problem_2_3_Sample_QandA/27_answers.txt b/exam/original-files/Problem_2_3_Sample_QandA/27_answers.txt new file mode 100644 index 0000000..4fb98b6 --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_QandA/27_answers.txt @@ -0,0 +1,134 @@ +Answer_1: + + Thanks, Judy. Again, just to quickly go through the quarter, as you said, volume was up 3%, sparkling volume really importantly was up 2%, and brand Coca-Cola up globally in North America. Those are really three important points. +Also, another quarter of value market share gains, I think more than 25 consecutive -- 28 to be exact -- consecutive quarters of gaining value share. You see us having at, with our system, very clear focus on priorities. We had our entire global bottling system get together with us a couple -- a few months ago, and again a recommitment to the focus on our priorities. +Sequential improvement in a lot of large markets, particularly Europe, France, Germany, Great Britain, Italy, Spain. And good results, very strong results out of Eurasia and Africa and improving in Nigeria, South Africa, Turkey, improvement again if you take Asia-Pacific. Again very strong quarter in China as well as in India, double-digit growth in India, Thailand again saw --. +So if you take all of those margins that are improving, gross margin has improved in the quarter compared to the prior year. Clear path on North America franchising. Strong belief that what we're doing is working in our system, is really important. Good bottler alignment. Yes, there are a few exceptions, but there always have been and will be, and more work to be done. +I am the first to say we operate in a very volatile global environment, both politically and economically. China is slowing down is impacting many commodity exporting countries and from Africa to Latin America. But overall, what we're doing is working: more marketing through productivity gains, better marketing. +We mentioned Share a Coke program in over 80 markets, tremendous leverage on our World Cup program in more than 170 markets with probably the biggest activation that we have ever had. And all this will not generally have an impact on the quarter that you spend in. It comes in after with better incidence, better brand loyalty, better purchasing time that we're all seeing. +What is happening in North America in terms of sparkling price mix also, you can see that we have a very disciplined approach both in the United States and globally where we have been able to achieve a 2% price mix on a global basis. And yes, there was Easter shift, but at the same time, our gallon shipments were below our unit case volume for the quarter. And if you say that would be a -- neutralize the benefit that we may have got from Easter, then I think overall we feel pretty confident with, again, the caveat that we need to do a lot more work and continue to do a lot more work, more focus, better execution. +But the five priorities are working, and early shoots, green shoots. And we expect that the balance of the year, as I mentioned in my script, that we should be able to fall within the corridor of the long-term growth targets. +And again, there may be issues along the way, bumps along the way. But the most important thing is that we are resolutely focused on continuing to build momentum here. + +Answer_2: + + I will say a few things and pass it over to Sandy, but all I will say is take note of the fact that a very big portion, percentage, 60% to be exact, of the growth came from smaller packages. That is obviously an enhancement of the mix driving revenue, but also rate. +So, I will ask Sandy and then maybe Irial if he has any commentary on North America, but we are operating with tremendous diligence and the discipline in the marketplace. And success for us is a combination of both the growth that we have on the volume, but importantly also growth in transactions which is a really good litmus test of the success of the business that is coming more into play each day as we progress. Sandy? + + + Thanks, Muhtar; hello, Judy. +We said at the beginning of the year that our focus in North America was going to be a disciplined combination of volume and price and that we would see that as a strategic priority. And the second quarter really reflects that; 3% price mix on sparkling while achieving volume growth on Coke. And Muhtar mentioned the importance of smaller packages in driving that outcome. It is also important in driving growth because consumers want more smaller packages, and we've been working on developing that as a part of our overall strategy. +So lots of discipline. As we look ahead, we are lapping some very promotional activity in the third quarter of last year, and our discipline will remain. And the bottlers in the Company around the country are focusing on marketing and selling our way through and maintaining an extraordinary amount of discipline on pricing, and we are optimistic that we will be able to hold that strategy. + + + Yes, it is Irial. All I can add is really repeat what Sandy said, and I have said in the last three calls now, which is we really are focused on building a long-term sustainable business. That is mixing pricing and volume and transactions in a very balanced way and coming up with a great result for our Company. And we will do that, and we continue to do it. + + + Yes, the only thing I would add here also, Judy, is that I think we see a path forward to being able to build more romance with the brand through smaller packages. And that is really an important element in what is also being discussed. + +Answer_3: + + Yes, Kathy? + + + Hi John, and thanks for the question. +The Venezuela impact, yes, that is a two penny drag on a comparable EPS, as well as reported EPS. So if you look at Venezuela, you take it in two pieces; there is currency impact as well as impact of the provision. The provision is less bolivar nominated revenue because of capital margins, and it is gone straight to the bottom line. And then the FX is, the impact is because, as well, we do not have as much bolivar-denominated revenue in income. So you could split those two pieces, and yes, it is comparable, as well as as reported. + +Answer_4: + + So I would split the question into two, and Ahmet will help answer with it, but the margins in Latin America have been impacted this quarter by the Venezuela provision. And then when you look at ongoing buying growth in contribution into the Company, I will let Ahmet -- + + + John, a couple of points. The rest of Latin America, the margin and the growth in profitability overall is in a good direction. No important issues there. Also keep in mind that we've been able to realize positive price mix in high-margin places like Europe, and we have been able to grow in Japan, so we are able to balance across the international territory to have positive price mix and margins. + + + John, just to add, I think yes, you are right in saying that Latin America has slowed down to where it traditionally has been. And we have seen these cyclical slowdowns in Latin America. +And as some parts will get better, I think, starting towards the end of the year, we also see some other volatility, continued volatility in like Argentina and other markets. But overall, I think for most of what we are cycling as well, we expect major markets in Latin America to have some sequential improvement in the second half of this year. And then overall longer-term, we feel very confident also about what is lying ahead in Latin America. + +Answer_5: + + Okay, hi Brian, thanks for your question. +Our outlook for leverage in the currency neutral basis remains flat to slightly positive. When you think about gross margins, so gross margins have improved for the second quarter and year-to-date. And when we look at -- when we look at our margins for the back half of the year, we delivered sound financial results, and we anticipate that we will continue to deliver sound financial results for the rest of the quarter -- for the back half of the year. And we do anticipate that margins will continue to in the same way they have been in the first half of the year. + +Answer_6: + + Yes, we are continuing to invest behind our brands. So yes, that is part of the leverage story. But that is causing the North America from negative -- slight negative leverage in North America because we are spending behind our brand. So, we are getting pricing and we are committed to rational pricing, so we're getting pricing which is helping us with the margins the gross margin, but we are continuing to invest behind our brands. + + + Just add to that, Bryan, if you look at the second quarter compared to the first quarter, marketing is substantially higher in the second quarter than it is in the first quarter, and particularly towards the back end of the second quarter, substantially higher. So, that explains some of the things again, what Kathy was saying, but also our productivity is on target. It has been on target for the first half of the year and will be on target for the second half. + +Answer_7: + + Yes Michael, it is Muhtar here, and I will ask Ahmet to provide additional commentary. +Think of Brazil as having a very tough macro environment in the first half. So if you look at the entire consumer disposable and non-disposable consumer goods sectors, we are under tremendous duress in the first half of the year, particularly leading up to -- particularly -- more so in the second quarter. +Think of it this way -- had it not been, the result would not have been what it would've been had we not done all that activity. So from that perspective, I think we see brand getting stronger, incidents and purchase intent getting stronger in Brazil as a result of all the activity, and I think that should benefit us going forward in Brazil. +So certainly the macro environment in Brazil, as you can read, as we can all see, has been very challenging. And so given that backdrop, I think, our results -- we're content with where we are, and we believe that what we have done will benefit us in the second half and going forward. In terms of Mexico, I think both times prices were adjusted, they included a certain portion for also inflation, so take it as that. But again, I will ask Ahmet to provide any further commentary for both Brazil and Mexico. + + + Thanks Muhtar. +On Brazil, the only thing I would add Michael is that we had a pricing packaging architecture which allows us to have different tax both for immediate and future consumption at different price points, and we are executing those with great discipline. And that in fact is helping us navigate this challenging external environment. +And we expect that to continue to bear fruits in the third and fourth quarters along with the strong marketing programs we have. With respect to Mexico, the only other thing I would add is that we do have a not just passing the tax and the inflation, but a consumer-driven pricing approach which has been very carefully calculated, and the elasticity that we have calculated in reality are happening better than that we have expected. So in other words, our Mexican business is showing more resilience in this area. + +Answer_8: + + I think success for us is certainly continuing our value share gains. You cannot obviously -- only value share gains without volume is not sustainable over the long term, but we have a very disciplined approach just like in North America, also for our international business related to more smaller packaging. +So the mix will benefit us, but also very importantly it is critical for us to achieve price mix on a global scale. Different geographies will again price differently into the picture. We have such disparate pricing per case depending on the geography we're talking about, so geographic mix is an important piece of this, as is package mix, as is rate. + +Answer_9: + + I will just say that once again, smaller size packs contributed significantly to, say, brand Coca-Cola volume and revenue growth into Q2 and year-to-date as a matter fact. So, if you take over 60% of the growth in brand Coca-Cola in Q2 was driven by double-digit growth in our mini can and 16-ounce immediate consumption packages, I think that is how I would like to leave you with -- that is what I would like to leave you with as an opportunity. + +Answer_10: + + Yes I will take the last first. The strategy is driven by what consumers want, and that is not just a phenomenon for the United States but smaller packages are a key focus. So that helps the mix. That helps the revenue. That helps also the price mix. +Then, couple that with a very disciplined approach towards also having the right balance between value and volume share gains. And so it is really important. +In terms of concentration of volume growth, I think the important thing is for you to focus on the improvements from quarter to quarter. If you take key geographies like Europe, France had an improvement, Germany had an improvement, Great Britain had a significant improvement. +Italy had a significant improvement, Spain had a significant improvement, and Europe overall had a huge improvement when you look at total. And again, this is just pure simply for volume, and if you look at pricing earnings, you will get also a similar picture. +So I think focus on the sequential improvements. Focus on us delivering on our focused priorities. And so what I see is that we will strive, and diligently strive to continue with sequential improvement, building momentum as we go forward. And I also mentioned as an answer to a previous question that I thought that in Latin America, we would also see sequential improvement. + +Answer_11: + + Well we announced significant cost cuts over the last four or five years, different programs. And as I mentioned earlier, again we are on target with our productivity. And that productivity is being reinvested to drive growth. + +Answer_12: + + I will talk about a couple of levers, and then ask Irial to join me. The growth and profitability in North America, the major opportunity exists in pricing and the overall effectiveness and efficiency of the system. +We talked about price as a lever and an area of discipline and focused, and price is achieved through rate as you know, and also mix. And a whole lot of innovation is going on inside of packaging to give consumers what they want and to earn a return as a result of that. +Couple that with our overall system architecture work, which Muhtar described earlier which is on track as we overhaul IT, product supply, as we overhaul customer management and shared services. And the refranchising progress which is on track with our bottlers, will create a system that is on one hand more effective and grows faster and on another level is more efficient at generating better margins. +But at the end of the day, that combination needs to be built on accelerating growth. And the focus of the near-term has been to reinvest the proceeds into marketing to rebuild brand momentum and brand momentum at price point. We're optimistic about the progress, but we have a lot more work to do. + + + Yes, the only add I would give is [we're in] to the bottling houses, we remain absolutely committed to deliver one of our core priorities, which is excellence and execution in the marketplace. And as every day goes by, I get more comfortable that we are starting to do things better every day, every time we go to an outlet. +And fundamentally that is the other piece that gives us the capability to get extra price and mix in the marketplace, and we will continue to do that. And it is a journey. It is not turning the light switch on. It happens day by day, weak by weak, month by month. +I feel pretty good that over the next number of years, our capability in the marketplace, married with great marketing, is going to deliver the price mix we all desire. And that is why the discipline in remaining focused on price mix married with transaction growth and married with volume is why we feel confident about the North American business over the long-term. + +Answer_13: + + Yes Bill, I think in the UK most of that loss was in Q1. If you look at Q2, we have had sequential improvement in the UK. And we expect that going forward in both Mexico and in Brazil that more minor losses to the B brands and local players will reverse themselves in the course of the year. +And we already see that happening in both markets. I think that was the difficult operating environment in Brazil in terms of also us having discipline in our pricing, and the same goes for also Mexico. + +Answer_14: + + And very transitory. + +Answer_15: + + Yes, two things. Spending increased as we moved through the quarter, and there was much more spending at the end of the quarter than there was at the beginning of the quarter. And therefore you would expect that not all of that benefit is going to flow, obviously, into the quarter. And this is again about generating long-term sustainable momentum, which we believe is happening. +Again I want to remind everyone that I am pleased with these results in a difficult operating environment. And to get growth back into sparkling is a significant achievement, to get growth back into Coca-Cola in the world globally and in the United States is a significant achievement, and we will continue to focus on where we need to be quarter after quarter, one quarter at a time. I just want to say that I believe our approach is working. + +Answer_16: + + Yes, Kevin. +Obviously, I cannot walk you through a wish list; that would be too much information to the whole market and everyone that plays in the market. But I would say our portfolio is really very rich, as you saw as from our $17 billion brand and so many more in the pipeline. +And again, our sparkling brands have really performed well on a global basis. Sprite and Fanta and Schweppes in addition to Coca-Cola. So, all of that tells me that what we're doing in different brands and creating more incidents, more transactions is working. +And you heard the numbers that I mentioned in tea both in the US and globally, in premium waters, in juice and juice drinks, in sports drinks, all of that. We are pleased with a much richer portfolio than we had, say, three years ago. And that portfolio is again yielding very good results, particularly, also, Simply in the juice category, [Dasani], Innocent, all those different brands. Del Valle across the world yielding very good results, and also in China too, and southeast Asia with new innovations that are really working well for us in both the fusion of dairy and juice, as well as pulpy drinks and also juice and juice drinks. + + + And on the second part of your question, yes, I believe the Company has always been very focused on driving long-term sustainable growth. And we have done that in a very consistent and disciplined way. We are very focused on reinvesting in the business and to accelerate growth and create value. I believe we focus on making sure we have share repurchase and we do give a healthy dividend back, but we will continue basically like we've been going with focusing on driving long-term growth. + + + Thank you Kathy, Ahmet, Sandy, Irial and Jackson. The performance year to date, progress against each of our strategic priorities and the positive signs that we are seeing in many global markets all illustrate our view that the 2020 vision and strategic plans are solid. +Proof points are out there. 3% growth in the quarter, global price mix of 2%, increased global media spending reflecting our confidence in building on the strength of our brands and also in our ability to engage our consumers and customers effectively, and global year-to-date value share growth in our categories. +And so we are winning in the vibrant beverage industry and also coupled with sound financial performance during the first half of the year. So we're making steady progress. And we are where we are expected to be at this stage in the year. +I look forward to providing all of you with additional updates as we continue to restore our global momentum in the months ahead. Thank you for your time this morning and for your continued interest and trust in the Coca-Cola Company. + diff --git a/exam/original-files/Problem_2_3_Sample_QandA/27_questions.txt b/exam/original-files/Problem_2_3_Sample_QandA/27_questions.txt new file mode 100644 index 0000000..fec3e4e --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_QandA/27_questions.txt @@ -0,0 +1,81 @@ +Question_1: + + Muhtar, if I look at your second-quarter performance buying growth of 3%, sequential improvement versus Q1, global price mix held steady at 2%. I guess second quarter also though benefited in part because of easy comp, and you had the Easter benefit. So can you talk about your ability to sustain the top line momentum as you look at the back half of the year and be mindful of some of the macroeconomic conditions that you see in the marketplace? + +Question_2: + + Okay, that is helpful. If I can just quickly follow up on North American pricing, particularly in the sparkling side, where you've got the 3% in the quarter. Maybe a little bit more details around the drivers of that, whether it was -- how much was mixed versus rate -- and your views on whether you can sustain that pricing and maybe even see acceleration if you look up the next -- + +Question_3: + + Thank you, good morning. Just wanted to get a clarification if I could, when you talk about the $0.02 impact, you mentioned it was comparable EPS, but it sounds like that is reported EPS, as well. Is that correct? + +Question_4: + + Okay great, thank you. +Kathy, if I could just follow-up, we are continuing to see weaker volumes in some of the higher-margin regions, like Latin America or Europe, what have you. So can you talk a little bit in terms of how you're going to look at--how should we think about margins going forward if these types of -- this type of relative weakness in some of these higher margin market continues, particularly Latin America which is your highest market region, and it's been a little bit softer over the last couple of quarters. + +Question_5: + + Good morning. +Kathy, I wanted to follow up on John's question relative to leverage and I have two parts to it. One, I think I caught in the prepared comments that you mentioned that on a comparable currency neutral basis, you would expect some leverage in the second half. So I am just trying to make sure I heard that correctly in that we should be thinking about ex the Venezuela impact and ex the structural change in currencies, there would be currency neutral operating profit growth. +And then second question, if I have done the calculations correctly, it looks like on a comparable basis currency neutral gross margins in the quarter were up. So if you could just talk a little bit A, is that true? And B, if you could talk a little bit about how you would expect gross margin to evolve going forward, what type of inflation you are seeing and just how what factors you might see driving gross margins in the second half. + +Question_6: + + So there was nothing unusual about the gross margins in the first half? We could potentially see more progress on gross margins and we're just spending more money back which is what is getting the leverage to slightly flat. Is that a good way to think about it? + +Question_7: + + Good morning. +Can I ask a couple of questions, couple of specific questions on Latin America? First on Brazil, given all of the investments you made in the market and the World Cup, I was just wondering why volume performance was not stronger in the quarter. +You mentioned in the release a tough macro environment and some competitive activity, but I was hoping you could give us a bit more detail. And second, with regards to Mexico, I know you've taken all of the pricing related to the tax increase early in the year, but have you also passed on pricing now for general inflation in the country? +Thanks. + +Question_8: + + Thanks, good morning gentlemen, hello Kathy. Muhtar, as you think about the sparkling global outlook and your efforts to build on where you are here in the second quarter, is it fair to think your emphasis will continue to be on volume share gains more so than dollar share gains, or do you think there is potential for more dollar share growth in spite of the volumes being a little below what you were hoping for? + +Question_9: + + Obviously, a lot of markets to talk about, and this call is not useful for going into many of them, but when you look at North America specifically and you see the 3% price mix on the carbonated and a bit of growth there on the stills, but you also have the flat volumes. And then data we look at is CPI for the larger carbonated space, which continues to be down, so retailers continue to promote the carbonated component of your business. How are you thinking about the opportunity for better value share performance in North America, given the volume share situation you are facing? + +Question_10: + + Hello. If you would've predicted back in December that price mix in North America was going to be up as much and your volumes would've remained flat. And Latin America, you indicated volumes would've been flat even with all the Mexico tax issues, I think I would've said you are being optimistic, but that is what you are delivering, which is good. +But it does raise two questions for me. One is, it is concentrated your volume growth in only two of your six reporting segments. I want to get a better sense of how comfortable you are with those two currently and your expansion of volume growth in the other segments, like what gives you confidence that the others can grow, as well? And then secondly, a question about the mix between volume and price mix, which if you look over the past 10 years, it is mainly driven by volume, obviously pricing now much more balanced. +Some try to understand how much of that is actually a change in strategic intensity that you described versus just FX driving you to raise more pricing? If you can help those two, that would be great in the broader volume context. + +Question_11: + + Okay, thanks. +And one other things you've been asked a bunch on this conference call is about margin and margin mix. And one of the things obviously that can offset margin pressures is incremental cost cutting. And you talk a little bit more about how you view incremental cost cutting versus what you've announced so far, what you think the potential is, and when you think we might hear more about more cost-cutting at the Company? + +Question_12: + + Thanks. +Maybe building on that and focusing back on North America, as you talked about, you had good price mix realization in sparkling, 3%, and you did see margin grow in the quarter which is great. But overall, we only saw 1% price mix, and year-to-date margins remained slightly below last year's level in the US based on my math. +So as I think about the path towards refranchisement and smoothing that path, it seems a greater profitability is a great enabler of that. What needs to be done? Is there a way to get even more aggressive on price mix realization or to Ali's point pushing on productivity more to get the North American profit pool to expand to facilitate entry of new partners? +Thanks. + +Question_13: + + Good morning. Can you just comment about some of the market share losses in Mexico, Brazil, and then a much smaller market in the UK? +So what do you think is driving that? And then when you think some of those trends will reverse. +Because some of these losses are substantial. I think it was a little over a point of value share and scan channels loss in Brazil, about a point in Mexico and then similar trends in the UK. + +Question_14: + + Got you. So you think your losses are really a function of maybe the more aggressive pricing you took and maybe as that stabilizes this year --. + +Question_15: + + Good morning, everyone. +Quick question I had is, if you think about the quarter and how trends move through the quarter, I am just curious if you actually saw correlation with the higher level of spending as the quarter progressed and your volume growth. Just again trying to understand if the spending is actually working. And when you think about the ROI in that spend, what discrete things and specific things is Coke doing to make sure there is a glide path to getting a better return out of that spend. Thanks. + +Question_16: + + Thanks for the question. +First Muhtar, you talked about increasing or broadening your product portfolio. So, maybe without tipping your hand too much, what would be the top of your wish list by product and geography, and do you still feel comfortable with your energy drink strategy? +And then separately, Kathy, now that you bring a fresh look here, do you plan on doing anything differently from a capital structure perspective? And I say that within the context that there is an argument to be made that Coke is under leveraging and could potentially add leverage, or by adding leverage could add value to shareholders. And we have seen a number of companies in the CPG space that have been rewarded by the market for such action, so any thoughts there would be appreciated. + diff --git a/exam/original-files/Problem_2_3_Sample_QandA/28_answers.txt b/exam/original-files/Problem_2_3_Sample_QandA/28_answers.txt new file mode 100644 index 0000000..c2ab246 --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_QandA/28_answers.txt @@ -0,0 +1,152 @@ +Answer_1: + + Yes. Bryan, good morning, again, this is Muhtar. I think the most important is that our EPS target remains high single-digits and our target for profit before tax is still 6% to 8%. Beginning in 2015, revenue growth will be added as a metric in the Company's incentive plans as well. So we're obviously looking at a metric, really, where the target remains 6% to 8% and moving the target to PBT really brings net interest and equity income into consideration. If you look back at the last three years, there really has not been a leverage between OI and PBT, meaningfully so. It would not have really made a difference. +Having said that, it does go back to what we said about broadening our long-term net revenue target to mid-single digits. We think that there's opportunity to grow equity income as we advance our existing partnerships, as well as explore similar models in the future. Using PBT instead of OI should make operations, in a way, agnostic in terms of evaluating alternatives to extract value in a certain given category; for example, what you mentioned also, which is partnership model versus concentrate model. So I think it's a better broadened way of ensuring that we can deliver long-term sustainable value to our shareowners. And I'll pass it on to Kathy if she wants to add anything. + + + I'd just also say, Bryan, remember we anticipate and we've been saying that with the increases in interest rates, we will have interest expense versus interest income that we've been generating. So we don't anticipate interest providing leverage below the line going forward. So the bottom line is we can't make the 6% to 8% PBT without a significant amount coming from operating income. + +Answer_2: + + No. Not at all. + + + No suggestion in any respect. + +Answer_3: + + Hi, Ian. This is Muhtar. Good morning. Firstly, let me just give you some context around the base. If you take, firstly, that's why we put out two numbers out there, $2 billion by 2017 and $3 billion by 2019, in order to ensure that everyone sees that this is not back end-loaded, it's just a number that really will be generated and the run rate will be flowing through into our system and then we will invest some and use some for margin enhancement. We did say that it will take some time to achieve. +2015 is a critical year where we really -- it's the most important year for us to make the changes that I mentioned to you in terms of a leaner, better operating model and therefore, I think that year should be seen as a year in transition. The base, really, when you look at our Company, you see about $5.5 billion in total in marketing, about $4 billion in OpEx, and really, of the $3 billion, about $1.5 billion will come out of that base of around $9.5 billion to $10 billion and then the other $1.5 billion of the $3 billion will come out of the about $25 billion COGS base. +It's important to understand for everyone that we will not be taking down the second number, $1.5 billion, when we refranchise with our aggressive refranchising program, particularly for the United States, between now and 2017. So that number will stay that way and then the bottlers will get additional opportunities for COGS synergies as the territories get refranchised on top of the $3 billion. So I hope that gives you some flavor and explanation into and answers some of your questions. Kathy, go ahead. + + + Ian, if I could just add, on the initial $1 billion program, $400 million was in 2014 and we are on track. So it continues into 2015 with the rest of the productivity giving us the flexibility to achieve our targets over the long-term. + +Answer_4: + + Yes, I think given the macroeconomic volatility out there and given the fact that marketing investments are taking some time to flowback in terms of benefit, I'd just say that's the best we see right now and we will come back with a more robust and more detailed discussion on 2015 in our December call. + +Answer_5: + + Yes, Ali. I think what we're talking about is a balanced approach that will bring us back to our long-term growth trajectory in terms of our financial performance. That is a combination of both growth, more realistic and better sustainable growth on the top line, as well as margin enhancements. So as we said before, this additional program of productivity will yield, will generate two things: we believe clearly better growth, as well as better margin enhancements. +The important thing here is that we will have a much better geographic segmented analysis of countries where, if you take the developed countries, we will be driving profitable growth through innovation and productivity; for example, with countries like Spain, Korea, Great Britain, Japan, US, France, and so forth. And then in terms of the developing countries, they will have a slightly different role maximizing value through segmentation and ensuring that we continue to build consumer loyalty markets like Latin America, Turkey, Poland, Nigeria. And in emerging markets like China, India, Indonesia, Thailand, and so forth, we'll be maximizing more skewed on the volume side and investing for accelerated growth. +That is why we believe we need to continue to invest and the world is a very big place. It's not just the countries that we live in and we know. It's a very wide place out there and there is significant opportunities to continue to generate growth, while at the same time -- and we believe that there is a very good line of sight of how we invest and how we get return from that investment, very disciplined and very important transparent line of sight. +That's the way we look at the segmentation approach and therefore, revenue, which is the target of what we've indicated to you will be a composition of volume and price and so we're not throwing volume out of the door. It's a very balanced approach towards how we will generate revenue, how that revenue will flow into bottom line, both through the additional revenue growth achieved, as well as through enhancements in terms of the margin. + +Answer_6: + + Yes. I think we're not ready to share that detail with you right now. However, I think as we go along, we'll give you more insights. But certainly, it will not all be invested and it will not all flow into the bottom line, but I think we see a clear balance there as we go forward. And I think there's a different role -- obviously, there's a different role of how you should think about the $1.5 billion that is coming out of the base of total marketing and OpEx and also the $1.5 billion that is coming out of the COGS and I think both of them have slightly different roles in how they will be played out. + +Answer_7: + + I think you should think of the entire Company as evolving and changing. But as I said, Dara, I think the important thing is roles and responsibilities on a geographic basis with complete clarity of roles. So if you take the markets like -- the more developed markets of Korea and Spain and Great Britain and so forth, Japan and United States, Canada, more focused on the balance of revenue. What will drive the revenue? Slightly skewed in favor of price versus volume. +What will happen in the developing markets, more like Latin America and some Eastern European markets, and so forth, Turkey, much more straight line, right in the middle balance of how that revenue number is going to be generated, that revenue growth target is going to be generated. Then you take the lower per capita, more emerging markets that I mentioned, of the Indonesias and Indias and Chinas of this world and Southeast Asia as skewed more towards volume. But that doesn't mean that there's not a pricing metric and that doesn't mean there's no incentives based on revenue. It's just how they're skewed. + +Answer_8: + + I'll ask Sandy to comment on that North America number. Sandy and Irial are here and I'll ask Sandy to first comment on that. + + + Yes, Dara, our view of the pricing strategy in the US is being very consistent with what we said at the beginning of the year. Very focused on making sure that we get our price, that we balance that with a package strategy that's focused on our premium packs and our smaller packs, which consumers want, and continue to grow double digits. We're pleased, as you can see in the Nielsen data and the marketplace, the consumer's responding with accelerating sales growth. Actual volume was slightly better than we expected and clearly the volume on the premium packs that are the focus of our brand building agenda and supported by our advertising are driving the train. We're just at the beginning, though. +I think North America's ability to play a primary revenue growth role in the Company with this disciplined balanced strategy is in the early stages and we see a rational environment and we see a good competitive environment in which the category sales performance is accelerating and we're optimistic about the future. + + + Irial, do you want to add to that? + + + Yes, I'd just remind all of us, in the first quarter, we said we were going to have a very disciplined approach to pricing in North America and the last three quarters we've demonstrated that and the intention is to keep doing it. We feel good about it. We feel we're going the right direction and feel very confident as we actually head into the future on pricing in North America. + + + Yes. Maybe I'll ask Ahmet to comment also on the same subject as it pertains to Europe and as it pertains to Latin America and some other markets. Ahmet? + + + Thanks, Muhtar. As we talk about the revenue focus, we are also focusing on balanced revenue growth in Coke International. Maybe a couple of examples I could share is in Mexico for example, where you see 2% growth in volumes for the quarter and more or less flat volumes, we're actually seeing fairly healthy price mix of about low to mid-single digits and our revenue growth reflects that as well. Likewise in Brazil, we're also seeing mid-single digit revenue growth, even though our volumes are up only 1%. We are quite cognizant of balancing our revenue growth with appropriate pricing realization and volume at the same time. + + + Do you want to say anything about Europe? + + + And in Europe, obviously we are not pleased with our volume performance of negative 5%, but the challenging macros are bringing with it a fairly aggressive pricing environment in the marketplace. We are always trying to balance our pricing with volume. In this quarter, I would say that we were a lot more in favor of pricing where we have realized 3 points of price mix in Europe, which resulted in a revenue decline of 2%, while our volumes were 5%. +Having said that, this is a journey and an ongoing balancing act. We would be focusing on balancing that a little bit better so that our share performance continues to be strong, which it has been for the last four years, and we are on that journey in Europe. + +Answer_9: + + I think, Bill, firstly, it's fair to say that we are in a challenged disposable income growth environment. That's no question. The consumer is challenged everywhere around the world. It's not just related to the Western developed markets of Europe and Japan and United States and Canada, but it's also related to emerging markets. There's a lot of volatility in the world when you look at in the currencies, when you look at interest rates, when you look at the growth rates, and when you actually factor in all the different geopolitical issues around the world. There just is a lot of apprehension. +Less people traveling because of disease, because of scares, because of other things, mobility is down and traffic is down and that all impacts, particularly, our immediate consumption business. So we've got to find newer, better ways to ensure that our products, our brands, our 3,000 products, 550 brands can meet up with consumers on different occasions, on better occasions, on newer occasions, and on more innovative ways to get our products in front of our consumers. Certainly, we recognize that, that is a challenging environment. We operate in that environment, but we have still one of the most dynamic consumer goods businesses in the world. +We believe that it can still, over time, grow at the rate that we have just outlined to you in terms of revenue growth. Is that going to happen overnight? No. Can we get there? Absolutely, yes. Then we have other elements to deal with in terms of trends. So we recognize that we have to do more work on diets and lights, for example. We continue to innovate. We continue to launch new products which have different sweeteners and different sweetener bases. That will continue in an expanded mode: more innovation, more packaging, and newer ways for consumers to connect. +Next year is the 100th year of the contour and we certainly will be expanding our IC focus -- our immediate consumption focus in the market, which is a really important way to build habit and build trends and build [team incidents] and then improve our marketing and improve our commercial strategies with our bottlers, which we keep working at. So that's where we are. It is a very challenging environment anywhere you go around the world. It's not different. +Everyone is apprehensive, whether it's governments, whether it's NGOs, whether it's businesses, local businesses and International businesses. I don't see that improving overnight, but I think it's the new normal. In that new normal, we need to generate better growth. + +Answer_10: + + No. No specific read through. I would just say that given where we are right now, this is the guidance we thought we should provide at this time. + +Answer_11: + + We did give a different outlook on currency, which does impact cash. + +Answer_12: + + It's Irial. On the supply chain in North America, basically this is a continuation of what started a few years ago and it's made up of many different aspects, which we'll share in due course, as Kathy has already said and Muhtar. But the key is that we're looking at becoming more effective and more efficient. We have a very substantial supply chain footprint and we believe and have the plans to make sure we become truly efficient and that means by streamlining in many different ways. +Simple illustrations are things like the bottle life weighting, which is pretty well carried out across the world today, whether it's mechanizing at different parts of our supply-chain, whether it's our footprint, our supply chain and so forth. So many different aspects, but very clear plans behind it and a high degree of confidence that we will achieve the synergies that we've set out. + + + On that, once again, I wanted to reiterate the point that I made earlier, this is Muhtar, that of the $2 billion by 2017 and the $3 billion by 2019, the incremental synergy program, that is not going down as we substantially refranchise our business in North America. + +Answer_13: + + Judy, this is Muhtar. Good morning. Yes, we are streamlining and simplifying our operating model for better speed, better decision-making and enhanced, also, local market focus that will help us to drive better growth. This work is moving forward aggressively. It's global. It involves a center and involves the entire Company and we expect to refocus the role for our corporate center and further scale our back-office to support our processes and also policies on a global basis to get more synergies there and better service to our business units that operate around the world that basically make up the Coca-Cola Company. +This will enable those operations to fully focus intently on demand creation in their market. So this is really important. It's a delayered organization. It is a simplified organization. It's less touch points, it's faster decision-making and that will take place, starting with the beginning of the year and you'll hear more about that in the coming weeks. So that's important. +I think it's important, if I just take back a minute and just to say again, this is certainly a difficult operating environment and that is clear. No question about that. But today, we're announcing, I believe, definitive actions as a team to address that environment and improve our execution. The $3 billion in synergy enhancements are an added layer and an added layer of segmented analysis on top of the $3 billion in metrics on a market-by-market basis is clear evidence, I think, of us taking action to control, in a way, what we can control. I'm so pleased that we have a team that has basically worked together for a long time and we know what it takes to win. Today, we are taking essentially additional steps to get us back on track over the longer term and we will do whatever we have to do to get there to get us to that bridge. +We know it can be done and we know we will do it. I think the synergy program will help, the new operating model will help, the enhanced execution will help, the better marketing will help, and the improved commercial strategy will help along those lines. Is the operating environment tough? It is tough. But we are fortunate to be in a business that is one of the most dynamic businesses in the world; the nonalcoholic, ready to drink business. And so that's what I would leave you with. + +Answer_14: + + Thanks, Judy. We don't like to talk about weather too much in this, but I would say there was probably not so favorable weather. You mentioned the macros. Let me start with China. You could see from the numbers in China that total food and beverage industry, NARTD industry is actually under pressure and the growth rates are coming down. But I'm very pleased with our performance in China because now we see a lot of traction on sparkling beverages, which actually grew in the quarter. Trademark Coke was up 4% in China, which shows that the strategy that we have shared with you all, beginning of the middle of last year, of segmented focus of our beverages in China is actually working. +We're very pleased with our new launches of the isotonics. That's doing very well. Very pleased with our innovations in sparkling with things like Schweppes C'Plus. So for China, I'm very pleased with the results and we're gaining share and our initiatives are working for us. +When it comes to Europe, I have shared with you all a little earlier, it is more a matter of balancing our price realization and volume a little bit more in the favor of volume and share, still realizing good price mix. I would say other than that, Europe performance was mostly to do with the macros and you've mentioned weather. I will not. + +Answer_15: + + John, this is Muhtar. When you look at the current revenue figure that we've put out there, if you take the midpoint of that, it's only 50 basis points different than what was out there before earlier. So I don't see that as a major difference in terms of the category, in terms of the cyclical long-term macroeconomic. I think we see tremendous opportunity in this segment, in this very dynamic consumer goods industry. So I see that's not any major shift. We've been pleased with productivity in terms of what we've done to date. Macros have not improved and so we have to do what we need to do in order to ensure that we can cross the bridge and get to better both top line growth, as well as bottom line delivery of performance and that's what you see us doing right now. +In the past, you would have cycles in macro, you would have a year or two years of down and then coming back up and now it's constant volatility and actually increased volatility every day around the world and increased apprehension by the consumer. So we have to do more. We have to ensure that we create the flexibility to deliver our results and that's what you see us doing. + +Answer_16: + + Kathy, you want to add anything in terms of investment, in terms of the efficiency, what John talked about? + + + Sure, Muhtar. First of all, going back to the first question around the net revenue, the two things that are primarily driving the change would be the value growth that we see coming from emerging markets, as well as the more volatile nature of the emerging markets and then recognition that our partnership models will drive value for the business that will impact equity income. So I just wanted to add that particular point. Then on the productivity -- sorry, I don't remember the productivity question. What was the question? + +Answer_17: + + Yes. There actually is, John. What we have done in the past is we've said that productivity, the original $1 billion is made up of both OpEx as well as reallocation of marketing to ensure that marketing is more effective and more efficient in terms of its delivery of results. So that is an ongoing program that we have in terms of how we will continue to reallocate marketing to drive better value and better return. That is there. That is ongoing. +However, of course, the scale of what we're doing in terms of OpEx flexibility is going to be much, much bigger here, but the vast majority of the additional savings program is hard savings in productivity. The vast majority is hard savings as opposed to reallocation. We will ensure that the amount of money that's invested has a return. That's a different answer, but we will make -- it is actually, I'd say, the vast majority, in fact, is hard savings. + +Answer_18: + + When all is said and done I'd say probably, Mark, it will be about mid-single digits in 2014. I think we'll give you, again, in December, we'll come back and give you more flavor about how we're thinking of that in 2015 and beyond. + +Answer_19: + + I wouldn't assume that. + +Answer_20: + + Look, I said the vast majority is hard savings in productivity programs and that is composed, as I mentioned earlier in answering another question, that is composed of a base of about $9.5 billion, $10 billion comprised of marketing and OpEx and then another base, which is driving about a $1.5 billion by 2019. The other half, $1.5 billion by 2019, is driven by COGS savings. But these are hard savings, not in terms of just soft or reallocations. + +Answer_21: + + This is Muhtar. First I think, based on the collective judgment of myself and my team, as I said to you, this is an acknowledgment of a continuing difficult operating environment and controlling and taking action to control what we can control. That will mean two things: create flexibility through the synergies and also ensure that we can enhance our margins and build a credible and sustainable revenue growth on the top line. That is the key here, which at this industry, lends us to believe and clearly, the history has shown that this industry is the most dynamic and it continues to be. +Therefore, we believe that when we segment our markets in the way we have segmented them, continue to ensure that we have the right metrics in place and the right incentives in place, that we will perform better. We're almost finished with this year and we're going to be embarking upon implementing this now so that we can start the year running. We will give you a very clear dashboard in December where you can -- with three or four things to follow you can judge our progress -- judge our progress as to how we're implementing and generating the results out of this program. That, to me, I think, is going to be key, following our progress and we will follow it and you will be able to follow it. +We'll give you that dashboard so that you can ensure that every quarter we can have a discussion on the key four or five elements of success on how we implement the new operating model, how we implement better marketing, how we implement better commercial strategies, and how that's impacting the top line and what impact that's having on margins. +As far as the North America franchising, I'll ask Sandy to comment on that. But, again, it's a clear timeline. First, by 2017 and then what we will have left is about one-third and then what we do with the rest is latest by 2020, again, finding the right home. Sandy? + + + Sure, Steve, on North America refranchising, I go back to the objectives of the effort, which is to restructure a system that was in place for over 100 years to get it in better position for growth with better focused customer management, more efficient product supply, and back services and to refranchised to the best Coca-Cola bottlers in the United States under a new franchise agreement that is fit for purpose of growth. We are very optimistic about our ability to deliver that kind of growth profile and to do that in a way that makes our business more economic and makes our system more economic going forward. +So as we point to the December discussion that Kathy's going to lead, we'll have a number of the details that will help you model this going forward. But our strategic mission has not changed and our optimism for success in doing this with our bottlers is as high as ever. + + + Thank you, Kathy, Ahmet, Sandy, Irial, and Tim. Despite gaining global value share, our year-to-date performance is not where it needs to be. The scope and pace of our actions have to increase and we're moving very quickly to streamline our operations and further align our incentives to drive revenue growth while simultaneously driving costs out of our business through an aggressive plan. +While the short-term macroeconomic environment remains challenging, we are confident in our ability to return to sustainable growth as the long-term dynamics of our industry remain promising. Our brands and our global system are unparalleled and we are all fully dedicated to strengthening our position as the world's leading beverage company. As always, we thank you for your interest, your investment in our Company, and for joining us this morning. + diff --git a/exam/original-files/Problem_2_3_Sample_QandA/28_questions.txt b/exam/original-files/Problem_2_3_Sample_QandA/28_questions.txt new file mode 100644 index 0000000..d4ec21c --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_QandA/28_questions.txt @@ -0,0 +1,87 @@ +Question_1: + + There's a lot of questions that could be asked, but I guess one that I wanted to focus in on is the change in target from focusing on operating profit growth to pretax income. It sort of suggests that there's a contribution that will come from growth in equity income. Can you just give us some sort of gauge in terms of how much of the growth you actually expect to come from equity income? How much comes from operating profit? Just trying to get an idea of the proportions and whether or not there's actually a suggestion that operating profit would glow grow slower than that in that goal? + +Question_2: + + Okay. So no suggestion that there was a material change in operating income growth, it's just trying to collect the other pieces below that? + +Question_3: + + Previously, you'd indicated on the $1 billion product due to savings that will be all reinvested in media. Perhaps you can give us some idea of how much of the $3 billion will be reinvested and also what the phasing of that will be through to 2019? It strikes me with the US production changes that's going to be quite back end-loaded in that timeframe. + +Question_4: + + If I could come back on the 2015 guide, which obviously looks quite bearish versus where the Street is, you seem to be highlighting there's going to be quite a lot of extra costs there without savings. Is it also a comment that you're quite cautious around revenue growth, i.e., you seem to be implying it will be in more in line with 2014, which is more like a 2%, not a 3%-plus. Is that right? + +Question_5: + + I think we're generally pleased that there's more urgency around price mix and North American [franchisement] and the cost-cutting. But I do want to understand a little bit better how much of the cost cutting you think you're going to need to reinvest and really, why you think you have to reinvest? And I say that because you're going to reinvest something and I want to hear what, but you're only going to get back to your previous growth rates, but this whole time, a lot of the discussion is about blaming mostly short-term macro issues. +So is there something that's underlyingly falling worse, e.g., perhaps consumer trends toward health and wellness or something? And in fact, is it a good ROI to reinvest in the business in marketing versus taking some to the bottom line and to shareholders who have been rather disappointed recently? So any help there would be great. + +Question_6: + + So that's very helpful. In terms of the clear line of sight, can you give us a sense of, this $3 billion, is it half reinvested, half of the bottom line? Is it 60/40? Can you give us a better sense of the split of reinvestment versus bringing it back to the bottom line? + +Question_7: + + Muhtar, I wanted to delve a bit more into the changes in price mix versus volume focus and the incentive plans. I'm assuming the enhanced pricing focus is more of a developed market phenomenon, but maybe you can review for us how much of the change in focus going forward is in developed markets versus emerging markets versus how you managed previously? Then in North America, has this enhanced pricing focus all ready played out to some extent, given you've already had compensation changes there or should we expect North America to be part of that change in focus going forward also? + +Question_8: + + Okay. That's helpful. While we're on the subject of pricing, can you characterize the pricing environment right now in North America? Obviously, the 3% sparkling number in the quarter was more favorable than you've seen recently, so I wanted to get an update there on how sustainable that performance could be going forward. + +Question_9: + + Can you just comment on how much you know, relative to the environment, what's secular and what's cyclical and then how your strategy changes if it's more secular than cyclical in terms of some of the consumption trends? Obviously, Muhtar, you have considerable experience here. Has there been a period where you've seen things as difficult as they are now and what it took to pull yourselves out of it? + +Question_10: + + Great. Thanks. Kathy, just one quick one: the share repurchase went from a range of $2.5 billion to $3 billion, now it's at the lower end of the range. Is there any read through on that, in why you guys took it down? I know it's not hugely substantial. + +Question_11: + + Okay, but is cash flow coming in softer? I'm just trying to figure out why it would come down if there's no change in the cash flow algorithm. + +Question_12: + + I was hoping you could provide us with some more detail regarding the restructuring of your North American manufacturing footprint as one of the areas of the productivity program you talked about earlier? What's the scope of that program? What are the milestones that we should be looking for? How does that tie in with your commitment to refranchise the bulk of your territories by 2017? + +Question_13: + + First question is just relating to, really, the new operating model that you're planning to implement. I'm just hoping to get a little bit more clarity around exactly what you're doing to change the operating model, both more at the business unit level and maybe even at the country level? Is this something that gets rolled out globally or does this have a phasing of how it gets rolled out? I know that you really have been emphasizing patience and just taking time to implement these changes, but just wanted to get a little bit better sense of what takes longer? What can be implemented more quickly and where can we see the benefit to some of the changes more quickly? + +Question_14: + + Okay. If I could follow-up, Ahmet, the two markets, where, obviously the volume was very challenged were Europe and China, which presumably had both the weather impact, as well as the macro impact. So if you can give us a little bit of color just in terms of how much you think the weather did play a role? It sounded like in the fourth quarter, you really are not anticipating much improvement, globally, from a volume perspective. Is the weakness expected in these two markets primarily or are there other markets that you think could potentially be weaker or more volatile as you get into the fourth quarter? + +Question_15: + + A couple of questions here. One on the change to the long-term algorithm: you talked about NARTD growth being more mid-single digits going forward. Going back to Bill Schmitz' question, is that going down permanently from the 6% number that you guys had put out there before or are you structurally calling for lower category growth? +Then the second question I had related to the restructuring program -- I guess two questions on this. First, is it the macros? Is it the lower structural growth of the category that's causing you to up this just eight months after your last program? And then a clarification on the numbers which is, part of the savings program announced in February related to not necessarily productivity, but more efficient spending? Is there any of that's built into this new $2 billion? Thanks. + +Question_16: + + Got it. Again, just a clarification on the reallocation versus what we would view as incremental cost saves. Any color on that? + +Question_17: + + What I was asking is, if I remember correctly, the February productivity program included some true productivity and then some sort of reallocation of spending to more efficient methods. I'm asking is there any of that also built into the incremental $2 billion from today? + +Question_18: + + Also on the subject of media and marketing spend, when all is said and done, Kathy or Muhtar, for calendar 2014, you mentioned a double-digit increase in media in the quarter. But when we look at the total marketing spend, how much do you think that'll be up when all is said and done for 2014? When we think about the comparatively lackluster 2015 you're talking about, how much of that is attributable to the rate of increase and marketing spend you're intending next year? + +Question_19: + + Is there anything -- is it reasonable to assume it goes up at a faster rate in 2015 given the top line challenges? + +Question_20: + + Okay. Just one point of clarification back on John's question, about the $3 billion, you mentioned, Muhtar, the vast majority being OpEx. Are you talking 80%, 70%, 90%? Can you give us some sense of that number? + +Question_21: + + Two questions if I could: first, despite some disappointment in some quarters, from a strategic standpoint, this does seem like a fairly substantial change from where you were in July, strategically. Can you talk about the process that you went through internally to get here? Do you view these changes more reactive or proactive? To the extent that much of the work has been accelerated since midsummer, how confident are you that this is the right program? Why is $2 billion, for example, the right number and not $3 billion or some other figure? That's the first question. +Secondly, as you seem closer to a defined timeline for refranchisement in North America, can you help us dimension the financial terms and the economics of that activity? Just in broad brush strokes, acknowledging you'll probably cover more this in December, but do you anticipate refranchising to result in economic loss or gain versus your 2010 investments? How much dilution should we expect as we go forward through the program, again just in broad brush strokes? Thanks. + diff --git a/exam/original-files/Problem_2_3_Sample_QandA/29_answers.txt b/exam/original-files/Problem_2_3_Sample_QandA/29_answers.txt new file mode 100644 index 0000000..0f08018 --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_QandA/29_answers.txt @@ -0,0 +1,111 @@ +Answer_1: + + First, just at a very high level, 10,000 feet, 2015, we expect the macro environment to even become a little more volatile versus 2013 and 2014, as the microeconomic vagaries get worse in certain parts of the world. Rate of interest, currency, certainly, will add to the volatility. +Growth gap will -- in some part versus other parts -- are going to grow. Take, for example, the United States and Great Britain, two large western economies, starting the year 2015 strong, whereas the eurozone, Japan, and most of the emerging world starting the year slower. +So there is this gap and some catching up to do. We're gaining share across the world in sparkling juices, important categories. The industry -- we see some evidence that there's some things that are working for us, but we need to be cautious and take it quarter-by-quarter. That's really important. +As far as Latin America is concerned, Colombia seems to continue to do really well as an economy. There's some more lifting to do in Mexico and Brazil and south cone, but I was recently in Latin America, and our business there continues to -- we have a fantastic group of bottling partners investing for the short- and long-term growth and we continue to gain share. We have a very strong package product channel segmentation and architecture in pricing, competitive, but at the same time, great revenue growth management strategies working there. +Europe, as per the last quarter, quarter four, which we are just reporting on, the southern European countries continue to be challenged. Germany, our business was very much in the positive. Northern Europe was a better environment for us than the south and Eastern Europe is again challenged by some of the macro volatility that spills over across from the east. So that's how we would see them. +Asia, we're still very bullish, and Africa. You see the actions we've taken related to reorganizing our bottling structure to even better suit the growth potential and the opportunities, there, in both Indonesia, the fourth most populous nation in the world, as well as the very dynamic 1 billion-plus consumers in Africa. + +Answer_2: + + Yes. When you look at LRB or nonalcoholic ready-to-drink beverages, Bryan, what you would see, probably, is maybe 100 basis points less growth versus the previous years, but, it's again, anybody's guess as to how quickly some of these economies are going to come back. +We have definitely those contingencies built in. Maybe I can refer to Ahmet to give you a few more snapshots of the world in terms of micro and macro picture? Ahmet? + + + Thanks, Muhtar. Bryan, the only thing I would add to Muhtar's characterization is that volatility comes on top of a slowdown, but what's working for us, is that we are getting more and more traction on our plans and programs working with our bottlers. I was in about four or five different countries over the last couple of weeks. +Even though we witness economic volatility or uncertainty, even in even in Northern Europe, yes there is quantitative easing, yes, there is lower oil prices, but it is uncertain yet whether the consumer will really benefit from that. But even within that, our plans that address the right pricing and packaging and the right level of media investments and our alignment with our bottling system, is giving us confidence that we could actually weather this volatility in line with the guidance that has been provided. +There are a couple of bright spots, too. I was in India, probably one country where there is a lot of optimism inside the country in terms of economic development. As you know, we have an incredible momentum in India over the last seven or eight years, especially last year. Our plans continue to build on each other from year-to-year. +I was in Brazil. Again, a similar story. After the elections, there was some cautious optimism and that caution side of that continues. There's still a bit of optimism, but we do continue to deliver our results despite that environment. As you know, Brazil had a mid-single-digit growth over the end of the quarter. +Yes, it was cycling better numbers from last year, but we've also had very strong share gains in Brazil. So I would say that is our story. There is volatility on top of a slowdown, but we do have traction with our plans and programs in the marketplace with close alignment with our bumpers. + + + Bryan, last thing I would add to what Ahmet and what I had said earlier, to your question about does it make sense to invest in media and marketing, and the answer is, absolutely, yes. When we are able to target our investments in media and the way we are doing it, segmenting them by the different countries and the different regions of the world and improving not just the quantity but also the quality of the media, that's one of the main important factors that we see driving a better revenue number, a better price mix number. So the two are really connected and that's what I really want to -- gaining share, improving on the top line through all the actions we're taking, of which targeted media, increased and improved quality media, is one of those. + +Answer_3: + + I'll let Irial answer that question, and then also, Sandy will add flavor to that, too. + + + Good morning, Judy. The most important thing is, four quarters ago, Sandy and I spoke on the topic and we reiterated our belief in having balanced price mix volume growth in North America. We've delivered on that in every quarter this year and our plan is to deliver again next year in the same way. +In terms of your question on mix and headline price, it's a balance approach. Yes, in the fourth quarter last year, we were trending some lower numbers where we had some promotional activity, but when you look over the half-year, as Muhtar said, we grew pricing 4%. +So we feel very good about the actions we are taking. We're feeling very good about how the trade is reacting and more importantly, we are feeling very good that our marketing and our execution are coming together in a way that really adds incremental value to our system. I will maybe ask Sandy to add to that. Sandy? + + + Good morning, Judy. As Irial said, it's a consistent strategy. The strategy is [born] of where the consumer wants us to go. The consumer is buying smaller special packages of our sparkling beverage brands and accelerating that purchase and we're seeing the kind of mix benefit from that, that you describe. +But that couples with a disciplined approach to rate and volume. Because in the end, what we're trying to do is expand the value and usefulness of our brands and create value for our customers. Through the consistent execution of that strategy, we are seeing, in 2014, a solid year, but a year of improving performance through the year, and we will continue to pursue that disciplined strategy in 2015. + +Answer_4: + + Okay, Judy. Our commodities environment for 2015, commodities we expect really to be benign for us, right? There are some that are absolutely favorable, but then we have other challenges, and depending on -- not a North America, but outside of North America, we also have impact of secondary exchange embedded into our commodities. So we really anticipate it being more of a benign commodity environment for us versus having any significant benefit from it. + +Answer_5: + + We're all going to watch what's happening with quantitative easing, John, in Europe, 18 months of the planned amount, EUR60 billion a month kicking in, whether that will have an impact or not, we will watch and see. Stability is the keyword for Europe, as we go into 2015, so not getting much worse, and in some areas, continued volatility. +South Europe is going to continue certainly to be challenged, so I don't think there's going to be suddenly a lifting of the cloud for the consumers in the southern belt of Europe. German -- the current exchange rates will help exporting countries, for sure. How soon will that trickle in related to Germany, related to other export markets from Europe? +But that's a positive. Quantitative easing is a positive. The notion that most consumers now are used to this environment and feel that it is not going to get much worse; it may get a little better because of the QE. +So we'll have to see. But we think that it will continue to be challenged, and then you've got, of course, the whole political environment to, basically, weave into the equation. That political environment is something that is an unknown for us all. +That's how I would see. As far as growth, yes, there will be pockets of growth in Europe and there will be continued pockets of challenges. What we see -- we have very strong plans in place with our bottling partners for growth in Europe and we will see how -- we have all kinds of contingencies built into the plan in Europe, also, and we're going to take it quarter-by-quarter. + +Answer_6: + + Sure, John. For 2016, we are also hedged on our major currencies at this point, and also have some on other currencies, as well. So we will manage the impact and we are at pretty good rates at this point with our hedging, so basically we don't think that there is a relative issue at this point. + +Answer_7: + + Steve, this is Muhtar. Good morning again. As far as the rate versus mix, it's basically completely dependent on the country and the environment and the region. There's no trend globally. This is, on average, this much rate and this much -- it all depends on our price/pack channel architecture, our position in our market, the strength of our brand, how effective is our marketing driving the results that we need, which is all work in progress. +So it all depends, and I will let Sandy comment on the United States on that, but it's very much dependent on the region and dependent on the country and dependent on the circumstances. That's really what I would say. Sandy, you want to just address the United States part of that question? + + + Sure. Our strategy in the US is, again, as Irial said, very consistent. We view there to be a significant upside pricing opportunity in the sparkling beverage category. We are driving that with significant investments in brand building and execution of a bright package architecture that will expand margins for our system and also for our customers. That involves a very healthy rate program. +But at the same time, we are executing with a tremendous amount of energy, multiple proprietary and other small packages that the consumer is buying at accelerating rates. For example, mini cans increased by 15% in the fourth quarter and that's us following the consumer to smaller package sizes of the brands they love. That combination of rate and mix is creating a good balance with volumes to a healthy top-line growth picture. + + + Steve, just on your question on productivity, I would say to you that the reorg and how we are flattening the Organization and the number of announced cuts were all part of the program, totally part of the program, so, there's nothing that has it's just been executed. That's all. +We stand by what Kathy said in the modeling call in December. We are on track with the $500 million-plus piece of the productivity program for 2015 and we are on track with that. But just to emphasize, all of what you see, what you hear, what you read, was part of the program. + +Answer_8: + + Just quickly on the last piece of your question, it was part of the initial $2 billion. Then, as far as the rate increases, I'll defer to Ahmet if you want to just refer to that part of the question. + + + On markets like EAG, we price in line with inflation. We may be slightly below inflation, slightly ahead of time. You should expect to see consistent rate increase more or less in that range. +Fourth quarter for EAG was a bit of an anomaly. There was a geographic mix impact that was driven by cycling of [jobend] shipments, so if you look at full-year price mix realization at EAG, it's a healthy 4 point, so, I wouldn't look at Q4 to draw any conclusions. + +Answer_9: + + Ali, just on a broad-based answer to your question, it's really critical that we balance the needs in the marketplace and the need for us to be healthy in the marketplace on a both medium- and long-term basis. That's why we hold accountable all our business unit presidents for local currency. We're very happy with our progress so far, with what we are doing with our productivity initiatives and what the current results are for those productivity initiatives, so far. Early days. +But we certainly are looking to do more where it makes sense. But one thing you will not see us is taking, basically, actions in the marketplace that weakens our position for the medium and long term. That's the critical piece that I want to stress. + +Answer_10: + + We work with all the different levers that are available to us, how our better marketing, more marketing is working, driving results, how the investments are working, that we're putting in the marketplace with our bottling partners, our basic brand strength in the marketplace. All of those things. Essentially, in terms of commodities, again, that's something that is very volatile in the world that we live in. +Four or five months ago, if someone said we'd be looking at current price of oil, no one would have believed is. So everything is changing very rapidly and we are remaining flexible and what we can achieve to the best of our ability, both in pricing, both in terms of investing for the future, as well as making sure that our investments are targeted and our segmentation works. +There is not one solution. The segmentation is really driving better results than we have anticipated when we put that program into place. + +Answer_11: + + I will just leave it at what I said. + +Answer_12: + + Based on our 4-4-5 calendar, the six additional days get pushed into the first quarter, but they come out in the fourth quarter. + +Answer_13: + + That's all local currency. So it is what it is. What we talk about is all pricing in terms of the local currency we take. Whether we measure that in SICAD 1 or 2, it will be the same number. + +Answer_14: + + For next year, the impact of fair pricing law will continue in Venezuela. That is what actually impacts our revenue in Venezuela. It caps our ability to take revenue. +That does continue. Obviously, it starts over in 2015, but it will not be a structural item because we cycle it as of the second quarter. So, then, yes, we also do have an impact to our revenues from a different exchange rate and that would be considered currency. + +Answer_15: + + Bill, this is Ahmet. I will try to address that. One big thing was the timing of the Chinese New Year, but I wouldn't conclude my comments without saying that the market in China, especially the food and beverage market, has been weakest in the last 10 years. But I would also say that we've been consistently applying our strategy that we have covered with you guys a number of times before and resulting in fairly significant share gains in China. +As you know, in Japan in the middle of last year, there was an increase in taxes and we're continuing to see the effect of that, but, still delivering almost close to flat but not that close. It's minus [1%]. But the biggest item there was the timing of the Chinese New Year, as well as continued industry headwinds in China. + +Answer_16: + + The Corporate unallocated line. Yes, that is one place where you will be able to see the restructuring come through, but as Muhtar said, we are on track and with everything that we have announced to date. + diff --git a/exam/original-files/Problem_2_3_Sample_QandA/29_questions.txt b/exam/original-files/Problem_2_3_Sample_QandA/29_questions.txt new file mode 100644 index 0000000..0135fdd --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_QandA/29_questions.txt @@ -0,0 +1,68 @@ +Question_1: + + I've got a question about -- Muhtar, in your prepared remark, you mentioned the consumer environment remaining volatile in terms of your expectations for 2015. Can you talk a little bit about what range of volatility you might have embedded in your plans for 2015? +Maybe talk a little bit more specifically about the consumer environment, both in Europe and Latin America, where since those are really two important markets for the Company and where it seems volatile? Finally, just maybe how that might affect your decision to spend more marketing in those markets this year given the volatility? I know there's a lot there, but thanks. + +Question_2: + + Fair to say that you've got a wider range of volatility or contingencies for that type of volatility built into the 2015 plans? Just maybe the normal, just since it's such a volatile environment? + +Question_3: + + My question is really relating to the strong price mix that you saw North America in the quarter. Obviously, you've been focused on getting mix impact and rational pricing. Can you just speak to how much of the improvement was mix-driven, as opposed to maybe cycling some of the heightened promotional environment last year, and as you think about 2015 and beyond, just thinking about some of the mix acceleration potential and the pricing side in North America? + +Question_4: + + Got it. Okay. Then Kathy, if I could just have a quick follow-up on just in terms of the commodities in 2015. What have you locked in, in terms of your exposure are there? As you think about different commodity complexes that are turning more favorable, how much of that could we expect to see drive some of that margin improvement, particularly markets like North America? + +Question_5: + + Wanted to follow up a little bit on, Muhtar, on your comments on Europe. Obviously, it's been a difficult market over the past couple of years. +What's the right way to think about a glide path getting back to growth there? Is it something where QE works and we start to see the economy come back, do you think you can get back to consistent growth? What are some realistic ranges of expectations for 2015 and potentially into 2016? + +Question_6: + + Great. Thanks. If I could ask one follow-up to Kathy. Kathy, you talked about your FX coverage on translational for 2015. Obviously, what this can lead to sometimes is a year or two year impact. Any thoughts on 2016 and how you'll manage what could potentially be some FX headwind there as the hedges roll off? + +Question_7: + + One quicker clarification question, then a slightly more thematic one. First, obviously there are a lot of moving parts driving price and mix in the quarter, globally. I wondered if you could just focus in on rate increases and talk about trends there because my guess is that rate lagged overall price mix in North America, which you talked, but Europe, the bottling investment, Latin American, and then rate was probably stronger than price mix in Eurasia, Africa, Pacific, and across the whole Company. Any help there would be great, just parsing out overall rate trends? +Then more broadly, it sounds like your productivity targets remain unchanged from last fall, which isn't really surprising as it has only been a few months. But at the same time, we've already seen announcements of headcount reductions that likely were not envisioned prior to your October update. I'm wondering why we are not seeing more incrementality sooner on that front, or perhaps we are, it's just being absorbed by the macro headwinds? If you could clarify that, that would be great? + +Question_8: + + Okay. Just two points of clarification, just to follow-up on those answers. Thank you very much. On the price mix, maybe just Kathy, specifically to Eurasia, Africa, where I'm assuming rate pricing in Russia, for example, is quite positive, should we be expecting this negative mix trend to persist in 2015? This is one follow-up on pricing. +Then Muhtar, to your point on the part of the plan, does that mean that the headcount reductions, for example, that were announced, was that part of the original $1 billion or was that part of the additional $2 billion that was announced last fall? + +Question_9: + + Given the pressure that currency is placing and all this macro volatility, do you anticipate or can you, actually, accelerate anything around your cost-cutting plans to offset this or do you plan taking even more pricing in places like Europe, Eurasia, Africa, or Asia-Pacific, where it does not look like you are offsetting your currency moves as much? + +Question_10: + + So in other words, we shouldn't anticipate more pricing as FX continues to be a negative pressure? If you can answer that, also, in the context of the benignness of commodities in 2015, and if that is a limit on your ability to take pricing, again, to offset FX and in the broader price context? + +Question_11: + + Okay. I'm just trying to understand. We could anticipate, if the consumer is ready to do it and if the segmentation suggests, we could see more pricing align with inflation because of currencies being so negative. Is that fair of what you are saying? + +Question_12: + + Just a quick one, Kathy, a technical question. The six additional days in the first quarter, is there some level of give-back later in the year? Do we see a reversal of that in the fourth quarter, for example? + +Question_13: + + One is a housekeeping question. Can you just tell us what the pricing would have been in Latin America if you were at SICAD 2 for this year and last? + +Question_14: + + Okay. I was just trying to get at what impact Venezuela had on the price, just for modeling for year, if there was a Venezuelan anomaly this quarter that might have take that pricing down next year? + +Question_15: + + Okay. That's very helpful. Thanks. Just on Asia-Pacific, it came in a little lighter than our expectations. It was one of the lowest volume outcomes in a while. In your prepared comments, it seems like you are fairly sanguine about that segments, so was there an anomaly this quarter that took the volume a little bit softer and the price mix, so negative? I know there was a mix element there, but any comments on that would be very much appreciated? + +Question_16: + + Great. One quick last one, if I could. Just to gauge the progress of the productivity program. Is a good metric to look at the Corporate unallocated line on the segment data? Does that come down as the restructuring savings come through? + diff --git a/exam/original-files/Problem_2_3_Sample_QandA/2_answers.txt b/exam/original-files/Problem_2_3_Sample_QandA/2_answers.txt new file mode 100644 index 0000000..58698da --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_QandA/2_answers.txt @@ -0,0 +1,306 @@ +Answer_1: + + John, we can't hear you. Apologies, John, we didn't hear the question. + +Answer_2: + + Yes, we can. + +Answer_3: + + We're growing, as you've probably seen, we showed you on Investor Day. And while there was a little bit of lower growth this quarter, we do expect to grow loans in our commercial bank loans in Asset Management, wholesale loans, Mortgage Banking. And we're growing our deposits very strongly. So it's really just the underlying business driver growth that we've been seeing and expect to continue. + +Answer_4: + + Yes. John, actually, if I refer you back -- and from recollection, I'll do it for you -- but if I refer you back to Investor Day, it's based upon our adjusted expenses, which are defined as our expenses excluding corporate litigation and foreclosure-related matters. Which in 2012 was $60 billion, plus or minus. I think $60.1 billion. And we're expecting to be $59 billion this year. And that's what we're on track to deliver. + +Answer_5: + + A little higher than that in the first quarter. But the first quarter is seasonally high. + +Answer_6: + + Yes. The fourth-quarter normalized run rate was $725 million. This quarter it's down a little off that, as you would expect, given the IFR completion. We said that we expected the fourth quarter to be running at $600 million. And we said that at Investor Day and we're still on track to do that. And we've also said that the long-term run rate for that part of the business would be about $325 million a quarter, and that would be over the next couple of years. + +Answer_7: + + The litigation dropped quarter over quarter. Clearly we had a large number last quarter on the back of IFR. And we did have litigation expense this quarter, you'll see in the supplementary there, just over $300 million. + +Answer_8: + + Yes, that's right, John. + +Answer_9: + + Yes, but also remember, we didn't buy back shares in the fourth quarter or the third quarter. So there was an overall net $2.6 billion gross] $2,6 billion net of employee issuance. + +Answer_10: + + Yes. + +Answer_11: + + No. I think the issuance number is fairly level and consistent quarter by quarter, because it's really based upon amortization of restricted stock and all that. And the buyback, the $2.6 billion, remember, that was over the course of the quarter, so it averaged out to 50% of that for the quarter. So we can give you more detail a little bit later. + + + Yes, we'll come back to you John. + +Answer_12: + + But the $6 billion will offset how much average amortization over the same 12-month period, like $2 billion. + + + Yes, $2 billion. John, that's a good way of looking at it. The $6 billion we're authorized to repurchase relates to employee issuance over the same period of just a little bit over $2 billion. + + + For accounting purposes. + +Answer_13: + + The second one is the big one, that's June 11, or something like that. + + + Yes, June 11. + + + And that's where you have a lot of bigger client stuff like that. People are still getting used to it. So we think -- I think we've got 30% or 40% lined up to do it. They're still reading documents, have to sign new documents. So hopefully it will go smoothly. It's unlikely to go smoothly the first round. The first round were really large participants and swap deals, et cetera. We'll have to just wait and see. + +Answer_14: + + Look, we really don't know. I would say temporary but probably still down a little bit because of the reason you gave. Some feel and just say -- we don't need to do this anymore. And we also know all the final rules, by the way, and how the SCFs are going to work in bidding. + +Answer_15: + + Yes. If you take -- our Basel I RWA went up about $200 million. That's all about the implementation of the new market risk rules in Basel 2.5. Which is also why you saw our ratio go down from a reported 11% last quarter. It's really all explained by that. And our Basel III RWA was flattish quarter over quarter, with some pluses and some minuses. + + + That was already in there essentially. + + + Yes. Of course, yes. + +Answer_16: + + My recollection -- and, again, Glenn, forgive me if I get this wrong -- it's on the slide from the firm overview and Investor Day -- but I think that 100 basis points equates to about $180 billion of RWA over the next two years. But, remember, the passive runoff will take place over time. Not completely linearly but over time. And the model enhancements can be a little bit lumpier and a little bit more back ended. So we'll just have to see how that plays out. But, yes, we're still expecting for those things to happen, for us to get 100 basis points of benefit from that, and that's without the active mitigation. That's going to happen over the course of time. Just check that slide for me, Glenn, when you get on. + +Answer_17: + + Glenn, I actually think you all on the line should be dealing with this issue a little bit because the reason you have companies is because they serve clients well at a good cost. There's a reason our numbers are good, because we have cross sell and clients come to us. And there are reasons for global banks, just like there are reasons for community banks. I think the real issue -- again, you guys do the numbers -- is the banking system has gotten so much stronger in the United States. And it's not just capital, but it's capital, liquidity, oversight. Activities that people like are no longer being done. Derivatives are going to clearing houses. And the initial wave of OLA and living wills, et cetera, those things should all work. I hope at one point we declare a victory and just stop eating our young at this thing. + +Answer_18: + + Betsy, there was a little bit of passive mitigation. There was a little bit of run-off. And there was also some declines as we purchased back some AFS securities, and those were offset by some other things. It wasn't a very big number because, as I say, that will bleed in over time. And the model enhancements which are about 50% of the 100-basis-point benefit will be a bit back ended. + +Answer_19: + + That's right. Yes, some of it later this year, some of it next. + +Answer_20: + + Yes. We showed you at Investor Day that we had a gap to be fully compliant. We're going to be fully compliant by the end of the year. We did close that gap this quarter, not completely, by about one-third. Obviously we also disclosed -- on the slide you'll see our HQLA, our high quality liquid assets which has a relationship. They've gone up. But that's the numerator and the denominator changes, too. So think about it as we've made good progress. We've closed the gap by about one-third and we're on the way to compliance. + + + And I think, when Marianne gave you the forecast going forward for NIM, that includes changing how we create more LCR. + +Answer_21: + + On the quantitative stuff we passed. And that's why we got the capital plan. There are criticisms around qualitative. And from what we know now, and we're still doing work, we're going to give you more, is around -- they want more granular type of forecasting. They want more idiosyncratic type of forecasting. So we're having conversations with them. Marianne has formed a CCAR department which is going to become experts in CCAR. + + + And, Betsy, in terms of the time line, we're resubmitting, as requested, in the third quarter. We're doing everything between now and then to remediate and improve our processes following their feedback. So we're committed to being successful. + +Answer_22: + + Yes, so Brennan, I think it's very hard to predict. And you're right, it bounces around and it can be noisy. We had a higher level of litigation reserves in the first quarter of last year. And we hope that the numbers will remain low but we can't predict them for you, I'm afraid. + +Answer_23: + + They're always going to be lumpy because we have to deal with these things in due course. I think in the prior years we put away a lot. We've always kept the same, predominantly mortgage, largely mortgage, et cetera. And obviously the fact we're not doing more means we think we've gotten there. We did a lot of work on that. It could always change. But we've done thorough analysis. As a lot of you all did, by the way. We did it at the tranche level almost. So, could it be permanently lower? Yes, it could be permanently lower. It doesn't have to go higher. But, obviously, a lot of things coming our way and we'll have to reserve appropriately as they come in. + +Answer_24: + + Yes, it's tough to predict but maybe the thing you could look at is, if you take our pretax spread right now of 100 basis points, that compares to a longer-term average run rate of 65 basis points before the crisis. We've been stepping down from a very high level at the beginning of 2012. And we're back to a level where, frankly, we're not that far away from the longer-term run rate. And it's driven by the primary-secondary spread, which came in about 20 basis points in the quarter, back to levels that, again, feel more normal. I don't know I could say what inning we're in, I'm not a sports person, but it doesn't feel like we have another big step change to go. + + + But we expect it might be up a little bit next quarter, not down, for a variety of reasons. + + + Yes. There's going to be volatility quarter on quarter, but for this year we think we're in and around this range. + +Answer_25: + + A lot of that business is -- we call it flow business. So we look at credit, emerging markets, rates, FX. The clients -- we deal with clients all around the world and they need those services. Obviously, we always try to become more efficient. So if you look at FX, I'm going to say 80% is electronic. If you look at rates, the electronic number's going to go up. And so we're going to drive efficiency. But we still think clients are going to need it. There will be spreads to pay for it. And, obviously, everyone is going to be adjusting to Basel III. As you pointed out, some people leaving the business, some are getting into the business. We think it has a good future. We don't think it's going to go away. + +Answer_26: + + I think you're confusing two different things. I really think that quality -- they're going to give us more feedback on where they say we fell short in quality. I've mentioned them -- idiosyncratic, more level detail, more enterprise-wide type of forecasting, et cetera. That's one issue. The second is the actual dollar amount. The Fed has made it very clear, they want people to get to their Basel III targets. Ours is at least 9.5%. Ben Bernanke said on a speech he gave that the banks that they did the stress tests on have more capital after extreme stress than they started in the crisis. So the Fed, I think, is feeling more and more comfortable, not just individual banks but the system as a whole. And we reduced the 15 down to 6 because we wanted to get to our 9.5% target faster. That's why we did it. We just changed our mind. We want to get to 9.5% this year, we want to get to LCR this year. And obviously they may change the stress test next year. And assume we're going to have a conservation buffer coming in. And we don't know how the interplay of those two things will work. + +Answer_27: + + I think it's too early. + + + Yes, it's too early for us to tell that. Remember, that's going to relate to how fast you grow and other requests from regulators. So we'll take that when we get there. + + + Yes, but we do -- Erika, we do expect that we will be continuing to grow capital just through this 100 basis points of passive runoff from mitigation. Certainly our capital levels will be stronger and we're just going to have to see how things play out. + +Answer_28: + + So, if I could -- a little difficult to side it for you. But we did see a lot of still the pull forward to the fourth quarter, just given the year-end issues that people were concerned about. And so that has had an impact. I think it's slightly less of an impact than in terms of the competitive landscape. And there are deals being done with terms and conditions and pricing that we're not comfortable with at the moment, and we're just remaining very disciplined. So that has had an impact for us. + +Answer_29: + + Broadly flat. Broadly flat, around 32%. + +Answer_30: + + Broadly flat at around 32%. + +Answer_31: + + Correct. + +Answer_32: + + Broadly flat. Flat. + +Answer_33: + + Actually, we saw declines in deposits. So they're using their cash. They're waiting it out. + +Answer_34: + + Mike, it's Marianne. We're in constant dialogue with our regulators. And so we know that we should be expecting some more consent orders. But to clarify for you, they relate to issues that we've been working on over the course of the last several years. So these are not new breaking issues that will surprise you in any material way. + +Answer_35: + + Mike, we can't really go into the detail of the reports in specifics. But we obviously respect the work of the subcommittee. We respect the findings they had and we're working very hard to fix our issues. As it relates to the proposal and the recommendation to require documentation associated with portfolio hedging, identifying the specific risks that the hedge is designed to mitigate, and then monitoring it over time, we tend to agree that that makes a lot of sense in the context of what we face. + +Answer_36: + + No. And actually there's a couple of things I would say. First, that we're organizing ourselves around the control and regulatory agenda because it's a high priority for us. And we're getting ourselves organized in the same way as we would around a merger or an acquisition. And in doing that we are prioritizing our work. But we're not changing our overall strategy. We're not going to change the way we treat our customers, how we think about growing our businesses. But at the margin we're going to refocus our energies on making sure that we execute on the commitments to improve the control and regulatory environments. + +Answer_37: + + Yes, so applications actually have come back up. Rates have come down a little in the second quarter. For us in particular, starting there, we're expecting re-fi volumes to stay high. We did see a little bit of an increase in purchase volumes in the applications in the first quarter, albeit from a smaller base. And also we did the Met Life transaction so we have the opportunity to be working that portfolio. So our view on volumes for the year is that they're going to remain solid, although there will be some volatility really on the back of continued strength in refinancing. And you saw the HARP extension so more broadly for the market I think re-fi including HARP will be a level of support for volumes this year. + +Answer_38: + + Honestly, it's really all part of how we think about positioning the organization. And being compliant with LCR is part of our new reality. It's just a part of -- we've embedded it into just how we're thinking about the overall positioning of the firm. So it's not something we're separating out for you. + +Answer_39: + + It's hard for me to predict the second quarter. It is a real reduction in risk across the portfolio including -- and not driven by but including -- the synthetic credit portfolio which we continue to derisk. But it is important to note, if you look across the asset classes, there's been a very significant decline in the levels of volatility that affect the time series for our lookback period. So that, necessarily, bad days rolled off and better days rolled on. And so, when we compute our VaR it's pushing the VaR down lower. So, as long as volatility remains low and we continue to derisk, there's reasons to believe they'll be at or around this level. But it is going to be subject to changes in volatility, as and when they happen. + +Answer_40: + + It's factored in. + + + Yes It's an all-in number for us. So, to the degree we expect that to happen by the year end, it's all part of the number, including some capacities to buy shares, the whole thing. + +Answer_41: + + I'll take the two things separately, the PPNR separate from trading losses. On the trading losses, obviously there's a number of different stresses that we do. And while our number was different, I don't think we feel like there's anything about our processes that is materially going to change. But as it relates to PPNR, we did get feedback that we need to look at certain of our revenue models and we need to look at them more centrally. And, as Jamie said, with a slightly more negative view, idiosyncratically. And we're going to do that. + +Answer_42: + + So, a couple of things. One is, we are expecting to, and hoping to -- we've set a target for ourselves to gain share -- we do expect volumes to be supported by refinancing this year. That is our expectation. It could change, of course. As it relates to the cost structure, obviously that comes down a little bit more slowly over time but we're making progress. And we talked about the fact that we expect that to be down at $600 million run rate for the fourth quarter. And down to $325 million sometime over the next couple of years. And we're actively working on optimizing our servicing business, both the core performing servicing -- and you saw that obviously with the Met Life deal -- but also, where it would make sense, we would be open to doing sales on subservicing of delinquent loans. And we're working through all those things to try and get to cost structures to the best place it can be. + +Answer_43: + + The private equity, we've always told you, is lumpy. It was just markdowns and write-downs of existing positions. And we don't go through the specific names. But, obviously, we hope it will earn a profit. It just wasn't a particularly good quarter for private equity. And the private equity legally can survive Volcker and all those things. We like the business. We like the people. And you just have to do it in a different basis, that's all. + +Answer_44: + + No. There's no seasonality in private equity. It's constantly being reviewed. + + + And it's lumpy. + +Answer_45: + + Absolutely. Guy, it's a big change from the fourth quarter, off a small number. So, not to diminish the size of the numbers, but positive $50 million, negative $80 million, plus or minus around the zero level. What that's a factor of, Guy, is that the reserve release is based upon our model, and realized losses is based upon agency activity. So the timing isn't exactly perfect. So realized losses came down from about $200 million to $180 million. And we didn't build reserves. We released them, just not at the same order of magnitude. And it's really to do with timing, which is why we say that we do expect over time they'll net to zero. Last quarter it was a small positive. This quarter it's a small negative. Nothing to read into it. + +Answer_46: + + We're in constant dialogue with the regulators. We obviously can't comment on the specifics of our conversations with them. We've had some very constructive conversations as we came out the 2013 CCAR process. And on the basis of those we're actively working to make the improvements they want us to make. But also expecting to continue to get more and more detailed feedback and actually hope to get some industry best practice information, too. So we're going to be working in partnership with them, in constant dialogue, all the way through this year so that we can be clear on what success looks like. + +Answer_47: + + We haven't gotten a lot of feedback yet. So there will be more to come. But we're going to be geared up to do it. And I think we want to be best-in-class in CCAR. The answer is [absolutely positive] in PPNR. I mentioned just one -- idiosyncratic exposure and risk in PPNR. When you go through a stress test, you can assume that your company is just dealing with all those macroeconomic factors with your forecast. You can assume your company is going through those macroeconomic forecasts plus you're under some other kind of stress and you can lose market shares. Obviously that would change your PPNR. So we'll be having more dialogue and trying to figure out and make sure we do the right thing here. + +Answer_48: + + No. This is just a resubmission of the progress program. And they like to see qualitative improvement. This is not a change of request at all. This is the one that Marianne referred to that will be in the third quarter. + + + We'll obviously do another CCAR in January. + +Answer_49: + + No. The through-the-year accruals is almost exactly the same. It's based upon -- there's a lot of stuff that goes into that number but that really hasn't changed that much. + + + Yes. And actually you've got to normalize out the DVA, which was a large loss last quarter. If we normalize that out, revenues are down. So it's not comped down on revenue. (multiple speakers) + + + I was referring to that we're constantly putting in new operationals, new systems to reduce overhead. Marianne already mentioned a bunch of things we're doing in Mortgage. You're seeing similar efforts in Consumer. That's a constant effort. We do have names for some of them, by the way. I'm just not going to mention them here. + +Answer_50: + + No. + + + No. + +Answer_51: + + I think you're referring to the CTL, the commercial term lending, which is lending against multi-family. And we have seen growth in it. Remember, that stuff is like 65% LTV. It did great through this last downturn so we're very comfortable with that kind of lending. I forgot where you --. + +Answer_52: + + I would say a little of both. + +Answer_53: + + Are you talking about the commercial bank or the total Company? + + + We would expect to be flat to down a little bit as companies use their -- they have a lot of deposits. So I think we, at Investor Day and earlier, told people they were really high and we expected it to come down, particularly before people start using their revolvers. So they do relate to each other. + +Answer_54: + + I don't know the answer to that. + +Answer_55: + + We did a whole page for you on where we thought the through-the-cycle reserve levels should be by business. And there are some businesses -- mortgage, most obviously -- that still have a way to go. And there are other businesses in the wholesale space, in the commercial bank, that are below that through the cycle. I would refer you back to that page. If you do the numbers, from recollection, on an annualized basis, our charge-offs have been more like $7 billion or $8 billion, which, while that is not dissimilar to charge-offs we've seen, it's for different reasons. So I would take a look at that page. + + + It's mostly mortgage that will come down. Think of everything else as close to normal. Mortgage, which in total is $9 billion, will eventually be a lot lower than that. But that could take a couple of years. + +Answer_56: + + To talk for us specifically, as you probably know, we've been very successful and proactive as it's relating to HARPing our own book. And by the end of this year we fully expected to have been as successful and mine that as far as possible, or they will carry on. That's not the case in the industry. So it's great news that HARP was extended out to the end of 2015. And it will allow for other servicers to get their ducks in a row and potentially to have cross service to HARP. Which, in turn, should be good in terms of volumes, although I don't think it will be a step change. For us we're not expecting it to be a significant difference in our production or in our MSR value. + +Answer_57: + + We talked about we peaked in our HARP volumes in about second quarter of last year. I think overall, first half of last year was high, came down slightly, overall 15% last year. We talked at Investor Day that we thought that would go down to the high single digits this year, and it is, in terms of percentage of our production. And we are very active and have been very proactive in mailing our HARP population. And expected to have completed the program by the end of the year. So we were on track and this doesn't change our expectations. + + + I think the total -- if you take all mortgages, I think the number's like 4 million would be HARP-able today if they went to it. I'm somewhat surprised that more people don't do it, to tell you the truth. Anything the government can do, either PR, I think the cross-servicing is probably a bigger one, will make it slightly better. The thing was just slightly better. It's not going to dramatically change mortgage. + +Answer_58: + + We hope so. We don't know any better than you. + +Answer_59: + + You really have to ask them. We'll leave this to them and the regulators, okay? + +Answer_60: + + You've got to ask them. + diff --git a/exam/original-files/Problem_2_3_Sample_QandA/2_questions.txt b/exam/original-files/Problem_2_3_Sample_QandA/2_questions.txt new file mode 100644 index 0000000..68a4be7 --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_QandA/2_questions.txt @@ -0,0 +1,240 @@ +Question_1: + + Good morning, Marianne. On the last point about NII outlook, what are the drivers of the strong growth(technical difficulty)? + +Question_2: + + Can you hear me? + +Question_3: + + Sorry about that. Can you tell me on the NII outlook, what are the drivers of the strong growth in earning assets you expect that you just mentioned on the NII page? + +Question_4: + + Okay. And on the expense outlook, you mentioned for the adjusted expenses to be down about $1 billion. What's the base that we should look at for you to be down from? Do you have that? + +Question_5: + + And what was it in the first quarter? + +Question_6: + + Okay, got it. And then can you repeat your outlook on the default servicing expense line? That came down a lot this quarter nicely and you mentioned the target for the end of the year. + +Question_7: + + Okay. And then the litigation dropped significantly this quarter. I think you said it was immaterial this quarter on the litigation provision. Is that right? + +Question_8: + + Okay. And the last thing is on the buybacks. You did a healthy buyback this quarter but the share count didn't shrink that much. Is the first quarter heavier than usual in terms of your issuance? And the question's getting at, would $2.6 billion of buybacks in other quarters be expected to shrink the share count in quarters when it's not the first quarter? + +Question_9: + + Okay. So your issuance is more weighted towards the first? Is that right? + +Question_10: + + I'm just getting at how that translates to reduction in the share count. It's offset by what you do issuance, right? -- each quarter? + +Question_11: + + Was this a normal quarter of issuance? So a $2.6 billion buyback keeps the share count flat? Is that the kind of ratio we might expect? + +Question_12: + + Okay. But it was steady throughout the year. That's what I was getting at. + +Question_13: + + First one. The first deadline for compliance with Central Clearing came and went, and it clearly didn't have much of an impact on your first-quarter FICC results. So I'm curious, I hear commentary in the market that a lot of clients might not be ready for either the second or the third deadlines later this year. Curious what you're expecting and if you do think it could produce any hiccup in activity levels. + +Question_14: + + And even on the wait and see, if some aren't ready, do you think of that as a temporary and just literally a function of processing, not -- maybe we don't need insurance anymore because it's too expensive? + +Question_15: + + Right. Okay. Marianne, on the RWA front, a bunch of little things in here. But Basel I RWAs were up 11% quarter on quarter but Basel III were pretty much flat. I know that has something to do with 2.5 starting in the first quarter. But if you can help us. + +Question_16: + + So that leads into the comment you made towards the beginning on any passive runoff and model enhancements are not pulled forward in your results. And I think you said it could be about 100 basis points. Is there a dollar amount of RWA natural runoff that we should be thinking about? Because obviously capital's building. + +Question_17: + + Will do. Last one, Jamie. I know you addressed some of this in your shareholder letter. But between everything related to Basel III -- stress test, Dodd-Frank -- in place already, and then OLA and living wills coming online, it feels like we're going down the path on containing too big to fail. But yet there's a steady drum beat, including Brown-Vitter, to change things. Just curious on where we're headed in this and what will stop the drum beat. When is enough enough? + +Question_18: + + Couple of follow-ups on RWA. How much of the passive mitigation was embedded within the RWA results for Basel III this quarter? + +Question_19: + + Okay. So, really, that's going to come later this year, is what you're saying? + +Question_20: + + And then on the NIM and the LCR, there's obviously an interplay there. And could you just give us an update on where you are with the LCR this quarter? Because your NIM decline this quarter actually was a lot lighter than what we were expecting. + +Question_21: + + Right. Okay. And then lastly, just on the CCAR conditional approval, can you just give us a sense? Because I think people were a little bit surprised to see that you had the conditional approval results and yet you were able to do the buyback and the dividend hike that you asked for. So the underlying question is, what can you speak to with regard to what's being asked? And what kind of time frame do you think you have for satisfying the regulatory requirements here? + +Question_22: + + Just a follow-up on the question on litigation. That dropped to the $0.3 billion. Is that potentially -- are we now adjusting to a lower level? Or was that just noise in what is an extremely volatile number bouncing around a little? + +Question_23: + + Sure. Okay. But said another way, you guys don't see anything changing in the environment that would lead you to believe or be comfortable with a lower level of assumption of litigation expenses when we think about you? + +Question_24: + + Let's hope so. Okay. And then the spread in mortgage compression was meaningful here this quarter. What inning do you think we're in there, ballpark? I know it's tough to predict, as well. + +Question_25: + + Okay. So this is the right way to think about it. That helps. And then last one from me, when you think about your cap markets business and the pending change, you guys chatted a little about it with Glenn on the swap clearing, that June seems like the bigger date, Basel and all of the subsequent changes to the competitive environment, competitors adjusting the size of their business and what have you, how do you feel about your business there, particularly on the fixed side, more capital intensive businesses? Do you think that this presents an opportunity to maybe go through review and right-size, maybe increase the efficiency measures there? Or do you feel comfortable keeping your business where it is, roughly? + +Question_26: + + Good morning. I just had one follow-up question to Betsy's inquiry on capital return. Clearly we now have two years of this stress test behind us. And you were initially approved in 2012 for a $15 billion buyback and $6 billion this year. What does the Fed need to see -- and you're building capital, clearly -- what do you think the Fed needs to see from you in terms of the qualitative issues, to get back to the kind of capital return that they clearly in 2012 -- they thought you had plenty of capacity to pay out? + +Question_27: + + Okay. And given what you just mentioned, is it too optimistic to assume for next year a buyback in the $12 billion to $15 billion range? + +Question_28: + + Loan growth, it's a little bit softer. And I think you mentioned there was some push forward to the fourth quarter. But you also mentioned more competition and lower levels of demand, if I heard you correctly. So my question is how much of the softer loan growth is due to JPMorgan perhaps pulling back and how much is due to the economy? + +Question_29: + + So, really, on the lower level of demand, what was your loan utilization in the first quarter versus the fourth quarter? + +Question_30: + + I'm sorry? + +Question_31: + + 32%? + +Question_32: + + And so what's that? Flat or down a little bit? + +Question_33: + + Flat. And is that just -- why aren't people borrowing more? + +Question_34: + + Okay. And then a separate question, looking at the annual report. Page 4 of the Chairman's letter refers to regulation and some of the issues that you faced, and said we will see more of these. So when you say we will see more of these, Jamie, what are you talking about? Because people's imaginations can go in a lot of different directions. Are we talking Department of Justice, SEC, FBI? Were you thinking of anything in particular or in general or a time frame? And really what I'm asking you to address is the regulatory tail risk of we don't know what we don't know in terms of potential government moves as it relates to JPMorgan. + +Question_35: + + Okay. And was there anything new as part of the '11 hearings that would change the way you would think about the London Whale incident because there was some pretty damning information, some unknowns, at least to those of us who follow the Company. But from your perspective, is there anything else you need to do as a result of the information from those hearings? + +Question_36: + + And then, lastly, when you talk about some additional changes that need to take place -- and I think some of these are organizational -- is there anything major new that you did not cover at the Investor Day recently? + +Question_37: + + Good morning. I wanted to drill down a little bit on the mortgage side of things. Mortgage originations were a little bit stronger than we expected, up about 3%. Applications were down about 8%. You suggested that you thought the gain on sale margins might be relatively flattish going through the next couple of quarters. I'm just curious as to what your thoughts are in terms of the mortgage origination market away from the gain on sale issues that you've been facing. + +Question_38: + + And then, Marianne, a question on NIM. Clearly, your moves on the LCR had some effect on NIM over the last quarter or two. Can you separate what you think the net interest margin movements will be for JPMorgan, excluding your moves for the LCR? Or is it just so intertwined that you really can't do that? + +Question_39: + + Okay. And then, just finally, we saw a fairly sizable decline in value at risk, both in the CIB and overall. Can you give us a little more color as to what's going on there and what we might be able to expect in the second quarter? + +Question_40: + + A couple of clean-up things. When you are looking at getting to the 9.5%, did you factor in that 100 basis points or is that something that would be on top of that? + +Question_41: + + Got it. Okay. And talking qualitatively about the CCAR process also, there was a pretty large impact on PPNR, which seemed to be like the Fed's looking at pretty harsh -- a pretty harsh look at trading losses. Have you had any clarity from them about whether they're looking at that revenue stream differently than other banking revenue streams? + +Question_42: + + Okay. And then, lastly, on the mortgage business, it looked like in the core production, the expense reduction was about 50% of the revenue decline. How do you think about, as that business continues to normalize, as you said, it's probably mostly normalized from a gain on sale perspective, although you probably have some volume issues as we go through the rest of the year. How do you think about the cost structure of that business as you go forward? + +Question_43: + + Good morning. I thought this was one of the cleaner quarters in a while. So I just had one follow-up here. In the private equity, you took some losses from the private portfolio. Just wondering what drove that. And then also the outlook for this business under Basel III and Volcker, even though we don't exactly know what Volcker is yet. + +Question_44: + + Is there any seasonality in terms of getting year-end or mid-year statements on the private portfolios? + +Question_45: + + The first thing I wanted to ask was if we could dig in a little bit on the repurchase losses within mortgage servicing. Such a big swing versus the fourth quarter, an $81 million -- it sounds like a reserve build because I think I heard you say that your actual realized losses were not significant. And yet the guidance remains that it should be a net zero. So it just seemed like there were a lot of moving parts there. I was hoping maybe you could give us a little sense for why you had the $81 million hit. + +Question_46: + + Okay, thanks for that. With regard to the CCAR process and some of the changes that the Fed is asking you to make, first of all, just qualitatively can you give us a sense for the amount of dialogue that you have with the Fed as you work towards satisfying their request, so that you really know exactly where they thought the deficiencies were? Or is there a lot of guesswork for you on that? + +Question_47: + + Okay. And just if I can follow up on I think it was Moshe's question about the PPNR. It sounded like you were saying that many of the deficiencies that they were focusing on were in the inputs to the calculation of the stress PPNR specifically. Did I understand that right? + +Question_48: + + Okay, that's very helpful. Thanks. I hope this doesn't sound too crazy but just to think about it the other way, is there any chance that after the resubmission, or as part of the resubmission, given how close you are to your Basel III targets, and with some of that 100 basis points coming in, is there any chance that you would ask for and could get an increase for this year? + +Question_49: + + Got it. And then final question. You mentioned, Jamie, in the shareholder letter that just because you don't have big fancily-named cost-cutting programs, it doesn't mean you're not very focused on cost reduction. Is that what we're seeing in the fact that if you look at the CIB your comp was down 7% versus your revenue being plus? Or is it that you did something different in the way you think about through-the-year accruals? + +Question_50: + + Okay. But there's nothing different, like you said, in terms of the way you accrue for bonuses within the investment bank? + +Question_51: + + Thank you. Good morning. I had some questions on the Commercial Banking line of business. You had a nice increase in the real estate lending area in the first quarter. It looked like it was about $9 billion after four quarters of essentially flat to down real estate loans. Can you give us some color on where the growth was? + +Question_52: + + Are you guys finding greater demand or are you just more comfortable with it now than you were maybe a year ago? + +Question_53: + + Following up on your answer about corporate deposits dropping in the quarter, which obviously is a good sign if companies are using this for capital improvements, what's your outlook? Do you expect that to continue? Should we see that as a continued positive trend? + +Question_54: + + I agree. Are your guys on the front line hearing that from your customers, that they expect to use more for the remainder of the year, do you think? + +Question_55: + + Okay. Coming back to loan loss reserves, obviously you've got a great capital position. You pointed out that Bernanke has indicated that the banking system is super strong going through the stress test. With the current level of loans of about $729 billion, what would be a normal reserve level in normal times compared to where you are today? + +Question_56: + + Yes, thank you very much. I know a lot of my questions have been answered but we saw yesterday that they extended the HARP out another two years. And there's also some discussion coming out of some of the -- inside the White House, really, that they could put some type of PR plan behind HARP to try to get more people to HARP. Do you think this will have any impact at all in getting more people off the sidelines and refi-ing through the HARP programs? + +Question_57: + + I don't know if you can disclose this or not, but how much do you think you have HARP eligible? And how many of those HARP-eligible loans did you do on a percentage basis? Do you think you've touched most of them already? + +Question_58: + + Okay. I think a lot of companies have told us that they think that they've gotten through most of the low-hanging fruit with HARP, and that the people that aren't HARPing they doubt they will ever HARP. So I'm just wondering, if there's a big PR push, if some of those guys will wake up and say -- maybe I need to look at this program. + +Question_59: + + A quick question back to the Brown stuff that's hanging around out there. I'm reading what everybody else is, that they're looking at a 10% capital ratio, with the possibility of another 5% buffer on top of that. And basically throwing away the concept of risk-weighted assets. And more or less eviscerating Basel III, as far as I can see. Do you guys have any sense where this 10%, 5% number comes from? Is there some empirical evidence? Or is this just a back door way to try to get the biggest banks to break up? + +Question_60: + + Do you have a sense where the numbers are coming from? What that 10% capital ratio, where it comes from? + diff --git a/exam/original-files/Problem_2_3_Sample_QandA/30_answers.txt b/exam/original-files/Problem_2_3_Sample_QandA/30_answers.txt new file mode 100644 index 0000000..7651724 --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_QandA/30_answers.txt @@ -0,0 +1,144 @@ +Answer_1: + + Good morning, Brian. + +Answer_2: + + Bryan, it is Muhtar here. Good morning again. In North America, I will start with North America, I'd say that the outlook appears to be trending a little positive, raising hopes that potential wage growth and lower fuel prices could translate into consumer spending. In Latin America, Mexico is, the best way I would say is, relatively stable and continues to track closer to the United States, because they're so closely linked. Brazil continues to deteriorate faster than we expected. I'd say that. +Venezuela continues to increase as a concern given the growing difficulty on maintaining supply in the marketplace. And Argentina just continues to be challenging. And Colombia is again a star in Latin America in terms of performance and macro conditions. +In Europe, I think there are also some green shoots on the back of monetary easing, but it's early days. That just started. Deflation still remains a concern this year, and overall, consumer spending in Europe I would say is still sluggish, as it will take time for I think monetary easing to flow to the consumer pocket and translate into increased consumer spending, and then risk to recovery [remains] a still volatile environment. Then of course you have the possible Greece exit issues lingering on. +In Eurasia and Africa, Russia continues to see significant challenges, the Russian consumer, and we expect it to continue to remain challenging throughout the year this year. Sub-Sahara Africa is a strong bright spot, and we are seeing that in our results. And then Middle East, we have got some pockets where it's defying the geopolitical environment, but overall, obviously increased geopolitical risks there. +Then in Asia and Pacific China continues, the disposable incomes, consumer spending, CSE in China continues to decelerate. We saw that happening in Q1, versus the stated GDP of 7%. Japan remains sluggish, I would say similar to Europe, although we are starting to see some green shoots in the economy. +And finally in Asia-Pacific, India continues to be a bright spot I would say inside the BRIC end markets, the four BRIC markets. That's a walk-through. +Then the commodity environment, again, talking about what we can control and what we can't, remains fairly benign, compared to previous years, stable and benign. Given that value growth for us is highly correlated to PCE growth, I hope I have been able to give you a quick walk-through of what is good and what is not so good and what is more stable. + +Answer_3: + + Brian, as Muhtar just said, commodities for us will be benign this year. In this quarter, and the first half we're cycling higher prices, in the first half of last year. And thinking about something like oil, oil doesn't really impact us. For our commodities, we are hedged. We basically are not going to see specific benefit there, and they are going to be basically benign. + +Answer_4: + + Okay, John, I will take the first part of that question. The gallons and the cases definitely, when you make the adjustment for days, gallons are behind cases, and that will moderate. That will be based on, as you just said, what we see in the first quarter is the higher revenue for CSE, and so we did benefit from positive geographic mix in our price mix. That will moderate. +We will start to see when it catches up more of the geographies that provide the lower revenue for CSE coming through, which will then give us the negative geographic mix coming through as well in the balance of year. I think the second part of your question, on the outlook of pricing, Sandy, do you want to talk about at all the North American pricing specifically? + + + Sure, Kathy. Good morning, John. The North America pricing situation is really the continuation of the strategy that we have been talking about for the last year and a half. Irial and I talked about this I think six calls ago that we were going to focus our business on the sustaining strategy of disciplined price and volume mix to maximize revenue, with an emphasis on price as a driver in the US business. That is exactly what we have been doing, and what we continue to plan to do with a lot of discipline and focus. +As you look at the first quarter, if you look at each business by themselves, we met our pricing objectives in the first quarter. We saw a little bit faster growth in our fountain business, which created a little bit of negative business mix, but net-net, the year started according to plan. We see the outlook as being rational, and our strategy remains very consistent. Ahmet, you want to talk about Europe? + + + Thanks, Sandy. Hi, John. Just a couple of comments in general and then Europe, we are following exactly the same strategy of managing our product mix and price versus volume around markets international. In fact, we are getting some pretty good results in many of our big markets. Specifically in Europe, one must remember that last year, we have had some fairly aggressive pricing, which resulted in our view somewhat of an imbalanced progression of our business, where we have lost some market share, but got great pricing. +We were saying before that we would be moderating that somewhat this year, so that we have a more balanced growth of volume and revenue. What you saw in the first quarter is a result of that moderation, but we do believe that we would be achieving reasonable price mix in Europe in the course of this year. + + + John, this is Muhtar. I will just add one other point, which is related to what I already mentioned, that we are reorganizing and have reorganized our marketing around the different clusters of developed, emerging, and developing markets. I think that is also working, beginning to yield some early results, and I think our new marketing leadership is very committed and very much part of this new reorganization of our marketing around the clusters. I can say very clearly that marketing is playing an important role in how we are generating enhanced revenue in our business. That is really an important takeaway, I think. + + + Thanks. I feel good. It is just my voice. + +Answer_5: + + The price mix obviously is 3 points, as I just spoke about. We did benefit from positive geographic mix in the first quarter. As we will get as concentrate shipments and timing starts to catch up, we will have the impact of a negative geographic mix which for us is not a surprise, in that it is normal run rate for several of our geographies. +We did get the pricing in the quarter and the benefit. Then the other side of that would be the costs, and when you adjust for structural, and you adjust for currencies, cost of goods is really in line with concentrate shipments. +Then the other issue would then just be commodities, and then as we said the commodities are basically going to be benign for us, and in the quarter, we are cycling higher costs from last year. That was a slight benefit. For the most part, I'm looking into the rest of the year, commodities are going to be benign. It is really basically the pricing that we got this quarter, offset by the costs that were better than prior year because we cycled better costs. + +Answer_6: + + I also would add one other thing in addition, in North America specifically, we had better business mix, which basically was around our food service business. For the first quarter, in a transition year, we are obviously very pleased with our results. And I would say that I would expect pricing to moderate for the back half of the year, and to continue with -- the cost of goods sold continue to be in line with the concentrate shipments. We were basically given the quarter in line with our expectations and we expect to be in line with our full-year expectations that we have provided. + +Answer_7: + + Steve, the comments I would make about overall pricing are, to reiterate what I said earlier, which is that on a business by business basis, our pricing results in the first quarter were solid. You saw in Nielsen, very strong price growth. Some of that was driven by wholesale improvement that we were achieving with our customers. Some of it was lapping some really aggressive promotional activity that happened in the end of February and early March, and some of it was our customers making more money in the category. The net effect of it was a really good start to the year, in line with our plan. +If you cross our business over into our chilled Minute Maid business, we saw price realization there. We launched some new items that drove some incremental revenue. Then as I mentioned, the fountain business was stronger than we expected at the beginning of the year, which creates a business mix drag overall. +What I would say from a profitability standpoint is that the combination of rate and mix was in line with our expectations, but I would also point out that as we get into the second half of the year, you are going to see more difficult pricing comparisons. We will continue our strategy of rigorous and disciplined and focused price volume management, but we will be lapping ourselves, and we'll be continuing to do so, but against a little bit tougher comparison. Net-net, off to the start we had hoped to. Irial, any additional dimension? + + + (Inaudible) repeating what you said, but I'd go back, and I've said this for six calls. We are being very disciplined and rational about our pricing. What we achieved in the first quarter is pretty well in line. Sandy's mentioned there's maybe some channel mix impacts in there, but generally speaking, very much in line. +We intend to stay disciplined, and I'd used the word [nearly] be boring in terms of how we approach the business. We want to remain disciplined and focus on doing the right things for the business. We believe we are on a good track. We intend to stay on that track, and I think as each quarter goes by, you will see positive momentum in the business. + + + Can I just add one more thing? What Irial just said then creates the environment for our small packages to grow. The consumer is moving strongly to small packages, and we are continuing to see low- to mid-teens growth in those packages, and all of which is supported by the impact of a step-up in marketing, which gives the whole thing more sustainability, as we work through the more challenging comps. + +Answer_8: + + The expected margin improvement over the balance of the year, as Sandy just said, so we got good pricing in the quarter. Irial said we are very focused on continuing to rationally price. We have higher comps in the back half of the year for pricing that we have to cycle. +As far as the refranchising is concerned, I wouldn't expect to see much benefit at this point from the sub-bottling payments. And as you know, if you look at it from an (inaudible) perspective, we structurally adjust those. We pulled them out. We pulled the benefits, so would we put it back on an apples-to-apples basis year-over-year. +There is not a big difference at operating versus PBT in our North American operations at this point. For the margin expansion, that is basically really good pricing. As we get really good pricing in the fourth quarter of last year, they are very focused on pricing. That will continue, but we are cycling higher prices in the back half of this year. + +Answer_9: + + Good morning, Bill. + +Answer_10: + + Bill, on Diet Coke, I would describe Diet Coke still as a work in progress. We have done a number of things on the basics of marketing, graphics, advertising, packaging. We have some very advanced big data driven customer relationship programs going on, with consumers who love Diet Coke. We are seeing some improvement in the year-over-year revenue, but we are still very much focused on that as a work in progress and expect to. +But I would say this. The team and I, and our whole system, believe that in fact we will return Diet Coke to growth in the long term, but recent improvement, but still work in progress. +On refranchising, the refranchising is going according to plan. It is, as we said before, a massive project. We are putting the entire system in on a common ERP system, and refranchising the territories one sales center at a time, to make sure that the capability that we build continues to grow, and that our customers are well served in the process. We are pleased with the progress. We have a plan in place that we expect to meet or beat, and we are always looking for opportunities to accelerate it, but not at the expense of really high quality customer service and capability. + +Answer_11: + + Ali, this is Muhtar. First, if it wasn't for the savings, we would not be able to do what you see us doing in terms of generating that increased marketing, generating all the other things that basically are part of our five point strategy of focusing on revenue, focusing on productivity, focusing on better and more marketing, rewiring the organization for better impact, and focusing on our core, which is the franchising that we talked about. +I would just say to you, had it not been for the productivity, we certainly would not be able to enable our organization to generate the kind of momentum that you see beginning to come back in. That is clear. There is no question about that. +This is not a four or five sequential compartments. These are a very integrated approach to how we bring more momentum into our business, and everything that I mentioned is happening at the same time, more better [wired] organization, better marketing, marketing that works around clusters, more effective marketing, linked to social media, as well as into a better cost per GRP, all of that funded by incremental productivity. I think that is how you need to see our entire different buckets of our strategy coming to life. + +Answer_12: + + First, I will just say that I agree with you, that those bottlers are doing really well. Germany is certainly a star in Europe. Southeast Asia bottlers are doing well, particularly Vietnam, the big one that we are running. I think it is important to keep in mind for you that Germany was not in a position to be re-franchised until after 2012, because the consolidation was still taking place. It is really been ready for the last, I feel like 18, 24 months. +It has been the real bright spot in Europe the last couple of years. It is profitable. We need to ensure that we find the right home and the right structure and the right value. And so I could be clear with you that Germany is not a strategic long-term holding, and the right home will be found. None of our, if you like, [BIG] operations are in a way long-term strategic holds. That is what I would say about your question. Irial, you want to add anything to that? + + + The only add I would give is the three markets you mentioned actually are not in a hospital ward. To Muhtar's point, actually they are all performing very well now. We have been very transparent about re-franchising. I've said this many times at conferences that we would re-franchise at the right time. Germany, we've clearly said is ready for re-franchising. +In the meantime, it continues to perform exceptionally well. We have a fantastic group of associates and management in Germany, and feel very good about it. I have also said we expect to get a fair price. Not get overpaid, but get a fair price for territory because we owe that to our shareholders. We take it from there. + + + Just to build on what Irial said, we are looking for three things in terms of the right partner, description of the right partner: one, proven management team; two, strong financial capabilities; and three, willing to invest in the business and grow the business. Those are the three things. I am confident that we will reach that goal. +Finally, on your question regarding head count reduction, I think you have heard about our previously announced plan, and we are sticking to that plan, simply said. + +Answer_13: + + Ian, it is Muhtar. It fits right into the strategy of what we said is bolt-on acquisitions where they make sense, and we will look at them, and where we believe that they fit into our portfolio, where they actually add value. We can generate value for our bottling partners through that acquisition, and it fits right in there, and so that is all I would say about that, Ian. + +Answer_14: + + Our equity income is impacted by currency. We actually don't pull out all of the currency that impacts that because if you think about some of our locations, they have, their geography, they have many geographies. When we report, we take the main currency, and translate that into US dollars. That means that there is still often a lot of currency impact in those numbers. I would read into it that it is a very, very difficult currency environment out there at the moment. + +Answer_15: + + No, there is nothing one-off that I'm aware of in the equity holdings. + +Answer_16: + + Good morning. + +Answer_17: + + I guess, Bill, the way I'd think about it is if you take our unit case sales of one and use that as a surrogate, because that doesn't have the extra days in it, and you take pricing of three, (inaudible) pricing, and then I would say that did benefit from positive geographic mix. That will moderate over the back half of the year, so I guess I would think of it using this price mix and average unit sales, unit cases. + +Answer_18: + + The operating expenses, I would say no, there was nothing specific in operating expenses that was helped by the 6 days. Then the sales and distribution expenses are impacted by the 6 days so they wash out, and I would say there is nothing there. + +Answer_19: + + Again, I hate to keep repeating myself, but then we did benefit from the size of the geographic mix, so I think the only thing I would say in terms of it will moderate in the back half of the year. We will get more of our normal run rate of negative geographic mix from concentrate shipments. +Then Sandy talked about the impact of the business mix with the food service business in North America. I think those are the things that basically would say that that number will moderate over the back half of the year, as we are still in a transition year. + +Answer_20: + + Yes, there is no issue there. We always expected it to close in the first quarter. Then basically just the regulatory process that we have to go through that is delaying the close. We fully anticipate that it will close. + + + Certainly. + +Answer_21: + + Good morning. + +Answer_22: + + Hi, Judy. On the structural, the structural is impacted by the timing of the Monster transaction. Then any time we accelerate into the re-franchising, that is also going to impact our numbers. That is why we gave you different structural guidance. +Then on the re-measurement gain, yes, that is basically, where we re-measured that euro debt, that impacted currency positively, and so that is what changed the outlook for currency over the back half of the year, and also the impact of Venezuela and change, using the Simadi rate going forward. + +Answer_23: + + The distribution is starting to transition. It has not fully transitioned. That transition will take place over the year, and so at various times, that is not something that is really under our control. That is really under Monster's control, as they transition that. We put an estimate of how we think it is going to transition, so it is not something that is already into our numbers. That is what is slowing up, slower than expected. We expected it to start earlier. + diff --git a/exam/original-files/Problem_2_3_Sample_QandA/30_questions.txt b/exam/original-files/Problem_2_3_Sample_QandA/30_questions.txt new file mode 100644 index 0000000..02c9d50 --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_QandA/30_questions.txt @@ -0,0 +1,101 @@ +Question_1: + + Hi. Good morning, everyone. + +Question_2: + + I guess as we look at this quarter, it just seems like some of the things that you laid out at the beginning of the year that were within your control have tracked in line, maybe even a little bit better than expected. It sounds like the refranchising in North America is pacing maybe a little faster. Closing the Monster transaction is taking a little bit longer, and it sounds like you're tracking pretty well in terms of cost savings and redeploying or spending more in marketing. +I guess when we think about the factors that are outside of your control, which would be I guess some of the macro factors, the change in the Venezuela exchange rate, how some of the markets are moving, I'm not sure if we have a great sense for maybe what is worse or what is better. If you could just maybe lay out for us versus where you were earlier this year, when you initially gave us guidance, what is better and what is worse, especially focusing on some of the things that are outside of your control? + +Question_3: + + That is very helpful, Muhtar. Thank you. I didn't mean to have you talk so long. Your voice is definitely under some pressure this morning. Kathy, if I could, just one follow-up on the commodity piece, the comparisons were a little bit better in the first quarter. Just looking forward, is there anything that we should be looking at that could make it maybe more favorable as the year goes on? Like how much of it is locked in and how much of it might move based on commodity movements? Thank you. + +Question_4: + + Thank you. I wanted to follow up on two questions related to the price mix number which is I guess one, if we look at the gallon variances you mentioned, it skews a little bit more towards high revenue per case. Can you give us an idea in the quarter in terms of how much of that benefit in geographic concentrate shipments, how much we'll need to take out over the balance of the year? +Then going back to some of the comments that you guys made, I think back in December, about a different global pricing strategy in terms of really trying to find the right balance region by region, can you talk about the outlook for pricing in Europe? It was obviously price mix was flat this quarter, but that's one where it seems like there are some opportunities going forward. What is the medium to longer term view on pricing in Europe? Thanks. + +Question_5: + + Hi, guys. I will give Muhtar's voice a break, and maybe start with Kathy. The quarter came in better than expected from a margin perspective clearly versus consensus, but with the extra shipping days and Easter shift, it is tough to judge your margin performance. I was just hoping you could give us some perspective on where margins and profit came in this quarter versus your original expectations, and some of the key puts and takes in the quarter, again versus those original expectations. + +Question_6: + + Okay. Then net-net, when you put everything together, would you say from a profit standpoint, or margin standpoint, where did the quarter come in versus original expectations at the corporate level? + +Question_7: + + Thanks. Muhtar, feel free to weigh in, but I will also try to give you a break and direct questions to Sandy and Kathy. Guys, on North America, the price realization was solid, but it was actually a little lower than I at least had expected just based on market data. I know were you lapping some fairly intense retailer promotions, so maybe that played a role. Maybe it was again negative mix from still. I know you mentioned fountain dynamic, Sandy. I was hoping you could just expand on the trends there and whether you think 2% is a representative number for the year, at least in terms of way you're targeting it. +On a related note, I was wondering if you could dimension for us the profit contribution to this price mix you're getting. Because clearly, if it was all rates, pure rate, then it would flow through 100% to profit, all else equal, but given a lot of what we're seeing is category mix and these are just introduction of new package types, I'm wondering how to think about the profit contribution. Should we be assuming 50% as a rule of thumb, roughly? Or are there reasons to be more optimistic or cautious related to extrapolating price mix to profit flow-through? + +Question_8: + + Okay. Maybe if I can just follow-up, related theme, different angle, and maybe this is for Kathy, but I noticed you changed the reporting of regional profit to profit before tax, so regional operating profits, to profit before tax, consistent with the incentive changes you made. +North American PBT was up like 100 basis points, 180 basis points or so, but I was wondering if you could comment, A, if there was any material benefit from sub-bottling payments in the quarter, and B, if [OI] margin trends would have mirrored PBT? +Then assuming so, how much of that 180 basis points improvement was driven by some of the better pricing realization, the better productivity, commodities, that can continue as a run rate versus timing benefits in the quarter related to the Easter and the calendar shift? If 180 is representative of the underlying OI trends, and then what is the real run rate that we should be thinking about as expected margin improvement on the year? Thanks. + +Question_9: + + Thanks, good morning. + +Question_10: + + I guess two questions, I will lump them together. One, on Diet Coke in the US, it did look like most recently the Nielsens looked like actually a positive number, and we haven't seen that in a while. I just wanted to see if maybe the trends, you feel like you've gotten behind that, where we could see some growth going forward or at least stabilization? +Then the second question, on the refranchising, anything you have seen thus far? I know it is early, where it is may be accelerated even further in terms of the bottler network, where it is maybe you have more of an update later as we move through the year? + +Question_11: + + Hi, guys. Throughout the press release and your commentary, we pleasingly had heard and read about marketing increases, so that is a good thing. That is very much on plan. However, we didn't really see or hear much reference to cost-cutting benefits offsetting or funding some of those at this point. +The only thing you said was we are on track for $500 million of cost savings this year, but we are not hearing or seeing a lot of that flowing through, even offsetting things. I'm not saying all the way to the bottom line but at least offsetting some of your investments. When can we start hearing more about that savings offsetting your investments? + +Question_12: + + A follow-up on that, and a separate question for Irial, just to follow up on that, Muhtar, if you could, is particularly in terms of the head count reduction and the savings there of, should we see that ramping up throughout the year? +At risk of being cut off, let me (inaudible) my second question here on a separate topic is we do keep hearing Germany, India, Vietnam bottlers in [BIG], continuing to do actually quite well. I always pause whenever I see that, and obviously there's been controversy about some of those names including (inaudible) Germany, but when is the right time to divest those and get them out of the hospital ward? What are you looking for to make sure that happens or potential buyers are looking for at this point to commit to buying them? + +Question_13: + + Good morning. You announced a deal in China last week, and I was just keen to get a bit more detail of quite how that fits in. It is obviously a very different structure to what we have seen with the more recent deals of Monster or Keurig. + +Question_14: + + Okay. Thank you. To follow up, for Kathy. I know it can be quite volatile but equity income at this time has almost gone to zero. Is there something specific in that that's causing that? + +Question_15: + + Okay. This is not a case of there being some big one-offs in some of the equity holdings there? + +Question_16: + + Hi, good morning. + +Question_17: + + Is there any way to strip out what the benefit in the quarter was on the operating profit side from the extra days? + +Question_18: + + Okay, but there is no fixed cost leverage or anything with the extra days that might have helped the gross and operating margin? + +Question_19: + + Okay. That is very helpful. Just on BIG, the year-over-year margin expansion was awesome. Massive. What is driving that, and how sustainable is it? + +Question_20: + + Okay. Great. Then just lastly, very quickly, the delay in the Monster transaction, is there any more color you can give us on why? I think it was supposed to close maybe late 2014, early 2015, and then you guys said March, and now it is towards the end of the quarter. Is there still a high probability that it is going to close then? + +Question_21: + + Thank you. Good morning, everyone. + +Question_22: + + I guess most of my questions were answered, so just a couple of P&L questions, Kathy. One, just in terms of the structural items impact this year, it sounds like a slight negative on revenues now as opposed to the prior call. Just a little bit of clarification of the puts and takes on the revenue impact, it sounds like the impact on bottom line is pretty minimal. +Then on the FX, you had the re-measurement gain in Q1 that was about a little bit more than a penny. Is that really what is the difference in terms of your full-year outlook for [PDP] impact being at the low end of that 7% to 8% that you had called out last time? + +Question_23: + + The timing of the Monster transaction though, the deal itself is delayed, but you are getting the distribution into your bottling in this quarter. That would be still a positive in terms of the revenue benefit, but is re-franchising pacing really what's dragging down in terms of the revenue impact? + diff --git a/exam/original-files/Problem_2_3_Sample_QandA/31_answers.txt b/exam/original-files/Problem_2_3_Sample_QandA/31_answers.txt new file mode 100644 index 0000000..a678318 --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_QandA/31_answers.txt @@ -0,0 +1,121 @@ +Answer_1: + + Good morning, John. It's Muhtar here. I'll just say a few top line remarks about it, and then also ask both Sandy and Ahmet to give some more specific details on their -- in specific markets. +I'd say overall, pleased with our initial results. But as we've previously discussed and as I have just recently said, it takes some time, anywhere from 12 to 18 months to realize the full value in terms of a return on those investments. We've found that disciplined quality marketing investments drive growth better than any other strategy or action. +We're seeing good initial results in markets that have received the incremental media investment, and also have improved the quality of marketing in our case. The marketing investments in North America is a great point. Which is a real contributing factor in the strong performance in the quarter, continued strong performance in North America. And the performance is getting better, with 5% growth in organic revenues and 4% price mix. That price mix, and that volume and that, therefore, growth in organic revenue would not have been achieved clearly without the infusion of that marketing and the quality and the quantity. +In China, also seeing positive trends, strong marketing activation, as I mentioned in my remarks. Sparkling growing at 7%, (inaudible) Coke growing at double digits in the quarter, allowing us to gain -- continue to gain significant share in that market. And additionally, we're seeing accelerated trends in our value sharing gains where you compare them against our trends a year ago. +So with that said, clear that it'll take some time for the full benefit on a quarterly basis as these investments take some time to ramp up. Also challenging consumer environments and macro environments. And so those are really what I would say. And in terms of our results, you see year to date, our marketing investments are growing and our margin is expanding by 50 basis points. +So I think the key is to be able to achieve both, and we are confident that we can -- that we will continue to see more positive results. With that, let me turn now for some more specifics to Sandy and then to Ahmet for international example. + + + Thanks, Muhtar. And good morning, John. +The core driver of our business across the world over time is the quality and quantity of our advertising, and the related execution and activation by our bottlers. And in the US over the past 18 months, we've vigorously pursued that strategy, increasing our advertising spend significantly. And you're seeing the payoff in the top line results that Muhtar just went through. But underneath that, a metric that you can watch also is just the price elasticity of our brands, and how volume reacts to price over time. And it's a good metric of the payoff of advertising, along with the efforts of our bottlers in the marketplace. +As we look ahead, we see advertising as an important proactive item to grow the business. But as you start to see in North America over the past few quarters, we're now leveraging the P&L so that the infusion of advertising is coming from the accelerated top line growth and expense efficiency across the total business. +So net-net, it's part of our outgoing algorithm, and an important part of the way we intend to drive growth going forward. Ahmet? + + + Thanks, Sandy. Hey, John. +We have a very similar story in Coke International. The bottlers and our teams have strong conviction about how better and more advertising drives top line. The example that Muhtar quoted, there's more depth to that. I would add developed markets such as Germany and Spain to that list. I would add a developing market such as Mexico to that list. I would add an emerging market such as Nigeria, as good examples. And there are other examples where we increased media, and we improved the quality of that communication, revenue results improved. +Having said that, the history of this increase is less than a year for most Coke International markets. I would caution that it is early days, but definitely we're seeing the positive examples of this action. + +Answer_2: + + Sure, Steve. On the share buybacks, basically, we've given the range of $2 billion to $3 billion, so we're still in that range. We looked at where we were for the first half of the year, and then we looked at cash, particularly because of the currency getting worse in the back half, and just tightened the range. So basically, we're still in that range and that corridor. We just tightened the range. +And then on the second question on productivity. We have basically stated that we are about $500 million for the year -- we are on track. The working capital has allowed us to basically focus on share repurchase, even with the significant currency headwind. So on our productivity initiatives, we are on track. +We didn't give specific initiatives that we were working on for this year. You know about the people initiatives that we had, and we said we're going to be on target with the $500 million for this year. They're still coming from the three areas, so we're still actively working on reducing our cost of goods sold and moving D&E from more promotional activities into media spend. +So we are basically on track. I don't how -- I can't give you any other specifics other than, we are basically on track for the $500 million that we anticipated that we would have for this year. + +Answer_3: + + I don't know that I can quantify how they come throughout the year. Part of it was dependent upon when we started to see movement with some of the people. And we've not gotten -- for instance, Europe had to focus on the working -- had to work with the Work Council, So their initiative was people really just starting, although everybody is aware the movement of people is just starting. +So part of that will be coming out now that they've been able to focus on their moving people initiative. But I don't know that I can quantify the how and when it all comes through, because we focus on dealing with the work first. And we deal with the work first, and then a lot of the other impact will rail making sure that we deal with -- that the organization is appropriately set up for success going forward. Which included focusing on the global organization, and restructuring how we worked with the global organization. So all I can say is, we're on target with everything that we've done. + + + Just adding to what Kathy mentioned, Steve. I'd say that also in terms of simplifying our organization, wiring our business units closer and more directly to the functional centers in our Company, that has largely taken place. We have essentially eliminated a functional layer in the Company, allowing us to make faster and quicker decisions -- and more effective decision making in the Company. That is already largely in place. And I think lots of continued work streams going on in COGs that will continue to benefit, and help us to deliver more than the $500 million in savings for the year. + +Answer_4: + + First, Mark, good morning. On the Asia PAC, I think it pretty much came in line with what we were expecting and it's related to timing. It's related to how you look at it on a year-to-date basis. And I'll have Ahmet comment on that once I finish. I'll just say a few things about the second question. +In terms of scale M&A and bolt-on M&A, I think you need to think we will be again looking at bolt-on targets that fit our strategic portfolio. That's the way you should think about our continued interest in any M&A and how we target M&A. Just the same way as you've seen us look at it in the last three, four, five years, how we look -- how the acquisitions that we made in terms of innocent, in terms of honesty, in terms of [zeco], in terms of other bolt-on. And then more recently, the announcement from China that we had. +So essentially, bolt-on acquisitions that complement our current portfolio and that give us the ability to also scale it up from a geographic scale goes up from a geographic point of view. Just like you saw us launch Smartwater in other new European markets more recently. That's a good example of how the scale up continues. And how we've converted -- how we've turned Smartwater into one of the leading premium waters in the world, both here in the United States and now in some other new markets. Ahmet, comments on Asia Pacific? + +Answer_5: + + It excludes anything. But I'm saying our focus would be -- I think you should assume that it would continue in that area. If there's something that obviously -- the future, none of us know what the future holds. We could never be -- we're always guided by the past. The future is something, and there may come some opportunities that we'll look at. But right now, what I will say to you is, base it on what I've said as the past few years being an indication of the future. + + + Mark, just to add on to the price mix on Asia Pacific, the minus [6%] was not a surprise to us. It was expected, and there was a lot of timing between the first and second quarters. If you look at first half price mix for Asia Pacific, we're in negative [2%]. Which is very much in line with what has been happening in Asia Pacific due to geographic mix and other channel mix issues. So no surprises there. + +Answer_6: + + Thanks. I'd say, look, I think North America delivered strong second quarter revenue profit value share performance driven by better increased marketing, better marketing, and a disciplined approach to both volume, price and mix management. +Few things, mix management is working in our favor. Consumer is very much approving the smaller packages. Smaller packages are growing much faster than larger packages. Smaller packages have a higher NSR per liter, per gallon, whatever per case. And therefore, there's -- that way price driven by -- and the ability to keep the volume where it is and gain the price mix are historic bests in terms of the past quarter performance in the United States. Why is that happening? More marketing, and more focus on better marketing as well. +So the rate is coming through, mix from transactions and packs coming through. That is the general comment I'd make. And, Sandy, if you want to provide more color to this. + + + Yes, I absolutely agree with that, Dara. And our strategy is, as Irial and I said a year and a half ago, we were putting in place a strategy of building strong valuable brands, with accelerated quantity and quantity of marketing. And we were going to take proactive opportunities to get our price in line with the value of the brands, and to lead price up in a consistent and strategic way. Working on the development of packages that consumers want, in particular premium packages. And the consumer is pulling very clearly to smaller packages, so they can enjoy the ice cold refreshing taste of one of our beverages but in a portion size that they want. +The net effect, as Muhtar said, is that we have a benefit from mix but our strategy as we look forward is to continue to lead. We see this strategy of disciplined price pack volume management underneath the brand building of strong powerful brands as a long-term strategy. And we continue to take action across our system every day to reinforce it, to grow our capability, and to continue to grow our business in a very balanced and disciplined way. + +Answer_7: + + Absolutely. The strategy is very consistent, and we continue to be optimistic about our ability to make the levers work. Because our brands are strong and we're investing in them, and because our bottling system is executing very well and we continue to get better. +I think one of the mantras in our team, Dara, is that we've got the right strategy. But we're just beginning to hit our stride from a capability standpoint, and we have much more opportunity to improve than we have progress made so far. + +Answer_8: + + Sure, Vivien. First out, I'd say the challenge is never taken for granted, but the challenge is broadly very much a US centric one. So let me just preface that, and then have Sandy comment on what's happening in the United States. And also comment -- give you some more comment on other diet drinks like Coke Zero performance and so forth. + + + Sure. As we've discussed in several of these calls and in our interactions more one on one, the diet and frozen parts of the food and beverage industry have been struggling for a number of quarters. It's getting into years now. +As the consumer -- the US consumer moves really strongly to fresh. It's a good dietary change actually for the country, but the impact on categories, and particularly categories that are appealing to diet oriented positionings has been pretty negative. Inside our particular portfolio, we have brands growing and have brands struggling. +Coke Zero, as Muhtar mentioned, grew in the quarter. Diet Coke continues to struggle. Our near-term improvements, though, are we're starting to see the consumer base stabilize. +We have an incredible number of very loyal drinkers in Diet Coke, that love Diet Coke. And our milestone that we're seeking to achieve soon is to level our revenue. To match price and volume, such that Diet Coke's revenue gets to flat and then starts to grow again. +As we look ahead, what I would tell you about Diet Coke is that we believe strongly in the Diet Coke franchise. Diet Coke, the brand, is the number one diet beverage in the United States, and it will be for a long time to come. +We also are looking at changes in the category. Our largest competitor is changing their formula, and they'll be launching that in August, and that will create a lot of buzz in the category. Some of it good, as the good science of the safety of non nutritive sweeteners gets out in the marketplace and is reinforced. +We are looking at multiple programs, to not only strengthen Diet Coke but to offer consumers adjacent innovation in the Diet Coke franchise. And we're excited about the long-term future. But as we say around here, it's work in progress and a lot more work to do, but we still are very optimistic about the long term. + +Answer_9: + + Hello, Bryan. Yes. On the margin question, our margins were negatively impacted by currency and by structural. Obviously, there's always some negative geographic mix that plays into that. But as you look at our margins and if you look at the specific growth margin, first of all, and if you look at them on a comparable basis, we lost some margin. +But then if you take out currency and then you take out structural, then we were at positive margins again. So -- and the issue more is about growth margin, it's not so much about operating margins. When you -- then your second question which was -- + +Answer_10: + + It's normal in the Pacific to have negative geographic mix, just because of the base of the country, Japan, and then all of the emerging markets there. So, yes, I would say for the remainder of the year, I would anticipate that we would have negative geographic mix in Pacific. Ahmet, you want to comment on that? + + + That's definitely not in the numbers that we've seen in the second quarter, but the general trend of around a couple points of to date number. However, we do continue to aggressively implement our more balanced top line growth in terms of price and volumes across the territory, and we are aiming to improve on that. + +Answer_11: + + Before Sandy comments on that, Bryan, let me just also say that, also in many parts of the Pacific, since your question was somewhat related to the Pacific and in terms of geographic mix. I think sparkling and particularly, Bryan, Coca-Cola, again, with things that are happening around advertising and media spend and better quality is getting stronger. +Whether you take Indonesia, or whether you take Southeast Asia, or whether you take China, sparkling is getting stronger and momentum on sparkling is getting better. And therefore, I think you're also seeing a positive shift in category mix for us that is somewhat countered by continued geographic mix. +So I think there's a balance there, and I think we're happy to see that balance coming through. I just want to mention that, that important this year, we see that balance beginning to come through, more favorable balance coming through. And then, Sandy, if you want to talk about the smaller packages reference. + + + Sure. The growth in North America transactions is healthy. And that's coming from a number of things. But the small packages clearly are driving a tremendous amount of positive growth. Some of it is cannibalistic, but the cannibalistic nature of it accrues to higher margins. So the mix shift is positive, and then you have the incremental transaction growth that's being driven there. And the primary reason is that the consumers want smaller packages, that's why they're buying more Cokes. +Our marketing model is about more people, enjoying more Cokes, more often for a little bit more money. And that's what we seek to accomplish in the marketing and execution of our brands. And what you can see by the mid-teen growth of the smaller packages is they're driving that transaction growth, and transaction performance is positive. So the net effect of it is that it's positive in net-net. +The other comment I would make is that we have data in some of our retail partnerships that shows that moms in particular like small packs and are returning to the category to use small packs as a way of giving treats to teenagers and others in the household. And it's a particularly positive thing, because moms can do that with a pack that isn't too big. Whereas, for many years in the category, we marketed packages that were too big, that were either wasted or over consumed. Our package mix no longer does that, and it's one of the reasons why our growth is accelerating. + +Answer_12: + + Thanks, Nik. First thing, I would say to you, as I mentioned in my scripted remarks, that we had a very successful global system meeting back in May. And I see the much more improved engagement, and also commitment by our bottling partners across the board, small, large, Asia, Europe, Latin America, Eurasia, and Africa, North America. +So I'd say to you, it's broad based. And I'd say to you that there's a great deal of excitement that is around our plans, particularly our reinvestment plans, and also great amount of commitment for better execution and more investment on the side of our bottling partners. So as I look at the pipeline of investment, I would say I am much more encouraged today than I was, say, 12 to 18 months ago. And I believe that that's driven by our plans and our -- basically our belief in the future and what is being -- and what is happening is yielding early results. And that is driving that engagement. + +Answer_13: + + No, we'll see it this year, and we will see it at a trend that continues to increase next year and beyond over -- certainly over a three-year period. Here in the United States, in Latin America, in Europe, in Asia Pacific, in Eurasia and Africa. + +Answer_14: + + So, Ali, volume, the algebra is volume times price, is what we generate as revenue. And I think it's good that you ask that question, and it's one of the important elements of the algebra. I think we're encouraged by actions where we basically expect it to be. We're cycling 3%, and we generated 2%. And I think the volatility, as I mentioned in Russia on the verge of a recession today, from a macro point of view. Or Brazil where there's still very significant challenges in disposable incomes. China disposable income levels haven't improved significantly. +But importantly, improving trends on share, we're at all-time high in many markets. Value share, particularly, which is very important, and value share is driven again by the actions that we're taking. +So based on your question, have you seen the bottom? I'd say we're about where we expected to be. And we see that what we're doing is continuing to help keep that equation in place at an improving trend. The equation being, if the marketing wasn't there, the volume wouldn't hold up where it was and the price wouldn't hold up where it was. See it in that respect, both being propped up by the investment that we're putting into the marketplace and those investments being driven by the zero-base work that we're generating. + +Answer_15: + + I think you said it. Those are continuing to improve. As they improve, they become -- there's more that are getting in line for those assets, and that's a good place to be. And I think that basically we see those are great markets, not just in our hands, but in the right hands. And that's the way we see it. And I think that we are encouraged by the internal plans we have, and I think that that's all I can say right now. But we have -- we're in a place where those -- let's call it this way. The fruit is getting riper. + + + This fruit will never get overripe. It will be good on the tree and off the tree. + diff --git a/exam/original-files/Problem_2_3_Sample_QandA/31_questions.txt b/exam/original-files/Problem_2_3_Sample_QandA/31_questions.txt new file mode 100644 index 0000000..83f04b1 --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_QandA/31_questions.txt @@ -0,0 +1,69 @@ +Question_1: + + Thank you. Good morning. I want to talk a little bit about the advertising spending. There's been some questions and I've had to myself in terms of whether you're just sort of fighting a headwind in terms of trying to advertise the categories. +So can you talk a little bit about what you're seeing? How you're gauging the success that you're having? And what we should expect from an advertising spending increase as a percentage of sales as we look out over the next 12 to 18 months? Thanks. + +Question_2: + + Hello. Good morning. Thanks. I guess first could you just -- maybe I missed it, but could you just address the reduction in net buybacks for the year and what lies behind that? Is free cash flow coming in weaker? Because that would be surprising just given your working capital comments, et cetera. Or is there a competing use for cash that we should be considering? Just a housekeeping question. +And then a broader question on productivity. The update in the report card you provided was certainly helpful. But I was wondering if you could maybe quantify what those initiatives translated into in terms of savings in the quarter, and how far along you are, admittedly early, against that ultimate $3 billion goal? Because I think that would help just frame where you are in the overarching initiative. And actually, if you could perhaps talk about other initiatives underway and what kinds of achievements we should look for on Q3 or Q4 report cards. That would be great as well. Thanks. + +Question_3: + + Okay. That's helpful. Is it fair to assume that the savings build and that there's more of an impact in the second half versus the first half, or is it more ratable throughout the year? + +Question_4: + + Thanks. That's Stifel Financial, but good morning, everyone. I guess two questions here. +One, a region question, Muhtar, and then a more strategy question. With Asia PAC, at least versus my model, the price mix was disappointing. It's only a quarter, and you highlighted China and I think some product mix issues. But when you think longer term about price mix in Asia PAC given the superior growth I think you expect from China, what's a sound way to think about that region in the larger Coke system? And then unrelated to that, or less related to that, when you think of scale and bolt-on M&A, can you just update us on you're thinking for the larger Coke, how you're thinking about scale M&A, and how you're thinking about bolt-on M&A? + +Question_5: + + Can I just ask one quick one there as a follow-up, Muhtar. It sounds like what you're saying there is precludes an interest in scale M&A. The focus -- just to be super clear, the focus is on bolt-on to the exclusion of scale. And we could debate scale I realize, but sounds like that's the focus. + +Question_6: + + Good morning. So, Muhtar, clearly, very strong 4% pricing in North America. Can you run through how much of that was mix versus price? And then comment on the sustainability of higher pricing as you look out for the back half of the year once you cycle the higher pricing from last year? +And longer term, how you think about any pricing? Clearly, we've seen a big improvement here over the last year. Looks like it's worked well in terms of limited demand elasticity, so more longer term type thoughts on pricing in North America. + +Question_7: + + Okay. So it sounds like the way you approach pricing in North America going forward, you think you'll continue to see progress both for main mix and rate perspective. And obviously, while we could see a sequential slowdown as you comp over this period, you're pretty committed to the efforts longer term. Is that fair? + +Question_8: + + Hello. Thank you so much for taking my question. I was going to focus on Diet Coke. While your total sparkling unit case line growth was clearly impressive, Diet Coke continues to be challenged. So, Sandy, could you please update us on what you're seeing in terms of North America? And then, Muhtar, if you could comment on any other geographies where you're seeing diet present a challenge. Thank you. + +Question_9: + + Good morning, everyone. So just I had a question about geographic mix. I think it came up earlier the geographic mix was negative in the quarter. And could you -- is there any way you could outline for us if geographic mix also had a negative effect on profit margins or profitability? +I know there is a lot of moving parts in the P&L. But when you look at it currency neutral, you saw some margin expansion. And my thought is you actually had, within that margin expansion, you actually had some negative geographic mix on margins. So any help on that would be helpful. +And then related to that, as we're modeling out the balance of this year, and I guess it goes to Mark Swartzberg's question about the Pacific region. Should we continue to expect to model in negative price -- geographic price mix into our models for Pacific in the back half of the year? Thank you. + +Question_10: + + Just related to price mix, price mix in Pacific. Should we continue to see negative geographic mix there? + +Question_11: + + All right. Thank you. And if I could sneak just one last one in for Sandy. +If we're looking at smaller pack -- the affect of smaller pack sizes in North America and just simply looking at it on transactions, I know it's kind of early, but is it incremental? So if we were just measuring transactions, are the purchases of those smaller packages, are they incremental to base business or is it cannibalistic? Thank you. + +Question_12: + + Thanks for the question. So I just wanted to go back to the bottler reinvestment question. And maybe, Muhtar, you can give us some perspective on where the bottling match in resourcing has been most significant. Just so we can get an understanding of where there could be potential leading indicators on that impact on volume growth. + +Question_13: + + Muhtar, are we starting to see cooler placements actually hit the market and more feet on the street? Or is this bottler commitments on that they're going to do it at some point in the next quarter or two? + +Question_14: + + Hey, guys, thanks. A couple of things I wanted to talk about if possible. One is around top line, and one is around asset base. First on the top line, I think you guys have done a good job explaining and playing out the thesis out in terms of price mix, which is great. +On the volume side, how would you describe the Company trajectory right now from a volume growth perspective? So do you think we've seen the bottom in terms of volume growth after a series of plus 1% to now a 2% and some user comps going forward? So do you think we should be projecting a turning point upward in terms of volume growth for the Company going forward? And I'll come back with the asset question in a second. + +Question_15: + + Okay. Very helpful answer. On the asset side of things, if you look at Germany and India and Vietnam, NBIG, those continue to do quite well. Seem like they're improving. And in North America from the discussions we've had, this call, other calls, looks like that's getting better, too. With productivity and profit actually growing finally. +Are -- do you think there are ways or are there -- what are the hurdles given all those improvements for you not to be able to divest or refranchise those assets more quickly? And have a smaller access base, which is the long-term plan, even more quickly than you've laid out so far? + diff --git a/exam/original-files/Problem_2_3_Sample_QandA/32_answers.txt b/exam/original-files/Problem_2_3_Sample_QandA/32_answers.txt new file mode 100644 index 0000000..7d7e62e --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_QandA/32_answers.txt @@ -0,0 +1,113 @@ +Answer_1: + + Good morning. + +Answer_2: + + Yes, thanks for the question. What I would say in general overall is, yes, we're pleased with the quarter and the progress we're making, but lots of more work to do. This is a transition year. +When we talked to you about 12 months ago, we outlined to you that with the changes we're going to make that our goal is to get to mid single digit, currency neutral revenue growth for the comparable revenue growth for the Company overall. And I think if you look at our progress to date for the first three-quarters of the year, we're at sort of the bottom end of that range, the mid single digit. +If you look at where we are in revenue in terms of currency neutral comparable, and what we have posted in this past quarter, the third quarter, you would see us, if you take those numbers that you mentioned in terms of volume growth of 3% and price mix of 3%, at the top end of that range. +So, in essence, we're pleased with the progress -- what all the five-point strategy and executing it diligently over the last nine months and even starting at the end of last year has brought us to where we are. And so we feel that -- we've always said the marketing has a lag, the incremental marketing, there's a lag in terms of when we input it and the results that we're getting. +But we see that the plan is working, and we certainly see that we're taking a very strategic approach in terms of marketing spend versus optimal levels. Consistent quality investment in media continues to be one of the strongest drivers of our business, enabling us to generate that revenue. We look at each market, how many weeks of consumer engagement there is. The goal over time is to apply the right pressure in the right way to each of our brands, and each of the segments that you mentioned, which is developed, developing and emerging. +The system alignment in our bottling system is matching our alignments with investments -- I'm sorry, with capabilities, execution, output development, cooler placement, et cetera. So we're pleased with what we see there. And, of course, all of this being said, we have a volatile macroeconomic environment which obviously is not getting any better anytime soon. +We realize that the global growth for 2015 is projected to be below last year, and even having said that, the disposable incomes are even lagging the growth rates that are projected. So, yes -- but in general, that's how I would frame your question, and both James and I and Kathy believe that the incremental and better marking is certainly giving us the results in terms of the top line currency neutral comparable top-line growth. + +Answer_3: + + Thanks, Steve. What we said again at the beginning of this journey back three, four years ago, is that we said that we have an intention to create a system in the United States that can benefit from the local empowerment in each of the communities in the markets that have built our business so successfully over the last 130 years, the franchise system, the alignment that that brings, the value and trust between us and our bottling partners. +But at the same time create the mechanism, so to speak, the processes, flexible processes in the marketplace, whether it be information systems, whether it be the customer management system, so that we can speak with one voice to customers coast to coast in the United States, and the national product supply system. +All of those negotiations with our expanding bottlers took some time to achieve. They are all achieved. That's why we're progressing with rapidly with our refranchising program, which is working very well, because when we have those processes in place, we can refranchise with confidence and speed and have the business continue to generate the results and the growth that we are seeing in revenue, particularly in the United States of America. +And the United States nonalcoholic beverage business is healthy. It is growing in revenues and dollars and cents, and that's the really important measure -- important element that I want to leave with you. But just to add more color and flavor to the National Product Supply System question that you had in terms of the governance model, I will ask James to comment further and give you more insights. James? + + + I think just specifically on governance, it's not going to be around unanimity. It's going to be based on the driving of the business case. Everyone is committed to doing what is economically the most rational answer for the system. Again, when it comes to the national issues, it's not necessarily the management of each local plant which will remain the job of each of the participating bottlers, or CCNA. + + + Steve, did that address your question? + +Answer_4: + + We're not laying out the precise mechanics, but I can tell you that there's not going to be a full consensus required for every decision. It is going to be a large majority, and if they support the economic case, then that's what's going to move forward. +We're not creating a system that can become blocked. We're creating a system to focus on the best economics of the system in North America and there are mechanisms for that to go forward. + +Answer_5: + + Correct. + +Answer_6: + + Judy, thanks. This is Muhtar. Good morning. Unit case, as I just said, did grow 4% in the quarter in Europe. They were cycling a minus 5% from prior year, and sparkling was up as well as stills growing faster than sparkling in Western Europe. Then our concentrate sales did trail also the unit cases in Western Europe as it did for the whole Company. +And I'll ask -- and we were pleased with the results and certainly, again, some early results from the marketing, but more to come. And I will ask James to add more color to that. James? + + + Thanks, Muhtar. As Muhtar referenced, we were cycling a pretty poor quarter from last year, so I think it was a favorable comparison. We had strong results from very favorable weather in the Southern and the Central part of Europe. But I wouldn't read too much into the one quarter. I think if you look at the longer-term trends, you can see that we're getting some volume growth in the year to date where the price mix is bouncing around flat. +I think it's important to recognize two things as it comes to price mix in the case of Europe. One is the general deflationary nature of the European market. Retail pricing is zero to one, at best in general. And then secondly, it's worth remembering that the starting point of pricing in Europe is, in comparison to the US, higher. So the opportunity is to drive price mix on a sustained long-term basis. +In a sense we've already captured some of that in Europe, and we will be chasing that in the US. So I don't think we'll see the same sort of price mix over time in Europe given our starting points. + +Answer_7: + + Good morning, Brian. + +Answer_8: + + Sure, thank you, Bryan. So the foreign exchange for next year, if you remember, we had said that for our hard currencies we are hedged, and so our real exposure is around our emerging currencies. That being said, we do have to cycle that euro debt bond offering which impacted the first and second quarter of this year, and for the full year it was about 3 points benefit to us. +So we do have to cycle that next year on top of the change in the rates and probably a more difficult currency environment going forward. So we will give more color on currency in February when we give our full-year results for 2016. But our issue is really going to be around the emerging markets where we've just -- it's not cost effective to hedge more than about a quarter at a time. +And then in terms of the structural impact, yes, Germany will be a structural impact next year. Obviously we continue with the North American refranchising, so that will still have a significant impact in North America. And there may be some slight impacts from whenever the things -- Africa closes -- the Africa transaction closes. But the majority of it will be the Germany transaction and the North America refranchising. + +Answer_9: + + Yes, I want to -- Bryan, this is Muhtar. What I'll say is it's in the regulatory approval process, and that's all I would say right now. We expect it to close sometime over the next three to four months. That's what I would say. + +Answer_10: + + Sure. So the unit cases to concentrate shipment, they were really impacted by Asia Pacific and Latin America. If you look at Latin America on a year-to-date basis, they are absolutely in line. And with Asia Pacific, on a year-to-date basis we expect them to be generally in line. So there's really no story there in terms of that gap. +When you -- moving on to productivity, so productivity initiatives, obviously we are seeing some benefit from productivity. In our margins, there is an impact in our margins from basically the structural changes. So if you were to exclude structural changes, gross margins and operating margins would be higher, and you would see margin expansion. +When you look at the third quarter, when you look at the leverage, so we are getting some productivity, but we also have an impact from timing of the DME from-- basically from prior years that's impacting that timing from this year, that, by the way, turns around in the fourth quarter. So I think there are a lot of puts and takes going on around productivity. You are seeing some productivity coming through. We are continuing to reinvest behind our brands, though. +But our margin expansion is masked right now by currency and structural. So if you pull those two things out, you see very good margin expansion. + + + And I would just add one point, Ali. I think what we saw in this past quarter in terms of operating margin expansion on a currency neutral comparable basis of about 100 basis points, we were pleased with that expansion. Now, the key is to do everything we can to continue and ensure that we execute fully on the five strategic points going forward so that we can continue to improve our trajectory. + +Answer_11: + + We will not comment on any specific matters related to our customers, bottlers, or any M&A matters. So I would just leave it at that. + +Answer_12: + + John, this is Muhtar. Actually they're not in conflict at all. They're basically very complementary to our strategy which is to ensure we have the local touch, and we have also the scale, and we have the processes to meet customer demands and customer partnerships. +And in the United States we've actually not -- you mentioned the word fragmented. We have a national customer management system. We have a national production system. We have a national information system that is basically all with their own governance models, and they're very fluid and very flexible to suit the needs of the business today. +And then at the same time, every piece of the United States that has those elements really have enough size for scale. And then we have the much smaller, the smaller distributor bottling system that also the smaller guys are doing a great job in growing the business for us. +And then in Europe, basically what we have is the customer landscape in Europe is much, much more concentrated in Western Europe where just a handful of customers account for a very large portion of the total future consumption, the retail business in Europe. And, therefore, when you look at what we have created in western Europe, it basically suits our future needs in terms of working proactively with our customer partners and also it gives the scale and also it gives the local touch in each of the markets. +So from that perspective, just like what we've done in Japan, just like what we've done in South Africa, in large markets I'm talking about, it basically very much aligns to our strategy in how you think about what we're doing in the marketplace. + +Answer_13: + + Well, the customer base in the United States and Western Europe is very, very different in terms of how it's structured. And so we follow the customer -- the needs of the customer, what matters. We follow the scale; we follow the necessity for speed. And we feel that the model that is being created in Western Europe will serve us very well for the next decade and beyond. +And the same thing goes for the United States. It is proving that it is serving us very well in terms of getting us to scale, in terms of getting us the costs in production and cost of goods sold, but at the same time retaining the local touch and retaining the local element that is really important in our business. Both of those are valid for Europe and for Western Europe and for Japan and for South Africa and for the United States, or wherever else you are seeing us create a better bottling system. + +Answer_14: + + Good morning. + +Answer_15: + + Well, I think based on what we're seeing is we're able to generate revenue growth both in the sparkling category very much so, as well as in the still side, and, therefore, that's what my comment referred to. This is not just one quarter, this is multiple quarters. +At the same time, inside that LRB category that is showing very good resilience in terms of both price elasticity, price discipline, approach with customers, generating value for our customers, both in the sparkling side, as well as large and small customers in the still side, we're also seeing that this is the 22nd consecutive quarter of us gaining value share in the marketplace in North America. +And then the mix is really working for us in terms of generating the marketing where the North American market is the first market where we've started employing incremental marketing, better marketing is generating also positive results for us in terms of the revenue growth from sparkling derived, particularly -- purely from sparkling as well as from the still side of the business. James, do you want to add any color to that? + + + Yes, I think, if you take a look at how we're driving the sparkling business, you can look at the transaction packages which represent about 15% of the volume, and they're growing still again this quarter into double digits. So we're very pleased with the marketing and the OBPC approach is driving positive revenue growth for sparkling on a consistent basis. + +Answer_16: + + So, of course, we need to wait and see whether the recent vote produces the [act of] law by the end of the process. It's only gone through one of the stages, so we'll see where that ends up. Obviously, we are in favor of reductions in discriminatory taxes. +I think as we look out on how that has impacted the world and how that's being viewed, and it will be used as a case study around the world, the data we have so far is the impact of the tax was to bring down about six calories from the Mexican diet by the end of the process. So we're conscious that obesity is a crisis, we know we need to play a role. +We don't think this is the silver bullet that anyone was looking for, and we think that much more work needs to be done if, indeed, a solution is to be brought to bear on the whole obesity crisis, which overconsumption of anything, including soft drinks, would be a contributor and a part of the problem. +So we'll see where this tax ends up. Clearly taxing diets and [lights] doesn't seem to be the right way forward, and, therefore, if this measure goes through, I think it would be positive. + +Answer_17: + + Yes, I mean, Nik, I'll just say, very broadly, at a high level, we're pleased with our performance in China. Obviously a lot of noise around China these days, but we have, as mentioned earlier in the script, we have an all-time high share for brand Coke in China and we're growing in China and we're gaining share in China and we're investing in China. And the same goes for India, two of the very large markets in Asia, certainly pleased with the results there. +We had some weather-related issues in the quarter before, but we're coming back, the business is really coming back and performing much better in India. So overall, I think -- and then in Japan we're seeing some green shoots in terms of disposable incomes. We're very early still to call it any color. But overall, I'd say -- and then obviously, back in South -- Australasia, the economy was very much related to commodities, and it has suffered, and we're seeing the macro spillover from that. +But I would say, overall, in this past quarter, we're happy with the results of the big economies, and recognizing that we've got more work to do. And that's how I would leave it. + diff --git a/exam/original-files/Problem_2_3_Sample_QandA/32_questions.txt b/exam/original-files/Problem_2_3_Sample_QandA/32_questions.txt new file mode 100644 index 0000000..d2e1c0f --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_QandA/32_questions.txt @@ -0,0 +1,78 @@ +Question_1: + + Hi, good morning. + +Question_2: + + So, Muhtar, it's been a year since you announced the plans to focus on greater pricing in developed markets as well as boost marketing spend starting in 2015, and I was hoping you could just take a step back and give us a more detailed review of your progress on those fronts, how much top-line growth is responding to those efforts relative to your expectations, both in terms of the market share payback from the higher marketing as well as the demand elasticity from the higher pricing. +Then just in terms of the quarter, on an adjusted basis ex the concentrate lag, it looks like underlying revenue results are returning to your long-term goals with 3% unit case result and 3% price mix. So at this point, do you feel comfortable you can generally meet those long-term top-line growth goals going forward, ex any timing issues, or with emerging markets macros still decelerating and perhaps easy comps from this quarter it's a bit too early to call for that? Thanks. + +Question_3: + + I actually want to talk a little bit more about the National Product Supply System that James detailed. And I guess specifically, maybe Muhtar or James, could you talk more about the governance process there and the makeup of the managing Board? As I understand it, there are five voting members, CCR, Coke North America, and then the three bottlers, Consolidated, United, and Swire. +I'm curious as to how you ensure that tough decisions get made in structure and implemented in that structure? Do you need unanimous consents? Is it majority rules? And if there isn't unanimous consent or support for a given measure, what gives the NPSG the power to enforce successful implementation? Thanks. + +Question_4: + + Yes. Sorry, I was on mute. No, thank you, that does help. But I guess, James, just to follow up, if there is friction on a given issue, or if there is debate about what is in the best economic interest of the system, what's the tie-breaker? How does the majority view get pushed through? + +Question_5: + + Great. There are mechanisms in place to break a tie? + +Question_6: + + I guess I was hoping to get a little bit more color in your performance in Europe this quarter. 4% volume growth, certainly an improvement there. You called out some of the factors, the green shoots in Europe, you've got the favorable weather conditions, as well as the marketing spending step-up. +So, number one, can you just talk about a little bit more about what really drove the volume improvement? How sustainable those improvements are in terms of volume? And then if you think about price mix performance in Europe, kind of flattish performance in a more developed market, how should we think about that number? How much was that geographic mix? And are you seeing actual price realization in some of the markets, understanding that obviously it's a tough deflationary market there. + +Question_7: + + Hi, good morning, everyone. + +Question_8: + + Kathy, just a question for you. And just thinking about some of the, I guess the macro drivers of the P&L as we move into the fourth quarter and maybe beyond into 2016. Other income this quarter was an expense that had all related to the euro bond gain that you had in the first half and how we think about lapping that next year. +FX, the negative effect on operating income is greater in the fourth quarter than it was in the third quarter. So should we think about FX carrying into 2016? +Then in terms of structural change, I guess with Germany now essentially being contributed to the partnership, or the new entity in Europe, that will be a structural change for next year. But just anything we should be thinking about in terms of changes in the structural change component of modeling, I guess, going into the fourth quarter and maybe into next year would be helpful. Thanks. + +Question_9: + + Okay. Thank you. With the Africa JV, do we still expect that that will close before the end of the year, or is there any update on timing there? + +Question_10: + + Hey, guys, just a few things. One is I was hoping you could set people just more at ease around the closure of the gap in unit case volume to concentrate sales. Getting a lot of questions there. If you're real comfortable with that, if that's the case, that that closes for all the regions in the world, it certainly does look like there's an inflection on top line. +But are we now comfortable enough to also start talking a little bit about perhaps a crossover point or an inflection point in the productivity savings being higher than reinvestment rate as well so margins can also look like they're expanding? It looks like you had flat operating margins here, including the FX effects there. But that's better than it has been in a little while as well. So can we clarify and give us a sense on the margin inflection potential as well? + +Question_11: + + Okay, that's helpful. Just from a structural perspective, as you mention it, one of the big changes obviously in the marketplace is the ABI SAB deal which is agreed upon, I guess. Can you talk about any of the deal implications to you structurally in that context? +For instance, would you let them produce both for you and the blue system? Is that something you can shed a little bit of light on as now it's an agreed-upon deal it sounds like? + +Question_12: + + Yes, thanks. I want to go back as sort of a little bit of a follow-up to Steve's question. If I look at slide 10 in the handouts, if I look at North America, you guys are fragmenting that sort of last piece to market, that last piece of the route to market. And then also to some extent the manufacturing piece, yet you're telling us on the flip side, as we look at Europe, as you create this wall that goes across Europe of all one big bottler, that consolidation is something that seems to be the right thing for Europe. +So can you talk a little bit about why fragmenting North America, yet consolidating Europe at the same time, those are both the right strategies when they -- I don't want to say they're diametrically opposed, but at least they appear to be somewhat in conflict with each other. Thank you. + +Question_13: + + Okay. If I can just ask a follow-up, I guess you talked about local touch with the smaller local bottlers in the US, then you also talked about local touch in Europe. And I guess, again, just to play devil's advocate here, aren't you moving away from the local -- I realize you are going to try and keep some of the local pieces through the new bottling entity, but it seems to me that's moving less local. It sounds like you're trying to have it both ways. +I guess I'm just not following why one is so dramatically better than the other? Is it just simply the smaller account piece on the US side that creates the difference here? + +Question_14: + + Hi, good morning. + +Question_15: + + Muhtar, I wanted to circle back on the comment that you made about the health of the US LRB category. Clearly that's apparent on the still side of the business. But as I look at the syndicated data for carbonated beverages in the United States, it does look like the category is softening a bit. And I think your revenues were down three out of the last four months. So I was hoping you could comment on the evolution of the US CSD side and demand elasticities and how they're evolving, please. Thank you. + +Question_16: + + Good morning. Thank you very much. I was wondering if I could ask you about the recent vote in Mexico. It looks like there's a proposal to reduce the tax on soda by about half on products with five grams of sugar or less per 100 milliliters. First, I was wondering what you thought about the prospects of that? If you could give us any clarity on what percentage of your portfolio that would cover? +And then if we just think about it from a high level, and maybe, James, you could give us some color for a number of these markets. If we look at the Mexican soda tax as a template for the rest of the world, does this suggest any tempering of how some of the regulatory authorities are looking at the category broadly speaking? Thank you. + +Question_17: + + Thanks. Just a quick question on Asia. Perhaps you can provide a little bit of context. It looks like that business may not be performing as well as you would like broadly speaking. Is this a portfolio issue? Can you just talk a little bit about what's going on across that region, so we can just think about that as we go into 2016? + diff --git a/exam/original-files/Problem_2_3_Sample_QandA/33_answers.txt b/exam/original-files/Problem_2_3_Sample_QandA/33_answers.txt new file mode 100644 index 0000000..8a25849 --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_QandA/33_answers.txt @@ -0,0 +1,140 @@ +Answer_1: + + Good morning, Bill. + +Answer_2: + + Great, thanks + +Answer_3: + + Yes, thanks Bill. Ever since I took over as CEO, I've always emphasized the importance of our franchise model. One of my clear priorities was to accelerate growth in our biggest profit pool, the United States. We bought the business of CCE US operations with that goal in mind. When you think about it, now we've been able to prove to ourselves we can accelerate the business in North America. We've had the best year in 2015. You saw the results from the quarter. +These results show our strategic focus on driving consumption of smaller package sizes is continuing to pay off. Transactions are growing. Price mix is healthy. Bringing those two things together, both the goal of going back, returning to our core model, which we've always emphasized -- even the first time we announced the purchase of CCE's US operations, we said there will be a role for partnerships going forward, as soon as we can put some things right. +We have got the three legs of the stool in place: the customer governance, production governance, and the IT platforms. We feel very confident. We have proven to ourselves that we can do it, and we feel very confident that this is the time. The new model is established, bottler performance is improving. We have a new structure to last us the next number of decades, and we've put the bottlers -- we're putting our bottlers in the right hands. As Kathy said, the bottlers a very healthy, and thanks to the great leadership and capability of our Bottling Investment Group. +Yes, we are now going to the core. This is the time, and we feel very confident that we can do the two things together -- accelerate momentum and bring the franchising to a bookend that really we feel is going to be very beneficial, both to our Company, our share owners, as well as leading to better customer service and better value creation on the bottler side. It's really a win-win from all those perspectives, Bill. + +Answer_4: + + Good morning, Bonnie. + +Answer_5: + + Sure, Bonnie. I'll say a few words, and then I'll let Kathy and James comment, too. I'll say that certainly we have the proof point in the United States. Our Chinese business, for example also, is giving us great -- has great momentum, gaining share, and growing in that difficult environment, if you look at the quarter, if you look at the full-year results. The capability that has been put into place in all of our expanding bottlers everywhere is really giving us the confidence. +Also, just look at the momentum of the business. Our revenue growth was a priority. We've got it up to the 4% to 5% range. The increased marketing is working, clearly. Now better marketing is even going to enhance that. At the same time, we feel that every time the territory has transitioned, it's actually continued to do well, continued to gain share, continued to drive momentum, continued to drive incremental transactions. From that, any of the territories in the last four, five quarters that have been transitioned, we've seen without exception that to be holding true. +If you look at all these bottlers that we re-franchised, look at the performance of our German bottler. It really has the greatest momentum and the confidence of Europe right now. All of these bottlers are going in to a system, to a structure, to an architecture, to a geography that will continue to do even better when you combine it and when you create the synergies with the combination. We feel confident. +What took a little while to get right was the governance model around production in the United States, the governance model around the IT platform, the governance model around the customer service. All those are in place and working well. I'll hand over to James to add some flavor to that and more details, and then Kathy can comment also on your questions related to the financial aspect of the cash. + + + Bonnie, let me add one thought to what Muhtar's laid out there on we've been fixing and building and we're finding the right partners. A simple way of looking at why it's working is there's just more people coming to the table saying we want to be partners. Our existing partners want more territories, and new people who aren't in the system want to get into the system. They are seeing we fixed the business and we've built momentum, and so there's a lot of heightened interest in being part of a growing Coke system, particularly in North America. + + + Okay, Bonnie I think the last part of your question you asked about the incremental dilution and the impact of that, as helping with the impact of that. For 2016 we gave you the impact. For 2017 we are doing several things, because we know you all have lots of questions about 2017. We are going to provide revised operating segment financial information later in the quarter. +At CAGNY, we're going to give you a look at what to anticipate the business will look like after everything is finished in 2018, because the actual dilution depends really on the timing of these transactions. The best way we can give you some indication of that is really to help you understand what our business will look like when everything is said and done in 2018 and beyond, which is what we're going to try to do at CAGNY. I would ask you just hold off on that, and more to come on that. +On your question about cash, we -- the cash will basically go into basically our capital structure and be part of our normal mix. At this point, no Board-level decisions have been made. We anticipate these proceeds will be used to strengthen our balance sheet. + +Answer_6: + + Thanks, Dara. As I mentioned, we're pleased with our market-share performance, value share gains across the world. I'll let James highlight some details on that. + + + Yes, thanks Muhtar. Dara, let me give you a quick run around the world in terms of share. Firstly, on an overall global basis, perhaps consistent with our strong fourth quarter, we gained a little more share in the fourth quarter than we had in the whole year, so a better performance at the tail end. +In terms of how that played out across the world, you see again in line with the volume performance, strong results in North America. We gained share in sparkling, we gained share in still, and we gained share overall in the quarter and in the year. Good momentum in North America coming through in share. +In Europe we're gaining share in sparkling and in stills. Given our different starting point, that's netting out to being flat overall; but we've got a strong growth in Europe as we build our stills business. Latin America, this is a long-term track record of success, so small gains there, building on a long history of building a great position. +Eurasia, despite some of the volatility in that part of the world we gained share in both sparkling and stills, and overall pretty strong momentum there in terms of share. Then in Asia-Pacific we focused more on re-staging and re-energizing the sparkling business where we're gaining share. We lost a little bit in stills and overall flat. I think wherever you look around the world, we're largely flat to gaining, so inconsistent with our volume growth, which is broad-based and across the world, we're also larger winning across the world. +In terms marketing pay-back, what you are seeing is there is results in the marketing pay-back. Our revenue in 2015, organic revenue growth in 2015 was better than 2014. We're guiding for a good number that's ahead of 2015 in 2016. We see the marketing pay-out beginning to build the momentum globally. +I think if you double down on that one and look under that, North America was one of the first places we started with the incremental marketing, and that's self-evidently building momentum. We see the underlying business results coming through in revenue very much tied to where the extra media money is going. +In terms of macro outlook and risk to top line, I think we feel we got underlying structural momentum in the business. Now when I said the macro, we are planning on the macros slightly better in 2016, and I really do mean slightly. I wouldn't be surprised if that was the same growth rate in 2015. But we think we have the right portfolio and the rate optionality to be able to deliver our financial numbers in that environment. + +Answer_7: + + For 2017, we are also fully hedged on our major currencies. Obviously the emerging market currencies are the ones where you can't really hedge more than a quarter or so out. Obviously we have done nothing on the emerging market currencies. On the hard currencies we are hedged at rates slightly worse than in 2016. There will be a slight impact, but it's not -- I wouldn't think it would be terribly significant. + +Answer_8: + + The gross margins in the fourth quarter impacted by the six fewer days, and the currency and then the structural impact. If you take all that out, basically, we had good growth margin expansion in the fourth quarter and for the full year. +For the balance sheet, basically as we've got so much cash that's outside of the United States, we are taking a little bit more of a conservative approach with our balance sheet. It was just more prudent to manage with the longer-term maturities than with short-term maturities. We still have a robust portfolio of commercial paper. We're just balancing that out differently. + +Answer_9: + + Yes, basically it's going to be on the interest expense line. I think we're expecting much more interest expense given the rate changes, but also the longer-term maturities are also causing more interest expense. + +Answer_10: + + Brett, I think if you look at our overall for the whole year and as well for the quarter our price mix globally, you can see that has improved. As was mentioned, part of the reason for that is we're beginning to see the results of increased marketing play through, as well as our packaging strategies and mix management. Coupled with that, the value share gains, which is even more pleasing, given that we're able to get healthy pricing in our business and in our markets around the world. I will let James comment in terms of Europe and Japan, and what's being seen in some of those developed markets, in addition to the United States. Okay? + + + Yes, thanks Muhtar. I think firstly it's important to remember, starting with Europe, that our price positioning in Europe, we have over time substantially taken a lot of rate and mix in Europe, such that we are more premium priced compared to our competitors than we are in North America -- less runway in that sense. +Now having said that, we continue to focus on smaller packages, more premium offerings in terms of the brand portfolio, such that despite what is a pretty deflationary retail environment in a number of western European markets, we're getting price mix in Europe, both in the quarter and for the full year. I think going out one should not expect the same levels the US has been able to develop, especially given the macro environment in Europe at the moment. +In terms of Japan, we are very focused on rebuilding our ability to get positive price mix in Japan. We've recently been able to get some. Again, very focused on leveraging both packaging options and the brand portfolio to re-shape it to allow us to drive positive mix. Again, I don't think you will see in Japan the same sorts of levels as the US, as much as anything to do with the deflationary pressures in Japan. But we are starting to see chances of a better pricing environment in Japan. + +Answer_11: + + Good morning, Bryan. + +Answer_12: + + Certainly. We will lose about $500 million of productivity, primarily out of cost of goods sold. Again, we are committed to making up that lost amount, and we're going to make it up between cost of goods sold, operating expenses, and DME. + +Answer_13: + + Well, we always said we were going to continue to look for additional productivity opportunities, and we have done just that. We've learned a lot about our costs as we have continued the programs -- ZBW, as well as other cost-optimization programs. Basically we've looked end to end, and we were able -- we saw additional opportunity, and we're going to take it. + +Answer_14: + + No, I think it will be captured by the system. + + + We're even hoping they can find additional areas, Bryan, to even increase that going forward. Part of the whole plan around the production governance is also to ensure that we can actually lever and pull more synergies out of our production system in the entire template of North American production. Yes, the answer is a definite yes. + +Answer_15: + + That's right. + +Answer_16: + + Sure. Let me start with the price mix in Asia-Pacific. I think the most important thing to know here is because the different geographies in the Asia-Pacific group have quite different pricing, and concentrate shipments can be lumpy, you do get some erratic price mix numbers on a quarterly basis. That's exactly what you're seeing in the fourth quarter in Asia-Pacific. There were more shipments to somewhere like India than Japan. +You can actually see the flip side of this in the Eurasia group, where we get very strong price mix in the fourth quarter, which was the flip side. We had more shipments to places like South Africa than the Middle East. This is all about country mix. I think it's important for particularly those two groups, Asia-Pacific and Eurasia, to look at some longer-term four-quarter trend line on price mix, given the very impactful country mix issue, and the lumpiness of concentrate shipments. That's the key thing there. +In terms of China, clearly not as much as we would have liked to have grown in China in the first quarter. I think that the environment in China is pretty clearly having slowed down. But we think we had a strong momentum over the last couple of years coming back into China. We're looking to do better in 2016, but we don't actually provide country-based forecasts. What I would say, however, is we're continuing to do very strongly in terms of share, particularly in sparkling, as we have re-energized that business. + +Answer_17: + + Yes, Steve. Related to juice and hot-fill and stills, stills continues to perform very well in North America for us. The template for stills production is completely different in terms of how it's configured to cold-fill. Therefore -- and juice is an integrated business. +Given those aspects, we intend that for the future to not change the structure related to both hot-fill as well as to juice and our food service business all will remain as integrated in that respect. They're doing very well, and we feel they add value to the overall structure of North America. They're an important strategic part of how we move forward and continue to make increase momentum in North America. +India -- look, you saw that number. Given all these changes we're announcing, basically if you brought it back to 2015 the total bottling assets that we would have under our management and on our balance sheet would actually go down from 18% of the total mix globally to about 3%. Yes, India there are opportunities in other parts of the world remaining, but it's a very small template based on where we are. We'll look at opportunities. +As James said earlier, one of the litmus tests I've always said, one of the great litmus tests for the health of the Coca-Cola business is the desire of investors and franchise partners to have more territory -- that's at an all-time high. Remains that -- we expect that to remain high, and therefore there may be other opportunities in the remaining geographies. But I can't comment on that any further right now. +Then I'll pass it over to James to take you through the longer-term question on portfolio stills versus sparkling, and then Kathy the question of 4% , 5% organic growth volume versus price. James? + + + Sure. Look, I think our aspiration is to have both of them growing, both sparkling and stills. That's what we achieved in the fourth quarter and in the full year of 2015. Now I think in a total portfolio sense, much in the same way it's happened over the last decade or so, we've gone from about 10% of the portfolio being stills to roughly 25% of the portfolio being stills. I think mathematically the stills will grow as a percent of total portfolio. +I would note, as Muhtar commented earlier, I think we need to break out the stills, and not just look at them as one thing, but look at them in terms of their individual categories. We gained share in packaged water. We gained share in juice and juice drinks. We gained share in energy, and we gained share in ready-to-drink tea. We think we can do well in each of the categories that represent non-alcoholic ready-to-drink. +In particular, we can still grow sparkling. That growth of sparkling into the future is not just in aggregate; but I think over the long-term we will see increased growth of low-, no-, and reduced-calorie variants. I know that's not the case yet in North America, but globally in our international business, those drinks out-grow the regular drinks within sparkling, and they're fueling our growth, so broad-based growth. + + + Okay. On your question of 4% to 5% organic growth, volume versus price mix, we expect that to be balanced, volume versus the price. As you know, we have the strategy where we are now focused more on net revenue and segmenting our markets, and we're focused on price realization. We do anticipate that strategy will continue, and that will be a balance between both volume -- and we will achieve a balance between both volume and price. +As advertising and promotions -- in 2014 we announced this program. We said $800 million to $1 billion that we would invest. We are still going to invest -- continuing to invest behind our brands on that program, although we're also going to start investing in R&D. Basically, we're still on our program we announced back in 2014, so you will continue to see investment in marketing slightly above gross profit. + +Answer_18: + + Well Ali, let me start with the last first. When we announced the acquisition of CCE, it was essentially a 25-year-old problem. We said it would take a while to basically course-correct. The level of investment was not where it was needed. Also, the level of customer service was not where it was needed. +Essentially, we believe that having more than just one bottler essentially having that big a territory was a better way -- scalable-size bottlers, right ownership values, right structure and right capability. That's what we have today in North America. We feel very good that this is a model that is going to stay where it is and continue to add value. It's not going to require any further -- all the time they'll be tweaking necessary, but not the scale that was needed when we did the transaction back at the end of 2010. That was a core decision that was needed. There was a major surgery that was needed, and that's really what took place. +As far as the juice business is concerned, as I said before, it's an integrated business. It basically performs well as an integrated business, similar to other juice businesses that we have around the world. It's a very different model, it's a very different production, it's a very different growth to table model, and requires a different way in terms of its distribution, especially when it's chilled. That's really where a lot of the growth is in value-added dairy. +That's what you see, whether it's in Fairlife or that's what you see whether it's in juice. It's a very distinct production model, very different, as well as the hot-fill is also the same. Same within a sense in Europe, the same with many parts of the world. [Kukustevayey] is also very similar in terms of the way it's produced. That is just a needed aspect for success and for performance in the hot-fill and juice business -- very different. To your other question related to dilution from franchising, maybe I'll pass it over to Kathy. + + + Certainly. We've given you guidance for 2016. 2017, it totally depends on timing. We plan to give you more information to help with that, with your modeling, between CAGNY and what we will give you before the end of the quarter. It's all based on timing. In 2018, you asked when will we grow out of this. The program -- we plan to complete the program by the end of 2017, so 2018 we are out of it. + + + Yes, and our long-term outlook -- just to add for the industry -- remains very positive, Ali. Our system is extremely well positioned to take advantage of this. We're going to be a much more focused Company. We're going to be building brands, leading the system, and driving new growth platforms. Our core business will have attractive growth going forward, in terms of ROIC, free cash flow, and so forth. We're very confident and very excited about where the Company is going from that aspect. + +Answer_19: + + Basically, 2018 obviously we will be -- there will be some dilution effect because of the -- we have -- the base hasn't been totally adjusted by that time. Once we get the base adjusted, short of other structural impacts -- which will not be North America re-franchising, obviously -- but other structural impact, we will have quote gone through that re-franchising impact. +Now we do have some residual costs that will come out, as I said, throughout 2016, 2017. There will be a little bit left in 2018. Certainly by mid to late 2018 even the residual costs will be gone. I think once the base is reset, short of other types of structural impacts, we will have transitioned through that. + +Answer_20: + + Ali, it's James here. Look, I think in the US business we did reasonably well in growing Coke Zero, or getting Coke Zero back to flat, and there's still a decline in Diet Coke. I think the bigger picture is in the 80% of our business which is the international business, the diets and lights and Coke Zeros out-grew Coke Classic. We're seeing broad-based growth outside the US of those Coca-Cola variants. That's what gives us the belief that in the long term we will be able to turn around the business also in the US. + + + To finally add on that, Ali, also with our recently announced one-brand approach to marketing trademark Coke, we are extending the strong brand equity of Coca-Cola across the trademark to offer consumers more choice, and to also better promote our great-tasting diet and light portfolio, which is going to no question help. I think that's going to also help us with the stability that is the target. I'll just leave it at that. + diff --git a/exam/original-files/Problem_2_3_Sample_QandA/33_questions.txt b/exam/original-files/Problem_2_3_Sample_QandA/33_questions.txt new file mode 100644 index 0000000..5b0443e --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_QandA/33_questions.txt @@ -0,0 +1,87 @@ +Question_1: + + Hi, good morning. + +Question_2: + + I'm great. How are you? + +Question_3: + + Can you talk about why now is the right time to pull all this stuff forward on the re-franchising front, because obviously there's a ton of macro-volatility? I know there's some challenges as you wanted to standardized the IT platform and even some of the key accounts stuff, which I thought had a little bit of longer tail. Any thoughts you have on that would be appreciated? + +Question_4: + + Good morning. + +Question_5: + + I was hoping you could actually give us a concrete example that gave you the confidence to make the decision to accelerate your re-franchising plans? While your margin should certainly expand and your returns will increase, could you help frame for us the incremental dilution expected from the new system? Finally, I would like to hear what your plans are for the cash you will receive from the planned sale of the 39 production facilities, which I guess I assume should raise a fair amount of cash, considering I think the earlier sales of the nine sites had a book value of $280 million, if I'm not mistaken? + +Question_6: + + Hi, good morning. Muhtar, you posted a couple quarters in a row with volume growth back up in the 3% range, along with solid pricing, despite the difficult emerging markets and macro-environment we're seeing. I wanted to get an update on your market-share performance. Obviously you're gaining share, but have you seen a relative change in terms of incremental market-share performance, and what level of payback you're getting on the higher marketing? As you look out to 2016, 4% to 5% organic sales growth is a fairly tight range. How much visibility do you think you have around that? Could macros pose a risk to the guidance, particularly given you're assuming higher GDP growth? Thanks. + +Question_7: + + Okay, great. If I could slip a detail question in, Kathy, I was hoping you could give us clarity on the impact to 2017 earnings from FX if spot rates stay at this level, given the hedging in 2016 and how much hedging you have in place for 2017 on some of the hard currencies? + +Question_8: + + Thank you very much. Good morning, everyone. Two questions here. First off, it's a little tough with all the restructuring, the re-franchising of the bottlers to get a handle in terms of what's truly going on, on the gross margin. Can you try and strip some of the impact out from the re-franchising, and give us an idea what the underlying gross margin's doing? +Kathy, going back to your points on the balance sheet, can you talk about what you're seeing out there that's causing you to maybe term out some of the longer-term debt? Is it the short-term market volatility, or is this something where you would expect to maybe go with a more conservative balance sheet approach on a go-forward basis? Thanks. + +Question_9: + + Okay. If I can ask one quick follow-up on that, in terms of the interest income line and some of the cash balances overseas, any change in that approach, or is this mostly going to be on the interest expense line? + +Question_10: + + Good morning. One of your stated strategies was to improve the balance of price mix and volume in your developed markets. We've clearly seen that in the US, but I was hoping you could walk around the world and offer us what you're seeing in other developed markets, provide with your prospects and confidence for improving price mix in other developed markets around the world going forward? Thanks. + +Question_11: + + Hi. Good morning, everyone + +Question_12: + + I wanted to get a couple of points of color on the productivity program. Kathy, to start, you were keeping the original $3-billion plan, but a portion of the COGS opportunity is now going to go off with the re-franchising. Could you give us some idea of just how big that is, how much you had to make up in terms of keeping the $3 billion where it is? + +Question_13: + + Net, this productivity plan is actually now a little bit bigger than it originally would have been. Is that just a function of as you're doing more you're finding more savings, or was the re-franchising motivating you to look for more savings? I'm trying to get a sense if there's more momentum building on the productivity program itself? + +Question_14: + + Okay. One last one. Of that $500 million that essentially goes off in re-franchising, will that actually still be realized within the franchise system? Does the Coke system itself still see the $500 million of savings, or is that lost because it needed to be integrated with Coke to get it? + +Question_15: + + Okay, from our systems perspective this is truly incremental savings, it's just a matter of where we're seeing it? + +Question_16: + + Thanks. Good morning, guys. I want to come back to the Asia-Pacific region. I have two questions, first is on price mix, and then second on China specifically. Price mix in the quarter was down 9%, and margins were down pretty significantly. James, I think you talked about re-staging the sparkling business, and I know there's been some negative geographic mix. A little more color there would be helpful? Then the second piece on China, 1% volume growth but you were cycling a pretty soft compare of down 1% last year. Maybe you could elaborate a bit on what you are seeing in that market, and your expectation here over the next 12 months? Thanks. + +Question_17: + + Thank you very much. Actually, a relatively quick set of questions for each of you, if I could. First, Muhtar, on re-franchising and the decision to retain hot-fill and juice assets, is that an indefinite plan, or is that subject to further review? Similarly on China, or thinking about China and rest of world, should we be thinking differently about your plans in India in terms of future re-franchising in that market, as well? +Then Kathy, the 4% to 5% organic growth you were calling out for next year, can you give us a rough sense of volume versus price within that, and how much if any you expect to spend incrementally on A&P in order to achieve what amounts to underlying acceleration? +Finally, James -- sorry for all the questions -- we debated this a while back, and I'm wondering if you've got additional thoughts in terms of your longer-term growth -- how much you expect the portfolio to lean on stills versus sparkling? Do you think you have the right balance of demand-building support against each of that, in order to achieve your long-term goals? Thank you. + +Question_18: + + Hi guys. On re-franchisement, obviously good news that it's going faster, but I still have a few questions on this. One is I get the discussion about holding on to juice. I'm not quite there on hot-fill, so if you could elaborate on that, that would be helpful? Trying to get a better sense secondarily about when you think you will actually be able to grow out of the dilution. It's clearly dilution right now, then 2016 three to four, and then probably 2017. At what point will you be able to grow out of the dilution, given better margin top-line growth, et cetera? +The core question is you mentioned your goal was by buying North America bottling you would be able to accelerate momentum for sales and profitability. I agree you've done that, going to smaller pack sizes, increasing prices closing some plants, increasing media spend, improving IT. +I'm still confused why you have to buy the bottlers -- or one consolidated bottler, I guess, in North America, to do a lot of those changes. Why do you have to spend billion of dollars to push these changes through? Was there not a more efficient-for-shareholders way to do it? +In that context, how do you give investors confidence? I get this question a lot. How do you give investors confidence that five, 10 years down the line, you won't have to buy these bottlers back again in North America? + +Question_19: + + I apologize, maybe I wasn't clear on the dilution piece to it. I understand the timing of the program. I'm not looking for timing in terms of when in 2017 something happens. I'm more looking longer-term. If you're getting rid of these businesses, you will be a better-growing business, right -- better margin, better-growing business, that's the hope, that's I think all of us, as we're trying to estimate longer-term. +I'm just trying to figure out, because you're going to be better, when do you offset the dilution? You're growing faster, you've taken a hit. When are you going to offset the dilution? At what point in time effectively do you become net positive and go beyond? That was the question; maybe Kathy you can refine your answer. I'll leave it at that, if you could help there? + +Question_20: + + Okay. Just one last question, sorry, on diets. It looks like volumes were down 5%, but that's better than we've seen recently. Can you give us some color on whether you're seeing that actually stabilize or perhaps a little bit improve, or is it because Pepsi changed formulation and you guys are getting the benefit of it? Some idea whether that's getting better on diets would be helpful? Thank you, that's it for me. + diff --git a/exam/original-files/Problem_2_3_Sample_QandA/34_answers.txt b/exam/original-files/Problem_2_3_Sample_QandA/34_answers.txt new file mode 100644 index 0000000..e4b2604 --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_QandA/34_answers.txt @@ -0,0 +1,117 @@ +Answer_1: + + Good morning. + +Answer_2: + + Hi, John. It's Muhtar here. I'll just preface by saying the following, and then pass over to James. First, you know how much we've done and how much we focus on creating successful brands in our still portfolio. Of the $20-billion brands we have now, 14 of them are still brands, and our still business is performing well. Whether we take value-added dairy or enhanced hydration or juices and nectars or juice drinks, we play in all of those categories. In 2015, we gained share in all of those categories. +If you look at how -- whether it's in developed markets or emerging or developing, our still beverage portfolio is being enhanced all the time. Also, and even in the case of waters and premium waters from Japan all the way through to Latin America, performing very well. +You just heard now again, we've invested in -- we just recently invested, as you know, in Suja in the United States. We invested in Chi and Culiangwang in China. We continue to always reference that wherever we look, and if there's opportunities for bolt-on acquisitions, we will look at those favorably. If there are also opportunities for organic development of brands like Fair Life, we will certainly look at those also favorably, as we have done. +I think we're very satisfied with our portfolio. Certainly we've got more work to do, as we have said in the call and in the remarks; but right now we feel that we've -- our portfolio is being transformed very well, and transitioned very well, and we are in a pretty good place -- and more work to continue. James? + + + Let me add one last thought, perhaps, John. At CAGNY, we talked about we have a 50 share of sparkling, and a 15 share of the stills. I think it's worth remembering that over the last 15 years we've gone from stills being less a single-digit part of our portfolio to now over 25% of our portfolio. +I think there's a long-term track record of generating growth and value in stills. Even given today our market position, we expect to continue to grow faster in stills. As we said in the call, we are gaining share in every sub-category apart from one where we held it. We'll continue to look for bolt-on acquisitions to accelerate our growth. I think it's going to continue to be a faster-growing part of the business. + + + Also, just on the sparkling you asked, we certainly see also continued growth opportunities in our sparkling portfolio. That is naturally with the focus on revenues, it will skew more towards revenues, but certainly also as we have demonstrated and with our new campaign for Taste The Feeling campaign just being launched, and everything else that we are doing in terms of the investments with our aligned partners, we see growth opportunities in revenue, and also in volume in our sparkling beverage portfolio. + +Answer_3: + + Hi, Steve, it's Muhtar. First, I think we did expect the first quarter to trend slightly below the full year, driven by a couple of things. One, the macros are trending to the bottom -- toward the bottom in the first quarter, recognizing that the environment continues to be challenging, but we will continue to monitor that closely. +The launch of our new campaign in the first quarter will certainly benefit the back half of the year. The benefit of Olympics marketing as we move into the second and third quarter, one less selling day which certainly you also mentioned. I think we are confident definitely in the strategy and initiatives in place to support our growth targets over the course of the year, and believe that we will land again in the corridor that we have stayed at in the past in February. James or Kathy, do you want to add anything? + + + No. + + + All right. + +Answer_4: + + Sure, Mark. There are really -- we look at the margins in CCR, the three primary drivers for what you're seeing. First of all, we have shifted some of the territories. We have transitioned some territories to date. We did that obviously before we put the financials out there earlier this quarter. +Then if you remember, we incurred back in early 2010, 2011, 2012 time period, there was a significant hit to us from a run-up in commodity prices that certainly adversely impacted margins. Then the third thing I would say was we had to incur incremental costs to prepare that business for now being ready to be franchised and to strengthen that business. I think what we're seeing is improvement in the results that I would say today. Those three things really are impacting what you saw in the financials that we put out there. + +Answer_5: + + It's James here. Look, volume grew 2%. Core price mix was 2%, so that's the right answer. + +Answer_6: + + Judy, it's James here. A couple of things on Europe. One, it is worth noting that in this quarter, there was a disruption to the business in GB due to the supply chain. There's a one-off impact that we expect to see not recurring in the balance of the year. I think that's worth taking into account, and it was a material impact. +Now looking for the rest of the year, you will see in the numbers we had pretty decent price mix in Europe in this quarter, and we are also looking to see volume improving versus the fourth quarter -- not just because of the supply situation, but also the new programs, the launch of the new marketing campaign, the launch of a new Coke Zero variant starting in GB, plus the Euro Cup, which will be in France this year. +Of course, shortly we will hopefully complete CC Coca-Cola European partners, where there are very strong plans being put in place to drive that forward. I think some temporary factors, and the build-up of our ongoing investments should drive a better result in Europe in the balance of the year. + +Answer_7: + + Sure, James here. Let me -- I'll come to the numerical piece. Let me start off with -- the Asia-Pacific price mix is always a little bit of an oddity, because it's a group that brings together Japan and Australia, which are very high-revenue markets, but don't grow as quickly, along with a lot of emerging markets -- not just China, but India, Indonesia, and the Philippines, which grow much faster. +There is an ongoing mechanical effect that creates a negative price mix for this group, which you can see over the years in Asia-Pacific. In 2013 full year it was minus 4%. In 2014, it was minus 2%. In 2015, it was minus 2%. In the first quarter of 2016 obviously it was minus 5%, but it was cycling a very atypical plus 3% in the first quarter of last year. +I think what you will see is in the future quarters, it is a little volatile and bumpy, but the long-term trend is for a negative price mix in Asia, because of the dynamic of the fast growth of the emerging markets versus Japan and Australia. + +Answer_8: + + Ali, I'll start just by saying, as I indicated, first on the core, with one less selling day and on the core price mix of the core business without BIG, we certainly did get to the 4% in this quarter. What we feel looking at the downhill comparisons and looking at also all the programs in place, looking at how our business performance in all the different quarters and different groups, we feel confident that we still will achieve what we have said in February in terms of the top line for the full year. +The marketing program, the additional marketing, the new marketing program that has just been launched, and then not having the one less selling day. Then also the continued franchising and all the programs that the bottlers have in place. Our US business is performing very well with its revenue growth, with its price mix, with its brands, with its portfolio. That will continue in -- we have every confidence that it will continue. +Then we will see -- we do believe that macros have -- are at the bottom, and that there will be in the second half a certain degree of improvement in the macros. Even if they do not -- if they stay the same, we feel confident with the current macro situation that we will get to the corridor that we have specified, we have indicated and shared with you in February. Any other comments, James, Kathy? + + + No, I think the one thing I would add, Ali, is obviously there's a strong momentum in the North America business. We called that out as the place where the strategies are working. Then the other countries I put in the other two buckets, there's degrees of implementation of the strategy. You can go to around the world. There were places which were struggling in 2014, and maybe even in 2015. As we've been executing the strategy, the momentum is starting to come back to some of those countries, and it's starting to build over time. +I think, as Muhtar said, the first quarter was within the envelope of expectation for our guidance, and we can see based on what we are doing within our control, within a reasonable scenario of macros, we will stay within that corridor for the rest of the year. But in the end, only results will answer the questions. + +Answer_9: + + I think on that, predominantly we have existing bottlers that are expanding, if you look at the percentages of territories that have been franchised. Then we have, in order to ensure that we can get to the right level of diversity in our bottling business and the right level of also representation, we have also selected some new partners like in Florida, like in Chicago, and like now, the most recent one announced. +We feel that is a healthy mix and that's also a healthy balance, and we have the right -- very much the right approach and the right alignment with our expanding bottling partners, whether they are just entering our system, or they are proven expanding bottlers like the ones that we have mostly franchised new distribution to in the past year. + +Answer_10: + + Certainly, Bill. Really, the gross margin decline is really impacted by two things, really. It's currency and it's the structural impact. Currency, I think like 80 basis points, would have added 80 basis points back to our gross margin. The structural impact actually would add significantly more than that. It's really as simple as that. It's really about currency and our structural adjustments. + +Answer_11: + + Let me take a bite of that, Kevin. I think the answer on the slow-down, we don't get all the category numbers necessarily. Clearly, as we're gaining share in that top-line number, there's got to be some weakness in the category versus the long-term target of 5%. I think we talked a little bit about that at CAGNY, about how our expectations for 2016 and 2017 were below the long-term 5% dollar value for any RTD. There's definitely some of that. +I think you can see the macros influencing the industry in the sense that a number of the emerging markets, particularly the commodity ones, where we have had the slow-down, and that's clearly flowing through into the industry. +I think what I would highlight is we're going to focus on what we can control. We have a long-standing game plan of what to do in countries that are in crisis, focusing on really gaining a lot of share to set ourselves up profitably for the long-term, as we did in a lot of countries in the past. It seems to be working now as we gain share in the Chinas and the Russias and Brazils. It will pay off in the end. +I think the visibility, look, we are managing to our corridors at the top and the bottom line. We feel that this quarter was within the envelope. Clearly the macros slightly better, slightly worse, will be an influence in where we end up; but we've got a lot of management left to do in the balance of the year. + +Answer_12: + + Good morning. + + + Good morning, Bill. + +Answer_13: + + Bill, this is Muhtar. We've said from the beginning first that the new campaign is not just a new campaign, but also it's a new strategy in terms of the one-brand strategy, and that it's got many advantages. We expect it to give us significant efficiencies and effectiveness. +But also in terms of how we communicate with our consumers, it will certainly play into that as we execute the strategy, and we've now launched the new campaign. Then I'll let James comment in terms of you asked the Mexico specific example, but also there's also many other places where it's been tested, and tested favorably. Go ahead, James. + + + Yes, Bill, a few thoughts. One, the initial pilot markets, the two sources of very clear impact were one, it helped us expand and grow the zero-calorie variant of Coca-Cola by driving availability and driving trials. We would expect to see benefits on the zero-sugar variance. +The second big area of benefit is it helps us create what we would call corporate blocking. In other words, we execute in stores all the variants of Coca-Cola together as one big block, has a much greater store impact, visual impact, engagement with people who are shopping the stores. +I think slightly more strategically and back to Muhtar's point, this is an implementation of a strategic idea. I'm sure we'll evolve it. I'm sure we'll make it better, but it's the strategic idea that's important. It's not just about the efficiency in the advertising. It's about helping consumers join and stay in the Coca-Cola franchise, whatever the ingredients they want to manage, including their management of added sugars, whether that's in drinks or any other categories that have added sugar in. This has a number of benefits that are going to play out strategically, and we will keep improving the execution. + +Answer_14: + + Good morning. + +Answer_15: + + One point I would just add, Amit, would be that the US compared to the rest of the world, the prevalence of small packages was much less in the United States three or four years ago compared to the rest of the world. If you look at Europe and places like Spain, or if you look at many countries in Latin America, you had much more prevalence of smaller packages then in the United States. +In a way, the United States in the last four or five years, but particularly last two and a half years, has moved very rapidly to the 12-ounce glass to the 8-ounce glass to the 7.5-ounce can, to the 8.5-ounce aluminum bottle. That has really worked. Those are all growing double digits in the United States because of two -- the consumer customer preferences, and also benefiting our system because they have a higher price per liter. That's in a way playing out from what was already prevailing in many parts of the world in the past. + +Answer_16: + + Good morning. + +Answer_17: + + Vivian, I think a couple of things. One, obviously most of our campaigns are weighted into the second, third, and fourth quarters. Those are the biggest quarters. Even Taste The Feeling, we announced it this quarter, but it's only really hitting at towards the end of the quarter and rolling out in the rest of the year, as with the Euro Cup and the Olympics. I think a lot of the programs are going in later this year. They -- obviously the execution is there, so we would expect to see better performance in trademark Coca-Cola going into the downhill. +I would make one other note, which is the relative change in where global growth is coming from, or industry growth is coming from -- a little more in developed and developing, a little less in emerging -- tends to create a portfolio effect that weighs a little more against sparkling and therefore Coca-Cola, because those emerging markets tend to be more sparkling orientated. You see North American, Latin America, Japan, with stronger stills growth. We do expect to see growth. We would expect to see it coming back. There is a geographic mix impact, but when we look at the markets, we believe we will be back on track with Coca-Cola. + +Answer_18: + + Robert, it's Muhtar here. I think first, in terms of the efficiencies, the most important benefit will be simpler and less-fragmented communication with the consumer. That will be the biggest benefit. But also, it will certainly help provide -- create more efficiencies and effectiveness in our non-working DME, and therefore will also provide some productivity in that respect. But the most important benefit will certainly be a less cluttered and better and more direct communication with the consumer base. +In terms of the trial of product, that will certainly come as a result of that, of what James mentioned in terms of better presence in the store, in terms of better merchandising, in terms of better interruptions in the store, and also in terms of the communication piece. +We believe that the most important benefit of this will infuse and will come to brands like Coca-Cola Zero with more availability, better communication, and have the broad perspective of the global campaign, as opposed to every different brand under the Coca-Cola trademark having their own campaigns. That will be how I think the benefits will come. We -- trials and pilots so far have proven that in Europe and other parts of the world. + diff --git a/exam/original-files/Problem_2_3_Sample_QandA/34_questions.txt b/exam/original-files/Problem_2_3_Sample_QandA/34_questions.txt new file mode 100644 index 0000000..a0e45fb --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_QandA/34_questions.txt @@ -0,0 +1,77 @@ +Question_1: + + Thank you. Good morning, everyone. + +Question_2: + + Good morning. As I look at your revenue performance this quarter, it highlights a concern that maybe the portfolio was still a little too CSD-heavy, despite some of the great results on the non-carb side. You've talked about -- James talked about this at CAGNY, 5% NARTD dollar growth longer term. +But given the fact you guys still under-indexed on the non-carb side that's providing really the majority of the growth in both dollars and volume for the category, don't you need to further accelerate the shift in the portfolio away from CSD, sparkling into non-carb? Is there a way to move that faster? On top of that, obviously the weakness in the CSD side this quarter with flat volumes, what do you think is really the right volume number on the CSD side going forward that gets you to your algorithm? Thank you. + +Question_3: + + Great, thanks. Good morning. Maybe sticking with the top line, I just want to better understand where you expect to source top-line acceleration from over the remainder of the year, against a difficult macro environment, and increasingly difficult year-over-year compares. I get that you were probably closer to 4% organic growth this quarter excluding the calendar shift and the price mix drag of BIG, but BIG will be with you over the balance of the year. In that context, is there truly enough in your control to have confidence in sequential improvement, or are you expecting the macros to improve? Along side all that, is it fair to say you're guiding us more towards the lower end of 4% to 5% at this point versus the mid-point? + +Question_4: + + Thanks. Good morning, everyone. Question on North America. We now have the filings you've given us, and we can therefore see the level of profitability here in CCR, which is pretty low. I think when you back out the numbers, you get a 2% operating margin. I'm sure there's some accounting matters in there that this isn't the forum to go into, but it does raise the question of what really has been going on in terms of profitability for CCR here in North America. +Could we -- if you think it's appropriate, I think it would be helpful to talk a little bit about the trends in that business as you have seen them, now that we're seeing a level -- the margin I'm getting is a 2% operating margin. Can you talk a little bit about the trends and what you think they reflect? It certainly speaks well to what you get left behind, if you will, but it raises questions about what someone might pay for that kind of business? + +Question_5: + + Hi. Good morning, everyone. I wanted to go back and tie a couple of comments that have been made about the effect that BIG had on organic sales growth for the quarter. I want to make sure I understand it correctly. If we look at sales excluding BIG and we add back the extra -- the effect of the extra day, organic sales growth was around 4%, is that correct? + +Question_6: + + Thank you, good morning. One of the markets where you point out you're taking more actions is Europe, and certainly from a top-line perspective, continues to be a pretty challenging market -- deflationary pressure there. I wanted to get a little bit more color. Really, what are some of the more tangible actions that we can see? How much dollars are really going in, in terms of the marketing investments that we should expect to see some of that improvement really coming through, and how long that would take as you think about for the balance of the year? + +Question_7: + + Hi, good morning. I wanted to delve a bit more into the Asia-Pacific pricing number in the quarter, a negative 5%. Can you run through how much of that was due to geographic or product mix or other factors, and thoughts going forward in the remainder of the year on if that pricing pressure will moderate, and how mix should trend in that segment? + +Question_8: + + Hi, guys. I'm still getting a lot of skepticism from investors about the 4% to 5% organic revenue growth target for the year. Openly, you don't sound 100% confident, and it feels likes there's a lot of kind of messiness and moving parts. Can you try again? Can you talk about what specifically you're seeing right now that gives you confidence in the 4% to 5% organic sales growth for the year? Clearly whether it's a 3% or a 4%, you delivered a 3% in some sense this quarter, so you're below pace. +Maybe in that you can tackle what you expect Eurasia, Africa to get to, why do you expect it to get better? Europe, you mentioned you're going to invest more and you hope that to get better, but we've sometimes heard that before. Why is it going to be better in Europe? +Then maybe as a jumping-off point as well, you can talk about what you're learning in North America, because that seems to be doing better for sure. A footnote, I'm not quite sure where you grow organically North America, because you want us to add 3 points back for concentrated sales up to unit case sales for one day missing. I'm not quite sure how to get there, so some explanation would be great. But just more specifics, very clearly on what gives you the confidence in your top-line target for the year? Thanks. + +Question_9: + + Thanks. The re-franchising that you announced today includes the creation of a new bottler from outside the industry. You have spoken a lot about the collective willingness of your existing bottlers to invest and a desire for more territory. Can you help us understand why you went outside of the existing system for this re-franchising? Is there something you're seeing from other new bottlers that makes this more appealing to you guys? + +Question_10: + + Hi, good morning. Can you guys give us a little bit more granular bridge on the gross margin decline this quarter, and then maybe some broad-stroke outlook for the rest of the year? I know the comps get easier as the year progresses, but it would be really helpful to aggregate the FX impacts, some of the re-franchise impacts, then what you're thinking for the rest of the year? + +Question_11: + + Thanks, good morning. Question, how much of the slow-down in the top line in the quarter was macro slowing in the NARTD category versus execution? You spoke to share gains in both stills and sparkling, so it would certainly seem to be broader slowing in the category? +Then of course there's been a lot of discussion on the top line. It would seem like the lower end of your 4% to 5% organic sales outlook would be prudent at this point. A follow-up question on that. How much visibility do you have on productivity and other levers to deliver the high end of the ES growth guidance range, should you come in toward the lower end on the top line? Thank you. + +Question_12: + + Thanks, good morning. Can you just -- + +Question_13: + + Talk a little bit more about, now that you've unveiled the one-brand packaging -- I guess it's being launched in Mexico -- expectations for that, and maybe what you've learned as you've tested it out? I say that just -- I understand it's certainly going to be more efficient from an advertising, marketing front on the one brand strategy, but didn't know if you expected a sales lift, or if there's been any confusion from consumers as they have seen it? Thoughts as we've started to launch that? + +Question_14: + + Hi. Good morning, everyone. + +Question_15: + + Thank you. + +Question_16: + + Good morning. + +Question_17: + + I was hoping we could talk a little bit more about the health of brand Coca-Cola. In your press release, you called out softness either around the total brand family or trademark Coca-Cola in a number of geographies. While I appreciate that you have a lot of new initiatives between Taste The Feeling and new packaging, in the past you guys have said that it does take time for some of those advertising initiatives to actually gain traction and show up in brand health and volume. How should we think about the trajectory of trademark Coca-Cola as you roll out these new initiatives, please? Thank you. + +Question_18: + + Great, thank you very much. I wanted to follow up on the questions on the one-brand strategy, and specifically ask when you look at let's say the full implementation of that two, three years from now, do you think the benefit will be 50/50 between cost savings and efficiency and greater demand? How do you see that breaking out? Specifically, also in terms of the answer to the prior question on that, how exactly is this strategy helping drive trial and availability for Coke Zero? Thank you. + diff --git a/exam/original-files/Problem_2_3_Sample_QandA/35_answers.txt b/exam/original-files/Problem_2_3_Sample_QandA/35_answers.txt new file mode 100644 index 0000000..978d3a7 --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_QandA/35_answers.txt @@ -0,0 +1,87 @@ +Answer_1: +Okay. Good morning, Steve. Let me try and get to China, and let me start from the top and work downwards, if I may. Firstly, it's clear that when you look at the whole company, almost half our revenue comes from bottling versus the other half comes from concentrate and franchise. But given, as you all know, that our bottling business comes with 4 to 5 times more revenue per drink sold and the accompanying cost, any effect on the revenue of the bottler is going to have a magnified impact on revenue and much less on profits, which is part of this dynamic. +In China, it's our largest international bottling operation. We own bottlers that are roughly 20% of the global business. But the business one outside the US is China. So, that's where it's coming from and it's the mechanical impact of being hit in China where we own about one-third of the system that is creating that whole difference between the 3% and 4%. +And what we have assumed in our outlook, just to be more confident and clear in our competence going forward, is we have not really assumed that China is going to get better in the rest of the year. If it did, that would be great, but we are assuming it's not in terms of our outlook and guidance, but obviously we're working to try and make it better. +Now, as I said, what's changing as you try to split the difference, what's changing is both the consumer and the supply chain. I think in round numbers from a revenue perspective, you've got about half the impact coming from the consumer and half coming from the supply chain. What's happening on the consumer, you can see it in the scan Nielsen, and the non-scan Nielsen is probably a bit worse than the scan Nielsen in terms of slowdown in sellouts to the consumers of all types of FMCG categories. So, it is a broad-based consumer slowdown. +Within that, from a beverage point of view, you have juice drinks and juices which are more to the rural areas and blue-collar. They are down double digits in terms of revenue from a consumer point of view. Something like Coke is down low single digits and premium waters is growing. +So, there's a shift in the category mix going on, which also actually impacts revenue because juice drink prices tend to be higher than sparkling or water. That doesn't flow through to profitability. So, there is a rebasing going on in there. +But, as I said, about half of it is the supply chain, the whiplash effect of the destocking by the customers. And that, as you say, is likely to be a much shorter-term impact. But, again, we're working on it but we're not including any improvement on that in our outlook, although clearly we want to get focused on it and get it to work. +I agree with you, the consumer thing will take a little more time to come back, which is why we are focused on the game plan we know that works in downturns where we focus on affordability, on premiumizing for those parts of the country, like the premium metro areas, and bringing out new products to them, and that way we believe we can gain value share, which we continue to do in China so that we are set up as the consumer starts recovering. So, about half and half, and we believe that the consumer will come back and the supply chain will sort itself out in the relative short term in the rest of this year. +Now, with regards to the refranchising, obviously can't really comment on the M&A, but I would say that we and our partners all believe in the long-term potential of the China market. We are very excited. And, as I said, because a large part of what's happening in the short term is destocking and inventory, everyone is looking past that and looking to the long term. And I think there is still good motivation and animation by everyone to get the deal done. And we'll obviously, from our point of view, make sure we do it on the right terms for ourselves, and they will be looking for the right terms for them, but we still think it is the right deal for everyone and with a good likelihood of getting done. + +Answer_2: +Dara, I'll just comment first and then maybe I ask Kathy and James if they want to add anything. But certainly you've answered part of it by saying that, yes, revenue challenges are coming from those areas that have much lower margins, number one, for sure. And then, secondly, productivity efforts are continuing that is driving the margin expansion in quarter two. Kathy mentioned the significant margin expansions that we achieved and I think productivity efforts are going to continue. +And then, finally, I think there's also a mix. Some of our better markets are doing well, like the United States and Mexico, and also in the Far East and Japan. So there's a mix issue. +And then, finally, the commodities continue to be pretty benign in terms of the outlook. So, those are the things that play into altogether, but primarily also the one that you mentioned which is the revenue, challenges are coming from much lower margin areas in terms of our business there. Kathy, anything to add? + +No, I would say those are the reasons, which I would say probably you're picking up the fact that we do have more difficult comps in the back half for some of the things that Muhtar mentioned. But we are confident that we will still be on our guidance. + +Yes, we are overall very confident. The changes in marketing, the strategy on innovation pipeline, the one-brand strategy which is just at the beginning, the promotions that we have in store in the summer around the Olympics, the price/mix expansion that we've experienced in quarter two, all of that we feel play into the equation, and give us confidence in the back half that there are slightly more challenging comps in the back, that we can actually cycle them and achieve them going forward, and feel confident that we can. + +Answer_3: +Okay, Ali. Basically, it's in the rounding. So, yes, we gave comparable currency-neutral guidance on EPS of 4% to 6%, and that was comparable currency neutral. So, then when you either take out another rounded point of structural -- so it rounds it down but it's really a rounding point of structural -- and if you take out currency, that gets you basically in that, the actual numbers, if you take out only 1 point of structural, gets you to 3% to 6%. But then it's in the rounding, so that's how we came up with the 4% to 7%. +If you start with the 4% to 6%, you back out the currency and you back at a rounded point of structural, that gets you down to your 3% to 6%, and then it's really in the rounding you get to the 4% to 7%. + +Answer_4: +No, that's correct. + +Answer_5: +Sure. I think perhaps that's two questions in the second question there, Ali. But let me have a go. In terms of re-assessing the actions, that's both on the places with momentum and the places that are suffering. There are parts of the business that are growing strongly, whether that's at one end of the spectrum like US and Japan where we've got good momentum. The US grew organically 4% in the quarter. Japan is growing well. +We are increasing the amount of spend as we see the tailwinds and the effectiveness of the market being the innovation or the execution. So, we are reallocating money to the places that have momentum. And that's on the developed end like the US and Japan, it's also on the emerging end like Indonesia and the Philippines and places like that. So, we are going where we see the opportunities to get the biggest bang for the buck. +Now, we're taking some of the money from those markets that are under the most pressure and in those places we are prioritizing. Yes, there's still some advertising, but we are doing innovations and we are doing execution, and, very importantly, doing affordability. The most extreme example, perhaps, is Venezuela where there was no sugar and we've actually doubled down and really driving Coke with zero sugar in Venezuela with a full read one-brand look. +There are places where we are adjusting to the need. Just because you advertise doesn't mean people are going to buy if it's an affordability problem. I think China is a good example of where affordability is in there, as well. And I think I've talked a bit about China. +But the game plan that we've used in those emerging markets under pressure, we're really rolling out. So, that reassessing is moving some top-line money to those with momentum, and doubling down on execution and affordability and innovation in those pressured markets. +That goes a bit to the advertising. Advertising is up this quarter as we continue to see the value of advertising as part of the marketing mix in combination with innovation and execution. It's only when you get all of those together that you really get the best returns. So, we always look to make sure that all three are there, otherwise we'll end up wasting our money. +We are out there and we're pushing ahead with it. And I think what we always have said is that advertising takes some time to work. So, for example, the one-brand strategy that we launched, announced, in the first quarter we started the rollout, the latest iteration of the graphics went into Mexico a couple of months ago. That sort of marketing innovation takes time to build up an effect. +So, we will keep pressing away with the investments and keep assessing. It's too early to call the success. We'd do that towards the end of the year. But we are focused on making that work. + +Just to add to the point of ROIC on the marketing, when you take into account the price/mix expansion going from 1% to 3% in the quarter, when you take into account the core business that we have, which is really the Company that's emerging out of this very rapid transformation and refranchising, is growing still at a point ahead of the total Company currently, consolidated number, which is at 4, which is within our long-term growth targets that we've espoused to and talked about. I think that's also not maybe a micro metric but certainly an important metric to consider in terms of the payback on also all the activity. +We're still in the early days of the one-brand strategy just launched in Mexico a few months ago, just launched in Europe and parts of Europe. Again, we feel confident that is going to continue to work in our benefit, coupled with the marketing that James talked about. + +Answer_6: +Sure, let me start. I don't think any of the unit case pressure in the second quarter was due to the reorganization. I think the trends on unit cases -- and let me just put out another way of looking at it -- have started at the beginning of the year. +I think it is probably one of the few times we've seen the developed and our developing countries grow volume, and actually seen the emerging markets decline in aggregate. I know we only put out the numbers by groups but if you look at developed economies and developing economies, you see volume growth in both those blocks of countries. +In the end, our business, when you take the segmented roles, we've got volume growth and price/mix growth in developed and developing countries, which is very positive in terms of the long-term trajectory of the business. North America has got multi years of making that work in the revenue line. So, that's very strong. +The volume weakness is all in the emerging markets and it's all concentrated in a few of the emerging markets. It's big in some of those markets but it's very concentrated. And the people then on the country levels are all largely still the same and working on these problems. +So, hopefully that gives you a little insight on where the volume weakness is, but I don't think it has anything to do with the reorganization. In fact, I think the reorganization is helping us bring some refreshed views and some experience on what to do in emerging market weakness going forward in the downhill this year and into the future. +And then on the price/mix, 3% is a good result. I think we've always talked about, our long-term growth model calls for 4% to 6% revenue growth, and we see a balanced split between volume and price/mix into the future. So, that gives you a 2% to 3% for price/mix component of the long-term growth. So, 3% is a strong result. Long may it live. But the long-term growth model, we are looking for 4% to 6% in a balanced way. + +Answer_7: +Sure. On Europe, I think Europe got a little bit better this quarter. There are things weighing on our business. I'm not a big fan of calling out weather as a driver of performance. The weather occurs for good or for bad all around the world. +Now, in the case of Spain and also France, that end of the Mediterranean, it was particularly poor in the middle part of the quarter. So, that's really what's driving, what's going on in the Spanish business, and also it impacted the French business. +We see Europe getting a little bit better. We had some good results out of Germany, and, as you said, some sequential improvement out of GB cycling out of some of the supply chain problems as they got fixed that came out of the first quarter. So, we see that starting to improve going forward. But I think -- I hate calling out the weather but I think that's really the reason in Spain and France, and I think we'll start to see those businesses get better. +Now, it is worth saying that we've got a lot of good programs in Europe, but the recent tragic events in Belgium, in France and recently in Germany, do weigh on consumer sentiment and consumer behavior. They go out less. We have strong on-premise businesses -- in fact, particularly in Spain -- and that is being dragged down as people respond to some of these tragic events by perhaps staying at home a little more. That hopefully will get better in time as the security situation improves. +But I don't want to get into weather and global events. I think the business in Europe can get better. We've got a lot of launches coming up and we've got some strong programs. So, I think Europe can continue to perform. + +Answer_8: +I'm not going to comment on the beginning of July from a volume perspective. I would note that I think July was the biggest ever month for Spain last year, so they've got some tough comps to cycle. They had a record summer last year. +The underlying business in Spain is improving. Firstly, the economy's getting better. Secondly, the supermarket environment in terms of rational pricing and some of the activities is getting better. And the Spanish bottler made a massive investment going into last year to reinvest in returnable glass, which is one of the preeminent places in the world where this is true in the on-premise account, and that's starting to show good results, notwithstanding the weather and the security impacts in the year to date. +And now with the CCEP deal closed, and management fully focused on leveraging the best of the marketing, the best of the innovation, and really doubling down on the execution, I think we'll start to see improvements in Spain and the other CCEP territories. + +And on currency, yes, we did not change our guidance this quarter. We've had a lot of movement in some key currencies but basically they are offsetting each other. +Given the volatility that we've seen across the portfolio, some currencies are getting better, like Brazil; some are staying the same or getting worse like in Mexico. Our hard currencies, we are hedged 100% basically. And then we hedge our emerging market currencies on a short-term basis opportunistically. With 2017 being fully hedged for our hard currencies, obviously our exposure then would be basically in our emerging market currencies. + +Answer_9: +2017, that's correct. + +Answer_10: +Judy, good morning. Again, it's Muhtar. First, I think James talked in detail about where the volume shortfalls were coming from, and specifically related to certain large emerging markets that drove that number. That's related to Brazil, that's related to China, being the large ones, but also Russia. All of those emerging markets that used to have better disposable incomes, better macro conditions, basically drove some of that. And going forward certainly we expect some improvement in that area. That's number one. +Number two, I think important to note that, again, mentioned the developed markets grew and developing markets grew volume, and were ahead of the total Company number, which was flat, and ahead of emerging markets. That itself will tell you that certainly the price/mix coming from those markets and then the total geographic mix that coupled with that is something that was instrumental in driving our price/mix number in the way it landed in the quarter. So, all of those factors and all the algebra coming together is what made that -- the country mix coming out of that, the geographic mix, and then the volume coupled with the pricing that we got. +Today, when you look at our US business, with 4% organic revenue growth in North America, that tells you that is in the upper certainly and very much in the upper quartile of all large consumer businesses in the country. We're doing very well. Japan performed well. Again, Mexico performed very well in terms of the volume and pricing combined driving the total number, of price/mix. +So all of that really goes to explain and hopefully that answers your question on that. Anything to add James, there? Okay. + +On the price/mix question, Judy, we did have this quarter price/mix was positive across in all other groups -- yes, primarily driven by Latin America and inflationary pricing but also operational pricing in EAG. But then it was offset by segment mix coming from the bottling investment segment. +So, as James said, pricing of 2% to 3% is what we expect and what we would think would be very good pricing and in line with our segmentation strategy. Even though EAG was probably out of its normal range at this point, North America pricing is still very strong. We do believe in the segment strategy, and the 2% to 3% is what we expect going forward. + +And then the sparkling segment, just to finalize that, continues to be a segment of the nonalcoholic ready-to-drink where consumers continue to spend a very large amount of money in terms of consumer spend and in terms of the dollar value. It's still very healthy and that's why it gives us confidence looking into the future about what we are doing in terms of the segmented revenue growth strategy and in terms of the marketing approach and the one-brand strategy in taking the lion's share of that spend going forward. + +Answer_11: +I think, in your first question, our medium-term outlook for the industry hasn't really changed. We're still expecting robust growth in the industry in the long term, driven by disposable income, urbanization, the middle class, innovation. We see these things expanding now. We've talked about that being in the 5% ballpark and then probably in the next few years talked about it being in the 4%. So, we do see it coming back over time, but we do see industry growth slightly moderated in the short term, as we talked a little bit about in some of the previous conferences. +Now, you did ask the question, we seemed short-term. Give me a second to just read on the line. From our point of view, the biggest mechanical impact in the quarter and the year to date is this asymmetry between where we own bottlers and where it's less than 20% of the volume, or about 20% of the volume, versus being in 200 countries. If you pass the bottling side and just look at the core concentrater franchise, we are running organic at 4% and we are meeting our profit guidance. +We are not trying to say small ups and downs in the macro economies is what should buffet us every quarter. We just need to deal with those things. I just think there's this one asymmetrical effect at the bottling thing, which is important, which is affecting the number. But I don't want to give the impression we're seeing a massive, or trying to signal a deterioration in outlook for the concentrater franchise business. +Now, with regard to Coke FEMSA, yes, we've talked about looking at some territories on a preferred basis. I'm not going to get into exactly how that means in terms of what preferred means versus exclusive, but they are our biggest bottling partner. We have a very strong relationship. We have made an agreement on how we're going to create more value together in Mexico and how they can look to participate in some of the refranchising of the territories that we own in bottling. And we're very excited about doing more stuff together. + +Answer_12: +Yes, in part, please read into this that we are moving the business to more of a revenue focus. Absolutely, under the heading -- everything communicates -- that is part of what we're trying to say. We believe in our segmented revenue approach. It's not that we have forgotten about volume or don't believe it's an underlying driver in the long term, particularly in the emerging markets, of what's going to create the business over the long term. +But as we look at places like North America and some of the other developed markets, clearly we're going after more of a revenue strategy that's driven by smaller packages, by some pricing actions. We do want to call out that perhaps the best way to think about health of the business going into the future is the revenue growth. And that's where I think what we're trying to say is, not just the beverage industry, the sparkling industry category and brand Coke all remain healthy in terms of revenue growth. All three of those are growing revenue globally, and we continue to see good attraction both in the US in terms of sparkling revenue growth and internationally in terms of sparkling revenue growth. + diff --git a/exam/original-files/Problem_2_3_Sample_QandA/35_questions.txt b/exam/original-files/Problem_2_3_Sample_QandA/35_questions.txt new file mode 100644 index 0000000..179dd0b --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_QandA/35_questions.txt @@ -0,0 +1,45 @@ +Question_1: +Great, hi, good morning. Maybe we could start with a question for James on China mainly, because it sounds like that market was the biggest driver of the gap between your reported 3% organic growth and the 4% core number that you cited. And I'm guessing it cost you roughly 1 point of unit case volume in the quarter, as well. So, first, is that right? +But, more importantly, is there a way to parse how much of the adverse impact is tied to the macro slowing, which I think is more likely to persist, versus supply chain corrections and wholesaler inventory destockings, which might hopefully be more transitory? I'm really trying to assess just how much of a headwind China was in Q2, and then how severe you expect the ongoing headwind to be, acknowledging the improvement initiatives that you called out? +And then, finally, do the issues facing BIG in China impede at all your ability to refranchise that market on time and on favorable terms? Thanks. + +Question_2: +Hi, good morning. I wanted to better understand why you maintain the FX neutral income before taxes guidance despite the negative full-year top-line revision. I'm assuming part of that is just the top-line weakness in lower-margin areas, so probably less of a margin impact. But can you give us more detail on why the local FX profit goals have not been as impacted by top-line weakness, and how much visibility you have on the profit side, and any leverage you have to protect downside if macros weaken further? + +Question_3: +Hey, guys, just a couple clarifications. One is, back to guidance, and look at comparable currency-neutral income before taxes is still in the 6% to 8% range for 2016 relative to Q1 guidance, so you gave that same guidance in Q1. And the structural move only went from negative 3% to 4%, to negative 4%, so like a 50 basis points change there. Currency is still an 8% to 9% drag. +I'm confused about what's driving the EPS guidance effectively down by 2 points at the midpoint. So, what's going on between before tax and the EPS to drag it down another 2 points? Because the only thing that seems like it's changing is the structural, in what you've told us, relative to Q1. That's my first question and I have another one, if you permit me. + +Question_4: +Okay. I have trouble getting there. Maybe I will follow. I still see it being an incremental point somewhere in there. But basically you are saying there's no real difference between -- there's no change in the gap between PBT and EPS, taxes and changing. There's no other things in there, right? + +Question_5: +Okay. Maybe I'll follow-up just about the rounding point to help me with my math. +The second piece is, in the press release, and, James, in some of your comments, I think, you said we are -- I'm quoting from the release -- re-assessing local market initiatives. Can you tell us a little bit more about what you mean exactly? So, where? Is it all about China, perhaps Argentina? And is advertising spend as a percentage of sales still up for you in the quarter? And does it impact in any way this confidence we had a year ago, six months ago, about really good ROIs on the marketing spend? Thanks. + +Question_6: +Yes, thanks for the question. Just two quick ones for me. There's a lot of stuff going on at Coke right now -- international organization, management, refranchising and accelerated pace. I'm just curious if you can give us some clarity on maybe how much of the volume issue this quarter was partly related to disruption. +And then just on the price/mix, it's a pretty good number. We've seen a 3% price/mix a couple times over the past two years. Just curious on what you think the sustainability of that magnitude of price/mix is as we think out the next one to two years? + +Question_7: +Yes, thanks. Good morning, everyone. Two questions, one on Europe specifically, James. I am surprised Spain was down in the quarter. You cited weather but it's been doing pretty well. So, what is going on in Spain beyond weather? +And can you give us any color on Great Britain, because Europe overall had a nice sequential, or at least did better than where consensus was. So, looking for some color there. +And then, Kathy, on FX, really no change in your FX view for the year. Can you remind us how you are hedged on some key currencies and how that might play out the duration of those hedges and what those currencies are? + +Question_8: +Great. And a quick follow-up on that specific to Spain. What does your work say about underlying health of the business either because of performance in July? You're saying it sequentially should get better but I'm just wondering what's underlying that? How are you getting to that? + +Question_9: +So, you said you are fully hedged for hard currencies for calendar 2017, for the duration of 2017? + +Question_10: +Thank you, good morning. I wanted to go back and follow-up on the price/mix question. Clearly the 3% is a good number, but obviously you are benefiting from pretty high inflationary markets. So, I just wanted to better understand how much of this is really coming from your segmentation, the revenue segmentation strategy, versus the price growth that you are seeing in inflationary markets. Any granularity that you can give us will be helpful. +And then a little bit related to that, I think the flat volume growth that you've seen this quarter, I can't recall the last time you had this kind of volume trend. So, again, how much of this is really a function of your strategy to focus more on revenue and not chase unprofitable volume growth, and if this is something that you'd be willing to accept for some period of time? + +Question_11: +Hi, good morning, everyone. Just two quick ones. One, for James, you talked a lot, I think, on this call about some of the short-term things that have affected organic sales and changes sequentially in the environment since the start of the year. Can you just update us on what your view for the industry forecast is, maybe not so much for this year but just over the medium term? Has there been any change in terms of what you think the nonalcoholic ready-to-drink beverage industry is going to grow over the medium term? +And then, second question, you had mentioned Coke FEMSA earlier. It looks like you've got an agreement with them to negotiate on a preferred basis. Can you just expand upon that a little bit? Are they exclusively looking at some of these territories or is it a matter that they are just getting the first look? Thank you. + +Question_12: +Hi, good morning. Thank you for the question. As I look at some of the disclosure in the press release, it seems like you've broken from convention a little bit -- a lot less brand disclosure, trademark Coca-Cola only hold out in North America, you guys aren't breaking out sparkling and stills anymore. So, I'm just curious if we can get a little more color on trademark Coke outside of North America and China, and also whether the change in convention speaks to a broader shift in terms of how you are thinking about balancing volumes across your portfolio? Thank you. + diff --git a/exam/original-files/Problem_2_3_Sample_QandA/36_answers.txt b/exam/original-files/Problem_2_3_Sample_QandA/36_answers.txt new file mode 100644 index 0000000..25130b6 --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_QandA/36_answers.txt @@ -0,0 +1,87 @@ +Answer_1: +Nik, good morning, this is Muhtar. Thanks for your questions. Look, I think first, once again, I want to reiterate the scale of what is being done here on a global basis. As I mentioned in my remarks, the geographies and the regions impacted by this refranchising, massive refranchising, is really, when you aggregate it all, is roughly around 50% of our -- it will impact 50% of our global volume. So this is really, really big, number one. +Number two, the early indications that we have from both the US refranchising efforts, which is the largest one, but also the European restructuring under the Coca-Cola European partners umbrella, which was the biggest refranchising in Europe in history, in its structure, essentially, has been -- early indications have been positive. In the United States, if you look at it, the last six quarters, consecutively, we have had volume growth and very encouraging price/mix in the United States continued. And the last sort of year, four quarters, have been the highest in terms of refranchising activity. +So early indications are positive. Europe, the same. And James mentioned the positive numbers coming out of the last quarter. Yes, helped by many other things other than just refranchising, but the impact is that there hasn't been the disruption, it has been going on very smoothly. And you know, when you look at this going forward, we've got four to five quarters of intense refranchising remaining, as we bring out at the other end of the tunnel a company that is going to be totally transformed, revitalized in terms of its organizational capabilities, leadership structure, revitalization of the brands, also with the investment in our brands as a new marketing, revitalization of our portfolio, of our bottling system, as well as our cost base. +So we are encouraged with what we see, as the transformed Coca-Cola Company coming out, and also the integrity of the refranchising, as evidenced by the continued good results in North America and in Europe. + +Answer_2: +Good morning, Dara. + +Answer_3: +Dara, this is Muhtar here, I will just mention very briefly, and then pass it over to James, that it is unusual, what you have just said is definitely is the fact that developed markets are growing at a higher pace than the developing and emerging markets, but it is not a surprise, given the volatility that we all know that is taking place. +But it is a mixed bag. It is not just a uniform, all emerging markets. Africa, for example, continues to be a very strong performer, both west Africa, led by Nigeria, but also other markets in Africa. So it is -- Mexico, to name another one -- so it is a mixed bag, but let me ask James to comment in more detail on how we see the future also in terms of the balance between emerging and developing versus developed markets. + +Yes. I think it is worth, as we go into this, just underlining, the collection of the developed markets are growing volume, growing price, strong revenue growth. We think we are taking actions to sustain that. +The emerging markets, I think it is going to be a combination here of doing the things that we need -- we know we need to do and can control, and then of course there is the question of what do the macro economics do, and what actions do each country's governments take to put them on a better course or not. So that is part of the unknown going forward at this stage and the uncertainty. +I think quite clearly, you see, as Muhtar commented, a mixed bag, across the world you see those markets that are doing well, sustained growth, and he called out Nigeria, South Africa, the Philippines, and other parts of the emerging market. So it is good. But it is a mixed bag. And I think the actions are under way in a number of these countries to stabilize them, where they are a little tougher like Brazil, like Argentina, which are called out on the call earlier. +And we will have to see how long it takes for this to take hold in the countries from a macro view. We don't have a clear sight on that. But what we do know is we need to focus on what we can control in those countries and go back to affordability, go back to execution, go back to the basics and build ourselves a better position with more market share so when it does turn, and that combines with the growth in developed markets, we can be solidly in our growth rates for our long-term model. Thank you. + +Answer_4: +Hi, Bill. So on your first question about the 3%, yes, we didn't find another way to make one and one equal three, it is rounding and it is really balanced. So it was in the rounding, but it was a balanced impact on volume as well as a balanced impact from pricing. + +On your second question, Bill, James here, I think what is worth remembering is essentially we are not trying to pass through the devaluation. We focus on being competitive in each local market beverage and fast moving consumer goods industry, and especially when the economies are in tough times, focusing on staying competitive and gaining share for the long term. +The net of all of that means we are much more likely to follow or be close to local inflation rates rather than adopt a strategy of a full pass-through of the devaluation of the dollar, so obviously if the exchange rates change, that will mean different dollar numbers for the Corporation. But the local strategy remains, stay competitive in the marketplace, and it looks more like local inflation. Does that answer your question? + +Answer_5: +Sure. I mean let me start by saying you're approximately right, in volume terms, on the current split between sparkling and stills, about 70/30. I think it is worth noting that that split has been moving in the favor of stills by about a point a year. The turn of the century, 10, 15 years ago, it was a single digit percent of the mix. It is going up at about a percent a year. Now, part of that is organic on the things we are doing, and part of that is the net or some of the bolt on acquisitions but it is going up about a percent a year of mix. +I think as you look forward, clearly, we, given that we have 50% of the sparkling industry value share, and 15% of the sum of all the stills categories value share, we fully expect to be able to grow faster in the stills categories, because it will be the culmination of the category growth rate, plus our ability to gain share, which then feeds into your third question, which is how are the investments aligned? +I feel they are aligned. Obviously it is an ongoing process. Each year, we look at it in the business planning process and we will be doing that again this year, but I would not characterize it as we are over-invested in sparkling and under-invested in stills. We are invested behind what is growing. And actually just add a little more texture to it we are doing the right things on sparkling, and we tend to be pushing more money towards driving the zeros, the lights, the smaller packages in the sparkling business. +In the stills, it is not a one size fits all category. In fact, we model categories and there we are selective on which ones have a most on trend with the consumers and which ones have more premium pricing. And therefore, we are very selective on where we funnel the dollars and invest ahead of the curve or in line with the growth rates that we are expecting. + +Answer_6: +Yes, Andrew, this is, good morning, this is Muhtar, I think you would expect us to be looking for proven capability, alignment, and bottlers that have already got a track record in our system, and that we have actually delivered together in alignment, where -- and we have good examples of that, that we can refer to. But that is basically, it in a nutshell, and I think, I know you probably have a loaded question, but you know, in answering to your actual question, that is what I would say. + +Answer_7: +Good morning. + +Answer_8: +We certainly did well in a number of the categories, particularly some of the premium categories. What was a little weaker in this quarter was some of the juice businesses and some of the tea businesses, which are not as high value to us. So that is what netted out on the 2%. +What you think -- what I think you see is over the year, you see very strong growth in Vitamin Water, in sports drinks, and some of the other categories, as well, so I think it is a broadening of the portfolio, a focus on innovation, but yet there's some head winds on juice, linked somewhat to commodities. + +Answer_9: +Sure, good morning, Ali, James here. +Look, North America, I think is a combination of many, many things. I mean it has I think been the result of a number of years working on multiple fronts. Working on innovation across the portfolio, getting into categories, refining the propositions, learning, refining the propositions. It is about, in the sparkling business, the better marketing, the more media spend. It is about the focus on the pricing and packaging architecture, with more smaller packages, and it is about getting the execution right. It is the refranchising, bringing new excited bottlers in. +In the end this is a result that has been built by a great team of people, who have been very focused over a number of years about regenerating growth in the North American business. As Muhtar said, they have had six very solid quarters of volume and revenue growth. And I think there are a lot of learnings. There is no silver bullet, but there are a lot of learnings. +Having said that, Japan has also been on a good run, the past three quarters are very good volume growth, you know, doing well on offsetting deflationary pressure. Again a similar story. The team is very focused on a multiple category approach, innovation in the products, increasing the quality and quantity of the marketing. But always in parallel and in alignment with the bottler where you got to get better execution. Good marketing on its own is not going to get you the answers. There's got to be more and better marketing along with more and better execution. I think that's you see. +And to some extent, Western Europe, that kind of came, new Coca-Cola European partners came well out of the stables on the first quarter. I think the formula is going to be the same. More and better marketing. More and better execution. And a multilane focus on categories and cranking out the learning, the [trying stuff], the innovation, and pushing ahead. And I think that is something we are going to continue to press across the developed markets. +Now, turning to China, I think China, again, I don't think, if I gave the impression it was all weather, that would be unfair to the team on the ground in China, and the system there. They have done a lot of work to address the big change in how the consumer responded to the economic circumstances in China. I think part of it is, you know, it is a part of the world that has had such consistent growth rates over the last decade, but a little bit of a slowdown maybe towards some exaggerated pull-back on spending, so I think there is a little bit of stabilization coming through in the macros. We saw that. +We have definitely taken action in the things that we can control. Not just in the commercial policies, to strengthen the wholesaler and distributor network and working through the inventory problem, but also on the pricing and packaging. To give you one example, a very small example, but it is symptomatic of how fast China can change. If you go to the cafe channel in China, all of the noodle shops up and down the street, people go there at lunchtime. +Last year they were packed with people. This year, you go, they are a third empty. You go okay, maybe the economy slowed down. No, that's not what is happening. +The explosion of online to offline ordering and the availability of lots of people on bikes and motorbikes to deliver stuff and the apps the aggregate wraps to buy food, it has been an explosion of ordering online and delivery food. Such that there's just as many people buying from these cafes, but sometimes in some parts of China, a third of it is being delivered to people, whether it is work or to students, so we have to adapt that packaging. Having a returnable glass bottle in that cafe doesn't help you with offline delivery. So we have had to revamp the packaging offer so we are there with the right package to go where the consumer is going. +That is a micro example of the sorts of thing we have had to do in China to adapt to how the market is changing and is contributing to the stabilization. But it is as I said, a country undergoing change in its economic model and that will throw up new and different consumer behaviors to which we will have to adapt. + +Answer_10: +Good morning. + +Answer_11: +Hi, Bryan, it is James. Look, we have had a much better run in the Philippines in the last few quarters, actually, strong numbers the first three quarters. This year actually, last year, was three very strong quarters as well; so I think since FEMSA has been in, there they have built on the work that [BIG] did, they have gone about fixing the fundamentals. There were some fundamental structural stuff that still needed to be improved and I think they grasped that in the early days an we are starting to see the benefits of that coming through in the last six quarters. +Again, it is not silver bullet stuff. It is not too complicated in the sense of, you know, it has been about adapting the price package architecture, it is about some of the emphasis on of some of the sparkling brands in the Philippines, some of the local brands that we de-emphasized and re-emphasized some of the more global brands and the stronger local brands, rebuilding and continuing to construct a more solid distributor network. +Obviously Philippines is complicated given all of the islands and the issue of moving product around. I think they have kind of worked the system in terms of getting the thing nicely oiled in terms of the cogs so the product could get everywhere, backed up with a little more marking and a little sharper focus on certain categories and I think that's played through. I think the team on the ground has done a good job of taking the performance to a higher level. + +Answer_12: +Good morning. + +Answer_13: +Hi, Brett, this is Muhtar. First, let me just say that over the last four or five years, we have been actually working really, really hard to reconfigure the Japanese bottling system. We had 13 bottlers what, back five years or six years ago, and now we are working towards having 85% of the total business in Japan, which as you know is a very large business for us, under one roof. And I think that [itself] first, and without looking outside, without looking anywhere, it is a huge re-architecture that is yielding substantial savings, and we can redeploy that into being, into route to market, into ways we actually get our products the most effective efficient way to the customer, and through the customer to the consumer in Japan. +Regardless of any encouragement from the outside, we are on track to end up in a very efficient, very 21st century bottling system and consumer goods delivery system in Japan that is working well +Now, are there other communities, as that is just not related to cost savings? And yes, there has been early, very early discussions in Japan. I can't say any more than that and we will continue to look at opportunities to see if we can even make our Japanese system even stronger. But that is very early days, again, in terms of the level of discussions that have taken place. + +Answer_14: +Good morning, Bill. + +Answer_15: +Sure, let me say a couple of thoughts, and then Kathy will give you some comments on the margin. Look, the stills, if I can say one thing, which is the stills is not a category. It is a combination of many different categories and even those categories re-segment between premium, mainstream, and more affordable. And so what we are focused on doing, as we invest in the stills business, is yes growing in aggregate, in top line numbers, but we are being selective on focusing on those places where we think we can generate a better return in the long term. +It is not a growth of bulk water. It is a focus on where is the consumer demand, what is on trend, and if you just pick out a couple of things that are on trend, things like coconut waters, or premium juices or premium ready to drink coffees, these are all very high revenue products. Kathy, do you want to talk about the margins? + +Sure. Hi, Bill. You are going to see some impact on margins, but mostly initially, because as we are going into these businesses, whether we are developing them internally or whether they are through bolt-on acquisitions, they do have a margin impact. But then as we get scale, as we continue to work on the supply chain, et cetera, we do start to improve the margins. +So I would say the initial issue for margins and then over time, we are able to do things that will improve the margin impact. But initially, yes, as a category itself, a lot of these stills have higher cost of goods -- they have higher revenue but higher cost of goods, so that does impact margins. + +Answer_16: +Sure. James here. Look, I think it is important to say that the premium opportunity in China is big, but it is not as big as the mainstream opportunity. We are absolutely focused on investing in that premium opportunity. It is very much about the big cities, the white collar. It is going to be also about some of the premium parts of the still categories. We are going to go after that. +But in the end, the biggest mass of consumers, the biggest mass of disposable income will be in the mainstream. So it will have to be a combination, of yes, addressing the premiums, but also going after the mainstream with the greater affordability, expanding the distribution reach, upgrading the execution into the third tier cities and in the rural areas, that is also going to be a big driver of our revenue. +In terms of the categories, I think what has been going really well, by example, is we have taken an approach of premiumizing our water business in China. One of our most recent billion dollar brands, Ice Dew, comes out of China. Effectively, we are driving the business from -- in the end -- a one RMB price point to a two RMB price point. That is one of the biggest drivers of growth, is the water at the two RMB. +The places where we have taken -- had a little tougher time is perhaps in the juice category, with sparkling in the middle. Again, when you look at what is growing in terms of the categories, what you do see is it maps quite closely to the consumer segments in terms of who is suffering and who is not suffering in terms of disposable income. The juices, the kind of ambient, more going to the rural areas, have been hit a little harder. The premium waters which are perhaps more in the cities have been doing well. + +And on the second question about the structural impact, so we will obviously give more information on 2017 later, as we get closer to the beginning of the year. But I will say that in the -- particularly in the North America refranchising, the impact will be significant in 2017, because as we are moving to get all of the refranchising completed in 2017, that is, we will be moving more than we have moved in all of 2015 and 2016 combined. So it will be a large impact in 2017, and we will work to give you all more color on that later in the year, or early 2017. +And as far as 2018 is concerned, the refranchising will be done, but it will be -- the impact will be basically the cycling of it, obviously the timing of these transitions will be significant, not only to 2017 but also the impact it will have on 2018. And then we have some costs that we have to get out in 2018 that we will be working to get out in early 2018, that will be basically a function of the refranchising as well. So we will give you more color as time passes. + diff --git a/exam/original-files/Problem_2_3_Sample_QandA/36_questions.txt b/exam/original-files/Problem_2_3_Sample_QandA/36_questions.txt new file mode 100644 index 0000000..2d45f56 --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_QandA/36_questions.txt @@ -0,0 +1,58 @@ +Question_1: +Thanks, good morning, everyone. So just a quick question for me on the refranchising. Now that you have kind of gone through the process, and we're getting toward the end of getting all of the announcements out of the way, can you give us any early indications on kind of what the growth delta has been in the markets that have been refranchised versus not? +And then also wanted to get some context on what is going on in Western Europe, obviously with the CCE integration going on there, have you seen any disruption? And if you think that will start to phase out over the coming quarters. Thanks. + +Question_2: +Hey, good morning. + +Question_3: +Developed market volume growth outperformed emerging marks in the quarter, that is fairly unusual. I was hoping you could give us a bit of a review in the emerging markets. You obviously had a number of cautionary notes in the prepared remarks, but are you seeing any signs that the macros may be close to bottoming here, or are things pretty tenuous? +And more importantly, as we look out to 2017 and beyond, do you think the year to date trends are more of a new normal, or is there hope that with easier comparisons and some of the strategy adjustments have you made, we can start to see emerging markets rebound closer to historical levels? + +Question_4: +A couple of quick questions. The first one is how do you get 3% organic in the quarter from 1 and 1? Was volume better? Or price/mix better? I know they both probably rounded but I was just curious. +And then the second question is, the inflationary pricing in Latin America, is that mostly currency pass-through or is there sort of real price realization in the market and kind of what happens into next year if these spot rates hold when some of the currency cross rates are to ease a little bit? Thanks. + +Question_5: +Thanks, good morning. I would like to actually go back and focus on the stills versus sparkling portfolio changes, James, you referenced in your prepared remarks. Correct me if I'm wrong, I think your level portfolio still skews, at least 70/30 toward sparkling but as you look forward, I am curious as to what percentage of your growth you expect will come from traditional sparkling versus still, I am guessing it is probably not 70/30, but is it 50/50 or some other split you could frame for us? +And more importantly, do you think your growth investments today are in line with the distribution? In other words, if it is 50/50, for example, are your incremental growth investments aligned with that? Or is there still a legacy skew toward sparkling that might need to be rethought. +I think from the outside there is still a perception -- right or wrong -- that your incremental investments are a bit over indexed towards core CSDs versus their future value contribution and I was hoping you could help clarify your thinking around that. Thanks. + +Question_6: +Hi could I just ask you, something, whether you could talk a little bit about the key qualities that are you looking for in a new bottler partner in Africa. Any particular experiences or qualities that you are looking for? + +Question_7: +Thank you. Good morning. + +Question_8: +I was actually hoping you could give us a little more detail on your stills portfolio in North America. You reported high single digit growth in Vitamin Water and then solid results in Smart Water, but your still portfolio only grew 2%, so curious what has been the drag there? And then do you expect some of the innovations that you mentioned to drive growth in your stills portfolio back up towards the mid or even high single digit range? + +Question_9: +Hey, guys, I would just like a little bit of your perspective on two markets, kind of at the extremes of maturity right now for you guys. So first on North America, which obviously remains a key concern when I talked to investors, just given the views of consumer preferences, but North America is doing pretty well, pretty robust, stable growth, and 3% organic sales growth, you know, good volume, relatively good volume, relatively good price/mix. +And what is working well for you in that market? Is it price and pack architecture? Stills? Better marketing? I'm assuming it's all that stuff? And what are you learning from that, that might work for similar geographies like Western Europe or Japan? Should we expect kind of in those markets a little bit of a similar ramp-up as we are seeing in North America? +And then as the other extreme, can you tell us a little bit more about the China rebound so to speak. I know you mentioned weather there, clearly the weather must have helped, but can you give us a sense of what you think the underlying growth is? Has the market gotten any better? Clearly you have worked through thanks to weather some of your destocking issues. But I want to get a better sense of China at the other extreme. Thanks for your time. + +Question_10: +Hi, good morning, everyone. + +Question_11: +Can you give us an update on the Philippines? In listening to the Coca-Cola FEMSA results last night, it sounds like volumes are up there, margins are improving, it is one of those markets where it has been sort of a long-term project to get that turned around. Could you just give us a sense of sort of you with you feel the Philippines are at this point, and maybe what have you done to improve things there. + +Question_12: +Good morning. + +Question_13: +If we look back, we have seen you implement a pretty significant cost savings program. What I think we would describe as accelerated or accelerating M&A activity in your bottling system yielding synergies. +And now there is talk in the system of looking outside and seeking efficiencies in Japan. Are there more innovative ways that are you open to, to help the system find funds to be more competitive? + +Question_14: +Thanks, good morning. + +Question_15: +Just wanted to follow up, back on Steve Power's question. There is definitely a noticeable kind of increase in talk about the still growth and investment in the last conference and on the call today. And just trying to understand -- I mean I certainly understand there is an opportunity, but what that means for margins as we move, especially gross margins going forward, because I think it is still much lower gross margin; and so you expect margin degradation? Or has the mix of business, with tea or higher [intake] products offset so as we look at kind of 2018, '19, we don't see that kind of margin degradation? + +Question_16: +Thank you, good morning. I wanted to go back to China and ask a couple of follow-ups. So one is within the 2% growth in China, can you talk about sparkling versus still? +And then I think, James, we are seeing certainly in that market, the premiumization is one of the key trends and just wanted to get a sense of how big you think that premium segment within NARTD in China is, and what the growth rate is and kind of what you are doing to sort of tackle that consumer preference. +And separately, Kathy, the structural impact obviously the fourth quarter is still a pretty big headwind. Is there any color you can give us as we think about 2017, sort of how much the structural impact kind of lingers into 2017 and maybe even 2018? Thanks. + diff --git a/exam/original-files/Problem_2_3_Sample_QandA/37_answers.txt b/exam/original-files/Problem_2_3_Sample_QandA/37_answers.txt new file mode 100644 index 0000000..e0366e2 --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_QandA/37_answers.txt @@ -0,0 +1,101 @@ +Answer_1: +Thank you. + +Answer_2: +Sure. Good morning, Brian. A couple of thoughts there. Over the long term we said we are looking for a balance between price and volume, or price mix and volume, and that's certainly our long-term objective. +Now, given what's happening I think it's almost as you said, it's easier to divide the world into the developed and the emerging markets. In the developed countries, we are looking to drive, probably a little more price than volume and you can see that happening in the US marketplace as we focus on smaller packages, as we focus on higher value categories or subcategories. So, you see that across North America, Western Europe is a little more balanced and similarly into Japan. So, that's our approach for developed markets. +In the emerging markets, obviously over the long term, we expect them to be a bigger source of underlying volume growth and that will bring the total Company equation into balance. So they would be more volume driven and less price driven. Now what's happening is in some of the markets, say for example, a Brazil, where the macros are really under pressure, I mean GDP over the last three years in Brazil has probably declined by more than it did in the great recession or the lost decade of the 80s. +So there what we focus on is in any moment we will do those promotional things that make sense and return. So we don't over protect volume. We do what makes sense on a quarterly or monthly basis and the principal access we act on is trying to reform the packaging strategy to make it more affordable. Whether that be smaller one-way packaging or more returnable packages backed up by good marketing, that really empathizes with the economic situation the consumers are in, and obviously great execution by the bottling system. +So net-net, likely over time developed markets will get more price mix and slightly less volume and in the emerging markets more volume and slightly less price mix, with that caveat that those markets that struggle, we have a game plan that we've developed over the years and that we find helps us really build a good, strong consumer franchise going forward and balances the short-term. + +Next question please. + +Answer_3: +Thank you + +Answer_4: +Sure. Well, I think you saw lots of flow-through actually in the fourth quarter. Operating income, currency neutral ex-structure, was up 18% off of gross profit of 8% so there was 10 points of leverage, so we got a lot of leverage coming through. +The reason I didn't translate from operating income to PBT, is more of those other factors like interest or other corporate items. The underlying operation, actually when I talk about PBT growing at 8% in 2016 and what we've guided in 2017, actually, the underlying operating income performance is actually even better than that. And then we've got a bit of a headwind in interest in some of those other items. +So there's actually a lot of leverage coming through from the operation as we focus on segmented revenue, as we focus on higher value categories, as we focus on smaller packages, we are getting a lot of operating leverage between that revenue line and the operating income line. Some of its getting netted off in the headwind. So, it is there. +In the fourth quarter, just to make the point, 6% is not projectable going forward. You will see in the numbers, for example, we were cycling a big negative in Asia from Pacific from last year so we've got a big positive this year. We had some very good results in improvements where we own bottling operations like China which was very -- much weaker in the first half. +So there's some oddities in the fourth quarter. I would encourage everyone to look at maybe the full-year 2016, look through to the core operation where we were drawing at 4%, 8% PBT, bear in mind some interest headwinds as a higher operating income growth, lots of leverage. This is the game plan for 2017. + +Answer_5: +Good morning + +Answer_6: +Sure. Of course I'll save some things for CAGNY. Let me start with the sparkling business is growing revenue. It grew revenue in 2015, it grew revenue in 2016, momentum's rebuilding. If you look at the US sparkling was up 1% in the fourth quarter in the US, in aggregate, in volume and obviously much more in revenue so there is the sparkling category is growing revenue. +Another piece under that just take a couple of examples, in this quarter and last quarter as well, total if you take the combination of Diet Coke, Coke Light, and Coke Zero, they came into robust growth in the back of the year. The growth of those all together, so no calorie colas exceeds the growth of -- sparkling actually exceeds the growth of our total portfolio in most of our other categories. +So, there's robust growth that we press into Zero sugar colas. We're getting the growth and in North America and some of the other places where we are pushing smaller packages we're getting the good growth. Smaller packages in the US grew almost 10% in the fourth quarter. +So, the game plan out there of smaller packages, Zero sugar, re-engagement with the sparkling category, is driving the revenue growth and we believe it will continue to do so and the shape and the quality of that, in terms of sustainability, is looking better over time. Obviously tuck-on M&A won't sparkling related, we've consistently done a few things each year, hopefully we'll do a few in 2017e will do those that make strategic sense, financial sense, and where we find willing partners. + +Answer_7: +I'll start maybe and then, Kathy, if you feel like jumping in at any point let me know. + +Okay + +The 2017 3%, I think we see a similar year in 2017 in terms of macros that we did in 2016. And I think we are making a prudent call given everything that's going on in the world on a consolidated basis we are expecting a similar outlook and a similar number for the total Company. Obviously as Kathy said, we'd like to see the core business grow above that as we did in 2016 where the consolidated was 3% in the core was 4% which is at the bottom end of our range and then obviously lots of operating leverage. So, that's how we are seeing it, we just see the way the world is going. +In terms of 2018 obviously we are not providing guidance on 2018, we are just providing some of the elements that we know are important from a modeling perspective. So obviously 2018 conversation will have to wait. But we wanted people to understand the structural piece because obviously the timing of when we sell those transactions makes a big difference. And so as timing varies the structural adjustment can move backwards and forwards between 2018, so we just wanted to give people a total perspective. I don't know Kathy about number three. I'm not sure we have the thing in front of us, Ali. + +The bridge of total structural versus what we shown at CAGNY. Part of what I think is a misunderstanding [stood in] structural adjustments, is particularly in this year we talk about the 5% to 6%. The two additional things you can factor in in your structural adjustments -- the CCR business is not standing still, it's continuing to grow, as well as the fact that they are taking out stranded costs. +Now, we think of stranded costs a lot like productivity, if you will, and so we have embedded those and that's why I said in my prepared remarks we have two points of productivity -- of two points of stranded costs that are coming out as well in our numbers. But the stranded costs are more like productivity and that they don't just transfer with the territories. There's work to do to get them out, and for some reason if they don't transfer, they are part of our business, and we have to do the work to get them out long-term. +So, the stranded costs, we treat that as part of the business and you can choose to net those or not to better understand the structural impact. But that's how they represent themselves in our numbers. And again we are not giving any other underlying growth guidance for 2018 at this point. + +Answer_8: +Good morning. + +Answer_9: +Good morning, Bill. James here. Firstly, the aggregate amount of marketing spend is slightly below [gross profit] you are correct. Now, what is super important to know, within that, is we will continue to increase what we would call working spend of the marketing ahead of revenue, but we are driving material productivity in the way we organize and produce the marketing to become much more efficient. +So, we are able to grow media, if you like, in all its different forms ahead of revenue, but with the extra productivity initiatives we are actually growing total spend less than revenue. That's how that dynamic is working. So we will be able to do much more in the marketplace in a more efficient way. +And then secondly, on Coke Zero Sugar, absolutely, you should expect us to move around the world things that are successful and that had a great start in GB in the backend of 2016, was growing double digits, very good start. We are rolling out in Europe, it's just launched in Australia, so you can absolutely expect us to push it into those markets where we think it can be really effective, including Latin America soon. So, absolutely and I think that is part of why you are now seeing the continued acceleration of Coke Zero sugar each year. +We grew several points faster in volume in 2015 than 2014 and we grew several points faster in 2016 than the rate we were growing in 2015. And as I said aggregate, no calorie colas, is in good mid-single digits growth as we exited the year. + +Answer_10: +Thank you. + +Answer_11: +Sure. Clearly there's a -- I'm not -- disconnect. The Nielsen universe is a much smaller piece of our total business. Obviously when you look at the aggregate of North America, fountain is very important to us, it's almost a third of the volume in North America and that's not going through Nielsen and obviously there's a lot of warehouse business there, where we sell some of the still categories directly. +But we have not deviated from our strategy. We talked on previous quarters that sometimes the pricing will be, at least -- the apparent pricing and Nielsen look a little softer or a little better. The important message is we have not changed our strategy. We continue to focus on realizing pricing intelligently and through packaging and pricing in the sparkling category and focusing on those bits of the other categories that we believe have value in terms of revenue and profitability. And so every now and again you will see this disconnect between Nielsen and our total results, but know that our strategy has not changed and we plan to continue to pursue it into 2017. +In terms of the other categories, absolutely we continue to innovate and invest there. I think the underlying trend is even better than it what it jumps out in the volume. Bearing in mind the strategy is to participate in those categories of the highest value to us, both in revenue and in terms of profitability. +So for example if you went to China and you looked at what was happening, some of the stills categories, maybe water, you'd see a growth rate of x, but what you don't see in the volume is actually, we are selling less of the cheap water and more of the higher value water as we cycle and re-innovate our business to drive the positioning and the premiumness through different brands and reset the way we attack some of these categories. We are after driving a consumer franchise that's about incidence of consumers, the number of times they drink our beverages, even if that's a smaller package, and about competing for value on the top and the bottom line. + +Answer_12: +Yes, Nik, good morning. Absolutely North America's had a great run. The team's done a good job, the strategy's working. The numbers in 2015 in 2016 have put us at the top end of CPGs in terms of revenue growth with our customers. We are very pleased with that. +I think what you see in the North American strategy, which is absolutely what you should expect, is a fusion. And what I mean by that is things that they have done they have taken from other parts of the world successfully and they have blended it with new ideas and things that are relevant for the North American market. And that's what turned into the winning plan they put in place and they've executed and it's been doing well. +And so you should expect us always to be taking ideas from one place, applying the learnings in another place, and fundamentally, North America is a great example of where we reinvest marketing behind the right strategy and a balanced portfolio, with execution by the bottling system. And I underline there the importance of the execution by the bottling system and our own fountain and what wholesale business is during a time of tremendous change through the refranchising. + +Answer_13: +Sure, I don't think it would be appropriate to comment on the M&A process of Bai so I'm going to skip that one, if I may. Refranchising in Africa, I think there's been a very robust process and I think the Management team of the bottler, both prior to the closing of the SAB transaction under ABI on the board as well and ongoing, the Management team has remained focused on doing the right things in the marketplace. So a creditable performance by the Management team in conjunction with the local business unit. +So we see no disruption there and I think everything is going well. The refranchising itself, as Muhtar commented, and as you've seen, we reached agreement with ABI at the close of last year and the rest of the process is ongoing, both from a regulatory process point of view and a selection and determination of the partner, from those that will be strongest and those that are interested. + +Answer_14: +Thank you. + +Answer_15: +Sure, I think the emerging markets is a very mixed bag. I mean there are some which are doing well, I called out some like Nigeria, which had a very strong year even in the close of the year, as the currency came under pressure. Places like Mexico -- there are a number of emerging markets, South Africa, which we did well in. +There are others where the macros were tough, whether that be Venezuela, very tough, Argentina, Brazil, and there we applied our strategies, a combination of what's the right tactical use of promotions to balance the system. We don't want to [do] scale but we don't want to over invest in promotions, while resetting the pack price architecture to really drive long-term affordability. It's very much a mixed bag across the world. Obviously India is something that a lot of people commented on, I'm not sure any more I can add on the India example. +In terms of China, I think China is a great example where you see us executing the game plan I talked about for Brazil. So, the China back end of 2015 coming into the first and the second quarters of 2016, was a very rough period for CPG, a rough period for beverages in China. We went for our game plan, exactly what I said about Brazil, we started to do some promotional things and then we reset some of the pack price architecture, we focused on the right package sizes, and the right brands, doing the marketing in the right way, and a reset of what was important in terms of execution, where you should execute in terms of channels and focus of the cities. +So, in the case of China, the markets are actually doing pretty well in the top tier cities. There was lots of growth, it looked more like the strategy of focus on the value end, focus on the premium end of the business, and then in the more rural and lower tier cities, really affordability and smaller package sizes. And then in the second half of 2016 China rebounded. We grew in both the third of the fourth quarter in volume terms and in revenue terms in China. +So the game plan worked, obviously it's not instantaneous, but we know what to do when markets get into trouble if we focus on understanding the consumer, understanding the customer, and getting organized as a system. + +Yes, I'll just add one point just to complement what James said is that this was the 38th consecutive quarter for us in gaining value share -- 38th in NARTD. And in sparkling this was the 12th consecutive quarter of share gains. And then in North America, importantly, 27th consecutive quarter of share gains. So we continue to gain share as we implement this play-book that's really working and the business is getting stronger over a much, much bigger base than any one of our competitors going forward. I just wanted to add that. + +Answer_16: +Good morning. + +Answer_17: +Sure, Mexico, in all honesty, I'm not sure the Mexican consumers, in terms of what happened to the marketplace, the purchasing patents, really changed that much pre and post that date. I think the Mexican economy, there's been a lot of focus on it. There were the reforms, I think it's performed well and we have a great business in Mexico. +I think our system there has been innovating. It's truly one of the places where we've been most innovative and most creative across the total portfolio where we compete in almost every category and they've done a really robust job of building a good business. And I think that is what you see in the Mexico results and they continued to build on strong a 2015, with a stronger 2016. And I think it's a wonderful operation down there and they did a very creditable result and hopefully that will all continue into 2017. Certainly we think that our system is up to the challenge come what may in Mexico. +In terms of Brazil and India I think they are two very different examples. India, it's certainly a truly one-off event. The demonetization effectively drained liquidity. I don't think that's about price elasticity, I think that's about the shock to the circulation and liquidity. +Clearly we're of the view that a formalization of the economy helps the formal players and I think it will be good in the medium term and the long-term. We expect the short-term disruptions to [mitigate] or to tail off as we come into 2017, though not from January 1. And I think what we just need to see is some stabilization there, and we will be able to then come back and execute our game plan. So I don't think that's particularly about resetting everything we do in India, I think it's about working through the effects of this one-off demonetization. +Brazil is a different thing. Brazil I talked about. I think we saw -- we've taken quite a bit of pricing in Brazil over the end of 2015 in the beginning of 2016. I think the consumer environment got worse towards the end of the year in Brazil. +I know a number of the states in Brazil had trouble with some of the public employee payrolls going into the back of the year. So there was a reduction in the mass of consumer disposable income, perhaps more aggravated Q3 going into Q4. And I think there, the elasticity's and the effects of pricing did become worse. +The value of the promotions wasn't as good as perhaps the high-lows, it wasn't as good as it was at the beginning of the year or even in 2015. And I think that's what's caused us to do some things in the fourth quarter to balance pricing and volume, but to recognize we need to come in for 2017 with a more aggressive reset of the pack price architecture. +Given the circumstances in Brazil they're not likely to be completely fixed overnight. I think there's some focus on improving things and we expect Brazil to slowly get better but we are going to execute and implement a packed price. Reset some parts of it with the expectation that it will start to rebuild the business as the economics get a bit better. + +Answer_18: +Good morning. + +Answer_19: +Certainly, hi, Bill. So, this year the commodity environment was relatively benign and we anticipate that next year -- the same thing. As we said, next year will be largely the same as what we've seen in 2016. We do anticipate that with the refranchising that our exposure to commodities goes down significantly. As we talked about (technical difficulty) CAGNY. So there is a -- we will give you some more flavor of this in the modeling call but yes, there's a significant change in the impact to the Coca-Cola Company as it relates to commodity. + diff --git a/exam/original-files/Problem_2_3_Sample_QandA/37_questions.txt b/exam/original-files/Problem_2_3_Sample_QandA/37_questions.txt new file mode 100644 index 0000000..b5fe74a --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_QandA/37_questions.txt @@ -0,0 +1,63 @@ +Question_1: +Good morning everybody. And I just wanted to offer my congratulations and best of luck to both you, Muhtar, and to James. + +Question_2: +I had a question James regarding price mix. And I guess as you're looking out over what the environment is like over the next couple of years, can you just talk a little about how you are balancing the desire to get some price mix in, with how you think about that relative volume? And also relative to affordability especially in some of the emerging markets where the consumer environment is still pretty tough. + +Question_3: +Thanks. Just congratulations from me as well to both of you. + +Question_4: +Just following on Bryan's question on price mix. When you have a great price mix quarter like you did here in Q4, I guess the question that is in my mind is why aren't we seeing more flow through to the bottom line because in a vacuum you'd think 5 or 6 points of price and mix would be significantly margin accretive. +So, is it the case that what may be mix accretive on the revenue line is actually margin or even penny profit dilutive on the bottom line? And I'm thinking here really around the structural shift from sparkling to stills, but perhaps some of the packaging changes and geographic shifts, in the balance of your overall business, may play a role as well. Can you just talk about that -- why we are not seeing more profit flow through on the price mix? + +Question_5: +Good morning. + +Question_6: +James, in your prepared remarks you touched on plans to reinvigorate sparkling growth. Can you give us more detail on where you think you stand currently in terms of the areas you mentioned? The fact that its a marketing shift to lower calorie products, et cetera and any big changes you are planning going forward to drive improved trends. And then you also mentioned tuck in M&A. So how big a role should we expect diversification into other subcategories to play out over the next few years for your Company? Thanks. + +Question_7: +Hey guys, a couple questions on guidance, especially in the context, James, of your focus on EPS growth going forward. So, for 2017 very helpful in line with our thought process at least. Except, why only 3% organic sales growth? +For 2018, it seems like your EPS would be barely ticking up based on an assumption of high single digit, comparable currency neutral income growth before taxes -- so 2017-like, based to growth. So 2018 doesn't look like it's growing EPS very much at all. Does that sound right on 2018 and why? Or is your statement in the prepared remarks suggesting that, look in 2018, we are going to do things like incremental cost-cutting, we are going to do things to really grow the EPS? +And then I can't resist have to throw this one and as well, slightly different. But why does a total growth structural PBT headwind look like something like 9% to 11% versus what you said at CAGNY at 7.5%? Thanks for throwing all those. Thanks. + +Question_8: +Good morning. + +Question_9: +Could you guys just give a little more color on what sounds like a little bit lower advertising spending next year. I think you mentioned that in the prepared comments. Is it something that you realize that maybe the advertising efficiency isn't as much. And how that -- what the numbers are, is it going to be lower as a ratio and in dollars? +And then, it seems like there's probably a lot of initiatives you [need] to support next year also, like the plan with getting Coke Zero Sugar out, beyond Europe if that's also in the plan for next year. So I tried to wrap two questions in one but it's the absolute and ratio of advertising spend and the rationale for reducing it. And then if you do in fact plan to take Coke Zero Sugar to other markets outside of Europe. Thanks. + +Question_10: +Thank you, good morning, And my congratulations to both of you as well. + +Question_11: +First, just a follow-up on price mix specifically in North America. Obviously we've all learned that the Nielsen data is not perfect, but there seems to be a pretty big disconnect between -- particularly in the fourth quarter, where you got the 4% pricing versus the softer pricing that we've seen in the data. So if you could just elaborate on that as a follow-up. James, I'm just wondering if you can talk a little bit about how much of a priority in 2017 is really a shift towards stills. If I look at 2016 performance, 3% growth that you got in still, it seems like it could be much stronger in the context of a lot of the categories that seems to be growing at a faster rate. So can you just talk about either on the innovation front or investment front, how much of that focus where really -- that you look towards in 2017 on the still category. + +Question_12: +Thanks and congrats guys from me as well. The question, James, is when we look at North America, numbers have looked pretty good relative to I think most people's expectations going back about a year and a half. A lot of initiatives that you have put in place have started in North America. So I'm just wondering if you can help us map out how to think about what's happening in North America and the applicability to the rest of the world? That would be helpful. Thank you. + +Question_13: +Great, thank you very much. Two questions. To the extent that you are able to talk about, it I'd love to understand the thought process about not purchasing Bai which Dr Pepper ended up buying. It seemed to check a lot of boxes, is it the product, is it the timing any color on that? +And second, could you discuss whether all the refranchising, and particularly in Africa, has caused any disruptions in the business, any headwinds through that process, and a little bit more on the timing -- expected timing on Africa? Thank you very much. + +Question_14: +Good morning and congratulations to both of you. + +Question_15: +I was hoping you guys could drill down a little further on headwinds and the consumer in some of your key emerging markets. And then how has the overall category been performing in these markets? And, really, how has it been holding up given some of the headwinds and pressures on consumer spending and whether you are taking share? And then specifically in China, things seemed to reaccelerate in the second half last year. So could you guys talk a little bit more about current trends, whether that be near and then long-term outlook for China? Thank you. + +Question_16: +Thanks. Good morning everyone, and my congratulations as well, James and Muhtar. + +Question_17: +I wanted to, if we could do a tale of three countries here, James. And what I mean by that is Mexico -- your results, Diageo's results, Walmex, ANTAD retail data, it seems that the consumer is doing rather fine there. And of course there's a lot of concern about Mexico since November 8. In Mexico specifically, could you just give us a feel for what you are seeing in terms of broad consumer behavior since November 8? +And then with Brazil and India with the pricing you have taken some of it invisible if you will because of what you are doing with price pack architecture, what's the level of confidence you have in those markets that the elasticity that you experience will not be worse than what you've actually -- you have an adverse elasticity impact greater than what your models say. + +Question_18: +Thanks. Good morning. + +Question_19: +A quick question on commodities. Maybe I missed it, but the net exposure as we look forward for this year in terms of headwind/tailwind. And then also, maybe help me understand how that changes with the refranchising? Do you have less exposure to certain things or is it really unchanged? + diff --git a/exam/original-files/Problem_2_3_Sample_QandA/38_answers.txt b/exam/original-files/Problem_2_3_Sample_QandA/38_answers.txt new file mode 100644 index 0000000..618ada2 --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_QandA/38_answers.txt @@ -0,0 +1,51 @@ +Answer_1: + + This is Muhtar. And just let me say a few things on the global macros, and I'll pass it over to James also to reflect on your -- particularly your second question on -- and I assume the second question you had was mainly talking to U.S. bottlers, but you can clarify that. As far as -- the world growth based on recent -- latest numbers from IMF or taken from any other organization is expected to rise in 2017 from -- versus 2016 by about 0.5 percent point, so, like, going from 3.1 to about 3.5, just under 0.5%, and further expected to slightly improve in '18. Based on the latest numbers, always what we have seen in our business is that the industrial production index, IPI, kind of goes a little bit ahead of disposable income growth, and that's what we are experiencing once again here. So yes, some countries, growth looks better, China for sure. India, with the impact of the currency exchange initiative, still is moving out of that, as James mentioned. And as well as Brazil and Venezuela, I think we can term as being in deep recession. And then geopolitical factors in the Middle East and part of North Africa probably means the balance of risks remain still tilted to the downside, if you like. But there was a divergence in terms of the consumer confidence index since 2014, and that's narrowing down between the developing world and the developed world, which is a positive. That means the developing world is getting a little better from a confidence index point of view. And I think we're seeing that in parts of Africa, like particularly big markets, in Nigeria, and then, again, in -- our business in China also is reflecting the improved macros. And then we still see growth in Japan, Korea, in the industrial markets, which is a very positive sign. Again, as we -- as the emerging and developing markets get better, we see there's still growth coming from the developed markets, as in Western Europe and Japan and Korea. So that's sort of what I would like to just say on the macros. And then, James, go ahead and... + + + Sure. Thanks, Muhtar. So Nik, I think particularly as your question seemed more U.S. oriented, I mean, in the end this is an and answer. Our objective is not to run from one side of the ship to the other. This is an and answer. We need the company and the bottlers individually and collectively to make both work. And I think the U.S. is an example, where we have a vibrantly growing revenue line for sparkling and a vibrantly growing revenue line for the other categories. We're -- there, we're engaging the consumers. We're improving our execution. So I think it's about growth. It's about expanding and responding to consumer and customer needs. And I think we have demonstrated over the last number of years that we can vibrantly grow both, and that is absolutely our strategy going forward. And that'll be good for us, and it will be good for the bottlers. + +Answer_2: + + Thanks. Thanks, Dara. And I'll probably go with the M&A and then the portfolio question. I mean, obviously, we're not going to comment on our outlook on likely M&A. I think we've said 3 things related to M&A in the past. I would re-underline them. One, anything we do needs to fit strategically in where we're trying to go. Secondly, it needs to be financially attractive, and that's not always the case. And third, there is some degree of opportunism because it takes 2 to tango. You need not just a willing acquiree; you need a willing seller. So I think whilst we have a view -- an ongoing view of what assets are out there, small, medium and large, that are attractive to us, of course, that is something that is not predictable in time. So whilst we imagine we will continue to do bolt-on acquisitions, everything else is not -- you can't predicate your strategy necessarily on that. So we focus on driving what we can organically. We have taken the rest of the portfolio outside of sparkling from a single-digit piece of our business at the turn of -- when -- 10, 15 years ago to over 1/4 of the business. Of course, we would love to increase the runway -- run rate at which we broaden our portfolio, and we were certainly seeking to do so. But the law of big numbers is also true. It's not going to magically change overnight. We need to build winning propositions with the consumers, with the customers and build the physical infrastructure that economically makes that happen in a profitable way. So yes, more acceleration outside of sparkling whilst -- and I return to the answer to the previous question, it's an and, continuing to grow the revenue of the sparkling category. And therefore, we will consecutively broaden out where we get to. At some point, will it be more balanced? Absolutely. Will it be broader? Absolutely. But we will look to do the right things at the right pace. + +Answer_3: + + Sure. I'm not sure that I'd base the dynamic of one question at a time, but I'll give it a go and cover off some of those pieces. Look, on the categories and balancing, of course, as we approach into new brands or new categories in new countries, there is an investment curve as you build the brand. But this needs to be managed through a portfolio. I mean, one -- the fact that a new brand is being launched in country X doesn't mean it's not already developed in country Y, and therefore, it's already profitable and generating cash. So we need to manage the total portfolio effect, which is not just across categories but across the life-stage development of any one brand and category across the world because they're not equally developed everywhere. So there's a portfolio management thing. Of course, our objective, whatever the category, is to build brands and positions that are inherently profitable once we get to the appropriate scale. So we're not trying to build things that will never arrive. We're trying to build brands in categories, whether it's inherent in the brand or inherent in the package side, that can be profitable for us and the bottling system. In terms of the leadership appointments and how the work will be impacted, I mean, we've done a lot of things. I mean, a lot of the impacts on the work is the nexus of we're about to enter the post-refranchising stage. So we're going to go from well over 110,000 employees to under 40,000 employees by some point next year. There's just physically less stuff that needs to get done at the Corporate Center to support that organization. Secondly, technology keeps advancing, and what is possible to anticipate and get done using technology and change the way work can be done is a lot more today than it was a number of years ago. We need to embed that in, in the organization. And then the third thing is the ongoing efforts to define new ways of doing the same thing with less resources or getting more bang for the buck because we can be innovative in the way we run our processes. So that goes across each of the corporate functions, including the enabling transaction-based services and there's a plan in each place. Now as it relates to Francisco and that organization, I think one of the -- there's 2 points that I base our logic to. The first one is if our principal operating model is local and geographic, that is the franchise system. I mean, you got to choose one principal avenue to organize against. Anything you organize against will have its blind spots, and then you can mitigate against that. So one of the roles of Francisco's group is to provide the global perspective and the category perspective because it's the inverse -- it's a theme that the field -- the sum of the field might miss. So that's part of why the Corporate Center exists. The second reason to bring all the pieces together is as brands and experiences are created today and into the future, it's less cleanly delineated between a TV ad or a customer program or anything else. There's a much greater intersection and integration of how to engage with consumers and shoppers. And therefore, bringing together in one group the classical marketing pieces with a customer piece with a commercial piece and with the strategy, underpinned with the digital engagement, is what's going to allow us to more seamlessly operate in this new environment. + +Answer_4: + + Sure. So I think the changes are structural and strategic. We need to reset the price/pack architecture. We're going to use more returnables as an infrastructure and investment channel. So we're resetting. I mean, it's worth remembering that the contraction in the Brazilian economy, it's contracted more in the last few years than it contracted in the last decade of the '80s and more than it contracted in the depression in the 1920s last year -- last century. So this is -- Brazil has undergone a major economic contraction. So we're resetting what we're doing in Brazil around pack/price architecture, how we go to market and how we push that forward. So it will take some time to get in place. And also, frankly, the stabilization in the Brazilian economy will continue to take time. Now the other thing impacting the Latin American numbers, it's worth underlining it doesn't always hit [ across our ] radar screen is Venezuela. And Venezuela is substantially negative in the first quarter, and I think that really is macroeconomic. And it's not about resetting our business. It's about the country is in the state it's in. But the Brazilian thing, just to summarize, the changes are strategic. They'll take some time. We expect that to play through this year. + +Answer_5: + + Sure. So starting with the additional $800 million, I mean, the driver of the change, the principal driver is the reorganization of the Corporate Center, the 1,200 positions I talked about. That's the majority of the $800 million or a little over half the $800 million. Then there are some parts in cost of goods and a little bit in marketing. So the majority is in operating expense and in the reorganization of the corporate organization that I've just talked about. So that's what's driving it, and it's about the 3 things I said. It's anticipating post-refranchising, it's the impacts of technology, and it's the choices on what work we're doing, doing the work differently. That's what's driving the extra $800 million. Now the $800 million -- the comment around reinvesting half was related to the $800 million very specifically. So that's, that one. Now obviously, we've seen some margin expansion. I mean, implicit in our guidance this year already is some dropping of the base productivity program through into margin because you'll calculate that the revenue currency-neutral structural is at the 3 and that when you take operating income is substantially higher than that, then obviously, that's offset by some negative financing leverage. So as -- the '14, '15 and '16, I think you're largely right. In '17, you're seeing much more drop into operating leverage. And the comment is about the $800 million going forward, half -- a little over half is reinvested. As it relates to refranchising, we don't -- we still believe we can meet the deadline and get the U.S. refranchised this year. Of course, we're not going to do the wrong deals for the sake of hitting a date. But we think the right deals are possible, and we think that we are still on track with our plan. And as you say, we're seeing benefits in the refranchised territories. I'm not sure I would give a specific number that can be kind of inserted over the top on everything else. But clearly, the idea of reorientating and rebuilding the U.S. system so that it's stronger, and putting in place the different pieces, the manufacturing, the governance, the IT, the way the system works, support our long-term strategy of rational pricing and some growth for continued revenue growth in the U.S. is underpinned by the success of the refranchisings in the U.S. And obviously, we closed out on the 1st of April in China and the merger of the Japanese bottlers. + +Answer_6: + + So firstly, Laurent, I hate to disappoint you, but we're not going to be disclosing that the starting point and break down the geographic groups as well by cluster and have all of that laid out. The goals by cluster, clearly, we have goals by cluster. The more they move from sparkling, the more they move from the things we've been building over the last 15 years, the faster we expect the percentage growth rate. But in terms in absolute, it is worth remembering that sparkling, still in absolute terms, provides the greatest incremental amount of revenue to the corporation of any one category. And the -- as I said, just let me make a detailed point. The growth officer, we're not moving to an operating model where we're having global category P&Ls and running the business through global category P&Ls. The operating model decision is to run the business locally, to drive local entrepreneurship and empowerment of the operating units but to use the growth opportunity setup to be strategic to make sure that we stay connected to what's happening when you take a top-down perspective or a category perspective and have the ripened -- and some authority on bringing those insights and those needs and those initiatives to the table so that when -- we, as the corporation, we're not going to try and run everything for the operating units, but we will make a few strategic bets, and some of those will be driven from the cluster approach. + +Answer_7: + + Sure. I think the principal difference on the reinvestment of the half of the $800 million is up to now, I would say the majority of what we've done has gone into the sparkling category business around the world. I think here, the clear intent is that this is more directed to some of the newer categories or some of the other categories to drive growth there. So it's principally orientated around growth of the other categories. That's the headline answer there. Then in terms of the North American sparkling pricing, as you say, that's -- as we called out, that's principally timing, and it's really related to the different channels. The price, the average -- obviously, we have a large fountain operation, which we run directly in North America. And so the timing of gallon shipments, whether they go to the bottlers or through the fountain business, can move the average price/mix by North America. And it's the timing around those gallons that has created that unusually lower 1%, and that's the majority of the difference between what we would expect to happen on sparkling pricing and what actually you see in the first quarter North America. And that should correct itself. + +Answer_8: + + Yes. Look, I don't think I would say this is a kind of a night-and-day change for us. Look, we've been on the journey for us to expand our portfolio. I think this is about making the commitment to press further and faster and make -- kind of make the full kind of psychological journey, too. This is about a full set of categories and responding to the consumer, not a central portfolio with some periphery. We're making good progress with Coca-Cola European Partners. Obviously, we did a lot of planning last year at the setup of the new bottler and its integration and the plans for the marketplace. I think you've seen a number of actions, whether it's the rolling out of smartwater, the launch of Honest Tea, where we've taken some proactive steps with them in different categories. But also, I would underline we've been very proactive with European Partners on Coke, Coca-Cola Zero Sugar, which drove a lot of growth in GB in this quarter. So we've got a great new bottler that's been stood up. We're broadening the portfolio. We're taking action across more categories, and I think that's part of the future. Now would I say that's the one place to look at? No. I think if you look at the U.S. or Japan, to take 2 other examples, you'll see a broader portfolio. And that's continuing to invest and expand across categories and even within categories, resegmenting each category for multiple different reasons to drive value growth for ourselves, the bottlers and collectively as a system. + +Answer_9: + + I'll go in reverse order. I mean, the incentive structure is balanced between the top line and the bottom line today. Having said that, we're going to take this year to have a fundamental relook at our total compensation approach. That may result in no changes whatsoever. We may end up going, "There's no perfect solution, and the one we've got is the right one," or we may make some tweaks. That is yet to be determined. But it is worth noting, the incentives are half top line effectively and half bottom line. In terms of the tangible benefits, I mean, we're obviously not going to provide guidance for '18 and '19 and beyond at this stage. Having said that, we've been pretty clear that we want to be in our long-term growth model in terms of the top line and have some leverage within that. So to the extent that we've guided for 3% this year, we would be disappointed if the opportunities in the marketplace and the macros offered us opportunity to get back into our range, and we did not achieve it. + +Answer_10: + + Sure. We've been steadily learning and getting better at the zero-based work over the last number of years. I think we can get -- getting better at doing less one-off events then don't necessarily always think we're getting much better at making it part of our discipline of going, how do we use the resources available for the best means possible to get the results we're after? So I think that's been a steady organizational learning process that's been going on. The latest changes are just another iteration. The $800 million is another iteration of that. Every year, we look at it. The back end of last year, we looked at the strategy evolutions coming up, imagining the post-refranchise world, the impacts of technology. And we just considered what we could do and how we could do things differently, and that's reflected in the strategy. And as part of the strategy, it's reflected in the organizational changes we are making and the increased productivity savings. We will continue to run the zero-based work process and be clear that the efficient use of resources is one of the ways to drive the top line and to enable long-term value creation. + +Answer_11: + + Well, on M&A, I mean, we have a track record of doing bolt-on acquisitions over the years. I think there should be a reasonable expectation that they will continue at some sort of similar rate. Larger opportunities, I think about are they logical. They have to be strategic, they have to be financially viable and they have to be available. As and when things are -- meet those 3 criteria, we will look harder at them. And that's as much as I can say at this stage. In terms of retailers in the U.S., look, I think they are looking -- they have their own -- each one has their own strategies, their own positions slightly differently. So I don't think one can look at them in an aggregate and say they're always trying to do the same thing. I think pricing rationalization is certainly our strategy. We are engaged with customers in how it fits their strategies, each one individually. And largely, I would say that we're finding how to create value together. Are there risks that for competitive reasons by customers or competitive reasons by our competitors, something happens in some quarters to knock that off course? Yes. But that risk is -- has existed and still exists, but we're clear on where we're trying to get to. + +Answer_12: + + Sure. I think look, in -- we talked at CAGNY, we have about a 50% share of the sparkling category. And of all the other categories, we're somewhere between a 10% and 15% share on a global basis. But even that's a very average number. You can go to some parts of the world, and we are clear market leaders at the same sort of share levels that we have in sparkling in other parts of the world we're operating. So there's not a short answer, except to say that we have -- we are going through and have gone through and always updating the process of looking at where are the next stages of growth, both bottom-up, each country going, "Look, I think I need to grow out this category or that category"; and top-down, both a global view and a category view, saying, "Look, if we want to progress, actually, we think we need to push out smartwater into more countries or tea, for example, Honest Tea into more countries." And that's the intersection of the global growth perspective and the country perspective. And then evolution of profitability in juice, probably depends whether we build the business through bolt-on acquisitions or whether we did it from scratch. Either way, the evolution is, as you'd expect, as we build a good, either leadership position or a close #2, we tend to come into much, much more attractive profitability status, which is why, if we have small positions in categories, we've either got to get up, have a clear path to leadership or a strong #2 or not overinvest because being subscale is not our path to profitability. + diff --git a/exam/original-files/Problem_2_3_Sample_QandA/38_questions.txt b/exam/original-files/Problem_2_3_Sample_QandA/38_questions.txt new file mode 100644 index 0000000..83eed96 --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_QandA/38_questions.txt @@ -0,0 +1,48 @@ +Question_1: + + Muhtar, congrats, and James, congrats again on your new roles. I guess a quick clarification, James, and then a broader question. Just on the clarification, just when you talked about the global macros, you sounded a bit more constructive. So I just wanted to get a sense, because we're hearing from a lot of companies, yes, January and February were tough, but March seemed to have improved not just in the U.S. but globally. So just wanted to get a clarification there. And the broader question is, as I'm out in the market and talking to the bottlers, there seems to be some concern regarding the focus outside of CSDs. Not that Coke doesn't need to do it, but there's just too much emphasis outside the CSD business where, in fact, the bottlers make 85% to 90% of the profit from CSDs. So when you speak to them, how do you reconcile that dilemma? Any context around that would be helpful. + +Question_2: + + I think down at CAGNY and again today that you're focused on becoming even more of a total beverage company. But it seems like it'll be difficult to transform your revenue mix quickly or substantially from an organic standpoint. So, a, I was just hoping for any thoughts on how quickly you can shift the business mix over the next few years, maybe what your ultimate vision is, whether that's percent of sales mix outside of sparkling or mix in low-sugar products versus today. However you define it or however you think about the topic, I'll leave that up to you. And then second, how big a part do you think M&A will play? Because clearly, that's a way of more rapidly shifting your portfolio. And then within that M&A theme, Coke staying within beverages, I think, has been sacrosanct at the company historically. How open would you be or what are your thoughts on potentially acquiring outside of beverages? + +Question_3: + + I mean, James, maybe you could just round that up by talking about the -- just firstly, the cost side of that organic growth push. Just sort of we talked a lot about the objective, which I think we all agree with, but what's the cost side? Will structural investments and growth in new categories have to accelerate? And if so, for how long? But my broader question was actually with respect to the leadership appointments and really the new operating model that you've announced over the last few months. Can you talk more about just how the day-to-day work is to be impacted and improved as a result, and specifically, what Francisco's role as Chief Growth Officer is going to look like, maybe how large his organization's going to be, how he's going to interface with the other group presidents, et cetera? Because I guess at some level, I've always thought of the CEO of Coke as the Chief Growth Officer. So maybe just talk about why separating that function out as a dedicated role, I think, at the group president level, is set up to structurally improve things? + +Question_4: + + I was hoping you could talk a little bit more about Brazil. I know you've talked about addressing price/pack architecture and trying to hit key price points. But it just looks like the downdraft in Latin America has significantly worsened its quarter, and I know, again, you said better by the end of the year. But are these kind of tactical changes longer-term strategic changes in Brazil that you're making? And any kind of detail would really be helpful. + +Question_5: + + So I do have 2 questions. One is on the cost savings. Excellent that it went up. Want to better understand the drivers of change. And I also want to better understand the drivers of the increase. But want to -- also want to better understand the long-term "value creation" that you mentioned as well as that at this point, we expect to "reinvest" at least half. Is that of the incremental? Or is that of the $3.8 billion total or $4.3 billion total? Is it of the $3.8 billion at least? Because you've cut about $2 billion so far. It sounds like it should be roughly on pace to that in short order at the very least. And almost all of that, I think, has been reinvested. So if you take almost 2 on a 3.0, that's already 1/2. So how much of what's going to be on the [ come ], so to speak, what's going forward will be reinvested? Is that going to be at least half? Or is that of the total program? So a very specific question on that. And then the second thing is around refranchising. And if you can talk a little bit about some of the potential delays that may happen in refranchising, if you see anything going forward that's very much on plan. And importantly, if you see the benefit so far of the refranchise territories from an improvement of performance perspective, volumetrically perhaps but even just overall top line. And we have heard on the order of 1 point as you move from company owned to non-company owned. So would love some inkling of that from your own experiences. Sorry for the 2. + +Question_6: + + You specified the sales growth by cluster, and that's great to give us, I mean, some more granularity of where the growth is coming from. If I may, I mean, could you tell us more specifically what's your starting point by revenue, by cluster, by region? And also, what are your goals by cluster? And what will be the incentive for the new Chief Growth Officer to achieve those goals? + +Question_7: + + So wanted to ask just a quick follow-up to earlier question about reinvestment, the $800 million, half of that going back to reinvestment. Just how would the nature of these reinvestments differ versus sort of the prior reinvestments that Coke has made, whether it's different categories or different activities? And just a little bit of color there would be great. And then on the price/mix in the quarter and North America sparkling up 1%, I think you called out some timing issues. So can you elaborate on how much of that was a factor? And as it relates to sort of the broader price/mix question, if you look at the clusters outside of sparkling, can you just talk about how much the price/mix plays a role in growing that -- those segments' revenues? + +Question_8: + + Just one question. And I guess from our perspective, we get a lot of questions about the total beverage company model and kind of what it looks like going forward, and it's difficult to see with a lot of the moving parts in the business today. But I guess from our perspective, Western Europe is really the one market -- or it's one of the markets this year where you can really see it sort of in action. So, a, James, do you agree with that? And, b, can you maybe talk a little bit more about sort of your planning with the bottlers in Western Europe this year and sort of how it's -- this beverage -- total beverage company model has really sort of been different in the planning process now versus maybe prior years? + +Question_9: + + James, I wanted to come back to some of the changes you've put in place, specifically with the new growth officer and 5 category clusters. The first question would be, when should investors expect to see tangible benefits from the new structure, understanding that the macro is very difficult and the company's skew towards sparkling? Or said differently, would you be disappointed if the company couldn't return to 4% core sales growth looking out to next year even if the environment doesn't change very much, including the macro? Or is this just more of an evolution of the strategy to deliver on the company's objectives? And then related to that, James, do you feel like the company has the right incentive structure in place internally for your leadership to balance the growth agenda with profit objectives? Or do you see any potential conflict that may exist there? + +Question_10: + + One question, James. On the larger subject of cost cutting and whether it's $800 million or some added number a year from now or 3 years from now, could you just characterize how far you believe the organization has gone and might yet go in the area of budgeting costs, whether it's on a ZBB basis or some other basis, to help us understand how you think about the opportunity to do what you're doing today as a habit, so to speak, versus something you do day 1, so to speak, as a new CEO? + +Question_11: + + A couple of quick questions. Number one, James, can you clarify your comments about M&A? You talked about bolt-ons are always in play. And then I think you didn't rule out if something larger or bigger came along, you would look at it. That's number one. And number two, from our retailers, we're hearing a lot more focus on pricing and maybe more promotion, private label. Are you hearing anything different from the retailers about price rationality that you have seen in the CSD category? Just rule out that, that's not at risk here in North America. + +Question_12: + + Two questions. Within your clusters, can you talk about where you have scale or the ability to lift and shift a subcategory from one country or region to another, where you see the most work needed? And then maybe as a reference for us, can you talk about the evolution of profitability in juice as you build that out to a global leadership position? + diff --git a/exam/original-files/Problem_2_3_Sample_QandA/39_answers.txt b/exam/original-files/Problem_2_3_Sample_QandA/39_answers.txt new file mode 100644 index 0000000..2149bcf --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_QandA/39_answers.txt @@ -0,0 +1,56 @@ +Answer_1: + + Yes. I think the -- we've said that we're going to manage the year, and we're going to try and pull into that balance the obvious building of the business over the long term. We have stated that we'd like to get out of the trend of declining EPS, which has been the last few years, and that we are going to invest where it makes sense. So we are constantly looking at where that places our momentum, and should we invest more, and we have done so. And we have increased our plans in the downhill in a couple of places where we see really good momentum and a good reason to invest for better results. But the world remains volatile, and there are places where the environment is better suited to affordability, to returnables, to adjustments. And where markets are, just frankly, under a lot of macro pressure, extra investment is not going to drive us very far. So we will continue to manage it with flexibility. We know that going forward, we'll have some of the money we're going to generate out of lean enterprise to look across the portfolio, but we're going to decide that on an ongoing basis. + +Answer_2: + + Yes, sure. I think a couple of things. On an as-reported basis, you will indeed see an acceleration in the back half, principally because we have an extra day in the fourth quarter, and we had the less days in the first quarter. So I think as you look at the reported numbers, there will be some acceleration. Now underlying that and seeing it in its most simple sense of taking unit cases and price/mix, as you say, we did roughly 3 in the first quarter and roughly 3 this quarter. We're guiding to 3 for the rest of the year because frankly, the world has not changed. We are doing a lot of the right things in the places that are going well, and frankly, there are some of the ones that need to be fixed. But we don't see the world as improving rapidly, and therefore, we're not banking on that happening. And so we're more focused on doing what we know needs to be done and having a moderate view of how that's going to play out in the rest of the year. And I think the expectation for the downhill should be more of the same of what we've had so far this year, hopefully with some of those macro situations improving as we get towards the end. + +Answer_3: + + Yes. So I think the headline answer is yes, it's happening, and I think it was part of the design and the strategy. To be fair to the team running CCR, they have been improving their operations of Coca-Cola Refreshments over the years and have been getting increasingly better results over time and doing a lot of the things that set the platform for better local operations and better coordinated national operations. But there's no question that as the bottlers have taken over these new territories, they have been very energetic in trying to improve them. They've made good progress, particularly in some of the non-directly measured channels, the up and down the street, the smaller stores, where they build on their local expertise. So I think it is, in aggregate, a tailwind. It was part of the strategy that it should be that way, and I think it's a compliment to the local bottlers that they are driving that forward. + +Answer_4: + + So the operating margin expansion, the 375 basis points, I mean, clearly, we see that we are -- that operating margins have expanded when you see that we are at 6% of profit before tax and on organic revenues of 3. Yes, that is driven by that price/mix. And so you know exactly where the price/mix came from in terms of there's a lot of it being driven by North America and EMEA and -- in this quarter. And then timing of SG&A expenses, yes, part of that is -- yes, it will (inaudible) over the balance of the year, but that wasn't really the bulk of what was driving that. It's more about the productivity and cost management that we have in the year. So we have more plans over the next couple of years for additional -- for the rest of the productivity. And that will continue to drive operating margin expansion. First, just the refranchising itself drives -- has driven a lot of that 375 basis points. As we have gotten out of the capital-intensive businesses, the more people-intensive businesses, that specifically drove that 375 basis points. So we had guided to the fact that our operating margins were going to go up after the refranchising. We plan to be in that range and continue to look for, obviously, other opportunities to increase operating margins as we go forward. But -- so basically, think about it as the refranchising driving most of that, good price/mix and the cost management and the productivity that we will continue to get over the next couple of years. + +Answer_5: + + Yes, sure. I think we're very happy that we're doing well in teas and coffees both globally and in North America. Obviously, the Dunkin' one is early days, good start. I think Gold Peak is a good tea brand, and again, an early start on the coffee. The basis of our kind of ready-to-drink coffee business, the -- its strong global position is actually Asia. So we have some strong brands there. So I don't think you should see it as there's going to be one brand for ready-to-drink coffee and ready-to-drink tea across the world. We're going to see some strong growth coming out of Asia in Asian teas. Yes, we're launching Honest Tea in Europe as the joint venture with Nestlé winds down on teas in the European space at the end of the year. So you will see us use some of our brands more broadly, but it won't be one brand everywhere. Net-net, we're positive on the long-term growth opportunity for both ready-to-drink teas and coffees. We'll end up with a portfolio of brands, particularly as it relates to different geographies. And each will have its own positioning, but in the end, the consumer will decide the one it wants. And if all work, great. If 2 work, then we'll take one out. Maybe we'll bring one more in. But we'll continue to pay attention to what the consumer wants and help customers grow their businesses by selling our brands. + +Answer_6: + + Sure. I mean, I'll give you a couple of ideas, but I think the net of the answer is it's more of a cultural process than a process process. Having said that, we're clear on when we're talking about test-and-learn or experiment, that people need to understand the scale and the potential impacts of the experiments they're undertaking. In other words, we are starting to use some frameworks to classify how people are going after things. So said in simple terms, if the test you're undertaking is not life-threatening, do lots of them, learn quickly and move on. I mean, if the experiment, it potentially creates a material risk if it goes wrong, then let's look at it more closely. So we're starting to push through some ways of looking at the portfolio and the market so they can categorize what sort of strategy and what sort of scale of experiment that they're undertaking, whether it's a launch of a product or a new marketing program, et cetera, et cetera. And so the risk can be managed appropriately, and it's all about what's the potential downside to the corporation and that if it's not big, or said differently, if it's very small, then it's okay to let them go. But as I said at the beginning of the answer, it's mainly a cultural mindset. It's the essential idea that the world is undergoing some important structural changes, multiple ones at the same time, and that is causing disruptions on many fronts. And we have to continue to do what we've done for 130-plus years, which is stay relevant to the consumer and help our customers grow their businesses. And that's cultural. So we need people to really be focused on where do we stand really, to be curious about what's going on in the world, to kind of look -- not look at things through rose-tinted glasses and come to quick conclusions and move on. Why? Not because it's -- we fancy it and it's a nice thing to have. It's because that's what's needed in the marketplace. And I think the employees understand that. I think that's why the lean enterprise is resonating, and I think that's why it'll get pushed through. And we'll back that up with some tools and processes to help people. We're making much more embedded into the organization the use of real agile processes and agile teams because that's the way that we're going to get to answers quicker. + +Answer_7: + + Yes. Yes, yes, we saw some weakness in kind of the water and sports drinks categories in the second quarter. Some of that was weather in May. There was a particularly poor period there. I don't like throwing the weather under the bus, but that's for Q2. I think in the longer-term trend, we'll -- I think water will continue to grow. Particularly enhanced water, premium waters, I think you see a lot of activity by ourselves, by competitors in that space. So I think that is going to come back and will continue to be a source of growth for the industry. And we will participate very competitively, and it will be a source of growth for us. So I think it's a moment in time. + +Answer_8: + + Sure. Clearly, I'm not going to say that 4% is the projectable price/mix for the U.S. I think that's at the top end of what would happen. I think it's important as you look at the U.S. result, I mean, clearly, it was a good quarter. And we're pleased that it comes on top of multiple years of the U.S. business performing at the top end of large consumer products companies. A couple of points that are very important to note. Firstly, we benefited in the second quarter from a little bit of extra gallons in the food service business that was kind of inventory, call that a point. So it's really more of at 4%. Now we're getting a lot of that in the non-measured channels. We're getting it through the small packs. It's about a balance between mix and rates. We've got transaction packs growing mid-single digits in the quarter, high single digits year-to-date in sparkling. So it really is a bit of a sweet spot between rate and mix. As I said, it won't stay up at that high level because of the effect of the extra food service gallons. But they are executing strategy, and I think it's playing out very nicely. + +Answer_9: + + Yes. Let me start with Asia and then walk towards Japan, Lauren. I think there was some softness in Asia. We'd have liked to see Asia come in better. I would call out obviously the slight disruption in India from the general sales tax, obviously affected us in the back end of the quarter. As I said in the opening remarks, we think that's good for the country, but it did obviously make some impact in the second quarter. And we're seeing softness across some of the ASEAN countries. Each has their own reasons, but the ASEAN region has been soft. China bounced back a little bit. Japan had a solid quarter. It wasn't knocking it out of the park like it has on some of the previous ones. There are some kind of cycling things in there, but we've had some good launches with some local products in Japan. Coca-Cola FOSHU, it needs more time than I have now to explain it, but pretty solid results. Year-to-date, Japan is going reasonably well. Obviously, we've got the new bottler coming into being, which sort of affects the inventories that we sell into them, which kind of makes it looks like they're not doing as well as they should. But I think Japan is going to continue to do well. China bounced back. So coming back to the beginning, it's really about India and ASEAN. + +Answer_10: + + Yes. Thanks, Kevin. Look, I think a couple of factors. Just mechanically, if Brazil and Venezuela had been flat in the quarter, we'd have grown a point faster. So I mean to say, okay, well, by next year, Venezuela will have declined so much it won't matter. And Brazil, I think there's some belief that it will get better as we come out of the year. So if you want it on a mechanical basis, [you go yes]. Mathematically, if everything else stays roughly the same, then we'll get there next year as Brazil and Venezuela [sober]. Now other countries could fall off the wagon, and so that's always an uncertainty. Having said that, our underlying core revenue growth, organic growth in the second quarter was actually 4%. So if you strip out the bottling operations that we know we're going to sell, we talked about the core growing 4% last year. It grew 4% in this quarter. So I think, in there is the seeds of that number as we go into 2018. We're not making a projection on 2018 yet, but I think underlying are the breadcrumbs towards that conclusion. + +Answer_11: + + Look, I think clearly, the company's role is to provide some leadership to the system and, obviously, the marketing -- the brands, the marketing and the innovation to create the business in the countries that they operate in. So to the extent the company doesn't do that, it's always going to be a problem on alignment. Similarly, the bottlers not taking advantage of when there are all those things and investing in execution, investing in the capabilities to develop the marketplace, to expand the number of outlets, to build a stronger base of cold drink equipment and the sales capability to help the customers develop their businesses, then there'll be alignment problems. So net-net, both sides need to come to the table with their piece of the equation and get it done. And when either side slips, yes, we have more robust conversations, but this is a business that really works well when both are coming to the table. + +Answer_12: + + Sure. I mean, I think, firstly, it's gone really well. I mean, global volume growth for Coke Zero Sugar has stepped up over the last few years to mid-single digits to high single digits, and now it's running in the teens. So it's done well in Western Europe, and that's really good. But actually, the global growth continues to accelerate, and we think it has a long way to go. And in terms of bringing it to the U.S., of course, we're bringing it to the U.S. because we think it'll do better and help the U.S. business grow. And you asked a question about, are we phasing out? So it is a reinvention of Coke Zero, and it is a slight repositioning. And yes, it is about helping the zero-calorie part of the portfolio grow, which is linked to playing a role in tackling obesity, and by that, I mean part of what we call the one-brand strategy. So Coke Zero Sugar, of course, is an improved version of the Coke Zero Sugar formula, but it comes in more of a red visual identity, more of a red can with more of a red label and will actually help people stay in the Coca-Cola franchise, and whether they want the original with sugar or they want a Coke Zero Sugar without any, and it's less switching between brands, which will ultimately help us keep and attract more consumers. + +Answer_13: + + Yes. Good question, Carlos. Look, I think the first thing is it's got to be clear to the associates why we want change rather than just asking for it. And so part of the task is helping everyone understand the business necessity of the need to change. As I mentioned earlier, the world is undergoing a lot of structural change. And what it's driving towards is a place where the speed at which consumers, customers and the rate at which insights can be generated from data to give competitive advantage is changing such that the cycle of speed, experimentation and learning will create higher business value. I mean, firstly, you have to land the idea that it's got an ultimate competitive and business value underpinning rather than, "I prefer X versus Y." How do you drive it forward? Well, clearly, in order to get that done, you do need some technical skills. We'll need more consumer digital engagement-type skills, more e-commerce-type skills, more artificial intelligence-type skills and more collaboration-type skills. And in terms of the behaviors, in order to take advantage of that competitive cycle, you need greater transparency. So we need to push behaviors where the information is made available more broadly, more transparently, more quickly. We need to keep encouraging a candor of looking at where [we] really are opportunities and issues, no rose-tinted glasses because then you get to the insight quicker. That's got to go along with a greater curiosity. We've got a -- one of the dangers of being 130-plus years successful is you think you got the answer to some things, whereas we really need to have lots of curiosity about how things could be different, could be better and how we respond to the way things are changing. And then of course, it's -- there needs to be some courage to try new things. I talked earlier about that's going to be managed with risk appetite, all experiments are not born equal, and there'll be lots of tolerance for doing it in a sensible way. And then commitment to making things better, and I think all of that can be created. Of course, the tone needs to be set from the top. We need to put in place the training and the programs. And if people understand why, I think you get a much more empowered autonomous organization that's capable of creating a better future. + +Answer_14: + + Yes, let me talk about the question around the bottling system and refranchising. The -- firstly, yes, there are some legacy small bottlers, but principally, the U.S. bottling system, by the end of this year, will be a relatively small number of bottlers, distributed in a very logical geographic distribution across the country, which has moved away from the great mosaic of the past -- of the patchwork group. I think then what we will have if people are really strong locally in their [bottling] places where they know what to do -- and the U.S. is not one place. There are lots of local differences. But the important element of the strategy in the U.S. is the putting in place of the structures and mechanisms so the system can act as one, act as one with customers, act as one from a production system, act as one in terms of IP, act as one in terms of really working out what's the strategy. So it will be a strong combination of local knowledge and the ability to act across the system. It's in place. I think they've done a great job over the last several years in bringing it to life and delivering top-class results in the U.S. environment. And I think that's going to continue to be the system of the future. + diff --git a/exam/original-files/Problem_2_3_Sample_QandA/39_questions.txt b/exam/original-files/Problem_2_3_Sample_QandA/39_questions.txt new file mode 100644 index 0000000..ab52b53 --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_QandA/39_questions.txt @@ -0,0 +1,56 @@ +Question_1: + + I guess my question is related to the flexibility to spend more. I guess as we're kind of watching the year evolve and watching the performance, it seems like you're having good traction with a lot of the revenue initiatives, packaging, product. So James, could you just talk to us about maybe sort of the flexibility you have within your plans to maybe increase some of the marketing investment or some of that investment to drive revenue growth given that it seems like you've got pretty good response to kind of what you're doing now? + +Question_2: + + So I guess my one question is just around your organic revenue growth guidance for the full year and just kind of how you're thinking about the puts and takes around it in the back half. So obviously, you're doing 3% year-to-date. The full year guidance implies the continuation of the similar growth rate. I think a lot of your peers are actually guiding to acceleration in the back half, and there may be some unique timing situation for you guys, but just kind of the puts and takes as you think about the back half from an organic sales growth perspective. + +Question_3: + + James, one of the things we've heard with regards to U.S. refranchising is that as they've taken it over, the territories, they're actually performing maybe better than Coke was when they were doing it. And you've seen an acceleration in some markets. They've been a little more aggressive. So I guess this is really one question. Is that the case? Why is that happening? And do you expect that to be kind of a tailwind for the business in the U.S. over the foreseeable future? + +Question_4: + + Wanted to talk a little bit more about the margin expansion that we saw, so 375 basis points on a non-GAAP basis. Can you quantify the disaggregation that you lay out in words? So quantify how much comes from bottling divestitures, how much from expense management, how much from timing of expenses, which I assume that means it's coming back at some point. So really want to disaggregate that and quantify that and then think about how we should think about the sustainability of each of those going forward to really kind of draw the path on gross -- on, sorry, operating margin expansion going forward. + +Question_5: + + I was just hoping to get an update on your Gold Peak and Dunkin' Donuts ready-to-drink coffees and whether you think there's an opportunity to expand these brands globally at some point. And then curious to hear how you're managing the launch of these in light of Monster Caffe in terms of, I guess, positioning. And then what gives you the confidence that the 3 new coffee brands will all be incremental? + +Question_6: + + James, I wanted to build on the test-and-learn comments that you made up front and the quest for speed and agility. There's some great examples that you've highlighted today in terms of the portfolio progress, especially in Europe with smartwater and Innocent and Zero Sugar and Honest. But what I'm trying to understand is, can you talk more about the specific -- any specific steps or tools or incentives that you're putting in place to facilitate that speed and agility? Because in the end, I'm just trying to get a better feel for what that looks like in terms of day-to-day changes and how you push for speed and, at the same time, efficiently manage risk and portfolio complexity as you accelerate into new SKUs and additional category-country combinations. + +Question_7: + + We have seen continued weakness in sports drinks in the U.S. in the scanner data. And you highlighted also that water, enhanced water and sports drinks were down mid-single digits in the second Q. So could you maybe comment on what you are seeing in the category? And would you expect the trends to improve in the back half of the year? + +Question_8: + + I think you will have surprised many with your 5% organic growth in the U.S., especially after the soft quarter for your major competitor and filled potentially with some disruption from transferring to a bottler. So how should we think about the price/mix going forward? Is 4%, I mean, the new norm in the U.S. and, by extension, in developed countries? And if you can give some colors about what's coming from price, what's coming from mix, that will be helpful. + +Question_9: + + I was hoping you could talk a little bit about Japan. It wasn't called out much in the release. And just Asia, at least for me, was a bit softer than I had modeled. So could you just tell us anything about what's doing in Japan, overall trends across the bigger categories? + +Question_10: + + So James, question on the company's ability and then timing around accelerating top line growth for the company. So to your new team's credit, there's been a universally positive response from the investment community around the changes that you've implemented. But organic sales is now trending around 3%, and you're gaining market share, which is great, but the implication is that the NARTD category is broadly growing sub-3%. So the question is, how quickly can you deliver on that trajectory of about 4%, which is where I think you sort of pegged overall NARTD growth, at least something reasonable longer term? How much can you drive with strategic changes and share gains? How much of this is maybe just cycling Brazil, which is a big market for the company? How much do you need an overall improvement in the macro to sort of take this growth rate from 3% to 4%? And over what time period do you think is sort of reasonable for investors? + +Question_11: + + From the outside, it seems bottler alignment is better than it's been in many times in the past. Just curious how dependent that is on you guys delivering better products to the market, whether that's organic, lift-and-shift, M&A or delivering better marketing, investing more in the market. And then how long do you think the grace period is for you guys to deliver something better than the bottlers before that alignment begins to break down? + +Question_12: + + So I just wanted to talk about Coke Zero, no sugar. How sustainable do you think the growth is of that brand in Europe? And I'd love to hear more about your motivation to bring this to the U.S. Is this really designed to sort of combat sugar taxes that we're seeing in a few of the markets? And are you -- how big do you think it can be? Are you going to phase out sort of Coke Zero over time? And is it meant to really target sort of the Coke Zero customer, the Coke Classic customer or more of a Diet Coke customer? + +Question_13: + + In order to realize the new strategic priorities, can you expand on the actual behaviors that are necessary for the next generation of leadership to succeed and how these might be different from the past? How do you provoke these behaviors, especially speed? + +Question_14: + + Look, when I think of refranchising being completed by the end of the year in the U.S., you're going to end up with a very, very segmented bottling system, which is the opposite of what you have in other parts of the world and [that you're asking for] consolidation. So why does it make sense? Isn't that a problem? Or should we assume that 5 years from now, that system would look a lot more consolidated? And related to that, the fountain business remains in the hands of Coke, seeing it's about 35% of volumes. Does it make sense for you to -- over time to gradually convert the fountain business into RTDs or that's just impossible to do? + diff --git a/exam/original-files/Problem_2_3_Sample_QandA/3_answers.txt b/exam/original-files/Problem_2_3_Sample_QandA/3_answers.txt new file mode 100644 index 0000000..a8c8ed3 --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_QandA/3_answers.txt @@ -0,0 +1,566 @@ +Answer_1: + + Hello, John. Good morning. So we don't disclose the bank leverage ratio. But it is lower than the Holding Company, so we would have a further way to go. As we said, we intend to be compliant at the Holding Company level by the beginning of 2015 and work on bank compliance shortly thereafter. + +Answer_2: + + John, obviously the rules are fairly new, and still a proposal and not final. So there's work to do before they get finalized. We're working through all of the things we'd need to do to comply. I would say we would aim to be compliant by the end of 2015, but we need to go do more detailed plans and we'll get back to you with some more specifics. + +Answer_3: + + Yes, all of those things could be considered and would be considered. + +Answer_4: + + So in terms of the cushion, while it's not scientific, there is a volatility in that number inherent in actually deposit flows. So we do see some things in deposit flows, particularly wholesale flows, and that could span a quarter end and drive the ratio up or down some. So it's prudent to run at a ratio above 100% and around about this level. And just in terms of acceleration, we just wanted to get there more quickly. The opportunity presented itself, so nothing more than that. + +Answer_5: + + So it's a great question, John, because as you alluded to in the question, there's a large number of moving parts in terms of the forecast, including points of yield on rates, which as you know have been choppy over the last several weeks. So we base our projections on modest loan growth and on our understanding of the implied rate curves and that they could all -- they could change. Also deposit flows, as you've seen, have been very, very strong. So we accelerated our LCR compliance back to the majority of the NIM compression we were previously expecting and guiding you to forward; and consequently, we expect to be more stable, with some loan yield compression being offset by lower cost of debt. + +Answer_6: + + I'll just give you two data points, and then you can maybe go and have a look at them. But I think in the Q, we disclose a couple of things. The first is a bit of a sweetener which says that over 12 months, it would deliver about $900 million of additional NII. It's not exactly what we've seen, but-- + + + That's the 10-year going up 100 basis points. + + + That's right. That's the 10-year going up 100 basis points. I'm sorry. And that's not exactly what we've seen, but it's the closest thing to what we're seeing right now. And then the other thing we've disclosed is on a parallel shift of 100 basis points, so if your short rates go up 2%, that would deliver just over $2 billion over 12 months. And not to say that recurs, but it takes time to build up to that. + + + And that's interest rates only, not Mortgage volume, Investment Banking volume. That's just isolating interest rates only, assuming the Company invests the way we're planning to. + +Answer_7: + + Those were the numbers from the last Q, and they are not meaningfully changed right now. + +Answer_8: + + Yes. So John, I would point you to -- and I can't remember the page, I apologize -- but we put a page in Investor Day that talked about what we thought through the cycle charge-off rates were for each of our businesses. And so what I would do is look at -- take NCI loans and a reserve balance at the end of the period of $3.3 billion, take a look at that page and figure out what a more normal sort of charge-off rate, and therefore reserve balance, would be. And that will be in large part a reduction over the course of the next several quarters. So we expect it to be a journey to get to that level throughout 2014. + + + And wholesale, we're kind of where we should be. We shouldn't expect much different. Credit Card, maybe a little bit more, but put that in the hundreds of millions. + + + Yes. + + + And on Mortgage, I think we said Investment Day, eventually it will be $1 billion to $1.5 billion, within a couple years. + + + And PCI, if we have home improvement, we may see some reduction in PCI loan loss reserves. Purchase credit (Inaudible). + +Answer_9: + + No, we haven't done that yet, John. But the reserve release we took at NCI was driven in large part by lower severity. So if this continues, you might see some of that. + +Answer_10: + + Good morning. + +Answer_11: + + Yes. So Brennan, what we laid on the page was an illustration. And you're absolutely right. What it shows you is that we want to be able to close that gap much more quickly, and so that might very well be what happens. We just aren't coming out now with a target of achieving it over the course of the next one or two quarters, because we have other objectives, including the continuation of being able to have some capital distributions to you guys that we want to be able to decide when we do CCAR at the end of the year. + + + We'll be able to do it pretty quickly when we know what it actually is. We don't want to start making actions that affect customers way in advance of knowing the real final rules. + + + Right. + + + But what you took away from the page was absolutely right. Closing that gap should not be difficult and could be more quick than this, but we wanted to be cautious. + +Answer_12: + + Yes. So we're not going to disclose the duration, but there was some changes in the portfolio as we moved out of non-eligible into eligible securities for LCR and also maintained more cash. So there were some changes. We also, as you saw, are making gains on sale and we were doing that. + +Answer_13: + + No. + + + No. + + + Remember, when rates go up, certain mortgages lengthen and a whole bunch of different things take place. But in general, the portfolio is several year duration, a couple years duration, AA-plus; and obviously, it changes over time to manage into short exposures. + +Answer_14: + + That's not a bad assumption. + + + All things being equal. + + + All things being equal, yes. (Laughter). + +Answer_15: + + Exactly. + +Answer_16: + + The Board -- we're not going to tell you what Board deliberations are. But the Board obviously has talked to shareholders, a bunch of ideas. And also, we think we have some of the best corporate governance out there, including -- which I think is more important than the separation of Chairman and CEO -- that the Board should make the decision based on the circumstance of the time. They know the Company, the strategy, the people, that the Board always meets without the CEO, the Board in total sets the agenda, the Board is completely engaged in CEO compensation, the Board can hire and fire the CEO at will. And those practices, some are in our charters, some are not. But hopefully, it won't be the distraction it was last year. + +Answer_17: + + Good morning. + + + Hello, Betsy. + +Answer_18: + + So Betsy, there's nothing underlying it. Let me just give you, hopefully, enough. It is a little bit lower than $4.7 million. And given that the ratio for the Bank Holding Company is 6%, then the gap is a little bit bigger. But measured in small terms of basis points, not more. + + + And a lot of it's historical, how JPMorgan Chase got built through mergers over time, what ended up in the bank, what ended up in broker dealers. And we'll have to change our legal entities a little bit overseas. So we'll have to modify our legal entities to accomplish our the objectives, and we'll be able to do that over time. + + + And over time, if we're able to push out, it will help. + + + Exactly. + + + And remember, the overriding constraint is the 5%. + +Answer_19: + + Yes, of course. + +Answer_20: + + Yes. + +Answer_21: + + We're not going to disclose it today, Betsy, and we can reconsider that, because we think there is some pretty fundamental issues with some of those proposals, not least of which is the absence of FIN-41 netting or netting on match securities financing, which we believe and are hopeful is going to be resolved. But it is a add-on and it's not insignificant. + + + And the thing that I stress in derivative receivables but not taking benefit for collateral, which we know we get. And there are a lot of issues in there that need to be looked at and analyzed. + + + Betsy, to Brennan's earlier question, I think in the context of what we've laid out as illustratively being achievable, then timelines would solve the problem. + + + The other important point is one of the things that Basel and all this stuff is supposed to do is harmonize global rules. This is clearly no longer harmonization, where we have one part of the world is talking about two times, with another part of the world is talking about. And I don't think there's any industry out there that would be comfortable with something like that in the long run. Because in the long run, that has a lot of effects that you can't determine, quarter-by-quarter. + +Answer_22: + + Right. + +Answer_23: + + The HPI improvement on RWA has a bit of a lag to it. So while it did contribute to the reduction in our RWA, our reduction was principally run-off, and some model enhancement and some lower risk. But in part, that lower risk was driven by better HCI. + +Answer_24: + + Yes, Betsy, it's a great question. And we will get back to you after the call. + +Answer_25: + + Hello, Matt. + +Answer_26: + + So you know, June was a bit more challenging, and so it wasn't as strong as April and May. But it really comes down to the fact that we really do have a client driven business model. And the client flows, they held up. And so if you surround that with robust and strong trading risk discipline, that's pretty much how it turned out. + + + And I think our folks in Emerging Markets also did a spectacularly good job, because I think you might see some real differentiation there from some other folks when all their numbers come out. + +Answer_27: + + A little of everything. + +Answer_28: + + I think we've been very consistent in how we look at comp and how we accrue it and things like that, after capital charges and by line of business, type of business and such, that it's just a change of mix and a change of capital, et cetera. + +Answer_29: + + Yes. + +Answer_30: + + Possibly. + +Answer_31: + + Good morning. + +Answer_32: + + Mike, all other things being equal, that's not an unreasonable assumption. But as we said before, things are never equal. + +Answer_33: + + I'm sorry, Mike, say that again? + +Answer_34: + + Yes, I guess that's about right. Or maybe a little less. A little less, Mike. + +Answer_35: + + Yes, I think we disclose all of the assumptions in the earnings risk tables in the 10-Q. But yes, it's short rates staying low and the 10-year going up 100 basis points, I think. + + + Yes, but it also drags up the five-year, the seven-year. + + + Yes. Yes. + + + So if you use one point, it's the 10-year. But it's the yield curve going up steeply. + +Answer_36: + + You're not mistaken, which is why if you actually get more of a parallel shift and short rates go up, our numbers go up by multiples. + +Answer_37: + + The pipeline? + + + Activity levels picked up some, and we expect that to carry into the third quarter. So a little better. + + + And you saw a real slowdown when we had the volatile markets in June, but we think that's not permanent, the markets kind of open up again. You've seen a bunch of IPOs and debt deals and a lot of M&A chatter. + +Answer_38: + + We didn't disclose that, Mike, for a couple of reasons. One is that, as we said, the proposals, we think, have some fundamental issues to them. But it would be lower. The gross up to our balance sheet on top of the 3.5% sitting on the page would not be insignificant, but we didn't disclose it. + +Answer_39: + + Yes, that is definitely one of the reasons. And that's one of the reasons why we said, of course, the timeline could be impacted if there are significant changes to the rules, and that would be one of those changes. + +Answer_40: + + First of all, I think it's going great. And the folks in the field will tell you that they are seeing huge benefits from putting together the corporate Global Investment Bank, the corporate Investment Bank, Treasury Services. But you are right. There's been flattening out a little bit in Treasury Services and Investor Services, which is mostly custody. Some of that's spread, some of that's margins. So some of that will benefit also a little bit from rising rates. And we don't know what the peers will show yet. So maybe you do, but I don't know yet. + +Answer_41: + + Mike, I don't know. And obviously, if we lag our peers, we'll be as disappointed as you are. + +Answer_42: + + Your last one. + + + Yes, it's balancing both, Erika, which is why, in response to the earlier question, we said we've been conservative on the timeline, because we want to reserve the flexibility to consider capital distributions when we do our CCAR in 2013, and it will be a factor we consider. + +Answer_43: + + So Erika, the truly truly variable, as in transaction variable proportion of the business, is some. But the majority of it is related to people and systems, so there's usually a several month lag to be able to get that out of the system. + +Answer_44: + + I think, think about it this way. I think that revenue margins will be down on competitive pressures, volumes are down, and expenses may go up because volumes are down, for a couple of quarters. + + + Sorry, expense margins would up. + + + In other words, a dramatic reduction in profits. + + + We're trying to be clear with you that this would be a significant event, if rates stay where they are, if mortgage rates stay where they are, or go higher. + +Answer_45: + + Yes, so let me just walk you through it. So this quarter, our expenses adjusted for litigation were $15.2 billion. For the first half, adjusted for corporate litigation and foreclosure-related matters, it was $30.7 billion, which would be against the $59 billion target, which is running a little high. But there are two important factors. One is in our definition of adjustment, we only adjusted out corporate litigation, so there's other litigation in the firm that's several hundred million dollars. It's disclosed in our supplement. You can see that. And also in the first half of the year, we did see out performance in terms of the Investment Bank, or CIB, revenues. And clearly, we pay compensation on that, which is a it good expense and we would waive it in all day long. So if you take the combination of those two things that we don't technically adjust out, our underlying core expenses are on track for that number, yes. + +Answer_46: + + You can't really think about a run rate trend in litigation costs, because they are somewhat lumpy. So we don't have a forecast for you, and they will go up and down. + +Answer_47: + + You're absolutely right. When you separate NIM, you try to tease it out and you make our interest rates. Because you've got to look at the underlying results, underlying volumes and things like that. There's no reason to think that we aren't going to have a good trading going forward, because if the economy is strengthening, and we believe, our view is that it is, and that capital markets are going to open up again, and people get adjusted to slightly new, higher rates. And yes, volatility helps certain trading areas. Higher interest rates hurt mortgages, but again, they can help other areas. So it's a whole potpourri. It's impossible almost to separate it out. And we try to do that for you, but I think it's a little bit of a mistake when you look at the Hold Company. + +Answer_48: + + So we are working really hard on the CCAR resubmission. And you're right, we're going to resubmit that before the end of the third quarter. We're in constant dialogue with the regulators, although we won't receive any formal feedback until we're in the fourth quarter. And so we're doing everything we can to be able to be successful in remediating any of the issues they identify for us. And if we're able to do that, then there should be no impact. + + + It won't be for lack of trying. + + + Yes, it will not be for the number of people who are -- + + + You have probably a thousand people now who are devoted-- + + + We have 500 people that are dedicated and thousands of people working on it. + +Answer_49: + + So just a point of clarification, if it wasn't clear, is that our guidance is that we're expecting to get our expenses down to $600 million in the fourth quarter from the level they're at now, which is $715 million for this quarter. So just to be very clear. And to remind you, our longer term run rate for that business is $325 million a quarter. So it is dominated by the default side, but there is some core performance obviously in there, too. + + + And to keep it really simple, we hope to get it to a run rate of $500 million the year after that, $400 million the year after that, and $325 million the year after, where we should be. And we have a lot of work to do in systems, et cetera to get all that done. And obviously the costly foreclosure, the legal stuff, is also coming down. + +Answer_50: + + Three-year. + + + Three years. And know that we're actively working the portfolio to be able to do what we can more quickly, so you would expect that we're looking at either sales or sub servicing of defaulted loans and capacatizing our performing servicing. So we're working on all of that. + +Answer_51: + + Sure. They're all calculated the same way, based upon the disclosed closed loan volumes that we have to use. So if you take the revenues and expenses and use the closed loans volumes for the quarter, that's how we derive the margins, which is why you see some short-term noise quarter over quarter and the increase this quarter to actually 116 basis points, because we actually book revenues when we lock loans, but we report them closed. + + + Which is different than you guys do it at Wells. + +Answer_52: + + Yes. So I would tell you that it's more of what we're seeing and feeling in discussions and activity with our clients, that we feel like deal activity levels have picked up and may be turning. And the pipeline feels a little better and solid, but not strong. So we're expecting that to translate into the second half. And obviously, as the economy continues to recover and confidence continues to grow, hopefully that will get even better. + +Answer_53: + + So I mean, listen, my comment on that is that Glass Steagall didn't have anything to do with the crisis, and our business model allowed us to be a port in the storm. Our customers like doing business with us in the model that we have now, so -- + + + We don't spend time thinking about that. + +Answer_54: + + Yes. So Gerard, just to be really clear, and you look at the title there, to be illustrative, we just, for the purposes of this analysis, we just hold everything flat. That's not to imply anything about what our capital distributions will be going forward, but rather to imply we can continue to do some. + +Answer_55: + + Yes, I mean it's just optimizing our mix between common and preferreds. + +Answer_56: + + It's too early for us to talk about passes on that level. + +Answer_57: + + I think, folks, this just came out. So we're trying to share information with you. And it might, but give us a little bit of time and we'll give you a deeper feel how it might affect -- how this might affect different businesses, different products. Because obviously when you do something like this, this will be pushed down, at one point, not just to the line of business, but to the client and the product and the country, and then we can answer that question for you. + +Answer_58: + + Nothing in particular, just demand. And I should temper that with, just demand and the continuation that we've talked about of very, very strong competition. And we are, as I said, we are prioritizing quality over growth. We would tactically under perform rather than chase a deal that we weren't comfortable with. + +Answer_59: + + The results are in our second quarter results. + + + Not that material. + +Answer_60: + + You should probably ask them. + + + We hope so. + +Answer_61: + + We're not going to give you monthly specific. I think our folks did a very good job in June. + + + Obviously, when spreads widen out, certain businesses are more of this than others. I already mentioned that Emerging Markets replies to the most volatility, both in terms of spreads volatility and equity markets, did a very good job. + +Answer_62: + + So you should think about mortgage as having some more releases, because we continue to see delinquencies and severities improve, particularly HPI improvement. And so you should expect that to continue, maybe not at the level that we saw this quarter, because we had a big revision to HPI, as you know, during the last several months. And in part, we've had $1.050 billion of reserve releases in the first half. Given what we're seeing, we expect more releases in the second half, but not at that level. + + + Think of the several hundred million. + + + Several hundred million dollars. + + + It's near the end, the car. And wholesale is kind of where it should be and will bounce around. + + + Thank you. + +Answer_63: + + You got it exactly right. At Investor Day, we gave you something that was far more dramatic than 100 basis points, and we already said the duration of this thing is not 10 years, it's a lot less than 10 years. So obviously, the effect will be less. + +Answer_64: + + Not really. + + + Not really. + +Answer_65: + + So the Investor Day scenario was a more severe scenario than the 230 basis points you're implying. + + + What was the number we gave at Investor Day? + + + It was 300 basis, plus or minus. And this is in line with our expectations. + + + Unfortunately, OCI is not, I hate to say, is not that big a deal. We all know about it. We're all prepared for it. Rates can go up. OCI gains are going to go down. 20 basis points, you're going to see this happen elsewhere. It's asynchronous. We have OCI going through capital and the benefits going through earnings in the future. So if it were up to us, we wouldn't have actually had this asynchronous accounting to this thing. And we're prepared, we're going to have buffers that could compare that. We know how a conservation buffer works, but it's not that big a deal. The duration of our portfolio, and you guys can do it yourself, AA-plus, couple your duration, you could almost calculate the number yourself. With one caveat is that the losses are less as rates go up, because of the complexity of the portfolio, currently. And the other thing about this, we can change it overnight at any time. + +Answer_66: + + If you move a trade to a central clearinghouse, it has no charge here and it has nothing to do with the margin that they put up with the clearinghouse. The trade is bilateral with us. You have the receivable get stressed, and you can't take the benefit of the fact that you're going to get collateral against it. That's the way the calculations are done. So any trade you move to a clearing house eliminates that exposure. + + + The margin of the clients with the clearing house is not with us. It's with the clearing house. + +Answer_67: + + We've already added in our forecast to you guys some moving derivatives, on liquid cap and all that. I do think at the margins this will support things in the clearing houses. But we don't have analysis to tell you about that right now. Will it be material? We don't really know yet. Remember, the clients, there's a lot of client business who, they are also going to determine what they want. It won't be just up to us. + + + And remember that the derivative add-on calculation is a calculation that is currently being rethought by the Basel committee because of some of the issues with it. So it could also, in and of itself, improve. + +Answer_68: + + We haven't done that analysis. + + + It's hard to tell. + + + To be honest, we were trying to be very transparent and give you some ideas about the sorts of things that we're considering. We haven't translated these into detailed plans yet, so we don't know the second order impacts of this yet. + + + I think Marianne gave numbers to show that we can handle this. But also, you have to be very cognizant of client effects. We have a client business, and we have to make sure that we continue to have a client franchise. And so over time, we'll adjust the businesses, and we'll meet LCR, we'll meet Basel III, we're going to meet whatever the leverage ratio is. And think of it in some ways of alternative minimum taxes. So if every client will be running what's your return on Basel III capital and then what's your return on leverage capital? + + + Stress capital. + + + And stress capital. So you'll try to manage all those as fair to the client and fair to the Company. + +Answer_69: + + Obviously, we can do stuff like that. + + + Yes. + + + Give us a little time. We're showing you that we can get to the consolidated pretty easily, maybe have to restructure some things and change the capital structure a little bit, and move businesses out of the FDIC-insured bank and all that. I just don't think any of that's going to be critical to the future function of our business. We'll adjust those things to accomplish what we need to accomplish. And give us a little more time. It just happened a couple days ago. + + + Thank you. + +Answer_70: + + Well, let me take do the first question -- second question first. If you have a world where some businesses have to hold twice as much capital as other companies, that obviously over time can create huge competitive disadvantages. I don't know of any industry in America who would want to compete globally in that basis. We have an interest in a safe and sound system, so not against the leverage ratio. But we would be, we're not for a hugely unbalanced competitive playing field. So put that aside. The regulators know that. They are trying to -- we thought part of Basel and all that is to harmonize these kind of things. And if you ask about it, what we show here, and Marianne just shows, anything which is a low RWA asset, including HQLA, revolvers, certain types of derivatives, those things obviously you'll look at a little bit differently because it's a leverage ratio asset. And we don't have to do it by business yet. We'll give you more detail later. +Like even Marianne had mentioned that we take huge deposits in from countries and from money funds, et cetera, that you may not take in, because you can't afford capital against a deposit of $1 billion dollars you get from a money fund that you park with the Fed for 25 basis points, you pay the FDIC 10 basis points, you pay the client 5 or 6 or 7 basis points, you got to put 6% capital against it. You simply stop doing -- there are a whole bunch of things we've got to figure out how we're going to do it. But we want to make sure we manage the client franchise properly. We'll figure out the other stuff over time. + +Answer_71: + + So separate the type of deposit, okay? So if it's a consumer deposit, it has a completely different LCR, how you can invest, the kind of spread you can make. If it's what we call big wholesale short-term deposits, you're absolutely correct. We would probably restrict some of that over time. + +Answer_72: + + Yes. This back up, although sharp, is not entirely unexpected. So as we talk about our longer term plans, and when we outlined all of that and the strategy for the mortgage business at Investor Day, that medium to long-term plan does not change. So it may accelerate some of the activities that we have and have, as we said, some impact on the next couple of quarters' results. But the long-term strategy hasn't changed. We're working the portfolio, optimizing servicing, trying to take costs out as quickly as possible and grow share. And actually, we think we should be able to grow share even more strongly in a more difficult market. + +Answer_73: + + No. No, Nancy. + + + Not yet. + + + Not yet. And as you know, traditionally that would, in any case, lag. Of course, that doesn't mean it will, but that's traditionally what happens. + +Answer_74: + + This is what the issue is with all this, you spend all your time talking about accounting, as opposed to business. The business is deposits, serving clients, doing things. And now we talk all the time about AOCI. And we have a lot of asynchronous accounting, and pro cyclical accounting and stuff like that, that we try to explain. But we try to look through all of that and build a business, more clients, more bankers, more branches, happier clients. So in all of our business, that's how we look at it. We'll work through the asynchronous accounting. If the loan loss reserve accounting changes, it would add, obviously the loan losses, though probably not as much as people think. But we still would run the business for economics in the long run. It wouldn't change how we run the business. We would be just be holding more reserves, which would be fine with us. + +Answer_75: + + Well, as you know, the industry commented, we commented in terms of the proposal. And we are generally in favor of it, but I think that a lifetime timeline is too long, so something shorter than that would make sense. I think we need to work that through. It would be implemented over, not the course of the next couple of quarters, but in a year or so. So we'll wait and see. + +Answer_76: + + I would say, so first of all, the industry groups haven't fully reforecast the market, so we'll wait and see what they come out with. We're trying to be transparent with our guidance, so that level, hopefully we're wrong and hopefully it will be better than that. I will say, for our own business, we didn't expect volumes to be down this much throughout the year, had this not happened with this space. + +Answer_77: + + Well, mostly this is refi. + + + So purchase, we actually saw go up a little bit. + + + They're not going to make up for refi. But they may go up, yes. + +Answer_78: + + Look, we're in favor of finishing. We've always believed in high capital, high liquidity, good regulation and things like that, and finishing it. And obviously, there are things that all countries have points of view about which would be different. But I think the better you get to real harmonization -- the closer you get to real harmonization, the better. If you want to start all over again, we'll spend another five years debating every single thing out there. + + + Yes. + +Answer_79: + + Yes. + +Answer_80: + + Well, as I said, we're expecting NIMs to stay broadly flat from here. We do expect some modest loan growth, that's our outlook. I'm not going to tell you how much, but some. And then we also have the improving cost of debt, lower cost of debt on actions that we've been taking throughout the first half. + +Answer_81: + + Yes. But we also have the yield compression. So you know, there's puts and takes. And so relatively flat on NIM, modestly up on NII. + +Answer_82: + + I'm sorry, I didn't understand. + +Answer_83: + + Yes. + +Answer_84: + + We're growing loans in Asset Management. We're growing loans in Auto. We're adding more mortgage loans. We're expecting some growth in Commercial. Our Commercial Real Estate is already growing strongly. We're expecting some growth in middle market and Corporate Client Banking space. Although we've seen loan reduction in CIB, we're expecting that to remain relatively flat. So all other things being equal, that's net growth. And Card, as I said, have hit that inflection point, so that will stop contributing to run-off, net. + +Answer_85: + + So our annual guidance was that, if you look at the first half of the year, you'll see that obviously already we're down year-to-date by more than that amount. So this is relative to the third quarter, we expect NII to go up. We're already down a little more than 1%. + +Answer_86: + + Well, thank you for bragging on our trading results. And for years, the Investment Bank is building FX rates, securitized products, commodities, emerging markets, credit. And they're good. And obviously, some go up and some go down. I wouldn't say it was-- at least, I didn't see any regional effects. We trade around the world and the books get handed off around the world, so it's hard to give it a region. But we build a lot of clients low businesses and that what's driving it. +I think it's better for the world to have harmonized rules around what Basel is trying to do, et cetera. But you're absolutely correct. It doesn't have to be exactly the same to have a competitive marketplace, et cetera. We always ran with higher capital liquidity than most of our competitors. I just think if one is 3% and one is 6%, that becomes just too big, and over time it could have huge competitive effects. And the regulators are working it out. We all want a fair, safe, sound financial system, okay? So that's in everyone's benefit, and there are huge capital issues -- capital requirements, liquidity requirements, leverage requirements, stress testing requirements. And among all of that, I feel that we're getting there. But at one point, this should be somewhat harmonized. +And your middle two questions, I now forgot. + + + Can we get back to you on some of that stuff? We're sort of running out of time rapidly. + + + Okay. + +Answer_87: + + Yes, correct. + + + I'm sorry, David. As of June 30, based upon the US proposed rules. + + + Estimated to the best of our ability. + +Answer_88: + + So, David, we did say at the beginning that we do think that having a leverage ratio is an important part of our capital management toolkit or process, as long as it's properly calibrated. And so for us the two questions, I think they are very important and the industry does, too. So we're participating in discussions. As Jamie's talked about, what should the quotient, or the ratio, be and making sure that that not only is appropriate but fair across the globe, and also what should the calculation for the denominator be. And we've alluded already to two specific questions, but there are more. +One is should high quality liquid assets, most particularly cash and cash at central banks, be treated the same as other balance sheet items? And then in terms of some of the additional add-ons that are being proposed, we think they could have issues, actual issues, for the operation of the financing market. So I think there's going to be a lot of work that takes place. There are comments due back on all of those proposals by mid-September, call it, plus or minus. And I think this will be worked through through the fourth quarter. + diff --git a/exam/original-files/Problem_2_3_Sample_QandA/3_questions.txt b/exam/original-files/Problem_2_3_Sample_QandA/3_questions.txt new file mode 100644 index 0000000..d33a3d1 --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_QandA/3_questions.txt @@ -0,0 +1,354 @@ +Question_1: + + Good morning. Hello, Marianne. I was wondering if you could -- do you have any sense that you could give us of where you stand on the leverage ratio at the bank level today relative to the 6% requirement? + +Question_2: + + Okay. So shortly thereafter, maybe within a quarter or two? Can you give us any feel there, or -- just to get a sense of --? + +Question_3: + + Okay. And you mentioned the mitigation you can do at the Holding Company. Is there mitigation you can also do to help specifically the bank level ratio in terms of assets that could be shifted to the parent or equity that could go from the Hold Company to the sub and things like that? + +Question_4: + + Okay. And then on the liquidity ratio, why have you decided to run with this level of cushion to LCR and why the acceleration in getting there now? Anything driving that, in particular? + +Question_5: + + Okay. And could you give us some of the assumptions behind your outlook for stable net interest margin and modest net interest income growth in the back half of the year, just in terms of what you're assuming on rates and loan growth, and what are the puts and takes on your outlook? + +Question_6: + + Okay. And then finally, I'm not sure if I saw it in here or not, but can you remind us how much you benefit from higher rates? And which rates in particular are most helpful for you, if you can delineate between the 10-year and the shorter based rates? + +Question_7: + + And then that's current numbers, that's last Q or that's as of right now? + +Question_8: + + Okay. And last thing for me, on reserve release, how can we gauge, if it is possible at all, how long this can go on for? Are there any base metrics that you think you can't go below that we could look at as a percent of loans or a percent of normalized charge-offs? Any help you can give us to gauge how much might be left on reserve release front? + +Question_9: + + You haven't done that yet in terms of taking the PCI out yet, right? + +Question_10: + + Good morning. + +Question_11: + + So another quick question on leverage. Could you help me understand why it takes until Q1 '15 for the Bank Holding Company to add the 30 basis points necessary to the leverage ratio? It looks like what you laid out puts you well above that earlier. + +Question_12: + + Understood. Thanks. And was there a change in the securities portfolio during the quarter, and maybe could you give us an update on where that duration stands? + +Question_13: + + So would the bias be to assume that it would be towards shorter? + +Question_14: + + Okay. And then just a quick follow-up on John's question. Is it generally right, given what you guys have disclosed and what you guys just verified and what we've seen in rates, if we assume that rates kind of stay where they're at, that you would get about 75% of that $900 million additional NII in 2014, if we stay status quo to where we are now? + +Question_15: + + Right. All things are never equal, but -- + +Question_16: + + And then last one, just trying to think about maybe the potential to avoid some of the really big distraction that we saw this quarter around what is sort of becoming an annual event at the shareholder vote. Have you guys considered maybe articulating some kind of plan or a blue print or a map or what have you to get people comfortable with the future state of CEO Chairman roles way down the line when there is sort of a succession that is in place? + +Question_17: + + Hello. Thanks. Good morning. + +Question_18: + + So one more question on page 4. Your $4.7 million is really close. We were looking for $4.5 million, so very much in line with what we're looking for. I'm just wondering why no bank sub disclosure. I realize that it's different, but -- and I heard your answer earlier. But I'm just wondering, why not just give us a number. Is it that there's too much uncertainty in estimating that denominator, you need understanding from the regulators as to what they're looking for? Could you just help us out on a little bit of the qualitative reasons? + +Question_19: + + Yes, I get that. If possible, I'd love to show you what our assumptions are and maybe we could understand where we differ. + +Question_20: + + Okay. And then separately, you put on here on this page the potential further add-ons for the Basel proposal. You're talking about the Basel consultative document that came out a couple weeks ago? + +Question_21: + + Is there any sense as to what kind of basis point hit that is? + +Question_22: + + Yes. So part of the challenge is a higher denominator in one side and a higher ratio on the other side, right? + +Question_23: + + Just on HPI, HPI obviously rose significantly in the quarter. Could you give us an indication as to how much that helped RWAs? Was that a big piece of the driver? + +Question_24: + + So can you give us a sense as to given where HPI is today, what kind of benefit that would have on RWAs if there wasn't a lag? + +Question_25: + + Good morning. + +Question_26: + + Just drilling down to some of the businesses here. Obviously June, as you mentioned and we've all seen, was very volatile in the credit markets and the fixed income markets in general. And I guess just a basic question, how did you do so well in fixed income? I know you commented early part of the month that things had deteriorated quite a bit, and I think some of us were surprised at how good it was in the quarter. + +Question_27: + + And is that just from managing a smaller inventory while the spreads were widening, or --? + +Question_28: + + Okay. And I guess from the other side, when we look at the comp rate at the Investment Bank, it was down, I think, 2% to 3% both linked quarter and year over year. What's driving that? Is it mix, is it the streamlining of the business lines that you announced about a year ago fully coming together, or just paying people less? + +Question_29: + + And I think you've been guiding towards 35%? + +Question_30: + + Should we think that maybe it's the lower end of that that is more sustainable? + +Question_31: + + Good morning. + +Question_32: + + First, I just wanted to follow-up on the comment, so over the next 12 months NII should benefit by 75% of the $900 million? So in other words, you should -- in 2014, you should benefit by about $700 million -- + +Question_33: + + No, I understand. It's more art than science. So I guess your run rate of net interest income, that would be about 1.5% of that. Is that in the ballpark of how you think about it? + +Question_34: + + So that benefit would equal about 1.5% of net interest income? + +Question_35: + + Okay. And when you say the benefit, it's the benefit of the 10-year increasing 100 basis points? I didn't fully hear how you explained that. + +Question_36: + + The reason I ask that is it seems as though maybe the 10-year is not as relevant as perhaps the five-year, or am I mistaken? Or the three-year? + +Question_37: + + Okay. Separately, the Investment Banking backlogs, where are they versus the first quarter, at the end? + +Question_38: + + And the leverage ratio, you said under the US rules, it's 4.7%. Under the proposed Basel rules, if adopted, where would the leverage ratio be? + +Question_39: + + Can you give us a ballpark? Or is that one reason you're being so conservative, you have 160 basis point potential benefit, but you're still saying wait until early 2015. Is that part of your thought process? + +Question_40: + + Okay. And then last question relates to the processing business, which to me looks like it's lagging for the second quarter in a row. And I'm asking a more broad question. For eight years, since Bank One merged with JPMorgan, and I think for a few decades before that, it was run as a separate business. And the fourth quarter of last year, it was merged into the Investment Bank. And now we have two quarters in a row of what looks like performance that will lag peer. So my question is how is the management and organizational restructuring going? Is it impacting the processing business, or is there something else taking place there? + +Question_41: + + Yes, I'm guessing it's going to lag. The assets under custody down 2% link quarter when markets are up as much as they are, is there anything else that's one-time or unique? + +Question_42: + + Good morning. My first question really has to do with some of the initial questions asked on capital. And what is the priority here on capital distribution versus leverage ratio? Is it compliance to the 5% at the Hold Co, or is it accelerating capital distribution over the next two years relative to what you announced out of this year's CCAR, or can JPMorgan both be compliant with the leverage ratio over time and accelerate buybacks and dividends? + +Question_43: + + Okay. And a follow-up question on what you mentioned, Marianne, in the beginning of the call on Mortgage. You mentioned that if loan rates stay where they are, that could mean the market shrinks by 30% or 40%. What is the proportionate expense in that scenario that you could take out of the business, and how long typically is the lag until you can take those expenses out? + +Question_44: + + And proportionately, if the revenues are down, let's say, origination revenues are down 30% to 40%, what's the efficiency ratio that we can think about as we think about the variable costs that can get taken out? + +Question_45: + + Good morning, guys. Want to ask, maybe I missed it, on expenses. Can you talk about how you're still feeling about the full-year target? You previously had talked about down $1 billion year over year, ex-legal. Does that still stand? + +Question_46: + + Got it. That's helpful. And the additional litigation costs this quarter, somewhat elevated. How do we think about them going forward, staying elevated but similar rate, or a little bit lower, or how do we think about that? + +Question_47: + + Got it. Thanks. And then in terms of the rates, obviously, impact a lot of different businesses, Mortgage, the balance sheet, NII, NIM discussion, but then also can you walk through how we should think about it in terms of the FIC business, heightened volatility, maybe more volume, but then obviously softer environment in June. How do we think about this current environment playing out for the back half of this year in terms of trading? + +Question_48: + + Thank you. And then my last question was just a clarification on there's been a lot of regulatory issues, capital, liquidity, buffers on buffers, OLA, et cetera. As well as I know you guys, I expect -- I think it's this quarter that you're resubmitting your CCAR plan. Is it fair to assume that despite all these things that have been coming out and there's still some hurdles that need to be met, that one shouldn't expect a change in capital deployment or should we? + +Question_49: + + Good morning. Just a couple of questions. First of all, Marianne, you mentioned servicing costs in the mortgage business being down by about $600 million in the fourth quarter. Is that largely coming out of the default side of things or is that -- do you think that will be more evenly spread between default and regular, more regular servicing? + +Question_50: + + So it's about a three- to four-year run rate to get down to ultimately where you want to be? + +Question_51: + + Okay. Marianne, just a further clarification question. On gain on sale margins, you mentioned those were 118 basis points this quarter. You mentioned last quarter that they were 100 basis points, and about 180 basis points on a normalized basis in the fourth quarter. Are all those calculated in the same way? Are those quarterly averages, or are those the gains at the end of the quarter? Just wanted to be sure we understand that. + +Question_52: + + Fair enough. And then one final question. Marianne, you mentioned deal activity appears to be turning, I think that was with respect to the commercial banking business. Could you provide a little more color on that? Did June's volatility in the interest rate scenario slow down business activity in the commercial banking business? And I'm not really specifically talking about the Investment Bank, but more in the commercial banking side of things. + +Question_53: + + Okay. And just finally, there's been a lot of talk, obviously, in the last couple of days about a potential reassertion of Glass Steagall. And I guess I'm curious, given your current business model, would that, if that were to come to pass, would that be a meaningful negative in terms of your ability to maintain your cross-sell opportunities across the businesses, or is that perhaps less of a challenge given how you currently have the businesses structured? + +Question_54: + + Thank you. Good morning. I just wanted to be clear, when you talk about on page 4 that you're going to hold your capital distributions flat, is that for all of 2014 relative to '13? + +Question_55: + + Yes, okay. And then second, you put in here the Tier 1 capital actions could add possibly 30 basis points. Could you give some color behind what you're thinking there? + +Question_56: + + Okay. And would the total leverage impact of 60 to 160 basis points, clearly that's over the 5%, I assume then that you're going to be comfortable running something north of 5% when you finally get there. + +Question_57: + + Okay. In your Investor Day, you gave us the ROEs for the different lines of businesses. And in the total firm, you felt 15% to16% was your target ROE. Will that change now that you've got to carry the higher leverage numbers? + +Question_58: + + Okay. You guys have had some great C&I loan growth in the middle market space over the last four, five, six quarters. It seemed to really slow down this quarter. Anything in particular happen? + +Question_59: + + And finally, can you give us any color on how the shared national credit exam has gone, and are those results in your second quarter results or will they be in third quarter results? + +Question_60: + + Good morning. Just a couple of quick follow-ups. I hate to focus on the leverage ratio, but just one question on the cash component. I think, by my calculation, if you were to exclude cash from the denominator, that would add almost 70 basis points to your leverage ratio. Do you think that that has any legs or any sticking with regulators, in terms of logic around excluding that? + +Question_61: + + Yes. It would make some sense. And maybe just getting to the FIC business, you alluded to it a little bit, some businesses benefit from volatility. Is it fair to assume that in June we saw things like foreign exchange and interest rate trading do better and credit and mortgages do worse, is that sort of the best way to think about it? + +Question_62: + + Yes. Thank you very much. On your reserve ratios, right around 2%, and you had a lot of reserve releases in the quarter. With credit improving, can you continue to do this type of releases in the next couple quarters or is that reserve ratio going to stick around 2%? + +Question_63: + + Good morning. So just looking at the hit to the OCI at $3.1 billion, it actually seems like it's less than would have been implied by the guidance that you gave at the Investor Day. Obviously, that was for a more severe shock, but just calibrating it relative to the number of basis points that the 10-year went up, et cetera. Any comment on that? + +Question_64: + + And is part of the reason why, besides the fact that it was 100 basis point not a 230 basis point move or whatever, is part of the reason linked to the derisking of the Treasury portfolio that you were talking about as you prepared for the LCR? + +Question_65: + + Okay. But then is there validity to the fact to the idea that if we recalibrate it for 100 basis points move versus the 230 basis points move that I think is implicit in that $15 billion number that you gave us in February, was the $3 billion in line with that or was it actually materially better? And if so, maybe if it wasn't related to the LCR derisking, why did you have a better outcome? + +Question_66: + + Right. Fair enough. As I think about the changes that you can make to the business that you referred to on page 4 to mitigate the impact of the leverage ratio changes, you talk about optimizing the use of central clearing, and yet there's also all these concerns about the disallowance of additional derivatives collateral. How comfortable are you that the way the rules are written right now, moving your derivatives business more towards central clearing really does, because of the collateral, give you a lot of relief on those leverage assets? + +Question_67: + + Right. So I guess the logical next question for that is given the central clearing mandate which has started to be implemented recently, should we, and as we think about leverage ratio going forward, should we be thinking about a large part of that derivatives add in to the denominator of the ratio as basically being in run-off? + +Question_68: + + Fair enough. When you think about those leverage asset actions that you're talking about, is there any linkage of taking those actions that further benefits LCR? + +Question_69: + + Okay. One last question I'll ask you is that, as I've talked with clients over the last couple of days about this leverage ratio issue, one of the questions that has come up is wouldn't it be possible to downstream more capital to the bank sub in order to deal with the 6% requirement there? Obviously, that incurs a double leverage issue, potentially. Your double leverage ratio right now is just over, I think it's like 1.05. I mean is there any room there? + +Question_70: + + Yes, just following up on Guy. It seems the thrust of the whole leverage ratio is that it's going to penalize the businesses that have the highest ratio of leverage ratio assets to risk weighted assets. And can you give us an idea where that gap is the biggest, and in particular, also are any of these global businesses where this would give European banks a leg up? + +Question_71: + + Great. Jamie, following up on that, it just seems like even the $100 billion of increase in deposits this quarter probably cost you 15 basis points in that leverage ratio. And so is there any movement, do you think, during the comment period towards exclusion of any of the risk -free assets at all? + +Question_72: + + Right. Okay. And maybe just a follow-up on the mortgage business. You talked about some of the financial impacts. Can we talk a little bit just about strategically what you're doing as you look at that business, and the competitive environment in a weaker refi environment? + +Question_73: + + Good morning. Two questions. First, on branch, on the branch banking network. I know this back up in rates has been primarily at the longer end and we have not yet had a corresponding rise in short-term rates, but do you see any needs, at this point, to reprice products, et cetera, at the branch level due to consumer perception of rising rates? + +Question_74: + + Secondly, Jamie, you talked about the asynchronous nature of OCI, with OCI getting dinged now with the benefits of the future. Something else asynchronous is staring us in the face, and that's this loan loss reserve methodology possible change to expected lifetime loss. What are your thoughts about that? I mean, where does that stand in an implementation process, and would you really get dinged by that? + +Question_75: + + Well, do you have any sense, I mean, I realize that you're going to run the business for the business, but do you have any sense if this is going to happen and when it might happen? + +Question_76: + + Marianne, could you go back to Mortgage and talk a little bit about the quality of the demand you're seeing? At the beginning of the year, the industry was guiding down about 20% in terms of volumes and for next year, as well. Your numbers suggest that that's basically doubled; in other words, instead of 20%, we're looking at 30% to 40%, given rates. Would it be fair to say that the two factors are equal? + +Question_77: + + So you think there is definitely a price reaction out there among consumers? + +Question_78: + + But Jamie, back to your point about harmonization, when you look at the totality of the way regulators are treating mortgage, MSRs, for example, which have been rallying very strongly in the past few months, and your comments last year about Basel. Should the US withdraw from Basel II? It's so unfriendly to businesses that are very important to you and to the economy, particularly in Mortgage. What are your thoughts on that? + +Question_79: + + Thanks very much. Marianne, can we just go back to the sequential NII guidance? + +Question_80: + + Can you help me understand how much of that is coming, or what the attribution is between benefits to NIM versus loan growth? + +Question_81: + + So I guess a couple of thoughts then. Shouldn't, presumably then, the benefits to the funding costs should show up through NIM, no? + +Question_82: + + And just within the composition of loan growth, if you divorce out the credit card seasonality, it's been within a very stable range. What is it that, in your view, takes the loans out of the current range? + +Question_83: + + So in other words, your loan growth has been -- sorry, not your growth, but rather your loan balances have been between $725 billion and $727 billion or $728 billion very consistently for many quarters, if you divorce out fourth quarter credit card seasonality. + +Question_84: + + But it sounds like you have some expectation that starts to move out of that range in order to generate this improvement in NII? I'm wondering what the driver of that is. + +Question_85: + + Got it. And then just finally, on the third quarter guidance, is that consistent with or relatively better than your prior annual guidance of down 1%? + +Question_86: + + Yes. Good morning. I have questions on a couple of topics. Perhaps the first one, on Equity Capital Markets. Clearly, I think the volumes were up about 2% quarter-on-quarter, and I think we all expected you to outperform. But it was an extremely good performance. And I wondered if you could brag a little bit about how you achieved that and how much you thought was from the market share and perhaps how much is down to geographic split. That's the first question. +The second one, I'm afraid, I'll get back on to leverage. I'm intrigued by the comments on page 4, which you've touched on in an earlier question on the Tier 1 capital actions, which you suggested would be perhaps issuance of some additional Tier 1 capital, as it's becoming now called, AT1. And I wondered if you actually had any indication yet, I know it's fairly early, from the regulator on what the terms of that new capital would have to be to qualify for Tier 1 under Basel III? And then perhaps talk about the $14 billion to $15 billion of current hybrids that you have within the Tier 1 calculation, which obviously you're going to phase out, I think in some cases, if not all, through to end of 2018, and what your strategy is for the placing those. +And just perhaps finally, I know Jamie's talked a lot about level playing field, and I asked him that last year on Basel III capital, but I'm just wondering actually the leverage ratio that you're looking to have to achieve now, whether it actually gives you a competitive advantage as opposed to a disadvantage, given 3% is pretty well being considered too skinny. Thanks very much. + +Question_87: + + Good morning. Just quickly. To be clear, on page 4, are you saying that your 4.7% leverage ratio is as of June 30 without any other assumptions or roll forward? + +Question_88: + + And congratulations for doing the work so quickly. But secondly, Jamie, how will you as a company respond to the proposal? Are you in favor of it largely? Are you against it? Will you have a lot of proposed changes to it? + diff --git a/exam/original-files/Problem_2_3_Sample_QandA/40_answers.txt b/exam/original-files/Problem_2_3_Sample_QandA/40_answers.txt new file mode 100644 index 0000000..9ec499d --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_QandA/40_answers.txt @@ -0,0 +1,109 @@ +Answer_1: + + Yes, sure, Dara. Look, a few thoughts. Firstly, I think the most important thing we focus on as a starting point is making sure we are bringing the innovation, the marketing and the execution to bear for each customer such that the beverage category grows faster than their overall business. And that is the basis on which you get better in-store placements, execution, and the pricing conversation becomes more manageable because the end, you're -- in the end, you're creating disproportionate value for the customer. So that's the first objective. +The second point I would make is we -- perhaps different to some people, we are a very multichannel business. Yes, we have large presence in the grocery channel, but we have multiple other environments where we sell our beverages. And therefore, part of it is being in lots of different places that helps manage the pack/price architecture dynamics and creates value for all our customers in the different channels. +And I would perhaps leave a last third thought on the marketplace, which is, yes, some of the extra pressures are from private labels or the stratification of retailers' own strategy in pricing is somewhat of an emerging dynamic in the U.S., but it has been present in other parts of the world, and we have found ways to work with each of our customers to make it work for them and for us. So we are believers in our ability to create value for ourselves by creating value with the customers even in this ongoing changing environment. +And I'll leave you with the last thought, which is there's no one better positioned to understand this in the context of North America than Jim Dinkins because he's run the national sales company for the U.S. system for a large number of years. He's worked as -- leading accounts in lots of other channels, too. So he understands this dynamic very clearly, and he has been at the forefront of leading a team to build value with our customers in collaboration with our bottling system. + +Answer_2: + + I -- well, I think the first and most important green shoot is to look at the performance once you get past the 12-month mark, by which I mean that it's much like having any new thing, management attention and focus gets heavily directed to new things. And so of course, you would expect better performance initially on refranchising, and we have got that in the vast majority of territories. +But I think the most interesting thing is that after 12 months when it's cycling and people have got the real hard work of building for the long term, we're still seeing the vast majority of the refranchised territories performing ahead of where they were before. So they've been able to build on the great refoundation work that CCR, in conjunction with the North American team, did. And the sorts of places we're seeing that performance coming from is not just doing better with the existing customers, which is true, but also in finding new customer outlets, expanding the universe of the customer outlets and performing better in the small formats, which in a way is partly the theory of the case of why refranchise to local partners. + +Answer_3: + + Yes. I mean, I'm not going to get into the mathematical specificity, but I think, look, the headline is that as Coke Zero Sugar is coming to marketplaces, and particularly interesting those ones where it's been there for more than 12 months, a bit like my comment on refranchising, we're seeing continued acceleration of Coke Zero Sugar. It's lifting the whole franchise. +Yes, it is cannibalizing at times either Coke Light or sometimes Coke Original, but in the net, there is additional volume and additional consumers coming back into the franchise. I think it's unrealistic to expect cannibalization to be 0, but obviously, the key is that it be a net positive. So we're pleased with how it's playing out. It's slightly different in different countries, depending on the mix of the Coke franchise in those countries, but it's a net positive, and we are encouraged. + +Answer_4: + + Okay. So I will take the first one, and James can decide if he plans to be generous or not. +So first of all, we separate those 2 programs, Ali, from the $3 billion program, the original program that we announced earlier and then the $800 million program that we added on. On the $3 billion program, I would say we are on target, that the productivity is clearly coming from 3 different places: cost of goods, DME and OpEx. And we have targets to do about -- around $400 million this year. And we had always said about half of that would be reinvested and -- to drive growth. +Of the $800 million program, that is associated with our lean enterprise activities. Those activities really just got started last quarter, so this year. So it -- they really will -- and we've said that you'll see the benefits of those in 2018 and '19, and they will be split between those 2 years. And again, about half of that will go to reinvestment, and half will hit the bottom line. So we are on target with both programs, and the lean enterprise programs have started off well so far. And we will plan to update you as we continue to go along. + + + And if we have time, we'll come back to Topo Chico, Ali, so that we can respect everyone's one question at a time. + +Answer_5: + + Sure. I mean, firstly, we over-index in terms of share, generally speaking, online. I think the second thing I would say is e-commerce is not one thing; it's a spectrum. And in part, what I mean by that is there are pure-play e-commerce players. There are bricks-and-mortars who have e-commerce. And you could say that's the omnichannel. There are aggregators -- remember, we're not just grocery. We work with a lot of restaurants, and there are all sorts of restaurant aggregator platforms and restaurants or some QSR chains have their own platforms as well. +So there's a wide spectrum of different versions of how consumers are interacting with customers that is digitally enabled. As I said, we very generally over-index. Our objective is to work with each customer, helping them drive value for the beverage category with their consumers. And generally speaking, we do better when that happens. And so you can see progress in the traditional grocery idea of e-commerce, whether omnichannel or pure play. You can see progress on restaurant or quick-service platforms. +So there's a lot of growth, a lot of activity. But in the simplest sense, it comes back to the central idea: if we can work with them to help the beverage business grow faster than their overall business and be a key participant, it creates a lot of value for them. And therefore, we have a lot of engagement with many of these companies on how can we help create value for them within the context of their strategy. + +Answer_6: + + Yes. I think let me take them in pieces as each one is a slightly different story although I -- the headline is I'm hoping to see the light at the end of the tunnel by the end of the year. What does that mean? In Brazil, we've talked about the actions we've been taking around price/package architecture, around returnables, investing in new infrastructure, not overpromoting to try and protect the volume but to try and reestablish our price/pack architecture that's going to work for the medium term. +It's -- Brazil as a country is struggling or has struggled. There are some signs, as I commented on the script, of light at the end of the tunnel. FMCG is lagging durables a bit in that. +Am I completely happy in Brazil? No, I wouldn't say so. I think there's more that we can do that's within our control. But I'm still somewhat hopeful that, that will all play out by the end of the year and things will start bottoming out in the fourth quarter. It has been sequentially improving as we've gone through the year. I think with more focus and more effort, we can see this play through, and so it'll bottom out by the end of the year. We'll see, but I think the signs are encouraging. +Venezuela. Venezuela is really a very tough human situation. It's almost a tragedy. And I think that the simple reality is the fourth quarter of significant declines in Venezuela will be the fourth quarter this year, at which point it'll have got to -- it'll have shrunk to a size that it won't be able to impact our overall numbers to the same extent in 2018. I would love to think it's going to get better. I'm not hopeful in the short term, but I would say it's going to stop impacting our numbers heavily once we get into 2018. +And then Colombia, similarly to Brazil. So I think the sum of all that is what I said at the beginning. We've been through a very tough year. We've been taking action. We are happy with some of the things we've done. We've got more work to do in places. But the floor should be set by the end of the year. + +Answer_7: + + I think there're a few questions in there, Judy. Look, I think as we disaggregate the categories, obviously, the categories intersect with the geographies. And so the story is not -- neither clean by geography nor by category. But let me try and add a little texture to what we see going on. +I think sparkling beverage growth got a little bit better volumetrically in the quarter, and I think that, that shows a slightly improving trend. So I think that's -- firstly, the sparkling has got volumetrically better. It's back to slightly across the 0 line, whereas it was negative at the beginning of the year, and that's coming with better revenue growth. So our focus on Coke Zero Sugar, the relaunch of Fanta, Sprite in some places, smaller packages, working with customers who are getting a better volume trend sequentially and good pricing. So I think there's good progress there. +In terms of juices, what we're really seeing there is doing a lot better on the top end, things like chilled juices, plant-based drinks, fairlife, the premium dairy, going strongly, would love to have more capacity to grow even faster. You're seeing some growth in the juice drinks end of the spectrum where there's some volume has come out. It's more in the nectars, and I think that's part of people converting up and converting down. So I think there's continued trend there. +In terms of teas, good growth there, volume growth, price growth. We're pleased with our performance in teas. We're going to continue to invest in tea. +Coffee, lots of up in coffee. In the U.S., we've launched our own brands. We've launched some brands in partnerships with some other players. All of those have gone successfully well. We've got new innovations coming. We did -- we had a bit of a bump in coffee in Japan in the quarter, not so pleased about that. But we have the plans in place to do better. The one where we have done less well, and it was a choiceful decision, is on water. In some parts of the world where we have been too heavily into very low-margin, large-bulk water, we have pulled back deliberately in the quarter, and that has affected some of our water growth rate numbers. + +Answer_8: + + So yes. I mean, we're going to reaccelerate smartwater. Look, I think the key in terms of North America is to see a bit of a trend on the price/mix. You'll remember from last quarter, for example, that we talked about a point of the revenue growth was extra inventory in our fountain business ahead of the summer. Obviously, that's been backed out in the third quarter. +So said in simple terms, I think the easiest way to understand North America and look through inventory and look through natural disasters is, if they look to summer as the period, let's add the second quarter and the third quarter together and look at what we've got. And there, I could -- I think you can see revenue is 3% to 4%, price/mix is on average 3%, which is in line with the year-to-date trend and is in line with what we did in previous years, more or less. +But I think when you just look past some of the blips, what you see is an ongoing successful track record of driving the North American strategy; reinvigorating the portfolio; a focus on revenue; a focus on smaller packages; a focus ultimately that drives price/mix ahead of volume, with transactions ahead of volume. And I think that's what you saw once you ignore the blips in the third quarter. And so we're committed to our strategy, and we continue to drive it. + +Answer_9: + + Look, I think we got -- the North American market is certainly one of the most competitive markets around the world. It's not just one large competitor we face. There are multiple competitors, large, medium and small. There's a lot of activity, a lot of innovation, a lot of jockeying. +In the end, we will continue to focus on our strategy. We have a clear strategy that's driving the portfolio inspired by the consumer, working with customers to create value for the beverage category and our underlying category because that includes all peoples, brands and products. We work with the customers to create value for the beverage category, which will drive ultimately growth. And I think that has shown that we have been able to gain share over the long term on a steady basis as we have deployed this strategy, supported, of course, by the increased and improved bottler execution investment through the refranchising. +It's a long-term game plan. I've commented on previous quarterly calls, will there occasionally be quarters where customers take certain decisions that cause disruption to that or competitors do? Of course, that may happen, and we will respond. But we believe in our strategy, we think it's the right long-term play, and we will always look to get back to it even if we respond to short-term actions. + +Answer_10: + + I think the top part of the answer is it's -- all the pieces work together. It's about having the right portfolio for the consumers, the right marketing, the right innovation and the right execution. There's no question that when you bring all those things together, that's when you get the best possible result. +In terms of what better execution from the refranchised bottlers, I think that they have been able to build on the foundation that was created by the CCR team. That was -- we pushed more devolution of accountability, of empowerment down into the organization of this national bottling company. We were -- refounded some of the manufacturing, supply chain and executional processes. +And I think the local bottlers have been able to take that, bringing their passion, their entrepreneurialism, their local knowledge, and turned that into an even better result. As I mentioned earlier, that's typified by things like more outlets, typified by things like working better with the smaller formats, yet also, at the same time, being able to increase the degree of execution and service to some of the larger customers. +So it's been an ability to work across the board. It wasn't a silver bullet. It was, in fact, getting a little bit better across the spectrum, from the largest customers to the smallest customers, in support of our portfolio marketing and innovation plan. + +Answer_11: + + So yes, it's safe to assume that we're going to invest where we see the opportunity for growth. And therefore, as the emerging markets begin to bounce back, I'm not sure they're all are going to bounce back to the same sort of degree as they were precrisis, but we absolutely will be investing to drive our market position. Now I would just underline that other than some situations very specifically, we don't tend to try and pull back very aggressively when markets turn down. +We, generally speaking, adopt the strategy of when there's a downturn, and particularly, in some of the emerging markets, it's better to invest through it to gain competitive position so that you're positioned even better for the upturn. So it's not the case that we pulled the cord on lots of markets. Having said that, as I said at the beginning, we will up the investment as we start to see the acceleration, and you can see that we've talked about things we started to do in India, things we started to do in China. +As we see the momentum starting to come back, we're investing behind those. Will it be across the portfolio? Yes. It won't be -- [shock them]. It needs to be focused on helping us achieve category leadership positions or near-leadership positions or driving new interest in consumer innovation in conjunction with the execution of our bottling partners. We're not trying to do more mediocre stuff. We're trying to generate good strong consumer brands, whether they be large or they be niche, whether they be profitable and they be successful. + +Answer_12: + + I think, in Western Europe, we've had a very good start to the creation of CCEP. Yes, it was a little bouncy in the third quarter with some localized poor weather that offset the better weather that was in Q2. If you look past those blips, I think you see momentum in Western Europe coming back in and good growth. +I've talked previously about expectations on price/mix where in Western Europe, I think we can have, in comparison perhaps to the U.S., a little more volume growth and therefore a little more balance between volume and price in Europe as we go forward. The U.S. is more assertively looking for a package/price architecture mix-led part of the equation. So I think that the sustained idea for Western Europe is a balance. +In terms of China and Africa, there are slightly different situations. In Africa, clearly, there's more opportunity for expansion of the portfolio volumetrically although of course, there'll be a price/mix element. And China is, again, a place where we're looking to get -- rebuild the volume momentum with a moderate degree of price/mix. + +Answer_13: + + Yes. I mean, there's -- I mean, clearly, the natural disasters in the whole Caribbean basin, whether we're talking Florida, Texas, Puerto Rico or Mexico with the earthquakes, all kind of occurred in the same quarter. So there's clearly an impact. I'm not going to attach a number to it because I'm not really a big fan of putting it all into the one-off temporary basket. But clearly, there was an impact. +The weather was a bit more miserable in the third quarter. And there is a bit of -- there was a bit of softening of consumer sentiment through the third quarter in Mexico. I don't think these are new enduring trends. I mean, certainly not the natural disasters, hopefully not, but nor is the consumer one. I think that will slowly reverse over the balance of the year. We'll see. +So I don't think there's a big issue in Mexico. Of course, it's one of those places, too, where we're looking to work on our price/package architecture and the full portfolio that we've developed as a system over the last few decades there to really be able to continue to drive revenue. And I think it was a strong revenue quarter for the system in Mexico, and I think that will continue. + +Answer_14: + + Look, I think the leadership change in North America -- I mean, leaders don't last forever, and this is another one of those changes. There's a new chapter about to begin in North America. We've had a great run of a few years. We've successfully carried out a humongous refranchising task. And I think Sandy made the decision this time for a new leader, and I think Jim is the right person. He's got full portfolio experience. He's got marketing experience. He knows the customers across the whole spectrum, and he has the right capabilities as a leader to take us to the next stage of growth. +What does that need to be? Clearly, it needs to be about continuing to execute the strategy we've got in place. But like all strategies, they need to evolve. In the same way that company's global strategy evolves for the circumstances we face, so will the North American one. It's not just due to the fact of the leader changes that you know you need to continue to evolve and build new capabilities. We knew that before. We had some things under development. Of course, we'll learn new things, and we'll identify new ideas. So I think it's about a continued journey of the North American business. It's a great team. It's a great system. They've got their mojo back. They know they need to do more things to execute and complete the mission in the short term and to evolve and build new capabilities for the long term. + +Answer_15: + + Yes. Look, I think it's not just a U.S. trend. You can look at Japan where arguably, beverage diversity is even greater than the U.S. But I think the central point is the following. If you look back over time and you look at what is the behavior of teens and young adults of each generation as it comes through, there's one key fact: each generation consumes and, importantly, buys more commercial beverages than the previous one. The second important fact is they do so across a greater variety of drinks. It's not that they buy more commercial beverages and drink ever-increasing amounts of the same thing. They go for diversity. +Therefore, you can see around the world that those places which have the highest amounts of disposable income, each generation is coming along and looking for that diversity. That's true in the U.S. It's true in Japan. It's true in other developed markets and other wealthy parts of even emerging markets. And so the learnings that are available are actually not just one-directional. They are actually from many different places across the world. +We've got to find ways to take new learnings from the U.S., from other parts, Japan, from Europe, from Australia and finding the best of the best and allowing ourselves to fuel the diversity of the portfolio yet understanding that, in the end, what grows are the global brands. I mean, the world, over the last number of years, has been typified, at least in beverages, by outsized growth by global brands and the entry of lots of new smaller brands. The bit in the middle was tougher. +So you either have to -- so you have to keep fueling the machine by having innovation and testing the frontier of variety yet, over time, graduating those to large-scale consumer franchises, not necessarily single-flavor franchises but consumer franchises. + +Answer_16: + + Yes. + + + Yes. + +Answer_17: + + No, that's the wrong conclusion, Andrew. The simple answer is that the regulatory process in South Africa is not time regulated. And the fact is we got regulatory clearance in the last month or so, and that then led us to closing. And now we will proceed to work with our -- the prospective partners that are interested, and there's substantive interest. And when we say 2018, that's because it includes regulatory and closing approval. So that's the simple answer. +So I think that's it. That's time, ladies and gentlemen. Thank you for joining in. To conclude, I think we delivered a solid quarter. We're on track to close out a successful year. And as always, we thank you for your interest, your investment in our company and for joining us. And again, we look forward to sharing with you more during our Investor Day on November 16. Thank you. + diff --git a/exam/original-files/Problem_2_3_Sample_QandA/40_questions.txt b/exam/original-files/Problem_2_3_Sample_QandA/40_questions.txt new file mode 100644 index 0000000..78dae50 --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_QandA/40_questions.txt @@ -0,0 +1,70 @@ +Question_1: + + So my question was really around North American pricing long term. Obviously, there's been a lot of concern in general over the pricing environment in the U.S., not just in beverages but across the CPG industry, with brick-and-mortar retailer struggles and theoretically pushback as they look for lower pricing to differentiate themselves or just the margin grab versus CPG suppliers. So I was hoping, in that context, you could give us a review on if Coke's increased focus on pricing in the U.S. over the last few years, is that pressured at all longer term by these retailer dynamics? How do you manage through that? What are you hearing from your customers? And also, just given the new leadership in North America as well as the bottler refranchisement, how does that play into that pricing focus longer term? And how do those changes impact that? + +Question_2: + + James, what might be some of the green shoots of performance lift that you're seeing in the North American territories that were first refranchised? + +Question_3: + + James, a quick question on Coke Zero Sugar. When you think about the launch in the markets that you have and also the early data points from the U.S., how much interaction is there with Coke Classic? And if you could just give us some context on kind of overlapping cannibalization rates. + +Question_4: + + Wanted to get an update on the progress from a productivity perspective, so the $3.8 billion that you'd mentioned last time. Where are we on reinvestment phase versus dropping to the bottom line phase? And essentially, coming to brass tacks, how much in billions of dollars should we expect to drop to the bottom line? And then if you want to be generous and answer a second question, a lower-priority question, but can you talk about the Topo Chico brand positioning versus a LaCroix, for example, in the marketplace? Please choose the first one if you're going to choose one. + +Question_5: + + My question is about e-commerce. I mean, your competitor in the last earnings laid down the size of the opportunity for -- of e-commerce and the way they were investing ahead of the curve in people and big data, saying that they had a larger market share in e-commerce than elsewhere. Could you please tell us, I mean, how you are doing as to that channel, your objectives and how you plan to get there? + +Question_6: + + I have a question about Latin America. And James, if you could just maybe give us a little bit of an update on -- it's been a drag to organic sales growth in unit case volume or I guess you'd say it's been a drag on unit case volume. A lot of that is Brazil, Venezuela, I guess, the Central America business unit as well. +Can you kind of give us a description of, a, how far away from -- are we from maybe the environment bottoming; second, maybe just some of the actions that Coke has taken to sort of adjust to the environment? Just trying to get a sense of how far away we are from being at a -- maybe a clean base where you can start to grow again. + +Question_7: + + James, can you give us your perspective around your performance in some of the non-sparkling category clusters? If you look at the quarter, I think the growth actually softened across all of your segments there. Why do you think we aren't really seeing stronger growth, setting aside what you're doing in China? And then I think you talked about maybe increasing investment behind some of your bigger brands. So -- and then maybe you can elaborate on your strategy in the investment, whether that will be funded by shifting investment from sparkling to these brands or the total portfolio you're really looking to further increase investments. + +Question_8: + + Just wanted to ask a bit about, in North America, to stick with the conversation around price/mix, so it just jumped out at me that sparkling price/mix is up 3%, but total for North America was 2%. So what was the drag there? Was it price? Was it mix? Was it category performance? And then in particular, if the answer, since I get one question, is that it was something in water and particularly with smartwater, are there plans in place for reaccelerating that business? + +Question_9: + + So James, just sticking with the topic of North America, but my question relates to your expectations with respect to competitive activity. And I guess I ask you in the context that your key competitor had probably one of the most difficult quarters they've had in a long time in North America beverages, and they've discussed ramping investment in key categories to address some of these market share losses, which will include carbonated soft drinks and sports drinks. +So can you talk about -- you've talked a lot about your strategy, which has been helpful. Can you talk about your expectations with respect to competitive -- the competitive environment in the near to intermediate term and your ability to flex up spending to respond, if necessary, within your guidance? + +Question_10: + + James, if you can expand on the comment about better execution of the refranchised bottlers in North America. And how -- so how was the performance gap of the refranchised territories against BIG in terms of volumes and pricing and as it relates to better execution at the trade? Or would you say the [flat 50] volumes, I guess, negative before has been mostly driven by innovation by Coke Zero Sugar, smaller packs? So basically, I wanted to ask you if the 3% is coming -- performance that you had is coming from better execution or just better mix. + +Question_11: + + Question on reinvestment. And when the company started the program of savings and reinvestment, emerging markets returning negative or, in some cases, were already negative, they probably didn't get as much investment as they otherwise would have. As we're seeing some signs of emerging markets improving, is it safe to assume that we'll see investments accelerate there? And then can you just expand on what you've learned from the activity you've undertaken in developed markets and then, finally, where those funds, if my assumption that increased investment is coming, will come from? + +Question_12: + + My one question, James, is refranchising related and how much runway you think you face for sustained improvement in price/mix in Western Europe where you're a little more into the exercise of refranchising and also China and Africa where refranchising has begun or will soon begin. Simply, the price/mix opportunity in front of you in those markets. + +Question_13: + + James, can you just talk a little bit more about Mexico? I think you alluded both to the weather, and then you did a little bit of a slowdown in the category. Any way to quantify what the hurricanes or anything had impact on the quarter and then if there's any lingering impact? And then -- and just kind of touching on the slowdown you said for the quarter. + +Question_14: + + James, talking about the leadership change in CCR, can you talk about what Jim Dinkins' key priorities would be? And then as this leadership transition happens here, do you see that as an opportunity to maybe reorient the organization to develop new muscles as you transition the portfolio? + +Question_15: + + Great. James, in the beginning, you talked about increasing desire of consumers for variety that'll help drive innovation and many new brands, new competitors. I think that's mostly a comment about the U.S., but I'm wondering if you could take that comment and those trends and talk about how that is playing out in the rest of the world and whether that is something that, if you've seen it sort of first in the U.S., you can kind of get ahead of it and take advantage of perhaps learnings in the U.S. to perhaps capture more of those opportunities in other countries. + +Question_16: + + Oh, yes. Can you hear me? + +Question_17: + + Okay, sorry. I'll try again. Yes. So just related to CCBA, you're saying that you're now expecting completion in 2018. I'm pretty sure that this time last year, you were expecting it in the second half of 2017. I'm just wondering what on earth is taking so long, mindful that, for example, Coke Icecek dropped out of that process, I think, as long ago as March. Are we left concluding that the business that is up for sale is not in a state where anybody wants to buy it? + diff --git a/exam/original-files/Problem_2_3_Sample_QandA/41_answers.txt b/exam/original-files/Problem_2_3_Sample_QandA/41_answers.txt new file mode 100644 index 0000000..6c40dc4 --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_QandA/41_answers.txt @@ -0,0 +1,77 @@ +Answer_1: + + Obviously, this year -- 2013 will be peak capital investment in Canada, about $1.5 billion. Next year, going forward, CapEx -- for the US, we'd expect something similar, perhaps growing a little bit, to $2.5 billion, something in that range; Canada dropping to somewhere -- still opening a fair number of stores -- $0.5 billion, perhaps a bit more than that. So we would expect free cash flow to expand, especially in light of Canada operations becoming accretive. As far as what we would intend to do with that, we said first, by 2017, assuming we get to $8.00 a share, we'd expect the dividend to be at $3.00 a share or more. So we'd expect to continue to increase the dividend at a rate approximately 20% on a compound basis over the next several years. And with the constraint of living within our current strong investment grade credit ratings, we'd expect to deploy the remainder of our excess cash flow as share repurchase. + +Answer_2: + + Yes. I think that's right, Mark. When we look back on where we're at right now with Canada, we feel really good about where we're at and our projections for returns in Canada. If we look back a year ago, or even two years ago when we signed the deal, the projected EBITDA for this quarter -- for this year, excuse me, is essentially right on where we thought it would be. The dilution is a bit higher even than we expected, perhaps a year ago; and all of that is attributable to independent capital investment decisions we've made, whether that's investing in three distribution centers to build them and own them ourselves, or the 40 store expansions that I mentioned that we worked through over the past year. So most of the increase, from our vantage point, is attributable to incremental depreciation and amortization. And of course, those capital investments were separate economic decisions and we expect to see economic benefit to that P&L through time. But the sequencing is that the depreciation and amortization shows up first. + +Answer_3: + + Yes. The property development team did an outstanding job working with some very good partners, our landlords in Canada. And the vast majority of the percent rent clauses, which of course never impacted Zellers, have been negotiated away. Percent rent is not a meaningful issue for us going forward. + +Answer_4: + + I think what I would say, Greg, is right now as we look at the retail business and model that, we've always modeled that independently of the Credit business, given the different leverage characteristics, as you noted. We think the Retail business right now is probably pretty close to the top end. There may be a little bit of room. But we think it's near about where the leverage which will support our current credit rating is at. + +Answer_5: + + Correct. For 2013, that's correct. + +Answer_6: + + Sure. The increase in REDcard sales is a mix of both, Greg. Certainly, the new accounts are creating a significant amount of that lift, with the amount of accounts. And you can see the increased penetration resulting from new accounts. But we have also seen an increase in lift, particularly over the first several quarters that the REDcard was out, in existing accounts. +The other thing I would mention, the big driver here of the increase in sales, as has been the case, the big driver in increase in the whole program, has been the debit card. And I think from our assumptions, perhaps two or three years ago when we were talking to you to you to now, the debit card is the one that has really surprised us. The credit card has probably grown pretty much with what we thought. But the debit card -- we're doing three accounts to one debit to credit now. And that has been the one -- the product that has been incredibly attractive to consumers who just don't want another credit card. And that's really what has driven the significant increase in our REDcard sales. + + + The other thing that I would add, Greg, is all of our guest segments love the REDcard somewhat equally, whether you are a VIP, which we would say somebody that visits us a lot and spends a lot, all the way through our enthusiast convenience users least engaged. All of those segments, once they get the REDcard, move toward visiting Target more often and spending more. So this is not just isolated in one group of demographics. It's very well dispersed and balanced. And we think that's a very positive attribute that, that many guest segments love the REDcard. + +Answer_7: + + The actual assumption for the US business was about a 3% comp through time. And some years will be a little bit above that, some years a little bit below that. But we think 3% comp is about the right level for our business. If you look back at our business over a really, really long period of time, back when we were running 5% comps, a couple hundred basis points of that were coming from new stores as they annualized, and we would ran about a 3% comp in our base business. And over the last couple of years, since 2010 -- last year a little bit lower, 2011 right on. We feel like that's the right neighborhood for where we can run the business. + +Answer_8: + + Well, typically in the US, we open stores in three cycles. Due to the number of stores we have in Canada, we're taking an approach that we're going to open five cycles this year. So think April, May, and every couple of months beyond that, we're going to open somewhere between 20 and 28 stores a cycle. We haven't defined all of that yet. But we're going to start in the greater Toronto area. Then we're going to move to Western Canada. Then we'll densify. Then we'll go East, and then we'll densify again. So we've got a good plan that is centered around our supply chain investments and the readiness of our distribute centers, and we just think it makes sense to spread out those kinds of openings over more cycles than we typically would do in the US. + + + Your other question was -- + +Answer_9: + + No. We're not holding back at all. We're not capital constrained, and we're pursuing every project that we can find that's going to generate the right kind of returns. So I would tell you that the real estate -- commercial real estate market is pretty much status quo and hasn't changed all that much over the last couple of years. There are pockets of opportunities, and we're anxious to either co-develop or develop on our own or be a partner in any development where we believe that it's the right demographics and we can generate the right kind of returns. So we're not holding back at all, it's just the environment is still a little cautious and a lot slower than we'd like it to be. And hopefully, things will change over the next couple of years. + + + Thank you. + +Answer_10: + + The revenue number, I would tell you, continues to move around even here, for the reasons Gregg just outlined. We continue to -- the store opening schedules continue to move around. We've only really set in place in concrete the first two. The rest of them, still moving around a little bit. So we're hesitant to provide pretty specific guidance. But what I would tell you is, the expectation is that these stores will open and grow and have a very similar annualization process to what we see in the US. So I think that's probably the most important assumption, and then the revenue will move around based on what stores we get open when. + +Answer_11: + + I think you hit on it. It'll be a little bit longer. We're not talking about five years or anything like that. But 2.5, three years, something like that, our current modeling would say, we'll get it back in, something like that. So a bit more than two years. + +Answer_12: + + Bob, I would say that we actually think we performed quite well on Black Friday. We saw the barbell intensify, as Gregg mentioned, between those early sales in Black Friday and then the lull and then coming back strong at the end of the holiday. For us, it was more about pretty weak seasonal businesses. The weather, as you know, was warm. And our seasonal businesses, which normally kick in, in early November, didn't. And then, with all of the, we think, economic turmoil and the elections and fiscal cliff and all of that, that it created that lull in between Black Friday and Christmas. So we've talked about planning conservatively for this past year, and we will again for next year, for the fourth quarter. And we think that the opportunity to pick up sales are really the other three quarters. And in particular, the second and third quarter this year. +We continue to manage our business. Our goal is to maintain or grow gross margins within categories. As you know, it was a very competitive year this year. And what we dropped was mainly reflecting the ongoing impact of 5% Rewards and PFresh, combined with a little higher clearance in some of our seasonal categories. But all in all, I think the team did a great job of managing our inventory. We did come out very clean. Our inventory headed into the first quarter was exactly where it was last year, on a per store basis. So we feel great about that. + + + The other thing I would add is, you have to take a look at the mix of our business, too. And there was industry softness in Electronics and Toys, which are really important to us. There was not any must-have, really super-hot new products that really drove consumers into the stores. And as others have reported, the Toy business was a little softer than expected. And same was true in Electronics, as we were post-peak in terms of the digital cycles and video game business, in particular, were softer. And that's a huge business for us. +So just the cyclical nature of some of these businesses, in addition to what Kathee said, cause comps to be a little bit softer than we expected. But we are not bashful about being hyper-competitve, and we want to be really super competitive every year as we head into the holiday season. But we also want to have a balanced approach in making sure that it's not all about market share. We want to gain market share, but do so profitably, and trying to find that right mix. And that's the approach we'll continue to take. Okay? + + + Thanks, Bob. We have time for one more question. + +Answer_13: + + We're competitive day in and day out. We have always maintained the position that we're going to be competitive in the marketplace. And so it's a position that we've taken. And as we continue to learn more and as more business migrates to the online channels, we're going to continue to sharpen up our online prices in that channel, as well, and be competitive with those competitors that are most meaningful in that channel. So there will be some sharpening up there; but I would tell you, we offer fantastic value, day in and day out. Our pricing strategy has not changed. And as we look across the competitive landscape, we're very, very well-positioned. + +Answer_14: + + Sure. The biggest impact is the impact of share repurchase, as that levers against growing profits, is the short story on that, Dan. And we're happy to spend a little bit more time with you, if you'd like, discussing that. But that's the short story. + + + Okay. Well, thank you very much. That concludes Target's fourth quarter 2012 earnings conference call. Thank you all for your participation. + diff --git a/exam/original-files/Problem_2_3_Sample_QandA/41_questions.txt b/exam/original-files/Problem_2_3_Sample_QandA/41_questions.txt new file mode 100644 index 0000000..a1b7a17 --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_QandA/41_questions.txt @@ -0,0 +1,57 @@ +Question_1: + + Could you give us a little outlook on what free cash flow is going to look like once Canada is over, on the $1.5 billion of spend, and where do you expect to deploy that? Is it going to be tilted more towards share repurchase, or how do you look at that? + +Question_2: + + Okay. Can you give us a little more color on the Canada dilution of $0.45? I think that's bigger than a lot of people were expecting, and it sounds like a lot of it's related to the capital spending decisions. If you could walk us through that a little bit? + +Question_3: + + Okay. And also, talk about the percent rent clauses in Canada. I know you got out of some of those. + +Question_4: + + I have a couple questions. First, John, on the leverage. Once Credit's gone, we get your debt to EBITDA around 1.7, 1.8. Could you put some context into how high you think that can or should go, given everything in terms of being great credit rating, as you take the dividend out? Should we model 2 as a cap, or how should we think of that? + +Question_5: + + Got it. So the incremental buy back is really the equity from the Credit business? Plus -- + +Question_6: + + And then secondly, maybe a bigger question for Kathee or Gregg, the REDcard growth compared to, say, three years ago has, I think, beaten all of our expectations, certainly mine. It looks like last year it was up over 50%. Could you help us understand a little bit more about that 50% growth in REDcard sales? How much of it is from new REDcard members? How much of it is existing members spending more? Anything you can provide there would be helpful. + +Question_7: + + Maybe just first, John, a clarification question on the $8.00 in EPS for 2017. I think before that was predicated on a 2% or more US annual US store growth. Do you still think that, that's the appropriate number to get to that $7.20 from the US business? + +Question_8: + + Okay. And also on the guidance for this year and thinking about the modeling, sounds like you're opening up a few more waves in Canada than your normal store opening cadence. Just from a modeling perspective, how should we think about some of those store openings this year? And then as a follow-up to the US, how does the real estate development market feel to you guys out there? + +Question_9: + + How does the US real estate development market feel in the US? Does it feel like it's loosening up a little bit, maybe a few more opportunities, or still you guys are holding back a little bit at this point and looking to be a little bit more prudent in the growth? + +Question_10: + + First question, John, can you give us a sense of what the revenue assumption is that's based into that $0.45 Canada dilution number for this year? + +Question_11: + + Okay. Sure. That's fair enough. +And then, I think in the past you guys have said that you'd expect to recapture the Canadian losses that you accrue within two years of turning profitable. So if you sum up the last three years -- well, the last two years plus this year -- it's a little over $1, maybe $1.10. Do you still expect to get that back in earnings from Canada in '14 and '15, or is the D&A going to make that a longer process? + +Question_12: + + Just have a question on the fourth quarter in general. Over the past few years, you guys have really made a nice trade-off between profitability and comps. And this year, it seemed to break down a little bit more than usual, where you've made a decision not to be a Black Friday door buster competitor, but the gross margins were down 60 basis points or so. Can you talk a little bit about what you learned from the traffic being down and gross margins being down, and how you might attack it differently in the fourth quarter this year? + +Question_13: + + On a similar topic of competition, you obviously introduced the Price Match guarantee. It's a step in the right direction. But given that, that's such a very low portion of the total transactions, do you think you need to do more on just everyday price and staying more competitive than perhaps you even are today? + +Question_14: + + Okay. Just one more, if I could. Can you just walk us through the path to $0.10 dilution getting to neutral over a few years, what causes that to happen on the Credit Card sale? + diff --git a/exam/original-files/Problem_2_3_Sample_QandA/42_answers.txt b/exam/original-files/Problem_2_3_Sample_QandA/42_answers.txt new file mode 100644 index 0000000..c11a0ba --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_QandA/42_answers.txt @@ -0,0 +1,138 @@ +Answer_1: + + The rate impact of the REDcard, Peter? + + + Yes, the combination of that with the store Remodel program, very consistent with what we've seen over the past several quarters, somewhere between 25 to 30 basis points of impact. + +Answer_2: + + Yes, I think your view of Q4 is right. I think in particular, this Q4 will be particularly difficult, given the fifty-third week and the way the calendar shifts this year, you'll recall we're going to lose six business days between Thanksgiving and Christmas this year, which will make the comp feel much more difficult than it otherwise might. I think over the longer term, we continue to think a 3% comp is about the right place to be. If you look, again, at our Company over 15 years or 20 years, if you net out the contribution of new-store annualization, we essentially ran a pretty consistently a 3% comp over time through good times and tougher times. So we think in an economic environment that might just be a little bit better than today, doesn't have to improve drastically but a little better than today, we think a 3% comp makes sense. + +Answer_3: + + I think you'll continue to see D&A grow throughout this year as we continue to put significant assets into service. And we'll provide a little bit more color, I think, as we get later into the year and have a little bit more clarity about sales margin and the entire P&L, we'll provide a little more clarity about the entire P&L for Canada. + +Answer_4: + + Actually, Sean, I'm not quite clear on your question. Units per transaction in the first quarter were up year over year. Help me with that again. + +Answer_5: + + No, selling price per unit was down 60 basis points. + + + That was mix related. + + + Right. Entirely mix. But units were up consistently for some of the reasons you described. + +Answer_6: + + Both the stores with the matching of competitors' physical ads and the online match has been fairly stable and has not grown materially over the last quarter. So it still represents a very small portion of our transaction. That's because our everyday price and our promotional prices are so strong, there is generally not much of a gap, if any. So we continue to watch our competitive prices on a day-in and day-out basis and move where we have to be competitive in the marketplace. And so we expect over time this not to change all that much. + +Answer_7: + + Yes, I think first I'd start with how we think about this longer term. And we think about, from a longer term perspective, sales through all of our channels, regardless of the channel, need to generate a return, and a return on investment that's similar to what we see in our current US store base. What we see today is, honestly, we're learning a lot about that channel and a lot of this depends on how we're going to ultimately settle on the supply chain that our guest wants to interact with us. How much is ship from store, how much is ship to store. That will have a significant impact ultimately on the EBITDA margin rates of that particular channel. But I think once again, depending on where those EBITDA margin rates land, sales or capital will move around and we feel very confident that we'll get back to a return that makes sense. Having said all that, I think as it relates to the rates embedded within that channel, we feel very comfortable that ultimately we'll get back and operate at that 10% EBITDA rate that we've set as part of our long-range plan. + + + Thank you. + +Answer_8: + + You know, we did see better results in areas that had more normal weather, so that would primarily be the West Coast and they were toughest in those seasonal categories where we saw weather off the most, and that would be primarily in the Midwest. So we did see quite a swing between the different geographies. + +Answer_9: + + Yes, like we said, the teams did a very good job of responding to the sale shortfall, retiming receipts and making cancellations. We're going to know a heck of a lot more in the next 30 days as we see what happens and how the sales of these categories play out before we have to take mark-downs in the 4th of July. And if we get really good weather and we have good sell-throughs, then we're going to be right back on plan. If things stay damp and cool for an extended period of time there might be some risk. We don't expect to see a significant risk, whatsoever. We're talking about things on the edges right now. + + + Matt, the other thing I'd add is it's a little bit hard to see with the inventory on the balance sheet. The inventory per store in the US is essentially flat to last year. All of the inventory build year over year is attributable to Canada. So we feel really good about where the inventory positions are in aggregate. + +Answer_10: + + Yes, you're right, first of all, that the vast majority of that is multi-channel technology and we've said a little bit of missed timing here. We expect to offset that on the year with expense savings and improvements we're making in our business, but the investment coming a little bit ahead of that. To your second point, I think that's absolutely right. It's interesting. We said this last year, when our sales accelerate or decelerate rapidly from our expectations, we tend to see our SG&A lag both directions. It doesn't climb as fast when sales go up like last year, and doesn't come down quite as quickly when we see sales decelerate. As we adapt to wherever sales are going to be, you'll see our SG&A settle in at a more appropriate level. + +Answer_11: + + Yes, I would say out of the blocks, 38% was a little higher than we expected because the mix was a little bit better than we expected out of the blocks. Whether it's in Canada or the US, clearly when we open a new store we get a higher gross margin rate, but the mix was even higher than the higher that we expected. So we do expect that to settle down and be slightly higher than what it is in the US, because we expect the mix to be a little bit better than it is here in the US. + +Answer_12: + + I wouldn't call it hoopla. I would just say that the guests were very, very excited and we experienced tremendous surges in sales. And it's just very, very early to draw any conclusions. And we really wanted to deliver a great experience and so to a certain extent we went in with staffing levels to make sure that we were taking care of the guest, both at the front end and we had the right team members there for the supply chain and we had the right teams on the sales floor. So we know that over time and in a run state in addition, we have to work hard at making sure that we get our productivity levels where the business models dictates them to be. And we know our gross margins will settle in and we've got to become more productive and run the business. Over time our consumables share will grow. +That's the hardest trip to change with the guest and so we're going to continue to focus on those frequency-oriented categories so that we can not only get the good mix that we're getting, but we want to now start driving more trip frequency into the store. We didn't want to come out of the blocks by hitting those categories too hard because we wanted to make sure that we led with our strength. And we wanted to make sure that all the supply chains and the operational disciplines were in place. We feel very confident now that they are. We're ready to start making those kinds of adjustments in merchandising and supply chain and in store operations to start refining the model. + +Answer_13: + + I use that sometimes here, too. (laughter) + +Answer_14: + + I think the one thing I'd remind you is, we only had a half a quarter's worth of profit sharing with TD. Next quarter we'll have a full quarter's worth of profit sharing with TD. + +Answer_15: + + No, no, no. That's net of our operating expenses as well. + +Answer_16: + + We can take it offline and walk through that in detail, Colin. + +Answer_17: + + Yes, no question. What we're seeing, I think we talked about this a little bit three or four or five weeks ago when we were together. You'll see the ramp-up in our expense initiatives throughout the year and through next year, actually. Many of them are a little bit longer lead times to pull out expense, all the easy stuff we've done long, long time ago. So we do expect through time, SG&A will come down and manage to a level that is more appropriate. + +Answer_18: + + I'll take the first part. I think the traffic -- this was a disappointing quarter for us. We had very, very strong traffic last year. There was pluses and minuses throughout 2012 and we expect traffic trends to get stronger as the year goes on. +And we have all of our initiatives designed to, not only deepen the relationship, but build frequency. So we'll perhaps be a little bit more aggressive on price. You have to look at the competitive environment, it was a little bit more aggressive than it had been in the past where there was more emphasis on price, and that, I think, impacted it a little bit. Overall, we really expect to be able to generate traffic levels that are flattish, give or take, over normalized periods of time. + + + Bob, the other thing I'd add, I don't think we need to run traffic numbers like we did last year in first quarter to generate that 3% comp. I think if you look over the past several years, about 0.5 points of traffic combined with ticket gets us to a 3% comp. That's about the formula that we feel really good about. + + + The only other thing that I would add is, this time of year our seasonal categories can be a big traffic driver for Target, and clearly they weren't in the quarter and they were last year. So all of the things you mentioned, 5%, PFresh, help us all year long but during key seasonal categories, key seasonal time frames, we need those categories to drive traffic as well. + +Answer_19: + + Our conversion has been improving over the past year, Deb, and we were up slightly in this quarter as well. So we're really pleased with the improvements that we've made on this site but I'll tell you, we still feel we have a long way to go with conversion. And we are very committed to continuing to work on our navigation and our search function and the basic functionality of our site to continue to make big improvements there. + + + I think the other thing I'd add, Deb, is we have a little bit of a mix headwind which is positive from our perspective. Mobile, in general has a much lower conversion rate than the site, and our mobile is growing much, much faster than the site. We think that's good because we think that's where things are going and it also shows that she is spending a lot of time with us on the mobile applications we have. But conversion's just naturally lower there, and so creates a little bit of a mix number as we look at the aggregate. + + + If you look at conversion on our site, it's up to last year. If you look at conversion on mobile, it's up to last year. But because of the big growth in mobile, to John's point, conversion comes down slightly in aggregate. + +Answer_20: + + I think we've said a couple times the Affordable Care Act, the changes for us will be relatively -- well, they won't be relatively -- they will not be material externally. We're still continuing to work through all the regulations and what we will exactly do, but it won't be material changes to what we're doing today, or financially from a financial perspective. + +Answer_21: + + We feel good about where we are. We've been working on this for a long time and we continue to deploy resources to get better and better at that. So this is just a long-term initiative that we have to continue to focus on, whether it's in Food, whether it's demographics, whether it is ethnic groups, we've just got to continue to get better at our localization efforts. We think we've made good progress there and we are going to continue to focus on it. + +Answer_22: + + I would just say, Deb, I think it's a little early to learn from Canada and bring that back to the US. I will tell you, though, we learned a lot from the City Targets that we applied to Canada. As you know, those stores are in dense urban areas and so are our Canada stores. We took a lot of that learning and the testing that we did last year and applied that to what we're doing in Canada. Throughout this year of course, we'll be reading the Canada results and bringing that back to the US. But the same teams work on localization for both countries. + + + Thank you. We have time for one more question. + +Answer_23: + + When we look at the stack comps, we feel a lot better about it, since you're just looking at this quarter, both were positive if we look on a stacked basis. Going forward, our compare in second quarter is not nearly as difficult as our first quarter, so we would expect our comps to improve and over time we want that two-year stack to improve. We're not happy with flat or up slightly. We want to make sure that we're making progress there. It was, on a two-year basis, better. + + + I think I'd just add a little color to that. Apparel, for instance, the two-year stack is around a 2%. Running that consistently through time, we'd feel really good about running 2%s in Apparel. As Kathee said, Home is positive. That's a big improvement from where Home has been over the past several years. On a two-year basis we feel good about both those businesses. + +Answer_24: + + Yes, you know, that's difficult to parce out. The example I would give you is exactly what Gregg said, where we started with the stores staffed very heavily. We know through time we have to refine that model, is that one-time expense or operating expense. Certainly the expenses related to hiring team members early and training them at the next cycle of stores we'll open up, that is all one-time and will drift away. What I'd tell you is, through time we expect ultimately well down the road to get to SG&A rates that make sense and productivities that are very similar to the US. So as I said before, as we get a little bit more clarity, right now expense dominates the P&L in Canada. And was we get more clarity on sales, margin, operations later in the year, we'll provide a lot more color about how we expect those stores to operate. + +Answer_25: + + This is something that we are always looking at and adjusting. But, I guess I would tell you I don't feel like we've gone too far. Our inventory as John mentioned, our average inventory per store is flat to last year. It's actually up a bit in Apparel given the softer sales in the first quarter. So we're always looking at that. We look as much at out-of-stocks as we do in-stocks, in trying to improve those stores. It's a constant focus for us and we can always improve, but I feel pretty good about where we are right now in terms of in-stock. + + + Okay. Thank you. That concludes Target's first quarter 2013 earnings conference call. Thank you all for your participation. + diff --git a/exam/original-files/Problem_2_3_Sample_QandA/42_questions.txt b/exam/original-files/Problem_2_3_Sample_QandA/42_questions.txt new file mode 100644 index 0000000..b1d1b8e --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_QandA/42_questions.txt @@ -0,0 +1,100 @@ +Question_1: + + Great. Thanks, guys. Just a couple questions. On the US gross margin performance, can you give us a sense of maybe what that REDcard impact was in the quarter? + +Question_2: + + Okay. That's helpful. And then a longer-term question. You said for the year you're now thinking 2% to 2.5%. I assume that's still has a pretty modest view for comping in the fourth quarter. A, is that correct? And then secondly, when you think out beyond, do you guys think that maybe 2% to 3% is the longer-term comp profile for the business? Or do you think it could still be north of 3%, when you think of a more normalized environment, on an annual basis? Thanks. + +Question_3: + + Okay, that's helpful. One last housekeeping. On the Canadian D&A, what do you think the run rate is for that, once you get out -- you've opened a bunch of the stores, once you get towards the end of the year, what kind of run rates were you thinking about for Canadian D&A? Thank you. + +Question_4: + + Thanks for taking the questions. In terms of dissecting the comp in Q1, transaction trends as you mentioned were relatively stable on a two-year basis and did improve from Q4. But the units per transaction were down 50 basis points, and I think that's the first time since '09. Just wondering what would explain that decline, given the increase in the Remodel program from Q1 last year. + +Question_5: + + Oh, I thought they were down 60 basis points. Maybe I'm missing something here. + +Question_6: + + Okay. Got it. And then, Gregg, you'd touched briefly on the price matching, curious if you are seeing the number of requests for the price match change at all. And has there been any competitive response to that in the marketplace? + +Question_7: + + Okay. Great. And then lastly on Digital, you're obviously seeing some nice traction, nice growth outside of the seasonal categories. Can you talk about the impact on margin for that sale today? Is it dilutive or is it accretive to the margin? What do you think that can -- how are you planning that over time? + +Question_8: + + Thanks for taking my questions. First, I'm wondering if you can comment on sales in geographic areas that have more neutral weather like Florida. Were the transactions and the comps positive in those markets? + +Question_9: + + In terms of the second-quarter guidance, do we assume that there's some incremental mark-down risk in seasonal categories? You did mention that within categories the rate improvement would be a little softer in the second quarter than the first quarter. So just wondering what the mark-down risk is in the seasonal categories. + +Question_10: + + That's very helpful. Lastly, if we look at your operating expenses in the US Retail segment, growth, dollar growth, accelerated a little bit versus last few quarters. I'm assuming a lot of that is technology investments. But given the more moderated view of comps for the full year, could we see the dollar growth potentially come back down a little bit? + +Question_11: + + Good morning, thank you. First question on Canada, understand that the gross margin rate of 38% is not the long run rate. But where do you think that settles out? And was the 38% above where you expected even adjusting for the mix that you saw? + +Question_12: + + Of course. As the consumables business ramps up it mixes down. From a productivity perspective, can you tell anything yet on these first stores that are open, in terms of opening expectations relative to what you had thought? Or was it just too much hoopla that you can't discern anything yet? + +Question_13: + + Okay, that's helpful. By the way, hoopla's a technical term we use here on Wall Street. (laughter) + +Question_14: + + Secondly, on the credit, I actually thought the contribution, $105 million, while you explained it was low, seemed to me it was higher than I would have expected, especially given the bad debt reserve release last year. Is there anything there that reflects the $105 million profit share? + +Question_15: + + So the $105 million was really a $210 million quarterly run rate? + +Question_16: + + All right. I'll follow up offline with you on that, John. + +Question_17: + + Finally, coming back to SG&A, the dollars were up I think $233 million. If I ex-out the credit difference of $36 million, the vendor allowance of $13 million, the technology spend, it still looks like the growth was pretty healthy. John, I know you mentioned that there's a lag in terms of how quickly you can get after that if sales are disappointing. Would you also expect some of the expense things you're doing on a longer term basis to impact that? I guess my question is, can we see better performance out of that line? Because sounds like 2Q guidance doesn't get us there. + +Question_18: + + I guess the question that I have for you is a two-fold. It revolves around traffic. When you look at the initiatives that you have in place, REDcard and PFresh and you consider -- I understand the seasonal piece Q1 this year versus last year. But when you think conceptually traffic was down in the fourth quarter and that was down again in the first quarter, how do you get us comfortable with, essentially, the efficiency and the effectiveness of these initiatives over the longer-term period? The second question that I have is when you -- the lower comp assumption for this year, can you maybe just break down the traffic component in that new 2% to 2.5% expectation? + +Question_19: + + Thank you so much. Appreciate all the color. Lot of conversation regarding mobile and digital traffic. Can you also talk about what conversion was like during the quarter? + +Question_20: + + All right. Then a broader question. Can you talk about how you're positioning yourself in terms of taking advantage of the Affordable Care Act? + +Question_21: + + Okay. And then I think Gregg touched on segmentation, how you're looking to match local taste and preferences. Where are you? I know there was a lot of work done in Canada, but where are you domestically in terms of that? + +Question_22: + + Was there anything that you learned from Canada that you could go back and apply to the US? Or is it exactly what you expected and you're just continuing on the path? + +Question_23: + + Good morning. Couple questions. First on the top line, in the Home and Apparel categories can you talk about the stacked comps that you had in the first quarter? And broadly how that has trended, those categories have trended over time, the past few quarters? + +Question_24: + + That's great. Also, thinking about the EPS pressure from Canada, can you talk about how much of the expenses in the first quarter are one-time in nature, pre-opens and so forth? And as you think about the guide for the second quarter, a similar question, how much of that expense pressure is actually something that goes away in future quarters? + +Question_25: + + And then one final one. In terms of being in the stores, it seems like at times you're actually too thin on inventory in some of the discretionary categories, whether that's Home or Apparel. What's the internal discussion around balancing rate versus balancing sales? And do you think that you've leaned too far towards the rate side? Thanks. + diff --git a/exam/original-files/Problem_2_3_Sample_QandA/43_answers.txt b/exam/original-files/Problem_2_3_Sample_QandA/43_answers.txt new file mode 100644 index 0000000..584e4c7 --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_QandA/43_answers.txt @@ -0,0 +1,77 @@ +Answer_1: + + I think on the sequentially, yes it improved month to month within the quarter. None of the quarters were negative, which compared to first quarter was significant progress. July was notably the strongest, but a portion of that certainly was attributable to that back-to-school week moving in from August last year. So we did see it strengthening, but I wouldn't want to overplay that, certainly a portion of it is attributable to the calendar. Geography wise, we have not seen anything meaningfully different in aggregate across the quarter. In any one week or day there's differences, depending on when back-to-school starts in various portions of the country, but nothing meaningful across the country. + +Answer_2: + + Well I would say, this is Gregg, in the US, we continue to offer hot pricing. There isn't going to be a meaningful change in our strategy, because day in and day out we have unbeatable prices when you take a look at our -- the fact that our prices are competitive, the price match policy both online and in store, and our REDcards performance day in and day out. We have a very strong value proposition. And then our circular pricing is even more aggressive than that, and we take market leading positions. +In Canada, we know that we have an opportunity to break those shopping habits and we've got to focus on driving need-based trips. So, there in particular we will sharpen up our pricing, and make sure that we are taking a more of a market leader position. Our REDcard penetration is still very, very small there, and we expect that to grow over time. But it's more in Canada that we're going to make sure that our prices get more noticed than they have been up to this point. +Part of that was a conscience plan on our part to make sure that we really won in Home and Apparel, and we feel real good about where we are in those two businesses today, so we're proud of that fact. Now we have to just turn on the gas a little bit on the other side of the equation to make sure that we're getting the Canadian guests to understand what great values we offer on frequency categories and break some of those well-established habits. + +Answer_3: + + So, I'm not entirely clear where you're going. Is it that why are we confident about the $0.80, or what will we see happen here as we go forward, Sean? + +Answer_4: + + So on 2014, I think it's very early here, and we've given you our best view. I think when you step back we've been operating 60 some stores for on average about 2.5 months, and so we're giving you our best information here for 2013. And clearly sales are a little bit short of where we need to work through some of the inventory and optimizing the business and optimizing our expense structure. +I think as we look forward getting another 56 stores open, getting through a holiday will certainly provide a lot more information about where we expect to be. But in 2014, I think we expect to see meaningful improvement in the profitability of Canada. We'll cycle past all of the start up expenses, we'll have our inventories more in line with sales patterns that we now have some information on. Our expense structure will be optimized to the sales level and we'll start to grow sales. So I think we'll see meaningful improvement in 2014, but I would say probably from this perspective today, unlikely that we'll see profitability on the full year. And we'll be back to provide a little bit more information on what that looks like, and the cadence throughout the quarters, again, as we get a little bit more information this year, get the stores open, get new markets and get through a holiday season most importantly. + +Answer_5: + + Yes, I think parsing that all out is difficult. I would say that the second one, incremental marketing and advertising is not material to the total move from where we were to where we are today. I think the biggest driver of the change in profitability or dilution this year comes from, we had a set of sales expectations as we entered in the market, and we also, given all of the excitement that we saw building over two years, we protected on the upside from an expense standpoint and from an inventory standpoint, and the sales have been somewhat disappointing. And so we need to work through those inventories. There's some clearance activity, there was some excess inventory this quarter, as well, that we work through. And we need to right size the entire expense structure for what -- for the sales numbers that are currently -- that we're operating at. So, I think that's the vast majority of it. +I don't think we see, I know we don't see going forward a change in the overall our view of what the margin rates were going to be, EBITDA or EBIT rates were going to be in Canada over the long term. We feel very good about gross margin, and frankly, we expect gross margin will deteriorate a little bit as we begin to drive these frequency categories. You don't see that in this quarters' results, because there was a fair bit of clearance and excess inventory that we moved through, but we expect margin rates will come down as we grow sales in those frequency categories. But net, net that'll be good for the business and start to apply leverage against the fixed expenses that we've built for the Business. + +Answer_6: + + You're right, Greg. Traffic was our issue, and I do think that somewhat that is the way it is right now. We're seeing a lot of trip consolidation across all guests. I think the part that I'm pleased about is that when you look at our basket, we are seeing that they're buying more units from Target, as well as increased selling price, and they are trading up into higher price point product, so that's great. I think as we move forward the thing that we're focused on and driving traffic is really making sure that as they're consolidating and they're doing more in one store, that we're offering that compelling value. And Gregg talked a lot about all of those components, but that we make sure that that continues to be rock solid. As well as the innovative product, and I mentioned a lot of those that we have coming like Phillip and Haggar and in our seasonal categories we've got a lot of new stuff coming, so that's key. +And then, I guess, the third thing that I would add is just making sure that our in-store experience remains outstanding. Because we want them to be pleased when they come, and continue to consolidate their trip and to do more at Target. So we have great service every day, but in addition to that, some of the new things that we're doing with flexible fulfillment, like buy online, pick up in store, I think will be fantastic in the back half. And then we're also looking at really upping the in-store experience in key categories like Beauty and the test that I described in Baby. So it's a combination of those three things. + +Answer_7: + + The inventory overhang is a function of the shortfall primarily in some of the seasonal categories. So, think of -- even though Apparel and Home was strong, the variability by store, and the fact that some of our seasonal categories, like Lawn and Patio didn't perform at the level that we were expecting. So, it was not in the basic categories or the non-discretionaries, primarily in a subset of the discretionary categories. But it's one of those things where it's more obvious, because it's such a large number of stores. +But it's the same kind of fine tuning that we go through every time we open a new store here in the United States, and they have experienced for years and years. There is always a tremendous amount of fine tuning and getting the right match of sales volatility, variability, assortment, and aligning that with inventory. What we're seeing in Canada is there's such a big critical mass that it stands out, and it's far more obvious. But it's no different than what we've experienced here. + +Answer_8: + + Yes, I think that we're seeing larger basket in many different areas they're shopping, as I said doing more in one store so shopping around the store. In terms of the selling price, we're seeing strength in trading up to higher price points in back-to-school. We're seeing strength, for example, in home with threshold, where they're buying that better product versus opening price point product. And then we're also seeing some softer sales in our one spot at the front of the store, which is very seasonal and impulsive product, so that combination I think is driving that selling price. + +Answer_9: + + Well we don't have a number that we can share on that. We have, as you know, been testing it with team members, and I think the key for us is just the convenience for guests to be able to buy it online. But then they want to pick it up in store. Sometimes they don't want it delivered and sitting on their doorstep, but oftentimes they want to be able to get other things in the store either that go along with that core item or just the rest of their list. So, we think it will be very interesting to our guests. It certainly has been with our team members, but we haven't quantified the sales number yet. + + + Yes, I would just say this is -- we're in a learning environment right now. We'll be able to give you a lot more specifics after we get through the holiday season. And for us to try and quantify at this stage would be, it would be a shot in the dark. So we really don't want to speculate how our guests are going to use that and -- but we'll be back to you at the end of the holiday and we'll give you a lot more color around the adoption, the acceptance rates by our guest. + +Answer_10: + + There is not really a meaningful difference in terms of the rate of spend first half, second half. We didn't overspend or under spend in the first half to shift dollars to the second half. We've always felt that the allocation of resources by quarter, by half has been pretty appropriate, and our spend is going to be similar in those kinds of percentages. What we have seen is, we've ramped up our spend in the digital channel. It's a less expensive channel that gives us different guests and broader reach, and we become far more efficient in the use of our marketing dollars. So, I think we're getting the same or more bang for our buck for essentially the same investments that we've made in the past. + +Answer_11: + + Yes, we're excited to have Metro as partner to run our pharmacies in the Quebecian Province in the eastern part of Canada. We think they are a great partner. They run a terrific business, and we're thrilled to have them as our partner. + +Answer_12: + + We're doing a lot with both e-mail and text. But I would tell you, Deb that we're in the beginning of that journey. We think there's a lot more that we can do, but we're doing things with personalization in terms of seasonal and timing, but also product categories that resonate with our guests and we're seeing great results. We've upped particularly e-mail a lot this year, and it's really paying off. And so we're on a journey, and we think that there's a lot of head room there, and we will go after that in a big way. + +Answer_13: + + I don't think that we'll be adding a lot of planogram versions. I think we're still tweaking what's on those planograms. But we've -- we understand that, and we've got many different versions throughout Canada for all of their differences across geography and their guests. But I think what Gregg was talking about was, number one, getting the buy right by store in all of those categories, and then some of the seasonal categories were softer. So making sure that we get that buy right going forward, that has less to do with the planogram itself. And then in addition to that, as we're driving more trips with our frequency categories, that's the side that's been weaker, we think that traffic will also help sales throughout the store, because the guests clearly likes our differentiated merchandise on the Apparel and Home side. So it's a combination, but it's more about the buy than it is about planograms. + + + The other thing I'd add, Jason, if you step back to where we were three months ago the gross margin rate was a little bit above 38%. And the two things we said at that time, I think, are still appropriate. One, it's going to be noisy here early by quarter because it's just naturally that way as we're opening up stores. But two, don't expect us to operate at that high a level. While the mix was very favorable, we hadn't gone through any seasonal clearance. And so seasonal clearance is going to naturally bring that rate down. +This quarter a little bit more than we would have expected, but there again I said we're working through some excess inventory given our sales levels. So we expect through time that the gross margin rate will normalize at a reasonable level that ultimately will allow us to deliver EBITDA margin rates let's say 12% in Canada like we've talked about all along. + +Answer_14: + + I would think of it as this way. In our Business in any point in time there are investments that we have to make to continue to get better at what we do, whether it's a service or supply chain or technology investment or investments in the guest experience. And so this is -- we're calling attention to this. But these are investments that we're going to make in the business because we want to provide a great experience, which means our expense optimization efforts, as they have in the past, have to more than offset these kinds of investments. +So, we look at it all-in holistically and we're saying hey we got to get leaner and meaner in certain parts of the organization, and become more efficient, and we demonstrated that last quarter. We were very, very rock solid in our expense and our productivity and that affords us the ability to -- and the capacity to get more aggressive and do some of these kinds of things, and invest in transforming the Business to the future. + +Answer_15: + + Jason, we said at the beginning of the year the investments in multi-channel and everything we were doing would be $0.20 to $0.25 of incremental dilution or incremental expense in our Business. And we said at that time that through our expense optimization efforts we expected to offset virtually all of that in the year. We do that in a variety of ways. The stores have continuously over a long period of years looked for ways to increase productivity faster than wage rate and faster than sales, so lowering our expense rate. And we think there's opportunities to continue to apply technology to improve productivity in our stores. But what Gregg was talking about, our expense optimization efforts are across the entire organization, headquarters, distribution, supply chain. Everywhere we operate, we are looking for ways to take expense out so that we can afford to invest in the Business. + + + Great. Well that concludes Target's second-quarter 2013 earnings conference call. Thank you all for your participation. + diff --git a/exam/original-files/Problem_2_3_Sample_QandA/43_questions.txt b/exam/original-files/Problem_2_3_Sample_QandA/43_questions.txt new file mode 100644 index 0000000..644c865 --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_QandA/43_questions.txt @@ -0,0 +1,60 @@ +Question_1: + + First question on the comp, John, I think you mentioned that it did get steadily better throughout the quarter. Any additional color you could give us there? And then on -- were there any regional differences that you could potentially isolate in terms of where some of the transaction weakness was in the quarter? + +Question_2: + + Okay, got it. And then you talked about some lower advertised prices in the circular, is this really just in Canada or is it also in the US, and is that some of the gross margin pressure that you're thinking about in the second half as you've done a very nice job in terms of a rate improvement in between categories over the last four or five quarters here? + +Question_3: + + Okay and then real quick, on the dilution in Canada, obviously up quite a bit here in 2013 from the initial expectation. Any way or ability to paint us a picture, I know you still remain confident in that five-year outlook on the progression towards that $0.80 in 2017? Thank you. + +Question_4: + + Yes, so the question is is there an ability to say that the Canadian business will be -- you believe the Canadian business may be accretive in 2014. + +Question_5: + + I wanted to follow up on Canada and then touch on the US. Just to make sure I've got that right, or maybe ask it a different way, John, if you look at the incremental Canadian dilution this year, how much of it is related to those items of clearance? How much of it would be related to, if you will, start up costs or advertising? How much of it do you think is just a different margin structure in the business to drive that frequency in trips? + +Question_6: + + Okay, great. And then second, turning to the US, Kathee it was helpful to go through all the initiatives you have, and it seems like the issue that is bigger than anything is traffic staying negative versus what you guys would have probably hoped or expected a year or two ago. If we think about the traffic side of it more specifically, what in the back half do you think is going to help stabilize and improve that traffic trend, or is it just the way it is now, that this trip consolidation and that's the way the consumer is, and if we're getting comp it needs to be with more items and top line? + +Question_7: + + A quick follow up on Canada and then a couple on the US business, as well. Could you talk to the inventory overhang in Canada, the clearance that you spoke to, is that primarily also on frequency items, or is that more a discretionary product? + +Question_8: + + Okay, great. And then in terms of the average transaction size, could you elaborate on which categories are benefiting from the larger basket and the trade up that you alluded to? + +Question_9: + + Okay, great. And then lastly, if we look at some of the omni channel and multi-channel initiatives that are launching in the back half, is there any way to quantify the potential impact or potentially in your survey work you could talk to how much demand there is for these products, specifically on Click and Collect or Buy Online, Pick Up in Store? I know that's half of the volume in some cases for some of your competitors' Online businesses. Could you talk to how big you think that could be for you in the back half? Thank you. + +Question_10: + + If you think about the spending in the first half of the year versus the back half of the year on marketing, and why the competitive environment, can you help us think about how that spending might take place in the back half versus the first half of the year? + +Question_11: + + Okay and with regards to Canada, can you elaborate a little bit on the announcement this week with regards to the metro partnership in Canada? + +Question_12: + + Okay, and then lastly, it seems like you have a unique opportunity with the REDcard to tailor communications between Canada and the US. You have almost 20% of your customer base. Can you talk about through e-mail and text what you're doing in terms of personalization? + +Question_13: + + I wanted to ask about Canada's gross margin again. I know there's been a few questions already. But if you did better on more of those discretionary items, and I guess there was some shortfalls store by store, in terms of certain seasonal items coming through. Is this -- how is this, I guess, affecting maybe some of your plans? Are you adding more planograms? Is that going to add to the SG&A cost to service all these stores, if it's just different demand for different products? And just reflecting how diverse Canada actually is, or is it just weather effects, and what have you learned from that process? + +Question_14: + + Okay, and then I wanted to ask on the US side about the efforts to increase service, omni channel, flexible fulfillment, and all those things, obviously that costs a lot to implement and the way I see it, and you can correct me if I'm wrong, you're very centralized already. So, should we think about this is just necessary to keep sales growing? And maybe it comes in at a lower margin or are there areas that you could offset that impact? + +Question_15: + + Could you maybe elaborate on that? I know that you talked a bit about that there's the compensation accrual and that that helped, but then you also mentioned that you were better on payrolls. Is that something where you think there's more room to go in terms of the in-store labor, or is that something where you really wouldn't want to push too hard on because of the potential implications on revenue? And if that's the case, where else could the savings be, if it's not the store? + diff --git a/exam/original-files/Problem_2_3_Sample_QandA/44_answers.txt b/exam/original-files/Problem_2_3_Sample_QandA/44_answers.txt new file mode 100644 index 0000000..4bc84ff --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_QandA/44_answers.txt @@ -0,0 +1,119 @@ +Answer_1: + + I will start, Greg. +I think a couple things. One, I think first of all, the stress on low-income consumers is certainly playing a role. We've seen all year long. The payroll tax increase has been a portion of that, for sure. I think we get to cycle past that in January, and we will get better information about what that looks like going forward. +But beyond that, and the things that we actually control, as you said, we continue to see meaningful growth in REDcard. That continues to drive 50% lifts in sales, all of that driven by traffic. Kansas City is above 25% penetration now. So it continues to grow hundreds of basis points a year. +Then beyond that, I think it's all about our multi-channel initiatives, and everything we are doing there. And as I said, we are starting to see strong digital sales growth. That, combined with the flex fulfillment activities that we are implementing now, piloting a little later this year, and we'll begin to roll out next year -- we think all of that put together will continue to drive meaningful traffic increases. + + + The only thing that I would add, Greg -- this is Kathee -- is just that, as guests are consolidating their trips and they're coming less frequently, it's really important for us to get them to shop around the store and to buy more. And you do see in our basket that we have been able to accomplish that for the past several quarters as well. So we will stay focused on how do we ensure that we get more of their wallet when they do come. + +Answer_2: + + Yes, they do. They get total credit for anything that is bought online, picked up in-store, or things that are in store where there is an extended aisle sale. So we are incenting this. Actually, we have a parallel environment where both teams -- both our dot-com team and our store teams -- get credit for growing the business in a collaborative way. + + + There is no penalties, or there is no internal conflict at all as it relates to who is going to get that credit for the sale. We are double crediting everybody from an internal standpoint, and then we take it out at the enterprise level to make sure that it all washes through on a consolidated basis. + +Answer_3: + + If it's shipped to your home from the store, yes. + +Answer_4: + + Most of what is driving it up for the fourth quarter will be those hot categories like electronics that are most popular in the holiday season. And there is a lot of newness there that drive up the average selling price. Think of iPads; think of all the new video game consoles and games, which Target does very well with. And we are really excited about that business for the holiday season. I would anticipate it will continue into the fourth quarter. + + + Think of it more as a change in the mix of what we are selling at this time of year versus trading up within category. + +Answer_5: + + First, I would tell you it is pretty early. I think we've got about six months in with Cartwheel; but as we mentioned, very excited. We've got over 3 million users right now that are very engaged. I think it is helping trips. I also think it's really helping basket, because they are using Cartwheel in the store on their mobile device, looking for deals on things that they want to buy and they are adding more to their basket. +It is still really early to see trends, but we are very excited about it, and are talking about it more and more. We are going to be using Cartwheel as one of our vehicles to help drive value this holiday season. And hopefully more and more people will hear about it and sign up for it. But we think this is a big success story for us that we can continue to grow. + +Answer_6: + + There is always hope, Sean. We are highly confident (laughter) it is going to be successful. +Your inventory question -- we talked a lot last time about, given the sales shortfall and the fact that we planned inventories to protect on the upside; given all the excitement, there's a pretty large inventory overhang. As the teams have worked hard over the past 90 days assessing the best way to handle that -- and it depends on the various categories about the best way to handle that -- we have clearly seen some markdowns come through. We're taking advantage of that, actually, to drive value messaging in Canada and get across how sharp our prices are. +And then we are also assessing what of the inventory do we think we're going to sell ultimately below cost or end up salvaging because there's just flat out too much of it. And that is the inventory reserves that we assess at the end of the third quarter. We do that every quarter anyway as a matter of course, and we will do that again at the end of the fourth quarter. But that was a large piece of what happened at the end of the third quarter. +I think as far as lumpiness of inventories -- as you would expect it's the long-lead categories where we tend to be lumpy. The stuff that turns quicker or that is domestically sourced we can obviously shut down receipts much quicker. But stuff that is long-lead -- and we will see this continue actually a little bit into spring -- and here think about categories like bikes, where those are a long-lead items, and it just -- we can't get out of the receipts once we have made commitments. Those are the type of items that will take us a little bit longer to clear through. +I think on signs of hope -- we wouldn't call it hope -- but on signs of our execution starting to improve, we are seeing -- and I think this is consistent with what Gregg said -- as we start to get sales histories, we can start to replenish stores more accurately, balance our inventories, and meet guest need when they need that. We are starting to see success there. As we look at our current results, we're pretty much hitting our current forecast, but we are seeing much stronger results in the cycles that have been open longer. Cycle one, cycle two, cycle three have actually begun to exceed our expectations a bit. +We're a little bit hopeful -- not hopeful; we are optimistic that we are seeing the right trend with those cycles improving. And we believe we will continue to see that as we get more age behind the cycle four and cycle five stores. + +Answer_7: + + I think our efforts on expense optimization continue to be very successful. The teams are very engaged across the Company and continuing to look for new ideas of ways that we can reduce expense. And I think part of this is about lowering our center of gravity that you are referring to. +But a big part of it, too, is reinvesting that in other parts of the business. You have really seen that this year. We had significant incremental investments in technology, supply chain. That will happen again next year, particularly around technology and flexible fulfillment. We will make SG&A investments, and expense optimization really allows us to offset that. I think leverage probably hasn't changed a whole lot -- somewhere between that 1% and 2% range -- but it gives us a lot of capacity to invest in the business as we continue to grow our multi-channel capabilities. + +Answer_8: + + We agree with the last part of that comment, and we have continued to say it's very early here, and we are going to see it move around again in the fourth quarter, given we see the surge in holiday sales. I don't have the exact weighted average on the store timing, Matt, but John Hulbert will get that to you -- we can get that to you today. + +Answer_9: + + Matt, I would say it's strong overall. Certainly that varies by category, but there are a lot of great trends in our business in electronics. I mentioned a couple that we are excited about for Black Friday and going into Cyber Monday and the rest of the holiday season. +Things like Beats by Dr. Dre -- the whole headphone category had been fantastic, and that's a lead item. Speaker systems like Sonos have been fantastic. So there are many different categories that are performing well. Some are little bit softer, like cameras, but in total, a really strong business in electronics right now. + +Answer_10: + + Hi Chris, this is Gregg. + Over the long term our expectations haven't changed at all. What we're experiencing now, and as John talked about it, it is those long lead time businesses that are mark-down sensitive, particularly home and apparel, that we have to exit and it is costly to do so. +Remember, the first cycle stores did not open until April, and the second cycle followed shortly after that. And that was only a handful number of stores. By the time we really got a good clear indication in terms of where the sales were going to level out for this year, in our long-cycle businesses -- and think six, seven, eight months -- these receipts were already planned and in production and on the way. +It's really the lump of inventory that we've got to work through, and once we do that, we are very confident that we are going to be back in the mid-30%s like we talked about in terms of the overall gross margin, because the mix continues to be strong, and we are very pleased with that. We don't see any signs of that abating. +It might come down a little bit as we get more aggressive in terms of building that trip frequency. And we will start those efforts in earnest when we turn the corner in 2014. But on an absolute basis, we are really pleased with where we are in home and apparel, and we've got to get through this next quarter and the early part of the beginnings of 2014 until we really get that sales history developed by item, by store and eliminate some of the huge variability that we have in the supply chain so that we can get a more even balance between receipt flow and what we are selling. And at that point in time, we fully believe that we are going to be back to where our initial expectations were from a gross margin standpoint. + +Answer_11: + + These are against the new, most recent level-setting expectations that we shared that at the Analyst Day that said they are not where they were when we originally planned the business, but now that we have had enough experience, we see where they were and we established and rebooted, essentially, our expectations for Canada. +So against that new, most current forecast, what we are seeing is encouraging signs out of those earlier-cycle stores. They are exceeding these newer, revised forecasts more than the later-cycle stores because they have had a chance to operate on their own. They are six months into it now. The inventories are flowing better; in-stock levels have improved; the guest is getting used to our stores; they are converting from more of a browser to a shopper. It is still very early, but we like what we see in some of those early-cycle stores. And so at this stage we are just encouraged by the fact that they're performing better against most revised, revised forecast. + +Answer_12: + + I don't know that number off the top of my head. It is definitely higher than our typical market share, but we can get back to you with that number. + + + Yes, it's much higher than our aggregate store or electronics market shares. + + + We will get back to you on that one. + +Answer_13: + + That's a lot of questions. +On the third quarter, I think clearly Halloween moving into the quarter benefited. I would remind you that we also said at the end of last quarter, our back-to-school week moved out of the quarter into second quarter. That benefited second quarter. Net/net, probably a wash, maybe 10 plus/minus --10, 20 basis points, I don't really know -- but net/net a wash. +WIC -- any time there is a decrease like that, there is an impact. But for us, grocery, food is about 20% of our business roughly; and it's a very different kind of trip for us than most grocers. So certainly there is an impact. But for us, meaningfully, that is just not -- again, this is a small impact relative to what we might see at other retailers who sell significantly more food as a percentage of their business than we do. +And then electronics -- what was the question in electronics? I'm sorry. + +Answer_14: + + We don't necessarily talk about categories and how big they are. But with two new console releases and all the games that will go with them -- as you know it has been a declining category for several years, given the maturity. It's been over seven years since we had a new console. So having two in the same year is very meaningful for the category. It is also very meaningful for electronics in the store. So we think its going to be one of the biggest gifts gifting categories of the year, and we will certainly benefit from that. + + + And then on fuel, there is no question that in a time when, particularly lower income consumers have very constrained budgets, having to spend less on fuel, it helps in some way. For us, I will tell you, through time we have looked at this many ways and it's really hard to quantify fuel price moves in our sales. There are times when fuel prices are going up in a good economy, and that is good for everybody, which is different than today. It's hard to quantify, but overall, lower fuel prices is definitely good for consumers. It just puts more money in their pocket. + +Answer_15: + + Apparel, I think, was -- most of what we have is own brand product and exclusive designer partnerships that we do. So that is the bulk of our business. Certainly we do a lot of basics with branded manufacturers -- Haynes for example. +But our comp in apparel was down slightly. It was much stronger online. So we are seeing some shifting happening there. We are pleased with the new releases that we have had. Phillip Lim was probably our best designer launch ever -- very clean sell-throughs, both in stores and online. Our launch of our holiday product is off to a good start, while it is still early. +We're feeling pretty good about apparel overall. I would say that the softest part of apparel has been in kids. And we are working on ways to make sure that we can drive that business and have the right price/value relationship for our guests to help drive better market share gains. But the rest I feel pretty confident in. + +Answer_16: + + The 50 basis points is about right. And I would say about half of that was due to the ongoing pressure we have seen for several years now related to REDcard and the store remodel program. +The other half, like we talked a little bit about, was really related to markdowns we took, given the Halloween sell-through that we saw. And we saw sales soften up, like we said, in the middle of the quarter, given everything that was going on with consumer confidence and in Washington. We saw sales soften up a bit, and really just some promotional markdowns to sell through our Halloween inventory. I think as we think about fourth quarter, as we talked about, it's going to be very promotional; there's no doubt about that. But the primary driver of our performance versus last year is, last year we took significant clearance markdowns last year, and that's what you'll see be the primary variance year over year in our gross margin rate. + +Answer_17: + + Yes. + + + Absolutely. + +Answer_18: + + We haven't disclosed the drag from start-up expenses all year long. So we haven't really talked about that a whole lot. As it relates to price investment and markdowns, I think it is all -- we view that as all one big bucket, really; and it's really the total value message we are able to give to the guests in Canada right now. As I said, we have a little bit of excess inventory. We will take advantage of that. To be sure, we are giving a great value message. +But beyond that, as we look at our pricing in Canada on like items, we are right on where we want to be. We are locally competitive and right on the price leaders in Canada. So we feel really good about our pricing in Canada on like-for-like items. + + + Great. That concludes Target's third-quarter 2013 earnings conference call. Thank you all for your participation. + diff --git a/exam/original-files/Problem_2_3_Sample_QandA/44_questions.txt b/exam/original-files/Problem_2_3_Sample_QandA/44_questions.txt new file mode 100644 index 0000000..154429c --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_QandA/44_questions.txt @@ -0,0 +1,85 @@ +Question_1: + + I wanted to start right with REDcard and traffic. That's a trend this year that has gotten locked in at this down 1% to 1 1/2%, and you gave some goals a few weeks ago where comps would be 2% or better over the next few years. How do you get to the 2% over time if traffic is still down 1% to 1 1/2%? What initiatives with REDcard or anything else do you have to really get that traffic stabilized? + +Question_2: + + A direct follow-up to that. I know that with all the multi-channel initiatives -- and you outlined them all in the call -- how have you changed how store managers and associates are incentivized so that they give the level of service to the online guest that is coming to pick up in-store? Do they get credit for that? Or how should we look for that to be changing going forward? + +Question_3: + + Is that true if I have it shipped to my home? + +Question_4: + + Kathee, just on the average ticket side -- Greg was talking about transactions, but just to get to the ticket -- there has sequentially been a pretty nice acceleration in AUR throughout the year, and you talked a little bit in the third quarter, electronics impacting that with the UPT being down. +As you plan the business into the fourth quarter, would you still expect your AUR to be up 3% and UPT to be down? Or how should we think about the dynamics that's driving average ticket? And also that points to, if AUR is up -- which points people are maybe buying up, you are moving them up -- how do you square that with the consumer that is constrained? + +Question_5: + + Got it. +And my question related to this, Kathee -- and it gets back to the trip issue. With what you have seen with Cartwheel, what trips is that group -- you've seen an extra trip, and how do you really jump on that at a faster rate to drive trips the way you did with REDcard? + +Question_6: + + Great, thanks. I have a couple-part question here on Canada. I think most of them are related. +John, I think you talked about the gross margin being impacted by some inventory issues in Canada late in the quarter. Can you just give us a little bit more color there on what happened there? +And then maybe also outline where are some of the pockets of excess inventory that you are looking to move through? And then, secondly, are there any signs of hope in the business, or glimmers of hope that you can point to, whether it's by region or category, that are going better than expected at this point in that market? + +Question_7: + + That is helpful, thank you. +And then just secondly on the, in terms of expense optimization in the US business, looks you guys did a great job of controlling that there in Q3 -- maybe even below what you would expect moving forward. Do you feel like you're in the right position now there? What type of comp do you feel like you need right now to leverage that SG&A moving forward, maybe in Q4? And then the first half of 2014? Thank you. + +Question_8: + + Good morning. My first question relates to Canada. +What kind of insight can you give us into the average number of stores opened over the course of the quarter as it relates to timing of openings? Just to give us the ability to measure an accurate sales productivity number. We have (inaudible) to try to get sales per store and sales per foot, but the growth is moving so quickly on such a small base that it is very easy for those numbers to get distorted. + +Question_9: + + That would be very helpful. + Second question I would ask relates to the electronics business. Clearly, the video cycle is here and is very prominent, and I know that mobile is still a relatively new business for you. If you look at the legacy consumer electronics businesses, and you mentioned tablets -- I know you had a fairly high profile promotion recently, and TV, and other businesses that have less industry-wide going on year on year. What has your experience been in those categories? Or what was it for the third quarter and what's your sense of the promotional environment here in Q4? + +Question_10: + + Thanks, good morning. +Wanted to follow up on the Canadian and gross margin, and just your thoughts about how that proceeds going forward. I think originally you had talked about the Canadian gross margin being above the US. I always interpret that as maybe a couple hundred basis points above the US rate. But you have these competing factors right now where the markdown pressure is a negative, but the mix factor is a positive. +As you look into the crystal ball, how do think -- how might -- are your gross margin expectations shifting, based on those two competing factors over what the long-term opportunity could be, relative to the your original expectations? + +Question_11: + + And then you mentioned that some of the early-cycle stores were starting to exceed your expectations a bit. I had a really interesting chart at the Analyst Day that talked about where the expected ramp in the stores initially versus where it is sitting now. +Could you just reference for us what you mean by exceeding your expectations a bit? Is that versus your original expectation on first-year sales versus what you rethought? + +Question_12: + + And then one quick last one -- can you share with us what your share in the gaming category is in the US? + +Question_13: + + Can I ask about the comps? I just want to get your thoughts on a few of these items, if you would quantify them. So one is how much of the shift from the timing of the calendar between Q3 and Q4 in your reporting benefited the current quarter that was reported and pulled forward from Q4? +And then get your thoughts about, if you think there's any impact on comps from SNAP, whether that is directly in your food sales or your general merchandise sales? If you'd quantify what kind of uplift you expect from video games? And also one thing that didn't come up yet -- but lower fuel prices, how you're thinking about that? + +Question_14: + + I guess the video game cycle itself. What kind of comp uplift you would expect just from that? And the last part of that was about fuel prices coming down -- if you see that as a benefit for yourselves or not? + +Question_15: + + If I can ask one more about comp trends. The apparel part of the business -- it sounds like the branded stuff is going well for you. Can you talk about your private label trends in apparel? Is that maybe where some of the weakness is? What you're doing to try to turn that around? + +Question_16: + + Good morning. +Just looking at the US business from a gross margin standpoint. If we exclude the vendor agreements accounting shift, I think gross margins would have been down about 50 basis points year over year. Can you prioritize, or rank for us the impact from markdowns versus category rate pressures and other factors? And just how we should think about that going into the fourth quarter, given the promotional intensity? + +Question_17: + + Okay, so improved performance on gross margin in 4Q versus 3Q experience? + +Question_18: + + Got it. +And then lastly, on Canada, you mentioned that there was a lot of markdowns in inventory. Is some of the gross margin hit also related to price investments being made in certain categories? If you can just give us an update on that, along with a reminder, John, on what the drag was from start-up expenses in Canada this year. + diff --git a/exam/original-files/Problem_2_3_Sample_QandA/45_answers.txt b/exam/original-files/Problem_2_3_Sample_QandA/45_answers.txt new file mode 100644 index 0000000..760a545 --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_QandA/45_answers.txt @@ -0,0 +1,102 @@ +Answer_1: + + Sean, I think a lot of the things that I talked about today with product as well as with in-store experience and our mobile experience, those are really the key things for us to help drive people to shop at Target beyond the food you talked about and, of course, the REDcard. + +Answer_2: + + Yes, in stocks have been rock solid for quite some time, and in terms of product, I would tell you that we're always making adjustments to what we carry in stores. We learn what's selling and what trends are picking up steam, things like organics and better for you products, so that's a never-ending thing that we work on. + +Answer_3: + + We are expanding the assortment right now. I don't have a date for you in terms of when we will get our whole assortment up online, and right now we're focusing on the most popular items and categories, so we recently added pets for example. And we will just continue to expand as we learn more and more about that program. + +Answer_4: + + Sure, inventory up about 10% year-over-year, and you could roughly think about that split about equally between Canada and the US. Canada obviously, we're just in a different place than we were a year ago. We built inventories all year as we opened stores. +I would tell you in Canada we feel much, much better. We feel very good about the progress we made in the fourth quarter clearing excess inventory. The average inventory per store in Canada from the beginning of the quarter to the end of the quarter went down about 30%, so we still have some lingering issues in Q1 with some long receipts but feel very good about the inventory there. +In the US, I would tell you the merchant team did an outstanding job reacting to the change in sales, and our inventories are in excellent shape. This is the time of year where in February, we are changing lots of things in the store, and frankly depending on where you snap the line for year-end relative to our receipts, we see inventory move around a little bit. If you go back over the past couple of years, our inventory per store in the US is up about 3% versus two years ago, so this is really more timing than anything else, and we feel very good about the inventory position. + +Answer_5: + + Well, we should go offline and review where you are, where you think we are versus our credit rating and where we think we are versus our credit rating. We've actually run pretty close to our credit rating not just last year, which was even higher, but for the past several years. +So our view is that we think we can do -- given our plans between $1 billion and $2 billion. We need to see our business results improve over the next couple of quarters. +We're starting to see that in February as we eluded to, and then also gave little bit of a view into what the potential costs are that may be coming our way as a result of the breach. But given all of that, we still think somewhere between $1 billion to $2 billion beginning in the back half of the year for the year makes sense. + +Answer_6: + + As we said, it's not estimable at this time. What the potential cost of the breach is and given where we are in the process, it'd be inappropriate for me to speculate. + +Answer_7: + + Just to be clear, that was insurance receivable, so we haven't actually received payment, but we feel pretty -- we feel very likely to receive payment for a portion of the expenses we incurred in the fourth quarter. What we can say about insurance right now is at this point we think there's $44 million of insurance that we will receive, and to the extent that number changes, we will be back to you to provide more information. + +Answer_8: + + Yes, in traffic your view of what happened post the breach is pretty accurate, and we have seen traffic continue to improve and firm up, and definitely throughout February we've seen traffic firm up. And as we said, sales have improved, and a big part of that has been traffic. On the REDcard, what we've seen is -- and Kathee talked about this a little bit. +In our core guests, REDcard guests, they've continued to shop with us. And we've seen very strong, very strong sales from that. REDcard penetration continues to grow meaningfully, hundreds of basis points year-over-year, and to the extent we're not growing where we used to, that's driven by new accounts, so the guests who have REDcards continue to shop our stores. + +Answer_9: + + As has been the case over the past couple the of years, the penetration growth comes from new accounts. + +Answer_10: + + Great question, Matt, and it's -- analyzing weather isn't a perfect science. I would tell you when we see in the Midwest and the Northeast, when we've seen these weather patterns go across the country, the spread is significant between the two, but ultimately as that passes, we see them restabilize and everything come back to normal. +But the difference while it is going on is pretty dramatic. It's in single digits difference, but it would be high single digits. + +Answer_11: + + We're always working on inventory accuracy, and that is a combination of how we use our systems as well as the processes in store. And so it's been less of an issue to date as we get into some of the additional categories, things like beauty where there's a lot of SKUs -- excuse me, we've got to make sure that the accuracy is there. +I will tell you apparel, while we've had good results there, it's a little bit harder. Partly accuracy, but partly being able to find the exact size when it's not in a [planagrammed] environment, so there are a few challenges for us to figure out, but overall I would tell you that our guest response has been very positive in the survey comments that they have back to us, they really love the service. +So, yes, we will keep working on accuracy to make sure we can fulfill as many orders as possible, but so far we're very pleased. + +Answer_12: + + First, the comparison to last year we have to be a little bit careful. There's a 53rd week in there. That's a relatively low volume week which creates a little bit of distortion year-over-year. +But I think as I said, we continue to work very hard on store productivity ensuring that we're driving great guest experience and in stocks, but also improving our productivity, and then all of the expense optimization efforts continue to go on, and some portion of that will fall to the bottom line. Some portion of that goes to gross margin, and some portion of that gets reinvested in the business as we invest in multi channel technologies supply chain. But I think flat to up slightly is probably about the best way to think about it. + + + Thank you. + +Answer_13: + + We didn't give a number, but I will tell you it was very positive above the industry and slightly above 20%. + + + Like the rest of the business, it was impacted by the breach as well. + +Answer_14: + + It's -- from our perspective, we've got to up our game on all fronts. It starts with delivering great content, great in stocks. Our team is more engaged than ever from a service standpoint both on the sales floor and at the lanes, and we're going to deliver as Kathee said just some eye popping, irresistible deals. +So we're going to really up the ante as it makes a statement on our unbeatable pricing proposition which we have. We've price matched the competition, and we run our circulars, and with our 5% REDcards rewards program, our value proposition is unbeatable. We're just going to call greater attention to that, and selectively we're going to go out and be more aggressive in that regard, so it's the combination of all of those elements. + +Answer_15: + + Sure, mix in Canada continues to be stronger in apparel and home, and we expect that to moderate through time. We ultimately think the mix there will be stronger than what we see in the US, but a lot like our high volume stores in the US, our urban stores in the US, we see a higher mix of home and apparel sales. That will moderate through time because we want to drive the frequency categories. +That's what we're working on the team in Canada. Ultimately as they're successful in driving conversion, commodities, groceries, food, all those categories, we will see that mix moderate. +I think we'll see margin, we expect to see some volatility. Q1 for instance, the margin rate won't be at 30%, but it will be significantly improved from the 4.4% we recorded in the fourth quarter. So we will make progress, and you should expect to see that throughout the year, and of course back in fourth quarter next year we will be down a little bit from that 30% as is typical in our US business given that time of year. + + + Okay. We have time for one more question, please. + +Answer_16: + + Chris, we don't break out promotions individually. It was a big time of year, and the number was relatively large, but in the big scheme of the fourth quarter, I would tell you it's not material. + +Answer_17: + + There's $200 million that we recorded in 2014, we will annualize on that. Or 2013, excuse me. We'll annualize on that next year, and the savings came from all over the corporation. +There were savings in gross margin around transportation expenses. That will grow again in 2014. There were savings -- really it's hard to pin it down. It was literally across the entire organization where we looked at things. +We looked at how we sourced product and aligning our non-retail product that we sourced and services and making that look more like we do in merchandising, and we saw significant savings there from our sourcing. There's more to do there, and we will see that grow in 2014 as well. As Gregg said, it was literally across the entire organization where we were focused on stopping things that we didn't need to do, and if we did need to do them, improving productivity. + +Answer_18: + + The chip technology makes it such that using the account numbers without the card becomes very much more difficult, and so the desire to obtain those card numbers goes down significantly. What we've seen in other countries that have adopted chip technology is fraud rates go down dramatically for in-store transactions, and I think in the UK or Europe, I can't remember exactly, down like 60% once chip technology was enabled. So the desire for those account numbers becomes less desirable. + +Answer_19: + + Chris, we're in the middle of an investigation, and we can't talk about the specifics. We continue to learn. There will be learnings that come out of that investigation, and from those learnings, we will take action, and that's about what we can say today. + + + Okay. Well, that concludes Targets fourth quarter 2013 earnings conference call. Thank you all for your participation. + diff --git a/exam/original-files/Problem_2_3_Sample_QandA/45_questions.txt b/exam/original-files/Problem_2_3_Sample_QandA/45_questions.txt new file mode 100644 index 0000000..82ffa5a --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_QandA/45_questions.txt @@ -0,0 +1,80 @@ +Question_1: + + Good morning and thanks for taking the question. I guess on the same store sales trends for February being down in that 0% to 2% range, probably a little bit better than people expected. I guess just over time, Target's been on an aggressive campaign to drive frequency with REDcard and remodeling more stores towards food, but given that PFresh is maturing here and the credit breach could curb some of the willingness to sign up for REDcards and online taking a bigger portion of the overall retail landscape, how should we think about some of the bigger picture initiatives to drive same-store sales trends in 2014 and beyond? + +Question_2: + + On the food aspect of things, how are you on the in stocks in that particular category, and are you happy with the product that you have out there on the shelves today? + +Question_3: + + Okay. Great, and then just one last thing you mentioned, the online and the flexible fulfillment. I think that all of those can now be viewed online which is great for the consumer, but is it going to be possible for all of those products for buying online and picking up in store? + +Question_4: + + Thanks a lot and good morning. I've got two questions, and the first relates to inventory. I know you cleared a lot of inventory in Canada. +Your year-on-year numbers still across the corporation or across the enterprise is still up quite substantially relative to sales. If you could comment on sort of the composition of that inventory and your thought process for its impact on margin going forward? + +Question_5: + + That's very helpful. Thank you. And then my follow-up relates to capital allocation and specifically the buyback. +I know that you alluded to the Company's desire to maintain its current credit rating and that you spoke about resuming buybacks as the year progressed presuming that you were on plan. I just want to talk about what your thought process is for contingencies and that based on the numbers we've looked at, it seems like you're a long way from coming close to the edge on your current credit rating. +So what would it take for you not to do that $1 billion to $2 billion? It seems like that should be well within your financial capacity even if frankly the numbers are a bit light of your current guide? + +Question_6: + + And just finally, I know you're not going to quantify the cost of the breach, but it sound like in thinking about the capacity to buy back stock, you have a sense somewhere internally a sense of that number that would enable you to pursue that course. + +Question_7: + + Hi, thanks. I have a couple questions, just a quick follow-up on the breach costs. You showed a net -- you got some insurance payments from the breach cost that you had? +Is that a -- should we expect that -- or do you have any insurance for these potential costs, whatever they may be, or is that sort of a one off in the quarter? And then I have a follow up. + +Question_8: + + Okay. Great. Bigger picture on REDcard and traffic, I mean if traffic was down 5.5% in the quarter, presumably post the breach it was down, pick a number like 7% or 8%. Is it fair to say that traffic has recovered back to what it was in January and February or where we are now, and how is REDcard seasoning, those people who have had it for three or four years, how are those people behaving following the breach? Thanks. + +Question_9: + + It's more of the penetration growth from new people signing up or from people that signed up shopping more? + +Question_10: + + Good morning. Thanks for taking my questions. I'm just wondering if you could provide a little more color on the comp spread that you're seeing between states that have been severely impacted by weather and some of your warmer weather states. + +Question_11: + + Okay. Thanks. And then secondly, as you gave some great detail on your investments in digital and eCommerce this year. As you enable click and collect and fulfillment from store, are there any significant investments you need to make in terms of inventory accuracy in the store, and could you just give us maybe a bit of color on how that's running in terms of being able to pick up in store? + +Question_12: + + Okay. And then lastly, your SG&A per foot in the US was down pretty substantially in the fourth quarter versus the last few years. How should we think about SG&A per foot on a full-year basis for 2014 in the US? Should it -- is that a number that you can keep relatively flat, or is there just some inherent inflation in there that we should expect? + +Question_13: + + Good morning. I just had a couple questions, first on -- did you give a number on the online business in terms of the increase that you had in the fourth quarter? + +Question_14: + + Okay. Okay. And then when you look at the full year, you gave a lot of details, in terms of like the sales recovery that you have, what are the key factors that give you the comfort and confidence in the recovery over this year as you plan the earnings and sales trajectory? + +Question_15: + + And then on the gross margin outlook for Canada, can you just talk about the mix assumptions in there and sort of the ramp from where you finished fourth quarter to get to that 30% number for the year? + +Question_16: + + Thanks and good morning. A couple random questions. So could you perhaps break out how much was the explicit impact of the 10% off deal that you did after the breach and right ahead of Christmas? + +Question_17: + + Okay. And then on the cost savings side, I guess how much of the $1 billion is done so far, and what have been the big drivers this year that have taken those costs out? + +Question_18: + + And one last one, if you had chip technology in your stores this past year, how would the breach outcomes have changed? Would it have stopped the actual theft of the credit card data, or would it have stopped the personal information disclosure? + +Question_19: + + But didn't the breach actually come from systems internally, not necessarily coming from the card readers? + diff --git a/exam/original-files/Problem_2_3_Sample_QandA/46_answers.txt b/exam/original-files/Problem_2_3_Sample_QandA/46_answers.txt new file mode 100644 index 0000000..5875d4e --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_QandA/46_answers.txt @@ -0,0 +1,89 @@ +Answer_1: + + Matt, all I can tell you is what we're focused on going forward, and Kathee and I and the whole leadership team have been talking to the team for the past couple of weeks about our focus on driving the Business forward. And we have three key objectives: drive sales and traffic in the US; accelerate our operational improvement in Canada, and ultimately our business performance; and then third, accelerate our transformation and get to be a leading omnichannel retailer in the US. And that's where we have the teams focused. + +Answer_2: + + Matt, as you know, when sales get out of -- when sales aren't on expectation, and inventories get a little heavy, they get lumpy. So, there's areas where we're a little bit heavier than we would like; there's areas where we are a little bit lighter than we would like. And we're working to, I'd say, balance all of the inventories. And a lot of it, frankly, will be dependent on: Do we meet our sales objectives? In the first quarter, a little bit light, but not materially so. And if we continue to hit our sales objectives, I think we will see our inventories smooth out over the course of the year and be in a manageable position for the remainder of the year. +I don't know if there's anything you'd add, Kathee? + + + The thing that I would add, Matt, is we're working on making sure that our forecasts are accurate. And then, as we buy into them, that we've got chase and cancel plans built in, so that we're able to react in-season versus what we've done this past year without any history and having to react at the end of the season to clear more. So, we are still lumpy; we still have product to clear, but we're getting our arms around that forecast, and I think that will help us as we move through the year. + +Answer_3: + + Sure, on the first question of the CEO search, certainly that's under the Board's purview, and I would tell you, rather than focused on time, they are focused on getting the right individual to lead the Company, as I said, to become an omnichannel retailer. So, that's their focus; and the time will take as long as is appropriate to get the right person. +On the second one, on share repurchase, and specifically related to the potential breach liabilities, getting visibility to that in the second half a year, there's a process that is agreed to with the networks. They get some information from their forensics investigator, and then they go through a process to evaluate incremental fraud where we may have potential liability. And then they come back to us after a period of time. And as we've looked at that historically, we've seen that that's taken several months, and that's why we get to the third quarter. We don't have, frankly, Bob, a lot of visibility to that, but as I said, as we looked at other incidents, that's what we've seen in the past for timing of when some of those potential liabilities may become more clear. + +Answer_4: + + Sure, I will talk maybe a little bit about where we are today, and Kathee can talk about what we're doing to drive growth there. The sales in our business, somewhere between 2% and 3% digital channel originated -- probably in the 2.5% range right now. +REDcards: Given the free shipping online, we have a lot of our REDcard guests shopping online. And I think, we talked in the past, Greg, we have a very high penetration of online orders that we free ship because of that REDcard. We think it's absolutely the right incentive or part of that loyalty package for REDcard, but it drives a very high penetration +And, Kathee, you can talk about where we're going. + + + In terms of growth, Greg, mobile is where we're really focused, and about two-thirds of our traffic right now comes from mobile. So, we're really pleased with the results that we've seen there, not only in traffic but also conversion. We did improve conversion, both on the site and on mobile, and in total. And you know that mobile conversion is lower than site conversion. So, that headwind from the mix is there, but we still improved overall conversion. So, we're happy with that. +There's also a lot of new things that we're doing. Certainly there's product introductions; I talked about the furniture a few minutes ago. There's always new stuff that we're adding on the site. We're expanding. We've got almost all store product online now set up online; lots to be sold online. But now we're adding out in other areas where we should have a much larger selection, and we think online is the place to do that; things like apparel, home, beauty. +In addition to that, there's a lot of services that we are adding that are doing really well. We've talked about buy online, pick up in store; subscriptions has been really successful for us. We started last Fall with about 150 SKUs, and those items -- our online sales were about 15% in subscriptions, with no marketing, just beta on the site. +So, we've now got about 1,500 items; and by June, we will have 5,000 items that will be available for subscriptions. And when guests purchase those items, they will be able to get a 5% discount for signing up for subscriptions. So, a lot of product and a lot of services that go with that, to drive our growth. + +Answer_5: + + Yes, if you mean for an annual number, getting to an annual positive traffic number, very difficult. We're working hard on increasing traffic for each of the quarters, and I think our benchmark is: Are we seeing continued improvement in traffic as we go sequentially? But for the full year, even if we just pick a number, ran a 1% comp, I don't think we will see positive traffic for the year. + +Answer_6: + + I don't think there's a target level of investment. I think, first, from a CapEx standpoint, our approach has been: We're going to invest in all the investments the business needs to grow profitably and generate appropriate returns. The length of time over which those returns occur -- we have a very long lead time as we think about capital investment. Stores have a very long return cycle, so we're used to making investments that pay back over a long period of time. +From an expense standpoint, I think there probably the biggest investment and where you will see us accelerate is in speed, and doing more testing and learning. And that's not just digital, but also in our store -- just getting more activities out into the Business that we're testing, we're modifying, and adjusting and improving on. And if it doesn't work, pull it back and retreat from that and learn from the testing. +I think the best example of that is Cartwheel. We put that out in beta; we knew there were things about the app that we didn't particularly like. Our guests let us know what they didn't like about the app. The team iterated and iterated, and one year later, and really not with much marketing until more recently, we have 7 million users, and the app has evolved as our guests have provided us feedback. +And as Kathee talked about, a lot of the merchandising initiatives in baby and in apparel and in toys and in electronics, that's the same approach we take, and get it out in the stores, modify it, test it somewhere else and modify it, and then we will move to scale. So, those are the investments we will see in expense, and I don't think that is limited by some false number of expense dollars we have to allocate toward it. It will be driven by the appropriateness of what we're testing. + + + The thing that I would add to that, Matt, the reason for getting more out, historically we've tended to work on our newness until we felt we got it to an almost complete level and then we would put it into pilot. The point now, and John's point about Cartwheel and some of the in-store things that we're doing, we want to get it in front of our guest very quickly, get their reaction to it so that we're fine tuning it much more quickly and then able to move out -- to roll out at a much faster pace with a product and a service that we know our guests will love. + +Answer_7: + + Yes, as we said, we continued to see improvement across the Business into April, as the guest data improved and our sales performance improved. And the early cycle stores continue to be the best. And it's, again, almost in order down the sheet: cycle one, cycle two, cycle three, cycle four, cycle five. +So, the earliest stores, the longer they have been open, they perform the better. But the good thing is: All cycles on an upward path. We're not where we need to be, and we're not where we need to be versus our expectations, but it's good to start to see some progress. + + + I think the key to each of those cycles and improving them is getting this history under our belt, and now we can forecast more accurately as we move forward. And as John said, we're very committed to accelerating our performance in Canada, and we think that it will continue to go by cycle as it has this past year. + +Answer_8: + + I will take the second one, and then Kathee can answer the first. On sales tax, we definitely see an impact when Amazon collects sales tax, and particularly in states that have much higher sales taxes to begin with, where essentially the price differential is much more meaningful. So, we've definitely seen that impact as we've watched them collect sales taxes across the country. +And, Kathee, you can talk about the rest. + + + In terms of our online business, the part that I'm very encouraged about is that, as comScore reports when we look at traffic on our site versus the top seven retailers, we led by far. And obviously, Amazon has a lot of traffic, but it was flat in the quarter, and ours was up considerably. So, I'm pleased with that the changes that we're making to the site with the user experience and the added product that we're adding is driving that guest behavior and that we're seeing the traffic. +Clearly, Amazon is doing very well, and they have, in the consumables category, a lot of business. We are now ramping that up, starting with the more style-related consumable business. If you think beauty, for example, you will see us pushing forward there faster versus grocery, which we're doing dry grocery now, but we're not working on refrigerated and frozen at this point. + +Answer_9: + + At this point, I don't think we're ready to commit to what that will do from a financial perspective. Our main focus right now is what will most resonate with our guest; getting pilots out in beta so that we can learn and experience from them. Ultimately, we have to work to be profitable on all of those. But our main goal right now is sales driven and understanding guest behavior so that we can then tailor the assortment to suit them and be profitable at it. +I will tell you I've been really pleased with some of these new initiatives and how rapidly our guest is responding to them. Store pick-up is the biggest because it's now rolled out. But ship from store, which was really a Minneapolis team member test so far, we're going to be expanding that in June and make that guest-facing, having that $10 rush delivery in Boston, Minneapolis and Miami. And based on our team member response and the feedback that they gave us, I think that this will also resonate with our guests. So I'm really excited to see where that goes. +And then, later in the year, we're going to be adding standard shipping from 135 stores in about 38 markets, and that will allow faster delivery, not the express that I just talked about, but 1- to 2-day delivery, and as well as provide access to the store assortment that you can't get right now on Target.com. So, lots of good things happening. Not yet ready to say what it means in terms of our sales or our profit. + + + I think Kathee's exactly right. Not ready to give a lot of guidance on sales profit and how it will all work out. But I would tell you, broadly, regardless of where the profit margin rates end up, pushing incremental sales across our existing assets will be a very good thing for return on invested capital, and we're very excited about that. +And with that, I think we have time for one more question. + +Answer_10: + + Well, I think the point is that we want to accelerate newness and innovation in this interim period here. We've talked about: interim doesn't mean idle. We are approaching our Business with as much passion and focus on improving results as we always have. +And in terms of this structure, I think, as John mentioned, focusing on our top three priorities and having this merchant team really focused on the US, improving US performance, and leveraging deep, functional expertise to be able to speed up that innovation and newness. So, for example, putting all of our style business together, both merchandising and design all under Trish Adams; having our essentials and hardlines business all under Jose Barra. Having all inventory and all operations under Keri Jones, and then our omnichannel efforts all under Casey Carl, are really important to be able to leverage that expertise and move very quickly in improving our results. + +Answer_11: + + I will just tell you that the Board has been very supportive on these changes. We've talked at length about getting the right people in the right chair to be able to drive our performance, and we're really pleased with this structure and the people that we have leading these teams. + +Answer_12: + + As we've been focusing on irresistible deals for our guests, we've invested in both sides. I gave you the example of the Coke ad that we ran in, I think it was in March, but we've also done broad categories on the want side like the ultimate Spring break sale or our baby sales. We're looking at really needs and wants, and how do we invest in both sides to be able to delight our guests, and we've had great success in both categories. + + + Thank you. + + + Thanks. Well, that concludes our first-quarter 2014 conference call. Thank you all for your participation. + diff --git a/exam/original-files/Problem_2_3_Sample_QandA/46_questions.txt b/exam/original-files/Problem_2_3_Sample_QandA/46_questions.txt new file mode 100644 index 0000000..fdf76d8 --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_QandA/46_questions.txt @@ -0,0 +1,50 @@ +Question_1: + + Two questions: The first one I want to ask -- it's sort of a governance-related question, so answer it as you can. You talked about some of the Company's initiatives, and in your case strategic direction in areas where you felt perhaps the Company had fallen short. Were any of these areas themes where perhaps Gregg and the Board, or Gregg and the rest of the management team had a difference of opinion such that your focus on them today would be different from what the Firm's focus on it had been under his leadership? + +Question_2: + + That's very helpful, thank you. And then my second question -- just a quick one on Canada. If you could try to help us frame the magnitude of inventory sort of left in the pipeline that you need to clear, maybe how much of a factor that was in the gross in Q1 and whether you're cleaned up at this stage? + +Question_3: + + Just two questions: I guess first, in terms of the search for a new CEO, is there a reasonable time frame that you think it can be resolved? And then the second question is: On the share repurchase, you gave a lot of detail on it. In terms of the second-half confidence level, do you think that you will have better visibility, and what gives you that visibility around the costs of the breach in that third quarter? I'd like to better understand that situation. + +Question_4: + + Hi, thanks. I had a couple questions. John and Kathee, it sounds like growing that digital is a key focus right now, and driving that faster. Could you help us understand where we start from, like, what percentage of your sales, or maybe some of the cross-shopping between REDcard members and how much they shop online, or maybe how those people season after they have had a REDcard a few years. And anything you have on that, I think, would be helpful. + +Question_5: + + That's great. If I could follow up on the guidance, it sounds like it's really margin investment in Canada that has taken the guidance down, if I've summarized that right. You left the comp the same in the US. If we get back to that 0% to plus 2%, do you expect traffic to be positive at all, as part of that guidance, or do you think it could still be negative through the year? + +Question_6: + + Thanks so much, good morning. I'm just wondering, on the digital transformation that you talked about, is there a target level of investment from both a P&L and a CapEx standpoint? + +Question_7: + + Okay, great. And secondly, can you talk to the early cycle stores versus the later cycle stores in Canada -- anything you can share on the difference between the financial metrics and the various cohorts? Thanks. + +Question_8: + + Two questions: First, on online and I guess specifically Amazon, it seems to continue to infringe on Target's everyday business, and increasingly the consumable category, so I guess the question is two-fold. Do you feel like that you're making good progress here on slowing the bleed of sales? And then secondly, have you seen any impact from the recent changes in your trends in markets where Amazon is now being forced to collect some sales tax online? + +Question_9: + + Understood, that's helpful. +And then, I guess the second question on the logistics side of the Organization, sounds like you're having good success with the ship from store test, and then buy online and pick up in store at 10% of the sales seems to be going relatively well. Can you talk about any of the longer-term P&L benefits from these initiatives, both maybe from a top-line and a margin perspective? + +Question_10: + + Thanks for taking the question, guys. A couple of quick things: I guess I was curious as to, Kathee, the change in the organizational structure under you in merchandising, and what really prompted this now versus six months ago or next month or waiting for a formal hire of a CEO in place? + +Question_11: + + Got it, thanks, that makes a lot of sense. +If I could follow up with that, was this something that Gregg was reluctant to doing? And did that have anything to do with the timing? + +Question_12: + + Got it, thank you. And then, just the one last thing I wanted to ask, and I apologize if I missed it in the discussion today, but as far as the price investments go, are they more in the consumable side, the discretionary side? Where are there areas you think you need to I guess make an investment? + diff --git a/exam/original-files/Problem_2_3_Sample_QandA/47_answers.txt b/exam/original-files/Problem_2_3_Sample_QandA/47_answers.txt new file mode 100644 index 0000000..c3f5cd3 --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_QandA/47_answers.txt @@ -0,0 +1,92 @@ +Answer_1: + + Wayne, let me start by answering your first question. My focus, right now, is to really understand the business in both the US and Canada. And I'm spending a lot of time with John and Kathee and the team to understand the guest perspective on Target, how we improve our traffic, how we enhance our performance in Canada, and how we continue to build out -- and rapidly build out -- our omnichannel capabilities. So I'm very focused on making sure that we're going to make progress against those key three initiatives, as I continue to look at the broader and longer term strategic options. So my focus is really understanding the business today and strategy before we have any discussions around organization modifications, going forward. + + + And then Wayne, in terms of the unit per transaction, most of that was driven by higher dollar items that we were selling -- things in electronics and in entertainment. So you see the healthy selling price, as you mentioned, but fewer units. The other portion of that, I would say, is that we are seeing really good momentum in our trade-up strategies. So we are selling, in some cases fewer units, but higher price points in other categories across the Company. But it's predominantly electronics and entertainment. + +Answer_2: + + Yes, David, there's no doubt that with e-commerce being as immature as it is, there is some pressure on gross margin. We are committed to going where our guests go, and they want to be able to shop online. And we are going to make sure that we've got all the right products for them, both online and in our stores. That does give us a little headwind on the gross margin. But as you pointed out, all of the newness that we're bringing in -- the things that our guests love most about Target -- that helps to offset it. So we don't have a number to share with you today, but we are very focused on driving sales, going where the guest is, and offering them those products that delight them. + +Answer_3: + + On the gross margin rate, I think Kathee said it really well. We're going to go where the guest is and meet them -- provide the product they want, where they want it, when they want it, and how they want it. But there's a lot of tools in our tool kit to manage gross margin rate. There's certainly the product that Kathee talked about -- emphasizing the style categories with newness and differentiation. Beyond that, there's the flexible fulfillment options, where we lower shipping expense by moving the product closer to our guest. And also, ultimately, balancing inventories better across the entire network and reducing mark downs that we incur today. +So there are lots of puts and takes. And like Kathee said, we don't have it all sorted out today. We'll provide more information as we do. But I think there are lots of puts and takes, as we think about gross margin rate more broadly. +On the store hourly payroll -- first, on the extended hours, the investment there was immaterial to the quarter. Again, that was about half the stores adding one hour of operations. So not significant investment there. But with Tina Schiel, our Head of Stores, we continually talk about ensuring that we're striking the right balance between productivity in those stores and we have great guest service results. What we see today, our guest survey scores are as high as they've ever been, and the team continues to drive really strong expense control. So we feel good about where we are today. But we constantly evaluate that. + +Answer_4: + + Matthew, as I mentioned earlier, I spent time just last week with the Canadian team. And I'm certainly aware that the expansion has been challenging. And from a Target standpoint, we've disappointed many of our Canadian guests. Kathee's already referenced the fact that we're conducting an in-depth evaluation of our Canadian business. That began several months ago. And we're certainly looking to make material improvements in that business. +Right now, short term, the focus is on improving in-stock conditions, our pricing, and assortment and really ensuring that we've got plans in place to improve our performance in the holiday upcoming. So you can expect me to be spending quite a bit of time with the Canadian team, along with Kathee, to make sure we understand the opportunities; we understand the challenges that we have to address; and we're focused on improving in-stocks, our value position, and assortment as we go forward. So I'm going to spend, clearly, the balance of the year working very closely with that team to make sure we've got plans in place to improve performance as we go into the holiday season. + +Answer_5: + + We did add it to the chain all at the same time. We don't have any markets that are more mature. We did do a little testing with team members in Minneapolis before we rolled out. But basically, we rolled it all around November 1 of last year to all stores. And we have been very pleased with the results from buy online, pick up in store. And about 14% of our digital sales today are being picked up in store. +And then when they go to store to pick up those orders, we're seeing about 20% of those guests shop in the store to pick up additional items. And there's a very healthy basket with that, as well. So still early, but very promising. We think it saves guests time, it saves them money, and it allows them to consolidate their shopping. + +Answer_6: + + Yes. Sure. You're right. It was -- the goal for expense optimization -- about $650 million incremental to last year, which gets us to $850 million total. Of the $650 million this year -- just rough numbers -- about $200 million of that was on the gross margin line, coming out of cost of goods. More of that back-weighted than front-weighted. We're probably about a little bit more than a third of the way through that. Probably a little bit more than that -- maybe half the way through that. So there was definitely some benefit in the quarter from expense optimization. That was also true in the first quarter. Both quarters have benefited. But later in the year, we'll see more benefit as we continue to grow those savings. + +Answer_7: + + Yes. It builds as the year goes on. We're annualizing on the, roughly, $200 million we saved last year. That was primarily SG&A. There's probably a little bit more good news in SG&A right now, but that will continue to build, as well, as we go throughout the year. + + + Thank you. Good to be back, Greg. + +Answer_8: + + Greg, I'm going to quickly immerse myself in the details of the business, both here in the US and Canada. And John and Kathee and the leadership team have already spent hours with me walking through a lot of the strategic work that they've been doing over the last 90 days. As I said earlier, during my very first week, I visited the Canadian market to spend time with that team, and I want to be a good student of the business. But clearly, we have to have a sense of urgency here and a sense of pace. And while I want to study the business and, certainly, listen and learn from our team, no one is happy with our current performance. +And our focus, right now, is to make sure we've got plans in place in the short term to improve traffic. We've got plans in place to improve our performance in Canada. And we've got to continue to move faster, from a digital and mobile standpoint, to meet the needs of our guests. So you can expect a clear sense of urgency. But I, certainly, want to make sure I give myself the time to listen, learn, understand the business, both from our team's standpoint but also from the eyes of the Target guest. And you can expect me to dive in very quickly to understand the business, to look for the opportunities, and to work with the leadership team to develop very focused priorities, as we go forward into 2015 and beyond. + + + Thank you, Greg. + +Answer_9: + + Yes, Matt. I think it's more about product and the newness that we have on the floor for back-to-school, back-to-college. We've seen both of those start off really strong. Even in their peak weeks, those stores are doing better the week after their peak. So we're seeing it stronger in the peak and then get even stronger after that. So I think it's really product related and newness. Certainly, we've had promotions. Most of them are devoted to those core categories like apparel, some of the back-to-college items. But the guest, right now, is more focused on the occasion than they are on the promotion. So that is very encouraging to us, and I think it's product-driven. + + + Matt, if I could, just early days -- but the current performance on back-to-school and the way Kathee and the team have put back-to-school together at Target has been very impressive to me. And I think it's a great example of getting the product right, the right balance of newness and innovation, great advertising communication that really captures the guest's attention, and very strong in-store and online execution. So I think that's one of the great examples that we're going to continue to build from, as we go forward. I think Kathee and the entire team have brought back-to-school to life -- back-to-college to life -- with the right products, the right newness and innovation, great advertising communication to support it, and then very strong in-store and online execution. + +Answer_10: + + UPT down 8% in Canada, Matt. I think a lot of that -- what I would tell you is, a lot of noise going on in the Canada comp, overall. So much of the surge last year, we saw very different types of transactions than we saw once we moved past that, as we opened stores. We saw that in each cycle. Very different behavior for those -- I don't know -- four to six weeks when we had the surge period. And then, as the business settled down and got into a more normal state, we saw more routine transaction counts and baskets. What I would tell you is, we're going to continue to see this. It's going to be noisy in Q3. And really, it won't be until we get to Q4, when we've cycled past all the opening cycles -- all the densification -- that we get a real read on what's going on, on a comparable basis from the business year-over-year. + + + Thanks. + + + Thank you. + +Answer_11: + + Thanks, Matt. + +Answer_12: + + Well, haven't thought about it in terms of innings, Matt. But I'll tell you, we are excited about what we have coming for the fall season. I highlighted a lot of things that are coming in September and October. But then moving on to the fourth quarter, which we won't be specific about today, but we're excited about what that brings as well. We have about 85,000 items in our assortment, and we'll have 35,000 new items this fall season. So I do feel pretty optimistic about the content, the quality, the trend, the presentation. But, clearly, in spring, I think you'll see that will be a full cycle out. And we'll have much more to come, as we turn the corner into the spring season. + + + Matt, thank you. Operator, I think we've got time for one last question. + +Answer_13: + + Yes. The guest that shops Target online is absolutely our best guest. They shop both online and in stores. It's really all about what's convenient for them, and sometimes it's just easier to knock an item off your list by buying it on your mobile device. Sometimes you want to purchase it online but pick it up in store to do the rest. But this is absolutely our best guest and one we will not cede. We will go after being a seamless, omnichannel retailer with confidence, knowing that it's the best thing for our guest and best thing for our business. And I do think that, when you think about the lapsed guests, they're basically back. +So traffic changes are more about consolidated trips and trips shifting online. So it's an important part for us to own, which is why you see all of the efforts in our omnichannel capabilities and strategies -- with subscriptions and with personalization and with ship from store and buy online, pick up in store. There's a lot of things that we're putting effort into that will help drive that momentum. + + + Right. + + + Simeon, thank you for the question. +That concludes our Target second-quarter 2014 earnings conference call. I thank all of you for your participation today. + + + + + + + diff --git a/exam/original-files/Problem_2_3_Sample_QandA/47_questions.txt b/exam/original-files/Problem_2_3_Sample_QandA/47_questions.txt new file mode 100644 index 0000000..444e14f --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_QandA/47_questions.txt @@ -0,0 +1,53 @@ +Question_1: + + Good morning, Brian and everyone. Brian, I had a question for you and then one for Kathee. When you arrived, the role of President was left open. I was curious whether or not you anticipate filling that role and any organizational structures that you might contemplate to speed the Company to getting to market. +And then Kathee, if you could just peel back the onion around why the UPT was down 1.7%. You made good progress on transactions, but you took a step back in UPT. And I'm just wondering why and what you expect for those metrics into the third and fourth quarter. Thank you. + +Question_2: + + Thank you very much. I just wanted to step back a little bit and look -- you talked about even gross margins for this year to 29% to 30% range. It's a pretty wide range. And as you think about a world -- an e-commerce world -- and how things are changing fairly rapidly out there, I'm just trying to get a sense if you think, over time, that the gross margins are within that range -- lower end of that range. And sort of how you're thinking about that competitive landscape. I mean, you talked a lot about a lot of new merchandising initiatives and stuff, which can help offset some of that. But at the same time, as every Company that we've seen get more focused and driven around e-commerce, seems to see their gross margins lower by the nature of what that business is. So I'd love to hear a little about your thought process there. Thank you. + +Question_3: + + I guess, just as a follow-up to that -- if the guest does go more rapidly towards dot-com, are you willing to accept lower gross margins to do that? And then, I guess, a related question to that, too -- you talked about opening stores for greater hours. Is there an SG&A investment, as well, that would be related to e-commerce -- aside from just the build out of e-commerce -- that you think that you need to add to the stores -- once again, as this world is shifting? Thank you very much. + +Question_4: + + Thanks a lot. Good morning. Brian, I'd like to start out by asking you for your long-term perspective of threshold for Canada, as relates to time and financial performance. Obviously, that business today is performing at a materially lower level than was originally conceived when it was opened and presumably well, well below its cost of capital. What would you want to see over time, to keep that business running? And what kind of time frame do you have in mind for seeing material improvement in that business? + +Question_5: + + Thanks for that. Just a quick follow-up on the US business. In the markets where buy online, pick up in store is more mature, how additive do you find that is, either to online sales or to the business overall? I know for some retailers, it can be as much as 30% or 40% of the overall online sales numbers. Where you have the most track record behind you, if you will, what's your sense of how additive that can be? + +Question_6: + + Thanks. John, I wanted to follow up of bit on the gross margin -- down 100 BPs in the quarter. If I remember correctly, you had a goal for $600 million of cost reductions this year, roughly a third of it in cost of goods sold. Could you give us an update as to where we are on that and how much that may have helped the quarter, in terms of US margin? + +Question_7: + + The same with the SG&A? Out of that $650 million, it's more back end? + +Question_8: + + For your opening comments, how long do you think it will take for you to get to understand the business and the customers and actually come up with a plan? Is that something we should expect by year end or early next year? Can you give us any time horizon on that? + +Question_9: + + Thanks a lot, and good morning. I was wanting to get some more detail on the improved performance in July and August. And I'm wondering if you have a sense, from your guest surveys, how much of that change is driven by price investments, efforts to improve the presentation, or maybe a change in the broader environment? + +Question_10: + + That's very helpful. And then one housekeeping follow-up if I may. Your Canada comp transactions were only down about 2%, which, frankly, was a little bit surprising against the grand opening halo. I'm wondering why UPT was down so much. I think it was down over 8%. + +Question_11: + + Hi, yes. Good morning, and welcome, Brian. Kathee, my question is actually -- + +Question_12: + + Kathee, my question is actually for you. You talk a lot about product and freshness and newness. And I was just wondering -- as you look to the fall merchandise plan, how far can you push freshness and newness into that plan? What inning would you say that represents, overall, relative to what you consider to be more optimal level? And when can we realistically expect you to reach that more optimal level? Thank you. + +Question_13: + + Thanks. Good morning, and welcome, Brian. Quick one for Kathee. We talked in New York, about a month ago, about traffic trips and that 9 out of 10 were still intact from the customer. But you had lost 1 out of 10. And that, maybe, e-commerce was the angle of you to get that back. My question is, how confident -- I don't know if you have any early indications from your own data -- that when that customer does shop online with you, that either they're not going to visit the store less, or that they'll not maintain the same level of purchasing? + diff --git a/exam/original-files/Problem_2_3_Sample_QandA/48_answers.txt b/exam/original-files/Problem_2_3_Sample_QandA/48_answers.txt new file mode 100644 index 0000000..4f6a6f2 --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_QandA/48_answers.txt @@ -0,0 +1,110 @@ +Answer_1: + + Yes, I think a couple things. Certainly there would likely be some benefits if we continue to see fuel prices come down. But we haven't reached the threshold where fuel surcharges begin to come out of our contracts. +And I think importantly, given the great work the team has done to manage some of the port issues out west, we're working around that and moving some freight further, expediting some freight, flying some freight, and I think net-net, that will probably be more of a drag than any fuel savings we will see. + +Answer_2: + + Yes, Sean, this is Kathee. It's predominantly a mix story for us. So we have higher ticket items like all the Apple products, including the launch of the iPhone 6 in the quarter. We've got video game consoles that are higher. +We have a lot of trade-up strategies both in essentials, like you talked about, like in grocery with organics, but also in areas like skin care, which I described a little bit earlier. So this is really a mix story. + +Answer_3: + + Correct, correct. + +Answer_4: + + Hi, Matt. Yes, I think the expense savings, I would tell you we've talked about the expense optimization efforts all year. Been very focused on that and has been across the entire enterprise. And we've seen good news in SG&A and also in cost of goods. +The couple of areas I would point out, the store's performance has been outstanding, driving productivity increases while still continuing to remain very strong guest service scores. Frankly, our guest service scores historically, so we've seen great performance there. +And then it's really many other areas. There's been great work done in marketing around the circular, there's been great work done in our transportation and how we optimize our network of transportation. So really across the enterprise. +I think importantly to your question about going forward, we believe there continues to be significant opportunity for us to continue to take expense out and so for the foreseeable future, we would expect to continue to see expenses very well controlled and to lever expenses at really relatively modest increases in sales. + + + Matt, it's Brian. And to build on John's point and as I discussed in my prepared comments, as we move forward, we recognize that we're going to continue to need to focus on expense management to fuel the investments we're going to make to drive continued growth across our store base and our digital platform. +So as we come back to you in the spring and we talk more specifically about our strategy, you should expect us to continue to talk about cost optimization efforts and how we'll use those efforts to reinvest in the fuel that's going to drive our growth. + +Answer_5: + + Yes, it's not accretive. I will tell you, we do ship even prior to the holiday free shipping, we do free ship a lot more than perhaps you would think and certainly more than some of our competitors, given REDcard and the fact that ships free all year around. +So we have seen -- we know it's the number one frustration with our guests and the number one reason for abandoned carts. And so it was important for us this holiday season to be able to take that friction away and we have seen a meaningful move in orders and conversion because of it. So we are very pleased with the results so far. + + + Matt, the only thing I'd add, while not accretive, the other thing I would add is not material either to our results in the fourth quarter. + +Answer_6: + + Oliver, I think as we go forward, and as Kathee and the team really elevate our focus around those signature categories, categories like baby and kids, wellness and style, you should expect to see additional focus in-store. You should see additional innovation, partnerships, but really ensuring that we're leading with trend. We're anticipating what our guest is looking for in those categories, and those are categories that Target becomes famous for. +And we're certainly going to double down our efforts in those categories because our guest has asked us to. They're categories that are very important to our guests. They're synonymous with the Target experience the guest is expecting. And you'll see signs of that as we move into 2015 and beyond. +Certainly, some of the work that Kathee and her team have done in preparation for the fourth quarter are already bringing our efforts to light in apparel. Some of the things that we've done in home, the partnerships that Kathee talked about in her prepared comments, our continued focus on baby and kids. And we know how important toys are during the holiday season. So we're already making progress in those spaces. +But I also want to make sure it's really clear that does not mean we're walking away from other categories in our stores. They just play a different role in our future strategy. And they'll continue to be areas where we're going to look to improve our execution and performance. +But from a prioritization standpoint, we think those signature categories that we've talked about are key to the guest. The guest has told us those are critically important to them. And Kathee and her team are working rapidly to ensure that we continue to build our position, enhance our assortment, and bring great newness and innovation to those key categories. + + + So couple things that I would add to that that you will already see in stores right now. Brian talked about those four areas, baby, kids, wellness and style. So in baby, about 200 stores have a new presentation where we've invested in labor in the stores to help guests create registry and gift givers find the perfect gifts. We've added mannequins and things that help the presentation. +I also shared today that the registry that we have redone completely, the whole experience, from the in-store hardware to the software that we use and how that helps guests create registries much easier, we're already seeing the benefit of that. +Wellness, we've talked a lot about Made to Matter, better-for-you products, and you see that already this year. And then in style, to touch on that for a minute, we now have about 650 stores that have our new presentation in apparel, including mannequins. So already some progress and we will continue to push forward in those areas and you'll see more and more as the months and year goes on. + + + However, the final point I'd add as we think about style, certainly apparel and home are critically important in that space, but so is beauty. And as John and Kathee have referenced, beauty was one of our standout categories in the third quarter, and we expect continued strong performance as we exit the year. + +Answer_7: + + Oliver I think we're making progress across a number of different areas. Certainly, we talked about omnichannel and really making sure that we are a significant player in this space. And we're seeing very strong performance, up over 30% in the third quarter. John talked about the fact that we expect that performance to accelerate in Q4. +We clearly took away the pain point of shipping by announcing free ship in the fourth quarter. And we think that's another way for us to declare we are significantly committed to this space. We're seeing a great response to Cartwheel, 11 million users to date. And we're going to use that to make sure that we use digital as the front door to connect to the Target brand going forward. +We've talked about some of the progress that's being made in merchandising and we've got 35,000 new items in stores for the holiday. And we're going to continue to test and partner as we continue to make sure we're bringing the right solutions to our guests. If you haven't seen some of the holiday creative, I think it's some of the best Target's delivered in years. +And I'm getting e-mails and comments from guests and friends and people I know every day talking about their reaction to the holiday creative and how the creative campaign, it's uniquely Target. And we're certainly upping our game both in-store. But we're also going to spend significantly more in digital this year, to touch our guests no matter how they're connecting with the brand. +In-store, we've made significant progress in a very short period of time, going from testing ship from store to now we're in 38 markets, 136 stores, where our stores are acting like flexible fulfillment centers. You can shop there, you can pick up there. But they're also shipping to, directly to our guests and allows us to cover 90% of our marketplace in a very short period of time. Takes the pain away from that last mile. +So I think you're going to continue to see us make these points. And that's a sneak peek of Target in the future. And I think that is creating positive energy in the organization. +Kathee and I are hearing really positive things from our vendors. Our organization knows we've got to be more -- we've got to show more agility. We've got to be responsive. We've got to make sure we're externally focused and following the guest. But I think you're seeing some of those things take shape today. + +Answer_8: + + Wayne, we haven't modeled exactly what that will be yet. But I would tell you, I think that it will be moving up for a couple of reasons. So you heard Brian talk about those areas that we're going to focus on and really being famous for them and delighting our guests. And when we are at our best, we offer both Expect More, Pay Less together in all of these categories. +And that means a really thoughtful balance of good, better, best, having clear features and benefits as we move up that ladder, allowing guests to be able to buy whatever's important to them. But importantly, offering really good trade-up opportunities. +So you're seeing some of that right now in some categories. But I think as we move forward and we become famous, again, for some of these categories, there will be a lot of trade-up opportunity. So I would say overall, seeing it moving up. + + + And then Wayne, your second question, inventory, I think the one thing I'd say, if you look at our number this quarter, 6% to 7% all the US, really only about a third of this do we view as temporary. The vast majority of that was receipt timing. But that third, we expect to stay around. We started that in second quarter this year. +We'll cycle it again next year in second quarter, somewhere around a 2% to 3% increase for the first half of next year. But offsetting that ultimately, as we start to get back to positive comp sales, we should see faster turn. That should ultimately lead to better payables leverage. So not a meaningful impact overall once we get past fourth quarter here on our working capital. + +Answer_9: + + On margin, it's definitely dilutive, Greg, if for no other reason than the shipping expense. And I think as it continues to grow, that will put margin pressure on the P&L. And we've talked a little bit about this. There are lots of puts and takes in gross margin as we think about it going forward that we're working through today. +As that business grows, it will be margin dilutive. But as we increase penetration of ship from store and pick up in store, that significantly not only improves our guest experience, but significantly improves the P&L. +We're also balancing how we look at pricing right now and balancing inventories across the network as we ship from store. So some of those are up, some of those are down. And we're working through right now where ultimately gross margin will land. + +Answer_10: + + Greg, we're assessing that right now as we think about 2015 and beyond. But you should expect us to be investing in the capabilities to continue to build out our digital experience. To continue to enhance our in-store experience. To make sure we have the analytical tools to properly manage expenses and margin even more surgically going forward. +And I talked about -- while certainly in the early stages, we're going to continue to look at smaller formats and how we use smaller formats to penetrate urban markets, allow our guest the chance to interact with the Target brand both in-store, but also continue to build out the opportunity for them to purchase online. +So we're in the early stages of assessing our long-term capital needs, but you should expect us to be investing in the right capabilities and tools to provide long-term shareholder value and allow us to continue to fuel our growth and enhance both margins and continue to manage operating expenses effectively. + +Answer_11: + + Greg, we think -- at least Brian said I think with the caveat that we're working through this right now, we think we're probably in about the right range right now. The spend may move around a little bit. I think the one wild card is the point Brian made about small formats. +But I would note that obviously the investment there is significantly below what a prototypical Target would look like. So it would take a lot of those to meaningfully move our CapEx number. Like we've talked about, something for the US in that $2 billion, $2.5 billion range still makes sense, but we're doing the work right now. + +Answer_12: + + Yes, most of it is marketing moved around. And the magnitude, if you think about us beating by somewhere in the neighborhood of $0.09, it was a little bit less than half the beat. So somewhere in that $30 million to $40 million moved between the quarters. + +Answer_13: + + Well, I wouldn't want to get into that level of detail. Clearly, last year pre breach was stronger than post breach, and we took that into account as we thought about the calendarization of the plan. And right now we're running ahead of that and we feel good about where we're at, not only relative to the plan, but on an absolute basis is what I'd say. But there is a lot of business left to be done before we get to the end of January. + +Answer_14: + + Yes and let's drop back and make sure we clarify our point on the food category. We have no intentions today to streamline those categories, but Kathee and the team are certainly stepping back and listening to the guest, really understanding what the Target guest is looking for in food. From an assortment standpoint, from a newness standpoint, we talked about the fact that as we go forward, you should expect to see more natural and organic offerings. +We've seen a terrific response from the guest as something that we call Made to Matter, a collection of items that are on trend for our Target guest, feature a number of exclusive items that Target from manufacturers that are in the organic and natural space, that can bring great innovation, gluten-free, on-trend products to our guests. And we certainly recognize that we have an opportunity to connect with the guest in a different way when it comes to food. +But you shouldn't expect us to deemphasize those categories. That's not the point. We're not streamlining our food offering, but we are stepping back and really listening to the guest, making sure we curate on their behalf the right items that are uniquely Target, that meet the needs of our guests in the food categories. +So a lot more to come as we talk about this in the first quarter, but to make sure we're really clear, we're not streamlining food. We're not deemphasizing food. We're not walking away from food. But we certainly want to make sure we put our mark on the food category with items that are uniquely Target, that are right for our guests, that are on trend. And you should certainly expect to see more natural, organic offerings in that space because the Target guest has asked for them. + +Answer_15: + + We would certainly expect to see that. And Kathee talked about some of the changes we're seeing in mix. And certainly when we talk about natural organic and when we talk about some of these unique items, they tend to have a higher average unit rank. +So you should expect to see some mix changes, but importantly, food is an important part of our future. We're not going to deemphasize the category. We're not looking to take away space. We want it to be more impactful, more on trend, and we want to fill it with items that the Target guest is looking for. + +Answer_16: + + That concludes Target's third-quarter 2014 earnings conference call. Thank you all for your participation. + diff --git a/exam/original-files/Problem_2_3_Sample_QandA/48_questions.txt b/exam/original-files/Problem_2_3_Sample_QandA/48_questions.txt new file mode 100644 index 0000000..65adb87 --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_QandA/48_questions.txt @@ -0,0 +1,68 @@ +Question_1: + + John, you mentioned there has been a lot of talk about gas prices and the potential positive benefits on the consumer. But curious if you could speak to the potential benefit you may receive on the P&L from a distribution standpoint and if those are savings that are there, how would you guys look to use those additional distribution savings between flowing through to earnings and potentially reinvesting to drive traffic? + +Question_2: + + Okay. So and then the second question on the overall basket, the UPT continues to be -- to decline and actually looks like it decelerated a little bit on a two-year basis. Wondering if you could give us a little bit more color around that particular dynamic, either at the store level perspective, given the higher food concentration, I would be expecting that to improve, but maybe this is being offset by online. And I guess the follow up would be, how do you improve that dynamic moving forward? Thanks. + +Question_3: + + Okay. So it's less about the shift between online and store at this point in time? + +Question_4: + + Good morning and congrats on improved US results. My first question is on expenses in the US. They basically have been running flat on a dollar basis this year, down a little bit per foot. I'm wondering if you can get into a little more detail on what's driving the cost savings? +And then in terms of the outlook, is this a line that you think you can run flat to up in dollars, up slightly in dollars over the next year or so, or should we expect it to grow a little faster than that? + +Question_5: + + Okay, that's great. And then secondly on www.target.com, I wanted to ask a question about the free shipping program. Does the incremental volume offset the incremental shipping expense? Is it profit accretive? And do you think the customers that are utilizing this offer are high lifetime value customers? + +Question_6: + + Thank you and congrats. Regarding the great idea regarding signature categories and where you're focusing there, how would you help us prioritize which categories have the most opportunities in terms of lead time and revenue mix and timing of impact? And is the extrapolation there that traffic will be the biggest comp upside driver as you do focus on these categories? Thanks. + +Question_7: + + Thank you. And as a follow up and it's related, there seems to be a lot of energized agility, Brian, regarding thinking about what Target stands for from a bigger picture perspective. What are some of the initial thoughts on where you see that opportunity as you work to further differentiate and innovate yourself? + +Question_8: + + Kathee, I had a question, this is maybe a little bit longer term and it plays into the context of how you evolve the Company. And that is related to where you see AUR trending, because you're talking about more emphasis in kids and baby, which typically is lower ticket and maybe pulling back on promotions in electronics because that's not a core. I'm wondering where you think your AUR might land over the next few years in light of the 2% to 3% growth you've been experiencing under the existing strategy. +And then if you could talk about -- John, if you could talk about the growth in inventory next year and its impact on working capital, as you think about being better in stock on the ad merchandise and the like. Thank you. + +Question_9: + + I have two questions that are a little bit lengthy. John, if we start off on dot-com, which if my algebra is right it's around 2.5% of sales in the quarter, what does that do to the margin going forward? +I know you mentioned it's immaterial for the fourth quarter, but tell us what it did in the third quarter and how we should think about it. It's probably dilutive of some effect and whether it's more in gross margin or SG&A. And then I had a follow up. + +Question_10: + + And then the follow up, and maybe Brian you in your comments, you talked about making sure in the five key operating principles, that invest to build capabilities. I love your perspective on this year CapEx is down a lot and we're running I guess a little over $2 billion is the run rate. What do you think is the CapEx need going forward to invest in what Target really needs to do to be the best it can be? + +Question_11: + + Would that mean CapEx would be above D&A at some point in the future or do you think you can stay below that? + +Question_12: + + I know there's a lot of big picture questions to discuss, but actually I have two quantitative ones related to the quarter. First of all, John, can you talk about the expense, the magnitude of the expense dollars that shifted from the third quarter to the fourth and talk about perhaps functionally speaking what they're related to? + +Question_13: + + Got it, thanks for that. And then secondly, you talked about running ahead of the fourth quarter plan. As we think about the cadence of that plan, obviously you had a tough January, as did many retailers particularly given the breach. +So when you say running ahead, is that running ahead of the 2% number as we speak or running ahead of a plan that's maybe a bit more nuanced than that as we think about where we are in the progression of the quarter and your compares a year ago? + +Question_14: + + Thanks a lot for taking my question, it's on the food category. And recognizing you're not going to deemphasize it, you're just going to streamline it, how are you thinking about the return profile of that space within the store? And then could there be any differences amongst how space is allocated, could that area get less over time? + +Question_15: + + Okay, that's very helpful. And you think you can manage the return profile on that space to certainly meet the hurdle [rates] that you expect from it? + +Question_16: + + Okay, that's very helpful and good luck with the rest of the holiday. + diff --git a/exam/original-files/Problem_2_3_Sample_QandA/49_answers.txt b/exam/original-files/Problem_2_3_Sample_QandA/49_answers.txt new file mode 100644 index 0000000..078e426 --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_QandA/49_answers.txt @@ -0,0 +1,121 @@ +Answer_1: + + Sure, I'll start, and I'm sure Kathee will jump in. But I think overall, what you observed is there's strictly some savings relative to last year with the clearance activity that went on. But I think much more important to that is, you saw the acceleration of the signature categories; home, apparel, style, kids. +Many of those with margin rates well in excess of our average margin rate. And I think for the first time, Kathee and I couldn't even remember the last time where both home and apparel out-comped the Company. So we saw a very strong mix in the quarter, delivered by the product in the stores. + + + Yes, so on top of the mix, I would also say that regular priced sell-through was very high. So less on clearance or mark down, and more at full retail which also contributed. + +Answer_2: + + We don't disclose the average wage for our team members. What I would tell you is, the store's team has always been appointed differentiation for Target. And we've always prided ourselves, and believe we have the best team in retail. So very focused on ensuring we have competitive wages and that we're developing our team members. +We're all the time assessing the marketplace to determine competitive wages and making adjustments, and we feel very confident that we'll be paying the teams appropriately. I think importantly, if you look at our team leaders, 60% of them came from team members. +So development is a really big part of what we offer to our team as they progress. Overall as we look at some of the announcements that have been made and the marketplace and the minimum wage legislation that's been [enacted], really hasn't changed our view of the quarter or the year really at all. And won't be material changes to us. + + + I just want to build on that. I'm sure we're going to receive this question again next week. But to John's point, and our goal is to make sure we have the very best team in retail. +And we're going to continue to invest in their development. And make sure that from a marketplace standpoint, we're very competitive with the wages we provide. So I've been very pleased to learn that over 60% of our team leaders actually started as part-time hourly employees. +That development is critically important. It allows us to attract terrific team members. And as John stated, we do not expect to see any material change next year. + +Answer_3: + + Well it's certainly going to be an area that we'll highlight next week. And I think you've captured it really, really well. Our focus right now throughout the organization is to reduce complexity, simplify the way we work, the way we operate each and every day, continue to empower our team members to make the right decisions that are going to impact the business. +We want to create an organization that's much more agile, that moves with much increased pace as we go forward. And we deliver the right innovation and product that our guest is looking for. So it is a significant area of focus for us. +We're going to talk about it in great detail. But we think it's going to be a very important part of our strategy going forward. It's going to fuel the key growth priorities that we've been talking about, and we'll go through in great detail next week. +But our goal is to make sure we eliminate complexity at Target, we simplify our operating model. We empower our team members. And create an environment where we're agile, we're taking advantage of marketplace opportunities, and we're bringing products and services to market that respond to the needs of our guest. + +Answer_4: + + Actually, the return rates were higher than our expectation, but they were essentially right on last year. We had seen some improvement throughout most of the year, and they basically just returned to last year. +So not a material change. Just a little bit different than our expectation for the last couple weeks. + +Answer_5: + + Scott, while there's certainly a number of critically important metrics as we look at the business going forward. I can tell you that the entire leadership team has prioritized, one, increasing traffic to our stores, and two, visits to our site. Those are critically important as we go forward. +So we're going to do that by executing many of the priorities that we outlined today. We certainly want to make sure we're building the right digital, and importantly mobile capabilities, that drive greater visits to our site and build greater engagement with our guests. Not only when they're shopping at home, but also when they're shopping inside of our stores. +And Cartwheel is a great example of how we've used digital to drive greater engagement. I am really pleased, and Kathee highlighted the fact that our signature categories drove our growth in the fourth quarter. And it's critically important that while we're in the early stages, we're already seeing the guests react well to our focus on style, on baby, and kids, and importantly wellness. +And the fact that healthcare and beauty and home and apparel outpaced our overall performance in the fourth quarter, is a sign that we're connecting with the guest. And we're certainly driving more of the traffic because of these great new offerings in store. +So our focus on elevating signature categories, we think brings our guest back to Target more often. They're going to be coming back in to see what's new. And Kathee and her team have a great lineup in 2015 of new exciting products, coupled with an improvement in our in-store experience and merchandising. +So those elements are critically important. We think localization allows us to build a more meaningful relationship with the guest, which will result in more traffic and more visits. And certainly as we expand our smaller formats. Both City Target and Target Express, it's a way for us to engage the guest in these urban settings that are critically important. +So all of those are focused on making sure we build greater engagement. But the metrics that are going to be important for us is to ensure it results in more traffic, like it did in the fourth quarter, and more visits to our site. So we're pleased with Q4. +Lots of work in front of us. But I felt very good, as did the entire leadership team, that our comp increase of 3.8% in the fourth quarter was primarily driven by traffic. And our industry-leading growth in digital was certainly going to be fueled by more visits and better conversion from our site. + +Answer_6: + + Scott, I think you already know the answer to that, and we're going to talk about this specifically next week. Food is very important to our guests. And they've confirmed that with us as we've gone back and researched the food category through the eyes of the guest recently. +We all know food trips drive traffic. And we want to make sure we compliment our signature categories with guests that are coming to us for the great food products we can curate. We recognize we have a lot of work to do in food. +And Kathee and I were recently out in the market together. We spent several days visiting our stores, looking at competitive food retailers, as we begin to build our reinvention plans for food. But as Kathee will talk about next week, we recognize we need to make changes to our assortment. +Made to Matter and some of the changes we're making right now in our assortment that deliver more organic, natural, gluten-free items critically important to the guest. And we also recognize we have to change the in-store experience, and really make sure our food and grocery merchandising compliments the great experience we create at Target. So a critically important area of opportunity. +We won't get there overnight. It will be a multi-year transition. But food is going to play a very important role in complimenting our other signature categories, and making sure we drive traffic to our stores and to our site. + + + Scott, thanks. Hopefully we'll see you next week. + +Answer_7: + + Matt, we'll certainly go through much more of this next week. I think if you were to look at the changes we made from a marketing standpoint in the fourth quarter, the big change would have been a significant increase in our digital support of our brands. So as we continue to make sure we're connecting with our guests, we're connecting with them the way they're looking to connect with the Target brand, digital is going to play an increasingly important role. +And we were very pleased with our overall marketing in the fourth quarter. We had some outstanding creative on air. It received very positive response from the guest, and we complimented that with a very strong digital campaign. +So I felt and the team felt very good about the progress we made from a marketing standpoint in the fourth quarter. We had creative that broke through the clutter, connected with our guest, drove traffic to our stores. We complimented that with really impactful digital and online communication, and tied that back in with great in-store marketing. +So you'll see more of that as we go forward into 2015. And we'll take you through a lot more of the investments and the plans we have when we see you next week. + +Answer_8: + + Sean, we're going to talk about food in much more depth next week. But fresh is a very important part of food. Not only traffic and number of trips for our guests, but just in terms of what's important to them, in terms of wellness. +Fresh food plays a very important part. And as Brian said, we've got a lot of work to do here. So both in Super Target as well as in P Fresh format. And it centers around our assortment, how fresh the product is, and ways that we can improve upon that, the presentation, showing abundance in that great product. +So we have a lot of work to do. But critically important to us because our guest has said they want to be able to eat better both natural and organic. We see it in our results today. And we know that there's much, much more opportunity. + +Answer_9: + + Sure. Lots of variability across categories, as is always the case. We saw some inflation in food. We saw a lot of deflation in electronics, like we always do. But if you look across the entirety of our business, essentially flat to last year. So no net impact to the business from inflation in aggregate, but as I said, lots of variability within that. + +Answer_10: + + Michael, let me start, and I'll let Kathee and John jump in. I think you've certainly identified some of the big levers. And I think as we sit here today, we recognize that the consumer confidence has certainly improved. Lower gas prices, certainly helping the industry overall. We did have some favorable overlaps certainly as we overlapped the breach. +But I also think we made significant strides from a merchandising standpoint, from a marketing standpoint, and we continue to deliver great execution and service inside the stores. And when you look at the two year stacks, we had a very challenging November, a very strong November from 2013 that we overlapped and saw growth. That to me was a sign that not only was the consumer healthier, but they were choosing to spend their dollars in Target stores. +And they came back in December, as Kathee alluded to. We had a very strong close to the holiday season. But importantly, we felt really good about traffic and our performance in January, particularly in the last two weeks of the quarter. +So a combination of we certainly did have some issues from last year that we are overlapping. The consumer, we do believe is healthier. And we're pleased that they're spending in our stores, both in our stores and online. +But I also think we made significant strides from a merchandising standpoint. We had terrific marketing, and a great digital connection with our guest. We were able to leverage both an improved in-store experience, the convenience of shopping online and picking up in store. +And we had industry-leading online sales, and we leveraged our stores to help make sure that we fulfilled the needs of our guest. So I think the combination of all those elements added up to a very solid quarter. + + + The only thing that I would add to that is just that a lot of that focus came in our signature categories, which is why you saw our growth there in particular. So major investment in product, both quality as well as aesthetic, and number of SKUs, newness that we brought to the market. +The marketing reinforced that, and that was very well received by our guest. And then coupled with presentation, both online with enhancements in our app and our desktop site. And the presentation in our store, driven by focus on signature categories really helped drive our growth. + +Answer_11: + + I think we continued to see gift card redemption. We intentionally -- we had a significant gift card promotion on Black Friday that was very successful. We saw all of those come back in January. I think that helped. +And we saw continued strength in the product in home and apparel. Very strong sales in home and apparel, and I think that was an element of it as well. And I think that it's a combination of both. + + + And our wellness business is healthy. As we turn the corner in to the new year, we saw that continue. +So the trade up that we had seen during Christmas, we saw continue into January. Which is just guest choice for products in our discretionary categories. So I think lots of things drove it. + + + Michael, I think, well summarized. I would put four elements on the list. John talked about gift cards, I think that was very important. And we certainly saw our guest come back to Target with gift cards after the holidays in through January. Our focus on wellness, certainly well received by the guest. We had great newness in our stores to start the new year. +And our store teams did a terrific job of recovering of the holidays. And we offered our guest a very strong in-store shopping experience. So a lot of the basics. +But our gift card plans were well executed. We saw the guest come back in January. Our focus on wellness, that important signature category. Well received. We brought newness into the stores to start the year. And our store teams did a traffic job of recovering after a very busy Christmas holiday season. + + + Thank you. I think we've got time for one more question today. + +Answer_12: + + Health and beauty were both very strong. So in the health categories, that spread across many categories. I talked about Made to Matter. I talked about better for you product in food. But it was also in our health business and our style business. Both beauty was strong, as well as in apparel it was driven really by kids and by babies. +And in home, it was domestics and seasonal product. And then in kids, we had incredible season in toys with a double-digit comp. We really were pleased with the overall holiday. + + + As we mentioned earlier in the call, wellness, home, apparel all comped in excess of the 3.8% we reported in the quarter. So strength across all those categories. +And in order to win in the fourth quarter, you have to win in toys. Well, our team won in toys, and showing a double-digit comp was critically important. So we felt very good about the early progress in those signature categories, and we'll build off of that momentum as we go in to 2015. + +Answer_13: + + I think Brian hit on it earlier. We're continuing to drive for positive traffic. I think positive in the store and growing digital online, and that's part of our guidance. + +Answer_14: + + Yes, I think like we said, it was a little bit of deleveraging. There was some marketing expense we talked about in November, moved from November into -- or from Q3 in to Q4. As Brian said, we made some investments in marketing. The other elements were ongoing all year. We had some technology. +And then the thing that really drove a lot of it relative to the other quarters was incentive expense. We clearly out delivered our expectations, and that will be reflected in our incentive expense. + + + Thanks for joining us today. That's going to conclude our fourth-quarter 2014 earnings conference call. We appreciate everyone's participation today, and we really look forward to seeing you next week in New York City. So thank you again. + diff --git a/exam/original-files/Problem_2_3_Sample_QandA/49_questions.txt b/exam/original-files/Problem_2_3_Sample_QandA/49_questions.txt new file mode 100644 index 0000000..90f5774 --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_QandA/49_questions.txt @@ -0,0 +1,60 @@ +Question_1: + + Thanks, good morning. It's Simeon Gutman. First question on gross margin for John or for Brian. It was quite solid in the fourth quarter. Last year, you had a little pressure but not nearly as much as I guess we all expected given some of the discounting. So can you talk about what drove the expansion year-over-year in this year's fourth quarter? + +Question_2: + + Okay, and just one follow up. I'm sure this will get addressed next week, but can you just tell us what the average wage for full-time associates and/or part-time associates are at Target? + +Question_3: + + Thanks for taking my question. I want to follow up on that last comment around wages. Brian, could you just provide some context around how much opportunity you think there is to reduce complexity and improve efficiency in case you needed to respond to wages or you wanted to respond? + +Question_4: + + Thanks. And then just a quick followup on the higher online return rates. Do you think that's primarily a function of the free shipping offer? Is it more prevalent in certain categories? And is it related at all to error rates? + +Question_5: + + Hey, guys. Thanks for taking my questions. The first thing I wanted to poke at was frequency. Brian, you mentioned that you were real pleased with the frequency going up in the quarter. +Is that a focus for the Company to drive frequency to the stores? And maybe as a preview, how do you get it done? + +Question_6: + + That's perfect. And I just had one quick follow up. I have a ton of questions, but I'm just going to do one quick followup to what you said, Brian. +You didn't mention, although Kathee did, she mentioned food. How do you think of food in context to traffic? And then I'll yield. Thank you. + +Question_7: + + Thanks a lot, and good morning. If you could frame some of the marketing and technology spending in the fourth quarter, just let us know what that was directed towards. And I know you're holding back to some degree on 2015 guidance, but were some of those initiatives that you would expect to persist through the upcoming year? + +Question_8: + + Hello, guys. Good morning. I just wanted to follow up on the food question, and then specifically inside of the fresh component of the business. This was supposed to be a big part of driving transactions to the store over the long-term. +Could you just maybe give us a little bit on where Target is with its fresh offering today? How is it evolving, and are you happy with the performance of the sales and margins on this segment of the business? + +Question_9: + + Okay. And then maybe as a follow up here. Just on the inflation front, can you just give us an idea of how inflation trended maybe across the store in the quarter, and your expectations in the near and medium term? Thank you. + +Question_10: + + Good morning. Thanks a lot for taking my question. As you look back at the fourth quarter, can you dimension what you think the -- how the performance was driven by your own initiatives, the easy comparison versus last year, and just an improving macro environment due in part to the lower fuel prices? If there's any way you could potentially quantify that, I think it would be really helpful. + +Question_11: + + That's helpful. The follow-up question I had is, are there any particular call outs you can offer about the strength in the last two weeks of the quarter? It just strikes us as interesting, and we're curious about what drove that strength. Thank you. + +Question_12: + + That's great. Thanks. I had a couple follow-ups. +It would be great to know -- you said the signature categories did well. Do you have the actual numbers, like which ones were better by category for food and wellness, et cetera? + +Question_13: + + And maybe a follow-up on that momentum and seeing the traffic get back to up 3%. When you look out to your first quarter, that 2% expectation, do you expect traffic to be half of that comp or positive in the first quarter? Or what's built into your expectation? + +Question_14: + + Great. And then, John, maybe a quick follow-up on SG&A. It looked like -- and I could be backing the math out wrong here, but SG&A dollars in the fourth quarter accelerated to maybe 4% or 5% growth. Was there anything that caused that in particular? + diff --git a/exam/original-files/Problem_2_3_Sample_QandA/4_answers.txt b/exam/original-files/Problem_2_3_Sample_QandA/4_answers.txt new file mode 100644 index 0000000..4c2a9af --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_QandA/4_answers.txt @@ -0,0 +1,337 @@ +Answer_1: + + I think it may be a little bit the DC shutdown, but in reality, it's a complex thing. It's a Board level issue and we want a fair and reasonable settlement, if we can. And that's all we can really say about it. + + + It involves multiple agencies, so you can imagine the complexity. + +Answer_2: + + No, John. Unfortunately, we did as much as we can, give you as much clarity as we can, but we aren't going to be able to break that down for you. + +Answer_3: + + Yes, so John, the way to think about it, very candidly, is that we didn't expect when we estimated that -- remember it's a very difficult thing to estimate, there's significant uncertainty in terms of the estimate, significant judgment. And when we made those judgments in the second quarter, we didn't anticipate the environment being as volatile and escalating to the point that it has now. So as we have taken our reserves, and the reserves reflect today, so it reflects the current environment and the situation in fact that we're in, and we've now taken that into consideration as we look forward with our reasonably possible range. That's why it hasn't gone down anywhere near dollar to dollar, obviously. + +Answer_4: + + All we can say, John, is that we reserve for what's equitable, based on the facts and circumstances specific to each individual exposure, and the overall environment. + + + It's a tough environment, John. We're just trying to reflect that. + +Answer_5: + + So just two things, John, and I think in the Barclays presentation there was a slide that showed that of the increase in our outlook, there was a chunk of it that related to non-core prep litigation, so it certainly isn't entirely to do with our investment in cost and control, much of which we are funding through efficiencies. Having said that, there is an incremental cost. It is in part permanent, and it's going to be reflected in our run rate, but there was a good, I think $500 million is my recollection of other expenses including non-corporate litigation, which as you know, we don't adjust out. + +Answer_6: + + Yes, so the longer term target was a $325 million quarterly run rate, but that's over the longer term. What we said about 2013 and are on track to deliver is that we would exit the year with about $600 million of expenses in the fourth quarter. + + + Which we still expect. + + + Yes. Which is expected. So if you look at the third quarter run rate adjusted, it's about $650 million, down from just over $700 million in the second quarter, so that trend is moving in the right direction. + +Answer_7: + + So first of all, we're going to get there when we get there, but obviously, this Company is very sound, plenty of capital. We want to pass CCAR, but when you talk about capital plans, it's going to be subject to several things. One is the stock price, subject to passing CCAR with flying colors, which is really the stress test of CCAR, and also subject to wanting to meet our own targets for capital. So we've already said we want to get probably something North of 10% Basel III Tier 1 capital, et cetera and when we know all those numbers, do our budgets, we'll put the proper CCAR plan in place. + +Answer_8: + + I was pointing out mainly, Glenn, because I think if you go back several quarters over a year ago, standardized for us was lower than advanced by a reasonable spread, and clearly, when the common [store] amendment is applicable, which is not for a period of time, we would be looking at the lower of those two ratios. Right now, it's higher than the advanced approach, by a little more than 10 basis points. + + + We should put out when we do CCAR next year, effectively, it's not the same for every quarter, but effectively, it will be based on Basel III, which is a former volatile number because RWA moves around under stress under Basel III, as opposed under Basel I. + +Answer_9: + + Yes. + +Answer_10: + + Yes, so SLR, which I think you're referring to is 4.7%, remember that would go up by 50 basis points if you just subtracted the cash we hold at central banks. So until final rules come out I wouldn't overreact to it. Obviously SLR, it causes you to optimize differently, and a lot of products which are very high user capital under SLR, think of those as deposits, repo, and any of the short-term and low margin, revolvers et cetera. +So it will make you optimize differently, but I think in reality the way we look at it is, we'll be able to adjust to it, we'll probably be able to do it by client. We're going to get to the ratio we need to get to, and we want to do it without disrupting all of our clients. So we will be able to give you more detail when we know the final roles. + + + And remember, Glenn, there is still the possibility there will be changes made to reflect I think the FIN41, which you're talking about, which I think would be positive for the repo market. + +Answer_11: + + So on NII, Glenn? + +Answer_12: + + So yes, I mean, growth has flattened out in terms of interest earning assets, you seen that obviously take place over the last couple of quarters, and so our guidance is reflecting the fact that we have seen things stabilize, both NIM and NII, and that further near term that's what we're expecting. + +Answer_13: + + Listen, it's your job to forecast the future. We do think that it's very good businesses, and like I said, it's underlying growth, but obviously it could be swamped in the short run by markets and events, et cetera. We'll provide a lot more in Investor Day, and give you much more insight. + +Answer_14: + + So, I think there's two major things. First of all, the pre trade and post trade rules are in place, and basically they didn't have that much of effect on the business. And now you have the steps in place, and from talking to folks on the trading floor, volumes seem to be down a little bit, but not because of the steps. +The steps are basically accepting data at this point. They are not effectively making mortgage yet, so you haven't seen a huge effect of it. And I think over time, it still remains to be seen. + +Answer_15: + + Yes, because we'll meet the new targets and retain the capital, and eventually, we are actually already pushing down to the business. We're sorting to push down to the business units SLR, all the capital, all the stuff. Eventually, I mean LCR, eventually we'll put down SLR, and that will affect pricing and stuff. +What we don't want to do is do a lot of anticipation, but if revolvers stay at SLR at 100% drawn, the cost will go up. I'm not sure they will go up immediately but they will go up over time so we'll be able to get there. We just don't want to do stupid things in anticipation of rules, which we don't know what they are yet. + + + Betsy, our businesses are thinking through all of the implications. When the rules come out, we'll be able to act, but think about it as a measured approach. We don't want to overreact. We want to see how things play out, and at the margin, there will be changes to products and pricing but we'll be very measured. + + + So cash at central banks doesn't have to hold capital against, that's 50 basis points. If you took revolvers down to what we say is a normal draw, like even a stress draw of 20% which is what we saw in the crisis, there will be another 50 basis points, so we just want to be a little measured in how we deal with this. + +Answer_16: + + No, Betsy, this is really just the basic underlying run rate, which is about $650 million. Which does include some severance obviously, given actions taken to adjust capacity in the business, together with the $200 million item, which relates to foreclosure, it's nothing else. + +Answer_17: + + No, not anything of any significance. We have done some, but nothing major. + +Answer_18: + + We would love to reduce the uncertainty around this for ourselves and for you, but it's very hard to do. So the way I'd look at it is it will probably be elevated for the next year or two, not like we just went through, but it will necessarily be lumpy. So it might be as we settle, as we negotiate, as we figure out -- remember there are multiple agencies involved in every case now, so you saw in the CIO that we paid four, maybe eventually five penalties, which we really did not expect. So we just have to deal with it and deal with the reality that it is. It will abate over time, and the underlying power of the Company you can see, so-- + + + I wish I could give you a better answer, but one day, it won't be a big number. + +Answer_19: + + Well, I think you have to look at first of all, the big ones are really Board-level type of discussions and we -- our preference is always to resolve it. It is very hard to fight with your regulators or the Federal Government, but we want them to be fair and reasonable. We have shareholders, and those shareholders, by the way, I remind people, it's not me. It's veterans or retirees and mothers and we're trying to do the right thing. It's very hard. We've got the top people involved inside and outside the Company, and hopefully over time, we will make this a much smaller issue. + +Answer_20: + + Well it does, but again, we think we've maintained pretty good margins and pretty good capital, and we have different ways to optimize. And not all of the things we're simplifying were very profitable, and so remember, let's just focus on other things and the other things we're doing pretty well. Like almost every single business, we're up in share. And remember, the reason you go up in share is because you're doing a good job for clients. They vote with their feet, which means you're satisfying them. +So we're comfortable we'll be able to adjust to the new world and still have great businesses, and again, you haven't seen all of the repricing that might take place, you haven't seen the reactions and change in business strategies, and some things may move to the shadow banking world, which is fine. We'll figure it out. Like I mentioned, the needs of our clients, consumer, small business, middle market, large corporate, are not going away. They have to be served and satisfied somewhere. + +Answer_21: + + We've said 30% to 35%, and remember we do it pretty consistently after capital, and looking at value created, stuff like that so that hasn't changed, just came down a little this quarter. + +Answer_22: + + We said there were modest loss last year (multiple speakers) and they were about breakeven this quarter, and it's getting very small. + +Answer_23: + + Erica, two things. One is, if you just look at the firm wide leverage ratio for a second that 4.7%, obviously that maybe changes when the final rules are issued, but just take that as a base. We're only 30 basis points from the minimum and while we're targeting to go higher than that, clearly 30 basis points is not a great distance for us to cover. +And then I'd just reiterate what Jamie said, which is when we look at our 2014 CCAR, it will take into account a balanced set of facts and circumstances, so obviously both the quantitative and qualitative nature of the results of the stress test, but also our desire to want to get to capital levels that we've expressed, together with maintaining flexibility to do appropriate dividends and repurchases. So all those things together will be considered in the capital plan. + +Answer_24: + + So three things, just to clarify. Currently our standardized ratio is higher than advanced, albeit not by very wide margin, so just to clarify that point. Just generically, the advanced approach RWA sensitivity to a stress environment would be more impacted than a standardized approach, but remember, that's a 2014, that's a future issue for us. +The 2014 CCAR, as we understand the instructions, we will be looking at an additional test on top of the 5% Basel I, that will have a Basel I risk weighted assets for the denominator for the first four quarters, and Basel III standardized for the second four quarters. So it's a 2014 CCAR, the advanced approach isn't one of the critical tests, although it will likely be in the future. But in theory and in reality, that will reduce more dramatically on the stress than the other measure. + +Answer_25: + + It was relatively flat, Mike, in the low 30s, between 30% and 31%. + +Answer_26: + + So it's consistent with what we said at Investor Day, in terms of the remaining jobs turning out of the branch networking consumer, as we implement new technology and new operating models, and new branch formats. + +Answer_27: + + Well, I guess we're making huge progress on it, but it's not going to stop for years. It's permanent. + +Answer_28: + + So Mike, just what it's worth on page 2, very small in the footnote, we talk about that estimate of about 80% of MBS deal losses related to heritage investments. + + + That's losses. + +Answer_29: + + Yes. + +Answer_30: + + When you saw mortgage putback, are you talking about the GSE putback? + +Answer_31: + + I think have you to get that from other analysts who actually have published numbers like that. + +Answer_32: + + I think -- obviously, that's true, Mike, so because this is very painful for the Company, and so Bear Sterns we did do quickly. We didn't anticipate that we would be paying anything for prior losses for Bear Sterns. I tell people, even the Bear Sterns number, I think it was $80 billion of bonds were made good which would have failed that day, had they gone bankrupt. +And we did ask, we weren't completely stupid. We did ask the SEC for and only the SEC for would they please agree not to take enforcement actions against JPMorgan against things that happened at Bear, which of course they couldn't do outright, but they did say they would take into consideration the circumstances in which the transaction took place. +And in WaMu, we don't believe we're responsible by contract. But that does not mean that people can't come after you. So that was a little bit of a lesson learned too. + +Answer_33: + + We're going to do what's in the best interest of our shareholders, all things considered, it's a Board level decision. And it needs to be fair, reasonable, taking consideration all of the facts and have some possible -- we would like to get it done, and if we can't, that's the Board will make that decision. It's not a good choice either way. + +Answer_34: + + Mike, the factor there was candidly that you were all trying to do this, you had most, or at least a large number of analysts that published research papers trying to recreate settlements and reserves three times, and for this one time only, we felt like it was helpful and transparent and constructive to show you the magnitude of reserves after these actions. So that you can have that context when you think about the future. + +Answer_35: + + Yes, so first of all just to give context to that 6% to 7% down quarter over quarter, there is a portion of our expense base related to mortgage that's truly variable, so as production levels go down, we pay less compensation on the loans, and as a result, that's what you're seeing in this quarter. With respect to then rightsizing the expense base for the opportunity in the market, we have taken actions, as you have are aware in the third quarter, to start to do that; however, once you go beyond the truly variable costs, those actions take some four, or cases six months to truly get to the run rate. +So while we would expect to see that start to come to fruition in the fourth quarter, not completely in the quarter, more as a run rate matter. And then there is a portion of costs that are more fixed, in terms of our ability to be able to participate, whether it's real estate technology and a core infrastructure. We are obviously also taking a look at that, but we are in this business, and so there will be an element of fixed costs into obviously next year. +But you should expect that we're still seeing, absent lots go down slightly into the fourth quarter, so you should expect revenues will maybe be down, but expenses will also be down, for that net slight negative pretax margin that we've guided you to. That's still what we expect. + +Answer_36: + + Let me brag on our commercial bank and investment bank bankers And they've opened up branches I want to say Jacksonville, Sacramento, Nashville, so we're actually in more places in the commercial bank. Obviously, we've been building in the WaMu footprint in Florida and California, they've been doing an exceptional job. +And more importantly a high quality job, like we're really happy with the quality of the business we're booking. And our Investment Bankers you see the numbers in equity and debt and we didn't mention all of the deals that we are involved in but Verizon, and Sprint, and Nokia, there's good pipelines and good traffic. You know that can change tomorrow, but the fact is, we are satisfying our clients and we're thrilled with the business we're generating. + +Answer_37: + + So we don't expect or believe there should be any repercussions, but ultimately that's the regulators' decision so we resubmitted CCAR in September. We're still waiting for feedback. We get feedback in early December. We will do a good, thoughtful and appropriate job of thinking through our capital asks as we do the 2014 CCAR, so those will be the things that we do. + + + And we're doing very little stock buyback right now. + +Answer_38: + + Yes, Volker, more detail on SLR, more detail on how much long term debt, I think we have almost 20% of available resources today. And then you could look at things very basic and simple and say okay, well if the cost is a little bit higher and pricing stays the same and capital is higher, returns a little bit lower, that's true. But that doesn't take into consideration things we don't know which is repricing, competitor strategies, and our ability to optimize by client, by state, by region, by product +So all those things, we just give you a better idea. We're very comfortable we've got a very good business, but we'll give you a better idea of what we think it means by business. For example, we're going to allocate more capital and operating capital to the businesses, we'll ask them to optimize on SLR, and without damaging the client franchise, but we just will give you more detail. That's all. + +Answer_39: + + No, I think that a lot of people mentioned that they think it was inappropriate to apply capital to that, but the regulators will decide, whatever it is, we will be able to adjust to and conform to the rules. I would just point out that some of these things can move that number quite a bit and there's a reason why you shouldn't overreact to it and just take the time and do it right. We know the final rules, we will conform. + + + We conform very quickly, so it's just why would you conform very quickly and disrupt clients? So just think of it that way. We're trying to do the right thing to the client base and the Company. + + + We don't want to restrict, we could go out tomorrow and say we aren't going to make anymore revolvers, and we will be there very quickly. We just don't want to do that. It's not a rational way to run a business. + +Answer_40: + + Right. + +Answer_41: + + We are going to meet our targets through the run-off portfolio, which will cause a couple of things. Part of the CRM was a synthetic credit portfolio, which is, I'll say, 1/10 of the size it was a year ago and I don't remember the exact numbers, and we're still going to be optimizing across other products. There's certain things in mortgages that use up a lot of capital, et cetera. So we have more to go in optimizing RWA. + +Answer_42: + + No, no, that one, but they had a small correlation book in the IB, this was a synthetic credit portfolio moved over to the IB, and eventually it will probably be put together. + + + And much smaller. + +Answer_43: + + Yes. + + + Yes, we've received instructions and that does feature. + +Answer_44: + + And it wouldn't be the first time we modeled such an event as part of our stress testing. + +Answer_45: + + No. I think you should take that, I mean obviously it's very painful for me personally, because I agree with you, I don't like losing money obviously for my shareholders, and we put up, and Marianne has been very clear. These are very tough numbers to estimate, it's a heightened environment, multiple agencies are involved in often the same thing. We're just trying to improve and get better and move on. Remember, these reserves relate to things that took place over multiple years, so it isn't a one year event, and we still didn't lose money during the crisis. + +Answer_46: + + So I'm not expecting that the details and results will necessarily become public. Remember, it wasn't a quantitative issue per se. It was a qualitative issue, so what the regulators are looking for is our response to their recommendations and substantial progress in that. +I do think that it obviously would be public what their response has been to that, some time in December, and we'll work out exactly when that would be. So I would expect you to understand whether our plan has been accepted or otherwise at some point in December. And we're already working on the 2014 CCAR submission. Obviously that submission in early January, which means it's will be Board approval in December and that is starting. +All of the work, and Jamie talked about it, he talked about 500 people, thousands of people involved, models, documentation, covenants, controls, all of that work that we did for the resubmission is fully being leveraged for our ongoing CCAR processes, and we're building on it. So this for us will continue to become better over time, and 2014 will be another step in that process. + +Answer_47: + + Really most significantly, the other thing that we just talked about, which is in addition to all of the other minimum levels that we've been testing against, we have new tests under Basel III, albeit a test that recognizes savings in the capital numerator, and also a slightly different denominator through time, with different minimum levels of 4% in 2014, and 4.5% in 2015. So that's the other real big framework change. + +Answer_48: + + So we obviously can't comment on any sort of discussions or status of any specifics on litigation. Yes, you're right, the framework is probably an estimate. Also you should obviously assume that we didn't or couldn't estimate, all of these events were not probable at the time. But today, our reserves are appropriate for the current environment, and the information that we're allowed. + +Answer_49: + + We're estimating some penalties, given the environment we would expect that some of the expenses would come with penalty nature, and you can obviously do the math from the front page. + + + But they are estimates and they include a range of matters not limited to mortgage. + +Answer_50: + + Actually, it's a great question. There is a fronting in that number of just shy of $2 billion, $1.7 billion that will ultimately be syndicated in the short-term, so I would adjust that out when you're looking at the quarter over quarter numbers. Other than that, it's relatively flat and steady performance in core middle market and strength in real estate. + +Answer_51: + + We can't comment. + + + We've already said all we can say about that. + +Answer_52: + + It's going well but we're still, I think they are still building the systems to actually do it, and come with the products and services that we think can do a better job both for the merchants and for customers. + + + But we're in active-- + + + We're still working on that. That's not going to happen overnight. We just think it could be a very good thing over time. + +Answer_53: + + Yes, we will try to. + + + We will. + +Answer_54: + + Essentially has flattened out at this point, yes. + + + And we've begun to reinvest, we're looking at the overall portfolio, we're doing some rotation, and that process has started. + + + Remember, rates did go up almost 100 basis points. + +Answer_55: + + So just at a macro level, talking at the firm-wide level for a second, we've said that we're looking at running the firm at a Basel III Tier 1 common ratio between 10% to 10.5%, which would imply, in any case Tier 1 capital minimums will be 11% ultimately, so we'll be at 11%-plus from Tier 1 capital and we talked about leverage running at 5.5% over time as well. And if you think about 11%-plus Tier 1 capital, 10% to 10.5% Basel III common and a 5.5% supplementary leverage ratio given the ratio of our risk weighted assets to our balance sheet, they actually co-exist quite happily. So it is going to be a multi-variance of finding constraints, but at those levels, they exist quite nicely. +Obviously the devil is in the detail when you push down into the businesses, client by client, product by product, and that work will go on, and as we do that work, as Jamie's talked about, we expect to be able to optimize, which will include some repricing and some restructuring of products. But at a macro level, they will co-exist relatively well. + + + I always add to that CCAR will be in our opinion another binding constraint over time. + + + Very good point. + +Answer_56: + + We don't know those rules yet, but presumably it's going to be equity plus preferred plus unsecured senior debt, and subordinated debt. And I think our number is at 20% of risk weighted assets there, so we're in a pretty good place but we'll see what the final rules are. + +Answer_57: + + So with PCI-- + + + I have to go because I have a meeting I have to go to, but appreciate the time with us, and Marianne can answer the remaining questions. + + + So the way to think about the PCI reserve release its the first one we've taken, and it reflects obviously improved home prices and lower severities, but it's divided by model, so if all other things from here are equal, then we are what we are. Obviously, if there are significant changes, probably primarily in home prices, but also in delinquencies, and you might see some more reserve releases. These are likely to be more periodic and lumpy, because obviously, we will be refreshing our loan loss reserves, or our life of loan forecasts over time. It's possible that you may see them in multiple quarters but that's not what we're expecting. + +Answer_58: + + No there's no cause and effect there, obviously. + + + Well there's no cause and effect there. Full stop. + +Answer_59: + + Well I can certainly talk for JPMorgan, where as soon as we understand rules, we start to push them down into the organization, so that the people who are transacting at the products and the client level can make the best and most appropriate decisions to maximize returns and meet hurdles, and all of those sorts of good things. And you're right. Over the last several years, we have seen capital and liquidity increase dramatically. +Meanwhile we are still delivering a core underlying performance in that mid-teens return on tangible common equity. So we're still competing effectively, which leads me to believe that others are doing the same thing, and that's being reflected in the competitive nature of the environment. I think it's obviously going to continue some, as we and others have set ourselves even higher targets for capital, and then obviously new rules including the SLR, but I also do think these things work through the system through time pretty quickly, given the nature of the business. + +Answer_60: + + So our LCR ratio last quarter was 118%. This quarter, we haven't disclosed it, but it's not far off that same level. and the increase in cash is not necessarily because we're trying to do anything from a liquidity perspective, but it also reflects inflows from clients, both operating bills, and importantly non-core non-operating deposits that we then place with the central banks. + diff --git a/exam/original-files/Problem_2_3_Sample_QandA/4_questions.txt b/exam/original-files/Problem_2_3_Sample_QandA/4_questions.txt new file mode 100644 index 0000000..7464d53 --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_QandA/4_questions.txt @@ -0,0 +1,240 @@ +Question_1: + + Just on the legal front, not sure exactly what you can say, I'll give it a shot here. Does the lack of a settlement so far with the government reflect the DC shutdown, or more the fact that you're still negotiating, or a combination of both, any comment there? + +Question_2: + + Okay, and in terms of the $9 billion provision this quarter, can you give us any sense of how much that reflects revised estimates of government penalties and fines, as opposed to refined estimates for damage claims from private parties and things like that? + +Question_3: + + Can you give one more shot, Marianne explaining how the range of possible loss doesn't go down more after such a big provision? + +Question_4: + + Okay, and one more thing on this, does the settlement, negotiations, and things that you're doing does that affect how you project losses on other aspects of legal that you were not negotiating in the last couple weeks? So you've upped the projection of what you might face on other stuff? + +Question_5: + + Okay, on the expense front, I guess Jamie just said that the things you've added in the control and compliance area are permanent, and that drove up the expense outlook on adjusted basis, Marianne of $59.5 billion to $60 billion, so this is this the go-forward run rate? The $60 billion adjusted expenses, what would be the opportunities to bring that down over time, is there any areas where that is still environmentally elevated? + +Question_6: + + Okay, and then also in there would be the default servicing, which is still elevated. Can you remind us what the longer term target and how that could come down? + +Question_7: + + Okay, and then the last thing for me is just wondering, Jamie Dimon, did the internal control issues this year and some of the headliners at regulators, does that affect your mindset as you go into CCAR and think about how you'll think about capital return next year? + +Question_8: + + Just a quick follow-up on the CCAR. You had mentioned the difference, well you didn't say the exact difference between advanced and standardized, but I wonder if you could shed light on the spread between the two. And I'm just curious, does it play a bigger role in the process this year, or you were just pointing it out? + +Question_9: + + Okay, but I mean that spread is a lot tighter, so it's less concerning so it's good. + +Question_10: + + Okay, curious, we don't have all of the answers on how the whole leverage focus is going to shake out but it seems I'm putting a little words in your mouth, but it seems to be working its way through a little bit. I think your book's down 15% or so year on year, and it's less than 10% of the overall balance sheet. But is that a correct way to think about it, that focus is going to start impacting the repo market? And I'm just curious if you could talk about for your book, what is balance sheet financing versus real customer financing? + +Question_11: + + Okay, understood, shifting gears just a quickie. So the guidance is for flat net interest income dollars, and the loan growth was 1% or 2%, quarter on quarter and year on year, but the underlying business, as you mentioned are a lot better. Just curious, it seems like conservative guidance, but curious on what is behind it. + +Question_12: + + Correct. In terms of NII dollars being flat. + +Question_13: + + Okay, maybe a last one. In a world that doesn't have a lot of loan growth, has very low interest rates and Capital Markets have been far from ideal to your point, your businesses, underlying business or operating goods. And extra charge, you're earning at that $6 run rate that people are hoping you could get to. I guess the question is, do you have more confidence than you did last year in terms of that $24 billion over the cycle, because you're at that run rate now with not ideal conditions. + +Question_14: + + A couple questions. One on, just another question on FIC. We've talked in the past about clearing and clearing requirements, and prior quarters we just had very few trades coming in under the new rules. Could you give us a sense as to how customer behavior has been, and how that's impacted your FIC line this quarter? + +Question_15: + + And then on SLR, did I hear you correctly that you aren't going to make any changes to how you're providing credit to clients, until you find out what the final rule is? There's no major changes on how you're approaching the market? + +Question_16: + + Okay, and then second thing on mortgage, in the mortgage servicing, relatively high charges, the foreclosure piece in there, but just wondering if there's anything else going on in the servicing expenses? + +Question_17: + + Okay, and portfolio sale coming up at all in that? + +Question_18: + + And then just lastly, just another question on the litigation on the page 2. I think the Street understands the reason for taking the $9 billion charge, and I see here you've got the two comments on page 2 which highlight that unpredictable, hard to forecast. But I guess what some folks are wondering is, should we be putting into the model just higher run rate of litigation expenses going forward, I think over the past couple years its been $300 million to $500 million normalized quarter, $1 billion to $2 billion, on a top and up quarter. Is that $1 billion to $2 billion the new normal until we get through this whole thing or--? + +Question_19: + + So Jamie, as you think about all of the litigation stuff that you've got, can you give us a sense as to how much you're currently in discussions to negotiate? I mean, to give us a sense of how far along you think you are? + +Question_20: + + Just looking at slide 15, I think it's very helpful in terms of laying out some of the things that you're targeting to reduce in the left hand side. I guess as we step back to the picture and we think about a couple hundred million of revenue you gave up on the left side, some expense pick up in the middle, and then we factor in the higher capital requirements, the higher liquidity, are you confident that both the long-term earnings impact won't be that meaningful, and that you don't need to adjust the model that much? And I think that's most people's view but the nickels and times, I think there's some concern that it does start to add up as well. + +Question_21: + + Just separately the compensation rate within the investment bank coming down this quarter, despite pretty good revenue trends overall, any additional color on that? I think you've been targeting 35% longer term, and we're maybe 31% or so. + +Question_22: + + Lastly could you just share what the CIO losses were a year ago? I'm not sure if you disclosed that before? + +Question_23: + + My first question is on the new leverage proposals. I think we're hearing loud and clear that you're not going to do anything rash in terms of how you run your businesses, but given that we're still in proposal form in the US and also with Basel, can JPMorgan accelerate capital return in next year's CCAR, even with these proposals fluid on the leverage side? + +Question_24: + + And my second follow-up question is on the advanced versus standardized approach, as it relates to the CCAR. You've told us that the standardized ratio is clearly lower, but as you run your models under stress, what is more punitive for your bank? Is it coming into a stress scenario with a lower starting point on standardized, or is it the RWA inflation, when you stressed the advanced? + +Question_25: + + Three small questions and one larger one. First, what was the loan utilization on the wholesale side for the quarter versus last quarter? + +Question_26: + + And as far as the headcount reduction, you said in CCB you're taking up 15,000 jobs this year and 11,000 in mortgage? Where are the rest of the jobs coming out from, and how are you able to do that? + +Question_27: + + Okay, and as it relates to slide 15, the repositioning of the business, what inning are you in for that derisking and the control agenda? It seems like the derisking might be earlier innings, and the control agenda the later stages but you tell me. + +Question_28: + + Okay, and then the larger question relates to the legal issue. How much of the investor losses for the mortgage putback and the mortgage securities relate to Bear? I know there's been a lot of numbers in the press, but we haven't heard those numbers from you. + +Question_29: + + Okay, 80% of the losses? + +Question_30: + + And what's the dollar amount of losses on the mortgage putback side? + +Question_31: + + Well what's the total dollar amount of all of the losses we're talking about the potential settlement? That must be public somewhere, for mortgage putback in aggregate, the mortgage securities, what are the dollar amounts of the original, what's the original principal amount, and what's the investor loss? Just the dollar amounts if you can break that down. + +Question_32: + + So I guess one question, it's 80% of the losses are from the deals, would you have done the deals differently? Did you not read the fine print? Did you not have some additional protection that you might have had? I know it was short notice for these transactions. On the other hand as you look back now maybe you wish you did something differently? + +Question_33: + + Can you talk more about the trade-off? Nobody is forcing you to sell off. If you really think this is a bad deal, then you obviously wouldn't do it so what's the trade-off of not settling versus settling? + +Question_34: + + And your decision to disclose the legal reserve, as we go back and asking all the other banks, what's your legal reserve, JPMorgan disclosed it, why don't you? What were the factors that led you to do that? + +Question_35: + + Just a couple of quick follow-up questions. First of all Marianne, in the expenses related to mortgage production, those were down about 6% quarter over quarter. Do you have a sense as to if the trajectory of those costs are going to come down faster over the next couple of quarters? Several banks have discussed that in terms of trying to reduce the expenses, at the same time production revenues are also coming down. + +Question_36: + + That's helpful and then just a question on pipelines. You mentioned that the pipeline in commercial banking was healthy. Just curious as to whether or not that is largely due to transactions that have been held up because of uncertainty in the economy on the part of your borrowers, or is that also being helped by more business being booked by your bankers? And also if you have a comment on the investment banking pipeline at this point, realizing it's early in the quarter, that would be helpful too. + +Question_37: + + Okay, and then just Jamie maybe a question on the buyback. At this point it doesn't sound like you have any concerns about the litigation expenses in this quarter being an issue for the CCAR submission, or future buyback trends, is that what I heard? + +Question_38: + + You mentioned in passing that at the Investor Day in February, you think that there will be a lot more of the rules in place that you'll be able to discuss the impact of. I was wondering the specific ones that you think will be available by then, Volker for example, is it your understanding that you'll have a good understanding by then? + +Question_39: + + Fair enough. One thing that you alluded to a couple of times this morning is the idea of the SLR being maybe 50 basis points higher, if you didn't have to carry capital, or count into the leverage exposure. You were deposits with central banks. Since you mentioned it a couple times, does that mean that you actually have a reasonably high degree of comfort that there will be an exemption for that? + +Question_40: + + Sure, that's completely fair. At this year's Investor Day, you identified in the investment bank a $65 billion run-off portfolio that you gave some targets of reduction for, at year-end. + +Question_41: + + I've also noticed that in your Pillar 3 disclosures you've got a very high CRM, which I have to assume is associated with correlation book stuff, which I guess that run-off portfolio is. Can you give us a sense for whether that's right, and where you are with that run-off portfolio? + +Question_42: + + And that was a separate synthetic credit portfolio than what you moved over from CIO, or is that a part of it? + +Question_43: + + We heard recently from some people in the industry that there's the expectation of a counterparty, a major counterparty default as part of the CCAR stress test this year. Do you have any sense for whether, are you hearing that that's going to be part of it? + +Question_44: + + It's a rational idiosyncratic event that people should be prepared for. Remember, we did go through that with Lehman. + +Question_45: + + Got it. Final question. So it's always been very important to you, Jamie, that you had a record of not losing money in a quarter, through the whole credit bubble and disaster. And yet this quarter, because of the size of the litigation reserve, you did. Not a large amount of money, but you actually had a net operating loss. Do we take that as a signal of the certainty and the timing of the size of the settlement? + +Question_46: + + Marianne, you'd mentioned the CCAR resubmission. When that comes out, will that be made public, and what will we be able to get from that, and how will that impact your submission going forward? + +Question_47: + + Great, and as far as other changes that you're aware of, you had mentioned the counterparty failure, are there any other large items that would be a change in the way, or in addition to the way they're approaching the submissions this year? + +Question_48: + + Got it, and related to taking the charges in this period, given what was the actual information that changed? In other words, the accounting rules tend to require a certain standard to recognize that, and if you haven't reached that agreement yet, what actually did change that required the recognition of that in Q3? + +Question_49: + + Did you say at the outset that the $9 billion wasn't fully taxed because of a portion related to penalties? That would imply like roughly about a third of it, does that make sense? + +Question_50: + + Can you talk about the commercial loan balances? I noticed that the period-end balance had a nice increase from the third quarter, but your averages were almost flat. Is there a pick up in lending activity in the month of September? + +Question_51: + + Okay, and I know the litigation questions are sensitive, so I don't know if you can answer this or not. The discussions that are going on, that we're reading about in the paper with the US government, is it more of a factor of the dollar amount that's holding it up, or is it more terms and conditions? + +Question_52: + + Okay, that's fair. Another question is, you at your Investor Day talked about the Visa partnerships that you were just announced, could you give us some more color on how that's going, with the merchant acquiring and the payment business? + +Question_53: + + I assume you'll give us a good update at the Investor Day in February? + +Question_54: + + Coming back to the asset yields, you talked about the deposit margins improving quarter to quarter, earlier in your call. Are we at a point where the asset yields in the securities portfolio have bottomed? Are you replacing securities with equal yields or higher? + +Question_55: + + Right. Finally, on a go forward basis once we get over all these issues that everybody is confronting today in the banking industry, with the regulatory and maybe the interest rate environment, what's going to be the capital ratio that's going to constrain your growth? Is it going to be the SLR ratio, the Tier 1 common? What's the one you think will be the real achilles heel? + +Question_56: + + Correct. Coming back to the capital, on the orderly liquidation authority, as we all know there are certain buckets of capital that have to be maintained. Do you have any clarity yet that the excess over the 9.5% under the Tier 1 common portion, will that be applicable to other buckets, so you don't have to raise as much in preferred or senior debt? + +Question_57: + + Most things have been covered but I'm looking at the loan loss reserve releases from the PCI portfolio, assuming credit gets better, that theory continues as well. How should we think of that going forward? Is that going to be something lumpy from time to time? Is it going to be more gradual, like it would be in a normal loan portfolio? + +Question_58: + + A few questions on the investment bank, and you touched on the comp expense earlier. It's obviously very low as a percent of revenues, excluding DDA, I think it's 27% So given revenues are down, your bonus accrual must be way down. And my question becomes is that just coincidence that it happens in a quarter where you take $9 billion of regulatory litigation costs, or is there a cause and effect there? + +Question_59: + + Perfect. And then my second question, you've talked a lot during this conference call about pushing things out to clients when you have more clarity on your leverage ratio, and I guess -- the rules and what not. I guess just broader, as you think back not the leverage ratio but all the Basel III rules we've faced and all the changes in higher capital requirements and whatnot. Are you surprised at how slowly some of those price increases have been pushed down, and how slowly capacity has left the industry, or do you think it's about right, or do you think we'll see more of that going forward? Maybe you can just make broad comments there. + +Question_60: + + One quick follow-up on your liquidity holdings here. Your excess liquidity pool looked like it increased almost $85 billion sequentially to $538 billion. Just want to know what's driving that, if there's anything you're worried about or thinking about, because I thought your LCR ratio last quarter was above 100%. And if you could just give us your updated LCR ratio, that would be great, thanks. + diff --git a/exam/original-files/Problem_2_3_Sample_QandA/50_answers.txt b/exam/original-files/Problem_2_3_Sample_QandA/50_answers.txt new file mode 100644 index 0000000..7df081e --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_QandA/50_answers.txt @@ -0,0 +1,157 @@ +Answer_1: + + Oliver, good morning, and thanks for joining us today. As we think about the balance of the year, I would ask you to think about three important variables and you saw those come to life in the first quarter. We're clearly focused on driving traffic to our stores and we expect that to be a very important driver of our growth over the balance of the year. But you're also seeing the benefit of our focus on signature categories and the higher ticket that that generates. +But importantly the third element is the increasingly important contribution we're seeing from our digital and online businesses. So as we go forward, we're going to continue to make sure we're seeing growth in traffic, growth in our signature categories that leads to that gross margin rate improvement we saw in first quarter and the higher ticket, but importantly, the ongoing contribution of our online channel. + +Answer_2: + + Oliver, you heard Kathee talk about some of the key initiatives that came to life in the first quarter and you're going to continue to see us build off of that over the balance of the year. We've completely rebuilt our app. We're focused on improving our subscription and registry. +We're leveraging our stores to shift to our guests. So we're going to continue to build on those initiatives as we go forward and continue to make sure that we're making the investments both in technology but importantly in the supply chain that brings that online business to light for our guests. + + + And, Oliver, if we can go back for a minute to your question on thinking about price versus innovation and how do we balance those. I would just say that we start from the guest, looking at what it is that they expect from any given product category and then how do we build the very best product? Which is, depending on what it is, could be a combination of both price and innovation or more heavily leaning on one or the other, depending on what we're talking about. +But very much guest focused to make sure that we're offering them the content that's going to inspire them and resonate. So there's not one size fits all. It's really guest-focused driven by each category. + +Answer_3: + + Oliver, thank you, appreciate it. + +Answer_4: + + Let me start with the gross margin and the focus for not only the quarter but for many years to come. And we've been very clear about the importance of focusing in on our signature categories. We believe that's our path to differentiating the brand. So you should continue to expect us to focus on building our style categories. And Kathee and her team are making great progress in apparel and home and beauty. And you saw the comps that those categories produced in the first quarter. +We'll continue to focus on baby and kids and accelerate our focus on wellness. So we believe those categories both in store, but importantly as we demonstrated in Q1 online, where a significant portion of our growth in the digital channel was driven by apparel and home. So that is a very favorable impact to mix, both in store and importantly as we improve and accelerate our online performance. + + + The other thing I'd add, Matt, is more tactically between Q2 and Q3, that's really last year where you saw us transition from focusing on significant promotions that were primarily hard lines or some of our lower margin categories' focus to the business, back to back-to-school and then into the holiday season. +So as we think about the way Q2 looks versus Q3, where that promotional impact was real in Q2 but it was also we had a significant mix impact because of where we focused those promotions. Little bit less of that as we go into Q3 and Q4. So the delta between last year's margin and this year's margin will change meaningfully. And as Kathee said, we continue to invest in price and quality across all of our brands. + +Answer_5: + + I think, Matt, I would answer it broadly and say that what we see across all guests is when they become engaged in the digital channel, we see incremental growth in that channel and, importantly, incremental growth in the stores. So their total engagement with us is very incremental, we pick up incremental sales and importantly incremental profitability in both channels. + +Answer_6: + + Yes, I would say that, Scott, it's pretty early in our transformation to say that we see momentum in that measure as it pertains to food. I will tell you a lot of our growth in transactions is driven by new guests and that's driven more in the signature categories that we have been talking about. Now we believe that we have an opportunity to drive traffic in food and that's why we're in the midst of putting a lot of tests out in front of our guests, both product and presentation, to get that business on track and to make sure that we've got a really compelling point of view for our guests. And then we will measure that over time to make sure that we're making progress. But today I would say it's more driven by the signature categories that we've highlighted. + +Answer_7: + + Scott, it's certainly something that we're going to continue to monitor and measure over time. It's still very early for us, but that is a measure that we're clearly looking at. We absolutely want to make sure we're building loyalty. We want to build engagement and traffic. +We believe our focus on signature categories brings guests back to Target looking for what's new, what's exciting. And we also want to make sure we complement that with an improved food assortment because we know food is critically important to building engagement and driving overall traffic. + +Answer_8: + + I think as we would measure that and as we look at the guest feedback that we get, Scott, I would say store execution is very high. Guests are very satisfied with the number of people that we have, their ability to help them. I would say that we have an opportunity on the in-stock side and we've been working on that collectively, stores and merchandising, as we worked through the port situation and getting those back in stock. But also just our everyday basics. +And it's one of the reasons why our inventory is elevated, as we've talked about, is that we have been making investments, particularly in essentials category to make sure that we can raise our inventory levels appropriate to be in-stock in those categories. So I think that's where we have the most opportunity right now. + + + And, Scott, that's reflected in the key initiatives we've been talking about. As we think about changes we're making in experience to elevate apparel with mannequins, to restructure our home layouts, to begin to make changes in electronics. We want to make sure we provide the guest with a great in-store experience particularly in those signature categories. +But as Kathee just noted, we also need to make sure we're focused on the basics every day. And we need to make sure we've got very high in-stock conditions, particularly in those key consumable categories. So for us, execution at store level is critically important. We believe we have the best team in retail and our focus now is on elevating the experience in those key signature areas of our store and ensuring that we're improving the in-stock conditions for basic essentials. + +Answer_9: + + Thanks, Scott. Appreciate the support. + +Answer_10: + + Yes, so this is something that we aim to do all the time and of course right now we're comping against some pretty weak numbers post breach last year, so certainly that's part of it. As we focus on signature categories, I do think that's getting more new guests back into the brands and in a variety of different areas because signature categories cover so much from beauty to home, et cetera, to the different style categories. +And I think the way that we're doing it is really what Brian was just talking about, presentations that are really compelling with product that's very inspirational. And inviting them into the store through our marketing, which resonates with them. And then when they get to the store or online, being able to convert them to a purchase. So it's all of those things that I think are moving the needle. + +Answer_11: + + No, we've seen this coming for a little bit now. Third quarter was the start of it, continued into fourth quarter and now again in our first quarter. But I think as we're improving quality, as we're stepping up our assortments to be more aspirational, we're seeing the guest really resonate with that product and move. And that's broad across virtually all of our categories. So not just in one segment of our business but really all of them. +So I think it's driven by the guest perhaps having a bit more money in their pocket. I think it's the quality that we've put in, they're recognizing those benefits and they're wanting to be able to trade up. + + + Robbie, the one point I'd emphasize so that we're really clear, this isn't an either/or, it's an and. So we want to make sure we're delivering exceptional value every day on those core essentials and continuing to bring great quality, newness, innovation and value to our guests as they look for these more aspirational items. So it's not a shift in strategy and it's not a either/or, it's an and. +And we've got to make sure that both elements of our strategy include a focus on core essentials and more experiential offerings. And when we bring those together, that is the Target brand promise and experience. That's where we bring expect more, pay less to life. So both of those elements are starting to work together and I think you're seeing the guests respond very positively to it. + + + Thank you. + +Answer_12: + + Let me start with the regional performance trends, and we didn't see any correlation between what you just referred to, changes in the oil and gas industry, and an influence on our comps. Obviously, like everyone else, and this happens every single year, weather did impact regional performance. We had some challenging days in the Northeast. We faced the same ice storms that others did in the Southeast and in the Texas market. +But overall, we saw very consistent comp performance across signature categories. The growth Kathee talked about was strong across the country in apparel and beauty and home. And we've seen very consistent performance trends and responses from our guests across the country. + + + And to the minimum-wage question, no, we haven't seen those types of impacts either. + +Answer_13: + + It's a great question, Robbie, and we're sorting through that. We wanted to get through annualizing past all of last year with the breach and the impact there. We're really pleased that we saw 110 basis points of penetration growth. We're seeing new accounts grow again, roughly split equally between credit and debit. +I think as we learn a little bit more here as we get through this year, we'll figure out where we want to go. We still are very energized by REDcard as a product offering. I think the opportunity for us is to tie that into a more holistic loyalty offering for our guests. We're testing some of that now out East, and you'll see us, as the year goes on, continue to test that, take those learnings and apply it more broadly to loyalty for our guests. + + + Thank you. + +Answer_14: + + Yes, I think -- yes, you're right and all of that increase is really incentive expense offset by, again, some productivity improvements. I think as the year progresses, we'll continue to see improvements in SG&A. +As we said throughout the year, as the year progresses, we'll continue to start to see the savings that we committed to, the $2 billion, $500 million of savings this year, about half in COGS, half in SG&A. In SG&A that will be offset somewhat by investments in technology. +So we should continue getting past the noise; as the year progresses we'll continue to see leverage probably similar to what you saw in Q1 as we get into Q3 and Q4. + +Answer_15: + + Greg, in some ways you've answered the question for me. And we've been very clear in the fact that we're going to make $1 billion investment in technology and supply chain to enhance those capabilities, to improve our capabilities, to make sure we're partnering up technology with the ability to provide the product effectively through our supply chain. +So the Lilly event, while a sensational event for the brand, and we're really proud that we were able to create a Black Friday-type event in the month of April with hundreds and thousands of our guests lining up waiting for that product. But online, we know we had some missteps and we're doing a deep dive, we're looking at root causes, and it's going to provide important learning for us as we get ready for the traffic we expect to generate during the holiday season. +But we are very committed to putting our capital behind improving technology capabilities and the supply chain requirements necessary to continue to grow that business at the accelerated rates we're delivering right now. + +Answer_16: + + Well, this afternoon would be nice, but we are actively tearing apart the learning and clearly want to make sure that we have the diagnostics in place as soon as possible. And we're making the necessary adjustments and investments to enhance our overall digital experience. So this afternoon would not be soon enough and the team has an incredible sense of urgency to ensure that we have the right capabilities so that we're constantly meeting the needs of the guests. + + + And, Greg, I would just add that we're never done with that. So certainly we're learning from the Lilly event and we will put that into play as soon as possible. But as we're growing at the rate that we are and we're introducing new code all the time, we are never done. So this is an ongoing effort probably until the end of time. + +Answer_17: + + Yes, so Made to Matter has been a fantastic program for us, Peter, as you know. We went from about 15 vendors last year and we increased that to about 30, 31 vendors this year, and we're seeing about 25% lift in sales. So the guest is really loving the product that we're offering. +It's in a variety of categories. There's certainly food products, but there's beauty products, there's OTC, there's baby. All of them, though, are really driven by simpler, better-for-you product, whether that's in food with cleaner labels and organic, or whether that's in baby, where it's cotton and more natural materials. +But really great results and we marketed it most recently in the past month in what we call the rear seasonal area of our store where we brought all the products together for the first time and had really fantastic results. There was a marketing campaign that went along with that that really resonated with the guests and then the in-store presence helped make it easy for them to find when they came to the stores. + + + Peter, I think the great part of the program is it's just another point of validation that when we understand what the guest is looking for and we deliver the right curated assortment, they respond really well. You know that we have over 25 million guests visit our stores every week. We know that 98% of our guests purchase natural or organic products. Thus we need to make sure we offer them the products and the selection they're looking for. +It doesn't mean that conventional products don't play a very important role going forward, but our guest has voted. We understand the guest better than ever before. And Kathee and her team are doing a sensational job of curating the right assortment and bringing the guests what they're looking for when they shop at Target. + +Answer_18: + + I think that's a pretty good number. We're still evaluating the program. We launched the new vendors this spring, so we're still analyzing those results. But to Brian's point, the guests will guide that work. The important part about Made to Matter is that while these brands might be carried elsewhere, we have exclusive product with meaningful innovation within the program within Target, and that's what's really resonating with the guests. +They recognize those brands are at Target and they love to buy them. But they come looking for those new exclusive, really innovative products. So I think keeping the number at a reasonable amount so that we're sure that we can drive that right innovation, it's very much a partnership with us and these suppliers, so I think we're in the hunt with the right number. + +Answer_19: + + Peter, Kathee and I have been talking about this for several months now. We're using 2015 to test and learn. Kathee's talked about key categories within food that we really think Target should stand for and we're looking very closely at how we evolve assortment and how we merchandise those categories going forward. But this is not about how fast we make the changes. We want to make sure we really have a chance to test, learn, get the feedback from the guest, iterate. +So then as we move into 2016 and beyond, we move forward with confidence. And with the confidence that the guest has guided us through the changes we're going to make. So we're clearly focused on it. The team is making very good progress. But we're in that test and learn and validate environment right now and you should expect to see much more unfold as we get into 2016. + + + The thing that I would add is, as we're going through the testing, as Brian mentioned, we're testing many different things, whether that's assortment changes that we're making, presentation changes that we're making, supply chain changes. Part of our testing is to try to isolate those tests so that we can get a good read. So there's not going to be one place that you can go to look at what does the new food innovation look like. We've got it all over the place. +And the other thing that I would add is you know that we just hired Anne Dament to run the Senior Vice President of Grocery and we're very excited about that. She's been on board now for about a month and brings us 19 years of experience in grocery and CPG. So she certainly is learning and onboarding into Target and bringing a wealth of knowledge from grocery, which will also impact what we put forth in terms of tests for the rest of the year. +But I think you can look to 2016, as we learn and prove out what's working with the guests, what's resonating, we will start rolling those in 2016, but don't expect a big bang on January 1. To Brian's point, this is really about getting it right and delighting the guest, not moving fast. + +Answer_20: + + So certainly shipping expense went up when we moved to $25, but I would tell you not a material impact on the quarter. And net, net, as we've said, as that brings more guests online, they shop our store and so a net positive, as far as we're concerned, across the lifetime value of those guests. +I don't have the actual number of REDcard holders that use free shipping on the site, but I can tell you the penetration of free shipping due to REDcard on the site is very, very high. In general we have a very high percentage of our shipping that goes out free from the site. +We talked about this last year when we shipped to free -- switched to free shipping during the holiday season, and I think that is why, going back to what Brian said, the supply chain investments we make are incredibly important for our guests because they provide speed to market from their perspective. But they're incredibly important for us because they improve the economics of our online business meaningfully. + +Answer_21: + + A lot of that depends on the categories. I think the good part about licenses at Target is that our guests respond to them very broadly, so it isn't just a toy or a video game. For us, there's apparel involved, there's back-to-school products like backpacks and notebooks. So they have a pretty healthy margin mix, just given the breadth of category, and most of them fall into our signature categories. So we're very excited about the lineup of licenses and the fact that they start this summer and really go all fall. + + + Okay, we have time for one more question. + +Answer_22: + + It was mix is what came in better and I think we see that in two ways. First of all, there's just the mix of selling those products. And then when we see strength in home and apparel, of course our sell-throughs go up and so we have less markdowns. And so the positive benefits of mix go on and on. + + + I'd only add, Christopher, that again, we saw that mix benefit both in store and online, so the combination of those two channels working together clearly impacts and improves gross margin rate. + +Answer_23: + + That is certainly core to our strategy as we go forward. And I think what you saw, what we saw in Q1, very solid performance. Kathee and her team did a terrific job of curating the right products, particularly in those signature categories for our guest. Despite some of the port challenges, our supply chain teams did an outstanding job of making sure we had inventory in place for the guests. +I was very pleased with our marketing program, and if you haven't seen the Target style campaign or some of the things we just did for Avengers, it's spectacular advertising and the guest is responding to it. And our store teams just did a phenomenal job throughout the quarter, despite port challenges and weather challenges of providing the guest with a good experience. And it added up to really solid results in Q1. +So we hope that continues. We're confident it's going to continue throughout the year. But we feel good about the progress, we know we've got a lot of work in front of us. But that combination of strong in-store and online growth in the first quarter gives us a lot of confidence that we're heading in the right direction. +So, Operator, that concludes our call today. I thank everybody for their participation and we look forward to talking to you next quarter. Thanks. + diff --git a/exam/original-files/Problem_2_3_Sample_QandA/50_questions.txt b/exam/original-files/Problem_2_3_Sample_QandA/50_questions.txt new file mode 100644 index 0000000..9c47b2f --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_QandA/50_questions.txt @@ -0,0 +1,93 @@ +Question_1: + + Hi, congratulations on really solid results. We're very pleased to hear about all of the progress. Regarding the comp in the back half, should we think about traffic as the main opportunity or would you feel like ticket will also be an opportunity? And as we think about gross margin and your product assortment, how are you balancing the idea of investing in price versus the innovation that you're conducting in your signature categories? + +Question_2: + + Brian, you've been very agile with strategic decisions around the online and digital business. As we look forward to back-to-school and holiday, are there any key pointers in terms of the strategies you're undertaking, particularly as mobile and shipping continue to be hot topics? + +Question_3: + + Thank you, congrats. And that was very clear on Lilly Pulitzer, congrats on that as well. Best regards. + +Question_4: + + Good morning, and I'll add my congrats as well. My first question is on gross margin. Does the gross margin guidance assume a continued mix shift to the signature categories that you enjoyed this quarter? And is the formula for Q2 in terms of price and quality investments what we should be thinking going forward, i.e., you were down about [100] last year and you recapture about half according to your guidance, does that seem like a reasonable formula for Q3 as well? + +Question_5: + + That's very helpful. If I could ask one follow-up on the eCommerce business. I'd love to get your insights, perhaps using REDcard data, in terms of how much digital growth do you think at this point is incremental, i.e., are these new customers or infrequent customers? Thanks. + +Question_6: + + Wanted to get into a topic of traffic. I think traffic was up second quarter in a row that it's been up. I was wondering if you could maybe dig a little deeper into that? Someone in the grocery space talks about loyal households and it seems to me when you think about Target, you guys want to build frequency and you want to build these loyal households. How are you thinking about that? Do you measure that? Is that measure improving? Some of our research suggests some of the early things you guys are doing should be building this number, but I wanted to get your take on it. + +Question_7: + + That was actually where I was going, not just food, just on the idea that I think your heavy users are up 25, 30 visits a year. Are you seeing increase in those types of loyal households? It seems to me that might be a key driver here as we go forward to get that frequency up. + +Question_8: + + Perfect; and I had one other one. We obviously are in the stores quite a bit and I wanted to get your take, some of the pushback that we hear from investors is on the store level execution, staffing levels, in-stock position. I think people wish you maybe just could be a little bit better. And I was wondering what you think of that and are there initiatives to improve some of those measures? And where do you think you are, what inning do you think you are in on these areas? + +Question_9: + + Perfect, our focus group of women was really pleased, so keep up the great work. Thanks. + +Question_10: + + I think maybe for Kathee, the comment you just made to Scott Mushkin about a lot of the growth in transactions being driven by new guests, can you give us a little more insight to that? Is that a shift in traffic away from frequency and towards new guests and how significant is that and is there -- how are you doing it? Is it -- are there some new marketing approaches you're taking to get people into the stores to alert them about the signature categories, et cetera? Some color on that would be great. + +Question_11: + + Kathee, can you comment more on the propensity to trade up for the guest? Is it -- is there something changing there or was that just easy comparisons? + +Question_12: + + I guess a regional question, in terms of the comp on a regional basis in the first quarter, did you see any differences in your sales trends in states that are potentially a little more dependent on oil and gas? And then the follow-up there is can you also address any negative or potentially positive impact on the organization you see in areas that are increasing the minimum wage? + +Question_13: + + Okay. And then secondly it looks like REDcard, nice pickup, looks like on a sequential basis and year over year. Can you talk about where Management expectation is now on this particular product and where we think this could potentially go over the next two or three years here? Thanks. + +Question_14: + + A couple questions. I wanted to make sure I understood the SG&A progression a little bit better. I think, John, in the guidance you said we would delever 20 to 30 bps in the second quarter, which if I take your comp guide suggests it'll be up around 5% in dollar terms. Is that -- are we thinking about that right? And what's the real run rate once you get through some of these other timing issues and the breaches on SG&A dollars? + +Question_15: + + Okay; got that. And then, Brian, I think in your prepared discussion, you've mentioned some disappointment on digital execution, particularly around the Lilly launch. Could you give us a little more detail on what's being done to address those issues in terms of how the website actually works or supply chain? Will you ultimately invest more in fulfillment center capacity or just some actual actions to try and address that? Thanks. + +Question_16: + + When do you think you'll know the things you need to get done for holiday? Is that something you'll know now or was it something we'll learn in the fall? + +Question_17: + + Hi, guys, couple questions. First on Made to Matter. Can you give us how many brands have been designated with that, what categories you're seeing being most impactful so far and what you're doing from a marketing standpoint to support them? + +Question_18: + + And that's helpful. Do you think, is 30 to 31 a good number that you guys think you'll stick with? Do you think you'll add additional vendors to that program over the next 12 months or rotate out some and keep the number at 30, 31? + +Question_19: + + Okay, that's how we've definitely seen it in the stores as well. Quick one on the food repositioning. What should we -- in terms of the cadence this year in terms of testing things, what should we be looking at? Is there going to be space allocation changes, is it going to be just new brands? +And once you do decide what you're going to do, is it going to be an early 2016 rollout, something that could impact a lot of that year or is it something that would happen later in 2016? Thank you. + +Question_20: + + I had a couple questions. On the gross margin line, did shipping expense at all impact you with the move to $25? And how many REDcard holders are utilizing their cards for free shipping, so how do we think about that as eCommerce continues to grow? + +Question_21: + + And then -- thanks, and the second question I have is there's a lot of license initiatives that are coming over the next several quarters. When you think about the year-over-year impact on the business overall, are those gross margins accretive in terms of what they're trying to do or would they be lower margin? And how should we think about that as it relates to the mix and the gross margin overall? + +Question_22: + + So two quick ones. You originally guided the first-quarter gross margin up 40% to 50%, so was curious what came in better versus your expectations? Is it mix or was it the level of promotions lapping the level of promotions year over year? And then I have a follow-up. + +Question_23: + + Understood. And so the outlook, and you mentioned this going forward, the outlook in the second quarter is predicated on recapturing both of those and then going on further in the year. It's really expectation that the signature categories out-comp more in the essential side? + diff --git a/exam/original-files/Problem_2_3_Sample_QandA/51_answers.txt b/exam/original-files/Problem_2_3_Sample_QandA/51_answers.txt new file mode 100644 index 0000000..fd1e755 --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_QandA/51_answers.txt @@ -0,0 +1,123 @@ +Answer_1: + + Overall, I think we're making really good progress against our key strategic initiatives that we've been talking about for a year now. The change we announced this week is to make sure that we elevate our focus on execution and really ensuring operational excellence throughout the organization. And that's why I'm so excited about John stepping into this new role to make sure that we complement the focus we've placed upon creating strategic clarity with a recommitment to operational execution. +And I think the combination of those two elements is critical to continuing to drive traffic, make sure we delight the guests, see an improvement in our net promoter scores, and make sure that both in-store and online, we're continuing to see an acceleration in traffic and visits to our site. +So I think we're making very good progress right now. I think that is showing up in the results we delivered this quarter. But we're not satisfied. And we know we've got more work to do to ensure that we do meet the needs of the guests every time they shop. And critically important in meeting those needs is to make sure that we provide a great in-store experience and dramatically improve our in-stock conditions, particularly about core essentials. +So I think very good progress. I think this is an excellent quarter where the entire team performed well. But we know we've got more work to do, and we've got to make sure both in-store and online, we deliver a consistently great experience for the guest. + +Answer_2: + + So on the comp guidance, we don't break out traffic and ticket. But I would tell you just from a business perspective, we are very focused on driving traffic over time. Ultimately, we have to bring people into our stores. We need to bring people to the site, onto mobile devices. And so that's a key driver for us for our sales as we continue to move forward. +Related to the supply chain, there's -- the team has done a great job responding to the needs of the organization over time to develop more flexible ways to meet the needs of our guests and really fulfill on-demand shopping. I think we're just at a point now where we need to step back and build broader capabilities across the entirety of the supply chain as we continue to expand the way we want to serve our guests. +So there is not one particular area of the Company or one particular part of the business that we are completely focused on. [Absent], I would tell you, as I said, and you heard from Brian, in stocks are a key priority. And then specifically, being sure day to day in every store we're in stock on essentials. That's a key priority for our guests. We hear it from them. +It's a key focus for the team, and we have teams working on improving those in stocks across our essential categories today. And that will be a focus as we go forward. + + + Oliver, I can build on that because as we talk about improving our focus on operational and executional initiatives, I go back to some conversations we've had in the past. I absolutely believe we have the best team in retail. Our store operations -- Tina and her team do a sensational job. +But one of the things that John will be focused on is ensuring we simplify the work. And we make it much easier for them to execute each day and take care of the guest. So we want to complement a very strong store leadership team that does a sensational job each and every day, executing store by store, by simplifying some of the work, by making sure that we push work upstream, and allow them to focus even more on the store experience and the service we provide our guest. + + + Thank you. + +Answer_3: + + Matt, I would tell you that the improvements we are seeing is really driven by mix. And as we've talked about, we've invested heavily in ensuring we're on trend; we're bringing great quality to the guest; we're accentuating our position in key categories. We were really pleased during the quarter to see how well be connected with sub cats like swim. We've seen really strong performance in ready-to-wear, and most recently, a very positive response to the changes we've made in denim. +So the improvements we are seeing in those categories are really driven by great quality, following the trend curves, bringing great style, and fashion to our guest. And it has not been driven by a reliance on pricing. + +Answer_4: + + No. Matt, we're in a place where we have, we believe, just great, great assets across the supply chain. Great distribution centers, great upstream distribution centers, food distribution centers, fulfillment centers, and, of course, the stores. +I think we've said over the past couple of years, our focus of our investment has been supply chain and technology in support of becoming an on-demand company. That will continue to be the case. We're going to continue to invest in technology and supply chain. But the physical asset side, we feel really, really good about. + +Answer_5: + + It is. And it would be. And we are seeing a very positive start to back-to-school and back-to-college. + + + Thanks, Matt. + +Answer_6: + + Morning. + +Answer_7: + + Sure. Let me start with localization. And as I said, during the last couple of calls, this is still a very nascent effort for us. We're in one market, a handful of stores in Chicago. But we've really been focusing on a handful of areas where we recognize we need to change our assortment, change our presentation, be more relevant, and really recognize the needs and the demographics of these local markets. +So there's a handful of categories I might lift up. One, craft beer. And really making sure that in a category like craft beer, we have locally relevant items. And we recognize that even in a market like Chicago, those need to be tailored neighborhood by neighborhood. +So we've looked at specialty foods; we've looked at categories like craft beer. We've looked at categories like patio and grills. And recognizing that in the suburbs of Chicago, we can offer, and should have in store, large patio sets, five-burner grills. +But for our stores located in more of the urban neighborhoods, of Chicago, we need bistro tables. And we need two-burner grills, because those guests are living in condos and apartments. They've got small patios, and we need to make sure we tailor our assortment and our presentation to recognize their needs and to make sure we're mode locally relevant. +So we're certainly spending a lot of time looking at food. And as we think about the food reinvention, a lot of this is going to be driven by making sure we have locally relevant brands, those hometown favorites. And also in broader categories, like patio and furniture, making sure that we're matching up our assortment in-store with the needs of that local guest. +So a lot of additional work for us to do, but we're really pleased with the progress. And I talked about a 1 to 2 point lift versus the test and control stores. That is a very important measure for us to continue to evaluate. And working with John and our merch team, we'll be looking to rapidly rollout the learning from Chicago into other relevant markets. +From a digital standpoint, David, obviously, we continue to see really positive responses in some of our efforts like Cartwheel. And Cartwheel has now been downloaded over 18 million times. And every time I'm in stores, I run into guests that have their smartphone in their hand and they are looking for their offers from cartwheel. +But we also recognize that Target is a brand that's talked about in social media, every day, thousands of times every day. So if you were to visit our headquarters here in Minneapolis, just down the hall from my office, we have what we call guest central. +It's our guest command center where we're monitoring what people are talking about, what they are blogging about, how Target's being referenced in the news. And we're making sure we're very engaged with those bloggers and making sure that we are in the discussion. So it's a very important part of how we think about the brand and making sure that we incorporate social into our overall brand development initiatives. + + + Thank you, David. + +Answer_8: + + Well, I think it starts, Scott, with the reaction we've seen from the guests to some of the changes we've made in signature categories. When I think about, in today's marketplace, apparel growing at 4% to 5%; the changes we've seen and the reaction we've seen from the guests to our home offering; the fact that within kids, toys growing this quarter at 12%. +And while, again, still in the early stages, the reaction to some of the changes we are making in our food assortment; the reaction the guest is taking to Made to Matter; our wellness initiatives, gives me a tremendous amount of confidence that as we continue to bring great design, fashion, quality, and excitement to our signature categories, and combine that with the opportunity to reinvent food, to bring the right assortment that meets the needs of our guests. That to me is the magic to unlock sustainable sales growth at Target and make sure we're driving traffic to our stores, more visits to our site. +And it gets back fundamentally, Scott, I believe we win. And we'll continue to grow by combining a great story experience, the convenience of allowing our guests to order online and pick up in our stores whenever they want, and also being able to ship directly to their homes and using our stores as flexible fulfillment centers to make sure that response is a quick one. +So I'm very optimistic about the future. I think you are starting to see that embedded in the results, and the results in signature categories is very encouraging for us. We're getting great feedback from the guests. +As I think about the third quarter, we expect Plaid to be a really exciting initiative, and the buzz that we are seeing already is really positive. So we've got work to do on food. But when we reinvent food and get the assortment right there and improve the presentation, I think that gives us all great confidence that we're going to continue to drive traffic to our stores. And that's going to convert to really solid and sustainable comps. + +Answer_9: + + I think we can all drive ourselves crazy doing two-year, three-year, five-year stacks whatever you want. But in this case, I do think the two-year stack is important. We've continued to see our two-year stacks improve. If you do last year's Q4 against the previous Q4, the average there is about -- or the number there is about a [1/3]. So we expect to cycle path that this Q4. +And we've seen putting our -- putting the applied guidance -- you guys can do a rough number around that. Putting that against last year's comp will be in acceleration of our two-year stack. And so we feel good about that. And I think to the points Brian just made, part of it is we need to continue to grow. +We feel confident we're going to continue to grow and comp against whatever it is we delivered in the prior year, and we feel good about doing that. We feel great about our fourth-quarter plans. We're cognizant that that's an intensely competitive time of year. We'll be very promotional. We're not going to get beat on promotions, and we'll be in the game. And we feel really good about what we'll offer the guests in Q4. + + + Yes. And Scott, obviously, we'll update our guidance for the fourth quarter at a later date. But trust me, we are spending a tremendous amount of time evaluating our plans week by week in the fourth quarter. I spent time just yesterday with our team, going through our fourth-quarter plans, our merchandising plans, our marketing plans, how we're going to approach the key holiday periods. +And, to me, it's all about making sure we've got the right content. We've got to have great product. We certainly know we need to make sure we're winning from a promotional standpoint. But then we've got to make sure we surround the guest with a great experience and really iconic marketing. And I think we're going to combine a great in-store with an online experience and be very competitive and well-prepared for the fourth quarter. + +Answer_10: + + Thanks, Scott. + +Answer_11: + + So Matt, I'm not going to go through the details of our plans. We'll kind of maintain that powder for the fourth quarter. But we are certainly looking at newness in electronics. We're looking at categories where we think we are uniquely positioned to win. +So working very closely with our suppliers, to ensure that we have the right newness, that we're ready with the right presentation. I think there's a lot of exciting things in the pipeline. We certainly think, as we continue to focus on wellness, that wearable technology is a space where we can and will win. +But we also recognize right now that many of those categories are waiting for new innovation. And we're working closely with our key suppliers to make sure that we are going to be bringing that innovation to the guest and featuring it throughout the fourth quarter. + +Answer_12: + + I'll take the second one first, and then let Brian comment on the growth. I think on our supply chain for the digital channel, we actually have six dedicated fulfillment centers. +And we think the combination of fulfillment centers with our existing regional distribution centers, and along with the stores, gives us all the capability we need. And then you'll see us continue to grow the store channel, our regional distribution channel, all three of those channels, as ways to fulfill, depending on the product and how quickly the guest wants it. + + + Yes. And Peter, I'll step back and just talk about some of the fundamentals. We've got to continue to make sure we build awareness. We've got to make sure that as our guest engages with us digitally, we make it really easy. We make it easy to find product, an easy checkout experience. +We believe that Available-to-Promise, which will roll out this fall, will give our guest the confidence that they know where the product is and when it will arrive for them. Either in a store for them to pick up or being available directly to their home. +So we are focused on making sure that we provide, not only a great in-store, but a great digital experience. And we've got to make sure that we continue to make our site easy to work with. And more and more that's the mobile interchange that we've got to make sure is easy for our guest to find product and check out. +We want to give them the confidence that when they order, they know it's available to promise. And we're going to have it there for them when they need it. And to the point John made, we don't need to be building upstream DCs. We're going to continue to convert more of our stores and as we go into the fourth quarter, close to 450. That will act as flexible fulfillment centers to make sure that we can quickly and efficiently get product to the guest. So those fundamentals are critically important as we think about driving industry-leading growth. + +Answer_13: + + Yes. So we're right on track with savings. We've got programs identified to deliver the entirety of the [$2 billion], the $1.5 billion in SG&A, plus the cost of goods savings. So we feel really good about that. We're on track for our commitment this year as well. +One of the things we talked about when we first announced this, and we've talked about it in a great detail in the Company, is the stores are already productive. And if we're going to take hours out of the store, it will be because we eliminate work, or to the point Brian made earlier, move work upstream into the distribution centers. And so we're not focused on taking hours out of the store. +We are focused on taking work out and we haven't -- we're in the process of working through that. That's a little bit longer lead process than some of the other things we've done. But we are very focused on, essentially, freeing up those hours in the store. And then we'll decide, do we need them for improved guest service or how we'll utilize them. +But in fact, there's a couple areas where we have invested hours back into the store. As we put in the whole merchandising sets and as we put in manikins, we've realized the need for dedicated store team members who can merchandise those displays and make them look great all the time. So that's an area where we've invested back into the store. + + + Thanks. + + + All right, we have time for one more question this morning. + +Answer_14: + + Yes. Good questions. On the credit side, the benefit, it was up, but not meaningful. And it was less than, I'd say, less than half a penny of improvement versus last year. So very, very small. We are pleased it was up given that the, as we said, payment rates continue to go up. And so we're seeing the portfolio continue to shrink. So clearly, a portion of where the gas dollars are going, at least from our perspective. +SG&A through time, we'd expect to lever SG&A, go up, over the long term here, go up modestly, slower than sales growth. I think we've said we're going to continue to take expense out. But we also said that the majority of that expense will likely get reinvested. So I wouldn't count on big reductions in our SG&A over time. There will be places where we have to add back expense to meet the needs of our guests I just talked about in the stores. So modestly slower than sales growth over the long term would be what I'd say. + + + Well, great. Thank you. And for all of you, that concludes our second-quarter earnings conference call. And I really appreciate you joining us today, so thank you. + + + + + + + diff --git a/exam/original-files/Problem_2_3_Sample_QandA/51_questions.txt b/exam/original-files/Problem_2_3_Sample_QandA/51_questions.txt new file mode 100644 index 0000000..0a2d888 --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_QandA/51_questions.txt @@ -0,0 +1,65 @@ +Question_1: + + Hi. Congratulations on a really solid quarter and all the traffic. Brian, as you've been so successful in this journey, as traffic has come back to the stores, just a bigger-picture question. How do you think your priorities have dynamically changed throughout the year? +And where would you say Target is in terms of customers coming back to the store versus increasing customer spend? And, John, I just had a question related to the comp guidance as well. + +Question_2: + + Thanks, Brian. And John, I just had a question on the comp guidance, would you expect this to be pretty broken out between traffic or ticket? Or do think it's going to be more traffic led? +And as you do embark on the opportunity and supply chain, what are you highlighting as the lower hanging fruit in terms of timing? And I was just curious about the categories that you see the most opportunity for when you think about further advancing your supply chain? + +Question_3: + + Thanks for taking my questions. John, congrats on your new role. And Kathy, it's nice to have you back in the retail sector. First, I was wondering to what extent you are using price to drive the 3x growth in signature categories. Can you comment on what the growth in gross profit dollars for those categories has been like? + +Question_4: + + Okay. That's helpful. And then, secondly, your comments regarding the supply chain being stretched, I realize that the analysis is just starting or in the early days. But do you believe that there is a significant reinvestment required in the supply chain in terms of either DCs or [FCs] or something else? + +Question_5: + + Okay. That's great news, and then if I could just sneak one more in. The early back-to-school strength and the marketing shift, is that fully embedded into the Q3 comp guide? + +Question_6: + + Hi. Good morning. + +Question_7: + + Wondering if you could give us a few more examples, concrete examples, of how your driving that localization success in Chicago, categories or items? And separately, if you could talk a little bit about digital approach outside of your own platform? +So we've seen it and we've heard from you what you're doing and that's exciting and driving growth. But we've seen a little bit of your outreach to bloggers and how you're working with them. If you could talk about the full view of how you are thinking about digital outside of the Target headquarters, that would be helpful as well. Thank you. + +Question_8: + + Hey, guys. Welcome, Kathy, and congratulations, John. Looking forward to working with you guys in your new capacity as we move forward. The stock, obviously, was up a lot. Earlier today it's kind of rolled over, and I think it's the sales line that people may be a little concerned about, the 1% to 2% guidance to the third quarter. +But I would also look out over time -- SG&A saves obviously taper down. And so as you look out to 2016 and 2017, getting the sales line moving is going to be more important here. I know, Brian, you pointed to some things like the signature categories, but I was wondering what else gives you confidence? +We actually have a lot of confidence because our focus groups are saying to us that people are really responding to what you guys are doing? But in your words what gives you the confidence we can see sales trend higher overtime? + +Question_9: + + All right. That's perfect. And then maybe just -- I hate to be the short-term focus, but it's a question I get all the time. As we look at the fourth quarter, we are going to be going over a pretty significant comp from last year. How should we think about that? +I mean, a lot of people look at stacks. Do you guys look at stacks? How do you think we should start framing the fourth quarter, maybe in a thought there? + +Question_10: + + Perfect, guys. I'll yield. Those were great answers. I appreciate it. + +Question_11: + + Hi. Yes. Congratulations both John and Kathy on the new roles. I was just wondering if we could focus just -- I know we've talked a lot about the signature categories. You've talked a lot about supply chain, but can we focus on -- and you've also talked about food -- can you focus a little bit on electronics? Continued weakness there. +Clearly the industry itself is a little bit challenged, but a lot of consumer interest in new products in that category, especially as we go into the holiday season, this upcoming holiday season you're talking about the fourth quarter. Maybe dive a little bit into what you're doing there in that specific category to try to gain market share in what is a challenged category. Thank you. + +Question_12: + + Hey, guys. Two quick ones. First, on the digital side, obviously impressive growth, 30%. I think the longer-term plan is closer to 40%. So curious, two things. One, what gets that channel growing faster the next couple of years? +And related to that, a number of large retailers out there are opening up a dedicated eCommerce fulfillment centers. I don't believe you guys have those. Is that something that makes sense for Target as you think out over the next few years? + +Question_13: + + Okay. That's helpful. And sorry, my bad, on that DC question, but thank you for that. And then quickly over to SG&A, I think you guys have outlined $1.5 billion over the next couple of years in savings, $500 million maybe coming this year. Where are you trending towards those savings? How are those savings kind of corporate versus in-store? I'm just curious how store level payroll dollars compare today versus, let's say, a year ago? + +Question_14: + + Hi, thanks. Made it in again. Kathy, welcome. John, I can't let you get promoted without hitting you with the finance questions. So how much did credit help? You said credit, I think, was a benefit in the core of the profit share. How much did that help in the quarter? +And linked to that, how should we think about SG&A dollar growth? It sounds like third quarter will be up [1 point to 2 points] with the comp. But it was flat in the second quarter. What's the normal run rate there now? + diff --git a/exam/original-files/Problem_2_3_Sample_QandA/52_answers.txt b/exam/original-files/Problem_2_3_Sample_QandA/52_answers.txt new file mode 100644 index 0000000..2af50ea --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_QandA/52_answers.txt @@ -0,0 +1,109 @@ +Answer_1: + + Well, Matt, I would tell you, we're feeling really good about the trends we're seeing, the reaction we're getting from the guests, certainly the growth in traffic for us is really encouraging. So we're seeing more Target guests come back to our stores and visit our sites. +And they're continuing to respond very positively to the work we've done in signature categories. So sitting here today, we're very confident about our position. +We think we're connecting with the consumer and our guest, and I feel fantastic about the plans we have in place for the fourth quarter. So while obviously still cautious, as we sit here early in November, we feel very good about the way the consumer and the guest is responding to our brand. And I feel as if we're really well-positioned for the fourth quarter. + +Answer_2: + + Let me talk about the owned brand investments we're making and then let Cathy talk through the Rx implications. As we've consistently talked about throughout the last year and year-and-a-half now, we think one of the things that differentiates Target is the value, the quality, the innovation we bring to our own brands. +So we're clearly looking to make sure we bring more value to our own brands. I talked about the number of handcrafted items we're going to have for the fourth quarter. +And we're being very surgical with those investments, but we're seeing a great reaction from the guest as we elevate the value we offer in our own brands. So we'll be very surgical, very selective, but we're certainly seeing a great return for the investments we're making. + + + And Matt, good morning, this is Cathy. With regards to the pharmacy reimbursement pressure, as we said when we announced the transaction with CVS, that we lack scale and we knew that we were going to continue to see pressure here over time. +So what we're seeing in this quarter is in the range of 15 to 20 basis points of pressure in the quarter. And -- which is why we're excited to be partnering with CVS, because they'll be able to help with that scale. + +Answer_3: + + Right now we're still very focused on testing localization in Chicago. We are very pleased with the results. +And certainly a lot of localization is taking place in our food and beverage offerings. We're seeing the guests respond to that, and we're going to take the learning from Chicago and apply it to the 25 stores we're remodeling in Los Angeles. +So we'll continue to expand the learning, take it from Chicago to LA, but I am very pleased with the progress we're making. And we're partnering with John and the store and supply chain teams to make sure over time we can scale the learning from Chicago and Los Angeles to multiple markets around the country. + +Answer_4: + + We are consistently seeing those kinds of returns. + +Answer_5: + + I think the most important measure to look at is what's happening with online growth overall. And just in the last 24 months -- or 24 hours we saw the October e-commerce growth rates in the US, and it was up about 8.6%. +The outlook that NRF has for e-commerce growth in the fourth quarter is somewhere between 6% and 8%. So while our 20% growth rate is not in line with our expectations, it's still dramatically outperforming the industry. +And I think the most important measure we're looking at is the fact that over 80% of our guests start their shopping journey online, either at home on their desktop or with a mobile device. And that digitally influenced guest is coming into our stores more often. +So as we've talked about our strategy, our strategy is to make sure we allow our guests to shop anywhere anytime they want with Target. And what we're seeing right now is they're voting with their feet to spend more time in our stores. +They're downloading our Cartwheel app: 20 million downloads so far to date. So I think we're seeing an overall slowdown in digital growth across retail. +And we're really pleased that we continue to outpace the industry -- dramatically outpace the industry, but our digital efforts are driving more traffic into our stores and helping us grow our overall comps. So while there's been a slowdown broadly across the sector, we continue to outpace the industry, and that's our fundamental goal. + + + Thank you. + +Answer_6: + + I think we're making some very good strides starting in apparel. And while 3% in Q3 was slightly less than the growth rate we saw in the second quarter, compared to many of our peers we recognize that we're continuing to build traffic and growth in an important apparel category. +So the work we've done with mannequins, with changing the in-store experience, clearly paying off. One of the changes that we've announced recently is the addition of 1,400 visual merchandiser's to make sure we combine the changes we're making with mannequins, and fixtures, and layouts with experts in store that can maintain that great in-store merchandising experience. +So that's a new venture for us, we're standing it up for the holidays, we expect that to continue to strengthen the in-store experience, and we know with our signature categories we're still at the very, very early stages of standing up our wellness position. But we feel like we're in an excellent position with baby and kids, feel very good about our performance in the third quarter with kids apparel. +Certainly toys has been a highlight throughout the year, and we feel as if we're well-positioned coming off of second and third quarter comps in toys that were up 12%. The reaction we've seen from the guests to our Star Wars assortment, where we've captured an industry-leading position and expect to be a destination during the holidays. +So while we still have much more work to do, we feel very good about the progress we're making in signature categories. And I think the addition of visual merchandiser's in store will help us maintain our merchandising appeal throughout the holidays. + +Answer_7: + + Scott, I'm glad you asked the question. I do think one of our highlights in Q3 was the improved performance in food. We've actually seen food comp acceleration throughout the year. +And while we haven't made major changes with fixtures and in-store decor, we've been very focused on assortment changes and bringing more natural, organic, local items into many of our categories. And we're seeing the guests react very favorably. +So, to me it's getting the basics right. And before we start making fixture changes and decor changes, it has to start with the right assortment and making sure we have the items, the brands, our guest is looking for when they shop food at Target. +So the acceleration you're seeing right now is driven by section by section getting the assortment right, bringing more appealing items to our guests, adding more natural, organic, gluten-free items that are on trend to those categories. We made some significant changes in yogurt in the third quarter and saw very, very positive responses; high single-digit growth rates in those categories. +So while we are not shouting about it, we're making steady progress in food. We'll learn a lot more in 25 stores in Los Angeles where you will see some changes in fixtures and decor. And as we learn, we'll continue to grow. +So I think we do have significant upside, but Scott, this is about making sure we get it right, and we're going to take a slow, steady approach, solid, consistent results every quarter. And continue to deliver what the guest is looking for from an assortment experience standpoint when they shop food at Target. + +Answer_8: + + Yes. Scott, we've looked at this very carefully. I know we've talked about it a number of times. We feel very confident that the CapEx budgets we've had in place will be very adequate over time to make the changes we need to make from a technology standpoint, a supply-chain standpoint, continue to refresh our stores, and maintain our focus on maintenance investments. +So sitting here, Cathy and I have spent a lot of time recently, obviously John's been a great steward of our CapEx spending. And we feel very comfortable that our current spending levels will allow us to modernize the organization, enhance technology, improve supply chain, and make sure along the way we're continuing to enhance the in-store experience and match that up with a great online experience for our guests. + + + I would offer just real quickly to add to that, because we have pressure tested this one ourselves a lot, we have not -- Target has not under-invested over the years. And I think that bodes well with the state of where you find our stores as well as our technology and supply chain investments we need. So I feel very good about where we are, and with that level of investment we've been pretty consistent. + +Answer_9: + + So I'll jump in and take that. I think from a tracking perspective, what we said, your point, $1.5 billion of SG&A, $0.5 billion of margin, and we would deliver in 2015 about $0.5 billion of that. +We're running a little bit ahead of that pace. And both in the cost of goods and in the SG&A space, both are running perhaps a little bit ahead of what we envisioned going into the year. So we feel really good about that. +I think stepping back and tying this back to Scott's question, the other thing we said at the time was we're taking $2 billion out of the P&L but we didn't expect EBITDA margin expansion. And our view was that we would need this to fuel the investments, exactly some of the expense investments that perhaps Scott was referring to, and this would provide the capacity to do that. +And that is in fact what we've seen. We've seen great expense discipline across the corporation, but where we needed to invest, we have had the capacity to do that. + +Answer_10: + + We will take out $600 million this year. And then part of next year's will be annualization of that, and part of it will be incremental. + +Answer_11: + + We don't see any material change in the marketplace. Again, we've talked a lot in the past about making sure we're investing to have the best retail team. +And we look at this very surgically year after year, market by market, we think we're in a great position and we think we're hiring terrific talent. And we're excited that we've got a great team in place as we get ready for the holidays. + +Answer_12: + + Greg, this is Cathy. I'll take the first part of it. To answer your question, yes, we expect it to be essentially flat and it will be pretty much offset. +We'll have pluses and minuses, so the savings we're getting we will continue to reinvest as we had planned. John will answer the 40% digital shipment. + + + Sure, Greg. 40% this quarter, and it will peak a little bit higher than that actually, typically running in more in the 20% to 25% range. But as we peak, this is a great way for us to utilize our store assets. +The labor model, what happens here is actually it's quite efficient because we have dedicated teams in those stores who do the picking, do the packing, I mean we're just able to utilize them more efficiently. And so while there is more store labor that we are using, the offset clearly comes in our shipping expense, because we're much closer to the guest we are shipping to and they aren't on the same P&L line, but it's an outstanding trait for us. + + + Greg, I think it's important as you tie out the math on the ship from store. Last year at this time we had just over 120 stores where we were shipping from store. As we sit here today, we're up to 462. So we've expanded the base. +We're going to leverage and sweat the assets I think much more effectively. But importantly, that enhanced base allows us to deliver to our guests in a much shorter timeframe. So we would expect that to grow during the holidays. +We've certainly ramped up for it. And we think that's going to provide a much better shopping experience and allow us to deliver product to our guests in a much shorter period of time. + +Answer_13: + + I'll answer briefly and then anyone can chime in. We're really not seeing an impact on it, in our product cost or in -- obviously in our margins. So it's really been kind of a non-event for us. + + + Remember, Greg, with many of those items, those are long lead time items. So we'll certainly be watching that over time, but as we sit here today many of those orders and POs were placed many, many months ago. +So we'll continue to monitor that over time, but we certainly like our position with our own brands as we enter the holidays, and that's an important way that we differentiate. Operator, it looks like we've got time for one more call. + +Answer_14: + + Bob, first on the A&A side, again, we think the guest is responding really well to some of the changes we've made with our own brand assortment. And the investments that we talked about today we've been consistently talking about for over a year now. +Making sure that we're reinvesting in quality and innovation, in style, making sure that we deliver that expect more pay less brand promise. So the guest is reacting really, really well to that. +And we're going to continue to make sure that we deliver great value in our own brands. So it shouldn't be a new phenomenon. It's something that we've been very clear and transparent about. +And we think it's paying off with increased traffic and growth in those core signature categories. So looks like we've run out of time for today. +I do appreciate everyone calling in. And that will conclude our third-quarter earnings call. So thanks, everyone, for joining us. + diff --git a/exam/original-files/Problem_2_3_Sample_QandA/52_questions.txt b/exam/original-files/Problem_2_3_Sample_QandA/52_questions.txt new file mode 100644 index 0000000..33cbd47 --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_QandA/52_questions.txt @@ -0,0 +1,67 @@ +Question_1: + + First, Brian, I'm hoping that we can get a little bit of the pulse of the consumer from you. Clearly there's been some weather impact in September and October. +But we're hearing negative comments about November from a number of retailers, so it feels like there's something else happening either from a macro or maybe a competitive standpoint. I'd love to get your sense for what you're hearing from your customers, your guests. + +Question_2: + + That's great to hear. Shifting gears to gross margins, I'm wondering if you can call out the impact of the reimbursement pressure in healthcare and any sense for the total impact or run rate impact following the closure of your deal with CVS, how that could help you next year? +And then secondly on gross margin, you did call out in the press release private brand investments. And I'm wondering if you could dimensionalize the potential size of that over the next few years? Thanks. + +Question_3: + + Wonder if you could give us any extra color or update on the localization work in Chicago? + +Question_4: + + So last time you had updated us I think you said 100 to 200 basis point comp lift. Does the very pleased mean we're continuing to see that? + +Question_5: + + Got it. And then quick on the dot-com side of the business, there was some deceleration, still good growth in that line. Can you talk about any other metrics that help us understand the shift? +Is it time spent on the site, capabilities? What is driving the difference in the growth rate? And it sounds like a growth rate you're comfortable with for next quarter. + +Question_6: + + It's encouraging to hear that a lot of the investments, especially in the signature categories, are panning out well for you. In your merchandising strategy specifically, where do you think you still have the most work to do, and what can we expect year over year when we see those categories for holiday? + +Question_7: + + I wanted to get back into the food discussion, if we could. I think you're testing stuff in Chicago, you're going to roll that into LA. +Brian, maybe a lot of people don't notice, maybe they do, but you had a good experience back when you were at Safeway and then onto Sam's. I think you talked about 200 basis points you're initially seeing, but what can we expect out of the Company? +I think Safeway saw more than that as they brought in some refurbishments. And when can we expect to see more from Target as far as refreshing the decor and maybe doing a fuller roll out? +And is 200 basis points a good expectation? It seems to me it could actually be higher than that as you refine your lift, but wanted to get some more details there. + +Question_8: + + Obviously key, and I think Cathy said you're measuring -- one of the big things you look at is frequency, and this is obviously core to that. So we look forward to seeing more. +But my follow-up question is on the investment side. We get it a lot, whether it be e-commerce, whether it be on the food and the logistics. Can you talk us through why there won't be a massive ramp up in investment as we go out the next couple years and that you have enough money in the CapEx and the SG&A to handle what the Company needs to do? + +Question_9: + + I'd like to ask a two-part question. The first relates to the cost cutting initiatives that you discussed at your analyst meeting earlier in the year. +You spoke about $1.5 billion of SG&A and $0.5 billion on cost of goods over two years. If you could talk about the run rate that you're at now against those goals? +I guess another twist on Scott's question, the degree to which you've had investments insight that would offset some of those. I think that was also part of the plan that you set forth. + +Question_10: + + If I could ask a quick follow-up, when you talk about $0.5 billion this year, is that delivered -- I noticed it's not been delivered to the bottom line because there are some offsets, but is that annualized run rate achieved or is that actual cost cuts that would have come out on the gross basis against your cost base offset by some of the investments? + +Question_11: + + And then a very quick follow up, on wages, obviously Walmart made an incremental announcement since your last call. Any sense as to whether this issue is brewing up organically in the field, as you think about hiring and you think about intrinsic wage pressure in the marketplace and how you're thinking about that relative to your plan? + +Question_12: + + I guess my two questions are a bit of a follow up. One on the last one, if you look at the fourth-quarter guidance, if I'm getting this right SG&A dollars are flattish. +And is that basically that cost out with the reinvestment going in? And then the nature of that question is really, John, you mentioned 40% of digital you thought would be ship from store in the fourth quarter. What has it been running and what does that do to the labor model? + +Question_13: + + That's helpful. If I could follow up, I think earlier you talked about private label penetration a little bit. Could you talk about how the stronger dollar or falling raw material costs or lower fuel costs could be impacting gross margin today differently than you would have thought a few quarters ago? + +Question_14: + + Just two quick questions. First one is on the apparel performance, you talked a little bit about margin pressure in private label and exclusive. Was that new to the third quarter, and how do you see that playing out in the fourth quarter? +Then the second question that I have is, on the e-commerce business, can you give us an update on the subscription offerings and how that's going from a fulfillment perspective as well? + diff --git a/exam/original-files/Problem_2_3_Sample_QandA/53_answers.txt b/exam/original-files/Problem_2_3_Sample_QandA/53_answers.txt new file mode 100644 index 0000000..c88c08a --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_QandA/53_answers.txt @@ -0,0 +1,70 @@ +Answer_1: + + We can now. + +Answer_2: + + Well, it's still very early and we'll be tracking this carefully over the next few months. John Mulligan was actually down in the Charlotte market just a few weeks ago, where we've rebranded some of the very first CVS pharmacies inside of Target. So John, why don't I let you share some of your impressions? + + + Yes, I think overall, I don't think the rebranding will be a significant disruption for the store or the technology changes that are going to go on. As we walk the store, it looked fantastic. The CVS brand looks great. I think they've done a great job, between our team and theirs, tying it into the total Target store environment. When we did this, we spoke a lot about the tools that CVS would bring, not only to our guests, but to our teams. The teams were certainly excited about the tools that CVS is bringing to them to help them do their job, so that they can focus more fully on guest service. So we're very excited about that. And we're excited to see, like Brian said, as we go along later in the year, we'll see more marketing to talk about the relationship of the two companies and also see the reaction of our guests as those capabilities are made more front and center for them, as well. + + + I'd only add, we've been working for months and months now with our colleagues at CVS to make sure this is a very smooth transition. And the plans we have in place will minimize the impact on the guest. So we're very excited about what this brings to Target, what it brings to our guests, and to our shareholders, and expect it to be a very seamless transition over the next six months. + + + Thank you. + +Answer_3: + + Why don't I start by talking about the promotional environment? And we approach every year recognizing that the fourth quarter, this holiday season, is a very important time of the year for us, and it's going to be a very promotional environment. And as we sit here today, we really believe our playbook that we rolled out during the holiday drove traffic to our stores, drove traffic to our site, allowed us to accelerate our comp performance. And remember, we were comping a very strong Q4 from 2014. So we felt very good about the effectiveness of our promotions. They were broad, they were very simple, and they worked both in store and online. So we feel great about the performance during the holiday, where our signature categories performed well. We've worked with Nielsen and NPD to look at market share performance and clearly recognize that we gained market share as a by-product of our playbook in the fourth quarter. So feel very good about our approach. +But to your question about the future, we're always stepping back and analyzing promotional effectiveness, looking back at our playbook. And as we plan for next year, we'll continue to enhance and refine and make sure that we have very broad, very simple and very effective offers that continue to drive traffic and profitably grow our sales. John, do you want to talk about the impact of in-stocks? + + + Yes, I think we certainly can analyze, triangulate around the sales impact of in-stocks, but that would be providing you very rough estimates. What I think is much more important when you talk about essential categories, ultimately this is about the guests trusting that you will have the merchandise they want when they come in our stores. If a new mom takes her baby out in 10-degree weather for diapers and formula, you better have diapers and formula in your store. And so really, it's about the trust that they have in the Target brand to always deliver wherever and whenever they want. And over time, there is no doubt in our minds that will drive sales growth for the long term. + + + Thank you, Michael. + +Answer_4: + + Good morning. + +Answer_5: + + I'll start out, and then I'll let Cathy and John also build on it. But as we talked about last year, we've had a very clear multi-year plan. We targeted over $2 billion of savings. And in 2015, we've made very good progress against that plan. We're on or ahead of all of the key metrics that we're tracking and we expect that to continue as we go forward. +So John and Cathy are working across the organization to make sure that those initiatives stay in place. And as John continues to build his team and we bring people like [Anu] Gupta on board to focus on operational excellence, we expect to find even greater opportunities for further improvement. So I think we're well positioned today. I feel very good about the progress we've made to drive productivity across the organization, and you should expect that to continue in 2016 and beyond. + + + I'll just add on a little bit. With regards to our performance with SG&A, the beauty of what we're seeing with the plan we laid out last year is we're delivering upon it, but we're also recognizing how we can reinvest back in the business on the priorities that matter to our guests. And so if you think about our investment in visual merchandise leaders, that's a great example. 1,400 stores now have someone who is an expert at helping to showcase the categories that matter most to our guests. And so we're seeing ability, as we save on one line, we can invest in other areas in our business. +And you had asked about wage pressure. I'm going to just put a plug in. We believe in having the best team in retail. And that has always been a differentiator for Target, and we believe more today than ever that is going to be a differentiator is our wonderful team member engagement with our guests every single day, any way they interact with them. So we're going to be competitive in wage. We always assess it market by market, because we believe in fielding that best team in retail. + +Answer_6: + + Yes. So Greg, thank you. First off, I'm going to put a plug in to say we look forward to seeing you next week, because we'll obviously unpack a little bit more of it then. But with regards to the share repurchase comment, in our guidance we did assume a consistent level of share repurchases, like we've been talking. However, we're also ending the year with a pretty heavy cash position, because we closed the transaction late in December. And so you'll see us provide additional color into that. But suffice it to say, it will be at the level of this year or higher, and we've included that in our EPS guidance of $5.20 to $5.40. + +Answer_7: + + Yes, so as we've said, it obviously was an impact on sales, but very little on the aggregate EBITDA line, which is what we've said longer term. + +Answer_8: + + Yes. + + + Thanks, Greg. + +Answer_9: + + Sean, as we think about our performance in the fourth quarter, it played out pretty much as expected. We know the fourth quarter is going to be very promotional, very competitive. We certainly saw the guests respond very positively to our offers and that drove great traffic. It allowed us to build market share in our signature categories, and I think it positioned us well for 2016. So as we sit here, there's a lot of variables that go into building our plans for a quarter like the fourth quarter, but we're very pleased with the way our plans drove traffic to our stores, visits to our site, allowed us to accelerate comps on top of a very strong quarter last year. And we saw very broad increases across many of our signature categories, as we reported. So I think our plans were in line with our expectation for the quarter. + +Answer_10: + + Sean, again, a number of puts and takes as we look at the impact of changes in currency and cost of goods, but it's all baked into our outlook for next year. And I think we approach 2016 with a lot of confidence that we've got great plans in place, terrific momentum. And as you'll see next week at the conference, the team's done a terrific job in building some exciting new brands that we'll showcase next week and we're already seeing some really positive responses from our guests to our new Kids line, Pillow Fort. So we're excited about 2016 and we look forward to seeing you next week. With that, Operator, we've got time for one last call today. + +Answer_11: + + We're going to spend a lot more time unpacking this next week, but we recognize that today, our Target guests interfaces with the brand in a number of different ways. Sometimes they are in our stores, sometimes they're shopping online. We certainly heard many times, because of some of the proprietary items that we offered during the fourth quarter, they were shopping online, but as John referenced, quickly coming to our stores to pick up those items. So we felt really good about the way the guests responded to our offers during the fourth quarter. And a great combination of in-store traffic, more guests than ever before clicking and collecting items in our store, and then the fact that we were able to leverage our stores, this year over 460, where we were shipping from stores to our guests' homes, that overall package came together really effectively throughout the holiday. So we feel as if we had a winning strategy in the holidays. It drove great comps on top of a very strong performance last year. +And you and many of the others that are on the call have asked me repeatedly throughout 2015, would we be able to comp the 3.8% increase in 2014? Well, hopefully, we answered that question. We answered it with strong momentum, and we were able to see both strong performance in our stores and we delivered industry leading performance online. So we feel really good about the way we're exiting Q4 and well positioned for 2016 and beyond. +So we're looking forward to seeing all of you next week in New York and thanks for your patience this morning. I know we started a few minutes late, but hopefully it was worth your time, and we look forward to seeing you again next Wednesday. So thank you. + diff --git a/exam/original-files/Problem_2_3_Sample_QandA/53_questions.txt b/exam/original-files/Problem_2_3_Sample_QandA/53_questions.txt new file mode 100644 index 0000000..5fe84cc --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_QandA/53_questions.txt @@ -0,0 +1,44 @@ +Question_1: + + Hello. Can you hear me? + +Question_2: + + Okay. Great. Thank you. My first question is on CVS. You had mentioned in your prepared comments that you've already converted some of the pharmacies. And I know it's early days, but wondered if you could provide any detail on if you've noticed any notable changes in traffic in those particular stores? And just how disruptive is the rebranding across the chain over the next six months? + +Question_3: + + Good morning. Thanks a lot for taking my question. Two parter. Number one is on the promotional activity. Can you give us a sense for how much you think that impacted the sales for the quarter and how is that going to influence your promotional posture moving forward? And then the second part of my question is on some of the stats, very helpful stats that Mr. Mulligan provided on the in-stocks, how much do you think that the increase in in-stocks helped in the fourth quarter? Thank you so much. + +Question_4: + + Thank you so much and good morning. + +Question_5: + + I'd like to talk for a moment about the SG&A line and just to put in context the cost cuts that you announced at last year's meeting, about $1.5 billion annualized, talk about where we are in recognizing those and just thinking about the expense performance that you had against that. And as part of that, if you could address whether there's any incipient wage pressure that you've noted in the market would be very helpful. Thank you so much. + +Question_6: + + Hello. I just wanted ask a little more detail on the guidance, Cathy, that you outlined. If you think about all of 2016, how much buyback is there or isn't there in that guidance? And also, how should we think about CVS impacting the guidance, however you want to frame it, in terms of you mentioned sales, but also margin, should we expect a certain margin benefit, if it's 50 to 70 bips up in the first quarter, is that a good run rate for the year or how should we think of it? + +Question_7: + + And on the margins? + +Question_8: + + So your full-year guidance assumes some slight EBITDA margin increase, it seems? + +Question_9: + + Hello. Good morning and thanks for taking the question. Just on Q4, the gross margin was just a little bit lighter than I think consensus and we modeled that. Could you provide just a little more detail on the variances or puts and takes in gross margin versus the internal plan that you had, or was that 50 basis point decline in line with your expectations? + +Question_10: + + Okay. Great. And real quick, a follow-up on how you're thinking about 2016. Just from getting a number of questions about how you feel about cost of goods sold, where are you seeing any inflation or deflation potentially in those categories, and specifically in Food, how is that playing through on the P&L right now? Thanks. + +Question_11: + + Thanks. Good morning. Thanks, Brian. Quick question that was follow-up on something, the top line versus gross margin tradeoff. First, I take it you're pleased with the outcome. I recognize it's very difficult to optimize, but can you tell us maybe at least the growth you saw in digital, was that existing customers versus new? I'm trying to gauge the stickiness of some of the customers that came to you in the fourth quarter. + diff --git a/exam/original-files/Problem_2_3_Sample_QandA/54_answers.txt b/exam/original-files/Problem_2_3_Sample_QandA/54_answers.txt new file mode 100644 index 0000000..c1034a7 --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_QandA/54_answers.txt @@ -0,0 +1,155 @@ +Answer_1: + + Hey, Greg. I'll start. We did see -- obviously, we had a very strong February and March, and felt really great around our performance in Easter. We saw that we took share in apparel in Easter and so we were really good there. But we did see a slowdown in April. A lot of it, though, is that ad shift that we were seeing. So that's part of what we're seeing with regard to April. But we did see slowdowns throughout the course of April. + + + Greg, let me provide some color as far as the geographic volatility, and I'm going to be really transparent with some of the examples. As we looked at business in April, and again in the start of May, we've seen a significant performance difference between our West Coast markets and, particularly, our Northeast markets. And significant variability, where we've seen some very positive growth performance across our entire portfolio -- in Los Angeles, in San Francisco, and many of our core West Coast markets -- offset by significant slowness in the Northeast -- in Boston, in New York, in Philadelphia, in DC. In given categories, we've seen dramatic performance differences. In the ready-to-wear category, on the West Coast and in parts of the Midwest, where we've seen an earlier spring, we're seeing double-digit growth in ready-to-wear, offset by fairly significant declines in the Northeast. +We had a review with our team yesterday. We looked at categories like fans. We have markets that are up 20% and markets that are down 90%, so we're seeing volatility driven by, certainly, climate, but I think a number of other factors that we're certainly analyzing. Cathy talked about an earlier Easter. We've certainly looked at weather patterns. We recognize that, year on year, fuel prices have increased. And our guests and the consumer is spending more than they did a year ago at the pump. +And we certainly recognize that within overall categories, today's consumer, our guest, is reinvesting in their homes. They're spending money on home improvement. We've seen that in our home category, which was up 4% in the first quarter. So, a lot of volatility, and it's both geographic and within category mixes. + +Answer_2: + + Greg, I'm really sorry but you literally cut out right when you said what you were trying to ask about EBIT margins. So, I'm sorry, can you please repeat? + +Answer_3: + + We did talk about gross margin. We expect gross margin to be 40 basis points at the midpoint. And we still expect a promotional environment, and we're planning for that. + + + Again, Greg, I think, under the circumstances, as we've looked at our competitors' reports, we recognize there's significant inventory in the marketplace. We expect the second quarter to continue to be very promotional, and that's factored into our guidance for the second quarter. + + + Thanks, Greg. + +Answer_4: + + Oliver, let me address the trips. And we talked about, in the prepared comments, we continue to see very strong performance in what we'll describe as that stock-up trip, where, as a Company, we performed very well throughout 2015 and again in the first quarter of 2016. Where we have seen some trip erosion is with the guest who is coming in for that fill-in trip. So, as we think about actions we're taking in our business right now, we want to continue to make sure we're serving the guest who's looking for that stock-up item, that stock-up trip. And we're going to be even more focused as we manage through the quarter and the balance of the year to make sure we're winning and driving more fill-in trips. +You'll see us enhance and change both our promotional calendar, our in-store presentation of more fill-in items to make sure that we're doing both -- continuing to win with the guest who's shopping Target for that stock-up occasion, but also making sure we're capturing more of that fill-in trip throughout the quarter. So those are actions that we're taking right now. The team's working on making adjustments in our promotional cadence and presentation to make sure that we're doing both. We're continuing to win with the stock-up shopper, but we're also capturing more share of wallet with that fill-in guest. +From a promotional standpoint, we would expect to see most of the intensity in the apparel space, where we certainly recognize that many of our competitors are sitting on high levels of inventory. We've got to be prepared for continued promotional intensity in that space. And I think we're well positioned, as both Cathy and John have noted, to manage through that throughout the quarter. + +Answer_5: + + Well, I think, Oliver, the one thing that we continue to see, and we've embraced as an organization, is whether our guest is shopping in-store or online, it starts digitally. So we continue to make sure we're investing in our digital assets to make sure we're providing the ease and convenience for our guests, whether they're in-store or shopping online. It's why we've made such a commitment, as John talked about, to enhancing our order online, pick up in-store capabilities. It's why we've elevated our focus on making sure that we provide an easy shopping experience for our guest online. We continue to build out those capabilities. +So, we recognize that, even as we look at the start of 2016, the majority of the retail business in the United States continues to be done in stores, but it starts online. So we better have great digital capabilities to make sure, when our guest is shopping Target -- no matter how they shop -- we make it a convenient, easy experience. So that has not changed dramatically. And one of the numbers that we feel best about in the first quarter is the fact that, on top of a very strong 38% growth in the first quarter of 2015, we grew our digital sales by 23%. So we're continuing to connect with that guest that wants to shop Target online, and we'll continue to invest and build our capabilities in that space. + + + Thank you. + +Answer_6: + + Joe, in some ways, you're looking inside of our current play-book. And, certainly, as we think about winning more trips with that fill-in guest, Cartwheel plays an incredibly important role. And we'll continue to make sure that we activate Cartwheel to drive those trips and meet that guest's need. +One of the things that we're certainly recognizing, as we look at 2016 shopping patterns, is there is a consumer and a guest who continues to look for value. And that value is expressed in more fill-in trips, buying smaller packs, smaller baskets. So, again, it's not a shift in our strategy; it's a recognition that we have to do both. We have to continue to delight the guests when they come to Target for that big stock-up occasion, and we have to have the right assortment, the right value, the right presentation for that guest who's coming to us for the fill-in trip. +So, Cartwheel plays a very important role in that. And, as we think about adjustments and modifications we're making to our plans, Cartwheel plays a very important role in driving more trips back to our stores and certainly meeting the needs of our guest who's coming to us for that fill-in occasion. + +Answer_7: + + Joe, it was a significant disruption. You know our stores. You know the layout. And for all of our center store dry grocery items, we moved every one of those aisles in all of our stores. So, significant disruption for the guest. +Short term, it certainly has an impact on our performance in grocery and food. But, as we've made the changes, the response we're seeing from the guest is very encouraging. They're recognizing the new assortment, the new brands, more local items, the fact that we have more organic and gluten-free items on our shelves. And, in many of these categories -- like the significant change we made in bars -- we're seeing very strong sales results coming out of the reset. +So, it was an investment we had to make, in both labor and in disruption, to make sure we continue to move forward in the reinvention of food. So, short term, it had a meaningful impact on our food sales. But we certainly expect to see the recovery over the balance of this year as we provide a more relevant assortment to our Target grocery shopper. + + + Thank you. + +Answer_8: + + We were as promotional as necessary. We drove, as we shared, a 4% comp in our signature categories, which are the areas that tend to be more promotional. So we feel very good about our promotional cadence. Continue to work on being more and more effective, but still have a long way to go there. So I wouldn't say that we saved any on promotions, in particular. We were as promotional as we thought was appropriate and it showed up in our comp. + + + Chris, I'd only add that, as we look at individual category performance, we felt like we were very competitive in categories like apparel, where, as we look at the NPD data, we look at the market-share results, we were one of the big market-share winners in the first quarter. And, clearly, in apparel, we picked up market share the two weeks leading up to Easter, during the Easter week, and the week following. +So, our assortment, our presentation, our promotions certainly connected with the guest. And, in important signature categories, we continue to advance market share. But we feel particularly good, in a tough apparel environment, that we posted positive comps, we grew market share, and, importantly, we grew market share before, during, and after the important Easter holiday, which is a critically important holiday for the apparel category. + +Answer_9: + + Well, on the in-stock question, I think it's hard to parse that out, a very difficult question to answer. Certainly we have some estimates internally, but it gets into trading behavior, as you know, and how guests will trade out. But, overall, I think the in-stock definitely having it there when the guest wants it. +But, more important than that, is ensuring that they trust us, that no matter when they come in the store, we'll have what they want. And that's about building trust for the brand over the long term. And so there is an immediate impact, but this is much more about being sure we're reliable all the time for the guest. + +Answer_10: + + You know what, I thought I had said gross margin. I meant 40 basis points on EBITDA. So we should see actually a slight uptick in gross margin, a slight downtick in SG&A, and then the EBITDA was the 40 basis points. So, thanks for asking that for clarification. + +Answer_11: + + The team did a great job of managing expenses in the first quarter and will continue to do that. And, yes, it was down year over year, and we'll continue to manage our expenses. + +Answer_12: + + No change. + + + $1.8 billion. No change at all. + + + Peter, thank you. + +Answer_13: + + Bob, it doesn't. Obviously, it's been a question that we've asked ourselves. And, as Cathy and John have both mentioned, we feel very good about the progress we're making from a strategic standpoint. We've talked multiple times now, certainly we talked to most of you on the call during our March Investor Day, our continued focus on building out our digital capabilities, we're making very good progress there. We think those are going to be essential to our future. +We feel very good about the progress we're making on signature categories, where we continue to build market share and drive differentiation. We're very excited about the early results of Pillowfort, and feel as if, when we launch our new Cat & Jack brand for kids, that is going to be another potential $1 billion brand in our portfolio. So, great progress from a category roll and signature category standpoint. +As John mentioned during his remarks, our flex formats continue to be very well received as we move into new urban markets. We're excited about our Tribeca store that will open up in October. But we've been excited about every one of these new flex formats, and they've been well received in both urban and college markets. We continue to think we've got significant opportunities in localization, and the work we've done in Chicago and now Los Angeles just continues to confirm that. +So, our strategy continues to perform well. John and the team continue to enhance our store and supply-chain capabilities to continue to meet the needs of our guests. So, as we sit here today, there's no significant change in our strategy, but, tactically, we recognize the consumer environment is tougher. +We've got to make sure we're delivering the right value, we're winning with both the stock-up and the fill-in trip. We're making sure that we have the right experience for our guests, where they're shopping in-store and online, and we don't see any structural change in the consumer environment. We think this is a short-term bump in the road. But we think we're well positioned. And everything we see from a GDP and consumer confidence standpoint gives us the confidence that this is going to be a short-term impact and we're going to see very solid results in both the third and fourth quarter, and keep us on our long-term guidance track. + + + Thank you. + + + Thank you. + +Answer_14: + + Scott, it took place right after Easter, during the month of April. So, a major effort inside of our stores. We touched, as I mentioned earlier, all of those center store grocery aisles. We added a number of new items, over 1,000. We brought new brands into those categories, and we've expanded our Simply Balanced line. +So all that took place and it was very disruptive, and we planned for it in April. We now have the work behind us, and I'm very excited about the feedback we're receiving and the responses we're seeing in many of these categories. And certainly expect that we'll see those businesses accelerate, now that we have more relevant assortment. And we've significantly increased the representation of organic and natural and gluten-free and local items in those aisles. + +Answer_15: + + Yes, I think that's largely the case, Scott. Again, as I said earlier, and I want to make sure we're really transparent about this with examples, we've seen very slow sales performance in the Northeast. And, we have the same presentation. We had the same ad. We had the same value. We had the same great in-store experience. But on a day-in, day-out basis we're getting very different outcomes. +So, on one hand, it gives me confidence to say what we're doing is working, because it's working in many parts of the country. But we have isolated geographies where, whether it's a late spring, whether it's a change in short-term consumer behavior, we're not seeing the same results. But we're delivering the same great content. +So, I expect the Northeast to recover. I think spring will arrive there. And I think when the guest is out shopping, they'll continue to choose Target and we'll continue to provide them a great in-store and online experience. But we are seeing very significant geographic volatility, unlike anything I've seen in many, many years. + +Answer_16: + + Scott, you're spot on. It's much more about consumables, household essentials. And, to be very clear, it's probably less about promotional intensity, but ensuring that we are promoting and presenting the right items, particularly at the back end of the month when the consumer and our guest is more likely to look for single-unit items, more items at a value. So we've got to make sure we're making the tactical adjustments to what we advertise, what we present in-store, and making sure that we're winning both with the stock-up guest, but also with the guest that's looking for value and looking for smaller, single-unit packs at the right value. + +Answer_17: + + It's a fabulous store. + +Answer_18: + + I'm smiling, and I may turn this over to John. We've all actually visited our Bixby store in Long Beach over the last few weeks. The store really captures the best of Target in a smaller, 30,000-square-foot environment. And very positive reaction from the guest. So as we think about future flex formats, that is a model that we're excited about, a model that certainly seems to be connecting with the guest, and you should expect to see more of those as we go forward. +But let me hand it over to John who's been intimately involved in the roll-out of flex formats and, specifically, the work we're doing in Long Beach. + + + I would just -- obviously, we're very excited about the performance of the stores. I think the financial performance, certainly, but I think, like Brian mentioned, really it's the guest reception of those stores. And, while they are very conveniently placed, like the Bixby store, they're not convenience stores. The intent is to lead forward with what Target does well -- home, apparel, our signature categories -- and that's what you really see in that Bixby store. +We will continue to increase the number we're doing as we go forward, but continue to test geographies and sizes of stores and how those two work together. Obviously, the Bixby store is quite large, and that's a little bit different neighborhood than we've done in the past. +So the Tribeca store that Brian referenced, again, very different. Very dense, urban store, two-level store. We continue to test configuration and neighborhood but feel very, very good about what we've found so far. And you'll see us continue to grow those number of stores that we open over the next several years. + + + Just to finish up on that, Scott, I think the Long Beach store that you visited is a great example that really shows how we're approaching each of these initiatives. We are testing, we're learning, we're refining. The team's getting better and better at layout and assortment, and you've seen that when you walk the Long Beach location. +And the feedback that we've received from the guest is, even in a smaller box, it feels like Target. And it feels like the best of Target. The work that the team's done in the center of that store to merchandise our soft lines is really outstanding. We're getting great feedback around our food presentation in that store. We've got the right home assortment. So we're tailoring that for the local market. +But it's an example of the fact that we've been disciplined. We're not sprinting, we're making sure that we're really thoughtful. We're learning. We're adjusting. And you're seeing each of the new flex formats get better and better in layout, assortment, and tailoring to meet the local market. So, we are very excited about it, and we'll continue to take that learning and build it into new flex formats that we'll be opening up over the balance of this year and into next year. + + + Thanks, Scott. + +Answer_19: + + Well, John, as you might imagine, we're spending a lot of time, and have spent a lot of time, as a team looking at performance from a number of different vantage points, both internally, but also certainly incorporating external data. Certainly it was an earlier Easter. We recognize the impact of that. Certainly weather in many major markets has been a factor. It's not an excuse. We've got to figure out how we perform under any circumstances. +We know, as the guest and our consumer has moved through the course of 2016, prices at the pump, fuel prices have risen, and that's certainly an impact. And then when we look at a macro basis on overall spending, we certainly recognize that consumers are spending more on travel, on leisure activities, they've been investing in their homes, as I mentioned before. But there's no structural change that gives us pause and has us changing our strategy, altering our outlook for the full year. +We think -- we're continuing to improve our digital capabilities. I think our store experience is improving each and every week. The response we're getting from the guest based on changes we made in apparel and home, and recently in food, are very encouraging. As John mentioned, our flex format's performing quite well. +So we feel confident that the content we have in place, the plans we have for the second half of the year, some of the enhancements we've made from a branding and in-store and online standpoint are going to continue to deliver solid results. So we see this as a momentary speed bump, but we see no reason to alter our strategy. These are tactical adjustments we have to make. And, market by market, we've got to make sure we're well positioned to compete going forward. + + + Thank you. + + + We've got time for one more question, operator. + +Answer_20: + + So we, obviously, have insight into where May is at today, and then we've got Memorial Day coming. We've got great plans around -- leading into Memorial Day and have every confidence we're going to have guests come to Target, whether in our stores or online. And then, summer and warmer weather will come, and so we have an expectation that the trend we see today doesn't change overnight. But it does improve throughout the quarter because we've got some really great plans to deliver for our guests. +And then also, in the latter part of this quarter, we have Cat & Jack launching, and we're very excited about Cat & Jack launching before back-to-school season. And we expect that to be a leading Target-only brand that will be a $1 billion brand in time. + + + So, Chris, thanks for your question. And I really appreciate everyone who called in today. We tried to make sure we allotted significant time for your questions. Hopefully, we had a chance to answer your questions, address some of your concerns. So, that will conclude our quarter. I appreciate your time today and thank you for dialing in. + diff --git a/exam/original-files/Problem_2_3_Sample_QandA/54_questions.txt b/exam/original-files/Problem_2_3_Sample_QandA/54_questions.txt new file mode 100644 index 0000000..d82b3f1 --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_QandA/54_questions.txt @@ -0,0 +1,82 @@ +Question_1: + + Hi. I had two questions. Thanks, Brian, and I think, John and Cathy, you all gave a nice overview there when you described how the quarter progressed. Could you help us understand where April was? Was it actually negative? And also, any geographic distinctions that you saw in the quarter? And then I had a follow-up on the margin. + +Question_2: + + That's great, that's helpful. That's also a transition into the margin. If I got your guidance right, the midpoint of it, if I take the comp and to get to that EPS I get (technical difficulty) margins down around (technical difficulty) in the second quarter. One, is that right? And, two, it sounds like the real reason for that might be a little bit of deleverage and then basically mark-down risk on inventory given the rest of your comment. Is that fair? + +Question_3: + + Yes, it looks to us from guidance, EBIT margin is down 50 BPs in the second quarter at the midpoint. How much of that is just deleverage and how much of that is mark-down risk from the elevated inventories and categories? + +Question_4: + + Hi. Thanks for all the details. We had a question regarding the smaller convenience trip slowdown. Could you just help us understand it, as you looked at the data, if there's patterns there that give you some insight into how that dynamic may be playing out and what's the opportunity there? +And, secondly, on the promotional pressure that you're seeing, what's the axes from which that may be happening in terms of, A, categories and, B, Amazon versus bricks-and-mortar competition? Are there different aspects of competition that you're facing as you look to determine what's optimal from an executional and strategic point of view? Thank you. + +Question_5: + + Okay. Thank you. Just a quick follow-up. As you've been monitoring, and you've been really ahead of thinking in terms of the omni-channel experience, Brian, are there any little changes that you've been seeing in terms of how customers view convenience or what you're seeing now in terms of the online plus offline experience that are different in terms of like the trends you've been recognizing? + +Question_6: + + Hi. Thanks for taking the question. I wanted to ask, Brian, if you could talk a little about the in-fill trips again. Wanted to go back to Cartwheel. If I recall, I don't think you even mentioned it on the call this time, and I'm just wondering if there's any changes going on there or what you're doing. Presumably, that would be a way to help stimulate the in-fill trips like localization, personalized marketing. I know you guys do a great job with that with your mobile effort. So just, did something fall apart on that front or maybe some things weren't as effective? Could you talk about that a little? + +Question_7: + + Got it. Thanks. And then, you guys mentioned the center store disruption and all of the efforts you made -- that you are making to improve the healthy living and that category. Were you able to quantify how much of an impact that had? Presumably it was a decent disruption in April that could have had a bit of a drag. + +Question_8: + + Hi, this is Chris filling in for Kate. With the comp coming in below your expectations, is there a reason why you didn't choose to get more promotional this quarter? Could you walk us through how much of your gross margin was impacted by promotions and was it more than last year? + +Question_9: + + And just looking ahead, you mentioned apparel's going to be very competitive. Are there any other categories you see that will also face pricing competition? And also, just really quickly, for your in-stock initiatives, how much did the improvement in those initiatives contribute to the comp in Q1? + +Question_10: + + Hey, guys, just a clarification. Just on the second-quarter gross margin outlook, I think you said down 40 basis points. I assume that's on a reported basis, right? So, excluding the pharmacy impact, it would be down maybe closer to 100. Am I right on that? + +Question_11: + + No, perfect. Okay. Thank you. That's helpful. Just on SG&A, is it fair to say that the SG&A dollars, if you exclude the pharmacy comparisons, were down slightly year over year in the first quarter? And I'm just curious if that's a trend that you think could persist over the balance of the year, given the tougher sales environment. + +Question_12: + + Okay. Last question, I apologize if I missed this. Any change to the CapEx plan for the year, which I think was around $1 billion? + +Question_13: + + Hi. Good morning. I'd just follow on Peter's last question. But when you look at the sales results that you had the last few weeks, and especially April, does that make you rethink your longer-term sales views that you laid out back in March? + +Question_14: + + Hey, guys. Thanks for taking my questions. So I just wanted to clarify, the resets in the dry grocery, when did that take place? Was that during the quarter or was that after the quarter closed? And, if it was during April, what was the drag? Do you guys know? + +Question_15: + + So, Brian, the weakness you continue to see into May -- because I think you say that reset went really well, that's a chunk of sales. So the weakness you see continuing into May would be non-consumable areas that are just, as you say, heavy inventory in some of these signature categories. Is that a good way to frame it? + +Question_16: + + Interesting. And so then I just wanted want to touch on the fill-in trip situation, and I think you talked about promoting a little bit more to try to get those trips. Is that promotion different? Is that promotion more in the consumable side of things as you look at it? It seemed intuitively that would be, but I just wanted to get your thoughts on it. + +Question_17: + + So then I had just one last one I want to sneak in because I was in your store in Long Beach, which I thought was wonderful, that small Target. + +Question_18: + + How close are you from test to actually rolling out more of those? And then I'll yield. Thank you. + +Question_19: + + Hi. Good morning. Thanks for taking my question. Wanted to ask about the second half of the year. You've already addressed this a little bit, and you've provided us a lot of evidence, I think, that points towards weather as a significant culprit in the volatility in the sales at the end of the first quarter and the start of the second quarter. +But you also alluded, at some points, that maybe there's something else going on with the consumer. So I was wondering if you could just talk about what else might be negatively impacting the consumer -- or your consumer, that you're aware of. And do you have any data, for example, if you look by segment of consumer, income levels or REDcard usage, that would help you understand the trends to a greater extent? Thanks. + +Question_20: + + Made it in. Thank you. So, following up on that question, just that thread of questions, so outside of the Northeast and California, has it been more consistent? And then, related to that, as you think about the second-quarter guidance, are you basically extrapolating current trends which have been weather impacted? Or are you taking a directional view, either more conservatively expecting to pick up as the quarter progresses or in either direction? Thanks. + diff --git a/exam/original-files/Problem_2_3_Sample_QandA/55_answers.txt b/exam/original-files/Problem_2_3_Sample_QandA/55_answers.txt new file mode 100644 index 0000000..c2d57fd --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_QandA/55_answers.txt @@ -0,0 +1,120 @@ +Answer_1: +Matt, as I discussed in my prepared comments, our traffic was impacted by a number of factors including CVS. Do we certainly saw a slowdown in our pharmacy operations. We're working closely with CVS to launch the new marketing campaigns to win back our Target guests, and certainly to begin to unlock the potential of their PBM network. So that certainly played a role. But we also had other factor that we're focused on right now. +We're not pleased with the performance we saw in food, despite making some really good progress in presentation, improving our assortment, and certainly the freshness of our products. So our number one focus, as we sit here today is driving traffic back to our stores, and accelerating visits to our site. And addressing the pharmacy impact is just one of the variables we're focused on today. + +Answer_2: +Matt, for us it's a broader story across the product suite. And one of the first things we've had Mark Tritton do, is actually spend time with our Apple partners, really making sure that we're putting the right plans together for the back half of the year, that we're ready to capitalize on their new innovation that they'll be bringing to market. +But again, as we think about factors that we have to address to improve our traffic and overall sales performance in the back half of the year, we have to improve electronic performance. It was a significant drag, 70 basis points on our overall comp decline in the quarter, and Apple played a significant role there. So we over-index with Apple products, our guests come to us looking for those products, they're looking for the newness and innovation, and we're putting together plans with Apple, and our merchandising teams to make sure we're ready to take advantage of that in the back half of the year. + +Thanks, Matt. + +Answer_3: +Good morning, David. + +Answer_4: +Well, Matt, I think we've seen this environment persist now for well over a year. It's a very cautious consumer. If we look at the overall trends within retail, we've certainly seen on a rolling 12 month basis a slowdown in retail sales growth, but that's not an excuse for us. +We got to make sure we're leveraging our strategic levers. We continue to make sure we improve our in-store experience. +As John talked about during the call, we've got to make sure that we offer a sensational in-store pick-up experience. And also make sure that our site is easier to work with and allows us to ship directly to home. So we've got to make sure we're leveraging the key components of our strategy. +I feel really good about the progress we've made in-store, in preparation for back-to-school, back-to-college, I've announced into a number of markets. I don't think our stores have ever looked better. +So it's a competitive environment, it's going to continue to be a competitive environment, and we've got to make sure that we leverage our strategy, make sure that we're bringing the best of our signature categories, and bringing the value the guest is looking for in core household essentials, to win trips, and win back trips in the second half of the year. So it's competitive, but it's always competitive. And we've got to make sure that we're leveraging our assets, and our strategy to continue to drive performance in the back half of the year. + +Answer_5: +David, you've used an important term that I've been using internally, and that is balance or rebalancing. And as I look at my experience now over the last couple of years at Target, we're best when we balance both ends of our brand positioning. We've got to deliver on the expect more component, and I think we've done a sensational job there. +Our progress in apparel and home has been really significant, and we've got to make sure we never lose track of the other side of our brand promise, and that's the pay less side. And that's all about those core household essentials that we have to make sure are presented effectively in-store, in our circular, on our end caps, to our guest each and every week. So as we think about the back half of the year, and the keys to driving our business going forward, we've got to have both of those levers in balance. +We've got to continue to make sure our signature categories, and particularly those important style categories, continue to connect with our guest. And we've got to deliver a great value through household essentials, those every day products that drive that Target run. So that balance or rebalance is critically important to the actions we're taking in the back half of the year. + +Thanks, David. + +Answer_6: +Oliver, let me try to break apart those three questions, and have Cathy and John jump in as appropriate. As we think about the rebalancing, and the work we're doing from a merchandising stance point, an in-store presentation standpoint, and also a weekly advertising standpoint. We recognize we have to continue to deliver the right presentation for that stock up occasion, and particularly in the back half of the month, have the right assortment, the right presentation, the right availability of the items our guest is looking for in that fill in occasion. +So we're activating and ensuring we put those changes in place, to find the balance as we speak today. So we're certainly very focused and aware of the fact that we have to win on both fronts. We have the right assortment for that stock [up] occasion, and we need to make sure we have the right pack price architecture to meet the needs of the guest during that fill in occasion -- so we're very focused on that. +From a CVS standpoint, I'll let John jump in here. It's not a surprise to us that there has been some disruption and I think, for all of us on the call, we know what it's like when we change a pharmacy prescription, and move from one provider to another. And while they're staying in our location, they've got to sign up for some new programs, they're entering a new environment. +There is some time that's going to take. But we've been very pleased. John has been working with his CVS counterparts on the transition. +We've had great collaboration, great partnership. We're starting to activating the marketing and the personalized messaging. And we expect over time, we'll see that business accelerate, and we expect pharmacy and the partnership to be a future driver of traffic and growth. +But John, why don't you talk about some of the things we're doing at the store level with CVS? + +Yes, I think I'd start by first echoing what Brian said, we talked going into the deal, we had a great partner. And that is certainly what we have observed through the transition here, been a great partner to work with. Our teams have worked together very well to transition. +We've done the best job we can, in transitioning guests. But as Brian said change is change, and sometimes you just need to work through that. From a go-forward perspective, we're working with CVS, certainly on some of their capabilities that they'll bring to bear for Target. And as Brian said, unlock their PBM network into our stores. +But more importantly day-to-day, in the stores, we see great guest service -- continue to see great guest service from our pharmacists. CVS would note that probably the best score they've ever seen in a transition like this. And then starting to work with them, to engage the pharmacy more back into the store, through things like the opportunity here at back-to-school, back-to-college with flu shots, and having the pharmacy play a more prominent role as we go forward. +And so the teams continue to develop plans like that. They're very focused on it. We're focused on it, and we're very excited about the opportunity here, as we continue to move forward. + +Hey, Oliver, this is Cathy. I'll add a little bit more too around priorities for driving traffic in the back half, and that we're really excited to be going to this part of the year, where we have a lot of events, and that's where Target really has some great plans. We always have great plans, back-to-school back-to-college. +We're excited about, obviously, the launch Cat & Jack has started out very successfully, with a lot of learnings that we took away from Pillowfort, both online and in stores. And then obviously, we go into our prime time. And so standing tall on the events that we typically have always done, but we're really well positioned. +And then, it's the things that Brian and John have already mentioned, the rebalancing of our messaging, that we are re-looking at all of our grocery efforts around presentation, assortment and promotion, at the electronics, the newness that Brian mentioned. Then, obviously, the work that John just said around CVS. + +Yes. So Oliver, as we think about the second half, we've got to continue to build on the things that are working today. Even in a challenging second quarter, we grew market share in the important apparel space. We saw very strong results in our home categories. +We continue to be a destination for toys. So we've got to build on the things that are working and ensure that we're also winning trips for those core household essentials. So we'll be focusing on rebalancing, on leveraging the improvements we've made both in-store, with our in-store pick-up process and also online. +And we're not altering our strategic focus, it's making sure we get our strategies in balance, and we deliver against both signature categories, and those important household essentials that drive traffic to our stores, and put cars in the parking lot. + +Thanks, Oliver. + +Answer_7: +Good morning. + +Answer_8: +Well, we certainly think we are winning in the apparel space. And I think a lot of that's really driven by the changes we've made, the improvement in our assortment, in quality, in being more on trend with some of our fashion assortment. I talked about Xhilaration performing very well in the quarter,. Who What Wear continues to be a real winner for us, and connecting well with our guests. +And we've also matched that up with an improved in-store experience. And we've been talking about mannequins for awhile, but the role that our visual merchandisers are playing. The investment that John and I made last year to ensure we had, not only mannequins and home vignettes, but the talent in our stores to maintain that experience 52 weeks a year is certainly connecting with the guests. +So we think we're benefiting by really executing against the strategy we've been talking about for several years, making sure we have the right quality, innovation, presentation in our stores, and we surround our guests with great service. And that's paying off with market share gains in a challenging environment, where we continue to see improvement in our apparel and home assortments. + +Thank you. + +Answer_9: +Yes, Greg, we certainly do, and Cathy and I talked about this at the end of the first quarter. We've seen quite a bit of variability on a day-to-day, week-to-week basis between different markets. +We've seen particular strength in many of our West Coast markets, very strong performance in California, driven by great performance in LA and San Francisco, but other parts of the West Coast. We've seen pockets of softness on the East Coast. +And we've really tried to make sure market by market, we're looking at those dynamics, looking at the competitive dynamics, understanding what we can leverage from the markets where we are seeing increases like Los Angeles, and bring that into challenged markets. But we've seen over the course of this year in 2016, much more variability than I've seen in many, many years. So we're drilling down on that. +And as we think about our plans for the second half of the year, we're building market-specific action plans to make sure we address the market-specific needs of our stores and our guests. + +Answer_10: +Yes. + +Answer_11: +Yes, so it's slightly down EBIT margin, we said gross margin and SG&A about where they were last year. + +Answer_12: +It is slightly up. So yes, so slightly down Q3, slightly up in Q4. + +Answer_13: +Greg, we're very comfortable right now with our inventory position. + +Thank you. + +Answer_14: +Dan, I think it's largely driven by the new innovation that we bring to the guests in the fourth quarter. So we've certainly seen pockets of strength. I mean, there's certainly winners and losers within that space. +We've seen continued performance with wearable technology. But it's not overcoming the softness we've seen in mobile, in tablets, and in some of the core items. So I think the success of that category, as always is going to be driven by new news, and news that connects with the guest, and drives traffic into those categories. +So again, it's why Mark and his team are very focused right now, in working with our electronics vendors to make sure we have the right innovation, we're presenting it in a way that's impactful for the guest, and we have to see improvements in a category that's been a big drag on our comps over the last couple of quarters. + +Answer_15: +Yes, I think, Dan there's been a lot written recently about the competitive nature of the food channel. And for us on one hand, we feel, I feel, really good about the progress we've made with assortment. If you walk our stores today versus even six months ago, aisle by aisle, you're seeing more organic, more natural, more gluten-free, more local items that are on trend. +The freshness and the work that John and his team have done from a supply chain standpoint is clearly connecting with the product we're delivering to the guests. And we've seen an uptick in categories like produce, because we're delivering better product. But at the same time, market by market, this is a very competitive space. There's clearly food deflation right now that we're facing, and it's a very competitive environment. +And back to the earlier question about traffic and performance trends by market, we're looking very specifically at food by market across the country, because we face a number of regional competitors, and we've got to make sure our presentation, our promotion, our approach enables us to compete market by market. + +Answer_16: +Well, Dan, we've certainly used it as a learning lab, but our intention is to lift the winners from LA25, and quickly bring them into other stores across the country. And while it's still very early, we have effectively one quarter of learning under our belt, I'm very pleased with some of the results we're seeing in apparel, in home. +And certainly in food, whereas I mentioned during my prepared comments, we're seeing performance in those 25 test stores that are clearly, really encouraging from a food standpoint, particularly in the perishable space. So we'll be looking to leverage that learning. That's part of our strategy that we've articulated for several quarters now, that we want to use LA as a test market to lift and shift the winning concepts into more stores across the country. And we'll continue to lift and leverage the learning from LA25, to improve the experience in the presentation of product throughout our Target stores. + +Thank you. + +Answer_17: +Well, Scott, I'll start with, we're playing to win. And we've invested heavily in that very important category. We've had a long-term commitment to food, we think it's very important for our guest. +And over the last couple of years, while we've done it in a very disciplined fashion, category by category, and I appreciate hearing you say that you've seen an improvement in execution, and hopefully in presentation. Now we've added thousands of new items, and we've worked with our vendor partners to make sure we're bringing the right innovation, category by category. Our team is absolutely going, literally item by item, commodity by commodity, to look at how we source, and how we flow product to improve freshness, and the quality we present to our guests. +So we've got to make sure we have the right assortment, the right presentation, the right quality. We have to have the right promotional strategy to compete, but we're playing to win both short- and long-term. We think that it's very important that we continue to make progress in this space. We're going to make sure we do it in a very focused manner. +We really like what we're seeing in LA25. We're not going to roll it out to 1,800 stores tomorrow. We're making sure we that can validate what's working, and how can we drive profitable sales in that space. +But we are playing to win in food. We're going to continue to roll up our sleeves, and make sure that we're into the details, finding ways to unlock the growth potential in that critically important category. + +Answer_18: +Yes, and Scott, in all due respect to the Journal, let me speak on behalf of our Leadership team and the Board. We have no hesitancy at all, in investing capital in our business that drives growth and the right returns. +As Cathy has demonstrated throughout the last few calls, even in challenging times, we generate significant cash flows. And we want to make sure the first thing we do with that cash is invest back in our business. So it's why we're spending time, looking at LA25. +It's why we've been testing a number of different features throughout our stores, from apparel, to home, to food. It's why we're so excited about investing in flex formats, where we see a very strong response from the guest. Those are delivering very strong returns, well ahead of our original plans, and food plays an important part in those smaller flex formats. +So despite what you may be hearing, we have absolutely complete support from the Board to make sure we're investing capital behind the initiatives that are going to drive future growth. So again, we're not just playing for just the short-term, we're playing for the long-term. Those capital investments have to be done on behalf of the guest and our shareholders, but we're looking right now at a number of different opportunities to continue to invest to drive growth. +So there's no hesitancy at all in making those investments. And as you just said, food and perishable and consumable categories will play a very important role in driving traffic to our stores. And in the future, we've got to continue to bundle that with the work John's doing, to make sure and we're investing and improving our in-store pick-up processes and experience. +That's an investment we're making, and an investment we're making for the holiday season. We're continuing to invest in our digital assets. So there's no hesitancy at all, from this Management team nor the Board, in making the right investments in our long-term success. + +Thanks, Scott. Operator, we've got time for one last call. + +Answer_19: +Yes. Joe, it's a great question for us to end on, and I'll take personal responsibility for this. I've talked earlier about the fact we've got to be rebalancing our messaging, and we've done a really terrific job of elevating our messaging and communication around our signature, and particularly our style categories. +As we go forward -- I've used this term before, we've got to make sure we're rebalancing, and we got to make sure we continue to elevate our messaging, our communication around style and those core household essential categories, which include food, that drive traffic to our store and are important to our guest. So making sure we go back to the brand promise. +We've got to make sure those expect more categories like style, we continue to elevate. And we've got to make sure we deliver the pay less component, and ensure that we balance the work that we're doing from a style standpoint, with the progress we're making on those core household essentials, which include food in that offering. +So it's really an important question. It's certainly a big area of focus for us, on the balance of the year, and into 2017. And I think, it's going to be part of the formula that drives traffic back to our stores, and improves comp store growth over the balance of the year and into 2017. +So operator, with that, we're going to conclude our call. And I thank all of you for joining us for our second quarter earnings call today. Thank you for participating. + diff --git a/exam/original-files/Problem_2_3_Sample_QandA/55_questions.txt b/exam/original-files/Problem_2_3_Sample_QandA/55_questions.txt new file mode 100644 index 0000000..5e6bb37 --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_QandA/55_questions.txt @@ -0,0 +1,70 @@ +Question_1: +Thanks a lot. Good morning. My first and primary question relates to the, how much impact do you think the CVS pharmacy transition had on traffic? Did you see that dynamic deteriorate from the first quarter, and is there a way to quantify perhaps, how much you feel like the spillover effect from that would have impacted the overall comp? + +Question_2: +Thank you for that. And by way of quick follow-up, a different topic. +You touched on Apple products down over 20%. We're obviously in the middle of a bit of a pause between the iPhone releases, leading up to one most likely later this year. Is the Apple softness at this point really an iPhone story, or is it a broader issue across the product suite? + +Question_3: +Hi, thanks. Good morning. + +Question_4: +How are you? My question is on the competitive environment. You talked about all of the different things you're working on with traffic, but is there anything out there that you're seeing, anything you could highlight in the major categories that's going on in the marketplace that might be affecting your -- either your traffic or customers attention, and how you're thinking about addressing that in the back half? + +Question_5: +I guess, the follow-up to that would be, it's competitive as you say, it continues to be competitive. Is there any change in the balance of whether it's new products and merchandising, or pathways brought to market or pricing, any thing changing in the way the competitive environment looks for you to make above it? + +Question_6: +Hi, we had a question regarding the dynamics you're seeing between fill in and stock up trips. How are you feeling about that in your research? And also as we look towards the back half and model our views on comp store sales, what would you prioritize as the biggest drivers to improve traffic, in terms of the different initiatives that you're pursuing in light of what you're seeing? +And just another question we had is, why do you think this happened in pharmacy, in terms of what was the consumer experiencing in your store that made the transition a little more disruptive than you would have wanted? Thank you. + +Question_7: +Hi, good morning. + +Question_8: +I think when you gave guidance for Q2 originally, it was because of some of the higher inventories that you flagged at other channels, especially with regards to apparel. So I was just wondering how much you think you're benefiting from some of the weakness that we have seen at the brick-and-mortar department stores, especially when considering your women's apparel comp was up mid single-digits during the quarter? + +Question_9: +Good morning. I want to follow-up a bit on traffic, and then get into the guidance a bit. On traffic, if you think about it a different way, I think about a year ago, traffic had recovered nicely, to stay up 1%, and overall retail sales were growing roughly where they were, if you look at the government data. +And now the traffic is obviously down a couple percent. Do you see any differences, in terms of geographies or other things going on, the income demographics around your stores, where that traffic trend is different, just looking at the last 12 months? + +Question_10: +That's helpful. And then Cathy, I think on the margins, just want to make sure I got the guidance right. If I take the midpoint, I get to the -- you mentioned the third quarter, flat EBIT margins, although I imagine ex the CVS sale, they would be down like 30 bps. + +Question_11: +Is that right? + +Question_12: +Got it -- but for the fourth quarter, does the guidance imply that EBIT margins will be flat? + +Question_13: +Okay. Just want to make sure I've got that right. +And then, I guess last on that, just to make sure the inventory up 4%, do you guys think -- I mean, that you're comfortable with that number? It's not like part of the third quarter is working that inventory down? + +Question_14: +Thanks. It's Dan Binder. I had a question on the consumer electronics category. You talked a lot about that today, and I've noticed in your stores recently you've had some reset activity, particularly in TV as you offer more 4K. +I am curious, as you work through these plans to improve that business, do you think that can be a category that returns to positive comps by holiday, given all the changes you're making? + +Question_15: +And then, a follow up on the food category. You mentioned you were reevaluating promotion in, I guess, food and consumables. +I'm just curious, it sounds like you'll increase it. So I'm just curious, are you seeing others out there being more aggressive in the category, is that what you would attribute softness to? And if that is the case, where -- which channels are you seeing it in? + +Question_16: +Well, congratulations on the LA25. It sounds like you're getting good results out of that. +I was just wondering if you could share with us, the likelihood of being able to roll that out? Is it a cost efficient format, or are you primarily using it just for learnings? + +Question_17: +Yes, hey, I wanted to continue on the path where Dan was going. But before I got started I'd just say, in our store visits, you can definitely see the improving execution, so kudos to John in getting that done. But getting back to the food discussion, our research is showing some pretty aggressive moves and I think Dan was getting at this. +I mean, are you guys going to match what's going on in the market? And it looks like we're at the beginning end of a pretty aggressive price war. How do you see it? Where do we -- we're now seeing deflation reported by the government of [1.5%] -- [1.5%, 1.6%], and our pricing surveys are even greater than that. So where do you see this going? +What do you guys plan to do to combat it tactically in the short-term? And then, I wanted to address the longer term food business after that? + +Question_18: +So Brian, thanks for that answer. So to dovetail more into the longer term, when you were at Safeway, you guys obviously did a lot of remodels and drove comp. LA25, it sounds like traffic positive there. +But in the article, I think it was in the Journal, they talked about the Board is very reluctant to put more capital behind the food effort. Talk us through this. I mean, you've got a traffic issue, consumables mean traffic. But if you want to invest, it's hard to get the traffic, so you're almost caught in a catch-22 here. +And I just want to get your outlook or your thoughts on what I'm saying, given the longer term need for traffic, and to drive traffic into the store, to make earnings rise continuously, as we look out into the out years? + +Question_19: +Hi guys. Thanks for taking the question. Brian, one of the questions I had was, you guys have made a lot of changes in the stores, and we clearly see them, and obviously we've talked all -- for the past hour about a lot of them. +I'm curious about the marketing or communication of that though, to the -- just the consumer. I mean, we see it, because we're all following the Company pretty aggressively and in the stores. But I wonder if there's more could be done on the advertising side, to tell people that you've made so many changes in grocery, or that the home department looks better in a lot of stores? +Or can you talk a little bit about that, and where we're at in terms of when we'll see something like that communication-wise? + diff --git a/exam/original-files/Problem_2_3_Sample_QandA/56_answers.txt b/exam/original-files/Problem_2_3_Sample_QandA/56_answers.txt new file mode 100644 index 0000000..ca78a4a --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_QandA/56_answers.txt @@ -0,0 +1,104 @@ +Answer_1: + + Bob, good morning. As we think about the holiday season, we expect it to be a very competitive promotional environment, like we've seen over the last couple of years. So we think we've got great plans in place. We're very excited about the merchandising, the marketing and promotional plans, and we think we're going to be very competitive throughout the season. +As it pertains to toys, again, we've had a multi-year positive run in that category. And one of the things that's really been important for us is working with key partners like Disney, Mattel, Hasbro, to make sure we bring new exclusive items to our assortment. As we go into the holiday season, we're excited to have 1,800 exclusive items in that category, and we think these are going to be very important to our guests throughout the holiday season. + +Answer_2: + + Bob, as we think about our strategy and our approach, while we're certainly very pleased with the progress we saw in the third quarter, it's a result of being very focused on the strategy we've had in place for almost 2.5 years now. Our results and the improvement we saw in the third quarter is really driven by, one, our focus on those signature categories, our commitment to apparel and home, baby and kids, where we continue to see very strong growth and market share improvement. +We've been very committed to improving our digital engagement and year-to-date we're up over 20%. We saw 26% growth in the third quarter. And the investments we've been making to improve functionality and ease online is certainly connecting with our guests. +We've been very focused, as we've talked about, in expanding our format into new urban neighborhoods. And every time we open up a new store, whether it's in New York in Tribeca, or Philadelphia, we're seeing a great response from our guests. +And we've been on a journey over the last couple of years to drive greater efficiency throughout our organization, and with John's leadership, we continue to see very strong improvement in operational efficiencies and costs that we're returning to the bottom line. So our focus over the third quarter is very similar to the journey we've been on for the last couple of years, and we've just intensified our focus on executing against our key strategic planks. + +Answer_3: + + As we think about the next several years, you're going to continue to see us make significant investments in our assets, improve the in-store experience. We're already seeing the benefits of the investments we've made in apparel and home. We're very pleased with some of the learnings from LA25 that we'll be transitioning into our new remodels as we go forward. +So we think the importance of the in-store experience, great customer service, continuing to bring newness to our assortment, elevating and developing our own brands. I think one of the big highlights for Target in 2016 is the way our guest has reacted to two great new brands, both Pillowfort and Cat & Jack have been incredibly well-received. The style, the quality, the value we're delivering is connecting with our guest. +So the combination of great in-store experience, making sure we surround our guest with great customer service, whether they're shopping in our store or they've ordered online and they're coming in to pick up that order. And then delivering great Target brands at a value. So we think that combination is the strategy that drives traffic into our stores, cars into our parking lot, and even more engagement online. + +Answer_4: + + Scott, I will start with, scripts matter a lot to us. And key to the partnership with CVS is making sure we're working together to drive scripts, because back to the importance of traffic, scripts will be an important part of driving traffic to our stores, and we were very pleased in the third quarter with the progress we were seeing. +We're seeing much greater awareness now that we've competed the new branding. The combination of our in-store marketing and CVS marketing at their PBM is driving increased traffic to the pharmacies, so that is a very important lever going forward. And we're very confident in our partnership. +John Mulligan works very closely with the CVS team. We've got great plans in place for the fourth quarter, and even stronger plans as we go into 2017. +So that is a very, very important part of the traffic equation. And we think over time that's going to be a key driver of traffic into our stores. + +Answer_5: + + Greg, let me start on the grocery side. Clearly, we have more work to do there, but we feel like we're making very good progress. Changes we made to assortment, improvements we've made to the quality of our produce items, and we're certainly pleased with the reaction we're seeing as we enhance the experience in our LA25 stores. +That being the case, we've got to continue to make sure we build a greater connection with our guest, as it pertains to the convenient food offering we provide. Mark and I are working closely on the next phase of our grocery evolution, to make sure that we continue to provide the right assortment, the right value, the right quality our guest expects from Target, while they're shopping our store. So you'll see a lot more of that, when we get together in February, but we recognize that's an area that we've got to continue to drive progress in. +From a loyalty standpoint, we are working very closely with the marketing team, to ensure that when we get together with you in February, we'll be able to talk about the next iteration of our personalization and loyalty programs. Key to that, Greg, is bringing together some of the great assets we already have in place, leveraging our REDcard, leveraging Cartwheel, which continues to see great response from the guests, and making it easy for the guests to leverage the existing loyalty assets we have in place. So we think that's a key unlock as we go into 2017 and beyond, and that will be a key topic of conversation when we see you in February. + +Answer_6: + + We're very focused on our own opportunity. We're in 30 locations today. We think we have the opportunity to enter many, many new neighborhoods. We're really focused on making sure we build the back-end capabilities in supply chain, in assortment management, the in-store operating capabilities it takes to run these smaller stores. +We think the unique opportunity we have is bringing the best of Target to these individual neighborhoods, making sure that we custom tailor assortment, we bring the right assortment of apparel and home, baby and kids that's right for that neighborhood, complement it with convenient foods and household essentials that really make that local Target run impactful for the guest. So we're still learning. We're very pleased with the feedback. +But as we enter very competitive markets like New York, we're going to learn a lot from Tribeca, we'll take that to other locations. As we do more and more business adjacent to college campuses, we'll understand more and more about the needs of the college student. We really think right now, we've got a unique opportunity to leverage this new footprint as a future growth element in our strategy, and the guest continues to say thank you every time we enter a new neighborhood. + +Answer_7: + + Matt, I'd start with, we feel really good about the way Mark and his team have managed gross margin throughout the quarter. But it's really a byproduct of the strength we continue to see in those important signature categories, and both in store, but importantly online. Our growth has been led by apparel and home, great strength in baby and kids, those important high-margin categories that drive differentiation for our brand. +So the benefits that we're seeing in gross margin are a byproduct of the strategy we had in place, and really making sure that we're building market share, we're bringing great style and design and newness to those signature categories. The payback has been margin expansion while we continue to invest in value, and getting back to rebalancing our brand promise. We're bringing tremendous product to the expect more side. +And now we've rebalanced our value message on a pay less side. So we were able to invest in value throughout the third quarter, and still see gross margin rate expansion. So we feel really good about the balance we're bringing there, and think that could be sustained over time. + +Answer_8: + + Again, John, it comes back to the mix of our business, and the strength we're seeing, particularly in categories like home. The strength we're seeing in apparel and accessories, some of the strength we're seeing in baby and kids. So those are important categories. +Obviously in many cases, higher ticket, still a great value for our guest, but higher ticket. And obviously offset by some weakness we've seen in the grocery category. +So the mix is clearly impacting those metrics you're seeing. And we feel very good about the way the guest has reacted to the quality, the style and the value we're offering in those signature categories. + +Answer_9: + + Absolutely, and again, as we noted in our earlier comments, while overall we saw our digital business grow by 26%, the bulk of that business, the high growth areas were in apparel and home. So again, higher ticket items, we feel really good about the progress we're making from a digital mix standpoint, and that's also coming through in the metrics you're seeing. + +Answer_10: + + Chris, backing up and I know there are a number of embedded questions there, there was some shift because of the promotion between Q2 and Q3. I'd really focus on the year-to-date number. Year-to-date from a digital standpoint, we've been growing at 20%. +As we talked about earlier in the call, we're very pleased with the reaction we're seeing during key event periods. Back-to-college, back-to-school, a very important period for us, both in-store and online. And we think the combination of the investments we've made to improve ease, functionality of our digital engagement, and the fact that we're certainly showing the ability to win during key holiday and thematic periods, that's the right balance for us going forward. +We think digital is going to be an important part of our growth strategy going forward. We think digital is certainly the way our guest interfaces with the brand, whether they're in-store or online, and we're very pleased with the progress we're making. Our overall growth rate is approximately 2X the digital industry. +So we're building market share. We're winning during key seasons. And we certainly expect that to be a key driver to our fourth-quarter success. + +Answer_11: + + Chris, this is Cathy. As we said, we're guiding for EBIT margin to be up about 10 basis points. We do -- CVS was -- we closed it remember, about halfway through the fourth quarter last year, so we'll get a little bit of that impact still. +The biggest driver in the fourth quarter as we said was the -- is SG&A. So we'll continue to see some improvement there, and that's going to get us that 10 basis of EBIT margin. + +Answer_12: + + Robert, we appreciate that. Thank you. + +Answer_13: + + Great question, Robbie. I think the team has made a lot of progress, and as we said, at least the way we measure it today, our in-stocks, out of stocks is actually the number we focus more on, is at our historically low number. So we feel great about that. +Having said that, we think there continues to be significant opportunity for us and I think we see opportunity first at a store level, ensuring we always have what the guest wants when they walk in, because even though we've improved meaningfully, there's still a lot of distance there to go. And then more important than that, digitally ensuring we have the right unit at the right place for the guest, whether they want to come in store and pick it up, whether we're going to ship that from a store, or ship that from a fulfillment center. +Today, we're not completely optimized there, either. While we've seen great progress, and there's absolutely benefit to the guest and their trust with us when they come into the store over time, we still think there's a lot of runway there for us to improve. And you'll continue to see us focus on reliability and speed in our supply chain, and those are the two things that we will continue to drive against, over not only next year but the next several years. + +Answer_14: + + Dan, it's a great question and obviously we feel really good about the support we received during back-to-college and back-to-school. In those off holiday periods, we've got to make sure we've got the right balance between newness and those important style categories, and great value in our household essentials and food. +Mark and his team have spent a tremendous amount of time reshaping our promotional strategies, making sure that both in our circular, but also in store. It's really clear to our guest that we've got this great combination of newness and style, and the value our guest deserves and is looking for in those key household essential areas. So we've done a lot of work in-store. +I think with Mark's leadership, we're clarifying value on our end caps, clear assortment that connects with the guest in those off-holiday periods. So I feel really good about the progress. You'll see more of that as we go into the fourth quarter. +But why don't I let Mark talk about some of the work that he's been leading, as we think about really ensuring that value message is very clear to our guests, when they're walking our stores each week? + + + Yes, hi Brian. Thanks, John. What we've seen is a hyper competitive market in the first half of the year and it really made us take stock to look at how do we represent and resonate value to our guest more readily. +So what you're seeing emerging in third quarter and more in the fourth quarter and beyond is a representation not just of price and value in our circulars, as Brian talked about, but in store ensuring the guest clearly sees that value up front and center. Representation on our end caps, increasing single price point end caps to really generate a buzz about our value, and really delivering on expect more, pay less. +So this is a continuing trend, and then the spaces between the key seasonal events that you raised, as Brian said, we're hyper focused on that. We've seen some strength in some of our options that we've put in place, and really looking forward to our plans about how do we continue guest traffic and post major events, where we do win. + +Answer_15: + + Let me start with E&E. As I mentioned in my earlier comments, we feel really good about our plans for the fourth quarter. And obviously entertainment, electronics and toys are critically important gifting items for the fourth quarter. +So again, I think the work that Mark and his team have done to make sure, working with our vendor partners, we have a combination of new items, exclusive items, items that are on trend, we've seen a great reaction to our toy and gifting catalog, and we think that we're very well positioned for the fourth quarter. Those categories did trend downward in Q3, but the important part of the year is in front of us, and I think we're very well-positioned. +From a script standpoint, we are still rebuilding some momentum in that space, but sequentially we've seen improvement from Q1 to Q2 and Q3. We recognize that with time, as the branding's in place, as our in store marketing and the CVS marketing takes shape, we're going to be rebuilding and growing scripts in that very important part of our store. Operator, we've got time for one more call. + +Answer_16: + + Oliver, great way to wrap up the call. From a fill-in and stock-up standpoint, again, the work that Mark just talked about on the value side, is clearly addressing the fill-in guest. I feel very good about the progress we've made and will continue to make in that space. +I think to the broader question, it's a terrific way for us to wrap up before we all get together in New York City. We continue to feel very good about the strategy we have in place, and how that will allow us to be very competitive, and continue to win in the current retail environment. We think the investments we're making in our stores are critically important, and that store experience that we continue to elevate is a very important measure for our guest. +We've learned, as I hope you have, guests still like physical stores. And year-to-date, still almost 90% of all retail shopping is taking place in a physical store. So we've got to make sure we've got a great experience, we've got great service, we continue to elevate that experience and service, and combine it with outstanding merchandise and value every time our guests shop. +We think our strategy of moving into new neighborhoods, whether it's these densely populated urban centers or on college campuses, is a critical growth vehicle. And again, the reaction we've seen every time he we open up a store in Boston, Philadelphia, Chicago, and certainly in New York, tells us our guest loves the convenience of having Target right there in their neighborhood. +But we're also continuing to make investments online. And we want to make sure we continue to give our guest the choice of shopping any way they want. The ease of shopping online and picking up in our store, which we think is going to be a very important factor during the fourth quarter. +But building out those capabilities, leveraging our stores as flexible fulfillment centers. As we go into this holiday season, well over 1,000 locations will be locations that not only you can shop in and pick up, but we're using to deliver the last mile. We think that's a huge competitive advantage. +So we feel very good about the strategy we have in place. We think it's a strategy that will win, not only in the short term, but over the long term. We look forward to seeing all of you in New York in February. +So with that, operator, we're go to wrap up our third-quarter call. I appreciate everyone participating, and we look forward to seeing you in New York in February. + diff --git a/exam/original-files/Problem_2_3_Sample_QandA/56_questions.txt b/exam/original-files/Problem_2_3_Sample_QandA/56_questions.txt new file mode 100644 index 0000000..5973594 --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_QandA/56_questions.txt @@ -0,0 +1,75 @@ +Question_1: + + I just had a couple of questions for you. On pricing throughout the quarter and into the holiday season, what are you seeing and what are you expecting in competition? +And you talk a little about your ongoing strength in toys. Can you just talk about the drivers to toys in the fourth quarter, and how you expect that to perform as a category? + +Question_2: + + Great, Brian. Can I just ask one more follow-up? So when you look at the business over a longer period of time, this has historically been a relatively steady business. +I was just wondering when you look at the volatility between what you saw last quarter and your results, and your forecast for the fourth quarter, within three months, it's a dramatic change in the outlook. Can you just talk a little about exactly what factors are driving this? + +Question_3: + + Good performance in controlling the controllable. Just kind of wanted to step back. We've got traffic that's negative, and trying to understand, as we get out to next year and the year beyond, where obviously you are doing a great job controlling SG&A costs, but it's very hard for a retailer like Target to run this balance with traffic down and sales flat, especially with wage costs rising as rapidly. +So Brian, if you could take us out and talk about the strategy to drive traffic, get the sales up. I think you threw the number out there, 3% comp growth 2017 and beyond. Just how do we get there? + +Question_4: + + Perfect. And just as a follow-up to thinking about the 2017 and beyond. I know CVS was out, it was last week. They're losing a lot of scripts because of dynamics that are going on there. +Clearly you don't -- scripts don't matter anymore to you, but how about the traffic impact on Target as we get into 2017 and beyond? Have you thought about that, and what that could mean? + +Question_5: + + I really wanted to follow up on grocery and food and the strategy there, and how we're going to use that to drive traffic. Also on traffic, an update on your digital initiatives. I know you were doing some tests of combining Cartwheel with REDcard. Just wanted to hear how those were going, and how you think those could help drive traffic into next year? + +Question_6: + + First time caller, long time listener. Great quarter, fantastic. Our core question is, who else can win in urban environments? +I know you only have a few dots with the flexible formats, but we think you are pretty far ahead in terms of the knowledge, how to run mass merchants in urban stores. And mostly of your competitors are pharmacy stores who are good competitors, but boy, they need a whole lot of price to make it work. Do you see somebody else who is dangerous around the corner for taking this spot in cities, obviously besides Amazon going ever more urban? + +Question_7: + + My question is focused on gross margin where you really turned the corner year-on-year when you back out the pharmacy business. You also spoke to the impact of mix. But can you talk about the impact that you're seeing from cost cuts at the point of purchase for you, and how deep we are into that effort, whether you expect that to be sustained going forward? + +Question_8: + + Great to see the sequential improvement in trends. Question about some of the metrics within the comp. +Looking at the average unit retail up 3.5%, and units per transactions down, I noticed that has been the case for about 10 consecutive quarters now. So just curious if you could talk about what's driving the average unit retail up, and units per transaction down? Thank you. + +Question_9: + + Is the e-commerce growth also a factor then? I would imagine that's more focused into the higher ticket categories. + +Question_10: + + I want to think about the shift of the digital promotion in the second to the third quarter. How large of a contributor was that to your delta in comp performance in the third quarter versus second quarter? I ask this because if we look at these two quarters together, that's the low end of your 4Q guide. +And so as we look ahead, what are the big efforts or big drivers that you think drive the business to potentially the higher end of that range? Is it the focus on your customer tends to shop more around events? Is it the merchandising side? +What drives the higher end of the comp outlook for 4Q? + +Question_11: + + And then just one quick follow-up question. Can you talk about how much -- I think CVS was 60 or 70 basis points to the gross margin in the third quarter. +You're going to start to lap that in the fourth quarter, it sounds like you're guiding to flat. Help us understand how that progresses out into the fourth quarter. Thanks very much. + +Question_12: + + Congrats, Brian and team on great work in what's not been an easy environment. + +Question_13: + + The question I had was just -- was actually, this might be more of a John Mulligan question. I was hoping, John, you could give a little more detail on what the opportunities are from here in terms of in-stocks, RFID, the stuff you're working on, and how that could support store comps as you -- in the fourth quarter and as you head into next year? + +Question_14: + + You highlighted that back-to-school was strong for you and it seems that the consumers are shopping Target when there is an event, which could be good for holiday. I'm curious what you saw in the post back-to-school period, and just generally, when you look back over the last year or so, in between big events, whether it's Memorial Day event, or Father's Day event or such. And what you're seeing in those traffic trends between the big events. + +Question_15: + + If I could just another question, the last quarter or two you've highlighted that the electronics business was I think about a 70 basis point hit to the comps. I was just curious if you could help us understand what that looked like in Q3. +On the scripts that you mentioned that are getting better, trend wise it sounds positive. But I was curious if you look at the script trends relative to what you were doing when you owned the pharmacy business, if there's some relevant measure could give us there, that would be helpful. + +Question_16: + + Solid margin and inventory control. Just wanted to ask you about fill-in versus stock-up. It's likely related to the progress you made toward the value messaging. So just curious about how you're feeling about that dynamic? +And then I wanted you to try to brief us on the reality versus Amazon. The near term strategies, in terms of how you'll be competitively positioned versus Amazon in the holiday season, and then, as you look to bricks and clicks in the seamless experience over the longer term for long-term investors, what should the key factors be, as we engage in that share opportunity versus Amazon? Thank you. + diff --git a/exam/original-files/Problem_2_3_Sample_QandA/57_answers.txt b/exam/original-files/Problem_2_3_Sample_QandA/57_answers.txt new file mode 100644 index 0000000..7019ed3 --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_QandA/57_answers.txt @@ -0,0 +1,183 @@ +Answer_1: + + Chris, let me talk about the pricing investments we're making. And I think, as most of you know, coming out of the data breach, we invested heavily in promotions. As we go forward, we're going back to our roots and reestablishing our everyday low price commitment. So that's going to take some time. It's starting today. +We're going to make sure that we reestablish our value with the guest. There's an investment we have to make. And we also recognize we have to continue to invest in digital, to grow that channel, to continue to make sure we are accelerating market share. You're going to see us invest in 2017. +As John talked about, we expect greater efficiencies over time. One, as we continue to optimize our digital performance, but importantly, as we transform our supply chain. But in the short term, we have to compete, we have to invest to make sure we're delivering the value the guest is looking for. We want to make sure we're taking market share, both in-store and online, and we think those are two very important investments in the near term that provide long-term benefits for the Company. + + + Thank you. + +Answer_2: + + I will go back to what Cathy talked about just a few minutes ago. We certainly view 2017 as year of investment. In 2018 we will continue to transition as these different initiatives begin to mature. As we get into 2019 and beyond, we certainly expect stability and a return to growth. That's the model we are looking at. +We can't lay it out for you quarter-by-quarter. We want to make sure we're properly investing and accelerating these initiatives. And if there's a message I want everyone to walk away with today, these aren't new initiatives. We've been working on these for several years. Now is the time for us to go faster. +This is about accelerating at the right pace for our business. But whether it's our digital channel, the work John talked about in the supply chain, the acceleration of remodeling our existing stores and reimagining that experience, or opening up these new smaller formats, we've got to step on the accelerator. And as they mature, we are going to return to growth, we're going to capture market share, and we're certainly going to see the benefits that our shareholders are looking for. + +Answer_3: + + Craig, it's a great question, and it's embedded in everything we've talked about today. The reinvestment in our stores, reimagining over the next few years hundreds and hundreds of stores. We've certainly learned in our tests in both Los Angeles, and as we've remodeled stores in Texas, that as we bring a new experience that drives traffic to our stores. +As Mark and his team continue to roll out these new proprietary brands that are unique to Target, that drives traffic to both our stores and our site, and we've seen that with Cat & Jack, a $1 billion brand in year one, on its way to being the number one kids brand in America. So as we continue to elevate brands, those drive traffic to both our stores and our site. As we move into our new urban neighborhoods, it's striving for traffic every single day. So as we think about how this smart network comes together, brands play an important role, that in-store experience is critically important, being in the right neighborhoods. +But then we also know from a digital standpoint, more and more of our guests are ordering online and conveniently coming to our stores to pick up that order. That allows us to really make sure that once they're in our store they continue to shop. All of these elements are all about driving traffic to our stores and more visits to our site, and as they mature, that certainly is going to be one of the key metrics that we will all be tracking. + +Answer_4: + + Let me start with price, let Mark talk about brands, and the Cathy can talk about our real estate portfolio. I think you answered the question for us. As we think about the investments we're making in price, we will start with those core essential and food categories. Those trip drivers that Craig just referred to. We've got to make sure that we move from a promotional cadence back to our traditional every day low price and great value every time the guest shops in those core personal care, household essential, and food categories. +We will certainly make sure we're revisiting price across the box, but it certainly starts with making sure we are priced right on those trip driving items that our guests depend on Target for every day. Mark, why don't you talk about some of the brand work? + + + Yes, as we roll out the new brand work we're looking at guest insights about what brands and what spaces we should play in, but more importantly, what is the sweet spot on pricing for regular everyday pricing. So as we reset these brands, we are going to be defining great value every day for our guest as we introduce in every niche in the business. + + + Robby, I will quickly address store portfolio. As we said, we've had a very disciplined process forever. The team has done a great job. Our pace doesn't change, we've been closing about 10 to 15 stores a year, that has been consistent year in and year out. We will continue to do that, but that's just normal course for us. We look at every store every year and say does it make sense to keep open. Today the answer is, yes. Universally generate positive cash + + + Cathy, on the store front, just to close that out, and I know we talked about it during our prepared remarks but our store portfolio is not mall-based. We are in some of the centers where most of the retailers are trying to migrate to. We're very fortunate that over time we built 1,800 stores that are effectively located. They are in the right neighborhoods, they are not off remotely on interstates, they are not tied to dying malls. +We have an obligation to revitalize some of those stores and re-image some of the stores, but one of the things that where most confident about is we have an exceptional store portfolio. So as we invest, as we bring those stores up to the expectation our guest has from Target, we expect those to drive traffic and continue to flourish in the years to come. + +Answer_5: + + Matt, I'd start out by talking about the last couple years as being a time of very disciplined capital allocation. We've taken a very surgical approach to some of these initiatives. We've remodeled 25 stores in Los Angeles. We've been testing and learning and iterating, improving the expectation that the guest has, making sure we deliver against that. Now that we've got the feedback, we're ready to accelerate. +John talked about we have opened up 32 small formats, not 300. We studied each one of those very carefully to make sure we understood how to customize them for new local neighborhoods. Now that we understand the expectation, we are ready to accelerate. From a capital standpoint, we've actually benefited from the fact that Mike has taken a very disciplined approach to setting priorities within technology, and we've seen phenomenal improvement in our platforms, our capabilities at a lower cost. +Our approach to capital has been very disciplined. We've been testing and validating and learning. Now that the learning is complete we are ready to accelerate those investments. But we have been very disciplined. John talked about supply chain. +We know the changes that we need to make, but we have been very surgical, very disciplined in putting together that playbook. Now that it's in place, we will begin to accelerate. So from a capital standpoint, we will continue to make sure we're very thorough, we test and validate, but once we've completed the learning, we will be ready to accelerate. And that's what you're seeing as we think about the next three years. + +Answer_6: + + Why don't I start and then I will let Mark talk about some of the progress we've seen on grocery. And while we didn't spend a lot of time on it today, I want to make sure it's very clear. We're very focused on improving our grocery performance. But we haven't just been standing still. We've made significant progress in procurement, in supply chain, in making sure we've improved our assortment, in making sure in those test stores in Los Angeles and Dallas we understand the changes that need to be made in the in-store experience. +We're going to follow it up immediately with the right investment in pricing to make sure we are competitively priced every day in those key categories. So we've got more work to do, we're certainly not satisfied with where we are, but we have been making progress, and there's bright spots, Mark, that I think you can talk to? + + + Yes, just looking at the format, fresh produce is a really good example where we've changed our supply chain, our assortment and are focused on quality and value. So investing there has really made a difference where the guest has perceived and responded to with great growth in key categories. +So here we've invested in fresh, and we've gone from an organization that used to deliver multi-times a week to every single day, increasing the freshness and quality and guests are responding. Some of the tests that Brian talked about in LA and Dallas have really paid dividends for us. And one great example of that is our adult beverage business where we've seen great growth in 2016, and we're going to amplify that growth and accelerate in 2017. This is a business that for us was our number one growth category throughout all Target, and we see an upside of $1 billion business here that we're fast tracking on in 2017. + +Answer_7: + + Mark? + + + Yes, so the key focus of the brand growth is really in what we talked about with John, and our key strength there is apparel, accessories, footwear and home. These are high margin and high strength areas for us. And we believe that Target has the right DNA on exclusivity and differentiation. Our guests love it, our brands, and have loved them. But we've been a little slow here in terms of the changing face of the guest. And I guess the insights showed that we could sharpen that and bring new ideas. +Great proof of concept in 2016 with the launch of who, what, where, Pillowfort and, of course, Cat & Jack, that showed us where we replaced our strengths with a new focus we could create double-digit comps and guest love and trips for our store. So we've taken key areas across -- men's, women's, home and kids and are going to amplify our offers there and redefine. In terms of overall space, we're just utilizing our existing space and really refreshing that. One of the things we're excited about in 2017 is this combination of new brands, capital investment in the space for those brands, but also the addition of extra resources like visual merchandising. They're really going to create a new experience for the guest in-store and create real excitement. + +Answer_8: + + Why don't I start. I think the proof is in the results we've delivered. Outstanding results, as we've talked about with the launch of Pillowfort. The same thing has been true with Cat & Jack. This is an example of where we've gotten the value equation right. +Great quality, on trend, at a great value and the guest response has been terrific. That's the same approach Mark is going to take with each one of those new brands, making sure we combine great quality, items that are on trend for the consumer with the right value that drives trips, but also makes sure the guest recognizes they're getting value from Target, so coming back to our brand promise. Expect more and pay less. Those elements have to work hand-in-hand with our new brands going forward. + +Answer_9: + + John, do you want to start with supply chain and we will finish up with guidance. + + + Sure. I think, the past year we spent doing really two things in supply chain. One was just optimizing what we do today to improve out-of-stocks in-store which had been a chronic problem for us. They have improved dramatically, they're not where they need to be but they have improved. +The second thing we focused on is right to the heart of your question, which is, how do we optimize the entirety of our supply chain, go back and relook at everything to, one, take work out of the store, and, two, be much more efficient in how we deliver and especially on the last mile. We spent the last couple years expanding our ship from store capability. We have believed for a long time that is the single best advantage we have in the supply chain is our store network. It puts us right next to the guest. And what we're working on today is how we move inventory more efficiently and more quickly in each because that is what is required for direct-to-guest. Out to the stores and then from the store directly to the guest and do that quickly. +You will see us this year, as I said, start to make those changes in the Northeast. Several pilots are already underway that have significantly improved our speed to guest. And, as I said -- as Cathy said, we will continue to come back and report on how we're doing. But that is the heart of what we're doing. That becomes the basis for improving. Everything Mike can do is giving him flexibility to put services on top and to deliver at whatever speed the guest wants. In a store like Tribeca that could be today. Hey, I came in, picked up my five things, I'm going to go run some errands with the kids, deliver this to my house in three hours. +It could also mean, hey, bring this to my house in 10 days, this patio set, bring it to the back of my house, set it up, detrash it and take the garbage way. It's really about flexibility and speed and allowing the guest to choose how they want to interact with us. And that's what we're building the platform of our supply chain around. + + + Kathy, why don't I start by talking about the competitive landscape and let Cathy talk about guidance. But to your point, we certainly see over the next three years significant market share opportunities as we see the contraction in our competitive store base. And that is going to be particularly true in the apparel and home spaces where we're strongest. But we also recognize, as you do, as many retailers are closing stores, if not exiting the business. The short-term implication is massive promotional discounts which takes consumers out of the marketplace for a period of time. +So over the long haul, this is a growth story we are putting together. We think we are going to see significant market share opportunities across a number of categories. To capture that, we need to make sure we've got the right in-store experience and a very strong and easy digital experience for that guest. But in the near term, you're going to see deep discounting, you are going to see liquidation sales, which takes prices down and takes consumer trips out of the marketplace. But over time, we see significant market share opportunities. + + + Yes, the only thing I'll add on to that, because that's where I was going to go too, is we are absolutely investing to be able to play offense. We see this as a huge opportunity for Target when you think about the playing field that's going to be available. And so we are investing to play offense. But I don't anticipate, and we don't anticipate, that to be demonstrably changing this year. This year is an investment year for us. As we set ourselves up for that great success to take the share over the next multiple years, there is going to be a ton of disruption in this space. + +Answer_10: + + Why don't I start by talking about food, let Mark add some additional color, and then give Mike a chance talk about our digital approach going forward. One of the things that we've talked about over the last year as it pertains to Target's food and beverage offering is the recognition that we don't have a full service grocery experience. We don't have meat and seafood counters, we don't have deli counters. We don't provide a full assortment of experiences and services that many of our full-line competitors do. +But we can offer a great self-service, convenient experience. And that starts with the right quality, the right assortment, the right in-store experience, great value. We've got to make sure we are supplying those products to our guests every single day to make sure the freshness is there. So we are embracing who we are. And we want to make sure that the guest knows while they're shopping at Target there is no compromise. +We've got to build trust, we've got to make sure that while they are there shopping for their baby, picking up a toy for a Saturday night birthday party, picking up something new to wear for dinner that night they have confidence in the selection and breadth of food products we offer. We are being true to who we are and we're not a full service grocer. We don't have rotisserie ovens in our stores, but we do have the right allocation of space and selection to compete and be that convenient alternative in food, and we're going to held on that going forward. +We're very pleased with the response we've seen in Los Angeles in Dallas where we enhance that experience, where we improve the assortment. The reaction, as Mark talked about, to categories like craft beer and wine that fit in very well with the Target guest. We've got to strengthen that offering, make sure we have got great quality, the right assortment, that we've got the right experience in-store. And that we provide the right value the guest is looking for. So we will continue to build off of that going forward and make sure that while our guests are shopping Target they are also shopping our food and beverage offering. + + + Yes, I think our space is set. We're not talking about flipping or divesting or investing in more space, it's how we utilize the space more definitively. And I think that what we've learned in these test markets is the role of fresh and convenience in creating trips and creating guest love as being very powerful. Reformatting the space and really curating the assortment is more of what we're focused on rather than wholesale changes to macro space. + + + Mike, why don't you talk about where we are with digital? + + + Sure. + + + We've spent very little time talking about our performance in 2016. We felt great about how we exited the year, comps up 34%, making really good progress, like we've doubled the business in the last couple of years. So why don't you talk about where we are and where we're going. + + + Look, I think, particularly in the last year the focus has been on guest experience and making our floor as a great guest experience. And while some of those investments may not have been obvious and they have pay dividends. We grew the business at almost twice the rate of the market last year. John talked about earlier how we expanded our ship from store capability which has been really, really important to as. We shipped about 1 million parcels to our guests in the two days following Cyber Monday. +And that's really important because that is our cheapest route to the guest at home is shipping from our stores. And as we can expand that model, we can be closer to our guests physically, and in time, and we have the lead time during the holiday period to guests, as well. So all of those investments have improved the guest experience. We've almost doubled our guest satisfaction rating over the course of the year whilst we grew the business at twice the rate of the market. And we see that again going into this year. +There will be a relentless focus on the guest experience going forward. All the work that John and his team are doing to reconfigure our supply chain will give us a lead time advantage and a cost advantage as we deliver more and more parcels to our guests doors. The work that Mark is doing on assortment and creating exclusive product, exclusive brand for Target that isn't available anywhere else will be vital to our online merchandising going forward. We will always look at other ways maybe of how we might expand our assortment online, but right now we've got our sites fairly firmly focused on how we can get to guests quicker, how we can execute flawlessly, and how we can bring exclusive brand and product to our guests. + +Answer_11: + + Bryan, we spent a lot of time as a leadership team looking at different alternatives. There was only one path forward. That's the path we've chosen. We've got to win best to grow. We've got to reimagine our stores, we've got to enter new neighborhoods, as we're doing with these small formats. We've got to transform our supply chain. We have to build out the digital capabilities required in this environment. +We have to continue to elevate our proprietary brands. And I think most importantly, we just have to embrace the realities of this new era of retailing, and make sure that we also embrace the way consumers are shopping today. We certainly debated whether there were other options. Every time we came to the table there was only one conclusion, and it's the path we've chosen to follow. We think this is the right path for our Company, the right path for our shareholders, and ultimately, it's a path back to growth and an expansion of market share. +We've done our homework, we've looked at this from every different angle. This was the path we kept coming back to, it's the right path for the Company today. It will be the right path for the Company 10 years from now. + +Answer_12: + + Greg, why don't I start with the metrics, the things that we're going to be watching closest. It's going to come back to, we're going to watch the guest. How does the guest respond when we reimagine a store? How do they respond when we move into new neighborhoods? How do they respond when a new digital offerings? How do they respond as we roll out new brands? +Ultimately, that guest satisfaction and that guest vote is the most important one. And when they are in our stores more frequently and visiting our site more frequently, and shopping with Target versus other retailers, we know we are winning. But we're going to clearly monitor the guest reaction as we remodel these next 100 stores in 2017, and we continue to accelerate with another 30 small formats. And as Mark introduces new brands throughout 2017, and Mike enhances our digital offering, it's going to come back to the guest reaction. And we are fighting for footsteps, we're fighting for clicks online and we're fighting for a share of mind. +So for this to be a growth story, it is all about gaining market share and that starts with building greater trust, greater loyalty with our guest. So we will be watching that each and every day across these initiatives we've laid out today. + + + Yes, Brian, maybe I can address the other two questions, Greg. This is a multi-phase, multi-year journey, and we tried to make sure we set that expectation. We are recognizing that the environment is going to be disruptive. And we've got a ton of work still to do, although, we're not we're not starting from scratch, we're going to accelerate that pace and that investment. +We are not, and we guided that in our guidance, planning for anything but low-single-digit negative declines this year. And that's what we said, it's an investment year. As we move into transition and then we will get into stability where we can sustainably, consistently drive profitable growth and market share gains, and so I want to make sure we do set that expectation appropriately. +On your question with regards to how the capital allocation is being spent over, that $7 billion investment over the next three years, it's really in the three areas of Brian talked about, the three big areas. The biggest ones being, obviously, as we reimagine our stores because they will still be central to our story. Their roles will evolve but they will be significant investments there, as well as the new stores, supply chain and digital. And that's exactly where you would expect us to be spending that money. + + + Mike, why don't we come back to the shipping question? + + + The reality is that in a digital business one of your biggest costs, biggest marginal costs is transportation, and it is cheaper for us to drive, or to deliver from our stores which are, as we said, about 10 miles from 75% of the population. So that last leg being very shorter makes it our cheapest option. The marginal cost of us getting product to the stores on the back of our existing network, that already -- to the distribution center is already out there -- is very, very low for us indeed. The additional cost on that last mile is very low. We also have, of course, order pickup which is probably our most economic fulfillment channel. + + + Why don't we, Oliver, you have been very patient waiting, waving your arm. Why don't we see if we can get him a microphone. + +Answer_13: + + Oliver, let's try to unpack those questions. Let me start with the last one, as we've think about the role of data science and analytics. I made the comment that three years ago this was a nascent capability for us. It's now quickly become one of the strengths of the Company. We're applying that across all of our various functions. +It's helping Mark and his merchant team make better choices. It's certainly enabling some of the work that John is leading from a supply chain standpoint. It's influencing how we lead and manage our stores. +And Mike can talk about the important role it plays as we think about digital and the personalization of our communication. Data science is going to play an important role across all of our functions going forward to make the Company focused on the right decisions, smarter decisions, more personalized decisions. Mike, why don't you talk about the role that it has played just recently as we think about digital and how we are interfacing with the guest? + + + I think, as Brian says, it's an important, it's a very important growing area for us. Data sciences team out in Sunnyvale we have over 40 PhDs who are doing nothing but thinking of clever ways to how we tune our supply chain and how we personalize the offer to our guests, particularly online. One recent improvement they've made is on some of the bottom recommendations that we give on our homepage. +We've seen an eightfold improvement on conversion rate on that. We do note that as you make that experience more relevant to the guest that we will improve our sales online. It will improve our conversion rates. That's just one example. And I've seen a lot of examples in John's area around how we are improving sales forecasting and our ordering algorithms which has helped the flow of stock all the way through our supply chain. + + + Let me try to come back to your question around the consumer trends, the role of the Millennial, how that takes shape over the next three to five years. I think as we look at it today, I will start with the investment we're making in our stores. And as we've looked at the outlook, as you've done the math, while we expect this continued accelerated shift to digital, stores are still going to be very important. And pick the number three years from now, the stores represent 85% or 80% or 75% of the business. I don't know? +But even if they are 75% of the business three to five years from now they are still the dominant portion. What we know every time we talk to the consumer, every time we talk to the guest, they crave experience. If they're going to shop a physical store, they want it to be a great experience. We've seen the reaction to the changes we've made with visual merchandising. +Some of the things that Mark and his team are bringing to light every day in our stores in our apparel and home categories. We have to make sure it's a great experience. If they're using our stores as a smart pickup point, we need to make sure when they come to our stores they are greeted by phenomenal team members who can quickly find their order and invite them to shop more often. So we've got to make sure that experience is critically important in our stores. +We know going forward that Millennial consumer that we serve, they are going to be digitally connected, and their shopping experiences are likely always going to start with that digital device. Then they will choose whether they want it delivered to their front door, they want to pick it up, or they just want to make sure they know where the products are placed inside of that Target store in their neighborhood. So we've got to embrace the way consumers are shopping, but we recognize when they come to a physical store they expect a great experience. When they shop online, they want it to be really easy. +When they come to pick up a product at one of our 1,800 stores, we've got to make sure the product is there, we've got the right items and we invite them to enjoy the convenience that we did the shopping for them. Now they can take the next 20 minutes and explore the store and discover and enjoy the merchandise that we have to offer. So physical stores will continue to be important. But we have to reimagine that store experience. +Today's Millennial shopper doesn't enjoy shopping one of our tired stores that has not been touched in 10 years. But they love the reimagined stores and they give us that feedback, as we've remodeled stores in Los Angeles and we have reimagine stores in Dallas, or as we open up new flex formats. The feedback we are receiving is sensational. And they use those flex formats, those smaller stores as places to fill in, but they're filling in two or three times a week. +We are looking at it very carefully, but we know stores will be very important, but it's going to be part of our smart network where we combine the digital experience, the store experience as one and make it really easy for the guest to connect with Target any time they want, any way they want in their local neighborhoods and towns. + +Answer_14: + + Let's go back to pricing. Let me make sure we are really clear about what we're doing and why. We spent a lot of time looking at the changes that we had made following the breach. We were very promotional. That promotional intensity has actually continued. +As we go into 2017, you're going to see us get back to our roots, get back to establishing every day low pricing in those essential categories. There will be a transition period, but it's really going back to it's always worked for us in the past, and moving away from that promotional intensity, the reliance on big promotions to making sure we give our guests the confidence and trust that every day they shop in our stores for those core essential items they're getting a great value. It's a transition, there's an investment involved in that, but it's really getting back to it's made as great going in the past and really making sure that's part of what we bring going forward. +We will continue to be very disciplined. As we talked about the question about capital allocation, we're still going to be Company that will continue to innovate, innovation is very important. Innovation is alive and well at Target. But we're going to make sure we test, we learn, we validate. The innovation has to benefit our core enterprise. It has to translate to driving more traffic to our stores, more trips to our site, greater guest loyalty and engagement. +Innovation will be an important part of our future. We will do it, as we've done in the past, in a very disciplined way. When things don't work we will shut them down. When we need to iterate, we will continue to iterate and learn, and when we've validated the model we will step on the accelerator, as we are right now, and we will move forward quickly. I guess we've got time for one only last question. Why don't we go over here. Scott? + +Answer_15: + + John, you want to start with stores and then I will come back and talk about pricing. + + + Yes, just to check off really quick, cost of a remodel for a prototype, what we call a P store, $5 million, $5.5 million, a little less for lower volume stores, a little more for higher volume stores. Super Target, what do you think, Cathy, about double? + + + No, a little less than that. + + + A little less than double. Store execution, I would say two things about. One, on out-of-stocks, made a lot of progress. When we talked about it last year they had improved by about 40% last year, almost another 15% improvement. We've seen significant improvement in doing what we do today. The next leap in improvements in out-of-stocks in our stores will come from fundamentally changing the supply chain, which is what we talked about today. That's on course, and we will keep working on them and we'll update you as we go forward, I guess. + + + And, Scott, I will finish by talking less about price and lot more about value. We know we have to be competitively priced every day on those core essentials. But we win when we deliver a compelling value, which means a great in store experience. Which means new exciting brands, which means surrounding the guest with great team members, which means a great online experience that's easy and friction free. +So it can't be just about price. It has to be about value. And value is the combination of all the things we do and historically have done so well. We've got to make sure we surround the guest with a great in-store experience. The reaction we've seen as we have brought visual merchandise to like in our stores has been fantastic. We've got to continue to build compelling brands that deliver great value for the guest. +We've got to surround them with a great experience, whether they're picking up an item or checking out in our stores. And that's got to translate to how we interface with the guest online. Value is critically important. We think we're positioned in a way that's unique in the industry with our assortment, our in-store experience, our multi-category portfolio, the capabilities we've now built online and the changes we're making in-store. +That's what gives us so much confidence that we are on the path back to growth. That it will take time, but there's going to be significant market share opportunities in front of us, and three years from now when we've reimagined stores, and we are in new neighborhoods, and we've rolled out new brands, and we've got it great new supply chain capability to complement what we've done from a digital standpoint, we will be sitting here talking about the new Target, a growth Company that's captured market share in this new era of retailing. So I appreciate your time and your patience today. Thanks for joining us, and we look forward to talking to you in the future. So thank you. + + + + + + + diff --git a/exam/original-files/Problem_2_3_Sample_QandA/57_questions.txt b/exam/original-files/Problem_2_3_Sample_QandA/57_questions.txt new file mode 100644 index 0000000..43e8674 --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_QandA/57_questions.txt @@ -0,0 +1,69 @@ +Question_1: + + Thanks, good morning. Chris Horvers, JPMorgan, and thanks for having the meeting. Trying to dig a little bit into the gross margin pressure, understand the first quarter you will have some pressure from markdowns and clearance. But then over the balance of the year, some channel shift pressure, as well as price investments. +Can you talk about the latter? What you're expecting in terms of gross margin pressure from the digital and pricing pressures? Will pricing largely be reset in 2017, and then we sort of neutralize from there? And is it your expectation that over time the supply chain improvements ultimately stabilize the gross margin, and is that an 2018 event? Thank you. + +Question_2: + + Thanks, Brian. I think the key question is we all appreciate that you don't want to provide long-term guidance, but how long are you anticipating it's going to take for you see a return on all the investments that you're making? Is it reasonable to expect that you are going to return to earnings growth in 2018, 2019? When should we expect that? + +Question_3: + + Craig Johnson at Customer Growth Partners. Brian, I understand the importance and the necessity that you've talked about doing here today. I want to look forward to how do you get back to growth. One pillar of growth, of course, is traffic growth, hallmark of all great retailers, is consistent traffic growth. And you showed to earlier in Costco and TJ Maxx and it applies to Wegman's and Home Depot. The question is, could you get more granular on how you can actually rebuild share-of-trip missions as a way of getting a share of traffic? + +Question_4: + + Robby Ohmes at Bank of America Merrill Lynch. As a follow-up to that question, can we get you guys to talk a little bit more about more about category outlooks, so how you're thinking about price investments in terms of food and consumables versus apparel, electronics, et cetera? +And also for the new brands, maybe some what categories you are thinking about launching some of these 12 new brands? And then, just a quick for Cathy, I guess, I might have missed it and I didn't understand, are you -- you have been disciplined about store closings, but is there a change in your pace of store closings? Thanks. + +Question_5: + + Hi, yes, Matt McClintock from Barclays. Clearly, the story today is about investment, right, you need to make substantial investments. And as I look back at the past two years, you've fallen shy of your capital plan by a significant amount. So as I look forward, one, can you help me understand where the shortfall to what the capital plan was this year? +Two, would you attribute some of the weakness today that you are seeing to some of the lack of investment, or shortfall, to your prior capital plans? And then, three, is the $2 billion enough for 2017 given that it falls to the low end of your prior long-term guide of $2 billion to $2.5 billion. Thanks. + +Question_6: + + Peter Benedict of Robert Baird. I was hoping you could maybe speak in a little bit more detail about your view of grocery, that side of the store. How's that going to look in the reimagined store? And then, Cathy, maybe a little view as to how much it costs to do the remodels and how long it takes? Thanks. + +Question_7: + + Joe Feldman, Telsey Advisory Group, way in the back, sorry. I wanted to follow up on that. Can you talk of little bit on the merchandising side areas of the store that maybe are expanding or contracting? And then a little more specifically about those dozen brands that you will be adding in. What categories with those be in and any preview can give us and how to think about that? + +Question_8: + + Hi, thank you. Mark Miller with Crystal Rock Capital. You talked earlier about making price investments across essentials. I wanted to ask, what do you think is a risk that you've taken too much margin on exclusive items? UPT has come down but average ticket has gone up with price per item. I thought also it might be helpful if you could share market research on the customer's perception of value on exclusives now versus several years ago? Thanks. + +Question_9: + + Hi, Kate McShane from Citi Investment Research. I have two unrelated questions today, one a short-term question, one a longer-term question. With regards to your guidance for the year, I'm wondering how much in terms of your competitor door closure are in your assumptions for guidance? +And, second, on the longer-term question for supply chain, just curious, it was a year ago that you walked us through some of the changes in your supply chain. And just wondering how much the game has changed since the last time we have heard about that strategy and how your approaching the last mile? + +Question_10: + + Dan Binder with Jefferies. I had a few questions. First, there's been a few questions on food today, I am curious, as you think about the role of food, and at your competitors it's been used as a traffic driver. Today we're not really hearing that from you, we're hearing more about remodels and brands outside of food. Can you just talk a little bit about why you think food shouldn't be the traffic driver for you, why you shouldn't be reallocating space away from dying categories to expand the food assortment? +And my second question is, can you make money online longer term, and why doesn't a marketplace make sense for you, particularly as a source of fee income to offset maybe some of the pressure in your own business? + +Question_11: + + Good morning, this is Bryan Cameron, Dodge & Cox. Thank you for your presentation this morning. With all the seismic shifts that are going on in retail, as you outlined, I'm guessing you've considered other strategic alternatives to the one you outlined this morning. What were some of those alternatives and why is the one you outlined you think the best for the Company going forward? + +Question_12: + + Hi, it's Greg Melich with Evercore ISI. I had three questions and I will make them quick, into one. Cathy, does the guidance for this year assume that comps turn positive by the fourth quarter? Second is on CapEx, when we look at that $7 billion budget over the next three years, if you could break that down into existing stores, new stores, supply chain and give us some sense of where the money is actually going? +And then lastly, and maybe, I don't know who this is for, but for everyone, I guess, Brian, what will you be watching to know that this is working so that basically we want to double down or not, or the go the other way towards the end of the year? And specifically, there was an interesting comment, can't remember who made it, that our cheapest way to fulfill is through the store. I would love to just hear -- that sort of shocks me given what we're seeing Amazon do and others, so just why is that true for Target, and maybe not true for some of the others? + +Question_13: + + Thank you very much. Oliver Chen, Cowen and Company. Had a question related to that topic of fill-in versus stock-up tactically in terms of what you're thinking about the future of fill-in and the opportunity there? And longer term, as you do your consumer insights on Millennials and Generation Z, what do you think the five-year story is for reimagining the store as you think about what the newest customers really want to see with disruption and transformation? +And finally, on the topic of big data and data sciences, how does that interplay with how we should think about the model over the longer term and what does that mean for what consumers want versus where you can deliver data science, whether it be supply chain, re-channel or predictive analytics, giving people something they don't even know they want? Thank you. + +Question_14: + + Brandon Fletcher with Bernstein. We see your competitive advantage as assortment and service, so when you talk about new brands, we love it. When you talk about service online and integrated ordering, matching online, awesome. Doing the picking from DCs for each is genius and I think only you and the Home Depot are close there. The only place we get nervous is when you say things about price and convenience. I've sat across way from many CEOs who were desperately trying to drive traffic with price investments when they were not the low cost operator, and it just doesn't usually work. +And if you're seeing death in department stores and retailers and sub-scale groceries, where you guys are already way better on price, are you really sure you need to invest that heavily? And the, secondly, is, with the rollouts to new project touches in stores will folks with disconfirming evidence have as much access to leadership as those with confirming evidence? You guys have been extremely disciplined in the way you did LA25, but it's hard to get right. So those are our two questions. Thanks, guys. + +Question_15: + + Thank you. Scott Mushkin from Wolfe Research. I wanted to ask a couple questions, one is just clarification, the cost of the remodels, I don't think we actually got that number, and I was wondering if we could get it? I was hoping for an update on store execution, specifically in-stock, I know that was a big focus? +And then the final question would be around price investments. You have two large competitors driving down price, most notably Walmart, but also Amazon is doing a lot of work with their Subscribe and Save and those prices are very low. What gives you the confidence that it's one and done here, as one of your largest competitors on a multi-year price lowering campaign? Thanks. + diff --git a/exam/original-files/Problem_2_3_Sample_QandA/58_answers.txt b/exam/original-files/Problem_2_3_Sample_QandA/58_answers.txt new file mode 100644 index 0000000..c9a7709 --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_QandA/58_answers.txt @@ -0,0 +1,80 @@ +Answer_1: + + It's Brian Cornell. Paul, we're very focused on executing the plan we laid out back on February 28. So you're going to continue to see us invest in store labor, making sure our standards continue to improve, and we saw very strong progress in the first quarter; invest in value and continue to invest in the growth of our digital business. So over the course of the year, we're committed to executing against that plan. We'll see that continue over the second, third and fourth quarter. But the plan we've laid out back in February is the plan we're going to continue to focus on executing throughout the year. Our overall focus is to continue to see traffic patterns grow in our stores, improve and accelerate our digital performance. We want to make sure we're capturing market share as we did in the first quarter; continue to build and invest in our brands and, ultimately, improve our value proposition with the guest. So there's going to be no change to the plan we laid out in February. We're committed to executing and making those investments over the balance of the year. + +Answer_2: + + Yes. So we are working to restore positive traffic and, more importantly, preference over the long term, and I think that's everything you continue to hear us say. And so over the course of Q2, we're going to just keep doing what we said we would do, and that is we're going to make sure we're continuing to invest in a great experience for our guests, both online and in stores, and you'll see us doing that. Mark and the team have some really exciting things coming into Q2, but don't want to dismiss the positives we saw around category mix in Q1 even. So I'm just going to tell you we're just in this for the long haul. We're going to keep doing what we said we'd do, and restoring positive traffic's high on our priority list. Mark, did you want to talk about anything in particular with regards to Food and beverage? + + + Yes. Paul, in terms of promotional posture and the price/value equation, we've made some rapid changes in a number of our signature categories, but probably the key areas that we're focusing on, of course, are Food and beverage and Essentials. So we've been testing and iterating quickly since Q4 and definitely in Q1, and we'll see an evolving pattern of change and evolution on how we'll roll out both the communication to the guests and the simplification of our everyday price positioning. And you'll see that evolve more deeply in Q2 and then beyond. + +Answer_3: + + Simeon, let me start by really summarizing Q1 performance. And certainly, I think we saw some changes in the overall macro environment, but I also saw -- we also saw very strong execution, both from a digital standpoint where we grew the business by 22%, but also meaningful changes in-store. And I think our store standards and our store execution continues to improve. I also think we showed great adaptability in the marketplace, and I'll let Mark talk about some of the successes we saw in categories like Apparel. But I'd highlight the efforts that we've put behind our swim business, where we started out with a #1 share position, but we saw changes in the marketplace, competitive closures, competitive exits. And as we talked about back in February, we are absolutely focused on taking advantage of market share opportunities over the next 2 or 3 years, and this was a great example where Mark and his team recognized the consumer opportunity, saw a change in the competitive environment, quickly build a brand by partnering with our vendors and introduced Shade & Shore during the first quarter, which allowed us to take even more market share in swim. And it's a great example of the work that we're going to continue to focus on over the next few years: looking at the market, recognizing where we have competitive opportunities, where we can gain share and how we use both our digital and physical channels to meet the needs of the guests. Mark, why don't you spend a few minutes just talking about the work you and the team did to take advantage of the opportunity in Q1 with swim? + + + Yes. I think it's a great example of we're excited about our new brand launches as we've been testing, learning and constantly iterating to create new ideas, and they're really resonating with our guests. So as Brian talked about, the story here is really one about agility and market insight. So in -- where we already had a strong #1 unit market positioning in swim, we didn't rest on our laurels, similarly to our action in Kids, and we looked at this market with declining players and saw an opportunity to win even further. So we looked at deep guest insights, market insights and worked really, clearly, closely with our vendor insights to create a new brand, a new paradigm and a new service level for our guests all in a very rapid period of time. Launched in Q1, Shade & Shore gained share in hearts and minds of our guests and is creating accelerated growth and real confidence for us as we build our brand portfolio. And it's important to note, as Brian said, this was an omnichannel play. So we looked at both stores and online to meet the guest needs and get exemplary results. + + + More work to do as we go into Q2. But as we talked about during our prepared comments, Q1, we remodeled 21 stores. We've got much more work to do over the balance of the year. We opened up 4 new small formats. We've started to make very surgical investments in value and simplify our value communication in-store and amplify that with a new advertising campaign that we call "Target Run. And Done." So in the early stages, we're going to continue to build off of that. We want to make progress every quarter. But we recognize it's going to take time, and we're going to stay very focused, very measured against the initiatives we've laid out. And quarter by quarter, we're going to strengthen our performance, continue to drive traffic to our stores, more visits to our site and capture market share as we improve our value perception and continue to build proprietary brands within our portfolio. + +Answer_4: + + I mean, as Mark and Cathy have both discussed, we are making investments in value, very much focused on household essentials and Food and beverage. Those are going to continue over the balance of the year, and we're going to be very surgical. We're going to measure and iterate. We've already made some significant progress in simplifying our overall value and promo communication and now enhancing it with additional advertising dedicated to those core household essential items that drive trips to our stores. So you're going to continue to see that focus, not only over the balance of this year but over time. + + + Maybe, Simeon, I'll add on just real quickly. So on -- let's look at the SG&A line, in particular, to give you an example. We invested more hours in the store, in store service and store experience, and obviously, we also invested in marketing. But it's being offset because of all of the work we're doing around -- in our supply chain and fulfillment. In the back rooms of our stores, we're starting to see some of the benefits there. Again, we're early days in a long journey, but you are seeing some of that offset. So it doesn't show up as apparently on the SG&A line. And then I'd remind you to look at -- I mean, clearly, not where we want to be with sales down slightly and EBIT down quite a bit more. So the investments are coming through as we said, and it's not going to show up in any given quarter. It's going to show up over the time. + +Answer_5: + + Let me start. First of all, Jeff has only been on board for a handful of weeks, so still in the early period of time, really trying to understand our business, assimilating to the Target environment. So we want to certainly give him plenty of time to assess our business and begin to build strategies going forward. But I think it's important to recognize he's not starting from square one. Over the last couple of years, we've been very focused on improving the quality of our fresh assortment. And the work that our merchandising team and our supply chain team have done, we've made significant progress in improving freshness, evolving our assortment to make sure we have more organic, natural, gluten-free items in our assortment in each and every category where we participate in Food and beverage. As you've heard us talk about time and time again over the last few quarters, we made significant progress in categories like adult beverages. So Jeff will build off of that work. We've certainly recognized, based on the work we've done in Los Angeles with the LA25 remodels and additional remodel activity in the Dallas-Fort Worth market, that as we change the in-store environment and elevate the presentation, the guest is responding very, very well. So we want to give Jeff plenty of time to take his own inventory, begin to build his own strategy that will enhance the work that we've been doing over the last couple of years. And we're very confident that over time, Jeff's going to build a plan that will allow us to continue to accelerate our performance in those important Food and beverage categories. + +Answer_6: + + Ed, we look at M&A opportunities all the time, but we look at them through a filter of what's going to really enhance our current business initiatives. So I would put out-of-the-box on the side and really think about M&A as something that's going to complement and strengthen our core strategy, help us accelerate, complement the interaction we have with the Target guest, and we'll continue to look strategically at M&A opportunities over time. + +Answer_7: + + Michael, we are very focused on executing against the initiatives and investments we outlined earlier in the year. So we'll continue to iterate as we learn through our remodel experience, as we continue to open up new small formats. We learn every day as we develop new brands. But our focus remains the same, so you shouldn't expect to see any drastic changes. And we'll continue to mature those initiatives over time. + + + If anything, what I would say, Michael, is we're accelerating. When we test and learn and validate, we accelerate our investment into that area. And so that's where we're looking across the company. When we see an opportunity to accelerate something that's working along our strategies, that's what we're doing. + + + Look, Michael, over the next couple of years, you should expect us to continue to focus on reimagining our existing stores. Adding new small formats that bring us into urban markets and on to college campuses, our continued investment in supply chain and technology, the support of our new brands that we'll be launching over the next 18 months, those commitments will not change. And our focus is on execution. And I think what we saw in the first quarter is a company that's making progress, we still have a long way to go, but continuing to focus on executing each and every day, both in our physical and digital channels. And that's not going to change over the next few years. + +Answer_8: + + Yes. I'm happy to take that, Michael. I think that -- we started work here in earnest in Q4 and continuing with healthy work in Q1. We actually show our indices are actually closer than the guest gives us credit for, and that's an issue for us because we know that's a bigger message that we need to convey. So we're continuing to sharpen our price and our value messaging at the same time and make sure that we move to a more regional-based pricing, localized pricing so we're more relevant to the guest and the competitive set, which is not what we're doing during '16 and we've rapidly iterated on in '17. So you'd see more of that activity and more of that benefit as we move through 2017. + +Answer_9: + + Yes. So I'm happy to start, Kate, and then Mark can amplify as well. So on the impact that we saw coming through gross margin, as Mark shared and we've shared actually for a couple of quarters, our biggest work has got to be around making sure that the value we're delivering is really clear. And it's going to take a while for our guest to give us credit for that, and so that's the work that we're going to continue to do. So while we're sharpening and making it more regionalized, you'll see that come through slightly. But the bigger effort is all of the work we're doing like the "Target Run. And Done." campaign that we launched this last quarter and making sure that our guests recognize the value we are delivering. + + + Yes. I'd just add into that, Kate. Our efforts, as we've discussed, are quite surgical. So we're doing this area by area, classification by classification as an evolving transfer. And we've really begun those efforts through Q1 but more in the back end as we matched to the "Target Run. And Done." campaign. So what we're seeing here is, on the handle side, we've been clear that we've had up to 28 different handles that we've been using to resonate value across all our classifications. So rationalizing the voice and the nomenclature down is part of that. So we -- that's why we've come into Q2 with an evolving position, and we'll assess its impact and its opportunity. + +Answer_10: + + Yes. As we said in our Q2 remarks and guidance, that we expect a couple hundred million dollars of EBIT decrease, and we also said that the majority of that would be in SG&A. So it's pretty -- I think it's pretty safe to assume that, that would be how I'd quantify the shift from Q1 into Q2. + +Answer_11: + + Greg, we'll talk more about that in the second half of the year. We're spending a lot of time right now with Rick Gomez, who's now our Chief Marketing Officer, really stepping back and thinking about loyalty and, importantly, as you just said, the integration of the REDcard into that loyalty program. And one of the other highlights from the first quarter is the continued penetration growth of our REDcard. So we recognize that's a very important asset that we need to leverage going forward, and Rick and his team are working right now to think about the next phase of loyalty and how we continue to leverage the REDcard to build even a stronger relationship with our guests. So you're spot on, and we'll talk about that much more in the second half of the year. + +Answer_12: + + Greg, you know we don't break out monthly sales. As we said, we saw strengthening in the latter half of February, into March and April. But obviously, our comps were still down for the quarter, so we've got work to do. We're not satisfied with where we ended up. But we certainly feel good about the progress we made in the quarter and, importantly, the market share gains that we saw in very important signature categories. So we're focused on driving traffic. We are certainly committed to restoring positive comps throughout our system. But one of the other important metrics that we're going to be looking at every single quarter is how we're performing from a market share standpoint, and I feel very good about some of the market share gains that our team achieved in Q1. We're going to continue to focus on market share opportunities throughout the year. + +Answer_13: + + John, there's a lot of learnings that we're bringing forward from those small stores, not only as we expand into new markets but as we think about application to our traditional stores. I think the biggest learning is, as we move into these new neighborhoods, consumers love Target and they love the brand. And the response we're seeing has been really outstanding. So we feel very good about our small-format strategy. As we move into new neighborhoods, we're getting better and better at curating and localizing assortments, understanding how to operate in various markets. And we're also encouraged to see the early comp results as we lap some of the new small formats we opened up last year. So encouraging signs, and we're going to build off of that as we go forward. So we feel good about the progress we made in Q1. But as a team, we're not doing high fives. We know we've got a lot of work to do. But I think it's important, as we end, to recognize, as a company, we have a very strong foundation. If you look at our results in the first quarter, we generated $16 billion of revenue. Our operating income was almost $1.2 billion. We were able to invest $500 million of CapEx and still see a very strong return on invested capital of over 14%. And as we did that, we were able to reduce inventories by over 5%. So we know we've got a lot of additional work to do, but I think it's important to recognize we're a fundamentally sound company. We've got a very clear strategy in place, and now our focus over the balance of the next 3 years is week-to-week execution, both from a physical and digital standpoint. +So we appreciate you dialing in today. We look forward to talking to you at the end of Q2. And operator, that concludes our call. Thank you. + + + + + + + diff --git a/exam/original-files/Problem_2_3_Sample_QandA/58_questions.txt b/exam/original-files/Problem_2_3_Sample_QandA/58_questions.txt new file mode 100644 index 0000000..148b964 --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_QandA/58_questions.txt @@ -0,0 +1,52 @@ +Question_1: + + Wanted to just inquire about the initial guidance given this year around the $1 billion investment. You mentioned some timing factors between SG&A in 1Q and 2Q. But even looking at the guidance provided for 2Q, the first half is certainly running at a run rate below that of $1 billion in investments. Help us just understand, have there been meaningful offsets? Or should we expect a spike perhaps in that investment pace in the second half? + +Question_2: + + And just as a quick follow-up, Cathy, you gave guidance for negative low single-digit comps in 2Q. Just help us understand some more of the puts and takes from a category standpoint. How are you guys focused on improving traffic trends back into positive -- on the positive side -- yes, sorry, excuse me, on the positive standpoint. And then also, specifically, if you can speak on Food and essentials, is really what I would like to dig on, on how we get that positive as well. + +Question_3: + + So just to follow up on the guidance for the second quarter, can you just talk about the change in momentum that you experienced in March? Do you think that was the environment improving? Or was it some of your actions? You mentioned, I think, Victoria Beckham, and I don't think these things have been material, but I know that, that product line came in March. And I don't know the timing of Electronics and Switch. And then the compares, I believe, get easier -- or got easier in April and stay relatively easy for the quarter. Can you give us a sense, is the run rate deteriorating? Or is your outlook just being conservative at this point? + +Question_4: + + And then, if I can ask one follow-up on investments. You mentioned you're starting to make some value investments. Can you give us any color on time frame, on categories? Is it broad-based? And back to the earlier question, it looked like this quarter, the decline in EBIT looked commensurate with the comp decline. It didn't look like this was a big period of investment. And again, behind the scenes, there might be that we don't see. So just curious of how we should lay that out for the rest of the year. + +Question_5: + + Could you talk about how your strategy in Food may evolve with the hiring of Jeff Burt from Kroger? And I guess, if you were to take a step back and really start to think about it, what are the 2 or 3 things that you really are looking for him to accomplish here? + +Question_6: + + Just a follow-up related to Food. On Monday, there was an article on -- in The Journal about you guys. I'm sure you saw. There was a mention in there about maybe your interest in Sprouts last year. I'm just curious as to -- how do you think about acquisitions generally? And are you interested, willing and thinking about out-of-the-box alternatives through maybe like M&A to reposition this business? + +Question_7: + + It's on the investments you're making this year. To what degree are you moderating and altering them based on the week-to-week and the sales trends that you're seeing? So if sales are better than expected, are you actually pulling back on some of those investments? + +Question_8: + + Brian, within the grocery and essentials category, can you give us a sense where you think your pricing gap is to the market today and where you think it needs to be over time? + +Question_9: + + With regards to moving to EDLP and the value messaging, I just wondered how much that move weighed on margins in Q1 and where you're seeing more success in that move and where you think you have more work to do. And then, in that same context, I think you've noted before that there's been fits and starts with how you've communicated your value message. Can you explain how and what you did during Q1 to convey that better to your customer? + +Question_10: + + I had a couple of questions. One, Cathy, sort of a housekeeping. You mentioned there was a timing issue in SG&A. Could you quantify how much that helped SG&A or how much we should expect it to come in, in the second quarter? + +Question_11: + + Got it. That's helpful. And then a bigger-picture question. We've talked a lot about traffic, but I don't think we've touched yet on the loyalty programs and the frequency you could drive from REDcard and Cartwheel. And been a lot of change in the market, whether it's Amazon Prime or Costco with their new credit card or Walmart with free shipping thresholds lowering. How are you guys thinking about integrating those programs to really help drive traffic? And is there a time this year we should expect to see that maybe enhanced or rolled out? + +Question_12: + + And on sales, if I could just follow up, it sounds like sales improved in March and April, but we're still negative. I just want to make sure that's right. + +Question_13: + + A question on the performance of the smaller-format stores. You mentioned that they had sales productivity roughly 2x that of the larger, more suburban-based stores. Aside from the difference in either being an urban or suburban location, what do you attribute -- or what can you tell us about why the productivity of those boxes is so much better? And is there any learnings you can take from the small-format stores to extend to the balance of the chain? + diff --git a/exam/original-files/Problem_2_3_Sample_QandA/59_answers.txt b/exam/original-files/Problem_2_3_Sample_QandA/59_answers.txt new file mode 100644 index 0000000..91284a4 --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_QandA/59_answers.txt @@ -0,0 +1,82 @@ +Answer_1: + + With regards to both third quarter, fourth quarter and full year remainder guidance, as we said, we'll continue to move with urgency but plan prudently. And I think that's what you should expect from us. We are finding every time we see results coming from our investments, we're choosing to continue to invest to accelerate our transformation. And so that's how I would think about the backside of the full year. With regards to the reclassification we did on the supply chain depreciation expense, we posted a great schedule, John and the team posted today to the IR website, gives you 3 full years by quarter. You can see the bottom line, it's 30 to 40 basis points a quarter change. And you would see that -- the shift from D&A to gross margin. + +Answer_2: + + Yes. + +Answer_3: + + Yes, so it is. It's related to our increasing store remodels as we accelerate some of the depreciation there. And for the full year, I was just quickly looking here, we're -- you'll see a little bit of continued pressure coming through, so it will pick up. But we'll follow up with some specifics if you need it. + +Answer_4: + + Mark, why don't you provide some insight into our view on Electronics? + + + Yes. Thanks, Chris. I think, firstly, just on the Apple comments, they weren't just driven by tablet. They were all driven across the board in categories. And we had really strong showing in Q2 on the iWatch, which we worked with Apple on clearly. And we have a lot in our plans to Q3 and Q4 with potential new launches as I've outlined. So we think that there's still room for growth and continuing the trend. In terms of Nintendo Switch, we worked really closely with those guys as well to develop not only a product but a marketing campaign that the guests really responded to. And so we've been able to secure inventory and a plan all through to the fourth quarter, so feeling positive about sustaining a trend there. + + + And Chris, I think it's consistent with our focus on bringing newness to the guest, not only in Electronics but through our assortment. And I think Mark and his team have done a terrific job of working with our vendors and also building own-brands that bring excitement and newness to our guests each and every day. + +Answer_5: + + So Chris, as we've said, we know that we've got a multiyear journey around the supply chain transformation, which will help that working capital continue to come through the business. And we want to just make sure we keep making that progress through time, so not going to commit longer term just yet as we -- it's really going to be associated with a lot of the supply chain transformation. On the increase in CapEx next year, again we're not giving all of next year guidance but thought important to signal where we were going with our CapEx. + +Answer_6: + + David, I would tell you it's a combination of both. And overall, we're very focused on improving the guest experience, whether they're shopping in store or online, making sure that we deepen the relationship with existing and new guests. And we are very pleased with the traffic increases we saw during the quarter. We're honestly very excited about the work that Mark and his team are doing around bringing new brands to our guests. And we recognize that to move forward and to continue to execute, we've got to continue to make sure we're providing fulfillment options that our guests are looking for today. So as John talked about during our prepared comments, we're very focused right now on testing and expanding different fulfillment options. We've seen some very positive responses to things like Target Restock. And we're going to continue to ensure that we could meet the needs of our guests no matter how they want to shop at Target. + +Answer_7: + + It's a very important question. And I'm going to turn it over to John here to build on that. But we're trying to make sure we are very, very focused right now and that we have the guest in mind first, that the initiatives that we're bringing forward are guest-centered. But importantly, that we have the right focus on execution each and every day. And I think what we saw in the second quarter is a by-product of our focus on execution each and every day in our stores, online, in our supply chain. And I think you're starting to see that focus really connect with the guests. + + + Yes, I think the only thing I'd add, you're 100% right about the focus. I think the key challenge there for us is to continue to take work that is not guest-facing out of the store. And guest-facing work there is, like we said, the investments we're making in Food and Beverage, in Beauty, in visual merchandising. That includes things like order pickup and shipping from the store. But there are opportunities everywhere else to pull work out of the store. And I think the stores' teams have done a great job optimizing within the box. We need to continue to optimize upstream to help them take work out. And that's a lot of the testing we're doing today. Now I didn't talk a lot about it, but we have test going on in multiple parts of the company focused on taking work out of the store, so they can be focused on the guest. + +Answer_8: + + So Robbie, there's 4 or 5 different questions there. And we'll try to unbundle each of them. But as Mark talked about during his prepared comments, during the second quarter, we saw very strong market share growth across a number of categories. We continue to see share growth in Apparel, in Home, in Hardlines. And one of the things that, I think, we felt best about in the quarter, and it's a by-product of the work we've done from a promote standpoint as we continue to see our businesses in Essentials shift back to regular-priced sales and the impact of our new marketing and advertising campaign, the Target Run and Done campaign, which has driven really positive reaction from the guests and accelerated our business in Essentials. So that was a real big highlight for us in the second quarter. And we've talked about this before. We're at our best when we balance both style and household essentials. And you're seeing that balance come to play in the second quarter. And we certainly are going to continue that over the balance of the year and into 2018. So it was a period of time where we feel good about the progress we're making as we pick up market share in many of our signature and style categories. We've seen growth in our Essentials businesses. And we'll build off of that as we go into the balance of 2017 and '18. + + + Sorry, Robbie, around Cartwheel. Cartwheel remains a really viable promotional vehicle and guest engagement tool for us. And what we're doing though, in the simplification of our pricing message and creating great priced-right daily items, is we're using Cartwheel, but we're reducing the amount of stacking that's coming in. And that's really helping us to clarify and simplify our message to guests about what true everyday value is as well as what's an exceptional promotion. So the rescoping of that has been tremendous so far. And really, our regular business is shining and our promotional business is rescoped in a great way. + +Answer_9: + + Obviously not. + +Answer_10: + + Yes. Why don't we turn it over to Mark to talk about both Food and what we saw during that Prime period? + + + Thanks, Bob. I think that we outlined in our Q1 comment around the emergence of our strategy and that we're going to be on a journey of implementation as Jeff Burt joined us in the business. And Jeff has already come in and begun start testing and iterating new ideas and concepts on top of our strategies that are creating growth vehicles, so we're excited about that. The new people entering our business are just creating new strength against those strategic intents. So firstly, Liz Nordlie will add value to our own brand growth potential there and strengthen our efforts there as well as Mark Kenny, really with his expertise in general grocery but specifically in the convenient meal area and in bakery, et cetera. I mean, that is part of our ongoing strategic intent to strengthen and focus there. So these are key investments in our strategy and in our team, balancing them against existing talent. In regards to your query around Prime, we're really happy to see ongoing trends maintained during Prime period. And we had positive comps and a really strong growth in regular price business continuing through those days both in-store and online. + +Answer_11: + + Yes. Thanks, Peter. So let me start with pet. We announced this month the addition of Blue Buffalo to our assortment, which is the #1 brand in the U.S. and a really core assortment get. And so excited to add that into our mix, and we already have a lot of data from our guests who suggested they wanted to see that at Target. We also embarked on an agreement with BarkBox. So really refocusing our accessory and our total assortment of doing business inside pet. So an exciting uptick there because that brings further guest trips and conversion. Around the Food and Beverage area, in terms of general assortment, we're still working on there and more to follow. + +Answer_12: + + I think that we've talked openly about a roster of more than 12 brands that we'll be bringing to life over a period of time. We've begun that journey. That continues into 2018. It highlights definitely the signature areas, but the strength, providing differentiation, exclusivity and therefore, preference that Target through this is applicable to many different areas. So we're looking at all areas and opportunities, and we have some plans in place. + +Answer_13: + + I think any time you focus on just one slice of the total fulfillment, you lose picture for the whole thing, right? We're trying to optimize the total economics for Target. And those economics include investments, capital investments we might otherwise have to make if we don't utilize the existing assets. So I think we can point to any one slice and say, "This one is going to be better or worse." But again, we're optimizing total economic picture. And I'd have you think about that. I think the remodels, where they will really help us, and it's in conjunction with us taking inventory out of the backroom, is our ability to optimize that backroom more efficiently to drive more productivity as we ship from the store. And so that's the real opportunity as we go through the remodel cycle. + +Answer_14: + + For sure. And in conjunction with operating changes to reduce inventory, like I was talking about earlier, and take work out of that -- other work out of the store. + +Answer_15: + + As you saw in the quarter, we are seeing the continued investment in both SG&A as well as gross margin. We also though are working really hard to make sure we can offset with efficiencies throughout the organization, where appropriate. And so you're seeing that -- you saw it come through in SG&A and in gross margin this first -- the second quarter, you saw in the first quarter as well to do that. So where we see the investments get the return that we expect and the results we expect, we're investing faster and heavier to accelerate the transformation. So I would say we're on path to what we said we would do. And you're seeing it come through in both Q1 and 2. + +Answer_16: + + Yes. Okay, I'll take that one. So our promotional efforts are really a roll through the quarter event. And we began them in first quarter in April. And our second round of taking key items that comprise our guest basket and focusing on priced-right daily items really took hold and then second wave by end of July. The next round of that is through October. And that's when we'll be coming together to have a more concise in-store marketing campaign and regular cadence of new brands to the guest to communicate value. So we think at that point that we have a strong base to maintain. And this is why in half 2, we've been prudent in how we forecasted our sales and margins based on also unit growth initially. We see trip growth initially. And we need to see that dollar growth balance out over time. But we know that we've been patient with that, hence some of our earlier discussions at the start of the year are about investing ahead of the curve. + + + Kate, I think promotions, along with many of the other things we've talked about, are still obviously in the early stages. Now we're excited about the results that we've seen with remodels. But we have hundreds of stores in front of us. We've seen great responses in some of our small formats. But again, we'll open up dozens of additional stores over the next couple of years. The brands that we've launched have been well received. But we're really just getting into the heart of the brand launches as we go into the back half of '17 and '18 as well as the pricing and promo work. So we're very pleased with the progress. We know we've got much more work in front of us. But we thought today would be a great chance to give you a progress report and give you a sense for the amount of work and the scope of work that's taking place within Target. So that concludes our second quarter 2017 earnings call. I really appreciate all of you participating, so thank you. + diff --git a/exam/original-files/Problem_2_3_Sample_QandA/59_questions.txt b/exam/original-files/Problem_2_3_Sample_QandA/59_questions.txt new file mode 100644 index 0000000..9ecd307 --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_QandA/59_questions.txt @@ -0,0 +1,64 @@ +Question_1: + + I have two brief questions for, I think, for Cathy. The first relates to the implied fourth quarter guidance, which seems quite subdued relative to a tough fourth quarter a year ago despite the fact that I believe you have an extra week in the quarter, and correct me on that if I'm wrong. And then the follow-up to that is just that you mentioned D&A moving higher. So if you could just give us some color on the magnitude of the move you'd expect of the restated D&A numbers. + +Question_2: + + We have that. But just in terms of the -- I think you said you expected D&A to be increasing at a faster rate as you accelerate the depreciation associated through upcoming remodels. + +Question_3: + + Can you try to contextualize the expected increase, how much the pace of D&A growth will change? + +Question_4: + + You had a very strong Electronics quarter. The Switch, which has been a huge hit, double-digit comps in that. And then Apple iPad sounded like they're bouncing back. So it seems like there's a material contributor to same-store sales. How do you think about the sustainability of this benefit? Presumably, the Switch moderates. But do you think the Apple benefits on tablet compares and the new phone? And what other categories do you think could come in and pick up for what the Switch has provided? + +Question_5: + + Understood. And then on the working capital CapEx side, you've seen some very nice benefits here on working capital this year. How do you think about this year, inventory outlook at the end of the year on the working capital benefit? And you raised CapEx a bit next year. Do you think that increased CapEx is largely offset by continued ongoing benefits in the working capital area? + +Question_6: + + I really wanted to simplify into one question all these different tests and get at one issue, whether it's the roll -- test of curbside and same day, whether it's the rollout of in-store, all the work you are doing. Could you talk about all the new initiatives? And is it -- does it have more traction with existing customers, anything you can share, existing customers, capturing back more of their wallet? Or is it new customers that are new to Target as you go through these new initiatives? + +Question_7: + + Just as a sort of an add-on to that, one of the things over the last decade that some retailers run into with all these attempts to reengage, a lot of which are very exciting, is either overdoing it or overcomplicating it. How are you guarding against at the store level the associates not being overwhelmed by these initiatives and managing through that? + +Question_8: + + Brian, you guys have been mentioning the environment challenges, and we're seeing the very aggressive promotions out there in categories like Apparel. Your store traffic improved a lot this quarter. I'm just curious, are there -- can you give us any color, are you picking up more share from competitors' store closings than you would have thought? And then also as you shift more to EDLP while others are getting maybe more promotional, any insights from what you've seen so far in August that you can share with us on how all this is working out? And sorry, just to add on this also, and I don't know whether John Mulligan or Mark want to jump in on this, but as you pull back on the promos more, you shift more to EDLP, can you remind us where things like Cartwheel fit into that as you move forward and also how you see REDcard penetration playing out in your strategy? + +Question_9: + + And any chance we can get you guys to comment on August? + +Question_10: + + Just a handful of questions. You've had some recent hires in sort of the Food umbrella. I'm just curious as to how the new individual fit into the current strategy and whether this is a catalyst for a shift and maybe something more into the prepared food sort of side of the equation. And then secondly, if you're willing to comment, I'd love to know what the trends look like, the business trends look like in and around Prime Day? + +Question_11: + + Mark, just was hoping you could expand maybe a little bit on some of the merchandising assortment changes that you're making in the consumable side of the business, the Food area, particularly in pet food. What's going on there? And anything to note there from a remodel perspective? + +Question_12: + + That's helpful. And then just leveraging on that, when you think about the private brand introductions, I mean, good color on what's coming this year. But when you think about next year, is it going to continue to be in kind of the signature categories? Or should we expect some private brand introductions to start to emerge on the consumable side of the store? + +Question_13: + + The only questions I have are essentially just on the pick for store concept. I just want to share a comment we had from an industrial engineer that was working for me a long time ago that it's about as efficient as a driver who takes 3 rights to take a left. There's a massive cost when you have people walk the store instead of it being your customers who walk back out on a simulated basis. I get incrementality. I get that you don't have to have the checkout cost and it offsets it a little bit. Is there something that's coming that you guys are confident on the operational side that will make pick from store the way you guys are doing it better than lots of other folks so that we don't face as much inefficiency? And similarly, will the remodels make those operational changes you think less difficult or more efficient in terms of cost structure? + +Question_14: + + And so the micro fulfillment in the backrooms would be one of the benefits of remodels? + +Question_15: + + Can you quantify how much of the $1 billion of operating profit investment you plan to make has already been deployed thus far this year? + +Question_16: + + I wanted to just ask about promotions a little bit more, if you don't mind. I know matching promotions are fluid. But how much more work do you need to do in moving your categories and products to EDLP? And what way are these changes impacting the second half outlook? And I know you've mentioned that there's been challenges in the past in terms of conveying value to your guests. And I just wondered how this messaging has changed. + diff --git a/exam/original-files/Problem_2_3_Sample_QandA/5_answers.txt b/exam/original-files/Problem_2_3_Sample_QandA/5_answers.txt new file mode 100644 index 0000000..8f10a39 --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_QandA/5_answers.txt @@ -0,0 +1,490 @@ +Answer_1: + + Good morning, Guy. + +Answer_2: + + Yes, so just a quick thing just to clarify. The 10 basis points is actually lower, not higher, so it's a deduct, not an add for the new Basel proposal relative to the US rules. So remember as we've previously been disclosing our ratios, we used the US proposed rules that referenced a prior Basel denominator, so it's a 10 basis point worsening. +And you're right that we had two major things contributing to that. We had a positive associated with better assumptions on draws on unfunded commitments, slightly more than offset by a negative on the risk [credit] protection. So we're still working through the prior details but our best estimate is that it's in the mid 20s in basis points, 25 basis points plus or minus. + +Answer_3: + + If you start with our gross growth CDS protection written, it's about $3.4 trillion, and by the time you net down from maturities it gets down to a couple hundred billion, but that is still impactful. + + + Another thing to think about, it will be manageable because really this is kind of a static analysis before we start running the business slightly differently due to it. + + + Right. + + + We saw the proposals as having been thoughtful and we don't necessarily have to agree with the finer points of all of them, but it doesn't materially change our position or our thoughts going forward. And as Jamie said, all of our businesses will now socialize and optimize against what we understand to be the final rules when the US regulators adopt them. + +Answer_4: + + Yes, so, Guy, we're obviously going to do a bit more of a detailed deep dive on expenses over time on Investor Day. So for now what we have said is that you should expect our adjusted expenses for 2014 to remain at or below that level of $60 billion. We also said that in 2014, the continuation of our control agenda is adding an incremental $1 billion over 2013, so by remaining flat we're effectively self-funding that $1 billion. That's down. + +Answer_5: + + We're not starving any expenses. We're just managing it in a disciplined way the way we've always done it and you look at the underlying numbers there's a lot of growth in the underlying numbers, but it's clearly true that some of the derisking and selling, spinoff OEP, and physical commodities will affect revenues a little bit, but obviously profits less. + + + And, Guy, we've always been investing in the businesses and been willing to invest where the business takes and the returns justify that, but we are also finding efficiencies in the combination of the businesses, both consumer and the wholesale businesses, efficiency in the same store, branches we talked about, CIB continues on its journey on the back office and front office integration, and obviously mortgage expenses will continue to trend down both in line with improved credit trends and also as we proactively manage the portfolio. So there's a lot of moving parts but it's not at the expense of our willingness to invest in the businesses for returns. + +Answer_6: + + It's not just about expenses. You have to think about the whole equation. If you look at a mortgage market we'll see some improvement in the first quarter 2014, and we'll also continue to work on expense efficiency in the business. But if you look at a market which is currently being estimated about $1.3 trillion, down from $1.9 trillion, and honestly a couple weeks ago it was $1.1 trillion, so it's a very small market, one we haven't seen the likes of since year 2000, in a market like that it's very challenging to deliver through the cycle returns. +So we went through over the last few years, years with very strong revenues and margins, and we are in a challenging environment as we look into 2014 but we're working on it. + +Answer_7: + + Okay, so the way to think about it in the short-term relative to say the submission that we just did or in the near future is that obviously, a realized loss experience that is higher than we have previously seen informs your view and judgment as to what you could reasonably expect to happen in a future stress period. So it is fair to say that that would drive our expectations (inaudible) on operational losses to be slightly higher. Having said that, it's not as if our previous submissions didn't contemplate there to be significant stresses in operating losses, so I would characterize it as incremental and certainly not from a low base. + + + And also, Guy, sorry, just remember that every quarter we move forward we generate capital, improve our ratios, so there's lots of moving parts to the ultimate outcome. + +Answer_8: + + Good morning, Betsy. + +Answer_9: + + I think the way you should look at it is something like $40 billion gets reinvested in a year. The basic assumption you should make is it's an average duration of three or four years, so think of a five-year bonds or something like that, and just use the implied yield curve. Obviously (inaudible) munis or MBS or something like that, but I need to point out that it's completely dependent upon the decisions we make, so we can change that kind of at will if we want to extend or reduce the duration of equity of the Company. + +Answer_10: + + It's both. + + + It's a little bit of both. It's mostly just the change in the yield curve. + + + We have slower mortgage fee payments, we're able to reinvest at higher yields, we're reinvesting in high quality assets, munis with high spreads, so it's both. + +Answer_11: + + Well you have got to separate the loans. On the commercial side we'll obviously be competitive and we're not assuming anything heroic in terms of rate spreads getting worse or better but they're low. You could argue down the road they might actually go up a little bit as capital requirements and liquidity requirements go way up, so but we'll be competitive. We're assuming you have to be competitive in loan spreads. + +Answer_12: + + Think of the card business, we try to run it fully match funded so the spreads are about the same, and somewhere like 65% is at an interest rate something like 40% is transactor almost locked in rates, so which we also match fund. + +Answer_13: + + So we have replaced 2 million debit cards or will have I think by the end of this week. + + + Credit and debit. + + + Credit and debit. To protect our employees, to protect our customers, et cetera. So I think that look, unfortunately, this cyber security stuff we've now pointed out for a year is a big deal, it's not going to go away, and all of us have a common interest in being protected so this might be a chance for retailers and banks to for once work together as opposed to sue each other like we've been doing the last decade, and but it's in all of our interest to do it. +And I think all people involved in this know that the third parties with its machines, regional machines, your mainframes, you really have to put an extreme effort into protect yourself so this story is not over, unfortunately. + +Answer_14: + + Yes, honestly I think you'll see both. I think you'll see chip and pin in all cards and then a lot of online type of transactions in tokenization. They both have very, very good technologies to protect consumers and companies from fraud. + +Answer_15: + + Yes, that's correct. + +Answer_16: + + Correct. + + + There's an unrealized gain approximately of like $3 billion today. It's on our books of zero. This goes back to when Visa was spun off many, many years ago. + + + But that's right, Betsy, net of hedging. + +Answer_17: + + Hi, Glenn. + +Answer_18: + + I guess look, there are some structural headwinds and you've seen a lot of adjustment in the marketplace, people reduce the size of their inventory, and what you don't know going forward is what's going to happen to spreads. But I look at it a little bit like there's a secular and a cyclical. There will be headwinds from regulations et cetera. But over time, assets that people need to manage and buy and sell is going to go up over time, not go down. So what happens in 2014 is hard to say, our business is plenty diversified between rates, credit, emerging markets, FX, commodities, et cetera. + + + Certainly helping out stability. + + + Which is definitely helping out stability. + +Answer_19: + + I would say Glenn it's ongoing and it will be beneficial. I think material might be a stretch at this point, but and it is a lot of work as you say, so there's a whole industry working on that and us too we expect to be beneficial but not a game changer. + + + So the SLR at 5% we do not think is going to be an issue for us. We barely begun to manage it, there are a lot of things you can do in how you change your business. The bank issue is a little bit different but think of that as more structural. What you did in the bank over the last 20 years and what we're not going to do in the bank going forward, that will take a little bit longer, but not because -- the reasons is it takes longer to change our business models to accommodate it. + + + I also think if you look at the other things I mentioned in terms of opportunity for putting NIM to one side, our estimate of the new Basel rules that we had we've given you a 10 basis point movement backwards has a conservative estimate of what we could ultimately achieve over time in terms of the ability to net cash collateral for derivatives just given certain of the conditions. But again over time that will also be manageable like compression trades and like many of those other things. +So we haven't changed our view, we can manage against these targets by doing it thoughtfully and methodically and not having to race through it. + +Answer_20: + + Well we've said already that we would be willing to run between 10% to 10.5% so we're on a journey here. We think we can get 10% plus or minus at the end of the year. It could be plus and it could be minus but we think at this point based on what we know that running at that level of buffer of margins should be enough. Obviously we'll be more informed as we go through CCAR processes, but that's our point of view at this point. + +Answer_21: + + Yes, so we have been adding, I mean I talked about the second half of the year gross adding $66 billion. We've never talked about second quarter, we added quite a lot in the second quarter, and yes we have plans to continue to do that in 2014, and yes, we expect our NII dollars to be relatively stable, possibly slightly up over the course of the top of the year, but relatively stable. + + + But not in a lot of investments. Look at the balance sheet today. We have almost $350 billion at central banks, most of it's Fed. Another $350 billion of very high quality investment securities, and those two things combined equal our loans of $700 billion. So the Company's very, very liquid. We don't really need to invest more, but it depends on how much we grow deposits. + +Answer_22: + + Well I already said what we're going to do is what you should assume now is implied yield curves and constant reinvestment, but if you had rates move up 100 basis points all at once, we would probably be much more aggressive doing something like that. + +Answer_23: + + So obviously, you're going to understand that the necessary caveat that we can't predict for you, the patent and the amount of legal expenses in any one quarter over several quarters; however it would be fair to say that we would certainly hope that for the full year, the full-year cost isn't the first quarter annualized, but we can't be certain of that. +And with respect to reasonably possible loss range, it did come down from $5.7 billion at the end of the third quarter to $5 billion at the end of the fourth quarter given the legal expense. + +Answer_24: + + Yes, so I mean, if you think about -- and you can do -- we've done about as much as you can do based on analyst estimates, but if you think about we want to get to 10% plus or minus by the end of next year all else other things being equal, that is a priority, but it is not the only priority. And so as we think about our capital plan, we've consistently said obviously it's a Board decision ultimately and they'll contemplate them in the natural course. But we would like to have the flexibility to be able to potentially increase dividends and also have flexibility to get to do reasonable repurchases, it wouldn't be unreasonable for you to think about how we thought about this year as being relatively consistent with last. + +Answer_25: + + So every year, we try to have a disciplined approach about what we stay in and what we don't, and I think we probably were more disciplined this year about the things we don't need, both from derisking, capital, management focus, controls, et cetera. +If you look at the prepaid card business we are not dealing directly with customers, it's kind of secondary, it's a complex business and we were just better off letting someone else do it. It won't affect the four main franchises that Marianne spoke about that are doing so well. It's just kind of a product we used to do so we're not going to do it anymore. There's a lot of risk associated with it. + +Answer_26: + + So we didn't use the word cautiously optimistic. We're using the word optimistic because we are actually optimistic, and if you have a US economy starting to grow you will see loan growth and volume growth and of course all these businesses, we are actually optimistic about the US economy in particular. +We spend a lot of time analyzing what rising rates, growth, change of QE3 taper will do to deposits, so it might actually have a diminishing effect on the growth of deposits, but we're happy with it, we're still growing share. I'm not sure you're going to see deposits go negative before you seen loan growth. I think you're trying to fine tune it too closely there. + +Answer_27: + + Yes, so remember that in our card business we have both dynamics of core growth as well as still some continued run-off. We did reach the inflection point during the second half of 2013 where that run-off was no longer exceeding growth, and so we're set to grow but very modestly in 2014. + + + But more importantly, 93% of the business awards, we've had 10% growth in spend, we've had was it 14% growth in merchant processing, so we are very happy with the card business. It performed exceptionally well, excellent credit trends so outstanding growth is less important but obviously we like to see some of that too. + +Answer_28: + + No. + +Answer_29: + + Just a little bit relating to Target but not in general. + + + A lot of the card growth is coming from T&E and travel and restaurants and things like that. + +Answer_30: + + Yes, so just to remind you what we said back in February or last year, in the consumer businesses we talked about over the two years, so 2013 and 2014, mortgage seeing headcount reductions of 13,000 to 15,000, and the consumer business predominantly in the branches of 4,000. By the end of 2013, we had seen a 16,500 in total, so in the consumer bank we are actually not only accelerated but outperforming our expectations in terms of our ability to run those branches efficiently and still maintain very strong customer satisfaction and retention rates. +And then in the mortgage base, we have seen total headcount down 11% year over year against that 13,000 to 15,000 two-year target. So obviously we continue to work on the strategy and the size and our approach to mortgage market, but they're obviously relative to those numbers, there's still a little way to go. + + + And remember sorry, remember that that was both production and servicing. What you saw given the rate environment in the middle of second half of 2013 is that some of the production-related headcount reductions were accelerated. We still have meaningful improvement expected in terms of delinquencies and foreclosures and modifications that will continue to drive cost and headcount down in 2014. + +Answer_31: + + So I would think about -- talking about the number of branches I would think about the fact that it all goes to retail distribution, houses will continue to do consolidations and relocations as it makes sense for us to do that in our footprint, and we'll continue to respond to customer preferences, which will mean that over the course of the next decade we'll be looking at obviously the size and use of branches as branches come up for renovation and release and things like that. But we're not expecting a material change in the number as a macro matter, so 5,600 plus or minus, and it is going to be based on customer preferences. +As it relates to headcount reductions, we're already aggressively looking at the efficiency in our same-store branches and have been very successful, so we are looking at starting models, physical capabilities, automation, we're on that journey and we continue to be on it, but I don't see that it's going to be a step change relative to our previous expectations. We've already exceeded them, might be some more, but it's not a step change. + +Answer_32: + + So let's start with commercial and say that it's plus or minus zero at this point, so I think it's going to be strong for long, but that's not really going to be a reserve story for a little while. In the card business, we had been talking about having potentially reached bottom for a period of time. +We haven't yet or it doesn't seem we have, so as you look into 2014, if things do continue to strengthen, it's possible there will be some more releases but not at the levels that you saw in 2013. So in the first couple of quarters, and usually the first quarters are instructive on that point, usually that's when you see a material improvement if there's going to be one in terms of flow rates. +And then on the mortgage space, two things. We have $2.6 billion of NCI reserve left. We've talked before about the fact that we think our more steady run rate number will be between $1 billion and $1.5 billion, so there's another $1 billion to $1.5 billion to come in that space over the course of the next year or so potentially, obviously environment allowing. +And then on an NCI --- I'm sorry --- on the purchased credit impaired portfolio, we have $4.2 billion left off the two releases we just took. But remember that it's a life-of-loan portfolio. So something would have to change now, and the environment improve, for us to expect to take more releases. It is possible, but nothing --- we don't expect to be taking releases up to that $4.2 billion. + +Answer_33: + + Good morning. + +Answer_34: + + Yes, we did have some tax benefits this quarter. We had about $300 million after-tax. + + + Related to a number of items but state and local tax, some reserve releases, not one particular thing. + +Answer_35: + + It was just a little over 30%, low 30%s. + +Answer_36: + + No change. + +Answer_37: + + Yes. + + + Yes, so we said I think at Investor Day plus 100, plus or minus in a year, when Gordon spoke earlier in 2013, we've revisited based upon our assessment of cost and preferences and activity and think we've got the footprint where we are happy at 5,600 plus or minus. --- + +Answer_38: + + So if you look at bab and then obviously also at Investor Day we'll go through it more. + +Answer_39: + + So it's a bit of both. Just one thing on mortgage. Just a tiny clarification. +We expect Mortgage deductions to be broadly the same as we've seen in the second half but we would expect to continue to see improvements in the expense base in the servicing business. But having said all of that it's a combination of relatively stable but potentially slightly higher NII. +Yes, strength in fees on the basis of the strong driver growth that we talked about, and then our $60 billion or less of expenses. So we're working through all of the efficiency opportunities across the businesses, including in the retail space to be able to deliver positive operating leverage. + + + And Mike I think the way you get to it is each of our businesses is always trying to drive efficiency while investing. That doesn't change any particular year. It's kind of a non-stop kind of thing and you see those efficiencies because every business has pretty good margins after investing. And sometimes the revenue growth itself is either episodic or the timing isn't exactly the same how you invest, but if you see the drivers, which is deposits, investable assets, asset management, number of corporate clients, market shares, they are all pretty positive so we're not going to -- + +Answer_40: + + Well VaR itself is a calculation that's based upon a whole bunch of different things. We don't deliberately lower VaR. + + + With VaR, Mike it really is just a feature of two things. If you look at our look back at VaR, across asset classes we're at very low levels of volatility, just across all of the asset classes, and that's actually driving it. If volatility picks up, that could pick up, we're not driving that down, and it's also derisking an SEP, that is a little bit proactive but it's obviously mostly done now, so then on CIB -- + + + Actually we did a number, if you would stay with the volatility that was 18 months ago, VaR itself would be like $60 million or $70 million just all on its own so without changing your position et cetera. +So Mike, the hardest business to get a handle on is CIB, when you talk about the short run, but what we see is investors still have to buy social securities, corporations have ECM and DCM, and you could predict the rolloff et cetera. The backlogs are pretty good. You saw a tremendous amount of IPOs in 2013. +You saw a lot of debt financings, you've already seen a bunch of M&A earlier this year, so we don't budget or plan that you're going to have an unbelievable year in CIB, but if you ask me, the long-term prospects are good. It's probably the business that has to go through the most adjustments in the new regulatory environment, but the long-term prospects are pretty good, so our margins are good, our returns are good. +You see our comp levels of 30%, down from 38% a couple years ago, really reflecting higher capital et cetera. But at that comp level we can pay our people well, grow the franchise all around the world, serve our clients, and still get decent returns. So we feel very good about the business and one of these days it's going to boom, and it's not going to boom because we, you can get just like I can guess when that might happen but it will happen one day. + +Answer_41: + + Volcker, all things equal we would say not much. I think when we referred to the $1 billion or $2 billion, we were talking about regulations in general, including derivatives, SAS, clearing houses, and Volcker, and that number we still kind of have in the back of our mind but it's hard to tell what the effect of all those things are. The $1 billion or $2 billion I would say was probably in the conservative category. + +Answer_42: + + That's the one that's hard to tell. I would guess-- + + + Yes, so it's very difficult to back test because these things are all interrelated so it's not entirely possible to disentangle everything, but obviously we've gone through the changes in 2013, some of that will be reflected, but this is a number that we would expect to be reflected to the degree that it is all over the course of the next two years. + + + Remember some of those things reduce capital requirements, some people are making dramatic changes in their business models which may free up market share for those of us that have additional market share, so it all remains to be seen. And that was also a static analysis. Some certain things we may reprice a little bit because of the capital liquidity requirements around them, so it all remains to be seen. + + + Thank you, Mike. + +Answer_43: + + So I would just reiterate what we previously said, which is if you look at Servicing and in particular, the quarterly run rate, which call it $600 million in line with our expectation that's going to continue to trend down towards $500 million by the end of the year in 2014. +And then on the production side while we obviously are going to see our expenses to a degree of variable with the size of the market, we're continuing to also work on opportunities to make the fixed cost base more efficient, so hopefully we'll deliver some of that in 2014 too. And we'll do a more precise job of putting a bow around that for you at Investor Day. + +Answer_44: + + So that's an excellent question. I would say assuming we have no significant losses going forward then we feel like we should be close to our high point, albeit maybe a little bit more in the first half of 2014. +The reality, just two comments on operational risk. The first is unlike market and credit risk, although all of the parameters and the confidence levels are effectively the same, it doesn't naturally recalibrate itself to changes in the business environment, or to your business mix or model, if you structurally reduce risk. It's very backward-looking, and in that sense it differs because it doesn't recalibrate. And so, as a result if you just let the models continue to predict based on historical losses going forward, you would need to be carrying that elevated level of operational risk capital forward for a reasonably long time. +It's a 1 in a 1,000 year horizon, so think about it in terms of 5 or 10 years, not 1 or 2 years. And so for that reason, we are very interested and working very hard with the industry to try and figure out how to better model changes in the business environment, and to both model and defend structural and permanent risk changes in our businesses in order to be able to recoup some of that more quickly. But at this point I would characterize that as work that has not yet been done, that is in progress, and so for the foreseeable futurity will be elevated. + +Answer_45: + + Good morning, Matt. + +Answer_46: + + Okay. So to put Volcker aside for a second, with respect we didn't update obviously the list, we are going to do that at Investor Day. We talked about that for you. It's more important to think less about revenue, but more on the impact on the bottom line, given some of these businesses they now have been returning hurdle, may have been in the investment phase, and actually not been breaking even. +So I think it's fair to say that if you consider the impact on the bottom line more so than revenues that it's going to be modest, and we will do work to update you on that. But remember, it also is going to do two things, release capital which will be a positive, and also improve the quality of the businesses and the control environment and the complexity which would all be positive too. + +Answer_47: + + It is the ones that you all mentioned, and we put them in our 10-K. + + + Yes, it is the ones you mentioned, and as you look at our disclosures in the 10-Q. Every quarter, the items that we think raise themselves to the level of public disclosure are in that document. So look to last quarter and next quarter and you will see, but we shouldn't comment specifically. + +Answer_48: + + I don't think so. + + + Not this point, but obviously the Ks are a few weeks away. + + + Yes. + +Answer_49: + + So I mean, I think -- if you think about the sort of basis for capital and put aside whether you like the way it works in a modeled environment, your reserves, that is for expected losses and capital to your expected losses. So in theory you shouldn't get explicit credit for them. I think the bigger point for us is, if you look at the sorts of things driving our capital levels to be as elevated as they are, they are things for example, like the PLMBS issues, and also certain of the very large mortgage DOJ and national mortgage settlement and ISR compensation issues. +It's our belief that this Firm is not exposed today or will not be exposed going forward to those levels of risk, at anywhere near that scale going forward. But as I have said, we have no ability at this point to scale those back, and that's what we are very focused on. So it's less really about whether we are getting credit for our reserves, and a little bit more about how we try in the industry to evolve the framework in partnership with the regulators, and defend over time that there are structural risk reductions that mean those risks are no longer present in that scale. + +Answer_50: + + Yes. + +Answer_51: + + Not specifically. We did fairly well in cash, but our cash platform is not as mature as some others. So I think we would characterize the performance as good, but coming off of as I said a very strong quarter for equity derivatives in the third quarter. + +Answer_52: + + So just I'll comment. On Page 15 last quarter, we showed you a bunch of things we're working on. We didn't replace the page, because it has not meaningfully changed. That is not to say that at the margins we don't continue to look at our businesses in terms of sophistication and derisking. So I would say that while there may be things that the margin that we will explore over time, then there is nothing structurally big that you should be aware of. + + + And again, we will do some more of that for you at Investor Day. + +Answer_53: + + That's a hard question but -- so Middle Market if you go back -- so I am going to do just Middle Market because that's the one that's kind of at a 30% too. Years ago, you used to average more like 45%. +It looks like to us, that what you have -- is they have a lot more deposits and a lot less utilization. And so obviously, they are going to use some of their own money before they borrow against a revolver or something like that, and one day, you would expect it to go up. We aren't guessing what's going to happen in 2014, but I would say, we will be sitting here one day when you have had a very strong economy it will be 10 points higher. + +Answer_54: + + Well multi-families a big portion of that and you see that in a lot of -- I would say obviously the major cities is pretty much where you would say -- it's hard to answer specifically. I think both multi-family and other real estate loans, it's really the big cities. + +Answer_55: + + Sure. Change either that, or how you reimburse clients for deposits, and obviously it will go into how you price them on your business. We are not expecting that to happen, but obviously we would do that, and you have other alternatives, so you might invest some of that money elsewhere. + + + Yes, and it's also important to point out there is a large portion of that $350 billion are deposits or cash that we would consider to be client non-operational deposit. And as a result, we don't give ourselves any liquidity value for those, so that is why we are putting them overnight in the Fed. + +Answer_56: + + Mostly marketing. + + + Yes, it's predominantly marketing, and with respect to marketing it can be lumpy quarter to quarter. So it's not an unexpected number for us, it's just higher in the fourth quarter than it was in the third. + + + But we have been doing a good job of card acquisition of high quality cards. You see -- I forgot the number, but it's up quite a bit. So we have some good active programs out there. + +Answer_57: + + Way optimistic. + + + Yes, I think that would be optimistic. Obviously, we will determine the third quarter as we go through it. We will cover employee issuance, but that's certainly our expectation and maybe more, but I don't think you should expect us to catch up from PB. + + + Remember, we want to meet our own objective of the 9.5% or 10%. And obviously the litigation costs hurt our ability to do that, so we caught up on that. And also the stock price is a lot higher than it was when we talked about trying to aggressively buyback some stock. So we always look at that as a important thing. We don't just buyback stock regardless of price. Not that we can't get that price, but when it was at $33 a share or whatever, that was a extraordinary compelling price. + +Answer_58: + + The Board will decide when the time comes and they look at all of the priorities et cetera. + + + I would just reiterate what I said before, which is getting to our target ratio is a priority, it is not the only one. We will have to see how things play out in 2014. But if you do the math then you can take your own estimates of what you think we will earn next year. We should be able to also have the opportunity to take it to buy more than just employee issuance, so you are just going have to -- we want that flexibility. That is what we submitted for, and we will obviously manage through each quarter as we see it. + + + It may depend on what we sell, how much we can mitigate, what the final rules are and stuff, so there is a lot of moving parts. + +Answer_59: + + It's just a little less than $100 million. + +Answer_60: + + Yes. So there is no change -- (Multiple Speakers). There is no real change in how we do anything. + +Answer_61: + + Are you talking about total loans -- ? + + + Are you talking about total and core, or are you talking about reported and -- ? + + + Yes. + + + Okay. + +Answer_62: + + Okay. So I am going to try to answer the question, and tell me if I don't I'm sorry. But if you look at our actual total loans for the whole Firm year-over-year, our gross reported was 0.6%, so just call it just shy of 1%. But underlying that core loan growth was about 4%. So I think that as we look forward, we expect core growth to continue at or stronger than those levels, and we have reached as you say in card the point where seasonality aside, that inflection point where we should expect net modest growth. +So and as I said, we are going to have to all wait and see how client demand plays out in the small business and Middle Market space. But we are hoping that at the second half of 2014, when the confidence in the economic recovery -- we have confidence but when others join us, that they will actually start to borrow and spend. + +Answer_63: + + Yes, that's our hope. + +Answer_64: + + Because we also are seeing -- we talked earlier about the fact we have been seeing and we expect to continue to see some spread compression in loans, that at this point in the near-term -- we didn't talk about the whole year for 2014 but in the near-term, we are expecting the improvement that we would see as a result of higher yields on investment securities et cetera to be offset by or largely offset by the compression in loan growth. + +Answer_65: + + The way to look at that is that, is what drives the Company is serving clients. And so, we don't target just to get rid of commitments or something like that. But obviously, we have asked all of the people in businesses who to start to optimize a little bit commitments, balance sheet, LCR, SLR, Basel III. And so, you probably see a little bit of a squeeze in commitments as they do that, but not at the expense of trying to do a good job for clients. + +Answer_66: + + The other thing I should point out is some of those commitments are much more capital or liquidity hogs than others. + + + So that is where you can see a little bit more of the squeeze. + +Answer_67: + + So I think if you look back and see that -- I mean, let's talk about this year and last year. If you look at 2013 reported, you would have seen that our commodities revenues counted for in the low teens of our markets revenues, but that's on an accounting basis. When you think about, so that's just a revenue pure only. +If you think about the economic revenue because obviously it's an accounting growth where it is much smaller number than that. So call it mid single digit, mid to 6%, 7%. But then it was a business that was in a combination of being built out so it wasn't fully mature. And also we are selling parts of the business that are highly capital intensive to us. So think about the impact of the bottom line as being considerably more modest and with some capital benefit. + +Answer_68: + + So I would -- a couple things. First of all, if you just take the second half versus first half, we said that we thought the overall market was down 30% to 40%. It was down about 33%. So it was in line with our expectations and our performance is in line with that too. So you have got to remember that the revenue versus closed loan volume, and how that gets recognized there is some timing differences. +With respect to market share, if you look backwards into 2013, the overall size of the market was revised up, which means that our market share was -- all else things being equal --just relatively revised down, doesn't change anything. But going forward, our market share will be a factor of obviously the size of the market, but also our pricing discipline to make sure we want to get an appropriate risk adjusted return. So we would gain share but only if we can do it, getting paid for the risk and the cost of servicing. + + + And the whole reduction was refi. + + + And the whole reductions was refi -- yes, I should say that, yes. (Multiple Speakers). + +Answer_69: + + So I would say that people in the business has slowly been extending the credit box, if you look at LTV -- I am talking about over the last 18 months, if you look at LTVs, if you go to different cities, I am not sure you are going to see a dramatic expansion of the credit box, because all of the rep and warranty and litigation and stuff like that, where anything that is not qualified mortgages. + + + Yes, and for qualified mortgages, credit is available, GSE is 90% LTV, on the Ginnie Mae side closer to 100% LTV, so there is credit availability. You just have to have the ability to pay. + + + And FHA will set its own policy. But even there I think you'll have a much tighter underwriting than the FHA guidelines, because of how much FHA's cost people. + +Answer_70: + + I think we know for the most part the contours of the regulation at this point, and some of the fine tuning still needs to be done. So you can see a lot of banks globally, adjusting to the new financial architecture, and the effect of that will be different, different parts of the world, slightly different for certain products, but it will probably be okay in total. But it's nice to, I mean -- + + + Have the rules. + + + Nice to have the rules and live with them, and now we have to push them down and understand them in a little more detail. + + + There is still a few things we are waiting for, I mean, long-term debt requirements, something to look out for in the first quarter, but I mean, having more clarity is definitely helpful. + + + You have seen some people make bigger strategic changes, some are making small tactical changes, and then we are going to report a lot more on what we think the effect of all of this in Investor Day. + +Answer_71: + + Again, I look a little bit different. I look like -- the pot will change and adjust to new world, but from there will probably grow. Because if you look at underlying numbers, the amount of investable assets around the world is going to double over 10 years, the amount of needs of corporations, i.e -- and sovereigns and super nationals, and ECM, DCM advice will double over 10 years, so there is a -- there will be a strong underlying business. Spreads, products, those things have always changed. Spreads have been coming down my whole life, and yet we have a healthy business -- and so we expect that fixed income after some adjustment will be a good business. We think a lot of these trends are cyclical, not secular and that's how we are positioned for it. + + + And we have paychecks. + + + And we have -- (Multiple Speakers). + + + And it is possible that -- if people leave and the things we price it will go back to -- all businesses have to have a normal return on capital for the average player otherwise they wouldn't exist. So we do think you will see some of that. There will be pieces that go to non-banks which is fine. + +Answer_72: + + Look, I think the reality is I don't know anymore than you do. I just that think given the changes that were made, it seemed to be positive and constructive as reason to believe that the US regulators would want to leverage that. I could be wrong, and I am not aware of -- obviously, we did comment letters on the US MPR, but I am not aware of any specifics on the portion. + + + So I would just add, if you listen to what regulators said, not this time, but going back they intended to make Basel and US rules common about the rules. They did not say they intended to have the same percent. So we are just assuming the 5% is going to stay. + + + Correct. + + + And we think there will be a couple other adjustments going forward too. + +Answer_73: + + So if you look at the total Firm consolidated, then they actually come out quite nicely. If you think about our target for [Tier 1] common at 10% to 10.5% and a leverage target of 5% to 5.5%. So I think the leverage ratio feels like as a consolidated matter, it is a simple backstop exactly as it is supposed to be and not a binding constraint. The devil is in the detail as you push that down, as I have said for the individual business and products. And then, obviously consider it in the context of the whole client relationship. I think as we look forward, CCAR is something to just be thoughtful about. Because it's a stressed scenario. It is evolving in terms of the maturity, as well as a move over time towards being on a Basel III advanced approach. So if I had to guess I would say CCAR could be. + +Answer_74: + + I would say -- so I would say that our Tier 1 capital needs to be at 11%-plus. We said we are going to run it at 10% to 10.5% above [Tier 1] common. I would suggest the gap will be prepped and maybe more. Maybe more prepped than that. + diff --git a/exam/original-files/Problem_2_3_Sample_QandA/5_questions.txt b/exam/original-files/Problem_2_3_Sample_QandA/5_questions.txt new file mode 100644 index 0000000..4c2b175 --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_QandA/5_questions.txt @@ -0,0 +1,299 @@ +Question_1: + + Good morning. + +Question_2: + + Just wanted to talk about the leverage ratio for a moment, you talked about a 10 basis point increase from the latest on Basel, if they do the add-ons. And I guess the big part that's hardest for us to see is really the impact of the CDS non-netting of mismatched maturities on protection bought versus protection sold. Can you give us a sense of what your numbers look like on that basis so we can try and reconcile to your 10 basis points? + +Question_3: + + Got it. And can you give just give us a sense for what the maturity profile looks like on your CDS protection purchased versus sold? I mean is there much of a maturity mismatch there or is there really not much? + +Question_4: + + Got it. That's helpful, thanks. On the $60 billion of core expense that you pointed out on balance having been pretty flat with last year despite the increases in control environment cost, can you give us a sense of how you currently see that evolving in 2014? + +Question_5: + + Got it. And how do you get comfortable that by doing that, you're not going to eat into revenue growth, by pardon the use of the word, but by starving other expenses? + +Question_6: + + And just if I could follow-up on the mortgage expense comment that you made, more just along the lines of the expense that's against the origination franchise. It sounded to me like you may be extending your view of what the time frame is to kind of get that to steady state beyond the first quarter, is that right or am I misreading that? + +Question_7: + + Fair enough. And the last one for me just you mentioned the impact of operating risk due to the very high level of litigation costs this year. How should we think about that and how are you thinking about that with respect to CCAR? + +Question_8: + + Hi, good morning. + +Question_9: + + Marianne, I just wanted to follow-up on a couple things. One was on NIM outlook. You did indicate that in the second half of 2014 you were expecting that the CIO and Treasury income would turn positive if I read it correctly, and I would think that it's a function of your security yields improving. Can you just give us a sense of what the net new investment yield is for the security investments that you're making in that book right now relative to what it's at? The balances are at? + +Question_10: + + Right. And so given your comments that you're expected to reach breakeven by the second half of 2014, that's a reflection of higher interest rates or a change in the way you're investing the funds? + +Question_11: + + Okay. And then your other point was you're going to be taking that better return on that portfolio and using it to be as competitive as you want to be on the loan portfolio, and so expectation is that loan spreads continue to pull-down over the next couple of quarters at least. Can you just give us a sense as to how willing you are to be competitive on price and loan spreads? Should we be expecting that overall NIM compression is what you're looking for here in the event that you get the quality of loan growth you want? + +Question_12: + + Okay. And on the consumer side, card balances have been rewritten post-crisis to be variable. Are you anticipating that you're going to be in a rising rate environment in the belly of the curve raising rates on card portfolio? + +Question_13: + + Okay. And then separate topic just on the security breach that you discussed and you indicated that the card replacements that you've done so far has been de minimis in terms of expense, but could you speak a little bit bigger picture to how you're thinking about fraud in the card space as well as in the debit space? + +Question_14: + + Right, and there's been this debate between tokenization versus chip and pin, and I'm just wondering do you guys have an angle as to which way you would prefer to see it go? + +Question_15: + + Okay. And then just last question, on the Visa, did I hear you correctly, Marianne that you basically realized one-third of the economic value in the Visa shares that you have, is that correct? + +Question_16: + + Okay, so two-thirds left and when you say economic you're talking about net of any hedging? + +Question_17: + + Hello. + +Question_18: + + First question on FICC in the IB. It's pretty stable, of course. As a matter of fact, if you look for the year it was about in line with last year which I think once everybody's done reporting will be a pretty good victory, so I guess the question is there's a bunch of structural headwinds blowing on the business and as you do your budgeting it's probably done already. Can the industry grow with the headwinds on it? In other words, the offset would be better activity levels, steeper curves, things like that, but there's a bunch of structural headwinds, I'm just curious how you think of that at the high level? + +Question_19: + + I see that in the numbers. Maybe on a related note, I got a sense with the renewed focus on SLR that there's a renewed attention to compression trades, and I'm just curious if that's ongoing and it could be material in 2014, as this goes on I know there's a lot of work involved, but the reward is pretty good too. + +Question_20: + + Okay last one for me. You've noted your 9.5% Basel III Tier 1 common, the 10% year-end target seems completely achievable given your earnings. I'm just curious how you think about balancing the absolute versus the relative, meaning you can get there on an absolute basis no problem. On a relative basis, some other large financial institutions have a little bit more. Just curious if that matters as you think about the capital planning process, or is it when you have enough it's enough? + +Question_21: + + Hi. One more quick follow-up on the net interest margin outlook, Marianne. The NIM expected to be flattish but I wasn't clear if in the current rate environment you expect it to continue to add investments as you have been doing, and would you expect the net interest income dollars to grow from here as they did slightly this quarter? + +Question_22: + + What about just taking advantage of the 10 year yields moving up and your overall sensitivity to higher rates? + +Question_23: + + Okay. And then in terms of the litigation reserves, you resolved a number of large issues in the fourth quarter, so two questions here. Can you help us think about how the litigation provision expense might trend in 2014, should we expect it to be lower than the $800 million? And then second, can you tell us if your range of possible loss has come down from the $6.8 billion that it stood at in October since you resolved a few big items? + +Question_24: + + Okay, thanks. And then last thing is you mentioned a little bit but can you just give us kind of the philosophy with which you approach this year's CCAR and how you're thinking about balancing your capital achievement goals on the ratios that you talked about with the goal of returning some capital to shareholders? + +Question_25: + + Good morning. Just a question on the announcement of the potential for selling the prepaid card business. I'm just curious as to what drove that given that it doesn't appear that it was a scale related decision given the size of that business relative to peers, but if you could just provide a little more color as to what you're seeing in that business and what caused you to potentially sell that business. + +Question_26: + + Right, okay. And then just moving on to your comments about being potentially cautiously optimistic about back-end growth for loans, I presume that's mostly focused on commercial lending. Is it still your view that the canary in the coal mine foreseeing that might be slower deposit growth or in fact negative deposit growth before you start to see loan growth? + +Question_27: + + Fair enough. And then just finally in terms of your outlook for card balances, it looks like just trying to take some of the fourth-quarter seasonality out of that business that they have sort of bottomed in terms of the overall balances. Are you equally optimistic for those balances to begin to grow in 2014 or are you still looking at sort of flattish balances through most of 2014? + +Question_28: + + And then just finally for me, are you seeing given some of the security breaches not only in your cards but across a couple of other issuers, have you seen any reduction in consumer spending potentially related to that via cards moving to other forms of purchases or is that? + +Question_29: + + No? Okay. + +Question_30: + + Good morning guys. Regarding expenses, can you remind us where we stand on the headcount reductions through I guess 2013 and then where you stand in terms of on track for 2014? + +Question_31: + + Got it, thank you. And then in terms of the retail branch banking discussion that you had mentioned that you're kind of comfortable with the 5,600 branches level that you're at now, and your focus on optimization going forward, does that imply that you could see additional headcount reductions or shrinkage of the branch network or square footage as we've seen from others? How should we think about that? + +Question_32: + + Got it, thank you. Then lastly just on credit quality. It feels like obviously still meaningful reserve releases, still largely in consumer. But is there much left to go in terms of cards or commercial, is that kind of inflecting if you will in terms of the degree of credit leverage that may still be there in terms of reserve release? How should we think about that? + +Question_33: + + Good morning. + +Question_34: + + Last quarter you had some tax benefits. Did you have tax benefits this quarter and can you quantify those? + +Question_35: + + And what was the loan utilization rate for wholesale or commercial loans? + +Question_36: + + So no change? + +Question_37: + + Okay, and you said the number of branches shouldn't change a whole lot. If I recall from Investor Day you had planned on opening a lot of new branches, I thought it was going to be a net increase, so is this a change in your expectations? + +Question_38: + + Gordon, if you look at that [bab] presentation, Gordon goes extensively through branches, branch size, technology, headcounts, and why. + +Question_39: + + Okay. And then the more general question is per your outlook you said that NII should be kind of flat, mortgage a little bit lower, and expenses only about flat or maybe lower from that $60 billion after you eat that extra $1 billion, so it makes a difference how optimistic you are. +If you are not optimist, you might want to cut expenses more, and if you are optimistic, maybe you assume that fees are going to grow a lot more because I know you want positive operating leverage so how do you see revenues growing faster than expenses? Is it the fees picking up, is it expenses going lower or how do you get there? + +Question_40: + + Can you just give us a general sense of your outlook for CIB? In the past you've given us a little bit more detailed future expectations. I mean how do you think 2014 is going to be for capital markets? What's your backlog like right now, and why do you lower VaR if you're more optimistic? + +Question_41: + + And then lastly, as it relates to Volcker, you said it should not hurt the results materially going ahead in the past, you said it might hurt $1 billion, and then another time you said it might even help. I know that was different Management at the head then, but now you don't think it should impact things too much? + +Question_42: + + And how much of that would be reflected already? + +Question_43: + + Good morning, just had two quick follow-up questions. The first is on the expectations for the expense base and CCB. If you take out that $400 million in legal expenses you're looking at a run rate of $6.9 billion. If you think about what the tailwinds could be for expenses for this year, is it fair to assume that that $6.9 billion quarterly run rate can improve throughout the year this year? + +Question_44: + + Okay. And the quick other follow-up is a follow-up to Guy's question on operational risk capital. You mentioned that there was a 50 basis point haircut due to litigation. Assuming that you're not going to have similar out sized litigation expense going forward, is that 50 basis point something that you can eventually recoup and how long would that take? + +Question_45: + + Good morning. + +Question_46: + + If we just add up kind of some of the odds and ends of the businesses that you are getting out of, or the niche products and impact of Volcker, is it still a relatively modest amount in aggregate? I think last quarter, you had said maybe a few hundred million of revenue give-up from the businesses that you are tweaking. And I just want to know if that still holds, and if we overlay Volcker, kind of what the all-in number might be? + +Question_47: + + Okay, and then just separately, as we think about potential legal uncertainly as a risk going forward, are there a couple that you kind of flag out there that are the ones we should be watching most closely for the industry, for you guys whether it's LIBOR or FX? Or feels like you have obviously settled a lot in the mortgage side, a couple other big ones that are specific to you, what should we be watching to make sure that we have a sense of what is going on? + +Question_48: + + And nothing new, if we knew coming out in the 10-K versus the third quarter Q? + +Question_49: + + Great, thanks. On that question about the operational risk capital, isn't it kind of double or triple counting against you when you have got like an $8 billion reserve which reduces your capital? And is it fair to say you don't get credit for that $8 billion in your capital base, when you think about that operational risk capital? + +Question_50: + + Got it. So in the short run the fact that you have settled them actually increases the operational risk, but you hope that over the longer term it will decrease it. + +Question_51: + + You had made a brief comment about the equities results about the comparable periods being higher. Were there any other reasons that equity raiding results were kind of down as much as they were? + +Question_52: + + Got it. And then any other areas, I mean, Gordon Smith has presented a few times and talked about kind of derisking some of his businesses. Any other areas that we should be looking at for sales? + +Question_53: + + Thank you. Good morning. You mentioned that your utilization rate in the commercial areas in the low 30% range presently, and you also pointed out that you are optimistic about the US economy for this year being stronger, and then the positive impact it will have on loan demand. What do you think the utilization rate could get to by year-end? + +Question_54: + + Good, and then on the commercial Real Estate, as you pointed out you are having real good success in this area. What geographic regions of the country are you seeing the best success, and then second, what product types are you finding are working the best in growing that book? + +Question_55: + + You also mentioned that you have about $350 billion on deposit at the Fed. If the Fed decides to eliminate the interest they pay on those deposits to all of the banks, will that change your strategy of keeping that amount up at the Fed? + +Question_56: + + Okay, I may have missed this, but in the card merchant and services auto business, the non-interest expenses for the fourth quarter jumped up to $2.2 billion from the prior quarters' $1.9 billion. They have been flat for the prior three quarters. Any particular reason why there was a jump like that? + +Question_57: + + It looks like in the quarter that you bought back about $300 million worth of stock in this quarter, and year-to-date or since the last CCAR, its just over $2.2 billion. If I recall you have an approval for $6 billion. Is it fair to assume you will use the next quarter to fill out the first -- the rest of the $6 billion or is that too optimistic? + +Question_58: + + You also gave us a little bit of guidance of what we should expect for this year's CCAR, maybe similar to what you did last year. Should we look at what you're approved for or what you executed in the repurchases is a better guide number since they are quite a bit different? + +Question_59: + + Thanks, good morning. I just have a few housekeeping questions left. I think you mentioned a mark-to-market gain in Asset Management revenues, wondering if you can just quantify that so we can straighten it out for our forecast? + +Question_60: + + Perfect. And then on the Investment Bank, on the comp to income ratio, it is clearly at the right end of your guidance. I am just wondering has there been any change in the deferred versus expense this year, and then I guess related do we enter 2014 with a similar amount of awarded not yet expensed? + +Question_61: + + Thanks very much. I just wanted to follow-up on the loan growth expectations. If we adjust for the typical seasonality associated with the credit card loans, which obviously is high in the fourth quarter, it looks like your core growth rate in loans was something like 60 or 70 basis points sequentially, which would obviously translate into roughly a 2.5% annual growth rate. + +Question_62: + + Yes. So it just seems that the 2.5% seems like a fairly robust figure, so I wanted to get your view about what the run rate of core loan growth might be? + +Question_63: + + Okay. So it sounds like continuing along this trajectory with potential strength in the back half of next year? + +Question_64: + + So I'm just trying to reconcile that back to the NII dollar expectations which seem fairly flat. But if we are -- if the loan growth continues fairly strong and the expectation is to continue to deploy capital into securities opportunistically, and the CIO portfolio is approaching breakeven, why is the expectation not for a stronger net interest income dollar growth? + +Question_65: + + Hi, thanks. Just two final follow-ups. Just on the commitment side, as you talked about adjusting the trade book and as we see the commitments continue to come down, how aggressively are you focusing on the commitment side from here, in terms of balancing the long-term growth potential versus the risk weightings and capital build? + +Question_66: + + Sure, okay. Great, and the one follow-up on just the run-off -- (Multiple Speakers). + +Question_67: + + And then one follow-up on the fixed income side, within that comments earlier about the run-off businesses. Is there a way you can update how we should think about the potential sale of physical commodities, and what proportion it is of the $15.5 billion of FIC revenues this year. And to Marianne, to your point about how that is in a relative profitable sense? + +Question_68: + + Yes, thank you very much. Most of my questions been answered, but I wanted to talk a little bit about your mortgage origination platform. It looks like you dropped from about $40 billion to $23 billion, and your overall market dropped like 25%, and that's like a 40% drop which drops probably your market share below 8%. +Can you add some color to that? Is that mainly a function of the refis going away? Should we see an increase in market share down the road? + +Question_69: + + And now that we have got -- I know you don't want to make any really comments about political figures. But now that we have got that Mel Watt coming to town, that is probably going to be more focused in extending the credit box that we have seen over the last couple of years, where most of the companies don't really want to get away from high FICO, high credit quality product. Do you --what type -- do you think that Watt can be successful in opening the credit curve, and what types of things would you want to hear where you would start extending that credit -- the credit box? + +Question_70: + + Yes, good morning. I have a couple of questions. The first one, maybe I suppose goes back to Sunday and the news that came out of [Bar]. I mean, I have the last 16 quarters we have been talking about regulation and you have often been quite aggressive in talking about the impact of some of that regulation. +But it seemed like we have reached the tipping point on Sunday, whereby we step back to most rules suggested in June, and came out with something that was sensible, but actually also was going to support the growth of your business, and indeed the growth of the economy. Do you think we are at a stage now where we can feel that we are over the worst of the regulation, and we can actually get on with running our and your businesses? + +Question_71: + + Okay, and the second question really relates down to the mix of your Investment Banking revenues. Clearly, what we have seen is obviously the downward on fixed income for some time now for a bunch of these, some of which you have touched on. But I suppose -- what a lot of people are talking about is the fixed income will no longer quite be the dominant parts of the revenue pool for big investment banks as it was. But in your case and one or two other big players, it's obviously very important business. Is your view, and perhaps don't just talk about yourself, but the really big players, the very successful players in fixed income, will actually probably be seeking to take share with what is going to be a smaller part going forward? + +Question_72: + + Hello, good morning. I had a couple questions regarding the Basel SLR. Specifically I wanted to clarify a comment where you made earlier where it sounds as though you expect the US regulators to adopt the revised Basel framework from over the weekend as a final SLR calculation approach. And I didn't know if that guidance was in the context of the higher 5% SLR requirement, which is being imposed on the US G-SIBS. + +Question_73: + + Okay, no, that's helpful. And then just looking at both the risk base and leverage based ratios, it sounds as though for the SLR, there are a lot of mitigation opportunities at your disposal. On a pro forma basis, which ratio do you anticipate will represent the binding constrain on capital return going forward? + +Question_74: + + Okay, thank you. And then transitioning to a risk-based ratio that is maybe I guess not spoken about as often, the Tier 1 capital ratio, that ultimately could compel increased preferred issuance. We did see capital market within the first six months of the year, and I didn't know how we should be thinking about the level of preferred issuance you are targeting going forward. Is it consisting with the 150 basis points noted within the Fed's proposal, or should we be thinking about that differently, i.e. some of the mandated buffer will be met with incremental equity? + diff --git a/exam/original-files/Problem_2_3_Sample_QandA/60_answers.txt b/exam/original-files/Problem_2_3_Sample_QandA/60_answers.txt new file mode 100644 index 0000000..602e3c5 --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_QandA/60_answers.txt @@ -0,0 +1,83 @@ +Answer_1: + + David, I think sitting here today, we feel very confident that we're making very good progress against the plans that we set out earlier this year. If I think about the state of our business today, we're seeing a great response to the 8 new brands that we've launched as we've remodeled now over 100 stores, which we continue to see the list that we're projecting of 2% to 4%. We've seen a tremendous response to our new small formats that we've been opening up in new neighborhoods and on college campuses. And as you know, we opened up a number of new stores in this last quarter. And whether it was the results we've seen in Herald Square or all the way out in Hawaii, the guests have responded very, very well. We continue to see very strong performance from a digital standpoint, outpacing industry by a 2x factor. And during the quarter again, we saw very strong digital growth. And that's been underpinned by the progress we've made from a digital fulfillment standpoint and some of the things that John talked about during his prepared remarks. So sitting here today, I think we're making great progress, and I think we'll continue to see that progress extend into the fourth quarter. So we entered the quarter with a lot of confidence. We know there's a lot of business that has to be done, and we're off to a very good start led by the reaction into Hearth and Hand as well as some of the other initiatives that are in place. So I think we're taking the right approach, but we entered the quarter with a lot of confidence and making a lot of progress against literally every initiative that we set forth earlier this year. + +Answer_2: + + David, we don't expect to see any deterioration in the progress that we've been making throughout the year. So again, I think we entered the fourth quarter highly confident and in a very strong position with our stores performing incredibly well, great merchandise, a terrific marketing campaign, great digital capabilities and an expanded suite of digital fulfillment capabilities. So we feel very good about how the entire business is set to perform in the fourth quarter. + +Answer_3: + + Peter, I think Mark and his team have made tremendous progress over the course of the year. And as we've talked about a number of times now, we're seeing a significant shift of our business towards everyday regular price, which is really important over the long term. So we're going to continue to make sure that we're committed to offering great value, that we're priced right daily, and during the fourth quarter, we'll provide exciting promotions to support those items that we know our guests are going to be interested in shopping for at Target. So it's an ongoing commitment. We want to make sure we deliver great value across the season. And we're going to make sure that we couple that with exciting promotions in the fourth quarter. + +Answer_4: + + Well, I think, clearly, as we do more fulfillment out of the store, we will add labor to support that. I think we've said since February, we're going to invest in the labor in our stores, invest in training, invest in having experts in the store, invest in having people on the sales floor and changing the operating model for those stores. So that's an important part of what we're doing. Almost separately and independently, we're building teams that -- so that we don't take hours away from everything else we're doing that are handling the fulfillment in the back room. So it's really a question of the operating model in the store that's evolving. And we feel really good about utilizing the stores, they're the closest, fastest and cheapest way to get merchandise to our guests. They have significant capabilities now. We're doing same-day, next-day, 2-day pick up, Drive Up, all kinds of ways to meet the guests' needs, and I think that's the important factor, all centered around using the store as the hub. And we think it's a highly efficient way to use our assets, and we have great teams that can meet the capabilities that we need for our guests. + +Answer_5: + + Ed, again, as we entered this season, I think we're in much a stronger position. John underscored the fact that we've got an expanded array of digital fulfillment capabilities. Mark's talked about the progress we've made from both a brand standpoint but also a value standpoint. I think we continue to enhance our digital capabilities. So I think we entered this season in a much stronger position. And I think what's really important to recognize is the investments we've made in our team and our stores puts us in a very strong position as we enter the fourth quarter. So I feel great about the investments we've made in wages, in hours, in seasonal hiring. And I think our stores are going to drive both our digital business and our store business throughout the fourth quarter. So I think we entered the season in a very different position versus last year. And I think that's reflected in the start that we've seen to the season and the approach we're taking throughout the fourth quarter. + +Answer_6: + + Well, Ed, we're hopeful that you'll join us in March for next year's Financial Community Day. Obviously, we're not going to provide 2018 guidance today. But I'll give you a preview. You're going to hear us talk about many of the same things we've been talking about this year: our commitment to the store experience and continuing to remodel stores across the country, our commitment to opening up new small formats in new neighborhoods and on college campuses, our continued commitment to digital, our commitment to enhancing our fulfillment capabilities, our continued commitment to new brands and building our proprietary fleet of brands and an ongoing commitment to value. And all of that will be underscored by our commitment to our team. So we'll go through that in much more detail in March. But as a preview, we're going to be talking about the exact same suite of initiatives next year that we've been talking about this year. We feel great about the progress. Our strategy is working. Each one of those initiatives is on track or ahead of schedule, and we expect to accelerate those initiatives in 2018. + +Answer_7: + + Sure, Chris. Why don't we let Mark walk you through how we're approaching our investments in Essentials? + + + Chris, yes, let me share with you. So we've been sharing this year that we took a journey in terms of ensuring we're priced right daily and that we were able to create and communicate to our guests the right value. And that started in April of this year and we completed that through the end of the third quarter. What we've seen with that is we had an expectation that's not an immediate just that (inaudible) response we need to build ongoing, deeper trust with the guests and get them to connect with that priced right daily ethos, and we've seen a really fast reaction, a positive reaction to that. So we're creating in trips and traffic within our adjustment on -- to be priced right daily. And as a result, we've seen an increase in our unit velocity. We fully expected and baked in some of the short-term sales deflation that we would see as a result. But we're starting to see that equal out, and we expect that stability to continue through the fourth quarter into 2018. + +Answer_8: + + Chris, I think that's exactly what we're saying, continued investment across multiple categories. And as Mark talked about, the first thing we see is an increase in units, an increase in trips and ultimately that's going to drive positive comps over time. So I think the efforts are paying off relatively quickly, and we feel really good about the guest response. + +Answer_9: + + I'll start with the in-stock question. I think, Bob, we talked about in-stocks last year in February. It's a journey for us, we know. I think we've made a lot of progress in in-stocks given our current capabilities. But we also said, in order to really solve the problem, we need to fix some fundamental capabilities in our supply chain around speed, reliability, inventory placement. And that's where we're on the journey. So the inventory increase at the end of Q3, as Mark said, more related to us being sure we're ready for the fourth quarter in categories like Electronics, Hearth and Hand, where we took positions, intentional inventory positions to increase inventories in advance of the fourth quarter. Less to do with our management of day-to-day in-stocks/out-of-stocks. We continue to work on those. And as I said, there is the short term, working within our current capabilities and in the longer term solve that comes as we continue to improve our overall supply chain capabilities. Your second question, I'm not entirely clear, Bob, on where your -- maybe you could clarify how -- your question, the store labor related to fulfillment, I'm not -- I didn't quite understand it. + +Answer_10: + + Yes, I wouldn't compare it to third quarter. Compared to last year, we are doing more fulfillment in-store. As we said, we think that's the most cost-effective way given the total P&L. So shipping plus store labor, we think that's the most cost-effective way to do it. Compared to last year, we saw significant spikes last year near the end of the quarter, approaching 80% fulfillment. And I would say, when you get into that 80% range, what really goes up is store pickup, and we'll take that model all day long, highly efficient for us, highly profitable from a digital perspective. So when our mix gets that high in store, we actually like the economics a lot. + +Answer_11: + + Matt, this is Cathy. I think I would look at it the way we -- we have all year been approaching it, which is, we're trying to be prudent as we plan into the fourth quarter. We're excited about what we've seen so far, but it's early in a very important quarter. The pressure that we are anticipating is around digital fulfillment as well as all the work we continue to do around value, and we're offsetting that with cost savings continuing into the fourth quarter. So I would look at it as just doing what we said we would do all year long, which is be prudent, plan appropriately and make sure that we set the business up for success. + + + Matt, I'd only build on a couple of comments that Cathy made. One, we feel very good about the performance of our own brands and from a gross margin standpoint, both short term and long term, that's going to be very beneficial to our mix. Two, we are clearly investing in digital and digital capabilities and expect that we're going to continue to see strong digital growth in the fourth quarter. So it is the mix of our business that really makes sure that our gross margin returns stay on track. But the work that Mark and his team have done with our own brands and the results that we're seeing across our 8 new brands is very beneficial, both short term and long term, to our gross margin rate performance. + +Answer_12: + + We are really excited about some of the capabilities we're adding to REDcard coming into this fourth quarter. I have to tell you, I'm one of the early users for our wallet application and it is phenomenally fast and convenient and a great experience for the guests. So as we continue to ramp up some exclusives around REDcard, our guests are responding. We're seeing additional capabilities come into REDcard holders, our best guest, into the fourth quarter. So I would expect that we'll see that trend continue to be favorable. + + + Yes, Matt, I think we also recognize that as a by-product of the investments we have been making in our stores, our plans moving into new neighborhoods, we're bringing in new guests to Target. So over time, we certainly want to convert them to REDcard holders. But I think what we're seeing is, as we move into new catchments, these are new guests that are shopping at Target. Over time, they'll start adopting our REDcard. I think our new brands are bringing new guests into our stores, and I think the focus that we placed around value is also attracting a new shopper. So over time that provides us tremendous opportunities to continue to build REDcard penetration. And one of the metrics that we haven't talked about on the call is the fact that traffic was up 1.4% as existing guests are shopping more often, but it also is new guests coming to our stores and our site. So over time, those are potential new prospects for REDcard. And we certainly expect to see that conversion as we go into 2018. + +Answer_13: + + Robbie, why don't we let John start by talking about that pickup shopper and then we'll come back to our guidance for the quarter. + + + I might start up with the Drive Up shopper there. I think our guest survey scores there, NPS scores are, frankly, off the charts. We see a high utility. It's mom with 2 kids in the back, right? A core Target shopper who just doesn't -- it's raining outside and doesn't want to get out of the car. So we've seen very, very high scores there. The baskets are mixed as you'd imagine, right? Sometimes they're larger, sometimes it's only one thing. And the same is very true for pickup in store, driven by -- it can be driven by promotional cadence, it can be driven by convenience. There's lots of different reasons people choose that option and so the basket varies. There's nothing really to glean from that other than for both of them, we see very high NPS scores for our guests, which is the most important thing from our perspective. + + + Robbie, why don't I clear up the question around guidance for the quarter and, really, I'll focus on the full year. I think our fourth quarter guidance is a reflection of the performance we've been delivering throughout the year. And I'll go back and note as Cathy discussed, our full year guidance is up $0.50. I'll do the math for it. That's $500 million of improvement versus our original guidance. So we certainly approach the fourth quarter with a level of balance and conservatism, but feel good about the momentum we have. And we think the performance we've been delivering throughout the year will be reflected in our fourth quarter. So we feel confident, we're making good progress, there's a lot of business still to be done in the fourth quarter. And I think our range of comp of flat to 2 and the approach we're taking from an EPS standpoint just reflects the approach we've been taking throughout the year. + +Answer_14: + + Yes, I'll let John talk about the profitability component. But Kate, I think one of the great things about our strategy is the important role our stores play. And as we think about Drive Up, we think about same day, those are going to be enabled by the 1,800 stores that are in neighborhoods around the country. So we should be able to continue to expand that over time and meet the needs of our guests no matter where they live and which store they shop in. + + + And on your question about profitability, clearly the closer we are to the store, the better we like it. When a guest comes in and picks it off the shelf, great. Only slightly disadvantaged to that would be pickup or Drive Up because there is one more touch. But really, again, economically, a great, great solution for us. As we get into shipping, same-day delivery is more expensive, there's no question about that. And at least today, our guest research leads us to believe, guests understand that. They want it priced right, they want the convenience and they understand there may be a charge to get it to them at the time they want it during that day, and we've seen that in the 4 stores in New York, no push back at all on the delivery charge. And the great thing is, we see the baskets, as I said, 6x to 9x larger. So that ends up being a highly, highly profitable transaction for us. And so there are markets where that will work, that type of transaction will work really well. There are other markets were, as you said, there will be standard 2-day shipping. And there, we're working hard to reduce costs throughout that shipping while improving the speed. So that's on our team so that the guest gets the great service and we make that a great economic transaction for Target as well. But we feel good about our ability to make it work. + + + So with that, operator, that concludes our third quarter 2017 earnings conference call. I want to thank everybody for participating and wish everyone a happy holiday season. So thank you. + + + + + + + diff --git a/exam/original-files/Problem_2_3_Sample_QandA/60_questions.txt b/exam/original-files/Problem_2_3_Sample_QandA/60_questions.txt new file mode 100644 index 0000000..f404a4e --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_QandA/60_questions.txt @@ -0,0 +1,56 @@ +Question_1: + + You mentioned several times throughout the call and, frankly, throughout the year that you're trying to take a conservative approach to planning, but you also mentioned -- and you also mentioned the strength and the confidence you have as this quarter that you just reported in the prior quarter happened in the traffic and the merchandising. Can you, sort of, square that circle for us because this is -- shares are obviously reacting to guidance this morning. So help us frame conservatism versus confidence. + +Question_2: + + Just a sort of follow-up to that, is there any -- what would be -- do you expect to backslide against any traction in key variables, comp, gross profit dollar comp? Help us understand that with this confidence in the guide. + +Question_3: + + Just on price perception, the work you've been doing, I mean, it sounds like you're pleased with where you've gotten that now at the end of the third quarter. Just -- I mean, do you think that, that's an ongoing process that you're going to have to do? How are you -- you mentioned some of the measurements you're using on that, but just trying to understand, is that something you let ride here for the fourth quarter and then reassess where you are next year? Or do you feel like you've gotten yourself to a spot where there's going to be no further adjustments required? + +Question_4: + + Okay. And then one maybe follow-up for John. You talked about a lot of the fulfillment options that you guys are working on. Help us through -- how does that impact the store labor model as you see kind of going forward? And within that, the $15 minimum wage plan. I understand it's not a fourth quarter question, it's more just as you lookout the next few years. How do you see that -- those having an impact on the labor? + +Question_5: + + Yes. So I guess, my first question really is around the fourth quarter and the comparisons that you're facing last year. So in-store comps were particularly soft, the gross margin was down a lot, there were issues around digital fulfillment. I guess -- you talk about the underlying momentum of the business not stalling at all, but can you talk about how you expect to cycle those issues from last year? + +Question_6: + + Okay. And second question for you. I just want to -- I know you don't want to give guidance for next year, but I was hoping that maybe you could talk about the puts and the takes in terms of what we should be thinking about, areas that you could see outsized investment, D&A is going to be headwind next year, wages clearly seem like they'll be a headwind. Your thoughts on price investments from here, the Street's sort of looking for a modest decline in earnings, seems like something like that -- larger than that's possible. It's just -- I don't know how much at this point, Brian, you can help with that, but I think it is an area that we're all sort of wrestling with. + +Question_7: + + Two questions. So first, can you talk about how is the Essentials category? It was down slightly. You mentioned more share being taken on the unit side. Can you talk about unit growth in Essentials and how that's progressed over the past couple of quarters as you've put more muscle behind the price investments? + +Question_8: + + So I think in the second quarter, I think Essentials was up slightly. So did it -- was it essentially that the price investment accelerated and the unit velocity maintained? Or maintained its positive trajectory or did it accelerate? + +Question_9: + + I have two questions. The first one is on in-stocks or out-of-stocks. You look at the inventory levels that Cathy talked about, are you seeing the in-stock levels where you'd like them at this point? And then the second question that I have is around fulfillment costs. When you look at -- I think you said -- I think John said stores are fulfilling more than 50% of digital, take it to 80%. When you think about the fourth quarter and the costs around that increased fulfillment of digital by the stores, is it a one-for-one basis in terms of the level of increases there? + +Question_10: + + Sorry. Just from the perspective of the expense levels, like the pressure that you saw in the third quarter versus the expectation of the pressure, fulfilling more than 80% in the stores on the expense lines specifically. + +Question_11: + + I've got 2 questions, and my first relates to gross margin. Just to revisit, the fact that you do have this very depressed compare from a year ago, and you're actually entering Q4 with pretty good gross margin momentum, down only very nominally in Q3 as some of your new brands are really starting to get traction. So is your thinking on the expectation of a decline in gross margin simply a factor of more business being done online each year and the cost of fulfillment associated with that? Or are some of the new fulfillment options that you're introducing just somewhat more costly and you're giving yourself room to absorb that pressure? + +Question_12: + + That's super helpful. The quick follow-up relates to REDcard penetration. So we noted that the year-on-year penetration seems to have stabilized this quarter after having shown some increases for a period of time. Anything to glean from the stabilization of that trend? + +Question_13: + + Just two quick questions. Just on the fourth quarter, the sort of the breadth of the range there, can you just give us the scenarios like, sort of, what brings you to the low end of the fourth quarter range, the $1.05 versus the $1.25? And the other question I had was just -- I was wondering if you would share some of the early results on the pickup customer versus the Drive Up customer? Which is better? Whose basket is bigger? How much bigger is the basket versus the store shopper or just plain online shopper that get shipped to home? Anything you can share about the metrics and what you're excited about there? + +Question_14: + + My question was around fulfillment as well and a little bit longer term in nature. I had wondered with regards to the Drive Up and the same-day delivery, if there are any early indications of what the limitations might be in terms of where you can introduce that and then also with regards to the profitability of how those 2 fulfillment options relate to the ship-from-store? + diff --git a/exam/original-files/Problem_2_3_Sample_QandA/6_answers.txt b/exam/original-files/Problem_2_3_Sample_QandA/6_answers.txt new file mode 100644 index 0000000..3962933 --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_QandA/6_answers.txt @@ -0,0 +1,327 @@ +Answer_1: + + Hi, Glenn. + +Answer_2: + + So hey, Glenn. Just so that I can give you the underlying core growth number, for the Firm for the quarter was 4% year on year, even though obviously if you take into consideration the run-off portfolios in Mortgage and Card we were closer to flat. +In C&I, you're right. The industry was up slightly. We were not. It's a continuation of the things we've talked about, which is a combination of client selection, of being very disciplined on credit, so not chasing growth at the cost of liberal credit structures or overly aggressive pricing, and also the fact that we continued to see some of our criticized and classified loans be refinanced away from us. +So we're just going to hold the line on discipline. We are seeing the ongoing aggressive competitive environment on both credit terms and pricing, and we'll do every rational and sensible deal we can do, but we're not going to chase growth at the expense of discipline. + +Answer_3: + + Yes, so a higher quality portfolio, higher quality clients. + +Answer_4: + + So I think very broadly if you look at the numbers here we've pushed down our capital, leverage, SLR to all of the businesses so they're all making adjustments as appropriate. In the rates business in particular, you're seeing that there's very few what I call exotic rates products being done anymore, so that will be a rather large change. A lot of things going electronic, which can reduce your expenses too, so we're pretty comfortable our rates business will be normal profitability going forward. It may take a little bit of time. + + + Glenn, I just want to make sure that it was clear in my remarks that the impact of the new proposal for leverage is included in the reported results. + +Answer_5: + + A little bit, yes. But we all don't know what's going to happen to spreads going forward, so we're comfortable, we want to stay in the business, do a good job at it for our clients. + +Answer_6: + + So with LCR, whether you take the Basel or the US proposals, we're compliant at this point with the margin, and importantly we're also compliant with our own internal stress framework. So we feel good about LCR, we're continuing to manage it as you would expect. +Yes, I am expecting us to get long-term debt rules this year, but I don't know when and I can't control it; we feel with over 19% available resources that we're in a good starting position, and so we're not really going to be in the business of guessing where that ends up. And we'll adjust accordingly if it's different from our expectations. + + + Thank you. + +Answer_7: + + So given that we did some restructuring of Bank level capital including some downstreaming, that was a fairly sizeable increase in the quarter, so you're not going to see progress be linear, but there are a number of different levers that we have in our toolkit so to speak to get to 6% over time, whether that's this year or whether that's into next year, we're going to be measured about the progress. So whether that's retaining earnings, potentially additional capital, we've been actioning leverage actions, both deposits as well as derivatives actions. +And then ultimately there's also the [good guide] when it comes, timing dependent that may be a 2015 thing of hopefully moving from CEM to the newly named FACCR calculations for derivatives central future exposure. We did take a look at the information on FACCR and it hasn't changed our point of view that we would expect that to have a favorable impact for the Bank of 40 basis points plus or minus. So when that comes that will be a nice boost, but through retaining earnings and the leverage actions we have and potentially more capital optimization, we have a clear path to 6%, whether it's this year or early into 2015. + +Answer_8: + + Yes, I would say it's fair to assume that our core margin should be relatively stable throughout the year, and I think plus or minus 2 basis points on a large balance sheet like ours with mix changes is relatively stable. So our expectation is for core NIM to be relatively stable in 2014, to be stable to slightly positive in 2015, assuming that the implied rate curve plays out the way it is. + +Answer_9: + + So it's a combination of factors and we are seeing delinquency trends and roll rate charge-offs flatten out. We knew that it would happen one day. That's what we're seeing at the moment. We'll continue to update you through the course of the year; based upon that we're not expecting anymore results. In addition, you should know that -- you saw our outstandings were flat, and underneath that our core portfolio is growing; we still do believe we are at that inflection point and that we should see some growth, but it will be relatively modest. + + + Thank you, Erika. + +Answer_10: + + Good morning. + +Answer_11: + + So you're talking about interchange fees in Card? + +Answer_12: + + Yes, so the sales volume obviously seasonally goes down quarter over quarter. I don't think that we have perceived there's been a significant impact from weather on Card sales in the first quarter; for us our sales were up 10% year on year, so pretty strong. No, I wouldn't attribute anything to the weather. + +Answer_13: + + Yes, so you saw -- obviously you saw in the first quarter that on the back of lower revenues in the markets business, we have lower compensation as an absolute matter albeit that the ratio is relatively in line. +So you're absolutely right depending upon how the rest of the year pans out will determine whether the compensation expenses inherent in our outlook for CIB are up or down or flat, and that will adjust our ending result. We're not ready yet to declare our position on the whole year, so less than $59 billion is still our guidance but we intend to be very, very disciplined. + +Answer_14: + + Yes, so on the timing, I mentioned the fact that we aren't expecting our capital accretion to 10% plus to be linear, we're expecting it to be much more in the second half of the year, flatter in the first half, so it's reasonable to expect that we will be covering employee issuance plus or minus in the first half of the year with most of our repurchase capacity being available for us in the second half. +As to how much of it we'll use will be dependent on a number of factors including obviously our share price at the time. But we do intend to take advantage of the opportunity that we have been given to buy back, and we'll see what the absolute level is when we get there. + +Answer_15: + + That's absolutely right, so when we declared at Investor Day that we had increased the target rate for that business, we pushed that down into the valuation of the asset one-time. + +Answer_16: + + So it's three things. There's a little bit of timing in there insofar as we did make continued improvement in expenses and we're going to continue to work on what we would characterize as the sort of fixed cost base. It's definitely the case that we are building this business for the long run, and so we continue to invest in technology and operations to make us more profitable and efficient through the cycle. But it is also the case that it is an incredibly small market. I mean, the market size was sub $250 billion, so annualized sub $1 trillion, which is not something we've seen since before 2000. +So the reality is in a market that size, it's very hard to have strong profitability or profitability when you have to have a core level of fixed expenses, and so we're thinking about this business over the longer run to be as efficient and profitable as possible through the cycle in markets that are on average bigger than this. + +Answer_17: + + So yes, I would say lower issuance was a factor but there were very many, so I wouldn't say that it was a single driving factor, lower mortgage issuance, lower debt issuance, a whole bunch of different things. And then as to catalysts, more volatility, more growth, and we'll just have to wait and see. + +Answer_18: + + I think John we've always been very consistent on this kind of thing. You guys have got to make your own estimates because they are just as good as ours. Great business with great people, technology, sales, research, but we can't predict it going forward. It will be what it is. + + + Similar to the mortgage comment where it's a long-term view, it affects the business and this is one quarter. + +Answer_19: + + Yes, we've accounted for it held for sale and no significant impacts to the results. + +Answer_20: + + So we obviously looked at the bid and the valuation and any of the difference versus book is in our P&L and it's insignificant, and we are engaged in ongoing relationship with the buyer, and we'll realize [that over] time. But it's not expected to be anything significant. + +Answer_21: + + Yes, correct. + +Answer_22: + + No, it's fully phased in, it's our best effort of fully phased in, Betsy. + +Answer_23: + + Correct, but remember that with the exception of the fact that we aren't baking in things that are not yet certain, so we haven't baked in the benefit that we would expect, for example, from FACCR, because it hasn't yet been acknowledged. + +Answer_24: + + The sensitivity is different at the Bank and the Holding Company, so it's more like 30 plus or minus at the Holding Company, 40 plus or minus at the Bank. + +Answer_25: + + With respect to the headcount reduction in the first quarter, the severance wasn't significant and the benefit is largely in. Remember we said that overall the Firm is expecting to see headcount go down by about 5,000 for the full year and it's down only by 2,000, so far so we have another way to go. + +Answer_26: + + Well so if you think about it gross, mortgage was 6,000 of the total gross and it's 3,000 in, so another 3,000 to go I would say in the nearer not longer term. And in the Consumer Bank that was 2,000, with 1,500 in, the remainder will just happen through time. + +Answer_27: + + Hi. + +Answer_28: + + Yes, I'll give you the sort of very short qualitative answer, and then if you want to really dig in, I'd do it off line with Investor Relations. But the very short answer is there's an additional ability to recognize collateral and [netting], that wasn't in the original CEM calculation, there's lots and lots of other complexity to it. We are doing our best to estimate it. We haven't fully built the models to do it, so we're continuing to work on that, but if you want to get into a very technical discussion on it we can arrange that for you. + +Answer_29: + + Okay, so a couple of things. First is that if you remember from Investor Day, notwithstanding the earlier comment about the volatility potentially in compensation in the Markets businesses, we said we would be below $59 billion, and there were four principal things driving that. So in our favor we have efficiencies in branches, efficiencies in CIB, and mainly mortgage down about $1.5 billion year over year. And against us we had the $1 billion incremental cost of control and some growth principally in asset management, so the net of all of those meant that we were effectively self-funding through efficiency and reduced mortgage expenses, the incremental cost and controls that you're seeing come through. +It isn't the case that we have broken out as a macro matter how much of that $1 billion is in our run rate now, and maybe we'll do that for you next quarter. I would say that we are adding heads and so these things do take some time; even though I believe that there will be a chunk of it in our run rate through the middle of the year, it's not all in our run rate yet. + +Answer_30: + + Well I'll have to confirm to you next quarter, but I would say that we would have a majority of it in through the midyear because we are obviously trying to hire up to be able to execute on the agenda. So if you think about the impact we're trying to add people to compliance, we are adding people to compliance, to legal, to audit, to finance, to risk, and we're doing that largely in the first half of the year, but there will be a tail. + +Answer_31: + + Yes, so I mean, it's very -- as you know it's very, very difficult to decouple everything but and so it's not clear that there's no impact, but it's not our sense that it was a significant driver of the performance in the quarter, and there is a limited amount of volume on SEF right now, albeit increasing, and there's been margin compression, but from tight margins to start with. So it's not our sense that it was a significant driver, not to say that there was no impact. + + + So it did come down a little bit but it's kind of back to where it was, the derivative trading, and we wouldn't blame that for anything. + +Answer_32: + + That's right. So I mean again, not to say there hasn't been any but the volumes are relatively low, the margins are relatively tight, the $1 billion we talked about which is by the way our best estimate, so it could be better than that, is something that would progress through time, it's not going to be a cliff. + +Answer_33: + + Thank you. + +Answer_34: + + So the best guidance that I could give you is the guidance that we gave at Investor Day, which is expect the Firm-wide charge-offs to be at around $5 billion plus or minus, and then I would point you to the guidance we just gave you on reserve releases, which is expect some more in mortgage but modest, expect we might have some in PCI but it's too early to know, and that little more in Card, so net those two down. + + + And there may be some noise to that, but that's our current best outlook. + +Answer_35: + + Yes, largely speaking. That seems about right, 10%, yes. + +Answer_36: + + So our production revenues this quarter, just to make sure we're talking about the same thing, was just about $300 million. I told you that we're expecting the second quarter to be negative, you're going to have higher revenues because seasonally you have higher volumes, but obviously it's market dependent. +So I would say given seasonality, the first quarter was small and volumes were depressed given the weather, we would be hopeful that the market would be above $1 trillion for the full year, maybe not quite as high as $1.2 trillion, so if you add seasonality back in and gross up the number, you could probably get quite close. But of course it could all change depending upon rates in the market. + + + The current outlook for the market size was about $1.2 trillion. I suspect that will be revised down slightly on the back of the first quarter, so we're going to have a small market. It won't be absolutely linear. + +Answer_37: + + Year-over-year revenues for asset management, institutional, no specific. We had some -- March was not strong, the first quarter for institutional was not as strong as the other segments, so no specific issues but there's some lumpiness there obviously. + +Answer_38: + + Yes, the securities, that line item is a funky feature of the fact that in our prime services business, when we -- our contractual income is LIBOR minus the spread which drives that to be a negative number; I wouldn't read too much into the trend and volatility there. The absolute economics of the business is still positive and the offset is in trading liability, so that's not a line item in its own right and alone that is very constructive. + +Answer_39: + + Reserve releases. + +Answer_40: + + And then we don't drill into every $50 million negative non-recurring item but there was some of them too. + +Answer_41: + + No, it's not far off the 30% plus or minus, which is our generally expected effective tax rate. Nothing else of any noteworthiness. I mean obviously it's always going to be impacted by the absolute level of pretax, the percentage of overseas income, the percentage of tax efficient income, but nothing special. + +Answer_42: + + We haven't really changed our guidance, to be fair our guidance was always to be negative for the year. We're just trying to be very specific about the degree of negative in the second quarter to make sure you have information for your models. + + + Thank you. + +Answer_43: + + So obviously the timing of sales is going to be a little bit opportunistic, so the best comment I can make is that $600 million number is two, three years away from now, not necessarily but we'll try and manage it the best way we can. +And then with respect to the ability to sell sub service, there is still the opportunity to do it. It's just not necessarily the case that you can defease your risk entirely, which I think is understood. + +Answer_44: + + Well I mean, insofar as I think that as we move loans to sub services, obviously we retain the risks and have to have third-party oversight. To the degree we sell them, I think the regulators are potentially looking at originators to continue to bear some of the origination and other risks. + + + We're going to run the MSR for returns and quality, so it's also a question of what you put into it so you should probably expect to see less FHA and things like that, and then you'll see some run-off over time. + +Answer_45: + + It's almost impossible to tell, but there are -- if you're jumbo you can get loans, if you are GSE you can get loans, but almost all the other stuff in between, anything with any hair on it like if you ever had a credit problem, if you are earning self-reported income, so a lot of people have overlay, they're being tougher than is required by FHA, GSE, or their own rules because of reps and warranties, et cetera. +And I don't know when that's going to go away. It's not getting worse. It's just sitting there and probably holding back a little bit the purchase market. + + + Think about the credit is available across the LTV spectrum, but the bar to be able to document income and prove ability to repay under QM is high. + +Answer_46: + + Good morning. + +Answer_47: + + So the models that were disapproved we understood that we were going to have certain of our models that needed additional work to be acceptable by the regulators of Basel III when we gave the guidance at Investor Day, so as a large matter as we sit here today, that's still our best understanding of how things will work out absent there being any new news or issues during the year. + + + It's a timing difference as opposed to a target difference. + + + Yes, the whole industry submitted a huge number of models under Basel 2.5 to the regulators to review at the beginning of 2013. We had an approval to use them for the year while they were being reviewed and pending after the review; we got some feedback and we're going to remediate the models and resubmit them for approval. So it will take us time but it is timing. + +Answer_48: + + Just assume it's going to be fairly constant. + + + When we know what the real rules are we may modify that. + + + That's right. We're not managing to an OLA that we don't know yet. + +Answer_49: + + Well we told you we are firmly supportive of having proper and good markets for everybody, and we think we have pretty good policies and protocols in place. But I don't know what it will do to other -- there are issues in market structures with some pools et cetera, but we just have to let that review take place. I should point out in Michael Lewis' book which I did not read on page 231, they refer to us as one of the good guys. + + + Thank you. + +Answer_50: + + So a couple of things. As you know, we have been investing and building our branch to the place it is now where we're happy with the distribution capability we have, so that was driving a lot of the investment. In 2014 we continue to invest in [quarterly] and digital and the cost to serve and efficiency so that we can drive the ratios down. +We guided at Investor Day to expect expenses in the business to be up 1%, so a little but not the kind of increase that we've been seeing after which you should expect it to start to come down. And we said that the overall CCB business including mortgage would be down $2 billion by 2016 over 2014, and a chunk of that is in CBD. +So we are very focused on it and investing in fact in the technology and processes to be able to be efficient; we started to see the increased turn as we stopped having to invest in branches because we're happy with the distribution and it will start to come down next year. + +Answer_51: + + So everything that I talked about in terms of expenses going down is all on a dollar basis, not an efficiency ratio basis, so we're absolutely expecting dollars to come down after 2014 in the business. +With respect to the new branches, I mean we said like there's a third of our branches that are less than 10 years old, and about 11% less than 3 years old, so we have a lot of branches in the deposit gathering phase. And deposit margins are relatively flat, so at the moment we've reached the point where volume is out, is providing support to NII, but not strong growth until we start to see rates continue to rise and be able to reinvest up the curve as deposits investments mature. + + + The underlying numbers are terrific, customer satisfaction, deposits, households, mobile, Chase Wealth Management, small business, et cetera, but they are being squeezed by NII and interest rates and we've always told you we're going to build for the long run, which is that will recover one day and you will see spreads go up in this business. And when that happens it happens, but we're not going to not grow deposits because of that. And that will also affect obviously efficiency ratio. + +Answer_52: + + Yes, so as much as I would love to be able to take a quarter that looks like this and say we could expect more of the same, the reality is we still have issues open in front of us. We still have large reserves and we still are working through them. So we've been clear that while we can't predict legal expenses, we do expect them to be lumpy, and for every zero or close to zero quarter, we could have a quarter that has several hundred millions of dollars or more, albeit that it should trend down and abate to something much lower over time. +So I don't think you can read into it that we're done, we're still working through issues, we're obviously glad to have some of them behind us and some of the bigger and most difficult ones. + +Answer_53: + + No. If you look at the customer flows, in every single business they are very good, and customer sat scores are up, investments are up, assets under management are up, market shares are up, credit card, consumer, deposits, that's all very good. So I would completely separate out this litigation stuff, and Marianne, you all have averaged your own estimates for litigation I think are $500 million a quarter. + + + By our quarterly models, it's about $500 million a quarter, yes. + + + So make believe, I'm going to use your number, nobody else's, it's not going to be $500 million consistent. It's going to be zero, something else, zero to $50 million, that's what it is until it goes away. It's not going to affect the underlying business. And as you know we're also going to have one-time benefits from stuff we don't anticipate too. + +Answer_54: + + We're growing share so-- + + + Clients go with their feet and they seem to be coming to our branches and our bankers. + + + Thank you. + +Answer_55: + + So it's a little bit of we don't know where capital markets revenues will go obviously, and if they stay low or we expect to pass that down to the bottom line, it's also a little bit of there are sometimes positive and sometimes negative surprises and issues in expenses at this time every quarter, so there's a little bit of cautiousness in there. We're going to obviously do everything we can to outperform that. + +Answer_56: + + So most of the improvement in this quarter was associated with the ability for us to net variation margin on derivatives across currencies as allowed by contracts rather than having to only net in the currency of the underlying transaction. So that was obviously sensible that you should be allowed to net margin across allowable currencies, but that was not the provision of the Basel committee; the US proposal changed that and that's favorable. That's driving most of it, there were other things up, down, complicated technical things, but not big numbers. + +Answer_57: + + That's correct but I'm not expecting that in the very near future. + +Answer_58: + + We're going to have to get back to you. + + + Chris I'll get back to you. I apologize. We'll get back to you. + + + Probably has to do with [awards], but we'll get back to you. + +Answer_59: + + So there are certain things which are secular. People who have gotten out of it -- I'm not talking about us per se, but people have gotten out of reduced dramatically credit hybrids, certain exotic derivatives et cetera, and I think there may be additional secular change. But it's not the whole business, so the way I look at the whole business is we have 120 trading desks around the world, we have 16,000 clients. +And if you look at the fuel of the business, the fuel of the business is investable assets in need of people to invest those, whether it's corporations, individual, et cetera. Those numbers will double over 10 years, they're going to triple in the emerging and developing markets. And spreads themselves have been coming down fairly consistently for 20 years, and that's called capitalism, that you're efficiently using capital. +So I look at it as a long-term business, it will be a good business, shares are going to change, there will be a whole bunch of adjustments. And as you know, it can change on a dime, and so we're not, I don't look at the $5 billion in markets revenue and cry in my soup. I think it's pretty good business, and we have had very consistent performance. Remember it's driven by technology, research, sales, ideas, of course border flows, and last year we didn't even have one trading day loss, which I consider really spectacular. +So it's a good business. It will grow over time and it will have some secular adjustments. And I don't know about your numbers being right, the 13 of 17 quarters. And I also wouldn't go back and look at the peak, the really peak markets of 2007 or something and I think you had some of that in 2009 and say that was a standard. I think that was a little high. Higher than normal. + +Answer_60: + + I have an answer to your other question, I apologize for not having it off the top of my head. In the first quarter of last year, in non-interest revenue in Card we had a one-time exit of a non-core product. So I think if you go back and dig out that transcript or have a look at the supplement there, there was actually a one-time item, so if we adjust for that, we would have been up more strongly. + + + I might mention on the credit card business we have beta tests going of our Chase net and you're not going to see it in the numbers this year, but we think it's a pretty exciting thing that we can do for merchants and customers over time. + diff --git a/exam/original-files/Problem_2_3_Sample_QandA/6_questions.txt b/exam/original-files/Problem_2_3_Sample_QandA/6_questions.txt new file mode 100644 index 0000000..3203716 --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_QandA/6_questions.txt @@ -0,0 +1,242 @@ +Question_1: + + Hello there. + +Question_2: + + Hello. Maybe with avoiding too much of the details, stay at the high level and talk about no loan growth on a year on year basis. I know there's a bunch of mix in there, and I guess I'm particularly interested in the C&I bucket, because that's the one area where we do see some growth in the industry. So A, there's a little bit of verbiage in your text on how you define C&I loan growth in the Corporate bucket, and B, are there areas where you just think pricing is getting a little high and you're purposely avoiding that growth? + +Question_3: + + I appreciate that. And then obviously over time we'll see that in both a steadier to up NIM and good delinquency trends I guess. + +Question_4: + + Okay. On the SLR that just came out you gave us the expected impacts so I appreciate that. In Jamie's annual letter I think you said quote, we began to make significant changes to the rates business and expect to maintain decent profitability. Could you talk about what you've done in rates, how much through those changes we've seen and then what to expect on the other side? + +Question_5: + + Yes, very clear, and normal profitability might mean lower revenues but normal profitability, right, as things change in that business? + +Question_6: + + Okay, last one. Marianne, I guess next on the hit parade is final rules on LCR and OLA. Do you feel that's coming this year, and do you expect -- how do you feel you're positioned for that? + +Question_7: + + Good morning, so Marianne thank you for walking us through the progress on the leverage ratio. I'm just wondering should we expect on the Bank level that you'd be compliant to 6% at some point this year, or was the quarterly progress this quarter or last quarter rather unusual? + +Question_8: + + Okay. And just a second question, given you're already compliant in the LCR, is it fair for us to assume that your core margin should continue to improve throughout the year at this measured pace? + +Question_9: + + Okay. And just last one for me, in terms of your comments on card provision, help us think about sort of the balance in terms of the catalyst for your guidance. Should we start to expect balance growth to come back or is this more of a comment that charge-offs are as low as they will go and should normalize here? + +Question_10: + + Good morning. + +Question_11: + + If we look at the traditional bank fees even outside of mortgage, they're a bit weaker year over year than I think most might have been expecting, and I'm looking at like the card fees, service charges. Do you think that's all weather related or just weaker macro backdrop than maybe we were looking for? + +Question_12: + + Just the overall credit card fee line that you give us that obviously would include the interchange, but probably some other things as well. + +Question_13: + + Okay. And then just separately, the expense guidance for this year I think is unchanged even though revenue's coming in a little bit weaker than expected. I realize it's just the first quarter and things could change, but is there opportunity to adjust the expense base a bit more if revenue is light? + +Question_14: + + All right. And then just lastly on the buybacks, net of issuance being approved for greater than $5 billion, any comments just on the timing or the likelihood of all that being used this year? + +Question_15: + + Hi, Marianne. In the mortgage area, the $400 million hit to the MSR risk management results, just to clarify that was a one-time hit related to your Corporate reallocation of capital that you did earlier this year? + +Question_16: + + Okay. And again, the reasons for the negative profit margin we're seeing on the origination side, is it just the timing of getting expenses adjusted to a new base originations, and it takes -- there's a lag, or is there also some investment expenses that you're running through there that are also hurting your mortgage profitability? + +Question_17: + + Okay. And then on the markets activity in the Investment Bank, I guess a bit disappointing that activity levels didn't pick up in March where it seemed like overall rate volatility picked up as people put different takes on the Fed statements. Do you attribute some of the weakness to the lower issuance compared to last year, which seems like that could continue, and what do you think is needed to stimulate better activity, particularly in FICC this year? + +Question_18: + + And any sense of what kind of year you're planning for there, or is it really just a wait and see how the environment unfolds and you react as it occurs? + +Question_19: + + Got it. Any impacts on the commodities sale that's planned? Did you move that to discontinued ops or did that have any impact on the market, the metrics this quarter, Marianne? + +Question_20: + + Hey, good morning. A couple of follow-ups. One on the commodities business that you are in the process of selling. Can you give a sense as to what the impact is likely to be post sale? + +Question_21: + + Okay, and then just a couple of clarifications. On OLA you mentioned 19% available resources. I assume that's against RWA, but I just wanted to clarify. + +Question_22: + + Okay. And then on SLR, on page 3, you show us the ratios. I just wanted to confirm, the Basel III line says that it's on a fully phased in basis, but we don't see fully phased in on SLR. Does that imply it's transitional? + +Question_23: + + On the SLR as well right? + +Question_24: + + And that 40 basis point benefit there is both for the Bank level and the Hold Co level. + +Question_25: + + Okay, great. Lastly on expenses you highlighted throughout all the areas where you had the headcount reduction. Could you just give us a sense as to whether or not the benefit to the expense dollars is fully in the first quarter, or was there a negative from things like severance that then the benefit to the expense dollars comes in Q2 and beyond? + +Question_26: + + And the pace of that 3,000 from here is ratable or front-end loaded? + +Question_27: + + Good morning. + +Question_28: + + Just wanted to follow-up on the FACCR. Thanks for the guidance on the potential benefit. Can you give us a sense of what specifically is driving that to be beneficial? I've gone through the BIS release, but frankly, without understanding what the underlying is, it's really difficult to understand why it's a benefit. Just maybe you can help us qualitatively understand it. + +Question_29: + + Okay, I'll probably follow-up but that's helpful, thanks. You mentioned a number of times as you went through and we could see it in the slides that a lot of the expense impacts to the extent that expenses were problematic relative to year ago, a lot of it was because of the control agenda, which obviously we appreciated and you have spoken to. +But can we step back and talk about in a holistic Firm-wide way where are we with implementing that, how much more impact do we expect to see, at what point do we kind of lap on that? + +Question_30: + + That's it, so if I could interpret that that means after midyear we should have sort of fully lapped, is that what you're saying? + +Question_31: + + Okay, that's also really helpful. In terms of FICC and the weakness that we saw, can you comment at all and if it's possible even to quantify a little bit what the impact was of some of the adoption of SEF mandates during the quarter? We could certainly see that SEF volumes themselves seem to get disrupted at certain points in the quarter when new mandates went into play, but just if you think about the impact of that regulatory change on the OTC derivatives markets, it would be really helpful to understand how much of the impact was just regulatory change. + +Question_32: + + So if one were to think that there were going to be spread compression over time as a result of some of these things that might still lie in the future, that's to your $1 billion plus or minus revenue impact that you've talked about? + +Question_33: + + Great, that's all very helpful. I appreciate you taking my questions. + +Question_34: + + Thank you. Good morning. Can you guys share with us on your loan loss provision this quarter, obviously last year the provision was greatly affected by loan loss reserve releases. Should we anticipate the provision reaching your net charge-off levels for this year to match them out? + +Question_35: + + Okay, speaking of the PCI loans, they're down year over year about 10% to 12%. Should we expect that type of run rate throughout the year as that portfolio continues to shrink? + +Question_36: + + Okay. You talked about in the mortgage business you're changing the way you're approaching it, and the revenue run rate you had this quarter of about $160 million, can you size for us where you think kind of the new approach that you're having with mortgages, what kind of revenues we might anticipate? Because I'm assuming this was unusually low, this quarter's number? + +Question_37: + + Okay. In the institutional asset management business, you pointed out the decline sequentially in the revenues because of some of the one-time items in the fourth quarter. On the year-over-year declines, even though the inflows were up, any comments on the revenues for the institutional revenue part of that business? + +Question_38: + + Okay, And then finally, it may just be market conditions or maybe something you can do, when you look at your net interest margin and you look at the interest earning asset yields, the securities borrowed number was a negative 30 basis points, it's been trending more negative each quarter. It was minus 2 basis points a year ago. Can you point to anything you could do to try to reverse that? + +Question_39: + + Thanks. I had a few questions. You had no significant items that you called to our attention, but then you said there were a few sort of non-core items and they broadly offset. And just as I'm looking at my notes I see there's like a $400 million negative in MSR, there's a $90 million in tax, there's $200 million of DVA/FVA, all negative, and then there's $400 million of private equity gains, but I guess I'm missing another sort of $300 million of positive. I just was wondering if you could kind of call out what that would be? + +Question_40: + + Oh, okay, the reserve releases. All right, understood. + +Question_41: + + Okay, that's fine. And then just on the tax rate, obviously I'd strip out the $90 million but it still feels like a high tax rate. Is there anything funny going on there? + +Question_42: + + Okay. And then the guidance on Mortgage Production that sort of pushed out the losses and we've talked about it a lot, but just so I'm clear the change in your guidance there is just essentially a change in your market expectations, the $1.2 trillion coming to a lower number, that's the only real change you've got there? + +Question_43: + + Yes, thank you very much. You guys mentioned I believe in a report or in comments that you want to get your servicing portfolio down from $800 billion to $600 billion on loans there, I guess just natural decay and selling MSRs. When do you think the timing of those sales of the MSRs, and do you think that -- a lot of people feel that you cannot transfer any MSRs anymore due to some of the headline risk. Can you add some color to that also? + +Question_44: + + Can you add more color, you can't get rid of the risk? Can you add more color around that? + +Question_45: + + And then Jamie, on the credit boxes not really expanding, what do you think, what kind of impact do you think that's having on the overall mortgage market, especially the purchase market, as we're seeing almost 14 year lows on the origination side? + +Question_46: + + Hi, good morning. + +Question_47: + + You had alluded to some of the drivers of the RWA growth earlier, and I was just hoping you could frame that in the context of your $40 billion targeted RWA decline from Investor Day, and whether that's potentially at risk or is the $1.55 trillion RWA level still achievable? + +Question_48: + + Okay, understood. And then transitioning to OLA for a second. Long-term debt outstanding did increase modestly about 2% in the quarter. I just wanted to confirm how we should be thinking about issuance plans over the course of the year. Are you managing it to a 19% bail in buffer, so we saw the modest increase in RWA and then saw a commensurate increase in long-term debt, or should we be thinking about it entirely differently? + +Question_49: + + Okay, fair enough. And then last one for me. The high frequency trading review and potential market structure overhaul continues to be an area of increasing focus, and I was hoping you could speak to the equities business and whether the anticipated SEC review and potential broader equity market structure reform will compel any adjustments? And how you're thinking about that at this juncture? + +Question_50: + + Hi good morning. A couple left for me. One, looking at Consumer and Business Banking such that it is a deposits business, the overhead and the efficiency ratio there has really trended up for a few years straight. I know there's been some investment as well, but how should we think of that going from kind of the 70% plus it's been now back to some kind of the mid 60 like it historically was? + +Question_51: + + So that is getting better to some extent as expenses going down, to what extent is revenues getting better? Does the WaMu footprint factor into that, or are we waiting for interest rate help? + +Question_52: + + Okay. And on the litigation side, nice to have a quarter where there aren't big charges, who knows what the market does, but in theory that's a good thing for the share price. Is there the potential for that to be a good thing for the underlying businesses too? Have all the headline risks been a negative on some of the business lines from a consumer customer perspective? + +Question_53: + + To the extent you're not looking hopefully at multi billion dollar quarterly settlements anymore, does that help on the volume side of the businesses? Did that have a negative impact on kind of customer interactions with you? + +Question_54: + + So you haven't noticed kind of a negative reputational impact with customers? It's been okay obviously, looking at the volumes I guess it must be okay. + +Question_55: + + Hi, good morning. Two follow-ups. First on the expense side, I think if you look at the run rate this quarter you had around $58.4 billion, and so well below; if you analyze that then your $59 billion target and seasonally this would be the higher expense quarter given capital markets revenue. Is there something we should be thinking about in the out quarters, whether it's higher regulatory compliance spending, marketing spending, or is this just some conservative because we don't know where capital markets revenues go? + +Question_56: + + Okay, fair enough. And maybe a quick question back on the SLR. You guys I think last quarter before the changes by Basel noted that the Basel committee's calculation would be a net drag of 10 basis points, this quarter it's 15 to 20 basis points benefit, right? Is that simply the changing in the credit conversion factors on the off-balance sheet credit lines, or is there anything else driving that improvement this quarter? + +Question_57: + + Okay. And that doesn't include the benefit of moving to say the non-internal model methodology, which would be another 40 basis points? + +Question_58: + + Yes, good morning. As you mentioned I'm looking at page 17 of your supplement on the credit card business, and as you mentioned all the volume metrics all look great. Sales volume up 10% and merchant processing up 11%, but then when you look at the fees, it's down 4%. And I would have thought we kind of anniversaried all of the regulatory changes and so on, so I guess a big question for me is in this business in particular, why aren't the favorable volume metrics translating into revenues? + +Question_59: + + Okay. And then just secondly on the broader philosophical level, Jamie, a couple years ago at Investor Day, you rhetorically asked a question about capital markets income, is it cyclical or is it secular, and you said believe me it's cyclical. +And now, you look industry wide by my numbers, we're down on a year-over-year basis 13 out of the last 17 quarters, and it's sure as heck feeling secular. And I'm curious, one, have you adjusted your point of view? Two, do you think there is some irreducible level of transaction volume business for the industry? And three, how do we gauge how far we are on that glide path from where we used to be to where we stabilize? + +Question_60: + + Well my numbers were industry from 2009 on, or 2010 on, so but anyway, but thanks. It's probably an unanswerable question. + diff --git a/exam/original-files/Problem_2_3_Sample_QandA/7_answers.txt b/exam/original-files/Problem_2_3_Sample_QandA/7_answers.txt new file mode 100644 index 0000000..cc5db78 --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_QandA/7_answers.txt @@ -0,0 +1,390 @@ +Answer_1: + + So you got cut off at the beginning but you are asking for our earnings at risk on 100 basis point shift? + + + Within the first quarter, we haven't disclosed it yet for the second quarter but it wouldn't be meaningfully different. In the first quarter, it was $2.5 billion. + +Answer_2: + + So I mean obviously earnings at risk is a representation -- it is an instantaneous parallel shift. If you look actually at our disclosures you can also see what a steepener looks like. So the way I would characterize the way to think about the impact of our asset sensitivity and interest rates rising is the way we described it both at Investor Day and at the Morgan Stanley conference which is when rates rise whenever that starts which may be in the second half of 2015 at the short end and the long end continues that over time that will deliver $8 billion to $10 billion of NII to the firm. But clearly the path to get there will be rate dependent and timing. + +Answer_3: + + This is Jamie. I think on the funding side, we said we have met pretty much LCR and [SFS] and we think will be the [GLAC] or least we are very close to it. That is all embedded in interest-rate exposure which Marianne gave you and that is our base case. Obviously if the world changes, we may change how we go about and do that. But I think it is a very good base case to look at. We don't have any need to change it dramatically. +I think you will all have to be prepared for the reason that rates raise -- obviously will change why people act a certain way. + +Answer_4: + + I think we have to wait and see. I mean remember the United States has already gone beyond most other countries and they may just be referring to that that they intend to keep that or how they modify that. + + + The way that we think about it, obviously we don't know how things may change in the future but between (inaudible), the buffers that we and other institutions are going to run above that with LCR and SFR, our own internal liquidity framework with capital stress pump testing under CCAR under extremely severe conditions, it feels like we have a box around this and so we are planning to run the firm based upon what we know today with an eye on obviously listening to all of the things you hear. + + + Thank you very much. + +Answer_5: + + Thank you. + +Answer_6: + + So keep in mind if the Fed, whether they use repo or just sell securities, that will reduce deposits, so factor with it, absolute formula. The question is whose deposits and what kind of deposits and when they might do something like that. I assume they will be fairly careful. +I think what we simply were saying is that some of the deposits will come out of -- nonoperating wholesale deposits already have (inaudible). Some won't. Some will come out of retail, and just people need to be prepared for. I wouldn't put it in the earth-shattering category. Just people need to be prepared and be very thoughtful about how they go about that. + +Answer_7: + + I think we are very comfortable with where we are. + + + Remember, we are running -- LCR is an important measure. It is a regulatory measure. We are measuring it, we are reporting it, but we run the firm based upon our own internal liquidity check framework and what comes with that. + +Answer_8: + + Really what I would point you to is the discussions that we had largely at Investor Day which was to say that we continue to expect the mortgage expense story to play out over the course of the next few years which will be obviously a tailwind for us on expenses both in servicing but more particularly in production. So that is obviously a focus in 2015 and beyond. +We also are expecting to start on a journey to delivering. You saw our CBB expenses, cost of control investment are moderating and Gordon outlined at Investor Day that the CBB business 2014 through 2016 as a relative matter would deliver approximately $1 billion of expense efficiency but the profile of that we haven't been through. And then Daniel is working through, as are all of the other CEOs, the expense story in the CIB and being as diligent as you would expect him to be given the environment. But one of our positions has always been that we are running this business for the longer term and we are going to be smart about the actions we take on expenses in order to make sure that we protect the franchise but that doesn't mean that we can't and won't be more efficient across the businesses. So we haven't actually given specific guidance at the firmwide level but that is the backdrop. + + + I just want to reiterate that we always have a waste cutting like real estate, people, straight-through processing, vendors, things where we think we got a little sloppy, where we are located, but we will never, ever ever stop investing in straight-through processing, better bankers, better training, Chase net, marketing, Sapphire, EBKs -- you know the new stuff from branches. So don't confuse the two. +We will lump it in together for you. Internally, no one goes to a budget meeting and says I get my expenses down by cutting expenses and the really important things we need for the future. No one. We are not going to run the Company that way. We would rather earn less money. + +Answer_9: + + Including in that is paying our people fairly. + +Answer_10: + + I would say that it is a matter of good housekeeping that we would constantly be looking at making sure that we are simplifying our businesses where it makes sense to do it. But as a large matter, the macro matter, we are working through the things that we talk about, some of the things that you mentioned and there are no significant changes + + + We've got 1000 foreign correspondent banks, we sold CWT, we might very well -- we sold RPS. There are a bunch of product lines we have either closed down or eliminated and a lot of that is in the works. We put a light -- enhanced monitoring our other businesses and so we are well along the way but if something comes up that we think we should look at again, we will look at it again. + +Answer_11: + + The most significant revenue effect that is not yet in our run rate because the transaction is not yet closed is the exit of the physical commodities business. So obviously when that closes which may be in the early part of the fourth-quarter that would have an impact in the revenues both in the quarter and then in our run rate in 2015. + + + We gave you a number at Investor Day which -- we should probably update that number. + + + I can give you the numbers now. So at Investor Day, we said that the impact in 2014 on revenues would be a decline of $1.6 billion. Just given the timing of the physical commodities deal, the impact in 2014 is going to be closer to $1.2 billion of which about $500 million is in our run rate already. +And then when you annualize the things that will be complete by the end of the year, that 85% of everything is obviously going to get done. So once we close the year this year the impact this year will be $1.2 billion, the annualized impact that we gave was $2.8 billion and that is still our best estimate. + + + The important thing is the four beautiful franchises, Asset Management, Commercial Bank, CIB, CCB are all doing really, really well and this doesn't affect their ability to serve their clients at all. + + + Remember also just for the purposes of completeness, it would be remiss of me not to say that expenses are also coming out as we take those revenues out and remember these are in large part businesses that were not at this time accretive to the overall firm's returns. So important to remember that. + +Answer_12: + + I think because the government is still buying a big portion of net treasury issuance and because they are doing -- going into the repo market and taking cash out of the system, I think that number maybe has gone from $100 billion to $200 billion over time. Remember I believe that that repo can't be rehypothecated. So I do think some of those things that cause issues in the repo market, my guess is that will sort through over time. We do believe we see dealers reducing their books in repo and you have had a lot of statements about repo and collateral and capital against it so I feel things are going to sort out over time. + +Answer_13: + + Not yet. + +Answer_14: + + So I would say that there hasn't been a shift in sentiment but sentiment is better. It is still better year-over-year and better quarter-over-quarter. It has allowed us to deliver growth in line with the industry and we do however maintain, absolutely maintain, our credit risk discipline as it relates to the commercial space. So it is competitive. It hasn't been the case that we have historically been losing on price, it has been more on credit discipline and on simplification and derisking but --. + + + I think Marianne mentioned it but in almost every category of C&I -- I'm talking about on the Commercial Bank -- utilization was up like 1% last quarter, maybe --. + + + Utilization in commercial was up 3% since the end of the year. + + + Since the end of the year and you know, utilization is usually a pretty good measure of companies starting to expand and early on, it's receivables and inventory. You haven't really seen it in capital expenditures yet and if you looked at US capital expenditures in total including big businesses, they are kind of flat to down, that will ultimately be the driver of real growth. So if you start to see that, you are going to hopefully see a stronger economy but utilization is I think is the first sign. + +Answer_15: + + No, but can I just give you a number? I think year-over-year that balance sheet is up mostly because of money we have in the Fed. Even quarter over quarter, we've got these -- we have $350 billion or almost $400 billion at central banks around the world. We have an investment portfolio of $350 billion. We have a loan portfolio of [$700 billion]. We have already told you when they start to reverse, Q3, some of those will automatically come down. +So our balance sheet is kind of high because of all of this huge liquidity and securities in the balance sheet and eventually hopefully there will be more loans which are more productive and less just holding excess cash. + +Answer_16: + + Just to illustrate the point, if you are looking at the slides, you are looking at end of period assets that grew by $40 billion or so. If you look at the average, it was only [18] and we get a lot of volatility around cash movement at quarter end. So Jamie is right, there has been a significant amount of our growth that has been deposits and ultimately found its way on deposit with the central bank. + + + I would say against that, having said that of course there is a natural healthy tension now with leverage rules that we are clearly strategically optimizing the way we use our balance sheet and that will have a natural tension to keep the balance sheet growth if there is growth to be more modest. + + + You are also seeing -- if you are talking about G-SIFI, the big Chinese banks, the big Japanese banks and some other banks around the world growing fairly rapidly, hopefully -- eventually we will use our G-SIFI scores a little bit too. + + + And if we are right about the liquidity drain in QE, you will see a bunch of deposits flow out potentially in the second half of next year and see some of that growth reverse. + +Answer_17: + + Thanks for the question because I want to make sure I am very clear. So in June, we did see an uptick in activity in terms of client activity but volatility stayed very, very low and there was no specific catalyst for it, no catalyst that would lead us to believe that that would necessarily continue. And as we have moved into July, it so far has been our experience that it has not continued at that level. So it is more our guidance in the second half is that the 15% to 20% and the 20% plus or minus decrease that we have seen in the first half, that kind of environment is the one that we are facing over the second half. +Now we are not guiding to a number because as you very well know however many trading days into the quarter and things can change so you are going to have to pick your level and we can't predict it any better than that. + + + It is just our operating assumption is that it will stay at low levels for a while. We know we are going to be wrong on that but you all have to pick whatever you think. We run the Company planning for low and hoping for better. + +Answer_18: + + We are not giving a specific guidance. It was 20% in the first quarter, 15% in the second, that kind of environment. + + + And the third and fourth are generally lower and it could be lower than that (multiple speakers) . + + + Normal seasonality drivers. + +Answer_19: + + We called out the $300 million if that is what you are referring to in the CIB because it in our view anyway is a modestly sized and nonrecurring item. We are not expecting to have similar items like that. We may have some but we are certainly not our forecast that we are going to have that kind of level recurring. So really it is just to give you a sense that in the quarter we absorb that number you choose that you will to do with it in terms of your models but we don't consider that to be core. + +Answer_20: + + Not at this time, not significant. + +Answer_21: + + So first of all, these are all the moving parts, none of them are materially significant so operational risk went up a little bit, growth went up a little bit and offset against that, we continue to always on board positions onto approved models, continue to develop our models and get approvals for our models so that we can have the most efficient RWAs that we can have. And so we saw some of that. And also portfolio runoff so we were just giving you some color that flat RWA is actually the continuation of the work that we articulated at Investor Day that will ultimately drive it down to be closer to $1.5 trillion over the next 18 months. + + + We are a little inconsistent upfronting all of the negatives we phased in. We are not upfronting model approvals we expect to get. Model on boarding and stuff like that. There is some of that coming and obviously those need to be approved by regulators. + +Answer_22: + + Not material. They are going to run off over time for RWA and everything else is not material. They can be restructured. I think it goes to 2017 now. + + + Thanks, Betsy. + +Answer_23: + + We said relatively flat. It came up slightly in the quarter, obviously we are pleased with that and we told you that we expected core growth for the year to be 5% plus or minus and at this point that would still be our best assessment. If loan growth does continue to improve and improves to the point where our core loan growth is above 5% then yes, we would hope to enjoy the NII benefit. +But as we look forward based upon current rates, we will be flat with a little bit of upward bias is our outlook until rates start to rise. + +Answer_24: + + Sorry, John, because you do continue to have albeit that everything is a little bit less than it was but you do continue to have offsets against that in terms of spread compression. + +Answer_25: + + Yes, if market implied curve is in fact how things play out. + +Answer_26: + + So first of all obviously what we can do is guided and limited by what we have approval to do. But yes, we did articulate that we were going to likely back end our share repurchases as we build towards our CET1 ratio. You can obviously see we built towards that nicely at 9.8%. And then yes, obviously particularly in the first half of the quarter, our price was favorable and we did share repurchases reflecting all of those things. +When we look at the second half without giving specifics because we don't give guidance on repurchases, we have the capacity to do $5 billion more gross over the next three quarters and we have a target to hit above 10% and we will juggle those two things together but that gives us the capacity to continue to do some repurchases. + +Answer_27: + + We assume none in that. Think about the MSR risk management as we generally speaking expect our results to be close to home so plus or minus zero outside of any model updates because of our hedging strategy. + +Answer_28: + + So as much as I know and you want to hear it, we are not going to be able to talk about the specifics of what we are reserving for and we told you -- we said before that we had very little in the first quarter, we have $700 million pretax now. It is going to be this way for a while. We are going to have elevated and lumpy litigation costs as we work through the issues that you are aware of. +And then with respect to mortgage, we have settled with a large proportion of our MBS risk with the governmental counterparties but we do still have some other civil claims. But we would characterize it more behind us than in front of us and we are working through it. + +Answer_29: + + On an absolute performance, so first of all two things primarily contributed to the better performance. We said 20% plus or minus. Remember that really could have been plus or minus when you go back three weeks before quarter end. So with the better activity in June, so June was a stronger month every day on average produces stronger results than the prior two months and that helped and we didn't have line of sight to that when we gave our guidance and when we affirmed our guidance. +And then the second, I called out the market partner's shares, the IPO. We sold our shares post the IPO and generated gains of over $100 million which is a couple of points. + + + And the VAR, I mean it is very hard to predict FICC. We are always reluctant to do it because somehow you think you actually know what is going to be the (inaudible) couple of weeks and the VAR jumps are around but some of that jumping around is really I think of underwriting positions, CMBS warehouse positions and stuff like that which come and go. + +Answer_30: + + What I would say, Mike, is that what we have seen in the second quarter gives us reasons to be optimistic that we are going to continue to see growth at around those levels in the second half of the year. Like I said, it is not that we have seen a step change but that we have seen generally better sentiment, generally better utilization rates, generally higher pipelines. The phones are ringing. It is across geographies so it just feels like the environment is conducive for us to continue to be able to add. +We have been very successful in the business banking space and yes, we have reached inflection in card. So it is our belief that we will have strong growth year-over-year in the second half but we are still in the early stages of seeing that happen. + +Answer_31: + + It is not really a factor of people who are already income producing, locked in rates and things like that. It may very well be a factor for people who want to build new things. Not on the commercial side but we did look at on the residential side there have been occasions we have rising rates and improving housing. So depending why rates are going may be the more determinant factor than just the fact that rates are going up. Rates are going up because you have a healthy economy, that may be more important than just the fact that rates are going up. We have not done the same thing in commercial, we probably should. + +Answer_32: + + For us what we are doing is being consistent on our credit discipline and so we have talked I think partly in the first half of the year about us not participating in some of the growth that others saw because we have maintained line as it relates to particularly structured credit structures and aggressive structures rather than pricing. And so we are consistently doing that. We are not changing that and our credit across products also mortgage, commercial remains broadly consistent, we are not changing that either. +So for us we are just maintaining our credit discipline. But yes, it is a very competitive place out there right now across the products and so we are seeing a little bit of that aggressiveness. We saw it in the quarters running up to this. We still see it now although it is not worse. + +Answer_33: + + I don't think we have disclosed that. It hasn't been a breakeven business over a long period of time. Obviously hasn't earned much money in the last few quarters and we are still negotiating something. It could be soon, it won't be all of OEP. It will be a part of it. +And then part of the number of you see, because I think there is $6 billion of total private equity are all heritage investment that were made by JPMorgan Chase and etc. before the Bank One merger. So they are all eventually -- that $6 billion will be zero and that frees up what, $3 billion of equity capital effectively. + +Answer_34: + + Yes, just to be clear, the $2.8 billion if you go back and look at Investor Day was for all of our business simplification agenda not the physical commodities. I just called out physical commodities as being A, a big piece of it, and B, as being the biggest piece left to happen in 2014. So just to be clear on that. +And then yes, the $2.8 billion came with expenses of $2.3 billion against it. We didn't disclose the capital but when you take that into consideration it was at or below our cost of capital, not additive to returns. + +Answer_35: + + Actually, it is in fixed. + +Answer_36: + + We haven't actually broken out specifically in that way but I can characterize it for you. Obviously in mortgage production, the first chunk of expenses is truly variable meaning it is paying for production on a variable basis to the salesforce and then you have a bunch of what we would called semi-fixed costs which are effectively the operators, the people, the FTEs. And then you do have true fixed costs which is the management, the real estate, the technology. +When you have a very, very small market which I think you would agree a $1.1 trillion or lower market is very small, then it is hard with the fixed cost structure to make a lot of money in the mortgage business particularly if you are taking a hard line which we are on the types of mortgage product that we want to participate in. But over time it doesn't stop the fact that this is going to be a healthy functioning mortgage market and we want to be a scale player. +So it is tricky in this kind of very, very small market but we are focusing on fixing our fixed cost base and trying to get out as much efficiency as possible. + + + We've been spending a lot of time in that and doing deep dives and trying to figure it out and unfortunately this one won't be the end of the year. I think of it as hopefully by the end of 2015 we give you clear sight about how we will be making normal profitability there which may take until 2016. + + + Right and it has always been a cyclical volatile business and we had very, very strong performance over the course of 2011 and 2012 and into the first half of 2013 and we are now at that cyclical point, that cyclical low and we need a lot of things to happen. But trust me when I tell you that the fixed cost base is our number one focus or among our number one focuses and we are working very hard at it. + +Answer_37: + + We are not exiting, just no longer doing it and it is in runoff mode. + + + Right. So we stopped originating new loans but we do have a portfolio of loans that we are managing and as they run off, we will experience all of the usual charge-offs, reserve releases but not exiting. + +Answer_38: + + We said it was driven by derivatives. Cash out of prime brokerage did better. Prim did better than cash. + +Answer_39: + + So just on the mortgage thing, we are giving up share but remember that we distribute a significant amount of the mortgages that we produce and in this quarter, we actually portfolio-ed $5 billion of mortgages so we are not losing share in (multiple speakers). So we are adding to the portfolio for mortgage at just a slightly different dynamic. +We are outperforming on sales growth in cards so ultimately that will fuel outstanding growth that hopefully will be better than the industry but clearly it is modest at this point. Our C&I, we are in line if not potentially gaining a little share but we continue to outperform in real estate particularly multi-family real estate and asset management. + +Answer_40: + + Yes. + +Answer_41: + + I think you called it well on mortgage. Obviously the mortgage market and housing conditions outside of home prices are challenging and that looks like it is set to be a slower journey. But if you step back and look across all of our other businesses, when I talked about the underlying core performance drivers growing strongly, that reflects our strategy. So we continue to build and grow our businesses demonstrated by those performance drivers as well as simplify and address the control agenda and we are making the appropriate progress on both of those. And it is showing in our results. +I mean a quarter where obviously there are some challenges to print over a 14% return on tangible common equity is evidence of the strategy working. If you go through each of the comments I made in asset management, we are investing in the sales force, we are seeing that deliver growth, we have record inflows, we are seeing international deliver loan growth. It is very consistent. + + + You haven't seen us give you a roadmap on how we are going to get from 7% return on tangible common equity to 14%. We are already at 14%. + +Answer_42: + + No, look, I can't over emphasize this. We do not run the Company for quarterly profits. We make long-term decisions in people, systems, technology, products, services, stuff like that and a lot of things drive short-term profits but the profit you have in any one quarter relates to the decisions you made the last five years. And so we feel great about these companies. The big weak spot which we all acknowledge is mortgage and we are going to put -- we have got great people there. We are going to put elbow to the metal there, we are going to invest some more money in their systems. +We've got some catch-up to do. We got caught in the middle of as you know WaMu, Bear Stearns, origination platforms. But if you look at each of these businesses, they are all doing fine and we are looking at how we can grow them over the next five or 10 years and that is what we are going to do. +I honestly mean it. I don't care whether FIC is up 10% or 15% or down 10% or 15% next quarter. I actually think that is a complete waste of time. + +Answer_43: + + I think most of that has been done. So you have seen not all of it but the full effect of that in terms of which segments we are getting out of, which ones we are going to focus on, which ones we put enhanced monitoring in so the same thing in the CIB with our correspondent banking. There may be more. We are always going to do good housekeeping and there are some clients we have had conversations with that are still on the books but they will be leaving down the road. But none of those things will be material to the future of this Company. +They may affect revenues a little bit in the fourth quarter or first quarter next year but that is not why we are doing it. We are doing this to protect ourselves, run the business properly, meet our regulatory and control objectives. + +Answer_44: + + Think about this, the core number, the reported number being primarily driven by the legacy mortgage and credit card portfolios so the high end activity that we have been talking about is immaterial in the context of that runoff portfolio. That is what is driving the difference. So we will continue to see that portfolio run off and as it runs off and gets smaller, it will have less of an impact but it has been a fairly consistent story. + +Answer_45: + + We have a large market share so while we may be outperforming the market what we see is generally a fairly good picture of what is happening. And what I can tell you is if you decompose our growth, you have still strong high single-digit growth in nondiscretionary spend categories driven principally in grocery and oil space which is not all that unsurprising but I think is actually instructive about consumer spending and inflation. +And then if you look at the discretionary growth which is growing even more strongly in the double-digit territory, it is across the board. It is travel, it is restaurants, it is retail, it is across the board so consumers are spending very strongly in both categories. + + + (multiple speakers) Merchant processing we are growing at like 12% a year and we are investing more money, do a better job for merchants there and we have 35 million people bank online. I think 15 million who use mobile bank, it was 12 million or 15 million that use mobile banking. So you are going to see us extend products and services all of which hopefully will be merchant friendly and consumer friendly. + +Answer_46: + + Mostly merchants aggregating their transactions. + + + Yes. + +Answer_47: + + Correct. + +Answer_48: + + Yes, so our general longer-term outlook is our tax rate is 30% plus or minus just given obviously the pre-tax (inaudible) of the 2014 market, it will be slightly lower than that more in line with this quarter. +(multiple speakers) + + + I don't remember if you mentioned it, but in other, there is private equity which was close to zero and bounces around. Treasury and CIO, which was close to zero and kind of will stay there and there is other corporate where a normal rate would be around 200, this quarter was around 400 because of some of the tax benefits. Think of that as going back to 200 give or take next quarter for your models. + +Answer_49: + + So of the $5 billion, $3.6 billion was jumbo, about $400 million was (inaudible) and then about $1 billion was conventional so that is how it breaks down. So mostly jumbo, yes, and we are holding share in jumbo. +And with respect to the market share loss, it was principally two things. It was principally a strategy that we've talked about to do less in the high -- high LTV, low FICO space. We priced to the risk-adjusted return that we see in that business given the cost of service the loans that default and that is what the impact has been on our market share. +And then also the HARP burn out, we were very successful in HARPing our loans over the course of the last couple of years. Our borrowers who our technically eligible are no longer responding so we are seeing that burn out. The bit that is really truly the conventional loss which there was some, is really on price competition and we absolutely intend to compete on price. + + + When you say high FICO -- that is FHA? So our FHA volumes are way down and we've studied FHA based upon the lawsuits and the premiums and stuff like that, we have lost a tremendous sum of money in FHA. We are trying to figure out what we should do about it going forward. +Just to give you three numbers, we collected $600 million in insurance. They disputed $200 million. The government called that a fraud. We reimbursed $600 million to get out of the lawsuit because it was a threatening lawsuit even though in my opinion it was a commercial dispute between FHA and ourselves about that. And the whole time FHA collected another $1.8 billion in premium. So the real question to me is should we be in the FHA business at all and we are still struggling with that. +We want to help the consumers there but we can't do it at great risk to JPMorgan so until they come up with some kind of safe harbors or something, we are going to be very, very cautious in that line of business. + +Answer_50: + + I think it has slowed down a little. + + + It went down slightly I think. + + + Remember, you are talking about different borrowers (inaudible) so it might be something that was two million deposits and some start to borrow money but in general, you are right. + + + So if you look at commercial just as an illustration of your point, what we have got going on is utilization rates in the last few quarters have picked up by 3 points. They are at 33% still much, much lower than you would expect them to be over time which would be slightly above 40%. But you do see deposits flattening out. In fact, there is a little bit of decline. +It is not absolutely the case at this point that we can say people are starting to spend their deposits and utilize their lines. As Jamie said, CapEx is still not really out there but that is what you would expect and in this business we did not see strong growth in deposits. + +Answer_51: + + First of all, just to make a conceptual point which is we didn't have a target for loan deposits. We were just trying to make the point that obviously as we think forward to the impact of interest rates on our performance over time, we would expect both a mix shift in deposits back towards interest earning and CDs but also expect to see the economy growing and loans growing and that needed to be taken into consideration. So it wasn't really a target, it was just a simulation to start with that. +But it was based loosely on levels that we have seen at least in part the cycle that we were referring to. And then you are right, there is a dynamic where because of LTR, we will always have a -- because of our liquidity requirements internally as well, we will have liquid assets that will be structurally higher than they would had previously been and therefore from a mix perspective, that would have an impact. But at this point given where loan to deposits are, I think that would be a high class problem to be talking about. + + + Remember there are some unused lines so there is not a loan on the balance sheet that still 100% LCR. So what's really going to happen is it is going to be done at the client level -- capital, LCR, commitments, etc, that is where you are really going to have to manage it, the capital level, the desk level, etc. + +Answer_52: + + What we have seen a little bit of is trade finance cost have gone up, a little bit in municipal businesses and there you have seen a little bit more restructuring on the type of business people do. Remember some of the repricing may not take place in the product, it may take place in the relationship because all products have loss leaders, etc. But we haven't seen a huge amount of repricing taking place yet. + + + I think if you think about --. + + + I have heard some complaints by the way that some of the revolvers are smaller and shorter. It is not the price as much as it is the sizing. And then you have heard some commentary in the market that inventories -- bonds are lower and spreads will gap out so you are starting to see some of it but eventually -- I have never seen a business where the cost of goods sold doesn't eventually get priced in the business. It doesn't have to be priced into the eggs and the milk, it just has to be priced in the transaction, the whole bag the person walks out of the supermarket with. + + + I think one way to look at it is to say while we are absolutely managing through this complex environment, Basel III Tier 1 common still is our binding constraint at the margin, that is how we allocate capital to the businesses and that is the sort of primary lend that we are using to price. And what you are going to see, as Jamie talked about, is that the leverage and LCR and other constraints including stressed capital are going to play out at the client level as we just are becoming more efficient at how we deploy our balance sheet rather than necessarily a repricing strategy. + + + And CCar, we are pushing CCAR down. To the extent we can, we are going to push CCAR down to those things which create CCAR-ness. + +Answer_53: + + I wouldn't hold your breath. Some people are leaving businesses, some are optimizing decline levels, some are having strategic changes and it will happen over time and we are quite patient about it. We are in no rush. We're not going to try to lead it or anything like that. It will happen over time. +Like I said, you have seen it in trade finance, you've seen it in certain municipal businesses, you have seen it in -- and all the rules aren't final. When the rules become final, people may react differently. + +Answer_54: + + Yes, the improvement at the bank and the holding company was retained earnings, [pressed] net of capital distributions but we continue to work through all of the other initiatives we have to optimize leverage including compression trades and pair ups and the like. That is actually happening a little bit more slowly than we had thought just broadly in the industry. It still presents an opportunity, it is not the most sizable opportunity but we are diligently getting after it. +And then with respect to (inaudible), we estimated clearly it is a complex calculation so we will be slightly wrong in our estimate. We estimated it to have a benefit for the firm of 30 basis points and for the bank at 40 basis points. Yes, we would expect that at some point it would be ultimately adopted by the US regulators but that doesn't look like it expects to be helping our numbers this year or next. + +Answer_55: + + It is essentially cyclical. I mean I wish we could actively manage it down because it is positive (inaudible) calculation but the truth of the matter is it is a factor of activity levels. + +Answer_56: + + We don't think it is significant. + +Answer_57: + + So CRA, remember is a combination of lower and middle income mortgages so we will obviously try to meet those commitments. It includes how many branches you have in lower and middle income so we will continue to build that. It is a function of CDFI, like lending to small business or community development funds which we will continue to do. So it runs a whole gamut and we will meet our CRA commitment. +Yes if you don't do in the FHA, it hurts you a little bit but to do FHA. lose billions of dollars that is a whole different level of shareholder responsibility and so we've got to be very careful how we handle that. I am hoping FHA comes forth and comes up with some real bright lines and harbors to make it easy for us to try to do what the government wants us to do but we can't get penalized severely for some of the things that happen. + +Answer_58: + + It is all of that. We are going to meet CRA. We report CRA to our sellers every month and like I said, it cuts across a wide variety of things that we do for people and we just did this great thing in Detroit that is a lot of CRA credits. We can you mortgages ourselves that we can put on balance sheet that we think are less risky than FHA insurance. So we will figure it out. +We are just thoroughly, thoroughly confused about how we got treated, how we've got it going forward and we are kind of waiting for -- we have spoken to government for some kind of guidance going forward. + +Answer_59: + + Yes. + + + It's deals and reps and warrants. + + + It is the reps and warrants that there should be a commercial resolution of the dispute but you don't have [treble] damages if something goes wrong. + diff --git a/exam/original-files/Problem_2_3_Sample_QandA/7_questions.txt b/exam/original-files/Problem_2_3_Sample_QandA/7_questions.txt new file mode 100644 index 0000000..a550ead --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_QandA/7_questions.txt @@ -0,0 +1,240 @@ +Question_1: + + -- that you have shared in the past if you have a parallel shift of 100 basis points, what that will do to your net interest revenue? + +Question_2: + + Do you see going forward that changing in the way you are approaching your interest sensitivity as the likelihood of rising interest rates increases in 2015 or should it remain pretty much constant? + +Question_3: + + Tying into the higher interest rates, you have been vocal about your funding side of the equation and what you expect there. Can you give us an update or more color of how you are positioned for the funding side of the balance sheet should rates rise and how much you expect to potentially maybe move off your balance sheet as it gets repriced into different types of products? + +Question_4: + + My final question is there has been some talk about the regulators, the Federal Reserve maybe increasing the capital ratios for the largest banks to even higher levels than what you are mandated today to carry. Do you guys have any thoughts on whether that may actually ever get through that they may even raise the current Tier 1 common ratio numbers? + +Question_5: + + Good morning. Jamie, first let me say it is nice to hear you on the call and that you are sounding good and that the prognosis sounds great and I wish you all the best. + +Question_6: + + Just a follow-up on the interest rate points first, second. I know you guys have been very focused on the potential for a deposit drain as things are handled somewhat differently by the Fed given the current circumstances when they eventually do raise rates. +Is there any change in that thinking of the potential for a $1 trillion-ish deposit drain and maybe $100 billion for yourselves on the basis of the Fed minutes from last week which maybe were a little contradictory in terms of the mechanics to that Peterson Institute article, which has been I think (inaudible) in everyone's thinking? + +Question_7: + + And given where you are on LCR, do you feel like JPMorgan is completely as positioned as it will want to be at that time, or is that still just a build that is going to take place in liquidity between now and a year from now or so? + +Question_8: + + Great. The other thing that I would like to touch on is the expense guidance. Obviously, it has ticked down somewhat again, and that is probably partly because of the revenue outlook that we are looking at for this year. But is there anything implicit in that in terms of what we should expect for expenses beyond 2014 and maybe you can elaborate a little bit on how you are thinking about core expense reductions given a consistently pretty sticky revenue environment? + +Question_9: + + Okay, that is helpful. And then one final one. + +Question_10: + + That is obviously important. One last one for me, there have been quite a few areas where you have pulled back in order to ensure the ability to monitor and be in compliance; third-party mortgage origination was one, trade finance and in particular correspondent banking, internationally another one. Is all of the foreseeable pullback in areas of business for control reasons pretty much known now or are there other things that we should expect that you might be looking at? + +Question_11: + + Let me just follow up on it then to make sure that we don't over model revenues. Are there still meaningful incremental revenue declines that we should expect from all of those areas that have been discontinued? + +Question_12: + + So we have seen a greater number of sales in the repo market. It seems to me just an issue of available collateral. But I am curious to get your take how much we are supposed to carry on it and whether or not some of the actions by Treasury in the reverse repo market can take care of that? + +Question_13: + + Okay, good. It sounds like you are not losing so much sleep over it. + +Question_14: + + Marianne, you mentioned a comment when you talk about C&I loan growth, I just wanted to get a clarification. Last quarter if I remember correctly it was about flattish on a year-on-year basis and you spoke about price competition and some discipline on JPMorgan's part. This quarter you have a little bit more year-on-year growth. Still mentioned the comment about discipline but I just wanted to get a clarifying statement. Is just growth a little bit better, is the backdrop a little bit better and you expect to participate in that a little bit more? + +Question_15: + + I appreciate that. Last one is I just couldn't help notice the balance sheet is now at $2.5 trillion. In your discussions, I know we can't purchase our way through without jumping through a lot of hurdles, but do you feel constrained on just sheer balance sheet size? And the reason I ask is I look across most of your franchises, they are growing and they are growing nice and they are growing organically through the investments you have made. I just want to know if anybody is bringing up the issue of just absolute size? + +Question_16: + + Eventually maybe a little capital return too. + +Question_17: + + Good morning. A couple of questions. One on FIC, one on expenses and one on RWAs. Just on the FIC line, you mentioned that it was a little bit better in the last part of June and then you went on to say that the outlook is for current environment to persist. So I just wanted to ask a little bit about which environment you are talking about just the overall quarter because the quarter ends up being a little bit better than expected right in the mid part of the quarter. Are you suggesting that the end of June activities is likely to keep a positive tone to what you are expecting in the third-quarter? + +Question_18: + + Okay, and that is 15% year on year? That is 15% plus or minus down year on year? + +Question_19: + + Okay. And then on the expenses, you have outlined a couple of different areas that you are working on to get the expenses down. The question is on why in the IB you've got the repositioning cost called out specifically because I'm just kind of thinking out loud that you have got to invest to get expense saves in a broad set of areas of the business. So why call it out in the IB? Does it suggest that we will see more repo costs coming through in other areas over the next several quarters as people roll out their expense plans? + +Question_20: + + Okay, but in the other areas where you are also working on expense programs you don't expect that you are going to have any of those one-time repo items, repositioning items? + +Question_21: + + Okay, all right. And then on the RWAs, you indicated that RWAs were up a little bit on operating risk, down on marketing credit risk and then you went on to say that was model related. Is that all your internal models, is that based on consultation with regulators? I am just wondering why the operating risk would have gone up for you given that you had your big settlement a couple of quarters ago. + +Question_22: + + Got it. Okay. And then Citi settled the other day including again CDOs, you had some CDOs back in the day. Does that impact how you are thinking about the operating risk charges? + +Question_23: + + Following up on loan growth commentary, net interest income dollars seemed a little better than you expected at the $11 billion, are you still looking for that to be flattish kind of top of the house NII for this year or is the outlook a little better given the loan growth trends? + +Question_24: + + Okay, then in terms of share buyback --? + +Question_25: + + Okay. So, yes, with the 5% core loan growth you would expect NII to be relatively flat this year and flat to up a little bit next year? + +Question_26: + + Okay. And then on share buybacks, could you give us some thoughts about how you are thinking about using your buyback approval for this year? Did you accelerate some of the buyback activity on price weakness this quarter and do you expect to do more in the second half because the RWA reductions are starting to happen? + +Question_27: + + Okay, that is helpful, thanks. On the mortgage servicing revenues, the outlook that you gave for the $600 million roughly, does that include any MSR risk management gains or do you assume none in that? Can you just clarify that? + +Question_28: + + Okay. Last question on legal costs, this quarter they were mostly in the IB and Corporate. Any commentary on what type of issues you are currently accruing for and also could you clarify whether you have any remaining outstanding material mortgage litigation or is that mostly settled from the mortgage area? + +Question_29: + + First, why did trading do better than the guidance earlier in the quarter and did that relate to the 8% increase in trading VAR which was a little surprising since volatility is still so low? + +Question_30: + + I always prefer more guidance than less. I have two very simple questions with complicated answers I guess. But you talked about loan growth. Is this the inflection point for loan growth? On the one hand you said there is some inventory build that is helping, on the other hand you are not seeing CapEx yet. And two quarters ago you said second half of the year loan growth should really accelerate. Do you still believe it should accelerate from this level? Is this the acceleration or are you revising back some of those expectations? + +Question_31: + + And if interest rates increase at some point, that could hurt the ability of commercial and commercial real estate borrowers to service their debt. How much cushion is there before you think that would become an issue or is that just not a factor? + +Question_32: + + I guess the more general question is what areas and credit are you watching the most? I think, Marianne, you said auto is the best since 2006 and that has been an area mentioned by regulators. Is that the point of greatest concern or are there other areas you are watching more closely? + +Question_33: + + Good morning. Can you remind us the timing of the private equity sale and how much capital is against that? It was roughly a breakeven business. I think you have about $6 billion of outstanding and what does that mean in terms of freeing up capital in a Basel III and SLR world? + +Question_34: + + Okay, $3 billion. That is helpful. And then the commodities business you gave us the $2.8 billion of annual revenue (inaudible) and said it was ROE dilutive but care to give the expenses and capital against that? + +Question_35: + + Okay. And then lastly, this is probably an obvious question but the $100 million gain related to IPO would have been booked in the equity trading business when you were talking about the impact of the markets revenues? + +Question_36: + + Great. Thanks. Most of my questions have been asked and answered but could you talk just a little bit about how much of the mortgage business costs are fixed and how much you would be willing to let the volume decline? + +Question_37: + + Great, thanks. Just kind of a small point, you mentioned a reserve release on the private student lending business. That was a business that you had kind of talked about potentially exiting I guess back in late last year. Is that still on the agenda? + +Question_38: + + Thanks. I have two questions. One is kind of a detailed question but I just want to make sure I understood correctly. You were talking about equity trading revenues and I think you sort of said the decline was attributable to the equity derivatives business. So can I imply that then the year-on-year cash and prime brokerage businesses were flat and all the decline came from equity derivatives? Is that what you said? + +Question_39: + + Okay, that is clear. Just sort of a more conceptual question. I look at your core loan growth of 4% and obviously everyone has commented that is very strong and I guess about two times the industry level and kind of reconciling that with the comment you made about C&I loan growth is kind of in line with the market and you are kind of ceding some market share on residential mortgage for all of the reasons you have explained to us. +So I was just wondering if you could give some color on those areas where you are clearly taking share and just some outlook on how sustainable that is or is it just kind of a good quarter? + +Question_40: + + So all of those areas are areas you are targeting so they should feel pretty sustainable? + +Question_41: + + Thanks very much. I just wanted to step back for a moment and think about what has occurred in the context of the key themes from the Investor Day last February and it sounds like there is a couple of areas where things maybe are progressing a bit more slowly and you thought mortgage it sounds like maybe one of them. But I wonder if in the context of the goals that you laid out how you feel broadly you are moving against them and whether there has been any real departures from your expectations sort of at the halfway point of the year? + +Question_42: + + Right, so I guess the real heart of my question is we look at these financial results which are clearly better than expectation against a backdrop which maybe is certainly not better, maybe worse than what we thought at the beginning of the year. And I wonder if that then suggests that in fact things are accelerating ahead of the timeline or in greater magnitude than the discussion in February? + +Question_43: + + Maybe just lastly, one of the themes for this year has been maybe the narrowing a little bit of the client base based on risk or profitability profile. I am just wondering how that is progressing particularly with respect to the commercial bank? + +Question_44: + + And so -- and this is the last thing for me. But does that suggests that maybe we are getting closer to the point where the reported numbers in terms of the balance sheet -- the loan expansion and the core numbers will get closer to converging? + +Question_45: + + Thanks, good morning. So on the consumer business, I wanted to ask a question about the payment side and we have seen really good volume growth metrics and that turn in the origination volumes. Can you talk of just about what you are seeing in the underlying customer as opposed to what you guys are benefiting from activation and new card growth, just your general sense of the customer and spending? + +Question_46: + + And on that merchant piece, just can you just explain the disconnect between the volume side continuing to look better and then the transaction growth rate slowing a little bit recently? Is it a larger ticket size or are there some different underlying thing in the metrics? + +Question_47: + + So it is how it flows through to you guys? + +Question_48: + + Okay, great. And then my little question. Tax rate was a little low this quarter so your outlook generally speaking on the tax rate going forward? + +Question_49: + + Thank you very much. I know a lot of questions have been asked. But I want to go back to the mortgages a little bit, the 16 billion. The market was up depending on who you listen to probably in the $260 billion to $300 billion range but you guys stayed relatively flat and it looks like really you guys gave up market share with MBS issuance stuff that you sell to Fannie and Freddie and maybe you picked up more market share in the jumbo market. +Of the $5 billion that you portfolio-ed that you talked about, was that all jumbos and you could talk a little bit about maybe stepping away from Fannie and Freddie? + +Question_50: + + And Jamie, on a follow-up question on your utilization comments which I thought was very good, but a lot of bankers have talked about as long as deposit is growing, it is hard for that utilization rate to go up and we did see strong deposit growth and we are still seeing utilization rates. Should that deposit growth start to go down if we are seeing an uptick in utilization rates? + +Question_51: + + Good morning. So, Marianne, I actually had a question about the presentation that you had given last month at the Morgan Stanley conference. You alluded to a targeted loan to deposit ratio of roughly 70% through the cycle. And I suppose what I was wondering when crunching some of the numbers given the tougher treatment for loans versus high-quality securities under the LCR, whether there is a peak level of loan to deposit ratio or growth that we should think about given the constraints which exist under the new liquidity regime? + +Question_52: + + Thank. Actually that is a great transition for my next question which relates to pricing in some of the multiple binding constraints on capital that exist today. And some of the discussions that we have had with your competitors have suggested that some believe it is still a little bit too early to fully bake in the cost of managing to all the different capital rule sets that exist today whether it is risk-based, leverage-based or even CCAR. And it appears that you have been managing more actively to all the different constraints out there. +And in light of that, I was wondering whether you have seen any impact for more aggressive pricing by peers in terms of your relative market share in certain product areas particularly within the CIB? + +Question_53: + + Thanks and I suppose could you give potentially any context as to what event may prompt that repricing? Even if the leverage rules are finalized and efficiently implemented this year, do you expect that that is when you will begin to see a lot of your peers began to reprice some of these effects into their inventory or into their trading securities or are they likely going to delay at least the repricing until the rules are fully implemented which is going to be a 2018 event? + +Question_54: + + Good morning. I just wanted to follow-up on the SLR. It seems like the improvement you had sequentially was I think mostly driven by capital and the preferred issuance. Can you give us where we are in terms of compression trade and the impact, is it still a lot more to come or is that mostly in there? Then I guess any thoughts or updates on what that impact can be and if you expect that to be adopted by the Fed? + +Question_55: + + Okay, got you. And then maybe just -- I don't if it is related or not but I looked at your derivatives receivable on the balance sheet, it has been declining pretty steadily down 20% year-over-year. Is that reflective of just demand given low volatility and low activity levels or is there something structural there? Are you guys actively managing your receivables down or just trying to get a sense of the cyclical versus structural argument? + +Question_56: + + Okay, it is primarily activity levels. Okay. One last one on the CDO question I think earlier, I think we saw Citigroup settle with the DoJ regarding -- and they included CDOs. I don't think your settlement included that. Is that something that you think remains out there or just something unique to them? I know you did settle one complaint with the SEC a few years ago. Just wanted to get a sense of how you think about any remaining litigation risk around CDOs. Thanks. + +Question_57: + + Just a follow-up, Jamie, on the FHA commentary that you had. I am just wondering about the implications for how you hit the CRA requirements. Is there any interplay there? + +Question_58: + + So doing it in the FHA, you have got the Ginnies to their 4-year RWAs are lower, getting the same credit for CRA and loans is obviously a little bit more capital consumptive so that is part of the challenge? + +Question_59: + + So this is on the reps and warranties on the FHA? + diff --git a/exam/original-files/Problem_2_3_Sample_QandA/8_answers.txt b/exam/original-files/Problem_2_3_Sample_QandA/8_answers.txt new file mode 100644 index 0000000..58aca00 --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_QandA/8_answers.txt @@ -0,0 +1,301 @@ +Answer_1: +Yes, I mean, so, Matt, I would say we I think -- and I can't remember which quarter it was, but several quarters ago we put a slide out in the presentation that showed what -- it was last year -- showed what the business simplification agenda looked like. +I think if you go back and now look at what we have done, including what we were able to either complete or sign this quarter, OEP, the RPS business, GSOG, Commodities, we've certainly broken the back of most of the business simplification agenda. Having said that, it is an ongoing process and we continue to de-risk clients and industries and continue to simplify our products in mortgage and the like. +So I would characterize that the actions that we have taken by the end of this year are substantially all of them. But at the margin we continue to look at client by client product by product to simplify things. + +Answer_2: +So, we have talked before about the fact that when you take into consideration a combination of the leverage and liquidity rules together with our own point of view on positioning the Company for rising rates. So therefore our own point of view as being under invested in the duration perspective, that we have, we believe, a relatively optimized balance sheet. +Although it likes like we have a significant amount of cash, that is in part non-operating deposits that at some point will either flow out or be adequately paid for by the client return and in other parts is part of our overall liquidity. +I mentioned that subsequent to the US LCR rules being made final that although we had been reporting previously against Basel compliance in the 20%-plus range, so a buffer of 20%-plus. The US rules are more punitive in a number of ways, most notably that they look at peak outflows in 30 days relevant cumulative and also on higher outflow assumptions across the categories. Given that we are not compliant with a more modest buffer. So we would say that we are largely optimized. + +Answer_3: +So, the capital is relatively minimal in comparison to the overall Firm. So while it obviously is positive for us, it is not a noteworthy number. And the expenses, just to note that I said the ROE is limited over time; this is a business that was still being built and therefore hadn't yet reached a maturity stage or a stage where it was returning its hurdle. +It will take a little bit more time to take the expenses out so there will be a slight lag in removing expenses. So in the fourth quarter it will be more modest, but over time it would be a large chunk of that $300 million. + +Answer_4: +Yes. So we had a better third quarter than we had been expecting earlier in the quarter. We will see how the fourth quarter pans out. So, yes, it is the case that if we have a better fourth quarter and therefore a stronger second half of the year that our expectations for comp will be higher. +They'll still be well within our comp to revenue ratio range of 30% to 35%, I mean you saw for the quarter 32% year to date the same. So in large part it is going to be based on higher revenues in market. This quarter we also had higher revenues in mortgage and also in corporate. So that is the principal driver. + +Answer_5: +Yes, sorry. + +Answer_6: +Yes. Before I do that, you had a second part to your question on the cost of controls. Let me just deal with that very quickly. +We talked about the fact that we expect our control cost to reach a peak this year, that is still the case. So I would say that they are substantially in our run rate by the end of the year. +They will over time be able to come down; they will still remain elevated relative to historical because that is the new business world we are in. But we are going to be able to become more efficient, automate things, finish remediations, look backs. So over time that will provide leverage. +In terms of looking out to 2015 and 2016, while we haven't given specific guidance I will just point you to a few things. The first is we do expect to continue to see mortgage servicing expense decline on the back of delinquency and credit trends. +We would also expect to see improvements in the production space albeit we are -- there is a reasonable fixed cost base. But nevertheless, as you saw this quarter, we continue to make great progress in resizing that expense base. +In the nonmortgage space in the consumer bank, Gordon has committed to $1 billion in 2016 over 2014 principally but not exclusively driven by automation and efficiencies in branch staffing leverage and also the branch footprint optimization. +And then while we didn't quantify it, Daniel is very much looking at the expense equation for positive leverage that is reasonably significant over the next two years in the CIB. So I would say across the board obviously we are growing in asset management, we are investing in our businesses notwithstanding. + +Answer_7: +So at the beginning what I did say is that there are a number of masses in our legal expenses for the quarter, but in large part it does relate to FX. And consequently you can read into that that things are further progressed this quarter than last, but obviously we can't comment any further. + +Answer_8: +So just to talk about it, so we did $1.5 billion of buybacks this quarter, same last quarter. Obviously we have another $2 billion to go in terms of our approval. We don't know what the rule is going to be, it will come out before the end of the year, we will have to see what that says. +There will be a transition timeline, it will transition on the same timeline phase and timeline that the rest of the buffers transition in on, so through to January 1, 2019. So there is no need for us to overreact and race to compliance. +So we would do much as we have done over the course of the last two years, which is balance continuing to make good progress getting to wherever it is that we need to be, which we are not going to get at at this moment, against the desire to want to continue to deliver capital to the shareholders in the form of increased dividends and repurchases. + +Remember, you all have the forecast where CET1 goes up to 10.5%, 10.8% or something like that. When that new CCAR rules come out we'll probably go fine-tune what it might look like at the end of 2015. + +Yes, I mean the reality of the situation is sitting at 10.1%; we are in good company with the rest of the industry in the context that just given how CCAR operates it is highly likely that there will be overall accretion to capital in the industry over the course of 2015 and we will be no exception. So we will continue to accrete capital up towards and potentially above our 10.5%. But we are not going to recalibrate a target until we understand the rules. + +And (multiple speakers) one thing on the target, just when you see the rules yourself know that in our 50 to 100 basis point buffer the reason why we had a range was to allow in part for some of uncertainty and things evolving. And so, we would obviously want to fine-tune and put a finer point on our buffer. So it is possible that our buffer may not be as high as 100% too. So we will deal with all of that when the rules come out. + +And we have also been, remember, very careful the purpose here is to protect and grow the client franchise, meet the regulatory agenda and then we will adjust to all of these changes as they take place. The big ones we're going to know by the end of the year, TLAC, G-SIB and new CCAR. + +CCAR, yes. + +Answer_9: +So you would have seen our other where it came down slightly in the quarter from the second quarter on the back of model improvement and on data and portfolio runoff. So we are starting to see that bend now. It is the case that as we project forward to the end of 2015 the number that we showed you at Investor Day is still relatively good. It is probably a little higher than that. We said [1.5%] it will be support between 1.5% and 1.55% by the end of next year. +We are not in complete control around the timing of model approvals. We obviously are doing everything we can to be timely and then the regulators need adequate time to approve them. So we have kind of been a little bit more conservative potentially about the duration it takes to get models approved. But we are still on that same basic trajectory. + +Answer_10: +Yes, I mean, yes, there is a significant benefit. If you look at our disclosures you can kind of see the short end versus long end impact. Basically there is a significant benefit coming off of the short end. So we would expect to capture a significant portion of that in the first 12 months. But we obviously are looking for a more normal curve overall over time. + +Answer_11: +Obviously not to comment on everybody else's results, but our results were -- in terms of the size of the economic downturn, they were relatively in line. And our results were relatively in line with a few minor sort of enhancements to our process. So we weren't actually looking for materially changed results in our midyear DFAST. +So obviously we haven't had instructions yet, we are expecting them absolutely eminently, possibly as early as this week. In terms of guidance from the regulators on how to think about the bank holding company scenario for 2015 CCAR, to the degree that there are more and more stressful idiosyncratic losses or stresses on leverage or other things it could have an impact. But we have to wait and see. + +Answer_12: +So, Mark Carney of the FSB and the Bank of England Chairman said that two major things remain to finish kind of the too big to fail issues. One is how you deal with derivatives and the second is TLAC, and both of those will be done this year. This is the thing, has been done, it is a great example -- I think it was 18 firms who got together and came up in a very complex way globally had to deal with this in a way that the regulators. +And the Fed put out a press release and Mark Carney has been very positive about it and it was industry led. So we do think it does solve that issue. So all of the buy side will do it. It will be -- eventually all the sell side -- I mean the other way around, all the buy side will eventually want to do it because it is actually better for the business as a whole. +May be not better for one trading desk, but it is better for the business as a whole and it is a little coercive. So that the regulators are basically saying that to do further derivatives you are going to have to adopt these new rules. And we think over time a lot of people will do it. + +And just one thing there, the [GA] team does sort of break the back of the problem, but we are still awaiting actual regulatory guidance. So there is still the strong possibility that the guidance will be broader and we would encourage it to be broader, if nothing else for simplicity purposes, not necessarily because the GA team alone don't really achieve the results. + +Right. And we're also in a position where even if the buy side doesn't for some reason, that we would be able to manage that risk over time and it would diminish over time because they're the short duration of the derivatives. + +Answer_13: +Yes, so, I mean, our repo business is, as you know, substantially client driven and our clients are very interested in ensuring that they are giving us sufficient wallets to allow us to dedicate sufficient balance sheet to their business. So in that sense we continue to see repo as a strategic product for our client and a scarce resource, quite frankly. +So, it is obviously the case that as we understand new rules that meanwhile leverage rules have been for a while and we've seen leverage reduce in the industry overall. But we continue to have a strong and healthy repo business. + +Answer_14: +We are okay with the higher margins, generalized margin rules. And if they go to kind of a tri-party CCP thing that will be fine too. And it would alleviate other issues at that point in time. + +Yes. I mean between the CCP and I think the FSC even put out a framework last night that talked about cross industry including nonfinancial standardized higher levels of haircut that we are supportive of. So I think the combination of those two things achieve a great deal. + +Answer_15: +Yes, so, I mean I think, Betsy, we would -- we will do exactly with this what we have done with everyone else to date which is overall we are only going to put our balance sheet to work and allow our clients to use it if the overall relationship over time pays us a sufficient return for that. +We have the ability to do that somewhat methodically and so we are being very surgical and very strategic about how we use our balance sheet. But it is a core strategic product for many of our clients and they want to continue to be able to do that. +So, yes, we could, I mean if you look at the numbers, however you want to cut them, there is -- within our repo business we do have a match book, we have inventory financing as well, we have client suites in our short-term wholesale funding. So there are things we could do, we just don't want to overreact. + +Answer_16: +Yes. So, I mean we talked before and you will see more over the coming few months about our own wallet and payment capability so [Chase pay] and Quick Checkout where we would provide the capability for our customers to be able to have a much more seamless experience. Also for merchants to have a lower abandonment rate and continuing with the safety and security of tokenization and other methods. +So we are continuing to work on our own proprietary wallet and payment capabilities that will be piloted and then subsequently launched over the course of the next coming months. And then as obviously the case that we are out of pilot and in production on our end-to-end capability including [Chase net]. +So we are signing up merchants at a faster rate than we expected and, again, you will hear more about that later. But our ability to now negotiate bilaterally economics with merchants and provide customers with compelling reasons to continue to bring share to us is also something we are working on. + +So our basic philosophy has been that you, the customer, who want to be able to use your debit cards, your credit cards in a way that you want and that we want to make it available to you whether it is Apple Pay, in-store apps, other people's wallets, Visa wallet, our own wallet -- all which will have benefits, etc. +And as Marianne said, we think that we can also be friendly to merchants with data, with pricing, with simplified contracts. So we are trying to make this an ecosystem that works better for everybody and is far more secure. I have customers on both sides and I'm far more secure. + +Answer_17: +Yes, I was just estimating it, I was taking a guess that it will double over the next four or five years. + +And I think it is fair to say, Betsy, that what we are seeing inside the space, not surprisingly, is this relentless constant and evolving set of attacks and we need to be constantly evolving and constantly vigilant in response. So it is entirely reasonable to assume that we will continue to increase our investment over the course of the next several years and we'll -- so it will be larger and we will let you know. + +I should clarify that was quoted in the press not accurately because this is one area where the government and businesses have been collaborating really well. And for a long time of course all these government agencies -- and I think we need that because the government sees all kind of attacks and they have a -- they are a fountain of information. +And then also the industry itself collaborates, which is we share information with other banks immediately when we see something happening. So maybe even if something happens to you, you can help one of your brethren avoid a problem like that. +And then cyber goes beyond just yourself. It's making sure that all of your vendors you deal with have proper cyber control, that all the exchanges have proper cyber control. So this is -- we have identified this as a huge effort. We've been very good at it until this recent breach, which we are not going to make excuses for. We will invest any and all things we need to do to get it right. +Our customers are protected, which is critical, but we don't want these things to be happening. But it is going to be a battle. We have already seen a lot of very, very serious -- far more serious than personal data being taken where Social Security numbers, security codes, account numbers, etc. +And we do think that unfortunately there are going to be some wins and losses in this. This is not going to be one of those things where it is going to be absolute and we don't want to be sitting here saying you can absolutely be protected because we think that will put you in a false sense of security. + +Answer_18: +Yes. Tokenization will be more broadly used and that avoids a certain type of fraud, but not other types of fraud. So you have to look at each one of these things and say, what does it accomplish. + +And that certainly helps across the payment space, but there are other areas of vulnerability, obviously. + +And there is (inaudible) security about who came to what systems, when they use private computers with private lines as opposed to public computers from home. There are all these things we're all doing and we've had some great people come in, audit us, and this is one area I suggest to most companies, get someone to come in who is an expert at this. We have our own attacker system where we have our own people trying to get through. So we are always trying to look where we might have a weak spot. + +Answer_19: +I don't think it makes it less attractive. For the one reason if you look at one contract that someone may have in one fund or someone like that yes, it may make it slightly less attractive. But if you look at the improved safety of the system I think it makes it more attractive. +So, if people believe that doing this makes whole system safer, every institution will say well, on the one contract side I would prefer to have the optionality, but for the total I like the fact the system is protected and we have time to work all this out. + +So if the resolution works that is really, really good for everybody. I mean everybody would have preferred that there was a resolution process in place for Lehman. The pain and suffering would have been far less across derivatives even though they didn't have the same -- they had more protection derivatives at the time. + +Answer_20: +So I think just an important point of clarification for what it is worth is that the FDIC found the industry's 2013 plans not credible, the Fed did not. So it wasn't a joint agency conclusion that point. And so, we haven't had comments on the 2014 plan yet. +Having said that we, talking for JPMorgan, we made substantial progress even between the 2013 and 2014 submissions. We are in dialogue with our regulators to understand even more detail of what they found as being the limitations or the vulnerabilities in our credibility of the plan. And we are committed to remediating them by 2015. +It has had little bearing on our business simplification agenda because it was already a very broad and appropriate agenda. But we continue to work on all number of things around the place, [crystal] operations, legal entity simplification and we will continue to do so. + +Remember the FSB led by Mark Carney has made it -- be said publicly that the two big remaining pieces are TLAC, which should be done this year, and the derivative stay that would be common harmonization around the globe. And those two pieces are going to be in place and make resolution much more achievable. + +Right and we should add that obviously the [Issa] protocol was specifically pointed out in that feedback and the industry voluntarily resolved the issue I think very well. + +Answer_21: +No. So I mean, my point of view on this is that while we have started doing the filing more recently we have been well aware of the requirement for a reasonably long if not very long period of time and have reoriented our business to be compliant in substance with the requirements. +So the fact that we are producing metrics at this point isn't having meaningful impact on our business. It is the case that over the course of the next year between now and the compliance date next July, we do expect to, as an industry, receive feedback on that data and we will have to see how that progresses. But it is our point of view that our business is compliant. + +Answer_22: +Industry wide as people pushed LCR and capital and some of these rules down to the trading desk that we did see a reduction in inventories, etc. But our view is that market making is a critical role in society and it has to take place. We have 16,000 clients and so we really do focus on serving those clients. +We electrified more of it, some of it will go to clearinghouses, some of it will be -- but we want to be there for the clients. And you will see how the industry sorts out. Some people in the industry are making much more drastic decisions than others. Our decision has been to be there to make markets and just try to adjust to the new rules which may make it a little bit more costly to trade. + +Answer_23: +I think it wasn't the reporting requirements, I think it was pushing down of LCR, the cost of capital, the cost of debt and the traders reduced their balance sheets a little bit and they were a little more cautious how they use a balance sheet. And that is industry wide. And then some people said we simply can't stay in these areas. I have seen people exit certain trading areas. + +Yes, I mean, repo is a good example of that where the level of, not concern, but the level of dialogue with clients around our willingness to continue to commit our balance sheet to that business has increased because others are less willing. And so, we are seeing some of that for sure. + +Answer_24: +Yes, okay so let me give you the down piece of it. One of them is not timing, it is just a continuation of a trend where trade finance loans are down substantially year over year (technical difficulty). And so when you look at it the overall loan balance is being impacted by trade, markedly. And then on the client overdraft side, that is something that is a little bit lumpier, you see. +So those two things driving it down. But the point to the comment was a little bit -- not to trivialize reported loan growth, which was still positive, but with those masking underlying performance in our credit portfolio and HFI loans. So our more traditional credit lending continues to grow and grow at 10% plus pace. + +Answer_25: +So I think a reasonable point of view on that would be at the lower end of that range, at the 50 basis points. So remember, when we -- obviously we will refine it and we will update you. But when we have thoughts about having a buffer it is there in order to protect us from a range of issues including capital volatility driven by AOCI. +We regularly and routinely stress our portfolio to understand how much stress we could see in AOCI in a short period of time and that is going to be one of the principal drivers. So I would say is that a reasonable sort of benchmark for the level that we would go to. +That doesn't mean we have to have that buffer in totality. As I said, buffers phase in between now and January of 2019. So whatever we decide it is, however we communicate that to you, that as well of all of the other buffers, capital conservation buffer and G-SIB we will phase in. + +And CCAR may still be a limiting factor, so --. + +Yes. I mean the reality -- as Jamie said, the reality is that the way CCAR is operating, while there has been good progress in the communication and dialogue with the regulator, the reality remains that it is still not clear, either quantitatively or qualitatively, exactly how everything is working and therefore it is unlikely to be the case that in this cycle that you are going to see 100% or greater than 100% distribution. That is my view. + +Answer_26: +Yes, so, I mean, just before we sort of get onto the business-by-business lens on it, I mean the reality mathematically is obviously true that if we have higher capital we would prima facie defacto have lower returns. But the reality hasn't been that way over time. So you know acutely that we have added significant capital over the last however many years and have been able to, over time, continue to reorient the business and optimize against it to deliver strong returns. +So could there be a decline in returns. Obviously we will have to see what the rules look like. Clearly at the moment the most clear and present danger relates to higher G-SIB surcharges on short-term wholesale funding. So in the first quarter impact of it would obviously have an impact on directing those businesses and products in the CIB. But obviously if the Company is holding more capital we will look more broadly. +But I don't think it is a foregone conclusion that you are going to see a pro rata decline in our returns. And obviously we are continuing to focus on our expenses in making sure that the overall business is as efficient as possible. + +Answer_27: +Yes. So I mean our 10% ROE, 13% ROTCE, remember the target is an ROTCE target. It's obviously -- right now in 2014 we are in a bit of a cyclical low in a number of ways and elevated expenses. So it is cyclical lows in mortgage, at least for the first half of the year cyclical lows and some secular headwinds in the market space. +Yes, we are reaching a peak in terms of control expenses, so that is in part contributing reserve releases are lower albeit that credit remains benign, but at a relative matter they are lower. But we are staring efficiencies in the face across our businesses over the course of the next two years. +So control costs will decline, CCB will deliver improvements in expense, CIB will also, rates will be a meaningful piece. Clearly you've seen our sensitivity to rising rates is relatively significant, but it is not the only piece. When the economy generally recovers, when loan growth recovers and volatility recovers, all those things, good things happen. + +Answer_28: +Just to talk about what will be included in CCAR, the truth is we don't know. So what you have seen we have also read. But that doesn't constitute any kind of guidance. We haven't received guidance yet, so we are going to have to wait to see that. It wouldn't be entirely surprising if there was some sort of leverage stress in there quantitatively; I can't speak to qualitatively. +And then, yes, there has been more stringent guidance on leverage lending from the regulators over the course of the last year. And we have taken a fairly strict line on applying that. So it has in part been one of the reasons why we believe we have seen lower loan growth in some of our business than we would otherwise have seen. + +And it is going to get a little stricter on the refi part of the leverage loans. And obviously whatever the terms are, we will meet the terms and some of that business will go to nonbanks or some banks who are not regulated by the OCC and the Fed. + +Answer_29: +It is still relative to 20-million-something customers in -- households and 23 million, something like that, households in the retail sales space is still relatively low. From recollection, and we will check the numbers for you, I think it is in that 2 million to 3 million range. But nevertheless -- no? + +Mobile was much higher than that. + +Mobile is higher? Okay, we will get back to you. + +Answer_30: +I'm sorry, I'm sorry --. + +I'm sorry, it's 18 million. + +Yes, it is 18 million out of --. + +18 million. + +I don't know is that individuals or households? It's a huge amount. + +Customers. + +Yes, customers. + +Sorry. + +Answer_31: +Look, again, our view is to, if you are a client and you want to use your Apple phone to pay with NFC at a merchant, that is fine, we don't want to say you can't use your JPMorgan Chase credit card or debit card. And like we said, we're going to be in other people's wallets too. And we're going to have our own which we think will have some competitive advantage. +So will it cannibalize? Sure. But we are not against cannibalizing our own business or disrupting ourselves if we are building a better business and are gaining share. Our goal to gain share. We do believe a little bit in -- you know when Jeff Bezos says, your margin is my opportunity, we want to be the people that are coming up with the new ideas and stuff that are getting more of our customers using our stuff and happier. And if it reduces certain margins somewhere, so be it. + +Answer_32: +Yes, look, if you look at year-over-year trends, they continue to be in the -- I mean I think the first quarter year over year was 4%, 8% in the second, 7% in the third. I think we are not expecting those year-over-year tends to decelerate. +Obviously quarter over quarter things can be impacted just by the timing of closing loans. So fundamentally I would say, no, we aren't seeing significant deceleration quarter over quarter within continued relative momentum. Solid across the board with obviously more challenges in the C&I space. + +Answer_33: +Relative to the 58 plus or minus that [was being said], no, it is principally in higher revenues on higher market performance. + +We always said that might be the case. + +Yes. + +So we are meeting our overhead numbers and the comp itself will bounce around a little bit. Remember, in the old days we used to break out IB comp in total for that reason. But --. + +Yes, sorry. + +Answer_34: +Okay. So just in terms of what is our binding constraint at the moment, it is CET1, so Basel III advanced capital, risk-based capital at the margin. So it is not to say that the other ratios leverage liquidity and the like aren't [comfortably] around it. But that -- and even stress capital. But that is currently our binding constraint. +It is very hard for us to give us a point of view where you should do this new model three years out when we are staring potentially new rules in the face in the next two months. As I said earlier, we are expecting over the course of the next 12 months that we will continue to accrete capital at 2% or above our 10.5% which is basically in-line with what you guys all have in your models. +Beyond that it is our expectation that, hopefully anyway, putting new rules aside that by the time we are in our fourth or fifth cycle of CCAR when you've made substantial industry wide progress in the sort of non-quantitative aspects of CCAR where we have more credible resolutions and the like that we will be able to me more aggressive in our ability to seek capital distribution capability. +So outside of any changes in rules we would hope at the end of 2015 into 2016 CCAR to be able to have -- payout ratios are much higher. But we will have to see. + +Answer_35: +Yes, there is. So about half of that I would call -- approximately half of that I would call relatively normal, but included in that result there is actually a one-time item associated with accounting for the previous interest accrual that we released in the quarter, which is one time. You should expect that interest expense to go back up next quarter to something more normal. + +Answer_36: +A little less than $100 million. + +Answer_37: +Yeah. So I think -- yes, it is our -- it is our belief that we should be able to manage the ratio to be stable to improving over time, ultimately getting down to something much more in the mid-50%, but that is dependent on revenue growth associated with rates but not limited to rates. +So in the absence of rate but, by the way just to point out, that it is still our case that based upon continued improvement in the domestic rate economy that rates will start to rise in the middle of next year. But having said that, even without rates we would hope to be able to continue to maintain the discipline to have that ratio be broadly flat to down. + +Answer_38: +So since we talked about the $100 billion estimated deposit outflows associated with liquidity draining out of the system, remember that was predicated on believing that it was possible that the Fed would use the reverse repo program much more -- in much more size than is likely to be the case today for two reasons. +One is that obviously they have made changes to the term deposit facility that allows them to now be LCR eligible, which is helpful in terms of providing another tool in their toolkit. +And the second is that in September, as you know, the RRP was capped in total at $300 billion. That cap may or may not be permanent. I'm sure it will be recalibrated over time. But it looks like it will be unlikely to reach the $1 billion that would have driven the $100 billion -- the $100 billion -- sorry the $1 trillion that would have driven the $100 billion. +So. you can make your decision about whether it is $300 million or $500 million in the fullness of time and scale our operating deposit outflows back relative to that, knowing of course that it is already in operation at $300 billion right now. + +Answer_39: +Yes, Brennan, we haven't disclosed that. I would -- a large chunk of it is client driven, that is what we will say. + +A large chunk -- a larger chunk of it -- the larger chunk of it. + +We have also lengthened the firm financing part of it --. + +Yes. + +-- to be more compliant with LCR, etc. + +Right. + +Answer_40: +So I would square it in two ways. The first is already did have a better performance in the third quarter then would have been anticipated in our previous guidance given that that guidance was given during the sort of harder times of the second quarter. So that is already in our run rate so to speak in terms of the comp that would accrue to that. +And then if you sort of go back and, in the fullness of time, look at the transcript, I did say if the performance continues into the fourth quarter. So it will depend. +We have always said, and evidently maybe we should strip out comp from our adjusted expenses. But we have always said that the adjusted expense absolute number in any period is obviously going to be calibrated to the performance of the market-related businesses. And clearly you would wave in good revenues every day at a 32% comp to revenue ratio. So that is really all we were saying, nothing more subtle than that. + +Answer_41: +No, no, it is not possible to talk about it in any more detail, I am afraid. + +It's just -- suffice to say that we are working with a number of regulators across a number of jurisdictions. + +Answer_42: +So you are right that when you roll forward beyond the first 12 months you do get the benefit of being able to continue to reinvest deposits as they mature up the curve in terms of their invest -- the underlying investment. So that is the compounding effect of what you are seeing in our earnings and risk shock. +But what we showed I think in -- I'm going to cease to recall it, but maybe it was in the Barclays conference in 2013 -- is that you would expect once rates start to rise, if they rise in a somewhat expected fashion. So obviously it depends on what rate [party] you want to put on that, that you could expect the cumulative NII to be in our [impact] in three to four years. + +Remember the benefit is more for the first hundred, a little bit less the second hundred, a little bit less the third hundred, a little bit less the fourth hundred, because there is increasing repricing of deposits at that level. And we don't know exactly what the yield curve will be four years out, but --. + +Right. + +And also we do embed in that our own estimates of competition and repricing. + +Yes. + +But --. + +Yes. That is a very good point actually, Brennan. Our scenario does contemplate not only a more normal loan to deposit ratio, more normal interest bearing versus non-interest-bearing deposit and also a higher (inaudible) on retail deposits just given the LCR competitive dynamics, technology advances and the like. So to the best of our ability we've tried to bake that in and that is included in our number. + +Answer_43: +Right. So the deposit -- so in part not totality, in part the deposits that were likely to outflow through the RRP were non-operating deposits. And non-operating deposits we do not count for significant liquidity value in the Firm; we fundamentally have them on deposit at central banks at the Fed. +And so, if they stay -- we will come back to whether we would be willing to let them stay, but if they stay they will continue to basically be treated in that way. And they are not included in terms of our assumption around asset sensitivity and forward-looking NII. +Obviously over time we are in the same way as we talked about repo we are looking at non-operating deposits for our clients in the context of their overall relationship. And so, that is another valuable use of our balance sheet with leverage capital and the like against it. And in the fullness of time we will expect the overall relationship to pay for that. But we are going to wait and see some of those dynamics play out. +So other than that I'll just go back to the earlier comments I made that we do have a high level of HQLA, not in [cash], not in securities, but it is in order to make sure that we have adequate liquidity both under our own stresses most importantly, but also under LCR and NSFR. And we feel good and at modest buffers relative to them. + +At the typical quarter end a lot of large clients leave a lot of deposits here which obviously are not necessarily good for us in terms of LCR or capital, etc., and we will be looking at how we manage those client relationships over time too. + +The other thing you remember of the securities portfolio is that as rates go up the duration of that extends on its own. + +Correct. + +And so, we will be managing that. And, yes, we might invest it longer at one point, but we are in a very conservative position right now. + +Answer_44: +So we are continuing to see credit trends improve, delinquencies come down, modification pipelines -- all the metrics are coming down. Obviously they are coming down from a much smaller place this year than that were last and the year before. So the pace of improvement or the relative pace is slower. +But we are expecting that to continue down through $500 million and into the $400 million's in 2015. And then just more longer-term, you know that we are focused on ensuring that through the next cycle we have a smaller delinquency portfolio. And so, a more normal level would be substantially less than this. + +Answer_45: +Sorry, that is a longer-term view. + +Answer_46: +Yes. So I mean we talked last quarter about the fact that we had loss share, a combination of things, primarily our strategy around the government mortgage space but also a little bit of share in the what I would call in our target segment. So we have made that back. +So in some part it is just continue to leverage our balance sheet properly, do very granular marginal pricing to really focus on changing and improving our customer operating processes. So across the board we just continue to get very granular and try and be as competitive as we can. + +Answer_47: +So, just to be very clear, it may be slightly -- (inaudible) slightly higher than Investor Day in terms of our guidance. So, look, obviously any guidance that we give you, and no good deed goes unpunished, but any guidance we give you is always predicated on based upon what we know today. And so, if something changes that would change that point of view we will obviously have to recalibrate it. +But just prima fascia having the requirement to have extra long-term debt or loss absorbing capital and/or capital wouldn't necessarily prima fascia change the overall RWA we have. I mean you have to be careful to ensure that by having higher levels of capital there's not an incentive to want to stretch in the credit box, but we have very tight credit discipline. So I wouldn't see that being a material change in the outlook. But obviously if there is a change in rules that directly affect RWA that would do. + +Answer_48: +Yes, I mean, look, it is the case that a lot of refinancing has already happened, so the debt maturity wall is smaller, although rates are lower than we may have expected at this point in time. So I would -- so, therefore yes, it is reasonable to assume that there is going to be some continued headwinds. But having said that, I think there is going to be windows of opportunity. So we are going to -- M&A and ECM are more constructive and likely to be buoyant, but I think debt capital market still has windows of opportunity. + diff --git a/exam/original-files/Problem_2_3_Sample_QandA/8_questions.txt b/exam/original-files/Problem_2_3_Sample_QandA/8_questions.txt new file mode 100644 index 0000000..113639b --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_QandA/8_questions.txt @@ -0,0 +1,155 @@ +Question_1: +Can you just give us a sense of what is left in terms of simplifying the model? Maybe split it between the CIB and consumer if that is a good way of approaching it. + +Question_2: +Okay, and as a follow-up, somewhat related, but as we think about having more clarity on the capital rules and specifically the supplemental leverage ratio as well as the LCR, is there some opportunity for optimization of the balance sheet now that you have more clarity on those rules? + +Question_3: +Okay. And then just lastly, the $300 million of revenue going away in the fourth quarter, what would be the expenses and capital against that? + +Question_4: +Marianne, I was wondering if you could give us some broader context on the core expenses. Is a principal driver of the updated outlook around the $58 billion -- is that just comp? And can you remind us where you are on the compliance control expenses in terms of leveling off there? + +Question_5: +And as we look out to 2015 (multiple speakers)? + +Question_6: +As we look out further to 2015 and 2016 can you give us a reminder of where you are looking to reduce the core expense base and get some savings on a one- to two-year basis? + +Question_7: +Okay, that is helpful. And then on the legal expense, did you give any color in the beginning on what was that for this quarter? And in terms of the FX and LIBOR investigations, are those at the stage yet where reserves can be built or can you offer anything on that? + +Question_8: +Okay. And then just in terms of share buybacks and capital levels, was wondering about your thoughts on the prospects for higher G-SIB buffers in the US. And how are you going to balance in the near term kind of your -- growing your space capital against executing the remaining buyback authorization that you have? + +Question_9: +Okay. And Marianne, just on that point, you had some RWA inflation in the first half as you waited some model approvals you are waiting for I believe. Where are you on those model approvals and your expectations for kind of the ratio of risk-weighted assets to total assets as we move forward? + +Question_10: +So first question on -- deposit growth has been growth and I guess I would love to see higher rates in loan growth. But you are positively positioned for the parallel shift up. I guess my first question is how does that change in more of a flattening environment that we are experiencing right now? Do you capture most of the benefit anyway just getting off zero on the short end? + +Question_11: +Okay. Just a -- I know we are not supposed to read too too much into it, but in everyone's mid-cycle [DFAST] results I think everyone was calling for -- or the big banks were calling for higher losses and lower PPNR in general relative to your own self test from the previous year. +Is that conservatism? Because it is a little different relative to the commentary about an improving economy, a little bit better loan growth, good expense control, things like that. I'm just curious what we are supposed to take away from that mid-cycle. + +Question_12: +Okay, okay, last one. There are a couple of articles on rewriting of banker's agreements between major dealers to resolve some of the early termination rights issues, which obviously is going towards the Fed's issues on living wills. +A, did that actually happen or is that just being talked about? And B, does it resolve the issue in the Fed's -- I know you can't speak for the Fed, but does it resolve the issue or do you still have the client side to deal with over time? + +Question_13: +Hey, a couple of questions. One is on just RWAs in general. There were some articles around potentially shifting some of the repo activity to more of an agent role than principal role. I don't know if that is one of the ways that you could potentially have a light impact maybe on RWAs but on total footings to help with the ratios. Is that something that is being considered? + +Question_14: +Would you be supportive of an industry move towards shifting repo to more of a CCP environment or no? + +Question_15: +Okay, no, that is great. I asked the question in part because as people are concerned about things like the SIFI buffer increasing and other regulatory capital requirements, I'm just trying to tease out what other options you have to do your client facing business but yet maybe shrink the footings in a way that deal with these ratios without having to, quote/unquote, break up the bank. + +Question_16: +Okay, thanks. And then just separately on the payments discussion. In your prepared remarks, Marianne, you highlighted that you are delighted to work with Apple Pay but that you are also working on some other things yourself. Could you speak to what other things you are doing independently? + +Question_17: +And I think is it accurate, Jamie, that you mentioned at a recent conference that you were looking to double the spend in cyber security, is that right? + +Question_18: +Those are all great points. I mean, you could imagine tokenization moving beyond just payments to any interface with clients at some point? + +Question_19: +I just wanted to follow-up first of all on the question that Glenn asked about the change in the derivatives contracts. From your perspective doesn't this fundamentally render the contract less attractive for users because of the loss of the automatic bankruptcy preference? And if so, would you expect this is one more potential pressure on the derivatives revenues that you've talked about in the past potentially depressing your revenues by as much as $1 billion? + +Question_20: +And while we are on that topic then, another thing that happened during the quarter obviously was the Fed and FDIC rejecting the living wills. And I was wondering if you could give us a sense for what changes that might have provoked from your point of view in terms of accelerating some of the simplifications that you were talking about earlier? + +Question_21: +Yes, fair enough. I mean I think a lot of times the press reports forget to pull together all the pieces like that. I hate to beat the regulatory horse too hard here, but one of the things that we were hearing towards the end of the quarter was that our clients were telling us that they were seeing a significant fall off in liquidity in some aspect of the credit markets in particular. +And I was wondering, is there any link between that and some of the new filings that you have had to start doing on a daily basis for -- not just you, but obviously all the dealers on liquidity? And I think some of the Volcker data gathering has started as well. And I was wondering if there was any linkage there? + +Question_22: +Okay, that helps. The last one for me -- sorry, go ahead. + +Question_23: +But what I think you hear you saying is that the recent imposition of some of these reporting requirements did not in itself have those liquidity impacts? + +Question_24: +Got it. And then the last one for me -- Marianne, you gave some clarification around loan growth in the CIB. But I am not sure I quite understood it. Basically you said the minus 5% headline number was affected by a couple of it sounded like one time-ish kind of things and what the underlying was. But as I said, I'm not sure I really caught your drift. + +Question_25: +Can you share with us -- obviously the federal reserve is asking for more capital for all the larger global SIFI type banks. What is the minimum cushion would you guys be comfortable running against? You mentioned your 50 to 100 basis points might be a little less. How low would you go in your cushion for meeting those new capital guidelines when they come out down the road? + +Question_26: +Yes. No, regarding the return on equity, at Investor Day you guys gave us the through the cycle target of 15% to 16%. Clearly I would assume that in this year's Investor Day when it comes up, if these capital levels are even higher now than what you originally thought when you gave that guidance, it probably will be a bit lower. +What lines of business do you think will see the lower ROE targets, if you decide that you need to lower it through the cycle from the 15% to 16% that you gave us last year? + +Question_27: +Is it fair to say that today's ROE in today's quarter of about 10% -- which obviously is below your through the cycle number -- is it primarily an interest rate issue that is holding it back or is there some other issue - the high elevated expenses that you are running due to all the new regulations and stuff? + +Question_28: +Shifting gears, if we look at leverage lending the federal reserve has come out recently concerned about some of the underwriting that is going on there. And I think they even pointed out that leverage lending now will be used in CCAR possibly from a qualitative standpoint. Can you guys give us any color on what your understanding is of what is going on with leverage lending today? And will it be included in CCAR? + +Question_29: +You guys gave some very good numbers on the mobile app usage by your customers. What is the penetration rate of your customer base that uses that mobile app? + +Question_30: +Okay. And then finally. you guys talked about Apple Pay --. + +Question_31: +You guys mentioned Apple Pay and the opportunities there. What are some of the -- where could you see the growth? But at the same time where can Apple Pay cannibalize some of your businesses or are there any that will be cannibalized? + +Question_32: +A follow-up on the loan question from before. You mentioned a little bit more caution with leverage loans. In the past you said you didn't want to compete too much in the commercial space if it's getting too competitive. There's been some current concerns about auto lending with regulators. +So my question is, slide 1 highlights that your core loans are up 1% quarter over quarter and the same slide in the second quarter said that core loans were up 4% quarter over quarter. So my question is, are you simply getting more cautious in the loans that you provide or is there a little bit less demand in the market? Really trying to get to is loan growth decelerating? + +Question_33: +Separately your expense guidance is now for over $58 billion, you said some of that is due to comp. Is any of that increase in guidance due not to comp? + +Question_34: +Separately which capital ratio is your binding constraint? And using that ratio, what should we use in our model three years out? And I know that's a tough question with all the moving parts, but what is your best guess? + +Question_35: +Okay. And then last question. On the supplement page 6, this is a smaller item, but it just kind of stands out. Your rate on trading liabilities declined from 48 basis points down to 12 basis points in just three months. Is there anything unusual there? + +Question_36: +And how much -- what was the dollar amount of that impact? + +Question_37: +Just wanted to follow up with two quick questions. The first is, Marianne, if we put together everything that you have said on expenses so far in this call, is it fair to assume that without rates the efficiency -- adjusted efficiency ratio of 59% can continue to improve in 2015 and 2016? + +Question_38: +Great. And the second follow-up question is, given your expectations for rates to rise in the middle of next year are you still -- and the progress that you -- continued progress you make on deposit share are you still expecting $100 billion in deposit outflows in that case? + +Question_39: +So, appreciate that the repo book is substantially client driven. Was maybe hoping that you guys could give us some sense for how much of your repo book is firm financing versus facilitation? + +Question_40: +Okay, that is fair. And I just wanted to try to square something here and maybe I am reading just a little too much into it. You had said that October on the capital markets side has been a bit mixed. But you have also at the same time brought up your expense guidance and it seems like it is driven by expected or potentially a component of comp and capital markets. +So are those two at odds? Are you just more optimistic that maybe what we're seeing here in October is not necessarily some sort of dramatic shift but a temporary bout in bad volatility? Or how can we square those two? + +Question_41: +Okay, okay, thanks for that. And then appreciate that there is not much color potentially to be added on this charge tied to FX. But just is it possible to let us know if it is tied to a particular geography? + +Question_42: +All right, that is fair. And then last one for me. So in looking at the NIM simulation that you guys have provided, and then taking a look at that in light of the interest rate shock disclosures you've got in your Q's, it looks like a 200 basis point rate shock adds about half of what you are looking for in a normalized rate environment. +So I guess does that mean that subsequent years sort of the benefit of rolling the portfolio into higher rates is going to exceed the higher deposit cost by about $4 billion to $5 billion? And then is there a particular time period that we should think about that or is it going to be too heavily influenced by competitive dynamics? + +Question_43: +A tactical follow-up just on the balance sheet. With the non-interest-bearing deposits basically being the fastest growing category of the balance sheet and the resulting asset, the deposit with banks also being the fastest-growing asset on the balance sheet. +Just within that context of what you just walked through with Brennan, I am just wondering what changes structurally with the way you think about reinvesting in the securities portfolio with rates as low as they are now. Loan growth is okay, but to your point you are being somewhat selective on -- and want to be careful with pricing and credit. +So, just from a -- more so taking the next year or so out, how are your thoughts changing at all with respect to what you do with these deposits given that they might actually not flow out as much given that change to the ROP function? + +Question_44: +Yes, okay. Got it. And then secondly, just two quick ones on mortgage. Default servicing costs have pretty much stabilized the last couple of quarters at a good level that you had talked about getting down to $500 million total by the fourth. And I am just wondering how much more room is there given that improvement in underlying trends that you're continuing to see for that to be a benefit to that cost side of the equation going forward? + +Question_45: +Okay. And I noticed that your (multiple speakers). + +Question_46: +Yes. And I noticed also that underneath the origination improvement this quarter there was a decent jump in correspondent. I am just not -- I just wanted to ask if you are doing anything differently in terms of market share opportunities on the mortgage side now that things have shaken out a little bit or any change in your underlying philosophy on where you are looking at originations? + +Question_47: +Marianne, I appreciated the color you had given on the RWA guidance. I suppose one thing that we have been hearing from a lot of clients, or at least concern from clients, is this notion of regulatory gold plating. Essentially the us regulators adopting tougher standards than those that are being enforced in other areas around the globe. +And I just wanted to get a sense as to how that is informing your thinking about RWA mitigation plans. You reaffirmed the guidance at Investor Day, but what should we expect in the event that a tougher capital as well as TLAC requirement is in fact enforced against US G-SIBs? + +Question_48: +All right, thank you. That is very helpful. And then just switching gears to the investment banking outlook that you had given. I appreciated the color which sounded quite constructive on the backlogs for M&A and ECM. And I guess not just you but the industry in general hasn't given much commentary on the outlook for debt capital markets activity. +It has been challenged this year. I think that was something which many of us had expected just given the strength that we had experienced over the last couple of years. But I didn't know if you can just provide some updated thoughts on that revenue stream in particular. + diff --git a/exam/original-files/Problem_2_3_Sample_QandA/9_answers.txt b/exam/original-files/Problem_2_3_Sample_QandA/9_answers.txt new file mode 100644 index 0000000..7b7c3e3 --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_QandA/9_answers.txt @@ -0,0 +1,343 @@ +Answer_1: + + So, Betsy, obviously two things. The first thing is that the most important time period when this is going to matter is when it's in full compliance and through the transition period in 2017 and 2018. So the result in the 450 bucket as we understand it is based on 2013 results, so we have to work over the course of the next three years to make sure we are maximizing every basis point of G-SIB and every dollar of capital to the fullest extent to deliver returns. +So rather say that to move down a bucket, just in general terms, is a fairly significant thing to do just given the types of things that are driving the overall score, but we're not complacent about it. We've worked in extreme granularity to make sure that from the very first basis point that we're certain we're maximizing the return opportunity for that within the context of the bucket we're in. So it would not be a trivial exercise to move down, but we're focused on making sure that we're optimizing the resources that is our most binding constraint. + +Answer_2: + + It's probably worth mentioning that while we were in or looked like we might be in the highest bucket relative to our peers, there were peers that were in higher buckets and they are not constrained by G-SIB but by CCAR. So it's likely to be the case -- we continue to believe it's likely to be the case that you're going to see the differential in required capital for a variety of reasons not being as wide as might be implied by the G-SIB. And so the key question is whether we're delivering the right shareholder value on the incremental capital, which we clearly think we are and can continue to do. +And so it is a -- we are trying to thread the needle, as you say, about making sure that we are as focused as we can on maximizing the use of that scarce resource, but within the bucket that we end up being, wherever that might be, that our key priority is to deliver the highest ROE and shareholder value we can, particularly in a world where others may be more constrained by balance sheet or leverage. So it is a fine dance and it's what we're working through. We'll obviously keep you updated as we continue to progress our plans. + +Answer_3: + + Yes. + +Answer_4: + + Yes, 50 basis points or possibly more. + +Answer_5: + + Okay, so let me start at the beginning, which is if you look at our Basel III advanced RWA on the slide, it's just a little over $1.6 trillion. When we were at Investor Day last year, we said that we expected to be able to provide reductions to that by the end of 2015 to get the number closer to $1.5 trillion on the back of model-related benefits, etc. It's still the case that that's the direction we will move in. Whether we get exactly to $1.5 trillion or slightly over will depend on the timing of some of those benefits. But that's directionally where we're going. So call it from a little over $1.6 trillion to a little over $1.5 trillion and we'll give you an update at Investor Day. +With respect to the assumptions, at the end of the day, we generate a lot of capital and if we need to comply more quickly than we intend to do, then we can clearly pull those levers. But we have always over the last couple of years had the approach of wanting to have a reasonable sense of urgency, but a measured pace to getting to where we need to be over the course of a transition period, as well as preserving the optionality to continue to increase dividends and do buybacks. That continues to be generally our philosophy and if you take -- I think I said this before. Don't read anything into this with respect to capital asks or anything else, but if you take analysts' estimates for the next two, three years, take a $1.5 trillion or even slightly higher RWA basis, you can continue to add 50 basis points of capital a year, as well as have meaningful buyback and capital distribution capacity and 50 basis points a year from a little over 10% over three or four years gets you to the other side of 11.5%. +So that's just an illustration of the capacity we have; not necessarily a commitment in terms of glide path, but that's the basis upon which we feel like we will be able to add 50 basis points this year, which is, on a fully phased in advanced basis, which is we think an appropriate glide path. + + + And we haven't really started to manage [E-SIFI], which we're going to do too now. + +Answer_6: + + John, she didn't say that. + + + John --. + + + We're going to meet our common Tier 1 with the buffer we think is appropriate and we're going to fill the rest of TLAC with the debt, subordinate debt and preferred we need to. + + + I think, John, if there's something you're looking at that we've confused you, I apologize for that. For the purpose of clarity, we expect to grow into our GSIB buffer, which will be excluded from TLAC with common equity and whatever the gap may be when the rules are finalized on TLAC, somewhere between nothing and something more meaningful, that's likely to be in debt issuance. + +Answer_7: + + I apologize. We'll take a look at that. + +Answer_8: + + So Guy, what the reserves that we have taken in the quarter represent is our best estimate based upon facts and circumstances as we know them at the end of the quarter with respect to ongoing dialogue and investigations, but they are not concluded. So as much as we would like to, we can give you no assurances with respect to the final conclusion and that's really all we can say about where we are on the FX matter. + +Answer_9: + + Just one quick thing on NIM before I talk about expenses. We don't manage to NIM. NIM can be reasonably volatile purely as a feature the amount of cash that we have on our balance sheet. What you saw this quarter in terms of NIM, which was a 5 or 6 basis point decline, whether you are looking at firm or core, is in very large part driven by incremental cash balances of close to $50 billion. + + + Which (inaudible) there for days. + + + Right. Some of which is there for days, some of which is accretive from an NII perspective, albeit modestly. So I think the more important measure, for us anyway, quarter-over-quarter is that our NII was flat, but flat and then just in terms of the flattening yield curve, we are more geared towards a short-end rates move and we're still expecting that to happen in the second half of the year. And so what really matters for us is Fed funds rate notwithstanding the overall yield curve. +With respect to expenses, yes, we will give you more updates at Investor Day, but I can continue to reiterate what we've said in the past, which is we would continue to expect to push our adjusted expense absolute dollars downwards over the course of the next several years and in combination with hopefully an improving economy and better interest rates move towards the 55% plus or minus, but 55% overhead ratio over the medium term. So you should expect our adjusted expenses in 2015 to be down, but we continue to have, albeit that we've reached a peak in the second half of the year, we continue to have elevated cost of controls and some of that leverage will be more in 2016 and 2017 than in 2015. + +Answer_10: + + So a little bit of what's driving the efficiency ratio in the second half versus the first half is seasonality in revenues and year-on-year revenues were down slightly. So obviously it's a little bit elevated relative to a 59% to 60% ratio, but obviously the absolute dollars are on a downward trend. Hopefully what we're going to see in combination over the course of the next year or two is we will continue to look at efficiency in our control spend. As I say, we're going to be looking at that in 2015 relative to the exit 2014 rate, but you're going to see more of that leverage in 2016 and 2017. We'll continue to bring mortgage costs down, cost within the branches down, but offsetting against that hopefully we'll have stronger performance in some of our businesses and show some expense growth. So overall trending down, but revenues are part of the story and they were down slightly year-on-year. + +Answer_11: + + So Mike, we'll give you the lowdown of that at Investor Day. You will see absolute reduction in dollars and we'll give you the outlook for the efficiency ratio then. + +Answer_12: + + So I would say a bit of both actually. So obviously, as you articulate, we do see seasonality, but we did reach an inflection point during the year where we're starting to see a little bit more demand anyway for credit extension, but I would say our outlook for Credit Card outstandings growth for 2015 is modest, low single digit growth, not higher than that. So a little bit of both, but we are flattered by seasonality in terms of the fourth quarter. + +Answer_13: + + So JPMorgan, taking it in three pieces, yes, we think it's very good for the consumer on balance and also for the economy on balance despite the strengthening dollar, so we think that the consumer spend, consumer even credit extension is likely to be positive as a result. From a trading perspective, there are pluses and minuses. The oil price volatility contributed to the softer quarter in the credit space, but was helpful as it related to the current season commodity space. So in fact, net-net neutral to maybe even slightly favorable. And then with respect to our traditional credit exposure to the sector, it's about 5% of our overall credit exposure. It's well secure, top of the capital structure where it's a name-by-name analysis that we do and we feel comfortable with where we are right now. It's a cyclical business and we're expecting downgrades, but we're not facing any meaningful issues in the face right now. But overall, oil a reasonable positive for the economy and consumers, so for JPMorgan from a financial perspective a modest issue, possibly more negative. + +Answer_14: + + So first of all, I dispute the fact that some investors -- some people wrote about it as a possibility because of excess capital and it's true; you have to hold more capital, all things being equal, it will reduce your returns. But even the people who wrote about that talk about the superior franchises, the benefits of synergies, the good things the Company brings to bear. So the first way to look at a business first and foremost has been and always will be what you do for customers, not what you do for yourself and your own returns, etc. and on the customer franchise in every business we're gaining share. We have good returns, we've got good marketshares, we've got good customer sat levels. The synergies are huge, both expense and revenue synergies, etc. and some, not all, disappear under the various schematics of a breakup or something like that, but that's number one. +And the question is now you are burying extra capital, how bad is that relative to that. And for the most part, we've been able to manage that. We've talked about products repricing and managing G-SIFI and managing CCAR and managing LCR and managing SLR and we're going to maintain the franchise, manage it and we still think we can get good returns. There's a point at which the capital drag would be so high that you may want to consider alternatives, but just remember they are not simple. Like anything you do, every company will have to have cash management, global trade ability, every company general ledgers and HR things and data centers and nerve data centers and cyber security and it isn't that simple a process. But so far, the Company has earned good returns in all those businesses throughout this crisis and I'm going back 2010, 2011, 2012 and that's a sign of stability. In fact, even Mike Mayo had a report, which there is a slide in it that shows the volatility of returns and that we were among the lowest with the better returns. So that is proving it. The model works from a business standpoint and yes, we'll have to carry more capital and we'll manage that over time. + + + Erika, just to add to that, we're still in a period of flux as it relates to broadly rules, not just capital rules and we're in a period of flux as it relates to the competitive environment and it would be, for us, it would be premature to take big strategic decisions that we don't think would add shareholder value in what is a very challenging influx and cyclical low for the environment. So we preserve optionality. We think we're generating significant shareholder value, significant synergies and any discount could erode regardless. + + + And remember the capital stuff is not an element -- what they are doing now is not a sign of riskiness; this Company has been a fortress company, it has delivered declines and its diversification is the reason why it's had less volatility of earnings and was able to go through the crisis and never lost money ever, not one quarter. So in the real-life crisis, we did fine and in any future crisis, we're going to do fine. There are a reason you have big global multinational banks and they serve big global multinational, including governments. This Company moves $6 trillion to $10 trillion a day; you're not going to do that as a small bank and you're not going to syndicate out of a $20 billion bridge loan and you can't do certain things globally in 20 countries if you aren't in 20 countries. So you've got to figure out what model you have and does it make sense and it's not necessarily comparable to all other companies. So our model makes sense because you've seen the returns in it. + +Answer_15: + + So you're right; the complexity bucket does stick out. Just for what it's worth, we're looking at each bucket and we're looking at it at a very granular level because obviously we need to look at the whole thing in combination and the complexity bucket -- Jamie said it I think earlier. If he didn't, I'll just repeat it. OTC derivative notionals drives a large chunk of it. Clearly, we're going to do everything we can in terms of netting and housekeeping and everything to reduce that. But to reduce that meaningfully is to have a meaningful impact on our client flow business. Level 3 assets is the second piece and obviously to the degree that those things are -- by definition, they are less liquid and so as a result --. + + + But that does not make them bad. + + + That does not make them bad. They are just less liquid and as a result, we obviously will take a look at whether or not there's opportunity to reduce that. But, again, it's also relative to market size and then, finally, our AFS portfolio, which to have that in a complexity bucket is not intuitive to all of us and over time that may reduce but right now it's a very core part of how we think about structuring the interest rate risk management of our balance sheet. So we're going to look at it, but we're going to get very, very granular and there's no silver bullet. + + + I would guess that over years we can drive it down without damaging the franchise. + + + Right. It's about looking at the first 10, 20 basis points, not the last 3 or 4. + +Answer_16: + + You mean commercial? + +Answer_17: + + So our exposures are about $46 billion, about 5% of our traditional Credit portfolio. About 70% of it is investment grade, about two-thirds of it is in the sort of CIB, so these are large, well-capitalized companies. The other third is in the Commercial Bank. Name by name, we understand what that looks like. These are asset-based loans, top of the capital structure, names we know and we're going to see downgrades and we're not suggesting that there isn't going to be some stress and we don't know where oil may bottom, but, yes, we do have reserves. We have reserves that are based upon a long history of data that includes cycles. We've seen cycles before like this and so we'll take downgrades, maybe we may need to take more reserves, but it doesn't feel like it's a very significant issue or an imminent series of charge-offs right now. + + + For us. There will be companies that are more invested in oil that may have different issues and then there's a secondary effect, which obviously you all can predict like Russia, Venezuela. So Russia, we have exposure; Venezuela, virtually none and other countries. And then there's another secondary effect. As you talked about, commercial or even consumer real estate in Dallas, Denver, Houston, as you saw in 1986 and 1989 and those are all slight negatives, but not again -- for us, they are not going to be material. We're very well-diversified and for us, you have the other side. In general, consumer credit would be better not worse and you can argue and I don't want to spend too much time on it that even retail would be better. There are a whole bunch of other beneficiaries of this change of credits. So some will be worse and some will be better, so net-net for us, it's not that big a deal. It's a perfectly legitimate thing for you all to be concerned about for companies, which are very concentrated in oil or even commercial real estate companies concentrated in oil areas. That's not something that we need to worry about. + + + But we're watching it closely. To Jamie's point, we're paying attention to our Real Estate Portfolios in those geographies, so there's going to be overall sector and geographical differences to how this plays out and we're paying attention to that. + + + I'll give you an example of diversity helps. + + + Diversity helps. Yes. + +Answer_18: + + On the first point, I think there's probably some truth to the less Liquidity, but it's more about oversupply and lack of global growth stimulating demand than it is I think a liquidity story from a capital markets perspective. Sorry, Jamie, you were going to --? + + + I would just add that when you look at -- I'm a little surprised that people are so surprised when commodities move like this. Commodities have moved like this my whole life and obviously there's supply and demand imbalance and Marianne mentioned that the United States supply has gone up by 5 million barrels a day over the last five or six years. People were a little surprised at the production that was positive out of Libya and Iran and Iraq and some other places. A lot of people need oil revenues, but the other thing that surprised people was the slightly increased demand. I say slightly out of China and some other places and the other one that surprised people is OPEC. Instead of OPEC making some kind of move to reduce supply, they didn't. But, to me, all commodities have had that kind of volatility and oil has had even more volatility, so in the oil business, you've got to prepare for something like that. That is the way it's going to be and that's the way it's going to be for the rest of your life and yes, speculations, inventory and all those things may affect it in the short run. +Remember there is a fulcrum point at which oil, the marginal dollars that are going to be produced and I think our economists say it's about $75 oil, deep drilling in the Gulf of Mexico and around the world and one day it will recover to that because the world still will use more oil and need more oil, etc. and in the meantime, you've got to manage around the volatility and I don't think any of that had to do with trading, none of it. It had to do with fundamental supply/demand imbalances and people getting prepared for it and taking views on -- and not us. I mean I'm talking about oil companies and you've read about countries who've hedged it and countries who didn't and companies who hedged it and companies who didn't and I think it is a legitimate concern about liquidity in markets that when we have volatile markets or violent markets how much liquidity will remain, but I think there you're talking more about -- what you saw a little bit in treasuries, but more about credit and it's possible; we just don't really know. We're a little worried about it, but we will be there hopefully making healthy margins for our clients when the time comes. + +Answer_19: + + Obviously, we need to get clear on what the final rules and calculation looks like, but I don't see it being a blanket number. I think it's pretty evident that it's intended to be at least measured relative to the size -- it's the one measure that's not measured relative to a marketshare, but relative to the size of your operation. So consequently, depending upon how the math works out, it could be a differentiator for other people. But my comments were not necessarily driven by whether or not somebody else was going to be more punitive, more penalized by short-term wholesale funding, but by the fact that GSIB hasn't been and is unlikely to be the binding constraint for some of our competitors. For some of those, it's CCAR stress; for some, it's leverage under CCAR stress. And as a result, they already are running at or above the levels that may be implied and that may continue to increase. +So here we have a situation where the transition period, the glide path is a four-year period. We're at 10.1 looking to put a glide path together that measures all of our objectives over the next few years where others are at or approaching 11%. So we will see obviously how that plays out in the medium term or in the short term I should say. Certainly in the short term we have a reasonably level playing field. The competitive landscape is changing and we're working very hard to make sure we're maximizing the return on every dollar we have. + + + Right, and the reason it went from 2.5 to 4 wasn't because of short-term wholesale funding; it was because they doubled -- they basically doubled the number under a new methodology. And so -- and I think when you spoke of 50 basis points of buffer, you weren't talking about a short-term wholesale funding buffer, you were talking about a buffer over the required number to handle volatility. + + + Yes, so the buffer, yes, totally volatility mainly AOTI-driven. The 50 basis points is the best estimate of what the short-term wholesale contribution --. + + + Added to it, yes. That is a GSIB requirement; that's not a buffer. + + + But we'll see. My view is it's not a blanket though, so you could see some people differentiated in that sense. + +Answer_20: + + So obviously, if you get sort of granular --. + + + We've moved it to 3.1. + + + Obviously if you get granular to different specific countries, we may have a different answer, but as a general matter, no. As a general matter for the US 2015 over 2014, we're calling for 2.5% and globally closer to 3%. + +Answer_21: + + It's a tough question to answer. We have seen some pricing changes in trade finance a little bit in prime broker, not really in credit, but I do think you're going to see some of it in credit. So over time, that's not because of JPMorgan, that's just because the market is going to reprice some of these things that are more expensive to do and we do expect that will happen somewhat over time. And remember, the other thing which is really important is we manage this by client, so you can actually do a better job under LCR, G-SIFI, CCAR by client and not change pricing, just change mix. So we're working 100 different ways to figure out how to get good returns for shareholders while doing a good job for clients. And remember, we have more options to do that. So whenever we talk to a client, they are going to want some of our balance sheet capability and they may be willing to do other business with you to make sure they get it. Even if the pricing doesn't change, it might be good for us. + +Answer_22: + + So let me address the Volcker rule in general. So we have accommodated the Volcker rule, which we have to do in private equity and investments in hedge funds and Marianne mentioned that we closed the sale of a couple billion dollars of private equity stuff and even the CLO issue is a very temporary thing. The only question to CLOs is should people be forced to sell it -- they are all going to run off in three to seven years. So the only question the bank -- and that's not a material issue to us. We're going to accommodate that. +The other thing that's important about Volcker now is the remaining one, how it affects market-making and obviously there the clients are going to be concerned. Do you have good market-making? There are all these rules around it. We're accommodating those, reporting client demand, aged inventory, different ways of reporting volatility and trading and now you have capital liquidity. So all the trading is to try to make it safer, but also so people can make markets and we hope at the end of the day that will happen. If there needs to be adjustments, it's going to be because you clients are going to say this isn't working for us. +The only other thing I'll mention about liquidity, spreads are the same in credit, but the size you can trade in is much smaller, which to me is an early indicator if something goes wrong you're going to have a gap out in spreads quicker and wider than you might have before. But at the end of the day, we hope to be able to be a good market-maker, earn a fair return for shareholders and obviously we got to -- we have to apply Volcker and all the other regulations to it. + + + And I think the thing to think about when you look at the comp to revenue ratio just for the purposes of clarity is that if you look at the fourth quarter of last year, excluding DVA and FVA, it was about closer to 26%, so closer to in line year-over-year. And that's evident when you look at the full-year ratio last year of 31% to 30%. So we're at the low end of our range at 30% but within the range relative to the performance and there was a big negative impact in the CIB on a revenue basis last year with FVA/DVA. + + + And I should say that we've always allocated capital to the investment bank and we've had SVA-adjusted returns and stuff like that. So as you allocate more capital, all things being equal, that number comes down a little bit. So we've been disciplined in trying to do that properly. + +Answer_23: + + I think if you look at the 2015 dynamic, there's going to be three principal things. 2014 was a year of larger deals. 2015 has still got a good pipeline, so we're expecting to have a reasonably strong at least start to the year and probably a strong year and it's very driven in the fourth quarter and likely to continue to be so by sort of M&A-related financings. So the downside we talked about is just less maturities to be refinanced, but nevertheless some, but we're going to continue to have support from the M&A space, which looks set to be fairly strong in 2015. So you've got some puts and takes, but what we think is going to be a solid to good year in 2015, maybe not a record, but certainly a good year. + + + And so JPMorgan maintained a number one share in global investment grade, number one share in global high yield, number one share in loan syndication, which we hope to maintain next year too and those are very powerful positions to have. + +Answer_24: + + So just, first of all, I think to put it into context, I think that the RWA growth was $12 billion, so nevertheless a growth, but not a huge number. A chunk of it was regular weight CDA, which, yes, in part has got to do with just normal market dynamics right now as spreads wider and volatility higher, but a chunk of it is unrelated to that. As we look forward to the end of next year at 1.5, and which just to be clear I think I said 1.5 or maybe slightly higher, but nevertheless in the law of big numbers, the same trajectory. It's more at risk from just the timing of our ability to execute on granular segmented models, model approvals internally and with regulators than necessarily any sort of market dynamic, notwithstanding that that will factor in. So I would say the bigger risks to achieving that are less than the market pricing impacts on CDA, but more the ability for us to get the right timing of those model benefits. + + + And I think like two-thirds are models and one-third is runoff of stuff we know is going to happen. And the other thing, as Marianne mentioned, the advanced where we're 10.1%, the standardized were 10.5% and yes, the advanced will change -- if spreads gap out, advanced will go up, but standardized won't. And eventually we think standardized is going to become the binding constraint, not advanced. + +Answer_25: + + So obviously, we talked about the card portfolio exits driving some revenue decline, also some elevated credit charge-offs. We've been experiencing, and I think we've guided to the low end of our 12.5% revenue rate range. We guided to that last quarter or the quarter before and at 12.2%, we're in that range and what we're experiencing is spread compression is largely offsetting the strong interchange and other fee growth from the volume, but when you acquire new customers and you pay the premium to acquire new customers that gets amortized through your results in the first year. So in years when you're net acquiring new customers, you will have a small net drag on your fees and on your revenue rate resulting from amortizing those premiums for the benefit of those strong relationships and the increased outstandings and spend sales volume you get in future years. So we've been on a journey for the last two years and we continue to be on it where there is some impact associated from the fact that we are net acquiring new customers, each of which we believe returns hurdle for us or more than hurdle for us, so is accretive over a period. + +Answer_26: + + I wouldn't spend too much time trying to build this into your models if I were you, but it is quite clear that when you add $800 a year to the consumer's cash flow statement that consumers on average spend most of that and I think you're seeing it in spend and you're seeing it in car sales and you're seeing it in retail spend, you're seeing it -- and it's also quite clear it helps consumers, it helps their credit broadly. We're not going out and saying that we're going to reduce credit costs and auto, card and a bunch of stuff by 10 or 15 basis points, but I'm just saying you know it's going to be there. Just like you know it was there on the flipside where people spent a lot of time talking about how much gas prices are hurting consumers and why sales are down at Walmart and Family Dollar Store, etc. This is just the flipside of that. + + + And if you just looked at the consumer spending statistics, if you look at fourth-quarter annualized up 4.7% is the best consumer spend data since 2003. So it's already taking effect in consumer spend and disposable income is -- as you say, we're already expecting new car sales to grow next year, but all of this is going to support the continued strong trends we've seen in consumer. + +Answer_27: + + So you're right; we're close to lapping the acquisition cost dynamic not this quarter, but in the near future, but what you are going to continue to see is that we have a portfolio that is in runoff and as those loans run off, they were loans that were higher APR, higher rate loans than the ones that we're originating right now and as a result, you're going to continue to see some spread compression in 2015 again to which you're going to see strong interchange. So I would say, yes, ultimately and in the fullness of time, you're going to start to see the interchange growth outpace the spread compression, but for a period of time, they are going to be somewhat of a wash. + +Answer_28: + + Yes. + +Answer_29: + + So overall, the way to think about it is it's not ultimately going to be necessarily zero, but when you think about it in the context of the capital and the relative returns, it was not accretive to our returns, and so we have the differential between 500 and 300. For the full year, it's still not zero. There is a slight lag. Clearly there's a slight lag taking out the expenses, but there's still an overall small net income impact, but for overall mutual to positive benefit on the return. + + + And regardless of that, remember that our rationale for business simplification included a bunch of different reasons. It included activities that weren't core to our core clients' activities that were outsized in terms of operational or other risks, as well as those that weren't returning hurdles. So there are other reasons to simplify your business and they will have other ancillary benefits. + +Answer_30: + + So no specific one-time items in the equity derivative performance. The uptick in VAR has to do generally speaking with higher levels of volatility than it does with anything in terms of risk direction. + + + Equity derivatives are largely Japan and Europe and Asia. + + + Yes. + + + The increase. + + + Largely Asia, yes. + +Answer_31: + + It's an example where volatility did actually help. + + + If you look at equities in total, particularly in the prime space, there was a small one-time item, but not in the derivatives space. + +Answer_32: + + It's not a significant increase in VAR, but, yes, you see increase in CPG VAR on spread widening and volatility, increase in equities. Just year-over-year and quarter-over-quarter, we've seen an increase in volatility. + +Answer_33: + + This quarter more than any quarter it's really honestly to early to make any comments of any note regarding trading performance, particularly given that the holiday fell midweek. So the reality of the situation is thematically nothing has changed from the end of the fourth quarter, but there's no big new news in the first few days of trading. + +Answer_34: + + It was year-end cleanup; it had nothing to do with business simplification. + + + And I think if you look at our revenues excluding FVA/DVA year-over-year, they are down reasonably in line with comp. + +Answer_35: + + I think they are two different issues. One is the correspondent business properly done is fine and obviously we do look at their credit underwriting because we've had a backup over the last 5 or 10 years. Correspondents are no longer in business and if they did a bad job, we had to pay for that. So you want to be very careful and do business with the proper kind of people. We have reduced our share of FHA loans just because the ongoing -- two reasons. One is the ongoing liability in the production side where the insurance was worthless over time and the second is just the cost of servicing FHA loans when they go into default and they have a much higher chance of going into default than not. So those are two reasons to do less. And maybe that will change over time, but we're still in the same place in that. + + + And just on the share gains, they are in jumbo and conventional conforming loans, not in the government space. So yes, we are competing aggressively on price, but with the right capital allocation and with the right hurdle and these are loans that are very high quality that we are willing to put on our balance sheet done with correspondents that we have confidence in the financial status of. + +Answer_36: + + So the GSE -- you could always get loans up to 97% in the government space, you could get it in the agency space with mortgage insurance. We've seen some movement from the FHA on [GCs] and mortgage insurance premiums, all of which I think is intended to try and help credit availability, which we would generally support. It doesn't change our strategy, however, which is that we are much more focused on originating in the very high quality jumbo and conventional conforming space. But, yes, properly underwritten we will do agency loans in the programs that they have available. + +Answer_37: + + Yes, I mean, look, we have, over the last, I think, two years and a quarter, two plus years or so, we've seen an inflow of cash of between $300 billion and $400 billion on our balance sheet. So our balance sheet size has grown slightly over the course of the last several quarters in the last year, but the vast majority of the growth is driven by incremental cash and there's two principal reasons for that. One is as we have been looking to become compliant with our own and with US rules on liquidity, which we are compliant with at this point and have been for a while, that the other is also that we've been receiving increased nonoperational cash predominantly from wholesale clients. And so to the degree that that cash is accretive from an NII perspective and that we aren't balance sheet or leverage constrained and it's a key part of the relationship with that client, that may not be a bad thing. But to the degree that it's not a key part of the relationship, we're going to be disciplined about trying to manage that balance. So I would say underlying that, we would expect our balance sheet to not be growing certainly not significantly, but cash can be the volatile factor. + +Answer_38: + + Yes, we saw loan growth year-over-year 8% core, 3% reported. We feel pretty good about the demand for loans across our businesses, particularly those that have been performing strongly now consistently like business banking, like prime mortgage on the portfolio, commercial real estate, even auto and we continue to be optimistic about C&I and even Card. So yes, we would expect to see robust loan growth into next year hopefully on the back of a continued improvement in the economy. + +Answer_39: + + I'll give you a (inaudible) one for you. On the back of robust loan demand and rising rates in the second half of the year, which is our current central case, then we would expect NII to be up in the second half of the year, flattish in the first half of the year. Obviously if those two things don't play out then that wouldn't be the case. I'll let you draw your own conclusions on the rest of it. + + + You're using the implied yield curve effectively, so if that changes then obviously that will affect the second half of the year. + +Answer_40: + + Look, unscrambling it would be extraordinarily complex and it would be extraordinarily complex in debt, in systems, in technology, in people and where certain things go and the businesses would start competing with each other right away, which I think is perfectly reasonable if they were all separate standalone. So look, we're very conscious of the narrative, which has become out there about this, but it is far more complex than that. The right way to look at it is we have these great franchises, we have a lot of time to manage through this and that is our objective, not unscrambling the egg. We're going to manage through it and we can manage almost every single part of it over -- think of over a long period, like five or seven years. Don't think of over six months or a year. There's nothing we couldn't set a limit, drive down, sell, manage and that would probably be far easier than the alternative. Even if it led to lower growth, it wouldn't necessarily lead to lower returns. So just keep in mind that obviously we're going to do the right thing at the end of the day for the shareholder. It might be lower growth and better returns and managing through that and not doing certain things at all. +Marianne mentioned for example the amount of deposits we take in. Well, it might be that we limit and restrict the amount of deposits we take in at quarter-end. We do it to accommodate clients, but all those nonoperational deposits go directly into the Federal Reserve. So that's what Marianne said. We do it and maybe make some spread. If you can get 25 basis points there and you maybe are paying the client something. There are some clients which aren't charged to take their quarter-end. They don't do enough business with us and we don't want their quarter-end balances. So we have a lot of levers, we have a lot of time and we are going to do it very intelligently over time. We're not going to damage this franchise just because of a current narrative. +And the other thing I want to point out about the current narrative, which kind of surprises me that people don't mention, when you all talk about P/Es and sum of the parts, P/Es are temporary, P/Es change over time and the real question you should be asking is is the E going to be much higher or much lower under scenario A or B, not just what is the P/E going to be because I could give you a lot of scenarios where your E is going to be a hell of a lot lower and that dwarfs the effect of the P/E change and the P/Es themselves are temporary. JPMorgan is already earning its cost of capital and you're comparing it to P/Es to a lot of guys who aren't earning their cost of capital. Meaning people expect them to have dramatic growth in earnings, which they will and so it's -- you've really got to have a much more forward-looking view of what P/Es will be, what values will be, what earnings will be, what the franchise will be then just the sum of the parts breakup based on current P/Es and false comparisons. +Some of the people out there that people compare it to they are not real comparisons. We are not in the same business with those people, but we are very shareholder-conscious. That's not to say we're not going to do the right thing for shareholders over time. We will; there are other ways to do it. + + + And the other thing which I think is important too is that we compete globally. Remember we have to be very conscious of who we're competing with and what they're going to do over time. And my guess is you're going to have some very large, very tough global competition over the next 20 years. They are not going away. They may have currently lower G-SIFI charges, but I'm not sure that's going to be true 10 years from now. Particularly the Chinese banks get bigger and bigger and some other global competitors decide they want to be in the global businesses. + +Answer_41: + + No, I would refer you to -- if you look at the 10-Q disclosure from last quarter, that will give you a sense for the things that are outstanding. We will obviously update and refresh it in the K, but we're not going to discuss specifically all of the remaining cases. + + + David, I think again I think the way people -- I know -- we know we cause problems with you all because we have this lumpy quarter-by-quarter type stuff. I wouldn't look at this as a quarter-by-quarter issue. If you owned 100% of this Company, the better way to look at it is it's going to cost us several billion dollars more somehow plus or minus another couple billion before we get to what I call a more normalized legalized basis. We disclose all that stuff in the 10-K. I think the RPL, if you ask me, is actually a fairly decent way to look at what those might be and we give you an RPL number, which is something that has not gone to the P&L, which is possible and we can't make something which is lumpy not lumpy and we can't make something which we wish we can bucket -- if we could, we would put all the reserves now and say we're done. We can't. + + + It's a number and the important part as a shareholder is I want to deal with that, acknowledge our mistakes, try to have a fortress controlled balance sheet, try to stop stepping in dog (expletive), which we do every now and then, but build a customer franchise is the important part. When you have a market cap of $230 billion, I want to make that worth $500 billion 10 years from now. There's several billion dollars that we're going to have to pay for legal, so we want to fix it and it's unfortunate we do this to you all, but it's unavoidable right now. + +Answer_42: + + So I can talk for JPMorgan very specifically that we are seeing the charge-off rate -- remember, we have had charge-off rates for the auto business that have been relatively low for an extended period. Now we're seeing them revert back to something more normal and when we think about pricing the business and through the cycle, we contemplate a more normal level of charge-offs. So this isn't as surprising to us. +Having said that, what we're also seeing in terms of just the broad competitive space is it's not irrationality necessarily, but longer duration, higher LTVs, more subprime originations. JPMorgan -- we are lower LTV than the industry and very concentrated on the near and super prime space. So there's part of that that we're just not participating in, but even for our own portfolio you're going to see some of those charge-off rates trend up to something a bit more normal, but that's how we think about the business through the cycle. + +Answer_43: + + I hate to say I'm confident about anything, but that's not our expectation. + + + It's a very good question because of what we all went through in the mortgage game where subprime was an early indicator for even prime. But when we look at credit card, we don't think it's an early indicator of credit card. We're going to be very conscious -- as Marianne said, auto did unbelievably well through the crisis, shockingly well we'd all say. So this is maybe a return to norm, but we're going to pay paying a lot of attention to it. + + + And the loans that we're originating now, the very far, the right side of 700 FICO loans with LTVs lower than the industry lower than 100%. + +Answer_44: + + I think, Nancy, views and facts are completely different, okay? This Company was a port in the storm in the real crisis in 2008 and 2009 and that was after we bought Bear Stearns and (inaudible). We had no issues whatsoever. We have a lot more capital now, we're more conservative now. We've got less credit exposure as a percent of the balance sheet. We've got less risk as a percent of the balance sheet. We've got more long-term debt, we've got more liquid assets. We've got more -- so it's even more true today. The fact is the Company is an extremely powerful thing. +People, when they talk about risk, they are just talking about -- a lot of people, they look at size and it scares them. I completely understand that. But that isn't the determinant and I don't think we should be making shareholder decisions based upon views of people who don't necessarily really know. So if the regulators at the end of the day want JPMorgan to be split up then that's what will have to happen. We can't fight the federal government if that's their intent or maybe their intent is what it is. If you are going to carry more capital and you've got to modify your business model over time to carry capital, that one we think we can earn a superior return still versus other banks and carry the higher capital and modify our business model over time without taking drastic action. +And remember, again, you've got to look forward in this. America has been the leader in global capital markets for the last 50 or 100 years. It's part of the reason the country is so strong. I look at it as a matter of public policy. I wouldn't want to see the next JPMorgan Chase be a Chinese company because someone has to be serving the global multinationals around the world and all the things that that means about knowledge and experience and research and capabilities. So I think that if you look ahead 10 years, you're going to have large global companies who compete and we may have to be slightly smaller than we might otherwise have been, but so be it. If we can do that and do a good return for shareholders, we should do that. + +Answer_45: + + So I will tell you that to answer the question maybe just slightly differently but with the same basic point that we saw an increase in cash of about $45 billion or a little bit more that $45 billion in the quarter and that drove the vast majority of the 5 to 6 basis points decline in NIM. + +Answer_46: + + So what dictates what we have on deposits at the central bank -- for any deposit that we have that is excess operating or nonoperating that we don't think has any significant or any liquidity value to the Company, on the whole, those are all on deposit with central bank earning a very small amount of interest income. And there is some passed onto the client net-net, so something slightly accretive. So that's what's driving the amount of cash, so to the degree that we have more nonoperating cash that will drive that. We are compliant with LCR under the US rules with an appropriate but modest buffer right now and that's based upon what we think is a fairly forward-leaning point of view about what true operating deposits really are. +So as we think about what the cash is in customers' accounts that they really require to operate their businesses and no more. So we think we've got a forward-leaning point of view on that. So I think the rules are for the US final. I think our ratio for US LCR right now will be favorable for a period of time and then if there are any changes, either to the US rules, which we don't have any line of sight on or if we are required to make changes or decide to make changes to our own internal liquidity framework, that could cause us to add to liquidity, but that's something that we'll inform you of as we go through time. + + + If you look at our balance sheet, forget all this rule stuff, we have almost $500 billion in central banks around the world. We have $300 billion plus of AA+ securities of very short duration. We have like $300 billion of repo and stock borrow, which is all secured in commodities by top credits with proper haircuts and stuff like that and with our capital base of equity capital of $200 billion, preferred stock of $30 billion, TLAC of debt of $150 billion plus, our loans are $700 billion, which has always been the riskiest part of our balance sheet. And receivable is like $70 billion and so this balance sheet of this Company is unbelievable. + +Answer_47: + + So for financial institutions and nonbanks -- for banks and nonbank financial institutions, yes, we passed on the overnight rate to our customers and it's basically on their operating cash flows. It is what it is. All we're doing is passing through the cost. It's operating cash for their business so there was --. + + + In euros. + + + Yes, in euros, so there was no significant reaction at all. It's a market (multiple speakers). + + + It's very hard -- I mean you're not going to be taking deposits at a loss that are just very temporary to help our clients, so I think everyone understands that. + diff --git a/exam/original-files/Problem_2_3_Sample_QandA/9_questions.txt b/exam/original-files/Problem_2_3_Sample_QandA/9_questions.txt new file mode 100644 index 0000000..67a91aa --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_QandA/9_questions.txt @@ -0,0 +1,188 @@ +Question_1: + + Hi, good morning. Okay, so a couple of questions. One is on the GSIB proposal. Obviously it looks like you're at the 450 over the 7% minimum and I know we can't exactly see, because we don't have all the rules around the short-term wholesale funding rule, but I'm wondering where you line up in that bucket; if you're close to the low end of that range. Is there anything that you could do to move down a bucket? + +Question_2: + + Right. It's a bit of a challenge because it's relative to global peers, so how do you run the business -- the follow-on question is how do you run the business when you've been used to trying to gain as much marketshare as you can, but now gaining marketshare works against you on this G-SIFI? + +Question_3: + + Okay. I assume we'll hear more on it at Investor Day. + +Question_4: + + Yes, hi, Marianne. Just following up on Betsy's questions, your hope is to grow or I guess your expectation is to grow the common equity Tier 1 from the 10.1 today to did you say 50 basis points this year you hope to add to that? + +Question_5: + + Okay. And I guess could you give us some sense of what the assumptions embedded in there are in terms of RWA mitigation? I guess Street estimates and earnings and some expectations for capital return and I guess is that pace enough to get to what you see as the new GSIB buffers where it looks to us you might have to be at 11.5, 12. Is it just a timing question that you have time to get to 11.5, 12? If you could just walk through that, it would be helpful. Thanks. + +Question_6: + + Okay. And then just a follow-up on that is on TLAC. You mentioned in some of the notes here that you might fill any potential shortfall to the current TLAC with additional common equity Tier 1, which I assume you mean as opposed to kind of debt issuance or preferred. Just wondering why you think that would be the best approach since you might already be building set one for a GSIB buffer. + +Question_7: + + Okay, got it. That's what I thought. I was just looking at that footnote 10 on page 20. Maybe just we could take a look at that afterwards. + +Question_8: + + Good morning. Just wanted to talk about expenses and initially focus in on the litigation charge of $1 billion after-tax. It's pretty clear, as you said, that the bulk of it goes to the Investment Bank and that it's FX as you said. But should this give us a sense that you now feel that it's reasonable -- that you have reasonable and probable basis to think in terms of what your settlement would be say with the DOJ or are there other elements that drove the increment? + +Question_9: + + Okay. And then more broadly on expenses, just given that we've seen another decline in net interest margin that we've got a flattening yield curve environment and quite a bit of sluggishness elsewhere, and of course all the regulatory capital requirements that continue to build, should we expect that you'll revisit your $58 billion-ish expense target in some way to bring that meaningfully down? + +Question_10: + + Hi, I'm following up on the expense question. If you look at slides 2 and 3, it looks like your adjusted efficiency ratio of 61% in the fourth quarter and 60% for the year got worse from 59% either the prior quarter or prior year. So it's gone the wrong direction and I thought you said that you had some peak in costs in midyear and I hear what you're saying about guidance at Investor Day and adjusted expenses in 2015 down, but can you give any more ins and outs on why you think the efficiency ratio on a core basis should improve? + +Question_11: + + It's been three years of stalled progress with overall efficiency. I know you have some of your reasons with regulatory costs. You mentioned 2016 and 2017 benefits, but can investors see an improvement in efficiency expenses for revenues in 2015? + +Question_12: + + Good morning. You had some good loan growth in consumer and in particular credit card in the fourth quarter. I'm just wondering how much of that is normal seasonality versus maybe some strengthening underlying demand for the consumer. + +Question_13: + + Okay, then just separately in terms of the sharp decline in energy in general and I guess oil specifically, how do we think about some of the puts and takes with your customer base? Obviously, this should be good for the consumer, maybe mixed for corporates and institutional. There might be some risk to certain countries. Like how should we think about this holistically and how do you try and stay on top of this? + +Question_14: + + Yes, good morning. My primary question is there's clearly been a lot of ink spilled recently in conversations again about a potential breakup of JPMorgan, especially relative to the higher capital buffers that could come from the Fed. And I guess, Jamie, could you remind us of how you're thinking about the benefits of keeping the franchise consolidated for the shareholders versus some of the conversation that investors are having today about breaking up or shrinking the bank in order to step down on your capital buffers? + +Question_15: + + Understood. And just a follow-up question to that, Marianne, if we look at the GSIB scoring process, not the proposed Fed process and we think about the five pillars that drive the buffers, it seems like if we look at publicly available data that where JPMorgan really sticks out is under the complexity pillar. Is there any way to move that down without giving up significant meaningful revenue and is that the bucket of focus in terms of potentially managing buffers from here? + +Question_16: + + Hi, thanks. Can we revisit the energy conversation for a sec? I mean in my experience when any asset class falls this much so quickly, it's usually pretty bad and I heard your comments and I completely agree that it's great for the consumer and net-net positive, but am I doing the math right? If it's 5% of your outstandings, is that on the $743 billion of loans (multiple speakers)? + +Question_17: + + Commercial, okay. Because what I want to get at is you made a comment it's 5% of outstandings; a lot of it is secured. I'm sure you have some reserves against it. It's just -- it seems like an odd thing. I know it's early and we'll see if it stays down here, but it seems like a big deal and yet it doesn't seem like a big deal to you guys. So I just want to make sure that we talk about what your exact exposures are and why you feel better than most people I talk to. + +Question_18: + + The only related follow-up I have is I don't know if the same thing is happening in oil. I know in and around October 15 when we had wild swings in the 10-year, people talked about less liquidity at the banks being a partial contributor. I'm curious to see if you think there's something to do with that on the oil side too because everybody's been downsizing commodities. And then the bigger question is does anybody care about it, are the regulators watching and paying attention and do you think some of this is contributing to the bigger volatile swings we're seeing? + +Question_19: + + Good morning. Marianne, I just wanted to follow up on some of the regulatory discussion that we've had. You mentioned back in December that you felt that even though at the 11.5% buffer there may not be as big a difference in terms of capital requirements between you and some of your US peers as the initial numbers may initially indicate. It sounded like that may have been a focus on the short-term wholesale funding buffer, which obviously hasn't been released. You mentioned in December you felt that that would be around 50 basis points in terms of at least a starting point for you all. Is it your sense that there could be calibrations above and below your level of 50 basis points or do you think at this point it could be a blanket number across all of the big banks? + +Question_20: + + Fair enough. And then, Marianne, just for a follow-up, in terms of your outlook for GDP, I think in December you also mentioned that you expected around 3% GDP growth is your operating assumption. A little stronger in the second half than the first half. Given your comments on when you think rates are going up, it doesn't sound like that has changed very much, but given your conversations about oil and some of the other growth numbers that have come out, has that changed very much? + +Question_21: + + Thank you. Good morning. Jamie, you were very clear on the success of the global franchise that you guys have built and the success that you've been having with it. Is there any evidence that you're seeing some pricing increases or you can generate some pricing increases because of this franchise? And if not yet, what do you think it's going to take where you'll be able to really get some better pricing because of the value of the franchise that you present to your customers? + +Question_22: + + And then as a follow-up, in the Corporate & Investment Bank, the world now has been operating under the Volcker rules since July of 2014. Can you share with us is there any secular trends that you're seeing because of that? And I noticed that your compensation expense as a percentage of revenue was a real low 27% versus 35% a year ago. Is that reflective of the changes because of the Volcker rule? + +Question_23: + + Hi, good morning. So first question I have is on actually the debt capital markets business. Clearly, the results were quite impressive in the quarter. Certainly better than what the public proxy suggested and I was hoping you could give some additional color as to what drove this strength and then maybe how that informs your outlook in 2015 given that, on the last earnings call, Marianne, you noted that there could be some pressure on that business certainly going into next year or now this coming year? + +Question_24: + + Certainly. Switching gears for a moment just back to the capital discussion, I just wanted to get a better understanding as to what drove the RWA inflation in the coming quarter. It sounded as though it was really primarily a function of counterparty credit risk inflation. I just wanted to get a better sense as to whether that was driven by some of the pressures on the corporates in the oil and energy space and also whether your $1.5 trillion target that you reaffirmed, whether that does contemplate the potential risk for further inflation in the coming quarters if those pressures continue. + +Question_25: + + Thanks, good morning. My question was on the Consumer & Community Banking business. There are a couple of moving pieces this quarter with the sale of the card results, but also underneath that it looked like a couple of the fee-related areas might have been a little soft. I was just wondering if you can try to disaggregate that for us and was there anything that was also more of a one-time in nature or seasonal about those businesses this quarter. + +Question_26: + + Okay. So it's a today versus tomorrow thing. And then on a follow-up, coming back to the energy discussion, you mentioned that it would be net to the consumer business and I just wanted to ask you to flesh that out for us. As you think about the benefits that you'd expect to get from the decline in oil prices, is it growth, is it spend, is it credit? How would you disaggregate that and give us an understanding of either magnitude or time to see that benefit? + +Question_27: + + Good morning. Just want to follow up on the card fee income discussion. If you looked at your new accounts opened year-over-year, you were flat. You're starting to seem -- you seem like you're starting to lap that higher amortization of acquisition costs. So is it fair to assume that we are at least getting closer to an inflection point where we're going to see fee incomes more track more closely with growth in spend or is there something else going on there? + +Question_28: + + Right, but I was just speaking specifically to the fee income where you were down I think 7% year-over-year. I would think that would start to turn positive at some point. + +Question_29: + + Okay, fair enough. And maybe just one quick question on the expense side. You talked about the simplification impact on revenues and expenses. You're still at sort of a net negative about $200 million pre-taxes. Should that get closer to zero? Is it just it takes a little longer to get the expenses out versus the revenues or is that going to be a permanent drag? + +Question_30: + + Good morning. A quick question on derivatives and equities. You guys highlighted the strength there. Were there any one-timers in those results because it certainly seemed like 4Q was volatile. Also did the uptick in equities VAR have anything to do with the revenue trends there? + +Question_31: + + And that's true across (multiple speakers). + +Question_32: + + Got it. And that change in VAR due to volatility was sort of across the board in the buckets, not just in the equities VAR? + +Question_33: + + Okay. And then sticking with capital markets, thinking about how we're starting the current quarter, it does feel a lot like deja vu here in the beginning of the fourth quarter where the markets are beginning with some pretty unconstructive volatility. I know we're very, very early going, but is that a fair comparison to make and are we starting off on a pretty tough foot here? Obviously there's a lot of road to hoe here, but any comments on that would be helpful. + +Question_34: + + Great. Last small cleanup one on capital markets. I know you've mentioned that there's going to be a lag from business simplification, but was any of the decline in comp in CIB tied to business simplification here? Just trying to think about how much of that drop might have been due to some other items aside from --. + +Question_35: + + Yes, thank you very much. On the mortgage banking side, you're definitely picking up marketshare from probably your -- you were shedding marketshare up until probably the second quarter of this year and one of the chatters out there is that you've gotten more aggressive in the correspondent markets and the comment you made, Jamie, back in I think June of this year was that you wanted to get out on -- maybe not get out of, but lessen your exposure to those low FICO, high LTVs, i.e. FHA loans. I was wondering if you are still trying to lower your marketshare in FHA loans. Can you make some comments about being more aggressive on the correspondent side too? + +Question_36: + + And then some of the rule -- on a follow-up -- some of the rule changes you're seeing coming out of GSEs that try to spur I guess loan demand is you're seeing the GSEs starting to do 3% down payment loans. Is that something that JPMorgan would go down underwritten correctly or is that just too risky? + +Question_37: + + Good morning. Just a couple of follow-up questions. Marianne, you talked about some of the loan growth that you've experienced and expect to continue to experience and also the driver of the RWA reductions. But can you just help us understand what we should expect from your GAAP balance sheet given that a portion of the RWA reduction sounds like it is coming from runoff? + +Question_38: + + Sure. I guess I was thinking about it more from the perspective of the loan portfolio. It sounds like the expectation is --. + +Question_39: + + Got it. So if I were to summarize all of the guidance that you gave today with those comments, it sounds like the expectation is for modestly higher net interest income, fee income reflecting whatever volatility we suffer from in the capital market space, an absolute decline in operating expense, but likely some increase in the provision. Is that generally correct? + +Question_40: + + You've been consistent about -- on the issue of dividing the firm up into constituent companies about the strategic benefits of it all, but I wonder if you've done any contingency planning on what if it ever came to the fact that it was too much of a drag to keep it all together? And I guess the question I have is is it even possible to unscramble the egg and specifically the issue I'm wondering about is you've got over $160 billion of debt at the parent company level. If you were to break the Company up into a consumer bank, a wholesale bank and an asset management business just for argument's sake, is there a way to fairly allocate that debt to the three various lines of business or how would one even go about that? + +Question_41: + + Good morning. Thanks very much. On the question of legal costs, and I realize you'll refresh your disclosure in the 10-K, but can you say anything about whether there are other cases or buckets of cases out there that have the potential to cost $1 billion in any one quarter? + +Question_42: + + Good morning. Two questions. Marianne, we had some numbers last week that indicated rising delinquency in auto loan portfolios and I think your commentary about your losses this quarter kind of confirm that. Are the numbers right now aberrational or is this a seasoning trend or how do you see this? + +Question_43: + + Do you feel confident that this is not sort of the canary in the coal mine with regard to perhaps other consumer segments? + +Question_44: + + Jamie, one final, hopefully final question on the breakup issue. We all listen to what you say about the strategic value of your businesses and the complementary nature of the businesses, etc. and it all sounds very logical. But in Washington, there is still a belief that your Company in its present form is a danger to the global financial system. Is there any -- in your view, is there any level of capital that is going to mitigate the too big to fail issue or does it go beyond that? + +Question_45: + + Thank you. Marianne, can you tell us -- obviously, you've built up your HQLA in the quarter and your net interest margin came down. How much of the margin pressure was due to the increase in the HQLA? + +Question_46: + + Are you guys -- I notice that the deposits at the central banks, as you pointed out, grew very largely in the quarter. Is this a level that now you're satisfied with? And also connected with that, what as outsiders should we look at that will drive the LCR ratio either higher or lower in terms of your calculation that you're going to be doing on a quarterly basis going forward? + +Question_47: + + Totally agree. One last thing on those deposits of the central banks, I know some of the big custody banks indicated that they were going to charge their customers that have euro deposits because the ECB is now charging for the deposits at the ECB. Did you guys do that in the quarter and if so how did the customers react when you passed on that cost to them? + diff --git a/exam/original-files/Problem_2_3_Sample_full_transcripts/2013-Apr-12-JPM.N-137249419186-Transcript.txt b/exam/original-files/Problem_2_3_Sample_full_transcripts/2013-Apr-12-JPM.N-137249419186-Transcript.txt new file mode 100644 index 0000000..17acad7 --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_full_transcripts/2013-Apr-12-JPM.N-137249419186-Transcript.txt @@ -0,0 +1,1196 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q1 2013 JPMorgan Chase & Co. Earnings Conference Call +04/12/2013 08:30 AM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Jamie Dimon + JPMorgan Chase & Co. - Chairman & CEO + * Marianne Lake + JPMorgan Chase & Co. - CFO + +================================================================================ +Conference Call Participiants +================================================================================ + + * Guy Moszkowski + Autonomous Research - Analyst + * Mike Mayo + CLSA - Analyst + * Gerard Cassidy + RBC Capital Markets - Analyst + * Betsy Graseck + Morgan Stanley - Analyst + * Moshe Orenbuch + Credit Suisse - Analyst + * Nancy Bush + NAB Research - Analyst + * Glenn Schorr + Nomura Asset Management - Analyst + * Brennan Hawken + UBS - Analyst + * Matt Burnell + Wells Fargo Securities, LLC - Analyst + * Erika Penala + BofA Merrill Lynch - Analyst + * John McDonald + Sanford C. Bernstein & Company, Inc. - Analyst + * Paul Miller + FBR & Co. - Analyst + * Matt O'Connor + Deutsche Bank - Analyst + +================================================================================ +Presentation +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Good morning, ladies and gentlemen. Welcome to JPMorgan Chase's first-quarter 2013 earnings call. This call is being recorded. Your line will be muted for the duration of the call. We will now go live to the presentation. Please stand by. At this time, I would like to turn the call over to JPMorgan Chase's Chairman and CEO, Jamie Dimon, and Chief Financial Officer, Marianne Lake. Ms. Lake, please go ahead. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [2] +-------------------------------------------------------------------------------- + + Thank you. Good morning, everyone. I'm going to take you through the presentation which is available on our website. Please refer to the disclaimer regarding forward-looking statements at the back of the presentation. +So if you turn to page 1, a very strong start to the year with record net income of $6.5 billion for the first quarter and record EPS of $1.59 a share. On revenue of $25.8 billion, and a return on tangible common equity of 17% for the quarter. You can see on page 1 we've highlighted up front two significant items. A $650 million reserve release in mortgage and a $500 million reserve release in card. And as I go through the presentation, I'll also be highlighting for you a number of smaller items, some positive and some negative. +We continue to maintain the leadership positions we highlighted at Investor Day. Number one ATM network. Number two branch network. Number two mortgage originator. Number one credit card issuer in the US. And number one ranking in global IB fees. And we're on track to deliver against our expense targets for the year. +On a reported basis, total loans for the Company were up 1%, with core loan growth, excluding run-off, up 5%. Favorable credit performance continued in our wholesale and core consumer portfolios, with low levels of delinquencies and charge-offs. As the housing market recovers, losses in the real estate portfolio continue to improve. And this quarter we saw 30 plus delinquencies decline by 14% and severities improve. +If you turn to page 3 for a brief capital update. We ended the quarter with Basel I and Basel III Tier One common of $143 billion, and $146 billion, respectively. Both up from last quarter. Our Basel I ratio is 10.2%, which reflects the impact of new market risk rules that went into effect in January. And the 10.2% compares to a ratio of 9.9% for last quarter as measured on the same basis. Our Basel III ratio of 8.9% is up from 8.7% last quarter and reflects the full impact of the rules as we understand them. And, as you know, we don't pull forward the impact of passive run-off or [mode] enhancements, which we expect to deliver around 100 basis points of benefit this year and next. And we still expect to reach our Basel III Tier 1 common target of 9.5% by the end of this year, including the capacity to continue share repurchases. +As we've also made progress this quarter and are on track for full LCR compliance this year. In the bullet at the bottom of the page, the Board intends to increase the quarterly dividend to $0.38 a share effective in the second quarter. And we repurchased $2.6 billion of common equity in the first quarter, with authorization to repurchase an additional $6 billion over the next four quarters. +Turning to the businesses. On page 4 we have Consumer- Community Banking. The combined consumer businesses generated $2.6 billion of net income for the quarter on $11.6 billion of revenue. With an ROE of 23% on new allocated capital. And as we go through the presentation, all of the current quarter ROEs are calculated based upon the new allocated capital numbers that we showed you at Investor Day. Overall, revenue was down year on year and quarter on quarter, driven by Mortgage Banking. Quarter on quarter, the reduction reflects the continuation of production margin compression. Credit costs reflect the releases in both Mortgage Banking and Cards that we referred to on page 1. And core expenses were flattish both year over year and quarter over quarter, normalizing prior periods. +We remain on track to deliver on our expense guidance. And headcount in the Consumer Bank and Mortgage business was down over 3,000 heads this quarter, a function of the evolution in the branch operating model and the completion of the IFR work. We ended the quarter with over 5,600 branches and close to 19,000 ATMs. And as of today we have over 1,400 Chase private client locations. +On page 5, Consumer- Business Banking. Net income of $641 million, and an ROE of 24%, on net revenue of $4.2 billion, down 2% year on year and quarter on quarter. The sequential decline is due to fewer days in the quarter for net interest income and seasonality in non-interest revenue. We continue to see pressure on deposit margins. 8 basis points down in the quarter and 32 basis points year over year. But this continues to be largely offset by deposit growth of 11% year over year, which we believe is significantly faster than the industry. And this quarter we had the lowest customer attrition on record, which reflects the great progress that we're making on the customer experience. +And we were just named winner of four TNS Choice Awards, recognizing superior performance in customer acquisitions, retention, satisfaction and market share with consumer and affluent banking customers, which is more than any financial institution has earned in any year. Average Business Banking loan balances of $18.7 billion are flattish quarter over quarter. And in the drivers you can see loan production decreased this quarter due to softer demand and higher competitive intensity. However, the pipeline in the second quarter is looking stronger. +We had record investment sales of over $9 billion, up 40% year on year. And client investment assets up 15%. Which shows that we're penetrating our customers more deeply, with 70% of those sales, up from 50% last year, being managed money, driving strong recurring revenues. Finally on this page, expenses are up year over year, reflecting the investments we are making in the business, including new branch builds and one-time costs related to a contract renegotiation. +Turning to page 6 and Mortgage Banking. Overall net income of $673 million, and an ROE of 14%. If you look at the top of the table in the first blue highlighted item, production pretax income was $427 million, down year-over-year and sequentially, driven by continued margin compression. As we expected and as we talked about last quarter, gain on sale margins continued to come down this quarter, and reached levels of around 100 basis points on a pretax basis. Which compares to a normalized pretax margin in the fourth quarter of last year of around 180 basis points. And was driven by a significant tightening in primary and secondary spreads, as well as pricing pressure, reflecting increased capacity in the market. +Strong originations of $53 billion were up 37% year on year and 3% sequentially. While applications were actually down 8% from last quarter. But we continue to expect high levels of refinancing and close loan volumes in the next quarter to remain solid. Production expense increased year on year on higher volumes, and net repurchases of $81 million in the quarter, reflects a reduction in realized losses, partially offset by reserve releases. We continue to believe we're adequately reserved and we do expect reserve releases to broadly offset losses over time. +Moving down to Servicing. Revenue of $778 million increased sequentially, primarily due to one-time gains associated with buying, curing and reselling certain delinquent loans out of securities. Servicing expenses of $737 million included a small amount of final IFR costs as we wound down the work this quarter, and also some severance. And if you back those costs out, Servicing expenses were slightly lower than the $725 million normalized run rate we talked about last quarter. IFR costs are now out of our run rate. And we continue to expect Servicing costs to reduce to $600 million by the fourth quarter of this year. +MSR risk management was a modest loss, $142 million. The driver of the net loss is an increase in our expectations for home price appreciation this year, which is a great thing but drove an approximate negative $400 million within the model update line in the supplement given higher prepayments. And, although there's an upfront negative in the mark of the Servicing assets, improvements in home prices will drive lower credit losses over time that will more than outweigh this mark. +Finally on this page, real estate portfolios showed pretax income of $784 million, which includes net charge-offs of around $450 million this quarter, and compared to a normalized fourth-quarter number of $520 million. This reflects lower delinquencies, as well as lower severities as home prices improve, and net to release reserves of $650 million this quarter. As you've seen, charge-offs have been steadily declining, and we do expect that to continue but at a more moderated pace. And we've updated our guidance for you to expect quarterly net charge-offs to be at or below $400 million. +If you turn to page 7, Cards, Merchant Services and Auto. Net income of $1.3 billion, up 8% year on year, or up 33% if you exclude the change in loan loss reserves and ROE of 33%. Revenue of $4.7 billion was flat year on year, but down quarter on quarter with quarter one having seasonally lower loan balances, sales volumes and merchant processing volumes. Expenses were down both year over year and quarter on quarter, primarily driven by non-core expense items in the comparable period. +Net charge-offs continue to be low. And we released $500 million of loan loss reserves this quarter, reflecting the continued improvement in early stage roll rates. The net charge-off rate of 3.55%, while down over 80 basis points year over year, was up slightly quarter on quarter on lower loan balances. And consistent with Investor Day, you should expect up to $1 billion of Card reserve releases in the full year of 2013, including the $500 million reflected this quarter. Year-on-year growth in sales volume was strong at 9%. And the revenue rate of 12.83% reflects strong interchange revenue and merchant processing fees, with merchant processing volumes up 15% year on year. +And moving on to Auto, originations were up 12% year on year, and 18% quarter on quarter. And although the first quarter is seasonally stronger, this growth outpaced the normal seasonal pattern. We gained share in the quarter through improved competitive positioning in prime. And also saw strong growth with our private-label manufacturing partners. +Moving on to slides 8 and 9 and the Corporate- Investment Bank. Very strong first-quarter results. And the results this quarter included a small DVA gain of $126 million, versus a loss in the same quarter of last year of $900 million. Both of which you'll see in the credit adjustments line item in the tables. So, if we focus on the numbers, excluding DDA, $2.5 billion of net income on $10 billion of revenue, down 2% year on year but up 22% quarter on quarter and with an ROE of 18%. Total banking revenue of $3 billion, up 12% year on year, driven by higher IB fees of $1.4 billion in the quarter, up 4% year on year with record bond underwriting. And lending-related revenue of $500 million, primarily core NII and fees on retained loans and commitments. And to a lesser extent gains on positions of fees in loan restructuring. +Total markets and investor services revenue of $7 billion, down 7% year on year, driven by fixed income markets of $4.8 billion. Down 5% year on year, coming off of a very strong first quarter last year. And up 50% quarter on quarter on seasonality, with continued strength in the client franchise. The P&L impact from the remaining synthetic credit portfolio included here was insignificant this quarter but positive. +Equity markets of $1.3 billion, down 6% year on year, but up 50% quarter on quarter. And the sequential change reflects seasonally strong equity derivatives results. Security services revenues of $974 million were flat year on year and down slightly quarter on quarter. And while a portion of this reflects the depository of receipts business, which is seasonally down, the portion that reflects our custody business has grown in line with assets under custody, which were $19.3 trillion, up 8% year on year. And we're seeing positive expense trends. Year on year, a net reduction of 2%, driven by lower compensation and efficiency initiatives, substantially offset this quarter by litigation expenses. If you take the DVA and the restructuring gains I mentioned, as well as the litigation expense, they net out. +The comp to revenue ratio ex DVA of 34% is in line with our guidance. And at the bottom of the driver section, you can see that our average CIB VAR continues to decline this quarter to $62 million, reflecting lower levels of risk including the continued derisking of the synthetic credit portfolio. But also reflecting very low levels of volatility across multiples assets classes. +On page 9, before I skip over this page, you can see that we continue to make progress growing our international loans and deposits. Our international loan balances were up 9% since the end of 2012, with particular strength across Asia and EMEA. +Moving on to page 10 and the Commercial Bank. This quarter saw net income of nearly $600 million, on $1.7 billion of revenue, flat year over year with a return on equity of 18%. Underlying loan growth of 11% year on year includes our C&I portfolio, which grew 12%, in line with the industry. And our commercial real estate book, which grew 10% year over year, significantly above the industry, driven by commercial term lending. Quarter over quarter, loan balances were generally flat, consistent with the industry, partly reflecting the fact that some demand was pulled forward into the fourth quarter. But also reflecting lower levels of demand and increased competition. Loan spreads held up well this quarter and remained stable to last quarter. And credit quality continued to be very strong. Lastly here, expenses up 8% year on year on the continued investment in the business, and increased operating expenses for Commercial Card. +Turning to page 11. Our Asset Management business had record net income for a first quarter of $487 million, up 26% year on year and 1% quarter on quarter, with an ROE of 22%. 12% year-on-year revenue growth reflects an increase in management fees, driven by strong long-term net inflows, including a record $31 billion this quarter, marking the 16th consecutive quarter of long-term net inflows. We also had higher equity and fixed income markets, up 9% based on our business mix. And saw higher performance fees driven by strong fund returns in 2012. +We had record loan balances, up over $20 billion, driven by increases in US mortgage and international loan growth. Total AUM was close to $1.5 trillion, with over $1 trillion in long-term AUM. And lastly, higher headcount expenses and performance-related comps contributed to a 9% year-over-year expense growth. But the pretax margin of 29% also increased from 26% last year, reflecting an improvement in operating leverage. +Moving on to page 12, Corporate and Private Equity. Total net income of $250 million for the quarter, and reflected a Private Equity net loss of $182 million, including nearly $300 million of unrealized losses related to specific positions. Treasury and CIO net income was $24 million. And included about $500 million of net securities gains, offset by about $470 million of negative NII due to low rates and limited reinvestment opportunities. Both the private equity losses and the securities gains were more significant this quarter than usual, and netted to positive $200 million pretax. Finally, other corporate net income of just over $400 million includes $230 million of prior period tax adjustments. And finishing on guidance, in CIO Treasury our guidance remains a net loss of $300 million plus or minus. And in other corporate, our guidance remains $100 million, plus or minus of net income. With both numbers able to vary quarter over quarter. +Turning to page 13 and net interest margin, firm-wide NIM declined 3 basis points and core NIM 2 basis points quarter on quarter. A number of items affected our NIM. First, to the negative. The low rate environment continues to affect our reinvestment opportunities. And also competitive pressures continue to impact loan yields. On the positive side, investment securities yields increased from higher mortgage-backed securities income, driven by slower prepayments and reduced secured financing. And lower long-term debt costs reflected a change in mix. +Lastly, our outlook on page 14. We've covered most of these items already. But you'll see that we've changed our NIM and NII guidance to put it all together in one place and on a consistent basis. All numbers shown are pretax and are estimates of net NII, reflecting both rate compression and volume growth. So you should expect modest NIM compression during the year with absolute levels of NII very strongly supported by growth in interest-earning assets. While overall NII expected to be down about 1% this year. Lastly, you may have seen we will redeem about $5 billion of outstanding trust preferreds in the second quarter. And as a heads up, this will lead to a modest one-time loss in the second quarter, but also a lower cost of debt over time. +Wrapping up, we had a record quarter with high-quality earnings and strong underlying business performance, seeing positive momentum across our businesses. Thank you for joining us. Operator, you can open up the call for Q&A. + + +================================================================================ +Questions and Answers +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) +John McDonald of Sanford Bernstein. + +-------------------------------------------------------------------------------- +John McDonald, Sanford C. Bernstein & Company, Inc. - Analyst [2] +-------------------------------------------------------------------------------- + + Good morning, Marianne. On the last point about NII outlook, what are the drivers of the strong growth(technical difficulty)? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [3] +-------------------------------------------------------------------------------- + + John, we can't hear you. Apologies, John, we didn't hear the question. + +-------------------------------------------------------------------------------- +John McDonald, Sanford C. Bernstein & Company, Inc. - Analyst [4] +-------------------------------------------------------------------------------- + + Can you hear me? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [5] +-------------------------------------------------------------------------------- + + Yes, we can. + +-------------------------------------------------------------------------------- +John McDonald, Sanford C. Bernstein & Company, Inc. - Analyst [6] +-------------------------------------------------------------------------------- + + Sorry about that. Can you tell me on the NII outlook, what are the drivers of the strong growth in earning assets you expect that you just mentioned on the NII page? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [7] +-------------------------------------------------------------------------------- + + We're growing, as you've probably seen, we showed you on Investor Day. And while there was a little bit of lower growth this quarter, we do expect to grow loans in our commercial bank loans in Asset Management, wholesale loans, Mortgage Banking. And we're growing our deposits very strongly. So it's really just the underlying business driver growth that we've been seeing and expect to continue. + +-------------------------------------------------------------------------------- +John McDonald, Sanford C. Bernstein & Company, Inc. - Analyst [8] +-------------------------------------------------------------------------------- + + Okay. And on the expense outlook, you mentioned for the adjusted expenses to be down about $1 billion. What's the base that we should look at for you to be down from? Do you have that? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [9] +-------------------------------------------------------------------------------- + + Yes. John, actually, if I refer you back -- and from recollection, I'll do it for you -- but if I refer you back to Investor Day, it's based upon our adjusted expenses, which are defined as our expenses excluding corporate litigation and foreclosure-related matters. Which in 2012 was $60 billion, plus or minus. I think $60.1 billion. And we're expecting to be $59 billion this year. And that's what we're on track to deliver. + +-------------------------------------------------------------------------------- +John McDonald, Sanford C. Bernstein & Company, Inc. - Analyst [10] +-------------------------------------------------------------------------------- + + And what was it in the first quarter? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [11] +-------------------------------------------------------------------------------- + + A little higher than that in the first quarter. But the first quarter is seasonally high. + +-------------------------------------------------------------------------------- +John McDonald, Sanford C. Bernstein & Company, Inc. - Analyst [12] +-------------------------------------------------------------------------------- + + Okay, got it. And then can you repeat your outlook on the default servicing expense line? That came down a lot this quarter nicely and you mentioned the target for the end of the year. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [13] +-------------------------------------------------------------------------------- + + Yes. The fourth-quarter normalized run rate was $725 million. This quarter it's down a little off that, as you would expect, given the IFR completion. We said that we expected the fourth quarter to be running at $600 million. And we said that at Investor Day and we're still on track to do that. And we've also said that the long-term run rate for that part of the business would be about $325 million a quarter, and that would be over the next couple of years. + +-------------------------------------------------------------------------------- +John McDonald, Sanford C. Bernstein & Company, Inc. - Analyst [14] +-------------------------------------------------------------------------------- + + Okay. And then the litigation dropped significantly this quarter. I think you said it was immaterial this quarter on the litigation provision. Is that right? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [15] +-------------------------------------------------------------------------------- + + The litigation dropped quarter over quarter. Clearly we had a large number last quarter on the back of IFR. And we did have litigation expense this quarter, you'll see in the supplementary there, just over $300 million. + +-------------------------------------------------------------------------------- +John McDonald, Sanford C. Bernstein & Company, Inc. - Analyst [16] +-------------------------------------------------------------------------------- + + Okay. And the last thing is on the buybacks. You did a healthy buyback this quarter but the share count didn't shrink that much. Is the first quarter heavier than usual in terms of your issuance? And the question's getting at, would $2.6 billion of buybacks in other quarters be expected to shrink the share count in quarters when it's not the first quarter? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [17] +-------------------------------------------------------------------------------- + + Yes, that's right, John. + +-------------------------------------------------------------------------------- +John McDonald, Sanford C. Bernstein & Company, Inc. - Analyst [18] +-------------------------------------------------------------------------------- + + Okay. So your issuance is more weighted towards the first? Is that right? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [19] +-------------------------------------------------------------------------------- + + Yes, but also remember, we didn't buy back shares in the fourth quarter or the third quarter. So there was an overall net $2.6 billion gross] $2,6 billion net of employee issuance. + +-------------------------------------------------------------------------------- +John McDonald, Sanford C. Bernstein & Company, Inc. - Analyst [20] +-------------------------------------------------------------------------------- + + I'm just getting at how that translates to reduction in the share count. It's offset by what you do issuance, right? -- each quarter? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [21] +-------------------------------------------------------------------------------- + + Yes. + +-------------------------------------------------------------------------------- +John McDonald, Sanford C. Bernstein & Company, Inc. - Analyst [22] +-------------------------------------------------------------------------------- + + Was this a normal quarter of issuance? So a $2.6 billion buyback keeps the share count flat? Is that the kind of ratio we might expect? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [23] +-------------------------------------------------------------------------------- + + No. I think the issuance number is fairly level and consistent quarter by quarter, because it's really based upon amortization of restricted stock and all that. And the buyback, the $2.6 billion, remember, that was over the course of the quarter, so it averaged out to 50% of that for the quarter. So we can give you more detail a little bit later. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [24] +-------------------------------------------------------------------------------- + + Yes, we'll come back to you John. + +-------------------------------------------------------------------------------- +John McDonald, Sanford C. Bernstein & Company, Inc. - Analyst [25] +-------------------------------------------------------------------------------- + + Okay. But it was steady throughout the year. That's what I was getting at. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [26] +-------------------------------------------------------------------------------- + + But the $6 billion will offset how much average amortization over the same 12-month period, like $2 billion. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [27] +-------------------------------------------------------------------------------- + + Yes, $2 billion. John, that's a good way of looking at it. The $6 billion we're authorized to repurchase relates to employee issuance over the same period of just a little bit over $2 billion. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [28] +-------------------------------------------------------------------------------- + + For accounting purposes. + +-------------------------------------------------------------------------------- +John McDonald, Sanford C. Bernstein & Company, Inc. - Analyst [29] +-------------------------------------------------------------------------------- + + $2 billion for the year, and $6 billion for the year. Okay, great. Thank you. + +-------------------------------------------------------------------------------- +Operator [30] +-------------------------------------------------------------------------------- + + Glenn Schorr of Nomura. + +-------------------------------------------------------------------------------- +Glenn Schorr, Nomura Asset Management - Analyst [31] +-------------------------------------------------------------------------------- + + First one. The first deadline for compliance with Central Clearing came and went, and it clearly didn't have much of an impact on your first-quarter FICC results. So I'm curious, I hear commentary in the market that a lot of clients might not be ready for either the second or the third deadlines later this year. Curious what you're expecting and if you do think it could produce any hiccup in activity levels. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [32] +-------------------------------------------------------------------------------- + + The second one is the big one, that's June 11, or something like that. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [33] +-------------------------------------------------------------------------------- + + Yes, June 11. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [34] +-------------------------------------------------------------------------------- + + And that's where you have a lot of bigger client stuff like that. People are still getting used to it. So we think -- I think we've got 30% or 40% lined up to do it. They're still reading documents, have to sign new documents. So hopefully it will go smoothly. It's unlikely to go smoothly the first round. The first round were really large participants and swap deals, et cetera. We'll have to just wait and see. + +-------------------------------------------------------------------------------- +Glenn Schorr, Nomura Asset Management - Analyst [35] +-------------------------------------------------------------------------------- + + And even on the wait and see, if some aren't ready, do you think of that as a temporary and just literally a function of processing, not -- maybe we don't need insurance anymore because it's too expensive? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [36] +-------------------------------------------------------------------------------- + + Look, we really don't know. I would say temporary but probably still down a little bit because of the reason you gave. Some feel and just say -- we don't need to do this anymore. And we also know all the final rules, by the way, and how the SCFs are going to work in bidding. + +-------------------------------------------------------------------------------- +Glenn Schorr, Nomura Asset Management - Analyst [37] +-------------------------------------------------------------------------------- + + Right. Okay. Marianne, on the RWA front, a bunch of little things in here. But Basel I RWAs were up 11% quarter on quarter but Basel III were pretty much flat. I know that has something to do with 2.5 starting in the first quarter. But if you can help us. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [38] +-------------------------------------------------------------------------------- + + Yes. If you take -- our Basel I RWA went up about $200 million. That's all about the implementation of the new market risk rules in Basel 2.5. Which is also why you saw our ratio go down from a reported 11% last quarter. It's really all explained by that. And our Basel III RWA was flattish quarter over quarter, with some pluses and some minuses. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [39] +-------------------------------------------------------------------------------- + + That was already in there essentially. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [40] +-------------------------------------------------------------------------------- + + Yes. Of course, yes. + +-------------------------------------------------------------------------------- +Glenn Schorr, Nomura Asset Management - Analyst [41] +-------------------------------------------------------------------------------- + + So that leads into the comment you made towards the beginning on any passive runoff and model enhancements are not pulled forward in your results. And I think you said it could be about 100 basis points. Is there a dollar amount of RWA natural runoff that we should be thinking about? Because obviously capital's building. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [42] +-------------------------------------------------------------------------------- + + My recollection -- and, again, Glenn, forgive me if I get this wrong -- it's on the slide from the firm overview and Investor Day -- but I think that 100 basis points equates to about $180 billion of RWA over the next two years. But, remember, the passive runoff will take place over time. Not completely linearly but over time. And the model enhancements can be a little bit lumpier and a little bit more back ended. So we'll just have to see how that plays out. But, yes, we're still expecting for those things to happen, for us to get 100 basis points of benefit from that, and that's without the active mitigation. That's going to happen over the course of time. Just check that slide for me, Glenn, when you get on. + +-------------------------------------------------------------------------------- +Glenn Schorr, Nomura Asset Management - Analyst [43] +-------------------------------------------------------------------------------- + + Will do. Last one, Jamie. I know you addressed some of this in your shareholder letter. But between everything related to Basel III -- stress test, Dodd-Frank -- in place already, and then OLA and living wills coming online, it feels like we're going down the path on containing too big to fail. But yet there's a steady drum beat, including Brown-Vitter, to change things. Just curious on where we're headed in this and what will stop the drum beat. When is enough enough? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [44] +-------------------------------------------------------------------------------- + + Glenn, I actually think you all on the line should be dealing with this issue a little bit because the reason you have companies is because they serve clients well at a good cost. There's a reason our numbers are good, because we have cross sell and clients come to us. And there are reasons for global banks, just like there are reasons for community banks. I think the real issue -- again, you guys do the numbers -- is the banking system has gotten so much stronger in the United States. And it's not just capital, but it's capital, liquidity, oversight. Activities that people like are no longer being done. Derivatives are going to clearing houses. And the initial wave of OLA and living wills, et cetera, those things should all work. I hope at one point we declare a victory and just stop eating our young at this thing. + +-------------------------------------------------------------------------------- +Glenn Schorr, Nomura Asset Management - Analyst [45] +-------------------------------------------------------------------------------- + + All right. Thanks. + +-------------------------------------------------------------------------------- +Operator [46] +-------------------------------------------------------------------------------- + + Betsy Graseck of Morgan Stanley. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [47] +-------------------------------------------------------------------------------- + + Couple of follow-ups on RWA. How much of the passive mitigation was embedded within the RWA results for Basel III this quarter? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [48] +-------------------------------------------------------------------------------- + + Betsy, there was a little bit of passive mitigation. There was a little bit of run-off. And there was also some declines as we purchased back some AFS securities, and those were offset by some other things. It wasn't a very big number because, as I say, that will bleed in over time. And the model enhancements which are about 50% of the 100-basis-point benefit will be a bit back ended. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [49] +-------------------------------------------------------------------------------- + + Okay. So, really, that's going to come later this year, is what you're saying? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [50] +-------------------------------------------------------------------------------- + + That's right. Yes, some of it later this year, some of it next. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [51] +-------------------------------------------------------------------------------- + + And then on the NIM and the LCR, there's obviously an interplay there. And could you just give us an update on where you are with the LCR this quarter? Because your NIM decline this quarter actually was a lot lighter than what we were expecting. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [52] +-------------------------------------------------------------------------------- + + Yes. We showed you at Investor Day that we had a gap to be fully compliant. We're going to be fully compliant by the end of the year. We did close that gap this quarter, not completely, by about one-third. Obviously we also disclosed -- on the slide you'll see our HQLA, our high quality liquid assets which has a relationship. They've gone up. But that's the numerator and the denominator changes, too. So think about it as we've made good progress. We've closed the gap by about one-third and we're on the way to compliance. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [53] +-------------------------------------------------------------------------------- + + And I think, when Marianne gave you the forecast going forward for NIM, that includes changing how we create more LCR. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [54] +-------------------------------------------------------------------------------- + + Right. Okay. And then lastly, just on the CCAR conditional approval, can you just give us a sense? Because I think people were a little bit surprised to see that you had the conditional approval results and yet you were able to do the buyback and the dividend hike that you asked for. So the underlying question is, what can you speak to with regard to what's being asked? And what kind of time frame do you think you have for satisfying the regulatory requirements here? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [55] +-------------------------------------------------------------------------------- + + On the quantitative stuff we passed. And that's why we got the capital plan. There are criticisms around qualitative. And from what we know now, and we're still doing work, we're going to give you more, is around -- they want more granular type of forecasting. They want more idiosyncratic type of forecasting. So we're having conversations with them. Marianne has formed a CCAR department which is going to become experts in CCAR. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [56] +-------------------------------------------------------------------------------- + + And, Betsy, in terms of the time line, we're resubmitting, as requested, in the third quarter. We're doing everything between now and then to remediate and improve our processes following their feedback. So we're committed to being successful. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [57] +-------------------------------------------------------------------------------- + + Okay. Thanks. + +-------------------------------------------------------------------------------- +Operator [58] +-------------------------------------------------------------------------------- + + Brennan Hawken of UBS. + +-------------------------------------------------------------------------------- +Brennan Hawken, UBS - Analyst [59] +-------------------------------------------------------------------------------- + + Just a follow-up on the question on litigation. That dropped to the $0.3 billion. Is that potentially -- are we now adjusting to a lower level? Or was that just noise in what is an extremely volatile number bouncing around a little? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [60] +-------------------------------------------------------------------------------- + + Yes, so Brennan, I think it's very hard to predict. And you're right, it bounces around and it can be noisy. We had a higher level of litigation reserves in the first quarter of last year. And we hope that the numbers will remain low but we can't predict them for you, I'm afraid. + +-------------------------------------------------------------------------------- +Brennan Hawken, UBS - Analyst [61] +-------------------------------------------------------------------------------- + + Sure. Okay. But said another way, you guys don't see anything changing in the environment that would lead you to believe or be comfortable with a lower level of assumption of litigation expenses when we think about you? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [62] +-------------------------------------------------------------------------------- + + They're always going to be lumpy because we have to deal with these things in due course. I think in the prior years we put away a lot. We've always kept the same, predominantly mortgage, largely mortgage, et cetera. And obviously the fact we're not doing more means we think we've gotten there. We did a lot of work on that. It could always change. But we've done thorough analysis. As a lot of you all did, by the way. We did it at the tranche level almost. So, could it be permanently lower? Yes, it could be permanently lower. It doesn't have to go higher. But, obviously, a lot of things coming our way and we'll have to reserve appropriately as they come in. + +-------------------------------------------------------------------------------- +Brennan Hawken, UBS - Analyst [63] +-------------------------------------------------------------------------------- + + Let's hope so. Okay. And then the spread in mortgage compression was meaningful here this quarter. What inning do you think we're in there, ballpark? I know it's tough to predict, as well. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [64] +-------------------------------------------------------------------------------- + + Yes, it's tough to predict but maybe the thing you could look at is, if you take our pretax spread right now of 100 basis points, that compares to a longer-term average run rate of 65 basis points before the crisis. We've been stepping down from a very high level at the beginning of 2012. And we're back to a level where, frankly, we're not that far away from the longer-term run rate. And it's driven by the primary-secondary spread, which came in about 20 basis points in the quarter, back to levels that, again, feel more normal. I don't know I could say what inning we're in, I'm not a sports person, but it doesn't feel like we have another big step change to go. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [65] +-------------------------------------------------------------------------------- + + But we expect it might be up a little bit next quarter, not down, for a variety of reasons. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [66] +-------------------------------------------------------------------------------- + + Yes. There's going to be volatility quarter on quarter, but for this year we think we're in and around this range. + +-------------------------------------------------------------------------------- +Brennan Hawken, UBS - Analyst [67] +-------------------------------------------------------------------------------- + + Okay. So this is the right way to think about it. That helps. And then last one from me, when you think about your cap markets business and the pending change, you guys chatted a little about it with Glenn on the swap clearing, that June seems like the bigger date, Basel and all of the subsequent changes to the competitive environment, competitors adjusting the size of their business and what have you, how do you feel about your business there, particularly on the fixed side, more capital intensive businesses? Do you think that this presents an opportunity to maybe go through review and right-size, maybe increase the efficiency measures there? Or do you feel comfortable keeping your business where it is, roughly? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [68] +-------------------------------------------------------------------------------- + + A lot of that business is -- we call it flow business. So we look at credit, emerging markets, rates, FX. The clients -- we deal with clients all around the world and they need those services. Obviously, we always try to become more efficient. So if you look at FX, I'm going to say 80% is electronic. If you look at rates, the electronic number's going to go up. And so we're going to drive efficiency. But we still think clients are going to need it. There will be spreads to pay for it. And, obviously, everyone is going to be adjusting to Basel III. As you pointed out, some people leaving the business, some are getting into the business. We think it has a good future. We don't think it's going to go away. + +-------------------------------------------------------------------------------- +Brennan Hawken, UBS - Analyst [69] +-------------------------------------------------------------------------------- + + Okay. Thanks a lot. + +-------------------------------------------------------------------------------- +Operator [70] +-------------------------------------------------------------------------------- + + Erika Penala of Bank of America. + +-------------------------------------------------------------------------------- +Erika Penala, BofA Merrill Lynch - Analyst [71] +-------------------------------------------------------------------------------- + + Good morning. I just had one follow-up question to Betsy's inquiry on capital return. Clearly we now have two years of this stress test behind us. And you were initially approved in 2012 for a $15 billion buyback and $6 billion this year. What does the Fed need to see -- and you're building capital, clearly -- what do you think the Fed needs to see from you in terms of the qualitative issues, to get back to the kind of capital return that they clearly in 2012 -- they thought you had plenty of capacity to pay out? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [72] +-------------------------------------------------------------------------------- + + I think you're confusing two different things. I really think that quality -- they're going to give us more feedback on where they say we fell short in quality. I've mentioned them -- idiosyncratic, more level detail, more enterprise-wide type of forecasting, et cetera. That's one issue. The second is the actual dollar amount. The Fed has made it very clear, they want people to get to their Basel III targets. Ours is at least 9.5%. Ben Bernanke said on a speech he gave that the banks that they did the stress tests on have more capital after extreme stress than they started in the crisis. So the Fed, I think, is feeling more and more comfortable, not just individual banks but the system as a whole. And we reduced the 15 down to 6 because we wanted to get to our 9.5% target faster. That's why we did it. We just changed our mind. We want to get to 9.5% this year, we want to get to LCR this year. And obviously they may change the stress test next year. And assume we're going to have a conservation buffer coming in. And we don't know how the interplay of those two things will work. + +-------------------------------------------------------------------------------- +Erika Penala, BofA Merrill Lynch - Analyst [73] +-------------------------------------------------------------------------------- + + Okay. And given what you just mentioned, is it too optimistic to assume for next year a buyback in the $12 billion to $15 billion range? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [74] +-------------------------------------------------------------------------------- + + I think it's too early. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [75] +-------------------------------------------------------------------------------- + + Yes, it's too early for us to tell that. Remember, that's going to relate to how fast you grow and other requests from regulators. So we'll take that when we get there. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [76] +-------------------------------------------------------------------------------- + + Yes, but we do -- Erika, we do expect that we will be continuing to grow capital just through this 100 basis points of passive runoff from mitigation. Certainly our capital levels will be stronger and we're just going to have to see how things play out. + +-------------------------------------------------------------------------------- +Erika Penala, BofA Merrill Lynch - Analyst [77] +-------------------------------------------------------------------------------- + + Okay. + +-------------------------------------------------------------------------------- +Operator [78] +-------------------------------------------------------------------------------- + + Mike Mayo of CLSA. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA - Analyst [79] +-------------------------------------------------------------------------------- + + Loan growth, it's a little bit softer. And I think you mentioned there was some push forward to the fourth quarter. But you also mentioned more competition and lower levels of demand, if I heard you correctly. So my question is how much of the softer loan growth is due to JPMorgan perhaps pulling back and how much is due to the economy? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [80] +-------------------------------------------------------------------------------- + + So, if I could -- a little difficult to side it for you. But we did see a lot of still the pull forward to the fourth quarter, just given the year-end issues that people were concerned about. And so that has had an impact. I think it's slightly less of an impact than in terms of the competitive landscape. And there are deals being done with terms and conditions and pricing that we're not comfortable with at the moment, and we're just remaining very disciplined. So that has had an impact for us. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA - Analyst [81] +-------------------------------------------------------------------------------- + + So, really, on the lower level of demand, what was your loan utilization in the first quarter versus the fourth quarter? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [82] +-------------------------------------------------------------------------------- + + Broadly flat. Broadly flat, around 32%. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA - Analyst [83] +-------------------------------------------------------------------------------- + + I'm sorry? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [84] +-------------------------------------------------------------------------------- + + Broadly flat at around 32%. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA - Analyst [85] +-------------------------------------------------------------------------------- + + 32%? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [86] +-------------------------------------------------------------------------------- + + Correct. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA - Analyst [87] +-------------------------------------------------------------------------------- + + And so what's that? Flat or down a little bit? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [88] +-------------------------------------------------------------------------------- + + Broadly flat. Flat. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA - Analyst [89] +-------------------------------------------------------------------------------- + + Flat. And is that just -- why aren't people borrowing more? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [90] +-------------------------------------------------------------------------------- + + Actually, we saw declines in deposits. So they're using their cash. They're waiting it out. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA - Analyst [91] +-------------------------------------------------------------------------------- + + Okay. And then a separate question, looking at the annual report. Page 4 of the Chairman's letter refers to regulation and some of the issues that you faced, and said we will see more of these. So when you say we will see more of these, Jamie, what are you talking about? Because people's imaginations can go in a lot of different directions. Are we talking Department of Justice, SEC, FBI? Were you thinking of anything in particular or in general or a time frame? And really what I'm asking you to address is the regulatory tail risk of we don't know what we don't know in terms of potential government moves as it relates to JPMorgan. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [92] +-------------------------------------------------------------------------------- + + Mike, it's Marianne. We're in constant dialogue with our regulators. And so we know that we should be expecting some more consent orders. But to clarify for you, they relate to issues that we've been working on over the course of the last several years. So these are not new breaking issues that will surprise you in any material way. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA - Analyst [93] +-------------------------------------------------------------------------------- + + Okay. And was there anything new as part of the '11 hearings that would change the way you would think about the London Whale incident because there was some pretty damning information, some unknowns, at least to those of us who follow the Company. But from your perspective, is there anything else you need to do as a result of the information from those hearings? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [94] +-------------------------------------------------------------------------------- + + Mike, we can't really go into the detail of the reports in specifics. But we obviously respect the work of the subcommittee. We respect the findings they had and we're working very hard to fix our issues. As it relates to the proposal and the recommendation to require documentation associated with portfolio hedging, identifying the specific risks that the hedge is designed to mitigate, and then monitoring it over time, we tend to agree that that makes a lot of sense in the context of what we face. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA - Analyst [95] +-------------------------------------------------------------------------------- + + And then, lastly, when you talk about some additional changes that need to take place -- and I think some of these are organizational -- is there anything major new that you did not cover at the Investor Day recently? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [96] +-------------------------------------------------------------------------------- + + No. And actually there's a couple of things I would say. First, that we're organizing ourselves around the control and regulatory agenda because it's a high priority for us. And we're getting ourselves organized in the same way as we would around a merger or an acquisition. And in doing that we are prioritizing our work. But we're not changing our overall strategy. We're not going to change the way we treat our customers, how we think about growing our businesses. But at the margin we're going to refocus our energies on making sure that we execute on the commitments to improve the control and regulatory environments. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA - Analyst [97] +-------------------------------------------------------------------------------- + + All right, thank you. + +-------------------------------------------------------------------------------- +Operator [98] +-------------------------------------------------------------------------------- + + Matt Burnell of Wells Fargo Securities. + +-------------------------------------------------------------------------------- +Matt Burnell, Wells Fargo Securities, LLC - Analyst [99] +-------------------------------------------------------------------------------- + + Good morning. I wanted to drill down a little bit on the mortgage side of things. Mortgage originations were a little bit stronger than we expected, up about 3%. Applications were down about 8%. You suggested that you thought the gain on sale margins might be relatively flattish going through the next couple of quarters. I'm just curious as to what your thoughts are in terms of the mortgage origination market away from the gain on sale issues that you've been facing. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [100] +-------------------------------------------------------------------------------- + + Yes, so applications actually have come back up. Rates have come down a little in the second quarter. For us in particular, starting there, we're expecting re-fi volumes to stay high. We did see a little bit of an increase in purchase volumes in the applications in the first quarter, albeit from a smaller base. And also we did the Met Life transaction so we have the opportunity to be working that portfolio. So our view on volumes for the year is that they're going to remain solid, although there will be some volatility really on the back of continued strength in refinancing. And you saw the HARP extension so more broadly for the market I think re-fi including HARP will be a level of support for volumes this year. + +-------------------------------------------------------------------------------- +Matt Burnell, Wells Fargo Securities, LLC - Analyst [101] +-------------------------------------------------------------------------------- + + And then, Marianne, a question on NIM. Clearly, your moves on the LCR had some effect on NIM over the last quarter or two. Can you separate what you think the net interest margin movements will be for JPMorgan, excluding your moves for the LCR? Or is it just so intertwined that you really can't do that? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [102] +-------------------------------------------------------------------------------- + + Honestly, it's really all part of how we think about positioning the organization. And being compliant with LCR is part of our new reality. It's just a part of -- we've embedded it into just how we're thinking about the overall positioning of the firm. So it's not something we're separating out for you. + +-------------------------------------------------------------------------------- +Matt Burnell, Wells Fargo Securities, LLC - Analyst [103] +-------------------------------------------------------------------------------- + + Okay. And then, just finally, we saw a fairly sizable decline in value at risk, both in the CIB and overall. Can you give us a little more color as to what's going on there and what we might be able to expect in the second quarter? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [104] +-------------------------------------------------------------------------------- + + It's hard for me to predict the second quarter. It is a real reduction in risk across the portfolio including -- and not driven by but including -- the synthetic credit portfolio which we continue to derisk. But it is important to note, if you look across the asset classes, there's been a very significant decline in the levels of volatility that affect the time series for our lookback period. So that, necessarily, bad days rolled off and better days rolled on. And so, when we compute our VaR it's pushing the VaR down lower. So, as long as volatility remains low and we continue to derisk, there's reasons to believe they'll be at or around this level. But it is going to be subject to changes in volatility, as and when they happen. + +-------------------------------------------------------------------------------- +Matt Burnell, Wells Fargo Securities, LLC - Analyst [105] +-------------------------------------------------------------------------------- + + Okay, thank you very much. + +-------------------------------------------------------------------------------- +Operator [106] +-------------------------------------------------------------------------------- + + Moshe Orenbuch of Credit Suisse. + +-------------------------------------------------------------------------------- +Moshe Orenbuch, Credit Suisse - Analyst [107] +-------------------------------------------------------------------------------- + + A couple of clean-up things. When you are looking at getting to the 9.5%, did you factor in that 100 basis points or is that something that would be on top of that? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [108] +-------------------------------------------------------------------------------- + + It's factored in. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [109] +-------------------------------------------------------------------------------- + + Yes It's an all-in number for us. So, to the degree we expect that to happen by the year end, it's all part of the number, including some capacities to buy shares, the whole thing. + +-------------------------------------------------------------------------------- +Moshe Orenbuch, Credit Suisse - Analyst [110] +-------------------------------------------------------------------------------- + + Got it. Okay. And talking qualitatively about the CCAR process also, there was a pretty large impact on PPNR, which seemed to be like the Fed's looking at pretty harsh -- a pretty harsh look at trading losses. Have you had any clarity from them about whether they're looking at that revenue stream differently than other banking revenue streams? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [111] +-------------------------------------------------------------------------------- + + I'll take the two things separately, the PPNR separate from trading losses. On the trading losses, obviously there's a number of different stresses that we do. And while our number was different, I don't think we feel like there's anything about our processes that is materially going to change. But as it relates to PPNR, we did get feedback that we need to look at certain of our revenue models and we need to look at them more centrally. And, as Jamie said, with a slightly more negative view, idiosyncratically. And we're going to do that. + +-------------------------------------------------------------------------------- +Moshe Orenbuch, Credit Suisse - Analyst [112] +-------------------------------------------------------------------------------- + + Okay. And then, lastly, on the mortgage business, it looked like in the core production, the expense reduction was about 50% of the revenue decline. How do you think about, as that business continues to normalize, as you said, it's probably mostly normalized from a gain on sale perspective, although you probably have some volume issues as we go through the rest of the year. How do you think about the cost structure of that business as you go forward? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [113] +-------------------------------------------------------------------------------- + + So, a couple of things. One is, we are expecting to, and hoping to -- we've set a target for ourselves to gain share -- we do expect volumes to be supported by refinancing this year. That is our expectation. It could change, of course. As it relates to the cost structure, obviously that comes down a little bit more slowly over time but we're making progress. And we talked about the fact that we expect that to be down at $600 million run rate for the fourth quarter. And down to $325 million sometime over the next couple of years. And we're actively working on optimizing our servicing business, both the core performing servicing -- and you saw that obviously with the Met Life deal -- but also, where it would make sense, we would be open to doing sales on subservicing of delinquent loans. And we're working through all those things to try and get to cost structures to the best place it can be. + +-------------------------------------------------------------------------------- +Moshe Orenbuch, Credit Suisse - Analyst [114] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Operator [115] +-------------------------------------------------------------------------------- + + Matt O'Connor of Deutsche Bank. + +-------------------------------------------------------------------------------- +Matt O'Connor, Deutsche Bank - Analyst [116] +-------------------------------------------------------------------------------- + + Good morning. I thought this was one of the cleaner quarters in a while. So I just had one follow-up here. In the private equity, you took some losses from the private portfolio. Just wondering what drove that. And then also the outlook for this business under Basel III and Volcker, even though we don't exactly know what Volcker is yet. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [117] +-------------------------------------------------------------------------------- + + The private equity, we've always told you, is lumpy. It was just markdowns and write-downs of existing positions. And we don't go through the specific names. But, obviously, we hope it will earn a profit. It just wasn't a particularly good quarter for private equity. And the private equity legally can survive Volcker and all those things. We like the business. We like the people. And you just have to do it in a different basis, that's all. + +-------------------------------------------------------------------------------- +Matt O'Connor, Deutsche Bank - Analyst [118] +-------------------------------------------------------------------------------- + + Is there any seasonality in terms of getting year-end or mid-year statements on the private portfolios? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [119] +-------------------------------------------------------------------------------- + + No. There's no seasonality in private equity. It's constantly being reviewed. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [120] +-------------------------------------------------------------------------------- + + And it's lumpy. + +-------------------------------------------------------------------------------- +Matt O'Connor, Deutsche Bank - Analyst [121] +-------------------------------------------------------------------------------- + + Okay. + +-------------------------------------------------------------------------------- +Operator [122] +-------------------------------------------------------------------------------- + + Guy Moszkowski of Autonomous Research. + +-------------------------------------------------------------------------------- +Guy Moszkowski, Autonomous Research - Analyst [123] +-------------------------------------------------------------------------------- + + The first thing I wanted to ask was if we could dig in a little bit on the repurchase losses within mortgage servicing. Such a big swing versus the fourth quarter, an $81 million -- it sounds like a reserve build because I think I heard you say that your actual realized losses were not significant. And yet the guidance remains that it should be a net zero. So it just seemed like there were a lot of moving parts there. I was hoping maybe you could give us a little sense for why you had the $81 million hit. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [124] +-------------------------------------------------------------------------------- + + Absolutely. Guy, it's a big change from the fourth quarter, off a small number. So, not to diminish the size of the numbers, but positive $50 million, negative $80 million, plus or minus around the zero level. What that's a factor of, Guy, is that the reserve release is based upon our model, and realized losses is based upon agency activity. So the timing isn't exactly perfect. So realized losses came down from about $200 million to $180 million. And we didn't build reserves. We released them, just not at the same order of magnitude. And it's really to do with timing, which is why we say that we do expect over time they'll net to zero. Last quarter it was a small positive. This quarter it's a small negative. Nothing to read into it. + +-------------------------------------------------------------------------------- +Guy Moszkowski, Autonomous Research - Analyst [125] +-------------------------------------------------------------------------------- + + Okay, thanks for that. With regard to the CCAR process and some of the changes that the Fed is asking you to make, first of all, just qualitatively can you give us a sense for the amount of dialogue that you have with the Fed as you work towards satisfying their request, so that you really know exactly where they thought the deficiencies were? Or is there a lot of guesswork for you on that? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [126] +-------------------------------------------------------------------------------- + + We're in constant dialogue with the regulators. We obviously can't comment on the specifics of our conversations with them. We've had some very constructive conversations as we came out the 2013 CCAR process. And on the basis of those we're actively working to make the improvements they want us to make. But also expecting to continue to get more and more detailed feedback and actually hope to get some industry best practice information, too. So we're going to be working in partnership with them, in constant dialogue, all the way through this year so that we can be clear on what success looks like. + +-------------------------------------------------------------------------------- +Guy Moszkowski, Autonomous Research - Analyst [127] +-------------------------------------------------------------------------------- + + Okay. And just if I can follow up on I think it was Moshe's question about the PPNR. It sounded like you were saying that many of the deficiencies that they were focusing on were in the inputs to the calculation of the stress PPNR specifically. Did I understand that right? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [128] +-------------------------------------------------------------------------------- + + We haven't gotten a lot of feedback yet. So there will be more to come. But we're going to be geared up to do it. And I think we want to be best-in-class in CCAR. The answer is [absolutely positive] in PPNR. I mentioned just one -- idiosyncratic exposure and risk in PPNR. When you go through a stress test, you can assume that your company is just dealing with all those macroeconomic factors with your forecast. You can assume your company is going through those macroeconomic forecasts plus you're under some other kind of stress and you can lose market shares. Obviously that would change your PPNR. So we'll be having more dialogue and trying to figure out and make sure we do the right thing here. + +-------------------------------------------------------------------------------- +Guy Moszkowski, Autonomous Research - Analyst [129] +-------------------------------------------------------------------------------- + + Okay, that's very helpful. Thanks. I hope this doesn't sound too crazy but just to think about it the other way, is there any chance that after the resubmission, or as part of the resubmission, given how close you are to your Basel III targets, and with some of that 100 basis points coming in, is there any chance that you would ask for and could get an increase for this year? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [130] +-------------------------------------------------------------------------------- + + No. This is just a resubmission of the progress program. And they like to see qualitative improvement. This is not a change of request at all. This is the one that Marianne referred to that will be in the third quarter. + +-------------------------------------------------------------------------------- +Guy Moszkowski, Autonomous Research - Analyst [131] +-------------------------------------------------------------------------------- + + Yes, that's what I'm talking about. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [132] +-------------------------------------------------------------------------------- + + We'll obviously do another CCAR in January. + +-------------------------------------------------------------------------------- +Guy Moszkowski, Autonomous Research - Analyst [133] +-------------------------------------------------------------------------------- + + Got it. And then final question. You mentioned, Jamie, in the shareholder letter that just because you don't have big fancily-named cost-cutting programs, it doesn't mean you're not very focused on cost reduction. Is that what we're seeing in the fact that if you look at the CIB your comp was down 7% versus your revenue being plus? Or is it that you did something different in the way you think about through-the-year accruals? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [134] +-------------------------------------------------------------------------------- + + No. The through-the-year accruals is almost exactly the same. It's based upon -- there's a lot of stuff that goes into that number but that really hasn't changed that much. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [135] +-------------------------------------------------------------------------------- + + Yes. And actually you've got to normalize out the DVA, which was a large loss last quarter. If we normalize that out, revenues are down. So it's not comped down on revenue. (multiple speakers) + +-------------------------------------------------------------------------------- +Guy Moszkowski, Autonomous Research - Analyst [136] +-------------------------------------------------------------------------------- + + That's fair. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [137] +-------------------------------------------------------------------------------- + + I was referring to that we're constantly putting in new operationals, new systems to reduce overhead. Marianne already mentioned a bunch of things we're doing in Mortgage. You're seeing similar efforts in Consumer. That's a constant effort. We do have names for some of them, by the way. I'm just not going to mention them here. + +-------------------------------------------------------------------------------- +Guy Moszkowski, Autonomous Research - Analyst [138] +-------------------------------------------------------------------------------- + + Okay. But there's nothing different, like you said, in terms of the way you accrue for bonuses within the investment bank? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [139] +-------------------------------------------------------------------------------- + + No. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [140] +-------------------------------------------------------------------------------- + + No. + +-------------------------------------------------------------------------------- +Guy Moszkowski, Autonomous Research - Analyst [141] +-------------------------------------------------------------------------------- + + Okay. Thank you. + +-------------------------------------------------------------------------------- +Operator [142] +-------------------------------------------------------------------------------- + + Gerard Cassidy of RBC. + +-------------------------------------------------------------------------------- +Gerard Cassidy, RBC Capital Markets - Analyst [143] +-------------------------------------------------------------------------------- + + Thank you. Good morning. I had some questions on the Commercial Banking line of business. You had a nice increase in the real estate lending area in the first quarter. It looked like it was about $9 billion after four quarters of essentially flat to down real estate loans. Can you give us some color on where the growth was? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [144] +-------------------------------------------------------------------------------- + + I think you're referring to the CTL, the commercial term lending, which is lending against multi-family. And we have seen growth in it. Remember, that stuff is like 65% LTV. It did great through this last downturn so we're very comfortable with that kind of lending. I forgot where you --. + +-------------------------------------------------------------------------------- +Gerard Cassidy, RBC Capital Markets - Analyst [145] +-------------------------------------------------------------------------------- + + Are you guys finding greater demand or are you just more comfortable with it now than you were maybe a year ago? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [146] +-------------------------------------------------------------------------------- + + I would say a little of both. + +-------------------------------------------------------------------------------- +Gerard Cassidy, RBC Capital Markets - Analyst [147] +-------------------------------------------------------------------------------- + + Following up on your answer about corporate deposits dropping in the quarter, which obviously is a good sign if companies are using this for capital improvements, what's your outlook? Do you expect that to continue? Should we see that as a continued positive trend? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [148] +-------------------------------------------------------------------------------- + + Are you talking about the commercial bank or the total Company? + +-------------------------------------------------------------------------------- +Gerard Cassidy, RBC Capital Markets - Analyst [149] +-------------------------------------------------------------------------------- + + Commercial bank. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [150] +-------------------------------------------------------------------------------- + + We would expect to be flat to down a little bit as companies use their -- they have a lot of deposits. So I think we, at Investor Day and earlier, told people they were really high and we expected it to come down, particularly before people start using their revolvers. So they do relate to each other. + +-------------------------------------------------------------------------------- +Gerard Cassidy, RBC Capital Markets - Analyst [151] +-------------------------------------------------------------------------------- + + I agree. Are your guys on the front line hearing that from your customers, that they expect to use more for the remainder of the year, do you think? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [152] +-------------------------------------------------------------------------------- + + I don't know the answer to that. + +-------------------------------------------------------------------------------- +Gerard Cassidy, RBC Capital Markets - Analyst [153] +-------------------------------------------------------------------------------- + + Okay. Coming back to loan loss reserves, obviously you've got a great capital position. You pointed out that Bernanke has indicated that the banking system is super strong going through the stress test. With the current level of loans of about $729 billion, what would be a normal reserve level in normal times compared to where you are today? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [154] +-------------------------------------------------------------------------------- + + We did a whole page for you on where we thought the through-the-cycle reserve levels should be by business. And there are some businesses -- mortgage, most obviously -- that still have a way to go. And there are other businesses in the wholesale space, in the commercial bank, that are below that through the cycle. I would refer you back to that page. If you do the numbers, from recollection, on an annualized basis, our charge-offs have been more like $7 billion or $8 billion, which, while that is not dissimilar to charge-offs we've seen, it's for different reasons. So I would take a look at that page. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [155] +-------------------------------------------------------------------------------- + + It's mostly mortgage that will come down. Think of everything else as close to normal. Mortgage, which in total is $9 billion, will eventually be a lot lower than that. But that could take a couple of years. + +-------------------------------------------------------------------------------- +Gerard Cassidy, RBC Capital Markets - Analyst [156] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Operator [157] +-------------------------------------------------------------------------------- + + Paul Miller of FBR. + +-------------------------------------------------------------------------------- +Paul Miller, FBR & Co. - Analyst [158] +-------------------------------------------------------------------------------- + + Yes, thank you very much. I know a lot of my questions have been answered but we saw yesterday that they extended the HARP out another two years. And there's also some discussion coming out of some of the -- inside the White House, really, that they could put some type of PR plan behind HARP to try to get more people to HARP. Do you think this will have any impact at all in getting more people off the sidelines and refi-ing through the HARP programs? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [159] +-------------------------------------------------------------------------------- + + To talk for us specifically, as you probably know, we've been very successful and proactive as it's relating to HARPing our own book. And by the end of this year we fully expected to have been as successful and mine that as far as possible, or they will carry on. That's not the case in the industry. So it's great news that HARP was extended out to the end of 2015. And it will allow for other servicers to get their ducks in a row and potentially to have cross service to HARP. Which, in turn, should be good in terms of volumes, although I don't think it will be a step change. For us we're not expecting it to be a significant difference in our production or in our MSR value. + +-------------------------------------------------------------------------------- +Paul Miller, FBR & Co. - Analyst [160] +-------------------------------------------------------------------------------- + + I don't know if you can disclose this or not, but how much do you think you have HARP eligible? And how many of those HARP-eligible loans did you do on a percentage basis? Do you think you've touched most of them already? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [161] +-------------------------------------------------------------------------------- + + We talked about we peaked in our HARP volumes in about second quarter of last year. I think overall, first half of last year was high, came down slightly, overall 15% last year. We talked at Investor Day that we thought that would go down to the high single digits this year, and it is, in terms of percentage of our production. And we are very active and have been very proactive in mailing our HARP population. And expected to have completed the program by the end of the year. So we were on track and this doesn't change our expectations. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [162] +-------------------------------------------------------------------------------- + + I think the total -- if you take all mortgages, I think the number's like 4 million would be HARP-able today if they went to it. I'm somewhat surprised that more people don't do it, to tell you the truth. Anything the government can do, either PR, I think the cross-servicing is probably a bigger one, will make it slightly better. The thing was just slightly better. It's not going to dramatically change mortgage. + +-------------------------------------------------------------------------------- +Paul Miller, FBR & Co. - Analyst [163] +-------------------------------------------------------------------------------- + + Okay. I think a lot of companies have told us that they think that they've gotten through most of the low-hanging fruit with HARP, and that the people that aren't HARPing they doubt they will ever HARP. So I'm just wondering, if there's a big PR push, if some of those guys will wake up and say -- maybe I need to look at this program. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [164] +-------------------------------------------------------------------------------- + + We hope so. We don't know any better than you. + +-------------------------------------------------------------------------------- +Paul Miller, FBR & Co. - Analyst [165] +-------------------------------------------------------------------------------- + + Okay. Thanks a lot, guys. Thanks. + +-------------------------------------------------------------------------------- +Operator [166] +-------------------------------------------------------------------------------- + + Nancy Bush of NAB Research. + +-------------------------------------------------------------------------------- +Nancy Bush, NAB Research - Analyst [167] +-------------------------------------------------------------------------------- + + A quick question back to the Brown stuff that's hanging around out there. I'm reading what everybody else is, that they're looking at a 10% capital ratio, with the possibility of another 5% buffer on top of that. And basically throwing away the concept of risk-weighted assets. And more or less eviscerating Basel III, as far as I can see. Do you guys have any sense where this 10%, 5% number comes from? Is there some empirical evidence? Or is this just a back door way to try to get the biggest banks to break up? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [168] +-------------------------------------------------------------------------------- + + You really have to ask them. We'll leave this to them and the regulators, okay? + +-------------------------------------------------------------------------------- +Nancy Bush, NAB Research - Analyst [169] +-------------------------------------------------------------------------------- + + Do you have a sense where the numbers are coming from? What that 10% capital ratio, where it comes from? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [170] +-------------------------------------------------------------------------------- + + You've got to ask them. + +-------------------------------------------------------------------------------- +Nancy Bush, NAB Research - Analyst [171] +-------------------------------------------------------------------------------- + + Okay. Thanks. + +-------------------------------------------------------------------------------- +Operator [172] +-------------------------------------------------------------------------------- + + We have no other questions at this time. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [173] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [174] +-------------------------------------------------------------------------------- + + Thank you for spending some time with us. + +-------------------------------------------------------------------------------- +Operator [175] +-------------------------------------------------------------------------------- + + This concludes today's conference call. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/exam/original-files/Problem_2_3_Sample_full_transcripts/2013-Apr-16-KO.N-139599548880-Transcript.txt b/exam/original-files/Problem_2_3_Sample_full_transcripts/2013-Apr-16-KO.N-139599548880-Transcript.txt new file mode 100644 index 0000000..2f9a6b2 --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_full_transcripts/2013-Apr-16-KO.N-139599548880-Transcript.txt @@ -0,0 +1,505 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q1 2013 The Coca-Cola Company Earnings Conference Call +04/16/2013 09:30 AM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Gary Fayard + The Coca-Cola Company - CFO + * Steve Cahillane + The Coca-Cola Company - President, Coca-Cola Americas + * Jackson Kelly + The Coca-Cola Company - VP & IR + * Muhtar Kent + The Coca-Cola Company - Chairman, CEO + +================================================================================ +Conference Call Participiants +================================================================================ + + * Caroline Levy + CLSA Limited - Analyst + * Bill Pecoriello + Consumer Edge Research - Analyst + * Dara Mohsenian + Morgan Stanley - Analyst + * Mark Swartzberg + Stifel Nicolaus - Analyst + * Judy Hong + Goldman Sachs - Analyst + * John Faucher + JPMorgan Chase & Co. - Analyst + * Bryan Spillane + BofA Merrill Lynch - Analyst + +================================================================================ +Presentation +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + At this time, I would like to welcome everyone to The Coca-Cola Company's first quarter 2013 earnings results conference call. Today's call is being recorded. If you have any objections, you may disconnect at this time. All participants will be in a listen-only mode until the formal question-and-answer portion of the call. +(Operator Instructions) +Due to the interest in this call, we request a limit of one question per person. I would like to remind everyone that the purpose of this conference is to talk with investors, and therefore questions from the media will not be addressed. Media participants should contact Coca-Cola's media relations department if they have questions. I would like to now introduce Jackson Kelly, Vice President and Investor Relations Officer. Mr. Kelly, you may begin. + +-------------------------------------------------------------------------------- +Jackson Kelly, The Coca-Cola Company - VP & IR [2] +-------------------------------------------------------------------------------- + + Good morning and thank you for being with us today. I'm joined by Muhtar Kent, our Chairman and Chief Executive Officer, and Gary Fayard, our Chief Financial Officer. Following prepared remarks by Muhtar and Gary this morning, we'll turn the call over for your questions. Ahmet Bozer, President of Coca-Cola International; Steve Cahillane, President of Coca-Cola Americas; and Irial Finan, President of our Bottling Investments Group will also be available for our Q&A session. +Before we begin, I would like to remind you that this conference call may contain forward-looking statements, including statements concerning long-term earnings objectives, and should be considered in conjunction with cautionary statements contained in our earnings release, and in the Company's most recent periodic SEC report. In addition, I would also like to note that we have posted schedules under the Financial Reports & Information tab in the investor section of our Company website at www.coca-colacompany.com. These schedules reconcile certain non-GAAP financial measures, which may be referred to by our senior executives during this morning's discussion, to our results as reported under generally accepted accounting principles. Please look on our website for this information. Now, let me turn the call over to Muhtar. + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Company - Chairman, CEO [3] +-------------------------------------------------------------------------------- + + Thank you, Jackson, and good morning, everyone. Before we review this quarter's operating results, I would like to take a moment to acknowledge the senseless events that took place in Boston yesterday. We were deeply saddened by this news, and our thoughts and prayers are with those affected by this horrible tragedy. +Now, turning to this quarter's results. We are pleased with our first quarter performance. The great women and men of The Coca-Cola Company, Coca-Cola system delivered solid performance results in line with our expectations. And on a global basis, we once again gained value share. We have now gained global value share in nonalcoholic ready-to-drink beverages for 23 consecutive quarters. +In spite of the challenging global economic times of the last few years, our people and our system bottling partners are executing the right strategies to advance us further towards our 2020 Vision. Since the launch of our 2020 Vision at the beginning of 2010, we've increased daily servings by more than 225 million. We have lifted global volume and value share to the highest levels since 2003, and more than $48 billion have been added to The Coca-Cola Company's market capitalization. Across the system, we are continuing to invest together for a better tomorrow. In fact, we enter 2013 and the fourth year of our journey to 2020 from a position of real strength clearly focused, and well on track to reach our goals and objectives. +And our global bottling system is healthier than ever before. The strength of our brands and the promise of sustainable growth are fueling our bottlers' efforts to become more efficient, improve capability, and further strengthen execution. We are working closely with our bottling partners around the world to rapidly realize opportunities, to execute with precision, and to continue winning at the point of sale. We are innovating and investing in the health of our brands, in our capabilities, and in new opportunities for growth across the entire nonalcoholic ready-to-drink beverage landscape. We are leading the industry dialogue around obesity, and strengthening the sparkling category by bringing forward new packaging choices, transparency in labeling, and new sweetener solutions, while also championing energy balance and promoting physical activity. +We are working across the golden triangle of government, civil society, and business to create real value and to make a lasting positive difference. And more importantly, we continue to generate shareowner value. To that end, in the first quarter of 2013, we grew worldwide volume by 4%, cycling 5% from prior year, and once again captured global nonalcoholic ready-to-drink beverage value share with volume and value share gains in core sparkling categories. Our global sparkling portfolio grew 3%, led by brand Coca-Cola growth of 3%, while Fanta grew 6% and Sprite grew 5%. Sparkling brands contributed nearly two-thirds of our global volume growth. Worldwide still beverage volume grew 6% in the quarter, with growth across most still beverage categories, including ready-to-drink tea, juices and juice drinks, as well as packaged water. +These gains enabled us to capture global still beverage volume and value share. And immediate consumption volume also grew 3%, with growth across both sparkling and still beverages. As announced during our 2012 year-end earnings call, we implemented a new organizational structure effective January 1 of this year that includes Coca-Cola Americas, which began 2013 by growing volume 3%, and Coca-Cola International, which grew volume by 5%. +Moving now to operating groups. I will start with North America, where we remain resolutely focused on driving sustainable growth. We are pleased to report that North America continued to build on three successive years of growth, with 1% volume growth in the first quarter, resulting in volume and value share gains. We are winning by investing in our portfolio of preferred brands by executing with excellence at the point of sale, and by creating efficiencies and synergies across our manufacturing, sales, and distribution networks. Although sparkling volume was down by 1% in the quarter, we achieved 3% sparkling price mix, reflecting our focus on value creation. Importantly, brand Coca-Cola grew this quarter, aided by double-digit growth in both mini cans and in our 1.25-liter package, underscoring the strength of our flagship brand and the success of our occasion-based package architecture. +Coca-Cola also extended its favorite brand lead to over two times its closest competitor in North America. Sparkling beverages gained volume and value share, as marketing and execution are enabling us to win in the marketplace. Still beverage volume grew 6% in the quarter, cycling 6% from prior year. Our portfolio of still beverage brands has now captured volume and value share for 21 of the past 23 quarters. Our tea brands grew strong double digits and captured volume and value share of the ready-to-drink tea category. Growth was driven by Honest Tea at the premium end of the market, the ongoing rollout of Fuze, which is now available in 70% of total US supermarkets, and continued Gold Peak growth. As you may know, we have built Gold Peak from scratch since launching it in 2006. The brand has grown by double digits for 24 consecutive quarters, and is rapidly on its way to becoming a billion-dollar brand. +Our juice and juice drink portfolio grew 3% in the quarter, gaining volume and value share. Simply was up 9%, thanks to the addition of new flavors and the growth in Simply single serve. Our Minute Maid trademark grew 4%, due to the expansion of Minute Maid punches and ades, as well as gains in the light segment of the chilled juice drink category. North America water business grew 5%, led by growth of Dasani, which continues to maintain a price premium to its primary competitors. smartwater maintained its streak, delivering its 20th consecutive quarter of double-digit growth. And our energy portfolio delivered its 11th consecutive quarter of volume growth and gained volume and value share. +As announced earlier today, we are taking a significant step towards our 2020 Vision by commencing the implementation of the 21st century beverage partnership model in the United States. The franchise system has always been the strength of the Coca-Cola business globally, and today we are accelerating the transformation of our US system in ways that will establish a clear path to help us achieve our 2020 Vision. In the coming months, we will be collaborating with five of our bottling partners to implement a plan which will include the granting of exclusive territory rights in the sale of distribution assets with cold drink equipment. In the near term, production assets will remain with Coca-Cola Refreshments, which will facilitate future implementation of a national product supply system. +These actions are being taken ahead of our previously stated timeline. The result will be further progress towards a more agile, modern, customer-focused franchise business model, unique to the United States. We remain confident that we have the right strategies for North America, and we are optimistic about the outlook for this important critical market, despite the challenging competitive environment and macroeconomic backdrop. As today's results indicate, The Coca-Cola Company's brand marketing, commercial execution, and category leadership efforts are all working together to enable us to sustainably win at the point of sale. +Turning now to Latin America. We are building the business from a position of real strength, having realized solid focus and volume growth in the quarter, cycling 5%. Sparkling beverages in Latin America grew 2%, with brand Coca-Cola also up 2%, enabling us to gain both volume and value share. Still beverages across Latin America delivered double-digit growth, gaining volume and value share, thanks to growth across the portfolio, including double-digit growth for both Del Valle juices and juice drinks, as well as Powerade. +In Mexico, brand Coca-Cola growth, combined with high single-digit growth of our still brands, helped drive overall volume growth of 3% in the quarter, enabling us to capture volume and value share of nonalcoholic ready-to-drink beverages. In Brazil, where volume also grew 3%, brand Coca-Cola delivered 2% growth, while Fanta grew 8%, and Del Valle delivered 15% growth, enabling us to gain volume and value share in this important market. +The Latin Center business unit, which stretches from Ecuador to Belize and encompasses the Caribbean, grew volume by double digits, and trademark Coca-Cola expanded its leadership, growing high single digits through consumer-relevant propositions that includes increasing availability of our 1.25-liter returnable glass bottle, and expanding immediate consumption PET. We continue to see growth opportunities across Latin America, which is the Company's largest operating group in terms of unit case volume, and where we have gained value share in 21 of the last 23 quarters. +Moving now to the Pacific Group. We generated 3% overall volume growth, cycling 9% from prior year, led by high single-digit growth in brand Coca-Cola. At a country level, volume in China grew by 1%, cycling strong 9% growth. Sparkling beverages grew high single digits, while the juice and juice drinks business grew by double digits, following the introduction of Minute Maid Pulpy Pear and Minute Maid Pulpy Mango. This growth was partially offset by a decline in water volume as we cycled strong water growth. These results reflect sequential improvement and are in line with the expectations we shared during our year-end call. +Importantly, we believe that we will continue to realize sequential improvements through 2013. At the same time, we also believe that it is going to take a period of time for consumption to return to the growth levels of previous years. Nevertheless, we have every confidence in the long-term resilience of our China business, and we remain optimistic about our long-term opportunities to generate robust growth in this region over time. +In Japan, volume growth was 1%, in line with expectations, cycling 3% growth from prior year. Sparkling growth was up mid-single digits, led by trademark Coca-Cola, and in particular Coca-Cola Zero up double digits, driven by the successful Zero Limit national promotion. Ayataka green tea and I LOHAS water, our newest billion-dollar brands in Japan, continued their double-digit growth, and contributed to solid growth in the important convenience store channel. +Turning to India, which as a reminder we're now reporting within the Pacific Group, we delivered high single-digit volume growth, cycling strong double-digit growth from last year. And we have gained volume and value share in sparkling, while also increasing our pricing. Growth was led by brand Coca-Cola, which grew a strong 30% in the quarter, thanks to a strong, robust, integrated marketing and communications campaign, and strong in-market execution. In the first quarter alone, we added over 250,000 incremental outlets in India, and significantly increased chilled availability for our brands. Our still beverages in India grew mid-single digits, cycling strong double-digit growth, while gaining both volume and value share. +In concluding our update of the Pacific, I would also like to recognize our continued strong performance in two exciting markets, Thailand and South Korea. In Thailand, we are maintaining double-digit volume growth while rapidly investing in additional capacity. We are working in close alignment with our local bottling partners to further expand our leadership position in this important market. In South Korea, we are generating broad-based growth across a diverse portfolio of strong brands, with sparkling beverages growing high single digits in the quarter, led by brand Coca-Cola, up 11%. +Turning now to the Eurasia and Africa Group. We once again delivered double-digit volume growth, growing 15%, while maintaining share. Brand Coca-Cola grew double digits, bolstered by our award-winning Crazy for Good campaign. Fanta, Sprite, and Coke Zero all generated double-digit growth as well. Our still brands delivered double-digit growth, led by Fuze Tea, and the acquired volume related to the Aujan partnership. +Russia continued to deliver strong results, outpacing the non-alcoholic ready-to-drink beverage industry with high single-digit volume growth. Growth was led by sparkling beverages, where we gained share for the eighth consecutive quarter, as brand Coca-Cola grew 15%. Our still beverage portfolio gained volume and value share, as Dobriy juice continued its double-digit expansion. +One highlight I would like to mention with regard to Russia is our effort to deepen the emotional connection with the consumers by leveraging the 2014 Winter Olympic Games in Sochi. Our sponsorship of these games and the torch relay will combine the passion of the Olympic spirit and Coca-Cola in the minds of millions of Russians, as the torch will pass through thousands of Russian towns. In fact, our activation of the torch relay is already driving real connections to our consumers, as evidenced by the more than 77,000 torchbearer nominations we have received during our latest consumer promotion. +The Turkey, Caucasus, and Central Asia business unit also continued its strong performance, delivering double-digit growth in the quarter. Prior to concluding my update on Eurasia and Africa, I would like to note that the Middle East and North Africa business unit was recently awarded the Company's Woodruff Cup. This is our most prestigious operating award, honoring the top performing business unit in our worldwide business systems. +Among other important accomplishments, the Middle East and North Africa business unit achieved double-digit volume and operating income growth for 2012. And we celebrated an important milestone with our partners at Aujan this quarter, as we toasted the billionth can of Rani juice produced since the start of our partnership. Rani is the leading juice brand in the Middle East, and a terrific compliment to our existing juice business in Eurasia and Africa, including Turkey, which gained volume and value share for a 10th consecutive quarter. +Turning now to Europe, the economic environment clearly remains uncertain across this region, as persistent high unemployment, coupled with severe austerity measures, are weighing on consumer sentiment and consumer spending. In fact, Nielsen's latest Global Survey of Consumer Confidence and Spending Intentions indicate that consumer confidence fell in 20 of the 29 European markets in the fourth quarter of last year. +Nevertheless, our volume was even in the quarter, cycling 1% growth from prior year, which is a significant sequential improvement from the fourth quarter of last year, and we grew volume and value share in nonalcoholic beverages, both sparkling beverages across the region, including key markets like France, Germany, and Great Britain. There were pockets of volume growth across Europe, with Germany growing a healthy 3%, the Nordic countries showing improvement, and Great Britain returning to growth, while gaining share due to strong integrated marketing campaigns and solid execution in the marketplace. +For the near future, as European consumers remain cautious in their spending, we will keep investing for the long-term health of our business. These results from around the world underscore the laser focus of our system -- that our system has on our strategic priorities as we advance further towards our 2020 Vision. +Our five core strategic priorities are as follows. First, we must continue to grow sustainably and provide meaningful solutions that enhance the health and well-being of the communities we proudly serve. Second, we will win with Coca-Cola, while actively promoting the brand and the category. Third, we must absolutely keep winning and executing with excellence at the point of sale. Fourth, we need to keep maximizing the value of our global beverage portfolio. And fifth, we will encourage and inspire our system and associates to deliver our mission. +Looking back at the first quarter of 2013, we were also honored and humbled to receive several recognitions. We were again ranked number four on FORTUNE's list of Most Admired Companies, and named one of the Most Innovative Companies in the world by Fast Company. Also one of the most meaningful recognitions for the Coca-Cola system came from Catalyst, the leading nonprofit organization with a mission to expand opportunities for women in business. We were honored to accept the 2013 Catalyst Award in recognition of our Global Women's Initiative. This important initiative is focused on fueling the advancement of women as dynamic leaders and entrepreneurs across the organization, and also in communities throughout the world where we serve our customers and consumers. +Before moving on, I want to revisit a complex societal issue that touches us all, obesity. Beginning last year, The Coca-Cola Company took new steps to give consumers even more choices in package sizes, sweeteners, and beverages, including more low- and no-calorie selections, while also providing clear nutritional information, and by supporting fitness programs. Coca-Cola has a rich heritage of being associated with exercise, sports, and active lifestyles. Today, we are using our marketing expertise and community connections to inform consumers about energy balance and to inspire more people to get moving. We firmly believe the challenges of obesity are solvable. The Coca-Cola system, together with industry partners, NGOs, and governments, is committed to being part of the solution. +In closing, I would like to reiterate that our brands are stronger than ever before. We delivered solid performance results this quarter, in line with our expectations, while continuing to gain global value share. Together, with our global system bottling partners, we are working diligently to unlock value, to execute with precision, and to continue gaining volume and value share. We are leading the industry dialogue around obesity by bringing forward solutions, adding transparency to the dialogue around calories, and championing energy balance and physical activity. +We are generating value for our shareowners, as evidenced by the recently announced 10% increase in our annual dividend, which is our 51st consecutive annual dividend increase. Even so, we remain constructively discontent, as we seek to make the most of the vast growth opportunities we continue to see around the globe. Please know that we are working each and every day to refresh the world, inspire moments of happiness and optimism, create value, and make a meaningful difference in the lives of our consumers, our customers, and in the communities that we proudly serve. +With that, let me now turn the call over to Gary. + +-------------------------------------------------------------------------------- +Gary Fayard, The Coca-Cola Company - CFO [4] +-------------------------------------------------------------------------------- + + Thanks, Muhtar, and good morning, everyone. We delivered solid results this quarter, underscoring once again that our Company and global system are well-positioned to execute our strategic plans in alignment with our 2020 Vision. Achieving such consistent performance during a time of ongoing macroeconomic uncertainty is a real testament to the strength of our global system and the investments we continue to make for long-term sustainable growth. +Before we get into the financial details of the quarter, let me remind you that we closed the sale of 51% of our bottling business in the Philippines to Coca-Cola FEMSA in January of this year, and therefore we no longer are consolidating the Philippines results. We anticipate that this transaction, along with the previously announced bottling merger in Brazil, will have a 3% structural impact on our full year 2013 net revenues; likewise our full year operating income results should see a 1% structural impact. However, there should be a corresponding improvement to equity income to account for our share of the results of these operations moving forward. As I was -- as I shared in our 2012 year-end call, we do not expect these transactions to have a material impact on our 2013 earnings results. +Moving now to our first quarter results, our comparable earnings per share were $0.46, up 5% versus the prior year quarter, despite currency headwinds of approximately 4%. Our comparable currency neutral operating income was up 5%, despite the impact of two fewer selling days, and the impact of certain structural items. Currency was a 3% headwind on comparable operating income. Comparable currency neutral net revenue grew 1%, and grew 2% after adjusting for the impact of structural items. After adjusting for the effect of two fewer selling days in the quarter, unit case sales were in line with concentrate sales. +Price mix for the quarter was even, cycling 3% in the prior year quarter, and remember in the second quarter we will also be cycling 3% price mix. However, stated in our last earnings call, we expect to earn low single-digit consolidated price mix for 2013, consistent with our long-term growth model. We continue executing our occasion-based brand price package and channel strategies with precision around the world. Our comparable gross margin was 61.5%. This represents a slight improvement compared to the prior year, primarily due to the impact of geographical mix, the deconsolidation of the Philippines bottler, and the impact of our foreign currency hedging program. We expect the improvement in our gross margin to moderate over the remainder of the year, due to a shift in geographic mix. +With regard to operating expense leverage, we achieved three points of favorable operating leverage in the quarter, despite the impact of two fewer selling days. Again, this was primarily due to the deconsolidation of the Philippines bottler, as well as the benefit from a reversal of expenses related to some of our long-term incentive plans. This was partially offset by sustained strategic investments in our brand building activities around the world. +As we have shared before, we continue to expect operating expense leverage to be even to slightly positive for the full year. As you model our 2013 operating results and our corresponding expense leverage, let me also remind everyone that the 2013 calendar will have one less day when compared to 2012. And based on our quarterly closing calendar, as I have said, we had two less days this quarter when compared to the first quarter of 2012, and our fourth quarter of 2013 will have one more day when compared to the fourth quarter of 2012. +Moving now to net interest income, we came in at $14 million of income this quarter, ahead of our initial forecast. We now expect net interest will be even to slightly positive for the remainder of the year. Our underlying effective tax rate is 23.5%. We expect this rate to remain unchanged through 2014. Cash flow from operations decreased 3%, primarily due to the impact of the two fewer selling days in the period, an unfavorable impact from currency, and an increase in the use of working capital in preparation for the peak season of our growing global business. Looking ahead to the remainder of the year, we expect our cash flow growth rate to be more in line with our earnings growth rate. +Turning to share repurchase, our net share repurchase use during the quarter totaled approximately $1.1 billion. This places us well on track to achieve the $3 billion to $3.5 billion range for full-year 2013 that we communicated during our last earnings call. As for currencies, we remain fully hedged on the euro, yen, and sterling for 2013 and into 2014, and we also have near-term coverage in place across several other currencies. After considering these hedge positions and current spot rates, we expect currencies to be a 3% headwind for the second quarter, and a 2% headwind for the full year. As you've all seen the movement of the yen in recent months, as mentioned, we've hedged our yen exposure for this year and into next year, but we do believe that the weaker yen will ultimately be beneficial for the Japanese economy and for our business. +In closing, and as Muhtar shared earlier, we are delivering on our strategic priorities and achieving real success. We fully expect operating income to be in line with our long-term growth targets for the full year. Our global system is committed to investing together for a better tomorrow, and our proven ability to achieve consistent quality results provides us with the confidence that together as a system, we will successfully crack the code to sustainable growth to meet our 2020 Vision goals. Operator, we're now ready for questions. + + + +================================================================================ +Questions and Answers +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Thank you. (Operator Instructions) +In respect to the number of individuals with questions, only one question per participant. Your first question is from John Faucher with JPMorgan Chase. Mr. Faucher, you may continue with your question. + +-------------------------------------------------------------------------------- +John Faucher, JPMorgan Chase & Co. - Analyst [2] +-------------------------------------------------------------------------------- + + Sorry. There's a lot of static. As you look at the bottle consolidation piece, is Spanish or Japanese bottler consolidation just sort of the beginning of the next wave of, let's say, a bottler-driven consolidation? And how much are you pushing this, as opposed to letting the bottlers lead where the system's going? + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Company - Chairman, CEO [3] +-------------------------------------------------------------------------------- + + Hi, John. Good morning. This is Muhtar. First, I think it's important to realize that there's not one model for the world. There's many different models for the world, as you can see. What's happening, this has been an exciting last several months with respect to the evolution, actually continuous evolution, of our franchise system. We manage our business to create sustainable long-term value, and evolution of our franchise system continues to play an absolutely critical role in that process. +And so what you have seen recently, the [Contal] merger in Japan, the Brazil merger of three bottling partners creating a large Brazilian-led bottling business, the Iberian merger of seven bottling partners in Iberia, the sale of the Philippines -- of the majority shares of the Philippines and the control to FEMSA, and now the US process, the journey starting in the United States, are all part of our vision, our plan, and to ensure that we can continue to deliver on the commitments we've made for our vision. +They use, in some cases, they use partially our capital. In some cases, where there's a sale, obviously, we bring back capital back into The Coca-Cola Company, but all the time ensuring that our bottling business is fully suited for the needs of the 21st century, delivering what is necessary ahead of consumer expectations, customer expectations, and so not one size fits all. And in the case of the United States, again I'm pleased to report, we are pleased to report today, that we've reached agreement in principle to start this journey. All along, since the first day we've closed the transaction with Coca-Cola Refreshments, I've always said there will be a meaningful role to invite partners back into the business. +When I was -- when we were asked about the timing, we've always said around the four- to five-year timeframe from the time we've closed, the close of the Coca-Cola Refreshments was, as you will recall, back in the latter part of 2010, and we are well within that timeline. And it's a continuous evolution. And sometimes it will necessitate for us to use our own capital, sometimes a mix, and sometimes no capital. And again, not one size fits all. The US model is very different, but it is, again, a model that invites partners to serve with us passionately the communities that we operate in. + +-------------------------------------------------------------------------------- +John Faucher, JPMorgan Chase & Co. - Analyst [4] +-------------------------------------------------------------------------------- + + Great, and if I could just ask a follow-up on that, which would be as you look at the different options you gave for the US pieces here, in terms of sub-bottler agreements, asset sales, swaps, things like that. Is there some way to think about the financial impact as you do this? I mean, this is a small piece of it. How long does this timeframe take out, as you sort of push these US pieces out? Thanks. + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Company - Chairman, CEO [5] +-------------------------------------------------------------------------------- + + Yes. I think from -- we can't comment on the timing for the end game, but all I can tell you is that we are intent on creating the evolution necessary for us to be able to serve both our large customers and small, independent customers in the best possible way with our bottling partners. Again, we've always said that, right from the beginning, and we're consistent to that, that the US will be slightly different. We want to create the best-in-class production, optimum cost production system, coast-to-coast, from the East to the West. That will be nationally managed. +We also want to create a nationally managed large customer -- customer management system that will essentially have the responsibility to put together a 21st century customer plans with our large partners in the United States, and at the same time invite partners to come in and be part of this new evolution in the United States. It will take as long as it is necessary. And that is not our focus. It's going to be about doing the right thing as quickly as possible, as efficiently as possible, and as effectively as possible, and that's what we are going to be doing. + +-------------------------------------------------------------------------------- +John Faucher, JPMorgan Chase & Co. - Analyst [6] +-------------------------------------------------------------------------------- + + Thanks. + +-------------------------------------------------------------------------------- +Operator [7] +-------------------------------------------------------------------------------- + + Thank you. Your next question comes from Bryan Spillane of Bank of America. + +-------------------------------------------------------------------------------- +Bryan Spillane, BofA Merrill Lynch - Analyst [8] +-------------------------------------------------------------------------------- + + Hi, good morning. A question for you, Gary, just on the operating leverage in the first quarter, and maybe more specifically, the gross margins. If I understood it right, this quarter would have been one of the highest in terms of the impact from commodity inflation? We also really had no positive benefit from price mix, and as we kind of look out going forward, right, we should get some benefit from price mix later in the year, and maybe some relief on commodity inflation. So why wouldn't there be maybe more leverage going through the year than we originally expected, given the leverage you had in the first quarter? + +-------------------------------------------------------------------------------- +Gary Fayard, The Coca-Cola Company - CFO [9] +-------------------------------------------------------------------------------- + + Bryan, thanks. There are a couple of things to consider. First is, as I mentioned previously in the prepared remarks, that we reversed some compensation accruals in the first quarter. So that gave you more leverage in the quarter, but you will not see that. That's more of a one-time impact, if you will. So it's more leverage in the quarter. +The other significant piece is you're going -- the currencies had an impact as well, and currencies moderate going out. But the biggest thing will be geographic mix. And we would expect to see geographic mix changing throughout the year as we go through the year. And as that happens, it will have an impact on gross margin and operating leverage. + +-------------------------------------------------------------------------------- +Bryan Spillane, BofA Merrill Lynch - Analyst [10] +-------------------------------------------------------------------------------- + + So the geographic mix would be more negative going through the back half, the rest of the year, is that --? + +-------------------------------------------------------------------------------- +Gary Fayard, The Coca-Cola Company - CFO [11] +-------------------------------------------------------------------------------- + + Yes, that's exactly right. And think about North America, actually. I would expect North America, actually in the first quarter of this year, North America's operating income on a recurring kind of comparable basis, was down 3%, and it's down 3% primarily because of two fewer selling days. So if you adjusted for those selling days, it would have been positive. But I would expect North America to actually improve versus where they were, the minus 3%, but as they improved, because it's a finished product business, it's going to have negative gross margin impact, and it'll be reduced leverage. + +-------------------------------------------------------------------------------- +Bryan Spillane, BofA Merrill Lynch - Analyst [12] +-------------------------------------------------------------------------------- + + Okay. So more growth from lower margin geographies going forward, and that's what will affect sort of that margin impact? + +-------------------------------------------------------------------------------- +Gary Fayard, The Coca-Cola Company - CFO [13] +-------------------------------------------------------------------------------- + + Yes. Yes, that's what I was trying to say more in code in the prepared remarks. + +-------------------------------------------------------------------------------- +Bryan Spillane, BofA Merrill Lynch - Analyst [14] +-------------------------------------------------------------------------------- + + All right. Thank you. + +-------------------------------------------------------------------------------- +Gary Fayard, The Coca-Cola Company - CFO [15] +-------------------------------------------------------------------------------- + + We normally don't think North America, but that's what it was. + +-------------------------------------------------------------------------------- +Bryan Spillane, BofA Merrill Lynch - Analyst [16] +-------------------------------------------------------------------------------- + + Okay. Thanks a lot. + +-------------------------------------------------------------------------------- +Gary Fayard, The Coca-Cola Company - CFO [17] +-------------------------------------------------------------------------------- + + Thanks, Bryan. + +-------------------------------------------------------------------------------- +Operator [18] +-------------------------------------------------------------------------------- + + Your next question comes from Dara Mohsenian with Morgan Stanley. + +-------------------------------------------------------------------------------- +Dara Mohsenian, Morgan Stanley - Analyst [19] +-------------------------------------------------------------------------------- + + Good morning. I was hoping to get an update on the competitive environment around the world, both in China and Western Europe, which have been hot spots recently. And also just your thoughts around how you manage the pricing environment in the US sparkling business in 2013 and beyond, in light of the moderate commodity pressure, and if that solid 3% sparkling growth we saw in Q1 could continue in the balance of the year? + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Company - Chairman, CEO [20] +-------------------------------------------------------------------------------- + + Yes, I think, Dara, I think -- this is Muhtar, I think that we haven't seen anything markedly different from previous quarters as far as the competitive environment is concerned. China remains a very competitive environment. Actually the whole world, and again, this is a competitive environment that is a mix of large international companies, but also very much local companies, very much local companies in Asia, in parts of Africa, in the Middle East. We also see a somewhat more rational pricing, particularly in Europe, as well as parts of -- other parts of the world, in Latin America, too. +And I think -- so the way we see the environment is, it will continue to be challenged from a consumer perspective. Whether you're talking about Asia coming back, or whether you're talking about Europe, consumer sentiment in Europe, will continue to be volatile and mixed at best. And therefore, pricing is going to be critical, and therefore also ensuring leverage and ensuring productivity can be generated out of operations for us to be able to continue to invest, is going to be critical. But we are intent on continuing to invest in this environment. I'll let Steve Cahillane talk a little bit about how we manage the pricing environment in the United States (technical difficulties) price mix of 3% in terms of leverage in pricing for sparkling beverages in the past quarter. + +-------------------------------------------------------------------------------- +Steve Cahillane, The Coca-Cola Company - President, Coca-Cola Americas [21] +-------------------------------------------------------------------------------- + + Yes, thanks, Muhtar. We would -- we have seen a rational pricing environment in the United States over the course of a good period of time right now. We would expect that to continue, and I've said many times that if commodities go down, don't look for us to reinvest that in price. We've worked very hard to earn the price that we take in the marketplace. We don't have an affordability problem in the United States with our sparkling beverages, and we would look to continue to invest behind our brands. +We've got a terrific summer program for the Coca-Cola brand. We've got an exciting new partnership with Taylor Swift around Diet Coke. We'll invest around activating those types of program to continue to focus on our most important objective, which is to continue to support, develop, and drive the sparkling, our sparkling category, inside the United States business. + +-------------------------------------------------------------------------------- +Dara Mohsenian, Morgan Stanley - Analyst [22] +-------------------------------------------------------------------------------- + + Okay. Great. Thanks. + +-------------------------------------------------------------------------------- +Operator [23] +-------------------------------------------------------------------------------- + + Your next question comes from Bill Pecoriello of Consumer Edge Research. + +-------------------------------------------------------------------------------- +Bill Pecoriello, Consumer Edge Research - Analyst [24] +-------------------------------------------------------------------------------- + + Morning, everybody. I wanted to follow up on the US bottling announcement. Coke held onto the production assets for the territories the five bottlers picked up. Do you see these bottlers eventually contributing their manufacturing assets into a national production company to get at the cost savings opportunity that you've talked about on the manufacturing side? And also, would Coke be willing to let new partners bring in outside capital to help finance some of the additional territory sales, given the size of the territory that Coke still holds onto in the US? Thanks. + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Company - Chairman, CEO [25] +-------------------------------------------------------------------------------- + + Hi, Bill. This is Muhtar. Good morning. + +-------------------------------------------------------------------------------- +Bill Pecoriello, Consumer Edge Research - Analyst [26] +-------------------------------------------------------------------------------- + + Hi. + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Company - Chairman, CEO [27] +-------------------------------------------------------------------------------- + + I would say to you that this is, again, we're at the beginning of this journey. We have reached agreement in principle with these five US bottling partners. It is very important that we did reach that agreement in principle, and now we can actually ensure that we put all the details into motion, and we can implement effectively. We have always said production is, in the United States, is critical to our success in achieving a optimum cost, 21st century production system, nationally managed coast-to-coast. That is going to take place. +We've also said that managing large, 30 or so, of our largest customers in the United States is going to be done nationally. That's also going to take place. In terms of who else would be coming in, we can't comment on that. In terms of what will happen, in what form an architecture production is going to take place in terms of what our current bottlers own, I can't comment on that. All I can tell you, and I can assure you, that we are intent on ensuring that we make the necessary changes in the format and architecture of production to achieve what I just said, which is a coast-to-coast, nationally run production system that generates the efficiencies, synergies, productivities that allow us to continue to win in the marketplace. And again, there may be a future where our partners in the United States take certain ownership in the national production. I wouldn't rule that out also, but it will be managed nationally from one point, single point. + +-------------------------------------------------------------------------------- +Bill Pecoriello, Consumer Edge Research - Analyst [28] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Operator [29] +-------------------------------------------------------------------------------- + + Your next question comes from Judy Hong of Goldman Sachs. + +-------------------------------------------------------------------------------- +Judy Hong, Goldman Sachs - Analyst [30] +-------------------------------------------------------------------------------- + + Thanks, good morning. I just had a couple of questions on North America. First, in terms of volume performance, I think the macro data points and consumer data points have been a little bit choppy more recently. So maybe if you could give us a little bit color just in terms of category of your performance, immediate consumption versus take-home. And sort of the expectation as you get out into the back half of the year, lapping of some of the transitory headwinds, whether it's payroll taxes or weather-related, if you expect volume performance to improve. +And then, Gary, just on the profitability in North America, I know you talked about this a little bit, but I look at first quarter. You had 1% volume growth, 2% price mix, and you did say profitability was up a little bit, but just why aren't we seeing the profitability really improve more meaningfully and what drives the sequential acceleration in North America profitability going forward? + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Company - Chairman, CEO [31] +-------------------------------------------------------------------------------- + + Okay, Judy. I'll have Steve answer the first part of your question before Gary comes in and sheds some light on the question on profitability. Steve? + +-------------------------------------------------------------------------------- +Steve Cahillane, The Coca-Cola Company - President, Coca-Cola Americas [32] +-------------------------------------------------------------------------------- + + Yes. Thanks, Judy. First quarter clearly had a lot of noise in it. We expected a benefit from Easter being in the first quarter. It's never as big a benefit when it comes that early in the year. Easter's always better when it comes later in April because of the warmer weather. But obviously you reference the weather. +We saw some very dramatic changes. Last year we benefited from one of the hottest summers -- sorry, hottest winters, warmest winters in the United States, and we cycled that with one of the coldest winters in the United States. So clearly that had an effect. And we saw any benefit from Easter really being washed away, if you like, by the poor weather. +There was clearly an effect in the payroll tax. It's a little bit of art and science, trying to pick apart what's weather and what's payroll tax. We would figure about two-thirds is probably weather-related and one-third of the slowdown is based on the economy. We are, though, optimistic, guardedly optimistic, that the consumer is coming back, that the payroll tax and the economy is kind of a short-term, need to get used to the discretionary impact that that has had. So we remain optimistic that we've got the right programs in place, that the economy is on the mend, and we would expect continued good performance as we go out into the next three quarters. +In terms of, I guess, questions around profitability, I'll turn that over to Gary. + +-------------------------------------------------------------------------------- +Gary Fayard, The Coca-Cola Company - CFO [33] +-------------------------------------------------------------------------------- + + Yes. Judy, I would say a couple of things on profitability. It's really kind of repeating what Steve just said. If you take the first quarter and you throw in lousy weather, payroll tax, actually the price of gasoline, what that then does to your immediate consumption versus future consumption business, it's going to have an impact on your profitability. Now, if I go back to the answer I gave to Bryan earlier, though, when I was talking about geographic mix and it's North America, I would expect North America to be improving, actually, from the first quarter and from where we were. And then North America also has this two fewer days. +Now, I can tell you, Steve's got a number from minus 3%. I said it would have been positive. Steve's got a number, but you can calculate it several different ways as to what would the impact of the two days be. We would all agree, I think, it is positive. They would have been positive at the operating income line. But you put all that together, the weather, by the way, as lousy as it's been, and the impact on Steve's business, has been given a lot of moisture to the Midwest for the drought for the corn crops. So you look for commodities, and we'll see what happens there. +Payroll tax, consumers hopefully are starting to get used to it. Gasoline prices, looks like they are starting to trend downward somewhat. So I think there are some reasons to be cautiously optimistic. CCR continues to execute with excellence, continuing to improve capability. So I think there are lots of reasons to be optimistic on North America. + +-------------------------------------------------------------------------------- +Judy Hong, Goldman Sachs - Analyst [34] +-------------------------------------------------------------------------------- + + Okay. But from a profitability perspective, though, the bigger delta is really the mix shifting towards more immediate consumption as weather normalizes, or is there step-up in cost savings or timing of marketing investments that help the profitability? + +-------------------------------------------------------------------------------- +Gary Fayard, The Coca-Cola Company - CFO [35] +-------------------------------------------------------------------------------- + + Judy, I would actually say the biggest impact on the first quarter for North America was two less selling days, by far, as a whole company as well. But by far, the biggest impact was the two selling days. + +-------------------------------------------------------------------------------- +Judy Hong, Goldman Sachs - Analyst [36] +-------------------------------------------------------------------------------- + + Okay. + +-------------------------------------------------------------------------------- +Steve Cahillane, The Coca-Cola Company - President, Coca-Cola Americas [37] +-------------------------------------------------------------------------------- + + Judy, I didn't answer this part. A secondary impact is clearly weather-impacted food service and immediate consumption more than the take-home channel. So we would expect as weather moderates, those profitable parts of our business will start to normalize as well. But, as Gary said, two less selling days, when you've got the fixed cost assets that we have in the North American business is really quite significant. Those extra two days are golden cases that are going out. And when you lose those two days, it obviously has a big impact. + +-------------------------------------------------------------------------------- +Judy Hong, Goldman Sachs - Analyst [38] +-------------------------------------------------------------------------------- + + Got it. Okay. Thank you very much. + +-------------------------------------------------------------------------------- +Gary Fayard, The Coca-Cola Company - CFO [39] +-------------------------------------------------------------------------------- + + Thanks, Judy. + +-------------------------------------------------------------------------------- +Operator [40] +-------------------------------------------------------------------------------- + + Your next question comes from Caroline Levy of CLSA. + +-------------------------------------------------------------------------------- +Caroline Levy, CLSA Limited - Analyst [41] +-------------------------------------------------------------------------------- + + Good morning, Muhtar, Gary, and team. I would like to just understand, Muhtar, your vision, again, going back to the United States. You talked a little bit about how manufacturing is going to evolve. A little bit of understanding the benefits of merging the operations of food service, your non-carbs, and your CSDs into one production facility. Just can that actually be done? And are there synergies there? And then secondly, do you feel strongly that your own people have to get the product to market from the plant, or could you use a third party, such as a Sysco? + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Company - Chairman, CEO [42] +-------------------------------------------------------------------------------- + + Yes. Caroline, I think first in terms of our capability in our system in the United States is I would say the best in the consumer products world in terms of how we go to market and how we can get the product from production facilities. I would like to comment on how we can improve that. If there is a way for us to even improve and generate more productivity, we'll certainly look at it. I think the most important thing, though, is that there is room to generate significant further synergies in production. I think today I wouldn't say that the United States production system, after three years of having integrated Coca-Cola Refreshments, it is where we need it to be. And we need to achieve that -- continue on that road map to proceed towards a modern and best-in-class optimum cost production system coast-to-coast. +That will mean, obviously, a lot of changes. That will mean building new plants. That will mean combining some facilities, but I would like to also comment, in terms of hot-fill and aseptic versus sparkling beverage plants, we will look at ensuring that we have the most modern, most productive facilities in place. I don't believe the answer is to combine all under one roof. I think the answer is to combine many that are scattered across the country, both in terms of still and sparkling separately, into some consolidation process, and I can't comment any further. +What I can tell you is that there is room for costs to come down. There is room for efficiencies to increase, and we will achieve all of those. This is all in line with our 2020 Vision. We laid out a plan when we took over the business of Coca-Cola Enterprises. We laid out a plan when I took over as the CEO back 4.5 years ago, and we are executing it meticulously, and we are doing what we have said we will do, and we're doing it ahead of time. + +-------------------------------------------------------------------------------- +Caroline Levy, CLSA Limited - Analyst [43] +-------------------------------------------------------------------------------- + + That's excellent. I was just wondering, in terms of getting shelf space, you see a big opportunity up and down the street, and to get better pricing, much as you've done in LatAm. I'm often asked how you compete with all the new things that come in, be it coconut water, energy drinks. I know you have some, but are you convinced you can keep or improve shelf space for your carbonated soft drinks? + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Company - Chairman, CEO [44] +-------------------------------------------------------------------------------- + + Absolutely. I think we can improve service levels. I think we can improve execution inside the point of sale. I think we can improve availability. I think we can improve availability of cold drink. I think we can improve how we serve independents, and all of those things are going to be played out as we implement, execute this new strategy in the United States. And I don't know, Steve, do you want to comment? + +-------------------------------------------------------------------------------- +Steve Cahillane, The Coca-Cola Company - President, Coca-Cola Americas [45] +-------------------------------------------------------------------------------- + + I agree completely. Part of what we're doing with this new bottler arrangement focuses on that up and down the street, where bottlers and CCR add the most value, which is not only big customer sales, but up and down the street execution. And we've got also our venture and emerging brands unit, which you're familiar with, which brings brands like ZICO Coconut Water, it brought Honest Tea. So in those spaces that you're talking about, we are very much innovating. We've got glaceau fruitwater, which we just launched to great success a couple of weeks ago. That's being executed, not only in the large stores, but importantly in the up and down the street, food service on-premise accounts as well. We see that as a very important capability. We see ourselves as having a competitive advantage there when it comes to not just shelf space, but cold drink space and overall availability. + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Company - Chairman, CEO [46] +-------------------------------------------------------------------------------- + + Yes, and just to finally add on to that point, Caroline. Rest assured, we are in a mode of evolution, rapid evolution, not just in the United States, across the whole world. But, and you will see us adapting, reinventing how we go to market, how we serve customers, and also how we communicate with consumers, very importantly. Our brand's at an all time high in terms of health and we will continue, again, to evolve and bring out the best modes of communication with our consumers as well. + +-------------------------------------------------------------------------------- +Operator [47] +-------------------------------------------------------------------------------- + + Thank you. Your next question is from Mark Swartzberg with Stifel Nicolaus. + +-------------------------------------------------------------------------------- +Mark Swartzberg, Stifel Nicolaus - Analyst [48] +-------------------------------------------------------------------------------- + + Yes, thanks. Good morning, everyone. Also a question on the US re-franchising, Muhtar or Gary. You talk about this new beverage agreement being ultimately what's at play here. Could you speak a little bit to how you're thinking about that, and the role of incidence-based pricing in that? Is it right to think that continues to have prominence in this new agreement, and any distinction you might draw between how stills and carbonateds are treated as you move production more squarely to staying, if you will, at least for a little while inside Coca-Cola? + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Company - Chairman, CEO [49] +-------------------------------------------------------------------------------- + + Yes, I think, Mark, it's -- I can't -- we can't comment on the details. What we can say is that it will be a model that will align us fully with our bottling partners to do what is right in the marketplace, and to focus on what is right in the marketplace, with full alignment model, and I think I can't just comment any further than that. But you will see us executing better, serving the customers better, with a better production template, as well as a customer service template. + +-------------------------------------------------------------------------------- +Mark Swartzberg, Stifel Nicolaus - Analyst [50] +-------------------------------------------------------------------------------- + + Is it fair to think that other markets, there's a sort of a fact pattern, an experience set, to draw on as you implement this new form of agreement here in the US? + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Company - Chairman, CEO [51] +-------------------------------------------------------------------------------- + + I think all of that will come into play, best practices, everywhere around the world. And I am certain that in four or five years time, many people will come into the United States to see the best practices, and as it used to be back in the 1980s when I used to bring bottlers, new bottlers, from Eastern Europe to see best practice in the United States at that time. + +-------------------------------------------------------------------------------- +Mark Swartzberg, Stifel Nicolaus - Analyst [52] +-------------------------------------------------------------------------------- + + Fair enough. Thanks, Muhtar. + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Company - Chairman, CEO [53] +-------------------------------------------------------------------------------- + + In closing, I would like to thank Gary, Ahmet, Steve, Irial, and Jackson, and to again say that we're pleased with our solid first quarter. We are working as a system to unlock real value, further strengthen execution, and to win at the point of sale. We are confident that a focus, a relentless focus on growth, will enable us to build capable, resilient, optimized, advantaged, and sustainable systems that are well positioned to deliver results in 2013 and achieve our 2020 Vision. As always, we thank you for your interest and your investment in our Company, and for joining us this morning. + +-------------------------------------------------------------------------------- +Operator [54] +-------------------------------------------------------------------------------- + + Thank you for participating in today's conference call with The Coca-Cola Company. Audio playback is available via the Company's website, thecoca-colacompany.com. You may now all disconnect. + + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/exam/original-files/Problem_2_3_Sample_full_transcripts/2013-Aug-21-TGT.N-139892388396-Transcript.txt b/exam/original-files/Problem_2_3_Sample_full_transcripts/2013-Aug-21-TGT.N-139892388396-Transcript.txt new file mode 100644 index 0000000..da159c2 --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_full_transcripts/2013-Aug-21-TGT.N-139892388396-Transcript.txt @@ -0,0 +1,458 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q2 2013 Target Corporation Earnings Conference Call +08/21/2013 09:30 AM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * John Mulligan + Target Corporation - EVP and CFO + * Kathee Tesija + Target Corporation - EVP Merchandising + * Gregg Steinhafel + Target Corporation - Chairman, President and CEO + +================================================================================ +Conference Call Participiants +================================================================================ + + * Greg Melich + ISI Group - Analyst + * Deborah Weinswig + Citigroup - Analyst + * Jason DeRise + UBS - Analyst + * Sean Naughton + Piper Jaffray - Analyst + * Matt Nemer + Wells Fargo Securities, LLC - Analyst + +================================================================================ +Presentation +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Ladies and gentlemen, thank you for standing by. Welcome to the Target Corporation's second-quarter earnings release conference call. During the presentation, all participants will be in a listen-only mode. Afterwards, we will invite you to participate in a question-and-answer session. +(Operator Instructions) +As a reminder, this conference is being recorded Wednesday, August 21, 2013. +I would now like to turn the conference over to Mr. Gregg Steinhafel, Chairman, President and Chief Executive Officer. Please go ahead, sir. + +-------------------------------------------------------------------------------- +Gregg Steinhafel, Target Corporation - Chairman, President and CEO [2] +-------------------------------------------------------------------------------- + + Good morning and welcome to our 2013 second-quarter earnings conference call. +On the line with me today are Kathee Tesija, Executive Vice President of Merchandising; and John Mulligan, Executive Vice President and Chief Financial Officer. This morning I'll provide a high level summary of our second-quarter results and strategic priorities for the rest of the year, and Kathee will discuss category results, guest insights and upcoming initiatives, and finally John will provide more detail on our financial performance along with our outlook for the third quarter and full year. Following John's remarks, we'll open up the phone lines for a question-and-answer session. As a reminder, we're joined on this conference call by investors and others who are listening to our comments via webcast. Following this conference call, John Hulbert and John Mulligan will be available throughout the day to answer any follow-up questions you may have. +Also as a reminder any forward-looking statements that we make this morning are subject to risks and uncertainties, the most important of which are described in our SEC filings. Finally in these remarks, we refer to adjusted earnings per share which is a non-GAAP financial measure. A reconciliation to our GAAP results is included in this morning's press release posted on our investor relations website. +Target's second-quarter financial results reflect strong US profit performance in spite of soft traffic and sales. Our second-quarter comparable sales increased 1.2% below our expectations going into the quarter, but nearly 2 percentage points ahead of our first-quarter pace. As a result, we delivered second-quarter adjusted EPS of $1.19, at the high end of our expectation going into the quarter. Our GAAP EPS of $0.95 was in the middle of our expected range, reflecting higher than expected dilution of $0.21 from our Canadian segment. As we monitor the economy and consumer sentiment, we continue to see a mix of signals in which emerging optimism is balanced with continuing challenges. +This year's payroll tax increase continues to affect spending, particularly among lower and moderate income households and household formation in the younger demographic groups remain stubbornly negative. Recent job growth numbers have been encouraging, but labor force participation and income growth remain weak. And while emerging strength in the housing and automotive sectors is a long-term positive, the near term spending on these big ticket items is crowding out other spending, particularly in today's environment in which access to consumer credit remains tight. As you've heard from all operators and other retailers, we continue to see the impact of trip consolidation in US households, as our second-quarter comp was entirely driven by an increase in basket size, partially offset by a small decline in traffic. Second-quarter sales in our digital channels grew in the teens overall with mobile traffic and sales continuing to grow at a triple-digit pace. +Second-quarter operating margins in the US were quite strong, especially in light of the pace of our sales. We delivered a healthy gross margin rate as we saw a relatively balanced mix of sales across categories. And our merchant teams did a great job managing inventory and price investments. In addition, we continue to benefit from very disciplined management of expenses, particularly in our stores. In fact, excluding the impact of the decline in the contribution from our credit card portfolio, US segment operating margins increased from last year's second quarter. +Altogether, we feel very good about our second-quarter US segment performance as we overcame softer than expected sales and the year-over-year impact of credit card profit sharing to deliver a 6.1% increase in adjusted earnings per share. These results demonstrate the resilience of our team and our operating model in the face of a challenging economic and consumer environment. +In our Canadian segment, we've reached the halfway point in our 2013 market launch. We opened another 44 Canadian Target stores in the second quarter, putting our total at 68 today, on the way to our goal of operating 124 Canadian stores by year end. Launching our Canadian segment has required a massive effort from teams throughout the Company, including building a completely new supply chain infrastructure and integrated technology solution, completely reconstructing former Zellers locations transforming them into brand new Target stores, hiring and training more than 15,000 Canadian team members, and creating unique merchandise strategies and assortments to fit the preferences of our Canadian guests, including a very strong presence in our home and apparel categories. +The teams execution on these efforts has been excellent. As a result, our Canadian stores have seen strong initial traffic and the mix of our sales in home and apparel has been even higher than expected. However, now that we've successfully opened 68 stores in Canada, we need to drive trips and conversion and frequency categories like healthcare, food and other basic commodities. Sales in these categories have grown much more slowly than we expected causing overall sales and profit momentum to build more slowly as well. +Multiple surveys indicate that our prices are very competitive and right where they need to be when compared to competition in local markets. Yet we know there is a gap in guest awareness of how low our prices really are. As a result, we are deploying multiple tactics to help our guests better understand the great value and convenience we provide in these categories. Over time we expect these efforts will drive greater awareness of the assortment and value we provide on these frequently purchased items, leading our Canadian guests to regularly shop Target for a balance of both wants and needs. +Our expectations are informed by our experience in launching the PFresh remodel program and City Target format, as well as our historical experience entering new markets in the US. In many of these markets we saw similar pattern in which sales momentum was slower than expected at the launch, but grew rapidly in the first several years after opening, resulting in achievement of our fifth year sales goals. For the stores we've opened, the team in Canada is working to adjust inventory and store staffing to match the pace of sales in each individual location. And for the segment in total, we have updated the expected timing of earnings accretion. +Having said that, we remain highly confident in our strategy. We are very pleased with the look and feel of these new stores and we have an outstanding Canadian team. We've invested in this segment to position it for long-term success and we continue to believe we'll achieve our longer term financial goals in Canada. +Across the Company, we are moving quickly to position our business to succeed in a rapidly changing retail environment. This requires our routine to stay laser focused on near-term execution while simultaneously allocating resources and effort to initiatives that will drive longer term sales growth and profitability. Recent examples of this include the beta launch of Cartwheel, our mobile coupon platform on Facebook that has experienced rapid growth since its launch in April. This platform which integrates our stores and mobile into guest social networks has seen very high levels of guest engagement. In fact, our partners at Facebook have told us that engagement statistics for Cartwheel are among the best they have seen in the beta stage of any App, both within and outside the retail space. +We're also dividing meaningful resources to enhance the flexibility of our fulfillment network, which includes our stores, regional distribution centers, online fulfillment centers and import warehouses. In addition, we're investing in data systems that will provide a single holistic view across vendors, items, or distribution infrastructure and stores that will allow us to more efficiently and seamlessly fulfill guest demand in whatever channel they choose. +And we're pleased with our recent agreement to acquire the DermStore Beauty Group. This unique opportunity, which follows our acquisitions of chefs.com and cooking.com earlier in the year, provide us insight into the superior online experience DermStore provides along with access to brands, content and resources that are valuable to our guests. +As we look to the remainder of the year and beyond, we're taking steps to drive guest traffic both today and over time. We're steadfast in our commitment to provide value to guests who continue to shop cautiously, investing in every day low prices and even lower prices in our weekly circular and flier, combined with compelling discounts available on Cartwheel. We reinforced this commitment to value with price matching policies for both online and local print ads from competitors, and 5% REDcard rewards and Pharmacy Rewards allows guests to save even more off our already great prices. The continued rapid adoption of both of these programs demonstrates the value they provide for our guests. +Beyond low prices, we work to differentiate our assortment and guest experience by partnering with designers and others to provide unique, unexpected, value-added products and services. For example, in our stores, we're adding service elements to categories including beauty and electronics. And outside our stores, we will continue to explore acquisition opportunities to augment our digital capabilities, content and brands. +Additionally, we're building the Digital Acumen of the organization through hiring and collaborations with leading technology partners. For example, our recently opened technology innovation center in San Francisco provides us the opportunity to benefit from technology talent in the area and rapidly explore opportunities that can be brought to Target, accelerating the pace of our innovation and adoption of emerging technologies and trends. +And we're building the capability to operate stores in smaller spaces, particularly in urban markets. We are analyzing results in our first seven City Target stores to understand where in the stores we have the ability to reduce space even more, allowing us to further shrink the size of this store format. Ultimately, we believe we will succeed over time by providing value to our guests in a world of and, where we provide the ability to conveniently shop in stores and digital channels, enjoyable shopping for both wants and needs, access to great design and low prices, and the ability to save money with an ethical Company that supports the communities where we operate. +At Target we've long understood the power of and, which is summed up by our brand promise to Expect More and Pay Less. We believe this promise is more relevant than ever in today's environment and we are committed across the organization to delivering on it every day in every channel. +Before I turn the call over to Kathee, I want to take a moment to thank the Target team for their outstanding effort in this challenging environment. The team has already accomplished a lot this year, successfully launching a record number of stores outside the US for the first time, selling our credit card portfolio to an outstanding partner in TD Bank and preserving profitability in a softer than expected sales environment in the US. Throughout the organization, we are focused on becoming more nimble, moving quickly to test and learn from new initiatives. I'm proud of this team and confident that our efforts will position Target for long-term success. +Now, Kathee will provide more detail on second-quarter results, outline initiatives for the third quarter and beyond. Kathee? + +-------------------------------------------------------------------------------- +Kathee Tesija, Target Corporation - EVP Merchandising [3] +-------------------------------------------------------------------------------- + + Thanks, Gregg. +We're very pleased with the ability of our team to manage inventory and profitability in our US business during a quarter in which consumers shop cautiously and competitors promoted heavily to clear excess inventory. In our second-quarter US results, we saw a relatively narrow spread in comparable sales between the strongest and softest performing categories. Not surprisingly, sales in less discretionary areas like food, healthcare and household essentials grew somewhat faster than the Company average. However, sales in our home category also grew faster than the Company average, driven by particular strength in our domestics and stationary categories. +Among the other more discretionary categories, second-quarter comparable sales in both apparel and hard lines declined slightly. Within apparel, our children's categories had the strongest results, while the more discretionary women's assortments experienced softer results in the face of a very promotional environment. +We continue to deliver excitement through limited time partnerships with influential designers who help us differentiate Target in support of our Expect More, Pay Less brand promise. In the second quarter, we were very pleased with the results of our collaboration with Lauren Bush Lauren and FEED USA, featuring products in home, sporting goods, stationary, apparel and accessories. Beyond the merchandise, this unique program reinforced our commitment to communities as Target provided more than 10 million meals for US families through this collaboration. +We're also very pleased with the initial results for the beta launch of Cartwheel, a differentiated mobile experience that delivers value for our guests. We launched the Cartwheel App on the IOS and Android platforms in June and its already a Top 20 Lifestyle App in the Apple Store. Cartwheel is growing rapidly. It currently has more than 1 million users who have saved more than $2 million so far. +Among active users, more than 50% have completed multiple Cartwheel transactions demonstrating the power of the program to drive sustained guest engagement. As expected, guests are searching for deals while they're shopping in stores and we've seen redemption rates in excess of 50% for offers downloaded by guests while they're shopping. We're pleased with these initial results and will apply what we've learned to improve both the Cartwheel experience, as well as the development of our multi-channel experiences in the future. +Beyond new mobile experiences like Cartwheel, our mobile sales and traffic continued to grow at a rapid pace. To build on this momentum, we're investing to enhance speed, search, product information and check out on our mobile site. And this Fall we'll begin testing other innovations to enhance the in-store mobile experience including wayfind -- wayfinding and improved search. And we continue to invest to further integrate the shopping experience across channels. Based on successful results from our team member test of buy online and pick up in store, we are moving quickly to begin offering this option for guests in the third quarter. We'll begin in the Minneapolis market before expanding the rollout to other markets. We expect to complete the rollout to all stores by the holiday season. +Simultaneously, we are planning team member tests of other flexible fulfillment capabilities which will begin later this year, including the ability to deliver online orders from stores as early as the same day, and the ability to pay in one store and pick up in another. Based on the results of the team member tests, we will look to move to guest facing tests next year. +And beyond investments to build on our own digital offering, we continue to monitor the landscape to identify opportunities to augment our capabilities through acquisitions. The recent decision to acquire DermStore reflects a strategic opportunity for Target to learn from their online expertise, customer service, content development and product curation which combine to create an exceptional online beauty experience. In addition, DermStore's broad assortment of prestige and dermatology brands will complement Target's product offerings. +We continue to approach the economic and competitive environment with longer term optimism but near-term caution. While overall consumer confidence statistics have improved this year, it's notable that optimism among lower income households is lagging behind. And as Gregg mentioned, this year's payroll tax increase and consumer spending on autos and housing are crowding out spending on other goods and services. For example, in surveys regarding expected spending on back-to-school and back-to-college items, consumers indicate they intend to spend less than a year ago by focusing on sales, discounts and reusing items they already own. +As a result, in preparing for the third quarter and beyond, we're building flexibility into our inventory plans and creating merchandise and marketing programs focused on driving traffic and sales with compelling offers, innovative partnerships, and key seasonal programs. Target is known for delivering key seasons for our guests and only the fourth-quarter holiday season is bigger than back-to-school and back-to-college. +This year we've created a multi-layer strategy to deliver a great guest experience and outstanding value. For back-to-school, we are offering parents a convenient one stop shop for all the must have items on their shopping list at a price -- at a range of price points to accommodate a variety of household budgets, including hundreds of unique items in fashion, school supplies and accessories for less than $20. In fact, we have nearly 400 items for $1 or less, clearly demonstrating our commitment to deliver value. Our back-to-school direct mail catalog includes more than $25 worth of coupons and we've increased the number of online coupons this year as well. And of course parents who use their Target REDcard will receive 5% off their entire purchase and free shipping on every order from target.com. +To support our back-to-school merchandising, we have a set of new broadcast themes in various lengths and languages which focus on telling stories around iconic school moments that make kids feel like real life heros. In addition to the unique Kids Got Style Instagram program, Target celebrated kids as the most original style leaders. Earlier this month, parents could Instagram a picture of their children showing off their individual style. Target's stylists use select photos as inspiration to create Kids Got Style mood boards of colors, fashion items and supplies inspired by each child's unique style which were posted to Instagram, Facebook and Twitter. Parents were tagged so they could view and share their photos to their social networks as inspiration for the new school year. +Because we know that quality education is the number one social priority for our guests, it's also the number one focus of our giving programs. So following last years' success, we're excited about the return of our Give with Target program, through which Target will donate $5 million to schools across the country. Last year, our guests impacted more than 30,000 schools through donations from this program which were used to purchase classroom resources like electronics, office supplies and storage and organization products. New this year, Target is inviting guests to allocate the full donation, double the amount designated by guests last year to schools of their choice. +For back-to-college, we've created innovative resources and new live experiences both online and in person to provide the inspiration and tools to make shopping fun and easy. Last month, Target introduced a first of its kind online live experience featuring popular YouTube personalities in life sized virtual dorms. From July 15 through the 18, visitors were invited to shop Target products from the dorm rooms, enter to win college gear and interact with the roommates. +Also online, we've created youth styler, a style focused design resource that puts students in the drivers seat as they put together their unique dorm room look. Looks can be named, saved and shared on their favorite social media sites where their friends are able to shop them. And we've created the checklist, a customizable list of key products available in store and at target.com to help students shop for small space living. +On campus, Target is hosting 95 shopping events for incoming freshmen around the country as part of welcome week festivities. These events include after-hours shopping events which provide free bus transportation to and from our store where students will be able to shop for everything they need and want. +Halloween is also a key season for Target and the holiday falls in our third quarter this year. We plan to deliver this season with a multi-channel approach focused on driving traffic and growing our market share. We'll offer a comprehensive assortment of costumes and accessories for the whole family including parents, kids and pets. We'll offer a dominant presentation in our stores and extend the assortment on target.com. In home, Target's product design and development team has created an innovative collection of halloween decor ranging from classic to scary to help mom decorate her home inside and out for the big night. +As Gregg mentioned, we're increasingly focused on differentiating our store experience through enhanced service. The baby category is already one of our signature strengths, but we believe we have an opportunity to further deepen relationships with guests who are entering this life stage. Expectant parents establish new shopping habits, and it's a time when they're looking for easy shopping solutions to save time. +As a result, we're continually exploring new ways to elevate the shopping experience for expectant parents. For example, in 10 Chicago stores we are testing an interactive shopping experience which features accessible product displays including feature fixtures with mannequins to showcase outfits and allow guests to touch and try out products. There's also a collaboration center in the area where guests can sit comfortably, access a registry or get personalized assistance from a team member. Digital tools on hand such as iPads also provide guests easy online access to product information. +Another part of the store where we see an opportunity for enhanced service is our beauty area. Based on results from our Chicago market test of the Beauty Concierge program, we've rolled out the concept to an additional 200 stores in the second quarter including stores in LA, Washington D.C., Baltimore and Minneapolis markets. These beauty consultants are brand agnostic and provide guests with detailed unbiased information on all beauty and personal care categories in the store, including product attributes and ingredient benefits serving as a knowledgeable source and a friendly face in what can often be an intimidating category. We believe this program serves to differentiate Target and the beauty space while still meeting guest needs for value and convenience. +And of course, in the third quarter we will continue to introduce unique merchandise throughout our assortments to deliver newness and excitement for our guests. For example, this Fall we're excited to be partnering with Phillip Lim. Phillip is a designer we've been watching for years. His aesthetic is chic, yet understated, and is focused on democratizing beautiful fashion, makes him a perfect fit for our brand. +Beginning September 15, Target will offer a limited edition collection of apparel and accessories including an assortment of bags, shoes and scarves for men and women at most Target stores and target.com. Prices will range from $20 to $300 with most items under $50. The entire Phillip Lim for Target collection will be presented in the women's apparel department when it debuts in our stores, allowing guests to find the entire collection in one easy to shop area of the store. After the first week, we plan to move items to their respective departments within the store. +In late September we'll launch a new line of mens pants from Haggar called Haggar H26. Haggar is a premium brand in men's pants, and we're excited to offer a no iron premium khaki in a classic fit, performance slack in a classic fit and original chino in a straight fit. And in beauty earlier this month, we expanded our hair care assortment with the exclusive launch of Toni & Guy, Hair Meet Wardrobe, a premium hair care line introduced in the UK in 2011. Available for the first time in the US at Target stores and on target.com, Hair Meet Wardrobe includes a full range of shampoos, conditioners, hair accessories and styling tools, and range in price from $5 to $40. +And finally, we continue to feature exclusive partnerships with influential artists, reigning Academy of Country Music Entertainer of the Year, Luke Bryan teamed up with Target for his latest release, Crash My Party, which set last week. The Target exclusive deluxe addition of the album contains four bonus tracks. And following last Spring's success, we're thrilled that once again we're partnering with Justin Timberlake to release the special edition of the continuation of his third studio album, the 20/20 Experience, 2 of 2 featuring two exclusive bonus tracks. Guests can preorder the album now on target.com, or purchase online or in stores beginning September 30. + While we continue to experience the impact of cautious consumer spending and trip consolidation, we continue to innovate across all our channels to provide our guests unbeatable value and unique experiences. We are confident we have the right plans in place for the third quarter, and we're moving quickly to ensure we stay relevant in an increasingly digital marketplace. +Now, John will share his insights on our second-quarter financial performance and our outlook for the third quarter and the full year. John? + +-------------------------------------------------------------------------------- +John Mulligan, Target Corporation - EVP and CFO [4] +-------------------------------------------------------------------------------- + + Thanks, Kathee. +I'm very pleased with our second-quarter US segment financial performance, as the team generated outstanding profitability despite softer than expected traffic and sales. Second-quarter US segment comparable sales increased 1.2%. Sales strengthened somewhat as the quarter progressed and were further aided by this years' calendar shift which move some early back-to-school sales into July. Like many other retailers, we continue to see the impact of trip consolidation among US consumers as average transaction size drove more than 100% of our comparable sales growth, reflecting increases in both item per basket and average retail per unit. +Year-over-year penetration of sales in our proprietary debit and credit cards were nearly 600 basis points in the second quarter, and for the first time in our history, debit penetration moved beyond credit. The debit card has proven to be the engine that has propelled REDcard rewards beyond our initial stretch goals. It is the right product for a large set of guests who simply don't want another credit card in their wallet. We continue to measure the change in household spending when guests begin using one of our debit or credit cards. And we continue to see on average a 50% increase in household spending when guests apply for and activate one of our cards. +Second-quarter gross margin rate in the US was 31.4%, up slightly from last year. As I outlined last quarter, this year we've made changes to our vendor agreements regarding payments received in support of our marketing programs, which create equivalent year-over-year increases in our US segment gross margin and SG&A expense rates. These changes raised our second-quarter gross margin rate by only 20 basis points -- by about 20 basis points. Excluding the benefit from vendor payments, gross margin would have declined slightly as our gross driving REDcard rewards and PFresh remodel programs created moderate pressure, which was partially offset by rate improvements within merchandise categories. The merchant teams also did a great job managing receipts in the face of softer than expected sales. At the end of the quarter, average inventory per store in the US was up only 1.8% from a year ago. +As expected, on the SG&A expense line, we continue to see the impact of a smaller contribution from the credit card portfolio, which we sold to TD Bank in March. And while we tried to do a thorough job last quarter explaining the impact of the sale and the associated change in our segment reporting, we've received feedback from some of you that we could have done a better job. You know who you are. So, to provide greater clarity this quarter, let's go back a year and revisit our second-quarter 2012 US Credit Card segment results, in which we earned EBIT of $143 million. +This segment EBIT reflected the impact of $74 million in profit sharing with the US retail segment, which was described as loyalty program charges in our financial statements. So in total, the Corporation earned EBIT from the credit card portfolio of $217 million, $143 million in the US Credit Card segment and $74 million in the US Retail segment. Importantly, all of this $217 million is reflected in the revised 2012 results for our new US segment. +Moving now to the second quarter 2013. We received profit sharing of $183 million from TD, which was partially offset by approximately $65 million of our expense to service accounts on their behalf, meaning second-quarter contribution from the credit card portfolio was about $118 million, down about $100 million from a year ago. Two other things are important to remember. +First, not all of the year-over-year decline in credit contribution was driven by the sale to TD, as the portfolio is smaller than a year ago and we're annualizing a $30 million reserve release in second quarter 2012. Second, outside the US segment, we continue to offset some of the impact of profit sharing as we have deployed proceeds from the sale to reduce our net debt position and repurchase shares. With that as context, we can turn to our second-quarter US segment SG&A expense rate of 20.6%, which was up from 20.2% in last years' revised US segment. More than 100% of this increase, or about 0.6 of 1 percentage point was driven by the decline in the contribution from the credit card portfolio. +In addition, we continue to experience expense pressure from this years' incremental investments in technology and distribution in support of our multi-channel efforts. And finally, the change in vendor payments increased our SG&A expense rate by about 20 basis points. Offsetting these multiple pressures, we benefited from favorable leverage of compensation expenses, including incentive compensation and store payroll. And we continue to benefit from our Company wide expense optimization efforts which are identifying opportunities to increase productivity throughout the organization. +Altogether, our second-quarter US segment EBITDA and EBIT margin rates were down only slightly from last years' revised US results. However, without the headwind from the credit card portfolio, those rates would have increased slightly. These results are outstanding and notably better than we would have expected in a quarter in which sales fell well short of our expected range. +In our Canadian segment, sales accelerated from the first quarter as we continued to open stores at a robust pace. However, we've seen a slower than expected ramp up in sales following the grand opening rush, particularly in our frequency categories. Second-quarter REDcard penetration in Canada was 2.3%, and consistent with our US segment, debit penetration was slightly ahead of credit. As we've seen in US since the launch of the program, we expect REDcard penetration to continue to grow in Canada driving incremental sales across all categories. +The Canadian segment earned second-quarter gross margin of $87 million, or 31.6%, reflecting a very favorable mix of sales in the home and apparel categories offset by the impact of some inventory clearance. Second-quarter SG&A expenses were $207 million, reflecting both ongoing operating expenses combined with meaningful start up expenses as we prepare to open new stores. Altogether, second-quarter dilution attributable to the Canadian segment including depreciation, amortization and interest expense recorded outside this segment was $0.21 compared with our estimate of $0.16 going into the quarter. +Even in a year where we are making meaningful investments in distribution, technology and our Canadian market launch, we have been able to return a large amount of cash to our shareholders through dividends and share repurchase. In the second quarter, we paid dividends of $231 million and repurchased more than $900 million worth of our shares. Year to date, we've paid dividends of nearly $0.5 billion and repurchased shares worth nearly $1.5 billion. And we were pleased to announce in June that our Board of Directors had approved a 19% increase to our quarterly dividend from $0.36 to $0.43 per share. As a result, 2013 will mark the 42nd consecutive year in which this Company has increased its annual dividend. +Now let's turn to our expectations for the third quarter and full year. In the US segment, we're expecting third-quarter comparable sales in the range of 1% to 2%. While this outlook is somewhat ahead of our second-quarter pace, it is supported by our experience so far in August and it reflects the benefit of this years' calendar shift, which moves the Halloween holiday into October from last years' fiscal November. +We expect a small decline in a gross margin rate compared with last year reflecting the impact of our growth initiatives partially offset by the benefit of the vendor payment shift. We expect our third-quarter SG&A expense rate will be approximately 21.4%, reflecting about 60 basis points of pressure from a lower credit portfolio contribution and continued pressure from our multi-channel investments and the shift in vendor patient payments, partially offset by the ongoing benefit of our expense optimization efforts. Altogether, these expectations deliver a third-quarter EBITDA margin rate about 1 full percentage point below last years' third-quarter revised US segment EBITDA margin rate. +In Canada, the team continues to refine operations in the stores already opened, ensuring that inventory and expenses match the current pace of sales in each individual store. It's important to note that we're still very early into our market launch, and as Gregg mentioned, we're deploying multiple tactics to drive sales in our frequency categories over time. However, given that we had initially positioned our expense structure, fulfillment network and inventory to support potential upside to our initial sales forecasts, we are incurring markdowns and higher than normal operating expense rates as we adjust to the current pace of sales. This has raised our dilution expectations for this segment through the end of the year. +Specifically, for the third quarter, we expect the Canadian segment will drive $0.22 of dilution to our consolidated earnings per share. In total, we expect third-quarter adjusted EPS of $0.80 to $0.90 and GAAP EPS of $0.55 to $0.65 reflecting Canada dilution along with $0.03 of expense from the unwind of the beneficial interest asset resulting from our credit card portfolio. +For the full year, we've become incrementally more cautious in our US sales outlook, given our own recent results and those of our competitors. We now expect a full-year comparable sales increase of about 1%, down from our prior outlook from an increase -- for an increase of 2% to 2.5%. We believe planning for this pace is appropriate and will help to mitigate downside risk of taking a more aggressive inventory position. As always, Kathee's team remains prepared to chase business if the US environment strengthens unexpectedly. +Even with our more tempered sales expectation we believe full-year adjusted EPS will remain in the $4.70 to $4.90 range we provided previously, although our expectation has moved to the low end of that range. We expect full-year GAAP EPS will be approximately $0.95 lower than adjusted EPS reflecting $0.82 of dilution from the Canadian segment combined with a net $0.13 of dilution from the credit card portfolio sale and associated debt repurchase. +Beyond this year, we expect year-over-year EPS performance in the Canadian segment to improve meaningfully in 2014. While Canadian segment sales are starting from a different base than we expected, we have ample experience with US market launches to give us confidence that we can drive stronger sales increases in the next several years and ultimately reach our longer term sales and profit goals. As we said many times, our experience in opening Target stores for more than 50 years has shown that we're much more accurate when estimating fifth-year sales than first-year sales. We're still very confident in our Canadian strategy, stores and team and continue to believe the segment will generate $0.80 or more of EPS in 2017. +And finally, beginning next year, we expect to see a meaningful increase in cash available for dividends and share repurchase. Our US operations continue to generate very strong cash flow. In addition, we expect capital expenditures in Canada to fall more than $1 billion in 2014 while US capital expenditures are expected to stay essentially fat -- flat. The resulting increase in free cash flow will allow us to continue growing the dividend at our current 20% annual rate and meaningfully grow share repurchase from the current pace while maintaining our goal to preserve our current strong investment grade credit ratings. +That concludes today's prepared remarks. Now Gregg, Kathee, and I would be happy to respond to your questions. + + +================================================================================ +Questions and Answers +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Thank you. +(Operator Instructions) +Sean Naughton, Piper Jaffray. + +-------------------------------------------------------------------------------- +Sean Naughton, Piper Jaffray - Analyst [2] +-------------------------------------------------------------------------------- + + First question on the comp, John, I think you mentioned that it did get steadily better throughout the quarter. Any additional color you could give us there? And then on -- were there any regional differences that you could potentially isolate in terms of where some of the transaction weakness was in the quarter? + +-------------------------------------------------------------------------------- +John Mulligan, Target Corporation - EVP and CFO [3] +-------------------------------------------------------------------------------- + + I think on the sequentially, yes it improved month to month within the quarter. None of the quarters were negative, which compared to first quarter was significant progress. July was notably the strongest, but a portion of that certainly was attributable to that back-to-school week moving in from August last year. So we did see it strengthening, but I wouldn't want to overplay that, certainly a portion of it is attributable to the calendar. Geography wise, we have not seen anything meaningfully different in aggregate across the quarter. In any one week or day there's differences, depending on when back-to-school starts in various portions of the country, but nothing meaningful across the country. + +-------------------------------------------------------------------------------- +Sean Naughton, Piper Jaffray - Analyst [4] +-------------------------------------------------------------------------------- + + Okay, got it. And then you talked about some lower advertised prices in the circular, is this really just in Canada or is it also in the US, and is that some of the gross margin pressure that you're thinking about in the second half as you've done a very nice job in terms of a rate improvement in between categories over the last four or five quarters here? + +-------------------------------------------------------------------------------- +Gregg Steinhafel, Target Corporation - Chairman, President and CEO [5] +-------------------------------------------------------------------------------- + + Well I would say, this is Gregg, in the US, we continue to offer hot pricing. There isn't going to be a meaningful change in our strategy, because day in and day out we have unbeatable prices when you take a look at our -- the fact that our prices are competitive, the price match policy both online and in store, and our REDcards performance day in and day out. We have a very strong value proposition. And then our circular pricing is even more aggressive than that, and we take market leading positions. +In Canada, we know that we have an opportunity to break those shopping habits and we've got to focus on driving need-based trips. So, there in particular we will sharpen up our pricing, and make sure that we are taking a more of a market leader position. Our REDcard penetration is still very, very small there, and we expect that to grow over time. But it's more in Canada that we're going to make sure that our prices get more noticed than they have been up to this point. +Part of that was a conscience plan on our part to make sure that we really won in Home and Apparel, and we feel real good about where we are in those two businesses today, so we're proud of that fact. Now we have to just turn on the gas a little bit on the other side of the equation to make sure that we're getting the Canadian guests to understand what great values we offer on frequency categories and break some of those well-established habits. + +-------------------------------------------------------------------------------- +Sean Naughton, Piper Jaffray - Analyst [6] +-------------------------------------------------------------------------------- + + Okay and then real quick, on the dilution in Canada, obviously up quite a bit here in 2013 from the initial expectation. Any way or ability to paint us a picture, I know you still remain confident in that five-year outlook on the progression towards that $0.80 in 2017? Thank you. + +-------------------------------------------------------------------------------- +John Mulligan, Target Corporation - EVP and CFO [7] +-------------------------------------------------------------------------------- + + So, I'm not entirely clear where you're going. Is it that why are we confident about the $0.80, or what will we see happen here as we go forward, Sean? + +-------------------------------------------------------------------------------- +Sean Naughton, Piper Jaffray - Analyst [8] +-------------------------------------------------------------------------------- + + Yes, so the question is is there an ability to say that the Canadian business will be -- you believe the Canadian business may be accretive in 2014. + +-------------------------------------------------------------------------------- +John Mulligan, Target Corporation - EVP and CFO [9] +-------------------------------------------------------------------------------- + + So on 2014, I think it's very early here, and we've given you our best view. I think when you step back we've been operating 60 some stores for on average about 2.5 months, and so we're giving you our best information here for 2013. And clearly sales are a little bit short of where we need to work through some of the inventory and optimizing the business and optimizing our expense structure. +I think as we look forward getting another 56 stores open, getting through a holiday will certainly provide a lot more information about where we expect to be. But in 2014, I think we expect to see meaningful improvement in the profitability of Canada. We'll cycle past all of the start up expenses, we'll have our inventories more in line with sales patterns that we now have some information on. Our expense structure will be optimized to the sales level and we'll start to grow sales. So I think we'll see meaningful improvement in 2014, but I would say probably from this perspective today, unlikely that we'll see profitability on the full year. And we'll be back to provide a little bit more information on what that looks like, and the cadence throughout the quarters, again, as we get a little bit more information this year, get the stores open, get new markets and get through a holiday season most importantly. + +-------------------------------------------------------------------------------- +Sean Naughton, Piper Jaffray - Analyst [10] +-------------------------------------------------------------------------------- + + Okay, that's really helpful. Best of luck in the back half, thank you. + +-------------------------------------------------------------------------------- +Operator [11] +-------------------------------------------------------------------------------- + + Greg Melich, ISI Group. + +-------------------------------------------------------------------------------- +Greg Melich, ISI Group - Analyst [12] +-------------------------------------------------------------------------------- + + I wanted to follow up on Canada and then touch on the US. Just to make sure I've got that right, or maybe ask it a different way, John, if you look at the incremental Canadian dilution this year, how much of it is related to those items of clearance? How much of it would be related to, if you will, start up costs or advertising? How much of it do you think is just a different margin structure in the business to drive that frequency in trips? + +-------------------------------------------------------------------------------- +John Mulligan, Target Corporation - EVP and CFO [13] +-------------------------------------------------------------------------------- + + Yes, I think parsing that all out is difficult. I would say that the second one, incremental marketing and advertising is not material to the total move from where we were to where we are today. I think the biggest driver of the change in profitability or dilution this year comes from, we had a set of sales expectations as we entered in the market, and we also, given all of the excitement that we saw building over two years, we protected on the upside from an expense standpoint and from an inventory standpoint, and the sales have been somewhat disappointing. And so we need to work through those inventories. There's some clearance activity, there was some excess inventory this quarter, as well, that we work through. And we need to right size the entire expense structure for what -- for the sales numbers that are currently -- that we're operating at. So, I think that's the vast majority of it. +I don't think we see, I know we don't see going forward a change in the overall our view of what the margin rates were going to be, EBITDA or EBIT rates were going to be in Canada over the long term. We feel very good about gross margin, and frankly, we expect gross margin will deteriorate a little bit as we begin to drive these frequency categories. You don't see that in this quarters' results, because there was a fair bit of clearance and excess inventory that we moved through, but we expect margin rates will come down as we grow sales in those frequency categories. But net, net that'll be good for the business and start to apply leverage against the fixed expenses that we've built for the Business. + +-------------------------------------------------------------------------------- +Greg Melich, ISI Group - Analyst [14] +-------------------------------------------------------------------------------- + + Okay, great. And then second, turning to the US, Kathee it was helpful to go through all the initiatives you have, and it seems like the issue that is bigger than anything is traffic staying negative versus what you guys would have probably hoped or expected a year or two ago. If we think about the traffic side of it more specifically, what in the back half do you think is going to help stabilize and improve that traffic trend, or is it just the way it is now, that this trip consolidation and that's the way the consumer is, and if we're getting comp it needs to be with more items and top line? + +-------------------------------------------------------------------------------- +Kathee Tesija, Target Corporation - EVP Merchandising [15] +-------------------------------------------------------------------------------- + + You're right, Greg. Traffic was our issue, and I do think that somewhat that is the way it is right now. We're seeing a lot of trip consolidation across all guests. I think the part that I'm pleased about is that when you look at our basket, we are seeing that they're buying more units from Target, as well as increased selling price, and they are trading up into higher price point product, so that's great. I think as we move forward the thing that we're focused on and driving traffic is really making sure that as they're consolidating and they're doing more in one store, that we're offering that compelling value. And Gregg talked a lot about all of those components, but that we make sure that that continues to be rock solid. As well as the innovative product, and I mentioned a lot of those that we have coming like Phillip and Haggar and in our seasonal categories we've got a lot of new stuff coming, so that's key. +And then, I guess, the third thing that I would add is just making sure that our in-store experience remains outstanding. Because we want them to be pleased when they come, and continue to consolidate their trip and to do more at Target. So we have great service every day, but in addition to that, some of the new things that we're doing with flexible fulfillment, like buy online, pick up in store, I think will be fantastic in the back half. And then we're also looking at really upping the in-store experience in key categories like Beauty and the test that I described in Baby. So it's a combination of those three things. + +-------------------------------------------------------------------------------- +Greg Melich, ISI Group - Analyst [16] +-------------------------------------------------------------------------------- + + Thanks. + +-------------------------------------------------------------------------------- +Operator [17] +-------------------------------------------------------------------------------- + + Matt Nemer, Wells Fargo Securities. + +-------------------------------------------------------------------------------- +Matt Nemer, Wells Fargo Securities, LLC - Analyst [18] +-------------------------------------------------------------------------------- + + A quick follow up on Canada and then a couple on the US business, as well. Could you talk to the inventory overhang in Canada, the clearance that you spoke to, is that primarily also on frequency items, or is that more a discretionary product? + +-------------------------------------------------------------------------------- +Gregg Steinhafel, Target Corporation - Chairman, President and CEO [19] +-------------------------------------------------------------------------------- + + The inventory overhang is a function of the shortfall primarily in some of the seasonal categories. So, think of -- even though Apparel and Home was strong, the variability by store, and the fact that some of our seasonal categories, like Lawn and Patio didn't perform at the level that we were expecting. So, it was not in the basic categories or the non-discretionaries, primarily in a subset of the discretionary categories. But it's one of those things where it's more obvious, because it's such a large number of stores. +But it's the same kind of fine tuning that we go through every time we open a new store here in the United States, and they have experienced for years and years. There is always a tremendous amount of fine tuning and getting the right match of sales volatility, variability, assortment, and aligning that with inventory. What we're seeing in Canada is there's such a big critical mass that it stands out, and it's far more obvious. But it's no different than what we've experienced here. + +-------------------------------------------------------------------------------- +Matt Nemer, Wells Fargo Securities, LLC - Analyst [20] +-------------------------------------------------------------------------------- + + Okay, great. And then in terms of the average transaction size, could you elaborate on which categories are benefiting from the larger basket and the trade up that you alluded to? + +-------------------------------------------------------------------------------- +Kathee Tesija, Target Corporation - EVP Merchandising [21] +-------------------------------------------------------------------------------- + + Yes, I think that we're seeing larger basket in many different areas they're shopping, as I said doing more in one store so shopping around the store. In terms of the selling price, we're seeing strength in trading up to higher price points in back-to-school. We're seeing strength, for example, in home with threshold, where they're buying that better product versus opening price point product. And then we're also seeing some softer sales in our one spot at the front of the store, which is very seasonal and impulsive product, so that combination I think is driving that selling price. + +-------------------------------------------------------------------------------- +Matt Nemer, Wells Fargo Securities, LLC - Analyst [22] +-------------------------------------------------------------------------------- + + Okay, great. And then lastly, if we look at some of the omni channel and multi-channel initiatives that are launching in the back half, is there any way to quantify the potential impact or potentially in your survey work you could talk to how much demand there is for these products, specifically on Click and Collect or Buy Online, Pick Up in Store? I know that's half of the volume in some cases for some of your competitors' Online businesses. Could you talk to how big you think that could be for you in the back half? Thank you. + +-------------------------------------------------------------------------------- +Kathee Tesija, Target Corporation - EVP Merchandising [23] +-------------------------------------------------------------------------------- + + Well we don't have a number that we can share on that. We have, as you know, been testing it with team members, and I think the key for us is just the convenience for guests to be able to buy it online. But then they want to pick it up in store. Sometimes they don't want it delivered and sitting on their doorstep, but oftentimes they want to be able to get other things in the store either that go along with that core item or just the rest of their list. So, we think it will be very interesting to our guests. It certainly has been with our team members, but we haven't quantified the sales number yet. + +-------------------------------------------------------------------------------- +Gregg Steinhafel, Target Corporation - Chairman, President and CEO [24] +-------------------------------------------------------------------------------- + + Yes, I would just say this is -- we're in a learning environment right now. We'll be able to give you a lot more specifics after we get through the holiday season. And for us to try and quantify at this stage would be, it would be a shot in the dark. So we really don't want to speculate how our guests are going to use that and -- but we'll be back to you at the end of the holiday and we'll give you a lot more color around the adoption, the acceptance rates by our guest. + +-------------------------------------------------------------------------------- +Matt Nemer, Wells Fargo Securities, LLC - Analyst [25] +-------------------------------------------------------------------------------- + + Great, thanks so much. + +-------------------------------------------------------------------------------- +Operator [26] +-------------------------------------------------------------------------------- + + Deborah Weinswig, Citi. + +-------------------------------------------------------------------------------- +Deborah Weinswig, Citigroup - Analyst [27] +-------------------------------------------------------------------------------- + + If you think about the spending in the first half of the year versus the back half of the year on marketing, and why the competitive environment, can you help us think about how that spending might take place in the back half versus the first half of the year? + +-------------------------------------------------------------------------------- +Gregg Steinhafel, Target Corporation - Chairman, President and CEO [28] +-------------------------------------------------------------------------------- + + There is not really a meaningful difference in terms of the rate of spend first half, second half. We didn't overspend or under spend in the first half to shift dollars to the second half. We've always felt that the allocation of resources by quarter, by half has been pretty appropriate, and our spend is going to be similar in those kinds of percentages. What we have seen is, we've ramped up our spend in the digital channel. It's a less expensive channel that gives us different guests and broader reach, and we become far more efficient in the use of our marketing dollars. So, I think we're getting the same or more bang for our buck for essentially the same investments that we've made in the past. + +-------------------------------------------------------------------------------- +Deborah Weinswig, Citigroup - Analyst [29] +-------------------------------------------------------------------------------- + + Okay and with regards to Canada, can you elaborate a little bit on the announcement this week with regards to the metro partnership in Canada? + +-------------------------------------------------------------------------------- +Gregg Steinhafel, Target Corporation - Chairman, President and CEO [30] +-------------------------------------------------------------------------------- + + Yes, we're excited to have Metro as partner to run our pharmacies in the Quebecian Province in the eastern part of Canada. We think they are a great partner. They run a terrific business, and we're thrilled to have them as our partner. + +-------------------------------------------------------------------------------- +Deborah Weinswig, Citigroup - Analyst [31] +-------------------------------------------------------------------------------- + + Okay, and then lastly, it seems like you have a unique opportunity with the REDcard to tailor communications between Canada and the US. You have almost 20% of your customer base. Can you talk about through e-mail and text what you're doing in terms of personalization? + +-------------------------------------------------------------------------------- +Kathee Tesija, Target Corporation - EVP Merchandising [32] +-------------------------------------------------------------------------------- + + We're doing a lot with both e-mail and text. But I would tell you, Deb that we're in the beginning of that journey. We think there's a lot more that we can do, but we're doing things with personalization in terms of seasonal and timing, but also product categories that resonate with our guests and we're seeing great results. We've upped particularly e-mail a lot this year, and it's really paying off. And so we're on a journey, and we think that there's a lot of head room there, and we will go after that in a big way. + +-------------------------------------------------------------------------------- +Deborah Weinswig, Citigroup - Analyst [33] +-------------------------------------------------------------------------------- + + Great, thanks so much and best of luck. + +-------------------------------------------------------------------------------- +Operator [34] +-------------------------------------------------------------------------------- + + Jason DeRise, UBS. + +-------------------------------------------------------------------------------- +Jason DeRise, UBS - Analyst [35] +-------------------------------------------------------------------------------- + + I wanted to ask about Canada's gross margin again. I know there's been a few questions already. But if you did better on more of those discretionary items, and I guess there was some shortfalls store by store, in terms of certain seasonal items coming through. Is this -- how is this, I guess, affecting maybe some of your plans? Are you adding more planograms? Is that going to add to the SG&A cost to service all these stores, if it's just different demand for different products? And just reflecting how diverse Canada actually is, or is it just weather effects, and what have you learned from that process? + +-------------------------------------------------------------------------------- +Kathee Tesija, Target Corporation - EVP Merchandising [36] +-------------------------------------------------------------------------------- + + I don't think that we'll be adding a lot of planogram versions. I think we're still tweaking what's on those planograms. But we've -- we understand that, and we've got many different versions throughout Canada for all of their differences across geography and their guests. But I think what Gregg was talking about was, number one, getting the buy right by store in all of those categories, and then some of the seasonal categories were softer. So making sure that we get that buy right going forward, that has less to do with the planogram itself. And then in addition to that, as we're driving more trips with our frequency categories, that's the side that's been weaker, we think that traffic will also help sales throughout the store, because the guests clearly likes our differentiated merchandise on the Apparel and Home side. So it's a combination, but it's more about the buy than it is about planograms. + +-------------------------------------------------------------------------------- +John Mulligan, Target Corporation - EVP and CFO [37] +-------------------------------------------------------------------------------- + + The other thing I'd add, Jason, if you step back to where we were three months ago the gross margin rate was a little bit above 38%. And the two things we said at that time, I think, are still appropriate. One, it's going to be noisy here early by quarter because it's just naturally that way as we're opening up stores. But two, don't expect us to operate at that high a level. While the mix was very favorable, we hadn't gone through any seasonal clearance. And so seasonal clearance is going to naturally bring that rate down. +This quarter a little bit more than we would have expected, but there again I said we're working through some excess inventory given our sales levels. So we expect through time that the gross margin rate will normalize at a reasonable level that ultimately will allow us to deliver EBITDA margin rates let's say 12% in Canada like we've talked about all along. + +-------------------------------------------------------------------------------- +Jason DeRise, UBS - Analyst [38] +-------------------------------------------------------------------------------- + + Okay, and then I wanted to ask on the US side about the efforts to increase service, omni channel, flexible fulfillment, and all those things, obviously that costs a lot to implement and the way I see it, and you can correct me if I'm wrong, you're very centralized already. So, should we think about this is just necessary to keep sales growing? And maybe it comes in at a lower margin or are there areas that you could offset that impact? + +-------------------------------------------------------------------------------- +Gregg Steinhafel, Target Corporation - Chairman, President and CEO [39] +-------------------------------------------------------------------------------- + + I would think of it as this way. In our Business in any point in time there are investments that we have to make to continue to get better at what we do, whether it's a service or supply chain or technology investment or investments in the guest experience. And so this is -- we're calling attention to this. But these are investments that we're going to make in the business because we want to provide a great experience, which means our expense optimization efforts, as they have in the past, have to more than offset these kinds of investments. +So, we look at it all-in holistically and we're saying hey we got to get leaner and meaner in certain parts of the organization, and become more efficient, and we demonstrated that last quarter. We were very, very rock solid in our expense and our productivity and that affords us the ability to -- and the capacity to get more aggressive and do some of these kinds of things, and invest in transforming the Business to the future. + +-------------------------------------------------------------------------------- +Jason DeRise, UBS - Analyst [40] +-------------------------------------------------------------------------------- + + Could you maybe elaborate on that? I know that you talked a bit about that there's the compensation accrual and that that helped, but then you also mentioned that you were better on payrolls. Is that something where you think there's more room to go in terms of the in-store labor, or is that something where you really wouldn't want to push too hard on because of the potential implications on revenue? And if that's the case, where else could the savings be, if it's not the store? + +-------------------------------------------------------------------------------- +John Mulligan, Target Corporation - EVP and CFO [41] +-------------------------------------------------------------------------------- + + Jason, we said at the beginning of the year the investments in multi-channel and everything we were doing would be $0.20 to $0.25 of incremental dilution or incremental expense in our Business. And we said at that time that through our expense optimization efforts we expected to offset virtually all of that in the year. We do that in a variety of ways. The stores have continuously over a long period of years looked for ways to increase productivity faster than wage rate and faster than sales, so lowering our expense rate. And we think there's opportunities to continue to apply technology to improve productivity in our stores. But what Gregg was talking about, our expense optimization efforts are across the entire organization, headquarters, distribution, supply chain. Everywhere we operate, we are looking for ways to take expense out so that we can afford to invest in the Business. + +-------------------------------------------------------------------------------- +Jason DeRise, UBS - Analyst [42] +-------------------------------------------------------------------------------- + + Okay, thank you. + +-------------------------------------------------------------------------------- +Gregg Steinhafel, Target Corporation - Chairman, President and CEO [43] +-------------------------------------------------------------------------------- + + Great. Well that concludes Target's second-quarter 2013 earnings conference call. Thank you all for your participation. + +-------------------------------------------------------------------------------- +Operator [44] +-------------------------------------------------------------------------------- + + Thank you. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/exam/original-files/Problem_2_3_Sample_full_transcripts/2013-Feb-12-KO.N-137022867242-Transcript.txt b/exam/original-files/Problem_2_3_Sample_full_transcripts/2013-Feb-12-KO.N-137022867242-Transcript.txt new file mode 100644 index 0000000..bb1d8e4 --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_full_transcripts/2013-Feb-12-KO.N-137022867242-Transcript.txt @@ -0,0 +1,494 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q4 2012 The Coca-Cola Company Earnings Conference Call +02/12/2013 09:30 AM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Gary Fayard + The Coca-Cola Company - CFO + * Jackson Kelly + The Coca-Cola Company - VP and IR + * Steve Cahillane + The Coca-Cola Company - President Coca-Cola Americas + * Muhtar Kent + The Coca-Cola Company - Chairman and CEO + +================================================================================ +Conference Call Participiants +================================================================================ + + * Bill Pecoriello + Consumer Edge Research - Analyst + * Judy Hong + Goldman Sachs - Analyst + * Bryan Spillane + BofA Merrill Lynch - Analyst + * Ali Dibadj + Sanford C. Bernstein & Co. - Analyst + * Bill Schmitz + Deutsche Bank - Analyst + * John Faucher + JPMorgan Chase & Co. - Analyst + +================================================================================ +Presentation +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + At this time, I would like to welcome everyone to The Coca-Cola Company's full year and fourth quarter 2012 earnings results conference call. Today's call is being recorded. If you have any objections, you may disconnect at this time. All participants will be in a listen-only mode until the formal question and answer portion of the call. +(Operator Instructions) +I would like to remind everyone that the purpose of this conference is to talk with investors, and therefore, questions from the media will not be addressed. Media participants should contact Coca-Cola's media relations department if they have questions. I would now like to introduce Jackson Kelly, Vice President and Investor Relations officer. Mr. Kelly, you may begin. + +-------------------------------------------------------------------------------- +Jackson Kelly, The Coca-Cola Company - VP and IR [2] +-------------------------------------------------------------------------------- + + Good morning. And thank you for being with us today. I'm joined by Muhtar Kent, our Chairman and Chief Executive Officer; Gary Fayard, our Chief Financial Officer; Ahmet Bozer, President Coca-Cola International; Steve Cahillane, President Coca-Cola Americas; and Irial Finan, President of our Bottling Investments Group. Following prepared remarks by Muhtar and Gary this morning, we will turn the call over for your questions. +Before we begin, I would like to remind you that this conference call may contain forward-looking statements, including statements concerning long-term earnings objectives and should be considered in conjunction with cautionary statements contained on our earnings release and in the Company's most recent periodic SEC report. In addition, I would also like to note that we have posted schedules on our company website at www.cocacolacompany.com, under the reports and financial information tab in the investor section, which reconciles certain non-GAAP financial measures that may be referred to by our senior executives in our discussions this morning and from time to time in discussing our financial performance to our results as reported under generally accepted accounting principles. Please look on our website for this information. +Now, let me turn the call over to Muhtar. + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Company - Chairman and CEO [3] +-------------------------------------------------------------------------------- + + Thank you, Jackson, and good morning, everyone. +Let me start by saying that we're pleased with our reported results today. In a year marked by further uncertainty in the global economy, we once again delivered solid volumes, solid revenue, and solid profit growth. We grew our worldwide volume by 3% in the quarter and 4% for the full year. We generated comparable currency-neutral net revenue growth of 5% in the quarter and 6% for the full year, in the process, delivering record net revenues of over $48 billion in 2012. Consistent with the outlook we provided last quarter, we delivered full-year comparable currency-neutral operating income growth of 6%. This growth also translated into our company generating record comparable operating income of more than $11 billion for 2012. And importantly, we met our long-term volume revenue and profit targets for the full year, an accomplishment we are proud of meeting or exceeding every year since we announced our 2020 vision. In fact, since the first quarter of 2010, and the start of our 2020 vision, during one of the most difficult macroeconomic environments in recent history, we have firstly grown our daily servings by more than 200 million, serving more consumers daily on a global basis than at any other time in our history. Secondly, increased our global volume and value share of both our core sparkling and non-alcoholic ready-to-drink beverages to their highest levels since 2003. And thirdly, we added over $30 billion to our company's market capitalization. +We are well on our way to doubling our systems revenues by 2020 to $200 billion, reflecting the ongoing commitment of our entire global system to keep investing together for a better tomorrow. And we are crystal clear on why we do what we do, for it is our mission to refresh the world, inspire moments of optimism and happiness and to create sustainable value while making a lasting difference. This year, we once again led industry growth and extended our volume and value share gains globally in non-alcoholic ready-to-drink beverages. We gained global share in the sparkling beverage category, where our portfolio was up 3% for the full year. This is the third straight year our sparkling beverages have grown by at least 550 million incremental cases. This has added more than 13 billion new servings annually to our global business for the past three years. This growth of our sparkling beverages has consistently and reliably been led by brand Coca-Cola, which grew a very healthy 3% for the full year of 2012. +We also gained global share in still beverages, with our portfolio growing a solid 10% for the full year. This year, this full-year growth was led by Powerade and Dasani, which were both up double digits, and our Glaceau trademark brands, which were up mid single digits. In fact, our still beverage portfolio growth was well balanced with mid single to double-digit growth across every single still beverage category in which we compete. +As we have shared for some time now, we recognize that consumers across the globe continue to feel the effects of a still uncertain global economy. 2012 saw the extension of prolonged uncertainty in Europe, the ongoing transition of the economy in China, the lukewarm recovery in the United States, and ongoing challenges for Japanese consumers. We expect this volatility to extend through 2013. Having said that, the non-alcoholic ready-to-drink beverage category on the whole continues to be vibrant and grow in line with the levels we forecasted when we first developed our 2020 vision. +Our experience also teaches us that it is critical to seize opportunities during these uncertain times, in order to lead and to succeed in any macro environment. To do so, we will, together with our bottling partners, keep investing in our business so that we not only grow bigger, but also we grow better. Better at collaborating, better at innovating, and better at listening to our consumers and customers, as well as bottling partners. And most importantly, better at executing with precision. So while 2013 will once again be a year of challenges, we are confident that we will continue to generate consistent quality growth in this, the fourth year of our 2020 vision. +So now, let's review our performance results across our global markets in more detail, beginning first with North America flagship market. Our business in North America delivered its 11th consecutive quarter of growth, up 1% for the quarter, and 2% for the full year. As a result, our North America business achieved its best-ever full-year volume sales results. In addition, we sustained 2% positive price mix in 2012, resulting in our North America beverage business generating 6% full year comparable currency-neutral net revenue growth. Importantly, we achieved this growth while also realizing full-year volume and value share gains in non-alcoholic ready-to-drink beverages. In fact, since we initiated our 2020 vision back at the end of 2009, our US business has seen consumer dollars spent across measured channels increase from approximately $56 to $60 per person in 2012. This represents over $1.5 billion of value created by our brand portfolio in these measured channels alone. I'm personally very pleased with our ability to deliver quality results, as well as to consistently create real value across our entire North America business. +This year's growth in North America was led by our still beverage portfolio, which was up 8% in both the quarter and also for the full year. This is the fifth consecutive year that our North America still beverage portfolio has either maintained or gained both volume and value share. Our Powerade brand grew double digits in both the quarter and for the full year, making this Powerade's third consecutive year of double-digit growth. More importantly, Powerade led the broader North America sports drinks category in both absolute volume and value growth for full-year 2012. This is further evidence of how today's consumers are increasingly demonstrating a growing preference for this innovative sports drink brand. In our premium Smartwater brand achieved its fifth straight year of double-digit growth. Our juice and juice drinks portfolio also delivered a year of positive growth with our Simply trademark up 7% on a full-year basis. As such, our total juice and juice drinks portfolio gained volume and value share in both the quarter and full year. +Finally, our tea portfolio in North America sustained its momentum, up double digits while gaining volume and value share in both the quarter and full year. This result was led by Gold Peak, which was up 36% in 2012, cycling 48% and making this Gold Peak's sixth consecutive year of double-digit growth. Our sparkling beverage business in North America delivered absolute value growth in 2012, with full-year volume down 1%, offset by a positive 2% price mix. Importantly, our strategy to provide meaningful and purposeful choice to consumers continued to yield benefits. +Our core sparkling beverage immediate consumption transactions were up 1% for the full year, enabling us to capture sparkling beverage volume and value share in North America in both the quarter and for the full year. Coke Zero sustained its momentum, up high single digits for the full year. And we also saw accelerated growth in Fanta, which was up mid single digits for the full year. As we look ahead, we remain positive that North America is a long-term growth market for our sparkling beverage business. We will keep investing in the category and in our winning sparkling portfolio and continue to promote active, healthy well-being in all the communities that we proudly serve. +Moving now to Latin America, our volume grew 5% in the quarter and for the full year. The incremental volume we generated in Latin America this year was equivalent to adding a business the size of Canada to this region's volume base. Our total business in Latin America set a new record with volume sales exceeding 8 billion unit cases, or the equivalent of 192 billion servings on a full-year basis for the first time in our company's history. Our sparkling beverages in Latin America grew a healthy 3% in 2012 with brand Coca-Cola also up 3%, both for the quarter and for the full year. Also, our still beverages in Latin America delivered double-digit growth in both the quarter and for the full year. These well-balanced results translated into Latin America capturing volume and value share in non-alcoholic beverages for the eighth consecutive year. +We also saw balanced results across all four of our Latin America business units, each generating mid to high single-digit growth for the full year. Our two largest markets in Latin America, Mexico and Brazil, were both up a solid 5% this quarter, while also growing volume and value share in non-alcoholic ready-to-drink beverages. On a full-year basis, Mexico was up 4%, supported by consistent brand Coca-Cola growth, up 3% in the quarter and the full year. Brazil grew 6% for the full year, with sparkling beverages up mid single digits in both the quarter and the full year. And last December, also three of our bottling partners in Brazil, including two operated by our Bottling Investments Group, signed an agreement to combine their operations. When completed, this transaction is going to create the second largest Coca-Cola bottling operation in Brazil. The proposed combination will form a company with a greater ability to invest in the market and accelerate growth, reflecting our franchise systems continuous evolution and our systems commitment to long term, sustainable growth in Brazil. +Now let me turn to our Pacific group, which grew 2% in the quarter and 5% for the full year. In Japan, our full-year volume grew 2%, in line with the outlook we provided in our previous earnings calls. This resulted in our business in Japan delivering a third consecutive year of record high sales volume. Our business in Japan also gained full-year share in non-alcoholic ready-to-drink beverages. This result was driven by volume growth across most channels, including drug stores, convenience retail outlets, and supermarkets. I'm also proud to announce that Ayataka, our premium green tea brand, as well as I LOHAS, our innovative water brand, achieved billion dollar brand status in late 2012. These are the fourth and fifth billion dollar brands we have added to our portfolio since announcing our 2020 vision. +Also, with regard to Japan, last December, the four Japanese bottlers from the greater Kanto region announced their agreement to merge into one integrated and publicly listed company called Coca-Cola East Japan. While this agreement is still pending final approval by each of the four bottler shareholders, once complete, Coca-Cola East Japan will become our fifth largest global bottling partner in terms of annual revenue. We support this bottler-led consolidation in Japan and see it as one example of the many ways our franchise system continues to evolve in full alignment with our 2020 vision. +Moving now to China, our last earnings -- during our last earnings call, we shared our clear expectation with China's ongoing economic transition would have a short-term impact on our industry and on our business. Since then, we have seen disposable consumer spending remain quite challenged in China, especially in the export-driven coastal areas where a higher proportion of our beverages are consumed. As a result, our China volume was down 4% in the fourth quarter, also impacted by unseasonably poor weather, the cycling of double-digit growth from last year, and the timing of the Chinese New Year. On a full-year basis, our volume in China grew mid single digits, cycling double-digit growth from last year. Our strong sparkling beverage portfolio in China continued to expand our nearly two to one share advantage over our primary international competitor. This portfolio is very well positioned in China, with leading brands in every major sparkling flavor category, including Sprite, the number one sparkling brand in China, Coca-Cola recently rated by Chinese consumers as their most favorite brand, and Fanta, which registered double-digit growth in 2012, exceeding 100 million annual unit cases for the first time. And we are committed to investing and innovating across our broader still beverage portfolio in China to strengthen our presence across all categories. +As we look ahead to 2013, we still expect ongoing uncertainty in China to have a short-term impact on our industry and on our business, although we do expect to see improvements in consumer disposable income as the year progresses. As such, from here on, we expect our business to deliver sequential improvement in 2013. As we have stated before, we have every confidence in the long-term resilience of our China business, and we remain very excited about our long-term opportunities in this region. Across the rest of the Pacific group, we realized several new milestone performances in fast-growing markets. South Korea was up double digits in 2012, with our business there achieving over 200 million annual unit cases for the first time. Thailand also delivered double-digit growth, up 22% for the full year, resulting in record value share and full-year unit case volume results. +The Philippines also achieved strong results, growing 5% for the full year, while also capturing volume and value share in non-alcoholic ready-to-drink beverages. As many of you know, we recently sold 51% of our bottling business in the Philippines to Coca-Cola Femsa. While every bottling transaction is unique, this transaction is yet another example of our long-standing and fundamental belief in the strength of our global franchise system. We look forward to this new partnership with Coca-Cola Femsa as we jointly invest and further strengthen our business in the Philippines to create sustainable long-term growth and value. Our Eurasia and Africa business also extended its strong momentum, growing a very solid 10% in the quarter and up 11% for the full year, including full-year double-digit growth for brand Coca-Cola. During both the quarter and the full year, our business in Eurasia and Africa grew both volume and value share in total non-alcoholic ready-to-drink beverages. +On a country level, Russia was one of the key drivers of this group's performance, up 8% in 2012, led once again by the outstanding growth of brand Coca-Cola, which grew 20% for the full year. And the momentum behind our Dobriy juice brand accelerated further with 13% growth for the full year. Viewed in total, we have out paced the non-alcoholic ready-to-drink industry in Russia for three consecutive quarters. As a result, our business in Russia now has achieved an all-time high market share. Our business in India, which grew 16% on a full-year basis, continues its long stretch of strong growth, realizing both volume and value share gains across both sparkling and still beverages. Importantly, India has now delivered six consecutive years of double-digit volume growth starting back in 2007. +Moving now to Europe, our business was down 5% in the quarter and was down 1% for the full year, reflecting the region's ongoing macroeconomic uncertainty. While we recognize the real challenges of today's European environment, it is important to place our results in the proper context and to recognize the resiliency of our industry and our business in Europe. Since the start of 2009, when austerity measures, unemployment, and fiscal concerns began to weigh heavily on European consumer confidence, Europe has seen its GDP decline. In contrast, during the same four-year period, our business in Europe has out paced the broader industry, making our company one of a select few able to deliver positive growth between 2009 and 2012. We successfully grew our business in Germany, up 1% in 2012, despite cycling 6% growth in 2011, while gaining full-year share in non-alcoholic beverages. This makes it three consecutive years that Germany has delivered full-year volume growth. As such, we remain confident that our business in Germany is in a sound position and capable of delivering long-term sustainable growth. +Looking ahead, we expect, we expect Europe's economic uncertainty to extend well into 2013. At the same time, we expect that the European economy and consumer sentiment will gradually improve and that our business is well positioned to return to volume growth as that occurs. We're also confident that our leadership team and our system will keep investing to outperform the industry in 2013 as Europe continues along the road to recovery. +Before concluding my prepared remarks, I would like to highlight our company's sustained efforts and resolve to work to find meaningful solutions to the complex issue of obesity. There's an important conversation going on about obesity and we want to be part of the solution. Together with partners in government, civil society, our own industry, and other businesses, I am personally committed to leveraging all our resources to lead and make a difference here. We're committed to use evidence-based science to guide the choices we offer. We are committed to investing innovation of our sweeteners, products, packaging and equipment that fosters active, healthy living. We are committed to bringing real choice to consumers everywhere and educating them on how the choices we offer can play a role in sensible, balanced diets and active healthy lifestyles. We are committed to transparency about the nutritional content of our products and we are committed to responsible marketing of our products. +In closing, we are pleased that our business has done so well in recent years and that we remain well on track to achieve our 2020 vision. Together, we as a system have delivered on our priorities and we are achieving real success. With passion and commitment and our collective focus, we are propelling ourselves forward during these challenging economic and social times. As we look back to January 2010 when we began our 2020 vision, we have reasons to be proud of our collective achievements and yet remain constructively discontent. We completed the largest transaction in our history leading to the formation of Coca-Cola Refreshments in North America. We added five new billion-dollar brands to our portfolio. We maintained Coca-Cola as the world's most valuable brand, a distinction it has earned from Interbrand every year since 2000. And we launched multiple programs to support the global communities we serve, such as our 5 by 20 initiative to empower 5 million women by 2020 and to provide entrepreneurial training to help grow local businesses. +All that said, we are keenly aware of how today's turbulent economic landscape is likely to extend through this year. As such, our 2013 strategic priorities remain absolutely clear. First, we must continue to grow sustainably and provide meaningful solutions that enhance the health and well-being of the communities we proudly serve. Second, we will win with Coca-Cola, while actively promoting the brand and the category. Third, we must absolutely keep winning and executing with excellence at the point of sale. Fourth, we need to keep maximizing the value of our global beverage portfolio. And fifth, we will encourage and inspire our system and associates to deliver our mission and our vision. +For there is still a great runway ahead of us, both for our sparkling beverages, as well as across the entire range of our broader portfolio. After all, global consumer expenditures are expected to grow strongly between 2013 and 2020, driven by further economic growth in developing emerging countries, as well as expected middle class expansion in populous economies. So while we are proud of our strong record of delivering results through the first three years of our 2020 vision, we know that we are really just getting started. All of us at The Coca-Cola Company and the Coca-Cola system remain diligent about what we need to do in order to achieve our results and to effectively and efficiently manage our business for sustainable, long-term success for all our stake holders. +With that, let me now turn the call over to Gary. + +-------------------------------------------------------------------------------- +Gary Fayard, The Coca-Cola Company - CFO [4] +-------------------------------------------------------------------------------- + + Thanks, Muhtar. And good morning, everyone. We are pleased to have once again delivered quality performance results in 2012, making this the seventh straight year that our volume and operating income results have been in line with or ahead of our long-term growth targets. Achieving such consistent performance during a time of ongoing macroeconomic uncertainty is a real testament to our global systems ability to execute our strategic priorities and alignment with our 2020 vision. Therefore, we remain confident that we will continue to deliver full-year volume, revenue, and operating income results in line with our long-term growth targets. +So let's review our results in more detail, starting with our comparable earnings per share, which came in at $0.45 this quarter, up 15% versus the prior year. Our full-year comparable earnings per share came in at $2.01, up 5%, despite facing what we estimate was about a 4% currency head wind for the year. Our comparable currency-neutral net revenues grew 5% in the quarter. The currency impact on this quarter's comparable net revenue results was a 1% head wind. Our full-year comparable currency-neutral net revenue growth was up 6%, in line with our long-term growth target. On a comparable basis, the impact of currency on our full-year net revenue results was a 3% head wind. Our comparable currency-neutral operating income was up double digits this quarter, consistent with the outlook that we shared in our earnings call last quarter. And as Muhtar shared a few moments ago, on a full-year basis, our comparable currency-neutral operating income came in at 6% as expected and in line with our long-term growth target. +During our last few earnings calls, we shared more specific full-year 2012 outlook across several financial items to help those of you who model our business. I'm pleased to say that our results were right in line with or slightly ahead of the outlook that we provided. So I want to take a moment to recap these results and where applicable, provide more and further insight into our full-year 2013 outlook. With regard to volume growth, our full-year 2012 concentrate sales growth was in line with our full-year unit case volume growth, as per our comments last quarter. Our consolidated price mix was up 1% for the full year 2012, consistent with our prior year full-year outlook. And for 2013, we expect to keep earning low single-digit consolidated price mix, as called for in our long-term growth model, as we continue executing our occasion-based brand/price package and channel strategies with precision around the world. +Our comparable currency-neutral SG&A expenses were up 5% on a full-year basis. This increase in SG&A reflects our ongoing commitment to keep investing for a better tomorrow, as we grew our direct marketing expenses in 2012 while simultaneously capturing incremental marketing efficiencies. We also added additional feet on the street, primarily in North America, to ensure support of our growing business in this important market. And our SG&A results for the quarter and full year also included a benefit from the reversal of certain expenses related to our long-term incentive plans, as well as a one point unfavorable impact of structural items, primarily in our bottling investments group and in North America. Our full-year comparable gross margin was roughly in line with the estimate we provided during our previous earnings calls. Our operating expense leverage was a positive nine points this quarter, as we benefited from having two additional selling days. And our full-year operating expense leverage came in at a positive one point. +For 2013, we expect our positive operating expense leverage to be even to slightly positive, as we sustain our strategic investments in brand building activities around the world, and efficiently manage our operating expenses. As you model our 2013 operating results and our corresponding operating expense leverage, let me also remind everyone that our 2013 calendar will have one less day when compared to 2012. Specifically, our first quarter of 2013 will have two less days when compared to the first quarter of 2012, and the first -- and the fourth quarter of 2013 will have one more day when compared to the fourth quarter of 2012. +Moving now to net interest, this came in at a positive $31 million in the fourth quarter. This was ahead of our initial expectations and raised our full-year net interest income to $74 million. For 2013, our best estimate is that net interest will come in as an expense ranging between $30 million and $50 million for the full year 2013. We'll update this outlook each quarter as we move through the year. For 2012, underlying effective tax rate held steady at 24% and we expect the tax rate for 2013 to be approximately the same. And our cash flow from operations increased 12% on the full year 2012, partially benefiting from favorable timing relating to certain working capital items. Looking ahead to 2013, we expect our cash flow growth rate to be more in line with our earnings growth rate. +Now, let me take a moment to update on the impact of several additional items that may help you model our business in 2013, starting with commodities. Incremental costs related to our big four commodities, which are sweeteners, metals, juices, and PET, came in at around $225 million for the full year 2012, in line with what we had provided previously. Looking ahead to 2013, and after considering our hedge positions, we anticipate a more moderate year of commodity inflation with incremental costs related to our big four commodities coming in at closer to $100 million. +As for currencies, we saw head winds of 4% on our fourth quarter comparable operating income and 5% for the full year 2012 comparable operating income, consistent with our previously provided outlook. In preparing for 2013, we are fully hedged on the Euro, Yen, and Sterling, and also have some near-term coverage in place across several other currencies. After considering these hedge positions, current spot rates and last week's devaluation announcement in Venezuela, we now expect currencies to be a 4% head wind of operating income for the first quarter of 2013 and at even to minus 1% head wind for the full year. It was even before Venezuela, so maybe slightly negative with Venezuela. We'll also report $100 million to $125 million devaluation loss in the first quarter related to monetary assets held in Venezuela. As for our normal practice, we'll update our currency forecast on a quarterly basis as we go through 2013. +Our full-year share repurchases net of employee option exercises totaled $3.1 billion in 2012, just slightly above the $2.5 billion to $3 billion range we communicated at the outset of the year. In 2013, we expect our net share repurchases to range between $3 billion and $3.5 billion. Now, let me take a moment to highlight a few other items that will also inform you about our business in 2013. First, as previously announced, starting this year we will have organized our company around three major operating businesses; Coca-Cola International, consisting of Europe, the Pacific, and Eurasia and Africa operations; Coca-Cola Americas, consisting of our North America and Latin American operations; and our Bottling Investments Group, which will continue to oversee our company-owned bottling operations outside of North America. As this organizational change does not impact our reporting segment, we'll continue to disclose our performance results for all five geographic operating groups, as well as for our Bottling Investment Group. +That said, starting with the first quarter of 2013, we will reflect our India and Southwest Asia business results within our Pacific operating group instead of within our Eurasia and Africa operating group. Prior to our next earnings call, we will provide information reclassifying the last three years of our results for these two geographic operating groups to facilitate your historical comparison of our results to our future results. Second, as previously mentioned by Muhtar, there have been several transactions announced these past few months, including bottler mergers in Japan and Brazil, and the sale of 51% of our bottling business in the Philippines. To be clear, we do not expect these transactions to have a material impact on our 2013 earnings results. However, these actions will generate a structural head wind on our year-over-year net revenue and operating income growth rates. As such, we anticipate these transactions to have a 3% structural impact on our full-year 2013 net revenue. Likewise, our full-year operating income results should see a 1% structural impact with this decline offset by a corresponding improvement in equity income. And as I mentioned, we do not see these transactions having a material impact on 2013 earnings per share. +As a final update and as part of our previously announced global productivity and reinvestment program, we are reorganizing our Coca-Cola refreshments business in the United States to align itself and operating functions around three geographies. We take this action as part of our consistent effort to improve our processes and systems, and to ensure greater operating effectiveness and productivity across our North American operations. This new alignment is in keeping with the ongoing evolution of our North American business model, as we invest even further to enhance our capabilities and deliver against our 2020 vision. +In closing, and as Muhtar said earlier, we are delivering on our strategic priorities and achieving real success. As we move into 2013, our global bottler system is healthier than ever and our financial priorities remain clear. We will invest in our core business with plans to spend around $3 billion in capital expenditures in 2013. We will strategically invest with our global bottling system to increase our share position across key growth categories. We will pay a healthy dividend, and as previously announced, we will repurchase shares between $3 billion and $3.5 billion in 2013. Our system is committed to investing together for a better tomorrow and our proven ability to achieve a consistent quality results provides us with the confidence that we will continue to successfully execute our growth strategies with precision, in line with our 2020 vision. +Before concluding our prepared remarks, I want to remind you that Ahmet, Steve and I look forward to seeing you when we present at the upcoming CAGNY Conference in Boca Raton on Friday, February 22. And Irial and I also look forward to being with you when we present together at the CAGE conference in London on Tuesday, March 19. +Operator, we're now ready for questions. + + +================================================================================ +Questions and Answers +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) +Bill Schmitz, Deutsche Bank. + +-------------------------------------------------------------------------------- +Bill Schmitz, Deutsche Bank - Analyst [2] +-------------------------------------------------------------------------------- + + Hi, guys. Good morning. Muhtar, I know you have been doing a lot of globe-hopping lately, so could you talk about the global macro, maybe some granularity about regional growth rates? I know you were at [sohishina dobos], just to give us some color on how you think things are going to trend over the next year. I know you kind of covered it big picture, but maybe some more granularity. + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Company - Chairman and CEO [3] +-------------------------------------------------------------------------------- + + Yes, Bill, I think -- I've recently been to Korea, to Australia, in the last 10 days to also southern Russia and Sochi, but I think essentially in Europe, there is a sentiment there that people are beginning to feel that it's not going to get any worse, that there will be some expansion happening as we move forward instead of just purely fiscal restraint and monetary restraint. So there is that feeling beginning to emerge, but I think it's going to be a long recovery. +Certainly in China, we are seeing the transition happen from a purely export-led economy to one that is more balanced with consumer spending and a combination of consumer spending, as well as export-led a balanced economy. I think there were some challenges in that transition initially where there was a divergence between GDP growth and pure disposable incomes for a while. But I think long-term, that's going to be very beneficial for everyone, this transition in China. I think in general, Japan is going to also -- I think the consumer sentiment will continue to be modeled and volatile there and subdued. +The rest of the world, whether it's Africa, the youngest billion, Latin America, Eurasia, Middle East, we see -- and of course Asia, Southeast Asia and other parts of Asia, Indian subcontinent, we see growth. We see very disciplined monetary policy, balanced budgets, good banking system, and the consumer is more positive. And so it's modeled and it's mixed. +And here in the United States, we see some signs of improvement. We need to wait and evaluate the impact of the payroll taxes, as well as the higher gasoline prices. It's too early to say, but it's a recovery that is at best lukewarm, but we feel that it could get better. That's how we see the world. And based on that, we continue to invest for opportunity. We continue to invest based on our long-term models and plans with our bottling partners, to continue to generate both volume, top line, and income growth. + +-------------------------------------------------------------------------------- +Bill Schmitz, Deutsche Bank - Analyst [4] +-------------------------------------------------------------------------------- + + Great. Thanks very much. And can I follow up with the change in the structure of CCR North America? Does this change your sort of philosophy on sort of how long you're going to own the asset and maybe how it's going to be operated going forward? + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Company - Chairman and CEO [5] +-------------------------------------------------------------------------------- + + Are you just -- sorry. Are you talking about just the restructuring? + +-------------------------------------------------------------------------------- +Bill Schmitz, Deutsche Bank - Analyst [6] +-------------------------------------------------------------------------------- + + Yes, exactly. Like for the three different regions. There were seven different businesses before and now there's three. Does that sort of change your view on how long that asset stays with TCC? + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Company - Chairman and CEO [7] +-------------------------------------------------------------------------------- + + Yes, it's got nothing to do with that at all. Think of it as last year we announced a new productivity and reinvestment program that includes continued synergies from our North America CCR, Coca-Cola Refreshment operations, to be able to enable us to continue to invest in our brands to grow in North America. 11 quarters of consecutive quarters of growth. When we first talked about growth in North America back in '09, people thought that we were trying to go to the moon with a glider. And now, it's reality. +11 quarters of consecutive growth. And we intend to continue that. We see this as a growth market. And therefore, to enable us to continue to invest in our brands, this is just ordinary course of business. Think about it exactly like that. It's not a big deal, ordinary course of business, and therefore, it's got nothing to do with the United States bottling structure. It's just part of ongoing business and I'll have -- Steve Cahillane is here with me on this call, as well as Ahmet Bozer and Irial Fanin, so I can ask Steve to also comment. + +-------------------------------------------------------------------------------- +Steve Cahillane, The Coca-Cola Company - President Coca-Cola Americas [8] +-------------------------------------------------------------------------------- + + Muhtar, you said it very well. This is very much an effectiveness play. Two years ago when we put these businesses together, we had a simple mantra. First, we were going to make it work. Then we were going to make it better. Then we were going to make it best. +We've learned a lot over the course of the last 2.5 years. One of our most successful organizations is our food service organization, which is aligned around three geographic units. We're moving our national retail sales and our field sales organizations also around the same three units, which will really build our total efficiency and effectiveness, our ability to work together, our ability to continue to invest in this market, invest against our brands, put more feet on the street. So we're very excited about the new organization and think it will get us from making it better to making it best. + +-------------------------------------------------------------------------------- +Bill Schmitz, Deutsche Bank - Analyst [9] +-------------------------------------------------------------------------------- + + Great. Thank you very much. + +-------------------------------------------------------------------------------- +Operator [10] +-------------------------------------------------------------------------------- + + Bill Pecoriello, Consumer Edge Research. + +-------------------------------------------------------------------------------- +Bill Pecoriello, Consumer Edge Research - Analyst [11] +-------------------------------------------------------------------------------- + + Good morning, everybody. I just wanted to clarify one thing first, Gary. When you are hitting the long-term FX neutral operating target, you expect to do that in 2013, as well as in the long run? Then with close to zero operating expense leverage guidance of '13, despite the savings, you're signaling stepped-up spending. Wanted to get an idea of where you're focusing that incremental spending on. Thanks. + +-------------------------------------------------------------------------------- +Gary Fayard, The Coca-Cola Company - CFO [12] +-------------------------------------------------------------------------------- + + Thanks, Bill. Yes, and I was trying to be pretty clear, but let me be very clear. We expect to hit our long-term growth targets both in 2013 and in long-term. But that applies to 2013 as well. So we're comfortable with that and would expect to be able to deliver that. +The second thing is we have always had a mantra that you invest through a crisis. We've been in a global crisis for a number of years now. But we've got history and we've seen what happens when you invest through the crisis, when you come out the other end. As Muhtar says, we think -- see things slowly improving across the world, but we expect to come out at the other end much stronger than we were even going in. So we're going to continue to drive efficiencies, productivity, and then reinvest that back to grow the business and growing the brands. The brands are stronger than they have ever been, but we think we can drive it even further so. We're going to continue to invest behind the brands. + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Company - Chairman and CEO [13] +-------------------------------------------------------------------------------- + + And just one point to add on that, Bill. I always say, as you go up, the air gets thinner. Always remember, we're adding on top of significant increases from prior year all the time. Just on sparkling beverages alone, we've added 500, over 0.5 billion cases each year. So we are cycling that every year and we're continuing to grow. I think that is really important. +And in three years, the worst, I guess, probably macroeconomic environment, we've seen for a long time. We're able to generate volume growth in line with our growth expectations, revenue growth in line with our growth expectations and income growth. Generating record revenues of $48 billion, record income, as well as record cash growth. It needs to be taken into that context, continue to crack the calculus for growth. + +-------------------------------------------------------------------------------- +Bill Pecoriello, Consumer Edge Research - Analyst [14] +-------------------------------------------------------------------------------- + + Thank you very much. + +-------------------------------------------------------------------------------- +Operator [15] +-------------------------------------------------------------------------------- + + Judy Hong, Goldman Sachs. + +-------------------------------------------------------------------------------- +Judy Hong, Goldman Sachs - Analyst [16] +-------------------------------------------------------------------------------- + + Thanks. Good morning. So Muhtar, I know you spoke a lot about the macro environment, but maybe you could speak a little bit about the competitive environment, particularly around US sparkling, China, and parts of Western Europe where you have seen some step-up in competitive pressure and how that's affected your volume performance and how you see that sort of trending in 2013. + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Company - Chairman and CEO [17] +-------------------------------------------------------------------------------- + + I think in the United States, we are -- as you have heard, we've gained -- continued to gain both volume and value share. And in all over the world, our share is at an all-time high, everywhere across the world, in NARTD, as well as in the different categories that we're operating in and competing in. We choose to compete in. And therefore, and similarly in China in sparkling, we've widened our gap to our nearest international competitor in sparkling. In Europe, I think there have been a month or two where we've had some challenges. But overall for the whole year, we've, again, gained share across the whole of broader Europe, in Western Europe, as well as Eastern Europe, and in Southeast Europe, across the whole continent in both volume and value share. +And to be -- I think to be frank, we see competition is healthy, and it keeps us on our toes, it keeps us executing better and being better, becoming more efficient and more productive, and that's all we strive every single day as a business system, together with our 275 bottlers around the world, is that we strive to get better. Better at making decisions quicker, so that we can be more nimble and more innovative and, as you know, we've launched more than 800 different products over the last four or five years. Many of them are new, innovative products that are gaining great traction, as they are in the United States. +Look at the still -- performance of our still business. Look at the relative performance of our sparkling business. I mentioned that between 2009 and 2012, spend per person on our brands went up from $56 to $60. So transactions are up in the United States. Our brand price pack channel location architecture is working in the United States. So both in China, transactions are ahead of our volume, as well as in the United States immediate consumption business. +So judge us not only by pure volume. Judge us by the quality of our volume and transaction growth. We sell -- in the end, consumers buy packages and products, combination of packages and products, each one at a time. They don't buy liters. That is really important, I think, to understand and how we think about our business. + +-------------------------------------------------------------------------------- +Judy Hong, Goldman Sachs - Analyst [18] +-------------------------------------------------------------------------------- + + Okay, and then Gary, following up on currency guidance for the full year. It seems like the first quarter guidance is actually a little bit worse than I thought. Can you help us understand, is it based on your hedge position and with the Yen moving pretty sharply, how much are you hedged on the Yen? + +-------------------------------------------------------------------------------- +Gary Fayard, The Coca-Cola Company - CFO [19] +-------------------------------------------------------------------------------- + + Judy, we're actually fully hedged on the Yen, Euro and Sterling, and in fact, the Yen positions that we have are actually in the money. They are in good play. That's not an issue. When you look at the first quarter, it was actually -- I said 4%, it was 3% pre-Venezuela. It is 4% now. The Venezuela devaluation obviously is a big one, when you devalue 50%. So that's number one. +But number two, the real impact is not what you would expect, is not the Yen. The impact are the rates that we're cycling in the emerging markets, particularly Latin America. If you look at Brazil, look at Mexico, those -- look at the rates at early last year, and then they started devaluing South Africa as well. If you look at those, you'll see there's an improving trend. So towards the latter part of 2013, based on where spot is today, we actually turned positive with kind of even to minus one for the full year. But it is front end loaded negative and then improving throughout the year. + +-------------------------------------------------------------------------------- +Judy Hong, Goldman Sachs - Analyst [20] +-------------------------------------------------------------------------------- + + And in Venezuela, Gary, just the impact you're purely looking at transitional impact or some sort of margin impact as you have the pricing control in place? + +-------------------------------------------------------------------------------- +Gary Fayard, The Coca-Cola Company - CFO [21] +-------------------------------------------------------------------------------- + + We've got a loss on monetary assets. That was the 100 to 125. And so if you look in the Wall Street Journal article this morning, we just joined a list of other companies that have the same issue. So that's kind of a one-time item that I'm just telling you has occurred and will occur. And then the translation impact of the revenues will be about a 1% drag in the first quarter. + +-------------------------------------------------------------------------------- +Judy Hong, Goldman Sachs - Analyst [22] +-------------------------------------------------------------------------------- + + Got it. Okay. Thank you. + +-------------------------------------------------------------------------------- +Gary Fayard, The Coca-Cola Company - CFO [23] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Operator [24] +-------------------------------------------------------------------------------- + + John Faucher, JPMC. + +-------------------------------------------------------------------------------- +John Faucher, JPMorgan Chase & Co. - Analyst [25] +-------------------------------------------------------------------------------- + + Thank you. Just two questions here. Gary, just sort of more of a housekeeping type of thing. As you look at the commentary on the net interest line, seems as though that's going to create a situation where there's probably not much leverage, if any, below the operating lines. If you could just sort of confirm that. +And then secondly, as we look at the organic top line growth in terms of just simply the bottler case sales volume plus price mix, it decelerated looks like to me at least every quarter this year. So can you talk about how you see that trending up as we go through the course of 2012? You've got difficult comparisons in the first half of the year and sort of how that's going to play into your comfort level of hitting that 6% to 8% currency neutral operating profit target. Thanks. + +-------------------------------------------------------------------------------- +Gary Fayard, The Coca-Cola Company - CFO [26] +-------------------------------------------------------------------------------- + + John, let me see if I can get the first half of your question. First, below operating income growth, you're right, because we will see net interest flip from interest income to interest expense. There are a couple of things going on in there. Primarily, it's rates. And just rates are down, particularly in some of the emerging markets where we've got some cash which was generating a lot of the interest income. You saw that happening during the latter part of this year. +And the reason that interest income was actually a lot better than in the fourth quarter than I told you to expect it to be was actually we put on some interest rate swap hedges a couple years ago. There's a small ineffectiveness piece to that hedge and the ineffective piece has to go through the P&L. That was actually pretty large this quarter positive, and it gave us a lot of interest income. So that's part of what you're seeing. So -- but then equity income, you're going to get some leverage. It's going to be up because of the structural items that I talked about from some of the transactions that have occurred. +Then if we go to, all right, the second half of your question was -- tell me again. + +-------------------------------------------------------------------------------- +John Faucher, JPMorgan Chase & Co. - Analyst [27] +-------------------------------------------------------------------------------- + + Just looking at the deceleration in the organic top line growth and how that maps out over the course of the year and the comfort on let's say the 6% there. + +-------------------------------------------------------------------------------- +Gary Fayard, The Coca-Cola Company - CFO [28] +-------------------------------------------------------------------------------- + + Well, I think there are a couple of different things. There, I think we're going to see improving and slowly improving trends in many of the markets around the world. Europe, I think will improve. My expectation is that Europe will improve in 2013 from well -- pretty good improvement form the fourth quarter of 2012, so I would say you're actually going to see sequential improvement in Europe. You're going to see sequential improvement in China for sure. I think the US is poised now also in a pretty good place. +So I think number one, I think volumes in 2012 dipped a little bit in the fourth quarter. Our view is that is not the start of a trend, that we think that's just -- it happened, but it's not the start of a trend. And we would expect volume actually to be okay in 2013 and we think it will sequentially start coming back and be better, be okay in 2013. + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Company - Chairman and CEO [29] +-------------------------------------------------------------------------------- + + John, just, just to add on that, I think very little is always said about the 120 or so countries which have a per capita of around 125 in our business, where volume growth for 2012 was, again, 7%. These countries represent about a little more than one third of our total global volume, countries that we never talk about, whether it's Sub-Sahara, or whether it's in Asia or Middle East or central Asia and so forth. But -- and we grew in these countries 9% in 2010, 7% in 2011, 7% in 2012, and we keep on growing. This is the beauty of our portfolio impact. +So while you may have a quarter where China doesn't grow or where Europe doesn't grow, we still continue to be able to deliver on our long-term growth model for volume and also for revenues, and I think that is -- imagine what would have happened to our volume if Europe did grow this past quarter and China. So this is the benefit of having this portfolio, which is getting stronger and bigger, as we continue to invest with our bottling partners in alignment. + +-------------------------------------------------------------------------------- +John Faucher, JPMorgan Chase & Co. - Analyst [30] +-------------------------------------------------------------------------------- + + Okay, and then finally, one housekeeping question. Gary, you mentioned the equity income line. That's coming out of the operating profit line. So is it -- as you look at hitting your target, I'm assuming that's before the bottler deconsolidation, right? So that's 6 to 8, sort of minus 1 for the bottler, minus 1 for the FX is how we should look at it? + +-------------------------------------------------------------------------------- +Gary Fayard, The Coca-Cola Company - CFO [31] +-------------------------------------------------------------------------------- + + Yes, John, that's exactly right. When I said hit the target, we hit the target before structural, but then you would have to adjust for structural. But with pretax or net income being the same, it's just what is the geography within the P&L. + +-------------------------------------------------------------------------------- +John Faucher, JPMorgan Chase & Co. - Analyst [32] +-------------------------------------------------------------------------------- + + Okay, great. Thank you. + +-------------------------------------------------------------------------------- +Gary Fayard, The Coca-Cola Company - CFO [33] +-------------------------------------------------------------------------------- + + Perfect. Thank you. + +-------------------------------------------------------------------------------- +Operator [34] +-------------------------------------------------------------------------------- + + Thank you. Ali Dibadj, Bernstein. + +-------------------------------------------------------------------------------- +Ali Dibadj, Sanford C. Bernstein & Co. - Analyst [35] +-------------------------------------------------------------------------------- + + Hi, guys. Can you give us a little bit more of a sense of the go-forward evolution of the bottling system globally and in the US? And you look at Germany that shrank this quarter and you want to do some system changes there. Japan certainly has seen some system changes and that's had some struggles. China is struggling a little bit and there were competitive system changes there. US sparkling volumes are still a little bit tough and you bought TCC about two years ago. +And whether, to Gary's point, these volume trends are a trend or not, it just seems to us that given all of that, you might actually see the next few years with very large changes to the Coca-Cola system and the industry overall. So if you were to kind of close your eyes and see with us, how would you see the structure of the system, of the future looking versus what it is today? + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Company - Chairman and CEO [36] +-------------------------------------------------------------------------------- + + Ali, I've always said the fact we are total believers in the franchise system. It is a beautiful system when you can get it to work as we have aligned towards the vision, aligned with its goals and aligned in its ownership objectives and goals. That's what we have. And therefore, we will continue to drive this bottling system towards an aligned vision, which we have. And as I said, we've got three years that we've accomplished that and seven years to go and we're confident that we can continue to accomplish it. +As we move through the system, you've already heard us talk about what we see, envisage for the US system, where we have a role again for bottling partners. We are on -- we still have the same time table for that. I won't repeat what the time table was. We said about four to five years since the time we closed the transaction. And you can figure we're still -- we still believe that is doable. And as we move along different parts of the world, you see us creating stronger systems, like Brazil, stronger systems like Kanto. That is a huge milestone in the 55-year history of our Japanese business, getting the four Kanto bottlers to unite and to take costs out of the system to be able to continue to invest to drive top line growth for our system. +And you will see us doing more of those as we move forward. And again, refranchising Philippines is another example. So don't think of this as seismic changes in our bottling system. We will continue to fine tune and evolve as needed, as necessary to drive the goals that we have outlined. + +-------------------------------------------------------------------------------- +Ali Dibadj, Sanford C. Bernstein & Co. - Analyst [37] +-------------------------------------------------------------------------------- + + So it's helpful, and I'm still struggling with what's -- what can we look forward to changes in terms of not being as reactionary, but maybe thinking going forward. Maybe if you can help me, you mentioned the US and Steve mentioned it a little while ago, so it's been about two years since you closed the CC North America transaction. +Can you give us a sense of where you think you are ahead of plan and where you are behind plan? Certainly for many investors, this quarter was probably pleasing, because operating margins start in reflect positively, but is this sustainable without any more meaningful restructuring, bigger things? And how do you think about the volume trends we've been seeing so far in sparkling and whether that changes anything about how you think -- not reactionary -- but going forward about the structure here, as just another example of what you're describing, Muhtar? + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Company - Chairman and CEO [38] +-------------------------------------------------------------------------------- + + First, let me just say that everything we're doing, none of it is reactionary. It's proactive, whether it's Brazil, whether it's Philippines, whether it's Japan, and we've got more to talk about that we're not in a position to talk about right now. All of that is actually proactive. And the US is all about proactive. +And I can tell you very clearly, once again, that as I mentioned in Judy's question, judge us not only by the leaders, judge us also by the transactions, judge us by how we are doing in terms of the value of the business that we are creating and the consumer spend that's coming into our business, into our brand and the health of our brands. This is ultimately a brand business. Our brands are healthier than they have ever been, both in sparkling, as well as in still beverages. So I think that we see -- I repeat, we see opportunities in the United States for it to keep growing and also for us to keep generating value in both sparkling and in still beverages. And that's how we see it and whatever it takes for us to be able -- investment, proactive long-term investment is the key. Whatever it takes for us to be able to continue our targeted, thoughtful, purposeful investments, you will see us continuing to do that so that our brands remain healthy, our system remains nimble, and flexible, as far as throughout the market, as far as production and as far as distribution and sales. + +-------------------------------------------------------------------------------- +Ali Dibadj, Sanford C. Bernstein & Co. - Analyst [39] +-------------------------------------------------------------------------------- + + Thanks. + +-------------------------------------------------------------------------------- +Operator [40] +-------------------------------------------------------------------------------- + + Bryan Spillane, Bank of America. + +-------------------------------------------------------------------------------- +Bryan Spillane, BofA Merrill Lynch - Analyst [41] +-------------------------------------------------------------------------------- + + Hi, good morning. I've got a question on the, just the productivity program, just really looking for an update. First, I think if you took the two elements of it, both what was initially announced last year plus the extension of the CCR integration, your expectation was $550 million to $650 million of annualized savings by the end of 2015. So is that still the same size or has there been any change to what you're expecting in terms of total savings? + +-------------------------------------------------------------------------------- +Gary Fayard, The Coca-Cola Company - CFO [42] +-------------------------------------------------------------------------------- + + Brian, this is Gary. No, no changes at all. We -- you're exactly right. What we announced the beginning of last year in productivity and reinvestment was $550 million to $650 million for total company, including North America. We are still on track. In fact, well on track on that program. It was a 2012 through 2015 program and we are continuing to execute against that. +We're on track. We are taking the savings and from the supply chain optimization, the marketing effectiveness, operational excellence, data and IT systems standardization were the areas of that whole program, in addition to what we're doing in CCR, and we're taking that and reinvesting behind innovation, as well as marketing of our brands and that's still working well. What we talked about in North America today is just a normal part and evolution of that program and we'll continue to do that around the world to drive effectiveness, because it really helps us in several different ways. It's not only about saving money. It's about operating more effectively so we can operate faster. Being more productive means we can make decisions quicker, and those are the things we are driving for. We want to be fast, flexible and very big. + +-------------------------------------------------------------------------------- +Bryan Spillane, BofA Merrill Lynch - Analyst [43] +-------------------------------------------------------------------------------- + + How much did it drive -- how much savings did you drive in 2012? + +-------------------------------------------------------------------------------- +Gary Fayard, The Coca-Cola Company - CFO [44] +-------------------------------------------------------------------------------- + + Outside of North America, we probably had about $40 million to $50 million in savings in 2012, and then North America continues to drive synergies and did fairly well against their part of their targets as well. + +-------------------------------------------------------------------------------- +Bryan Spillane, BofA Merrill Lynch - Analyst [45] +-------------------------------------------------------------------------------- + + Fair to say you think '13 will be a bigger aggregate pull to savings to spend back than you had in '12? + +-------------------------------------------------------------------------------- +Gary Fayard, The Coca-Cola Company - CFO [46] +-------------------------------------------------------------------------------- + + Yes, it will be. It will be. + +-------------------------------------------------------------------------------- +Bryan Spillane, BofA Merrill Lynch - Analyst [47] +-------------------------------------------------------------------------------- + + Okay, and then just one last one. How much in terms of charges are you expecting to take over the life of the plan relative to the savings? + +-------------------------------------------------------------------------------- +Gary Fayard, The Coca-Cola Company - CFO [48] +-------------------------------------------------------------------------------- + + Let me, Brian, answer it this way, because as we continue -- I'll continue to update you on where we are and how big the plan is. So let's call it $550 million to $650 million today, but as you know, a few years ago, we had another program as well that we kind of concluded and then started this one. So we continue to look for efficiencies and effectiveness. But everything we look at when we evaluate it, we would expect that the one-time costs ought to be in a ratio no more than 1 to 1.5 to 1 payback. So you're talking about a 12 to 18-month payback on something that's then continuous benefit to the P&L going forward. + +-------------------------------------------------------------------------------- +Bryan Spillane, BofA Merrill Lynch - Analyst [49] +-------------------------------------------------------------------------------- + + Okay. That's helpful. Thanks, Gary. + +-------------------------------------------------------------------------------- +Gary Fayard, The Coca-Cola Company - CFO [50] +-------------------------------------------------------------------------------- + + Okay, great. Thanks, Brian. + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Company - Chairman and CEO [51] +-------------------------------------------------------------------------------- + + Thank you, Gary, Ahmet, Steve, Irial and Jackson. In closing, we had a strong 2012 and have once again delivered quality full-year performance results. Our business continues to grow, even in the midst of ongoing global economic challenges. Our system is aligned. And it's on track to achieve our 2020 vision. +Together, we are consistently investing in our brands on a global scale through world class marketing and commercial strategy. And as we get closer to the midpoint of our 2020 vision, our system remains resolutely focused on refreshing our consumers, creating value for our customers, maintaining strong partnerships with our bottling partners, strategically investing for the future, and expanding shareholder value. As always, we thank you for your interest and your investment in our company and for joining us this morning. + +-------------------------------------------------------------------------------- +Operator [52] +-------------------------------------------------------------------------------- + + Thank you for participating in today's conference call with the Coca-Cola Company. Audio playback is available via the Company's website, thecoca-colacompany.com. You may all now disconnect. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/exam/original-files/Problem_2_3_Sample_full_transcripts/2013-Feb-27-TGT.N-139792946792-Transcript.txt b/exam/original-files/Problem_2_3_Sample_full_transcripts/2013-Feb-27-TGT.N-139792946792-Transcript.txt new file mode 100644 index 0000000..a3ca531 --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_full_transcripts/2013-Feb-27-TGT.N-139792946792-Transcript.txt @@ -0,0 +1,470 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q4 2012 Target Corporation Earnings Conference Call +02/27/2013 09:30 AM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * John Mulligan + Target Corp - EVP, CFO + * Kathee Tesija + Target Corp - EVP, Merchandising + * Gregg Steinhafel + Target Corp - President & CEO + +================================================================================ +Conference Call Participiants +================================================================================ + + * Bob Drbul + Barclays Capital - Analyst + * Dan Binder + Jefferies & Company - Analyst + * Peter Benedict + Robert W. Baird & Company, Inc. - Analyst + * Greg Melich + ISI Group - Analyst + * Mark Wiltamuth + Morgan Stanley - Analyst + * Sean Naughton + Piper Jaffray - Analyst + +================================================================================ +Presentation +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Ladies and gentlemen, thank you for standing by. Welcome to Target Corporation's fourth quarter earnings conference call. During the presentation, all participants will be in a listen-only mode. Afterwards, you will be invited to participate in the question-and-answer session. +(Operator Instructions) + As a reminder, this conference is being recorded Wednesday, February 27, 2013. I would now like to turn the conference over to Mr. Gregg Steinhafel, President and Chief Executive Officer. Please go ahead, sir. + +-------------------------------------------------------------------------------- +Gregg Steinhafel, Target Corp - President & CEO [2] +-------------------------------------------------------------------------------- + + Good morning, and welcome to our 2012 fourth quarter earnings conference call. On the line with me today are Kathee Tesija, Executive Vice President of Merchandising, and John Mulligan, Executive Vice President and Chief Financial Officer. This morning, I'll provide a high level summary of our fourth quarter and full-year 2012 results and strategic priorities as we enter 2013. Then Kathee will discuss category results, guest insights and upcoming initiatives. And finally, John will provide more detail on our financial performance, along with our outlook for 2013. Following John's remarks, we'll open the phone lines for a Q&A session. +As a reminder, we're joined on this conference call by investors and others who are listening to our comments today via webcast. Following this conference call, John Hulbert and John Mulligan will be available throughout the day to answer any follow-up questions you may have. Also, as a reminder, any forward-looking statements that we make this morning are subject to risks and uncertainties, the most important of which are described in our SEC filings. Finally, in these remarks we refer to adjusted earnings per share, which is a non-GAAP financial measure. A reconciliation to our GAAP results is included in this morning's press release posted on our Investor Relations website. +We're very pleased with our fourth quarter financial performance, which reflects outstanding execution by our team during a volatile and promotional holiday season. Our US operations generated fourth quarter adjusted earnings per share of $1.65, 10.1% above last year and in line with our prior guidance, even though sales fell short of our expectations. Our fourth quarter GAAP earnings per share were $1.47, reflecting Canadian segment dilution that was slightly favorable to our expectations. As we previously reported, fourth quarter comparable store sales in our US retail segment grew 0.4%, compared with an expected increase of 2% to 3%. In addition, our holiday season sales became even more concentrated around Black Friday and in the days leading up to and just after the Christmas holiday. This presented challenges for both our merchandising and stores teams, who did an excellent job maintaining profitability, adjusting receipts to mitigate mark down exposure and maintaining outstanding guest service while delivering productivity improvements. +We're very pleased with fourth quarter sales in our digital channels, as online and mobile sales grew faster than industry averages. As a result of our efforts to improve the website throughout 2012, key performance metrics are meaningfully improved, and our mobile sales and traffic are growing at a triple digit pace off a much smaller base. As we described in the past, our investments in the website and mobile technology drive guest engagement with Target and lead them to shop more across all of our channels. For example, following the launch of free wireless in all of our stores in the fourth quarter, Target.com was by far the site most commonly accessed by guests while they were shopping in our stores. As Kathee and John will describe in more detail, our plans for 2013 reflect our ongoing commitment to investing in a robust multi-channel experience for our guests. +Our US credit card segment maintained its long string of outstanding quarterly results, as the portfolio is producing healthy profits in conjunction with very favorable risk metrics. We are working to complete the sale of our portfolio to TD Bank Group and expect the transaction to close in this quarter. John will provide more detail in a few minutes. +When we step back and view the year just ended, we are proud of the ambitious strategic agenda and financial results we delivered. Beyond our multi-channel initiatives and significant work in Canada to prepare for this year's openings, we're very pleased with initial performance of our first five City Target stores, where we're seeing robust sales and traffic, as well as favorable payroll expense and gross margin mix. And we're thrilled that our efforts on this unique urban format were recognized earlier this month, when Fast Company magazine ranked Target among its top 10 most innovative companies. As we continue to hone the operational model for City Target, we will apply what we learn across all of our formats in the US and Canada. +In our Canadian segment, preparations for our market launch are reaching their peak. We expect to open our first 24 Canadian stores by early April; and after more than two years of effort, our Target Canada team is eager to welcome their first guests and begin generating sales. The former Zellers sites are being completely transformed into a brand new Target stores that look terrific and feature our latest thinking in terms of layout, fixtures and design. For the year, we expect to open 124 Canadian Target stores in five waves before the Christmas holiday season. This ambitious launch has required the team to be both nimble and disciplined, setting an outstanding example for the entire organization. +In addition to Canadian store openings, we're planning to open 15 to 20 new stores in the US this year, including three additional City Targets. Net of closings and relocations, we expect these openings will add 10 to 15 new locations to the chain. Combining these expected US store openings with our Canadian expansion plans, we expect to open many more new stores this year than any other year in our history. Also, in keeping with our commitment to invest in our existing stores, we plan to remodel just over 100 of our stores in 2013. This is a more moderate pace than in each of the past three years, as the majority of our stores now reflect our newly reinvented general merchandise format. This layout is much more appealing to our guests and incorporates a deeper food assortment, merchandise reinventions across the store, and a more visually compelling shopping environment. +As we enter 2013, we will plan appropriately, as the US economy is growing at a painfully slow rate and unemployment remains persistently high. While there are some encouraging signs in the housing market, volatility in consumer confidence, the payroll tax increase, and rise in the price of gas all present incremental headwinds. Given these new challenges facing an already sluggish economy, we have a tempered view of the near-term sales environment. However, as we have seen in the past, our guests are quite resilient. We will be vigilant in monitoring our business, and our teams will be ready to capitalize on unexpected strength, as they demonstrated in the first quarter last year. +We believe that we are well positioned to succeed, even in this uncertain environment. We'll focus on providing unbeatable value and back up that commitment with our newly enhanced price match policy, which now covers offers from key online competitors year round. We're also committed to taking smart risks on bold innovative ideas and learning quickly from the results. We'll raise the bar in differentiation, providing our guests unique products and experiences at affordable prices. And as Kathee will outline in more detail, we will continue to partner with designers on unique collections that embody the Expect More side of our brand promise and remind guests why Target is special. +In addition to investments in our stores, website, and award winning mobile apps, Target REDcards provide a key platform for our loyalty initiatives. We are seeing continued strong growth in the penetration of sales on these cards, as REDcard guests respond to the opportunity to save 5% on practically every purchase, receive free shipping every time they shop on Target.com, and benefit from an extended return policy. +As I reflect on 2012, I'm incredibly proud of what the Target team has accomplished. As John will outline in a few minutes, we performed very well against all of our financial goals for the year, keeping us on track to attain our long range financial objectives, despite a challenging environment. Beyond these financial goals, a year ago we had an ambitious list of priorities for 2012, including improving the performance of Target.com following our platform relaunch in 2011; an unprecedented effort required in Canada to finish three distribution centers, begin renovating stores, build an IT solution, and hire thousands of Canadian team members; launching a completely new urban format with our first five City Targets; finding the right partner to purchase our credit card receivables assets on appropriate financial terms; and transitioning two key positions on our executive management team. While this was a bold agenda, our team embraced it and emerged from the year with more energy than ever. As I mentioned we made meaningful progress on the website, City Target is an operational and financial success, Canada is on track, and we're on the verge of closing the sale of our credit card receivables. And importantly, we've added two outstanding members to our executive management team in Jeff Jones and John Mulligan. +The challenges facing us in the year ahead are more short-term in nature, and I'm confident in the clarity of our strategy, the power of our brand, and the strength and commitment of our talented team to achieve our goals and deliver another year of outstanding results in 2013. In other words, we are quite optimistic about our ability to successfully compete in a dynamic retail environment, while generating meaningful shareholder value over time. +Now, Kathee will provide more detail on our fourth quarter results and outline initiatives for the first quarter and beyond. Kathee? + +-------------------------------------------------------------------------------- +Kathee Tesija, Target Corp - EVP, Merchandising [3] +-------------------------------------------------------------------------------- + + Thanks, Gregg. Though we fell short of our overall sales goal for the fourth quarter, we were pleased that we grew comparable store sales in four of our five merchandising categories and that we sustained our profitability in the face of choppy consumer spending and an intensely competitive environment. Consistent with the rest of the year, fourth quarter comparable store sales were strongest in our less discretionary frequency businesses, which saw growth in the low to mid-single digits. In both of our discretionary Home and Apparel categories, fourth quarter comparable store sales increased in line with the Company average and saw rapid growth in our digital channels. Fourth quarter comparable store sales in hard lines declined in the mid-single-digit range and were softest in Electronics. Many more electronics categories are in mature stages of the product cycle; and during the holiday season, electronics constitutes the primary battleground where competitors engage in their most irrational promotions. In Toys, overall fourth quarter comparable store sales were down slightly overall, but increased about 30% through our digital channels. +When we look back at our 2012 results, we're pleased that we also grew full-year comparable store sales in both Home and Apparel, while research indicated that our guests were focused on reducing discretionary spending overall. We achieved this outcome by gaining meaningful wallet share from our best guests, and our loyalty initiatives played a key role through three separate programs in 2012. First, our PFresh remodel program is designed to drive more trips among our core guests by offering them more convenience and the ability to do more of their shopping in a store layout they love. Second, our 5% REDcard Rewards program let our guests, regardless of their previous level of engagement, to increase their shopping frequency and spending dramatically. Our research shows that on average, REDcard guests shop almost two times more per month than guests without a REDcard. And these guests shop 2.5 more departments per visit compared with non-REDcard guests. +Finally, our newest loyalty program, Pharmacy Rewards, saw phenomenal success in 2012. Pharmacy guests are already among our best guests, shopping about three times more often than a non-pharmacy guest. However, Pharmacy Rewards guests are even more valuable, shopping, on average, more than 50% more often than our already valuable pharmacy guests. Notably, these programs complement one another, driving even stronger guest loyalty and incremental sales. For instance, guests participating in both 5% Rewards and Pharmacy Rewards shop more often and spend more across the store than guests who participate in only one of these programs. Throughout 2013 and beyond, we will explore ways to extend these programs and find new ways to drive guest engagement, traffic and sales. +As Gregg mentioned, fourth quarter sales grew in our digital channels was quite strong, having accelerated throughout the year, as we improved site stability and speed while enhancing search and navigation. These investments are clearly driving higher overall guest satisfaction; and with our continued focus on expanded content and site functionality, we expect continued improvement in 2013. We're also seeing amazing growth in traffic and sales through our mobile platforms. Mobile purchases now constitute more than 7% of our digital sales and mobile traffic is now more than 25% of our overall digital traffic. Guests are responding to the significant enhancements we made to our mobile offering in 2012, including improved design and navigation, becoming one of the first retailers to participate in Apple's Passbook, and rolling out a wayfinding pilot in select stores. +As mobile continues to grow in importance, we will focus on creating in-store guest experiences and testing new technologies that make smart phones an even more useful shopping companion, with enhanced mobile product search, maps and shopping lists. We are also exploring ways to integrate relevant product offers and promotions with the in-store mobile shopping experience. And of course, as a member of MCX, the Merchant Customer Exchange, we're involved a collaborative effort among a broad group of top US merchants to develop a mobile payment system that's widely accepted, secure, and easy and convenient for our guests to use. +In 2013, we're planning to increase our investment in technology and supply chain to enhance our multi-channel capabilities. We will apply a test-and-learn approach to discover what our guests value most, while assessing the impact on our operations. Our goal is to leverage existing assets to enable more flexible fulfillment of our guests' shopping needs in a way that makes sense, both operationally and financially. In 2012, through small pilots in the Twin Cities and San Francisco, we plan to test the ability for guests to pay online and pick up in-store, the ability for guests to pay in one store and pick up at another store, and the ability to pay online and have items shipped from a store, including the option for same-day delivery. We believe these tests will provide valuable information, as we continue to shape our multi-channel strategies. Ultimately, we expect to evolve towards more integration across our inventory and supply chain, in which our stores, regional distribution centers and web fulfillment centers all interact seamlessly to satisfy guests' wants and needs through all our channels. +After improving gradually in 2012, consumer sentiment fell sharply in the fourth quarter, reflecting turmoil surrounding the fiscal cliff and overall political uncertainty. In addition, more than 50% of US consumers believe that the economy will either remain the same or get worse in 2013, and 85% indicate they expect the economy to impact their lifestyle for the next several years. Beyond these potential headwinds to consumer spending, the average US household will see a $1,000 reduction in their after-tax income as a result of the recent increase in payroll tax rates. However, even in this challenging environment, we expect to win by strengthening guest loyalty and driving increased sales through merchandising that supports both sides of our Expect More, Pay Less brand promise. We'll continue to match prices on identical items offered by both store-based and online competitors. And we'll offer guests affordable products and experiences that allow them to treat themselves and their families, while staying within their budgets. +For example, in Apparel we're very pleased with the response to our current designer partnership, Prabal Gurung for Target. Prabal is one of the most celebrated designers in the fashion industry, and this collection embodies his signature style and design aesthetic, all at affordable prices. The Prabal Gurung for Target collection features ready-to-wear, handbags, shoes and jewelry that provide key differentiation for Target this spring. +We're also very pleased with the response to our partnership with Sports Illustrated and their swimsuit issue. As you know, spring swim wear is already a signature business for Target. Through this collaboration, Sports Illustrated is creating its first style guide, which will feature original content from the publication's esteemed editorial team specifically geared towards their female readers. This partnership reinforces Target as a swim wear destination by allowing us to reach a unique audience with our on trend, affordable offering. +Also this spring, Target is collaborating with Kate Young, one of the most influential stylists in the fashion industry, to introduce a limited edition collection of women's apparel, accessories and shoes. We've worked with Kate as a stylist for years, but for this project she took on the role of designer, translating her unique aesthetic and ability to create memorable red carpet moments into a standout collection for women. The Kate Young for Target collection will be available beginning April 14 at all Target stores and Target.com. +In Home, we continue to build on the success of the Nate Berkus collection, which launched last fall. This collection includes more than 150 home products, with prices ranging from $6 to $150, featuring stylish and relatable pieces that feel like they were collected over time and designed to be easily layered into existing decor. We'll be adding new items to this ongoing collection in 2013. And throughout the spring, we'll continue to roll out our Threshold brand to replace Target Home. Initial results from this brand launch have been favorable, as guests respond to this fully redesigned, high quality collection that's inspiring guests to update their homes. +In Entertainment, we're following up our very successful fourth quarter partnership with Bruno Mars and One Direction with an exclusive version of Josh Groban's new album, All That Echoes, which launched February 5. And we were very excited to announce our latest partnership with Justin Timberlake during the Grammy awards earlier this month. Target will offer an exclusive version of Justin's latest release, The 20/20 Experience, featuring two exclusive tracks, available at Target and Target.com beginning March 19. +In Electronics, we continue to focus on service as a value added differentiator for our guests. In the fourth quarter, we announced that we would be ending our current relationship with RadioShack in our mobile phone business and would begin working with Brightstar to provide supply chain and point-of-sale activation, and Market Source as our new in-store labor partner. This change demonstrates our continued commitment to mobile as a key element of our Electronics offering, and we believe it will enhance Target's position in the wireless retail marketplace. This transition will occur in early April. Also as you know, last October we launched a test with Geek Squad to provide in-store service agents in 20 Denver Target stores. Based on positive feedback from our guests, Target expanded this test by offering Geek Squad service and replacement plans in 20 stores in Kansas City, beginning February 17. Future partnership plans will be determined following the results of these tests. +And finally, our Beauty category continues to experience very strong and consistent growth on an assortment that generates better than average profitability while serving as a key differentiator for Target. As you know, last year we began testing a store service program, in which dedicated consultants offer friendly guidance and expertise for guests shopping our Beauty area. Based on 2012 results in 28 Chicago area test stores, we are looking to expand this program to additional markets in 2013 and beyond. +While we remain cautious about the economy and its impact on consumer spending, we are confident in our brand, our strategy, and our merchandising and marketing plans. We believe we offer an unbeatable balance of value and excitement, on both wants and needs, that continues to drive guest loyalty and engagement with Target. +Now, John will share his insights on the fourth quarter and full-year performance, and outlook for 2013. John? + +-------------------------------------------------------------------------------- +John Mulligan, Target Corp - EVP, CFO [4] +-------------------------------------------------------------------------------- + + Thanks, Kathee. As Gregg mentioned, we're very pleased with the performance of our business, particularly in the face of an intense holiday season promotional environment. Our fourth quarter adjusted EPS of $1.65 is 10.1% above last year and reflects solid performance in our US retail segment, combined with continued outstanding performance in our US Credit Card segment. Fourth quarter GAAP EPS was $1.47, $0.02 above last year, as growth in adjusted EPS was offset by Canadian segment dilution. +Before I provide more detail on our fourth quarter performance and our outlook for 2013, I want to pause briefly to recap our full-year 2012 performance. One year ago, in my first quarterly call with all of you, I explained our plans which would keep us on track to attain our long range financial plan of generating $8.00 or more in EPS on $100 billion or more in sales in 2017. That 2012 plan was based on the following expectations across our three segments. US comp store sales growth of 3% or more; continuation of our very healthy US retail EBITDA and EBIT margin rates of 10% and 7%, with a moderate decline in our gross margin rate offset by leverage in SG&A and D&A; an increase of REDcard penetration of 300 basis points or more throughout the year; a decline in the size of our credit card portfolio of $500 million or more, with a portfolio spread to LIBOR of 7% or better; and about $0.50 of EPS dilution related to our Canadian market launch. I also outlined that in 2012, we expected to invest a total of about $3.3 billion, between the US and Canada; continue our uninterrupted record of paying quarterly dividends; increase the annual dividend during the year; and invest $1.5 billion or more to repurchase our shares. All together, these expectations combined to an expected range of $4.55 to $4.75 in 2012 adjusted EPS, and an expected GAAP EPS range of $4.05 to $4.25, reflecting expected Canadian dilution. +Today, when you compare our actual 2012 performance against all of these metrics, you'll see we met or exceeded all of them, except for US same-store sales, which we missed by three tenths of a point. All together, we earned full-year 2012 adjusted EPS of $4.76, above the range going into the year. GAAP EPS ended up well above its expected range, reflecting adjusted EPS performance, lower than expected dilution in Canada, and the gain we recognized on our credit card receivables held for sale. This gain reflected the attainment of another one of our goals, to reach an agreement to sell the receivables portfolio to the right partner on appropriate terms. I want to thank the entire Target team for their contributions to the achievements of our strategic and financial goals in 2012, a remarkable accomplishment, particularly in light of the environment we faced. +In the call a year ago, both Gregg and I outlined that our expectations for US retail segment sales were stronger in the first three quarters of 2012 and more modest in the fourth quarter. It's clear that we got the cadence right, but the contrast between the first three quarters and the holiday season was even more pronounced than we expected. With that as context, let's turn to the specifics of our fourth quarter segment results. +In the US Retail segment, fourth quarter comparable store sales increased 0.4%, driven by a 1.4% increase in average ticket, which offset a 1% decline in comparable store transactions. As we mentioned several times throughout 2012, our fourth quarter retail strategy was focused on providing relevant offers to core guests, profitably growing sales and market share from guests who want to shop with us all year long. We believe this strategy was effective, because despite softer than expected sales, our teams managed the business effectively and Retail profitability held up remarkably well. Our fourth quarter gross margin rate was about 60 basis points below last year, reflecting the ongoing impact of 5% Rewards and our remodel program, combined with clearance mark downs on seasonal inventory. +In the fourth quarter, our team managed SG&A expense incredibly well, leading to a small amount of rate leverage. This is something we generally wouldn't expect on a 0.4% comp, particularly when our sales plan for the quarter was higher. This performance is even more noteworthy, because we were able to offset incremental expenses related to technology investments in multi-channel and other initiatives. This pressure was offset by continued expense discipline across the organization; and once again, our Stores team was able to generate meaningful productivity improvements, while providing great guest service. We also experienced fourth quarter leverage on the depreciation and amortization expense line, reflecting the moderate pace of US capital investment in recent years, combined with the benefit from the 53rd week of sales in this fiscal year. +In our US Credit Card segment, performance in the fourth quarter was outstanding once again. Portfolio spread to LIBOR was $30 million higher than last year, a 27% increase, even though average receivables were more than 4% lower than a year ago. Portfolio profitability continues to benefit from historically low delinquency and write-off rates that continue to improve. I want to thank our Financial Services team. The quality of our receivables portfolio reflects their dedication and effort in managing through a recession and credit crisis worse than many of us thought possible. The superior performance and profitability of this asset enabled us to reach a sale and servicing agreement with TD Bank, a premier financial institution that shares our goals for portfolio growth and profitability. +In our Canadian segment, we're pleased with the plans we have in place and we're on track to open our first 24 stores this quarter. In the fourth quarter, we recorded expenses related to investments in technology, supply chain, store renovations and the team, as we continue to ramp up our efforts to open more stores in Canada in 2013 than any single year of US store openings in our history. These activities drove $118 million of SG&A expense in the fourth quarter which, along with D&A and interest expense associated with the segment, reduced our fourth quarter GAAP EPS by $0.18. +Even as we prepare for peak Canada capital investment in 2013, our business continues to generate ample cash to allow us to fund investments in our business, support the dividend and engage in share repurchase. In the fourth quarter, we invested about $645 million to retire more than 10.4 million shares. This means that, combined with the dividend, we returned nearly $900 million to our shareholders in the fourth quarter, representing more than 90% of net earnings. +Now let's turn our attention to our plans for 2013. This year will clearly be a year of transition, which will result in some unique dynamics in our P&L. First, when we close the receivables sale with TD Bank Group, we will recognize non-recurring accounting items related to the sale and discontinue reporting our US Credit Card segment. At the same time, in the US Retail segment, we will begin recognizing income from profit sharing, net of account servicing costs, as an offset to SG&A expense. On an annualized basis, we expect this change will reduce our US Retail segment SG&A rate by about 30 basis points, leading to an equivalent increase in our US Retail segment EBITDA and EBIT margin rates. Of course, the impact of full-year 2013 will be less than this annualized impact. The fiscal year has already begun and we have not yet closed the transaction. +One housekeeping note. My guidance today will compare against last year's financial results, which included separate Retail and Credit Card segments. Once we have closed the receivables sale, we will report performance of a single US segment and compare against restated prior-year results, which combine the results from the former US Credit Card segment and US Retail segment. To provide clarity on these restated comparisons, after the sale closes, we plan to furnish three years of quarterly restated US segment results. While we don't have a definite closing date, we're confident it will occur before the end of the first quarter. Second, in the Canadian segment, we expect to transition from recording meaningful quarterly dilution in the year to recognizing accretion by the fourth quarter. +And finally, I need to briefly discuss a geography change on our US Retail segment P&L that will influence gross margin and SG&A expense rates in 2013. Beginning this year, we've made changes to our vendor agreements regarding payments received in support of our marketing programs. As a result, beginning in fiscal 2013, these payments will be accounted for as a reduction in our cost of sales rather than a reduction to SG&A expense. This change will create equivalent year-over-year increases in both our gross margin and SG&A expense rates of 20 to 25 basis points, without affecting our US retail EBITDA and EBIT margin rates. So as you can see, we have a lot of changes that will create some noise in our numbers throughout the year. +With that context, let's begin with a look at our 2013 expectations for our US Retail segment. As Gregg mentioned, we are ending the year with a cautious view, in light of heightened economic uncertainty in which challenged consumers are now facing additional pressures, including rapidly rising gas prices and a payroll tax increases. We're planning full year 2013 comparable store sales to grow in line with our 2012 rate of 2.7%. This growth will be combined with a moderate benefit from new square footage and offset by the comparison against this year's 53rd week, meaning total sales are expected to grow about 2%. We expect a slightly higher US retail gross margin rate, reflecting the vendor payment geography shift I mentioned above, combined with category rate improvements which should offset ongoing pressure from 5% Rewards and our remodel program. +We also expect to see a slight improvement in our US Retail SG&A expense rate for the full year. This expectation reflects continued discipline throughout the organization, along with the benefit from credit card profit-sharing, which will offset the geography shift in vendor payments, and continued pressure from investments in technology and supply chain, including multi-channel. Those investments are expected to be worth $0.20 to $0.25 of EPS in 2013. All together, we expect a 2013 US Retail segment EBITDA margin rate in the range of 10.3%, and an expansion of the US retail segment EBIT margin rate to around 7.5%, reflecting very healthy underlying performance combined with the impact of the receivables transaction I discussed earlier. +We expect to invest about $2.3 billion in the US in 2013. While that amount is in line with our US capital investment in 2011 and 2012, the mix continues to shift toward investments beyond our stores. In fact, for 2013, the sum of our US investments in supply chain and technology, including multi-channel, will likely be as high as our investments in new stores and remodels. +In the US Credit Card segment, we expect the portfolio to continue to slowly decline in size until it stabilizes at between $5.5 billion and $6 billion. We expect the portfolio will continue to generate outstanding profitability, both before and after it is sold to TD Bank Group, and we expect delinquencies and write-offs to stabilize near current, historically low levels. As I mentioned before we continue to expect to close the deal before the end of the first quarter, causing GAAP EPS to reflect some one-time items, including a gain on sale and the recording of a beneficial interest receivable on our balance sheet. We posted a document outlining those expected impacts last October when we announced the agreement, and it's still available on the website. If you have additional questions about these one-time items, John Hulbert and I would be happy to discuss them with you after this call. +Beyond expected one-time items that we'll exclude from our adjusted EPS measure, we continue to expect the transaction will reduce our adjusted EPS by about $0.10 in the 12 months following the closing, compared with the scenario in which we kept the portfolio. This impact reflects the sharing of a portion of the portfolio profits with TD, partially offset by the benefit of reduced interest expense and lower share count as we deploy proceeds from the sale. We expect to provide more color on the impact of the sale once the closing date for the transaction is known. +Turning to the Canadian segment, as we've discussed with many of you, the sites we obtained in the Zellers deal were extremely well located, with very attractive leases, were notably smaller than stores we open in the US, and in very poor physical condition. As a result, when we announced the Zellers deal, we indicated that we expected to invest $10 million to $11 million per existing building to make them into brand-new Target stores. Also at the time, we indicated that were working with Canadian landlords to understand which of those sites might have adjacent open space and whether we would have an opportunity to invest capital in an expansion, when it made financial sense. As a result of these discussions, I'm happy to tell you that of the 124 stores we expect to open in 2013, we have decided to expand 40 sites beyond the space they occupied as Zellers stores, creating more than 600,000 square feet of incremental retail selling space. For each expansion, we've made a separate underwriting decision in which we measured the added investment against incremental the cash flow we believe a larger building will generate. All in, we expect to invest about $1.5 billion of capital in the Canadian segment in 2013, as we complete renovations and expansions for this year's openers and begin work on an additional stores to open in 2014. +In 2013, we expect Canadian segment to generate approximately $0.45 of dilution to our GAAP EPS, as the cost to open and operate Canadian stores, along with the depreciation related to our capital investments, offsets the profitability we generate from the locations after they open. Dilution is expected to exceed $0.45 through the first three quarters, after which we expect the segment to contribute several cents of positive GAAP EPS in the fourth quarter. +Even with total 2013 capital investment close to $4 billion, we expect to return meaningful amounts of capital to shareholders. Specifically, we expect to continue our uninterrupted record of paying a quarterly dividends, and we will recommend that our Board approve another increase to the annual dividend later in the year. In addition, in 2013 we expect to be able to invest another $1.5 billion or so in share repurchase, beyond the $600 million or more we expect to invest in share repurchase as a result of the receivables sale. +Finally, we expect our 2013 effective tax rate to be in the range of 35.7% to 36.7%. All together, these expectations lead to a full year 2013 adjusted EPS in the range of $4.85 to $5.05. Many of you will note that the center point of this range would put us slightly below the smooth path to attaining our long range financial plan in the US. This reflects the fact that 2013 is indeed a year of transition, including an expected $0.08 to $0.09 of near-term dilution to adjusted EPS from the receivables sale that should [achieve] neutrality and ultimately accretion over the next few years. We remain fully committed and on track to attain our long range financial plan of $8.00 or more in earnings per share in 2017. For full-year 2013, we expect full-year GAAP EPS will be about $0.15 lower than adjusted EPS, reflecting $0.45 of dilution related to our Canadian segment offset by one-time accounting impacts of the receivables sale. +Let's turn, finally, to our expectations for the quarter. In the US Retail segment, as you know, in addition to economic uncertainty, we face a tough comparison due to exceptionally strong sales we delivered in the first quarter last year. As a result, we expect to generate first quarter comparable store sales growth of 0% to 2% in the US. Like some others have reported, sales results have been softer than expected so far in February and daily volatility has been elevated. Yet trends have improved somewhat as the month has progressed, and it's still early in the quarter, so we believe our guidance is appropriate. +In the US Retail segment, we expect our first quarter EBITDA margin rate to be somewhat higher than last year, driven by improvements in both our gross margin and SG&A expense rates. Our gross margin forecast anticipates category rate improvements, combined with the impact of the vendor payment geography shift, which are expected to offset ongoing pressure from 5% Rewards and our store remodel program. Our SG&A forecast anticipates continued expense discipline throughout the organization, combined with the impact of a receivables portfolio profit-sharing, which we expect to offset vendor payment geography and continued pressure from our multi-channel investments. We also expect some leverage on D&A compared with last year. Together these expectations for our US Retail segment lead to expected first quarter adjusted EPS of $1.10 to $1.20. +Looking to Canada, we expect that the first quarter will mark the peak of dilution attributable to this segment, at about $0.23. However, this is expected to be more than offset by accounting gains from the receivables sale, leading to an expectation of first quarter GAAP EPS in the range of $1.22 to $1.32. +One comment on the expected cadence of US sales throughout 2013. In our first quarter outlook, we obviously expect comparable-store sales growth to strengthen later in the year, namely in the second and third quarters. Like last year, we have an appropriately tempered view of fourth quarter sales. +As I mentioned earlier, 2013 will be a transition year, not just for our P&L, but for our capital plan as well, as we expect peak investment in Canada, the mix of our US capital investment to move increasingly into technology and distribution in support of our multi-channel strategy, and we divest our credit card receivable assets. Following this year, our current view of 2014 has us fully on or above the path outlined in our long range financial plan, benefiting from Canadian segment accretion and a meaningful increase in the amount of capital available to return to our shareholders through dividends and share repurchase. +With that, I'll turn it back over to Gregg for a few brief closing remarks. + +-------------------------------------------------------------------------------- +Gregg Steinhafel, Target Corp - President & CEO [5] +-------------------------------------------------------------------------------- + + That concludes today's prepared remarks. Now Kathee, John and I will be happy to respond to your questions. + + +================================================================================ +Questions and Answers +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) +Mark Wiltamuth, Morgan Stanley. + +-------------------------------------------------------------------------------- +Mark Wiltamuth, Morgan Stanley - Analyst [2] +-------------------------------------------------------------------------------- + + Could you give us a little outlook on what free cash flow is going to look like once Canada is over, on the $1.5 billion of spend, and where do you expect to deploy that? Is it going to be tilted more towards share repurchase, or how do you look at that? + +-------------------------------------------------------------------------------- +John Mulligan, Target Corp - EVP, CFO [3] +-------------------------------------------------------------------------------- + + Obviously, this year -- 2013 will be peak capital investment in Canada, about $1.5 billion. Next year, going forward, CapEx -- for the US, we'd expect something similar, perhaps growing a little bit, to $2.5 billion, something in that range; Canada dropping to somewhere -- still opening a fair number of stores -- $0.5 billion, perhaps a bit more than that. So we would expect free cash flow to expand, especially in light of Canada operations becoming accretive. As far as what we would intend to do with that, we said first, by 2017, assuming we get to $8.00 a share, we'd expect the dividend to be at $3.00 a share or more. So we'd expect to continue to increase the dividend at a rate approximately 20% on a compound basis over the next several years. And with the constraint of living within our current strong investment grade credit ratings, we'd expect to deploy the remainder of our excess cash flow as share repurchase. + +-------------------------------------------------------------------------------- +Mark Wiltamuth, Morgan Stanley - Analyst [4] +-------------------------------------------------------------------------------- + + Okay. Can you give us a little more color on the Canada dilution of $0.45? I think that's bigger than a lot of people were expecting, and it sounds like a lot of it's related to the capital spending decisions. If you could walk us through that a little bit? + +-------------------------------------------------------------------------------- +John Mulligan, Target Corp - EVP, CFO [5] +-------------------------------------------------------------------------------- + + Yes. I think that's right, Mark. When we look back on where we're at right now with Canada, we feel really good about where we're at and our projections for returns in Canada. If we look back a year ago, or even two years ago when we signed the deal, the projected EBITDA for this quarter -- for this year, excuse me, is essentially right on where we thought it would be. The dilution is a bit higher even than we expected, perhaps a year ago; and all of that is attributable to independent capital investment decisions we've made, whether that's investing in three distribution centers to build them and own them ourselves, or the 40 store expansions that I mentioned that we worked through over the past year. So most of the increase, from our vantage point, is attributable to incremental depreciation and amortization. And of course, those capital investments were separate economic decisions and we expect to see economic benefit to that P&L through time. But the sequencing is that the depreciation and amortization shows up first. + +-------------------------------------------------------------------------------- +Mark Wiltamuth, Morgan Stanley - Analyst [6] +-------------------------------------------------------------------------------- + + Okay. And also, talk about the percent rent clauses in Canada. I know you got out of some of those. + +-------------------------------------------------------------------------------- +John Mulligan, Target Corp - EVP, CFO [7] +-------------------------------------------------------------------------------- + + Yes. The property development team did an outstanding job working with some very good partners, our landlords in Canada. And the vast majority of the percent rent clauses, which of course never impacted Zellers, have been negotiated away. Percent rent is not a meaningful issue for us going forward. + +-------------------------------------------------------------------------------- +Mark Wiltamuth, Morgan Stanley - Analyst [8] +-------------------------------------------------------------------------------- + + Okay. Thank you. + +-------------------------------------------------------------------------------- +Operator [9] +-------------------------------------------------------------------------------- + + Greg Melich, ISI Group. + +-------------------------------------------------------------------------------- +Greg Melich, ISI Group - Analyst [10] +-------------------------------------------------------------------------------- + + I have a couple questions. First, John, on the leverage. Once Credit's gone, we get your debt to EBITDA around 1.7, 1.8. Could you put some context into how high you think that can or should go, given everything in terms of being great credit rating, as you take the dividend out? Should we model 2 as a cap, or how should we think of that? + +-------------------------------------------------------------------------------- +John Mulligan, Target Corp - EVP, CFO [11] +-------------------------------------------------------------------------------- + + I think what I would say, Greg, is right now as we look at the retail business and model that, we've always modeled that independently of the Credit business, given the different leverage characteristics, as you noted. We think the Retail business right now is probably pretty close to the top end. There may be a little bit of room. But we think it's near about where the leverage which will support our current credit rating is at. + +-------------------------------------------------------------------------------- +Greg Melich, ISI Group - Analyst [12] +-------------------------------------------------------------------------------- + + Got it. So the incremental buy back is really the equity from the Credit business? Plus -- + +-------------------------------------------------------------------------------- +John Mulligan, Target Corp - EVP, CFO [13] +-------------------------------------------------------------------------------- + + Correct. For 2013, that's correct. + +-------------------------------------------------------------------------------- +Greg Melich, ISI Group - Analyst [14] +-------------------------------------------------------------------------------- + + And then secondly, maybe a bigger question for Kathee or Gregg, the REDcard growth compared to, say, three years ago has, I think, beaten all of our expectations, certainly mine. It looks like last year it was up over 50%. Could you help us understand a little bit more about that 50% growth in REDcard sales? How much of it is from new REDcard members? How much of it is existing members spending more? Anything you can provide there would be helpful. + +-------------------------------------------------------------------------------- +John Mulligan, Target Corp - EVP, CFO [15] +-------------------------------------------------------------------------------- + + Sure. The increase in REDcard sales is a mix of both, Greg. Certainly, the new accounts are creating a significant amount of that lift, with the amount of accounts. And you can see the increased penetration resulting from new accounts. But we have also seen an increase in lift, particularly over the first several quarters that the REDcard was out, in existing accounts. +The other thing I would mention, the big driver here of the increase in sales, as has been the case, the big driver in increase in the whole program, has been the debit card. And I think from our assumptions, perhaps two or three years ago when we were talking to you to you to now, the debit card is the one that has really surprised us. The credit card has probably grown pretty much with what we thought. But the debit card -- we're doing three accounts to one debit to credit now. And that has been the one -- the product that has been incredibly attractive to consumers who just don't want another credit card. And that's really what has driven the significant increase in our REDcard sales. + +-------------------------------------------------------------------------------- +Gregg Steinhafel, Target Corp - President & CEO [16] +-------------------------------------------------------------------------------- + + The other thing that I would add, Greg, is all of our guest segments love the REDcard somewhat equally, whether you are a VIP, which we would say somebody that visits us a lot and spends a lot, all the way through our enthusiast convenience users least engaged. All of those segments, once they get the REDcard, move toward visiting Target more often and spending more. So this is not just isolated in one group of demographics. It's very well dispersed and balanced. And we think that's a very positive attribute that, that many guest segments love the REDcard. + +-------------------------------------------------------------------------------- +Greg Melich, ISI Group - Analyst [17] +-------------------------------------------------------------------------------- + + That's great. Thanks a lot. + +-------------------------------------------------------------------------------- +Operator [18] +-------------------------------------------------------------------------------- + + Sean Naughton, Piper Jaffray. + +-------------------------------------------------------------------------------- +Sean Naughton, Piper Jaffray - Analyst [19] +-------------------------------------------------------------------------------- + + Maybe just first, John, a clarification question on the $8.00 in EPS for 2017. I think before that was predicated on a 2% or more US annual US store growth. Do you still think that, that's the appropriate number to get to that $7.20 from the US business? + +-------------------------------------------------------------------------------- +John Mulligan, Target Corp - EVP, CFO [20] +-------------------------------------------------------------------------------- + + The actual assumption for the US business was about a 3% comp through time. And some years will be a little bit above that, some years a little bit below that. But we think 3% comp is about the right level for our business. If you look back at our business over a really, really long period of time, back when we were running 5% comps, a couple hundred basis points of that were coming from new stores as they annualized, and we would ran about a 3% comp in our base business. And over the last couple of years, since 2010 -- last year a little bit lower, 2011 right on. We feel like that's the right neighborhood for where we can run the business. + +-------------------------------------------------------------------------------- +Sean Naughton, Piper Jaffray - Analyst [21] +-------------------------------------------------------------------------------- + + Okay. And also on the guidance for this year and thinking about the modeling, sounds like you're opening up a few more waves in Canada than your normal store opening cadence. Just from a modeling perspective, how should we think about some of those store openings this year? And then as a follow-up to the US, how does the real estate development market feel to you guys out there? + +-------------------------------------------------------------------------------- +Gregg Steinhafel, Target Corp - President & CEO [22] +-------------------------------------------------------------------------------- + + Well, typically in the US, we open stores in three cycles. Due to the number of stores we have in Canada, we're taking an approach that we're going to open five cycles this year. So think April, May, and every couple of months beyond that, we're going to open somewhere between 20 and 28 stores a cycle. We haven't defined all of that yet. But we're going to start in the greater Toronto area. Then we're going to move to Western Canada. Then we'll densify. Then we'll go East, and then we'll densify again. So we've got a good plan that is centered around our supply chain investments and the readiness of our distribute centers, and we just think it makes sense to spread out those kinds of openings over more cycles than we typically would do in the US. + +-------------------------------------------------------------------------------- +Sean Naughton, Piper Jaffray - Analyst [23] +-------------------------------------------------------------------------------- + + Okay. + +-------------------------------------------------------------------------------- +Gregg Steinhafel, Target Corp - President & CEO [24] +-------------------------------------------------------------------------------- + + Your other question was -- + +-------------------------------------------------------------------------------- +Sean Naughton, Piper Jaffray - Analyst [25] +-------------------------------------------------------------------------------- + + How does the US real estate development market feel in the US? Does it feel like it's loosening up a little bit, maybe a few more opportunities, or still you guys are holding back a little bit at this point and looking to be a little bit more prudent in the growth? + +-------------------------------------------------------------------------------- +Gregg Steinhafel, Target Corp - President & CEO [26] +-------------------------------------------------------------------------------- + + No. We're not holding back at all. We're not capital constrained, and we're pursuing every project that we can find that's going to generate the right kind of returns. So I would tell you that the real estate -- commercial real estate market is pretty much status quo and hasn't changed all that much over the last couple of years. There are pockets of opportunities, and we're anxious to either co-develop or develop on our own or be a partner in any development where we believe that it's the right demographics and we can generate the right kind of returns. So we're not holding back at all, it's just the environment is still a little cautious and a lot slower than we'd like it to be. And hopefully, things will change over the next couple of years. + +-------------------------------------------------------------------------------- +Sean Naughton, Piper Jaffray - Analyst [27] +-------------------------------------------------------------------------------- + + Okay. Fair enough. Best of luck in Q1. + +-------------------------------------------------------------------------------- +Gregg Steinhafel, Target Corp - President & CEO [28] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Operator [29] +-------------------------------------------------------------------------------- + + Peter Benedict, Robert Baird. + +-------------------------------------------------------------------------------- +Peter Benedict, Robert W. Baird & Company, Inc. - Analyst [30] +-------------------------------------------------------------------------------- + + First question, John, can you give us a sense of what the revenue assumption is that's based into that $0.45 Canada dilution number for this year? + +-------------------------------------------------------------------------------- +John Mulligan, Target Corp - EVP, CFO [31] +-------------------------------------------------------------------------------- + + The revenue number, I would tell you, continues to move around even here, for the reasons Gregg just outlined. We continue to -- the store opening schedules continue to move around. We've only really set in place in concrete the first two. The rest of them, still moving around a little bit. So we're hesitant to provide pretty specific guidance. But what I would tell you is, the expectation is that these stores will open and grow and have a very similar annualization process to what we see in the US. So I think that's probably the most important assumption, and then the revenue will move around based on what stores we get open when. + +-------------------------------------------------------------------------------- +Peter Benedict, Robert W. Baird & Company, Inc. - Analyst [32] +-------------------------------------------------------------------------------- + + Okay. Sure. That's fair enough. +And then, I think in the past you guys have said that you'd expect to recapture the Canadian losses that you accrue within two years of turning profitable. So if you sum up the last three years -- well, the last two years plus this year -- it's a little over $1, maybe $1.10. Do you still expect to get that back in earnings from Canada in '14 and '15, or is the D&A going to make that a longer process? + +-------------------------------------------------------------------------------- +John Mulligan, Target Corp - EVP, CFO [33] +-------------------------------------------------------------------------------- + + I think you hit on it. It'll be a little bit longer. We're not talking about five years or anything like that. But 2.5, three years, something like that, our current modeling would say, we'll get it back in, something like that. So a bit more than two years. + +-------------------------------------------------------------------------------- +Peter Benedict, Robert W. Baird & Company, Inc. - Analyst [34] +-------------------------------------------------------------------------------- + + Okay. Good. Thanks a lot. + +-------------------------------------------------------------------------------- +Operator [35] +-------------------------------------------------------------------------------- + + Bob Drbul, Barclays. + +-------------------------------------------------------------------------------- +Bob Drbul, Barclays Capital - Analyst [36] +-------------------------------------------------------------------------------- + + Just have a question on the fourth quarter in general. Over the past few years, you guys have really made a nice trade-off between profitability and comps. And this year, it seemed to break down a little bit more than usual, where you've made a decision not to be a Black Friday door buster competitor, but the gross margins were down 60 basis points or so. Can you talk a little bit about what you learned from the traffic being down and gross margins being down, and how you might attack it differently in the fourth quarter this year? + +-------------------------------------------------------------------------------- +Kathee Tesija, Target Corp - EVP, Merchandising [37] +-------------------------------------------------------------------------------- + + Bob, I would say that we actually think we performed quite well on Black Friday. We saw the barbell intensify, as Gregg mentioned, between those early sales in Black Friday and then the lull and then coming back strong at the end of the holiday. For us, it was more about pretty weak seasonal businesses. The weather, as you know, was warm. And our seasonal businesses, which normally kick in, in early November, didn't. And then, with all of the, we think, economic turmoil and the elections and fiscal cliff and all of that, that it created that lull in between Black Friday and Christmas. So we've talked about planning conservatively for this past year, and we will again for next year, for the fourth quarter. And we think that the opportunity to pick up sales are really the other three quarters. And in particular, the second and third quarter this year. +We continue to manage our business. Our goal is to maintain or grow gross margins within categories. As you know, it was a very competitive year this year. And what we dropped was mainly reflecting the ongoing impact of 5% Rewards and PFresh, combined with a little higher clearance in some of our seasonal categories. But all in all, I think the team did a great job of managing our inventory. We did come out very clean. Our inventory headed into the first quarter was exactly where it was last year, on a per store basis. So we feel great about that. + +-------------------------------------------------------------------------------- +Gregg Steinhafel, Target Corp - President & CEO [38] +-------------------------------------------------------------------------------- + + The other thing I would add is, you have to take a look at the mix of our business, too. And there was industry softness in Electronics and Toys, which are really important to us. There was not any must-have, really super-hot new products that really drove consumers into the stores. And as others have reported, the Toy business was a little softer than expected. And same was true in Electronics, as we were post-peak in terms of the digital cycles and video game business, in particular, were softer. And that's a huge business for us. +So just the cyclical nature of some of these businesses, in addition to what Kathee said, cause comps to be a little bit softer than we expected. But we are not bashful about being hyper-competitve, and we want to be really super competitive every year as we head into the holiday season. But we also want to have a balanced approach in making sure that it's not all about market share. We want to gain market share, but do so profitably, and trying to find that right mix. And that's the approach we'll continue to take. Okay? + +-------------------------------------------------------------------------------- +Bob Drbul, Barclays Capital - Analyst [39] +-------------------------------------------------------------------------------- + + Yes. Thank you very much. + +-------------------------------------------------------------------------------- +Gregg Steinhafel, Target Corp - President & CEO [40] +-------------------------------------------------------------------------------- + + Thanks, Bob. We have time for one more question. + +-------------------------------------------------------------------------------- +Operator [41] +-------------------------------------------------------------------------------- + + Dan Binder, Jefferies and Company. + +-------------------------------------------------------------------------------- +Dan Binder, Jefferies & Company - Analyst [42] +-------------------------------------------------------------------------------- + + On a similar topic of competition, you obviously introduced the Price Match guarantee. It's a step in the right direction. But given that, that's such a very low portion of the total transactions, do you think you need to do more on just everyday price and staying more competitive than perhaps you even are today? + +-------------------------------------------------------------------------------- +Gregg Steinhafel, Target Corp - President & CEO [43] +-------------------------------------------------------------------------------- + + We're competitive day in and day out. We have always maintained the position that we're going to be competitive in the marketplace. And so it's a position that we've taken. And as we continue to learn more and as more business migrates to the online channels, we're going to continue to sharpen up our online prices in that channel, as well, and be competitive with those competitors that are most meaningful in that channel. So there will be some sharpening up there; but I would tell you, we offer fantastic value, day in and day out. Our pricing strategy has not changed. And as we look across the competitive landscape, we're very, very well-positioned. + +-------------------------------------------------------------------------------- +Dan Binder, Jefferies & Company - Analyst [44] +-------------------------------------------------------------------------------- + + Okay. Just one more, if I could. Can you just walk us through the path to $0.10 dilution getting to neutral over a few years, what causes that to happen on the Credit Card sale? + +-------------------------------------------------------------------------------- +John Mulligan, Target Corp - EVP, CFO [45] +-------------------------------------------------------------------------------- + + Sure. The biggest impact is the impact of share repurchase, as that levers against growing profits, is the short story on that, Dan. And we're happy to spend a little bit more time with you, if you'd like, discussing that. But that's the short story. + +-------------------------------------------------------------------------------- +Dan Binder, Jefferies & Company - Analyst [46] +-------------------------------------------------------------------------------- + + Okay. Great. Thanks. + +-------------------------------------------------------------------------------- +Gregg Steinhafel, Target Corp - President & CEO [47] +-------------------------------------------------------------------------------- + + Okay. Well, thank you very much. That concludes Target's fourth quarter 2012 earnings conference call. Thank you all for your participation. + +-------------------------------------------------------------------------------- +Operator [48] +-------------------------------------------------------------------------------- + + Ladies and gentlemen, this concludes today's conference call. Thank you again for joining Target Corporation's fourth quarter earnings call. You may now disconnect. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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Earnings Conference Call +01/16/2013 09:00 AM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Jamie Dimon + JPMorgan Chase & Co. - Chairman & CEO + * Marianne Lake + JPMorgan Chase & Co. - CFO + +================================================================================ +Conference Call Participiants +================================================================================ + + * Matt Burnell + Wells Fargo Securities - Analyst + * John McDonald + Sanford Bernstein - Analyst + * Mike Mayo + CLSA - Analyst + * Guy Moszkowski + Autonomous Research - Analyst + * Ed Najarian + ISI Group - Analyst + * Gerard Cassidy + RBC Capital Markets - Analyst + * Jim Mitchell + Buckingham Research Group - Analyst + * Erika Penala + Bank of America-Merrill Lynch - Analyst + * Moshe Orenbuch + Credit Suisse - Analyst + * Christopher Wheeler + Mediobanca - Analyst + * Glenn Schorr + Nomura Asset Management - Analyst + * Matt O'Connor + Deutsche Bank - Analyst + * Brennan Hawken + UBS - Analyst + * Betsy Graseck + Morgan Stanley - Analyst + * Marty Mosby + Guggenheim Partners - Analyst + +================================================================================ +Presentation +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Good morning, ladies and gentlemen. Welcome to JPMorgan Chase's fourth-quarter 2012 earnings call. This call is being recorded. Your line will be muted for the duration of the call. We will now go live to the presentation. Please stand by. At this time, I would like to turn the call over to JPMorgan Chase's, Chairman and CEO, Jamie Dimon and Chief Financial Officer, Marianne Lake. Mr. Dimon, please go ahead. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [2] +-------------------------------------------------------------------------------- + + Thanks, operator. Thank you very much. Welcome, everybody, to our fourth-quarter call. I just want to start by telling you that Doug Braunstein won't be doing this call. I just want to thank him for his service to the Company. I do want to remind people, in spite of the fact that the whale happened during that time, during that time, we also had three record years of net income and something we all are very proud of this Company. And so Doug, thank you for your service if you are listening. +And we are thrilled to have Marianne here. Marianne, some of you may know, but Marianne has extensive experience in accounting, numbers. She was the Controller of the investment bank for several years, so she knows the investment banking wholesale side pretty cold. She was also the CFO of the consumer side, so uniquely she has got deep experience in both parts of the Company. And so I'm going to turn it over to Marianne. We are thrilled to have you here. She's going to take you through the numbers and then we will take any and all time you need to answer your questions as usual. +The only point before we start is I think the numbers here are really good. I mean look at the underlying detail of this Company, the third year, record income, 15% returns on tangible capital and growth in virtually every single business. And some negatives like NIM and stuff like that, which will, over time, reverse. So Marianne, let me turn it over to you and just take it through the details. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [3] +-------------------------------------------------------------------------------- + + Thanks, Jamie. Good morning, everyone. This is Marianne. I am going to take you through the presentation this morning, which is available on our website. I refer you to the disclaimer regarding forward-looking statements, which is at the back of the presentation. +And just before we turn to earnings, we also announced today the completion of the Board review of CIO and the management task force report. Both reports are available on our website. +So with that, we will turn to page 1. The firm generated net income of $5.7 billion for the fourth quarter, or $1.39 a share, on revenue of $24.4 billion, up 10% year-on-year and down 6% quarter-on-quarter. And on the page, you see we had a few significant items for the quarter and these (technical difficulty) offset each other and we will go through them as we go through the presentation. +But what you don't see on the page is we also had a number of smaller items, many of which we will mention when we go through. For example, we made a contribution to our foundation and realized some securities gains this quarter. These smaller items also largely offset slightly to the negative. +So for the full year, we generated record net income of $21.3 billion, or $5.20 a share, on revenue of $100 billion, flat year-over-year. Return on tangible common equity was 15% for both the quarter and the year and in fact, as Jamie said, this is the third consecutive year of both record net income and 15% return on tangible common equity. +And before I turn to the businesses, I would characterize the overall performance of the quarter as strong performance across our businesses and highlight four themes. First, the positive trends in marketshare that we have been seeing continued this quarter. Year-over-year, we saw strong consumer deposit growth of 10%, mortgage origination volumes up 33% and sales volume in card up 9%. Also, the number one ranking in global IB fees, including record debt underwriting fees, record assets under custody in CIB, record revenue in Commercial Banking and record revenue in AUM in Asset Management. +Second, we continued to see positive year-over-year loan growth. On a reported basis, the total loans for the Company were up 1%, while excluding runoff portfolios, our core loan growth was 9% with record loan balances in Commercial Banking up 14%, record Business Banking loan balances up 7% and record Asset Management loan balances of $80 billion. +Third, strong credit performance continued in our wholesale portfolios, as well as in the core consumer portfolios, which have stabilized at low levels of charge-off and delinquency. The real estate portfolios continue to show improvement as the housing market continues to recover, but losses are still high. +So finally, we continue to strengthen our capital position and you can see that if you turn to page 4 and I will take you there. We ended the year with Basel I and Basel III Tier 1 common of $140 billion and $144 billion respectively, both up $5 billion this quarter. And we had strong Basel I and Basel III ratios of 11% and 8.7% respectively. And to note, the estimate for Basel III of 8.7% includes the full impact of MPR as we understand it compared to 8.4% last quarter and is approximately 150 basis points over last year on a comparable basis. The return on Basel I RWA was 1.9% for the quarter ex-DBA. +And we added a few points to the bottom of the slide, which we think are important and we will spend some time at Investor Day going through our balance sheet in more detail, but just some salient points. You can see we have $450 billion of equity and long-term debt, under $100 billion of short-term debt, which is small relative to our $700 billion of cash, high-quality securities and secured financing and finally, deposits of $1.2 trillion, which fund our $700 billion of loans. +So turning onto the businesses, if you move to page 5, Consumer & Community Banking, this includes our Consumer & Business Banking, Mortgage Banking, Card and Auto businesses. There's some facts here that show the strength of our Consumer franchise. The combined Consumer businesses generated $2 billion of net income for the quarter on $12 billion of revenue. We have the number one ATM network and the number two branch network with a 150 new branches this year. We're the number two mortgage originator and number one card issuer in the US and ended the year with over 100,000 Chase Private Clients in over 1200 locations. And we have over 31 million active online and 12 million active mobile customers. +And just another thing that we are particularly proud of this year is a new accomplishment. We achieved the number one ranking in the American Customer Satisfaction Index Survey for customer satisfaction among large banks. +In the appendix, we included a page on Hurricane Sandy, which I won't take you through, but it was amazing to see how our employees rallied to support our customers and while the financial impact wasn't significant of the firm, the impact we were able to have on our customers was significant. +So onto page 6, Consumer & Business Banking. You can see net income of $756 million on revenue of $4.3 billion, down 1% year-on-year and sequentially. We continue to see pressure on deposit margins, 12 basis points in the quarter and 32 year-on-year, which negatively impacts NII, but this continues to be largely offset by deposit growth. We are growing customer deposits at more than twice the industry average, 10% year-on-year. +And also in December, we saw the lowest customer attrition rate we have seen in the last 10 years and if you take that together with the customer satisfaction results I mentioned earlier, it speaks to the great progress we are making on the customer experience. We are deepening relationships with averages balances per account up, customer satisfaction up, transaction per debit card up, active online and mobile customers up. +And just two more revenue drivers this quarter. We had record business banking loan balances of $18.9 billion with a strong pipeline and investment sales up almost 50% year-on-year with client investment assets up 15%. And almost two-thirds of these sales are managed accounts, which generate a strong recurring source of revenue for this business. Expenses were flat quarter-on-quarter and up slightly year-on-year driven by new branch builds. +Mortgage Banking on page 7, the overall net income for the mortgage bank was $418 million and there are a couple of significant items here this quarter, which I will take you through as we go through the results. Moving up to the top and production, production pretax income of $789 million on strong originations of $51 billion, up 33% year-on-year and 8% in the quarter, which reflected strong refi activity, as well as an increase in correspondence. And although margins remain elevated, as we expected, we did see compression this quarter relative to the peaks of last quarter and we do expect them to continue to normalize into 2013. +Production expense this quarter includes a litigation expense, which is a part of the significant item for mortgage-related matters that we had on page 1. Agency repurchased demand and the outstanding pipeline were both down significantly this quarter and cure rates improved driving lower losses, which resulted in a net positive $53 million for the quarter. +So on Servicing, net servicing results in the portfolio at the end of the quarter include the impact of the acquisition of $70 billion of MetLife servicing and just a reminder, it closed late in the quarter. It is high-quality agency servicing with the added benefit of additional HARP opportunity for us. Looking at Servicing expense, you can see it includes the net charge for the IFR settlement of about $700 million, which is the balance of the significant items for mortgage-related matters. +And just finally on this page, real estate portfolios, you can see pretax income of $812 million, including net charge-offs of $417 million. Charge-offs for the quarter were positively impacted by adjustments relating to Chapter 7 loans that we wrote down last quarter. And if you back those adjustments out, charge-offs would have been about $520 million this quarter versus $600 million last on an equivalent basis. And the improvement was driven by lower home-equity delinquencies. +Looking at the whole year, we saw significant improvement in charge-offs driven by a 20% to 30% decline in delinquencies and to a lesser extent improving house prices. We expect these positive trends to continue next year, but not necessarily at the same pace as this. And given these trends, we released $700 million of loan-loss reserves this quarter, which is also a significant item. And going forward, you can expect quarterly net charge-offs of $550 million plus or minus going forward. +On page 8, we will talk to you for a minute on the IFR settlement. The settlement requires us to make a cash payment of about $750 million and also provide modifications, short sales and other relief commitments of $1.2 billion. +In terms of the earnings impact, we are booking a current period charge, but we are going to see significant future run rate savings and here is how you can think about it. In 2012, our run rate expense for the IFR was between $100 million and $150 million a quarter and we expect this to continue at these levels or even higher throughout 2013. These costs will now be eliminated almost immediately and the remaining work completed by the end of the month. +If you exclude both the net settlement costs and also the IFR run rate costs, our Servicing expenses would have been around $725 million this quarter, which is obviously still very high relative to our longer-term guidance of $300 million to $350 million a quarter, but we expect that to continue to trend down and we don't expect any additional costs associated with the settlement in 2013. We already have many programs in place to help borrowers and these are fully in our reserve. +Moving on to Card, Merchant Services and Auto on page 9. Net income of $840 million, down 20% year-on-year and 12% quarter-on-quarter on revenue of $4.8 billion, flat year-on-year and up slightly quarter-on-quarter. We saw strong sales volume again in Card, up 9% year-on-year. The revenue rate you see of 12.82% reflects strong interchange revenue and merchant processing fees and low revenue reversals on strong credit performance and our merchant processing volumes were up 17% year-on-year. The net charge-off rate you see of 3.5% is down slightly quarter-on-quarter and down 79 basis points year-on-year and we believe we are at or near the bottom here. We took no reserve actions this quarter, but there may be some additional reserve releases in the first half of 2013. +On Auto, originations up 12% year-on-year, but down 13% quarter-on-quarter due to seasonality. And a final note on expenses, our fourth-quarter expenses were elevated due to the impairment of an asset related to a nonstrategic partnership. +Slide 10 and 11, and the Corporate & Investment Bank. Strong results here for a fourth quarter, net income of $2 billion on revenue of $7.6 billion for the quarter, which included DVA of $567 million, which is in the credit adjustment line item. And for clarity going forward, in addition to DVA, this line item will also include CVA and related hedges. +So if you focus on the numbers ex-DVA, $2.4 billion of net income on $8.2 billion of revenue, up 19% year-on-year and down 4% quarter-on-quarter. And just a reminder, our new reporting here reflects how we manage our clients. The traditional banking relationships are in banking and investor clients in market and investment services and we will talk more about these segments at Investor Day. +Total banking revenue of $3.2 billion is up 29% year-on-year driven by higher IB fees of $1.7 billion in the quarter, up over 50% year-on-year, making this the strongest fee quarter this year and including record debt underwriting fees. Total markets and investor services revenue of $5 billion, up 14% year-on-year, driven by markets revenue of $4.1 billion, up 19% year-on-year and down 15% quarter-on-quarter. And just to remind you, this is in line with the better end of guidance we gave you at Goldman Sachs. +It was a solid quarter for Fixed Income, up 21% year-on-year, down 15% quarter-on-quarter across products. Reminder, the impact of the remaining synthetic credit portfolio is included here in the Fixed Income result and was a modest loss again this quarter. Progress continued to be made derisking this position. +Equity markets of $895 million, up 11% year-on-year, down 14% quarter-on-quarter. The sequential change was primarily due to seasonally slower equity derivatives with CapEx [piece] holding up well. +So just moving onto drivers and at the bottom, you can see our average CIB VAR declined to $106 million this quarter, which is a significant reduction and although it is not on the page on a spot basis, VAR declined even further reflecting lower volatility in the look-back period and also the risk reduction in synthetic credit. We also had record assets under custody of $18.8 trillion, up 12% on the year and record (inaudible) revenues. +The comp to revenue ratio ex-DVA for the whole business was 27% for the quarter and 32% for the year and both for the quarter and the year, comp to revenue ratios both including and excluding DVA were basically the same for TSS, the IB and CIB. And going forward, we expect the combined business comp to revenue to be 35% plus or minus. +And just a comment on credit. Trends are stable at low levels and provisions this quarter benefited from recoveries and a reduction in the allowance related to restructured nonperforming loans. +On page 11, just before we leave CIB, there's a few metrics. Number one rank in global IB fees, number one fixed income markets revenue share through the third quarter of this year, number one ranking from institutional investor for all American fixed income and equity research and we have also made progress on our international expansion in the last couple of years. International loans and assets under custody up 50% and 33% respectively since 2010 and almost half of the revenue this year for CIB was international. +Commercial Banking on page 12. This year was the third consecutive year of record revenue and net income for this business. The quarter saw net income of $692 million, up 8% year-on-year and flat quarter-on-quarter on record revenue on $1.7 billion and record loan balances. +(inaudible) data shows we are growing our loan balances faster than the industry average with C&I loan growth up 18% and record middle-market loan balances for the 11th consecutive quarter up 14%. We continue to see competitive pricing pressure, but spreads remained stable this quarter and lastly, we continue to see strong credit performance this quarter. +Asset management, page 13. Continued strong investment performance and long-term inflows drove the third consecutive year of record revenue. For the quarter, net income of $483 million, up 60% year-on-year and 9% quarter-on-quarter on record revenue of $2.8 billion. Total results this quarter driven by higher performance fees and improving markets and net inflows of $32 billion driving AUM growth. This is the 15th consecutive quarter of long-term net inflows for this business. +Other positive trends included loan growth up $20 billion year-on-year driven by both mortgage and international growth and average deposits of $134 billion, up 10%. Expenses up 11% year-on-year due to higher comp expense, but the pretax margin of 29% was also up. +Moving on to page 14 and Corporate and Private Equity, overall net income of close to $500 million for the quarter included private equity net income of $50 million principally from gains on sale. Treasury and CIO had a net loss of $157 million, which included negative NII due to the low rate environment and limited reinvestment opportunities, which was partially offset by about $200 million of net securities gains and mark to market. Excluding these gains, treasury and CIO's net loss was about $300 million, in line with our guidance and we are continuing to guide to a net loss of $300 million plus or minus. +And finally, other corporate, net income here of just over $600 million includes $620 million of tax adjustments, which is our final significant item. It resulted from a reduction in tax rate for the full year and also a number of discrete items, most significantly a tax return adjustment. And although large, these items are not unusual. The tax adjustments were partially offset by $184 million of additional litigation reserves and again, if I adjust for the two items I just mentioned, other corporate net income would have been about $100 million and we continue to expect it to run at that level, $100 million plus or minus, going forward. And remember, both treasury CIO and other corporate results are likely to vary quarter-on-quarter. +Moving on to net interest margin, turn to page 15. You can see firmwide NIM declined 3 basis points and core NIM 7 basis points in the quarter. Of note, our NII held up this quarter and in fact, it grew despite this compression. There is obviously a number of items affecting NIM. First, the negative. Competitive pressure and the runoff of higher-yielding loans drove lower loan yields across the board. Lower rates in Europe drove lower investment security yields and the low rate environment continued to impact reinvestment opportunities. +And on the positive, increased hedging and a change in mix reduced the cost of our long-term debt. Hedge accounting had a neutral impact on NIM this quarter with some offsets in assets and liabilities and going forward, given the environment, we continue to expect modest pressure on NIM for the next several quarters. +So just turning on page 16, our final page, the outlook, we have covered most of these items already and we will provide more detail on our outlook at Investor Day, but we remain optimistic about 2013 and the continuation of marketshare gains, positive loan growth and improving credit trends all contributing to our results. So thank you for joining us and with that, we will open up the call to Q&A. + + + +================================================================================ +Questions and Answers +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions). Glenn Schorr, Nomura. + +-------------------------------------------------------------------------------- +Glenn Schorr, Nomura Asset Management - Analyst [2] +-------------------------------------------------------------------------------- + + Hi there. Thanks. So over time, we have talked back and forth about housing improving and you were right and it is improving. But curious if you have any metrics for us on say what is built into the reserve models and how -- what kind of sensitivity we could have on say -- let's just say hypothetically housing improves 5% in 2013 and again in '14. Just -- I don't know if you can put metrics around it, but -- (multiple speakers). + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [3] +-------------------------------------------------------------------------------- + + Yes, we obviously have to make some assumptions going forward in house prices and they are not that different than the assumptions you would see in most other that get published by Case-Shiller, etc. Right now, they have a modest increase in home prices in 2013 and '14. I will stick with just those two years. But if it was 5% better than that, which is possible, that would run through our books in lower charge-offs and lower reserves. And just as a rule of thumb, $500 million for one year. + +-------------------------------------------------------------------------------- +Glenn Schorr, Nomura Asset Management - Analyst [4] +-------------------------------------------------------------------------------- + + Got it. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [5] +-------------------------------------------------------------------------------- + + It's a very rough rule of thumb. + +-------------------------------------------------------------------------------- +Glenn Schorr, Nomura Asset Management - Analyst [6] +-------------------------------------------------------------------------------- + + I appreciate that. From what I understand on CCAR this year, the Fed is going to be taking a closer look at internal stress testing and all the procedures that go around that. And I think we are going to get to see -- you are going to be disclosing some of those results. I am not front-running what we are going to see. I am just curious. In general, are we going to see that at the same time, are we going to see that on a lag basis and what you plan on disclosing? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [7] +-------------------------------------------------------------------------------- + + Yes, no, we are required under Dodd-Frank to disclose our stress tests. Remember, we do -- in March. We do it almost immediately after the Fed's report. And remember, we do hundreds. The Fed is four. So we look at multiple kind of stress tests and we are going to try to give you a full view of how we look at the Company under stress. I should point out that a lot of you did it yourselves in the past. You were pretty accurate some of you. + +-------------------------------------------------------------------------------- +Glenn Schorr, Nomura Asset Management - Analyst [8] +-------------------------------------------------------------------------------- + + Jamie, maybe the last one, on things related to part of the liquidation authority. I know we haven't seen the white paper yet, but there has been a lot of back-and-forth and I am not a believer that we are going to get the worst-case scenario that some of the people at the FDIC had thought about, but long story short is, as ironic as it is, every bank has spent the last couple of years reducing their subdebt because Basel III doesn't count it. Now, shocker, we are going to have to (inaudible) some more because the OLA is going to want it. Just curious on how much prep you can do ahead of that and what your expectations are in terms of a phase-in if that is going to be impactful in the near term. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [9] +-------------------------------------------------------------------------------- + + Just to give you a view, we have $200 billion of equity and $250 billion of unsecured debt. That is $450 billion. That is a lot of capital before anyone else bears a loss. It is not clear to me that subordinated versus just unsecured, and it would take time to develop those markets. If a bank has 50/50 or -- obviously it changes the nature a little bit over time, so it will take time to develop. But I think we're working with the authorities to get it right, to do the analysis right, to have the right numbers. I think you have a little time before someone says it has to be this amount. +Remember, we have got Basel I, Basel II, Basel III, OLA, LCR NSF and the new one and we are going to be able to accommodate all of them. It will take a little bit of time. I do want to point out that we fully intend in 2013, late 2013, to be a 9.5% Basel III and to be fully compliant with LCR. + +-------------------------------------------------------------------------------- +Glenn Schorr, Nomura Asset Management - Analyst [10] +-------------------------------------------------------------------------------- + + Okay, great. I'm good. Thank you very much. + +-------------------------------------------------------------------------------- +Operator [11] +-------------------------------------------------------------------------------- + + Brennan Hawken, UBS. + +-------------------------------------------------------------------------------- +Brennan Hawken, UBS - Analyst [12] +-------------------------------------------------------------------------------- + + Good morning. Thanks for taking the question. So you all are about to start buying back stock here in the first quarter and the share price is at about $45. Ironically, this is the price point historically where there has been an indication of some price sensitivity. So maybe I was hoping for an update on your thinking on that front. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [13] +-------------------------------------------------------------------------------- + + Well, we had done giving you some numbers in our annual report last year about where it is a no-brainer to buy back stock, which I said is tangible book value. Tangible book value is now $38 or $39, which has gone up, what is it, $4 this year, almost $5 this year. So we still think if you haircut earnings and buy stuck at these prices, it's probably still a good deal. We got permission to buy back $3 billion in the first quarter. Obviously, it is going to be a little price-sensitive and then CCAR will set what we can buy back for the next four quarters after that. I hope that answers your -- yes. + +-------------------------------------------------------------------------------- +Brennan Hawken, UBS - Analyst [14] +-------------------------------------------------------------------------------- + + Yes, no, I think so. So basically we can look at the tangible book value growth versus the last comments and imply from there? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [15] +-------------------------------------------------------------------------------- + + You can do the same numbers at today's prices. Discount, if you want to be conservative, discount earnings, buy back stock. At the end of a two or three-year period, you will apply earnings per share and higher tangible book value per share even at these prices. It seems like a pretty good deal to me. Typically, you have a good company. + +-------------------------------------------------------------------------------- +Brennan Hawken, UBS - Analyst [16] +-------------------------------------------------------------------------------- + + Okay. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [17] +-------------------------------------------------------------------------------- + + And you are not going to need the capital down the road. I am not talking about for one year, but down the road. + +-------------------------------------------------------------------------------- +Brennan Hawken, UBS - Analyst [18] +-------------------------------------------------------------------------------- + + Fair enough. And then the $100 million to $150 million that is coming out of your legacy costs, is that part of that $500 million per quarter that you all have highlighted in the past or is that in addition to that? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [19] +-------------------------------------------------------------------------------- + + Think about it as all in and we are expecting our run rate in the future to be I think $300 million to $350 million, as I said, excluding the items we talked about. Including IFR, we are at $725 million. We have got a ways to go, but it is coming down. Think about it in there. + +-------------------------------------------------------------------------------- +Brennan Hawken, UBS - Analyst [20] +-------------------------------------------------------------------------------- + + Okay. Good deal. And then the comp ratio in CIB is down this year or I should say maybe full-year 2012 about 2.5 percentage points from year prior. How should we think about the comp ratio in the IB on a going-forward basis? Have we hit a structural shift here? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [21] +-------------------------------------------------------------------------------- + + Well, I think let me just put out first off that our comp ratio was 33%. If you, by the way, if you added back some of the bonuses paid in corporate that don't show up as comp in the IB, it would be like 35%. We think that the roundest number is kind of an ongoing run rate. We have formulas. We don't pay out necessarily by the formula, but we have formulas that are capital-adjusted, risk-adjusted, etc., etc. that -- that is what really guides it and it is not -- so it is really done at a much more detailed level than it will bounce around that 35%. +I should point out that again we feel good that our ROE in the investment bank was 17% this year. It was 16% or 17% last year and the year before and we are paying our people fair and well. I feel good about that. That is a good thing. That is a good business model to have something like that. + +-------------------------------------------------------------------------------- +Brennan Hawken, UBS - Analyst [22] +-------------------------------------------------------------------------------- + + Sure, but probably, on the whole, upward comp pressure across the street competitively is probably nowhere near as it had been. So in improvements and increased cost leverage is probably decently sustainable wouldn't you say? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [23] +-------------------------------------------------------------------------------- + + Yes, I think that is probably true, but other firms have ratios of 50%, 55%. Ours is already fairly low. We want to win in the business. We are going to be competitive in compensation and obviously that will adjust over time as competition changes. + +-------------------------------------------------------------------------------- +Brennan Hawken, UBS - Analyst [24] +-------------------------------------------------------------------------------- + + Okay. And then last one from me, as we start to move forward towards the central clearing of swaps here late in the first quarter of '13, do you maybe have an updated view of what this transition might mean for JPMorgan's FICC business or your capital markets revenues for 2013? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [25] +-------------------------------------------------------------------------------- + + At Investor Day, we will try to give you a better view of that. So there are clearly some negatives and we don't know all the rules, also some positives. So we are in a position between custody and clearing and our brokers businesses to provide some of those services for investors so they can allocate capital properly, transform the collateral and serve them better. So let the rules come out. Obviously, this is going to affect our revenues a bit, but there will be opportunities there too. + +-------------------------------------------------------------------------------- +Brennan Hawken, UBS - Analyst [26] +-------------------------------------------------------------------------------- + + Terrific. Thanks a lot. + +-------------------------------------------------------------------------------- +Operator [27] +-------------------------------------------------------------------------------- + + Betsy Graseck, Morgan Stanley. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [28] +-------------------------------------------------------------------------------- + + Hey, good morning. A question on LCR. Jamie, you mentioned that you were going to be -- looking to be 100% compliant by the end of 2013 and I wanted to understand did the Basel release on LCR align with your sense of how it is going to shake out in the US? And I ask because the RMBS looks like it was very tightly worded, so I wonder if there is any caveats to your comment that you will hit the 100% by -- (multiple speakers). + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [29] +-------------------------------------------------------------------------------- + + No, here is my caveat. We are going to meet LCR this year whatever it is. It doesn't matter to us whether we like it or not. Now to answer your question, there were some changes in LCR; I think they were good, but they still capped the benefit like mortgages and we have like almost $90 billion of MBS. So government-guaranteed MBS is in what they call level 2 and therefore, you are restricted in how much [capital] liquidity. +Now personally I think that is wrong, but it is okay. We will live with it, we are moving on. I don't know why the American regulators would agree to that. Government-guaranteed MBS in a market you want where they treated liquid and remember, they already have a 15% haircut. I could argue they don't need any haircut, but look, whether changes are made or not, we are going to be compliant. It is not going to affect our earnings that much. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [30] +-------------------------------------------------------------------------------- + + Okay. And then just separately, a small item, but on mortgages, you talked about the gain on sale that came down on the quarter and that you are looking forward to that normalizing over the course of the next year or so. Could you just give us a sense of how much we are talking about normalizing because we could go back to precrisis and it is a much bigger implication on mortgage revenues than if you are talking about just before the long end of the curve started to come down dramatically. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [31] +-------------------------------------------------------------------------------- + + Yes, so hey, Betsy, we talked about the third quarter being -- peaking at over 200 basis points before the margins compress in some 40 or so basis points in the quarter and we do expect that to continue into 2013, not at that level. If you go back in time, you would see gain-on-sale margins more in the 65 basis points. I don't know if that is where it will end, but certainly we expect for that to be seen through 2013, but with gaining marketshare. We hope to keep our volumes up. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [32] +-------------------------------------------------------------------------------- + + Obviously, it will normalize over time, but it may not go that low because our expenses could also be permanently higher. To be in the business is going to cost more money and obviously that will be part of your -- what you have to earn back. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [33] +-------------------------------------------------------------------------------- + + Right. I get it. Okay, thanks. + +-------------------------------------------------------------------------------- +Operator [34] +-------------------------------------------------------------------------------- + + Ed Najarian, ISI Group. + +-------------------------------------------------------------------------------- +Ed Najarian, ISI Group - Analyst [35] +-------------------------------------------------------------------------------- + + Yes, good morning. Jamie, a quick question. Any update with respect to how quickly you expect your Basel III risk-weighted assets to decline? We saw a little bit of a decline this quarter, expecting more decline, but is there sort of any change in the outlook for the pace of that decline or how you are thinking about it? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [36] +-------------------------------------------------------------------------------- + + Yes, so we -- the number that Marianne showed you is the Basel III Tier 1 common 8.7. If you look at what I call for the next two years passive mitigation, that is run-off and what I call normal models, so we still have to get certain models in there and there is not arguing with anybody, it's just models that should be put in place, that would add almost 1% to Basel right off the bat. About I am going to say $100 billion of that would be models, $80 billion to $100 billion would be models. Part of that is the runoff to synthetic credit, which is obviously coming down over time. +And the other thing, which I think you're going to see, is we are pushing Basel III down, we have, but we are pushing it down at a very detailed level. I think over time you're going to see (inaudible) down capital Basel RWA even more. And there are things in Basel, which I don't know what the future portends. We have $200 billion plus of operational RWA in there now. That is driven very -- that is like $16 billion of capital. That is driven very high by obviously the mortgage litigation and stuff like that, some of which will go away. So one day, a lot -- that $200 million should come down a lot too. I just don't know the timetable for that. + +-------------------------------------------------------------------------------- +Ed Najarian, ISI Group - Analyst [37] +-------------------------------------------------------------------------------- + + Okay. And then just a quick follow-up to that, you mentioned wanting to get to 9.5% by the end of 2013. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [38] +-------------------------------------------------------------------------------- + + No, I didn't mention -- we are going to get there late in 2013 whatever it takes. + +-------------------------------------------------------------------------------- +Ed Najarian, ISI Group - Analyst [39] +-------------------------------------------------------------------------------- + + Okay. Along with that, we see a number of companies sort of building a little bit, 50 basis points or something like that, of sort of a buffer on the buffer to account for AOCI fluctuation and things like that. For you guys maybe getting up to 10% or wherever the ultimate endpoint in, is that more of a '14 event or is that also something that you would like to get done this year? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [40] +-------------------------------------------------------------------------------- + + We will answer -- to give you more feedback -- maybe we have to have a buffer. We don't know what the final rules are for capital. So you already have a conservation buffer. You go below what happens. Obviously, OCI could be a big swing. Like if you model -- I forgot -- we had modeled it. Like 300 basis points would be $20 billion after tax or something like that. But you could handle that too because it is going to come in over time and you can manage your balance sheet going forward, your stock buyback going forward. So we really need to see the future rules to make that determination. If we need a buffer, we will have a buffer. + +-------------------------------------------------------------------------------- +Ed Najarian, ISI Group - Analyst [41] +-------------------------------------------------------------------------------- + + Okay. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [42] +-------------------------------------------------------------------------------- + + Whatever that is, we will go there right away too, but we just don't know what it is yet. And we don't know whether CCAR is going to drive capital or the conservation buffer is going to drive capital or whatever. And we don't know how the G-SIFI exactly works, even though we know it's a 2.5%. We will probably find ways to reduce that over time. So we have plenty of capital. Right now, I am -- far more than I personally think we need, but we have plenty of capital. + +-------------------------------------------------------------------------------- +Ed Najarian, ISI Group - Analyst [43] +-------------------------------------------------------------------------------- + + Well, I think everyone is trying to sort of do math on how much capital you might return this year. So all of those are questions -- (multiple speakers). + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [44] +-------------------------------------------------------------------------------- + + Well, unfortunately, that is a one-year thing, okay and I should point out that before you ask is that when we started the dividends, we said that the intent would be to increase them a little bit every year, so you should expect to see that. We are going to ask for less capital return from stock buyback than we have in the past so where I can do $3 billion in the first quarter. We are going to do less because we have determined, and this is a Board-level determination too, that we want to get to 9.5% quicker and we don't exactly know how these stress tests work. So we think under severe stress, we would have plenty of capital, but the last time the Fed's numbers were very different. We don't understand that and the way CCAR has done this year has even more volatility. Basel 2.5 is far more volatile in how you calculate RWA, OCI and all that than the old Basel I test. So we are a little cautious, which I think is what obviously the Fed expected people to do. + +-------------------------------------------------------------------------------- +Ed Najarian, ISI Group - Analyst [45] +-------------------------------------------------------------------------------- + + Okay, great. That's helpful. Thank you. + +-------------------------------------------------------------------------------- +Operator [46] +-------------------------------------------------------------------------------- + + Erika Penala, Bank of America-Merrill Lynch. + +-------------------------------------------------------------------------------- +Erika Penala, Bank of America-Merrill Lynch - Analyst [47] +-------------------------------------------------------------------------------- + + Good morning. Some of the pushback that I have gotten from some investors on your strong quarter is on the provisionals overall. So I guess I want to follow on Glenn's question because clearly CIB is unsustainable from a provision basis, but it seems like there is still a lot of leverage left on the provision side from CCB. So Jamie, was your comment that if house prices were up 5% over what is in your model, the additional leverage provision is $500 million per year? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [48] +-------------------------------------------------------------------------------- + + Yes, let me just separate the two. In Consumer, credit card is near the end. There could be more, but it is near the end. It's really mortgage. Mortgage reserves are going to have to come down as charge-offs come down and charge-offs are going to come down. We are not trying to manipulate our earnings or anything like that. They are going to come down. The portfolios are smaller; housing prices are going up. We just don't know exactly the pace they are going to come down, but remember they are half what they were a year and a half ago and my guess is, in a year and a half to two from now, they will be half of what they are today, which implies the reserves will come down. We have $5 billion left; that implied would be $2.5 billion. So nothing magical there. That is what is in the numbers. It is really a matter of timing, etc. +On the CIB side, it was really -- we had one or two big recoveries, so we did have, what was it, $400 million, but Marianne also pointed out there were some other negatives that got booked in CIB too. So you are right; we are not going to have much reserve takedown in CIB, but the other negatives won't be there either. So it is a little bit of a wash in CIB too from other non-reserve-related stuff. + +-------------------------------------------------------------------------------- +Erika Penala, Bank of America-Merrill Lynch - Analyst [49] +-------------------------------------------------------------------------------- + + Got it. And in terms of CIB activity levels, I think that the investor base did expect some strength this quarter more than seasonal. I guess could you give us a sense of whether or not the strong fourth-quarter showing is sort of a harbinger for activity levels finally picking up in 2013? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [50] +-------------------------------------------------------------------------------- + + I wouldn't call it a strong fourth-quarter showing. We kind of made an assumption that the last two weeks of the year are pretty dead in terms of activity and we were a little bit wrong about that. But here is what I would say. Activity now is continuing; it is usually strong in the first part of the year. We don't know. But I personally believe that this has been, and I have been consistent about this, a cyclical, a secular change. We deal with 16,000 investors. Investable assets are going up; they are not going down. Global trade is going up; it is not going down. High net worth assets, I'm talking over 10 years and so there is a need that people have to buy and sell securities, etc. So I think the underlying trend is up and obviously spreads will compress over time. They have by the way for 20 years. That will continue. +And now we have got a bunch of model changes, not models, but like business model changes from swaps and derivatives and regulations. We will adjust all that, but there is a chance you're going to wake up one day and it will be a boomer year and no one is going to predict that either. There is a chance we happen to go into recession that it will get worse, but my attitude is I think we are very well-positioned in the business. It is very broad-based between FX rates, credits, securitized products, commodities. It is very global, emerging markets driven by research, which Marianne mentioned we are number one. So over time, it will grow. I just can't predict what it is going to do next quarter. + +-------------------------------------------------------------------------------- +Erika Penala, Bank of America-Merrill Lynch - Analyst [51] +-------------------------------------------------------------------------------- + + Okay. And just I wanted to sneak one more in on Card. We appreciate the color on sales volume in Card and I think there is a thesis out there that if the US consumer is taking home less because taxes are higher, but the underlying economy is okay, then that could potentially translate into receivables growth finally. Is that a reasonable leap to make as we look at receivables growth for next year? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [52] +-------------------------------------------------------------------------------- + + Yes. Look, I think the American economy -- I've said the table is rather well set. Consumers, businesses, housing, small business they are all in pretty good shape and I think we need good policy and good fiscal policy, but yes, so we expect to see -- we have had, which I think you mentioned, we have had run-off in consumer too. Remember, in Card, from (inaudible) and some other stuff and we are running off sort of businesses and certain things we got out of, but you could start to see a little bit of growth now going forward in outstandings. Good growth in spending, a little bit of growth in outstandings. + +-------------------------------------------------------------------------------- +Erika Penala, Bank of America-Merrill Lynch - Analyst [53] +-------------------------------------------------------------------------------- + + Got it. Thank you. + +-------------------------------------------------------------------------------- +Operator [54] +-------------------------------------------------------------------------------- + + John McDonald, Sanford Bernstein. + +-------------------------------------------------------------------------------- +John McDonald, Sanford Bernstein - Analyst [55] +-------------------------------------------------------------------------------- + + Yes, hi. Marianne, it looks like your adjusted expenses ex-litigation IB comp came in around $49 billion or so for the year. Do you have an outlook for this number in 2013? Are you looking for some improvement in that above and beyond what you save from the foreclosure settlement? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [56] +-------------------------------------------------------------------------------- + + Yes, so, hey, John, we will do that for you at our Investor Day in a lot of detail. I think the way to think about our adjusted expenses going forward, you should think about them being flat to down in terms of direction and we will go through all of that for you in February. + +-------------------------------------------------------------------------------- +John McDonald, Sanford Bernstein - Analyst [57] +-------------------------------------------------------------------------------- + + Is that the right number like flat to down from around that $49 billion or so level? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [58] +-------------------------------------------------------------------------------- + + Yes, around $50 billion. + +-------------------------------------------------------------------------------- +John McDonald, Sanford Bernstein - Analyst [59] +-------------------------------------------------------------------------------- + + Okay, okay. And then that excludes litigation. It looks like litigation for the full year came in at about $3.7 billion. That is down from $4.5 billion the year before. Do you expect that trend of declining litigation expense in '13? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [60] +-------------------------------------------------------------------------------- + + One day we hope. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [61] +-------------------------------------------------------------------------------- + + (multiple speakers). So we don't -- yes, we won't -- we can't predict the litigation expense, I'm sorry. + +-------------------------------------------------------------------------------- +John McDonald, Sanford Bernstein - Analyst [62] +-------------------------------------------------------------------------------- + + Not clear yet. Okay. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [63] +-------------------------------------------------------------------------------- + + I think the one part, which I just want to reiterate, is that obviously that one is going to be lumpy and be ongoing except the part relating to mortgages. We have done a lot of work on and we are hoping that we are properly reserved there and they are not going to see duplication of that. In the last couple of years of litigation, a lot of it related to mortgages. Not all of it, but a lot of it. + +-------------------------------------------------------------------------------- +John McDonald, Sanford Bernstein - Analyst [64] +-------------------------------------------------------------------------------- + + And then on the buybacks, the first quarter is usually a big issuance quarter for you on shares, but knowing you have approval for $3 billion of gross repurchases, do you expect to have a net reduction in your share count by the end of the first quarter? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [65] +-------------------------------------------------------------------------------- + + You have got me there. I think if we buy back $3 billion and what we issue -- I think we issue -- + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [66] +-------------------------------------------------------------------------------- + + 2.5. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [67] +-------------------------------------------------------------------------------- + + -- amortizes in over time as we issue it -- + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [68] +-------------------------------------------------------------------------------- + + Right. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [69] +-------------------------------------------------------------------------------- + + -- so my guess is it will go down a little bit in the first quarter. When you issue restricted stock, it doesn't immediately go into fully diluted. That goes in as it amortizes. Remember this stuff amortizes over three years generally. + +-------------------------------------------------------------------------------- +John McDonald, Sanford Bernstein - Analyst [70] +-------------------------------------------------------------------------------- + + Okay. Like for 2012, your share count didn't go down. That is because you suspended the buybacks and it didn't do enough in the first quarter to take the share count down. I assume you would like to see it decrease at some level. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [71] +-------------------------------------------------------------------------------- + + If we spend the whole $3 billion, my guess is it will go down, yes. + +-------------------------------------------------------------------------------- +John McDonald, Sanford Bernstein - Analyst [72] +-------------------------------------------------------------------------------- + + And then when you say you are going to ask for less, just to clarify, you mean you will ask for less than $3 billion per quarter? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [73] +-------------------------------------------------------------------------------- + + Yes. + +-------------------------------------------------------------------------------- +John McDonald, Sanford Bernstein - Analyst [74] +-------------------------------------------------------------------------------- + + Okay. Last thing, on risk-weighted assets, it looks like your assets were up 2%, but Basel III RWA came down. What drove that delta? Are we starting to see the mitigation take effect? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [75] +-------------------------------------------------------------------------------- + + Yes, I think, John, in part, that is it. I can get back to you with more specific details. It did come down slightly in the quarter. It does reflect the combination of our full understanding of all of the rules, plus some model changes and everything else in the quarter and BAU activity, but we can get you more detail. + +-------------------------------------------------------------------------------- +John McDonald, Sanford Bernstein - Analyst [76] +-------------------------------------------------------------------------------- + + Okay. And one more thing. Your net interest income grew in the fourth quarter despite the NIM headwinds and the runoff. And I understand your NIM percentage outlook, but I guess what helped you grow NII dollars this quarter and do you think you can grow NII dollars in 2013? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [77] +-------------------------------------------------------------------------------- + + Yes, well, so we are continuing to grow our deposits very strongly. We are continuing to grow our loans very strongly, so core loan growth up 9%. So all in all, we are generally holding pace with NIM compression and hope to see the same next year plus or minus. + +-------------------------------------------------------------------------------- +John McDonald, Sanford Bernstein - Analyst [78] +-------------------------------------------------------------------------------- + + Okay, thank you. + +-------------------------------------------------------------------------------- +Operator [79] +-------------------------------------------------------------------------------- + + Mike Mayo, CLSA. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA - Analyst [80] +-------------------------------------------------------------------------------- + + Good morning. Just first a factual question. How much were fourth-quarter performance fees in asset management? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [81] +-------------------------------------------------------------------------------- + + It was better by over $100 million versus the fourth quarter last year. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA - Analyst [82] +-------------------------------------------------------------------------------- + + Okay. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [83] +-------------------------------------------------------------------------------- + + Of course, last year wasn't particularly good by the way. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA - Analyst [84] +-------------------------------------------------------------------------------- + + Okay. My main question is does the CIO incident change how JPMorgan is run? And as you said, you have had record net income, 15% return on tangible equity. I think you said in the past -- someone at JPMorgan at least implied that the CIO incident shouldn't change things. On the other hand, you have the new cease-and-desist orders, regulatory actions by the Fed and the OCC and this change in reporting format is the most radical that has ever been put in place since, Jamie, you have been CEO and then all the changes in management. You have a new head of consumer, commercial, investment bank, international, CFO, CIO. +So on the one hand, you highlighted the record net income. I guess my question goes to sustainability of the results over the next several years given how many people have changed, the change in reporting format and the regulatory action. Maybe it is like if you are driving on the Long Island Expressway and you get a ticket for going 80 miles per hour, then you drive 50 miles an hour. Is that just completely off? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [85] +-------------------------------------------------------------------------------- + + Completely off. Let me tell you where - you raised a lot of subjects; let me do them one by one. Obviously, when you have a problem like the whale, you have mistakes, which you should acknowledge and then fix. So we obviously fixed CIO totally 100%. People in it, reporting, risk, controls, committees, guidelines and we don't do synthetic credit there at all. But some of those mistakes obviously scared us and we went and checked everywhere in the Company. So we are fixing certain things across the Company. Not that they are bad, they are not disasters, but they require fixing. And so when you have an accident like that, you want to say we are going to use this to get stronger, better, smarter, tougher. And we have to and we are going to. Obviously you can't meet every demand of the regulators. So we have got real resources doing it. We have already done a lot of it. We are going to continue to do more. So yes, they were changes from the whale. +Number two, we are in business to build the business over time by serving clients. That is what we do. We do it every -- we take risk. When you take risks, you make loans; you take risks when you invest money; you take risk when you build systems and branches. But that is what we have been doing consistently and I hope you see in the underlying numbers more branches, more bankers, more custody, more trading, more products, more services, more countries, happier clients in every business. Record results in Commercial Banking, Asset Management, a lot of cross-sell in that and we are going to do a lot more to describe to you the competitive benefits that we get in this Company because the different business units work together and things like that. +So that part of the business hasn't changed. That is why we are here. Even CIO has always been doing that, investing assets conservatively because I was watching something on TV today -- you have to earn a return on your assets. The book -- you are not going to try to earn a return on your assets is ludicrous to me and to manage asset liability exposure generally conservatively. We obviously made a mistake. +And the third thing, the reorganization, that was around -- and I (inaudible) do a lot of this for you, around the client. If you said rebuild the Company from the ground up, you probably would have organized it around the clients, not necessarily by product. It is not that we were bad or banks were bad or anything like that; it is that companies acquired mortgage companies, they acquired credit card companies, they acquired retail branches. The power of that franchise is extraordinary. 40% of our retail branches own credit cards -- are credit cards today. A big chunk of our mortgage sales come out of the branches. Most of our small businesses serve out of the branches. Middle-market is served out of the branches. The branches are becoming an enormous competitive advantage for asset management. The commercial bank couldn't survive without them. +So all we did is say put together those businesses under one roof where you want to have -- you want to treat the client the way they want to be treated when they come in the front door. Same thing for CIB, the same client set in the investor side and the issuer side, the corporate side. So we go to any country. We serve the big companies, we serve the sovereign wealth funds, we serve the governments. We serve them out of TSS and we serve them out of the investment bank. +All we are doing here is better coordination, which we think will have more cross-sell and believe it or not lower expenses. Plus it will help us deal with the new regulatory environment. So both of these things are going to help us deal with the new regulatory environment to have consistent standards across all the businesses, etc. So that is why we had the reorg. +And management changes, you went through the litany of changes, but just remember Daniel Pinto has been in that business his whole life. Mike Cavanagh has been here for many years and was already running TS&S. Doug Petno has been running the Commercial Bank for several years now. Gordon Smith and Todd Maclin, we did it a little bit faster than we told people. We told people we were going to put that under one roof. Marianne Lake has been the Controller of the IB and the CFO of the consumer bank. All the people in these jobs have been here a long time and they are very good. I mean I think it is an exceptional management team. +It is too much turnover, but again the way I look at the turnover, if I have 15 people in the operating committee, you should assume that 15% to 20% every year will turn over. Some years will be zero and some years will be more. When you have reorgs and stuff like that, it is a little bit more. Hopefully, you're going to have stability. We have got a great management team. They are working a lot of different things. Most have been here a long time. And part of it, part of it relates to -- remember if you were on my Board of Directors, you would be asking me, in fact instructing me to make sure you were putting in place in big jobs the people who have to be tested to see if they can do my job. That is -- I mentioned this many years ago, that is job number one. That takes precedence over all other things. And sometimes it leads to turnover. I'm sorry. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA - Analyst [86] +-------------------------------------------------------------------------------- + + I guess we will hear more at Investor Day next month, but what are you watching for since there is so much rotation among top managers around the same time? What are you looking for to make -- ensure that this current team will work? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [87] +-------------------------------------------------------------------------------- + + Well, look, you should get to know them, but you could evaluate their quality, their integrity, their brains. Mary Erdoes has been here a long time. Matt Zames, who is now Co-Chief Operating -- Frank Bisignano both been here a long time. So these are long tenured, very good, respected employees. And so I know it is going to work. Obviously, you have to make that evaluation yourself. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA - Analyst [88] +-------------------------------------------------------------------------------- + + Then last follow-up, does your positioning to ask for less than $3 billion per quarter in buybacks have anything to do with the regulatory actions that recently came about? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [89] +-------------------------------------------------------------------------------- + + Not really, but the CCAR does have this qualitative aspect, which I don't exactly know what that means, but not really. It really related more to the desire -- the stock price is higher and the desire to get to 9.5% quicker. Everyone's being doing it and obviously we shouldn't lag. That's all. + +-------------------------------------------------------------------------------- +Operator [90] +-------------------------------------------------------------------------------- + + Moshe Orenbuch, Credit Suisse. + +-------------------------------------------------------------------------------- +Moshe Orenbuch, Credit Suisse - Analyst [91] +-------------------------------------------------------------------------------- + + Great. Jamie, I was wondering if you could kind of talk just a little bit about given the strong results that you've got and kind of the hopes of continuing to drive them, which areas you think are the best in terms of where you can see investment in either share gains or growth into 2013. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [92] +-------------------------------------------------------------------------------- + + Also, Mike (inaudible) because you had me do a little work after one of your reports came out about stock price. So do this yourself. Take Bank One's stock price from the day before I got there to today, and take JPMorgan's stock price from the day we announced the deal to today, compare it to the S&P, the bank, the bank index or all other major firms and it's actually rather good. It outperformed in both cases, the bank by a long shot. In both cases, the S&P not by a long shot but by a significant margin and almost most other financial companies. So obviously something has been working a little bit here. +Opportunity, I think the opportunities are fabulous. So next year, we are going to focus a tremendous amount of regulatory requirements, these consent orders getting things done, but also just organic growth. Small business, Marianne mentioned, is up almost everywhere, partially in Florida and California where WaMu gave us the opportunity to do that. We opened our 1000th branch in California. We are still going to open net over 100 branches this year. Our credit card has been growing. The Chase Private Client, we have got 250 branches to 1200 Chase Private Client. That number is going to go up -- and I don't know if we've -- I don't know if that is public -- okay, now it's public -- to something like 2000 end of next year. It is really working. So it is growing dramatically. +Our mutual fund complex has been growing. TS&S, actually not TS&S, the Global Corporate Bank has opened multiple branches overseas. We have gone from 120 Global Corp bankers to 286 or something. It is going to be north of 300 and it is working. +If you look at Investment Banking revenues out of the commercial bank, when we first got here, I think it was like $450 million. This year, it hit almost $2 billion and we think the opportunity to continue to grow is large. So in almost every single business, we see very good opportunities to grow and obviously, we operate in a difficult world, the financial services, but in the Investment Bank, it was -- it has been -- Marianne went through the numbers, but we don't see why we can't continue to grow that around the world and serve more clients in more places like Colombia or in some of the emerging markets. +In Commercial Banking, we opened branches in non -- states we don't have branches, which have been focused on kind of larger clients and international. That is working well. International commercial bank is working well and all these numbers are in here. You guys should go through it soon. They are all pretty good and you are going to see us continue to focus on growing those businesses in a quality way. + +-------------------------------------------------------------------------------- +Moshe Orenbuch, Credit Suisse - Analyst [93] +-------------------------------------------------------------------------------- + + Just as a separate issue, you have obviously responded to the orders from both the OCC and the Fed. Are there any kind of impacts while those are out there until they have kind of deemed them to be kind of fully dealt with and what is the timeframe for that? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [94] +-------------------------------------------------------------------------------- + + Well, I think you should look at it -- we are already fully engaged in meeting all of those concents and other regulatory demands. Remember, we have changing rules and requirements. We also have a lot of items that the regulators have asked us to focus on, their consent orders. So yes, it is a tremendous amount of resource, but it is not going to change the numbers you see. It is just the people involved -- a lot of people involved in risk credit, legal compliance, audit, HR all are really involved in getting a lot of this stuff right and we have to do that. Of course and people in the business too of course. + +-------------------------------------------------------------------------------- +Moshe Orenbuch, Credit Suisse - Analyst [95] +-------------------------------------------------------------------------------- + + Okay. Thank you. + +-------------------------------------------------------------------------------- +Operator [96] +-------------------------------------------------------------------------------- + + Matt O'Connor, Deutsche Bank. + +-------------------------------------------------------------------------------- +Matt O'Connor, Deutsche Bank - Analyst [97] +-------------------------------------------------------------------------------- + + Good morning. A couple questions in the mortgage banking business and as we think about the mortgage asset, I guess the first one is what is your appetite either now or as you look forward to actually portfolioing some of the mortgages you originate? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [98] +-------------------------------------------------------------------------------- + + Yes, so, Matt, you would have seen that we pretty much portfolio all the jumbos we originate right now. We price them to great returns and we would continue to do that. We like that asset. I think overall across the firm, we did $5 billion of jumbos this quarter and so you should expect to see that continue. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [99] +-------------------------------------------------------------------------------- + + I would just add that one of the things you learn to live with a little bit is that you could put a mortgage on your balance sheet and earn or 3.75% or 4% if it is a jumbo or something like that. It doesn't have OCI. It holds more capital, but it might be a wiser thing to do than taking the gain on sale and then buying an MBS at 2.25%. So there are all these opportunities to think through how to manage in the new world properly both for the client and for the shareholder. (multiple speakers). Go ahead. + +-------------------------------------------------------------------------------- +Matt O'Connor, Deutsche Bank - Analyst [100] +-------------------------------------------------------------------------------- + + That is really what I was getting to because I think you have one of the shorter MBS books out there. Obviously has a strong mortgage origination platform. And as we strip out kind of the legacy residential mortgages, what you are left with is not a huge number. So just trying to gauge what the appetite might be to --. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [101] +-------------------------------------------------------------------------------- + + It may be -- and that may change over time and get bigger. So we are doing a little bit more and right now, it is the jumbos. We have done a little bit like C pluses and stuff like that, but there may be others. + +-------------------------------------------------------------------------------- +Matt O'Connor, Deutsche Bank - Analyst [102] +-------------------------------------------------------------------------------- + + Okay. And then maybe somewhat related, as we think about just the underwriting standards in the mortgage business -- + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [103] +-------------------------------------------------------------------------------- + + We would much prefer loans than securities like in commercial bank, credit card, etc. So the reason we have securities is because we can't generate that kind of loan right now. + +-------------------------------------------------------------------------------- +Matt O'Connor, Deutsche Bank - Analyst [104] +-------------------------------------------------------------------------------- + + As we think about underwriting standards in the mortgage business -- I mean we can see the average FICO scores that the banks do collectively that Fannie and Freddie backed still quite high. There has been some good progress with dealing with the legacy issues, not just for JPMorgan, but for the industry as a whole. Got the new guidance from the CFPB, home prices going up. What else do we need to see for banks to loosen underwriting standards of mortgage a bit? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [105] +-------------------------------------------------------------------------------- + + I think the QM was a really big start and kind of well thought through, but it also needs to be coordinated with Basel III, some of these NPR rules, this whole thing about OCI. So all these things are going to affect mortgage a little bit and a lot of players involved in that who have to coordinate it. But I do think over time they will open up the mortgage markets. How rep and warranty is going to be handled, etc. + +-------------------------------------------------------------------------------- +Matt O'Connor, Deutsche Bank - Analyst [106] +-------------------------------------------------------------------------------- + + Okay, thank you very much. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [107] +-------------------------------------------------------------------------------- + + TRN, skin in the game. I think securitization will be important. So if I was the government, I would want to get QRM and securitization rules fixed as quickly as I can to allow people to start. + +-------------------------------------------------------------------------------- +Operator [108] +-------------------------------------------------------------------------------- + + Matt Burnell, Wells Fargo Securities. + +-------------------------------------------------------------------------------- +Matt Burnell, Wells Fargo Securities - Analyst [109] +-------------------------------------------------------------------------------- + + Good morning. Maybe a question for Marianne. Marianne, I noticed that the global liquidity balance was up about $50 billion quarter-over-quarter to just a little bit under $500 billion. Is that in line with your guidance that you are going to meet the LCR requirements by the end of the year or is there something else going on there? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [110] +-------------------------------------------------------------------------------- + + I would say that is probably in line with that. We have excess cash and excess capacity at central banks and that is what that reflects. + +-------------------------------------------------------------------------------- +Matt Burnell, Wells Fargo Securities - Analyst [111] +-------------------------------------------------------------------------------- + + Okay. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [112] +-------------------------------------------------------------------------------- + + They are two different numbers, but they move in the same direction. And we will probably disclose more about that at the Investor Day too. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [113] +-------------------------------------------------------------------------------- + + We will. + +-------------------------------------------------------------------------------- +Matt Burnell, Wells Fargo Securities - Analyst [114] +-------------------------------------------------------------------------------- + + Okay. And how much of an effect, if any, was that on the margin in the quarter? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [115] +-------------------------------------------------------------------------------- + + Probably not much. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [116] +-------------------------------------------------------------------------------- + + Yes, not much. + +-------------------------------------------------------------------------------- +Matt Burnell, Wells Fargo Securities - Analyst [117] +-------------------------------------------------------------------------------- + + Okay. That's it for me. Thank you. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [118] +-------------------------------------------------------------------------------- + + The average yield in the investment portfolio is coming down a little bit every quarter and that will continue for a while. + +-------------------------------------------------------------------------------- +Matt Burnell, Wells Fargo Securities - Analyst [119] +-------------------------------------------------------------------------------- + + Okay, thank you. + +-------------------------------------------------------------------------------- +Operator [120] +-------------------------------------------------------------------------------- + + Gerard Cassidy, RBC. + +-------------------------------------------------------------------------------- +Gerard Cassidy, RBC Capital Markets - Analyst [121] +-------------------------------------------------------------------------------- + + Thank you. Good morning. Could you tell us what the duration of the securities portfolio is? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [122] +-------------------------------------------------------------------------------- + + No. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [123] +-------------------------------------------------------------------------------- + + We do break it out. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [124] +-------------------------------------------------------------------------------- + + We disclosed it. We haven't disclosed it in the fourth quarter. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [125] +-------------------------------------------------------------------------------- + + What was it last time? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [126] +-------------------------------------------------------------------------------- + + Probably like 3. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [127] +-------------------------------------------------------------------------------- + + Interest duration. So it is probably about the same. + +-------------------------------------------------------------------------------- +Gerard Cassidy, RBC Capital Markets - Analyst [128] +-------------------------------------------------------------------------------- + + Okay. And I may have missed this, so I apologize if you -- (multiple speakers). + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [129] +-------------------------------------------------------------------------------- + + The other thing -- right, but the important -- I think the way to look at (inaudible), we would benefit from rising rates. So I've always said that that portfolio is subordinated to the interest of the Company. It is very short. You can extend that duration or a lot more income, but then we would be hurt by rising rates and we break out the earnings and risk from rising rates -- if the whole curve goes up 100 basis points, it is about a $2 billion plus pretax. And that comes through the investment portfolio and loan repricing, etc. + +-------------------------------------------------------------------------------- +Gerard Cassidy, RBC Capital Markets - Analyst [130] +-------------------------------------------------------------------------------- + + How much would you estimate at the long end of the curve would you need to see the long end of the curve go up to mitigate the margin pressures so that you could actually see maybe margins not go down? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [131] +-------------------------------------------------------------------------------- + + I can't -- offhand, it is hard for me to say that, but I think I am going to guess, but like 30 or 40 basis points. It's not a lot to neutralize it -- + +-------------------------------------------------------------------------------- +Gerard Cassidy, RBC Capital Markets - Analyst [132] +-------------------------------------------------------------------------------- + + Correct, no, I agree. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [133] +-------------------------------------------------------------------------------- + + -- to eliminate -- right, something like that. + +-------------------------------------------------------------------------------- +Gerard Cassidy, RBC Capital Markets - Analyst [134] +-------------------------------------------------------------------------------- + + Yep. The other question, and I apologize if you guys already gave this answer, but what was the gain on sale of mortgages this quarter? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [135] +-------------------------------------------------------------------------------- + + The margin? + +-------------------------------------------------------------------------------- +Gerard Cassidy, RBC Capital Markets - Analyst [136] +-------------------------------------------------------------------------------- + + Or the dollar amount. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [137] +-------------------------------------------------------------------------------- + + So I think it is in the supplement. I am afraid I --. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [138] +-------------------------------------------------------------------------------- + + It's in the production revenue. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [139] +-------------------------------------------------------------------------------- + + Yes, it's in production revenue, which I think was close to $800 million. + +-------------------------------------------------------------------------------- +Gerard Cassidy, RBC Capital Markets - Analyst [140] +-------------------------------------------------------------------------------- + + And what was the spread, like 3%, the revenue spread? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [141] +-------------------------------------------------------------------------------- + + Revenue was 3%, 3.5% and net was -- (multiple speakers). + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [142] +-------------------------------------------------------------------------------- + + So it's like 3.5 times 50, actually is on closed, not --. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [143] +-------------------------------------------------------------------------------- + + We will do the math for you. + +-------------------------------------------------------------------------------- +Gerard Cassidy, RBC Capital Markets - Analyst [144] +-------------------------------------------------------------------------------- + + Okay. And then coming back to the return of capital, Jamie, I know this at a stock price you are not going to want to buy back your stock. I am not asking for that stock price, but let's assume for a moment bank stocks do well this year, your stock gets to that level where you are not real comfortable in buying it back. Would you guys consider, as the excess capital builds up on the balance sheet and the Fed limits your regular dividend to maybe 30% of earnings, would you consider special dividends as an avenue to give back that excess capital if you feel it is not -- you are not comfortable buying back the stock at the price at some future level? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [145] +-------------------------------------------------------------------------------- + + First of all, it is a Board-level decision and in some ways, it is a nice problem to have, but the way you set the question up you almost have no option. You can't buy back stock and you can't raise your dividend. All you have left is something like that. So we will get there when we get there. Again, we need to see all the new rules and how they are going to apply like this conservation buffer and we may know more by Investor Day, but when we know more, we will let you know. + +-------------------------------------------------------------------------------- +Gerard Cassidy, RBC Capital Markets - Analyst [146] +-------------------------------------------------------------------------------- + + Fine, thank you. + +-------------------------------------------------------------------------------- +Operator [147] +-------------------------------------------------------------------------------- + + Christopher Wheeler, Mediobanca. + +-------------------------------------------------------------------------------- +Christopher Wheeler, Mediobanca - Analyst [148] +-------------------------------------------------------------------------------- + + Yes, good morning. A couple of questions. The first one, on the latest reorganization, I guess that comes with you in the light of having completed the integration of both Bear Stearns and Washington Mutual. It makes complete sense, but have you actually set any targets in terms of both the revenue and cost synergies you think you might achieve in the medium term? That is the first question. +And the second one was on the $80 billion to $100 billion of RWA you think you could shed by reworking your models. Something ironically you have been pretty critical about in the past in terms of the Europeans' view on that. But can you just tell me is it getting more difficult to do that in the market (inaudible) at the moment? We are getting some pushback from (inaudible) on some of the risk-weighted asset calculations or are you finding it pretty straightforward to actually negotiate that? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [149] +-------------------------------------------------------------------------------- + + So the first one is obviously we do budgets and stuff. We put targets in place, things we would like to accomplish. So that is in how we look at -- we are not going to disclose it to you. But I did say that we do think it is going to enhance revenues and reduce expenses a little bit. So a little bit is in there for the CIB and a little bit in there for consumer. And we are going to disclose more at Investor Day about kind of cross-sell and how we look at it and where we think we can benefit, etc. +And if you look at risk-weighted assets, we are up to -- our balance sheet is $2.4 trillion. We have got $200 billion of money deposited in central banks around the world or in repo, very short-term investments, $350 billion in AA securities and $400 billion in securities borrowed or resales. We have a really, really liquid balance sheet. I just mentioned $750 billion, almost $1 trillion of very short-term stuff that is sitting there on our balance sheet in the asset side and our risk-weighted assets are now $1.65 trillion. They have gone up dramatically because of Basel 2.5, the fact that we don't have certain models in place that will be accepted. +So some of the benefit arguably is going to be just -- I am going to call it run-off. Some is from models that regulators expect people to design and put in place that we don't have yet. We just don't have the history or we haven't done the modeling and that is -- a lot of it is around credit-related, synthetic credit type stuff, securitizations and things like that. So we are going to put those in place. And that is not arguing with regulators; they would expect us to do that over time. Obviously, regulators -- I know they are going to look at how people do models around the world and they want this done fairly, etc. + +-------------------------------------------------------------------------------- +Christopher Wheeler, Mediobanca - Analyst [150] +-------------------------------------------------------------------------------- + + Okay, thanks very much. I appreciate it. + +-------------------------------------------------------------------------------- +Operator [151] +-------------------------------------------------------------------------------- + + Marty Mosby, Guggenheim. + +-------------------------------------------------------------------------------- +Marty Mosby, Guggenheim Partners - Analyst [152] +-------------------------------------------------------------------------------- + + I wanted to ask a detailed question about the mortgage rate purchase expense. You were able to show this quarter that you had a reduction in the reserve of $249 million and only experienced $196 million of losses. So you actually net brought down the impact there. And in your outlook, you talked about being able to offset future losses with release of reserves. So I wanted to ask that question first and then I had one more follow-up after that. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [153] +-------------------------------------------------------------------------------- + + Sure. So think about repurchase. So both sides of that we do them separately. So repurchase losses, I told you you will see demand down significantly, you will see the outstanding pipeline down significantly. We have seen cure rates improve and so our realized losses were sub $200 million and it is what it is and it is a factor, a feature of activity obviously and it can vary a little. +On the repurchase reserve side, it is obviously model-driven and we use inputs, including things like cure rates. So it is not going to be a perfect offset in this quarter. It happened to be slightly more and over time, over the next few quarters, we think they could largely offset that you might see some small pluses and minuses. + +-------------------------------------------------------------------------------- +Marty Mosby, Guggenheim Partners - Analyst [154] +-------------------------------------------------------------------------------- + + So we should see a -- we have gone through an inflection point here where you think the demands are coming down and improvement of what you are seeing overall but that drain should be somewhat mitigating going forward? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [155] +-------------------------------------------------------------------------------- + + Yes, and I would say we are in constant dialogue with the agencies and obviously people ask about behavior and we are in constant dialogue, we think we understand the direction it is going and we feel good about where we are right now and we will continue to monitor that. + +-------------------------------------------------------------------------------- +Marty Mosby, Guggenheim Partners - Analyst [156] +-------------------------------------------------------------------------------- + + And then as we look into 2013, I was trying to take a little bit of your outlook and just kind of create a net progression. If you look at the $1 million that you basically highlighted in margin compression, you have a natural offset that you have explained in the servicing expenses for about $400 million. So if you take your current run rate of operating of $1.35, annualize that to $5.40, you have probably got somewhere between $0.07 and $0.10 worth of negative that comes out of that from netting out the positive that you have in the servicing expenses from margin compression. +If you then move incrementally for growth, if you offset a lot of the margin compression with loan and deposit growth, then you are being able to generate about $1 billion of incremental by just growth and overall balance sheet. If you look at expense savings and then some reduction in shares, you can kind of look at how you would layer in towards something like 10% kind of growth next year as you kind of mirror those kind of big moving pieces. So I just want to make sure we were tracking those and if you had any other thoughts about incremental opportunities to create EPS next year? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [157] +-------------------------------------------------------------------------------- + + I don't know how to respond to that. I think -- maybe you can call later and get some more feedback on some of the stuff you said. You can call Sarah Youngwood at investor relations. But you went through a lot of the stuff that is accurate. Obviously we are in an environment -- the environment changes all the time, but we have growth plans everywhere. So it isn't like we are sitting on our laurels and just looking at what is going to -- NIM compression, stuff like that. So we expect to grow earnings next year. I may be wrong, but that is what we expect. + +-------------------------------------------------------------------------------- +Marty Mosby, Guggenheim Partners - Analyst [158] +-------------------------------------------------------------------------------- + + And I guess, Jamie, the bottom line is that you have product growth to offset margin compression, but then you have got share repurchase and some efficiencies that create incremental growth. I guess that is the bottom line. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [159] +-------------------------------------------------------------------------------- + + Yes, okay. + +-------------------------------------------------------------------------------- +Marty Mosby, Guggenheim Partners - Analyst [160] +-------------------------------------------------------------------------------- + + Thanks. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [161] +-------------------------------------------------------------------------------- + + You're welcome. + +-------------------------------------------------------------------------------- +Operator [162] +-------------------------------------------------------------------------------- + + Jim Mitchell, Buckingham Research. + +-------------------------------------------------------------------------------- +Jim Mitchell, Buckingham Research Group - Analyst [163] +-------------------------------------------------------------------------------- + + Good morning. Can you just give us an update on where you are on the synthetic portfolio? I know you probably don't want to give a dollar amount, but is it mostly gone and what the timeframe is of that -- even if it is a modest drag, just having that off the books completely? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [164] +-------------------------------------------------------------------------------- + + I think we had said earlier, on July 13, we hope it is almost a nonissue by the end of the year. I think we are getting there. I think from the day that -- and we are not going to give you more detail than what I am about to tell you so don't ask. We had modest losses in the fourth quarter. There is no reason to have any losses going forward. The risk from the date of the investment bank got and they have done a good job continuing to derisk it are down, I am going to say, another 50%. +So obviously, there is still risk. It is still a portfolio which has got -- the average duration I am going to say is 2, 2.5 years left. So if you did nothing, it is going to diminish dramatically over time, but I think we have got it well-controlled at this point. There could be some volatility because of the nature of it. It has got some idiosyncratic exposures in there, but we think we are fine. We don't think there's anything that anyone needs to worry about anymore. + +-------------------------------------------------------------------------------- +Jim Mitchell, Buckingham Research Group - Analyst [165] +-------------------------------------------------------------------------------- + + Okay, that's helpful. And then maybe just on the deposit growth, I think you were up on a period-end basis $54 billion. Is there any way to kind of get a sense of how much of that is stickier? Was that just sort of fiscal cliff concerns or was it the TAG-related deposits? Do you have any sense on what was driving that and if it is just more sustainable organic growth that would be helpful? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [166] +-------------------------------------------------------------------------------- + + You have got to do it a little bit by business because I think in consumer mostly sticky, but it is probably a little bit of TAG -- like you guys had an estimate for that. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [167] +-------------------------------------------------------------------------------- + + Yes, like (inaudible) plus or minus. Mostly those deposits we would consider core and sticky. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [168] +-------------------------------------------------------------------------------- + + Right. And then TS&S is a lot of seasonal year-end deposits, so it bounces all over the place. Asset management I put in the sticky category. Commercial Bank has been kind of flat, but it is sticky. + +-------------------------------------------------------------------------------- +Jim Mitchell, Buckingham Research Group - Analyst [169] +-------------------------------------------------------------------------------- + + Okay, that's helpful. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [170] +-------------------------------------------------------------------------------- + + It is flat because the loans are starting to grow and it is huge. Commercial has $190 billion of deposits. I think that number was $100 billion 3.5 years ago. So they have a lot of money there. We actually expect that might have come down one day as companies start to grow and expand more aggressively, which would be a good thing. + +-------------------------------------------------------------------------------- +Jim Mitchell, Buckingham Research Group - Analyst [171] +-------------------------------------------------------------------------------- + + Okay, thanks. + +-------------------------------------------------------------------------------- +Operator [172] +-------------------------------------------------------------------------------- + + Guy Moszkowski, Autonomous Research. + +-------------------------------------------------------------------------------- +Guy Moszkowski, Autonomous Research - Analyst [173] +-------------------------------------------------------------------------------- + + Yes, good morning. This first question is a little bit short term, so forgive me, but the CFTC, as somebody mentioned earlier, did push back the timing of some of the OTC reforms with respect to central clearing. And I guess my question is, from your point of view, all other things being equal, should we expect stronger fixed income revenues as a result of that in the first half than we otherwise might have? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [174] +-------------------------------------------------------------------------------- + + That's a woulda', shoulda', coulda'. I don't know, Guy, the answer to that question. I think if they had been put in place -- it depends how they would have ultimately been put in place. So they were delayed to get more work and how it gets done. I think if they had been put in place for JPMorgan where the rules constrained us overseas, but didn't constrain other companies overseas, we would be down from what we might now have. If the rules were put in place as we can compete freely in Frankfurt, London, Singapore and Shanghai, my guess is our US revenues would have been down a little bit, our international revenues would have been up a little bit. + +-------------------------------------------------------------------------------- +Guy Moszkowski, Autonomous Research - Analyst [175] +-------------------------------------------------------------------------------- + + Okay, that is actually real helpful. Thanks. My other couple of questions have to do with your outlook slide. First of all, on corporate private equity, I just want to make sure that there is no distinction that I should read. When you talk about treasury and CIO, you talk about the net loss of $300 million plus or minus specifically in the first quarter. When you talk about the other corporate $100 million, you don't mention a timeframe. So does that mean that you expect more potential variability over say the course of this year in the treasury and CIO number than the other number, which is more of a run rate? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [176] +-------------------------------------------------------------------------------- + + No, so private equity is $8 billion invested. We expect to earn a return on that. We are obviously getting a great return on it, so that is lumpy, but it should be more than $50 million on average. Treasury -- think of treasury as NII. It is very predictable. The NII (inaudible) by quarter. That number will go down a little bit. That is just how we allocate capital and funds between all the business units. And then how we invest the assets. +So we can change that tomorrow by having longer duration in our investment portfolio. The lumpier part of treasury and CIO is when we have mark-to-market gains and securities gains. That bounces around a little bit and again some of that is discretionary. So we don't look at that -- we should almost call it a net loss, and that number -- I think the $300 million will come down over time, not go up for a whole bunch of different reasons, which I won't go through right now. +And then the other corporate -- that has net allocations, BOLI, COLI, taxes, all these lumpy items and we will just try to tell you it should be plus 100 -- it could be on average 100, plus or minus a couple hundred because of lumpiness of those items. Like corporate taxes are lumpy for a whole bunch of different reasons and so our numbers would be 100 on average. And we always explain the difference if there is ever a big difference there. + +-------------------------------------------------------------------------------- +Guy Moszkowski, Autonomous Research - Analyst [177] +-------------------------------------------------------------------------------- + + So if I add the two together, and obviously we know there is lumpiness, but just adding those two numbers together at face value, we are talking about a quarterly loss of a couple hundred million. You used to guide to quarterly earnings of I think it was $100 million to $200 million on that kind of combined line. So if I was trying to assess what the swing had been relative to a few years ago, how much of it would you say is just the compression of net interest margins and how much of it is moving away from some of the, pardon the word, but exotic investment strategies that CIO used to --? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [178] +-------------------------------------------------------------------------------- + + It has got not a damned thing to do with exotic investment strategies, zero, nada, nothing, okay? The bulk of those assets are always invested conservatively, AA plus. We had to do it around the world, so deposits around the world, etc., nothing to do with that. It has all got to do with some of the NIM compression that shows up there because obviously investment portfolio yield has gone down a little over 2%. It was 4% three years ago and how we allocate capital and things like that. +The changes you have seen. Some of them are the differences due to the regulatory changes of B3, RWA and stuff like that. So we will try to make this a little bit clearer going forward. But on average, that number will come down, not go up over time. + +-------------------------------------------------------------------------------- +Guy Moszkowski, Autonomous Research - Analyst [179] +-------------------------------------------------------------------------------- + + Okay, that's fair. And then the final question I have is just on the [firmwide] right below that. You talked about capital allocations a moment ago. It sounds like your LOB return on equity targets are, like you say here, are going to come down for some units and therefore overall but the corporate guidance is the same. So does that mean that basically all this change just is because you're allocating more capital out to the business units and you will have less at the corporate parent? That is the only real change? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [180] +-------------------------------------------------------------------------------- + + Yes, when we allocate the new Basel III operational capital debt, the capital allocations will go up mostly to the CIB by I am going to say 20% or so and to the commercial bank by 20% or so or maybe a little bit more than that. And that will obviously change the return targets for those units. It will also be very healthy, so it will just come down. The Company will be exactly the same. +I mean so we just have -- I think when we allocate all this stuff intelligently, it will actually probably end up driving better returns over time as people learn how to manage it a little bit differently. So we will be allocating -- again, it eventually will show more. We will be allocating out -- think of it as everything at one point, LCR, G-SIFI, Basel III, Basel II, whatever comes down the pike will be allocated out so our managers can manage through it. + +-------------------------------------------------------------------------------- +Guy Moszkowski, Autonomous Research - Analyst [181] +-------------------------------------------------------------------------------- + + Got it. That's great. Thank you very much. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [182] +-------------------------------------------------------------------------------- + + And the other thing we haven't decided permanently is how you look at each business because my feeling has been, this is open for debate, is that the business should be capitalized the way its competitors are going to be capitalized so they would feel free -- they are free to compete in that category. I think the people lump their capital ratios around their competitors. That could be very hard for someone for example to be -- run with 7.5% capital and all their competitors are at 10% or vice versa. + +-------------------------------------------------------------------------------- +Guy Moszkowski, Autonomous Research - Analyst [183] +-------------------------------------------------------------------------------- + + So you are going to try to move both capital and cost allocations more to each unit being on a stand-alone basis, is that right? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [184] +-------------------------------------------------------------------------------- + + No, cost is cost. It has nothing to do with that. I am talking about capital -- saying we may capitalize the commercial bank at 8.5% and the investment bank at 10%. It may not be 9.5% for everybody because they have to operate, they have to compete in different environments. So that is where you just -- we just haven't figured out exactly how to do that yet. + +-------------------------------------------------------------------------------- +Guy Moszkowski, Autonomous Research - Analyst [185] +-------------------------------------------------------------------------------- + + Fair enough. Thanks. + +-------------------------------------------------------------------------------- +Operator [186] +-------------------------------------------------------------------------------- + + We have no further questions at this time. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [187] +-------------------------------------------------------------------------------- + + Folks, thank you for spending time with us. Marianne, great job. Folks, we will talk to you all soon. Thank you. + +-------------------------------------------------------------------------------- +Operator [188] +-------------------------------------------------------------------------------- + + This concludes today's conference call. You may now disconnect. + + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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Earnings Conference Call +07/12/2013 08:30 AM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Jamie Dimon + JPMorgan Chase & Co - Chairman & CEO + * Marianne Lake + JPMorgan Chase & Co - CFO + +================================================================================ +Conference Call Participiants +================================================================================ + + * Guy Moszkowski + Autonmous Research - Analyst + * Mike Mayo + CLSA - Analyst + * Andrew Marquardt + Evercore Partners - Analyst + * David Hilder + Drexel Hamilton - Analyst + * Gerard Cassidy + RBC Capital Markets - Analyst + * Betsy Graseck + Morgan Stanley - Analyst + * Chris Whelan + Carrington Investment - Analyst + * Moshe Orenbuch + Credit Suisse - Analyst + * Nancy Bush + NAB Research - Analyst + * Brennan Hawken + UBS - Analyst + * Christopher Wheeler + Mediobanca - Analyst + * Matt Burnell + Wells Fargo Securities - Analyst + * Erika Penala + BofA Merrill Lynch - Analyst + * Eric Wasserstrom + SunTrust Robinson Humphrey - Analyst + * John McDonald + Sanford C. Bernstein & Co. - Analyst + * Jim Mitchell + Buckingham Research - Analyst + * Paul Miller + FBR Capital Markets - Analyst + * Chris Kotowski + Oppenheimer & Co. - Analyst + * Matt O'Connor + Deutsche Bank - Analyst + +================================================================================ +Presentation +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Good morning, ladies and gentlemen. Welcome to JPMorgan Chase's second quarter 2013 earnings call. This call is being recorded. Your line will be muted for the duration of the call. We will now go live to the presentation. Please standby. +At this time, I would like to turn the call over to JPMorgan Chase's Chairman and CEO, Jamie Dimon, and Chief Financial Officer, Marianne Lake. Ms. Lake, please go ahead. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [2] +-------------------------------------------------------------------------------- + + Thank you, Operator. Good morning, everyone. I'm going to take you through the earnings presentation, which is available on our website; and please refer to the disclaimer regarding forward-looking statements at the back of the presentation. +So turning to page 1, we carried strong momentum into the second quarter, with net income of $6.5 billion and an EPS of $1.60 a share on revenue of $26 billion, up 13% year-on-year and flat versus a seasonally strong first quarter, with a return on tangible common equity of 17%. And you can see on the page that we've highlighted several significant items up front here. A $950 million reserve release in mortgage. And this quarter we saw net charge-offs less than 50% of what they were a year ago. A $550 million reserve release in Card, with charge-offs remaining historically low; and $600 million of expenses for additional litigation reserves in Corporate. In addition, the results for the quarter included a $355 million DVA gain in the Corporate and Investment Bank. +Outside of these four items, we had a number of other smaller items, both positive and negative in the quarter, which offset each other, many of which I'll call out as we go through the presentation. And we want to be very transparent with you, we don't count items like reserve releases and other non-core items when we think about our own performance. So if we adjust for all of these items both big and small, our return on tangible common equity would have been about 15%, reflecting strong underlying core performance. +This quarter, a couple of important themes, the Markets environment in June, as well as several capital developments. But just a quick note on each. Rising long term rates and higher levels of volatility in June have an impact both on the quarter as well as in terms of our mortgage outlook guidance. Our Market businesses held up well in June and our Asset Management platform outperformed during the backup. And importantly, remember that given the firm's positioning, rising rates will drive significant benefits in higher NII over time. However, in the near term, higher long term rates and wider spreads drove a significant reduction in the unrealized gains in our securities portfolio, or a reduction in AOCI, which did impact Basel III capital negatively. Despite that impact, we were able to add to our capital and improve capital ratios as we began to realize some of the run-off and model benefits that we've previously guided you to. And finally, higher rates will have a significant impact on mortgage refi volumes and margins in the second half of the year. +On capital, we've added a new page in the debt on leverage, which I'll cover in a moment; but our headline capital number is a Basel III Tier 1 common ratio of 9.3%, including the impact of the final Basel III capital rules approved this month by our regulators. In general, the approvals were the same or similar to the NPRs, and in that sense were broadly in line with our expectations, including the confirmation of no exception for AOCI. The estimated impact on our ratio was a modest benefit. +So on page 3 let me take you through the details. We ended the quarter with Basel III Tier 1 common of $148 billion, up from the prior quarter. We've put a Basel III capital walk here on the page in the blue call out box, which steps you through each component of the change quarter-on-quarter. Our Basel III Tier 1 common ratio before the impact of final US rules increased to 9.1% from 8.9%, even after the 20 basis points impact from the change in AOCI. This impact was offset by a $40 billion reduction in risk -weighted assets, reflecting impact of portfolio run-off as well as lower levels of risk. So then adding in the benefit of final rules, which was principally related to changes in MSR rules and securitization benefits, our ratio at the quarter end was estimated at 9.3%. And as you know, although we reflect our best understanding of all the rules in our ratio, we don't pull forward the impact of passive run-off or model enhancements, some of which we saw this quarter. Together, these will deliver approximately an additional 75 basis points of benefits by the end of 2014; and we remain committed to reaching a 9.5% Basel III Tier 1 common ratio by year-end. +Briefly on liquidity. In addition to building our capital, we accelerated compliance with the proposed Basel III liquidity coverage rules. And not only did we become compliant with the rule during the quarter, but at quarter end, our estimated ratio was 118%, and we feel great about the progress we've made. Although there can be short-term volatility in the number, you should expect that we will run around this level going forward. And to finish on page 3 in the bullets, the Board increased the quarterly dividend to $0.38 a share from the previous $0.30; and during the quarter we repurchased $1.2 billion of common equity. As a reminder, that's $1.2 billion of the $6 billion CCAR authorization. +So turning to page 4, we've added this page to help walk you through our current thoughts on the new proposals regarding Basel III leverage. Let me start with two things. We believe the leverage ratio is an appropriate complement to a Tier 1 common ratio if properly calibrated, and our Holding Company leverage ratio is estimated at 4.7% at the end of the quarter, based upon the US proposed rules. And to be clear, these rules do not reflect the most recent Basel proposal which would further increase our leverage balance sheet. Just a few comments on the proposal in the US. The denominated build on GAAP assets with add-ons for derivative potential future exposures and off-balance sheet commitments, resulting in a gross up for us of approximately $1 billion. And remember, included on our balance sheet is over $450 billion of cash and other high quality liquid assets, which we think there's a strong argument that they should not attract capital at these levels. +So I'm going to take you through the analysis on the page. We started with analysts' estimates for net income, and we held our dividend flat and assumed repurchases generally consistent with our current levels. Given those assumptions, we would be able to add approximately 60 basis points to the leverage ratio by the end of 2014. Additionally, we will continue to recalibrate our Tier 1 capital through the issuance of preferreds. And finally, we will take appropriate actions to reduce our leverage assets, which may include some of the points on the slide, for example, repricing or restructuring of commitments or unwinding certain derivative positions. And if you take those together, this could add another approximately 100 basis points over time, for a total of up to 160 basis points. So we will adjust our business, but we do expect the Holding Company to be able to be compliant in early 2015, with the bank to follow. Of course, a caution that the timeline could be impacted if there are significant changes to the rules which are not yet final. +Changing gears, let's turn to the business performance, starting on page 5 with Consumer and Community Banking. The combined Consumer businesses generated $3.1 billion of net income for the quarter on $12 billion of revenue, with an ROE of 27%. Just a quick look at the franchise. We ended the quarter with over 5,600 branches, over 19,000 ATMs, and we now have nearly 1,700 Chase Private Client locations. We continue to see really strong growth in the underlying drivers for the Consumer businesses. Deposits were up over $40 billion year-on-year, an increase of 10%, customer attrition levels remain historically low, and our active mobile customer base grew by 32% year-on-year. So we're adding customers, we're retaining them through superior customer experience, and we're deepening our relationships with them. Also, Mortgage and Auto originations showed strong growth, up 12% and 17% year-on-year respectively; and we have record Credit Card sales volumes of $105 billion, up 10% year-on-year, and record client investment assets of $172 billion, up 16%. +Turning to page 6, Consumer and Business Banking. Net income of close to $700 million and an ROE of 25% on net revenue of $4.3 billion, down 1% year-on-year and up 3% quarter-on-quarter. While we continue to see pressure on deposit margins, five basis points down in the quarter, this continues to be largely offset by very strong growth. And on the non-interest revenue side, we're seeing strong growth in both debit and investment revenue. Expenses are up year-on-year, reflecting the investments we're making in the business, including branch builds, as well as the absence of some one-time items that benefited the prior year. +During the quarter, we had record Investment sales of $9.5 billion, up 53% year-on-year. And a note that approximately 70% of those sales are managed money, driving strong recurring revenue for the business up 13% year-on-year. Average business banking loan balances are flat quarter-on-quarter, up 4% versus last year; and you can see here in the drivers that the loan production stabilized just above the very low levels we saw in the first quarter. We believe that we are maintaining share despite increased competition; and the pipeline is up relative to the first quarter, which should support origination levels in the second half of the year. +Turning to page 7 and Mortgage Banking. Overall Mortgage Banking net income was $1.1 billion, with an ROE of 23%. At the top of the table, looking at the first blue highlighted line, reduction in pretax income was $582 million. Top line production revenue, excluding repurchases, was up slightly quarter-on-quarter, with a higher reported gain on sale pretax margin of 116 basis points more than offsetting lower closed loan volumes, down 7%. $49 billion of mortgage production saw a change in mix this quarter, as the purchase market continued to recover. +Our purchase volumes increased over 40% quarter-on-quarter and contributed 36% to volumes, up from 23% last quarter. And despite the strong start in April, the environment in late May and June drove mortgage rates up significantly, around 100 basis points. This pressure has continued into July and we expect it could have a significant impact on the refinance market side in the second half of the year. So if mortgage rates stay at or above current levels, the market could be reduced by an estimated 30% to 40%. Although we will adjust capacity, expense reductions will lag volume reductions and will challenge profitability and production. +Moving down to Servicing, pretax income of $133 million, up quarter-on-quarter and year-on-year, on lower expenses and modest gain in the MSR. Servicing expenses of $715 million decreased quarter-over-quarter, in line with our expectations, and we continue to see Servicing, or expect Servicing costs, to decrease to $600 million by the fourth quarter. At the bottom of the table, Real Estate portfolio pretax was $1.2 billion. Run-off of the legacy portfolio continued; although in the quarter, given the positive economics of retaining certain loans, we added close to $5 billion of mortgage loans to our portfolio, which is up $1.3 billion quarter-on-quarter, and we expect to be able to sustain these levels in the second half. +On Credit, delinquencies and foreclosure in our portfolio are each down around 10% quarter-on-quarter. Net charge-offs continue to come down, less than $300 million this quarter, which was in line with our guidance, and we released $950 million of reserves. The majority of this release related to the impact of lower severities, reflecting real and sustainable HTI improvement. Going forward, we expect quarterly net charge-offs of less than $250 million; and as credit trends continue to improve, expect additional reserve releases in the next several quarters. +Turning to Card Merchant Services and Auto on page 8. Net income of $1.2 billion, up 21% year-on-year, with an ROE of 32%, or 23% if you exclude reserve releases, reflecting excellent underlying performance in the business. Revenue of $4.7 billion was up 3% year-on-year, and despite strong volumes, down slightly quarter-on-quarter as a result of spread compression. In Card, year-on-year growth in both sales and merchant processing volumes was strong and consistent, at 10% and 15% respectively. And importantly, we saw a stabilization of outstandings at the end of the second quarter after 15 quarters of net run-off. And we believe we've reached an inflection point and expect some modest growth from here. +Expenses are down year-on-year, primarily driven by lower remediation expenses on our legacy product. And the net charge-off rate continues to be very low and we released $550 million of credit card loan loss reserves this quarter. This reflected both the continued improvement in early stage roll rates, as well as higher than expected levels of pay downs on modified loans. The net charge-off rate was 3.31%, down over 100 basis points year-on-year. And if we continue to see favorable roll rates, as well as our modified loans continuing to pay down, we will see incremental reserve releases in the second half of 2013. And before we move on, a few words on Auto. Originations up 17% year-on-year, reflecting market share gains and driving loan balances up 5%. +Moving on to slides 9 and 10 and the Corporate Investment Bank. A strong second quarter performance, which included a DDA gain of $355 million. This was versus a gain in the same quarter of last year of $755 million, both of which are shown in the credit adjustments line. As usual, we'll focus on the numbers excluding DDA. $2.6 billion of net income was the highest second quarter net income since 2009, up 37% year-on-year and 3% quarter-on-quarter. Revenue of $9.5 billion was up 16% year-on-year, and the business delivered an ROE of 19%. Total banking revenue was $3.1 billion, up 17% year-on-year, on higher IDCs of $1.7 billion, up 38%, primarily driven by strong debt and equity underwriting. We continue to be Bank Number 1 year-to-date in IDCs; and despite weaker credit markets towards the end of the quarter, we have near record debt underwriting fees in the first half of 2013. And equity capital markets, we have the Number 1 wallet share for the first half of the year. +Moving on to Markets revenue, which was up 18% year-on-year in line with our guidance, a very strong performance, particularly given the challenging environment in June, reflecting strong client flows throughout the quarter, the diversification of the business and trading risk discipline. Fixed Income Markets revenue of $4.1 billion was up 17% year-on-year, with credit and spread-related products benefiting from less Euro zone uncertainty and a stronger US housing market. Equity Markets of $1.3 billion was up 24% year-on-year, with strong client flows in cash and equity derivatives. And before we leave Markets, just a quick update on OTC clearing. The implementation of Phase II in June went very smoothly, although volumes were relatively light at launch, we have seen activity pick up and we feel we have the right level of participation. Security Services revenue of $1.1 billion was up 1% year-on-year, and within this number, you should note growth in custody fees is in line with asset growth, but is offset by declines in agent lending as well as lower volumes in clearance and capital management. +Just a comment on credit. Trends are stable at low levels, with small net recoveries for the quarter. Loans were down 6% quarter-on-quarter, driven by lower balances in trade and conduits; and expenses were up 8% year-on-year, driven primarily by higher comp on higher revenues, with a comp to revenue ratio excluding DDA of 31% for the quarter. Finally on this page, at the bottom of the driver section, you see the CIB average VAR which continued to decline to $40 million, reflecting generally lower levels of risk but also lower volatility across asset classes. A note that the increased volatility in June did, however, drive spot VAR up higher to over $50 million. Before we skip over page 10, just a comment. If you take a look at the numbers for the first half of 2013, you can see we continued to make great progress in the international space and had particular strength in Asia during this quarter. +Turning to page 11. Commercial Banking saw net income of $621 million on revenue of $1.7 billion, with an ROE of 18%. Revenue was up 3% quarter-on-quarter, despite the softer lending environment driven by higher average loan balances, stable spreads, and positive momentum on cross-sale and IDCs. Although end of period loans were flat this quarter, we saw very strong growth in Commercial Real Estate, up 3% and gaining share, offset by lower corporate lending. Our clients have excess cash and are keeping their utilization rate low, but we've also seen the continuation of competitive pricing and aggressive structuring. We're holding the line and choosing quality over growth; and this, of course, is reflected in our strong credit performance. But we're still adding very good clients and doing many more business with our existing clients. As we look forward, we expect continued strong growth in the Real Estate business, given our competitive position. And for C&I loans, pipelines are up from the first quarter and deal activity feels like it may be turning. We are expecting a more constructive second half, and therefore should see some growth; but the environment remains competitive. +Turning to page 12 and Asset Management. An excellent quarter, and despite challenging markets in June, we saw net income of $500 million, up 28% year-on-year and 3% quarter-on-quarter, with an ROE of 22%. $2.7 billion of revenue, up 15% year-on-year, reflects an increase in management fees driven by strong long-term net inflows, $25 billion this quarter, marking the 17th consecutive quarter of long-term inflows; and higher equity in Fixed Income markets, up 12% based on our business mix. We also saw higher performance fees, driven by strong fund returns, and record loan balances, up $16 billion year-on-year across products and geographies. +A moment on expenses. Growth and performance in the business led to 11% year over year expense growth. But as our investments season, the business is delivering positive operating leverage, which you can see in the pretax margin which is 30%, up from 27% last year. We ended the quarter with assets under management of $1.5 trillion, up 9% year-on-year, and client assets of $2.2 trillion, up 10%, despite small net outflows in June. However, the breadth of our platform should enable us to continue to gather net new assets globally looking forward, and we delivered strong relative performance in both Fixed Income and Equities. +Moving on to page 13 and Corporate and Private Equity. A net loss of $552 million for the quarter. Private Equity generated net income of just over $200 million, which included over $400 million of gains, in part driven by investments that are in active sales discussions. Treasury and CIO net loss was $429 million, driven by negative NII due to continued low rates and slower reinvestment, as well as a change in portfolio mix, shifting from higher yielding securities to LCR-eligible securities and cash. The results also included net securities gains and a modest loss on (Inaudible) redemption which we guided to last quarter. Excluding the net of these two items, CIO Treasury will have generated a net loss of about $350 million, which is generally in line with our guidance; and our quarterly guidance remains unchanged. +Finally, Other Corporate. A net loss of $335 million includes the $600 million of pretax expense for additional litigation reserve in the quarter. Excluding litigation, Other Corporate was around $100 million net income, in line with our guidance. And again, our guidance, which does exclude litigation and significant items, remains unchanged for Other Corporate. +Turning to page 14 and net interest margin. Net interest income was down slightly and core NIM was down 23 basis points quarter-on-quarter. We acknowledge this is larger than you may have expected, but let me give you some color. Importantly, it was principally a result of actions we took to build liquidity to comply with Basel requirements more quickly, which we believe is a strong positive; and to a degree, it was also our pull forward compression we guided to over time. So we've added a table on this slide which shows our cash balances and how they progress over time, and what you can see circled is that our cash was up more than $100 billion quarter-on-quarter, with other interest-earning assets being broadly flat. This changed the relative mix and also the size of our interest-earning assets and drove core NIM down the 18 basis points we circled on the page. While the increase in cash does reflect accelerated LCR compliance, it does also reflect very strong deposit growth and slower reinvestments and a little less robust loan growth. The balance of the reduction in NIMs relates to loan yield compression, partially offset by the lower cost of debt. So going forward, all else being equal, what we expect from here is relatively stable NIM in the second half of the year and net interest income to increase modestly next quarter. +So finally on slide 15, here's our outlook. I've covered these items as we went through the presentation. So in wrap up, overall a very strong quarter, returning 17% on tangible common equity with excellent underlying performance across businesses, while making significant progress on capital and liquidity ratios; and the firm overall is positioned to benefit from a higher rate environment. +Thank you for joining us. Operator, you can open up the call for Q&A. + + +================================================================================ +Questions and Answers +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) +Our first question comes from John McDonald of Sanford Bernstein. + +-------------------------------------------------------------------------------- +John McDonald, Sanford C. Bernstein & Co. - Analyst [2] +-------------------------------------------------------------------------------- + + Good morning. Hello, Marianne. I was wondering if you could -- do you have any sense that you could give us of where you stand on the leverage ratio at the bank level today relative to the 6% requirement? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [3] +-------------------------------------------------------------------------------- + + Hello, John. Good morning. So we don't disclose the bank leverage ratio. But it is lower than the Holding Company, so we would have a further way to go. As we said, we intend to be compliant at the Holding Company level by the beginning of 2015 and work on bank compliance shortly thereafter. + +-------------------------------------------------------------------------------- +John McDonald, Sanford C. Bernstein & Co. - Analyst [4] +-------------------------------------------------------------------------------- + + Okay. So shortly thereafter, maybe within a quarter or two? Can you give us any feel there, or -- just to get a sense of --? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [5] +-------------------------------------------------------------------------------- + + John, obviously the rules are fairly new, and still a proposal and not final. So there's work to do before they get finalized. We're working through all of the things we'd need to do to comply. I would say we would aim to be compliant by the end of 2015, but we need to go do more detailed plans and we'll get back to you with some more specifics. + +-------------------------------------------------------------------------------- +John McDonald, Sanford C. Bernstein & Co. - Analyst [6] +-------------------------------------------------------------------------------- + + Okay. And you mentioned the mitigation you can do at the Holding Company. Is there mitigation you can also do to help specifically the bank level ratio in terms of assets that could be shifted to the parent or equity that could go from the Hold Company to the sub and things like that? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [7] +-------------------------------------------------------------------------------- + + Yes, all of those things could be considered and would be considered. + +-------------------------------------------------------------------------------- +John McDonald, Sanford C. Bernstein & Co. - Analyst [8] +-------------------------------------------------------------------------------- + + Okay. And then on the liquidity ratio, why have you decided to run with this level of cushion to LCR and why the acceleration in getting there now? Anything driving that, in particular? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [9] +-------------------------------------------------------------------------------- + + So in terms of the cushion, while it's not scientific, there is a volatility in that number inherent in actually deposit flows. So we do see some things in deposit flows, particularly wholesale flows, and that could span a quarter end and drive the ratio up or down some. So it's prudent to run at a ratio above 100% and around about this level. And just in terms of acceleration, we just wanted to get there more quickly. The opportunity presented itself, so nothing more than that. + +-------------------------------------------------------------------------------- +John McDonald, Sanford C. Bernstein & Co. - Analyst [10] +-------------------------------------------------------------------------------- + + Okay. And could you give us some of the assumptions behind your outlook for stable net interest margin and modest net interest income growth in the back half of the year, just in terms of what you're assuming on rates and loan growth, and what are the puts and takes on your outlook? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [11] +-------------------------------------------------------------------------------- + + So it's a great question, John, because as you alluded to in the question, there's a large number of moving parts in terms of the forecast, including points of yield on rates, which as you know have been choppy over the last several weeks. So we base our projections on modest loan growth and on our understanding of the implied rate curves and that they could all -- they could change. Also deposit flows, as you've seen, have been very, very strong. So we accelerated our LCR compliance back to the majority of the NIM compression we were previously expecting and guiding you to forward; and consequently, we expect to be more stable, with some loan yield compression being offset by lower cost of debt. + +-------------------------------------------------------------------------------- +John McDonald, Sanford C. Bernstein & Co. - Analyst [12] +-------------------------------------------------------------------------------- + + Okay. And then finally, I'm not sure if I saw it in here or not, but can you remind us how much you benefit from higher rates? And which rates in particular are most helpful for you, if you can delineate between the 10-year and the shorter based rates? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [13] +-------------------------------------------------------------------------------- + + I'll just give you two data points, and then you can maybe go and have a look at them. But I think in the Q, we disclose a couple of things. The first is a bit of a sweetener which says that over 12 months, it would deliver about $900 million of additional NII. It's not exactly what we've seen, but-- + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co - Chairman & CEO [14] +-------------------------------------------------------------------------------- + + That's the 10-year going up 100 basis points. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [15] +-------------------------------------------------------------------------------- + + That's right. That's the 10-year going up 100 basis points. I'm sorry. And that's not exactly what we've seen, but it's the closest thing to what we're seeing right now. And then the other thing we've disclosed is on a parallel shift of 100 basis points, so if your short rates go up 2%, that would deliver just over $2 billion over 12 months. And not to say that recurs, but it takes time to build up to that. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co - Chairman & CEO [16] +-------------------------------------------------------------------------------- + + And that's interest rates only, not Mortgage volume, Investment Banking volume. That's just isolating interest rates only, assuming the Company invests the way we're planning to. + +-------------------------------------------------------------------------------- +John McDonald, Sanford C. Bernstein & Co. - Analyst [17] +-------------------------------------------------------------------------------- + + And then that's current numbers, that's last Q or that's as of right now? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [18] +-------------------------------------------------------------------------------- + + Those were the numbers from the last Q, and they are not meaningfully changed right now. + +-------------------------------------------------------------------------------- +John McDonald, Sanford C. Bernstein & Co. - Analyst [19] +-------------------------------------------------------------------------------- + + Okay. And last thing for me, on reserve release, how can we gauge, if it is possible at all, how long this can go on for? Are there any base metrics that you think you can't go below that we could look at as a percent of loans or a percent of normalized charge-offs? Any help you can give us to gauge how much might be left on reserve release front? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [20] +-------------------------------------------------------------------------------- + + Yes. So John, I would point you to -- and I can't remember the page, I apologize -- but we put a page in Investor Day that talked about what we thought through the cycle charge-off rates were for each of our businesses. And so what I would do is look at -- take NCI loans and a reserve balance at the end of the period of $3.3 billion, take a look at that page and figure out what a more normal sort of charge-off rate, and therefore reserve balance, would be. And that will be in large part a reduction over the course of the next several quarters. So we expect it to be a journey to get to that level throughout 2014. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co - Chairman & CEO [21] +-------------------------------------------------------------------------------- + + And wholesale, we're kind of where we should be. We shouldn't expect much different. Credit Card, maybe a little bit more, but put that in the hundreds of millions. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [22] +-------------------------------------------------------------------------------- + + Yes. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co - Chairman & CEO [23] +-------------------------------------------------------------------------------- + + And on Mortgage, I think we said Investment Day, eventually it will be $1 billion to $1.5 billion, within a couple years. + +-------------------------------------------------------------------------------- +John McDonald, Sanford C. Bernstein & Co. - Analyst [24] +-------------------------------------------------------------------------------- + + Got it. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co - Chairman & CEO [25] +-------------------------------------------------------------------------------- + + And PCI, if we have home improvement, we may see some reduction in PCI loan loss reserves. Purchase credit (Inaudible). + +-------------------------------------------------------------------------------- +John McDonald, Sanford C. Bernstein & Co. - Analyst [26] +-------------------------------------------------------------------------------- + + You haven't done that yet in terms of taking the PCI out yet, right? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [27] +-------------------------------------------------------------------------------- + + No, we haven't done that yet, John. But the reserve release we took at NCI was driven in large part by lower severity. So if this continues, you might see some of that. + +-------------------------------------------------------------------------------- +John McDonald, Sanford C. Bernstein & Co. - Analyst [28] +-------------------------------------------------------------------------------- + + Great. Okay. Thank you. + +-------------------------------------------------------------------------------- +Operator [29] +-------------------------------------------------------------------------------- + + Our next question comes from Brennan Hawken of UBS. + +-------------------------------------------------------------------------------- +Brennan Hawken, UBS - Analyst [30] +-------------------------------------------------------------------------------- + + Good morning. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [31] +-------------------------------------------------------------------------------- + + Good morning. + +-------------------------------------------------------------------------------- +Brennan Hawken, UBS - Analyst [32] +-------------------------------------------------------------------------------- + + So another quick question on leverage. Could you help me understand why it takes until Q1 '15 for the Bank Holding Company to add the 30 basis points necessary to the leverage ratio? It looks like what you laid out puts you well above that earlier. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [33] +-------------------------------------------------------------------------------- + + Yes. So Brennan, what we laid on the page was an illustration. And you're absolutely right. What it shows you is that we want to be able to close that gap much more quickly, and so that might very well be what happens. We just aren't coming out now with a target of achieving it over the course of the next one or two quarters, because we have other objectives, including the continuation of being able to have some capital distributions to you guys that we want to be able to decide when we do CCAR at the end of the year. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co - Chairman & CEO [34] +-------------------------------------------------------------------------------- + + We'll be able to do it pretty quickly when we know what it actually is. We don't want to start making actions that affect customers way in advance of knowing the real final rules. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [35] +-------------------------------------------------------------------------------- + + Right. + +-------------------------------------------------------------------------------- +Brennan Hawken, UBS - Analyst [36] +-------------------------------------------------------------------------------- + + Sure. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [37] +-------------------------------------------------------------------------------- + + But what you took away from the page was absolutely right. Closing that gap should not be difficult and could be more quick than this, but we wanted to be cautious. + +-------------------------------------------------------------------------------- +Brennan Hawken, UBS - Analyst [38] +-------------------------------------------------------------------------------- + + Understood. Thanks. And was there a change in the securities portfolio during the quarter, and maybe could you give us an update on where that duration stands? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [39] +-------------------------------------------------------------------------------- + + Yes. So we're not going to disclose the duration, but there was some changes in the portfolio as we moved out of non-eligible into eligible securities for LCR and also maintained more cash. So there were some changes. We also, as you saw, are making gains on sale and we were doing that. + +-------------------------------------------------------------------------------- +Brennan Hawken, UBS - Analyst [40] +-------------------------------------------------------------------------------- + + So would the bias be to assume that it would be towards shorter? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co - Chairman & CEO [41] +-------------------------------------------------------------------------------- + + No. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [42] +-------------------------------------------------------------------------------- + + No. + +-------------------------------------------------------------------------------- +Brennan Hawken, UBS - Analyst [43] +-------------------------------------------------------------------------------- + + Okay. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co - Chairman & CEO [44] +-------------------------------------------------------------------------------- + + Remember, when rates go up, certain mortgages lengthen and a whole bunch of different things take place. But in general, the portfolio is several year duration, a couple years duration, AA-plus; and obviously, it changes over time to manage into short exposures. + +-------------------------------------------------------------------------------- +Brennan Hawken, UBS - Analyst [45] +-------------------------------------------------------------------------------- + + Okay. And then just a quick follow-up on John's question. Is it generally right, given what you guys have disclosed and what you guys just verified and what we've seen in rates, if we assume that rates kind of stay where they're at, that you would get about 75% of that $900 million additional NII in 2014, if we stay status quo to where we are now? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [46] +-------------------------------------------------------------------------------- + + That's not a bad assumption. + +-------------------------------------------------------------------------------- +Brennan Hawken, UBS - Analyst [47] +-------------------------------------------------------------------------------- + + Okay. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co - Chairman & CEO [48] +-------------------------------------------------------------------------------- + + All things being equal. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [49] +-------------------------------------------------------------------------------- + + All things being equal, yes. (Laughter). + +-------------------------------------------------------------------------------- +Brennan Hawken, UBS - Analyst [50] +-------------------------------------------------------------------------------- + + Right. All things are never equal, but -- + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co - Chairman & CEO [51] +-------------------------------------------------------------------------------- + + Exactly. + +-------------------------------------------------------------------------------- +Brennan Hawken, UBS - Analyst [52] +-------------------------------------------------------------------------------- + + And then last one, just trying to think about maybe the potential to avoid some of the really big distraction that we saw this quarter around what is sort of becoming an annual event at the shareholder vote. Have you guys considered maybe articulating some kind of plan or a blue print or a map or what have you to get people comfortable with the future state of CEO Chairman roles way down the line when there is sort of a succession that is in place? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co - Chairman & CEO [53] +-------------------------------------------------------------------------------- + + The Board -- we're not going to tell you what Board deliberations are. But the Board obviously has talked to shareholders, a bunch of ideas. And also, we think we have some of the best corporate governance out there, including -- which I think is more important than the separation of Chairman and CEO -- that the Board should make the decision based on the circumstance of the time. They know the Company, the strategy, the people, that the Board always meets without the CEO, the Board in total sets the agenda, the Board is completely engaged in CEO compensation, the Board can hire and fire the CEO at will. And those practices, some are in our charters, some are not. But hopefully, it won't be the distraction it was last year. + +-------------------------------------------------------------------------------- +Brennan Hawken, UBS - Analyst [54] +-------------------------------------------------------------------------------- + + Yes, let's hope so. Thanks for the answers. + +-------------------------------------------------------------------------------- +Operator [55] +-------------------------------------------------------------------------------- + + Our next question comes from Betsy Graseck of Morgan Stanley. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [56] +-------------------------------------------------------------------------------- + + Hello. Thanks. Good morning. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [57] +-------------------------------------------------------------------------------- + + Good morning. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co - Chairman & CEO [58] +-------------------------------------------------------------------------------- + + Hello, Betsy. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [59] +-------------------------------------------------------------------------------- + + So one more question on page 4. Your $4.7 million is really close. We were looking for $4.5 million, so very much in line with what we're looking for. I'm just wondering why no bank sub disclosure. I realize that it's different, but -- and I heard your answer earlier. But I'm just wondering, why not just give us a number. Is it that there's too much uncertainty in estimating that denominator, you need understanding from the regulators as to what they're looking for? Could you just help us out on a little bit of the qualitative reasons? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [60] +-------------------------------------------------------------------------------- + + So Betsy, there's nothing underlying it. Let me just give you, hopefully, enough. It is a little bit lower than $4.7 million. And given that the ratio for the Bank Holding Company is 6%, then the gap is a little bit bigger. But measured in small terms of basis points, not more. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co - Chairman & CEO [61] +-------------------------------------------------------------------------------- + + And a lot of it's historical, how JPMorgan Chase got built through mergers over time, what ended up in the bank, what ended up in broker dealers. And we'll have to change our legal entities a little bit overseas. So we'll have to modify our legal entities to accomplish our the objectives, and we'll be able to do that over time. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [62] +-------------------------------------------------------------------------------- + + And over time, if we're able to push out, it will help. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co - Chairman & CEO [63] +-------------------------------------------------------------------------------- + + Exactly. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [64] +-------------------------------------------------------------------------------- + + Okay, and then-- + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co - Chairman & CEO [65] +-------------------------------------------------------------------------------- + + And remember, the overriding constraint is the 5%. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [66] +-------------------------------------------------------------------------------- + + Yes, I get that. If possible, I'd love to show you what our assumptions are and maybe we could understand where we differ. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [67] +-------------------------------------------------------------------------------- + + Yes, of course. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [68] +-------------------------------------------------------------------------------- + + Okay. And then separately, you put on here on this page the potential further add-ons for the Basel proposal. You're talking about the Basel consultative document that came out a couple weeks ago? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [69] +-------------------------------------------------------------------------------- + + Yes. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [70] +-------------------------------------------------------------------------------- + + Is there any sense as to what kind of basis point hit that is? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [71] +-------------------------------------------------------------------------------- + + We're not going to disclose it today, Betsy, and we can reconsider that, because we think there is some pretty fundamental issues with some of those proposals, not least of which is the absence of FIN-41 netting or netting on match securities financing, which we believe and are hopeful is going to be resolved. But it is a add-on and it's not insignificant. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co - Chairman & CEO [72] +-------------------------------------------------------------------------------- + + And the thing that I stress in derivative receivables but not taking benefit for collateral, which we know we get. And there are a lot of issues in there that need to be looked at and analyzed. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [73] +-------------------------------------------------------------------------------- + + Right, agreed. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [74] +-------------------------------------------------------------------------------- + + Betsy, to Brennan's earlier question, I think in the context of what we've laid out as illustratively being achievable, then timelines would solve the problem. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [75] +-------------------------------------------------------------------------------- + + Got it. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co - Chairman & CEO [76] +-------------------------------------------------------------------------------- + + The other important point is one of the things that Basel and all this stuff is supposed to do is harmonize global rules. This is clearly no longer harmonization, where we have one part of the world is talking about two times, with another part of the world is talking about. And I don't think there's any industry out there that would be comfortable with something like that in the long run. Because in the long run, that has a lot of effects that you can't determine, quarter-by-quarter. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [77] +-------------------------------------------------------------------------------- + + Yes. So part of the challenge is a higher denominator in one side and a higher ratio on the other side, right? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [78] +-------------------------------------------------------------------------------- + + Right. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [79] +-------------------------------------------------------------------------------- + + Just on HPI, HPI obviously rose significantly in the quarter. Could you give us an indication as to how much that helped RWAs? Was that a big piece of the driver? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [80] +-------------------------------------------------------------------------------- + + The HPI improvement on RWA has a bit of a lag to it. So while it did contribute to the reduction in our RWA, our reduction was principally run-off, and some model enhancement and some lower risk. But in part, that lower risk was driven by better HCI. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [81] +-------------------------------------------------------------------------------- + + So can you give us a sense as to given where HPI is today, what kind of benefit that would have on RWAs if there wasn't a lag? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [82] +-------------------------------------------------------------------------------- + + Yes, Betsy, it's a great question. And we will get back to you after the call. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [83] +-------------------------------------------------------------------------------- + + Okay, cool. Thank you. + +-------------------------------------------------------------------------------- +Operator [84] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Matt O'Connor of Deutsche Bank. + +-------------------------------------------------------------------------------- +Matt O'Connor, Deutsche Bank - Analyst [85] +-------------------------------------------------------------------------------- + + Good morning. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [86] +-------------------------------------------------------------------------------- + + Hello, Matt. + +-------------------------------------------------------------------------------- +Matt O'Connor, Deutsche Bank - Analyst [87] +-------------------------------------------------------------------------------- + + Just drilling down to some of the businesses here. Obviously June, as you mentioned and we've all seen, was very volatile in the credit markets and the fixed income markets in general. And I guess just a basic question, how did you do so well in fixed income? I know you commented early part of the month that things had deteriorated quite a bit, and I think some of us were surprised at how good it was in the quarter. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [88] +-------------------------------------------------------------------------------- + + So you know, June was a bit more challenging, and so it wasn't as strong as April and May. But it really comes down to the fact that we really do have a client driven business model. And the client flows, they held up. And so if you surround that with robust and strong trading risk discipline, that's pretty much how it turned out. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co - Chairman & CEO [89] +-------------------------------------------------------------------------------- + + And I think our folks in Emerging Markets also did a spectacularly good job, because I think you might see some real differentiation there from some other folks when all their numbers come out. + +-------------------------------------------------------------------------------- +Matt O'Connor, Deutsche Bank - Analyst [90] +-------------------------------------------------------------------------------- + + And is that just from managing a smaller inventory while the spreads were widening, or --? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co - Chairman & CEO [91] +-------------------------------------------------------------------------------- + + A little of everything. + +-------------------------------------------------------------------------------- +Matt O'Connor, Deutsche Bank - Analyst [92] +-------------------------------------------------------------------------------- + + Okay. And I guess from the other side, when we look at the comp rate at the Investment Bank, it was down, I think, 2% to 3% both linked quarter and year over year. What's driving that? Is it mix, is it the streamlining of the business lines that you announced about a year ago fully coming together, or just paying people less? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co - Chairman & CEO [93] +-------------------------------------------------------------------------------- + + I think we've been very consistent in how we look at comp and how we accrue it and things like that, after capital charges and by line of business, type of business and such, that it's just a change of mix and a change of capital, et cetera. + +-------------------------------------------------------------------------------- +Matt O'Connor, Deutsche Bank - Analyst [94] +-------------------------------------------------------------------------------- + + And I think you've been guiding towards 35%? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co - Chairman & CEO [95] +-------------------------------------------------------------------------------- + + Yes. + +-------------------------------------------------------------------------------- +Matt O'Connor, Deutsche Bank - Analyst [96] +-------------------------------------------------------------------------------- + + Should we think that maybe it's the lower end of that that is more sustainable? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co - Chairman & CEO [97] +-------------------------------------------------------------------------------- + + Possibly. + +-------------------------------------------------------------------------------- +Matt O'Connor, Deutsche Bank - Analyst [98] +-------------------------------------------------------------------------------- + + Okay. All right. Thank you. + +-------------------------------------------------------------------------------- +Operator [99] +-------------------------------------------------------------------------------- + + Our next question comes from Mike Mayo of CLSA. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA - Analyst [100] +-------------------------------------------------------------------------------- + + Good morning. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [101] +-------------------------------------------------------------------------------- + + Good morning. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA - Analyst [102] +-------------------------------------------------------------------------------- + + First, I just wanted to follow-up on the comment, so over the next 12 months NII should benefit by 75% of the $900 million? So in other words, you should -- in 2014, you should benefit by about $700 million -- + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [103] +-------------------------------------------------------------------------------- + + Mike, all other things being equal, that's not an unreasonable assumption. But as we said before, things are never equal. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA - Analyst [104] +-------------------------------------------------------------------------------- + + No, I understand. It's more art than science. So I guess your run rate of net interest income, that would be about 1.5% of that. Is that in the ballpark of how you think about it? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [105] +-------------------------------------------------------------------------------- + + I'm sorry, Mike, say that again? + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA - Analyst [106] +-------------------------------------------------------------------------------- + + So that benefit would equal about 1.5% of net interest income? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [107] +-------------------------------------------------------------------------------- + + Yes, I guess that's about right. Or maybe a little less. A little less, Mike. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA - Analyst [108] +-------------------------------------------------------------------------------- + + Okay. And when you say the benefit, it's the benefit of the 10-year increasing 100 basis points? I didn't fully hear how you explained that. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [109] +-------------------------------------------------------------------------------- + + Yes, I think we disclose all of the assumptions in the earnings risk tables in the 10-Q. But yes, it's short rates staying low and the 10-year going up 100 basis points, I think. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co - Chairman & CEO [110] +-------------------------------------------------------------------------------- + + Yes, but it also drags up the five-year, the seven-year. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [111] +-------------------------------------------------------------------------------- + + Yes. Yes. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co - Chairman & CEO [112] +-------------------------------------------------------------------------------- + + So if you use one point, it's the 10-year. But it's the yield curve going up steeply. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA - Analyst [113] +-------------------------------------------------------------------------------- + + The reason I ask that is it seems as though maybe the 10-year is not as relevant as perhaps the five-year, or am I mistaken? Or the three-year? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [114] +-------------------------------------------------------------------------------- + + You're not mistaken, which is why if you actually get more of a parallel shift and short rates go up, our numbers go up by multiples. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA - Analyst [115] +-------------------------------------------------------------------------------- + + Okay. Separately, the Investment Banking backlogs, where are they versus the first quarter, at the end? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co - Chairman & CEO [116] +-------------------------------------------------------------------------------- + + The pipeline? + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA - Analyst [117] +-------------------------------------------------------------------------------- + + Yes. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [118] +-------------------------------------------------------------------------------- + + Activity levels picked up some, and we expect that to carry into the third quarter. So a little better. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co - Chairman & CEO [119] +-------------------------------------------------------------------------------- + + And you saw a real slowdown when we had the volatile markets in June, but we think that's not permanent, the markets kind of open up again. You've seen a bunch of IPOs and debt deals and a lot of M&A chatter. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA - Analyst [120] +-------------------------------------------------------------------------------- + + And the leverage ratio, you said under the US rules, it's 4.7%. Under the proposed Basel rules, if adopted, where would the leverage ratio be? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [121] +-------------------------------------------------------------------------------- + + We didn't disclose that, Mike, for a couple of reasons. One is that, as we said, the proposals, we think, have some fundamental issues to them. But it would be lower. The gross up to our balance sheet on top of the 3.5% sitting on the page would not be insignificant, but we didn't disclose it. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA - Analyst [122] +-------------------------------------------------------------------------------- + + Can you give us a ballpark? Or is that one reason you're being so conservative, you have 160 basis point potential benefit, but you're still saying wait until early 2015. Is that part of your thought process? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [123] +-------------------------------------------------------------------------------- + + Yes, that is definitely one of the reasons. And that's one of the reasons why we said, of course, the timeline could be impacted if there are significant changes to the rules, and that would be one of those changes. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA - Analyst [124] +-------------------------------------------------------------------------------- + + Okay. And then last question relates to the processing business, which to me looks like it's lagging for the second quarter in a row. And I'm asking a more broad question. For eight years, since Bank One merged with JPMorgan, and I think for a few decades before that, it was run as a separate business. And the fourth quarter of last year, it was merged into the Investment Bank. And now we have two quarters in a row of what looks like performance that will lag peer. So my question is how is the management and organizational restructuring going? Is it impacting the processing business, or is there something else taking place there? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co - Chairman & CEO [125] +-------------------------------------------------------------------------------- + + First of all, I think it's going great. And the folks in the field will tell you that they are seeing huge benefits from putting together the corporate Global Investment Bank, the corporate Investment Bank, Treasury Services. But you are right. There's been flattening out a little bit in Treasury Services and Investor Services, which is mostly custody. Some of that's spread, some of that's margins. So some of that will benefit also a little bit from rising rates. And we don't know what the peers will show yet. So maybe you do, but I don't know yet. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA - Analyst [126] +-------------------------------------------------------------------------------- + + Yes, I'm guessing it's going to lag. The assets under custody down 2% link quarter when markets are up as much as they are, is there anything else that's one-time or unique? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co - Chairman & CEO [127] +-------------------------------------------------------------------------------- + + Mike, I don't know. And obviously, if we lag our peers, we'll be as disappointed as you are. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA - Analyst [128] +-------------------------------------------------------------------------------- + + Okay. All right. Thank you. + +-------------------------------------------------------------------------------- +Operator [129] +-------------------------------------------------------------------------------- + + Our next question comes from Erika Penala of Bank of America. + +-------------------------------------------------------------------------------- +Erika Penala, BofA Merrill Lynch - Analyst [130] +-------------------------------------------------------------------------------- + + Good morning. My first question really has to do with some of the initial questions asked on capital. And what is the priority here on capital distribution versus leverage ratio? Is it compliance to the 5% at the Hold Co, or is it accelerating capital distribution over the next two years relative to what you announced out of this year's CCAR, or can JPMorgan both be compliant with the leverage ratio over time and accelerate buybacks and dividends? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co - Chairman & CEO [131] +-------------------------------------------------------------------------------- + + Your last one. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [132] +-------------------------------------------------------------------------------- + + Yes, it's balancing both, Erika, which is why, in response to the earlier question, we said we've been conservative on the timeline, because we want to reserve the flexibility to consider capital distributions when we do our CCAR in 2013, and it will be a factor we consider. + +-------------------------------------------------------------------------------- +Erika Penala, BofA Merrill Lynch - Analyst [133] +-------------------------------------------------------------------------------- + + Okay. And a follow-up question on what you mentioned, Marianne, in the beginning of the call on Mortgage. You mentioned that if loan rates stay where they are, that could mean the market shrinks by 30% or 40%. What is the proportionate expense in that scenario that you could take out of the business, and how long typically is the lag until you can take those expenses out? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [134] +-------------------------------------------------------------------------------- + + So Erika, the truly truly variable, as in transaction variable proportion of the business, is some. But the majority of it is related to people and systems, so there's usually a several month lag to be able to get that out of the system. + +-------------------------------------------------------------------------------- +Erika Penala, BofA Merrill Lynch - Analyst [135] +-------------------------------------------------------------------------------- + + And proportionately, if the revenues are down, let's say, origination revenues are down 30% to 40%, what's the efficiency ratio that we can think about as we think about the variable costs that can get taken out? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [136] +-------------------------------------------------------------------------------- + + I think, think about it this way. I think that revenue margins will be down on competitive pressures, volumes are down, and expenses may go up because volumes are down, for a couple of quarters. + +-------------------------------------------------------------------------------- +Erika Penala, BofA Merrill Lynch - Analyst [137] +-------------------------------------------------------------------------------- + + I see. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [138] +-------------------------------------------------------------------------------- + + Sorry, expense margins would up. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co - Chairman & CEO [139] +-------------------------------------------------------------------------------- + + In other words, a dramatic reduction in profits. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [140] +-------------------------------------------------------------------------------- + + We're trying to be clear with you that this would be a significant event, if rates stay where they are, if mortgage rates stay where they are, or go higher. + +-------------------------------------------------------------------------------- +Erika Penala, BofA Merrill Lynch - Analyst [141] +-------------------------------------------------------------------------------- + + Okay. Thanks. + +-------------------------------------------------------------------------------- +Operator [142] +-------------------------------------------------------------------------------- + + Our next question comes from Andrew Marquardt of Evercore Partners. + +-------------------------------------------------------------------------------- +Andrew Marquardt, Evercore Partners - Analyst [143] +-------------------------------------------------------------------------------- + + Good morning, guys. Want to ask, maybe I missed it, on expenses. Can you talk about how you're still feeling about the full-year target? You previously had talked about down $1 billion year over year, ex-legal. Does that still stand? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [144] +-------------------------------------------------------------------------------- + + Yes, so let me just walk you through it. So this quarter, our expenses adjusted for litigation were $15.2 billion. For the first half, adjusted for corporate litigation and foreclosure-related matters, it was $30.7 billion, which would be against the $59 billion target, which is running a little high. But there are two important factors. One is in our definition of adjustment, we only adjusted out corporate litigation, so there's other litigation in the firm that's several hundred million dollars. It's disclosed in our supplement. You can see that. And also in the first half of the year, we did see out performance in terms of the Investment Bank, or CIB, revenues. And clearly, we pay compensation on that, which is a it good expense and we would waive it in all day long. So if you take the combination of those two things that we don't technically adjust out, our underlying core expenses are on track for that number, yes. + +-------------------------------------------------------------------------------- +Andrew Marquardt, Evercore Partners - Analyst [145] +-------------------------------------------------------------------------------- + + Got it. That's helpful. And the additional litigation costs this quarter, somewhat elevated. How do we think about them going forward, staying elevated but similar rate, or a little bit lower, or how do we think about that? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [146] +-------------------------------------------------------------------------------- + + You can't really think about a run rate trend in litigation costs, because they are somewhat lumpy. So we don't have a forecast for you, and they will go up and down. + +-------------------------------------------------------------------------------- +Andrew Marquardt, Evercore Partners - Analyst [147] +-------------------------------------------------------------------------------- + + Got it. Thanks. And then in terms of the rates, obviously, impact a lot of different businesses, Mortgage, the balance sheet, NII, NIM discussion, but then also can you walk through how we should think about it in terms of the FIC business, heightened volatility, maybe more volume, but then obviously softer environment in June. How do we think about this current environment playing out for the back half of this year in terms of trading? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co - Chairman & CEO [148] +-------------------------------------------------------------------------------- + + You're absolutely right. When you separate NIM, you try to tease it out and you make our interest rates. Because you've got to look at the underlying results, underlying volumes and things like that. There's no reason to think that we aren't going to have a good trading going forward, because if the economy is strengthening, and we believe, our view is that it is, and that capital markets are going to open up again, and people get adjusted to slightly new, higher rates. And yes, volatility helps certain trading areas. Higher interest rates hurt mortgages, but again, they can help other areas. So it's a whole potpourri. It's impossible almost to separate it out. And we try to do that for you, but I think it's a little bit of a mistake when you look at the Hold Company. + +-------------------------------------------------------------------------------- +Andrew Marquardt, Evercore Partners - Analyst [149] +-------------------------------------------------------------------------------- + + Thank you. And then my last question was just a clarification on there's been a lot of regulatory issues, capital, liquidity, buffers on buffers, OLA, et cetera. As well as I know you guys, I expect -- I think it's this quarter that you're resubmitting your CCAR plan. Is it fair to assume that despite all these things that have been coming out and there's still some hurdles that need to be met, that one shouldn't expect a change in capital deployment or should we? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [150] +-------------------------------------------------------------------------------- + + So we are working really hard on the CCAR resubmission. And you're right, we're going to resubmit that before the end of the third quarter. We're in constant dialogue with the regulators, although we won't receive any formal feedback until we're in the fourth quarter. And so we're doing everything we can to be able to be successful in remediating any of the issues they identify for us. And if we're able to do that, then there should be no impact. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co - Chairman & CEO [151] +-------------------------------------------------------------------------------- + + It won't be for lack of trying. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [152] +-------------------------------------------------------------------------------- + + Yes, it will not be for the number of people who are -- + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co - Chairman & CEO [153] +-------------------------------------------------------------------------------- + + You have probably a thousand people now who are devoted-- + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [154] +-------------------------------------------------------------------------------- + + We have 500 people that are dedicated and thousands of people working on it. + +-------------------------------------------------------------------------------- +Andrew Marquardt, Evercore Partners - Analyst [155] +-------------------------------------------------------------------------------- + + Okay. Thank you. + +-------------------------------------------------------------------------------- +Operator [156] +-------------------------------------------------------------------------------- + + Our next question comes from Matt Burnell of Wells Fargo. + +-------------------------------------------------------------------------------- +Matt Burnell, Wells Fargo Securities - Analyst [157] +-------------------------------------------------------------------------------- + + Good morning. Just a couple of questions. First of all, Marianne, you mentioned servicing costs in the mortgage business being down by about $600 million in the fourth quarter. Is that largely coming out of the default side of things or is that -- do you think that will be more evenly spread between default and regular, more regular servicing? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [158] +-------------------------------------------------------------------------------- + + So just a point of clarification, if it wasn't clear, is that our guidance is that we're expecting to get our expenses down to $600 million in the fourth quarter from the level they're at now, which is $715 million for this quarter. So just to be very clear. And to remind you, our longer term run rate for that business is $325 million a quarter. So it is dominated by the default side, but there is some core performance obviously in there, too. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co - Chairman & CEO [159] +-------------------------------------------------------------------------------- + + And to keep it really simple, we hope to get it to a run rate of $500 million the year after that, $400 million the year after that, and $325 million the year after, where we should be. And we have a lot of work to do in systems, et cetera to get all that done. And obviously the costly foreclosure, the legal stuff, is also coming down. + +-------------------------------------------------------------------------------- +Matt Burnell, Wells Fargo Securities - Analyst [160] +-------------------------------------------------------------------------------- + + So it's about a three- to four-year run rate to get down to ultimately where you want to be? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co - Chairman & CEO [161] +-------------------------------------------------------------------------------- + + Three-year. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [162] +-------------------------------------------------------------------------------- + + Three years. And know that we're actively working the portfolio to be able to do what we can more quickly, so you would expect that we're looking at either sales or sub servicing of defaulted loans and capacatizing our performing servicing. So we're working on all of that. + +-------------------------------------------------------------------------------- +Matt Burnell, Wells Fargo Securities - Analyst [163] +-------------------------------------------------------------------------------- + + Okay. Marianne, just a further clarification question. On gain on sale margins, you mentioned those were 118 basis points this quarter. You mentioned last quarter that they were 100 basis points, and about 180 basis points on a normalized basis in the fourth quarter. Are all those calculated in the same way? Are those quarterly averages, or are those the gains at the end of the quarter? Just wanted to be sure we understand that. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [164] +-------------------------------------------------------------------------------- + + Sure. They're all calculated the same way, based upon the disclosed closed loan volumes that we have to use. So if you take the revenues and expenses and use the closed loans volumes for the quarter, that's how we derive the margins, which is why you see some short-term noise quarter over quarter and the increase this quarter to actually 116 basis points, because we actually book revenues when we lock loans, but we report them closed. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co - Chairman & CEO [165] +-------------------------------------------------------------------------------- + + Which is different than you guys do it at Wells. + +-------------------------------------------------------------------------------- +Matt Burnell, Wells Fargo Securities - Analyst [166] +-------------------------------------------------------------------------------- + + Fair enough. And then one final question. Marianne, you mentioned deal activity appears to be turning, I think that was with respect to the commercial banking business. Could you provide a little more color on that? Did June's volatility in the interest rate scenario slow down business activity in the commercial banking business? And I'm not really specifically talking about the Investment Bank, but more in the commercial banking side of things. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [167] +-------------------------------------------------------------------------------- + + Yes. So I would tell you that it's more of what we're seeing and feeling in discussions and activity with our clients, that we feel like deal activity levels have picked up and may be turning. And the pipeline feels a little better and solid, but not strong. So we're expecting that to translate into the second half. And obviously, as the economy continues to recover and confidence continues to grow, hopefully that will get even better. + +-------------------------------------------------------------------------------- +Matt Burnell, Wells Fargo Securities - Analyst [168] +-------------------------------------------------------------------------------- + + Okay. And just finally, there's been a lot of talk, obviously, in the last couple of days about a potential reassertion of Glass Steagall. And I guess I'm curious, given your current business model, would that, if that were to come to pass, would that be a meaningful negative in terms of your ability to maintain your cross-sell opportunities across the businesses, or is that perhaps less of a challenge given how you currently have the businesses structured? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [169] +-------------------------------------------------------------------------------- + + So I mean, listen, my comment on that is that Glass Steagall didn't have anything to do with the crisis, and our business model allowed us to be a port in the storm. Our customers like doing business with us in the model that we have now, so -- + +-------------------------------------------------------------------------------- +Matt Burnell, Wells Fargo Securities - Analyst [170] +-------------------------------------------------------------------------------- + + Okay. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [171] +-------------------------------------------------------------------------------- + + We don't spend time thinking about that. + +-------------------------------------------------------------------------------- +Matt Burnell, Wells Fargo Securities - Analyst [172] +-------------------------------------------------------------------------------- + + Okay. Fair enough. Thanks for taking my questions. + +-------------------------------------------------------------------------------- +Operator [173] +-------------------------------------------------------------------------------- + + Our next question comes from Gerard Cassidy of RBC. + +-------------------------------------------------------------------------------- +Gerard Cassidy, RBC Capital Markets - Analyst [174] +-------------------------------------------------------------------------------- + + Thank you. Good morning. I just wanted to be clear, when you talk about on page 4 that you're going to hold your capital distributions flat, is that for all of 2014 relative to '13? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [175] +-------------------------------------------------------------------------------- + + Yes. So Gerard, just to be really clear, and you look at the title there, to be illustrative, we just, for the purposes of this analysis, we just hold everything flat. That's not to imply anything about what our capital distributions will be going forward, but rather to imply we can continue to do some. + +-------------------------------------------------------------------------------- +Gerard Cassidy, RBC Capital Markets - Analyst [176] +-------------------------------------------------------------------------------- + + Yes, okay. And then second, you put in here the Tier 1 capital actions could add possibly 30 basis points. Could you give some color behind what you're thinking there? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [177] +-------------------------------------------------------------------------------- + + Yes, I mean it's just optimizing our mix between common and preferreds. + +-------------------------------------------------------------------------------- +Gerard Cassidy, RBC Capital Markets - Analyst [178] +-------------------------------------------------------------------------------- + + Okay. And would the total leverage impact of 60 to 160 basis points, clearly that's over the 5%, I assume then that you're going to be comfortable running something north of 5% when you finally get there. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [179] +-------------------------------------------------------------------------------- + + It's too early for us to talk about passes on that level. + +-------------------------------------------------------------------------------- +Gerard Cassidy, RBC Capital Markets - Analyst [180] +-------------------------------------------------------------------------------- + + Okay. In your Investor Day, you gave us the ROEs for the different lines of businesses. And in the total firm, you felt 15% to16% was your target ROE. Will that change now that you've got to carry the higher leverage numbers? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co - Chairman & CEO [181] +-------------------------------------------------------------------------------- + + I think, folks, this just came out. So we're trying to share information with you. And it might, but give us a little bit of time and we'll give you a deeper feel how it might affect -- how this might affect different businesses, different products. Because obviously when you do something like this, this will be pushed down, at one point, not just to the line of business, but to the client and the product and the country, and then we can answer that question for you. + +-------------------------------------------------------------------------------- +Gerard Cassidy, RBC Capital Markets - Analyst [182] +-------------------------------------------------------------------------------- + + Okay. You guys have had some great C&I loan growth in the middle market space over the last four, five, six quarters. It seemed to really slow down this quarter. Anything in particular happen? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [183] +-------------------------------------------------------------------------------- + + Nothing in particular, just demand. And I should temper that with, just demand and the continuation that we've talked about of very, very strong competition. And we are, as I said, we are prioritizing quality over growth. We would tactically under perform rather than chase a deal that we weren't comfortable with. + +-------------------------------------------------------------------------------- +Gerard Cassidy, RBC Capital Markets - Analyst [184] +-------------------------------------------------------------------------------- + + And finally, can you give us any color on how the shared national credit exam has gone, and are those results in your second quarter results or will they be in third quarter results? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [185] +-------------------------------------------------------------------------------- + + The results are in our second quarter results. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co - Chairman & CEO [186] +-------------------------------------------------------------------------------- + + Not that material. + +-------------------------------------------------------------------------------- +Gerard Cassidy, RBC Capital Markets - Analyst [187] +-------------------------------------------------------------------------------- + + Okay. Great. Thank you. + +-------------------------------------------------------------------------------- +Operator [188] +-------------------------------------------------------------------------------- + + Our next question comes from Jim Mitchell of Buckingham Research. + +-------------------------------------------------------------------------------- +Jim Mitchell, Buckingham Research - Analyst [189] +-------------------------------------------------------------------------------- + + Good morning. Just a couple of quick follow-ups. I hate to focus on the leverage ratio, but just one question on the cash component. I think, by my calculation, if you were to exclude cash from the denominator, that would add almost 70 basis points to your leverage ratio. Do you think that that has any legs or any sticking with regulators, in terms of logic around excluding that? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co - Chairman & CEO [190] +-------------------------------------------------------------------------------- + + You should probably ask them. + +-------------------------------------------------------------------------------- +Jim Mitchell, Buckingham Research - Analyst [191] +-------------------------------------------------------------------------------- + + Okay. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [192] +-------------------------------------------------------------------------------- + + We hope so. + +-------------------------------------------------------------------------------- +Jim Mitchell, Buckingham Research - Analyst [193] +-------------------------------------------------------------------------------- + + Yes. It would make some sense. And maybe just getting to the FIC business, you alluded to it a little bit, some businesses benefit from volatility. Is it fair to assume that in June we saw things like foreign exchange and interest rate trading do better and credit and mortgages do worse, is that sort of the best way to think about it? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co - Chairman & CEO [194] +-------------------------------------------------------------------------------- + + We're not going to give you monthly specific. I think our folks did a very good job in June. + +-------------------------------------------------------------------------------- +Jim Mitchell, Buckingham Research - Analyst [195] +-------------------------------------------------------------------------------- + + Okay. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co - Chairman & CEO [196] +-------------------------------------------------------------------------------- + + Obviously, when spreads widen out, certain businesses are more of this than others. I already mentioned that Emerging Markets replies to the most volatility, both in terms of spreads volatility and equity markets, did a very good job. + +-------------------------------------------------------------------------------- +Jim Mitchell, Buckingham Research - Analyst [197] +-------------------------------------------------------------------------------- + + Okay. Thanks. + +-------------------------------------------------------------------------------- +Operator [198] +-------------------------------------------------------------------------------- + + Our next question comes from Paul Miller of FBR. + +-------------------------------------------------------------------------------- +Paul Miller, FBR Capital Markets - Analyst [199] +-------------------------------------------------------------------------------- + + Yes. Thank you very much. On your reserve ratios, right around 2%, and you had a lot of reserve releases in the quarter. With credit improving, can you continue to do this type of releases in the next couple quarters or is that reserve ratio going to stick around 2%? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [200] +-------------------------------------------------------------------------------- + + So you should think about mortgage as having some more releases, because we continue to see delinquencies and severities improve, particularly HPI improvement. And so you should expect that to continue, maybe not at the level that we saw this quarter, because we had a big revision to HPI, as you know, during the last several months. And in part, we've had $1.050 billion of reserve releases in the first half. Given what we're seeing, we expect more releases in the second half, but not at that level. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co - Chairman & CEO [201] +-------------------------------------------------------------------------------- + + Think of the several hundred million. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [202] +-------------------------------------------------------------------------------- + + Several hundred million dollars. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co - Chairman & CEO [203] +-------------------------------------------------------------------------------- + + It's near the end, the car. And wholesale is kind of where it should be and will bounce around. + +-------------------------------------------------------------------------------- +Paul Miller, FBR Capital Markets - Analyst [204] +-------------------------------------------------------------------------------- + + Okay. Thanks a lot, guys. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [205] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Operator [206] +-------------------------------------------------------------------------------- + + Our next question comes from Guy Moszkowski of Autonomous Research. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [207] +-------------------------------------------------------------------------------- + + Hello, Guy. + +-------------------------------------------------------------------------------- +Guy Moszkowski, Autonmous Research - Analyst [208] +-------------------------------------------------------------------------------- + + Good morning. So just looking at the hit to the OCI at $3.1 billion, it actually seems like it's less than would have been implied by the guidance that you gave at the Investor Day. Obviously, that was for a more severe shock, but just calibrating it relative to the number of basis points that the 10-year went up, et cetera. Any comment on that? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co - Chairman & CEO [209] +-------------------------------------------------------------------------------- + + You got it exactly right. At Investor Day, we gave you something that was far more dramatic than 100 basis points, and we already said the duration of this thing is not 10 years, it's a lot less than 10 years. So obviously, the effect will be less. + +-------------------------------------------------------------------------------- +Guy Moszkowski, Autonmous Research - Analyst [210] +-------------------------------------------------------------------------------- + + And is part of the reason why, besides the fact that it was 100 basis point not a 230 basis point move or whatever, is part of the reason linked to the derisking of the Treasury portfolio that you were talking about as you prepared for the LCR? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co - Chairman & CEO [211] +-------------------------------------------------------------------------------- + + Not really. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [212] +-------------------------------------------------------------------------------- + + Not really. + +-------------------------------------------------------------------------------- +Guy Moszkowski, Autonmous Research - Analyst [213] +-------------------------------------------------------------------------------- + + Okay. But then is there validity to the fact to the idea that if we recalibrate it for 100 basis points move versus the 230 basis points move that I think is implicit in that $15 billion number that you gave us in February, was the $3 billion in line with that or was it actually materially better? And if so, maybe if it wasn't related to the LCR derisking, why did you have a better outcome? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [214] +-------------------------------------------------------------------------------- + + So the Investor Day scenario was a more severe scenario than the 230 basis points you're implying. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co - Chairman & CEO [215] +-------------------------------------------------------------------------------- + + What was the number we gave at Investor Day? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [216] +-------------------------------------------------------------------------------- + + It was 300 basis, plus or minus. And this is in line with our expectations. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co - Chairman & CEO [217] +-------------------------------------------------------------------------------- + + Unfortunately, OCI is not, I hate to say, is not that big a deal. We all know about it. We're all prepared for it. Rates can go up. OCI gains are going to go down. 20 basis points, you're going to see this happen elsewhere. It's asynchronous. We have OCI going through capital and the benefits going through earnings in the future. So if it were up to us, we wouldn't have actually had this asynchronous accounting to this thing. And we're prepared, we're going to have buffers that could compare that. We know how a conservation buffer works, but it's not that big a deal. The duration of our portfolio, and you guys can do it yourself, AA-plus, couple your duration, you could almost calculate the number yourself. With one caveat is that the losses are less as rates go up, because of the complexity of the portfolio, currently. And the other thing about this, we can change it overnight at any time. + +-------------------------------------------------------------------------------- +Guy Moszkowski, Autonmous Research - Analyst [218] +-------------------------------------------------------------------------------- + + Right. Fair enough. As I think about the changes that you can make to the business that you referred to on page 4 to mitigate the impact of the leverage ratio changes, you talk about optimizing the use of central clearing, and yet there's also all these concerns about the disallowance of additional derivatives collateral. How comfortable are you that the way the rules are written right now, moving your derivatives business more towards central clearing really does, because of the collateral, give you a lot of relief on those leverage assets? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co - Chairman & CEO [219] +-------------------------------------------------------------------------------- + + If you move a trade to a central clearinghouse, it has no charge here and it has nothing to do with the margin that they put up with the clearinghouse. The trade is bilateral with us. You have the receivable get stressed, and you can't take the benefit of the fact that you're going to get collateral against it. That's the way the calculations are done. So any trade you move to a clearing house eliminates that exposure. + +-------------------------------------------------------------------------------- +Guy Moszkowski, Autonmous Research - Analyst [220] +-------------------------------------------------------------------------------- + + Right, so-- + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co - Chairman & CEO [221] +-------------------------------------------------------------------------------- + + The margin of the clients with the clearing house is not with us. It's with the clearing house. + +-------------------------------------------------------------------------------- +Guy Moszkowski, Autonmous Research - Analyst [222] +-------------------------------------------------------------------------------- + + Right. So I guess the logical next question for that is given the central clearing mandate which has started to be implemented recently, should we, and as we think about leverage ratio going forward, should we be thinking about a large part of that derivatives add in to the denominator of the ratio as basically being in run-off? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co - Chairman & CEO [223] +-------------------------------------------------------------------------------- + + We've already added in our forecast to you guys some moving derivatives, on liquid cap and all that. I do think at the margins this will support things in the clearing houses. But we don't have analysis to tell you about that right now. Will it be material? We don't really know yet. Remember, the clients, there's a lot of client business who, they are also going to determine what they want. It won't be just up to us. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [224] +-------------------------------------------------------------------------------- + + And remember that the derivative add-on calculation is a calculation that is currently being rethought by the Basel committee because of some of the issues with it. So it could also, in and of itself, improve. + +-------------------------------------------------------------------------------- +Guy Moszkowski, Autonmous Research - Analyst [225] +-------------------------------------------------------------------------------- + + Fair enough. When you think about those leverage asset actions that you're talking about, is there any linkage of taking those actions that further benefits LCR? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [226] +-------------------------------------------------------------------------------- + + We haven't done that analysis. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co - Chairman & CEO [227] +-------------------------------------------------------------------------------- + + It's hard to tell. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [228] +-------------------------------------------------------------------------------- + + To be honest, we were trying to be very transparent and give you some ideas about the sorts of things that we're considering. We haven't translated these into detailed plans yet, so we don't know the second order impacts of this yet. + +-------------------------------------------------------------------------------- +Guy Moszkowski, Autonmous Research - Analyst [229] +-------------------------------------------------------------------------------- + + Okay. Fair enough. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co - Chairman & CEO [230] +-------------------------------------------------------------------------------- + + I think Marianne gave numbers to show that we can handle this. But also, you have to be very cognizant of client effects. We have a client business, and we have to make sure that we continue to have a client franchise. And so over time, we'll adjust the businesses, and we'll meet LCR, we'll meet Basel III, we're going to meet whatever the leverage ratio is. And think of it in some ways of alternative minimum taxes. So if every client will be running what's your return on Basel III capital and then what's your return on leverage capital? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [231] +-------------------------------------------------------------------------------- + + Stress capital. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co - Chairman & CEO [232] +-------------------------------------------------------------------------------- + + And stress capital. So you'll try to manage all those as fair to the client and fair to the Company. + +-------------------------------------------------------------------------------- +Guy Moszkowski, Autonmous Research - Analyst [233] +-------------------------------------------------------------------------------- + + Okay. One last question I'll ask you is that, as I've talked with clients over the last couple of days about this leverage ratio issue, one of the questions that has come up is wouldn't it be possible to downstream more capital to the bank sub in order to deal with the 6% requirement there? Obviously, that incurs a double leverage issue, potentially. Your double leverage ratio right now is just over, I think it's like 1.05. I mean is there any room there? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co - Chairman & CEO [234] +-------------------------------------------------------------------------------- + + Obviously, we can do stuff like that. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [235] +-------------------------------------------------------------------------------- + + Yes. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co - Chairman & CEO [236] +-------------------------------------------------------------------------------- + + Give us a little time. We're showing you that we can get to the consolidated pretty easily, maybe have to restructure some things and change the capital structure a little bit, and move businesses out of the FDIC-insured bank and all that. I just don't think any of that's going to be critical to the future function of our business. We'll adjust those things to accomplish what we need to accomplish. And give us a little more time. It just happened a couple days ago. + +-------------------------------------------------------------------------------- +Guy Moszkowski, Autonmous Research - Analyst [237] +-------------------------------------------------------------------------------- + + Of course, that's fair. Thank very much for taking my questions. I appreciate it. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [238] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Operator [239] +-------------------------------------------------------------------------------- + + Our next question comes from Chris Kotowski from Oppenheimer. + +-------------------------------------------------------------------------------- +Chris Kotowski, Oppenheimer & Co. - Analyst [240] +-------------------------------------------------------------------------------- + + Yes, just following up on Guy. It seems the thrust of the whole leverage ratio is that it's going to penalize the businesses that have the highest ratio of leverage ratio assets to risk weighted assets. And can you give us an idea where that gap is the biggest, and in particular, also are any of these global businesses where this would give European banks a leg up? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co - Chairman & CEO [241] +-------------------------------------------------------------------------------- + + Well, let me take do the first question -- second question first. If you have a world where some businesses have to hold twice as much capital as other companies, that obviously over time can create huge competitive disadvantages. I don't know of any industry in America who would want to compete globally in that basis. We have an interest in a safe and sound system, so not against the leverage ratio. But we would be, we're not for a hugely unbalanced competitive playing field. So put that aside. The regulators know that. They are trying to -- we thought part of Basel and all that is to harmonize these kind of things. And if you ask about it, what we show here, and Marianne just shows, anything which is a low RWA asset, including HQLA, revolvers, certain types of derivatives, those things obviously you'll look at a little bit differently because it's a leverage ratio asset. And we don't have to do it by business yet. We'll give you more detail later. +Like even Marianne had mentioned that we take huge deposits in from countries and from money funds, et cetera, that you may not take in, because you can't afford capital against a deposit of $1 billion dollars you get from a money fund that you park with the Fed for 25 basis points, you pay the FDIC 10 basis points, you pay the client 5 or 6 or 7 basis points, you got to put 6% capital against it. You simply stop doing -- there are a whole bunch of things we've got to figure out how we're going to do it. But we want to make sure we manage the client franchise properly. We'll figure out the other stuff over time. + +-------------------------------------------------------------------------------- +Chris Kotowski, Oppenheimer & Co. - Analyst [242] +-------------------------------------------------------------------------------- + + All right. That's it for me. Thank you. + +-------------------------------------------------------------------------------- +Operator [243] +-------------------------------------------------------------------------------- + + Our next question comes from Moshe Orenbuch of Credit Suisse. + +-------------------------------------------------------------------------------- +Moshe Orenbuch, Credit Suisse - Analyst [244] +-------------------------------------------------------------------------------- + + Great. Jamie, following up on that, it just seems like even the $100 billion of increase in deposits this quarter probably cost you 15 basis points in that leverage ratio. And so is there any movement, do you think, during the comment period towards exclusion of any of the risk -free assets at all? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co - Chairman & CEO [245] +-------------------------------------------------------------------------------- + + So separate the type of deposit, okay? So if it's a consumer deposit, it has a completely different LCR, how you can invest, the kind of spread you can make. If it's what we call big wholesale short-term deposits, you're absolutely correct. We would probably restrict some of that over time. + +-------------------------------------------------------------------------------- +Moshe Orenbuch, Credit Suisse - Analyst [246] +-------------------------------------------------------------------------------- + + Right. Okay. And maybe just a follow-up on the mortgage business. You talked about some of the financial impacts. Can we talk a little bit just about strategically what you're doing as you look at that business, and the competitive environment in a weaker refi environment? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [247] +-------------------------------------------------------------------------------- + + Yes. This back up, although sharp, is not entirely unexpected. So as we talk about our longer term plans, and when we outlined all of that and the strategy for the mortgage business at Investor Day, that medium to long-term plan does not change. So it may accelerate some of the activities that we have and have, as we said, some impact on the next couple of quarters' results. But the long-term strategy hasn't changed. We're working the portfolio, optimizing servicing, trying to take costs out as quickly as possible and grow share. And actually, we think we should be able to grow share even more strongly in a more difficult market. + +-------------------------------------------------------------------------------- +Moshe Orenbuch, Credit Suisse - Analyst [248] +-------------------------------------------------------------------------------- + + Great. Thanks. + +-------------------------------------------------------------------------------- +Operator [249] +-------------------------------------------------------------------------------- + + Our next question comes from Nancy Bush of NAB Research. + +-------------------------------------------------------------------------------- +Nancy Bush, NAB Research - Analyst [250] +-------------------------------------------------------------------------------- + + Good morning. Two questions. First, on branch, on the branch banking network. I know this back up in rates has been primarily at the longer end and we have not yet had a corresponding rise in short-term rates, but do you see any needs, at this point, to reprice products, et cetera, at the branch level due to consumer perception of rising rates? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [251] +-------------------------------------------------------------------------------- + + No. No, Nancy. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co - Chairman & CEO [252] +-------------------------------------------------------------------------------- + + Not yet. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [253] +-------------------------------------------------------------------------------- + + Not yet. And as you know, traditionally that would, in any case, lag. Of course, that doesn't mean it will, but that's traditionally what happens. + +-------------------------------------------------------------------------------- +Nancy Bush, NAB Research - Analyst [254] +-------------------------------------------------------------------------------- + + Secondly, Jamie, you talked about the asynchronous nature of OCI, with OCI getting dinged now with the benefits of the future. Something else asynchronous is staring us in the face, and that's this loan loss reserve methodology possible change to expected lifetime loss. What are your thoughts about that? I mean, where does that stand in an implementation process, and would you really get dinged by that? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co - Chairman & CEO [255] +-------------------------------------------------------------------------------- + + This is what the issue is with all this, you spend all your time talking about accounting, as opposed to business. The business is deposits, serving clients, doing things. And now we talk all the time about AOCI. And we have a lot of asynchronous accounting, and pro cyclical accounting and stuff like that, that we try to explain. But we try to look through all of that and build a business, more clients, more bankers, more branches, happier clients. So in all of our business, that's how we look at it. We'll work through the asynchronous accounting. If the loan loss reserve accounting changes, it would add, obviously the loan losses, though probably not as much as people think. But we still would run the business for economics in the long run. It wouldn't change how we run the business. We would be just be holding more reserves, which would be fine with us. + +-------------------------------------------------------------------------------- +Nancy Bush, NAB Research - Analyst [256] +-------------------------------------------------------------------------------- + + Well, do you have any sense, I mean, I realize that you're going to run the business for the business, but do you have any sense if this is going to happen and when it might happen? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [257] +-------------------------------------------------------------------------------- + + Well, as you know, the industry commented, we commented in terms of the proposal. And we are generally in favor of it, but I think that a lifetime timeline is too long, so something shorter than that would make sense. I think we need to work that through. It would be implemented over, not the course of the next couple of quarters, but in a year or so. So we'll wait and see. + +-------------------------------------------------------------------------------- +Nancy Bush, NAB Research - Analyst [258] +-------------------------------------------------------------------------------- + + All right. Thank you. + +-------------------------------------------------------------------------------- +Operator [259] +-------------------------------------------------------------------------------- + + Our next question comes from Chris Whelan of Carrington. + +-------------------------------------------------------------------------------- +Chris Whelan, Carrington Investment - Analyst [260] +-------------------------------------------------------------------------------- + + Marianne, could you go back to Mortgage and talk a little bit about the quality of the demand you're seeing? At the beginning of the year, the industry was guiding down about 20% in terms of volumes and for next year, as well. Your numbers suggest that that's basically doubled; in other words, instead of 20%, we're looking at 30% to 40%, given rates. Would it be fair to say that the two factors are equal? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [261] +-------------------------------------------------------------------------------- + + I would say, so first of all, the industry groups haven't fully reforecast the market, so we'll wait and see what they come out with. We're trying to be transparent with our guidance, so that level, hopefully we're wrong and hopefully it will be better than that. I will say, for our own business, we didn't expect volumes to be down this much throughout the year, had this not happened with this space. + +-------------------------------------------------------------------------------- +Chris Whelan, Carrington Investment - Analyst [262] +-------------------------------------------------------------------------------- + + So you think there is definitely a price reaction out there among consumers? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co - Chairman & CEO [263] +-------------------------------------------------------------------------------- + + Well, mostly this is refi. + +-------------------------------------------------------------------------------- +Chris Whelan, Carrington Investment - Analyst [264] +-------------------------------------------------------------------------------- + + Right. Exactly. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co - Chairman & CEO [265] +-------------------------------------------------------------------------------- + + So purchase, we actually saw go up a little bit. + +-------------------------------------------------------------------------------- +Chris Whelan, Carrington Investment - Analyst [266] +-------------------------------------------------------------------------------- + + But purchase isn't catching up, though. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co - Chairman & CEO [267] +-------------------------------------------------------------------------------- + + They're not going to make up for refi. But they may go up, yes. + +-------------------------------------------------------------------------------- +Chris Whelan, Carrington Investment - Analyst [268] +-------------------------------------------------------------------------------- + + But Jamie, back to your point about harmonization, when you look at the totality of the way regulators are treating mortgage, MSRs, for example, which have been rallying very strongly in the past few months, and your comments last year about Basel. Should the US withdraw from Basel II? It's so unfriendly to businesses that are very important to you and to the economy, particularly in Mortgage. What are your thoughts on that? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co - Chairman & CEO [269] +-------------------------------------------------------------------------------- + + Look, we're in favor of finishing. We've always believed in high capital, high liquidity, good regulation and things like that, and finishing it. And obviously, there are things that all countries have points of view about which would be different. But I think the better you get to real harmonization -- the closer you get to real harmonization, the better. If you want to start all over again, we'll spend another five years debating every single thing out there. + +-------------------------------------------------------------------------------- +Chris Whelan, Carrington Investment - Analyst [270] +-------------------------------------------------------------------------------- + + Yes. Precisely. Thank you very much. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co - Chairman & CEO [271] +-------------------------------------------------------------------------------- + + Yes. + +-------------------------------------------------------------------------------- +Operator [272] +-------------------------------------------------------------------------------- + + Our next question comes from Eric Wasserstrom of SunTrust Robinson Humphrey. + +-------------------------------------------------------------------------------- +Eric Wasserstrom, SunTrust Robinson Humphrey - Analyst [273] +-------------------------------------------------------------------------------- + + Thanks very much. Marianne, can we just go back to the sequential NII guidance? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [274] +-------------------------------------------------------------------------------- + + Yes. + +-------------------------------------------------------------------------------- +Eric Wasserstrom, SunTrust Robinson Humphrey - Analyst [275] +-------------------------------------------------------------------------------- + + Can you help me understand how much of that is coming, or what the attribution is between benefits to NIM versus loan growth? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [276] +-------------------------------------------------------------------------------- + + Well, as I said, we're expecting NIMs to stay broadly flat from here. We do expect some modest loan growth, that's our outlook. I'm not going to tell you how much, but some. And then we also have the improving cost of debt, lower cost of debt on actions that we've been taking throughout the first half. + +-------------------------------------------------------------------------------- +Eric Wasserstrom, SunTrust Robinson Humphrey - Analyst [277] +-------------------------------------------------------------------------------- + + So I guess a couple of thoughts then. Shouldn't, presumably then, the benefits to the funding costs should show up through NIM, no? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [278] +-------------------------------------------------------------------------------- + + Yes. But we also have the yield compression. So you know, there's puts and takes. And so relatively flat on NIM, modestly up on NII. + +-------------------------------------------------------------------------------- +Eric Wasserstrom, SunTrust Robinson Humphrey - Analyst [279] +-------------------------------------------------------------------------------- + + And just within the composition of loan growth, if you divorce out the credit card seasonality, it's been within a very stable range. What is it that, in your view, takes the loans out of the current range? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [280] +-------------------------------------------------------------------------------- + + I'm sorry, I didn't understand. + +-------------------------------------------------------------------------------- +Eric Wasserstrom, SunTrust Robinson Humphrey - Analyst [281] +-------------------------------------------------------------------------------- + + So in other words, your loan growth has been -- sorry, not your growth, but rather your loan balances have been between $725 billion and $727 billion or $728 billion very consistently for many quarters, if you divorce out fourth quarter credit card seasonality. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [282] +-------------------------------------------------------------------------------- + + Yes. + +-------------------------------------------------------------------------------- +Eric Wasserstrom, SunTrust Robinson Humphrey - Analyst [283] +-------------------------------------------------------------------------------- + + But it sounds like you have some expectation that starts to move out of that range in order to generate this improvement in NII? I'm wondering what the driver of that is. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [284] +-------------------------------------------------------------------------------- + + We're growing loans in Asset Management. We're growing loans in Auto. We're adding more mortgage loans. We're expecting some growth in Commercial. Our Commercial Real Estate is already growing strongly. We're expecting some growth in middle market and Corporate Client Banking space. Although we've seen loan reduction in CIB, we're expecting that to remain relatively flat. So all other things being equal, that's net growth. And Card, as I said, have hit that inflection point, so that will stop contributing to run-off, net. + +-------------------------------------------------------------------------------- +Eric Wasserstrom, SunTrust Robinson Humphrey - Analyst [285] +-------------------------------------------------------------------------------- + + Got it. And then just finally, on the third quarter guidance, is that consistent with or relatively better than your prior annual guidance of down 1%? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [286] +-------------------------------------------------------------------------------- + + So our annual guidance was that, if you look at the first half of the year, you'll see that obviously already we're down year-to-date by more than that amount. So this is relative to the third quarter, we expect NII to go up. We're already down a little more than 1%. + +-------------------------------------------------------------------------------- +Eric Wasserstrom, SunTrust Robinson Humphrey - Analyst [287] +-------------------------------------------------------------------------------- + + Great. Thanks very much. + +-------------------------------------------------------------------------------- +Operator [288] +-------------------------------------------------------------------------------- + + Our next question comes from Christopher Wheeler of Mediobanca. + +-------------------------------------------------------------------------------- +Christopher Wheeler, Mediobanca - Analyst [289] +-------------------------------------------------------------------------------- + + Yes. Good morning. I have questions on a couple of topics. Perhaps the first one, on Equity Capital Markets. Clearly, I think the volumes were up about 2% quarter-on-quarter, and I think we all expected you to outperform. But it was an extremely good performance. And I wondered if you could brag a little bit about how you achieved that and how much you thought was from the market share and perhaps how much is down to geographic split. That's the first question. +The second one, I'm afraid, I'll get back on to leverage. I'm intrigued by the comments on page 4, which you've touched on in an earlier question on the Tier 1 capital actions, which you suggested would be perhaps issuance of some additional Tier 1 capital, as it's becoming now called, AT1. And I wondered if you actually had any indication yet, I know it's fairly early, from the regulator on what the terms of that new capital would have to be to qualify for Tier 1 under Basel III? And then perhaps talk about the $14 billion to $15 billion of current hybrids that you have within the Tier 1 calculation, which obviously you're going to phase out, I think in some cases, if not all, through to end of 2018, and what your strategy is for the placing those. +And just perhaps finally, I know Jamie's talked a lot about level playing field, and I asked him that last year on Basel III capital, but I'm just wondering actually the leverage ratio that you're looking to have to achieve now, whether it actually gives you a competitive advantage as opposed to a disadvantage, given 3% is pretty well being considered too skinny. Thanks very much. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co - Chairman & CEO [290] +-------------------------------------------------------------------------------- + + Well, thank you for bragging on our trading results. And for years, the Investment Bank is building FX rates, securitized products, commodities, emerging markets, credit. And they're good. And obviously, some go up and some go down. I wouldn't say it was-- at least, I didn't see any regional effects. We trade around the world and the books get handed off around the world, so it's hard to give it a region. But we build a lot of clients low businesses and that what's driving it. +I think it's better for the world to have harmonized rules around what Basel is trying to do, et cetera. But you're absolutely correct. It doesn't have to be exactly the same to have a competitive marketplace, et cetera. We always ran with higher capital liquidity than most of our competitors. I just think if one is 3% and one is 6%, that becomes just too big, and over time it could have huge competitive effects. And the regulators are working it out. We all want a fair, safe, sound financial system, okay? So that's in everyone's benefit, and there are huge capital issues -- capital requirements, liquidity requirements, leverage requirements, stress testing requirements. And among all of that, I feel that we're getting there. But at one point, this should be somewhat harmonized. +And your middle two questions, I now forgot. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [291] +-------------------------------------------------------------------------------- + + Can we get back to you on some of that stuff? We're sort of running out of time rapidly. + +-------------------------------------------------------------------------------- +Christopher Wheeler, Mediobanca - Analyst [292] +-------------------------------------------------------------------------------- + + Okay. I do appreciate that. Thank you very much. Thank you. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [293] +-------------------------------------------------------------------------------- + + Okay. + +-------------------------------------------------------------------------------- +Operator [294] +-------------------------------------------------------------------------------- + + Our next question comes from David Hilder of Drexel Hamilton. + +-------------------------------------------------------------------------------- +David Hilder, Drexel Hamilton - Analyst [295] +-------------------------------------------------------------------------------- + + Good morning. Just quickly. To be clear, on page 4, are you saying that your 4.7% leverage ratio is as of June 30 without any other assumptions or roll forward? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [296] +-------------------------------------------------------------------------------- + + Yes, correct. + +-------------------------------------------------------------------------------- +David Hilder, Drexel Hamilton - Analyst [297] +-------------------------------------------------------------------------------- + + Okay. And then secondly-- + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [298] +-------------------------------------------------------------------------------- + + I'm sorry, David. As of June 30, based upon the US proposed rules. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co - Chairman & CEO [299] +-------------------------------------------------------------------------------- + + Estimated to the best of our ability. + +-------------------------------------------------------------------------------- +David Hilder, Drexel Hamilton - Analyst [300] +-------------------------------------------------------------------------------- + + And congratulations for doing the work so quickly. But secondly, Jamie, how will you as a company respond to the proposal? Are you in favor of it largely? Are you against it? Will you have a lot of proposed changes to it? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [301] +-------------------------------------------------------------------------------- + + So, David, we did say at the beginning that we do think that having a leverage ratio is an important part of our capital management toolkit or process, as long as it's properly calibrated. And so for us the two questions, I think they are very important and the industry does, too. So we're participating in discussions. As Jamie's talked about, what should the quotient, or the ratio, be and making sure that that not only is appropriate but fair across the globe, and also what should the calculation for the denominator be. And we've alluded already to two specific questions, but there are more. +One is should high quality liquid assets, most particularly cash and cash at central banks, be treated the same as other balance sheet items? And then in terms of some of the additional add-ons that are being proposed, we think they could have issues, actual issues, for the operation of the financing market. So I think there's going to be a lot of work that takes place. There are comments due back on all of those proposals by mid-September, call it, plus or minus. And I think this will be worked through through the fourth quarter. + +-------------------------------------------------------------------------------- +David Hilder, Drexel Hamilton - Analyst [302] +-------------------------------------------------------------------------------- + + Okay. Thanks very much. + +-------------------------------------------------------------------------------- +Operator [303] +-------------------------------------------------------------------------------- + + And we have no further questions at this time. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [304] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co - Chairman & CEO [305] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Operator [306] +-------------------------------------------------------------------------------- + + This concludes today's conference call. You may now disconnect. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/exam/original-files/Problem_2_3_Sample_full_transcripts/2013-Jul-16-KO.N-140843862347-Transcript.txt b/exam/original-files/Problem_2_3_Sample_full_transcripts/2013-Jul-16-KO.N-140843862347-Transcript.txt new file mode 100644 index 0000000..4b4f8cb --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_full_transcripts/2013-Jul-16-KO.N-140843862347-Transcript.txt @@ -0,0 +1,531 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q2 2013 The Coca-Cola Company Earnings Conference Call +07/16/2013 09:30 AM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Ahmet Bozer + The Coca-Cola Co - President, Coca-Cola International + * Gary Fayard + The Coca-Cola Co - CFO + * Irial Finan + The Coca-Cola Co - President, Bottling Investments Group + * Steve Cahillane + The Coca-Cola Co - President, Coca-Cola Americas + * Jackson Kelly + The Coca-Cola Co - VP & IR Officer + * Muhtar Kent + The Coca-Cola Co - Chairman & CEO + +================================================================================ +Conference Call Participiants +================================================================================ + + * Bill Schmitz + Deutsche Bank - Analyst + * Bill Pecoriello + Consumer Edge Research - Analyst + * Mark Swartzberg + Stifel Nicolaus - Analyst + * Judy Hong + Goldman Sachs - Analyst + * John Faucher + JPMorgan - Analyst + * Bryan Spillane + BofA Merrill Lynch - Analyst + * Ali Dibadj + Sanford C. Bernstein & Co. - Analyst + +================================================================================ +Presentation +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + At this time I would like to welcome everyone to The Coca-Cola Company's second-quarter 2013 earnings results conference call. Today's call is being recorded. If you have any objections, please disconnect at this time. All participants will be on a listen-only mode until the formal question-and-answer portion of the call. +(Operator Instructions) +Participants will be announced by their name and company. Due to the interest in this call, we request a limit of one question per person. +I would like to remind everyone that the purpose of this conference is to talk with investors and therefore questions from the media will not be addressed. Media participants should contact Coca-Cola's Media Relations department if they have questions. I would like to now introduce Jackson Kelly, Vice President and Investor Relations Officer. Mr. Kelly, you may begin. + +-------------------------------------------------------------------------------- +Jackson Kelly, The Coca-Cola Co - VP & IR Officer [2] +-------------------------------------------------------------------------------- + + Good morning and thank you for being with us today. I'm joined by Muhtar Kent, our Chairman and Chief Executive Officer, and Gary Fayard, our Chief Financial Officer. Following prepared remarks by Muhtar and Gary this morning, we will turn the call over for your questions. Ahmet Bozer, President of Coca-Cola International, Steve Cahillane, President of Coca-Cola Americas, and Irial Finan, President of our Bottling Investments Group, will also be available for the Q&A session. +Before we begin, I would like to remind you that this conference call may contain forward-looking statements, including statements concerning long-term earnings objectives, and should be considered in conjunction with cautionary statements contained in our earnings release and in the Company's most recent periodic SEC report. +In addition, I would also like to note that we have posted schedules under the Financial Reports and Information tab in the Investors section of our Company website at www.coca-colacompany.com. These schedules reconcile certain non-GAAP financial measures, which should be referred to by our Senior Executives during this morning's discussions, [which our results] is reported under Generally Accepted Accounting Principles. Please look on our website for this information. Now let me turn the call over to Muhtar. + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Co - Chairman & CEO [3] +-------------------------------------------------------------------------------- + + Thank you, Jackson, and good morning, everyone. Our second-quarter volume performance came in below our expectations. There was a confluence of factors that collectively led to unusually weak second-quarter volume results. We continued to see [further] (technical difficulty) slowing economic conditions across the markets like Asia and Latin America and social unrest in southeast Europe, Middle East, and Brazil. On top of this, we were faced with unusually widespread wet and cold weather conditions across multiple regions including North America, across northern Europe and India, all of which impacted the entire industry. Consequently, we grew global volume 1% in the second quarter, leading to year-to-date volume growth of 3%. Our comparable currency neutral operating income, excluding structural, grew 5% year-to-date. And both in the quarter and year-to-date, we gained global volume and value share in nonalcoholic ready-to-drink beverages, as well as in both sparkling and still beverages. These gains included volume and value share increases in core sparkling juice, tea, and water, all of which underscores the real strength of our brand and the global reach of our system. +While we are not happy with our second-quarter volume performance, I can assure you that we are intensely focused on improving those areas we can control to ensure better performance in the second half of the year. Looking forward, we remain absolutely confident in our 2020 Vision and in our system's ability to execute, to grow, and to create value all across the world. As we have often said during these challenging global economic times, there will occasionally be a bump in the road and the real strength of a business is how you deal with that bump. In that respect, together with our system bottling partners, we continue to invest in our brand, the strength in our system for the future, and to achieve our long-term growth targets. The fact that we have outperformed the industry in this most recent quarter reinforces our belief that we are navigating these circumstances in a way that further strengthens our position of leadership within this extremely vibrant and resilient beverage industry. +Let me now provide you with an overview of our business performance by operating group starting with North America. In North America, volume declined 1% in the quarter as a 4% decline in sparkling beverages offset 5% volume growth in our still beverage portfolio. Year-to-date, volume in North America was even. Prior to this quarter, we consistently grew our business in North America for 12 consecutive quarters. Unfortunately, we experienced an extremely wet and cold second quarter with more rain in the US in June than we have seen in 50 years and 44% more precipitation than in June of last year. This weather clearly impacted our entire industry's volume growth. Nevertheless, we gained sparkling volume and value share both in the quarter and year-to-date, reflecting the strength of our brand, and we have robust marketing plans in place for the balance of 2013. +Still beverages gained volume and value share in the quarter making this the 24th consecutive quarter that our still beverage portfolio has either maintained or gained value share. Our growth in still beverages this quarter was led by strong performance across the ready-to-drink tea and packaged water categories, with brands such as Gold Peak, smartwater, and Dasani leading the way. Further, our volume and value share gains in the juices and juice drinks category were driven by solid growth for Simply and Minute Maid. We are confident that we are on the right track in North America and we continue to work diligently with our bottlers as we advance our refranchising plan. Indeed, we saw sequential improvement across the quarter in both the convenience retail and quick service restaurant channels, suggesting that category trends are beginning to improve. +While we do recognize that we still have work to do in North America, we remain laser-focused on the strategies that we have shared with you. First, we are building a balanced portfolio of strong brands, led by Coca-Cola, and ensuring that our portfolio remains relevant to all generations of consumers and across all beverage occasions. Second, we are focused on translating this brand value into unsurpassed customer value by delivering best-in-class customer service each and every single day. And third, we are continuously investing to build the capabilities we will need to sustain and to repeat our success. These strategies are taking a real hold and we are building on them with the evolution of the United States franchise system announced earlier this year. We therefore believe we are well-positioned to continue outperforming the nonalcoholic ready-to-drink beverage industry for the balance of the year. +Turning now to Latin America, we grew volume 2% in the quarter and 3% year-to-date. Volume growth was a little softer in the quarter due to macroeconomic challenges in a few major markets, specifically increasing consumer debt levels and higher food inflation along with concern over transportation fees contributed to some civil unrest and softer consumer spending in Brazil. In Mexico, weaker job creation and higher inflation impacted disposable income, resulting in reduced retail sales. These macro factors led to low single-digit volume growth in Mexico while the volume results in Brazil were even. Given slower growth rates in personal consumption across the region, we estimate that, year-to-date, beverage industry growth rates are currently 1.5 to 2 percentage points lower than the average of the last four years in Latin America. In the second quarter, we again gained volume share in Latin America in nonalcoholic ready-to-drink beverages, including both volume share gains in both sparkling and still beverages. +Moving to brand performance, trademark Coca-Cola grew 1% during the quarter and maintained volume share within the sparkling beverages category. These results reflect sustained marketing across the brand and the category. Our other sparkling brands grew volume and value share in the quarter, as we expanded Mundet in Mexico and Fanta in Colombia while reigniting marketing behind Schweppes in both Brazil and Argentina. High single-digit growth in still beverages led to volume share gains in the quarter. These results were driven by the expansion of Fuze Tea, continued strong performance of the Del Valle portfolio and strong share gains in Powerade, thanks to superior execution of our program. We expect that our Latin America Group will return to rates of volume growth that we have been more accustomed to in the last few years given current dynamics. Continued marketing and bottler investments along with solid execution plans for the second half of the year will also contribute to this improvement. I will bring my Americas update to a close by congratulating the associates of Solar, our new bottling partner in Brazil. With the close of this transaction, Solar forms the second largest operation in The Coca-Cola Brazil system, serving over 70 million consumers. +Now turning to Coca-Cola International, starting with Europe. The weak economy continues to be a key factor affecting our performance in Europe, especially in the southern regions where unemployment remains high, while consumer confidence and expenditures remain low. We are seeing this continue to play out across most fast-moving consumer goods categories with several of them slowing between the first and second quarters. Additionally, historically wet and cold conditions across Europe, including the coldest spring for Germany in 40 years, further dampened already weak consumer sentiment and industry trends and contributed to volume declining 3% in Germany in the quarter. While our European volume fell 4% in the quarter and is down 2% year-to-date, we maintain the positive share momentum of the first quarter, growing volume and value share across total nonalcoholic beverages and core sparkling beverages. +Across the continent, our team and bottling partners are activating a number of marketing and trade execution programs. Among them is our new Share a Coke summer campaign, launched across Europe in May and early signs are very positive. In fact, excitement surrounding the launch helped to partially offset the impact of weather on immediate consumption. Our current European outlook remains cautious for the time being given ongoing macroeconomic conditions. However, we believe with our commitment to our brands and execution, we should continue to gain share through the remainder of the year. +Moving on to our Eurasia and Africa Group, we achieved 9% volume growth in the quarter, up double-digits year-to-date. All business units grew in the quarter with our Middle East and North Africa business unit as well as our Central East and West Africa business units delivering double-digit growth. For the quarter, we've strengthened our competitive position as we gained volume and value share in nonalcoholic ready-to-drink beverages. Local execution of our global marketing campaign, along with continued price pack innovation, fueled this growth, which was led by brand Coca-Cola up 7% in the quarter and 9% year-to-date. Fanta and Sprite further contributed to core sparkling growth, while our still brands grew double-digits, led by Rani, Crystal, and Fuze Tea. Volume in Russia grew 3% with trademark Coca-Cola up double-digits. A successful sparkling promotion fueled Coca-Cola, Fanta, and Sprite growth as consumers collected under-the-cap points to obtain a limited edition set of limited Winter Olympic-themed glassware. In Spain and Portugal, we are encouraged by the early integration efforts underway at Coca-Cola Iberian Partners, our bottler in Spain and Portugal. We now have eight bottlers in those markets now operating as a single entity. +Shifting to our Pacific Group, we saw volume growth of 2% and we maintained nonalcoholic ready-to-drink value share. As is well publicized, China's economy has been slowing and this is now being felt in consumer spending. China's first half retail sales were the slowest in 10 years, while much of the growth in the nonalcoholic ready-to-drink beverage industry in the second quarter came from the value-orientated water category. As a result, our volume performance in China remained soft and was even for the quarter, cycling 7% growth from prior year. We command a leadership position in China in both brand preference and market share in sparkling as well as in juices and juice drinks. Sparkling volume grew 2% and our juices and juice drinks volume grew 7% year-to-date. This is driven by solid execution of key consumer and commercial initiatives and continual new product innovation. Looking forward, we are keenly focused on adjusting our strategies and improving our business in China. We recently strengthened our Management team in that region, adding to the already strong talent that we have in China and we are evolving our strategy, reallocating resources across our brand portfolio and strengthening our consumer communication. We anticipate a return to growth in our China business in the second half of the year. +In India, volume grew low single-digits in the quarter, cycling 20% growth last year, and importantly, we again improved our volume and value share of total nonalcoholic beverages, as well as sparkling and still beverages, further strengthening our competitive position as trademark Coca-Cola grew by double-digits. Our business in Japan delivered 1% volume growth while cycling 4% growth last year and we are seeing sequential improvements on share trends as we are moving through the year. Japan's sparkling beverage volume grew 1% in the quarter supported by the music-themed integrated marketing campaigns, such as the Zero Limit campaign for Coca-Cola Zero, up 13%. Solid growth in tea and sports drinks up 3% and 7% respectively also contributed to this momentum. Our Georgia Coffee performance was below our expectations and we are keenly focused on strategies and new launches to improve performance in the second half of the year. +I do want to acknowledge and congratulate our Coca-Cola East Japan associates on the successful completion of their merger and the launch of their Company on July 1. With this merger, our system is building on its deep roots and a 50-year history of strong partnerships in Japan. Coca-Cola East Japan will be well-positioned to meet the business growth needs of our customers while also engaging and refreshing consumers of all ages and lifestyles. +Lastly, our ASEAN business unit delivered strong results with 10% volume growth cycling double-digit growth from the previous year as Thailand, Indonesia, and Vietnam all delivered strong double-digit growth. Going forward, we expect to see an improvement in our Pacific Group's performance in the second half of the year. On a global scale, we were recently humbled by several accolades, including rising to number five on Barron's list of the World's Most Respected Companies and receiving the 2013 Creative Marketer of the Year award at the Cannes Lions International Festival. +In my 35 years of experience in the Coca-Cola system, I have learned that we proudly participate in one of the fastest growing and most dynamic industries in the world. As I think about the second quarter, nothing has changed in our ability to continue winning in this industry. There's no question that our system's commitment to superior execution is stronger than ever before and our business fundamentals remain firmly intact. Our leadership team is firmly in place and I'm confident in our ability to capitalize on the abundant opportunities that lie ahead. Given this, we are confident that we have the right strategies, we have the right vision, and the right initiatives to drive long-term sustainable growth and value. And our focus on achieving our 2020 Vision is unwavering with current dynamics leading us to believe that our performance will be better in the back half of the year. Why? +Quite simply a few important reasons. First, our global brands are stronger than ever and we will continue to invest in them to capture long-term volume and value share. Second, we have an unparalleled global business system focused on delivering on our 2020 Vision and, third, we have great confidence in our plans and we will sharpen our focus to ensure our resources are directed to those strategic priorities that will drive our business and certain key markets will return to growth. The nonalcoholic ready-to-drink industry is and has always -- and always will be a terrific, terrific business. We will continue to capitalize on our unprecedented global reach, the broad portfolio of preferred premium brands, and superior system execution. And we continue to invest alongside our global bottling partners and we are well-positioned to effectively manage our Business for long-term profitable growth both in today's economic environment and also as we look forward to our future. With that, let me now turn the call over to Gary. + +-------------------------------------------------------------------------------- +Gary Fayard, The Coca-Cola Co - CFO [4] +-------------------------------------------------------------------------------- + + Thank you, Muhtar, and good morning, everyone. As Muhtar has shared, the industry clearly slowed a little due to a number of factors that impacted various markets around the world. The combination of these factors resulted in weaker volume performance in the second quarter than we expected. At the same time, we recognize the need for improved performance in certain markets. Having said that, we remain absolutely focused on doing the right things for the long-term health of the business and investing for long-term sustainable growth. Increasing share during times like these further strengthens our position and can ultimately lead to accelerated growth as market conditions normalize. And we continue to win on this front, gaining both global volume and value share in both total nonalcoholic ready-to-drink beverages as well as volume and value share in global sparkling and still beverages. So let's review our results in more detail starting with a review of the key drivers of our financial performance. +Our second quarter and year-to-date financial performance reflects concentrated sales growth in line with unit case, volume growth, as well as a strong increase in direct marketing expenses, as we sustain our commitment to invest in the health and the strength of our brands. From an operating segment standpoint, our operating income growth this quarter reflected strong profit growth in Latin America and Eurasia and Africa, as well as the continued solid financial performance of the Bottling Investments Group. Operating income in North America and Pacific was even while Europe experienced a slight decline in profit. Comparable currency neutral net revenue declined 1% this quarter and we were even year-to-date. However, excluding the impact of structural items, primarily the sale of the Philippines bottler, net revenues increased 2% both for the quarter and year-to-date. We continue to earn pricing in the marketplace, but at the consolidated level, the positive pricing was offset by the impact of geographic mix, resulting in even price mix for both the quarter and year-to-date. +Although geographic mix unfavorably impacted price mix at the consolidated level, it contributed to the improvement of our gross margin in the quarter and year-to-date. Our comparable gross margin was 61.2%. This represents a slight improvement compared to the prior year, primarily due to the impact of geographic mix, structural items, and our foreign currency hedging program. As we shared in our first quarter earnings call, we expect our gross margin to moderate somewhat over the remainder of this year primarily due to a shift in geographic mix. Excluding the impact of structural items, we achieved 2 points of favorable operating expense leverage for both the quarter and year-to-date and we now expect to achieve low single-digit operating expense leverage for the full year. On comparable currency neutral operating income, it was up 4% this quarter and year-to-date. Excluding the impact of structural items, operating income grew 5% year-to-date. On a comparable basis, the impact of currency was a 3% headwind on this quarter's operating income results. And based on our hedge positions, current spot rates and the cycling of our prior year rates, we expect currencies to be a 4% headwind on our operating income for the third quarter and full year. +Below the line, we have benefited from an increase in net interest income, an improved tax rate, and fewer shares outstanding due to our continued share repurchase program. We expect net interest income in the second half of the year to be relatively in line with comparable net interest income year-to-date. Additionally, we now expect our full-year tax rate to be 23% and we expect to hold this rate through 2014. Comparable earnings per share grew 4% in the second quarter despite currency headwinds of approximately 2%. Year-to-date comparable earnings per share also grew 4% despite currency headwinds of approximately 4%, as well as the impact of two fewer selling days. We continue to generate a strong $4 billion from cash from operations year-to-date, providing us significant financial flexibility. As I have shared with you over the years, we redeploy our cash flows utilizing a consistent and disciplined framework. +First, our first is to reinvest back into the Business and to strengthen our global system. Secondly, to continue to expand our portfolio and capabilities through bolt-on acquisitions and partnerships. Third, continue to return cash to shareholders through our dividends and we increased our dividend 10% in 2013, our 51st consecutive year of dividend increases. And lastly, repurchase shares. Year-to-date, our net share repurchases totaled $2 billion and we continue to expect full-year share repurchase to be between $3 billion and $3.5 billion. As you model our 2013 operating results, let me again remind you that the steps we have taken along with our bottling partners to strengthen our global system will have a structural impact on our operating results over the remainder of the year. As you're aware, we closed the transaction in the Philippines earlier this year and the merger of our bottling partners in Brazil and Japan recently closed. +As I shared in our 2012 year-end call, we do not expect these transactions to have a material impact on our 2013 earnings results. However, these transactions will impact various line items within our P&L. We anticipate that these transactions will have a 3% structural impact on our full-year 2013 net revenues. Likewise, our full-year operating income results should see a 1% structural impact. However, there should be a corresponding improvement in our equity income to account for our share of the results of these operations moving forward. Additionally, the structural impact from these transactions will be larger in the second half due to the impact of the deconsolidation of our Brazilian bottling operations beginning in the third quarter. +In closing, we delivered solid financial performance through the first two quarters of 2013 and we expect to continue our solid financial performance during the second half of this year. Our Company and our system are well-positioned to capitalize on the real opportunities for growth and we remain very confident as we continue to win in the marketplace with volume and value share, we continue to deliver solid financial results, we continue to innovate and invest in our brands, our global system continues to get stronger, and we are best-positioned to continue capturing growth in the dynamic nonalcoholic ready-to-drink industry. Operator, we are now ready for any questions. + + + +================================================================================ +Questions and Answers +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Bill Pecoriello, Consumer Edge Research. + +-------------------------------------------------------------------------------- +Bill Pecoriello, Consumer Edge Research - Analyst [2] +-------------------------------------------------------------------------------- + + Muhtar, I was hoping you could step around the world and dive a little bit deeper into certain markets and regions to help us separate out the impact of nonrecurring factors that hit your second quarter. First is any macro related factors that can continue to pressure the business in the second half. You had mentioned macro factors in Brazil, Mexico, Europe, and China. Will those continue to be as big an impact in the second half as the second quarter and if not why? And then maybe if you could help quantify maybe what you think the weather-related impact was in the second quarter? + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Co - Chairman & CEO [3] +-------------------------------------------------------------------------------- + + Yes, hello, Bill, thanks. Overall both from -- in Europe, United States, India, some other parts, we did have a pretty significant impact from weather -- unusual weather, monsoons coming very early in India as you probably all read, many thousands missing in flooding, worst flooding since the tsunami back 10 years ago. So -- and then Europe -- also Central Europe, Germany, all the issues around the river beds rising and flooding and very heavy, wet conditions. So we did, yes, have impact both from a consumer sentiment, both from a mobility sentiment in the United States also, and both also from just the pure, in some cases, distribution issues that hindered our performance and as you know, when we lose a sale that doesn't recur any more, we lost it that day and so. And also in some cases we were cycling very unusually warm and favorable weather conditions from prior year in some cases like India last year the monsoons actually started later, that gave us a 20% growth in India, unusual for the second quarter in India. Usually the first half in India is always less than the second half in India because of the anomalies of the weather. So, yes. +And then macro conditions, we all have felt it in social issues in Southeast Europe, demonstrations across the Middle East, and then more recently in Brazil, but we feel confident both in terms of looking at our plans in place, looking at current dynamics, that both Brazil will have a better second half, China will have a better second half, Russia will have a better second half, and certainly a better quarter than this last quarter where we grew volume 3%. Overall, Mexico as well as India. So while we have -- we continue to invest in our brands, our brands are stronger than ever before, we have taken market share, our system is stronger and so all these key markets we believe will perform better in the second half. In fact, as I've said, we have seen this -- we always know that the second half in a country like India is significantly better than the first half. In any case, if you look back at our performance over last few years. So -- and then in the United States, we've got very robust plans to return back to growth. +So we feel pretty confident that this was a confluence of events that happened all at the same time. The portfolio effect of our global business did not work in our favor in this particular case in the second quarter and I feel and my colleagues feel and our bottlers feel very confident. I have been across many markets recently. I've traveled to China, Japan, Thailand, Myanmar, many other parts of Asia, I have been in Southeast Europe, I've been in France, and all in the last four, five weeks and I feel that we will look towards a definitely a better quarter volumetrically, and again, we can talk to you about how we feel about the financial numbers too later in the call and I can ask Gary to reflect on that too in terms of the second half. You want to -- Gary? + +-------------------------------------------------------------------------------- +Gary Fayard, The Coca-Cola Co - CFO [4] +-------------------------------------------------------------------------------- + + Sure. Well, let me continue on [then] versus the volume. On the second half on the P&L, we had a very solid first half, we would expect to have a solid second half of the year as well. We have said there would be bumps along the road, the industry had one, obviously and it slowed. But we continued to take share and we feel very confident about the second half. As we look at the second half financial results, we will be very close to our long-term growth targets, particularly in volume and earnings per share should be coming back in line with what we would all have been expecting at the first of this year. + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Co - Chairman & CEO [5] +-------------------------------------------------------------------------------- + + Yes, I would just add, Bill, that this is more an anomaly. We should not see this as a trend or a systemic issue and that is simply how I believe one should think about it and again I can ask Steve and Ahmet to reflect upon how they see the second half from their vantage point in both Americas and International. Maybe Steve, you can start? + +-------------------------------------------------------------------------------- +Steve Cahillane, The Coca-Cola Co - President, Coca-Cola Americas [6] +-------------------------------------------------------------------------------- + + Sure. Thanks, Muhtar. Starting with Latin America, Muhtar said it well. We saw things in Brazil that we hadn't seen before the economy slowed. There was social unrest. It didn't last very long, things are slowly getting back to normal, and we expect a better performance sequentially as we progress through the year in Brazil and in Mexico. In Latin Center and in South Latin, we have seen very good results. High single-digit results continue so there's a lot still going very well that continue to go well in Latin America and Brazil and Mexico, getting back to what we would expect to see on a normal basis. In North America, Muhtar said it, it's -- we don't like to talk about the weather, but the first half of last year saw unusually good weather conditions. We had warm weather, we had dry weather coming out of winter and going into spring. This year in North America we had some of the worst weather and you've all seen it. It's been very wet, it's been very cold, it's been historically wet and cold, which obviously impacts our business. +On top of that, we had the payroll tax effect which started at the beginning of the year, which affects lower income households, obviously much more, affects their disposable income, their ability to spend. We saw late payroll tax -- late payroll -- or tax refunds coming into the marketplace. But as we look forward we expect the weather pattern to obviously normalize. The weather will not continue to be a factor in a country as big as the United States like it's been and from an economic standpoint, people are used to the payroll tax now. They have had four to five months to moderate their household budgets, to get used to it. The refunds, obviously, have been back in the marketplace and we are already starting to see better trends in QSR, better trends in Convenience Retail, better trends across our business. So we look forward to the second half of the year across the Americas, much more favorably than the first half. Muhtar used the word anomaly -- especially an anomaly in North America and we see ourselves coming out of that. + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Co - Chairman & CEO [7] +-------------------------------------------------------------------------------- + + Ahmet? + +-------------------------------------------------------------------------------- +Ahmet Bozer, The Coca-Cola Co - President, Coca-Cola International [8] +-------------------------------------------------------------------------------- + + Thanks, Steve. Thanks, Muhtar. Yes, just to build further on Muhtar's comments, I'll start with India, that's definitely completely weather-related. All our investments in the route to markets coolers and capabilities will continue to deliver the kind of levels that we are used to having from India in the rest of the year. So we are quite comfortable on that. On China, there were probably impacts of -- as you hear, the continuing slowdown in macro levels, as well as there was some weather impact, but we do expect volume to return for a number of reasons. First of all, China is a country with very, very low per capitas. I have been there a number of times in the last three, four months and we have been working on evolving our strategy with better OBPPC, more price points, and more packs, as well as improving our capability. +As Muhtar mentioned, we have recently strengthened our Management team there, and I'm very confident that in the second half of the year we are going to start returning to growth in China, maybe not at the levels of double-digits that you might have been seeing but we will certainly be looking to returning to growth in China. Now, the other anomaly in the International results was Europe. I could comfortably say that a very, very big part of that 4% decline was driven by unseasonable weather, as it has already been mentioned. It shows the strength of our system that we were able to gain volume and value share in both sparkling and NARTD and as we see weather normalizing we again look forward to coming back to our normal range of growth in Europe. The rest of International territory, such as EAG continued to deliver at historical growth rates. + +-------------------------------------------------------------------------------- +Gary Fayard, The Coca-Cola Co - CFO [9] +-------------------------------------------------------------------------------- + + And Bill, this is Gary. Just add one or two other quick data points as well. When we talk about 1% volume, you have to wonder, is that a weak 1% or a strong 1%. Let me just assure you, it's as strong as it can be and still be 1%. So that's number one. The other thing is we talk about some of these anomalies on some of these markets. One of the things that gives me some confidence as well because there's been a lot of discussion about what's happening with the emerging markets and all around the world with the slowdown from China, et cetera, but we have always talked about the markets where the per capita consumption is less than 150 and has always been a real strength of ours. Well again even in the second quarter, if you looked at those markets under 150 and exclude China and India, which we have just discussed separately, if you excluded those, our volume in those markets was plus 7% in the second quarter, so it still shows underlying strength of the markets in those emerging markets. + +-------------------------------------------------------------------------------- +Bill Pecoriello, Consumer Edge Research - Analyst [10] +-------------------------------------------------------------------------------- + + Thanks for the comprehensive answers. + +-------------------------------------------------------------------------------- +Operator [11] +-------------------------------------------------------------------------------- + + John Faucher, JPMorgan. + +-------------------------------------------------------------------------------- +John Faucher, JPMorgan - Analyst [12] +-------------------------------------------------------------------------------- + + Gary, I just wanted to ask a clarification about the back half of the year. Your commentary on the financials, it sounds like you're saying you're going to get to that level in the back half of the year and not the back half of the year will get you to the long-term algorithm for the full year. At least that's how I interpreted it. Can you just clarify that? + +-------------------------------------------------------------------------------- +Gary Fayard, The Coca-Cola Co - CFO [13] +-------------------------------------------------------------------------------- + + Yes, John. Thanks for the question. Here's how I would say it. We are actually very close in the first half of the year, year-to-date, if you look at operating income, I think year-to-date ex structural, currency neutral is plus 5% and our volume is plus 3% so we are not that far away. So our view would be that we should be and in fact year-to-date earnings per share ex currency is 8%, rounds up to 8%. So we are not that far away in the first half. That's why I was saying, solid results, and when I say it's solid -- you've followed us long enough, we like to be at the top end of ranges and not at the bottom end of ranges. Unfortunately, we are at the bottom end right now but that's the world we are dealing with but we feel very good about the second half. + +-------------------------------------------------------------------------------- +John Faucher, JPMorgan - Analyst [14] +-------------------------------------------------------------------------------- + + Okay. + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Co - Chairman & CEO [15] +-------------------------------------------------------------------------------- + + John, this is Muhtar. Just one point that I can add to that is the following. It's customary sometimes that when in the kind of businesses that we are in, when you have a blip in your volume because of a confluence of events, some of which are not in your control, the first thing you do is go out and cut marketing and if you look at our numbers, we have continued to invest aggressively in our brands through the second quarter, through -- in the first half and, as you know, every investment in marketing does not pay back in that quarter. It pays back in future quarters and therefore we are confident that with the share gains, we are confident with the strength of our brands, we are confident about the metrics on our brands both in sparkling and stills across the world and we are confident in our bottling partners' investment plans that are taking place in the second quarter that we can continue our momentum going into the second half of the year and also improve on it, volumetrically, but also continue with our mission to achieve our 2020 Vision through the next -- the years ahead. + +-------------------------------------------------------------------------------- +John Faucher, JPMorgan - Analyst [16] +-------------------------------------------------------------------------------- + + Got it. Okay. Thanks. Then my actual question here was, Gary, you got positive price mix in the vast -- in every region this quarter with the exception of Pacific. And yet it's not going up to full positive price mix here. How do we view the regional price mix versus the geographic offset and how does this fit into your long-term algorithm? Because it seems like this is something that's most likely going to continue to be a notable overhang? + +-------------------------------------------------------------------------------- +Gary Fayard, The Coca-Cola Co - CFO [17] +-------------------------------------------------------------------------------- + + Okay, John, first I want to compliment you on your creativity with that first question and then here's the real question. But anyway. Great question, actually. And the first thing I would say around pricing is we believe strongly that we have premium brands and our brands should command a premium in the market. And they do command a premium across the world. Number one, we are seeing pricing across -- rational and within the industry we think pricing is rational, particularly in the United States. But if you look at price mix and I'm going to go year-to-date, but the second quarter is essentially the same thing. If you look at price mix, price mix year-to-date is even. But within that you've got positive pricing and you've got negative geographic mix. +So year-to-date consolidated, we actually have positive 1% pricing. If you look at it by region, year-to-date North America has positive pricing up 1%. Eurasia and Africa has positive pricing up 8%. Europe has -- looks like positive pricing up 2%, although I'll tell you a lot of that is because of Innocent and our acquisition of Innocent so absent Innocent, I think Europe is closer to flat. Latin America is positive 8 points of pricing year-to-date. The Pacific is even. And Bottling Investments Group is plus 2% as well. So we are actually getting very nice, positive pricing as well as category mix, brand mix, channel mix, all of those things are working. +What's happening to us and where the ding comes in, if you will, is that we've got negative geographic mix so we've got significant negative geographic mix across many of those regions, which brings us back to even when you put price and geography together overall at the consolidated level. As I've often said, geographic mix would -- is always going to be probably negative because you're going to expect those emerging market countries to be growing faster than the developed market countries and you've got better pricing in the developed market countries. What's amplified it a little bit this quarter particularly was the result in Europe that we talked about and North America being -- coming out even where they were. So, you put all that together, we are actually getting the kind of pricing we would expect to be getting in the market. + +-------------------------------------------------------------------------------- +John Faucher, JPMorgan - Analyst [18] +-------------------------------------------------------------------------------- + + Thanks. + +-------------------------------------------------------------------------------- +Operator [19] +-------------------------------------------------------------------------------- + + Judy Hong, Goldman Sachs. + +-------------------------------------------------------------------------------- +Judy Hong, Goldman Sachs - Analyst [20] +-------------------------------------------------------------------------------- + + I just wanted to go back to the second half expectations and clearly you can't control the macros and the weather, but I would just like to hear a little bit more specifically on some of the actions that you're doing to improve the volume performance, particularly in markets like China where there's a macro issue but there's also competitive issue, there's also portfolio issue just in terms of not participating in some of the fast growth segments. So can you just talk about how you're thinking about marketing investments, how you're thinking about your portfolio? Can you accelerate price tag architecture strategy more aggressively to really get the volume performance even if the macros don't come back and/or the weather continues to be challenging? + +-------------------------------------------------------------------------------- +Ahmet Bozer, The Coca-Cola Co - President, Coca-Cola International [21] +-------------------------------------------------------------------------------- + + Should I take this? + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Co - Chairman & CEO [22] +-------------------------------------------------------------------------------- + + Yes. Judy, let me just reflect on that and I'll ask Ahmet also to comment. But what we have said again is there was a coming together of many events that usually don't come together all the time. We have performed overall globally at rates that are much more commensurate to what you've been used to in the last three, four years despite the fact that we've had issues, some of these issues happening to us from quarter to quarter, but you haven't felt them because of the fact that the portfolio worked. And this time, you have the issues around in Latin America and the two key markets -- Brazil and Mexico -- on slowing down and on also consumer spending being impacted because of the Brazilian crunch in consumer credit that was taken away from the consumers and generally the consumer spending went away. And then you also had China, the issues in China that was consumer spending is actually much below GDP levels and that is documented across the macro numbers in China and as well as the weather issues related to India and also other issues coming together in North America where it went for the first time in 12 quarters from a plus to a negative, which we don't expect. +All of these things we don't expect to continue at the same time. Some of these things may still continue to impact us. Therefore, the portfolio will work. Now, related specifically to China, we are participating in two great categories in China and we are the leaders, which is sparkling and juices, those categories we have grown in and they are adding tremendous value to our portfolio and to our business in China. We have also, as we said, retargeting all our efforts in China, refocusing all our efforts. Yes, there's a different competitive landscape. We feel that actually that is not -- has not been the issue for us. The main issue for us is to ensure that we can continue to distribute in outlying areas in China that we have had some issues and we are correcting those and also that our marketing is working, which we feel definitely our brands are stronger, our innovation pipeline is working in terms of what we are providing to the consumer, also in terms of packaging. +And we feel confident that those two categories -- playing in those two categories -- and then also innovating across some other categories like dairy is going to create the growth and the value for us starting in the second quarter but also continuing and we also feel confident that the Chinese leadership -- the new Chinese leadership -- are going to ensure that they take the right actions and we are seeing that to reposition and transform the economy without creating a major bump as they transform the economy from a purely export-led economy to a more balanced economy with also consumer spending and both Deputy Vice Premier Yang in charge of the economy, as well as the new team, we feel confident and have the plans in place to ensure that that takes place. So again, Ahmet, you can reflect more on that, as well as any other markets you want to. + +-------------------------------------------------------------------------------- +Ahmet Bozer, The Coca-Cola Co - President, Coca-Cola International [23] +-------------------------------------------------------------------------------- + + Yes. Thanks, Muhtar. Thanks, Judy, for the question. A couple of messages here, Judy. Message number one is that the economy may be down but the growth prospects in China, even in the short term, is there simply because of the very low level of per capitas and strength of our system. Point number two, if you look at all the competitors in China, nobody really participated in all the categories. All the players have one or two categories that they are strong in and then they drive their businesses through those categories and maybe extend them to others. Our position is the same so our strategy is basically first of all, we definitely can do better in the categories that we already exist, such as sparkling. So to give you some specific actions we are taking to do that, I have highlighted the OBPPC and that's actually accelerated, we have pilots running on various multi-serve and single-serve packages for different price points in different parts of China. And as those things roll out of the pilot, we will be rolling some of them nationally, so those are already in a way in the market and they will be accelerated into the second quarter. We have also relooked at our communication strategies and we are going to be communicating more intensely on the intrinsics of our products as well as extrinsics. +You might have heard about our nickname promotion, that's the similar promotion to the Share a Coke promotion around the world elsewhere, which is getting incredibly positive reaction from the consumer, and all the other things of improving our route-to-markets, et cetera, those are all underway and we are very confident that that's going to give us our strength in sparkling. Now we also play in juices as you know, and we, as Muhtar mentioned, we are the number one player there. We are refocusing our efforts back around Pulpy and we are just looking at an extension of that into Mango, which is getting very strong consumer reaction. So as we consolidate our efforts behind that you would see a continued increase. +Now, obviously we are not only focused on just our existing categories. We have a pretty successful brand in Super Milky Pulpy, which is a value-added dairy, and we are beginning to increase our focus on that and we are getting high single-digit growth of that brand and we are building our innovation pipeline for the future. So it's a fairly robust strategy and, yes, under lower economic environments we might have lower growth rates than what you're used to, but we are ever strengthening our position in China to capitalize on this market for not just immediate future but the very long term. + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Co - Chairman & CEO [24] +-------------------------------------------------------------------------------- + + And we have Irial also, which oversees Bottling Investments Group and, as you know, we are one of the three system players in China in terms of bottling. Maybe, Irial, you can comment on what you're seeing down on -- very close to the ground? + +-------------------------------------------------------------------------------- +Irial Finan, The Coca-Cola Co - President, Bottling Investments Group [25] +-------------------------------------------------------------------------------- + + Yes, Judy, good morning. Just to build on something Muhtar said earlier, which is around investment and I would say from a bottling perspective, we continue to invest heavily in the market and particularly in our execution capability, route-to-market capability, and critically in developing the talent to be successful in the next years ahead. So when you add those to the revitalized marketing strategies, OBPPC, I actually feel very confident about the future. Yes, we have bumps along the way but our Business is growing, our challenge is to grow a healthy long-term Business and I think, from a bottling perspective, we are really putting in place the infrastructure and the capability to really drive a success for the future and that's basically where I would leave it. + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Co - Chairman & CEO [26] +-------------------------------------------------------------------------------- + + Judy, what I would just say finally is I wouldn't read anything more into this than what it is. As Gary said earlier, we were fractionally away from rounding up to 2% and we could -- it would not have been hard for us to do something which would not be right for this Business and take the volume up to 3% and selling low, cheap product. That is not what we are about. We are about investing. We are about doing the right thing for this Business and we are about -- and I've always said there may be a bump along the road, the one bump along -- we have grown this business consistently in line every year on an annual basis since 2008 on our way to our 2020 Vision in the range -- in the upper range of our long-term growth plan despite very, very challenging macroeconomic conditions and that is going to happen in 2013 also. + +-------------------------------------------------------------------------------- +Judy Hong, Goldman Sachs - Analyst [27] +-------------------------------------------------------------------------------- + + Okay. Great. Thank you very much. + +-------------------------------------------------------------------------------- +Operator [28] +-------------------------------------------------------------------------------- + + Bill Schmitz, Deutsche Bank. + +-------------------------------------------------------------------------------- +Bill Schmitz, Deutsche Bank - Analyst [29] +-------------------------------------------------------------------------------- + + Just two quick questions. What are the trends like recently? It seems like you're pretty bullish in the back half. So as you exited June and got into July, it looks like some of the weather normalized, so what are you seeing more recently? And then minutia but the big margin decline percentage year-over-year in Europe, what's the primary driver of that? + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Co - Chairman & CEO [30] +-------------------------------------------------------------------------------- + + Yes, let me just comment on what you just said. We are not -- this is not about managing on a day -- yes, we manage this business on an hourly basis but it's not healthy to comment on what has happened in the last two weeks. Yes, of course, we expect the weather to normalize. As you know, whoever is in the Northeast now and whoever was in the West Coast of the United States in the last 10 days, you know that weather has -- it does normalize. That's probability and statistics, so it just happened all in a very short period of time where everything was negative in many major markets, it's -- and it will turn -- it will normalize and that's what we are saying, part of what we are saying, so I have every confidence that with the normalized conditions, as I've said, we will again, 2013 will be another year when volume will grow at the range of the long-term growth model. As far as the margins are concerned, I will turn it over to Gary in terms of what -- the margin of what you mentioned in terms of the margin numbers in Europe. + +-------------------------------------------------------------------------------- +Gary Fayard, The Coca-Cola Co - CFO [31] +-------------------------------------------------------------------------------- + + Yes, in Europe it's a structural anomaly. It's actually Innocent. So when the juice business, juice having lower margin, when it came in, that's what changed the margins. It's nothing more than that. + +-------------------------------------------------------------------------------- +Bill Schmitz, Deutsche Bank - Analyst [32] +-------------------------------------------------------------------------------- + + Got you but so they should be down going forward though because of that because Innocent is now fully consolidated? + +-------------------------------------------------------------------------------- +Gary Fayard, The Coca-Cola Co - CFO [33] +-------------------------------------------------------------------------------- + + Yes. + +-------------------------------------------------------------------------------- +Bill Schmitz, Deutsche Bank - Analyst [34] +-------------------------------------------------------------------------------- + + Okay, great. + +-------------------------------------------------------------------------------- +Gary Fayard, The Coca-Cola Co - CFO [35] +-------------------------------------------------------------------------------- + + And that's actually the flip side, if you will, of what I said when I was answering John's question, that if you looked at price, the price inside of price mix in Europe is actually plus 2%, but it's really Innocent giving us a lift on price but it gives the opposite effect on the margin. + +-------------------------------------------------------------------------------- +Bill Schmitz, Deutsche Bank - Analyst [36] +-------------------------------------------------------------------------------- + + Got you. So from a dollar margin perspective it's almost neutral but the percentages change because of the price component? + +-------------------------------------------------------------------------------- +Gary Fayard, The Coca-Cola Co - CFO [37] +-------------------------------------------------------------------------------- + + Yes, exactly right. + +-------------------------------------------------------------------------------- +Bill Schmitz, Deutsche Bank - Analyst [38] +-------------------------------------------------------------------------------- + + Oh, great. Thanks very much for your time. + +-------------------------------------------------------------------------------- +Operator [39] +-------------------------------------------------------------------------------- + + Bryan Spillane, Bank of America. + +-------------------------------------------------------------------------------- +Bryan Spillane, BofA Merrill Lynch - Analyst [40] +-------------------------------------------------------------------------------- + + Gary, just a question for you related to share repurchases. With the stock the way it's performed in the second quarter, did you accelerate or do anything different in terms of timing of maybe pulling forward share repurchases? And then the business right now is bouncing around the low end of your algorithm and the stock has bounced around in a pretty tight range here recently. So is there any consideration to maybe even buying back more stock than you originally planned just because you've got an opportunity to buy it here at the -- around the $40 level? + +-------------------------------------------------------------------------------- +Gary Fayard, The Coca-Cola Co - CFO [41] +-------------------------------------------------------------------------------- + + Yes, great question, Bryan. Well, first, you will see that we did accelerate purchases in the first half of the year. As I said, if our annual target was in the $3 billion to $3.5 billion range and we actually have repurchased $2 billion in the first half, we did exactly what you said and we accelerated in the first half of the year. Where we are right now is we are sticking with the annual target, which we originally set at $3 billion to $3.5 billion and I'd just tell you, we will give you an update on that at the end of the third quarter. + +-------------------------------------------------------------------------------- +Bryan Spillane, BofA Merrill Lynch - Analyst [42] +-------------------------------------------------------------------------------- + + Okay. But not out of the realm of possibility that you could go higher if you chose to? + +-------------------------------------------------------------------------------- +Gary Fayard, The Coca-Cola Co - CFO [43] +-------------------------------------------------------------------------------- + + I've learned to never say never to anything. + +-------------------------------------------------------------------------------- +Bryan Spillane, BofA Merrill Lynch - Analyst [44] +-------------------------------------------------------------------------------- + + All right. Thank you. + +-------------------------------------------------------------------------------- +Operator [45] +-------------------------------------------------------------------------------- + + Mark Swartzberg, Stifel Nicolaus. + +-------------------------------------------------------------------------------- +Mark Swartzberg, Stifel Nicolaus - Analyst [46] +-------------------------------------------------------------------------------- + + Muhtar or Gary, question on the gross margin evolution. I don't want to put words in your mouth but it seems like one of the silver linings here is that the price pack architecture work you've been doing over several years has allowed you to put up a pretty decent gross margin number and offset some of the corresponding earnings disappointment that comes from the revenues being what they were in the quarter. If that is a fair assessment, can you give us a bit of an update on what's going on in terms of innovation, not in terms of the price, the pack but in terms of what's really in the bottle because that seems to be one of the problems you're facing from a larger share performance absolute NARTD performance perspective? + +-------------------------------------------------------------------------------- +Gary Fayard, The Coca-Cola Co - CFO [47] +-------------------------------------------------------------------------------- + + Perhaps, Mark, let me take the margin question and then we can come back to the innovation question. But this is actually -- let me get back into actually what I talked about, price mix and margins when I was talking about Innocent. The same thing applies actually at a higher level for the total Company. So what you've got is very positive pricing and you're seeing that and that being offset by geographic mix. But what you're seeing is when an operation like North America is minus 1% in the quarter, that actually -- this is counterintuitive -- but it actually improves margins, okay, because North America having the finished product business has lower margins. So in our expectation is, number one, to continue to get positive pricing and we are going to be rational in pricing and we intend to stay premium as I said earlier. But in addition to that, we expect North America's performance to improve in the second half of the year, which will actually put pressure on margins, which is why we said earlier that we would expect gross margins to moderate over the second half of the year and it's really the geographic mix of where the income is coming from. Does that make sense? + +-------------------------------------------------------------------------------- +Mark Swartzberg, Stifel Nicolaus - Analyst [48] +-------------------------------------------------------------------------------- + + It does, yes. Absolutely. The geographic headwind is what it is. + +-------------------------------------------------------------------------------- +Gary Fayard, The Coca-Cola Co - CFO [49] +-------------------------------------------------------------------------------- + + Yes. + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Co - Chairman & CEO [50] +-------------------------------------------------------------------------------- + + Yes, also on innovation, as we have said before, we don't look at innovation only as ingredients, we look at it as packaging, ingredients, equipment, even in terms of the marketing, social media, the brand price pack channel, architecture, occasion architecture, all of that is working for us and also our -- in terms of our new campaign to be part of the solution around the world, working closely with local governments, national governments, working with the government of Mexico, working with mayors in Chicago, in San Antonio, other parts of the United States, in different states, in Atlanta, and you can look at the patents that we have been filing of recent. So we are working and freestyle and the next generation of what is behind -- what's coming next after that, we are working on a host of new innovations. +Also ingredients. Continue to work with our partnerships across the world in different incubators around the world. The best -- we always believe here in The Coca-Cola Company, the best ideas are outside. So the plant bottle came from the outside from one of the incubators in India. Many new ideas are coming from different incubators in Israel or in China or in Japan or in Latin America. We have many -- we have substantial partnerships from here in -- with the University of Georgia to across many institutions around the world in techno parks. So, yes, we are very, very active and we are content that we have the right pipeline and maybe I can ask Steve to reflect on -- from just a North America and Americas perspective. + +-------------------------------------------------------------------------------- +Steve Cahillane, The Coca-Cola Co - President, Coca-Cola Americas [51] +-------------------------------------------------------------------------------- + + Yes, thanks, Muhtar. From a -- starting with the Latin America perspective, we've got Coca-Cola Light, which we are kicking off in Argentina. Which we are excited about watching the prospects of that. We are doing terrific innovation around our Jugos Del Valle platform in juices in Latin America, as well as in North America we have launched Fruitwater, a brand new product off to a very good start. Powerade Zero Drops have joined Dasani Drops as a very exciting innovation. NOS Active, with is a fusion between sports drinks and energy, kicked off in April, again off to a very good start. From a packaging perspective, we continue to innovate around our price package architecture. We've just launched 16-ounce sparkling icy cans in our major packages. We've got Taylor Swift Slim cans coming into the marketplace. We've got 19.2 ounce sparkling cans coming into the marketplace. Again, lots of excitement around the packaging innovation. +In terms of some marketing innovations, we've got Coke Zero, which is going to be launching College GameDay this fall, which we are very excited about. We've got Caffeine-Free Coke Zero coming into the marketplace. We feel very good about that. Really building out the Coke Zero platform as an all-day brand, so we've got lots in the marketplace and lots more coming into the marketplace and it builds on one of Muhtar's earlier points that throughout this rough period of time, we have continued our marketing pressure, we have continued our marketing investment. We have not cut it. We have increased it and it allows us to continue to innovate and bring new innovations into the marketplace. + +-------------------------------------------------------------------------------- +Mark Swartzberg, Stifel Nicolaus - Analyst [52] +-------------------------------------------------------------------------------- + + That's helpful. And if I could simply follow up on this subject of a stevia-based sweetener in the brand -- on the door, so to speak. Coca-Cola, we have seen what you've said recently about globally taking down the portion of your volume that is in the full-cal portion of your business. Should we infer here that there's an increased resolve to use organic sweeteners against the main brand here and there's some optimism globally for that potential? + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Co - Chairman & CEO [53] +-------------------------------------------------------------------------------- + + Yes, I would just comment on that that it's all about ensuring that you provide the right choices at the right time for the right consumers in the right environment and that you shouldn't read that we have an increased resolve to use any specific ingredient. It's all about ensuring that we do have viable lights and no-calorie versions for every one of our major brands available to the consumer, ensure that we [front the pack] label transparently, ensure that we have active lifestyle programs, as per all our global commitments, and ensure that we have responsible marketing. That's our -- those are our four commitments and our Business, we've said many times, is about brands. Today, we have $16 billion brands, that are growing. We have in the pipeline another 19 brands that are bigger than $750 million in revenue and less than $1 billion. Those are all going to become $1 billion brands in the next increment of time because they are growing and we are confident that we will have multiple -- more $1 billion brands than we have today and I think that's what this Business is all about, adding value through brands to our system and I'm confident that you will see us add many more $1 billion brands to our [rostrum] in the near future. + +-------------------------------------------------------------------------------- +Mark Swartzberg, Stifel Nicolaus - Analyst [54] +-------------------------------------------------------------------------------- + + Great. Thank you, gentlemen. + +-------------------------------------------------------------------------------- +Operator [55] +-------------------------------------------------------------------------------- + + Ali Dibadj, Bernstein. + +-------------------------------------------------------------------------------- +Ali Dibadj, Sanford C. Bernstein & Co. - Analyst [56] +-------------------------------------------------------------------------------- + + So the general theme of my couple questions is really what we are all trying to figure out, which is, what's going to get better from here and why, and not only in terms of volume but also in terms of some of the other key drivers of profitability. So if I may, my first question is around North America and although you say in the press release, you remain committed to rational pricing, price mix was only up 1% and do you think volumes would have been down more than negative 4% if you had taken more than 1% pricing so taken 2% to 3% pricing or can we hope for that part of the business, the pricing in North America improving going forward? And as a follow-up to that, in a completely different per cap market like China, following up to Ahmet's point a second ago, I just want to get a better sense of if evolving a strategy has anything to do with increased price promotion as well, as it sometimes does with some companies? + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Co - Chairman & CEO [57] +-------------------------------------------------------------------------------- + + Steve, you want to go? + +-------------------------------------------------------------------------------- +Steve Cahillane, The Coca-Cola Co - President, Coca-Cola Americas [58] +-------------------------------------------------------------------------------- + + Yes, thanks, Ali. I will start. In terms of pricing, we have always said that our pricing strategy in North America is consumer-based and it continues to be consumer-based. We captured, if you look at Nielsen, we captured very good pricing across our portfolio in North America and we think it was an appropriate amount of pricing by channel. The unfortunate 4% volume decline was, as we said, had a lot more to do with weather and the economy, at least 60% to 70% having to do with a one-time, really poor weather event, so we didn't put more price in the marketplace to try and chase volume that wasn't there. We put appropriate price increases in the marketplace and we maintained our margins and we maintained our price strategy going forward and we continue to bring new products and new packages into the marketplace to help our whole architecture achieve the type of pricing that we deserve. +And we have given some examples of this in the past and a good one is our 1.25 liter, which continues to be very successful. One-third of the 1.25 liter volume is in fact incremental volume, so it is good in and of itself but it has also allowed it -- so if you look at our 2-liter pricing over the course of the past 12, 15 months, we are out of the $0.99 price promotion for 2-liter and have been for quite some time. So we are not going to put too much price in the marketplace. We take appropriate price, based on what the consumer and what's right for the consumer and what's right for the customer and we fully expect that based on the price plans we have in place for the back half of the year, based on the innovations we have on the back half of the year, that sparkling volume will in fact improve from what happened in the second quarter. + +-------------------------------------------------------------------------------- +Ahmet Bozer, The Coca-Cola Co - President, Coca-Cola International [59] +-------------------------------------------------------------------------------- + + Ali, I would move onto your question on China. The answer is there's absolutely no plans for increased price promotion. In fact, the reason for having a evolving OBBPC is to have more sustained volume at the right price point and the right packs for all the consumers. Now, to give you an example, you might be familiar that there's been a lot of upsizing going on in China and we have launched our 300 mL package last year. Now, we will tactically respond to such upsizing to be able to balance our volume and share performance but that's a -- those are limited tactical moves rather than a strategy to have increased price promotion so that's not really in the cards. Now, to maybe build on this a little bit and also to address some of the innovation questions that I didn't have a chance to share, is that we have small cans -- either slim can or sleek can -- and small PET launches all across the International territory, all across Europe, all across Eurasia Africa Group, and some of the Pacific markets. +That I believe is an important innovation in a way and also allows us to drive revenue and gross margin. In addition to that, let's also keep in mind that we had some very successful products such as Pulpy that hasn't been fully launched in all of our International territories. Eurasia Africa Group, for example, have taken that and they have launched it in Morocco. In a very short period of time, we were able to achieve a 20% plus market share with that launch. We've just had a recent launch of extensions of coffee into PET in Japan. In the CVS channel, the recruiting female consumers were quite happy and pleased with the results of that. We have been innovating in energy drinks in Russia and Turkey by extending them into PET packages, resealable PET packages that the consumers want so we continue to innovate in different packages, different categories across our International territory as well as using successful innovations from the previous years. + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Co - Chairman & CEO [60] +-------------------------------------------------------------------------------- + + Thank you, Jackson, Irial, Steve, Amit, and Gary. Our Business continues to grow and to capture global volume and value share even in the midst of ongoing global economic challenges and importantly we do not manage our Business for the short term but rather for the medium and long-term and, as I mentioned earlier, our focus on achieving our 2020 Vision is unwavering with current dynamics leading us to believe that our performance will be better in the back half of this year and beyond. As always, we thank you for your interest, your investment in our Company, and for joining us this morning. + +-------------------------------------------------------------------------------- +Operator [61] +-------------------------------------------------------------------------------- + + Thank you. And this concludes today's conference. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/exam/original-files/Problem_2_3_Sample_full_transcripts/2013-May-22-TGT.N-136980779761-Transcript.txt b/exam/original-files/Problem_2_3_Sample_full_transcripts/2013-May-22-TGT.N-136980779761-Transcript.txt new file mode 100644 index 0000000..0941548 --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_full_transcripts/2013-May-22-TGT.N-136980779761-Transcript.txt @@ -0,0 +1,636 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q1 2013 Target Corporation Earnings Conference Call +05/22/2013 09:30 AM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * John Mulligan + Target Corp - EVP and CFO + * Kathee Tesija + Target Corp - EVP of Merchandising + * Gregg Steinhafel + Target Corp - Chairman, President, CEO + +================================================================================ +Conference Call Participiants +================================================================================ + + * Peter Benedict + Robert W. Baird & Company, Inc. - Analyst + * Matt Nemer + Wells Fargo Securities, LLC - Analyst + * Sean Naughton + Piper Jaffray - Analyst + * Chris Horvers + JPMorgan Chase & Co. - Analyst + * Colin McGranahan + Sanford C. Bernstein & Company, Inc. - Analyst + * Deborah Weinswig + Citigroup - Analyst + * Bob Drbul + Barclays Capital - Analyst + +================================================================================ +Presentation +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Ladies and gentlemen, thank you for standing by. Welcome to the Target Corporation first-quarter Earnings Release conference call. During the presentation, all participants will be in a listen-only mode. Afterwards, we will invite you to participate in a question-and-answer session. +(Operator Instructions) +As a reminder, this conference is being recorded Wednesday, May 22, 2013. I would now like to turn the conference over to Mr. Gregg Steinhafel, Chairman, President and Chief Executive Officer. Please go ahead, sir. + +-------------------------------------------------------------------------------- +Gregg Steinhafel, Target Corp - Chairman, President, CEO [2] +-------------------------------------------------------------------------------- + + Good morning and welcome to our 2013 first quarter earnings conference call. On the line with me today are Kathee Tesija, Executive Vice President of Merchandising; and John Mulligan, Executive Vice President and Chief Financial Officer. This morning I'll provide a high level summary of our first quarter results and strategic priorities for the rest of the year. Then Kathee will discuss category results, guest insights and upcoming initiatives. And finally, John will provide more detail on our financial performance along with our outlook for second quarter and the full year. Following John's remarks, we'll open the phone lines for a question-and-answer session. +As a reminder, we're joined on this conference call by investors and others who are listening to our comments via Webcast. Following this conference call, John Hulbert and John Mulligan will be available throughout the day to answer any follow-up questions you may have. Also, as a reminder, any forward-looking statements that we make this morning are subject to risks and uncertainties, the most important of which are described in our SEC filings. Finally, in these remarks we refer to adjusted earnings per share which is a non-GAAP financial measure. A reconciliation to our GAAP results is included in this morning's press release posted on our Investor Relations website. +Our first quarter earnings fell short of our expectations, as we faced a choppy and challenging environment caused by unfavorable weather and this year's payroll tax increase. Our US business generated softer-than-expected sales and traffic, particularly in our seasonal categories, as we experienced one of the coldest spring seasons on record, following record warmth a year ago. While we are not satisfied with this quarter's performance, we remain highly confident in our strategy and our team's ability to deliver strong results going forward across a broad range of conditions. In the first quarter our US segment generated adjusted earnings per share of $1.05, down 5% from last year's outstanding performance. Our first quarter GAAP earnings per share were $0.77, $0.28 lower than adjusted EPS, driven primarily by $0.24 of dilution attributable to our Canadian segment. +As we mentioned in our fourth quarter call, this year there are several notable changes affecting our financial reporting, which John will cover in detail in a few minutes. In the quarter, comparable store sales declined 0.6% from last year's 5.3% increase. First quarter comparable transactions were down 1.9%, following last year's increase of 2%, keeping us essentially flat on a two-year basis. In much of the US, traffic in our seasonal categories was unexpectedly soft as guests held off purchasing spring items in the face of cold and wet weather. Our merchandising teams did a great job reacting to the pace of sales in these categories, retiming receipts and adjusting them downward so we are still in a healthy inventory position today. +Despite the weather impact on seasonal categories, sales and traffic in our digital channels continued to grow at a robust pace. Overall first-quarter digital sales grew in the high teens and increased more than 20%, net of our most seasonally sensitive categories. Target's mobile traffic and sales continued to grow at a triple-digit pace, with mobile traffic representing more than 30% of our digital traffic in the first quarter. We're pleased with these results as mobile is rapidly becoming the key platform for digital commerce across all of retail and we know that Target guests have a particular affinity for mobile engagement. +After two years of preparation, in March we opened our first 24 Canadian stores in the greater Toronto area and we're very pleased with the reception we received from our new Canadian guests. We experienced an unexpectedly strong surge in sales as guests were eager to see their newly opened Target store. The mix of sales in Home and Apparel was even higher than expected as guests shopped our assortment of stylish own brands and national brands responding to the outstanding value we provide on both. Now that we are beyond the grand opening surge in this first cycle of stores, we're encouraging our new Canadian guests to make Target a preferred destination for categories throughout the store including Food, Health, Beauty and Household Essentials as these categories play a key role in driving trip frequency over time. As it is already in the US, REDcard rewards will be a key differentiator for Target in Canada, and we're encouraged that REDcard penetration of sales in our Canadian segment was ahead of plan in the first quarter. +Two weeks ago we opened our second wave of 24 Canadian stores in British Columbia, Alberta and Manitoba and we're very pleased with the initial guest response in these markets and the ability of our teams and systems to accommodate the increasing volume of traffic and sales. We plan to open another 20 stores in Canada later in the quarter, on the way to operating 124 Canadian stores by the end of the year. This means we expect to open more Target stores in our first year in Canada than we opened in our first 10 years in the United States, an incredible accomplishment that has required unprecedented effort by teams throughout the Company. In the US, we opened six new stores in the first quarter, including an additional City Target location in Los Angeles. We now operate six City Target locations in four cities, and we continue to be pleased with the results in these stores. Sales have essentially met our expectations and the mix of Home and Apparel has been better than expected. Similar to our Canadian stores, we are focused on our City Target stores on driving sales and visits in our Frequency and Commodity categories, changing guest habits and inspiring them to visit us more often for both wants and needs. +In the first quarter, we also closed the sale of our US Credit Card receivable portfolio to TD Bank Group and began deploying proceeds to reduce debt and repurchase shares. We're very pleased to have reached the right agreement with the right partner in a transaction that removes these more volatile assets from our balance sheet. The portfolio continues to perform well, generating meaningful income for Target through our profit sharing arrangement with TD. +As we look ahead to the second quarter and the remainder of the year, we remain cautiously optimistic about both the macroeconomic environment and consumer behavior. Both of these business drivers continue to reflect slow, uneven growth and ongoing cross-currents of positive and negative indicators, just as they have for the past few years. For example, while we're pleased that the housing market has stabilized and jobless claims have been declining, we're mindful that household formation and job growth remain particularly weak among younger demographic groups. In addition, guests continue to face the headwinds of this year's payroll tax increase and a meaningful lack of income growth. With these considerations in mind, we remain focused on strategies that position our business for profitable growth, both today and in the long term. We continue to invest in initiatives that integrate multiple channels, like our recent beta launch of Cartwheel, a result of our collaboration with Facebook along with tests of same-day delivery with Google and eBay. And we're testing opportunities within our own supply chain that will leverage our existing store and distribution assets to provide additional services and capabilities our guests value most. +We're investing to drive adoption of our 5% REDcard Rewards and Pharmacy Rewards loyalty programs, which have proven to be unique and powerful differentiators and sales drivers for Target. Both of these programs offer guests the opportunity for even greater savings, leading them to shop more merchandise categories more often. We're investing in efforts to better serve all of our guests, driving traffic and sales by segmenting our stores and assortments to match local tastes and preferences. And we continue to offer digital innovations that create a link between our stores and social media. We're continuing to pursue new and differentiated merchandise in all of our assortments, including our recently announced partnership with Warner Brothers and DC Entertainment to feature Justice League merchandise across multiple categories. Kathee will provide more detail on programs like these that create a sense of discovery for our guests while deepening their loyalty for Target. +Beyond the value we provide on exclusive, well-designed merchandise, we continue to invest in everyday low prices which we reduce even further in our weekly ad. In addition, we stand behind our prices with policy to match local competitor print ads as well as our largest online competitors. And through REDcard Rewards and Pharmacy Rewards our most loyal guests have the opportunity to save even more. Throughout the Company we take a disciplined approach to the deployment of cash, combining strong financial rigor and capital investment decisions with a focus on returning cash to our shareholders through dividends and share repurchase. And of course, none of our efforts would be possible without the outstanding work of our more than 360,000 team members who greet and serve our guests every day, carefully manage inventories and expenses in this challenging environment, and proudly represent our brand in the communities where they live. +In spite of first quarter tax increases, unseasonably cold weather and challenging prior-year comparisons, our underlying business continues to be stable and healthy. Our team is focused on driving outstanding results across categories, channels, regions and guest segments every day, even while we continue to position our business for success with investments in new stores and formats and more flexible ways of serving our guests. We believe that our outstanding team, aligned in support of a well-defined strategy will drive strong performance both this year and over time. +Before I turn the call over to Kathee, I want to take a moment to thank Terry Scully, who retired from his role as President of Target's Financial and Retail Services team in April. Terry has been a valuable member of the Target team for nearly 35 years and under his leadership the Financial and Retail Services team has played a key role in strengthening guest loyalty and delivering substantial profitable growth for Target. Over the last few years, Terry and his team have worked tirelessly to find the right partner to purchase our Credit Card Receivables portfolio, culminating in this quarter's sale. +And finally, I want to pause to express our condolences to the residents of Moore, Oklahoma, including Target team members, guests and their families who were affected by this week's devastating tornado. We have been working with emergency responders, community organizations and local schools to evaluate immediate needs and ways that Target can help. And yesterday we announced that Target is donating $250,000 in support of relief efforts. $200,000 of cash and in-kind donations to emergency responders and community organizations including the Red Cross, and the Salvation Army, and $50,000 to support rebuilding efforts at the two elementary schools that were badly damaged by the tornado. Now, Kathee will provide more detail on first-quarter results and outline initiatives for the second quarter and beyond. Kathee? + +-------------------------------------------------------------------------------- +Kathee Tesija, Target Corp - EVP of Merchandising [3] +-------------------------------------------------------------------------------- + + Thanks, Gregg. Those of you who have listened to our conference calls over time know that often when we're asked about weather impacts, we point out that on average, the weather is average. This is certainly proven true in the last two spring seasons. Last year it was an unusually early and warm spring across much of the country. We saw very strong sales in our seasonal and weather-sensitive categories. +This year in the face of a cold and late spring, sales were quite soft in those same categories. And while we are committed to delivering strong results in all types of environments, we believe it's important to understand the impact of this year's weather on our first-quarter sales results. Specifically, first-quarter comparable store sales in weather-dependent categories like Seasonal Apparel, Lawn, Patio and Sporting Goods lagged the rest of our assortments by 6 to 7 percentage points. This sales gap was even wider in areas of the country which experienced below-average temperatures, and which was much smaller in areas that experienced much more normal spring temperatures, like the Western US. +Looking more broadly at our category results, first quarter comparable store sales continued to be strongest in less discretionary categories such as Food, Health, Beauty and Household Essentials, all of which experienced low single-digit increases. Our Home and Apparel categories were both down in the low single-digits and Hardlines saw a mid single-digit decline in comps. Within Hardlines, Electronics continues to see softness in video games, along with televisions, particularly early in the quarter as last year's fifty-third accounting week moved Super Bowl-related sales out of the quarter. As Gregg mentioned, our guests continue to shop cautiously, planning their spending and sticking to shopping lists as they continue to feel the burden of economic pressures. Recent guest surveys indicate that 75% of our guests are aware of this year's payroll tax increase and among those, the majority have noticed the impact of the tax increase on their paychecks and indicate that it's affected their spending. +Basket data confirms that needs-based trips have been increasing while wants-based trips focused on discretionary categories have been declining. And notably, recent data from the conference board indicates that while sentiment among consumers regarding their current situation has been improving since late last year, consumer sentiment regarding the future has been declining in recent months. To drive traffic and sales in this environment, we know it's more important than ever to provide value to our guests on a high-quality, differentiated assortment delivered through a convenient shopping experience. In the Digital space, we continue to apply a test-and-learn approach when rolling out applications and capabilities so we can determine what works best for our guests. We're pleased that our Digital traffic grew faster than industry benchmarks again this quarter. +We continue to explore ways to integrate digital technologies with social media and our stores to provide a unique shopping experience for our guests. This quarter's beta launch of Cartwheel, which we developed in collaboration with Facebook, is a perfect example. This first-of-a-kind experience gives guests a fun way to save on hundreds of items throughout our stores. Upon authenticating this application through their Facebook profile, guests receive ten spots to fill with deals of their choice from among hundreds of items throughout our store. Depending on the product, the deals feature a range of discounts and expiration dates and guests can switch between offers at any time. Deals are redeemed at checkout in our stores either by scanning a single bar code on a mobile device or a printout from our desktop computer. +Guests can share Cartwheel with their friends on Facebook to show off their latest finds and see what their friends are buying. And the more guests interact with Cartwheel by choosing and redeeming deals and sharing those deals with friends, the more offers they unlock for themselves. We launched Cartwheel in beta and we're encouraging guests to provide feedback so we can make ongoing, real-time enhancements to the Cartwheel experience. Initial sign-ups for Cartwheel have exceeded expectations. Thousands of guests signed up in the first week and we saw a meaningful increase when we added a link to Cartwheel on Target.com. More than 10% of guests who have signed up already have redeemed Cartwheel offers in one of our stores. +Also this quarter, we launched a Beauty Box test to understand our guests' appetite to pay for samples of Beauty products. We tested this offer on Target's Facebook style page and sold through our inventory within a week. In addition, the offer generated favorable media coverage and positive feedback in social media. Based on these results, we will continue to explore ways to surprise and delight guests with Box-based offers that support our Expect More, Pay Less brand promise. +In March, we were very pleased to announce our agreement to acquire Chefs Catalog and assets of cooking.com in two separate transactions. These e-commerce acquisitions are aimed at expanding Target's presence in the growing cooking and kitchenware market. We combined the assets of cooking.com with Chefs Catalog to create a new wholly-owned subsidiary which will continue to operate the two brands under their current names. We believe these transactions present a strategic growth opportunity to serve guests who are increasingly looking online for cooking solutions to make their lives easier, from utensils and cookware to recipes. These strategic transactions provide us a great way to address this growing opportunity and provide expanded online options for our guests. +In select markets, we're continuing to test same-day delivery in partnership with Google and eBay. Our focus in these tests is to understand the level of guest engagement and this fulfillment opportunity. These projects, which are still in the test phase, continue to provide valuable information on the store backroom capabilities and processes needed to support this offering. And as we mentioned last quarter, this year we're launching our own test Flexible Fulfillment in the Minneapolis market. This month we launched a test in which team members are given the opportunity to order online and pick up in store. We will use our team members' feedback to improve the process and experience before the pilot becomes guest-facing later in the year. Two other team member pilots, Pay in Store to Pick Up at Another Store and Pay Online and Ship From Store are planned for late in the year. +In both our stores and online, we feature great designers and brands and continue to roll out new, unique merchandise that creates a sense of discovery for our guests. Our goal is to show guests that design means more than fashion and that great design doesn't have to mean high prices. In Home, we continue to be pleased with results from our partnership with Nate Berkus. The collection includes a growing list of products in a wide range of categories including Bedding, Bath, Accessories, Lighting, Rugs and Stationery. We also continue to see great results from the roll-out of the Threshold brand which is replacing Target Home, our largest own brand. We debuted Threshold last fall and guests continue to respond to this fully redesigned, high-quality collection that's inspiring them to update their homes. To celebrate this new brand, earlier this month Target constructed a life-sized dollhouse in New York's iconic Grand Central Terminal, where guests could explore a two-story, seven room doll house decorated with more than 3,500 pieces from the Threshold collection. Select furnishings were tagged with QR codes to be shoppable right from the dollhouse. +In our Stationery category, we're excited about our collaboration with Todd Oldham on the Kid Made Modern collection, which offers creative activity kits and supplies to inspire kids through art. The collection has a clean, simple and fresh design that's gender-neutral and age-appropriate to inspire all children and parents. We launched this collection of creative design tools late last year and set a new collection this spring. Following our successful first quarter partnership with Prabal Gurung and Kate Young, we recently announced our latest design collaboration with Lauren Bush Lauren and the roll-out of the FEED USA + Target collection. In late June, we'll feature a lifestyle collection of stylish products in Home, Sporting Goods, Stationery, Apparel and Accessories. The collection, which reflects a modern Americana aesthetic while supporting an important cause, includes more than 50 products across a range of price points, with most items less than $25. Each item in the collection has an associated number of meals listed with it and with each sale, Target will donate the monetary equivalent of that number of meals to Feeding America, the nation's leading domestic hunger-relief charity, and a partner of Target since 2001. During the time that the products will be available, we expect to provide more than 10 million meals for families across the US. +In Canada, we've been very pleased with results from our partnership with Roots Outfitters, an iconic Canadian brand that offers quality craftsmanship and comfortable styling on a line of apparel for men, women and kids. And we're very excited that we recently announced a fall partnership with Beaver Canoe, a member of the Roots Canada family, to offer an exclusive collection of cabin-chic apparel and home items in our Canadian stores this fall. Entertainment had a great first quarter, including the release of our exclusive deluxe version of the 20/20 experience from Justin Timberlake. The strength of the guest response put this release among the top three at Target in the last 10 years. We followed this success with releases of exclusive albums from the Band Perry and Michael Buble in April. In Electronics, we've partnered with Wired Magazine to offer a custom curated assortment of consumer Electronics and gadgets tested by their editors, featuring their expert tips on usage and key features. And in April, Target became the exclusive mass retailer to debut the Beats by Dr. Dre neon mixer headphones, available in eye-catching green, orange, pink, yellow and blue. +We've long known the value we can create through segmentation of our stores and assortments based on store location and demographics. We continue to develop tools and processes that allow us to further localize assortments and experiences to match the specific markets where our stores are located. We are focused on providing a deeper presence of locally relevant products and brands across the store, including categories like Food, Beauty, Home and Entertainment. And we continue to invest in unique multi-channel experiences like Cartwheel that allow guests to choose their own offers and further integrate their Target experience into their social networks. Now John will share his insights on our first quarter financial performance and our outlook for the second quarter and full year. John? + +-------------------------------------------------------------------------------- +John Mulligan, Target Corp - EVP and CFO [4] +-------------------------------------------------------------------------------- + + Thanks, Kathee. As Gregg mentioned, we're disappointed with our first-quarter financial performance. Sales in the US were softer than expected, even relative to updated guidance we provided in April, causing our reported earnings per share to fall short of our updated guidance, as well. Adjusted earnings per share, which measures the results of our US operations, were $1.05, representing a 5% decrease from last year. First quarter GAAP earnings per share were $0.77, reflecting losses on early retirement of debt which reduced our EPS by $0.41, EPS dilution related to our Canadian segment of $0.24, and net accounting gains of $0.36 related to the sale of our Credit Card portfolio. +Before I turn to our segment results, I want to remind you of a couple of factors that will be affecting our financial reporting this year. First, with the sale of our receivables, beginning with the first quarter we are no longer reporting a Credit Card segment and we now have two reportable segments, a new US segment and a Canadian segment. In the first quarter we began recognizing profit sharing payments from TD, net of operating expenses within SG&A expense in the US segment. To provide context, in an April 16 8-K, we provided revised quarterly segment reporting for fiscal years 2010 through 2012, in which Credit Card revenues net of expenses from our former US Credit Card segment, were recognized within SG&A expenses in the new US segment. In this year's financial reporting revised 2012 US segment results will be presented at prior-year results. +To provide additional context, this year's rate analysis includes a comparison to last year's performance in the historical US Retail segment. For simplicity, to the extent that's possible, in my discussion today I will focus only on this year's US segment results compared with last year's revised US segment results. Second, as I mentioned in our last conference call, we've made changes to our vendor agreements regarding payments received in support of our marketing programs. As a result, in fiscal 2013 these payments will be recognized as a reduction in our cost of sales rather than a reduction to SG&A expense. This change is expected to create equivalent year over year increases in our US segment gross margin and SG&A expense rates of 20 to 25 basis points, without affecting EBITDA and EBIT margin rates. +With that as context, I'll turn to the first quarter performance in our new US segment. Total sales increased 0.5% on a 0.6% decline in comparable store sales combined with the contribution from new stores. Among the drivers of comparable store sales, traffic was down 1.9% partially offset by a 1.3% increase in average ticket. Our first-quarter traffic decline essentially offset a 2% increase a year ago. As we told you at the time, we believed first-quarter 2012 traffic was unusually strong due to the warm weather, and that proved to be the case as full-year 2012 traffic was up 0.5%. While we expect traffic will continue to be challenging given our near term outlook for the economy and the consumer, we don't expect to continue to see traffic declines of the magnitude we saw in the first quarter. +With the added pressure on household budgets from the recent payroll tax increase, the simplicity and compelling nature of our 5% REDcard Rewards discount is clearly attracting an increasing number of guests. The penetration of sales on REDcards reached 17.1% in the first quarter, up from less than 12% a year ago. While discounts from this program continue to put pressure on our gross margin rate, this investment pays back through the benefit of increased loyalty and sales. We continue to see households increase their spending more than 50% on average when they begin using a REDcard. And in Kansas City, which is a year ahead of the rest of the country, penetration is above 20%. And the rate of increase has shown no sign of slowing down. +Our US segment gross margin rate was 30.7% in the first quarter, up about 50 basis points from a year ago. The change in recognition of vendor payments explains about 20 basis points of this increase. The remainder of the improvement was driven by rate increases within categories, which more than offset continuing gross margin rate pressure from our sales-driving REDcard Rewards and Remodel programs. Every year, Kathee's team works hard to incrementally improve gross margin rates within categories, and the year over year benefit from these efforts can vary meaningfully from quarter to quarter. In the first quarter, the magnitude of category rate improvement was stronger than normal and we're expecting to see a more modest benefit in upcoming quarters. +Our first quarter US segment SG&A rate of 20.3%, was about 130 basis points higher than last year's revised US segment rate. The primary drivers of this variance are about 50 basis points resulting from lower earnings on the Credit Card portfolio, and about 40 basis points related to technology, including our multi-channel efforts. In addition, the change in vendor payments drove the rate higher by about 20 basis points and of course, with lower than expected sales, we saw less overall expense leverage than we anticipated. On this last point, it's important to note that our first quarter results reflected meaningful store productivity improvements and the entire organization did a great job controlling expenses. As I mentioned in the last call, we're anticipating incremental expense pressure from technology investments throughout 2013 and we plan to offset that pressure through disciplined expense management across the enterprise as the year progresses. +Also, I think it's important to provide more context for the decline in our earnings from the Credit Card portfolio, because the portfolio continues to experience outstanding performance. However, there are three separate reasons which drove lower earnings from the Credit Card portfolio in the first quarter. First, the asset is smaller than a year ago. Second, we're annualizing a $35 million reserve release in the first quarter of 2012. And finally, we began sharing portfolio profits with TD after the sale closed in March. Notably, among these three reasons, profit sharing drove less than 50% of the year over year reduction in Target's earnings from the Credit Card portfolio. And we expect all of these pressures will continue for the next several quarters. +Moving down the US segment P&L, we reported a first quarter EBITDA rate of 10.4%, about 80 basis points lower than last year's revised US segment rate. With about 50 basis points related to our Credit Card portfolio, that means our US Retail operations accounted for only a 30-basis-point decline in EBITDA rate compared with last year, which is remarkably stable when one considers that sales were unexpectedly soft this year and we were annualizing a 5.3% comp last year. In our Canadian segment, we generated $86 million in sales from 24 stores that were open on average a little more than half the quarter. Whenever we open a new store in the US, there is a rush of traffic and sales as curious guests shop it for the first time. But the rush in Canada exceeded our expectations. +The first quarter gross margin rate in Canada was more than 38%, which is much stronger than our long-term expectations for a couple of reasons. First, in new stores we experience a strong initial mix of Home and Apparel sales as guests tend to shop these categories on their first trip to these stores. In addition, given the short time these stores have been open, they have not yet experienced any meaningful transitions or clearance activity. So this quarter's Canadian gross margin rate didn't reflect the impact of mark-downs we'd expect to see over time. The first-quarter Canadian segment P&L was dominated by start-up expenses related to the 100 additional stores we're preparing to open later in the quarter. For the quarter, Canadian segment operations drove $0.24 of dilution to our consolidated earnings per share. +With the sale of our Credit Card portfolio in March, we recognized a pretax accounting gain of $391 million, of which $166 million was cash received in excess of book value and $225 million was related to a beneficial interest asset. This asset effectively represents a receivable for the present value of future profit sharing payments we expect to receive from TD on the credit card balances transferred at the time of the sale. Going forward, a portion of the profit sharing payments from TD will be applied to unwind the beneficial interest assets. We expect to fully unwind it in three to four years and expect to reduce its size by about 50% in the first 12 months following the sale. Also following the portfolio sale, we began deploying proceeds to retire debt and repurchase shares. +Concurrent with the sale, we repaid at par $1.5 billion in funding that was previously backed by the receivables. We also launched debt tender offers to repurchase another $1 billion in high-coupon debt, which led to losses recorded in interest expense of $445 million in the quarter. Of course, these tender offers created a meaningful economic benefit not reflected in the accounting for these losses. During the quarter, we also paid off commercial paper that we had used to provide short-term funding following the $2 billion in debt maturities last January. +Finally, there is another $500 million maturity in June which we expect to fund with proceeds from the sale. We're pleased that with the completion of the sale, we were able to remove these more volatile assets from our balance sheet and quickly reduce a meaningful amount of debt that was funding them. Over time, we expect to apply the remainder of the proceeds from the portfolio sale to repurchase shares. In the first quarter, we invested $547 million to repurchase 8.5 million Target shares at an average price of just over $64. +For the full year, we continue to expect to invest in more than $2 billion to retire shares. And we'll continue to govern the pace of execution in support of our goal to maintain our strong investment-grade credit ratings. We paid first quarter dividends of $232 million, marking the 182nd consecutive quarterly dividend we've paid since becoming a public Company. We will recommend that the Board approve an increase in the dividend later this year, which would make 2013 our forty-second straight year in which we increased the annual dividend. +Now let's turn the to our expectations for the second quarter and the year. In the US we remain cautious about the near-term sales environment given the economic and consumer challenges Kathee and Gregg mentioned earlier. Yet with the recent weather challenge behind us and an easier comparison from last year we expect second-quarter comparable store sales will recover into the 2% to 3% range. So far in May, we've continued to see cautious buying behavior from our guests but the pace of sale has supported our view of the quarter. In the US segment, we expect the second quarter gross margin rate will be up slightly from last year, driven entirely by the change in recognition of vendor payments. We expect our second quarter SG&A expense rate will be just over 21%, nearly a full percentage point higher than last year's revised US segment rate, driven primarily by a smaller benefit from credit card income and the change in recognition of vendor payments. This would put our second quarter EBITDA margin rate at about 10.5%, and with expected leverage on D&A an EBIT margin rate of 7.5%. +In Canada, second-quarter sales will ramp up meaningfully from the first-quarter pace, yet startup expenses will continue to dominate the P&L. As a result, for the quarter we anticipate expenses from our Canadian operations, including interest expense measured outside the segment, will create $0.16 of dilution to our earnings per share. We continue to expect Canadian dilution will come down further in the third quarter and by the fourth quarter we expect our Canadian operations will be slightly accretive to our consolidated earnings. All together, we expect second quarter adjusted EPS of $1.09 to $1.19. We expect our GAAP EPS will be $0.19 lower than adjusted EPS, in the range of $0.90 to $1, reflecting $0.16 of dilution due to Canada and $0.03 of dilution related to the unwind of the beneficial interest asset related to the receivable sale. +For the year, we have an even more tempered view of sales than we did three months ago. Without some unexpected improvement in the economy and the consumer, our full year comparable store sales will likely grow in the 2% to 2.5% range, somewhat below the 2.7% we outlined at the beginning of the year. This updated view of sales has also tempered our view of full-year earnings per share, costing us to take our expected range for adjusted EPS down $0.15 to the $4.70 to $4.90 range. We expect full year GAAP EPS to be $0.58 lower than adjusted EPS, in the $4.12 to $4.32 range, reflecting Canadian segment dilution, losses on early debt retirement and net gains from the Credit Card portfolio sale. +Longer term, we continue to feel very good about the health of our business and the steps we are taking to keep our business relevant over time. We continue of to invest in our remodel program, loyalty initiatives, technology, the integration of our store and digital experience, the new City Target format and our Canadian segment. Yet even with those initiatives, we continue to expect to generate far more cash than we need to invest in our business, giving us the opportunity to return billions of dollars to our shareholders through dividends and share repurchase. As a result, we continue to expect Target will deliver earnings per share of $8 or more by 2017, combined with a dividend of $3 or more that same year. That concludes today's prepared remarks. Now Gregg, Kathee and I will be happy to respond to your questions. + + + +================================================================================ +Questions and Answers +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + + + (Operator Instructions) +Peter Benedict, Robert Baird. + +-------------------------------------------------------------------------------- +Peter Benedict, Robert W. Baird & Company, Inc. - Analyst [2] +-------------------------------------------------------------------------------- + + Great. Thanks, guys. Just a couple questions. On the US gross margin performance, can you give us a sense of maybe what that REDcard impact was in the quarter? + +-------------------------------------------------------------------------------- +John Mulligan, Target Corp - EVP and CFO [3] +-------------------------------------------------------------------------------- + + The rate impact of the REDcard, Peter? + +-------------------------------------------------------------------------------- +Peter Benedict, Robert W. Baird & Company, Inc. - Analyst [4] +-------------------------------------------------------------------------------- + + Yes, John. + +-------------------------------------------------------------------------------- +John Mulligan, Target Corp - EVP and CFO [5] +-------------------------------------------------------------------------------- + + Yes, the combination of that with the store Remodel program, very consistent with what we've seen over the past several quarters, somewhere between 25 to 30 basis points of impact. + +-------------------------------------------------------------------------------- +Peter Benedict, Robert W. Baird & Company, Inc. - Analyst [6] +-------------------------------------------------------------------------------- + + Okay. That's helpful. And then a longer-term question. You said for the year you're now thinking 2% to 2.5%. I assume that's still has a pretty modest view for comping in the fourth quarter. A, is that correct? And then secondly, when you think out beyond, do you guys think that maybe 2% to 3% is the longer-term comp profile for the business? Or do you think it could still be north of 3%, when you think of a more normalized environment, on an annual basis? Thanks. + +-------------------------------------------------------------------------------- +John Mulligan, Target Corp - EVP and CFO [7] +-------------------------------------------------------------------------------- + + Yes, I think your view of Q4 is right. I think in particular, this Q4 will be particularly difficult, given the fifty-third week and the way the calendar shifts this year, you'll recall we're going to lose six business days between Thanksgiving and Christmas this year, which will make the comp feel much more difficult than it otherwise might. I think over the longer term, we continue to think a 3% comp is about the right place to be. If you look, again, at our Company over 15 years or 20 years, if you net out the contribution of new-store annualization, we essentially ran a pretty consistently a 3% comp over time through good times and tougher times. So we think in an economic environment that might just be a little bit better than today, doesn't have to improve drastically but a little better than today, we think a 3% comp makes sense. + +-------------------------------------------------------------------------------- +Peter Benedict, Robert W. Baird & Company, Inc. - Analyst [8] +-------------------------------------------------------------------------------- + + Okay, that's helpful. One last housekeeping. On the Canadian D&A, what do you think the run rate is for that, once you get out -- you've opened a bunch of the stores, once you get towards the end of the year, what kind of run rates were you thinking about for Canadian D&A? Thank you. + +-------------------------------------------------------------------------------- +John Mulligan, Target Corp - EVP and CFO [9] +-------------------------------------------------------------------------------- + + I think you'll continue to see D&A grow throughout this year as we continue to put significant assets into service. And we'll provide a little bit more color, I think, as we get later into the year and have a little bit more clarity about sales margin and the entire P&L, we'll provide a little more clarity about the entire P&L for Canada. + +-------------------------------------------------------------------------------- +Peter Benedict, Robert W. Baird & Company, Inc. - Analyst [10] +-------------------------------------------------------------------------------- + + Okay. Fair enough. Thank you. + +-------------------------------------------------------------------------------- +Operator [11] +-------------------------------------------------------------------------------- + + Sean Naughton, Piper Jaffray. + +-------------------------------------------------------------------------------- +Sean Naughton, Piper Jaffray - Analyst [12] +-------------------------------------------------------------------------------- + + Thanks for taking the questions. In terms of dissecting the comp in Q1, transaction trends as you mentioned were relatively stable on a two-year basis and did improve from Q4. But the units per transaction were down 50 basis points, and I think that's the first time since '09. Just wondering what would explain that decline, given the increase in the Remodel program from Q1 last year. + +-------------------------------------------------------------------------------- +John Mulligan, Target Corp - EVP and CFO [13] +-------------------------------------------------------------------------------- + + Actually, Sean, I'm not quite clear on your question. Units per transaction in the first quarter were up year over year. Help me with that again. + +-------------------------------------------------------------------------------- +Sean Naughton, Piper Jaffray - Analyst [14] +-------------------------------------------------------------------------------- + + Oh, I thought they were down 60 basis points. Maybe I'm missing something here. + +-------------------------------------------------------------------------------- +John Mulligan, Target Corp - EVP and CFO [15] +-------------------------------------------------------------------------------- + + No, selling price per unit was down 60 basis points. + +-------------------------------------------------------------------------------- +Gregg Steinhafel, Target Corp - Chairman, President, CEO [16] +-------------------------------------------------------------------------------- + + That was mix related. + +-------------------------------------------------------------------------------- +John Mulligan, Target Corp - EVP and CFO [17] +-------------------------------------------------------------------------------- + + Right. Entirely mix. But units were up consistently for some of the reasons you described. + +-------------------------------------------------------------------------------- +Sean Naughton, Piper Jaffray - Analyst [18] +-------------------------------------------------------------------------------- + + Okay. Got it. And then, Gregg, you'd touched briefly on the price matching, curious if you are seeing the number of requests for the price match change at all. And has there been any competitive response to that in the marketplace? + +-------------------------------------------------------------------------------- +Gregg Steinhafel, Target Corp - Chairman, President, CEO [19] +-------------------------------------------------------------------------------- + + Both the stores with the matching of competitors' physical ads and the online match has been fairly stable and has not grown materially over the last quarter. So it still represents a very small portion of our transaction. That's because our everyday price and our promotional prices are so strong, there is generally not much of a gap, if any. So we continue to watch our competitive prices on a day-in and day-out basis and move where we have to be competitive in the marketplace. And so we expect over time this not to change all that much. + +-------------------------------------------------------------------------------- +Sean Naughton, Piper Jaffray - Analyst [20] +-------------------------------------------------------------------------------- + + Okay. Great. And then lastly on Digital, you're obviously seeing some nice traction, nice growth outside of the seasonal categories. Can you talk about the impact on margin for that sale today? Is it dilutive or is it accretive to the margin? What do you think that can -- how are you planning that over time? + +-------------------------------------------------------------------------------- +John Mulligan, Target Corp - EVP and CFO [21] +-------------------------------------------------------------------------------- + + Yes, I think first I'd start with how we think about this longer term. And we think about, from a longer term perspective, sales through all of our channels, regardless of the channel, need to generate a return, and a return on investment that's similar to what we see in our current US store base. What we see today is, honestly, we're learning a lot about that channel and a lot of this depends on how we're going to ultimately settle on the supply chain that our guest wants to interact with us. How much is ship from store, how much is ship to store. That will have a significant impact ultimately on the EBITDA margin rates of that particular channel. But I think once again, depending on where those EBITDA margin rates land, sales or capital will move around and we feel very confident that we'll get back to a return that makes sense. Having said all that, I think as it relates to the rates embedded within that channel, we feel very comfortable that ultimately we'll get back and operate at that 10% EBITDA rate that we've set as part of our long-range plan. + +-------------------------------------------------------------------------------- +Sean Naughton, Piper Jaffray - Analyst [22] +-------------------------------------------------------------------------------- + + Got it. That's helpful. Best of luck in Q2. + +-------------------------------------------------------------------------------- +Gregg Steinhafel, Target Corp - Chairman, President, CEO [23] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Operator [24] +-------------------------------------------------------------------------------- + + Matt Nemer, Wells Fargo Securities. + +-------------------------------------------------------------------------------- +Matt Nemer, Wells Fargo Securities, LLC - Analyst [25] +-------------------------------------------------------------------------------- + + Thanks for taking my questions. First, I'm wondering if you can comment on sales in geographic areas that have more neutral weather like Florida. Were the transactions and the comps positive in those markets? + +-------------------------------------------------------------------------------- +Kathee Tesija, Target Corp - EVP of Merchandising [26] +-------------------------------------------------------------------------------- + + You know, we did see better results in areas that had more normal weather, so that would primarily be the West Coast and they were toughest in those seasonal categories where we saw weather off the most, and that would be primarily in the Midwest. So we did see quite a swing between the different geographies. + +-------------------------------------------------------------------------------- +Matt Nemer, Wells Fargo Securities, LLC - Analyst [27] +-------------------------------------------------------------------------------- + + In terms of the second-quarter guidance, do we assume that there's some incremental mark-down risk in seasonal categories? You did mention that within categories the rate improvement would be a little softer in the second quarter than the first quarter. So just wondering what the mark-down risk is in the seasonal categories. + +-------------------------------------------------------------------------------- +Gregg Steinhafel, Target Corp - Chairman, President, CEO [28] +-------------------------------------------------------------------------------- + + Yes, like we said, the teams did a very good job of responding to the sale shortfall, retiming receipts and making cancellations. We're going to know a heck of a lot more in the next 30 days as we see what happens and how the sales of these categories play out before we have to take mark-downs in the 4th of July. And if we get really good weather and we have good sell-throughs, then we're going to be right back on plan. If things stay damp and cool for an extended period of time there might be some risk. We don't expect to see a significant risk, whatsoever. We're talking about things on the edges right now. + +-------------------------------------------------------------------------------- +John Mulligan, Target Corp - EVP and CFO [29] +-------------------------------------------------------------------------------- + + Matt, the other thing I'd add is it's a little bit hard to see with the inventory on the balance sheet. The inventory per store in the US is essentially flat to last year. All of the inventory build year over year is attributable to Canada. So we feel really good about where the inventory positions are in aggregate. + +-------------------------------------------------------------------------------- +Matt Nemer, Wells Fargo Securities, LLC - Analyst [30] +-------------------------------------------------------------------------------- + + That's very helpful. Lastly, if we look at your operating expenses in the US Retail segment, growth, dollar growth, accelerated a little bit versus last few quarters. I'm assuming a lot of that is technology investments. But given the more moderated view of comps for the full year, could we see the dollar growth potentially come back down a little bit? + +-------------------------------------------------------------------------------- +John Mulligan, Target Corp - EVP and CFO [31] +-------------------------------------------------------------------------------- + + Yes, you're right, first of all, that the vast majority of that is multi-channel technology and we've said a little bit of missed timing here. We expect to offset that on the year with expense savings and improvements we're making in our business, but the investment coming a little bit ahead of that. To your second point, I think that's absolutely right. It's interesting. We said this last year, when our sales accelerate or decelerate rapidly from our expectations, we tend to see our SG&A lag both directions. It doesn't climb as fast when sales go up like last year, and doesn't come down quite as quickly when we see sales decelerate. As we adapt to wherever sales are going to be, you'll see our SG&A settle in at a more appropriate level. + +-------------------------------------------------------------------------------- +Matt Nemer, Wells Fargo Securities, LLC - Analyst [32] +-------------------------------------------------------------------------------- + + Great. That's helpful. Good luck this quarter. + +-------------------------------------------------------------------------------- +Operator [33] +-------------------------------------------------------------------------------- + + Colin McGranahan, Bernstein. + +-------------------------------------------------------------------------------- +Colin McGranahan, Sanford C. Bernstein & Company, Inc. - Analyst [34] +-------------------------------------------------------------------------------- + + Good morning, thank you. First question on Canada, understand that the gross margin rate of 38% is not the long run rate. But where do you think that settles out? And was the 38% above where you expected even adjusting for the mix that you saw? + +-------------------------------------------------------------------------------- +Gregg Steinhafel, Target Corp - Chairman, President, CEO [35] +-------------------------------------------------------------------------------- + + Yes, I would say out of the blocks, 38% was a little higher than we expected because the mix was a little bit better than we expected out of the blocks. Whether it's in Canada or the US, clearly when we open a new store we get a higher gross margin rate, but the mix was even higher than the higher that we expected. So we do expect that to settle down and be slightly higher than what it is in the US, because we expect the mix to be a little bit better than it is here in the US. + +-------------------------------------------------------------------------------- +Colin McGranahan, Sanford C. Bernstein & Company, Inc. - Analyst [36] +-------------------------------------------------------------------------------- + + Of course. As the consumables business ramps up it mixes down. From a productivity perspective, can you tell anything yet on these first stores that are open, in terms of opening expectations relative to what you had thought? Or was it just too much hoopla that you can't discern anything yet? + +-------------------------------------------------------------------------------- +Gregg Steinhafel, Target Corp - Chairman, President, CEO [37] +-------------------------------------------------------------------------------- + + I wouldn't call it hoopla. I would just say that the guests were very, very excited and we experienced tremendous surges in sales. And it's just very, very early to draw any conclusions. And we really wanted to deliver a great experience and so to a certain extent we went in with staffing levels to make sure that we were taking care of the guest, both at the front end and we had the right team members there for the supply chain and we had the right teams on the sales floor. So we know that over time and in a run state in addition, we have to work hard at making sure that we get our productivity levels where the business models dictates them to be. And we know our gross margins will settle in and we've got to become more productive and run the business. Over time our consumables share will grow. +That's the hardest trip to change with the guest and so we're going to continue to focus on those frequency-oriented categories so that we can not only get the good mix that we're getting, but we want to now start driving more trip frequency into the store. We didn't want to come out of the blocks by hitting those categories too hard because we wanted to make sure that we led with our strength. And we wanted to make sure that all the supply chains and the operational disciplines were in place. We feel very confident now that they are. We're ready to start making those kinds of adjustments in merchandising and supply chain and in store operations to start refining the model. + +-------------------------------------------------------------------------------- +Colin McGranahan, Sanford C. Bernstein & Company, Inc. - Analyst [38] +-------------------------------------------------------------------------------- + + Okay, that's helpful. By the way, hoopla's a technical term we use here on Wall Street. (laughter) + +-------------------------------------------------------------------------------- +Gregg Steinhafel, Target Corp - Chairman, President, CEO [39] +-------------------------------------------------------------------------------- + + I use that sometimes here, too. (laughter) + +-------------------------------------------------------------------------------- +Colin McGranahan, Sanford C. Bernstein & Company, Inc. - Analyst [40] +-------------------------------------------------------------------------------- + + Secondly, on the credit, I actually thought the contribution, $105 million, while you explained it was low, seemed to me it was higher than I would have expected, especially given the bad debt reserve release last year. Is there anything there that reflects the $105 million profit share? + +-------------------------------------------------------------------------------- +John Mulligan, Target Corp - EVP and CFO [41] +-------------------------------------------------------------------------------- + + I think the one thing I'd remind you is, we only had a half a quarter's worth of profit sharing with TD. Next quarter we'll have a full quarter's worth of profit sharing with TD. + +-------------------------------------------------------------------------------- +Colin McGranahan, Sanford C. Bernstein & Company, Inc. - Analyst [42] +-------------------------------------------------------------------------------- + + So the $105 million was really a $210 million quarterly run rate? + +-------------------------------------------------------------------------------- +John Mulligan, Target Corp - EVP and CFO [43] +-------------------------------------------------------------------------------- + + No, no, no. That's net of our operating expenses as well. + +-------------------------------------------------------------------------------- +Colin McGranahan, Sanford C. Bernstein & Company, Inc. - Analyst [44] +-------------------------------------------------------------------------------- + + All right. I'll follow up offline with you on that, John. + +-------------------------------------------------------------------------------- +John Mulligan, Target Corp - EVP and CFO [45] +-------------------------------------------------------------------------------- + + We can take it offline and walk through that in detail, Colin. + +-------------------------------------------------------------------------------- +Colin McGranahan, Sanford C. Bernstein & Company, Inc. - Analyst [46] +-------------------------------------------------------------------------------- + + Finally, coming back to SG&A, the dollars were up I think $233 million. If I ex-out the credit difference of $36 million, the vendor allowance of $13 million, the technology spend, it still looks like the growth was pretty healthy. John, I know you mentioned that there's a lag in terms of how quickly you can get after that if sales are disappointing. Would you also expect some of the expense things you're doing on a longer term basis to impact that? I guess my question is, can we see better performance out of that line? Because sounds like 2Q guidance doesn't get us there. + +-------------------------------------------------------------------------------- +John Mulligan, Target Corp - EVP and CFO [47] +-------------------------------------------------------------------------------- + + Yes, no question. What we're seeing, I think we talked about this a little bit three or four or five weeks ago when we were together. You'll see the ramp-up in our expense initiatives throughout the year and through next year, actually. Many of them are a little bit longer lead times to pull out expense, all the easy stuff we've done long, long time ago. So we do expect through time, SG&A will come down and manage to a level that is more appropriate. + +-------------------------------------------------------------------------------- +Colin McGranahan, Sanford C. Bernstein & Company, Inc. - Analyst [48] +-------------------------------------------------------------------------------- + + Okay. Thank you. + +-------------------------------------------------------------------------------- +Operator [49] +-------------------------------------------------------------------------------- + + Bob Drbul, Barclays. + +-------------------------------------------------------------------------------- +Bob Drbul, Barclays Capital - Analyst [50] +-------------------------------------------------------------------------------- + + I guess the question that I have for you is a two-fold. It revolves around traffic. When you look at the initiatives that you have in place, REDcard and PFresh and you consider -- I understand the seasonal piece Q1 this year versus last year. But when you think conceptually traffic was down in the fourth quarter and that was down again in the first quarter, how do you get us comfortable with, essentially, the efficiency and the effectiveness of these initiatives over the longer-term period? The second question that I have is when you -- the lower comp assumption for this year, can you maybe just break down the traffic component in that new 2% to 2.5% expectation? + +-------------------------------------------------------------------------------- +Gregg Steinhafel, Target Corp - Chairman, President, CEO [51] +-------------------------------------------------------------------------------- + + I'll take the first part. I think the traffic -- this was a disappointing quarter for us. We had very, very strong traffic last year. There was pluses and minuses throughout 2012 and we expect traffic trends to get stronger as the year goes on. +And we have all of our initiatives designed to, not only deepen the relationship, but build frequency. So we'll perhaps be a little bit more aggressive on price. You have to look at the competitive environment, it was a little bit more aggressive than it had been in the past where there was more emphasis on price, and that, I think, impacted it a little bit. Overall, we really expect to be able to generate traffic levels that are flattish, give or take, over normalized periods of time. + +-------------------------------------------------------------------------------- +John Mulligan, Target Corp - EVP and CFO [52] +-------------------------------------------------------------------------------- + + Bob, the other thing I'd add, I don't think we need to run traffic numbers like we did last year in first quarter to generate that 3% comp. I think if you look over the past several years, about 0.5 points of traffic combined with ticket gets us to a 3% comp. That's about the formula that we feel really good about. + +-------------------------------------------------------------------------------- +Kathee Tesija, Target Corp - EVP of Merchandising [53] +-------------------------------------------------------------------------------- + + The only other thing that I would add is, this time of year our seasonal categories can be a big traffic driver for Target, and clearly they weren't in the quarter and they were last year. So all of the things you mentioned, 5%, PFresh, help us all year long but during key seasonal categories, key seasonal time frames, we need those categories to drive traffic as well. + +-------------------------------------------------------------------------------- +Bob Drbul, Barclays Capital - Analyst [54] +-------------------------------------------------------------------------------- + + Okay, thank you very much. + +-------------------------------------------------------------------------------- +Operator [55] +-------------------------------------------------------------------------------- + + Deborah Weinswig, Citigroup. + +-------------------------------------------------------------------------------- +Deborah Weinswig, Citigroup - Analyst [56] +-------------------------------------------------------------------------------- + + Thank you so much. Appreciate all the color. Lot of conversation regarding mobile and digital traffic. Can you also talk about what conversion was like during the quarter? + +-------------------------------------------------------------------------------- +Kathee Tesija, Target Corp - EVP of Merchandising [57] +-------------------------------------------------------------------------------- + + Our conversion has been improving over the past year, Deb, and we were up slightly in this quarter as well. So we're really pleased with the improvements that we've made on this site but I'll tell you, we still feel we have a long way to go with conversion. And we are very committed to continuing to work on our navigation and our search function and the basic functionality of our site to continue to make big improvements there. + +-------------------------------------------------------------------------------- +John Mulligan, Target Corp - EVP and CFO [58] +-------------------------------------------------------------------------------- + + I think the other thing I'd add, Deb, is we have a little bit of a mix headwind which is positive from our perspective. Mobile, in general has a much lower conversion rate than the site, and our mobile is growing much, much faster than the site. We think that's good because we think that's where things are going and it also shows that she is spending a lot of time with us on the mobile applications we have. But conversion's just naturally lower there, and so creates a little bit of a mix number as we look at the aggregate. + +-------------------------------------------------------------------------------- +Kathee Tesija, Target Corp - EVP of Merchandising [59] +-------------------------------------------------------------------------------- + + If you look at conversion on our site, it's up to last year. If you look at conversion on mobile, it's up to last year. But because of the big growth in mobile, to John's point, conversion comes down slightly in aggregate. + +-------------------------------------------------------------------------------- +Deborah Weinswig, Citigroup - Analyst [60] +-------------------------------------------------------------------------------- + + All right. Then a broader question. Can you talk about how you're positioning yourself in terms of taking advantage of the Affordable Care Act? + +-------------------------------------------------------------------------------- +John Mulligan, Target Corp - EVP and CFO [61] +-------------------------------------------------------------------------------- + + I think we've said a couple times the Affordable Care Act, the changes for us will be relatively -- well, they won't be relatively -- they will not be material externally. We're still continuing to work through all the regulations and what we will exactly do, but it won't be material changes to what we're doing today, or financially from a financial perspective. + +-------------------------------------------------------------------------------- +Deborah Weinswig, Citigroup - Analyst [62] +-------------------------------------------------------------------------------- + + Okay. And then I think Gregg touched on segmentation, how you're looking to match local taste and preferences. Where are you? I know there was a lot of work done in Canada, but where are you domestically in terms of that? + +-------------------------------------------------------------------------------- +Gregg Steinhafel, Target Corp - Chairman, President, CEO [63] +-------------------------------------------------------------------------------- + + We feel good about where we are. We've been working on this for a long time and we continue to deploy resources to get better and better at that. So this is just a long-term initiative that we have to continue to focus on, whether it's in Food, whether it's demographics, whether it is ethnic groups, we've just got to continue to get better at our localization efforts. We think we've made good progress there and we are going to continue to focus on it. + +-------------------------------------------------------------------------------- +Deborah Weinswig, Citigroup - Analyst [64] +-------------------------------------------------------------------------------- + + Was there anything that you learned from Canada that you could go back and apply to the US? Or is it exactly what you expected and you're just continuing on the path? + +-------------------------------------------------------------------------------- +Kathee Tesija, Target Corp - EVP of Merchandising [65] +-------------------------------------------------------------------------------- + + I would just say, Deb, I think it's a little early to learn from Canada and bring that back to the US. I will tell you, though, we learned a lot from the City Targets that we applied to Canada. As you know, those stores are in dense urban areas and so are our Canada stores. We took a lot of that learning and the testing that we did last year and applied that to what we're doing in Canada. Throughout this year of course, we'll be reading the Canada results and bringing that back to the US. But the same teams work on localization for both countries. + +-------------------------------------------------------------------------------- +Deborah Weinswig, Citigroup - Analyst [66] +-------------------------------------------------------------------------------- + + Great. Thanks so much and best of luck. + +-------------------------------------------------------------------------------- +Gregg Steinhafel, Target Corp - Chairman, President, CEO [67] +-------------------------------------------------------------------------------- + + Thank you. We have time for one more question. + +-------------------------------------------------------------------------------- +Operator [68] +-------------------------------------------------------------------------------- + + Chris Horvers, JPMorgan. + +-------------------------------------------------------------------------------- +Chris Horvers, JPMorgan Chase & Co. - Analyst [69] +-------------------------------------------------------------------------------- + + Good morning. Couple questions. First on the top line, in the Home and Apparel categories can you talk about the stacked comps that you had in the first quarter? And broadly how that has trended, those categories have trended over time, the past few quarters? + +-------------------------------------------------------------------------------- +Kathee Tesija, Target Corp - EVP of Merchandising [70] +-------------------------------------------------------------------------------- + + When we look at the stack comps, we feel a lot better about it, since you're just looking at this quarter, both were positive if we look on a stacked basis. Going forward, our compare in second quarter is not nearly as difficult as our first quarter, so we would expect our comps to improve and over time we want that two-year stack to improve. We're not happy with flat or up slightly. We want to make sure that we're making progress there. It was, on a two-year basis, better. + +-------------------------------------------------------------------------------- +John Mulligan, Target Corp - EVP and CFO [71] +-------------------------------------------------------------------------------- + + I think I'd just add a little color to that. Apparel, for instance, the two-year stack is around a 2%. Running that consistently through time, we'd feel really good about running 2%s in Apparel. As Kathee said, Home is positive. That's a big improvement from where Home has been over the past several years. On a two-year basis we feel good about both those businesses. + +-------------------------------------------------------------------------------- +Chris Horvers, JPMorgan Chase & Co. - Analyst [72] +-------------------------------------------------------------------------------- + + That's great. Also, thinking about the EPS pressure from Canada, can you talk about how much of the expenses in the first quarter are one-time in nature, pre-opens and so forth? And as you think about the guide for the second quarter, a similar question, how much of that expense pressure is actually something that goes away in future quarters? + +-------------------------------------------------------------------------------- +John Mulligan, Target Corp - EVP and CFO [73] +-------------------------------------------------------------------------------- + + Yes, you know, that's difficult to parce out. The example I would give you is exactly what Gregg said, where we started with the stores staffed very heavily. We know through time we have to refine that model, is that one-time expense or operating expense. Certainly the expenses related to hiring team members early and training them at the next cycle of stores we'll open up, that is all one-time and will drift away. What I'd tell you is, through time we expect ultimately well down the road to get to SG&A rates that make sense and productivities that are very similar to the US. So as I said before, as we get a little bit more clarity, right now expense dominates the P&L in Canada. And was we get more clarity on sales, margin, operations later in the year, we'll provide a lot more color about how we expect those stores to operate. + +-------------------------------------------------------------------------------- +Chris Horvers, JPMorgan Chase & Co. - Analyst [74] +-------------------------------------------------------------------------------- + + And then one final one. In terms of being in the stores, it seems like at times you're actually too thin on inventory in some of the discretionary categories, whether that's Home or Apparel. What's the internal discussion around balancing rate versus balancing sales? And do you think that you've leaned too far towards the rate side? Thanks. + +-------------------------------------------------------------------------------- +Kathee Tesija, Target Corp - EVP of Merchandising [75] +-------------------------------------------------------------------------------- + + This is something that we are always looking at and adjusting. But, I guess I would tell you I don't feel like we've gone too far. Our inventory as John mentioned, our average inventory per store is flat to last year. It's actually up a bit in Apparel given the softer sales in the first quarter. So we're always looking at that. We look as much at out-of-stocks as we do in-stocks, in trying to improve those stores. It's a constant focus for us and we can always improve, but I feel pretty good about where we are right now in terms of in-stock. + +-------------------------------------------------------------------------------- +Chris Horvers, JPMorgan Chase & Co. - Analyst [76] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Gregg Steinhafel, Target Corp - Chairman, President, CEO [77] +-------------------------------------------------------------------------------- + + Okay. Thank you. That concludes Target's first quarter 2013 earnings conference call. Thank you all for your participation. + +-------------------------------------------------------------------------------- +Operator [78] +-------------------------------------------------------------------------------- + + Thank you for participating in today's conference call. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/exam/original-files/Problem_2_3_Sample_full_transcripts/2013-Nov-21-TGT.N-138993533906-Transcript.txt b/exam/original-files/Problem_2_3_Sample_full_transcripts/2013-Nov-21-TGT.N-138993533906-Transcript.txt new file mode 100644 index 0000000..d0c9fc5 --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_full_transcripts/2013-Nov-21-TGT.N-138993533906-Transcript.txt @@ -0,0 +1,564 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q3 2013 Target Corporation Earnings Conference Call +11/21/2013 10:30 AM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * John Mulligan + Target Corp - EVP & CFO + * Kathee Tesija + Target Corp - EVP Merchandising + * Gregg Steinhafel + Target Corp - Chairman, President & CEO + +================================================================================ +Conference Call Participiants +================================================================================ + + * Paul Trussell + Deutsche Bank - Analyst + * Wayne Hood + BMO Capital Markets - Analyst + * Christopher Horvers + JPMorgan Chase & Co. - Analyst + * Greg Melich + ISI Group - Analyst + * Jason DeRise + UBS - Analyst + * Matthew Fassler + Goldman Sachs - Analyst + * Sean Naughton + Piper Jaffray - Analyst + +================================================================================ +Presentation +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Ladies and gentlemen, thank you for standing by. Welcome to the Target Corporation third-quarter earnings release conference call. +(Operator Instructions) +As reminder, this conference is being recorded Thursday November 21, 2013. I would now like to turn the conference over to Mr. Gregg Steinhafel, Chairman, President, and Chief Executive Officer. Please go ahead, sir. + +-------------------------------------------------------------------------------- +Gregg Steinhafel, Target Corp - Chairman, President & CEO [2] +-------------------------------------------------------------------------------- + + Thank you. Good morning. Welcome to our 2013 third-quarter earnings conference call. On the line with me today are Kathee Tesija, Executive Vice President of Merchandising, and John Mulligan, Executive Vice President and Chief Financial Officer. This morning, I'll provide a high level summary of our third quarter results and strategic priorities for the remainder of the year, and Kathee will discuss category results, guest insights, and plans for the holiday season. And finally John will provide more detail on our financial performance, along with our financial outlook for the fourth quarter and the year. Following John's remarks, we will open the phone lines for a question-and-answer session. +As reminder, we are joined on this conference call by investors and others who are listening to our comments via webcast. Following this conference call, John Hulbert and John Mulligan will be available throughout the day to answer any follow-up questions you may have. Also as a reminder, any forward-looking statements that we make this morning are subject to risks and uncertainties, the most important of which are described in our SEC filings. Finally, in these remarks we refer to adjusted earnings per share, which is a non-GAAP financial measure. A reconciliation to our GAAP results is included in this morning's press release, posted on our Investor Relations website. +Target's third quarter financial results reflect continued strong operating performance in the US, despite an environment in which traffic and sales remain challenging. Comparable sales increased 0.9% in the quarter, near the low end of our guidance, and our US operations generated adjusted earnings per share of $0.84, near the midpoint of our expected range. We continue to manage our business thoughtfully, investing to maintain our relevance over the long term while we focus on disciplined execution to drive current performance. We continually work to anticipate and respond to the ever-changing needs of our guests, as we monitor the economy and the competitive landscape. +GDP continues to grow at a painfully slow place while household income and consumer spending remain constrained. In particular, lower and middle income households are shopping cautiously, as they work to stay within tight, very tight household budgets, which has seen additional pressure from this year's payroll tax increase. And consumer confidence, which has been generally recovering since the recession, took a dramatic step backward in October during the government shutdown. This decline was particularly evident in lower and middle income households, and we saw lower than expected sell-throughs on Halloween merchandise. Not surprisingly, in this environment our competitors have become increasingly focused on promotions, both to gain the attention of value-conscious consumers and to clear heavy inventories of discretionary categories. Our results show that guests continues to consolidate trips, as evidenced by a slight decline in our third-quarter transactions, which was offset by an increase in average ticket. +Given their focus on value, guests continue to respond to initiatives that connect them with Target and allow them to save even more off our already low prices. We are very pleased with the rapid growth of 5% REDcard Rewards, as penetration grew beyond 20% in October, and averaged just below 20% for the full quarter. And the response to Cartwheel, our digital coupon portable, has been remarkable. Cartwheel now has nearly 3 million users, most of whom access it exclusively on their mobile device. Even though we launched Cartwheel only six months ago, guests have already saved more than $14 million. +We continue to generate strong operating margins in our US segment, which is especially notable in an environment where sales growth is slow and consumers and competitors are focused on promotions and value. Inventory and in-stock levels in the US remain healthy, and expenses remain very will controlled. Teams throughout the organization are contributing to our expense optimization efforts, finding innovative ways to reduce expenses which we can reinvest to drive future growth. In addition, our stores' teams has done an excellent job increasing productivity while delivering a great guest experience. +In the third quarter, we opened our eighth CityTarget, and we continue to be pleased with the results from this new format. We opened our first CityTarget stores more than a year ago, and we're seeing very strong comparable sales growth in these locations as we raise awareness of our frequency categories and communicate the breadth of our assortment and the great values we deliver across the store. +In Canada, we are nearing the end of this year's unprecedented market launch. Earlier this month, we opened an additional 31 stores, our largest cycle so far, and with 2 remaining stores opening tomorrow, we will reach our goal to open 124 Canadian Target stores in 2013. The Target Canada team has shown remarkable energy and perseverance, allowing us to open a record number of new Target stores across Canada less than three years from the announcement of our agreement to purchase leasehold interest from Zellers. With this final cycle of openings behind us, the team is completely focused on improving operations in run state, enhancing systems and processes to better deliver the full Target experience to our new Canadian guests. +The Target Canada team is energized and prepared for the holiday season, and preparing to enter 2014 with improved in-stocks and a much better inventory position. We continue to see a very strong mix of our higher margin home and apparel categories in Canada. However, third quarter gross margin rate in Canada was unusually low as the team worked diligently to eliminate excess inventory and enhance flow throughout the supply chain. This activity led to heavier third quarter mark-downs and higher than expected dilution of $0.29 in our Canadian segment. Process improvement efforts and inventory clean-up will continue in the fourth quarter as well. As we gain experience in operating Canadian stores and accumulate sales histories by item by location, inventory flow and allocation will become much more reliable and accurate, setting the stage for improved sales and operating efficiency in 2014. +Given that this is our first holiday season in Canada, we will focus on delivering everything that is special about the season while continuing to emphasize that our prices in Canada are unbeatable. Over time we are confident that the Canadian consumers well recognize that Target's combination of low everyday prices, compelling discounts in the flyer, price matching policies, and 5% REDcard Rewards savings offer an unbeatable value in the marketplace. +While our initial sales and profits in Canada have not met our expectations, we remain enthusiastic about the Canadian market and confident in the long-term success of these stores. They are located in densely populated, vibrant trade areas, and based on 50 years of experience building stores and entering markets in the US, we continue to believe that our Canadian segment will contribute meaningfully to Target sales and profits over time. We also believe the sales shortfalls and earnings dilution from excess inventory and start-up costs will moderate next year, leading to significant improvement in the Canadian segment profitability in 2014. +In the US, it is clear that the holiday season will be highly promotional and that consumers will be laser-focused on value. In past holiday seasons we have consistently offered compelling value, investing billions of dollars in low prices. Yet we believe we have an opportunity to communicate this focus on value more clearly to the marketplace. As a result, this holiday season we will be much more overt in our price messaging across our marketing vehicles, stressing our unbeatable combination of everyday low prices, deep discounts on promotions, our price match policies, and our 5% REDcard Rewards program. And, while we are entering the season with guarded expectations for sales, we feel very good about our inventory levels, merchandising and marketing plans, and we expect to deliver profitable fourth quarter sales while offering unbeatable value for our guests. +While we all know about the loss of six shopping days between Thanksgiving and Christmas this year, at Target we are entering the holiday season with cautious optimism, as we annualize over last year's election and consumer uncertainty surrounding the fiscal cliff Based on our results a year ago, we are investing our merchandising and marketing resources with a stronger focus on key holiday categories like toys and electronics. In particular, given our market share in video game hardware and software, we expect to benefit this holiday season from the most meaningful platform launches in more than seven years. +In addition to fourth quarter merchandising and marketing plans, teams across the Company have been preparing for the full-chain rollout of in-store pickup, the first of multiple efforts to deliver flexible fulfillment for our guests. The team has moved quickly to roll out this capability, growing from a limited second-quarter test with Minneapolis team members to all of our stores earlier this month. The initial response from our guests have been encouraging, and we are looking forward to measuring their response throughout the holiday season, providing valuable insight as we prepare to roll out additional capabilities in 2014. +We entered 2013 with an ambitious agenda, as we committed capital [and expense] to transform the Company and create value over time. Throughout this year of transition, both in the US and Canada, our team has been remarkably resilient, energetically embracing every challenge as they work to position Target for long-term success. Our entire team is focused on developing Target's multi-channel capabilities while offering merchandise and experiences to create loyalty and position Target to deliver strong performance in any environment. Now, Kathee we will provide more detail on our third-quarter results and outline initiatives for the fourth quarter and beyond. Kathee? + +-------------------------------------------------------------------------------- +Kathee Tesija, Target Corp - EVP Merchandising [3] +-------------------------------------------------------------------------------- + + Thanks, Gregg. We are pleased with the ability of our team to manage the business in the third quarter, maintaining profitability in a soft sales environment while we continue to develop digital capabilities that allow us to connect with our guests in new ways. Across our merchandising categories we saw a relatively balanced mix of third quarter sales between lower margin and higher margin categories. Among the lower margin categories, need-based areas like food and healthcare continue to outpace our overall comp. And electronics had a greater -- had a great quarter, driven by sales and mobile devices and video games. Our discretionary higher margin apparel and home categories both saw small declines in comparable sales. In apparel, third quarter trends were strongest in jewelry, accessories, and newborn/infant/toddler. In home, sales trends were strongest in domestics. In our digital channels, we saw very strong growth in apparel, hard lines, and beauty. +Early in the quarter, we were pleased with the comparable sales results in our back-to-school categories, which outpaced both the industry and our overall results. Results were particularly strong in supplies, which saw a big increase in penetration of our up & up brand. Performance in back-to-college was also stronger than average, both in-store and online. In September, our collaboration with Phillip Lim was one of our most successful to date. Sell-through levels were very strong overall, and particularly high in our digital channels. The most popular items in the collaboration included handbags, men's shoes, and women's dresses. In October, this year's calendar shift benefited comparable sales as a portion of Halloween-related sales moved into the month from November last year. However as Gregg mentioned, in conjunction with the government shutdown and pullback in consumer confidence, we saw a slowdown in our sales trends, leading to the lower than expected sell-throughs on Halloween merchandise at the end of the quarter. +We continue to see remarkable guest engagement with Cartwheel. In response to guest feedback, we moved quickly to integrate Cartwheel into the Target app for both Android and iOS in time for the holiday season. Now guests can find Cartwheel deals in four places, on their shopping list, on the product listing page, on the product detail page, and the what's-in-store content section. Beyond Cartwheel, we are very pleased with the progress we're making in our digital channels. We continue to see double-digit growth in overall digital traffic and triple-digit growth in mobile. This is notable because mobile is a much higher percentage of our digital traffic compared with some of our closest competitors. We're also seeing improved conversion on both the traditional site and on mobile as we continue to benefit from investments to improve search and navigation. +As we survey our guests and monitor the overall consumer environment, we continue to see anxiety regarding the economy and the ability to stay within household budgets, particularly among lower and middle income consumers. In October, a very high percentage of our guests were aware of the government shutdown and concerned it would hurt the economy. In addition, a meaningful portion indicated they were changing their shopping behavior in light of their current financial situation. This was evident in our guest metrics. In the third quarter, we were pleased to measure a year-over-year increase in the number of guests shopping with us, but this increase was offset by a decrease in their average shopping frequency. We even heard from some guests that they were cutting trips for fear they would be tempted to spend too much, a behavior we first observed in the recession. In light of this environment, we are entering the holiday season with a cautious outlook for sales and a very liquid inventory position. Specifically, at the end of the third quarter our average inventory per US store was up only 1%. We believe this position is appropriate as it protects against the downside in a tough environment, knowing that our base inventory is large enough to enable sales well beyond our fourth quarter plan if the season turns out to be unexpectedly strong. +As we look ahead to the rest of the holiday shopping season, we are excited about our plans to deliver on both sides of our Expect More, Pay Less brand promise, beginning with our plans for next week. On Thanksgiving, we are excited to open at 8.00 PM, based on the response to our Thursday opening last year and the higher number of families who shop together, making Target part of their family tradition. This year we have pushed our opening time up by one hour to help accommodate our guests and remain competitive in the marketplace. Of course, on Black Friday we will offer hundreds of door buster deals, including some of Target's lowest prices ever on electronics, toys, home decor, fashion, and more. These deals will be available while supplies last in store and at Target.com from Thanksgiving Day though Saturday. +We've also integrated Cartwheel into our plans. When guests redeem any Cartwheel offer this Sunday through Wednesday, they will unlock one additional offer card to select the Cartwheel deal of their choice. Also next Wednesday, Cartwheel will feature Black Friday-like deals on about 30 items, including some of the seasons hottest toys and electronics. +And no matter how, where, or when they want to shop, guests will find Black Friday deals in stores and at Target.com with even more deals available throughout Cyber Week. Target.com will feature 15 online-only daily deals for two straight weeks, beginning Sunday November 24. The only exception will be Thanksgiving Day, when hundreds of Black Friday deals, including almost all of the in-store deals, will be available starting in the early morning hours. Also, on the two days before Thanksgiving, Target.com will be running a special REDcard preview sale with 25 exclusive offers for REDcard guests in items ranging from electronics and entertainment to toys and housewares. Guests can also use Target's mobile app throughout the holidays to review the weekly ad, make shopping lists, check item availability at nearby Target stores, find store maps, and more. +To raise awareness of our outstanding offers, we are increasing media weight over last year and concentrating efforts during the entire week of Black Friday with TV, digital, cinema, and radio support. This will be the most digitally-enabled holiday campaign in our history, with an enhanced presence in the channels where we know our guests are most engaged. And finally, next week we will be testing a special offer in Northern California stores where all apparel and accessory items will be 40% off from the time we open on Thanksgiving through close of business on Saturday. This offer will be available in 89 stores, and will include women's, men's, kids', baby apparel, along with jewelry, accessories, and shoes. The only exclusion is clearance items. We will monitor results from the test to determine whether to extend a similar offer in other markets in future years. +In electronics this season, we are very excited about the highly anticipated platform launches from Sony PlayStation and Xbox, bringing newness to a category which hasn't seen meaningful change in many years. We're also featuring the hottest new headphones from Beats by Dr. Dre and wireless speaker systems from Sonos. +For this year's toy catalog, we will feature more than 500 items. We are offering more than $100 of coupon savings. In addition, we are offering free shipping on every item in the catalog until November 27. These savings are on top of the 5% guests receive when they use their REDcard. +In beauty, we recently launched a complete line of bath and body products from our long time beauty partner, Sonia Kashuk, including four beautiful scents created by Sonia in collaboration with French perfume house Robertet. The line is available in stores and online, and will include gift sets for the holiday season. +In home, guests continue to respond to the unique affordable designs from Nate Berkus. New for the season, we have rolled out exclusive Nate Berkus holiday collection in bedding, gifts, and decor available in stores and Target.com. Also new in home this season, we are excited to feature high-end kitchen items from Vitamix and Nespresso. +In entertainment, we continue to offer guests exclusive content from a wide spectrum of artists and genres. In October we launch exclusive albums from artists including Mary J Blige, The Head and The Heart, Paul McCartney, the Avid Brothers, and Kelly Clarkson. In November we added exclusives from Celine Dion, Avril Lavigne, and James Blunt. On December 3 we will release the Target exclusive version of country star Jake Owens' new album, Days of Gold, which includes four bonus tracks. +In grocery, we are following up on the recent success of Target exclusive pumpkin M&Ms with a wide variety of big brand holiday treats, including exclusive items from M&Ms, OREO and Hershey. +Beyond the fourth quarter and the holiday season, our team continues to develop services and multi-channel capabilities to delight our guests and keep Target relevant over time. We are pleased with the initial response to our store pick-up program, which became available in all US stores on November 1. Early results indicate that guests are using the service to reserve high-ticket items, such as iPads and weekly ad items, to ensure they get the item before it sells out. Top categories for in-store pick-up include baby, furniture, and electronics, and our strongest markets have been New York, Chicago, and Seattle. +Following the strong guest response to our Chicago test of our baby 360 layout, which features added service and an enhance presentation, last month we extended the test to an additional 20 stores across the country. We will continue to monitor sales and registry trends in these stores to determine future rollout plans. We're also excited about results from our beauty concierge program, which we extended this month to another 95 stores in new markets across the country including New York, New Jersey, San Francisco, and Dallas-Fort Worth. This program is exceeding its sales goals, and we're seeing particular strength in core categories like cosmetics, skin care, and hair care. +While Target Ticket is still new, since its launch a little over a month ago, we have driven millions of page views to the site. Visits consist of a blend of new and existing users who come back to review the new movies and TV shows that are continuously added. The number of Target Ticket accounts has exceeded our expectations to date, and we are excited to continue introducing this service to new guests as it expands and evolves in 2014. +In late September, following a three-month team member pilot, we rolled out a subscription service that allows guests to order baby diapers, training pants, wipes and formula to their doorsteps on a recurring schedule. Target subscription service has unique advantages, including free shipping and easy in-store or online returns, 5% off subscription purchases when using a Target credit or debit card, and a compelling assortment that includes national brands and popular own brand products like up & up diapers. Based on the initial guest response, we plan to expand our subscription service to more categories by the end of year to learn more about guest interest in this type of service. For example, we'll be adding a limited assortment from categories like coffee, personal care, paper towels, and toilet paper. +And finally, last week Pinterest added tools which allow us to highlight the most pinned items. We will be integrating top pins on Target.com in two ways. We will feature top pinned items on key category pages, and as guests click on a link to a product that is no longer available, they will see top pinned product alternatives in the same category. And in our stores, we will use signing to highlight top pinned items throughout our assortments. +While we are cautious about the near-term sales outlook, we are confident in our fourth quarter plans and believe we are taking the right steps to position our business for long-term success. Our guests rely on Target to help them save money and stay within their budgets, but they also expect us to surprise and inspire them in new ways. That is the essence of our Expect More, Pay Less brand promise, which guides our efforts every day. Now, John will share his insights on our third quarter financial performance and our outlook for the fourth quarter. John? + +-------------------------------------------------------------------------------- +John Mulligan, Target Corp - EVP & CFO [4] +-------------------------------------------------------------------------------- + + Thanks, Kathee. Our third-quarter financial performance reflected continued strong execution in our US segment and higher than expected dilution in our Canadian segment as we continue to refine operations and clear excess inventory. This morning we reported adjusted EPS of $0.84, near the midpoint of our guidance, despite comparable sales near the low end of our planned range. Our GAAP EPS of $0.54 was below expectations, reflecting $0.29 of dilution from our Canadian segment. In the US, comparable sales trends were fairly consistent throughout the quarter. As Kathee mentioned, trends were softer than expected in October as consumers witnessed the dysfunction in Washington. However, on a reported basis, this weakness was offset by the calendar shift, which moved a meaningful amount of Halloween sales into the third quarter. +Our sales continue to be driven by a small decline in transactions, which is being more than offset by an increase in average transaction size. In the third quarter, this increasing basket was entirely driven by an increase in average retail per item, driven largely by electronics, which as Kathee mentioned, saw a much stronger comp in the third quarter that we saw earlier in the year. Sales penetrations on our REDcards continue to grow as more and more guests understand the compelling value of our 5% Rewards program and decide to deepen their relationship with Target. We continue to see a consistent response to households who apply for and activate a new REDcard, increasing their spending at Target by about 50% on average as they respond to the ability to save with REDcard rewards. +Third-quarter US segment EBITDA and EBIT margin rates were consistent with the guidance provided at the beginning of the quarter. Among the drivers of EBITDA margin, we saw a moderate decline in gross margin rate, reflecting the rate impact of 5% Rewards and a small mix impact from our remodel program, combined with underlying rate pressure, driven largely by seasonal mark-downs. A portion of these mark-downs were driven by the calendar shift, which moved Halloween clearance sales into the quarter, with the remainder driven by lower than expected sell-throughs on Halloween merchandise. +Third-quarter US segment SG&A rate was somewhat better than expected, at about 70 basis points higher than last years revised US segment rate. Among the drivers of this increase, the credit card portfolio drove about 60 basis points of pressure, consistent with results from the first two quarters of the year, reflecting a smaller portfolio, last year's reserve release, and this year's profit-sharing arrangement with TD Bank. And, consistent with our prior quarters, we experienced about 20 basis points of pressure related to this year's change in vendor agreements. +This means that outside these two factors, the underlying US retail business generated a small amount of SG&A expense leverage on a 0.9% comparable sales increase, overcoming ongoing pressure from investments in technology and supply chain to support our multi-channel efforts. This is outstanding performance, better than we'd expect over time, and reflective of the Company-wide expense optimization efforts, which we have been discussing with you throughout the year. +In our Canadian segment, we opened another 23 stores in the third quarter, even as we continue to work to refine operations and improve performance. In the quarter, the team made a lot of progress in their efforts to begin to rationalize our inventory position, update item counts in stores and distribution centers, and improve network flow. As a result of these efforts, and recognition of incremental inventory reserves at the end of the quarter, we saw a much lower than expected gross margin rate in the Canadian segment of about 15%. Clearly, this is not the rate we expect over the long term, particularly as we continue to see a much richer mix of sales in our higher margin home and apparel categories in Canada. +However, we do expect pressure on Canadian segment gross margin to persist in the fourth quarter as we continue to do whatever it takes to enter 2014 with improved operations and a notably better inventory position. Obviously, expense rates in Canada are unusually high due to start-up costs, incremental activity to clear inventory, and lower than expected initial sales. While expense rates are expected to improve over the next several years, we expect meaningful improvement in 2014. As we move past first-year start-up costs, we gain efficiencies through systems and process improvements, and we drive sales increases through our efforts to drive shopping frequency. +Turning to consolidated metrics, third-quarter interest expense declined $27 million, or 14%, from last year as we continue to benefit from the debt retirement following the receivables sale. We returned $271 million to shareholders through dividends in the third quarter, marking our 184th consecutive quarterly dividend since we became a public company in 1967. +You have likely noted that we did not repurchase any of our shares in the third quarter. While we remain committed to share repurchase over time, we have consistently maintained that we will govern the pace of repurchases with the goal of maintaining our strong A credit rating. As a result, in the third quarter we took a pause in our share repurchase activity in light of the incremental dilution we are currently experiencing in the Canadian segment. Looking ahead, we will continue to monitor our results while maintaining a dialogue with the debt rating agencies, and we will resume the program when conditions are appropriate. I should emphasize that given the compelling increase in free cash flow we expect next year, we believe we will have the capacity within our rating objectives to return up to $4 billion through share repurchase in 2014. +Now let's turn to our expectations for the fourth quarter and resulting metrics for the full year. In the US, we are planning for approximately flat comparable sales, given there are six fewer shopping days between Thanksgiving and Christmas, the current state of the consumer, and the expectation for a very promotional and competitive environment. As Kathee mentioned, we have ample base inventory to generate much stronger sales than planned if consumer demand turns out to be stronger than expected. While most of the season is still ahead of us, I can tell you that so far in November sales have been right on our forecast, supporting our expectations for the quarter. Notably, the pace of our digital sales growth so far this month has been on plan and much stronger than we have seen so far this year. +Fourth quarter US segment EBITDA margin rate is expected to be down slightly from last year. On the gross margin line, we expect to see year-over-year improvements, reflective of the comparison against last year's unusually high seasonal mark-downs, this year's change in vendor payments and the comparison to last years 53rd week, which added a relatively low gross margin week to the quarter. We expect the fourth quarter US segment SG&A expense rate to be a full percentage point above last year's revised rate of 17.3%. About half of this increase, or $110 million, is related to the credit card portfolio, driven by its smaller size, comparing against a small reserve release last year, and this year's profit-sharing arrangement with TD. The remaining expense pressure in the US segment reflects the change in vendor payments, investments in technology and supply chain, and a lack of leverage on flattish comparable sales growth. +In the Canadian segment, we expect another meaningful acceleration in sales dollars, reflective of the stores we opened in the third quarter, additional openings this quarter, and the surge from holiday-related sales. We expect gross margin expense rate pressures to continue as we move beyond a record year of store openings to refining operations and clearing inventory in preparation for 2014. Our forecast is for the Canadian segment dilution in the range of $0.22 to $0.32 in the fourth quarter. ¶ In the US, we expect fourth quarter adjusted EPS in the range of $1.50 to $1.60. As you will recall, last year's 53rd week added $0.05 to $0.10 to adjusted EPS in the fourth quarter and full year. Adjusting for this benefit, this year's expectation would keep us flat to down slightly from last year's performance on an apples-to-apples basis, despite an expected $110 million headwind from the credit card portfolio. +Combining our expectations for adjusted EPS, Canadian segment dilution, and a $0.02 impact from the reduction in the beneficial interest asset, we expect fourth quarter GAAP EPS in the range centered around $1.26. For the full year, our expectations are for adjusted EPS in the $4.59 to $4.69 range, down slightly from last year's performance of $4.76, reflecting outstanding operational discipline when you consider that it reflects more than $400 million in lower expected earnings from the credit card portfolio, driven by a smaller asset base, annualizing last year's reserve reductions, and the profit-sharing arrangement with TD. It reflects more than $200 million of expense pressure from incremental investments in technology and supply chain to support our multi-channel efforts. It's comparing against last year's 53rd week, which added $50 million to $100 million to last year's pretax earnings. Combining these factors, we faced a headwind in the neighborhood of $700 million this year, of which we've offset a meaningful portion in a tough environment with expected comparable sales of less than 1% for the year. As a result, we are very pleased with the operating discipline reflected in our expected 2013 results for the US segment. +In Canada, we have accomplished a great deal and remain confident in the long run potential for these stores. In the near term however, dilution has been higher than expected as the team works diligently to refine operations, enhance inventory flow, and position the segment for meaningful improvement in profitability throughout 2014. For the year, our expectations are for Canadian dilution in the range of $0.95 to $1.05. Combined with the net accounting impacts from debt retirement, the credit card sale, and nonrecurring tax benefits, our outlook in the US and Canada leads to an expectation for full-year GAAP EPS in a range centered around $3.52. +While the economic environment for the next year remains quite uncertain and beyond our control, we feel good about our plans for 2014 for a number of reasons that are within our control. In Canada, we will move past start-up expenses from this year's market launch, and we are confident in our plans to rationalize inventory, drive sales, and improve operations. In the US, we've demonstrated our ability to continue to manage the business with discipline, regardless of the economic environment, including our continued focus on expense optimization. We feel very good about our plans regarding capital deployment, as we expect to have a dramatic increase in share repurchase capacity, driven by a reduction of Canadian CapEx of more than $1 billion, meaningful improvement in Canadian segment EBITDA, and continued strong cash flow generation by our US business, with US CapEx essentially flat to 2013. +As of today we expect the combination of factors will allow us to repurchase up to $4 billion of our shares in 2014 while continuing to grow the dividend and maintain our A credit rating. With that, we will conclude today's prepared remarks. Now Gregg, Kathee, and I will be happy to respond to your questions. + + +================================================================================ +Questions and Answers +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) +Greg Melich with ISI Group. + +-------------------------------------------------------------------------------- +Greg Melich, ISI Group - Analyst [2] +-------------------------------------------------------------------------------- + + I wanted to start right with REDcard and traffic. That's a trend this year that has gotten locked in at this down 1% to 1 1/2%, and you gave some goals a few weeks ago where comps would be 2% or better over the next few years. How do you get to the 2% over time if traffic is still down 1% to 1 1/2%? What initiatives with REDcard or anything else do you have to really get that traffic stabilized? + +-------------------------------------------------------------------------------- +John Mulligan, Target Corp - EVP & CFO [3] +-------------------------------------------------------------------------------- + + I will start, Greg. +I think a couple things. One, I think first of all, the stress on low-income consumers is certainly playing a role. We've seen all year long. The payroll tax increase has been a portion of that, for sure. I think we get to cycle past that in January, and we will get better information about what that looks like going forward. +But beyond that, and the things that we actually control, as you said, we continue to see meaningful growth in REDcard. That continues to drive 50% lifts in sales, all of that driven by traffic. Kansas City is above 25% penetration now. So it continues to grow hundreds of basis points a year. +Then beyond that, I think it's all about our multi-channel initiatives, and everything we are doing there. And as I said, we are starting to see strong digital sales growth. That, combined with the flex fulfillment activities that we are implementing now, piloting a little later this year, and we'll begin to roll out next year -- we think all of that put together will continue to drive meaningful traffic increases. + +-------------------------------------------------------------------------------- +Kathee Tesija, Target Corp - EVP Merchandising [4] +-------------------------------------------------------------------------------- + + The only thing that I would add, Greg -- this is Kathee -- is just that, as guests are consolidating their trips and they're coming less frequently, it's really important for us to get them to shop around the store and to buy more. And you do see in our basket that we have been able to accomplish that for the past several quarters as well. So we will stay focused on how do we ensure that we get more of their wallet when they do come. + +-------------------------------------------------------------------------------- +Greg Melich, ISI Group - Analyst [5] +-------------------------------------------------------------------------------- + + A direct follow-up to that. I know that with all the multi-channel initiatives -- and you outlined them all in the call -- how have you changed how store managers and associates are incentivized so that they give the level of service to the online guest that is coming to pick up in-store? Do they get credit for that? Or how should we look for that to be changing going forward? + +-------------------------------------------------------------------------------- +Gregg Steinhafel, Target Corp - Chairman, President & CEO [6] +-------------------------------------------------------------------------------- + + Yes, they do. They get total credit for anything that is bought online, picked up in-store, or things that are in store where there is an extended aisle sale. So we are incenting this. Actually, we have a parallel environment where both teams -- both our dot-com team and our store teams -- get credit for growing the business in a collaborative way. + +-------------------------------------------------------------------------------- +Greg Melich, ISI Group - Analyst [7] +-------------------------------------------------------------------------------- + + Is that -- + +-------------------------------------------------------------------------------- +Gregg Steinhafel, Target Corp - Chairman, President & CEO [8] +-------------------------------------------------------------------------------- + + There is no penalties, or there is no internal conflict at all as it relates to who is going to get that credit for the sale. We are double crediting everybody from an internal standpoint, and then we take it out at the enterprise level to make sure that it all washes through on a consolidated basis. + +-------------------------------------------------------------------------------- +Greg Melich, ISI Group - Analyst [9] +-------------------------------------------------------------------------------- + + Is that true if I have it shipped to my home? + +-------------------------------------------------------------------------------- +Gregg Steinhafel, Target Corp - Chairman, President & CEO [10] +-------------------------------------------------------------------------------- + + If it's shipped to your home from the store, yes. + +-------------------------------------------------------------------------------- +Greg Melich, ISI Group - Analyst [11] +-------------------------------------------------------------------------------- + + Great, thanks a lot. + +-------------------------------------------------------------------------------- +Operator [12] +-------------------------------------------------------------------------------- + + Wayne Hood with BMO capital. + +-------------------------------------------------------------------------------- +Wayne Hood, BMO Capital Markets - Analyst [13] +-------------------------------------------------------------------------------- + + Kathee, just on the average ticket side -- Greg was talking about transactions, but just to get to the ticket -- there has sequentially been a pretty nice acceleration in AUR throughout the year, and you talked a little bit in the third quarter, electronics impacting that with the UPT being down. +As you plan the business into the fourth quarter, would you still expect your AUR to be up 3% and UPT to be down? Or how should we think about the dynamics that's driving average ticket? And also that points to, if AUR is up -- which points people are maybe buying up, you are moving them up -- how do you square that with the consumer that is constrained? + +-------------------------------------------------------------------------------- +Kathee Tesija, Target Corp - EVP Merchandising [14] +-------------------------------------------------------------------------------- + + Most of what is driving it up for the fourth quarter will be those hot categories like electronics that are most popular in the holiday season. And there is a lot of newness there that drive up the average selling price. Think of iPads; think of all the new video game consoles and games, which Target does very well with. And we are really excited about that business for the holiday season. I would anticipate it will continue into the fourth quarter. + +-------------------------------------------------------------------------------- +Gregg Steinhafel, Target Corp - Chairman, President & CEO [15] +-------------------------------------------------------------------------------- + + Think of it more as a change in the mix of what we are selling at this time of year versus trading up within category. + +-------------------------------------------------------------------------------- +Wayne Hood, BMO Capital Markets - Analyst [16] +-------------------------------------------------------------------------------- + + Got it. +And my question related to this, Kathee -- and it gets back to the trip issue. With what you have seen with Cartwheel, what trips is that group -- you've seen an extra trip, and how do you really jump on that at a faster rate to drive trips the way you did with REDcard? + +-------------------------------------------------------------------------------- +Kathee Tesija, Target Corp - EVP Merchandising [17] +-------------------------------------------------------------------------------- + + First, I would tell you it is pretty early. I think we've got about six months in with Cartwheel; but as we mentioned, very excited. We've got over 3 million users right now that are very engaged. I think it is helping trips. I also think it's really helping basket, because they are using Cartwheel in the store on their mobile device, looking for deals on things that they want to buy and they are adding more to their basket. +It is still really early to see trends, but we are very excited about it, and are talking about it more and more. We are going to be using Cartwheel as one of our vehicles to help drive value this holiday season. And hopefully more and more people will hear about it and sign up for it. But we think this is a big success story for us that we can continue to grow. + +-------------------------------------------------------------------------------- +Wayne Hood, BMO Capital Markets - Analyst [18] +-------------------------------------------------------------------------------- + + Thank you very much. + +-------------------------------------------------------------------------------- +Operator [19] +-------------------------------------------------------------------------------- + + Sean Naughton with Piper Jaffray. + +-------------------------------------------------------------------------------- +Sean Naughton, Piper Jaffray - Analyst [20] +-------------------------------------------------------------------------------- + + Great, thanks. I have a couple-part question here on Canada. I think most of them are related. +John, I think you talked about the gross margin being impacted by some inventory issues in Canada late in the quarter. Can you just give us a little bit more color there on what happened there? +And then maybe also outline where are some of the pockets of excess inventory that you are looking to move through? And then, secondly, are there any signs of hope in the business, or glimmers of hope that you can point to, whether it's by region or category, that are going better than expected at this point in that market? + +-------------------------------------------------------------------------------- +John Mulligan, Target Corp - EVP & CFO [21] +-------------------------------------------------------------------------------- + + There is always hope, Sean. We are highly confident (laughter) it is going to be successful. +Your inventory question -- we talked a lot last time about, given the sales shortfall and the fact that we planned inventories to protect on the upside; given all the excitement, there's a pretty large inventory overhang. As the teams have worked hard over the past 90 days assessing the best way to handle that -- and it depends on the various categories about the best way to handle that -- we have clearly seen some markdowns come through. We're taking advantage of that, actually, to drive value messaging in Canada and get across how sharp our prices are. +And then we are also assessing what of the inventory do we think we're going to sell ultimately below cost or end up salvaging because there's just flat out too much of it. And that is the inventory reserves that we assess at the end of the third quarter. We do that every quarter anyway as a matter of course, and we will do that again at the end of the fourth quarter. But that was a large piece of what happened at the end of the third quarter. +I think as far as lumpiness of inventories -- as you would expect it's the long-lead categories where we tend to be lumpy. The stuff that turns quicker or that is domestically sourced we can obviously shut down receipts much quicker. But stuff that is long-lead -- and we will see this continue actually a little bit into spring -- and here think about categories like bikes, where those are a long-lead items, and it just -- we can't get out of the receipts once we have made commitments. Those are the type of items that will take us a little bit longer to clear through. +I think on signs of hope -- we wouldn't call it hope -- but on signs of our execution starting to improve, we are seeing -- and I think this is consistent with what Gregg said -- as we start to get sales histories, we can start to replenish stores more accurately, balance our inventories, and meet guest need when they need that. We are starting to see success there. As we look at our current results, we're pretty much hitting our current forecast, but we are seeing much stronger results in the cycles that have been open longer. Cycle one, cycle two, cycle three have actually begun to exceed our expectations a bit. +We're a little bit hopeful -- not hopeful; we are optimistic that we are seeing the right trend with those cycles improving. And we believe we will continue to see that as we get more age behind the cycle four and cycle five stores. + +-------------------------------------------------------------------------------- +Sean Naughton, Piper Jaffray - Analyst [22] +-------------------------------------------------------------------------------- + + That is helpful, thank you. +And then just secondly on the, in terms of expense optimization in the US business, looks you guys did a great job of controlling that there in Q3 -- maybe even below what you would expect moving forward. Do you feel like you're in the right position now there? What type of comp do you feel like you need right now to leverage that SG&A moving forward, maybe in Q4? And then the first half of 2014? Thank you. + +-------------------------------------------------------------------------------- +John Mulligan, Target Corp - EVP & CFO [23] +-------------------------------------------------------------------------------- + + I think our efforts on expense optimization continue to be very successful. The teams are very engaged across the Company and continuing to look for new ideas of ways that we can reduce expense. And I think part of this is about lowering our center of gravity that you are referring to. +But a big part of it, too, is reinvesting that in other parts of the business. You have really seen that this year. We had significant incremental investments in technology, supply chain. That will happen again next year, particularly around technology and flexible fulfillment. We will make SG&A investments, and expense optimization really allows us to offset that. I think leverage probably hasn't changed a whole lot -- somewhere between that 1% and 2% range -- but it gives us a lot of capacity to invest in the business as we continue to grow our multi-channel capabilities. + +-------------------------------------------------------------------------------- +Sean Naughton, Piper Jaffray - Analyst [24] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Operator [25] +-------------------------------------------------------------------------------- + + Matthew Fassler with Goldman Sachs. + +-------------------------------------------------------------------------------- +Matthew Fassler, Goldman Sachs - Analyst [26] +-------------------------------------------------------------------------------- + + Good morning. My first question relates to Canada. +What kind of insight can you give us into the average number of stores opened over the course of the quarter as it relates to timing of openings? Just to give us the ability to measure an accurate sales productivity number. We have (inaudible) to try to get sales per store and sales per foot, but the growth is moving so quickly on such a small base that it is very easy for those numbers to get distorted. + +-------------------------------------------------------------------------------- +John Mulligan, Target Corp - EVP & CFO [27] +-------------------------------------------------------------------------------- + + We agree with the last part of that comment, and we have continued to say it's very early here, and we are going to see it move around again in the fourth quarter, given we see the surge in holiday sales. I don't have the exact weighted average on the store timing, Matt, but John Hulbert will get that to you -- we can get that to you today. + +-------------------------------------------------------------------------------- +Matthew Fassler, Goldman Sachs - Analyst [28] +-------------------------------------------------------------------------------- + + That would be very helpful. + Second question I would ask relates to the electronics business. Clearly, the video cycle is here and is very prominent, and I know that mobile is still a relatively new business for you. If you look at the legacy consumer electronics businesses, and you mentioned tablets -- I know you had a fairly high profile promotion recently, and TV, and other businesses that have less industry-wide going on year on year. What has your experience been in those categories? Or what was it for the third quarter and what's your sense of the promotional environment here in Q4? + +-------------------------------------------------------------------------------- +Kathee Tesija, Target Corp - EVP Merchandising [29] +-------------------------------------------------------------------------------- + + Matt, I would say it's strong overall. Certainly that varies by category, but there are a lot of great trends in our business in electronics. I mentioned a couple that we are excited about for Black Friday and going into Cyber Monday and the rest of the holiday season. +Things like Beats by Dr. Dre -- the whole headphone category had been fantastic, and that's a lead item. Speaker systems like Sonos have been fantastic. So there are many different categories that are performing well. Some are little bit softer, like cameras, but in total, a really strong business in electronics right now. + +-------------------------------------------------------------------------------- +Matthew Fassler, Goldman Sachs - Analyst [30] +-------------------------------------------------------------------------------- + + Okay, thank you so much. + +-------------------------------------------------------------------------------- +Operator [31] +-------------------------------------------------------------------------------- + + Chris Horvers with JPMorgan. + +-------------------------------------------------------------------------------- +Christopher Horvers, JPMorgan Chase & Co. - Analyst [32] +-------------------------------------------------------------------------------- + + Thanks, good morning. +Wanted to follow up on the Canadian and gross margin, and just your thoughts about how that proceeds going forward. I think originally you had talked about the Canadian gross margin being above the US. I always interpret that as maybe a couple hundred basis points above the US rate. But you have these competing factors right now where the markdown pressure is a negative, but the mix factor is a positive. +As you look into the crystal ball, how do think -- how might -- are your gross margin expectations shifting, based on those two competing factors over what the long-term opportunity could be, relative to the your original expectations? + +-------------------------------------------------------------------------------- +Gregg Steinhafel, Target Corp - Chairman, President & CEO [33] +-------------------------------------------------------------------------------- + + Hi Chris, this is Gregg. + Over the long term our expectations haven't changed at all. What we're experiencing now, and as John talked about it, it is those long lead time businesses that are mark-down sensitive, particularly home and apparel, that we have to exit and it is costly to do so. +Remember, the first cycle stores did not open until April, and the second cycle followed shortly after that. And that was only a handful number of stores. By the time we really got a good clear indication in terms of where the sales were going to level out for this year, in our long-cycle businesses -- and think six, seven, eight months -- these receipts were already planned and in production and on the way. +It's really the lump of inventory that we've got to work through, and once we do that, we are very confident that we are going to be back in the mid-30%s like we talked about in terms of the overall gross margin, because the mix continues to be strong, and we are very pleased with that. We don't see any signs of that abating. +It might come down a little bit as we get more aggressive in terms of building that trip frequency. And we will start those efforts in earnest when we turn the corner in 2014. But on an absolute basis, we are really pleased with where we are in home and apparel, and we've got to get through this next quarter and the early part of the beginnings of 2014 until we really get that sales history developed by item, by store and eliminate some of the huge variability that we have in the supply chain so that we can get a more even balance between receipt flow and what we are selling. And at that point in time, we fully believe that we are going to be back to where our initial expectations were from a gross margin standpoint. + +-------------------------------------------------------------------------------- +Christopher Horvers, JPMorgan Chase & Co. - Analyst [34] +-------------------------------------------------------------------------------- + + And then you mentioned that some of the early-cycle stores were starting to exceed your expectations a bit. I had a really interesting chart at the Analyst Day that talked about where the expected ramp in the stores initially versus where it is sitting now. +Could you just reference for us what you mean by exceeding your expectations a bit? Is that versus your original expectation on first-year sales versus what you rethought? + +-------------------------------------------------------------------------------- +Gregg Steinhafel, Target Corp - Chairman, President & CEO [35] +-------------------------------------------------------------------------------- + + These are against the new, most recent level-setting expectations that we shared that at the Analyst Day that said they are not where they were when we originally planned the business, but now that we have had enough experience, we see where they were and we established and rebooted, essentially, our expectations for Canada. +So against that new, most current forecast, what we are seeing is encouraging signs out of those earlier-cycle stores. They are exceeding these newer, revised forecasts more than the later-cycle stores because they have had a chance to operate on their own. They are six months into it now. The inventories are flowing better; in-stock levels have improved; the guest is getting used to our stores; they are converting from more of a browser to a shopper. It is still very early, but we like what we see in some of those early-cycle stores. And so at this stage we are just encouraged by the fact that they're performing better against most revised, revised forecast. + +-------------------------------------------------------------------------------- +Christopher Horvers, JPMorgan Chase & Co. - Analyst [36] +-------------------------------------------------------------------------------- + + And then one quick last one -- can you share with us what your share in the gaming category is in the US? + +-------------------------------------------------------------------------------- +Kathee Tesija, Target Corp - EVP Merchandising [37] +-------------------------------------------------------------------------------- + + I don't know that number off the top of my head. It is definitely higher than our typical market share, but we can get back to you with that number. + +-------------------------------------------------------------------------------- +John Mulligan, Target Corp - EVP & CFO [38] +-------------------------------------------------------------------------------- + + Yes, it's much higher than our aggregate store or electronics market shares. + +-------------------------------------------------------------------------------- +Christopher Horvers, JPMorgan Chase & Co. - Analyst [39] +-------------------------------------------------------------------------------- + + Okay, appreciate it, thanks. + +-------------------------------------------------------------------------------- +Gregg Steinhafel, Target Corp - Chairman, President & CEO [40] +-------------------------------------------------------------------------------- + + We will get back to you on that one. + +-------------------------------------------------------------------------------- +Operator [41] +-------------------------------------------------------------------------------- + + Jason DeRise with UBS. + +-------------------------------------------------------------------------------- +Jason DeRise, UBS - Analyst [42] +-------------------------------------------------------------------------------- + + Can I ask about the comps? I just want to get your thoughts on a few of these items, if you would quantify them. So one is how much of the shift from the timing of the calendar between Q3 and Q4 in your reporting benefited the current quarter that was reported and pulled forward from Q4? +And then get your thoughts about, if you think there's any impact on comps from SNAP, whether that is directly in your food sales or your general merchandise sales? If you'd quantify what kind of uplift you expect from video games? And also one thing that didn't come up yet -- but lower fuel prices, how you're thinking about that? + +-------------------------------------------------------------------------------- +John Mulligan, Target Corp - EVP & CFO [43] +-------------------------------------------------------------------------------- + + That's a lot of questions. +On the third quarter, I think clearly Halloween moving into the quarter benefited. I would remind you that we also said at the end of last quarter, our back-to-school week moved out of the quarter into second quarter. That benefited second quarter. Net/net, probably a wash, maybe 10 plus/minus --10, 20 basis points, I don't really know -- but net/net a wash. +WIC -- any time there is a decrease like that, there is an impact. But for us, grocery, food is about 20% of our business roughly; and it's a very different kind of trip for us than most grocers. So certainly there is an impact. But for us, meaningfully, that is just not -- again, this is a small impact relative to what we might see at other retailers who sell significantly more food as a percentage of their business than we do. +And then electronics -- what was the question in electronics? I'm sorry. + +-------------------------------------------------------------------------------- +Jason DeRise, UBS - Analyst [44] +-------------------------------------------------------------------------------- + + I guess the video game cycle itself. What kind of comp uplift you would expect just from that? And the last part of that was about fuel prices coming down -- if you see that as a benefit for yourselves or not? + +-------------------------------------------------------------------------------- +Kathee Tesija, Target Corp - EVP Merchandising [45] +-------------------------------------------------------------------------------- + + We don't necessarily talk about categories and how big they are. But with two new console releases and all the games that will go with them -- as you know it has been a declining category for several years, given the maturity. It's been over seven years since we had a new console. So having two in the same year is very meaningful for the category. It is also very meaningful for electronics in the store. So we think its going to be one of the biggest gifts gifting categories of the year, and we will certainly benefit from that. + +-------------------------------------------------------------------------------- +Gregg Steinhafel, Target Corp - Chairman, President & CEO [46] +-------------------------------------------------------------------------------- + + And then on fuel, there is no question that in a time when, particularly lower income consumers have very constrained budgets, having to spend less on fuel, it helps in some way. For us, I will tell you, through time we have looked at this many ways and it's really hard to quantify fuel price moves in our sales. There are times when fuel prices are going up in a good economy, and that is good for everybody, which is different than today. It's hard to quantify, but overall, lower fuel prices is definitely good for consumers. It just puts more money in their pocket. + +-------------------------------------------------------------------------------- +Jason DeRise, UBS - Analyst [47] +-------------------------------------------------------------------------------- + + If I can ask one more about comp trends. The apparel part of the business -- it sounds like the branded stuff is going well for you. Can you talk about your private label trends in apparel? Is that maybe where some of the weakness is? What you're doing to try to turn that around? + +-------------------------------------------------------------------------------- +Kathee Tesija, Target Corp - EVP Merchandising [48] +-------------------------------------------------------------------------------- + + Apparel, I think, was -- most of what we have is own brand product and exclusive designer partnerships that we do. So that is the bulk of our business. Certainly we do a lot of basics with branded manufacturers -- Haynes for example. +But our comp in apparel was down slightly. It was much stronger online. So we are seeing some shifting happening there. We are pleased with the new releases that we have had. Phillip Lim was probably our best designer launch ever -- very clean sell-throughs, both in stores and online. Our launch of our holiday product is off to a good start, while it is still early. +We're feeling pretty good about apparel overall. I would say that the softest part of apparel has been in kids. And we are working on ways to make sure that we can drive that business and have the right price/value relationship for our guests to help drive better market share gains. But the rest I feel pretty confident in. + +-------------------------------------------------------------------------------- +Jason DeRise, UBS - Analyst [49] +-------------------------------------------------------------------------------- + + Okay, thank you. + +-------------------------------------------------------------------------------- +Operator [50] +-------------------------------------------------------------------------------- + + Paul Trussell with Deutsche Bank. + +-------------------------------------------------------------------------------- +Paul Trussell, Deutsche Bank - Analyst [51] +-------------------------------------------------------------------------------- + + Good morning. +Just looking at the US business from a gross margin standpoint. If we exclude the vendor agreements accounting shift, I think gross margins would have been down about 50 basis points year over year. Can you prioritize, or rank for us the impact from markdowns versus category rate pressures and other factors? And just how we should think about that going into the fourth quarter, given the promotional intensity? + +-------------------------------------------------------------------------------- +John Mulligan, Target Corp - EVP & CFO [52] +-------------------------------------------------------------------------------- + + The 50 basis points is about right. And I would say about half of that was due to the ongoing pressure we have seen for several years now related to REDcard and the store remodel program. +The other half, like we talked a little bit about, was really related to markdowns we took, given the Halloween sell-through that we saw. And we saw sales soften up, like we said, in the middle of the quarter, given everything that was going on with consumer confidence and in Washington. We saw sales soften up a bit, and really just some promotional markdowns to sell through our Halloween inventory. I think as we think about fourth quarter, as we talked about, it's going to be very promotional; there's no doubt about that. But the primary driver of our performance versus last year is, last year we took significant clearance markdowns last year, and that's what you'll see be the primary variance year over year in our gross margin rate. + +-------------------------------------------------------------------------------- +Paul Trussell, Deutsche Bank - Analyst [53] +-------------------------------------------------------------------------------- + + Okay, so improved performance on gross margin in 4Q versus 3Q experience? + +-------------------------------------------------------------------------------- +John Mulligan, Target Corp - EVP & CFO [54] +-------------------------------------------------------------------------------- + + Yes. + +-------------------------------------------------------------------------------- +Gregg Steinhafel, Target Corp - Chairman, President & CEO [55] +-------------------------------------------------------------------------------- + + Absolutely. + +-------------------------------------------------------------------------------- +Paul Trussell, Deutsche Bank - Analyst [56] +-------------------------------------------------------------------------------- + + Got it. +And then lastly, on Canada, you mentioned that there was a lot of markdowns in inventory. Is some of the gross margin hit also related to price investments being made in certain categories? If you can just give us an update on that, along with a reminder, John, on what the drag was from start-up expenses in Canada this year. + +-------------------------------------------------------------------------------- +John Mulligan, Target Corp - EVP & CFO [57] +-------------------------------------------------------------------------------- + + We haven't disclosed the drag from start-up expenses all year long. So we haven't really talked about that a whole lot. As it relates to price investment and markdowns, I think it is all -- we view that as all one big bucket, really; and it's really the total value message we are able to give to the guests in Canada right now. As I said, we have a little bit of excess inventory. We will take advantage of that. To be sure, we are giving a great value message. +But beyond that, as we look at our pricing in Canada on like items, we are right on where we want to be. We are locally competitive and right on the price leaders in Canada. So we feel really good about our pricing in Canada on like-for-like items. + +-------------------------------------------------------------------------------- +Paul Trussell, Deutsche Bank - Analyst [58] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Gregg Steinhafel, Target Corp - Chairman, President & CEO [59] +-------------------------------------------------------------------------------- + + Great. That concludes Target's third-quarter 2013 earnings conference call. Thank you all for your participation. + +-------------------------------------------------------------------------------- +Operator [60] +-------------------------------------------------------------------------------- + + Thank you. This concludes today's conference call. You may now disconnect. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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Earnings Conference Call +10/11/2013 08:30 AM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Jamie Dimon + JPMorgan Chase & Co. - Chairman & CEO + * Marianne Lake + JPMorgan Chase & Co. - CFO + +================================================================================ +Conference Call Participiants +================================================================================ + + * Matthew O'Connor + Deutsche Bank - Analyst + * Guy Moszkowski + Autonomous Research LLP - Analyst + * Mike Mayo + Credit Agricole Securities - Analyst + * David Hilder + Drexel Hamilton - Analyst + * Gerard Cassidy + RBC Capital Markets - Analyst + * Betsy Graseck + Morgan Stanley - Analyst + * Derek De Vries + UBS - Analyst + * Moshe Orenbuch + Credit Suisse - Analyst + * Glenn Schorr + ISI Group - Analyst + * Matt Burnell + Wells Fargo Securities, LLC - Analyst + * John McDonald + Sanford C. Bernstein & Company, Inc. - Analyst + * Jim Mitchell + Buckingham Research Group - Analyst + * Erica Najerian + BofA Merrill Lynch - Analyst + * Chris Kotowski + Oppenheimer & Co. - Analyst + * Jeffery Harte + Sandler O'Neill & Partners - Analyst + +================================================================================ +Presentation +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Good morning, ladies and gentlemen, welcome to JPMorgan Chase's third-quarter 2013 earnings call. This call is being recorded. Your line will be muted for the duration of the call. +We will now go live to the presentation. Please stand by. At this time I'd like to turn the call over to JP Morgan Chase's Chairman and CEO, Jamie Dimon, and Chief Financial Officer, Marianne Lake. Ms. Lake, please go ahead. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [2] +-------------------------------------------------------------------------------- + + Thank you. Good morning, everyone. I'm going to take you through the earnings presentation, which is available on our website. Please refer to the disclaimer regarding forward-looking statements at the back of the presentation. +The firm made a net loss of $380 million for the third quarter, on the back of very significant litigation expenses, so I want to take you first to page 2. We've added this page for this quarter only as we want to be as transparent with you as we can be, and give you as complete a picture as possible of our litigation reserves, and a current perspective on the evolution of our reasonably possible range of losses in litigation. And as you know, as transparent as we would like to be, we are necessarily constrained in what we can actually say. +Having said that on page 2, I'll start by saying that we appreciate the litigation expense of $9.2 billion is much more significant than you've been expecting. It's much more significant than we expected, until very recently. The reality is that over the last few weeks, the environment has become highly charged and very volatile. Things have been very fluid, and the situation escalated to the point where we're facing very large premiums and penalties, the level of which has gone far beyond what we reasonably expected; however, those are the facts we're dealing with today in our reserving actions this quarter and are trying as far as possible to put these issues behind us. +So let me quickly take you through the table on the top of page 2, which is a roll forward of our reserves. We started 2010 with $3 billion in reserves, added around $28 billion through the third quarter, including the actions this period, and have settled a little less than $8 billion across matters, which leaves us with $23 billion approximately of ending reserves, which relates to a broad range of matters, and includes a significant reserve for mortgage-related matters, including both securities and repurchase litigation exposure. Remember our GSE repurchase reserves of over $2 billion are separate from this. +The balance at quarter-end reflects the $9.2 billion we're expensing this quarter. This expense also covers a range of matters, including but not limited to mortgage backed securities. And the impact to net income you can see is high, as it's being affected by a portion of the expense estimated to relate to enforcement penalties, which would not be tax deductible. Again, these estimates relate to a number of cases, including among other things, mortgage, as well as the recently-announced CIO settlements. We do expect litigation expenses to normalize over time to much lower levels, but they may be somewhat lumpy quarter over quarter. +Finally on this page, we've included a table, which shows a revised range of reasonably possible losses, and those are losses that would be in addition to our reserves, and remember, it's pretax. It's very important to emphasize that when estimating this range, it's difficult, and there are significant inherent uncertainties and judgment required. As you can see, this was estimated at $6.8 billion last quarter, and while the range has gone down versus last quarter, its only gone down modestly in comparison to the reserve adds. +Think of it simply as the estimate of what was reasonably possible back in the second quarter reflected our best assessment of the environment we were in, and our best judgment at that time. But as I said, we didn't, even a few weeks ago, reasonably expect things to have escalated to where they are now, so we have therefore revised our range to better reflect the reality of this current environment, with a range of up to $5.7 billion. Before we go back to page 1, just a final comment, as we said in the press release, the Board and senior management continues to seek fair and reasonable settlement with the government on mortgage related issues, but at this time, we're unable to report on any specifics. +So just flipping back to page 1, and just to finish off the front page, the other significant item we've highlighted on the page is the combined $1.6 billion of loan loss reserve releases for the consumer businesses, and if you add the two significant items in the table, which we don't consider to be core to our earnings, they total a loss of $6.2 billion, and $1.59 of EPS to the negative. If you adjust our results for these two non-core items, we would have earned $5.8 billion and an EPS of $1.42 with a return on tangible common equity of 15%, and that's not to discount the items, but rather to show the strength of our underlying performance. +The businesses showed double-digit growth in key drivers, as well as market share gains in consumer and CIB, in banking and market. For the second consecutive year, we lead the nation in deposit growth, up 10%, credit card sales volumes were up 11%, and we maintained our number one IDC ranking, with 130 basis points increase in market share, and asset management saw $19 billion of long term net inflows, the 18th consecutive quarter. +So turning with that to page 4 and the detail of our balance sheet and capital. First, after allowing for dividends and repurchases, our capital declined in the quarter by approximately $2 billion. As a result, our Basel III Tier 1 common ratio remained flat at 9.3% quarter over quarter, with a decline in capital being offset by lower risk-weighted assets, primarily driven by legacy portfolio run-off. We're targeting 9.5% by the end of this year, and still aiming to run at about a 50 to 100 basis point buffer above this level over time, and our 2014 CCAR submission will take both these targets into consideration, as well as maintaining the flexibility to increase dividends and to repurchase shares. And just a note, our Basel III ratio under the advanced approach is currently lower than under the standardized approach. +An update then on leverage. The firm-wide supplementary leverage ratio under US rules remains at 4.7% this quarter, and similarly, the bank leverage ratio remains at 4.3%. And as you know, comment letters were provided recently relating to both the US NPR as well as Basel proposals, which included requests for revised treatment for certain assets and exposures, and we don't know what the outcome of the final rules will be, but it's possible there will be some things to improve those numbers. Finally, we remain compliant with LCR this quarter, and have HQLA of over $530 billion, with around $350 billion in cash at central banks. And as you know, we resubmitted our CCAR at the end of September, and expect to receive feedback from the Fed in early December. +So now let's turn to business performance, and while the environment has been and continues to be very challenging, remember that there are more than 250,000 people in this Company focused day-in and day-out on serving our customers and communities. So with that on page 5 I'll start with Consumer & Community Banking. The combined consumer businesses generated $2.7 billion in net income for the quarter, on $11 billion of revenue, and with an ROE of 23%. As expected, we've seen a sharp drop in mortgage banking origination volumes and margins that's impacted noninterest revenue in the quarter. +But taking a look at the franchise, we ended the quarter with over 5,600 branches, over 19,000 ATMs, and 1,900 Chase Private Client locations. And we continue to see really strong growth in the underlying drivers for the consumer businesses. Average deposits were up $40 billion year on year, an increase of 10% and for the second year in a row, we lead the FDIC survey with the highest deposit growth, and a growth rate more than twice the industry average, with that strength being broad based across markets. We're number one in our three largest markets and we gained share in 20 of the 25 largest markets. Our active mobile customer base grew by 30% year on year. +We had record credit card sales volume of $107 billion, up 11% year on year, and outperforming the industry for the fifth consecutive year. This quarter also had record client investment assets of $179 billion, up 16% year on year, reflecting strong positive momentum of the Chase Private Client initiative, as well as overall higher market levels. And to close a moment on expenses, which were down $89 million year on year primarily due to lower mortgage banking expenses, and across CCB, we will have reduced headcount by over 15,000 for the full year of 2013. +Turning to page 6, consumer and business banking. Generated net income of $762 million, and an ROE of 27% on net revenue of $4.4 billion, up 2% year on year, and 3% quarter on quarter. Net interest income is up 3% quarter on quarter, driven by the strong growth in deposits I mentioned, partially offset by spread compression. But for the first time in about three years, the deposit margin has not declined quarter over quarter, meaning that rate compression is being offset by higher reinvestment rates. And at current market rates we would expect, all other things being equal, for our deposit margin to be relatively stable in the medium term. +On the noninterest revenue side, we continue to see strong growth in both debit and investment revenue. Expenses are up year on year, reflecting the investments we've made in the business, including Chase Private Client, as well as costs related to strengthening control and compliance. In a minute on business banking, you can see loan balances are flat quarter over quarter, up 2% versus last year, and production levels have stabilized at around these levels with a healthy pipeline in that context. +Turning to page 7 and the mortgage bank. Overall mortgage banking net income was around $700 million, with an ROE of 14%. And the short story here is significantly lower production income offsetting higher reserve releases, but if you start at the top with production pretax, we guided you that production pretax margins would be slightly negative in each of the third and fourth quarters. Excluding repurchases, you can see that's the case for the third quarter, with a net loss of $85 million or a net negative 21 basis points of pretax margin. As you see, revenues are down over 50% quarter on quarter. This reflects both a reduction in lots, and the impact of a mix change, together driving 120 basis points of revenue margin compression in the quarter. While lots were down 40%, quarter on quarter closed loan volumes were down 17%, reflecting a pull through of the second-quarter pipeline. +And although you do see that our expenses are down some, around 7%, this reflects primarily the transaction level variable costs. We have taken appropriate actions this quarter to adjust capacity, which will fully hit our run rate and exit Q4. On the positive side, our purchase volumes continue to increase and purchase mix was nearly 50% of loans this quarter, up from 35% last quarter. +Moving on to servicing, a loss of $226 million pretax excluding MSR risk management. Lower revenues were down due to a couple of items, including the exit of lender place reinsurance. While on an adjusted basis, the servicing revenue would have been up slightly, reflecting the impact of higher rates. Also, servicing expenses were $858 million for the quarter, including approximately $200 million of foreclosure-related matters. If you adjust for this, our core expenses would have been around $650 million, on track for approximately $600 million in the fourth quarter as we guided at Investor Day. Finally, you see the MSR showed a modest loss this quarter of $180 million, which includes a negative $120 million due to further HPI improvement, which is also driving higher reserve releases in the real estate portfolios. +So on to the real estate portfolio, pretax income of $1.5 billion includes net charge-offs of a little over $200 million, with charge-offs expected at around that same level next quarter. As expected, a continued reduction in delinquencies, but importantly improvement in HPI drove severity down in both NCI and PCI portfolios, which led us to release a combined $1.25 billion of reserves this quarter. +Turning the page to page 8, will be card, merchant services, and auto. Revenue of $4.6 billion was down slightly year on year and quarter on quarter, as a result of spread compression, despite strong sales volumes. With net income of $1.2 billion, up 29% year on year, and an ROE of 26%, excluding reserve releases, which reflects strong and consistent growth in sales and interchange revenue. +In card, year over year growth in both sales and merchant processing volumes, was consistent and strong, at 11% and 14%, respectively, and we saw a slight increase in average outstandings quarter on quarter. Expenses are flat year over year, and down a little quarter over quarter, but the second quarter included a one-time item. The net charge-off rate has reached historic lows at 2.86%, which is down over 70 basis points year on year, and we released $350 million of loan loss reserves this quarter. We expect an additional $150 million of reserve releases next quarter, consistent with our guidance for the second half of the year. Before we move on, a few things on auto, with originations up 2% year on year, and balances 4% year on year. And despite higher rates leading to increased competitive intensity, we are still expecting growth in the fourth quarter year over year. +Moving on to slide 9, the corporate & investment bank. We had very strong performance in CIB, with net income of $2.2 billion and an ROE of 16%, despite being a seasonally weaker third quarter and including a DDA loss of nearly $400 million. As usual, we'll focus on the numbers, excluding DDA. We had net income of $2.5 billion on revenues of $8.6 billion, and an ROE of 17%. In banking, total revenue was $2.9 billion, and we maintained our number-one ranking in global IB fees with $1.5 billion, up 6% year on year. We were up in a market that is down overall in wallet, and captured 130 basis points of wallet share over last year. Our market share gains were significantly larger than any of the other top 10 players, and supported by landmark transactions like Verizon. +I'll take a second to just give you some color on the strong competitive performance in ECM this quarter. We're number one year-to-date in terms of wallet, gaining 140 basis points a share, and this quarter, we're number one in volume, number one in wallet, and number one in deals. +Moving on to markets, $4.7 billion of revenue, down 2% year on year, versus a strong third quarter last year, in line with our guidance that we provided at Barclays. Fixed income markets revenue of $3.4 billion was down 8% year on year, but remember, the third quarter of 2012 did include modest losses in the synthetic credit portfolio. Equity markets revenues of $1.2 billion were up 20% year on year, with broad based strength across cash and derivatives and across regions. Security service revenue of $1 billion was up 3% year on year, with growth in custody and fund services, partially offset by lower agent lending spreads. And credit adjustments and other have a negative $409 million, with almost entirely DDA. +Expenses of $5 billion were down 7% year on year, primarily driven by comp, with a comp to revenue ratio of 27% for the quarter. Loans were down slightly primarily due to trade finance, and finally, average CIB VaR remained relatively flat quarter over quarter, at $45 million. The current quarter continues to reflect historically low levels of volatility, as well as continued risk reduction. +I'll skip page 10 and take you to page 11 and the commercial bank. The quarter saw net income of $665 million on revenue of $1.7 billion, with an ROE of 20%. Revenues were flat year on year and quarter on quarter, reflecting pressure on NII, offset by favorable franchise trends. Spreads compressed in the quarter 5 basis points or so, from the relatively stable landscape in the last few quarters across most client segments and geographies, and given the environment, it's likely spreads will continue to be under some pressure. +In terms of loan balances of $135 billion, up 9% year on year, and 3% quarter on quarter. This remains a tale of two cities. The commercial real estate business continues to grow strongly, up 4% quarter on quarter with loan growth outpacing the market and growing every month for the last 13 months. Multi-family fundamentals are very strong and traditional commercial real estate is building momentum, with both CRE and multi-family pipelines remaining robust. However in C&I, demand remains soft and competitive pressures high, the combination of which has continued to drive relatively flat C&I loans in the quarter, and we continue to focus on quality over growth. Every day we're adding new quality clients, clients with whom we expect to do lots of business over decades to come, and we've added over 600 of these clients year-to-date. +And aside from lending, we continue to cross-sell our existing clients, so evidence that growth IB revenues were a record $448 million for the quarter, up 16%. Before we leave CB, two final points. Expenses were up 10% year over year reflecting higher products and headcount expenses as we invest in front office and controls, and credit reflected a relief this quarter as the risk profile of the portfolio continues to improve. +Page 12 and asset management. Another very strong quarter for asset management, with net income of $476 million, up 7% year on year, and an ROE of 21%. Revenue was $2.8 billion, up 12% over last year, and while overall higher market levels did help, very strong fund performance and flows drove the story. 74% of our Mutual Fund AUM is ranked in the first or second quartiles of performance over five years, and we saw $19 billion of long term net inflows. This is the 18th consecutive quarter of long term net inflows. Importantly, we saw this in every single long term asset class from every region, and it's brought our year-to-date long term flows to $74 billion, which compares to just less than $60 billion for the full year of 2012. +We ended the quarter with AUM of $1.5 trillion, up 12% year on year, and in banking, we continued to see deposit and loan growth across-the-board. And while we expect loan growth to continue to be relatively strong, it's likely to be somewhat lower in Q4, given the lower mortgage pipeline. Expenses increased 16% year on year as we continue to grow and invest in client advisors, and looking forward, we expect long term flows to remain positive, and the breadth of our platform to enable us to grow our business and continue to sustain strong trends. +Moving on to page 13, corporate and private equity. A total net loss of $6.5 billion for the quarter, but breaking it down into its constituent pieces, private equity generated net income of $242 million, reflecting gains on certain investments in our $9 billion portfolio. Treasury and CIO showed a net loss of around $200 million, but you'll see that the $261 million of negative NII this quarter is lower than the run rate seen over the last several quarters, which reflects the impact of higher rates, specifically higher yields quarter over quarter, driven by mortgages and reinvestment in munis. +In the quarter we deployed $32 billion gross in new investments, primarily agency mortgages and munis, including $5 billion of agency mortgages, which we've classified as held to maturity. As we continue to reinvest, if you follow the forward curve, you should expect NII to continue to improve the CIO Treasury over the next several quarters. And finally, although AOCI ended up relatively flat quarter over quarter, or even up slightly, we did obviously see significant volatility during the quarter. +The other corporate net loss of $6.5 billion is driven by the $9.2 billion pretax or $7.2 billion aftertax for litigation expense in the quarter. If you exclude litigation, results for the quarter did include a few positive tax adjustments totaling around $500 million, relating to prior period adjustments, settlements, resolutions and reserve changes, mostly BAU items. +So finally, page 14 and our outlook. We've covered most of the outlook going through the presentation, but just a couple of things I would highlight. As expected, our firm-wide NIM, core NIM, and NII were relatively flat this quarter, and given market rates, we expect relatively flat NIM and NII in the near term. The Firm is positioned to benefit from a higher rate environment, and we are starting to see that in our results. +Turning to expenses, we expect adjusted expenses in the full year to be between $59.5 billion and $60 billion, as we continue to invest in controls and compliance. Overall our businesses are delivering in terms of leadership growth and financial performance, with double digit growth in key business drivers, as well as market share gains. And as I said, excluding corporate litigation and releases, we returned a 15% return on tangible common equity. I'll hand it over to Jamie who will go through the final slide. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [3] +-------------------------------------------------------------------------------- + + Great, Marianne. Thank you very much and hello everybody. So I'm going to just talk a little bit about things on page 15, because a lot of questions were getting asked about it. +It's the three columns, I'll do each one shortly. First, simplifying our business. If you look at what we're doing, we're spinning off one equity partner, selling physical commodities and we closed down a bunch of business lines. I think it's a core business principle to always simplify your business, and to focus on where you can really win. It's a little more amplified this time, because obviously there's a new regulatory environment, capital, and we need to focus a lot of our management mindset on controls. You also, on that first column, you see we're derisking. We're trying to meet new standards we set for ourselves and the regulators wanted to set, to reduce risk to our Company, particularly on anti-money laundering. It will have a revenue effect, so my guess is if you ask, probably a couple hundred million dollars across all of our businesses. +The middle column shows you the investments we're making in control. We want to be best-in-class. We want to get to Six Sigma. Its become the number one priority. Just give you an idea, we're going to spend about $1 billion more, and but that's not the effort. The real effort to think about is how much resource we directed to get this right, and there are unprecedented work streams, like 500 people working on CCAR, 500 people working on resolution recovery, we just turned in, a believe it or not 100,000 page plan. We've added 5,000 people, and so this is a permanent investment, these costs aren't going to go away, and it's important we get this exactly right. +If you look at the right-hand column, I want to go down that one by one. So I just mentioned it is permanent cost structure will stay in place, but our overhead is very competitive, we're very rigorous in expenses, and we intend to stay that way. So you shouldn't expect to see tremendous increase in our expense base. While we simplified our business, it does not really affect our core businesses, our core products, so Marianne went through the four business lines, it's not going to affect our ability to be extremely competitive. Our fortress balance sheet is intact, and as you know, critically important to us. The high levels of capital liquidity will ultimately affect pricing to clients, but we'll also be able to push down and optimize across the globe effectively, as we adjust to the new global financial architecture. +I think it's important to point out that we do have to adjust to a new global financial architecture. It's not just the consentor, there's really rules around the world. We're working hard to do that. We think we will be able to do that, but we go into that with excellent franchises, good underlying growth, and a pretty good long term outlook, because while we operate in violent and volatile businesses around the world, markets go up and down, the underlying growth of asset management, equity, debt, capital markets, global multi-nationals, US consumer needs, middle market needs in the US, will be growing over time. So we think we're in a very good place to serve them. +Our people really have done an outstanding job persevering and performing through these difficult times, and you can go back and say its been over five or six years. If you came to the building, I know a lot of you have, you see the employee morale is very high, and hopefully will stay there. +And then the last thing, at Investor Day, since a lot of new rules, they won't be completely finalized but we'll know most of them, we'll be able to give you a lot more of an update on how we think this affects our businesses going forward. We're pretty optimistic we'll be able to continue to build a great Company. So we'll stop there, and open the floor to questions. + + +================================================================================ +Questions and Answers +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) +Our first question comes from John McDonald of Sanford Bernstein. + +-------------------------------------------------------------------------------- +John McDonald, Sanford C. Bernstein & Company, Inc. - Analyst [2] +-------------------------------------------------------------------------------- + + Just on the legal front, not sure exactly what you can say, I'll give it a shot here. Does the lack of a settlement so far with the government reflect the DC shutdown, or more the fact that you're still negotiating, or a combination of both, any comment there? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [3] +-------------------------------------------------------------------------------- + + I think it may be a little bit the DC shutdown, but in reality, it's a complex thing. It's a Board level issue and we want a fair and reasonable settlement, if we can. And that's all we can really say about it. + +-------------------------------------------------------------------------------- +John McDonald, Sanford C. Bernstein & Company, Inc. - Analyst [4] +-------------------------------------------------------------------------------- + + Okay. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [5] +-------------------------------------------------------------------------------- + + It involves multiple agencies, so you can imagine the complexity. + +-------------------------------------------------------------------------------- +John McDonald, Sanford C. Bernstein & Company, Inc. - Analyst [6] +-------------------------------------------------------------------------------- + + Okay, and in terms of the $9 billion provision this quarter, can you give us any sense of how much that reflects revised estimates of government penalties and fines, as opposed to refined estimates for damage claims from private parties and things like that? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [7] +-------------------------------------------------------------------------------- + + No, John. Unfortunately, we did as much as we can, give you as much clarity as we can, but we aren't going to be able to break that down for you. + +-------------------------------------------------------------------------------- +John McDonald, Sanford C. Bernstein & Company, Inc. - Analyst [8] +-------------------------------------------------------------------------------- + + Can you give one more shot, Marianne explaining how the range of possible loss doesn't go down more after such a big provision? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [9] +-------------------------------------------------------------------------------- + + Yes, so John, the way to think about it, very candidly, is that we didn't expect when we estimated that -- remember it's a very difficult thing to estimate, there's significant uncertainty in terms of the estimate, significant judgment. And when we made those judgments in the second quarter, we didn't anticipate the environment being as volatile and escalating to the point that it has now. So as we have taken our reserves, and the reserves reflect today, so it reflects the current environment and the situation in fact that we're in, and we've now taken that into consideration as we look forward with our reasonably possible range. That's why it hasn't gone down anywhere near dollar to dollar, obviously. + +-------------------------------------------------------------------------------- +John McDonald, Sanford C. Bernstein & Company, Inc. - Analyst [10] +-------------------------------------------------------------------------------- + + Okay, and one more thing on this, does the settlement, negotiations, and things that you're doing does that affect how you project losses on other aspects of legal that you were not negotiating in the last couple weeks? So you've upped the projection of what you might face on other stuff? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [11] +-------------------------------------------------------------------------------- + + All we can say, John, is that we reserve for what's equitable, based on the facts and circumstances specific to each individual exposure, and the overall environment. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [12] +-------------------------------------------------------------------------------- + + It's a tough environment, John. We're just trying to reflect that. + +-------------------------------------------------------------------------------- +John McDonald, Sanford C. Bernstein & Company, Inc. - Analyst [13] +-------------------------------------------------------------------------------- + + Okay, on the expense front, I guess Jamie just said that the things you've added in the control and compliance area are permanent, and that drove up the expense outlook on adjusted basis, Marianne of $59.5 billion to $60 billion, so this is this the go-forward run rate? The $60 billion adjusted expenses, what would be the opportunities to bring that down over time, is there any areas where that is still environmentally elevated? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [14] +-------------------------------------------------------------------------------- + + So just two things, John, and I think in the Barclays presentation there was a slide that showed that of the increase in our outlook, there was a chunk of it that related to non-core prep litigation, so it certainly isn't entirely to do with our investment in cost and control, much of which we are funding through efficiencies. Having said that, there is an incremental cost. It is in part permanent, and it's going to be reflected in our run rate, but there was a good, I think $500 million is my recollection of other expenses including non-corporate litigation, which as you know, we don't adjust out. + +-------------------------------------------------------------------------------- +John McDonald, Sanford C. Bernstein & Company, Inc. - Analyst [15] +-------------------------------------------------------------------------------- + + Okay, and then also in there would be the default servicing, which is still elevated. Can you remind us what the longer term target and how that could come down? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [16] +-------------------------------------------------------------------------------- + + Yes, so the longer term target was a $325 million quarterly run rate, but that's over the longer term. What we said about 2013 and are on track to deliver is that we would exit the year with about $600 million of expenses in the fourth quarter. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [17] +-------------------------------------------------------------------------------- + + Which we still expect. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [18] +-------------------------------------------------------------------------------- + + Yes. Which is expected. So if you look at the third quarter run rate adjusted, it's about $650 million, down from just over $700 million in the second quarter, so that trend is moving in the right direction. + +-------------------------------------------------------------------------------- +John McDonald, Sanford C. Bernstein & Company, Inc. - Analyst [19] +-------------------------------------------------------------------------------- + + Okay, and then the last thing for me is just wondering, Jamie Dimon, did the internal control issues this year and some of the headliners at regulators, does that affect your mindset as you go into CCAR and think about how you'll think about capital return next year? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [20] +-------------------------------------------------------------------------------- + + So first of all, we're going to get there when we get there, but obviously, this Company is very sound, plenty of capital. We want to pass CCAR, but when you talk about capital plans, it's going to be subject to several things. One is the stock price, subject to passing CCAR with flying colors, which is really the stress test of CCAR, and also subject to wanting to meet our own targets for capital. So we've already said we want to get probably something North of 10% Basel III Tier 1 capital, et cetera and when we know all those numbers, do our budgets, we'll put the proper CCAR plan in place. + +-------------------------------------------------------------------------------- +John McDonald, Sanford C. Bernstein & Company, Inc. - Analyst [21] +-------------------------------------------------------------------------------- + + Okay, thanks. + +-------------------------------------------------------------------------------- +Operator [22] +-------------------------------------------------------------------------------- + + Our next question comes from Glenn Schorr of ISI. + +-------------------------------------------------------------------------------- +Glenn Schorr, ISI Group - Analyst [23] +-------------------------------------------------------------------------------- + + Just a quick follow-up on the CCAR. You had mentioned the difference, well you didn't say the exact difference between advanced and standardized, but I wonder if you could shed light on the spread between the two. And I'm just curious, does it play a bigger role in the process this year, or you were just pointing it out? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [24] +-------------------------------------------------------------------------------- + + I was pointing out mainly, Glenn, because I think if you go back several quarters over a year ago, standardized for us was lower than advanced by a reasonable spread, and clearly, when the common [store] amendment is applicable, which is not for a period of time, we would be looking at the lower of those two ratios. Right now, it's higher than the advanced approach, by a little more than 10 basis points. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [25] +-------------------------------------------------------------------------------- + + We should put out when we do CCAR next year, effectively, it's not the same for every quarter, but effectively, it will be based on Basel III, which is a former volatile number because RWA moves around under stress under Basel III, as opposed under Basel I. + +-------------------------------------------------------------------------------- +Glenn Schorr, ISI Group - Analyst [26] +-------------------------------------------------------------------------------- + + Okay, but I mean that spread is a lot tighter, so it's less concerning so it's good. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [27] +-------------------------------------------------------------------------------- + + Yes. + +-------------------------------------------------------------------------------- +Glenn Schorr, ISI Group - Analyst [28] +-------------------------------------------------------------------------------- + + Okay, curious, we don't have all of the answers on how the whole leverage focus is going to shake out but it seems I'm putting a little words in your mouth, but it seems to be working its way through a little bit. I think your book's down 15% or so year on year, and it's less than 10% of the overall balance sheet. But is that a correct way to think about it, that focus is going to start impacting the repo market? And I'm just curious if you could talk about for your book, what is balance sheet financing versus real customer financing? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [29] +-------------------------------------------------------------------------------- + + Yes, so SLR, which I think you're referring to is 4.7%, remember that would go up by 50 basis points if you just subtracted the cash we hold at central banks. So until final rules come out I wouldn't overreact to it. Obviously SLR, it causes you to optimize differently, and a lot of products which are very high user capital under SLR, think of those as deposits, repo, and any of the short-term and low margin, revolvers et cetera. +So it will make you optimize differently, but I think in reality the way we look at it is, we'll be able to adjust to it, we'll probably be able to do it by client. We're going to get to the ratio we need to get to, and we want to do it without disrupting all of our clients. So we will be able to give you more detail when we know the final roles. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [30] +-------------------------------------------------------------------------------- + + And remember, Glenn, there is still the possibility there will be changes made to reflect I think the FIN41, which you're talking about, which I think would be positive for the repo market. + +-------------------------------------------------------------------------------- +Glenn Schorr, ISI Group - Analyst [31] +-------------------------------------------------------------------------------- + + Okay, understood, shifting gears just a quickie. So the guidance is for flat net interest income dollars, and the loan growth was 1% or 2%, quarter on quarter and year on year, but the underlying business, as you mentioned are a lot better. Just curious, it seems like conservative guidance, but curious on what is behind it. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [32] +-------------------------------------------------------------------------------- + + So on NII, Glenn? + +-------------------------------------------------------------------------------- +Glenn Schorr, ISI Group - Analyst [33] +-------------------------------------------------------------------------------- + + Correct. In terms of NII dollars being flat. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [34] +-------------------------------------------------------------------------------- + + So yes, I mean, growth has flattened out in terms of interest earning assets, you seen that obviously take place over the last couple of quarters, and so our guidance is reflecting the fact that we have seen things stabilize, both NIM and NII, and that further near term that's what we're expecting. + +-------------------------------------------------------------------------------- +Glenn Schorr, ISI Group - Analyst [35] +-------------------------------------------------------------------------------- + + Okay, maybe a last one. In a world that doesn't have a lot of loan growth, has very low interest rates and Capital Markets have been far from ideal to your point, your businesses, underlying business or operating goods. And extra charge, you're earning at that $6 run rate that people are hoping you could get to. I guess the question is, do you have more confidence than you did last year in terms of that $24 billion over the cycle, because you're at that run rate now with not ideal conditions. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [36] +-------------------------------------------------------------------------------- + + Listen, it's your job to forecast the future. We do think that it's very good businesses, and like I said, it's underlying growth, but obviously it could be swamped in the short run by markets and events, et cetera. We'll provide a lot more in Investor Day, and give you much more insight. + +-------------------------------------------------------------------------------- +Glenn Schorr, ISI Group - Analyst [37] +-------------------------------------------------------------------------------- + + Okay, I have more confidence. Thanks, Jamie, Bye. + +-------------------------------------------------------------------------------- +Operator [38] +-------------------------------------------------------------------------------- + + Our next question comes from Betsy Graseck of Morgan Stanley. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [39] +-------------------------------------------------------------------------------- + + A couple questions. One on, just another question on FIC. We've talked in the past about clearing and clearing requirements, and prior quarters we just had very few trades coming in under the new rules. Could you give us a sense as to how customer behavior has been, and how that's impacted your FIC line this quarter? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [40] +-------------------------------------------------------------------------------- + + So, I think there's two major things. First of all, the pre trade and post trade rules are in place, and basically they didn't have that much of effect on the business. And now you have the steps in place, and from talking to folks on the trading floor, volumes seem to be down a little bit, but not because of the steps. +The steps are basically accepting data at this point. They are not effectively making mortgage yet, so you haven't seen a huge effect of it. And I think over time, it still remains to be seen. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [41] +-------------------------------------------------------------------------------- + + And then on SLR, did I hear you correctly that you aren't going to make any changes to how you're providing credit to clients, until you find out what the final rule is? There's no major changes on how you're approaching the market? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [42] +-------------------------------------------------------------------------------- + + Yes, because we'll meet the new targets and retain the capital, and eventually, we are actually already pushing down to the business. We're sorting to push down to the business units SLR, all the capital, all the stuff. Eventually, I mean LCR, eventually we'll put down SLR, and that will affect pricing and stuff. +What we don't want to do is do a lot of anticipation, but if revolvers stay at SLR at 100% drawn, the cost will go up. I'm not sure they will go up immediately but they will go up over time so we'll be able to get there. We just don't want to do stupid things in anticipation of rules, which we don't know what they are yet. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [43] +-------------------------------------------------------------------------------- + + Betsy, our businesses are thinking through all of the implications. When the rules come out, we'll be able to act, but think about it as a measured approach. We don't want to overreact. We want to see how things play out, and at the margin, there will be changes to products and pricing but we'll be very measured. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [44] +-------------------------------------------------------------------------------- + + So cash at central banks doesn't have to hold capital against, that's 50 basis points. If you took revolvers down to what we say is a normal draw, like even a stress draw of 20% which is what we saw in the crisis, there will be another 50 basis points, so we just want to be a little measured in how we deal with this. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [45] +-------------------------------------------------------------------------------- + + Okay, and then second thing on mortgage, in the mortgage servicing, relatively high charges, the foreclosure piece in there, but just wondering if there's anything else going on in the servicing expenses? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [46] +-------------------------------------------------------------------------------- + + No, Betsy, this is really just the basic underlying run rate, which is about $650 million. Which does include some severance obviously, given actions taken to adjust capacity in the business, together with the $200 million item, which relates to foreclosure, it's nothing else. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [47] +-------------------------------------------------------------------------------- + + Okay, and portfolio sale coming up at all in that? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [48] +-------------------------------------------------------------------------------- + + No, not anything of any significance. We have done some, but nothing major. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [49] +-------------------------------------------------------------------------------- + + And then just lastly, just another question on the litigation on the page 2. I think the Street understands the reason for taking the $9 billion charge, and I see here you've got the two comments on page 2 which highlight that unpredictable, hard to forecast. But I guess what some folks are wondering is, should we be putting into the model just higher run rate of litigation expenses going forward, I think over the past couple years its been $300 million to $500 million normalized quarter, $1 billion to $2 billion, on a top and up quarter. Is that $1 billion to $2 billion the new normal until we get through this whole thing or--? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [50] +-------------------------------------------------------------------------------- + + We would love to reduce the uncertainty around this for ourselves and for you, but it's very hard to do. So the way I'd look at it is it will probably be elevated for the next year or two, not like we just went through, but it will necessarily be lumpy. So it might be as we settle, as we negotiate, as we figure out -- remember there are multiple agencies involved in every case now, so you saw in the CIO that we paid four, maybe eventually five penalties, which we really did not expect. So we just have to deal with it and deal with the reality that it is. It will abate over time, and the underlying power of the Company you can see, so-- + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [51] +-------------------------------------------------------------------------------- + + Got it. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [52] +-------------------------------------------------------------------------------- + + I wish I could give you a better answer, but one day, it won't be a big number. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [53] +-------------------------------------------------------------------------------- + + So Jamie, as you think about all of the litigation stuff that you've got, can you give us a sense as to how much you're currently in discussions to negotiate? I mean, to give us a sense of how far along you think you are? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [54] +-------------------------------------------------------------------------------- + + Well, I think you have to look at first of all, the big ones are really Board-level type of discussions and we -- our preference is always to resolve it. It is very hard to fight with your regulators or the Federal Government, but we want them to be fair and reasonable. We have shareholders, and those shareholders, by the way, I remind people, it's not me. It's veterans or retirees and mothers and we're trying to do the right thing. It's very hard. We've got the top people involved inside and outside the Company, and hopefully over time, we will make this a much smaller issue. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [55] +-------------------------------------------------------------------------------- + + Okay, thanks. + +-------------------------------------------------------------------------------- +Operator [56] +-------------------------------------------------------------------------------- + + Our next question comes from Matt O'Connor of Deutsche Bank. + +-------------------------------------------------------------------------------- +Matthew O'Connor, Deutsche Bank - Analyst [57] +-------------------------------------------------------------------------------- + + Just looking at slide 15, I think it's very helpful in terms of laying out some of the things that you're targeting to reduce in the left hand side. I guess as we step back to the picture and we think about a couple hundred million of revenue you gave up on the left side, some expense pick up in the middle, and then we factor in the higher capital requirements, the higher liquidity, are you confident that both the long-term earnings impact won't be that meaningful, and that you don't need to adjust the model that much? And I think that's most people's view but the nickels and times, I think there's some concern that it does start to add up as well. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [58] +-------------------------------------------------------------------------------- + + Well it does, but again, we think we've maintained pretty good margins and pretty good capital, and we have different ways to optimize. And not all of the things we're simplifying were very profitable, and so remember, let's just focus on other things and the other things we're doing pretty well. Like almost every single business, we're up in share. And remember, the reason you go up in share is because you're doing a good job for clients. They vote with their feet, which means you're satisfying them. +So we're comfortable we'll be able to adjust to the new world and still have great businesses, and again, you haven't seen all of the repricing that might take place, you haven't seen the reactions and change in business strategies, and some things may move to the shadow banking world, which is fine. We'll figure it out. Like I mentioned, the needs of our clients, consumer, small business, middle market, large corporate, are not going away. They have to be served and satisfied somewhere. + +-------------------------------------------------------------------------------- +Matthew O'Connor, Deutsche Bank - Analyst [59] +-------------------------------------------------------------------------------- + + Just separately the compensation rate within the investment bank coming down this quarter, despite pretty good revenue trends overall, any additional color on that? I think you've been targeting 35% longer term, and we're maybe 31% or so. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [60] +-------------------------------------------------------------------------------- + + We've said 30% to 35%, and remember we do it pretty consistently after capital, and looking at value created, stuff like that so that hasn't changed, just came down a little this quarter. + +-------------------------------------------------------------------------------- +Matthew O'Connor, Deutsche Bank - Analyst [61] +-------------------------------------------------------------------------------- + + Lastly could you just share what the CIO losses were a year ago? I'm not sure if you disclosed that before? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [62] +-------------------------------------------------------------------------------- + + We said there were modest loss last year (multiple speakers) and they were about breakeven this quarter, and it's getting very small. + +-------------------------------------------------------------------------------- +Matthew O'Connor, Deutsche Bank - Analyst [63] +-------------------------------------------------------------------------------- + + Okay, thank you. + +-------------------------------------------------------------------------------- +Operator [64] +-------------------------------------------------------------------------------- + + Our next question comes from [Erica Najerian] of Bank of America. + +-------------------------------------------------------------------------------- +Erica Najerian, BofA Merrill Lynch - Analyst [65] +-------------------------------------------------------------------------------- + + My first question is on the new leverage proposals. I think we're hearing loud and clear that you're not going to do anything rash in terms of how you run your businesses, but given that we're still in proposal form in the US and also with Basel, can JPMorgan accelerate capital return in next year's CCAR, even with these proposals fluid on the leverage side? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [66] +-------------------------------------------------------------------------------- + + Erica, two things. One is, if you just look at the firm wide leverage ratio for a second that 4.7%, obviously that maybe changes when the final rules are issued, but just take that as a base. We're only 30 basis points from the minimum and while we're targeting to go higher than that, clearly 30 basis points is not a great distance for us to cover. +And then I'd just reiterate what Jamie said, which is when we look at our 2014 CCAR, it will take into account a balanced set of facts and circumstances, so obviously both the quantitative and qualitative nature of the results of the stress test, but also our desire to want to get to capital levels that we've expressed, together with maintaining flexibility to do appropriate dividends and repurchases. So all those things together will be considered in the capital plan. + +-------------------------------------------------------------------------------- +Erica Najerian, BofA Merrill Lynch - Analyst [67] +-------------------------------------------------------------------------------- + + And my second follow-up question is on the advanced versus standardized approach, as it relates to the CCAR. You've told us that the standardized ratio is clearly lower, but as you run your models under stress, what is more punitive for your bank? Is it coming into a stress scenario with a lower starting point on standardized, or is it the RWA inflation, when you stressed the advanced? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [68] +-------------------------------------------------------------------------------- + + So three things, just to clarify. Currently our standardized ratio is higher than advanced, albeit not by very wide margin, so just to clarify that point. Just generically, the advanced approach RWA sensitivity to a stress environment would be more impacted than a standardized approach, but remember, that's a 2014, that's a future issue for us. +The 2014 CCAR, as we understand the instructions, we will be looking at an additional test on top of the 5% Basel I, that will have a Basel I risk weighted assets for the denominator for the first four quarters, and Basel III standardized for the second four quarters. So it's a 2014 CCAR, the advanced approach isn't one of the critical tests, although it will likely be in the future. But in theory and in reality, that will reduce more dramatically on the stress than the other measure. + +-------------------------------------------------------------------------------- +Erica Najerian, BofA Merrill Lynch - Analyst [69] +-------------------------------------------------------------------------------- + + Got it, thank you. + +-------------------------------------------------------------------------------- +Operator [70] +-------------------------------------------------------------------------------- + + Our next question comes from Mike Mayo of CLSA. + +-------------------------------------------------------------------------------- +Mike Mayo, Credit Agricole Securities - Analyst [71] +-------------------------------------------------------------------------------- + + Three small questions and one larger one. First, what was the loan utilization on the wholesale side for the quarter versus last quarter? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [72] +-------------------------------------------------------------------------------- + + It was relatively flat, Mike, in the low 30s, between 30% and 31%. + +-------------------------------------------------------------------------------- +Mike Mayo, Credit Agricole Securities - Analyst [73] +-------------------------------------------------------------------------------- + + And as far as the headcount reduction, you said in CCB you're taking up 15,000 jobs this year and 11,000 in mortgage? Where are the rest of the jobs coming out from, and how are you able to do that? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [74] +-------------------------------------------------------------------------------- + + So it's consistent with what we said at Investor Day, in terms of the remaining jobs turning out of the branch networking consumer, as we implement new technology and new operating models, and new branch formats. + +-------------------------------------------------------------------------------- +Mike Mayo, Credit Agricole Securities - Analyst [75] +-------------------------------------------------------------------------------- + + Okay, and as it relates to slide 15, the repositioning of the business, what inning are you in for that derisking and the control agenda? It seems like the derisking might be earlier innings, and the control agenda the later stages but you tell me. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [76] +-------------------------------------------------------------------------------- + + Well, I guess we're making huge progress on it, but it's not going to stop for years. It's permanent. + +-------------------------------------------------------------------------------- +Mike Mayo, Credit Agricole Securities - Analyst [77] +-------------------------------------------------------------------------------- + + Okay, and then the larger question relates to the legal issue. How much of the investor losses for the mortgage putback and the mortgage securities relate to Bear? I know there's been a lot of numbers in the press, but we haven't heard those numbers from you. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [78] +-------------------------------------------------------------------------------- + + So Mike, just what it's worth on page 2, very small in the footnote, we talk about that estimate of about 80% of MBS deal losses related to heritage investments. + +-------------------------------------------------------------------------------- +Mike Mayo, Credit Agricole Securities - Analyst [79] +-------------------------------------------------------------------------------- + + And what's the dollar-- + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [80] +-------------------------------------------------------------------------------- + + That's losses. + +-------------------------------------------------------------------------------- +Mike Mayo, Credit Agricole Securities - Analyst [81] +-------------------------------------------------------------------------------- + + Okay, 80% of the losses? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [82] +-------------------------------------------------------------------------------- + + Yes. + +-------------------------------------------------------------------------------- +Mike Mayo, Credit Agricole Securities - Analyst [83] +-------------------------------------------------------------------------------- + + And what's the dollar amount of losses on the mortgage putback side? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [84] +-------------------------------------------------------------------------------- + + When you saw mortgage putback, are you talking about the GSE putback? + +-------------------------------------------------------------------------------- +Mike Mayo, Credit Agricole Securities - Analyst [85] +-------------------------------------------------------------------------------- + + Well what's the total dollar amount of all of the losses we're talking about the potential settlement? That must be public somewhere, for mortgage putback in aggregate, the mortgage securities, what are the dollar amounts of the original, what's the original principal amount, and what's the investor loss? Just the dollar amounts if you can break that down. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [86] +-------------------------------------------------------------------------------- + + I think have you to get that from other analysts who actually have published numbers like that. + +-------------------------------------------------------------------------------- +Mike Mayo, Credit Agricole Securities - Analyst [87] +-------------------------------------------------------------------------------- + + So I guess one question, it's 80% of the losses are from the deals, would you have done the deals differently? Did you not read the fine print? Did you not have some additional protection that you might have had? I know it was short notice for these transactions. On the other hand as you look back now maybe you wish you did something differently? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [88] +-------------------------------------------------------------------------------- + + I think -- obviously, that's true, Mike, so because this is very painful for the Company, and so Bear Sterns we did do quickly. We didn't anticipate that we would be paying anything for prior losses for Bear Sterns. I tell people, even the Bear Sterns number, I think it was $80 billion of bonds were made good which would have failed that day, had they gone bankrupt. +And we did ask, we weren't completely stupid. We did ask the SEC for and only the SEC for would they please agree not to take enforcement actions against JPMorgan against things that happened at Bear, which of course they couldn't do outright, but they did say they would take into consideration the circumstances in which the transaction took place. +And in WaMu, we don't believe we're responsible by contract. But that does not mean that people can't come after you. So that was a little bit of a lesson learned too. + +-------------------------------------------------------------------------------- +Mike Mayo, Credit Agricole Securities - Analyst [89] +-------------------------------------------------------------------------------- + + Can you talk more about the trade-off? Nobody is forcing you to sell off. If you really think this is a bad deal, then you obviously wouldn't do it so what's the trade-off of not settling versus settling? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [90] +-------------------------------------------------------------------------------- + + We're going to do what's in the best interest of our shareholders, all things considered, it's a Board level decision. And it needs to be fair, reasonable, taking consideration all of the facts and have some possible -- we would like to get it done, and if we can't, that's the Board will make that decision. It's not a good choice either way. + +-------------------------------------------------------------------------------- +Mike Mayo, Credit Agricole Securities - Analyst [91] +-------------------------------------------------------------------------------- + + And your decision to disclose the legal reserve, as we go back and asking all the other banks, what's your legal reserve, JPMorgan disclosed it, why don't you? What were the factors that led you to do that? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [92] +-------------------------------------------------------------------------------- + + Mike, the factor there was candidly that you were all trying to do this, you had most, or at least a large number of analysts that published research papers trying to recreate settlements and reserves three times, and for this one time only, we felt like it was helpful and transparent and constructive to show you the magnitude of reserves after these actions. So that you can have that context when you think about the future. + +-------------------------------------------------------------------------------- +Mike Mayo, Credit Agricole Securities - Analyst [93] +-------------------------------------------------------------------------------- + + Okay, thank you. + +-------------------------------------------------------------------------------- +Operator [94] +-------------------------------------------------------------------------------- + + Our next question comes from Matt Burnell of Wells Fargo Securities. + +-------------------------------------------------------------------------------- +Matt Burnell, Wells Fargo Securities, LLC - Analyst [95] +-------------------------------------------------------------------------------- + + Just a couple of quick follow-up questions. First of all Marianne, in the expenses related to mortgage production, those were down about 6% quarter over quarter. Do you have a sense as to if the trajectory of those costs are going to come down faster over the next couple of quarters? Several banks have discussed that in terms of trying to reduce the expenses, at the same time production revenues are also coming down. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [96] +-------------------------------------------------------------------------------- + + Yes, so first of all just to give context to that 6% to 7% down quarter over quarter, there is a portion of our expense base related to mortgage that's truly variable, so as production levels go down, we pay less compensation on the loans, and as a result, that's what you're seeing in this quarter. With respect to then rightsizing the expense base for the opportunity in the market, we have taken actions, as you have are aware in the third quarter, to start to do that; however, once you go beyond the truly variable costs, those actions take some four, or cases six months to truly get to the run rate. +So while we would expect to see that start to come to fruition in the fourth quarter, not completely in the quarter, more as a run rate matter. And then there is a portion of costs that are more fixed, in terms of our ability to be able to participate, whether it's real estate technology and a core infrastructure. We are obviously also taking a look at that, but we are in this business, and so there will be an element of fixed costs into obviously next year. +But you should expect that we're still seeing, absent lots go down slightly into the fourth quarter, so you should expect revenues will maybe be down, but expenses will also be down, for that net slight negative pretax margin that we've guided you to. That's still what we expect. + +-------------------------------------------------------------------------------- +Matt Burnell, Wells Fargo Securities, LLC - Analyst [97] +-------------------------------------------------------------------------------- + + That's helpful and then just a question on pipelines. You mentioned that the pipeline in commercial banking was healthy. Just curious as to whether or not that is largely due to transactions that have been held up because of uncertainty in the economy on the part of your borrowers, or is that also being helped by more business being booked by your bankers? And also if you have a comment on the investment banking pipeline at this point, realizing it's early in the quarter, that would be helpful too. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [98] +-------------------------------------------------------------------------------- + + Let me brag on our commercial bank and investment bank bankers And they've opened up branches I want to say Jacksonville, Sacramento, Nashville, so we're actually in more places in the commercial bank. Obviously, we've been building in the WaMu footprint in Florida and California, they've been doing an exceptional job. +And more importantly a high quality job, like we're really happy with the quality of the business we're booking. And our Investment Bankers you see the numbers in equity and debt and we didn't mention all of the deals that we are involved in but Verizon, and Sprint, and Nokia, there's good pipelines and good traffic. You know that can change tomorrow, but the fact is, we are satisfying our clients and we're thrilled with the business we're generating. + +-------------------------------------------------------------------------------- +Matt Burnell, Wells Fargo Securities, LLC - Analyst [99] +-------------------------------------------------------------------------------- + + Okay, and then just Jamie maybe a question on the buyback. At this point it doesn't sound like you have any concerns about the litigation expenses in this quarter being an issue for the CCAR submission, or future buyback trends, is that what I heard? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [100] +-------------------------------------------------------------------------------- + + So we don't expect or believe there should be any repercussions, but ultimately that's the regulators' decision so we resubmitted CCAR in September. We're still waiting for feedback. We get feedback in early December. We will do a good, thoughtful and appropriate job of thinking through our capital asks as we do the 2014 CCAR, so those will be the things that we do. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [101] +-------------------------------------------------------------------------------- + + And we're doing very little stock buyback right now. + +-------------------------------------------------------------------------------- +Matt Burnell, Wells Fargo Securities, LLC - Analyst [102] +-------------------------------------------------------------------------------- + + Right, okay. Thank you very much. + +-------------------------------------------------------------------------------- +Operator [103] +-------------------------------------------------------------------------------- + + Our next question comes from Guy Moszkowski of Autonomous. + +-------------------------------------------------------------------------------- +Guy Moszkowski , Autonomous Research LLP - Analyst [104] +-------------------------------------------------------------------------------- + + You mentioned in passing that at the Investor Day in February, you think that there will be a lot more of the rules in place that you'll be able to discuss the impact of. I was wondering the specific ones that you think will be available by then, Volker for example, is it your understanding that you'll have a good understanding by then? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [105] +-------------------------------------------------------------------------------- + + Yes, Volker, more detail on SLR, more detail on how much long term debt, I think we have almost 20% of available resources today. And then you could look at things very basic and simple and say okay, well if the cost is a little bit higher and pricing stays the same and capital is higher, returns a little bit lower, that's true. But that doesn't take into consideration things we don't know which is repricing, competitor strategies, and our ability to optimize by client, by state, by region, by product +So all those things, we just give you a better idea. We're very comfortable we've got a very good business, but we'll give you a better idea of what we think it means by business. For example, we're going to allocate more capital and operating capital to the businesses, we'll ask them to optimize on SLR, and without damaging the client franchise, but we just will give you more detail. That's all. + +-------------------------------------------------------------------------------- +Guy Moszkowski , Autonomous Research LLP - Analyst [106] +-------------------------------------------------------------------------------- + + Fair enough. One thing that you alluded to a couple of times this morning is the idea of the SLR being maybe 50 basis points higher, if you didn't have to carry capital, or count into the leverage exposure. You were deposits with central banks. Since you mentioned it a couple times, does that mean that you actually have a reasonably high degree of comfort that there will be an exemption for that? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [107] +-------------------------------------------------------------------------------- + + No, I think that a lot of people mentioned that they think it was inappropriate to apply capital to that, but the regulators will decide, whatever it is, we will be able to adjust to and conform to the rules. I would just point out that some of these things can move that number quite a bit and there's a reason why you shouldn't overreact to it and just take the time and do it right. We know the final rules, we will conform. + +-------------------------------------------------------------------------------- +Guy Moszkowski , Autonomous Research LLP - Analyst [108] +-------------------------------------------------------------------------------- + + Sure. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [109] +-------------------------------------------------------------------------------- + + We conform very quickly, so it's just why would you conform very quickly and disrupt clients? So just think of it that way. We're trying to do the right thing to the client base and the Company. + +-------------------------------------------------------------------------------- +Guy Moszkowski , Autonomous Research LLP - Analyst [110] +-------------------------------------------------------------------------------- + + Sure. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [111] +-------------------------------------------------------------------------------- + + We don't want to restrict, we could go out tomorrow and say we aren't going to make anymore revolvers, and we will be there very quickly. We just don't want to do that. It's not a rational way to run a business. + +-------------------------------------------------------------------------------- +Guy Moszkowski , Autonomous Research LLP - Analyst [112] +-------------------------------------------------------------------------------- + + Sure, that's completely fair. At this year's Investor Day, you identified in the investment bank a $65 billion run-off portfolio that you gave some targets of reduction for, at year-end. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [113] +-------------------------------------------------------------------------------- + + Right. + +-------------------------------------------------------------------------------- +Guy Moszkowski , Autonomous Research LLP - Analyst [114] +-------------------------------------------------------------------------------- + + I've also noticed that in your Pillar 3 disclosures you've got a very high CRM, which I have to assume is associated with correlation book stuff, which I guess that run-off portfolio is. Can you give us a sense for whether that's right, and where you are with that run-off portfolio? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [115] +-------------------------------------------------------------------------------- + + We are going to meet our targets through the run-off portfolio, which will cause a couple of things. Part of the CRM was a synthetic credit portfolio, which is, I'll say, 1/10 of the size it was a year ago and I don't remember the exact numbers, and we're still going to be optimizing across other products. There's certain things in mortgages that use up a lot of capital, et cetera. So we have more to go in optimizing RWA. + +-------------------------------------------------------------------------------- +Guy Moszkowski , Autonomous Research LLP - Analyst [116] +-------------------------------------------------------------------------------- + + And that was a separate synthetic credit portfolio than what you moved over from CIO, or is that a part of it? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [117] +-------------------------------------------------------------------------------- + + No, no, that one, but they had a small correlation book in the IB, this was a synthetic credit portfolio moved over to the IB, and eventually it will probably be put together. + +-------------------------------------------------------------------------------- +Guy Moszkowski , Autonomous Research LLP - Analyst [118] +-------------------------------------------------------------------------------- + + Got it. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [119] +-------------------------------------------------------------------------------- + + And much smaller. + +-------------------------------------------------------------------------------- +Guy Moszkowski , Autonomous Research LLP - Analyst [120] +-------------------------------------------------------------------------------- + + We heard recently from some people in the industry that there's the expectation of a counterparty, a major counterparty default as part of the CCAR stress test this year. Do you have any sense for whether, are you hearing that that's going to be part of it? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [121] +-------------------------------------------------------------------------------- + + Yes. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [122] +-------------------------------------------------------------------------------- + + Yes, we've received instructions and that does feature. + +-------------------------------------------------------------------------------- +Guy Moszkowski , Autonomous Research LLP - Analyst [123] +-------------------------------------------------------------------------------- + + It's a rational idiosyncratic event that people should be prepared for. Remember, we did go through that with Lehman. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [124] +-------------------------------------------------------------------------------- + + And it wouldn't be the first time we modeled such an event as part of our stress testing. + +-------------------------------------------------------------------------------- +Guy Moszkowski , Autonomous Research LLP - Analyst [125] +-------------------------------------------------------------------------------- + + Got it. Final question. So it's always been very important to you, Jamie, that you had a record of not losing money in a quarter, through the whole credit bubble and disaster. And yet this quarter, because of the size of the litigation reserve, you did. Not a large amount of money, but you actually had a net operating loss. Do we take that as a signal of the certainty and the timing of the size of the settlement? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [126] +-------------------------------------------------------------------------------- + + No. I think you should take that, I mean obviously it's very painful for me personally, because I agree with you, I don't like losing money obviously for my shareholders, and we put up, and Marianne has been very clear. These are very tough numbers to estimate, it's a heightened environment, multiple agencies are involved in often the same thing. We're just trying to improve and get better and move on. Remember, these reserves relate to things that took place over multiple years, so it isn't a one year event, and we still didn't lose money during the crisis. + +-------------------------------------------------------------------------------- +Guy Moszkowski , Autonomous Research LLP - Analyst [127] +-------------------------------------------------------------------------------- + + Fair enough. Okay, thanks for taking my questions. Appreciate it. + +-------------------------------------------------------------------------------- +Operator [128] +-------------------------------------------------------------------------------- + + Our next question comes from Moshe Orenbuch of Credit Suisse. + +-------------------------------------------------------------------------------- +Moshe Orenbuch, Credit Suisse - Analyst [129] +-------------------------------------------------------------------------------- + + Marianne, you'd mentioned the CCAR resubmission. When that comes out, will that be made public, and what will we be able to get from that, and how will that impact your submission going forward? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [130] +-------------------------------------------------------------------------------- + + So I'm not expecting that the details and results will necessarily become public. Remember, it wasn't a quantitative issue per se. It was a qualitative issue, so what the regulators are looking for is our response to their recommendations and substantial progress in that. +I do think that it obviously would be public what their response has been to that, some time in December, and we'll work out exactly when that would be. So I would expect you to understand whether our plan has been accepted or otherwise at some point in December. And we're already working on the 2014 CCAR submission. Obviously that submission in early January, which means it's will be Board approval in December and that is starting. +All of the work, and Jamie talked about it, he talked about 500 people, thousands of people involved, models, documentation, covenants, controls, all of that work that we did for the resubmission is fully being leveraged for our ongoing CCAR processes, and we're building on it. So this for us will continue to become better over time, and 2014 will be another step in that process. + +-------------------------------------------------------------------------------- +Moshe Orenbuch, Credit Suisse - Analyst [131] +-------------------------------------------------------------------------------- + + Great, and as far as other changes that you're aware of, you had mentioned the counterparty failure, are there any other large items that would be a change in the way, or in addition to the way they're approaching the submissions this year? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [132] +-------------------------------------------------------------------------------- + + Really most significantly, the other thing that we just talked about, which is in addition to all of the other minimum levels that we've been testing against, we have new tests under Basel III, albeit a test that recognizes savings in the capital numerator, and also a slightly different denominator through time, with different minimum levels of 4% in 2014, and 4.5% in 2015. So that's the other real big framework change. + +-------------------------------------------------------------------------------- +Moshe Orenbuch, Credit Suisse - Analyst [133] +-------------------------------------------------------------------------------- + + Got it, and related to taking the charges in this period, given what was the actual information that changed? In other words, the accounting rules tend to require a certain standard to recognize that, and if you haven't reached that agreement yet, what actually did change that required the recognition of that in Q3? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [134] +-------------------------------------------------------------------------------- + + So we obviously can't comment on any sort of discussions or status of any specifics on litigation. Yes, you're right, the framework is probably an estimate. Also you should obviously assume that we didn't or couldn't estimate, all of these events were not probable at the time. But today, our reserves are appropriate for the current environment, and the information that we're allowed. + +-------------------------------------------------------------------------------- +Moshe Orenbuch, Credit Suisse - Analyst [135] +-------------------------------------------------------------------------------- + + Did you say at the outset that the $9 billion wasn't fully taxed because of a portion related to penalties? That would imply like roughly about a third of it, does that make sense? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [136] +-------------------------------------------------------------------------------- + + We're estimating some penalties, given the environment we would expect that some of the expenses would come with penalty nature, and you can obviously do the math from the front page. + +-------------------------------------------------------------------------------- +Moshe Orenbuch, Credit Suisse - Analyst [137] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [138] +-------------------------------------------------------------------------------- + + But they are estimates and they include a range of matters not limited to mortgage. + +-------------------------------------------------------------------------------- +Moshe Orenbuch, Credit Suisse - Analyst [139] +-------------------------------------------------------------------------------- + + Thanks very much. + +-------------------------------------------------------------------------------- +Operator [140] +-------------------------------------------------------------------------------- + + Our next question comes from Gerard Cassidy of RBC. + +-------------------------------------------------------------------------------- +Gerard Cassidy, RBC Capital Markets - Analyst [141] +-------------------------------------------------------------------------------- + + Can you talk about the commercial loan balances? I noticed that the period-end balance had a nice increase from the third quarter, but your averages were almost flat. Is there a pick up in lending activity in the month of September? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [142] +-------------------------------------------------------------------------------- + + Actually, it's a great question. There is a fronting in that number of just shy of $2 billion, $1.7 billion that will ultimately be syndicated in the short-term, so I would adjust that out when you're looking at the quarter over quarter numbers. Other than that, it's relatively flat and steady performance in core middle market and strength in real estate. + +-------------------------------------------------------------------------------- +Gerard Cassidy, RBC Capital Markets - Analyst [143] +-------------------------------------------------------------------------------- + + Okay, and I know the litigation questions are sensitive, so I don't know if you can answer this or not. The discussions that are going on, that we're reading about in the paper with the US government, is it more of a factor of the dollar amount that's holding it up, or is it more terms and conditions? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [144] +-------------------------------------------------------------------------------- + + We can't comment. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [145] +-------------------------------------------------------------------------------- + + We've already said all we can say about that. + +-------------------------------------------------------------------------------- +Gerard Cassidy, RBC Capital Markets - Analyst [146] +-------------------------------------------------------------------------------- + + Okay, that's fair. Another question is, you at your Investor Day talked about the Visa partnerships that you were just announced, could you give us some more color on how that's going, with the merchant acquiring and the payment business? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [147] +-------------------------------------------------------------------------------- + + It's going well but we're still, I think they are still building the systems to actually do it, and come with the products and services that we think can do a better job both for the merchants and for customers. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [148] +-------------------------------------------------------------------------------- + + But we're in active-- + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [149] +-------------------------------------------------------------------------------- + + We're still working on that. That's not going to happen overnight. We just think it could be a very good thing over time. + +-------------------------------------------------------------------------------- +Gerard Cassidy, RBC Capital Markets - Analyst [150] +-------------------------------------------------------------------------------- + + I assume you'll give us a good update at the Investor Day in February? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [151] +-------------------------------------------------------------------------------- + + Yes, we will try to. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [152] +-------------------------------------------------------------------------------- + + We will. + +-------------------------------------------------------------------------------- +Gerard Cassidy, RBC Capital Markets - Analyst [153] +-------------------------------------------------------------------------------- + + Coming back to the asset yields, you talked about the deposit margins improving quarter to quarter, earlier in your call. Are we at a point where the asset yields in the securities portfolio have bottomed? Are you replacing securities with equal yields or higher? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [154] +-------------------------------------------------------------------------------- + + Essentially has flattened out at this point, yes. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [155] +-------------------------------------------------------------------------------- + + And we've begun to reinvest, we're looking at the overall portfolio, we're doing some rotation, and that process has started. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [156] +-------------------------------------------------------------------------------- + + Remember, rates did go up almost 100 basis points. + +-------------------------------------------------------------------------------- +Gerard Cassidy, RBC Capital Markets - Analyst [157] +-------------------------------------------------------------------------------- + + Right. Finally, on a go forward basis once we get over all these issues that everybody is confronting today in the banking industry, with the regulatory and maybe the interest rate environment, what's going to be the capital ratio that's going to constrain your growth? Is it going to be the SLR ratio, the Tier 1 common? What's the one you think will be the real achilles heel? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [158] +-------------------------------------------------------------------------------- + + So just at a macro level, talking at the firm-wide level for a second, we've said that we're looking at running the firm at a Basel III Tier 1 common ratio between 10% to 10.5%, which would imply, in any case Tier 1 capital minimums will be 11% ultimately, so we'll be at 11%-plus from Tier 1 capital and we talked about leverage running at 5.5% over time as well. And if you think about 11%-plus Tier 1 capital, 10% to 10.5% Basel III common and a 5.5% supplementary leverage ratio given the ratio of our risk weighted assets to our balance sheet, they actually co-exist quite happily. So it is going to be a multi-variance of finding constraints, but at those levels, they exist quite nicely. +Obviously the devil is in the detail when you push down into the businesses, client by client, product by product, and that work will go on, and as we do that work, as Jamie's talked about, we expect to be able to optimize, which will include some repricing and some restructuring of products. But at a macro level, they will co-exist relatively well. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [159] +-------------------------------------------------------------------------------- + + I always add to that CCAR will be in our opinion another binding constraint over time. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [160] +-------------------------------------------------------------------------------- + + Very good point. + +-------------------------------------------------------------------------------- +Gerard Cassidy, RBC Capital Markets - Analyst [161] +-------------------------------------------------------------------------------- + + Correct. Coming back to the capital, on the orderly liquidation authority, as we all know there are certain buckets of capital that have to be maintained. Do you have any clarity yet that the excess over the 9.5% under the Tier 1 common portion, will that be applicable to other buckets, so you don't have to raise as much in preferred or senior debt? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [162] +-------------------------------------------------------------------------------- + + We don't know those rules yet, but presumably it's going to be equity plus preferred plus unsecured senior debt, and subordinated debt. And I think our number is at 20% of risk weighted assets there, so we're in a pretty good place but we'll see what the final rules are. + +-------------------------------------------------------------------------------- +Gerard Cassidy, RBC Capital Markets - Analyst [163] +-------------------------------------------------------------------------------- + + Great, thank you. + +-------------------------------------------------------------------------------- +Operator [164] +-------------------------------------------------------------------------------- + + Our next question comes from Jeffery Harte of Sandler O'Neill. + +-------------------------------------------------------------------------------- +Jeffery Harte, Sandler O'Neill & Partners - Analyst [165] +-------------------------------------------------------------------------------- + + Most things have been covered but I'm looking at the loan loss reserve releases from the PCI portfolio, assuming credit gets better, that theory continues as well. How should we think of that going forward? Is that going to be something lumpy from time to time? Is it going to be more gradual, like it would be in a normal loan portfolio? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [166] +-------------------------------------------------------------------------------- + + So with PCI-- + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [167] +-------------------------------------------------------------------------------- + + I have to go because I have a meeting I have to go to, but appreciate the time with us, and Marianne can answer the remaining questions. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [168] +-------------------------------------------------------------------------------- + + So the way to think about the PCI reserve release its the first one we've taken, and it reflects obviously improved home prices and lower severities, but it's divided by model, so if all other things from here are equal, then we are what we are. Obviously, if there are significant changes, probably primarily in home prices, but also in delinquencies, and you might see some more reserve releases. These are likely to be more periodic and lumpy, because obviously, we will be refreshing our loan loss reserves, or our life of loan forecasts over time. It's possible that you may see them in multiple quarters but that's not what we're expecting. + +-------------------------------------------------------------------------------- +Jeffery Harte, Sandler O'Neill & Partners - Analyst [169] +-------------------------------------------------------------------------------- + + Okay, thank you. + +-------------------------------------------------------------------------------- +Operator [170] +-------------------------------------------------------------------------------- + + Our next question comes from Derek De Vries of UBS. + +-------------------------------------------------------------------------------- +Derek De Vries, UBS - Analyst [171] +-------------------------------------------------------------------------------- + + A few questions on the investment bank, and you touched on the comp expense earlier. It's obviously very low as a percent of revenues, excluding DDA, I think it's 27% So given revenues are down, your bonus accrual must be way down. And my question becomes is that just coincidence that it happens in a quarter where you take $9 billion of regulatory litigation costs, or is there a cause and effect there? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [172] +-------------------------------------------------------------------------------- + + No there's no cause and effect there, obviously. + +-------------------------------------------------------------------------------- +Derek De Vries, UBS - Analyst [173] +-------------------------------------------------------------------------------- + + You say obviously, but okay. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [174] +-------------------------------------------------------------------------------- + + Well there's no cause and effect there. Full stop. + +-------------------------------------------------------------------------------- +Derek De Vries, UBS - Analyst [175] +-------------------------------------------------------------------------------- + + Perfect. And then my second question, you've talked a lot during this conference call about pushing things out to clients when you have more clarity on your leverage ratio, and I guess -- the rules and what not. I guess just broader, as you think back not the leverage ratio but all the Basel III rules we've faced and all the changes in higher capital requirements and whatnot. Are you surprised at how slowly some of those price increases have been pushed down, and how slowly capacity has left the industry, or do you think it's about right, or do you think we'll see more of that going forward? Maybe you can just make broad comments there. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [176] +-------------------------------------------------------------------------------- + + Well I can certainly talk for JPMorgan, where as soon as we understand rules, we start to push them down into the organization, so that the people who are transacting at the products and the client level can make the best and most appropriate decisions to maximize returns and meet hurdles, and all of those sorts of good things. And you're right. Over the last several years, we have seen capital and liquidity increase dramatically. +Meanwhile we are still delivering a core underlying performance in that mid-teens return on tangible common equity. So we're still competing effectively, which leads me to believe that others are doing the same thing, and that's being reflected in the competitive nature of the environment. I think it's obviously going to continue some, as we and others have set ourselves even higher targets for capital, and then obviously new rules including the SLR, but I also do think these things work through the system through time pretty quickly, given the nature of the business. + +-------------------------------------------------------------------------------- +Derek De Vries, UBS - Analyst [177] +-------------------------------------------------------------------------------- + + Okay, that's clear. Thank you. + +-------------------------------------------------------------------------------- +Operator [178] +-------------------------------------------------------------------------------- + + Our next question comes from Jim Mitchell of Buckingham Research. + +-------------------------------------------------------------------------------- +Jim Mitchell, Buckingham Research Group - Analyst [179] +-------------------------------------------------------------------------------- + + One quick follow-up on your liquidity holdings here. Your excess liquidity pool looked like it increased almost $85 billion sequentially to $538 billion. Just want to know what's driving that, if there's anything you're worried about or thinking about, because I thought your LCR ratio last quarter was above 100%. And if you could just give us your updated LCR ratio, that would be great, thanks. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [180] +-------------------------------------------------------------------------------- + + So our LCR ratio last quarter was 118%. This quarter, we haven't disclosed it, but it's not far off that same level. and the increase in cash is not necessarily because we're trying to do anything from a liquidity perspective, but it also reflects inflows from clients, both operating bills, and importantly non-core non-operating deposits that we then place with the central banks. + +-------------------------------------------------------------------------------- +Jim Mitchell, Buckingham Research Group - Analyst [181] +-------------------------------------------------------------------------------- + + Okay, thanks. + +-------------------------------------------------------------------------------- +Operator [182] +-------------------------------------------------------------------------------- + + Our next question comes from Chris Kotowski of Oppenheimer. + +-------------------------------------------------------------------------------- +Chris Kotowski, Oppenheimer & Co. - Analyst [183] +-------------------------------------------------------------------------------- + + Mine were asked and answered, thank you. + +-------------------------------------------------------------------------------- +Operator [184] +-------------------------------------------------------------------------------- + + Our next question comes from David Hilder of Drexel Hamilton. + +-------------------------------------------------------------------------------- +David Hilder, Drexel Hamilton - Analyst [185] +-------------------------------------------------------------------------------- + + Sorry, mine were asked as well, thanks very much. + +-------------------------------------------------------------------------------- +Operator [186] +-------------------------------------------------------------------------------- + + And we have no further questions at this time. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [187] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Operator [188] +-------------------------------------------------------------------------------- + + This concludes today's conference call. You may now disconnect. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/exam/original-files/Problem_2_3_Sample_full_transcripts/2013-Oct-15-KO.N-138489121635-Transcript.txt b/exam/original-files/Problem_2_3_Sample_full_transcripts/2013-Oct-15-KO.N-138489121635-Transcript.txt new file mode 100644 index 0000000..4d15835 --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_full_transcripts/2013-Oct-15-KO.N-138489121635-Transcript.txt @@ -0,0 +1,651 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q3 2013 The Coca-Cola Company Earnings Conference Call +10/15/2013 09:30 AM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Ahmet Bozer + The Coca-Cola Co - President Coca-Cola International + * Gary Fayard + The Coca-Cola Co - CFO + * Irial Finan + The Coca-Cola Co - President Bottling Investments Group + * Steve Cahillane + The Coca-Cola Co - President Coca-Cola Americas + * Jackson Kelly + The Coca-Cola Co - VP & IR Relations Officer + * Muhtar Kent + The Coca-Cola Co - Chairman & CEO + +================================================================================ +Conference Call Participiants +================================================================================ + + * Bill Schmitz + Deutsche Bank - Analyst + * Bill Pecoriello + Consumer Edge Research - Analyst + * Dara Mohsenian + Morgan Stanley - Analyst + * Judy Hong + Goldman Sachs - Analyst + * Bryan Spillane + Bank of America - Analyst + * John Faucher + JPMorgan Chase & Co. - Analyst + * Ali Dibadj + Bernstein - Analyst + * Wendy Nicholson + Citi Research - Analyst + +================================================================================ +Presentation +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + At this time, I would like to welcome everyone to the Coca-Cola Company's third-quarter 2013 earnings results conference call. Today's call is being recorded. +(Operator Instructions) +I would like to remind everyone that the purpose of this conference call is to talk with investors and, therefore, questions from the media will not be addressed. Media participants should contact Coca-Cola's media relations department if they have questions. I now would like to introduce Jackson Kelly, Vice President and Investor Relations officer. Mr. Kelly, you may begin. + +-------------------------------------------------------------------------------- +Jackson Kelly, The Coca-Cola Co - VP & IR Relations Officer [2] +-------------------------------------------------------------------------------- + + Thank you. Good morning and thank you for being with us today. I'm joined by Muhtar Kent, our Chairman and Chief Executive Officer, and Gary Fayard, our Chief Financial Officer. Following prepared remarks by Muhtar and Gary this morning, we'll turn the call over for your questions. Ahmet Bozer, President of Coca-Cola International; Steve Cahillane, President of Coca-Cola Americas; and Irial Finan, President of our Bottling Investments Group will also be available for the Q&A session. +Before we begin, I would like to remind you that this conference call may contain forward-looking statements, including statements concerning long-term earnings objectives, and should be considered in conjunction with cautionary statements contained in our earnings release and in the Company's most recent periodic SEC report. In addition, I would also like to note that we've posted schedules under the financial reports and information tab in the investor section of our Company website at www.coca-colacompany.com. These schedules reconcile certain non-GAAP financial measures which may be referred to by our senior executives during this morning's discussion to our results as reported under Generally Accepted Accounting Principles. Please look on our website for this information. +Now, let me turn the call over to Muhtar. + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Co - Chairman & CEO [3] +-------------------------------------------------------------------------------- + + Thank you, Jackson, and good morning, everyone. We delivered sequential volume growth in the third quarter, while capturing global nonalcoholic ready-to-drink beverage value shares for the 25th consecutive quarter. We gained volume and value share across core sparkling and juice drinks, sports drinks, and ready-to-drink teas. Importantly, we're able to do this in combination with a 2% increase in price mix. Excluding the impact of structural items, we generated comparable currency-neutral net revenue growth of 4% and strong operating income growth of 8%. Our broad diversified product portfolio, the disciplined approach to extracting and reinvesting savings, and our global geographic reach are enabling us to effectively navigate the still uncertain macroeconomic environment. +History has taught us that when we invest through difficult times we emerge even stronger. This quarter, our system delivered the highest number of servings ever reported in the third quarter, both for brand Coca-Cola and across our portfolio. In all, we delivered 181 billion servings, thanks to global volume growth of 2%, driven by 2% global growth in brand Coca-Cola. This record number of servings speaks not only to our system's worldwide strength, but also to the opportunities ahead of us as we engage with the next generation of global consumers. Our global still brands also delivered solid results growing 3% and gaining global value share. These third-quarter results bring our year-to-date volume growth to 2%, cycling 5%. +In line with our expectations for the third quarter, we delivered sequential volume growth in many key markets including North America, China, India, and regions across Europe. That said, clearly, the global economy remains challenged, as noted by the international monetary fund last week, which trimmed its forecast for global output for the sixth time since early last year. And as we have all noted, emerging markets have become increasingly more volatile further exasperating a challenging global landscape. Hence, disposable income in consumer spending have become challenged and consummately have impacted the overall growth of the non-alcohol ready-to-drink industry. Yet despite these on-going headwinds, our business remains healthy and we continue to invest in the strength of our brands. +We are fully implementing our productivity and reinvestment plans and together with our global bottling partners, we continue to advance our system. All of this leads us to remain confident in our ability to drive our volume growth trajectory back in line with our long-term growth model over time. Looking first to our operations in North America, brand Coca-Cola grew an impressive 2% in the quarter, leading our total beverage portfolio to 2% growth on top of 2% growth in the prior-year quarter. Year-to-date volume growth in North America is even as we cycled 2%. Sparkling beverages were even in the quarter with sparkling price mix increasing 1%. Year-to-date sparkling price mix is up 2% as we remain committed to a rational pricing environment. +We also remain focused on consistent investments in packaging innovation, in immediate consumption growth, and increased team recruitment, all of which are yielding positive results. Specifically, packages like the 1.25-liter and mini packs, mini can packs, have increased our household base by more than 1.8 million in the last year. In addition, Coca-Cola has generated over 19 million incremental immediate consumption transactions year-to-date, and importantly, Coca-Cola remains the most preferred beverage brand amongst teens by a 2 to 1 margin. Still beverage volume grew a solid 5%, with volume and value share gains across the energy, juice and juice drinks, water, and tea categories. +In sports drinks, we gained volume share while maintaining value share. As these results indicate, our revenue growth management strategies are working and enabling our system to provide consumers the brands they love, the convenience that they crave, and the value that they need while also expanding our top line. We continue to outperform the industry, gaining volume and value share across both sparkling and still categories. I'm also pleased to share that we are making progress on the evolution of our North America system, as our North America team continues to advance discussions with existing and prospective partners who are eager to be part of this dynamic franchise system. +Turning now to Latin America, our volume growth was even in the third quarter cycling 5% growth, and coupled with a double-digit increase in price mix due primarily to continued and disciplined focus on price and pack architecture enhancements, as well as inflationary environments in some markets. Across the region, we gained non-alcoholic ready-to-drink volume share, making this the 25th consecutive quarter that we have maintained or gained volume share. Similar to what we have experienced in other markets, we're seeing a slowdown in economic growth in Mexico and Brazil. Falling GDP growth rates have led to slower growth rates in personal consumption and, consequently, in non-alcoholic ready-to-drink beverages. As in other instances where we have witnessed economic slowdowns in recent years, we're expanding our marketing efforts while actively working with our bottling partners to invest in these markets and to offer consumers attractive price pack combinations. Examples include the expansion of returnable glass bottle distribution, and initiatives to ensure affordability tied to magic price points. Outside of Mexico and Brazil, we experienced solid performance with volume growth of 4% in the quarter. +Moving on now to Europe, we again witnessed diverging results with 3% volume growth in Northern European countries, offset by a 5% volume decline in countries that make up Central and South Europe, for a net decline of 1% in our European business in the third quarter. In spite of this challenging environment, we gained volume share in core sparkling across the entire continent, while continuing to strengthen our competitive positions across the non-alcoholic ready-to-drink beverage industry in our Central and Southern European business units. Price mix increased 8% in the quarter, including the impact of the consolidation of Innocent. Our Share a Coke campaign was extremely well received. We placed over 2.5 billion customized packages into the market to drive team recruitment and further bolster immediate consumption. +Lastly, our operations in Germany continue to perform well, delivering 3% growth in the quarter, cycling 3%. This performance was fueled by high single-digit growth in brand Coca-Cola and double-digit Coke Zero growth. Sprite and Fanta also contributed to growth in the quarter in Europe. The Eurasia and Africa group grew 4%, cycling 11%, as we maintained focus on broadening distribution, honing our marketing efforts, and strengthening brand loyalty in the more than 80 countries that make up our business in this dynamic region. Volume growth grew 4%, led by brand Coca-Cola which grew 3%, and Sprite which grew 4%. Still beverage volume grew 3% in the quarter. +The Eurasia and Africa group maintained volume share in non-alcoholic ready-to-drink beverages, while growing volume share in sparkling beverages and juice and juice drinks. Both the Middle East and North Africa business unit and the Central East and West Africa business unit maintain their strong first half volume performance in the third quarter. On a year-to-date basis, the Eurasia and Africa group is up high single digits, cycling 10% growth, and has been an important contributor to our year-to-date performance. Our Pacific group delivered 5% growth in the quarter, improving sequentially from the second quarter and cycling 4% from the prior-year quarter. Sparkling beverages led with 5% growth as brand Coca-Cola delivered 7% growth and Sprite grew 5%. Still beverage volume also grew 5% in the quarter while cycling 7% growth. +As noted during our second-quarter call, we anticipated a better second half of the year in China and I'm pleased to report that we were able to deliver 9% volume growth in the quarter, led by 8% growth in sparkling beverages. Earlier this year, we began to evolve our strategies in China to reflect the current economic and competitive environment and also to position ourselves for continued sustainable profit growth. Our business in India delivered 6% growth in the quarter, cycling double digits. We achieved this growth while increasing prices across our juice brands to offset higher cost of goods. In addition, volume grew by strong double digits in September, once the impact of the extended monsoons abated. Brand Coca-Cola again led the way with 22% growth in the quarter. +We are pleased with these results and with our solid volume and value share gains across sparkling and still beverages in India. Looking ahead, we have strong marketing programs planned for the fourth quarter of this year and into next year. I'm particularly excited about two iconic marketing programs that will ignite consumer passions across key markets. Specifically, the Olympic torch relay recently departed from ancient Olympia as it begins its relay journey across Russia. And the FIFA World Cup Trophy Tour is also under way, with stops planned in 89 countries where passions for futbol run high. +Further, throughout our Company's history, we've always been at the forefront of cultural change in forming the conversation, inspiring our youth to act, and bringing resources to our local communities all across the world. This legacy has strained our thinking about forging effective and lasting partnerships, creating shared value and making a positive societal difference in areas that are of critical importance to our business, specifically water, woman, and well-being. Returning to our global performance, we benefited from marked sequential improvement in several key markets. We achieved robust and widespread growth of our flagship brand, and we delivered solid financial results. +Our efforts to enhance the health of our system are working, as evidenced by our broad-based growth, improving execution, and strong cash generation. At the same time, we also acknowledge that we have more work to do, as we will no doubt face headwinds as we work towards our 2020 vision. Nevertheless, the non-alcoholic ready-to-drink beverage industry is a vibrant and rewarding business to compete in and our business has consistently grown. And I can assure you that the underlying forces that shaped our 2020 vision just a few years ago remains very much intact today. Together with our global system partners, our road map is enabling us to strategically invest, both through good times and challenging times, to deliver long-term sustainable performance. +I'll now turn the call over to Gary. + +-------------------------------------------------------------------------------- +Gary Fayard, The Coca-Cola Co - CFO [4] +-------------------------------------------------------------------------------- + + Thanks, Muhtar, and good morning, everyone. Our third-quarter results underscore several key points. First, the global economy is still struggling to recover, with increasing volatility across emerging markets. Second, slowing economic growth clearly impacted consumer spending and overall non-alcoholic ready-to-drink industry growth in the quarter. And third, in spite of these macro trends, our strategies and solid execution enabled us to once again capture global value share and to deliver solid financial performance. As Muhtar said, we grew our global volume 2% in the quarter, while at the same time delivering solid financial results. While we're pleased with this sequential volume improvement, we remain focused on further advancing our volume growth trajectory over time. Concentrate sales were slightly below unit case volume growth in the quarter, but were in line with unit case sales year-to-date. +Moving on to our financial results, each of our geographic operating units contributed to comparable currency-neutral operating income growth in the quarter. Comparable currency-neutral net revenues were even, both in the quarter and year-to-date. Excluding the impact of structural items, this would primarily be the Philippines and the Brazil bottler, net revenues increased 4% for the quarter and 3% year-to-date. We realized a healthy 2% global price mix for the quarter, and 1% price mix year-to-date. Importantly, year-to-date price mix was positive across each of our geographies, with the exception of the Pacific due to geographic mix. Also, as you know, we consolidated the Innocent brands in Europe, which helped our price mix in the quarter. But just to be clear, our global price mix was 2% without the Innocent brands benefit. +As expected, our gross margins moderated somewhat this quarter due to geographic mix. We expect our full-year gross margins to be relatively in line with our year-to-date comparable gross margins. Excluding the impact of structural items, we achieved 5 points of favorable operating expense leverage for the quarter, while we continued to support our brands through increased marketing investments. Our operating expense leverage now stands at 3 points year-to-date, and we expect low single-digit leverage for the full year. As a reminder, we are cycling the reversal of expenses related to one of our long-term incentive plans in the fourth quarter of last year. +Our comparable currency-neutral operating income was up 7% this quarter and 5% year-to-date. Excluding the impact of the structural items, operating income grew 8% in the quarter and 6% year-to-date. Therefore, we now expect our full-year operating income to be generally in line with our year-to-date performance. On a comparable basis, the impact of currency was a 5% headwind on this quarter's operating income results, a full point more than we expected due to the -- and this is due to the weakening of many of the emerging market currencies. We now anticipate continued currency headwinds will have an unfavorable impact on operating income in the 5% to 6% range in the fourth quarter. +Comparable earnings per share grew 4% in the third quarter, despite currency headwinds of about 5%. Year-to-date comparable earnings per share also grew 4%, despite headwinds from currency of about 4%. We generated $7.7 billion in cash from operations year-to-date, and have repurchased $2.7 billion of our shares in line with our plans to repurchase $3 billion to $3.5 billion this year. Equity income came in lower than in the prior year quarter due to the ongoing challenging macroeconomic conditions around the world. We expect equity income will continue to be impacted by these factors. +Let me now provide you just with a couple of reminders as we look to the balance of the year. Looking forward, as mentioned in our second-quarter earnings call, we anticipate that bottling transactions, including the impact of the deconsolidation of our Brazilian bottling operations early in the third quarter, will have a 3% structural impact on our full-year 2013 net revenues. Likewise, our full-year operating income results should see a 1% negative structural impact. In closing, we are strategically navigating through these challenging macroeconomic times, investing in our business, steadily strengthen our competitive position, and to drive balanced growth and long-term sustainable performance. +Operator, we're now ready for questions. + + + +================================================================================ +Questions and Answers +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Thank you. We will now begin the question-and-answer session. +(Operator Instructions) +Our first question comes from Dara Mohsenian from Morgan Stanley. + +-------------------------------------------------------------------------------- +Dara Mohsenian, Morgan Stanley - Analyst [2] +-------------------------------------------------------------------------------- + + Good morning. + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Co - Chairman & CEO [3] +-------------------------------------------------------------------------------- + + Good morning. + +-------------------------------------------------------------------------------- +Dara Mohsenian, Morgan Stanley - Analyst [4] +-------------------------------------------------------------------------------- + + Muhtar, I was hoping for more granularity on emerging markets given the Q3 slowdown, particularly in Latin America, which was in contrast to some improvement we saw in China and India. So can you give us an update on the macro environment as you look around the world? And also, some of the strategies you mention you were implementing, are you gaining traction at this point from a market share standpoint? And should we expect to see volume performance in emerging markets improve as we look out going forward from here? + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Co - Chairman & CEO [5] +-------------------------------------------------------------------------------- + + Yes, Dara, good morning. I think first it's important to realize that there is different timing across the world to some of the volatility and macroeconomics, and particularly what's interesting for us which is disposable incomes. So I think China has already had a slowdown and is beginning to recover. We see that. And there's always also a lag between the GDP per capitas and disposable income. So also important to realize that they don't all happen at the same time. The numbers don't correspond to each other one-to-one. +And so we do see an improvement in Southeast Asia and parts of certainly China, where things have stabilized and things, people are beginning to normalize their habits. And in the last three, four months we've seen a flight of currency from emerging markets, market stock exchanges in countries back into North America. That's had impact on disposable incomes in Latin America, in Eurasia, in countries like Turkey, and other countries, in certain other countries in North Africa. So, yes, those -- and you can track stock exchange indexes and you can track disposable income growth or slowdowns. They are all very related and we do see that the world is not just one city or one element of volatility. There's different pockets of volatility happening at the same time. And what is, what we are fortunate with is the great portfolio, a wonderful portfolio where India slowed down maybe seven, eight, nine months ago. +We see some comeback in terms of disposable income I'm talking about, and China is the same. Southeast Asia I would say are similar. Philippines also pretty much in that camp. And then we certainly also see that we've still got some headwinds maybe in other parts of the world. So there's some tailwinds coming and some headwinds coming. And we continue to invest in our brands and when you look at our performance, we have sequential improvement in many parts of the world, particularly when you look at places like India, places like China, Atayan, even also developed markets such as Australia and also South Africa. And our African continent, I haven't mentioned that, countries that are some sub-South Africa that are usually south of 80 per capita, again, grew in a very healthy manner this past quarter, about 5% up. And we expect Africa to continue to generate good results and economies in Africa seem to be pretty buoyant and seem not to be too impacted. But of course they are very slow level of their per capita development as well. I hope that helps. + +-------------------------------------------------------------------------------- +Dara Mohsenian, Morgan Stanley - Analyst [6] +-------------------------------------------------------------------------------- + + Yes, that's helpful. And then some of the strategies you're implementing, do you think it's helping to drive an improvement in market growth at all or drive market share gains? And do you feel comfortable that emerging markets trends have bottomed in general at this point and we should see some improvement going forward, or is it still too volatile to call right now? + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Co - Chairman & CEO [7] +-------------------------------------------------------------------------------- + + I thinks it's pretty -- as I said, different pockets showing different results, but we have a very, very sharp focus on -- I was down in Latin America recently a month ago. I visited many countries in Africa recently as well as in Asia. We have an incredibly sharp focus on brand price pack channel architecture, new price points, lower price points, more focus on affordability, more focus on returnable packs and smaller packs. Individual packs that help continue to keep the drinkers' base growing, which is key and essential to when economies also start turning up and when disposable income starts heading north. + +-------------------------------------------------------------------------------- +Dara Mohsenian, Morgan Stanley - Analyst [8] +-------------------------------------------------------------------------------- + + Great, thanks. + +-------------------------------------------------------------------------------- +Operator [9] +-------------------------------------------------------------------------------- + + Thank you. Our next question is from Bill Pecoriello from Consumer Edge Research. + +-------------------------------------------------------------------------------- +Bill Pecoriello, Consumer Edge Research - Analyst [10] +-------------------------------------------------------------------------------- + + Good morning, everybody. + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Co - Chairman & CEO [11] +-------------------------------------------------------------------------------- + + Good morning. + +-------------------------------------------------------------------------------- +Bill Pecoriello, Consumer Edge Research - Analyst [12] +-------------------------------------------------------------------------------- + + Muhtar, critics have said that Coke's growth story is over, reflected in the stock price, pointing to the slowing emerging market growth you were just talking about, declines in diet soft drinks. Some say the pricing in the US is irrational, and an inability to grow in big markets like US and Mexico. Can you explain why you still see solid growth ahead for the Company? And what the Company is doing in terms of innovation, productivity, you mentioned price pack earlier, to drive that growth and why the critics who have declared the growth story is over are wrong? Thanks. + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Co - Chairman & CEO [13] +-------------------------------------------------------------------------------- + + Yes, thanks, Bill. First, philosophically, from a strategic vantage point, the whole story of balanced growth we believe is still very impact. Balance being growth in western markets, growth in emerging markets, balance being growth in sparkling and growth in still beverages. And you see that happening in this past quarter as well. So we've grown in markets like the United States, which we believe is a long-term growth market. When you think about it, 14 of the last -- of the last 14 consecutive quarters, we've grown in all but one of them. And now we've generated, again, 2% growth, with 2% growth of brand Coca-Cola. +So we -- Australia grew. Many important markets in Western Europe grew. Germany grew again 3%. Countries in Northwest Europe generated good healthy growth for us. And then emerging markets. Yes, there's some headwinds that are happening in emerging markets but we believe they are very temporary. The whole demographic, the whole investment, the whole story of 1 billion new middle class still holds very strong in our opinion by 2020. Over this past decade that we're in, this decade that we're in, a billion new middle class. +That bodes very well for the industry we're in and we believe we can continue to generate very healthy good growth. We believe we can continue to generate very healthy price earnings. I mean, I'm sorry, price mix. And we believe that, therefore, in this, like in this past quarter which was where we did see a lot of headwinds, we generated 4% revenue growth and 8% currency-neutral operating income growth. And we believe that we had a lot of headwinds. So as economies begin to move, I think we'll see a lot of improvement. And I'll ask Ahmet as well to make some comments on this and if need be also ask Steve to add his commentary. + +-------------------------------------------------------------------------------- +Ahmet Bozer, The Coca-Cola Co - President Coca-Cola International [14] +-------------------------------------------------------------------------------- + + Thank you, Muhtar. Bill, you mentioned a few items. I'll just focus on a couple of them. Emerging markets, as you know, if you look at the history that it goes through cycles. So it has a cycle of years and years of growth and every now and then you have economic headwind, and you manage through that. But emerging growth, emerging markets growth economically certainly isn't over, and we have a formula which pretty much closely shows that as personal consumption grows, we actually grow with it. +Now, having said that, in some of the emerging markets where there might be personal consumption and macro headwinds, we could still grow, like India, because we have very low per caps and we have significant investments in feet on the street, infrastructure, brands. We're just really building our business. And India showed that again this year. So that's what I would say about your comment of emerging markets. The growth story there is far from over for a long time to come. And I guess the rest were about US pricing and decline in soft drinks. So maybe I should just pass that on to Steve. + +-------------------------------------------------------------------------------- +Steve Cahillane, The Coca-Cola Co - President Coca-Cola Americas [15] +-------------------------------------------------------------------------------- + + Yes. Thanks, Ahmet. First, I would just underscore on the broader question, what Muhtar said in his prepared remarks, that in this quarter we delivered the highest number of servings ever reported in the third quarter. So I think that bodes well for our growth story going forward. But with regards to North America pricing, which I heard you ask, Bill, and in particular, sparkling price. We feel good about delivering positive price mix in the quarter of plus 1%, in line with our strategy to consistently earn at least 1 to 2 points of sparkling with consumers. And in the US Coke system remains committed to taking rational pricing and we've done this very well over the past several years. In fact, we achieved 2 to 3 points of price mix in sparkling beverages and across our total portfolio in both 2011 and 2012. Year-to-date, we're 2% sparkling price mix, which we feel good about. +But I think it's important to remember, we've always said that we're going to focus on consumer-centric pricing. And if I can give you an example of that, the average price today of an 8-ounce serving of Coca-Cola is $0.25, exactly $0.25. This is up over 5% versus two years ago and it's up nearly 10% versus three years ago, which compares very favorably to the US inflation market. And this tells me really three things. First, at $0.25 we do not have an affordability issue. Coca-Cola remains a very affordable indulgence. Two, we've been able to earn price above inflation in the United States. And three, we still have plenty of room to continue to take price. +But now addressing the third quarter in particular, we acknowledge we did strategically invest in select promotional activity in the back half of the summer through the Labor Day holiday. Given that we essentially didn't have much of a Fourth of July holiday and Memorial Day holiday, this Labor Day acted much more like a Fourth of July holiday. But these investments were tied to specific occasion-based brands and packages to help drive incremental household penetration, which they did, attract more consumers into the category, which happened, and is very much in line with our long-standing North American strategy. And all of these activities that we did, all of them, to take price in the marketplace, I think set us up very well to take more price in this quarter and going into 2014. So we're very confident that the pricing environment in North America remains very rational and that we'll be able to continue to earn price in the marketplace in this quarter and going forward in the next year. + +-------------------------------------------------------------------------------- +Ahmet Bozer, The Coca-Cola Co - President Coca-Cola International [16] +-------------------------------------------------------------------------------- + + Yes, just let me round out that question with one final remark, Bill, and that is that once again if you take our world average per capita of around 90, just under 90, and you take the most populous nations of the world that are less than half of that per capita, India, China, Indonesia. Way below that number, way below half of that number, we believe there's -- and many other parts of the world as well in Africa, the youngest billion, we believe the critics, whoever they are, are wrong. I don't understand that sentiment. We're growing while others are not at the moment. And our business and balanced portfolio is built for times like these. So we see this as a time of opportunity. + +-------------------------------------------------------------------------------- +Bill Pecoriello, Consumer Edge Research - Analyst [17] +-------------------------------------------------------------------------------- + + Thank you very much. + +-------------------------------------------------------------------------------- +Operator [18] +-------------------------------------------------------------------------------- + + Thank you. Our next question or comment comes from Bryan Spillane from Bank of America. + +-------------------------------------------------------------------------------- +Bryan Spillane, Bank of America - Analyst [19] +-------------------------------------------------------------------------------- + + Hello, good morning. + +-------------------------------------------------------------------------------- +Ahmet Bozer, The Coca-Cola Co - President Coca-Cola International [20] +-------------------------------------------------------------------------------- + + Good morning. + +-------------------------------------------------------------------------------- +Bryan Spillane, Bank of America - Analyst [21] +-------------------------------------------------------------------------------- + + Question about Mexico and excise taxes. It's been in the press over the last, especially more so over the last couple of weeks, and in speaking to some of your bottling partners in Mexico specifically, it seems like they are more resigned to the potential that it's going to be a reality. So if you could talk a little bit about just how you see the situation unfolding in Mexico and to the extent you'll get an excise tax increase, how you plan -- or do you plan to do anything differently in Mexico in response to it? Maybe some thoughts about elasticity? And then finally, just any concern that there's spill-over into other markets would also be helpful? + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Co - Chairman & CEO [22] +-------------------------------------------------------------------------------- + + Yes. Look, Bryan, firstly let me just address that by saying regressive taxes do not work, period. And wherever we have seen them being implemented in some cases, they have been taken away by the government after two, three years, basically like in Denmark. They are not working wherever else they have been implemented, and so the consumer suffers in them. It's proven time and time after again. We've made our case to the government. We have tremendous respect for the government of President Pena Niento. And we need to understand that, and we've made our case that this really does not have anything to do with health policy. In order to address the health policy properly, we have to come and work together with government and with civil society to raise the awareness and to create programs that really work. That really drive physical activity and, therefore, just a regressive discriminatory tax on one part of the food industry just is not going to work and apparently that's all I would really like to say, because its discussions are in progress and I don't want to comment any further. + +-------------------------------------------------------------------------------- +Bryan Spillane, Bank of America - Analyst [23] +-------------------------------------------------------------------------------- + + Are there any preparations for -- I guess, just trying to understand if it does become a reality, do you have plans in place to deal with it if it does occur? + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Co - Chairman & CEO [24] +-------------------------------------------------------------------------------- + + I just don't want to comment on it at this moment. As I said, there are a lot of discussions going on and it would be wrong for me to publicly comment on any of those discussions and, therefore, we'll deal with whatever the result is in the most effective way. I can assure you that we will continue to prosper the business. We're one of the largest, we are the largest consumer goods business in the country. We are one of the largest contributors to the GDP in that country by a big margin, and we support millions of retailers in the country effectively for their livelihood and, therefore, I think that we will certainly find the right way forward, whatever happens. + +-------------------------------------------------------------------------------- +Bryan Spillane, Bank of America - Analyst [25] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Operator [26] +-------------------------------------------------------------------------------- + + Our next question or comment comes from John Faucher from JPMC. + +-------------------------------------------------------------------------------- +John Faucher, JPMorgan Chase & Co. - Analyst [27] +-------------------------------------------------------------------------------- + + Thank you very much. Muhtar and Gary, you guys talked about the price mix number improving sequentially, which was good to see. So Gary, can you talk a little bit about how you see this playing out over the next 12 to 24 months? Where you have the negative geographic mix offset by the positive mix on a per case basis is the bottler territories, where you own the bottler gets better like North America, versus the absolute level of pricing. How should we look at those factors competing against each other to try and map something out? +And then one other housekeeping question, which was your comments on operating profit for the year, could you just revise those and, or restate those, just because there's some confusion about whether it was currency-neutral or non-currency-neutral, what have you? Thanks. + +-------------------------------------------------------------------------------- +Gary Fayard, The Coca-Cola Co - CFO [28] +-------------------------------------------------------------------------------- + + Okay, John. Let me see how well I can do on this and then you can come back and ask. But first, going to price mix, and just as a reprise in general on price mix, generally what we see, and I'm going to take this in steps, generally what we see is you see pricing. So you see rate and mix, positive rate and mix, would be positive across almost all of the groups. You would then see negative, generally, you would see negative geographic mix and it's basically a function of higher growth in emerging market countries than developed market countries, which would give you a negative geographic mix. Then on top of that, and you're absolutely right, then where we own bottlers and they're growing, and that gives you then a positive price mix because they're finished products versus concentrate. +So a couple things. So if you go back to the second quarter, I talked about margins and I thought margins would moderate and because of geographic mix. And the follow-up to questions I remember, I said because we expect North America to actually perform better and that will actually hurt margins because it's a finished product business where margins are lower. But it helps price mix. And what you're seeing today is while price mix in North America was even for the quarter, we are getting positive price mix from our finished product businesses. +Going forward, and not talking specifically about 2014 because we're still in the midst of planning 2014 and we'll give you a full review on our views on next year in the February call, we are planning to take appropriate pricing and Steve referred to taking pricing in North America as well. So we are expecting to take pricing. So going forward, what I would expect to see is that we should have a positive in rate going forward. We should have a positive in mix going forward. We should have a positive from finished products going forward. And we should have a negative from geographic mix. So that's the kind of -- and if you add all of that up, it should be a positive price mix. That's what we would expect and it's what we would expect as what's in our long-term earnings road model, is positive price mix long term. +Now, let me see if I can turn to operating income. When I was talking about operating income, it was definitely currency-neutral. It was -- and ex structural. So let's be very clear on both of those, currency-neutral and ex structural So operating income was 8% currency-neutral ex structural for the quarter, and 6% year-to-date currency-neutral ex structural. And what I said was we now expect the full year to be generally in line with the first half of the year. So somewhere in that ball park and that is net of currency-neutral and net of the structural impact because I can tell you with the structural impact, it's a point of negative structural impact and so that would take our year-to-date from 6% to 5%, for example. So just to be clear, ex structural, currency-neutral. + +-------------------------------------------------------------------------------- +John Faucher, JPMorgan Chase & Co. - Analyst [29] +-------------------------------------------------------------------------------- + + Okay. So, and I'm not trying to trick you into guidance or anything here, but it basically sounds like you're saying currency-neutral, ex structural, mid-single digits year-to-date. So, therefore, that implies the Q4 but then you talked about the currency impact. So as we're looking at those, should basically offset to get you to slight operating profit growth for the quarter? + +-------------------------------------------------------------------------------- +Gary Fayard, The Coca-Cola Co - CFO [30] +-------------------------------------------------------------------------------- + + Yes, without giving guidance, what we're basically saying is that the full year we think ex structural and ex currency, it ought to be in line pretty much with where we are year-to-date. + +-------------------------------------------------------------------------------- +John Faucher, JPMorgan Chase & Co. - Analyst [31] +-------------------------------------------------------------------------------- + + Okay. + +-------------------------------------------------------------------------------- +Gary Fayard, The Coca-Cola Co - CFO [32] +-------------------------------------------------------------------------------- + + Yes. + +-------------------------------------------------------------------------------- +John Faucher, JPMorgan Chase & Co. - Analyst [33] +-------------------------------------------------------------------------------- + + Thank you very much. + +-------------------------------------------------------------------------------- +Gary Fayard, The Coca-Cola Co - CFO [34] +-------------------------------------------------------------------------------- + + Okay. + +-------------------------------------------------------------------------------- +Operator [35] +-------------------------------------------------------------------------------- + + Our next question is from Judy Hong from Goldman Sachs. + +-------------------------------------------------------------------------------- +Judy Hong, Goldman Sachs - Analyst [36] +-------------------------------------------------------------------------------- + + Thanks, good morning. I had one follow-up question on North America and then a question about Europe. So in North America, there's been a lot written about the declines that we've seen in diet sodas. And, Steve, I'm not sure if you went through that and whether you shared some of the similar concerns that people have written about the decline in diets and your perspective on whether the artificial sweetener issue is impacting that category at all and from your strategy in dealing with that situation? + +-------------------------------------------------------------------------------- +Gary Fayard, The Coca-Cola Co - CFO [37] +-------------------------------------------------------------------------------- + + Yes, Steve, you want to address that? + +-------------------------------------------------------------------------------- +Steve Cahillane, The Coca-Cola Co - President Coca-Cola Americas [38] +-------------------------------------------------------------------------------- + + Yes, thanks, Judy. First, I did talk specifically about diets. I would underscore that we have a very wide portfolio in North America led by brand Coca-Cola, which is twice the size of Diet Coke, and brand Coca-Cola, as you know, grew 2% in the quarter which we're very pleased with. Diet Coke is like a lot of diet products in the United States, and not just beverages but across the whole array of food, are under a bit of pressure as people are questioning ingredients, ingredient safety, and so forth. But we believe very strongly in the future of Diet Coke, the number two sparkling brand in the United States. We've got terrific programs against it. We're actually seeing increased incidents in the past quarter, between 19- and 24-year olds. We think a lot of that has to do with the exciting new promotions with Taylor Swift, some of the new packaging we're bringing into the marketplace, an increased focus on Diet Coke. +But there are headwinds. There are headwinds that we're facing. And we face headwinds in a lot of different areas, a lot of different places, and this is just one of them. But last year it became the second best selling sparkling in the United States and we're continuing to focus on it. Coke Zero, also a part of our zero-calorie portfolio, grew mid-single digits in the quarter. So we're very happy about that. We've got a great program around Coke Zero, College GameDay just kicked off, it's really becoming ever-more relevant with young males. So we're confident that throughout our whole portfolio, we're offering consumers exactly what they want, when they want it, how they want it, at the right prices that they want it, and we'll continue to focus on any of the headwinds around Diet Coke. And we're confident that it has a bright future in this country. + +-------------------------------------------------------------------------------- +Judy Hong, Goldman Sachs - Analyst [39] +-------------------------------------------------------------------------------- + + Okay. And then just on Europe, the improvement that we saw in Northwest Europe and Germany as well, to what do you attribute that to? Perhaps weather getting much better in the quarter as opposed to the macros in consumers and what you guys are doing to really rejuvenate growth in those markets? + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Co - Chairman & CEO [40] +-------------------------------------------------------------------------------- + + Well, Judy this, is Muhtar. First, I think it's important to understand that, and I've said this in the past, that economies that are performing at a different pace in the continent of Europe, not everywhere is really bad, not everywhere is really good. And so you still have very challenging consumer sentiments in Spain and Italy and Greece and Portugal and the South, in Southeast Europe, in what used to be termed as the Balkans, Romania, Bulgaria, former Yugoslavia. It's very challenging environment. And then you've got a better environment in Northwest Europe and then certainly the best environment still in Germany. And so based on those, our business also reflects some of those conditions and so it's a pretty good mirror actually. And I'll ask Irial to comment on Germany and why we've been consistently performing in Germany and growing our business and, again, there is tremendous sequential improvement versus the first half in many countries of Northwest Europe, in Scandinavia and also Northwest European countries. Irial? + +-------------------------------------------------------------------------------- +Irial Finan, The Coca-Cola Co - President Bottling Investments Group [41] +-------------------------------------------------------------------------------- + + Thanks, Muhtar. And this actually goes back to one of the earlier questions. I think in Germany we've got an economy that's doing okay. We have got actually really good marketing married up with continued excellent execution. And you bring all of that together and you get great results. And for me in Germany, it gives me great confidence about the future of our business, quite frankly, because we are seeing where we put in the hard work, where we do the right things in the business, we do get good results. And Germany is just an example of what can happen, quite frankly, in many markets around the world as the economies turn and improve. + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Co - Chairman & CEO [42] +-------------------------------------------------------------------------------- + + Ahmet, do you want to comment? + +-------------------------------------------------------------------------------- +Ahmet Bozer, The Coca-Cola Co - President Coca-Cola International [43] +-------------------------------------------------------------------------------- + + Yes, I just wanted to -- hello, Judy. I just wanted to add to the others that we had a very, very strong Share a Coke campaign across Europe this summer that worked extremely well. We are ever-more closely aligned with our bottling partners, really driving growth. And just on the macro, I would like to add that there's a clear divergence between North and South. So North continues to do better and South continues to do worse. So our business in the North certainly is reflective of that. + +-------------------------------------------------------------------------------- +Judy Hong, Goldman Sachs - Analyst [44] +-------------------------------------------------------------------------------- + + Okay, great. Thank you. + +-------------------------------------------------------------------------------- +Operator [45] +-------------------------------------------------------------------------------- + + Our next question is from Bill Schmitz from Deutsche Bank. + +-------------------------------------------------------------------------------- +Bill Schmitz, Deutsche Bank - Analyst [46] +-------------------------------------------------------------------------------- + + Hello, good morning. + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Co - Chairman & CEO [47] +-------------------------------------------------------------------------------- + + Good morning. + +-------------------------------------------------------------------------------- +Bill Schmitz, Deutsche Bank - Analyst [48] +-------------------------------------------------------------------------------- + + Hey, can you just talk about the timing of some of the refranchise in the US? Because I think we talked a lot about it earlier in the year and it's kind of hit a lull recently? And then I have a follow-up, if I may. + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Co - Chairman & CEO [49] +-------------------------------------------------------------------------------- + + Yes, I think it's on target, as we have said, reported previously, where we make very sound significant good progress with, in discussions with some of our existing partners, as well as discussions ongoing with some other prospective partners. So we are on target, if not a little bit ahead. And I think you'll hear more about it in the coming period ahead of us, and I'll ask Steve just to maybe shed some more light on it. + +-------------------------------------------------------------------------------- +Steve Cahillane, The Coca-Cola Co - President Coca-Cola Americas [50] +-------------------------------------------------------------------------------- + + Yes, thanks, Muhtar. Bill, the one thing I would really underscore is we absolutely have not hit a lull. Don't take the absence of public commentary to mean that we are not making very good, very constructive progress. All our bottling partners, both current and prospective, are extremely excited about this business in the United States, about the opportunity to continue to be franchise partners in the United States, to grow the business in the United States, and we're making very exciting progress and we'll have more to report in the coming months. + +-------------------------------------------------------------------------------- +Bill Schmitz, Deutsche Bank - Analyst [51] +-------------------------------------------------------------------------------- + + Great. Thanks so much. And then just on the SG&A costs, can you just give us a little bit more color on what drove some pretty significant efficiencies, which is obviously great, but with the advertising ratio flat or up and then maybe what drove some of the other improvements on that line item? + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Co - Chairman & CEO [52] +-------------------------------------------------------------------------------- + + Talking about productivity, Bill? + +-------------------------------------------------------------------------------- +Bill Schmitz, Deutsche Bank - Analyst [53] +-------------------------------------------------------------------------------- + + Yes, productivity and SG&A broadly, yes. + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Co - Chairman & CEO [54] +-------------------------------------------------------------------------------- + + I'll ask Gary, do you want --? + +-------------------------------------------------------------------------------- +Gary Fayard, The Coca-Cola Co - CFO [55] +-------------------------------------------------------------------------------- + + Sure, Bill. Within the quarter, we continue to invest in marketing, so marketing is actually up in the quarter and up year-to-date. We had significant productivity savings in the quarter. We have some previously announced productivity programs that we announced back in 2012. Those 2012 programs will go through 2015, and really focus around productivity and then reinvesting those back into the business. They were focused on information systems, marketing, supply chain, innovation, operational excellence, that sort of thing. +I can tell you, we'll give you a full update on it at the year-end call, so I can give you the full year. But we are making very good progress against the goals and you'll see that on the February call when we go through a full update. And we've got hard savings and soft savings. So let me give you some examples of what's happening and it's adding into the productivity and some of the leverage that you're seeing. +So in things like supply chain, if you buy things cheaper, hard savings. And we're doing a lot around supply chain and actually getting a lot of hard savings. And those you're seeing being reflected. In marketing, if you can buy media cheaper, then we just buy more media basically is what we're doing. So we're reinvesting back into marketing and being able to buy more media for the same price, if you will. So we, as I say, we'll give you a full update on all the productivity programs in February at our year-end call. But we're making excellent progress and you're seeing a lot of that just what's coming through the G&A line with, as I say, within that marketing, SG&A marketing, being up for the quarter and year-to-date. + +-------------------------------------------------------------------------------- +Bill Schmitz, Deutsche Bank - Analyst [56] +-------------------------------------------------------------------------------- + + Got you. Was there any benefits from the incentive compensation accruals either this quarter, maybe into the fourth quarter as well? + +-------------------------------------------------------------------------------- +Gary Fayard, The Coca-Cola Co - CFO [57] +-------------------------------------------------------------------------------- + + Very, very little. There's a huge cycling of last year in the fourth quarter, as I've mentioned earlier. But there's very little. I mean, there's a little bit but nothing of significance in the quarter this year. + +-------------------------------------------------------------------------------- +Bill Schmitz, Deutsche Bank - Analyst [58] +-------------------------------------------------------------------------------- + + Great. Thanks so much. + +-------------------------------------------------------------------------------- +Gary Fayard, The Coca-Cola Co - CFO [59] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Operator [60] +-------------------------------------------------------------------------------- + + Our next question is from Ali Dibadj from Bernstein. + +-------------------------------------------------------------------------------- +Ali Dibadj, Bernstein - Analyst [61] +-------------------------------------------------------------------------------- + + Hello, guys, thanks. Just one quick thing and then a real question. So I just want to underscore something again, because it's a key controversy and, look, I'll be fair. I think what Steve said a moment ago is music to a lot of investors' ears. And I want to just replay to make sure I understand. So did you say that the past couple months in North America from a price promo investment perspective, we're a little bit more of a blip and that we should expect something like higher pricing that we saw in 2011 and 2012 going forward in North America? + +-------------------------------------------------------------------------------- +Steve Cahillane, The Coca-Cola Co - President Coca-Cola Americas [62] +-------------------------------------------------------------------------------- + + Yes, thanks, Ali. I think that's a fair interpretation of what I said. This was a very different summer. It's been a difficult year starting with the fiscal cliff and sequestration and payroll taxes and so forth. And then the summer was very sluggish and it's very important in our business to keep consumers engaged with our brands, to make sure that we're in the households, to make sure that teens are being recruited. And so Labor Day acted very much like a Fourth of July or Memorial Day, whereas typically it would not. It would be the end of summer. +And Labor Day acted like the only summer, so it was more promotional than you would have seen. It would be more promotional than what we would expect going forward. But those things happen from time to time. And we think that the pricing environment will continue to be very strong, very rational, and because of all the investments we're making in our brands, we feel that we have the opportunity to earn even more price going forward in the marketplace. And that would be absolutely our intention to do that. + +-------------------------------------------------------------------------------- +Ali Dibadj, Bernstein - Analyst [63] +-------------------------------------------------------------------------------- + + Okay. That makes perfect sense. + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Co - Chairman & CEO [64] +-------------------------------------------------------------------------------- + + And I just want to add one thing. In terms of the Nielsen data, yes, that's exactly the reflection. But don't underestimate. We took very healthy pricing and I see also in the quarter. And so, overall, that's how you get to the one price mix positive on sparkling. And so, don't let that point go unnoticed at the moment. + +-------------------------------------------------------------------------------- +Ali Dibadj, Bernstein - Analyst [65] +-------------------------------------------------------------------------------- + + I appreciate that. That makes a lot of sense. And then a broader question, and I don't know how often you revisit this, but what do you think the Company has to grow volumes between now and 2020 to deliver on the 2020 vision, given some of the recent slowdown in volumes? And I guess in that context, do you think as a Company you have to acquire more to reach that vision? + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Co - Chairman & CEO [66] +-------------------------------------------------------------------------------- + + I would say that first, we believe that our long-term growth model, with appropriate mix which we believe we can take and we can generate, it would definitely get us to our 2020 vision of, from a system revenue point of view, of doubling our business with the base of 2010. So that's the sort of trajectory, if you like, and we're on track in terms of moving ahead to doing, achieving our goal. The second piece is we'll always be looking for any kind of bolt-on acquisitions that may make sense, but that's the extent of what I would say that right now we would be looking at. Bolt-on acquisitions and if there's an opportunity, we will look at it seriously. + +-------------------------------------------------------------------------------- +Ali Dibadj, Bernstein - Analyst [67] +-------------------------------------------------------------------------------- + + And from a difference of volume versus price mix to reach the system doubling goal, has it shifted at all between the two? + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Co - Chairman & CEO [68] +-------------------------------------------------------------------------------- + + Sorry, say that again? + +-------------------------------------------------------------------------------- +Ali Dibadj, Bernstein - Analyst [69] +-------------------------------------------------------------------------------- + + Well, so to double the system sales by 2020, there is perhaps an ingoing assumption of what would be from volume and what would be from price mix. Has the recent global slowdown shifted that mix at all between volume growth and price mix growth to reach the doubling of sales? + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Co - Chairman & CEO [70] +-------------------------------------------------------------------------------- + + I don't think materially. You know, if you look at our long-term growth of corridor of volume plus what we've been achieving, I think the balance is still there the same as it used to be. + +-------------------------------------------------------------------------------- +Ali Dibadj, Bernstein - Analyst [71] +-------------------------------------------------------------------------------- + + Thanks very much. Very helpful. + +-------------------------------------------------------------------------------- +Operator [72] +-------------------------------------------------------------------------------- + + Our next question is from Wendy Nicholson from Citi Research. + +-------------------------------------------------------------------------------- +Wendy Nicholson, Citi Research - Analyst [73] +-------------------------------------------------------------------------------- + + Hello, thanks, good morning. First question on China, can you talk about the acceleration, the pickup in volumes there, whether that was driven by any change in pricing or promotional levels? And what your outlook of a normalized run rate, because that region's just been so lumpy in terms of volume growth as we go into 2014, where's a base case of volume growth? +And then my second question is looking at the buyback program, the stock's on track for two years of relative under-performance, and we haven't seen that for a while and yet your target for buybacks hasn't changed since the beginning of the year. So I'm kind of surprised with the balance sheet you have, with the weakness in the stock, and certainly, Muhtar, with your resounding confidence about the long-term outlook, you're not getting more aggressive on the buyback here? Thanks. + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Co - Chairman & CEO [74] +-------------------------------------------------------------------------------- + + Yes, I'll have Ahmet just comment on China. Then maybe Gary can finish off the second part of the question. Sure. + +-------------------------------------------------------------------------------- +Ahmet Bozer, The Coca-Cola Co - President Coca-Cola International [75] +-------------------------------------------------------------------------------- + + Thanks, Wendy. You might remember that in our last call, we talked about the fact that we were evolving both our organization and our strategy in China. And what we see in the third quarter really encourages us that we had not only 9% growth in total, but also 8% growth in sparkling. And that's pretty much delivers on the expectation that we've said that we would expect sequential improvement from the first half results, in the second half of this year, and we expect that sequential improvement from the first half results to continue into 2014. +To your question of pricing promotion, we did not have any significant marked pricing promotions in the marketplace. It was basically a combination of, A, beginning to implement parts of our new strategy in the marketplace, B, the same Share a Coke promotion as we're scaling up these wonderful global assets in all parts of the world. And then our new team beginning to gel together, connecting with our bottling system and really improving execution. So we are encouraged by those results and we expect to continue to, as I said, improve sequentially from the first half results. + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Co - Chairman & CEO [76] +-------------------------------------------------------------------------------- + + Okay, Gary. + +-------------------------------------------------------------------------------- +Gary Fayard, The Coca-Cola Co - CFO [77] +-------------------------------------------------------------------------------- + + Yes, Wendy, relative to share repurchase, let me first, let me just start with a preface that don't particularly agree with you on saying our share price is relatively underperformed for the last two years. But absent that, a couple of thoughts on share repurchase. Our view on share repurchase is that share repurchase is value neutral. It is not something that grows value. It does for the short-term holder. Because maybe you can get a bump in the share price. But for the long-term holder, it is not something that is value-enhancing. It is much more like a cash-efficient dividend, which is the way we treat it in that our priorities for cash are number one, to reinvest in the business, to grow the business that would include bolt-on acquisitions, et cetera. +Number two would be dividends which we have increased for the last 51 years, 10% this year. And third, excess cash would be put into share repurchase and just because we don't need that cash in the business. So it's a return of cash to shareholders. But leveraging the balance sheet to do something that we would view as value-neutral, we don't think is the right thing to do so we continue to just perform exactly in line with the targets that we set at the beginning of the year. Thanks. + +-------------------------------------------------------------------------------- +Wendy Nicholson, Citi Research - Analyst [78] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Co - Chairman & CEO [79] +-------------------------------------------------------------------------------- + + Thank you Gary, Ahmet, Steve, Irial, and Jackson. We delivered sound third-quarter results within an ongoing challenged macroeconomic environment. While we saw sequential improvement in the business, we remain constructively discontent and resolutely focused on further advancing our growth trajectory. Our 2020 vision and long-term strategies remain firmly intact. And together with our global bottling partners, we're investing in our brands and our capabilities to further strengthen our system and to drive sustainable growth and value. As always, we thank you for your interest, your investment in our Company, and for joining us this morning. + +-------------------------------------------------------------------------------- +Operator [80] +-------------------------------------------------------------------------------- + + That concludes today's conference call. Thank you for your participation. You may disconnect at this time. + + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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Earnings Conference Call +04/11/2014 08:30 AM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Marianne Lake + JPMorgan Chase & Co - CFO + * Jamie Dimon + JPMorgan Chase & Co - Chairman & CEO + +================================================================================ +Conference Call Participiants +================================================================================ + + * John McDonald + Sanford C. Bernstein & Company, Inc. - Analyst + * Paul Miller + FBR & Co. - Analyst + * Erika Najarian + BofA Merrill Lynch - Analyst + * Matthew O'Connor + Deutsche Bank - Analyst + * Guy Moszkowski + Autonomous - Analyst + * Steven Chubak + Nomura - Analyst + * Gerard Cassidy + RBC Capital Markets - Analyst + * Jim Mitchell + Buckingham Research Group - Analyst + * Derek De Vries + UBS - Analyst + * Jeff Harte + Sandler O'Neill & Partners - Analyst + * Chris Kotowski + Oppenheimer & Co. - Analyst + * Glenn Schorr + ISI Group - Analyst + * Betsy Graseck + Morgan Stanley - Analyst + +================================================================================ +Presentation +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Good morning, ladies and gentlemen. Welcome to JPMorgan Chase's first-quarter 2014 earnings call. This call is being recorded. Your line will be muted for the duration of the call. We will now go live to the presentation. Please stand by. +At this time I would like to turn the call over to JPMorgan Chase's Chairman and CEO, Jamie Dimon, and Chief Financial Officer, Marianne Lake. Ms. Lake, please go ahead. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [2] +-------------------------------------------------------------------------------- + + Thank you Operator, good morning everybody. As of right now, I'm going to take you through the earnings presentation which is available on our website. Please refer to the disclaimer regarding forward-looking statements which is at the back of the presentation. +Starting on page 1, the Firm generated net income of $5.3 billion for the first quarter, $1.28 a share, with a return on tangible common equity of 13% on revenue of $24 billion, down 8% year on year driven by lower markets revenue, down 17%, and continued headwinds in mortgage. Reported expenses for the Firm were basically the same as adjusted expenses this quarter at $14.6 billion, in line with our expectations and our guidance for full-year adjusted expenses to be below $59 billion. Firm-wide legal expense for the quarter was immaterial. +Of note, you will see that we didn't disclose any significant items this quarter on the front page of the presentation. There were items in the quarter that we consider non-core or non-recurring. Each individually didn't rise to the level of being disclosed on the front page, and importantly, the net of all such items across businesses was not significant to the Firm's reported results. To be clear, this means our reported net income of $5.3 billion is very close to being a core performance number, which we consider a solid result given the challenging environment for both markets and mortgage. Importantly, underlying drivers across most businesses continued along impressive trends. +Finally, we're pleased that our capital plan was approved in the quarter, and the Board announced its intention to increase our quarterly common stock dividend to $0.40 a share effective in the second quarter, as well as the authorization to repurchase a gross $6.5 billion of common equity, or net a little over $5 billion, that's net of expected employee issuance. +So skipping over page 2 and turning to page 3. Our Basel III Tier 1 common ratio was 9.5%, flat to last quarter, being over 40 basis points of capital generated and run-off in the quarter, largely offset by the impact of certain specific risk models that were approved for use in Basel I last year, but which our regulators disapproved for use under Basel III effective at the beginning of this year. We believe it should largely be timing with partial remediation in the second half of 2014 and further remediation in 2015. The impact of these models approvals was contemplated in our Investor Day guidance of reaching 10% plus by the year end, but it won't be in a linear fashion and the majority of capital accretion will occur in the second half of the year. +Effective this quarter our regulatory reported ratio moves from a Basel I measure to a Basel III standardized transitional measure, and having been approved to exit Basel parallel effective April 1, starting in the second quarter, the common floor would apply. This means that there are a variety of measures we could talk about, but suffice to say that we're hundreds of basis points above the minimum for any of them. Therefore, our primary ratio will continue to be the one we used to manage the place, which also happens to be our lowest, the fully phased-in Basel III advance ratio of 9.5%. +Before we leave the page I want to spend a minute on leverage. You'll notice that the Firm and the bank SLR progressed by 50 and 70 basis points, respectively, and importantly, that the Firm is above 5% today. The Firm's ratio benefited from net retained earnings as well as from preferred issuance of close to $4 billion, as we took advantage of market opportunities in the first quarter. The bank's ratio benefited from both retained earnings as well as the impact of actions taken, including downstreaming and restructuring certain capital for the bank. +Additionally, other leverage actions taken across our businesses helped the Firm and the bank by 10 basis points. We also analyzed the rule proposed by regulators this past Tuesday. In general it was relatively consistent with the Basel proposal, which is how we based our estimates. There were a couple of nuanced technical changes. The net of those changes we estimated to add approximately 15 to 20 basis points to leverage, which is included in the ratios reported on the page. +Turning to the business performance and moving on to Page 4, for Consumer and Community Banking. The combined Consumer businesses generated $1.9 billion of net income for the quarter on $10.5 billion of revenue and an ROE of 15%. Overall, revenue was down both year on year and quarter on quarter, driven by Mortgage Banking, which I will talk about later. +Despite margin compression across CCB, excluding mortgage, revenue was flat year on year as we continued to add new customers and deepen our relationships with them. Deposits were up $30 billion year on year. We had record client investment assets of $196 billion, up 16%, and credit card sales volume of $105 billion was up 10% year on year being the 24th consecutive quarter that sales outperformed the industry. +Expense was down $350 million year on year and close to $900 million quarter on quarter, despite the ongoing investment in controls. The reduction was also driven by mortgage, as well as by the timing of certain investments in marketing and card. And across CCB, we are on track relative to our headcount reduction outlined at Investor Day. +On Page 5, Consumer and Business Banking. Business generated $740 million of net income and an ROE of 27% on $4.4 billion of net revenue, up 5% year on year and down 1% from the prior quarter seasonally. Net interest income was up over 5% year on year, driven by deposit growth of 9%, among the highest in the industry; we saw strong household growth and the lowest attrition ever this quarter. While the deposit margin flattened quarter over quarter, it did decline 9 basis points over last year, driven by lower reinvestment rates. +On the non-interest revenue side, we continued to see strong year-over-year growth in both debit and in investment revenue, driven by the record client investment assets I mentioned. Expense was up 1% year on year, reflecting investments we've made in the business, including the costs relating to strengthening the control and compliance infrastructure, partially offset by improving efficiency in our branches. CBB headcount was down around 1,500 this quarter. +On Business Banking originations we're beginning to see stronger lending, with production for the quarter of $1.5 billion, up 22% year over year and 16% quarter on quarter. We have the right team in place and targeted strategies which have proved successful. We're also seeing improved banker productivity. So although some challenges remain in the environment, the pipeline is strong and at the highest level since 2012 and utilization rates have stabilized. So we are cautiously optimistic that improved lending trends will continue in 2014. +Turning to page 6, Mortgage Banking. Overall Mortgage Banking net income was $114 million for the quarter, and despite a relatively favorable rate environment, the market got off to a slow start in 2014. We're seeing tight housing inventory in some markets, and the purchase market was affected adversely by the severe weather. This led to a challenging quarter for the Mortgage business with production of $17 billion, down 27% quarter over quarter and 68% over last year. +On the back of this lower volume, production pre-tax excluding repurchases was a loss of $186 million, consistent with our guidance. We did, however, continue to make good progress on right sizing capacity and reducing expenses, with production core expense being lower by over $110 million quarter on quarter. +Total Mortgage Banking headcount was down nearly 3,000 since the end of the year and about 14,000 since the beginning of last year. Mortgage Production also benefited from a repurchase reserve release. Repurchases for the quarter was positive $128 million, principally driven by a significant improvement in actual and projected cure rates for remaining repurchase risks. +So before I move off of production, just briefly on market share. As we pointed out at Investor Day, we're pricing the business to reflect the inherent risks. The risk of default and the cost associated with servicing defaulted loans is significantly higher for high LTD loans. As a result of pricing actions taken, we believe we may have lost some share in the first quarter, but we will remain disciplined with respect to appropriate risk adjusted returns, and this is consistent with our objective to have a smaller, higher quality, less volatile mortgage business in the future. +Now on to servicing. Excluding MSR risk management, pre-tax income of $131 million was favorable by over $100 million quarter on quarter. That was driven by the absence of an adjustment to compensatory fees, which we incurred in the fourth quarter. If you exclude this item, servicing pre-tax remained relatively flat, and we remain on track to deliver servicing expense of $500 million plus or minus by the fourth quarter of this year. +MSR risk management was a net loss for the quarter of about $400 million. The loss was driven by a negative $460 million fair value adjustment, principally on higher allocated capital to the business, in line with the capital we showed at Investor Day. +Lastly on real estate portfolios, pre-tax income of $517 million includes $174 million of charge-offs and an NCI reserve release for the quarter of $200 million, in line with guidance. You'll see that net charge-offs were broadly flat to the fourth quarter on flattening delinquencies at the end of last year and the early part of the first quarter, but we do expect improvement in the loss trend to resume in the second quarter as recent delinquency trends have been positive. Lastly on mortgage, the NCI portfolio remains flat. We added $3.5 billion of loans this quarter. +Turning to page 7. Card, Merchant Services and Auto had net income of $1.1 billion, down 15% year on year with an ROE of 23%, or 20% if you exclude reserve releases. Revenue of $4.5 billion was down 3% seasonally quarter on quarter and 4% year on year, driven by continued margin compression from growth in transacted balances and from the pay down of higher-yielding run-off loans. Underlying trends remain robust, strong sales and merchant processing volumes up 10% and 11%, respectively, and gaining share. +Total outstandings remained approximately flat for us and for the industry, and we have strong momentum in new account originations in the quarter, up 24% year on year, and the quality of our new account origination is very strong. Expense was down $260 million or 12% quarter on quarter, due to the timing of marketing spend as well as the absence of remediation payments to customers that was recorded in the fourth quarter. +The net charge-off rate has remained very low at 293 basis points, picking up slightly quarter on quarter just on seasonality of loan balances. We released $200 million of Card loan loss reserves this quarter in line with guidance, and $50 million of student lending reserves. +And before we move on, a few words on Auto. We saw a very strong industry rebound in March with the highest new Auto sales since 2007, coming off of the slower start to the year, again on a severe winter. This drove originations up 3% year on year and loan balances up 5%, gaining share, and it was the 10th consecutive quarter of Auto loan and lease growth. +Moving on to Slide 8 and the Corporate and Investment Bank. CIB reported net income of $2 billion on revenue of $8.6 billion and an ROE of 13%. You'll see in the table on the top right of the slide that we've shown adjusted results for comparable periods excluding DVA and FVA. The net DVA/FVA impact for this quarter was an insignificant loss. Gross DVA would have been over $200 million negative on 9 basis points tightening of CDS spreads, so as expected what we saw was a sensitivity to our spread significantly muted given the implementation of FVA, and you should expect the impact of DVA/FVA in our results to continue to be modest going forward, all other things equal. +In Banking, total revenue was $2.7 billion down 8% year on year. IB fees were $1.4 billion, up 1% year on year, driven by higher advisory and equity underwriting fees but with lower debt underwriting fees, and we maintained our number-one ranking in global IB fees per Dealogic. +Going forward, the environment remains compelling for M&A with announced volumes up 20%. We have a robust pipeline of IPOs with a large backlog across sectors and regions, and DCM activity is expected to be relatively stable. +Lending revenue was down $200 million year over year and down quarter over quarter, but mark-to-market gains on securities drove the variance in both prior periods. We also had Treasury Services revenue of $1 billion, down 3% year on year, with higher net interest income on higher deposits, offset by the impact of business simplification and lower trade loans and spreads. +Moving on to markets and investor services. The challenging environment and lower client volumes we talked about at Investor Day continued through the end of the quarter, ending with overall markets revenues down 17% year on year, and there was no discernible single driver of the weakness. It was across products and regions. +In general it feels like the market consensus at the quarter beginning was for a growth story which didn't transpire, and combined with several other factors this lead to generally lower levels of client activity across the board. We didn't see a meaningful pickup in activity in March, so it's reasonable to expect that some of this first-quarter softness may continue in April. +Securities Services revenue of $1 billion was up 4% year on year, primarily driven by higher NII on higher deposits and higher asset-based fees on higher assets under custody. And you see the credit adjustments and other line items showed a negative $197 million, which includes the net DVA/FVA loss together with the impact of changes in CVA. +The credit environment continues to be benign and we believe our exposure to Russia is manageable. We are appropriately reserved based on what we know today and we are closely monitoring the situation. +Expense came down 8% year on year to $5.6 billion, lower compensation given lower revenue driving the decline. The comp to revenue ratio for the quarter was 33%, broadly in line with 34% in the same quarter of last year. And finally on drivers, you can see client deposit balances were up 15% year on year, but down 2% quarter on quarter seasonally. +Moving on to Commercial Banking on page 9. This quarter saw net income of about $580 million on revenue of $1.7 billion, with an ROE of 17%. Revenue was relatively flat year over year and declined by approximately $200 million sequentially. The sequential decline was about two-thirds NII, driven by a large recovery we reported in the prior quarter, together with lower day count. The balance of the decline was lower NIR on seasonally lower fees. +A bright spot in the quarter was gross IB revenues of $450 million for the quarter, up over 30% year on year, a record for a first quarter, and representing nearly 35% of North America IB fees. Our credit book continued to show very strong performance with a net recovery rate of 4 basis points, and expense was up 7% year on year given the investments we've been making in the business as well as the impact of costs of control and compliance. +Loan balances were up 7% year on year and 1% quarter on quarter. Consistent with recent trends, real estate growth remains really strong at 15%. Both our Commercial Term Lending and Real Estate Banking portfolios grew in the double digits, outpacing the industry. +In C&I, loan growth remains tepid and the environment remains extremely competitive. There were pockets of growth including the expansion markets, which were up 17%, and increased activity in healthcare, oil and gas, and technology sectors. With respect to pipeline, we saw the pipeline trend up or strengthen a little from the lows of last year, trending in the right direction but still relatively weak versus a year ago. +Moving on to page 10, Asset Management. The quarter saw net income of about $440 million, down 9% year on year with an ROE of 20%. Revenue was up 5% year on year, driven by flows and market performance, primarily Europe and the US, off of a very strong first quarter a year ago. +Quarter-on-quarter revenue was down 13% despite continued inflows; two-thirds of the decline was driven by normal seasonality and performance fees. The remainder of the decline related to the change in a mark-to-market of a seed investment. We did mention $100 million or so positive mark-to-market reflected in the fourth quarter's results. We gave some of that back this quarter, driving the sequential variance impact to be over $150 million. +This is the 20th consecutive quarter of long-term inflows, $20 billion for the quarter, driving record AUM of $1.6 trillion, up 11% year on year, and we've seen a strong start to April. Expense increased 11% year on year, given higher investments and cost of control, and decreased 8% quarter on quarter, largely driven by lower comp on lower revenue. Lastly in Banking, we continued to see strong loan and deposit growth with record balances up 19% and 7%, respectively. +Moving on to page 11 and Corporate and Private Equity. Private Equity net income of over $200 million included approximately $400 million of gains on investments in the quarter. Treasury and CIO reported a net loss of $94 million. NII remained relatively flat quarter on quarter at a negative $90 million (sic - see slide 11 "$87mm"), and we continue to expect NII in Treasury and CIO to break even by the year end, driven by higher securities yields as we benefit from higher rates. Additionally, we deployed $25 billion gross of new investments in the quarter, with the portfolio being relatively flat net of maturities, pay downs, and sales. +And before I continue, let me just tell you about NIM and NII for a second. The page is in the appendix. Total NIM was flat quarter on quarter and core NIM was up 2 basis points, primarily driven by higher investment securities yields, offset by loan spread compression. +Finally on this page, Other Corporate net income of a little over $200 million, included in this result is a $90 million after-tax impact of writing down our deferred tax assets following changes to New York State's tax which was enacted at quarter end. This upfront impact to DTA will be offset over time. +And as I said earlier, no significant legal expense to report for the quarter. It obviously feels good to have a quarter with such a small number and to have put such large issues behind us; however, I want to remind you that we still expect legal expenses to be lumpy quarter over quarter for the next couple of years as we work through remaining issues. +Now on page 12. We've covered most of the outlook as we went through the presentation, just a couple of additional things to cover. First, Mortgage Production. We told you to expect Mortgage Production to be negative for the year, we do, and we expect it to be negative for the second quarter. Obviously, the final result will be market dependent; however at this point, our outlook is for production pretax, excluding repurchase, to be a loss of between $100 million and $150 million, slightly improved from the first quarter on higher volumes seasonally. +Second, on releases. Expect mortgage reserve releases to be more modest going forward, except for potentially PCI, purchase credit impaired loans, where we could see some lumpy releases if we have any, and expect card releases to be essentially over. +So to wrap up, we feel good about the simplicity of the quarter and the solid core performance given challenging industry conditions. We are also pleased with the progress we've made on key items, including announcing the sale of our physical commodities business and our retirement planning services business, passing CCAR both qualitatively and quantitatively, exceeding 5% for the Firm and Bank leverage ratios, and maintaining strong expense discipline while investing in growth and control. And perhaps most importantly, continuing to deliver outstanding customer service and continuing to grow underlying performance drivers. With that, operator, you can open up the line please for Q&A. + + + +================================================================================ +Questions and Answers +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) +Our first question comes from Glenn Schorr of ISI. + +-------------------------------------------------------------------------------- +Glenn Schorr, ISI Group - Analyst [2] +-------------------------------------------------------------------------------- + + Hello there. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [3] +-------------------------------------------------------------------------------- + + Hi, Glenn. + +-------------------------------------------------------------------------------- +Glenn Schorr, ISI Group - Analyst [4] +-------------------------------------------------------------------------------- + + Hello. Maybe with avoiding too much of the details, stay at the high level and talk about no loan growth on a year on year basis. I know there's a bunch of mix in there, and I guess I'm particularly interested in the C&I bucket, because that's the one area where we do see some growth in the industry. So A, there's a little bit of verbiage in your text on how you define C&I loan growth in the Corporate bucket, and B, are there areas where you just think pricing is getting a little high and you're purposely avoiding that growth? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [5] +-------------------------------------------------------------------------------- + + So hey, Glenn. Just so that I can give you the underlying core growth number, for the Firm for the quarter was 4% year on year, even though obviously if you take into consideration the run-off portfolios in Mortgage and Card we were closer to flat. +In C&I, you're right. The industry was up slightly. We were not. It's a continuation of the things we've talked about, which is a combination of client selection, of being very disciplined on credit, so not chasing growth at the cost of liberal credit structures or overly aggressive pricing, and also the fact that we continued to see some of our criticized and classified loans be refinanced away from us. +So we're just going to hold the line on discipline. We are seeing the ongoing aggressive competitive environment on both credit terms and pricing, and we'll do every rational and sensible deal we can do, but we're not going to chase growth at the expense of discipline. + +-------------------------------------------------------------------------------- +Glenn Schorr, ISI Group - Analyst [6] +-------------------------------------------------------------------------------- + + I appreciate that. And then obviously over time we'll see that in both a steadier to up NIM and good delinquency trends I guess. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [7] +-------------------------------------------------------------------------------- + + Yes, so a higher quality portfolio, higher quality clients. + +-------------------------------------------------------------------------------- +Glenn Schorr, ISI Group - Analyst [8] +-------------------------------------------------------------------------------- + + Okay. On the SLR that just came out you gave us the expected impacts so I appreciate that. In Jamie's annual letter I think you said quote, we began to make significant changes to the rates business and expect to maintain decent profitability. Could you talk about what you've done in rates, how much through those changes we've seen and then what to expect on the other side? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co - Chairman & CEO [9] +-------------------------------------------------------------------------------- + + So I think very broadly if you look at the numbers here we've pushed down our capital, leverage, SLR to all of the businesses so they're all making adjustments as appropriate. In the rates business in particular, you're seeing that there's very few what I call exotic rates products being done anymore, so that will be a rather large change. A lot of things going electronic, which can reduce your expenses too, so we're pretty comfortable our rates business will be normal profitability going forward. It may take a little bit of time. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [10] +-------------------------------------------------------------------------------- + + Glenn, I just want to make sure that it was clear in my remarks that the impact of the new proposal for leverage is included in the reported results. + +-------------------------------------------------------------------------------- +Glenn Schorr, ISI Group - Analyst [11] +-------------------------------------------------------------------------------- + + Yes, very clear, and normal profitability might mean lower revenues but normal profitability, right, as things change in that business? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co - Chairman & CEO [12] +-------------------------------------------------------------------------------- + + A little bit, yes. But we all don't know what's going to happen to spreads going forward, so we're comfortable, we want to stay in the business, do a good job at it for our clients. + +-------------------------------------------------------------------------------- +Glenn Schorr, ISI Group - Analyst [13] +-------------------------------------------------------------------------------- + + Okay, last one. Marianne, I guess next on the hit parade is final rules on LCR and OLA. Do you feel that's coming this year, and do you expect -- how do you feel you're positioned for that? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [14] +-------------------------------------------------------------------------------- + + So with LCR, whether you take the Basel or the US proposals, we're compliant at this point with the margin, and importantly we're also compliant with our own internal stress framework. So we feel good about LCR, we're continuing to manage it as you would expect. +Yes, I am expecting us to get long-term debt rules this year, but I don't know when and I can't control it; we feel with over 19% available resources that we're in a good starting position, and so we're not really going to be in the business of guessing where that ends up. And we'll adjust accordingly if it's different from our expectations. + +-------------------------------------------------------------------------------- +Glenn Schorr, ISI Group - Analyst [15] +-------------------------------------------------------------------------------- + + Okay, thank you both. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [16] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Operator [17] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Erika Najarian of Bank of America. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [18] +-------------------------------------------------------------------------------- + + Hello, Erika. + +-------------------------------------------------------------------------------- +Erika Najarian, BofA Merrill Lynch - Analyst [19] +-------------------------------------------------------------------------------- + + Good morning, so Marianne thank you for walking us through the progress on the leverage ratio. I'm just wondering should we expect on the Bank level that you'd be compliant to 6% at some point this year, or was the quarterly progress this quarter or last quarter rather unusual? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [20] +-------------------------------------------------------------------------------- + + So given that we did some restructuring of Bank level capital including some downstreaming, that was a fairly sizeable increase in the quarter, so you're not going to see progress be linear, but there are a number of different levers that we have in our toolkit so to speak to get to 6% over time, whether that's this year or whether that's into next year, we're going to be measured about the progress. So whether that's retaining earnings, potentially additional capital, we've been actioning leverage actions, both deposits as well as derivatives actions. +And then ultimately there's also the [good guide] when it comes, timing dependent that may be a 2015 thing of hopefully moving from CEM to the newly named FACCR calculations for derivatives central future exposure. We did take a look at the information on FACCR and it hasn't changed our point of view that we would expect that to have a favorable impact for the Bank of 40 basis points plus or minus. So when that comes that will be a nice boost, but through retaining earnings and the leverage actions we have and potentially more capital optimization, we have a clear path to 6%, whether it's this year or early into 2015. + +-------------------------------------------------------------------------------- +Erika Najarian, BofA Merrill Lynch - Analyst [21] +-------------------------------------------------------------------------------- + + Okay. And just a second question, given you're already compliant in the LCR, is it fair for us to assume that your core margin should continue to improve throughout the year at this measured pace? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [22] +-------------------------------------------------------------------------------- + + Yes, I would say it's fair to assume that our core margin should be relatively stable throughout the year, and I think plus or minus 2 basis points on a large balance sheet like ours with mix changes is relatively stable. So our expectation is for core NIM to be relatively stable in 2014, to be stable to slightly positive in 2015, assuming that the implied rate curve plays out the way it is. + +-------------------------------------------------------------------------------- +Erika Najarian, BofA Merrill Lynch - Analyst [23] +-------------------------------------------------------------------------------- + + Okay. And just last one for me, in terms of your comments on card provision, help us think about sort of the balance in terms of the catalyst for your guidance. Should we start to expect balance growth to come back or is this more of a comment that charge-offs are as low as they will go and should normalize here? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [24] +-------------------------------------------------------------------------------- + + So it's a combination of factors and we are seeing delinquency trends and roll rate charge-offs flatten out. We knew that it would happen one day. That's what we're seeing at the moment. We'll continue to update you through the course of the year; based upon that we're not expecting anymore results. In addition, you should know that -- you saw our outstandings were flat, and underneath that our core portfolio is growing; we still do believe we are at that inflection point and that we should see some growth, but it will be relatively modest. + +-------------------------------------------------------------------------------- +Erika Najarian, BofA Merrill Lynch - Analyst [25] +-------------------------------------------------------------------------------- + + Okay, thank you for taking my questions. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [26] +-------------------------------------------------------------------------------- + + Thank you, Erika. + +-------------------------------------------------------------------------------- +Operator [27] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Matthew O'Connor of Deutsche Bank. + +-------------------------------------------------------------------------------- +Matthew O'Connor, Deutsche Bank - Analyst [28] +-------------------------------------------------------------------------------- + + Good morning. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [29] +-------------------------------------------------------------------------------- + + Good morning. + +-------------------------------------------------------------------------------- +Matthew O'Connor, Deutsche Bank - Analyst [30] +-------------------------------------------------------------------------------- + + If we look at the traditional bank fees even outside of mortgage, they're a bit weaker year over year than I think most might have been expecting, and I'm looking at like the card fees, service charges. Do you think that's all weather related or just weaker macro backdrop than maybe we were looking for? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [31] +-------------------------------------------------------------------------------- + + So you're talking about interchange fees in Card? + +-------------------------------------------------------------------------------- +Matthew O'Connor, Deutsche Bank - Analyst [32] +-------------------------------------------------------------------------------- + + Just the overall credit card fee line that you give us that obviously would include the interchange, but probably some other things as well. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [33] +-------------------------------------------------------------------------------- + + Yes, so the sales volume obviously seasonally goes down quarter over quarter. I don't think that we have perceived there's been a significant impact from weather on Card sales in the first quarter; for us our sales were up 10% year on year, so pretty strong. No, I wouldn't attribute anything to the weather. + +-------------------------------------------------------------------------------- +Matthew O'Connor, Deutsche Bank - Analyst [34] +-------------------------------------------------------------------------------- + + Okay. And then just separately, the expense guidance for this year I think is unchanged even though revenue's coming in a little bit weaker than expected. I realize it's just the first quarter and things could change, but is there opportunity to adjust the expense base a bit more if revenue is light? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [35] +-------------------------------------------------------------------------------- + + Yes, so you saw -- obviously you saw in the first quarter that on the back of lower revenues in the markets business, we have lower compensation as an absolute matter albeit that the ratio is relatively in line. +So you're absolutely right depending upon how the rest of the year pans out will determine whether the compensation expenses inherent in our outlook for CIB are up or down or flat, and that will adjust our ending result. We're not ready yet to declare our position on the whole year, so less than $59 billion is still our guidance but we intend to be very, very disciplined. + +-------------------------------------------------------------------------------- +Matthew O'Connor, Deutsche Bank - Analyst [36] +-------------------------------------------------------------------------------- + + All right. And then just lastly on the buybacks, net of issuance being approved for greater than $5 billion, any comments just on the timing or the likelihood of all that being used this year? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [37] +-------------------------------------------------------------------------------- + + Yes, so on the timing, I mentioned the fact that we aren't expecting our capital accretion to 10% plus to be linear, we're expecting it to be much more in the second half of the year, flatter in the first half, so it's reasonable to expect that we will be covering employee issuance plus or minus in the first half of the year with most of our repurchase capacity being available for us in the second half. +As to how much of it we'll use will be dependent on a number of factors including obviously our share price at the time. But we do intend to take advantage of the opportunity that we have been given to buy back, and we'll see what the absolute level is when we get there. + +-------------------------------------------------------------------------------- +Matthew O'Connor, Deutsche Bank - Analyst [38] +-------------------------------------------------------------------------------- + + Okay, thank you very much. + +-------------------------------------------------------------------------------- +Operator [39] +-------------------------------------------------------------------------------- + + Our next question comes from the line of John McDonald of Sanford Bernstein. + +-------------------------------------------------------------------------------- +John McDonald, Sanford C. Bernstein & Company, Inc. - Analyst [40] +-------------------------------------------------------------------------------- + + Hi, Marianne. In the mortgage area, the $400 million hit to the MSR risk management results, just to clarify that was a one-time hit related to your Corporate reallocation of capital that you did earlier this year? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [41] +-------------------------------------------------------------------------------- + + That's absolutely right, so when we declared at Investor Day that we had increased the target rate for that business, we pushed that down into the valuation of the asset one-time. + +-------------------------------------------------------------------------------- +John McDonald, Sanford C. Bernstein & Company, Inc. - Analyst [42] +-------------------------------------------------------------------------------- + + Okay. And again, the reasons for the negative profit margin we're seeing on the origination side, is it just the timing of getting expenses adjusted to a new base originations, and it takes -- there's a lag, or is there also some investment expenses that you're running through there that are also hurting your mortgage profitability? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [43] +-------------------------------------------------------------------------------- + + So it's three things. There's a little bit of timing in there insofar as we did make continued improvement in expenses and we're going to continue to work on what we would characterize as the sort of fixed cost base. It's definitely the case that we are building this business for the long run, and so we continue to invest in technology and operations to make us more profitable and efficient through the cycle. But it is also the case that it is an incredibly small market. I mean, the market size was sub $250 billion, so annualized sub $1 trillion, which is not something we've seen since before 2000. +So the reality is in a market that size, it's very hard to have strong profitability or profitability when you have to have a core level of fixed expenses, and so we're thinking about this business over the longer run to be as efficient and profitable as possible through the cycle in markets that are on average bigger than this. + +-------------------------------------------------------------------------------- +John McDonald, Sanford C. Bernstein & Company, Inc. - Analyst [44] +-------------------------------------------------------------------------------- + + Okay. And then on the markets activity in the Investment Bank, I guess a bit disappointing that activity levels didn't pick up in March where it seemed like overall rate volatility picked up as people put different takes on the Fed statements. Do you attribute some of the weakness to the lower issuance compared to last year, which seems like that could continue, and what do you think is needed to stimulate better activity, particularly in FICC this year? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [45] +-------------------------------------------------------------------------------- + + So yes, I would say lower issuance was a factor but there were very many, so I wouldn't say that it was a single driving factor, lower mortgage issuance, lower debt issuance, a whole bunch of different things. And then as to catalysts, more volatility, more growth, and we'll just have to wait and see. + +-------------------------------------------------------------------------------- +John McDonald, Sanford C. Bernstein & Company, Inc. - Analyst [46] +-------------------------------------------------------------------------------- + + And any sense of what kind of year you're planning for there, or is it really just a wait and see how the environment unfolds and you react as it occurs? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co - Chairman & CEO [47] +-------------------------------------------------------------------------------- + + I think John we've always been very consistent on this kind of thing. You guys have got to make your own estimates because they are just as good as ours. Great business with great people, technology, sales, research, but we can't predict it going forward. It will be what it is. + +-------------------------------------------------------------------------------- +John McDonald, Sanford C. Bernstein & Company, Inc. - Analyst [48] +-------------------------------------------------------------------------------- + + Okay. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [49] +-------------------------------------------------------------------------------- + + Similar to the mortgage comment where it's a long-term view, it affects the business and this is one quarter. + +-------------------------------------------------------------------------------- +John McDonald, Sanford C. Bernstein & Company, Inc. - Analyst [50] +-------------------------------------------------------------------------------- + + Got it. Any impacts on the commodities sale that's planned? Did you move that to discontinued ops or did that have any impact on the market, the metrics this quarter, Marianne? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [51] +-------------------------------------------------------------------------------- + + Yes, we've accounted for it held for sale and no significant impacts to the results. + +-------------------------------------------------------------------------------- +John McDonald, Sanford C. Bernstein & Company, Inc. - Analyst [52] +-------------------------------------------------------------------------------- + + Okay. Great, thank you. + +-------------------------------------------------------------------------------- +Operator [53] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Betsy Graseck of Morgan Stanley. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [54] +-------------------------------------------------------------------------------- + + Hey, good morning. A couple of follow-ups. One on the commodities business that you are in the process of selling. Can you give a sense as to what the impact is likely to be post sale? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [55] +-------------------------------------------------------------------------------- + + So we obviously looked at the bid and the valuation and any of the difference versus book is in our P&L and it's insignificant, and we are engaged in ongoing relationship with the buyer, and we'll realize [that over] time. But it's not expected to be anything significant. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [56] +-------------------------------------------------------------------------------- + + Okay, and then just a couple of clarifications. On OLA you mentioned 19% available resources. I assume that's against RWA, but I just wanted to clarify. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [57] +-------------------------------------------------------------------------------- + + Yes, correct. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [58] +-------------------------------------------------------------------------------- + + Okay. And then on SLR, on page 3, you show us the ratios. I just wanted to confirm, the Basel III line says that it's on a fully phased in basis, but we don't see fully phased in on SLR. Does that imply it's transitional? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [59] +-------------------------------------------------------------------------------- + + No, it's fully phased in, it's our best effort of fully phased in, Betsy. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [60] +-------------------------------------------------------------------------------- + + On the SLR as well right? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [61] +-------------------------------------------------------------------------------- + + Correct, but remember that with the exception of the fact that we aren't baking in things that are not yet certain, so we haven't baked in the benefit that we would expect, for example, from FACCR, because it hasn't yet been acknowledged. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [62] +-------------------------------------------------------------------------------- + + And that 40 basis point benefit there is both for the Bank level and the Hold Co level. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [63] +-------------------------------------------------------------------------------- + + The sensitivity is different at the Bank and the Holding Company, so it's more like 30 plus or minus at the Holding Company, 40 plus or minus at the Bank. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [64] +-------------------------------------------------------------------------------- + + Okay, great. Lastly on expenses you highlighted throughout all the areas where you had the headcount reduction. Could you just give us a sense as to whether or not the benefit to the expense dollars is fully in the first quarter, or was there a negative from things like severance that then the benefit to the expense dollars comes in Q2 and beyond? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [65] +-------------------------------------------------------------------------------- + + With respect to the headcount reduction in the first quarter, the severance wasn't significant and the benefit is largely in. Remember we said that overall the Firm is expecting to see headcount go down by about 5,000 for the full year and it's down only by 2,000, so far so we have another way to go. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [66] +-------------------------------------------------------------------------------- + + And the pace of that 3,000 from here is ratable or front-end loaded? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [67] +-------------------------------------------------------------------------------- + + Well so if you think about it gross, mortgage was 6,000 of the total gross and it's 3,000 in, so another 3,000 to go I would say in the nearer not longer term. And in the Consumer Bank that was 2,000, with 1,500 in, the remainder will just happen through time. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [68] +-------------------------------------------------------------------------------- + + Got it, thanks. + +-------------------------------------------------------------------------------- +Operator [69] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Guy Moszkowski of Autonomous. + +-------------------------------------------------------------------------------- +Guy Moszkowski, Autonomous - Analyst [70] +-------------------------------------------------------------------------------- + + Good morning. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [71] +-------------------------------------------------------------------------------- + + Hi. + +-------------------------------------------------------------------------------- +Guy Moszkowski, Autonomous - Analyst [72] +-------------------------------------------------------------------------------- + + Just wanted to follow-up on the FACCR. Thanks for the guidance on the potential benefit. Can you give us a sense of what specifically is driving that to be beneficial? I've gone through the BIS release, but frankly, without understanding what the underlying is, it's really difficult to understand why it's a benefit. Just maybe you can help us qualitatively understand it. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [73] +-------------------------------------------------------------------------------- + + Yes, I'll give you the sort of very short qualitative answer, and then if you want to really dig in, I'd do it off line with Investor Relations. But the very short answer is there's an additional ability to recognize collateral and [netting], that wasn't in the original CEM calculation, there's lots and lots of other complexity to it. We are doing our best to estimate it. We haven't fully built the models to do it, so we're continuing to work on that, but if you want to get into a very technical discussion on it we can arrange that for you. + +-------------------------------------------------------------------------------- +Guy Moszkowski, Autonomous - Analyst [74] +-------------------------------------------------------------------------------- + + Okay, I'll probably follow-up but that's helpful, thanks. You mentioned a number of times as you went through and we could see it in the slides that a lot of the expense impacts to the extent that expenses were problematic relative to year ago, a lot of it was because of the control agenda, which obviously we appreciated and you have spoken to. +But can we step back and talk about in a holistic Firm-wide way where are we with implementing that, how much more impact do we expect to see, at what point do we kind of lap on that? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [75] +-------------------------------------------------------------------------------- + + Okay, so a couple of things. First is that if you remember from Investor Day, notwithstanding the earlier comment about the volatility potentially in compensation in the Markets businesses, we said we would be below $59 billion, and there were four principal things driving that. So in our favor we have efficiencies in branches, efficiencies in CIB, and mainly mortgage down about $1.5 billion year over year. And against us we had the $1 billion incremental cost of control and some growth principally in asset management, so the net of all of those meant that we were effectively self-funding through efficiency and reduced mortgage expenses, the incremental cost and controls that you're seeing come through. +It isn't the case that we have broken out as a macro matter how much of that $1 billion is in our run rate now, and maybe we'll do that for you next quarter. I would say that we are adding heads and so these things do take some time; even though I believe that there will be a chunk of it in our run rate through the middle of the year, it's not all in our run rate yet. + +-------------------------------------------------------------------------------- +Guy Moszkowski, Autonomous - Analyst [76] +-------------------------------------------------------------------------------- + + That's it, so if I could interpret that that means after midyear we should have sort of fully lapped, is that what you're saying? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [77] +-------------------------------------------------------------------------------- + + Well I'll have to confirm to you next quarter, but I would say that we would have a majority of it in through the midyear because we are obviously trying to hire up to be able to execute on the agenda. So if you think about the impact we're trying to add people to compliance, we are adding people to compliance, to legal, to audit, to finance, to risk, and we're doing that largely in the first half of the year, but there will be a tail. + +-------------------------------------------------------------------------------- +Guy Moszkowski, Autonomous - Analyst [78] +-------------------------------------------------------------------------------- + + Okay, that's also really helpful. In terms of FICC and the weakness that we saw, can you comment at all and if it's possible even to quantify a little bit what the impact was of some of the adoption of SEF mandates during the quarter? We could certainly see that SEF volumes themselves seem to get disrupted at certain points in the quarter when new mandates went into play, but just if you think about the impact of that regulatory change on the OTC derivatives markets, it would be really helpful to understand how much of the impact was just regulatory change. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [79] +-------------------------------------------------------------------------------- + + Yes, so I mean, it's very -- as you know it's very, very difficult to decouple everything but and so it's not clear that there's no impact, but it's not our sense that it was a significant driver of the performance in the quarter, and there is a limited amount of volume on SEF right now, albeit increasing, and there's been margin compression, but from tight margins to start with. So it's not our sense that it was a significant driver, not to say that there was no impact. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co - Chairman & CEO [80] +-------------------------------------------------------------------------------- + + So it did come down a little bit but it's kind of back to where it was, the derivative trading, and we wouldn't blame that for anything. + +-------------------------------------------------------------------------------- +Guy Moszkowski, Autonomous - Analyst [81] +-------------------------------------------------------------------------------- + + So if one were to think that there were going to be spread compression over time as a result of some of these things that might still lie in the future, that's to your $1 billion plus or minus revenue impact that you've talked about? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [82] +-------------------------------------------------------------------------------- + + That's right. So I mean again, not to say there hasn't been any but the volumes are relatively low, the margins are relatively tight, the $1 billion we talked about which is by the way our best estimate, so it could be better than that, is something that would progress through time, it's not going to be a cliff. + +-------------------------------------------------------------------------------- +Guy Moszkowski, Autonomous - Analyst [83] +-------------------------------------------------------------------------------- + + Great, that's all very helpful. I appreciate you taking my questions. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [84] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Operator [85] +-------------------------------------------------------------------------------- + + Our next question comes from Gerard Cassidy of RBC. + +-------------------------------------------------------------------------------- +Gerard Cassidy, RBC Capital Markets - Analyst [86] +-------------------------------------------------------------------------------- + + Thank you. Good morning. Can you guys share with us on your loan loss provision this quarter, obviously last year the provision was greatly affected by loan loss reserve releases. Should we anticipate the provision reaching your net charge-off levels for this year to match them out? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [87] +-------------------------------------------------------------------------------- + + So the best guidance that I could give you is the guidance that we gave at Investor Day, which is expect the Firm-wide charge-offs to be at around $5 billion plus or minus, and then I would point you to the guidance we just gave you on reserve releases, which is expect some more in mortgage but modest, expect we might have some in PCI but it's too early to know, and that little more in Card, so net those two down. + +-------------------------------------------------------------------------------- +Gerard Cassidy, RBC Capital Markets - Analyst [88] +-------------------------------------------------------------------------------- + + Okay. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [89] +-------------------------------------------------------------------------------- + + And there may be some noise to that, but that's our current best outlook. + +-------------------------------------------------------------------------------- +Gerard Cassidy, RBC Capital Markets - Analyst [90] +-------------------------------------------------------------------------------- + + Okay, speaking of the PCI loans, they're down year over year about 10% to 12%. Should we expect that type of run rate throughout the year as that portfolio continues to shrink? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [91] +-------------------------------------------------------------------------------- + + Yes, largely speaking. That seems about right, 10%, yes. + +-------------------------------------------------------------------------------- +Gerard Cassidy, RBC Capital Markets - Analyst [92] +-------------------------------------------------------------------------------- + + Okay. You talked about in the mortgage business you're changing the way you're approaching it, and the revenue run rate you had this quarter of about $160 million, can you size for us where you think kind of the new approach that you're having with mortgages, what kind of revenues we might anticipate? Because I'm assuming this was unusually low, this quarter's number? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [93] +-------------------------------------------------------------------------------- + + So our production revenues this quarter, just to make sure we're talking about the same thing, was just about $300 million. I told you that we're expecting the second quarter to be negative, you're going to have higher revenues because seasonally you have higher volumes, but obviously it's market dependent. +So I would say given seasonality, the first quarter was small and volumes were depressed given the weather, we would be hopeful that the market would be above $1 trillion for the full year, maybe not quite as high as $1.2 trillion, so if you add seasonality back in and gross up the number, you could probably get quite close. But of course it could all change depending upon rates in the market. + +-------------------------------------------------------------------------------- +Gerard Cassidy, RBC Capital Markets - Analyst [94] +-------------------------------------------------------------------------------- + + Great and then --. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [95] +-------------------------------------------------------------------------------- + + The current outlook for the market size was about $1.2 trillion. I suspect that will be revised down slightly on the back of the first quarter, so we're going to have a small market. It won't be absolutely linear. + +-------------------------------------------------------------------------------- +Gerard Cassidy, RBC Capital Markets - Analyst [96] +-------------------------------------------------------------------------------- + + Okay. In the institutional asset management business, you pointed out the decline sequentially in the revenues because of some of the one-time items in the fourth quarter. On the year-over-year declines, even though the inflows were up, any comments on the revenues for the institutional revenue part of that business? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [97] +-------------------------------------------------------------------------------- + + Year-over-year revenues for asset management, institutional, no specific. We had some -- March was not strong, the first quarter for institutional was not as strong as the other segments, so no specific issues but there's some lumpiness there obviously. + +-------------------------------------------------------------------------------- +Gerard Cassidy, RBC Capital Markets - Analyst [98] +-------------------------------------------------------------------------------- + + Okay, And then finally, it may just be market conditions or maybe something you can do, when you look at your net interest margin and you look at the interest earning asset yields, the securities borrowed number was a negative 30 basis points, it's been trending more negative each quarter. It was minus 2 basis points a year ago. Can you point to anything you could do to try to reverse that? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [99] +-------------------------------------------------------------------------------- + + Yes, the securities, that line item is a funky feature of the fact that in our prime services business, when we -- our contractual income is LIBOR minus the spread which drives that to be a negative number; I wouldn't read too much into the trend and volatility there. The absolute economics of the business is still positive and the offset is in trading liability, so that's not a line item in its own right and alone that is very constructive. + +-------------------------------------------------------------------------------- +Gerard Cassidy, RBC Capital Markets - Analyst [100] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Operator [101] +-------------------------------------------------------------------------------- + + Our next question comes from Derek De Vries of UBS. + +-------------------------------------------------------------------------------- +Derek De Vries, UBS - Analyst [102] +-------------------------------------------------------------------------------- + + Thanks. I had a few questions. You had no significant items that you called to our attention, but then you said there were a few sort of non-core items and they broadly offset. And just as I'm looking at my notes I see there's like a $400 million negative in MSR, there's a $90 million in tax, there's $200 million of DVA/FVA, all negative, and then there's $400 million of private equity gains, but I guess I'm missing another sort of $300 million of positive. I just was wondering if you could kind of call out what that would be? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [103] +-------------------------------------------------------------------------------- + + Reserve releases. + +-------------------------------------------------------------------------------- +Derek De Vries, UBS - Analyst [104] +-------------------------------------------------------------------------------- + + Oh, okay, the reserve releases. All right, understood. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [105] +-------------------------------------------------------------------------------- + + And then we don't drill into every $50 million negative non-recurring item but there was some of them too. + +-------------------------------------------------------------------------------- +Derek De Vries, UBS - Analyst [106] +-------------------------------------------------------------------------------- + + Okay, that's fine. And then just on the tax rate, obviously I'd strip out the $90 million but it still feels like a high tax rate. Is there anything funny going on there? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [107] +-------------------------------------------------------------------------------- + + No, it's not far off the 30% plus or minus, which is our generally expected effective tax rate. Nothing else of any noteworthiness. I mean obviously it's always going to be impacted by the absolute level of pretax, the percentage of overseas income, the percentage of tax efficient income, but nothing special. + +-------------------------------------------------------------------------------- +Derek De Vries, UBS - Analyst [108] +-------------------------------------------------------------------------------- + + Okay. And then the guidance on Mortgage Production that sort of pushed out the losses and we've talked about it a lot, but just so I'm clear the change in your guidance there is just essentially a change in your market expectations, the $1.2 trillion coming to a lower number, that's the only real change you've got there? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [109] +-------------------------------------------------------------------------------- + + We haven't really changed our guidance, to be fair our guidance was always to be negative for the year. We're just trying to be very specific about the degree of negative in the second quarter to make sure you have information for your models. + +-------------------------------------------------------------------------------- +Derek De Vries, UBS - Analyst [110] +-------------------------------------------------------------------------------- + + Perfect, and we appreciate that. That's all for me, thanks. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [111] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Operator [112] +-------------------------------------------------------------------------------- + + Our next question comes from Paul Miller of FBR. + +-------------------------------------------------------------------------------- +Paul Miller, FBR & Co. - Analyst [113] +-------------------------------------------------------------------------------- + + Yes, thank you very much. You guys mentioned I believe in a report or in comments that you want to get your servicing portfolio down from $800 billion to $600 billion on loans there, I guess just natural decay and selling MSRs. When do you think the timing of those sales of the MSRs, and do you think that -- a lot of people feel that you cannot transfer any MSRs anymore due to some of the headline risk. Can you add some color to that also? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [114] +-------------------------------------------------------------------------------- + + So obviously the timing of sales is going to be a little bit opportunistic, so the best comment I can make is that $600 million number is two, three years away from now, not necessarily but we'll try and manage it the best way we can. +And then with respect to the ability to sell sub service, there is still the opportunity to do it. It's just not necessarily the case that you can defease your risk entirely, which I think is understood. + +-------------------------------------------------------------------------------- +Paul Miller, FBR & Co. - Analyst [115] +-------------------------------------------------------------------------------- + + Can you add more color, you can't get rid of the risk? Can you add more color around that? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [116] +-------------------------------------------------------------------------------- + + Well I mean, insofar as I think that as we move loans to sub services, obviously we retain the risks and have to have third-party oversight. To the degree we sell them, I think the regulators are potentially looking at originators to continue to bear some of the origination and other risks. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co - Chairman & CEO [117] +-------------------------------------------------------------------------------- + + We're going to run the MSR for returns and quality, so it's also a question of what you put into it so you should probably expect to see less FHA and things like that, and then you'll see some run-off over time. + +-------------------------------------------------------------------------------- +Paul Miller, FBR & Co. - Analyst [118] +-------------------------------------------------------------------------------- + + And then Jamie, on the credit boxes not really expanding, what do you think, what kind of impact do you think that's having on the overall mortgage market, especially the purchase market, as we're seeing almost 14 year lows on the origination side? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co - Chairman & CEO [119] +-------------------------------------------------------------------------------- + + It's almost impossible to tell, but there are -- if you're jumbo you can get loans, if you are GSE you can get loans, but almost all the other stuff in between, anything with any hair on it like if you ever had a credit problem, if you are earning self-reported income, so a lot of people have overlay, they're being tougher than is required by FHA, GSE, or their own rules because of reps and warranties, et cetera. +And I don't know when that's going to go away. It's not getting worse. It's just sitting there and probably holding back a little bit the purchase market. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [120] +-------------------------------------------------------------------------------- + + Think about the credit is available across the LTV spectrum, but the bar to be able to document income and prove ability to repay under QM is high. + +-------------------------------------------------------------------------------- +Paul Miller, FBR & Co. - Analyst [121] +-------------------------------------------------------------------------------- + + Okay, guys, thank you very much. + +-------------------------------------------------------------------------------- +Operator [122] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Steven Chubak of Nomura. + +-------------------------------------------------------------------------------- +Steven Chubak, Nomura - Analyst [123] +-------------------------------------------------------------------------------- + + Hi, good morning. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [124] +-------------------------------------------------------------------------------- + + Good morning. + +-------------------------------------------------------------------------------- +Steven Chubak, Nomura - Analyst [125] +-------------------------------------------------------------------------------- + + You had alluded to some of the drivers of the RWA growth earlier, and I was just hoping you could frame that in the context of your $40 billion targeted RWA decline from Investor Day, and whether that's potentially at risk or is the $1.55 trillion RWA level still achievable? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [126] +-------------------------------------------------------------------------------- + + So the models that were disapproved we understood that we were going to have certain of our models that needed additional work to be acceptable by the regulators of Basel III when we gave the guidance at Investor Day, so as a large matter as we sit here today, that's still our best understanding of how things will work out absent there being any new news or issues during the year. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co - Chairman & CEO [127] +-------------------------------------------------------------------------------- + + It's a timing difference as opposed to a target difference. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [128] +-------------------------------------------------------------------------------- + + Yes, the whole industry submitted a huge number of models under Basel 2.5 to the regulators to review at the beginning of 2013. We had an approval to use them for the year while they were being reviewed and pending after the review; we got some feedback and we're going to remediate the models and resubmit them for approval. So it will take us time but it is timing. + +-------------------------------------------------------------------------------- +Steven Chubak, Nomura - Analyst [129] +-------------------------------------------------------------------------------- + + Okay, understood. And then transitioning to OLA for a second. Long-term debt outstanding did increase modestly about 2% in the quarter. I just wanted to confirm how we should be thinking about issuance plans over the course of the year. Are you managing it to a 19% bail in buffer, so we saw the modest increase in RWA and then saw a commensurate increase in long-term debt, or should we be thinking about it entirely differently? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co - Chairman & CEO [130] +-------------------------------------------------------------------------------- + + Just assume it's going to be fairly constant. + +-------------------------------------------------------------------------------- +Steven Chubak, Nomura - Analyst [131] +-------------------------------------------------------------------------------- + + Okay. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co - Chairman & CEO [132] +-------------------------------------------------------------------------------- + + When we know what the real rules are we may modify that. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [133] +-------------------------------------------------------------------------------- + + That's right. We're not managing to an OLA that we don't know yet. + +-------------------------------------------------------------------------------- +Steven Chubak, Nomura - Analyst [134] +-------------------------------------------------------------------------------- + + Okay, fair enough. And then last one for me. The high frequency trading review and potential market structure overhaul continues to be an area of increasing focus, and I was hoping you could speak to the equities business and whether the anticipated SEC review and potential broader equity market structure reform will compel any adjustments? And how you're thinking about that at this juncture? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co - Chairman & CEO [135] +-------------------------------------------------------------------------------- + + Well we told you we are firmly supportive of having proper and good markets for everybody, and we think we have pretty good policies and protocols in place. But I don't know what it will do to other -- there are issues in market structures with some pools et cetera, but we just have to let that review take place. I should point out in Michael Lewis' book which I did not read on page 231, they refer to us as one of the good guys. + +-------------------------------------------------------------------------------- +Steven Chubak, Nomura - Analyst [136] +-------------------------------------------------------------------------------- + + Okay, fair enough. Thank you for taking my questions. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [137] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Operator [138] +-------------------------------------------------------------------------------- + + Our next question comes from Jeff Harte of Sandler O'Neill. + +-------------------------------------------------------------------------------- +Jeff Harte, Sandler O'Neill & Partners - Analyst [139] +-------------------------------------------------------------------------------- + + Hi good morning. A couple left for me. One, looking at Consumer and Business Banking such that it is a deposits business, the overhead and the efficiency ratio there has really trended up for a few years straight. I know there's been some investment as well, but how should we think of that going from kind of the 70% plus it's been now back to some kind of the mid 60 like it historically was? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [140] +-------------------------------------------------------------------------------- + + So a couple of things. As you know, we have been investing and building our branch to the place it is now where we're happy with the distribution capability we have, so that was driving a lot of the investment. In 2014 we continue to invest in [quarterly] and digital and the cost to serve and efficiency so that we can drive the ratios down. +We guided at Investor Day to expect expenses in the business to be up 1%, so a little but not the kind of increase that we've been seeing after which you should expect it to start to come down. And we said that the overall CCB business including mortgage would be down $2 billion by 2016 over 2014, and a chunk of that is in CBD. +So we are very focused on it and investing in fact in the technology and processes to be able to be efficient; we started to see the increased turn as we stopped having to invest in branches because we're happy with the distribution and it will start to come down next year. + +-------------------------------------------------------------------------------- +Jeff Harte, Sandler O'Neill & Partners - Analyst [141] +-------------------------------------------------------------------------------- + + So that is getting better to some extent as expenses going down, to what extent is revenues getting better? Does the WaMu footprint factor into that, or are we waiting for interest rate help? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [142] +-------------------------------------------------------------------------------- + + So everything that I talked about in terms of expenses going down is all on a dollar basis, not an efficiency ratio basis, so we're absolutely expecting dollars to come down after 2014 in the business. +With respect to the new branches, I mean we said like there's a third of our branches that are less than 10 years old, and about 11% less than 3 years old, so we have a lot of branches in the deposit gathering phase. And deposit margins are relatively flat, so at the moment we've reached the point where volume is out, is providing support to NII, but not strong growth until we start to see rates continue to rise and be able to reinvest up the curve as deposits investments mature. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co - Chairman & CEO [143] +-------------------------------------------------------------------------------- + + The underlying numbers are terrific, customer satisfaction, deposits, households, mobile, Chase Wealth Management, small business, et cetera, but they are being squeezed by NII and interest rates and we've always told you we're going to build for the long run, which is that will recover one day and you will see spreads go up in this business. And when that happens it happens, but we're not going to not grow deposits because of that. And that will also affect obviously efficiency ratio. + +-------------------------------------------------------------------------------- +Jeff Harte, Sandler O'Neill & Partners - Analyst [144] +-------------------------------------------------------------------------------- + + Okay. And on the litigation side, nice to have a quarter where there aren't big charges, who knows what the market does, but in theory that's a good thing for the share price. Is there the potential for that to be a good thing for the underlying businesses too? Have all the headline risks been a negative on some of the business lines from a consumer customer perspective? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [145] +-------------------------------------------------------------------------------- + + Yes, so as much as I would love to be able to take a quarter that looks like this and say we could expect more of the same, the reality is we still have issues open in front of us. We still have large reserves and we still are working through them. So we've been clear that while we can't predict legal expenses, we do expect them to be lumpy, and for every zero or close to zero quarter, we could have a quarter that has several hundred millions of dollars or more, albeit that it should trend down and abate to something much lower over time. +So I don't think you can read into it that we're done, we're still working through issues, we're obviously glad to have some of them behind us and some of the bigger and most difficult ones. + +-------------------------------------------------------------------------------- +Jeff Harte, Sandler O'Neill & Partners - Analyst [146] +-------------------------------------------------------------------------------- + + To the extent you're not looking hopefully at multi billion dollar quarterly settlements anymore, does that help on the volume side of the businesses? Did that have a negative impact on kind of customer interactions with you? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co - Chairman & CEO [147] +-------------------------------------------------------------------------------- + + No. If you look at the customer flows, in every single business they are very good, and customer sat scores are up, investments are up, assets under management are up, market shares are up, credit card, consumer, deposits, that's all very good. So I would completely separate out this litigation stuff, and Marianne, you all have averaged your own estimates for litigation I think are $500 million a quarter. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [148] +-------------------------------------------------------------------------------- + + By our quarterly models, it's about $500 million a quarter, yes. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co - Chairman & CEO [149] +-------------------------------------------------------------------------------- + + So make believe, I'm going to use your number, nobody else's, it's not going to be $500 million consistent. It's going to be zero, something else, zero to $50 million, that's what it is until it goes away. It's not going to affect the underlying business. And as you know we're also going to have one-time benefits from stuff we don't anticipate too. + +-------------------------------------------------------------------------------- +Jeff Harte, Sandler O'Neill & Partners - Analyst [150] +-------------------------------------------------------------------------------- + + So you haven't noticed kind of a negative reputational impact with customers? It's been okay obviously, looking at the volumes I guess it must be okay. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [151] +-------------------------------------------------------------------------------- + + We're growing share so-- + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co - Chairman & CEO [152] +-------------------------------------------------------------------------------- + + Clients go with their feet and they seem to be coming to our branches and our bankers. + +-------------------------------------------------------------------------------- +Jeff Harte, Sandler O'Neill & Partners - Analyst [153] +-------------------------------------------------------------------------------- + + Okay, thank you. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [154] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Operator [155] +-------------------------------------------------------------------------------- + + Our next question comes from Jim Mitchell of Buckingham Research. + +-------------------------------------------------------------------------------- +Jim Mitchell, Buckingham Research Group - Analyst [156] +-------------------------------------------------------------------------------- + + Hi, good morning. Two follow-ups. First on the expense side, I think if you look at the run rate this quarter you had around $58.4 billion, and so well below; if you analyze that then your $59 billion target and seasonally this would be the higher expense quarter given capital markets revenue. Is there something we should be thinking about in the out quarters, whether it's higher regulatory compliance spending, marketing spending, or is this just some conservative because we don't know where capital markets revenues go? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [157] +-------------------------------------------------------------------------------- + + So it's a little bit of we don't know where capital markets revenues will go obviously, and if they stay low or we expect to pass that down to the bottom line, it's also a little bit of there are sometimes positive and sometimes negative surprises and issues in expenses at this time every quarter, so there's a little bit of cautiousness in there. We're going to obviously do everything we can to outperform that. + +-------------------------------------------------------------------------------- +Jim Mitchell, Buckingham Research Group - Analyst [158] +-------------------------------------------------------------------------------- + + Okay, fair enough. And maybe a quick question back on the SLR. You guys I think last quarter before the changes by Basel noted that the Basel committee's calculation would be a net drag of 10 basis points, this quarter it's 15 to 20 basis points benefit, right? Is that simply the changing in the credit conversion factors on the off-balance sheet credit lines, or is there anything else driving that improvement this quarter? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [159] +-------------------------------------------------------------------------------- + + So most of the improvement in this quarter was associated with the ability for us to net variation margin on derivatives across currencies as allowed by contracts rather than having to only net in the currency of the underlying transaction. So that was obviously sensible that you should be allowed to net margin across allowable currencies, but that was not the provision of the Basel committee; the US proposal changed that and that's favorable. That's driving most of it, there were other things up, down, complicated technical things, but not big numbers. + +-------------------------------------------------------------------------------- +Jim Mitchell, Buckingham Research Group - Analyst [160] +-------------------------------------------------------------------------------- + + Okay. And that doesn't include the benefit of moving to say the non-internal model methodology, which would be another 40 basis points? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [161] +-------------------------------------------------------------------------------- + + That's correct but I'm not expecting that in the very near future. + +-------------------------------------------------------------------------------- +Jim Mitchell, Buckingham Research Group - Analyst [162] +-------------------------------------------------------------------------------- + + Right. Okay, great thank you. + +-------------------------------------------------------------------------------- +Operator [163] +-------------------------------------------------------------------------------- + + Our next question comes from Chris Kotowski of Oppenheimer. + +-------------------------------------------------------------------------------- +Chris Kotowski, Oppenheimer & Co. - Analyst [164] +-------------------------------------------------------------------------------- + + Yes, good morning. As you mentioned I'm looking at page 17 of your supplement on the credit card business, and as you mentioned all the volume metrics all look great. Sales volume up 10% and merchant processing up 11%, but then when you look at the fees, it's down 4%. And I would have thought we kind of anniversaried all of the regulatory changes and so on, so I guess a big question for me is in this business in particular, why aren't the favorable volume metrics translating into revenues? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co - Chairman & CEO [165] +-------------------------------------------------------------------------------- + + We're going to have to get back to you. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [166] +-------------------------------------------------------------------------------- + + Chris I'll get back to you. I apologize. We'll get back to you. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co - Chairman & CEO [167] +-------------------------------------------------------------------------------- + + Probably has to do with [awards], but we'll get back to you. + +-------------------------------------------------------------------------------- +Chris Kotowski, Oppenheimer & Co. - Analyst [168] +-------------------------------------------------------------------------------- + + Okay. And then just secondly on the broader philosophical level, Jamie, a couple years ago at Investor Day, you rhetorically asked a question about capital markets income, is it cyclical or is it secular, and you said believe me it's cyclical. +And now, you look industry wide by my numbers, we're down on a year-over-year basis 13 out of the last 17 quarters, and it's sure as heck feeling secular. And I'm curious, one, have you adjusted your point of view? Two, do you think there is some irreducible level of transaction volume business for the industry? And three, how do we gauge how far we are on that glide path from where we used to be to where we stabilize? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co - Chairman & CEO [169] +-------------------------------------------------------------------------------- + + So there are certain things which are secular. People who have gotten out of it -- I'm not talking about us per se, but people have gotten out of reduced dramatically credit hybrids, certain exotic derivatives et cetera, and I think there may be additional secular change. But it's not the whole business, so the way I look at the whole business is we have 120 trading desks around the world, we have 16,000 clients. +And if you look at the fuel of the business, the fuel of the business is investable assets in need of people to invest those, whether it's corporations, individual, et cetera. Those numbers will double over 10 years, they're going to triple in the emerging and developing markets. And spreads themselves have been coming down fairly consistently for 20 years, and that's called capitalism, that you're efficiently using capital. +So I look at it as a long-term business, it will be a good business, shares are going to change, there will be a whole bunch of adjustments. And as you know, it can change on a dime, and so we're not, I don't look at the $5 billion in markets revenue and cry in my soup. I think it's pretty good business, and we have had very consistent performance. Remember it's driven by technology, research, sales, ideas, of course border flows, and last year we didn't even have one trading day loss, which I consider really spectacular. +So it's a good business. It will grow over time and it will have some secular adjustments. And I don't know about your numbers being right, the 13 of 17 quarters. And I also wouldn't go back and look at the peak, the really peak markets of 2007 or something and I think you had some of that in 2009 and say that was a standard. I think that was a little high. Higher than normal. + +-------------------------------------------------------------------------------- +Chris Kotowski, Oppenheimer & Co. - Analyst [170] +-------------------------------------------------------------------------------- + + Well my numbers were industry from 2009 on, or 2010 on, so but anyway, but thanks. It's probably an unanswerable question. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [171] +-------------------------------------------------------------------------------- + + I have an answer to your other question, I apologize for not having it off the top of my head. In the first quarter of last year, in non-interest revenue in Card we had a one-time exit of a non-core product. So I think if you go back and dig out that transcript or have a look at the supplement there, there was actually a one-time item, so if we adjust for that, we would have been up more strongly. + +-------------------------------------------------------------------------------- +Chris Kotowski, Oppenheimer & Co. - Analyst [172] +-------------------------------------------------------------------------------- + + Okay, thank you. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co - Chairman & CEO [173] +-------------------------------------------------------------------------------- + + I might mention on the credit card business we have beta tests going of our Chase net and you're not going to see it in the numbers this year, but we think it's a pretty exciting thing that we can do for merchants and customers over time. + +-------------------------------------------------------------------------------- +Operator [174] +-------------------------------------------------------------------------------- + + We have no further questions at this time. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [175] +-------------------------------------------------------------------------------- + + Thanks for joining us. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co - Chairman & CEO [176] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Operator [177] +-------------------------------------------------------------------------------- + + This concludes today's conference call. You may now disconnect. + + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/exam/original-files/Problem_2_3_Sample_full_transcripts/2014-Apr-15-KO.N-139157937760-Transcript.txt b/exam/original-files/Problem_2_3_Sample_full_transcripts/2014-Apr-15-KO.N-139157937760-Transcript.txt new file mode 100644 index 0000000..6bf5aa0 --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_full_transcripts/2014-Apr-15-KO.N-139157937760-Transcript.txt @@ -0,0 +1,540 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q1 2014 The Coca-Cola Company Earnings Conference Call +04/15/2014 09:30 AM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Gary Fayard + The Coca-Cola Co - CFO + * Ahmet Bozer + The Coca-Cola Co - EVP & President - Coca-Cola International + * Sandy Douglas + The Coca-Cola Co - SVP, Global Chief Customer Officer, President of Coca-Cola North America + * Jackson Kelly + The Coca-Cola Co - VP of IR + * Irial Finan + The Coca-Cola Co - EVP & President - Bottling Investments and Supply Chain + * Kathy Waller + The Coca-Cola Co - VP of Finance, Controller & Incoming CFO + * Muhtar Kent + The Coca-Cola Co - Chairman and CEO + +================================================================================ +Conference Call Participiants +================================================================================ + + * Bill Pecoriello + Consumer Edge Research - Analyst + * Judy Hong + Goldman Sachs - Analyst + * Bryan Spillane + BofA Merrill Lynch - Analyst + * Dara Mohsenian + Morgan Stanley - Analyst + * Michael Steib + Credit Suisse - Analyst + * John Faucher + JPMorgan Chase & Co. - Analyst + +================================================================================ +Presentation +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + At this time, I would like to welcome everyone to the Coca-Cola Company's first quarter 2014 earnings results conference call. Today's call is being recorded. If you have any objections, you may disconnect at this time. +(Operator Instructions) +I would like to remind everyone that the purpose of this conference is to talk with investors, and therefore questions from the media will not be addressed. Media participants should contact Coca-Cola's media relations department if they have questions. I now would like to introduce Jackson Kelly, Vice President and Investor Relations Officer. Mr. Kelly, you may begin. + +-------------------------------------------------------------------------------- +Jackson Kelly, The Coca-Cola Co - VP of IR [2] +-------------------------------------------------------------------------------- + + Good morning, and thank you for being with us today. I am joined by Muhtar Kent, our Chairman and Chief Executive Officer, Gary Fayard, our Chief Financial Officer, who as you know has elected to retire next month, as well as Kathy Waller who will be recommended for the role of CFO at next week's Board meeting. Following prepared remarks by Muhtar and Gary this morning, we will turn the call over to you for your questions. Ahmet Bozer, Executive Vice President and President of Coca-Cola International; Sandy Douglas, Senior Vice President, Global Chief Customer Officer and President of Coca-Cola North America; and Irial Finan, Executive Vice and President and President of Bottling Investments and Supply Chain will also be available for the Q&A session. +Before we begin, I would like to remind you that this conference call may contain forward-looking statements including statements concerning long-term earnings objectives, and should be considered in conjunction with cautionary statements contained in our earnings release, and in the Company's most recent periodic SEC reports. In addition, I would also like to note that we have posted schedules under the financial reports and information tab in the investors Section of our Company website at www.coca-colacompany.com. These schedules reconcile certain non-GAAP financial measures which may be referred to by our senior executives during this morning's discussion to our results as reported under Generally Accepted Accounting Principles. Please look on our website for this information. Now I will turn the call over to Muhtar. + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Co - Chairman and CEO [3] +-------------------------------------------------------------------------------- + + Thank you, Jackson, and good morning, everyone. I appreciate your joining us for an update on our first quarter performance. As you know, we started 2014 with a clear objective of restoring the momentum of our global business. This morning, I am pleased to report that our growth momentum is improving in line with our expectations. +In the midst of continued headwinds, we achieved sequentially stronger 2% volume cycling, 4% volume growth in the prior-year quarter, despite the shift of the Easter holiday into the second quarter of this year, comparable currency neutral net revenue growth of 2% after excluding the impact of structural items, growth of an incremental 100 million unit cases or the equivalent of 27 million incremental servings per each day, and both volume and value share gains in nonalcoholic ready-to-drink beverages, with value share gains ahead of volume share gains. +These top line results underscore our system's ability to leverage our occasion brand price pack channel architecture across our entire portfolio of leading brands. They are also a reflection of our ability to drive performance, improved incidents, and simultaneously enhance price mix which increased 2% globally in the quarter. And we increased our marketing investments while decreasing other SG&A costs, consistent with our commitment to identify savings opportunities, and to increase support for our brands. +From a geographic perspective, volume in our developed markets was down 1%, however, volume grew in key developed markets including Japan and Australia, while volume in North America was even. Importantly, volume grew 3% in our developing and emerging markets, with China up 12% and Brazil up 4%. Both India and Russia also grew volume in the mid single-digit range, while gaining nonalcoholic ready-to-drink volume and value share. +We remain steadfastly focused on the five strategic priorities we announced on our fourth quarter earnings call, and later which I outlined at CAGNY. As a reminder, those five strategic priorities are as follows. Firstly, to accelerate sparkling growth led by Coca-Cola, strategically expand our portfolio -- profitable stills portfolio. Thirdly, increase brand investments by maximizing productivity. Fourth, win at the point-of-sale by unlocking the power of our system. And last but not least, invest in our next generation of leaders. +I will devote the majority of my remarks today to talking about these strategies, and the progress we are making in restoring our momentum. As usual, you will find further operating group performance details in our earnings press release issued earlier this morning. These five important strategic priorities serve as a means to further sharpen our focus. They also serve as beacons to collectively align the efforts of our more than 700,000 system associates all around the world. +Now beginning with our first priority, we are determined to accelerate sparkling beverage growth led by Coca-Cola, and we have established comprehensive strategies to do so. The foundation of this plan is to invest in, and deliver great marketing to support our sparkling brands. We are adding a sharpened focus with our bottling partners to increase sparkling brand penetration, as well as cold drink availability. +We are overlaying disciplined occasion brand price pack channel strategies, supported by revenue growth management capabilities to drive sustained value growth. We are continuously innovating to meet evolving consumer needs. And also, we are engaging with partners and stakeholders to promote trust and to address category misperceptions. These strategies to accelerate sparkling growth are solid, and we expect to see improving results throughout the year. +Highlights of actions we took in this past quarter include a terrific Sochi Olympics campaign executed across all over Russia, supported by solid trade activations that resulted in 7% sparkling volume growth, and 9% brand Coca-Cola growth, the 17th consecutive quarter of growth for brand Coke. A successful recruitment strategy in China, where immediate consumption packs drove sparkling volume growth of 6%, brand Coke growth of 3%, and transaction growth of 10%, and ongoing sparkling innovation in Japan that contributed to 3% sparkling growth in the first quarter. +We clearly see growth potential in the sparkling category. And along with our system partners, we are investing in the wide-ranging sparkling innovation, world-class marketing, and unparalleled local execution to satisfy our consumers' thirst for refreshment. It is still early in our journey to restore sparkling momentum, yet we are tenaciously focused on building and improving upon this quarter's performance. +This is underscored by the programs and the marketing campaigns that are already underway in the second quarter, like our FIFA World Cup campaign that has 175 countries participating, the broadest reach of any campaign in Coca-Cola's history. We are happy to share that the FIFA World Cup Trophy tour is visiting the United States this week, with stops in Washington, DC yesterday, Miami today, and Atlanta and LA later in the week. From here, the FIFA World Cup Trophy tour is heading to Brazil, on the final leg of its 90 country journey. The activation of this exciting global property, coupled with initiatives such as our Share a Coke program with individualized personalized Coca-Cola bottles and cans, continued support and innovation on Sprite and Fanta, and a wide range of new package introductions across our entire sparkling portfolio is going to bring excitement and engagement to our sparkling brands all around the world. +Moving now to our second priority, to strategically expand our profitable still beverage portfolio. Our still beverage brands account for approximately a quarter of our total global volume currently. Today we are the global value leader in still beverages, with $11 billion still brands, more than any of our competitors. In the first quarter of this year, our still beverage volume grew 8%, while gaining both volume and value share. Given our leadership position in the industry, we are keenly focused on working with our global system partners to build strong, profitable and competitively advantaged brands in fast-growing and profitable still beverage categories. +We are building on our leading juice and juice drink portfolio, growing volume 3% in the quarter. This was fueled by exceptional black brands like Simply, which grew double-digits in North America, and Minute Maid Pulpy which grew 8% in China. This also marks our ninth consecutive quarter of value share gains in juice and juice drinks. +Our global still -- our global tea portfolio grew 4%, as we delivered double-digit growth across Honest and Gold Peak in North America, as well as Ayataka and Sokenbicha in China -- in Japan, I beg your pardon. This resulted in the 10th consecutive quarter of global ready-to-drink value share gains in tea. +We are leveraging our packaging leadership to expand our plant bottle and crushable bottle packaging, creating an important point of value differentiation for brands ranging from Dasani in North America to I LOHAS in Japan. And we are developing a new profit-enhancing beverage drop platform that now includes the Dasani, Powerade, Minute Maid and [our] Vitaminwater brands. As you will note, we continue to innovate across our still portfolio to further drive and enhance our leading position. +Our third strategic priority is to increase brand investments by maximizing productivity. On the brand side, and as announced earlier this year, we will grow our investments by $400 million in 2014, and by $1 billion by 2016. We began to ramp up our investments in the first quarter to support robust marketing programs like our Sochi Winter Olympics campaign across multiple markets. +We are also increasing our media investment and quality in North America, as evidenced by our Super Bowl ads, It's Beautiful and Going All the Way. In Latin America, the first of our operating groups to launch the FIFA World Cup activation, viral marketing efforts targeting millennials included short films that have already exceeded 10 million views on YouTube. +And also, our worldwide marketing team is collaborating with our partners to deliver enhanced consumer experiences. A couple of examples that leverage new technology platforms include Misfit Wearables which produces the Shine fitness tracker, and Spotify, the world's leading on-demand music streaming service. Our strategic partnerships with these two companies in which we have made minority equity investments, will enable us to forge even more meaningful connections with our consumers. +And while it is too early to speak to results from our increased level of investment, we are confident in our plans and approach, which is based on robust analytics across our top markets. The insights from this analysis have equipped us with the necessary information to prioritize both the quantity and quality of our investments across markets, across brands, and across media channels. +With regards to productivity, we are diligently seeking, identifying and securing efficiencies across all parts of the business. This effort is focused on standardizing and streamlining our processes, while also clarifying roles and accountabilities. Let me just provide you with three examples of how we are doing this across North America. +We have instituted an ownership cost management focus, thanks to which our associates are identifying and delivering significant savings. Second, about 50% of our plants in North America have completed an operational excellence diagnostic, with the remainder scheduled to do so by 2015. This is resulting in savings of approximately $1 million for each location. And following each implementation, the focus on year-over-year productivity continues. And third, in our warehouse and delivery operations, we have focused on our layout and process standardization. +Thanks to initiatives ranging from realtime data transfer to smart selling, we can now optimize warehouse capacity, work more efficiently, and reduce out-of-stocks. These are just a few examples of the productivity work that we are doing to identify and extract savings that will be redeployed and reinvested to drive long-term growth. +We have also made progress on our fourth priority, which is to win at the point-of-sale by unlocking the power of our system. Our focus on winning at the point-of-sale is not new. What is new is the increased emphasis on flawless execution across our system. This includes an accelerated focus on capturing new outlook, and greater alignment in the execution of new brand and package launches. +We are also intent on exceeding our right execution daily or RED target, and ensuring that our products are well-placed, as well as merchandised to optimize our sales. This fourth priority emphasizes the importance of capability building and collaboration on all front lines, where our sales associates, drivers, merchandisers are often the final link in ensuring that our Coca-Cola and all our brands are always within an arm's reach of desire. +The first quarter, we saw many concrete examples of how, together with our bottling partners, we are winning at the point-of-sale, including: excellent execution of our Sochi marketing campaign leading to significant share gains across almost all beverage categories in Russia; occasion brand price pack channel architecture changes in many countries including a significant focus on immediate consumption pack introductions, leading to immediate consumption volume growth ahead of future consumption growth; and an improved RED penetration and scores. Right execution daily now covers approximately 40% of our volume, an increase of about 3 points over the past year. And our FIFA World Cup Trophy tour program has now reached 90 countries, where our bottling partners have activated the program in 400,000 retail outlets. +Importantly, the partnership required to win at the point-of-sale extends beyond our bottling partners to include our customers, the more than 24 million retail outlets that we proudly visit on a weekly basis. We are continuously collaborating with our customers to identify ways to add value to their business. +Our fifth and final priority is to invest in our next generation of leaders, both here in the US and all across the world. In this context, I want to remind everyone that today is Gary's last quarterly earnings call, and I want to commend and acknowledge him on an outstanding 14 years as the Coca-Cola Company's CFO. We sincerely thank Gary for his many years of outstanding leadership service, his steady focus, countless insights, and the enormous value he has helped to generate for our Company and all of our shareowners. Collectively, he and his finance leadership team have carried out a thoughtful and purposeful transition. +I am going to recommend that our Board elect Kathy Waller as our new CFO next week, and this is a great example of the talented and experienced bench strength that we are building with our next generation of talented leaders. I hope all of you welcome Kathy to the role of Chief Financial Officer. +As our fifth priority outlines, we are committed to investing in our next-generation of leaders across all levels of the Coca-Cola Company and Coca-Cola system. So as you can see, we are making progress across each of these critical strategic priorities, and I look forward to providing you with further updates as we progress throughout this year. +Now let me address a couple of other topics across our operating groups. First, there is the question of profitability in North America, where comparable currency neutral operating income declined 8% in the quarter. This decline was largely due to the impact of one less selling day, and the shift of Easter into the second quarter. We have been encouraged by the results of targeted marketing efforts in several North American markets in recent months, and we are excited about the trends that we are seeing. +Enhanced marketing and disciplined retail pricing strategies in North America resulted in volume that was even for the brand Coca-Cola. At the same time, we achieved a 2% increase in sparkling price mix. We also gained sparkling value share ahead of volume share, making this our16th consecutive quarter of value share gains. +Our priorities in North America remain very clear. As we shared in our year-end call, our focus remains on building strong brands, creating customer value and enhancing our capabilities. We are streamlining the way we work, and identifying ways to operate more effectively and efficiently in our sales, warehouse and delivery operations. +I also want to speak to our results in Europe where our volume was down 4%, as our business was adversely impacted due to the Easter shift, and by ongoing macroeconomic challenges. Volume in France increased 4%, and volume in Germany was even with prior year. During the quarter, our Europe group realized 10 points of price mix, thanks to the consolidation of Innocent, and to a broad focus on earnings price -- earning price across our business units in Europe. +We seek to continuously earn price mix by balancing disciplined pricing with packaging changes. A recent example of this is the transition from a straight wall 2 liter to a contoured 1.75-liter at the same price in Great Britain at the end of the first quarter. As we look ahead, we are cautiously optimistic about our outlook in Europe, despite the continuing volatile operating environment. The strong and integrated program that we have developed, together with our bottling partners fuel this optimism. +These initiatives will help us leverage our marketing assets, implement critical innovative packaging and dispensing initiatives, and execute impactful marketing programs during the year to come. A number of these initiatives in Europe began in the first quarter, including the FIFA World Cup promotions and three-time World Cup winner Germany offering our Coke Zero customers a chance to win one of the 200 tickets to Brazil, a new Fanta marketing campaign, and [In and Out] flavors successfully launched in Austria, Switzerland, Romania and Hungary, as well as Cappy Pulpy's geographical expansion in the southern European belt. However, we see most of the benefit coming during the remainder of the year due to various factors such as the timing of Easter, the ramp-up in World Cup activations, as well as the timing and intensity of our marketing programs. +Before handing over the call to Gary, I want to also remind you about our recently announced partnership with Keurig Green Mountain which closed in the first quarter. We believe Keurig Green Mountain is the perfect strategic partner to collaborate with, to capitalize on the many opportunities we see available in the market, and we look forward to providing you with further updates later in the year. +As I complete my prepared remarks, I want to reinforce that there is much -- so much runway ahead of us, and the Coca-Cola system is well-positioned to capture more than our fair share of growth. This is a business that has barely tapped into its full potential. Globally, consumer populations are growing. Purchasing power is increasing and spreading to a new middle class. Urbanization continues to intensify, and lifestyles and consumer preferences are changing in ways that significantly favor our expanding and evolving beverage portfolio. We have an unparalleled reach with leading global brands, and a bottling system that is investing for sustainable growth. +Having said that, we do not take anything for granted. We fully understand that obtaining our 2020 vision will require more than just counting on industry growth. Indeed, it is up to all of us, up to our global system leaders, and up to each of our associates to make the right decisions, and to take the right actions that is going to enable us to seize the abundant opportunities that are before us. Gary will now provide you with some additional details on our first quarter financial performance. + +-------------------------------------------------------------------------------- +Gary Fayard, The Coca-Cola Co - CFO [4] +-------------------------------------------------------------------------------- + + Thanks, Muhtar, and good morning, everyone. In the first quarter of this year, we began executing and delivering the strategic plan that we outlined and shared with you on our 2013 year-end call, and at the CAGNY and CAGE investor conferences earlier this year. Our clear and focused commitment remains on long-term value creation, and the strategic priorities which Muhtar just outlined today, and they are tailored to do just that. While much work remains to be done, we are confident in our strategies, and are fully committed to this plan as we firmly believe that the Coca-Cola company is a sustainable and great long-term growth business. +As mentioned, we grew unit case volume 2%, a sequential improvement from last quarter, and cycling 4% growth in the prior year. Global price mix increased by 2%, and we gained both volume and value share in nonalcoholic ready-to-drink beverages in the first quarter, a constructive start towards restoring our momentum in 2014. +Comparable currency neutral net revenue grew 2% after excluding structural items, while concentrate sales were even with the prior year. We do expect concentrate sales and unit case sales to be in line for the full year. Comparable currency neutral operating income grew a solid 7% after excluding structural items, while also including an increase in marketing investments in support of our brands. Comparable currency neutral earnings per share grew 5%, with currency creating a 10 point headwind on comparable EPS. And for the math people in the room, you will notice a comparable EPS declined 4% implying a 9 point headwind. I just wanted to point out that the 10 point headwind is in the rounding. +We generated $1.1 billion in cash from operations, and our net share repurchases through the first quarter were $713 million. Our cash from operations increased significantly versus the prior year quarter, primarily because we made a large contribution to our pension plan in the first quarter of last year. Cash from operations also benefited from efficient management of working capital, and these benefits were partially offset by unfavorable exchange. +Because our largest pension plan is currently fully funded, I do not foresee any significant cash contributions to our pension plan in the near-term. As it relates to overall cash management, as we have discussed in the past, we follow disciplined guidelines for how we use our cash to create sustainable shareowner value. +First, we are reinvesting in the business to further strengthen the equity of our brands and to accelerate growth. This includes capital investments in new cooler placements, route to market enhancements, brand and packaging innovation, and marketing investments that include not only more marketing, but better quality marketing as well. Importantly, along with our increased investments, our bottling partners are also stepping up their investments thus further enhancing growth for their overall system. +Second, we continue to reward shareholders by paying a healthy dividend which is $1.22 per share this year, a 9% increase over last year. It is worth noting that we have increased our dividend every year for more than half a century. Third, we evaluate opportunities to grow through bolt-on acquisitions, strategic partnerships, and value added joint ventures when appropriate. Recent examples include the Keurig Green Mountain partnership, which opens up an exciting new packaging format for our brands, investments to further enhance our leading juice portfolio like Innocent and Rani, and investments that allow us to broaden our reach, like Zico and Core Power. And finally, we conduct meaningful, regular share repurchase. +As we look to the second quarter of 2014, we plan on continuing to execute our five strategic priorities, and our full-year plan remains firmly intact. First, let me address operating leverage. As you can see in our release, we achieved 4 points of operating expense leverage in the quarter, as we benefited from the timing of year-over-year expenses. Consistent with what we shared with you on our year-end 2013 call, our outlook for operating expense leverage for the full year 2014 has not changed. We expect to achieve even to slightly positive operating expense leverage for the full year as we increase brand investments. +Secondly, let me address the outlook for currencies. We now estimate, based on current spot rates and hedging, that currencies will have a 7 point headwind on operating income, both in the second quarter and for the full year. Our analysis reflects and includes the negative impact of the Venezuela currency devaluation, partly offset by improvements in other currencies as compared to the outlook we provided at the time of our year-end earnings release. +While we are very cautious in forecasting currency movements, we have managed through more than $2 billion of currency headwinds at the top line in the last two years, and as you know we anticipate significant currency headwinds for the remainder of this year. As we look further into the future, we think it is unlikely that we will have the same level of headwinds going forward. +Third, I would like to comment on structural change. As we have previously disclosed, the bottling transactions completed in 2013 are anticipated to have an unfavorable 1% structural impact on both our full-year 2014 revenues and operating income. As a reminder, this impact hits the first and second quarter results, as the Brazilian bottler transaction took place on July 3 of last year. +As Muhtar noted earlier, I have elected to retire next month after a very special and memorable 20 years at the Coca-Cola Company, and I want to congratulate Kathy Waller on being recommended to the Board for election as the Company's new CFO, and to reinforce my full confidence in her leadership in this position, given her 25 years at the Company. I have to say, as a retiring officer with this wonderful Company, it is comforting to know that I leave the CFO office in great hands, and that we have built a talented and deep finance leadership organization that will support both Kathy and Muhtar. It also gives me great comfort to look around this room this morning during our conference call with Muhtar, Irial, Ahmet, Sandy, Kathy and Jackson, and to think about the experience, focus and dedication of this Company's senior leadership. It has been a tremendous honor to serve as CFO of the Coca-Cola Company over the past 14 years, and I have greatly enjoyed building long-lasting relationships with all of you across our investment community. +In closing, I want to leave you with a few thoughts. First, I have every confidence in our ability to reignite sparkling growth, beginning with brand Coca-Cola. Second, we are continuing to build leadership positions in still beverages, much like we have done in the sparkling category since 1886. And third, our franchise system is not only the strongest it has ever been, but it also provides us with a global footprint and an invaluable local resource, all at the heart of a real value creation model. And lastly, there is nothing quite as refreshing as an ice-cold Coca-Cola. +So to all of you on this call, I sincerely thank you for your candor, your partnership, and your thoughtful questions over the last 14 years. And I encourage you to continue to reach out to the senior leadership team for meaningful dialogue on ways to further enhance our business, and to build long-term value for you and all of our shareowners. Operator, we are now ready for questions. + + +================================================================================ +Questions and Answers +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Thank you. +(Operator Instructions) +The first question today is from Bill Pecoriello with Consumer Edge Research. + +-------------------------------------------------------------------------------- +Bill Pecoriello, Consumer Edge Research - Analyst [2] +-------------------------------------------------------------------------------- + + Good morning, and congratulations again, Gary and Kathy. + +-------------------------------------------------------------------------------- +Gary Fayard, The Coca-Cola Co - CFO [3] +-------------------------------------------------------------------------------- + + Thank you, Bill. + +-------------------------------------------------------------------------------- +Kathy Waller, The Coca-Cola Co - VP of Finance, Controller & Incoming CFO [4] +-------------------------------------------------------------------------------- + + Thank you, Bill. + +-------------------------------------------------------------------------------- +Bill Pecoriello, Consumer Edge Research - Analyst [5] +-------------------------------------------------------------------------------- + + Muhtar, if you could talk about what gives you the confidence that Coke can hit its long-term growth algorithm in 2014 specifically? And also, when you look at the improving momentum here in the first quarter, how much would you attribute to any relief you are seeing in external headwinds versus the impact of the internal actions that you are taking? Thanks. + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Co - Chairman and CEO [6] +-------------------------------------------------------------------------------- + + Thanks, Bill. Good morning. First let me say again, that I am pleased to report that our growth momentum is improving in line with our expectations. And in the midst of still -- continued volatility headwinds, achieving sequentially stronger 2% volume growth, that means delivering an incremental 100 million unit cases in the past 90 days or so. That means incrementally, every single day, an additional 27 million actual servings per each day. As the base grows, we are still very proud that we can continue to drive growth. +This is a quarter that is where Easter has shifted, where we were cycling 4% from prior year, whereas I said macro volatility continued, and where we had the harshest winter in northern hemisphere particularly in the US. We don't think this is a great result, but satisfying, as one step in the right direction to restore momentum. Germany, US was flat. In the past quarter, we think, given where -- what we went through and what economies and consumer and climate. Turkey was up 2%, Japan was up 3%. France was up 4%, Brazil was up 4%, India and Russia was up 6%. China was up 12%. These are -- these show, and give us the proof points that our actions are working. +And I think this is a quarter again where only a small fraction of our incremental marketing went -- was deployed. I would say probably around -- so 5% of our total incremental marketing for the year was deployed in this quarter. As we ramp up the quality and also quantity of our marketing, I believe that certainly we are going to drive better alignment. We have really good plans in place, fully aligned with our bottling partners. And I would be disappointed, as would be all my colleagues and associates, if we don't go back into the corridor of our long-term growth algorithm for volume growth. +But also importantly, we are driving not just volume growth, but we are driving immediate consumption growth. When you look -- which is really important for our business. When you look at -- say in this past quarter, of top five countries growing as -- China up 18% in IC growth. Indonesia up 9% in IC growth. Vietnam up 8%, Brazil up 5%. +These are really important numbers, because it is sustainable growth. It is profitable growth, and it is growth in transactions, which is directly married to the health of the brands, and the health of our portfolio. So from that perspective again, I want to just register cautious optimism that I feel we would be disappointed if we do not fall back into the corridor of our long-term growth algorithm for the remainder of the year, in terms of the volume growth picture, and also the other key metrics that follow on from there. + +-------------------------------------------------------------------------------- +Bill Pecoriello, Consumer Edge Research - Analyst [7] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Operator [8] +-------------------------------------------------------------------------------- + + Thank you. The next question is from Bryan Spillane with Bank of America Merrill Lynch. + +-------------------------------------------------------------------------------- +Bryan Spillane, BofA Merrill Lynch - Analyst [9] +-------------------------------------------------------------------------------- + + Hello, good morning, and Gary and Kathy both, congratulations to both of you. + +-------------------------------------------------------------------------------- +Gary Fayard, The Coca-Cola Co - CFO [10] +-------------------------------------------------------------------------------- + + Thanks, Bryan. + +-------------------------------------------------------------------------------- +Bryan Spillane, BofA Merrill Lynch - Analyst [11] +-------------------------------------------------------------------------------- + + So just wanted to drill in a little bit further on Latin America, and I guess, sort of three topics. One, in Mexico with volumes, the volume decline was a little bit less than we thought. So if you could talk about whether what we are seeing now is sort of the expected elasticity? Or if there is something else in the future that might change the elasticity, so has the consumer really seen the full effect of the pricing? +And then second, if you could talk a little bit about some of the drivers of price mix in the Latin America segment in the quarter, how much of it was driven by Venezuela? And then finally, just in terms of the Brazil comp being better sequentially, how much of that do you think is just that -- maybe the consumer is a little bit better? Was there anything specific that Coke did in the first quarter to drive that better performance in Brazil? + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Co - Chairman and CEO [12] +-------------------------------------------------------------------------------- + + Bryan, good morning. Last question first on Brazil, I think Brazil was out the gate first, in terms of the FIFA World Cup activation, a lot of noise around that, a lot of activation in stores. And I think that certainly, we also see a little less malaise in terms of the macroeconomic environment. So and again, in terms of also the relationship between durables and nondurable consumer goods was a little bit more in favor for us. +So we feel that is going to continue, and that Brazil will have a better year. And I think the government is also aware of what they need to do, as they lead into one of the biggest events in their history, which is hosting a memorable event like the World Cup. +As far as Mexico is concerned, I think sparkling volume for us was sort of in the mid single-digits decline for the first quarter. The important thing here is that, because of the strength of our brand, because of also the incredible richness of our packaged portfolio, and our occasion brand price pack channel architecture, the strength of that in Mexico, we are seeing that we are gaining market share, versus both local competitors and our international competitor in Mexico as well. And that -- and again, we -- it is too early days related to Mexico. But I would say that we are again, executing with great precision and passion in Mexico with our great bottling partners. +And then, in terms of price mix, including a favorable geographic mix, other points came as the result of high inflation in local markets. And again, I will ask Gary to comment related to the Venezuela piece. + +-------------------------------------------------------------------------------- +Gary Fayard, The Coca-Cola Co - CFO [13] +-------------------------------------------------------------------------------- + + Yes, Bryan, Venezuela definitely contributed positively in the quarter to positive price mix. Now with going forward, that will no longer really be the case, because we have adjusted the -- as of the end of the quarter, we have adjusted the exchange rate and we will be using the [VEF]10.8 exchange rate going forward for most of the revenues, a large part of the revenues in Venezuela. So that will come down. But that impact is included in the latest currency forecast that I gave you. So again, some of the other currencies actually have improved from what we talked about in the February call, that offset now by Venezuela. So still at the same 7% impact. + +-------------------------------------------------------------------------------- +Bryan Spillane, BofA Merrill Lynch - Analyst [14] +-------------------------------------------------------------------------------- + + As we're modeling price mix in Latin America, just going forward, there is some price mix in there that is positive excluding Venezuela? I guess, that is what I was after. + +-------------------------------------------------------------------------------- +Gary Fayard, The Coca-Cola Co - CFO [15] +-------------------------------------------------------------------------------- + + Oh, yes. (Multiple Speakers). Definitely positive price mix going in there. And I think the other thing to point out, and Muhtar said it, I said it. But I think it is really important as you look at this quarter how we drove value share ahead of volume share. So we are definitely focused on rational pricing across the world, and getting -- earning price. + +-------------------------------------------------------------------------------- +Bryan Spillane, BofA Merrill Lynch - Analyst [16] +-------------------------------------------------------------------------------- + + Okay. Thank you. + +-------------------------------------------------------------------------------- +Gary Fayard, The Coca-Cola Co - CFO [17] +-------------------------------------------------------------------------------- + + Thanks. + +-------------------------------------------------------------------------------- +Operator [18] +-------------------------------------------------------------------------------- + + Thank you. The next question is from John Faucher with JPMC. + +-------------------------------------------------------------------------------- +John Faucher, JPMorgan Chase & Co. - Analyst [19] +-------------------------------------------------------------------------------- + + Thank you very much, and Gary, it has been great over the last 14 years. So best of luck, as you move forward, and Kathy, looking forward to working with you as well. + +-------------------------------------------------------------------------------- +Gary Fayard, The Coca-Cola Co - CFO [20] +-------------------------------------------------------------------------------- + + Thanks, John. + +-------------------------------------------------------------------------------- +John Faucher, JPMorgan Chase & Co. - Analyst [21] +-------------------------------------------------------------------------------- + + Gary, I had to finish off with sort of one accounting question here. So you drove tremendous SG&A leverage in the quarter, and you talked a little bit about sort of how you haven't put a whole lot of marketing spend to work yet. +So can you walk us through maybe how we should think about the sales curve over the next couple of quarters, and what we should look for on the SG&A line as we look to model out the balance of the year? Thanks. + +-------------------------------------------------------------------------------- +Gary Fayard, The Coca-Cola Co - CFO [22] +-------------------------------------------------------------------------------- + + Yes. Well, I will try John, and we will see how this goes. But basically, they are -- let's go to marketing first, and let's talk about it in two different ways. One is, how much of the marketing is actually in the market. And that is what Muhtar was referring to, how much is -- of the marketing is actually hitting the consumer, and a lot of our incremental spend actually has not hit the consumer yet. It will -- it is much more weighted, starting in the second quarter going through Q4. A lot of the first quarter really focused on getting the quality of our marketing up, and that sort of thing. +That is different from the way we account for marketing, and marketing as you referenced is on the sales curve. So on the sales curve, that incremental marketing is included in what we expensed in the first quarter. Now, then we get into the marketing that we are cycling quarter by quarter from last year. And so, it was an increase in marketing. In the first quarter, the increase will significantly grow during the year based on what we are cycling. That is part of why I said, that 4 points of operating leverage will go to even to slightly positive, and we are also benefiting from some other timing in the first quarter in just some of the OpEx expenses as well. + +-------------------------------------------------------------------------------- +John Faucher, JPMorgan Chase & Co. - Analyst [23] +-------------------------------------------------------------------------------- + + Okay. And then, Muhtar, if I could ask you a follow-up question on -- you talked about the strength of the bottling system. And obviously, the equity income line is getting hit by FX, but we have seen some comments from Amatil, in terms of what is going on there. And then, also SAB talked about cutting some positions in their soft drink business. +Can you just talk a little bit about the mood of the bottlers and what they are seeing now? And how we should look at some of the headwinds they are facing in the shorter-term? And how that maybe will differ with what happens in the longer-term there? Thank you. + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Co - Chairman and CEO [24] +-------------------------------------------------------------------------------- + + Yes. I would say the mood is positive, in terms of their willingness to invest, their appetite for new territories. I have always -- you have heard me say this before in terms of litmus test for the health of the business. There is a lot of appetite for growing in -- horizontally in territory, and trying to get -- expand. And I think in terms of the quality of our marketing, in terms of the quantity of our marketing, I feel that based on all the bottlers that I have [priced] in this past quarter, I feel good. +I feel positive about the sentiment, both here in the United States, as we start our path to franchising, and as we look at how we expand and how we hasten the pace of franchising, but also across the world. I have recently have been with many bottling leaders, and talked to many of them. We have a global system meeting next month. Also, about 50 of the top bottlers get together with their CEOs and Chairmen, and we are there to further align our plans for 2015 and beyond. But I feel good related to the plans in place, related to everyone's desire to execute better and to invest more into the future. +And again, based on the investments that have gone into the marketplace, in the third and fourth quarter of last year. I feel -- that is why I feel confident that you are going to see us back into the corridor of the 3% to 4% long-term growth algorithm for the balance of the year, as we keep restoring momentum. So that is what I would say. +Do we have some pockets of challenges? You mentioned Coca-Cola Amatil. I feel, again, very cautiously optimistic as Alison Watkins assumes her new role there, and we are working very closely with her and her team. And again, we are very much aligned as to how we move forward with SAB Miller and their management team related to their nonalcoholic beverage business. + +-------------------------------------------------------------------------------- +John Faucher, JPMorgan Chase & Co. - Analyst [25] +-------------------------------------------------------------------------------- + + Okay. Great. Thank you. + +-------------------------------------------------------------------------------- +Operator [26] +-------------------------------------------------------------------------------- + + Thank you. The next question is from Judy Hong with Goldman Sachs. + +-------------------------------------------------------------------------------- +Judy Hong, Goldman Sachs - Analyst [27] +-------------------------------------------------------------------------------- + + Thank you. Good morning, everyone, and I also echo my congratulations to Kathy. And Gary, it has been great. We will miss you. + +-------------------------------------------------------------------------------- +Gary Fayard, The Coca-Cola Co - CFO [28] +-------------------------------------------------------------------------------- + + Thank you, Judy. + +-------------------------------------------------------------------------------- +Kathy Waller, The Coca-Cola Co - VP of Finance, Controller & Incoming CFO [29] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Judy Hong, Goldman Sachs - Analyst [30] +-------------------------------------------------------------------------------- + + So just wanted to maybe delve a little bit into Europe in the quarter. And the question, number one, just relating to Great Britain. Obviously, sparkling being down double-digits, if you can give us some context of trends that you have seen throughout the quarter? And sort of strip out some of the one-off factors with respect to the Easter timing, as well as some of the transition into the 1.75-liter packaging, and whether you are seeing some improvement there? +And then, just in terms of southern Europe, we are hearing more from some of the consumer companies that things are trending a little bit better in markets like Spain and Portugal. So maybe you can also just give us whether we are seeing a similar improvement for your business in that part of Europe? + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Co - Chairman and CEO [31] +-------------------------------------------------------------------------------- + + Thanks, Judy. I will ask Ahmet to give you a response onto your question. Ahmet? + +-------------------------------------------------------------------------------- +Ahmet Bozer, The Coca-Cola Co - EVP & President - Coca-Cola International [32] +-------------------------------------------------------------------------------- + + Yes, thanks, Judy. Yes, the results obviously for Europe for the first quarter was less than what we would have desired, with the minus 4%. A lot of things came into play with that. You mentioned that Easter obviously, that was definitely a factor. And Muhtar has mentioned the transition into a new future consumption pack in GB. +I would add to that, that there was sort of a pricing activity in the marketplace on future consumption packs that had also had some impact. And we are in very close discussion and alignment with our bottlers to make sure that we actually sort of respond in a way that we maintain rational pricing in the marketplace, but also balance volume growth and value growth at the same time. So that was one. +You mentioned southern Europe. The slight improvement that everybody sees in Iberia and Spain, that we see as well. Our numbers had a bit of noise in it, with regards to the strike in our Iberian bottling partners that you all have heard about before. We have had great mitigation plans in place and executed them. And the negotiations -- or sorry, the restructuring is expected to end in May, and we continue to see improvements in our Iberian business as well. So we expect, as we move into Quarter 2, remove the effect of Easter, fully implement our OBPPC in GB and continue to finish our restructuring in Spain, we expect to see improvements in Europe over the next quarter and the rest of the year. + +-------------------------------------------------------------------------------- +Judy Hong, Goldman Sachs - Analyst [33] +-------------------------------------------------------------------------------- + + Okay. Great. And then, if I can follow-up on North America, just on the pricing side. So sparkling up 2% seems encouraging, but the broader North American pricing kind of being flattish. How should we think about that going forward? Do you expect to see the still pricing being a little bit more pressured, or do we see improvement there going forward, for the broader North American pricing turning positive? + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Co - Chairman and CEO [34] +-------------------------------------------------------------------------------- + + Yes, Judy, this is Muhtar. Let me frame again, just a couple important takeaways. For Britain, rational pricing was really the theme for us in Q1. And the very -- the strength of our marketing program, the strength of our commercial program leads us to believe that we will see improvement as we go into Q2 and Q3 and Q4 in Britain. That is the takeaway, I would say. +Again, the same phrase and motto for our US business, rational pricing. That is the takeaway. And we had 2% to 3% price mix in our sparkling portfolio in the US, and you will see that continuing. And I will ask Sandy to and Irial to reflect on further details on that for the year. + +-------------------------------------------------------------------------------- +Sandy Douglas, The Coca-Cola Co - SVP, Global Chief Customer Officer, President of Coca-Cola North America [35] +-------------------------------------------------------------------------------- + + Thanks, Muhtar. Pricing, we expect pricing for the full year in sparkling to actually improve from the first quarter. Our plans are in place with our customers. The market is rational. Our focus on immediate consumption growth will drive mix, and our rate should continue to be healthy, and even improve as we move through the second quarter and into the third quarter where we are lapping some promotional activity. So that is point one, +Point two is, on stills, the case pack water business continues to grow, so it pulls down mix. We see opportunities, however, on a targeted basis in our bottle can stills to improve pricing, and we will take action to do that. Paul, Irial and I see opportunities on a category by category basis. +And then finally, in our chilled juice business, we have just fielded a significant price increase to respond to the commodity issues with our orange juice in Florida, and that is taking root. And our juice business continues to be advantaged from a share perspective. +And I think all of that wraps up, from a pricing standpoint to a much more favorable profit outlook for the full-year. I mean, we saw some timing related issues, and obviously we have talked about having 1 less selling day in the first quarter. But all of that is going to come to do with our price and volume plan for the year to produce profit growth for the full year. Irial? + +-------------------------------------------------------------------------------- +Irial Finan, The Coca-Cola Co - EVP & President - Bottling Investments and Supply Chain [36] +-------------------------------------------------------------------------------- + + Yes. The only add I would give is, we are about building a long-term sustainable profitable business in the US. And to do that, we must have a balance of pricing and volume growth. And pricing is a really critical part of that, and we will in this year end up with sparkling in the 2% to 3% range in pricing, or price mix, I should say. +And that is really it, and that is what we are focused on. That is what Sandy, and the team, Paul and the team, all of us together are focused on delivering that -- delivering a healthy business that is going back to growth as well. + +-------------------------------------------------------------------------------- +Judy Hong, Goldman Sachs - Analyst [37] +-------------------------------------------------------------------------------- + + Great. Thank you. + +-------------------------------------------------------------------------------- +Operator [38] +-------------------------------------------------------------------------------- + + Thank you. The next question is from Michael Steib with Credit Suisse. + +-------------------------------------------------------------------------------- +Michael Steib, Credit Suisse - Analyst [39] +-------------------------------------------------------------------------------- + + Good morning. I was wondering if you could comment on the performance of your key markets in Asia, and particularly China and Indonesia. The China volumes have rebounded quite strongly now for two or three quarters, and I was just hoping you could shed some light on what has been driving that? Was it the new strategies and the new team that has been put in place there, whether that is all paying off, or whether it is really mostly due to relatively low comparison basis still? +And then, a similar question on Indonesia, volumes continue to be strong there. I am just wondering what is driving that? + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Co - Chairman and CEO [40] +-------------------------------------------------------------------------------- + + Yes. Michael, this is Muhtar I will say, just a couple of top line, and then ask again, Ahmet to contribute. But I will repeat what I said about IC, particularly pleasing was China, IC was up 18%. Indonesia, IC was up 9%, Vietnam up 8%. These are really important for us when -- as we drive profitable growth in our business. And again, our newly architected packaging portfolio in China is really working with the smaller packs and the new price points. +And I think also, the new team certainly is really delivering what we expect of them, as well as our bottlers with renewed focus. Both the Bottling Investments Group but also Swire as well as COFCO are really doing a good job in the first quarter. And I think a lot of really good investments and activity and commercial leadership is in place to continue to drive that momentum, both in the stills as well as in the sparkling portfolio in China. And so, again Ahmet, if you want to just -- (Multiple Speakers). + +-------------------------------------------------------------------------------- +Ahmet Bozer, The Coca-Cola Co - EVP & President - Coca-Cola International [41] +-------------------------------------------------------------------------------- + + Yes. Thanks, Muhtar. Yes, I think, Michael, you have listed a lot of reasons. But my headline would be, it is all of the above. But let me color it a little bit. +Certainly, the new team and the new strategy that we covered with you last year is really coming together nicely, and we are happy with the quality of the growth. Sparkling is growing. Juices are growing and those are the categories that we have told you that we were betting on for our growth in China. +You might see us -- growth in waters. That is an important category. But we just had some recent launches into a [RMB2] water, which improves the profitability of that. Very, very early days, and it is doing well. Also, we are quite encouraged with, again very early results on some of our innovations with Schweppes and plus. And just a couple weeks out, the plans is our isotonic. So we are getting that good mix of sparkling juices and innovation that is beginning to work for us. +I would just caution us though, you did mention the easier cycle rates from last year. That is definitely the case, and 12% growth we are very happy with. But we would expect to see growth in China, continued growth in China, probably in the range of mid to high single-digits that we could expect over time. So that is basically -- I think covers everything. + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Co - Chairman and CEO [42] +-------------------------------------------------------------------------------- + + And just one other point I would highlight, Michael, is Japan, very pleasing that it grew 3%, 3% in sparkling and stills grew 4% in Japan in the quarter. And again, despite the longest monsoon that I have ever experienced in terms of seasons and how long it took, India grew 6% and should do much better going forward. So and again, I am certainly very proud that this is the 31st consecutive quarter of growth in India for us, including continued share gains. + +-------------------------------------------------------------------------------- +Michael Steib, Credit Suisse - Analyst [43] +-------------------------------------------------------------------------------- + + And in Indonesia, could you just comment similarly? + +-------------------------------------------------------------------------------- +Ahmet Bozer, The Coca-Cola Co - EVP & President - Coca-Cola International [44] +-------------------------------------------------------------------------------- + + Yes, and again, Michael, that is very important market for us, and we have been focused on aligning with our bottling partner, Amatil, there on a new plan. Or let's say, an evolved plan as was the case in China with the revised OBPCC investments in sparkling and still beverages. There has been a recent change in management in -- on the ground. And all of that again, we are cautiously optimistic about the progress we are making in Indonesia, are beginning to deliver good results. And certainly, that market has a -- has so much more opportunity to grow in the coming years. + +-------------------------------------------------------------------------------- +Michael Steib, Credit Suisse - Analyst [45] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Operator [46] +-------------------------------------------------------------------------------- + + Thank you. The next question is from Dara Mohsenian with Morgan Stanley. + +-------------------------------------------------------------------------------- +Dara Mohsenian, Morgan Stanley - Analyst [47] +-------------------------------------------------------------------------------- + + Good morning. First, Gary, congrats on a great run, and best wishes on the farm, and congrats to Kathy also. + +-------------------------------------------------------------------------------- +Gary Fayard, The Coca-Cola Co - CFO [48] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Dara Mohsenian, Morgan Stanley - Analyst [49] +-------------------------------------------------------------------------------- + + And Muhtar, I was hoping to discuss if your expectations have changed at all here over the last year, just regarding the long-term growth potential of the sparkling category? Not necessarily from a market share front, but more just in terms of category growth? +And if one looks at industry data, it looks like sparkling trends slowed more in 2013 than we have seen in other CPG categories. So I was just hoping for some perspective on that, the drivers behind it, and expectations going forward? + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Co - Chairman and CEO [50] +-------------------------------------------------------------------------------- + + Now -- no changes as far as my perspective is concerned. And I can confirm that both our entire team, as well as our bottling partners feel the same way as a system. We are blessed to be in a great business, both in the sparkling area, as well as in the stills. We continue to innovate. I believe that we have a great future, where so many hundreds of millions of people in so many large markets haven't tasted a Coca-Cola in the last month, or in the last six months, or in the last year. +We have tremendous opportunity going forward. And I believe that innovation, packaging, equipment and great marketing will continue to grow our business going forward, both in sparkling and in stills. And I feel confident that we will go back into the corridors of our long-term growth algorithm this year and years to follow. +And with new innovations, like creating new paths to consumption, creating new consumption occasions like the Keurig Green Mountain innovation, like Freestyle that is driving, we know everywhere, every time, it is actually installed in an outlet, it drives traffic, it drives incidence, it drives increased sales, and it drives excitement for the consumer. +And at the same time, our contour packages, you will see us being focused much more on the contour. Next year is the 100th anniversary of the contour bottle, the iconic contour bottle. You will see a lot of activity around that also. So we feel we have a lot of work to do. But we feel that, isn't that a great place, where you have a lot of work to do, and you believe in your future. + +-------------------------------------------------------------------------------- +Dara Mohsenian, Morgan Stanley - Analyst [51] +-------------------------------------------------------------------------------- + + Okay. And on the innovation front in the US, can you give us a bit more detail in terms of maybe potential timing of sweetener innovation? And how impactful you think natural sweeteners could be to your top line results eventually? + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Co - Chairman and CEO [52] +-------------------------------------------------------------------------------- + + I think they will -- I am certain innovation is going to be impactful, and I can't give you any more details on timing. + +-------------------------------------------------------------------------------- +Dara Mohsenian, Morgan Stanley - Analyst [53] +-------------------------------------------------------------------------------- + + Okay. Thanks. + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Co - Chairman and CEO [54] +-------------------------------------------------------------------------------- + + Yes. Sure. So just thank you again, Gary, Kathy, Ahmet, Sandy, Irial, Jackson, we are just once again, firmly committed to advancing our growth trajectory in 2014. Our strategic priorities are yielding tangible and measurable results, and they are consistent with our long-term goals, and our overarching business strategy. Increased marketing investments and a focus, a relentless focus on execution underscore the confidence we have in our systems alignment, as we seek to execute these strategies, while we further strengthen the foundation for profitable and sustainable long-term growth. +Our 2020 vision calls for a well-balanced growth, that is growth in sparkling beverages, and also growth in still beverages across more than 200 markets, countries, and in revenues and margins. And thanks to this balanced growth in both portfolio, as well as geographic mix, we see a path that leads to global volume, revenue and profit growth in line with our long-term targets. Our focus is unwavering, and our execution of our five strategic priorities is going to enable us to restore momentum for growth to our business. Thank you for your time this morning, and for your continued interest and trust in our Company. + +-------------------------------------------------------------------------------- +Operator [55] +-------------------------------------------------------------------------------- + + Thank you. This concludes today's conference. Thank you for joining. You may disconnect at this time. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. While the Preliminary Transcript is highly +accurate, it has not been edited to ensure the entire transcription +represents a verbatim report of the call. + +EDITED TRANSCRIPT: "Edited Transcript" indicates that a team of professional +editors have listened to the event a second time to confirm that the +content of the call has been transcribed accurately and in full. + +-------------------------------------------------------------------------------- +Disclaimer +-------------------------------------------------------------------------------- +Thomson Reuters reserves the right to make changes to documents, content, or other +information on this web site without obligation to notify any person of +such changes. + +In the conference calls upon which Event Transcripts are based, companies +may make projections or other forward-looking statements regarding a variety +of items. Such forward-looking statements are based upon current +expectations and involve risks and uncertainties. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/exam/original-files/Problem_2_3_Sample_full_transcripts/2014-Aug-20-TGT.N-138325416922-Transcript.txt b/exam/original-files/Problem_2_3_Sample_full_transcripts/2014-Aug-20-TGT.N-138325416922-Transcript.txt new file mode 100644 index 0000000..4842f98 --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_full_transcripts/2014-Aug-20-TGT.N-138325416922-Transcript.txt @@ -0,0 +1,532 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q2 2014 Target Corporation Earnings Conference Call +08/20/2014 10:30 AM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * John Hulbert + Target Corporation - Senior Director of Investor Communications + * John Mulligan + Target Corp - CFO + * Kathee Tesija + Target Corp - Chief Merchandising & Supply Chain Officer + * Brian Cornell + Target Corp - Chairman & CEO + +================================================================================ +Conference Call Participiants +================================================================================ + + * Simeon Gutman + Morgan Stanley - Analyst + * Wayne Hood + BMO Capital Markets - Analyst + * Matt McClintock + Barclays Capital - Analyst + * Greg Melich + ISI Group - Analyst + * Matthew Fassler + Goldman Sachs - Analyst + * David Strasser + Janney Montgomery Scott - Analyst + * Matt Nemer + Wells Fargo Securities, LLC - Analyst + +================================================================================ +Presentation +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Ladies and gentlemen, thank you for standing by. Welcome to the Target Corporation second-quarter earnings release conference call. +(Operator Instructions) +As a reminder, this conference is being recorded, Wednesday, August 20, 2014. +I would now like to turn the conference over to Mr. John Hulbert, Senior Director, Investor Communications. Please go ahead, sir. + +-------------------------------------------------------------------------------- +John Hulbert, Target Corporation - Senior Director of Investor Communications [2] +-------------------------------------------------------------------------------- + + Good morning. And thank you for joining us on our 2014 second-quarter earnings conference call. On the line with me today are Brian Cornell, Chairman and Chief Executive Officer; John Mulligan, Chief Financial Officer; and Kathee Tesija, Chief Merchandising and Supply Chain Officer. +This morning, Brian will provide his initial impressions on joining Target and his priorities going forward. Then, Kathee will discuss results in the US and Canada, and plans for the third quarter and beyond. And finally, John will provide more detail on our financial performance, along with our financial outlook for the third quarter and the full year. +Following their remarks, we'll open the phone lines for a question-and-answer session. As a reminder, we're joined on this conference call by investors and others who are listening to our [comments] via webcast. Following this conference call, John and I will be available throughout the day to answer any follow-up questions you may have. +Also, as a reminder, any forward-looking statements that we make this morning are subject to risks and uncertainties, the most important of which are described in our SEC filings. Finally, in these remarks, we refer to adjusted earnings per share, which is a non-GAAP financial measure. A reconciliation to our GAAP EPS is included in this morning's press release, posted on our Investor Relations website. +With that, I'll turn it over to Brian for his initial impressions of Target and his priorities going forward. Brian? + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corp - Chairman & CEO [3] +-------------------------------------------------------------------------------- + + Thank you, John. +Before Kathee and John provide their perspective on Target's second-quarter performance, I want to take a few minutes and discuss why I made the decision to come to Target, and outline my priorities over the next few months. Even before I accepted the offer to lead this Company, I have known and admired Target from multiple perspectives throughout my career. As a vendor partner, I've known Target as a smart, savvy, innovative, ethical, and guest-focused merchandiser. As a competitor, I've known Target as a disciplined, tough, focused retailer: a Company that redefined the discount space by delivering outstanding design, world-class fashion, innovative products, and amazing prices. +As a guest, my family and I have known Target as a unique place that makes shopping fun, saves us time, and offers a differentiated experience based on newness and discovery. And finally, as a member of the community, I've known and admired Target for its commitment to making the places where we live and work better, both through its corporate giving programs and the commitment to volunteerism from our team members. +With my appointment as Chairman and CEO, I now have the opportunity to learn about Target from the inside. And I could not be more thrilled to have the opportunity to lead this great Company. +In the weeks and months ahead, I'm planning to spend a great deal of my time listening to the team here in the US and Canada, in both our stores and headquarter locations, hearing directly from them about what's working and, importantly, what we need to change. In fact, I just got back from a visit to Canada, where I spent time with the team to get a first-hand update on their review of strategy and operations. While that review is not yet complete, based on what they've learned already, the Canadian team is making broad changes as they focus on improving performance in time for the key holiday season. +In the US, I've been spending time with John, Kathee, and others on the leadership team to understand, in detail, our plans for the remainder of the year. In those discussions, I'm ensuring that the team is focused on execution across every aspect of our Business, particularly in the holiday season. In addition, I'm deepening my understanding of Target's pipeline of omni-channel innovation, and I'm focused on our opportunities going forward. +While I'm very impressed with the progress the team has made recently, including innovations on our mobile platform, subscription service, Cartwheel, and flexible fulfillment, we need to continue to move faster and grow faster than the marketplace. We need to build capabilities focused on satisfying the wants and the needs of our guests, and ensuring that our digital and store operations operate seamlessly to provide a single superior experience. +Finally, I'm working with the leadership team to begin detailed planning of next year's strategy and financial results. I'm impressed with the progress that John and the team made in the last three months, including a strategy review that is the most comprehensive effort I've seen in my career. Their foundational work is providing me with a fresh, fact-based perspective on Target's strengths and opportunities, serving as the foundation for next year's plan and beyond. +Now, before I turn the call over to Kathee, I want to thank Roxanne Austin and John for their commitment to Target and to the team, which they demonstrated through their willingness to serve as Interim Chair and CEO over the last three months. In addition to the critical strategy work they initiated, Roxanne, John and the leadership team moved forward competently to make important changes to internal processes, removing roadblocks, empowering teams, and accelerating the pace of decision making. +While there's a lot of work ahead, I've been blown away by the passion and commitment displayed by team members across the country. This team is focused on winning in the marketplace by better serving our guests, in both stores and digital channels. I look forward to working with this team to harness their passion, and develop the appropriate strategies that position Target for success, both today and over time. +Now I'll turn the call over to Kathee and John for a view of the quarter and our outlook for the rest of the year, starting with Kathee, who will provide detailed plans on our category performance, merchandising plans for the third quarter, and beyond. Kathee? + +-------------------------------------------------------------------------------- +Kathee Tesija, Target Corp - Chief Merchandising & Supply Chain Officer [4] +-------------------------------------------------------------------------------- + + Thanks, Brian. +The second quarter marked a period of transition in both of our segments, as the US traffic trend improved over recent quarters, and our monthly US comps increased throughout the quarter. In Canada, Mark Schindele and the leadership team have been engaged in a comprehensive review of strategy and operations, and are beginning to make changes to address their initial findings. +In our US business, second-quarter comparable sales were strongest in hard lines, driven by both toys and electronics. Comparable sales were also positive in our less discretionary food, health and beauty categories, while they were down slightly in apparel, and down low-single digit in home. In our digital channels, second-quarter sales, including flexible fulfillment, grew most quickly in health and beauty, hard lines, and home. +US segment comparable transactions were down 1.3%, completely offset by an increase in the average basket. While we aren't satisfied with the traffic decline, we are pleased that the US traffic trend improved a full percentage point compared with the first quarter. +Our US segment first-quarter gross margin rate was down a full percentage point from last year, driven by higher promotional intensity compared with the year ago. While the impact of promotions was a bit less than we experienced in the first quarter, it was more than we expected at the beginning of the quarter, reflecting a retail environment in which a broad set of competitors are leaning heavily on promotions, and a consumer environment in which shoppers are still cautious, and focused on deals. However, while it's still early, we have been pleased with the results so far in the back-to-school and back-to-college season, in which we've seen improved sales trends from guests focused on the occasion, rather than promotions. +Second-quarter digital sales, including flexible fulfillment, increased more than 30% over last year. This increase reflects a nearly 50% increase in visits to our mobile website, including iOS and Android apps, which more than offset a decline in visits to our conventional site. Importantly, conversion continues to improve rapidly on both our conventional site and mobile platforms, driving a meaningful improvement in overall conversion, despite the unfavorable mix shift between the migration to mobile. +To build on our momentum in digital, we recently launched a new ad campaign focused on millennials that aims to expand the brand perception of Target from a brick-and-mortar destination to a total retail experience. The campaign features three of our most prominent omni-channel initiatives: subscriptions, store pickup, and Cartwheel. Market research indicates that these three solutions are among the most important to guests because they help them save time, save money, and stay organized. +This year's back-to-college assortment includes a set of unique owned-brand items that our own product design and development team developed in partnership with college students, based on the challenges they face when living with roommates in very small spaces. And since we are already planning for back-to-college 2015, we recently partnered with Betterific, an open, crowd-sourcing community focused on innovation, to help us think of other innovative products that could make life in a first apartment or dorm room even better. +The community proposed hundreds of ideas. Then, together, Target and the community built on each other's ideas, and voted on the best ones. Now, our team is using the ideas to identify unmet guest needs, determine if there are products that we can bring to market for back-to-college next year, and uncover completely new industry-first products. Betterific is part of Target's larger guest-to-guest initiative that is working to connect guests to each other and to Target in meaningful ways. +Our first TargetExpress store opened in late July, here in the Twin Cities, right next to the University of Minnesota campus. This store looks great, and we're excited about the insights we'll gain from operating this new format over time. At approximately 20,000 square feet, 15% of a typical general merchandise store, TargetExpress is designed so guests can get what they need and get out quickly. +So far, sales at the store have come in as expected; and not surprisingly, we are seeing much more traffic and a much smaller basket than our chain-wide average. Also as expected, sales have been heavy in food and essentials, with the mix of owned-brand sales in those categories far outpacing the chain average. We're also seeing strong sales in mobile electronics, including accessories, and in our fan central area, where we feature University of Minnesota clothing. We plan to expand our test of this new format to several additional locations outside the Twin Cities next year. +Cartwheel just celebrated its first birthday, and we celebrated with a crowd-sourced Cartwheel offer, a first for Target, for a special, limited-time discount. The winning offer generated a high level of engagement during the promotion period, more than doubling the typical rate of new users and activations. +Also in July, we launched a proof of concept to integrate Target.com into Cartwheel, with the goal of making it simple for guests to shop with Cartwheel across channels. In this test, guests can see online eligible offers in their Cartwheel app, and are directed to the Target.com mobile website to add them to their Target.com cart. After testing these initial deals, we'll expand the number of offers, and we'll begin promoting the functionality when the testing period is complete. +In June, we meaningfully simplified the Target.com shopping experience by rolling out free shipping on all orders over $50. We made this change because research shows that the number-one cause of abandoned carts is a surprise at checkout, including uncertain shipping charges. +Since we made this change, we have already seen measurable improvements in digital conversion rates and sales. Of course, I should mention that Target Card guests continue to receive free shipping on every order, every day. +In late July, for the first time, we ran a promotion on our store pick-up program, with the goal of raising awareness of the service while testing systems and processes before the fourth-quarter peak. The guest response to the offer was far ahead of our expectations, at 5 times the volume of a regular week, with a particularly strong response in mobile. The offer attracted many guests to use store pickup for the first time, and some were even new to Target.com. Importantly, about 1/5 of those guests engaged in additional shopping in store when they picked up their online purchases. +We're pleased with continued strong growth in the number of guests signing up for Target subscriptions. Among the nearly 4,000 eligible items, subscription orders account for more than 15% of digital sales. +In the back half of 2014, we're focused on enhancing the guest experience, including continued assortment expansion, consolidating shipments, simplifying communication, and right-sizing packaging. We're also developing an optimized mobile experience, and moving to test in-store acquisition via mobile devices. And we're exploring gifting subscriptions, which would allow guests to register for subscriptions that are easy for gift givers to fulfill. +We're pleased with results from our second-quarter test of ship-from-store capability in the Boston, Miami, and Minneapolis markets. As part of the test, some guests were offered the option of a $10 service to get same-day delivery on Target.com orders placed before 1:30 PM. In the three test markets, the ability to leverage our store's cross-over inventory has allowed us to capture more sales by meaningfully improving digital in-stocks. +In addition, shipping from a store dramatically reduces shipping times without the need to rely on air freight. This fall, when we roll out standard ship-from-store capabilities to 35 additional markets, we will be within one- to two-day ground transit of 91% of the US population. +In Canada, second-quarter sales accelerated meaningfully from the first quarter, but fell somewhat short of our expectations. Gross margin was also lower than expected, driven by elevated markdowns resulting from continued operational issues. +As I mentioned earlier, the Target Canada team is engaged in a comprehensive review of strategy and operations, which incorporates feedback from guests, teams, and business partners. And the team is taking decisive steps to address our guests' concerns head on, including changes to address in-stocks, pricing and assortment. +To address in-stocks, the team is taking action on four dimensions: better reporting to identify in-stock issues sooner; retraining our teams on best methods; developing new best methods tailored to Canadian segment systems; and reconfiguring systems to work more effectively over the long run. +On pricing, while both our own studies and external surveys show that we are already priced very competitively, the team has made decisive changes to ensure we respond even more quickly to pricing dynamics in the Canadian marketplace, including: comparison shopping our prices versus competitors on more items, more frequently; implementing enhanced tracking of competitor promotions to ensure we react quickly; and implementing a price match policy, which includes online and local competition, with a more flexible process for guests. +Regarding the Canadian assortment, we are adding product lines that our guests told us were missing from our everyday lineup. We're adding more newness to our stores, and we're adding more exclusive items and designer partnerships -- what we're known for in both the US and Canada. Putting all these changes together means that, of the 70,000 items in a typical Canadian Target store, about 30,000 items will be new between now and the holiday season. We believe these changes will position the Canadian segment for improved performance in time for this holiday season, and the Canada leadership team will look for additional opportunities as they continue their review. +As we look ahead to the third quarter and beyond, we are excited about our plans to introduce new products, partnerships, and capabilities in our stores and digital channels. We've been very pleased with early results from the back-to-school season, including the response to Buy One, Give One offers on our own up&up supplies, along with our exclusive line of colorful notebooks, pens, and rulers from Yoobi. Like our back-to-college assortment, many up&up back-to-college products were developed by our own design team, in partnership with students and teachers who tested them and gave us report cards on how they could be improved. +The guest response to the up&up school assortment has been phenomenal. Last year, comp sales in up&up school supplies were up more than 25% during the back-to-school season, and we're planning another healthy increase this year. +Our back-to-college assortment highlights mix-and-match options for guys and gals to outfit their entire dorm in a stylish and affordable way. Some of our guest favorites are space-saving, multi-use items like a storage mirror, a task lamp with iPhone and iPad storage, multi-functional and collapsible tables and desks, and innovative storage solutions designed to go over the bed or chair to hold laptops and mobile phones. +This year's addition of registry capability for college students has been outpacing expectations. On average, a student registers for 30 items, totaling more than $1,000. +We are excited about our upcoming designer partnership, Altuzarra for Target, which will arrive on September 14. Designer and Creative Director, Joseph Altuzarra, created a limited edition fall collection of women's ready-to-wear, lingerie, accessories, and shoes, which will be available at most Target stores in the US and Canada, as well as Target.com. In addition, an edited assortment of the collection will be available globally at NET-A-PORTER.com. +In May 2013, Target entered into a partnership with Sam & Libby, and it's been a huge hit with our guests who love classic styles like the original leather boat ballet at an unexpected value of $30. In September, we'll be extending our Sam & Libby assortment with the launch of the exclusive Sam & Libby handbag line in over 1,000 stores throughout the US, with two fall collections featuring 20 styles in stores and an extended assortment on Target.com. +In women's apparel, the fall assortment will reflect the number-one current trend we call neo-traditional with feminine menswear-inspired looks in plaids and florals. This look will be most visible in Merona, with hints in our Xhilaration and Mossimo Supply Company lines. After rapid growth in 2013, we're expecting another big increase this fall in women's boots, including riding boots for Merona and lace-up ankle boots from Mossimo Supply Company. Another hot trend is sport; and this fall, we'll be riding the leisure trend in our juniors assortments with leggings, sweatshirts, yoga pants, joggers, and fashion athletic shoes. +In denim, a huge category for back-to-college, we just launched a new improved shopping experience for our guests, with improved navigation, new fits, a broader range of sizes, more stretch, and the most relevant washes and styling, all highlighted through compelling promotions. In Threshold, the fall season is all about natural materials, beautiful textures, and warm metallics, with key solutions in entertaining, like our warm metallic bar cart, accessories, glassware and flatware, and decorative items like lanterns, throws, toss pillows, and perfect accent tables. +In July, Target launched S-Sport, designed by Sketchers, partnering with one of the hottest footwear brands in the industry today. The S-Sport label is a lifestyle brand targeted to appeal to the entire family, with offerings in kids, men's, and women's. The initial response has been overwhelming, and we have seen styles performing at 4 to 8 times the average of our shoe category. S-Sport shoes for men, women, and children are available at all US and Canadian stores, and at Target.com, ranging in price from $25 to $40. +In housewares in September, we'll be featuring new products from some of the hottest national brands in small appliances, with the introduction of the VertuoLine from Nespresso, single-serve blenders from Vitamix, and the new Keurig 2.0 line. +In June, Target teamed up with The Honest Company to offer guests non-toxic, eco-friendly products by co-designers Jessica Alba and Christopher Gavigan, featuring diapers, biodegradable wipes, organic bath and skin care, and an expanded assortment on Target.com. Based on the success of the collaboration, we recently expanded our Honest Company assortment to include a line of all-natural cleaning supplies. +Like Honest Company, our Made to Matter collection was inspired by our guests' desire for better-for-you natural and organic products. This unique collection differentiates Target in the marketplace, and provides vendor partners a stage to innovate in support of their leadership positions in respective categories. The collection launched in April with an initial set of items, and the guest response has been outstanding. So, we're excited about the upcoming launch in September of an expanded assortment of more than 100 Made to Matter products, including exclusive, new-to-market items from Method, Seventh Generation, and many others. +At CHEFS Catalog, which just celebrated its 35th anniversary, we're excited about our upcoming October collaboration with chef and long-time host of Bizarre Foods, Andrew Zimmern. The partnership includes several products which meld the design elements of Japanese, Chinese, and French cutlery into items Andrew describes as one-knife-fits-all pieces of kitchen magic. The collaboration also features spice blends with names like Flex your Mex; Winner, Winner, Chicken Dinner; or Grill Buddy. +For Halloween, we're excited to be partnering, once again, with designer Chris March to offer a whimsical wig and accessory collection. This unique assortment reinforces both sides of our Expect More. Pay Less brand promise, with wigs that look like curlers or lobsters, and decor items from candy bowls to hand towels -- all priced at $20 or less. The collection, available exclusively at Target stores in the US and Canada, and at Target.com, will launch mid-September online, and later that month in our stores. +In Canada, we just announced that we've extended our very successful Beaver Canoe collaboration, with an expansion of home decor items, along with men's and women's sleepwear and slippers. Also in Canada, on September 7, we'll be launching two new lines of cleaning products: Better Life, an all-natural line of cleaning products designed by two fathers with charismatic packaging designed to speak to younger generations; and Ecover, a European brand recently merged with Method, which will relaunch with better formulations and modernized packaging. +Increasingly, consumers expect everything they do to be personalized. And this is particularly true of millennials, Target's fastest-growing guest segment. For the last six months, Target.com has been building an engine that will enable personalization across all of Target's selling channels. +Personalized product recommendations, the first iteration of this work, will launch this fall at Target.com. When a guest shops our site, we will suggest products based on their store, and digital purchase and browse history. This presents a significant opportunity to ensure guests see the products and offers most relevant to them, both in store and online, and in turn, generate additional sales. We'll continue improving the guest experience. And we're working to extend personalization to more guest experiences, including product content and offers, in the future. +We also continue to add mobile enhancements to drive additional traffic and conversion. Just today, we launched a new header to enhance navigation on the mobile landing page. And we're streamlining mobile checkout to two clicks. +Also this year, we're overhauling our registry service with a new, best-in-class experience that combines the power of online and mobile shopping, together with in-store tools like new web-enabled smart scanners and iPad kiosks. Registry is already important for Target, and the new experience puts us at the forefront of the industry by making the entire process easier, smarter, and faster. Improvements include faster scanning and adding of products, easy addition of companion products, full product information, access to reviews, and inspiration through collections and lists. +And in our stores, we're pleased with results from our efforts to refresh the shopping experience in key categories including baby, apparel, and beauty. In July, we added another 167 stores with the enhanced baby layout, bringing the total number to more than 200. In apparel, we have about 50 stores today with an enhanced presentation, including mannequins, and we're planning to expand this layout to another 600 stores by October. And in beauty, we continue to see strong results from this year's refresh of displays throughout the US, while featuring beauty concierge service in more than 400 stores. +We're excited with our plans for the fall, and believe we're taking the right steps to improve results in both the US and Canada. And we're encouraged that, based on the changes we are making, we've seen positive comps over the last six weeks in the US. We are working hard to ensure that teams in both countries are focused on execution during the upcoming holiday season, and we look forward to working with Brian to map our vision for Target's future. +Now, I'll turn it over to John, who will share his insights on the second-quarter financial performance, and our third-quarter and full-year outlook. John? + +-------------------------------------------------------------------------------- +John Mulligan, Target Corp - CFO [5] +-------------------------------------------------------------------------------- + + Thanks, Kathee. +As I mentioned in today's press release, we're not satisfied with our second-quarter results, but we are seeing early signs of progress. In the US, our second-quarter traffic was notably better than the first quarter pace; enough to improve the traffic trends on a two-year basis. +However, the level of second-quarter promotions in the US remained elevated, and looking ahead, we're working to moderate our promotional intensity to a level we believe is more appropriate in the long run. We are encouraged with the recently improved US comparable sales trend, in particular because our promotional intensity over this period was not as elevated as earlier in the year. +In Canada, the team has been working hard to assess root causes for underperformance, and implement changes to improve operations and the product assortment, with a focus on improving results in time for the holiday season. However, I want to be clear that current financial performance in Canada remains unacceptable. +Our second-quarter comp in the US segment was flat, largely in line with our guidance. As Kathee mentioned, digital sales, including flexible fulfillment, grew more than 30% compared with last year, contributing about 60 basis points to comparable sales. While this demonstrates meaningful progress on our omni-channel journey, we will continue to invest in digital capabilities, as the importance of this channel continues to grow. +Our second-quarter US segment EBITDA margin was lower than expected -- about 80 basis points below last year -- driven by a lower-than-expected gross margin rate, partially offset by better-than-expected SG&A expenses. Specifically, the US segment gross margin rate was down about 100 basis points from last year, somewhat better than our first-quarter experience, but not where we expect to perform over the longer term. The US segment's second-quarter SG&A rate improved about 20 basis points versus last year, reflecting impressive discipline across the Organization, combined with the benefit of our expense optimization efforts. +In the US, second-quarter sales penetration on REDcards was 28.8%, up more than 2 percentage points over last year. As I mentioned on the last call, we have seen a slower trend in debit card applications since the data breach, which is leading to slower growth in sales penetration. We've taken steps to reaccelerate growth in REDcard applications, including increased activity in our stores. And we've begun to see improvement in REDcard issuance as a result, particularly in the last few weeks. +However, given there is a lagged impact of applications on penetration, we expect penetration growth will continue to moderate in the third and fourth quarter, reflecting the slowdown in new REDcard accounts we've seen so far this year. Specifically, our current expectation is that US REDcard penetration growth will be in the range of flat to up 1% in the third quarter, and will reach a trough at around flat in the fourth quarter before reaccelerating into next year. +In the Canadian segment, second-quarter sales were 63% higher than last year, and about 14% above the first quarter. For the first time, we began reporting comparable sales in Canada this quarter, as 48 stores became mature at various points within the quarter. However, this metric is expected to be very noisy initially, due to the strong and longer-than-normal grand opening sales surges we saw last year, and the fact that we densified around these initial openers later in 2013. As a result, this quarter the Canadian comp was down more than 11%, reflecting these impacts and less-than-adequate progress in our efforts to grow sales in these stores. +On our Canadian sales, we earned a gross margin rate of just over 18% in the second quarter, well below where we should operate in the long run. Both sales and gross margin rate continue to reflect operations that are not working optimally, resulting in lumpy inventory. +We continue to see inconsistent in-stock levels by item and location, and we have excess inventory overall, leading to elevated levels of clearance markdowns. This is why the Canadian leadership team has put its highest priority on implementing system and process changes designed to improve operations, with the goal of improving performance in time for the holiday season. And, as Kathee outlined, the team is already making a host of changes based on findings from our operational review. +Second-quarter Canadian segment expense rates were better than last year, reflecting the start-up nature of results a year ago. However, these rates will remain elevated until we gain more scale in this segment. +REDcard penetration in Canada was 4.8% in the second quarter, more than double last year's 2.3%, as Canadian guests continue to respond to the value these cards provide. We expect to continue to see robust growth in penetration for quite some time. +Beyond operating results in the US and Canada, our second-quarter GAAP EPS reflected the impact of several items not included in adjusted EPS. The largest adjustment was a $0.27-per-share charge for the accounting loss associated with our second-quarter early debt retirement. We funded this retirement, along with a $1-billion maturity, with the issuance of $2 billion of debt at very favorable rates in the quarter. Not reflected in this accounting loss is the fact that the early debt retirement has a positive net present value. +Also in the quarter, we recognized data breach expenses of $148 million, partially offset by the recognition of a $38-million insurance receivable. In addition to legal, consulting and administrative fees, second-quarter breach expenses included an additional accrual for estimated probable losses for what we believe to be the vast majority of actual and potential breach-related claims, including claims by payment card networks for fraud and administrative costs. +This means that, in total, over the last three quarters, we have recognized and accumulated $236 million of gross expenses related to the breach, offset by a $90-million insurance receivable, for a net of $146 million. This number is dramatically lower than many external estimates at the time of the breach, and it reflects the benefits of our efforts to rapidly notify both card networks and our guests when we learned of the breach, enhancing the effectiveness of fraud prevention and detection. +Looking ahead, we will continue to incur legal, consulting, and administrative costs related to the breach, but we don't expect those costs to be material in any period. And of course, it will take more time to resolve all breach-related claims. And while we don't believe it is probable, it is possible that we could incur material losses beyond the amounts we've already accrued. +Beyond these two larger adjustments, in the second quarter we also recognized $0.01 each related to the impairment of some undeveloped land and the continued reduction in the beneficial interest asset associated with last year's credit card portfolio sale. +Turning to the consolidated metrics: Second-quarter interest expense was $282 million higher than last year, due entirely to the loss on early debt retirement I covered earlier. We also paid $272 million in dividends this quarter, up 18% from $231 million last year. +As expected, the Board approved a quarterly dividend increase during the quarter, raising it 21% from $0.43 to $0.52. This increase builds on our Company's track record of annual dividend increases, which have occurred every year since 1971. +Beyond the non-cash share settlement of forward contracts related to our deferred compensation plans, we did not engage in any share repurchase in the second quarter, and we don't expect to do so in the third quarter as well. While we continue to expect to return robust amounts of cash through share repurchase over time, our business performance is not where it needs to be to sustain our middle A credit ratings. +As I've said previously, to resume share repurchase, two things need to happen. First, we need to have sufficient visibility into our potential liability for claims related to the data breach. Second, we need to see sufficient improvement in our US and Canadian operations to create a clear path for our credit metrics to return to acceptable levels in support of our single A rating. +While this quarter's recognition of an additional breach-related accrual reflects progress on the first condition, our current and expected operating performance does not meet the second. As a result, we expect to continue to suspend cash investments and share repurchase until operating performance improves. +Now, let's turn to our outlook for the third quarter and full year. As I mentioned last quarter, in light of the environment and our performance so far this year, we will continue to maintain a cautious outlook for sales in both segments, allowing us to plan inventory and expenses flexibly, while maintaining contingency plans to flex higher when sales grow faster than expected. One note: Consistent with guidance last quarter, our outlook does not include potential additional costs related to the data breach beyond what we have already recognized, as they are not estimable. +With that, let's turn to our third-quarter expectations. We're currently forecasting US comparable sales will be flat to up 1% this quarter. And, as Kathee mentioned, we're encouraged by the positive comps we've seen so far in August. +On our sales, we expect to see an EBITDA margin rate of 8% or a bit better. This rate reflects continued expected pressure on the gross margin line. But we expect about half the pressure we experienced in the second quarter. Consistent with earlier in the year, our third-quarter EBITDA performance will benefit from our ongoing expense optimization efforts. +In Canada, we expect sales growth of more than 50% above last year, and more than 10% from the second quarter. This growth would lead to an expected positive, single-digit comparable sales growth rate. +EBITDA and EBIT margin rates are expected to improve compared with last year, and be in line with, or slightly better than, the rates we saw in the second quarter. All together, these expectations would improve third-quarter Canadian segment EBITDA by approximately $25 million compared with last year. +We expect third-quarter consolidated interest expense to be approximately flat to last year, and tax expense to be somewhat lower. All together, these expectations would generate adjusted EPS, reflecting results from both our US and Canadian operations, of $0.40 to $0.50, excluding $0.02 related to the reduction in the beneficial interest asset, and any potential costs related to the data breach, which are not expected to be material. +For the full year, we now expect US comparable sales in the range of flat to up 1%. In the US, we continue to expect an SG&A expense rate of about 20% for the full year, and a gross margin rate between 29% and 30%. These expectations reflect year-to-date results, along with anticipated year-over-year favorability in fourth-quarter gross margin and SG&A expense rates, as we annualize the impacts of the data breach in fourth-quarter 2013. +In our Canadian segment, we continue to expect full-year sales of about $2 billion. However, given our recent experience, and moderated expectations for gross margin in the near term, we now expect an EBITDA margin rate near minus 25% for the full year. +All together, these updated expectations would put our full-year adjusted EPS in the range of $3.10 to $3.30, below the range we provided a quarter ago. These expected results are clearly not where we expect to perform over time. +Over the last 90 days, Kathee and I have worked with the leadership team to take visible steps to continue healing our US business by removing unnecessary bureaucracy to speed up decision making, devoting resources to drive increased newness and innovation in our merchandise assortments and store presentation, and investing in our digital transformation. While there is a lot more work to do, I'm encouraged with our quarter-over-quarter improvement in US traffic and our sales experience so far in July and August, particularly because this improvement has not been driven by intense promotions. In Canada, Mark and the team are making meaningful changes to operations, pricing, and assortment as they focus on improving performance in the upcoming holiday season. +Finally, as Brian mentioned earlier, over the last three months, in partnership with interim Chair Roxanne Austin, the leadership team has conducted an in-depth review of our strategy, our brand, our guest, and our capabilities in both the US and Canada. Since Brian arrived, we have spent a great deal of time with him sharing insights from this review, and we believe this work will provide the foundation from which we can build a longer-term vision for our strategy and financial model. +We are so excited to welcome Brian to the team, and committed to working with him to move this Company forward. And, like Brian, we believe the best days for Target lie ahead. +With that, we'll conclude today's prepared remarks. Now, Brian, Kathee, and I will be happy to respond to your questions. + + +================================================================================ +Questions and Answers +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) +Our first question will come from the line of Wayne Hood with BMO Capital. Please go ahead. + +-------------------------------------------------------------------------------- +Wayne Hood, BMO Capital Markets - Analyst [2] +-------------------------------------------------------------------------------- + + Good morning, Brian and everyone. Brian, I had a question for you and then one for Kathee. When you arrived, the role of President was left open. I was curious whether or not you anticipate filling that role and any organizational structures that you might contemplate to speed the Company to getting to market. +And then Kathee, if you could just peel back the onion around why the UPT was down 1.7%. You made good progress on transactions, but you took a step back in UPT. And I'm just wondering why and what you expect for those metrics into the third and fourth quarter. Thank you. + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corp - Chairman & CEO [3] +-------------------------------------------------------------------------------- + + Wayne, let me start by answering your first question. My focus, right now, is to really understand the business in both the US and Canada. And I'm spending a lot of time with John and Kathee and the team to understand the guest perspective on Target, how we improve our traffic, how we enhance our performance in Canada, and how we continue to build out -- and rapidly build out -- our omnichannel capabilities. So I'm very focused on making sure that we're going to make progress against those key three initiatives, as I continue to look at the broader and longer term strategic options. So my focus is really understanding the business today and strategy before we have any discussions around organization modifications, going forward. + +-------------------------------------------------------------------------------- +Kathee Tesija, Target Corp - Chief Merchandising & Supply Chain Officer [4] +-------------------------------------------------------------------------------- + + And then Wayne, in terms of the unit per transaction, most of that was driven by higher dollar items that we were selling -- things in electronics and in entertainment. So you see the healthy selling price, as you mentioned, but fewer units. The other portion of that, I would say, is that we are seeing really good momentum in our trade-up strategies. So we are selling, in some cases fewer units, but higher price points in other categories across the Company. But it's predominantly electronics and entertainment. + +-------------------------------------------------------------------------------- +Wayne Hood, BMO Capital Markets - Analyst [5] +-------------------------------------------------------------------------------- + + All right. Thank you. + +-------------------------------------------------------------------------------- +Operator [6] +-------------------------------------------------------------------------------- + + Your next question will come from the line of David Strasser with Janney. Please go ahead. + +-------------------------------------------------------------------------------- +David Strasser, Janney Montgomery Scott - Analyst [7] +-------------------------------------------------------------------------------- + + Thank you very much. I just wanted to step back a little bit and look -- you talked about even gross margins for this year to 29% to 30% range. It's a pretty wide range. And as you think about a world -- an e-commerce world -- and how things are changing fairly rapidly out there, I'm just trying to get a sense if you think, over time, that the gross margins are within that range -- lower end of that range. And sort of how you're thinking about that competitive landscape. I mean, you talked a lot about a lot of new merchandising initiatives and stuff, which can help offset some of that. But at the same time, as every Company that we've seen get more focused and driven around e-commerce, seems to see their gross margins lower by the nature of what that business is. So I'd love to hear a little about your thought process there. Thank you. + +-------------------------------------------------------------------------------- +Kathee Tesija, Target Corp - Chief Merchandising & Supply Chain Officer [8] +-------------------------------------------------------------------------------- + + Yes, David, there's no doubt that with e-commerce being as immature as it is, there is some pressure on gross margin. We are committed to going where our guests go, and they want to be able to shop online. And we are going to make sure that we've got all the right products for them, both online and in our stores. That does give us a little headwind on the gross margin. But as you pointed out, all of the newness that we're bringing in -- the things that our guests love most about Target -- that helps to offset it. So we don't have a number to share with you today, but we are very focused on driving sales, going where the guest is, and offering them those products that delight them. + +-------------------------------------------------------------------------------- +David Strasser, Janney Montgomery Scott - Analyst [9] +-------------------------------------------------------------------------------- + + I guess, just as a follow-up to that -- if the guest does go more rapidly towards dot-com, are you willing to accept lower gross margins to do that? And then, I guess, a related question to that, too -- you talked about opening stores for greater hours. Is there an SG&A investment, as well, that would be related to e-commerce -- aside from just the build out of e-commerce -- that you think that you need to add to the stores -- once again, as this world is shifting? Thank you very much. + +-------------------------------------------------------------------------------- +John Mulligan, Target Corp - CFO [10] +-------------------------------------------------------------------------------- + + On the gross margin rate, I think Kathee said it really well. We're going to go where the guest is and meet them -- provide the product they want, where they want it, when they want it, and how they want it. But there's a lot of tools in our tool kit to manage gross margin rate. There's certainly the product that Kathee talked about -- emphasizing the style categories with newness and differentiation. Beyond that, there's the flexible fulfillment options, where we lower shipping expense by moving the product closer to our guest. And also, ultimately, balancing inventories better across the entire network and reducing mark downs that we incur today. +So there are lots of puts and takes. And like Kathee said, we don't have it all sorted out today. We'll provide more information as we do. But I think there are lots of puts and takes, as we think about gross margin rate more broadly. +On the store hourly payroll -- first, on the extended hours, the investment there was immaterial to the quarter. Again, that was about half the stores adding one hour of operations. So not significant investment there. But with Tina Schiel, our Head of Stores, we continually talk about ensuring that we're striking the right balance between productivity in those stores and we have great guest service results. What we see today, our guest survey scores are as high as they've ever been, and the team continues to drive really strong expense control. So we feel good about where we are today. But we constantly evaluate that. + +-------------------------------------------------------------------------------- +David Strasser, Janney Montgomery Scott - Analyst [11] +-------------------------------------------------------------------------------- + + Thank you very much. I appreciate the answers. + +-------------------------------------------------------------------------------- +Operator [12] +-------------------------------------------------------------------------------- + + Your next question will come from the line of Matthew Fassler with Goldman Sachs. Please go ahead. + +-------------------------------------------------------------------------------- +Matthew Fassler, Goldman Sachs - Analyst [13] +-------------------------------------------------------------------------------- + + Thanks a lot. Good morning. Brian, I'd like to start out by asking you for your long-term perspective of threshold for Canada, as relates to time and financial performance. Obviously, that business today is performing at a materially lower level than was originally conceived when it was opened and presumably well, well below its cost of capital. What would you want to see over time, to keep that business running? And what kind of time frame do you have in mind for seeing material improvement in that business? + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corp - Chairman & CEO [14] +-------------------------------------------------------------------------------- + + Matthew, as I mentioned earlier, I spent time just last week with the Canadian team. And I'm certainly aware that the expansion has been challenging. And from a Target standpoint, we've disappointed many of our Canadian guests. Kathee's already referenced the fact that we're conducting an in-depth evaluation of our Canadian business. That began several months ago. And we're certainly looking to make material improvements in that business. +Right now, short term, the focus is on improving in-stock conditions, our pricing, and assortment and really ensuring that we've got plans in place to improve our performance in the holiday upcoming. So you can expect me to be spending quite a bit of time with the Canadian team, along with Kathee, to make sure we understand the opportunities; we understand the challenges that we have to address; and we're focused on improving in-stocks, our value position, and assortment as we go forward. So I'm going to spend, clearly, the balance of the year working very closely with that team to make sure we've got plans in place to improve performance as we go into the holiday season. + +-------------------------------------------------------------------------------- +Matthew Fassler, Goldman Sachs - Analyst [15] +-------------------------------------------------------------------------------- + + Thanks for that. Just a quick follow-up on the US business. In the markets where buy online, pick up in store is more mature, how additive do you find that is, either to online sales or to the business overall? I know for some retailers, it can be as much as 30% or 40% of the overall online sales numbers. Where you have the most track record behind you, if you will, what's your sense of how additive that can be? + +-------------------------------------------------------------------------------- +Kathee Tesija, Target Corp - Chief Merchandising & Supply Chain Officer [16] +-------------------------------------------------------------------------------- + + We did add it to the chain all at the same time. We don't have any markets that are more mature. We did do a little testing with team members in Minneapolis before we rolled out. But basically, we rolled it all around November 1 of last year to all stores. And we have been very pleased with the results from buy online, pick up in store. And about 14% of our digital sales today are being picked up in store. +And then when they go to store to pick up those orders, we're seeing about 20% of those guests shop in the store to pick up additional items. And there's a very healthy basket with that, as well. So still early, but very promising. We think it saves guests time, it saves them money, and it allows them to consolidate their shopping. + +-------------------------------------------------------------------------------- +Matthew Fassler, Goldman Sachs - Analyst [17] +-------------------------------------------------------------------------------- + + Thanks for that clarity. + +-------------------------------------------------------------------------------- +Operator [18] +-------------------------------------------------------------------------------- + + Your next question will come from the line of Greg Melich with ISI Group. Please go ahead. + +-------------------------------------------------------------------------------- +Greg Melich, ISI Group - Analyst [19] +-------------------------------------------------------------------------------- + + Thanks. John, I wanted to follow up of bit on the gross margin -- down 100 BPs in the quarter. If I remember correctly, you had a goal for $600 million of cost reductions this year, roughly a third of it in cost of goods sold. Could you give us an update as to where we are on that and how much that may have helped the quarter, in terms of US margin? + +-------------------------------------------------------------------------------- +John Mulligan, Target Corp - CFO [20] +-------------------------------------------------------------------------------- + + Yes. Sure. You're right. It was -- the goal for expense optimization -- about $650 million incremental to last year, which gets us to $850 million total. Of the $650 million this year -- just rough numbers -- about $200 million of that was on the gross margin line, coming out of cost of goods. More of that back-weighted than front-weighted. We're probably about a little bit more than a third of the way through that. Probably a little bit more than that -- maybe half the way through that. So there was definitely some benefit in the quarter from expense optimization. That was also true in the first quarter. Both quarters have benefited. But later in the year, we'll see more benefit as we continue to grow those savings. + +-------------------------------------------------------------------------------- +Greg Melich, ISI Group - Analyst [21] +-------------------------------------------------------------------------------- + + The same with the SG&A? Out of that $650 million, it's more back end? + +-------------------------------------------------------------------------------- +John Mulligan, Target Corp - CFO [22] +-------------------------------------------------------------------------------- + + Yes. It builds as the year goes on. We're annualizing on the, roughly, $200 million we saved last year. That was primarily SG&A. There's probably a little bit more good news in SG&A right now, but that will continue to build, as well, as we go throughout the year. + +-------------------------------------------------------------------------------- +Greg Melich, ISI Group - Analyst [23] +-------------------------------------------------------------------------------- + + Great. If I could, Brian, thanks a lot, and welcome back to retail. + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corp - Chairman & CEO [24] +-------------------------------------------------------------------------------- + + Thank you. Good to be back, Greg. + +-------------------------------------------------------------------------------- +Greg Melich, ISI Group - Analyst [25] +-------------------------------------------------------------------------------- + + For your opening comments, how long do you think it will take for you to get to understand the business and the customers and actually come up with a plan? Is that something we should expect by year end or early next year? Can you give us any time horizon on that? + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corp - Chairman & CEO [26] +-------------------------------------------------------------------------------- + + Greg, I'm going to quickly immerse myself in the details of the business, both here in the US and Canada. And John and Kathee and the leadership team have already spent hours with me walking through a lot of the strategic work that they've been doing over the last 90 days. As I said earlier, during my very first week, I visited the Canadian market to spend time with that team, and I want to be a good student of the business. But clearly, we have to have a sense of urgency here and a sense of pace. And while I want to study the business and, certainly, listen and learn from our team, no one is happy with our current performance. +And our focus, right now, is to make sure we've got plans in place in the short term to improve traffic. We've got plans in place to improve our performance in Canada. And we've got to continue to move faster, from a digital and mobile standpoint, to meet the needs of our guests. So you can expect a clear sense of urgency. But I, certainly, want to make sure I give myself the time to listen, learn, understand the business, both from our team's standpoint but also from the eyes of the Target guest. And you can expect me to dive in very quickly to understand the business, to look for the opportunities, and to work with the leadership team to develop very focused priorities, as we go forward into 2015 and beyond. + +-------------------------------------------------------------------------------- +Greg Melich, ISI Group - Analyst [27] +-------------------------------------------------------------------------------- + + Thanks a lot. + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corp - Chairman & CEO [28] +-------------------------------------------------------------------------------- + + Thank you, Greg. + +-------------------------------------------------------------------------------- +Operator [29] +-------------------------------------------------------------------------------- + + Your next question will come from the line of Matt Nemer with Wells Fargo Securities. Please go ahead. + +-------------------------------------------------------------------------------- +Matt Nemer, Wells Fargo Securities, LLC - Analyst [30] +-------------------------------------------------------------------------------- + + Thanks a lot, and good morning. I was wanting to get some more detail on the improved performance in July and August. And I'm wondering if you have a sense, from your guest surveys, how much of that change is driven by price investments, efforts to improve the presentation, or maybe a change in the broader environment? + +-------------------------------------------------------------------------------- +Kathee Tesija, Target Corp - Chief Merchandising & Supply Chain Officer [31] +-------------------------------------------------------------------------------- + + Yes, Matt. I think it's more about product and the newness that we have on the floor for back-to-school, back-to-college. We've seen both of those start off really strong. Even in their peak weeks, those stores are doing better the week after their peak. So we're seeing it stronger in the peak and then get even stronger after that. So I think it's really product related and newness. Certainly, we've had promotions. Most of them are devoted to those core categories like apparel, some of the back-to-college items. But the guest, right now, is more focused on the occasion than they are on the promotion. So that is very encouraging to us, and I think it's product-driven. + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corp - Chairman & CEO [32] +-------------------------------------------------------------------------------- + + Matt, if I could, just early days -- but the current performance on back-to-school and the way Kathee and the team have put back-to-school together at Target has been very impressive to me. And I think it's a great example of getting the product right, the right balance of newness and innovation, great advertising communication that really captures the guest's attention, and very strong in-store and online execution. So I think that's one of the great examples that we're going to continue to build from, as we go forward. I think Kathee and the entire team have brought back-to-school to life -- back-to-college to life -- with the right products, the right newness and innovation, great advertising communication to support it, and then very strong in-store and online execution. + +-------------------------------------------------------------------------------- +Matt Nemer, Wells Fargo Securities, LLC - Analyst [33] +-------------------------------------------------------------------------------- + + That's very helpful. And then one housekeeping follow-up if I may. Your Canada comp transactions were only down about 2%, which, frankly, was a little bit surprising against the grand opening halo. I'm wondering why UPT was down so much. I think it was down over 8%. + +-------------------------------------------------------------------------------- +John Mulligan, Target Corp - CFO [34] +-------------------------------------------------------------------------------- + + UPT down 8% in Canada, Matt. I think a lot of that -- what I would tell you is, a lot of noise going on in the Canada comp, overall. So much of the surge last year, we saw very different types of transactions than we saw once we moved past that, as we opened stores. We saw that in each cycle. Very different behavior for those -- I don't know -- four to six weeks when we had the surge period. And then, as the business settled down and got into a more normal state, we saw more routine transaction counts and baskets. What I would tell you is, we're going to continue to see this. It's going to be noisy in Q3. And really, it won't be until we get to Q4, when we've cycled past all the opening cycles -- all the densification -- that we get a real read on what's going on, on a comparable basis from the business year-over-year. + +-------------------------------------------------------------------------------- +Matt Nemer, Wells Fargo Securities, LLC - Analyst [35] +-------------------------------------------------------------------------------- + + Okay. Thanks so much, and good luck. + +-------------------------------------------------------------------------------- +John Mulligan, Target Corp - CFO [36] +-------------------------------------------------------------------------------- + + Thanks. + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corp - Chairman & CEO [37] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Operator [38] +-------------------------------------------------------------------------------- + + Your next question will come from the line of Matt McClintock with Barclays. Please go ahead. + +-------------------------------------------------------------------------------- +Matt McClintock, Barclays Capital - Analyst [39] +-------------------------------------------------------------------------------- + + Hi, yes. Good morning, and welcome, Brian. Kathee, my question is actually -- + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corp - Chairman & CEO [40] +-------------------------------------------------------------------------------- + + Thanks, Matt. + +-------------------------------------------------------------------------------- +Matt McClintock, Barclays Capital - Analyst [41] +-------------------------------------------------------------------------------- + + Kathee, my question is actually for you. You talk a lot about product and freshness and newness. And I was just wondering -- as you look to the fall merchandise plan, how far can you push freshness and newness into that plan? What inning would you say that represents, overall, relative to what you consider to be more optimal level? And when can we realistically expect you to reach that more optimal level? Thank you. + +-------------------------------------------------------------------------------- +Kathee Tesija, Target Corp - Chief Merchandising & Supply Chain Officer [42] +-------------------------------------------------------------------------------- + + Well, haven't thought about it in terms of innings, Matt. But I'll tell you, we are excited about what we have coming for the fall season. I highlighted a lot of things that are coming in September and October. But then moving on to the fourth quarter, which we won't be specific about today, but we're excited about what that brings as well. We have about 85,000 items in our assortment, and we'll have 35,000 new items this fall season. So I do feel pretty optimistic about the content, the quality, the trend, the presentation. But, clearly, in spring, I think you'll see that will be a full cycle out. And we'll have much more to come, as we turn the corner into the spring season. + +-------------------------------------------------------------------------------- +Matt McClintock, Barclays Capital - Analyst [43] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corp - Chairman & CEO [44] +-------------------------------------------------------------------------------- + + Matt, thank you. Operator, I think we've got time for one last question. + +-------------------------------------------------------------------------------- +Operator [45] +-------------------------------------------------------------------------------- + + Our final question will come from the line of Simeon Gutman with Morgan Stanley. Please go ahead. + +-------------------------------------------------------------------------------- +Simeon Gutman, Morgan Stanley - Analyst [46] +-------------------------------------------------------------------------------- + + Thanks. Good morning, and welcome, Brian. Quick one for Kathee. We talked in New York, about a month ago, about traffic trips and that 9 out of 10 were still intact from the customer. But you had lost 1 out of 10. And that, maybe, e-commerce was the angle of you to get that back. My question is, how confident -- I don't know if you have any early indications from your own data -- that when that customer does shop online with you, that either they're not going to visit the store less, or that they'll not maintain the same level of purchasing? + +-------------------------------------------------------------------------------- +Kathee Tesija, Target Corp - Chief Merchandising & Supply Chain Officer [47] +-------------------------------------------------------------------------------- + + Yes. The guest that shops Target online is absolutely our best guest. They shop both online and in stores. It's really all about what's convenient for them, and sometimes it's just easier to knock an item off your list by buying it on your mobile device. Sometimes you want to purchase it online but pick it up in store to do the rest. But this is absolutely our best guest and one we will not cede. We will go after being a seamless, omnichannel retailer with confidence, knowing that it's the best thing for our guest and best thing for our business. And I do think that, when you think about the lapsed guests, they're basically back. +So traffic changes are more about consolidated trips and trips shifting online. So it's an important part for us to own, which is why you see all of the efforts in our omnichannel capabilities and strategies -- with subscriptions and with personalization and with ship from store and buy online, pick up in store. There's a lot of things that we're putting effort into that will help drive that momentum. + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corp - Chairman & CEO [48] +-------------------------------------------------------------------------------- + + Right. + +-------------------------------------------------------------------------------- +Simeon Gutman, Morgan Stanley - Analyst [49] +-------------------------------------------------------------------------------- + + Okay. + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corp - Chairman & CEO [50] +-------------------------------------------------------------------------------- + + Simeon, thank you for the question. +That concludes our Target second-quarter 2014 earnings conference call. I thank all of you for your participation today. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/exam/original-files/Problem_2_3_Sample_full_transcripts/2014-Feb-18-KO.N-138408934080-Transcript.txt b/exam/original-files/Problem_2_3_Sample_full_transcripts/2014-Feb-18-KO.N-138408934080-Transcript.txt new file mode 100644 index 0000000..0eb88f8 --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_full_transcripts/2014-Feb-18-KO.N-138408934080-Transcript.txt @@ -0,0 +1,516 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q4 2013 The Coca-Cola Company Earnings Conference Call +02/18/2014 09:30 AM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Ahmet Bozer + The Coca-Cola Co - EVP & President of Coca-Cola International + * Gary Fayard + The Coca-Cola Co - CFO + * Irial Finan + The Coca-Cola Co - EVP & President Bottling Investments and Supply Chain + * Sandy Douglas + The Coca-Cola Co - SVP, Global Chief Customer Officer & President, Coca-Cola North America + * Jackson Kelly + The Coca-Cola Co - VP & IR Officer + * Muhtar Kent + The Coca-Cola Co - Chairman & CEO + +================================================================================ +Conference Call Participiants +================================================================================ + + * Bill Schmitz + Deutsche Bank - Analyst + * Dara Mohsenian + Morgan Stanley - Analyst + * Judy Hong + Goldman Sachs - Analyst + * Bryan Spillane + BofA Merrill Lynch - Analyst + * John Faucher + JPMorgan Chase & Co. - Analyst + * Ali Dibadj + Sanford C. Bernstein & Company, Inc. - Analyst + +================================================================================ +Presentation +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + At this time, I would like to welcome, everyone to the Coca-Cola Company's fourth-quarter 2013 earnings results conference call. Today's call is being recorded. If you have any objections, please disconnect at this time. +(Operator Instructions) +I would like to remind everyone that the purpose of this conference is to talk with investors and therefore questions from the media will not be addressed. Media participants should contact Coca-Cola's Media Relations department if they have questions. +I would now like to introduce Jackson Kelly, Vice President and Investor Relations Officer. Mr. Kelly, you may begin. + +-------------------------------------------------------------------------------- +Jackson Kelly, The Coca-Cola Co - VP & IR Officer [2] +-------------------------------------------------------------------------------- + + Good morning and thank you for being with us today. I'm joined by Muhtar Kent, our Chairman and Chief Executive Officer; and Gary Fayard, our Chief Financial Officer. +Following prepared remarks by Muhtar and Gary this morning, we will turn the call over for your questions. Ahmet Bozer, Executive Vice President and President of Coca-Cola International; Sandy Douglas, Senior Vice President, Global Chief Customer Officer, and President, Coca-Cola North America; and Irial Finan, Executive Vice President, The Coca-Cola Company, and President of Bottling Investments and Supply Chain, will also be available for the Q&A session. +Before we begin, I would like to remind you that this conference call may contain forward-looking statements, including statements concerning long-term earnings objectives, and should be considered in conjunction with the cautionary statements contained in our earnings release and in the Company's most recent periodic SEC reports. In addition, I would also like to note that we have posted schedules under the Financial Reports and Information tab in the Investors section of our Company website at www.coca-colacompany.com. +These schedules reconcile certain non-GAAP financial measures, which may be referred to by our Senior Executives during this morning's discussion, to our results as reported under Generally Accepted Accounting Principles. Please look on our website for this information. I would now like to turn the call over to Muhtar. + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Co - Chairman & CEO [3] +-------------------------------------------------------------------------------- + + Thank you, Jackson, and good morning, everyone. I want to start off today by recognizing that many of you are attending the CAGNY Conference this week. Given the timing of our earnings call and the fact that I will also be presenting at CAGNY this coming Friday, we will keep our prepared remarks a little bit shorter to ensure that we have adequate time for your questions and that we can get you back into the conference. +With 2013 behind us, I am now looking forward to joining forces with our global system associates as we work to restore momentum to our Business in 2014. 2013 was clearly marked by ongoing persistent macroeconomic challenges and our Business was not immune to these pressures. Nevertheless, we delivered sound financial results and we grew global value share in nonalcoholic ready-to-drink beverages for a 26th consecutive quarter. +Our worldwide volume grew 1% in the fourth quarter and 2% for the full year. We delivered full-year comparable currency-neutral operating income growth of 6% after excluding the impact of structural changes off of a comparable currency-neutral ex-structural revenue growth of 3% for the full year. +And we delivered full-year comparable currency-neutral EPS growth of 8%, in line with our long-term growth targets. This performance underscores our ability to generate sound financial results even in a challenging environment. +Our sparkling brands grew 1% in the full year, cycling 3% with brand Coca-Cola, adding nearly 100 million unit cases. In fact, all of $1 billion sparkling brands, except for Diet Coke, Coca-Cola Light grew in 2013, contributing more than 140 million incremental cases in the full year. As of the end of 2013, we've gained core sparkling value share for 17 consecutive quarters. +For the full-year, our portfolio of still beverage brands contributed over 300 million incremental cases, or 5% growth, while cycling 10% growth in the prior year. Importantly, we gained volume share and value share for the year. +Our tea volume grew 11% for the full year, with solid performance across our entire tea portfolio. Juice and juice drinks grew 5% for the full year, with strong performance by Minute Maid, Simply, Del Valle, Minute Maid Pulpy, Rani, and Innocent. We are proud of our robust portfolio of leading juice and juice drink brands. +Sports drinks grew 2% for the full year, with Powerade continuing its solid and consistent growth performance. Packaged water grew 5% for the full year as we focused on growing our premium water brands and on expanding our PlantBottle and Eco-Flex packaging. +While 2013 was an unusual and challenging year, it has certainly not deterred us from our commitment to our 2020 Vision. Many economies around the world remain volatile in 2013, developed markets are slowly starting to recover from this turbulent time, and consumer expenditures remain moderated. +Emerging markets face a substantial challenges as they dealt with fluctuating currencies and other structural issues. However, we remain optimistic and excited about the future of our Business and brands in emerging markets. After all, per capita consumption for our brands remains relatively low in most emerging countries. +That said, these emerging market conditions simply reinforce our commitment to remain focused on our long-term strategies and to keep investing through these tough times to ensure that we continue to deliver long-term sustainable growth. +In Europe, we saw a 1% volume decline for the year. However, we gained sparkling and still value share and we were pleased by improving volume performance in certain key markets. A better second half of the year helped our Northwest Europe and Nordics business unit close 2013 with 1% volume growth, while Germany continued to outperform, delivering 6% volume growth for the quarter and 2% growth for the year. ¶ Our successful Share a Coke campaign last summer contributed to full-year trademark Coca-Cola volume growth of 1% in Northwest Europe and Nordics, and 5% in Germany. We also launched Share a Coke in our Iberia business unit in the fourth quarter of the past year, and as in other markets, the campaign has generated tremendous excitement, contributing to strong double-digit immediate consumption growth and to trademark Coca-Cola growth of 2% in the quarter. +Moving now to Eurasia and Africa, full-year volume grew 7% cycling 10% in the prior-year, and we grew volume and value share in nonalcoholic ready-to-drink beverages for the full year. All our business units delivered solid full-year volume growth, including double-digit volume growth in our Middle East and North Africa business units. +In Russia, strong Olympic and Christmas campaigns activated across the country fueled double-digit growth in trademark Coca-Cola for the full year and enabled us to gain core sparkling volume share while maintaining value share. Fittingly, leading up to this Olympic year, our Business achieved an all-time high market share for nonalcoholic ready-to-drink beverages. +We recently completed a successful Olympic torch relay, bringing the torch to thousands of Russian towns and cities. I was pleased to have an opportunity to host our customers and our bottling partners in Sochi last week, where I saw our best ever activation of an Olympic [asset]. Our local team and bottler are doing an excellent job in Sochi. +Our Pacific group grew 3% in the full year, cycling 7% in the prior year. We were pleased to see improving trends across key markets, including India, China, and Japan as the year progressed. +For the full year, our volume in Japan grew 1%, with Sprite, Minute Maid, and Ayataka each growing by double-digits. China contributed 3% volume growth for the full-year, cycling 4% in 2012, and grew 5% in the fourth quarter. +We delivered balanced growth across sparkling and still beverages thanks to strong campaigns and a renewed focus on execution. We're engaging teams and driving category excitement in China through campaigns like our Mini-Me Coca-Cola campaign, which contributed to double-digit immediate consumption growth in the fourth quarter, and our popular Share a Coke campaign last summer. +India cycled 16% full-year growth, with a 4% volume increase in 2013, closing out the year with our 30th consecutive quarter of volume growth. It is remarkable to think of the business that we have built in India over the last two decades. In 2013, our system generated nearly $1.8 billion in revenue, and we have four of the top five core sparkling brands, the number one juice drink brand, a commanding nonalcoholic ready-to-drink share, and so much, so much untapped opportunity still ahead. +Turning now to Latin America, we grew 1% for the full year, cycling 5% from the prior year. Argentina, Mexico, and Brazil all come to mind as we consider what worked for us and what was challenging in 2013 in Latin America. +We were pleased with our performance in Argentina, where despite challenging economic conditions, our brands performed well, resulting in 7% volume growth for the full year. Sparkling was an important volume driver in Argentina, with Coca-Cola, Sprite, and Fanta each growing mid to high single-digits. +Coca-Cola Life met our expectations and is playing a meaningful role, as it is not just delivering incremental volume, but also enhancing the positive feelings that consumers have for Coca-Cola. We're excited about the potential of Coca-Cola Life, as it has shown great promise in bringing people back into the category. It's another example of how we are working to be part of the solution to the obesity issue, giving consumers a blend of sugar and natural zero-calorie sweeteners. +Returning to our business in Argentina, our still brands grew double-digits, with strong performance in packaged water, with the launch of the Bonaqua Eco-Flex bottle, as well as solid growth in juice and juice drinks and sports drinks. +In Mexico, volume growth was even for the year with still beverage volume growth offset by sparkling. Despite a solid start to 2013, we had a challenging second half of the year, mostly due to severe weather. We continue to see opportunity in Mexico where our strong brands, world-class execution, and an improving economy bode well for the future. +Our bottling partners have adjusted their pricing as the result of the newly implemented tax and we are closely monitoring any further adjustments as needed. While we expect the change to adversely impact our volume in Mexico in the short-term, it is too early to tell what the exact impact will be at this time. +I will wrap up my commentary on Latin America with an update on our Business in Brazil, where consumers have been impacted by a slowing economy, rising prices, and reduced disposable income. Full-year volume was down 2% due to a disappointing 6% drop in the fourth quarter. +Our local team, working closely with our bottling partners, have now launched an upgraded affordability strategy, enhancing our [occasion] brand, price pack, and channel architecture. We are optimistic that this strategy, together with our World Cup program, will enable us to return to growth in Brazil in 2014. +Turning now to North America, we remain steadfast in our commitment to building long-term value in our flagship market and a commitment that calls for building strong brands, creating customer value, and enhancing our system capabilities. Sandy Douglas is leading our North America business, where we will again benefit from the strong customer and strategic brand expertise. Adding Paul Mulligan and Irial Finan's disciplined focus on execution at the point-of-sale will enable us to refine these strategies and to enhance their impact. +The combined experience and expertise of this leadership team and a joint accountability for driving value will ensure that we are laser-focused on continued improvement of our overall performance in this important market. We will therefore continue to assess and to evaluate the operating results in North America as an integrated business. +In October of 2010, we established a four- to five-year timeframe to commence the refranchising of our bottling operations in North America. 2014 is the fourth year, and as the North America operating model evolves, it will not only streamline our focus, but it will also expedite refranchising to independent bottling partners. +To date, we've closed on the first transaction of our 21st century beverage partnership model at the end of 2013, and we are very encouraged with the seamless transition of the territory. Looking ahead, we are well-aligned on the transition with the other four bottlers that we announced back in 2013. +We expect to reach agreements with those partners shortly and for those transactions to begin closing later in the year that we are in. We will also imminently announce new bottling partnerships whose ownership reflects the diversity of the consumers and customers we proudly serve in North America. +We expect North America to deliver consistent volume, revenue, and transaction growth, with the balance, volume, and price mix that you would expect from an industry leader. We also firmly believe that the Business will deliver consistent profitable growth over the long-term. +2013 was a challenging year in North America and I'm not satisfied with our overall performance. Nevertheless, we gained volume and value share while generating positive price mix of 1% across our portfolio and positive price mix of 2% for our sparkling brands. However, our volume was even versus prior year and operating income fell short of our targets. +Sparkling beverage volume fell 2%, largely due to softer Diet Coke volume. We have implemented a multi-faceted approach to address category headwinds and the various misperceptions that fuel them. This effort is targeting both obesity and ingredient concerns and increased aggressive sweetener innovation, transparent consumer communications, continued packaging evolution, and new partnerships with credible third parties around the world who will use meaningful facts to defend and protect the sparkling category. +While we work to nurture our sparkling business back to growth, our still beverage business continues to perform well. Still beverages grew 5% for the full year, as our diverse portfolio of still beverage brands continues to outperform the competition. Thanks to continuous innovation and to growing brands like Powerade, Simply, Gold Peak, and smartwater, the fourth quarter marked the 15th consecutive quarter in which our still beverage portfolio gained or maintained volume and value share in North America. +As we approach the mid-point of our 2020 Vision, we remain fully committed to taking the necessary bold actions to realize our vision. One such action is our recently-announced global partnership with Green Mountain Coffee Roasters. This partnership is a real game-changing innovation in the nonalcoholic beverage category. +Consumers are demanding more beverage variety, functionality, and convenience, and we believe Green Mountain is the perfect strategic partner to collaborate with and to capitalize on the many transformative opportunities we see available in the marketplace. Importantly for The Coca-Cola Company, with this exciting partnership, we're leveraging new technology to create a transformative platform for consumers to enjoy our great brands through new consumption occasions and new channels. ¶ By combining Coca-Cola's brand leadership and global footprint with Green Mountain's cutting-edge technology and innovation capabilities, together we will capitalize on the many exciting opportunities in the single-serve pod-based segment of the cold beverage industry, as well as explore other future opportunities to collaborate on the entire Keurig platform. +As evidenced by this recent announcement, our Management team is constantly identifying and constantly evaluating creative ways to formulate and fuel the power of partnerships that keep us at the forefront of consumer trends driving the dynamic global beverage industry. We are fortunate to participate in a global and resilient industry fueled by robust long-term demographic trends. We are part of a great business system and unparalleled in its reach and its commitment to invest and we are the stewards of some of the world's most loved brands. +Thus, there is no doubt that the lingering effects of the global recession in 2009 have created a challenging environment over the last few years. In addition, obesity and ingredient concerns have raised some questions about growth in developed markets. +Throughout this time period, our Company has consistently delivered on our profit objectives and we will not allow ourselves to become distracted or to make decisions focused on short-term gains. Instead, we have thoroughly evaluated what we need to do to accelerate sustainable growth and we're acting with urgency and decisiveness. Historically, we know that when we invest in our brands, commit to near-flawless execution, and control what we know we can control, we can accelerate our growth. +With this in mind, we aligned on five strategic priorities to restore our momentum and to keep us on the path to achieve our 2020 Vision. These priorities focus on the growth drivers for our (inaudible) system, sparkling beverages, still beverages, and global system execution, and on securing and strengthening the financial and human capital necessary to deliver long-term sustainable growth. +Our five strategic system priorities to restore momentum are: firstly, accelerate sparkling growth, led by Coca-Cola; secondly, strategically expanding our profitable still portfolio; third, increasing media investments by maximizing productivity; fourth, winning at the point-of-sale by unlocking the power of our system; and five, investing in our next generation of leaders. Let me just spend a few minutes providing some detail on each of these system priorities. +First, we will accelerate sparkling growth, led by Coca-Cola. There is quite simply no other brand in the world like Coca-Cola, the world's most universal beverage brand. We're fortunate to be its stewards. +Indeed, in many markets around the world, brand Coca-Cola remains magical, but we need to work even harder to enhance the romance of the brand in every market around the world. Our global marketing community is laser-focused on doing their best work while reallocating resources to the most impactful campaigns and mediums. +A good example of this great work is Share a Coke, which I have referenced several times in my remarks earlier. Since the initial launch of Share a Coke in Australia back in 2011, we've now executed the campaign in 21 other markets. +This is much more than a marketing campaign; in fact, it's a system-wide collaborative effort to engage consumers in a meaningful and very authentic Coca-Cola way. Markets that have launched Share a Coke have experienced increased household penetration, higher immediate consumption volume, and improved brand [love] scores as a redirect result of this campaign. This is the kind of marketing that we love to invest in and we look forward to again sharing a Coke with millions of consumers around the world this year. +At the same time, we're working hard to empower our consumers and we're making progress against our four commitments to further contribute to healthier, happier, and more active communities. To that end, we've placed a special emphasis on innovation efforts to enhance low- or no-calorie versions of our brands, as well as on supporting active, healthy living programs all around the world. +Our second priority is to strategically expand our profitable still portfolio. We are the world's largest still beverage Company with $11 billion still brands and many more in the pipeline. +We've shown in juices that when we approach an objective and a goal systematically, aligning with our partners, planning from end-to-end, we win and we win big. Today, The Coca-Cola Company is also the world's largest juice and juice drinks Company, almost twice the size of our closest competitor. We are the stewards of $4 billion juice and juice drink brands and we are working diligently to raise that number. +We're bringing the same disciplined thinking to other categories, partnering across our system and across our supply chain to establish a scalable formula for value creation in new categories. This effort involves re-examining every stage of a beverage's lifecycle and developing category-specific plans that balance organic growth innovation and acquisitions. +Our third system priority is to increase media investments by maximizing productivity. We're in a business where great marketing works, so we have committed to increasing our media spending behind our brands by up to $1 billion by 2016. We will fund this increased investment through a combination of supply chain optimization, systems standardization, diligent resource and cost allocation, as well as improved utilization of our global marketing network. +This incremental productivity goal will further enable us to drive long-term profitable growth and momentum towards realizing our 2020 Vision. Gary will share further details about this new opportunity in a few moments. +Our fourth priority is to win at the point-of-sale by unlocking the power of our global system. Working together with our marketing partners, we are continuously building capabilities and leveraging best practices to improve our execution. In the last four years alone, our system has invested over $50 billion to enhance our competitive position in markets all around the world. +As you know, execution in the global marketplace is about doing many common things uncommonly well and doing them in an aligned way across our great system. It is about presenting our brands in the right package, in the right outlet, in the right channel, at the right price [code] available, and within an arms reach of our consumers. This is why we're calling 2014 the year of execution at the point-of-sale, beginning with brand Coca-Cola. +Our final, but perhaps most important priority, is to continue to invest in our pipeline of leaders. There is nothing more critical to our Business than our people and we have to continue to hire the best, retain the best, train the best, and mentor the best. Our Company and leadership must inspire our people to live our values of focusing on the market, working smart, acting like owners, and being passionate ambassadors for our Company and for our brands. +As we look forward to 2014 and beyond, we remain very confident in our ability to drive our volume growth trajectory back in line with our long-term growth model. The overall beverage industry remains healthy, generating both volume and value growth. +Our diverse portfolio of $17 billion brands, combined with our unparalleled scale, provides us with many opportunities to accelerate market share gains. We have identified opportunities to significantly enhance our productivity initiatives and we've made important commitments to increase our brand investments. +Consequently, we are no less enthusiastic about the future ahead of us and the beverage industry than when we embarked on our 2020 Vision back four years ago. With that, let me turn the call over to Gary. + +-------------------------------------------------------------------------------- +Gary Fayard, The Coca-Cola Co - CFO [4] +-------------------------------------------------------------------------------- + + Thanks, Muhtar, and good morning, everyone. As Muhtar shared earlier, 2013 presented numerous challenges to our industry and to our Business. As a result, our full-year volume growth was below our expectations. +However, before we put 2013 behind us, I wanted to reflect on a few items that I shared with you all at CAGNY last February. Specifically, I talked about our unwavering focus on long-term value creation for our share owners. Apart from competing in a great industry, there were three specific points I emphasized. +First, we are focused on delivering value-creating volume growth. Despite volume growth being below our expectations in 2013, we delivered full-year operating income and EPS growth in line with our long-term growth targets. +Secondly, our goal is to take volume share and value share. Although we fell short on volume, we again gained global value share in nonalcoholic ready-to-drink beverages in 2013. +Lastly, I emphasized the critical role that the evolution of our franchise system plays in creating sustainable long-term growth. Our Company and our system made solid progress on this front throughout 2013. We sold 51% of our Philippines bottling operations to Coca-Cola FEMSA; our four bottling partners in the greater Tokyo area emerged to form Coca-Cola East Japan; our seven bottling partners in Spain and Portugal merged and the integration of that bottler is underway; we merged our Company-owned bottling operations in Brazil, with an independent local bottler, to form the second largest bottler in Brazil; and we also continued to advance the system of the future work in North America. +Having said that, let's quickly review a few key drivers of our financial performance this year. Unit case sales and concentrate sales were in line on a consolidated basis in the fourth quarter and for the full year. Our comparable currency-neutral operating income was up 6% in the quarter and for the full year, after excluding the impact of structural items. +Comparable currency-neutral earnings per share grew 7% in the quarter and 8% for the full year. We generated $10.5 billion in cash from operations, which was down 1%, primarily due to the impact of foreign currency exchange rates, an increase in tax payments, and the impact of the deconsolidation of bottling operations in the Philippines and Brazil. +Now let me take a moment to update everyone on our productivity initiatives before I move to our outlook for 2014. First, let me start by saying, we've made significant progress on our previously-announced productivity and reinvestment programs. In fact, I'm pleased to report that by the end of 2013, we have substantially accomplished the objectives of the program and captured the savings associated with those objectives. +Secondly, as Muhtar mentioned earlier, we are expanding our previously-announced productivity and reinvestment program to drive an incremental $1 billion in productivity by 2016 that will be redirected primarily into increased media investments. Our incremental productivity goal consists of two relatively equal components. +First, expanded savings through global supply chain optimization, data and information technology system standardization, and resource and cost reallocation, which will be reinvested in global brand building initiatives, with an emphasis on increased media spending. Also we'll be increasing the effectiveness of our marketing investments by transforming our marketing and commercial model to redeploy resources into more consumer-facing marketing investments to accelerate growth. +As we look ahead to 2014, let me take a minute to update you on a few outlook items as you model our business. After considering our hedge positions, current spot rates, and the cycling of prior-year rates, we currently expect a currency headwind at the operating income of approximately 10 points in the first quarter of 2014 and 7 points for the full year. +In terms of coverage, we're fully hedged on the euro and the yen, almost totally covered on Sterling, and also have near-term coverage in place across several other major currencies. We anticipate that operating leverage on a currency-neutral basis will be flat to slightly positive. +We expect net interest income will contribute roughly the equivalent of $0.01 per share to our full-year 2014 earnings per share and will be evenly distributed throughout the year. We expect the tax rate for 2014 to hold steady at approximately 23%. +With respect to structural items, we'll still be cycling the impact of some bottling divestitures during the first six months of 2014, and even though these structural items will not have a significant impact on earnings per share, they will result in a 1 point headwind at both net revenue and operating income for the full year. +To be clear, our 2014 outlook for the impact of structural items does not include the potential impact of refranchising bottling assets in North America related to our system of the future work. We will continue to provide updates as we move forward throughout the year. +As for cash, as I've shared with you over the years, we utilize a very disciplined and consistent framework. First, we reinvest in the Business, which includes making the necessary investments to strengthen our brands to accelerate growth. It also includes capital investments, which we expect to be in the range of $2.5 billion to $3 billion this year. +Second, we reward share owners by paying a healthy dividend. We've increased our dividend every year for more than a half-century and we will recommend another increase in the dividend this year at our Board meeting this week. +Next we evaluate opportunities to grow through acquisitions, partnerships, and joint ventures. We view these as enablers to help accelerate growth when appropriate and where there is a need within our existing portfolio. +Finally, we put what's left over into share repurchase. In 2014, we expect share repurchases to be in the range of $2.5 billion to $3 billion. +Although our 2014 outlook for net share repurchase is below 2013, I would remind everyone that our 2013 buybacks represented a 15% increase from the prior year and was partially funded by cash inflows related to bottling divestitures. Also given the forecasted exchange headwinds in 2014, we believe this is the right approach and will obviously continue to update you as we move forward throughout the year. +In terms of quarterly phasing, our first quarter in 2014 will have one less selling day and our fourth quarter will have one additional selling day. In addition, we expect the impact of the Easter holiday to fully benefit the second quarter of 2014, and we'll be cycling the reversal of certain expenses related to long-term compensation in the first and second quarters of 2014. +In closing, we continue to be focused on doing the right things for the health of our Business and to ensure we can deliver sustainable, long-term growth to create value for our share owners. I believe our Company and our system are well-positioned to capitalize on the opportunities within our great industry. +I look forward to seeing many of you at CAGNY later this week and at CAGE in March. Operator, we're now ready for questions. + + + +================================================================================ +Questions and Answers +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Thank you. +(Operator Instructions) +Bill Schmitz, Deutsche Bank. + +-------------------------------------------------------------------------------- +Bill Schmitz, Deutsche Bank - Analyst [2] +-------------------------------------------------------------------------------- + + Can you please talk about the outlook geography-by-geography and then maybe how the pace of growth is going to differ between volume and pricing given some of the big currency moves and also obviously the tax in Mexico? I have a follow-up if I could? + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Co - Chairman & CEO [3] +-------------------------------------------------------------------------------- + + Sure, Bill. Good morning. This is Muhtar. +Let me first just take a step back and just say that, in a way, we've had a speed bump. We know it would have come on our road to 2020. We dealt with commodities and in 2011 and 2012. Volatility in weather has become a norm. +Uncertain economies -- internal, also execution issues caused us to under-perform versus our expectations in 2013. I'll start by saying that. +We have looked at everything. We have looked at our people, priorities, marketing, selling, and innovation, and we have refreshed our plans with a simple but scaled up set of priorities on marketing our brands, system execution by our franchisees and bottling partners and Company-owned bottlers, and on innovation of all kinds. Business models like the one that we recently announced with Green Mountain, brands, equipment, packaging, the lot. +Our long-term outlook is our performance algorithm which we have and will deliver going forward. And 2014 will be a year of steady improvement as we get back up to speed. +But make no mistake, our leadership team is confident, accountable. Our system will market well. We will sell well and we are going to achieve our 2020 Vision. +Now let me just take you through a quick tour of the world and I'll ask Ahmet also to comment. Starting with Asia, China is going to sustain its growth, India in terms of its macroeconomic outlook, and we will continue to benefit from that. +In India, there is elections coming up and usually when there are elections, there is a little bit of easing of fiscal discipline. That will play into a little bit of added disposable incomes. +In Southeast Asia, certainly we've seen quite a lot of political turmoil, especially in Thailand. That will -- as we go into 2014, my expectation is that, that will ease a little bit. +Indonesia, also there's an election coming up. But Indonesia is certainly having some macroeconomic issues that will probably continue into 2014. Philippines, we'll see a slightly improved outlook in the Philippines versus 2013. +In Japan, obviously everyone is looking very closely at the new policies of Prime Minister Abe's government. There's a new tax coming up. We'll see how that impacts but certainly we all feel -- that our operating in Japan -- feel that there is some hope for a little bit of more inflation in the economy that will benefit also businesses like ours. Although recently, the last economic numbers from Japan were a little bit below expectations. +Africa, youngest continent, we're very well-positioned. We feel that we will continue to grow well in the years to come in the African continent and benefit from also improvements in governance across the whole continent. +In Eurasia, there's elections coming up in Turkey. Lots of again political issues in the Middle East will continue. +Russia, all Russians can be very proud of the Olympics that are taking place. We will as we move forward -- and I was there in Russia, looking at some of the great activations that we've had in our Business -- and Russia, our Business will continue to grow in Russia with all the investments that we're making with our bottling partners. +Europe is a continued tale of two cities. If you take the southern zone, the high unemployment and low growth is going to continue but it's not going to get worse. +As far as northern Europe, Britain is certainly ahead of all the other economies in terms of the growth outlook. Germany also is in that area. We will continue to benefit from the robustness of policies in those two economies and the rest of the continent is somewhat behind Germany and England. +In Latin America, again, 2014 is going to be a year leading into an election in early 2015. We'll have also the benefit of the World Cup and our biggest ever activation globally on the World Cup. Southern Cone -- Argentina, Chile -- we should continue to see the benefit of all the programs we have in place and also continued inflationary environment in those two areas. +Mexico, President Pena Nieto's programs are taking effect, all the reforms. Long-term, that is a benefit to our Business, to the economy, to the people of Mexico. Again, as I said in my commentary, it's too early to say about the impact of the price increase we've had there. +So I hope that gives you a good tour of the world. Then finally, in terms of our flagship market in the United States, clearly the best right now, as far as we can see -- the best Western developed economy in the world, we think we will see slightly improved mobility in the United States in 2014 versus 2013. We hope that, that will also mean a little bit of increased spending for consumer products as we go into 2014. +So -- and again, we will benefit from all the robustness in our marketing programs and our increased expenditure and quality of marketing as we move into 2014 for our flagship market. +Ahmet, do you want to add some commentary? + +-------------------------------------------------------------------------------- +Ahmet Bozer, The Coca-Cola Co - EVP & President of Coca-Cola International [4] +-------------------------------------------------------------------------------- + + Yes, I'll add a few things to really compare some of these issues that have existed even last year, how they are different now. So for example emerging market currencies, when the first news on discontinuation of tapering came out last year around May or June, there was a bit of a shock in emerging markets. +We see that over the last seven or eight months, these emerging markets are finding ways to deal with it -- by no means it's certain, by no means it's perfect -- but it certainly feels a little bit more under control compared to when it first came up, and the interest rate and things like that have been baked into those expectations. So the message there is countries and our Business, we are finding ways to deal with that new reality of less liquidity coming out of the United States. +I would just add, Muhtar, to your comment on Europe north-south divide, that is very much true but we are beginning to see different shades of gray in the south as well. There are some encouraging signs in Spain; less so in Italy at this point in time, although there's a new prime minister there and we're hopeful with the new programs to be announced if they are. +And Eastern Europe -- it continues to struggle in terms of consumer confidence and economics. So North continues to do well and South is even showing different performance now. +The other point that, Muhtar, you mentioned, is political uncertainty. It's another common theme to many of our emerging markets. They eventually could impact the economic realities, but again, so far, in countries like Turkey and Thailand, it's been fine. +And let me, just, in the interest of giving time to other questions, let me just stop it here. + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Co - Chairman & CEO [5] +-------------------------------------------------------------------------------- + + Sandy, do you want to add any commentary to North America? It's important to say in North America that we believe in the North American market; we believe in the demographics; we believe this is a growth market. +We have grown in all but 2 quarters of the last 15 quarters in the United States. We believe we can do better and we're intent and resolutely focused on achieving that. Sandy? + +-------------------------------------------------------------------------------- +Sandy Douglas, The Coca-Cola Co - SVP, Global Chief Customer Officer & President, Coca-Cola North America [6] +-------------------------------------------------------------------------------- + + Thanks, Muhtar. We have a great Business in North America. Our focus in accelerating the Business is on our brands, on our customers, and on our capability. +I'm really happy to be working with Irial and Paul and all of our US bottlers. Irial Finan and Paul bring a tremendous amount of selling and executional energy that will help us build on our momentum. +On my end, over the last 6 to 7 weeks, Paul and I have met with our major customers, we've met with our bottlers, and we've gone through the brand plans in detail looking at opportunities to focus and strengthen them and to move resources to emphasize advertising and brand-building on our largest brands. With the plan in place, our focus as a system -- Irial, Paul, and I, and our bottlers -- is to improve all aspects of our execution whether it's marketing or sales or in the marketplace. +We believe as a result of that, that we will improve steadily over time, and we share the confidence that Muhtar expressed in the long-term health of North America. It's a great market, it will grow, and I think we can be confident about our long-term future there. + +-------------------------------------------------------------------------------- +Bill Schmitz, Deutsche Bank - Analyst [7] +-------------------------------------------------------------------------------- + + Thanks. + +-------------------------------------------------------------------------------- +Operator [8] +-------------------------------------------------------------------------------- + + Bryan Spillane, Bank of America. + +-------------------------------------------------------------------------------- +Bryan Spillane, BofA Merrill Lynch - Analyst [9] +-------------------------------------------------------------------------------- + + Just a follow-up to Bill's question, if we think about 2014 there's a lot of moving parts, with exchange rates and some of the volatility in emerging markets. Gary, could you talk a little bit about how we should think about currency-neutral and also maybe neutral of the effects of structural change? +Are you still looking at a currency-neutral on-algorithm year in operating profits? And also just some of the other major drivers behind volume that might influence that cost of goods sold inflation, price mix, country mix, that sort of thing? That would be helpful? + +-------------------------------------------------------------------------------- +Gary Fayard, The Coca-Cola Co - CFO [10] +-------------------------------------------------------------------------------- + + Bryan, thanks, and let me see if I can go through all of those. Let me start at the top. +When you're the industry leader, you have to believe in rational pricing and we believe we should get pricing for our brands because our brands are worth it and we would expect to have positive price mix this year to go with the volume that we will have this year. When you look at commodities, they're fairly benign from what we're seeing for 2014 so not a big deal. +Now let's say currency, among the worst we've seen in years. There's not a whole lot you can do about it when all the emerging market currencies melt down as they did earlier at the end of December, early January. With that said, let me be very clear. Ours is a growth business, is a business model that is built on growth, and we know that we cannot save our way to prosperity. +We will have productivity, but that productivity will be reinvested for growth. While we are reinvesting for growth in our marketing, we have -- our goals are also, in addition, while we're increasing the marketing, we will also have a goal and it is the goal for this year of hitting our long-term growth models this year. So we're going to significantly increase our marketing but at the same time the goal is we will hit long-term growth model this year. + +-------------------------------------------------------------------------------- +Bryan Spillane, BofA Merrill Lynch - Analyst [11] +-------------------------------------------------------------------------------- + + Thanks for that clarity, Gary. Look forward to seeing you guys Friday. + +-------------------------------------------------------------------------------- +Gary Fayard, The Coca-Cola Co - CFO [12] +-------------------------------------------------------------------------------- + + Right. Thank you. + +-------------------------------------------------------------------------------- +Operator [13] +-------------------------------------------------------------------------------- + + John Faucher, JPMorgan. + +-------------------------------------------------------------------------------- +John Faucher, JPMorgan Chase & Co. - Analyst [14] +-------------------------------------------------------------------------------- + + Just one quick follow-up to Gary's question and then a question for Muhtar or Gary to answer, rather. Gary, does that include a Mexico impact in hitting your long-term algorithm program in 2014? +Then Muhtar, responding to Gary's question about ramping up the marketing, how do we view -- there's a sense out there in the market that given the headwinds for the category, that adding more marketing could be pushing on a string, so to speak. So what is it that you're seeing that says these headwinds that you are facing can be offset with higher marketing? Thanks. + +-------------------------------------------------------------------------------- +Gary Fayard, The Coca-Cola Co - CFO [15] +-------------------------------------------------------------------------------- + + John, this is Gary. Thanks for the question. +First, as Muhtar said in the prepared remarks, it's too early to tell what's going to happen in Mexico. We have planned around Mexico of what we believe is the most likely case, but we have a portfolio of brands that are marketed and sold across 200 countries, and our job is to manage that portfolio. +So unless something unforeseen should happen, the answer has to be yes. It includes what could happen in Mexico. If that changes, we'll update you obviously, but we're going on what we believe would happened today. + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Co - Chairman & CEO [16] +-------------------------------------------------------------------------------- + + And just to add to Gary's answer and to the second part of your question, John, I'll just tell you very simply that the Coca-Cola way is to grow our way to success. We invest for growth together with our bottling partners and we have the greatest system in the world. +We have a tremendous amount of experience to say that good marketing, good selling works for our Business. And it will work for our business. We have numerous cases to prove that. +We're going to continue to build on our marketing in both quantity and quality. This is a global increase in marketing. +In every country that we operate in, large or small, we know it works. When we invest in marketing, our global partners invest in feet-on-the-street, in more coolers, in more trucks, in more [lines], and that's what we see happening. That's what we will see, we believe, happening to our Business as we restore steady momentum in through 2014 and beyond. + +-------------------------------------------------------------------------------- +John Faucher, JPMorgan Chase & Co. - Analyst [17] +-------------------------------------------------------------------------------- + + Great. Thanks. + +-------------------------------------------------------------------------------- +Operator [18] +-------------------------------------------------------------------------------- + + Judy Hong, Goldman Sachs. + +-------------------------------------------------------------------------------- +Judy Hong, Goldman Sachs - Analyst [19] +-------------------------------------------------------------------------------- + + A few questions. First, just the North America, Gary, the profitability decline in fourth quarter was pretty surprising. So maybe you could give us a little bit color in terms of the components of the profit decline in North America? +Just broadly in North America from a profitability perspective, the Business hasn't really grown since the acquisition of the bottlers. So as you think about the next couple of years, thinking about the refranchising opportunities, and all the productivity savings, are we at a point where we can actually see growth in this Business from a profitability perspective in 2014, or is this more of a transition year still with the investment that's going on? + +-------------------------------------------------------------------------------- +Gary Fayard, The Coca-Cola Co - CFO [20] +-------------------------------------------------------------------------------- + + Judy, it's Gary. Let me take the first part of that question on the fourth-quarter operating profit declined was down 12% in the fourth quarter. By the way, I know the answer to this one specifically because I asked the same question some time back and got into the minute detail on it. +100% of that change is because it's in all in OpEx, or primarily all in OpEx and it's what we're cycling from 2012. There were some incentive compensation accrual reversals in the fourth quarter of 2012 that did not happen in 2013. That cycling caused a significant change in OpEx swing year-on-year in the fourth quarter only and it's what swung North America to that 12% operating income loss. +So it's much more reasonable to actually look at North America, look at it for the full year, and you'll get a better picture of actual performance versus the fourth quarter. When you look at the full year, then you will see that is where we've got some challenges, as Muhtar said, around volume and particularly in sparkling -- around diets and lights. But that's what we're specifically on. + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Co - Chairman & CEO [21] +-------------------------------------------------------------------------------- + + Yes, just let me add to in terms of the outlook, and that is that, as I said, we are confident about and excited about, first, our performance our algorithm worldwide. But also in terms of steady improvement as we get back up to speed in the United States and that will -- when we start restoring the momentum in the United States, which we believe is going to happen, that will also bring the financial results that we will be happier with as we move into 2014 and beyond. +It's going to take a while. This is not an immediate fix but we know that it's going to be a steady improvement. + +-------------------------------------------------------------------------------- +Judy Hong, Goldman Sachs - Analyst [22] +-------------------------------------------------------------------------------- + + And just in terms of the media investments, is there any color you can give us in terms of the breakdown by regions, by categories? Is North America likely to get a disproportionate amount in terms of the media spending increase in 2014? + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Co - Chairman & CEO [23] +-------------------------------------------------------------------------------- + + Can't give you the specifics on the geographic mix, Judy, but as we announced, it's about $1 billion by 2016. And it is a global number. +Again, there will be a good distribution. We will be again also looking and tracking through franchise leadership, resulting also system increase in investment in all the key markets. + +-------------------------------------------------------------------------------- +Judy Hong, Goldman Sachs - Analyst [24] +-------------------------------------------------------------------------------- + + Okay. Thank you. See you Friday. + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Co - Chairman & CEO [25] +-------------------------------------------------------------------------------- + + Yes. See you Friday. Thanks. + +-------------------------------------------------------------------------------- +Operator [26] +-------------------------------------------------------------------------------- + + Dara Mohsenian, Morgan Stanley. + +-------------------------------------------------------------------------------- +Dara Mohsenian, Morgan Stanley - Analyst [27] +-------------------------------------------------------------------------------- + + I also wanted to touch on profit in North America. It sounds like, in 2013, you view the profit challenges as more driven from a volume perspective, but given that diet soft drinks worries seem to be more secular around longer-term health concerns, I'm just wondering if going forward, you may manage more for profitability and lean more on pricing than driving volume growth. Is there any change as you look at the algorithm between pricing and volume and which metric you'll focus on going forward? + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Co - Chairman & CEO [28] +-------------------------------------------------------------------------------- + + Thanks, Dara. Sandy, you want to take the (multiple speakers) and then, Irial, you want to comment? + +-------------------------------------------------------------------------------- +Sandy Douglas, The Coca-Cola Co - SVP, Global Chief Customer Officer & President, Coca-Cola North America [29] +-------------------------------------------------------------------------------- + + The key to the North America growth algorithm is investing in our brands and our feet-on-the-street. A key element to that is getting our pricing so that we can have the revenue to be able to reinvest in sustainable growth. +Where we've had issues over the years, in my experience, in North America, is when we did not get the price we needed, when our marketing execution was not what it need to be, and therefore the feet-on-the-street started to get reduced and ultimately it hurt sustainable growth. Our plan going forward, and it's going to take some time, and we're focused on improving it, is to make sure that we get the price and that we execute the marketing well and feed the feet-on-the-street, which creates the virtuous cycle in the United States just like it does around the world. Irial, do you want to add to that? + +-------------------------------------------------------------------------------- +Irial Finan, The Coca-Cola Co - EVP & President Bottling Investments and Supply Chain [30] +-------------------------------------------------------------------------------- + + The only comment I'd say -- Muhtar already mentioned that we are an industry leader. And industry leaders have to set the tone in terms of price, in terms of how to market the brand in any given markets. +Actually less than 50 days in to my new involvement in North America, I'm really excited about the future. I'm excited about the enthusiasm, the passion of our people, our job -- mine, Paul's, Sandy's -- is really to make sure that excitement translates into performance and to results. +As Sandy said, it's not going to happen overnight. I feel we've already started on the journey, and over the next quarters and next couple of years, you will see very positive momentum in our market in North America. + +-------------------------------------------------------------------------------- +Dara Mohsenian, Morgan Stanley - Analyst [31] +-------------------------------------------------------------------------------- + + Okay, and then Muhtar, post the investment in Green Mountain, I was just hoping to get an update on how important a role acquisitions might play in meeting your 2020 Vision goals. You mentioned the focus on partnerships earlier in the call -- I was hoping you could elaborate there? And if acquisitions are a greater priority here given some of the difficult macro conditions and a somewhat favorable environment with your healthy balance sheet and still low rates here? + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Co - Chairman & CEO [32] +-------------------------------------------------------------------------------- + + Yes. Nothing different than before. So no change. +We're obviously very excited with our new opportunities for consumption as will be brought to us by the partnership with Green Mountain over time. The key is to fuel the power of partnerships. +The Coca-Cola Company and system is an incredible integration of power of partnerships in every respect. And therefore, this is yet another one. So think about -- if you look at household consumption, in particular the Western markets, there's a tremendous opportunity to gain incremental consumption occasions for our brands through these kind of partnerships. +This is what the Green Mountain partnership is all about. When you look at how beverages are consumed at home and when you look at trends in the next 10 years, people are going to spend more time at home. +They're going to work more from home. Home is going to be an even more important place for people, for consumers. And we need to be present there with different technologies, different packaging, different ways to serve our brands, and that's why this is important and partnerships like these are going to be important for us over time going forward. +Our thinking has not really evolved or changed in terms of bolt-on acquisitions. If we see opportunities, we will get them, like Innocent, like [Oshan] and so forth. And we will continue to seek new power partnerships -- to leverage new power partnerships also going into the remaining part of our 2020 Vision for the next six years. + +-------------------------------------------------------------------------------- +Dara Mohsenian, Morgan Stanley - Analyst [33] +-------------------------------------------------------------------------------- + + Okay. Thanks. + +-------------------------------------------------------------------------------- +Operator [34] +-------------------------------------------------------------------------------- + + Ali Dibadj, Bernstein. + +-------------------------------------------------------------------------------- +Ali Dibadj, Sanford C. Bernstein & Company, Inc. - Analyst [35] +-------------------------------------------------------------------------------- + + The frustration I'm hearing from many investors and a lot of questions on this call is just that there's a feeling that the Company isn't doing enough to change itself, despite that the world around it has clearly changed and many, like us, believe secularly. There is continued emphasis on the Coca-Cola way and history, which is respectable in volumes, market share, spending even more on marketing, blaming some short-term externalities. But it's been a little while now that we've seen tougher volumes, North America profit pool continues to shrink, there's only $1 billion cost savings, when some of your competitors are doing more [only] from a pro rata basis. There is limited movement on refranchising your health innovations so far. +So might the Company ever believe that it needs to focus on new levers of shareholder value creation, like pricing up even more, lower promotions, massive cost cutting, big portfolio or innovation change, and indeed returning more cash to shareholders? I know there's lots there, but should investors expect bigger, bolder change at KO to meet this truly different world and if so what should specifically should we be looking forward to, to just sharing in your confidence about the story, or should we just expect the same status quo, going forward? + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Co - Chairman & CEO [36] +-------------------------------------------------------------------------------- + + First, Ali, I disagree with you. We have a great portfolio of brands; we have a great system, the best consumer product system in the world; and I believe that our programs will work and have worked. +We've significantly outperformed and grown since 2010. Yes, we've had a speed bump and certainly that makes us even more focused and more resolute to continue on our road to 2020. +We have -- I will share at CAGNY on Friday, the real reasons why we believe in our future. And so that's all I would say. + +-------------------------------------------------------------------------------- +Ali Dibadj, Sanford C. Bernstein & Company, Inc. - Analyst [37] +-------------------------------------------------------------------------------- + + But I don't disagree with you about the strength of the brands at all actually, Muhtar. And I don't disagree with you about the strength of the system. I'm just looking at the results and I'm trying to figure out whether enough is changing, enough is different and whether you guys actually do you the world as different enough and so you're taking action but I actually don't disagree with you--? + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Co - Chairman & CEO [38] +-------------------------------------------------------------------------------- + + I understand. I understand it's easy for people to have very short memories. But we have the experience and we know what we are doing and we will continue to do what we believe and we are focused and we will execute the best and we will achieve our 2020 Vision. +That's what this is all about. So that's what I will say. +And we have talked about pricing. You've heard my colleagues also talk about pricing. And we don't want to repeat ourselves. + +-------------------------------------------------------------------------------- +Ali Dibadj, Sanford C. Bernstein & Company, Inc. - Analyst [39] +-------------------------------------------------------------------------------- + + Okay. Thanks very much. + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Co - Chairman & CEO [40] +-------------------------------------------------------------------------------- + + Thank you, Gary, Ahmet, Sandy, Irial, and Jackson. We've delivered sound full-year financial results. We're implementing the strategic actions that will enable us to restore momentum in 2014 and we see many reasons to believe that we can accelerate our growth over time, achieve our long-term growth model targets, and realize our 2020 Vision. +Our global beverage industry is healthy. The trends that have historically fueled it continue to be strong, and our global systems' commitment and reach are unparalleled. This commitment has never wavered and the strategic decisions that we have made over recent years have not only enabled us to deliver solid financial results, they've also advanced our competitive position, enhanced our capabilities, and strengthened our resolve as a global system to achieve our 2020 Vision. +That is our promise to our investors, to our customers, to our consumers, and the daily objective of the more than 700,000 associates of the Coca-Cola system all around the world. As always, we thank you for your interest, your investment in our Company, and for joining us this morning. + +-------------------------------------------------------------------------------- +Operator [41] +-------------------------------------------------------------------------------- + + Thank you. And this does conclude today's conference. You may disconnect at this time. + + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/exam/original-files/Problem_2_3_Sample_full_transcripts/2014-Feb-26-TGT.N-137355844814-Transcript.txt b/exam/original-files/Problem_2_3_Sample_full_transcripts/2014-Feb-26-TGT.N-137355844814-Transcript.txt new file mode 100644 index 0000000..d3b1a7e --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_full_transcripts/2014-Feb-26-TGT.N-137355844814-Transcript.txt @@ -0,0 +1,582 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q4 2013 Target Corporation Earnings Conference Call +02/26/2014 10:30 AM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * John Mulligan + Target Corp - EVP and CFO + * Kathee Tesija + Target Corp - EVP of Merchandising + * Gregg Steinhafel + Target Corp - Chairman, President and CEO + * John Hulbert + Target Corp - IR + +================================================================================ +Conference Call Participiants +================================================================================ + + * Matthew Fassler + Goldman Sachs - Analyst + * Greg Melich + ISI Group - Analyst + * Matt Nemer + Wells Fargo Securities, LLC - Analyst + * Sean Naughton + Piper Jaffray - Analyst + * Chris Horvers + JPMorgan Chase & Co. - Analyst + * Bob Drbul + Nomura Equity Research - Analyst + +================================================================================ +Presentation +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Ladies and gentlemen, thank you for standing by. Welcome to the Target Corporation fourth quarter earnings release conference call. +(Operator Instructions) +As a reminder, this conference is being recorded Wednesday, February 26, 2014. I would now like to turn the conference over to Mr. Gregg Steinhafel, Chairman, President and Chief Executive Officer. Please go ahead. + +-------------------------------------------------------------------------------- +Gregg Steinhafel, Target Corp - Chairman, President and CEO [2] +-------------------------------------------------------------------------------- + + Good morning, and welcome to our 2013 fourth quarter earnings conference call. On the line with me today are Kathee Tesija, Executive Vice President of Merchandising; and John Mulligan, Executive Vice President and Chief Financial Officer. +This morning, I will provide a high-level summary of our fourth quarter results and strategic priorities for the year ahead. Then Kathee will discuss category results, guest insights and the holiday season. +And finally, John will provide more detail on our financial performance along with our financial outlook for 2014. Following John's remarks, we will open the phone lines for a question and answer session. +As a reminder, we're joined on this conference call by investors and others who are listening to our comments via webcast. Following this conference call, John Hulbert and John Mulligan will be available throughout the day to answer any follow-up questions you may have. +Also, as a reminder, any forward-looking statements that we make this morning are subject to risks and uncertainties, the most important of which are described in the 8-K we filed this morning. Finally, in these remarks, we refer to adjusted earnings per share, which is a non-GAAP financial measure. A reconciliation to our GAAP results is included in this morning's press release posted on our Investor Relations web site. +Target's fourth quarter financial results reflect better than expected US segments performance through the first three weeks of the holiday season, followed by meaningfully softer results following our December 19 announcement that criminals had gained access to guest payment card data in our US stores. In total, fourth quarter comparable sales decreased 2.5%, consistent with our updated guidance in January. +Throughout the quarter, our team managed the business extremely well, adjusting both inventory and expenses to match the rapidly changing pace of sales. As a result, our US operations generated fourth quarter adjusted earnings per share of $1.30, at the high end of the updated guidance we provided in January. +In Canada, we worked diligently to leverage holiday traffic in an effort to clear excess inventory. Markdowns resulting from this effort drove a very low gross margin rate, but allowed us to reduce average inventory per store in Canada by approximately 30% between the beginning and end of the fourth quarter. +Canadian segment EPS dilution was $0.40 in the quarter, $0.05 better than the updated guidance we provided in January. We're pleased that our early cycle Canadian stores have seen the most improvement, giving us confidence that we will continue to see continued improvement across all our Canadian stores in 2014. Fourth quarter GAAP EPS of $0.81 reflects US and Canadian segment performance along with costs related to our recent restructuring and data breach along with small accounting and tax matters. +As we've worked to address the impact of the mid-December data breach, we have put the welfare of our guests at the center of every decision we've made. We've communicated early and often, providing the best information we had about new facts on the ongoing investigation. We consistently assured our guests that they would have zero liability for any unauthorized charges on their card accounts resulting from the breach. +We increased fraud detection for REDcard holders and extended free credit monitoring and identity theft protection for any guest who has ever shopped one of our US stores. We're truly sorry for the impact this breach has had on our guests, team members and other stakeholders, and I want to reiterate we are committed to making things right. +Yet we know these initial steps are part of a longer process. We continue to listen to our guests, and we know that this incident and recent security breaches at other companies have shaken their confidence in both Target and the US payment system more broadly. +To rebuild guest confidence, we are committed to an end-to-end review in cooperation with third-party experts to understand how the breach occurred, the identification and acceleration of solutions to provide enhanced protection in the future, and engagement with third-party experts to protect the industry and consumer from future threats. Accordingly we are taking the following steps. +We are conducting an end-to-end forensic investigation of our processes, systems, and personnel to make informed decisions on potential security enhancements. We are accelerating the adoption of advanced chip enabled technology, investing more than $100 million to equip our stores and to issue Target branded smart chip credit and debit cards. +We have long supported this more secure technology, but broad adoption in the US market has been elusive. We believe that recent events will help the industry to reach a tipping point toward accelerated adoption in the US, and we are investing to ensure that Target is a clear leader in driving this change. +We're working collaboratively with a broad set of stakeholders in the payment card space, including banks, retailers, trade associations, payment processors and networks to share and advance best practices and foster future innovation. We helped launch and will be an active leader in a retail industry cyber security and data privacy initiative. +In addition, we are investing $5 million in a new coalition with the Better Business Bureau, the National Cyber Security Alliance and the National Cyber Forensics and Training Alliance to advance public education around cyber security and the dangers of consumer scams. While we can't yet assess the full impact of this crime against Target and our guests, we are pleased that sales have started to recover from the trends we observed following breach-related announcements in December and January. +Importantly, because we are in a strong financial position, we expect to absorb any near-term financial impacts while continuing to invest in projects that are key to our long-term success. Our company has a long history of innovation, discipline management, and a strong long-term financial performance, and we are committed to upholding the principles which have sustained this company's success for many decades. And while 2013 was a disappointing year financially, we've entered the new year with the right plans in place to grow profitably and generate meaningfully improved financial performance in 2014 and beyond. +In the US, we've demonstrated our ability to manage the business with discipline and generate strong financial performance even in a challenging environment. In fact, Kathee will outline in more detail, we were very pleased with our holiday season results prior to the announcement of the data breach. +In preparation for fourth quarter, we made changes to our holiday promotions and marketing, and we were pleased that our in stocks were running at all-time highs. As a result US segment fourth quarter sales were running ahead of plan prior to December 19. Looking ahead, we will apply the insights we gained in the holiday season to connect with our guests by delivering merchandise and promotions thoughtfully designed to appeal to them based on what's on their mind at each point in the year, moving Target beyond compelling to becoming irresistible for our guests. +We made enormous progress in our multi channel efforts throughout 2013 as we meaningfully increased conversion both on our web site and on our mobile apps. We acquired CHEFS Catalog, Cooking.com and DermStore, extending our online assortment by providing our guests access to additional high-end brands in key home and beauty categories. +We launched Cartwheel, our unique mobile savings tool which has far exceeded expectations in both adoption and engagement, and we accelerated our investments in flexible fulfillment. As a result, throughout the year, growth in our digital traffic and sales outpaced industry averages. +We launched in-store pickup chain wide at the beginning of November, and with very little marketing, this new offering became a meaningful driver of digital traffic and sales. Our stores' teams did an outstanding job delivering great service when guests arrived to pick up these orders, and this is particularly impressive since we launched the service during the busiest time of the year. We will continue to invest in systems, data and processes to enhance our flexible fulfillment capabilities in 2014 and beyond. +In our stores, we are committed to enhancing the guest experience by adding dedicated service to key categories like beauty, baby and electronics and by providing training and technology that allows our stores' team to go beyond providing basic service to solving problems for our guests. And we're continuing to pilot innovations to our store formats. Based on the initial rollout of the CityTarget format and the high single digit comparable sales we're seeing in our second year CityTarget stores, we're analyzing opportunities to reduce the size and enhance the flexibility of this format, opening up a wider universe of potential sites in dense urban areas. +While the work on CityTarget continues, we've also developed a separate smaller format called TargetExpress at about 15% of the size of one of our general merchandise stores. We believe this design provides us with a fantastic opportunity to expand into new trade areas, providing a convenient solution to guests who can't easily visit one of our other formats. +While we expect to offer a carefully curated assortment in frequency categories like food, health care, beauty and other household essentials, TargetExpress will also offer discretionary categories including home, electronics and seasonal. Throughout the store, we will feature our own brands which offer guests an unbeatable combination of quality and price. We plan to open our first pilot location of this format here in our home market in July so we can carefully study both operational and financial results before we determine our plans to expand this format to other markets. +Throughout the organization, we continue to find new opportunities to optimize expenses, freeing up resources we can apply to new initiatives. In 2013, our teams saved approximately $200 million by reprioritizing their activities and finding more efficient ways to get things done. +Our expense optimization efforts are not a short-term project but a complete overhaul of the way we work. And the team continues to find new opportunities. +As a result, we expect the benefit of our expense optimization efforts to reach $1 billion in annualized savings by 2015. I'm proud that our entire team has embraced this effort to transform how we work. +In Canada, the team has moved from a year focused on opening a record number of stores to optimizing the business in run state. As we enter 2014 with a much cleaner inventory position, the team's number 1 operational focus is on in stocks, ensuring we have the right quantity of each item in the right place at the right time. In addition, we continue to invest in technology and training to enhance both the tools our team uses and their ability to deploy them most effectively. +We're also continuing to implement innovative marketing and merchandising programs in Canada to raise awareness for our frequency categories like grocery, household essentials, beauty and health care. Throughout 2014, we will focus on conveying the depth and breadth of our assortment in those categories and the unbeatable value we provide through our everyday pricing, 5% rewards, price match, and our flier. With enhanced guest awareness of our unbeatable prices combined with the benefit of improved operations, we expect guest shopping frequency to build throughout 2014, driving improvement in sales and profitability. +While 2013 will clearly be remembered as a challenging year, I am proud of the team's efforts to transform our business and position the Company for long-term success. And I want to sincerely thank the Target team for their tireless effort to help our guests recover from the data breach. While there is much more work to be done, I'm inspired by their singular focus on our guests and making things right. +As a result, I'm confident we will look back on this incident and see that we emerged from it even stronger than before. Now Kathee will provide more detail on our fourth quarter results and key initiatives as we enter 2014. Kathee? + +-------------------------------------------------------------------------------- +Kathee Tesija, Target Corp - EVP of Merchandising [3] +-------------------------------------------------------------------------------- + + Thanks Gregg. In our last conference call, we outlined our plans for the holiday season and mentioned that fourth quarter sales were on track through the first half of November. As we progressed through Black Friday week and the first two weeks of December, guests continued to respond to our promotions, and sales ran ahead of our plan. +Following the data breach announcement and the rapid change in the pace of our sales, the team reacted quickly, making nimble adjustments to minimize excess inventory. This quick response allowed us to end the year with a clean inventory position, and while our fourth quarter gross margin rate reflected the additional clearance activity resulting from the sales slowdown, our team did a great job minimizing the impact. +As we built our holiday plans, our goal was to cut through the clutter and reach our guests with compelling offers on exciting merchandise; specifically we aligned our weekly deals and events so guests were receiving a clear message across all channels. And because our guests are budget conscious and love to find deals, we intentionally layered promotions across our circular Cartwheel and our catalogs to provide unbeatable value. +We used our direct channels to drive urgency at key points in the season, and we offered more broad attention-getting promotions like 40% off sweaters. Consistent with past years, we featured hot deals on key items, but attracted more attention by offering deeper discounts on fewer items, and we were very pleased with the guest response. +For the quarter overall, our nondiscretionary categories generally saw the strongest sales performance. However, among our more discretionary categories, electronics saw an increase in fourth quarter comparable sales led by mobile phones, tablets and video game hardware and software. We also saw relative strength in our sporting goods and housewares categories. +Our digital channels had a very strong holiday season. Thanksgiving was our biggest digital sales day ever with mobile devices accounting for a full 25% of those sales. +We were recently recognized as having the most browsed app by a smartphone and tablet in 2013, and Mobile Commerce Daily just named Target mobile retailer and commerce web site of the year. This is the second time we've been named mobile retailer of the year, and we're pleased to be the only retailer to be honored with the award twice. +An important factor in our digital success was the fourth quarter rollout of the opportunity to buy online and pick up in store. In store pickup requests represented about 10% of fourth quarter digital orders, but they peaked at a much higher rate before Christmas as guests relied on the service as a great solution for last minute gift shopping. About 30% of store visits to pick up an online order resulted in store shopping on that same trip, and the size of that store transaction was much larger than an average store trip. +While we rolled out this capability with an external commitment to have orders ready in four hours or less, our team quickly attained our internal goal to have most orders ready in one hour or better. Our surveys showed consistently high levels of guest satisfaction with this service, and this capability has accelerated our mobile conversion rates. +We're also pleased with the continued growth of Cartwheel, our digital social savings app, which ended 2013 with over 5 million users who have already saved more than $43 million. Younger guests are particularly engaged by Cartwheel as more than half of its users are millennials, a much higher percentage than they represent in our overall guest base. +Redemption rates on Cartwheel are more than 10times higher than we see in other direct channels like receipt marketing and email, and our analysis indicate it's driving incremental trips and sales. Our pre-Black Friday deals resulted in one of the biggest days ever for Cartwheel as they drove one-third of our active users into Target stores on the Wednesday before Thanksgiving. +We continue to work to enhance the Cartwheel experience. We recently added the ability to scan bar codes to find out if there's a Cartwheel deal on an item and added the capability to sign up for Cartwheel directly through a Target account and e-mail while continuing to provide access to the app through Facebook. +As Gregg mentioned, we continue to listen to our guests to understand how we can help them move beyond the data breach and feel confident in shopping at Target. While sales have started to recover in recent weeks and sentiment metrics have begun to improve, most notably among our best guests, we continue to invest to ensure this recovery continues. +Beyond our efforts in data security and chip enabled technology, we are applying insights from the holiday season to make our merchandise, stores and digital channels even more irresistible to our guests. We continue to innovate in ways that differentiate both our product assortment and the guest experience, and we're investing in pricing and promotions to make our value proposition even stronger. +We're very pleased with the response to Peter Pilotto for Target, our most recent designer partnership which launched earlier this month. This collection which features a limited edition assortment of women's apparel, accessories and swim wear is available at most of our US and Canadian stores and on Target.com. +We've also partnered with net-a-porter.com to offer a curated assortment of the collection to fans across the globe. With lots of social media buzz, we saw long lines outside many of our urban stores on the morning of the launch, and the collection quickly became net-a-porter's fastest selling collaboration in history. +Based on last year's results, Target and Sports Illustrated are once again partnering in support of the magazine's annual swimsuit issue which is celebrating its 50th anniversary this year. Target is the exclusive mass retail advertiser and official marketing partner for the issue. This year's partnership includes a new 20-page flip cover that celebrates swimsuit style over the past 50 years and features Target's limited edition swim wear collection. The collection launched at Target stores and on Target.com February 17 in advance of the issue's on-stand date and includes 10 black, gold, and ivory swimsuits priced from $15 to $30. +Earlier this month, Target began offering AMBAR, a new apparel collection designed with the Latina guest in mind. AMBAR's set in 50 US stores this month and is also available on Target.com. +The line of apparel and accessories features vibrant prints and flattering cuts and silhouettes. This stylish and affordable collection has items ranging from $17 to $40. +This spring, Target will introduce an assortment of premium skin care featuring seven notable brands, four of which will be exclusively sold at Target. 29 by Lydia Mondavi, Borghese, Laneige, and MD Complete by Dr. Zelickson alongside industry favorites Vichy, La Roche-Posay, and Own Skin Health. +These brands will be merchandised in two distinct sections -- dermatological skin care and specialty skin care -- and they've already launched on Target.com. We will begin rolling out the assortment to 749 US Target stores beginning in March. +For what's likely to be the biggest Blu-ray and DVD release of the year, Target will offer an exclusive edition of Catching Fire, the second film in the Hunger Games trilogy, in stores and on Target.com next month. The Target exclusive Blu-ray edition includes 45 minutes of exclusive content from never-before-seen footage and cast interviews to a behind the scenes look at the making of the film. +This spring, award-winning singer Shakira is teaming up with Target for her tenth studio album, and our exclusive deluxe edition featuring three bonus tracks hits stores on March 25. We announced the partnership and kicked off album preordering with a special spot during the 56th Annual Grammy Awards in January. +Last month, we became the exclusive retailer to feature Beats Music play list. Beats Music is a curated digital music streaming service that allows its users to peer into the personal music libraries of their favorite artists and brands and have them create play lists just for them. By subscribing to Target's play list, guests can expect a varied mix of songs inspired by Target's rich heritage of music and the tastes of the millions who shop for albums at Target each year. +In December, we launched the Awesome Shop, a beta site that features the top Target products recently pinned on Pinterest. The site lets guests explore, get inspired and see what other guests love, just like they do in stores. Awesome Shop's highlighted the best of the best by only featuring items with a Target.com review of four stars or better. +We're also leveraging Pinterest in another unique way to collaborate with three of the site's most influential pinners on a series of party planning collections that will make it easy to throw a Pinterest-worthy event. Joy Cho of Oh, Joy!, Jan Halvarson of Poppytalk, and Kate Arends of Wit & Delight will each create limited time only collections launched over the course of 2014 including party decor, paper products and serving pieces designed in their signature aesthetic. +Beyond differentiated merchandise, we continue to provide enhanced service in key areas of the store. Based on guest response to last year's launch, we've expanded the Target beauty concierge program to more than 300 stores across the country with new markets including New York, New Jersey, San Francisco, and Dallas-Fort Worth. These beauty consultants are brand agnostic and provide guests with detailed, unbiased information and a friendly face in what can often be an intimidating category. +We also continue to see great results from the pilot of our new baby layout, a completely redesigned shopping experience that offers guests inspiring, insightful solutions combined with the great value they've come to expect from Target. This new layout features a dedicated service desk with a knowledgeable baby advisory to help guests navigate the area and provide unbiased product information. Digital screens and iPads feature inspiration and interactive comparison tools and baby center content such as buying guides and product reviews. +We've also incorporated an in-department registry kiosk for expectant moms or guests looking to give a gift. Merchandise displays have been lowered so guests can more easily interact with large products like travel systems and strollers. We've removed barriers to enhance navigation between apparel, gear and baby essentials, and we've highlighted the availability of additional online only items in key categories. +This summer, we plan to grow from 30 stores to more than 200 locations featuring this enhanced baby experience. And based on encouraging initial results in 2014, we will expand our test of using mannequins in apparel in our larger format US stores to elevate the store experience, create an enhanced sense of discovery and bring our unique designs to life. +We also continue to augment our digital capabilities, driving traffic and sales to all of our channels. Online, our top priority in 2014 is continuing to improve the guest experience. All of our efforts will be designed to make things simple, seamless, and enjoyable for our guests. +To support this priority, we continue to hire external talent with deep, functional expertise in online merchandising, site merchandising, mobile and analytics. We've recently made enhancements focused on search, product information, and checkout, making it easier for guests to browse and purchase. In addition, now nearly all store products are viewable online, making this the only place that guests can view Target's full assortment. +Importantly, we're making enhancements while continuing to focus on stability and speed. As a result, Target.com consistently ranks in the top ten for retailer site availability and performance. +Given the profile of our guests, mobile is more important at Target than for many of our peers. For example, Target's guest traffic from tablets and mobile phones is greater than our traffic from traditional computers, and the shift towards mobile shows no signs of slowing down. In fact, usage of the Target app doubled in the short period between last summer and the end of the year. +To maintain our strong momentum in mobile, we're testing and learning from new features including list building, mapping and Cartwheel capabilities launched during the holiday season. We're improving conversion by streamlining checkout and enhancing product information and dynamic content, and we're investing to amplify the in-store mobile experience by rolling out guided maps, in-store search and expanded assortment chain wide later this year. +We also continue to invest in our flexible fulfillment capabilities which combine the strengths of our digital, store, and distribution assets to provide speed and convenience for our guests. These capabilities allow our stores to add value in new ways, serve our guests as both showrooms and fulfillment centers. +Following the holiday season success of in-store pickup, we're moving quickly to roll out the capability to ship online orders from our stores this fall. This new capability will create multiple benefits for both Target and our guests, including shorter shipping times, reduced expenses, lower markdown rates and improved in stocks. And because our investments in flexible fulfillment drive greater utilization of our existing stores and distribution center assets, we expect to earn an outstanding return on these investments over time. +And finally, we're pleased with initial performance of Target Ticket, our streaming video service, and we continue to invest in features to better serve guests' changing needs and behaviors both inside and outside their home. In 2014, we will coordinate our promotions across channels to provide irresistible video offers across our stores, Target.com, and Target Ticket. +While our fourth quarter results softened following the December 19 announcement of the data breach, we are pleased with the guest response to our holiday season merchandising and marketing efforts, and we're confident in our plans for 2014. As always, our focus remains on our guests, helping them regain their confidence in Target while delivering irresistible content and experiences in every channel. We believe that our efforts will drive a continued recovery in the pace of our sales and position Target for profitable growth in 2014 and beyond. +Now John will share his insights on our fourth quarter financial performance and our plans for the coming year. John. + +-------------------------------------------------------------------------------- +John Mulligan, Target Corp - EVP and CFO [4] +-------------------------------------------------------------------------------- + + Thanks Kathee. Our fourth quarter financial results reflect strong efforts by our team to handle separate challenges in both our US and Canadian segments. +In the US, comparable sales declined 2.5%, consistent with the updated guidance we provided in our January press release. This sales performance reflects a 5.5% decline in transactions, partially offset by an increase in average ticket. +Prior to the announcement of the data breach, fourth quarter comparable sales were running positive, reflecting the success of our holiday merchandising and marketing plan. Immediately following news of the breach, sales turned meaningfully negative, but began to recover in January. While it's impossible to measure precisely, we believe we would have seen even more improvement had there not been extreme weather across much of the country. +Fourth quarter sales penetration on our REDcards was 20.9%, up 5.4 percentage points from a year ago. While the rate of increase slowed down following the breach, year-over-year penetration continued to grow hundreds of basis points through the end of the quarter. +Fourth quarter US EBITDA and EBIT margin rates were down more than 1 percentage point from last year's rates, which we were advised to reflect combined results from our former US retail and credit card segments. These profit margins were below our expectations going into the quarter, driven almost entirely by gross margin rate which declined about 20 basis points from a year ago. This performance reflects about 20 basis points of benefit from this year's change in vendor payments, offset by higher than expected markdowns related to the 10% off we offered prior to Christmas as well as the impact of clearance markdowns at the end of the holiday season. +Margin mix was somewhat less favorable than in recent quarters driven by strong sales in electronics. While below our expectations, fourth quarter US segment gross margin rate was remarkably strong considering the team had to rapidly manage excess inventory in the middle of the quarter when we experienced a sudden change in the pace of sales following the data breach announcement. +Our fourth quarter US segment SG&A rate was 18.4%, about 110 basis points above last year's revised rate. About 50 basis points of this headwind was related to the credit card portfolio, reflecting a smaller asset base, last year's reserve release and this year's profit sharing arrangement with TD Bank. +Another 20 basis points of headwind was driven by this year's change in vendor payments. The remaining unfavorability reflects the deleveraging effect of negative comp sales. The fact that we experienced only 40 basis points of deleverage reflects strong control of variable expenses given the magnitude of our comparable sales decline. +In the Canadian segment, sales came in just below expectations. Importantly as Gregg mentioned, we took advantage of holiday traffic to clear through a significant amount of excess inventory in the quarter, and while we expect some small lingering issues with long lean receipts this year, the Canadian segment ended 2013 in a much cleaner inventory position. paving the way for smoother operations in 2014. In all, the segment drove $0.40 of EPS dilution in the fourth quarter, better than the expectations we provided in our January press release. +Turning now to our consolidated metrics, fourth quarter interest expense was 21% lower than last year, reflecting the continued benefit of debt retirement funded by the proceeds from the sale of the credit card portfolio. We paid dividends of $0.43 per share in the quarter, an increase of more than 19% from fourth quarter 2012. This was the 185th consecutive quarter in which our company has paid a dividend, and 2013 marked the 42nd year of annual dividend increases, a track record few companies can match. +Consistent with last quarter, we didn't purchase any shares in the fourth quarter, reflecting current performance and our desire to maintain our debt ratings in the middle A range. This approach aligns with our long-standing point of view on capital deployment. +First, we invest what we believe is appropriate in our core business. Second, we support the dividend which we have grown annually for more than four decades, and third, we use share repurchase to return cash within the limits of our middle A debt rating. +We believe a middle A rating is a strategically important as it supports our ability to reliably deliver on our unbeatable pricing strategy over time. In addition, our balance sheet provides the flexibility to maintain our long-term focus in the face of unexpected events like the data breach, enabling investment in strategic initiatives like flexible fulfillment while we deal with a temporary setback in traffic and sales along with other costs related to the breach. +In addition to operating results in the US and Canada, our fourth quarter GAAP earnings reflect several items that reduced EPS by approximately $0.09. These items include charges related to our January restructuring, data breach related costs, net of an insurance receivable, and continued reduction in the beneficial interest asset partially offset by a small benefit from the resolution of income tax matters. +Combining fourth quarter results with performance in the first nine months of 2013 yields full year results that reflect the impact of clear successes and certain challenges. In our US segment, full year comparable sales declined 0.4%, well below our expectations going into the year. This reflects a tougher than expected consumer environment including the impact of the payroll tax increase which just annualized last month, the fourth quarter impact of the data breach, and recent headwinds from unfavorable weather as you've heard from many other retailers. +On our US sales, we earned a gross margin rate of 29.8% in 2013, up about 10 basis points from 2012. This rate reflects about 20 basis points of benefit from this year's change in vendor payments combined with very strong underlying margin performance in the face of softer than expected sales. Throughout the year, Kathee's team did a great job managing inventory, resulting in outstanding in stock levels while avoiding unnecessary clearance markdowns. +Our full-year SG&A expense rate in the US was 20%, up about 90 basis points from last year's revised rate. Contrary to what you might initially think, this reflects outstanding performance in light of softer than expected sales and some notable challenges representing more than $600 million of incremental pressure including credit card portfolio income, which as you know reduces our SG&A rate about $400 million lower than 2012, impacting profit sharing with TD, prior year reserve reductions, and a smaller asset base this year. And more than $200 million of expense pressure from incremental investments in technology and supply chain to support our multi channel efforts. +Without these impacts, our SG&A expense rate would have been slightly higher than 2012 but would have been neutral without this year's change in vendor payments. This is better expense performance than we'd expect on a decline in comparable sales and was driven primarily by two factors: outstanding performance by our store's organization, which continues to provide outstanding guest service while delivering productivity increases, and our company-wide expense optimization efforts through which our teams are finding better ways to work while deprioritizing less productive activities. As Gregg mentioned, the team continues to find new opportunities to optimize expenses, and we expect to reach $1 billion in annualized savings by 2015, helping to fund our efforts to drive profitable growth over the next several years. +For full-year 2013, US REDcard penetration grew nearly 6 percentage points to 19.3% of sales as more and more guests increased their level of engagement and their spending with Target. Penetration in Kansas City, where we began offering REDcard Rewards a year ahead of the rest of the country, continues to run well ahead of the US overall. Importantly as part of our broader effort to rebuild traffic and sales in 2014, we will work to reaccelerate REDcard growth in light of the recent slowdown in growth we've seen following the data breach. +In Canada in 2013, we generated just over $1.3 billion in sales on 124 stores which were open on average for a little more than half the year. These sales were well below our plan going into the year, leading to greater than expected markdowns on a meaningful amount of excess inventory. Expense rates were unusually high as well as a result of opening early cycle stores with too many payroll hours, incurring incremental expense related to clearing inventory, and experiencing less leverage on fixed expenses. +In the face of these challenges, the team worked tirelessly to improve operations and work through excess inventory throughout the year, clearing the way for an acceleration of sales and profitability beginning this year. Our early cycle store continued to outperform later cycle stores, giving us confidence that our operation will continue to become more efficient as our business matures. +And having dramatically reduced the congestion in our Canadian supply chain, we will increase the intensity of our marketing message in 2014 regarding value and assortment in our frequency categories. Over time, we expect this will lead our Canadian guests to choose Target more often in these categories, driving meaningful increases in traffic and sales. +Turning to capital deployment, our total capital investment was about $3.5 billion in 2013, somewhat lower than expected as US CapEx of about $1.9 billion was approximately $300 million lower than anticipated. This outcome doesn't reflect a change in strategy but is simply the result of a lower than expected costs for certain projects and retiming of suspending into 2014. +Having sold our credit card portfolio for about $5.7 billion in March, we've significantly reduced our net debt position in 2013, including the early retirement of high coupon debt. And importantly, even in a year of peak CapEx and dilution related to the Canadian segment, combined with the impact of softer than expected US sales, we still had the capacity to return about $2.5 billion to our shareholders in the form of dividends and share repurchase. +With that as context, let's turn now to our outlook for 2014. But before we get to the numbers, I want to discuss a change in our reporting and guidance practices in 2014. +Given that our Canadian segment is now fully operating, beginning with the first quarter of 2014, we will no longer exclude Canadian segment performance from adjusted EPS. To allow for appropriate comparison, last year's adjusted EPS will also reflect Canadian segment performance as well. +With that, let's turn to our full-year outlook beginning with sales. While trends have improved in recent weeks, severe winter weather has been a headwind, and we continue to see the impact of the data breach on guest sentiment and traffic. We believe that we'll continue to see muted trends in the next few months, but the breach impact will diminish throughout the year as we engage in a vigorous effort to address our guests' concerns and provide irresistible content and offers, driving visits to our stores and digital channels. +In addition, while economic trends are improving, we continue to expect our lower and middle income guests to shop very cautiously in 2014. With that backdrop, our current view is that US comparable sales will grow in the range of 0% to 2% in 2014. On those sales, we expect a US segment EBITDA rate of 10.1% to 10.3%, meaning EBITDA dollars should grow between 5% and 8% this year. +Among the drivers of EBITDA margin, we expect gross margin will improve 30 to 40 basis points from our 2013 rate of 29.8%, reflecting improved clearance markdown rates and, more significantly, the gross margin benefit of our expense optimization efforts. These benefits will be partially offset by the impact of additional promotional activities and continued investment in 5% REDcard Rewards. +We expect the US segment SG&A expense rate slightly better than last year's 20% rate, reflecting continued discipline expense control and the benefit of our expense optimization efforts, offset by our continued investments in distribution and technology in support of our multi channel efforts. We expect these expense investments to be worth $0.05 to $0.10 of incremental EPS pressure in 2014. +In Canada, we expect total sales will be approximately double our 2013 experience as we annualize last year's 124 openings and begin generating comparable sales growth in mature stores. On those sales, we expect to earn a much higher gross margin rate in a range approaching 30%, but clearly we will continue to see some near-term volatility until the Canadian business matures. +While we expect to see better fixed expense leverage in 2014, the SG&A rate will likely remain well above our long-term outlook in a range approaching 40%. Altogether, this would lead to a Canadian segment EBITDA margin rate of minus 8% to minus 10%, representing more than $400 million of expected EBITDA improvement from 2013. +We expect US capital expenditures of $2.1 billion to $2.3 billion, up slightly from actual 2013 spending. The mix of US CapEx will continue to tilt from investments in new stores towards supply chain and technology as we accelerate our multi channel efforts and continue to find a limited number of new store sites that meet our strategic and financial criteria. +I should also note that US CapEx reflects incremental investment related to our recent decision to accelerate deployment of chip enabled card readers to all our US stores before the end of the year. In Canada we expect 2014 capital expenditures in the $300 million to $400 million range, down more than $1 billion from peak spending in 2013. +We expect once again to raise our annual dividend in the neighborhood of 20% this year, which would mark our 43rd consecutive annual increase. And even with a temperate outlook for near term traffic and sales, and understanding there will be further cost related to the data breach, our current outlook envisions share repurchase capacity of $1 billion to $2 billion in 2014 beginning later in the year as our business stabilizes and we have more clarity on potential breach related costs. +Altogether, these expectations would lead to full-year adjusted EPS representing results from operations in the US and Canada of $3.85 to $4.15. This estimate excludes approximately $0.07 of dilution related to the continued reduction in the beneficial interest asset. These 2014 expectations represent an improvement of more than 20% from combined US and Canadian segment results in 2013. +Please note that our full-year outlook does not include potential additional costs related to the data breach beyond what we already recorded in the fourth quarter as they are not estimable at this time. While I realize this may result in a wide range of speculation on the magnitude of these costs, given our investigation of the breech breach is ongoing, it would not be appropriate to say anything more about it than we already have this morning. Regardless of the ultimate dollar amounts, as Gregg mentioned, we have the financial strength to move beyond these near term impacts while we continue to invest in the future, and as always, we're focused on what's most important, addressing the concerns of our guests and helping them to feel confident shopping with us. +Now let's briefly turn to our first quarter outlook. In the US we expect first quarter comparable sales in the range of flat to down 2%. So far in February comparable sales have been running within that range ahead of our forecast and nearly flat to last year. +And I should note while growth isn't running where it had been earlier in 2013, REDcard penetration so far in February has been running hundreds of basis points ahead of last year. On our first quarter US sales, we expect an EBITDA margin rate of 9.7% to 9.9%. +In Canada, we expect to generate first quarter sales in a range of $400 million to $450 million with EBITDA of minus $150 million to minus $170 million. In light of this near-term operating outlook, we don't expect to have the capacity to repurchase shares in the first quarter, but we expect to resume this activity later in the year. Altogether, our expectations would lead to first quarter adjusted EPS reflecting operating results in the US and Canada in the range of $0.60 to $0.75 excluding $0.02 related to the reduction in the beneficial interest asset and any potential costs related to the data breach. +While this has been a challenging year, we are proud of the work of our team, and we believe we have the right plans in place to generate meaningfully improved performance in 2014. As we focus on making Target irresistible for our guests both today and over time, we believe we will grow profitably for many years to come. +With that, we will conclude today's prepared remarks. Now Gregg, Kathee and I will be happy to respond to your questions. + + + +================================================================================ +Questions and Answers +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) +Your first question comes from the line of Sean Naughton with Piper Jaffray. + +-------------------------------------------------------------------------------- +Sean Naughton, Piper Jaffray - Analyst [2] +-------------------------------------------------------------------------------- + + Good morning and thanks for taking the question. I guess on the same store sales trends for February being down in that 0% to 2% range, probably a little bit better than people expected. I guess just over time, Target's been on an aggressive campaign to drive frequency with REDcard and remodeling more stores towards food, but given that PFresh is maturing here and the credit breach could curb some of the willingness to sign up for REDcards and online taking a bigger portion of the overall retail landscape, how should we think about some of the bigger picture initiatives to drive same-store sales trends in 2014 and beyond? + +-------------------------------------------------------------------------------- +Kathee Tesija, Target Corp - EVP of Merchandising [3] +-------------------------------------------------------------------------------- + + Sean, I think a lot of the things that I talked about today with product as well as with in-store experience and our mobile experience, those are really the key things for us to help drive people to shop at Target beyond the food you talked about and, of course, the REDcard. + +-------------------------------------------------------------------------------- +Sean Naughton, Piper Jaffray - Analyst [4] +-------------------------------------------------------------------------------- + + On the food aspect of things, how are you on the in stocks in that particular category, and are you happy with the product that you have out there on the shelves today? + +-------------------------------------------------------------------------------- +Kathee Tesija, Target Corp - EVP of Merchandising [5] +-------------------------------------------------------------------------------- + + Yes, in stocks have been rock solid for quite some time, and in terms of product, I would tell you that we're always making adjustments to what we carry in stores. We learn what's selling and what trends are picking up steam, things like organics and better for you products, so that's a never-ending thing that we work on. + +-------------------------------------------------------------------------------- +Sean Naughton, Piper Jaffray - Analyst [6] +-------------------------------------------------------------------------------- + + Okay. Great, and then just one last thing you mentioned, the online and the flexible fulfillment. I think that all of those can now be viewed online which is great for the consumer, but is it going to be possible for all of those products for buying online and picking up in store? + +-------------------------------------------------------------------------------- +Kathee Tesija, Target Corp - EVP of Merchandising [7] +-------------------------------------------------------------------------------- + + We are expanding the assortment right now. I don't have a date for you in terms of when we will get our whole assortment up online, and right now we're focusing on the most popular items and categories, so we recently added pets for example. And we will just continue to expand as we learn more and more about that program. + +-------------------------------------------------------------------------------- +Sean Naughton, Piper Jaffray - Analyst [8] +-------------------------------------------------------------------------------- + + Okay. Thank you. + +-------------------------------------------------------------------------------- +Operator [9] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Matthew Fassler with Goldman Sachs. + +-------------------------------------------------------------------------------- +Matthew Fassler, Goldman Sachs - Analyst [10] +-------------------------------------------------------------------------------- + + Thanks a lot and good morning. I've got two questions, and the first relates to inventory. I know you cleared a lot of inventory in Canada. +Your year-on-year numbers still across the corporation or across the enterprise is still up quite substantially relative to sales. If you could comment on sort of the composition of that inventory and your thought process for its impact on margin going forward? + +-------------------------------------------------------------------------------- +Gregg Steinhafel, Target Corp - Chairman, President and CEO [11] +-------------------------------------------------------------------------------- + + Sure, inventory up about 10% year-over-year, and you could roughly think about that split about equally between Canada and the US. Canada obviously, we're just in a different place than we were a year ago. We built inventories all year as we opened stores. +I would tell you in Canada we feel much, much better. We feel very good about the progress we made in the fourth quarter clearing excess inventory. The average inventory per store in Canada from the beginning of the quarter to the end of the quarter went down about 30%, so we still have some lingering issues in Q1 with some long receipts but feel very good about the inventory there. +In the US, I would tell you the merchant team did an outstanding job reacting to the change in sales, and our inventories are in excellent shape. This is the time of year where in February, we are changing lots of things in the store, and frankly depending on where you snap the line for year-end relative to our receipts, we see inventory move around a little bit. If you go back over the past couple of years, our inventory per store in the US is up about 3% versus two years ago, so this is really more timing than anything else, and we feel very good about the inventory position. + +-------------------------------------------------------------------------------- +Matthew Fassler, Goldman Sachs - Analyst [12] +-------------------------------------------------------------------------------- + + That's very helpful. Thank you. And then my follow-up relates to capital allocation and specifically the buyback. +I know that you alluded to the Company's desire to maintain its current credit rating and that you spoke about resuming buybacks as the year progressed presuming that you were on plan. I just want to talk about what your thought process is for contingencies and that based on the numbers we've looked at, it seems like you're a long way from coming close to the edge on your current credit rating. +So what would it take for you not to do that $1 billion to $2 billion? It seems like that should be well within your financial capacity even if frankly the numbers are a bit light of your current guide? + +-------------------------------------------------------------------------------- +Gregg Steinhafel, Target Corp - Chairman, President and CEO [13] +-------------------------------------------------------------------------------- + + Well, we should go offline and review where you are, where you think we are versus our credit rating and where we think we are versus our credit rating. We've actually run pretty close to our credit rating not just last year, which was even higher, but for the past several years. +So our view is that we think we can do -- given our plans between $1 billion and $2 billion. We need to see our business results improve over the next couple of quarters. +We're starting to see that in February as we eluded to, and then also gave little bit of a view into what the potential costs are that may be coming our way as a result of the breach. But given all of that, we still think somewhere between $1 billion to $2 billion beginning in the back half of the year for the year makes sense. + +-------------------------------------------------------------------------------- +Matthew Fassler, Goldman Sachs - Analyst [14] +-------------------------------------------------------------------------------- + + And just finally, I know you're not going to quantify the cost of the breach, but it sound like in thinking about the capacity to buy back stock, you have a sense somewhere internally a sense of that number that would enable you to pursue that course. + +-------------------------------------------------------------------------------- +Gregg Steinhafel, Target Corp - Chairman, President and CEO [15] +-------------------------------------------------------------------------------- + + As we said, it's not estimable at this time. What the potential cost of the breach is and given where we are in the process, it'd be inappropriate for me to speculate. + +-------------------------------------------------------------------------------- +Matthew Fassler, Goldman Sachs - Analyst [16] +-------------------------------------------------------------------------------- + + Fair enough. Thank you so much. + +-------------------------------------------------------------------------------- +Operator [17] +-------------------------------------------------------------------------------- + + Your next question comes from the line of Greg Melich with ICI Group. + +-------------------------------------------------------------------------------- +Greg Melich, ISI Group - Analyst [18] +-------------------------------------------------------------------------------- + + Hi, thanks. I have a couple questions, just a quick follow-up on the breach costs. You showed a net -- you got some insurance payments from the breach cost that you had? +Is that a -- should we expect that -- or do you have any insurance for these potential costs, whatever they may be, or is that sort of a one off in the quarter? And then I have a follow up. + +-------------------------------------------------------------------------------- +Gregg Steinhafel, Target Corp - Chairman, President and CEO [19] +-------------------------------------------------------------------------------- + + Just to be clear, that was insurance receivable, so we haven't actually received payment, but we feel pretty -- we feel very likely to receive payment for a portion of the expenses we incurred in the fourth quarter. What we can say about insurance right now is at this point we think there's $44 million of insurance that we will receive, and to the extent that number changes, we will be back to you to provide more information. + +-------------------------------------------------------------------------------- +Greg Melich, ISI Group - Analyst [20] +-------------------------------------------------------------------------------- + + Okay. Great. Bigger picture on REDcard and traffic, I mean if traffic was down 5.5% in the quarter, presumably post the breach it was down, pick a number like 7% or 8%. Is it fair to say that traffic has recovered back to what it was in January and February or where we are now, and how is REDcard seasoning, those people who have had it for three or four years, how are those people behaving following the breach? Thanks. + +-------------------------------------------------------------------------------- +Gregg Steinhafel, Target Corp - Chairman, President and CEO [21] +-------------------------------------------------------------------------------- + + Yes, in traffic your view of what happened post the breach is pretty accurate, and we have seen traffic continue to improve and firm up, and definitely throughout February we've seen traffic firm up. And as we said, sales have improved, and a big part of that has been traffic. On the REDcard, what we've seen is -- and Kathee talked about this a little bit. +In our core guests, REDcard guests, they've continued to shop with us. And we've seen very strong, very strong sales from that. REDcard penetration continues to grow meaningfully, hundreds of basis points year-over-year, and to the extent we're not growing where we used to, that's driven by new accounts, so the guests who have REDcards continue to shop our stores. + +-------------------------------------------------------------------------------- +Greg Melich, ISI Group - Analyst [22] +-------------------------------------------------------------------------------- + + It's more of the penetration growth from new people signing up or from people that signed up shopping more? + +-------------------------------------------------------------------------------- +Gregg Steinhafel, Target Corp - Chairman, President and CEO [23] +-------------------------------------------------------------------------------- + + As has been the case over the past couple the of years, the penetration growth comes from new accounts. + +-------------------------------------------------------------------------------- +Greg Melich, ISI Group - Analyst [24] +-------------------------------------------------------------------------------- + + Okay. Thanks a lot. Good luck. + +-------------------------------------------------------------------------------- +Operator [25] +-------------------------------------------------------------------------------- + + Your next question comes from the line Matt Nemer with Wells Fargo Securities. + +-------------------------------------------------------------------------------- +Matt Nemer, Wells Fargo Securities, LLC - Analyst [26] +-------------------------------------------------------------------------------- + + Good morning. Thanks for taking my questions. I'm just wondering if you could provide a little more color on the comp spread that you're seeing between states that have been severely impacted by weather and some of your warmer weather states. + +-------------------------------------------------------------------------------- +Gregg Steinhafel, Target Corp - Chairman, President and CEO [27] +-------------------------------------------------------------------------------- + + Great question, Matt, and it's -- analyzing weather isn't a perfect science. I would tell you when we see in the Midwest and the Northeast, when we've seen these weather patterns go across the country, the spread is significant between the two, but ultimately as that passes, we see them restabilize and everything come back to normal. +But the difference while it is going on is pretty dramatic. It's in single digits difference, but it would be high single digits. + +-------------------------------------------------------------------------------- +Matt Nemer, Wells Fargo Securities, LLC - Analyst [28] +-------------------------------------------------------------------------------- + + Okay. Thanks. And then secondly, as you gave some great detail on your investments in digital and eCommerce this year. As you enable click and collect and fulfillment from store, are there any significant investments you need to make in terms of inventory accuracy in the store, and could you just give us maybe a bit of color on how that's running in terms of being able to pick up in store? + +-------------------------------------------------------------------------------- +Kathee Tesija, Target Corp - EVP of Merchandising [29] +-------------------------------------------------------------------------------- + + We're always working on inventory accuracy, and that is a combination of how we use our systems as well as the processes in store. And so it's been less of an issue to date as we get into some of the additional categories, things like beauty where there's a lot of SKUs -- excuse me, we've got to make sure that the accuracy is there. +I will tell you apparel, while we've had good results there, it's a little bit harder. Partly accuracy, but partly being able to find the exact size when it's not in a [planagrammed] environment, so there are a few challenges for us to figure out, but overall I would tell you that our guest response has been very positive in the survey comments that they have back to us, they really love the service. +So, yes, we will keep working on accuracy to make sure we can fulfill as many orders as possible, but so far we're very pleased. + +-------------------------------------------------------------------------------- +Matt Nemer, Wells Fargo Securities, LLC - Analyst [30] +-------------------------------------------------------------------------------- + + Okay. And then lastly, your SG&A per foot in the US was down pretty substantially in the fourth quarter versus the last few years. How should we think about SG&A per foot on a full-year basis for 2014 in the US? Should it -- is that a number that you can keep relatively flat, or is there just some inherent inflation in there that we should expect? + +-------------------------------------------------------------------------------- +Gregg Steinhafel, Target Corp - Chairman, President and CEO [31] +-------------------------------------------------------------------------------- + + First, the comparison to last year we have to be a little bit careful. There's a 53rd week in there. That's a relatively low volume week which creates a little bit of distortion year-over-year. +But I think as I said, we continue to work very hard on store productivity ensuring that we're driving great guest experience and in stocks, but also improving our productivity, and then all of the expense optimization efforts continue to go on, and some portion of that will fall to the bottom line. Some portion of that goes to gross margin, and some portion of that gets reinvested in the business as we invest in multi channel technologies supply chain. But I think flat to up slightly is probably about the best way to think about it. + +-------------------------------------------------------------------------------- +Matt Nemer, Wells Fargo Securities, LLC - Analyst [32] +-------------------------------------------------------------------------------- + + Thanks, good luck this year. + +-------------------------------------------------------------------------------- +Gregg Steinhafel, Target Corp - Chairman, President and CEO [33] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Operator [34] +-------------------------------------------------------------------------------- + + Your next question comes from the line of Bob Drbul with Nomura. + +-------------------------------------------------------------------------------- +Bob Drbul, Nomura Equity Research - Analyst [35] +-------------------------------------------------------------------------------- + + Good morning. I just had a couple questions, first on -- did you give a number on the online business in terms of the increase that you had in the fourth quarter? + +-------------------------------------------------------------------------------- +Kathee Tesija, Target Corp - EVP of Merchandising [36] +-------------------------------------------------------------------------------- + + We didn't give a number, but I will tell you it was very positive above the industry and slightly above 20%. + +-------------------------------------------------------------------------------- +Gregg Steinhafel, Target Corp - Chairman, President and CEO [37] +-------------------------------------------------------------------------------- + + Like the rest of the business, it was impacted by the breach as well. + +-------------------------------------------------------------------------------- +Bob Drbul, Nomura Equity Research - Analyst [38] +-------------------------------------------------------------------------------- + + Okay. Okay. And then when you look at the full year, you gave a lot of details, in terms of like the sales recovery that you have, what are the key factors that give you the comfort and confidence in the recovery over this year as you plan the earnings and sales trajectory? + +-------------------------------------------------------------------------------- +Gregg Steinhafel, Target Corp - Chairman, President and CEO [39] +-------------------------------------------------------------------------------- + + It's -- from our perspective, we've got to up our game on all fronts. It starts with delivering great content, great in stocks. Our team is more engaged than ever from a service standpoint both on the sales floor and at the lanes, and we're going to deliver as Kathee said just some eye popping, irresistible deals. +So we're going to really up the ante as it makes a statement on our unbeatable pricing proposition which we have. We've price matched the competition, and we run our circulars, and with our 5% REDcards rewards program, our value proposition is unbeatable. We're just going to call greater attention to that, and selectively we're going to go out and be more aggressive in that regard, so it's the combination of all of those elements. + +-------------------------------------------------------------------------------- +Bob Drbul, Nomura Equity Research - Analyst [40] +-------------------------------------------------------------------------------- + + And then on the gross margin outlook for Canada, can you just talk about the mix assumptions in there and sort of the ramp from where you finished fourth quarter to get to that 30% number for the year? + +-------------------------------------------------------------------------------- +Gregg Steinhafel, Target Corp - Chairman, President and CEO [41] +-------------------------------------------------------------------------------- + + Sure, mix in Canada continues to be stronger in apparel and home, and we expect that to moderate through time. We ultimately think the mix there will be stronger than what we see in the US, but a lot like our high volume stores in the US, our urban stores in the US, we see a higher mix of home and apparel sales. That will moderate through time because we want to drive the frequency categories. +That's what we're working on the team in Canada. Ultimately as they're successful in driving conversion, commodities, groceries, food, all those categories, we will see that mix moderate. +I think we'll see margin, we expect to see some volatility. Q1 for instance, the margin rate won't be at 30%, but it will be significantly improved from the 4.4% we recorded in the fourth quarter. So we will make progress, and you should expect to see that throughout the year, and of course back in fourth quarter next year we will be down a little bit from that 30% as is typical in our US business given that time of year. + +-------------------------------------------------------------------------------- +Bob Drbul, Nomura Equity Research - Analyst [42] +-------------------------------------------------------------------------------- + + Great. Thank you very much. + +-------------------------------------------------------------------------------- +John Hulbert, Target Corp - IR [43] +-------------------------------------------------------------------------------- + + Okay. We have time for one more question, please. + +-------------------------------------------------------------------------------- +Operator [44] +-------------------------------------------------------------------------------- + + Okay. Your final question comes from the line of Chris Horvers with JPMorgan. + +-------------------------------------------------------------------------------- +Chris Horvers, JPMorgan Chase & Co. - Analyst [45] +-------------------------------------------------------------------------------- + + Thanks and good morning. A couple random questions. So could you perhaps break out how much was the explicit impact of the 10% off deal that you did after the breach and right ahead of Christmas? + +-------------------------------------------------------------------------------- +John Mulligan, Target Corp - EVP and CFO [46] +-------------------------------------------------------------------------------- + + Chris, we don't break out promotions individually. It was a big time of year, and the number was relatively large, but in the big scheme of the fourth quarter, I would tell you it's not material. + +-------------------------------------------------------------------------------- +Chris Horvers, JPMorgan Chase & Co. - Analyst [47] +-------------------------------------------------------------------------------- + + Okay. And then on the cost savings side, I guess how much of the $1 billion is done so far, and what have been the big drivers this year that have taken those costs out? + +-------------------------------------------------------------------------------- +John Mulligan, Target Corp - EVP and CFO [48] +-------------------------------------------------------------------------------- + + There's $200 million that we recorded in 2014, we will annualize on that. Or 2013, excuse me. We'll annualize on that next year, and the savings came from all over the corporation. +There were savings in gross margin around transportation expenses. That will grow again in 2014. There were savings -- really it's hard to pin it down. It was literally across the entire organization where we looked at things. +We looked at how we sourced product and aligning our non-retail product that we sourced and services and making that look more like we do in merchandising, and we saw significant savings there from our sourcing. There's more to do there, and we will see that grow in 2014 as well. As Gregg said, it was literally across the entire organization where we were focused on stopping things that we didn't need to do, and if we did need to do them, improving productivity. + +-------------------------------------------------------------------------------- +Chris Horvers, JPMorgan Chase & Co. - Analyst [49] +-------------------------------------------------------------------------------- + + And one last one, if you had chip technology in your stores this past year, how would the breach outcomes have changed? Would it have stopped the actual theft of the credit card data, or would it have stopped the personal information disclosure? + +-------------------------------------------------------------------------------- +John Mulligan, Target Corp - EVP and CFO [50] +-------------------------------------------------------------------------------- + + The chip technology makes it such that using the account numbers without the card becomes very much more difficult, and so the desire to obtain those card numbers goes down significantly. What we've seen in other countries that have adopted chip technology is fraud rates go down dramatically for in-store transactions, and I think in the UK or Europe, I can't remember exactly, down like 60% once chip technology was enabled. So the desire for those account numbers becomes less desirable. + +-------------------------------------------------------------------------------- +Chris Horvers, JPMorgan Chase & Co. - Analyst [51] +-------------------------------------------------------------------------------- + + But didn't the breach actually come from systems internally, not necessarily coming from the card readers? + +-------------------------------------------------------------------------------- +John Mulligan, Target Corp - EVP and CFO [52] +-------------------------------------------------------------------------------- + + Chris, we're in the middle of an investigation, and we can't talk about the specifics. We continue to learn. There will be learnings that come out of that investigation, and from those learnings, we will take action, and that's about what we can say today. + +-------------------------------------------------------------------------------- +Chris Horvers, JPMorgan Chase & Co. - Analyst [53] +-------------------------------------------------------------------------------- + + Fair enough. Thanks very much. + +-------------------------------------------------------------------------------- +Gregg Steinhafel, Target Corp - Chairman, President and CEO [54] +-------------------------------------------------------------------------------- + + Okay. Well, that concludes Targets fourth quarter 2013 earnings conference call. Thank you all for your participation. + +-------------------------------------------------------------------------------- +Operator [55] +-------------------------------------------------------------------------------- + + Again, thank you for your participation. 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Earnings Conference Call +01/14/2014 08:30 AM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Marianne Lake + JPMorgan Chase & Co - CFO + * Jamie Dimon + JPMorgan Chase & Co - Chairman and CEO + +================================================================================ +Conference Call Participiants +================================================================================ + + * Matt Burnell + Wells Fargo Securities, LLC - Analyst + * Andrew Marquardt + Evercore Partners - Analyst + * John McDonald + Sanford C. Bernstein & Company, Inc. - Analyst + * Paul Miller + FBR & Co. - Analyst + * Erika Najarian + BofA Merrill Lynch - Analyst + * Mike Mayo + Credit Agricole Securities - Analyst + * Eric Wasserstrom + SunTrust Robinson Humphrey - Analyst + * Matthew O'Connor + Deutsche Bank - Analyst + * Guy Moszkowski + Autonomous - Analyst + * Steven Chubak + Nomura Securities - Analyst + * Gerard Cassidy + RBC Capital Markets - Analyst + * Derek De Vries + UBS - Analyst + * Moshe Orenbuch + Credit Suisse - Analyst + * Christopher Wheeler + Mediobanca - Analyst + * Glenn Schorr + ISI Group - Analyst + * Ken Usdin + Jefferies & Co. - Analyst + * Betsy Graseck + Morgan Stanley - Analyst + +================================================================================ +Presentation +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Good morning, ladies and gentlemen. Welcome to JPMorgan Chase's fourth-quarter 2013 earnings call. This call is being recorded. +Your line will be muted for the duration of the call. We will now go live to the presentation. Please stand by. +At this time I would like to turn the call over to JPMorgan Chase's Chairman and CEO, Jamie Dimon; and Chief Financial Officer, Marianne Lake. +Ms. Lake, please go ahead. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [2] +-------------------------------------------------------------------------------- + + Thank you, Operator. Good morning everyone. I'm going to take you through the earnings presentation which is available on our website. Please refer to the disclaimer regarding forward-looking statements at the back of the presentation. +So we start on Page 1. The Firm generated net income of $5.3 billion for the fourth quarter, or $1.30 a share with a return on tangible common equity of 14% on revenues of $24 billion, down 1% year-on-year, and up 1% quarter-on-quarter. +As you see, we had several significant items in the quarter, which I will review as we go through the presentation in more detail, but they include a $1.3 billion gain on the sale of Visa shares, and a $0.5 billion gain on the sale of One Chase Manhattan Plaza, both in the corporate segment; as well as a $0.8 billion pretax or a $1.1 billion after-tax impact of legal expense in the quarter, partly booked in mortgage with the remainder that's in corporate, principally the Madoff settlement recently announced; a $1.3 billion benefit from reduced loan loss reserves in consumer businesses. And then in addition, CIB's results for the quarter include a $2 billion loss for DVA and FVA, or funding valuation adjustments, which I'll also come back to in more detail. The total impact of these items is a negative $0.10 of EPS. +So not to diminish their importance but to illustrate the strength of the core performance of the underlying businesses, if you do adjust our results for these items we would have earned $5.7 billion of net income, $1.40 a share, and a return on tangible common equity of 15%. +So talking about the full year, skipping over Page 2 and straight to Page 3, reported net income of nearly $18 billion or $4.35 a share on revenue of approximately $100 billion, and a return on tangible common equity reported of 11%. Again if you adjust it for all reported significant items in the year we would have earned net income of over $23 billion, $5.70 a share, and a return on tangible common equity of 15%. Again, strong underlying performance for the full year. +Of note, let me talk for a minute about adjusted expenses. You can see on the page that our adjusted expenses, that's excluding corporate litigation and foreclosure related matters, are a flat $60 billion. This is in line, albeit at the high end of our guidance of $59.5 billion to $60 billion for the year, but included in this number is a total of close to $1 billion of other non-corporate legal expense, which if we had adjusted would have left a more core number at just over $59 billion, despite the incremental investment in controls of a $1 billion we made in the year. +So briefly recapping on 2013, clearly a year marked by regulated development and significant legal settlements; however, more importantly, also a year in which our businesses together and individually performed strongly. We succeeded in further progressing our customer satisfaction agenda and gaining market share across businesses. 2013 saw very strong credit performance across businesses, including significant improvements in mortgage, and finally we ended the year with strong capital liquidity and margins. +So let's talk about capital on Page 4. So I'm not going to talk much about Basel I, except to say that you can see we progressed our ratio in the quarter to 10.7% Basel I Tier 1 common, but importantly if you look at the middle section, you see that our Basel III Tier 1 common ratio is 9.5%, meeting our year-end target. +Just a few words on the component underlying this ratio. Three things. First, we generated approximately $5 billion of net capital in the quarter. Second, we also saw significant RWA benefits of model and parameter updates, including HPI and lower spreads, as well as portfolio run-off. And third, these positives together worth over 60 basis points of improvement were reduced by about 50 basis points due to higher levels of operational risk capital. +The significant increase in operation risk capital this quarter is largely driven by the inclusion of the large legal expense from the prior quarter, and we will spend some more time on capital at Investor Day, but despite headwinds we still anticipate reaching 10% plus or minus Basel III Tier 1 common by the end of this year. +So a quick update on leverage. Both the Firm-wide and the bank supplementary leverage ratio under US rules increased to 4.7%, and I'll come back on the next page to talk about the final Basel SLR framework that was issued this weekend. During the quarter, the Holding Company converted certain inter-Company debt at the bank into capital, improving the bank's relative ratios. We remain compliant with LCR at the Firm level this quarter, including the impact of the proposed new rules, and we continue to have about 19% available resources relative to risk-weighted assets at the end of the year. +So before we move on, as you know, the Volcker rule was finalized in the quarter and having had the opportunity to consider the rule, some thoughts. So the certainty provided by having a final rule and the implementation date of July 2015 were welcome. +It is a tough rule and the regulators have laid out stringent standards for compliance policies, procedures, controls, and testing, which will bring operational challenges to implement; however, we believe that the Firm will be materially compliant across our businesses with the rule. We have work to do to get there but we don't expect any material impact to our results. +So let's take a closer look at the impact of the final SLR framework from this weekend on Page 5. So as you saw, the Basel committee released the framework this weekend which has gone a long way towards closing the gap relative to the US NPR. And the changes they made are responsive to industry feedback and seem sensitive to potential market impacts. +Our initial analysis estimates that the impact will worsen both the Holding Company and bank ratios by only approximately 10 basis points relative to US proposed rules, so that would be 4.6% for each of the Holding Company and the bank. This impact is primarily driven by a positive related to improved assumptions on unfunded commitments, being slightly more than offset by the inclusion of written credit protection provisions previously not in the US rules. +However, between the likely implementation in the future of NIM for derivative potential for future exposure, and the ability over time for us to improve netting for cash collateral, there should be significant improvement opportunity to our ratios in tens of basis points. So overall, our leverage action plans don't change materially. +We'll be thoughtful and measured about implementation in 2014 and beyond, and our perspective on specific products and businesses is not just driven by capital implications but also by the importance to the broader franchise and client relationships. We do expect to reach 5% plus or minus at the Holding Company by the end of this year and to be compliant at the bank shortly thereafter. So the next step is for the US regulators to determine when and if they will adopt this new denominator, although we feel it's reasonably likely that they will. +In addition over the weekend there was a consultation paper issued on NSFR. The proposal more closely aligns NSFR to the current evolved LCR framework in terms of definitions and assumptions, which we see as a positive step, and based upon the proposal, we estimate that the Firm is compliant today with NSFR. +So turning to business performance, let's start with the Consumer and Community Banking on Page 6. The combined Consumer businesses generated $2.4 billion of net income for the quarter on $11.3 billion of revenue with a return on equity of 20%. +A couple of comments on drivers. We continue to make strong progress as I said on our customer satisfaction agenda, being recognized by the American Consumer Satisfaction Index, ACSI, for the second year running, as number one among largest banks, as well as number one in small business in three of four regions in the US, and number one among large banks for mortgage originations both by JD Power. +On our Retail branch network, we've completed building out our key expansion markets, including California and Florida, and have reached leadership positions in each of our key markets. So we feel good about our footprints, at or around this level of 5,600 branches plus or minus, and our focus from here is on optimization including branch size and usage and leveraging digital capabilities. +Lastly, our other key business drivers continue to grow strongly, reflecting increased consumer engagement evidenced by growth in deposits, investments, sales, and processing volumes. And our expenses, which are down nearly $700 million from last year, primarily due to lower mortgage banking expenses. And across CCB, we've reduced headcounts by 16,500 year over year. +Turning to Page 7, Consumer and Community Banking generated net income of $780 million and an ROE of 28% on net revenue of $4.4 billion, up 4% and flat to the prior quarter. Net interest income is up 3% year-on-year, driven by the continued strong growth in deposits, partially offset by spread compression. And it's our investments in customer satisfaction, new builds, and CPC that's driving deposit growth, and also the highest account retention rates in a decade. +On the non-interest revenue side we continue to see strong growth in both debit and investment revenue, with close to $190 billion of client investment assets, up 19% or $30 billion year over year, about half related to market performance and half due to net new money gains. Expenses are up 3% year-on-year, reflecting cost relating to the strengthening of the control environments, but have flattened sequentially as we improve efficiency in our same-store branches with starting down by over 6,000 year over year. +Business banking loan balances are flat quarter-on-quarter and up 1% year-on-year, and production levels in the pipeline remain stable; however the environment has been challenging throughout the year due to competitive pressures, and we've maintained a high level of credit discipline. But we're cautiously optimistic that we'll see small businesses start to spend some of their cash reserves in 2014 but growth may be back-ended. +Turning to Page 8, Mortgage Banking. Overall, Mortgage Banking net income was $562 million with an ROE of 11%. There are a couple of non-recurring items this quarter which I'll explain as we go through the results, but if you look at the top of the page you see production ex-repurchases with a reported pretax loss of $500 million, but if you look at the table on the top right, we've adjusted for the one-time items and you can see a loss of $91 million, slightly negative as expected and as we guided to. Revenues in the quarter were down 15% on lower application volumes, down 23%, and from a mix perspective, nearly 60% of loans were purchase loans this quarter, up from a little over 20% at the same time last year. +Production expense includes approximately $400 million of non-MBS related legal expense. This is part of the significant item on the front page. Again, adjusting for this, we're seeing the benefits of actions we've taken to reduce expenses, with adjusted expenses coming down around $80 million quarter over quarter. +Dealing with repurchases, as you know, during the quarter we reached a settlement with the GSEs on agency repurchase exposure. After allowing for the settlement amount we are releasing a net $130 million of repurchase reserves this quarter, with $90 million being added to compensatory fee reserves, as the settlement did not cover these potential fees. +And before moving on to servicing, just looking out to the third quarter of 2014. The overall mortgage market is estimated to be roughly flat versus the fourth quarter, and although we do expect to see some continuation and expense improvements, revenues will continue to be challenged, and we're guiding for the first quarter similar to the last two quarters to be slightly negative in pretax deductions. +Moving to servicing, pretax income about breakeven in the quarter. Servicing expenses of $663 million includes that $90 million of compensatory fee expense that I just mentioned, which related to loans previously contemplated in the repurchase reserves. Adjusting for this item our core expenses would have been slightly better than our previous guidance of $600 million for the quarter. +Finally on Real Estate portfolio, pretax income of $1.2 billion including charge-offs of $167 million and a total reserve release of $950 million. The non-credit impaired reserve release for the quarter was $200 million, reflecting continued improvements in the portfolio but at a lower rate. But also we released $750 million of reserves in the purchase credit impaired portfolios, given recent significant improvements in HPI forecasts of approximately 5% for our portfolio through 2015. +Turning to Page 9, Card, Merchant Services, and Auto. Net income of $1 billion, up 23% year-on-year with an ROE of 26%, or 22% excluding reserve releases, reflecting underlying excellent performance in the business. Consumer spending has been increasing and we're seeing strong growth in interchange revenue, reflecting growth in sales volume as well as seasonality in the Fourth Quarter. +Year over year growth in both sales and merchant processing volumes was consistently strong at 11% and 14% respectively, with average outstanding flat year over year and quarter over quarter, yields remaining healthy but lower than a year ago. We do continue to see run-off of high rate and low FICO balances, with a move towards more engaged customers or transactors, which is a positive trend for spend and for credit performance but a negative for yield and we expect spread compression to continue into 2014. +Net, this drove revenues of $4.7 billion, down 3% year over year and up 1% quarter-on-quarter on seasonality with a revenue rate of 12.34% for the quarter. Consistent with these portfolio trends, the net charge-off rate has stayed at historical lows at 2.85%, and we released $300 million of loan loss reserves this quarter, given improved delinquencies and portfolio seasoning. Expenses are up 3% year-on-year but 16% quarter-on-quarter, primarily driven by increased marketing investment spend and costs associated with payments to customers required by consent order. +A few words on Auto. Originations up 16% year-on-year, driving loan balances up 5% year-on-year and outpacing new car sales growth of 5%. +And before we move on, as you know, there were two security -- data security breaches affecting our customers over the last several weeks. We took quick action to protect our customers and we continue to monitor both situations. The financial impact for the quarter is not significant. +Moving on to Slide 10 and the Corporate Investment Bank. The CIB results this quarter include a $1.5 billion loss as a result of implementing the FVA, or funding valuation framework, as well as a $0.5 billion DVA loss. On this page we'll focus on the numbers excluding FVA and DVA in the table on the top right, and then I'll come look back to FVA on the next page. +So we have net income of $2.1 billion on revenues of $8 billion and an ROE of 15%, and we maintained our number one ranking in both global IB fees and markets revenue, gaining share year over year of over 100 basis points in each. In banking, total revenue of $3 billion with IB fees slightly ahead of our guidance. +IB fees of $1.7 billion for the quarter, up 11% quarter-on-quarter and down 3% year-on-year, driven by lower debt underwriting compared with a record prior-year quarter, partially offset by strength in equity underwriting. Treasury services revenues of $1 billion down 7% year-on-year, driven primarily by decision to reposition our trade loan portfolio. +Moving on to Markets and Investor Services, our Markets revenue of $4.1 billion was flat year-on-year, also slightly ahead of the guidance we provided in the fourth quarter. Fixed Income Markets revenues of $3.2 billion flat year-on-year with continued solid client flows, and Equity Markets of $873 million, down quarter-on-quarter off of a very strong equity derivative results last quarter as well as seasonality. Security Services revenue of $1 billion, up 3% year-on-year, primarily driven by higher custody and fund services revenue on record Assets Under Custody of $20.5 trillion and also on higher deposits. +Just a comment on credit. We continue to see a favorable credit environment with stable credit quality trends, and our provisions continue to benefit from repayments and recoveries. Expenses of $4.9 billion, down 2% both year over year and quarter over quarter, driven by lower compensation. The comp to revenue ratio excluding FVA and DVA was 27% for the quarter, in line with the same quarter last year, and 30% for the full year, which is in line with our guidance albeit at the lower end on higher capital year over year. +Loan balances are down 7% year-on-year, flat quarter-on-quarter, again primarily driven by trade loan balances which could trend down or continue to trend down as we optimize the portfolio. And at the bottom of the driver section, VaR remains low at $42 million for the quarter. +So turning to Page 11 and coming back to the FVA adjustments. We are recording a $1.5 billion loss as a result of implementing a funding valuation, or an FVA framework for our OTC derivatives and structured notes this quarter, reflecting an industry migration towards incorporating the lifetime cost or benefit of unsecured funding into valuations. +Just a couple of minutes on the background and dealing with -- why now? To date there has been no broad consensus that funding should be explicitly incorporated into valuation estimates; however, we believe that market practice for pricing and valuing derivatives has noticeably evolved during 2013 as we've been actively and continuously evaluating the market. +We've now accumulated compelling evidence, both from transactions as well as industry pricing services, that dealers are pricing funding into uncollateralized derivatives with a degree of consistency. This supports incorporating an FVA framework this quarter. +In very simple terms, you can think of FVA which represents a funding spread over LIBOR as having the effect of present valuing market funding costs into the value of derivative receivables today. These funding costs otherwise would have affected net income over the life of the derivatives. +Although the FVA framework applies to both assets and liabilities, the adjustment in the quarter is largely related to uncollateralized derivative receivables for two reasons. First, the funding value of collateral is already incorporated in the valuation of collateralized derivatives. And second, credit spreads, which are a significant component of funding spreads, are already recorded on liabilities through DVA. +So in thinking about the size of the adjustments, you have to consider the size, the tenor, the composition of the relevant portfolio, as well as the appropriate spread. So to give you some context, if you start with derivative receivables net of cash and securities collateral of approximately $50 billion, apply an average duration of approximately five years, and a spread of approximately 50 basis points, that accounts for about $1 billion plus or minus the adjustment. Additionally, although there is a material overlap between DVA and FVA, the remaining difference contributes to the adjustments. +So the loss in the quarter represents a transition adjustment to this new framework and can be thought of as a one-time event as we incorporate the concept into the portfolio value. Going forward, FVA will be incorporated into day-one valuation of derivatives, and implementing FVA should have the effect of significantly reducing our sensitivity to funding spreads going forward. We'll continue to refine FVA as the framework matures within the industry. +So moving on to Page 12, the Commercial Bank saw a net income of nearly $700 million this quarter on revenue of $1.8 billion with an ROE of 20%. Revenues were up 6% per year-on-year and 7% quarter-on-quarter. Net interest income increasing by 5% year over year, reflecting a one-time gain of approximately $100 million related to a lending related work out. +Pricing spreads have continued to tighten across the board. Non-interest revenues were 8% up year-on-year, driven by record growth IB fees of over $500 million for the quarter. Our credit book continues to show very strong performance with net charge-off rates of only 7 basis points as we continue to focus on quality names and are comfortable passing on deals that don't meet our standards. +Expenses were up 9% year-on-year, continuing to reflect higher product and headcount related expenses, primarily in controls. Loan balances were up 7% year-on-year and 1% quarter-on-quarter. +Our commercial Real Estate businesses continue to outperform the industry, up 15% year-on-year, 16 consecutive months of growth. But in C&I, overall loan growth remains flat, performing slightly below the industry as client demand continues to be low, competition high, and we remain focused on credit discipline over growth. +While sentiment remains fragile there are pockets of activity and we are cautiously optimistic that borrowing demand may improve as confidence in the recovery spreads, but again that may be back-ended in the year as clients are very liquid. Finally, deposits are up 3% year-on-year and 4% quarter-on-quarter on seasonality. +Page 13 and Asset Management. Continued strong investment performance and long-term inflows drove a fourth consecutive year of record revenue. The quarter saw a net income of $568 million, up 18% year-on-year with an ROE of 25%. +Record revenues of $3.2 billion, up 15% year-on-year are driven by three main factors. Strong fund performance as well as long term flows in every single asset class and from every region. Overall, benefiting from higher markets. And finally, a mark-to-market gain from a seed capital investment. +This is the 19th consecutive quarter of long term inflows, with $16 billion for the quarter, bringing the full year to a total $90 billion, driving record Assets Under Management of $1.6 trillion, up 12%. We saw particular strength in multi-asset and equities and achieved number one ranking in 2013 for net flows in active long-term mutual funds. Expenses increased in line with performance of the business. And finally, in banking we continued to see growth across the board with record loan balances over $95 billion, up 19% year-on-year. +Page 14, a total net income of nearly $800 million for corporate and private equity for the quarter. In private equity, a relatively quiet quarter with aggregate results more modest than in prior quarters. +Treasury CIO showed a net loss of $78 million, driven by negative NII of nearly $100 million. But that compared to a run rate of negative NII of approximately $500 million in each of the first two quarters. This improvement reflects the benefit of higher investment security deals, up 50 basis points. +The investment securities portfolio has also been a significant contributor to firm-wide NIM stability. And in the second half of the year we deployed $66 billion gross in new investments, principally mortgages and munis. +Our ending balance of securities that classified as held to maturity grew to $24 billion and will continue to grow this quarter. And you should expect CIO Treasury NII to reach breakeven in the second half of 2014, all other things equal. +And before I continue just let me talk for a second about NIM and NII, details of which are in the appendix. Firm-wide NIM, core NIM, and NII were all up slightly quarter over quarter given market rates, and we expect both NIM and NII to be relatively stable in the near term, with the higher security deals I talked about being largely offset by loan spread compressions. +Finally on this page, other corporate, sees a net income of $852 million and has a call out on the page. First, a net gain, all of these are after-tax, first a net gain of $800 million on the sale of Visa shares. We were and we remain a large Visa shareholder; however in the quarter, we saw the opportunity to risk manage approximately one-third of our Visa price risk exposure, but we clearly retain the ongoing litigation risks, both the ultimate amount and timing of settlements. +Secondly, a net Real Estate gain of over $300 million on the sale of One Chase Manhattan Plaza, and these two gains are being offset by nearly $800 million in legal expense, substantially all Madoff related. In addition, a few positive tax items in the quarter, largely the release of prior reserves. +So Page 15 and our outlook to wrap up. We've actually covered all of the items on this page. So wrapping up just to say that our four leading franchises are all performing very strongly and we remain focused on serving our clients. We're committed to accomplishing our control agenda and adjusting successfully to the new global financial architecture, and we look forward to diving deeper into all of these things at Investor Day which is coming up in a few weeks' time. +With that, thank you. And operator, you can open up the line to Q&A. + + + +================================================================================ +Questions and Answers +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) +Our first question comes from Guy Moszkowski of Autonomous. + +-------------------------------------------------------------------------------- +Guy Moszkowski, Autonomous - Analyst [2] +-------------------------------------------------------------------------------- + + Good morning. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [3] +-------------------------------------------------------------------------------- + + Good morning, Guy. + +-------------------------------------------------------------------------------- +Guy Moszkowski, Autonomous - Analyst [4] +-------------------------------------------------------------------------------- + + Just wanted to talk about the leverage ratio for a moment, you talked about a 10 basis point increase from the latest on Basel, if they do the add-ons. And I guess the big part that's hardest for us to see is really the impact of the CDS non-netting of mismatched maturities on protection bought versus protection sold. Can you give us a sense of what your numbers look like on that basis so we can try and reconcile to your 10 basis points? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [5] +-------------------------------------------------------------------------------- + + Yes, so just a quick thing just to clarify. The 10 basis points is actually lower, not higher, so it's a deduct, not an add for the new Basel proposal relative to the US rules. So remember as we've previously been disclosing our ratios, we used the US proposed rules that referenced a prior Basel denominator, so it's a 10 basis point worsening. +And you're right that we had two major things contributing to that. We had a positive associated with better assumptions on draws on unfunded commitments, slightly more than offset by a negative on the risk [credit] protection. So we're still working through the prior details but our best estimate is that it's in the mid 20s in basis points, 25 basis points plus or minus. + +-------------------------------------------------------------------------------- +Guy Moszkowski, Autonomous - Analyst [6] +-------------------------------------------------------------------------------- + + Got it. And can you give just give us a sense for what the maturity profile looks like on your CDS protection purchased versus sold? I mean is there much of a maturity mismatch there or is there really not much? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [7] +-------------------------------------------------------------------------------- + + If you start with our gross growth CDS protection written, it's about $3.4 trillion, and by the time you net down from maturities it gets down to a couple hundred billion, but that is still impactful. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co - Chairman and CEO [8] +-------------------------------------------------------------------------------- + + Another thing to think about, it will be manageable because really this is kind of a static analysis before we start running the business slightly differently due to it. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [9] +-------------------------------------------------------------------------------- + + Right. + +-------------------------------------------------------------------------------- +Guy Moszkowski, Autonomous - Analyst [10] +-------------------------------------------------------------------------------- + + Got it. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [11] +-------------------------------------------------------------------------------- + + We saw the proposals as having been thoughtful and we don't necessarily have to agree with the finer points of all of them, but it doesn't materially change our position or our thoughts going forward. And as Jamie said, all of our businesses will now socialize and optimize against what we understand to be the final rules when the US regulators adopt them. + +-------------------------------------------------------------------------------- +Guy Moszkowski, Autonomous - Analyst [12] +-------------------------------------------------------------------------------- + + Got it. That's helpful, thanks. On the $60 billion of core expense that you pointed out on balance having been pretty flat with last year despite the increases in control environment cost, can you give us a sense of how you currently see that evolving in 2014? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [13] +-------------------------------------------------------------------------------- + + Yes, so, Guy, we're obviously going to do a bit more of a detailed deep dive on expenses over time on Investor Day. So for now what we have said is that you should expect our adjusted expenses for 2014 to remain at or below that level of $60 billion. We also said that in 2014, the continuation of our control agenda is adding an incremental $1 billion over 2013, so by remaining flat we're effectively self-funding that $1 billion. That's down. + +-------------------------------------------------------------------------------- +Guy Moszkowski, Autonomous - Analyst [14] +-------------------------------------------------------------------------------- + + Got it. And how do you get comfortable that by doing that, you're not going to eat into revenue growth, by pardon the use of the word, but by starving other expenses? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co - Chairman and CEO [15] +-------------------------------------------------------------------------------- + + We're not starving any expenses. We're just managing it in a disciplined way the way we've always done it and you look at the underlying numbers there's a lot of growth in the underlying numbers, but it's clearly true that some of the derisking and selling, spinoff OEP, and physical commodities will affect revenues a little bit, but obviously profits less. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [16] +-------------------------------------------------------------------------------- + + And, Guy, we've always been investing in the businesses and been willing to invest where the business takes and the returns justify that, but we are also finding efficiencies in the combination of the businesses, both consumer and the wholesale businesses, efficiency in the same store, branches we talked about, CIB continues on its journey on the back office and front office integration, and obviously mortgage expenses will continue to trend down both in line with improved credit trends and also as we proactively manage the portfolio. So there's a lot of moving parts but it's not at the expense of our willingness to invest in the businesses for returns. + +-------------------------------------------------------------------------------- +Guy Moszkowski, Autonomous - Analyst [17] +-------------------------------------------------------------------------------- + + And just if I could follow-up on the mortgage expense comment that you made, more just along the lines of the expense that's against the origination franchise. It sounded to me like you may be extending your view of what the time frame is to kind of get that to steady state beyond the first quarter, is that right or am I misreading that? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [18] +-------------------------------------------------------------------------------- + + It's not just about expenses. You have to think about the whole equation. If you look at a mortgage market we'll see some improvement in the first quarter 2014, and we'll also continue to work on expense efficiency in the business. But if you look at a market which is currently being estimated about $1.3 trillion, down from $1.9 trillion, and honestly a couple weeks ago it was $1.1 trillion, so it's a very small market, one we haven't seen the likes of since year 2000, in a market like that it's very challenging to deliver through the cycle returns. +So we went through over the last few years, years with very strong revenues and margins, and we are in a challenging environment as we look into 2014 but we're working on it. + +-------------------------------------------------------------------------------- +Guy Moszkowski, Autonomous - Analyst [19] +-------------------------------------------------------------------------------- + + Fair enough. And the last one for me just you mentioned the impact of operating risk due to the very high level of litigation costs this year. How should we think about that and how are you thinking about that with respect to CCAR? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [20] +-------------------------------------------------------------------------------- + + Okay, so the way to think about it in the short-term relative to say the submission that we just did or in the near future is that obviously, a realized loss experience that is higher than we have previously seen informs your view and judgment as to what you could reasonably expect to happen in a future stress period. So it is fair to say that that would drive our expectations (inaudible) on operational losses to be slightly higher. Having said that, it's not as if our previous submissions didn't contemplate there to be significant stresses in operating losses, so I would characterize it as incremental and certainly not from a low base. + +-------------------------------------------------------------------------------- +Guy Moszkowski, Autonomous - Analyst [21] +-------------------------------------------------------------------------------- + + Okay, great. Thanks very much for answering my questions. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [22] +-------------------------------------------------------------------------------- + + And also, Guy, sorry, just remember that every quarter we move forward we generate capital, improve our ratios, so there's lots of moving parts to the ultimate outcome. + +-------------------------------------------------------------------------------- +Guy Moszkowski, Autonomous - Analyst [23] +-------------------------------------------------------------------------------- + + Got it. Thanks. + +-------------------------------------------------------------------------------- +Operator [24] +-------------------------------------------------------------------------------- + + Our next question comes from Betsy Graseck of Morgan Stanley. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [25] +-------------------------------------------------------------------------------- + + Hi, good morning. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [26] +-------------------------------------------------------------------------------- + + Good morning, Betsy. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [27] +-------------------------------------------------------------------------------- + + Marianne, I just wanted to follow-up on a couple things. One was on NIM outlook. You did indicate that in the second half of 2014 you were expecting that the CIO and Treasury income would turn positive if I read it correctly, and I would think that it's a function of your security yields improving. Can you just give us a sense of what the net new investment yield is for the security investments that you're making in that book right now relative to what it's at? The balances are at? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co - Chairman and CEO [28] +-------------------------------------------------------------------------------- + + I think the way you should look at it is something like $40 billion gets reinvested in a year. The basic assumption you should make is it's an average duration of three or four years, so think of a five-year bonds or something like that, and just use the implied yield curve. Obviously (inaudible) munis or MBS or something like that, but I need to point out that it's completely dependent upon the decisions we make, so we can change that kind of at will if we want to extend or reduce the duration of equity of the Company. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [29] +-------------------------------------------------------------------------------- + + Right. And so given your comments that you're expected to reach breakeven by the second half of 2014, that's a reflection of higher interest rates or a change in the way you're investing the funds? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [30] +-------------------------------------------------------------------------------- + + It's both. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co - Chairman and CEO [31] +-------------------------------------------------------------------------------- + + It's a little bit of both. It's mostly just the change in the yield curve. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [32] +-------------------------------------------------------------------------------- + + We have slower mortgage fee payments, we're able to reinvest at higher yields, we're reinvesting in high quality assets, munis with high spreads, so it's both. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [33] +-------------------------------------------------------------------------------- + + Okay. And then your other point was you're going to be taking that better return on that portfolio and using it to be as competitive as you want to be on the loan portfolio, and so expectation is that loan spreads continue to pull-down over the next couple of quarters at least. Can you just give us a sense as to how willing you are to be competitive on price and loan spreads? Should we be expecting that overall NIM compression is what you're looking for here in the event that you get the quality of loan growth you want? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co - Chairman and CEO [34] +-------------------------------------------------------------------------------- + + Well you have got to separate the loans. On the commercial side we'll obviously be competitive and we're not assuming anything heroic in terms of rate spreads getting worse or better but they're low. You could argue down the road they might actually go up a little bit as capital requirements and liquidity requirements go way up, so but we'll be competitive. We're assuming you have to be competitive in loan spreads. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [35] +-------------------------------------------------------------------------------- + + Okay. And on the consumer side, card balances have been rewritten post-crisis to be variable. Are you anticipating that you're going to be in a rising rate environment in the belly of the curve raising rates on card portfolio? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co - Chairman and CEO [36] +-------------------------------------------------------------------------------- + + Think of the card business, we try to run it fully match funded so the spreads are about the same, and somewhere like 65% is at an interest rate something like 40% is transactor almost locked in rates, so which we also match fund. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [37] +-------------------------------------------------------------------------------- + + Okay. And then separate topic just on the security breach that you discussed and you indicated that the card replacements that you've done so far has been de minimis in terms of expense, but could you speak a little bit bigger picture to how you're thinking about fraud in the card space as well as in the debit space? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co - Chairman and CEO [38] +-------------------------------------------------------------------------------- + + So we have replaced 2 million debit cards or will have I think by the end of this week. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [39] +-------------------------------------------------------------------------------- + + Credit and debit. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co - Chairman and CEO [40] +-------------------------------------------------------------------------------- + + Credit and debit. To protect our employees, to protect our customers, et cetera. So I think that look, unfortunately, this cyber security stuff we've now pointed out for a year is a big deal, it's not going to go away, and all of us have a common interest in being protected so this might be a chance for retailers and banks to for once work together as opposed to sue each other like we've been doing the last decade, and but it's in all of our interest to do it. +And I think all people involved in this know that the third parties with its machines, regional machines, your mainframes, you really have to put an extreme effort into protect yourself so this story is not over, unfortunately. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [41] +-------------------------------------------------------------------------------- + + Right, and there's been this debate between tokenization versus chip and pin, and I'm just wondering do you guys have an angle as to which way you would prefer to see it go? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co - Chairman and CEO [42] +-------------------------------------------------------------------------------- + + Yes, honestly I think you'll see both. I think you'll see chip and pin in all cards and then a lot of online type of transactions in tokenization. They both have very, very good technologies to protect consumers and companies from fraud. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [43] +-------------------------------------------------------------------------------- + + Okay. And then just last question, on the Visa, did I hear you correctly, Marianne that you basically realized one-third of the economic value in the Visa shares that you have, is that correct? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [44] +-------------------------------------------------------------------------------- + + Yes, that's correct. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [45] +-------------------------------------------------------------------------------- + + Okay, so two-thirds left and when you say economic you're talking about net of any hedging? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [46] +-------------------------------------------------------------------------------- + + Correct. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [47] +-------------------------------------------------------------------------------- + + Okay. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co - Chairman and CEO [48] +-------------------------------------------------------------------------------- + + There's an unrealized gain approximately of like $3 billion today. It's on our books of zero. This goes back to when Visa was spun off many, many years ago. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [49] +-------------------------------------------------------------------------------- + + But that's right, Betsy, net of hedging. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [50] +-------------------------------------------------------------------------------- + + Right, okay, thanks. + +-------------------------------------------------------------------------------- +Operator [51] +-------------------------------------------------------------------------------- + + Our next question comes from Glenn Schorr of ISI. + +-------------------------------------------------------------------------------- +Glenn Schorr, ISI Group - Analyst [52] +-------------------------------------------------------------------------------- + + Hello. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [53] +-------------------------------------------------------------------------------- + + Hi, Glenn. + +-------------------------------------------------------------------------------- +Glenn Schorr, ISI Group - Analyst [54] +-------------------------------------------------------------------------------- + + First question on FICC in the IB. It's pretty stable, of course. As a matter of fact, if you look for the year it was about in line with last year which I think once everybody's done reporting will be a pretty good victory, so I guess the question is there's a bunch of structural headwinds blowing on the business and as you do your budgeting it's probably done already. Can the industry grow with the headwinds on it? In other words, the offset would be better activity levels, steeper curves, things like that, but there's a bunch of structural headwinds, I'm just curious how you think of that at the high level? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co - Chairman and CEO [55] +-------------------------------------------------------------------------------- + + I guess look, there are some structural headwinds and you've seen a lot of adjustment in the marketplace, people reduce the size of their inventory, and what you don't know going forward is what's going to happen to spreads. But I look at it a little bit like there's a secular and a cyclical. There will be headwinds from regulations et cetera. But over time, assets that people need to manage and buy and sell is going to go up over time, not go down. So what happens in 2014 is hard to say, our business is plenty diversified between rates, credit, emerging markets, FX, commodities, et cetera. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [56] +-------------------------------------------------------------------------------- + + Certainly helping out stability. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co - Chairman and CEO [57] +-------------------------------------------------------------------------------- + + Which is definitely helping out stability. + +-------------------------------------------------------------------------------- +Glenn Schorr, ISI Group - Analyst [58] +-------------------------------------------------------------------------------- + + I see that in the numbers. Maybe on a related note, I got a sense with the renewed focus on SLR that there's a renewed attention to compression trades, and I'm just curious if that's ongoing and it could be material in 2014, as this goes on I know there's a lot of work involved, but the reward is pretty good too. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [59] +-------------------------------------------------------------------------------- + + I would say Glenn it's ongoing and it will be beneficial. I think material might be a stretch at this point, but and it is a lot of work as you say, so there's a whole industry working on that and us too we expect to be beneficial but not a game changer. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co - Chairman and CEO [60] +-------------------------------------------------------------------------------- + + So the SLR at 5% we do not think is going to be an issue for us. We barely begun to manage it, there are a lot of things you can do in how you change your business. The bank issue is a little bit different but think of that as more structural. What you did in the bank over the last 20 years and what we're not going to do in the bank going forward, that will take a little bit longer, but not because -- the reasons is it takes longer to change our business models to accommodate it. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [61] +-------------------------------------------------------------------------------- + + I also think if you look at the other things I mentioned in terms of opportunity for putting NIM to one side, our estimate of the new Basel rules that we had we've given you a 10 basis point movement backwards has a conservative estimate of what we could ultimately achieve over time in terms of the ability to net cash collateral for derivatives just given certain of the conditions. But again over time that will also be manageable like compression trades and like many of those other things. +So we haven't changed our view, we can manage against these targets by doing it thoughtfully and methodically and not having to race through it. + +-------------------------------------------------------------------------------- +Glenn Schorr, ISI Group - Analyst [62] +-------------------------------------------------------------------------------- + + Okay last one for me. You've noted your 9.5% Basel III Tier 1 common, the 10% year-end target seems completely achievable given your earnings. I'm just curious how you think about balancing the absolute versus the relative, meaning you can get there on an absolute basis no problem. On a relative basis, some other large financial institutions have a little bit more. Just curious if that matters as you think about the capital planning process, or is it when you have enough it's enough? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [63] +-------------------------------------------------------------------------------- + + Well we've said already that we would be willing to run between 10% to 10.5% so we're on a journey here. We think we can get 10% plus or minus at the end of the year. It could be plus and it could be minus but we think at this point based on what we know that running at that level of buffer of margins should be enough. Obviously we'll be more informed as we go through CCAR processes, but that's our point of view at this point. + +-------------------------------------------------------------------------------- +Glenn Schorr, ISI Group - Analyst [64] +-------------------------------------------------------------------------------- + + Okay, thank you. + +-------------------------------------------------------------------------------- +Operator [65] +-------------------------------------------------------------------------------- + + Our next question comes from John McDonald of Sanford Bernstein. + +-------------------------------------------------------------------------------- +John McDonald, Sanford C. Bernstein & Company, Inc. - Analyst [66] +-------------------------------------------------------------------------------- + + Hi. One more quick follow-up on the net interest margin outlook, Marianne. The NIM expected to be flattish but I wasn't clear if in the current rate environment you expect it to continue to add investments as you have been doing, and would you expect the net interest income dollars to grow from here as they did slightly this quarter? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [67] +-------------------------------------------------------------------------------- + + Yes, so we have been adding, I mean I talked about the second half of the year gross adding $66 billion. We've never talked about second quarter, we added quite a lot in the second quarter, and yes we have plans to continue to do that in 2014, and yes, we expect our NII dollars to be relatively stable, possibly slightly up over the course of the top of the year, but relatively stable. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co - Chairman and CEO [68] +-------------------------------------------------------------------------------- + + But not in a lot of investments. Look at the balance sheet today. We have almost $350 billion at central banks, most of it's Fed. Another $350 billion of very high quality investment securities, and those two things combined equal our loans of $700 billion. So the Company's very, very liquid. We don't really need to invest more, but it depends on how much we grow deposits. + +-------------------------------------------------------------------------------- +John McDonald, Sanford C. Bernstein & Company, Inc. - Analyst [69] +-------------------------------------------------------------------------------- + + What about just taking advantage of the 10 year yields moving up and your overall sensitivity to higher rates? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co - Chairman and CEO [70] +-------------------------------------------------------------------------------- + + Well I already said what we're going to do is what you should assume now is implied yield curves and constant reinvestment, but if you had rates move up 100 basis points all at once, we would probably be much more aggressive doing something like that. + +-------------------------------------------------------------------------------- +John McDonald, Sanford C. Bernstein & Company, Inc. - Analyst [71] +-------------------------------------------------------------------------------- + + Okay. And then in terms of the litigation reserves, you resolved a number of large issues in the fourth quarter, so two questions here. Can you help us think about how the litigation provision expense might trend in 2014, should we expect it to be lower than the $800 million? And then second, can you tell us if your range of possible loss has come down from the $6.8 billion that it stood at in October since you resolved a few big items? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [72] +-------------------------------------------------------------------------------- + + So obviously, you're going to understand that the necessary caveat that we can't predict for you, the patent and the amount of legal expenses in any one quarter over several quarters; however it would be fair to say that we would certainly hope that for the full year, the full-year cost isn't the first quarter annualized, but we can't be certain of that. +And with respect to reasonably possible loss range, it did come down from $5.7 billion at the end of the third quarter to $5 billion at the end of the fourth quarter given the legal expense. + +-------------------------------------------------------------------------------- +John McDonald, Sanford C. Bernstein & Company, Inc. - Analyst [73] +-------------------------------------------------------------------------------- + + Okay, thanks. And then last thing is you mentioned a little bit but can you just give us kind of the philosophy with which you approach this year's CCAR and how you're thinking about balancing your capital achievement goals on the ratios that you talked about with the goal of returning some capital to shareholders? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [74] +-------------------------------------------------------------------------------- + + Yes, so I mean, if you think about -- and you can do -- we've done about as much as you can do based on analyst estimates, but if you think about we want to get to 10% plus or minus by the end of next year all else other things being equal, that is a priority, but it is not the only priority. And so as we think about our capital plan, we've consistently said obviously it's a Board decision ultimately and they'll contemplate them in the natural course. But we would like to have the flexibility to be able to potentially increase dividends and also have flexibility to get to do reasonable repurchases, it wouldn't be unreasonable for you to think about how we thought about this year as being relatively consistent with last. + +-------------------------------------------------------------------------------- +John McDonald, Sanford C. Bernstein & Company, Inc. - Analyst [75] +-------------------------------------------------------------------------------- + + Okay, thank you. + +-------------------------------------------------------------------------------- +Operator [76] +-------------------------------------------------------------------------------- + + Our next question comes from Matt Burnell of Wells Fargo. + +-------------------------------------------------------------------------------- +Matt Burnell, Wells Fargo Securities, LLC - Analyst [77] +-------------------------------------------------------------------------------- + + Good morning. Just a question on the announcement of the potential for selling the prepaid card business. I'm just curious as to what drove that given that it doesn't appear that it was a scale related decision given the size of that business relative to peers, but if you could just provide a little more color as to what you're seeing in that business and what caused you to potentially sell that business. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co - Chairman and CEO [78] +-------------------------------------------------------------------------------- + + So every year, we try to have a disciplined approach about what we stay in and what we don't, and I think we probably were more disciplined this year about the things we don't need, both from derisking, capital, management focus, controls, et cetera. +If you look at the prepaid card business we are not dealing directly with customers, it's kind of secondary, it's a complex business and we were just better off letting someone else do it. It won't affect the four main franchises that Marianne spoke about that are doing so well. It's just kind of a product we used to do so we're not going to do it anymore. There's a lot of risk associated with it. + +-------------------------------------------------------------------------------- +Matt Burnell, Wells Fargo Securities, LLC - Analyst [79] +-------------------------------------------------------------------------------- + + Right, okay. And then just moving on to your comments about being potentially cautiously optimistic about back-end growth for loans, I presume that's mostly focused on commercial lending. Is it still your view that the canary in the coal mine foreseeing that might be slower deposit growth or in fact negative deposit growth before you start to see loan growth? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co - Chairman and CEO [80] +-------------------------------------------------------------------------------- + + So we didn't use the word cautiously optimistic. We're using the word optimistic because we are actually optimistic, and if you have a US economy starting to grow you will see loan growth and volume growth and of course all these businesses, we are actually optimistic about the US economy in particular. +We spend a lot of time analyzing what rising rates, growth, change of QE3 taper will do to deposits, so it might actually have a diminishing effect on the growth of deposits, but we're happy with it, we're still growing share. I'm not sure you're going to see deposits go negative before you seen loan growth. I think you're trying to fine tune it too closely there. + +-------------------------------------------------------------------------------- +Matt Burnell, Wells Fargo Securities, LLC - Analyst [81] +-------------------------------------------------------------------------------- + + Fair enough. And then just finally in terms of your outlook for card balances, it looks like just trying to take some of the fourth-quarter seasonality out of that business that they have sort of bottomed in terms of the overall balances. Are you equally optimistic for those balances to begin to grow in 2014 or are you still looking at sort of flattish balances through most of 2014? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [82] +-------------------------------------------------------------------------------- + + Yes, so remember that in our card business we have both dynamics of core growth as well as still some continued run-off. We did reach the inflection point during the second half of 2013 where that run-off was no longer exceeding growth, and so we're set to grow but very modestly in 2014. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co - Chairman and CEO [83] +-------------------------------------------------------------------------------- + + But more importantly, 93% of the business awards, we've had 10% growth in spend, we've had was it 14% growth in merchant processing, so we are very happy with the card business. It performed exceptionally well, excellent credit trends so outstanding growth is less important but obviously we like to see some of that too. + +-------------------------------------------------------------------------------- +Matt Burnell, Wells Fargo Securities, LLC - Analyst [84] +-------------------------------------------------------------------------------- + + And then just finally for me, are you seeing given some of the security breaches not only in your cards but across a couple of other issuers, have you seen any reduction in consumer spending potentially related to that via cards moving to other forms of purchases or is that? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co - Chairman and CEO [85] +-------------------------------------------------------------------------------- + + No. + +-------------------------------------------------------------------------------- +Matt Burnell, Wells Fargo Securities, LLC - Analyst [86] +-------------------------------------------------------------------------------- + + No? Okay. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co - Chairman and CEO [87] +-------------------------------------------------------------------------------- + + Just a little bit relating to Target but not in general. + +-------------------------------------------------------------------------------- +Matt Burnell, Wells Fargo Securities, LLC - Analyst [88] +-------------------------------------------------------------------------------- + + Okay. Thank you very much. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co - Chairman and CEO [89] +-------------------------------------------------------------------------------- + + A lot of the card growth is coming from T&E and travel and restaurants and things like that. + +-------------------------------------------------------------------------------- +Matt Burnell, Wells Fargo Securities, LLC - Analyst [90] +-------------------------------------------------------------------------------- + + Okay, thank you. + +-------------------------------------------------------------------------------- +Operator [91] +-------------------------------------------------------------------------------- + + Our next question comes from Andrew Marquardt of Evercore Partners. + +-------------------------------------------------------------------------------- +Andrew Marquardt, Evercore Partners - Analyst [92] +-------------------------------------------------------------------------------- + + Good morning guys. Regarding expenses, can you remind us where we stand on the headcount reductions through I guess 2013 and then where you stand in terms of on track for 2014? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [93] +-------------------------------------------------------------------------------- + + Yes, so just to remind you what we said back in February or last year, in the consumer businesses we talked about over the two years, so 2013 and 2014, mortgage seeing headcount reductions of 13,000 to 15,000, and the consumer business predominantly in the branches of 4,000. By the end of 2013, we had seen a 16,500 in total, so in the consumer bank we are actually not only accelerated but outperforming our expectations in terms of our ability to run those branches efficiently and still maintain very strong customer satisfaction and retention rates. +And then in the mortgage base, we have seen total headcount down 11% year over year against that 13,000 to 15,000 two-year target. So obviously we continue to work on the strategy and the size and our approach to mortgage market, but they're obviously relative to those numbers, there's still a little way to go. + +-------------------------------------------------------------------------------- +Andrew Marquardt, Evercore Partners - Analyst [94] +-------------------------------------------------------------------------------- + + Okay, and then -- + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [95] +-------------------------------------------------------------------------------- + + And remember sorry, remember that that was both production and servicing. What you saw given the rate environment in the middle of second half of 2013 is that some of the production-related headcount reductions were accelerated. We still have meaningful improvement expected in terms of delinquencies and foreclosures and modifications that will continue to drive cost and headcount down in 2014. + +-------------------------------------------------------------------------------- +Andrew Marquardt, Evercore Partners - Analyst [96] +-------------------------------------------------------------------------------- + + Got it, thank you. And then in terms of the retail branch banking discussion that you had mentioned that you're kind of comfortable with the 5,600 branches level that you're at now, and your focus on optimization going forward, does that imply that you could see additional headcount reductions or shrinkage of the branch network or square footage as we've seen from others? How should we think about that? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [97] +-------------------------------------------------------------------------------- + + So I would think about -- talking about the number of branches I would think about the fact that it all goes to retail distribution, houses will continue to do consolidations and relocations as it makes sense for us to do that in our footprint, and we'll continue to respond to customer preferences, which will mean that over the course of the next decade we'll be looking at obviously the size and use of branches as branches come up for renovation and release and things like that. But we're not expecting a material change in the number as a macro matter, so 5,600 plus or minus, and it is going to be based on customer preferences. +As it relates to headcount reductions, we're already aggressively looking at the efficiency in our same-store branches and have been very successful, so we are looking at starting models, physical capabilities, automation, we're on that journey and we continue to be on it, but I don't see that it's going to be a step change relative to our previous expectations. We've already exceeded them, might be some more, but it's not a step change. + +-------------------------------------------------------------------------------- +Andrew Marquardt, Evercore Partners - Analyst [98] +-------------------------------------------------------------------------------- + + Got it, thank you. Then lastly just on credit quality. It feels like obviously still meaningful reserve releases, still largely in consumer. But is there much left to go in terms of cards or commercial, is that kind of inflecting if you will in terms of the degree of credit leverage that may still be there in terms of reserve release? How should we think about that? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [99] +-------------------------------------------------------------------------------- + + So let's start with commercial and say that it's plus or minus zero at this point, so I think it's going to be strong for long, but that's not really going to be a reserve story for a little while. In the card business, we had been talking about having potentially reached bottom for a period of time. +We haven't yet or it doesn't seem we have, so as you look into 2014, if things do continue to strengthen, it's possible there will be some more releases but not at the levels that you saw in 2013. So in the first couple of quarters, and usually the first quarters are instructive on that point, usually that's when you see a material improvement if there's going to be one in terms of flow rates. +And then on the mortgage space, two things. We have $2.6 billion of NCI reserve left. We've talked before about the fact that we think our more steady run rate number will be between $1 billion and $1.5 billion, so there's another $1 billion to $1.5 billion to come in that space over the course of the next year or so potentially, obviously environment allowing. +And then on an NCI --- I'm sorry --- on the purchased credit impaired portfolio, we have $4.2 billion left off the two releases we just took. But remember that it's a life-of-loan portfolio. So something would have to change now, and the environment improve, for us to expect to take more releases. It is possible, but nothing --- we don't expect to be taking releases up to that $4.2 billion. + +-------------------------------------------------------------------------------- +Andrew Marquardt, Evercore Partners - Analyst [100] +-------------------------------------------------------------------------------- + + Got it. Thank you. + +-------------------------------------------------------------------------------- +Operator [101] +-------------------------------------------------------------------------------- + + Our next question comes from Mike Mayo of CLSA. + +-------------------------------------------------------------------------------- +Mike Mayo, Credit Agricole Securities - Analyst [102] +-------------------------------------------------------------------------------- + + Good morning. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [103] +-------------------------------------------------------------------------------- + + Good morning. + +-------------------------------------------------------------------------------- +Mike Mayo, Credit Agricole Securities - Analyst [104] +-------------------------------------------------------------------------------- + + Last quarter you had some tax benefits. Did you have tax benefits this quarter and can you quantify those? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [105] +-------------------------------------------------------------------------------- + + Yes, we did have some tax benefits this quarter. We had about $300 million after-tax. + +-------------------------------------------------------------------------------- +Mike Mayo, Credit Agricole Securities - Analyst [106] +-------------------------------------------------------------------------------- + + Okay. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [107] +-------------------------------------------------------------------------------- + + Related to a number of items but state and local tax, some reserve releases, not one particular thing. + +-------------------------------------------------------------------------------- +Mike Mayo, Credit Agricole Securities - Analyst [108] +-------------------------------------------------------------------------------- + + And what was the loan utilization rate for wholesale or commercial loans? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [109] +-------------------------------------------------------------------------------- + + It was just a little over 30%, low 30%s. + +-------------------------------------------------------------------------------- +Mike Mayo, Credit Agricole Securities - Analyst [110] +-------------------------------------------------------------------------------- + + So no change? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [111] +-------------------------------------------------------------------------------- + + No change. + +-------------------------------------------------------------------------------- +Mike Mayo, Credit Agricole Securities - Analyst [112] +-------------------------------------------------------------------------------- + + Okay, and you said the number of branches shouldn't change a whole lot. If I recall from Investor Day you had planned on opening a lot of new branches, I thought it was going to be a net increase, so is this a change in your expectations? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co - Chairman and CEO [113] +-------------------------------------------------------------------------------- + + Yes. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [114] +-------------------------------------------------------------------------------- + + Yes, so we said I think at Investor Day plus 100, plus or minus in a year, when Gordon spoke earlier in 2013, we've revisited based upon our assessment of cost and preferences and activity and think we've got the footprint where we are happy at 5,600 plus or minus. --- + +-------------------------------------------------------------------------------- +Mike Mayo, Credit Agricole Securities - Analyst [115] +-------------------------------------------------------------------------------- + + Gordon, if you look at that [bab] presentation, Gordon goes extensively through branches, branch size, technology, headcounts, and why. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [116] +-------------------------------------------------------------------------------- + + So if you look at bab and then obviously also at Investor Day we'll go through it more. + +-------------------------------------------------------------------------------- +Mike Mayo, Credit Agricole Securities - Analyst [117] +-------------------------------------------------------------------------------- + + Okay. And then the more general question is per your outlook you said that NII should be kind of flat, mortgage a little bit lower, and expenses only about flat or maybe lower from that $60 billion after you eat that extra $1 billion, so it makes a difference how optimistic you are. +If you are not optimist, you might want to cut expenses more, and if you are optimistic, maybe you assume that fees are going to grow a lot more because I know you want positive operating leverage so how do you see revenues growing faster than expenses? Is it the fees picking up, is it expenses going lower or how do you get there? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [118] +-------------------------------------------------------------------------------- + + So it's a bit of both. Just one thing on mortgage. Just a tiny clarification. +We expect Mortgage deductions to be broadly the same as we've seen in the second half but we would expect to continue to see improvements in the expense base in the servicing business. But having said all of that it's a combination of relatively stable but potentially slightly higher NII. +Yes, strength in fees on the basis of the strong driver growth that we talked about, and then our $60 billion or less of expenses. So we're working through all of the efficiency opportunities across the businesses, including in the retail space to be able to deliver positive operating leverage. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co - Chairman and CEO [119] +-------------------------------------------------------------------------------- + + And Mike I think the way you get to it is each of our businesses is always trying to drive efficiency while investing. That doesn't change any particular year. It's kind of a non-stop kind of thing and you see those efficiencies because every business has pretty good margins after investing. And sometimes the revenue growth itself is either episodic or the timing isn't exactly the same how you invest, but if you see the drivers, which is deposits, investable assets, asset management, number of corporate clients, market shares, they are all pretty positive so we're not going to -- + +-------------------------------------------------------------------------------- +Mike Mayo, Credit Agricole Securities - Analyst [120] +-------------------------------------------------------------------------------- + + Can you just give us a general sense of your outlook for CIB? In the past you've given us a little bit more detailed future expectations. I mean how do you think 2014 is going to be for capital markets? What's your backlog like right now, and why do you lower VaR if you're more optimistic? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co - Chairman and CEO [121] +-------------------------------------------------------------------------------- + + Well VaR itself is a calculation that's based upon a whole bunch of different things. We don't deliberately lower VaR. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [122] +-------------------------------------------------------------------------------- + + With VaR, Mike it really is just a feature of two things. If you look at our look back at VaR, across asset classes we're at very low levels of volatility, just across all of the asset classes, and that's actually driving it. If volatility picks up, that could pick up, we're not driving that down, and it's also derisking an SEP, that is a little bit proactive but it's obviously mostly done now, so then on CIB -- + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co - Chairman and CEO [123] +-------------------------------------------------------------------------------- + + Actually we did a number, if you would stay with the volatility that was 18 months ago, VaR itself would be like $60 million or $70 million just all on its own so without changing your position et cetera. +So Mike, the hardest business to get a handle on is CIB, when you talk about the short run, but what we see is investors still have to buy social securities, corporations have ECM and DCM, and you could predict the rolloff et cetera. The backlogs are pretty good. You saw a tremendous amount of IPOs in 2013. +You saw a lot of debt financings, you've already seen a bunch of M&A earlier this year, so we don't budget or plan that you're going to have an unbelievable year in CIB, but if you ask me, the long-term prospects are good. It's probably the business that has to go through the most adjustments in the new regulatory environment, but the long-term prospects are pretty good, so our margins are good, our returns are good. +You see our comp levels of 30%, down from 38% a couple years ago, really reflecting higher capital et cetera. But at that comp level we can pay our people well, grow the franchise all around the world, serve our clients, and still get decent returns. So we feel very good about the business and one of these days it's going to boom, and it's not going to boom because we, you can get just like I can guess when that might happen but it will happen one day. + +-------------------------------------------------------------------------------- +Mike Mayo, Credit Agricole Securities - Analyst [124] +-------------------------------------------------------------------------------- + + And then lastly, as it relates to Volcker, you said it should not hurt the results materially going ahead in the past, you said it might hurt $1 billion, and then another time you said it might even help. I know that was different Management at the head then, but now you don't think it should impact things too much? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co - Chairman and CEO [125] +-------------------------------------------------------------------------------- + + Volcker, all things equal we would say not much. I think when we referred to the $1 billion or $2 billion, we were talking about regulations in general, including derivatives, SAS, clearing houses, and Volcker, and that number we still kind of have in the back of our mind but it's hard to tell what the effect of all those things are. The $1 billion or $2 billion I would say was probably in the conservative category. + +-------------------------------------------------------------------------------- +Mike Mayo, Credit Agricole Securities - Analyst [126] +-------------------------------------------------------------------------------- + + And how much of that would be reflected already? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co - Chairman and CEO [127] +-------------------------------------------------------------------------------- + + That's the one that's hard to tell. I would guess-- + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [128] +-------------------------------------------------------------------------------- + + Yes, so it's very difficult to back test because these things are all interrelated so it's not entirely possible to disentangle everything, but obviously we've gone through the changes in 2013, some of that will be reflected, but this is a number that we would expect to be reflected to the degree that it is all over the course of the next two years. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co - Chairman and CEO [129] +-------------------------------------------------------------------------------- + + Remember some of those things reduce capital requirements, some people are making dramatic changes in their business models which may free up market share for those of us that have additional market share, so it all remains to be seen. And that was also a static analysis. Some certain things we may reprice a little bit because of the capital liquidity requirements around them, so it all remains to be seen. + +-------------------------------------------------------------------------------- +Mike Mayo, Credit Agricole Securities - Analyst [130] +-------------------------------------------------------------------------------- + + Alright, thank you. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [131] +-------------------------------------------------------------------------------- + + Thank you, Mike. + +-------------------------------------------------------------------------------- +Operator [132] +-------------------------------------------------------------------------------- + + Our next question comes from Erika Najarian of Bank of America. + +-------------------------------------------------------------------------------- +Erika Najarian, BofA Merrill Lynch - Analyst [133] +-------------------------------------------------------------------------------- + + Good morning, just had two quick follow-up questions. The first is on the expectations for the expense base and CCB. If you take out that $400 million in legal expenses you're looking at a run rate of $6.9 billion. If you think about what the tailwinds could be for expenses for this year, is it fair to assume that that $6.9 billion quarterly run rate can improve throughout the year this year? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [134] +-------------------------------------------------------------------------------- + + So I would just reiterate what we previously said, which is if you look at Servicing and in particular, the quarterly run rate, which call it $600 million in line with our expectation that's going to continue to trend down towards $500 million by the end of the year in 2014. +And then on the production side while we obviously are going to see our expenses to a degree of variable with the size of the market, we're continuing to also work on opportunities to make the fixed cost base more efficient, so hopefully we'll deliver some of that in 2014 too. And we'll do a more precise job of putting a bow around that for you at Investor Day. + +-------------------------------------------------------------------------------- +Erika Najarian, BofA Merrill Lynch - Analyst [135] +-------------------------------------------------------------------------------- + + Okay. And the quick other follow-up is a follow-up to Guy's question on operational risk capital. You mentioned that there was a 50 basis point haircut due to litigation. Assuming that you're not going to have similar out sized litigation expense going forward, is that 50 basis point something that you can eventually recoup and how long would that take? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [136] +-------------------------------------------------------------------------------- + + So that's an excellent question. I would say assuming we have no significant losses going forward then we feel like we should be close to our high point, albeit maybe a little bit more in the first half of 2014. +The reality, just two comments on operational risk. The first is unlike market and credit risk, although all of the parameters and the confidence levels are effectively the same, it doesn't naturally recalibrate itself to changes in the business environment, or to your business mix or model, if you structurally reduce risk. It's very backward-looking, and in that sense it differs because it doesn't recalibrate. And so, as a result if you just let the models continue to predict based on historical losses going forward, you would need to be carrying that elevated level of operational risk capital forward for a reasonably long time. +It's a 1 in a 1,000 year horizon, so think about it in terms of 5 or 10 years, not 1 or 2 years. And so for that reason, we are very interested and working very hard with the industry to try and figure out how to better model changes in the business environment, and to both model and defend structural and permanent risk changes in our businesses in order to be able to recoup some of that more quickly. But at this point I would characterize that as work that has not yet been done, that is in progress, and so for the foreseeable futurity will be elevated. + +-------------------------------------------------------------------------------- +Erika Najarian, BofA Merrill Lynch - Analyst [137] +-------------------------------------------------------------------------------- + + Okay, thank you. + +-------------------------------------------------------------------------------- +Operator [138] +-------------------------------------------------------------------------------- + + Our next question comes from Matthew O'Connor of Deutsche Bank. + +-------------------------------------------------------------------------------- +Matthew O'Connor, Deutsche Bank - Analyst [139] +-------------------------------------------------------------------------------- + + Good morning. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [140] +-------------------------------------------------------------------------------- + + Good morning, Matt. + +-------------------------------------------------------------------------------- +Matthew O'Connor, Deutsche Bank - Analyst [141] +-------------------------------------------------------------------------------- + + If we just add up kind of some of the odds and ends of the businesses that you are getting out of, or the niche products and impact of Volcker, is it still a relatively modest amount in aggregate? I think last quarter, you had said maybe a few hundred million of revenue give-up from the businesses that you are tweaking. And I just want to know if that still holds, and if we overlay Volcker, kind of what the all-in number might be? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [142] +-------------------------------------------------------------------------------- + + Okay. So to put Volcker aside for a second, with respect we didn't update obviously the list, we are going to do that at Investor Day. We talked about that for you. It's more important to think less about revenue, but more on the impact on the bottom line, given some of these businesses they now have been returning hurdle, may have been in the investment phase, and actually not been breaking even. +So I think it's fair to say that if you consider the impact on the bottom line more so than revenues that it's going to be modest, and we will do work to update you on that. But remember, it also is going to do two things, release capital which will be a positive, and also improve the quality of the businesses and the control environment and the complexity which would all be positive too. + +-------------------------------------------------------------------------------- +Matthew O'Connor, Deutsche Bank - Analyst [143] +-------------------------------------------------------------------------------- + + Okay, and then just separately, as we think about potential legal uncertainly as a risk going forward, are there a couple that you kind of flag out there that are the ones we should be watching most closely for the industry, for you guys whether it's LIBOR or FX? Or feels like you have obviously settled a lot in the mortgage side, a couple other big ones that are specific to you, what should we be watching to make sure that we have a sense of what is going on? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co - Chairman and CEO [144] +-------------------------------------------------------------------------------- + + It is the ones that you all mentioned, and we put them in our 10-K. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [145] +-------------------------------------------------------------------------------- + + Yes, it is the ones you mentioned, and as you look at our disclosures in the 10-Q. Every quarter, the items that we think raise themselves to the level of public disclosure are in that document. So look to last quarter and next quarter and you will see, but we shouldn't comment specifically. + +-------------------------------------------------------------------------------- +Matthew O'Connor, Deutsche Bank - Analyst [146] +-------------------------------------------------------------------------------- + + And nothing new, if we knew coming out in the 10-K versus the third quarter Q? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co - Chairman and CEO [147] +-------------------------------------------------------------------------------- + + I don't think so. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [148] +-------------------------------------------------------------------------------- + + Not this point, but obviously the Ks are a few weeks away. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co - Chairman and CEO [149] +-------------------------------------------------------------------------------- + + Yes. + +-------------------------------------------------------------------------------- +Matthew O'Connor, Deutsche Bank - Analyst [150] +-------------------------------------------------------------------------------- + + Okay, thank you very much. + +-------------------------------------------------------------------------------- +Operator [151] +-------------------------------------------------------------------------------- + + Our next question comes from Moshe Orenbuch of Credit Suisse. + +-------------------------------------------------------------------------------- +Moshe Orenbuch, Credit Suisse - Analyst [152] +-------------------------------------------------------------------------------- + + Great, thanks. On that question about the operational risk capital, isn't it kind of double or triple counting against you when you have got like an $8 billion reserve which reduces your capital? And is it fair to say you don't get credit for that $8 billion in your capital base, when you think about that operational risk capital? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [153] +-------------------------------------------------------------------------------- + + So I mean, I think -- if you think about the sort of basis for capital and put aside whether you like the way it works in a modeled environment, your reserves, that is for expected losses and capital to your expected losses. So in theory you shouldn't get explicit credit for them. I think the bigger point for us is, if you look at the sorts of things driving our capital levels to be as elevated as they are, they are things for example, like the PLMBS issues, and also certain of the very large mortgage DOJ and national mortgage settlement and ISR compensation issues. +It's our belief that this Firm is not exposed today or will not be exposed going forward to those levels of risk, at anywhere near that scale going forward. But as I have said, we have no ability at this point to scale those back, and that's what we are very focused on. So it's less really about whether we are getting credit for our reserves, and a little bit more about how we try in the industry to evolve the framework in partnership with the regulators, and defend over time that there are structural risk reductions that mean those risks are no longer present in that scale. + +-------------------------------------------------------------------------------- +Moshe Orenbuch, Credit Suisse - Analyst [154] +-------------------------------------------------------------------------------- + + Got it. So in the short run the fact that you have settled them actually increases the operational risk, but you hope that over the longer term it will decrease it. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [155] +-------------------------------------------------------------------------------- + + Yes. + +-------------------------------------------------------------------------------- +Moshe Orenbuch, Credit Suisse - Analyst [156] +-------------------------------------------------------------------------------- + + You had made a brief comment about the equities results about the comparable periods being higher. Were there any other reasons that equity raiding results were kind of down as much as they were? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [157] +-------------------------------------------------------------------------------- + + Not specifically. We did fairly well in cash, but our cash platform is not as mature as some others. So I think we would characterize the performance as good, but coming off of as I said a very strong quarter for equity derivatives in the third quarter. + +-------------------------------------------------------------------------------- +Moshe Orenbuch, Credit Suisse - Analyst [158] +-------------------------------------------------------------------------------- + + Got it. And then any other areas, I mean, Gordon Smith has presented a few times and talked about kind of derisking some of his businesses. Any other areas that we should be looking at for sales? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [159] +-------------------------------------------------------------------------------- + + So just I'll comment. On Page 15 last quarter, we showed you a bunch of things we're working on. We didn't replace the page, because it has not meaningfully changed. That is not to say that at the margins we don't continue to look at our businesses in terms of sophistication and derisking. So I would say that while there may be things that the margin that we will explore over time, then there is nothing structurally big that you should be aware of. + +-------------------------------------------------------------------------------- +Moshe Orenbuch, Credit Suisse - Analyst [160] +-------------------------------------------------------------------------------- + + Great. Thanks so much. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [161] +-------------------------------------------------------------------------------- + + And again, we will do some more of that for you at Investor Day. + +-------------------------------------------------------------------------------- +Moshe Orenbuch, Credit Suisse - Analyst [162] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Operator [163] +-------------------------------------------------------------------------------- + + Our next question comes from Gerard Cassidy of RBC. + +-------------------------------------------------------------------------------- +Gerard Cassidy, RBC Capital Markets - Analyst [164] +-------------------------------------------------------------------------------- + + Thank you. Good morning. You mentioned that your utilization rate in the commercial areas in the low 30% range presently, and you also pointed out that you are optimistic about the US economy for this year being stronger, and then the positive impact it will have on loan demand. What do you think the utilization rate could get to by year-end? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co - Chairman and CEO [165] +-------------------------------------------------------------------------------- + + That's a hard question but -- so Middle Market if you go back -- so I am going to do just Middle Market because that's the one that's kind of at a 30% too. Years ago, you used to average more like 45%. +It looks like to us, that what you have -- is they have a lot more deposits and a lot less utilization. And so obviously, they are going to use some of their own money before they borrow against a revolver or something like that, and one day, you would expect it to go up. We aren't guessing what's going to happen in 2014, but I would say, we will be sitting here one day when you have had a very strong economy it will be 10 points higher. + +-------------------------------------------------------------------------------- +Gerard Cassidy, RBC Capital Markets - Analyst [166] +-------------------------------------------------------------------------------- + + Good, and then on the commercial Real Estate, as you pointed out you are having real good success in this area. What geographic regions of the country are you seeing the best success, and then second, what product types are you finding are working the best in growing that book? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co - Chairman and CEO [167] +-------------------------------------------------------------------------------- + + Well multi-families a big portion of that and you see that in a lot of -- I would say obviously the major cities is pretty much where you would say -- it's hard to answer specifically. I think both multi-family and other real estate loans, it's really the big cities. + +-------------------------------------------------------------------------------- +Gerard Cassidy, RBC Capital Markets - Analyst [168] +-------------------------------------------------------------------------------- + + You also mentioned that you have about $350 billion on deposit at the Fed. If the Fed decides to eliminate the interest they pay on those deposits to all of the banks, will that change your strategy of keeping that amount up at the Fed? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co - Chairman and CEO [169] +-------------------------------------------------------------------------------- + + Sure. Change either that, or how you reimburse clients for deposits, and obviously it will go into how you price them on your business. We are not expecting that to happen, but obviously we would do that, and you have other alternatives, so you might invest some of that money elsewhere. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [170] +-------------------------------------------------------------------------------- + + Yes, and it's also important to point out there is a large portion of that $350 billion are deposits or cash that we would consider to be client non-operational deposit. And as a result, we don't give ourselves any liquidity value for those, so that is why we are putting them overnight in the Fed. + +-------------------------------------------------------------------------------- +Gerard Cassidy, RBC Capital Markets - Analyst [171] +-------------------------------------------------------------------------------- + + Okay, I may have missed this, but in the card merchant and services auto business, the non-interest expenses for the fourth quarter jumped up to $2.2 billion from the prior quarters' $1.9 billion. They have been flat for the prior three quarters. Any particular reason why there was a jump like that? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co - Chairman and CEO [172] +-------------------------------------------------------------------------------- + + Mostly marketing. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [173] +-------------------------------------------------------------------------------- + + Yes, it's predominantly marketing, and with respect to marketing it can be lumpy quarter to quarter. So it's not an unexpected number for us, it's just higher in the fourth quarter than it was in the third. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co - Chairman and CEO [174] +-------------------------------------------------------------------------------- + + But we have been doing a good job of card acquisition of high quality cards. You see -- I forgot the number, but it's up quite a bit. So we have some good active programs out there. + +-------------------------------------------------------------------------------- +Gerard Cassidy, RBC Capital Markets - Analyst [175] +-------------------------------------------------------------------------------- + + It looks like in the quarter that you bought back about $300 million worth of stock in this quarter, and year-to-date or since the last CCAR, its just over $2.2 billion. If I recall you have an approval for $6 billion. Is it fair to assume you will use the next quarter to fill out the first -- the rest of the $6 billion or is that too optimistic? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co - Chairman and CEO [176] +-------------------------------------------------------------------------------- + + Way optimistic. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [177] +-------------------------------------------------------------------------------- + + Yes, I think that would be optimistic. Obviously, we will determine the third quarter as we go through it. We will cover employee issuance, but that's certainly our expectation and maybe more, but I don't think you should expect us to catch up from PB. + +-------------------------------------------------------------------------------- +Gerard Cassidy, RBC Capital Markets - Analyst [178] +-------------------------------------------------------------------------------- + + And finally -- (Multiple Speakers). + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co - Chairman and CEO [179] +-------------------------------------------------------------------------------- + + Remember, we want to meet our own objective of the 9.5% or 10%. And obviously the litigation costs hurt our ability to do that, so we caught up on that. And also the stock price is a lot higher than it was when we talked about trying to aggressively buyback some stock. So we always look at that as a important thing. We don't just buyback stock regardless of price. Not that we can't get that price, but when it was at $33 a share or whatever, that was a extraordinary compelling price. + +-------------------------------------------------------------------------------- +Gerard Cassidy, RBC Capital Markets - Analyst [180] +-------------------------------------------------------------------------------- + + You also gave us a little bit of guidance of what we should expect for this year's CCAR, maybe similar to what you did last year. Should we look at what you're approved for or what you executed in the repurchases is a better guide number since they are quite a bit different? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co - Chairman and CEO [181] +-------------------------------------------------------------------------------- + + The Board will decide when the time comes and they look at all of the priorities et cetera. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [182] +-------------------------------------------------------------------------------- + + I would just reiterate what I said before, which is getting to our target ratio is a priority, it is not the only one. We will have to see how things play out in 2014. But if you do the math then you can take your own estimates of what you think we will earn next year. We should be able to also have the opportunity to take it to buy more than just employee issuance, so you are just going have to -- we want that flexibility. That is what we submitted for, and we will obviously manage through each quarter as we see it. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co - Chairman and CEO [183] +-------------------------------------------------------------------------------- + + It may depend on what we sell, how much we can mitigate, what the final rules are and stuff, so there is a lot of moving parts. + +-------------------------------------------------------------------------------- +Gerard Cassidy, RBC Capital Markets - Analyst [184] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Operator [185] +-------------------------------------------------------------------------------- + + Our next question comes from Derek De Vries of UBS. + +-------------------------------------------------------------------------------- +Derek De Vries, UBS - Analyst [186] +-------------------------------------------------------------------------------- + + Thanks, good morning. I just have a few housekeeping questions left. I think you mentioned a mark-to-market gain in Asset Management revenues, wondering if you can just quantify that so we can straighten it out for our forecast? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [187] +-------------------------------------------------------------------------------- + + It's just a little less than $100 million. + +-------------------------------------------------------------------------------- +Derek De Vries, UBS - Analyst [188] +-------------------------------------------------------------------------------- + + Perfect. And then on the Investment Bank, on the comp to income ratio, it is clearly at the right end of your guidance. I am just wondering has there been any change in the deferred versus expense this year, and then I guess related do we enter 2014 with a similar amount of awarded not yet expensed? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co - Chairman and CEO [189] +-------------------------------------------------------------------------------- + + Yes. So there is no change -- (Multiple Speakers). There is no real change in how we do anything. + +-------------------------------------------------------------------------------- +Derek De Vries, UBS - Analyst [190] +-------------------------------------------------------------------------------- + + That's it for me, thank you. + +-------------------------------------------------------------------------------- +Operator [191] +-------------------------------------------------------------------------------- + + Our next question comes from Eric Wasserstrom of SunTrust Robinson Humphrey. + +-------------------------------------------------------------------------------- +Eric Wasserstrom, SunTrust Robinson Humphrey - Analyst [192] +-------------------------------------------------------------------------------- + + Thanks very much. I just wanted to follow-up on the loan growth expectations. If we adjust for the typical seasonality associated with the credit card loans, which obviously is high in the fourth quarter, it looks like your core growth rate in loans was something like 60 or 70 basis points sequentially, which would obviously translate into roughly a 2.5% annual growth rate. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co - Chairman and CEO [193] +-------------------------------------------------------------------------------- + + Are you talking about total loans -- ? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [194] +-------------------------------------------------------------------------------- + + Are you talking about total and core, or are you talking about reported and -- ? + +-------------------------------------------------------------------------------- +Eric Wasserstrom, SunTrust Robinson Humphrey - Analyst [195] +-------------------------------------------------------------------------------- + + Card. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co - Chairman and CEO [196] +-------------------------------------------------------------------------------- + + Yes. + +-------------------------------------------------------------------------------- +Eric Wasserstrom, SunTrust Robinson Humphrey - Analyst [197] +-------------------------------------------------------------------------------- + + Yes, I am talking about reported, correct. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [198] +-------------------------------------------------------------------------------- + + Okay. + +-------------------------------------------------------------------------------- +Eric Wasserstrom, SunTrust Robinson Humphrey - Analyst [199] +-------------------------------------------------------------------------------- + + Yes. So it just seems that the 2.5% seems like a fairly robust figure, so I wanted to get your view about what the run rate of core loan growth might be? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [200] +-------------------------------------------------------------------------------- + + Okay. So I am going to try to answer the question, and tell me if I don't I'm sorry. But if you look at our actual total loans for the whole Firm year-over-year, our gross reported was 0.6%, so just call it just shy of 1%. But underlying that core loan growth was about 4%. So I think that as we look forward, we expect core growth to continue at or stronger than those levels, and we have reached as you say in card the point where seasonality aside, that inflection point where we should expect net modest growth. +So and as I said, we are going to have to all wait and see how client demand plays out in the small business and Middle Market space. But we are hoping that at the second half of 2014, when the confidence in the economic recovery -- we have confidence but when others join us, that they will actually start to borrow and spend. + +-------------------------------------------------------------------------------- +Eric Wasserstrom, SunTrust Robinson Humphrey - Analyst [201] +-------------------------------------------------------------------------------- + + Okay. So it sounds like continuing along this trajectory with potential strength in the back half of next year? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [202] +-------------------------------------------------------------------------------- + + Yes, that's our hope. + +-------------------------------------------------------------------------------- +Eric Wasserstrom, SunTrust Robinson Humphrey - Analyst [203] +-------------------------------------------------------------------------------- + + So I'm just trying to reconcile that back to the NII dollar expectations which seem fairly flat. But if we are -- if the loan growth continues fairly strong and the expectation is to continue to deploy capital into securities opportunistically, and the CIO portfolio is approaching breakeven, why is the expectation not for a stronger net interest income dollar growth? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [204] +-------------------------------------------------------------------------------- + + Because we also are seeing -- we talked earlier about the fact we have been seeing and we expect to continue to see some spread compression in loans, that at this point in the near-term -- we didn't talk about the whole year for 2014 but in the near-term, we are expecting the improvement that we would see as a result of higher yields on investment securities et cetera to be offset by or largely offset by the compression in loan growth. + +-------------------------------------------------------------------------------- +Eric Wasserstrom, SunTrust Robinson Humphrey - Analyst [205] +-------------------------------------------------------------------------------- + + Okay, thanks very much. + +-------------------------------------------------------------------------------- +Operator [206] +-------------------------------------------------------------------------------- + + Our next question comes from Ken Usdin of Jefferies. + +-------------------------------------------------------------------------------- +Ken Usdin, Jefferies & Co. - Analyst [207] +-------------------------------------------------------------------------------- + + Hi, thanks. Just two final follow-ups. Just on the commitment side, as you talked about adjusting the trade book and as we see the commitments continue to come down, how aggressively are you focusing on the commitment side from here, in terms of balancing the long-term growth potential versus the risk weightings and capital build? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co - Chairman and CEO [208] +-------------------------------------------------------------------------------- + + The way to look at that is that, is what drives the Company is serving clients. And so, we don't target just to get rid of commitments or something like that. But obviously, we have asked all of the people in businesses who to start to optimize a little bit commitments, balance sheet, LCR, SLR, Basel III. And so, you probably see a little bit of a squeeze in commitments as they do that, but not at the expense of trying to do a good job for clients. + +-------------------------------------------------------------------------------- +Ken Usdin, Jefferies & Co. - Analyst [209] +-------------------------------------------------------------------------------- + + Sure, okay. Great, and the one follow-up on just the run-off -- (Multiple Speakers). + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co - Chairman and CEO [210] +-------------------------------------------------------------------------------- + + The other thing I should point out is some of those commitments are much more capital or liquidity hogs than others. + +-------------------------------------------------------------------------------- +Ken Usdin, Jefferies & Co. - Analyst [211] +-------------------------------------------------------------------------------- + + Yes. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co - Chairman and CEO [212] +-------------------------------------------------------------------------------- + + So that is where you can see a little bit more of the squeeze. + +-------------------------------------------------------------------------------- +Ken Usdin, Jefferies & Co. - Analyst [213] +-------------------------------------------------------------------------------- + + And then one follow-up on the fixed income side, within that comments earlier about the run-off businesses. Is there a way you can update how we should think about the potential sale of physical commodities, and what proportion it is of the $15.5 billion of FIC revenues this year. And to Marianne, to your point about how that is in a relative profitable sense? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [214] +-------------------------------------------------------------------------------- + + So I think if you look back and see that -- I mean, let's talk about this year and last year. If you look at 2013 reported, you would have seen that our commodities revenues counted for in the low teens of our markets revenues, but that's on an accounting basis. When you think about, so that's just a revenue pure only. +If you think about the economic revenue because obviously it's an accounting growth where it is much smaller number than that. So call it mid single digit, mid to 6%, 7%. But then it was a business that was in a combination of being built out so it wasn't fully mature. And also we are selling parts of the business that are highly capital intensive to us. So think about the impact of the bottom line as being considerably more modest and with some capital benefit. + +-------------------------------------------------------------------------------- +Ken Usdin, Jefferies & Co. - Analyst [215] +-------------------------------------------------------------------------------- + + Okay. Thanks very much. + +-------------------------------------------------------------------------------- +Operator [216] +-------------------------------------------------------------------------------- + + Our next question comes from Paul Miller of FBR. + +-------------------------------------------------------------------------------- +Paul Miller, FBR & Co. - Analyst [217] +-------------------------------------------------------------------------------- + + Yes, thank you very much. Most of my questions been answered, but I wanted to talk a little bit about your mortgage origination platform. It looks like you dropped from about $40 billion to $23 billion, and your overall market dropped like 25%, and that's like a 40% drop which drops probably your market share below 8%. +Can you add some color to that? Is that mainly a function of the refis going away? Should we see an increase in market share down the road? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [218] +-------------------------------------------------------------------------------- + + So I would -- a couple things. First of all, if you just take the second half versus first half, we said that we thought the overall market was down 30% to 40%. It was down about 33%. So it was in line with our expectations and our performance is in line with that too. So you have got to remember that the revenue versus closed loan volume, and how that gets recognized there is some timing differences. +With respect to market share, if you look backwards into 2013, the overall size of the market was revised up, which means that our market share was -- all else things being equal --just relatively revised down, doesn't change anything. But going forward, our market share will be a factor of obviously the size of the market, but also our pricing discipline to make sure we want to get an appropriate risk adjusted return. So we would gain share but only if we can do it, getting paid for the risk and the cost of servicing. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co - Chairman and CEO [219] +-------------------------------------------------------------------------------- + + And the whole reduction was refi. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [220] +-------------------------------------------------------------------------------- + + And the whole reductions was refi -- yes, I should say that, yes. (Multiple Speakers). + +-------------------------------------------------------------------------------- +Paul Miller, FBR & Co. - Analyst [221] +-------------------------------------------------------------------------------- + + And now that we have got -- I know you don't want to make any really comments about political figures. But now that we have got that Mel Watt coming to town, that is probably going to be more focused in extending the credit box that we have seen over the last couple of years, where most of the companies don't really want to get away from high FICO, high credit quality product. Do you --what type -- do you think that Watt can be successful in opening the credit curve, and what types of things would you want to hear where you would start extending that credit -- the credit box? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co - Chairman and CEO [222] +-------------------------------------------------------------------------------- + + So I would say that people in the business has slowly been extending the credit box, if you look at LTV -- I am talking about over the last 18 months, if you look at LTVs, if you go to different cities, I am not sure you are going to see a dramatic expansion of the credit box, because all of the rep and warranty and litigation and stuff like that, where anything that is not qualified mortgages. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [223] +-------------------------------------------------------------------------------- + + Yes, and for qualified mortgages, credit is available, GSE is 90% LTV, on the Ginnie Mae side closer to 100% LTV, so there is credit availability. You just have to have the ability to pay. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co - Chairman and CEO [224] +-------------------------------------------------------------------------------- + + And FHA will set its own policy. But even there I think you'll have a much tighter underwriting than the FHA guidelines, because of how much FHA's cost people. + +-------------------------------------------------------------------------------- +Paul Miller, FBR & Co. - Analyst [225] +-------------------------------------------------------------------------------- + + Okay, thank you very much. + +-------------------------------------------------------------------------------- +Operator [226] +-------------------------------------------------------------------------------- + + Our next question comes from Christopher Wheeler of Mediobanca. + +-------------------------------------------------------------------------------- +Christopher Wheeler, Mediobanca - Analyst [227] +-------------------------------------------------------------------------------- + + Yes, good morning. I have a couple of questions. The first one, maybe I suppose goes back to Sunday and the news that came out of [Bar]. I mean, I have the last 16 quarters we have been talking about regulation and you have often been quite aggressive in talking about the impact of some of that regulation. +But it seemed like we have reached the tipping point on Sunday, whereby we step back to most rules suggested in June, and came out with something that was sensible, but actually also was going to support the growth of your business, and indeed the growth of the economy. Do you think we are at a stage now where we can feel that we are over the worst of the regulation, and we can actually get on with running our and your businesses? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co - Chairman and CEO [228] +-------------------------------------------------------------------------------- + + I think we know for the most part the contours of the regulation at this point, and some of the fine tuning still needs to be done. So you can see a lot of banks globally, adjusting to the new financial architecture, and the effect of that will be different, different parts of the world, slightly different for certain products, but it will probably be okay in total. But it's nice to, I mean -- + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [229] +-------------------------------------------------------------------------------- + + Have the rules. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co - Chairman and CEO [230] +-------------------------------------------------------------------------------- + + Nice to have the rules and live with them, and now we have to push them down and understand them in a little more detail. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [231] +-------------------------------------------------------------------------------- + + There is still a few things we are waiting for, I mean, long-term debt requirements, something to look out for in the first quarter, but I mean, having more clarity is definitely helpful. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co - Chairman and CEO [232] +-------------------------------------------------------------------------------- + + You have seen some people make bigger strategic changes, some are making small tactical changes, and then we are going to report a lot more on what we think the effect of all of this in Investor Day. + +-------------------------------------------------------------------------------- +Christopher Wheeler, Mediobanca - Analyst [233] +-------------------------------------------------------------------------------- + + Okay, and the second question really relates down to the mix of your Investment Banking revenues. Clearly, what we have seen is obviously the downward on fixed income for some time now for a bunch of these, some of which you have touched on. But I suppose -- what a lot of people are talking about is the fixed income will no longer quite be the dominant parts of the revenue pool for big investment banks as it was. But in your case and one or two other big players, it's obviously very important business. Is your view, and perhaps don't just talk about yourself, but the really big players, the very successful players in fixed income, will actually probably be seeking to take share with what is going to be a smaller part going forward? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co - Chairman and CEO [234] +-------------------------------------------------------------------------------- + + Again, I look a little bit different. I look like -- the pot will change and adjust to new world, but from there will probably grow. Because if you look at underlying numbers, the amount of investable assets around the world is going to double over 10 years, the amount of needs of corporations, i.e -- and sovereigns and super nationals, and ECM, DCM advice will double over 10 years, so there is a -- there will be a strong underlying business. Spreads, products, those things have always changed. Spreads have been coming down my whole life, and yet we have a healthy business -- and so we expect that fixed income after some adjustment will be a good business. We think a lot of these trends are cyclical, not secular and that's how we are positioned for it. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [235] +-------------------------------------------------------------------------------- + + And we have paychecks. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co - Chairman and CEO [236] +-------------------------------------------------------------------------------- + + And we have -- (Multiple Speakers). + +-------------------------------------------------------------------------------- +Christopher Wheeler, Mediobanca - Analyst [237] +-------------------------------------------------------------------------------- + + I wish you luck. Thank you very much. (Multiple Speakers). + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co - Chairman and CEO [238] +-------------------------------------------------------------------------------- + + And it is possible that -- if people leave and the things we price it will go back to -- all businesses have to have a normal return on capital for the average player otherwise they wouldn't exist. So we do think you will see some of that. There will be pieces that go to non-banks which is fine. + +-------------------------------------------------------------------------------- +Christopher Wheeler, Mediobanca - Analyst [239] +-------------------------------------------------------------------------------- + + Okay, thank you very much. Appreciate it. + +-------------------------------------------------------------------------------- +Operator [240] +-------------------------------------------------------------------------------- + + Our next question comes from Steven Chubak of Nomura. + +-------------------------------------------------------------------------------- +Steven Chubak, Nomura Securities - Analyst [241] +-------------------------------------------------------------------------------- + + Hello, good morning. I had a couple questions regarding the Basel SLR. Specifically I wanted to clarify a comment where you made earlier where it sounds as though you expect the US regulators to adopt the revised Basel framework from over the weekend as a final SLR calculation approach. And I didn't know if that guidance was in the context of the higher 5% SLR requirement, which is being imposed on the US G-SIBS. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [242] +-------------------------------------------------------------------------------- + + Look, I think the reality is I don't know anymore than you do. I just that think given the changes that were made, it seemed to be positive and constructive as reason to believe that the US regulators would want to leverage that. I could be wrong, and I am not aware of -- obviously, we did comment letters on the US MPR, but I am not aware of any specifics on the portion. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co - Chairman and CEO [243] +-------------------------------------------------------------------------------- + + So I would just add, if you listen to what regulators said, not this time, but going back they intended to make Basel and US rules common about the rules. They did not say they intended to have the same percent. So we are just assuming the 5% is going to stay. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [244] +-------------------------------------------------------------------------------- + + Correct. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co - Chairman and CEO [245] +-------------------------------------------------------------------------------- + + And we think there will be a couple other adjustments going forward too. + +-------------------------------------------------------------------------------- +Steven Chubak, Nomura Securities - Analyst [246] +-------------------------------------------------------------------------------- + + Okay, no, that's helpful. And then just looking at both the risk base and leverage based ratios, it sounds as though for the SLR, there are a lot of mitigation opportunities at your disposal. On a pro forma basis, which ratio do you anticipate will represent the binding constrain on capital return going forward? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [247] +-------------------------------------------------------------------------------- + + So if you look at the total Firm consolidated, then they actually come out quite nicely. If you think about our target for [Tier 1] common at 10% to 10.5% and a leverage target of 5% to 5.5%. So I think the leverage ratio feels like as a consolidated matter, it is a simple backstop exactly as it is supposed to be and not a binding constraint. The devil is in the detail as you push that down, as I have said for the individual business and products. And then, obviously consider it in the context of the whole client relationship. I think as we look forward, CCAR is something to just be thoughtful about. Because it's a stressed scenario. It is evolving in terms of the maturity, as well as a move over time towards being on a Basel III advanced approach. So if I had to guess I would say CCAR could be. + +-------------------------------------------------------------------------------- +Steven Chubak, Nomura Securities - Analyst [248] +-------------------------------------------------------------------------------- + + Okay, thank you. And then transitioning to a risk-based ratio that is maybe I guess not spoken about as often, the Tier 1 capital ratio, that ultimately could compel increased preferred issuance. We did see capital market within the first six months of the year, and I didn't know how we should be thinking about the level of preferred issuance you are targeting going forward. Is it consisting with the 150 basis points noted within the Fed's proposal, or should we be thinking about that differently, i.e. some of the mandated buffer will be met with incremental equity? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [249] +-------------------------------------------------------------------------------- + + I would say -- so I would say that our Tier 1 capital needs to be at 11%-plus. We said we are going to run it at 10% to 10.5% above [Tier 1] common. I would suggest the gap will be prepped and maybe more. Maybe more prepped than that. + +-------------------------------------------------------------------------------- +Operator [250] +-------------------------------------------------------------------------------- + + Okay, thank you. That's helpful, and that's it for me. There are no further questions at this time. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co - CFO [251] +-------------------------------------------------------------------------------- + + Thank you, everyone. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co - Chairman and CEO [252] +-------------------------------------------------------------------------------- + + Thank you. Talk to you in another quarter. + +-------------------------------------------------------------------------------- +Operator [253] +-------------------------------------------------------------------------------- + + This concludes today's conference call. 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Earnings Conference Call +07/15/2014 08:30 AM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Jamie Dimon + JPMorgan Chase & Co. - Chairman and CEO + * Marianne Lake + JPMorgan Chase & Co. - CFO + +================================================================================ +Conference Call Participiants +================================================================================ + + * John McDonald + Sanford C. Bernstein - Analyst + * Paul Miller + FBR & Co. - Analyst + * Erika Najarian + BofA Merrill Lynch - Analyst + * Mike Mayo + Credit Agricole Securities - Analyst + * Eric Wasserstrom + SunTrust Robinson Humphrey - Analyst + * Guy Moszkowski + Autonomous Research - Analyst + * Steve Chubak + Nomura Asset Management - Analyst + * Gerard Cassidy + RBC Capital Markets - Analyst + * Jim Mitchell + Buckingham Research Group - Analyst + * Derek De Vries + UBS - Analyst + * Moshe Orenbuch + Credit Suisse - Analyst + * Glenn Schorr + ISI Group - Analyst + * Ken Usdin + Jefferies & Co. - Analyst + * Matt O'Connor + Deutsche Bank - Analyst + * Betsy Graseck + Morgan Stanley - Analyst + +================================================================================ +Presentation +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Good morning, ladies and gentlemen. Welcome to JPMorgan Chase's second-quarter 2014 earnings call. (Operator Instructions). We will now go live to the presentation. Please stand by. +At this time I would like to turn the call over to JPMorgan Chase's Chairman and CEO, Jamie Dimon, and Chief Financial Officer, Marianne Lake. Ms. Lake, please go ahead. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman and CEO [2] +-------------------------------------------------------------------------------- + + So this is Jamie and I am going to start if you don't mind. I know some of you have many questions on my recent cancer diagnosis so I would like to make a few comments on that so we can then hopefully focus on the reason for our call which is our quarterly earnings and the results of the Company. +First, I want to thank everybody for their calls, their notes, their good wishes. It does mean a lot to me and my family. To start with, I feel great. I think I have some of the best doctors in the world and I will be receiving the best treatment. I am very fortunate that this is curable. +To recap, we have already talked about and what my doctors have told me about, we caught it early, it is confined to the original site in the adjacent lymph nodes in the right side of my neck. It is isolated to that specific area. The cancer has not spread. Importantly, with all the tests they have done there is no evidence of cancer anywhere else in my body and it is curable with radiation and chemotherapy which I would put down as fairly standard for this kind of cancer and the prognosis is excellent. +The Board will be fully briefed on my condition and if they and I feel that it is necessary to make additional disclosures we will do that but I really do think the next disclosure I am going to make will be in about seven or eight weeks saying the therapy is over, I am feeling better and the prognosis is excellent. +My doctors have finalized their treatment plans with me over the last several days though I do plan as I go through treatment to be actively involved in managing our business. I've also been told that after the seven-week treatment period I have been advised to take rest, that does not mean that I won't work, they just simply say that rest and recuperation should come before other things which by the way is the exact same advice I give my friends, my family and anyone working at JPMorgan or any one of you who came down with something like this. +So I do plan to work. I do plan to read. I will be accessible. +Succession planning, that is why it is here, is exactly as it was before. There is no change whatsoever. The Board has plans in place and they talk about all the time for various scenarios and we are fortunate enough to have an exceptional group of executives. You know them all. I hope you take the time to tell some of the reporters the quality -- I was told people there is a book in every body and the book on a lot of the management team here is brains, ethics, work ethic, partnering, knowledge, experience, high-quality people and I actually think that many of them could run a major financial company and my Board feels the same way. +Importantly the Board has been fully engaged with the senior leaders the whole time they have been at this Company. I also want to point out that we have a standing protocol in place before this, during this, and after this. We think it is simply good governance that if I am unreachable for any reason -- remember I took a three-week trip to Asia. So if for a minute, an hour, a day or a week that they are to contact our lead director who will get them the consent, the advice and a help that they need so that the Company continues to go on as usual. +So I will stop there and hand it off to Marianne who will take you through the earnings of the Company. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [3] +-------------------------------------------------------------------------------- + + Okay, thanks, Jamie. Good morning, everyone. I am going to take you through the earnings presentation which is available on our website. Please refer to the disclaimer regarding forward-looking statements at the back of the presentation. +Starting then on page 1, the firm delivered strong performance this quarter with net income of $6 billion on revenues of over $25 billion; EPS of $1.46 and a return on tangible common equity of over 14%. The reported results as you can see on the page includes approximately $670 million of firmwide legal expense. In addition to that item, there were a number of other smaller items, some positive, some negative in the results, most notably $350 million of consumer reserve releases. And we estimate our core performance for the quarter was also $6 billion plus or minus which is among the best we have ever had which is a very good result especially given the challenging environment for markets and mortgage which persisted during the second quarter and interest rates remaining low and the cost of control high. +Importantly in the firm's performance this quarter, we are releasing the benefit of our diversified earnings profile as well as the focus on investing and growing the underlying performance drivers in each of our businesses which has translated into net income growth and operating leverage in a number of businesses most notably CBB, Commercial Banking and Asset Management. +We also continued to make significant progress against our capital targets with a CET1 ratio of 9.8%, firmwide and bank supplementary leverage ratios of 5.4% and 5.6% respectively, and remaining compliant with liquidity requirements all while returning $3 billion of capital to shareholders this quarter with gross share repurchases of $1.5 billion. +Core loan growth was strong for the quarter at 4% and 8% up year on year with encouraging signs across our businesses. And NII was up slightly this quarter on a relatively flat core NIM. +Turning to page 2, before getting into each of the businesses, a couple of comments here. You can see circled the adjusted expense for the quarter was $14.8 billion for an adjusted overhead ratio of 58%. This number does obviously exclude legal expense but of note, it includes a little less than $300 million of expenses related to business simplification which we consider to be non-core. +Including lower incentive compensation on lower CIB revenues for the first half, we have updated our adjusted full-year expense guidance to be $58 billion plus or minus with a caveat that obviously the final number will depend on performance-related compensation for the full year. +We continue to be focused and diligent on managing expenses and operating as efficiently as possible across our businesses. You can also see on the page the returns generated this quarter by each of our businesses which is driving strong performance of the firm overall. +Moving on to page 3, as I said, the firm reported a CET1 ratio of 9.8%, up from 9.6% last quarter as we increased our common equity Tier 1 capital base by over $4 billion principally through net retained earnings. Risk-weighted assets were broadly flat in the quarter with higher operational risk RWA and some growth largely offset by lower market and credit risk RWA reflecting increased model usage and portfolio runoff. We are still on track to reach 10% plus CET1 ratio by the end of the year as previously guided. +The lower of our two transitional measures and you will recall we exited Basel III Parallel at the beginning of the quarter so the lower of our two transitional measures which is technically the measure effective this quarter under the common floor is the Basel III Advanced transitional ratio which is also at 9.8%. And what isn't on the page but for your information, the fully phased in standardized ratio is 10.1%. +We continue to make good progress on our leverage ratios this quarter. Both the firm and the bank SLR improved quarter over quarter by about 30 basis points so we are obviously within sight of our 5.5% target for the firm. And at 5.6% for the bank, we do have a clear path to our 6% plus target. +Finally on this page, we continue to have a very strong liquidity position and remain in compliance with LCR. +Moving on to the businesses starting on page 4 Consumer & Community Banking. The combined consumer businesses generated $2.4 billion of net income for the quarter on $11.4 billion of revenue and an ROE of 19%. We continue to see excellent growth in the underlying business drivers with average deposits up 9% in CBB, our active mobile customers up 23%, credit card sales volume of 12%, client investment assets up 19% and crossing the $200 billion mark. And according to J.D. Power, we continue to be ranked number one in overall customer satisfaction as well as for mortgage originations among large banks and number one in three of four regions for small business banking customer satisfaction. +Finally across CCB, we expect to exceed our headcount reductions outlined at Investor Day. +Turning to page 5, Consumer & Business Banking. CBB generated net income of $894 million, up a significant 28% year on year on net revenue of $4.6 billion with an ROE of 33%. While we do continue to see some pressure on deposit margins, this continues to be more than offset by strong growth in deposit balances, the 9% I just mentioned among the highest in the industry. This deposit growth is driven by strong household growth and record customer retention. We added 800,000 net households since last year as our new branches continue to mature. +On the noninterest revenue side, we continue to see strong year over year growth in both debit and investment revenues as we deepen relationships with customers and as we see our Global Wealth Management strategy play out with more affluent customers. +In Business Banking, the momentum that we saw in the first quarter continued. We had record originations up 46% year on year and 27% over last quarter back to levels that we last saw in 2012. We believe that this reflects a combination of improving industry trends driven by business optimism generally continuing to trend higher, and improving banker performance especially in our expansion markets where we have been investing and as our positive strategies mature. +Our pipeline continues to strengthen. 2Q 2014 was the highest level since 2012 and we do expect this positive momentum and strong growth year-over-year to continue in the second half of the year. +Expense is flat year on year with efficiency gains in the branches being offset by higher cost of controls that we have spoken about. But it was down quarter on quarter as cost of investments in controls are moderating. +Turning to page 6 and Mortgage Banking. Overall Mortgage Banking net income was $700 million for the quarter with an ROE of 16%. As expected, the production environment remains challenging and mortgage production pretax income excluding repurchase was a negative $74 million for the quarter a little (technical difficulty) of our guidance reflecting higher revenue margin on a mix shift towards retail loans and higher pipeline as well as good progress made in the quarter to reduce our fixed expenses. +At this point market dependent, we expect the third-quarter results to be broadly similar to the second quarter, a small negative. +Originations of $17 billion were flat quarter on quarter and down 66% year on year which is in a market that we estimate was seasonally up 25% quarter on quarter which shows that we continued to lose some share. Key drivers behind the share loss were the continuation of our strategy to reduce our participation in lower FICO and higher LTV government loans as well as the burnout of HARP. In addition, we did lose some share in other conventional resulting from price competition as we maintained discipline regarding pricing to our required returns. +Mortgage production benefited in the quarter from a repurchase reserve release, a positive $137 million driven primarily by refinements in expectations regarding certain residual risks following the settlement in the fourth quarter of 2013. +Onto servicing, net servicing-related revenue of $693 million is down slightly quarter on quarter but is higher than guidance due primarily to higher gains on [SIO] securities and Ginnie Mae loan sales. While we do expect to continue to benefit from both during the second half of the year to a lesser extent than the first and these gains can be lumpy. So we expect servicing revenue to decline in the third quarter to $600 million plus or minus and servicing expenses are modestly down quarter on quarter. +MSR Risk Management was a net gain this quarter of $338 million driven by a $220 million positive model update on slower prepayment speeds which remember, we would have earned otherwise over time through model [miss] and which reflects the impact of the burnout on HARP as well as I mentioned. +On real estate portfolios concentrating on credit, we see net charge-offs for the quarter of $111 million and reserve releases of $300 million in the purchase credit impaired portfolio reflecting actual and expected appreciation in home prices. There were no reserve releases in the quarter for the non-credit impaired portfolio although favorable loss and delinquency trends do continue. +We do expect to see reserve releases in NCI over the next couple of years in total between $500 million and $1 billion as the credit quality of the portfolio continues to improve. And lastly on real estate portfolios in the quarter, we added $5 billion of loans to the portfolio. +Finally, mortgage headcount was down approximately 5000 year to date and we expect to exceed our Investor Day target of approximately 6000 for the full year of 2014. +Turning to page 7, Card, Merchant Services & Auto. Net income of $840 million, down 33% year on year were down 11% excluding reserve releases delivering an ROE of 18%. While down on declining reserve releases, the results do reflect strong underlying metrics. Sales growth of 12% led the industry for the 25th consecutive quarter primarily due to strong sales engagement of new customers. Our new acquisition vintages are performing exceptionally well. +In merchant services, we have seen strong volume and transaction growth year-over-year with our signed sales volume gaining momentum reflecting several large account wins in the quarter. Strong revenue of $4.6 billion was up slightly quarter on quarter but down 3% year on year and when you think about the year-on-year decline, we have reached the point where spread compression and strong fee growth offsets. So the net decline is driven by higher amortization of customer acquisition costs and the absence of fees related to discontinued products in 2013. +Expense is up 8% quarter on quarter and 7% year on year driven by controls, the timing of marketing investments and this quarter includes $125 million of the legal expense I talked about. +Moving on to credit, losses continue to improve albeit at a slower pace and the card net charge-off rate has remained very low at 288 basis points and we released $50 million of student lending reserves in the quarter. +Card outstandings momentum has shifted. End of period outstandings grew by $1.8 billion or 1.5% year over year with growth coming across our product sets fueled by the strong sales performance I highlighted. Core growth is now outpacing runoff and we acquired over 2 million new accounts in the quarter, up 40% year on year. +Before we move on, a few words on auto. New vehicle sales continued to grow year on year and the June SAR results reached the highest level since 2006. We have seen the 11th straight quarter of loan and lease growth as our partners continue to outpace the general market which remains competitive. The auto pipeline remains healthy, consistent with the recovery in the auto market. +Moving on to slide 8 and the Corporate & Investment Bank. CIB reported net income of $2 billion on revenue of $9 billion and an ROE of 13%. In banking, total revenue was $3.1 billion, down 2% year on year. IB fees, $1.8 billion, up 3%. We maintained our number one ranking in global IB fees per Dealogic, and widened the gap to number two. +Revenue growth was driven by higher advisory and equity underwriting fees and while debt underwriting fees were lower, we had strong relative performance for the quarter. The IB pipeline remains solid with an environment supportive of M&A and a large diversified IPO backlog. +Treasury Services revenue of $1 billion was in line with our guidance, down 4% year on year driven by lower trade finance revenue and the impact of business simplification. Lending revenue was down $80 million year on year driven by lower NII but was up 5% quarter over quarter. +Moving onto markets and investor services, reported markets revenue was down 14% year on year versus our guidance of 20% plus or minus with FIC down 15% and equities revenue down 10%. Included in these results are gains of over $100 million on the sale of market partner shares post-IPO. Excluding this, our results would have been down 15% year-on-year. In FIC the decline was driven broadly across macro products and in commodities with volatility remaining very low and with the exception of a few more active weeks in June, volumes also low. In equities, the decline was driven by derivatives while client volumes are highly correlated to volatility levels. +In terms of outlook for the coming quarter and the second half, June was a better month somewhat broadly but that momentum has not continued into July so far and volatility remains very low across products. As such it is our [central case] that the third-quarter will face a similar environment through the first half of 2014 and we expect normal seasonal trends. +Security Services revenue of $1.1 billion was up 5% year on year primarily driven by higher NII on higher deposits and higher asset-based fees on higher assets under custody. AUC reached a record $21.7 trillion, up 14% year on year. +Quarter on quarter, revenue was up on seasonality in a depository receipt and agent lending businesses. +Moving on to the expense, total expense was up 6% year on year. Compensation expense was down 8% with a comp to revenue ratio for the quarter of 31% and we expect a full-year comps revenue ratio to likely end between 30% and 35% rather than at the low end of the range. +Non-compensation expense was up year on year by 20% with the quarter including over $300 million of legal expense and a little less than $300 million of non-core expenses associated with business simplification I mentioned earlier. +Moving onto page 9 and the Commercial Bank, we had very good earnings in the Commercial Bank this quarter with net income up 6% from last year and an ROE 19%. We saw strong performance on key underlying business drivers driving revenue of $1.7 billion, up 3% sequentially with gross IB fees up 25% year on year driving the first half of the year to a record. And on higher NII driven by higher loan volumes and day counts. +We added $3.3 billion of loans in the quarter with growth across the board in all of our businesses. Our consistent growth in real estate continued with loans up 2% in the quarter and 14% in the year. After a flat start to the year we are happy to see C&I growth of 3% in the quarter in line with the industry. Revolver utilization picked up 3 percentage points versus the end of last year. Pipelines are up which should be supportive for trends in the second half of the year. +The environment remains competitive but stable driving some continued spread compression and we continue to see some pricing pressure to varying degrees in the businesses. +Expense was relatively flat quarter on quarter but higher than last year reflecting our commitment to the regulatory and control agenda. Expect expenses for the business of approximately $700 million in the third quarter. Our credit performance remains exceptional with net recoveries in the quarter. +Moving on to page 10 and Asset Management. An excellent quarter in Asset Management with net income of $552 million up 10% year on year and 25% quarter on quarter with a 25% ROE and a 30% pretax margin hitting our through the cycle targets. For the full year, these ratios will be slightly lower as the business continues to invest in both infrastructure and control as well as select front office hiring but we are on track to deliver at or through the cycle target for the full year of 2015. +Revenue of $3 billion was up 8% year on year reflecting an increase in management fees driven by record long-term net inflows of $34 billion for the quarter including the benefit of a large institutional fixed income mandate. This marks the 21st consecutive quarter of long-term net inflows driving AUM of $1.7 trillion, up 16% year on year and we continue to expect strong flows going forward. +Looking at the mix of flows by product, we saw continued strength in our multi-asset and alternative flows in line with our best quarter. In fixed income, we had our strongest quarter of flows ever and our best quarter in over a year excluding the large mandates I mentioned. And lastly despite solid equity market performance in the quarter, flows did not follow as investors showed hesitance to add to their positions at these levels. +Expense of $2.1 billion was up 9% from a year ago primarily driven by higher cost of controls and investment in growth. Lastly in Banking, we reported solid performance in both lending and deposits. Record loan balances surpassed the $100 billion mark, up 17% year on year and 4% quarter over quarter with growth coming from both our US and our international markets. We continue to see a solid pipeline for loan demand for the remainder of the year and average deposits were also up year over year by 8% but seasonally down 1% sequentially. +Moving on to page 11 and Corporate/Private Equity. Private Equity overall had a flattish result driven by net gains on dispositions partially offset by unrealized losses and our Private Equity portfolio declined by approximately $1 billion. Treasury and CIO reported a net loss of $46 million. NII was a negative $10 million, better by $80 million quarter on quarter driven by higher investment securities balances and the continued benefit of higher reinvestment yields. In the quarter we deployed $27 billion in gross new investments. +Finally on this page, other corporate. Net income was over $400 million. Included in the results are tax-related benefits of over $200 million and as I mentioned earlier, we reported firmwide legal expense pretax of $670 million for the quarter of which $227 million is here in other corporate. +Moving on to outlook on page 12, we did receive positive feedback from our most recent guidance disclosure in the 10-Q so we have replicated it and updated it here. A few final comments. It is too early for us to give specific guidance for markets revenues but we do expect the current environment to persist into the third quarter and for the second half and also to experience normal seasonal trends. +For the third-quarter, we generally expect mortgage production to be similar to this quarter, a small negative. We expect firmwide unadjusted expenses for the full-year of $58 billion plus or minus and expect credit trends to continue to be very strong across the board with consumer reserve releases that will be more periodic and modest. +So to wrap up, a very, very strong result for the quarter notwithstanding headwinds reflecting the strength of each of our businesses and the benefit of our operating model. +With that, operator, we would like to open up the line for questions. + + +================================================================================ +Questions and Answers +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions). Gerard Cassidy, RBC. + +-------------------------------------------------------------------------------- +Gerard Cassidy, RBC Capital Markets - Analyst [2] +-------------------------------------------------------------------------------- + + -- that you have shared in the past if you have a parallel shift of 100 basis points, what that will do to your net interest revenue? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [3] +-------------------------------------------------------------------------------- + + So you got cut off at the beginning but you are asking for our earnings at risk on 100 basis point shift? + +-------------------------------------------------------------------------------- +Gerard Cassidy, RBC Capital Markets - Analyst [4] +-------------------------------------------------------------------------------- + + That is great. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [5] +-------------------------------------------------------------------------------- + + Within the first quarter, we haven't disclosed it yet for the second quarter but it wouldn't be meaningfully different. In the first quarter, it was $2.5 billion. + +-------------------------------------------------------------------------------- +Gerard Cassidy, RBC Capital Markets - Analyst [6] +-------------------------------------------------------------------------------- + + Do you see going forward that changing in the way you are approaching your interest sensitivity as the likelihood of rising interest rates increases in 2015 or should it remain pretty much constant? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [7] +-------------------------------------------------------------------------------- + + So I mean obviously earnings at risk is a representation -- it is an instantaneous parallel shift. If you look actually at our disclosures you can also see what a steepener looks like. So the way I would characterize the way to think about the impact of our asset sensitivity and interest rates rising is the way we described it both at Investor Day and at the Morgan Stanley conference which is when rates rise whenever that starts which may be in the second half of 2015 at the short end and the long end continues that over time that will deliver $8 billion to $10 billion of NII to the firm. But clearly the path to get there will be rate dependent and timing. + +-------------------------------------------------------------------------------- +Gerard Cassidy, RBC Capital Markets - Analyst [8] +-------------------------------------------------------------------------------- + + Tying into the higher interest rates, you have been vocal about your funding side of the equation and what you expect there. Can you give us an update or more color of how you are positioned for the funding side of the balance sheet should rates rise and how much you expect to potentially maybe move off your balance sheet as it gets repriced into different types of products? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman and CEO [9] +-------------------------------------------------------------------------------- + + This is Jamie. I think on the funding side, we said we have met pretty much LCR and [SFS] and we think will be the [GLAC] or least we are very close to it. That is all embedded in interest-rate exposure which Marianne gave you and that is our base case. Obviously if the world changes, we may change how we go about and do that. But I think it is a very good base case to look at. We don't have any need to change it dramatically. +I think you will all have to be prepared for the reason that rates raise -- obviously will change why people act a certain way. + +-------------------------------------------------------------------------------- +Gerard Cassidy, RBC Capital Markets - Analyst [10] +-------------------------------------------------------------------------------- + + My final question is there has been some talk about the regulators, the Federal Reserve maybe increasing the capital ratios for the largest banks to even higher levels than what you are mandated today to carry. Do you guys have any thoughts on whether that may actually ever get through that they may even raise the current Tier 1 common ratio numbers? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman and CEO [11] +-------------------------------------------------------------------------------- + + I think we have to wait and see. I mean remember the United States has already gone beyond most other countries and they may just be referring to that that they intend to keep that or how they modify that. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [12] +-------------------------------------------------------------------------------- + + The way that we think about it, obviously we don't know how things may change in the future but between (inaudible), the buffers that we and other institutions are going to run above that with LCR and SFR, our own internal liquidity framework with capital stress pump testing under CCAR under extremely severe conditions, it feels like we have a box around this and so we are planning to run the firm based upon what we know today with an eye on obviously listening to all of the things you hear. + +-------------------------------------------------------------------------------- +Gerard Cassidy, RBC Capital Markets - Analyst [13] +-------------------------------------------------------------------------------- + + Great. Jamie, good luck on your treatment and hope for a speedy recovery. Thank you. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman and CEO [14] +-------------------------------------------------------------------------------- + + Thank you very much. + +-------------------------------------------------------------------------------- +Operator [15] +-------------------------------------------------------------------------------- + + Guy Moszkowski, Autonomous. + +-------------------------------------------------------------------------------- +Guy Moszkowski, Autonomous Research - Analyst [16] +-------------------------------------------------------------------------------- + + Good morning. Jamie, first let me say it is nice to hear you on the call and that you are sounding good and that the prognosis sounds great and I wish you all the best. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman and CEO [17] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Guy Moszkowski, Autonomous Research - Analyst [18] +-------------------------------------------------------------------------------- + + Just a follow-up on the interest rate points first, second. I know you guys have been very focused on the potential for a deposit drain as things are handled somewhat differently by the Fed given the current circumstances when they eventually do raise rates. +Is there any change in that thinking of the potential for a $1 trillion-ish deposit drain and maybe $100 billion for yourselves on the basis of the Fed minutes from last week which maybe were a little contradictory in terms of the mechanics to that Peterson Institute article, which has been I think (inaudible) in everyone's thinking? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman and CEO [19] +-------------------------------------------------------------------------------- + + So keep in mind if the Fed, whether they use repo or just sell securities, that will reduce deposits, so factor with it, absolute formula. The question is whose deposits and what kind of deposits and when they might do something like that. I assume they will be fairly careful. +I think what we simply were saying is that some of the deposits will come out of -- nonoperating wholesale deposits already have (inaudible). Some won't. Some will come out of retail, and just people need to be prepared for. I wouldn't put it in the earth-shattering category. Just people need to be prepared and be very thoughtful about how they go about that. + +-------------------------------------------------------------------------------- +Guy Moszkowski, Autonomous Research - Analyst [20] +-------------------------------------------------------------------------------- + + And given where you are on LCR, do you feel like JPMorgan is completely as positioned as it will want to be at that time, or is that still just a build that is going to take place in liquidity between now and a year from now or so? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman and CEO [21] +-------------------------------------------------------------------------------- + + I think we are very comfortable with where we are. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [22] +-------------------------------------------------------------------------------- + + Remember, we are running -- LCR is an important measure. It is a regulatory measure. We are measuring it, we are reporting it, but we run the firm based upon our own internal liquidity check framework and what comes with that. + +-------------------------------------------------------------------------------- +Guy Moszkowski, Autonomous Research - Analyst [23] +-------------------------------------------------------------------------------- + + Great. The other thing that I would like to touch on is the expense guidance. Obviously, it has ticked down somewhat again, and that is probably partly because of the revenue outlook that we are looking at for this year. But is there anything implicit in that in terms of what we should expect for expenses beyond 2014 and maybe you can elaborate a little bit on how you are thinking about core expense reductions given a consistently pretty sticky revenue environment? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [24] +-------------------------------------------------------------------------------- + + Really what I would point you to is the discussions that we had largely at Investor Day which was to say that we continue to expect the mortgage expense story to play out over the course of the next few years which will be obviously a tailwind for us on expenses both in servicing but more particularly in production. So that is obviously a focus in 2015 and beyond. +We also are expecting to start on a journey to delivering. You saw our CBB expenses, cost of control investment are moderating and Gordon outlined at Investor Day that the CBB business 2014 through 2016 as a relative matter would deliver approximately $1 billion of expense efficiency but the profile of that we haven't been through. And then Daniel is working through, as are all of the other CEOs, the expense story in the CIB and being as diligent as you would expect him to be given the environment. But one of our positions has always been that we are running this business for the longer term and we are going to be smart about the actions we take on expenses in order to make sure that we protect the franchise but that doesn't mean that we can't and won't be more efficient across the businesses. So we haven't actually given specific guidance at the firmwide level but that is the backdrop. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman and CEO [25] +-------------------------------------------------------------------------------- + + I just want to reiterate that we always have a waste cutting like real estate, people, straight-through processing, vendors, things where we think we got a little sloppy, where we are located, but we will never, ever ever stop investing in straight-through processing, better bankers, better training, Chase net, marketing, Sapphire, EBKs -- you know the new stuff from branches. So don't confuse the two. +We will lump it in together for you. Internally, no one goes to a budget meeting and says I get my expenses down by cutting expenses and the really important things we need for the future. No one. We are not going to run the Company that way. We would rather earn less money. + +-------------------------------------------------------------------------------- +Guy Moszkowski, Autonomous Research - Analyst [26] +-------------------------------------------------------------------------------- + + Okay, that is helpful. And then one final one. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman and CEO [27] +-------------------------------------------------------------------------------- + + Including in that is paying our people fairly. + +-------------------------------------------------------------------------------- +Guy Moszkowski, Autonomous Research - Analyst [28] +-------------------------------------------------------------------------------- + + That is obviously important. One last one for me, there have been quite a few areas where you have pulled back in order to ensure the ability to monitor and be in compliance; third-party mortgage origination was one, trade finance and in particular correspondent banking, internationally another one. Is all of the foreseeable pullback in areas of business for control reasons pretty much known now or are there other things that we should expect that you might be looking at? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [29] +-------------------------------------------------------------------------------- + + I would say that it is a matter of good housekeeping that we would constantly be looking at making sure that we are simplifying our businesses where it makes sense to do it. But as a large matter, the macro matter, we are working through the things that we talk about, some of the things that you mentioned and there are no significant changes + +-------------------------------------------------------------------------------- +Guy Moszkowski, Autonomous Research - Analyst [30] +-------------------------------------------------------------------------------- + + Okay, that is great. Thanks so much. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman and CEO [31] +-------------------------------------------------------------------------------- + + We've got 1000 foreign correspondent banks, we sold CWT, we might very well -- we sold RPS. There are a bunch of product lines we have either closed down or eliminated and a lot of that is in the works. We put a light -- enhanced monitoring our other businesses and so we are well along the way but if something comes up that we think we should look at again, we will look at it again. + +-------------------------------------------------------------------------------- +Guy Moszkowski, Autonomous Research - Analyst [32] +-------------------------------------------------------------------------------- + + Let me just follow up on it then to make sure that we don't over model revenues. Are there still meaningful incremental revenue declines that we should expect from all of those areas that have been discontinued? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [33] +-------------------------------------------------------------------------------- + + The most significant revenue effect that is not yet in our run rate because the transaction is not yet closed is the exit of the physical commodities business. So obviously when that closes which may be in the early part of the fourth-quarter that would have an impact in the revenues both in the quarter and then in our run rate in 2015. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman and CEO [34] +-------------------------------------------------------------------------------- + + We gave you a number at Investor Day which -- we should probably update that number. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [35] +-------------------------------------------------------------------------------- + + I can give you the numbers now. So at Investor Day, we said that the impact in 2014 on revenues would be a decline of $1.6 billion. Just given the timing of the physical commodities deal, the impact in 2014 is going to be closer to $1.2 billion of which about $500 million is in our run rate already. +And then when you annualize the things that will be complete by the end of the year, that 85% of everything is obviously going to get done. So once we close the year this year the impact this year will be $1.2 billion, the annualized impact that we gave was $2.8 billion and that is still our best estimate. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman and CEO [36] +-------------------------------------------------------------------------------- + + The important thing is the four beautiful franchises, Asset Management, Commercial Bank, CIB, CCB are all doing really, really well and this doesn't affect their ability to serve their clients at all. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [37] +-------------------------------------------------------------------------------- + + Remember also just for the purposes of completeness, it would be remiss of me not to say that expenses are also coming out as we take those revenues out and remember these are in large part businesses that were not at this time accretive to the overall firm's returns. So important to remember that. + +-------------------------------------------------------------------------------- +Guy Moszkowski, Autonomous Research - Analyst [38] +-------------------------------------------------------------------------------- + + Great. Thanks for the completeness of the answer. + +-------------------------------------------------------------------------------- +Operator [39] +-------------------------------------------------------------------------------- + + Glenn Schorr, ISI. + +-------------------------------------------------------------------------------- +Glenn Schorr, ISI Group - Analyst [40] +-------------------------------------------------------------------------------- + + So we have seen a greater number of sales in the repo market. It seems to me just an issue of available collateral. But I am curious to get your take how much we are supposed to carry on it and whether or not some of the actions by Treasury in the reverse repo market can take care of that? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman and CEO [41] +-------------------------------------------------------------------------------- + + I think because the government is still buying a big portion of net treasury issuance and because they are doing -- going into the repo market and taking cash out of the system, I think that number maybe has gone from $100 billion to $200 billion over time. Remember I believe that that repo can't be rehypothecated. So I do think some of those things that cause issues in the repo market, my guess is that will sort through over time. We do believe we see dealers reducing their books in repo and you have had a lot of statements about repo and collateral and capital against it so I feel things are going to sort out over time. + +-------------------------------------------------------------------------------- +Glenn Schorr, ISI Group - Analyst [42] +-------------------------------------------------------------------------------- + + Okay, good. It sounds like you are not losing so much sleep over it. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman and CEO [43] +-------------------------------------------------------------------------------- + + Not yet. + +-------------------------------------------------------------------------------- +Glenn Schorr, ISI Group - Analyst [44] +-------------------------------------------------------------------------------- + + Marianne, you mentioned a comment when you talk about C&I loan growth, I just wanted to get a clarification. Last quarter if I remember correctly it was about flattish on a year-on-year basis and you spoke about price competition and some discipline on JPMorgan's part. This quarter you have a little bit more year-on-year growth. Still mentioned the comment about discipline but I just wanted to get a clarifying statement. Is just growth a little bit better, is the backdrop a little bit better and you expect to participate in that a little bit more? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [45] +-------------------------------------------------------------------------------- + + So I would say that there hasn't been a shift in sentiment but sentiment is better. It is still better year-over-year and better quarter-over-quarter. It has allowed us to deliver growth in line with the industry and we do however maintain, absolutely maintain, our credit risk discipline as it relates to the commercial space. So it is competitive. It hasn't been the case that we have historically been losing on price, it has been more on credit discipline and on simplification and derisking but --. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman and CEO [46] +-------------------------------------------------------------------------------- + + I think Marianne mentioned it but in almost every category of C&I -- I'm talking about on the Commercial Bank -- utilization was up like 1% last quarter, maybe --. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [47] +-------------------------------------------------------------------------------- + + Utilization in commercial was up 3% since the end of the year. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman and CEO [48] +-------------------------------------------------------------------------------- + + Since the end of the year and you know, utilization is usually a pretty good measure of companies starting to expand and early on, it's receivables and inventory. You haven't really seen it in capital expenditures yet and if you looked at US capital expenditures in total including big businesses, they are kind of flat to down, that will ultimately be the driver of real growth. So if you start to see that, you are going to hopefully see a stronger economy but utilization is I think is the first sign. + +-------------------------------------------------------------------------------- +Glenn Schorr, ISI Group - Analyst [49] +-------------------------------------------------------------------------------- + + I appreciate that. Last one is I just couldn't help notice the balance sheet is now at $2.5 trillion. In your discussions, I know we can't purchase our way through without jumping through a lot of hurdles, but do you feel constrained on just sheer balance sheet size? And the reason I ask is I look across most of your franchises, they are growing and they are growing nice and they are growing organically through the investments you have made. I just want to know if anybody is bringing up the issue of just absolute size? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman and CEO [50] +-------------------------------------------------------------------------------- + + No, but can I just give you a number? I think year-over-year that balance sheet is up mostly because of money we have in the Fed. Even quarter over quarter, we've got these -- we have $350 billion or almost $400 billion at central banks around the world. We have an investment portfolio of $350 billion. We have a loan portfolio of [$700 billion]. We have already told you when they start to reverse, Q3, some of those will automatically come down. +So our balance sheet is kind of high because of all of this huge liquidity and securities in the balance sheet and eventually hopefully there will be more loans which are more productive and less just holding excess cash. + +-------------------------------------------------------------------------------- +Glenn Schorr, ISI Group - Analyst [51] +-------------------------------------------------------------------------------- + + Eventually maybe a little capital return too. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [52] +-------------------------------------------------------------------------------- + + Just to illustrate the point, if you are looking at the slides, you are looking at end of period assets that grew by $40 billion or so. If you look at the average, it was only [18] and we get a lot of volatility around cash movement at quarter end. So Jamie is right, there has been a significant amount of our growth that has been deposits and ultimately found its way on deposit with the central bank. + +-------------------------------------------------------------------------------- +Glenn Schorr, ISI Group - Analyst [53] +-------------------------------------------------------------------------------- + + Great. I appreciate the answers. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [54] +-------------------------------------------------------------------------------- + + I would say against that, having said that of course there is a natural healthy tension now with leverage rules that we are clearly strategically optimizing the way we use our balance sheet and that will have a natural tension to keep the balance sheet growth if there is growth to be more modest. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman and CEO [55] +-------------------------------------------------------------------------------- + + You are also seeing -- if you are talking about G-SIFI, the big Chinese banks, the big Japanese banks and some other banks around the world growing fairly rapidly, hopefully -- eventually we will use our G-SIFI scores a little bit too. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [56] +-------------------------------------------------------------------------------- + + And if we are right about the liquidity drain in QE, you will see a bunch of deposits flow out potentially in the second half of next year and see some of that growth reverse. + +-------------------------------------------------------------------------------- +Glenn Schorr, ISI Group - Analyst [57] +-------------------------------------------------------------------------------- + + Okay, thanks. + +-------------------------------------------------------------------------------- +Operator [58] +-------------------------------------------------------------------------------- + + Betsy Graseck, Morgan Stanley. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [59] +-------------------------------------------------------------------------------- + + Good morning. A couple of questions. One on FIC, one on expenses and one on RWAs. Just on the FIC line, you mentioned that it was a little bit better in the last part of June and then you went on to say that the outlook is for current environment to persist. So I just wanted to ask a little bit about which environment you are talking about just the overall quarter because the quarter ends up being a little bit better than expected right in the mid part of the quarter. Are you suggesting that the end of June activities is likely to keep a positive tone to what you are expecting in the third-quarter? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [60] +-------------------------------------------------------------------------------- + + Thanks for the question because I want to make sure I am very clear. So in June, we did see an uptick in activity in terms of client activity but volatility stayed very, very low and there was no specific catalyst for it, no catalyst that would lead us to believe that that would necessarily continue. And as we have moved into July, it so far has been our experience that it has not continued at that level. So it is more our guidance in the second half is that the 15% to 20% and the 20% plus or minus decrease that we have seen in the first half, that kind of environment is the one that we are facing over the second half. +Now we are not guiding to a number because as you very well know however many trading days into the quarter and things can change so you are going to have to pick your level and we can't predict it any better than that. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman and CEO [61] +-------------------------------------------------------------------------------- + + It is just our operating assumption is that it will stay at low levels for a while. We know we are going to be wrong on that but you all have to pick whatever you think. We run the Company planning for low and hoping for better. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [62] +-------------------------------------------------------------------------------- + + Okay, and that is 15% year on year? That is 15% plus or minus down year on year? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [63] +-------------------------------------------------------------------------------- + + We are not giving a specific guidance. It was 20% in the first quarter, 15% in the second, that kind of environment. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman and CEO [64] +-------------------------------------------------------------------------------- + + And the third and fourth are generally lower and it could be lower than that (multiple speakers) . + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [65] +-------------------------------------------------------------------------------- + + Normal seasonality drivers. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [66] +-------------------------------------------------------------------------------- + + Okay. And then on the expenses, you have outlined a couple of different areas that you are working on to get the expenses down. The question is on why in the IB you've got the repositioning cost called out specifically because I'm just kind of thinking out loud that you have got to invest to get expense saves in a broad set of areas of the business. So why call it out in the IB? Does it suggest that we will see more repo costs coming through in other areas over the next several quarters as people roll out their expense plans? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [67] +-------------------------------------------------------------------------------- + + We called out the $300 million if that is what you are referring to in the CIB because it in our view anyway is a modestly sized and nonrecurring item. We are not expecting to have similar items like that. We may have some but we are certainly not our forecast that we are going to have that kind of level recurring. So really it is just to give you a sense that in the quarter we absorb that number you choose that you will to do with it in terms of your models but we don't consider that to be core. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [68] +-------------------------------------------------------------------------------- + + Okay, but in the other areas where you are also working on expense programs you don't expect that you are going to have any of those one-time repo items, repositioning items? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [69] +-------------------------------------------------------------------------------- + + Not at this time, not significant. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [70] +-------------------------------------------------------------------------------- + + Okay, all right. And then on the RWAs, you indicated that RWAs were up a little bit on operating risk, down on marketing credit risk and then you went on to say that was model related. Is that all your internal models, is that based on consultation with regulators? I am just wondering why the operating risk would have gone up for you given that you had your big settlement a couple of quarters ago. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [71] +-------------------------------------------------------------------------------- + + So first of all, these are all the moving parts, none of them are materially significant so operational risk went up a little bit, growth went up a little bit and offset against that, we continue to always on board positions onto approved models, continue to develop our models and get approvals for our models so that we can have the most efficient RWAs that we can have. And so we saw some of that. And also portfolio runoff so we were just giving you some color that flat RWA is actually the continuation of the work that we articulated at Investor Day that will ultimately drive it down to be closer to $1.5 trillion over the next 18 months. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman and CEO [72] +-------------------------------------------------------------------------------- + + We are a little inconsistent upfronting all of the negatives we phased in. We are not upfronting model approvals we expect to get. Model on boarding and stuff like that. There is some of that coming and obviously those need to be approved by regulators. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [73] +-------------------------------------------------------------------------------- + + Got it. Okay. And then Citi settled the other day including again CDOs, you had some CDOs back in the day. Does that impact how you are thinking about the operating risk charges? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman and CEO [74] +-------------------------------------------------------------------------------- + + Not material. They are going to run off over time for RWA and everything else is not material. They can be restructured. I think it goes to 2017 now. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [75] +-------------------------------------------------------------------------------- + + All right. Thanks a lot. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [76] +-------------------------------------------------------------------------------- + + Thanks, Betsy. + +-------------------------------------------------------------------------------- +Operator [77] +-------------------------------------------------------------------------------- + + John McDonald, Sanford Bernstein. + +-------------------------------------------------------------------------------- +John McDonald, Sanford C. Bernstein - Analyst [78] +-------------------------------------------------------------------------------- + + Following up on loan growth commentary, net interest income dollars seemed a little better than you expected at the $11 billion, are you still looking for that to be flattish kind of top of the house NII for this year or is the outlook a little better given the loan growth trends? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [79] +-------------------------------------------------------------------------------- + + We said relatively flat. It came up slightly in the quarter, obviously we are pleased with that and we told you that we expected core growth for the year to be 5% plus or minus and at this point that would still be our best assessment. If loan growth does continue to improve and improves to the point where our core loan growth is above 5% then yes, we would hope to enjoy the NII benefit. +But as we look forward based upon current rates, we will be flat with a little bit of upward bias is our outlook until rates start to rise. + +-------------------------------------------------------------------------------- +John McDonald, Sanford C. Bernstein - Analyst [80] +-------------------------------------------------------------------------------- + + Okay, then in terms of share buyback --? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [81] +-------------------------------------------------------------------------------- + + Sorry, John, because you do continue to have albeit that everything is a little bit less than it was but you do continue to have offsets against that in terms of spread compression. + +-------------------------------------------------------------------------------- +John McDonald, Sanford C. Bernstein - Analyst [82] +-------------------------------------------------------------------------------- + + Okay. So, yes, with the 5% core loan growth you would expect NII to be relatively flat this year and flat to up a little bit next year? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [83] +-------------------------------------------------------------------------------- + + Yes, if market implied curve is in fact how things play out. + +-------------------------------------------------------------------------------- +John McDonald, Sanford C. Bernstein - Analyst [84] +-------------------------------------------------------------------------------- + + Okay. And then on share buybacks, could you give us some thoughts about how you are thinking about using your buyback approval for this year? Did you accelerate some of the buyback activity on price weakness this quarter and do you expect to do more in the second half because the RWA reductions are starting to happen? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [85] +-------------------------------------------------------------------------------- + + So first of all obviously what we can do is guided and limited by what we have approval to do. But yes, we did articulate that we were going to likely back end our share repurchases as we build towards our CET1 ratio. You can obviously see we built towards that nicely at 9.8%. And then yes, obviously particularly in the first half of the quarter, our price was favorable and we did share repurchases reflecting all of those things. +When we look at the second half without giving specifics because we don't give guidance on repurchases, we have the capacity to do $5 billion more gross over the next three quarters and we have a target to hit above 10% and we will juggle those two things together but that gives us the capacity to continue to do some repurchases. + +-------------------------------------------------------------------------------- +John McDonald, Sanford C. Bernstein - Analyst [86] +-------------------------------------------------------------------------------- + + Okay, that is helpful, thanks. On the mortgage servicing revenues, the outlook that you gave for the $600 million roughly, does that include any MSR risk management gains or do you assume none in that? Can you just clarify that? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [87] +-------------------------------------------------------------------------------- + + We assume none in that. Think about the MSR risk management as we generally speaking expect our results to be close to home so plus or minus zero outside of any model updates because of our hedging strategy. + +-------------------------------------------------------------------------------- +John McDonald, Sanford C. Bernstein - Analyst [88] +-------------------------------------------------------------------------------- + + Okay. Last question on legal costs, this quarter they were mostly in the IB and Corporate. Any commentary on what type of issues you are currently accruing for and also could you clarify whether you have any remaining outstanding material mortgage litigation or is that mostly settled from the mortgage area? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [89] +-------------------------------------------------------------------------------- + + So as much as I know and you want to hear it, we are not going to be able to talk about the specifics of what we are reserving for and we told you -- we said before that we had very little in the first quarter, we have $700 million pretax now. It is going to be this way for a while. We are going to have elevated and lumpy litigation costs as we work through the issues that you are aware of. +And then with respect to mortgage, we have settled with a large proportion of our MBS risk with the governmental counterparties but we do still have some other civil claims. But we would characterize it more behind us than in front of us and we are working through it. + +-------------------------------------------------------------------------------- +John McDonald, Sanford C. Bernstein - Analyst [90] +-------------------------------------------------------------------------------- + + Okay, thank you. + +-------------------------------------------------------------------------------- +Operator [91] +-------------------------------------------------------------------------------- + + Mike Mayo, CLSA. + +-------------------------------------------------------------------------------- +Mike Mayo, Credit Agricole Securities - Analyst [92] +-------------------------------------------------------------------------------- + + First, why did trading do better than the guidance earlier in the quarter and did that relate to the 8% increase in trading VAR which was a little surprising since volatility is still so low? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [93] +-------------------------------------------------------------------------------- + + On an absolute performance, so first of all two things primarily contributed to the better performance. We said 20% plus or minus. Remember that really could have been plus or minus when you go back three weeks before quarter end. So with the better activity in June, so June was a stronger month every day on average produces stronger results than the prior two months and that helped and we didn't have line of sight to that when we gave our guidance and when we affirmed our guidance. +And then the second, I called out the market partner's shares, the IPO. We sold our shares post the IPO and generated gains of over $100 million which is a couple of points. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman and CEO [94] +-------------------------------------------------------------------------------- + + And the VAR, I mean it is very hard to predict FICC. We are always reluctant to do it because somehow you think you actually know what is going to be the (inaudible) couple of weeks and the VAR jumps are around but some of that jumping around is really I think of underwriting positions, CMBS warehouse positions and stuff like that which come and go. + +-------------------------------------------------------------------------------- +Mike Mayo, Credit Agricole Securities - Analyst [95] +-------------------------------------------------------------------------------- + + I always prefer more guidance than less. I have two very simple questions with complicated answers I guess. But you talked about loan growth. Is this the inflection point for loan growth? On the one hand you said there is some inventory build that is helping, on the other hand you are not seeing CapEx yet. And two quarters ago you said second half of the year loan growth should really accelerate. Do you still believe it should accelerate from this level? Is this the acceleration or are you revising back some of those expectations? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [96] +-------------------------------------------------------------------------------- + + What I would say, Mike, is that what we have seen in the second quarter gives us reasons to be optimistic that we are going to continue to see growth at around those levels in the second half of the year. Like I said, it is not that we have seen a step change but that we have seen generally better sentiment, generally better utilization rates, generally higher pipelines. The phones are ringing. It is across geographies so it just feels like the environment is conducive for us to continue to be able to add. +We have been very successful in the business banking space and yes, we have reached inflection in card. So it is our belief that we will have strong growth year-over-year in the second half but we are still in the early stages of seeing that happen. + +-------------------------------------------------------------------------------- +Mike Mayo, Credit Agricole Securities - Analyst [97] +-------------------------------------------------------------------------------- + + And if interest rates increase at some point, that could hurt the ability of commercial and commercial real estate borrowers to service their debt. How much cushion is there before you think that would become an issue or is that just not a factor? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman and CEO [98] +-------------------------------------------------------------------------------- + + It is not really a factor of people who are already income producing, locked in rates and things like that. It may very well be a factor for people who want to build new things. Not on the commercial side but we did look at on the residential side there have been occasions we have rising rates and improving housing. So depending why rates are going may be the more determinant factor than just the fact that rates are going up. Rates are going up because you have a healthy economy, that may be more important than just the fact that rates are going up. We have not done the same thing in commercial, we probably should. + +-------------------------------------------------------------------------------- +Mike Mayo, Credit Agricole Securities - Analyst [99] +-------------------------------------------------------------------------------- + + I guess the more general question is what areas and credit are you watching the most? I think, Marianne, you said auto is the best since 2006 and that has been an area mentioned by regulators. Is that the point of greatest concern or are there other areas you are watching more closely? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [100] +-------------------------------------------------------------------------------- + + For us what we are doing is being consistent on our credit discipline and so we have talked I think partly in the first half of the year about us not participating in some of the growth that others saw because we have maintained line as it relates to particularly structured credit structures and aggressive structures rather than pricing. And so we are consistently doing that. We are not changing that and our credit across products also mortgage, commercial remains broadly consistent, we are not changing that either. +So for us we are just maintaining our credit discipline. But yes, it is a very competitive place out there right now across the products and so we are seeing a little bit of that aggressiveness. We saw it in the quarters running up to this. We still see it now although it is not worse. + +-------------------------------------------------------------------------------- +Mike Mayo, Credit Agricole Securities - Analyst [101] +-------------------------------------------------------------------------------- + + All right, thank you. + +-------------------------------------------------------------------------------- +Operator [102] +-------------------------------------------------------------------------------- + + Erika Najarian, Bank of America Merrill Lynch. + +-------------------------------------------------------------------------------- +Erika Najarian, BofA Merrill Lynch - Analyst [103] +-------------------------------------------------------------------------------- + + Good morning. My questions have all been asked and answered. Thank you. + +-------------------------------------------------------------------------------- +Operator [104] +-------------------------------------------------------------------------------- + + Matt O'Connor, Deutsche Bank. + +-------------------------------------------------------------------------------- +Matt O'Connor, Deutsche Bank - Analyst [105] +-------------------------------------------------------------------------------- + + Good morning. Can you remind us the timing of the private equity sale and how much capital is against that? It was roughly a breakeven business. I think you have about $6 billion of outstanding and what does that mean in terms of freeing up capital in a Basel III and SLR world? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman and CEO [106] +-------------------------------------------------------------------------------- + + I don't think we have disclosed that. It hasn't been a breakeven business over a long period of time. Obviously hasn't earned much money in the last few quarters and we are still negotiating something. It could be soon, it won't be all of OEP. It will be a part of it. +And then part of the number of you see, because I think there is $6 billion of total private equity are all heritage investment that were made by JPMorgan Chase and etc. before the Bank One merger. So they are all eventually -- that $6 billion will be zero and that frees up what, $3 billion of equity capital effectively. + +-------------------------------------------------------------------------------- +Matt O'Connor, Deutsche Bank - Analyst [107] +-------------------------------------------------------------------------------- + + Okay, $3 billion. That is helpful. And then the commodities business you gave us the $2.8 billion of annual revenue (inaudible) and said it was ROE dilutive but care to give the expenses and capital against that? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [108] +-------------------------------------------------------------------------------- + + Yes, just to be clear, the $2.8 billion if you go back and look at Investor Day was for all of our business simplification agenda not the physical commodities. I just called out physical commodities as being A, a big piece of it, and B, as being the biggest piece left to happen in 2014. So just to be clear on that. +And then yes, the $2.8 billion came with expenses of $2.3 billion against it. We didn't disclose the capital but when you take that into consideration it was at or below our cost of capital, not additive to returns. + +-------------------------------------------------------------------------------- +Matt O'Connor, Deutsche Bank - Analyst [109] +-------------------------------------------------------------------------------- + + Okay. And then lastly, this is probably an obvious question but the $100 million gain related to IPO would have been booked in the equity trading business when you were talking about the impact of the markets revenues? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [110] +-------------------------------------------------------------------------------- + + Actually, it is in fixed. + +-------------------------------------------------------------------------------- +Matt O'Connor, Deutsche Bank - Analyst [111] +-------------------------------------------------------------------------------- + + Okay, all right. Thank you. + +-------------------------------------------------------------------------------- +Operator [112] +-------------------------------------------------------------------------------- + + Moshe Orenbuch, Credit Suisse. + +-------------------------------------------------------------------------------- +Moshe Orenbuch, Credit Suisse - Analyst [113] +-------------------------------------------------------------------------------- + + Great. Thanks. Most of my questions have been asked and answered but could you talk just a little bit about how much of the mortgage business costs are fixed and how much you would be willing to let the volume decline? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [114] +-------------------------------------------------------------------------------- + + We haven't actually broken out specifically in that way but I can characterize it for you. Obviously in mortgage production, the first chunk of expenses is truly variable meaning it is paying for production on a variable basis to the salesforce and then you have a bunch of what we would called semi-fixed costs which are effectively the operators, the people, the FTEs. And then you do have true fixed costs which is the management, the real estate, the technology. +When you have a very, very small market which I think you would agree a $1.1 trillion or lower market is very small, then it is hard with the fixed cost structure to make a lot of money in the mortgage business particularly if you are taking a hard line which we are on the types of mortgage product that we want to participate in. But over time it doesn't stop the fact that this is going to be a healthy functioning mortgage market and we want to be a scale player. +So it is tricky in this kind of very, very small market but we are focusing on fixing our fixed cost base and trying to get out as much efficiency as possible. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman and CEO [115] +-------------------------------------------------------------------------------- + + We've been spending a lot of time in that and doing deep dives and trying to figure it out and unfortunately this one won't be the end of the year. I think of it as hopefully by the end of 2015 we give you clear sight about how we will be making normal profitability there which may take until 2016. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [116] +-------------------------------------------------------------------------------- + + Right and it has always been a cyclical volatile business and we had very, very strong performance over the course of 2011 and 2012 and into the first half of 2013 and we are now at that cyclical point, that cyclical low and we need a lot of things to happen. But trust me when I tell you that the fixed cost base is our number one focus or among our number one focuses and we are working very hard at it. + +-------------------------------------------------------------------------------- +Moshe Orenbuch, Credit Suisse - Analyst [117] +-------------------------------------------------------------------------------- + + Great, thanks. Just kind of a small point, you mentioned a reserve release on the private student lending business. That was a business that you had kind of talked about potentially exiting I guess back in late last year. Is that still on the agenda? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman and CEO [118] +-------------------------------------------------------------------------------- + + We are not exiting, just no longer doing it and it is in runoff mode. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [119] +-------------------------------------------------------------------------------- + + Right. So we stopped originating new loans but we do have a portfolio of loans that we are managing and as they run off, we will experience all of the usual charge-offs, reserve releases but not exiting. + +-------------------------------------------------------------------------------- +Moshe Orenbuch, Credit Suisse - Analyst [120] +-------------------------------------------------------------------------------- + + Got it. Thank you very much. + +-------------------------------------------------------------------------------- +Operator [121] +-------------------------------------------------------------------------------- + + Derek De Vries, UBS. + +-------------------------------------------------------------------------------- +Derek De Vries, UBS - Analyst [122] +-------------------------------------------------------------------------------- + + Thanks. I have two questions. One is kind of a detailed question but I just want to make sure I understood correctly. You were talking about equity trading revenues and I think you sort of said the decline was attributable to the equity derivatives business. So can I imply that then the year-on-year cash and prime brokerage businesses were flat and all the decline came from equity derivatives? Is that what you said? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [123] +-------------------------------------------------------------------------------- + + We said it was driven by derivatives. Cash out of prime brokerage did better. Prim did better than cash. + +-------------------------------------------------------------------------------- +Derek De Vries, UBS - Analyst [124] +-------------------------------------------------------------------------------- + + Okay, that is clear. Just sort of a more conceptual question. I look at your core loan growth of 4% and obviously everyone has commented that is very strong and I guess about two times the industry level and kind of reconciling that with the comment you made about C&I loan growth is kind of in line with the market and you are kind of ceding some market share on residential mortgage for all of the reasons you have explained to us. +So I was just wondering if you could give some color on those areas where you are clearly taking share and just some outlook on how sustainable that is or is it just kind of a good quarter? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [125] +-------------------------------------------------------------------------------- + + So just on the mortgage thing, we are giving up share but remember that we distribute a significant amount of the mortgages that we produce and in this quarter, we actually portfolio-ed $5 billion of mortgages so we are not losing share in (multiple speakers). So we are adding to the portfolio for mortgage at just a slightly different dynamic. +We are outperforming on sales growth in cards so ultimately that will fuel outstanding growth that hopefully will be better than the industry but clearly it is modest at this point. Our C&I, we are in line if not potentially gaining a little share but we continue to outperform in real estate particularly multi-family real estate and asset management. + +-------------------------------------------------------------------------------- +Derek De Vries, UBS - Analyst [126] +-------------------------------------------------------------------------------- + + So all of those areas are areas you are targeting so they should feel pretty sustainable? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [127] +-------------------------------------------------------------------------------- + + Yes. + +-------------------------------------------------------------------------------- +Derek De Vries, UBS - Analyst [128] +-------------------------------------------------------------------------------- + + Understood. Thank you very much. + +-------------------------------------------------------------------------------- +Operator [129] +-------------------------------------------------------------------------------- + + Eric Wasserstrom, SunTrust Robinson. + +-------------------------------------------------------------------------------- +Eric Wasserstrom, SunTrust Robinson Humphrey - Analyst [130] +-------------------------------------------------------------------------------- + + Thanks very much. I just wanted to step back for a moment and think about what has occurred in the context of the key themes from the Investor Day last February and it sounds like there is a couple of areas where things maybe are progressing a bit more slowly and you thought mortgage it sounds like maybe one of them. But I wonder if in the context of the goals that you laid out how you feel broadly you are moving against them and whether there has been any real departures from your expectations sort of at the halfway point of the year? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [131] +-------------------------------------------------------------------------------- + + I think you called it well on mortgage. Obviously the mortgage market and housing conditions outside of home prices are challenging and that looks like it is set to be a slower journey. But if you step back and look across all of our other businesses, when I talked about the underlying core performance drivers growing strongly, that reflects our strategy. So we continue to build and grow our businesses demonstrated by those performance drivers as well as simplify and address the control agenda and we are making the appropriate progress on both of those. And it is showing in our results. +I mean a quarter where obviously there are some challenges to print over a 14% return on tangible common equity is evidence of the strategy working. If you go through each of the comments I made in asset management, we are investing in the sales force, we are seeing that deliver growth, we have record inflows, we are seeing international deliver loan growth. It is very consistent. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman and CEO [132] +-------------------------------------------------------------------------------- + + You haven't seen us give you a roadmap on how we are going to get from 7% return on tangible common equity to 14%. We are already at 14%. + +-------------------------------------------------------------------------------- +Eric Wasserstrom, SunTrust Robinson Humphrey - Analyst [133] +-------------------------------------------------------------------------------- + + Right, so I guess the real heart of my question is we look at these financial results which are clearly better than expectation against a backdrop which maybe is certainly not better, maybe worse than what we thought at the beginning of the year. And I wonder if that then suggests that in fact things are accelerating ahead of the timeline or in greater magnitude than the discussion in February? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman and CEO [134] +-------------------------------------------------------------------------------- + + No, look, I can't over emphasize this. We do not run the Company for quarterly profits. We make long-term decisions in people, systems, technology, products, services, stuff like that and a lot of things drive short-term profits but the profit you have in any one quarter relates to the decisions you made the last five years. And so we feel great about these companies. The big weak spot which we all acknowledge is mortgage and we are going to put -- we have got great people there. We are going to put elbow to the metal there, we are going to invest some more money in their systems. +We've got some catch-up to do. We got caught in the middle of as you know WaMu, Bear Stearns, origination platforms. But if you look at each of these businesses, they are all doing fine and we are looking at how we can grow them over the next five or 10 years and that is what we are going to do. +I honestly mean it. I don't care whether FIC is up 10% or 15% or down 10% or 15% next quarter. I actually think that is a complete waste of time. + +-------------------------------------------------------------------------------- +Eric Wasserstrom, SunTrust Robinson Humphrey - Analyst [135] +-------------------------------------------------------------------------------- + + Maybe just lastly, one of the themes for this year has been maybe the narrowing a little bit of the client base based on risk or profitability profile. I am just wondering how that is progressing particularly with respect to the commercial bank? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman and CEO [136] +-------------------------------------------------------------------------------- + + I think most of that has been done. So you have seen not all of it but the full effect of that in terms of which segments we are getting out of, which ones we are going to focus on, which ones we put enhanced monitoring in so the same thing in the CIB with our correspondent banking. There may be more. We are always going to do good housekeeping and there are some clients we have had conversations with that are still on the books but they will be leaving down the road. But none of those things will be material to the future of this Company. +They may affect revenues a little bit in the fourth quarter or first quarter next year but that is not why we are doing it. We are doing this to protect ourselves, run the business properly, meet our regulatory and control objectives. + +-------------------------------------------------------------------------------- +Eric Wasserstrom, SunTrust Robinson Humphrey - Analyst [137] +-------------------------------------------------------------------------------- + + And so -- and this is the last thing for me. But does that suggests that maybe we are getting closer to the point where the reported numbers in terms of the balance sheet -- the loan expansion and the core numbers will get closer to converging? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [138] +-------------------------------------------------------------------------------- + + Think about this, the core number, the reported number being primarily driven by the legacy mortgage and credit card portfolios so the high end activity that we have been talking about is immaterial in the context of that runoff portfolio. That is what is driving the difference. So we will continue to see that portfolio run off and as it runs off and gets smaller, it will have less of an impact but it has been a fairly consistent story. + +-------------------------------------------------------------------------------- +Eric Wasserstrom, SunTrust Robinson Humphrey - Analyst [139] +-------------------------------------------------------------------------------- + + Thank you very much. + +-------------------------------------------------------------------------------- +Operator [140] +-------------------------------------------------------------------------------- + + Ken Usdin, Jefferies. + +-------------------------------------------------------------------------------- +Ken Usdin, Jefferies & Co. - Analyst [141] +-------------------------------------------------------------------------------- + + Thanks, good morning. So on the consumer business, I wanted to ask a question about the payment side and we have seen really good volume growth metrics and that turn in the origination volumes. Can you talk of just about what you are seeing in the underlying customer as opposed to what you guys are benefiting from activation and new card growth, just your general sense of the customer and spending? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [142] +-------------------------------------------------------------------------------- + + We have a large market share so while we may be outperforming the market what we see is generally a fairly good picture of what is happening. And what I can tell you is if you decompose our growth, you have still strong high single-digit growth in nondiscretionary spend categories driven principally in grocery and oil space which is not all that unsurprising but I think is actually instructive about consumer spending and inflation. +And then if you look at the discretionary growth which is growing even more strongly in the double-digit territory, it is across the board. It is travel, it is restaurants, it is retail, it is across the board so consumers are spending very strongly in both categories. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman and CEO [143] +-------------------------------------------------------------------------------- + + (multiple speakers) Merchant processing we are growing at like 12% a year and we are investing more money, do a better job for merchants there and we have 35 million people bank online. I think 15 million who use mobile bank, it was 12 million or 15 million that use mobile banking. So you are going to see us extend products and services all of which hopefully will be merchant friendly and consumer friendly. + +-------------------------------------------------------------------------------- +Ken Usdin, Jefferies & Co. - Analyst [144] +-------------------------------------------------------------------------------- + + And on that merchant piece, just can you just explain the disconnect between the volume side continuing to look better and then the transaction growth rate slowing a little bit recently? Is it a larger ticket size or are there some different underlying thing in the metrics? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman and CEO [145] +-------------------------------------------------------------------------------- + + Mostly merchants aggregating their transactions. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [146] +-------------------------------------------------------------------------------- + + Yes. + +-------------------------------------------------------------------------------- +Ken Usdin, Jefferies & Co. - Analyst [147] +-------------------------------------------------------------------------------- + + So it is how it flows through to you guys? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [148] +-------------------------------------------------------------------------------- + + Correct. + +-------------------------------------------------------------------------------- +Ken Usdin, Jefferies & Co. - Analyst [149] +-------------------------------------------------------------------------------- + + Okay, great. And then my little question. Tax rate was a little low this quarter so your outlook generally speaking on the tax rate going forward? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [150] +-------------------------------------------------------------------------------- + + Yes, so our general longer-term outlook is our tax rate is 30% plus or minus just given obviously the pre-tax (inaudible) of the 2014 market, it will be slightly lower than that more in line with this quarter. +(multiple speakers) + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman and CEO [151] +-------------------------------------------------------------------------------- + + I don't remember if you mentioned it, but in other, there is private equity which was close to zero and bounces around. Treasury and CIO, which was close to zero and kind of will stay there and there is other corporate where a normal rate would be around 200, this quarter was around 400 because of some of the tax benefits. Think of that as going back to 200 give or take next quarter for your models. + +-------------------------------------------------------------------------------- +Ken Usdin, Jefferies & Co. - Analyst [152] +-------------------------------------------------------------------------------- + + Perfect. Thank you. + +-------------------------------------------------------------------------------- +Operator [153] +-------------------------------------------------------------------------------- + + Paul Miller, FBR Capital Markets. + +-------------------------------------------------------------------------------- +Paul Miller, FBR & Co. - Analyst [154] +-------------------------------------------------------------------------------- + + Thank you very much. I know a lot of questions have been asked. But I want to go back to the mortgages a little bit, the 16 billion. The market was up depending on who you listen to probably in the $260 billion to $300 billion range but you guys stayed relatively flat and it looks like really you guys gave up market share with MBS issuance stuff that you sell to Fannie and Freddie and maybe you picked up more market share in the jumbo market. +Of the $5 billion that you portfolio-ed that you talked about, was that all jumbos and you could talk a little bit about maybe stepping away from Fannie and Freddie? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [155] +-------------------------------------------------------------------------------- + + So of the $5 billion, $3.6 billion was jumbo, about $400 million was (inaudible) and then about $1 billion was conventional so that is how it breaks down. So mostly jumbo, yes, and we are holding share in jumbo. +And with respect to the market share loss, it was principally two things. It was principally a strategy that we've talked about to do less in the high -- high LTV, low FICO space. We priced to the risk-adjusted return that we see in that business given the cost of service the loans that default and that is what the impact has been on our market share. +And then also the HARP burn out, we were very successful in HARPing our loans over the course of the last couple of years. Our borrowers who our technically eligible are no longer responding so we are seeing that burn out. The bit that is really truly the conventional loss which there was some, is really on price competition and we absolutely intend to compete on price. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman and CEO [156] +-------------------------------------------------------------------------------- + + When you say high FICO -- that is FHA? So our FHA volumes are way down and we've studied FHA based upon the lawsuits and the premiums and stuff like that, we have lost a tremendous sum of money in FHA. We are trying to figure out what we should do about it going forward. +Just to give you three numbers, we collected $600 million in insurance. They disputed $200 million. The government called that a fraud. We reimbursed $600 million to get out of the lawsuit because it was a threatening lawsuit even though in my opinion it was a commercial dispute between FHA and ourselves about that. And the whole time FHA collected another $1.8 billion in premium. So the real question to me is should we be in the FHA business at all and we are still struggling with that. +We want to help the consumers there but we can't do it at great risk to JPMorgan so until they come up with some kind of safe harbors or something, we are going to be very, very cautious in that line of business. + +-------------------------------------------------------------------------------- +Paul Miller, FBR & Co. - Analyst [157] +-------------------------------------------------------------------------------- + + And Jamie, on a follow-up question on your utilization comments which I thought was very good, but a lot of bankers have talked about as long as deposit is growing, it is hard for that utilization rate to go up and we did see strong deposit growth and we are still seeing utilization rates. Should that deposit growth start to go down if we are seeing an uptick in utilization rates? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman and CEO [158] +-------------------------------------------------------------------------------- + + I think it has slowed down a little. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [159] +-------------------------------------------------------------------------------- + + It went down slightly I think. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman and CEO [160] +-------------------------------------------------------------------------------- + + Remember, you are talking about different borrowers (inaudible) so it might be something that was two million deposits and some start to borrow money but in general, you are right. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [161] +-------------------------------------------------------------------------------- + + So if you look at commercial just as an illustration of your point, what we have got going on is utilization rates in the last few quarters have picked up by 3 points. They are at 33% still much, much lower than you would expect them to be over time which would be slightly above 40%. But you do see deposits flattening out. In fact, there is a little bit of decline. +It is not absolutely the case at this point that we can say people are starting to spend their deposits and utilize their lines. As Jamie said, CapEx is still not really out there but that is what you would expect and in this business we did not see strong growth in deposits. + +-------------------------------------------------------------------------------- +Paul Miller, FBR & Co. - Analyst [162] +-------------------------------------------------------------------------------- + + Okay. Thank you very much, guys. + +-------------------------------------------------------------------------------- +Operator [163] +-------------------------------------------------------------------------------- + + Steve Chubak, Nomura. + +-------------------------------------------------------------------------------- +Steve Chubak, Nomura Asset Management - Analyst [164] +-------------------------------------------------------------------------------- + + Good morning. So, Marianne, I actually had a question about the presentation that you had given last month at the Morgan Stanley conference. You alluded to a targeted loan to deposit ratio of roughly 70% through the cycle. And I suppose what I was wondering when crunching some of the numbers given the tougher treatment for loans versus high-quality securities under the LCR, whether there is a peak level of loan to deposit ratio or growth that we should think about given the constraints which exist under the new liquidity regime? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [165] +-------------------------------------------------------------------------------- + + First of all, just to make a conceptual point which is we didn't have a target for loan deposits. We were just trying to make the point that obviously as we think forward to the impact of interest rates on our performance over time, we would expect both a mix shift in deposits back towards interest earning and CDs but also expect to see the economy growing and loans growing and that needed to be taken into consideration. So it wasn't really a target, it was just a simulation to start with that. +But it was based loosely on levels that we have seen at least in part the cycle that we were referring to. And then you are right, there is a dynamic where because of LTR, we will always have a -- because of our liquidity requirements internally as well, we will have liquid assets that will be structurally higher than they would had previously been and therefore from a mix perspective, that would have an impact. But at this point given where loan to deposits are, I think that would be a high class problem to be talking about. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman and CEO [166] +-------------------------------------------------------------------------------- + + Remember there are some unused lines so there is not a loan on the balance sheet that still 100% LCR. So what's really going to happen is it is going to be done at the client level -- capital, LCR, commitments, etc, that is where you are really going to have to manage it, the capital level, the desk level, etc. + +-------------------------------------------------------------------------------- +Steve Chubak, Nomura Asset Management - Analyst [167] +-------------------------------------------------------------------------------- + + Thank. Actually that is a great transition for my next question which relates to pricing in some of the multiple binding constraints on capital that exist today. And some of the discussions that we have had with your competitors have suggested that some believe it is still a little bit too early to fully bake in the cost of managing to all the different capital rule sets that exist today whether it is risk-based, leverage-based or even CCAR. And it appears that you have been managing more actively to all the different constraints out there. +And in light of that, I was wondering whether you have seen any impact for more aggressive pricing by peers in terms of your relative market share in certain product areas particularly within the CIB? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman and CEO [168] +-------------------------------------------------------------------------------- + + What we have seen a little bit of is trade finance cost have gone up, a little bit in municipal businesses and there you have seen a little bit more restructuring on the type of business people do. Remember some of the repricing may not take place in the product, it may take place in the relationship because all products have loss leaders, etc. But we haven't seen a huge amount of repricing taking place yet. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [169] +-------------------------------------------------------------------------------- + + I think if you think about --. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman and CEO [170] +-------------------------------------------------------------------------------- + + I have heard some complaints by the way that some of the revolvers are smaller and shorter. It is not the price as much as it is the sizing. And then you have heard some commentary in the market that inventories -- bonds are lower and spreads will gap out so you are starting to see some of it but eventually -- I have never seen a business where the cost of goods sold doesn't eventually get priced in the business. It doesn't have to be priced into the eggs and the milk, it just has to be priced in the transaction, the whole bag the person walks out of the supermarket with. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [171] +-------------------------------------------------------------------------------- + + I think one way to look at it is to say while we are absolutely managing through this complex environment, Basel III Tier 1 common still is our binding constraint at the margin, that is how we allocate capital to the businesses and that is the sort of primary lend that we are using to price. And what you are going to see, as Jamie talked about, is that the leverage and LCR and other constraints including stressed capital are going to play out at the client level as we just are becoming more efficient at how we deploy our balance sheet rather than necessarily a repricing strategy. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman and CEO [172] +-------------------------------------------------------------------------------- + + And CCar, we are pushing CCAR down. To the extent we can, we are going to push CCAR down to those things which create CCAR-ness. + +-------------------------------------------------------------------------------- +Steve Chubak, Nomura Asset Management - Analyst [173] +-------------------------------------------------------------------------------- + + Thanks and I suppose could you give potentially any context as to what event may prompt that repricing? Even if the leverage rules are finalized and efficiently implemented this year, do you expect that that is when you will begin to see a lot of your peers began to reprice some of these effects into their inventory or into their trading securities or are they likely going to delay at least the repricing until the rules are fully implemented which is going to be a 2018 event? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman and CEO [174] +-------------------------------------------------------------------------------- + + I wouldn't hold your breath. Some people are leaving businesses, some are optimizing decline levels, some are having strategic changes and it will happen over time and we are quite patient about it. We are in no rush. We're not going to try to lead it or anything like that. It will happen over time. +Like I said, you have seen it in trade finance, you've seen it in certain municipal businesses, you have seen it in -- and all the rules aren't final. When the rules become final, people may react differently. + +-------------------------------------------------------------------------------- +Steve Chubak, Nomura Asset Management - Analyst [175] +-------------------------------------------------------------------------------- + + All right, great. That is extremely helpful. Thank you for taking my questions. + +-------------------------------------------------------------------------------- +Operator [176] +-------------------------------------------------------------------------------- + + Jim Mitchell, Buckingham Research. + +-------------------------------------------------------------------------------- +Jim Mitchell, Buckingham Research Group - Analyst [177] +-------------------------------------------------------------------------------- + + Good morning. I just wanted to follow-up on the SLR. It seems like the improvement you had sequentially was I think mostly driven by capital and the preferred issuance. Can you give us where we are in terms of compression trade and the impact, is it still a lot more to come or is that mostly in there? Then I guess any thoughts or updates on what that impact can be and if you expect that to be adopted by the Fed? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [178] +-------------------------------------------------------------------------------- + + Yes, the improvement at the bank and the holding company was retained earnings, [pressed] net of capital distributions but we continue to work through all of the other initiatives we have to optimize leverage including compression trades and pair ups and the like. That is actually happening a little bit more slowly than we had thought just broadly in the industry. It still presents an opportunity, it is not the most sizable opportunity but we are diligently getting after it. +And then with respect to (inaudible), we estimated clearly it is a complex calculation so we will be slightly wrong in our estimate. We estimated it to have a benefit for the firm of 30 basis points and for the bank at 40 basis points. Yes, we would expect that at some point it would be ultimately adopted by the US regulators but that doesn't look like it expects to be helping our numbers this year or next. + +-------------------------------------------------------------------------------- +Jim Mitchell, Buckingham Research Group - Analyst [179] +-------------------------------------------------------------------------------- + + Okay, got you. And then maybe just -- I don't if it is related or not but I looked at your derivatives receivable on the balance sheet, it has been declining pretty steadily down 20% year-over-year. Is that reflective of just demand given low volatility and low activity levels or is there something structural there? Are you guys actively managing your receivables down or just trying to get a sense of the cyclical versus structural argument? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [180] +-------------------------------------------------------------------------------- + + It is essentially cyclical. I mean I wish we could actively manage it down because it is positive (inaudible) calculation but the truth of the matter is it is a factor of activity levels. + +-------------------------------------------------------------------------------- +Jim Mitchell, Buckingham Research Group - Analyst [181] +-------------------------------------------------------------------------------- + + Okay, it is primarily activity levels. Okay. One last one on the CDO question I think earlier, I think we saw Citigroup settle with the DoJ regarding -- and they included CDOs. I don't think your settlement included that. Is that something that you think remains out there or just something unique to them? I know you did settle one complaint with the SEC a few years ago. Just wanted to get a sense of how you think about any remaining litigation risk around CDOs. Thanks. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [182] +-------------------------------------------------------------------------------- + + We don't think it is significant. + +-------------------------------------------------------------------------------- +Jim Mitchell, Buckingham Research Group - Analyst [183] +-------------------------------------------------------------------------------- + + Okay. Thank you. + +-------------------------------------------------------------------------------- +Operator [184] +-------------------------------------------------------------------------------- + + Betsy Graseck, Morgan Stanley. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [185] +-------------------------------------------------------------------------------- + + Just a follow-up, Jamie, on the FHA commentary that you had. I am just wondering about the implications for how you hit the CRA requirements. Is there any interplay there? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman and CEO [186] +-------------------------------------------------------------------------------- + + So CRA, remember is a combination of lower and middle income mortgages so we will obviously try to meet those commitments. It includes how many branches you have in lower and middle income so we will continue to build that. It is a function of CDFI, like lending to small business or community development funds which we will continue to do. So it runs a whole gamut and we will meet our CRA commitment. +Yes if you don't do in the FHA, it hurts you a little bit but to do FHA. lose billions of dollars that is a whole different level of shareholder responsibility and so we've got to be very careful how we handle that. I am hoping FHA comes forth and comes up with some real bright lines and harbors to make it easy for us to try to do what the government wants us to do but we can't get penalized severely for some of the things that happen. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [187] +-------------------------------------------------------------------------------- + + So doing it in the FHA, you have got the Ginnies to their 4-year RWAs are lower, getting the same credit for CRA and loans is obviously a little bit more capital consumptive so that is part of the challenge? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman and CEO [188] +-------------------------------------------------------------------------------- + + It is all of that. We are going to meet CRA. We report CRA to our sellers every month and like I said, it cuts across a wide variety of things that we do for people and we just did this great thing in Detroit that is a lot of CRA credits. We can you mortgages ourselves that we can put on balance sheet that we think are less risky than FHA insurance. So we will figure it out. +We are just thoroughly, thoroughly confused about how we got treated, how we've got it going forward and we are kind of waiting for -- we have spoken to government for some kind of guidance going forward. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [189] +-------------------------------------------------------------------------------- + + So this is on the reps and warranties on the FHA? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman and CEO [190] +-------------------------------------------------------------------------------- + + Yes. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [191] +-------------------------------------------------------------------------------- + + It's deals and reps and warrants. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman and CEO [192] +-------------------------------------------------------------------------------- + + It is the reps and warrants that there should be a commercial resolution of the dispute but you don't have [treble] damages if something goes wrong. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [193] +-------------------------------------------------------------------------------- + + Okay. Thanks a lot. + +-------------------------------------------------------------------------------- +Operator [194] +-------------------------------------------------------------------------------- + + There are no other questions at this time. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [195] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Operator [196] +-------------------------------------------------------------------------------- + + Thank you for participating in today's call. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/exam/original-files/Problem_2_3_Sample_full_transcripts/2014-Jul-22-KO.N-138547566546-Transcript.txt b/exam/original-files/Problem_2_3_Sample_full_transcripts/2014-Jul-22-KO.N-138547566546-Transcript.txt new file mode 100644 index 0000000..3e38bb7 --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_full_transcripts/2014-Jul-22-KO.N-138547566546-Transcript.txt @@ -0,0 +1,614 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q2 2014 The Coca-Cola Company Earnings Conference Call +07/22/2014 09:30 AM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Ahmet Bozer + The Coca-Cola Company - EVP and President Coca-Cola International + * Sandy Douglas + The Coca-Cola Company - SVP, Global Chief Customer Officer and President Coca-Cola North America + * Jackson Kelly + The Coca-Cola Company - VP and IR Officer + * Irial Finan + The Coca-Cola Company - EVP and President Bottling Investments Group + * Kathy Waller + The Coca-Cola Company - CFO + * Muhtar Kent + The Coca-Cola Company - Chairman and CEO + +================================================================================ +Conference Call Participiants +================================================================================ + + * Judy Hong + Goldman Sachs - Analyst + * Mark Swartzberg + Stifel Nicolaus - Analyst + * Bryan Spillane + BofA Merrill Lynch - Analyst + * Kevin Grundy + Jefferies & Co. - Analyst + * Ali Dibadj + Sanford C. Bernstein & Company, Inc. - Analyst + * Bill Schmitz + Deutsche Bank - Analyst + * Nik Modi + RBC Capital Markets - Analyst + * Michael Steib + Credit Suisse - Analyst + * Steve Powers + UBS - Analyst + * John Faucher + JPMorgan Chase & Co. - Analyst + +================================================================================ +Presentation +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + At this time, I would like to welcome everyone to the Coca-Cola Company's second-quarter 2014 earnings results conference call. Today's call is being recorded. If you have any objections, please disconnect at this time. +(Operator Instructions) +Due to the interest in this call, we request a limit of one question per person. I would like to remind everyone that the purpose of this conference is to talk with the investors, and therefore, questions from the media will not be addressed. Media participants should contact Coca-Cola's Media Relations Department if they have any questions. +I would now like to introduce Jackson Kelly, Vice President and Investor Relations Officer. Mr. Kelly, you may begin. + +-------------------------------------------------------------------------------- +Jackson Kelly, The Coca-Cola Company - VP and IR Officer [2] +-------------------------------------------------------------------------------- + + Good morning, and thank you for being with us today. I am joined by Muhtar Kent, our Chairman and Chief Executive Officer; and Kathy Waller, our Chief Financial Officer. +Following prepared remarks by Muhtar and Kathy this morning, we will turn the call over for your questions. Ahmet Bozer, Executive Vice President, and President of Coca-Cola International; Sandy Douglas, Senior Vice President, Global Chief Customer Officer, and President of Coca-Cola North America; and Irial Finan, Executive Vice President, and President of Bottling Investments, will also be available for our Q&A session. +Before we begin, I would like to remind you that this conference call may contain forward-looking statements, including statements concerning long-term earnings objectives, and should be considered in conjunction with cautionary statements contained in our earnings release and in the Company's most recent periodic SEC report. +In addition, I would also like to note that we have posted schedules under the Financial Reports and Information tab in the Investor section of our Company website at www.coca-colacompany.com. These schedules reconcile certain non-GAAP financial measures, which may be referred to by our senior executives during this morning's discussion, to our results as reported under generally accepted accounting principles. Please look on our website for this information. +Now I will turn the call over to Muhtar. + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Company - Chairman and CEO [3] +-------------------------------------------------------------------------------- + + Thank you, Jackson, and good morning, everyone. Earlier this year, we established five global strategic priorities to restore our global growth momentum. Halfway through the year, I am pleased to report that we've delivered another quarter of sequentially improving performance results. While I am pleased with this year-to-date progress, we're conscious of the fact that we still have more work to do. +In spite of continued sluggish global economic growth, the beverage industry remains vibrant. Consumers today have a wider array of beverages to choose from than ever before, and our system is responding by evolving the way we operate, leveraging our strengths to create new competitive advantages. Our second-quarter and year-to-date performance results reflect the steady progress that we are making and that we expect to continue as we further solidify the foundation for long-term sustainable growth. +We closed out the second quarter with 3% global volume growth, including global sparkling growth of 2%. Importantly, price mix increased 2% on a consolidated basis, as we strive to deliver balanced volume and revenue growth. +We are seeing a number of encouraging signs across our global operating system. In the second quarter, brand Coca-Cola grew 1% in North America, along with solid 3% sparkling price mix. +We saw improving volume growth across several key markets in Europe. Eurasia and Africa continue to deliver balanced volume growth. Key markets in our Asia-Pacific operations delivered strong performance, including 9% growth in China, double-digit growth in India, and 1% growth in Japan. And we saw steady execution in the face of a challenging macro environment in Latin America. +As mentioned, this progress is built on the implementation and execution of our five global strategic priorities, priorities that emerged from a disciplined, fact-based look at what drives results and long-term sustainable growth. We know, for example, that great marketing combined with great in-market execution are fundamental building blocks of our formula for long-term sustainable growth. +When we conducted a comprehensive review of our Business last year, we identified areas where we could improve and put a focus plan in place to address them. With that in mind, I will now provide an update on our progress against each of our five strategic priorities. +Our first strategic priority is to accelerate global sparkling growth led by brand Coca-Cola. We grew global brand Coca-Cola 1%, a sequential improvement from the first quarter of 2014. +As noted earlier, our global sparkling brands grew 2% in the second quarter, thanks to solid performance across our portfolio of billion-dollar sparkling brands including Sprite, Fanta, Coca-Cola Zero and Schweppes. This led our 19th consecutive quarter of core sparkling value share gains. +Diet Coke and Coca-Cola Light declined mid-single digits. While this was a sequential improvement from the first quarter, we do recognize that we have more work to do here. +Progress in growing our global sparkling beverages is built on proven strategies that include delivering best-in-class marketing, driving immediate consumption transactions and leading industry innovation. While I could point to multiple examples of each, I would particularly like to highlight our Share-a-Coke campaign, as it successfully combines all three strategies, and it is being rolled out in more than 80 markets this year. The viral impact of this campaign and the engagement among teens has been more than encouraging. +We are excited about the campaign's expansion not only to new markets, but also its return for an encore in many markets. For example, this year in our northwest Europe and Nordics business unit, we are extending the program to include all Coca-Cola trademark immediate consumption and future consumption packs, and increasing the number of names from 250 to 1,000 per market. This is a tremendous logistical feat and marketing achievement befitting the world's most loved beverage brand. +The growth of brand Coca-Cola in North America in the second quarter gives us confidence that our focus on driving incidents, delivering best-in-class marketing and evolving our price pack architecture is setting the foundation for well-balanced growth in our flagship market. Through these efforts, we are reviving the romance of brand Coca-Cola, driving household penetration and increasing consumption frequency, all of which contributed to growth in the second quarter. +Our smaller-size packs contributed significantly to brand Coca-Cola growth in the second quarter and year to date. Over 60% of the volume growth in brand Coca-Cola in the second quarter was driven by double-digit growth in our mini-can and 16-ounce immediate consumption packages, reflecting strong consumer demand for smaller packages of ice-cold Coca-Cola. So we remain optimistic about our sparkling business in North America and around the world, and we are committed to supporting our brands, committed to driving execution and staying at the forefront of evolving consumer needs. +Our second global priority is to strategically expand our profitable still beverage portfolio. We have delivered 5% still beverage volume growth in the second quarter, and 6% growth year to date. Sports drinks, tea, energy, coffee and water all contributed to global growth, and enabled us to gain volume and value share in still beverages year to date. +Juice and juice drinks growth slowed year to date due to price adjustments, primarily to offset cost of goods increases in North America. However, we gained volume in value share in North America and also on a global basis. +Overall, the global juice growth story remains very robust. We are strengthening our leading brands, as demonstrated by the double-digit growth of Maaza and Rani year to date, along with high single-digit growth for Simply and mid-single-digit growth for Del Valle. +Our tea volume increased 4% in the quarter, growing volume and value share in the second quarter and year to date. Importantly, our tea brands within the US and Japan, our two largest tea markets, performed very well. Tea volume grew 6% in North America, driven by double-digit Gold Peak and Honest Tea growth; while in Japan, tea volume grew 5%, led by 8% growth of Ayataka, the 21st consecutive quarter of strong growth for this dynamic brand. +As a system, we are enhancing our premium water brands to drive revenue while investing in our value chains to improve profitability. Examples of premium water brands growing double digits in both the quarter and year to date include Smartwater in North America, I Lohas in Japan, and Vio in Germany. As we focus on building great brands, we are pleased to share that Smartwater will soon be available in Great Britain, and that addition of DASANI sparkling and DASANI drops is enhancing our brand margins in North America. Our water portfolio grew 7% in the second quarter and 10% year to date. +In the sports drinks category, we grew volume 6% in the quarter, fueled by our FIFA World Cup POWERADE activation. As the global value leader in still beverages, and with 11 billion-dollar brands and many more in the pipeline, we are diligently working to enhance the value of our still portfolio. And as exemplified by our recent partnership with Keurig Green Mountain, we will continue to strategically target opportunities to strengthen our position and build our breadth across new categories while building category beverage depth. +Moving now on to our third strategic priority, which is to increase brand investments by maximizing productivity, our productivity initiatives are on track, as is our commitment to increase media investments in key markets. We are delivering more and better-quality marketing by focusing on increased efficiency and effectiveness. Our global marketing campaign charters are fueling productivity and efficiency, while at the same time driving media effectiveness through higher-quality communication. +An example of the power of this approach is the full-scale activation of our FIFA World Cup campaign where a single creative idea, This Is The World's Cup, was executed across more than 170 markets in the second quarter. The success of our Coca-Cola music anthem for the 2014 FIFA World Cup reinforces the engaging nature of this campaign, as the anthem reached over 2 billion impressions, charting in the top-10 songs in 40 countries, and was ranked as the number-one song in Brazil at the start of the World Cup. The full impact of our enhanced marketing and productivity initiatives will clearly build over time. +Our fourth priority is to win at the point of sale by unlocking the power of our system. Our global system is committed to investing in new plants, investing in new distribution capabilities, investing in coolers and marketing, enhancing our immediate consumption capabilities while optimizing in-store activations and advancing our customers' business strategies, and finally, putting more feet on the street to service these accounts. +To that end, you may have read last week that, together with our bottling partners, we will be investing an additional $8.2 billion by 2020 to support our long-term business plan and vision in Mexico. Since 2010, our total system investments globally have exceeded $60 billion. +Our fifth priority is to invest in our next generation of leaders. We are doing this by inspiring our people to live our values of focusing on the market, working smart, acting like owners, and being passionate ambassadors for our Company and for our brands. +We are harnessing the potential of our millennial associates. Their optimism, their global mindedness, entrepreneurialism and social awareness drive them to build sustainable practices into every aspect of what they do, including right here at the Coca-Cola Company. We, therefore, established an internal group of millennial voices, and we are working with the World Economic Forum's Global Shapers to provide our leaders with insights on how to continue to evolve to meet the needs of this and also future generations. +We continue to focus on strengthening the core front-facing capabilities of franchise leadership, commercial leadership and marketing leadership, while also embracing emerging capabilities in the digital, mobile and social media arena. We are working with our global bottling partners to encourage more cross-system experience, having Company associates join bottlers, and bottling associates join the Company, to instill a one-team mentality across our global system ranks. +And another terrific example of how we're living our fifth priority is the Woodruff Cup, our most prestigious internal award named after our legendary Chairman, Robert Woodruff, whose tenure with the Company spanned from 1923 to 1985. Each year, our business unit Presidents select one of their peers as winner of this award, and people leadership is a key criteria. Our most recent winner of the South Latin business unit exemplifies what it means to inspire our next generation of leaders, as demonstrated by the fact that women make up more than half of their workforce, and that they've consistently been ranked among the top-three best places to work in that whole geography. +Our focus on our five strategic priorities enables us to execute the fundamentals while simultaneously transforming and advancing our Business. An important example of this is our North American refranchising effort to build a 21st-Century beverage partnership model. Our ongoing work is underpinned by our full commitment to create a modern, agile, consumer- and customer-focused operating model and system which balances national scale and local capability. +As we continue to roll out an evolved business model in North America, we expect to franchise the large portion of North America territories into a handful of proven regional bottlers that can best serve every local community within their contiguous operating territories. These larger bottling partners will be complemented by a select group of local bottling partners, enabling us to benefit from the passion and local touch of a franchise model, and to grow our Business faster and more profitably over time. +We are making progress, and we're implementing this work by executing smaller-scale transitions today so that we can seamlessly transfer larger portions of territory in the future. It is important for us to follow this deliberate process as we establish a structure to maximize long-term value for our shareowners while ensuring that there is no business disruption to our customers and consumers. We will provide you with additional details regarding this transformational initiative before the end of the year. +In summary, and as mentioned at the beginning of the year, we are committed to executing strategies that will deliver stronger growth. Notwithstanding the volatile environment in which we are operating, we are making steady and sequential progress as we invest in our brands together with our bottling partners, and we expect to fall within the corridors of our long-term growth algorithm in the second half of the year. Indeed, our second-quarter and year-to-date performance results reflect the steady progress that we are making to restore our global growth momentum, and I look forward to providing you with further updates later in the year. +Now I am happy to hand the call over to our new Chief Financial Officer, Kathy Waller, who will provide you with an update on our financial performance, as well as an outlook on our Business for the balance of the year. Following Kathy's prepared remarks, Irial Finan, Sandy Douglas, Ahmet Bozer and I will participate in our Q&A session to address any market-specific questions that you may have today. Kathy? + +-------------------------------------------------------------------------------- +Kathy Waller, The Coca-Cola Company - CFO [4] +-------------------------------------------------------------------------------- + + Thank you, Muhtar, and good morning, everyone. I would like to start by saying that it is an honor to serve as the CFO of The Coca-Cola Company. In my more than 25 years with the Company, I have seen our Business evolve and grow over time, while remaining strategically focused on doing the right things to drive long-term sustainable growth. That is why I am confident about our Business, and I look forward to working with each of you. +As Muhtar mentioned, we have continued to execute the five strategic priorities we laid out at the beginning of the year. We achieved 3% volume growth in the quarter and delivered sound financial results over the first half of 2014. +Let's start by reviewing a few key drivers of our financial performance. Unit case growth was ahead of concentrate sales growth in the quarter, primarily due to timing of shipments. Importantly, after considering the impact of one less selling day, unit cases and concentrate sales were in line year to date, and we expect them to be in line for the full year. +Comparable currency-neutral net revenue growth was 3% for both the quarter and year to date, after excluding the impact of structural items. Our top-line growth included 2 points of positive price mix in both the quarter and year to date. Comparable currency-neutral operating income was up 5% in the quarter and 6% year to date, after excluding the impact of structural items. +Operating leverage was even in the quarter, as we continued to make the necessary investments behind our brands to accelerate growth, including a mid-single-digit increase in DME as we invest in the growth of our brands together with our global system partners. On a comparable basis, currency unfavorably impacted this quarter's operating income by 4%, which was 3 points better than the outlook we provided during our last earnings call. +The difference between the outlook we provided and the actual currency impact was primarily due to a new provision in Venezuela that imposed a maximum threshold for profit margins, and decreased our bolivar-denominated revenue and profit. The new provision resulted in an approximate $0.01 drag on comparable EPS in the second quarter, which was partially offset by the impact of slight improvement in other currencies compared to our previous expectations. Despite a difficult operating environment in Venezuela, the Coca-Cola system remains committed to the market, and will continue producing and selling our products that Venezuelan consumers enjoy on a daily basis. +We also benefited in the quarter from lowering our underlying effective tax rate from 23% to 22.5% for the full year. +Cash generated from operating activities was a strong $4.5 billion in the first half of the year, and we continue to make capital deployment decisions based on a consistent and disciplined framework, as we have outlined before. First, we reinvest in the Business, which includes making the necessary investments to strengthen our brand, and includes capital investments, which we expect to be roughly $2.5 billion for the year. Second, we reward our shareowners by paying a healthy dividend, which we have increased annually for more than half a century. +Next, we evaluate opportunities to grow through acquisitions, partnerships and joint ventures. We view these as enablers to help accelerate growth and create value in a capital-efficient manner. Lastly, we repurchase shares. Year to date, our net share repurchases totaled $1.3 billion, and we are on track for net share repurchases in the $2.5 billion to $3 billion range for the full year. +As we look ahead to the second half of 2014, let me take a minute to update you on a few outlook items as you model our Business. We previously communicated that we expected structural items to unfavorably impact the first half of the year as we cycle the deconsolidation of certain bottling operations in 2013. However, we now expect structural items, including Venezuela, to be a 1- to 2-point drag on net revenue growth, and an approximate 3-point drag on operating income growth during the second half of 2014. The refranchise territories in North America had a nominal impact on our comparable results in the second quarter, and are not expected to have a meaningful impact over the balance of the year. +After considering our hedge positions, current spot rates and the cycling of our prior-year rates, we expect a 3-point currency headwind at operating income during the second half of 2014, with a relatively similar impact on both the third and fourth quarters. And we now expect a currency headwind in the 5- to 6-point range at operating income for the full year. This is an improvement compared to the previous outlook we provided, primarily due to the decrease in bolivar-denominated revenue and profit. +After taking into consideration all of these factors, we expect the impact of structural items, net of the benefit from the change in our underlying effective tax rate, to be a $0.02 drag on comparable EPS during the second half of the year. Finally, we continue to expect operating leverage on a currency-neutral basis to be even to slightly positive for the full year. +In closing, we delivered sound financial performance in the first half of 2014, and we expect to continue our sound financial performance over the remainder of the year. And I believe our Company and our global system are well positioned to capitalize on the opportunities within our great industry. +Operator, we are now ready for questions. + + +================================================================================ +Questions and Answers +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) +Judy Hong, Goldman Sachs. + +-------------------------------------------------------------------------------- +Judy Hong, Goldman Sachs - Analyst [2] +-------------------------------------------------------------------------------- + + Muhtar, if I look at your second-quarter performance buying growth of 3%, sequential improvement versus Q1, global price mix held steady at 2%. I guess second quarter also though benefited in part because of easy comp, and you had the Easter benefit. So can you talk about your ability to sustain the top line momentum as you look at the back half of the year and be mindful of some of the macroeconomic conditions that you see in the marketplace? + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Company - Chairman and CEO [3] +-------------------------------------------------------------------------------- + + Thanks, Judy. Again, just to quickly go through the quarter, as you said, volume was up 3%, sparkling volume really importantly was up 2%, and brand Coca-Cola up globally in North America. Those are really three important points. +Also, another quarter of value market share gains, I think more than 25 consecutive -- 28 to be exact -- consecutive quarters of gaining value share. You see us having at, with our system, very clear focus on priorities. We had our entire global bottling system get together with us a couple -- a few months ago, and again a recommitment to the focus on our priorities. +Sequential improvement in a lot of large markets, particularly Europe, France, Germany, Great Britain, Italy, Spain. And good results, very strong results out of Eurasia and Africa and improving in Nigeria, South Africa, Turkey, improvement again if you take Asia-Pacific. Again very strong quarter in China as well as in India, double-digit growth in India, Thailand again saw --. +So if you take all of those margins that are improving, gross margin has improved in the quarter compared to the prior year. Clear path on North America franchising. Strong belief that what we're doing is working in our system, is really important. Good bottler alignment. Yes, there are a few exceptions, but there always have been and will be, and more work to be done. +I am the first to say we operate in a very volatile global environment, both politically and economically. China is slowing down is impacting many commodity exporting countries and from Africa to Latin America. But overall, what we're doing is working: more marketing through productivity gains, better marketing. +We mentioned Share a Coke program in over 80 markets, tremendous leverage on our World Cup program in more than 170 markets with probably the biggest activation that we have ever had. And all this will not generally have an impact on the quarter that you spend in. It comes in after with better incidence, better brand loyalty, better purchasing time that we're all seeing. +What is happening in North America in terms of sparkling price mix also, you can see that we have a very disciplined approach both in the United States and globally where we have been able to achieve a 2% price mix on a global basis. And yes, there was Easter shift, but at the same time, our gallon shipments were below our unit case volume for the quarter. And if you say that would be a -- neutralize the benefit that we may have got from Easter, then I think overall we feel pretty confident with, again, the caveat that we need to do a lot more work and continue to do a lot more work, more focus, better execution. +But the five priorities are working, and early shoots, green shoots. And we expect that the balance of the year, as I mentioned in my script, that we should be able to fall within the corridor of the long-term growth targets. +And again, there may be issues along the way, bumps along the way. But the most important thing is that we are resolutely focused on continuing to build momentum here. + +-------------------------------------------------------------------------------- +Judy Hong, Goldman Sachs - Analyst [4] +-------------------------------------------------------------------------------- + + Okay, that is helpful. If I can just quickly follow up on North American pricing, particularly in the sparkling side, where you've got the 3% in the quarter. Maybe a little bit more details around the drivers of that, whether it was -- how much was mixed versus rate -- and your views on whether you can sustain that pricing and maybe even see acceleration if you look up the next -- + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Company - Chairman and CEO [5] +-------------------------------------------------------------------------------- + + I will say a few things and pass it over to Sandy, but all I will say is take note of the fact that a very big portion, percentage, 60% to be exact, of the growth came from smaller packages. That is obviously an enhancement of the mix driving revenue, but also rate. +So, I will ask Sandy and then maybe Irial if he has any commentary on North America, but we are operating with tremendous diligence and the discipline in the marketplace. And success for us is a combination of both the growth that we have on the volume, but importantly also growth in transactions which is a really good litmus test of the success of the business that is coming more into play each day as we progress. Sandy? + +-------------------------------------------------------------------------------- +Sandy Douglas, The Coca-Cola Company - SVP, Global Chief Customer Officer and President Coca-Cola North America [6] +-------------------------------------------------------------------------------- + + Thanks, Muhtar; hello, Judy. +We said at the beginning of the year that our focus in North America was going to be a disciplined combination of volume and price and that we would see that as a strategic priority. And the second quarter really reflects that; 3% price mix on sparkling while achieving volume growth on Coke. And Muhtar mentioned the importance of smaller packages in driving that outcome. It is also important in driving growth because consumers want more smaller packages, and we've been working on developing that as a part of our overall strategy. +So lots of discipline. As we look ahead, we are lapping some very promotional activity in the third quarter of last year, and our discipline will remain. And the bottlers in the Company around the country are focusing on marketing and selling our way through and maintaining an extraordinary amount of discipline on pricing, and we are optimistic that we will be able to hold that strategy. + +-------------------------------------------------------------------------------- +Irial Finan, The Coca-Cola Company - EVP and President Bottling Investments Group [7] +-------------------------------------------------------------------------------- + + Yes, it is Irial. All I can add is really repeat what Sandy said, and I have said in the last three calls now, which is we really are focused on building a long-term sustainable business. That is mixing pricing and volume and transactions in a very balanced way and coming up with a great result for our Company. And we will do that, and we continue to do it. + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Company - Chairman and CEO [8] +-------------------------------------------------------------------------------- + + Yes, the only thing I would add here also, Judy, is that I think we see a path forward to being able to build more romance with the brand through smaller packages. And that is really an important element in what is also being discussed. + +-------------------------------------------------------------------------------- +Judy Hong, Goldman Sachs - Analyst [9] +-------------------------------------------------------------------------------- + + Okay, great. Thank you. + +-------------------------------------------------------------------------------- +Operator [10] +-------------------------------------------------------------------------------- + + John Faucher, JPMorgan Chase & Co. + +-------------------------------------------------------------------------------- +John Faucher, JPMorgan Chase & Co. - Analyst [11] +-------------------------------------------------------------------------------- + + Thank you, good morning. Just wanted to get a clarification if I could, when you talk about the $0.02 impact, you mentioned it was comparable EPS, but it sounds like that is reported EPS, as well. Is that correct? + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Company - Chairman and CEO [12] +-------------------------------------------------------------------------------- + + Yes, Kathy? + +-------------------------------------------------------------------------------- +Kathy Waller, The Coca-Cola Company - CFO [13] +-------------------------------------------------------------------------------- + + Hi John, and thanks for the question. +The Venezuela impact, yes, that is a two penny drag on a comparable EPS, as well as reported EPS. So if you look at Venezuela, you take it in two pieces; there is currency impact as well as impact of the provision. The provision is less bolivar nominated revenue because of capital margins, and it is gone straight to the bottom line. And then the FX is, the impact is because, as well, we do not have as much bolivar-denominated revenue in income. So you could split those two pieces, and yes, it is comparable, as well as as reported. + +-------------------------------------------------------------------------------- +John Faucher, JPMorgan Chase & Co. - Analyst [14] +-------------------------------------------------------------------------------- + + Okay great, thank you. +Kathy, if I could just follow-up, we are continuing to see weaker volumes in some of the higher-margin regions, like Latin America or Europe, what have you. So can you talk a little bit in terms of how you're going to look at--how should we think about margins going forward if these types of -- this type of relative weakness in some of these higher margin market continues, particularly Latin America which is your highest market region, and it's been a little bit softer over the last couple of quarters. + +-------------------------------------------------------------------------------- +Kathy Waller, The Coca-Cola Company - CFO [15] +-------------------------------------------------------------------------------- + + So I would split the question into two, and Ahmet will help answer with it, but the margins in Latin America have been impacted this quarter by the Venezuela provision. And then when you look at ongoing buying growth in contribution into the Company, I will let Ahmet -- + +-------------------------------------------------------------------------------- +Ahmet Bozer, The Coca-Cola Company - EVP and President Coca-Cola International [16] +-------------------------------------------------------------------------------- + + John, a couple of points. The rest of Latin America, the margin and the growth in profitability overall is in a good direction. No important issues there. Also keep in mind that we've been able to realize positive price mix in high-margin places like Europe, and we have been able to grow in Japan, so we are able to balance across the international territory to have positive price mix and margins. + +-------------------------------------------------------------------------------- +John Faucher, JPMorgan Chase & Co. - Analyst [17] +-------------------------------------------------------------------------------- + + Yes, okay, great. + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Company - Chairman and CEO [18] +-------------------------------------------------------------------------------- + + John, just to add, I think yes, you are right in saying that Latin America has slowed down to where it traditionally has been. And we have seen these cyclical slowdowns in Latin America. +And as some parts will get better, I think, starting towards the end of the year, we also see some other volatility, continued volatility in like Argentina and other markets. But overall, I think for most of what we are cycling as well, we expect major markets in Latin America to have some sequential improvement in the second half of this year. And then overall longer-term, we feel very confident also about what is lying ahead in Latin America. + +-------------------------------------------------------------------------------- +John Faucher, JPMorgan Chase & Co. - Analyst [19] +-------------------------------------------------------------------------------- + + Okay great, thank you. + +-------------------------------------------------------------------------------- +Operator [20] +-------------------------------------------------------------------------------- + + Bryan Spillane, BofA Merrill Lynch. + +-------------------------------------------------------------------------------- +Bryan Spillane, BofA Merrill Lynch - Analyst [21] +-------------------------------------------------------------------------------- + + Good morning. +Kathy, I wanted to follow up on John's question relative to leverage and I have two parts to it. One, I think I caught in the prepared comments that you mentioned that on a comparable currency neutral basis, you would expect some leverage in the second half. So I am just trying to make sure I heard that correctly in that we should be thinking about ex the Venezuela impact and ex the structural change in currencies, there would be currency neutral operating profit growth. +And then second question, if I have done the calculations correctly, it looks like on a comparable basis currency neutral gross margins in the quarter were up. So if you could just talk a little bit A, is that true? And B, if you could talk a little bit about how you would expect gross margin to evolve going forward, what type of inflation you are seeing and just how what factors you might see driving gross margins in the second half. + +-------------------------------------------------------------------------------- +Kathy Waller, The Coca-Cola Company - CFO [22] +-------------------------------------------------------------------------------- + + Okay, hi Brian, thanks for your question. +Our outlook for leverage in the currency neutral basis remains flat to slightly positive. When you think about gross margins, so gross margins have improved for the second quarter and year-to-date. And when we look at -- when we look at our margins for the back half of the year, we delivered sound financial results, and we anticipate that we will continue to deliver sound financial results for the rest of the quarter -- for the back half of the year. And we do anticipate that margins will continue to in the same way they have been in the first half of the year. + +-------------------------------------------------------------------------------- +Bryan Spillane, BofA Merrill Lynch - Analyst [23] +-------------------------------------------------------------------------------- + + So there was nothing unusual about the gross margins in the first half? We could potentially see more progress on gross margins and we're just spending more money back which is what is getting the leverage to slightly flat. Is that a good way to think about it? + +-------------------------------------------------------------------------------- +Kathy Waller, The Coca-Cola Company - CFO [24] +-------------------------------------------------------------------------------- + + Yes, we are continuing to invest behind our brands. So yes, that is part of the leverage story. But that is causing the North America from negative -- slight negative leverage in North America because we are spending behind our brand. So, we are getting pricing and we are committed to rational pricing, so we're getting pricing which is helping us with the margins the gross margin, but we are continuing to invest behind our brands. + +-------------------------------------------------------------------------------- +Bryan Spillane, BofA Merrill Lynch - Analyst [25] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Company - Chairman and CEO [26] +-------------------------------------------------------------------------------- + + Just add to that, Bryan, if you look at the second quarter compared to the first quarter, marketing is substantially higher in the second quarter than it is in the first quarter, and particularly towards the back end of the second quarter, substantially higher. So, that explains some of the things again, what Kathy was saying, but also our productivity is on target. It has been on target for the first half of the year and will be on target for the second half. + +-------------------------------------------------------------------------------- +Operator [27] +-------------------------------------------------------------------------------- + + Michael Steib, Credit Suisse. + +-------------------------------------------------------------------------------- +Michael Steib, Credit Suisse - Analyst [28] +-------------------------------------------------------------------------------- + + Good morning. +Can I ask a couple of questions, couple of specific questions on Latin America? First on Brazil, given all of the investments you made in the market and the World Cup, I was just wondering why volume performance was not stronger in the quarter. +You mentioned in the release a tough macro environment and some competitive activity, but I was hoping you could give us a bit more detail. And second, with regards to Mexico, I know you've taken all of the pricing related to the tax increase early in the year, but have you also passed on pricing now for general inflation in the country? +Thanks. + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Company - Chairman and CEO [29] +-------------------------------------------------------------------------------- + + Yes Michael, it is Muhtar here, and I will ask Ahmet to provide additional commentary. +Think of Brazil as having a very tough macro environment in the first half. So if you look at the entire consumer disposable and non-disposable consumer goods sectors, we are under tremendous duress in the first half of the year, particularly leading up to -- particularly -- more so in the second quarter. +Think of it this way -- had it not been, the result would not have been what it would've been had we not done all that activity. So from that perspective, I think we see brand getting stronger, incidents and purchase intent getting stronger in Brazil as a result of all the activity, and I think that should benefit us going forward in Brazil. +So certainly the macro environment in Brazil, as you can read, as we can all see, has been very challenging. And so given that backdrop, I think, our results -- we're content with where we are, and we believe that what we have done will benefit us in the second half and going forward. In terms of Mexico, I think both times prices were adjusted, they included a certain portion for also inflation, so take it as that. But again, I will ask Ahmet to provide any further commentary for both Brazil and Mexico. + +-------------------------------------------------------------------------------- +Ahmet Bozer, The Coca-Cola Company - EVP and President Coca-Cola International [30] +-------------------------------------------------------------------------------- + + Thanks Muhtar. +On Brazil, the only thing I would add Michael is that we had a pricing packaging architecture which allows us to have different tax both for immediate and future consumption at different price points, and we are executing those with great discipline. And that in fact is helping us navigate this challenging external environment. +And we expect that to continue to bear fruits in the third and fourth quarters along with the strong marketing programs we have. With respect to Mexico, the only other thing I would add is that we do have a not just passing the tax and the inflation, but a consumer-driven pricing approach which has been very carefully calculated, and the elasticity that we have calculated in reality are happening better than that we have expected. So in other words, our Mexican business is showing more resilience in this area. + +-------------------------------------------------------------------------------- +Operator [31] +-------------------------------------------------------------------------------- + + Mark Swartzberg, Stifel Nicolaus + +-------------------------------------------------------------------------------- +Mark Swartzberg, Stifel Nicolaus - Analyst [32] +-------------------------------------------------------------------------------- + + Thanks, good morning gentlemen, hello Kathy. Muhtar, as you think about the sparkling global outlook and your efforts to build on where you are here in the second quarter, is it fair to think your emphasis will continue to be on volume share gains more so than dollar share gains, or do you think there is potential for more dollar share growth in spite of the volumes being a little below what you were hoping for? + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Company - Chairman and CEO [33] +-------------------------------------------------------------------------------- + + I think success for us is certainly continuing our value share gains. You cannot obviously -- only value share gains without volume is not sustainable over the long term, but we have a very disciplined approach just like in North America, also for our international business related to more smaller packaging. +So the mix will benefit us, but also very importantly it is critical for us to achieve price mix on a global scale. Different geographies will again price differently into the picture. We have such disparate pricing per case depending on the geography we're talking about, so geographic mix is an important piece of this, as is package mix, as is rate. + +-------------------------------------------------------------------------------- +Mark Swartzberg, Stifel Nicolaus - Analyst [34] +-------------------------------------------------------------------------------- + + Obviously, a lot of markets to talk about, and this call is not useful for going into many of them, but when you look at North America specifically and you see the 3% price mix on the carbonated and a bit of growth there on the stills, but you also have the flat volumes. And then data we look at is CPI for the larger carbonated space, which continues to be down, so retailers continue to promote the carbonated component of your business. How are you thinking about the opportunity for better value share performance in North America, given the volume share situation you are facing? + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Company - Chairman and CEO [35] +-------------------------------------------------------------------------------- + + I will just say that once again, smaller size packs contributed significantly to, say, brand Coca-Cola volume and revenue growth into Q2 and year-to-date as a matter fact. So, if you take over 60% of the growth in brand Coca-Cola in Q2 was driven by double-digit growth in our mini can and 16-ounce immediate consumption packages, I think that is how I would like to leave you with -- that is what I would like to leave you with as an opportunity. + +-------------------------------------------------------------------------------- +Mark Swartzberg, Stifel Nicolaus - Analyst [36] +-------------------------------------------------------------------------------- + + Got it, okay, thank you. + +-------------------------------------------------------------------------------- +Operator [37] +-------------------------------------------------------------------------------- + + Ali Dibadj, Bernstein. + +-------------------------------------------------------------------------------- +Ali Dibadj, Sanford C. Bernstein & Company, Inc. - Analyst [38] +-------------------------------------------------------------------------------- + + Hello. If you would've predicted back in December that price mix in North America was going to be up as much and your volumes would've remained flat. And Latin America, you indicated volumes would've been flat even with all the Mexico tax issues, I think I would've said you are being optimistic, but that is what you are delivering, which is good. +But it does raise two questions for me. One is, it is concentrated your volume growth in only two of your six reporting segments. I want to get a better sense of how comfortable you are with those two currently and your expansion of volume growth in the other segments, like what gives you confidence that the others can grow, as well? And then secondly, a question about the mix between volume and price mix, which if you look over the past 10 years, it is mainly driven by volume, obviously pricing now much more balanced. +Some try to understand how much of that is actually a change in strategic intensity that you described versus just FX driving you to raise more pricing? If you can help those two, that would be great in the broader volume context. + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Company - Chairman and CEO [39] +-------------------------------------------------------------------------------- + + Yes I will take the last first. The strategy is driven by what consumers want, and that is not just a phenomenon for the United States but smaller packages are a key focus. So that helps the mix. That helps the revenue. That helps also the price mix. +Then, couple that with a very disciplined approach towards also having the right balance between value and volume share gains. And so it is really important. +In terms of concentration of volume growth, I think the important thing is for you to focus on the improvements from quarter to quarter. If you take key geographies like Europe, France had an improvement, Germany had an improvement, Great Britain had a significant improvement. +Italy had a significant improvement, Spain had a significant improvement, and Europe overall had a huge improvement when you look at total. And again, this is just pure simply for volume, and if you look at pricing earnings, you will get also a similar picture. +So I think focus on the sequential improvements. Focus on us delivering on our focused priorities. And so what I see is that we will strive, and diligently strive to continue with sequential improvement, building momentum as we go forward. And I also mentioned as an answer to a previous question that I thought that in Latin America, we would also see sequential improvement. + +-------------------------------------------------------------------------------- +Ali Dibadj, Sanford C. Bernstein & Company, Inc. - Analyst [40] +-------------------------------------------------------------------------------- + + Okay, thanks. +And one other things you've been asked a bunch on this conference call is about margin and margin mix. And one of the things obviously that can offset margin pressures is incremental cost cutting. And you talk a little bit more about how you view incremental cost cutting versus what you've announced so far, what you think the potential is, and when you think we might hear more about more cost-cutting at the Company? + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Company - Chairman and CEO [41] +-------------------------------------------------------------------------------- + + Well we announced significant cost cuts over the last four or five years, different programs. And as I mentioned earlier, again we are on target with our productivity. And that productivity is being reinvested to drive growth. + +-------------------------------------------------------------------------------- +Ali Dibadj, Sanford C. Bernstein & Company, Inc. - Analyst [42] +-------------------------------------------------------------------------------- + + Okay thanks. + +-------------------------------------------------------------------------------- +Operator [43] +-------------------------------------------------------------------------------- + + Steve Powers, UBS. + +-------------------------------------------------------------------------------- +Steve Powers, UBS - Analyst [44] +-------------------------------------------------------------------------------- + + Thanks. +Maybe building on that and focusing back on North America, as you talked about, you had good price mix realization in sparkling, 3%, and you did see margin grow in the quarter which is great. But overall, we only saw 1% price mix, and year-to-date margins remained slightly below last year's level in the US based on my math. +So as I think about the path towards refranchisement and smoothing that path, it seems a greater profitability is a great enabler of that. What needs to be done? Is there a way to get even more aggressive on price mix realization or to Ali's point pushing on productivity more to get the North American profit pool to expand to facilitate entry of new partners? +Thanks. + +-------------------------------------------------------------------------------- +Ahmet Bozer, The Coca-Cola Company - EVP and President Coca-Cola International [45] +-------------------------------------------------------------------------------- + + I will talk about a couple of levers, and then ask Irial to join me. The growth and profitability in North America, the major opportunity exists in pricing and the overall effectiveness and efficiency of the system. +We talked about price as a lever and an area of discipline and focused, and price is achieved through rate as you know, and also mix. And a whole lot of innovation is going on inside of packaging to give consumers what they want and to earn a return as a result of that. +Couple that with our overall system architecture work, which Muhtar described earlier which is on track as we overhaul IT, product supply, as we overhaul customer management and shared services. And the refranchising progress which is on track with our bottlers, will create a system that is on one hand more effective and grows faster and on another level is more efficient at generating better margins. +But at the end of the day, that combination needs to be built on accelerating growth. And the focus of the near-term has been to reinvest the proceeds into marketing to rebuild brand momentum and brand momentum at price point. We're optimistic about the progress, but we have a lot more work to do. + +-------------------------------------------------------------------------------- +Irial Finan, The Coca-Cola Company - EVP and President Bottling Investments Group [46] +-------------------------------------------------------------------------------- + + Yes, the only add I would give is [we're in] to the bottling houses, we remain absolutely committed to deliver one of our core priorities, which is excellence and execution in the marketplace. And as every day goes by, I get more comfortable that we are starting to do things better every day, every time we go to an outlet. +And fundamentally that is the other piece that gives us the capability to get extra price and mix in the marketplace, and we will continue to do that. And it is a journey. It is not turning the light switch on. It happens day by day, weak by weak, month by month. +I feel pretty good that over the next number of years, our capability in the marketplace, married with great marketing, is going to deliver the price mix we all desire. And that is why the discipline in remaining focused on price mix married with transaction growth and married with volume is why we feel confident about the North American business over the long-term. + +-------------------------------------------------------------------------------- +Steve Powers, UBS - Analyst [47] +-------------------------------------------------------------------------------- + + Great, thanks. + +-------------------------------------------------------------------------------- +Operator [48] +-------------------------------------------------------------------------------- + + Bill Schmitz, Deutsche Bank. + +-------------------------------------------------------------------------------- +Bill Schmitz, Deutsche Bank - Analyst [49] +-------------------------------------------------------------------------------- + + Good morning. Can you just comment about some of the market share losses in Mexico, Brazil, and then a much smaller market in the UK? +So what do you think is driving that? And then when you think some of those trends will reverse. +Because some of these losses are substantial. I think it was a little over a point of value share and scan channels loss in Brazil, about a point in Mexico and then similar trends in the UK. + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Company - Chairman and CEO [50] +-------------------------------------------------------------------------------- + + Yes Bill, I think in the UK most of that loss was in Q1. If you look at Q2, we have had sequential improvement in the UK. And we expect that going forward in both Mexico and in Brazil that more minor losses to the B brands and local players will reverse themselves in the course of the year. +And we already see that happening in both markets. I think that was the difficult operating environment in Brazil in terms of also us having discipline in our pricing, and the same goes for also Mexico. + +-------------------------------------------------------------------------------- +Bill Schmitz, Deutsche Bank - Analyst [51] +-------------------------------------------------------------------------------- + + Got you. So you think your losses are really a function of maybe the more aggressive pricing you took and maybe as that stabilizes this year --. + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Company - Chairman and CEO [52] +-------------------------------------------------------------------------------- + + And very transitory. + +-------------------------------------------------------------------------------- +Bill Schmitz, Deutsche Bank - Analyst [53] +-------------------------------------------------------------------------------- + + Okay great, I appreciate that. Thanks so much. + +-------------------------------------------------------------------------------- +Operator [54] +-------------------------------------------------------------------------------- + + Nik Modi, RBC Capital Markets. + +-------------------------------------------------------------------------------- +Nik Modi, RBC Capital Markets - Analyst [55] +-------------------------------------------------------------------------------- + + Good morning, everyone. +Quick question I had is, if you think about the quarter and how trends move through the quarter, I am just curious if you actually saw correlation with the higher level of spending as the quarter progressed and your volume growth. Just again trying to understand if the spending is actually working. And when you think about the ROI in that spend, what discrete things and specific things is Coke doing to make sure there is a glide path to getting a better return out of that spend. Thanks. + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Company - Chairman and CEO [56] +-------------------------------------------------------------------------------- + + Yes, two things. Spending increased as we moved through the quarter, and there was much more spending at the end of the quarter than there was at the beginning of the quarter. And therefore you would expect that not all of that benefit is going to flow, obviously, into the quarter. And this is again about generating long-term sustainable momentum, which we believe is happening. +Again I want to remind everyone that I am pleased with these results in a difficult operating environment. And to get growth back into sparkling is a significant achievement, to get growth back into Coca-Cola in the world globally and in the United States is a significant achievement, and we will continue to focus on where we need to be quarter after quarter, one quarter at a time. I just want to say that I believe our approach is working. + +-------------------------------------------------------------------------------- +Operator [57] +-------------------------------------------------------------------------------- + + Kevin Grundy, Jefferies. + +-------------------------------------------------------------------------------- +Kevin Grundy, Jefferies & Co. - Analyst [58] +-------------------------------------------------------------------------------- + + Thanks for the question. +First Muhtar, you talked about increasing or broadening your product portfolio. So, maybe without tipping your hand too much, what would be the top of your wish list by product and geography, and do you still feel comfortable with your energy drink strategy? +And then separately, Kathy, now that you bring a fresh look here, do you plan on doing anything differently from a capital structure perspective? And I say that within the context that there is an argument to be made that Coke is under leveraging and could potentially add leverage, or by adding leverage could add value to shareholders. And we have seen a number of companies in the CPG space that have been rewarded by the market for such action, so any thoughts there would be appreciated. + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Company - Chairman and CEO [59] +-------------------------------------------------------------------------------- + + Yes, Kevin. +Obviously, I cannot walk you through a wish list; that would be too much information to the whole market and everyone that plays in the market. But I would say our portfolio is really very rich, as you saw as from our $17 billion brand and so many more in the pipeline. +And again, our sparkling brands have really performed well on a global basis. Sprite and Fanta and Schweppes in addition to Coca-Cola. So, all of that tells me that what we're doing in different brands and creating more incidents, more transactions is working. +And you heard the numbers that I mentioned in tea both in the US and globally, in premium waters, in juice and juice drinks, in sports drinks, all of that. We are pleased with a much richer portfolio than we had, say, three years ago. And that portfolio is again yielding very good results, particularly, also, Simply in the juice category, [Dasani], Innocent, all those different brands. Del Valle across the world yielding very good results, and also in China too, and southeast Asia with new innovations that are really working well for us in both the fusion of dairy and juice, as well as pulpy drinks and also juice and juice drinks. + +-------------------------------------------------------------------------------- +Kathy Waller, The Coca-Cola Company - CFO [60] +-------------------------------------------------------------------------------- + + And on the second part of your question, yes, I believe the Company has always been very focused on driving long-term sustainable growth. And we have done that in a very consistent and disciplined way. We are very focused on reinvesting in the business and to accelerate growth and create value. I believe we focus on making sure we have share repurchase and we do give a healthy dividend back, but we will continue basically like we've been going with focusing on driving long-term growth. + +-------------------------------------------------------------------------------- +Kevin Grundy, Jefferies & Co. - Analyst [61] +-------------------------------------------------------------------------------- + + So no real change on that front? Okay, very good, thank you. + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Company - Chairman and CEO [62] +-------------------------------------------------------------------------------- + + Thank you Kathy, Ahmet, Sandy, Irial and Jackson. The performance year to date, progress against each of our strategic priorities and the positive signs that we are seeing in many global markets all illustrate our view that the 2020 vision and strategic plans are solid. +Proof points are out there. 3% growth in the quarter, global price mix of 2%, increased global media spending reflecting our confidence in building on the strength of our brands and also in our ability to engage our consumers and customers effectively, and global year-to-date value share growth in our categories. +And so we are winning in the vibrant beverage industry and also coupled with sound financial performance during the first half of the year. So we're making steady progress. And we are where we are expected to be at this stage in the year. +I look forward to providing all of you with additional updates as we continue to restore our global momentum in the months ahead. Thank you for your time this morning and for your continued interest and trust in the Coca-Cola Company. + +-------------------------------------------------------------------------------- +Operator [63] +-------------------------------------------------------------------------------- + + Thank you, and this does conclude today's conference. You may disconnect at this time. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/exam/original-files/Problem_2_3_Sample_full_transcripts/2014-May-21-TGT.N-139074919254-Transcript.txt b/exam/original-files/Problem_2_3_Sample_full_transcripts/2014-May-21-TGT.N-139074919254-Transcript.txt new file mode 100644 index 0000000..4f284b4 --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_full_transcripts/2014-May-21-TGT.N-139074919254-Transcript.txt @@ -0,0 +1,497 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q1 2014 Target Corporation Earnings Conference Call +05/21/2014 10:30 AM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * John Mulligan + Target Corporation - Interim President & CEO, CFO + * Kathee Tesija + Target Corporation - Chief Merchandising & Supply Chain Officer + * John Hulbert + Target Corp - Senior Director Investor Communications + +================================================================================ +Conference Call Participiants +================================================================================ + + * Matthew Fassler + Goldman Sachs - Analyst + * Joe Feldman + Telsey Advisory Group - Analyst + * Greg Melich + ISI Group - Analyst + * Matthew Nemer + Wells Fargo Securities, LLC - Analyst + * Sean Naughton + Piper Jaffray - Analyst + * Bob Drbul + Nomura - Analyst + +================================================================================ +Presentation +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Ladies and gentlemen, thank you for standing by. Welcome to the Target Corporation first-quarter earnings release conference call. +(Operator Instructions) +As a reminder, this conference is being recorded Wednesday, May 21, 2014. I would now like to turn the conference over to Mr. John Hulbert, Senior Director Investor Communications. Please go ahead, sir. + +-------------------------------------------------------------------------------- +John Hulbert, Target Corp - Senior Director Investor Communications [2] +-------------------------------------------------------------------------------- + + Good morning and thank you for joining us on our 2014 first quarter earnings conference call. On the line with me today are John Mulligan, Interim President and Chief Executive Officer, and Chief Financial Officer; and Kathee Tesija, Chief Merchandising and Supply Chain Officer. +This morning, John will provide a high-level summary of our first-quarter results and strategic priorities for the remainder of the year. Then Kathee will discuss results in the US and Canada, guest insights, and plans for the second quarter and beyond. And finally, John will provide more detail on our financial performance along with our outlook for the second quarter and the full year. Following the remarks, we will open the phone lines for a question and answer session. As a reminder, we're joined on this conference call by investors and others who are listening to our comments via webcast. Following this conference call, John and I will be available throughout the day to answer any follow-up questions you may have. +Also, as a reminder, any forward-looking statements that we make this morning are subject to risks and uncertainties, the most important of which are described in our SEC filings. Finally, in these remarks we refer to adjusted earnings per share, which is a non-GAAP financial measure. A reconciliation to our GAAP EPS is included in this morning's press release posted on our Investor Relations website. +With that, I will turn it over to John for a review of the quarter and our priorities going forward. John? + +-------------------------------------------------------------------------------- +John Mulligan, Target Corporation - Interim President & CEO, CFO [3] +-------------------------------------------------------------------------------- + + Thanks, John. +First off today, I want to thank the Target team for their energy and commitment. The first quarter was unusually challenging as we worked hard to help our guests recover from the data breach. Because of the team's efforts, traffic and sales trends have improved substantially, and we're in a much better position today than we were just three months ago. +Also, before I turn to the first-quarter operating results, I want to briefly discuss the Board's recent announcement of Gregg Steinhafel's departure and the initiation of a comprehensive internal and external search for a permanent replacement. I want to thank Gregg for all his contributions to Target over his 35-year career, and I'm humbled to follow him into this role even on an interim basis. +With the full support of the Board, Kathee and I, along with the rest of the leadership team, have made it clear to the entire Target team that we are not going to wait for a permanent CEO to improve our operations and performance. We are already taking important steps, including management changes announced yesterday, to move the organization forward. +This morning we reported adjusted earnings per share of $0.70, above the midpoint of our guidance. This is the result of generally in line performance in both the US and Canada, combined with a better than expected tax rate, driven by a variety of small matters, none of which was individually significant. +Our US segment comparable sales decline of 0.3% was near the upper end of our guidance and reflects meaningful improvement from trends we are experiencing shortly after the breach. When we survey consumers, we increasingly hear they have put the breach behind them and are resuming their Target shopping habits. We're pleased with this progress and continuing to take steps that reinforce our commitment to earn back the trust of our guests. +We recently announced we've hired Bob DeRodes as our new Chief Information Officer, and I am confident that Bob is the right person to lead our technology transformation and data security remediation efforts. That same day, we also announced the important decision to move all of our REDcards onto MasterCard's industry-leading Chip and PIN technology. This decision, along with our accelerated rollout of chip-enabled card readers to all of our stores by this September are among many crucial steps we're taking to restore confidence among our guests that it's safe to shop at Target. +First-quarter Canadian segment results were also largely in line with our expectations. Sales were just below the expected range, driven by softness early in the quarter. While losses were meaningfully lower in the fourth quarter, we're still far from where we need to be. +We continue to roll out enhanced tools and technology, we've increased the intensity of our value messaging, and we made several important changes to the Target Canada leadership team during the quarter. As a result, we're beginning to see improved guest satisfaction measures regarding instocks and price perception. +While these early signs of progress indicate we're moving in the right direction, we're committed to moving faster. As we look ahead to the second quarter and beyond, the Board and our team are aligned on three priorities. The first is growing traffic and sales in our US segment. While the environment is challenging, we can do better. +We need to improve on something we've historically done well: delivering unique products and services at great prices. As a result, we're working quickly to drive more newness in our merchandising and presentation, helping to keep Target top of mind with guests by continually reminding them why they fell in love with Target in the first place. +Second, we must improve our Canadian segment performance. Canada is a great market and Target is a great retailer, but so far we have not lived up to our potential, or our expectations. Improving operations is key, but we need to think broadly about all aspects of our business and whether other changes are needed. We made changes to the Target Canada leadership team so they could take a hard look at our current performance and apply fresh thinking about how to improve. +Finally, we need to accelerate our digital transformation and become a leading omni-channel retailer. To do this, we will move more quickly to become more flexible in how we serve our guests, eliminating barriers that prevent them from shopping with us where and when they want. This includes delivering products and services more flexibly, in our stores or anywhere else the guest wants to receive them. +A common theme across all of these priorities is a continued focus on our guests -- not just the ones we currently have, but the potential guests who aren't shopping with us today. We need to listen intently to all of them, how they're feeling, what they want, and how well we're serving them. With that knowledge, we need to make decisions based on what will inspire them, deepening their love for Target by making their lives easier, and apply all of our energy to make that happen. +Finally, we know we can't accomplish any of this unless we unleash the talents of our great team, so we are focused on prioritizing and aligning our efforts to provide greater clarity and removing roadblocks that have been slowing our team down. We will empower them to take smart risks and hold ourselves accountable for learning quickly from the results. +We have been on this journey for some time, but the Board believes, and we agree, that we can accelerate our progress. Given recent announcements of leadership changes, many of you asked what is going to change. While that is certainly important, I want to make sure we discuss what is and is not going to change. +What clearly will change includes our emphasis on speed throughout the organization, our commitment to more rapid improvement in Canada, our focus on digital and becoming a leading omni-channel retailer, and the level of investment in newness and innovation in what we offer to our guests. +While we work toward those goals, we will continue to develop smaller, more flexible store formats to allow us to serve guests in markets that can't accommodate our larger store layouts. We will continue our expense optimization efforts. Our goal is not to cut our way to prosperity, but to free up resources we can leverage in support of faster growth. +Finally, our point of view on capital deployment remains the same. This has always been a Board-level discussion, and we continue to be aligned with them on the following priorities. Invest everything appropriate in our core business on projects that will support Target's growth and generate superior returns; support the dividend and build on our record of more than 40 years of annual dividend increases. And beyond those first two uses, return cash through share repurchase when we have room within our middle A credit ratings. +The Board has made it clear that they agree with these priorities and that our leadership team has their full support. Our mission from the Board is clear: provide focus, remove roadblocks, and unleash the team to move faster. +As Jeff Jones, our Chief Marketing Officer, likes to say, interim will not mean idle. We are committed to making real changes now, accelerating our transformation during this transition period while the Board conducts its search for a permanent CEO. +Now Kathee will provide more details on first-quarter results, second-quarter plans, and key priorities for the remainder of the year. Kathee? + +-------------------------------------------------------------------------------- +Kathee Tesija, Target Corporation - Chief Merchandising & Supply Chain Officer [4] +-------------------------------------------------------------------------------- + + Thank, John. +As John mentioned, we entered the first quarter during a tumultuous time for our US business, as traffic and sales trends were still recovering from the meaningful declines we saw following the data breach. Our plan was clear: make Target irresistible to our guests with exciting content and compelling deals. +Our efforts produced mixed results for the quarter, reflecting unfavorable weather in February followed by the strongest results in March and weaker than expected Easter sales in April. In total, first-quarter performance was meaningfully better than the fourth quarter, as comparable sales improved by more than 2 percentage points and comparable transactions improved even more. +In our US business, first-quarter comparable sales were strongest in hardlines, driven by a mid single-digit increase in electronics which continues to benefit from strong trends in mobile. Comparable sales in our less discretionary food, health, and beauty categories were slightly positive, while home and apparel saw small comp declines. Within our digital channels, first-quarter sales were strongest in health and beauty and home. +US segment comparable traffic was down a little more than 2%, which was nearly offset by a healthy 2.1% increase in basket size. Within the average basket, we saw an increase in both units and average retail, reflecting our continued success in attracting guests to add more items to their carts and trade up to higher price points. +First-quarter digital visits were up more than 20% from a year ago, which, according to comScore, was the fastest growth among a group consisting of Target and seven of our largest online competitors. The share of digital visits from a mobile phone or a tablet continues to grow. And in the first quarter, almost two-thirds of our digital traffic was on one of these devices. +Conversion rates on both our conventional and mobile sites improved in the first quarter, driving an increase in overall conversion despite the mix headwind created by the shift into mobile. The combined benefit of traffic and conversion improvements drove first-quarter digital channel sales up more than 30% from last year. +Our US segment first-quarter gross margin rate was down more than 1 percentage point from last year as our team focused on providing irresistible deals for our guests. Based on the success of fourth-quarter promotions prior to the data breach, we had already planned for a steady drumbeat of compelling offers this spring. However, following the data breach, we decided to ramp up the intensity of these promotions even more, to motivate guests to reestablish their shopping routine at Target. +For example, in late February we offered five 12-packs of Coke products for $10, our lowest price in more than a decade. In early March, we featured a spring cleaning incentive, offering $20 in savings when guests spent $50 on cleaning products. Also in March, our shoe sale featured a buy one, get one half off promotion; and in April, we ran a Cartwheel offer to save an extra 10% on 42 of our biggest deals from the front and back cover of our weekly ad. +In the US, to help reinforce Target as the destination to shop for anything, anytime, anywhere, we've launched the year-long Target Run marketing campaign featuring national and owned brand items across categories like food, personal care, baby, paper, and pets. This fun campaign will change with seasons and other timely events, and is intended to make Target our guests' destination for those fill-in trips they might consider making at a drug or grocery store. +While there is certainly more work to do, we are pleased that so many of our guests have responded to our promotions and moved beyond the data breach to resume their Target shopping habits. In fact, recent survey research shows the vast majority of our lapsed guests, those who had changed their shopping habits and not visited Target since the data breach, had come back for at least one visit by the end of the first quarter. And while irresistible first-quarter promotions were key to reinforcing the pay-less side of our brand promise, we were equally focused on initiatives that offer newness and deliver on the expect-more side of that promise. +We led off the quarter with the February launch of Peter Pilotto for Target. Guests in the US and Canada, and worldwide through our collaboration with NET-A-PORTER, responded enthusiastically to Target's exclusive collection of women's apparel, accessories, and swim wear. +Home is already one of our fastest growing online categories, and while we feel good about our opening price point offerings, we believe we can more fully serve guests at higher price points. To begin addressing this opportunity, in March, Target.com launched over 2,000 new furniture items from Safavieh, a brand that online guests recognize for having great style at an accessible price. Target's assortment features stylish items in furniture, rugs, lighting and soft home, including many Target exclusives. Safavieh anchored the spring home sale during April week three, and was showcased on the Target.com homepage, and we're happy with early sales results. +Guests are increasingly locking for natural, organic, and sustainable products that are better for them and their families, so in March we launched Made to Matter - handpicked by Target, a first of its kind collection that brings together 16 leading natural, organic, and sustainable brands to showcase new products and make them more accessible for our guests. The Made to Matter products span six categories, featured both in their regular locations and in specialized displays, while select products are available at Target.com and our mobile app. We will be adding new items to this collection throughout the year and enticing guests to try these products with offers on Cartwheel. +Also in the first quarter, we were blown away by the response to the release of Disney's Frozen on DVD and BluRay, as we saw amazing results across music, movies and books. In fact, when Frozen was released on DVD and BluRay in March, it became the most successful first-day release for any movie in Target history. And in the short time since, the movie has become Target's biggest movie ever. In the first month alone, we sold more units than we sold in the first year of Finding Nemo, which previously held the record for our biggest release. +In children's books, Frozen continues to be the number one license in the first quarter, and we sold hundreds of thousands of units since its set last September. And finally in music, the Frozen sound track also held the number one spot throughout the first quarter, selling more units in April than all of our other releases combined. +Cartwheel just celebrated its one year anniversary, having far outpaced our expectations. Cartwheel has attracted more than 7 million users in that time, most of whom continue to use Cartwheel after their first redemption. Cumulative Cartwheel savings have grown past $70 million, and our active Cartwheel users have on average increased their trips and spend at Target by nearly 30%, driving hundreds of millions of incremental sales from these households. And in the first quarter, we saw 33% increase in new Cartwheel users when we integrated the app into our weekly ad for the first time. +We continue to see encouraging results from our recent rollout of in-store pickup of digital orders. These orders make up about 10% of our digital transactions, and when guests pick up their items, more than 20% of the time they take the opportunity to shop the store and spend much more than our average basket. In the first quarter, we expanded the number of SKUs eligible for in-store pickup to more than 60,000, including some shelf-stable grocery items. +Following a successful ship-from-store test with Minneapolis team members, we are planning to launch a guest-facing $10 rush delivery pilot in June in the Minneapolis, Boston, and Miami markets, offering guests the ability to order as late as 1:30 PM in the afternoon and receive a delivery of qualifying items between 6 and 9 PM the same day. +Later in the year, we plan to roll out standard shipping from 136 stores in 38 markets across the country. By leveraging the store network as fulfillment centers, we can offer faster standard shipping, typically one to two days, and provide access to store-only items not previously available from Target.com. We will continue to monitor results to determine further rollout plans. +As John mentioned, in Canada we continued to enhance our operations in the first quarter, and our instocks have started to show meaningful improvement. At the same time, we ramped up our promotional intensity to show our guests the depth, breadth, and pricing of our assortment in frequency categories, and our guests have taken notice. In a recent survey of Canadian guests, we saw double-digit improvements in favorable responses to questions regarding our instocks, whether we provide a good value, our everyday pricing, and the quality of our deals. +First-quarter Canadian segment sales were slightly below plan, driven by softness in February and March and stronger performance in April. Our gross margin rate of 18.7% improved dramatically from the fourth quarter, but it remains far below where it needs to be as we continue to clear excess inventory on long lead receipts. +While our progress in Canada is encouraging, we have an opportunity to move much faster. Yesterday, we announced that Mark Schindele has assumed the role of President, Target Canada, reporting to me. Mark is a strong leader who has spent the last 15 years at Target. He has broad experience in merchandising and operations, and he will bring a fresh perspective to the Target Canada team. +Mark will join Janna Adair-Potts, who recently took on responsibility for our Canadian stores and distribution; John Butcher, our new leader of merchandising in Canada; Livia Zufferli, who leads Target Canada marketing; Tiffany Monroe, who leads Target Canada Human Resources; and Mark Wong, Target Canada's General Counsel, as they elevate all aspects of our Canadian business and implement changes to improve our performance. Yesterday, we also announced that Target will be naming a non-executive Chair in Canada, someone with deep knowledge and expertise in the Canadian market who will collaborate with the President of Target Canada to ensure our strategies and tactics align with the Canadian marketplace. +Here in the US, as we survey our guests and monitor consumer sentiment, we continue to see what we have seen for some time: signs of optimism, combined with reasons for continued caution. On the positive side, recent stock market highs, slow but persistent job growth, and rising home values are driving improved consumer sentiment metrics. However, lack of income growth among more moderate-income families and persistent lack of household formation are hampering the pace of recovery. Given our exposure to lower- and middle-income households, the environment remains challenging overall, and we face the additional challenge of addressing the lingering effects of the data breach. +Consumer survey data shows that we've made substantial progress on measures of Target's favorability and integrity in the US, and they are approaching levels we were seeing prior to the data breach. However, while trust measures have improved as well, we need to make more progress to restore them to pre-breach levels. That's why we're focused on delivering on our commitment to accelerate the rollout of Chip and PIN on our cards and in our stores, along with many other visible steps we are taking to increase the security of the entire US card payment system. +As John mentioned, for the remainder of the year we are working quickly to enhance the flow of newness and innovation in our products, presentation, and promotions. For the second quarter we've lined up compelling deals, services, and products designed to accelerate trips to Target across all of our channels. We're further enhancing our mobile platform to improve the experience and drive continued increases in conversion. Advancements under way or planned for this year include more sorting options for guest shopping on a mobile device, a Save for Later option in the mobile basket, better visibility to our in-store pick up capabilities, streamlined mobile check out, and dynamic customized landing pages. +We're also growing services like Target subscriptions that make life easier for our guests. With very little marketing, the pilot of our subscriptions program quickly grew to account for more than 15% of Target.com sales on eligible items. As a result, we recently enhanced the program by expanding eligible items nearly ten-fold and offering a 5% discount on all subscription orders, helping our guests save even more time and money. +We're continuing to integrate last year's acquisitions into Target's digital and store experiences. At DermStore, we're testing integration into our weekly digital ad, and will begin selling DermStore gift cards in all stores in July. At Chef's and Cooking.com, we're working to integrate their site content into our overall digital experience, continuing to expand the Chef's Assortment on Target.com and promoting both digital brands through inserts in millions of Target.com orders for cooking and kitchen items. +Beyond acquisitions, we are excited about our investment in startup company Cosmic Cart, which offers a universal shopping cart for publishing websites and blogs. Their technology allows retailers to make sales directly from Cosmic Cart affiliate sites and allows shoppers to easily buy items while browsing online content. Beyond our investment, Target incubated the Cosmic Cart team at our Minneapolis headquarters for three months. During that time, the team built a white label product for Target to use on our own online and social channels. This product allows shoppers to purchase a Target product they see on a specific channel, like the Instagram page of Target Style, without having to leave to check out on Target.com. We look forward to seeing how our guests respond to Cosmic Cart as we continue to test new ways to use their technology. +Our wedding and baby registries have always been a smart way to shop for gifts, but in US stores this summer, they will get even smarter with new web-enabled iPod-based scanners that give guests a much more user-friendly experience. In apparel earlier this month, we launched a new exclusive Mossimo Supply Company apparel collection in partnership with San Francisco-based artist and avid surfer Jeff Canham. This collection of classic surf-inspired apparel includes tees, tanks, board shorts, flip-flops, and beach towels. +Also this month, we launched the new Archer Farms mix and match meals program in all of our Super Target and PFresh locations, more than 1,500 stores in all. With this program, guests can create a custom designed meal for their family of four that's ready in 10 to 15 minutes and costs less than $18. These meals are comprised of unique sauces, fresh cut and pre-washed vegetables, fully cooked pastas and starches, and all-natural pre-cooked meats. And of course, we're investing in service, in-store service, and layout enhancements that will continue to differentiate the Target experience. +In baby, we heard from guests that they love shopping our stores but want help in making the smartest choices. Our enhanced baby experience provides just that, with dedicated service, enhanced technology, expert information from baby center, and an easier to shop layout that allows guests to try out items like strollers. We expanded the test of this layout to nearly 30 stores this spring on our way to more than 200 locations this summer. +Like baby, the beauty category can be overwhelming, and we want to inspire, educate, and engage our guests. Our beauty concierge program, currently in more than 400 stores, offers guests the opportunity to interact with brand-agnostic, non-commissioned based advisors who help them feel confident in their purchases, driving sales through increased trips and bigger baskets. +This spring, we executed the largest physical update to the skincare and cosmetic aisles since 2001. The new environment includes brighter, more inviting LED lighting; large backlit signage highlighting product attributes and ingredients to help inform decisions; and shelving that allows for brand customization and cleaner presentations. +In entertainment and electronics, we're testing a new layout that invites guests to discover products and make more informed purchase decisions. Examples include discovery tables to display featured items, and allow guests to interact and play with products; as well as the integration of all children's books, movies, and video game products in one convenient location. In addition to physical changes, this test incorporates enhanced team member training on product features and functionality. This redesigned experience is currently being tested in 17 stores and will determine future plans based on guest feedback. +Based on our experience in Canada and our CityTarget stores, we are testing enhanced displays including mannequins which elevate the environment and help our guests save time by providing navigational cues throughout the area. Based on positive results from a limited test this spring, we plan to roll out enhanced apparel displays to 50 additional stores this summer and several hundred more stores this fall. And we're in early stages of a test of a new toy floor pad that offers more hands-on experiences where families can explore and interact with products. The reinvention offers fun, interactive experiences including larger than life toys and features streamlined shelving to improve sight lines for the guest. Based on results of this small test, we expect to roll out this layout to a number of additional stores this fall. +In Canada, we're introducing a new format for the flier, their version of our weekly circular, with a radical new design based on feedback from our Canadian guests. The new format features a clean design, bolder price points, and more products across all categories. +We will use a consistent format each week that separates needs from wants, making it clear to our guests that we offer great deals on both. Specifically, we're adding an 8- to12-page wrap filled with frequency items so that the actual flier has more room for discretionary categories like apparel and accessories, kids, seasonal, and home, the categories Canadian guests most associate with Target. +And to further drive awareness and consideration of Target's frequency categories, Target Canada launched an integrated essentials marketing campaign, highlighting products such as laundry detergent, diapers, grocery, multivitamins, and more. The Check It Off Your List for Less campaign, which includes radio, TV, digital, and the flier, launched on March 14 and is planned to run for 18 weeks. +While we've made considerable progress in the first quarter, the entire leadership team is working to achieve faster growth in the US, dramatically improve Canadian segment performance, and accelerate Target's digital transformation. To accomplish this goal, we're going to leverage the fantastic assets we already have: a world-class brand, a strong network of newly-built or remodeled stores across the US and Canada, strong partnerships with leading national brands combined with a set of powerful owned and exclusive brands which benefit from our design and sourcing capabilities, and most importantly, a motivated and talented team that's eager to win in the marketplace. +Beyond the changes to the Canada team, yesterday we also announced changes to my team in the US, which will better leverage functional expertise to speed up innovation, drive newness, and accelerate our digital transformation. With these changes, the team will be more agile, better positioned to deliver increased traffic and sales in the US, on our way to becoming a leading omni-channel retailer. These leadership changes are among several we've made to focus our priorities and remove roadblocks that might slow down our teams. With these changes in place, we believe we can move faster, and the team has enthusiastically embraced the challenge. +Now, I will turn it back over to John, who will share his insights on our first-quarter financial performance and our second-quarter and full-year outlook. John? + +-------------------------------------------------------------------------------- +John Mulligan, Target Corporation - Interim President & CEO, CFO [5] +-------------------------------------------------------------------------------- + + Thanks, Kathee. +As Kathee mentioned, our first-quarter results were markedly better than our fourth-quarter performance, specifically compared with the trends we are seeing late in the fourth quarter following the announcement of the data breach. +In the US segment, our comparable sales decline of 0.3% was near the high end of our guidance of flat to down 2%. Comparable traffic declined 2.3%, dramatically better than our late fourth-quarter trends but well below where we should perform over time. Consistent with broader trends in the US market, traffic in our stores has been declining while transactions in our digital channels have been growing rapidly, particularly in mobile. However, given the relative size of these two channels at Target today, the mix effect of these opposing trends is driving a decline in overall transactions. +The key to reversing this decline is clear: accelerate our digital capabilities and leverage assets across both our physical and digital channels to lead guests to choose us more often than they are today. The distinction between channels is increasingly unimportant, because single transactions are already straddling both the physical and digital channels. Ultimately we should be agnostic about which channels guests choose, and enable them to interact with us where and when they want to -- in our stores, digitally, or preferably both. +First-quarter penetration on our REDcards was 20.4%, up 3.3 percentage points from last year. This is very healthy growth, but a couple of percentage points below rates we were seeing prior to the data breach. In the first quarter, as research showed that most consumers were putting the breach behind them, we ramped up REDcard offers to guests in our stores, and by the end of the quarter, we were making those offers with the same frequency as before the breach. When we make an offer, the application rate for our credit card has largely recovered to pre-breach levels, but the rate for the debit card is responding less quickly. +As a result, we expect slower US REDcard penetration growth in the second quarter, up between 200 and 300 basis points from last year. Looking ahead, as part of our broader effort to rebuild traffic and sales, we will work hard to reaccelerate REDcard growth, particularly the debit product, through our marketing and an enhanced focus on the role our store team members play in generating REDcard applications. +Our first-quarter US segment EBITDA margin rate was 9.5%, down nearly a percentage point from last year, driven by a gross margin rate decline of more than a percentage point. As Kathee mentioned, we ramped up the intensity of our deals in the first quarter to get guests back into our stores, and this decision was reflected both in better sales and traffic and a lower gross margin rate. Our SG&A rate improved about 30 basis points from last year, reflecting outstanding discipline across the Company, including the benefit of our expense optimization efforts, as well as the timing of some expenses compared to last year. +In our Canadian segment, first-quarter sales were below expectations in February and March but were better than expected in April. Our first-quarter gross margin rate was 18.7%, much better than the fourth quarter but still below our full-year expectation as we work to clear excess inventory on long lead-time receipts. Expense rates were much better than a year ago, reflecting scale benefits and the comparison to last year's pre-opening costs. +First-quarter REDcard penetration of 3.9% was nearly double last year's rate, but still well below where we believe it will be over time. Consistent with last quarter, beyond operating results, our first-quarter GAAP earnings reflected several items that reduced EPS by approximately $0.04. These items included data breach-related costs, net of an insurance receivable, continued reduction in the beneficial interest asset, and a charge related to our decision to move from Visa to MasterCard for our co-branded REDcard credit product. +Turning to consolidated metrics, our first-quarter interest expense of $170 million was down more than $450 million from a year ago as we annualized the first-quarter 2013 charge for the early retirement of high coupon debt. We returned $272 million in dividends this quarter, up from $232 million last year, as our $0.43 per share quarterly dividend was more than 19% higher than a year ago. We plan to recommend that our Board authorize another similar increase this summer. +We did not repurchase any shares in the first quarter. While we expect to generate cash well beyond our expected uses over the next several years, our current metrics are beyond the typical boundaries of our middle A credit rating. As a result, we do not expect to repurchase shares in the second quarter and may resume repurchases in the back half of the year at the earliest. To resume this activity, we need to see continued improvement in our US and Canadian operations, moving our credit metrics back to acceptable levels relative to our single A rating. In addition, we believe it's prudent to hold off on any repurchases until we have more visibility into our potential liability for third-party card network fraud and administrative costs related to the data breach. Based on what we know today, we do not expect to have visibility into those claims until the third quarter or later. +I will turn now to our outlook for both the second quarter and our updated expectations for the full year. Given our current trends and challenges in both the US and Canada, we believe it's appropriate to maintain a cautious outlook for sales in both segments. This allows us to plan inventory and hours effectively while building contingency plans to allow us to flex higher if sales grow more rapidly than expected. We've updated our full-year expectations for profitability in both segments, taking a more cautious view in light of the environment and the additional steps we're taking to grow US traffic and sales, accelerate improvement in our Canadian operations, and step up the development of our digital capabilities. +While we don't expect these additional efforts to change our 2014 capital expenditures in a meaningful way, we are planning for lower operating margins in both segments as we dedicate additional resources to make progress. Specifically, we expect to invest more in gross margin for newness, product innovation, and promotions in both the US and Canada to enhance our value proposition across both sides of the expect more-pay less brand promise, and incur incremental expenses as we devote more resources to improve operations in Canada and speed up the development of digital and flexible fulfillment capabilities in the US. Longer term, we believe these investments will be paid back in the form of faster, profitable growth and increasing market share in both segments. +One note -- consistent with guidance last quarter, our outlook does not include potential additional costs related to the data breach beyond what we've already recognized, as they are still not estimable. As I mentioned, we continue to believe we have the financial strength to move beyond these near-term impacts, once they are known, even as we continue to invest to grow in both of our segments. +So with that context, let's turn first to our expectations for the second quarter. In the US, we expect a slow improvement in sales trends, meaning second-quarter comparable sales should be flat to slightly positive. We expect US segment EBITDA margin rate will be below last year's 10.8% rate, but we expect a smaller year-over-year decline than we experienced in the first quarter. Both gross margin and SG&A expenses will be pressured by our efforts to grow traffic and expand our digital capabilities. But we also expect an offsetting benefit on both the gross margin and SG&A expense lines from our expense optimization efforts. +In Canada, we expect sales measured in US dollars to be up about 75% from last year's second quarter and about 25% higher than the first quarter. We will report Canadian segment comparable sales for the first time in the second quarter, but this measure will be highly volatile in the near term as we will be measuring on a small set of stores. Specifically, we expect to report a single-digit decline in second-quarter Canadian segment comparable sales as we will be comparing against the very large grand opening surges we experienced a year ago, combined with the impact of our market densification later in 2013, which redistributed sales from our initial openers. +We expect the Canadian segment gross margin weight will improve beyond 20% in the second quarter but will continue to reflect pressures from promotions and efforts to eliminate excess inventory. Expense rates in this segment should show modest improvement from our first-quarter rates but will remain elevated far beyond what they will be in the long run. Altogether, second-quarter Canadian segment EBITDA losses, measured in US dollars, are expected to be approximately flat to last year. +We expect second-quarter consolidated interest expense to be approximately flat to last year, and tax expenses to be somewhat lower. Altogether, our expectations would generate adjusted EPS, reflecting results from both US and Canadian operations, of $0.85 to $1, excluding $0.02 related to the reduction in beneficial interest asset and any potential costs related to the data breach. +For the full year, we continue to expect US comparable sales in a range of flat to up 2%, and we still expect an SG&A expense rate of about 20%. However, we've taken our gross margin rate expectation down below 30% to make room to invest more in products and promotion. +In our Canadian segment, in light of recent trends, we've taken down our full-year sales expectation to closer to $2 billion, and with that new view of sales, we expect a lower gross margin rate and higher expense rates than before. Specifically, we now expect our full-year Canadian segment EBITDA margin rate will be closer to minus-20% compared with our prior expectation of closer to minus-10%. Altogether, these updated expectations would put our full-year adjusted EPS in a range of $3.60 to $3.90, $0.25 lower than the range we provided a quarter ago. +While these are our current expectations based on where we are today, I don't want to create the impression that we're satisfied. Recent management changes, including yesterday's announcements, demonstrate that we believe meaningful change is needed to put us on a different long-run trajectory. +In Canada, we need much more urgency to improve our operations so our systems and supply chain can enable the rapid growth in sales will be driving to achieve scale. And in the US, even though we're seeing industry-leading growth in the digital channel, we need to grow even faster to catch up with others who have been on the journey for a much longer time. And we need to become much more willing to deliver more newness and differentiation to our guests. Given we're already known for it, we need to continually raise the bar on what newness means, providing our guests with a sense of inspiration and discovery that makes them want to visit us more often in whatever channel they choose. +With that, we will conclude today's prepared remarks, and now Kathee and I will be happy to respond to your questions. + + + +================================================================================ +Questions and Answers +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) +Your first question comes from the line of Matthew Fassler with Goldman Sachs. + +-------------------------------------------------------------------------------- +Matthew Fassler, Goldman Sachs - Analyst [2] +-------------------------------------------------------------------------------- + + Two questions: The first one I want to ask -- it's sort of a governance-related question, so answer it as you can. You talked about some of the Company's initiatives, and in your case strategic direction in areas where you felt perhaps the Company had fallen short. Were any of these areas themes where perhaps Gregg and the Board, or Gregg and the rest of the management team had a difference of opinion such that your focus on them today would be different from what the Firm's focus on it had been under his leadership? + +-------------------------------------------------------------------------------- +John Mulligan, Target Corporation - Interim President & CEO, CFO [3] +-------------------------------------------------------------------------------- + + Matt, all I can tell you is what we're focused on going forward, and Kathee and I and the whole leadership team have been talking to the team for the past couple of weeks about our focus on driving the Business forward. And we have three key objectives: drive sales and traffic in the US; accelerate our operational improvement in Canada, and ultimately our business performance; and then third, accelerate our transformation and get to be a leading omnichannel retailer in the US. And that's where we have the teams focused. + +-------------------------------------------------------------------------------- +Matthew Fassler, Goldman Sachs - Analyst [4] +-------------------------------------------------------------------------------- + + That's very helpful, thank you. And then my second question -- just a quick one on Canada. If you could try to help us frame the magnitude of inventory sort of left in the pipeline that you need to clear, maybe how much of a factor that was in the gross in Q1 and whether you're cleaned up at this stage? + +-------------------------------------------------------------------------------- +John Mulligan, Target Corporation - Interim President & CEO, CFO [5] +-------------------------------------------------------------------------------- + + Matt, as you know, when sales get out of -- when sales aren't on expectation, and inventories get a little heavy, they get lumpy. So, there's areas where we're a little bit heavier than we would like; there's areas where we are a little bit lighter than we would like. And we're working to, I'd say, balance all of the inventories. And a lot of it, frankly, will be dependent on: Do we meet our sales objectives? In the first quarter, a little bit light, but not materially so. And if we continue to hit our sales objectives, I think we will see our inventories smooth out over the course of the year and be in a manageable position for the remainder of the year. +I don't know if there's anything you'd add, Kathee? + +-------------------------------------------------------------------------------- +Kathee Tesija, Target Corporation - Chief Merchandising & Supply Chain Officer [6] +-------------------------------------------------------------------------------- + + The thing that I would add, Matt, is we're working on making sure that our forecasts are accurate. And then, as we buy into them, that we've got chase and cancel plans built in, so that we're able to react in-season versus what we've done this past year without any history and having to react at the end of the season to clear more. So, we are still lumpy; we still have product to clear, but we're getting our arms around that forecast, and I think that will help us as we move through the year. + +-------------------------------------------------------------------------------- +Matthew Fassler, Goldman Sachs - Analyst [7] +-------------------------------------------------------------------------------- + + Thank you so much. + +-------------------------------------------------------------------------------- +Operator [8] +-------------------------------------------------------------------------------- + + Your next question comes from the line of Bob Drbul with Nomura. + +-------------------------------------------------------------------------------- +Bob Drbul, Nomura - Analyst [9] +-------------------------------------------------------------------------------- + + Just two questions: I guess first, in terms of the search for a new CEO, is there a reasonable time frame that you think it can be resolved? And then the second question is: On the share repurchase, you gave a lot of detail on it. In terms of the second-half confidence level, do you think that you will have better visibility, and what gives you that visibility around the costs of the breach in that third quarter? I'd like to better understand that situation. + +-------------------------------------------------------------------------------- +John Mulligan, Target Corporation - Interim President & CEO, CFO [10] +-------------------------------------------------------------------------------- + + Sure, on the first question of the CEO search, certainly that's under the Board's purview, and I would tell you, rather than focused on time, they are focused on getting the right individual to lead the Company, as I said, to become an omnichannel retailer. So, that's their focus; and the time will take as long as is appropriate to get the right person. +On the second one, on share repurchase, and specifically related to the potential breach liabilities, getting visibility to that in the second half a year, there's a process that is agreed to with the networks. They get some information from their forensics investigator, and then they go through a process to evaluate incremental fraud where we may have potential liability. And then they come back to us after a period of time. And as we've looked at that historically, we've seen that that's taken several months, and that's why we get to the third quarter. We don't have, frankly, Bob, a lot of visibility to that, but as I said, as we looked at other incidents, that's what we've seen in the past for timing of when some of those potential liabilities may become more clear. + +-------------------------------------------------------------------------------- +Bob Drbul, Nomura - Analyst [11] +-------------------------------------------------------------------------------- + + Great, thank you very much. + +-------------------------------------------------------------------------------- +Operator [12] +-------------------------------------------------------------------------------- + + Your next question comes from the line of Greg Melich with ISI Group. + +-------------------------------------------------------------------------------- +Greg Melich, ISI Group - Analyst [13] +-------------------------------------------------------------------------------- + + Hi, thanks. I had a couple questions. John and Kathee, it sounds like growing that digital is a key focus right now, and driving that faster. Could you help us understand where we start from, like, what percentage of your sales, or maybe some of the cross-shopping between REDcard members and how much they shop online, or maybe how those people season after they have had a REDcard a few years. And anything you have on that, I think, would be helpful. + +-------------------------------------------------------------------------------- +John Mulligan, Target Corporation - Interim President & CEO, CFO [14] +-------------------------------------------------------------------------------- + + Sure, I will talk maybe a little bit about where we are today, and Kathee can talk about what we're doing to drive growth there. The sales in our business, somewhere between 2% and 3% digital channel originated -- probably in the 2.5% range right now. +REDcards: Given the free shipping online, we have a lot of our REDcard guests shopping online. And I think, we talked in the past, Greg, we have a very high penetration of online orders that we free ship because of that REDcard. We think it's absolutely the right incentive or part of that loyalty package for REDcard, but it drives a very high penetration +And, Kathee, you can talk about where we're going. + +-------------------------------------------------------------------------------- +Kathee Tesija, Target Corporation - Chief Merchandising & Supply Chain Officer [15] +-------------------------------------------------------------------------------- + + In terms of growth, Greg, mobile is where we're really focused, and about two-thirds of our traffic right now comes from mobile. So, we're really pleased with the results that we've seen there, not only in traffic but also conversion. We did improve conversion, both on the site and on mobile, and in total. And you know that mobile conversion is lower than site conversion. So, that headwind from the mix is there, but we still improved overall conversion. So, we're happy with that. +There's also a lot of new things that we're doing. Certainly there's product introductions; I talked about the furniture a few minutes ago. There's always new stuff that we're adding on the site. We're expanding. We've got almost all store product online now set up online; lots to be sold online. But now we're adding out in other areas where we should have a much larger selection, and we think online is the place to do that; things like apparel, home, beauty. +In addition to that, there's a lot of services that we are adding that are doing really well. We've talked about buy online, pick up in store; subscriptions has been really successful for us. We started last Fall with about 150 SKUs, and those items -- our online sales were about 15% in subscriptions, with no marketing, just beta on the site. +So, we've now got about 1,500 items; and by June, we will have 5,000 items that will be available for subscriptions. And when guests purchase those items, they will be able to get a 5% discount for signing up for subscriptions. So, a lot of product and a lot of services that go with that, to drive our growth. + +-------------------------------------------------------------------------------- +Greg Melich, ISI Group - Analyst [16] +-------------------------------------------------------------------------------- + + That's great. If I could follow up on the guidance, it sounds like it's really margin investment in Canada that has taken the guidance down, if I've summarized that right. You left the comp the same in the US. If we get back to that 0% to plus 2%, do you expect traffic to be positive at all, as part of that guidance, or do you think it could still be negative through the year? + +-------------------------------------------------------------------------------- +John Mulligan, Target Corporation - Interim President & CEO, CFO [17] +-------------------------------------------------------------------------------- + + Yes, if you mean for an annual number, getting to an annual positive traffic number, very difficult. We're working hard on increasing traffic for each of the quarters, and I think our benchmark is: Are we seeing continued improvement in traffic as we go sequentially? But for the full year, even if we just pick a number, ran a 1% comp, I don't think we will see positive traffic for the year. + +-------------------------------------------------------------------------------- +Greg Melich, ISI Group - Analyst [18] +-------------------------------------------------------------------------------- + + That's great. Thanks a lot. + +-------------------------------------------------------------------------------- +Operator [19] +-------------------------------------------------------------------------------- + + Your next question comes from the line of Matthew Nemer with Wells Fargo. + +-------------------------------------------------------------------------------- +Matthew Nemer, Wells Fargo Securities, LLC - Analyst [20] +-------------------------------------------------------------------------------- + + Thanks so much, good morning. I'm just wondering, on the digital transformation that you talked about, is there a target level of investment from both a P&L and a CapEx standpoint? + +-------------------------------------------------------------------------------- +John Mulligan, Target Corporation - Interim President & CEO, CFO [21] +-------------------------------------------------------------------------------- + + I don't think there's a target level of investment. I think, first, from a CapEx standpoint, our approach has been: We're going to invest in all the investments the business needs to grow profitably and generate appropriate returns. The length of time over which those returns occur -- we have a very long lead time as we think about capital investment. Stores have a very long return cycle, so we're used to making investments that pay back over a long period of time. +From an expense standpoint, I think there probably the biggest investment and where you will see us accelerate is in speed, and doing more testing and learning. And that's not just digital, but also in our store -- just getting more activities out into the Business that we're testing, we're modifying, and adjusting and improving on. And if it doesn't work, pull it back and retreat from that and learn from the testing. +I think the best example of that is Cartwheel. We put that out in beta; we knew there were things about the app that we didn't particularly like. Our guests let us know what they didn't like about the app. The team iterated and iterated, and one year later, and really not with much marketing until more recently, we have 7 million users, and the app has evolved as our guests have provided us feedback. +And as Kathee talked about, a lot of the merchandising initiatives in baby and in apparel and in toys and in electronics, that's the same approach we take, and get it out in the stores, modify it, test it somewhere else and modify it, and then we will move to scale. So, those are the investments we will see in expense, and I don't think that is limited by some false number of expense dollars we have to allocate toward it. It will be driven by the appropriateness of what we're testing. + +-------------------------------------------------------------------------------- +Kathee Tesija, Target Corporation - Chief Merchandising & Supply Chain Officer [22] +-------------------------------------------------------------------------------- + + The thing that I would add to that, Matt, the reason for getting more out, historically we've tended to work on our newness until we felt we got it to an almost complete level and then we would put it into pilot. The point now, and John's point about Cartwheel and some of the in-store things that we're doing, we want to get it in front of our guest very quickly, get their reaction to it so that we're fine tuning it much more quickly and then able to move out -- to roll out at a much faster pace with a product and a service that we know our guests will love. + +-------------------------------------------------------------------------------- +Matthew Nemer, Wells Fargo Securities, LLC - Analyst [23] +-------------------------------------------------------------------------------- + + Okay, great. And secondly, can you talk to the early cycle stores versus the later cycle stores in Canada -- anything you can share on the difference between the financial metrics and the various cohorts? Thanks. + +-------------------------------------------------------------------------------- +John Mulligan, Target Corporation - Interim President & CEO, CFO [24] +-------------------------------------------------------------------------------- + + Yes, as we said, we continued to see improvement across the Business into April, as the guest data improved and our sales performance improved. And the early cycle stores continue to be the best. And it's, again, almost in order down the sheet: cycle one, cycle two, cycle three, cycle four, cycle five. +So, the earliest stores, the longer they have been open, they perform the better. But the good thing is: All cycles on an upward path. We're not where we need to be, and we're not where we need to be versus our expectations, but it's good to start to see some progress. + +-------------------------------------------------------------------------------- +Kathee Tesija, Target Corporation - Chief Merchandising & Supply Chain Officer [25] +-------------------------------------------------------------------------------- + + I think the key to each of those cycles and improving them is getting this history under our belt, and now we can forecast more accurately as we move forward. And as John said, we're very committed to accelerating our performance in Canada, and we think that it will continue to go by cycle as it has this past year. + +-------------------------------------------------------------------------------- +Matthew Nemer, Wells Fargo Securities, LLC - Analyst [26] +-------------------------------------------------------------------------------- + + Thanks so much. Best of luck. + +-------------------------------------------------------------------------------- +Operator [27] +-------------------------------------------------------------------------------- + + Your next question comes from the line of Sean Naughton with Piper Jaffray. + +-------------------------------------------------------------------------------- +Sean Naughton, Piper Jaffray - Analyst [28] +-------------------------------------------------------------------------------- + + Two questions: First, on online and I guess specifically Amazon, it seems to continue to infringe on Target's everyday business, and increasingly the consumable category, so I guess the question is two-fold. Do you feel like that you're making good progress here on slowing the bleed of sales? And then secondly, have you seen any impact from the recent changes in your trends in markets where Amazon is now being forced to collect some sales tax online? + +-------------------------------------------------------------------------------- +John Mulligan, Target Corporation - Interim President & CEO, CFO [29] +-------------------------------------------------------------------------------- + + I will take the second one, and then Kathee can answer the first. On sales tax, we definitely see an impact when Amazon collects sales tax, and particularly in states that have much higher sales taxes to begin with, where essentially the price differential is much more meaningful. So, we've definitely seen that impact as we've watched them collect sales taxes across the country. +And, Kathee, you can talk about the rest. + +-------------------------------------------------------------------------------- +Kathee Tesija, Target Corporation - Chief Merchandising & Supply Chain Officer [30] +-------------------------------------------------------------------------------- + + In terms of our online business, the part that I'm very encouraged about is that, as comScore reports when we look at traffic on our site versus the top seven retailers, we led by far. And obviously, Amazon has a lot of traffic, but it was flat in the quarter, and ours was up considerably. So, I'm pleased with that the changes that we're making to the site with the user experience and the added product that we're adding is driving that guest behavior and that we're seeing the traffic. +Clearly, Amazon is doing very well, and they have, in the consumables category, a lot of business. We are now ramping that up, starting with the more style-related consumable business. If you think beauty, for example, you will see us pushing forward there faster versus grocery, which we're doing dry grocery now, but we're not working on refrigerated and frozen at this point. + +-------------------------------------------------------------------------------- +Sean Naughton, Piper Jaffray - Analyst [31] +-------------------------------------------------------------------------------- + + Understood, that's helpful. +And then, I guess the second question on the logistics side of the Organization, sounds like you're having good success with the ship from store test, and then buy online and pick up in store at 10% of the sales seems to be going relatively well. Can you talk about any of the longer-term P&L benefits from these initiatives, both maybe from a top-line and a margin perspective? + +-------------------------------------------------------------------------------- +Kathee Tesija, Target Corporation - Chief Merchandising & Supply Chain Officer [32] +-------------------------------------------------------------------------------- + + At this point, I don't think we're ready to commit to what that will do from a financial perspective. Our main focus right now is what will most resonate with our guest; getting pilots out in beta so that we can learn and experience from them. Ultimately, we have to work to be profitable on all of those. But our main goal right now is sales driven and understanding guest behavior so that we can then tailor the assortment to suit them and be profitable at it. +I will tell you I've been really pleased with some of these new initiatives and how rapidly our guest is responding to them. Store pick-up is the biggest because it's now rolled out. But ship from store, which was really a Minneapolis team member test so far, we're going to be expanding that in June and make that guest-facing, having that $10 rush delivery in Boston, Minneapolis and Miami. And based on our team member response and the feedback that they gave us, I think that this will also resonate with our guests. So I'm really excited to see where that goes. +And then, later in the year, we're going to be adding standard shipping from 135 stores in about 38 markets, and that will allow faster delivery, not the express that I just talked about, but 1- to 2-day delivery, and as well as provide access to the store assortment that you can't get right now on Target.com. So, lots of good things happening. Not yet ready to say what it means in terms of our sales or our profit. + +-------------------------------------------------------------------------------- +John Mulligan, Target Corporation - Interim President & CEO, CFO [33] +-------------------------------------------------------------------------------- + + I think Kathee's exactly right. Not ready to give a lot of guidance on sales profit and how it will all work out. But I would tell you, broadly, regardless of where the profit margin rates end up, pushing incremental sales across our existing assets will be a very good thing for return on invested capital, and we're very excited about that. +And with that, I think we have time for one more question. + +-------------------------------------------------------------------------------- +Operator [34] +-------------------------------------------------------------------------------- + + Your final question comes from the line of Joe Feldman with Telsey Advisors Group. + +-------------------------------------------------------------------------------- +Joe Feldman, Telsey Advisory Group - Analyst [35] +-------------------------------------------------------------------------------- + + Thanks for taking the question, guys. A couple of quick things: I guess I was curious as to, Kathee, the change in the organizational structure under you in merchandising, and what really prompted this now versus six months ago or next month or waiting for a formal hire of a CEO in place? + +-------------------------------------------------------------------------------- +Kathee Tesija, Target Corporation - Chief Merchandising & Supply Chain Officer [36] +-------------------------------------------------------------------------------- + + Well, I think the point is that we want to accelerate newness and innovation in this interim period here. We've talked about: interim doesn't mean idle. We are approaching our Business with as much passion and focus on improving results as we always have. +And in terms of this structure, I think, as John mentioned, focusing on our top three priorities and having this merchant team really focused on the US, improving US performance, and leveraging deep, functional expertise to be able to speed up that innovation and newness. So, for example, putting all of our style business together, both merchandising and design all under Trish Adams; having our essentials and hardlines business all under Jose Barra. Having all inventory and all operations under Keri Jones, and then our omnichannel efforts all under Casey Carl, are really important to be able to leverage that expertise and move very quickly in improving our results. + +-------------------------------------------------------------------------------- +Joe Feldman, Telsey Advisory Group - Analyst [37] +-------------------------------------------------------------------------------- + + Got it, thanks, that makes a lot of sense. +If I could follow up with that, was this something that Gregg was reluctant to doing? And did that have anything to do with the timing? + +-------------------------------------------------------------------------------- +Kathee Tesija, Target Corporation - Chief Merchandising & Supply Chain Officer [38] +-------------------------------------------------------------------------------- + + I will just tell you that the Board has been very supportive on these changes. We've talked at length about getting the right people in the right chair to be able to drive our performance, and we're really pleased with this structure and the people that we have leading these teams. + +-------------------------------------------------------------------------------- +Joe Feldman, Telsey Advisory Group - Analyst [39] +-------------------------------------------------------------------------------- + + Got it, thank you. And then, just the one last thing I wanted to ask, and I apologize if I missed it in the discussion today, but as far as the price investments go, are they more in the consumable side, the discretionary side? Where are there areas you think you need to I guess make an investment? + +-------------------------------------------------------------------------------- +Kathee Tesija, Target Corporation - Chief Merchandising & Supply Chain Officer [40] +-------------------------------------------------------------------------------- + + As we've been focusing on irresistible deals for our guests, we've invested in both sides. I gave you the example of the Coke ad that we ran in, I think it was in March, but we've also done broad categories on the want side like the ultimate Spring break sale or our baby sales. We're looking at really needs and wants, and how do we invest in both sides to be able to delight our guests, and we've had great success in both categories. + +-------------------------------------------------------------------------------- +Joe Feldman, Telsey Advisory Group - Analyst [41] +-------------------------------------------------------------------------------- + + Got it. That's great, thank you, and good luck with this quarter, guys. + +-------------------------------------------------------------------------------- +Kathee Tesija, Target Corporation - Chief Merchandising & Supply Chain Officer [42] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +John Mulligan, Target Corporation - Interim President & CEO, CFO [43] +-------------------------------------------------------------------------------- + + Thanks. Well, that concludes our first-quarter 2014 conference call. Thank you all for your participation. + +-------------------------------------------------------------------------------- +Operator [44] +-------------------------------------------------------------------------------- + + Thank you for participating in today's conference call. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/exam/original-files/Problem_2_3_Sample_full_transcripts/2014-Nov-19-TGT.N-141033583785-Transcript.txt b/exam/original-files/Problem_2_3_Sample_full_transcripts/2014-Nov-19-TGT.N-141033583785-Transcript.txt new file mode 100644 index 0000000..f8c24c5 --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_full_transcripts/2014-Nov-19-TGT.N-141033583785-Transcript.txt @@ -0,0 +1,553 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q3 2014 Target Corp Earnings Call +11/19/2014 10:30 AM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * John Hulbert + Target Corporation - Senior Director of Investor Communications + * John Mulligan + Target Corporation - CFO + * Kathee Tesija + Target Corporation - Chief Merchandising & Supply Chain Officer + * Brian Cornell + Target Corporation - Chairman & CEO + +================================================================================ +Conference Call Participiants +================================================================================ + + * Oliver Chen + Cowen and Company - Analyst + * Wayne Hood + BMO Capital Markets - Analyst + * Greg Melich + Evercore ISI Group - Analyst + * Michael Lasser + UBS - Analyst + * Matthew Fassler + Goldman Sachs - Analyst + * Sean Naughton + Piper Jaffray - Analyst + * Matt Nemer + Wells Fargo Securities, LLC - Analyst + +================================================================================ +Presentation +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Ladies and gentlemen, thank you for standing by. Welcome to the Target Corporation third-quarter earnings release conference call. +(Operator Instructions) +As a reminder, this conference is being recorded Wednesday, November 19, 2014. +I would now like to turn the conference over to Mr. John Hulbert, Senior Director, Investor Communications. Please go ahead, sir. + +-------------------------------------------------------------------------------- +John Hulbert, Target Corporation - Senior Director of Investor Communications [2] +-------------------------------------------------------------------------------- + + Good morning, everyone, and thank you for joining us on our third quarter 2014 earnings conference call. On the line with me today are Brian Cornell, Chairman and Chief Executive Officer; John Mulligan, Chief Financial Officer; and Kathee Tesija, Chief Merchandising and Supply Chain Officer. +This morning, Brian will discuss our third-quarter performance and our priorities for the fourth quarter and beyond. Then Kathee will provide more detail on recent performance and outline our plans for the fourth quarter, including the holiday season. And finally, John will provide more detail on our financial performance and outlook for the rest of the year. Following their remarks, we'll open the phone lines for a question-and-answer session. +As a reminder, we're joined on this conference call by investors and others who are listening to our comments via webcast. Following this conference call, John and I will be available throughout the day to answer any follow-up questions you may have. +Also as a reminder, any forward-looking statements that we make this morning are subject to risks and uncertainties, the most important of which are described in our SEC filings. +Finally, in these remarks, we refer to adjusted earnings per share, which is a non-GAAP financial measure. A reconciliation to our GAAP EPS is included in this morning's press release posted on our investor relations website. With that, I'll turn it over to Brian for his comments on the third quarter and our priorities going forward. Brian? + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman & CEO [3] +-------------------------------------------------------------------------------- + + Thanks, John, and good morning to all of you. We're pleased with Target's third-quarter financial performance, which we announced earlier this morning. Our adjusted earnings per share of $0.54 was better than our guidance of $0.40 to $0.50, driven by US segment comp sales growth of 1.2%, which is also better than our expectations. +Importantly, the US segment saw positive comps in all three months of the quarter. And we're encouraged that the pace of US traffic continues to recover from a very challenging trend earlier in the year. While US traffic still declined slightly in the third quarter, performance was more than a full percentage point stronger than traffic trends through the first half of the year. +As we mentioned in our second quarter earning call, we saw a strong start to back-to-school and to the back-to-college season. And that strength continued in September. Like many others, our sales slowed as we entered October, but recovered nicely towards the end of the month as we approached Halloween. +While our Canadian segment continues to see robust year-over-year growth, third-quarter sales in Canada fell short of our expectations. As Kathee outlined in our last earnings call, the team in Canada has been working diligently to make improvements to operations, assortments and pricing in preparation for the fourth quarter. +With these changes, we believe we're better positioned to serve our guests at a time of the year when traffic will naturally be higher. The guest response to these changes, both in their shopping behavior and overall sentiment towards Target will inform our perspective as we continue to assess our longer term potential in Canada. +As I have visited stores across the US and Canada and work with the Target team, I've been continually impressed with the level of their talent and passion to perform. As the Leadership team has begun, our work to develop Target's longer term goals, we've aligned around five key operating principles. +First, we will provide strategic clarity to the team. Second, we'll articulate what Target stands for in today's retail marketplace. Third, we will thoughtfully prioritize what we do, applying discipline to ensure we're focused on work that adds the most long-term value. +Fourth, we'll invest resources and build capabilities to support our priorities so the team is equipped to deliver on these goals. And finally, we will foster a culture of accountability at all levels of the organization. +While our work to define Target's longer term vision is not yet complete, we've made significant progress in defining the short and longer term priorities for our business. First, omnichannel and flexible fulfillment capabilities are key to our long-term success. Target's digital sales are growing much faster than the industry and they've been accelerating all year, and we're planning for even faster growth in the fourth quarter. +But our omnichannel journey is just beginning. As we plan for the future, we will take a channel agnostic view of our growth, allowing our guests to interact with us where and when they want, online, in stores and on their mobile device. And because an increasing number of Target visits begin on a digital platform, we will continue to push ourselves to innovate and build capabilities and features into our digital experience that will inspire our guests while removing friction from their daily lives. +Second, we're defining how we'll strategically segment our categories and increase our focus on signature categories we can and should be known for. Categories like baby, kids, wellness and style. Over time, we will work to grow these areas more quickly, by investing a higher share of our resources, including capital, marketing and product development. +Importantly, this view of segmentation doesn't mean we're abandoning our other categories. Let me restate this. It does not mean we're abandoning our other categories. But we will have different expectation for those categories compared to the ones in which we're investing to outperform. +For example, we believe we should continue to present a meaningful food offering in our stores and online, but we need to ensure that our food offering is uniquely Target and clearly differentiated from our competitors. Looking ahead, we know our identity in food will continue to involve a combination of national brands and our own and exclusive brands, with increased emphasis on natural and better-for-you products. +Third, we know that localization and personalization will be a key focus going forward. 15 years ago, all Target stores were virtually identical and were focused on providing consistent assortment and experience across the country. In today's world, we need to continue to maintain our brand standards across every store, but our guests expect each of our stores to reflect the local communities in which they operate. +In the past, we've taken some initial steps to localize our store environment and assortment, but we've only scratched the surface of this opportunity. Similarly, Target's digital experience will become increasingly personalized for every guest. This year, we've developed and rolled out a new personalization engine, which is currently generating product recommendations for guests on our digital platforms. +Even though this new engine is still in the beta rollout stage, conversion rates from its recommendations are already exceeding what we were previously seeing with a third-party product. As we continue to make changes based on initial learning, we expect conversion rates will expand further over time. Looking ahead, we expect to leverage this engine's capability to provide customized experiences across our digital platforms. +As we contemplate potential store growth, we believe that smaller formats present an exciting opportunity for Target, because urban consumers have such a high affinity for our brand. If we can reach more of these guests with small, flexible formats, like City Target and Target Express, we can offer urban consumers greater convenience, unique merchandise and an outstanding value with extended assortment available at www.target.com. +And finally, as we plan for the future, we must focus on ways to responsibly control costs to help fuel investments in our growth. The team has made solid progress in expense optimization efforts over the last few years, but we believe we must continue to find cost-saving opportunities in the years to come. +In the coming months, the leadership team will continue our work to more fully map out longer term aspirations for Target and we will communicate those plans to you early next year. In the near term, we are focused on strong execution of our fourth-quarter plans in both the US and Canada. These plans are designed to embrace the core of our Expect More, Pay Less brand promise, inspiring our guests with unique products and experiences, while providing unbeatable value through our low prices. Kathee will provide more detail in a few minutes. +In Canada, we're expecting much better fourth-quarter performance than we experienced last year. But we know that to succeed in Canada, we will need a major step change in performance. The fact is, given where we are performing today, we need to see improved financial performance from every Target store in Canada over time. The team has worked hard to prepare for the Canadian operations for the fourth quarter and we'll be watching to see how those improvements connect with our guests during the holiday season. +While there is much more work to be done, I'm very pleased with the momentum we're seeing in the US business and the changes we've implemented to better position our Canadian segment. My confidence in the potential of this Company and this brand have only been reinforced in the last three months, as I've gained deeper knowledge of Target through my work with the team. +I'm committed to realizing the potential this Great American brand to the benefit of our guests, team, shareholders and communities, and I believe we're taking the right first steps in that journey. Now, I'll turn the call over to Kathee for a recap of the third-quarter performance and our plans for the holiday season. Kathee? + +-------------------------------------------------------------------------------- +Kathee Tesija, Target Corporation - Chief Merchandising & Supply Chain Officer [4] +-------------------------------------------------------------------------------- + + Thanks, Brian. On our last conference call, we outlined that we had already seen a strong start to the third quarter, driven by initial results in the back-to-school and back-to-college season. A key question at the time was whether this early strength would prove to be temporary, resulting in a pullback later in the quarter. With the quarter now behind us, I'm happy to report that we continue to outperform our US forecast throughout the quarter and saw positive US comps all three months. +As Brian mentioned earlier, third-quarter US traffic was down slightly from a year ago, but we're encouraged that our traffic trend has improved meaningfully every quarter this year. Consistent with year-to-date trends, average ticket increased 1.6% in the third quarter, driven by growth in average retail per item, particularly partially offset by a decline in items per basket. +At a category level in the US, third-quarter comparable sales performance was strongest in healthcare and beauty, led by beauty, which continues to benefit from this year's store fixture innovations and the introduction of new brands. Third-quarter comps in home were up in the low single digits, with particular strength in seasonal categories benefiting from back-to-school, back-to-college sales early in the quarter and late quarter strength in Halloween. +Third-quarter comp sales in grocery were up in the low single digits and hard lines was up slightly, led by toys, which saw a high single-digit increase on strength in licenses like Frozen and Teenage Mutant Ninja Turtles. Comp sales in apparel were down slightly, as strength in baby and kids was offset by softness in jewelry, accessories and intimates. +From a mix perspective, it's worth noting that our combined home -- our combined comp in home and apparel was the strongest we've seen in two years. In October and early November, we completed the rollout of our new apparel fixtures and layout to an additional 600 stores, bringing the total to about 650 locations featuring this enhanced presentation. +Consistent with our expectations, the US third-quarter gross margin rate was about 50 basis points lower than last year, about half the decline we saw in the second quarter. This reflects continued moderation of our promotional intensity, which we intentionally moved higher in the wake of last December's data breach. Digital sales were up more than 30% in the third quarter and contributed about 60 basis points to our US comparable sales growth. +Consistent with the rest of the industry, all of our digital traffic growth is on our mobile platforms, where third-quarter traffic grew more than 50%. Conversion this quarter was up strongly on both the conventional site and on mobile, compounding the benefit from the traffic growth. +Following the success of our second-quarter decision to offer free shipping on all www.target.com orders over $50, in October we announced that we're offering our guests free shipping on all orders this holiday season. Since the announcement, our guests have responded enthusiastically. We've seen a meaningful increase in both orders and conversion compared with trends prior to the announcement. Of course I'd be remise if I didn't point out that REDcard holders continue to receive free shipping on all orders year round. +In Canada, third-quarter sales were up 44% from a year ago, moderately below our expectations. Our third-quarter gross margin rate of 19.5% was consistent with our expectations as we continued to clear excess inventory from earlier in the year. As Brian mentioned, the team in Canada has been working diligently to improve operations, assortment and pricing, and our internal measures show that we are making progress. +However, we're also measuring the impact these changes are having on Canadian consumer sentiment and that data is more mixed. We will continue to measure guest sentiment in the fourth quarter when all of our recent improvements will be fully in place and traffic will be naturally higher. +As we look ahead to the fourth quarter and the holiday shopping season, we're excited about our plans to inspire our guests with unique products, outstanding deals and increased convenience provided by our flexible fulfillment efforts. On our digital platforms, we're coming into this holiday season with many more capabilities than we had a year ago. In fact, it was about a year ago that we rolled out in-store pick up across all of our US stores. +So far this year, store pick up orders have averaged about 15% of digital traffic, with more than 80% of orders ready within an hour. Based on last year's results, we expect in-store pick up orders will become a much higher share of digital traffic in the days leading up to Christmas, as consumers increasingly value the certainty this service provides compared with the potential risk posed by weather-related shipping delays. And we continue to explore potential enhancements to flexible fulfillment, like our curbside test, pick up test in 10 San Francisco Bay area stores and our same-day delivery test in Minneapolis, Boston and Miami. +The Target app and Cartwheel are both top 10 retail apps and we continue to innovate to maintain our leadership position in this space. In the third quarter, we relaunched our mobile and tablet apps, making it easier for guests to locate and purchase what they're looking for, with interactive store maps and shopping lists, streamlined checkout and the addition of Apple pay for the iPhone app. +Our new list function automatically notifies guests when an item is on sale or eligible for an offer on Cartwheel. And our new interactive store maps show item locations throughout each store. For our in-store Black Friday guests this year, special interactive maps will show door buster locations throughout each store. +We completed a successful nationwide rollout of ship-from-store capability in October. With this rollout, we are now shipping about 60,000 eligible products from 136 stores in 38 markets, covering more than 90% of the US population. The ability to access stores' inventory to fulfill online orders improves our digital instocks and drives incremental sales in situations where we are out of stock in our fulfillment centers. And while shipping from stores significantly lowers shipping costs, most importantly, it allows us to get items into our guests' hands more quickly. +This change is already being noticed. In the third quarter, Internet Retailer reported a survey showing that we were leading our competitors with the fastest delivery, having been near the back of the pack earlier in the year. We've recently rolled out an improved omnichannel experience for our registries, with new web-enabled smart scanners and a matching www.target.com user experience. +The new smart scanners allow guests to add items more quickly to a registry and new features like collections and checklists provide inspiration and help guests build registries more quickly. Guests can add online-only items, like specific colors or models right from the device in the store, without having to edit online at home later. And companion and related products are suggested immediately when a guest adds an item to their registry. +And when gift givers access a registry on our new in-store iPad kiosks, they can send gift lists to their Smartphones via SMS, with -- saving time, reducing costs and eliminating waste from paper printouts. +As we enter the holiday shopping season, we are featuring a dazzling array of unique and exclusive products and, of course, outstanding deals. In September, we announced that Target would be partnering with TOMS on a limited edition holiday collection of home goods, apparel, accessories and shoes for women, men and children. +Similar to TOMS one-for-one giving model, for each item purchased, a donation will be made with the potential to provide more than 11 million meals, blankets and shoes to those in need. The collection rolls out at all Target stores in the US and Canada and on www.target.com on November 16. +We also recently announced our holiday collaboration with Faribault Woolen Mill, founded in 1865 and located on the banks of the Cannon River in Faribault, Minnesota. This mill is part of American history, having provided woolen blankets for pioneers headed west and for American troops in two world wars. On November 2, we rolled out a variety of American made giftable items from this iconic company, featuring 100% wool scarves, throws, tote bags, and tech accessories in four patterns, available exclusively on www.target.com. +If there's one thing we've learned from our past three partnerships with Taylor Swift, it's that our guests can't get enough of Taylor and her music. Even though gifting season is yet to come, our Target exclusive deluxe edition of Taylor's CD, titled 1989, featuring three exclusive songs and voice memos that give fans unique insight into her song-writing process has already become our bestselling album of all time. +Disney's Frozen has been huge for us all year and it's positioned to be one of the most popular licensed brands at Target this holiday season, with 600 Frozen products, 60 exclusive to Target across 20 categories. +For the holidays, we're partnering with Renee Ehrlich Kalfus costume designer for the contemporized Annie film, to offer guests a limited edition collection of kids apparel and accessories inspired by the film. Annie for Target will be available through December 26, or while supplies last, at all US Target stores and on www.target.com. The film debuts in theaters nationwide on December 19. +In beauty, we continue to experience strong growth in natural products and we are constantly on the look out for new lines that will appeal to our guests. We've already launched seven premium skin care brands this year and we're thrilled to announce that two more superlux lines are on the way. Available now on www.target.com and in select stores in March 2015, Target is adding S.W. Basics of Brooklyn and NUXE to its lineup of premium skin care products. +Also new in beauty, Skinfix, the experts in steroid-free skin healing solutions for the whole family, debuted its incredibly effective product exclusively at all US Target stores and online at www.target.com. Skinfix products are based on an original formula created over 150 years ago by pharmacist Thomas Dixon in Yorkshire, England. +And in hair care, we're seeing continued momentum in naturals with our Made to Matter products and we're excited about recently added salon products, like ProGanic from Vogue and exclusives like Proctor & Gamble's hair food and L'Oreal's Dessange. +In healthcare, we announced earlier this week that Target and Kaiser Permanente are teaming up to launch four Target clinics in Southern California. For the first time at Target, guests will have access to expanded services not typically available in retail clinics, including pediatric and adolescent care, well woman care, family planning and management of chronic conditions, like diabetes and high blood pressure. +And coming in 2015, our new pharmacy app, Target Healthful, will allow guests to organize and transfer prescriptions, check prescription status and order refills. +And finally, of course, we're designing our marketing plans to bring the entire holiday season together from amazing products to outstanding deals. Our holiday marketing campaign is designed to encourage people of all ages to let loose, get into the spirit and feel the unmistakable joy of the holiday season. +The advertising will boldly embrace the iconic elements that make Target, Target. Lots of red, white and our lovable mascot, Bullseye. The campaign will include broadcast, radio, out of home and catalogs and we're increasing digital media support by 50% over last year. +Target stores will be transformed with fun and whimsical in-store decor created in partnership with David Stark, one of the top event planners. This year, we're partnering with innovative New York retailer Story, which brings an editorial lens to retail and reinvents itself every four to eight weeks, from merchandise and store design to floor plans and fixtures, bringing to light a new theme or trend. +From Target's design partnerships to its everyday collections, Story has curated its favorite holiday treasures from Target, alongside its other must-have items for the season. We just launched our kids wish list app on October 31, a modern and digital take on the classic tradition of creating holiday wish lists for parents and kids. Kids can add must-have items to their list, while parents can share the list with friends and family. Plus, guests can save 10% on their wish list on one day of their choosing before November 26. +Through the holiday shopping season, Cartwheel, Target's industry-leading savings app, will offer daily deals for it's more than 11 million users. And from November 2 to December 24, it will feature 50% off a different toy every day. The app will have new features for the holidays, including special deals for top users, personalized recommendations and a select number of popular offers that don't expire. +As always, REDcard holders get 5% off nearly all purchases, free shipping at www.target.com and an extra 30 days for returns. Since 5% REDcard rewards rolled out in 2010, Target has saved guests more than $2 billion and we will thank guests for their loyalty with perks throughout the holiday season. +We know our guests are pulled in a million different directions as the holidays get under way, so we're helping them save time and money by offering more access to Black Friday deals. Whether shopping online, on their phone, or in our stores, Target guests will find Black Friday deals on top guests throughout November. +We already offered early access to Black Friday deals for one day only on November 10. We've announced a presale on Wednesday, November 26 and Cartwheel will feature access to additional Black Friday deals between November 23 and November 29. +On Thanksgiving day, Black Friday deals will be available first in the morning on www.target.com. Then at 6:00 PM, Target stores will open for Black Friday shoppers. And the first several hundred guests will receive a Christmas cracker, a gift synonymous with the holidays in many parts of the world, which will include a Target gift card or a coupon. +On Black Friday, from 6:00 AM to noon, guests can purchase up to $300 in Target gift cards at a 10% off at Target stores and www.target.com, the first time Target has ever offered a discount on Target gift card purchases. The following day, additional Saturday-only deals will be available in Target stores and at www.target.com. +And finally, beginning Monday, December 1, guests will find new deals every day at www.target.com as part of Target's largest ever cyber week sale, with more than 100,000 items on sale throughout the week. The offers will include category-wide sales in key gifting areas and steep discounts on apparel, toys and housewares. More information and deals will be available at the end of November. +As we look back at an eventful year, we're pleased with the steps we've taken to improve our performance in both the US and Canada and our financial results show that we're making meaningful progress. While there is much more work to be done, we are confident in our plans for the upcoming holiday shopping season and pleased with our progress in charting a longer term course for the Target of the future. +Now I'll turn it over to John, who will share his insights on our third-quarter financial performance and our fourth-quarter outlook. John? + +-------------------------------------------------------------------------------- +John Mulligan, Target Corporation - CFO [5] +-------------------------------------------------------------------------------- + + Thanks, Kathee. Our third-quarter financial performance was better than expected, driven by stronger than expected sales and operating margin performance in our US segment. Adjusted EPS of $0.54 was $0.02, or 2.9% below last year, reflecting a decline in US segment profit, partially offset by the benefit of reduced losses in our Canadian segment. GAAP EPS of $0.55 was $0.01, or 2.7% higher than last year, benefiting from the resolution of tax matters in the quarter. +Our third-quarter US comparable sales increase of 1.2% matches our best performance in the last two years. Digital sales in the US, including flexible fulfillment, grew more than 30%, contributing about 60 basis points to our US comparable sales. With ship-from-store capabilities now fully in place, we expect digital sales growth to accelerate to nearly 40% in the fourth quarter. +Our third quarter US segment EBITDA margin rate of 8.5% was ahead of our expectations, driven by a better than expected SG&A expense rate of 21%, which is about 20 basis points lower than last year. This performance was the result of our expense optimization efforts, better leverage on stronger than expected sales and retiming of some expenses into the fourth quarter. +US REDcard penetration was 21% in the third quarter, up about 110 basis points from last year, driven by growth in both credit and debit penetration. As we described last quarter, applications for new REDcard debit cards are running below last year, causing penetration growth to decelerate from last year's pace. We believe this trend will continue in the fourth quarter, when we expect US REDcard penetration will be flat or up slightly compared with last year. With the success of recent initiatives designed to increase REDcard applications, we expect the fourth quarter will mark the low point in year-over-year penetration growth, after which we should see a reacceleration in 2015. +In our Canadian segment, third-quarter sales were below our expectations, growing 44% above last year, reflecting sales from new stores and a comparable sales increase of 1.6%. As I mentioned last quarter, the comparable sales metric in Canada will be noisy until we fully annualize the rapid pace of last year's store rollout given the sustained grand opening surges we experienced in those stores and the densification around early cycle stores that occurred later in 2013. +REDcard penetration continues to grow in the Canadian segment, reaching 4.2% in the third quarter compared with 2.9% last year. As expected, third-quarter Canadian segment EBITDA and EBIT margin rates improved somewhat from last year. And EBIT dollar losses were about 18% lower than a year ago. While this improvement is encouraging, financial results in this segment remain unacceptable. And as Brian mentioned earlier, we need to see a significant step change in Canadian segment financial performance. +Outside of operating results in the US and Canada, our third-quarter GAAP EPS of $0.55 reflects a few items not included in adjusted EPS. Specifically, $0.05 of accretion related to the resolution of income tax matters, and $0.04 of offsetting dilution from data breach-related costs, reduction in beneficial interest asset and impairment losses. +Moving to consolidated metrics, third-quarter interest expense was flat to last year. And we paid $330 million in dividends in the quarter, an increase of 21% over last year. As expected, we didn't repurchase any shares in the third quarter, and given current performance and our goal to maintain our single-A debt ratings, we don't anticipate any share repurchase in the fourth quarter as well. Of course the timing and magnitude of any future share repurchase activity will depend on the pace of improved financial performance in both the US and Canada. +Before I move to our outlook, I want to first address our inventory, which at quarter end was about 7% above last year. This increase was entirely driven by our US segment and was the result of two factors. About a third of this increase relates to our recent efforts to reduce out-of-stocks on commodity products, while the remainder reflects receipt timing, including the impact of our efforts to manage around the slowdown at West Coast ports. Bottom line, we feel very good about our current US inventory levels. +Now let's move to our outlook for the fourth quarter. As we consider the broader environment, we see some encouraging signs, including lower gas prices than we've seen in sometime. However, consumer spending patterns remain quite volatile and we expect the competitive environment will remain highly promotional this holiday season. +Based on this backdrop and the Q3 to Q4 expense retiming I covered earlier, we're continuing to plan cautiously and maintaining our prior full-year guidance, despite stronger than expected third-quarter performance. In the US, we're expecting a fourth-quarter comparable sales increase of about 2%. So far in November, we're running ahead of our forecast, but I'll quickly remind everyone that the bulk of the season remains ahead of us. +We expect our fourth-quarter US gross margin rate will improve somewhat from a year ago. Last year in the US, we faced unexpected gross margin headwinds because of the data breach, including the pre Christmas weekend in which we gave our guests 10% off every transaction, along with incremental clearance mark downs resulting from softer sales. So while we expect the typical year-over-year gross margin pressure from an intensely promotional and highly competitive fourth quarter, we believe that pressure will be more than offset by the benefit from annualizing last year's breach-related mark downs. +We expect our US segment SG&A expense rate to be flat to down slightly from last year, as the benefit from expense optimization and better leverage on a 2% comp is expected to be offset by the timing of expenses, which moved from the third to the fourth quarter. All together, our outlook is for the US segment EBITDA margin rate to improve 50 to 60 basis points compared with last year. +In Canada, we expect a high single-digit increase in total sales driven by a mid to high single-digit increase in comparable sales. We expect a gross margin rate of around 20%, much better than last year's 4% rate, which resulted from extreme clearance activity and reserves taken on excess inventory. With an expected SG&A expense rate of between 35% and 40%, we anticipate fourth-quarter Canadian segment EBITDA losses of about $100 million, an improvement of about $160 million compared with last year. +Turning to consolidated metrics, we expect a small increase in fourth quarter interest expense compared with last year. And for the first time this year, we expect our tax expense to be higher than last year, in light of the expected improvement in profitability. All together, these expectations will lead to fourth-quarter adjusted EPS of $1.13 to $1.23, well above the $0.90 we earned last year. +Fourth-quarter GAAP EPS is expected to include $0.02 of dilution from the reduction in the beneficial interest asset, and any future data breach expenses, which are not expected to be material. For the full year, the center of our adjusted EPS expectation remains at $3.20. GAAP EPS is expected to be $0.45 lower than adjusted EPS, reflecting a variety of adjustments, including debt retirement and breach-related expenses. +Fourth quarter will mark a notable inflection point, as we annualize the data breach and expect to see the first year-over-year increase in operating profit this year. This would provide clear financial evidence of the healing process we've been engaged in throughout the year. And we look forward to entering next year with an energized team and positive momentum in our financial results. +With that, we'll conclude today's prepared remarks. Now, Brian, Kathee and I will be happy to respond to your questions. + + +================================================================================ +Questions and Answers +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) +Your first question coming from Sean Naughton from Piper Jaffray. + +-------------------------------------------------------------------------------- +Sean Naughton, Piper Jaffray - Analyst [2] +-------------------------------------------------------------------------------- + + John, you mentioned there has been a lot of talk about gas prices and the potential positive benefits on the consumer. But curious if you could speak to the potential benefit you may receive on the P&L from a distribution standpoint and if those are savings that are there, how would you guys look to use those additional distribution savings between flowing through to earnings and potentially reinvesting to drive traffic? + +-------------------------------------------------------------------------------- +John Mulligan, Target Corporation - CFO [3] +-------------------------------------------------------------------------------- + + Yes, I think a couple things. Certainly there would likely be some benefits if we continue to see fuel prices come down. But we haven't reached the threshold where fuel surcharges begin to come out of our contracts. +And I think importantly, given the great work the team has done to manage some of the port issues out west, we're working around that and moving some freight further, expediting some freight, flying some freight, and I think net-net, that will probably be more of a drag than any fuel savings we will see. + +-------------------------------------------------------------------------------- +Sean Naughton, Piper Jaffray - Analyst [4] +-------------------------------------------------------------------------------- + + Okay. So and then the second question on the overall basket, the UPT continues to be -- to decline and actually looks like it decelerated a little bit on a two-year basis. Wondering if you could give us a little bit more color around that particular dynamic, either at the store level perspective, given the higher food concentration, I would be expecting that to improve, but maybe this is being offset by online. And I guess the follow up would be, how do you improve that dynamic moving forward? Thanks. + +-------------------------------------------------------------------------------- +Kathee Tesija, Target Corporation - Chief Merchandising & Supply Chain Officer [5] +-------------------------------------------------------------------------------- + + Yes, Sean, this is Kathee. It's predominantly a mix story for us. So we have higher ticket items like all the Apple products, including the launch of the iPhone 6 in the quarter. We've got video game consoles that are higher. +We have a lot of trade-up strategies both in essentials, like you talked about, like in grocery with organics, but also in areas like skin care, which I described a little bit earlier. So this is really a mix story. + +-------------------------------------------------------------------------------- +Sean Naughton, Piper Jaffray - Analyst [6] +-------------------------------------------------------------------------------- + + Okay. So it's less about the shift between online and store at this point in time? + +-------------------------------------------------------------------------------- +Kathee Tesija, Target Corporation - Chief Merchandising & Supply Chain Officer [7] +-------------------------------------------------------------------------------- + + Correct, correct. + +-------------------------------------------------------------------------------- +Sean Naughton, Piper Jaffray - Analyst [8] +-------------------------------------------------------------------------------- + + Okay. Thank you and best of luck for the holiday. + +-------------------------------------------------------------------------------- +Operator [9] +-------------------------------------------------------------------------------- + + Your next question comes from Matt Nemer from Wells Fargo. + +-------------------------------------------------------------------------------- +Matt Nemer, Wells Fargo Securities, LLC - Analyst [10] +-------------------------------------------------------------------------------- + + Good morning and congrats on improved US results. My first question is on expenses in the US. They basically have been running flat on a dollar basis this year, down a little bit per foot. I'm wondering if you can get into a little more detail on what's driving the cost savings? +And then in terms of the outlook, is this a line that you think you can run flat to up in dollars, up slightly in dollars over the next year or so, or should we expect it to grow a little faster than that? + +-------------------------------------------------------------------------------- +John Mulligan, Target Corporation - CFO [11] +-------------------------------------------------------------------------------- + + Hi, Matt. Yes, I think the expense savings, I would tell you we've talked about the expense optimization efforts all year. Been very focused on that and has been across the entire enterprise. And we've seen good news in SG&A and also in cost of goods. +The couple of areas I would point out, the store's performance has been outstanding, driving productivity increases while still continuing to remain very strong guest service scores. Frankly, our guest service scores historically, so we've seen great performance there. +And then it's really many other areas. There's been great work done in marketing around the circular, there's been great work done in our transportation and how we optimize our network of transportation. So really across the enterprise. +I think importantly to your question about going forward, we believe there continues to be significant opportunity for us to continue to take expense out and so for the foreseeable future, we would expect to continue to see expenses very well controlled and to lever expenses at really relatively modest increases in sales. + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman & CEO [12] +-------------------------------------------------------------------------------- + + Matt, it's Brian. And to build on John's point and as I discussed in my prepared comments, as we move forward, we recognize that we're going to continue to need to focus on expense management to fuel the investments we're going to make to drive continued growth across our store base and our digital platform. +So as we come back to you in the spring and we talk more specifically about our strategy, you should expect us to continue to talk about cost optimization efforts and how we'll use those efforts to reinvest in the fuel that's going to drive our growth. + +-------------------------------------------------------------------------------- +Matt Nemer, Wells Fargo Securities, LLC - Analyst [13] +-------------------------------------------------------------------------------- + + Okay, that's great. And then secondly on www.target.com, I wanted to ask a question about the free shipping program. Does the incremental volume offset the incremental shipping expense? Is it profit accretive? And do you think the customers that are utilizing this offer are high lifetime value customers? + +-------------------------------------------------------------------------------- +Kathee Tesija, Target Corporation - Chief Merchandising & Supply Chain Officer [14] +-------------------------------------------------------------------------------- + + Yes, it's not accretive. I will tell you, we do ship even prior to the holiday free shipping, we do free ship a lot more than perhaps you would think and certainly more than some of our competitors, given REDcard and the fact that ships free all year around. +So we have seen -- we know it's the number one frustration with our guests and the number one reason for abandoned carts. And so it was important for us this holiday season to be able to take that friction away and we have seen a meaningful move in orders and conversion because of it. So we are very pleased with the results so far. + +-------------------------------------------------------------------------------- +John Mulligan, Target Corporation - CFO [15] +-------------------------------------------------------------------------------- + + Matt, the only thing I'd add, while not accretive, the other thing I would add is not material either to our results in the fourth quarter. + +-------------------------------------------------------------------------------- +Matt Nemer, Wells Fargo Securities, LLC - Analyst [16] +-------------------------------------------------------------------------------- + + Okay, very helpful. Best of luck this holiday. + +-------------------------------------------------------------------------------- +Operator [17] +-------------------------------------------------------------------------------- + + Your next question comes from Oliver Chen from Cowen and Company. + +-------------------------------------------------------------------------------- +Oliver Chen, Cowen and Company - Analyst [18] +-------------------------------------------------------------------------------- + + Thank you and congrats. Regarding the great idea regarding signature categories and where you're focusing there, how would you help us prioritize which categories have the most opportunities in terms of lead time and revenue mix and timing of impact? And is the extrapolation there that traffic will be the biggest comp upside driver as you do focus on these categories? Thanks. + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman & CEO [19] +-------------------------------------------------------------------------------- + + Oliver, I think as we go forward, and as Kathee and the team really elevate our focus around those signature categories, categories like baby and kids, wellness and style, you should expect to see additional focus in-store. You should see additional innovation, partnerships, but really ensuring that we're leading with trend. We're anticipating what our guest is looking for in those categories, and those are categories that Target becomes famous for. +And we're certainly going to double down our efforts in those categories because our guest has asked us to. They're categories that are very important to our guests. They're synonymous with the Target experience the guest is expecting. And you'll see signs of that as we move into 2015 and beyond. +Certainly, some of the work that Kathee and her team have done in preparation for the fourth quarter are already bringing our efforts to light in apparel. Some of the things that we've done in home, the partnerships that Kathee talked about in her prepared comments, our continued focus on baby and kids. And we know how important toys are during the holiday season. So we're already making progress in those spaces. +But I also want to make sure it's really clear that does not mean we're walking away from other categories in our stores. They just play a different role in our future strategy. And they'll continue to be areas where we're going to look to improve our execution and performance. +But from a prioritization standpoint, we think those signature categories that we've talked about are key to the guest. The guest has told us those are critically important to them. And Kathee and her team are working rapidly to ensure that we continue to build our position, enhance our assortment, and bring great newness and innovation to those key categories. + +-------------------------------------------------------------------------------- +Kathee Tesija, Target Corporation - Chief Merchandising & Supply Chain Officer [20] +-------------------------------------------------------------------------------- + + So couple things that I would add to that that you will already see in stores right now. Brian talked about those four areas, baby, kids, wellness and style. So in baby, about 200 stores have a new presentation where we've invested in labor in the stores to help guests create registry and gift givers find the perfect gifts. We've added mannequins and things that help the presentation. +I also shared today that the registry that we have redone completely, the whole experience, from the in-store hardware to the software that we use and how that helps guests create registries much easier, we're already seeing the benefit of that. +Wellness, we've talked a lot about Made to Matter, better-for-you products, and you see that already this year. And then in style, to touch on that for a minute, we now have about 650 stores that have our new presentation in apparel, including mannequins. So already some progress and we will continue to push forward in those areas and you'll see more and more as the months and year goes on. + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman & CEO [21] +-------------------------------------------------------------------------------- + + However, the final point I'd add as we think about style, certainly apparel and home are critically important in that space, but so is beauty. And as John and Kathee have referenced, beauty was one of our standout categories in the third quarter, and we expect continued strong performance as we exit the year. + +-------------------------------------------------------------------------------- +Oliver Chen, Cowen and Company - Analyst [22] +-------------------------------------------------------------------------------- + + Thank you. And as a follow up and it's related, there seems to be a lot of energized agility, Brian, regarding thinking about what Target stands for from a bigger picture perspective. What are some of the initial thoughts on where you see that opportunity as you work to further differentiate and innovate yourself? + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman & CEO [23] +-------------------------------------------------------------------------------- + + Oliver I think we're making progress across a number of different areas. Certainly, we talked about omnichannel and really making sure that we are a significant player in this space. And we're seeing very strong performance, up over 30% in the third quarter. John talked about the fact that we expect that performance to accelerate in Q4. +We clearly took away the pain point of shipping by announcing free ship in the fourth quarter. And we think that's another way for us to declare we are significantly committed to this space. We're seeing a great response to Cartwheel, 11 million users to date. And we're going to use that to make sure that we use digital as the front door to connect to the Target brand going forward. +We've talked about some of the progress that's being made in merchandising and we've got 35,000 new items in stores for the holiday. And we're going to continue to test and partner as we continue to make sure we're bringing the right solutions to our guests. If you haven't seen some of the holiday creative, I think it's some of the best Target's delivered in years. +And I'm getting e-mails and comments from guests and friends and people I know every day talking about their reaction to the holiday creative and how the creative campaign, it's uniquely Target. And we're certainly upping our game both in-store. But we're also going to spend significantly more in digital this year, to touch our guests no matter how they're connecting with the brand. +In-store, we've made significant progress in a very short period of time, going from testing ship from store to now we're in 38 markets, 136 stores, where our stores are acting like flexible fulfillment centers. You can shop there, you can pick up there. But they're also shipping to, directly to our guests and allows us to cover 90% of our marketplace in a very short period of time. Takes the pain away from that last mile. +So I think you're going to continue to see us make these points. And that's a sneak peek of Target in the future. And I think that is creating positive energy in the organization. +Kathee and I are hearing really positive things from our vendors. Our organization knows we've got to be more -- we've got to show more agility. We've got to be responsive. We've got to make sure we're externally focused and following the guest. But I think you're seeing some of those things take shape today. + +-------------------------------------------------------------------------------- +Oliver Chen, Cowen and Company - Analyst [24] +-------------------------------------------------------------------------------- + + Thank you. Thank you very much, best regards for the holidays. + +-------------------------------------------------------------------------------- +Operator [25] +-------------------------------------------------------------------------------- + + Your next question comes from Wayne Hood from BMO Capital. + +-------------------------------------------------------------------------------- +Wayne Hood, BMO Capital Markets - Analyst [26] +-------------------------------------------------------------------------------- + + Kathee, I had a question, this is maybe a little bit longer term and it plays into the context of how you evolve the Company. And that is related to where you see AUR trending, because you're talking about more emphasis in kids and baby, which typically is lower ticket and maybe pulling back on promotions in electronics because that's not a core. I'm wondering where you think your AUR might land over the next few years in light of the 2% to 3% growth you've been experiencing under the existing strategy. +And then if you could talk about -- John, if you could talk about the growth in inventory next year and its impact on working capital, as you think about being better in stock on the ad merchandise and the like. Thank you. + +-------------------------------------------------------------------------------- +Kathee Tesija, Target Corporation - Chief Merchandising & Supply Chain Officer [27] +-------------------------------------------------------------------------------- + + Wayne, we haven't modeled exactly what that will be yet. But I would tell you, I think that it will be moving up for a couple of reasons. So you heard Brian talk about those areas that we're going to focus on and really being famous for them and delighting our guests. And when we are at our best, we offer both Expect More, Pay Less together in all of these categories. +And that means a really thoughtful balance of good, better, best, having clear features and benefits as we move up that ladder, allowing guests to be able to buy whatever's important to them. But importantly, offering really good trade-up opportunities. +So you're seeing some of that right now in some categories. But I think as we move forward and we become famous, again, for some of these categories, there will be a lot of trade-up opportunity. So I would say overall, seeing it moving up. + +-------------------------------------------------------------------------------- +John Mulligan, Target Corporation - CFO [28] +-------------------------------------------------------------------------------- + + And then Wayne, your second question, inventory, I think the one thing I'd say, if you look at our number this quarter, 6% to 7% all the US, really only about a third of this do we view as temporary. The vast majority of that was receipt timing. But that third, we expect to stay around. We started that in second quarter this year. +We'll cycle it again next year in second quarter, somewhere around a 2% to 3% increase for the first half of next year. But offsetting that ultimately, as we start to get back to positive comp sales, we should see faster turn. That should ultimately lead to better payables leverage. So not a meaningful impact overall once we get past fourth quarter here on our working capital. + +-------------------------------------------------------------------------------- +Wayne Hood, BMO Capital Markets - Analyst [29] +-------------------------------------------------------------------------------- + + All right, thank you. + +-------------------------------------------------------------------------------- +Operator [30] +-------------------------------------------------------------------------------- + + Your next question is from Greg Melich from Evercore ISI. + +-------------------------------------------------------------------------------- +Greg Melich, Evercore ISI Group - Analyst [31] +-------------------------------------------------------------------------------- + + I have two questions that are a little bit lengthy. John, if we start off on dot-com, which if my algebra is right it's around 2.5% of sales in the quarter, what does that do to the margin going forward? +I know you mentioned it's immaterial for the fourth quarter, but tell us what it did in the third quarter and how we should think about it. It's probably dilutive of some effect and whether it's more in gross margin or SG&A. And then I had a follow up. + +-------------------------------------------------------------------------------- +John Mulligan, Target Corporation - CFO [32] +-------------------------------------------------------------------------------- + + On margin, it's definitely dilutive, Greg, if for no other reason than the shipping expense. And I think as it continues to grow, that will put margin pressure on the P&L. And we've talked a little bit about this. There are lots of puts and takes in gross margin as we think about it going forward that we're working through today. +As that business grows, it will be margin dilutive. But as we increase penetration of ship from store and pick up in store, that significantly not only improves our guest experience, but significantly improves the P&L. +We're also balancing how we look at pricing right now and balancing inventories across the network as we ship from store. So some of those are up, some of those are down. And we're working through right now where ultimately gross margin will land. + +-------------------------------------------------------------------------------- +Greg Melich, Evercore ISI Group - Analyst [33] +-------------------------------------------------------------------------------- + + And then the follow up, and maybe Brian you in your comments, you talked about making sure in the five key operating principles, that invest to build capabilities. I love your perspective on this year CapEx is down a lot and we're running I guess a little over $2 billion is the run rate. What do you think is the CapEx need going forward to invest in what Target really needs to do to be the best it can be? + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman & CEO [34] +-------------------------------------------------------------------------------- + + Greg, we're assessing that right now as we think about 2015 and beyond. But you should expect us to be investing in the capabilities to continue to build out our digital experience. To continue to enhance our in-store experience. To make sure we have the analytical tools to properly manage expenses and margin even more surgically going forward. +And I talked about -- while certainly in the early stages, we're going to continue to look at smaller formats and how we use smaller formats to penetrate urban markets, allow our guest the chance to interact with the Target brand both in-store, but also continue to build out the opportunity for them to purchase online. +So we're in the early stages of assessing our long-term capital needs, but you should expect us to be investing in the right capabilities and tools to provide long-term shareholder value and allow us to continue to fuel our growth and enhance both margins and continue to manage operating expenses effectively. + +-------------------------------------------------------------------------------- +Greg Melich, Evercore ISI Group - Analyst [35] +-------------------------------------------------------------------------------- + + Would that mean CapEx would be above D&A at some point in the future or do you think you can stay below that? + +-------------------------------------------------------------------------------- +John Mulligan, Target Corporation - CFO [36] +-------------------------------------------------------------------------------- + + Greg, we think -- at least Brian said I think with the caveat that we're working through this right now, we think we're probably in about the right range right now. The spend may move around a little bit. I think the one wild card is the point Brian made about small formats. +But I would note that obviously the investment there is significantly below what a prototypical Target would look like. So it would take a lot of those to meaningfully move our CapEx number. Like we've talked about, something for the US in that $2 billion, $2.5 billion range still makes sense, but we're doing the work right now. + +-------------------------------------------------------------------------------- +Greg Melich, Evercore ISI Group - Analyst [37] +-------------------------------------------------------------------------------- + + That's great. Thanks a lot, good luck for holiday. + +-------------------------------------------------------------------------------- +Operator [38] +-------------------------------------------------------------------------------- + + Your next question comes from Matthew Fassler from Goldman Sachs. + +-------------------------------------------------------------------------------- +Matthew Fassler, Goldman Sachs - Analyst [39] +-------------------------------------------------------------------------------- + + I know there's a lot of big picture questions to discuss, but actually I have two quantitative ones related to the quarter. First of all, John, can you talk about the expense, the magnitude of the expense dollars that shifted from the third quarter to the fourth and talk about perhaps functionally speaking what they're related to? + +-------------------------------------------------------------------------------- +John Mulligan, Target Corporation - CFO [40] +-------------------------------------------------------------------------------- + + Yes, most of it is marketing moved around. And the magnitude, if you think about us beating by somewhere in the neighborhood of $0.09, it was a little bit less than half the beat. So somewhere in that $30 million to $40 million moved between the quarters. + +-------------------------------------------------------------------------------- +Matthew Fassler, Goldman Sachs - Analyst [41] +-------------------------------------------------------------------------------- + + Got it, thanks for that. And then secondly, you talked about running ahead of the fourth quarter plan. As we think about the cadence of that plan, obviously you had a tough January, as did many retailers particularly given the breach. +So when you say running ahead, is that running ahead of the 2% number as we speak or running ahead of a plan that's maybe a bit more nuanced than that as we think about where we are in the progression of the quarter and your compares a year ago? + +-------------------------------------------------------------------------------- +John Mulligan, Target Corporation - CFO [42] +-------------------------------------------------------------------------------- + + Well, I wouldn't want to get into that level of detail. Clearly, last year pre breach was stronger than post breach, and we took that into account as we thought about the calendarization of the plan. And right now we're running ahead of that and we feel good about where we're at, not only relative to the plan, but on an absolute basis is what I'd say. But there is a lot of business left to be done before we get to the end of January. + +-------------------------------------------------------------------------------- +Matthew Fassler, Goldman Sachs - Analyst [43] +-------------------------------------------------------------------------------- + + Got it. Thank you for both of those, appreciate it. + +-------------------------------------------------------------------------------- +Operator [44] +-------------------------------------------------------------------------------- + + Your final question comes from Michael Lasser from UBS. + +-------------------------------------------------------------------------------- +Michael Lasser, UBS - Analyst [45] +-------------------------------------------------------------------------------- + + Thanks a lot for taking my question, it's on the food category. And recognizing you're not going to deemphasize it, you're just going to streamline it, how are you thinking about the return profile of that space within the store? And then could there be any differences amongst how space is allocated, could that area get less over time? + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman & CEO [46] +-------------------------------------------------------------------------------- + + Yes and let's drop back and make sure we clarify our point on the food category. We have no intentions today to streamline those categories, but Kathee and the team are certainly stepping back and listening to the guest, really understanding what the Target guest is looking for in food. From an assortment standpoint, from a newness standpoint, we talked about the fact that as we go forward, you should expect to see more natural and organic offerings. +We've seen a terrific response from the guest as something that we call Made to Matter, a collection of items that are on trend for our Target guest, feature a number of exclusive items that Target from manufacturers that are in the organic and natural space, that can bring great innovation, gluten-free, on-trend products to our guests. And we certainly recognize that we have an opportunity to connect with the guest in a different way when it comes to food. +But you shouldn't expect us to deemphasize those categories. That's not the point. We're not streamlining our food offering, but we are stepping back and really listening to the guest, making sure we curate on their behalf the right items that are uniquely Target, that meet the needs of our guests in the food categories. +So a lot more to come as we talk about this in the first quarter, but to make sure we're really clear, we're not streamlining food. We're not deemphasizing food. We're not walking away from food. But we certainly want to make sure we put our mark on the food category with items that are uniquely Target, that are right for our guests, that are on trend. And you should certainly expect to see more natural, organic offerings in that space because the Target guest has asked for them. + +-------------------------------------------------------------------------------- +Michael Lasser, UBS - Analyst [47] +-------------------------------------------------------------------------------- + + Okay, that's very helpful. And you think you can manage the return profile on that space to certainly meet the hurdle [rates] that you expect from it? + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman & CEO [48] +-------------------------------------------------------------------------------- + + We would certainly expect to see that. And Kathee talked about some of the changes we're seeing in mix. And certainly when we talk about natural organic and when we talk about some of these unique items, they tend to have a higher average unit rank. +So you should expect to see some mix changes, but importantly, food is an important part of our future. We're not going to deemphasize the category. We're not looking to take away space. We want it to be more impactful, more on trend, and we want to fill it with items that the Target guest is looking for. + +-------------------------------------------------------------------------------- +Michael Lasser, UBS - Analyst [49] +-------------------------------------------------------------------------------- + + Okay, that's very helpful and good luck with the rest of the holiday. + +-------------------------------------------------------------------------------- +John Hulbert, Target Corporation - Senior Director of Investor Communications [50] +-------------------------------------------------------------------------------- + + That concludes Target's third-quarter 2014 earnings conference call. Thank you all for your participation. + +-------------------------------------------------------------------------------- +Operator [51] +-------------------------------------------------------------------------------- + + This concludes today's conference call. Thank you for participating. At this time, you may now disconnect. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/exam/original-files/Problem_2_3_Sample_full_transcripts/2014-Oct-14-JPM.N-138918479517-Transcript.txt b/exam/original-files/Problem_2_3_Sample_full_transcripts/2014-Oct-14-JPM.N-138918479517-Transcript.txt new file mode 100644 index 0000000..de245dc --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_full_transcripts/2014-Oct-14-JPM.N-138918479517-Transcript.txt @@ -0,0 +1,1168 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q3 2014 JPMorgan Chase & Co Earnings Call +10/14/2014 08:30 AM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Marianne Lake + JPMorgan Chase & Co. - CFO + * Jamie Dimon + JPMorgan Chase & Co. - Chairman, President & CEO + +================================================================================ +Conference Call Participiants +================================================================================ + + * John McDonald + Sanford C. Bernstein - Analyst + * Erika Najarian + BofA Merrill Lynch - Analyst + * Mike Mayo + CLSA - Analyst + * Glenn Schorr + ISI Group - Analyst + * Guy Moszkowski + Autonomous - Analyst + * Ken Usdin + Jefferies & Co. - Analyst + * Matt O'Connor + Deutsche Bank - Analyst + * Steve Chubak + Nomura Asset Management - Analyst + * Gerard Cassidy + RBC Capital Markets - Analyst + * Brennan Hawken + UBS - Analyst + * Betsy Graseck + Morgan Stanley - Analyst + +================================================================================ +Presentation +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- +Good morning, ladies and gentlemen, welcome to the JPMorgan Chase third-quarter 2014 earnings call. This call is being recorded. Your line will be muted for the duration of the call. We will now go live to the presentation. Please stand by. At this time I would like to turn the call over to JPMorgan Chase's Chairman and CEO, Jamie Dimon, and Chief Financial Officer, Marianne Lake. Ms. Lake, please go ahead. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [2] +-------------------------------------------------------------------------------- +Thank you, operator, good morning, everyone. I'm going to take you through the earnings presentation which is available on our website. Please refer to the disclaimer regarding forward-looking statements at the back of the presentation. +Starting on page 1, the Firm delivered strong underlying performance this quarter with net income of $5.6 billion on strong revenue of over $25 billion, up 5% year on year, reflecting growth across most of our businesses; and EPS of $1.36 and a return on tangible common equity of 13% for the quarter. +Included in our results is Firm wide legal expense of approximately $1 billion after-tax, which relates to a number of matters, in large part an estimated amount for FX, which was treated as non-deductible tax purposes. +There were also a number of smaller items, most notably a benefit of approximately $400 million of tax discrete items in corporate, as well as consumer reserve releases of $200 million pretax. Excluding these and other non-core items net income was approximately $5.8 billion reflecting strong core performance. +The quarter was characterized by continued strength in our leadership positions as well as market share gains across the consumer businesses, higher levels of market volatility and client volumes than anticipated in CIB and record performance and asset management. +Core loan growth for the quarter was strong, up 7% year on year, while maintaining strong discipline across the board and with encouraging trends in consumer. We've also continued to make progress against our capital targets with a CET1 ratio of 10.1% and firm supplementary leverage ratio of 5.5%, all while returning approximately $3 billion of capital to shareholders the quarter, with gross share repurchases of $1.5 billion. +Turning to page 2 -- adjusted expense that -- excluding legal, was $14.7 billion in the third quarter, down approximately $30 million quarter on quarter with an adjusted overhead ratio of 59%. We continue to be focused and diligent on managing expenses. +Although our third-quarter adjusted expense may appear elevated in comparison to our full-year target of $58 billion, it was substantially driven by higher market performance versus our earlier expectations. If the positive momentum continues in the fourth quarter it is likely that our total adjusted expense will be above $58 billion, but obviously on higher revenues. +On credit, despite lower reserve releases, Firm wide credit costs remain very low, driven by reduced net charge-offs. We expect total net charge-offs for 2014 to be less than $5 billion, which is below our previous guidance. +Also included on this page are the returns generated by each of our businesses this quarter. Of note the commercial bank and asset management achieved 18% and 25% ROEs respectively, in-line with their through the cycle targets. CCB was at 19% and, if you back out the impact of legal expense in CIB, its ROE would've been around 14%. +Moving on to capital on page 3 -- the Firm reported a fully phased in advanced CET1 ratio of 10.1%, up from 9.8% last quarter, reaching our year-end target of 10% plus. Not on the page but for your information the fully phased in standardized ratio was 10.5%. +As you know, the final US rules on SLR and LCR were published in September. On SLR there were no notable changes and, as I just mentioned, the Firm's SLR was 5.5%, reaching our target level and we were at 5.7% for the bank this quarter. +The LCR final US rule had some changes versus the NPR. Remember, we have been disclosing our LCR compliance relative to the Basel rules. The US final rule is in some ways more punitive, but we remain compliant with a more modest buffer. +Moving on to business performance starting with CCB on page 4 -- the combined consumer businesses generated $2.5 billion of net income for the quarter on $11.3 billion of revenue and an ROE of 19%. +I'd like to draw your attention to the right-hand side of the page; it shows that the long-term investments we've been making in the business are paying off, illustrated by the many leadership positions we hold. We are particularly proud of our customer satisfaction rankings. +We're seeing continued strong growth in the underlying business drivers. Average deposits were up $35 billion year on year, an increase of 8%. Our active mobile customer base is up 22% and credit card sales volume of $120 billion was up 12% on strong new account originations. +Across CCB we reduced headcount by over 10,000 this year against our year-end target of 8,000 outlined at Investor Day. And we expect a total reduction of 11,000 or so by year end. +Finally, before I move on, as you are aware, JPMorgan and certain others in the financial services industry experienced cyber attacks this quarter. We are taking every step to protect our customers and our Firm, but these attacks highlight the need for continued and increased cooperation among businesses and the government to systemically reduce and resolve cyber threats. We are committed to doing our part. To date we have not observed elevated levels of fraud related to this matter. +Turning to page 5, Consumer & Business Banking -- CBB generated net income of $914 million, up 20% year on year. The business continues to improve its operating leverage with an ROE of 33%, up 6 percentage points versus a year ago, with revenue up 5% and expense relatively flat. +Underlying business drivers remain strong. Average deposits of $476 billion were up 9% year on year and client investment assets were up 16% to a record $208 billion. +We continue to see strong deposit growth across regions and markets. In fact, for the third consecutive year we led the FDIC survey with the highest deposit growth among the largest 50 US Banks. Overall we grow our deposit share in 46 of our 50 largest markets nationwide and we remain number one in three of the largest deposit markets. +Moving on to revenue, net interest income was up 4% year on year driven by strong deposit growth offset by continued pressure on margins. And noninterest revenue was up 6% with investment revenue growth driven by Chase Private Client and with the addition of over 700,000 households driving stronger fee income. Expense is relatively flat with efficiency improvement in the business being offset by increased cost of control. +Finally, on business banking originations, the momentum that we've seen in recent quarters continues and we believe we have outperformed the industry with loan originations for the quarter of $1.6 billion, up 27% year on year, down quarter on quarter seasonally. +This reflects a combination of industry trends improving driven by business optimism generally continuing to remain strong and improving banking performance, especially in the expansion market as our targeted strategies mature. We do expect the strong growth to continue through the remainder of the year. +Mortgage Banking on page 6. Overall mortgage banking net income was $439 million for the quarter with an ROE of 10%. As expected, the production environment remains challenging, mortgage production pretax income, ex-repurchase, was slightly positive for the quarter, a little better than guidance on better-than-expected expense performance. +Originations are approximately $21 billion or up 26% quarter on quarter against a market that we estimate to be up approximately 10%. Therefore we believe we've gained share and that share gain has been in high-quality jumbo and conventional eligible bonds which, as you know, are the segments we are focusing on. +As a reminder, with purchase mix up the business has become much more seasonal with volume and profitability peaks in the second and third quarters and lows in the first and fourth. Given this we still expect the fourth-quarter results to be a small negative as previously guided. +Finally, on production we had a $62 million benefit in the quarter driven by refinements to our repurchase reserve. +On to servicing, net servicing-related revenue of $639 million was down $54 million quarter on quarter, again on the better side of our guidance due to gains on the sale of Ginnie Mae loans. +Looking forward into the fourth quarter, core servicing revenue will continue to decline and we expect less benefits from other revenue sources, such as those from Ginnie Mae sales, given lower delinquencies and lower loan modification volume. As a result we do expect fourth-quarter servicing revenues to be $600 million or slightly lower. +Servicing expense increased approximately $25 million quarter on quarter due to investments in control and operational improvements. You will note that this represents a delay in achieving our target of $500 million for the fourth quarter. However, we are doing what is necessary to improve our controls and operational processes and we expect servicing expense to continue to decline through 2015 at a slower pace. +MSR risk management was a modest gain of $76 million reflecting regular model updates. On real estate portfolios we added approximately $6.8 billion of high-quality loans to our portfolio this quarter, up from $5 billion in the second quarter. +Loan quality remains very strong, we recorded net charge-offs of $81 million and reserve releases of $100 million in the noncredit impaired portfolio, reflecting improvements in home prices as well as delinquencies. +Lastly on mortgage, headcount was down approximately 6,000 year to date, meeting our target for the year outlined at Investor Day. And we are on track to reduce it by an incremental 1,000 or so by year end. +Turning to page 7, Card, Merchant Services & Auto -- net income of $1.1 billion, down 10% year on year, but up 4% excluding reserve releases with an ROE of 23%, reflecting very strong spend as well as balanced growth of $3 billion year over year. Continuing momentum we saw last quarter as growth and our core business is now outpacing the runoff portfolio. +Overall we saw strong and stable revenue of $4.6 billion, flat year on year. Loan growth as well as strong sales volume was offset by spread compression and higher amortization of customer acquisition costs. Expense is up 4% year on year predominately driven by higher [forward] expense related to Home Depot and higher auto lease depreciation. +In Card sales growth of 12% led the industry for the 26th consecutive quarter. This industry outperformance is being driven by the value proposition of our core Chase branded and partner products and the investments we are making in customer acquisition, ultimate rewards, marketing and customer service. These investments are driving strong new account originations, up 29%. And the performance of these new accounts, 2013 and 2014 vintages, is exceeding our expectation. +In merchant services volume was up 15% year on year driven by continued strong sales performance. But transaction growth was up 6% year on year lagging sales growth, driven by merchant mix and aggregation trends. +In auto new vehicle sales continue to grow year over year with the third quarter up 8%. We've seen the 12th consecutive quarter of loan and lease growth despite a very competitive market and credit losses continue to be stable and low with the auto pipeline remaining healthy, consistent with a recovery in the auto market. +Moving on to credit, the environment remains benign. We continue to see improvements in card early delinquencies and the card net charge-off rate was 252 basis points, an all-time low. This quarter we released $100 million of auto and student lending reserve with no releases in card. +During September a new step forward in the evolution of payments was announced, Apple Pay. We are excited to be a key player in a solution that offers improved security and a streamlined customer experience. At the same time we are continuing to develop other innovative payment solutions. +Moving on to page 8 and the Corporate & Investment Bank -- CIB reported net income of $1.5 billion on revenue of $8.8 billion and an ROE of 10% or 14% if you adjust for legal expense. In banking total revenue was $2.7 billion, down 6% year over year. IDCs were $1.5 billion, up 2%, with revenue growth in advisory and equity underwriting fees on strong market activity being offset by lower debt underwriting fees. +We maintained our number one ranking in global IDCs per Dealogic with particular strength in ECM in Europe and IPOs globally and we remain a go to bank for large deals and related financing. The ID pipeline is strong with an environment supported of M&A and a strong equity underwriting market. +Treasury Services revenue was $1 billion, in line with our guidance, and Lending revenue was down approximately $200 million year on year, primarily driven by mark-to-market losses of over $100 million in this quarter versus modest gains in the prior year on securities received from restructuring. +So let's spend a moment on market revenues. The green shoot and the potential upside to our performance that we've been seeing in early September did in fact materialize and our reported markets revenues were up 1% year on year, despite a strong third quarter last year, a quarter in which we significantly outperformed. +In fixed income in currencies and emerging markets a strong quarter and a particularly strong September with pickup in both volumes and volatility as currency markets benefited from divergence across global monetary policies, an average quarter for commodities and credit and an improving quarter for rates. +In equities we saw quite strong performance for a third quarter in line with last year. Cash was very strong in EMEA on the back of a strong primary market and equity derivatives results were lower versus a record last year, offset by an uptick in prime services revenue on higher balances and continued growth. +Of note, customers are taking notice of the progress we've been making in building out our electronic trading platform. And we are seeing strong growth in electronic trading volumes, up 50% in year on year in Europe and nearly 20% in the US. +Moving on to the outlook for the fourth quarter, we are pleased to have completed the sales of our physical commodities business and detailed portfolios, which were major parts of our business simplification agenda and with limited impact on ROE over time. +However, these sales will present revenue headwinds in the fourth quarter. And based upon their contributions to last year's results, these will drive an approximately 8% revenue decline year-over-year or approximately $300 million. +So outside of the year-over-year decline driven by business exit, we are cautiously optimistic that momentum may carry over. However, October so far has been mixed, likely on the back of a changing market sentiment around the prospect for global growth and inflation. +Security Services revenue of $1.1 billion was up 8% year on year, primarily driven by higher NII on higher deposits, down quarter on quarter 5% on seasonality. Assets under custody were $21.2 trillion, up 8% year on year. Credit adjustments and other, a positive $240 million, is driven primarily by DVA and FVA as a result of credit spread widening and refinements to certain assumptions. +Moving on to expense, total expense was up 21% year on year with a comp to revenue ratio of 32% for the quarter and year to date. Non-comp expense was up 21% year on year primarily driven by legal expense, but down 2% quarter on quarter as increased legal expenses were more than offset by lower cost of business simplification and other expenses. +Just quickly on CIB loans, the headline 5% decline for loans is driven by lower client overdraft and trade. Underlying that, traditional credit portfolio and other HFI loans were up by over 10%. +Moving on to page 9 and Commercial Banking -- the quarter saw net income of $649 million on revenue of $1.7 billion with a strong ROE of 18%. Revenue was down 3% from the prior year and 2% sequentially, reflecting yield compression in our lending book as well as business simplification, partially offset by higher loan and deposit balances. +Expense of $668 million was in line with guidance and relatively flat year on year and quarter on quarter, despite ongoing investments in controls. Loan balances increased $1.6 billion in the quarter driven by continued strong performance in our commercial real estate businesses. +CRE loans increased 13% year on year and 3% quarter on quarter, both in excess of the industry, and our CRE book has now grown for 14 consecutive quarters. C&I loans were relatively flat from the prior quarter, broadly in line with industry trends. +Of note, deposits increased $5 billion in the quarter, mostly in Middle Market and corporate client banking. This is reflective of our clients still managing with very high levels of liquidity. Having said that, utilization rates were up slightly for the quarter and pipelines continue to move incrementally higher across the board. +Outside of lending we continue to make good progress in building our core franchise. This quarter growth investment banking revenue was approximately $500 million, up 12% from last year, and on a year-to-date basis the commercial bank has generated $1.4 billion of investment banking revenues for the Firm up 22%. +Card and merchant services revenue increased 7% from the prior year. And finally, since this time last year we've added approximately 500 new clients in targeted industries. +Overall credit performance remains strong with net charge-offs of only 1 basis point, marking the seventh consecutive quarter with net charge-offs in the single-digit or very low or recoveries. +As you think about the coming quarter, we do expect returns to continue. We would like to remind you of the one-time proceeds of approximately $100 million that we received in the fourth quarter of last year from a lending-related workout. +Moving on to page 10, Asset Management -- an excellent quarter in asset management with record net income of $572 million, up 20% year on year and 4% quarter on quarter with a 25% ROE and a 31% pretax margin, in line with our through the cycle target. For the full year we expect these ratios to below our through the cycle target. +You will see that we changed from reporting our revenue by client segment to reporting revenue by line of business to be consistent with how we manage the business. So we are introducing sub line of business results for revenues in global investment management and global wealth management. +Overall revenue of $3 billion was up 9% year on year, reflecting an increase in management fees driven by long-term net inflows, including $16 billion this quarter. This marks the 22nd consecutive quarter of long-term inflows driving AUM of $1.7 trillion up 11% year on year. +While we continue to see strength in our multi-asset and fixed income flows equity flows were flat this quarter. Asset Management expense of $2.1 billion was up 4% from a year ago and up modestly 1% versus last quarter. +In banking we reported strong performance in both lending and deposits. Record loan balances up 16% year on year and 3% quarter on quarter with growth coming from both our US and our international markets and a solid pipeline for demands for the remainder of the year. Deposits were also a record, up 9% year on year and 2% quarter on quarter. +Lastly as reported, client assets of $2.3 trillion were up 4% year on year and down 5% quarter on quarter. However as part of business simplification we closed the sale of the RPS business during this quarter, recognizing a small gain reflected in [GIM]. Excluding the impact of the RPS sale client assets would have been up 10% year on year and flat quarter on quarter. +Moving on to page 11 and Corporate and Private Equity -- Private Equity reported $71 million of net income driven by net violation gains including a small net gain related to the portfolio sale in OEP which we announced in the quarter, predominantly offset by related expenses. Year to date the portfolio balance is down by approximately $2.5 billion and with the sale we expect it to be down by about $4 billion by year end. +Treasury and CIO reported a small net loss of $30 million with NII slightly positive in the quarter, and other corporate net income at $357 million; included in this result were a tax-related benefit of approximately $400 million, as I previously mentioned, as well as approximately $500 million pretax of legal expense with the remainder of the Firm wide legal expense principally in the IB. +At the Firm level our tax rate for the quarter was 28%, broadly in line with a normalized tax rate of 30% plus or minus. Nondeductible legal expenses in CIB were offset by tax benefits here and other corporate. +Before moving on to our outlook page, Firm NII was up approximately $320 million quarter on quarter driven by lower interest expense in CIB and core NII was up approximately $110 million. +Moving on to page 12 -- you can see on the page our current outlook which I've already addressed throughout the presentation. Wrapping up, a strong result for a third quarter despite legal expense of $1 billion after-tax. This reflects the strength of each of our franchises and the benefit of the diversified business model. +We have made substantial progress against our control and regulatory agenda as well as business simplification, albeit with more work to do. And we have successfully executed against our 2014 target of capital leverage and liquidity. +As I have shown you today, the investments we are making in our businesses are fueling growth and underpinning strong earnings now and in the future and we remain focused on serving our customers and safeguarding their assets and our Company. With that, operator, please open up the lines for Q&A. + + +================================================================================ +Questions and Answers +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- +(Operator Instructions). Matt O'Connor, Deutsche Bank. + +-------------------------------------------------------------------------------- +Matt O'Connor, Deutsche Bank - Analyst [2] +-------------------------------------------------------------------------------- +Can you just give us a sense of what is left in terms of simplifying the model? Maybe split it between the CIB and consumer if that is a good way of approaching it. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [3] +-------------------------------------------------------------------------------- +Yes, I mean, so, Matt, I would say we I think -- and I can't remember which quarter it was, but several quarters ago we put a slide out in the presentation that showed what -- it was last year -- showed what the business simplification agenda looked like. +I think if you go back and now look at what we have done, including what we were able to either complete or sign this quarter, OEP, the RPS business, GSOG, Commodities, we've certainly broken the back of most of the business simplification agenda. Having said that, it is an ongoing process and we continue to de-risk clients and industries and continue to simplify our products in mortgage and the like. +So I would characterize that the actions that we have taken by the end of this year are substantially all of them. But at the margin we continue to look at client by client product by product to simplify things. + +-------------------------------------------------------------------------------- +Matt O'Connor, Deutsche Bank - Analyst [4] +-------------------------------------------------------------------------------- +Okay, and as a follow-up, somewhat related, but as we think about having more clarity on the capital rules and specifically the supplemental leverage ratio as well as the LCR, is there some opportunity for optimization of the balance sheet now that you have more clarity on those rules? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [5] +-------------------------------------------------------------------------------- +So, we have talked before about the fact that when you take into consideration a combination of the leverage and liquidity rules together with our own point of view on positioning the Company for rising rates. So therefore our own point of view as being under invested in the duration perspective, that we have, we believe, a relatively optimized balance sheet. +Although it likes like we have a significant amount of cash, that is in part non-operating deposits that at some point will either flow out or be adequately paid for by the client return and in other parts is part of our overall liquidity. +I mentioned that subsequent to the US LCR rules being made final that although we had been reporting previously against Basel compliance in the 20%-plus range, so a buffer of 20%-plus. The US rules are more punitive in a number of ways, most notably that they look at peak outflows in 30 days relevant cumulative and also on higher outflow assumptions across the categories. Given that we are not compliant with a more modest buffer. So we would say that we are largely optimized. + +-------------------------------------------------------------------------------- +Matt O'Connor, Deutsche Bank - Analyst [6] +-------------------------------------------------------------------------------- +Okay. And then just lastly, the $300 million of revenue going away in the fourth quarter, what would be the expenses and capital against that? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [7] +-------------------------------------------------------------------------------- +So, the capital is relatively minimal in comparison to the overall Firm. So while it obviously is positive for us, it is not a noteworthy number. And the expenses, just to note that I said the ROE is limited over time; this is a business that was still being built and therefore hadn't yet reached a maturity stage or a stage where it was returning its hurdle. +It will take a little bit more time to take the expenses out so there will be a slight lag in removing expenses. So in the fourth quarter it will be more modest, but over time it would be a large chunk of that $300 million. + +-------------------------------------------------------------------------------- +Matt O'Connor, Deutsche Bank - Analyst [8] +-------------------------------------------------------------------------------- +Okay, thanks for taking my questions. + +-------------------------------------------------------------------------------- +Operator [9] +-------------------------------------------------------------------------------- +John McDonald, Sanford Bernstein. + +-------------------------------------------------------------------------------- +John McDonald, Sanford C. Bernstein - Analyst [10] +-------------------------------------------------------------------------------- +Marianne, I was wondering if you could give us some broader context on the core expenses. Is a principal driver of the updated outlook around the $58 billion -- is that just comp? And can you remind us where you are on the compliance control expenses in terms of leveling off there? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [11] +-------------------------------------------------------------------------------- +Yes. So we had a better third quarter than we had been expecting earlier in the quarter. We will see how the fourth quarter pans out. So, yes, it is the case that if we have a better fourth quarter and therefore a stronger second half of the year that our expectations for comp will be higher. +They'll still be well within our comp to revenue ratio range of 30% to 35%, I mean you saw for the quarter 32% year to date the same. So in large part it is going to be based on higher revenues in market. This quarter we also had higher revenues in mortgage and also in corporate. So that is the principal driver. + +-------------------------------------------------------------------------------- +John McDonald, Sanford C. Bernstein - Analyst [12] +-------------------------------------------------------------------------------- +And as we look out to 2015 (multiple speakers)? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [13] +-------------------------------------------------------------------------------- +Yes, sorry. + +-------------------------------------------------------------------------------- +John McDonald, Sanford C. Bernstein - Analyst [14] +-------------------------------------------------------------------------------- +As we look out further to 2015 and 2016 can you give us a reminder of where you are looking to reduce the core expense base and get some savings on a one- to two-year basis? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [15] +-------------------------------------------------------------------------------- +Yes. Before I do that, you had a second part to your question on the cost of controls. Let me just deal with that very quickly. +We talked about the fact that we expect our control cost to reach a peak this year, that is still the case. So I would say that they are substantially in our run rate by the end of the year. +They will over time be able to come down; they will still remain elevated relative to historical because that is the new business world we are in. But we are going to be able to become more efficient, automate things, finish remediations, look backs. So over time that will provide leverage. +In terms of looking out to 2015 and 2016, while we haven't given specific guidance I will just point you to a few things. The first is we do expect to continue to see mortgage servicing expense decline on the back of delinquency and credit trends. +We would also expect to see improvements in the production space albeit we are -- there is a reasonable fixed cost base. But nevertheless, as you saw this quarter, we continue to make great progress in resizing that expense base. +In the nonmortgage space in the consumer bank, Gordon has committed to $1 billion in 2016 over 2014 principally but not exclusively driven by automation and efficiencies in branch staffing leverage and also the branch footprint optimization. +And then while we didn't quantify it, Daniel is very much looking at the expense equation for positive leverage that is reasonably significant over the next two years in the CIB. So I would say across the board obviously we are growing in asset management, we are investing in our businesses notwithstanding. + +-------------------------------------------------------------------------------- +John McDonald, Sanford C. Bernstein - Analyst [16] +-------------------------------------------------------------------------------- +Okay, that is helpful. And then on the legal expense, did you give any color in the beginning on what was that for this quarter? And in terms of the FX and LIBOR investigations, are those at the stage yet where reserves can be built or can you offer anything on that? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [17] +-------------------------------------------------------------------------------- +So at the beginning what I did say is that there are a number of masses in our legal expenses for the quarter, but in large part it does relate to FX. And consequently you can read into that that things are further progressed this quarter than last, but obviously we can't comment any further. + +-------------------------------------------------------------------------------- +John McDonald, Sanford C. Bernstein - Analyst [18] +-------------------------------------------------------------------------------- +Okay. And then just in terms of share buybacks and capital levels, was wondering about your thoughts on the prospects for higher G-SIB buffers in the US. And how are you going to balance in the near term kind of your -- growing your space capital against executing the remaining buyback authorization that you have? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [19] +-------------------------------------------------------------------------------- +So just to talk about it, so we did $1.5 billion of buybacks this quarter, same last quarter. Obviously we have another $2 billion to go in terms of our approval. We don't know what the rule is going to be, it will come out before the end of the year, we will have to see what that says. +There will be a transition timeline, it will transition on the same timeline phase and timeline that the rest of the buffers transition in on, so through to January 1, 2019. So there is no need for us to overreact and race to compliance. +So we would do much as we have done over the course of the last two years, which is balance continuing to make good progress getting to wherever it is that we need to be, which we are not going to get at at this moment, against the desire to want to continue to deliver capital to the shareholders in the form of increased dividends and repurchases. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman, President & CEO [20] +-------------------------------------------------------------------------------- +Remember, you all have the forecast where CET1 goes up to 10.5%, 10.8% or something like that. When that new CCAR rules come out we'll probably go fine-tune what it might look like at the end of 2015. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [21] +-------------------------------------------------------------------------------- +Yes, I mean the reality of the situation is sitting at 10.1%; we are in good company with the rest of the industry in the context that just given how CCAR operates it is highly likely that there will be overall accretion to capital in the industry over the course of 2015 and we will be no exception. So we will continue to accrete capital up towards and potentially above our 10.5%. But we are not going to recalibrate a target until we understand the rules. + +-------------------------------------------------------------------------------- +John McDonald, Sanford C. Bernstein - Analyst [22] +-------------------------------------------------------------------------------- +Okay, and (multiple speakers). + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [23] +-------------------------------------------------------------------------------- +And (multiple speakers) one thing on the target, just when you see the rules yourself know that in our 50 to 100 basis point buffer the reason why we had a range was to allow in part for some of uncertainty and things evolving. And so, we would obviously want to fine-tune and put a finer point on our buffer. So it is possible that our buffer may not be as high as 100% too. So we will deal with all of that when the rules come out. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman, President & CEO [24] +-------------------------------------------------------------------------------- +And we have also been, remember, very careful the purpose here is to protect and grow the client franchise, meet the regulatory agenda and then we will adjust to all of these changes as they take place. The big ones we're going to know by the end of the year, TLAC, G-SIB and new CCAR. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [25] +-------------------------------------------------------------------------------- +CCAR, yes. + +-------------------------------------------------------------------------------- +John McDonald, Sanford C. Bernstein - Analyst [26] +-------------------------------------------------------------------------------- +Okay. And Marianne, just on that point, you had some RWA inflation in the first half as you waited some model approvals you are waiting for I believe. Where are you on those model approvals and your expectations for kind of the ratio of risk-weighted assets to total assets as we move forward? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [27] +-------------------------------------------------------------------------------- +So you would have seen our other where it came down slightly in the quarter from the second quarter on the back of model improvement and on data and portfolio runoff. So we are starting to see that bend now. It is the case that as we project forward to the end of 2015 the number that we showed you at Investor Day is still relatively good. It is probably a little higher than that. We said [1.5%] it will be support between 1.5% and 1.55% by the end of next year. +We are not in complete control around the timing of model approvals. We obviously are doing everything we can to be timely and then the regulators need adequate time to approve them. So we have kind of been a little bit more conservative potentially about the duration it takes to get models approved. But we are still on that same basic trajectory. + +-------------------------------------------------------------------------------- +John McDonald, Sanford C. Bernstein - Analyst [28] +-------------------------------------------------------------------------------- +Okay, thank you. + +-------------------------------------------------------------------------------- +Operator [29] +-------------------------------------------------------------------------------- +Glenn Schorr, ISI. + +-------------------------------------------------------------------------------- +Glenn Schorr, ISI Group - Analyst [30] +-------------------------------------------------------------------------------- +So first question on -- deposit growth has been growth and I guess I would love to see higher rates in loan growth. But you are positively positioned for the parallel shift up. I guess my first question is how does that change in more of a flattening environment that we are experiencing right now? Do you capture most of the benefit anyway just getting off zero on the short end? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [31] +-------------------------------------------------------------------------------- +Yes, I mean, yes, there is a significant benefit. If you look at our disclosures you can kind of see the short end versus long end impact. Basically there is a significant benefit coming off of the short end. So we would expect to capture a significant portion of that in the first 12 months. But we obviously are looking for a more normal curve overall over time. + +-------------------------------------------------------------------------------- +Glenn Schorr, ISI Group - Analyst [32] +-------------------------------------------------------------------------------- +Okay. Just a -- I know we are not supposed to read too too much into it, but in everyone's mid-cycle [DFAST] results I think everyone was calling for -- or the big banks were calling for higher losses and lower PPNR in general relative to your own self test from the previous year. +Is that conservatism? Because it is a little different relative to the commentary about an improving economy, a little bit better loan growth, good expense control, things like that. I'm just curious what we are supposed to take away from that mid-cycle. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [33] +-------------------------------------------------------------------------------- +Obviously not to comment on everybody else's results, but our results were -- in terms of the size of the economic downturn, they were relatively in line. And our results were relatively in line with a few minor sort of enhancements to our process. So we weren't actually looking for materially changed results in our midyear DFAST. +So obviously we haven't had instructions yet, we are expecting them absolutely eminently, possibly as early as this week. In terms of guidance from the regulators on how to think about the bank holding company scenario for 2015 CCAR, to the degree that there are more and more stressful idiosyncratic losses or stresses on leverage or other things it could have an impact. But we have to wait and see. + +-------------------------------------------------------------------------------- +Glenn Schorr, ISI Group - Analyst [34] +-------------------------------------------------------------------------------- +Okay, okay, last one. There are a couple of articles on rewriting of banker's agreements between major dealers to resolve some of the early termination rights issues, which obviously is going towards the Fed's issues on living wills. +A, did that actually happen or is that just being talked about? And B, does it resolve the issue in the Fed's -- I know you can't speak for the Fed, but does it resolve the issue or do you still have the client side to deal with over time? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman, President & CEO [35] +-------------------------------------------------------------------------------- +So, Mark Carney of the FSB and the Bank of England Chairman said that two major things remain to finish kind of the too big to fail issues. One is how you deal with derivatives and the second is TLAC, and both of those will be done this year. This is the thing, has been done, it is a great example -- I think it was 18 firms who got together and came up in a very complex way globally had to deal with this in a way that the regulators. +And the Fed put out a press release and Mark Carney has been very positive about it and it was industry led. So we do think it does solve that issue. So all of the buy side will do it. It will be -- eventually all the sell side -- I mean the other way around, all the buy side will eventually want to do it because it is actually better for the business as a whole. +May be not better for one trading desk, but it is better for the business as a whole and it is a little coercive. So that the regulators are basically saying that to do further derivatives you are going to have to adopt these new rules. And we think over time a lot of people will do it. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [36] +-------------------------------------------------------------------------------- +And just one thing there, the [GA] team does sort of break the back of the problem, but we are still awaiting actual regulatory guidance. So there is still the strong possibility that the guidance will be broader and we would encourage it to be broader, if nothing else for simplicity purposes, not necessarily because the GA team alone don't really achieve the results. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman, President & CEO [37] +-------------------------------------------------------------------------------- +Right. And we're also in a position where even if the buy side doesn't for some reason, that we would be able to manage that risk over time and it would diminish over time because they're the short duration of the derivatives. + +-------------------------------------------------------------------------------- +Glenn Schorr, ISI Group - Analyst [38] +-------------------------------------------------------------------------------- +Right. And as long as the Fed counts that as, quote, material progress by July 15 I'm cool with it too. Thanks. + +-------------------------------------------------------------------------------- +Operator [39] +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [40] +-------------------------------------------------------------------------------- +Hey, a couple of questions. One is on just RWAs in general. There were some articles around potentially shifting some of the repo activity to more of an agent role than principal role. I don't know if that is one of the ways that you could potentially have a light impact maybe on RWAs but on total footings to help with the ratios. Is that something that is being considered? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [41] +-------------------------------------------------------------------------------- +Yes, so, I mean, our repo business is, as you know, substantially client driven and our clients are very interested in ensuring that they are giving us sufficient wallets to allow us to dedicate sufficient balance sheet to their business. So in that sense we continue to see repo as a strategic product for our client and a scarce resource, quite frankly. +So, it is obviously the case that as we understand new rules that meanwhile leverage rules have been for a while and we've seen leverage reduce in the industry overall. But we continue to have a strong and healthy repo business. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [42] +-------------------------------------------------------------------------------- +Would you be supportive of an industry move towards shifting repo to more of a CCP environment or no? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman, President & CEO [43] +-------------------------------------------------------------------------------- +We are okay with the higher margins, generalized margin rules. And if they go to kind of a tri-party CCP thing that will be fine too. And it would alleviate other issues at that point in time. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [44] +-------------------------------------------------------------------------------- +Yes. I mean between the CCP and I think the FSC even put out a framework last night that talked about cross industry including nonfinancial standardized higher levels of haircut that we are supportive of. So I think the combination of those two things achieve a great deal. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [45] +-------------------------------------------------------------------------------- +Okay, no, that is great. I asked the question in part because as people are concerned about things like the SIFI buffer increasing and other regulatory capital requirements, I'm just trying to tease out what other options you have to do your client facing business but yet maybe shrink the footings in a way that deal with these ratios without having to, quote/unquote, break up the bank. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [46] +-------------------------------------------------------------------------------- +Yes, so, I mean I think, Betsy, we would -- we will do exactly with this what we have done with everyone else to date which is overall we are only going to put our balance sheet to work and allow our clients to use it if the overall relationship over time pays us a sufficient return for that. +We have the ability to do that somewhat methodically and so we are being very surgical and very strategic about how we use our balance sheet. But it is a core strategic product for many of our clients and they want to continue to be able to do that. +So, yes, we could, I mean if you look at the numbers, however you want to cut them, there is -- within our repo business we do have a match book, we have inventory financing as well, we have client suites in our short-term wholesale funding. So there are things we could do, we just don't want to overreact. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [47] +-------------------------------------------------------------------------------- +Okay, thanks. And then just separately on the payments discussion. In your prepared remarks, Marianne, you highlighted that you are delighted to work with Apple Pay but that you are also working on some other things yourself. Could you speak to what other things you are doing independently? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [48] +-------------------------------------------------------------------------------- +Yes. So, I mean we talked before and you will see more over the coming few months about our own wallet and payment capability so [Chase pay] and Quick Checkout where we would provide the capability for our customers to be able to have a much more seamless experience. Also for merchants to have a lower abandonment rate and continuing with the safety and security of tokenization and other methods. +So we are continuing to work on our own proprietary wallet and payment capabilities that will be piloted and then subsequently launched over the course of the next coming months. And then as obviously the case that we are out of pilot and in production on our end-to-end capability including [Chase net]. +So we are signing up merchants at a faster rate than we expected and, again, you will hear more about that later. But our ability to now negotiate bilaterally economics with merchants and provide customers with compelling reasons to continue to bring share to us is also something we are working on. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman, President & CEO [49] +-------------------------------------------------------------------------------- +So our basic philosophy has been that you, the customer, who want to be able to use your debit cards, your credit cards in a way that you want and that we want to make it available to you whether it is Apple Pay, in-store apps, other people's wallets, Visa wallet, our own wallet -- all which will have benefits, etc. +And as Marianne said, we think that we can also be friendly to merchants with data, with pricing, with simplified contracts. So we are trying to make this an ecosystem that works better for everybody and is far more secure. I have customers on both sides and I'm far more secure. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [50] +-------------------------------------------------------------------------------- +And I think is it accurate, Jamie, that you mentioned at a recent conference that you were looking to double the spend in cyber security, is that right? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman, President & CEO [51] +-------------------------------------------------------------------------------- +Yes, I was just estimating it, I was taking a guess that it will double over the next four or five years. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [52] +-------------------------------------------------------------------------------- +And I think it is fair to say, Betsy, that what we are seeing inside the space, not surprisingly, is this relentless constant and evolving set of attacks and we need to be constantly evolving and constantly vigilant in response. So it is entirely reasonable to assume that we will continue to increase our investment over the course of the next several years and we'll -- so it will be larger and we will let you know. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [53] +-------------------------------------------------------------------------------- +I mean tokenization --. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman, President & CEO [54] +-------------------------------------------------------------------------------- +I should clarify that was quoted in the press not accurately because this is one area where the government and businesses have been collaborating really well. And for a long time of course all these government agencies -- and I think we need that because the government sees all kind of attacks and they have a -- they are a fountain of information. +And then also the industry itself collaborates, which is we share information with other banks immediately when we see something happening. So maybe even if something happens to you, you can help one of your brethren avoid a problem like that. +And then cyber goes beyond just yourself. It's making sure that all of your vendors you deal with have proper cyber control, that all the exchanges have proper cyber control. So this is -- we have identified this as a huge effort. We've been very good at it until this recent breach, which we are not going to make excuses for. We will invest any and all things we need to do to get it right. +Our customers are protected, which is critical, but we don't want these things to be happening. But it is going to be a battle. We have already seen a lot of very, very serious -- far more serious than personal data being taken where Social Security numbers, security codes, account numbers, etc. +And we do think that unfortunately there are going to be some wins and losses in this. This is not going to be one of those things where it is going to be absolute and we don't want to be sitting here saying you can absolutely be protected because we think that will put you in a false sense of security. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [55] +-------------------------------------------------------------------------------- +Those are all great points. I mean, you could imagine tokenization moving beyond just payments to any interface with clients at some point? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman, President & CEO [56] +-------------------------------------------------------------------------------- +Yes. Tokenization will be more broadly used and that avoids a certain type of fraud, but not other types of fraud. So you have to look at each one of these things and say, what does it accomplish. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [57] +-------------------------------------------------------------------------------- +Right. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [58] +-------------------------------------------------------------------------------- +And that certainly helps across the payment space, but there are other areas of vulnerability, obviously. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [59] +-------------------------------------------------------------------------------- +Appreciate --. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman, President & CEO [60] +-------------------------------------------------------------------------------- +And there is (inaudible) security about who came to what systems, when they use private computers with private lines as opposed to public computers from home. There are all these things we're all doing and we've had some great people come in, audit us, and this is one area I suggest to most companies, get someone to come in who is an expert at this. We have our own attacker system where we have our own people trying to get through. So we are always trying to look where we might have a weak spot. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [61] +-------------------------------------------------------------------------------- +Okay, appreciate the color on that. Thanks. + +-------------------------------------------------------------------------------- +Operator [62] +-------------------------------------------------------------------------------- +Guy Moszkowski, Autonomous. + +-------------------------------------------------------------------------------- +Guy Moszkowski, Autonomous - Analyst [63] +-------------------------------------------------------------------------------- +I just wanted to follow-up first of all on the question that Glenn asked about the change in the derivatives contracts. From your perspective doesn't this fundamentally render the contract less attractive for users because of the loss of the automatic bankruptcy preference? And if so, would you expect this is one more potential pressure on the derivatives revenues that you've talked about in the past potentially depressing your revenues by as much as $1 billion? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman, President & CEO [64] +-------------------------------------------------------------------------------- +I don't think it makes it less attractive. For the one reason if you look at one contract that someone may have in one fund or someone like that yes, it may make it slightly less attractive. But if you look at the improved safety of the system I think it makes it more attractive. +So, if people believe that doing this makes whole system safer, every institution will say well, on the one contract side I would prefer to have the optionality, but for the total I like the fact the system is protected and we have time to work all this out. + +-------------------------------------------------------------------------------- +Guy Moszkowski, Autonomous - Analyst [65] +-------------------------------------------------------------------------------- +Fair point. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman, President & CEO [66] +-------------------------------------------------------------------------------- +So if the resolution works that is really, really good for everybody. I mean everybody would have preferred that there was a resolution process in place for Lehman. The pain and suffering would have been far less across derivatives even though they didn't have the same -- they had more protection derivatives at the time. + +-------------------------------------------------------------------------------- +Guy Moszkowski, Autonomous - Analyst [67] +-------------------------------------------------------------------------------- +And while we are on that topic then, another thing that happened during the quarter obviously was the Fed and FDIC rejecting the living wills. And I was wondering if you could give us a sense for what changes that might have provoked from your point of view in terms of accelerating some of the simplifications that you were talking about earlier? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [68] +-------------------------------------------------------------------------------- +So I think just an important point of clarification for what it is worth is that the FDIC found the industry's 2013 plans not credible, the Fed did not. So it wasn't a joint agency conclusion that point. And so, we haven't had comments on the 2014 plan yet. +Having said that we, talking for JPMorgan, we made substantial progress even between the 2013 and 2014 submissions. We are in dialogue with our regulators to understand even more detail of what they found as being the limitations or the vulnerabilities in our credibility of the plan. And we are committed to remediating them by 2015. +It has had little bearing on our business simplification agenda because it was already a very broad and appropriate agenda. But we continue to work on all number of things around the place, [crystal] operations, legal entity simplification and we will continue to do so. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman, President & CEO [69] +-------------------------------------------------------------------------------- +Remember the FSB led by Mark Carney has made it -- be said publicly that the two big remaining pieces are TLAC, which should be done this year, and the derivative stay that would be common harmonization around the globe. And those two pieces are going to be in place and make resolution much more achievable. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [70] +-------------------------------------------------------------------------------- +Right and we should add that obviously the [Issa] protocol was specifically pointed out in that feedback and the industry voluntarily resolved the issue I think very well. + +-------------------------------------------------------------------------------- +Guy Moszkowski, Autonomous - Analyst [71] +-------------------------------------------------------------------------------- +Yes, fair enough. I mean I think a lot of times the press reports forget to pull together all the pieces like that. I hate to beat the regulatory horse too hard here, but one of the things that we were hearing towards the end of the quarter was that our clients were telling us that they were seeing a significant fall off in liquidity in some aspect of the credit markets in particular. +And I was wondering, is there any link between that and some of the new filings that you have had to start doing on a daily basis for -- not just you, but obviously all the dealers on liquidity? And I think some of the Volcker data gathering has started as well. And I was wondering if there was any linkage there? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [72] +-------------------------------------------------------------------------------- +No. So I mean, my point of view on this is that while we have started doing the filing more recently we have been well aware of the requirement for a reasonably long if not very long period of time and have reoriented our business to be compliant in substance with the requirements. +So the fact that we are producing metrics at this point isn't having meaningful impact on our business. It is the case that over the course of the next year between now and the compliance date next July, we do expect to, as an industry, receive feedback on that data and we will have to see how that progresses. But it is our point of view that our business is compliant. + +-------------------------------------------------------------------------------- +Guy Moszkowski, Autonomous - Analyst [73] +-------------------------------------------------------------------------------- +Okay, that helps. The last one for me -- sorry, go ahead. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman, President & CEO [74] +-------------------------------------------------------------------------------- +Industry wide as people pushed LCR and capital and some of these rules down to the trading desk that we did see a reduction in inventories, etc. But our view is that market making is a critical role in society and it has to take place. We have 16,000 clients and so we really do focus on serving those clients. +We electrified more of it, some of it will go to clearinghouses, some of it will be -- but we want to be there for the clients. And you will see how the industry sorts out. Some people in the industry are making much more drastic decisions than others. Our decision has been to be there to make markets and just try to adjust to the new rules which may make it a little bit more costly to trade. + +-------------------------------------------------------------------------------- +Guy Moszkowski, Autonomous - Analyst [75] +-------------------------------------------------------------------------------- +But what I think you hear you saying is that the recent imposition of some of these reporting requirements did not in itself have those liquidity impacts? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman, President & CEO [76] +-------------------------------------------------------------------------------- +I think it wasn't the reporting requirements, I think it was pushing down of LCR, the cost of capital, the cost of debt and the traders reduced their balance sheets a little bit and they were a little more cautious how they use a balance sheet. And that is industry wide. And then some people said we simply can't stay in these areas. I have seen people exit certain trading areas. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [77] +-------------------------------------------------------------------------------- +Yes, I mean, repo is a good example of that where the level of, not concern, but the level of dialogue with clients around our willingness to continue to commit our balance sheet to that business has increased because others are less willing. And so, we are seeing some of that for sure. + +-------------------------------------------------------------------------------- +Guy Moszkowski, Autonomous - Analyst [78] +-------------------------------------------------------------------------------- +Got it. And then the last one for me -- Marianne, you gave some clarification around loan growth in the CIB. But I am not sure I quite understood it. Basically you said the minus 5% headline number was affected by a couple of it sounded like one time-ish kind of things and what the underlying was. But as I said, I'm not sure I really caught your drift. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [79] +-------------------------------------------------------------------------------- +Yes, okay so let me give you the down piece of it. One of them is not timing, it is just a continuation of a trend where trade finance loans are down substantially year over year (technical difficulty). And so when you look at it the overall loan balance is being impacted by trade, markedly. And then on the client overdraft side, that is something that is a little bit lumpier, you see. +So those two things driving it down. But the point to the comment was a little bit -- not to trivialize reported loan growth, which was still positive, but with those masking underlying performance in our credit portfolio and HFI loans. So our more traditional credit lending continues to grow and grow at 10% plus pace. + +-------------------------------------------------------------------------------- +Guy Moszkowski, Autonomous - Analyst [80] +-------------------------------------------------------------------------------- +Great. Thanks very much. + +-------------------------------------------------------------------------------- +Operator [81] +-------------------------------------------------------------------------------- +Gerard Cassidy, RBC. + +-------------------------------------------------------------------------------- +Gerard Cassidy, RBC Capital Markets - Analyst [82] +-------------------------------------------------------------------------------- +Can you share with us -- obviously the federal reserve is asking for more capital for all the larger global SIFI type banks. What is the minimum cushion would you guys be comfortable running against? You mentioned your 50 to 100 basis points might be a little less. How low would you go in your cushion for meeting those new capital guidelines when they come out down the road? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [83] +-------------------------------------------------------------------------------- +So I think a reasonable point of view on that would be at the lower end of that range, at the 50 basis points. So remember, when we -- obviously we will refine it and we will update you. But when we have thoughts about having a buffer it is there in order to protect us from a range of issues including capital volatility driven by AOCI. +We regularly and routinely stress our portfolio to understand how much stress we could see in AOCI in a short period of time and that is going to be one of the principal drivers. So I would say is that a reasonable sort of benchmark for the level that we would go to. +That doesn't mean we have to have that buffer in totality. As I said, buffers phase in between now and January of 2019. So whatever we decide it is, however we communicate that to you, that as well of all of the other buffers, capital conservation buffer and G-SIB we will phase in. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman, President & CEO [84] +-------------------------------------------------------------------------------- +And CCAR may still be a limiting factor, so --. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [85] +-------------------------------------------------------------------------------- +Yes. I mean the reality -- as Jamie said, the reality is that the way CCAR is operating, while there has been good progress in the communication and dialogue with the regulator, the reality remains that it is still not clear, either quantitatively or qualitatively, exactly how everything is working and therefore it is unlikely to be the case that in this cycle that you are going to see 100% or greater than 100% distribution. That is my view. + +-------------------------------------------------------------------------------- +Gerard Cassidy, RBC Capital Markets - Analyst [86] +-------------------------------------------------------------------------------- +Yes. No, regarding the return on equity, at Investor Day you guys gave us the through the cycle target of 15% to 16%. Clearly I would assume that in this year's Investor Day when it comes up, if these capital levels are even higher now than what you originally thought when you gave that guidance, it probably will be a bit lower. +What lines of business do you think will see the lower ROE targets, if you decide that you need to lower it through the cycle from the 15% to 16% that you gave us last year? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [87] +-------------------------------------------------------------------------------- +Yes, so, I mean, just before we sort of get onto the business-by-business lens on it, I mean the reality mathematically is obviously true that if we have higher capital we would prima facie defacto have lower returns. But the reality hasn't been that way over time. So you know acutely that we have added significant capital over the last however many years and have been able to, over time, continue to reorient the business and optimize against it to deliver strong returns. +So could there be a decline in returns. Obviously we will have to see what the rules look like. Clearly at the moment the most clear and present danger relates to higher G-SIB surcharges on short-term wholesale funding. So in the first quarter impact of it would obviously have an impact on directing those businesses and products in the CIB. But obviously if the Company is holding more capital we will look more broadly. +But I don't think it is a foregone conclusion that you are going to see a pro rata decline in our returns. And obviously we are continuing to focus on our expenses in making sure that the overall business is as efficient as possible. + +-------------------------------------------------------------------------------- +Gerard Cassidy, RBC Capital Markets - Analyst [88] +-------------------------------------------------------------------------------- +Is it fair to say that today's ROE in today's quarter of about 10% -- which obviously is below your through the cycle number -- is it primarily an interest rate issue that is holding it back or is there some other issue - the high elevated expenses that you are running due to all the new regulations and stuff? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [89] +-------------------------------------------------------------------------------- +Yes. So I mean our 10% ROE, 13% ROTCE, remember the target is an ROTCE target. It's obviously -- right now in 2014 we are in a bit of a cyclical low in a number of ways and elevated expenses. So it is cyclical lows in mortgage, at least for the first half of the year cyclical lows and some secular headwinds in the market space. +Yes, we are reaching a peak in terms of control expenses, so that is in part contributing reserve releases are lower albeit that credit remains benign, but at a relative matter they are lower. But we are staring efficiencies in the face across our businesses over the course of the next two years. +So control costs will decline, CCB will deliver improvements in expense, CIB will also, rates will be a meaningful piece. Clearly you've seen our sensitivity to rising rates is relatively significant, but it is not the only piece. When the economy generally recovers, when loan growth recovers and volatility recovers, all those things, good things happen. + +-------------------------------------------------------------------------------- +Gerard Cassidy, RBC Capital Markets - Analyst [90] +-------------------------------------------------------------------------------- +Shifting gears, if we look at leverage lending the federal reserve has come out recently concerned about some of the underwriting that is going on there. And I think they even pointed out that leverage lending now will be used in CCAR possibly from a qualitative standpoint. Can you guys give us any color on what your understanding is of what is going on with leverage lending today? And will it be included in CCAR? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [91] +-------------------------------------------------------------------------------- +Just to talk about what will be included in CCAR, the truth is we don't know. So what you have seen we have also read. But that doesn't constitute any kind of guidance. We haven't received guidance yet, so we are going to have to wait to see that. It wouldn't be entirely surprising if there was some sort of leverage stress in there quantitatively; I can't speak to qualitatively. +And then, yes, there has been more stringent guidance on leverage lending from the regulators over the course of the last year. And we have taken a fairly strict line on applying that. So it has in part been one of the reasons why we believe we have seen lower loan growth in some of our business than we would otherwise have seen. + +-------------------------------------------------------------------------------- +Gerard Cassidy, RBC Capital Markets - Analyst [92] +-------------------------------------------------------------------------------- +You guys mentioned (multiple speakers) yes. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman, President & CEO [93] +-------------------------------------------------------------------------------- +And it is going to get a little stricter on the refi part of the leverage loans. And obviously whatever the terms are, we will meet the terms and some of that business will go to nonbanks or some banks who are not regulated by the OCC and the Fed. + +-------------------------------------------------------------------------------- +Gerard Cassidy, RBC Capital Markets - Analyst [94] +-------------------------------------------------------------------------------- +You guys gave some very good numbers on the mobile app usage by your customers. What is the penetration rate of your customer base that uses that mobile app? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [95] +-------------------------------------------------------------------------------- +It is still relative to 20-million-something customers in -- households and 23 million, something like that, households in the retail sales space is still relatively low. From recollection, and we will check the numbers for you, I think it is in that 2 million to 3 million range. But nevertheless -- no? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman, President & CEO [96] +-------------------------------------------------------------------------------- +Mobile was much higher than that. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [97] +-------------------------------------------------------------------------------- +Mobile is higher? Okay, we will get back to you. + +-------------------------------------------------------------------------------- +Gerard Cassidy, RBC Capital Markets - Analyst [98] +-------------------------------------------------------------------------------- +Okay. And then finally. you guys talked about Apple Pay --. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [99] +-------------------------------------------------------------------------------- +I'm sorry, I'm sorry --. + +-------------------------------------------------------------------------------- +Gerard Cassidy, RBC Capital Markets - Analyst [100] +-------------------------------------------------------------------------------- +-- can you show -- + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [101] +-------------------------------------------------------------------------------- +I'm sorry, it's 18 million. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman, President & CEO [102] +-------------------------------------------------------------------------------- +Yes, it is 18 million out of --. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [103] +-------------------------------------------------------------------------------- +18 million. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman, President & CEO [104] +-------------------------------------------------------------------------------- +I don't know is that individuals or households? It's a huge amount. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [105] +-------------------------------------------------------------------------------- +Customers. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman, President & CEO [106] +-------------------------------------------------------------------------------- +Yes, customers. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [107] +-------------------------------------------------------------------------------- +Sorry. + +-------------------------------------------------------------------------------- +Gerard Cassidy, RBC Capital Markets - Analyst [108] +-------------------------------------------------------------------------------- +You guys mentioned Apple Pay and the opportunities there. What are some of the -- where could you see the growth? But at the same time where can Apple Pay cannibalize some of your businesses or are there any that will be cannibalized? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman, President & CEO [109] +-------------------------------------------------------------------------------- +Look, again, our view is to, if you are a client and you want to use your Apple phone to pay with NFC at a merchant, that is fine, we don't want to say you can't use your JPMorgan Chase credit card or debit card. And like we said, we're going to be in other people's wallets too. And we're going to have our own which we think will have some competitive advantage. +So will it cannibalize? Sure. But we are not against cannibalizing our own business or disrupting ourselves if we are building a better business and are gaining share. Our goal to gain share. We do believe a little bit in -- you know when Jeff Bezos says, your margin is my opportunity, we want to be the people that are coming up with the new ideas and stuff that are getting more of our customers using our stuff and happier. And if it reduces certain margins somewhere, so be it. + +-------------------------------------------------------------------------------- +Gerard Cassidy, RBC Capital Markets - Analyst [110] +-------------------------------------------------------------------------------- +Thank you very much. + +-------------------------------------------------------------------------------- +Operator [111] +-------------------------------------------------------------------------------- +Mike Mayo, CLSA. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA - Analyst [112] +-------------------------------------------------------------------------------- +A follow-up on the loan question from before. You mentioned a little bit more caution with leverage loans. In the past you said you didn't want to compete too much in the commercial space if it's getting too competitive. There's been some current concerns about auto lending with regulators. +So my question is, slide 1 highlights that your core loans are up 1% quarter over quarter and the same slide in the second quarter said that core loans were up 4% quarter over quarter. So my question is, are you simply getting more cautious in the loans that you provide or is there a little bit less demand in the market? Really trying to get to is loan growth decelerating? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [113] +-------------------------------------------------------------------------------- +Yes, look, if you look at year-over-year trends, they continue to be in the -- I mean I think the first quarter year over year was 4%, 8% in the second, 7% in the third. I think we are not expecting those year-over-year tends to decelerate. +Obviously quarter over quarter things can be impacted just by the timing of closing loans. So fundamentally I would say, no, we aren't seeing significant deceleration quarter over quarter within continued relative momentum. Solid across the board with obviously more challenges in the C&I space. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA - Analyst [114] +-------------------------------------------------------------------------------- +Separately your expense guidance is now for over $58 billion, you said some of that is due to comp. Is any of that increase in guidance due not to comp? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [115] +-------------------------------------------------------------------------------- +Relative to the 58 plus or minus that [was being said], no, it is principally in higher revenues on higher market performance. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman, President & CEO [116] +-------------------------------------------------------------------------------- +We always said that might be the case. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [117] +-------------------------------------------------------------------------------- +Yes. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman, President & CEO [118] +-------------------------------------------------------------------------------- +So we are meeting our overhead numbers and the comp itself will bounce around a little bit. Remember, in the old days we used to break out IB comp in total for that reason. But --. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA - Analyst [119] +-------------------------------------------------------------------------------- +Okay, separate -- yes. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [120] +-------------------------------------------------------------------------------- +Yes, sorry. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA - Analyst [121] +-------------------------------------------------------------------------------- +Separately which capital ratio is your binding constraint? And using that ratio, what should we use in our model three years out? And I know that's a tough question with all the moving parts, but what is your best guess? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [122] +-------------------------------------------------------------------------------- +Okay. So just in terms of what is our binding constraint at the moment, it is CET1, so Basel III advanced capital, risk-based capital at the margin. So it is not to say that the other ratios leverage liquidity and the like aren't [comfortably] around it. But that -- and even stress capital. But that is currently our binding constraint. +It is very hard for us to give us a point of view where you should do this new model three years out when we are staring potentially new rules in the face in the next two months. As I said earlier, we are expecting over the course of the next 12 months that we will continue to accrete capital at 2% or above our 10.5% which is basically in-line with what you guys all have in your models. +Beyond that it is our expectation that, hopefully anyway, putting new rules aside that by the time we are in our fourth or fifth cycle of CCAR when you've made substantial industry wide progress in the sort of non-quantitative aspects of CCAR where we have more credible resolutions and the like that we will be able to me more aggressive in our ability to seek capital distribution capability. +So outside of any changes in rules we would hope at the end of 2015 into 2016 CCAR to be able to have -- payout ratios are much higher. But we will have to see. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA - Analyst [123] +-------------------------------------------------------------------------------- +Okay. And then last question. On the supplement page 6, this is a smaller item, but it just kind of stands out. Your rate on trading liabilities declined from 48 basis points down to 12 basis points in just three months. Is there anything unusual there? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [124] +-------------------------------------------------------------------------------- +Yes, there is. So about half of that I would call -- approximately half of that I would call relatively normal, but included in that result there is actually a one-time item associated with accounting for the previous interest accrual that we released in the quarter, which is one time. You should expect that interest expense to go back up next quarter to something more normal. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA - Analyst [125] +-------------------------------------------------------------------------------- +And how much -- what was the dollar amount of that impact? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [126] +-------------------------------------------------------------------------------- +A little less than $100 million. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA - Analyst [127] +-------------------------------------------------------------------------------- +Okay. All right, thank you. + +-------------------------------------------------------------------------------- +Operator [128] +-------------------------------------------------------------------------------- +Erika Najarian, Bank of America-Merrill Lynch. + +-------------------------------------------------------------------------------- +Erika Najarian, BofA Merrill Lynch - Analyst [129] +-------------------------------------------------------------------------------- +Just wanted to follow up with two quick questions. The first is, Marianne, if we put together everything that you have said on expenses so far in this call, is it fair to assume that without rates the efficiency -- adjusted efficiency ratio of 59% can continue to improve in 2015 and 2016? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [130] +-------------------------------------------------------------------------------- +Yeah. So I think -- yes, it is our -- it is our belief that we should be able to manage the ratio to be stable to improving over time, ultimately getting down to something much more in the mid-50%, but that is dependent on revenue growth associated with rates but not limited to rates. +So in the absence of rate but, by the way just to point out, that it is still our case that based upon continued improvement in the domestic rate economy that rates will start to rise in the middle of next year. But having said that, even without rates we would hope to be able to continue to maintain the discipline to have that ratio be broadly flat to down. + +-------------------------------------------------------------------------------- +Erika Najarian, BofA Merrill Lynch - Analyst [131] +-------------------------------------------------------------------------------- +Great. And the second follow-up question is, given your expectations for rates to rise in the middle of next year are you still -- and the progress that you -- continued progress you make on deposit share are you still expecting $100 billion in deposit outflows in that case? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [132] +-------------------------------------------------------------------------------- +So since we talked about the $100 billion estimated deposit outflows associated with liquidity draining out of the system, remember that was predicated on believing that it was possible that the Fed would use the reverse repo program much more -- in much more size than is likely to be the case today for two reasons. +One is that obviously they have made changes to the term deposit facility that allows them to now be LCR eligible, which is helpful in terms of providing another tool in their toolkit. +And the second is that in September, as you know, the RRP was capped in total at $300 billion. That cap may or may not be permanent. I'm sure it will be recalibrated over time. But it looks like it will be unlikely to reach the $1 billion that would have driven the $100 billion -- the $100 billion -- sorry the $1 trillion that would have driven the $100 billion. +So. you can make your decision about whether it is $300 million or $500 million in the fullness of time and scale our operating deposit outflows back relative to that, knowing of course that it is already in operation at $300 billion right now. + +-------------------------------------------------------------------------------- +Erika Najarian, BofA Merrill Lynch - Analyst [133] +-------------------------------------------------------------------------------- +Got it. Thank you for taking my questions. + +-------------------------------------------------------------------------------- +Operator [134] +-------------------------------------------------------------------------------- +Brennan Hawken, UBS. + +-------------------------------------------------------------------------------- +Brennan Hawken, UBS - Analyst [135] +-------------------------------------------------------------------------------- +So, appreciate that the repo book is substantially client driven. Was maybe hoping that you guys could give us some sense for how much of your repo book is firm financing versus facilitation? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [136] +-------------------------------------------------------------------------------- +Yes, Brennan, we haven't disclosed that. I would -- a large chunk of it is client driven, that is what we will say. + +-------------------------------------------------------------------------------- +Brennan Hawken, UBS - Analyst [137] +-------------------------------------------------------------------------------- +Okay, worth a shot. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [138] +-------------------------------------------------------------------------------- +A large chunk -- a larger chunk of it -- the larger chunk of it. + +-------------------------------------------------------------------------------- +Brennan Hawken, UBS - Analyst [139] +-------------------------------------------------------------------------------- +Okay. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman, President & CEO [140] +-------------------------------------------------------------------------------- +We have also lengthened the firm financing part of it --. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [141] +-------------------------------------------------------------------------------- +Yes. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman, President & CEO [142] +-------------------------------------------------------------------------------- +-- to be more compliant with LCR, etc. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [143] +-------------------------------------------------------------------------------- +Right. + +-------------------------------------------------------------------------------- +Brennan Hawken, UBS - Analyst [144] +-------------------------------------------------------------------------------- +Okay, that is fair. And I just wanted to try to square something here and maybe I am reading just a little too much into it. You had said that October on the capital markets side has been a bit mixed. But you have also at the same time brought up your expense guidance and it seems like it is driven by expected or potentially a component of comp and capital markets. +So are those two at odds? Are you just more optimistic that maybe what we're seeing here in October is not necessarily some sort of dramatic shift but a temporary bout in bad volatility? Or how can we square those two? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [145] +-------------------------------------------------------------------------------- +So I would square it in two ways. The first is already did have a better performance in the third quarter then would have been anticipated in our previous guidance given that that guidance was given during the sort of harder times of the second quarter. So that is already in our run rate so to speak in terms of the comp that would accrue to that. +And then if you sort of go back and, in the fullness of time, look at the transcript, I did say if the performance continues into the fourth quarter. So it will depend. +We have always said, and evidently maybe we should strip out comp from our adjusted expenses. But we have always said that the adjusted expense absolute number in any period is obviously going to be calibrated to the performance of the market-related businesses. And clearly you would wave in good revenues every day at a 32% comp to revenue ratio. So that is really all we were saying, nothing more subtle than that. + +-------------------------------------------------------------------------------- +Brennan Hawken, UBS - Analyst [146] +-------------------------------------------------------------------------------- +Okay, okay, thanks for that. And then appreciate that there is not much color potentially to be added on this charge tied to FX. But just is it possible to let us know if it is tied to a particular geography? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [147] +-------------------------------------------------------------------------------- +No, no, it is not possible to talk about it in any more detail, I am afraid. + +-------------------------------------------------------------------------------- +Brennan Hawken, UBS - Analyst [148] +-------------------------------------------------------------------------------- +Okay. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [149] +-------------------------------------------------------------------------------- +It's just -- suffice to say that we are working with a number of regulators across a number of jurisdictions. + +-------------------------------------------------------------------------------- +Brennan Hawken, UBS - Analyst [150] +-------------------------------------------------------------------------------- +All right, that is fair. And then last one for me. So in looking at the NIM simulation that you guys have provided, and then taking a look at that in light of the interest rate shock disclosures you've got in your Q's, it looks like a 200 basis point rate shock adds about half of what you are looking for in a normalized rate environment. +So I guess does that mean that subsequent years sort of the benefit of rolling the portfolio into higher rates is going to exceed the higher deposit cost by about $4 billion to $5 billion? And then is there a particular time period that we should think about that or is it going to be too heavily influenced by competitive dynamics? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [151] +-------------------------------------------------------------------------------- +So you are right that when you roll forward beyond the first 12 months you do get the benefit of being able to continue to reinvest deposits as they mature up the curve in terms of their invest -- the underlying investment. So that is the compounding effect of what you are seeing in our earnings and risk shock. +But what we showed I think in -- I'm going to cease to recall it, but maybe it was in the Barclays conference in 2013 -- is that you would expect once rates start to rise, if they rise in a somewhat expected fashion. So obviously it depends on what rate [party] you want to put on that, that you could expect the cumulative NII to be in our [impact] in three to four years. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman, President & CEO [152] +-------------------------------------------------------------------------------- +Remember the benefit is more for the first hundred, a little bit less the second hundred, a little bit less the third hundred, a little bit less the fourth hundred, because there is increasing repricing of deposits at that level. And we don't know exactly what the yield curve will be four years out, but --. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [153] +-------------------------------------------------------------------------------- +Right. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman, President & CEO [154] +-------------------------------------------------------------------------------- +And also we do embed in that our own estimates of competition and repricing. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [155] +-------------------------------------------------------------------------------- +Yes. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman, President & CEO [156] +-------------------------------------------------------------------------------- +But --. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [157] +-------------------------------------------------------------------------------- +Yes. That is a very good point actually, Brennan. Our scenario does contemplate not only a more normal loan to deposit ratio, more normal interest bearing versus non-interest-bearing deposit and also a higher (inaudible) on retail deposits just given the LCR competitive dynamics, technology advances and the like. So to the best of our ability we've tried to bake that in and that is included in our number. + +-------------------------------------------------------------------------------- +Brennan Hawken, UBS - Analyst [158] +-------------------------------------------------------------------------------- +Sure, sure. Okay, thanks, that is fair. + +-------------------------------------------------------------------------------- +Operator [159] +-------------------------------------------------------------------------------- +Ken Usdin, Jefferies. + +-------------------------------------------------------------------------------- +Ken Usdin, Jefferies & Co. - Analyst [160] +-------------------------------------------------------------------------------- +A tactical follow-up just on the balance sheet. With the non-interest-bearing deposits basically being the fastest growing category of the balance sheet and the resulting asset, the deposit with banks also being the fastest-growing asset on the balance sheet. +Just within that context of what you just walked through with Brennan, I am just wondering what changes structurally with the way you think about reinvesting in the securities portfolio with rates as low as they are now. Loan growth is okay, but to your point you are being somewhat selective on -- and want to be careful with pricing and credit. +So, just from a -- more so taking the next year or so out, how are your thoughts changing at all with respect to what you do with these deposits given that they might actually not flow out as much given that change to the ROP function? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [161] +-------------------------------------------------------------------------------- +Right. So the deposit -- so in part not totality, in part the deposits that were likely to outflow through the RRP were non-operating deposits. And non-operating deposits we do not count for significant liquidity value in the Firm; we fundamentally have them on deposit at central banks at the Fed. +And so, if they stay -- we will come back to whether we would be willing to let them stay, but if they stay they will continue to basically be treated in that way. And they are not included in terms of our assumption around asset sensitivity and forward-looking NII. +Obviously over time we are in the same way as we talked about repo we are looking at non-operating deposits for our clients in the context of their overall relationship. And so, that is another valuable use of our balance sheet with leverage capital and the like against it. And in the fullness of time we will expect the overall relationship to pay for that. But we are going to wait and see some of those dynamics play out. +So other than that I'll just go back to the earlier comments I made that we do have a high level of HQLA, not in [cash], not in securities, but it is in order to make sure that we have adequate liquidity both under our own stresses most importantly, but also under LCR and NSFR. And we feel good and at modest buffers relative to them. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman, President & CEO [162] +-------------------------------------------------------------------------------- +At the typical quarter end a lot of large clients leave a lot of deposits here which obviously are not necessarily good for us in terms of LCR or capital, etc., and we will be looking at how we manage those client relationships over time too. + +-------------------------------------------------------------------------------- +Ken Usdin, Jefferies & Co. - Analyst [163] +-------------------------------------------------------------------------------- +Understood, okay. And (multiple speakers). + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman, President & CEO [164] +-------------------------------------------------------------------------------- +The other thing you remember of the securities portfolio is that as rates go up the duration of that extends on its own. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [165] +-------------------------------------------------------------------------------- +Correct. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman, President & CEO [166] +-------------------------------------------------------------------------------- +And so, we will be managing that. And, yes, we might invest it longer at one point, but we are in a very conservative position right now. + +-------------------------------------------------------------------------------- +Ken Usdin, Jefferies & Co. - Analyst [167] +-------------------------------------------------------------------------------- +Yes, okay. Got it. And then secondly, just two quick ones on mortgage. Default servicing costs have pretty much stabilized the last couple of quarters at a good level that you had talked about getting down to $500 million total by the fourth. And I am just wondering how much more room is there given that improvement in underlying trends that you're continuing to see for that to be a benefit to that cost side of the equation going forward? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [168] +-------------------------------------------------------------------------------- +So we are continuing to see credit trends improve, delinquencies come down, modification pipelines -- all the metrics are coming down. Obviously they are coming down from a much smaller place this year than that were last and the year before. So the pace of improvement or the relative pace is slower. +But we are expecting that to continue down through $500 million and into the $400 million's in 2015. And then just more longer-term, you know that we are focused on ensuring that through the next cycle we have a smaller delinquency portfolio. And so, a more normal level would be substantially less than this. + +-------------------------------------------------------------------------------- +Ken Usdin, Jefferies & Co. - Analyst [169] +-------------------------------------------------------------------------------- +Okay. And I noticed that your (multiple speakers). + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [170] +-------------------------------------------------------------------------------- +Sorry, that is a longer-term view. + +-------------------------------------------------------------------------------- +Ken Usdin, Jefferies & Co. - Analyst [171] +-------------------------------------------------------------------------------- +Yes. And I noticed also that underneath the origination improvement this quarter there was a decent jump in correspondent. I am just not -- I just wanted to ask if you are doing anything differently in terms of market share opportunities on the mortgage side now that things have shaken out a little bit or any change in your underlying philosophy on where you are looking at originations? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [172] +-------------------------------------------------------------------------------- +Yes. So I mean we talked last quarter about the fact that we had loss share, a combination of things, primarily our strategy around the government mortgage space but also a little bit of share in the what I would call in our target segment. So we have made that back. +So in some part it is just continue to leverage our balance sheet properly, do very granular marginal pricing to really focus on changing and improving our customer operating processes. So across the board we just continue to get very granular and try and be as competitive as we can. + +-------------------------------------------------------------------------------- +Ken Usdin, Jefferies & Co. - Analyst [173] +-------------------------------------------------------------------------------- +Okay, thanks very much. + +-------------------------------------------------------------------------------- +Operator [174] +-------------------------------------------------------------------------------- +Steve Chubak, Nomura. + +-------------------------------------------------------------------------------- +Steve Chubak, Nomura Asset Management - Analyst [175] +-------------------------------------------------------------------------------- +Marianne, I appreciated the color you had given on the RWA guidance. I suppose one thing that we have been hearing from a lot of clients, or at least concern from clients, is this notion of regulatory gold plating. Essentially the us regulators adopting tougher standards than those that are being enforced in other areas around the globe. +And I just wanted to get a sense as to how that is informing your thinking about RWA mitigation plans. You reaffirmed the guidance at Investor Day, but what should we expect in the event that a tougher capital as well as TLAC requirement is in fact enforced against US G-SIBs? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [176] +-------------------------------------------------------------------------------- +So, just to be very clear, it may be slightly -- (inaudible) slightly higher than Investor Day in terms of our guidance. So, look, obviously any guidance that we give you, and no good deed goes unpunished, but any guidance we give you is always predicated on based upon what we know today. And so, if something changes that would change that point of view we will obviously have to recalibrate it. +But just prima fascia having the requirement to have extra long-term debt or loss absorbing capital and/or capital wouldn't necessarily prima fascia change the overall RWA we have. I mean you have to be careful to ensure that by having higher levels of capital there's not an incentive to want to stretch in the credit box, but we have very tight credit discipline. So I wouldn't see that being a material change in the outlook. But obviously if there is a change in rules that directly affect RWA that would do. + +-------------------------------------------------------------------------------- +Steve Chubak, Nomura Asset Management - Analyst [177] +-------------------------------------------------------------------------------- +All right, thank you. That is very helpful. And then just switching gears to the investment banking outlook that you had given. I appreciated the color which sounded quite constructive on the backlogs for M&A and ECM. And I guess not just you but the industry in general hasn't given much commentary on the outlook for debt capital markets activity. +It has been challenged this year. I think that was something which many of us had expected just given the strength that we had experienced over the last couple of years. But I didn't know if you can just provide some updated thoughts on that revenue stream in particular. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [178] +-------------------------------------------------------------------------------- +Yes, I mean, look, it is the case that a lot of refinancing has already happened, so the debt maturity wall is smaller, although rates are lower than we may have expected at this point in time. So I would -- so, therefore yes, it is reasonable to assume that there is going to be some continued headwinds. But having said that, I think there is going to be windows of opportunity. So we are going to -- M&A and ECM are more constructive and likely to be buoyant, but I think debt capital market still has windows of opportunity. + +-------------------------------------------------------------------------------- +Steve Chubak, Nomura Asset Management - Analyst [179] +-------------------------------------------------------------------------------- +Okay, great, that is it for me. Thank you for taking my questions. + +-------------------------------------------------------------------------------- +Operator [180] +-------------------------------------------------------------------------------- +There are no further questions at this time. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman, President & CEO [181] +-------------------------------------------------------------------------------- +Folks, thank you very much for joining us -- + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [182] +-------------------------------------------------------------------------------- +Thank you. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman, President & CEO [183] +-------------------------------------------------------------------------------- +And we will talk to you soon. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. While the Preliminary Transcript is highly +accurate, it has not been edited to ensure the entire transcription +represents a verbatim report of the call. + +EDITED TRANSCRIPT: "Edited Transcript" indicates that a team of professional +editors have listened to the event a second time to confirm that the +content of the call has been transcribed accurately and in full. + +-------------------------------------------------------------------------------- +Disclaimer +-------------------------------------------------------------------------------- +Thomson Reuters reserves the right to make changes to documents, content, or other +information on this web site without obligation to notify any person of +such changes. + +In the conference calls upon which Event Transcripts are based, companies +may make projections or other forward-looking statements regarding a variety +of items. Such forward-looking statements are based upon current +expectations and involve risks and uncertainties. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/exam/original-files/Problem_2_3_Sample_full_transcripts/2014-Oct-21-KO.N-140354489389-Transcript.txt b/exam/original-files/Problem_2_3_Sample_full_transcripts/2014-Oct-21-KO.N-140354489389-Transcript.txt new file mode 100644 index 0000000..573f6da --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_full_transcripts/2014-Oct-21-KO.N-140354489389-Transcript.txt @@ -0,0 +1,661 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q3 2014 The Coca-Cola Co Earnings Call +10/21/2014 09:30 AM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Ahmet Bozer + The Coca-Cola Company - EVP & President Coca-Cola International + * Sandy Douglas + The Coca-Cola Company - SVP & Global Chief Customer Officer + * Irial Finan + The Coca-Cola Company - EVP & President Bottling Investments Group + * Kathy Waller + The Coca-Cola Company - CFO + * Muhtar Kent + The Coca-Cola Company - Chairman & CEO + * Tim Leveridge + The Coca-Cola Company - VP & IR Officer + +================================================================================ +Conference Call Participiants +================================================================================ + + * Judy Hong + Goldman Sachs - Analyst + * Mark Swartzberg + Stifel Nicolaus - Analyst + * Bryan Spillane + BofA Merrill Lynch - Analyst + * Dara Mohsenian + Morgan Stanley - Analyst + * Ian Shackleton + Nomura - Analyst + * Ali Dibadj + Sanford C. Bernstein & Company, Inc. - Analyst + * Bill Schmitz + Deutsche Bank - Analyst + * Michael Steib + Credit Suisse - Analyst + * Steve Powers + UBS - Analyst + * John Faucher + JPMorgan - Analyst + +================================================================================ +Presentation +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + At this time, I would like to welcome everyone to the Coca-Cola Company's Third Quarter 2014 Earnings Results Conference Call. Today's call is being recorded. If you have any objections please disconnect at this time. +(Operator Instructions) +I would like to remind everyone that the purpose of this conference is to talk with investors and therefore, questions from the media will not be addressed. Media participants should contact Coca-Cola Company's Media Relations Department if they have questions. +I would now like to introduce Tim Leveridge, Vice President and Investor Relations Officer. Mr. Leveridge, you may begin. + +-------------------------------------------------------------------------------- +Tim Leveridge, The Coca-Cola Company - VP & IR Officer [2] +-------------------------------------------------------------------------------- + + Good morning and thank you for being with us today. I'm joined by Muhtar Kent, our Chairman and Chief Executive Officer, and Kathy Waller, our Chief Financial Officer. +Before we begin, I would like to inform you that you can find supplemental materials on our website that support the prepared remarks by Muhtar and Kathy this morning. This conference call may contain forward-looking statements, including statements concerning long-term earnings objectives, and should be considered in conjunction with cautionary statements contained in our earnings release and in the Company's most recent periodic SEC report. +I would also like to note that we have posted schedules under the Financial Reports and Information tab in the Investor section of our Company website at www.coca-colacompany.com. These schedules reconcile certain non-GAAP financial measures, which may be referred to by our senior executives during this morning's discussion, to our results as reported under generally accepted accounting principles. Please look on our website for this information. +Following prepared remarks by Muhtar and Kathy this morning, we will turn the call over for your questions. Ahmet Bozer, Executive Vice President and President of Coca-Cola International; Sandy Douglas, Senior Vice President, Global Chief Customer Officer, and President of Coca-Cola North America; and Irial Finan, Executive Vice President and President of Bottling Investments, will also be available for our Q&A discussion. I will now turn the call over to Muhtar. + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Company - Chairman & CEO [3] +-------------------------------------------------------------------------------- + + Thank you, Tim, and good morning, everyone. Today, I'm going to start with an overview of our quarterly performance and then spend the rest of the time addressing the strategic initiatives we announced earlier this morning in our separate release. +So, let's look at our performance for the third quarter. Our overall top line results for the third quarter were below our expectations. Comparable currency neutral net revenues grew 1% in the quarter and after adjusting for structural items due to factors both within and outside of our control. +We continue to face a challenging macroenvironment, more challenging than was expected when we started the year. In many of our key emerging markets, we see deteriorating economic environments coupled with continued softness in consumer spending in the US and particularly Japan and Europe. +This is placing strong pressure on the short-term performance of our business. These factors have driven a deceleration in personal consumption expenditures and as a result, the nonalcoholic beverage industry is growing 1 to 2 points slower than our initial forecast at the beginning of the year. With that said, there's no question that we need to improve our execution in many markets, especially our consumer marketing and commercial strategies. +Although we could point to various markets, this was most prominent in Europe where we saw a continued challenging macroeconomic environment and also aggressive competitive pricing. We achieved a 3% price mix in Europe, which was partially offset by a volume decline of 5%. While we're not comfortable with our year-to-date share performance in Europe, we, along with our bottling partners, know we must drive better consumer and commercial strategies and execution that can benefit from incremental investment in the marketplace and we're taking actions to address this situation. +That said, we are not discouraged nor are we any less enthusiastic about the opportunities in front of us. In markets where we executed our strategies well, we saw solid progress. In North America, our disciplined approach to pricing, supported by incremental media investments, high-quality, marketing programs such as Share a Coke, and disciplined price back strategies, as well as improved execution, is paying dividends with increased incidence, particularly among teens, and revenue growth in our sparkling portfolio. +In key emerging markets, including India, sub-Sahara Africa, as well as the Middle East, our incremental media investments drove recruitment with solid net revenue and volume growth. This gives us confidence that when we invest in our brands, align on our system plan, and focus on execution, we do see positive results. But to be clear, we recognize that our incremental media investments, which have really started in earnest around the around the FIFA World Cup, will take time to pay off. +Stepping back from our quarterly performance, we've taken a hard look at our progress to date, our strategies, and our actions and realized that, while the five strategic priorities we laid out at the beginning of the year are on the right track, we recognize that we must do more. Above all, the scope and pace of our actions must change to improve our ability to capture nonalcoholic beverage industry growth. That change starts with me. +I've asked my leadership team to take this journey with me and to facilitate this change throughout our Company. It's a journey we are ready to embark upon. In some ways, we've already enhanced our business with strategic investments in Keurig Green Mountain and intend to further do so with our pending investment in Monster beverages, which underscore not only our ability to adapt to changing consumer trends, but also our commitment to further innovation. +But these partnerships alone are not enough. That is why we're laying out today a series of actions we firmly believe will drive the necessary changes to continue to deliver long-term shareholder value. +First, we're streamlining and simplifying our operating model in order to speed decision-making and enhance our local market focus to drive growth. This work is moving forward aggressively and we expect to focus the role for our corporate center and further scale our back office to support processes and policies globally. +This will also enable our local operations to focus intently on demand creation in their individual markets. As previously announced, we're revising our long-term incentive metrics to provide a clear line of sight between our employees around the globe and the metrics they can best influence. +Second, we will drive efficiency through aggressively expanding our productivity program. We plan to expand the program from $1 billion in savings by 2016 to $2 billion in annualized savings by 2017 and $3 billion by 2019. This productivity program will build on previous successful programs encompassing our entire spend base and will supplant our existing plan announced earlier this year. +A number of actions are already taking place. We're restructuring our global supply chain, including optimizing our manufacturing footprint in North America and investing in technology to further streamline our operations. +We're implementing zero-based budgeting across our organization and aggressively prioritizing and redesigning our normal activities to further reduce costs. As I previously mentioned, we're streamlining and simplifying our operating model, which will enhance our speed and agility and result in lower operating expenses over time. +Finally, we're working on to drive even more discipline and efficiency in our direct marketing investments. As a result of these initiatives, we plan to fund the marketing programs and innovation required to reinvigorate and deliver sustainable net revenue growth. At the same time, we expect these actions will drive margin expansion and increase return on invested capital over time. +Our third action is to refocus on our core business model of building the world's greatest beverage brands and leading an unmatched global system of strong local bottling partners. In North America, we have a clear and definitive plan to refranchise the majority of our Company-owned bottling territories by the end of 2017. So at that time, we will retain approximately 1/3 of the total bottler-distributed volume in North America. +With respect to the remaining territories, our intent is to ensure the bulk of these are refranchised at the latest by 2020. Finally, outside of North America, we will continue to pursue opportunities to refranchise other Company-owned bottlers where it makes sense, where the business is ready, and where we have able and willing partners. +Fourth, we will drive disciplined brand and growth investments with a long-term view across both sparkling and still categories. We will take a balanced approach to ensure we can build our business while consistently delivering bottom-line results. +In sparkling, as outlined earlier this year, we will continue to work to improve the quality of our marketing and scale our global investments through a network marketing model to improve top line growth across trademark Coca-Cola, Fanta, and Sprite. +During the second quarter of this year, we began to step up our media investments. Our investments target markets and categories where our current media is underfunded relative to the market opportunity we see, as well as where we have the right price package architecture, and finally, of course, execution alignment with our bottlers. +In still beverages, we will continue to invest in our core growth priorities where we are a leader in notably juice and juice drinks and enhanced hydration. We will expand our investments in selected profitable categories where we believe we can capture value, such as value added dairy. +And we will continue to leverage our partnership model with companies such as Keurig Green Mountain, Monster, and FairLife, as well as targeted M&A to enhance our growth in key categories. We expect these efforts to build on our global leadership in still beverages and accelerate growth over time. +Fifth, we will drive revenue and profit growth across our markets with a further focus on geographic segmentation, recognizing that each market has an important role to play within our portfolio. We've targeted our markets with clear roles to drive top line growth with some markets focused on price, others on volume, and the remainder on a balance of the two. Beginning 2015, our incentive metrics will be expanded to include revenue growth and will be tied to these clear portfolio roles. +We're confident that the actions we're announcing today will ensure that the Coca-Cola Company is best positioned to capture growth in nonalcoholic beverages and continues to deliver long-term value to our shareholders. Since its inception, our 2020 vision has served to focus our system on the opportunity and to align on a common set of strategies. We began the process of evolving our 2020 vision with our bottlers earlier this year; a process that will continue over the coming months. +Together, we remain confident in the growth potential for nonalcoholic beverages. While growth rates will be challenging in the short term given the macroeconomic volatility, we believe that, over time, consumer trends will support mid-single digit revenue growth. Importantly, the core sparkling category remains resilient and has grown retail value globally for the first nine months of the year; 3% outpacing the nonalcoholic ready to drink industries total value growth of 2%. +And we also see effective profitable growth opportunities in still beverages: ones that we are well-positioned to take advantage of, but ones that require faster action and greater and focused investments. While we have more work to do here, it is clear that our 2020 vision will remain focused on delivering value growth for our systems ahead of the industry. Importantly, the goal of doubling system revenues is one our system can always aspire towards, but it is not a goal to be pursued at any cost over a fixed timeframe and we are realigning our expectations based on where we are today and the outlook for our industry. +Let me be clear. We see no change to our long-term target of high single-digit comparable currency-neutral EPS growth. We're updating our net revenue growth target to mid-single digit growth in order to reflect current reality, including the increased contribution from our new partnership model, which will impact equity income rather than flowing through net revenues and operating income. +And we're evolving our primary profit metric from operating income to profit before tax. Going forward, the profit before tax target will be 6% to 8% on a comparable currency-neutral basis consistent with the previous operating income target of 6% to 8%. With that said, we must also be realistic. While we are very confident in our actions, we are cautious in our outlook. +The actions announced today and the additional work we have to do will take time to implement and deliver improvement in our results. As such, we expect to be below our long-term EPS growth target for 2014 on a full-year basis. +We will come back to you with more context in December. However, we see 2015 as a critical year; a year in transition as we flawlessly implement our new operating model amidst a continued challenging macroeconomic environment. +I'm confident, however, that we have the brands, the greatest and most wide-reaching consumer product distribution system in the world, the critical partnerships, and most importantly, the people to return us to a more robust growth trajectory. +I'll now hand the call over to our Chief Financial Officer, Kathy Waller, who will provide you with a more detailed look at our financial performance, as well as an outlook on our business for the balance of the year. Following Kathy's prepared remarks, Irial Finan, Sandy Douglas, Ahmet Bozer, Kathy, and I will participate in our question-and-answer session to address any questions that you may have today. Kathy? + +-------------------------------------------------------------------------------- +Kathy Waller, The Coca-Cola Company - CFO [4] +-------------------------------------------------------------------------------- + + Thank you, Muhtar, and good morning, everyone. In recognition of our time, I plan to cover key highlights from the quarter and outlook and then we can move to your questions. +Let's start by reviewing a few key drivers of our financial performance. After adjusting for unit cases without concentrate sales equivalents, concentrate sales were in line with unit case sales for both the quarter and year-to-date. +Comparable currency-neutral net revenue growth was 1% in the quarter and 2% year-to-date, after excluding the impact of structural items. Our top line growth slowed from the first half of the year, due primarily to a volume deceleration, principally in Europe and China. +Price mix was positive across each of our geographies, with the exception of Asia-Pacific, due to geographic mix. However, due to the composition of growth, we saw a negative geographic mix at the consolidated level, resulting in 1% global price mix for both the quarter and year-to-date. +Comparable currency-neutral gross profit was up 4% in both the quarter and year-to-date after excluding the impact of structural items. Our gross margin expanded in the quarter due to pricing, favorable geographic and product mix, and a slight tailwind from commodity costs. We generated 1 point of operating leverage in the quarter as continued investments behind our brands to accelerate growth, including a mid-single digit increase in DME, were offset by tight control over operating expenses and the reversal of certain expenses related to our long-term incentive plan. +Comparable currency-neutral operating income was up 5% in both the quarter and year-to-date after excluding the impact of structural items. The impact of currency was a 3 point headwind on this quarter's comparable operating income results. Comparable EPS was even in the third quarter, including a currency headwind of 6 points. +Although the currency headwind at operating income was in line with the outlook we provided last quarter, foreign currency unfavorably impacted EPS by 6 points due to additional currency headwinds related to remeasurement gains and losses recorded in the line item other income. We generated $8 billion in cash from operations year-to-date and returned $1.9 billion to shareowners through net share repurchases. +As we look ahead to the fourth quarter of 2014, let me take a minute to update you on a few outlook items as you model our business. We do not expect the current trajectory for unit case volume growth to improve materially for the remainder of the year. We expect structural items to be a 1 to 2 point drag on net revenue growth and an approximate 2 point drag on operating income growth in the fourth quarter of 2014. +After considering our hedge positions, current spot rates, and the cycling of our prior-year rates, we now expect a 7 point currency headwind on operating income during the fourth quarter of 2014, with a 6 point impact on operating income for the full year 2014. We expect net interest income to be approximately $100 million for the full year 2014. +We now expect approximately $2.5 billion in net share repurchases for the year. And we now expect our full-year comparable currency-neutral EPS growth to be below our long-term targets. +As we look ahead to 2015, we anticipate continued challenging macroeconomic conditions in most developed markets, as well as some key emerging markets. The best way to think about 2015 is as a year of transition. We will start implementing changes to create our new operating model in the beginning of 2015, but incremental marketing investments and margin enhancements will take time to fully materialize. +Therefore, based on what we see today with our continuing need to invest in our business and recognizing that we are early in our planning process, we do not expect our comparable currency-neutral financial performance in 2015 to differ significantly from this year. As we move through our planning process, we look forward to providing more details and a methodology to benchmark our progress through 2015 and beyond. As such, we plan to host a modeling call in December to discuss our 2015 outlook, including further details of the impact from our refranchising efforts in North America. +However, given the amount of questions around currency for next year, we did want to provide an initial estimate of the impact at the PBT line to better help you model into next year. We currently expect a mid-single digit currency headwind on profit before tax in 2015. We will come back with more context on the December call. +As Muhtar said, we are committed to taking the right actions to reinvigorate our top line growth over time. We have a strong plan in place and we are aligned as a team to deliver against our objectives. +Operator, we are now ready for questions. + + +================================================================================ +Questions and Answers +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) +Bryan Spillane, Bank of America. + +-------------------------------------------------------------------------------- +Bryan Spillane, BofA Merrill Lynch - Analyst [2] +-------------------------------------------------------------------------------- + + There's a lot of questions that could be asked, but I guess one that I wanted to focus in on is the change in target from focusing on operating profit growth to pretax income. It sort of suggests that there's a contribution that will come from growth in equity income. Can you just give us some sort of gauge in terms of how much of the growth you actually expect to come from equity income? How much comes from operating profit? Just trying to get an idea of the proportions and whether or not there's actually a suggestion that operating profit would glow grow slower than that in that goal? + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Company - Chairman & CEO [3] +-------------------------------------------------------------------------------- + + Yes. Bryan, good morning, again, this is Muhtar. I think the most important is that our EPS target remains high single-digits and our target for profit before tax is still 6% to 8%. Beginning in 2015, revenue growth will be added as a metric in the Company's incentive plans as well. So we're obviously looking at a metric, really, where the target remains 6% to 8% and moving the target to PBT really brings net interest and equity income into consideration. If you look back at the last three years, there really has not been a leverage between OI and PBT, meaningfully so. It would not have really made a difference. +Having said that, it does go back to what we said about broadening our long-term net revenue target to mid-single digits. We think that there's opportunity to grow equity income as we advance our existing partnerships, as well as explore similar models in the future. Using PBT instead of OI should make operations, in a way, agnostic in terms of evaluating alternatives to extract value in a certain given category; for example, what you mentioned also, which is partnership model versus concentrate model. So I think it's a better broadened way of ensuring that we can deliver long-term sustainable value to our shareowners. And I'll pass it on to Kathy if she wants to add anything. + +-------------------------------------------------------------------------------- +Kathy Waller, The Coca-Cola Company - CFO [4] +-------------------------------------------------------------------------------- + + I'd just also say, Bryan, remember we anticipate and we've been saying that with the increases in interest rates, we will have interest expense versus interest income that we've been generating. So we don't anticipate interest providing leverage below the line going forward. So the bottom line is we can't make the 6% to 8% PBT without a significant amount coming from operating income. + +-------------------------------------------------------------------------------- +Bryan Spillane, BofA Merrill Lynch - Analyst [5] +-------------------------------------------------------------------------------- + + Okay. So no suggestion that there was a material change in operating income growth, it's just trying to collect the other pieces below that? + +-------------------------------------------------------------------------------- +Kathy Waller, The Coca-Cola Company - CFO [6] +-------------------------------------------------------------------------------- + + No. Not at all. + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Company - Chairman & CEO [7] +-------------------------------------------------------------------------------- + + No suggestion in any respect. + +-------------------------------------------------------------------------------- +Bryan Spillane, BofA Merrill Lynch - Analyst [8] +-------------------------------------------------------------------------------- + + Okay. Thank you. + +-------------------------------------------------------------------------------- +Operator [9] +-------------------------------------------------------------------------------- + + Ian Shackleton, Nomura. + +-------------------------------------------------------------------------------- +Ian Shackleton, Nomura - Analyst [10] +-------------------------------------------------------------------------------- + + Previously, you'd indicated on the $1 billion product due to savings that will be all reinvested in media. Perhaps you can give us some idea of how much of the $3 billion will be reinvested and also what the phasing of that will be through to 2019? It strikes me with the US production changes that's going to be quite back end-loaded in that timeframe. + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Company - Chairman & CEO [11] +-------------------------------------------------------------------------------- + + Hi, Ian. This is Muhtar. Good morning. Firstly, let me just give you some context around the base. If you take, firstly, that's why we put out two numbers out there, $2 billion by 2017 and $3 billion by 2019, in order to ensure that everyone sees that this is not back end-loaded, it's just a number that really will be generated and the run rate will be flowing through into our system and then we will invest some and use some for margin enhancement. We did say that it will take some time to achieve. +2015 is a critical year where we really -- it's the most important year for us to make the changes that I mentioned to you in terms of a leaner, better operating model and therefore, I think that year should be seen as a year in transition. The base, really, when you look at our Company, you see about $5.5 billion in total in marketing, about $4 billion in OpEx, and really, of the $3 billion, about $1.5 billion will come out of that base of around $9.5 billion to $10 billion and then the other $1.5 billion of the $3 billion will come out of the about $25 billion COGS base. +It's important to understand for everyone that we will not be taking down the second number, $1.5 billion, when we refranchise with our aggressive refranchising program, particularly for the United States, between now and 2017. So that number will stay that way and then the bottlers will get additional opportunities for COGS synergies as the territories get refranchised on top of the $3 billion. So I hope that gives you some flavor and explanation into and answers some of your questions. Kathy, go ahead. + +-------------------------------------------------------------------------------- +Kathy Waller, The Coca-Cola Company - CFO [12] +-------------------------------------------------------------------------------- + + Ian, if I could just add, on the initial $1 billion program, $400 million was in 2014 and we are on track. So it continues into 2015 with the rest of the productivity giving us the flexibility to achieve our targets over the long-term. + +-------------------------------------------------------------------------------- +Ian Shackleton, Nomura - Analyst [13] +-------------------------------------------------------------------------------- + + If I could come back on the 2015 guide, which obviously looks quite bearish versus where the Street is, you seem to be highlighting there's going to be quite a lot of extra costs there without savings. Is it also a comment that you're quite cautious around revenue growth, i.e., you seem to be implying it will be in more in line with 2014, which is more like a 2%, not a 3%-plus. Is that right? + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Company - Chairman & CEO [14] +-------------------------------------------------------------------------------- + + Yes, I think given the macroeconomic volatility out there and given the fact that marketing investments are taking some time to flowback in terms of benefit, I'd just say that's the best we see right now and we will come back with a more robust and more detailed discussion on 2015 in our December call. + +-------------------------------------------------------------------------------- +Ian Shackleton, Nomura - Analyst [15] +-------------------------------------------------------------------------------- + + Okay. Thanks very much. + +-------------------------------------------------------------------------------- +Operator [16] +-------------------------------------------------------------------------------- + + Ali Dibadj, Bernstein. + +-------------------------------------------------------------------------------- +Ali Dibadj, Sanford C. Bernstein & Company, Inc. - Analyst [17] +-------------------------------------------------------------------------------- + + I think we're generally pleased that there's more urgency around price mix and North American [franchisement] and the cost-cutting. But I do want to understand a little bit better how much of the cost cutting you think you're going to need to reinvest and really, why you think you have to reinvest? And I say that because you're going to reinvest something and I want to hear what, but you're only going to get back to your previous growth rates, but this whole time, a lot of the discussion is about blaming mostly short-term macro issues. +So is there something that's underlyingly falling worse, e.g., perhaps consumer trends toward health and wellness or something? And in fact, is it a good ROI to reinvest in the business in marketing versus taking some to the bottom line and to shareholders who have been rather disappointed recently? So any help there would be great. + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Company - Chairman & CEO [18] +-------------------------------------------------------------------------------- + + Yes, Ali. I think what we're talking about is a balanced approach that will bring us back to our long-term growth trajectory in terms of our financial performance. That is a combination of both growth, more realistic and better sustainable growth on the top line, as well as margin enhancements. So as we said before, this additional program of productivity will yield, will generate two things: we believe clearly better growth, as well as better margin enhancements. +The important thing here is that we will have a much better geographic segmented analysis of countries where, if you take the developed countries, we will be driving profitable growth through innovation and productivity; for example, with countries like Spain, Korea, Great Britain, Japan, US, France, and so forth. And then in terms of the developing countries, they will have a slightly different role maximizing value through segmentation and ensuring that we continue to build consumer loyalty markets like Latin America, Turkey, Poland, Nigeria. And in emerging markets like China, India, Indonesia, Thailand, and so forth, we'll be maximizing more skewed on the volume side and investing for accelerated growth. +That is why we believe we need to continue to invest and the world is a very big place. It's not just the countries that we live in and we know. It's a very wide place out there and there is significant opportunities to continue to generate growth, while at the same time -- and we believe that there is a very good line of sight of how we invest and how we get return from that investment, very disciplined and very important transparent line of sight. +That's the way we look at the segmentation approach and therefore, revenue, which is the target of what we've indicated to you will be a composition of volume and price and so we're not throwing volume out of the door. It's a very balanced approach towards how we will generate revenue, how that revenue will flow into bottom line, both through the additional revenue growth achieved, as well as through enhancements in terms of the margin. + +-------------------------------------------------------------------------------- +Ali Dibadj, Sanford C. Bernstein & Company, Inc. - Analyst [19] +-------------------------------------------------------------------------------- + + So that's very helpful. In terms of the clear line of sight, can you give us a sense of, this $3 billion, is it half reinvested, half of the bottom line? Is it 60/40? Can you give us a better sense of the split of reinvestment versus bringing it back to the bottom line? + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Company - Chairman & CEO [20] +-------------------------------------------------------------------------------- + + Yes. I think we're not ready to share that detail with you right now. However, I think as we go along, we'll give you more insights. But certainly, it will not all be invested and it will not all flow into the bottom line, but I think we see a clear balance there as we go forward. And I think there's a different role -- obviously, there's a different role of how you should think about the $1.5 billion that is coming out of the base of total marketing and OpEx and also the $1.5 billion that is coming out of the COGS and I think both of them have slightly different roles in how they will be played out. + +-------------------------------------------------------------------------------- +Ali Dibadj, Sanford C. Bernstein & Company, Inc. - Analyst [21] +-------------------------------------------------------------------------------- + + Okay. Thanks very much. + +-------------------------------------------------------------------------------- +Operator [22] +-------------------------------------------------------------------------------- + + Dara Mohsenian, Morgan Stanley. + +-------------------------------------------------------------------------------- +Dara Mohsenian, Morgan Stanley - Analyst [23] +-------------------------------------------------------------------------------- + + Muhtar, I wanted to delve a bit more into the changes in price mix versus volume focus and the incentive plans. I'm assuming the enhanced pricing focus is more of a developed market phenomenon, but maybe you can review for us how much of the change in focus going forward is in developed markets versus emerging markets versus how you managed previously? Then in North America, has this enhanced pricing focus all ready played out to some extent, given you've already had compensation changes there or should we expect North America to be part of that change in focus going forward also? + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Company - Chairman & CEO [24] +-------------------------------------------------------------------------------- + + I think you should think of the entire Company as evolving and changing. But as I said, Dara, I think the important thing is roles and responsibilities on a geographic basis with complete clarity of roles. So if you take the markets like -- the more developed markets of Korea and Spain and Great Britain and so forth, Japan and United States, Canada, more focused on the balance of revenue. What will drive the revenue? Slightly skewed in favor of price versus volume. +What will happen in the developing markets, more like Latin America and some Eastern European markets, and so forth, Turkey, much more straight line, right in the middle balance of how that revenue number is going to be generated, that revenue growth target is going to be generated. Then you take the lower per capita, more emerging markets that I mentioned, of the Indonesias and Indias and Chinas of this world and Southeast Asia as skewed more towards volume. But that doesn't mean that there's not a pricing metric and that doesn't mean there's no incentives based on revenue. It's just how they're skewed. + +-------------------------------------------------------------------------------- +Dara Mohsenian, Morgan Stanley - Analyst [25] +-------------------------------------------------------------------------------- + + Okay. That's helpful. While we're on the subject of pricing, can you characterize the pricing environment right now in North America? Obviously, the 3% sparkling number in the quarter was more favorable than you've seen recently, so I wanted to get an update there on how sustainable that performance could be going forward. + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Company - Chairman & CEO [26] +-------------------------------------------------------------------------------- + + I'll ask Sandy to comment on that North America number. Sandy and Irial are here and I'll ask Sandy to first comment on that. + +-------------------------------------------------------------------------------- +Sandy Douglas, The Coca-Cola Company - SVP & Global Chief Customer Officer [27] +-------------------------------------------------------------------------------- + + Yes, Dara, our view of the pricing strategy in the US is being very consistent with what we said at the beginning of the year. Very focused on making sure that we get our price, that we balance that with a package strategy that's focused on our premium packs and our smaller packs, which consumers want, and continue to grow double digits. We're pleased, as you can see in the Nielsen data and the marketplace, the consumer's responding with accelerating sales growth. Actual volume was slightly better than we expected and clearly the volume on the premium packs that are the focus of our brand building agenda and supported by our advertising are driving the train. We're just at the beginning, though. +I think North America's ability to play a primary revenue growth role in the Company with this disciplined balanced strategy is in the early stages and we see a rational environment and we see a good competitive environment in which the category sales performance is accelerating and we're optimistic about the future. + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Company - Chairman & CEO [28] +-------------------------------------------------------------------------------- + + Irial, do you want to add to that? + +-------------------------------------------------------------------------------- +Irial Finan, The Coca-Cola Company - EVP & President Bottling Investments Group [29] +-------------------------------------------------------------------------------- + + Yes, I'd just remind all of us, in the first quarter, we said we were going to have a very disciplined approach to pricing in North America and the last three quarters we've demonstrated that and the intention is to keep doing it. We feel good about it. We feel we're going the right direction and feel very confident as we actually head into the future on pricing in North America. + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Company - Chairman & CEO [30] +-------------------------------------------------------------------------------- + + Yes. Maybe I'll ask Ahmet to comment also on the same subject as it pertains to Europe and as it pertains to Latin America and some other markets. Ahmet? + +-------------------------------------------------------------------------------- +Ahmet Bozer, The Coca-Cola Company - EVP & President Coca-Cola International [31] +-------------------------------------------------------------------------------- + + Thanks, Muhtar. As we talk about the revenue focus, we are also focusing on balanced revenue growth in Coke International. Maybe a couple of examples I could share is in Mexico for example, where you see 2% growth in volumes for the quarter and more or less flat volumes, we're actually seeing fairly healthy price mix of about low to mid-single digits and our revenue growth reflects that as well. Likewise in Brazil, we're also seeing mid-single digit revenue growth, even though our volumes are up only 1%. We are quite cognizant of balancing our revenue growth with appropriate pricing realization and volume at the same time. + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Company - Chairman & CEO [32] +-------------------------------------------------------------------------------- + + Do you want to say anything about Europe? + +-------------------------------------------------------------------------------- +Irial Finan, The Coca-Cola Company - EVP & President Bottling Investments Group [33] +-------------------------------------------------------------------------------- + + And in Europe, obviously we are not pleased with our volume performance of negative 5%, but the challenging macros are bringing with it a fairly aggressive pricing environment in the marketplace. We are always trying to balance our pricing with volume. In this quarter, I would say that we were a lot more in favor of pricing where we have realized 3 points of price mix in Europe, which resulted in a revenue decline of 2%, while our volumes were 5%. +Having said that, this is a journey and an ongoing balancing act. We would be focusing on balancing that a little bit better so that our share performance continues to be strong, which it has been for the last four years, and we are on that journey in Europe. + +-------------------------------------------------------------------------------- +Dara Mohsenian, Morgan Stanley - Analyst [34] +-------------------------------------------------------------------------------- + + Great. Thanks. + +-------------------------------------------------------------------------------- +Operator [35] +-------------------------------------------------------------------------------- + + Bill Schmitz, Deutsche Bank. + +-------------------------------------------------------------------------------- +Bill Schmitz, Deutsche Bank - Analyst [36] +-------------------------------------------------------------------------------- + + Can you just comment on how much you know, relative to the environment, what's secular and what's cyclical and then how your strategy changes if it's more secular than cyclical in terms of some of the consumption trends? Obviously, Muhtar, you have considerable experience here. Has there been a period where you've seen things as difficult as they are now and what it took to pull yourselves out of it? + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Company - Chairman & CEO [37] +-------------------------------------------------------------------------------- + + I think, Bill, firstly, it's fair to say that we are in a challenged disposable income growth environment. That's no question. The consumer is challenged everywhere around the world. It's not just related to the Western developed markets of Europe and Japan and United States and Canada, but it's also related to emerging markets. There's a lot of volatility in the world when you look at in the currencies, when you look at interest rates, when you look at the growth rates, and when you actually factor in all the different geopolitical issues around the world. There just is a lot of apprehension. +Less people traveling because of disease, because of scares, because of other things, mobility is down and traffic is down and that all impacts, particularly, our immediate consumption business. So we've got to find newer, better ways to ensure that our products, our brands, our 3,000 products, 550 brands can meet up with consumers on different occasions, on better occasions, on newer occasions, and on more innovative ways to get our products in front of our consumers. Certainly, we recognize that, that is a challenging environment. We operate in that environment, but we have still one of the most dynamic consumer goods businesses in the world. +We believe that it can still, over time, grow at the rate that we have just outlined to you in terms of revenue growth. Is that going to happen overnight? No. Can we get there? Absolutely, yes. Then we have other elements to deal with in terms of trends. So we recognize that we have to do more work on diets and lights, for example. We continue to innovate. We continue to launch new products which have different sweeteners and different sweetener bases. That will continue in an expanded mode: more innovation, more packaging, and newer ways for consumers to connect. +Next year is the 100th year of the contour and we certainly will be expanding our IC focus -- our immediate consumption focus in the market, which is a really important way to build habit and build trends and build [team incidents] and then improve our marketing and improve our commercial strategies with our bottlers, which we keep working at. So that's where we are. It is a very challenging environment anywhere you go around the world. It's not different. +Everyone is apprehensive, whether it's governments, whether it's NGOs, whether it's businesses, local businesses and International businesses. I don't see that improving overnight, but I think it's the new normal. In that new normal, we need to generate better growth. + +-------------------------------------------------------------------------------- +Bill Schmitz, Deutsche Bank - Analyst [38] +-------------------------------------------------------------------------------- + + Great. Thanks. Kathy, just one quick one: the share repurchase went from a range of $2.5 billion to $3 billion, now it's at the lower end of the range. Is there any read through on that, in why you guys took it down? I know it's not hugely substantial. + +-------------------------------------------------------------------------------- +Kathy Waller, The Coca-Cola Company - CFO [39] +-------------------------------------------------------------------------------- + + No. No specific read through. I would just say that given where we are right now, this is the guidance we thought we should provide at this time. + +-------------------------------------------------------------------------------- +Bill Schmitz, Deutsche Bank - Analyst [40] +-------------------------------------------------------------------------------- + + Okay, but is cash flow coming in softer? I'm just trying to figure out why it would come down if there's no change in the cash flow algorithm. + +-------------------------------------------------------------------------------- +Kathy Waller, The Coca-Cola Company - CFO [41] +-------------------------------------------------------------------------------- + + We did give a different outlook on currency, which does impact cash. + +-------------------------------------------------------------------------------- +Bill Schmitz, Deutsche Bank - Analyst [42] +-------------------------------------------------------------------------------- + + Okay. Great. Thank you. + +-------------------------------------------------------------------------------- +Operator [43] +-------------------------------------------------------------------------------- + + Michael Steib, Credit Suisse. + +-------------------------------------------------------------------------------- +Michael Steib, Credit Suisse - Analyst [44] +-------------------------------------------------------------------------------- + + I was hoping you could provide us with some more detail regarding the restructuring of your North American manufacturing footprint as one of the areas of the productivity program you talked about earlier? What's the scope of that program? What are the milestones that we should be looking for? How does that tie in with your commitment to refranchise the bulk of your territories by 2017? + +-------------------------------------------------------------------------------- +Irial Finan, The Coca-Cola Company - EVP & President Bottling Investments Group [45] +-------------------------------------------------------------------------------- + + It's Irial. On the supply chain in North America, basically this is a continuation of what started a few years ago and it's made up of many different aspects, which we'll share in due course, as Kathy has already said and Muhtar. But the key is that we're looking at becoming more effective and more efficient. We have a very substantial supply chain footprint and we believe and have the plans to make sure we become truly efficient and that means by streamlining in many different ways. +Simple illustrations are things like the bottle life weighting, which is pretty well carried out across the world today, whether it's mechanizing at different parts of our supply-chain, whether it's our footprint, our supply chain and so forth. So many different aspects, but very clear plans behind it and a high degree of confidence that we will achieve the synergies that we've set out. + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Company - Chairman & CEO [46] +-------------------------------------------------------------------------------- + + On that, once again, I wanted to reiterate the point that I made earlier, this is Muhtar, that of the $2 billion by 2017 and the $3 billion by 2019, the incremental synergy program, that is not going down as we substantially refranchise our business in North America. + +-------------------------------------------------------------------------------- +Operator [47] +-------------------------------------------------------------------------------- + + Judy Hong, Goldman Sachs. + +-------------------------------------------------------------------------------- +Judy Hong, Goldman Sachs - Analyst [48] +-------------------------------------------------------------------------------- + + First question is just relating to, really, the new operating model that you're planning to implement. I'm just hoping to get a little bit more clarity around exactly what you're doing to change the operating model, both more at the business unit level and maybe even at the country level? Is this something that gets rolled out globally or does this have a phasing of how it gets rolled out? I know that you really have been emphasizing patience and just taking time to implement these changes, but just wanted to get a little bit better sense of what takes longer? What can be implemented more quickly and where can we see the benefit to some of the changes more quickly? + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Company - Chairman & CEO [49] +-------------------------------------------------------------------------------- + + Judy, this is Muhtar. Good morning. Yes, we are streamlining and simplifying our operating model for better speed, better decision-making and enhanced, also, local market focus that will help us to drive better growth. This work is moving forward aggressively. It's global. It involves a center and involves the entire Company and we expect to refocus the role for our corporate center and further scale our back-office to support our processes and also policies on a global basis to get more synergies there and better service to our business units that operate around the world that basically make up the Coca-Cola Company. +This will enable those operations to fully focus intently on demand creation in their market. So this is really important. It's a delayered organization. It is a simplified organization. It's less touch points, it's faster decision-making and that will take place, starting with the beginning of the year and you'll hear more about that in the coming weeks. So that's important. +I think it's important, if I just take back a minute and just to say again, this is certainly a difficult operating environment and that is clear. No question about that. But today, we're announcing, I believe, definitive actions as a team to address that environment and improve our execution. The $3 billion in synergy enhancements are an added layer and an added layer of segmented analysis on top of the $3 billion in metrics on a market-by-market basis is clear evidence, I think, of us taking action to control, in a way, what we can control. I'm so pleased that we have a team that has basically worked together for a long time and we know what it takes to win. Today, we are taking essentially additional steps to get us back on track over the longer term and we will do whatever we have to do to get there to get us to that bridge. +We know it can be done and we know we will do it. I think the synergy program will help, the new operating model will help, the enhanced execution will help, the better marketing will help, and the improved commercial strategy will help along those lines. Is the operating environment tough? It is tough. But we are fortunate to be in a business that is one of the most dynamic businesses in the world; the nonalcoholic, ready to drink business. And so that's what I would leave you with. + +-------------------------------------------------------------------------------- +Judy Hong, Goldman Sachs - Analyst [50] +-------------------------------------------------------------------------------- + + Okay. If I could follow-up, Ahmet, the two markets, where, obviously the volume was very challenged were Europe and China, which presumably had both the weather impact, as well as the macro impact. So if you can give us a little bit of color just in terms of how much you think the weather did play a role? It sounded like in the fourth quarter, you really are not anticipating much improvement, globally, from a volume perspective. Is the weakness expected in these two markets primarily or are there other markets that you think could potentially be weaker or more volatile as you get into the fourth quarter? + +-------------------------------------------------------------------------------- +Ahmet Bozer, The Coca-Cola Company - EVP & President Coca-Cola International [51] +-------------------------------------------------------------------------------- + + Thanks, Judy. We don't like to talk about weather too much in this, but I would say there was probably not so favorable weather. You mentioned the macros. Let me start with China. You could see from the numbers in China that total food and beverage industry, NARTD industry is actually under pressure and the growth rates are coming down. But I'm very pleased with our performance in China because now we see a lot of traction on sparkling beverages, which actually grew in the quarter. Trademark Coke was up 4% in China, which shows that the strategy that we have shared with you all, beginning of the middle of last year, of segmented focus of our beverages in China is actually working. +We're very pleased with our new launches of the isotonics. That's doing very well. Very pleased with our innovations in sparkling with things like Schweppes C'Plus. So for China, I'm very pleased with the results and we're gaining share and our initiatives are working for us. +When it comes to Europe, I have shared with you all a little earlier, it is more a matter of balancing our price realization and volume a little bit more in the favor of volume and share, still realizing good price mix. I would say other than that, Europe performance was mostly to do with the macros and you've mentioned weather. I will not. + +-------------------------------------------------------------------------------- +Judy Hong, Goldman Sachs - Analyst [52] +-------------------------------------------------------------------------------- + + Got it. Okay. Thank you. + +-------------------------------------------------------------------------------- +Operator [53] +-------------------------------------------------------------------------------- + + John Faucher, JPMorgan. + +-------------------------------------------------------------------------------- +John Faucher, JPMorgan - Analyst [54] +-------------------------------------------------------------------------------- + + A couple of questions here. One on the change to the long-term algorithm: you talked about NARTD growth being more mid-single digits going forward. Going back to Bill Schmitz' question, is that going down permanently from the 6% number that you guys had put out there before or are you structurally calling for lower category growth? +Then the second question I had related to the restructuring program -- I guess two questions on this. First, is it the macros? Is it the lower structural growth of the category that's causing you to up this just eight months after your last program? And then a clarification on the numbers which is, part of the savings program announced in February related to not necessarily productivity, but more efficient spending? Is there any of that's built into this new $2 billion? Thanks. + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Company - Chairman & CEO [55] +-------------------------------------------------------------------------------- + + John, this is Muhtar. When you look at the current revenue figure that we've put out there, if you take the midpoint of that, it's only 50 basis points different than what was out there before earlier. So I don't see that as a major difference in terms of the category, in terms of the cyclical long-term macroeconomic. I think we see tremendous opportunity in this segment, in this very dynamic consumer goods industry. So I see that's not any major shift. We've been pleased with productivity in terms of what we've done to date. Macros have not improved and so we have to do what we need to do in order to ensure that we can cross the bridge and get to better both top line growth, as well as bottom line delivery of performance and that's what you see us doing right now. +In the past, you would have cycles in macro, you would have a year or two years of down and then coming back up and now it's constant volatility and actually increased volatility every day around the world and increased apprehension by the consumer. So we have to do more. We have to ensure that we create the flexibility to deliver our results and that's what you see us doing. + +-------------------------------------------------------------------------------- +John Faucher, JPMorgan - Analyst [56] +-------------------------------------------------------------------------------- + + Got it. Again, just a clarification on the reallocation versus what we would view as incremental cost saves. Any color on that? + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Company - Chairman & CEO [57] +-------------------------------------------------------------------------------- + + Kathy, you want to add anything in terms of investment, in terms of the efficiency, what John talked about? + +-------------------------------------------------------------------------------- +Kathy Waller, The Coca-Cola Company - CFO [58] +-------------------------------------------------------------------------------- + + Sure, Muhtar. First of all, going back to the first question around the net revenue, the two things that are primarily driving the change would be the value growth that we see coming from emerging markets, as well as the more volatile nature of the emerging markets and then recognition that our partnership models will drive value for the business that will impact equity income. So I just wanted to add that particular point. Then on the productivity -- sorry, I don't remember the productivity question. What was the question? + +-------------------------------------------------------------------------------- +John Faucher, JPMorgan - Analyst [59] +-------------------------------------------------------------------------------- + + What I was asking is, if I remember correctly, the February productivity program included some true productivity and then some sort of reallocation of spending to more efficient methods. I'm asking is there any of that also built into the incremental $2 billion from today? + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Company - Chairman & CEO [60] +-------------------------------------------------------------------------------- + + Yes. There actually is, John. What we have done in the past is we've said that productivity, the original $1 billion is made up of both OpEx as well as reallocation of marketing to ensure that marketing is more effective and more efficient in terms of its delivery of results. So that is an ongoing program that we have in terms of how we will continue to reallocate marketing to drive better value and better return. That is there. That is ongoing. +However, of course, the scale of what we're doing in terms of OpEx flexibility is going to be much, much bigger here, but the vast majority of the additional savings program is hard savings in productivity. The vast majority is hard savings as opposed to reallocation. We will ensure that the amount of money that's invested has a return. That's a different answer, but we will make -- it is actually, I'd say, the vast majority, in fact, is hard savings. + +-------------------------------------------------------------------------------- +John Faucher, JPMorgan - Analyst [61] +-------------------------------------------------------------------------------- + + Okay. Thank you very much. + +-------------------------------------------------------------------------------- +Operator [62] +-------------------------------------------------------------------------------- + + Mark Swartzberg, Stifel Nicholas. + +-------------------------------------------------------------------------------- +Mark Swartzberg, Stifel Nicolaus - Analyst [63] +-------------------------------------------------------------------------------- + + Also on the subject of media and marketing spend, when all is said and done, Kathy or Muhtar, for calendar 2014, you mentioned a double-digit increase in media in the quarter. But when we look at the total marketing spend, how much do you think that'll be up when all is said and done for 2014? When we think about the comparatively lackluster 2015 you're talking about, how much of that is attributable to the rate of increase and marketing spend you're intending next year? + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Company - Chairman & CEO [64] +-------------------------------------------------------------------------------- + + When all is said and done I'd say probably, Mark, it will be about mid-single digits in 2014. I think we'll give you, again, in December, we'll come back and give you more flavor about how we're thinking of that in 2015 and beyond. + +-------------------------------------------------------------------------------- +Mark Swartzberg, Stifel Nicolaus - Analyst [65] +-------------------------------------------------------------------------------- + + Is there anything -- is it reasonable to assume it goes up at a faster rate in 2015 given the top line challenges? + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Company - Chairman & CEO [66] +-------------------------------------------------------------------------------- + + I wouldn't assume that. + +-------------------------------------------------------------------------------- +Mark Swartzberg, Stifel Nicolaus - Analyst [67] +-------------------------------------------------------------------------------- + + Okay. Just one point of clarification back on John's question, about the $3 billion, you mentioned, Muhtar, the vast majority being OpEx. Are you talking 80%, 70%, 90%? Can you give us some sense of that number? + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Company - Chairman & CEO [68] +-------------------------------------------------------------------------------- + + Look, I said the vast majority is hard savings in productivity programs and that is composed, as I mentioned earlier in answering another question, that is composed of a base of about $9.5 billion, $10 billion comprised of marketing and OpEx and then another base, which is driving about a $1.5 billion by 2019. The other half, $1.5 billion by 2019, is driven by COGS savings. But these are hard savings, not in terms of just soft or reallocations. + +-------------------------------------------------------------------------------- +Mark Swartzberg, Stifel Nicolaus - Analyst [69] +-------------------------------------------------------------------------------- + + Got it. Okay. Great. Thanks, Muhtar. + +-------------------------------------------------------------------------------- +Operator [70] +-------------------------------------------------------------------------------- + + Steve Powers, UBS. + +-------------------------------------------------------------------------------- +Steve Powers, UBS - Analyst [71] +-------------------------------------------------------------------------------- + + Two questions if I could: first, despite some disappointment in some quarters, from a strategic standpoint, this does seem like a fairly substantial change from where you were in July, strategically. Can you talk about the process that you went through internally to get here? Do you view these changes more reactive or proactive? To the extent that much of the work has been accelerated since midsummer, how confident are you that this is the right program? Why is $2 billion, for example, the right number and not $3 billion or some other figure? That's the first question. +Secondly, as you seem closer to a defined timeline for refranchisement in North America, can you help us dimension the financial terms and the economics of that activity? Just in broad brush strokes, acknowledging you'll probably cover more this in December, but do you anticipate refranchising to result in economic loss or gain versus your 2010 investments? How much dilution should we expect as we go forward through the program, again just in broad brush strokes? Thanks. + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Company - Chairman & CEO [72] +-------------------------------------------------------------------------------- + + This is Muhtar. First I think, based on the collective judgment of myself and my team, as I said to you, this is an acknowledgment of a continuing difficult operating environment and controlling and taking action to control what we can control. That will mean two things: create flexibility through the synergies and also ensure that we can enhance our margins and build a credible and sustainable revenue growth on the top line. That is the key here, which at this industry, lends us to believe and clearly, the history has shown that this industry is the most dynamic and it continues to be. +Therefore, we believe that when we segment our markets in the way we have segmented them, continue to ensure that we have the right metrics in place and the right incentives in place, that we will perform better. We're almost finished with this year and we're going to be embarking upon implementing this now so that we can start the year running. We will give you a very clear dashboard in December where you can -- with three or four things to follow you can judge our progress -- judge our progress as to how we're implementing and generating the results out of this program. That, to me, I think, is going to be key, following our progress and we will follow it and you will be able to follow it. +We'll give you that dashboard so that you can ensure that every quarter we can have a discussion on the key four or five elements of success on how we implement the new operating model, how we implement better marketing, how we implement better commercial strategies, and how that's impacting the top line and what impact that's having on margins. +As far as the North America franchising, I'll ask Sandy to comment on that. But, again, it's a clear timeline. First, by 2017 and then what we will have left is about one-third and then what we do with the rest is latest by 2020, again, finding the right home. Sandy? + +-------------------------------------------------------------------------------- +Sandy Douglas, The Coca-Cola Company - SVP & Global Chief Customer Officer [73] +-------------------------------------------------------------------------------- + + Sure, Steve, on North America refranchising, I go back to the objectives of the effort, which is to restructure a system that was in place for over 100 years to get it in better position for growth with better focused customer management, more efficient product supply, and back services and to refranchised to the best Coca-Cola bottlers in the United States under a new franchise agreement that is fit for purpose of growth. We are very optimistic about our ability to deliver that kind of growth profile and to do that in a way that makes our business more economic and makes our system more economic going forward. +So as we point to the December discussion that Kathy's going to lead, we'll have a number of the details that will help you model this going forward. But our strategic mission has not changed and our optimism for success in doing this with our bottlers is as high as ever. + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Company - Chairman & CEO [74] +-------------------------------------------------------------------------------- + + Thank you, Kathy, Ahmet, Sandy, Irial, and Tim. Despite gaining global value share, our year-to-date performance is not where it needs to be. The scope and pace of our actions have to increase and we're moving very quickly to streamline our operations and further align our incentives to drive revenue growth while simultaneously driving costs out of our business through an aggressive plan. +While the short-term macroeconomic environment remains challenging, we are confident in our ability to return to sustainable growth as the long-term dynamics of our industry remain promising. Our brands and our global system are unparalleled and we are all fully dedicated to strengthening our position as the world's leading beverage company. As always, we thank you for your interest, your investment in our Company, and for joining us this morning. + +-------------------------------------------------------------------------------- +Operator [75] +-------------------------------------------------------------------------------- + + Thank you and this does conclude today's conference. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/exam/original-files/Problem_2_3_Sample_full_transcripts/2015-Apr-14-JPM.N-137731590648-Transcript.txt b/exam/original-files/Problem_2_3_Sample_full_transcripts/2015-Apr-14-JPM.N-137731590648-Transcript.txt new file mode 100644 index 0000000..93cb868 --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_full_transcripts/2015-Apr-14-JPM.N-137731590648-Transcript.txt @@ -0,0 +1,705 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q1 2015 JPMorgan Chase & Co Earnings Call +04/14/2015 08:30 AM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Marianne Lake + JPMorgan Chase & Co. - CFO + * Jamie Dimon + JPMorgan Chase & Co. - Chairman & CEO + +================================================================================ +Conference Call Participiants +================================================================================ + + * John McDonald + Sanford C. Bernstein & Company, Inc. - Analyst + * Paul Miller + FBR & Co. - Analyst + * Erika Najarian + BofA Merrill Lynch - Analyst + * Eric Wasserstrom + Guggenheim Securities LLC - Analyst + * Steven Chubak + Nomura Asset Management - Analyst + * Gerard Cassidy + RBC Capital Markets - Analyst + * Jim Mitchell + Buckingham Research Group - Analyst + * Nancy Bush + NAB Research LLC - Analyst + * Glenn Schorr + Evercore ISI - Analyst + * Chris Spahr + CLSA Limited - Analyst + * Ken Usdin + Jefferies LLC - Analyst + * Matt O'Connor + Deutsche Bank - Analyst + * Brennan Hawken + UBS - Analyst + +================================================================================ +Presentation +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Good morning ladies and gentlemen. Welcome to JPMorgan Chase's first-quarter 2015 earnings call. This call is being recorded. +(Operator Instructions) +We will now go live to the presentation. Please stand by. +At this time I would like to turn the call over to JPMorgan Chase's Chairman and CEO Jamie Dimon and Chief Financial Officer Marianne Lake. Ms. Lake, please go ahead. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [2] +-------------------------------------------------------------------------------- + + Thanks, operator. Good morning everyone. I'm going to take you through the earnings presentation which is available on our website. +Please refer to the disclaimer regarding forward-looking statements at the back of the presentation. +So starting on page 1, the firm reported net income of $5.9 billion for the quarter and EPS of $1.45 a share and a return on tangible common equity of 14%. On revenue of nearly $25 billion, up 4% year on year reflecting strong performance. The quarter was characterized by a constructive environment supporting broad strength in underlying performance. +We saw higher levels of volatility and client activity on the back of a number of macro events driving higher markets revenues. We also saw strength across IBCs and core loan growth was strong up 10% year on year. +Included in the results was firm-wide legal expense of approximately $500 million after-tax. Outside of legal other small and notable items on a net basis did not contribute significantly to the result which means that a more core earnings number would have been well the other side of $6 billion. Adjusted expense which excludes legal was $14.2 billion, down $100 million from the fourth quarter with an adjusted overhead ratio of 57%. +And outside of a modest reserve bill for oil and gas which I will come back to credit trends remained benign and firm-wide net charge-offs remained low at $1.1 billion. We continued to make progress against our capital targets reaching a fully phased in CET1 ratio of 10.6% while returning over $3 billion to shareholders in the quarter. Finally we're pleased that we did not receive an objection to our capital plan and the Board announced its intention to increase the quarterly dividend by 10% to $0.44 a share and authorized gross share repurchases of $6.4 billion. +Before I move on you will notice we streamlined our earnings press release for the quarter, simplified the format and focused in on key messages. +Skipping over page 2, turning to page 3 and our balance sheet. As I said the firm's fully phased in CET1 ratio advanced with 10.6% up about 45 basis points quarter on quarter with earnings, model benefit and the combined impact of portfolio runoff and other RWA reductions being offset by capital distributions. The fully phased in standardized CET1 ratio was 10.8%, up from 10.5% in the fourth quarter of 2014. +While we made very good progress during the first quarter the pace of capital accretion during the year won't be linear particularly given the timing of model benefit. We continue to expect our ratio to be 11% plus or minus at the end of this year. The firm and the bank SLR improved slightly from last quarter at 5.7% and 6% respectively. +On the next page on page 4, we've added a new page on our balance sheet given the objectives we outlined at Investor Day on nonoperating deposits. So turn to page 4. As you look at the balance sheet it's important to look both on an average and on a spot basis. +If you look on the left our average balance sheet is higher by $46 billion which reflects a significant ramp up in deposits in the fourth quarter. But if you look next to that you can see on a spot basis that March is actually relatively flat to December. And if you move to the right end of the period deposits are also flat quarter on quarter but with a relatively significant mix shift towards retail deposits. +With other deposits down $24 billion predominantly driven by client actions related to nonoperating deposits reflecting good progress towards our goal in what has effectively been a matter of weeks since Investor Day. We're actively engaged with our clients and working with them to implement plans to further reduce these deposits and we expect the second quarter to be meaningful in this context. We're still committed to our goal of reducing them by up to $100 billion by the end of the year. +Moving on to NIM and NII it's the higher average cash balances on deposit growth as well as some asset reductions that drove the 7 basis point compression in NIM. And in terms of NII day count was a large driver of the decline. +Turning to page 5 and Consumer & Community Banking, the combined Consumer businesses generated $2.2 billion of net income for the quarter and an ROE of 17%. Revenue of $10.7 billion was up 2% year on year driven by healthy growth in balances and in noninterest revenue partially offset by spread compression. Revenue declined 2% sequentially reported or 4% if you were to exclude the loss in the fourth quarter associated with portfolio exits in Card. +And this decline is driven by seasonality in NIR as well as fewer days in the quarter. We remain focused on the customer experience and on our strong customer satisfaction rankings and we continue to grow households and see very low levels of attrition. And we're deepening relationships. +Our average deposits are now over $0.5 trillion, up 9% year on year. We have record client investment assets up 12%. Our active mobile customer base is a 22%, Card sales volume up 8% and our overall loan book grew for the third consecutive quarter with core loan growth of 15% year on year. +And across CCB we remain disciplined on expense management. Year-on-year expenses were lower by nearly $250 million and our headcount is down about 1,900 so far this year. +You will recall that at Investor Day we committed to reduce expenses by about $2 billion in 2017 relative to 2014. And while it will not be exactly linear you should assume a meaningful down payment towards that $2 billion in 2015. +Moving to page 6 Consumer & Business Banking. CBB generated net income of $828 million for the quarter up 10% year on year and with an ROE of 28%. +We continue to see robust performance across our drivers. Average deposit balance growth was up 9%, up $39 billion from last year and in Business Banking the momentum we saw in 2014 carried over into 2015 and supported loan originations of $1.5 billion, up 2% year on year but with average loan balances up 6% also driven by higher utilization rates. +These underlying drivers helped offset the impact of the low rate environment. NII was down 5% quarter over quarter in line with our guidance on lower deposit margin which was down 12 basis points driven by lower reinvestment rates as well as day count. +NIR while down seasonally quarter on quarter was up 5% year on year due to strong client investment and debit revenues. Expenses were down 3% year on year reflecting continued improvement in branch efficiency. +Mortgage Banking on page 7, you'll notice we simplified the reporting for Mortgage Banking here; it's now consistent with the other CCB lines of business. But the additional detail by sub line of business is still available in our earnings supplement. +So overall net income was $326 million for the quarter, originations were strong at $25 billion up 7% quarter over quarter as we maintain share in a larger market and realized higher revenue margins. And we added $15 billion of high-quality loans in the quarter to our balance sheet driving slightly higher NII quarter on quarter despite fewer days. +Although production was higher our total revenue declined quarter over quarter on lower repurchase benefits and lower servicing revenue. Expense of $1.2 billion was down 6% quarter over quarter and down 13% year on year but excluding legal would have been down 19% year on year, over $0.25 billion despite higher volumes as we continue to tightly control our costs. +On credit we continued to see improvements in home prices and delinquencies and released $100 million of NCI reserves this quarter. And you can see the net charge-off rate at 30 basis points was down 25 basis points year on year. +Moving on to Card, Commerce Solutions & Auto net income of $1.1 billion down 3% year on year with an ROE of 22% but excluding reserve releases net income was up 11%. In the quarter we moved our commercial card loans to the CIB to align with the client relationships. This was a $1.3 billion reduction in Card loan balances and relatively modest impact of less than $50 million on each of revenue and expense. +Revenue of $4.6 billion was relatively flat year on year with the Card revenue rate of 12.2% in line with guidance. On solid sales growth and reflecting continued investment in acquisitions. +And in Auto we saw solid loan and lease growth partially offset by spread compression. Expense was up 2% year on year predominantly driven by higher auto lease depreciation. In Card we saw end-of-period loan growth of $3 billion excluding the commercial card transfer I just mentioned and we saw sales growth of 8%. +This sales growth is lower than recent growth rates which have typically been in the double digits reflecting the impact of lower gas prices estimated to be about 200 basis points as well as a generally competitive environment. In Commerce Solutions we're gaining share; volume was up 13% year on year, driven by continued strong spend as well as the addition of new merchants. And in Auto results continue to reflect steady growth in new vehicle sales and stable used-car values. +It was the 14th consecutive quarter of loan and lease growth with average balances up 6% year on year. Year to date the pipeline remains healthy reflecting continued strength in the market as well as the strength of our manufacturing partners. Finally on credit, card delinquency rates and net charge-offs remained low. +On page 9 the Corporate & Investment Bank, CIB reported net income of $2.5 billion on revenue of $9.6 billion and an ROE of 16%. Revenue was up 8% year on year as market conditions in the quarter benefited both investment banking and markets and our businesses performed well. +In banking our IB fees of $1.8 billion were up 22% year on year. We continue to rank number one in global IB fees with 8.6% share up 100 basis points since last year. +Advisory fees were up 42% which was a strong start for both JPMorgan as well as the market with some large transactions. In fact this was our highest first quarter on record and we saw share gains of 150 basis points. +Debt underwriting fees were up 16% driven by acquisition financing. Aside from that debt issuance was generally lower and equity underwriting fees were up 13% in a market that was up only 4%. Our wallet rank improved to number one both globally and in the US. +Looking forward for IB fees we had some notable large transactions in the first quarter and so we do expect the second quarter to be lower although our pipeline remains strong. Treasury services revenue of $1 billion was down 2% year on year mainly driven by lower deposit NII and lower trade finance revenue. And lending revenue was $353 million, up 9% given dividends on restructured securities. +Moving on to markets revenue of $5.7 billion it was up 9% year on year but if you exclude business simplification both total markets as well as fixed income markets would have been up 20%. A number of macro events occurred in the quarter including Central Bank actions, the Swiss franc decoupling, a stronger dollar and oil price volatility which supported markets performance broadly in currencies, emerging markets, rates, commodities and equities. In fact equities had one of its strongest quarters up 22% with strength in derivatives and cash in particular across the US and Asia. +The first half of the quarter was particularly strong. The market has absorbed a number of the macro events at this point and recent sentiment is that the Fed will act later rather than sooner this year. As a result while we are still seeing good client flow and volatility does remain elevated it is somewhat lower coming into the second quarter. +With respect to business simplification in the second quarter it will happen overall neutral impact to our P&L but will have or drive a $300 million decline year on year in revenue with a $300 million offset in lower expenses. Security services revenue $934 million was down 9% year on year driven by two factors. +First the impact of change in presentation for client revenue sharing agreements in our ADR issuance business. Effective this quarter these past few payments to clients will be treated as a reduction of revenue having formerly been treated as an expense but with no P&L impact. +Second at the end of the fourth quarter of last year there was a significant client exit and the revenue impact of this is reflected in this quarter's results. So for the remainder of 2015 given those two facts we expect security services revenue to be in the range of $950 million to $1 billion a quarter depending on seasonality. +Lastly on expense total expense was $5.7 billion up 1% year on year with a comp to revenue ratio of 32% for the quarter flat year on year and an overhead ratio of $0.59. Non-compensation expense declined due to business simplification partially offset by higher legal expense year on year. +Moving on to page 10 and the Commercial Bank, it was a strong quarter with respect to the underlying fundamentals in this business, another record quarter for investment banking revenue with gross revenues of over $750 million. In absolute dollars it was our strongest quarter ever for loan growth adding over $5 billion in loans across C&I and CRE and revolver utilization was at its highest level since 2009. Credit quality remained exceptional with continued loan net charge-offs of only 3 basis points. +So overall financial performance for the quarter was solid. Net income was $600 million on $1.7 billion of revenue and an ROE of 17%. Revenue increased 4% year on year driven by record investment banking revenue which was up nearly 70%. +On increased equity underwriting and M&A activity was partially offset by continued yield compression. Expenses increased 3% year on year as we continued to invest in controls but our overhead ratio is consistent with the prior year. We're reaching a peak in control cost in this business and you should expect expenses to stabilize from here. +Loan balances increased 11% year on year and 3% quarter on quarter. C&I loans grew 4% sequentially in line with the industry driven by higher utilization in our corporate client banking book. And in CRE loan growth was 3% continuing to exceed the industry on strong activity in both multifamily lending as well as real estate banking. +Finally on credit and reserve for the full firm we added a little over $100 million to reserves relating to oil and gas exposure this quarter, the majority of which is here in the Commercial Bank. We review our energy exposure on a name-by-name basis and under a range of commodity price assumptions. +This quarter's reserve build reflects downgrades in the E&P portfolio and if the current price environment continues it's reasonable to expect some further reserve builds during 2015 but relatively modest. However, in the context of a funded portfolio of $15 billion this is a very modest build and is fully within the range of our expectations at this part of the cycle for energy. +And although we're taking reserve it is not clear that they will translate into credit losses as the industry and our clients are not standing still but actively working to manage liquidity and leverage in the face of lower prices. +Moving to page 11 and Asset Management a good quarter in Asset Management, net income of $500 million and ROE of 22% and 27% pretax margin on $3 billion of revenue. Revenue was up 7% year on year driven by flows and higher banking balances and expense of $2.2 billion was up 5% year on year primarily driven by investments in infrastructure and controls and including modest legal expenses. This marks the 24th consecutive quarter of long-term net inflows at $16 billion driving record AUM of $1.8 trillion up 7% year on year and client assets of $2.4 trillion, the strength in multi-asset and equity flows. +In banking we reported strong balances in both lending and deposits, average loan balances were up 8% year on year and average deposits up 6%. And we reported strong investment performance with 79% of mutual fund AUMs ranked in the first or second quartiles over five years. +Turning to Corporate and turning to page 12 Treasury and CIO reported a net loss of $221 million but the results included a loss in the quarter of $173 million pretax primarily due to a timing impact of cost associated with certain nonoperating deposits we plan to exit. On other corporate as we've completed the spinoff of OEP and other portfolio sales during the first quarter the remaining private equity business is not expected to be a significant contributor to the firm's earnings. Therefore, beginning this quarter and going forward we will be disclosing our corporate private equity results as part of other corporate. +This quarter private equity contributed a modest positive to the results. Also included in the results of other corporate were $300 million pretax of legal expense which is largely offset by $177 million of net income from tax items. +Moving to page 13 and the outlook, I addressed most of this guidance through the presentation. I just want to highlight a couple of items. +First in CCB, in the Consumer businesses, a couple of geography points relative to analyst models. We guided in the fourth quarter to expect the first quarter's Consumer Bank revenues to be down on deposit margin compression. We saw that this quarter as expected and we expect deposit margins to remain pressured as rates remain low. +In the mortgage bank at Investor Day we guided for revenues to be down approximately $1 billion for the year on lower servicing revenues as well as lower repurchase benefit. We saw some of that this quarter and that guidance remains. +Against that as I said earlier across CCB we do expect to deliver a meaningful portion of the $2 billion expense reduction guidance in 2015. Finally on this page on Asset Management for the full-year expect the pretax margin in ROE to be at the low end of the through the cycle target range. +So wrapping up a strong result for the quarter in a constructive environment. We saw strong market and transaction activity despite continued margin compression. The performance continues to reflect the strength of each of our franchises, strong markets revenue and IB fees, 9% growth in retail deposits, 10% core loan growth and good progress against our capital, our balance sheet and our expense commitment. +With that, operator, please can you open up the line to questions. + + +================================================================================ +Questions and Answers +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Glenn Schorr, Evercore ISI. + +-------------------------------------------------------------------------------- +Glenn Schorr, Evercore ISI - Analyst [2] +-------------------------------------------------------------------------------- + + Hello there. Just one quick clarification question on the performance in equities was great. You mentioned pretty much across the board, do you think there's any seasonality, any one-time events, block trades, anything like that that would lift such good performance in the quarter? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [3] +-------------------------------------------------------------------------------- + + There wasn't anything particularly noteworthy in terms of one-time events. It was really quite broad particularly in derivatives. +In cash the performance was I would say solid year over year because we saw strength in the Americas this year but we had strength in Europe last year. And I think the first-quarter 2014 wasn't particularly strong, so I think we were flatter a little bit with a relative comparison but it was a really strong absolute and we think probably strong relative performance. + +-------------------------------------------------------------------------------- +Glenn Schorr, Evercore ISI - Analyst [4] +-------------------------------------------------------------------------------- + + And maybe this is a related question but I'm not sure which line it would flow through. From what I understand you guys and others have been pushing or talking with your prime brokerage clients to help improve ROAs in the business. Is part of that flowing through and just better equity performance, more business with clients? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [5] +-------------------------------------------------------------------------------- + + Yes, this is where it would be. I wouldn't say it's a driver, but we are as you said and the whole industry is looking to work with clients to optimize the use of the balance sheet and improve returns. +So we've seen some of that. But I wouldn't say it was a key driver. + +-------------------------------------------------------------------------------- +Glenn Schorr, Evercore ISI - Analyst [6] +-------------------------------------------------------------------------------- + + Okay, switching gears in Jamie's letter he talked about mentioning the need to push the new G-SIB rules to the product and the client level. And it piqued my curiosity. +I'm just curious, how different is that from what you've already done? In other words each step of the way you've been early in adopting and pushing out to the desk level higher capital charges. Does this just mean more of the same meaning, higher capital charge, higher capital charge or is there something different there that you need to do? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [7] +-------------------------------------------------------------------------------- + + It is more of the same. Obviously G-SIB took on a slightly heightened focus when we had some doubling happen in the proposal in December. +So we've always been measuring and monitoring and tracking G-SIB at a very granular level. But we are obviously on a path now to aggressively manage it which means that we are going to be just a little bit more focused on that constraint, not uniquely also with advanced capital, standardized limits, balance sheet caps, the like. So it's more of the same, honestly, than just a heightened focus on this given the US proposal and given the impact of at least at this point FX translations. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [8] +-------------------------------------------------------------------------------- + + And different than RWA it affects certain products more than others. And we pointed out nonoperating deposits, stuff like that. Certain businesses more than others we've pointed out clearing and certain clients more than others we've pointed out financial institutions. +So it's just kind of a multi-variant theme. It's not mystical and we're actually already starting to reprice some of these businesses to get an adequate return on G-SIB capital. And we're seeing other people do that too. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [9] +-------------------------------------------------------------------------------- + + That's right. We may be in a different position with G-SIB but others are leverage constrained. And just generally speaking we are starting to see a lot more discipline around balance sheet and pricing is following somewhat generally. + +-------------------------------------------------------------------------------- +Operator [10] +-------------------------------------------------------------------------------- + + Mike Mayo, CLSA. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [11] +-------------------------------------------------------------------------------- + + We can put Mike back in the queue later. + +-------------------------------------------------------------------------------- +Operator [12] +-------------------------------------------------------------------------------- + + John McDonald, Bernstein. + +-------------------------------------------------------------------------------- +John McDonald, Sanford C. Bernstein & Company, Inc. - Analyst [13] +-------------------------------------------------------------------------------- + + Hi, good morning Marianne. I was wondering on net interest income, do you have an outlet for how the net interest income dollars could trend from here? Assuming that you don't get much help from higher rates what are the key drivers and what's your outlook for NIM and NII dollars for the year? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [14] +-------------------------------------------------------------------------------- + + So again assuming for a second that rates don't rise until the backend if not the end of the year and we can come back to that if you like we would expect our NII dollars to be stable to slightly up because we're still seeing growth in our interest-earning assets. Obviously this quarter we were down some on day count, it was a big chunk of the quarter-on-quarter reduction. +So we're really going to see the biggest lift in NII when we do see interest rates rise and we'll see when that is. And similarly on our NIM we would expect NIM to be stable particularly given as we talked about what we've seen dilute our NIM more particularly over the course of the last year or two has been this significant increase in cash and we're going to see some of that at least stabilize and turn as we start to reduce nonoperating deposits. So we should see our NIM relatively stable and again start to rise when rates rise. + +-------------------------------------------------------------------------------- +Operator [15] +-------------------------------------------------------------------------------- + + (Operator Instructions) Erika Najarian, Bank of America. + +-------------------------------------------------------------------------------- +Erika Najarian, BofA Merrill Lynch - Analyst [16] +-------------------------------------------------------------------------------- + + Good morning. On the CCAR do you expect any potential surcharges on the CCAR to come out when the US final rules on SIFI buffers come out? +And in addition to that have you learned anything from the CCAR in terms of the transparency of the process? Is there progression in terms of the back-and-forth with the regulators as you go through the CCAR process and their expectations? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [17] +-------------------------------------------------------------------------------- + + Okay, so taking your first point, Erika, obviously I don't know the next time we're going to in all likelihood get CCAR instructions including the rules and the minimums is likely to be some time towards the end of this year for the next CCAR cycle as we get prepared to deliver that. So all I can say is what you know which is clearly the door was left open for the minimum to be increased or potentially to include some element of the surcharge. +We're hopeful that that won't be the case because we would say the surcharge should be carried in baseline times to be used in stress and to have all firms end up well-capitalized afterwards. But I have no more insight than that for you. +With respect to the dialogue with the Fed look, it's definitely much, much further progressed than it was two years and three years ago and every year it gets better in terms of the bilateral conversations and it's constructive. I don't think, however, you could today or will likely ever be able to characterize it as transparent and clear, maybe potentially by design in terms of understanding or being able to reconcile exactly what their models do and what their results are driven by. So I won't be able to clarify for you what changed in their results or what differs between ours and theirs but the dialogue itself is definitely more constructive and more bilateral and more continuous. + +-------------------------------------------------------------------------------- +Operator [18] +-------------------------------------------------------------------------------- + + Matt O'Connor, Deutsche Bank. + +-------------------------------------------------------------------------------- +Matt O'Connor, Deutsche Bank - Analyst [19] +-------------------------------------------------------------------------------- + + Good morning. The drop in the adjusted expenses I think about 3% year over year came in a little bit better than we were thinking while revenues were also a little bit better. Obviously you've got a lot of cost-saving programs underway that you mentioned earlier in the call and at Investor Day but should we think that maybe you're running ahead of schedule or that the cost saves could be more or is it just lumpiness as we go quarter to quarter? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [20] +-------------------------------------------------------------------------------- + + Look, I think that the best way to answer that is that we are still firmly with our guidance of adjusted expenses being $57 billion plus or minus by the end of the year or for the year, sorry. Obviously we will always try and outperform that but I wouldn't characterize one quarter as a change in that guidance at this point. + +-------------------------------------------------------------------------------- +Matt O'Connor, Deutsche Bank - Analyst [21] +-------------------------------------------------------------------------------- + + Okay, and then just separately obviously a big company out there announced it's exiting most of its banking assets and just wondering if there's any interest or appetite within your Commercial Bank to bulk up the acquisition there in terms of asset purchases versus a complete company? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [22] +-------------------------------------------------------------------------------- + + So look the most important thing obviously in all of that is that we were delighted to be able to partner with the large company on their strategic transformation and that's the most important thing about that transaction for us. I'm not going to comment specifically on whether or what JPMorgan would be interested in in terms of asset purchases. We're much more focused on partnering strategically with the company. + +-------------------------------------------------------------------------------- +Operator [23] +-------------------------------------------------------------------------------- + + Mike Mayo, CLSA. + +-------------------------------------------------------------------------------- +Chris Spahr, CLSA Limited - Analyst [24] +-------------------------------------------------------------------------------- + + Hi, this is Chris Spahr on behalf of Mike Mayo. I just have a question relating to your CET1 ratio guidance. Do you give any kind of guidance on the Tier 1 leverage ratio by the end of this year given your CET1 of 11%? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [25] +-------------------------------------------------------------------------------- + + No, we haven't given any specific guidance, Chris. + +-------------------------------------------------------------------------------- +Chris Spahr, CLSA Limited - Analyst [26] +-------------------------------------------------------------------------------- + + Do you think there is any way you will be able to kind of manage that ratio higher in the context of this year's CCAR? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [27] +-------------------------------------------------------------------------------- + + In the context of the CCAR we just had? + +-------------------------------------------------------------------------------- +Chris Spahr, CLSA Limited - Analyst [28] +-------------------------------------------------------------------------------- + + Yes. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [29] +-------------------------------------------------------------------------------- + + We expect our -- it's a little complicated this year and we sort of articulated it at Investor Day because we're going to move at some point whether it's the third of the fourth quarter to have standardized RWA be our binding constraint. So 11% plus or minus is our target on CET1 and that's all we've said. + +-------------------------------------------------------------------------------- +Operator [30] +-------------------------------------------------------------------------------- + + Gerard Cassidy, RBC. + +-------------------------------------------------------------------------------- +Gerard Cassidy, RBC Capital Markets - Analyst [31] +-------------------------------------------------------------------------------- + + Thank you and good morning. Marianne you mentioned that Treasury Service revenues were down due to the trade finance revenue area. And I noticed on the balance sheet the trade finance outstandings have dropped meaningfully on a year-over-year basis. Can you share with us what's going on in that line of business? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [32] +-------------------------------------------------------------------------------- + + There's a couple of different things. One was a little specific. +We had a portfolio of loans that we held for sale and have subsequently exited from the balance sheet which drives some of it. But in addition just generally a competitive environment and lower demand particularly in Asia. + +-------------------------------------------------------------------------------- +Gerard Cassidy, RBC Capital Markets - Analyst [33] +-------------------------------------------------------------------------------- + + And then second you mentioned that you obviously had a very strong advisory business in the quarter and you gained marketshare of 150 basis points. Do you have a sense of who you took the marketshare from? Was it European investment banks or US? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [34] +-------------------------------------------------------------------------------- + + Not specifically, no. I will tell you that while we are obviously delighted with the performance it was a relatively strong market and there were some larger transactions so we're happy with the gains. I can't specifically comment on where it came from. + +-------------------------------------------------------------------------------- +Operator [35] +-------------------------------------------------------------------------------- + + Eric Wasserstrom, Guggenheim. + +-------------------------------------------------------------------------------- +Eric Wasserstrom, Guggenheim Securities LLC - Analyst [36] +-------------------------------------------------------------------------------- + + Thanks and good morning. I just wanted to follow-up on your energy comments. +Could you help us understand what events it was that led to the reserve building? Was it company-specific events in the form of bankruptcies or just something else in your internal ratings migration? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [37] +-------------------------------------------------------------------------------- + + Yes, it's definitely more the latter. So basically if you think about our E&P portfolio in particular when we think about the redetermination somewhat semiannually of the borrowing base and looked at those companies on a client-specific name by name basis there was some contraction in the borrowing base and therefore some downgrades that drive our reserving methodology. +It doesn't mean that we feel that those companies are necessarily in significant difficulty but that's the way the reserving methodology works. And as I said we do this on a client by client basis, we're comfortable with our exposures and clients are looking to manage their own defensive position. So it's not clear that they will necessarily be realized in losses; in fact, if the implied curve rather than flat to long oil prices is in fact how things play out it's possible that there will be very little in the way of credit loss we'd experience. + +-------------------------------------------------------------------------------- +Eric Wasserstrom, Guggenheim Securities LLC - Analyst [38] +-------------------------------------------------------------------------------- + + And just on that last point your view on that is because of a recovery in prices rather than restructuring actions or things that your clients are undertaking. Is that fair or is it a bit of both? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [39] +-------------------------------------------------------------------------------- + + Both. Both. + +-------------------------------------------------------------------------------- +Operator [40] +-------------------------------------------------------------------------------- + + Ken Usdin, Jefferies. + +-------------------------------------------------------------------------------- +Ken Usdin, Jefferies LLC - Analyst [41] +-------------------------------------------------------------------------------- + + Hi, good morning. I just wanted to see if I could just follow-up on the energy point. +Obviously you have the reserving and then you mentioned the 200 basis point impact on spend. I'm wondering if you'd just expand the discussion of energy, are there positive offsets that you're starting to see in the businesses elsewhere, either in terms of whether it's credit or borrowing or investment banking opportunities that may be popping up? Can you summarize the benefit if at this point you can see any positive offsets? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [42] +-------------------------------------------------------------------------------- + + Yes, so first of all just on the contraction in spend driven by oil prices it's pretty typical in this part of the cycle that you would see lower energy prices in the first instance drive savings rates up and you see consumer spend for the energy dividend so to speak lag back. So the fact that we saw that happen in the first quarter is not atypical and it doesn't mean that we don't expect the spend to grow and for that energy dividend to ultimately translate into higher spend going forward. So it's more of a normal timing phenomenon is our expectation but with respect to other activity, yes we saw active equity capital markets with some defensive issuance and generally I think it's a positive overall for the businesses and for the economy. + +-------------------------------------------------------------------------------- +Ken Usdin, Jefferies LLC - Analyst [43] +-------------------------------------------------------------------------------- + + And my follow-up question is just with respect to the security services business you mentioned the change in presentation and then there was the client loss. Is there a way you can help us understand just what the organic growth rate of the business is adjusted for the reclassifications whether it's on a sequential-quarter or a year-over-year basis? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [44] +-------------------------------------------------------------------------------- + + Not readily but we can get back to you. + +-------------------------------------------------------------------------------- +Operator [45] +-------------------------------------------------------------------------------- + + Jim Mitchell, Buckingham Research. + +-------------------------------------------------------------------------------- +Jim Mitchell, Buckingham Research Group - Analyst [46] +-------------------------------------------------------------------------------- + + Good morning. Maybe just go back to the capital ratio issue for a second. You noted that standardized you're at 10.8% and that you still feel that will be your constraining factor by the end of this year. +So if you're already at 10.8% and your target is 11%, I know it's plus or minus, but it does seem like you got three quarters you hit 20 basis points. So is there anything unusual that you're expecting in the coming quarters or is it just you can never know quarter to quarter but all else being equal it looks like you can probably hit 11% if not better. Is that a fair way to think about it? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [47] +-------------------------------------------------------------------------------- + + Yes, nothing specific to call out in the second half of the year. And we should hit 11% if not a little better, yes. + +-------------------------------------------------------------------------------- +Jim Mitchell, Buckingham Research Group - Analyst [48] +-------------------------------------------------------------------------------- + + And as you've looked at the surcharge, at the G-SIB surcharge more the proposal is do you feel better or worse, you feel is there any areas where you think you can pull the lever more significantly to improve that ratio or lower the charge? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [49] +-------------------------------------------------------------------------------- + + Look, I would say seven weeks or six weeks or whatever it is after Investor Day that the messaging hasn't really changed which is we have every intention of aggressively managing the score, doing it as we talked about earlier in a very granular way. And we're already working on that and you see that in the most obvious place which is in the reduction already to date in nonoperating deposits. +But we continue to work on all of the things so derivative notional compression, level III assets, financing, obviously we're still thinking about what the response should be in terms of risk intermediation and clearing. And so I think six weeks on from Investor Day the story is the same, we feel we are fully committed to ensuring that we are safely within the 4.5% bucket and we may not stop there but we're only a few months into this. + +-------------------------------------------------------------------------------- +Operator [50] +-------------------------------------------------------------------------------- + + Gerard Cassidy, RBC. + +-------------------------------------------------------------------------------- +Gerard Cassidy, RBC Capital Markets - Analyst [51] +-------------------------------------------------------------------------------- + + Thank you. Marianne, going back to the reserve build which obviously was done for the oil and gas as you mentioned can you share with us in the Corporate & Investment Bank I know on a total dollar amount relative to the corporation it's not significant but there was a big increase in the nonaccrual loans from 110 to 251 in the quarter. Can you give us some color on what drove that? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [52] +-------------------------------------------------------------------------------- + + Yes, I was obviously you noted it from a small base so that's notable. There are two specific transactions or two specific exposures that were moved to nonaccrual. +One of them was moved on a somewhat of a technicality, a sovereign downgrade which we fully expect to recover on. But that is just the way we have to present it and the other smaller piece was one other isolated exposure. +So I wouldn't overthink it right now. It's two exposures and it's $200 million in total. + +-------------------------------------------------------------------------------- +Gerard Cassidy, RBC Capital Markets - Analyst [53] +-------------------------------------------------------------------------------- + + And again that was not oil and gas related obviously, it's in the CIB area that was in the Commercial Bank? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [54] +-------------------------------------------------------------------------------- + + The first the sovereign downgrade was did have oil and gas underlying exposure but again it was on a technicality rather than on the fundamentals of the Company. And we fully expect to recover on that. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [55] +-------------------------------------------------------------------------------- + + Focus on the very, very small number. + +-------------------------------------------------------------------------------- +Operator [56] +-------------------------------------------------------------------------------- + + Brennan Hawken, UBS. + +-------------------------------------------------------------------------------- +Brennan Hawken, UBS - Analyst [57] +-------------------------------------------------------------------------------- + + Good morning. You highlighted the Swiss franc is a tailwind for FICC. Could you may be size that for us? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [58] +-------------------------------------------------------------------------------- + + No, I would just say that overall our sense is that the market is neutral relative to the event. We happen to be able to benefit a little from it. Some others will be more neutral and some may have lost. +As these happen regular way in trading businesses and it just happens to be the case that that event and the volatility it drove is good for our client franchise. And I think it really just goes to show you that we're in a business where expertise matters and risk discipline matters and we were able to capitalize on both of those not just for the Swiss franc but also for the other macro events in the quarter. + +-------------------------------------------------------------------------------- +Brennan Hawken, UBS - Analyst [59] +-------------------------------------------------------------------------------- + + Sure. I know that the higher volatility of course would drive higher volumes, I was just talking about the event specifically and if there was some one-time gains involved in that so that we can adjust for a core figure here? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [60] +-------------------------------------------------------------------------------- + + No, I wouldn't even characterize them as one-time gains. I would characterize them as one of a number of items that drove our performance in the business. + +-------------------------------------------------------------------------------- +Brennan Hawken, UBS - Analyst [61] +-------------------------------------------------------------------------------- + + Okay, fair enough. And then on the energy front a lot of the focus was on the CB and the energy exposure there but you all mentioned that there's exposures in CIB, too. Can you give us may be an update if there was any changes in any of those exposures or loans this quarter? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [62] +-------------------------------------------------------------------------------- + + Yes, so overall the total firm the reserve build that we took was a little over $100 billion, 4/5 of which was in the Commercial Bank. So we did experience -- we do all of this on a name-by-name basis, so we did it across our portfolios but the majority was in the CB E&P portfolio. + +-------------------------------------------------------------------------------- +Operator [63] +-------------------------------------------------------------------------------- + + Paul Miller, FBR Capital Market. + +-------------------------------------------------------------------------------- +Paul Miller, FBR & Co. - Analyst [64] +-------------------------------------------------------------------------------- + + Yes, thank you very much. On your deposit discussion about pushing out I think you said during your Investor Day that you would like to get about $3 billion of noncore deposits off the balance sheet and I know you said you hope to make progress in the second quarter. How should we model that out and what type of benefit have you modeled out to the NIM with that $3 billion of deposits? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [65] +-------------------------------------------------------------------------------- + + It was $100 billion. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [66] +-------------------------------------------------------------------------------- + + $100 billion. + +-------------------------------------------------------------------------------- +Paul Miller, FBR & Co. - Analyst [67] +-------------------------------------------------------------------------------- + + $100 billion. I'm sorry, I'm sorry. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [68] +-------------------------------------------------------------------------------- + + No worries. $100 billion, I mean look at the end of the day you can see that over the course of the last since whatever the third quarter of 2012 our cash balances grew by a couple hundred billion dollars and that has been a very large contributor to the compression in our NIM, not the only one. +So as we push out the nonoperating deposits we would expect to see that help but remember we're still growing retail deposits. So if you look at this quarter in particular even though we reduced our nonop deposits related to client actions by about $20 billion, the majority of that $24 billion, we have flat deposits so we're continuing to grow the good retail deposits. So I would say it would be a tailwind but it would be a tailwind to a stabilizing and slightly improving NIM outside of rate rises. + +-------------------------------------------------------------------------------- +Paul Miller, FBR & Co. - Analyst [69] +-------------------------------------------------------------------------------- + + And then real quick on your professional services, professional services was down from $2 billion to $1.6 billion. Is that mainly due to some of that legal cost maybe starting to go away from the crisis? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [70] +-------------------------------------------------------------------------------- + + No, I'm sorry of the top of my head can't remember the number you're saying. But no, our legal expenses, forget the legal expense that relates to reserves that we've taken and settlements that we reached, our regular way expense for third parties in legal isn't down substantially quarter on quarter or year on year at this point, although at some point it will be. + +-------------------------------------------------------------------------------- +Operator [71] +-------------------------------------------------------------------------------- + + Steven Chubak, Nomura. + +-------------------------------------------------------------------------------- +Steven Chubak, Nomura Asset Management - Analyst [72] +-------------------------------------------------------------------------------- + + Hi, good morning. So Marianne I was hoping that we could dig into the RWA progress that we saw in the quarter and specifically was hoping that you could disaggregate how much of the sequential decline that we saw was a function of the planned mitigation actions and model benefits that you've cited versus actual FX driven declines? +Because assuming that the US dollar strength persists all else equal one could surmise that we should expect RWAs in a long-term context actually coming out below that $1.5 trillion target that you've cited in the past. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [73] +-------------------------------------------------------------------------------- + + So specifically with respect to the quarter I would say that the wholesale parameter update -- wholesale credit parameter updates model benefits is about half of the RWA reduction with the other half coming from regular way portfolio run off as well as some reductions in market risk associated with market risk positions, reductions in private equity, reductions in commitment. So some position reductions rather than driven specifically by FX. +Look, we're running above $1.5 trillion now and we said we're going to manage both the advance and standardize to that number over the course of the next couple of years. So if FX or if the currency translation is a tailwind then we would hope to do better but at this point let's get there. + +-------------------------------------------------------------------------------- +Steven Chubak, Nomura Asset Management - Analyst [74] +-------------------------------------------------------------------------------- + + Okay, fair enough. And another question on capital but relating to CCAR. Marianne you've noted on this call and in the past that you don't expect CCAR to be JPMorgan's binding constraint longer term but just given the reduction that we saw in the ask or the need to use the Mulligan in the last exam I was just hoping you could cite some of the planned mitigation actions that you expect to take so that we could see you guys get on the path towards delivering on that 55% to 75% net payout target. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [75] +-------------------------------------------------------------------------------- + + So at the moment our CET1 ratio launching into CCAR was below 10%, not the 12% that we expect to run at once we have built our capital to our target level. And so you are right that right now under CCAR Tier 1 leverage was our binding constraint both last year and this year. +And so a combination of our capital strategy around how we think about the issuance of preferred together with balance sheet actions will be how we think about mitigating that limitation in the short to medium term. But ultimately it doesn't change the fact that once we get to our target assuming that is the 12% that we articulated at Investor Day that again we don't think we should be leverage constrained, so yes we're going to work on that obviously and we are continuing to build capital but when we launched into CCAR we weren't at that level. + +-------------------------------------------------------------------------------- +Operator [76] +-------------------------------------------------------------------------------- + + Nancy Bush, NAB Research LLC. + +-------------------------------------------------------------------------------- +Nancy Bush, NAB Research LLC - Analyst [77] +-------------------------------------------------------------------------------- + + Good morning. Jamie you warned in your annual letter about the possibility of another flash crash. Yesterday I think Simon Potter at the Fed warned about it and cited HFT as one of the issues. +Larry Summers warned about it about a week ago. Are these warnings going anywhere, are they being translated into action anywhere in the system? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [78] +-------------------------------------------------------------------------------- + + To give you a little perspective I also spoke in that the banking system is much stronger to start with and every bank in the system is much stronger. So just trying to think through what are the effects of some of these things and we look at it is kind of a warning shot across the bow. What I worry about more is what happens in a stress environment and I think people are paying attention to what's going on in the markets and if there has to be changes down the road there might be some changes that are relevant to that. + +-------------------------------------------------------------------------------- +Nancy Bush, NAB Research LLC - Analyst [79] +-------------------------------------------------------------------------------- + + Secondly, Marianne a question about Commercial Banking. The returns in Commercial Banking have remained in sort of the high teens over the last number of quarters and it's certainly respectable sort of 17% to 19%. Is there any way those returns improve materially or as rates go up or does that get offset by competitive factors and are we at a normalized level for that business? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [80] +-------------------------------------------------------------------------------- + + I think the best way to think about it is through the cycle target that Doug Petno put out at Investor Day which is 18%. So that doesn't mean to say that we will benefit when rates rise in this business and it is very competitive and spreads are compressing and there's a lot of factors going on but through the cycle 18% so we're some years below and some above. +Just the question on core growth and security services outside of presentation changes and client exits is currently in the low single digits. So obviously a little bit muted because we're working on the balance sheet optimization but certainly growing and in the low single digits and in terms of looking at advisory and who we are gaining share from principally European banks. +Okay, no more questions? + +-------------------------------------------------------------------------------- +Operator [81] +-------------------------------------------------------------------------------- + + There are no more questions. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [82] +-------------------------------------------------------------------------------- + + Thanks everybody. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [83] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Operator [84] +-------------------------------------------------------------------------------- + + Thank you for participating in today's conference call. You may now disconnect. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/exam/original-files/Problem_2_3_Sample_full_transcripts/2015-Apr-22-KO.N-137018502034-Transcript.txt b/exam/original-files/Problem_2_3_Sample_full_transcripts/2015-Apr-22-KO.N-137018502034-Transcript.txt new file mode 100644 index 0000000..75acd63 --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_full_transcripts/2015-Apr-22-KO.N-137018502034-Transcript.txt @@ -0,0 +1,656 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q1 2015 The Coca-Cola Co Earnings Call +04/22/2015 09:30 AM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Ahmet Bozer + The Coca-Cola Company - EVP & President of Coca-Cola, International + * Kathy Waller + The Coca-Cola Company - CFO + * Irial Finan + The Coca-Cola Company - EVP & President of Bottling Investments Group + * Sandy Douglas + The Coca-Cola Company - SVP & President of Coca-Cola North America + * Tim Leveridge + The Coca-Cola Company - VP of IR + * Muhtar Kent + The Coca-Cola Company - Chairman & CEO + +================================================================================ +Conference Call Participiants +================================================================================ + + * Bill Schmitz + Deutsche Bank - Analyst + * Dara Mohsenian + Morgan Stanley - Analyst + * Judy Hong + Goldman Sachs - Analyst + * Steve Powers + UBS - Analyst + * Bryan Spillane + Bank of America Merrill Lynch - Analyst + * John Faucher + JPMorgan - Analyst + * Bill Chappell + SunTrust - Analyst + * Ian Shackleton + Nomura Securities - Analyst + * Ali Dibadj + Sanford C. Bernstein & Company - Analyst + +================================================================================ +Presentation +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Thank you. At this time, I would like to welcome everyone to the Coca-Cola Company's first quarter 2015 earnings results conference call. Today's call is being recorded. If you have any objections, please disconnect at this time. +(Operator Instructions) +I would like to remind everyone that the purpose of this conference is to talk with investors, and therefore questions from the media will not be addressed. Media participants should contact Coca-Cola's media relations department if they have any questions. I would now like to introduce Tim Leveridge, Vice President and Investor Relations Officer. Mr. Leveridge, you may begin. + +-------------------------------------------------------------------------------- +Tim Leveridge, The Coca-Cola Company - VP of IR [2] +-------------------------------------------------------------------------------- + + Good morning, and thank you for being with us today. I'm joined by Muhtar Kent, our Chairman and Chief Executive Officer, and Kathy Waller, our Chief Financial Officer. Before we begin, I would like to inform you that you can find webcast materials in the Investors section of our Company website at www.Coca-ColaCompany.com that support the prepared remarks by Muhtar and Kathy this morning. +I would also like to note that we have posted schedules under the Financial Reports & Information tab in the Investors section of our Company website. These schedules reconcile certain non-GAAP financial measures, which may be referred to by our senior executives during this morning's discussion, to our results as reported under generally accepted accounting principles. Please look on our website for this information. +In addition, this conference call may contain forward-looking statements, including statements concerning long-term earnings objectives, and should be considered in conjunction with cautionary statements contained in our earnings release and in the Company's most recent periodic SEC report. +Following prepared remarks by Muhtar and Kathy this morning, we will turn the call over for your questions. Ahmet Bozer, Executive Vice President and President of Coca-Cola International; Sandy Douglas, Senior Vice President and President of Coca-Cola North America; and Irial Finan, Executive Vice President and President of Bottling Investment, will also be available for our Q&A session. Now, I will turn the call over to Muhtar. + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Company - Chairman & CEO [3] +-------------------------------------------------------------------------------- + + Thank you, Tim, and good morning, everyone. First apologies for the state of my voice. I have a cold, so please bear with me. +I am going to start with some highlights from our first quarter performance, and then review the progress we have made against our five strategic actions we laid out last October to reignite growth. Finally, I will touch on our outlook for the remainder of the year before I turn the call over to Kathy to take you through more details on the financial results. +Let me begin by saying that I am pleased to report early momentum, the beginning of 2015, a year of transition for the Company. We delivered promising first quarter results, especially in light of the significant macroeconomic volatility in many regions around the world, and the productivity and rewiring initiatives we are implementing this year. +For those of you following our webcast, you can see our quarterly performance score card on slide 4. Our performance was largely driven by the strength of our global brand portfolio and the strong distribution capabilities of our bottling partners as evidenced by our continued global value share gains in NARTD, sparkling beverages, as well as still beverages in the quarter. +While certain markets faced significant currency devaluation, economic slowdown, or political unrest, our focus on improving our execution enabled us to deliver overall solid results. We grew our top line and bottom line due to initial improvements in the underlying business, the timing of Easter, and six extra days in our fiscal quarter. +Importantly, net revenues grew 8% on an organic basis, driven by the extra selling days and positive 3% price mix globally. While it is still early in the year, we are pleased with the 3% global price mix, and the 2% price mix in North America, both ahead of full-year 2014 results. +This price mix is the result of disciplined implementation of our price backed channel strategies which is a key and consistent portion of our long-term approach to creating value for consumers, customers, bottlers, and ourselves. Productivity initiatives, benign commodity costs, and favorable product mix in key markets drove gross and operating margin improvement, and we continue to invest substantially behind advertising, leading to double-digit increase in marketing spend. The bottom line result was double-digit growth in comparable currency neutral income before tax. +Now turning to the five strategic actions we laid out for this year. One of our key strategic initiatives is making disciplined brand and growth investments. As mentioned earlier, we increased our media investments double digits in the quarter as we work towards fully funded brand plans in markets around the world, while at the same time enhancing the quality of our advertising. A great example of this is the new Coca-Cola marketing campaign during the Chinese New Year which helped our China business grow brand Coca-Cola volume 9% despite slowing economic conditions. +As we said previously, media investments take about 12 to 24 months to realize their full value. While we are seeing initial positive results, we are even more encouraged by the knowledge that it is still early in the process, and we have tremendous runway for continued improvement in our top line growth. +We remain resolutely focused on driving costs out of business and embedding a culture of productivity into our DNA, which is enabling us to fund our brand and growth investments. This change in culture is reflected in incorporating zero-based work processes into all phases of our annual planning cycles. +We remain on track across all spend areas to deliver more than $0.5 billion in savings this year and $3 billion in annualized savings by 2019. The difficult but necessary changes made during the end of 2014 are now accounted for in our budgets and tied to our objectives and goals. The initial implementation of our new operating model is on track, and the previously announced head count reductions associated with this change are well underway. +We are continuing to work through the rewiring of business processes within the entire organization. For example, we have eliminated a layer in many of our functions at the group levels in different geographies and linked our corporate center directly to our business units. In R&D, this means connecting our corporate R&D efforts directly to our global development centers, and linking both of these to service our business across business units across the world. This allows us to scale our efforts in innovation, share new developments faster, and accelerate development of new products. +In addition, we are also rewiring our marketing organization around consumer clusters to drive speed, to drive efficiency, and effectiveness. This will allow us to better leverage learnings from similar markets, regardless of the geographic location, and improve the quality of our advertising through our networked marketing model. A great example of this is how we are strategically leveraging the 100th anniversary of our contour Coca-Cola bottle to drive our business forward through integrating marketing, commercial, and innovation under one umbrella to reach approximately 140 markets. +This campaign centers on the magic of drinking a Coke with the emphasis on the experience as much as the bottle. As such, it is focused on driving profitable immediate consumption packages and purchase transactions. As part of this campaign, our system is investing in glass bottles all around the world, while introducing the next generation contour [PT] bottle and expanding the supply of our premium aluminum bottles in key developed markets. +Importantly, this is not simply a global campaign. Rather, it is a new way of networked marketing that has led to the creation of 20 marketing assets that markets can use leverage in a more cost-effective model or manner. Some of our markets will leverage the campaign throughout the year, while others quarter by quarter. +As a result, we have significantly been able to reduce our production and development costs per gross rating point, allowing more dollars to be focused against the consumer. We are seeing initial positive results in the markets that have already launched the campaign, such as South Africa, Australia, and Latin Center. +Across the entire Company, our deeper market segmentation strategy is also starting to yield early results. Two examples are North America and India here. In North America, we are focused on generating revenue through a greater reliance on price realization, increased media investments, coupled with our segmented price pack strategies, drove revenue growth in our sparkling portfolio through a strong 3% price mix and a 1% increase in transactions. +Simply put, more consumers are enjoying our products more often, and are increasingly choosing smaller packages including our iconic contour bottle. Whereas in India, where our revenue growth strategies focus on expanding distribution and recruiting new consumers, we grow double-digit unit case volume growth in both our sparkling as well as still portfolio. +Turning to our focus on our core business model, we continue to make progress on our North America re-franchising efforts in the quarter. First, we remain on track with our previously announced territory transfers to existing partners. During the quarter, we transitioned four territories to Coca-Cola consolidated, and are on track to transfer additional territories in Kentucky and Tennessee to consolidated and [current] Coca-Cola [currents] this year. +We are slightly ahead of schedule to close the previously-announced transaction with new entrants into our bottling network. Territory transfers to both Troy Taylor in Central Florida and Reyes Holdings in Chicago are slated to close in the second quarter. Together, the territories pending to transition to these two new partners will represent approximately 5% of US bottle/can volume. +Finally, just this morning, we announced the signing of new letters of intent with existing bottling partners for territories covering more than 5% of bottle/can volume. In aggregate, territories transitioned to date, and those covered by definitive agreements or letters of intent, represent a little over 15% of total US bottle/can volume. +Further, as we continue to transition territories, we are getting better and faster which is why we are confident that our previously-stated timeline to have two-thirds of bottle/can volume distributed by our independent bottling partners by 2017 is very much on track. +Looking outside of North America, we closed our joint venture in Coca-Cola Amatil Indonesia in early April. I was in Jakarta earlier this year with the Indonesian bottler to celebrate this new venture. This investment will help us capture the growth opportunity in one of the largest and most dynamic countries in the world, as we enable our system to be even more responsive to consumer and customer needs. +We are off to a solid start in 2015, and we are on track to deliver against our full-year currency neutral EPS expectation of mid-single digit growth. Importantly, I am encouraged by the progress we have made, and we remain confident that we have the right strategies in place to create sustainable shareholder value. +However, there is still much work ahead of us. We continue to expect that the benefits from the announced initiatives will take time to fully materialize. Further, we are operating in a very challenging environment. A cautious recovery in the US is offset by a relatively sluggish expansion in Europe and Japan, as well as weaknesses in emerging markets, notably Brazil and Russia, as well as China slowing down. +Therefore, we remain cautious in our outlook, so we will continue to focus on what we can control and execute against our strategic initiatives to emerge stronger and better positioned to capture growth in the global nonalcoholic beverage industry. I will now hand the call over to our Chief Financial Officer, Kathy Waller, who will provide you with a more detailed look at our financial performance, as well as update on our outlook on our business for 2015. + +-------------------------------------------------------------------------------- +Kathy Waller, The Coca-Cola Company - CFO [4] +-------------------------------------------------------------------------------- + + Thank you, Muhtar, and good morning, everyone. I am going to spend a few minutes discussing the quarter and then our outlook for 2015 as Muhtar just stated. Overall, we are pleased with our performance in the quarter and encouraged by some of the early signs of success. Our positive pricing continues as we focus on driving revenue in the marketplace, and our reinvestment in brand Coca-Cola is starting to yield results. +Focusing on the quarter, organic revenue growth was driven by 5% growth in concentrate shipments and 3 points of positive price mix. The concentrate shipment growth benefited from the six extra days in the period. These extra days will reverse in the fourth quarter, so you will see a corresponding impact in that period. +After adjusting for the six extra days in this quarter, concentrate shipments lagged unit cases primarily due to the timing of shipments in our international markets. For the full year, we expect concentrate shipments to be generally in line with unit cases. Consolidated price mix in the quarter was driven by positive pricing and product mix initiatives across many of our markets. +In addition, we benefited from positive geographic mix, as markets where shipments lagged reported unit cases were in lower revenue per CSE market. As we moved through the year, I would like to remind you of a couple of points. First, we will begin to cycle better underlying pricing, and second, as we catch up from the timing of shipments in international markets, we will see negative pressure from geographic mix at the consolidated level. Therefore, while we remain resolutely focused on driving revenue in our markets, we do expect price mix to moderate from the current level. +Our comparable gross margins improved about 75 basis points on a consolidated basis. This increase was driven primarily by better margins in North America, due to positive pricing and business mix, as well as moderately lower commodity costs. As you think about the remainder of the year, we would also expect many of these drivers to moderate, as we begin to cycle more difficult comparisons. Therefore, our full-year outlook on gross margins has not changed from our prior guidance. +Comparable currency neutral operating leverage came in better than anticipated in the quarter, primarily due to the stronger growth in gross profit, driven by the factors just mentioned. Comparable currency neutral income before tax grew 13%. The combined impact of structural items and the provision in Venezuela resulted in a 3 point headwind on income before tax which was consistent with our previous outlook. +Our first quarter comparable EPS was $0.48 which included a 6 point currency headwind. On a comparable currency neutral basis, our EPS grew 15% in the quarter. The 6 point currency headwind was slightly less than our original expectations, primarily due to the benefit from foreign exchange gains associated with the euro-denominated debt issued during the quarter. +Items impacting comparability in the quarter were primarily related to the early extinguishment of certain long-term debt, costs associated with our previously-announced $3 billion productivity program, and charges related to our Venezuelan operations. +As many of you know, the Venezuelan government introduced a new floating exchange rate mechanism, called Simadi, in mid-February. We re-measured our bolivar-denominated net monetary assets at the end of the first quarter using the new Simadi floating exchange rate of approximately VEF193 to the dollar, and translated our Venezuelan subsidiaries' local currency income statement into US dollars using that same rate. +We generated $1.1 billion in free cash flow, up 72%, primarily due to the efficient management of working capital, the impact of six additional days, and the timing of capital expenditures, and it's partially offset by an unfavorable impact from currency exchange rates. +We returned $1.8 billion to share owners in the form of dividends and net share repurchases during the quarter, which is reflective of our commitment to return cash to share owners. For 2015, we increased our annual dividend by 8%, to $1.32 per share, and it is worth noting that we have increased our dividend every year for more than half a century. +Turning to outlook, while we are encouraged by some of the early signs of success, it is still early in the year, and global economic growth remains constrained by challenges in many markets, as evidenced in regions like Brazil, Russia, and China. Therefore, we are maintaining our underlying full-year currency neutral growth expectations as previously provided. However, we are updating the expected impact from structural items and currency. +During our last call, we said we expected the transaction with Monster Beverage Corporation to close in early Q2. We now expect closing to happen in the latter half of the second quarter, as the parties work to satisfy contractual closing considerations. However, distribution of Monster products in the US has already begun transitioning to the KO system. +Finally, we are slightly ahead of schedule on closing the US territory transfers to Troy Taylor and Reyes Holdings. We now estimate that the net impact of structural items on full-year 2015 results will be a slight headwind on net revenue growth, with no material change to our prior outlook on income before tax. Therefore, consistent with what we said in February, for the full-year 2015, we continue to expect mid-single digit comparable currency neutral EPS growth. However, we do see a slight change in the impact from currency exchange rates. +After considering our hedge positions, current spot rates, and the cycling of our prior-year rates, we now expect an approximate 6 point currency headwind on net revenue, an approximate 10 point currency headwind on operating income, and an approximate 7 point headwind on income before tax for the full year 2015. +The currency impact on income before tax remains roughly the same as our previous outlook, as the foreign exchange gains associated with our euro-denominated debt issued this quarter is offset by the effects from translating our bolivar-denominated profits at the Simadi exchange rate, as well as the continued decline in several emerging and developing market currencies. +So when modeling the second quarter, there are a couple of phasing items you should consider. The timing of Easter benefited the first quarter this year, while it benefited the second quarter of last year. We expect structural items to be roughly neutral impact on net revenue, and a 1 to 2 point headwind on income before tax. +Then finally, we currently expect currency will be an approximate 7 point headwind on net revenue and an approximately 10 point headwind on operating income, and a 5 to 6 point headwind on income before tax in the second quarter as we cycle more favorable rates from the prior year. The variance between the currency headwind and operating income and income before tax is primarily due to that foreign exchange gains associated with our euro debt. +In closing, we are cautiously optimistic about the progress we see in the business, which gives us increased confidence that our strategies and actions are working. With that said, it is still early days in a transition year, as we implement significant change in our Company amidst a volatile and challenging operating environment. We absolutely believe that the Coca-Cola Company is best positioned to capture growth in nonalcoholic beverages and to continue to deliver long-term value to our shareholders. +Operator, we are now ready for questions. + + +================================================================================ +Questions and Answers +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + The first question is from Bryan Spillane of Bank of America. + +-------------------------------------------------------------------------------- +Bryan Spillane, Bank of America Merrill Lynch - Analyst [2] +-------------------------------------------------------------------------------- + + Hi. Good morning, everyone. + +-------------------------------------------------------------------------------- +Tim Leveridge, The Coca-Cola Company - VP of IR [3] +-------------------------------------------------------------------------------- + + Good morning, Brian. + +-------------------------------------------------------------------------------- +Bryan Spillane, Bank of America Merrill Lynch - Analyst [4] +-------------------------------------------------------------------------------- + + I guess as we look at this quarter, it just seems like some of the things that you laid out at the beginning of the year that were within your control have tracked in line, maybe even a little bit better than expected. It sounds like the refranchising in North America is pacing maybe a little faster. Closing the Monster transaction is taking a little bit longer, and it sounds like you're tracking pretty well in terms of cost savings and redeploying or spending more in marketing. +I guess when we think about the factors that are outside of your control, which would be I guess some of the macro factors, the change in the Venezuela exchange rate, how some of the markets are moving, I'm not sure if we have a great sense for maybe what is worse or what is better. If you could just maybe lay out for us versus where you were earlier this year, when you initially gave us guidance, what is better and what is worse, especially focusing on some of the things that are outside of your control? + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Company - Chairman & CEO [5] +-------------------------------------------------------------------------------- + + Bryan, it is Muhtar here. Good morning again. In North America, I will start with North America, I'd say that the outlook appears to be trending a little positive, raising hopes that potential wage growth and lower fuel prices could translate into consumer spending. In Latin America, Mexico is, the best way I would say is, relatively stable and continues to track closer to the United States, because they're so closely linked. Brazil continues to deteriorate faster than we expected. I'd say that. +Venezuela continues to increase as a concern given the growing difficulty on maintaining supply in the marketplace. And Argentina just continues to be challenging. And Colombia is again a star in Latin America in terms of performance and macro conditions. +In Europe, I think there are also some green shoots on the back of monetary easing, but it's early days. That just started. Deflation still remains a concern this year, and overall, consumer spending in Europe I would say is still sluggish, as it will take time for I think monetary easing to flow to the consumer pocket and translate into increased consumer spending, and then risk to recovery [remains] a still volatile environment. Then of course you have the possible Greece exit issues lingering on. +In Eurasia and Africa, Russia continues to see significant challenges, the Russian consumer, and we expect it to continue to remain challenging throughout the year this year. Sub-Sahara Africa is a strong bright spot, and we are seeing that in our results. And then Middle East, we have got some pockets where it's defying the geopolitical environment, but overall, obviously increased geopolitical risks there. +Then in Asia and Pacific China continues, the disposable incomes, consumer spending, CSE in China continues to decelerate. We saw that happening in Q1, versus the stated GDP of 7%. Japan remains sluggish, I would say similar to Europe, although we are starting to see some green shoots in the economy. +And finally in Asia-Pacific, India continues to be a bright spot I would say inside the BRIC end markets, the four BRIC markets. That's a walk-through. +Then the commodity environment, again, talking about what we can control and what we can't, remains fairly benign, compared to previous years, stable and benign. Given that value growth for us is highly correlated to PCE growth, I hope I have been able to give you a quick walk-through of what is good and what is not so good and what is more stable. + +-------------------------------------------------------------------------------- +Bryan Spillane, Bank of America Merrill Lynch - Analyst [6] +-------------------------------------------------------------------------------- + + That is very helpful, Muhtar. Thank you. I didn't mean to have you talk so long. Your voice is definitely under some pressure this morning. Kathy, if I could, just one follow-up on the commodity piece, the comparisons were a little bit better in the first quarter. Just looking forward, is there anything that we should be looking at that could make it maybe more favorable as the year goes on? Like how much of it is locked in and how much of it might move based on commodity movements? Thank you. + +-------------------------------------------------------------------------------- +Kathy Waller, The Coca-Cola Company - CFO [7] +-------------------------------------------------------------------------------- + + Brian, as Muhtar just said, commodities for us will be benign this year. In this quarter, and the first half we're cycling higher prices, in the first half of last year. And thinking about something like oil, oil doesn't really impact us. For our commodities, we are hedged. We basically are not going to see specific benefit there, and they are going to be basically benign. + +-------------------------------------------------------------------------------- +Operator [8] +-------------------------------------------------------------------------------- + + The next question is John Faucher of JPMorgan. + +-------------------------------------------------------------------------------- +John Faucher, JPMorgan - Analyst [9] +-------------------------------------------------------------------------------- + + Thank you. I wanted to follow up on two questions related to the price mix number which is I guess one, if we look at the gallon variances you mentioned, it skews a little bit more towards high revenue per case. Can you give us an idea in the quarter in terms of how much of that benefit in geographic concentrate shipments, how much we'll need to take out over the balance of the year? +Then going back to some of the comments that you guys made, I think back in December, about a different global pricing strategy in terms of really trying to find the right balance region by region, can you talk about the outlook for pricing in Europe? It was obviously price mix was flat this quarter, but that's one where it seems like there are some opportunities going forward. What is the medium to longer term view on pricing in Europe? Thanks. + +-------------------------------------------------------------------------------- +Kathy Waller, The Coca-Cola Company - CFO [10] +-------------------------------------------------------------------------------- + + Okay, John, I will take the first part of that question. The gallons and the cases definitely, when you make the adjustment for days, gallons are behind cases, and that will moderate. That will be based on, as you just said, what we see in the first quarter is the higher revenue for CSE, and so we did benefit from positive geographic mix in our price mix. That will moderate. +We will start to see when it catches up more of the geographies that provide the lower revenue for CSE coming through, which will then give us the negative geographic mix coming through as well in the balance of year. I think the second part of your question, on the outlook of pricing, Sandy, do you want to talk about at all the North American pricing specifically? + +-------------------------------------------------------------------------------- +Sandy Douglas, The Coca-Cola Company - SVP & President of Coca-Cola North America [11] +-------------------------------------------------------------------------------- + + Sure, Kathy. Good morning, John. The North America pricing situation is really the continuation of the strategy that we have been talking about for the last year and a half. Irial and I talked about this I think six calls ago that we were going to focus our business on the sustaining strategy of disciplined price and volume mix to maximize revenue, with an emphasis on price as a driver in the US business. That is exactly what we have been doing, and what we continue to plan to do with a lot of discipline and focus. +As you look at the first quarter, if you look at each business by themselves, we met our pricing objectives in the first quarter. We saw a little bit faster growth in our fountain business, which created a little bit of negative business mix, but net-net, the year started according to plan. We see the outlook as being rational, and our strategy remains very consistent. Ahmet, you want to talk about Europe? + +-------------------------------------------------------------------------------- +Ahmet Bozer, The Coca-Cola Company - EVP & President of Coca-Cola, International [12] +-------------------------------------------------------------------------------- + + Thanks, Sandy. Hi, John. Just a couple of comments in general and then Europe, we are following exactly the same strategy of managing our product mix and price versus volume around markets international. In fact, we are getting some pretty good results in many of our big markets. Specifically in Europe, one must remember that last year, we have had some fairly aggressive pricing, which resulted in our view somewhat of an imbalanced progression of our business, where we have lost some market share, but got great pricing. +We were saying before that we would be moderating that somewhat this year, so that we have a more balanced growth of volume and revenue. What you saw in the first quarter is a result of that moderation, but we do believe that we would be achieving reasonable price mix in Europe in the course of this year. + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Company - Chairman & CEO [13] +-------------------------------------------------------------------------------- + + John, this is Muhtar. I will just add one other point, which is related to what I already mentioned, that we are reorganizing and have reorganized our marketing around the different clusters of developed, emerging, and developing markets. I think that is also working, beginning to yield some early results, and I think our new marketing leadership is very committed and very much part of this new reorganization of our marketing around the clusters. I can say very clearly that marketing is playing an important role in how we are generating enhanced revenue in our business. That is really an important takeaway, I think. + +-------------------------------------------------------------------------------- +John Faucher, JPMorgan - Analyst [14] +-------------------------------------------------------------------------------- + + Great. Thank you, and feel better, Muhtar. + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Company - Chairman & CEO [15] +-------------------------------------------------------------------------------- + + Thanks. I feel good. It is just my voice. + +-------------------------------------------------------------------------------- +Operator [16] +-------------------------------------------------------------------------------- + + Thank you. The next question is Dara Mohsenian of Morgan Stanley. + +-------------------------------------------------------------------------------- +Dara Mohsenian, Morgan Stanley - Analyst [17] +-------------------------------------------------------------------------------- + + Hi, guys. I will give Muhtar's voice a break, and maybe start with Kathy. The quarter came in better than expected from a margin perspective clearly versus consensus, but with the extra shipping days and Easter shift, it is tough to judge your margin performance. I was just hoping you could give us some perspective on where margins and profit came in this quarter versus your original expectations, and some of the key puts and takes in the quarter, again versus those original expectations. + +-------------------------------------------------------------------------------- +Kathy Waller, The Coca-Cola Company - CFO [18] +-------------------------------------------------------------------------------- + + The price mix obviously is 3 points, as I just spoke about. We did benefit from positive geographic mix in the first quarter. As we will get as concentrate shipments and timing starts to catch up, we will have the impact of a negative geographic mix which for us is not a surprise, in that it is normal run rate for several of our geographies. +We did get the pricing in the quarter and the benefit. Then the other side of that would be the costs, and when you adjust for structural, and you adjust for currencies, cost of goods is really in line with concentrate shipments. +Then the other issue would then just be commodities, and then as we said the commodities are basically going to be benign for us, and in the quarter, we are cycling higher costs from last year. That was a slight benefit. For the most part, I'm looking into the rest of the year, commodities are going to be benign. It is really basically the pricing that we got this quarter, offset by the costs that were better than prior year because we cycled better costs. + +-------------------------------------------------------------------------------- +Dara Mohsenian, Morgan Stanley - Analyst [19] +-------------------------------------------------------------------------------- + + Okay. Then net-net, when you put everything together, would you say from a profit standpoint, or margin standpoint, where did the quarter come in versus original expectations at the corporate level? + +-------------------------------------------------------------------------------- +Kathy Waller, The Coca-Cola Company - CFO [20] +-------------------------------------------------------------------------------- + + I also would add one other thing in addition, in North America specifically, we had better business mix, which basically was around our food service business. For the first quarter, in a transition year, we are obviously very pleased with our results. And I would say that I would expect pricing to moderate for the back half of the year, and to continue with -- the cost of goods sold continue to be in line with the concentrate shipments. We were basically given the quarter in line with our expectations and we expect to be in line with our full-year expectations that we have provided. + +-------------------------------------------------------------------------------- +Dara Mohsenian, Morgan Stanley - Analyst [21] +-------------------------------------------------------------------------------- + + Okay. That's helpful. Thanks. + +-------------------------------------------------------------------------------- +Operator [22] +-------------------------------------------------------------------------------- + + Thank you. Next question is Steve Powers of UBS. + +-------------------------------------------------------------------------------- +Steve Powers, UBS - Analyst [23] +-------------------------------------------------------------------------------- + + Thanks. Muhtar, feel free to weigh in, but I will also try to give you a break and direct questions to Sandy and Kathy. Guys, on North America, the price realization was solid, but it was actually a little lower than I at least had expected just based on market data. I know were you lapping some fairly intense retailer promotions, so maybe that played a role. Maybe it was again negative mix from still. I know you mentioned fountain dynamic, Sandy. I was hoping you could just expand on the trends there and whether you think 2% is a representative number for the year, at least in terms of way you're targeting it. +On a related note, I was wondering if you could dimension for us the profit contribution to this price mix you're getting. Because clearly, if it was all rates, pure rate, then it would flow through 100% to profit, all else equal, but given a lot of what we're seeing is category mix and these are just introduction of new package types, I'm wondering how to think about the profit contribution. Should we be assuming 50% as a rule of thumb, roughly? Or are there reasons to be more optimistic or cautious related to extrapolating price mix to profit flow-through? + +-------------------------------------------------------------------------------- +Sandy Douglas, The Coca-Cola Company - SVP & President of Coca-Cola North America [24] +-------------------------------------------------------------------------------- + + Steve, the comments I would make about overall pricing are, to reiterate what I said earlier, which is that on a business by business basis, our pricing results in the first quarter were solid. You saw in Nielsen, very strong price growth. Some of that was driven by wholesale improvement that we were achieving with our customers. Some of it was lapping some really aggressive promotional activity that happened in the end of February and early March, and some of it was our customers making more money in the category. The net effect of it was a really good start to the year, in line with our plan. +If you cross our business over into our chilled Minute Maid business, we saw price realization there. We launched some new items that drove some incremental revenue. Then as I mentioned, the fountain business was stronger than we expected at the beginning of the year, which creates a business mix drag overall. +What I would say from a profitability standpoint is that the combination of rate and mix was in line with our expectations, but I would also point out that as we get into the second half of the year, you are going to see more difficult pricing comparisons. We will continue our strategy of rigorous and disciplined and focused price volume management, but we will be lapping ourselves, and we'll be continuing to do so, but against a little bit tougher comparison. Net-net, off to the start we had hoped to. Irial, any additional dimension? + +-------------------------------------------------------------------------------- +Irial Finan, The Coca-Cola Company - EVP & President of Bottling Investments Group [25] +-------------------------------------------------------------------------------- + + (Inaudible) repeating what you said, but I'd go back, and I've said this for six calls. We are being very disciplined and rational about our pricing. What we achieved in the first quarter is pretty well in line. Sandy's mentioned there's maybe some channel mix impacts in there, but generally speaking, very much in line. +We intend to stay disciplined, and I'd used the word [nearly] be boring in terms of how we approach the business. We want to remain disciplined and focus on doing the right things for the business. We believe we are on a good track. We intend to stay on that track, and I think as each quarter goes by, you will see positive momentum in the business. + +-------------------------------------------------------------------------------- +Sandy Douglas, The Coca-Cola Company - SVP & President of Coca-Cola North America [26] +-------------------------------------------------------------------------------- + + Can I just add one more thing? What Irial just said then creates the environment for our small packages to grow. The consumer is moving strongly to small packages, and we are continuing to see low- to mid-teens growth in those packages, and all of which is supported by the impact of a step-up in marketing, which gives the whole thing more sustainability, as we work through the more challenging comps. + +-------------------------------------------------------------------------------- +Steve Powers, UBS - Analyst [27] +-------------------------------------------------------------------------------- + + Okay. Maybe if I can just follow-up, related theme, different angle, and maybe this is for Kathy, but I noticed you changed the reporting of regional profit to profit before tax, so regional operating profits, to profit before tax, consistent with the incentive changes you made. +North American PBT was up like 100 basis points, 180 basis points or so, but I was wondering if you could comment, A, if there was any material benefit from sub-bottling payments in the quarter, and B, if [OI] margin trends would have mirrored PBT? +Then assuming so, how much of that 180 basis points improvement was driven by some of the better pricing realization, the better productivity, commodities, that can continue as a run rate versus timing benefits in the quarter related to the Easter and the calendar shift? If 180 is representative of the underlying OI trends, and then what is the real run rate that we should be thinking about as expected margin improvement on the year? Thanks. + +-------------------------------------------------------------------------------- +Kathy Waller, The Coca-Cola Company - CFO [28] +-------------------------------------------------------------------------------- + + The expected margin improvement over the balance of the year, as Sandy just said, so we got good pricing in the quarter. Irial said we are very focused on continuing to rationally price. We have higher comps in the back half of the year for pricing that we have to cycle. +As far as the refranchising is concerned, I wouldn't expect to see much benefit at this point from the sub-bottling payments. And as you know, if you look at it from an (inaudible) perspective, we structurally adjust those. We pulled them out. We pulled the benefits, so would we put it back on an apples-to-apples basis year-over-year. +There is not a big difference at operating versus PBT in our North American operations at this point. For the margin expansion, that is basically really good pricing. As we get really good pricing in the fourth quarter of last year, they are very focused on pricing. That will continue, but we are cycling higher prices in the back half of this year. + +-------------------------------------------------------------------------------- +Operator [29] +-------------------------------------------------------------------------------- + + Thank you. Next question is Bill Chappell of SunTrust. + +-------------------------------------------------------------------------------- +Bill Chappell, SunTrust - Analyst [30] +-------------------------------------------------------------------------------- + + Thanks, good morning. + +-------------------------------------------------------------------------------- +Tim Leveridge, The Coca-Cola Company - VP of IR [31] +-------------------------------------------------------------------------------- + + Good morning, Bill. + +-------------------------------------------------------------------------------- +Bill Chappell, SunTrust - Analyst [32] +-------------------------------------------------------------------------------- + + I guess two questions, I will lump them together. One, on Diet Coke in the US, it did look like most recently the Nielsens looked like actually a positive number, and we haven't seen that in a while. I just wanted to see if maybe the trends, you feel like you've gotten behind that, where we could see some growth going forward or at least stabilization? +Then the second question, on the refranchising, anything you have seen thus far? I know it is early, where it is may be accelerated even further in terms of the bottler network, where it is maybe you have more of an update later as we move through the year? + +-------------------------------------------------------------------------------- +Sandy Douglas, The Coca-Cola Company - SVP & President of Coca-Cola North America [33] +-------------------------------------------------------------------------------- + + Bill, on Diet Coke, I would describe Diet Coke still as a work in progress. We have done a number of things on the basics of marketing, graphics, advertising, packaging. We have some very advanced big data driven customer relationship programs going on, with consumers who love Diet Coke. We are seeing some improvement in the year-over-year revenue, but we are still very much focused on that as a work in progress and expect to. +But I would say this. The team and I, and our whole system, believe that in fact we will return Diet Coke to growth in the long term, but recent improvement, but still work in progress. +On refranchising, the refranchising is going according to plan. It is, as we said before, a massive project. We are putting the entire system in on a common ERP system, and refranchising the territories one sales center at a time, to make sure that the capability that we build continues to grow, and that our customers are well served in the process. We are pleased with the progress. We have a plan in place that we expect to meet or beat, and we are always looking for opportunities to accelerate it, but not at the expense of really high quality customer service and capability. + +-------------------------------------------------------------------------------- +Bill Chappell, SunTrust - Analyst [34] +-------------------------------------------------------------------------------- + + Got it. Thanks for the color. + +-------------------------------------------------------------------------------- +Operator [35] +-------------------------------------------------------------------------------- + + Thank you. Next question is Ali Dibadj from Bernstein. + +-------------------------------------------------------------------------------- +Ali Dibadj, Sanford C. Bernstein & Company - Analyst [36] +-------------------------------------------------------------------------------- + + Hi, guys. Throughout the press release and your commentary, we pleasingly had heard and read about marketing increases, so that is a good thing. That is very much on plan. However, we didn't really see or hear much reference to cost-cutting benefits offsetting or funding some of those at this point. +The only thing you said was we are on track for $500 million of cost savings this year, but we are not hearing or seeing a lot of that flowing through, even offsetting things. I'm not saying all the way to the bottom line but at least offsetting some of your investments. When can we start hearing more about that savings offsetting your investments? + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Company - Chairman & CEO [37] +-------------------------------------------------------------------------------- + + Ali, this is Muhtar. First, if it wasn't for the savings, we would not be able to do what you see us doing in terms of generating that increased marketing, generating all the other things that basically are part of our five point strategy of focusing on revenue, focusing on productivity, focusing on better and more marketing, rewiring the organization for better impact, and focusing on our core, which is the franchising that we talked about. +I would just say to you, had it not been for the productivity, we certainly would not be able to enable our organization to generate the kind of momentum that you see beginning to come back in. That is clear. There is no question about that. +This is not a four or five sequential compartments. These are a very integrated approach to how we bring more momentum into our business, and everything that I mentioned is happening at the same time, more better [wired] organization, better marketing, marketing that works around clusters, more effective marketing, linked to social media, as well as into a better cost per GRP, all of that funded by incremental productivity. I think that is how you need to see our entire different buckets of our strategy coming to life. + +-------------------------------------------------------------------------------- +Ali Dibadj, Sanford C. Bernstein & Company - Analyst [38] +-------------------------------------------------------------------------------- + + A follow-up on that, and a separate question for Irial, just to follow up on that, Muhtar, if you could, is particularly in terms of the head count reduction and the savings there of, should we see that ramping up throughout the year? +At risk of being cut off, let me (inaudible) my second question here on a separate topic is we do keep hearing Germany, India, Vietnam bottlers in [BIG], continuing to do actually quite well. I always pause whenever I see that, and obviously there's been controversy about some of those names including (inaudible) Germany, but when is the right time to divest those and get them out of the hospital ward? What are you looking for to make sure that happens or potential buyers are looking for at this point to commit to buying them? + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Company - Chairman & CEO [39] +-------------------------------------------------------------------------------- + + First, I will just say that I agree with you, that those bottlers are doing really well. Germany is certainly a star in Europe. Southeast Asia bottlers are doing well, particularly Vietnam, the big one that we are running. I think it is important to keep in mind for you that Germany was not in a position to be re-franchised until after 2012, because the consolidation was still taking place. It is really been ready for the last, I feel like 18, 24 months. +It has been the real bright spot in Europe the last couple of years. It is profitable. We need to ensure that we find the right home and the right structure and the right value. And so I could be clear with you that Germany is not a strategic long-term holding, and the right home will be found. None of our, if you like, [BIG] operations are in a way long-term strategic holds. That is what I would say about your question. Irial, you want to add anything to that? + +-------------------------------------------------------------------------------- +Irial Finan, The Coca-Cola Company - EVP & President of Bottling Investments Group [40] +-------------------------------------------------------------------------------- + + The only add I would give is the three markets you mentioned actually are not in a hospital ward. To Muhtar's point, actually they are all performing very well now. We have been very transparent about re-franchising. I've said this many times at conferences that we would re-franchise at the right time. Germany, we've clearly said is ready for re-franchising. +In the meantime, it continues to perform exceptionally well. We have a fantastic group of associates and management in Germany, and feel very good about it. I have also said we expect to get a fair price. Not get overpaid, but get a fair price for territory because we owe that to our shareholders. We take it from there. + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Company - Chairman & CEO [41] +-------------------------------------------------------------------------------- + + Just to build on what Irial said, we are looking for three things in terms of the right partner, description of the right partner: one, proven management team; two, strong financial capabilities; and three, willing to invest in the business and grow the business. Those are the three things. I am confident that we will reach that goal. +Finally, on your question regarding head count reduction, I think you have heard about our previously announced plan, and we are sticking to that plan, simply said. + +-------------------------------------------------------------------------------- +Ali Dibadj, Sanford C. Bernstein & Company - Analyst [42] +-------------------------------------------------------------------------------- + + Okay. Thanks very much. + +-------------------------------------------------------------------------------- +Operator [43] +-------------------------------------------------------------------------------- + + Thank you. Next question is Ian Shackleton of Nomura. + +-------------------------------------------------------------------------------- +Ian Shackleton, Nomura Securities - Analyst [44] +-------------------------------------------------------------------------------- + + Good morning. You announced a deal in China last week, and I was just keen to get a bit more detail of quite how that fits in. It is obviously a very different structure to what we have seen with the more recent deals of Monster or Keurig. + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Company - Chairman & CEO [45] +-------------------------------------------------------------------------------- + + Ian, it is Muhtar. It fits right into the strategy of what we said is bolt-on acquisitions where they make sense, and we will look at them, and where we believe that they fit into our portfolio, where they actually add value. We can generate value for our bottling partners through that acquisition, and it fits right in there, and so that is all I would say about that, Ian. + +-------------------------------------------------------------------------------- +Ian Shackleton, Nomura Securities - Analyst [46] +-------------------------------------------------------------------------------- + + Okay. Thank you. To follow up, for Kathy. I know it can be quite volatile but equity income at this time has almost gone to zero. Is there something specific in that that's causing that? + +-------------------------------------------------------------------------------- +Kathy Waller, The Coca-Cola Company - CFO [47] +-------------------------------------------------------------------------------- + + Our equity income is impacted by currency. We actually don't pull out all of the currency that impacts that because if you think about some of our locations, they have, their geography, they have many geographies. When we report, we take the main currency, and translate that into US dollars. That means that there is still often a lot of currency impact in those numbers. I would read into it that it is a very, very difficult currency environment out there at the moment. + +-------------------------------------------------------------------------------- +Ian Shackleton, Nomura Securities - Analyst [48] +-------------------------------------------------------------------------------- + + Okay. This is not a case of there being some big one-offs in some of the equity holdings there? + +-------------------------------------------------------------------------------- +Kathy Waller, The Coca-Cola Company - CFO [49] +-------------------------------------------------------------------------------- + + No, there is nothing one-off that I'm aware of in the equity holdings. + +-------------------------------------------------------------------------------- +Ian Shackleton, Nomura Securities - Analyst [50] +-------------------------------------------------------------------------------- + + Excellent. Thanks for clarifying. Thank you. + +-------------------------------------------------------------------------------- +Operator [51] +-------------------------------------------------------------------------------- + + Thank you. Next question is Bill Schmitz of Deutsche Bank. + +-------------------------------------------------------------------------------- +Bill Schmitz, Deutsche Bank - Analyst [52] +-------------------------------------------------------------------------------- + + Hi, good morning. + +-------------------------------------------------------------------------------- +Kathy Waller, The Coca-Cola Company - CFO [53] +-------------------------------------------------------------------------------- + + Good morning. + +-------------------------------------------------------------------------------- +Bill Schmitz, Deutsche Bank - Analyst [54] +-------------------------------------------------------------------------------- + + Is there any way to strip out what the benefit in the quarter was on the operating profit side from the extra days? + +-------------------------------------------------------------------------------- +Kathy Waller, The Coca-Cola Company - CFO [55] +-------------------------------------------------------------------------------- + + I guess, Bill, the way I'd think about it is if you take our unit case sales of one and use that as a surrogate, because that doesn't have the extra days in it, and you take pricing of three, (inaudible) pricing, and then I would say that did benefit from positive geographic mix. That will moderate over the back half of the year, so I guess I would think of it using this price mix and average unit sales, unit cases. + +-------------------------------------------------------------------------------- +Bill Schmitz, Deutsche Bank - Analyst [56] +-------------------------------------------------------------------------------- + + Okay, but there is no fixed cost leverage or anything with the extra days that might have helped the gross and operating margin? + +-------------------------------------------------------------------------------- +Kathy Waller, The Coca-Cola Company - CFO [57] +-------------------------------------------------------------------------------- + + The operating expenses, I would say no, there was nothing specific in operating expenses that was helped by the 6 days. Then the sales and distribution expenses are impacted by the 6 days so they wash out, and I would say there is nothing there. + +-------------------------------------------------------------------------------- +Bill Schmitz, Deutsche Bank - Analyst [58] +-------------------------------------------------------------------------------- + + Okay. That is very helpful. Just on BIG, the year-over-year margin expansion was awesome. Massive. What is driving that, and how sustainable is it? + +-------------------------------------------------------------------------------- +Kathy Waller, The Coca-Cola Company - CFO [59] +-------------------------------------------------------------------------------- + + Again, I hate to keep repeating myself, but then we did benefit from the size of the geographic mix, so I think the only thing I would say in terms of it will moderate in the back half of the year. We will get more of our normal run rate of negative geographic mix from concentrate shipments. +Then Sandy talked about the impact of the business mix with the food service business in North America. I think those are the things that basically would say that that number will moderate over the back half of the year, as we are still in a transition year. + +-------------------------------------------------------------------------------- +Bill Schmitz, Deutsche Bank - Analyst [60] +-------------------------------------------------------------------------------- + + Okay. Great. Then just lastly, very quickly, the delay in the Monster transaction, is there any more color you can give us on why? I think it was supposed to close maybe late 2014, early 2015, and then you guys said March, and now it is towards the end of the quarter. Is there still a high probability that it is going to close then? + +-------------------------------------------------------------------------------- +Kathy Waller, The Coca-Cola Company - CFO [61] +-------------------------------------------------------------------------------- + + Yes, there is no issue there. We always expected it to close in the first quarter. Then basically just the regulatory process that we have to go through that is delaying the close. We fully anticipate that it will close. + +-------------------------------------------------------------------------------- +Bill Schmitz, Deutsche Bank - Analyst [62] +-------------------------------------------------------------------------------- + + Okay. Great. That's very helpful. Thanks very much for the time. + +-------------------------------------------------------------------------------- +Kathy Waller, The Coca-Cola Company - CFO [63] +-------------------------------------------------------------------------------- + + Certainly. + +-------------------------------------------------------------------------------- +Operator [64] +-------------------------------------------------------------------------------- + + Thank you. Our final question comes from Judy Hong of Goldman Sachs. + +-------------------------------------------------------------------------------- +Judy Hong, Goldman Sachs - Analyst [65] +-------------------------------------------------------------------------------- + + Thank you. Good morning, everyone. + +-------------------------------------------------------------------------------- +Kathy Waller, The Coca-Cola Company - CFO [66] +-------------------------------------------------------------------------------- + + Good morning. + +-------------------------------------------------------------------------------- +Judy Hong, Goldman Sachs - Analyst [67] +-------------------------------------------------------------------------------- + + I guess most of my questions were answered, so just a couple of P&L questions, Kathy. One, just in terms of the structural items impact this year, it sounds like a slight negative on revenues now as opposed to the prior call. Just a little bit of clarification of the puts and takes on the revenue impact, it sounds like the impact on bottom line is pretty minimal. +Then on the FX, you had the re-measurement gain in Q1 that was about a little bit more than a penny. Is that really what is the difference in terms of your full-year outlook for [PDP] impact being at the low end of that 7% to 8% that you had called out last time? + +-------------------------------------------------------------------------------- +Kathy Waller, The Coca-Cola Company - CFO [68] +-------------------------------------------------------------------------------- + + Hi, Judy. On the structural, the structural is impacted by the timing of the Monster transaction. Then any time we accelerate into the re-franchising, that is also going to impact our numbers. That is why we gave you different structural guidance. +Then on the re-measurement gain, yes, that is basically, where we re-measured that euro debt, that impacted currency positively, and so that is what changed the outlook for currency over the back half of the year, and also the impact of Venezuela and change, using the Simadi rate going forward. + +-------------------------------------------------------------------------------- +Judy Hong, Goldman Sachs - Analyst [69] +-------------------------------------------------------------------------------- + + The timing of the Monster transaction though, the deal itself is delayed, but you are getting the distribution into your bottling in this quarter. That would be still a positive in terms of the revenue benefit, but is re-franchising pacing really what's dragging down in terms of the revenue impact? + +-------------------------------------------------------------------------------- +Kathy Waller, The Coca-Cola Company - CFO [70] +-------------------------------------------------------------------------------- + + The distribution is starting to transition. It has not fully transitioned. That transition will take place over the year, and so at various times, that is not something that is really under our control. That is really under Monster's control, as they transition that. We put an estimate of how we think it is going to transition, so it is not something that is already into our numbers. That is what is slowing up, slower than expected. We expected it to start earlier. + +-------------------------------------------------------------------------------- +Judy Hong, Goldman Sachs - Analyst [71] +-------------------------------------------------------------------------------- + + Right. Okay. That's clear. All right. Thank you. + +-------------------------------------------------------------------------------- +Operator [72] +-------------------------------------------------------------------------------- + + Thank you. I would now like to turn the call back over to Muhtar Kent for closing remarks. + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Company - Chairman & CEO [73] +-------------------------------------------------------------------------------- + + Thank you, Kathy, Ahmet, Sandy, Irial, and Tim. In summary, we are seeing initial progress in our plan to reinvigorate top line growth. However, we still have much to do, and the full benefits from the announced initiatives are going to take time to materialize. 2015 is a transition year as we transform our operating model for sustainable growth amidst a challenging global consumer environment. +While the macro environment remains challenging in the near term, we are confident in our ability to return to sustainable growth. As the long-term dynamics our industry remain promising, our brands and our global system are unparalleled. We are fully dedicated to strengthening our position as the world's leading beverage Company. +As always, thank you for your interest. Thank you for your investment in our Company, and for joining us this morning. + +-------------------------------------------------------------------------------- +Operator [74] +-------------------------------------------------------------------------------- + + Thank you for your participation. That does conclude today's conference. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/exam/original-files/Problem_2_3_Sample_full_transcripts/2015-Aug-19-TGT.N-137786497465-Transcript.txt b/exam/original-files/Problem_2_3_Sample_full_transcripts/2015-Aug-19-TGT.N-137786497465-Transcript.txt new file mode 100644 index 0000000..18c45dd --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_full_transcripts/2015-Aug-19-TGT.N-137786497465-Transcript.txt @@ -0,0 +1,532 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q2 2015 Target Corp Earnings Call +08/19/2015 10:30 AM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Brian Cornell + Target Corporation - Chairman & CEO + * John Mulligan + Target Corporation - CFO + * Kathy Smith + Target Corporation - Incoming CFO + * John Hulbert + Target Corporation - VP of IR + +================================================================================ +Conference Call Participiants +================================================================================ + + * Scott Mushkin + Wolfe Research - Analyst + * Peter Benedict + Robert W. Baird & Company, Inc. - Analyst + * Greg Melich + Evercore ISI - Analyst + * Matt Nemer + Wells Fargo Securities, LLC - Analyst + * Oliver Chen + Cowen and Company - Analyst + * Matt McClintock + Barclays Capital - Analyst + * David Schick + Stifel Nicolaus - Analyst + +================================================================================ +Presentation +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Ladies and gentlemen, thank you for standing by. Welcome to the Target Corporation's second-quarter earnings release conference call. +(Operator Instructions) +As a reminder, this conference is being recorded, Wednesday, August 19, 2015. I would now like to turn the conference over to Mr. John Hulbert, Vice President, Investor Relations. Please go ahead, sir. + +-------------------------------------------------------------------------------- +John Hulbert, Target Corporation - VP of IR [2] +-------------------------------------------------------------------------------- + + Good morning, everyone, and thank you for joining us on our second-quarter 2015 earnings conference call. On the line with me today are Brian Cornell, Chairman and Chief Executive Officer; John Mulligan, currently our Chief Financial Officer, who has been promoted to Chief Operating Officer effective September 1; and Kathy Smith, who has been named Chief Financial Officer effective September 1. +This morning, Brian will discuss our second-quarter performance, including results across our merchandise categories and plans for the third quarter and remainder of the year. Then Kathy will provide her perspective as she prepares to join the team as Chief Financial Officer next month. And finally, John will offer more detail on our second-quarter financial performance and discuss our outlook for the third quarter and full year. Following their remarks, we'll open the phone lines for a question-and-answer session. As a reminder, we're joined on this conference call by investors and others who are listening to our comments via webcast. Following the call, John and I will be available throughout the day to answer any follow-up questions you may have. +Also, as a reminder, any forward-looking statements that we make this morning are subject to risks and uncertainties, the most important of which are described in our SEC filings. Also, in these remarks, we refer to adjusted earnings per share, which is a non-GAAP financial measure, and return on invested capital, which is a ratio based on GAAP information with the exception of adjustments made to capitalize operating leases. Reconciliations to our GAAP EPS and to our GAAP total rent expense are included in this morning's press release which is posted on our Investor Relations website. +With that, I'll turn it over to Brian for his perspective on our second-quarter performance. Brian? + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman & CEO [3] +-------------------------------------------------------------------------------- + + Thanks, John, and good morning to all of you. We are very pleased with our second-quarter financial results, which we announced earlier this morning. Our second-quarter adjusted EPS of $1.22 is 20.6% higher than last year and $0.08 above the high end of the guidance range we provided at the beginning of the quarter. +We are also pleased that once again this quarter, we were able to grow traffic and sales, both in stores and in digital channels, even as we were cycling over a very promotional second quarter from last year. Our second-quarter comparable sales increase of 2.4% was just ahead of our first-quarter performance and consistent with our expectations. Notably, about two-thirds of this comp increase was driven by growth in traffic, combined with a smaller increase in average ticket. +Second-quarter digital sales grew 30% from a year ago, slightly below our expectations, as we compared against very intense digital channel promotions last year. Digital growth contributed about 60 basis points to our comp sales growth this quarter. Our second-quarter gross margin rate was a half percent point higher than last year, as we continued to benefit from favorable merchandise mix and the comparison over last year's promotional markdowns. On the SG&A expense line, we had an unexpectedly strong quarter as we benefited from discipline throughout the organization, along with the impact of expense timing, as John will cover in a few minutes. +With these results, we continue to benefit from very strong cash generation by our core business, which enabled us to return a combined $1 billion to our shareholders in the second quarter through dividends and share repurchase. As we've outlined in the last several quarters, we are working to define clear roles for each of our merchandise categories and devoting resources to growing what we call our signature categories. Style, which includes the majority of apparel; home and beauty categories; along with Baby, Kids, and Wellness. While we're still in the early days of this work, we're already seeing a compelling benefit from our efforts. +Specifically, comp sales in signature categories grew more than 7% in the second quarter, 3 times our overall comp growth. This performance represents an acceleration from the first quarter, when comp growth in signature categories was about double Target's overall comp growth. With strong signature category performance, comps in both home and apparel were in the 4% to 5% range this quarter. +In apparel, results were strongest in baby and kids, along with women's ready-to-wear. Within home, results were strongest in decor and seasonal, including back-to-school. Other category highlights this quarter included toys, part of our kids focus in hard lines, which saw more than a 12% increase in comp sales. This growth helped offset comp declines in electronics, which is a primary beneficiary of the second-quarter promotions last year and where we're also seeing soft sales in tablets. +Outside our stores, our focus on style was evident, as more than 80% of our second-quarter digital channel sales growth was driven by home and apparel. In home, where digital penetration is much higher than average, digital channel growth drove half of our total comp this quarter. +Looking ahead, we'll continue to work to advance the key strategic priorities we laid out last fall. First on our list is to become a leader in digital. This is critically important because guest research shows that digital relevance drives traffic and engagement across all selling channels. While we are pleased with the industry-leading growth we've seen so far this year, we have much more work to do. +And a key asset we'll deploy is our stores. We are already shipping digital orders from approximately 140 stores, and by the end of this year we'll be shipping from more than 450 locations. Ship-from-store capabilities allows us to balance inventory across the network, leverage the capital and labor already in our stores, and reach guests more quickly. +To highlight the benefits of improved shipping times, this fall we'll begin testing what we're calling available to promise, in which we'll offer the guests a specific delivery commitment -- typically two or three business days -- if the guest orders on a specific date. We believe this capability will drive further increases in digital conversion rates, which are already improving rapidly, as guests respond to a faster and firmer delivery commitment. +Second, on the list of key priorities is working on category roles. Beyond our efforts to grow signature categories, we're also focused on testing and learning how we can reposition our food offering to better serve our guests. While this work won't be complete until next year, we are engaged in many small tasks throughout the country to gain a deeper understanding to how guests will respond to potential changes in assortment and presentation. Through guest research, we already know we need to be more clearly highlighting wellness in our food offering through both assortment and the information we provide. +We're also focused on ways to elevate our food presentation and experience to fit the way the guests live and shop. We know we have an opportunity to provide fresh, healthy options and more relevant and localized assortment, as our guests are responding to healthy choices we're offering today. Within food, our market share and wellness is already double our food share overall. And this quarter, we continue to see double-digit sales growth in these important categories. This clearly shows that our guests are already responding when we enhance our assortment of natural, organic, and better-for-you items in our stores. As a result, in the third quarter, we'll continue to expand our wellness assortment in food with new food items in our Made to Matter collection and nearly 50 new items across six categories in our Simply Balanced brand. +Our third priority is it to develop capabilities to offer more localized experiences across our stores and a more personalized digital experience for our guests. While this work is ongoing, we're already seeing encouraging signs of the early progress on both fronts. To inform our localization efforts, we launched a small test in the Chicago market, where we're working with a set of stores to test changes to assortment, presentation, and inventory commitments on certain items. In these stores, we're highlighting locally-relevant items, updating category adjacencies, and changing shelf facings to reflect of the demographics around these individual stores. While this test is still early, we are encouraged with the guest response so far. +Specifically, comp performance in this group of test stores has been 1 to 2 points higher than the rest of the Chicago market and a set of control stores. Items featured in the tests are present in 5% to 10% of the guest baskets in the stores. And we've seen a meaningful improvement in our guest a survey scores for variety of products in the stores. +Given these strong initial results, we are working to quickly build our capabilities and create an operating model that will allow us to scale our efforts across a broader set of stores and demographic clusters. As part of our personalization efforts, last year we replaced a third-party recommendation engine with an internally-developed product which incorporates both in-store and online guest history. +In 2015, we've expanded the use of this engine across our mobile offerings, email, subscriptions, and cartwheel. This new engine is driving a meaningful increase in conversion compared with the results on the prior third-party product, generating incremental sales of $50 million to $100 million so far this year. We've rolled out personalization recommendations to cartwheel only a few weeks ago, but early data indicates the change is driving more than a 10% increase in the number of offers downloaded per user, a critical measure of engagement with this app. +Our fourth priority is to test and rollout new, more flexible formats to urban markets where populations are increasing, guest affinity for Target is high, and our store penetration is low. This quarter, we were very excited to open a new City Target store in Boston; literally, next door to Fenway Park. And we are pleased with the look and feel of the store and the positive response we've seen from our neighbors. We began working to develop the store a decade ago, well before we had smaller formats. And for this project we were able to open a full-size store in a dense urban area. +However, this opening begged the question of the criteria we're using to designate stores as City Target, a Target Express, or simply Target. As a result, we announced last month that going forward, we will no longer use the City Target or Target Express names on any of these new stores. This announcement doesn't reflect a change in our desire to open stores in urban areas. It simply reflects our goal to become flexible in how we fit into every community with an ability to open up a variety of stores, different sizes, and layouts; offer a locally relevant assortment; and provide guests with easy access to items from our entire digital assortment through in-store pickup. +Our fifth and final priority is to advance our growth initiatives by changing the way we work and becoming a more effective and agile organization. This week we announced several changes to our team, including John's promotion to the newly created Chief Operating Officer role and the hiring of Kathy Smith as our new Chief Financial Officer. I am a very excited about these changes and confident that John and Kathy will play a critical role in Target's long-term success. +In the past year I've developed a deep appreciation of John's knowledge and insight, and I believe he is the right person to improve our operations. Retail is changing more rapidly today than any time in my career. And we need to ensure that core operations keep pace with the new ways we're serving the guest. +Over time, Target has developed an incredibly complex supply chain, built to serve an outdated linear model in which product flowed from vendors through distribution centers to stores. To serve guests today, we're becoming much more flexible in the way we fulfill demand for products and services. And this is stretching our supply chain well beyond its core capabilities. +And frankly, as a result, some retail fundamentals have started to suffer. +Specifically, in stocks in our stores have been unacceptable so far this year, and our guests deserve better. In this new role, I've asked to John to focus first and foremost on improving the capabilities of our supply chain, working across organizational boundaries to understand and address root causes that are hampering day-to-day execution. Beyond these immediate needs, I've asked John to continually assess and evolve our capabilities to ensure our operations keep up with our strategy in a rapidly evolving retail landscape. +As we plan to move John into this critical Chief Operating Officer role, it was really important to me that we hired a Chief Financial Officer who is a proven leader, someone capable of upholding Target's strong track record of disciplined financial management. +So I am very excited that we've convinced Kathy Smith to join our leadership team. She's served as a CFO at other large organizations, including Walmart, where Kathy and I were colleagues. I have the utmost confidence in Kathy as a strong financial and business leader. She'll be an outstanding addition to our leadership team, and John and I look forward to supporting her transition into this role. +One year ago, I was only a week into my new position when I spoke on this earnings call. As I look back in the last year, I am very pleased with our progress and confident we're focused on the right strategic priorities, because our guests are responding. As we plan for this year, we face the daunting challenge of sustaining traffic and sales without repeating last year's promotional intensity. +So far this year, traffic and sales are increasing, digital growth is far ahead of the industry, and signature categories are leading the way. Yet we will not slow down. We'll continue to invest in newness, innovation, and presentation, while we focus on maintaining strong execution. We're seeing encouraging results in back-to-school and back-to-college, and we'll work hard to maintain that momentum for the rest of the season. +Also this quarter, we are excited about our new plaid program, including more than 50 items from our latest design partner, Adam Lippes. Beyond Adam's design, our plaid takeover will feature hundreds of other products across a broad set of categories. Beyond apparel, accessories, home, and pets, you'll find plaid soda bottles, shampoo, bandages, paper towels, and more. We are pleased with the early guest reaction and the media buzz, and looking forward to rolling out these items throughout the quarter. +Target is also featured prominently in the September issue of Vogue, which includes a 21 page insert where we've reimagined some of the most iconic covers by incorporating products we sell. This insert will be digitally shoppable, so our guests can go behind the scenes to buy what they see and access additional content. And while they'll become even more important in the fourth quarter, we're already ramping up our support around this year's hot licensed products for kids both young and old from Minions to Marvel, Avengers to Peanuts, and, of course, Star Wars. These licenses are prominent in our assortment of back-to-school backpacks. And this fall we'll feature them on Halloween customs, decor, apparel, toys, and much more. +Before I end my remarks, I want to pause and thank the Target team, including the colleagues I met on my recent trip to India, who are doing amazing work in sourcing and technology, to support our strategic growth priorities. For our team members around the world, this has already been a very eventful year as we've made changes to our team and our structure to better support our guests. Throughout all these changes, the team has remained resilient and energetic, with a passion to serve our guests that is contagious. +Every day I step back and marvel at the amazing things this team can deliver, iconic marketing, amazing products at an incredible price, fast and easy digital experiences, and, of course, a unique store experience that brings our Expect More Pay Less promise to life every day. None of this would be possible without our great team. And the outstanding results we've seen so far this year are a testament to their efforts. +Now, I'd like to turn the call over to Kathy Smith. Kathy won't officially begin her role until September 1, but I'm pleased that she's here today, to introduce herself and share a few thoughts about target and her new role. Kathy? + +-------------------------------------------------------------------------------- +Kathy Smith, Target Corporation - Incoming CFO [4] +-------------------------------------------------------------------------------- + + Thanks Brian, and good morning, everyone. Like Brian, I have long admired Target as a retailer and an iconic brand and a great American Company. During my career, I've had the opportunity to be Target through the lens of a competitor and, of course, a guest. And now I'm really excited and humbled to have the opportunity to join the team as we work to transform how we serve guests while preserving what consumers love about this brand. While I won't start working here until next month, I've really enjoyed getting to know the leadership team and I've had the opportunity to meet with many of the members of the finance team this week. +Target's success comes from many things. Beyond the iconic brand, the Company has an impressive array of owned and exclusive brands. As a guest and someone who loves retail, I am constantly impressed by Target's ability to deliver new, trendy, high-quality items at amazingly low prices. And I just know there are incredible product designs, develop, and sourcing teams behind those items. +In addition, I appreciate that Target has just at 1,800 well-maintained great-looking stores in convenient locations, delivering a great shopping experience. And near and dear to every CFO's heart, we have a healthy balance sheet, which, when combined with our strong cash flow generation, creates ample capacity to fund robust investments in growth and the return of billions of dollars to shareholders annually through dividends and share repurchases. +And lastly, Target is full of passionate team members who work tirelessly to serve our guests everyday and who are proud of their Target. Let me tell you a brief story. As I was exploring the possibility of joining this amazing Company, I wanted to move beyond the familiar experience of shopping at my Target, so I dedicated a couple of weeks to visit more than 65 stores across 10 states, and I drug my family along for most of the ride. I spoke to guests in every store I visited, and I can tell you that they are clearly demanding enthusiasts. They love Target, and they enjoyed sharing their personal stories about why they choose to shop with us. +Before I close, I want to say that I'm looking forward to reconnecting with those of you I know and getting to know those of you I don't. I plan to spend my first few months with the team immersing myself in the business to ensure I have a detailed understanding of where we've been, where we are today, and where we need to go in the future. With that foundation, I look forward to meeting you and hearing your perspective. +Now I'll turn it over to John who will share his insights on our second-quarter financial performance and our outlook for the third quarter and beyond. John? + +-------------------------------------------------------------------------------- +John Mulligan, Target Corporation - CFO [5] +-------------------------------------------------------------------------------- + + Thanks, Kathy, and hello, everyone. We are really pleased with our second-quarter results, as virtually every line on the P&L came in at or better than our expectations. Compared with our guidance going into the quarter, overall comparable sales were in line with expectations, but the mix of store sales was a bit stronger than expected. Second-quarter gross margin performance also met our expectations. But SG&A expense performance was much better than planned, reflecting our continued efforts to control costs, along with the impact of a timing change in marketing expense. +As a result, our second-quarter adjusted EPS was $1.22, $0.08 above the high end of the guidance range provided at the beginning of the quarter. Second-quarter EPS through continuing operations was $1.21, $0.01 lower than adjusted EPS. As pretax restructuring costs and breach-related expenses, worth $0.01 each, were partially offset by a $0.01 benefit from the favorable resolution of income tax matters. +Second-quarter GAAP EPS of $1.18 reflects a $0.03 loss on discontinued Canadian operations, compared with a $0.25 loss on Canadian operations last year. This year's Canada losses were consistent with our expectations as an increase in our accrual for estimated probable losses, primarily guarantee of leases, was offset by an adjustment to the tax benefit from the Company's investment loss in Canada. +Our second-quarter comparable sales increase of 2.4% was just ahead of our first-quarter performance and consistent with our guidance at the beginning of the quarter. Within the quarter, comps were strongest in May and June. However, this year's monthly pattern was the mirror image of last year's second quarter when the comp growth was strongest in July, which featured the most intense promotions in the quarter. As a result, on a two-year basis, monthly comp trends were very consistent throughout the quarter. +Importantly, transactions were positive both in stores and online throughout the quarter, driving two-thirds of our comparable sales growth. Digital channel sales increased 30% in the second quarter on top of more than 30% growth in the second quarter last year. As Brian mentioned, second-quarter 2014 was intensely promotional. And those promotions were a key driver of digital channel sales last year. Looking ahead, we will continue to focus on achieving our digital channel sales goals through a combination of both traffic growth and conversion improvement. +REDcard penetration was 22.1% in the second quarter, about 130 basis points ahead of last year. Portfolio delinquency and write-off metrics are at historically low levels, and we continue to see an increase in payment rates. This means the size of the portfolio continues to slowly decline, but better-than-expected risk metrics are offsetting this impact. As a result, profit sharing income on the portfolio was up this quarter compared to last year. +One other note, this week we began accepting EMV or chip card transactions, at all stores across the country. As a result, this quarter we will initiate the process of replacing all of our REDcard products with chip and pin cards, including our private label credit and debit products. While sales were in line with expectations, our second-quarter segment EBITDA margin rate of 10.9% was much stronger than expected. +Our second-quarter gross margin rate of 30.9% was 0.5 point higher than a year ago, right on our guidance. Consistent with the first quarter, this year's rate benefited from lower markdowns as we annualized last year's post-breach promotional activity, and we saw very favorable mix of sales in our signature categories. I mentioned this last quarter, but I want to emphasize it once again. It is really important that we've been able to grow our traffic in sales, even as we cycle over very intense promotions last year. +Beyond the benefit of growing sales, there is a compelling gross margin benefit from growing our signature categories three times as fast as the Company, which more than offsets the pressure on our cost of goods for investments in quality, innovation, and presentation. +On the SG&A expense line, we had a standout quarter, with rate improvement of about 60 basis points compared with last year. This performance was driven by outstanding discipline across the enterprise, combined with the benefit of our cost control initiatives. These benefits more than offset a 40 basis point headwind from incentive compensation, which was unusually low in the second quarter 2014 in light of the financial performance we were experiencing at the time. +As I noted earlier, marketing expense timing was a meaningful benefit this quarter. As last year's second-quarter spending was unusually high to support our promotions. And this year we've re-timed some spending into the third-quarter in support of our back-to-school licenses and Target style. This timing shift benefited our second-quarter SG&A rate by about 30 basis points, or about half our overall rate favorability. And we expect this shift will reverse in the third quarter. +Before I leave our segment discussion, I want to comment on our quarter end inventory position, which was about 4% above last year. This reflects a meaningful improvement from the 9% year-over-year increase we reported at the end of first quarter, driven by issues at the West Coast ports. While we made a lot of progress in the second quarter, the year-over-year increase has moderated even further so far in August, as our quarter-end inventory supported back-to-school sales that moved into early August as a result of re-timing of some tax-free holidays. +Bottom line, we feel very good about our overall inventory levels in relation to our sales plans. However, we have a big opportunity to improve in-stock levels which I'll cover in a few minutes. +One note, you'll see on the balance sheet that we've moved pharmacy inventory into the other current assets line in all periods, reflecting the current status as held-for-sale pending the close of our transaction with CVS. +Moving to consolidated metrics, second-quarter interest expense was $148 million, flat to second-quarter 2014, excluding last year's $285 million charge for early debt retirement. We paid second quarter dividends of $331 million, up 22% from last year, and we invested another $675 million to retire shares. That adds up to a total of $1 billion returned to our shareholders this quarter, representing more than 130% of net income. +Looking ahead, with healthy business results and an ample cash position, we expect to have the capacity to continue to returning a meaningful amount of cash through both dividends and share repurchases within the limits of our current investment-grade credit ratings. As anticipated, given our continued desire to repurchase shares, in the second quarter, our Board of Directors approved a $5 billion increase in our share repurchase authorization. +As of quarter end under this program, we have retired more than 65 million shares at an average price of just over $67 a share, for a total investment of about $4.4 billion. With the expansion of the program, we expect to have sufficient repurchase authority well into next year, including any potential repurchase resulting from the proceeds of the CVS transaction. Regarding that transaction, things are continuing as expected as we work with CVS and regulators to advance the process of gaining approval for the sale. +Given the uncertainty of potential timing for regulatory approval and the closing of the transaction, the guidance we provide today does not reflect any expected impacts of the transaction, which includes application of proceeds and removal of prescription sales, costs, and assets from our financial statements. +As I described last quarter, this year we began reporting return on invested capital from continuing operations, or ROIC, because we believe it is an important metric in assessing the quality of our capital allocation decisions over time. And as we covered in the financial community meeting in March, our goal is to reach the mid teens or higher on this metric over the next five years. Not surprisingly, given our strong operating results, we reported a meaningful improvement in trailing 12-month ROIC this quarter, as it grew 2 full percentage points to 13.3%, compared with 11.3% a year ago. +Now let's move to our outlook for the third quarter and the remainder of the year. In the third quarter we are cycling over stronger sales results from last year, both in stores and digital channels. And we expect the consumer and competitive environment to remain choppy. As a result, we are planning for a third-quarter comparable sales increase of 1% to 2%, including expected digital channel sales growth of about 30%. We expect our third-quarter gross margin rate to increase 20 basis points to 30 basis points compared with last year, reflecting a continued mix from the signature category sales and the benefit from cycling last year's promotional activity, partially offset by investments in quality and price on our own and exclusive brand products. +On the SG&A expense line, we expect our third-quarter rate will be about flat to last year, as the benefit from cross control is expected to be offset by a 30-basis-point headwind from the shift in marketing spend from Q2. Combining our gross margin and expense rate reductions, we're looking for improvement in our third-quarter EBITDA and EBIT margin rates of 20 basis points to 30 basis points compared with last year. +Third-quarter interest expense is expected to be approximately flat to last year and tax expense is expected to increase by about $60 million, reflecting improved profitability and non-recurring favorable tax items in third quarter last year. Altogether, these expectations would lead to third-quarter adjusted EPS of $0.79 to $0.89, compared with $0.79 a year ago. Note that this includes the impact of the shift in marketing timing, which translates to a $0.05 per share headwind in the third quarter. +As we look ahead to the full year, we are certainly pleased with our results so far, which have been notably stronger than expected. And we've been pleased with comp performance so far this month, including back-to-school sales, which reflected re-timing of some tax-free holidays into early August. +At the same time, we remain mindful of the intensely competitive nature of our holiday season and have noted the inventory levels we're seeing at some competitors. Taking both of those factors into account, we are updating our guidance for the full-year adjusted EPS to $4.60 to $4.75, a $0.10 increase compared with the prior range. +Before I conclude my remarks, I want to pause and comment on my priorities as I enter the new role as Chief Operations Officer next month. As Brian mentioned, the number one priority for my new team is to improve the way our supply chain functions from end to end. Achieving this goal will lead too many benefits. Perhaps the most visible of which is an improvement in our in stocks. Given the breadth and complexity of our business, it will always be a challenge to be in stock on every item in every store in every moment of every day. +But our guests need us to be consistent in delivering everyday essentials. And unfortunately, in the last couple of quarters, our in stocks have been deteriorating. This challenge is understandable because we been asking our supply chain to move well beyond its original design and become more flexible in the way we serve our guests. However, while we understand the reasons, the simple fact is that our current performance is unacceptable. +So beginning this quarter, my team will be looking for both quick and more comprehensive solutions to make improvements in the supply chain both this year and over time. And beyond this initial effort, we will work to ensure that our operations and strategy move in lock step enabling us to serve our guests in a rapidly evolving retail landscape. +I look forward to updating you on our progress over the coming months and years. +With that, we'll conclude today's prepared remarks. Now, Brian, Kathy, and I will be happy to respond to your questions. + + +================================================================================ +Questions and Answers +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) +Oliver Chen, Cowen and Company. + +-------------------------------------------------------------------------------- +Oliver Chen, Cowen and Company - Analyst [2] +-------------------------------------------------------------------------------- + + Hi. Congratulations on a really solid quarter and all the traffic. Brian, as you've been so successful in this journey, as traffic has come back to the stores, just a bigger-picture question. How do you think your priorities have dynamically changed throughout the year? +And where would you say Target is in terms of customers coming back to the store versus increasing customer spend? And, John, I just had a question related to the comp guidance as well. + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman & CEO [3] +-------------------------------------------------------------------------------- + + Overall, I think we're making really good progress against our key strategic initiatives that we've been talking about for a year now. The change we announced this week is to make sure that we elevate our focus on execution and really ensuring operational excellence throughout the organization. And that's why I'm so excited about John stepping into this new role to make sure that we complement the focus we've placed upon creating strategic clarity with a recommitment to operational execution. +And I think the combination of those two elements is critical to continuing to drive traffic, make sure we delight the guests, see an improvement in our net promoter scores, and make sure that both in-store and online, we're continuing to see an acceleration in traffic and visits to our site. +So I think we're making very good progress right now. I think that is showing up in the results we delivered this quarter. But we're not satisfied. And we know we've got more work to do to ensure that we do meet the needs of the guests every time they shop. And critically important in meeting those needs is to make sure that we provide a great in-store experience and dramatically improve our in-stock conditions, particularly about core essentials. +So I think very good progress. I think this is an excellent quarter where the entire team performed well. But we know we've got more work to do, and we've got to make sure both in-store and online, we deliver a consistently great experience for the guest. + +-------------------------------------------------------------------------------- +Oliver Chen, Cowen and Company - Analyst [4] +-------------------------------------------------------------------------------- + + Thanks, Brian. And John, I just had a question on the comp guidance, would you expect this to be pretty broken out between traffic or ticket? Or do think it's going to be more traffic led? +And as you do embark on the opportunity and supply chain, what are you highlighting as the lower hanging fruit in terms of timing? And I was just curious about the categories that you see the most opportunity for when you think about further advancing your supply chain? + +-------------------------------------------------------------------------------- +John Mulligan, Target Corporation - CFO [5] +-------------------------------------------------------------------------------- + + So on the comp guidance, we don't break out traffic and ticket. But I would tell you just from a business perspective, we are very focused on driving traffic over time. Ultimately, we have to bring people into our stores. We need to bring people to the site, onto mobile devices. And so that's a key driver for us for our sales as we continue to move forward. +Related to the supply chain, there's -- the team has done a great job responding to the needs of the organization over time to develop more flexible ways to meet the needs of our guests and really fulfill on-demand shopping. I think we're just at a point now where we need to step back and build broader capabilities across the entirety of the supply chain as we continue to expand the way we want to serve our guests. +So there is not one particular area of the Company or one particular part of the business that we are completely focused on. [Absent], I would tell you, as I said, and you heard from Brian, in stocks are a key priority. And then specifically, being sure day to day in every store we're in stock on essentials. That's a key priority for our guests. We hear it from them. +It's a key focus for the team, and we have teams working on improving those in stocks across our essential categories today. And that will be a focus as we go forward. + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman & CEO [6] +-------------------------------------------------------------------------------- + + Oliver, I can build on that because as we talk about improving our focus on operational and executional initiatives, I go back to some conversations we've had in the past. I absolutely believe we have the best team in retail. Our store operations -- Tina and her team do a sensational job. +But one of the things that John will be focused on is ensuring we simplify the work. And we make it much easier for them to execute each day and take care of the guest. So we want to complement a very strong store leadership team that does a sensational job each and every day, executing store by store, by simplifying some of the work, by making sure that we push work upstream, and allow them to focus even more on the store experience and the service we provide our guest. + +-------------------------------------------------------------------------------- +Oliver Chen, Cowen and Company - Analyst [7] +-------------------------------------------------------------------------------- + + Thanks a lot. Best regards for the holiday season. + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman & CEO [8] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Operator [9] +-------------------------------------------------------------------------------- + + Matt Nemer, Wells Fargo. + +-------------------------------------------------------------------------------- +Matt Nemer, Wells Fargo Securities, LLC - Analyst [10] +-------------------------------------------------------------------------------- + + Thanks for taking my questions. John, congrats on your new role. And Kathy, it's nice to have you back in the retail sector. First, I was wondering to what extent you are using price to drive the 3x growth in signature categories. Can you comment on what the growth in gross profit dollars for those categories has been like? + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman & CEO [11] +-------------------------------------------------------------------------------- + + Matt, I would tell you that the improvements we are seeing is really driven by mix. And as we've talked about, we've invested heavily in ensuring we're on trend; we're bringing great quality to the guest; we're accentuating our position in key categories. We were really pleased during the quarter to see how well be connected with sub cats like swim. We've seen really strong performance in ready-to-wear, and most recently, a very positive response to the changes we've made in denim. +So the improvements we are seeing in those categories are really driven by great quality, following the trend curves, bringing great style, and fashion to our guest. And it has not been driven by a reliance on pricing. + +-------------------------------------------------------------------------------- +Matt Nemer, Wells Fargo Securities, LLC - Analyst [12] +-------------------------------------------------------------------------------- + + Okay. That's helpful. And then, secondly, your comments regarding the supply chain being stretched, I realize that the analysis is just starting or in the early days. But do you believe that there is a significant reinvestment required in the supply chain in terms of either DCs or [FCs] or something else? + +-------------------------------------------------------------------------------- +John Mulligan, Target Corporation - CFO [13] +-------------------------------------------------------------------------------- + + No. Matt, we're in a place where we have, we believe, just great, great assets across the supply chain. Great distribution centers, great upstream distribution centers, food distribution centers, fulfillment centers, and, of course, the stores. +I think we've said over the past couple of years, our focus of our investment has been supply chain and technology in support of becoming an on-demand company. That will continue to be the case. We're going to continue to invest in technology and supply chain. But the physical asset side, we feel really, really good about. + +-------------------------------------------------------------------------------- +Matt Nemer, Wells Fargo Securities, LLC - Analyst [14] +-------------------------------------------------------------------------------- + + Okay. That's great news, and then if I could just sneak one more in. The early back-to-school strength and the marketing shift, is that fully embedded into the Q3 comp guide? + +-------------------------------------------------------------------------------- +John Mulligan, Target Corporation - CFO [15] +-------------------------------------------------------------------------------- + + It is. And it would be. And we are seeing a very positive start to back-to-school and back-to-college. + +-------------------------------------------------------------------------------- +Matt Nemer, Wells Fargo Securities, LLC - Analyst [16] +-------------------------------------------------------------------------------- + + That's great news. Thanks again. + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman & CEO [17] +-------------------------------------------------------------------------------- + + Thanks, Matt. + +-------------------------------------------------------------------------------- +Operator [18] +-------------------------------------------------------------------------------- + + David Schick, Stifel. + +-------------------------------------------------------------------------------- +David Schick, Stifel Nicolaus - Analyst [19] +-------------------------------------------------------------------------------- + + Hi. Good morning. + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman & CEO [20] +-------------------------------------------------------------------------------- + + Morning. + +-------------------------------------------------------------------------------- +David Schick, Stifel Nicolaus - Analyst [21] +-------------------------------------------------------------------------------- + + Wondering if you could give us a few more examples, concrete examples, of how your driving that localization success in Chicago, categories or items? And separately, if you could talk a little bit about digital approach outside of your own platform? +So we've seen it and we've heard from you what you're doing and that's exciting and driving growth. But we've seen a little bit of your outreach to bloggers and how you're working with them. If you could talk about the full view of how you are thinking about digital outside of the Target headquarters, that would be helpful as well. Thank you. + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman & CEO [22] +-------------------------------------------------------------------------------- + + Sure. Let me start with localization. And as I said, during the last couple of calls, this is still a very nascent effort for us. We're in one market, a handful of stores in Chicago. But we've really been focusing on a handful of areas where we recognize we need to change our assortment, change our presentation, be more relevant, and really recognize the needs and the demographics of these local markets. +So there's a handful of categories I might lift up. One, craft beer. And really making sure that in a category like craft beer, we have locally relevant items. And we recognize that even in a market like Chicago, those need to be tailored neighborhood by neighborhood. +So we've looked at specialty foods; we've looked at categories like craft beer. We've looked at categories like patio and grills. And recognizing that in the suburbs of Chicago, we can offer, and should have in store, large patio sets, five-burner grills. +But for our stores located in more of the urban neighborhoods, of Chicago, we need bistro tables. And we need two-burner grills, because those guests are living in condos and apartments. They've got small patios, and we need to make sure we tailor our assortment and our presentation to recognize their needs and to make sure we're mode locally relevant. +So we're certainly spending a lot of time looking at food. And as we think about the food reinvention, a lot of this is going to be driven by making sure we have locally relevant brands, those hometown favorites. And also in broader categories, like patio and furniture, making sure that we're matching up our assortment in-store with the needs of that local guest. +So a lot of additional work for us to do, but we're really pleased with the progress. And I talked about a 1 to 2 point lift versus the test and control stores. That is a very important measure for us to continue to evaluate. And working with John and our merch team, we'll be looking to rapidly rollout the learning from Chicago into other relevant markets. +From a digital standpoint, David, obviously, we continue to see really positive responses in some of our efforts like Cartwheel. And Cartwheel has now been downloaded over 18 million times. And every time I'm in stores, I run into guests that have their smartphone in their hand and they are looking for their offers from cartwheel. +But we also recognize that Target is a brand that's talked about in social media, every day, thousands of times every day. So if you were to visit our headquarters here in Minneapolis, just down the hall from my office, we have what we call guest central. +It's our guest command center where we're monitoring what people are talking about, what they are blogging about, how Target's being referenced in the news. And we're making sure we're very engaged with those bloggers and making sure that we are in the discussion. So it's a very important part of how we think about the brand and making sure that we incorporate social into our overall brand development initiatives. + +-------------------------------------------------------------------------------- +David Schick, Stifel Nicolaus - Analyst [23] +-------------------------------------------------------------------------------- + + Thanks a lot. + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman & CEO [24] +-------------------------------------------------------------------------------- + + Thank you, David. + +-------------------------------------------------------------------------------- +Operator [25] +-------------------------------------------------------------------------------- + + Scott Mushkin, Wolfe Research. + +-------------------------------------------------------------------------------- +Scott Mushkin, Wolfe Research - Analyst [26] +-------------------------------------------------------------------------------- + + Hey, guys. Welcome, Kathy, and congratulations, John. Looking forward to working with you guys in your new capacity as we move forward. The stock, obviously, was up a lot. Earlier today it's kind of rolled over, and I think it's the sales line that people may be a little concerned about, the 1% to 2% guidance to the third quarter. +But I would also look out over time -- SG&A saves obviously taper down. And so as you look out to 2016 and 2017, getting the sales line moving is going to be more important here. I know, Brian, you pointed to some things like the signature categories, but I was wondering what else gives you confidence? +We actually have a lot of confidence because our focus groups are saying to us that people are really responding to what you guys are doing? But in your words what gives you the confidence we can see sales trend higher overtime? + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman & CEO [27] +-------------------------------------------------------------------------------- + + Well, I think it starts, Scott, with the reaction we've seen from the guests to some of the changes we've made in signature categories. When I think about, in today's marketplace, apparel growing at 4% to 5%; the changes we've seen and the reaction we've seen from the guests to our home offering; the fact that within kids, toys growing this quarter at 12%. +And while, again, still in the early stages, the reaction to some of the changes we are making in our food assortment; the reaction the guest is taking to Made to Matter; our wellness initiatives, gives me a tremendous amount of confidence that as we continue to bring great design, fashion, quality, and excitement to our signature categories, and combine that with the opportunity to reinvent food, to bring the right assortment that meets the needs of our guests. That to me is the magic to unlock sustainable sales growth at Target and make sure we're driving traffic to our stores, more visits to our site. +And it gets back fundamentally, Scott, I believe we win. And we'll continue to grow by combining a great story experience, the convenience of allowing our guests to order online and pick up in our stores whenever they want, and also being able to ship directly to their homes and using our stores as flexible fulfillment centers to make sure that response is a quick one. +So I'm very optimistic about the future. I think you are starting to see that embedded in the results, and the results in signature categories is very encouraging for us. We're getting great feedback from the guests. +As I think about the third quarter, we expect Plaid to be a really exciting initiative, and the buzz that we are seeing already is really positive. So we've got work to do on food. But when we reinvent food and get the assortment right there and improve the presentation, I think that gives us all great confidence that we're going to continue to drive traffic to our stores. And that's going to convert to really solid and sustainable comps. + +-------------------------------------------------------------------------------- +Scott Mushkin, Wolfe Research - Analyst [28] +-------------------------------------------------------------------------------- + + All right. That's perfect. And then maybe just -- I hate to be the short-term focus, but it's a question I get all the time. As we look at the fourth quarter, we are going to be going over a pretty significant comp from last year. How should we think about that? +I mean, a lot of people look at stacks. Do you guys look at stacks? How do you think we should start framing the fourth quarter, maybe in a thought there? + +-------------------------------------------------------------------------------- +John Mulligan, Target Corporation - CFO [29] +-------------------------------------------------------------------------------- + + I think we can all drive ourselves crazy doing two-year, three-year, five-year stacks whatever you want. But in this case, I do think the two-year stack is important. We've continued to see our two-year stacks improve. If you do last year's Q4 against the previous Q4, the average there is about -- or the number there is about a [1/3]. So we expect to cycle path that this Q4. +And we've seen putting our -- putting the applied guidance -- you guys can do a rough number around that. Putting that against last year's comp will be in acceleration of our two-year stack. And so we feel good about that. And I think to the points Brian just made, part of it is we need to continue to grow. +We feel confident we're going to continue to grow and comp against whatever it is we delivered in the prior year, and we feel good about doing that. We feel great about our fourth-quarter plans. We're cognizant that that's an intensely competitive time of year. We'll be very promotional. We're not going to get beat on promotions, and we'll be in the game. And we feel really good about what we'll offer the guests in Q4. + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman & CEO [30] +-------------------------------------------------------------------------------- + + Yes. And Scott, obviously, we'll update our guidance for the fourth quarter at a later date. But trust me, we are spending a tremendous amount of time evaluating our plans week by week in the fourth quarter. I spent time just yesterday with our team, going through our fourth-quarter plans, our merchandising plans, our marketing plans, how we're going to approach the key holiday periods. +And, to me, it's all about making sure we've got the right content. We've got to have great product. We certainly know we need to make sure we're winning from a promotional standpoint. But then we've got to make sure we surround the guest with a great experience and really iconic marketing. And I think we're going to combine a great in-store with an online experience and be very competitive and well-prepared for the fourth quarter. + +-------------------------------------------------------------------------------- +Scott Mushkin, Wolfe Research - Analyst [31] +-------------------------------------------------------------------------------- + + Perfect, guys. I'll yield. Those were great answers. I appreciate it. + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman & CEO [32] +-------------------------------------------------------------------------------- + + Thanks, Scott. + +-------------------------------------------------------------------------------- +Operator [33] +-------------------------------------------------------------------------------- + + Matt McClintock, Barclays. + +-------------------------------------------------------------------------------- +Matt McClintock, Barclays Capital - Analyst [34] +-------------------------------------------------------------------------------- + + Hi. Yes. Congratulations both John and Kathy on the new roles. I was just wondering if we could focus just -- I know we've talked a lot about the signature categories. You've talked a lot about supply chain, but can we focus on -- and you've also talked about food -- can you focus a little bit on electronics? Continued weakness there. +Clearly the industry itself is a little bit challenged, but a lot of consumer interest in new products in that category, especially as we go into the holiday season, this upcoming holiday season you're talking about the fourth quarter. Maybe dive a little bit into what you're doing there in that specific category to try to gain market share in what is a challenged category. Thank you. + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman & CEO [35] +-------------------------------------------------------------------------------- + + So Matt, I'm not going to go through the details of our plans. We'll kind of maintain that powder for the fourth quarter. But we are certainly looking at newness in electronics. We're looking at categories where we think we are uniquely positioned to win. +So working very closely with our suppliers, to ensure that we have the right newness, that we're ready with the right presentation. I think there's a lot of exciting things in the pipeline. We certainly think, as we continue to focus on wellness, that wearable technology is a space where we can and will win. +But we also recognize right now that many of those categories are waiting for new innovation. And we're working closely with our key suppliers to make sure that we are going to be bringing that innovation to the guest and featuring it throughout the fourth quarter. + +-------------------------------------------------------------------------------- +Matt McClintock, Barclays Capital - Analyst [36] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Operator [37] +-------------------------------------------------------------------------------- + + Peter Benedict, Robert Baird. + +-------------------------------------------------------------------------------- +Peter Benedict, Robert W. Baird & Company, Inc. - Analyst [38] +-------------------------------------------------------------------------------- + + Hey, guys. Two quick ones. First, on the digital side, obviously impressive growth, 30%. I think the longer-term plan is closer to 40%. So curious, two things. One, what gets that channel growing faster the next couple of years? +And related to that, a number of large retailers out there are opening up a dedicated eCommerce fulfillment centers. I don't believe you guys have those. Is that something that makes sense for Target as you think out over the next few years? + +-------------------------------------------------------------------------------- +John Mulligan, Target Corporation - CFO [39] +-------------------------------------------------------------------------------- + + I'll take the second one first, and then let Brian comment on the growth. I think on our supply chain for the digital channel, we actually have six dedicated fulfillment centers. +And we think the combination of fulfillment centers with our existing regional distribution centers, and along with the stores, gives us all the capability we need. And then you'll see us continue to grow the store channel, our regional distribution channel, all three of those channels, as ways to fulfill, depending on the product and how quickly the guest wants it. + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman & CEO [40] +-------------------------------------------------------------------------------- + + Yes. And Peter, I'll step back and just talk about some of the fundamentals. We've got to continue to make sure we build awareness. We've got to make sure that as our guest engages with us digitally, we make it really easy. We make it easy to find product, an easy checkout experience. +We believe that Available-to-Promise, which will roll out this fall, will give our guest the confidence that they know where the product is and when it will arrive for them. Either in a store for them to pick up or being available directly to their home. +So we are focused on making sure that we provide, not only a great in-store, but a great digital experience. And we've got to make sure that we continue to make our site easy to work with. And more and more that's the mobile interchange that we've got to make sure is easy for our guest to find product and check out. +We want to give them the confidence that when they order, they know it's available to promise. And we're going to have it there for them when they need it. And to the point John made, we don't need to be building upstream DCs. We're going to continue to convert more of our stores and as we go into the fourth quarter, close to 450. That will act as flexible fulfillment centers to make sure that we can quickly and efficiently get product to the guest. So those fundamentals are critically important as we think about driving industry-leading growth. + +-------------------------------------------------------------------------------- +Peter Benedict, Robert W. Baird & Company, Inc. - Analyst [41] +-------------------------------------------------------------------------------- + + Okay. That's helpful. And sorry, my bad, on that DC question, but thank you for that. And then quickly over to SG&A, I think you guys have outlined $1.5 billion over the next couple of years in savings, $500 million maybe coming this year. Where are you trending towards those savings? How are those savings kind of corporate versus in-store? I'm just curious how store level payroll dollars compare today versus, let's say, a year ago? + +-------------------------------------------------------------------------------- +John Mulligan, Target Corporation - CFO [42] +-------------------------------------------------------------------------------- + + Yes. So we're right on track with savings. We've got programs identified to deliver the entirety of the [$2 billion], the $1.5 billion in SG&A, plus the cost of goods savings. So we feel really good about that. We're on track for our commitment this year as well. +One of the things we talked about when we first announced this, and we've talked about it in a great detail in the Company, is the stores are already productive. And if we're going to take hours out of the store, it will be because we eliminate work, or to the point Brian made earlier, move work upstream into the distribution centers. And so we're not focused on taking hours out of the store. +We are focused on taking work out and we haven't -- we're in the process of working through that. That's a little bit longer lead process than some of the other things we've done. But we are very focused on, essentially, freeing up those hours in the store. And then we'll decide, do we need them for improved guest service or how we'll utilize them. +But in fact, there's a couple areas where we have invested hours back into the store. As we put in the whole merchandising sets and as we put in manikins, we've realized the need for dedicated store team members who can merchandise those displays and make them look great all the time. So that's an area where we've invested back into the store. + +-------------------------------------------------------------------------------- +Peter Benedict, Robert W. Baird & Company, Inc. - Analyst [43] +-------------------------------------------------------------------------------- + + Thanks for that, John, and good luck in the new role. + +-------------------------------------------------------------------------------- +John Mulligan, Target Corporation - CFO [44] +-------------------------------------------------------------------------------- + + Thanks. + +-------------------------------------------------------------------------------- +John Hulbert, Target Corporation - VP of IR [45] +-------------------------------------------------------------------------------- + + All right, we have time for one more question this morning. + +-------------------------------------------------------------------------------- +Operator [46] +-------------------------------------------------------------------------------- + + Greg Melich, Evercore ISI. + +-------------------------------------------------------------------------------- +Greg Melich, Evercore ISI - Analyst [47] +-------------------------------------------------------------------------------- + + Hi, thanks. Made it in again. Kathy, welcome. John, I can't let you get promoted without hitting you with the finance questions. So how much did credit help? You said credit, I think, was a benefit in the core of the profit share. How much did that help in the quarter? +And linked to that, how should we think about SG&A dollar growth? It sounds like third quarter will be up [1 point to 2 points] with the comp. But it was flat in the second quarter. What's the normal run rate there now? + +-------------------------------------------------------------------------------- +John Mulligan, Target Corporation - CFO [48] +-------------------------------------------------------------------------------- + + Yes. Good questions. On the credit side, the benefit, it was up, but not meaningful. And it was less than, I'd say, less than half a penny of improvement versus last year. So very, very small. We are pleased it was up given that the, as we said, payment rates continue to go up. And so we're seeing the portfolio continue to shrink. So clearly, a portion of where the gas dollars are going, at least from our perspective. +SG&A through time, we'd expect to lever SG&A, go up, over the long term here, go up modestly, slower than sales growth. I think we've said we're going to continue to take expense out. But we also said that the majority of that expense will likely get reinvested. So I wouldn't count on big reductions in our SG&A over time. There will be places where we have to add back expense to meet the needs of our guests I just talked about in the stores. So modestly slower than sales growth over the long term would be what I'd say. + +-------------------------------------------------------------------------------- +John Hulbert, Target Corporation - VP of IR [49] +-------------------------------------------------------------------------------- + + Well, great. Thank you. And for all of you, that concludes our second-quarter earnings conference call. And I really appreciate you joining us today, so thank you. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/exam/original-files/Problem_2_3_Sample_full_transcripts/2015-Feb-10-KO.N-138013855540-Transcript.txt b/exam/original-files/Problem_2_3_Sample_full_transcripts/2015-Feb-10-KO.N-138013855540-Transcript.txt new file mode 100644 index 0000000..b392f6c --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_full_transcripts/2015-Feb-10-KO.N-138013855540-Transcript.txt @@ -0,0 +1,531 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q4 2014 The Coca-Cola Co Earnings Call +02/10/2015 09:30 AM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Ahmet Bozer + The Coca-Cola Company - EVP & President of Coca-Cola International + * Sandy Douglas + The Coca-Cola Company - SVP & VP of Coca-Cola North America + * Irial Finan + The Coca-Cola Company - EVP & President of Bottling Investments + * Kathy Waller + The Coca-Cola Company - CFO + * Muhtar Kent + The Coca-Cola Company - Chairman & CEO + * Tim Leveridge + The Coca-Cola Company - VP & IR Officer + +================================================================================ +Conference Call Participiants +================================================================================ + + * Judy Hong + Goldman Sachs - Analyst + * Mark Swartzberg + Stifel Nicolaus - Analyst + * Bryan Spillane + BofA Merrill Lynch - Analyst + * Ali Dibadj + Sanford C. Bernstein & Company, Inc. - Analyst + * Bill Schmitz + Deutsche Bank - Analyst + * Steve Powers + UBS - Analyst + * John Faucher + JPMorgan - Analyst + +================================================================================ +Presentation +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Good morning, and thank you all for holding. At this time, I would like to welcome everyone to The Coca-Cola Company's fourth-quarter 2014 earnings results conference call. Today's call is being recorded; if you have any objections, please disconnect at this time. +(Operator Instructions) +I would like to remind everyone that the purpose of this conference is to talk with investors and therefore questions from the media will not be addressed. Media participants should contact Coca-Cola's Media Relations department if they have questions. I would now like to introduce Tim Leveridge, Vice President and Investor Relations Officer. Mr. Leveridge, you may begin. + +-------------------------------------------------------------------------------- +Tim Leveridge, The Coca-Cola Company - VP & IR Officer [2] +-------------------------------------------------------------------------------- + + Good morning, and thank you for being with us today. I'm joined by Muhtar Kent, our Chairman and Chief Executive Officer; and Kathy Waller, our Chief Financial Officer. Before we begin, I would like to inform you that you can find webcast materials on the Investor section of our Company website at www.coca-colacompany.com that support the prepared remarks by Muhtar and Kathy this morning. +I would also like to note that we have posted schedules under the Financial Reports and Information tab in the Investor section of our Company website. These schedules reconcile certain non-GAAP financial measures, which may be referred to by our senior executives during this morning session, to our results as reported under Generally Accepted Accounting Principles. Please look on our website for this information. +In addition, this conference call may contain forward-looking statements, including statements concerning long-term earnings objectives, and should be considered in conjunction with cautionary statements contained in our earnings release and in the Company's most recent periodic SEC report. Following prepared remarks by Muhtar and Kathy this morning, we will turn the call over for your questions. +Ahmet Bozer, Executive Vice President and President of Coca-Cola International; Sandy Douglas, Senior Vice President and Vice President of Coca-Cola North America; and Irial Finan, Executive Vice President and President of Bottling Investment will also be available for our Q&A session. Now I'll turn the call over to Muhtar. + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Company - Chairman & CEO [3] +-------------------------------------------------------------------------------- + + Thank you, Tim, and good morning, everyone. During our last earnings call, we articulated five strategic actions to reignite our growth and committed to providing you an update on our progress as we move forward and into 2015. So today, I'm going to start with some highlights from our fourth-quarter performance and then review the progress we've made against our five strategic actions. For those of you following our webcast, you can see our quarterly performance and our new scorecard on slide 4. +Overall, our performance came in slightly ahead of where we had previously expected. This was driven by some net positives above the operating income line, slightly offset by higher-than-expected currency remeasurement impacting profit before tax. At the top line, structurally adjusted comparable currency-neutral net revenues grew 4% in the quarter, driven by a balance between volume and underlying price mix in what was a challenging macro environment. At the profit level, structurally adjusted comparable currency-neutral operating income grew 7% in the quarter, while we continue to invest heavily behind our media, with double-digit increases in the quarter and full year. +Importantly, there are some highlights for the quarter. We continued to focus pricing and revenue realization in key developed markets with North America and Europe both delivering positive price mix in the quarter and for the full year. Our core strategies and our diversified global portfolio enables us to gain global value share in nonalcoholic ready-to-drink sparkling beverages, as well as still beverages in the quarter. This is a key metric for us, particularly in a challenging macro environment. +As we announced last week, we also continued to strengthen our overall portfolio of billion-dollar brands and, in particular, our still brands. Gold Peak, a premium tea brand in the United States, benefited from great marketing, strong media, and stepped-up execution to achieve this status. Furthermore, FUZE TEA, our popular mainstream tea brand -- now available in nearly 40 markets around the world -- reached this status in less than three years, demonstrating the strength of our systems, marketing, and executional capabilities. +Finally, I LOHAS, our innovative water brand in Japan, regained billion-dollar brand status in 2014. This brings our total number of billion-dollar brands to 20, out of which 14 are still brands. Just five years ago, we had 14 billion-dollar brands. Since 2010, on average, we've added more than one new billion-dollar brand each year to the list. +Stepping back from our quarterly performance, I'd like to talk about the bigger picture in 2014, a year of significant change for our Company that will continue in 2015. Specifically, I want to discuss our five strategic actions to reignite our growth, which are: first, targeting disciplined brand and growth investments; second, driving revenue and profit growth with clear portfolio roles across our markets; thirdly, refocusing on our core business model; fourth, driving efficiency through more aggressive productivity; and fifth, last but not least, streamline and simplify our organization. +While we're making solid progress, we have more to do. In 2014, we invested significantly in both our brands and in incremental growth opportunities. We substantially increased our media investments in markets and categories where our media was underfunded relative to the market opportunity, where we had the right price/pack channel architectures, and where we had clear executional alignment with our bottlers. +The quality of our media has been increasing and we intend to approve it even further under the leadership of our new global Chief Marketing Officer, Marcos de Quinto. We're seeing initial success, as exemplified by North America, where our incremental media investments, coupled with our segmented price/pack strategies, drove revenue growth in our sparkling portfolio through strong 4% price/mix in the second half of the year. This gives us confidence that when we invest in our brands, align on our system plan, and focus on execution, we do see positive results. +Looking beyond our existing portfolio, we continue to focus on expanding our participation across a range of consumption occasions. Today, the average household globally consumes 26 beverages per day; and of these 26 beverages, only 1.4 are Coca-Cola Company brands. Our opportunity to capture more beverage occasions is just immense. For that reason, we've announced strategic investment in Keurig Green Mountain and Monster Beverage Corporation. Both of these investments underscore not only our ability to adapt to changing consumer trends, but also our commitment to accelerate innovation. +Next, we expanded our market segmentation, recognizing that each of our markets has a specific role in order to drive sustainable revenue growth. Some markets focus on price realization, others on volume, and the remainder on a balance of the two. Importantly, our proxy statement will be coming out in the coming weeks and you will see the revised incentive metrics, which will add revenue growth directly aligned to those market roles. +We also made headway in refranchising our bottling operations, both in the United States and internationally. In North America, we closed several refranchising transactions in 2014 and laid out a clear path and timeline to refranchise the remaining territories. Specifically, we refranchised territories representing approximately 5% of the US bottler-delivered business in 2014 and have already signed definitive agreements to continue refranchising a similar amount in the first half of 2015. +These agreements, along with our ongoing work, give us confidence that we will continue to accelerate our rate of refranchising each year and achieve our goal to retain a maximum of about one-third of the US bottler-delivered business by the end of 2017. And it is our intent to refranchise the remaining territories by 2020 at the latest. As we reach the end state in North America, these actions will drive higher operating margins, lower capital spending and invested capital, and improved ROIC for our Company. +Outside of North America, we announced two transformative changes to our bottling landscape in critical high-growth markets around the world. First, in Indonesia, we announced a joint venture in Coca-Cola Amatil Indonesia that will help our system to capture the long-term opportunity in this extremely attractive emerging market. +We also entered into an agreement to rearchitect our African bottling system with the creation of Coca-Cola Beverages Africa, which will serve 12 Southern and East African countries and will be a top-10 global bottler once the transaction is completed. Importantly, Coca-Cola Beverages Africa will have the scale, resources, and efficiencies to fund the investment required to capture the strong long-term growth potential in Africa. These markets will be long-term growth engines for our Company, so it is absolutely critical that we invest sufficiently today to prime those engines for decades to come. +In order to reinvest our business and deliver against our long-term financial targets, we embarked upon an expanded productivity plan that will result in a total of $3 billion in annualized savings by 2019. As Kathy discussed in detail during our modeling call in December, this represents a significant reduction to our addressable spend base, and our efforts are on track. +As you've seen in the press, we've begun work on reducing positions that are no longer aligned to our growth priorities or are deemed redundant as we streamline our operations. While this is never an easy process, it is absolutely essential to ensuring that our business is wired for greater speed, responsiveness, as well as innovation. And, importantly, it also frees up the resources we need to reinvest in the business to accelerate our growth. +Fifth and finally, towards the end of 2014, we began the process of streamlining and simplifying our operating model. We announced the streamlining of group functional layers and began standardizing key processes across our business units. This will not only reduce our cost structure, but more importantly, will create a more nimble organization that is wired to act swiftly and rapidly in today's dynamic landscape. +In summary, I am confident that these strategic actions are laying the groundwork for accelerated top- and bottom-line growth in the future and delivering the long-term shareholder value you expect. Looking ahead, we will continue to make progress against our actions to regain momentum. But, as we've said before, 2015 will be a transition year for the Company as we implement our new operating model and our incremental media investments in both 2014 and 2015 take time to pay off in full. +Further, we expect the global consumer environment to remain volatile. Geopolitical hot spots around the world and potential deflationary environments in Europe, and continued softness in many emerging and developing markets around the world, could be partially offset by an improving environment in the United States. So, against this backdrop, what remains to be seen is how quickly and to what extent lower oil prices trickle down to impact consumer discretionary spending in both importing as well as oil-exporting nations. +Therefore, we will focus on what we can control. We will implement our strategies with focus and conviction, investing for the long term in emerging markets, as well as taking advantage of opportunities to solidify our position in the growth markets of today and tomorrow. While, in 2015, we expect to grow comparable currency-neutral EPS mid-single digits, from 2016 on, we intend to be back to delivering against our long-term targets of high single-digit comparable currency-neutral EPS growth. +We will strengthen our leading brands through incremental media investments and best-in-class marketing campaigns. We will deliver a step-change in productivity and complete the majority of North America franchising, both of which will drive growth and improve our margin structure. And, finally, we will continue to enhance our market-leading capabilities to provide our customers and consumers with the innovative and refreshing products they expect from The Coca-Cola Company. +I will now hand the call over to our Chief Financial Officer, Kathy Waller, who will provide you with a more detailed look at our financial performance, as well as an outlook on our business for 2015. + +-------------------------------------------------------------------------------- +Kathy Waller, The Coca-Cola Company - CFO [4] +-------------------------------------------------------------------------------- + + Thank you, Muhtar, and good morning, everyone. Our performance in the fourth quarter was slightly ahead of our expectations, due primarily to three factors: first, several markets around the world delivered slightly better top-line performance, thanks to a strong finish during the holiday season; second, gross margins came in slightly better than anticipated; and, third, operating expenses were lower than expected, which led to comparable currency-neutral margin expansion. +We are pleased with where the quarter landed. Structurally adjusted comparable currency-neutral revenue growth was driven by a 3% growth in concentrate shipments and 2% underlying price/mix. Concentrate shipments outpaced unit cases in the quarter, driven by an extra selling day. However, for the full year, concentrate shipments were in line with unit cases. +Consolidated price/mix in the quarter was driven by pricing initiatives in North America, Latin America, and Europe. Importantly, as we've done throughout 2014, we continue to invest behind our brands. During the quarter, our marketing expenditures grew high-single digits, resulting in mid-single-digit growth for the year. This increase in annual marketing expenditures was driven by a double-digit increase in media investments, as we continued to drive efficiencies within our overall marketing budget to put against our media spend. +Our fourth-quarter comparable EPS was $0.44, which included a 10-point currency headwind. On a comparable currency-neutral basis, our EPS grew 5% in both the quarter and the full year. Items impacting comparability in the quarter were primarily related to the impact of changing the exchange rate used to remeasure our Venezuelan subsidiary's net monetary assets into US dollars; a write-down on the concentrate sales receivables from our bottling partner in Venezuela; non-cash charges related to refranchising certain territories in North America; and costs associated with our previously announced $3 billion productivity program. +Given increased uncertainty and lack of liquidity in Venezuela, we remeasured our bolivar-denominated net monetary assets at the end of the quarter using the SICAD II exchange rate. We are also using the SICAD II exchange rate to translate our Venezuelan subsidiary's local currency income statement into US dollars, beginning in January 2015. The receivable write-down was recorded as a result of the revised assessment of the US dollar value we expect to receive. Despite a difficult operating environment in Venezuela, the Coca-Cola system remains committed to the market and will continue producing and selling our products that Venezuelan consumers enjoy on a daily basis. +As you saw on our scorecard, full-year free cash flow was $8.2 billion, up 3%, primarily due to the efficient management of working capital and cycling incremental pension contributions last year, partially offset by an unfavorable impact from foreign currency exchange rate fluctuations and the deconsolidation of the Company's Brazilian bottling operations in July 2013. For the year, cash return on invested capital declined 32 basis points, due to the $1.5-billion investment we made in Keurig Green Mountain. +As we look ahead to 2015, we anticipate continued challenging macroeconomic conditions in many markets around the world. Despite this, we are on track with the actions we laid out during our last earnings call, and we remain confident in the outlook we provided in December. Therefore, we expect our comparable currency-neutral EPS growth in 2015 to be mid-single digits, roughly in line with our growth rate in 2014. +As you will recall from our modeling call in December, there are many puts and takes to our P&L in 2015. With the exception of currency, these have not changed. Therefore, I will not go into detail on this call, but you can see the various line items on slide 13. +After considering our hedge positions, current spot rates, and the cycling of our prior-year rates, we now expect an approximate 5-point currency headwind on net revenues, with a 7- to 8-point headwind on profit before tax for the full-year 2015. This is a stronger headwind than the previously communicated 5 to 6 points for profit before tax, due primarily to the effect from translating our bolivar-denominated profit at the SICAD II rate and to the recent decline in several emerging market currencies, which we do not hedge. In terms of coverage, we are fully hedged on the euro, yen, and sterling for 2015. We also have near-term coverage in place across several other major currencies. +There are a couple of phasing items you should consider when modeling the first quarter. Due to our fiscal calendar, there are six additional days in the first quarter of 2015 as compared to the first quarter of 2014. Although that will benefit revenue, variable costs such as marketing, sales, and distribution expenses will also occur to a much greater degree in the first quarter. +We expect the Venezuelan pricing provisions will continue to negatively impact our net revenue and operating income in the first quarter of 2015, as we began to recognize the impact in the second quarter of last year. And we expect structural items, primarily related to North America, to be a headwind in the first quarter. Taken together, we expect structural adjustments and the Venezuelan pricing provisions to be an approximate 2-point headwind on net revenues and an approximate 3-point headwind on our profit before tax. +In addition, we will cycle the timing of expenses in the first quarter of last year, when we had 4 points of operating leverage. Therefore, we expect that comparable currency-neutral operating leverage will be negative in the first quarter. Finally, we currently expect currency will be an approximate 6-point headwind on net revenues and an approximate 8-point headwind on profit before tax in the first quarter as we cycle more favorable rates from the prior year. +We currently anticipate closing the transaction with Monster Beverage Corporation at the beginning of the second quarter. Note that this is slightly later than our initial expectations of the first quarter, due to various closing considerations. At this stage, we do not anticipate any material changes to our structural impact guidance from December. But, of course, we will update you along the way if there were to be a change. +In closing, we are confident in our strategies and in the actions we have already taken to regain our momentum. 2015 will be a transition year as we implement significant change in our Company and continue to reinvest in our business. We absolutely believe that The Coca-Cola Company is best positioned to capture growth in the nonalcoholic beverages and to continue to deliver long-term value to our shareholders. +Operator, we are now ready for questions. + + +================================================================================ +Questions and Answers +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) +Bryan Spillane, Bank of America. + +-------------------------------------------------------------------------------- +Bryan Spillane, BofA Merrill Lynch - Analyst [2] +-------------------------------------------------------------------------------- + + I've got a question about -- Muhtar, in your prepared remark, you mentioned the consumer environment remaining volatile in terms of your expectations for 2015. Can you talk a little bit about what range of volatility you might have embedded in your plans for 2015? +Maybe talk a little bit more specifically about the consumer environment, both in Europe and Latin America, where since those are really two important markets for the Company and where it seems volatile? Finally, just maybe how that might affect your decision to spend more marketing in those markets this year given the volatility? I know there's a lot there, but thanks. + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Company - Chairman & CEO [3] +-------------------------------------------------------------------------------- + + First, just at a very high level, 10,000 feet, 2015, we expect the macro environment to even become a little more volatile versus 2013 and 2014, as the microeconomic vagaries get worse in certain parts of the world. Rate of interest, currency, certainly, will add to the volatility. +Growth gap will -- in some part versus other parts -- are going to grow. Take, for example, the United States and Great Britain, two large western economies, starting the year 2015 strong, whereas the eurozone, Japan, and most of the emerging world starting the year slower. +So there is this gap and some catching up to do. We're gaining share across the world in sparkling juices, important categories. The industry -- we see some evidence that there's some things that are working for us, but we need to be cautious and take it quarter-by-quarter. That's really important. +As far as Latin America is concerned, Colombia seems to continue to do really well as an economy. There's some more lifting to do in Mexico and Brazil and south cone, but I was recently in Latin America, and our business there continues to -- we have a fantastic group of bottling partners investing for the short- and long-term growth and we continue to gain share. We have a very strong package product channel segmentation and architecture in pricing, competitive, but at the same time, great revenue growth management strategies working there. +Europe, as per the last quarter, quarter four, which we are just reporting on, the southern European countries continue to be challenged. Germany, our business was very much in the positive. Northern Europe was a better environment for us than the south and Eastern Europe is again challenged by some of the macro volatility that spills over across from the east. So that's how we would see them. +Asia, we're still very bullish, and Africa. You see the actions we've taken related to reorganizing our bottling structure to even better suit the growth potential and the opportunities, there, in both Indonesia, the fourth most populous nation in the world, as well as the very dynamic 1 billion-plus consumers in Africa. + +-------------------------------------------------------------------------------- +Bryan Spillane, BofA Merrill Lynch - Analyst [4] +-------------------------------------------------------------------------------- + + Fair to say that you've got a wider range of volatility or contingencies for that type of volatility built into the 2015 plans? Just maybe the normal, just since it's such a volatile environment? + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Company - Chairman & CEO [5] +-------------------------------------------------------------------------------- + + Yes. When you look at LRB or nonalcoholic ready-to-drink beverages, Bryan, what you would see, probably, is maybe 100 basis points less growth versus the previous years, but, it's again, anybody's guess as to how quickly some of these economies are going to come back. +We have definitely those contingencies built in. Maybe I can refer to Ahmet to give you a few more snapshots of the world in terms of micro and macro picture? Ahmet? + +-------------------------------------------------------------------------------- +Ahmet Bozer, The Coca-Cola Company - EVP & President of Coca-Cola International [6] +-------------------------------------------------------------------------------- + + Thanks, Muhtar. Bryan, the only thing I would add to Muhtar's characterization is that volatility comes on top of a slowdown, but what's working for us, is that we are getting more and more traction on our plans and programs working with our bottlers. I was in about four or five different countries over the last couple of weeks. +Even though we witness economic volatility or uncertainty, even in even in Northern Europe, yes there is quantitative easing, yes, there is lower oil prices, but it is uncertain yet whether the consumer will really benefit from that. But even within that, our plans that address the right pricing and packaging and the right level of media investments and our alignment with our bottling system, is giving us confidence that we could actually weather this volatility in line with the guidance that has been provided. +There are a couple of bright spots, too. I was in India, probably one country where there is a lot of optimism inside the country in terms of economic development. As you know, we have an incredible momentum in India over the last seven or eight years, especially last year. Our plans continue to build on each other from year-to-year. +I was in Brazil. Again, a similar story. After the elections, there was some cautious optimism and that caution side of that continues. There's still a bit of optimism, but we do continue to deliver our results despite that environment. As you know, Brazil had a mid-single-digit growth over the end of the quarter. +Yes, it was cycling better numbers from last year, but we've also had very strong share gains in Brazil. So I would say that is our story. There is volatility on top of a slowdown, but we do have traction with our plans and programs in the marketplace with close alignment with our bumpers. + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Company - Chairman & CEO [7] +-------------------------------------------------------------------------------- + + Bryan, last thing I would add to what Ahmet and what I had said earlier, to your question about does it make sense to invest in media and marketing, and the answer is, absolutely, yes. When we are able to target our investments in media and the way we are doing it, segmenting them by the different countries and the different regions of the world and improving not just the quantity but also the quality of the media, that's one of the main important factors that we see driving a better revenue number, a better price mix number. So the two are really connected and that's what I really want to -- gaining share, improving on the top line through all the actions we're taking, of which targeted media, increased and improved quality media, is one of those. + +-------------------------------------------------------------------------------- +Bryan Spillane, BofA Merrill Lynch - Analyst [8] +-------------------------------------------------------------------------------- + + All right. Thank you for that. I look forward to seeing you next week down at CAGNY. + +-------------------------------------------------------------------------------- +Operator [9] +-------------------------------------------------------------------------------- + + Judy Hong, Goldman Sachs. + +-------------------------------------------------------------------------------- +Judy Hong, Goldman Sachs - Analyst [10] +-------------------------------------------------------------------------------- + + My question is really relating to the strong price mix that you saw North America in the quarter. Obviously, you've been focused on getting mix impact and rational pricing. Can you just speak to how much of the improvement was mix-driven, as opposed to maybe cycling some of the heightened promotional environment last year, and as you think about 2015 and beyond, just thinking about some of the mix acceleration potential and the pricing side in North America? + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Company - Chairman & CEO [11] +-------------------------------------------------------------------------------- + + I'll let Irial answer that question, and then also, Sandy will add flavor to that, too. + +-------------------------------------------------------------------------------- +Irial Finan, The Coca-Cola Company - EVP & President of Bottling Investments [12] +-------------------------------------------------------------------------------- + + Good morning, Judy. The most important thing is, four quarters ago, Sandy and I spoke on the topic and we reiterated our belief in having balanced price mix volume growth in North America. We've delivered on that in every quarter this year and our plan is to deliver again next year in the same way. +In terms of your question on mix and headline price, it's a balance approach. Yes, in the fourth quarter last year, we were trending some lower numbers where we had some promotional activity, but when you look over the half-year, as Muhtar said, we grew pricing 4%. +So we feel very good about the actions we are taking. We're feeling very good about how the trade is reacting and more importantly, we are feeling very good that our marketing and our execution are coming together in a way that really adds incremental value to our system. I will maybe ask Sandy to add to that. Sandy? + +-------------------------------------------------------------------------------- +Sandy Douglas, The Coca-Cola Company - SVP & VP of Coca-Cola North America [13] +-------------------------------------------------------------------------------- + + Good morning, Judy. As Irial said, it's a consistent strategy. The strategy is [born] of where the consumer wants us to go. The consumer is buying smaller special packages of our sparkling beverage brands and accelerating that purchase and we're seeing the kind of mix benefit from that, that you describe. +But that couples with a disciplined approach to rate and volume. Because in the end, what we're trying to do is expand the value and usefulness of our brands and create value for our customers. Through the consistent execution of that strategy, we are seeing, in 2014, a solid year, but a year of improving performance through the year, and we will continue to pursue that disciplined strategy in 2015. + +-------------------------------------------------------------------------------- +Judy Hong, Goldman Sachs - Analyst [14] +-------------------------------------------------------------------------------- + + Got it. Okay. Then Kathy, if I could just have a quick follow-up on just in terms of the commodities in 2015. What have you locked in, in terms of your exposure are there? As you think about different commodity complexes that are turning more favorable, how much of that could we expect to see drive some of that margin improvement, particularly markets like North America? + +-------------------------------------------------------------------------------- +Kathy Waller, The Coca-Cola Company - CFO [15] +-------------------------------------------------------------------------------- + + Okay, Judy. Our commodities environment for 2015, commodities we expect really to be benign for us, right? There are some that are absolutely favorable, but then we have other challenges, and depending on -- not a North America, but outside of North America, we also have impact of secondary exchange embedded into our commodities. So we really anticipate it being more of a benign commodity environment for us versus having any significant benefit from it. + +-------------------------------------------------------------------------------- +Judy Hong, Goldman Sachs - Analyst [16] +-------------------------------------------------------------------------------- + + Understood. Okay. Thank you. + +-------------------------------------------------------------------------------- +Operator [17] +-------------------------------------------------------------------------------- + + John Faucher, JPMC. + +-------------------------------------------------------------------------------- +John Faucher, JPMorgan - Analyst [18] +-------------------------------------------------------------------------------- + + Wanted to follow up a little bit on, Muhtar, on your comments on Europe. Obviously, it's been a difficult market over the past couple of years. +What's the right way to think about a glide path getting back to growth there? Is it something where QE works and we start to see the economy come back, do you think you can get back to consistent growth? What are some realistic ranges of expectations for 2015 and potentially into 2016? + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Company - Chairman & CEO [19] +-------------------------------------------------------------------------------- + + We're all going to watch what's happening with quantitative easing, John, in Europe, 18 months of the planned amount, EUR60 billion a month kicking in, whether that will have an impact or not, we will watch and see. Stability is the keyword for Europe, as we go into 2015, so not getting much worse, and in some areas, continued volatility. +South Europe is going to continue certainly to be challenged, so I don't think there's going to be suddenly a lifting of the cloud for the consumers in the southern belt of Europe. German -- the current exchange rates will help exporting countries, for sure. How soon will that trickle in related to Germany, related to other export markets from Europe? +But that's a positive. Quantitative easing is a positive. The notion that most consumers now are used to this environment and feel that it is not going to get much worse; it may get a little better because of the QE. +So we'll have to see. But we think that it will continue to be challenged, and then you've got, of course, the whole political environment to, basically, weave into the equation. That political environment is something that is an unknown for us all. +That's how I would see. As far as growth, yes, there will be pockets of growth in Europe and there will be continued pockets of challenges. What we see -- we have very strong plans in place with our bottling partners for growth in Europe and we will see how -- we have all kinds of contingencies built into the plan in Europe, also, and we're going to take it quarter-by-quarter. + +-------------------------------------------------------------------------------- +John Faucher, JPMorgan - Analyst [20] +-------------------------------------------------------------------------------- + + Great. Thanks. If I could ask one follow-up to Kathy. Kathy, you talked about your FX coverage on translational for 2015. Obviously, what this can lead to sometimes is a year or two year impact. Any thoughts on 2016 and how you'll manage what could potentially be some FX headwind there as the hedges roll off? + +-------------------------------------------------------------------------------- +Kathy Waller, The Coca-Cola Company - CFO [21] +-------------------------------------------------------------------------------- + + Sure, John. For 2016, we are also hedged on our major currencies at this point, and also have some on other currencies, as well. So we will manage the impact and we are at pretty good rates at this point with our hedging, so basically we don't think that there is a relative issue at this point. + +-------------------------------------------------------------------------------- +John Faucher, JPMorgan - Analyst [22] +-------------------------------------------------------------------------------- + + Great. Thank you. + +-------------------------------------------------------------------------------- +Operator [23] +-------------------------------------------------------------------------------- + + Steve Powers, UBS. + +-------------------------------------------------------------------------------- +Steve Powers, UBS - Analyst [24] +-------------------------------------------------------------------------------- + + One quicker clarification question, then a slightly more thematic one. First, obviously there are a lot of moving parts driving price and mix in the quarter, globally. I wondered if you could just focus in on rate increases and talk about trends there because my guess is that rate lagged overall price mix in North America, which you talked, but Europe, the bottling investment, Latin American, and then rate was probably stronger than price mix in Eurasia, Africa, Pacific, and across the whole Company. Any help there would be great, just parsing out overall rate trends? +Then more broadly, it sounds like your productivity targets remain unchanged from last fall, which isn't really surprising as it has only been a few months. But at the same time, we've already seen announcements of headcount reductions that likely were not envisioned prior to your October update. I'm wondering why we are not seeing more incrementality sooner on that front, or perhaps we are, it's just being absorbed by the macro headwinds? If you could clarify that, that would be great? + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Company - Chairman & CEO [25] +-------------------------------------------------------------------------------- + + Steve, this is Muhtar. Good morning again. As far as the rate versus mix, it's basically completely dependent on the country and the environment and the region. There's no trend globally. This is, on average, this much rate and this much -- it all depends on our price/pack channel architecture, our position in our market, the strength of our brand, how effective is our marketing driving the results that we need, which is all work in progress. +So it all depends, and I will let Sandy comment on the United States on that, but it's very much dependent on the region and dependent on the country and dependent on the circumstances. That's really what I would say. Sandy, you want to just address the United States part of that question? + +-------------------------------------------------------------------------------- +Sandy Douglas, The Coca-Cola Company - SVP & VP of Coca-Cola North America [26] +-------------------------------------------------------------------------------- + + Sure. Our strategy in the US is, again, as Irial said, very consistent. We view there to be a significant upside pricing opportunity in the sparkling beverage category. We are driving that with significant investments in brand building and execution of a bright package architecture that will expand margins for our system and also for our customers. That involves a very healthy rate program. +But at the same time, we are executing with a tremendous amount of energy, multiple proprietary and other small packages that the consumer is buying at accelerating rates. For example, mini cans increased by 15% in the fourth quarter and that's us following the consumer to smaller package sizes of the brands they love. That combination of rate and mix is creating a good balance with volumes to a healthy top-line growth picture. + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Company - Chairman & CEO [27] +-------------------------------------------------------------------------------- + + Steve, just on your question on productivity, I would say to you that the reorg and how we are flattening the Organization and the number of announced cuts were all part of the program, totally part of the program, so, there's nothing that has it's just been executed. That's all. +We stand by what Kathy said in the modeling call in December. We are on track with the $500 million-plus piece of the productivity program for 2015 and we are on track with that. But just to emphasize, all of what you see, what you hear, what you read, was part of the program. + +-------------------------------------------------------------------------------- +Steve Powers, UBS - Analyst [28] +-------------------------------------------------------------------------------- + + Okay. Just two points of clarification, just to follow-up on those answers. Thank you very much. On the price mix, maybe just Kathy, specifically to Eurasia, Africa, where I'm assuming rate pricing in Russia, for example, is quite positive, should we be expecting this negative mix trend to persist in 2015? This is one follow-up on pricing. +Then Muhtar, to your point on the part of the plan, does that mean that the headcount reductions, for example, that were announced, was that part of the original $1 billion or was that part of the additional $2 billion that was announced last fall? + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Company - Chairman & CEO [29] +-------------------------------------------------------------------------------- + + Just quickly on the last piece of your question, it was part of the initial $2 billion. Then, as far as the rate increases, I'll defer to Ahmet if you want to just refer to that part of the question. + +-------------------------------------------------------------------------------- +Ahmet Bozer, The Coca-Cola Company - EVP & President of Coca-Cola International [30] +-------------------------------------------------------------------------------- + + On markets like EAG, we price in line with inflation. We may be slightly below inflation, slightly ahead of time. You should expect to see consistent rate increase more or less in that range. +Fourth quarter for EAG was a bit of an anomaly. There was a geographic mix impact that was driven by cycling of [jobend] shipments, so if you look at full-year price mix realization at EAG, it's a healthy 4 point, so, I wouldn't look at Q4 to draw any conclusions. + +-------------------------------------------------------------------------------- +Steve Powers, UBS - Analyst [31] +-------------------------------------------------------------------------------- + + Thanks. + +-------------------------------------------------------------------------------- +Operator [32] +-------------------------------------------------------------------------------- + + Ali Dibadj, Bernstein. + +-------------------------------------------------------------------------------- +Ali Dibadj, Sanford C. Bernstein & Company, Inc. - Analyst [33] +-------------------------------------------------------------------------------- + + Given the pressure that currency is placing and all this macro volatility, do you anticipate or can you, actually, accelerate anything around your cost-cutting plans to offset this or do you plan taking even more pricing in places like Europe, Eurasia, Africa, or Asia-Pacific, where it does not look like you are offsetting your currency moves as much? + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Company - Chairman & CEO [34] +-------------------------------------------------------------------------------- + + Ali, just on a broad-based answer to your question, it's really critical that we balance the needs in the marketplace and the need for us to be healthy in the marketplace on a both medium- and long-term basis. That's why we hold accountable all our business unit presidents for local currency. We're very happy with our progress so far, with what we are doing with our productivity initiatives and what the current results are for those productivity initiatives, so far. Early days. +But we certainly are looking to do more where it makes sense. But one thing you will not see us is taking, basically, actions in the marketplace that weakens our position for the medium and long term. That's the critical piece that I want to stress. + +-------------------------------------------------------------------------------- +Ali Dibadj, Sanford C. Bernstein & Company, Inc. - Analyst [35] +-------------------------------------------------------------------------------- + + So in other words, we shouldn't anticipate more pricing as FX continues to be a negative pressure? If you can answer that, also, in the context of the benignness of commodities in 2015, and if that is a limit on your ability to take pricing, again, to offset FX and in the broader price context? + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Company - Chairman & CEO [36] +-------------------------------------------------------------------------------- + + We work with all the different levers that are available to us, how our better marketing, more marketing is working, driving results, how the investments are working, that we're putting in the marketplace with our bottling partners, our basic brand strength in the marketplace. All of those things. Essentially, in terms of commodities, again, that's something that is very volatile in the world that we live in. +Four or five months ago, if someone said we'd be looking at current price of oil, no one would have believed is. So everything is changing very rapidly and we are remaining flexible and what we can achieve to the best of our ability, both in pricing, both in terms of investing for the future, as well as making sure that our investments are targeted and our segmentation works. +There is not one solution. The segmentation is really driving better results than we have anticipated when we put that program into place. + +-------------------------------------------------------------------------------- +Ali Dibadj, Sanford C. Bernstein & Company, Inc. - Analyst [37] +-------------------------------------------------------------------------------- + + Okay. I'm just trying to understand. We could anticipate, if the consumer is ready to do it and if the segmentation suggests, we could see more pricing align with inflation because of currencies being so negative. Is that fair of what you are saying? + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Company - Chairman & CEO [38] +-------------------------------------------------------------------------------- + + I will just leave it at what I said. + +-------------------------------------------------------------------------------- +Ali Dibadj, Sanford C. Bernstein & Company, Inc. - Analyst [39] +-------------------------------------------------------------------------------- + + Okay. Thanks. + +-------------------------------------------------------------------------------- +Operator [40] +-------------------------------------------------------------------------------- + + Mark Swartzberg, Stifel Financial. + +-------------------------------------------------------------------------------- +Mark Swartzberg, Stifel Nicolaus - Analyst [41] +-------------------------------------------------------------------------------- + + Just a quick one, Kathy, a technical question. The six additional days in the first quarter, is there some level of give-back later in the year? Do we see a reversal of that in the fourth quarter, for example? + +-------------------------------------------------------------------------------- +Kathy Waller, The Coca-Cola Company - CFO [42] +-------------------------------------------------------------------------------- + + Based on our 4-4-5 calendar, the six additional days get pushed into the first quarter, but they come out in the fourth quarter. + +-------------------------------------------------------------------------------- +Mark Swartzberg, Stifel Nicolaus - Analyst [43] +-------------------------------------------------------------------------------- + + Okay. Fair enough. That's all I've got. Thank you. + +-------------------------------------------------------------------------------- +Operator [44] +-------------------------------------------------------------------------------- + + Bill Schmitz, Deutsche Bank. + +-------------------------------------------------------------------------------- +Bill Schmitz, Deutsche Bank - Analyst [45] +-------------------------------------------------------------------------------- + + One is a housekeeping question. Can you just tell us what the pricing would have been in Latin America if you were at SICAD 2 for this year and last? + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Company - Chairman & CEO [46] +-------------------------------------------------------------------------------- + + That's all local currency. So it is what it is. What we talk about is all pricing in terms of the local currency we take. Whether we measure that in SICAD 1 or 2, it will be the same number. + +-------------------------------------------------------------------------------- +Bill Schmitz, Deutsche Bank - Analyst [47] +-------------------------------------------------------------------------------- + + Okay. I was just trying to get at what impact Venezuela had on the price, just for modeling for year, if there was a Venezuelan anomaly this quarter that might have take that pricing down next year? + +-------------------------------------------------------------------------------- +Kathy Waller, The Coca-Cola Company - CFO [48] +-------------------------------------------------------------------------------- + + For next year, the impact of fair pricing law will continue in Venezuela. That is what actually impacts our revenue in Venezuela. It caps our ability to take revenue. +That does continue. Obviously, it starts over in 2015, but it will not be a structural item because we cycle it as of the second quarter. So, then, yes, we also do have an impact to our revenues from a different exchange rate and that would be considered currency. + +-------------------------------------------------------------------------------- +Bill Schmitz, Deutsche Bank - Analyst [49] +-------------------------------------------------------------------------------- + + Okay. That's very helpful. Thanks. Just on Asia-Pacific, it came in a little lighter than our expectations. It was one of the lowest volume outcomes in a while. In your prepared comments, it seems like you are fairly sanguine about that segments, so was there an anomaly this quarter that took the volume a little bit softer and the price mix, so negative? I know there was a mix element there, but any comments on that would be very much appreciated? + +-------------------------------------------------------------------------------- +Ahmet Bozer, The Coca-Cola Company - EVP & President of Coca-Cola International [50] +-------------------------------------------------------------------------------- + + Bill, this is Ahmet. I will try to address that. One big thing was the timing of the Chinese New Year, but I wouldn't conclude my comments without saying that the market in China, especially the food and beverage market, has been weakest in the last 10 years. But I would also say that we've been consistently applying our strategy that we have covered with you guys a number of times before and resulting in fairly significant share gains in China. +As you know, in Japan in the middle of last year, there was an increase in taxes and we're continuing to see the effect of that, but, still delivering almost close to flat but not that close. It's minus [1%]. But the biggest item there was the timing of the Chinese New Year, as well as continued industry headwinds in China. + +-------------------------------------------------------------------------------- +Bill Schmitz, Deutsche Bank - Analyst [51] +-------------------------------------------------------------------------------- + + Great. One quick last one, if I could. Just to gauge the progress of the productivity program. Is a good metric to look at the Corporate unallocated line on the segment data? Does that come down as the restructuring savings come through? + +-------------------------------------------------------------------------------- +Kathy Waller, The Coca-Cola Company - CFO [52] +-------------------------------------------------------------------------------- + + The Corporate unallocated line. Yes, that is one place where you will be able to see the restructuring come through, but as Muhtar said, we are on track and with everything that we have announced to date. + +-------------------------------------------------------------------------------- +Bill Schmitz, Deutsche Bank - Analyst [53] +-------------------------------------------------------------------------------- + + Great. Thank you guys so much. + +-------------------------------------------------------------------------------- +Operator [54] +-------------------------------------------------------------------------------- + + I would now like to turn the call back to Muhtar Kent for closing remarks. + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Company - Chairman & CEO [55] +-------------------------------------------------------------------------------- + + Thank you, Kathy, Ahmet, Sandy, Irial, and Tim. In summary, we are moving quickly to reignite revenue growth while simultaneously driving costs out of our business through an aggressive productivity plan. While we've already made progress against our five strategic actions to regain our momentum, we are just beginning. 2015 will be a transition year, as we rewire our operating model for growth amidst an uncertain global consumer environment. +While the macroeconomic environment remains challenging in the near-term, we are confident in our ability to return to sustainable growth as the long-term dynamics of our industry remain promising, our brands and our global system are unparalleled, and we are fully dedicated to strengthening our position as the world's leading beverage Company. As always, we thank you for your interest, your investment in our Company, and for joining us this morning. + +-------------------------------------------------------------------------------- +Operator [56] +-------------------------------------------------------------------------------- + + Thank you. This does conclude today's conference. You may disconnect at this time. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. While the Preliminary Transcript is highly +accurate, it has not been edited to ensure the entire transcription +represents a verbatim report of the call. + +EDITED TRANSCRIPT: "Edited Transcript" indicates that a team of professional +editors have listened to the event a second time to confirm that the +content of the call has been transcribed accurately and in full. + +-------------------------------------------------------------------------------- +Disclaimer +-------------------------------------------------------------------------------- +Thomson Reuters reserves the right to make changes to documents, content, or other +information on this web site without obligation to notify any person of +such changes. + +In the conference calls upon which Event Transcripts are based, companies +may make projections or other forward-looking statements regarding a variety +of items. Such forward-looking statements are based upon current +expectations and involve risks and uncertainties. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/exam/original-files/Problem_2_3_Sample_full_transcripts/2015-Feb-25-TGT.N-138988132416-Transcript.txt b/exam/original-files/Problem_2_3_Sample_full_transcripts/2015-Feb-25-TGT.N-138988132416-Transcript.txt new file mode 100644 index 0000000..e612ea9 --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_full_transcripts/2015-Feb-25-TGT.N-138988132416-Transcript.txt @@ -0,0 +1,565 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q4 2014 Target Corp Earnings Call +02/25/2015 09:30 AM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * John Hulbert + Target Corporation - VP of IR + * John Mulligan + Target Corp - CFO + * Kathee Tesija + Target Corp - CMO & Supply Chain Officer + * Brian Cornell + Target Corp - Chairman & CEO + +================================================================================ +Conference Call Participiants +================================================================================ + + * Simeon Gutman + Morgan Stanley - Analyst + * Scott Mushkin + Wolfe Research - Analyst + * Michael Lasser + UBS - Analyst + * Greg Melich + Evercore ISI - Analyst + * Matthew Fassler + Goldman Sachs - Analyst + * Sean Naughton + Piper Jaffray - Analyst + * Matt Nemer + Wells Fargo Securities, LLC - Analyst + +================================================================================ +Presentation +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Ladies and gentlemen, thank you for standing by. Welcome to the Target Corporation Fourth-Quarter Earnings Release conference call. +(Operator Instructions) +As a reminder, this conference is being recorded Wednesday, February 25, 2015. I would now like to turn the conference over to Mr. John Hulbert, Vice President, Investor Relations. Please go ahead, sir. + +-------------------------------------------------------------------------------- +John Hulbert, Target Corporation - VP of IR [2] +-------------------------------------------------------------------------------- + + Good morning, everyone, and thank you for joining us on our fourth-quarter 2014 earnings conference call. Sorry about the technical difficulties that delayed us a couple minutes there. On the line with me today are Brian Cornell, Chairman and Chief Executive Officer; John Mulligan, Chief Financial Officer; and Kathee Tesija, Chief Merchandising and Supply Chain Officer. +This morning, Brian will discuss our fourth-quarter performance and our priorities going forward, then Kathee will provide insights into holiday and fourth-quarter results across our merchandise category. And finally, John will provide more detail on our fourth quarter and full-year financial performance. Following their remarks, we'll open the phone lines for a question-and-answer session. +As a reminder, we're joined on this conference call by investors and others who are listening to our comments via webcast. Following this conference call, John and I will be available throughout the day to answer any follow-up questions you may have. +Also, as a reminder, any forward-looking statements that we make this morning are subject to risks and uncertainties, the most important of which are described in our SEC filings. Also in these remarks, we refer to adjusted earnings-per-share, which is a non-GAAP financial measure. A reconciliation to our GAAP EPS is included in our press release posted on our Investor Relations website. +Finally, given that we're hosting our Financial Community Meeting in New York next week, our remarks today will focus on Target's fourth-quarter performance and our guidance for the first quarter of 2015. At next week's meeting, we will describe in detail our longer-term expectations including full-year 2015 financial performance. As a result, we are shortening today's call to 45 minutes, and will look forward to spending another two and a half hours with all of you next week. +With that, I'll turn it over to Brian for his comments on the fourth quarter and holiday season. Brian? + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corp - Chairman & CEO [3] +-------------------------------------------------------------------------------- + + Thanks, John, and good morning to all of you. Appreciate your patience this morning. +We're very pleased with our fourth-quarter financial results, which we announced earlier this morning. Our fourth-quarter adjusted EPS of $1.50 was 14.9% higher than last year, and above the high end of the updated range we provided in our January 15th press release. Our fourth-quarter comparable sales increase of 3.8% was also stronger than the updated guidance we provided in January, as we saw unexpected strength in our store channel sales in the last two weeks of the quarter. +And of course, when we look back at our point of view going in to the fourth quarter, comparable sales growth turned out to be nearly double our original expectation. As our combination of products, promotions, holiday marketing, fulfillment capabilities, and in-store execution drove profitable growth in an intensely promotional environment. +We're pleased that comps in all three months of the quarter were positive. And November strength was particularly notable, given that we were annualizing a strong increase in November 2013. +We're also pleased that traffic was the primary driver of our fourth-quarter growth. As well as the fact that the digital channel growth contributed nearly a full percentage point to our fourth-quarter comparable sales increase. +Our fourth-quarter gross margin performance was also very strong, with a favorable mix reflecting strength in signature categories. Our merchantees did an outstanding job managing inventory flow, benefiting both in stock and gross margin; which was particularly challenging this quarter in light of the slowdown in productivity at the west coast ports. Once again, our store team did an outstanding job of managing costs in the fourth quarter, delivering productivity improvements along with outstanding service to our guests. +As I've mentioned to many of you, one of our priorities going forward is to harness best practices from our stores and apply them to the rest of the organization. To modernize the way we work, and drive productivity improvements while maintaining quality in everything we do. If we look back at the full year, it's clear that 2014 was a year of transition, in which we began to lay the foundation for the transformation we will accomplish in the next few years. +A year ago, we were in the recovery mode. Working to repair guest relationships following the data breach, while we undertook an assessment of the long-term prospects for our Canadian business. Fast forward to today, and we've ended the year with the data breach fully behind us. And now that we've made the tough decision to exit the Canadian business, our team is focused and aligned on five priorities I outlined in our third quarter call. +The first priority is to drive industry-leading digital sales growth, as we build the capabilities to become a leading omni channel retailer. Our digital growth led the industry in 2014, and we're working to build on that success in 2015 and beyond. +Our second priority is to clearly define roles for each of our merchandise categories, and build appropriate plans for each of them. While we're in the early stages of this journey, I'm pleased with our efforts to invest in the growth of our signature categories like style, baby, kids, and wellness. +These are the categories we're most famous for, and our guest has asked us to lead with them in the years ahead. Beyond these signature categories, we're defining appropriate roles for each of our categories. And we'll invest in them appropriately to ensure we're providing our guests convenience through a differentiated, inspirational, and one-stop shopping experience. +Our third priority is to become much more localized in the assortment and experience we provide in our stores, and more personalized in our digital interaction with our guests. We are in the very early stage of these efforts, and we see huge opportunity ahead of us. So while we're investing these capabilities we'll need to make progress on this priority over the next few years. +Our fourth priority is [roll out] and test new formats that will help us better serve our guests over time. We're seeing strong financial results from our eight City Target stores, and we've seen very strong initial performance in the test of our first Target Express location, which opened here in the Twin Cities last August. In 2015, of the 15 new stores we're planning to open, more than half of these are new formats, with eight additional express stores and a new City Target set to open in Boston next to Fenway Park. +And finally, we're committed to reducing complexity and controlling costs in order to fuel our investments and the growth priorities I've just outlined. As mentioned earlier, our stores have been leading the way in these efforts. So in the next few years, we're looking for opportunities outside our stores to become more agile, move faster, gain scale efficiencies in the way we work. +We believe meaningful opportunities exist. And the leadership team is committed to moving decisively to modernize the way we work, and create the capacity we'll need to invest in the priorities that will drive growth and return on investment capital. At our meeting with you next week, we're looking forward to providing you more specifics on how we're planning to advance these five priorities, while providing insight in how our plans will translate into financial results both this year and over the long-term. +Our plan for the day is as follows. I'll lead off the day by providing details on our strategic priorities, our approach to growth, and the principles guiding our leadership team as we work to deliver on these priorities. Then John will provide more detail on our financial expectations for each line of the P&L going forward, and he will provide full year guidance for 2015, financial results from continuing operations, reflecting our plan to grow earnings-per-share this year. +Casey Carr will follow with details on our digital progress. And his plans to transform the organization by developing new capabilities that will support our growth, control cost, and recapture the innovative spirit that's part of the Company's DNA. +Then, Kathee Tesija will provide more insights in to our core guests and our plans to develop products, experience, and formats to serve those guests over time. And then Jeff Jones will provide insights in to the guest relationship with the Target brand, and his team's work to modernize our marketing and the way we interact with today's core guest. Finally, we'll end with a Q&A session. +We're looking forward to the opportunity to share these plans with you next week, and we're confident that we can build on the early momentum we've seen over the last few quarters. We have a fantastic foundation to build on with a great brand, loyal guests, and an outstanding team. And we're committed to maintaining our focus on our key priorities, and making the tough decisions to position Target for long-term success. +Now, I'll turn the call over to Kathee to recap our fourth quarter and holiday season performance. Kathee? + +-------------------------------------------------------------------------------- +Kathee Tesija, Target Corp - CMO & Supply Chain Officer [4] +-------------------------------------------------------------------------------- + + Thanks, Brian. +Across the US retail landscape, this year's holiday shopping season began earlier and ended later than ever before. This lengthening of the season reinforced a pattern we've seen for well over a decade. Where we saw the strongest sales in the early and late portions of the season, and experienced a period of softness in the middle. +Specifically, throughout November, our comparable sales performance, including the Black Friday weekend, was very strong, on both the one-year and two-year basis, driven by strong promotions throughout the month, combined with in-store events and cartwheel daily deals. +In December, following the characteristic lull that we've seen for more than a decade, we saw a very strong surge in traffic and sales in the days leading up to and after Christmas. And in January, we continued to see unexpected strong results throughout the month. +As Brian mentioned, we saw particularly strong trends in fourth-quarter sales in our signature categories. Specifically, healthcare, beauty, apparel, and home all grew faster than our overall sales. Within apparel, results were strongest in baby and kids, and home comps were led by domestics and seasonal items. +In hard lines, our toy category had a fantastic quarter recording a double-digit increase in comparable sales, driven by a strong lineup of Target exclusive items throughout the assortment. Average retails were up across all of our categories, as guests were trading up within assortments and we saw strong regular price sell-throughs in seasonal and markdown sensitive categories. +Digital channel growth also contributed to the growth in the average retail, particularly in home and apparel. Both of which saw digital channel penetration growth of more than a percentage point in the fourth quarter. +Throughout the holiday season, we were very pleased with the performance of our fourth-quarter limited time partnerships with TOMS and Faribault Woolen Mill. Guests responded to the stories behind these brands, and were delighted by the combination of quality and price we could deliver. +I already mentioned the great quarter in toys, which we supported this year with the launch of our Kids' Wish List app. A fun interactive way for kids to let their families know which gifts were at the top of their list. +We saw strong guest engagement with this new app, as nearly half the families who used it created a list for two or more kids. And by the end of the season, thousands of new Target.com accounts had been created by Wish List users. +Our attention getting offer to ship all digital orders for free during the holiday season provided compelling value and convenience to our guests. The offer created a surge in traffic and conversion on both our conventional site and mobile, which as expected, was partially offset by a moderate decline in average transaction size. +Because our guests responded so well to this holiday promotion, we were excited earlier this week to announce that going forward, we are reducing the order threshold for free shipping from $50 to $25, with virtually no exclusions. This new minimum is among the most compelling offers in digital retailing, putting us ahead of many of our key competitors. +In our digital channel, for the fourth quarter overall, we saw a high single-in digit increase in visits. Driven entirely by growth in mobile, which includes both tablets and smart phones. Orders were up well over 50%, driven by very strong conversion increases on both the conventional site and mobile. Mobile is becoming increasingly important to all digital retailers. And given the profile of our guests, it's particularly important for Target as mobile accounted for more than 40% of our digital orders in the fourth quarter. And notably on Black Friday, 10% of our iPhone app revenue was from guests purchasing on their phone while they were simultaneously shopping one of our stores. +Our flexible fulfillment efforts play a key role in supporting our digital growth. And we're pleased with results of our store pickup program, and our recent rollout of ship from store capabilities. +This is the second holiday season in which we've offered store pickup. And since last year, we've added more dry grocery items, extended the pickup window from two to four days, and we've begun testing dedicated parking spots. This year, we had more than 400,000 store pickup orders on the Black Friday week alone, and they accounted for half of our digital traffic in the last four days leading up to Christmas. +For the year in total, 84% of store pickup orders were picked on time, and 35% of the time, guests who picked up a digital order, also shopped the store on the same visit. This was our first holiday season with ship-from-store capabilities, having rolled out to 139 stores at the end of the third quarter. This capability allows us to ship more than 60,000 items directly from stores to our guests' front doors, dramatically cutting shipping times while reducing our shipping costs. +We were pleased with the ability of this initial group of stores to handle the shipments from their back rooms, which peaked in the last week of November. And importantly, this capability allowed us to continue to fulfill holiday orders late in the season for items which were already sold through in our fulfillment centers, but still available in our stores, allowing us to capture incremental sales. +Before I move to our plans going forward, I want to pause and discuss the situation at the west coast ports. As you know, the slowdown at these ports began several months ago, and our fourth-quarter performance clearly demonstrates that our team was effective in handling this slowdown. By rerouting, expediting, and preordering inventory to support in-stocks. We were very pleased with last weekend's news that a tentative agreement had been reached, but we know it will be some time before the backlog at these ports will be fully eliminated. In the meantime, we have contingency plans to continue to work around potential issues. But at times, we may experience periods of light inventory in some assortments. +Now, I want to give you a few highlights of our plans going forward, and of course, we will have much more to cover with you next week. Last year, we began to test and roll out a variety of store presentation innovations to elevate the shopping experience, and differentiate our brand. Based on the guest response to these changes, we are planning to accelerate our rollout in 2015. +For example, following the addition of mannequins at the apparel floor pad, in more than 600 stores last Fall, we're planning to roll them out to another 400 stores this quarter. And based on the guest response to our enhanced entertainment and electronics experience, which is currently in 42 stores, we plan to roll this environment out to another 275 stores this year. In home, we've begun testing highly inspirational vignettes to show product in lifestyle settings, which we're rolling out to another 15 stores this quarter. +Farther back in the testing phase, we're looking at innovations to bring even more fun to our toy area. With easier navigation, interactive experiences, larger than life displays, and floor graphics. We're always looking for creative platforms to engage guests in new ways that are meaningful to them. Snapchat provides a fun channel for us to quickly share exclusive behind the scenes content with our guests that they can't get anywhere else. +If you were one of the fans who witnessed Target's Snapchat debut, you caught a glimpse of the first story. Which teased our history-making Grammy commercial with Imagine Dragons, to announce the Target exclusive version of their new album containing four exclusive bonus tracks. Jeff will have more to say about this groundbreaking Grammy moment at our meeting next week. +Guests are excited about the recent launch of our new plus-sized brand Ava & Viv which launched earlier this month. Designed by our own product design and development team, Ava & Viv feature stylish basics, along with trend-driven statement pieces. Similar to Target's other apparel lines, Ava & Viv will be updated monthly, with prices ranging from $10 to $80. +And the anticipation is building for our upcoming partnership with Lilly Pulitzer. With a modern interpretation of the american resort wear brands exuberant prints and patterns. The limited edition Lilly Pulitzer for Target collection features 15 exclusive prints, which are original works of art created by Lilly Pulitzer artists, specifically for this modern collaboration. Available exclusively at all Target stores in the US and on Target.com beginning April 19th; the 250-piece collection includes apparel, accessories and shoes for women and girls, as well as home accents, outdoor entertaining accessories, beach gear, travel essentials, and more. +And finally, as Brian mentioned, wellness is one of the signature categories in which we're investing to differentiate our brand and our assortment from the competition. We have a huge opportunity in this space, because our guests have told us it's particularly important to them. Specifically, nearly every household that shops at Target buys natural and organic products, and more than half of them indicate that they'd prefer to purchase natural and organic products when available. +These guest insights are reinforced by their behavior in our stores. While overall sales in the natural and organic industry are growing rapidly, sales of these categories at Target are growing even faster, outpacing the industry by 50% in 2014. +The Made to Matter collection remains one of the most prominent and active examples of Target's focus on wellness. Offering guests a selection of natural, organic, and sustainable products across multiple categories. In 2014, sales of the brands featured in our Made to Matter collection grew twice as fast at Target than they did elsewhere in the market. In 2015, we'll reinforce our commitment to newness and better for you choices with a refreshed Made to Matter, hand picked by Target, collection. This year's collection will double in size compared to last year, delivering more than 200 new and exclusive products from 31 leading and upcoming brands. +As we look ahead to the new year, our priorities in merchandising are clear. We will build appropriate plans for each of our categories, based on the role they play in supporting our brand and delivering a superior shopping experience. In our signature categories, we will invest in product development, marketing, fixtures and store service to elevate and differentiate both the assortments and the shopping experience; fully delivering on our Expect More, Pay Less, brand promise. Our fourth-quarter results demonstrate that we are making some early progress in this work, and we are dedicated to moving much faster in this transformation in 2015. +Now I'll turn it over to John, who will share his insights on our fourth-quarter financial performance and our outlook for first quarter 2015. John? + +-------------------------------------------------------------------------------- +John Mulligan, Target Corp - CFO [5] +-------------------------------------------------------------------------------- + + Thanks, Kathee. +Our first-quarter financial results were stronger than expected, driven by better than expected sales performance in the US. Our adjusted EPS of $1.50 was better than the high end of the guidance provided in our January 15th update, and about $0.11 better than our expectations for US performance at the beginning of the quarter. +The fourth quarter diluted EPS from continuing operations was $1.49, about $0.01 lower than adjusted EPS. Driven by a combined by $0.02 of dilution from the reduction of the beneficial interest asset, combined with net data breach expenses. Partially offset by the benefit from the resolution of income tax matters. +Fourth-quarter GAAP EPS losses of $4.10 reflected $5.59 in losses from discontinued Canadian operations. Our fourth quarter comparable sales increase of 3.8% was above the guidance of around 3% that we provided in our January update, and nearly double the 2% growth we expected at the beginning of the quarter. More than all of the sales out performance in the last few weeks of the quarter was in our stores, as digital channel sales came in a bit softer than expected in those last few weeks. +Reflecting a slowdown in demand sales growth as we annualized over promotions from a year ago, combined with returns which came in somewhat higher than expected. Even so, digital channel sales increased a robust 36% in the fourth quarter on top of a very strong increase in the fourth quarter of 2013. And, as Brian mentioned, digital channel growth delivered about 90 basis points of our fourth-quarter comparable sales increase, up from a 60 basis point contribution in the third quarter. +US REDcard penetration of 21.1% was about 20 basis points ahead of last year, and in line with our expectations. As I mentioned last quarter, based on trends and new accounts, we believe this quarter represented a trough in penetration growth. And we expect to see a moderate reacceleration in penetration growth in 2015. This growth should benefit later in the year from the introduction of chip and pin technology for all of our REDcards. And the changeover to MasterCard on our legacy co-branded Credit Card program. +Our fourth quarter EBITDA margin rate of 9.9% was somewhat stronger than expected, driven by very strong gross margin rate performance, partially offset by a small increase in our SG&A expense rate. Specifically, our fourth-quarter gross margin rate of 28.5% was nearly a percentage point higher than a year ago, and the strongest fourth-quarter performance we've seen since 2010. +This year's rate benefited from a favorable mix of sales growth in our signature categories, combined with better markdown rates, as we annualized last year's clearance and promotional activity, following the announcement of the data breach. +I want to pause here and comment on our inventory position at the end of the quarter, which was about 6% higher than last year. This increase was intentional, and reflects two separate decisions. First, in the last six months, we've chosen to increase our inventory in commodity categories to enhance in stocks in these frequency driving businesses. And second, we are ahead in some import categories in light of the slow down at the west coast ports. Bottom line, the inventory increase was the result of specific decisions we've made, and we feel very good about our overall inventory level as we enter the new fiscal year. +Getting back to the fourth quarter P&L, on the SG&A expense line, we benefited from productivity improvements in the stores and overall leverage on pay in benefit, offset by higher marketing, technology, and incentive expense rates compared with last year. All together, our fourth quarter SG&A expense rate was about 20 basis points higher than last year. +Moving to consolidated metrics, fourth-quarter interest expense was up about 6% to last year. And we paid $330 million in dividends in the quarter, an increase of 22% over last year. +As expected, we didn't repurchase any shares in the fourth quarter. However, as we discussed in our January update, the exit from the Canadian market will meaningfully improve our credit metrics going forward. And provided the wind down of our Canadian operations continues to operate to push [seed] as planned, we will be in a position to revisit the possibility of share repurchase later in 2015. As always, I will reiterate, that we will only resume repurchase activity if we believe it can be accomplished within the limits of our current investment-grade credit ratings. +As we look back at full-year performance in the US, our 2014 adjusted EPS of $4.27 was down slightly from $4.38 in 2013, driven by early year challenges, as we recovered from the data breach. However, the healing of our business has been evident in the progression of our financial results throughout the year. Specifically, comparable sales, digital channel growth, and year-over-year gross margin rate performance all improved as we moved throughout 2014. And expenses remained well controlled throughout the year. Next week at our meeting with you in New York, we will outline in detail our plans to build on this early momentum over the next few years. +Before I turn to the outlook for the first quarter of 2015, I want to cover a small change to our adjusted EPS reporting, which we present in order to reflect the results of operations, from what is now a single segment business. Given that we have now amortized $151 million or two-thirds of the original value of the beneficial interest asset, related to the 2013 sale of our credit card receivables portfolio, beginning in 2015, we will no longer remove the amortization of the beneficial interest from our adjusted EPS calculation. +This is because both the quarterly amortization amounts and the year over year changes in those amounts are expected to be immaterial going forward. And therefore, we believe our reporting will be streamlined if we make this change. In our reporting throughout 2015, prior-year adjusted EPS results will also reflect this change to ensure consistency for comparison purposes. +With that, let's move to our outlook for the first quarter. We expect our comparable sales to increase about 2% driven by an increase in digital channel sales of 30% or more, combined with the modest growth in store channel sales. While it's still early in the quarter, our results for the first few weeks of February are consistent with that forecast. On our first quarter sales, we expect our gross margin rate to improve 40 to 50 basis points from last year; as we annualize last year's very intense promotions, which we used to recapture traffic coming out of the data breach. +On the SG&A expense line, we expect our first quarter rate to be flat to down slightly from a year ago, as we expect that the benefit from store productivity improvements, will be offset by higher marketing and technology expense rates compared with last year. We expect our D&A expense rate to be about 10 basis points higher than last year, reflecting the impact of continued investments in technology to support our digital and flexible fulfillment efforts. All together, we expect an improvement in our first quarter EBIT margin of 30 to 40 basis points above last year. +First-quarter interest expense should be approximately flat to last year. And tax expense is expected to be about $50 million higher than last year, reflecting improved profitability and a higher consolidated tax rate compared with a year ago. All together, these expectations would lead to first quarter adjusted EPS representing results of continuing operations in our single segment business of $0.95 to $1.05 compared with $0.92 a year ago. +As John mentioned at the beginning of the call, I'm going to wait till next week's Financial Community meeting to provide specific guidance for full-year 2015 earnings growth, as well as our expected financial algorithm over the longer term. This will allow us to present our financial outlook in the full context of our specific business plans, which reflect necessary investments to accelerate growth and build capabilities, along with the opportunity to reduce costs over time, providing fuel to fund those investments. +With that, we'll conclude today's prepared remarks. Now Brian, Kathee and I will be happy to respond to your questions. + + +================================================================================ +Questions and Answers +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator instructions) +Simeon Gutman, Morgan Stanley. + +-------------------------------------------------------------------------------- +Simeon Gutman, Morgan Stanley - Analyst [2] +-------------------------------------------------------------------------------- + + Thanks, good morning. It's Simeon Gutman. First question on gross margin for John or for Brian. It was quite solid in the fourth quarter. Last year, you had a little pressure but not nearly as much as I guess we all expected given some of the discounting. So can you talk about what drove the expansion year-over-year in this year's fourth quarter? + +-------------------------------------------------------------------------------- +John Mulligan, Target Corp - CFO [3] +-------------------------------------------------------------------------------- + + Sure, I'll start, and I'm sure Kathee will jump in. But I think overall, what you observed is there's strictly some savings relative to last year with the clearance activity that went on. But I think much more important to that is, you saw the acceleration of the signature categories; home, apparel, style, kids. +Many of those with margin rates well in excess of our average margin rate. And I think for the first time, Kathee and I couldn't even remember the last time where both home and apparel out-comped the Company. So we saw a very strong mix in the quarter, delivered by the product in the stores. + +-------------------------------------------------------------------------------- +Kathee Tesija, Target Corp - CMO & Supply Chain Officer [4] +-------------------------------------------------------------------------------- + + Yes, so on top of the mix, I would also say that regular priced sell-through was very high. So less on clearance or mark down, and more at full retail which also contributed. + +-------------------------------------------------------------------------------- +Simeon Gutman, Morgan Stanley - Analyst [5] +-------------------------------------------------------------------------------- + + Okay, and just one follow up. I'm sure this will get addressed next week, but can you just tell us what the average wage for full-time associates and/or part-time associates are at Target? + +-------------------------------------------------------------------------------- +John Mulligan, Target Corp - CFO [6] +-------------------------------------------------------------------------------- + + We don't disclose the average wage for our team members. What I would tell you is, the store's team has always been appointed differentiation for Target. And we've always prided ourselves, and believe we have the best team in retail. So very focused on ensuring we have competitive wages and that we're developing our team members. +We're all the time assessing the marketplace to determine competitive wages and making adjustments, and we feel very confident that we'll be paying the teams appropriately. I think importantly, if you look at our team leaders, 60% of them came from team members. +So development is a really big part of what we offer to our team as they progress. Overall as we look at some of the announcements that have been made and the marketplace and the minimum wage legislation that's been [enacted], really hasn't changed our view of the quarter or the year really at all. And won't be material changes to us. + +-------------------------------------------------------------------------------- +Simeon Gutman, Morgan Stanley - Analyst [7] +-------------------------------------------------------------------------------- + + Okay. Thanks. + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corp - Chairman & CEO [8] +-------------------------------------------------------------------------------- + + I just want to build on that. I'm sure we're going to receive this question again next week. But to John's point, and our goal is to make sure we have the very best team in retail. +And we're going to continue to invest in their development. And make sure that from a marketplace standpoint, we're very competitive with the wages we provide. So I've been very pleased to learn that over 60% of our team leaders actually started as part-time hourly employees. +That development is critically important. It allows us to attract terrific team members. And as John stated, we do not expect to see any material change next year. + +-------------------------------------------------------------------------------- +Simeon Gutman, Morgan Stanley - Analyst [9] +-------------------------------------------------------------------------------- + + Okay. Thanks. See you next week. + +-------------------------------------------------------------------------------- +Operator [10] +-------------------------------------------------------------------------------- + + Matt Nemer, Wells Fargo Securities. + +-------------------------------------------------------------------------------- +Matt Nemer, Wells Fargo Securities, LLC - Analyst [11] +-------------------------------------------------------------------------------- + + Thanks for taking my question. I want to follow up on that last comment around wages. Brian, could you just provide some context around how much opportunity you think there is to reduce complexity and improve efficiency in case you needed to respond to wages or you wanted to respond? + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corp - Chairman & CEO [12] +-------------------------------------------------------------------------------- + + Well it's certainly going to be an area that we'll highlight next week. And I think you've captured it really, really well. Our focus right now throughout the organization is to reduce complexity, simplify the way we work, the way we operate each and every day, continue to empower our team members to make the right decisions that are going to impact the business. +We want to create an organization that's much more agile, that moves with much increased pace as we go forward. And we deliver the right innovation and product that our guest is looking for. So it is a significant area of focus for us. +We're going to talk about it in great detail. But we think it's going to be a very important part of our strategy going forward. It's going to fuel the key growth priorities that we've been talking about, and we'll go through in great detail next week. +But our goal is to make sure we eliminate complexity at Target, we simplify our operating model. We empower our team members. And create an environment where we're agile, we're taking advantage of marketplace opportunities, and we're bringing products and services to market that respond to the needs of our guest. + +-------------------------------------------------------------------------------- +Matt Nemer, Wells Fargo Securities, LLC - Analyst [13] +-------------------------------------------------------------------------------- + + Thanks. And then just a quick followup on the higher online return rates. Do you think that's primarily a function of the free shipping offer? Is it more prevalent in certain categories? And is it related at all to error rates? + +-------------------------------------------------------------------------------- +John Mulligan, Target Corp - CFO [14] +-------------------------------------------------------------------------------- + + Actually, the return rates were higher than our expectation, but they were essentially right on last year. We had seen some improvement throughout most of the year, and they basically just returned to last year. +So not a material change. Just a little bit different than our expectation for the last couple weeks. + +-------------------------------------------------------------------------------- +Matt Nemer, Wells Fargo Securities, LLC - Analyst [15] +-------------------------------------------------------------------------------- + + Understood. Thanks so much. + +-------------------------------------------------------------------------------- +Operator [16] +-------------------------------------------------------------------------------- + + Scott Mushkin, Wolfe Research. + +-------------------------------------------------------------------------------- +Scott Mushkin, Wolfe Research - Analyst [17] +-------------------------------------------------------------------------------- + + Hey, guys. Thanks for taking my questions. The first thing I wanted to poke at was frequency. Brian, you mentioned that you were real pleased with the frequency going up in the quarter. +Is that a focus for the Company to drive frequency to the stores? And maybe as a preview, how do you get it done? + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corp - Chairman & CEO [18] +-------------------------------------------------------------------------------- + + Scott, while there's certainly a number of critically important metrics as we look at the business going forward. I can tell you that the entire leadership team has prioritized, one, increasing traffic to our stores, and two, visits to our site. Those are critically important as we go forward. +So we're going to do that by executing many of the priorities that we outlined today. We certainly want to make sure we're building the right digital, and importantly mobile capabilities, that drive greater visits to our site and build greater engagement with our guests. Not only when they're shopping at home, but also when they're shopping inside of our stores. +And Cartwheel is a great example of how we've used digital to drive greater engagement. I am really pleased, and Kathee highlighted the fact that our signature categories drove our growth in the fourth quarter. And it's critically important that while we're in the early stages, we're already seeing the guests react well to our focus on style, on baby, and kids, and importantly wellness. +And the fact that healthcare and beauty and home and apparel outpaced our overall performance in the fourth quarter, is a sign that we're connecting with the guest. And we're certainly driving more of the traffic because of these great new offerings in store. +So our focus on elevating signature categories, we think brings our guest back to Target more often. They're going to be coming back in to see what's new. And Kathee and her team have a great lineup in 2015 of new exciting products, coupled with an improvement in our in-store experience and merchandising. +So those elements are critically important. We think localization allows us to build a more meaningful relationship with the guest, which will result in more traffic and more visits. And certainly as we expand our smaller formats. Both City Target and Target Express, it's a way for us to engage the guest in these urban settings that are critically important. +So all of those are focused on making sure we build greater engagement. But the metrics that are going to be important for us is to ensure it results in more traffic, like it did in the fourth quarter, and more visits to our site. So we're pleased with Q4. +Lots of work in front of us. But I felt very good, as did the entire leadership team, that our comp increase of 3.8% in the fourth quarter was primarily driven by traffic. And our industry-leading growth in digital was certainly going to be fueled by more visits and better conversion from our site. + +-------------------------------------------------------------------------------- +Scott Mushkin, Wolfe Research - Analyst [19] +-------------------------------------------------------------------------------- + + That's perfect. And I just had one quick follow up. I have a ton of questions, but I'm just going to do one quick followup to what you said, Brian. +You didn't mention, although Kathee did, she mentioned food. How do you think of food in context to traffic? And then I'll yield. Thank you. + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corp - Chairman & CEO [20] +-------------------------------------------------------------------------------- + + Scott, I think you already know the answer to that, and we're going to talk about this specifically next week. Food is very important to our guests. And they've confirmed that with us as we've gone back and researched the food category through the eyes of the guest recently. +We all know food trips drive traffic. And we want to make sure we compliment our signature categories with guests that are coming to us for the great food products we can curate. We recognize we have a lot of work to do in food. +And Kathee and I were recently out in the market together. We spent several days visiting our stores, looking at competitive food retailers, as we begin to build our reinvention plans for food. But as Kathee will talk about next week, we recognize we need to make changes to our assortment. +Made to Matter and some of the changes we're making right now in our assortment that deliver more organic, natural, gluten-free items critically important to the guest. And we also recognize we have to change the in-store experience, and really make sure our food and grocery merchandising compliments the great experience we create at Target. So a critically important area of opportunity. +We won't get there overnight. It will be a multi-year transition. But food is going to play a very important role in complimenting our other signature categories, and making sure we drive traffic to our stores and to our site. + +-------------------------------------------------------------------------------- +Scott Mushkin, Wolfe Research - Analyst [21] +-------------------------------------------------------------------------------- + + Thanks. That was a great answer. I appreciate it. + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corp - Chairman & CEO [22] +-------------------------------------------------------------------------------- + + Scott, thanks. Hopefully we'll see you next week. + +-------------------------------------------------------------------------------- +Scott Mushkin, Wolfe Research - Analyst [23] +-------------------------------------------------------------------------------- + + Definitely see you next week. Looking forward to it. + +-------------------------------------------------------------------------------- +Operator [24] +-------------------------------------------------------------------------------- + + Matthew Fassler, Goldman Sachs. + +-------------------------------------------------------------------------------- +Matthew Fassler, Goldman Sachs - Analyst [25] +-------------------------------------------------------------------------------- + + Thanks a lot, and good morning. If you could frame some of the marketing and technology spending in the fourth quarter, just let us know what that was directed towards. And I know you're holding back to some degree on 2015 guidance, but were some of those initiatives that you would expect to persist through the upcoming year? + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corp - Chairman & CEO [26] +-------------------------------------------------------------------------------- + + Matt, we'll certainly go through much more of this next week. I think if you were to look at the changes we made from a marketing standpoint in the fourth quarter, the big change would have been a significant increase in our digital support of our brands. So as we continue to make sure we're connecting with our guests, we're connecting with them the way they're looking to connect with the Target brand, digital is going to play an increasingly important role. +And we were very pleased with our overall marketing in the fourth quarter. We had some outstanding creative on air. It received very positive response from the guest, and we complimented that with a very strong digital campaign. +So I felt and the team felt very good about the progress we made from a marketing standpoint in the fourth quarter. We had creative that broke through the clutter, connected with our guest, drove traffic to our stores. We complimented that with really impactful digital and online communication, and tied that back in with great in-store marketing. +So you'll see more of that as we go forward into 2015. And we'll take you through a lot more of the investments and the plans we have when we see you next week. + +-------------------------------------------------------------------------------- +Matthew Fassler, Goldman Sachs - Analyst [27] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Operator [28] +-------------------------------------------------------------------------------- + + Sean Naughton, Piper Jaffray. + +-------------------------------------------------------------------------------- +Sean Naughton, Piper Jaffray - Analyst [29] +-------------------------------------------------------------------------------- + + Hello, guys. Good morning. I just wanted to follow up on the food question, and then specifically inside of the fresh component of the business. This was supposed to be a big part of driving transactions to the store over the long-term. +Could you just maybe give us a little bit on where Target is with its fresh offering today? How is it evolving, and are you happy with the performance of the sales and margins on this segment of the business? + +-------------------------------------------------------------------------------- +Kathee Tesija, Target Corp - CMO & Supply Chain Officer [30] +-------------------------------------------------------------------------------- + + Sean, we're going to talk about food in much more depth next week. But fresh is a very important part of food. Not only traffic and number of trips for our guests, but just in terms of what's important to them, in terms of wellness. +Fresh food plays a very important part. And as Brian said, we've got a lot of work to do here. So both in Super Target as well as in P Fresh format. And it centers around our assortment, how fresh the product is, and ways that we can improve upon that, the presentation, showing abundance in that great product. +So we have a lot of work to do. But critically important to us because our guest has said they want to be able to eat better both natural and organic. We see it in our results today. And we know that there's much, much more opportunity. + +-------------------------------------------------------------------------------- +Sean Naughton, Piper Jaffray - Analyst [31] +-------------------------------------------------------------------------------- + + Okay. And then maybe as a follow up here. Just on the inflation front, can you just give us an idea of how inflation trended maybe across the store in the quarter, and your expectations in the near and medium term? Thank you. + +-------------------------------------------------------------------------------- +John Mulligan, Target Corp - CFO [32] +-------------------------------------------------------------------------------- + + Sure. Lots of variability across categories, as is always the case. We saw some inflation in food. We saw a lot of deflation in electronics, like we always do. But if you look across the entirety of our business, essentially flat to last year. So no net impact to the business from inflation in aggregate, but as I said, lots of variability within that. + +-------------------------------------------------------------------------------- +Sean Naughton, Piper Jaffray - Analyst [33] +-------------------------------------------------------------------------------- + + That's helpful. Thank you. + +-------------------------------------------------------------------------------- +Operator [34] +-------------------------------------------------------------------------------- + + Michael Lasser, UBS. + +-------------------------------------------------------------------------------- +Michael Lasser, UBS - Analyst [35] +-------------------------------------------------------------------------------- + + Good morning. Thanks a lot for taking my question. As you look back at the fourth quarter, can you dimension what you think the -- how the performance was driven by your own initiatives, the easy comparison versus last year, and just an improving macro environment due in part to the lower fuel prices? If there's any way you could potentially quantify that, I think it would be really helpful. + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corp - Chairman & CEO [36] +-------------------------------------------------------------------------------- + + Michael, let me start, and I'll let Kathee and John jump in. I think you've certainly identified some of the big levers. And I think as we sit here today, we recognize that the consumer confidence has certainly improved. Lower gas prices, certainly helping the industry overall. We did have some favorable overlaps certainly as we overlapped the breach. +But I also think we made significant strides from a merchandising standpoint, from a marketing standpoint, and we continue to deliver great execution and service inside the stores. And when you look at the two year stacks, we had a very challenging November, a very strong November from 2013 that we overlapped and saw growth. That to me was a sign that not only was the consumer healthier, but they were choosing to spend their dollars in Target stores. +And they came back in December, as Kathee alluded to. We had a very strong close to the holiday season. But importantly, we felt really good about traffic and our performance in January, particularly in the last two weeks of the quarter. +So a combination of we certainly did have some issues from last year that we are overlapping. The consumer, we do believe is healthier. And we're pleased that they're spending in our stores, both in our stores and online. +But I also think we made significant strides from a merchandising standpoint. We had terrific marketing, and a great digital connection with our guest. We were able to leverage both an improved in-store experience, the convenience of shopping online and picking up in store. +And we had industry-leading online sales, and we leveraged our stores to help make sure that we fulfilled the needs of our guest. So I think the combination of all those elements added up to a very solid quarter. + +-------------------------------------------------------------------------------- +Michael Lasser, UBS - Analyst [37] +-------------------------------------------------------------------------------- + + Okay, thanks for that. Please go ahead, Kathee. + +-------------------------------------------------------------------------------- +Kathee Tesija, Target Corp - CMO & Supply Chain Officer [38] +-------------------------------------------------------------------------------- + + The only thing that I would add to that is just that a lot of that focus came in our signature categories, which is why you saw our growth there in particular. So major investment in product, both quality as well as aesthetic, and number of SKUs, newness that we brought to the market. +The marketing reinforced that, and that was very well received by our guest. And then coupled with presentation, both online with enhancements in our app and our desktop site. And the presentation in our store, driven by focus on signature categories really helped drive our growth. + +-------------------------------------------------------------------------------- +Michael Lasser, UBS - Analyst [39] +-------------------------------------------------------------------------------- + + That's helpful. The follow-up question I had is, are there any particular call outs you can offer about the strength in the last two weeks of the quarter? It just strikes us as interesting, and we're curious about what drove that strength. Thank you. + +-------------------------------------------------------------------------------- +John Mulligan, Target Corp - CFO [40] +-------------------------------------------------------------------------------- + + I think we continued to see gift card redemption. We intentionally -- we had a significant gift card promotion on Black Friday that was very successful. We saw all of those come back in January. I think that helped. +And we saw continued strength in the product in home and apparel. Very strong sales in home and apparel, and I think that was an element of it as well. And I think that it's a combination of both. + +-------------------------------------------------------------------------------- +Kathee Tesija, Target Corp - CMO & Supply Chain Officer [41] +-------------------------------------------------------------------------------- + + And our wellness business is healthy. As we turn the corner in to the new year, we saw that continue. +So the trade up that we had seen during Christmas, we saw continue into January. Which is just guest choice for products in our discretionary categories. So I think lots of things drove it. + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corp - Chairman & CEO [42] +-------------------------------------------------------------------------------- + + Michael, I think, well summarized. I would put four elements on the list. John talked about gift cards, I think that was very important. And we certainly saw our guest come back to Target with gift cards after the holidays in through January. Our focus on wellness, certainly well received by the guest. We had great newness in our stores to start the new year. +And our store teams did a terrific job of recovering of the holidays. And we offered our guest a very strong in-store shopping experience. So a lot of the basics. +But our gift card plans were well executed. We saw the guest come back in January. Our focus on wellness, that important signature category. Well received. We brought newness into the stores to start the year. And our store teams did a traffic job of recovering after a very busy Christmas holiday season. + +-------------------------------------------------------------------------------- +Michael Lasser, UBS - Analyst [43] +-------------------------------------------------------------------------------- + + Awesome. Thank you so much, I appreciate it. + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corp - Chairman & CEO [44] +-------------------------------------------------------------------------------- + + Thank you. I think we've got time for one more question today. + +-------------------------------------------------------------------------------- +Operator [45] +-------------------------------------------------------------------------------- + + Greg Melich, Evercore ISI. + +-------------------------------------------------------------------------------- +Greg Melich, Evercore ISI - Analyst [46] +-------------------------------------------------------------------------------- + + That's great. Thanks. I had a couple follow-ups. +It would be great to know -- you said the signature categories did well. Do you have the actual numbers, like which ones were better by category for food and wellness, et cetera? + +-------------------------------------------------------------------------------- +Kathee Tesija, Target Corp - CMO & Supply Chain Officer [47] +-------------------------------------------------------------------------------- + + Health and beauty were both very strong. So in the health categories, that spread across many categories. I talked about Made to Matter. I talked about better for you product in food. But it was also in our health business and our style business. Both beauty was strong, as well as in apparel it was driven really by kids and by babies. +And in home, it was domestics and seasonal product. And then in kids, we had incredible season in toys with a double-digit comp. We really were pleased with the overall holiday. + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corp - Chairman & CEO [48] +-------------------------------------------------------------------------------- + + As we mentioned earlier in the call, wellness, home, apparel all comped in excess of the 3.8% we reported in the quarter. So strength across all those categories. +And in order to win in the fourth quarter, you have to win in toys. Well, our team won in toys, and showing a double-digit comp was critically important. So we felt very good about the early progress in those signature categories, and we'll build off of that momentum as we go in to 2015. + +-------------------------------------------------------------------------------- +Greg Melich, Evercore ISI - Analyst [49] +-------------------------------------------------------------------------------- + + And maybe a follow-up on that momentum and seeing the traffic get back to up 3%. When you look out to your first quarter, that 2% expectation, do you expect traffic to be half of that comp or positive in the first quarter? Or what's built into your expectation? + +-------------------------------------------------------------------------------- +John Mulligan, Target Corp - CFO [50] +-------------------------------------------------------------------------------- + + I think Brian hit on it earlier. We're continuing to drive for positive traffic. I think positive in the store and growing digital online, and that's part of our guidance. + +-------------------------------------------------------------------------------- +Greg Melich, Evercore ISI - Analyst [51] +-------------------------------------------------------------------------------- + + Great. And then, John, maybe a quick follow-up on SG&A. It looked like -- and I could be backing the math out wrong here, but SG&A dollars in the fourth quarter accelerated to maybe 4% or 5% growth. Was there anything that caused that in particular? + +-------------------------------------------------------------------------------- +John Mulligan, Target Corp - CFO [52] +-------------------------------------------------------------------------------- + + Yes, I think like we said, it was a little bit of deleveraging. There was some marketing expense we talked about in November, moved from November into -- or from Q3 in to Q4. As Brian said, we made some investments in marketing. The other elements were ongoing all year. We had some technology. +And then the thing that really drove a lot of it relative to the other quarters was incentive expense. We clearly out delivered our expectations, and that will be reflected in our incentive expense. + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corp - Chairman & CEO [53] +-------------------------------------------------------------------------------- + + Thanks for joining us today. That's going to conclude our fourth-quarter 2014 earnings conference call. We appreciate everyone's participation today, and we really look forward to seeing you next week in New York City. So thank you again. + +-------------------------------------------------------------------------------- +Operator [54] +-------------------------------------------------------------------------------- + + Ladies and gentlemen, this does conclude today's conference call. Thank you for participating. At this time, you may now disconnect. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/exam/original-files/Problem_2_3_Sample_full_transcripts/2015-Jan-14-JPM.N-140213325968-Transcript.txt b/exam/original-files/Problem_2_3_Sample_full_transcripts/2015-Jan-14-JPM.N-140213325968-Transcript.txt new file mode 100644 index 0000000..6178c7a --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_full_transcripts/2015-Jan-14-JPM.N-140213325968-Transcript.txt @@ -0,0 +1,1290 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q4 2014 JPMorgan Chase & Co Earnings Call +01/14/2015 08:30 AM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Marianne Lake + JPMorgan Chase & Co. - CFO + * Jamie Dimon + JPMorgan Chase & Co. - Chairman & CEO + +================================================================================ +Conference Call Participiants +================================================================================ + + * Matt Burnell + Wells Fargo Securities - Analyst + * John McDonald + Sanford Bernstein - Analyst + * Paul Miller + FBR & Co. - Analyst + * Erika Najarian + Bank of America Merrill Lynch - Analyst + * Mike Mayo + CLSA - Analyst + * Eric Wasserstrom + Guggenheim Securities - Analyst + * Guy Moszkowski + Autonomous Research - Analyst + * David Hilder + Drexel Hamilton - Analyst + * Steven Chubak + Nomura Asset Management - Analyst + * Gerard Cassidy + RBC Capital Markets - Analyst + * Jim Mitchell + Buckingham Research Group - Analyst + * Chris Kotowski + Oppenheimer & Co. - Analyst + * Nancy Bush + NAB Research - Analyst + * Glenn Schorr + Evercore ISI - Analyst + * Ken Usdin + Jefferies & Co. - Analyst + * Matt O'Connor + Deutsche Bank - Analyst + * Brennan Hawken + UBS - Analyst + * Betsy Graseck + Morgan Stanley - Analyst + +================================================================================ +Presentation +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Good morning, ladies and gentlemen and welcome to JPMorgan Chase's fourth-quarter 2014 earnings call. This call is being recorded. (Operator Instructions). We will now go live to the presentation. Please stand by. At this time, I would like to turn the call over to JPMorgan Chase's Chairman and CEO, Jamie Dimon and Chief Financial Officer, Marianne Lake. Ms. Lake, please go ahead. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [2] +-------------------------------------------------------------------------------- + + Thank you, operator. Good morning, everyone. I'm going to take you through the earnings presentation, which is available on our website. Please refer to the disclaimer regarding forward-looking statements, which is at the back of the presentation. +Starting on page 1, the firm reported net income of $4.9 billion and EPS of $1.19 and a return on tangible common equity of 11% on $23.6 billion of revenue for the quarter. Included in our results was total legal expense of $1.1 billion or approximately $1 billion after tax. In large part an incremental amount for FX. +As we go through the presentation, I will call out other notable items. For your reference, we've included the EPS impact of those here on the front page. In total, they contributed a net positive $0.12 to EPS. So adjusting for legal expense, as well as these items, gives net income of $5.5 billion and an EPS of $1.33 reflecting solid core performance. +I'm going to skip over page 2 and we're going to go straight to the full-year results on page 3. The firm reported record net income of nearly $22 billion and record EPS of $5.29 and a return on tangible common equity of 13% on nearly $98 billion of revenue. Excluding legal expense, which remains elevated, net income for the year was $24 billion and return on tangible common equity 14%. +You can see on the page at the bottom that adjusted expense was $58.4 billion, in line with guidance and down $650 million from the prior year despite the impact of incremental cost control, as well as continuing to invest in our businesses. +A final couple of points for the year, core loan growth was strong at 8% year-on-year and net capital distributions for the year were approximately $10 billion, including record dividends of $6 billion. +Turning to page 4, the firm's fully phased in advanced CET1 ratio was 10.1%, flat to last quarter with earnings and portfolio runoff offset by capital distributions and an increase in risk-weighted assets predominantly driven by higher counterparty credit risk. In terms of 2015 outlook, we expect to add 50 basis points or more to this ratio. +Similarly, the firm's fully phased in standardized ratio not on the page also remained flat at 10.5%. The firm's SLR was 5.6% and the bank's SLR improved to 5.9%. And given the recent FSB proposal, we've added our best estimate of TLAC at approximately 15%, excluding buffers, which will be refined as the rules are finalized. +Moving on to page 5 and before we move into each of the businesses, this quarter, we've changed the presentation of preferred dividends in our lines of business and show the impact here on the page. For the Company, preferred dividends were and continue to be below the line; however, we've historically allocated the cost of preferred stock to the businesses as a net interest expense or a contra revenue with a corresponding positive impact in corporate NII. +In order to have cleaner trends and better peer comparability, we're now presenting preferred dividends below the line for each of our LOBs, which is particularly important given recent increases in preferred issuance. You can see on the slide the change in methodology has no impact on firm-wide financials nor on LOB returns on equity. While LOB revenue, net income and overhead ratios improve, additionally the adjustment affects the contra revenue ratio in the CIB. So from here throughout this presentation and also in the supplement, all numbers in all periods consistently reflect this change. +Moving on to business performance on page 6, the Consumer & Community Bank. The combined businesses generated $2.2 billion of net income for the quarter and an ROE of 16% on nearly $11 billion of revenue. Excluding the impact of losses related to noncore portfolio exits in Card, the ROE was 18%. Consumer & Community Banking continues to deliver strong underlying performance, maintaining our number one ranking in customer satisfaction among largest banks for the third year in a row by ACSI. And in addition, we continue to deepen relationships with our customers. Average deposits were up 8% year-on-year with growth across regions and markets. Record client investment assets were up 13%. Our active mobile customer base was up 22% and credit card sales volume was up 10% on strong new account originations. +Across CCB, we've outperformed our expense targets for the year and have reduced headcount by 12,000 this year exceeding Investor Day guidance by roughly 4,000 and over the last three years, headcount is down approximately 32,000 across the consumer businesses. +Turning to page 7, Consumer & Business Banking. For the fourth quarter, CBB generated net income of $861 million, up 8% year-on-year and an ROE of 31% on improved operating leverage. Net interest income was relatively flat year-on-year, but down slightly quarter-on-quarter on lower deposit margin. For the first quarter of 2015, we expect continued spread compression in CBB deposit margin driven by lower reinvestment rates will drive a modest decline in NII quarter-over-quarter. Noninterest revenue continued to grow, up 6%, across investment, debit and other fees with the addition of approximately 700,000 net new households. And expense was relatively flat with efficiencies self-funding investments. +Finally, in Business Banking, the momentum we have seen in recent quarters continued with loan originations for the quarter of $1.5 billion, up 18% year-on-year. Businesses remain relatively optimistic and banker performance continues to improve. +Mortgage Banking on page 8. Overall Mortgage Banking net income was $338 million for the quarter and a 7% ROE. We reduced expenses for the year by $2.3 billion, outperforming our $2 billion target. Moving to the top of the page, production pre-tax income, excluding repurchase, was slightly positive for the quarter, which was better than guidance on higher volumes and revenue margins. The origination market was more robust due to a strong rate rally, but we estimate it was down about 5% quarter-on-quarter seasonally against which our originations were $23 billion, up 8% quarter-on-quarter, reflecting corresponding share gains in jumbo and conventional. +So this quarter, we increased volumes, we gained approximately 100 basis points of marketshare estimated and realized higher revenue margin. Expenses were flat quarter-on-quarter despite the increase in volumes as we continue to focus on controlling costs. +On to Servicing, net Servicing-related revenue of $624 million was down slightly quarter-on-quarter on lower balances with Servicing expense of $560 million also down slightly. On Real Estate Portfolios, we continue to add high-quality loans to our portfolio. We added another $10 billion this quarter, up from $7 billion last quarter. We recorded net charge-offs of $111 million and reserve releases of $100 million in the non-credit impaired portfolio. Lastly, headcount was down over 7,500 for the year and approximately 22,000 over the last three years. +Moving on to page 9, Card, Merchant Services & Auto net income of $980 million, down 7% year-on-year with an ROE of 20%. If you exclude reserve releases, net income was up 2%. The strong momentum in our business continues with very strong spend, as well as card balance growth of $3 billion in the year. Revenue of $4.5 billion was down 4% year-on-year, but up 1% adjusting for losses related to portfolio exits that went through the quarter's results with an adjusted revenue rate for Card shown on the page of 12.2%, in line with our guidance. +Strong loan and sales growth was offset by spread compression and higher acquisition costs as we continue to add more customers. In 2015, expect the revenue rate to remain at the low end of our target range of 12% to 12.5%. Expense was down 6% year-on-year predominantly driven by remediation costs included in the prior period. +In Card, we led the industry for the 27th consecutive quarter gaining nearly 500 basis points of share during the same period. This quarter, we saw sales growth of 10% driven by enhanced client acquisition and reward strategies. +In Merchant Services, volume was up 13% year-on-year driven by continued strong sales performance and in Auto, results continue to reflect steady growth in new vehicle sales, as well as stable used-car values. This was the 13th consecutive quarter of loan and lease growth with average balances up 5% year-on-year. Coming into this year, the pipeline is strong, which reflects continued strength in the Auto market. +Finally on Credit, in Card, we continued to see improvements in early delinquencies and we released $150 million of reserves this quarter. You can see the net charge-off rate adjusted for portfolio exits was down slightly at 248 basis points. In 2015, expect the charge-off rate to decline modestly. For Auto, credit losses were higher on balance growth and as the charge-off rate starts to trend up from historical lows. +Now moving on to page 10 and the Corporate & Investment Bank. CIB reported net income of $972 million and an ROE of 5% on $7.4 billion of revenue for the quarter. Adjusting for legal expense, ROE would have been 11% for the quarter and 13% for the year. In banking, IBCs were $1.8 billion, up 8%. We continue to rank number one in global IBCs per Dealogic, number one in the US and we moved up to number one in EMEA this year. +Record debt underwriting was driven by M&A-related financings. Strong advisory fees for the quarter contributed to the full-year increase, up 24% and equity underwriting fees were down from a strong quarter last year, but in line with the overall decline in market issuance. We continue to [book on] more deals than any other firm for both the quarter and the year and the fee pipeline continues to be strong into 2015 with a favorable environment generally across most products. +Treasury Services revenue was up 3% and lending-related revenue was $264 million, was down $129 million year-on-year given mark-to-market gains in the prior year. +Moving on to Markets revenues of $3.6 billion, down 13% year-on-year, but as guided, excluding business simplification, the core business was down 5%. Fixed Income was $2.5 billion, down 14% excluding business simplification driven primarily by lower results in credit-related and securitized products and with rate markets remaining challenging. However, currencies in emerging markets had a strong quarter with higher volatility leading to increased client activity as our remaining financial commodities business is doing well. +In Equities, we saw strong performance for the quarter, up 25% year-on-year at $1.1 billion. Derivatives was very strong, one of the best fourth quarters in recent years, largely driven by Asia as client activity increased on central bank actions. Cash was solid driven primarily by EMEA on the back of strong ECM results. +With respect to Markets revenues for the first quarter of 2015, business simplification will continue to drive a negative year-on-year variant for the quarter, approximately $500 million or 10% with a corresponding expense decline of approximately $300 million. Security Services revenues of $1.1 billion was up 6% year-on-year, including higher NII on higher average deposits. Assets under custody were $20.5 trillion, flat year-on-year with market appreciation largely offset by a significant client exit. Credit Adjustments & Other shows a loss driven by net CVA losses, as well as the inclusion of nonrecurring DVA/FVA valuation adjustments totaling approximately $200 million. +Moving on to Expenses, total expenses up 14% year-on-year, compensation was down 6% from the fourth quarter of 2013 and down 4% for the year with a comp to revenue ratio for the year of 30%. The increase is driven by noncomp expense primarily by over $900 million of legal expense, as well as higher control-related expenses with those being partially offset by business simplification. +Moving on to Commercial Banking on page 11, this quarter saw net income of $693 million with an ROE of 19% on $1.8 billion of revenue. Revenue was up 4% sequentially and flat year-on-year, excluding the one-time proceeds of $100 million from a lending-related workout that was included in the prior year. Continued yield compression in our lending book, as well as the impact of business simplification is being offset by higher loan and deposit balances. +Quarter-on-quarter, revenues increased on better fee revenue and it was an incredible story for investment banking this quarter with record gross revenue of $557 million, up 11% year-on-year and quarter-on-quarter. For the full year, Commercial Banking clients generated $2 billion of investment banking revenues for the firm, reaching our goal. Expense is in line with guidance, slightly higher year-on-year and flat quarter-on-quarter due to the ongoing investment in controls. +In loan balances, we saw an increase of $4.7 billion, our best quarter of growth since 2011, driven by strong performance in our commercial real estate businesses, as well as growth in the C&I portfolio this quarter. Our CRE book has now grown for 15 consecutive quarters and for the quarter grew 4% ahead of the industry. C&I loans grew 3% this quarter, in line with the industry and with pipelines remaining solid. Finally, in terms of credit performance, an exceptional year, another single-digit net charge-off rate for the quarter at 8 basis points and a slight net recovery position for the full year. +Moving on to page 12, a solid quarter in Asset Management with net income of $540 million on $3.2 billion of revenue. Last year included a mark-to-market gain of approximately $100 million. Adjusting for that revenue was up 4%, expense of $2.3 billion was up 3% and net income up 5% on positive operating leverage. +This quarter marks the 23rd consecutive quarter of long-term net inflows at $10 billion driving AUM of $1.7 trillion, up 9% year-on-year and we achieved the number one ranking in 2014 for global net inflows in active long-term mutual funds. We continue to see strength in our multi-asset and fixed income flows and although smaller equity inflows outpaced the industry. +Banking had record loan balances up 11% year-on-year with growth coming from both US and international markets and record deposits up 6%. As reported, client assets of $2.4 trillion were up 2% both year-on-year and quarter-on-quarter, but excluding business simplification, client assets would've been up 8% year-on-year. +Lastly, for the full year, we saw continued strong investment performance. This was the second consecutive year of long-term net inflows of over $80 billion, driving a fifth year of record revenue and a second year of record net income with 23% ROE and 29% pre-tax margin. AUM loans and deposits were also records for the year. +Turning to page 13, Corporate and Private Equity. Private Equity reported $107 million of net income primarily driven by Private Equity gains of approximately $450 million, partially offset by a little over $200 million of related goodwill impairments. This past Friday, we completed the spinout of One Equity Partners and the investment professionals have formed a new independent company, OEP Capital Advisors. At the same time, we closed on the sale of a portion of our private equity portfolio to a group of private equity firms. OEP Capital Advisors will continue to manage both the investments we've sold, as well as the investments we've retained and closing this transaction had no significant impact to fourth-quarter financials. +Treasury and CIO reported a net loss of $205 million, but remember this is after the impact of the change in how we allocate preferred dividends. Firm NII was $11.3 billion, flat quarter-on-quarter. And finally in Other Corporate, net income was $645 million. Included in this result were tax-related benefits of approximately $500 million, partially offset by a contribution we made to our foundation of approximately $150 million and close to $100 million pre-tax of legal expense. +So to wrap up, 2014 was a record year for both net income and EPS with a 13% return on tangible common equity despite elevated legal expense and despite headwinds from capital markets, mortgage and the low interest rate environment. We maintained excellent customer satisfaction results and we gained share in many of our businesses. Delivered on our commitments, including business simplification, controls and expense discipline and we also met our capital targets for the year while returning $10 billion of net capital to shareholders. So with that, we'll open up to Q&A, operator, if you could open up the line. + + +================================================================================ +Questions and Answers +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Betsy Graseck, Morgan Stanley. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [2] +-------------------------------------------------------------------------------- + + Hi, good morning. Okay, so a couple of questions. One is on the GSIB proposal. Obviously it looks like you're at the 450 over the 7% minimum and I know we can't exactly see, because we don't have all the rules around the short-term wholesale funding rule, but I'm wondering where you line up in that bucket; if you're close to the low end of that range. Is there anything that you could do to move down a bucket? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [3] +-------------------------------------------------------------------------------- + + So, Betsy, obviously two things. The first thing is that the most important time period when this is going to matter is when it's in full compliance and through the transition period in 2017 and 2018. So the result in the 450 bucket as we understand it is based on 2013 results, so we have to work over the course of the next three years to make sure we are maximizing every basis point of G-SIB and every dollar of capital to the fullest extent to deliver returns. +So rather say that to move down a bucket, just in general terms, is a fairly significant thing to do just given the types of things that are driving the overall score, but we're not complacent about it. We've worked in extreme granularity to make sure that from the very first basis point that we're certain we're maximizing the return opportunity for that within the context of the bucket we're in. So it would not be a trivial exercise to move down, but we're focused on making sure that we're optimizing the resources that is our most binding constraint. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [4] +-------------------------------------------------------------------------------- + + Right. It's a bit of a challenge because it's relative to global peers, so how do you run the business -- the follow-on question is how do you run the business when you've been used to trying to gain as much marketshare as you can, but now gaining marketshare works against you on this G-SIFI? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [5] +-------------------------------------------------------------------------------- + + It's probably worth mentioning that while we were in or looked like we might be in the highest bucket relative to our peers, there were peers that were in higher buckets and they are not constrained by G-SIB but by CCAR. So it's likely to be the case -- we continue to believe it's likely to be the case that you're going to see the differential in required capital for a variety of reasons not being as wide as might be implied by the G-SIB. And so the key question is whether we're delivering the right shareholder value on the incremental capital, which we clearly think we are and can continue to do. +And so it is a -- we are trying to thread the needle, as you say, about making sure that we are as focused as we can on maximizing the use of that scarce resource, but within the bucket that we end up being, wherever that might be, that our key priority is to deliver the highest ROE and shareholder value we can, particularly in a world where others may be more constrained by balance sheet or leverage. So it is a fine dance and it's what we're working through. We'll obviously keep you updated as we continue to progress our plans. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [6] +-------------------------------------------------------------------------------- + + Okay. I assume we'll hear more on it at Investor Day. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [7] +-------------------------------------------------------------------------------- + + Yes. + +-------------------------------------------------------------------------------- +Operator [8] +-------------------------------------------------------------------------------- + + John McDonald, Sanford Bernstein. + +-------------------------------------------------------------------------------- +John McDonald, Sanford Bernstein - Analyst [9] +-------------------------------------------------------------------------------- + + Yes, hi, Marianne. Just following up on Betsy's questions, your hope is to grow or I guess your expectation is to grow the common equity Tier 1 from the 10.1 today to did you say 50 basis points this year you hope to add to that? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [10] +-------------------------------------------------------------------------------- + + Yes, 50 basis points or possibly more. + +-------------------------------------------------------------------------------- +John McDonald, Sanford Bernstein - Analyst [11] +-------------------------------------------------------------------------------- + + Okay. And I guess could you give us some sense of what the assumptions embedded in there are in terms of RWA mitigation? I guess Street estimates and earnings and some expectations for capital return and I guess is that pace enough to get to what you see as the new GSIB buffers where it looks to us you might have to be at 11.5, 12. Is it just a timing question that you have time to get to 11.5, 12? If you could just walk through that, it would be helpful. Thanks. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [12] +-------------------------------------------------------------------------------- + + Okay, so let me start at the beginning, which is if you look at our Basel III advanced RWA on the slide, it's just a little over $1.6 trillion. When we were at Investor Day last year, we said that we expected to be able to provide reductions to that by the end of 2015 to get the number closer to $1.5 trillion on the back of model-related benefits, etc. It's still the case that that's the direction we will move in. Whether we get exactly to $1.5 trillion or slightly over will depend on the timing of some of those benefits. But that's directionally where we're going. So call it from a little over $1.6 trillion to a little over $1.5 trillion and we'll give you an update at Investor Day. +With respect to the assumptions, at the end of the day, we generate a lot of capital and if we need to comply more quickly than we intend to do, then we can clearly pull those levers. But we have always over the last couple of years had the approach of wanting to have a reasonable sense of urgency, but a measured pace to getting to where we need to be over the course of a transition period, as well as preserving the optionality to continue to increase dividends and do buybacks. That continues to be generally our philosophy and if you take -- I think I said this before. Don't read anything into this with respect to capital asks or anything else, but if you take analysts' estimates for the next two, three years, take a $1.5 trillion or even slightly higher RWA basis, you can continue to add 50 basis points of capital a year, as well as have meaningful buyback and capital distribution capacity and 50 basis points a year from a little over 10% over three or four years gets you to the other side of 11.5%. +So that's just an illustration of the capacity we have; not necessarily a commitment in terms of glide path, but that's the basis upon which we feel like we will be able to add 50 basis points this year, which is, on a fully phased in advanced basis, which is we think an appropriate glide path. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [13] +-------------------------------------------------------------------------------- + + And we haven't really started to manage [E-SIFI], which we're going to do too now. + +-------------------------------------------------------------------------------- +John McDonald, Sanford Bernstein - Analyst [14] +-------------------------------------------------------------------------------- + + Okay. And then just a follow-up on that is on TLAC. You mentioned in some of the notes here that you might fill any potential shortfall to the current TLAC with additional common equity Tier 1, which I assume you mean as opposed to kind of debt issuance or preferred. Just wondering why you think that would be the best approach since you might already be building set one for a GSIB buffer. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [15] +-------------------------------------------------------------------------------- + + John, she didn't say that. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [16] +-------------------------------------------------------------------------------- + + John --. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [17] +-------------------------------------------------------------------------------- + + We're going to meet our common Tier 1 with the buffer we think is appropriate and we're going to fill the rest of TLAC with the debt, subordinate debt and preferred we need to. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [18] +-------------------------------------------------------------------------------- + + I think, John, if there's something you're looking at that we've confused you, I apologize for that. For the purpose of clarity, we expect to grow into our GSIB buffer, which will be excluded from TLAC with common equity and whatever the gap may be when the rules are finalized on TLAC, somewhere between nothing and something more meaningful, that's likely to be in debt issuance. + +-------------------------------------------------------------------------------- +John McDonald, Sanford Bernstein - Analyst [19] +-------------------------------------------------------------------------------- + + Okay, got it. That's what I thought. I was just looking at that footnote 10 on page 20. Maybe just we could take a look at that afterwards. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [20] +-------------------------------------------------------------------------------- + + I apologize. We'll take a look at that. + +-------------------------------------------------------------------------------- +John McDonald, Sanford Bernstein - Analyst [21] +-------------------------------------------------------------------------------- + + Okay, thanks. + +-------------------------------------------------------------------------------- +Operator [22] +-------------------------------------------------------------------------------- + + Guy Moszkowski, Autonomous Research. + +-------------------------------------------------------------------------------- +Guy Moszkowski, Autonomous Research - Analyst [23] +-------------------------------------------------------------------------------- + + Good morning. Just wanted to talk about expenses and initially focus in on the litigation charge of $1 billion after-tax. It's pretty clear, as you said, that the bulk of it goes to the Investment Bank and that it's FX as you said. But should this give us a sense that you now feel that it's reasonable -- that you have reasonable and probable basis to think in terms of what your settlement would be say with the DOJ or are there other elements that drove the increment? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [24] +-------------------------------------------------------------------------------- + + So Guy, what the reserves that we have taken in the quarter represent is our best estimate based upon facts and circumstances as we know them at the end of the quarter with respect to ongoing dialogue and investigations, but they are not concluded. So as much as we would like to, we can give you no assurances with respect to the final conclusion and that's really all we can say about where we are on the FX matter. + +-------------------------------------------------------------------------------- +Guy Moszkowski, Autonomous Research - Analyst [25] +-------------------------------------------------------------------------------- + + Okay. And then more broadly on expenses, just given that we've seen another decline in net interest margin that we've got a flattening yield curve environment and quite a bit of sluggishness elsewhere, and of course all the regulatory capital requirements that continue to build, should we expect that you'll revisit your $58 billion-ish expense target in some way to bring that meaningfully down? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [26] +-------------------------------------------------------------------------------- + + Just one quick thing on NIM before I talk about expenses. We don't manage to NIM. NIM can be reasonably volatile purely as a feature the amount of cash that we have on our balance sheet. What you saw this quarter in terms of NIM, which was a 5 or 6 basis point decline, whether you are looking at firm or core, is in very large part driven by incremental cash balances of close to $50 billion. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [27] +-------------------------------------------------------------------------------- + + Which (inaudible) there for days. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [28] +-------------------------------------------------------------------------------- + + Right. Some of which is there for days, some of which is accretive from an NII perspective, albeit modestly. So I think the more important measure, for us anyway, quarter-over-quarter is that our NII was flat, but flat and then just in terms of the flattening yield curve, we are more geared towards a short-end rates move and we're still expecting that to happen in the second half of the year. And so what really matters for us is Fed funds rate notwithstanding the overall yield curve. +With respect to expenses, yes, we will give you more updates at Investor Day, but I can continue to reiterate what we've said in the past, which is we would continue to expect to push our adjusted expense absolute dollars downwards over the course of the next several years and in combination with hopefully an improving economy and better interest rates move towards the 55% plus or minus, but 55% overhead ratio over the medium term. So you should expect our adjusted expenses in 2015 to be down, but we continue to have, albeit that we've reached a peak in the second half of the year, we continue to have elevated cost of controls and some of that leverage will be more in 2016 and 2017 than in 2015. + +-------------------------------------------------------------------------------- +Guy Moszkowski, Autonomous Research - Analyst [29] +-------------------------------------------------------------------------------- + + Okay, thank you. + +-------------------------------------------------------------------------------- +Operator [30] +-------------------------------------------------------------------------------- + + Mike Mayo, CLSA. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA - Analyst [31] +-------------------------------------------------------------------------------- + + Hi, I'm following up on the expense question. If you look at slides 2 and 3, it looks like your adjusted efficiency ratio of 61% in the fourth quarter and 60% for the year got worse from 59% either the prior quarter or prior year. So it's gone the wrong direction and I thought you said that you had some peak in costs in midyear and I hear what you're saying about guidance at Investor Day and adjusted expenses in 2015 down, but can you give any more ins and outs on why you think the efficiency ratio on a core basis should improve? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [32] +-------------------------------------------------------------------------------- + + So a little bit of what's driving the efficiency ratio in the second half versus the first half is seasonality in revenues and year-on-year revenues were down slightly. So obviously it's a little bit elevated relative to a 59% to 60% ratio, but obviously the absolute dollars are on a downward trend. Hopefully what we're going to see in combination over the course of the next year or two is we will continue to look at efficiency in our control spend. As I say, we're going to be looking at that in 2015 relative to the exit 2014 rate, but you're going to see more of that leverage in 2016 and 2017. We'll continue to bring mortgage costs down, cost within the branches down, but offsetting against that hopefully we'll have stronger performance in some of our businesses and show some expense growth. So overall trending down, but revenues are part of the story and they were down slightly year-on-year. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA - Analyst [33] +-------------------------------------------------------------------------------- + + It's been three years of stalled progress with overall efficiency. I know you have some of your reasons with regulatory costs. You mentioned 2016 and 2017 benefits, but can investors see an improvement in efficiency expenses for revenues in 2015? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [34] +-------------------------------------------------------------------------------- + + So Mike, we'll give you the lowdown of that at Investor Day. You will see absolute reduction in dollars and we'll give you the outlook for the efficiency ratio then. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA - Analyst [35] +-------------------------------------------------------------------------------- + + All right, thank you. + +-------------------------------------------------------------------------------- +Operator [36] +-------------------------------------------------------------------------------- + + Matt O'Connor, Deutsche Bank. + +-------------------------------------------------------------------------------- +Matt O'Connor, Deutsche Bank - Analyst [37] +-------------------------------------------------------------------------------- + + Good morning. You had some good loan growth in consumer and in particular credit card in the fourth quarter. I'm just wondering how much of that is normal seasonality versus maybe some strengthening underlying demand for the consumer. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [38] +-------------------------------------------------------------------------------- + + So I would say a bit of both actually. So obviously, as you articulate, we do see seasonality, but we did reach an inflection point during the year where we're starting to see a little bit more demand anyway for credit extension, but I would say our outlook for Credit Card outstandings growth for 2015 is modest, low single digit growth, not higher than that. So a little bit of both, but we are flattered by seasonality in terms of the fourth quarter. + +-------------------------------------------------------------------------------- +Matt O'Connor, Deutsche Bank - Analyst [39] +-------------------------------------------------------------------------------- + + Okay, then just separately in terms of the sharp decline in energy in general and I guess oil specifically, how do we think about some of the puts and takes with your customer base? Obviously, this should be good for the consumer, maybe mixed for corporates and institutional. There might be some risk to certain countries. Like how should we think about this holistically and how do you try and stay on top of this? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [40] +-------------------------------------------------------------------------------- + + So JPMorgan, taking it in three pieces, yes, we think it's very good for the consumer on balance and also for the economy on balance despite the strengthening dollar, so we think that the consumer spend, consumer even credit extension is likely to be positive as a result. From a trading perspective, there are pluses and minuses. The oil price volatility contributed to the softer quarter in the credit space, but was helpful as it related to the current season commodity space. So in fact, net-net neutral to maybe even slightly favorable. And then with respect to our traditional credit exposure to the sector, it's about 5% of our overall credit exposure. It's well secure, top of the capital structure where it's a name-by-name analysis that we do and we feel comfortable with where we are right now. It's a cyclical business and we're expecting downgrades, but we're not facing any meaningful issues in the face right now. But overall, oil a reasonable positive for the economy and consumers, so for JPMorgan from a financial perspective a modest issue, possibly more negative. + +-------------------------------------------------------------------------------- +Matt O'Connor, Deutsche Bank - Analyst [41] +-------------------------------------------------------------------------------- + + Okay, thank you. + +-------------------------------------------------------------------------------- +Operator [42] +-------------------------------------------------------------------------------- + + Erika Najarian, Bank of America. + +-------------------------------------------------------------------------------- +Erika Najarian, Bank of America Merrill Lynch - Analyst [43] +-------------------------------------------------------------------------------- + + Yes, good morning. My primary question is there's clearly been a lot of ink spilled recently in conversations again about a potential breakup of JPMorgan, especially relative to the higher capital buffers that could come from the Fed. And I guess, Jamie, could you remind us of how you're thinking about the benefits of keeping the franchise consolidated for the shareholders versus some of the conversation that investors are having today about breaking up or shrinking the bank in order to step down on your capital buffers? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [44] +-------------------------------------------------------------------------------- + + So first of all, I dispute the fact that some investors -- some people wrote about it as a possibility because of excess capital and it's true; you have to hold more capital, all things being equal, it will reduce your returns. But even the people who wrote about that talk about the superior franchises, the benefits of synergies, the good things the Company brings to bear. So the first way to look at a business first and foremost has been and always will be what you do for customers, not what you do for yourself and your own returns, etc. and on the customer franchise in every business we're gaining share. We have good returns, we've got good marketshares, we've got good customer sat levels. The synergies are huge, both expense and revenue synergies, etc. and some, not all, disappear under the various schematics of a breakup or something like that, but that's number one. +And the question is now you are burying extra capital, how bad is that relative to that. And for the most part, we've been able to manage that. We've talked about products repricing and managing G-SIFI and managing CCAR and managing LCR and managing SLR and we're going to maintain the franchise, manage it and we still think we can get good returns. There's a point at which the capital drag would be so high that you may want to consider alternatives, but just remember they are not simple. Like anything you do, every company will have to have cash management, global trade ability, every company general ledgers and HR things and data centers and nerve data centers and cyber security and it isn't that simple a process. But so far, the Company has earned good returns in all those businesses throughout this crisis and I'm going back 2010, 2011, 2012 and that's a sign of stability. In fact, even Mike Mayo had a report, which there is a slide in it that shows the volatility of returns and that we were among the lowest with the better returns. So that is proving it. The model works from a business standpoint and yes, we'll have to carry more capital and we'll manage that over time. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [45] +-------------------------------------------------------------------------------- + + Erika, just to add to that, we're still in a period of flux as it relates to broadly rules, not just capital rules and we're in a period of flux as it relates to the competitive environment and it would be, for us, it would be premature to take big strategic decisions that we don't think would add shareholder value in what is a very challenging influx and cyclical low for the environment. So we preserve optionality. We think we're generating significant shareholder value, significant synergies and any discount could erode regardless. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [46] +-------------------------------------------------------------------------------- + + And remember the capital stuff is not an element -- what they are doing now is not a sign of riskiness; this Company has been a fortress company, it has delivered declines and its diversification is the reason why it's had less volatility of earnings and was able to go through the crisis and never lost money ever, not one quarter. So in the real-life crisis, we did fine and in any future crisis, we're going to do fine. There are a reason you have big global multinational banks and they serve big global multinational, including governments. This Company moves $6 trillion to $10 trillion a day; you're not going to do that as a small bank and you're not going to syndicate out of a $20 billion bridge loan and you can't do certain things globally in 20 countries if you aren't in 20 countries. So you've got to figure out what model you have and does it make sense and it's not necessarily comparable to all other companies. So our model makes sense because you've seen the returns in it. + +-------------------------------------------------------------------------------- +Erika Najarian, Bank of America Merrill Lynch - Analyst [47] +-------------------------------------------------------------------------------- + + Understood. And just a follow-up question to that, Marianne, if we look at the GSIB scoring process, not the proposed Fed process and we think about the five pillars that drive the buffers, it seems like if we look at publicly available data that where JPMorgan really sticks out is under the complexity pillar. Is there any way to move that down without giving up significant meaningful revenue and is that the bucket of focus in terms of potentially managing buffers from here? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [48] +-------------------------------------------------------------------------------- + + So you're right; the complexity bucket does stick out. Just for what it's worth, we're looking at each bucket and we're looking at it at a very granular level because obviously we need to look at the whole thing in combination and the complexity bucket -- Jamie said it I think earlier. If he didn't, I'll just repeat it. OTC derivative notionals drives a large chunk of it. Clearly, we're going to do everything we can in terms of netting and housekeeping and everything to reduce that. But to reduce that meaningfully is to have a meaningful impact on our client flow business. Level 3 assets is the second piece and obviously to the degree that those things are -- by definition, they are less liquid and so as a result --. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [49] +-------------------------------------------------------------------------------- + + But that does not make them bad. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [50] +-------------------------------------------------------------------------------- + + That does not make them bad. They are just less liquid and as a result, we obviously will take a look at whether or not there's opportunity to reduce that. But, again, it's also relative to market size and then, finally, our AFS portfolio, which to have that in a complexity bucket is not intuitive to all of us and over time that may reduce but right now it's a very core part of how we think about structuring the interest rate risk management of our balance sheet. So we're going to look at it, but we're going to get very, very granular and there's no silver bullet. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [51] +-------------------------------------------------------------------------------- + + I would guess that over years we can drive it down without damaging the franchise. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [52] +-------------------------------------------------------------------------------- + + Right. It's about looking at the first 10, 20 basis points, not the last 3 or 4. + +-------------------------------------------------------------------------------- +Erika Najarian, Bank of America Merrill Lynch - Analyst [53] +-------------------------------------------------------------------------------- + + Understood. Thank you for taking my questions. + +-------------------------------------------------------------------------------- +Operator [54] +-------------------------------------------------------------------------------- + + Glenn Schorr, Evercore. + +-------------------------------------------------------------------------------- +Glenn Schorr, Evercore ISI - Analyst [55] +-------------------------------------------------------------------------------- + + Hi, thanks. Can we revisit the energy conversation for a sec? I mean in my experience when any asset class falls this much so quickly, it's usually pretty bad and I heard your comments and I completely agree that it's great for the consumer and net-net positive, but am I doing the math right? If it's 5% of your outstandings, is that on the $743 billion of loans (multiple speakers)? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [56] +-------------------------------------------------------------------------------- + + You mean commercial? + +-------------------------------------------------------------------------------- +Glenn Schorr, Evercore ISI - Analyst [57] +-------------------------------------------------------------------------------- + + Commercial, okay. Because what I want to get at is you made a comment it's 5% of outstandings; a lot of it is secured. I'm sure you have some reserves against it. It's just -- it seems like an odd thing. I know it's early and we'll see if it stays down here, but it seems like a big deal and yet it doesn't seem like a big deal to you guys. So I just want to make sure that we talk about what your exact exposures are and why you feel better than most people I talk to. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [58] +-------------------------------------------------------------------------------- + + So our exposures are about $46 billion, about 5% of our traditional Credit portfolio. About 70% of it is investment grade, about two-thirds of it is in the sort of CIB, so these are large, well-capitalized companies. The other third is in the Commercial Bank. Name by name, we understand what that looks like. These are asset-based loans, top of the capital structure, names we know and we're going to see downgrades and we're not suggesting that there isn't going to be some stress and we don't know where oil may bottom, but, yes, we do have reserves. We have reserves that are based upon a long history of data that includes cycles. We've seen cycles before like this and so we'll take downgrades, maybe we may need to take more reserves, but it doesn't feel like it's a very significant issue or an imminent series of charge-offs right now. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [59] +-------------------------------------------------------------------------------- + + For us. There will be companies that are more invested in oil that may have different issues and then there's a secondary effect, which obviously you all can predict like Russia, Venezuela. So Russia, we have exposure; Venezuela, virtually none and other countries. And then there's another secondary effect. As you talked about, commercial or even consumer real estate in Dallas, Denver, Houston, as you saw in 1986 and 1989 and those are all slight negatives, but not again -- for us, they are not going to be material. We're very well-diversified and for us, you have the other side. In general, consumer credit would be better not worse and you can argue and I don't want to spend too much time on it that even retail would be better. There are a whole bunch of other beneficiaries of this change of credits. So some will be worse and some will be better, so net-net for us, it's not that big a deal. It's a perfectly legitimate thing for you all to be concerned about for companies, which are very concentrated in oil or even commercial real estate companies concentrated in oil areas. That's not something that we need to worry about. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [60] +-------------------------------------------------------------------------------- + + But we're watching it closely. To Jamie's point, we're paying attention to our Real Estate Portfolios in those geographies, so there's going to be overall sector and geographical differences to how this plays out and we're paying attention to that. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [61] +-------------------------------------------------------------------------------- + + I'll give you an example of diversity helps. + +-------------------------------------------------------------------------------- +Glenn Schorr, Evercore ISI - Analyst [62] +-------------------------------------------------------------------------------- + + Yes, I appreciate that. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [63] +-------------------------------------------------------------------------------- + + Diversity helps. Yes. + +-------------------------------------------------------------------------------- +Glenn Schorr, Evercore ISI - Analyst [64] +-------------------------------------------------------------------------------- + + The only related follow-up I have is I don't know if the same thing is happening in oil. I know in and around October 15 when we had wild swings in the 10-year, people talked about less liquidity at the banks being a partial contributor. I'm curious to see if you think there's something to do with that on the oil side too because everybody's been downsizing commodities. And then the bigger question is does anybody care about it, are the regulators watching and paying attention and do you think some of this is contributing to the bigger volatile swings we're seeing? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [65] +-------------------------------------------------------------------------------- + + On the first point, I think there's probably some truth to the less Liquidity, but it's more about oversupply and lack of global growth stimulating demand than it is I think a liquidity story from a capital markets perspective. Sorry, Jamie, you were going to --? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [66] +-------------------------------------------------------------------------------- + + I would just add that when you look at -- I'm a little surprised that people are so surprised when commodities move like this. Commodities have moved like this my whole life and obviously there's supply and demand imbalance and Marianne mentioned that the United States supply has gone up by 5 million barrels a day over the last five or six years. People were a little surprised at the production that was positive out of Libya and Iran and Iraq and some other places. A lot of people need oil revenues, but the other thing that surprised people was the slightly increased demand. I say slightly out of China and some other places and the other one that surprised people is OPEC. Instead of OPEC making some kind of move to reduce supply, they didn't. But, to me, all commodities have had that kind of volatility and oil has had even more volatility, so in the oil business, you've got to prepare for something like that. That is the way it's going to be and that's the way it's going to be for the rest of your life and yes, speculations, inventory and all those things may affect it in the short run. +Remember there is a fulcrum point at which oil, the marginal dollars that are going to be produced and I think our economists say it's about $75 oil, deep drilling in the Gulf of Mexico and around the world and one day it will recover to that because the world still will use more oil and need more oil, etc. and in the meantime, you've got to manage around the volatility and I don't think any of that had to do with trading, none of it. It had to do with fundamental supply/demand imbalances and people getting prepared for it and taking views on -- and not us. I mean I'm talking about oil companies and you've read about countries who've hedged it and countries who didn't and companies who hedged it and companies who didn't and I think it is a legitimate concern about liquidity in markets that when we have volatile markets or violent markets how much liquidity will remain, but I think there you're talking more about -- what you saw a little bit in treasuries, but more about credit and it's possible; we just don't really know. We're a little worried about it, but we will be there hopefully making healthy margins for our clients when the time comes. + +-------------------------------------------------------------------------------- +Glenn Schorr, Evercore ISI - Analyst [67] +-------------------------------------------------------------------------------- + + Okay, thanks both. + +-------------------------------------------------------------------------------- +Operator [68] +-------------------------------------------------------------------------------- + + Matt Burnell, Wells Fargo Securities. + +-------------------------------------------------------------------------------- +Matt Burnell, Wells Fargo Securities - Analyst [69] +-------------------------------------------------------------------------------- + + Good morning. Marianne, I just wanted to follow up on some of the regulatory discussion that we've had. You mentioned back in December that you felt that even though at the 11.5% buffer there may not be as big a difference in terms of capital requirements between you and some of your US peers as the initial numbers may initially indicate. It sounded like that may have been a focus on the short-term wholesale funding buffer, which obviously hasn't been released. You mentioned in December you felt that that would be around 50 basis points in terms of at least a starting point for you all. Is it your sense that there could be calibrations above and below your level of 50 basis points or do you think at this point it could be a blanket number across all of the big banks? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [70] +-------------------------------------------------------------------------------- + + Obviously, we need to get clear on what the final rules and calculation looks like, but I don't see it being a blanket number. I think it's pretty evident that it's intended to be at least measured relative to the size -- it's the one measure that's not measured relative to a marketshare, but relative to the size of your operation. So consequently, depending upon how the math works out, it could be a differentiator for other people. But my comments were not necessarily driven by whether or not somebody else was going to be more punitive, more penalized by short-term wholesale funding, but by the fact that GSIB hasn't been and is unlikely to be the binding constraint for some of our competitors. For some of those, it's CCAR stress; for some, it's leverage under CCAR stress. And as a result, they already are running at or above the levels that may be implied and that may continue to increase. +So here we have a situation where the transition period, the glide path is a four-year period. We're at 10.1 looking to put a glide path together that measures all of our objectives over the next few years where others are at or approaching 11%. So we will see obviously how that plays out in the medium term or in the short term I should say. Certainly in the short term we have a reasonably level playing field. The competitive landscape is changing and we're working very hard to make sure we're maximizing the return on every dollar we have. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [71] +-------------------------------------------------------------------------------- + + Right, and the reason it went from 2.5 to 4 wasn't because of short-term wholesale funding; it was because they doubled -- they basically doubled the number under a new methodology. And so -- and I think when you spoke of 50 basis points of buffer, you weren't talking about a short-term wholesale funding buffer, you were talking about a buffer over the required number to handle volatility. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [72] +-------------------------------------------------------------------------------- + + Yes, so the buffer, yes, totally volatility mainly AOTI-driven. The 50 basis points is the best estimate of what the short-term wholesale contribution --. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [73] +-------------------------------------------------------------------------------- + + Added to it, yes. That is a GSIB requirement; that's not a buffer. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [74] +-------------------------------------------------------------------------------- + + But we'll see. My view is it's not a blanket though, so you could see some people differentiated in that sense. + +-------------------------------------------------------------------------------- +Matt Burnell, Wells Fargo Securities - Analyst [75] +-------------------------------------------------------------------------------- + + Fair enough. And then, Marianne, just for a follow-up, in terms of your outlook for GDP, I think in December you also mentioned that you expected around 3% GDP growth is your operating assumption. A little stronger in the second half than the first half. Given your comments on when you think rates are going up, it doesn't sound like that has changed very much, but given your conversations about oil and some of the other growth numbers that have come out, has that changed very much? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [76] +-------------------------------------------------------------------------------- + + So obviously, if you get sort of granular --. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [77] +-------------------------------------------------------------------------------- + + We've moved it to 3.1. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [78] +-------------------------------------------------------------------------------- + + Obviously if you get granular to different specific countries, we may have a different answer, but as a general matter, no. As a general matter for the US 2015 over 2014, we're calling for 2.5% and globally closer to 3%. + +-------------------------------------------------------------------------------- +Matt Burnell, Wells Fargo Securities - Analyst [79] +-------------------------------------------------------------------------------- + + Great. Thanks very much. + +-------------------------------------------------------------------------------- +Operator [80] +-------------------------------------------------------------------------------- + + Gerard Cassidy, RBC. + +-------------------------------------------------------------------------------- +Gerard Cassidy, RBC Capital Markets - Analyst [81] +-------------------------------------------------------------------------------- + + Thank you. Good morning. Jamie, you were very clear on the success of the global franchise that you guys have built and the success that you've been having with it. Is there any evidence that you're seeing some pricing increases or you can generate some pricing increases because of this franchise? And if not yet, what do you think it's going to take where you'll be able to really get some better pricing because of the value of the franchise that you present to your customers? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [82] +-------------------------------------------------------------------------------- + + It's a tough question to answer. We have seen some pricing changes in trade finance a little bit in prime broker, not really in credit, but I do think you're going to see some of it in credit. So over time, that's not because of JPMorgan, that's just because the market is going to reprice some of these things that are more expensive to do and we do expect that will happen somewhat over time. And remember, the other thing which is really important is we manage this by client, so you can actually do a better job under LCR, G-SIFI, CCAR by client and not change pricing, just change mix. So we're working 100 different ways to figure out how to get good returns for shareholders while doing a good job for clients. And remember, we have more options to do that. So whenever we talk to a client, they are going to want some of our balance sheet capability and they may be willing to do other business with you to make sure they get it. Even if the pricing doesn't change, it might be good for us. + +-------------------------------------------------------------------------------- +Gerard Cassidy, RBC Capital Markets - Analyst [83] +-------------------------------------------------------------------------------- + + And then as a follow-up, in the Corporate & Investment Bank, the world now has been operating under the Volcker rules since July of 2014. Can you share with us is there any secular trends that you're seeing because of that? And I noticed that your compensation expense as a percentage of revenue was a real low 27% versus 35% a year ago. Is that reflective of the changes because of the Volcker rule? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [84] +-------------------------------------------------------------------------------- + + So let me address the Volcker rule in general. So we have accommodated the Volcker rule, which we have to do in private equity and investments in hedge funds and Marianne mentioned that we closed the sale of a couple billion dollars of private equity stuff and even the CLO issue is a very temporary thing. The only question to CLOs is should people be forced to sell it -- they are all going to run off in three to seven years. So the only question the bank -- and that's not a material issue to us. We're going to accommodate that. +The other thing that's important about Volcker now is the remaining one, how it affects market-making and obviously there the clients are going to be concerned. Do you have good market-making? There are all these rules around it. We're accommodating those, reporting client demand, aged inventory, different ways of reporting volatility and trading and now you have capital liquidity. So all the trading is to try to make it safer, but also so people can make markets and we hope at the end of the day that will happen. If there needs to be adjustments, it's going to be because you clients are going to say this isn't working for us. +The only other thing I'll mention about liquidity, spreads are the same in credit, but the size you can trade in is much smaller, which to me is an early indicator if something goes wrong you're going to have a gap out in spreads quicker and wider than you might have before. But at the end of the day, we hope to be able to be a good market-maker, earn a fair return for shareholders and obviously we got to -- we have to apply Volcker and all the other regulations to it. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [85] +-------------------------------------------------------------------------------- + + And I think the thing to think about when you look at the comp to revenue ratio just for the purposes of clarity is that if you look at the fourth quarter of last year, excluding DVA and FVA, it was about closer to 26%, so closer to in line year-over-year. And that's evident when you look at the full-year ratio last year of 31% to 30%. So we're at the low end of our range at 30% but within the range relative to the performance and there was a big negative impact in the CIB on a revenue basis last year with FVA/DVA. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [86] +-------------------------------------------------------------------------------- + + And I should say that we've always allocated capital to the investment bank and we've had SVA-adjusted returns and stuff like that. So as you allocate more capital, all things being equal, that number comes down a little bit. So we've been disciplined in trying to do that properly. + +-------------------------------------------------------------------------------- +Operator [87] +-------------------------------------------------------------------------------- + + Steven Chubak, Nomura. + +-------------------------------------------------------------------------------- +Steven Chubak, Nomura Asset Management - Analyst [88] +-------------------------------------------------------------------------------- + + Hi, good morning. So first question I have is on actually the debt capital markets business. Clearly, the results were quite impressive in the quarter. Certainly better than what the public proxy suggested and I was hoping you could give some additional color as to what drove this strength and then maybe how that informs your outlook in 2015 given that, on the last earnings call, Marianne, you noted that there could be some pressure on that business certainly going into next year or now this coming year? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [89] +-------------------------------------------------------------------------------- + + I think if you look at the 2015 dynamic, there's going to be three principal things. 2014 was a year of larger deals. 2015 has still got a good pipeline, so we're expecting to have a reasonably strong at least start to the year and probably a strong year and it's very driven in the fourth quarter and likely to continue to be so by sort of M&A-related financings. So the downside we talked about is just less maturities to be refinanced, but nevertheless some, but we're going to continue to have support from the M&A space, which looks set to be fairly strong in 2015. So you've got some puts and takes, but what we think is going to be a solid to good year in 2015, maybe not a record, but certainly a good year. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [90] +-------------------------------------------------------------------------------- + + And so JPMorgan maintained a number one share in global investment grade, number one share in global high yield, number one share in loan syndication, which we hope to maintain next year too and those are very powerful positions to have. + +-------------------------------------------------------------------------------- +Steven Chubak, Nomura Asset Management - Analyst [91] +-------------------------------------------------------------------------------- + + Certainly. Switching gears for a moment just back to the capital discussion, I just wanted to get a better understanding as to what drove the RWA inflation in the coming quarter. It sounded as though it was really primarily a function of counterparty credit risk inflation. I just wanted to get a better sense as to whether that was driven by some of the pressures on the corporates in the oil and energy space and also whether your $1.5 trillion target that you reaffirmed, whether that does contemplate the potential risk for further inflation in the coming quarters if those pressures continue. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [92] +-------------------------------------------------------------------------------- + + So just, first of all, I think to put it into context, I think that the RWA growth was $12 billion, so nevertheless a growth, but not a huge number. A chunk of it was regular weight CDA, which, yes, in part has got to do with just normal market dynamics right now as spreads wider and volatility higher, but a chunk of it is unrelated to that. As we look forward to the end of next year at 1.5, and which just to be clear I think I said 1.5 or maybe slightly higher, but nevertheless in the law of big numbers, the same trajectory. It's more at risk from just the timing of our ability to execute on granular segmented models, model approvals internally and with regulators than necessarily any sort of market dynamic, notwithstanding that that will factor in. So I would say the bigger risks to achieving that are less than the market pricing impacts on CDA, but more the ability for us to get the right timing of those model benefits. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [93] +-------------------------------------------------------------------------------- + + And I think like two-thirds are models and one-third is runoff of stuff we know is going to happen. And the other thing, as Marianne mentioned, the advanced where we're 10.1%, the standardized were 10.5% and yes, the advanced will change -- if spreads gap out, advanced will go up, but standardized won't. And eventually we think standardized is going to become the binding constraint, not advanced. + +-------------------------------------------------------------------------------- +Steven Chubak, Nomura Asset Management - Analyst [94] +-------------------------------------------------------------------------------- + + Okay, understood. Thank you for taking my questions. + +-------------------------------------------------------------------------------- +Operator [95] +-------------------------------------------------------------------------------- + + Ken Usdin, Jefferies. + +-------------------------------------------------------------------------------- +Ken Usdin, Jefferies & Co. - Analyst [96] +-------------------------------------------------------------------------------- + + Thanks, good morning. My question was on the Consumer & Community Banking business. There are a couple of moving pieces this quarter with the sale of the card results, but also underneath that it looked like a couple of the fee-related areas might have been a little soft. I was just wondering if you can try to disaggregate that for us and was there anything that was also more of a one-time in nature or seasonal about those businesses this quarter. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [97] +-------------------------------------------------------------------------------- + + So obviously, we talked about the card portfolio exits driving some revenue decline, also some elevated credit charge-offs. We've been experiencing, and I think we've guided to the low end of our 12.5% revenue rate range. We guided to that last quarter or the quarter before and at 12.2%, we're in that range and what we're experiencing is spread compression is largely offsetting the strong interchange and other fee growth from the volume, but when you acquire new customers and you pay the premium to acquire new customers that gets amortized through your results in the first year. So in years when you're net acquiring new customers, you will have a small net drag on your fees and on your revenue rate resulting from amortizing those premiums for the benefit of those strong relationships and the increased outstandings and spend sales volume you get in future years. So we've been on a journey for the last two years and we continue to be on it where there is some impact associated from the fact that we are net acquiring new customers, each of which we believe returns hurdle for us or more than hurdle for us, so is accretive over a period. + +-------------------------------------------------------------------------------- +Ken Usdin, Jefferies & Co. - Analyst [98] +-------------------------------------------------------------------------------- + + Okay. So it's a today versus tomorrow thing. And then on a follow-up, coming back to the energy discussion, you mentioned that it would be net to the consumer business and I just wanted to ask you to flesh that out for us. As you think about the benefits that you'd expect to get from the decline in oil prices, is it growth, is it spend, is it credit? How would you disaggregate that and give us an understanding of either magnitude or time to see that benefit? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [99] +-------------------------------------------------------------------------------- + + I wouldn't spend too much time trying to build this into your models if I were you, but it is quite clear that when you add $800 a year to the consumer's cash flow statement that consumers on average spend most of that and I think you're seeing it in spend and you're seeing it in car sales and you're seeing it in retail spend, you're seeing it -- and it's also quite clear it helps consumers, it helps their credit broadly. We're not going out and saying that we're going to reduce credit costs and auto, card and a bunch of stuff by 10 or 15 basis points, but I'm just saying you know it's going to be there. Just like you know it was there on the flipside where people spent a lot of time talking about how much gas prices are hurting consumers and why sales are down at Walmart and Family Dollar Store, etc. This is just the flipside of that. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [100] +-------------------------------------------------------------------------------- + + And if you just looked at the consumer spending statistics, if you look at fourth-quarter annualized up 4.7% is the best consumer spend data since 2003. So it's already taking effect in consumer spend and disposable income is -- as you say, we're already expecting new car sales to grow next year, but all of this is going to support the continued strong trends we've seen in consumer. + +-------------------------------------------------------------------------------- +Ken Usdin, Jefferies & Co. - Analyst [101] +-------------------------------------------------------------------------------- + + Okay, thank you. + +-------------------------------------------------------------------------------- +Operator [102] +-------------------------------------------------------------------------------- + + Jim Mitchell, Buckingham Research. + +-------------------------------------------------------------------------------- +Jim Mitchell, Buckingham Research Group - Analyst [103] +-------------------------------------------------------------------------------- + + Good morning. Just want to follow up on the card fee income discussion. If you looked at your new accounts opened year-over-year, you were flat. You're starting to seem -- you seem like you're starting to lap that higher amortization of acquisition costs. So is it fair to assume that we are at least getting closer to an inflection point where we're going to see fee incomes more track more closely with growth in spend or is there something else going on there? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [104] +-------------------------------------------------------------------------------- + + So you're right; we're close to lapping the acquisition cost dynamic not this quarter, but in the near future, but what you are going to continue to see is that we have a portfolio that is in runoff and as those loans run off, they were loans that were higher APR, higher rate loans than the ones that we're originating right now and as a result, you're going to continue to see some spread compression in 2015 again to which you're going to see strong interchange. So I would say, yes, ultimately and in the fullness of time, you're going to start to see the interchange growth outpace the spread compression, but for a period of time, they are going to be somewhat of a wash. + +-------------------------------------------------------------------------------- +Jim Mitchell, Buckingham Research Group - Analyst [105] +-------------------------------------------------------------------------------- + + Right, but I was just speaking specifically to the fee income where you were down I think 7% year-over-year. I would think that would start to turn positive at some point. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [106] +-------------------------------------------------------------------------------- + + Yes. + +-------------------------------------------------------------------------------- +Jim Mitchell, Buckingham Research Group - Analyst [107] +-------------------------------------------------------------------------------- + + Okay, fair enough. And maybe just one quick question on the expense side. You talked about the simplification impact on revenues and expenses. You're still at sort of a net negative about $200 million pre-taxes. Should that get closer to zero? Is it just it takes a little longer to get the expenses out versus the revenues or is that going to be a permanent drag? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [108] +-------------------------------------------------------------------------------- + + So overall, the way to think about it is it's not ultimately going to be necessarily zero, but when you think about it in the context of the capital and the relative returns, it was not accretive to our returns, and so we have the differential between 500 and 300. For the full year, it's still not zero. There is a slight lag. Clearly there's a slight lag taking out the expenses, but there's still an overall small net income impact, but for overall mutual to positive benefit on the return. + +-------------------------------------------------------------------------------- +Jim Mitchell, Buckingham Research Group - Analyst [109] +-------------------------------------------------------------------------------- + + Okay, got you. Thanks. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [110] +-------------------------------------------------------------------------------- + + And regardless of that, remember that our rationale for business simplification included a bunch of different reasons. It included activities that weren't core to our core clients' activities that were outsized in terms of operational or other risks, as well as those that weren't returning hurdles. So there are other reasons to simplify your business and they will have other ancillary benefits. + +-------------------------------------------------------------------------------- +Operator [111] +-------------------------------------------------------------------------------- + + Brennan Hawken, UBS. + +-------------------------------------------------------------------------------- +Brennan Hawken, UBS - Analyst [112] +-------------------------------------------------------------------------------- + + Good morning. A quick question on derivatives and equities. You guys highlighted the strength there. Were there any one-timers in those results because it certainly seemed like 4Q was volatile. Also did the uptick in equities VAR have anything to do with the revenue trends there? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [113] +-------------------------------------------------------------------------------- + + So no specific one-time items in the equity derivative performance. The uptick in VAR has to do generally speaking with higher levels of volatility than it does with anything in terms of risk direction. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [114] +-------------------------------------------------------------------------------- + + Equity derivatives are largely Japan and Europe and Asia. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [115] +-------------------------------------------------------------------------------- + + Yes. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [116] +-------------------------------------------------------------------------------- + + The increase. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [117] +-------------------------------------------------------------------------------- + + Largely Asia, yes. + +-------------------------------------------------------------------------------- +Brennan Hawken, UBS - Analyst [118] +-------------------------------------------------------------------------------- + + And that's true across (multiple speakers). + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [119] +-------------------------------------------------------------------------------- + + It's an example where volatility did actually help. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [120] +-------------------------------------------------------------------------------- + + If you look at equities in total, particularly in the prime space, there was a small one-time item, but not in the derivatives space. + +-------------------------------------------------------------------------------- +Brennan Hawken, UBS - Analyst [121] +-------------------------------------------------------------------------------- + + Got it. And that change in VAR due to volatility was sort of across the board in the buckets, not just in the equities VAR? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [122] +-------------------------------------------------------------------------------- + + It's not a significant increase in VAR, but, yes, you see increase in CPG VAR on spread widening and volatility, increase in equities. Just year-over-year and quarter-over-quarter, we've seen an increase in volatility. + +-------------------------------------------------------------------------------- +Brennan Hawken, UBS - Analyst [123] +-------------------------------------------------------------------------------- + + Okay. And then sticking with capital markets, thinking about how we're starting the current quarter, it does feel a lot like deja vu here in the beginning of the fourth quarter where the markets are beginning with some pretty unconstructive volatility. I know we're very, very early going, but is that a fair comparison to make and are we starting off on a pretty tough foot here? Obviously there's a lot of road to hoe here, but any comments on that would be helpful. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [124] +-------------------------------------------------------------------------------- + + This quarter more than any quarter it's really honestly to early to make any comments of any note regarding trading performance, particularly given that the holiday fell midweek. So the reality of the situation is thematically nothing has changed from the end of the fourth quarter, but there's no big new news in the first few days of trading. + +-------------------------------------------------------------------------------- +Brennan Hawken, UBS - Analyst [125] +-------------------------------------------------------------------------------- + + Great. Last small cleanup one on capital markets. I know you've mentioned that there's going to be a lag from business simplification, but was any of the decline in comp in CIB tied to business simplification here? Just trying to think about how much of that drop might have been due to some other items aside from --. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [126] +-------------------------------------------------------------------------------- + + It was year-end cleanup; it had nothing to do with business simplification. + +-------------------------------------------------------------------------------- +Brennan Hawken, UBS - Analyst [127] +-------------------------------------------------------------------------------- + + Perfect. Thanks. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [128] +-------------------------------------------------------------------------------- + + And I think if you look at our revenues excluding FVA/DVA year-over-year, they are down reasonably in line with comp. + +-------------------------------------------------------------------------------- +Operator [129] +-------------------------------------------------------------------------------- + + Paul Miller, FBR. + +-------------------------------------------------------------------------------- +Paul Miller, FBR & Co. - Analyst [130] +-------------------------------------------------------------------------------- + + Yes, thank you very much. On the mortgage banking side, you're definitely picking up marketshare from probably your -- you were shedding marketshare up until probably the second quarter of this year and one of the chatters out there is that you've gotten more aggressive in the correspondent markets and the comment you made, Jamie, back in I think June of this year was that you wanted to get out on -- maybe not get out of, but lessen your exposure to those low FICO, high LTVs, i.e. FHA loans. I was wondering if you are still trying to lower your marketshare in FHA loans. Can you make some comments about being more aggressive on the correspondent side too? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [131] +-------------------------------------------------------------------------------- + + I think they are two different issues. One is the correspondent business properly done is fine and obviously we do look at their credit underwriting because we've had a backup over the last 5 or 10 years. Correspondents are no longer in business and if they did a bad job, we had to pay for that. So you want to be very careful and do business with the proper kind of people. We have reduced our share of FHA loans just because the ongoing -- two reasons. One is the ongoing liability in the production side where the insurance was worthless over time and the second is just the cost of servicing FHA loans when they go into default and they have a much higher chance of going into default than not. So those are two reasons to do less. And maybe that will change over time, but we're still in the same place in that. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [132] +-------------------------------------------------------------------------------- + + And just on the share gains, they are in jumbo and conventional conforming loans, not in the government space. So yes, we are competing aggressively on price, but with the right capital allocation and with the right hurdle and these are loans that are very high quality that we are willing to put on our balance sheet done with correspondents that we have confidence in the financial status of. + +-------------------------------------------------------------------------------- +Paul Miller, FBR & Co. - Analyst [133] +-------------------------------------------------------------------------------- + + And then some of the rule -- on a follow-up -- some of the rule changes you're seeing coming out of GSEs that try to spur I guess loan demand is you're seeing the GSEs starting to do 3% down payment loans. Is that something that JPMorgan would go down underwritten correctly or is that just too risky? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [134] +-------------------------------------------------------------------------------- + + So the GSE -- you could always get loans up to 97% in the government space, you could get it in the agency space with mortgage insurance. We've seen some movement from the FHA on [GCs] and mortgage insurance premiums, all of which I think is intended to try and help credit availability, which we would generally support. It doesn't change our strategy, however, which is that we are much more focused on originating in the very high quality jumbo and conventional conforming space. But, yes, properly underwritten we will do agency loans in the programs that they have available. + +-------------------------------------------------------------------------------- +Paul Miller, FBR & Co. - Analyst [135] +-------------------------------------------------------------------------------- + + Thank you very much. + +-------------------------------------------------------------------------------- +Operator [136] +-------------------------------------------------------------------------------- + + Eric Wasserstrom, Guggenheim Securities. + +-------------------------------------------------------------------------------- +Eric Wasserstrom, Guggenheim Securities - Analyst [137] +-------------------------------------------------------------------------------- + + Good morning. Just a couple of follow-up questions. Marianne, you talked about some of the loan growth that you've experienced and expect to continue to experience and also the driver of the RWA reductions. But can you just help us understand what we should expect from your GAAP balance sheet given that a portion of the RWA reduction sounds like it is coming from runoff? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [138] +-------------------------------------------------------------------------------- + + Yes, I mean, look, we have, over the last, I think, two years and a quarter, two plus years or so, we've seen an inflow of cash of between $300 billion and $400 billion on our balance sheet. So our balance sheet size has grown slightly over the course of the last several quarters in the last year, but the vast majority of the growth is driven by incremental cash and there's two principal reasons for that. One is as we have been looking to become compliant with our own and with US rules on liquidity, which we are compliant with at this point and have been for a while, that the other is also that we've been receiving increased nonoperational cash predominantly from wholesale clients. And so to the degree that that cash is accretive from an NII perspective and that we aren't balance sheet or leverage constrained and it's a key part of the relationship with that client, that may not be a bad thing. But to the degree that it's not a key part of the relationship, we're going to be disciplined about trying to manage that balance. So I would say underlying that, we would expect our balance sheet to not be growing certainly not significantly, but cash can be the volatile factor. + +-------------------------------------------------------------------------------- +Eric Wasserstrom, Guggenheim Securities - Analyst [139] +-------------------------------------------------------------------------------- + + Sure. I guess I was thinking about it more from the perspective of the loan portfolio. It sounds like the expectation is --. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [140] +-------------------------------------------------------------------------------- + + Yes, we saw loan growth year-over-year 8% core, 3% reported. We feel pretty good about the demand for loans across our businesses, particularly those that have been performing strongly now consistently like business banking, like prime mortgage on the portfolio, commercial real estate, even auto and we continue to be optimistic about C&I and even Card. So yes, we would expect to see robust loan growth into next year hopefully on the back of a continued improvement in the economy. + +-------------------------------------------------------------------------------- +Eric Wasserstrom, Guggenheim Securities - Analyst [141] +-------------------------------------------------------------------------------- + + Got it. So if I were to summarize all of the guidance that you gave today with those comments, it sounds like the expectation is for modestly higher net interest income, fee income reflecting whatever volatility we suffer from in the capital market space, an absolute decline in operating expense, but likely some increase in the provision. Is that generally correct? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [142] +-------------------------------------------------------------------------------- + + I'll give you a (inaudible) one for you. On the back of robust loan demand and rising rates in the second half of the year, which is our current central case, then we would expect NII to be up in the second half of the year, flattish in the first half of the year. Obviously if those two things don't play out then that wouldn't be the case. I'll let you draw your own conclusions on the rest of it. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [143] +-------------------------------------------------------------------------------- + + You're using the implied yield curve effectively, so if that changes then obviously that will affect the second half of the year. + +-------------------------------------------------------------------------------- +Eric Wasserstrom, Guggenheim Securities - Analyst [144] +-------------------------------------------------------------------------------- + + Sure, sure. Great, thanks very much. + +-------------------------------------------------------------------------------- +Operator [145] +-------------------------------------------------------------------------------- + + Chris Kotowski, Oppenheimer. + +-------------------------------------------------------------------------------- +Chris Kotowski, Oppenheimer & Co. - Analyst [146] +-------------------------------------------------------------------------------- + + You've been consistent about -- on the issue of dividing the firm up into constituent companies about the strategic benefits of it all, but I wonder if you've done any contingency planning on what if it ever came to the fact that it was too much of a drag to keep it all together? And I guess the question I have is is it even possible to unscramble the egg and specifically the issue I'm wondering about is you've got over $160 billion of debt at the parent company level. If you were to break the Company up into a consumer bank, a wholesale bank and an asset management business just for argument's sake, is there a way to fairly allocate that debt to the three various lines of business or how would one even go about that? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [147] +-------------------------------------------------------------------------------- + + Look, unscrambling it would be extraordinarily complex and it would be extraordinarily complex in debt, in systems, in technology, in people and where certain things go and the businesses would start competing with each other right away, which I think is perfectly reasonable if they were all separate standalone. So look, we're very conscious of the narrative, which has become out there about this, but it is far more complex than that. The right way to look at it is we have these great franchises, we have a lot of time to manage through this and that is our objective, not unscrambling the egg. We're going to manage through it and we can manage almost every single part of it over -- think of over a long period, like five or seven years. Don't think of over six months or a year. There's nothing we couldn't set a limit, drive down, sell, manage and that would probably be far easier than the alternative. Even if it led to lower growth, it wouldn't necessarily lead to lower returns. So just keep in mind that obviously we're going to do the right thing at the end of the day for the shareholder. It might be lower growth and better returns and managing through that and not doing certain things at all. +Marianne mentioned for example the amount of deposits we take in. Well, it might be that we limit and restrict the amount of deposits we take in at quarter-end. We do it to accommodate clients, but all those nonoperational deposits go directly into the Federal Reserve. So that's what Marianne said. We do it and maybe make some spread. If you can get 25 basis points there and you maybe are paying the client something. There are some clients which aren't charged to take their quarter-end. They don't do enough business with us and we don't want their quarter-end balances. So we have a lot of levers, we have a lot of time and we are going to do it very intelligently over time. We're not going to damage this franchise just because of a current narrative. +And the other thing I want to point out about the current narrative, which kind of surprises me that people don't mention, when you all talk about P/Es and sum of the parts, P/Es are temporary, P/Es change over time and the real question you should be asking is is the E going to be much higher or much lower under scenario A or B, not just what is the P/E going to be because I could give you a lot of scenarios where your E is going to be a hell of a lot lower and that dwarfs the effect of the P/E change and the P/Es themselves are temporary. JPMorgan is already earning its cost of capital and you're comparing it to P/Es to a lot of guys who aren't earning their cost of capital. Meaning people expect them to have dramatic growth in earnings, which they will and so it's -- you've really got to have a much more forward-looking view of what P/Es will be, what values will be, what earnings will be, what the franchise will be then just the sum of the parts breakup based on current P/Es and false comparisons. +Some of the people out there that people compare it to they are not real comparisons. We are not in the same business with those people, but we are very shareholder-conscious. That's not to say we're not going to do the right thing for shareholders over time. We will; there are other ways to do it. + +-------------------------------------------------------------------------------- +Chris Kotowski, Oppenheimer & Co. - Analyst [148] +-------------------------------------------------------------------------------- + + Okay, thanks. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [149] +-------------------------------------------------------------------------------- + + And the other thing which I think is important too is that we compete globally. Remember we have to be very conscious of who we're competing with and what they're going to do over time. And my guess is you're going to have some very large, very tough global competition over the next 20 years. They are not going away. They may have currently lower G-SIFI charges, but I'm not sure that's going to be true 10 years from now. Particularly the Chinese banks get bigger and bigger and some other global competitors decide they want to be in the global businesses. + +-------------------------------------------------------------------------------- +Chris Kotowski, Oppenheimer & Co. - Analyst [150] +-------------------------------------------------------------------------------- + + Okay, thanks. + +-------------------------------------------------------------------------------- +Operator [151] +-------------------------------------------------------------------------------- + + David Hilder, Drexel Hamilton. + +-------------------------------------------------------------------------------- +David Hilder, Drexel Hamilton - Analyst [152] +-------------------------------------------------------------------------------- + + Good morning. Thanks very much. On the question of legal costs, and I realize you'll refresh your disclosure in the 10-K, but can you say anything about whether there are other cases or buckets of cases out there that have the potential to cost $1 billion in any one quarter? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [153] +-------------------------------------------------------------------------------- + + No, I would refer you to -- if you look at the 10-Q disclosure from last quarter, that will give you a sense for the things that are outstanding. We will obviously update and refresh it in the K, but we're not going to discuss specifically all of the remaining cases. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [154] +-------------------------------------------------------------------------------- + + David, I think again I think the way people -- I know -- we know we cause problems with you all because we have this lumpy quarter-by-quarter type stuff. I wouldn't look at this as a quarter-by-quarter issue. If you owned 100% of this Company, the better way to look at it is it's going to cost us several billion dollars more somehow plus or minus another couple billion before we get to what I call a more normalized legalized basis. We disclose all that stuff in the 10-K. I think the RPL, if you ask me, is actually a fairly decent way to look at what those might be and we give you an RPL number, which is something that has not gone to the P&L, which is possible and we can't make something which is lumpy not lumpy and we can't make something which we wish we can bucket -- if we could, we would put all the reserves now and say we're done. We can't. + +-------------------------------------------------------------------------------- +David Hilder, Drexel Hamilton - Analyst [155] +-------------------------------------------------------------------------------- + + Understood. Thanks very much and for your comments on (multiple speakers). + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [156] +-------------------------------------------------------------------------------- + + It's a number and the important part as a shareholder is I want to deal with that, acknowledge our mistakes, try to have a fortress controlled balance sheet, try to stop stepping in dog (expletive), which we do every now and then, but build a customer franchise is the important part. When you have a market cap of $230 billion, I want to make that worth $500 billion 10 years from now. There's several billion dollars that we're going to have to pay for legal, so we want to fix it and it's unfortunate we do this to you all, but it's unavoidable right now. + +-------------------------------------------------------------------------------- +David Hilder, Drexel Hamilton - Analyst [157] +-------------------------------------------------------------------------------- + + Well, I would agree with all of that. Thanks very much. + +-------------------------------------------------------------------------------- +Operator [158] +-------------------------------------------------------------------------------- + + Nancy Bush, NAB Research. + +-------------------------------------------------------------------------------- +Nancy Bush, NAB Research - Analyst [159] +-------------------------------------------------------------------------------- + + Good morning. Two questions. Marianne, we had some numbers last week that indicated rising delinquency in auto loan portfolios and I think your commentary about your losses this quarter kind of confirm that. Are the numbers right now aberrational or is this a seasoning trend or how do you see this? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [160] +-------------------------------------------------------------------------------- + + So I can talk for JPMorgan very specifically that we are seeing the charge-off rate -- remember, we have had charge-off rates for the auto business that have been relatively low for an extended period. Now we're seeing them revert back to something more normal and when we think about pricing the business and through the cycle, we contemplate a more normal level of charge-offs. So this isn't as surprising to us. +Having said that, what we're also seeing in terms of just the broad competitive space is it's not irrationality necessarily, but longer duration, higher LTVs, more subprime originations. JPMorgan -- we are lower LTV than the industry and very concentrated on the near and super prime space. So there's part of that that we're just not participating in, but even for our own portfolio you're going to see some of those charge-off rates trend up to something a bit more normal, but that's how we think about the business through the cycle. + +-------------------------------------------------------------------------------- +Nancy Bush, NAB Research - Analyst [161] +-------------------------------------------------------------------------------- + + Do you feel confident that this is not sort of the canary in the coal mine with regard to perhaps other consumer segments? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [162] +-------------------------------------------------------------------------------- + + I hate to say I'm confident about anything, but that's not our expectation. + +-------------------------------------------------------------------------------- +Nancy Bush, NAB Research - Analyst [163] +-------------------------------------------------------------------------------- + + Okay. And second --. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [164] +-------------------------------------------------------------------------------- + + It's a very good question because of what we all went through in the mortgage game where subprime was an early indicator for even prime. But when we look at credit card, we don't think it's an early indicator of credit card. We're going to be very conscious -- as Marianne said, auto did unbelievably well through the crisis, shockingly well we'd all say. So this is maybe a return to norm, but we're going to pay paying a lot of attention to it. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [165] +-------------------------------------------------------------------------------- + + And the loans that we're originating now, the very far, the right side of 700 FICO loans with LTVs lower than the industry lower than 100%. + +-------------------------------------------------------------------------------- +Nancy Bush, NAB Research - Analyst [166] +-------------------------------------------------------------------------------- + + Jamie, one final, hopefully final question on the breakup issue. We all listen to what you say about the strategic value of your businesses and the complementary nature of the businesses, etc. and it all sounds very logical. But in Washington, there is still a belief that your Company in its present form is a danger to the global financial system. Is there any -- in your view, is there any level of capital that is going to mitigate the too big to fail issue or does it go beyond that? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [167] +-------------------------------------------------------------------------------- + + I think, Nancy, views and facts are completely different, okay? This Company was a port in the storm in the real crisis in 2008 and 2009 and that was after we bought Bear Stearns and (inaudible). We had no issues whatsoever. We have a lot more capital now, we're more conservative now. We've got less credit exposure as a percent of the balance sheet. We've got less risk as a percent of the balance sheet. We've got more long-term debt, we've got more liquid assets. We've got more -- so it's even more true today. The fact is the Company is an extremely powerful thing. +People, when they talk about risk, they are just talking about -- a lot of people, they look at size and it scares them. I completely understand that. But that isn't the determinant and I don't think we should be making shareholder decisions based upon views of people who don't necessarily really know. So if the regulators at the end of the day want JPMorgan to be split up then that's what will have to happen. We can't fight the federal government if that's their intent or maybe their intent is what it is. If you are going to carry more capital and you've got to modify your business model over time to carry capital, that one we think we can earn a superior return still versus other banks and carry the higher capital and modify our business model over time without taking drastic action. +And remember, again, you've got to look forward in this. America has been the leader in global capital markets for the last 50 or 100 years. It's part of the reason the country is so strong. I look at it as a matter of public policy. I wouldn't want to see the next JPMorgan Chase be a Chinese company because someone has to be serving the global multinationals around the world and all the things that that means about knowledge and experience and research and capabilities. So I think that if you look ahead 10 years, you're going to have large global companies who compete and we may have to be slightly smaller than we might otherwise have been, but so be it. If we can do that and do a good return for shareholders, we should do that. + +-------------------------------------------------------------------------------- +Nancy Bush, NAB Research - Analyst [168] +-------------------------------------------------------------------------------- + + Thank you. Well said. + +-------------------------------------------------------------------------------- +Operator [169] +-------------------------------------------------------------------------------- + + Gerard Cassidy, RBC. + +-------------------------------------------------------------------------------- +Gerard Cassidy, RBC Capital Markets - Analyst [170] +-------------------------------------------------------------------------------- + + Thank you. Marianne, can you tell us -- obviously, you've built up your HQLA in the quarter and your net interest margin came down. How much of the margin pressure was due to the increase in the HQLA? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [171] +-------------------------------------------------------------------------------- + + So I will tell you that to answer the question maybe just slightly differently but with the same basic point that we saw an increase in cash of about $45 billion or a little bit more that $45 billion in the quarter and that drove the vast majority of the 5 to 6 basis points decline in NIM. + +-------------------------------------------------------------------------------- +Gerard Cassidy, RBC Capital Markets - Analyst [172] +-------------------------------------------------------------------------------- + + Are you guys -- I notice that the deposits at the central banks, as you pointed out, grew very largely in the quarter. Is this a level that now you're satisfied with? And also connected with that, what as outsiders should we look at that will drive the LCR ratio either higher or lower in terms of your calculation that you're going to be doing on a quarterly basis going forward? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [173] +-------------------------------------------------------------------------------- + + So what dictates what we have on deposits at the central bank -- for any deposit that we have that is excess operating or nonoperating that we don't think has any significant or any liquidity value to the Company, on the whole, those are all on deposit with central bank earning a very small amount of interest income. And there is some passed onto the client net-net, so something slightly accretive. So that's what's driving the amount of cash, so to the degree that we have more nonoperating cash that will drive that. We are compliant with LCR under the US rules with an appropriate but modest buffer right now and that's based upon what we think is a fairly forward-leaning point of view about what true operating deposits really are. +So as we think about what the cash is in customers' accounts that they really require to operate their businesses and no more. So we think we've got a forward-leaning point of view on that. So I think the rules are for the US final. I think our ratio for US LCR right now will be favorable for a period of time and then if there are any changes, either to the US rules, which we don't have any line of sight on or if we are required to make changes or decide to make changes to our own internal liquidity framework, that could cause us to add to liquidity, but that's something that we'll inform you of as we go through time. + +-------------------------------------------------------------------------------- +Gerard Cassidy, RBC Capital Markets - Analyst [174] +-------------------------------------------------------------------------------- + + And one last issue on --. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [175] +-------------------------------------------------------------------------------- + + If you look at our balance sheet, forget all this rule stuff, we have almost $500 billion in central banks around the world. We have $300 billion plus of AA+ securities of very short duration. We have like $300 billion of repo and stock borrow, which is all secured in commodities by top credits with proper haircuts and stuff like that and with our capital base of equity capital of $200 billion, preferred stock of $30 billion, TLAC of debt of $150 billion plus, our loans are $700 billion, which has always been the riskiest part of our balance sheet. And receivable is like $70 billion and so this balance sheet of this Company is unbelievable. + +-------------------------------------------------------------------------------- +Gerard Cassidy, RBC Capital Markets - Analyst [176] +-------------------------------------------------------------------------------- + + Totally agree. One last thing on those deposits of the central banks, I know some of the big custody banks indicated that they were going to charge their customers that have euro deposits because the ECB is now charging for the deposits at the ECB. Did you guys do that in the quarter and if so how did the customers react when you passed on that cost to them? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [177] +-------------------------------------------------------------------------------- + + So for financial institutions and nonbanks -- for banks and nonbank financial institutions, yes, we passed on the overnight rate to our customers and it's basically on their operating cash flows. It is what it is. All we're doing is passing through the cost. It's operating cash for their business so there was --. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [178] +-------------------------------------------------------------------------------- + + In euros. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [179] +-------------------------------------------------------------------------------- + + Yes, in euros, so there was no significant reaction at all. It's a market (multiple speakers). + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [180] +-------------------------------------------------------------------------------- + + It's very hard -- I mean you're not going to be taking deposits at a loss that are just very temporary to help our clients, so I think everyone understands that. + +-------------------------------------------------------------------------------- +Gerard Cassidy, RBC Capital Markets - Analyst [181] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Operator [182] +-------------------------------------------------------------------------------- + + There are no other questions. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [183] +-------------------------------------------------------------------------------- + + Okay, thanks very much. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [184] +-------------------------------------------------------------------------------- + + All right. Thank you very much. Talk to you soon. + +-------------------------------------------------------------------------------- +Operator [185] +-------------------------------------------------------------------------------- + + Thank you again for joining today's conference call. You may now disconnect. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/exam/original-files/Problem_2_3_Sample_full_transcripts/2015-Jul-14-JPM.N-137463527529-Transcript.txt b/exam/original-files/Problem_2_3_Sample_full_transcripts/2015-Jul-14-JPM.N-137463527529-Transcript.txt new file mode 100644 index 0000000..9ece29e --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_full_transcripts/2015-Jul-14-JPM.N-137463527529-Transcript.txt @@ -0,0 +1,996 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q2 2015 JPMorgan Chase & Co Earnings Call +07/14/2015 08:30 AM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Marianne Lake + JPMorgan Chase & Co. - CFO + * Jamie Dimon + JPMorgan Chase & Co. - Chairman & CEO + +================================================================================ +Conference Call Participiants +================================================================================ + + * Matt Burnell + Wells Fargo Securities - Analyst + * John McDonald + Sanford C. Bernstein & Co. - Analyst + * Paul Miller + FBR & Co. - Analyst + * Erika Najarian + BofA Merrill Lynch - Analyst + * Mike Mayo + CLSA - Analyst + * Eric Wasserstrom + Guggenheim Securities - Analyst + * Steven Chubak + Nomura Securities - Analyst + * Gerard Cassidy + RBC Capital Markets - Analyst + * Jim Mitchell + Buckingham Research Group - Analyst + * Chris Kotowski + Oppenheimer & Co. - Analyst + * Nancy Bush + NAB Research - Analyst + * Glenn Schorr + Evercore ISI - Analyst + * Ken Usdin + Jefferies - Analyst + * Matt O'Connor + Deutsche Bank - Analyst + * Brennan Hawken + UBS - Analyst + * Betsy Graseck + Morgan Stanley - Analyst + +================================================================================ +Presentation +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Good morning, ladies and gentlemen. Welcome to JPMorgan Chase's second-quarter earnings call. This call is being recorded. (Operator Instructions) We will now go live to the presentation. Please stand by. +At this time I would like to turn the call over to JPMorgan Chase's Chairman and CEO, Jamie Dimon, and Chief Financial Officer, Marianne Lake. Ms. Lake, please go ahead. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [2] +-------------------------------------------------------------------------------- + + Thank you and good morning, everyone. I'm going to take you through the earnings presentation. It's available on our website and please, if you could, refer to the disclaimer regarding forward-looking statements at the back of the presentation. +So starting off on page 1, firm different delivered strong performance this quarter: net income of $6.3 billion, EPS of $1.54, and a return on tangible common equity of 14% on revenue of $24.5 billion. The quarter's performance was characterized by strong underlying fundamentals across each of our businesses. With stable NIM and NII, good growth in fee drivers as well as strong IBCs, good expense discipline with adjusted expenses flat quarter on quarter at $14.2 billion, and an adjusted overhead ratio of 58%, and low levels of charge-offs and call loans up 12% year on year. +We also made significant progress on our balance sheet and we've delivered on our non-operating deposit commitment. +While there were no significant items this quarter, there were some small items that are worth calling out. On the positive side, we had consumer loan loss reserves releases of a little over $300 million as well as a little under $300 million of a benefit in DDA/SEA and wider spreads. Against that we saw reserve builds across wholesale of $250 million, of which approximately $140 million related to oil and gas, as well as firm-wide legal expense of a little less than $300 million. If you take those for items and net them, together they contributed zero to net income. +So finally included in the result is $330 million of a benefit from tax discrete items. If you adjust for all of those, our net income is strong at $6 billion. +Skipping over page 2 and on to page 3, we continued to make progress against our capital targets with the firm's advanced fully phased-in CET1 ratio reaching 11%, up 35 basis points quarter on quarter, and standardized fully phased-in was 11.2%. The improvement to both ratios was driven by net capital generation along with an overall reduction to risk-weighted assets, primarily from lower risk across market and counterparty credit as well as some data enhancements with loan growth offsetting runoff. +We continue to build Tier 1 capital, adding $3.4 billion of preferred stock this quarter, and we returned $2.6 billion of net capital to shareholders, including $1 billion of net repurchases and dividends of $0.44 a share. Preferred issuance, together with a reduction in average assets, drove the firms SLR to reach 6%. +For more details on our balance sheet reduction, turn to page 4. +The last quarter I told you that you should expect us to make meaningful progress on our balance sheet in this quarter and we did just that. Year-to-date our balance sheet is down over $120 billion on a spot basis, driven by a reduction of over $100 billion of non-operating deposits across our wholesale businesses, partially offset by continued growth in consumer deposits. We also saw a $36 billion reduction in trading assets and secured financing as we continue to make progress simplifying our balance sheet. +On the previous page you may have seen that HQLA was down $82 billion this quarter, primarily reflecting those lower levels of cash. However, the firm remains LCR compliant given the significant outflow assumptions that was associated with those deposits. +In addition, the reduction in deposits together with strong core loan growth resulted in an improved loan-to-deposit ratio, up 5% since year-end. These balance sheets actions translate into relatively flat NIM, up 2 basis points quarter on quarter and NII. Quarter on quarter, the reduction in cash drove a 4 basis point improvement that was partially offset by lower yields, and as I said, firm NII was flat. +Turning to page 5 and consumer and community banking, the performance for the combined consumer businesses was characterized by sequential revenue growth on stronger fee revenue and positive operating leverage, generating $2.5 billion of net income, an ROE of 19%, and an overhead ratio of 56%. Revenue of $11 billion was down 4% year on year, driven by mortgage, but up 3% quarter on quarter on seasonally higher credit and debit sales volume as well as higher MSR revenue. +Our focus on customer experience continues to drive growth broadly and we have 19% core loan growth driven by mortgage. Also, our active mobile customer base is up 22% to over 21 million customers. We are the largest and fastest-growing among major US banks, reflecting our strategic objective to have a best-in-class mobile offering. +We remain focused on our commitment to reduce expenses by $2 billion in 2017 relative to 2014, while continuing to self-fund investment in the business. In the first half of this year expenses were down approximately $0.5 billion versus the same period last year and our headcount down roughly 6,000 year to date. +Moving to consumer and business banking on page 6, CBB generated net income of $831 million, flat quarter on quarter and down 8% year on year with an ROE of 28%. Net interest income was flat sequentially with modest spread compression offset by deposit growth and NIR was up 7% seasonally and 2% year on year on continued strong client investment and debit revenue. +Expenses were up 1% year on year, largely due to increased legal costs. Excluding these, expenses were down 2% due to continued improvements in branch efficiency. We continue to see robust performance across our drivers with attrition well below industry averages, average deposit balances up 9%, or $41 billion year on year, and we are pleased to see that 30% of this growth is driven by our investments in business banking and CPC and new builds. +Client investment assets were a record, up 8% or $16 billion, and in business banking average loan balances were up 6% with loan originations flat against a record last year and in a highly competitive environment. +Stepping back and looking forward to the second half, our NII is stable and will increase when rates rise. Non-interest revenue is growing solidly and expenses will decrease, so we expect positive operating leverage. +Mortgage banking on page 7. Mortgage net income was $584 million for the quarter. Originations were $29 billion, up 19% quarter on quarter on seasonal increases in the purchase market. We continued to execute our strategy of adding high-quality loans to our balance sheet, totaling $19 billion this quarter and the origination pipeline continues to look strong. +Total revenue increased sequentially, primarily driven by higher MSR revenue, but as you can see, you look at our non-interest revenue it's down $500 million year on year. We still expect non-interest revenue to be down about $1 billion for the full year in line with previous guidance. +Expenses of $1.1 billion were down $200 million, or 15%, year on year and down 9% quarter on quarter despite higher volumes as we continued to manage down our costs. On credit we continued to see improvements in home prices and delinquencies, and as a result we released $300 million of NCI reserves this quarter. And you can see our charge-off rate was 21 basis points. +Moving on to page 8, card commerce solutions and auto. Overall net income of $1.1 billion, up 30% year on year, and an ROE of 23%. Revenue of $4.7 billion was up 3% year on year on card sales volume and auto loan and lease growth, partially offset by spread compression. Card revenue rate for the quarter at 12.4% was up quarter on quarter seasonally. +Expense was down 4% year on year driven by lower legal expense with the recent settlement regarding debt sale and collection practices having previously been reserved. And in card we saw core loan growth of 3% and sales growth of 7%, with delinquency rates and charge-offs remaining low. +Commerce solutions continued to experience strong growth with volumes up 12% year on year, driven by continued strong spend and the addition of new merchants. We've recently signed several new strategic clients including Chevron, Cinemark, Gap Inc., Marriott, and Rite Aid. Together they represent an incremental 5% to our volume and the majority have signed up for ChaseNet. +Lastly in auto, results continue to reflect steady growth in new vehicle sales and stable used-car values. We saw average loan and lease balances up 8% year on year and the pipeline is healthy. +Moving to page 9 and the corporate and investment bank. Before I dig into the numbers, we did make some reporting changes this quarter. If you look at the top of the table, investment banking fees is now named investment banking revenue and principally this now incorporates the revenue share with the commercial bank here in this line, rather than in the market revenues where it was previously being reported. +Additionally, trade finance revenue, which was previously reported in treasury services, is now being reported in lending. +So digging into the numbers, CIB reported net income of $2.3 billion on revenue of $8.7 billion and an ROE of 14%, reflecting a strong result in a mixed environment. In banking, IB revenue of $1.7 billion is up 4% year on year. This quarter we continued to rank number one in global IB fees with 8.2% wallet share and widening the gap to number two. We ranked number one in fees in North America and EMEA and gained share, improving to number two, in Asia. +Another strong quarter for advisory, up 17% year on year as activity levels remained high. We maintained our number-two ranking and grew share by over by over 100 basis points from last quarter. Equity underwriting fees were down 5% from a strong prior year for IPOs in EMEA with lower wallet share as we gave back some of the outsized share gain we had in the first quarter. This quarter we ranked number two globally with strong performance in the US on acquisition finance and follow-ons. +Debt underwriting up 1% and we maintained our number-one ranking with strength in high grade also on the back of the healthy M&A market. Treasury services was down 2% year on year on lower net interest income and the lending item of $302 million was down 32% year on year, primarily driven by losses on restructured securities. Given the reporting changes we've made, going forward we should expect for treasury services revenues would be about $875 million, plus or minus, per quarter and lending approximately $350 million. And that is given the trade finance transfer. +Moving on to markets, revenue of $4.5 billion was down 1% year on year, excluding business simplification and the gain in the prior year on the IPO of Markit, which we previously disclosed, but with strong relative performance in rates and in equity markets. Fixed income revenue was $2.9 billion, down 10% year on year similarly adjusted. +In macro products the quarter was dominated by EMEA with a bond selloff and economic and political uncertainty, including Greece. This uncertainty slowed the momentum we saw in the first quarter and kept clients on the sidelines in currencies and emerging markets, but drove strong performance in rates. +Credit and securitized products were down on a continuation of general weakness in the market. And as I mentioned, equity markets had another strong quarter, up 27% year on year on revenue of $1.6 billion with strong performance in all three regions relative to last year and outperformance in Asia, particularly China and Hong Kong, on the back of client interest, first to participate in the rally and later to hedge. +Looking forward, business simplification would drive a 9% decline year on year in third-quarter markets revenues with a corresponding decline in expenses. And as I look into the third quarter in analyst models, I see relative to our markets results this quarter you have revenues in markets going up sequentially. We are fully expecting to see normal seasonal declines in the third-quarter markets revenues. +Security service revenues of $1 billion was in line with guidance, up seasonally on the European dividend season. And moving on to expense, total expense was down 15% year on year at $5.1 billion and an overhead ratio of 59% as we successfully executed the expense reduction associated with business simplification and with lower legal expense. Compensation expense down 4% year on year comped a revenue ratio for the second quarter of 30%, flat year on year. +Moving on to the commercial bank. In commercial banking the underlying businesses continued to perform well with strong loan growth, up $6 billion dollars quarter on quarter and record end-of-period loan balances, with good credit fundamentals and no non-performing loans. We also saw continued momentum in IB revenue off of a record last quarter, which was driven by a large transaction. However, we added $187 million to reserves in the quarter, reflecting select downgrades including oil and gas. Despite this, BAU credit performance at the portfolio, as I said, remains very strong. +This drove net income of $525 million on revenue of $1.7 billion and an ROE of 14%. Revenue was flat year on year, driven by continued spread compression in loans and deposits partially offset by growth in loans, and flat sequentially despite the record investment banking performance in the first quarter. Expenses were up 4% year on year on increased control-related staffing and down slightly quarter on quarter. For the rest of the year for each quarter we expect expenses to remain around $720 million. +Loan balances increased 12% year on year and 4% quarter on quarter. C&I loans grew 3% sequentially, in line with the industry, with middle-market growth being somewhat challenged by strong competition but with more strength in corporate client banking driven by short-term financing activity and new facilities for our existing client base. CRE loans grew 5% and continued to exceed the industry on strong activity in both commercial term lending, which had record originations in the quarter, and in real estate banking. +Moving on to page 11 and asset management. Net income of $451 million on revenue of $3.2 billion reflected solid growth, up 6% year on year and 6% quarter on quarter, driven by continued net long-term inflows marking the 25th consecutive quarter at $13 billion with strength in North America and multi-asset flows; driving record AUMs of $1.8 trillion, up 4% year on year, and client assets of $2.4 trillion. In addition, we had record loan balances which were up 9% year on year. +Expense of $2.4 billion was up 17% year on year, primarily driven by legal expense and to a lesser extent the impact of moving assets to held-for-sale. Adjusting for those two items, expense would have been up more in line with revenue and margins in line with our targets. Lastly, we reported strong investment performance with 78% of mutual fund AUM ranked in the first or second quartiles over five years. +Turning to page 12 and corporate, treasury and CIO reported a net loss of a little over $100 million and other corporate reported net income of $552 million, which included a benefit on discrete tax items I previously mentioned. So on page 13 is our outlook page. Any guidance that I was going to give I've made through the presentation. The page is here for your reference. +So to wrap up, strong reported and strong underlying results this quarter across our businesses in an environment that continues to remain somewhat challenging with double-digit core loan growth, with broad-based strength in our underlying drivers, and with continued execution and excellent progress against our capital, our balance sheet, and expense commitments. +So with that, operator, we will open up the line now for Q&A. + + +================================================================================ +Questions and Answers +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Erika Najarian, Bank of America. + +-------------------------------------------------------------------------------- +Erika Najarian, BofA Merrill Lynch - Analyst [2] +-------------------------------------------------------------------------------- + + My first question is the capital progress has currently been solid this quarter; last week, however, there seems to have been more support in the Fed in terms of including the SIFI surcharge in the CCAR test. And I guess the question is in two parts: one, what do you think the chances are of the -- any or all of the CCAR surcharge or the CET1 surcharge to be included in CCAR; and two, what are the next steps in terms of business model adjustments, if that did pass? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [3] +-------------------------------------------------------------------------------- + + So to -- obviously we don't have any particular insight. I think the comments you're referring to were comments about the support for evaluating the possible inclusion of some or all [of it]. And so really it hasn't changed relative to previous comments and the door has clearly been left open for that, but we have no further information. And so far it's evaluating the possible inclusion of some or all of the surcharge, so we're just going to have to I suppose and see. +Meanwhile, as you know, we are -- and by the way, if it happens for us it would happen for everyone. We have shown you before -- not that that's a good outcome, but we've shown you before that we think that regardless the competitive peers set that we have is going to cluster at or around similar capital levels. And so if everybody has to increase their minimum, it is going to be a similar position for everyone. +Meanwhile, we are continuing to execute on everything that we've already told you we are going to do to optimize our capital. Our commitment is to go to firmly within the 4.5% bucket for the surcharge, and if we believe we can do it and it's economic and it's not going to hurt our clients, we may go further. So we will respond when we see the rules and we are not going to stop continuing to do the best we can to optimize our returns based on scarce resources. + +-------------------------------------------------------------------------------- +Erika Najarian, BofA Merrill Lynch - Analyst [4] +-------------------------------------------------------------------------------- + + Got it. And just the second question is you've clearly made also progress in terms of your deposit mix. As we potentially anticipate a rising rate environment for the back half of the year, given what the regulators have done in terms of saying, okay, here are the good deposits, here are the not-so-good deposits, how should we expect the pace and magnitude of retail deposit repricing or pass-through if the Fed does raise rates in the second half of this year? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [5] +-------------------------------------------------------------------------------- + + We actually haven't really changed our point of view since the investor day and previously about the fact that we are expecting retail deposit -- and there are other people who have slightly differing views. But we are expecting retail deposits to reprice higher and faster in this cycle than in previous rising rate cycles, given the competition for good, high-quality, LCR-compliant retail deposits; given the advancements in mobile banking; given the awareness in the general environment around low rates and the desire to participate in rising rates. So when we think about our sensitivity and our reprice, we model it in assumption that it's going to be higher, somewhat higher. + +-------------------------------------------------------------------------------- +Operator [6] +-------------------------------------------------------------------------------- + + Mike Mayo, CLSA. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA - Analyst [7] +-------------------------------------------------------------------------------- + + I see your markets revenue are down 1% year over year the way you look at this, but I'm trying to reconcile that with Jamie's comments two months ago at a New York conference where you said there is repricing in rates derivatives, prime brokerage, clearing, and trade finance. I'm guessing it's just risk off. +Can you shed more light on what type of repricing you are seeing with any specific examples, because the transparency for us on the outside is pretty weak? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [8] +-------------------------------------------------------------------------------- + + Obviously, when you talk about trading, when you have two months to go in a quarter you don't know the exact number and repricing is a complex issue. I'll give you some very specific things and then I'll tell you why it's hard to figure out exactly what shows up. +Clearing, we've definitely seen people start to charge for clearing and effectively charge the balance sheet 25, 50 basis points. It's a small business so I don't think it's going to dramatically affect those lines. Prime broker, we've seen similar type of thing. +Repo, it seems that people are charging pretty much for repo. We need to get a return on it. Exotic derivatives, which are again very small, are being repriced to, I would say, full capital and liquidity. Muni credit has probably been repriced a little bit. Again, it's a small market. +If you go to credit and trading, so credit we've really not seen any repricing effectively in commercial credit. You've seen a little bit in mortgage to make up for the extra costs in mortgage. You've seen a little bit in auto; it got more aggressive, not less aggressive. So trade finance you've seen a little bit of repricing, and I know these are not all trading numbers. +What you don't see, Mike, is that in a lot of cases, while you may have repriced a little bit, you're also shedding business so that you have -- as you are protecting your margins by -- because of AML costs you are going to not do certain types of business anymore. In FHA the lifetime cost of servicing, you cut back on FHA volumes, etc. So you're protecting your margins, but you're actually shrinking your revenues in some cases. That's happening a little bit in clearing and prime broker and stuff like that; you want your best clients. +In other categories clients are -- like deposits, we haven't seen repricing effectively, I don't think, in non-operating deposits. On the other hand, some clients are saying let's restructure our relationship; it makes more sense for you, JPMorgan. I'm willing to give you other business which is not credit sensitive, etc. +It's kind of a whole of the amount of things taking place in there, but the goal is to get a proper return on your capital, not necessarily to show revenue growth in that line item. It's very easy to show revenue growth. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA - Analyst [9] +-------------------------------------------------------------------------------- + + And just one follow-up. When you say (multiple speakers)? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [10] +-------------------------------------------------------------------------------- + + Mostly what you see in trading is just volume related and spread related, etc. Even in trading, spreads are narrow but breadth is also very low, which means spreads get gap out pretty quickly, which eventually could be good for trading. So it's unclear (multiple speakers). + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA - Analyst [11] +-------------------------------------------------------------------------------- + + When you say a little repricing, is it bigger than a breadbox? Are we talking about basis points or 1% or 5%? What are you talking about here? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [12] +-------------------------------------------------------------------------------- + + I'm talking about basis points, 20 basis points, 15 basis points, 10 basis points. That's all you need in some of these things to get an adequate return on capital as we currently look at capital. + +-------------------------------------------------------------------------------- +Operator [13] +-------------------------------------------------------------------------------- + + Betsy Graseck, Morgan Stanley. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [14] +-------------------------------------------------------------------------------- + + Question on the deposit shrinkage. You obviously finished the program you announced at investor day. Just wondering if you're going to take it further; what the impact on revenues has been. And do you expect that the full benefit to NIM is already in 2Q or -- in the 2Q numbers or we are going to see more benefit in 3Q from the actions you took? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [15] +-------------------------------------------------------------------------------- + + So what I said, and hopefully it was clear, is that we actually exceeded our commitment. We actually shrunk our non-operating deposits by more than $100 billion and not just through our consumer deposits, but we are also able to grow wholesale operating deposits. So we had a good mix shift both in consumer versus wholesale, but also within wholesale and so we feel really great about that. +There are two priorities after that. The first is protecting that position and making sure that we are able to not have inflows of those deposits as the industry continues to absorb them. But the second is we will likely look to potentially push a little farther, but it gets harder and harder each margin, the next $5 billion or $10 billion, as you get more and more closely aligned to operating accounts and operating business. And we've always said that we want to do this for the right reasons, for capital efficiency, but not do it in a way that's going to materially harm our clients. So that's the lens. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [16] +-------------------------------------------------------------------------------- + + The [product] has also been made in the Level III assets: derivative receivables, certain balance sheet items, RWA. So the effort to optimize the balance sheet for G-SIFI, etc., is not going to stop; that we are going to continue to do. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [17] +-------------------------------------------------------------------------------- + + But you know what, I don't anticipate us launching another and announcing another program. We've already done a little better. We will continue to try and do a little better. +In terms of revenue impact, not very much right now, as you might very well know, because you can see that the balance is much more on a spot basis that on an average basis. But the equation looking forward will be much the same math we said at investor day, approximately 25 basis points revenue on approximately $100 billion average for a half a year, but there would be some expense benefits on FDIC costs, etc. So not a very big number. +I think that was the question? + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [18] +-------------------------------------------------------------------------------- + + Yes, and the NIM benefit should flow into 3Q as well? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [19] +-------------------------------------------------------------------------------- + + A little bit, yes. + +-------------------------------------------------------------------------------- +Operator [20] +-------------------------------------------------------------------------------- + + John McDonald, Sanford Bernstein. + +-------------------------------------------------------------------------------- +John McDonald, Sanford C. Bernstein & Co. - Analyst [21] +-------------------------------------------------------------------------------- + + Marianne, was wondering if could remind us about the timing of your expense reduction targets in the consumer and investment bank. Specifically, if you hit the $57 billion in adjusted expenses for 2015, how much of the ultimate cost saves does that $57 billion target for this year incorporate? How much would you have achieved already in 2015 and any thoughts on the trajectory for remaining saves after this year? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [22] +-------------------------------------------------------------------------------- + + Yes, so let me do this in two parts, and I'm going to start with the consumer businesses, where the commitment is actually a couple of years old and we are sort of well, well on our way to delivering against that -- the commitment $2 billion dollars in 2017 versus 2014. It's not exactly linear, but you can consider it to flow through time. +And if you look at the CCB page on whatever page that is, I think we show that for the first half of the year our expenses are down over the first half of last year by $0.5 billion. So that gives you a sense for how we are tracking. On the CIB, obviously the commitment is somewhat newer; at investor day this year $2.8 billion in 2017 versus 2014. +I would characterize that in two parts. $1.5 billion is business simplification. The majority of business simplification -- not all, but the majority -- will come out of our run rate in 2015. And you've already seen that in the first and second quarter when you've seen the $300 million, $400 million expense reductions in each of the quarters on business simplification. +The other $1.3 billion, which is all the reductions in technology and operations and headcount, is going to be things. We are working on it actively -- we have programs, we have people -- but it's going to be more of a 2016 and 2017 benefit. If I was to look at the first half of 2015 versus the first half of 2014, take the $500 billion in consumer and business simplification in the CIB space -- that's probably the right way to size it, about a quarter so far this year. + +-------------------------------------------------------------------------------- +John McDonald, Sanford C. Bernstein & Co. - Analyst [23] +-------------------------------------------------------------------------------- + + A quarter of the total? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [24] +-------------------------------------------------------------------------------- + + Yes. + +-------------------------------------------------------------------------------- +John McDonald, Sanford C. Bernstein & Co. - Analyst [25] +-------------------------------------------------------------------------------- + + Okay, great. Then a quick follow-up is on RWA. Any update to your year-end RWA targets and thoughts about how we should think about potential RWA levels longer term? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [26] +-------------------------------------------------------------------------------- + + RWA, advance RWA is down $36 billion, $37 billion; [one five three six]. We said a little greater than $1.5 trillion. We are still on track to be $1.5 trillion or a little greater, $1.5 trillion advanced at the end of the year. Standardized right now is at $1.5 trillion, $1.5 trillion, so pretty close to $1.5 trillion against the target at the end of the year of $1.55 trillion. +That's a little better, but obviously on the standardized you have some upward pressure as we continue to grow those really great loans that we are growing. If you look to our investor day targets, we are still hoping to maintain the discipline around both of those at approximately $1.5 trillion through time. + +-------------------------------------------------------------------------------- +Operator [27] +-------------------------------------------------------------------------------- + + Matt Burnell, Wells Fargo. + +-------------------------------------------------------------------------------- +Matt Burnell, Wells Fargo Securities - Analyst [28] +-------------------------------------------------------------------------------- + + I'm just curious in terms of your core loan growth; you mentioned that that's up about 12% year over year. Can you give us a sense as to where that's growing the strongest and where you're seeing a bit more weakness? Within the core loan growth, specifically. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [29] +-------------------------------------------------------------------------------- + + Of course. I'll do it in three parts. First of all, it is growing pretty solidly or strongly, so either in-line or in many cases better than the industry across most of the product categories. The one that's growing the most strongly because of the way we are portfolioing loans is mortgage, so that's driving some of that outperformance. And the one that is most challenging, but still growing, is middle market. Fiercely competitive; everybody is chasing that sector. +But you can go through the businesses. We had 6% loan growth, 8% loan and lease growth in auto; 6% business banking; 19% core in consumer; 4% in commercial, so 3% core in card. So it's solid to strong pretty much across the board; most competitive in middle-market and flattered by portfolio and mortgages. + +-------------------------------------------------------------------------------- +Matt Burnell, Wells Fargo Securities - Analyst [30] +-------------------------------------------------------------------------------- + + Okay, Marianne, and for my follow-up I noticed I guess you were quoted in an earlier meeting today suggesting that there could be further provisions for the oil and gas portfolio. There's been some media reports prior to this week about regulators potentially looking a bit more carefully at your portfolio as well as a number of other banks. +Can you give us a little more color as to how you are thinking about the potential trends there and any comment you might want to give in terms of where the regulators are focusing? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [31] +-------------------------------------------------------------------------------- + + What I said earlier is not inconsistent; it's entirely consistent with what we said last quarter. We built reserves modestly for oil and gas last quarter on the back of the spring redetermination of borrowing base. We feel another modest reserve this quarter. +And we said we don't -- we might expect more reserves in the second half of the year. There's another redetermination cycle in the fall and it's I'm not going to say likely, but it's possible we will be selectively downgrading some clients. If none of that is out of our expectations, it's completely normal levels considering the cycle and how we think about the credits, we are still very happy. +And we are not going to make any comments on regulators. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [32] +-------------------------------------------------------------------------------- + + Those reserves do not mean we're going to have losses. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [33] +-------------------------------------------------------------------------------- + + Correct. We are reserving for downgrades; doesn't necessarily mean that they are going to be cash losses. + +-------------------------------------------------------------------------------- +Operator [34] +-------------------------------------------------------------------------------- + + Ken Usdin, Jefferies. + +-------------------------------------------------------------------------------- +Ken Usdin, Jefferies - Analyst [35] +-------------------------------------------------------------------------------- + + Marianne, just wanted to follow up on that last point. Your commentary about credit, for the second half, is in line, you're $4 billion plus and you've got $1 billion of charge-offs this quarter again. So on that point just one question about where you continue to see underling improvements. Card obviously is still above your guidance, but can you give us some of the thoughts about where any existing improvement can come from? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [36] +-------------------------------------------------------------------------------- + + So credit, like charge-offs, have been very benign across the whole sales base. They have reverted to somewhat more normal levels in auto, so I'm not expecting there to be a big step changes in the underlying charge-offs in the wholesale space. We continue to see improvements at a slower pace in mortgage, but at 21 basis points we are sort of getting down there. +And card, while it is slightly above -- 2.6% above our 2.5% is also pretty much getting there. It's one of the reasons why we've said expect the second half to look like the first half in terms of order of magnitude and expect net-net low for long. + +-------------------------------------------------------------------------------- +Ken Usdin, Jefferies - Analyst [37] +-------------------------------------------------------------------------------- + + And then to your point about not expecting to be much loss from the energy provisioning and that we could see energy provisioning, plus this quarter you had a nice $300 million release from the NCI portfolio, is this kind of it for reserve release and can you talk about your outlook there? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [38] +-------------------------------------------------------------------------------- + + I would say in the non-credit -- sorry, just to clarify the comment on oil and gas; we said they will not necessarily translate into losses. We are not going to predict which ones will or won't. +On the reserves, for non-credit-impaired portfolio we are continuing to see improvements in charge-offs as well as home prices, albeit a little bit more gradually. So I would still expect there to be more reserve releases over the course of the next 18 months in hundreds of millions of dollars in total; not billions any longer, of course. We have $1.8 billion reserved right now. +In the post-credit-impaired space clearly that's life-of-loan model and so we will continue to evaluate that model against parameters that we have in it and expectations, so that will be what it is at the time. And in card we're not expecting any significant reserve actions. + +-------------------------------------------------------------------------------- +Operator [39] +-------------------------------------------------------------------------------- + + Jim Mitchell, Buckingham Research. + +-------------------------------------------------------------------------------- +Jim Mitchell, Buckingham Research Group - Analyst [40] +-------------------------------------------------------------------------------- + + Maybe we could just ask a question on card fees? That's been an area where growth in card fees have been pretty flat for a while as you ramp up reward spending. We saw a pretty nice jump quarter over quarter; some of that is seasonal, but it was a little stronger than what we saw the last couple of years. +Are we getting to a point where you are lapping some of these higher reward costs and growth in new accounts and we should start to see that revenue line track more closely with spending, or is this something unusual this quarter? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [41] +-------------------------------------------------------------------------------- + + So you are absolutely right; all the underlying phenomenon are still there. We are still seeing spread compression, but we are seeing very strong growth in spend. We aren't quite lapped yet on new accounts going through the revenue rate. We will eventually be, but it's a good thing to be adding these new accounts that will drive strong spend in the future. +So I would say our near-term guidance is that we are expecting our revenue rate to be at the lower end of that 12%, 12.5% range. And, yes, over time as spread compression abates and we continue to drive strong growth with the quality of our products and our partnerships we would expect that to start to edge up. + +-------------------------------------------------------------------------------- +Jim Mitchell, Buckingham Research Group - Analyst [42] +-------------------------------------------------------------------------------- + + Okay. And on the card loan side it seemed like you saw a decent uptick this quarter. You are starting to get past some of the runoff and it seemed more of a core driver. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [43] +-------------------------------------------------------------------------------- + + Yes. We told you we would hope to drive core loan growth in the card space low single digits and this quarter it was 3%. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [44] +-------------------------------------------------------------------------------- + + I just want to emphasize -- Marianne mentioned it, but emphasize; Chase Paymentech, which is seeing really good growth, probably 50% faster than the industry, but we are also signing people with Chase Paymentech combined with ChaseNet. We are running real volume across it and we are signing up a lot of folks for that and ChasePay. So the strategy of ours is kind of coming to fruition and we hope it will be a good driver; happy customers and good growth for the next 10 years. + +-------------------------------------------------------------------------------- +Operator [45] +-------------------------------------------------------------------------------- + + Steven Chubak, Nomura. + +-------------------------------------------------------------------------------- +Steven Chubak, Nomura Securities - Analyst [46] +-------------------------------------------------------------------------------- + + So first question on capital. I just want to get a sense as to how we should be thinking about preferred issuance plans going forward now that you've met the 150 basis point RWA target. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [47] +-------------------------------------------------------------------------------- + + Obviously we don't give you lots of details on our issuance plans. You are right; one of the drivers for us to issue in part, not exclusively, was it's not -- as you know, we were Tier 1 leverage constrained in CCAR and so as a result of issuing this we not only helped TLAP, but we help our CCAR stress capacity. And we are about 164 RWA. So we are not going to talk about forward issuance but we've made progress. + +-------------------------------------------------------------------------------- +Steven Chubak, Nomura Securities - Analyst [48] +-------------------------------------------------------------------------------- + + Okay. And then just a follow-up regarding, Marianne, your comments about the trading outlook for at least in the near term, recognizing it's still very early days in the quarter. Since the very start we've seen, or at least we've experienced, a number of global shocks and on the regulatory front we do have the Volcker implementation deadline, which is looming. So taking all those factors into consideration, how should we be thinking about the near-term trading outlook? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [49] +-------------------------------------------------------------------------------- + + So to start with Volcker, we aren't expecting Volcker to have an impact in the near-term trading outlook. We've been talking very consistently over an extended period of time about the fact that we've reshaped our business through time to be compliant in substance and in form with Volcker. And so while that was real reshaping of the business, the last 18 months have been really focused on getting operationally ready around the reporting and the metrics; it's been hard work and we are ready. +So I don't expect it to have a direct impact on our near-term trading. Clearly over time we need to continue to evolve the feedback loop with regulators, but that will be entirely gradual. +With respect to the trading, it is too early for us to say anything specific about the second quarter -- sorry, the third quarter -- except to say we are -- all other things equal, we would expect to see normal seasonality from the market. Nothing has changed that fundamentally wouldn't have us expecting normal seasonality in the third quarter. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [50] +-------------------------------------------------------------------------------- + + I just want to point out that trading, if you look at it over a long period of time, has been -- we've become very consistent. I think in 2014 we had no trading loss days and even this year there were only a handful of trading loss days. Obviously some areas are up and some are down, but our shares are high. I think we are doing a great job servicing clients. +We are adopting all the new rules. Like [50%] of interest-rate swaps are on SEF today and I think it's 95% of FX trading by transaction is electronic. You can do a lot on your mobile phone or iPad now, so the business is actually doing fine. The returns on risk are very good. We used to report that, but kind of return on VAR are very good. It's become a much more stable business that clients need overtime. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [51] +-------------------------------------------------------------------------------- + + Right. And just to add to that, I would say that we also talked about, in the period of transition towards a more normal economy and rising rates, you might see some shocks like this. We've weathered both the EMEA bond sell off and China well, and it just speaks to the strength of our risk management discipline. And we generally do pretty well in more difficult markets. + +-------------------------------------------------------------------------------- +Operator [52] +-------------------------------------------------------------------------------- + + Paul Miller, FBR. + +-------------------------------------------------------------------------------- +Paul Miller, FBR & Co. - Analyst [53] +-------------------------------------------------------------------------------- + + You guys had a very decent mortgage banking quarter in the second quarter with rates going up. We know that the refis have started to come down, but the purchase market has been stronger I think than people expected in the second quarter. What do you see going into the third and fourth quarter, especially with the new regulations coming out with the disclosures with (inaudible)? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [54] +-------------------------------------------------------------------------------- + + So with respect to -- we saw a stronger seasonal purchase market. We actually gained a little share in the purchase market in the quarter and refi held up pretty well because of pipelines coming into the quarter. But we are expecting that to grow seasonally in purchase and in refi to pull that down to smaller levels in the third seasonally. And no direct impact from the disclosure requirements. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [55] +-------------------------------------------------------------------------------- + + Part of the quarter is the reserve takedown, so don't double count that. That may not be there next quarter. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [56] +-------------------------------------------------------------------------------- + + Right. + +-------------------------------------------------------------------------------- +Paul Miller, FBR & Co. - Analyst [57] +-------------------------------------------------------------------------------- + + (multiple speakers) Can you talk a little bit about the tax --? My follow-up question on the tax rate. Should we be modeling in 28% to 30% going forward; is that 25% just an outlier? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [58] +-------------------------------------------------------------------------------- + + The way I would think about it is normal tax rate for the year is 30%, plus or minus. Just given the way tax reserving is it's usually biased to being fairly conservative and so, as you know, we have seen discrete tax gains periodically, some of them not insignificant, resulting from completion of settlements and audits with tax authorities. Not to say that you should necessarily model in directly 30%, but we don't predict or forecast the tax benefits. + +-------------------------------------------------------------------------------- +Paul Miller, FBR & Co. - Analyst [59] +-------------------------------------------------------------------------------- + + Okay. Thank you very much. + +-------------------------------------------------------------------------------- +Operator [60] +-------------------------------------------------------------------------------- + + Matt O'Connor, Deutsche Bank. + +-------------------------------------------------------------------------------- +Matt O'Connor, Deutsche Bank - Analyst [61] +-------------------------------------------------------------------------------- + + The equity trading has been very strong the last couple quarters, both for you and for others, assuming it continues the rest of this earnings season. As you step back and think about some of the drivers there, you mentioned some repricing; we've obviously seen some deepening of some markets, increased volatility. Can we think about there being potentially a long-term secular recovery in the equities trading, or do you think it's more just stocks are going up, just global QE, or too early to tell? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [62] +-------------------------------------------------------------------------------- + + It's definitely the latter and I think it's perhaps a little too early to tell on the former. + +-------------------------------------------------------------------------------- +Matt O'Connor, Deutsche Bank - Analyst [63] +-------------------------------------------------------------------------------- + + Okay. And then just separately, what type of mortgage loans are you adding? Are these jumbo? Are they fixed rate? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [64] +-------------------------------------------------------------------------------- + + Jumbo. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [65] +-------------------------------------------------------------------------------- + + Yes. So over half are jumbo, the other are conventional performing fee plus. + +-------------------------------------------------------------------------------- +Matt O'Connor, Deutsche Bank - Analyst [66] +-------------------------------------------------------------------------------- + + Okay. And I guess are you choosing to add some mortgage loans instead of securities? Because you've got a smaller securities book than a lot of peers and it seems like there's capacity to add there. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [67] +-------------------------------------------------------------------------------- + + We have a fairly large securities portfolio and our decisions around that are in part driven by our overall interest-rate risk positioning, but with respect to the mortgages it's fundamentally a better execution decision for us. We will portfolio or loan where it makes economic sense to do it relative to distributing it, other than jumbo where, clearly, they will always go on our balance sheet. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [68] +-------------------------------------------------------------------------------- + + If you can put a jumbo on a higher ROE than a Fannie/Freddie, you would do that. And part of the investment portfolio is for liquidity and obviously, because non-operating deposits are down, proportions of that will come down too. + +-------------------------------------------------------------------------------- +Operator [69] +-------------------------------------------------------------------------------- + + Glenn Schorr, Evercore ISI. + +-------------------------------------------------------------------------------- +Glenn Schorr, Evercore ISI - Analyst [70] +-------------------------------------------------------------------------------- + + I just want to follow up on the conversation in fixed income, and I agree with you; it seems like you weathered the whole Greece and China storm pretty well. The thought on the lack of liquidity in the fixed income markets gets a lot of attention. You guys have the most market share; have the lowest standard deviation in the business. As a liquidity provider that's a good thing for you. +But curious on how you are thinking about preparing for what seems to be a pretty serious issue and how serious of an issue do you think it is in terms of the potential disruption? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [71] +-------------------------------------------------------------------------------- + + There's been a lot of press and reports, including recently, on market liquidity and there are a number of factors playing into it. It's true that liquidity, in some cases, has dried up quite quickly when there's been extreme volatility and it fed on itself. But the reality is that we've talked about the fact that that was likely to be a phenomenon that happened more frequently as we transition to a more normal environment. +We are very disciplined about how we trade and support our clients and generally we've been able to weather them very well, as has generally the community. Not that we know, but we haven't got any stories or horror stories around (inaudible) a bond sell-off or other things this quarter. So I think it's definitely an issue; one that we need to watch, one that has multiple root causes, and one that we are generally taking in our stride. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [72] +-------------------------------------------------------------------------------- + + And look at the big picture and we pointed it out, the financial system -- like in the United States banks are much more sound. Trading books have more capital liquidity. The whole system is better off. So you can't look at one piece and say what will that do. +The second is that these -- obviously there's less liquidity in the marketplace and it's a whole bunch of factors. It's hard to tease out exactly which one, but trading books have more capital and more liquidity. I think people are a little worried about potential Volcker rule violations, so they are being a little more cautious. +There are obviously structural changes in electronic trading, HFT, and each business is slightly different. So not every -- I wouldn't say everyone is affected exactly the same. It's also true that the system is pretty resilient to what happened with the currencies and treasury, and that's a good sign. +I think what we are going to be really cautious about is when markets aren't that good. JPMorgan is fine. We are not talking about whether or not JPMorgan is going to have a hard time with liquidity. We are not. The question I really would have is, when markets are tough, will there be a feedback from -- these violent markets, will there be more volume or less volume. +Someone was quoted the other day saying markets always pull back when there are tough times; that is true. The question is will be harder and worse, will it feed back into the real economy. It's not will there be lack of liquidity. +During the crisis they were two market makers out there and we were one of them and so you need them a little bit, but it doesn't stop markets from gapping out. We are not saying this is a terrible thing, just being very cautious about it. And we are always trying to be very cautious. + +-------------------------------------------------------------------------------- +Matt O'Connor, Deutsche Bank - Analyst [73] +-------------------------------------------------------------------------------- + + Speaking of cautious, the last one I have is on living wills. I know we have a little bit of time before we hear anything, but if you look at the comments from the previous year, what they wanted you all to address, it seems like there was a massive amount of progress made. I'm not sure what you can tell us, but curious your thoughts on progress made and then maybe timing on when we might hear regulators thoughts. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [74] +-------------------------------------------------------------------------------- + + So I can tell you that obviously we took the feedback from the regulators as the industry did exactly as you would expect, entirely seriously; put loads of resources and effort to bear in making as much progress as we thought was humanly possible over the course of the period. And we feel that we made very, very -- I would agree with you; the industry, but JPMorgan specifically, made very, very significant progress in addressing the feedback between getting it and the July submission date. And obviously we feel like we have a credible plan. +That's not to say that we won't continue and some of our plans, and you saw it in some other disclosures. We are going to continue to work very hard at simplifying our legal entity structure over the next few years and interconnectedness and operational resiliency and all the things -- and reporting readiness, all the things that are going to make it even better. +So we think we made very, very significant progress. We think our plan is credible. We don't know exactly when we will get feedback, probably in the fall. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [75] +-------------------------------------------------------------------------------- + + And we respond to every single thing regulators raise with the huge resources to meet their needs. It will probably be iterative over time about they'll make more demands this year, etc. and --. By the way, I think there is a 50-page public part that you can actually read and it shows you. That's a 50-page summary of I think a 200,000 page detailed report. + +-------------------------------------------------------------------------------- +Operator [76] +-------------------------------------------------------------------------------- + + Gerard Cassidy, RBC. + +-------------------------------------------------------------------------------- +Gerard Cassidy, RBC Capital Markets - Analyst [77] +-------------------------------------------------------------------------------- + + Marianne, you mentioned a couple of times about the competitiveness in the middle-market lending space. Can you give us some color on what you are seeing, whether it's underwriting standards, and what kind of product type in the middle market that is most competitive? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [78] +-------------------------------------------------------------------------------- + + It's very broadly competitive and we compete obviously with big banks, regional banks, and non-banks. It's not that we are losing loans and deals most often on price. It's normally on size of holds or non-bank taking whole deals or on structures, but it's very, very competitive. Everybody likes the sector for growth and everybody likes -- so everybody is trying to make progress. +We are being very, very disciplined, and as a result of that, slightly lower growth than the industry average. And you might not always want us to always grow at the industry average. You want us to hold true to discipline. + +-------------------------------------------------------------------------------- +Gerard Cassidy, RBC Capital Markets - Analyst [79] +-------------------------------------------------------------------------------- + + Right. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [80] +-------------------------------------------------------------------------------- + + Remember, we looked at the whole relationship. I forgot the exact number, but if you look at the middle market relationship, I think something like half, maybe even a little bit less, of the revenues are from the lending. + +-------------------------------------------------------------------------------- +Gerard Cassidy, RBC Capital Markets - Analyst [81] +-------------------------------------------------------------------------------- + + You guys have made great progress with the penetration of the mobile banking app that you've created as well as online banking. You showed us that your branch count is down over 100 branches on year-over-year basis. What do you see for the branches as you go forward? Is that trend line likely to continue as you continue with the increased penetration from the mobile app? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [82] +-------------------------------------------------------------------------------- + + The way I would characterize it is we had a period of time following the Wampum merger where we were in new markets and we didn't have the right distribution footprint where we were building. We said about a year and a half ago that we felt like we had the right footprint as a macro matter, about 5,600, and that now we are around perfecting that, which is about consolidating certain branches where it makes sense but building new ones where makes sense. Consolidating them together where it makes sense. +You will see I think Gordon said approximately 150 net down in each of the next couple of years and that's probably still the right way to look at it, but it's really perfecting the network. Moving branches to the areas we like where there's a high density of affluence. And then, as you know, really looking at the nature of branches: so the footprint, the way we are using them, the way we are staffing them, importantly, moving them to more advice and less transaction, more automation. +Definitely responsive to the evolution in customer preferences. And mobile and online is not only a fantastic customer experience evidenced in our experience stat, but it's also a lower cost to serve, so we are also improving the profitability of the very highly transactional customers. I think Gordon used the word omnichannel. We have a place for everything in our suite and branches are very important. We're just going to be evolving them to continue to meet customer needs. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [83] +-------------------------------------------------------------------------------- + + One add is that we are thinking about attacking a new city for the first time, like in a major way, because we want to see how that works out. + +-------------------------------------------------------------------------------- +Operator [84] +-------------------------------------------------------------------------------- + + Chris Kotowski, Oppenheimer. + +-------------------------------------------------------------------------------- +Chris Kotowski, Oppenheimer & Co. - Analyst [85] +-------------------------------------------------------------------------------- + + I was just curious about the reduction of the non-operating deposits and I would have expected that to come mainly out of the corporate and investment bank. But when you look at the disclosures on your average asset level, it's essentially been $850 billion plus/minus each of the last five quarters. Where is the shrink really happening, or how do we see it? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [86] +-------------------------------------------------------------------------------- + + In the non-operating deposits within the wholesale deposits, the majority is the CIB, but not quite two-thirds. And then you've got the commercial bank and you've got a little bit in asset management. So it is the majority of the number, but there are still sizable numbers, particularly in the commercial bank in the financial (inaudible) space. +And then, when you look at our overall balance sheet, you see cash going down because of the deposits. You see securities going down, but strong loan growth offsetting, and then small reductions in trading and secured financing. + +-------------------------------------------------------------------------------- +Chris Kotowski, Oppenheimer & Co. - Analyst [87] +-------------------------------------------------------------------------------- + + But when I look at total assets in the CIB, it's 845 this quarter versus 846 last year. It just doesn't look like a whole bunch came out of there. It looks like it all came out of the --. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [88] +-------------------------------------------------------------------------------- + + Are you doing year-over-year? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [89] +-------------------------------------------------------------------------------- + + You're starting in the wrong time period. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [90] +-------------------------------------------------------------------------------- + + Are you starting at the year-end or year over year? + +-------------------------------------------------------------------------------- +Chris Kotowski, Oppenheimer & Co. - Analyst [91] +-------------------------------------------------------------------------------- + + Well, if you go linked quarter it's 865 to 845. I'm just curious; it doesn't seem to mesh up to --. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [92] +-------------------------------------------------------------------------------- + + Well, we are getting more operating deposits, too. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [93] +-------------------------------------------------------------------------------- + + We talked about the deposit reduction is overachieving in non-op and improving mix in operating. So, trust me -- and I'm not looking at what you're looking at, so I do trust you -- but trust me that 60%-ish of it is CIB. + +-------------------------------------------------------------------------------- +Chris Kotowski, Oppenheimer & Co. - Analyst [94] +-------------------------------------------------------------------------------- + + Okay. When you see it in your public disclosures it all looks like it's coming out of corporate and other, which is down more than 100 linked quarter, so I was just kind of curious how it all works. Because if --. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [95] +-------------------------------------------------------------------------------- + + We will clarify off this line because (multiple speakers). + +-------------------------------------------------------------------------------- +Matt O'Connor, Deutsche Bank - Analyst [96] +-------------------------------------------------------------------------------- + + Okay. All right, thank you. + +-------------------------------------------------------------------------------- +Operator [97] +-------------------------------------------------------------------------------- + + Eric Wasserstrom, Guggenheim Securities. + +-------------------------------------------------------------------------------- +Eric Wasserstrom, Guggenheim Securities - Analyst [98] +-------------------------------------------------------------------------------- + + Thanks. My questions have been addressed, thank you. + +-------------------------------------------------------------------------------- +Operator [99] +-------------------------------------------------------------------------------- + + Brennan Hawken, UBS. + +-------------------------------------------------------------------------------- +Brennan Hawken, UBS - Analyst [100] +-------------------------------------------------------------------------------- + + Just following up on the markets discussion. Curious whether or not you have seen some of the drama around Greece impact M&A discussions in Europe this quarter and maybe an update on the IB backlog at this point. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [101] +-------------------------------------------------------------------------------- + + The M&A -- we don't think Greece has affected the M&A dialogue very much, because it's been very active pretty much around the world. And when I say around the world, it's also like European companies coming to America and American companies going to Europe, etc., and those conversations continue. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [102] +-------------------------------------------------------------------------------- + + A lot to Europe, yes. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [103] +-------------------------------------------------------------------------------- + + A lot to Europe, yes. So Greece had no real effect on that. Greece is a very, very small percent of the Eurozone in total, so economically it's not a driving factor for most of the companies there. Psychologically maybe it's going to affect some people, but I don't see why a company that has its own ambitions is going to change them because of Greece. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [104] +-------------------------------------------------------------------------------- + + And would just -- with respect to the backlog, I would say it's very good. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [105] +-------------------------------------------------------------------------------- + + We did see a tremendous amount of something that we've almost never seen before, of American companies financing in euro because it was cheaper to do that, even if you swap back to dollars. So you saw a lot of American companies going to Europe to do that. + +-------------------------------------------------------------------------------- +Brennan Hawken, UBS - Analyst [106] +-------------------------------------------------------------------------------- + + Okay. Thanks for that. And then on security services, I know that you all highlighted that it's up quarter over quarter on the seasonal strength for the dividend season, but it was down year over year. Can you help us reconcile the year-over-year decline? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [107] +-------------------------------------------------------------------------------- + + I think if you go back to last quarter, Brennan, and take a look at the remarks from last quarter, we talked about the change in presentation of some expenses versus revenues for the ADR business that drove a reduction, but just a classification issue. And then in addition we did lose a large client at the end of last year and that is having an impact. I think if you go back and look at the second quarter, hopefully that will make it clear. +And so the guidance, when we did those -- when we made that presentational change and obviously we talked about the client exit a few quarters ago, the guidance was, given those, we would expect the revenues to run between $950 million seasonally. And this is obviously a strong season and, therefore, it at through $950 million and $1 billion seasonally and, therefore, it's at the $1 billion. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [108] +-------------------------------------------------------------------------------- + + So Marianne gave you all very specific guidelines, which we don't normally do, on treasury services, investor services, and expenses in the commercial bank because a lot of you have your models wrong. And Sarah finds it very frustrating that you can't get it corrected quarter after quarter, so we've said here is the number that is actually our best guess. So, please, put it in your third- and fourth-quarter models. +And mortgage revenue was another one which has been ongoing to us. And what's the other one so we can just get it on the table whatever it is? + +-------------------------------------------------------------------------------- +Operator [109] +-------------------------------------------------------------------------------- + + Nancy Bush, NAB Research. + +-------------------------------------------------------------------------------- +Nancy Bush, NAB Research - Analyst [110] +-------------------------------------------------------------------------------- + + Jamie, you made a comment about attacking new markets and that sort of tags on to what I was going to ask, which is whether there are any of the old WaMu markets where you've not been able to expand as aggressively as you've wanted to and that you might be thinking about exiting. So I'm just wondering, can you just tell us how you feel about individual markets right now? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [111] +-------------------------------------------------------------------------------- + + Nancy, it's really important -- when we talk about these numbers, by the way, RWA and branches, we are not making commitments to anybody. That's our best guess knowing what we know today, but we reserve the right to change that on a moment's notice for whatever reason that makes sense for the Company and the clients. +And so branches -- it is very important that you look at branches city by city until you have the right footprint. So if you remember, the old A&P which never changed its locations and it never changed sizes and it failed. Any retail business should always be adding in new communities, subtracting in some; having the branches to adjust to a new reality, whether it's getting bigger or getting smaller. +In our case it's getting smaller, but again we are not getting smaller because we are guessing at this stuff. We are getting smaller because of the less need for operations and branches now. People are doing far more on mobile phones like that. +So we actually do it city by city. You don't set an overall guideline and say you have to do X, Y, or Z. It's city by city. And so, for the most part, in the WaMu footprint, I think Florida and California for the most part, city by city we went in and added what we thought we should have. +Wampum -- remember we also added on top of that small business, private banking, some middle-market, other businesses that WaMu wasn't even in. It was part of the expansion of those businesses, too. And so when I said a new city, I'm talking about what we've never really done -- I was talking about this way back to BankOne and the stocks when we did the merger with JPMorgan -- is going into a city de novo that we never been in. There you've got to look at how many branches you are going to open, how long is it going to take. And so we do want to do one of those and that will have nothing to do with WaMu because they are also places that WaMu wasn't. + +-------------------------------------------------------------------------------- +Nancy Bush, NAB Research - Analyst [112] +-------------------------------------------------------------------------------- + + Okay. Another geographic question. I get that Greece is not that important to the Eurozone and the events of the past couple weeks seem to have been a lot of theater, frankly. But the events in China in the last couple of weeks have been somewhat worrisome. Have your plans for China changed at all, given what seems to be a retreat from open markets there? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [113] +-------------------------------------------------------------------------------- + + No. I don't think there's been a retreat from open markets there either. +Remember, we've always said about China is you got to look and plan for the long run, which we do in all businesses. McKinsey has a report that shows that they are going to have 25% or so of some of the Fortune 1000 in I think it was 10 or 12 years. Enormous growth in their companies. Their companies are going overseas. Their companies are doing more M&A. +We did that one unique transaction where ChemChina bought Pirelli in Italy. Obviously, when we have a unique network, we can help a Chinese company and an Italian company at the same time, so we are building there for the long run. +As a risk management tool we've always said that the way we treat that is we will be prepared for very tough times and I think it's a mistake not to grow because you're going to have tough times. I have never seen an economy that didn't have tough times. If you went back to the United States, when J.P. Morgan was building JPMorgan back in 1850 and 1860, look every single time that you panic because America had a recession there would be no JPMorgan. So we are not going to change. +What we've seen with the officials in China is that they are very responsive to changes, and you can argue whether they should have gotten that involved in the stock market. You can't manipulate stock markets. But they are very responsive to lending. +They've changed their reserve policies, their RMB policies, the QFII policies, the Hong Kong Shanghai Connect. Not everything they do is going to work, but they still seem very committed to more and more market reform, more and more of taking SOE -- rationalization of SOEs and taking them public, so some market discipline there. Creating more of a consumer society. +And what we've always said -- and I think they have the wherewithal to meet their short-term objectives of growth, but we expect that they will have bumps in the road. We expect that and we are going to look right through that. The fact that their -- I also remember their market went from $4 trillion value -- so it's a $10 trillion economy. It went from $4 trillion market value to $10 trillion; now it's back to $6 trillion. I think those are the numbers. +The American stock market has done that roundtrip a couple times itself and so the American economy is $18 trillion. I think our stock market is $25 trillion, so there will still be huge opportunities there. If they ever completely reverse what they are talking about doing, you will see it in far more significant ways than them getting involved in the stock market. + +-------------------------------------------------------------------------------- +Operator [114] +-------------------------------------------------------------------------------- + + Betsy Graseck, Morgan Stanley. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [115] +-------------------------------------------------------------------------------- + + Just a quick follow-up. Marianne, earlier on you were talking about deposit betas and, for a lot of very good reasons, expecting that deposit betas will be a little bit faster this time around. But could you round out the conversation as to how you are thinking about how your NIM is going to traject in a rising rate scenario? Because I got a few questions on whether the deposit betas being a little faster means that the NIM trajectory is likely to be different from last time rates rose for you guys. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [116] +-------------------------------------------------------------------------------- + + Marianne, you showed a NIM thing that NIM would go back to 265 to 275. And, remember, when we say deposit beta it is by product, by --and it's got gamma, so the first 25 basis points, the second are a different 25 basis points, they are different than the third 25 basis points. It's a pretty intensive analysis to try to get accurate; that's what we're trying to do. And it's all in that number that was presented and we don't think that's changed dramatically. +As Marianne said, we are assuming that whatever happened in the last cycle, this one will be worse. In other words, you will gather less of the benefit from rates going up than we have in the past. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [117] +-------------------------------------------------------------------------------- + + Okay, because the last time rates rose your NIM didn't move up that much. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [118] +-------------------------------------------------------------------------------- + + Listen, there's a unique --. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [119] +-------------------------------------------------------------------------------- + + Yes, (multiple speakers). + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [120] +-------------------------------------------------------------------------------- + + It is a unique circumstance when you're at zero. There are a lot of things that happen when rates grow to 25 basis points that there will be -- you will pass very little of that also. And we also see that -- we will see that in money market funds. We will see that in some forms of deposits, etc. +The beta gets much higher as rates go up. If I had to guess, I would say we are conservative, not aggressive. + +-------------------------------------------------------------------------------- +Operator [121] +-------------------------------------------------------------------------------- + + Gerard Cassidy, RBC. + +-------------------------------------------------------------------------------- +Unidentified Audience Member [122] +-------------------------------------------------------------------------------- + + This is actually Steve dialing in for Gerard. Just two follow-ups. You had mentioned the credit downgrades; I believe you said oil and gas. Were there any other sectors, and if there were, just some figures on them? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [123] +-------------------------------------------------------------------------------- + + Yes, the credit downgrades included oil and gas and we called it out just because in total oil and gas was $140 million of our total net $250 million reserve build. But also I said that there were select names, it's like a dozen names, so it's not really like there's another sector, just very discrete names. + +-------------------------------------------------------------------------------- +Unidentified Audience Member [124] +-------------------------------------------------------------------------------- + + Okay, great. Thank you. And just a second follow-up. Can you just give us your mortgage duration and how far you are willing to take it? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [125] +-------------------------------------------------------------------------------- + + No, we are not going to give you that. We disclose -- when you say mortgage duration, obviously we build into all of our models mortgage duration. You guys can calculate that yourself by looking at disclosures in the 10-K that show mortgages at 3%, 3.5%, 4%, 4.5%, etc. And obviously we can change that at will with our investment portfolio and things like that. +It's all in the NIM already. So obviously we have negative convexity in our portfolio. + +-------------------------------------------------------------------------------- +Operator [126] +-------------------------------------------------------------------------------- + + There are no further questions. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [127] +-------------------------------------------------------------------------------- + + Thank you, everyone. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [128] +-------------------------------------------------------------------------------- + + Wait. Before you all go, I just want to tell you one of these days I'm not going to come in on this call. I'm not doing it because I want to avoid it; I don't like it. And obviously, if anything is important or really bad, I'm not going to ever try to avoid bad news here because we like to tell the whole truth, nothing but the truth, the good, bad, and ugly. +But Marianne has started to do such a good job that I've become unnecessary to be in all of them and I can obviously go do other things. So don't be surprised if one of these days I don't show up; don't read anything into it. Thank you for being here. + +-------------------------------------------------------------------------------- +Operator [129] +-------------------------------------------------------------------------------- + + Ladies and gentlemen, this concludes today's call. You may now disconnect. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/exam/original-files/Problem_2_3_Sample_full_transcripts/2015-Jul-22-KO.N-139813926443-Transcript.txt b/exam/original-files/Problem_2_3_Sample_full_transcripts/2015-Jul-22-KO.N-139813926443-Transcript.txt new file mode 100644 index 0000000..99cdfed --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_full_transcripts/2015-Jul-22-KO.N-139813926443-Transcript.txt @@ -0,0 +1,564 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q2 2015 Coca-Cola Co Earnings Call +07/22/2015 09:30 AM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Ahmet Bozer + Coca-Cola Company - EVP & President Coca-Cola International + * Sandy Douglas + Coca-Cola Company - EVP & President Coca-Cola North America + * Kathy Waller + Coca-Cola Company - CFO + * Muhtar Kent + Coca-Cola Company - Chairman & CEO + * Tim Leveridge + Coca-Cola Company - VP & IR + +================================================================================ +Conference Call Participiants +================================================================================ + + * Mark Swartzberg + Stifel Nicolaus - Analyst + * Dara Mohsenian + Morgan Stanley - Analyst + * Bryan Spillane + BofA Merrill Lynch - Analyst + * Ali Dibadj + Bernstein - Analyst + * Nik Modi + RBC Capital Markets - Analyst + * Vivien Azer + Cowen and Company - Analyst + * Steve Powers + UBS - Analyst + * John Faucher + JPMorgan - Analyst + +================================================================================ +Presentation +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + At this time, I would like to welcome everyone to the Coca-Cola Company's second quarter 2015 earnings results conference call. Today's call is being recorded. If you have any objections, please disconnect at this time. +(Operator Instructions) +I would like to remind everyone that the purpose of this conference is to talk with investors. And therefore, questions from the media will not be addressed. Media participants should contact Coca-Cola's Media Relations Department if they have questions. +I would now like to introduce Tim Leveridge, Vice President and Investor Relations Officer. Mr. Leveridge, you may begin. + +-------------------------------------------------------------------------------- +Tim Leveridge, Coca-Cola Company - VP & IR [2] +-------------------------------------------------------------------------------- + + Good morning, and thank you for being with us today. I'm joined by Muhtar Kent, our Chairman and Chief Executive Officer, and Kathy Waller, our Chief Financial Officer. +Before we begin, I would like to inform you that you can find webcast materials in the Investors section of our Company website at www.cocacolacompany.com that support the prepared remarks by Muhtar and Kathy this morning. I would also like to not that we have posted schedules under the Financial Reports and Information tab in the Investors section of our Company website. These schedules reconcile certain non-GAAP financial measures. Which may be referred to by our senior executives during this morning's discussion to our results as reported under general accepting accounting principles. Please look on our website for this information. +In addition, this conference call may contain forward-looking statements, including statements concerning long-term earnings objectives. And should be considered in conjunction with cautionary statements contained in our earnings release, and in the Company's most recent periodic SEC report. +Following prepared remarks by Muhtar and Kathy this morning, we will turn the call over for your questions. Ahmet Bozer, Executive Vice President and President of Coca-Cola International, Sandy Douglas, Executive Vice President and President of Coca-Cola North America, and Irial Finan, Executive Vice President and President of Bottling Investments will also be available for our Q&A session. Now let me turn the call over to Muhtar. + +-------------------------------------------------------------------------------- +Muhtar Kent, Coca-Cola Company - Chairman & CEO [3] +-------------------------------------------------------------------------------- + + Thank you, Tim. And good morning, everyone. +While many markets around the world faced macroeconomic challenges, our focus on improving our execution enabled us to deliver improved top line results. Net revenues grew 4% on an organic basis, driven by positive price mix, and 3% growth in concentrate shipments, as outlined on our second-quarter performance scorecard on slide 4. +Our top line performance was broad based, with each operating segment delivering positive organic revenue growth, demonstrating the strength of our global brand portfolio, and the robust distribution capabilities of our bottling partners. As a result, we once again gained global value share in non-alcoholic ready-to-drink beverages in the quarter, with gains in both sparkling and still beverages. This represents the 32nd quarter in a row that we've gained NARTD value share, an important metric for us, particularly in a tough macroeconomic environment. Notably, the levels of our volume and value share gains are accelerating versus the second quarter of last year. +Unit case volume grew 2% in the quarter, cycling 3% in the prior year. We've seen an improvement, with all operating groups growing despite a shift in Easter holiday sales from the second quarter last year into the first quarter this year. As well as challenges in key emerging markets, most notably Brazil, Russia and India. +During the quarter, we continued our strong focus on controlling operating expenses. Even with a double-digit increase in our media spend, we were able to deliver a 50 basis point improvement in our operating margin on a comparable currency neutral basis. And grow our comparable currency neutral operating income and PBT by 6% and 3%, respectively, in the quarter. Finally, we generated record cash from operations, and grew free cash flow 16% on a year-to-date basis, due in part to the six extra days in the first quarter, but also due to effective working capital initiatives. Something Kathy will talk about later in the call. +Last year, we took decisive action to reinvigorate our growth and increase profitability. Halfway through our transition year, we're pleased with the progress we're making, but recognize that we still have much to do. We're acting with speed, with urgency against each of our five strategic initiatives. First and foremost, our enhanced focus on revenue growth across markets is delivering value share gains ahead of volume share gains on a consolidated basis, as well as in our international and North America businesses. +Our North America business delivered a very strong quarter, with 5% growth in organic revenues and 8% in comparable income before tax. This performance reflects increased marketing, a disciplined approach to managing volume, price and mix. As well as the shift of July 4th holiday sales, and our Share a Coke campaign into the second quarter this year versus the third quarter last year. +Importantly, in North America we delivered revenue growth in our sparkling portfolio in the quarter due to further expansion of our pricing strategy, resulting in 4% sparkling price mix. Our disciplined price [back] strategy has seen wide adoption across all retail channels as we emphasize smaller proprietary packages, while also raising prices on traditional packages, including 12-ounce cans and 2-liter bottles. While sparkling unit case volume grew 1%, transactions increased 2%, due to strong growth in the smaller packages, which are on trend with consumer preferences, such as our mini cans, which grew volume double digits during the quarter. +The second action to reinvigorate growth is to increase our media investments globally. To fully fund our brands across our market around the world, while enhancing the quality of our advertising at the same time. In the markets where we are investing more, with better quality, we're seeing better performance. Let me just give you an example of how marketing along with solid execution by our bottling partners is driving top line growth across our emerging, developing and developed markets. +Starting with our emerging markets. Despite a soft macro environment in China, we grew brand Coca-Cola volume double digits. A record 20 million consumers participated in China's Coca-Cola Break consumer promotion, which along with the third edition of the Share a Coke campaign, fueled our growth. +Turning to our developing market. In Argentina we gained both volume and value share, and importantly gained value share ahead of volume share for the second quarter in a row, due in part to integrated marketing campaigns around Copa America, the main international football tournament for national teams in South America. +Finally, both the quantity and quality of marketing in North America helped us realize 4 points of sparkling price mix, resulting in solid revenue performance. The trends we're seeing in these markets, as well as initial results in other markets, gives us continued confidence that our stepped up investments are working. Further, we still have significant opportunity in many other markets, where we began increasing media investments towards the end of 2014. Given the typical 12 to 24-month time period for these investments to deliver their full return, it will be 2016 before we see real results in some of these other regions. +Turning to productivity. We remain focused on fueling our re-investments through embedding productivity into our DNA. We're on track across all spend areas to hit key milestones this year, and deliver $3 billion in annualized savings by 2019. One area which we are seeing momentum is supply chain related savings, which benefited our gross margin in the quarter. Year to date, we consolidated three distribution centers and closed one plant in North America, as well as began the process of installing in-line blow molding equipment. +Further, we recently kicked off the next phase of our zero base work, which consists of a launch in our international market, and a second year of this work in corporate as well as North America. Zero base work is a mechanism that helps our leaders make very tough choices to free up resources that can be redeployed and reinvested to fund growth. As we go through this process, we're working to ensure that the priorities we are funding to drive growth in our business units are also seamlessly prioritized across our entire system. +The implementation of our new operating model is on track, and we have made significant headway on the previously announced head count reductions. This now includes Europe, where we began implementing changes this quarter, following the appropriate consultations. As we begin operating within our new structure, we are actively engaging in connecting our global organization and implementing our standard processes. +Finally, focusing on our core business model, we continued to make progress on our North America re-franchising efforts. During the quarter, we transitioned territories representing over 5% of the US bottle can volume. Additionally, we announced the signing of new letters of intent for territories covering close to another 10% of the US bottle can volume. +In aggregate, territories transitioned to date and those covered by definite agreements or letters of intent represent approximately 25% of the total US bottle can volume. We're getting better. We're getting faster. Which is why we are confident we're going to achieve our previously stated goal to have approximately two-thirds of US bottle can volume distributed by our independent bottlers by the end of 2017. Our bottling Partners are critical to our success. We held our annual global system meeting in May this year, and I can tell you that the level of engagement among our bottling Partners was very high. They're encouraged by our plans, and have committed to support our investments with further enhanced focus on local market execution. +To conclude, I would like to address the macro environment given the challenges many CPG companies are encountering today. And the fact that approximately 75% of our operating income is generated overseas. The global economic recovery remains uneven. Given the continued slowdown of the Chinese economy, the prospective US tightening cycle as the US prepares to increase interest rates, and the ongoing uncertainty surrounding Greece and its place in the Euro zone. Additionally, many emerging markets, large and small, remain challenged. As evidenced by our low single-digit volume declines in both Brazil and Russia this quarter. +While we have the right strategic plans in place to navigate through the volatile operating environment, we're not fully immune. With that said, as we pass the mid point of 2015, we're broadly where we expected to be. I remain encouraged by our progress to date, but also acknowledge that there's still much work ahead of us. We're confident in our strategies and execution, and remain on track to deliver against our full-year comparable currency neutral growth expectations. +I'm now hand the call over to our Chief Financial Officer, Kathy Waller, who will provide you with a more detailed look at our financial performance, as well as update on our outlook for 2015. + +-------------------------------------------------------------------------------- +Kathy Waller, Coca-Cola Company - CFO [4] +-------------------------------------------------------------------------------- + + Thank you, Muhtar. And good morning, everyone. +The second quarter came in broadly as we expected. Organic revenue growth was driven by 3% growth in concentrate shipments, and 1 point of positive price mix. Consolidated price mix in the quarter was driven by positive pricing and product mix initiatives across many of our markets, partially offset by a negative geographic mix, consistent with the outlook we provided last quarter. Concentrate shipments outpaced unit cases in the quarter, primarily due to the timing of shipments in our Asia Pacific group. After adjusting for the additional days in the first quarter, year-to-date concentrate shipments were generally in line with unit cases on a consolidated basis. +Our comparable gross margin declined on a consolidated basis as positive pricing, productivity savings, and a slightly lower commodity cost were offset by currency headwinds and structural changes. Positive comparable currency neutral operating leverage was driven primarily by the impact of structural items. Which unfavorably impacted gross margins, but was roughly neutral at operating income and income before taxes. For the quarter, comparable currency neutral operating income grew 6%, including a mid single digit increase in DME. +Below the operating line, on a comparable currency neutral basis, net interest income, equity income and other income were lower, resulting in 3% growth in comparable currency neutral income before tax. Consistent with the outlook we provided on the last call, on a comparable basis, other income benefited from foreign exchange gains associated with the euro denominated debt issued during the first quarter. +Our second-quarter comparable EPS was $0.63, which included a 6 point currency headwind. On a comparable currency neutral basis, our EPS grew 4% in the quarter. Items impacting comparability in the quarter were primarily related to a net gain recognized in connection with the closing of the transaction with Monster Beverage Corporation. +During the first six months of the year, we generated $4 billion in free cash flow, up 16%, primarily due to the efficient management of working capital, and the impact of six additional days, partially offset by an unfavorable impact from currency exchange rates. We returned $3.8 billion to share owners in the form of dividends and net share repurchases during the first six months. +I'd like to take a moment to talk about working capital management. Which we view as another key focus of productivity, as it is incremental to our P&L targets and it adds significant value to the Company and share owners by targeting cash flow improvement. In 2013, we initiated a program to better manage our working capital, with an initial focus on our trade receivables and payables. As a result of this program, we have improved our cash conversion cycle, which resulted in $400 million of incremental cash flow for the first six months of 2015 versus the prior year. +Turning to outlook. Halfway through our transition year, we are where we expected to be, recognizing that economic growth remains challenging in many markets, notably Brazil, Russia and China. For the full year 2015, our comparable currency neutral outlook remains unchanged. Although there are a few adjustments to specific items. Our outlook for net interest is slightly more favorable, offset by a slightly larger impact from structural items at the profit before tax line. +We estimate an increase in the currency impact in the back half of the year, based on the latest exchange rate. And after considering our hedge positions, current spot rate, and the cycling of our prior year rates, we now expect an approximate 6 point currency headwind on net revenue, 11 point headwind on operating income, and a 7 to 8 point headwind on income before tax for the full year 2015. And we expect net share repurchases for the year to be in the range of $2 billion to $2.5 billion. +In addition, there are a couple of phasing items you should consider when modeling the third quarter. Due to the timing of our fiscal quarter end, the benefit associated with the July 4th holiday fell in the second quarter this year versus the third quarter last year. We expect structural items to be a slight headwind on net revenue, and a 1 to 2 point headwind on income before tax. +We currently estimate currency will be an approximate 7 point headwind on net revenues, 13 point headwind on operating income and a 10 point headwind on income before tax in the third quarter, as we cycle more favorable rates from the prior year. The variance between the currency headwind on operating income and on income before tax is primarily due to the cycling re-measurement losses in the prior year. Finally, while not a third-quarter consideration, I wanted to remind you that in 2015, our fourth quarter will have six fewer selling days. +In summary, we are seeing initial progress based on our plan to reinvigorate top line growth, while recognizing that we continue to operate in a challenging macro environment. Therefore, while currency headwinds are increasing, we see no change to our full year comparable currency neutral growth expectations. +Operator, we are now ready for questions. + + +================================================================================ +Questions and Answers +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Thank you, ma'am. The first question on queue is from Mr. John Faucher of JPMorgan. Sir, your line is open. + +-------------------------------------------------------------------------------- +John Faucher, JPMorgan - Analyst [2] +-------------------------------------------------------------------------------- + + Thank you. Good morning. I want to talk a little bit about the advertising spending. There's been some questions and I've had to myself in terms of whether you're just sort of fighting a headwind in terms of trying to advertise the categories. +So can you talk a little bit about what you're seeing? How you're gauging the success that you're having? And what we should expect from an advertising spending increase as a percentage of sales as we look out over the next 12 to 18 months? Thanks. + +-------------------------------------------------------------------------------- +Muhtar Kent, Coca-Cola Company - Chairman & CEO [3] +-------------------------------------------------------------------------------- + + Good morning, John. It's Muhtar here. I'll just say a few top line remarks about it, and then also ask both Sandy and Ahmet to give some more specific details on their -- in specific markets. +I'd say overall, pleased with our initial results. But as we've previously discussed and as I have just recently said, it takes some time, anywhere from 12 to 18 months to realize the full value in terms of a return on those investments. We've found that disciplined quality marketing investments drive growth better than any other strategy or action. +We're seeing good initial results in markets that have received the incremental media investment, and also have improved the quality of marketing in our case. The marketing investments in North America is a great point. Which is a real contributing factor in the strong performance in the quarter, continued strong performance in North America. And the performance is getting better, with 5% growth in organic revenues and 4% price mix. That price mix, and that volume and that, therefore, growth in organic revenue would not have been achieved clearly without the infusion of that marketing and the quality and the quantity. +In China, also seeing positive trends, strong marketing activation, as I mentioned in my remarks. Sparkling growing at 7%, (inaudible) Coke growing at double digits in the quarter, allowing us to gain -- continue to gain significant share in that market. And additionally, we're seeing accelerated trends in our value sharing gains where you compare them against our trends a year ago. +So with that said, clear that it'll take some time for the full benefit on a quarterly basis as these investments take some time to ramp up. Also challenging consumer environments and macro environments. And so those are really what I would say. And in terms of our results, you see year to date, our marketing investments are growing and our margin is expanding by 50 basis points. +So I think the key is to be able to achieve both, and we are confident that we can -- that we will continue to see more positive results. With that, let me turn now for some more specifics to Sandy and then to Ahmet for international example. + +-------------------------------------------------------------------------------- +Sandy Douglas, Coca-Cola Company - EVP & President Coca-Cola North America [4] +-------------------------------------------------------------------------------- + + Thanks, Muhtar. And good morning, John. +The core driver of our business across the world over time is the quality and quantity of our advertising, and the related execution and activation by our bottlers. And in the US over the past 18 months, we've vigorously pursued that strategy, increasing our advertising spend significantly. And you're seeing the payoff in the top line results that Muhtar just went through. But underneath that, a metric that you can watch also is just the price elasticity of our brands, and how volume reacts to price over time. And it's a good metric of the payoff of advertising, along with the efforts of our bottlers in the marketplace. +As we look ahead, we see advertising as an important proactive item to grow the business. But as you start to see in North America over the past few quarters, we're now leveraging the P&L so that the infusion of advertising is coming from the accelerated top line growth and expense efficiency across the total business. +So net-net, it's part of our outgoing algorithm, and an important part of the way we intend to drive growth going forward. Ahmet? + +-------------------------------------------------------------------------------- +Ahmet Bozer, Coca-Cola Company - EVP & President Coca-Cola International [5] +-------------------------------------------------------------------------------- + + Thanks, Sandy. Hey, John. +We have a very similar story in Coke International. The bottlers and our teams have strong conviction about how better and more advertising drives top line. The example that Muhtar quoted, there's more depth to that. I would add developed markets such as Germany and Spain to that list. I would add a developing market such as Mexico to that list. I would add an emerging market such as Nigeria, as good examples. And there are other examples where we increased media, and we improved the quality of that communication, revenue results improved. +Having said that, the history of this increase is less than a year for most Coke International markets. I would caution that it is early days, but definitely we're seeing the positive examples of this action. + +-------------------------------------------------------------------------------- +John Faucher, JPMorgan - Analyst [6] +-------------------------------------------------------------------------------- + + Great. Thanks. + +-------------------------------------------------------------------------------- +Operator [7] +-------------------------------------------------------------------------------- + + Thank you. Our next question is from Mr. Steve Powers of UBS. Sir, your line is open. + +-------------------------------------------------------------------------------- +Steve Powers, UBS - Analyst [8] +-------------------------------------------------------------------------------- + + Hello. Good morning. Thanks. I guess first could you just -- maybe I missed it, but could you just address the reduction in net buybacks for the year and what lies behind that? Is free cash flow coming in weaker? Because that would be surprising just given your working capital comments, et cetera. Or is there a competing use for cash that we should be considering? Just a housekeeping question. +And then a broader question on productivity. The update in the report card you provided was certainly helpful. But I was wondering if you could maybe quantify what those initiatives translated into in terms of savings in the quarter, and how far along you are, admittedly early, against that ultimate $3 billion goal? Because I think that would help just frame where you are in the overarching initiative. And actually, if you could perhaps talk about other initiatives underway and what kinds of achievements we should look for on Q3 or Q4 report cards. That would be great as well. Thanks. + +-------------------------------------------------------------------------------- +Kathy Waller, Coca-Cola Company - CFO [9] +-------------------------------------------------------------------------------- + + Sure, Steve. On the share buybacks, basically, we've given the range of $2 billion to $3 billion, so we're still in that range. We looked at where we were for the first half of the year, and then we looked at cash, particularly because of the currency getting worse in the back half, and just tightened the range. So basically, we're still in that range and that corridor. We just tightened the range. +And then on the second question on productivity. We have basically stated that we are about $500 million for the year -- we are on track. The working capital has allowed us to basically focus on share repurchase, even with the significant currency headwind. So on our productivity initiatives, we are on track. +We didn't give specific initiatives that we were working on for this year. You know about the people initiatives that we had, and we said we're going to be on target with the $500 million for this year. They're still coming from the three areas, so we're still actively working on reducing our cost of goods sold and moving D&E from more promotional activities into media spend. +So we are basically on track. I don't how -- I can't give you any other specifics other than, we are basically on track for the $500 million that we anticipated that we would have for this year. + +-------------------------------------------------------------------------------- +Steve Powers, UBS - Analyst [10] +-------------------------------------------------------------------------------- + + Okay. That's helpful. Is it fair to assume that the savings build and that there's more of an impact in the second half versus the first half, or is it more ratable throughout the year? + +-------------------------------------------------------------------------------- +Kathy Waller, Coca-Cola Company - CFO [11] +-------------------------------------------------------------------------------- + + I don't know that I can quantify how they come throughout the year. Part of it was dependent upon when we started to see movement with some of the people. And we've not gotten -- for instance, Europe had to focus on the working -- had to work with the Work Council, So their initiative was people really just starting, although everybody is aware the movement of people is just starting. +So part of that will be coming out now that they've been able to focus on their moving people initiative. But I don't know that I can quantify the how and when it all comes through, because we focus on dealing with the work first. And we deal with the work first, and then a lot of the other impact will rail making sure that we deal with -- that the organization is appropriately set up for success going forward. Which included focusing on the global organization, and restructuring how we worked with the global organization. So all I can say is, we're on target with everything that we've done. + +-------------------------------------------------------------------------------- +Muhtar Kent, Coca-Cola Company - Chairman & CEO [12] +-------------------------------------------------------------------------------- + + Just adding to what Kathy mentioned, Steve. I'd say that also in terms of simplifying our organization, wiring our business units closer and more directly to the functional centers in our Company, that has largely taken place. We have essentially eliminated a functional layer in the Company, allowing us to make faster and quicker decisions -- and more effective decision making in the Company. That is already largely in place. And I think lots of continued work streams going on in COGs that will continue to benefit, and help us to deliver more than the $500 million in savings for the year. + +-------------------------------------------------------------------------------- +Steve Powers, UBS - Analyst [13] +-------------------------------------------------------------------------------- + + Thanks very much. + +-------------------------------------------------------------------------------- +Operator [14] +-------------------------------------------------------------------------------- + + Thank you. Our next question is from Mr. Mark Swartzberg of Stifel Financial. Sir, your line is open. + +-------------------------------------------------------------------------------- +Mark Swartzberg, Stifel Nicolaus - Analyst [15] +-------------------------------------------------------------------------------- + + Thanks. That's Stifel Financial, but good morning, everyone. I guess two questions here. +One, a region question, Muhtar, and then a more strategy question. With Asia PAC, at least versus my model, the price mix was disappointing. It's only a quarter, and you highlighted China and I think some product mix issues. But when you think longer term about price mix in Asia PAC given the superior growth I think you expect from China, what's a sound way to think about that region in the larger Coke system? And then unrelated to that, or less related to that, when you think of scale and bolt-on M&A, can you just update us on you're thinking for the larger Coke, how you're thinking about scale M&A, and how you're thinking about bolt-on M&A? + +-------------------------------------------------------------------------------- +Muhtar Kent, Coca-Cola Company - Chairman & CEO [16] +-------------------------------------------------------------------------------- + + First, Mark, good morning. On the Asia PAC, I think it pretty much came in line with what we were expecting and it's related to timing. It's related to how you look at it on a year-to-date basis. And I'll have Ahmet comment on that once I finish. I'll just say a few things about the second question. +In terms of scale M&A and bolt-on M&A, I think you need to think we will be again looking at bolt-on targets that fit our strategic portfolio. That's the way you should think about our continued interest in any M&A and how we target M&A. Just the same way as you've seen us look at it in the last three, four, five years, how we look -- how the acquisitions that we made in terms of innocent, in terms of honesty, in terms of [zeco], in terms of other bolt-on. And then more recently, the announcement from China that we had. +So essentially, bolt-on acquisitions that complement our current portfolio and that give us the ability to also scale it up from a geographic scale goes up from a geographic point of view. Just like you saw us launch Smartwater in other new European markets more recently. That's a good example of how the scale up continues. And how we've converted -- how we've turned Smartwater into one of the leading premium waters in the world, both here in the United States and now in some other new markets. Ahmet, comments on Asia Pacific? + +-------------------------------------------------------------------------------- +Mark Swartzberg, Stifel Nicolaus - Analyst [17] +-------------------------------------------------------------------------------- + + Can I just ask one quick one there as a follow-up, Muhtar. It sounds like what you're saying there is precludes an interest in scale M&A. The focus -- just to be super clear, the focus is on bolt-on to the exclusion of scale. And we could debate scale I realize, but sounds like that's the focus. + +-------------------------------------------------------------------------------- +Muhtar Kent, Coca-Cola Company - Chairman & CEO [18] +-------------------------------------------------------------------------------- + + It excludes anything. But I'm saying our focus would be -- I think you should assume that it would continue in that area. If there's something that obviously -- the future, none of us know what the future holds. We could never be -- we're always guided by the past. The future is something, and there may come some opportunities that we'll look at. But right now, what I will say to you is, base it on what I've said as the past few years being an indication of the future. + +-------------------------------------------------------------------------------- +Mark Swartzberg, Stifel Nicolaus - Analyst [19] +-------------------------------------------------------------------------------- + + Great. Okay. Got it. Thank you. + +-------------------------------------------------------------------------------- +Ahmet Bozer, Coca-Cola Company - EVP & President Coca-Cola International [20] +-------------------------------------------------------------------------------- + + Mark, just to add on to the price mix on Asia Pacific, the minus [6%] was not a surprise to us. It was expected, and there was a lot of timing between the first and second quarters. If you look at first half price mix for Asia Pacific, we're in negative [2%]. Which is very much in line with what has been happening in Asia Pacific due to geographic mix and other channel mix issues. So no surprises there. + +-------------------------------------------------------------------------------- +Mark Swartzberg, Stifel Nicolaus - Analyst [21] +-------------------------------------------------------------------------------- + + Got it. Great. Okay. Great. Thank you, gentlemen. + +-------------------------------------------------------------------------------- +Operator [22] +-------------------------------------------------------------------------------- + + Thank you. Our next question is from Dara Mohsenian of Morgan Stanley. Your line is open. + +-------------------------------------------------------------------------------- +Dara Mohsenian, Morgan Stanley - Analyst [23] +-------------------------------------------------------------------------------- + + Good morning. So, Muhtar, clearly, very strong 4% pricing in North America. Can you run through how much of that was mix versus price? And then comment on the sustainability of higher pricing as you look out for the back half of the year once you cycle the higher pricing from last year? +And longer term, how you think about any pricing? Clearly, we've seen a big improvement here over the last year. Looks like it's worked well in terms of limited demand elasticity, so more longer term type thoughts on pricing in North America. + +-------------------------------------------------------------------------------- +Muhtar Kent, Coca-Cola Company - Chairman & CEO [24] +-------------------------------------------------------------------------------- + + Thanks. I'd say, look, I think North America delivered strong second quarter revenue profit value share performance driven by better increased marketing, better marketing, and a disciplined approach to both volume, price and mix management. +Few things, mix management is working in our favor. Consumer is very much approving the smaller packages. Smaller packages are growing much faster than larger packages. Smaller packages have a higher NSR per liter, per gallon, whatever per case. And therefore, there's -- that way price driven by -- and the ability to keep the volume where it is and gain the price mix are historic bests in terms of the past quarter performance in the United States. Why is that happening? More marketing, and more focus on better marketing as well. +So the rate is coming through, mix from transactions and packs coming through. That is the general comment I'd make. And, Sandy, if you want to provide more color to this. + +-------------------------------------------------------------------------------- +Sandy Douglas, Coca-Cola Company - EVP & President Coca-Cola North America [25] +-------------------------------------------------------------------------------- + + Yes, I absolutely agree with that, Dara. And our strategy is, as Irial and I said a year and a half ago, we were putting in place a strategy of building strong valuable brands, with accelerated quantity and quantity of marketing. And we were going to take proactive opportunities to get our price in line with the value of the brands, and to lead price up in a consistent and strategic way. Working on the development of packages that consumers want, in particular premium packages. And the consumer is pulling very clearly to smaller packages, so they can enjoy the ice cold refreshing taste of one of our beverages but in a portion size that they want. +The net effect, as Muhtar said, is that we have a benefit from mix but our strategy as we look forward is to continue to lead. We see this strategy of disciplined price pack volume management underneath the brand building of strong powerful brands as a long-term strategy. And we continue to take action across our system every day to reinforce it, to grow our capability, and to continue to grow our business in a very balanced and disciplined way. + +-------------------------------------------------------------------------------- +Dara Mohsenian, Morgan Stanley - Analyst [26] +-------------------------------------------------------------------------------- + + Okay. So it sounds like the way you approach pricing in North America going forward, you think you'll continue to see progress both for main mix and rate perspective. And obviously, while we could see a sequential slowdown as you comp over this period, you're pretty committed to the efforts longer term. Is that fair? + +-------------------------------------------------------------------------------- +Sandy Douglas, Coca-Cola Company - EVP & President Coca-Cola North America [27] +-------------------------------------------------------------------------------- + + Absolutely. The strategy is very consistent, and we continue to be optimistic about our ability to make the levers work. Because our brands are strong and we're investing in them, and because our bottling system is executing very well and we continue to get better. +I think one of the mantras in our team, Dara, is that we've got the right strategy. But we're just beginning to hit our stride from a capability standpoint, and we have much more opportunity to improve than we have progress made so far. + +-------------------------------------------------------------------------------- +Dara Mohsenian, Morgan Stanley - Analyst [28] +-------------------------------------------------------------------------------- + + Okay. Thanks. + +-------------------------------------------------------------------------------- +Operator [29] +-------------------------------------------------------------------------------- + + Thank you. Next question is from Vivien Azer from Cowen and Company. Your line is open. + +-------------------------------------------------------------------------------- +Vivien Azer, Cowen and Company - Analyst [30] +-------------------------------------------------------------------------------- + + Hello. Thank you so much for taking my question. I was going to focus on Diet Coke. While your total sparkling unit case line growth was clearly impressive, Diet Coke continues to be challenged. So, Sandy, could you please update us on what you're seeing in terms of North America? And then, Muhtar, if you could comment on any other geographies where you're seeing diet present a challenge. Thank you. + +-------------------------------------------------------------------------------- +Muhtar Kent, Coca-Cola Company - Chairman & CEO [31] +-------------------------------------------------------------------------------- + + Sure, Vivien. First out, I'd say the challenge is never taken for granted, but the challenge is broadly very much a US centric one. So let me just preface that, and then have Sandy comment on what's happening in the United States. And also comment -- give you some more comment on other diet drinks like Coke Zero performance and so forth. + +-------------------------------------------------------------------------------- +Sandy Douglas, Coca-Cola Company - EVP & President Coca-Cola North America [32] +-------------------------------------------------------------------------------- + + Sure. As we've discussed in several of these calls and in our interactions more one on one, the diet and frozen parts of the food and beverage industry have been struggling for a number of quarters. It's getting into years now. +As the consumer -- the US consumer moves really strongly to fresh. It's a good dietary change actually for the country, but the impact on categories, and particularly categories that are appealing to diet oriented positionings has been pretty negative. Inside our particular portfolio, we have brands growing and have brands struggling. +Coke Zero, as Muhtar mentioned, grew in the quarter. Diet Coke continues to struggle. Our near-term improvements, though, are we're starting to see the consumer base stabilize. +We have an incredible number of very loyal drinkers in Diet Coke, that love Diet Coke. And our milestone that we're seeking to achieve soon is to level our revenue. To match price and volume, such that Diet Coke's revenue gets to flat and then starts to grow again. +As we look ahead, what I would tell you about Diet Coke is that we believe strongly in the Diet Coke franchise. Diet Coke, the brand, is the number one diet beverage in the United States, and it will be for a long time to come. +We also are looking at changes in the category. Our largest competitor is changing their formula, and they'll be launching that in August, and that will create a lot of buzz in the category. Some of it good, as the good science of the safety of non nutritive sweeteners gets out in the marketplace and is reinforced. +We are looking at multiple programs, to not only strengthen Diet Coke but to offer consumers adjacent innovation in the Diet Coke franchise. And we're excited about the long-term future. But as we say around here, it's work in progress and a lot more work to do, but we still are very optimistic about the long term. + +-------------------------------------------------------------------------------- +Vivien Azer, Cowen and Company - Analyst [33] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Operator [34] +-------------------------------------------------------------------------------- + + Thank you. Next question is from Bryan Spillane of Bank of America. + +-------------------------------------------------------------------------------- +Bryan Spillane, BofA Merrill Lynch - Analyst [35] +-------------------------------------------------------------------------------- + + Good morning, everyone. So just I had a question about geographic mix. I think it came up earlier the geographic mix was negative in the quarter. And could you -- is there any way you could outline for us if geographic mix also had a negative effect on profit margins or profitability? +I know there is a lot of moving parts in the P&L. But when you look at it currency neutral, you saw some margin expansion. And my thought is you actually had, within that margin expansion, you actually had some negative geographic mix on margins. So any help on that would be helpful. +And then related to that, as we're modeling out the balance of this year, and I guess it goes to Mark Swartzberg's question about the Pacific region. Should we continue to expect to model in negative price -- geographic price mix into our models for Pacific in the back half of the year? Thank you. + +-------------------------------------------------------------------------------- +Kathy Waller, Coca-Cola Company - CFO [36] +-------------------------------------------------------------------------------- + + Hello, Bryan. Yes. On the margin question, our margins were negatively impacted by currency and by structural. Obviously, there's always some negative geographic mix that plays into that. But as you look at our margins and if you look at the specific growth margin, first of all, and if you look at them on a comparable basis, we lost some margin. +But then if you take out currency and then you take out structural, then we were at positive margins again. So -- and the issue more is about growth margin, it's not so much about operating margins. When you -- then your second question which was -- + +-------------------------------------------------------------------------------- +Bryan Spillane, BofA Merrill Lynch - Analyst [37] +-------------------------------------------------------------------------------- + + Just related to price mix, price mix in Pacific. Should we continue to see negative geographic mix there? + +-------------------------------------------------------------------------------- +Kathy Waller, Coca-Cola Company - CFO [38] +-------------------------------------------------------------------------------- + + It's normal in the Pacific to have negative geographic mix, just because of the base of the country, Japan, and then all of the emerging markets there. So, yes, I would say for the remainder of the year, I would anticipate that we would have negative geographic mix in Pacific. Ahmet, you want to comment on that? + +-------------------------------------------------------------------------------- +Ahmet Bozer, Coca-Cola Company - EVP & President Coca-Cola International [39] +-------------------------------------------------------------------------------- + + That's definitely not in the numbers that we've seen in the second quarter, but the general trend of around a couple points of to date number. However, we do continue to aggressively implement our more balanced top line growth in terms of price and volumes across the territory, and we are aiming to improve on that. + +-------------------------------------------------------------------------------- +Bryan Spillane, BofA Merrill Lynch - Analyst [40] +-------------------------------------------------------------------------------- + + All right. Thank you. And if I could sneak just one last one in for Sandy. +If we're looking at smaller pack -- the affect of smaller pack sizes in North America and just simply looking at it on transactions, I know it's kind of early, but is it incremental? So if we were just measuring transactions, are the purchases of those smaller packages, are they incremental to base business or is it cannibalistic? Thank you. + +-------------------------------------------------------------------------------- +Muhtar Kent, Coca-Cola Company - Chairman & CEO [41] +-------------------------------------------------------------------------------- + + Before Sandy comments on that, Bryan, let me just also say that, also in many parts of the Pacific, since your question was somewhat related to the Pacific and in terms of geographic mix. I think sparkling and particularly, Bryan, Coca-Cola, again, with things that are happening around advertising and media spend and better quality is getting stronger. +Whether you take Indonesia, or whether you take Southeast Asia, or whether you take China, sparkling is getting stronger and momentum on sparkling is getting better. And therefore, I think you're also seeing a positive shift in category mix for us that is somewhat countered by continued geographic mix. +So I think there's a balance there, and I think we're happy to see that balance coming through. I just want to mention that, that important this year, we see that balance beginning to come through, more favorable balance coming through. And then, Sandy, if you want to talk about the smaller packages reference. + +-------------------------------------------------------------------------------- +Sandy Douglas, Coca-Cola Company - EVP & President Coca-Cola North America [42] +-------------------------------------------------------------------------------- + + Sure. The growth in North America transactions is healthy. And that's coming from a number of things. But the small packages clearly are driving a tremendous amount of positive growth. Some of it is cannibalistic, but the cannibalistic nature of it accrues to higher margins. So the mix shift is positive, and then you have the incremental transaction growth that's being driven there. And the primary reason is that the consumers want smaller packages, that's why they're buying more Cokes. +Our marketing model is about more people, enjoying more Cokes, more often for a little bit more money. And that's what we seek to accomplish in the marketing and execution of our brands. And what you can see by the mid-teen growth of the smaller packages is they're driving that transaction growth, and transaction performance is positive. So the net effect of it is that it's positive in net-net. +The other comment I would make is that we have data in some of our retail partnerships that shows that moms in particular like small packs and are returning to the category to use small packs as a way of giving treats to teenagers and others in the household. And it's a particularly positive thing, because moms can do that with a pack that isn't too big. Whereas, for many years in the category, we marketed packages that were too big, that were either wasted or over consumed. Our package mix no longer does that, and it's one of the reasons why our growth is accelerating. + +-------------------------------------------------------------------------------- +Bryan Spillane, BofA Merrill Lynch - Analyst [43] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Operator [44] +-------------------------------------------------------------------------------- + + Thank you. Next question is from Nik Modi of RBC Capital. Sir, your line is open. + +-------------------------------------------------------------------------------- +Nik Modi, RBC Capital Markets - Analyst [45] +-------------------------------------------------------------------------------- + + Thanks for the question. So I just wanted to go back to the bottler reinvestment question. And maybe, Muhtar, you can give us some perspective on where the bottling match in resourcing has been most significant. Just so we can get an understanding of where there could be potential leading indicators on that impact on volume growth. + +-------------------------------------------------------------------------------- +Muhtar Kent, Coca-Cola Company - Chairman & CEO [46] +-------------------------------------------------------------------------------- + + Thanks, Nik. First thing, I would say to you, as I mentioned in my scripted remarks, that we had a very successful global system meeting back in May. And I see the much more improved engagement, and also commitment by our bottling partners across the board, small, large, Asia, Europe, Latin America, Eurasia, and Africa, North America. +So I'd say to you, it's broad based. And I'd say to you that there's a great deal of excitement that is around our plans, particularly our reinvestment plans, and also great amount of commitment for better execution and more investment on the side of our bottling partners. So as I look at the pipeline of investment, I would say I am much more encouraged today than I was, say, 12 to 18 months ago. And I believe that that's driven by our plans and our -- basically our belief in the future and what is being -- and what is happening is yielding early results. And that is driving that engagement. + +-------------------------------------------------------------------------------- +Nik Modi, RBC Capital Markets - Analyst [47] +-------------------------------------------------------------------------------- + + Muhtar, are we starting to see cooler placements actually hit the market and more feet on the street? Or is this bottler commitments on that they're going to do it at some point in the next quarter or two? + +-------------------------------------------------------------------------------- +Muhtar Kent, Coca-Cola Company - Chairman & CEO [48] +-------------------------------------------------------------------------------- + + No, we'll see it this year, and we will see it at a trend that continues to increase next year and beyond over -- certainly over a three-year period. Here in the United States, in Latin America, in Europe, in Asia Pacific, in Eurasia and Africa. + +-------------------------------------------------------------------------------- +Nik Modi, RBC Capital Markets - Analyst [49] +-------------------------------------------------------------------------------- + + Great, thanks so much. + +-------------------------------------------------------------------------------- +Operator [50] +-------------------------------------------------------------------------------- + + Thank you. The last question is from Ali Dibadj of Bernstein. Your line is open. + +-------------------------------------------------------------------------------- +Ali Dibadj, Bernstein - Analyst [51] +-------------------------------------------------------------------------------- + + Hey, guys, thanks. A couple of things I wanted to talk about if possible. One is around top line, and one is around asset base. First on the top line, I think you guys have done a good job explaining and playing out the thesis out in terms of price mix, which is great. +On the volume side, how would you describe the Company trajectory right now from a volume growth perspective? So do you think we've seen the bottom in terms of volume growth after a series of plus 1% to now a 2% and some user comps going forward? So do you think we should be projecting a turning point upward in terms of volume growth for the Company going forward? And I'll come back with the asset question in a second. + +-------------------------------------------------------------------------------- +Muhtar Kent, Coca-Cola Company - Chairman & CEO [52] +-------------------------------------------------------------------------------- + + So, Ali, volume, the algebra is volume times price, is what we generate as revenue. And I think it's good that you ask that question, and it's one of the important elements of the algebra. I think we're encouraged by actions where we basically expect it to be. We're cycling 3%, and we generated 2%. And I think the volatility, as I mentioned in Russia on the verge of a recession today, from a macro point of view. Or Brazil where there's still very significant challenges in disposable incomes. China disposable income levels haven't improved significantly. +But importantly, improving trends on share, we're at all-time high in many markets. Value share, particularly, which is very important, and value share is driven again by the actions that we're taking. +So based on your question, have you seen the bottom? I'd say we're about where we expected to be. And we see that what we're doing is continuing to help keep that equation in place at an improving trend. The equation being, if the marketing wasn't there, the volume wouldn't hold up where it was and the price wouldn't hold up where it was. See it in that respect, both being propped up by the investment that we're putting into the marketplace and those investments being driven by the zero-base work that we're generating. + +-------------------------------------------------------------------------------- +Ali Dibadj, Bernstein - Analyst [53] +-------------------------------------------------------------------------------- + + Okay. Very helpful answer. On the asset side of things, if you look at Germany and India and Vietnam, NBIG, those continue to do quite well. Seem like they're improving. And in North America from the discussions we've had, this call, other calls, looks like that's getting better, too. With productivity and profit actually growing finally. +Are -- do you think there are ways or are there -- what are the hurdles given all those improvements for you not to be able to divest or refranchise those assets more quickly? And have a smaller access base, which is the long-term plan, even more quickly than you've laid out so far? + +-------------------------------------------------------------------------------- +Muhtar Kent, Coca-Cola Company - Chairman & CEO [54] +-------------------------------------------------------------------------------- + + I think you said it. Those are continuing to improve. As they improve, they become -- there's more that are getting in line for those assets, and that's a good place to be. And I think that basically we see those are great markets, not just in our hands, but in the right hands. And that's the way we see it. And I think that we are encouraged by the internal plans we have, and I think that that's all I can say right now. But we have -- we're in a place where those -- let's call it this way. The fruit is getting riper. + +-------------------------------------------------------------------------------- +Ali Dibadj, Bernstein - Analyst [55] +-------------------------------------------------------------------------------- + + Okay. I just hope it's not overripe at some point. I appreciate it. Thanks, guys. + +-------------------------------------------------------------------------------- +Muhtar Kent, Coca-Cola Company - Chairman & CEO [56] +-------------------------------------------------------------------------------- + + This fruit will never get overripe. It will be good on the tree and off the tree. + +-------------------------------------------------------------------------------- +Ali Dibadj, Bernstein - Analyst [57] +-------------------------------------------------------------------------------- + + Thanks, guys. + +-------------------------------------------------------------------------------- +Operator [58] +-------------------------------------------------------------------------------- + + Thank you. I would now like to turn the call back to Muhtar Kent for closing remarks. + +-------------------------------------------------------------------------------- +Muhtar Kent, Coca-Cola Company - Chairman & CEO [59] +-------------------------------------------------------------------------------- + + Thank you, Kathy, Ahmet, Sandy, Irial and Tim. In summary, our second quarter results were in line with our expectations. And as we enter the second half of our transition year, we are where we expected to be. +While there's more work to do, as I said, we remain confident that we have the right plans in place, to restore momentum in our global business. The long-term dynamics of our industry remain promising, and we absolutely believe that The Coca-Cola Company's best position to capture that growth in non-alcoholic beverages and to deliver long-term value to our shareholders. As always, we thank you for your interest, your investment in our Company and for joining us this morning. + +-------------------------------------------------------------------------------- +Operator [60] +-------------------------------------------------------------------------------- + + That concludes today's call. Thank you for participating. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/exam/original-files/Problem_2_3_Sample_full_transcripts/2015-May-20-TGT.N-137082306821-Transcript.txt b/exam/original-files/Problem_2_3_Sample_full_transcripts/2015-May-20-TGT.N-137082306821-Transcript.txt new file mode 100644 index 0000000..74f8bac --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_full_transcripts/2015-May-20-TGT.N-137082306821-Transcript.txt @@ -0,0 +1,672 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q1 2015 Target Corp Earnings Call +05/20/2015 10:30 AM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Brian Cornell + Target Corporation - Chairman and CEO + * John Mulligan + Target Corporation - CFO + * Kathee Tesija + Target Corporation - Chief Merchandising and Supply Chain Officer + * John Hulbert + Target Corporation - VP of IR + +================================================================================ +Conference Call Participiants +================================================================================ + + * Scott Mushkin + Wolfe Research - Analyst + * Peter Benedict + Robert W. Baird & Company, Inc. - Analyst + * Robbie Ohmes + BofA Merrill Lynch - Analyst + * Greg Melich + Evercore ISI - Analyst + * Matt Nemer + Wells Fargo Securities, LLC - Analyst + * Oliver Chen + Cowen and Company - Analyst + * Sean Naughton + Piper Jaffray & Co. - Analyst + * Christopher Horvers + JPMorgan - Analyst + * Bob Drbul + Nomura Securities Intl - Analyst + +================================================================================ +Presentation +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Ladies and gentlemen, thank you for standing by. Welcome to the Target Corporation first-quarter earnings release conference call. +(Operator Instructions) +As a reminder this conference is being recorded Wednesday, May 20, 2015. +I would now like to turn the conference over to Mr. John Hulbert, Vice President Investor Relations. Please go ahead, sir. + +-------------------------------------------------------------------------------- +John Hulbert, Target Corporation - VP of IR [2] +-------------------------------------------------------------------------------- + + Good morning, everyone, and thanks for joining us on our first quarter 2015 earnings conference call. On the line with me today are Brian Cornell, Chairman and Chief Executive Officer, John Mulligan, Chief Financial Officer, and Kathee Tesija, Chief Merchandising and Supply Chain Officer. +This morning, Brian will discuss our first-quarter performance and priorities going forward. Then Kathee will provide insights into our first-quarter results across our merchandise categories and plans for the second quarter and beyond. And finally, John will provide more detail on our first-quarter financial performance and expectations for the second quarter and the remainder of the year. Following their remarks, we'll open the phone lines for a question-and-answer session. +As a reminder, we're joined on this conference call by investors and others who are listening to our comments via webcast. Following this conference call, John and I will be available throughout the day to answer any follow-up questions you may have. +Also, as a reminder, any forward-looking statements that we make this morning are subject to risks and uncertainties, the most important of which are described in our SEC filings. Also, in these remarks, we refer to adjusted earnings per share, which is a non-GAAP financial measure, and return on invested capital, which is a ratio based on GAAP information with the exception of adjustments made to capitalized operating leases. Reconciliations to our GAAP EPS and to our GAAP total rent expense are included in this morning's press release posted on our investor relations website. +With that I'll turn it over to Brian for his perspective on our first-quarter performance. Brian? + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman and CEO [3] +-------------------------------------------------------------------------------- + + Thanks, John, and good morning to all of you. We're very pleased with our first-quarter financial results which we announced earlier this morning. Our first-quarter adjusted EPS of $1.10 is 19.6% higher than last year and $0.05 better than the high end of the range we provided at the beginning of the quarter. Comp sales increased 2.3% in the quarter, a bit ahead of our expectations. This increase was driven by a healthy balance of growth in both traffic and average ticket. +First-quarter digital sales increased 38% over last year driven by higher traffic and a substantial increase in conversion. Digital growth contributed 80 basis points to our comp sales increase in the first quarter. +While we enjoyed a healthy pace of sales throughout the first quarter, we saw particularly strong results in March as weather warmed across many parts of the country and Easter timing moved seasonal sales into the month. In April, we were thrilled with the overwhelming demand for items from our collaboration with Lilly Pulitzer with most of the collection selling out in the first few days. +We were disappointed however that our digital channels were not able to properly accommodate the surge in traffic at the time of the launch, and the team is working to address root causes and learn from the experience as we prepare for holiday season peak later this year. +The first quarter saw a meaningful increase in our gross margin rate, as we cycled over a promotional first quarter 2014 and we benefited from very strong mix of sales in our signature categories this year, both in stores and online. First-quarter comp sales in signature categories grew more than twice as fast as our comparable sales overall. And mix in our digital channels was even stronger. +Specifically, about two-thirds of our first-quarter digital sales increase was driven by growth in home and apparel. Kathee will provide more detail on category performance in a few minutes. Once again, our stores did a great job controlling costs this quarter, while outside of the stores we continue to move to a leaner, more agile way of working. +During the first quarter we recorded restructuring charges related to headcount reductions at our headquarters. While these reductions were very difficult for all of us, I strongly believe they were a necessary step to remove roadblocks which were preventing us from moving more quickly and responsively to the guest needs. I want to thank the team for their perseverance during this time of significant transition. I continue to admire the energy they bring to work every single day. +As you know, we are committed to returning cash to our shareholders through both dividends and share repurchase over time. And I'm very pleased that this quarter we began returning cash through share repurchase for the first time in nearly two years. This change reflects the improving health of our US business along with the cash flow benefit of our fourth-quarter decision to discontinue operations in Canada. +For several quarters now, I've been talking about the five priorities we are focused on as a leadership team. Becoming a leader in delivering shopping on demand for our guests. Establishing clear roles in our merchandising categories with particular focus on growing our signature categories, style, baby, kids and wellness. +Developing capabilities to become more localized in our store experience and more personalized in our digital interaction with guests. Continuing to develop and test urban formats like City Target and Target Express. And finally transforming the way we work to create capacity to invest appropriately in the growth initiatives I've just described. +I strongly believe if we make progress on these five priorities over the next few years, Target will deliver outstanding financial results and become an even stronger retailer. While we're at the early stages, I'm encouraged with signs of progress on these efforts. Specifically, our strong mix of first-quarter sales in signature categories demonstrates the value of the work to define category roles. +We continue to rollout upgraded fixtures in apparel, beauty, baby and home while investing in wellness with programs like Made to Matter. Our buying teams are focused on delivering enhanced newness, quality and value to our guests, and we're communicating this renewed focus in both traditional and digital channels. +Our digital sales growth of nearly 40% on top of 30% growth a year ago shows that we have a meaningful opportunity to generate comp sales growth through investments in digital channels. And following our March headcount reductions at headquarters, our teams are taking a fresh look at everything we do and taking steps to remove approval layers and increase the speed of decision-making. While there will certainly be a meaningful adjustment process, I believe we will emerge with an agile and engaged team that is equipped and empowered to act quickly on behalf of the guests. +These signs of progress are meaningful to the team and they demonstrate the value of our efforts and validate our strategic priorities. Yet as we look ahead, we realize we're on a much longer journey and need to accomplish many more things. Specifically, we're in the very early stages of our work on localization and personalization. In the future, these efforts should benefit both sales and gross margin rate. +And while we're still in the testing phase, we're very encouraged by the progress in evaluating and rolling out urban formats like City Target and Target Express. We opened two new Express locations in the San Francisco market this quarter, both of which are quite different from our first location in the Minneapolis market. We expect to open six more locations this year in a variety of markets and demographic areas, to continue to learn how to operate this new format in a diverse array of sizes and settings. +Finally, we are just beginning to reinvent our food assortment and presentation. We have an opportunity to drive more traffic in sales in this critical area of the store by becoming more specialized in our assortment, more focused on healthy options in support of wellness. We're testing potential assortment and presentation options. And this year we plan to study the guest response to potential changes before determining what we'll rollout more extensively next year. +While this quarters' results are encouraging, we're focused on the work ahead of us as we transform ourselves to become a truly modern retailer and more relevant to our guests. We're taking the necessary steps both in our investment decisions and the way we work to position Target for continued profitable growth in the years ahead. The momentum we've seen so far makes us more confident than ever that we're moving in the right direction and encourages us to move even faster. +Yet we know that long-term success depends on achieving the right balance between speed and the time it takes to confirm we're making the right changes that we can execute at scale. Once we have that confirmation, we're committed to moving forward both quickly and confidently and becoming the retailer our guests want Target to be. Now I'll turn it over to Kathee to recap our first-quarter results and plans going forward. + +-------------------------------------------------------------------------------- +Kathee Tesija, Target Corporation - Chief Merchandising and Supply Chain Officer [4] +-------------------------------------------------------------------------------- + + Thanks, Brian. In the first quarter, we saw encouraging trends across many dimensions of our business including traffic, sales, merchandise mix, mark down rates, digital channel growth and overall profitability. +Within our sales, our results reflect our continued focus on growing signature categories. Beauty had another outstanding quarter and delivered more than a 5% comp, but apparel and home were right behind with a mid 4% comp. Given weather trends and Easter timing, apparel comps peaked in March but were strong throughout the quarter. +Among the drivers was swim where we saw better than expected results across the board in women's, mens and kids. In ready-to-wear we saw particular strength in Merona, and our new plus size brand Ava & Viv. And while it's small relative to the quarter, the response to the Lilly Pulitzer partnership was the icing on the cake as more than 90% of the apparel items sold out the first day. +Across the rest of our assortment, food comps were just below the Company average and hard lines experienced a mid single-digit comp decline reflecting a very tough comparison to last year when we saw particularly strong sales from Disney's Frozen and elevated promotions drove sales in electronics. +As Brian mentioned, first-quarter comparable sales were driven by a healthy combination of growth in both traffic and average ticket. Within average ticket, an increase in average retail was partially offset by a decline in units per transaction. This decline in average units was driven by category mix, particularly apparel, along with channel mix as digital transactions typically have fewer units at higher average retail. +Besides channel mix, growth in average retail was driven by a lower level of promotional activity this year and a trend in which our guests are trading up to higher quality and premium branded items. We were really pleased with the pace of digital channel sales growth this quarter and even happier that it was driven by home and apparel. But our digital goals are ambitious and we have a lot more work to do, so we're continuing to invest in and rollout new initiatives to maintain our momentum. +The February launch of a lower $25 free shipping threshold drove a meaningful increase in conversion this quarter, and guests continue to embrace store pick up, which was up more than 100% from a year ago. Subscriptions are also growing rapidly. Sales on subscription grew 32% between the fourth quarter and the first quarter and the active subscriber base grew 20% within the first quarter. +And we continue to see great results from our ship from store capability which delivers shipping savings for us and reduced delivery times for our guests. And we expect to rollout this capability to more than 200 additional stores this Fall. +As I mentioned in the last call, we were very happy to see the West Coast port situation resolved, yet we knew it would take a few months for the shipping backlog to be completely relieved. As of today, I am pleased to say that those delays are fully behind us. +Consistent with our fourth-quarter experience, the team did a great job in the first quarter working around port-related issues by pre-ordering inventory and rerouting shipments. However, despite these efforts, some categories including shoes, saw spotty in stocks in the quarter and saw sales accelerate as receipts began to flow and in stocks recovered. +As we look ahead, we are working to build on our current momentum in the second quarter and beyond. In apparel, beyond swim, we've been seeing encouraging trends in shorts, dresses, tanks and sandals and expect these businesses to be a key driver of second-quarter sales. +In jewelry and accessories, this morning we announced a new limited time partnership, Eddie Borgo for Target, which launches -- that launches July 12. Eddie has crafted a first of its kind limited edition collection of customizable jewelry, accessories and wall art featuring the designer's signature aesthetic and on trend colors and finishes. +In Home we're seeing great momentum in our table top business and will expand the offering this quarter with a broader selection of both indoor and outdoor options for summer entertaining. We're also excited about our programs which will launch in July featuring more exclusive content from licensed and exclusive brands and do-it-yourself programs which will allow students to decorate their own journals, notebooks and lockers. +In wellness we continue to see amazing results from the Made to Matter collection, since the announcement of this collection, featured brands are running up 25% to last year and the collection is on track to record $1 billion in sales this year. +And in kids we have a blockbuster set of licensed programs planned for the second quarter and beyond. In stores now, we're offering about 150 items from the new Avengers movie including many that are exclusive to Target. To support the release, we've created an Omnichannel marketing campaign that includes social media engagement and a uniquely creative stop motion broadcast spot that brings the actual 12-inch action figures to life. +Also this Summer, looks for exclusive items across multiple categories in celebration of the June release of Jurassic World and the July release of Minions. On target.com we've expanded our licensed offering by creating experiences for our top 29 licenses. Each of these experiences includes favorite items that we carry in both channels plus expanded -- extended assortments that include collectibles, more apparel choices and hard to find toys. We will continue to rollout experiences to more of our favorite characters throughout the year. +To celebrate the 65th anniversary of the iconic comic strip Peanuts we're rolling out a summer collection of more than 100 exclusive products. These items are the work of our own product design and development team who partnered with current Peanuts cartoonists and the Charles M. Schulz Museum to design fresh, fun items that are true to the comic strip's roots. We'll rollout more exclusive items across multiple categories throughout the year leading up to the release of the new Peanuts feature film in November. +And finally, like moviegoers, we're already excited about the December movie release from the most famous license of them all, Star Wars. Earlier this month, as part of the worldwide May the Fourth Be With You event, we allowed Darth Vader and Yoda to take over the target.com homepage offering special online only deals on Star Wars licensed product. We'll provide more details on our next earnings call, but for now I can assure you that Star Wars fans will find plenty of reasons to visit our stores and target.com this year. +As we've said many times, we're encouraged by our progress but recognize that we are only at the beginning of a multi-year journey to transform our business. We continue to rollout new store fixtures to enhance the shopping experience in apparel, baby, electronics and home. +And we're working quickly to develop and test ideas to reinvent our food area to become more specialized, and more clearly embrace wellness with local products, naturals, organics and clean labels. And we continue to invest in our technology and supply chain capabilities to allow our guests to shop on demand and receive products where and when they want. +The good news is that even though we have much more to do, the positive guest response to what we've already accomplished makes us confident we are moving in the right direction. Now, I'll turn it over to John who will share his insights on our first-quarter financial performance and our outlook for the second quarter and beyond. + +-------------------------------------------------------------------------------- +John Mulligan, Target Corporation - CFO [5] +-------------------------------------------------------------------------------- + + Thanks, Kathee. Our first-quarter financial results were stronger than expected driven by better than expected sales performance, particularly in our signature categories. Adjusted EPS of $1.10 was $0.05 above the high end of the guidance range provided at the beginning of the quarter. +First quarter diluted EPS from continuing operations of $1.01, about $0.09 lower than adjusted EPS driven primarily by pretax restructuring costs of $103 million combined with small adjustments for breach related expenses and the favorable resolution of income tax matters. First quarter GAAP EPS is of $0.98 included a $0.03 loss on discontinued Canadian operations compared with a $0.24 loss on Canadian operations in the first quarter 2014. +Our first-quarter comparable sales increase of 2.3% was just ahead of the guidance of 2% we provided at the beginning of the quarter. We are pleased with the sales results throughout the quarter but they were particularly strong in March as weather warmed and Easter timing moved seasonal sales into the month. Comparable sales growth for March and April combined, which eliminates the effect of Easter timing, was stronger than we experienced in February. +Digital channel sales increased 38% in the first quarter on top of more than 30% growth in the first quarter last year. Digital channels drove about 80 basis points of our first-quarter comparable sales increase, in line with our fourth-quarter experience. Comparable transactions were up both in the store and digital channels accounting for approximately 90 basis points of our comp increase. +REDcard penetration of 21.5% was about 110 basis points ahead of last year, in line with our expectations. This growth is faster than our fourth-quarter pace and consistent with new account growth in the latter half of 2014. +Risk levels on the portfolio continue to run at historically low levels and this quarter we saw an increase in payment rates. This increase is consistent with commentary from others and potentially explains what consumers are choosing to do with some of their savings from lower gas prices. +One other note. We've now begun piloting acceptance of chip transactions at our stores, as the entire US payment industry prepares to move to chip technology later in the year. +Our first-quarter segment EBITDA margin rate of 10.5% was stronger than expected driven by an unexpectedly strong gross margin rate. Specifically, our first-quarter gross margin rate of 30.4% was nearly a percentage point higher than a year ago. This rate -- this year's rate benefited from lower mark downs as we analyzed last --annualized the last year's promotional activity following the data breach. +And we saw a very favorable mix of sales in our signature category. In fact, the last two quarters are the only two in recent history in which sales mix has been a positive contributor to our overall gross margin rate. This shows the value of our focus on driving growth in our signature category. This quarter, we grew sales and traffic while replacing promotionally-driven sales on lower margin items with higher margin sales in signature categories and the benefit to our P&L was compelling. +On the SG&A expense line, this quarter we benefited from productivity improvements in the stores and overall leverage of paying benefits, partially offset by higher technology expense compared with a year ago. Altogether, our first-quarter segment SG&A expense rate improved about 20 basis points compared with last year. +Before I leave our segment discussion, I want to comment on our inventory position at the end of the quarter, which was about 9% higher than a year ago. This increase was intentional and reflects some decisions we've discussed in the past calls. First, beginning last Summer we increased our inventory commitment in commodity categories to support in stocks in these frequency driving businesses. +And second, our receipts this quarter reflected some pre-buying of imported product that the team had undertaken to mitigate risk before the West Coast port slowdown had been resolved. Looking ahead, we continue to feel very good about our overall inventory level and we expect year-over-year growth to moderate in the second quarter and beyond. +Moving to consolidated metrics, first-quarter interest expense was essentially flat to last year and we'll return $333 million to shareholders in the form of dividends in the first quarter, an increase of 22% over last year. As we mentioned during the last call, the improvements in our business results and cash balance have positioned us to once again return cash through share repurchase within the limits of our capital structure goals. +As a result, this quarter we bought back shares for the first time since the second quarter of 2013, investing $297 million in open market repurchases and another $265 million through an accelerated share repurchase agreement late in the quarter. This means that in the quarter, we returned over 140% of our net income through dividends and share repurchase. +Given our current cash position, and continued strong cash generation by our business, we expect to continue to repurchase shares in the second quarter and beyond and believe we will have the capacity to retire $2 billion or more of our shares in this fiscal year, within the limits of our current investment grade credit ratings. +One note, we ended the quarter with about $1.2 billion remaining on our current share repurchase authorization, meaning that if this activity continues as expected, we would exhaust the current authorization later this year. As a result we will be reviewing with our Board the need to increase our share repurchase authorization at an upcoming meeting. +Before I turn to our outlook, I want to pause and discuss our decision to begin reporting after-tax return on invested capital from continuing operations, or ROIC, in this quarter's earnings press release. As you know from our previous discussions and the long term performance incentives described in our proxy statement, we believe ROIC is an important metric to measure the quality of our capital allocation decisions over time. +Also as you know, we presented our long-term aspirations for this metric during our financial community meeting in March. Specifically, we intend to reach the mid teens or higher on this metric over the next five years. Beginning this quarter, we report how we have performed on this metric for the most recent trailing 12 months, providing clarity on how we are measuring our own performance while allowing everyone to track our progress. +To provide additional context, we're posting the last two years of quarterly calculations of this metric on our investor relations website in the summary financials section. With that back drop, this morning we reported that for the trailing 12 months through first quarter 2015, our after-tax return on invested capital was 12.5%, up about 60 basis points from a year before reflecting improved profitability on a relatively stable base of invested capital in our continuing operations. +Now let's move to our outlook for the second quarter and the remainder of the year. In the second quarter, we expect our comparable sales to increase between 2% and 2.5% reflecting expected growth in digital channel sales in the high 30% range. Both of these expectations are similar to our first quarter performance. And while it is still early, our results through the first few weeks of the second quarter are consistent with that forecast. +We expect our second quarter gross margin rate to improve about 50 basis points from last year as we benefit from the comparison to last year's promotional activity while we continue to make price investments and add quality back into our owned and exclusive brand products. +On the SG&A expense line, we expect our second quarter rate will be 20 to 30 basis points higher than a year ago, as the rate benefit from productivity improvement is expected to be offset by a planned year-over-year increase in compensation expense. You'll recall that compensation expense was unusually low in the second quarter last year as we significantly reduced our accrual for full-year incentive compensation in light of softening financial performance. +Combining our gross margin and expense rate expectations, we're looking for improvement in our second-quarter EBITDA and EBIT margin rates of 20 to 30 basis points compared with last year. Second-quarter interest expense is expected to be about $150 million well below last year which is unusually -- which was unusually high due to the retirement of some high coupon debt. +Our effective tax rate is expected to be just over 35%, higher than last year's 33.7% rate driven by improved profitability. Altogether, these expectations would lead to second-quarter adjusted EPS representing results of continuing operations in our single segment business of $1.04 to $1.14 compared with $1.01 a year ago. +While we've seen a strong start to the year so far, it is early and we have a lot more to accomplish as the year progresses. However, our first-quarter performance validates that we are focused on the right strategic priorities to propel our business forward and it certainly adds to our confidence that we can deliver on our guidance for the year. As a result, we've taken a lower end of our prior full-year guidance up by $0.05 and now expect full-year adjusted EPS from continuing operations of $4.50 to $4.65. With that, we'll conclude today's prepared remarks. Now Brian, Kathee and I will be happy to respond to your questions. + + +================================================================================ +Questions and Answers +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) +Your first question will come from the line of Oliver Chen with Cowen and Company. + +-------------------------------------------------------------------------------- +Oliver Chen, Cowen and Company - Analyst [2] +-------------------------------------------------------------------------------- + + Hi, congratulations on really solid results. We're very pleased to hear about all of the progress. Regarding the comp in the back half, should we think about traffic as the main opportunity or would you feel like ticket will also be an opportunity? And as we think about gross margin and your product assortment, how are you balancing the idea of investing in price versus the innovation that you're conducting in your signature categories? + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman and CEO [3] +-------------------------------------------------------------------------------- + + Oliver, good morning, and thanks for joining us today. As we think about the balance of the year, I would ask you to think about three important variables and you saw those come to life in the first quarter. We're clearly focused on driving traffic to our stores and we expect that to be a very important driver of our growth over the balance of the year. But you're also seeing the benefit of our focus on signature categories and the higher ticket that that generates. +But importantly the third element is the increasingly important contribution we're seeing from our digital and online businesses. So as we go forward, we're going to continue to make sure we're seeing growth in traffic, growth in our signature categories that leads to that gross margin rate improvement we saw in first quarter and the higher ticket, but importantly, the ongoing contribution of our online channel. + +-------------------------------------------------------------------------------- +Oliver Chen, Cowen and Company - Analyst [4] +-------------------------------------------------------------------------------- + + Brian, you've been very agile with strategic decisions around the online and digital business. As we look forward to back-to-school and holiday, are there any key pointers in terms of the strategies you're undertaking, particularly as mobile and shipping continue to be hot topics? + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman and CEO [5] +-------------------------------------------------------------------------------- + + Oliver, you heard Kathee talk about some of the key initiatives that came to life in the first quarter and you're going to continue to see us build off of that over the balance of the year. We've completely rebuilt our app. We're focused on improving our subscription and registry. +We're leveraging our stores to shift to our guests. So we're going to continue to build on those initiatives as we go forward and continue to make sure that we're making the investments both in technology but importantly in the supply chain that brings that online business to light for our guests. + +-------------------------------------------------------------------------------- +Kathee Tesija, Target Corporation - Chief Merchandising and Supply Chain Officer [6] +-------------------------------------------------------------------------------- + + And, Oliver, if we can go back for a minute to your question on thinking about price versus innovation and how do we balance those. I would just say that we start from the guest, looking at what it is that they expect from any given product category and then how do we build the very best product? Which is, depending on what it is, could be a combination of both price and innovation or more heavily leaning on one or the other, depending on what we're talking about. +But very much guest focused to make sure that we're offering them the content that's going to inspire them and resonate. So there's not one size fits all. It's really guest-focused driven by each category. + +-------------------------------------------------------------------------------- +Oliver Chen, Cowen and Company - Analyst [7] +-------------------------------------------------------------------------------- + + Thank you, congrats. And that was very clear on Lilly Pulitzer, congrats on that as well. Best regards. + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman and CEO [8] +-------------------------------------------------------------------------------- + + Oliver, thank you, appreciate it. + +-------------------------------------------------------------------------------- +Operator [9] +-------------------------------------------------------------------------------- + + Your next question will come from the line of Matt Nemer with Wells Fargo Securities. + +-------------------------------------------------------------------------------- +Matt Nemer, Wells Fargo Securities, LLC - Analyst [10] +-------------------------------------------------------------------------------- + + Good morning, and I'll add my congrats as well. My first question is on gross margin. Does the gross margin guidance assume a continued mix shift to the signature categories that you enjoyed this quarter? And is the formula for Q2 in terms of price and quality investments what we should be thinking going forward, i.e., you were down about [100] last year and you recapture about half according to your guidance, does that seem like a reasonable formula for Q3 as well? + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman and CEO [11] +-------------------------------------------------------------------------------- + + Let me start with the gross margin and the focus for not only the quarter but for many years to come. And we've been very clear about the importance of focusing in on our signature categories. We believe that's our path to differentiating the brand. So you should continue to expect us to focus on building our style categories. And Kathee and her team are making great progress in apparel and home and beauty. And you saw the comps that those categories produced in the first quarter. +We'll continue to focus on baby and kids and accelerate our focus on wellness. So we believe those categories both in store, but importantly as we demonstrated in Q1 online, where a significant portion of our growth in the digital channel was driven by apparel and home. So that is a very favorable impact to mix, both in store and importantly as we improve and accelerate our online performance. + +-------------------------------------------------------------------------------- +John Mulligan, Target Corporation - CFO [12] +-------------------------------------------------------------------------------- + + The other thing I'd add, Matt, is more tactically between Q2 and Q3, that's really last year where you saw us transition from focusing on significant promotions that were primarily hard lines or some of our lower margin categories' focus to the business, back to back-to-school and then into the holiday season. +So as we think about the way Q2 looks versus Q3, where that promotional impact was real in Q2 but it was also we had a significant mix impact because of where we focused those promotions. Little bit less of that as we go into Q3 and Q4. So the delta between last year's margin and this year's margin will change meaningfully. And as Kathee said, we continue to invest in price and quality across all of our brands. + +-------------------------------------------------------------------------------- +Matt Nemer, Wells Fargo Securities, LLC - Analyst [13] +-------------------------------------------------------------------------------- + + That's very helpful. If I could ask one follow-up on the eCommerce business. I'd love to get your insights, perhaps using REDcard data, in terms of how much digital growth do you think at this point is incremental, i.e., are these new customers or infrequent customers? Thanks. + +-------------------------------------------------------------------------------- +John Mulligan, Target Corporation - CFO [14] +-------------------------------------------------------------------------------- + + I think, Matt, I would answer it broadly and say that what we see across all guests is when they become engaged in the digital channel, we see incremental growth in that channel and, importantly, incremental growth in the stores. So their total engagement with us is very incremental, we pick up incremental sales and importantly incremental profitability in both channels. + +-------------------------------------------------------------------------------- +Matt Nemer, Wells Fargo Securities, LLC - Analyst [15] +-------------------------------------------------------------------------------- + + Okay. Thanks, John. + +-------------------------------------------------------------------------------- +Operator [16] +-------------------------------------------------------------------------------- + + Your next question will come from the line of Scott Mushkin with Wolfe Research. + +-------------------------------------------------------------------------------- +Scott Mushkin, Wolfe Research - Analyst [17] +-------------------------------------------------------------------------------- + + Wanted to get into a topic of traffic. I think traffic was up second quarter in a row that it's been up. I was wondering if you could maybe dig a little deeper into that? Someone in the grocery space talks about loyal households and it seems to me when you think about Target, you guys want to build frequency and you want to build these loyal households. How are you thinking about that? Do you measure that? Is that measure improving? Some of our research suggests some of the early things you guys are doing should be building this number, but I wanted to get your take on it. + +-------------------------------------------------------------------------------- +Kathee Tesija, Target Corporation - Chief Merchandising and Supply Chain Officer [18] +-------------------------------------------------------------------------------- + + Yes, I would say that, Scott, it's pretty early in our transformation to say that we see momentum in that measure as it pertains to food. I will tell you a lot of our growth in transactions is driven by new guests and that's driven more in the signature categories that we have been talking about. Now we believe that we have an opportunity to drive traffic in food and that's why we're in the midst of putting a lot of tests out in front of our guests, both product and presentation, to get that business on track and to make sure that we've got a really compelling point of view for our guests. And then we will measure that over time to make sure that we're making progress. But today I would say it's more driven by the signature categories that we've highlighted. + +-------------------------------------------------------------------------------- +Scott Mushkin, Wolfe Research - Analyst [19] +-------------------------------------------------------------------------------- + + That was actually where I was going, not just food, just on the idea that I think your heavy users are up 25, 30 visits a year. Are you seeing increase in those types of loyal households? It seems to me that might be a key driver here as we go forward to get that frequency up. + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman and CEO [20] +-------------------------------------------------------------------------------- + + Scott, it's certainly something that we're going to continue to monitor and measure over time. It's still very early for us, but that is a measure that we're clearly looking at. We absolutely want to make sure we're building loyalty. We want to build engagement and traffic. +We believe our focus on signature categories brings guests back to Target looking for what's new, what's exciting. And we also want to make sure we complement that with an improved food assortment because we know food is critically important to building engagement and driving overall traffic. + +-------------------------------------------------------------------------------- +Scott Mushkin, Wolfe Research - Analyst [21] +-------------------------------------------------------------------------------- + + Perfect; and I had one other one. We obviously are in the stores quite a bit and I wanted to get your take, some of the pushback that we hear from investors is on the store level execution, staffing levels, in-stock position. I think people wish you maybe just could be a little bit better. And I was wondering what you think of that and are there initiatives to improve some of those measures? And where do you think you are, what inning do you think you are in on these areas? + +-------------------------------------------------------------------------------- +Kathee Tesija, Target Corporation - Chief Merchandising and Supply Chain Officer [22] +-------------------------------------------------------------------------------- + + I think as we would measure that and as we look at the guest feedback that we get, Scott, I would say store execution is very high. Guests are very satisfied with the number of people that we have, their ability to help them. I would say that we have an opportunity on the in-stock side and we've been working on that collectively, stores and merchandising, as we worked through the port situation and getting those back in stock. But also just our everyday basics. +And it's one of the reasons why our inventory is elevated, as we've talked about, is that we have been making investments, particularly in essentials category to make sure that we can raise our inventory levels appropriate to be in-stock in those categories. So I think that's where we have the most opportunity right now. + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman and CEO [23] +-------------------------------------------------------------------------------- + + And, Scott, that's reflected in the key initiatives we've been talking about. As we think about changes we're making in experience to elevate apparel with mannequins, to restructure our home layouts, to begin to make changes in electronics. We want to make sure we provide the guest with a great in-store experience particularly in those signature categories. +But as Kathee just noted, we also need to make sure we're focused on the basics every day. And we need to make sure we've got very high in-stock conditions, particularly in those key consumable categories. So for us, execution at store level is critically important. We believe we have the best team in retail and our focus now is on elevating the experience in those key signature areas of our store and ensuring that we're improving the in-stock conditions for basic essentials. + +-------------------------------------------------------------------------------- +Scott Mushkin, Wolfe Research - Analyst [24] +-------------------------------------------------------------------------------- + + Perfect, our focus group of women was really pleased, so keep up the great work. Thanks. + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman and CEO [25] +-------------------------------------------------------------------------------- + + Thanks, Scott. Appreciate the support. + +-------------------------------------------------------------------------------- +Operator [26] +-------------------------------------------------------------------------------- + + Your next question will come from the line of Robbie Ohmes with Bank of America Merrill Lynch. + +-------------------------------------------------------------------------------- +Robbie Ohmes, BofA Merrill Lynch - Analyst [27] +-------------------------------------------------------------------------------- + + I think maybe for Kathee, the comment you just made to Scott Mushkin about a lot of the growth in transactions being driven by new guests, can you give us a little more insight to that? Is that a shift in traffic away from frequency and towards new guests and how significant is that and is there -- how are you doing it? Is it -- are there some new marketing approaches you're taking to get people into the stores to alert them about the signature categories, et cetera? Some color on that would be great. + +-------------------------------------------------------------------------------- +Kathee Tesija, Target Corporation - Chief Merchandising and Supply Chain Officer [28] +-------------------------------------------------------------------------------- + + Yes, so this is something that we aim to do all the time and of course right now we're comping against some pretty weak numbers post breach last year, so certainly that's part of it. As we focus on signature categories, I do think that's getting more new guests back into the brands and in a variety of different areas because signature categories cover so much from beauty to home, et cetera, to the different style categories. +And I think the way that we're doing it is really what Brian was just talking about, presentations that are really compelling with product that's very inspirational. And inviting them into the store through our marketing, which resonates with them. And then when they get to the store or online, being able to convert them to a purchase. So it's all of those things that I think are moving the needle. + +-------------------------------------------------------------------------------- +Robbie Ohmes, BofA Merrill Lynch - Analyst [29] +-------------------------------------------------------------------------------- + + Kathee, can you comment more on the propensity to trade up for the guest? Is it -- is there something changing there or was that just easy comparisons? + +-------------------------------------------------------------------------------- +Kathee Tesija, Target Corporation - Chief Merchandising and Supply Chain Officer [30] +-------------------------------------------------------------------------------- + + No, we've seen this coming for a little bit now. Third quarter was the start of it, continued into fourth quarter and now again in our first quarter. But I think as we're improving quality, as we're stepping up our assortments to be more aspirational, we're seeing the guest really resonate with that product and move. And that's broad across virtually all of our categories. So not just in one segment of our business but really all of them. +So I think it's driven by the guest perhaps having a bit more money in their pocket. I think it's the quality that we've put in, they're recognizing those benefits and they're wanting to be able to trade up. + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman and CEO [31] +-------------------------------------------------------------------------------- + + Robbie, the one point I'd emphasize so that we're really clear, this isn't an either/or, it's an and. So we want to make sure we're delivering exceptional value every day on those core essentials and continuing to bring great quality, newness, innovation and value to our guests as they look for these more aspirational items. So it's not a shift in strategy and it's not a either/or, it's an and. +And we've got to make sure that both elements of our strategy include a focus on core essentials and more experiential offerings. And when we bring those together, that is the Target brand promise and experience. That's where we bring expect more, pay less to life. So both of those elements are starting to work together and I think you're seeing the guests respond very positively to it. + +-------------------------------------------------------------------------------- +Robbie Ohmes, BofA Merrill Lynch - Analyst [32] +-------------------------------------------------------------------------------- + + Sounds great. Thanks very much. + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman and CEO [33] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Operator [34] +-------------------------------------------------------------------------------- + + Your next question will come from the line of Sean Naughton with Piper Jaffray. + +-------------------------------------------------------------------------------- +Sean Naughton, Piper Jaffray & Co. - Analyst [35] +-------------------------------------------------------------------------------- + + I guess a regional question, in terms of the comp on a regional basis in the first quarter, did you see any differences in your sales trends in states that are potentially a little more dependent on oil and gas? And then the follow-up there is can you also address any negative or potentially positive impact on the organization you see in areas that are increasing the minimum wage? + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman and CEO [36] +-------------------------------------------------------------------------------- + + Let me start with the regional performance trends, and we didn't see any correlation between what you just referred to, changes in the oil and gas industry, and an influence on our comps. Obviously, like everyone else, and this happens every single year, weather did impact regional performance. We had some challenging days in the Northeast. We faced the same ice storms that others did in the Southeast and in the Texas market. +But overall, we saw very consistent comp performance across signature categories. The growth Kathee talked about was strong across the country in apparel and beauty and home. And we've seen very consistent performance trends and responses from our guests across the country. + +-------------------------------------------------------------------------------- +John Mulligan, Target Corporation - CFO [37] +-------------------------------------------------------------------------------- + + And to the minimum-wage question, no, we haven't seen those types of impacts either. + +-------------------------------------------------------------------------------- +Sean Naughton, Piper Jaffray & Co. - Analyst [38] +-------------------------------------------------------------------------------- + + Okay. And then secondly it looks like REDcard, nice pickup, looks like on a sequential basis and year over year. Can you talk about where Management expectation is now on this particular product and where we think this could potentially go over the next two or three years here? Thanks. + +-------------------------------------------------------------------------------- +John Mulligan, Target Corporation - CFO [39] +-------------------------------------------------------------------------------- + + It's a great question, Robbie, and we're sorting through that. We wanted to get through annualizing past all of last year with the breach and the impact there. We're really pleased that we saw 110 basis points of penetration growth. We're seeing new accounts grow again, roughly split equally between credit and debit. +I think as we learn a little bit more here as we get through this year, we'll figure out where we want to go. We still are very energized by REDcard as a product offering. I think the opportunity for us is to tie that into a more holistic loyalty offering for our guests. We're testing some of that now out East, and you'll see us, as the year goes on, continue to test that, take those learnings and apply it more broadly to loyalty for our guests. + +-------------------------------------------------------------------------------- +Sean Naughton, Piper Jaffray & Co. - Analyst [40] +-------------------------------------------------------------------------------- + + That's helpful. Best of luck in Q2; thanks. + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman and CEO [41] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Operator [42] +-------------------------------------------------------------------------------- + + Your next question will come from the line of Greg Melich with Evercore ISI. + +-------------------------------------------------------------------------------- +Greg Melich, Evercore ISI - Analyst [43] +-------------------------------------------------------------------------------- + + A couple questions. I wanted to make sure I understood the SG&A progression a little bit better. I think, John, in the guidance you said we would delever 20 to 30 bps in the second quarter, which if I take your comp guide suggests it'll be up around 5% in dollar terms. Is that -- are we thinking about that right? And what's the real run rate once you get through some of these other timing issues and the breaches on SG&A dollars? + +-------------------------------------------------------------------------------- +John Mulligan, Target Corporation - CFO [44] +-------------------------------------------------------------------------------- + + Yes, I think -- yes, you're right and all of that increase is really incentive expense offset by, again, some productivity improvements. I think as the year progresses, we'll continue to see improvements in SG&A. +As we said throughout the year, as the year progresses, we'll continue to start to see the savings that we committed to, the $2 billion, $500 million of savings this year, about half in COGS, half in SG&A. In SG&A that will be offset somewhat by investments in technology. +So we should continue getting past the noise; as the year progresses we'll continue to see leverage probably similar to what you saw in Q1 as we get into Q3 and Q4. + +-------------------------------------------------------------------------------- +Greg Melich, Evercore ISI - Analyst [45] +-------------------------------------------------------------------------------- + + Okay; got that. And then, Brian, I think in your prepared discussion, you've mentioned some disappointment on digital execution, particularly around the Lilly launch. Could you give us a little more detail on what's being done to address those issues in terms of how the website actually works or supply chain? Will you ultimately invest more in fulfillment center capacity or just some actual actions to try and address that? Thanks. + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman and CEO [46] +-------------------------------------------------------------------------------- + + Greg, in some ways you've answered the question for me. And we've been very clear in the fact that we're going to make $1 billion investment in technology and supply chain to enhance those capabilities, to improve our capabilities, to make sure we're partnering up technology with the ability to provide the product effectively through our supply chain. +So the Lilly event, while a sensational event for the brand, and we're really proud that we were able to create a Black Friday-type event in the month of April with hundreds and thousands of our guests lining up waiting for that product. But online, we know we had some missteps and we're doing a deep dive, we're looking at root causes, and it's going to provide important learning for us as we get ready for the traffic we expect to generate during the holiday season. +But we are very committed to putting our capital behind improving technology capabilities and the supply chain requirements necessary to continue to grow that business at the accelerated rates we're delivering right now. + +-------------------------------------------------------------------------------- +Greg Melich, Evercore ISI - Analyst [47] +-------------------------------------------------------------------------------- + + When do you think you'll know the things you need to get done for holiday? Is that something you'll know now or was it something we'll learn in the fall? + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman and CEO [48] +-------------------------------------------------------------------------------- + + Well, this afternoon would be nice, but we are actively tearing apart the learning and clearly want to make sure that we have the diagnostics in place as soon as possible. And we're making the necessary adjustments and investments to enhance our overall digital experience. So this afternoon would not be soon enough and the team has an incredible sense of urgency to ensure that we have the right capabilities so that we're constantly meeting the needs of the guests. + +-------------------------------------------------------------------------------- +Kathee Tesija, Target Corporation - Chief Merchandising and Supply Chain Officer [49] +-------------------------------------------------------------------------------- + + And, Greg, I would just add that we're never done with that. So certainly we're learning from the Lilly event and we will put that into play as soon as possible. But as we're growing at the rate that we are and we're introducing new code all the time, we are never done. So this is an ongoing effort probably until the end of time. + +-------------------------------------------------------------------------------- +Greg Melich, Evercore ISI - Analyst [50] +-------------------------------------------------------------------------------- + + Good luck; thanks. + +-------------------------------------------------------------------------------- +Operator [51] +-------------------------------------------------------------------------------- + + Your next question will come from the line of Peter Benedict with Robert W. Baird. + +-------------------------------------------------------------------------------- +Peter Benedict, Robert W. Baird & Company, Inc. - Analyst [52] +-------------------------------------------------------------------------------- + + Hi, guys, couple questions. First on Made to Matter. Can you give us how many brands have been designated with that, what categories you're seeing being most impactful so far and what you're doing from a marketing standpoint to support them? + +-------------------------------------------------------------------------------- +Kathee Tesija, Target Corporation - Chief Merchandising and Supply Chain Officer [53] +-------------------------------------------------------------------------------- + + Yes, so Made to Matter has been a fantastic program for us, Peter, as you know. We went from about 15 vendors last year and we increased that to about 30, 31 vendors this year, and we're seeing about 25% lift in sales. So the guest is really loving the product that we're offering. +It's in a variety of categories. There's certainly food products, but there's beauty products, there's OTC, there's baby. All of them, though, are really driven by simpler, better-for-you product, whether that's in food with cleaner labels and organic, or whether that's in baby, where it's cotton and more natural materials. +But really great results and we marketed it most recently in the past month in what we call the rear seasonal area of our store where we brought all the products together for the first time and had really fantastic results. There was a marketing campaign that went along with that that really resonated with the guests and then the in-store presence helped make it easy for them to find when they came to the stores. + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman and CEO [54] +-------------------------------------------------------------------------------- + + Peter, I think the great part of the program is it's just another point of validation that when we understand what the guest is looking for and we deliver the right curated assortment, they respond really well. You know that we have over 25 million guests visit our stores every week. We know that 98% of our guests purchase natural or organic products. Thus we need to make sure we offer them the products and the selection they're looking for. +It doesn't mean that conventional products don't play a very important role going forward, but our guest has voted. We understand the guest better than ever before. And Kathee and her team are doing a sensational job of curating the right assortment and bringing the guests what they're looking for when they shop at Target. + +-------------------------------------------------------------------------------- +Peter Benedict, Robert W. Baird & Company, Inc. - Analyst [55] +-------------------------------------------------------------------------------- + + And that's helpful. Do you think, is 30 to 31 a good number that you guys think you'll stick with? Do you think you'll add additional vendors to that program over the next 12 months or rotate out some and keep the number at 30, 31? + +-------------------------------------------------------------------------------- +Kathee Tesija, Target Corporation - Chief Merchandising and Supply Chain Officer [56] +-------------------------------------------------------------------------------- + + I think that's a pretty good number. We're still evaluating the program. We launched the new vendors this spring, so we're still analyzing those results. But to Brian's point, the guests will guide that work. The important part about Made to Matter is that while these brands might be carried elsewhere, we have exclusive product with meaningful innovation within the program within Target, and that's what's really resonating with the guests. +They recognize those brands are at Target and they love to buy them. But they come looking for those new exclusive, really innovative products. So I think keeping the number at a reasonable amount so that we're sure that we can drive that right innovation, it's very much a partnership with us and these suppliers, so I think we're in the hunt with the right number. + +-------------------------------------------------------------------------------- +Peter Benedict, Robert W. Baird & Company, Inc. - Analyst [57] +-------------------------------------------------------------------------------- + + Okay, that's how we've definitely seen it in the stores as well. Quick one on the food repositioning. What should we -- in terms of the cadence this year in terms of testing things, what should we be looking at? Is there going to be space allocation changes, is it going to be just new brands? +And once you do decide what you're going to do, is it going to be an early 2016 rollout, something that could impact a lot of that year or is it something that would happen later in 2016? Thank you. + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman and CEO [58] +-------------------------------------------------------------------------------- + + Peter, Kathee and I have been talking about this for several months now. We're using 2015 to test and learn. Kathee's talked about key categories within food that we really think Target should stand for and we're looking very closely at how we evolve assortment and how we merchandise those categories going forward. But this is not about how fast we make the changes. We want to make sure we really have a chance to test, learn, get the feedback from the guest, iterate. +So then as we move into 2016 and beyond, we move forward with confidence. And with the confidence that the guest has guided us through the changes we're going to make. So we're clearly focused on it. The team is making very good progress. But we're in that test and learn and validate environment right now and you should expect to see much more unfold as we get into 2016. + +-------------------------------------------------------------------------------- +Kathee Tesija, Target Corporation - Chief Merchandising and Supply Chain Officer [59] +-------------------------------------------------------------------------------- + + The thing that I would add is, as we're going through the testing, as Brian mentioned, we're testing many different things, whether that's assortment changes that we're making, presentation changes that we're making, supply chain changes. Part of our testing is to try to isolate those tests so that we can get a good read. So there's not going to be one place that you can go to look at what does the new food innovation look like. We've got it all over the place. +And the other thing that I would add is you know that we just hired Anne Dament to run the Senior Vice President of Grocery and we're very excited about that. She's been on board now for about a month and brings us 19 years of experience in grocery and CPG. So she certainly is learning and onboarding into Target and bringing a wealth of knowledge from grocery, which will also impact what we put forth in terms of tests for the rest of the year. +But I think you can look to 2016, as we learn and prove out what's working with the guests, what's resonating, we will start rolling those in 2016, but don't expect a big bang on January 1. To Brian's point, this is really about getting it right and delighting the guest, not moving fast. + +-------------------------------------------------------------------------------- +Peter Benedict, Robert W. Baird & Company, Inc. - Analyst [60] +-------------------------------------------------------------------------------- + + Understood. Thanks, Kathee; thanks, Brian. + +-------------------------------------------------------------------------------- +Operator [61] +-------------------------------------------------------------------------------- + + Your next question will come from the line of Bob Drbul with Nomura. + +-------------------------------------------------------------------------------- +Bob Drbul, Nomura Securities Intl - Analyst [62] +-------------------------------------------------------------------------------- + + I had a couple questions. On the gross margin line, did shipping expense at all impact you with the move to $25? And how many REDcard holders are utilizing their cards for free shipping, so how do we think about that as eCommerce continues to grow? + +-------------------------------------------------------------------------------- +John Mulligan, Target Corporation - CFO [63] +-------------------------------------------------------------------------------- + + So certainly shipping expense went up when we moved to $25, but I would tell you not a material impact on the quarter. And net, net, as we've said, as that brings more guests online, they shop our store and so a net positive, as far as we're concerned, across the lifetime value of those guests. +I don't have the actual number of REDcard holders that use free shipping on the site, but I can tell you the penetration of free shipping due to REDcard on the site is very, very high. In general we have a very high percentage of our shipping that goes out free from the site. +We talked about this last year when we shipped to free -- switched to free shipping during the holiday season, and I think that is why, going back to what Brian said, the supply chain investments we make are incredibly important for our guests because they provide speed to market from their perspective. But they're incredibly important for us because they improve the economics of our online business meaningfully. + +-------------------------------------------------------------------------------- +Bob Drbul, Nomura Securities Intl - Analyst [64] +-------------------------------------------------------------------------------- + + And then -- thanks, and the second question I have is there's a lot of license initiatives that are coming over the next several quarters. When you think about the year-over-year impact on the business overall, are those gross margins accretive in terms of what they're trying to do or would they be lower margin? And how should we think about that as it relates to the mix and the gross margin overall? + +-------------------------------------------------------------------------------- +Kathee Tesija, Target Corporation - Chief Merchandising and Supply Chain Officer [65] +-------------------------------------------------------------------------------- + + A lot of that depends on the categories. I think the good part about licenses at Target is that our guests respond to them very broadly, so it isn't just a toy or a video game. For us, there's apparel involved, there's back-to-school products like backpacks and notebooks. So they have a pretty healthy margin mix, just given the breadth of category, and most of them fall into our signature categories. So we're very excited about the lineup of licenses and the fact that they start this summer and really go all fall. + +-------------------------------------------------------------------------------- +Bob Drbul, Nomura Securities Intl - Analyst [66] +-------------------------------------------------------------------------------- + + Great. Thank you very much. + +-------------------------------------------------------------------------------- +John Hulbert, Target Corporation - VP of IR [67] +-------------------------------------------------------------------------------- + + Okay, we have time for one more question. + +-------------------------------------------------------------------------------- +Operator [68] +-------------------------------------------------------------------------------- + + Your final question will come from the line of Christopher Horvers with JPMorgan. + +-------------------------------------------------------------------------------- +Christopher Horvers, JPMorgan - Analyst [69] +-------------------------------------------------------------------------------- + + So two quick ones. You originally guided the first-quarter gross margin up 40% to 50%, so was curious what came in better versus your expectations? Is it mix or was it the level of promotions lapping the level of promotions year over year? And then I have a follow-up. + +-------------------------------------------------------------------------------- +John Mulligan, Target Corporation - CFO [70] +-------------------------------------------------------------------------------- + + It was mix is what came in better and I think we see that in two ways. First of all, there's just the mix of selling those products. And then when we see strength in home and apparel, of course our sell-throughs go up and so we have less markdowns. And so the positive benefits of mix go on and on. + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman and CEO [71] +-------------------------------------------------------------------------------- + + I'd only add, Christopher, that again, we saw that mix benefit both in store and online, so the combination of those two channels working together clearly impacts and improves gross margin rate. + +-------------------------------------------------------------------------------- +Christopher Horvers, JPMorgan - Analyst [72] +-------------------------------------------------------------------------------- + + Understood. And so the outlook, and you mentioned this going forward, the outlook in the second quarter is predicated on recapturing both of those and then going on further in the year. It's really expectation that the signature categories out-comp more in the essential side? + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman and CEO [73] +-------------------------------------------------------------------------------- + + That is certainly core to our strategy as we go forward. And I think what you saw, what we saw in Q1, very solid performance. Kathee and her team did a terrific job of curating the right products, particularly in those signature categories for our guest. Despite some of the port challenges, our supply chain teams did an outstanding job of making sure we had inventory in place for the guests. +I was very pleased with our marketing program, and if you haven't seen the Target style campaign or some of the things we just did for Avengers, it's spectacular advertising and the guest is responding to it. And our store teams just did a phenomenal job throughout the quarter, despite port challenges and weather challenges of providing the guest with a good experience. And it added up to really solid results in Q1. +So we hope that continues. We're confident it's going to continue throughout the year. But we feel good about the progress, we know we've got a lot of work in front of us. But that combination of strong in-store and online growth in the first quarter gives us a lot of confidence that we're heading in the right direction. +So, Operator, that concludes our call today. I thank everybody for their participation and we look forward to talking to you next quarter. Thanks. + +-------------------------------------------------------------------------------- +Operator [74] +-------------------------------------------------------------------------------- + + This does conclude today's conference call. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/exam/original-files/Problem_2_3_Sample_full_transcripts/2015-Nov-18-TGT.N-140736694649-Transcript.txt b/exam/original-files/Problem_2_3_Sample_full_transcripts/2015-Nov-18-TGT.N-140736694649-Transcript.txt new file mode 100644 index 0000000..683c285 --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_full_transcripts/2015-Nov-18-TGT.N-140736694649-Transcript.txt @@ -0,0 +1,525 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q3 2015 Target Corp Earnings Call +11/18/2015 10:30 AM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * John Hulbert + Target Corporation - VP of IR + * John Mulligan + Target Corporation - COO + * Cathy Smith + Target Corporation - CFO + * Brian Cornell + Target Corporation - Chairman and CEO + +================================================================================ +Conference Call Participiants +================================================================================ + + * Bob Drbul + Nomura Securities Intl - Analyst + * David Schick + Stifel Nicolaus - Analyst + * Scott Mushkin + Wolfe Research - Analyst + * Kate McShane + Citigroup - Analyst + * Greg Melich + Evercore ISI - Analyst + * Matthew Fassler + Goldman Sachs - Analyst + * Matt Nemer + Wells Fargo Securities, LLC - Analyst + +================================================================================ +Presentation +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Ladies and gentlemen, thank you for standing by. Welcome to the Target Corporation third-quarter earnings release conference call. +(Operator Instructions) +As a reminder, this conference is being recorded, Wednesday, November 18, 2015. I would now like to turn the conference over to Mr. John Hulbert, Vice President, Investor Relations. Please go ahead, sir. + +-------------------------------------------------------------------------------- +John Hulbert, Target Corporation - VP of IR [2] +-------------------------------------------------------------------------------- + + Good morning, everyone, and thank you for joining us on our third-quarter 2015 earnings conference call. On the line with me today are Brian Cornell, Chairman and Chief Executive Officer; John Mulligan, Chief Operating Officer; and Cathy Smith, Chief Financial Officer. +This morning Brian will discuss our third-quarter performance, including results across our merchandise categories and plans for the fourth quarter and remainder of the year. Then John will throw in an update on our operations and priorities going forward. And finally Cathy will offer more detail on our third-quarter financial performance and discuss our outlook for the remainder of the year. Following their remarks we'll open the phone lines for a question-and-answer session. +As a reminder, we're joined on this conference call by investors and others who are listening to our comments via webcast. Following the call Cathy and I will be available to answer any follow-up questions you may have. +Also as a reminder, any forward-looking statements that we make this morning are subject to risks and uncertainties, the most important of which are described in our SEC filings. Also, in these remarks we refer to adjusted earnings per share, which is a non-GAAP financial measure, and return on invested capital, which is a ratio based on GAAP information with the exception of adjustments made to capitalize operating leases. Reconciliations to our GAAP EPS and to our GAAP total rent expense are included in this morning's press release, which is posted on our investor relations website. +With that, I'll turn it over to Brian for his perspective on our third-quarter performance. Brian? + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman and CEO [3] +-------------------------------------------------------------------------------- + + Thanks, John, and good morning, everyone. As we step back and look at our third-quarter results and our year-to-date performance, it's clear that our strategy is working and we're delivering on the financial commitments we laid out last March. Following an extended period of declines, traffic has turned positive over the last four quarters and has been accelerating on a two-year basis. Sales in signature categories have been growing much faster than our overall sales, and they are clearly exceeding industry benchmarks. +So while consumers continue to spend cautiously, we feel confident as we enter the holiday season. And we're focused on continuing to deliver on both our strategic priorities and our financial goals. +As we mentioned in our last conference call, our third-quarter plans were based on the knowledge that we are facing stronger prior-year comparisons than we had experienced earlier in the year. Now with the quarter behind us, I'm pleased to report that not only did we meet our forecast, we saw continued progress on our strategy. Specifically, two-year growth trends in comp sales, traffic, and signature category performances each accelerated in the third quarter following strong performance in the second quarter. +Our third-quarter adjusted EPS of $0.86 was 8.6% higher than last year and above the midpoint of our guidance range we provided at the beginning of the quarter. Third-quarter comparable sales were up 1.9%, also near the high end of our guidance and driven primarily by growth in traffic. We're really pleased that our guests are responding to the investments we're making in our assortment, presentation, and shopping experience. And we're focused on building on this year's traffic increases in both stores and our digital platforms in the quarters and years ahead. +Our third-quarter gross margin rate was down slightly to last year, reflecting the benefits of a favorable merchandising mix and the comparison over last year's intense promotional markdowns. These benefits were offset by reimbursement pressure in pharmacy combined with the impact of investments in quality and innovation on our own and exclusive brands. Third-quarter SG&A expenses were solid and in line with our expectation, as Kathy will cover in a few minutes. +We reported a very healthy after-tax return on invested capital of 13% this quarter, nearly 2 percentage points higher than a year ago as progress on our strategic priorities has driven improved profitability on a relatively stable basis of invested capital. Given this stable performance, we continue to have capacity to invest in our business while returning a compelling amount of cash to our shareholders. This quarter we will return well over $1 billion to a combination of dividends and share repurchases, bringing our total cash return to well over $3 billion so far this year. +Consistent with our guidance, our third-quarter comp sales increase was somewhat smaller than in the second quarter. From a category perspective the entire change of pace in sales was attributable to apparel and electronics. In apparel, third-quarter comp sales grew just under 3% compared with nearly 5% in the second quarter. This slowdown was correlated with warm weather in September followed by a reacceleration when somewhat cooler temperatures arrived in October. +In the electronics category, we saw a double-digit decline in the third-quarter comp sales. This performance reflects a comparison over last year's most intense electronic promotions, which occurred in August, and the continued softness in tablets consistent with industry trends. One standout in electronics was wearable devices, part of the signature wellness category, where we saw nearly 100% growth in comparable sales. +Another standout was our toy category, part of the signature kids business, which matched its second-quarter growth with another 12% comp sales increase this quarter. Beyond strength in licensed products, growth in toys was broad-based across multiple sub-categories including small dolls, Lego, action toys, and board games. We were also pleased with third-quarter results from seasonal programs, beginning with solid performance in back-to-school and back to college, all the way through Halloween when we saw very strong increases in costumes and decor and solid growth in candy. +And to show you why we're so excited about the upcoming Star Wars release, we had the number one market share in Star Wars when we launched it in our store back in September. Looking through the lens of our category roles, third-quarter comp sales growth was led by signature categories which grew more than 2.5 times as fast as our overall sales. And as I mentioned, given the tougher prior-year comparisons, our two-year stack comps in signature categories were stronger in the third quarter than either of the first two quarters of this year. +Beyond toys and wearable electronics, our third-quarter standouts within signature included baby and kids apparel, women's ready-to-wear, and wellness items and food. In food overall, for the first time this year third-quarter comp sales growth out-paced comp sales overall, as our work to reinvigorate this category is beginning to shape our performance. In key categories like yogurt, where we added premium and better for you brands, we saw high single-digit comps sales increase in the third quarter. +We saw similar comp increases in craft beer and wine, reflecting our work to enhance the assortment and bring locally relevant brands to our guests. Looking forward, we'll continue to enhance our food assortment with a focus on wellness, local relevance, and seasonally appropriate items. And following the holiday season, we'll begin testing changes to food shopping environments in a set of 25 remodels scheduled for the LA market along with a set of SuperTarget remodels scheduled for next year. +Digital sales increased 20% in the third quarter, contributing about 40 basis points to our comp sales increase. While significantly outpacing the industry, this performance was well below our expectation of 30% growth which we outlined in the last call. As we look at the drivers of this performance, it's clear the third quarter softness in electronics was particularly impactful online. And like our stores, digital sales growth in apparel was slower during much of the quarter correlating with the relatively warm weather across much of the country. +We know that our digital investments drive engagement and sales in all of our channels, and we're pleased that our third-quarter sales were near the high end of our expectation. However, we believe we have an opportunity to accelerate digital transactions by enhancing the experience on target.com. Beyond our efforts to streamline the guest experience on our site, our team is rolling out multiple initiatives that we expect to drive digital traffic and sales over time. +And once again this holiday season we expect to be offering free shipping on all digital orders. We're very pleased with the guest response to this offer a year ago, and we expect it to be a key differentiator for Target again this holiday season. +Regardless of where our guest demand is ultimately fulfilled, in a store or on a guest's front porch, we know the vast majority of our sales in all of our channels are digitally enabled. For example, our guests access our brand through a digital device both in advance of and during their trip to one of our stores. As a result, we don't think of digital as simply a selling channel, but a critical enabler of the shopping experience in all of our channels. +This has significant strategic implications both in terms of organizational structure and the way we reward our team. Since I arrived last year, we have been evolving our approach to focus first on our core guest and build a total Target assortment that best serves the needs and expectations of our guests. Only after we've determined the appropriate assortment do we plan on how to offer it to each of our selling channels. +Consider our efforts in signature categories. For more than a year now we've been investing in these categories with the expectation that they will grow most rapidly. And we've seen this play out in all of our channels. +In fact, even while our digital footprint remains relatively small, we're approaching $1 billion of annual sales in our home category, making us one of the leading digital retailers in this space. As we look ahead to the holidays, we are excited about our merchandising and marketing plans, and we believe we'll further differentiate Target during a critical retail season. In hardlines, toys has already turned in a terrific performance so far this year, and we expect this strength to continue throughout the fourth quarter when we typically generate half of our annual toy sales. +This year, more than 15% of our toy assortment is exclusive to Target, including the exclusive BB-8 droid from the upcoming Star Wars movie, which we expect to be a top seller. We're also bringing back our Kids' Wish List App, this year with enhanced features to make it easy and fun for family and friends to shop for the perfect gift for every kid in their life. Our gift catalog, featuring more than 700 items, was distributed to 40 million guests this year through direct mail, newspaper, and distribution in our stores. +On Cartwheel, we are seeing great results from our daily toy deal, which is featuring a different toy at 50% off every day through December 24. And finally, we're bringing everything together on our kids' gifting hub on target.com, which is designed to make shopping easy for parents and gift givers while creating a destination that's fun and inspirational for kids. +In electronics, we are excited to be one of the few retailers offering the Apple Watch in stores this season, and we expect this item to be a top gift item in wearable categories. Also in wearables, we partner with UNICEF to offer their Kids' Power Band, which increases kids to get more active and, based on the points they accumulate, improve the lives of kids around the world. We also expect drones to be a big hit this season, so we're featuring nearly 20 in store and about 4 times as many online. +We are planning for a big season in video games, a key gifting category, where hardware prices continue to moderate and software libraries continue to grow. And in entertainment, where we're very excited to be featuring a Target exclusive version of Adele's new 25 release that features three bonus tracks available only at Target. As we enter the holiday season, about 1,400 of our stores are featuring mannequins in apparel, which is about double the number we had a year ago. +Also this year we've enhanced the shopping experience by updating presentations in home and electronics in more than 200 additional stores for each group. So we feel great about the ability of our stores to showcase our assortment. And this year when our guests shop at Target for the holidays, they'll find an assortment focused on three key themes: entertaining, decorating, and gifting. +To support each of these themes, we've invested in quality and differentiation featuring real marble, hand carved wood, copper accents, and genuine leather. In fact, more than 20% of our holiday gifting items are handcrafted this year. +In food, we're highlighting exclusive brands and flavors, including Republic of Wine, our new exclusive brand which features unique discoveries from around the world. We're rolling out classic holiday and harvest flavors in Archer Farms. And we're offering exclusive indulgent seasonal flavors from great national brand partners with M&Ms, Hershey's, Dove, and Ghirardelli. +And finally, anticipation is building for Black Friday, which is just over a week away. Once again this year, we're opening our stores at 6 PM on Thanksgiving, and our team is already preparing to deliver a combination of great deals and a shopping experience that makes Target different from everyone else. +But we're committed to offering compelling savings, value beyond the traditional Black Friday event. Beginning this Sunday, we'll launch 10 Days of Deals on electronics, kitchenware, toys and more, which will run through Tuesday, December 1. This Sunday's weekly ad will also reveal special deals from our Black Friday presale, which takes place on Wednesday, November 25. +For our guests who prefer to shop digitally, all of our Black Friday deals will be offered on target.com. And finally, guests who spend $75 or more on Friday, November 27, will receive a voucher for 20% off on future purchases, redeemable from December 4 through the 13th. +Last March, in our meeting with the financial community we outlined our plan to grow profitably by focusing on a set of key enterprise priorities. And while we have much more work to do, we remain committed to that plan and are pleased with our progress so far. Through the first three quarters of 2015, we've successfully grown traffic, sales, and profits a bit faster than we originally expected by focusing on our core guests and providing them with differentiated assortment and the experience they expect and deserve. +But we're not slowing down because we see enormous opportunity still ahead of us. We're going to continue to focus on elevating the assortment, quality, and the presentation in our signature categories. Across every category, we'll differentiate Target's assortment by providing exclusive items from both our national branded partners, and one-of-a-kind items from our outstanding product design and development team. And while we're encouraged with the recent acceleration in food sales, we are still in the very early stages of our work to provide a unique assortment of fresh, local, and healthy items to our guests. +And finally, while I'm pleased that we've already made early progress in our efforts to improve our in-stock performance, I believe we've got a multi-year opportunity to improve our reliability, both in stores and in digital channels by modernizing the way we work and refocusing on retail fundamentals. +Now I'll turn the call over to John Mulligan, who will discuss his team's early efforts to improve operations as well as John's priorities going forward. John? + +-------------------------------------------------------------------------------- +John Mulligan, Target Corporation - COO [4] +-------------------------------------------------------------------------------- + + Thanks, Brian. Good morning, everyone. Today I'm going to provide an update on our initial efforts to reinforce our retail fundamentals, particularly our in-stock position. And I'll cover our priorities and progress in our work to modernize the supply chain in support of our strategic initiatives. The good news is that while we have lots of work still ahead of us, we've seen meaningful improvement in key in-stock measures based on changes we've made in the last few months. +While we strive to be in stock on every item in every store throughout every day, we know that need-based commodity categories are the most critical. If our guests don't believe that they can rely on Target to have their shopping list items available every time they shop, they will begin to skip some trips to Target even though they enjoy shopping our more discretionary categories. As a result, when in-stock metrics on our core commodity categories began deteriorating this year, we created an out-of-stock action team to conduct deep dives by category to identify both short-term and long-term solutions. +When the team identifies solutions within a category, we can quickly test them to confirm they improve our performance and then determine if those solutions can be applied more broadly. This team focused first on our household personal baby category, and more recently they've done work on our center store grocery category. In a short amount of time they've identified opportunities related to the way we generate vendor orders, optimize trade-offs between order quantities and frequency, and our reliance on system-generated solutions versus manual processes. +In high volume stores, the team has implemented adjustments to plan-o-grams to enhance holding capacity on fast turning SKUs, reducing the need for frequent store replenishment. And in our distribution centers, the team has identified opportunities to reduce lead-time variability, tighten delivery windows, and in some cases increase safety stock on key items. I should note that this increase in safety stock is one of the drivers of the 4% inventory growth we reported at the end of the quarter. +In a very short time, the results of our efforts have been encouraging. In household personal baby we've been able to reduce overall out-of-stock measures by approximately 50% in about 8 weeks. In center store grocery, in less than a month the team was able to reduce out-of-stock measures by about 25%. And importantly, we've been able to reduce out of stock even further on the items most important to our guests. +Given these encouraging initial results, the team is moving quickly to scale these solutions to a broader set of categories throughout the store, and conducting additional deep dives in categories like health and beauty. Looking ahead, the team has a number of key priorities, including work to optimize case packs which will better accommodate variability in store sales volumes across our network. In addition, they are implementing technology and process improvement to improve count integrity throughout our stores and distribution network. +Included in these efforts will be a test of RFID technology in a few of our apparel categories to gauge the effectiveness of the technology relative to the cost of implementation. This work is being supported by the roll out of an agile technology development in partnership with Mike McNamara, our new Chief Information Officer and our newly hired Senior Vice President of Operational Excellence, Anu Gupta. We are very excited to have Anu on the team. She has more than 20 years of relevant experience in driving operational excellence by leveraging best practices in a variety of operating models, including procurement and Lean Six Sigma process redesign across a range of industries, including retail. We're confident Anu will accelerate the efforts of the outstanding team we already have in place. +Beyond our work to improve reliability, our store teams are working diligently to support Target's efforts to become more flexible in the way we fulfill guest demand. As a result of last year's roll out of ship-from-store capability, stores have already shipped more than 10 million items directly to guests so far this year. And the percent of digital orders delivered in a three-day window has more than doubled compared with a year ago. +To showcase this improvement in our capabilities, last quarter we rolled out new functionality we call available to promise, which offers guests a more precise shipping window. With available to promise, we expect nearly two-thirds of our digital orders will offer a guest a delivery window of 3 business days or fewer, compared with our typical window of 4-7 business days prior to the rollout. We recently expanded our ship-from-store capability to more than 300 additional stores, bringing the total to more than one-quarter of the chain. This will enable about 40% of digital transactions to be shipped from our stores in the fourth quarter. +In addition, two new direct-to-guest fulfillment centers became operational in the third quarter in advance of the holiday season. With the expanded capacity these changes provide, we expect to continue making progress on shipping speed next year. +As Brian mentioned, most of our store sales are digitally enabled, so we continue to integrate digital experiences into the stores. Guests increasingly use Cartwheel, our digital savings app with more than 20 million authenticated users, to plan their store trips in advance and then use the app to search for additional deals while shopping in store. In addition, because 10% to 15% of our digital orders are picked up in stores, we are exploring ways to streamline the pickup process by expanding holding capacity at the service counter and implementing process improvements to reduce wait times. +For next year's LA 25 remodels, we will feature all of our latest merchandising enhancements. We will test changes to the front end that will make order pick up even more convenient, including dedicated ambassadors to help store guests better understand Target's digital capabilities. +Before I turn the call over to Cathy, I want to thank our store and distribution center teams for their great performance so far this year and for their current efforts to ensure we provide an outstanding guest experience this holiday season. It's an enormous challenge for both our stores and distribution teams to accommodate the surge in volumes we see at Black Friday. +But our store teams don't focus only on moving merchandise. They focus first on our guests, and do an amazing amount of preparation to ensure guests have a pleasant and safe experience. It's one of the many things that makes Target unique, and one of the reasons why guests love our stores and our brand. +With that, I'll turn it over to Cathy who will share her insights on our third-quarter financial performance and our outlook for the fourth quarter and full year. Cathy? + +-------------------------------------------------------------------------------- +Cathy Smith, Target Corporation - CFO [5] +-------------------------------------------------------------------------------- + + Thanks, John, and hello, everyone. As Brian mentioned earlier, we are pleased that this quarter's performance was near the high end of our guidance for both sales and adjusted EPS. As is often the case when you get into the detailed P&L, there were some ins and outs within the quarter that generally offset each other, which I'll cover in a few minutes. +This quarter adjusted EPS was $0.86 above the midpoint of our guidance range and 8.6% above last year. GAAP EPS from continuing operations was $0.76, $0.10 lower than adjusted EPS, driven by $0.05 of asset impairments, $0.03 of data breach expense, and $0.02 related to the corporate restructuring we announced last spring. Third-quarter GAAP EPS was $0.87, compared with the $0.55 a year ago, as this year we recognized $0.11 of tax benefit related to our investment losses in Canada, while last year we incurred $0.27 of after-tax losses related to Canadian operations. +Let's turn to third-quarter segment results. Among the drivers of our 1.9% comparable sales growth, we are pleased that traffic grew a very healthy 1.4% in the third quarter. This growth is even more encouraging when we look at performance on a two-year basis, as we faced a tougher comparison in the third quarter than either of the first two quarters of the year. October marked our 12th straight month of traffic growth, and we are laser-focused on this metric as a key indicator of the health of our business over time. +Breaking out our sales growth between stores and our digital platforms, the stores accounted for a little over three-quarters of our comparable sales growth, while digital contributed about 40 basis points to our third-quarter comp. Consistent with results from earlier in the year, our digital growth continues to be driven by a meaningful improvement in conversion. And although we have seen an acceleration in the last two months, we haven't seen the growth in digital traffic we expected to see this year. We believe our biggest opportunity to drive traffic continues to be our work to streamline and enhance the digital experience. +Third-quarter REDcard penetration was 22.3%, up about 130 basis points from a year ago. And we remain on track to meet our guidance for an increase of 100 basis points or more for the full year. As you'll recall, we tested REDcard rewards in a Kansas City market for a year before we launched the program nationwide. With the benefit of that head start, penetration in Kansas City continues to run well ahead of the rest of the country, giving us confidence that we have continued room to grow this rewards program in the years ahead. +In addition, we are optimistic that the industry's moved to EMV, or chip and PIN technology, will help restore confidence in the US payment system and increase the willingness of consumers to add new cards to their wallet. Regarding our move to EMV, we are pleased to be one of only a few large retailers in the United States that are accepting chipped cards for both credit and debit transactions in advance of this holiday season. We've already reissued chip cards to about half of our Target branded debit and credit card holders, and we expect to complete the rollout early next year following a pause for the holiday season. +Our third-quarter segment EBITDA and EBIT margin rates were both about 20 basis points higher than last year consistent with our guidance, as strong SG&A performance offset the impact of a lower than expected gross margin rate. On the gross margin line, third-quarter performance was about 10 basis points below last year, short of our expectations. While we continued to benefit from the comparison to last year's promotions, the benefit is waning as the intensity of those promotions began to taper in the third quarter of last year. In addition, consistent with results from earlier in the year, we're seeing continued margin pressure from quality investments in our owned and exclusive brands. +Finally, this quarter we saw reimbursement pressure in our pharmacy business, which we expect to continue until we complete the sale of this business to CVS. I want to pause for a moment and comment on the CVS transaction. We continue to work closely with the CVS team to obtain regulatory approval for the transaction. And while we don't have an update on the potential timing for the transaction to close, we are pleased with our progress to date. +Turning back to the third quarter P&L, on the SG&A expense line we saw unexpectedly strong performance in the third quarter, about 30 basis points lower than last year. As part of our efforts to control costs, this quarter's expense rate benefited from the discontinuation of an outdated, little used retiree medical plan. But we also saw discipline across the organization, which drove outstanding underlying performance. Even on the marketing line, where some expenses were retimed into the third quarter from the second quarter of last year, we recognized savings in other programs that led to overall favorability compared with last year. +As John mentioned and consistent with last quarter, our inventory position at the end of the third quarter was about 4% above last year. This reflects a significant improvement from the higher year-over-year increases we were seeing earlier this year. And while inventory growth is slightly higher than our pace of sales, it reflects changes in receipt timing compared with last year, combined with the intentional investments we're making in commodity categories to improve our in-stock position. As a result, we feel very good about our inventory position going into the holiday season in relation to both our sales plan and our work to improve in-stock reliability. +Turning back to consolidated metrics, third-quarter interest expense was $151 million, $5 million higher than last year. Our third-quarter effective tax rate on continuing operations was 34.3%, up from 30.6% last year when we recognized a $30 million benefit from the resolution of tax matters. We paid third-quarter dividends of $352 million, up about 7% from last year. And given our cash position and continued strong business results, we had the opportunity to invest another $942 million in share repurchase this quarter. +Given our long-range plan to generate profitable growth, we believe the continued opportunity to retire shares will prove to be a productive use of cash. To illustrate that point, under our current $10 billion share repurchase program we have retired more than 77 million shares, representing more than 12% of our current shares outstanding at an average price of less than $69. +As Brian mentioned, our after-tax return on invested capital, or ROIC, was a very healthy 13% for the trailing 12 months through the third quarter. This is nearly 2 percentage points higher than last year when our business results were under pressure following the data breach. Given our plan to generate profitable growth on a relatively stable base of invested capital, we expect to continue to grow this metric over time, with a goal to reach the mid-teens or higher in the next five years. +Now let's turn to our guidance for the fourth quarter and what that guidance implies for our expected full-year performance. As we look ahead to the holiday season, we're mindful that the consumer remains cautious, and there are indications of heavy inventory levels at some competitors. However, we remain focused on the things we can control and what has been working all year. +These include our ability to deliver on our expect more pay less brand promise, by offering great products at a compelling value, iconic marketing, that guests love, and an outstanding store experience that differentiates Target from everyone else. With that context, we expect to deliver a fourth-quarter comparable sales increase of 1% to 2%, consistent with our third-quarter guidance. Underlying that guidance we expect digital growth of about 20%, consistent with our third-quarter performance. +Before I move down -- further down the Q4 P&L, I want to pause and discuss a challenge we hear a lot, which is based on the acceleration in two-year stacked performance we're planning for the fourth quarter. John answered this question last call, but I think it's worth addressing in more detail today. Last year our fourth-quarter comparable sales growth was 3.8%, but that was on top of a 2.5% sales decline in the fourth quarter 2013 when we announced the data breach on the weekend before Christmas. +So while the analysis of multi-year sales performance isn't always useful, I think in this case it's important to think about a 3-year stack of our comp sales. Specifically, if we hit the midpoint of our fourth-quarter sales guidance, the simple three-year stack would be a 2.8% comp, slightly less than the 3%, three-year stack we've delivered year-to-date. So while there are always risks to every sales forecast, we don't believe the two-year stack provides useful insight in this case. +Moving back to the P&L, we expect our fourth-quarter EBITDA margin rate to be flat to down slightly from last year's 9.8% rate. Among the drivers of EBITDA margin, we expect to moderate gross margin rate decline to be offset by similar improvement in our SG&A expense rate this quarter. We expect our fourth-quarter interest expense to be consistent with our third-quarter, and our tax rate is expected to be approximately 34% as we annualize over last year's favorable resolution of tax matters. +With our current cash position and expected business results, we plan to continue repurchasing our shares this quarter, and we will continue to manage the magnitude and pace of repurchase activity with the goal of maintaining our current investment-grade ratings. Altogether, this performance would lead to fourth-quarter adjusted EPS of $1.48 to $1.58 compared with $1.49 in fourth-quarter 2014. Let's look at what this guidance implies for our expectations for full-year 2015 financial performance, which I'll compared to the guidance we provided at our financial community meeting last March. +At that meeting, we laid out an expectation for 2015 comparable sales growth in the range of 1.5% to 2.5%. Given our year-to-date performance and fourth-quarter expectations, we expect our full-year comp to remain firmly in that range. I would note that the channel mix of our sales has been different than expectations. Specifically with year-to-date digital sales growth of 29% and our expected 20% growth in the fourth quarter, it's clear that in 2015 we don't expect to attain the longer-term 40% goal we laid out in March. However, we've delivered on our overall comparable sales goal every quarter this year, and we still expect to deliver industry-leading digital sales growth, both important benchmarks for us. +In March we laid out an expectation to grow our segment EBITDA margin rate by 20 to 30 basis points for the year. And we are on track to outperform that expectation with growth closer to 40 to 50 basis points in 2015. Regarding capital deployment, we are on track to meet our guidance for 5% to 10% dividend growth this year, and we've already met our goal for $2 billion or more in share repurchases through the first three quarters of the year. +And finally, we told you in March that we expected to generate $4.45 to $4.65 in adjusted EPS for the year. And despite a challenging backdrop, with our updated guidance today we are positioned to deliver performance at the high end or above that range for the year. +Beyond my love for the brand, I was attracted to Target because of our singular focus on delighting our guests and our tremendous desire to win. It's evident across our stores, online team, distribution centers, and headquarters. I recently visited one of our stores and had the opportunity to meet Bev, who has been with the Company for an amazing 44 years. In her current role Bev is involved in the ship-from-store process, and she says their whole team loves this new capability because it allows our stores to drive sales by serving guests in new ways. +Now that I've been immersed in our business for the past three months, I am mindful of the opportunity ahead of us and the work we still need to do -- to accomplish. But I'm encouraged by the progress we've seen already. Traffic has increased for a full year. +Signature categories are leading our sales every quarter, and with a renewed focus on retail fundamentals and the dedication of team members like Bev, we are delivering on our vision to provide shopping on demand while maintaining our focus on everyday in-stock reliability across our store network. The ultimate measure of this year's accomplishments can be seen in our earnings. We've delivered a 16.9% increase in our adjusted earnings per share so far this year, and with our fourth-quarter guidance we are well-positioned to deliver double-digit growth for the year. We're excited about this initial progress, and we remain laser focused on building on this momentum over time. +With that, we'll conclude today's prepared remarks. Now Brian, John, and I will be happy to respond to your questions. + + +================================================================================ +Questions and Answers +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) +Matt Nemer, Wells Fargo Securities. + +-------------------------------------------------------------------------------- +Matt Nemer, Wells Fargo Securities, LLC - Analyst [2] +-------------------------------------------------------------------------------- + + First, Brian, I'm hoping that we can get a little bit of the pulse of the consumer from you. Clearly there's been some weather impact in September and October. +But we're hearing negative comments about November from a number of retailers, so it feels like there's something else happening either from a macro or maybe a competitive standpoint. I'd love to get your sense for what you're hearing from your customers, your guests. + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman and CEO [3] +-------------------------------------------------------------------------------- + + Well, Matt, I would tell you, we're feeling really good about the trends we're seeing, the reaction we're getting from the guests, certainly the growth in traffic for us is really encouraging. So we're seeing more Target guests come back to our stores and visit our sites. +And they're continuing to respond very positively to the work we've done in signature categories. So sitting here today, we're very confident about our position. +We think we're connecting with the consumer and our guest, and I feel fantastic about the plans we have in place for the fourth quarter. So while obviously still cautious, as we sit here early in November, we feel very good about the way the consumer and the guest is responding to our brand. And I feel as if we're really well-positioned for the fourth quarter. + +-------------------------------------------------------------------------------- +Matt Nemer, Wells Fargo Securities, LLC - Analyst [4] +-------------------------------------------------------------------------------- + + That's great to hear. Shifting gears to gross margins, I'm wondering if you can call out the impact of the reimbursement pressure in healthcare and any sense for the total impact or run rate impact following the closure of your deal with CVS, how that could help you next year? +And then secondly on gross margin, you did call out in the press release private brand investments. And I'm wondering if you could dimensionalize the potential size of that over the next few years? Thanks. + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman and CEO [5] +-------------------------------------------------------------------------------- + + Let me talk about the owned brand investments we're making and then let Cathy talk through the Rx implications. As we've consistently talked about throughout the last year and year-and-a-half now, we think one of the things that differentiates Target is the value, the quality, the innovation we bring to our own brands. +So we're clearly looking to make sure we bring more value to our own brands. I talked about the number of handcrafted items we're going to have for the fourth quarter. +And we're being very surgical with those investments, but we're seeing a great reaction from the guest as we elevate the value we offer in our own brands. So we'll be very surgical, very selective, but we're certainly seeing a great return for the investments we're making. + +-------------------------------------------------------------------------------- +Cathy Smith, Target Corporation - CFO [6] +-------------------------------------------------------------------------------- + + And Matt, good morning, this is Cathy. With regards to the pharmacy reimbursement pressure, as we said when we announced the transaction with CVS, that we lack scale and we knew that we were going to continue to see pressure here over time. +So what we're seeing in this quarter is in the range of 15 to 20 basis points of pressure in the quarter. And -- which is why we're excited to be partnering with CVS, because they'll be able to help with that scale. + +-------------------------------------------------------------------------------- +Matt Nemer, Wells Fargo Securities, LLC - Analyst [7] +-------------------------------------------------------------------------------- + + Thanks for that color and have a great holiday. + +-------------------------------------------------------------------------------- +Operator [8] +-------------------------------------------------------------------------------- + + David Schick, Stifel. + +-------------------------------------------------------------------------------- +David Schick, Stifel Nicolaus - Analyst [9] +-------------------------------------------------------------------------------- + + Wonder if you could give us any extra color or update on the localization work in Chicago? + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman and CEO [10] +-------------------------------------------------------------------------------- + + Right now we're still very focused on testing localization in Chicago. We are very pleased with the results. +And certainly a lot of localization is taking place in our food and beverage offerings. We're seeing the guests respond to that, and we're going to take the learning from Chicago and apply it to the 25 stores we're remodeling in Los Angeles. +So we'll continue to expand the learning, take it from Chicago to LA, but I am very pleased with the progress we're making. And we're partnering with John and the store and supply chain teams to make sure over time we can scale the learning from Chicago and Los Angeles to multiple markets around the country. + +-------------------------------------------------------------------------------- +David Schick, Stifel Nicolaus - Analyst [11] +-------------------------------------------------------------------------------- + + So last time you had updated us I think you said 100 to 200 basis point comp lift. Does the very pleased mean we're continuing to see that? + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman and CEO [12] +-------------------------------------------------------------------------------- + + We are consistently seeing those kinds of returns. + +-------------------------------------------------------------------------------- +David Schick, Stifel Nicolaus - Analyst [13] +-------------------------------------------------------------------------------- + + Got it. And then quick on the dot-com side of the business, there was some deceleration, still good growth in that line. Can you talk about any other metrics that help us understand the shift? +Is it time spent on the site, capabilities? What is driving the difference in the growth rate? And it sounds like a growth rate you're comfortable with for next quarter. + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman and CEO [14] +-------------------------------------------------------------------------------- + + I think the most important measure to look at is what's happening with online growth overall. And just in the last 24 months -- or 24 hours we saw the October e-commerce growth rates in the US, and it was up about 8.6%. +The outlook that NRF has for e-commerce growth in the fourth quarter is somewhere between 6% and 8%. So while our 20% growth rate is not in line with our expectations, it's still dramatically outperforming the industry. +And I think the most important measure we're looking at is the fact that over 80% of our guests start their shopping journey online, either at home on their desktop or with a mobile device. And that digitally influenced guest is coming into our stores more often. +So as we've talked about our strategy, our strategy is to make sure we allow our guests to shop anywhere anytime they want with Target. And what we're seeing right now is they're voting with their feet to spend more time in our stores. +They're downloading our Cartwheel app: 20 million downloads so far to date. So I think we're seeing an overall slowdown in digital growth across retail. +And we're really pleased that we continue to outpace the industry -- dramatically outpace the industry, but our digital efforts are driving more traffic into our stores and helping us grow our overall comps. So while there's been a slowdown broadly across the sector, we continue to outpace the industry, and that's our fundamental goal. + +-------------------------------------------------------------------------------- +David Schick, Stifel Nicolaus - Analyst [15] +-------------------------------------------------------------------------------- + + Thanks so much. + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman and CEO [16] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Operator [17] +-------------------------------------------------------------------------------- + + Kate McShane, Citi Research. + +-------------------------------------------------------------------------------- +Kate McShane, Citigroup - Analyst [18] +-------------------------------------------------------------------------------- + + It's encouraging to hear that a lot of the investments, especially in the signature categories, are panning out well for you. In your merchandising strategy specifically, where do you think you still have the most work to do, and what can we expect year over year when we see those categories for holiday? + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman and CEO [19] +-------------------------------------------------------------------------------- + + I think we're making some very good strides starting in apparel. And while 3% in Q3 was slightly less than the growth rate we saw in the second quarter, compared to many of our peers we recognize that we're continuing to build traffic and growth in an important apparel category. +So the work we've done with mannequins, with changing the in-store experience, clearly paying off. One of the changes that we've announced recently is the addition of 1,400 visual merchandiser's to make sure we combine the changes we're making with mannequins, and fixtures, and layouts with experts in store that can maintain that great in-store merchandising experience. +So that's a new venture for us, we're standing it up for the holidays, we expect that to continue to strengthen the in-store experience, and we know with our signature categories we're still at the very, very early stages of standing up our wellness position. But we feel like we're in an excellent position with baby and kids, feel very good about our performance in the third quarter with kids apparel. +Certainly toys has been a highlight throughout the year, and we feel as if we're well-positioned coming off of second and third quarter comps in toys that were up 12%. The reaction we've seen from the guests to our Star Wars assortment, where we've captured an industry-leading position and expect to be a destination during the holidays. +So while we still have much more work to do, we feel very good about the progress we're making in signature categories. And I think the addition of visual merchandiser's in store will help us maintain our merchandising appeal throughout the holidays. + +-------------------------------------------------------------------------------- +Operator [20] +-------------------------------------------------------------------------------- + + Scott Mushkin, Wolfe Research. + +-------------------------------------------------------------------------------- +Scott Mushkin, Wolfe Research - Analyst [21] +-------------------------------------------------------------------------------- + + I wanted to get back into the food discussion, if we could. I think you're testing stuff in Chicago, you're going to roll that into LA. +Brian, maybe a lot of people don't notice, maybe they do, but you had a good experience back when you were at Safeway and then onto Sam's. I think you talked about 200 basis points you're initially seeing, but what can we expect out of the Company? +I think Safeway saw more than that as they brought in some refurbishments. And when can we expect to see more from Target as far as refreshing the decor and maybe doing a fuller roll out? +And is 200 basis points a good expectation? It seems to me it could actually be higher than that as you refine your lift, but wanted to get some more details there. + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman and CEO [22] +-------------------------------------------------------------------------------- + + Scott, I'm glad you asked the question. I do think one of our highlights in Q3 was the improved performance in food. We've actually seen food comp acceleration throughout the year. +And while we haven't made major changes with fixtures and in-store decor, we've been very focused on assortment changes and bringing more natural, organic, local items into many of our categories. And we're seeing the guests react very favorably. +So, to me it's getting the basics right. And before we start making fixture changes and decor changes, it has to start with the right assortment and making sure we have the items, the brands, our guest is looking for when they shop food at Target. +So the acceleration you're seeing right now is driven by section by section getting the assortment right, bringing more appealing items to our guests, adding more natural, organic, gluten-free items that are on trend to those categories. We made some significant changes in yogurt in the third quarter and saw very, very positive responses; high single-digit growth rates in those categories. +So while we are not shouting about it, we're making steady progress in food. We'll learn a lot more in 25 stores in Los Angeles where you will see some changes in fixtures and decor. And as we learn, we'll continue to grow. +So I think we do have significant upside, but Scott, this is about making sure we get it right, and we're going to take a slow, steady approach, solid, consistent results every quarter. And continue to deliver what the guest is looking for from an assortment experience standpoint when they shop food at Target. + +-------------------------------------------------------------------------------- +Scott Mushkin, Wolfe Research - Analyst [23] +-------------------------------------------------------------------------------- + + Obviously key, and I think Cathy said you're measuring -- one of the big things you look at is frequency, and this is obviously core to that. So we look forward to seeing more. +But my follow-up question is on the investment side. We get it a lot, whether it be e-commerce, whether it be on the food and the logistics. Can you talk us through why there won't be a massive ramp up in investment as we go out the next couple years and that you have enough money in the CapEx and the SG&A to handle what the Company needs to do? + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman and CEO [24] +-------------------------------------------------------------------------------- + + Yes. Scott, we've looked at this very carefully. I know we've talked about it a number of times. We feel very confident that the CapEx budgets we've had in place will be very adequate over time to make the changes we need to make from a technology standpoint, a supply-chain standpoint, continue to refresh our stores, and maintain our focus on maintenance investments. +So sitting here, Cathy and I have spent a lot of time recently, obviously John's been a great steward of our CapEx spending. And we feel very comfortable that our current spending levels will allow us to modernize the organization, enhance technology, improve supply chain, and make sure along the way we're continuing to enhance the in-store experience and match that up with a great online experience for our guests. + +-------------------------------------------------------------------------------- +Cathy Smith, Target Corporation - CFO [25] +-------------------------------------------------------------------------------- + + I would offer just real quickly to add to that, because we have pressure tested this one ourselves a lot, we have not -- Target has not under-invested over the years. And I think that bodes well with the state of where you find our stores as well as our technology and supply chain investments we need. So I feel very good about where we are, and with that level of investment we've been pretty consistent. + +-------------------------------------------------------------------------------- +Scott Mushkin, Wolfe Research - Analyst [26] +-------------------------------------------------------------------------------- + + Thanks, guys. Appreciate it. + +-------------------------------------------------------------------------------- +Operator [27] +-------------------------------------------------------------------------------- + + Matthew Fassler, Goldman Sachs. + +-------------------------------------------------------------------------------- +Matthew Fassler, Goldman Sachs - Analyst [28] +-------------------------------------------------------------------------------- + + I'd like to ask a two-part question. The first relates to the cost cutting initiatives that you discussed at your analyst meeting earlier in the year. +You spoke about $1.5 billion of SG&A and $0.5 billion on cost of goods over two years. If you could talk about the run rate that you're at now against those goals? +I guess another twist on Scott's question, the degree to which you've had investments insight that would offset some of those. I think that was also part of the plan that you set forth. + +-------------------------------------------------------------------------------- +John Mulligan, Target Corporation - COO [29] +-------------------------------------------------------------------------------- + + So I'll jump in and take that. I think from a tracking perspective, what we said, your point, $1.5 billion of SG&A, $0.5 billion of margin, and we would deliver in 2015 about $0.5 billion of that. +We're running a little bit ahead of that pace. And both in the cost of goods and in the SG&A space, both are running perhaps a little bit ahead of what we envisioned going into the year. So we feel really good about that. +I think stepping back and tying this back to Scott's question, the other thing we said at the time was we're taking $2 billion out of the P&L but we didn't expect EBITDA margin expansion. And our view was that we would need this to fuel the investments, exactly some of the expense investments that perhaps Scott was referring to, and this would provide the capacity to do that. +And that is in fact what we've seen. We've seen great expense discipline across the corporation, but where we needed to invest, we have had the capacity to do that. + +-------------------------------------------------------------------------------- +Matthew Fassler, Goldman Sachs - Analyst [30] +-------------------------------------------------------------------------------- + + If I could ask a quick follow-up, when you talk about $0.5 billion this year, is that delivered -- I noticed it's not been delivered to the bottom line because there are some offsets, but is that annualized run rate achieved or is that actual cost cuts that would have come out on the gross basis against your cost base offset by some of the investments? + +-------------------------------------------------------------------------------- +John Mulligan, Target Corporation - COO [31] +-------------------------------------------------------------------------------- + + We will take out $600 million this year. And then part of next year's will be annualization of that, and part of it will be incremental. + +-------------------------------------------------------------------------------- +Matthew Fassler, Goldman Sachs - Analyst [32] +-------------------------------------------------------------------------------- + + And then a very quick follow up, on wages, obviously Walmart made an incremental announcement since your last call. Any sense as to whether this issue is brewing up organically in the field, as you think about hiring and you think about intrinsic wage pressure in the marketplace and how you're thinking about that relative to your plan? + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman and CEO [33] +-------------------------------------------------------------------------------- + + We don't see any material change in the marketplace. Again, we've talked a lot in the past about making sure we're investing to have the best retail team. +And we look at this very surgically year after year, market by market, we think we're in a great position and we think we're hiring terrific talent. And we're excited that we've got a great team in place as we get ready for the holidays. + +-------------------------------------------------------------------------------- +Matthew Fassler, Goldman Sachs - Analyst [34] +-------------------------------------------------------------------------------- + + Thank you so much, guys. + +-------------------------------------------------------------------------------- +Operator [35] +-------------------------------------------------------------------------------- + + Greg Melich, Evercore ISI. + +-------------------------------------------------------------------------------- +Greg Melich, Evercore ISI - Analyst [36] +-------------------------------------------------------------------------------- + + I guess my two questions are a bit of a follow up. One on the last one, if you look at the fourth-quarter guidance, if I'm getting this right SG&A dollars are flattish. +And is that basically that cost out with the reinvestment going in? And then the nature of that question is really, John, you mentioned 40% of digital you thought would be ship from store in the fourth quarter. What has it been running and what does that do to the labor model? + +-------------------------------------------------------------------------------- +Cathy Smith, Target Corporation - CFO [37] +-------------------------------------------------------------------------------- + + Greg, this is Cathy. I'll take the first part of it. To answer your question, yes, we expect it to be essentially flat and it will be pretty much offset. +We'll have pluses and minuses, so the savings we're getting we will continue to reinvest as we had planned. John will answer the 40% digital shipment. + +-------------------------------------------------------------------------------- +John Mulligan, Target Corporation - COO [38] +-------------------------------------------------------------------------------- + + Sure, Greg. 40% this quarter, and it will peak a little bit higher than that actually, typically running in more in the 20% to 25% range. But as we peak, this is a great way for us to utilize our store assets. +The labor model, what happens here is actually it's quite efficient because we have dedicated teams in those stores who do the picking, do the packing, I mean we're just able to utilize them more efficiently. And so while there is more store labor that we are using, the offset clearly comes in our shipping expense, because we're much closer to the guest we are shipping to and they aren't on the same P&L line, but it's an outstanding trait for us. + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman and CEO [39] +-------------------------------------------------------------------------------- + + Greg, I think it's important as you tie out the math on the ship from store. Last year at this time we had just over 120 stores where we were shipping from store. As we sit here today, we're up to 462. So we've expanded the base. +We're going to leverage and sweat the assets I think much more effectively. But importantly, that enhanced base allows us to deliver to our guests in a much shorter timeframe. So we would expect that to grow during the holidays. +We've certainly ramped up for it. And we think that's going to provide a much better shopping experience and allow us to deliver product to our guests in a much shorter period of time. + +-------------------------------------------------------------------------------- +Greg Melich, Evercore ISI - Analyst [40] +-------------------------------------------------------------------------------- + + That's helpful. If I could follow up, I think earlier you talked about private label penetration a little bit. Could you talk about how the stronger dollar or falling raw material costs or lower fuel costs could be impacting gross margin today differently than you would have thought a few quarters ago? + +-------------------------------------------------------------------------------- +Cathy Smith, Target Corporation - CFO [41] +-------------------------------------------------------------------------------- + + I'll answer briefly and then anyone can chime in. We're really not seeing an impact on it, in our product cost or in -- obviously in our margins. So it's really been kind of a non-event for us. + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman and CEO [42] +-------------------------------------------------------------------------------- + + Remember, Greg, with many of those items, those are long lead time items. So we'll certainly be watching that over time, but as we sit here today many of those orders and POs were placed many, many months ago. +So we'll continue to monitor that over time, but we certainly like our position with our own brands as we enter the holidays, and that's an important way that we differentiate. Operator, it looks like we've got time for one more call. + +-------------------------------------------------------------------------------- +Operator [43] +-------------------------------------------------------------------------------- + + Bob Drubl, Nomura. + +-------------------------------------------------------------------------------- +Bob Drbul, Nomura Securities Intl - Analyst [44] +-------------------------------------------------------------------------------- + + Just two quick questions. First one is on the apparel performance, you talked a little bit about margin pressure in private label and exclusive. Was that new to the third quarter, and how do you see that playing out in the fourth quarter? +Then the second question that I have is, on the e-commerce business, can you give us an update on the subscription offerings and how that's going from a fulfillment perspective as well? + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman and CEO [45] +-------------------------------------------------------------------------------- + + Bob, first on the A&A side, again, we think the guest is responding really well to some of the changes we've made with our own brand assortment. And the investments that we talked about today we've been consistently talking about for over a year now. +Making sure that we're reinvesting in quality and innovation, in style, making sure that we deliver that expect more pay less brand promise. So the guest is reacting really, really well to that. +And we're going to continue to make sure that we deliver great value in our own brands. So it shouldn't be a new phenomenon. It's something that we've been very clear and transparent about. +And we think it's paying off with increased traffic and growth in those core signature categories. So looks like we've run out of time for today. +I do appreciate everyone calling in. And that will conclude our third-quarter earnings call. So thanks, everyone, for joining us. + +-------------------------------------------------------------------------------- +Operator [46] +-------------------------------------------------------------------------------- + + Ladies and gentlemen, this does conclude today's conference call. Thank you for participating. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/exam/original-files/Problem_2_3_Sample_full_transcripts/2015-Oct-13-JPM.N-140561706149-Transcript.txt b/exam/original-files/Problem_2_3_Sample_full_transcripts/2015-Oct-13-JPM.N-140561706149-Transcript.txt new file mode 100644 index 0000000..294c30e --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_full_transcripts/2015-Oct-13-JPM.N-140561706149-Transcript.txt @@ -0,0 +1,785 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q3 2015 JPMorgan Chase & Co Earnings Call +10/13/2015 05:00 PM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Jamie Dimon + JPMorgan Chase & Co. - Chairman & CEO + * Marianne Lake + JPMorgan Chase & Co. - CFO + +================================================================================ +Conference Call Participiants +================================================================================ + + * Mike Mayo + CLSA - Analyst + * Erika Najarian + BofA Merrill Lynch - Analyst + * Gerard Cassidy + RBC Capital Markets - Analyst + * Betsy Graseck + Morgan Stanley - Analyst + * Steven Chubak + Nomura Securities Co., Ltd. - Analyst + * Glenn Schorr + Evercore ISI - Analyst + * Brennan Hawken + UBS - Analyst + * Matt Burnell + Wells Fargo Securities, LLC - Analyst + * Eric Wasserstrom + Guggenheim Securities LLC - Analyst + * John McDonald + Bernstein - Analyst + * Jim Mitchell + Buckingham Research Group - Analyst + * Chris Kotowski + Oppenheimer & Co. - Analyst + * Paul Miller + FBR Capital Markets - Analyst + * Matt O'Connor + Deutsche Bank - Analyst + * Ken Usdin + Jefferies LLC - Analyst + +================================================================================ +Presentation +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Good morning, ladies and gentlemen. Welcome to JPMorgan Chase's third quarter 2015 earnings call. This call is being recorded. +(Operator Instructions) +At this time, I would like to turn the call over to JPMorgan Chase's Chairman and CEO, Jamie Dimon and Chief Financial Officer, Marianne Lake. Ms. Lake, please go ahead. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [2] +-------------------------------------------------------------------------------- + + Thank you, operator. Good afternoon, everyone. Thank you for joining us. I'm going to take you through the earnings presentation which is available on our website. Please refer to the disclaimer regarding forward-looking statements at the back of the presentation. +Starting on page 1, the firm reported net income of $6.8 billion, EPS of $1.68 and a return on tangible common equity of 15% on $23.5 billion of revenue. If you exclude tax adjustments, legal expense and net reserve releases, our adjusted performance was $1.32 a share with a 12% return on tangible common equity. And we've only adjusted for these three items because other small items that might be considered non-core netted to zero. +Underlying results were somewhat mixed on the back of market conditions. The Consumer business had strong performance with loan growth across products driving overall firm-wide core loan growth of 15%. In the Corporate and Investment Bank, we saw outperformance in investment banking revenue and solid trading performance. Commercial banking revenue was down driven by lower IB revenues in a declining market. And Asset Management revenues reflected lower market levels, driving weaker client sentiment and transactional revenues. +There were two significant items this quarter. First, tax benefits of $2.2 billion, the size of which speaks of the complexity of tax matters during the financial crisis. We took appropriately prudent position in our tax reserves and now we've reached resolution on those matters. The majority of this is in Corporate with a portion in the CIB. The second item is firm-wide legal expense of $1 billion after tax relating to a range of matters but including the recently announced CDS settlement. +Also reflected in our results is a net reserve release of $281 million pretax. Which reflects a little less than $600 million of consumer reserve releases as favorable credit trends continue, offset by a build of a little over $300 million in Wholesale, approximately $160 million of which is additional reserves associated with the oil and gas sector given expectations that energy prices will remain lower for longer. +Skipping over page 2 and turning onto page 3 and our balance sheet. We continue to make progress against our capital targets and as expected, advanced and standardized fully phased in CET1 ratios are in line with each other at 11.4% this quarter. Also, we continue to expect the standardized ratio will be our floor from here and the improvement to both ratios was driven by net capital generation. +We also built Tier 1 and total capital, adding $1.2 billion of preferred stock and $1.5 billion of subordinated debt this quarter. We returned $2.7 billion of net capital to shareholders including $1 billion of net repurchases and dividends of $0.44 a share. Firm and Bank SLR were at 6.3% and 6.5% respectively with the increase driven almost equally by capital generation and a reduction in average assets. +While we're on the balance sheet, you can see on the call out from the page that on a spot basis our balance sheet is down $160 billion year-to-date and an incremental $32 billion this quarter as we reduced nonoperating deposits by over $150 billion exceeding our commitment. Total deposits are only down $90 billion, reflecting growth in more stable balances, particularly Consumer. Finally, with respect to GSIB, we estimate that today we are squarely in the 4% bucket given actions taken and final US rules as compared to 4.5% at the beginning of the year. +Now let's turn to page 4 and Consumer and Community Banking. The combined Consumer businesses generated $2.6 billion of net income and an ROE of 20%. Revenue of $10.9 billion was down 4% year on year, driven by mortgage on lower net servicing revenue. We remain on track to deliver expense reductions versus our $2 billion commitment and year-to-date expenses were down around $600 million reported and over $700 million adjusted for legal expense. +Our headcount is down 10,000 year-to-date and more than 40,000 since 2012. Underlying business drivers are strong and based on the 2015 FDIC deposit survey which just came out, we grew our deposits nearly 2 times the industry growth rate. Average loans are up 8% with core loans up 23%. Our customer base continues to expand. We added 900,000 households year-over-year and our active mobile base is up 21%. +Moving to page 5, Consumer and Business Banking. CBB generated strong results with net income of $954 million and an ROE of 32%. NII was down 1% quarter on quarter and 7% year on year driven by spread compression offset by continued growth in deposits. And non-interest revenue is growing solidly, up 5% quarter on quarter seasonally and 5% year on year on continued strong debit and investment revenue. Overall expenses were down 3% year on year on lower headcount from branch efficiency. +We continue to see robust performance across key drivers. Average deposits were up 9% and we grew deposits in all of our top 50 MSAs and gained share in nine of our top 10. Client assets were up 3% but down 4% quarter on quarter, broadly in line with the market and net new money was positive $3 billion for the quarter. Business Banking loan growth remained strong with average loan balances up 6% year on year and originations up 4% from a strong 2014. +Next Mortgage Banking on page 6. Overall net income was $602 million for the quarter. Originations of $30 billion were up 41% from the prior year and up slightly quarter on quarter as we benefited from a strong pipeline and continued improvement in the purchase market. We continue to add high quality loans to our balance sheet, totaling $19 billion this quarter. +Total revenue decreased sequentially, primarily driven by lower net servicing revenue on lower MSR risk management. We expect non-interest revenue to be down around $250 million year-over-year in the fourth quarter. Expenses of $1.1 billion were down 13% year on year despite higher volumes as we continued to manage down our costs. +On credit we released $575 million of reserves, including $200 million in the noncredit impaired portfolio and $375 million in the purchased credit impaired portfolio reflecting an improvement in both actual and expected delinquencies and a sustained improvement in home prices. Finally, our net charge-offs were $41 million and approximately $60 million normalized and this is a reasonable estimate for the near term. +Moving on to page 7, Card, Commerce Solutions & Auto. Overall net income of $1.1 billion with an ROE of 22% and revenue of $4.8 billion, was up 2% year on year on higher operating lease income in Auto as well Card revenue up slightly reflecting higher NII on volume, spread and lower interest reversals, offset by the impact of changes to some of our co-brand partnerships. On our partners we were thrilled to announce the renewal of two of our key partners, United Airlines and Southwest Airlines. We look forward to continued investment and growth in these important relationships. +And while we repriced to the current competitive market, our ROE target for the Card business in total remains unchanged. However, expect the revenue rate for the fourth quarter to be 11.75% plus or minus. Expense was $2.2 billion, up 8% year on year, driven by higher auto lease depreciation and higher marketing spend. On drivers, we continued to see strong year-over-year growth in volumes and transactions across our businesses. +In Card, core loan growth was 3%, sales growth was 6%. Commerce solutions volumes were up 11% driven by continued strong spend from existing clients but also from the addition of new merchants. Lastly, in Auto, results continued to reflect steady growth in new vehicle sales and stable used car values. We saw average loan and lease balances up 9% and the pipeline is good. Finally, on Credit, the net charge-off rate for the quarter was 241 basis points and we expect net charge-offs of around 250 basis points over the medium term. +Turning to page 8 and the Corporate & Investment Bank. CIB reported net income of $1.5 billion on revenue of $8.2 billion and an ROE of 13% adjusted for legal taxes and reserves. In Banking, it was a strong quarter with IB revenue of $1.5 billion, up 5% year on year. We continue to rank number one in global IBCs and ranked number one in North America and EMEA. +It was another outstanding quarter for Advisory, up 22%. We grew wallet share by 150 basis points year-over-year, maintaining our number two ranking. Equity underwriting fees were down 35%, generally in line with the market but from a particularly strong prior year. This quarter we ranked number one both in North America and EMEA. +Set Underwriting was up 17%, driven by higher non-investment grade fees, we maintained our number one ranking, gaining 30 basis points of share. However, expect DTMCs to be down year-over-year given the current pipeline. Treasury services revenue were flat quarter on quarter but down 4% year on year on lower deposit spreads with underlying transaction volumes remaining stable. +Moving on to Markets. Revenue of $4.3 billion was down 6% adjusted for business simplification. With mixed results in Fixed Income but another strong performance in Equities. Fixed income revenue was $2.9 billion, down 11% adjusted. In macro products we saw strong performance in currencies and emerging markets driven by higher activity on the back of market volatility in Asia and Brazil. Rates was down slightly given a particularly strong September of last year. And Commodities was down on low levels of client activity, again, compared to a strong prior year. It was a slow quarter in Credit with lower volumes as clients were on the sidelines given the challenging market conditions. +Equity markets had another strong quarter with revenues of $1.4 billion, up 9% year on year, driven by reasonably broad strength across products and regions with good performance in cash, but particular strength in Asia and derivatives. Security Services revenue was $915 million, versus guidance of $950 million. Given depressed market levels which impacted both revenues and as assets under custody with Emerging Markets, which is one of our more profitable segments, being hit particularly hard. If markets remain at these levels, fourth quarter revenues will also be lower than previous guidance. On Credit we saw a reserve build of $232 million, including $128 million for Oil & Gas. +Finally onto Expenses. Total expense was up 2% year on year at $6.1 billion. Compensation expense was down 13% with a comp-to-revenue ratio of 30% in the quarter. And non-compensation expense was up 14% driven by higher legal expense, partially offset as we realized the expense benefits of business simplification. +Moving on to Commercial Banking and page 9. Commercial Banking generated net income of $518 million on revenue of $1.6 billion and an ROE of 14%. Revenue was down 5% quarter on quarter driven by lower investment banking revenue as we saw fewer large transactions in the quarter. However, the pipeline for the fourth quarter is solid and we still expect record growth IB revenues this year, exceeding $2 billion. +Expenses of $719 million were in line with guidance. Loan balances were a record at $162 billion, up 13% year on year and 2% quarter on quarter. Driven by continued outperformance in Commercial Real Estate where quarter on quarter growth of 4% exceeded the industry across both multi-family and real estate banking. +C&I loans were flat, in line with the industry. Mature markets were relatively flat but we saw growth in our expansion markets, up 4% quarter on quarter. Credit performance with the portfolio remains strong with no net charge-offs and an $84 million increase in reserves included a modest build for Oil & Gas. +Overall, while results were mixed this quarter, the underlying fundamentals of the Commercial Bank remain strong. Pipelines are trending higher in C&I and remain robust in commercial real estate. Our expansion market loan balances are up 20% year on year. Calling activity is up substantially across line segments and we've added around 400 new middle market relationships this year. +Moving on to page 10 and Asset Management. Net income of $475 million with a 28% pretax margin and 20% ROE. Revenue of $2.9 billion was down 5% year on year, driven by lower markets which also drove lower transactional revenue as well as the sale of retirement planning services in 2014 which drove $70 million of the year-over-year decline. Looking forward to the fourth quarter, expect revenues to show normal seasonality from this low base assuming current market levels. +Expenses were relatively flat. And AUM of $1.7 trillion and client assets of $2.3 trillion held up well and were relatively flat year on year with negative markets and outflows driving a 4% sequential decline. We were not immune to the impact of interest rate uncertainty and equity markets and while we did experience overall modest net outflows, we had positive flows in our less market sensitive multi-asset class and alternative platforms. +In Banking we had record loan balances of $109 billion, up 7% year on year, driven by Mortgage which was up 19%. And lastly, we continue to report strong investment performance with 81% of mutual fund AUM ranked in the first or second quartiles over five years. +Turning to page 11 and Corporate. Treasury and CIO results for the quarter were very close to home. The Corporate reported net income of $1.8 billion, driven by tax benefits. And finally, firm-wide NIM was up 7 basis points quarter on quarter given the mix shift away from cash and securities, towards higher loan balances and on an overall smaller balance sheet. Loans are the primary driver of nearly $250 million improvement in NII and given market implied NIM and NII should be relatively flat in the fourth quarter. Finally, our loan-to-deposit ratio improved 8 percentage points year-to-date to 64%. +Turning to page 12 and moving on to the fourth quarter outlook. Just a few items to call out. First, you'll see we updated our adjusted expense target to $56.5 billion, plus or minus for the full year, which is better than our previous guidance and would equate to the fourth quarter adjusted expense being relatively flat to the third. We're expecting core loan growth of 15% plus or minus to continue in the fourth quarter. +And finally, on Markets revenue. Starting with business simplification, which will drive a 2% decline year on year. In addition, we expect to see normal seasonal declines in the fourth quarter versus the third. And looking back over the last three years, that decline has been on average around 15%. And so far in October across asset classes, the markets are pretty quiet. Obviously we're only two weeks into the quarter and it's too early to give specific guidance, but based on those facts alone analyst estimates appear high. +Wrapping up, overall the Company performed quite well against a backdrop of interest rate uncertainty and volatile markets. We continue to invest in our businesses and our underlying drivers are growing strongly and we're gaining share and we have more than successfully delivered against each of our capital, balance sheet and expense targets. +Just before I finish, on one of those investments we're making, I want to update you on the progress we're making on our payment strategy. We continue to capitalize on our leadership position in payments, we have unparalleled assets in our issuing scale, we have the largest wholly owned merchant acquirer, our own close leaf network in ChaseNet and now a digital wallet in Chase Pay, which will be launched more broadly this year. +The beauty of this is that we're able to bundle all of these capabilities together to provide better pricing experiences for merchants, including access to data, as well as a better and more relevant experience for customers. We expect to process more than $50 billion of Chase card volumes over ChaseNet in 2016 and Gordon will share more details at Money 2020. With that, operator, please open up the line to Q&A. + + +================================================================================ +Questions and Answers +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) +Your first question will come from the line of Glenn Schorr with Evercore ISI. + +-------------------------------------------------------------------------------- +Glenn Schorr, Evercore ISI - Analyst [2] +-------------------------------------------------------------------------------- + + Thanks very much. So I'm curious, the capital markets related commentary, I get there could be a hangover effect into fourth quarter and I'm guessing that's the primary driver behind your analyst estimates appear high on fourth quarter. But could we talk about what you're actually seeing in terms of where the financing markets are maybe drawing the line? Meaning, are the deals that underwriting you expect to fall off in the fourth quarter based on your pipeline, is that a function of timing that you think could come back next year? Are these marginal deals where markets are drawing the line? I'm trying to get at -- + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [3] +-------------------------------------------------------------------------------- + + Yes. + +-------------------------------------------------------------------------------- +Glenn Schorr, Evercore ISI - Analyst [4] +-------------------------------------------------------------------------------- + + The ultimate question of is this the first time that FICC could actually grow in 2016 just because of the beat down it took in the back half of this year? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [5] +-------------------------------------------------------------------------------- + + There are a couple of different questions in there and maybe I'll try and separate them. My comments about the seasonality in the fourth quarter were most particularly towards Markets revenues and less so towards the IB revenue space. With IB revenues, it's a mixed story. Talking now about the sort of Banking revenues rather than Markets revenues. So the pipeline for M&A remains very constructive and really pretty good, so we're expecting to continue to have strength in M&A in the fourth quarter. +With ECM you saw obviously a pretty sharp falloff in activity in the third quarter. We have seen the pipeline in ECM to the degree that that shows you visibility into the fourth quarter which is somewhat limited. We have seen that build up and so there is possibility that we'll be able to pull through some of that into the fourth quarter. But that will depend upon how the markets behave. +With respect to DCM, our sort of guidance there was a commentary really mainly to the strength of the fourth quarter last year and on relative basis, the pipeline is down. And it's really to do with normal refinances are slowing and the maturity wall is smaller but it's still healthy. It's just not going to be at the same levels that we saw last year. + +-------------------------------------------------------------------------------- +Glenn Schorr, Evercore ISI - Analyst [6] +-------------------------------------------------------------------------------- + + Maybe just a follow-up in FICC in general, I know none of us have a crystal ball. The slowdown in activity that we see, some of it's clients sitting on hands. Maybe you could separate that between any providing of liquidity [and marks] along the way. Because we did see a really wide credit spread widening in the quarter. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [7] +-------------------------------------------------------------------------------- + + Look, the situation for us in markets was one where there was volatility, regardless of you how you want to characterize it, and people were acting -- our clients were acting on the back of that. We were able to capitalize on that flow. We were able to intermediate for our clients, put our capital [at risk and make] some money. We did pretty well where there was volatility. Where there wasn't, it was more about, to your point, more about low levels of activity, people on the sidelines. It was tougher to make money because less was happening rather than anything else more significant than that. So far in the fourth quarter we're two weeks in, it's too early to say, but there's not been a tremendous change in the landscape. + +-------------------------------------------------------------------------------- +Operator [8] +-------------------------------------------------------------------------------- + + Your next question is from the line of Ken Usdin with Jefferies. + +-------------------------------------------------------------------------------- +Ken Usdin, Jefferies LLC - Analyst [9] +-------------------------------------------------------------------------------- + + Thanks. Marianne, can you talk a little bit more about the Card business and try to help us understand the Card revenue pressure that we saw this quarter into the fourth? How much of that is the NII side of things and how much of that is the partner repricing? And how far past the fourth quarter do those resets continue before growth can overcome it? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [10] +-------------------------------------------------------------------------------- + + Looking at the revenue rate, the guidance, remember our guidance previously had been you should expect our revenue rate to be at the low end of the 12% to 12.5% range. The most important thing we want you to take away from talking about our co-brand partners is that we feel great about having signed up United Airlines and Southwest Airlines and partnering with them again for the medium term. +And the economics of those deals on a standalone basis are still really very good. But the co-brand space is very competitive and when any of those contracts are going to be renegotiated at this point, they're going to be renegotiated to competitive levels. And so, it's really the fact that we're seeing that is going to come through in our revenue rate in the fourth quarter which is going to push it down to below 12%. It doesn't change the fact that the ROE target for the business is still 20% and that the economics of those partnerships are still good. Remember, these -- + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [11] +-------------------------------------------------------------------------------- + + Just given the numbers, it's $200 million a quarter for four quarters until it lapse. + +-------------------------------------------------------------------------------- +Ken Usdin, Jefferies LLC - Analyst [12] +-------------------------------------------------------------------------------- + + Got it. Okay. Second question, just on -- in this tough revenue environment, first of all, can you give us a quick update on the progress on the expense plans? And then, any -- does anything change given how tough this revenue environment has changed as far as either accelerating or digging in again? I know your prior comments have focused on obviously always needing to invest. But in terms just of your focus as you think about next year and building the expense budget against the environment that we're seeing. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [13] +-------------------------------------------------------------------------------- + + So I would say, first of all, we gave some expense goals in Investor Day for both Consumer Businesses as well as for the CIB. And those were I think pretty sizable goals, $2 billion in 2017 versus 2014 for the Consumer Businesses and $2.8 billion in 2017 versus 2014 for the CIB. And we are working through that. We are on track in both of them. I think I said earlier that adjusted, the Consumer Businesses in the three quarters so far are $700 million down year-over-year in expenses. So against the $2 billion target, we're certainly getting there. +And on the CIB, we expected 2015 to be mainly about forcing out those business simplification expenses and we've essentially done that too. So we're on track. We're pushing hard. We still have work to do. We are always going to be diligent on our expenses and generally speaking at Investor Day we also said we're going to be on or down which is actually pushing hard to keep them down but not at the expense of good investments in the business. So obviously we are going to respond appropriately to the revenue pressure but not overreact. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [14] +-------------------------------------------------------------------------------- + + I've spoken my whole life about good expenses and bad expenses. Bad expenses are waste, things you don't need. You don't have [to trade through] processing, things like that. We want certain expenses to go up. When we find marketing opportunities in Card, we're going to spend it. If the Investment Bank does better, the comp accrual is going to go up. That's how we run the Company. That's not ever going to change. + +-------------------------------------------------------------------------------- +Operator [15] +-------------------------------------------------------------------------------- + + Your next question comes from the line of Mike Mayo with CLSA. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA - Analyst [16] +-------------------------------------------------------------------------------- + + Hi. Just a follow-up to that last question. So of the total $4.8 billion of expense savings, how much have you achieved? And if you're on track, why did the adjusted overhead ratio go backwards? It's 60% in the third quarter versus 58% in the second and 59% last year. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [17] +-------------------------------------------------------------------------------- + + So Mike, thanks for that. So $700 million, if you adjust for legal expense in the Consumer Businesses year-to-date, we'll do some more in the fourth quarter. And year-to-date on business simplification, which I think for in total was about $1.5 billion, we've done $1.3 billion. In total, that's $2 billion so far. Obviously more work to do in 2016. With respect to the adjusted overhead ratio, it speaks a bit more to seasonality of revenues than anything else. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA - Analyst [18] +-------------------------------------------------------------------------------- + + All right. And one follow-up. Clearly it's due to revenues. So the question Jamie, if you could answer this, a simple yes or no question. Is the economy getting stronger or weaker? And the reason I ask that, the jobs report from a couple weeks ago seems to imply the economy's getting softer. Yet, your loan growth actually -- your core loan growth accelerated and you're guiding for faster loan growth in the fourth quarter. So is there noise in that loan growth figure or is the economy, based on what you're seeing, getting stronger and the jobs number is misleading? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [19] +-------------------------------------------------------------------------------- + + I'll start. Jamie, you can yes or no at the end. Mike, we would say that the US economy is doing pretty well there. We're seeing good demand for loans in the Consumer space and reasonably good sentiment in the Business Banking space and our core loan growth numbers do show that. There's nothing particularly funky in the loan growth numbers. We do our very best to show them in the right light. +I would take a slightly different perspective on the jobs report on the non-farm payrolls. And not to sort of over think it, but while I know it was somewhat lower than people were expecting or possibly hoping for, it's still at around 140,000, almost two times what would be required to have stable unemployment. So it's only one report too. You can't overreact to it. It's not that we're seeing anything that's causing us any concern and our outlook for the fourth quarter is pretty solid I think. Jamie, anything? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [20] +-------------------------------------------------------------------------------- + + Nothing to add. + +-------------------------------------------------------------------------------- +Operator [21] +-------------------------------------------------------------------------------- + + Your next question comes from the line of John McDonald with Bernstein. + +-------------------------------------------------------------------------------- +John McDonald, Bernstein - Analyst [22] +-------------------------------------------------------------------------------- + + Hi, Marianne. You saw some very good improvement in the GSIB surcharge from the 4.5% to 4%, probably came a little faster than some of us expected. Do you have good momentum there to do more there and how are you thinking about the tradeoff, the cost benefit tradeoff, of pushing further down on that GSIB bucket? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [23] +-------------------------------------------------------------------------------- + + We did better than we had targeted on our non-op deposits. We worked very, very hard but we told you we would on derivative notionals, compressionals, so our level 3 assets. It is absolutely the case, not to diminish the amount of work we've done and the progress we've made, that we obviously went after the most impactful -- least impactful to the client franchise, most impactful to the ratio with a less revenue [give-up] first. We made great progress. It becomes increasingly, not exponentially, but increasingly more difficult for every net basis point. +That's not to say, by the way, that we aren't continuing to work very hard at it and optimize and that we won't push further. But we're not at a place right now where we're going to target anything structurally below this, except for over the longer term just continuing to work through it. And our overall capital target, we're at 11.4% now. Our overall capital target still in the short to medium term is still 12%. + +-------------------------------------------------------------------------------- +John McDonald, Bernstein - Analyst [24] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [25] +-------------------------------------------------------------------------------- + + I just want to add, in the new world we have to obviously monitor and push down to all the business levels, GSIB, CCAR, Basel, LCR and SLR, and we want to optimize all of them. So we're only living with this for a couple years now. As we embed it in our systems, we'll have a better way to track it and monitor it. Over time, I would expect the GSIB will come down a little bit. It only comes down in lumps. You got to make a big difference to go from 4% to 3.5% but imagine over time, I'm talking about years. I'm not talking about anything you'd see this quarter. We are very comfortable where we are today. Over years, you might have to change some of your business strategies but I think it's a better thing not to be an outlier in GSIB. + +-------------------------------------------------------------------------------- +Operator [26] +-------------------------------------------------------------------------------- + + Your next question is from the line of Betsy Graseck with Morgan Stanley. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [27] +-------------------------------------------------------------------------------- + + Hi, thanks. So just a question on the capital, getting to 4% now with a goal over time to get to something lower, 3.5%, 3%. Does it also give you more room for capital return requests next year, Jamie? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [28] +-------------------------------------------------------------------------------- + + It has nothing to do with next year, Betsy. When I say over time, it just happens that JPMorgan built a global corporate investment bank. 70% of it is financial institutions, 30% corporate. We easily could have been built the other way around, we focused on it over time. When I say over time, it might be quite easy for us to say that over five to six years let's focus more on corporates and less on financials and that will affect your GSIB fairly substantially. That's what I'm talking about. It has nothing to do with CCAR for next year or anything like that. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [29] +-------------------------------------------------------------------------------- + + A couple of really small points on CCAR for next year for what it's worth is we were constrained in CCAR by leverage. We have issued $6 billion of preferreds in the year. We are reacting to try and make sure that we are managing our binding constraints or our most binding constraints. So we're working on that. +The other thing to note is that we're at 11.4% as we sit here now. So we're not gliding a long way from where we need to get to. Both of those things together, with obviously our profitability, should mean that we have incremental opportunity. But our range is 55% to 75% and we hope to be in that range. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [30] +-------------------------------------------------------------------------------- + + Okay. And then just on TLAC, I know we're still waiting for the Fed decision but we did get FSA recently. Anything in there that you can respond to as to how you're prepared for TLAC? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [31] +-------------------------------------------------------------------------------- + + So just a couple of things. First of all, I think the [FSB] thing was a sort of leak. So it's as good as it is. I will tell you that the news on structured notes was not strongly positive but we hadn't banked on it being. So not entirely pleasing but not disappointing relative to our models and expectations. +Other things to pay attention to anyway are there's no change to the internal TLAC assumptions. The clean holding Company rule is one that we're watching out for. But fundamentally -- and then there was the timing. Is there going to be a substantially elongated transition period? I would call it all fairly marginal. It hasn't changed the overall picture for us. We're at around 16% and we'll figure out the FSB proposal that's leaked out wasn't shockingly different and we'll see how the Fed responds. + +-------------------------------------------------------------------------------- +Operator [32] +-------------------------------------------------------------------------------- + + Your next question is from the line of Jim Mitchell with Buckingham Research. + +-------------------------------------------------------------------------------- +Jim Mitchell, Buckingham Research Group - Analyst [33] +-------------------------------------------------------------------------------- + + Good afternoon. Just maybe a question on NII and NIM. I think Marianne you said it would be relatively flat in the fourth quarter yet you're still expecting some pretty strong loan growth. Just wondering if you could maybe discuss why you think it would remain flat in that scenario? And maybe a bit longer term in an environment where we're looking at lower for longer potentially in the rates, how do we think about the NIM a little bit over the intermediate term? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [34] +-------------------------------------------------------------------------------- + + So with respect to the fourth quarter, we are expecting our loans to grow and overall net-net [rotation out], cash and securities to loans would be supportive of NII. But remember, the biggest boost to our NIM was associated -- or was a big boost to our NIM was associated with changing the mix, reducing our overall cash balances. So, a few things going on. +The outlook for the fourth quarter being relatively flat was associated with market implied rates which are relatively flat. And so in the law of big numbers, that plus or minus a few basis points is what we're expecting. With respect to looking out to 2016, obviously we don't know what's going to happen with the rate curve. If rates stay very flat we should still have upward pressure on our NII associated with the change in mix of our balance sheet. +So the fact that we've got a smaller interest earning asset base and more loans and less cash and less securities should be supportive even on flat rates. We don't know when rates will rise but if market [implies] are followed or if the Fed [dots] or anything like realistic, then that will be even more constructive. Remember in the first year, we get the biggest benefit from short end rates and the first 50 basis points of them. + +-------------------------------------------------------------------------------- +Jim Mitchell, Buckingham Research Group - Analyst [35] +-------------------------------------------------------------------------------- + + Right, I was hoping you would know when rates go up. Thanks. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [36] +-------------------------------------------------------------------------------- + + No, unfortunately not. + +-------------------------------------------------------------------------------- +Jim Mitchell, Buckingham Research Group - Analyst [37] +-------------------------------------------------------------------------------- + + Thanks. + +-------------------------------------------------------------------------------- +Operator [38] +-------------------------------------------------------------------------------- + + Your next question is from the line of Erika Najarian with Bank of America. + +-------------------------------------------------------------------------------- +Erika Najarian, BofA Merrill Lynch - Analyst [39] +-------------------------------------------------------------------------------- + + Yes, good afternoon. My question is on the Credit outlook. The consumer reserve release has continued to offset the wholesale reserve build and I'm just wondering, how should we think about how much is left on the Consumer side over the next several quarters, especially given the 23% loan growth that we saw this quarter and your note saying that this momentum should continue? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [40] +-------------------------------------------------------------------------------- + + So I would say that first of all, with respect to purchased credit impaired, with this release we did on the $375 million, that's our baseline expectation for that portfolio. Our baseline expectation is no material incremental reserves. Obviously if things improve and they're sustained, then there may be more reserve releases. But I wouldn't try and model those. +With respect to the noncredit impaired portfolio we talked about, you've seen our charge-offs at normalized 14 basis points. Our portfolio quality is really getting quite high. We're cycling through most of the significant risks. Reserve releases will be more modest and a little bit more periodic and several hundred million dollars next year, maybe $300 million plus or minus but not significantly more than that. + +-------------------------------------------------------------------------------- +Erika Najarian, BofA Merrill Lynch - Analyst [41] +-------------------------------------------------------------------------------- + + And just my follow-up question, following on Ken and Mike's question on expenses, maybe I'll ask it another way. Over the past two quarters your adjusted overhead ratio was 58% to 60%. You noted that you think that net interest income could grow next year even if rates stay low. Could you potentially slide below the 58% to 60% band that you reported over the past two quarters relative to -- you mentioned an efficiency target of 55% if rates actually normalize? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [42] +-------------------------------------------------------------------------------- + + Look, our efficiency target at 55% was over three years or so and we still will be driving to get to around that level. But it does, as you quite rightly mention, include not just rates rising but a fair degree of normalization in rates. We'll see what happens in 2016. Obviously it's possible but we're not going to call an outlook on rates next year. + +-------------------------------------------------------------------------------- +Erika Najarian, BofA Merrill Lynch - Analyst [43] +-------------------------------------------------------------------------------- + + Thanks. + +-------------------------------------------------------------------------------- +Operator [44] +-------------------------------------------------------------------------------- + + Your next question comes from the line of Matt Burnell with Wells Fargo Securities. + +-------------------------------------------------------------------------------- +Matt Burnell, Wells Fargo Securities, LLC - Analyst [45] +-------------------------------------------------------------------------------- + + Good afternoon. Thanks for taking my call. First of all, Marianne, if I could in terms of some of the credit numbers that you mentioned in terms of the Oil & Gas provisions? They seemed pretty modest in the scheme of your more than $20 billion of exposure to that industry. How are you thinking about the redetermination process that started this quarter and how would you guide us in terms of thinking about what the provisions could be in the fourth quarter following the redetermination this quarter? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [46] +-------------------------------------------------------------------------------- + + Okay. So we've taken some large reserves in the last few quarters and our overall reserve number obviously is consistent with our expectations based upon the outlook for oil prices. There was a redetermination cycle that we reserved for in the first quarter and so there will be another one in the fall. We've been as forward leaning on that as we can be. Obviously I'm not saying that there may not be any net incremental reserve build but we're not expecting them to be significant. A lot of companies have tried to adjust their expense bases and otherwise help their position. So if energy prices stay around these levels and recover slowly, we're expecting, net, not to have material incremental reserves in the next quarter. We may see some. + +-------------------------------------------------------------------------------- +Matt Burnell, Wells Fargo Securities, LLC - Analyst [47] +-------------------------------------------------------------------------------- + + Okay. And then in terms of Mortgage Banking, you noted that production -- the production amount was actually up quite nicely year-over-year but the revenues in terms of production and also in servicing were a bit weaker, certainly on a quarter-over-quarter basis. But the expenses were relatively stable on a quarter-over-quarter basis. Is there something going on there that we might see further improvement in the expense base on the Mortgage side of the business in the fourth quarter? Or are we sort of -- are you at where you need to be in terms of the $1 billion to $1.1 billion a quarter in that business? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [48] +-------------------------------------------------------------------------------- + + Let me deal first of all with production quarter-over-quarter revenues. Margins are down. Margins are down for two principal reasons. Remember, quarter-over-quarter, at least on a closed loan volume, we were at a consistent level. Margins are down because we moved a mix shift towards correspondent from retail towards purchase from re-fi as well as capacity in the industry, more capacity in the industry and therefore less constraints. So the production quarter-over-quarter revenue is more of a margin number than anything. +With respect to year-over-year, I do want to make this clear. With respect to the guidance year-over-year that we should expect non-interest revenue for the mortgage Company in totality to be down $250 million. That brings our total year-over-year NIR down around $1 billion, maybe a little more, which is what we guided to at Investor Day. And it's more off the back of lower repurchase reserve releases, lower gains on Ginnie Mae sales and [XI] gains, non fee-based revenues that are to do with our third party UPB as well as run off in the UPB. So it's consistent with our guidance. It wasn't fully reflected in everyone's models. +I think there was a third part to your question but I have to say I've -- oh, expenses, yes. Thank you. On expenses -- we continue to work very hard on our expense equation, both in terms of managing down the -- particularly in the servicing space by the way, managing down the default inventory in a number of different ways but also investing in our operating model. So in technology, to improve the production operations cycle process, also in our site strategy. So no, we are not done. We continue to work very hard at it. We have made great progress but we continue to work hard at it. + +-------------------------------------------------------------------------------- +Operator [49] +-------------------------------------------------------------------------------- + + Your next question is from the line of Matt O'Connor with Deutsche Bank. + +-------------------------------------------------------------------------------- +Matt O'Connor, Deutsche Bank - Analyst [50] +-------------------------------------------------------------------------------- + + We've seen some assets change hands and you guys have been mentioned as a buyer for some of the other assets that are out there. Just wondering on what the ability and appetite is out there to buy loans. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [51] +-------------------------------------------------------------------------------- + + Obviously, we're not going to comment on anything specific. We would be willing to take and we do take a look at things when they come up and if we are able to price for the risk and it's in a client segment or an entry we like we might be interested. But there's no -- we have no special comments on it. What we're really interested in is growing our underlying core loans with our customers that we can continue to do business with. + +-------------------------------------------------------------------------------- +Matt O'Connor, Deutsche Bank - Analyst [52] +-------------------------------------------------------------------------------- + + Just separately, following up on energy, how exactly do you re-evaluate the portfolio? Is it as the defaults happen, that's where there's a big boost to reserves or you get in front of that? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [53] +-------------------------------------------------------------------------------- + + Not as defaults happen. It's to do -- depends on whether it's reserve based lending or whether it's not. But as companies are either downgraded or as they are experiencing financial -- change in financial condition or the borrowing base is redetermined, we will act accordingly. We try to be as forward-leaning on that as is possible. We don't have perfect insight until some of that information becomes clear. That's the process. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [54] +-------------------------------------------------------------------------------- + + And the reserve base lending, you basically take essentially current prices, you discount at a discount rate, you assume expenses, you [active real engineer] your force and things like that, and you see if you can make rollover the loan at a sound -- I'm going to call it 65% LTV and we think it's pretty good. That's what we're here for is to lend to clients particularly in tough times. You can't be a bank that every time something goes wrong you run away from your client. +We also do things like stress test down to $30 oil, maintain $30 for 18 months and say, how much more reserve do you have to put up? I think I said somewhere, you can correct this number, Marianne, we're not in the same room, that if that happened, we think we're going to have to put up another $500 million or $750 million in reserves. Which is just not something we worry a lot about. + +-------------------------------------------------------------------------------- +Operator [55] +-------------------------------------------------------------------------------- + + Your next question is from the line of Steven Chubak with Nomura. + +-------------------------------------------------------------------------------- +Steven Chubak, Nomura Securities Co., Ltd. - Analyst [56] +-------------------------------------------------------------------------------- + + Good evening. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [57] +-------------------------------------------------------------------------------- + + Good evening. + +-------------------------------------------------------------------------------- +Steven Chubak, Nomura Securities Co., Ltd. - Analyst [58] +-------------------------------------------------------------------------------- + + Marianne, I appreciate your commentary on the preferred issuance that you guys have done so far throughout the year. Looks like you're now above the 150 basis point target. You alluded to that being a function of efforts to manage to your binding constraint under CCAR. Just wanted to get a sense as to what -- how you guys are thinking about issuance plans going forward? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [59] +-------------------------------------------------------------------------------- + + So it's obviously a really great question. Unfortunately we really don't guide to our forward-looking issuance. You're right, we are above 150 basis points right now and we're also working on our leverage balance sheet. So we're working the dials exactly what you would expect us to, but we're not going to make any comments about forward issuance. + +-------------------------------------------------------------------------------- +Steven Chubak, Nomura Securities Co., Ltd. - Analyst [60] +-------------------------------------------------------------------------------- + + Understood. Had to give it a shot. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [61] +-------------------------------------------------------------------------------- + + Yep, I got it. + +-------------------------------------------------------------------------------- +Steven Chubak, Nomura Securities Co., Ltd. - Analyst [62] +-------------------------------------------------------------------------------- + + So just moving over to the Investment Banking side and maybe trying to dig a little bit deeper into some of the guidance you've given on M&A. Looks like the backlogs and expected completions for the fourth quarter are quite healthy but at the same time, post the August volatility, some of the historically strong M&A indicators like market cap, CEO confidence, those measures appear to be deteriorating. I just wanted to get a sense as to how you're thinking about the M&A outlook beyond the fourth quarter, just given some of the weakness that we've seen in some of those measures. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [63] +-------------------------------------------------------------------------------- + + The pipeline for 2016 is building up, so we don't have perfect visibility yet. We think obviously the deals that were being done in 2015 were skewed toward larger deals and we think there may be more flow in 2016 but it looks pretty healthy to us so far, but it's building up. + +-------------------------------------------------------------------------------- +Steven Chubak, Nomura Securities Co., Ltd. - Analyst [64] +-------------------------------------------------------------------------------- + + Okay. Thanks for taking my questions. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [65] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Operator [66] +-------------------------------------------------------------------------------- + + Your next question comes from the line of Gerard Cassidy with RBC. + +-------------------------------------------------------------------------------- +Gerard Cassidy, RBC Capital Markets - Analyst [67] +-------------------------------------------------------------------------------- + + Thank you. Good afternoon. Marianne, can you share with us -- you mentioned that you've built out 400 new relationships in the middle market area of the Commercial bank. But when we look at the loans outstanding, they're essentially flat on a year-over-year basis whereas the Corporate Client business has grown very rapidly. Can you give us some more color behind what's driving those numbers? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [68] +-------------------------------------------------------------------------------- + + I think over the last several quarters, forgive me if I'm slightly wrong but I don't think I'm entirely wrong, our sort of C&I growth has been broadly in line with the industry. Remember that over the course of 2013 and 2014, we did a lot of work on simplifying our businesses and that had an impact on the pace of our loan growth. But our mature markets are performing well. We're seeing growth in our expansion markets. We're adding new clients. We're culling our prospects. So everything is set to continue to see growth more going forward than we have in the past. + +-------------------------------------------------------------------------------- +Gerard Cassidy, RBC Capital Markets - Analyst [69] +-------------------------------------------------------------------------------- + + Okay. And then you talked about the reserve build in the CIB, about $128 million was for Oil & Gas and the total number was $232 million. What was the other areas that required reserve building this quarter? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [70] +-------------------------------------------------------------------------------- + + There was about -- in CIB, there was about $47 million of metals and mining, about net-net $20 million of BAU growth and then just a few other normal BAU puts and takes, downgrades, upgrades. Other than those three things there was no one specific call out. + +-------------------------------------------------------------------------------- +Operator [71] +-------------------------------------------------------------------------------- + + Your next question is from the line of Chris Kotowski from Oppenheimer. + +-------------------------------------------------------------------------------- +Chris Kotowski, Oppenheimer & Co. - Analyst [72] +-------------------------------------------------------------------------------- + + Mine were asked and answered. Thank you. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [73] +-------------------------------------------------------------------------------- + + Thanks, Chris. + +-------------------------------------------------------------------------------- +Operator [74] +-------------------------------------------------------------------------------- + + Your next question comes from the line of Paul Miller with FBR Capital Markets. + +-------------------------------------------------------------------------------- +Paul Miller, FBR Capital Markets - Analyst [75] +-------------------------------------------------------------------------------- + + Yes. On the Mortgage Banking side, I noticed that your jumbo loans -- not your jumbo loans -- that your residential loans on your balance sheet's grown. Are they mostly jumbos and are they coming out of your normal production, that $29 billion and you're selling less to the government? Can you add some color around those numbers? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [76] +-------------------------------------------------------------------------------- + + Of the $19 billion that we put on our balance sheet, around $10 billion, just a little over $10 billion was jumbo. The rest was conventional conforming. + +-------------------------------------------------------------------------------- +Paul Miller, FBR Capital Markets - Analyst [77] +-------------------------------------------------------------------------------- + + And are they mainly ARM loans or are they fixed rate loans? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [78] +-------------------------------------------------------------------------------- + + We'll have to get you the split. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Co. - Chairman & CEO [79] +-------------------------------------------------------------------------------- + + I think the jumbo's like a third ARM. Counting the conforming, I think it's all fixed. That's what I remember. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [80] +-------------------------------------------------------------------------------- + + We'll confirm for you. + +-------------------------------------------------------------------------------- +Operator [81] +-------------------------------------------------------------------------------- + + Your next question is from the line of Eric Wasserstrom with Guggenheim Securities. + +-------------------------------------------------------------------------------- +Eric Wasserstrom, Guggenheim Securities LLC - Analyst [82] +-------------------------------------------------------------------------------- + + Thanks very much. Marianne, if I can just follow up on some of the consumer credit quality metrics. At the Investor Day and subsequently Gordon was indicating unsurprisingly just given the very low levels that the expectation should probably be for some moderate rate of deterioration. And yet, we haven't seen it and I'm guessing that's partly because of the underwriting that's occurred over the past few years. My question is, what are the circumstances in which we should expect more significant deterioration there? Is it only macro or is there something else competitively that could influence that at this stage? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [83] +-------------------------------------------------------------------------------- + + You are right that at these kind of 2.5%, 250 basis point levels in Card, it does speak to the quality of the loans we're originating and the engagement with the customers. Which is much more now about driving, yes, some NII but really, really good spend and therefore lower credit quality. It's an integrated equation. We're expecting, given our originations and the runoff portfolio, the work loans running off in the portfolio that we're building is really very, very clean. +We're expecting that those charge-off rates to be low for the short to medium term, to read out for the next year for sure. And there will be a combination of things that would drive that. But largely it would be environmental. We don't expect at this point, we have made changes to our credit box but they aren't material changes and we'll continue to test our appetite to want to do that and that may have an impact. But we're originating the vast majority of our cards in the super prime sector. + +-------------------------------------------------------------------------------- +Eric Wasserstrom, Guggenheim Securities LLC - Analyst [84] +-------------------------------------------------------------------------------- + + And are the dynamics similar in Auto as well? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [85] +-------------------------------------------------------------------------------- + + Similar, yes. Compared to the industry, our originations are skewed to the prime space. + +-------------------------------------------------------------------------------- +Eric Wasserstrom, Guggenheim Securities LLC - Analyst [86] +-------------------------------------------------------------------------------- + + Thank you very much. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [87] +-------------------------------------------------------------------------------- + + And our LTVs are lower and our durations are in line or lower. + +-------------------------------------------------------------------------------- +Eric Wasserstrom, Guggenheim Securities LLC - Analyst [88] +-------------------------------------------------------------------------------- + + Great. Thanks very much. + +-------------------------------------------------------------------------------- +Operator [89] +-------------------------------------------------------------------------------- + + Your next question comes from the line of Brennan Hawken with UBS. + +-------------------------------------------------------------------------------- +Brennan Hawken, UBS - Analyst [90] +-------------------------------------------------------------------------------- + + Yes, hi. Just a quick one at this point. Equities, Marianne, you highlighted strength in Asia which I think probably was better than maybe some had expected given some of the volatility. So could you give some color on the trends you saw in that region in your Equities business? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [91] +-------------------------------------------------------------------------------- + + The biggest comment I would make is that there was a lot of volatility, particularly in China, in the second part of or the last part of the second quarter. We were -- we did pretty well. We helped our clients. We didn't have significant open risk positions. We weren't very directional. We were able to do well in that situation. Also in the reversal, also on currency moves. It really is a comment I made about we're here to serve our clients, they were transacting, we were able to do risk intermediation in today for them and so we made money on both ends. + +-------------------------------------------------------------------------------- +Brennan Hawken, UBS - Analyst [92] +-------------------------------------------------------------------------------- + + Thanks for that. + +-------------------------------------------------------------------------------- +Operator [93] +-------------------------------------------------------------------------------- + + You have another question from the line of Gerard Cassidy with RBC. + +-------------------------------------------------------------------------------- +Gerard Cassidy, RBC Capital Markets - Analyst [94] +-------------------------------------------------------------------------------- + + Thank you. Hi, Marianne. Quick question on your Consumer business. You guys have shown very strong steady growth in the mobile users. I think it's over $22 million in this quarter. That's up from $18 million a year ago. Can you share with us what percentage of your customers are actually mobile users and how does that compare to a year ago? And what does Gordon think? What's the penetration rate that you think you can finally get to there? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [95] +-------------------------------------------------------------------------------- + + Let me just talk qualitatively for a second and we'll get you some numbers. But we're focused on mobile and digital primarily because it's going to be great for the customer experience, it's what our customers want. And also because it's a significant enabler for reducing cost to serve and improving efficiency. So we've been very focused on whether it's quick deposit, whether it's quick pay, whether it's our mobile wallet, whether it's our mobile app and we've been seeing great results. I'm off the top of my head not going to be able to tell you the penetration rates but we can get back to you. + +-------------------------------------------------------------------------------- +Gerard Cassidy, RBC Capital Markets - Analyst [96] +-------------------------------------------------------------------------------- + + Is there any evidence that you guys can point to where you're actually taking market share from other banks because your mobile products are just more superior than some of the smaller regional banks and community banks? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [97] +-------------------------------------------------------------------------------- + + I can tell you that we are growing our deposits nearly twice the industry. That we know. I think that's a reasonable indication for a bunch of different reasons and that we have a very highly rated app. I think the most highly rated bank app but we'll check that too. + +-------------------------------------------------------------------------------- +Gerard Cassidy, RBC Capital Markets - Analyst [98] +-------------------------------------------------------------------------------- + + Okay. And then finally, your asset yields jumped this quarter which was good to see of course. Can you share with us how the Fed funds rate went up as much as it did sequentially? And also your securities yield went up in the quarter sequentially, can you give us some color behind both those numbers? Thank you. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [99] +-------------------------------------------------------------------------------- + + On the Fed funds and reverse repos, we had moved toward higher yielding, for example, emerging markets assets there. So we got some high yield there. We saw some yield on our trading book moving out of emerging markets. Just a bit of puts and takes. On securities, was it significant? I'm sorry, I'll come back to you. Operator, any more? + +-------------------------------------------------------------------------------- +Operator [100] +-------------------------------------------------------------------------------- + + There are no further questions. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [101] +-------------------------------------------------------------------------------- + + Thank you everyone. + +-------------------------------------------------------------------------------- +Operator [102] +-------------------------------------------------------------------------------- + + Ladies and gentlemen, this concludes today's call. You may now disconnect. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/exam/original-files/Problem_2_3_Sample_full_transcripts/2015-Oct-21-KO.N-137832140186-Transcript.txt b/exam/original-files/Problem_2_3_Sample_full_transcripts/2015-Oct-21-KO.N-137832140186-Transcript.txt new file mode 100644 index 0000000..feaabab --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_full_transcripts/2015-Oct-21-KO.N-137832140186-Transcript.txt @@ -0,0 +1,573 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q3 2015 Coca-Cola Co Earnings Call +10/21/2015 09:30 AM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * James Quincey + The Coca-Cola Company - President and COO + * Kathy Waller + The Coca-Cola Company - CFO + * James Quincy + The Coca-Cola Company - President and COO + * Muhtar Kent + The Coca-Cola Company - Chairman and CEO + * Tim Leveridge + The Coca-Cola Company - VP and IR Officer + +================================================================================ +Conference Call Participiants +================================================================================ + + * Judy Hong + Goldman Sachs - Analyst + * Dara Mohsenian + Morgan Stanley - Analyst + * Bryan Spillane + BofA Merrill Lynch - Analyst + * Ali Dibadj + Sanford Bernstein - Analyst + * Bill Marshall + Barclays Capital - Analyst + * Nik Modi + RBC Capital Markets - Analyst + * Vivien Azer + Cowen and Company - Analyst + * Steve Powers + UBS - Analyst + * John Faucher + JPMorgan - Analyst + +================================================================================ +Presentation +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + At this time I would like to welcome everyone to The Coca-Cola Company's third-quarter 2015 earnings results conference call. Today's call is being recorded. If you have any objections, please disconnect at this time. +(Operator Instructions) +Participants will be announced by name and company. I would like to remind everyone that the purpose of this conference is to talk with investors. Therefore, questions from the media will not be addressed. Media participants should contact Coca-Cola's media relations department if they have questions. +I would now like to introduce Tim Leveridge, Vice President and Investor Relations Officer. Mr. Leveridge, you may begin. + +-------------------------------------------------------------------------------- +Tim Leveridge, The Coca-Cola Company - VP and IR Officer [2] +-------------------------------------------------------------------------------- + + Good morning and thank you for being with us today. I'm joined by Muhtar Kent, our Chairman and Chief Executive Officer; James Quincey, our President and Chief Operating Officer; and Kathy Waller, our Chief Financial Officer. +Before we begin I would like to inform you that you can find webcast materials in the investor section of our Company website at www.cocacolacompany.com that support the prepared remarks by Muhtar, James, and Kathy this morning. I would also like to note that we have posted schedules under the financial reports and information tab in the investor section of our Company website. These schedules reconcile certain non-GAAP financial measures which may be referred to by our senior executives during this morning's discussion to our results as reported under Generally Accepted Accounting Principles. Please look on our website for this information. +In addition, this conference call may contain forward-looking statements including statements concerning long-term earnings objectives and should be considered in conjunction with cautionary statements contained in our earnings release and in the Company's most recent periodic SEC report. +Following prepared remarks this morning, we will turn the call over for your questions. In order to allow as many people to ask questions as possible, we ask that you limit yourself to one question. If you have multiple questions, please reenter the queue in order to ask additional questions. +Now I will turn the call over to Muhtar. + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Company - Chairman and CEO [3] +-------------------------------------------------------------------------------- + + Thank you, Tim, and good morning, everyone. 12 months ago we announced a five-point strategic plan to reignite our performance. Since then, our Company has undergone substantial change while navigating a slowing global macroeconomic environment. +Before handing the call over to James Quincey, our recently announced President and Chief Operating Officer, to review our third quarter performance results, let me recap the decisive actions we have taken over the past year as well as highlight why we believe the Coca-Cola Company is well-positioned to continue winning in the vibrant nonalcoholic beverage industry. +First, we said we would drive revenue and profit growth with clear portfolio roles across our markets. We have and will continue to do so. We segmented our markets to develop long-term revenue growth strategies based on clear volume price investment and profit expectations which were built into our 2015 plans and strategies going forward. Importantly, we revised our annual incentive metrics to include revenue growth and tied them directly to these clear portfolio roles in order to drive the right behavior in each market. +Second, we said we would target disciplined brand and growth investments. Last year we significantly increased our media investments and we're doing so again this year. Also under the leadership of Marcos de Quinto, who was named Chief Marketing Officer at the beginning of this year, we've improved the quality of our advertising while rewiring our marketing organization around consumer clusters to drive speed, efficiency, and effectiveness. And we're seeing results with year-to-date value share performance accelerating across several markets. +In addition, the incremental marketing is helping to accelerate revenue growth in some of our markets, key markets, including North America. We also made investments in new growth platforms. We closed the transaction with Monster Beverage Corporation to compete more effectively in the global energy category, and just recently our brands launched on the Keurig KOLD system in the home dispensing platform. +In China, we've announced plans to expand into plant-based protein drinks through the acquisition of the beverage business of China Green Culiangwang Beverages Holding that recently received regulatory approval. And in the United States we invested in and signed a distribution agreement with Suja, a high-growth, organic cold-pressed juice company. All these are long-term investments that we believe will allow us to add profitable new transactions in the nonalcoholic beverage industry. +Third, we said we would drive efficiency through more aggressive productivity. Our current $3 billion productivity program touches every part of our business and organization from our operating model to cost of goods sold to marketing expenses. We're driving these savings through a disciplined process that involves our entire leadership team and associates. Ultimately it's about building a culture that is focused on getting better every single day and challenging every dollar we spend. We're on track against our overall goals, and importantly, have implemented a broad set of changes in 2015 that will help us continue progress into 2016 and beyond. These include the implementation of Zero-based work across our entire Company as well as our corporate center and operating units and disciplined program management approach to drive cost of goods sold savings in everything from our formulas to our packaging, to our day-to-day operations in our plants. +Fourth, we said we would streamline and simplify our organization. To date, we standardized key processes, linked our business units with our corporate center and eliminated group functional roles in order to speed up decision-making and enhance focus at the local level to drive growth. Our previously announced headcount reductions are substantially completed and we are operating within our new structure. Importantly, we're ahead in terms of scope and timing. +Finally, we said we would refocus on our core business model of building the world's greatest beverage brands and leading an unmatched global system. Over the past year, we made substantial progress in evolving and strengthening our bottling landscape. Starting in North America, so far we have transferred or signed agreements for territories covering over 30% of US bottle/can volume. And just recently, we announced the creation of the National Product Supply System in order to align on a clear path forward for our 21st century manufacturing footprint in the United States. In Europe, we announced the creation of Coca-Cola European Partners which will transform the Western European bottling landscape. +And looking outside the developed world, we've made critical changes to our bottling system in key emerging markets. At the end of last year, we entered into an agreement to rearchitect our African bottling system with the creation of Coca-Cola Beverages Africa, which will have the scale, resources, and efficiencies to fund the investment required to capture the strong long-term growth potential in Africa. Also, during the first quarter of this year, we invested in our Indonesian bottler to help our system capture the long-term opportunity in this attractive and large emerging market. +In short, our Company has undergone a significant amount of streamlining and change these past 12 months. And while we are encouraged by our progress, we know we need to do more, which leads me to our most recent change. As we continue to increase our focus on improving global execution, we recently appointed James Quincey to the position of President and Chief Operating Officer. James has a deep knowledge of the global system, has solid existing relationships with both bottlers and customers all around the world. He is uniquely qualified to celebrate the Company's five strategic initiatives for growth in the months and years ahead. +I will now hand the call over to James who will walk you through our quarterly performance. + +-------------------------------------------------------------------------------- +James Quincey, The Coca-Cola Company - President and COO [4] +-------------------------------------------------------------------------------- + + Thank you, Muhtar. Good morning, everyone. Let me start on this first earnings call by saying that it's a tremendous honor for me to serve as the President and Chief Operating Officer of The Coca-Cola Company. In my 19 years with the Company, I've seen our business evolve and grow while remaining strategically focused on doing the right things to drive long-term sustainable growth. As Muhtar referenced, we are resolutely focused on executing against the five strategic initiatives laid out last year, and a significant part of my role will be ensuring that we deliver. +Now, during the quarter, we made two important announcements that provide clarity on the future of our distribution and bottling structures in the United States and in Europe. First, in our flagship market, we announced the creation of the National Product Supply System, or NPSS, to strengthen and streamline US production as part of our effort to refranchise bottling territories in North America. Our approach embodies the best of both worlds by encompassing a national production system that generates efficiencies in scale for our system in combination with regional production that leverages the expertise and local knowledge of our longstanding bottling partners, Coca-Cola Consolidated, Coca-Cola United, and Swire Coca-Cola USA. These bottlers will continue to own and operate their own plants, and, where applicable, acquire additional production assets from the Company owned Coca-Cola Refreshments. This will provide a clear profit incentive to make the local operations as efficient as possible. +However, to ensure the benefits of scale remain, the NPSS will have a governing Board with the power to implement measures to ensure the production assets owned by NPSS bottlers are optimally deployed to produce at the lowest cost benefiting the entire system. This Board will focus on making decisions on infrastructure planning, innovation planning, and optimal sourcing for the national level. The Board will be comprised of is representatives from Coca-Cola North America, Coca-Cola Refreshments and the three independent bottlers which together currently represent approximately 95% of the US produced volume. +We believe this structure allows us to leverage our significant system scale with the unique competitive advantage of being able to act locally with speed. Together with our focus on driving revenue, this will result in system margin expansion over the coming years. In addition to systemwide benefits, this approach has the additional benefit for The Coca-Cola Company in that it accelerates our return to an asset-light model which will result in higher operating margins, lower capital spending and invested capital, and improved return on invested capital for our Company as we transition these production assets. +We also continue to make progress on the refranchising of the US distribution territories. Just this morning we announced that we signed nonbinding letters of intent on additional distribution territories in seven states. As Muhtar referenced, this will bring the total amount of volume in territories transitioned to date, all covered by agreements, to over 30% of US bottle/can volume. +Also during the quarter, we announced the merger of our Company-owned German bottling operations with Coca-Cola Iberian Partners and Coca-Cola Enterprises into a new Company named Coca-Cola European Bottlers. This will transform our Western European bottling landscape and create the world's largest independent Coca-Cola bottler based on revenue. The creation of a larger unified bottling partner in Western Europe represents an important step in our global systems evolution as we continue to adapt our business model to innovate, invest, and grow along with the changing demands of the marketplace. This merger enhances alignment within the Coca-Cola system, enabling us to more effectively compete and drive growth across developed European markets. Importantly, the new Company will position to deliver world-class execution and customer service by leveraging the best practices of each party to drive sustainable growth in multiple categories. +Now, turning to the performance in this quarter. While the global economic environment remains challenging, as the slowdown in the Chinese economy and the lower oil prices are putting pressure on many commodity-dependent economies, such as Australia, Brazil, and Russia, while volatility rippling through the Middle East causes further economic uncertainty. Despite these macroeconomic challenges, our five-point plan and our focus on execution and reinvestment drove improved results with both unit case volume and price mix growing 3% each in the quarter as outlined in our quarterly performance scorecard on slide 11. Organic revenues grew 3%, driven by the previously mentioned strong price mix and slight growth in concentrate shipments. +Our top-line performance was broad based with five of the six operating segments delivering organic revenue growth. North America continued this disciplined approach to volume, price, and mix management, and I'm encouraged by the solid progress we've seen in this market over the past two years. In Europe, we drove top-line growth through strong commercial and marketing activities whilst also benefiting from some good weather in much of the region. We are seeing green shoots in Europe and our business in Central and Southern Europe delivered a particularly strong quarter due to investments in media, changes in our price pack architecture and favorable weather. +In Latin America, we delivered double-digit organic revenue growth despite worsening conditions in Brazil. Our Mexico business unit helped to balance the weakness in Brazil by accelerating unit case volume growth of 4% in the quarter with growth across all the major categories. In Eurasia and Africa, deteriorating conditions in Russia and volatility in the Middle East partially offset the solid performance in the Africa businesses. +Turning finally to the Asia Pacific Group, China and India both grew unit case volume mid single digits in the quarter. In India, this marks a return to growth for our business after a tough second quarter with our volume growth trends improving in each month. In China, our consistent strategy and focus on execution led to continued value and volume share gains in nonalcoholic ready-to-drink beverages. Notably trademark Coca-Cola reached its highest year-to-date share levels since 2011. In Japan, volume did decline, driven by poor weather in the quarter as well as a move to focus on price realization by reducing discounting on certain low-value multiserve packs. While this may have short-term consequences in volume and share, it is more important to improve our pricing in the marketplace. +Finally, our Bottling Investments Group delivered 3% organic revenue growth led by operations in Germany, India, and Vietnam. As a result, we once again gained global value share in nonalcoholic ready-to-drink beverages in the quarter with gains in both sparkling and still beverages worldwide. +In summary, our third-quarter performance marks another positive step towards achieving our goal of accelerating top-line growth with the Company delivering both solid pricing and unit case volume growth. We are confident in our strategies and execution and remain on track to deliver against expectations for this year. +I will now hand over to Kathy who will provide you a more detailed look at our financial performance, as well as our outlook on our business for the rest of 2015. + +-------------------------------------------------------------------------------- +Kathy Waller, The Coca-Cola Company - CFO [5] +-------------------------------------------------------------------------------- + + Thank you, James, and good morning, everyone. Organic revenue growth was driven by three points of positive price mix. Consolidated price mix in the quarter was driven by positive pricing and product mix initiatives across many of our key markets and benefited from positive geographic mix due to the strong volume growth in our Bottling Investments Group. +After adjusting for the additional days in the first quarter, year-to-date concentrate shipments were slightly behind unit cases, primarily due to the timing of shipments in the prior year in our Asia Pacific and Eurasia and Africa groups. For the full year, we continue to expect concentrate shipments to be generally in line with unit cases. +Our comparable currency neutral growth margin expanded on a consolidated basis due to positive pricing, productivity savings, and a slightly lower commodity costs, partially offset by structural changes. Positive comparable currency neutral operating leverage was driven primarily by cycling the timing of marketing [dispenses], the impact of which we expect to reverse in the fourth quarter, as well as by a continued focus on controlling our operating costs. +For the quarter, comparable currency neutral operating income grew 8%. Below the operating line, net interest income was lower versus prior year, resulting in 7% growth in comparable currency neutral income before tax, which included a 1-point structural headwind. Our third quarter comparable EPS was $0.51, which included a 12-point currency headwind. On a comparable currency neutral basis, our EPS grew 8% in the quarter. +Items impacting comparability in the quarter were primarily related to noncash charges related to the announced refranchising of territories in North America. During the first nine months of the year, we generated $6.7 billion in free cash flow, up 6%, primarily due to the efficient management of working capital and the impact of six additional days, partially offset by an unfavorable impact from currency exchange rates, the impact from refranchising territories in North America, and the brand transfer agreement with Monster Beverage Corporation. +Our focus on improving working capital contributed an incremental $600 million of cash flow for the first nine months of 2015 versus the prior year. We returned $5.6 billion to shareowners in the form of dividends and net share repurchases during the first nine months. +Turning to outlook, we are broadly in line with our expectations for the first nine months of the year. With one quarter remaining, we expect our full-year comparable currency neutral EPS to grow 5%, in line with our previous expectations. However, due to the strength of the US dollar, we now expect the currency impact to be slightly more unfavorable. After considering our hedge positions, current spot rates, and the cycling of our prior-year rates, we now expect an approximate 7-point currency headwind on net revenue, 11-point headwind on operating income, and an 8-point headwind on income before tax for the full-year 2015. Therefore, we expect our comparable EPS to decline 3% for the year. Our full-year outlook implies that our fourth-quarter comparable currency neutral EPS will decline mid to high single digits. +There are a couple of points to consider when modeling the fourth quarter. As we communicated at the beginning of the year, our fourth quarter will have six fewer selling days this year. Due to the timing of expenses last year, combined with the increase in media investments this year, we expect DME to increase substantially in the fourth quarter. We expect structural items to be a slight headwind on net revenue and a 2-point headwind on gross profit -- on both gross profit and income before tax. +We currently estimate currency will be a 6-point headwind on net revenues, a 12-point headwind on operating income, and a 10-point headwind on income before tax in the fourth quarter as we cycle more favorable rates from the prior year. As a reminder, these impacts are based on current spot rates and given the volatile currency environment, these amounts are subject to change. +In summary, as you heard from Muhtar and James, our financial performance is consistent with what we discussed early in the year, and we continue to execute as we outlined. Operator, we are now ready for questions. + + +================================================================================ +Questions and Answers +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Thank you. We will now begin the question-and-answer portion of today's call. +(Operator Instructions) +Our first question is from Dara Mohsenian of Morgan Stanley. Your line is open. You may proceed. + +-------------------------------------------------------------------------------- +Dara Mohsenian, Morgan Stanley - Analyst [2] +-------------------------------------------------------------------------------- + + Hi, good morning. + +-------------------------------------------------------------------------------- +Kathy Waller, The Coca-Cola Company - CFO [3] +-------------------------------------------------------------------------------- + + Good morning. + +-------------------------------------------------------------------------------- +Dara Mohsenian, Morgan Stanley - Analyst [4] +-------------------------------------------------------------------------------- + + So, Muhtar, it's been a year since you announced the plans to focus on greater pricing in developed markets as well as boost marketing spend starting in 2015, and I was hoping you could just take a step back and give us a more detailed review of your progress on those fronts, how much top-line growth is responding to those efforts relative to your expectations, both in terms of the market share payback from the higher marketing as well as the demand elasticity from the higher pricing. +Then just in terms of the quarter, on an adjusted basis ex the concentrate lag, it looks like underlying revenue results are returning to your long-term goals with 3% unit case result and 3% price mix. So at this point, do you feel comfortable you can generally meet those long-term top-line growth goals going forward, ex any timing issues, or with emerging markets macros still decelerating and perhaps easy comps from this quarter it's a bit too early to call for that? Thanks. + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Company - Chairman and CEO [5] +-------------------------------------------------------------------------------- + + Yes, thanks for the question. What I would say in general overall is, yes, we're pleased with the quarter and the progress we're making, but lots of more work to do. This is a transition year. +When we talked to you about 12 months ago, we outlined to you that with the changes we're going to make that our goal is to get to mid single digit, currency neutral revenue growth for the comparable revenue growth for the Company overall. And I think if you look at our progress to date for the first three-quarters of the year, we're at sort of the bottom end of that range, the mid single digit. +If you look at where we are in revenue in terms of currency neutral comparable, and what we have posted in this past quarter, the third quarter, you would see us, if you take those numbers that you mentioned in terms of volume growth of 3% and price mix of 3%, at the top end of that range. +So, in essence, we're pleased with the progress -- what all the five-point strategy and executing it diligently over the last nine months and even starting at the end of last year has brought us to where we are. And so we feel that -- we've always said the marketing has a lag, the incremental marketing, there's a lag in terms of when we input it and the results that we're getting. +But we see that the plan is working, and we certainly see that we're taking a very strategic approach in terms of marketing spend versus optimal levels. Consistent quality investment in media continues to be one of the strongest drivers of our business, enabling us to generate that revenue. We look at each market, how many weeks of consumer engagement there is. The goal over time is to apply the right pressure in the right way to each of our brands, and each of the segments that you mentioned, which is developed, developing and emerging. +The system alignment in our bottling system is matching our alignments with investments -- I'm sorry, with capabilities, execution, output development, cooler placement, et cetera. So we're pleased with what we see there. And, of course, all of this being said, we have a volatile macroeconomic environment which obviously is not getting any better anytime soon. +We realize that the global growth for 2015 is projected to be below last year, and even having said that, the disposable incomes are even lagging the growth rates that are projected. So, yes -- but in general, that's how I would frame your question, and both James and I and Kathy believe that the incremental and better marking is certainly giving us the results in terms of the top line currency neutral comparable top-line growth. + +-------------------------------------------------------------------------------- +Dara Mohsenian, Morgan Stanley - Analyst [6] +-------------------------------------------------------------------------------- + + Great. Thanks. + +-------------------------------------------------------------------------------- +Operator [7] +-------------------------------------------------------------------------------- + + Thank you. The next question is from Steve Powers of UBS. Your line is open. You may proceed. + +-------------------------------------------------------------------------------- +Steve Powers, UBS - Analyst [8] +-------------------------------------------------------------------------------- + + I actually want to talk a little bit more about the National Product Supply System that James detailed. And I guess specifically, maybe Muhtar or James, could you talk more about the governance process there and the makeup of the managing Board? As I understand it, there are five voting members, CCR, Coke North America, and then the three bottlers, Consolidated, United, and Swire. +I'm curious as to how you ensure that tough decisions get made in structure and implemented in that structure? Do you need unanimous consents? Is it majority rules? And if there isn't unanimous consent or support for a given measure, what gives the NPSG the power to enforce successful implementation? Thanks. + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Company - Chairman and CEO [9] +-------------------------------------------------------------------------------- + + Thanks, Steve. What we said again at the beginning of this journey back three, four years ago, is that we said that we have an intention to create a system in the United States that can benefit from the local empowerment in each of the communities in the markets that have built our business so successfully over the last 130 years, the franchise system, the alignment that that brings, the value and trust between us and our bottling partners. +But at the same time create the mechanism, so to speak, the processes, flexible processes in the marketplace, whether it be information systems, whether it be the customer management system, so that we can speak with one voice to customers coast to coast in the United States, and the national product supply system. +All of those negotiations with our expanding bottlers took some time to achieve. They are all achieved. That's why we're progressing with rapidly with our refranchising program, which is working very well, because when we have those processes in place, we can refranchise with confidence and speed and have the business continue to generate the results and the growth that we are seeing in revenue, particularly in the United States of America. +And the United States nonalcoholic beverage business is healthy. It is growing in revenues and dollars and cents, and that's the really important measure -- important element that I want to leave with you. But just to add more color and flavor to the National Product Supply System question that you had in terms of the governance model, I will ask James to comment further and give you more insights. James? + +-------------------------------------------------------------------------------- +James Quincy, The Coca-Cola Company - President and COO [10] +-------------------------------------------------------------------------------- + + I think just specifically on governance, it's not going to be around unanimity. It's going to be based on the driving of the business case. Everyone is committed to doing what is economically the most rational answer for the system. Again, when it comes to the national issues, it's not necessarily the management of each local plant which will remain the job of each of the participating bottlers, or CCNA. + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Company - Chairman and CEO [11] +-------------------------------------------------------------------------------- + + Steve, did that address your question? + +-------------------------------------------------------------------------------- +Steve Powers, UBS - Analyst [12] +-------------------------------------------------------------------------------- + + Yes. Sorry, I was on mute. No, thank you, that does help. But I guess, James, just to follow up, if there is friction on a given issue, or if there is debate about what is in the best economic interest of the system, what's the tie-breaker? How does the majority view get pushed through? + +-------------------------------------------------------------------------------- +James Quincy, The Coca-Cola Company - President and COO [13] +-------------------------------------------------------------------------------- + + We're not laying out the precise mechanics, but I can tell you that there's not going to be a full consensus required for every decision. It is going to be a large majority, and if they support the economic case, then that's what's going to move forward. +We're not creating a system that can become blocked. We're creating a system to focus on the best economics of the system in North America and there are mechanisms for that to go forward. + +-------------------------------------------------------------------------------- +Steve Powers, UBS - Analyst [14] +-------------------------------------------------------------------------------- + + Great. There are mechanisms in place to break a tie? + +-------------------------------------------------------------------------------- +James Quincy, The Coca-Cola Company - President and COO [15] +-------------------------------------------------------------------------------- + + Correct. + +-------------------------------------------------------------------------------- +Steve Powers, UBS - Analyst [16] +-------------------------------------------------------------------------------- + + Thank you very much. + +-------------------------------------------------------------------------------- +Operator [17] +-------------------------------------------------------------------------------- + + Thank you. The next question is from Judy Hong of Goldman Sachs. You may proceed. + +-------------------------------------------------------------------------------- +Judy Hong, Goldman Sachs - Analyst [18] +-------------------------------------------------------------------------------- + + I guess I was hoping to get a little bit more color in your performance in Europe this quarter. 4% volume growth, certainly an improvement there. You called out some of the factors, the green shoots in Europe, you've got the favorable weather conditions, as well as the marketing spending step-up. +So, number one, can you just talk about a little bit more about what really drove the volume improvement? How sustainable those improvements are in terms of volume? And then if you think about price mix performance in Europe, kind of flattish performance in a more developed market, how should we think about that number? How much was that geographic mix? And are you seeing actual price realization in some of the markets, understanding that obviously it's a tough deflationary market there. + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Company - Chairman and CEO [19] +-------------------------------------------------------------------------------- + + Judy, thanks. This is Muhtar. Good morning. Unit case, as I just said, did grow 4% in the quarter in Europe. They were cycling a minus 5% from prior year, and sparkling was up as well as stills growing faster than sparkling in Western Europe. Then our concentrate sales did trail also the unit cases in Western Europe as it did for the whole Company. +And I'll ask -- and we were pleased with the results and certainly, again, some early results from the marketing, but more to come. And I will ask James to add more color to that. James? + +-------------------------------------------------------------------------------- +James Quincy, The Coca-Cola Company - President and COO [20] +-------------------------------------------------------------------------------- + + Thanks, Muhtar. As Muhtar referenced, we were cycling a pretty poor quarter from last year, so I think it was a favorable comparison. We had strong results from very favorable weather in the Southern and the Central part of Europe. But I wouldn't read too much into the one quarter. I think if you look at the longer-term trends, you can see that we're getting some volume growth in the year to date where the price mix is bouncing around flat. +I think it's important to recognize two things as it comes to price mix in the case of Europe. One is the general deflationary nature of the European market. Retail pricing is zero to one, at best in general. And then secondly, it's worth remembering that the starting point of pricing in Europe is, in comparison to the US, higher. So the opportunity is to drive price mix on a sustained long-term basis. +In a sense we've already captured some of that in Europe, and we will be chasing that in the US. So I don't think we'll see the same sort of price mix over time in Europe given our starting points. + +-------------------------------------------------------------------------------- +Judy Hong, Goldman Sachs - Analyst [21] +-------------------------------------------------------------------------------- + + Got it. Thank you. + +-------------------------------------------------------------------------------- +Operator [22] +-------------------------------------------------------------------------------- + + Thank you. The next question is from Bryan Spillane of Bank of America. Your line is open. Please proceed. + +-------------------------------------------------------------------------------- +Bryan Spillane, BofA Merrill Lynch - Analyst [23] +-------------------------------------------------------------------------------- + + Hi, good morning, everyone. + +-------------------------------------------------------------------------------- +Kathy Waller, The Coca-Cola Company - CFO [24] +-------------------------------------------------------------------------------- + + Good morning, Brian. + +-------------------------------------------------------------------------------- +Bryan Spillane, BofA Merrill Lynch - Analyst [25] +-------------------------------------------------------------------------------- + + Kathy, just a question for you. And just thinking about some of the, I guess the macro drivers of the P&L as we move into the fourth quarter and maybe beyond into 2016. Other income this quarter was an expense that had all related to the euro bond gain that you had in the first half and how we think about lapping that next year. +FX, the negative effect on operating income is greater in the fourth quarter than it was in the third quarter. So should we think about FX carrying into 2016? +Then in terms of structural change, I guess with Germany now essentially being contributed to the partnership, or the new entity in Europe, that will be a structural change for next year. But just anything we should be thinking about in terms of changes in the structural change component of modeling, I guess, going into the fourth quarter and maybe into next year would be helpful. Thanks. + +-------------------------------------------------------------------------------- +Kathy Waller, The Coca-Cola Company - CFO [26] +-------------------------------------------------------------------------------- + + Sure, thank you, Bryan. So the foreign exchange for next year, if you remember, we had said that for our hard currencies we are hedged, and so our real exposure is around our emerging currencies. That being said, we do have to cycle that euro debt bond offering which impacted the first and second quarter of this year, and for the full year it was about 3 points benefit to us. +So we do have to cycle that next year on top of the change in the rates and probably a more difficult currency environment going forward. So we will give more color on currency in February when we give our full-year results for 2016. But our issue is really going to be around the emerging markets where we've just -- it's not cost effective to hedge more than about a quarter at a time. +And then in terms of the structural impact, yes, Germany will be a structural impact next year. Obviously we continue with the North American refranchising, so that will still have a significant impact in North America. And there may be some slight impacts from whenever the things -- Africa closes -- the Africa transaction closes. But the majority of it will be the Germany transaction and the North America refranchising. + +-------------------------------------------------------------------------------- +Bryan Spillane, BofA Merrill Lynch - Analyst [27] +-------------------------------------------------------------------------------- + + Okay. Thank you. With the Africa JV, do we still expect that that will close before the end of the year, or is there any update on timing there? + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Company - Chairman and CEO [28] +-------------------------------------------------------------------------------- + + Yes, I want to -- Bryan, this is Muhtar. What I'll say is it's in the regulatory approval process, and that's all I would say right now. We expect it to close sometime over the next three to four months. That's what I would say. + +-------------------------------------------------------------------------------- +Bryan Spillane, BofA Merrill Lynch - Analyst [29] +-------------------------------------------------------------------------------- + + Okay, thank you. + +-------------------------------------------------------------------------------- +Operator [30] +-------------------------------------------------------------------------------- + + Our next question is from Ali Dibadj from Bernstein. Your line is open. You may proceed. + +-------------------------------------------------------------------------------- +Ali Dibadj, Sanford Bernstein - Analyst [31] +-------------------------------------------------------------------------------- + + Hey, guys, just a few things. One is I was hoping you could set people just more at ease around the closure of the gap in unit case volume to concentrate sales. Getting a lot of questions there. If you're real comfortable with that, if that's the case, that that closes for all the regions in the world, it certainly does look like there's an inflection on top line. +But are we now comfortable enough to also start talking a little bit about perhaps a crossover point or an inflection point in the productivity savings being higher than reinvestment rate as well so margins can also look like they're expanding? It looks like you had flat operating margins here, including the FX effects there. But that's better than it has been in a little while as well. So can we clarify and give us a sense on the margin inflection potential as well? + +-------------------------------------------------------------------------------- +Kathy Waller, The Coca-Cola Company - CFO [32] +-------------------------------------------------------------------------------- + + Sure. So the unit cases to concentrate shipment, they were really impacted by Asia Pacific and Latin America. If you look at Latin America on a year-to-date basis, they are absolutely in line. And with Asia Pacific, on a year-to-date basis we expect them to be generally in line. So there's really no story there in terms of that gap. +When you -- moving on to productivity, so productivity initiatives, obviously we are seeing some benefit from productivity. In our margins, there is an impact in our margins from basically the structural changes. So if you were to exclude structural changes, gross margins and operating margins would be higher, and you would see margin expansion. +When you look at the third quarter, when you look at the leverage, so we are getting some productivity, but we also have an impact from timing of the DME from-- basically from prior years that's impacting that timing from this year, that, by the way, turns around in the fourth quarter. So I think there are a lot of puts and takes going on around productivity. You are seeing some productivity coming through. We are continuing to reinvest behind our brands, though. +But our margin expansion is masked right now by currency and structural. So if you pull those two things out, you see very good margin expansion. + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Company - Chairman and CEO [33] +-------------------------------------------------------------------------------- + + And I would just add one point, Ali. I think what we saw in this past quarter in terms of operating margin expansion on a currency neutral comparable basis of about 100 basis points, we were pleased with that expansion. Now, the key is to do everything we can to continue and ensure that we execute fully on the five strategic points going forward so that we can continue to improve our trajectory. + +-------------------------------------------------------------------------------- +Ali Dibadj, Sanford Bernstein - Analyst [34] +-------------------------------------------------------------------------------- + + Okay, that's helpful. Just from a structural perspective, as you mention it, one of the big changes obviously in the marketplace is the ABI SAB deal which is agreed upon, I guess. Can you talk about any of the deal implications to you structurally in that context? +For instance, would you let them produce both for you and the blue system? Is that something you can shed a little bit of light on as now it's an agreed-upon deal it sounds like? + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Company - Chairman and CEO [35] +-------------------------------------------------------------------------------- + + We will not comment on any specific matters related to our customers, bottlers, or any M&A matters. So I would just leave it at that. + +-------------------------------------------------------------------------------- +Ali Dibadj, Sanford Bernstein - Analyst [36] +-------------------------------------------------------------------------------- + + Okay. Thanks, anyway. + +-------------------------------------------------------------------------------- +Operator [37] +-------------------------------------------------------------------------------- + + Our next question is from John Faucher of JPMorgan. Your line is open. Please proceed. + +-------------------------------------------------------------------------------- +John Faucher, JPMorgan - Analyst [38] +-------------------------------------------------------------------------------- + + Yes, thanks. I want to go back as sort of a little bit of a follow-up to Steve's question. If I look at slide 10 in the handouts, if I look at North America, you guys are fragmenting that sort of last piece to market, that last piece of the route to market. And then also to some extent the manufacturing piece, yet you're telling us on the flip side, as we look at Europe, as you create this wall that goes across Europe of all one big bottler, that consolidation is something that seems to be the right thing for Europe. +So can you talk a little bit about why fragmenting North America, yet consolidating Europe at the same time, those are both the right strategies when they -- I don't want to say they're diametrically opposed, but at least they appear to be somewhat in conflict with each other. Thank you. + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Company - Chairman and CEO [39] +-------------------------------------------------------------------------------- + + John, this is Muhtar. Actually they're not in conflict at all. They're basically very complementary to our strategy which is to ensure we have the local touch, and we have also the scale, and we have the processes to meet customer demands and customer partnerships. +And in the United States we've actually not -- you mentioned the word fragmented. We have a national customer management system. We have a national production system. We have a national information system that is basically all with their own governance models, and they're very fluid and very flexible to suit the needs of the business today. +And then at the same time, every piece of the United States that has those elements really have enough size for scale. And then we have the much smaller, the smaller distributor bottling system that also the smaller guys are doing a great job in growing the business for us. +And then in Europe, basically what we have is the customer landscape in Europe is much, much more concentrated in Western Europe where just a handful of customers account for a very large portion of the total future consumption, the retail business in Europe. And, therefore, when you look at what we have created in western Europe, it basically suits our future needs in terms of working proactively with our customer partners and also it gives the scale and also it gives the local touch in each of the markets. +So from that perspective, just like what we've done in Japan, just like what we've done in South Africa, in large markets I'm talking about, it basically very much aligns to our strategy in how you think about what we're doing in the marketplace. + +-------------------------------------------------------------------------------- +John Faucher, JPMorgan - Analyst [40] +-------------------------------------------------------------------------------- + + Okay. If I can just ask a follow-up, I guess you talked about local touch with the smaller local bottlers in the US, then you also talked about local touch in Europe. And I guess, again, just to play devil's advocate here, aren't you moving away from the local -- I realize you are going to try and keep some of the local pieces through the new bottling entity, but it seems to me that's moving less local. It sounds like you're trying to have it both ways. +I guess I'm just not following why one is so dramatically better than the other? Is it just simply the smaller account piece on the US side that creates the difference here? + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Company - Chairman and CEO [41] +-------------------------------------------------------------------------------- + + Well, the customer base in the United States and Western Europe is very, very different in terms of how it's structured. And so we follow the customer -- the needs of the customer, what matters. We follow the scale; we follow the necessity for speed. And we feel that the model that is being created in Western Europe will serve us very well for the next decade and beyond. +And the same thing goes for the United States. It is proving that it is serving us very well in terms of getting us to scale, in terms of getting us the costs in production and cost of goods sold, but at the same time retaining the local touch and retaining the local element that is really important in our business. Both of those are valid for Europe and for Western Europe and for Japan and for South Africa and for the United States, or wherever else you are seeing us create a better bottling system. + +-------------------------------------------------------------------------------- +John Faucher, JPMorgan - Analyst [42] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Operator [43] +-------------------------------------------------------------------------------- + + Our next question is from Vivian Azer of Cowen and Company. Your line is open. You may proceed. + +-------------------------------------------------------------------------------- +Vivien Azer, Cowen and Company - Analyst [44] +-------------------------------------------------------------------------------- + + Hi, good morning. + +-------------------------------------------------------------------------------- +Kathy Waller, The Coca-Cola Company - CFO [45] +-------------------------------------------------------------------------------- + + Good morning. + +-------------------------------------------------------------------------------- +Vivien Azer, Cowen and Company - Analyst [46] +-------------------------------------------------------------------------------- + + Muhtar, I wanted to circle back on the comment that you made about the health of the US LRB category. Clearly that's apparent on the still side of the business. But as I look at the syndicated data for carbonated beverages in the United States, it does look like the category is softening a bit. And I think your revenues were down three out of the last four months. So I was hoping you could comment on the evolution of the US CSD side and demand elasticities and how they're evolving, please. Thank you. + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Company - Chairman and CEO [47] +-------------------------------------------------------------------------------- + + Well, I think based on what we're seeing is we're able to generate revenue growth both in the sparkling category very much so, as well as in the still side, and, therefore, that's what my comment referred to. This is not just one quarter, this is multiple quarters. +At the same time, inside that LRB category that is showing very good resilience in terms of both price elasticity, price discipline, approach with customers, generating value for our customers, both in the sparkling side, as well as large and small customers in the still side, we're also seeing that this is the 22nd consecutive quarter of us gaining value share in the marketplace in North America. +And then the mix is really working for us in terms of generating the marketing where the North American market is the first market where we've started employing incremental marketing, better marketing is generating also positive results for us in terms of the revenue growth from sparkling derived, particularly -- purely from sparkling as well as from the still side of the business. James, do you want to add any color to that? + +-------------------------------------------------------------------------------- +James Quincy, The Coca-Cola Company - President and COO [48] +-------------------------------------------------------------------------------- + + Yes, I think, if you take a look at how we're driving the sparkling business, you can look at the transaction packages which represent about 15% of the volume, and they're growing still again this quarter into double digits. So we're very pleased with the marketing and the OBPC approach is driving positive revenue growth for sparkling on a consistent basis. + +-------------------------------------------------------------------------------- +Vivien Azer, Cowen and Company - Analyst [49] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Operator [50] +-------------------------------------------------------------------------------- + + Thank you. The next question is from Bill Marshall of Barclays. Your line is open. You may proceed. + +-------------------------------------------------------------------------------- +Bill Marshall, Barclays Capital - Analyst [51] +-------------------------------------------------------------------------------- + + Good morning. Thank you very much. I was wondering if I could ask you about the recent vote in Mexico. It looks like there's a proposal to reduce the tax on soda by about half on products with five grams of sugar or less per 100 milliliters. First, I was wondering what you thought about the prospects of that? If you could give us any clarity on what percentage of your portfolio that would cover? +And then if we just think about it from a high level, and maybe, James, you could give us some color for a number of these markets. If we look at the Mexican soda tax as a template for the rest of the world, does this suggest any tempering of how some of the regulatory authorities are looking at the category broadly speaking? Thank you. + +-------------------------------------------------------------------------------- +James Quincy, The Coca-Cola Company - President and COO [52] +-------------------------------------------------------------------------------- + + So, of course, we need to wait and see whether the recent vote produces the [act of] law by the end of the process. It's only gone through one of the stages, so we'll see where that ends up. Obviously, we are in favor of reductions in discriminatory taxes. +I think as we look out on how that has impacted the world and how that's being viewed, and it will be used as a case study around the world, the data we have so far is the impact of the tax was to bring down about six calories from the Mexican diet by the end of the process. So we're conscious that obesity is a crisis, we know we need to play a role. +We don't think this is the silver bullet that anyone was looking for, and we think that much more work needs to be done if, indeed, a solution is to be brought to bear on the whole obesity crisis, which overconsumption of anything, including soft drinks, would be a contributor and a part of the problem. +So we'll see where this tax ends up. Clearly taxing diets and [lights] doesn't seem to be the right way forward, and, therefore, if this measure goes through, I think it would be positive. + +-------------------------------------------------------------------------------- +Bill Marshall, Barclays Capital - Analyst [53] +-------------------------------------------------------------------------------- + + Great. Thank you very much. Appreciate it. + +-------------------------------------------------------------------------------- +Operator [54] +-------------------------------------------------------------------------------- + + Thank you. The last question is from Nik Modi of RBC. Your line is open. You may proceed. + +-------------------------------------------------------------------------------- +Nik Modi, RBC Capital Markets - Analyst [55] +-------------------------------------------------------------------------------- + + Thanks. Just a quick question on Asia. Perhaps you can provide a little bit of context. It looks like that business may not be performing as well as you would like broadly speaking. Is this a portfolio issue? Can you just talk a little bit about what's going on across that region, so we can just think about that as we go into 2016? + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Company - Chairman and CEO [56] +-------------------------------------------------------------------------------- + + Yes, I mean, Nik, I'll just say, very broadly, at a high level, we're pleased with our performance in China. Obviously a lot of noise around China these days, but we have, as mentioned earlier in the script, we have an all-time high share for brand Coke in China and we're growing in China and we're gaining share in China and we're investing in China. And the same goes for India, two of the very large markets in Asia, certainly pleased with the results there. +We had some weather-related issues in the quarter before, but we're coming back, the business is really coming back and performing much better in India. So overall, I think -- and then in Japan we're seeing some green shoots in terms of disposable incomes. We're very early still to call it any color. But overall, I'd say -- and then obviously, back in South -- Australasia, the economy was very much related to commodities, and it has suffered, and we're seeing the macro spillover from that. +But I would say, overall, in this past quarter, we're happy with the results of the big economies, and recognizing that we've got more work to do. And that's how I would leave it. + +-------------------------------------------------------------------------------- +Nik Modi, RBC Capital Markets - Analyst [57] +-------------------------------------------------------------------------------- + + Great. Thanks. + +-------------------------------------------------------------------------------- +Operator [58] +-------------------------------------------------------------------------------- + + Thank you. I would now like to turn the call back to Muhtar Kent for closing remarks. + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Company - Chairman and CEO [59] +-------------------------------------------------------------------------------- + + Thank you, James, Kathy, and Tim. So in summary, our Company has undergone a substantial amount of change over the past 10 to 12 months. And our third quarter results demonstrate continued progress against our five strategic initiatives. +The long-term dynamics of our industry remain promising, and we absolutely believe that The Coca-Cola Company and the Coca-Cola system is best positioned to capture that growth in nonalcoholic beverages and to deliver long-term value to our shareholders. As always, we thank you for your interest, your investment in our Company, and for joining us this morning. + +-------------------------------------------------------------------------------- +Operator [60] +-------------------------------------------------------------------------------- + + And that concludes today's call. Thank you for your participation. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/exam/original-files/Problem_2_3_Sample_full_transcripts/2016-Apr-13-JPM.N-138592450715-Transcript.txt b/exam/original-files/Problem_2_3_Sample_full_transcripts/2016-Apr-13-JPM.N-138592450715-Transcript.txt new file mode 100644 index 0000000..2f89e55 --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_full_transcripts/2016-Apr-13-JPM.N-138592450715-Transcript.txt @@ -0,0 +1,979 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q1 2016 JPMorgan Chase & Co Earnings Call +04/13/2016 08:30 AM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Jason Scott + JPMorgan Chase & Company - Head of IR + * Sarah Youngwood + JPMorgan Chase & Company - CFO Consumer Banking + * Jamie Dimon + JPMorgan Chase & Company - Chairman & CEO + * Marianne Lake + JPMorgan Chase & Company - CFO + +================================================================================ +Conference Call Participiants +================================================================================ + + * Gerard Cassidy + RBC Capital Markets - Analyst + * Erika Najarian + BofA Merrill Lynch - Analyst + * Betsy Graseck + Morgan Stanley - Analyst + * Steven Chubak + Nomura Securities Co., Ltd. - Analyst + * Brian Foran + Autonomous Research - Analyst + * Glenn Schorr + Evercore ISI - Analyst + * Brennan Hawken + UBS - Analyst + * Christopher Wheeler + Atlantic Equities - Analyst + * Matthew Burnell + Wells Fargo Securities, LLC - Analyst + * Eric Wasserstrom + Guggenheim Securities LLC - Analyst + * John McDonald + Sanford C. Bernstein & Co. - Analyst + * Jim Mitchell + Buckingham Research Group - Analyst + * Michael Mayo + CLSA Limited - Analyst + * Paul Miller + FBR & Co. - Analyst + * Matt O'Connor + Deutsche Bank - Analyst + * Ken Usdin + Jefferies LLC - Analyst + +================================================================================ +Presentation +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Good morning, ladies and gentlemen. Welcome to JPMorgan Chase's first-quarter 2016 earnings call. This call is being recorded. +(Operator Instructions) +We will now go live to the presentation. Please stand by. At this time I would like to turn the call over to JPMorgan Chase's Chairman and CEO, Jamie Dimon, and Chief Financial Officer, Marianne Lake. Ms. Lake, please go ahead. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Company - CFO [2] +-------------------------------------------------------------------------------- + + Thank you, operator. Good morning, everyone. I'm going to take you through the earnings presentation which is available on our website. Please refer to the disclaimer regarding forward-looking statements at the back of the presentation. +Starting on page 1. The Firm reported net income of $5.5 billion, EPS of $1.35, and a return on tangible common equity of 12% on $24 billion of revenue. And despite the general market backdrop and energy, our results this quarter were quite good, and pretty straightforward. Consumers remain on solid footing, leading to robust growth in business drivers and strong financial performance. In Consumer we saw double digit growth in deposits year on year, healthy loan growth across products driving 17% core loan growth for the Firm, and high single digit card sales volumes. The wholesale businesses performed in line, or better than expectations expressed at Investor Day, and delivered decent financial results in challenging markets with significant volatility and global macro uncertainty. +The Firm's results included one significant item, [$713] million of wholesale credit costs, of which $529 million related to oil & gas reserves and $162 million in metals and mining reserves, which were generally in line with [our guidance]. But we also experienced some charge-offs this quarter in these sectors totaling $48 million, (technical difficulties) guidance of up to $4.75 billion of charge-offs this year. +While oil prices have improved somewhat in March, they do remain near historically low levels and the market is not expecting the recovery to be strong. Further natural gas, which is a meaningful portion of our portfolio, does remain depressed. We don't feel that current prices are sufficient to [spare] a meaningful restart of production. And many of the cost reductions and conservation actions that have been taken are not easily and quickly reversed. Therefore, the impact of oil prices is somewhat asymmetric on credit costs. +Reserves are main specific. They're based on downgrades reflecting the actual financial condition and the [crediting] position of borrowers. As such, we likely will see some incremental reserve builds for the rest of the year, but they will be increasingly situation specific and our ability to estimate them will improve over time. However using reasonable stress assumptions, on draws, downgrades and considering spin-over effects to closely related companies, those incremental reserves could reach $500 million, plus or minus, this year but with a very high degree of variability around that number. +We continue to believe overall our client base is relatively well positioned to weather this downturn. And we will be there to support them whenever feasible. We also monitor for contagion. And aside from experiencing a couple of main specific issues in very closely related companies and observing some general stress in oil regions, we are not seeing anything broad based and would not expect losses to be significant. +Moving on to page 2. Pausing on this page for just a moment, a few comments from overall revenue and expense. We told you that the first rate hike, together with our strong loan growth, would drive 2016 NII higher by $2 billion. And the $700 million increase in net interest income year over year that you see here is in line with that. However sequentially NII was only up slightly as expected, given the absence of certain securities gains that we had in the fourth quarter, as well as day count. +Non-interest revenue was down $1.5 billion year on year, primarily driven by the market environment in both the Corporate & Investment Bank as well as Asset Management, with the biggest drivers being lower IBCs and fixed income markets revenue. In both case versus a very strong prior year. Adjusted expense of $13.9 billion was down 2% year on year on lower performance-based compensation while continuing to self-fund incremental investments and growth. +Turning to page 3. The Firm's fully phased-in advanced fee ET1 ratio was 11.7%, with standardized at 11.9%. The improvement to both ratios was driven primarily by net capital generation. Recall that we ended the year with very low levels of inventory, and as expected we did see that reverse with our spot balance sheet up $70 billion quarter on quarter reflecting growth in deposits and an increase in trading assets and secure financing activity. This also drove a slight increase in RWA, net of run-off and model calibration. +Firm SLR improved to 6.6%. And we returned $3 billion of net capital to shareholders this quarter, including $1.3 billion of net repurchases and common dividends of $0.44 a share. Lastly, the Fed did not object to a $1.9 billion increase in our capital plan, giving incremental capacity for repurchases next quarter. +Moving onto page 4 and Consumer and Community Banking. You'll notice that we consolidated Consumer into one page, and for your reference we've included the old pages in the appendix. CCB generated $2.5 billion of net income and an ROE of 19% with strength across all lines of business. And TNS just announced that for the fourth consecutive year we are the Number One consumer retail bank, reflecting our ability to attract, satisfy and retain customers. The fundamental business drivers remain strong, with average loans up 12% year on year and core loans up 25% driven by mortgage and auto but with strength across products. And we saw record deposit growth of $50 billion, up 10%. +We added over one million households since last year. And our active mobile customer base was up 19%. Revenue of $11.1 billion was up 4% year on year, and up 1% sequentially if you exclude from last quarter nearly $200 million from the Square IPO and a branch sale. In Consumer & Business Banking revenue was up 4% year on year reflecting that record deposit growth I mentioned, as well as higher account and transaction volumes, and investment revenue up 4% despite the challenging environment. +Mortgage revenue increased 7% on higher MSR risk management and strong loan growth, partially offset by lower servicing revenue. Card Commerce Solutions and Auto revenue was up [2%] on strong auto loan and lease growth, 8% growth in card sales and 12% in merchant processing volumes, all of which more than offset the impact of card renegotiations. Expense was down 2% year on year with an overhead ratio improving to 55% as we continued to make progress against our commitments, more than offsetting $200 million in incremental marketing and auto lease growth. Finally, credit trends in the Consumer businesses continue to be favorable. +Now turning to page 5 and the Corporate and Investment Bank. CIB reported net income of $2 billion on revenue of $8.1 billion and an ROE of 11%. In banking, IB revenue was $1.2 billion, down 24% year on year driven by lower equity and debt underwriting fees, but in line with the market which was down 27%. We continue to rank number one in global IBCs and rank number one in three regions: North America, EMEA and LatAm. +It was another strong quarter for advisory, up 8%, versus a wallet that declined 15%. We gained share, ranking number one, as we benefited from a number of deals that were announced in 2015 and closed this quarter. Equity underwriting fees were down 49%, in line with the market, as volatility kept issuers on the sidelines. We maintained our number one rank globally and increased our lead. +Debt underwriting fees were down 35%. And while we were down more than the market, it can be explained by a tough comparison with several large acquisition finance deals in the first quarter of last year, as well as being conflicted out of several large deals this quarter. +In terms of the outlook we expect a sequential decline in M&A to be more than offset by an increase in debt and equity underwriting, if the recent market improvements continue. Treasury services revenue was down 5% driven by business simplification. Lending revenue was down 31% primarily reflecting mark-to-market changes on both hedges of accrual loans and securities received from restructuring. +Moving onto markets. Markets revenue was $5.2 billion and was down 11% year on year, reflecting decent performance given the environment and especially in light of the strength in the [first] quarter of 2015 where we saw elevated client wallet and trading, particularly in January last year particularly around the Swiss franc event. In fact if you indulge me, adjusting for our outperformance year over year results would have been down by mid single digits. +Fixed income revenue was down 13%. The first couple of months of this quarter, as you know, were challenging across markets, but is some stability returned in March. And overall I would characterize the quarter as seeing reasonably solid client activity, but given the market backdrop it was more difficult to monetize flows. We saw better performance in rates and lower performance across other asset classes. +Equity markets revenue was down 5%. And although flows were steady, idiosyncratic events and sharp moves were tough for our clients, both on the way down and back up. Asia equities continued to outperform, driven by market volatility particularly in Japan. +With respect to the second quarter, the relative stability we saw in March has continued into April so far; however, it's also the case that markets are still quite illiquid in certain parts and will be prone to somewhat [abrupt] corrections. So while investors have started to deploy cash and capital markets are wide open for well understood names, there is still remaining caution for more challenging issuers. Although there's been noise in the data globally, there is an emerging belief that it's fundamentally better but we need to continue to see no downward surprises. And as such, we remain somewhat cautious about the second quarter. +Security services revenue was $881 million, in line with guidance. Credit adjustments and other was a loss of $336 million, mainly driven by CVA on spread widening. Credit costs of $459 million were driven by reserve builds for oil and gas and metals and mining, as discussed earlier. Finally, expense of $4.8 billion was down 15% year on year driven by lower performance-based compensation and lower legal expense, with a comp-to-revenue ratio for the quarter of 32%. +Moving onto page 6 and Commercial Banking. The Commercial Bank generated net income of $500 million on revenue of $1.8 billion and an ROE of 11%. Outside of credit costs for oil and gas the first quarter was very solid performance. +Revenue was up 4% year on year, driven by higher loan balances and deposit net interest income offset by lower IB revenues versus a record last year. Expense of $713 million was up 1% year on year and down 5% quarter on quarter, but in line with recent trends if you exclude the impairment taken on leased corporate aircraft last quarter. +We saw strong growth in our loan book with average loan balances up 13% year on year and 3% quarter on quarter, and with portfolio spreads relatively flat for a couple of quarters now. Our commercial real estate business continued to exceed the industry with growth of 18% year on year reflecting superior execution while maintaining credit discipline. +In C&I loans were up 9% year on year driven by robust originations in corporate client banking. Finally on credit, we added $300 million to reserves, mostly related to oil and gas, but we continued to see very low net charge-offs. +Moving onto page 7 and Asset Management. Asset Management reported net income of $587 million with a 30% pretax margin and 25% ROE. Revenue of $3 billion was down 1% year on year driven by weaker markets and lower brokerage revenues. Excluding the impact of the sale of an asset this quarter which contributed $150 million to the revenue number, adjusted revenue AUM and client assets were down each generally in line with lower markets. +Expense of $2.1 billion was down 5% year on year largely driven by lower performance-based compensation. Despite these lower markets we saw positive long-term flows of $12 billion this quarter with strength in fixed income multi-assets and alternatives, and including the benefit of a large mandate being partially offset by outflows in equity products given volatility. +Our long-term investment performance remains strong, with 80% of mutual fund AUM ranked in the first or second quartiles over five years. Loan balances of $110 billion were up 7% year on year, with record mortgage balances up 20% and solid growth in traditional lending. +Before I move on, as you're aware the Department of Labor issued the final fiduciary rule last week. It's a long and complex set of requirements and details will matter. It will take time to fully digest. +On first read there are no significant new provisions from the proposal that would change our position, which is that we've been a fiduciary for over 150 years. And based on our current advisory business we are confident in our ability to adjust and be successful. Perhaps one of the biggest positives is the longer time to implement, which allows us to be even better prepared. +Skipping page 8, as we actually have nothing significant to call out on Corporate and I will move onto the outlook on page 9. We've included our guidance from Investor Day on the page. It's unchanged so I won't go through it, just two new points to highlight. For Asset Management. The first-quarter revenues adjusted for the $150 million were a little over $2.8 billion. And assuming relatively constructive markets we would expect those revenues in the second quarter to be flat to up, but to be less than $3 billion. And obviously expense will also be flat to up in line with those revenues on performance-based compensation. +In the Commercial Bank we expect revenues will be up modestly on continued loan growth, but we also expect expenses to increase to about $725 million as we add bankers and execute on our technology and product investment strategies. The upshot of which is we expect pre-provision net revenue for the Commercial Bank to be relatively in line with the first quarter. +Before moving to Q&A, I want to make a few comments about the news this morning regarding living wills. Obviously we were disappointed with the conclusion reached by the joint agencies on our resolution plan. We have taken this planning process very seriously, and we believe we've made substantial progress. Having said that, the most important thing is we work with our regulators to understand their feedback fully and in more detail. And we are fully committed to meeting their expectations. +So wrapping up, despite challenging market conditions we delivered really quite good performance in the quarter with diversification allowing us to perform well in difficult environments and be there for our clients. Operator, you can open up to Q&A. + + +================================================================================ +Questions and Answers +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) +Your first question comes from the line of Matthew Burnell. + +-------------------------------------------------------------------------------- +Matthew Burnell, Wells Fargo Securities, LLC - Analyst [2] +-------------------------------------------------------------------------------- + + Good morning. Thanks for taking my questions. Marianne, maybe a couple of questions on energy. You noted that the provision was slightly above your guidance this quarter relative to what you mentioned you thought it might be in late February. +Guess I'm curious in terms of what your expectations are in terms of your guidance relative to potential draw-downs, particularly in the $10 billion of high yield loans that you have undrawn? And what your ability is to potentially mitigate potential draw-downs based on the financial condition of your borrowers? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Company - CFO [3] +-------------------------------------------------------------------------------- + + So the first thing I'd say is with respect to oil and gas, obviously I think $529 million is pretty close to $500 million, plus or minus. So that was pretty much in line. But you are saying it'll be a little bit higher with metals and mining. We were expecting close to $100 million and there were a couple of extra downgrades that came through in the quarter, and that kind of timing is going to happen. It doesn't change the overall sort of perspective for us. +With respect to draws, when I gave some sort of indicative guidance about what you might expect to see potentially in the rest of the year in terms of reserve build, we do try to take into consideration the likelihood that we will see incremental draws. And clearly we will work with borrowers to try and help them such that that may not be necessary, and in other cases we can reduce our exposure in redetermination cases. But we will expect to see draws and that's contemplated in our guidance. + And I want to make sure that everyone understood that we tried to be very complete. So this is not just oil and gas and metals and mining, as the [Mace] Code would suggest. We've looked at very closely related companies in shipping and marine transportation and the like. So we're trying to be very complete. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Company - Chairman & CEO [4] +-------------------------------------------------------------------------------- + + We've yet to take a loss. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Company - CFO [5] +-------------------------------------------------------------------------------- + + We have taken a couple. Not very much. + +-------------------------------------------------------------------------------- +Matthew Burnell, Wells Fargo Securities, LLC - Analyst [6] +-------------------------------------------------------------------------------- + + Fair enough, that makes sense. But that dovetails nicely actually into my follow-up. In terms of the wholesale non-accrual balances, those are up about $1.2 billion quarter over quarter. +Can you give us a sense as to how much of that was energy and metals and mining? And were there other areas of the portfolio that added to that? And what's your outlook for wholesale non-accruals over the course of the next couple of quarters? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Company - CFO [7] +-------------------------------------------------------------------------------- + + So of the $1.2 billion, $1 billion was a combination of oil and gas and metal and mining, so the vast majority and outside of that, consistent with my comments on contagion, there's not any sort of thematic other noteworthy thing to mention to you. And obviously as we continue to watch the cycle play out over the next several quarters and reevaluate some clients that may be experiencing stress, it's likely that we will see some more MPLs. But I gave you context around what we're expecting to see in terms of reserve. So they will go up, but not to numbers I would consider to be large in the context of our wholesale portfolio. + +-------------------------------------------------------------------------------- +Operator [8] +-------------------------------------------------------------------------------- + + Your next question comes from the line of Glenn Schorr with Evercore ISI. + +-------------------------------------------------------------------------------- +Glenn Schorr, Evercore ISI - Analyst [9] +-------------------------------------------------------------------------------- + + Hi. Just one follow-up. What was the drawn-on energy facilities this quarter? It doesn't seem to be too big, but -- and then related to that, what's the reserve as a percentage of drawn credit right now? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Company - CFO [10] +-------------------------------------------------------------------------------- + + The draws are about $1.3 billion in the quarter. So some but not excessive. And after the reserves that we put up in the first quarter the coverage ratio is 6.3%. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Company - Chairman & CEO [11] +-------------------------------------------------------------------------------- + + What is it on balance and stuff? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Company - CFO [12] +-------------------------------------------------------------------------------- + + That is the on balance sheet. + +-------------------------------------------------------------------------------- +Glenn Schorr, Evercore ISI - Analyst [13] +-------------------------------------------------------------------------------- + + And then maybe a little bit of different question. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Company - CFO [14] +-------------------------------------------------------------------------------- + + Sorry Glenn, just on that 6.3%, that's the Firm. If you look in the Commercial Bank, obviously it's higher. So you've got a sort of a different portfolio mix in the Commercial Bank versus the CIB. So if it's some parts of our portfolio it's closer to 9% or 10% and in other parts it's lower. Sorry. Your second question? + +-------------------------------------------------------------------------------- +Glenn Schorr, Evercore ISI - Analyst [15] +-------------------------------------------------------------------------------- + + I appreciate that, and I thank you. +The other question is on growth. We've been waiting for a long time, but you've been seeing great growth across a lot of different products. CRE up 18% and the commercial bank C&I up 9%. +At this stage of the cycle, I appreciate the consumer's showing a lot of strength. Is there any growth where we scratch our heads and said, wow is that growing too much? It sounds funny for me to be asking for less growth, but just curious to get your thoughts. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Company - CFO [16] +-------------------------------------------------------------------------------- + + It's a perfectly reasonable question. And obviously when we look at growth in CRE, or the commercial real estate business, of 18% it's an obvious question, are you doing something different? And the answer is, no we're not. We haven't changed our geographies, we haven't changed our risk appetite. It just simply is the case that we have a good process and we are continuing to focus on our sort of core capabilities and our core risk segments. But we've been able to take advantage of the opportunity because our process is better, and to a lesser degree, but nonetheless to a degree, given that the CMBS market has been somewhat disrupted. + +-------------------------------------------------------------------------------- +Operator [17] +-------------------------------------------------------------------------------- + + Your next question comes from the line of Betsy Graseck with Morgan Stanley. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [18] +-------------------------------------------------------------------------------- + + Hi, good morning. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Company - CFO [19] +-------------------------------------------------------------------------------- + + Hi. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [20] +-------------------------------------------------------------------------------- + + I have a question on the living wills. The indication today was that there were four areas that you needed to enhance. Liquidity was one of those and I was a little surprised to see that, given the strength of your liquidity book. I guess what I'm wondering is, does the living will submission and the changes that you have to make have an impact on your current business at all? In other words, do you need to build liquidity to meet the requirements that the regulators have, or this is in a obviously worse case scenario you'd build at that time? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Company - CFO [21] +-------------------------------------------------------------------------------- + + So Betsy obviously, with having only received the specific feedback less than 24 hours ago we still have to get into the analysis phase about what it all means. +I would start with your opening comment that considering our liquidity you were surprised. This doesn't appear to be a statement about the adequacy obviously of JPMorgan's liquidity, which is very significant, as you know. But it really about how we analyze and think about that at the material legal entity level and the inter-affiliate nature of how we formed our entity. So I can't tell you with any clarity exactly what will be required as we get into the analysis. It wouldn't be my core expectation that it would require us to do a meaningful overall new liquidity actions, but we have to do the work. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [22] +-------------------------------------------------------------------------------- + + As we think about the implications of this morning's announcement, it's around your planning and procedures as opposed to a likely impact on the business operations today and the results that you can generate, is that a reasonable conclusion? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Company - CFO [23] +-------------------------------------------------------------------------------- + + Again, just based on our preliminary read, I think there's going to be significant work to meet the expectation of the regulators. And our plan already had us doing a lot of work around actual real simplification of legal entities and other things. So I don't know that there are going to be significant changes. It's not my primary expectation that there would be, but we do need to have a moment to go through the details. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Company - Chairman & CEO [24] +-------------------------------------------------------------------------------- + + The liquidity of the Company is extraordinary. We have $400 billion in central banks around the world, $300 billion of AA-plus short duration securities, just about $300 billion of very short-term secure -- really top quality repo or type of stuff like that. The trading book is $300 billion, which is mostly very liquid kind of stuff. So the liquidity of the Company is extraordinary. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Company - CFO [25] +-------------------------------------------------------------------------------- + + I would say, just again, we need to do the work and we need to figure out obviously what the response to that will be. But it is encouraging that sometimes we're found to be credible for large systemic financial institutions. And if they have been able to adequately show their preparedness, we're confident we should be able to do the same. We just need to make sure that we understand the details of what it is that we don't have in our plan today that we need to change, and we're committed to doing it. + +-------------------------------------------------------------------------------- +Operator [26] +-------------------------------------------------------------------------------- + + Your next question comes from the line of Gerard Cassidy with RBC. + +-------------------------------------------------------------------------------- +Gerard Cassidy, RBC Capital Markets - Analyst [27] +-------------------------------------------------------------------------------- + + Thank you. Good morning. Marianne, can you expand upon your comments in your opening dialogue about the energy exposure? You're not too worried about the contagion risk, but you did say there are a couple of specific issues relating to some very closely related companies. Can you give us more color on what you're referring to? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Company - CFO [28] +-------------------------------------------------------------------------------- + + Yes, absolutely. So I just wanted -- if you used the industry codes the way that you could if you want to expand your thinking to just what is technically considered to be an oil and gas company, you'd miss out on, for example, a marine shipping company that all they do is ship oil and therefore their financial and their performance is going to be directly related to the health of the energy sector. +Those companies we have identified them specifically, they are managed within our energy risk team. They are not managed by a different team. So I was simply saying that some of the companies that we are watching, and in one or two small cases that have experienced some stress, are not traditional energy companies. But their condition is directly related to oil and gas. + +-------------------------------------------------------------------------------- +Gerard Cassidy, RBC Capital Markets - Analyst [29] +-------------------------------------------------------------------------------- + + Thank you. And then on the loan growth, which is obviously very strong, what are your people on the front lines saying about commercial real estate? Are there any changes in terms of underwriting metrics that your front line people are seeing since we are starting to see in certain markets, like multifamily, which you guys have already identified as some weak spots? Are there any other underwriting issues that are cropping up now that you didn't see three months ago or six months ago? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Company - CFO [30] +-------------------------------------------------------------------------------- + + So obviously not for us. I would say that it's competitive, as the C&I space is very competitive. Commercial real estate is also competitive, but it's not irrational. And we aren't seeing, or at least we are not seeing very rational proposals on structure and risk. +Meanwhile we haven't changed our risk appetite, we haven't changed our underwriting standards. We continue to have lower LTVs and higher debt coverage ratios, pretty consistent geography. So speaking for JPMorgan specifically, there's been no change in our underwriting standards. In fact if anything since the last crisis, obviously the last recession, we tightened our underwriting standards and we've moved away from some of the riskier types of that business, so home builders and a lot of construction loan business. + +-------------------------------------------------------------------------------- +Operator [31] +-------------------------------------------------------------------------------- + + Your next question comes from the line of Michael Mayo with CLSA. + +-------------------------------------------------------------------------------- +Michael Mayo, CLSA Limited - Analyst [32] +-------------------------------------------------------------------------------- + + Hi. That was a very serious CEO letter you had in the Annual Report. But two questions related to that. +One would be you, Jamie, indicate the potential for higher interest rates, and just looking for some more color into why you think that's the case and if you're preparing the bank for a scenario of higher rates or if you're just trying to set a tone at the top, or perhaps be a contrarian. I know you gave some technical factors in the CEO letter. +And then the second thing is just the contrast between what you have in the CEO letter, liquidity trading governance oversight with the living will letter that came out today. And just a follow-up on the earlier question, do you simply have to write a better resolution plan or might you have to change a little bit the way you do business? And does this make you have a more conservative CCAR ask? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Company - CFO [33] +-------------------------------------------------------------------------------- + + Hey, Mike. I'll start and then Jamie can add to it. +So on the interest rate point, the colors are pretty consistent with what we said over time, which is we have the belief that the US economy is continuing to move in the right direction, that the consumer is on solid footing, and that despite the noise in the data and some of the volatility in the market, global growth will continue albeit at a moderate pace. And obviously stability in the markets in March has continued to help us with that thesis. So that coupled with the fact that the Fed themselves, while they are dovish in their narratives in the minutes and also they are [dots] are continuing to talk about gradual increases, and the debate around negative rates has kind of quieted. +So we don't particularly run the Company with a day-to-day view on what's going to happen with interest rates, we are positioned for rising rates, as you know, and have been. But we also understand what the performance of the Company looks like if there are no more rate rises, or when we stress our portfolios in lots of different ways. +So we are positioned for rising rates, it is our central case that will happen. The market is pricing less than one hike in this year. The Fed dot says two. Our research says two. We're just going to have to wait and see. +I'll also start and then Jamie can jump in on the living will thing. We have to take it at face value in discussions with our regulators that we need to meet their requirements, whatever they may be, all of the rules whether it's capital, whether it's liquidity, whether it's stress testing, whether it's resolution plans. And if we do that and satisfy them, then we can continue to operate the Company the way that we think it is best for our clients and communities around the world. + So at this point we need to remediate and address the issues and the feedback they've given us and resubmit a plan for assessment that we hope will be credible. And that's certainly what we will commit to do. And that's what we are focused on. + +-------------------------------------------------------------------------------- +Michael Mayo, CLSA Limited - Analyst [34] +-------------------------------------------------------------------------------- + + Was there anything else from Jamie on that, because if you compare and contrast the CEO letter to what the regulators just said about you guys, it's not completely consistent? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Company - Chairman & CEO [35] +-------------------------------------------------------------------------------- + + Well I don't think it's inconsistent. We're trying to meet all the regulations, all the rules and all the requirements. We've been doing that now for five or six years. What is it, six years since Dodd-Frank was passed. They had their job to do and we have to conform to it. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Company - CFO [36] +-------------------------------------------------------------------------------- + + I know it's easy to sort of overlook the quite a few statements where there's an acknowledgment that progress has been made. And none of the feedback in the letter negates the significant progress across the industry on capital liquidity stress testing. So it is consistent, but we have more work to do and we'll do it. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Company - Chairman & CEO [37] +-------------------------------------------------------------------------------- + + On the interest rate stuff, I wasn't predicting it. I'm simply saying I think there's a chance it will be different than what people expect, and it will be a little -- I said it'll gradual until it's sudden. + +-------------------------------------------------------------------------------- +Operator [38] +-------------------------------------------------------------------------------- + + Your next question is from the line of Brian Foran with Autonomous. + +-------------------------------------------------------------------------------- +Brian Foran, Autonomous Research - Analyst [39] +-------------------------------------------------------------------------------- + + Hi, good morning. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Company - CFO [40] +-------------------------------------------------------------------------------- + + Good morning. + +-------------------------------------------------------------------------------- +Brian Foran, Autonomous Research - Analyst [41] +-------------------------------------------------------------------------------- + + I wonder on trading, you appreciate that you reported first so you haven't seen the market yet. But two questions around the whole thesis, the last man standing versus restructures. +One, do you have any sense of whether your performance overall and really thick represented market share gains or not this quarter? And then two, with some of the guidance coming out of the European banks in particular being very poor and some of the restructurings maybe accelerating steam, is there any thought around comp and maybe using that as a lever to improve returns over the remainder of the year and into next? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Company - CFO [42] +-------------------------------------------------------------------------------- + + So obviously we're the first to read out, and it's very difficult when you think about performance because you also have to think about the relative performance in the comparable periods and prior years and the like. So I would say that down mid-single digits adjusted for what we would consider to have been outperformance last year is really quite good performance. So I don't know that we gained share, but I certainly think we protected share, and it may differ across the different product sets. But I think in general we feel pretty good about our performance and we don't know anything to the contrary. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Company - Chairman & CEO [43] +-------------------------------------------------------------------------------- + + I'd just add that $5 billion-plus of sales and trading in a quarter like this look as good, earning decent returns. We have good margins. We're not quite sure about share, but it was -- I would look as quite a good performance. And trading losses, while we, was it six days you said to me? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Company - CFO [44] +-------------------------------------------------------------------------------- + + Six days, yes. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Company - Chairman & CEO [45] +-------------------------------------------------------------------------------- + + Six days, there was -- like $40,000. So that the actual results were just -- that's really good. I look at that as a very healthy business. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Company - CFO [46] +-------------------------------------------------------------------------------- + + And then with respect to the restructuring and whether that presents opportunities for us broadly [define], including in compensation for -- we pay for performance and we pay risk (inaudible) returns, and we're not looking to try and make changes to what we've been very consistent about over time. And you can see our comp-to-revenue ratio of 32% this quarter is in line with the ratio in the first quarter of last year, and in fact the first quarter of the year before. So lower -- obviously on lower revenues, but a fair pay for the performance. And obviously we intend to insure that we are competitive, but we're not going to take any direct actions as a result of that in terms of (multiple speakers) -- + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Company - Chairman & CEO [47] +-------------------------------------------------------------------------------- + + We've also got some big deals done near the end of the quarter in Western Digital and [Newmar] Cable, which is part of sales and trading. We also got -- we did this, I thought, a very creative Chase, [what I would call], a Chase Trust in order to secure the first real securitization in a long time in the mortgage business, we do revenue risk-sharing, and I think it's quite good. + +-------------------------------------------------------------------------------- +Operator [48] +-------------------------------------------------------------------------------- + + Your next question comes from the line of John McDonald with Bernstein. + +-------------------------------------------------------------------------------- +John McDonald, Sanford C. Bernstein & Co. - Analyst [49] +-------------------------------------------------------------------------------- + + Hi. Just a question on expenses. First, was there any legal expense in the quarter? And then just a broader question, Marianne. +Are the incremental expense saves you're getting from your programs flowing through the bottom line, or is it some of it getting reinvesting, like in CCB I noticed the headcount is up a little bit on page 11, just the last couple quarters? Is that reflect like reinvestment of the cost saves? And then just on the legal side, if you had anything this quarter? Thanks. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Company - CFO [50] +-------------------------------------------------------------------------------- + + On legal, the number is [circ] $0. Pretax is actually slightly positive. After-tax we did some true-ups, assessments on penalty. So actually net/net about $0 this quarter, which I'll take it for the quarter but it doesn't necessarily predict the future. +In terms of expenses, so we talked at Investor Day, Gordon in particular but also Daniel, that we are continuing to invest in our businesses. And across the board in fact adding bankers and technology and digital, digitizing, et cetera. So we continue to do that across the businesses and I mentioned in the CCB page that the net expenses, albeit down, includes self-funding $200 million of incremental investments year over year and growth. + But you did notice the headcount in the Consumer businesses is up slightly. And that's a combination of the investments we're making in technology and digital, that's about 500 of the heads and other 1500 is increasing part-time staffing in the branches so that we have flexibility to make sure that we have loading at the right times of day for making sure the customer experience is good. So I would characterize it all as very consistent and yes, we continue to invest. And that is in part what you're seeing in the headcount in CCB. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Company - Chairman & CEO [51] +-------------------------------------------------------------------------------- + + And you saw new credit card Freedom Unlimited 1.5% back. We're doing a lot of stuff in Chase Pay. So the Starbucks thing, we apply the top digital side, and we continue to win awards in the Consumer Bank. So we'll always be investing there. + +-------------------------------------------------------------------------------- +Operator [52] +-------------------------------------------------------------------------------- + + Your next question comes from the line of Erika Najarian with Bank of America. + +-------------------------------------------------------------------------------- +Erika Najarian, BofA Merrill Lynch - Analyst [53] +-------------------------------------------------------------------------------- + + Yes, good morning. You're fielding a lot of questions on energy credit quality. But taking a step back, given that the delinquency statistics outside of energy still remain fairly stable, could you give us an outlook for how you think credit quality trends will play out for the rest of the year if the base case is slow growth in the US? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Company - CFO [54] +-------------------------------------------------------------------------------- + + So it is our expectation across both the consumer and the wholesale businesses outside of energy that the credit trends will remain favorable, or credit will be relatively benign. We're not expecting to see material increases, except for the fact that we are growing our loan portfolio. +So when we did Investor Day we talked about charge-offs this year will go up year on year, and they will go up to potentially as high as $4.75 billion. But half of that would be on the back of the fact that we are growing our portfolios. So you'd just have natural sort of BAU levels of charge-off from that and then the other half would be on energy. So we're not expecting or seeing at this point anything, other than good credit quality for the rest of 2016, outside of the obvious. + +-------------------------------------------------------------------------------- +Erika Najarian, BofA Merrill Lynch - Analyst [55] +-------------------------------------------------------------------------------- + + Great. And just one more follow-up question on the living will. Could you help us understand what you think the regulators meant in terms of if the remediation is not met by October 1 of this year that there could be more stringent prudential requirements? Could that possibly mean higher capital or liquidity standards if the expectations aren't met by October? I guess we always thought of the living will as more of a cost issue rather than a further tax on regulatory ratios. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Company - CFO [56] +-------------------------------------------------------------------------------- + + So I will start by saying that as you know our regulators have extraordinary powers over a wide range of requirements for us regardless, and many ways of influencing those and you're familiar with most of them. It is absolutely the case that as you look at the resolution process that there are provisions that talk about if remediation is not satisfactory with, or cured within a two-year period, there are - there's a possibility that the regulators could jointly decide, may jointly decide, to take other actions that could include capital or liquidity or leverage or operating model discussions. So obviously they do have those powers. +October is not that far away. We're going to do our very, very best to make sure that we put our best foot forward and remediate the issues and then we have another submission in July 2017. So not to suggest that we won't fully remediate them to the very best of our ability, but the living will process I expect to continue to be somewhat iterative over the next several cycles, and we continue to push ourselves to raise the bar. And I'm certain that the bar will continue to be raised on us, as it should. + +-------------------------------------------------------------------------------- +Operator [57] +-------------------------------------------------------------------------------- + + Your next question comes from the line of Matt O'Connor with Deutsche Bank. + +-------------------------------------------------------------------------------- +Matt O'Connor, Deutsche Bank - Analyst [58] +-------------------------------------------------------------------------------- + + Good morning. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Company - CFO [59] +-------------------------------------------------------------------------------- + + Good morning, Matt. + +-------------------------------------------------------------------------------- +Matt O'Connor, Deutsche Bank - Analyst [60] +-------------------------------------------------------------------------------- + + If I look at the first-quarter net interest income, which was at least better than what I had, good NIM, and think about your full-year outlook. If I take it literally it implies flattish net interest income dollars from here. And I'm just wondering if that's too literal of an interpretation, or if maybe there are some offsets to the loan growth from, say, lower long-term rates as we think about the rest of the year? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Company - CFO [61] +-------------------------------------------------------------------------------- + + Okay. So we talked about the fact that if there's no change in rates and if we continue to grow our loans, we would expect our NII to go up by $2 billion. So you're right, if you look at the run rate right now that would be relatively flat from here. +I think in our favor, because of the easing that's still going on around the rest of the world and the sort of the dovish Fed comments, there's been a lower re-price just in the industry generally. So that's in our favor and we're much more sensitive to the front end of rates. So we're not suggesting that the long end of the curve has no impact, it's relatively modest. So $2 billion, maybe a little more. The biggest driver of significantly higher NII above that guidance would be if we had another hike earlier than December. + +-------------------------------------------------------------------------------- +Matt O'Connor, Deutsche Bank - Analyst [62] +-------------------------------------------------------------------------------- + + And then just separately, any comments on the Treasuries ruling on inversion as you think about M&A, kind of broadly speaking for the industry and for you guys specifically? And if you can frame how much that driven your M&A revenues in the past, or the industry? Any color around that would be helpful. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Company - CFO [63] +-------------------------------------------------------------------------------- + + So not going to talk specifically about the Treasuries' actions, other than saying that we would support Fed tax reform in general. With respect to the impact on our business, either historically or going forward, it wouldn't be zero and it wouldn't be significant. + +-------------------------------------------------------------------------------- +Operator [64] +-------------------------------------------------------------------------------- + + Your next question comes from the line of Jim Mitchell with Buckingham Research. + +-------------------------------------------------------------------------------- +Jim Mitchell, Buckingham Research Group - Analyst [65] +-------------------------------------------------------------------------------- + + Good morning. Maybe we could talk a little bit about CCAR. I've had some investors express concern about the Fed's inclusion of negative rates. Have you found that to be difficult in terms of modeling? And overall, I guess given the improvement -- on the flip side, given the improvement in your capital ratios, do you think that there's -- you should be able to see some improvement or increase in CCAR into -- now that you've looked at it for a few months? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Company - CFO [66] +-------------------------------------------------------------------------------- + + Okay. So obviously I'm not going to be able to talk specifically about our plans that we've submitted because we just submitted them and we haven't had any feedback and they are confidential, but I will tell you that obviously negative rates, it was the first time this has been in the scenario. It's not the first time we have thought about it, and it is not the first time that we've experienced it, and at least in other parts of the world in Europe, Japan and elsewhere. So we have had strategic discussions, we understand broadly what we think we would do and what would happen to our balance sheet. We can model it and we can effect it. So in that sense, now I mean obviously, we'll continue to work that process through if it continues to be a feature of CCAR. +You're absolutely right that year over year our launch point is a higher level of capital and our balance sheet and our credit quality continues to improve, and our risk levels have not materially changed. So as a general matter we would hope, and we've also added [press]. So as a general matter we would hope to have incremental capacity but nothing inconsistent with what we have said externally, which is that the Board would like over time to continue to have the capacity to potentially increase dividends and that we would likely the capacity to, within a reasonable range, repurchase our stock. And that's the framework that we have used to submit our plan. + +-------------------------------------------------------------------------------- +Operator [67] +-------------------------------------------------------------------------------- + + Your next question is from the line of Steve Chubak with Nomura. + +-------------------------------------------------------------------------------- +Steven Chubak, Nomura Securities Co., Ltd. - Analyst [68] +-------------------------------------------------------------------------------- + + Hi, good morning. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Company - CFO [69] +-------------------------------------------------------------------------------- + + Good morning. + +-------------------------------------------------------------------------------- +Steven Chubak, Nomura Securities Co., Ltd. - Analyst [70] +-------------------------------------------------------------------------------- + + So Marianne, within the Asset Management segment you noted that the revenues were down in line with the market. But if we isolate the fee income components to exclude some of the gains you highlighted as well as other income, the revenues declined by double digit both quarter on quarter and year on year, which is a bit more pronounced than what we had expected. And I was hoping you could speak to maybe some of the factors outside of the market declines that may be impacting revenues in that business, specifically what you're seeing in terms of retail engagement and maybe whether you've seen improvement in sentiment now that the markets have recovered pretty nicely off the February trough? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Company - CFO [71] +-------------------------------------------------------------------------------- + + So if I do the -- I don't want to use the word call, if I adjust for the full impact of the asset sale that was in the quarter not just the $150 million in this quarter but also the revenues that were present with respect to that in the first quarter of last year, my adjusted revenues are down about 4% to a market that on average, while I appreciate that it recovered in March, but the market on average for the quarter was down around 5%. So we would characterize that as generally in line. And similarly if you do adjustments on the balance sheet side, the Assets Under Management and client assets. So certainly you can speak to Jason afterwards and reconcile our numbers so that we're not confusing each other. +I'm sorry what was the second part of your question? + +-------------------------------------------------------------------------------- +Steven Chubak, Nomura Securities Co., Ltd. - Analyst [72] +-------------------------------------------------------------------------------- + + The retail engagement. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Company - CFO [73] +-------------------------------------------------------------------------------- + + Retail engagement. So retail engagement picked up in March, as you would expect. We saw positive flows. We obviously saw negative flows for the quarter in equities, that's not surprising. And then we saw positive flows, particularly in multi-asset. So we did see some reasonably healthier retail flows in the quarter, but primarily in March, and some were offset by outflows in equities. + +-------------------------------------------------------------------------------- +Steven Chubak, Nomura Securities Co., Ltd. - Analyst [74] +-------------------------------------------------------------------------------- + + Excellent. Thank you. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Company - CFO [75] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Operator [76] +-------------------------------------------------------------------------------- + + Your next question is from the line of Brennan Hawken with UBS. + +-------------------------------------------------------------------------------- +Brennan Hawken, UBS - Analyst [77] +-------------------------------------------------------------------------------- + + Good morning, Marianne. Quick question on NIM here. Can you talk about how sustainable you think the NIM expansion might be and whether or not there's anything one-time in the numbers we should adjust for? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Company - CFO [78] +-------------------------------------------------------------------------------- + + As luck would have it, in this quarter there is nothing one-time that you need to adjust for. Last quarter there obviously was. So we would expect that our NIM should be stable to improving over the course of 2016. The extent to which it would improve, obviously depending upon what happens in term of gradual rising rates. + +-------------------------------------------------------------------------------- +Brennan Hawken, UBS - Analyst [79] +-------------------------------------------------------------------------------- + + Okay, great. Thank you. And then on the energy exposures in the loan book, can you comment on maybe whether or not some of the equity capital raising that we've seen in the energy space has perhaps taken some of the tail risk away from that book? And then is it possible also to update us on the criticized exposures in oil and gas? I believe in the 10K it was somewhere around $4.5 billion at year end? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Company - CFO [80] +-------------------------------------------------------------------------------- + + Okay. So with respect to equity capital raises, I mean obviously to a degree that would be true, although those companies that were able to access the equity markets are not those that are experiencing the most stress. So obviously all other things equal it's a positive, but I'm not necessarily thinking it's going to take significant steam or the pressure off. With respect to second part of your question I'm so sorry? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Company - Chairman & CEO [81] +-------------------------------------------------------------------------------- + + The C&C. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Company - CFO [82] +-------------------------------------------------------------------------------- + + Jason will get back to you. I'm sorry, I don't have the answer. + +-------------------------------------------------------------------------------- +Brennan Hawken, UBS - Analyst [83] +-------------------------------------------------------------------------------- + + No problem. Thanks so much. + +-------------------------------------------------------------------------------- +Operator [84] +-------------------------------------------------------------------------------- + + Your next question comes from the line of Eric Wasserstrom with Guggenheim Securities. + +-------------------------------------------------------------------------------- +Eric Wasserstrom, Guggenheim Securities LLC - Analyst [85] +-------------------------------------------------------------------------------- + + Thanks. Marianne, can you comment on what competitive conditions are like in the credit card market currently and if there's been any change around the intensity of competition for co-brands and awards? And I think Jamie you alluded to the launch of a new product. I'd love to get an update on your initial thoughts about how it's going. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Company - CFO [86] +-------------------------------------------------------------------------------- + + Okay. So no, nothing has changed in the card competitive landscape, including in co-brands. It's still very competitive, albeit that we saw a little bit of deceleration in sales growth year over year last year and we've seen that trend back positively for us this year. So we feel good about that and we've been increasing our marketing spend and as Jamie did say, we launched Freedom Unlimited quite recently and it has been quite recent, but early feedback is very positive. With respect to Freedom with a 50% increases in activity and interest, there's going to be a degree of cannibalization of other products, we would expect that. But so far, so good. And we just like to give our customers choices. And its been favorably received. + +-------------------------------------------------------------------------------- +Eric Wasserstrom, Guggenheim Securities LLC - Analyst [87] +-------------------------------------------------------------------------------- + + Great, thank you. And on the -- auto has been a big area of focus, and you touched on it certainly during your Investor Day. But on the mid-FICO range is there anything going on, on a macro level, that would suggest some significant likelihood of credit quality deterioration? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Company - CFO [88] +-------------------------------------------------------------------------------- + + So the Manheim is down slightly. We continue to believe and expect that it will continue to trend downwards and so [also seeing] it will continue to trend upwards, just given where it is today and also the amount of leased inventory that will ultimately go into the used car space over the course of the next several years. However the fundamentals are still good, the market is still solid. + We have pulled back on subprime a while ago. It's a small part of our originations. So other than seeing some delinquencies tick up, as expected, in some of the energy-related states but not very significantly, there's nothing at the moment that's on the burner. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Company - Chairman & CEO [89] +-------------------------------------------------------------------------------- + + For us. I do think you'll see issues in the market. + +-------------------------------------------------------------------------------- +Operator [90] +-------------------------------------------------------------------------------- + + Your next question comes from the line of Paul Miller with FBR. + +-------------------------------------------------------------------------------- +Paul Miller, FBR & Co. - Analyst [91] +-------------------------------------------------------------------------------- + + Thank you very much. In the mortgage banking segment you wrote down the MSR by almost as like $0.9 billion. Was there any hedging gains? I couldn't find them in the documents, any hedging gains to offset that? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Company - CFO [92] +-------------------------------------------------------------------------------- + + So the MSR P&L for the quarter was a positive $124 million, and they are a combination of BAU and material factors that added up to that, and probably about half of it was a combination of hedge performance and the market. + +-------------------------------------------------------------------------------- +Paul Miller, FBR & Co. - Analyst [93] +-------------------------------------------------------------------------------- + + And the other. And then on the mortgage banking side, have you been seeing -- you saw the MBA today release that the purchase applications are the high since 2010 or something in that order. Are you seeing the Spring buying season, especially on the purchase side, starting to pick up? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Company - CFO [94] +-------------------------------------------------------------------------------- + + Yes, yes. So purchase applications are up 30%, I think, year on year. We continue to be positive momentum in that space, and we are seeing Spring activity continue to be robust, as expected. + +-------------------------------------------------------------------------------- +Operator [95] +-------------------------------------------------------------------------------- + + Your next question comes from the line of Ken Usdin with Jefferies. + +-------------------------------------------------------------------------------- +Ken Usdin, Jefferies LLC - Analyst [96] +-------------------------------------------------------------------------------- + + Hi, thanks. Good morning. Just two quick follow-ups on the fee side. Understanding that market dependence is built into the outlook to get the $50 billion of fees for the year. I'm just wondering, have we now run-rated the combination of the business repositioning, the card revenue run rate, and so -- and the toughness of this first quarter? I guess the question is really, what are the things that you expect to get better from the first quarter on the fee side upside of normal seasonality? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Company - CFO [97] +-------------------------------------------------------------------------------- + + Okay. So in terms of run rated, the two biggest drivers of the walk that we gave at Investor Day were the card co-brand renegotiations and the mortgage banking non-interest revenue. I would just point out that while we are seeing some of the incremental impact of card renegotiation, that will play out over the course of the year. But on the positive side -- and on the positive side mortgage banking, just given where rates were over the quarter, has been positive relative to central expectations when we did Investor Day. So those two things are worth noting. +But we are seeing really quite good drivers in non-interest revenue drivers across the consumer space generally, in debit investments, in fees and accounts, in the sort of 4%, 5% range, and sometimes in the range higher than that. So we are continuing to see exactly what we expected, which is the majority of our businesses will continue to deliver mid- to high single digit growth, and they seem set to do that. The card impact will be what it will be, and mortgage NII will end up down year over year, whether it's $700 million or $600 million we'll see. And so the biggest driver of what the end result will be is going to be markets. + +-------------------------------------------------------------------------------- +Ken Usdin, Jefferies LLC - Analyst [98] +-------------------------------------------------------------------------------- + + Yes, okay. And I know it's a smaller line item, but just noticing in the guide for security services to be flat from here, there's always some seasonality in there too. But I'm just wondering if you could just give a comment about what you're seeing in that business and are there any incremental challenges that leave you with a flat outlook? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Company - CFO [99] +-------------------------------------------------------------------------------- + + Yes. Look, the business is not immune to markets either. So obviously as you look at the performance for the quarter our fees have been impacted by low asset levels. And we also have got the tail impact of some business simplification, just getting the tail of that out of the performance. We are also seeing the benefit of higher rates. +So I'd characterize the majority of those negatives on lower fees and simplification as being behind us. So the trajectory, if rates continue to rise, would be upwards. But that's why we said market dependence. We were not expecting our performance to go down from here. Flat to up, but depending on rates. + +-------------------------------------------------------------------------------- +Operator [100] +-------------------------------------------------------------------------------- + + Your next question comes from the line of Christopher Wheeler with Atlantic Equities. + +-------------------------------------------------------------------------------- +Christopher Wheeler, Atlantic Equities - Analyst [101] +-------------------------------------------------------------------------------- + + Yes, good morning. The question is already on the compensation ratio. You've obviously done a fantastic job on the cost base. But one of the issues that strikes me is clearly with the reduced revenues, particularly in the capital markets business. Your comp down about $400 million in the --compared to the first quarter of last year. +Obviously what we've experienced generally is you holding the ratio steady for the second or third quarter and then tooling up with a lower ratio in the fourth quarter. So I'm looking at the estimates we have for revenues on a well-known provider of data. We've got pretty flat revenues being forecast by people like me, whether we're right or wrong. Should we be thinking about how you're going to build a bonus pool on the -- against this background and whether we should be looking at thinking -- or thinking that you're going to have to [retain] the comp ratio at a pretty similar level through the year, if indeed we don't see any uptick in revenues and they remain reasonably flat? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Company - CFO [102] +-------------------------------------------------------------------------------- + + So -- + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Company - Chairman & CEO [103] +-------------------------------------------------------------------------------- + + I'd just use 32%. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Company - CFO [104] +-------------------------------------------------------------------------------- + + We've given a range 30% to 35%. We've been at the lower end of that range. When we performed very strongly we could drift up. If we perform less strongly, we pay for performance and I think we did a good job in the first quarter. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Company - Chairman & CEO [105] +-------------------------------------------------------------------------------- + + We have among the lowest ratio. + +-------------------------------------------------------------------------------- +Christopher Wheeler, Atlantic Equities - Analyst [106] +-------------------------------------------------------------------------------- + + Okay, thanks. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Company - Chairman & CEO [107] +-------------------------------------------------------------------------------- + + We're paying our people properly and well. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Company - CFO [108] +-------------------------------------------------------------------------------- + + And consistently. + +-------------------------------------------------------------------------------- +Christopher Wheeler, Atlantic Equities - Analyst [109] +-------------------------------------------------------------------------------- + + But I'm not [be] talking about the quality of the ratio. I'm interested in (inaudible) because clearly what we're seeing are mostly this, and indeed in Europe, is the difficulty of building a pool when you have been so used to having a very strong first quarter, obviously makes it quite difficult. Maybe just as a follow-up which is vaguely related, could I just ask, you talked earlier about where there's question about competition and picking up market share, which indeed you clearly have. But one of the questions I perhaps just wanted to ask is, I know that you've been pushing hard on these equities, cash equities in particular. +My sense is that actually a lot of the players, including the Europeans who are doing massively structural, are putting more capital into equities on the back of the fact that it's a lower capital business and therefore they think they can get higher returns. And just maybe that's why [Nomura] pulled out of European equities yesterday. What are you seeing in the equity space in particular, because I'm not seeing as much sort of withdrawal as we have done in the fixed space? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Company - CFO [110] +-------------------------------------------------------------------------------- + + That's very fair. And we've talked about it pretty often, that people when they restructure, they restructure out of the things that they were less strong at, less comfortable at, and in many cases they double down where they continue to have strength. And we are seeing that. And that's what we mean when we say there's always someone left to fiercely compete in every part of our business, and equities is no exception. It's not the poster child for that. + However, the equities business here at JPMorgan, we've rebuilt our technology platform. We have rebuilt the prime -- we've built the prime brokerage, international capabilities. The two of those work hand in glove. And we have every opportunity to continue to gain share and win. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Company - Chairman & CEO [111] +-------------------------------------------------------------------------------- + + And we've done very well gaining share in electronic trading and the prime broker has been built in Asia and Europe where we had weaknesses. So you've seen our share go up and we intend to win it. We have topnotch research, which obviously helps drive the equity business too. + +-------------------------------------------------------------------------------- +Operator [112] +-------------------------------------------------------------------------------- + + Your next question comes from the line of Gerard Cassidy with RBC. + +-------------------------------------------------------------------------------- +Gerard Cassidy, RBC Capital Markets - Analyst [113] +-------------------------------------------------------------------------------- + + Thank you. Marianne, just as a follow-up I just want to make sure I understood you correctly. On the $500 million of incremental reserve build for energy for the remainder of the year, that's for the total of the following nine months is that correct? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Company - CFO [114] +-------------------------------------------------------------------------------- + + That's correct. + +-------------------------------------------------------------------------------- +Gerard Cassidy, RBC Capital Markets - Analyst [115] +-------------------------------------------------------------------------------- + + I mean, give or take. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Company - CFO [116] +-------------------------------------------------------------------------------- + + Give or take, and that's right. Obvious are there's a high degree of variability around it. If we had complete ability to understand it we would lean into those reserves. But it's name specific and situation specific, it would evolve over time. We just wanted to give you an indication that there's likely to be some more costs. It could be plus or minus quite a bit from that because we've had to make stress assumptions in there. But $500 million for nine months, yes. + +-------------------------------------------------------------------------------- +Gerard Cassidy, RBC Capital Markets - Analyst [117] +-------------------------------------------------------------------------------- + + Okay, thank you. And then I know there was the energy specific shared national credit exam that the first quarter results for the industry will reflect similar to your own. But we also have the traditional shared national credit exam that's been done for 20-plus years. Any color on how that's going, the normal shared national credit exam? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Company - CFO [118] +-------------------------------------------------------------------------------- + + Yes. No Gerard, I'm not going to make any comments about SNC, except to say that everything that we know and aware of is reflected in our results. + +-------------------------------------------------------------------------------- +Operator [119] +-------------------------------------------------------------------------------- + + Your next question comes from the line of John McDonald with Bernstein. + +-------------------------------------------------------------------------------- +John McDonald, Sanford C. Bernstein & Co. - Analyst [120] +-------------------------------------------------------------------------------- + + Hi. Two quick follow-ups, Marianne. Getting a couple questions about just the math on the energy reserve ratio. I think you mentioned 6.3%. Just to be clear, is that the reserve for loans, over-funded loans, and then there's an additional reserve for unfunded commitments? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Company - CFO [121] +-------------------------------------------------------------------------------- + + Correct. Yes. + +-------------------------------------------------------------------------------- +John McDonald, Sanford C. Bernstein & Co. - Analyst [122] +-------------------------------------------------------------------------------- + + Okay, got it. And then did you tell us the size of your energy commitments and whether they changed at all this quarter? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Company - CFO [123] +-------------------------------------------------------------------------------- + + They changed by a couple of billion dollars on a single name that we like, up. + +-------------------------------------------------------------------------------- +Operator [124] +-------------------------------------------------------------------------------- + + And there are no further questions at this time. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Company - CFO [125] +-------------------------------------------------------------------------------- + + Thanks very much. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Company - Chairman & CEO [126] +-------------------------------------------------------------------------------- + + Wait. Before you all go. We should say goodbye to Sarah Youngwood who goes on to a bigger and brighter job as CFO of the Consumer Bank, and she did an outstanding job. And she's succeeded by Jason, who's going to say hi right now. + +-------------------------------------------------------------------------------- +Jason Scott, JPMorgan Chase & Company - Head of IR [127] +-------------------------------------------------------------------------------- + + Hello, hi. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Company - Chairman & CEO [128] +-------------------------------------------------------------------------------- + + So congratulations. You guys have done an outstanding job. + +-------------------------------------------------------------------------------- +Sarah Youngwood, JPMorgan Chase & Company - CFO Consumer Banking [129] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Company - CFO [130] +-------------------------------------------------------------------------------- + + Thank you, everyone. I nearly forgot. + +-------------------------------------------------------------------------------- +Operator [131] +-------------------------------------------------------------------------------- + + Thank you for joining today's conference call. You may now disconnect. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/exam/original-files/Problem_2_3_Sample_full_transcripts/2016-Apr-20-KO.N-141172130225-Transcript.txt b/exam/original-files/Problem_2_3_Sample_full_transcripts/2016-Apr-20-KO.N-141172130225-Transcript.txt new file mode 100644 index 0000000..e6b6e7a --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_full_transcripts/2016-Apr-20-KO.N-141172130225-Transcript.txt @@ -0,0 +1,602 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q1 2016 Coca-Cola Co Earnings Call +04/20/2016 09:00 AM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * James Quincy + Coca-Cola Company - President and COO + * Kathy Waller + Coca-Cola Company - CFO + * Muhtar Kent + Coca-Cola Company - Chairman and CEO + * Tim Leveridge + Coca-Cola Company - VP and IR Officer + +================================================================================ +Conference Call Participiants +================================================================================ + + * Judy Hong + Goldman Sachs - Analyst + * Robert Ottenstein + Evercore ISI - Analyst + * Mark Swartzberg + Stifel Nicolaus - Analyst + * Bryan Spillane + BofA Merrill Lynch - Analyst + * Dara Mohsenian + Morgan Stanley - Analyst + * Ali Dibadj + Bernstein - Analyst + * Brett Cooper + Consumer Edge Research - Analyst + * Bill Chappell + SunTrust Robinson Humphrey - Analyst + * Kevin Grundy + Jefferies & Company - Analyst + * Bill Schmitz + Deutsche Bank - Analyst + * Amit Sharma + BMO Capital Markets - Analyst + * Vivien Azer + Cowen and Company - Analyst + * Steve Powers + UBS - Analyst + * John Faucher + JPMorgan - Analyst + +================================================================================ +Presentation +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + At this time, I would like to welcome everyone to the Coca-Cola Company's first-quarter 2016 earnings results conference call. +Today's call is being recorded. If you have any objections, please disconnect at this time. All participants will be in a listen-only mode until the formal question-and-answer portion of the call. +(Operator Instructions) +I would like to remind everyone that the purpose of this conference is to talk with investors, and therefore questions from the media will not be addressed. Media participants should contact Coca-Cola's Media Relations department if they have questions. +I would now like to introduce Tim Leveridge, Vice President and Investor Relations Officer. Mr. Leveridge, you may begin. + +-------------------------------------------------------------------------------- +Tim Leveridge, Coca-Cola Company - VP and IR Officer [2] +-------------------------------------------------------------------------------- + + Good morning, and thank you for being with us today. +I'm joined by Muhtar Kent, our Chairman and Chief Executive Officer, James Quincy, our President and Chief Operating Officer, and Kathy Waller, our Chief Financial Officer. Before we begin, I would like to inform you that you can find webcast materials in the Investors section of our Company website at www.Coca-ColaCompany.com that support the prepared remarks by Muhtar, James, and Kathy this morning. +I would also like to note that we have posted schedules under the Financial Reports and Information tab in the Investors section of our Company website. These schedule reconcile certain non-GAAP financial measures, which may be referred to by our senior executives during this morning's discussions to the results as reported under Generally Accepted Accounting Principles. Please look on our website for this information. In addition, this conference call may contain forward-looking statements, including statements concerning the long-term earnings objectives, and should be considered in conjunction with cautionary statements contained in our earnings release and in the Company's most recent periodic SEC report. +Following prepared remarks this morning, we will turn the call over to your questions. In order to allow as many people to ask questions as possible, we ask that you limit yourself to one question. If you have multiple questions, please ask your most pressing question first, and then re-enter the queue in order to ask any additional ones. +Now I would like to turn the call over to Muhtar. + +-------------------------------------------------------------------------------- +Muhtar Kent, Coca-Cola Company - Chairman and CEO [3] +-------------------------------------------------------------------------------- + + Thank you, Tim, and good morning, everyone. +18 months ago I communicated a clear five-point plan to reinvigorate our growth and increase profitability. In February we reported a successful transition year in 2015, where we made tangible progress on our plan, and delivered the full-year expectations we laid out. +I'm pleased to report that in the quarter -- first quarter of 2016, we took another positive step in the macro environment that continues to be challenging. Today, I will touch briefly on a few key highlights in the quarter before handing off to James to provide a more detailed review of our operational performance. +We're in the midst of transforming The Coca-Cola Company to one that is even more focused on our core value-creation model of building and supporting strong brands, enhancing customer value, and leading our franchise system. During the first quarter, our continued focus on our five strategic initiatives enabled us to gain value share and deliver positive top-line growth with underlying margin expansion. With the first quarter behind us, we see the challenging global environment continuing, but we remain committed to our full-year targets we laid out in February in both the top- and bottom-line performance. +From a highlights perspective, we continue to execute our strategic initiatives. In the first quarter, we unveiled our new global One Brand marketing strategy for trademark Coca-Cola under the Taste The Feeling campaign, which is elevating system engagement with our employees, bottling partners, and customers. The initial consumer response is encouraging and positive. +Additionally, we added to our portfolio of fast-growing still beverages. We closed our Chinese plant-based protein acquisition of Culiangwang in March. We also invested in Chi, the leading juice and value-added dairy company in Nigeria, Africa's largest economy. Both transactions are further proof points of how we are strengthening our leading stills position, effectively responding to evolving consumer preferences. +Finally, we're accelerating our global re-franchising efforts. In North America, we continued to make progress against our stated goal of re-franchising 100% of our bottling operations by the end of 2017. Including the territories announced this morning, we have transferred or signed agreements on almost 2/3 of the US territories we originally acquired from CCE. +Looking outside of North America to Western Europe, our Coca-Cola European Partners transaction remains on track to close by the end of the second quarter. In Africa, the regulatory approval process continues. The South Africa competition commission has recommended for the competition tribunal to approve the Coca-Cola Beverages Africa merger with certain conditions. The tribunal is set to meet in May to review the pending transaction. +In summary, we recognize that we still have much work to do, but we have defined a clear path to transform the Company, and we are making consistent progress to create long-term value for our share owners. The Coca-Cola Company is becoming stronger, more efficient, and more focused on our core strengths of marketing and brand building, customer value creation, and leading our franchise bottling system. +We're making progress implementing our disciplined global revenue growth management strategy. We're also building new growth opportunities with still and sparkling brands that we develop internally, we acquire from the outside, and we invest in through partnerships. Our franchise bottling system is also getting stronger, faster, more nimble, and more closely aligned. In short, my colleagues and I are getting up every single day with a fresh passion for doing the things that will create long-term sustainable value. +I'll now hand the call over to James, who is going to provide you with a more detailed look at our operating performance in the first quarter. + +-------------------------------------------------------------------------------- +James Quincy, Coca-Cola Company - President and COO [4] +-------------------------------------------------------------------------------- + + Thank you, Muhtar, and good morning everyone. +From an industry perspective, we gained global value share in NERTD beverages in the quarter, with increases in both sparkling and still beverages worldwide. We gained value share in all but one of the sub-categories in stills, where there we maintained value share. +We delivered 2% unit case volume growth, as solid performance in many of our developed markets was partially offset by challenges in emerging markets suffering from the worst of the macro slow-down. This had a disproportionate effect on sparkling volume growth, as the non-alcoholic beverage industry in many of these markets is more weighted towards sparkling beverages. +Consolidated price mix grew 1%, cycling 3%, as solid underlying pricing was partially offset by 1 point of segment mix. We accelerated our price mix across every operating segment except Asia-Pacific versus the first quarter last year. Given the geographic footprint of our own bottling investment group, our consolidated price mix was lower. Given the scale of our pending re-franchising, as you consider the sustainability of our distilling pricing strategy, I think it's helpful to exclude BIG and focus instead on our core business, which delivered 2 points of global price realization. +Results were also impacted by one less day in our fiscal quarter compared to the same period last year, which reduced organic revenue growth by roughly 1 point. As a result, we delivered 2% organic revenue growth, including 1 point head wind from one less day. +In the quarter, structurally adjusted comparable currency-neutral income before tax grew a solid 9%, with the underlying margin expansion reflecting our focus on productivity, as well as the timing of operating expenses. Notably, this expansion occurred alongside the continued growth in our marketing investments. +Now to describe more clearly our operating performance, let me briefly describe our results in three groupings of our markets. First, in markets where our strategies are in place and being executed fairly well, we are seeing strong results. This cluster is led by North America, Latin America, also includes Japan and India. Here, strong marketing, disciplined revenue management, and improving execution are driving results. +For example, specifically in North America, we delivered 2% organic revenue growth, with one less day, 3 points of price realization, led by 3% sparkling price mix, and good operating leverage in the quarter. North America also grew value share again this quarter, and continued to successfully implement its accelerated re-franchising program. +Latin America delivered double-digit organic revenue growth, due to a strong focus on consumer and customer segmentation, despite worsening conditions in Brazil, Venezuela, and Argentina. In Mexico, brand investments, including new products such as del Valle Nada, a sparkling fruit drink, as well as Ciel mineral water and Ciel flavored water, helped increase unit volume by 5%, with growth across all major categories. +Our Japan business unit had a very strong start to the year, supported by several recent innovations, such as I Lohas Peach, an extension of our premium water brand, and a premium-priced Georgia coffee bottle can. We also leveraged innovation from China, launching Lemon Plus C, which is seeing strong early results. These products enabled our value share to out-perform volume share as they skew higher to higher revenue single-serve packaging. +Finally, India. Here we delivered strong performance in the quarter due to the rapid scaling of a new price pack architecture across sparkling and juice segments, coupled with brand marketing and execution efforts. In addition, we expanded our still beverage portfolio in India, with the launch of Vio, our latest value-added dairy beverage. +These positive results give us confidence our strategies are working. While we are making progress in these markets, we also recognize there is more work to be done, and the opportunity for improvement in these good, performing markets continues to be significant. +The second group is comprised of markets where we are taking action to positively transform our Business for the future. Here I would include Europe, where we continue to make progress to the establishments of our newly integrated Western European bottler. Here, several key markets performed very well, led by Spain, up 3%, Germany up 1%, and in the Central and Southern European business unit we grew volume 2%. We look forward to improving performance in Europe as the year progresses. +A second transition market is our African business, where we are taking steps to strengthen our bottling business through the creation of new Coca-Cola Beverages Africa bottler. As Muhtar mentioned, we are also taking steps to diversify our brand portfolio through our investment in Chi, and we continue to improve our execution in key markets on the continent, as exemplified by improving performance in South Africa and Nigeria, where we grew unit case volume 7% and 13%, respectively. +The final bunch of markets where we face clear macro head winds in 2016, Russia and Brazil continue to be challenging. China's transition to a consumer-led economy is putting pressure on commodity-dependent emerging and developing markets. The lower oil price continues to weigh on the Middle East and other oil-driven economies. While Argentina is taking the right steps to secure its economic recovery, short-term results are challenging. +Let me refer to a few of these markets. In China, we are adjusting our plans to reflect these realities. China's macro environment was challenging in 2015, and that continued to be so in the first quarter. While the economic slow-down is not new, the degree to which the NERTD industry was impacted this past quarter was worse than expected. Key success factors going forward require focusing on both affordability and premiumization through segmented growth strategies. +The more premium segments continue to grow in China, as consumers who purchase these products are relatively insulated from broader economic issues. We are working to increase our premium offerings like sleek cans and Schwepps Plus C in high-value channels. +At the same time, however, we continue to evolve our price pack architecture to deliver affordable options in both single-serve and multi-serve packages to ensure we can capture key occasions and recruit new consumers. While the top line has been challenging, our initiatives have enabled us to gain both value and volume share in China in the quarter. +Turning to Brazil, here we are segmenting our price pack architecture to provide packages at key affordable price points, while delivering and driving pricing to cover inflation. This strategy enabled us to gain volume share during the quarter. Finally, in Brazil -- in Russia, we gained value share driven by good marketing and promotional activities, with a focus on premium sparkling beverages and juice. Given the volatility in these markets, we are proactively managing our investments, keeping an eye towards the long term, but ensuring our near-term investments have the right pay-back. +The challenging macro environment is also a key reason why productivity is critical. We remain on track to deliver more than $600 million in productivity savings this year, enabling us to fund our brand and growth investments, while covering cost inflation and driving margin expansion. +We are delivering these savings through a disciplined process that involves our entire leadership team and associates. Ultimately, it's about building a culture that is focused on getting better every day whilst also improving the employee experience. This quarter, the results of our ongoing efforts were evident in supporting the underlying strong operating margin expansion. +Before I hand over to Kathy, let me conclude by saying we are resolutely focused on evolving our growth strategies, and transforming our business to deliver sustainable shareholder value. With the challenges around the world, we will focus on what we can control in order to deliver solid revenue growth and strong underlying operating margin expansion through the effective management of our portfolio, price mix, and productivity efforts. +With that, I'll turn the call over to Kathy. + +-------------------------------------------------------------------------------- +Kathy Waller, Coca-Cola Company - CFO [5] +-------------------------------------------------------------------------------- + + Thank you, James, and good morning, everyone. +I would like to touch upon a few areas of our financial performance in the quarter before providing our full-year outlook. Starting at the top line, as James mentioned, our 2% organic revenue growth was impacted by one less day in the quarter, as well as by our segment mix, as our Bottling Investments Group grew at a slightly slower rate than our core business. +Let me take a moment to explain what we mean by segment mix, and why the impacts will be more pronounced in 2016 and 2017, until we have finished our previously announced re-franchising actions. Starting in the first quarter, we revised our operating segments so that our Company-owned bottling operations in North America are now reported within our Bottling Investments Group. This greatly increases the relative size of the bottling segment to the rest of our geographic segments. Since our bottling operations earns significantly higher revenues per case than concentrate operations, slower growth among our Company-owned bottling operations results in negative pressure on our consolidated price mix, regardless of the underlying pricing in either the bottling operations or our core business. +However, due to the relatively lower profitability of our bottling business, slower growth among our bottling operations has an opposite effect on our consolidated margins. At gross profit, our comparable margin declined, as we were impacted by currency head winds, the effects from North America re-franchising, and the sale of our legacy energy brand to Monster. Excluding the year-over-year effects of these items, we would have seen gross margin expansion driven by a benign cost environment, benefits from productivity, and segment mix. +As you think about the downhill, keep in mind that the cost environment becomes more difficult to cycle in the second quarter and beyond, due to the timing of when commodity prices eased last year. Our comparable operating margin improved about 25 basis points on a consolidated basis. Similar to gross margin, currency head winds, the North America re-franchising, and the sale of our legacy energy brands to Monster impacted our operating margins. Comparable currency-neutral operating margins increased 140 basis points in the quarter. Excluding these effects, we achieved strong operating leverage in the quarter, driven by the benefits of our productivity initiatives, the timing of certain expenses, and segment mix. +Looking at our productivity initiatives, the first quarter benefited from the timing of when certain productivity initiatives were implemented last year. For example, the majority of the head count reductions began in April, with Europe's implementation closer to the mid-year, so the associated expense savings began in the second quarter. As you think about the remainder of this year, while we expect solid currency-neutral ex-structural operating leverage, we expect some of these drivers to moderate as we begin to cycle more difficult comparisons. This was reflected in our previously provided full-year guidance. +Let me stop here and touch briefly on an ongoing structural impact to provide additional clarity based on some of the questions I have received from you. At CAGNY, we noted that by the time we complete our re-franchising, we will see significant increases in both gross and operating margins. +While that is the case, I want to remind you that until we would get to increase the transfer of our production operations in North America, the existing re-franchising of the distribution business actually has a dilutive effect to both growth and operating margins. Given that we do not expect the sale of production assets to significantly increase until 2017, our margins will continue to be affected by this dynamic this year. +Moving to cash flow, we generated $1.1 billion in cash from operations before making a nearly half billion dollar contribution to our pension plan. Looking ahead to the remainder of the year, we expect our cash flow growth rate to be more in line with our earnings growth rate. +For 2016, we increased our annual dividend by 6% to $1.40 per share, our 54th consecutive annual dividend increase. Our net share repurchases during the quarter totaled approximately $150 million. For the full year, we expect to achieve the $2-billion to $2.5-billion range that we communicated during our last earnings call. +Turning to outlook, the first quarter reflected more challenging operating environments in markets like China and Brazil. We see that our strategies are working, however, in key markets like North America, Japan, and India. Further, our strategies allow us to scenario plan to adjust to market dynamics. Therefore, we are maintaining our currency-neutral outlook we previously provided. However, we are updating the expected impact from currency. +We expect organic revenue growth of 4% to 5%, and comparable currency-neutral EPS growth of 4% to 6%, inclusive of a 3- to 4-point structural head wind to income before tax. +Moving to currency, while current spot rates have improved since our fourth quarter call, these rates have been extremely volatile, as well. Therefore I will caveat our currency outlook, knowing that it is definitely subject to change. We will update you accordingly as we move through the year. +Based on current spot rates, hedging activity, and what we are cycling, we now expect the full-year impact of currency to be a 2- to 3-point head wind on net revenue versus our previous expectation of 4 points. Relative to income before tax, we now expect an 8- to 9-point head wind, as compared to our previous expectation of a 9-point head wind. +As you model the second quarter, there are a couple of items to consider. We expect the net impact of acquisitions, divestitures, and other structural items to be a 2- to 3-point head wind on net revenue, and a 3-point head wind on income before tax. Based on current spot rates, hedging activity, and what we are cycling, we expect that currency will be a 2- to 3-point head wind on net revenue, and a 6-point head wind on operating income. +In addition, we will be cycling the Euro debt re-measurement gain we recorded in Other Income during the second quarter of 2015. For this reason, we expect an 11-point currency head wind on income before tax as we cycle this gain. +In closing, we are working diligently to deliver our commitment for 2016. We continue to focus on our core capabilities of building brands, driving customer value, and leading the system, so that when we complete our re-franchising, we will be a lower-risk, higher-return business, with even greater confidence to achieve our long-term growth target. +Operator, we are now ready for questions. + + +================================================================================ +Questions and Answers +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Thank you. We will now begin the question-and-answer session. +(Operator Instructions) +Our first question is from John Faucher of JPMorgan. Your line is now open. + +-------------------------------------------------------------------------------- +John Faucher, JPMorgan - Analyst [2] +-------------------------------------------------------------------------------- + + Thank you. Good morning, everyone. + +-------------------------------------------------------------------------------- +Kathy Waller, Coca-Cola Company - CFO [3] +-------------------------------------------------------------------------------- + + Good morning. + +-------------------------------------------------------------------------------- +John Faucher, JPMorgan - Analyst [4] +-------------------------------------------------------------------------------- + + Good morning. As I look at your revenue performance this quarter, it highlights a concern that maybe the portfolio was still a little too CSD-heavy, despite some of the great results on the non-carb side. You've talked about -- James talked about this at CAGNY, 5% NARTD dollar growth longer term. +But given the fact you guys still under-indexed on the non-carb side that's providing really the majority of the growth in both dollars and volume for the category, don't you need to further accelerate the shift in the portfolio away from CSD, sparkling into non-carb? Is there a way to move that faster? On top of that, obviously the weakness in the CSD side this quarter with flat volumes, what do you think is really the right volume number on the CSD side going forward that gets you to your algorithm? Thank you. + +-------------------------------------------------------------------------------- +Muhtar Kent, Coca-Cola Company - Chairman and CEO [5] +-------------------------------------------------------------------------------- + + Hi, John. It's Muhtar here. I'll just preface by saying the following, and then pass over to James. First, you know how much we've done and how much we focus on creating successful brands in our still portfolio. Of the $20-billion brands we have now, 14 of them are still brands, and our still business is performing well. Whether we take value-added dairy or enhanced hydration or juices and nectars or juice drinks, we play in all of those categories. In 2015, we gained share in all of those categories. +If you look at how -- whether it's in developed markets or emerging or developing, our still beverage portfolio is being enhanced all the time. Also, and even in the case of waters and premium waters from Japan all the way through to Latin America, performing very well. +You just heard now again, we've invested in -- we just recently invested, as you know, in Suja in the United States. We invested in Chi and Culiangwang in China. We continue to always reference that wherever we look, and if there's opportunities for bolt-on acquisitions, we will look at those favorably. If there are also opportunities for organic development of brands like Fair Life, we will certainly look at those also favorably, as we have done. +I think we're very satisfied with our portfolio. Certainly we've got more work to do, as we have said in the call and in the remarks; but right now we feel that we've -- our portfolio is being transformed very well, and transitioned very well, and we are in a pretty good place -- and more work to continue. James? + +-------------------------------------------------------------------------------- +James Quincy, Coca-Cola Company - President and COO [6] +-------------------------------------------------------------------------------- + + Let me add one last thought, perhaps, John. At CAGNY, we talked about we have a 50 share of sparkling, and a 15 share of the stills. I think it's worth remembering that over the last 15 years we've gone from stills being less a single-digit part of our portfolio to now over 25% of our portfolio. +I think there's a long-term track record of generating growth and value in stills. Even given today our market position, we expect to continue to grow faster in stills. As we said in the call, we are gaining share in every sub-category apart from one where we held it. We'll continue to look for bolt-on acquisitions to accelerate our growth. I think it's going to continue to be a faster-growing part of the business. + +-------------------------------------------------------------------------------- +Muhtar Kent, Coca-Cola Company - Chairman and CEO [7] +-------------------------------------------------------------------------------- + + Also, just on the sparkling you asked, we certainly see also continued growth opportunities in our sparkling portfolio. That is naturally with the focus on revenues, it will skew more towards revenues, but certainly also as we have demonstrated and with our new campaign for Taste The Feeling campaign just being launched, and everything else that we are doing in terms of the investments with our aligned partners, we see growth opportunities in revenue, and also in volume in our sparkling beverage portfolio. + +-------------------------------------------------------------------------------- +Operator [8] +-------------------------------------------------------------------------------- + + Thank you. Our next question is from Steve Powers of UBS. Your line is now open. + +-------------------------------------------------------------------------------- +Steve Powers, UBS - Analyst [9] +-------------------------------------------------------------------------------- + + Great, thanks. Good morning. Maybe sticking with the top line, I just want to better understand where you expect to source top-line acceleration from over the remainder of the year, against a difficult macro environment, and increasingly difficult year-over-year compares. I get that you were probably closer to 4% organic growth this quarter excluding the calendar shift and the price mix drag of BIG, but BIG will be with you over the balance of the year. In that context, is there truly enough in your control to have confidence in sequential improvement, or are you expecting the macros to improve? Along side all that, is it fair to say you're guiding us more towards the lower end of 4% to 5% at this point versus the mid-point? + +-------------------------------------------------------------------------------- +Muhtar Kent, Coca-Cola Company - Chairman and CEO [10] +-------------------------------------------------------------------------------- + + Hi, Steve, it's Muhtar. First, I think we did expect the first quarter to trend slightly below the full year, driven by a couple of things. One, the macros are trending to the bottom -- toward the bottom in the first quarter, recognizing that the environment continues to be challenging, but we will continue to monitor that closely. +The launch of our new campaign in the first quarter will certainly benefit the back half of the year. The benefit of Olympics marketing as we move into the second and third quarter, one less selling day which certainly you also mentioned. I think we are confident definitely in the strategy and initiatives in place to support our growth targets over the course of the year, and believe that we will land again in the corridor that we have stayed at in the past in February. James or Kathy, do you want to add anything? + +-------------------------------------------------------------------------------- +Kathy Waller, Coca-Cola Company - CFO [11] +-------------------------------------------------------------------------------- + + No. + +-------------------------------------------------------------------------------- +Muhtar Kent, Coca-Cola Company - Chairman and CEO [12] +-------------------------------------------------------------------------------- + + All right. + +-------------------------------------------------------------------------------- +Operator [13] +-------------------------------------------------------------------------------- + + Thank you. Our next question is from Mark Schwartzberg of Stifel. Your line is now open. + +-------------------------------------------------------------------------------- +Mark Swartzberg, Stifel Nicolaus - Analyst [14] +-------------------------------------------------------------------------------- + + Thanks. Good morning, everyone. Question on North America. We now have the filings you've given us, and we can therefore see the level of profitability here in CCR, which is pretty low. I think when you back out the numbers, you get a 2% operating margin. I'm sure there's some accounting matters in there that this isn't the forum to go into, but it does raise the question of what really has been going on in terms of profitability for CCR here in North America. +Could we -- if you think it's appropriate, I think it would be helpful to talk a little bit about the trends in that business as you have seen them, now that we're seeing a level -- the margin I'm getting is a 2% operating margin. Can you talk a little bit about the trends and what you think they reflect? It certainly speaks well to what you get left behind, if you will, but it raises questions about what someone might pay for that kind of business? + +-------------------------------------------------------------------------------- +Kathy Waller, Coca-Cola Company - CFO [15] +-------------------------------------------------------------------------------- + + Sure, Mark. There are really -- we look at the margins in CCR, the three primary drivers for what you're seeing. First of all, we have shifted some of the territories. We have transitioned some territories to date. We did that obviously before we put the financials out there earlier this quarter. +Then if you remember, we incurred back in early 2010, 2011, 2012 time period, there was a significant hit to us from a run-up in commodity prices that certainly adversely impacted margins. Then the third thing I would say was we had to incur incremental costs to prepare that business for now being ready to be franchised and to strengthen that business. I think what we're seeing is improvement in the results that I would say today. Those three things really are impacting what you saw in the financials that we put out there. + +-------------------------------------------------------------------------------- +Operator [16] +-------------------------------------------------------------------------------- + + Thank you. Our next question is from Bryan Spillane of Bank of America. Your line is now open. + +-------------------------------------------------------------------------------- +Bryan Spillane, BofA Merrill Lynch - Analyst [17] +-------------------------------------------------------------------------------- + + Hi. Good morning, everyone. I wanted to go back and tie a couple of comments that have been made about the effect that BIG had on organic sales growth for the quarter. I want to make sure I understand it correctly. If we look at sales excluding BIG and we add back the extra -- the effect of the extra day, organic sales growth was around 4%, is that correct? + +-------------------------------------------------------------------------------- +James Quincy, Coca-Cola Company - President and COO [18] +-------------------------------------------------------------------------------- + + It's James here. Look, volume grew 2%. Core price mix was 2%, so that's the right answer. + +-------------------------------------------------------------------------------- +Operator [19] +-------------------------------------------------------------------------------- + + Thank you. Our next question is from Judy Hong of Goldman Sachs. Your line is now open. + +-------------------------------------------------------------------------------- +Judy Hong, Goldman Sachs - Analyst [20] +-------------------------------------------------------------------------------- + + Thank you, good morning. One of the markets where you point out you're taking more actions is Europe, and certainly from a top-line perspective, continues to be a pretty challenging market -- deflationary pressure there. I wanted to get a little bit more color. Really, what are some of the more tangible actions that we can see? How much dollars are really going in, in terms of the marketing investments that we should expect to see some of that improvement really coming through, and how long that would take as you think about for the balance of the year? + +-------------------------------------------------------------------------------- +James Quincy, Coca-Cola Company - President and COO [21] +-------------------------------------------------------------------------------- + + Judy, it's James here. A couple of things on Europe. One, it is worth noting that in this quarter, there was a disruption to the business in GB due to the supply chain. There's a one-off impact that we expect to see not recurring in the balance of the year. I think that's worth taking into account, and it was a material impact. +Now looking for the rest of the year, you will see in the numbers we had pretty decent price mix in Europe in this quarter, and we are also looking to see volume improving versus the fourth quarter -- not just because of the supply situation, but also the new programs, the launch of the new marketing campaign, the launch of a new Coke Zero variant starting in GB, plus the Euro Cup, which will be in France this year. +Of course, shortly we will hopefully complete CC Coca-Cola European partners, where there are very strong plans being put in place to drive that forward. I think some temporary factors, and the build-up of our ongoing investments should drive a better result in Europe in the balance of the year. + +-------------------------------------------------------------------------------- +Operator [22] +-------------------------------------------------------------------------------- + + Thank you. Our next question is from Dara Mohsenian of Morgan Stanley. Your line is now open. + +-------------------------------------------------------------------------------- +Dara Mohsenian, Morgan Stanley - Analyst [23] +-------------------------------------------------------------------------------- + + Hi, good morning. I wanted to delve a bit more into the Asia-Pacific pricing number in the quarter, a negative 5%. Can you run through how much of that was due to geographic or product mix or other factors, and thoughts going forward in the remainder of the year on if that pricing pressure will moderate, and how mix should trend in that segment? + +-------------------------------------------------------------------------------- +James Quincy, Coca-Cola Company - President and COO [24] +-------------------------------------------------------------------------------- + + Sure, James here. Let me -- I'll come to the numerical piece. Let me start off with -- the Asia-Pacific price mix is always a little bit of an oddity, because it's a group that brings together Japan and Australia, which are very high-revenue markets, but don't grow as quickly, along with a lot of emerging markets -- not just China, but India, Indonesia, and the Philippines, which grow much faster. +There is an ongoing mechanical effect that creates a negative price mix for this group, which you can see over the years in Asia-Pacific. In 2013 full year it was minus 4%. In 2014, it was minus 2%. In 2015, it was minus 2%. In the first quarter of 2016 obviously it was minus 5%, but it was cycling a very atypical plus 3% in the first quarter of last year. +I think what you will see is in the future quarters, it is a little volatile and bumpy, but the long-term trend is for a negative price mix in Asia, because of the dynamic of the fast growth of the emerging markets versus Japan and Australia. + +-------------------------------------------------------------------------------- +Operator [25] +-------------------------------------------------------------------------------- + + Thank you. Our next question is from Ali Dibadj of Bernstein. Your line is now open. + +-------------------------------------------------------------------------------- +Ali Dibadj, Bernstein - Analyst [26] +-------------------------------------------------------------------------------- + + Hi, guys. I'm still getting a lot of skepticism from investors about the 4% to 5% organic revenue growth target for the year. Openly, you don't sound 100% confident, and it feels likes there's a lot of kind of messiness and moving parts. Can you try again? Can you talk about what specifically you're seeing right now that gives you confidence in the 4% to 5% organic sales growth for the year? Clearly whether it's a 3% or a 4%, you delivered a 3% in some sense this quarter, so you're below pace. +Maybe in that you can tackle what you expect Eurasia, Africa to get to, why do you expect it to get better? Europe, you mentioned you're going to invest more and you hope that to get better, but we've sometimes heard that before. Why is it going to be better in Europe? +Then maybe as a jumping-off point as well, you can talk about what you're learning in North America, because that seems to be doing better for sure. A footnote, I'm not quite sure where you grow organically North America, because you want us to add 3 points back for concentrated sales up to unit case sales for one day missing. I'm not quite sure how to get there, so some explanation would be great. But just more specifics, very clearly on what gives you the confidence in your top-line target for the year? Thanks. + +-------------------------------------------------------------------------------- +Muhtar Kent, Coca-Cola Company - Chairman and CEO [27] +-------------------------------------------------------------------------------- + + Ali, I'll start just by saying, as I indicated, first on the core, with one less selling day and on the core price mix of the core business without BIG, we certainly did get to the 4% in this quarter. What we feel looking at the downhill comparisons and looking at also all the programs in place, looking at how our business performance in all the different quarters and different groups, we feel confident that we still will achieve what we have said in February in terms of the top line for the full year. +The marketing program, the additional marketing, the new marketing program that has just been launched, and then not having the one less selling day. Then also the continued franchising and all the programs that the bottlers have in place. Our US business is performing very well with its revenue growth, with its price mix, with its brands, with its portfolio. That will continue in -- we have every confidence that it will continue. +Then we will see -- we do believe that macros have -- are at the bottom, and that there will be in the second half a certain degree of improvement in the macros. Even if they do not -- if they stay the same, we feel confident with the current macro situation that we will get to the corridor that we have specified, we have indicated and shared with you in February. Any other comments, James, Kathy? + +-------------------------------------------------------------------------------- +James Quincy, Coca-Cola Company - President and COO [28] +-------------------------------------------------------------------------------- + + No, I think the one thing I would add, Ali, is obviously there's a strong momentum in the North America business. We called that out as the place where the strategies are working. Then the other countries I put in the other two buckets, there's degrees of implementation of the strategy. You can go to around the world. There were places which were struggling in 2014, and maybe even in 2015. As we've been executing the strategy, the momentum is starting to come back to some of those countries, and it's starting to build over time. +I think, as Muhtar said, the first quarter was within the envelope of expectation for our guidance, and we can see based on what we are doing within our control, within a reasonable scenario of macros, we will stay within that corridor for the rest of the year. But in the end, only results will answer the questions. + +-------------------------------------------------------------------------------- +Operator [29] +-------------------------------------------------------------------------------- + + Thank you. Our next question is from Brett Cooper of Consumer Edge Research. Your line is now open. + +-------------------------------------------------------------------------------- +Brett Cooper, Consumer Edge Research - Analyst [30] +-------------------------------------------------------------------------------- + + Thanks. The re-franchising that you announced today includes the creation of a new bottler from outside the industry. You have spoken a lot about the collective willingness of your existing bottlers to invest and a desire for more territory. Can you help us understand why you went outside of the existing system for this re-franchising? Is there something you're seeing from other new bottlers that makes this more appealing to you guys? + +-------------------------------------------------------------------------------- +Muhtar Kent, Coca-Cola Company - Chairman and CEO [31] +-------------------------------------------------------------------------------- + + I think on that, predominantly we have existing bottlers that are expanding, if you look at the percentages of territories that have been franchised. Then we have, in order to ensure that we can get to the right level of diversity in our bottling business and the right level of also representation, we have also selected some new partners like in Florida, like in Chicago, and like now, the most recent one announced. +We feel that is a healthy mix and that's also a healthy balance, and we have the right -- very much the right approach and the right alignment with our expanding bottling partners, whether they are just entering our system, or they are proven expanding bottlers like the ones that we have mostly franchised new distribution to in the past year. + +-------------------------------------------------------------------------------- +Operator [32] +-------------------------------------------------------------------------------- + + Thank you. Our next question is from Bill Schmitz of Deutsche Bank. Your line is now open. + +-------------------------------------------------------------------------------- +Bill Schmitz, Deutsche Bank - Analyst [33] +-------------------------------------------------------------------------------- + + Hi, good morning. Can you guys give us a little bit more granular bridge on the gross margin decline this quarter, and then maybe some broad-stroke outlook for the rest of the year? I know the comps get easier as the year progresses, but it would be really helpful to aggregate the FX impacts, some of the re-franchise impacts, then what you're thinking for the rest of the year? + +-------------------------------------------------------------------------------- +Kathy Waller, Coca-Cola Company - CFO [34] +-------------------------------------------------------------------------------- + + Certainly, Bill. Really, the gross margin decline is really impacted by two things, really. It's currency and it's the structural impact. Currency, I think like 80 basis points, would have added 80 basis points back to our gross margin. The structural impact actually would add significantly more than that. It's really as simple as that. It's really about currency and our structural adjustments. + +-------------------------------------------------------------------------------- +Operator [35] +-------------------------------------------------------------------------------- + + Thank you. Our next question is from Kevin Grundy of Jefferies. Your line is now open. + +-------------------------------------------------------------------------------- +Kevin Grundy, Jefferies & Company - Analyst [36] +-------------------------------------------------------------------------------- + + Thanks, good morning. Question, how much of the slow-down in the top line in the quarter was macro slowing in the NARTD category versus execution? You spoke to share gains in both stills and sparkling, so it would certainly seem to be broader slowing in the category? +Then of course there's been a lot of discussion on the top line. It would seem like the lower end of your 4% to 5% organic sales outlook would be prudent at this point. A follow-up question on that. How much visibility do you have on productivity and other levers to deliver the high end of the ES growth guidance range, should you come in toward the lower end on the top line? Thank you. + +-------------------------------------------------------------------------------- +James Quincy, Coca-Cola Company - President and COO [37] +-------------------------------------------------------------------------------- + + Let me take a bite of that, Kevin. I think the answer on the slow-down, we don't get all the category numbers necessarily. Clearly, as we're gaining share in that top-line number, there's got to be some weakness in the category versus the long-term target of 5%. I think we talked a little bit about that at CAGNY, about how our expectations for 2016 and 2017 were below the long-term 5% dollar value for any RTD. There's definitely some of that. +I think you can see the macros influencing the industry in the sense that a number of the emerging markets, particularly the commodity ones, where we have had the slow-down, and that's clearly flowing through into the industry. +I think what I would highlight is we're going to focus on what we can control. We have a long-standing game plan of what to do in countries that are in crisis, focusing on really gaining a lot of share to set ourselves up profitably for the long-term, as we did in a lot of countries in the past. It seems to be working now as we gain share in the Chinas and the Russias and Brazils. It will pay off in the end. +I think the visibility, look, we are managing to our corridors at the top and the bottom line. We feel that this quarter was within the envelope. Clearly the macros slightly better, slightly worse, will be an influence in where we end up; but we've got a lot of management left to do in the balance of the year. + +-------------------------------------------------------------------------------- +Operator [38] +-------------------------------------------------------------------------------- + + Thank you. Our next question is from Bill Chappell of SunTrust. Your line is now open. + +-------------------------------------------------------------------------------- +Bill Chappell, SunTrust Robinson Humphrey - Analyst [39] +-------------------------------------------------------------------------------- + + Thanks, good morning. Can you just -- + +-------------------------------------------------------------------------------- +Kathy Waller, Coca-Cola Company - CFO [40] +-------------------------------------------------------------------------------- + + Good morning. + +-------------------------------------------------------------------------------- +Muhtar Kent, Coca-Cola Company - Chairman and CEO [41] +-------------------------------------------------------------------------------- + + Good morning, Bill. + +-------------------------------------------------------------------------------- +Bill Chappell, SunTrust Robinson Humphrey - Analyst [42] +-------------------------------------------------------------------------------- + + Talk a little bit more about, now that you've unveiled the one-brand packaging -- I guess it's being launched in Mexico -- expectations for that, and maybe what you've learned as you've tested it out? I say that just -- I understand it's certainly going to be more efficient from an advertising, marketing front on the one brand strategy, but didn't know if you expected a sales lift, or if there's been any confusion from consumers as they have seen it? Thoughts as we've started to launch that? + +-------------------------------------------------------------------------------- +Muhtar Kent, Coca-Cola Company - Chairman and CEO [43] +-------------------------------------------------------------------------------- + + Bill, this is Muhtar. We've said from the beginning first that the new campaign is not just a new campaign, but also it's a new strategy in terms of the one-brand strategy, and that it's got many advantages. We expect it to give us significant efficiencies and effectiveness. +But also in terms of how we communicate with our consumers, it will certainly play into that as we execute the strategy, and we've now launched the new campaign. Then I'll let James comment in terms of you asked the Mexico specific example, but also there's also many other places where it's been tested, and tested favorably. Go ahead, James. + +-------------------------------------------------------------------------------- +James Quincy, Coca-Cola Company - President and COO [44] +-------------------------------------------------------------------------------- + + Yes, Bill, a few thoughts. One, the initial pilot markets, the two sources of very clear impact were one, it helped us expand and grow the zero-calorie variant of Coca-Cola by driving availability and driving trials. We would expect to see benefits on the zero-sugar variance. +The second big area of benefit is it helps us create what we would call corporate blocking. In other words, we execute in stores all the variants of Coca-Cola together as one big block, has a much greater store impact, visual impact, engagement with people who are shopping the stores. +I think slightly more strategically and back to Muhtar's point, this is an implementation of a strategic idea. I'm sure we'll evolve it. I'm sure we'll make it better, but it's the strategic idea that's important. It's not just about the efficiency in the advertising. It's about helping consumers join and stay in the Coca-Cola franchise, whatever the ingredients they want to manage, including their management of added sugars, whether that's in drinks or any other categories that have added sugar in. This has a number of benefits that are going to play out strategically, and we will keep improving the execution. + +-------------------------------------------------------------------------------- +Operator [45] +-------------------------------------------------------------------------------- + + Thank you. Our next question is from Amit Sharma of BMO Capital Markets. Your line is now open. + +-------------------------------------------------------------------------------- +Amit Sharma, BMO Capital Markets - Analyst [46] +-------------------------------------------------------------------------------- + + Hi. Good morning, everyone. + +-------------------------------------------------------------------------------- +Kathy Waller, Coca-Cola Company - CFO [47] +-------------------------------------------------------------------------------- + + Good morning. + +-------------------------------------------------------------------------------- +Operator [48] +-------------------------------------------------------------------------------- + + James, as we look to the rest of the year and 2017 as well, can you also talk about the progress of the small pack architecture? We've heard a lot about that in North America, but if you can give us a little bit more detail, where are we with that in rest of your divisions? Is that a source of incremental growth or price mix as we go forward? + +-------------------------------------------------------------------------------- +James Quincy, Coca-Cola Company - President and COO [49] +-------------------------------------------------------------------------------- + + Yes, a few thoughts then. Clearly, North America has had a lot of traction in pushing forward smaller packages away from the traditional two-liter and multi-pack of cans. It is worth noting that some of those packages are premium packages, and some of those are intended to create affordability or low-price-point entry points for the category, whether it be the mini cans. That combination does generally help price mix. +You can see that starting to roll out across other parts of the world. I think Latin America has traditionally been very good at that. You do see more of it coming into Asia-Pacific and Eurasia on a global basis. The immediate consumption packages out-paced general volume growth, so it is part of our strategy to push more into smaller packages. +Just this last month, India launched a new technology, very small package, with a special technology that allows a much longer shelf life in ambient environment of rural India, so it will be able to get to many more places. A lot of innovation in the technology. A lot of innovation in the package and the sizes and the occasions and the channels, so that we can bring down the price points for affordability, take advantage of premiumization, and also offer people the right amount of any beverage that they want to actually consume. + +-------------------------------------------------------------------------------- +Amit Sharma, BMO Capital Markets - Analyst [50] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Muhtar Kent, Coca-Cola Company - Chairman and CEO [51] +-------------------------------------------------------------------------------- + + One point I would just add, Amit, would be that the US compared to the rest of the world, the prevalence of small packages was much less in the United States three or four years ago compared to the rest of the world. If you look at Europe and places like Spain, or if you look at many countries in Latin America, you had much more prevalence of smaller packages then in the United States. +In a way, the United States in the last four or five years, but particularly last two and a half years, has moved very rapidly to the 12-ounce glass to the 8-ounce glass to the 7.5-ounce can, to the 8.5-ounce aluminum bottle. That has really worked. Those are all growing double digits in the United States because of two -- the consumer customer preferences, and also benefiting our system because they have a higher price per liter. That's in a way playing out from what was already prevailing in many parts of the world in the past. + +-------------------------------------------------------------------------------- +Operator [52] +-------------------------------------------------------------------------------- + + Thank you. Our next question is from Vivien Azer of Cowen and Company. Your line is now open. + +-------------------------------------------------------------------------------- +Vivien Azer, Cowen and Company - Analyst [53] +-------------------------------------------------------------------------------- + + Good morning. + +-------------------------------------------------------------------------------- +Kathy Waller, Coca-Cola Company - CFO [54] +-------------------------------------------------------------------------------- + + Good morning. + +-------------------------------------------------------------------------------- +Vivien Azer, Cowen and Company - Analyst [55] +-------------------------------------------------------------------------------- + + I was hoping we could talk a little bit more about the health of brand Coca-Cola. In your press release, you called out softness either around the total brand family or trademark Coca-Cola in a number of geographies. While I appreciate that you have a lot of new initiatives between Taste The Feeling and new packaging, in the past you guys have said that it does take time for some of those advertising initiatives to actually gain traction and show up in brand health and volume. How should we think about the trajectory of trademark Coca-Cola as you roll out these new initiatives, please? Thank you. + +-------------------------------------------------------------------------------- +James Quincy, Coca-Cola Company - President and COO [56] +-------------------------------------------------------------------------------- + + Vivian, I think a couple of things. One, obviously most of our campaigns are weighted into the second, third, and fourth quarters. Those are the biggest quarters. Even Taste The Feeling, we announced it this quarter, but it's only really hitting at towards the end of the quarter and rolling out in the rest of the year, as with the Euro Cup and the Olympics. I think a lot of the programs are going in later this year. They -- obviously the execution is there, so we would expect to see better performance in trademark Coca-Cola going into the downhill. +I would make one other note, which is the relative change in where global growth is coming from, or industry growth is coming from -- a little more in developed and developing, a little less in emerging -- tends to create a portfolio effect that weighs a little more against sparkling and therefore Coca-Cola, because those emerging markets tend to be more sparkling orientated. You see North American, Latin America, Japan, with stronger stills growth. We do expect to see growth. We would expect to see it coming back. There is a geographic mix impact, but when we look at the markets, we believe we will be back on track with Coca-Cola. + +-------------------------------------------------------------------------------- +Operator [57] +-------------------------------------------------------------------------------- + + Thank you. Our next question is from Robert Ottenstein of Evercore ISI. Your line is now open. + +-------------------------------------------------------------------------------- +Robert Ottenstein, Evercore ISI - Analyst [58] +-------------------------------------------------------------------------------- + + Great, thank you very much. I wanted to follow up on the questions on the one-brand strategy, and specifically ask when you look at let's say the full implementation of that two, three years from now, do you think the benefit will be 50/50 between cost savings and efficiency and greater demand? How do you see that breaking out? Specifically, also in terms of the answer to the prior question on that, how exactly is this strategy helping drive trial and availability for Coke Zero? Thank you. + +-------------------------------------------------------------------------------- +Muhtar Kent, Coca-Cola Company - Chairman and CEO [59] +-------------------------------------------------------------------------------- + + Robert, it's Muhtar here. I think first, in terms of the efficiencies, the most important benefit will be simpler and less-fragmented communication with the consumer. That will be the biggest benefit. But also, it will certainly help provide -- create more efficiencies and effectiveness in our non-working DME, and therefore will also provide some productivity in that respect. But the most important benefit will certainly be a less cluttered and better and more direct communication with the consumer base. +In terms of the trial of product, that will certainly come as a result of that, of what James mentioned in terms of better presence in the store, in terms of better merchandising, in terms of better interruptions in the store, and also in terms of the communication piece. +We believe that the most important benefit of this will infuse and will come to brands like Coca-Cola Zero with more availability, better communication, and have the broad perspective of the global campaign, as opposed to every different brand under the Coca-Cola trademark having their own campaigns. That will be how I think the benefits will come. We -- trials and pilots so far have proven that in Europe and other parts of the world. + +-------------------------------------------------------------------------------- +Operator [60] +-------------------------------------------------------------------------------- + + Thank you. I would now like to turn the call back to Muhtar Kent for closing remarks. + +-------------------------------------------------------------------------------- +Muhtar Kent, Coca-Cola Company - Chairman and CEO [61] +-------------------------------------------------------------------------------- + + Thank you, James, Kathy, and Tim. We're in the midst of transforming The Coca-Cola Company to one that's even more focused on our core value creation model of building strong brands, enhancing customer value, and leading our franchise system. At the same time, we continue to evolve and strengthen our global bottling system as we accelerate re-franchising, and as we return to a predominantly concentrative model with significantly higher margins and returns. +We remain confident that the long-term dynamics of our industry are promising, and we absolutely believe that The Coca-Cola Company is well-positioned to deliver long-term value to our shareholders. As always, we thank you for your interest, your investment in our Company, and for joining us this morning. + +-------------------------------------------------------------------------------- +Operator [62] +-------------------------------------------------------------------------------- + + Thank you, speakers. That concludes today's conference. Thank you for participating. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/exam/original-files/Problem_2_3_Sample_full_transcripts/2016-Aug-17-TGT.N-137580578182-Transcript.txt b/exam/original-files/Problem_2_3_Sample_full_transcripts/2016-Aug-17-TGT.N-137580578182-Transcript.txt new file mode 100644 index 0000000..883b1aa --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_full_transcripts/2016-Aug-17-TGT.N-137580578182-Transcript.txt @@ -0,0 +1,564 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q2 2016 Target Corp Earnings Call +08/17/2016 08:00 AM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Brian Cornell + Target Corporation - Chairman and CEO + * John Mulligan + Target Corporation - COO + * Cathy Smith + Target Corporation - CFO + * John Hulbert + Target Corporation - VP of IR + +================================================================================ +Conference Call Participiants +================================================================================ + + * Matt Fassler + Goldman Sachs - Analyst + * Scott Mushkin + Wolfe Research - Analyst + * Joe Feldman + Telsey Advisory Group - Analyst + * Oliver Chen + Cowen and Company - Analyst + * Greg Melich + Evercore ISI - Analyst + * Kate McShane + Citigroup - Analyst + * Dan Binder + Jefferies LLC - Analyst + * David Schick + Consumer Edge Research - Analyst + +================================================================================ +Presentation +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- +Ladies and gentlemen, thank you for standing by. Welcome to the Target Corporation second-quarter earnings release conference call. +(Operator Instructions) +As a reminder, this conference is being recorded, Wednesday, August 17, 2016. I would now like to turn the conference over to Mr. John Hulbert, Vice President, Investor Relations. Please go ahead, sir. + +-------------------------------------------------------------------------------- +John Hulbert, Target Corporation - VP of IR [2] +-------------------------------------------------------------------------------- +Good morning, everyone, and thank you for joining us on our second-quarter 2016 earnings conference call. On the line with me today are Brian Cornell, Chairman and Chief Executive Officer, John Mulligan, Chief Operating Officer, and Cathy Smith, Chief Financial Officer. This morning, Brian will recap our second-quarter performance including results across our merchandise categories. Then John will provide an update on our efforts to improve in-stocks and modernize our supply chain. And finally, Cathy will offer more detail on our second-quarter financial performance, and our outlook for the third quarter and full year. Following their remarks, we will open the phone lines for a question-and-answer session. +As a reminder, we're joined on this conference call by investors and others who are listening to our comments via webcast. Following the call, Cathy and I will be available to answer your follow-up questions. Also as a reminder, any forward-looking statements that we make this morning are subject to risks and uncertainties, the most important of which are described in our SEC filings. +Also in these remarks, we refer to adjusted earnings per share which is a non-GAAP financial measure, and return on invested capital which is a ratio based on GAAP information, with the exception of adjustments made to capitalize operating leases. Reconciliations to our GAAP EPS from continuing operations and to our GAAP total rent expense are included in this morning's press release which is posted on our Investor Relations website. +With that, I'll turn it over to Brian for his comments on the second quarter and our priorities going forward. Brian? + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman and CEO [3] +-------------------------------------------------------------------------------- +Thanks, John, and good morning, everyone. Our second-quarter comparable sales decline of 1.1% was near the middle of our guidance range for the quarter, but well below the results we expect to deliver over time. Against that back drop, we reported a much stronger than expected profitability. This outperformance was driven by our ongoing cost saving efforts, which benefited both our gross margin and expense rates in the second quarter. These benefits helped to offset pressure from the current promotional environment, declining comp sales, and the investments we're making in our team. I want to pause, and thank our team for delivering this outstanding financial performance. +At the same time, I want to emphasize that we are committed first and foremost, to restoring positive comp sales growth in the quarters and years ahead. Based on the conversations with many of you, we know there's a great deal of focus on the broad macro challenges facing retailers, including a consumer focus on experiences, the impact of price deflation, and the channel shift into digital. These are real challenges, but they are not new to our business. With the right strategy and strong execution, we've demonstrated our ability to perform in the face of those challenges, and our expectation is that we will continue to be a top retail performer over time. +In the second quarter, our number one challenge was traffic, which affected sales in all of our merchandise categories, and consistent with the first quarter, we saw higher than normal variability in sales patterns. Despite these challenges, we're encouraged that we saw the strongest sales performance around key second-quarter events, including Memorial Day, the 4th of July, and the beginning of the back-to-school season. As we analyze the drivers of our second-quarter performance, we've identified some company-specific challenges we are actively addressing. +This includes meaningful pressure in electronics, where we saw a double-digit decline in comp sales this quarter, accounting for approximately 70 basis points of overall comp decline. Notably about a third of this pressure was driven by Apple products, which were down more than 20% in the quarter. We're focused on reversing these trends, and we're collaborating with Apple and other vendor partners to evolve our assortment and accelerate innovation to deliver stronger sales. +In grocery, despite improvements in assortments, quality, freshness, presentation and in-stocks, we were disappointed with our sales performance as we saw a small comp sales decline in the second quarter. While our grocery business was negatively impacted by food deflation which accounted for about 20 basis points of pressure, we clearly have more work to do to unlock the growth potential in this important category. Given our recent performance in the increasingly competitive food environment, we are revisiting our second-half grocery efforts from presentation to assortment to promotion to improve our competitive position. And as I will discuss in a few minutes, we will be leveraging the learning from our LA25 remodels to help guide our plans going forward. +Beyond food, we are rebalancing our messaging and promotions to ensure we continue to drive strong performance in style categories, and reach consumers who are intently focused on value in this environment. +Finally, we experienced soft second-quarter traffic trends in the pharmacies in our stores, as we completed the rebranding transition from Target to CVS across the country. The execution of transition went very smoothly, and we've been very pleased with the level of collaboration [between] our teams and our partners at CVS. While it's not surprising that the rebranding activity has resulted in some near-term disruption, we're focused on restoring growth in this traffic-driving area in our stores. +As a result, we're working closely with our partners at CVS as they launch media, marketing, and member engagement campaigns to increase awareness and utilization of CVS pharmacies in our stores. In addition, CVS is executing an in-store engagement campaign, and plans to offer special flu shot incentives at the pharmacies in our stores. As we take steps to increase awareness of the CVS Target partnership, both from our guests and members of the CVS PBM business, we expect to reaccelerate pharmacy traffic in our stores over time. +Despite this quarter' challenges, we're pleased that the fundamental elements of our strategy are continuing to shape our results. Comparable sales in signature categories continue to lead the Company, reflecting investments we've made in quality, presentation, and marketing. In the second quarter, comp-sales growth in these categories outpaced the Company by approximately 3 percentage points. +Within Signature, we saw particular strength in both kids and style. Results in kids reflected the launch of Cat & Jack which is now positioned to become our biggest owned brand. After the July rollout of this brand, we saw double-digit growth in Cat & Jack sales when measured against comparable sales of Circo and Cherokee last year. +Within style, we continue to benefit from strength in women's apparel which saw a mid single-digit comp increase in the quarter. This performance was driven by double-digit growth in our Xhilaration brand which is focused on a younger style-savvy guest. In addition, we're really pleased with the performance of Who What Wear, which is one of the most productive brands on our women's floor pad. As a result, we're expanding the size range of this assortment for the fall, inviting more of our guests to enjoy the items from this fashion-forward collaboration. +Digital sales grew more than 16% in the second quarter, on top of 30% growth last year. We continue to invest in Target's digital assets to enhance the guest experience and drive sales in all channels, and our results demonstrate the impact of the investments we've made over time. For example, several years ago we told you we had an opportunity to improve our digital conversion. Since then we've invested to improve our conversion performance by streamlining online check-out, making the site more appealing and easy to use, enhancing our personalization capabilities and improving search. +As a result, for several years in a row we've seen meaningful improvement in our digital conversion across all platforms, particularly in mobile. In the second quarter, we launched a brand-new fully adapted site, which means we now provide a seamless experience across all platforms from desktop to tablets to smartphones. This is increasingly important because for many guests, a single purchase journey crosses over two or more of these digital devices. +We're really pleased with the results in our new flexible format stores, which are designed for very dense urban and suburban neighborhoods. These stores allow us to operate in areas we've never been able to serve with our large format stores, allowing us to extend our reach to consumers with high affinity for our brand. In July, we opened up new flex-format stores in Washington Square in Philadelphia, Lincoln Park in Chicago, Commonwealth in Boston, and Forest Hills in Queens. We're excited to be serving guests in these iconic neighborhoods, and the guest response to these new locations has been fantastic. +Financially, flexible formats are very successful. Their sales productivity is much higher than our Company average, and they've been meeting or exceeding our profit targets. In total this year, we're planning to open 14 flex-format stores, including a multi-level location in Tribeca this October. Based on our experience to date and our investments in capabilities, we're increasingly confident in our ability to successfully open and operate stores in a variety of neighborhood settings across the country. As a result, we're accelerating our pipeline of locations we can open in the future years, and we expect flex-format stores to be a key driver of future growth. +In our existing stores, we continue to invest in presentation and experience, particularly in Signature categories. We completed the remodeling of our LA25 test stores in the second quarter, and we're in the early stages of a robust learning plan to measure guest reaction to the changes we've made. Overall, we're encouraged by initial results in these stores, and we're already rolling out some of the innovations from these stores more broadly. Namely, we're pleased with the presentation innovations in home and apparel, and results from our work to elevate the order pick-up experience, so we're already extending these innovations beyond the LA market. +In addition, the changes we've made to the food area in the LA25 test stores has really resonated with guests. Grocery sales in these stores are trending 2 to 3 percentage points higher than comparison stores. Relative performance in produce is even stronger, driving perishable comps that are more than 5 percentage points higher than comparison stores. Guests have told us the new food area now feels more intimate and separate from the rest of the store, providing a distinct grocery shopping experience they prefer. We're very encouraged with these initial observations, and we'll continue to leverage learnings from these stores as we work to improve grocery performance across the chain. +We are fortunate to have a strong balance sheet, and a business that generates a lot of cash, even in challenging times. This cash allows us to make long-term investments in our business, while returning cash to our shareholders at the same time. In June, we announced that our Board had approved a 7.1% increase in our quarterly dividend, supporting our 45-year record of annual dividend increases. In addition, our cash position allowed us to return well over a $1 billion through share repurchase in the second quarter, in support of our goal to return $3.5 billion or more this year. +Looking ahead, we're very excited about the back-to-school and back-to-college season, which is second only to the fourth quarter holiday season in terms of importance. In back-to-school, we continue to work with kids and parents who inform our product design and development process. So it's only natural that this year, we engaged with kids to design and execute our back-to-school marketing campaign. Kids led all aspects of this campaign, drafting story boards, illustrating the creative content, directing the spots, and performing the music. To make shopping fast and convenient for busy families, this year, we partnered with teacherslist.com, to make nearly a million school supply lists available with our school list assist tool on Target.com. This tool allows parents to quickly and seamlessly purchase supplies off their kid's class lists, arrange for store pick-up, or have the items delivered directly to their home. +In back-to-college, our marketing campaign is designed around today's students which are digital natives. In this campaign, we're partnering with three recent graduates to create inspiring, do-it-yourself videos to help college students make their new dorm room, or apartment feel like home. In addition, we provided tools to make college shopping convenient and fun, including college registry, order pick-up, subscriptions and special offers on Cartwheel. As we've done for more than 15 years, we're hosting back-to-college after hours shopping events, which will take place at 85 colleges and universities in the next couple of months. In these events, we provide free bus transportation from campus, and provide students the opportunity to stock up and save on everything they'll need for school. +I want to pause here, and mention how happy we are to have Mark Tritton on the Target team. Mark took on the role of Chief Merchandising Officer in the second quarter, and he spent the last couple of months getting to know his team, and becoming immersed in our business. Mark is creative and passionate about retail. He's had an amazing career building iconic brands, and I'm confident he will be able to grow both our owned brands and our Target brand. Mark is planning to speak on this conference call next quarter, when he will outline our merchandising and marketing plans for the holiday season. +We continue to believe we're focused on the right strategic priorities, and we're confident in our ability to grow profitably over time. We believe it's appropriate to update our sales and EPS outlook for the remainder of the year. Our decision is informed by the retail sales environment, and the variability we continue to see in our weekly and regional results. While we are laser-focused on accelerating traffic and sales, it's prudent to build near-term business and inventory plans that are consistent with recent trends. As always, we'll be prepared to flex those plans upward, if results begin to recover in the second half of the year. +Before I turn the call over to John, I want to spend a second, with a special thank you to our team and our stores. I visit our stores around the country nearly every week, and I'm so grateful to have a group of such smart and friendly team members serving our guests. John's team at headquarters is focused on ways to simplify our processes, modernize our supply chain, and help ensure our stores feature the right assortment of items that are in stock every day. When we back up an outstanding team with the right business fundamentals, we offer an unparalleled experience in retail. +With that, I'll turn the call over to John who will provide more details on his team's efforts to modernize our supply chain and improve our operations. John? + +-------------------------------------------------------------------------------- +John Mulligan, Target Corporation - COO [4] +-------------------------------------------------------------------------------- +Thanks, Brian. Good morning, everyone. As Brian just mentioned, our store teams do an outstanding job serving our guests every day. It's long been a key point of differentiation for our brand. +What I didn't fully appreciate until I came into my new role as COO was the workload that our supply chain processes have been driving into our stores. Historically, when we designed processes to improve upstream efficiencies in our supply chain, we often achieved those benefits by moving work and complexity into our stores. One of the key priorities of my new team has been to look at the entire supply chain and find ways to optimize it, end-to-end to deliver reliability for our guests while driving efficiency for the organization as a whole. +A key measure of reliability is our ability to stay in stock, and I'm pleased that we continue to see improvement, even as we begin to compare against improvements from a year ago. In stores, as we entered the back-to-school and back-to-college seasons, Target's overall out-of-stock position was better than we've ever measured historically. In addition, out of stocks on frequency and commodity items, the items for which reliability is most important for our guests are in an even stronger position. And in the digital channel, while we have much work yet to do, we have already reduced out of stocks by more than 50% in the last six months. +Our work to reduce variability in our distribution centers has been one of the drivers of these improvements. In the past, an unacceptable number of vendor shipments were received by our DCs either too early or too late. This variability drove a lot of extra workload in the DCs, while reducing our reliability downstream. As a result, this year we have been collaborating with our vendors to increase the percent of shipments that arrive on the correct day, and we've already seen meaningful progress. The percent of shipments that arrive on time has more than doubled, and we expect to see additional improvement as we roll out new processes to additional vendors over time. +As shipments arrive at our distribution centers, we've made changes to the prioritization of inbound processing, which have already cut the time to unload trailers by more than 50%, and we believe we can cut that time even further. In addition, we've improved process flow between our import warehouses and our regional DCs, reducing the average time it takes for an item in an import warehouse to reach the store shelves by more than half. +We're also focused on our outbound processing, with the goal of enabling daily deliveries to every store throughout the week, regardless of a store's sales volume. When implemented, this change will drive additional improvements to store in-stocks, while reducing backroom inventory and store workload. I want to thank the entire team, from merchandise planning to our distribution centers, logistics teams and our stores, for these improvements. Without the engagement of the entire end-to-end supply chain, we couldn't have made such amazing progress. +Before I move on to our work in the stores, I want to comment briefly on our overall inventory position. As we've mentioned over the last several quarters, a portion of our year-over-year inventory growth reflects intentional investments we're making in non-seasonal, commodity categories to support in-stock improvements on items most important to our guests. In addition, our second quarter inventory reflected an investment to offer additional items in certain categories, as we work with merchant teams to reliably offer appropriate assortment, both online and in our stores, to best serve our guests. +Beyond our upstream supply chain work, our investment in self-checkout lanes is also reducing store work load, freeing up time for our store teams to focus on guest service while providing our guests a checkout option that many of them prefer. As of today, we have self-checkout in just over 1,000 of our stores. We're planning to add it to another 200 stores by the end of the year, and we will continue the rollout in 2017. In stores with self-checkout, nearly a third of transactions go through these lanes, much higher than our initial projections. +Our flexible fulfillment initiatives including store pick-up and ship-from-store, are one way we're reinvesting store labor savings to serve guests in new ways. At the end of 2015, more than 460 stores were shipping items directly to guest's homes, and we're planning to double our capacity this year, by expanding this capability to more than 500 additional stores. These additional locations will further improve our average ship time, while providing deeper access to our store inventories, increasing the likelihood that we can ship a guest's entire order from a single nearby store location. And importantly, because we are now pre-positioning high velocity web-only items in the backroom of ship-from-store locations, we are able to reduce last mile and split-shipment expenses dramatically. +In-store pick-up is an increasingly popular option for many of our guests. This year we've seen 50% growth in pick-up orders, on top of 60% growth a year ago. Year to date more than 90% of our pick-up orders have been ready in one hour, and we've implemented process improvements to reduce wait times in stores. As a result, guest satisfaction with the pick-up experience is up from a year ago, and a higher percent of guests are repeatedly using this service. +To prepare for this holiday season surge, we're investing to ensure our stores can continue to deliver a great pick-up experience, in the face of rapidly increasing demand. In 75 of our highest volume stores, we're increasing holding capacity to allow our team to retrieve items more quickly even during peak times. We're also investing in additional digital devices to support peak demand. And across all of our stores, we're rolling out new guidance on how our stores can optimize their storage space to enhance speed and efficiency. +New this year, we've implemented systems and processes to allow stores to forecast and monitor pick-up demand, ensuring we maintain proper staffing levels. In addition, during the holiday season, about 300 stores will be testing separate, branded shirts for the team members in the pick-up area, and distinctive bags for pick-up orders to underscore our commitment to this experience. +Finally, as Brian mentioned, the back-to-school, back-to-college season is our second most important sales driver of the year. As a result, we're planning to carefully measure our pick-up reliability and speed during promotional peaks this quarter, so we can apply those learnings in time for the holiday season, when peak demand will be even higher. +It was just a year ago that I began working with my new team. I'm very proud of what we've accomplished since then. However, I'm also energized by the opportunity still ahead of us, to further increase the speed, flexibility and reliability of our supply chain, to drive unnecessary workload out of our stores, and to enable operational excellence across the organization. As we work to accomplish these goals, I'm fortunate to work with an experienced team, led by both internal talent and some amazing new hires. And I'm confident that with their leadership, we will continue to improve Target's operations on behalf of our guests. +With that I'll turn it over to Cathy who will share her insights on our second-quarter financial performance, and our outlook going forward. Cathy? + +-------------------------------------------------------------------------------- +Cathy Smith, Target Corporation - CFO [5] +-------------------------------------------------------------------------------- +Thanks, John, and hello, everyone. Our second-quarter adjusted earnings per share of $1.23 was better than the high end of our guidance, and just better than last year. Second-quarter GAAP EPS from continuing operations was $0.16 lower than adjusted EPS, driven by $0.17 of debt retirement costs due to settlement timing on a subset of our first-quarter debt tender offer. +This quarter's profit performance was quite impressive, in light of the challenging sales environment. Specifically, comparable sales declined 1.1% this quarter, in line with our guidance and well below our plan at the beginning of the year. As expected, the total sales in the second quarter were down more than 7% from last year, driven by the sale of our pharmacy and clinic businesses to CVS. Digital sales grew 16% in the second quarter, contributing 0.5 point to our comparable sales growth. +Looking at the components of our comparable sales, comp transactions declined 2.2%, partially offset by a 1.1% increase in average ticket. While ticket growth was broadly consistent with the last couple of years, traffic performance showed a meaningful change from prior trend. I want to pause, and make it clear, that we are not satisfied with our second-quarter traffic and sales performance. And as Brian described earlier, we are taking steps to grow both our traffic and sales over time. +REDcard penetration was 23.9% in the first quarter, up about 180 basis points from last year. However, given that last year's pharmacy sales had a much lower than average REDcard penetration, the removal of those sales from this year's results drove a portion of the penetration improvement. Excluding that benefit, REDcard penetration was up about 70 basis points from a year ago. +Moving down the P&L, our second-quarter EBITDA margin rate was 11.2%, up about 30 basis points from 10.9% a year ago. This improvement was entirely driven by a year-over-year increase in our gross margin rate, partially offset by a modest increase in our SG&A expense rate. Among the drivers of our gross margin rate, the pharmacy sale drove about 70 basis points of improvement from last year. This improvement was offset by pressure from shipping expense resulting from online growth, along with the impact of second quarter promotional and clearance markdowns, partially offset by the benefit of our cost control efforts. +On the SG&A line, we saw pressure from investments in our team and in marketing, along with the deleveraging impact of the decline in sales. These pressures were offset by the rate impact of the pharmacy sale, combined with the benefit of our cost savings initiative. Overall, we saw a year-over-year increase in our SG&A expense rate of about 20 basis points. Given the pressures we were facing, this is really impressive expense performance, and I want to thank the team for their tireless efforts to control cost. +Quarter-end inventory was up a little more than 4%, consistent with last quarter. Given the investments we've made in essential categories and assortment enhancements, as well as the impact of the sales slowdown that occurred in the second quarter, our quarter-end inventory position was relatively healthy. And of course, given our cost of sales outlook for the back half of the year, we will continue to monitor our receipts and inventory levels closely. +Let's now turn to capital deployment. As we mentioned in our last conference call, this quarter we deployed about $1 billion to settle a portion of our first-quarter tender offers, and we funded a $750 million debt maturity in July. In addition, during the quarter, we returned another $1.7 billion to our shareholders through dividends of $330 million, and share repurchase of more than $1.3 billion. By the end of the second quarter, we had about $1.5 billion of cash and equivalent on our balance sheet, consistent with the guidance we provided in our first-quarter conference call. +One other note. Through the end of the second quarter, we have repurchased approximately $8.8 billion of shares under the Company's current $10 billion repurchase authorization. As a result, we plan to request additional repurchase capacity from our Board in the next several months, given that our outlook anticipates continued cash available for share repurchase going forward. +I want to reiterate that our priorities for capital deployment have not changed. First, we fully invest in projects that meet our strategic and financial criteria. Second, we support the dividend, and intend to build on our 45-year record of annual dividend increases. And finally, we return cash by repurchasing shares when we have the capacity within the limits of our single-A long-term credit rating. Looking ahead, we will continue to govern the pace and magnitude of share repurchase in support of our goal to maintain those credit ratings. +Despite the challenging environment, our business continues to generate very strong returns. For the 12-month period through second quarter, we reported an after-tax return on invested capital of 15.8%, up from 13.3% a year ago. I'll quickly note, however, that this year's ROIC includes the one-time gain from the sale of our pharmacy business to CVS, which occurred last December. Without that one-time benefit, our second-quarter after-tax ROIC was still a very healthy 13.7%, up about 40 basis points from last year. +Before I turn to our outlook, I want to pause, and discuss the factors that are shaping our expectations going forward. Obviously, one consideration is the sales and traffic environment we've faced over the last several months, in which overall trends have been challenging, and weekly and regional patterns have been more variable than normal. The second consideration pertains to the relative benefit of planning our business conservatively. If actual sales turn out to be stronger than our expectations, our teams are prepared to chase inventory, and ramp up hours in our stores and distribution centers. +In those situations, we generally generate healthy profit rates on incremental sales. However, those same profit dynamics typically work in reverse when we miss our sales outlook, given that it's more difficult to cancel orders and to pull back on labor hours. So despite the fact that we continue to believe in our long-term strategy, and we're taking steps to address some of the Company-specific challenges Brian addressed earlier, we believe it's appropriate to temper our near-term sales and EPS expectations. +So let's turn first to our outlook for the third quarter, beginning with sales. This quarter we are planning for a comparable sales range of a minus 2% to flat, consistent with our second-quarter guidance. If our comp sales are near the midpoint of that range, we expect to generate gross margin and SG&A expense rates similar to last-year's levels. This expectation reflects the continued benefit from the removal of the pharmacy sales from this year's results, offset by a continuation of the headwinds we faced in the second quarter. +One note, the pharmacy sale is expected to cause a delta of a little more than 6 percentage points between comp sales and total sales this quarter, similar to what we saw in the second quarter. As a result, we expect to deleverage depreciation and amortization line in the third quarter, as the depreciation and amortization dollars are expected to be essentially flat to last year, but spread over a smaller sales base. Altogether in the third quarter, we expect to generate both GAAP EPS from continuing operations and adjusted EPS in the range of $0.75 to $0.95. +As we look beyond the third quarter, we are planning fourth-quarter comp sales in the same range as third quarter. And given our third- and fourth-quarter profit outlook, combined with our year-to-date performance through the second quarter, we're planning to generate full-year adjusted EPS of $4.80 to $5.20. We expect full-year GAAP EPS from continuing operations to be about $0.44 lower than adjusted EPS, as a result of the debt retirement and pharmacy transaction costs which we recorded in the first half of the year. +While this outlook for full-year EPS is somewhat lower than our expectation at the beginning of the year, it reflects healthy profit performance in the face of challenging sales. And consistent with our performance through the first half of the year, it reflects the benefit of our cost savings initiatives, and disciplined management by our team. +Before I conclude my remarks, I want to thank the team for making cost control a long-term habit, not a short-term focus. Last year we announced a plan to save $2 billion over two years. And I'm pleased to say that we're not only running ahead of that goal, but the team continues to find new opportunities to eliminate unnecessary cost and activities. These savings allow us to reinvest resources in our enterprise priorities, while still generating solid financial performance even in challenging times. +With that, we'll conclude today's prepared remarks. Now Brian, John and I will be happy to respond to your questions. + + +================================================================================ +Questions and Answers +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- +(Operator Instructions) +Your first question comes from Matt Fassler with Goldman Sachs. + +-------------------------------------------------------------------------------- +Matt Fassler, Goldman Sachs - Analyst [2] +-------------------------------------------------------------------------------- +Thanks a lot. Good morning. My first and primary question relates to the, how much impact do you think the CVS pharmacy transition had on traffic? Did you see that dynamic deteriorate from the first quarter, and is there a way to quantify perhaps, how much you feel like the spillover effect from that would have impacted the overall comp? + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman and CEO [3] +-------------------------------------------------------------------------------- +Matt, as I discussed in my prepared comments, our traffic was impacted by a number of factors including CVS. Do we certainly saw a slowdown in our pharmacy operations. We're working closely with CVS to launch the new marketing campaigns to win back our Target guests, and certainly to begin to unlock the potential of their PBM network. So that certainly played a role. But we also had other factor that we're focused on right now. +We're not pleased with the performance we saw in food, despite making some really good progress in presentation, improving our assortment, and certainly the freshness of our products. So our number one focus, as we sit here today is driving traffic back to our stores, and accelerating visits to our site. And addressing the pharmacy impact is just one of the variables we're focused on today. + +-------------------------------------------------------------------------------- +Matt Fassler, Goldman Sachs - Analyst [4] +-------------------------------------------------------------------------------- +Thank you for that. And by way of quick follow-up, a different topic. +You touched on Apple products down over 20%. We're obviously in the middle of a bit of a pause between the iPhone releases, leading up to one most likely later this year. Is the Apple softness at this point really an iPhone story, or is it a broader issue across the product suite? + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman and CEO [5] +-------------------------------------------------------------------------------- +Matt, for us it's a broader story across the product suite. And one of the first things we've had Mark Tritton do, is actually spend time with our Apple partners, really making sure that we're putting the right plans together for the back half of the year, that we're ready to capitalize on their new innovation that they'll be bringing to market. +But again, as we think about factors that we have to address to improve our traffic and overall sales performance in the back half of the year, we have to improve electronic performance. It was a significant drag, 70 basis points on our overall comp decline in the quarter, and Apple played a significant role there. So we over-index with Apple products, our guests come to us looking for those products, they're looking for the newness and innovation, and we're putting together plans with Apple, and our merchandising teams to make sure we're ready to take advantage of that in the back half of the year. + +-------------------------------------------------------------------------------- +Matt Fassler, Goldman Sachs - Analyst [6] +-------------------------------------------------------------------------------- +Brian, thank you very much. + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman and CEO [7] +-------------------------------------------------------------------------------- +Thanks, Matt. + +-------------------------------------------------------------------------------- +Operator [8] +-------------------------------------------------------------------------------- +Your next question is from David Schick from Consumer Edge Research. + +-------------------------------------------------------------------------------- +David Schick, Consumer Edge Research - Analyst [9] +-------------------------------------------------------------------------------- +Hi, thanks. Good morning. + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman and CEO [10] +-------------------------------------------------------------------------------- +Good morning, David. + +-------------------------------------------------------------------------------- +David Schick, Consumer Edge Research - Analyst [11] +-------------------------------------------------------------------------------- +How are you? My question is on the competitive environment. You talked about all of the different things you're working on with traffic, but is there anything out there that you're seeing, anything you could highlight in the major categories that's going on in the marketplace that might be affecting your -- either your traffic or customers attention, and how you're thinking about addressing that in the back half? + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman and CEO [12] +-------------------------------------------------------------------------------- +Well, Matt, I think we've seen this environment persist now for well over a year. It's a very cautious consumer. If we look at the overall trends within retail, we've certainly seen on a rolling 12 month basis a slowdown in retail sales growth, but that's not an excuse for us. +We got to make sure we're leveraging our strategic levers. We continue to make sure we improve our in-store experience. +As John talked about during the call, we've got to make sure that we offer a sensational in-store pick-up experience. And also make sure that our site is easier to work with and allows us to ship directly to home. So we've got to make sure we're leveraging the key components of our strategy. +I feel really good about the progress we've made in-store, in preparation for back-to-school, back-to-college, I've announced into a number of markets. I don't think our stores have ever looked better. +So it's a competitive environment, it's going to continue to be a competitive environment, and we've got to make sure that we leverage our strategy, make sure that we're bringing the best of our signature categories, and bringing the value the guest is looking for in core household essentials, to win trips, and win back trips in the second half of the year. So it's competitive, but it's always competitive. And we've got to make sure that we're leveraging our assets, and our strategy to continue to drive performance in the back half of the year. + +-------------------------------------------------------------------------------- +David Schick, Consumer Edge Research - Analyst [13] +-------------------------------------------------------------------------------- +I guess, the follow-up to that would be, it's competitive as you say, it continues to be competitive. Is there any change in the balance of whether it's new products and merchandising, or pathways brought to market or pricing, any thing changing in the way the competitive environment looks for you to make above it? + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman and CEO [14] +-------------------------------------------------------------------------------- +David, you've used an important term that I've been using internally, and that is balance or rebalancing. And as I look at my experience now over the last couple of years at Target, we're best when we balance both ends of our brand positioning. We've got to deliver on the expect more component, and I think we've done a sensational job there. +Our progress in apparel and home has been really significant, and we've got to make sure we never lose track of the other side of our brand promise, and that's the pay less side. And that's all about those core household essentials that we have to make sure are presented effectively in-store, in our circular, on our end caps, to our guest each and every week. So as we think about the back half of the year, and the keys to driving our business going forward, we've got to have both of those levers in balance. +We've got to continue to make sure our signature categories, and particularly those important style categories, continue to connect with our guest. And we've got to deliver a great value through household essentials, those every day products that drive that Target run. So that balance or rebalance is critically important to the actions we're taking in the back half of the year. + +-------------------------------------------------------------------------------- +David Schick, Consumer Edge Research - Analyst [15] +-------------------------------------------------------------------------------- +Thanks so much. + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman and CEO [16] +-------------------------------------------------------------------------------- +Thanks, David. + +-------------------------------------------------------------------------------- +Operator [17] +-------------------------------------------------------------------------------- +Your next question is from Oliver Chen with Cowen and Company. + +-------------------------------------------------------------------------------- +Oliver Chen, Cowen and Company - Analyst [18] +-------------------------------------------------------------------------------- +Hi, we had a question regarding the dynamics you're seeing between fill in and stock up trips. How are you feeling about that in your research? And also as we look towards the back half and model our views on comp store sales, what would you prioritize as the biggest drivers to improve traffic, in terms of the different initiatives that you're pursuing in light of what you're seeing? +And just another question we had is, why do you think this happened in pharmacy, in terms of what was the consumer experiencing in your store that made the transition a little more disruptive than you would have wanted? Thank you. + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman and CEO [19] +-------------------------------------------------------------------------------- +Oliver, let me try to break apart those three questions, and have Cathy and John jump in as appropriate. As we think about the rebalancing, and the work we're doing from a merchandising stance point, an in-store presentation standpoint, and also a weekly advertising standpoint. We recognize we have to continue to deliver the right presentation for that stock up occasion, and particularly in the back half of the month, have the right assortment, the right presentation, the right availability of the items our guest is looking for in that fill in occasion. +So we're activating and ensuring we put those changes in place, to find the balance as we speak today. So we're certainly very focused and aware of the fact that we have to win on both fronts. We have the right assortment for that stock [up] occasion, and we need to make sure we have the right pack price architecture to meet the needs of the guest during that fill in occasion -- so we're very focused on that. +From a CVS standpoint, I'll let John jump in here. It's not a surprise to us that there has been some disruption and I think, for all of us on the call, we know what it's like when we change a pharmacy prescription, and move from one provider to another. And while they're staying in our location, they've got to sign up for some new programs, they're entering a new environment. +There is some time that's going to take. But we've been very pleased. John has been working with his CVS counterparts on the transition. +We've had great collaboration, great partnership. We're starting to activating the marketing and the personalized messaging. And we expect over time, we'll see that business accelerate, and we expect pharmacy and the partnership to be a future driver of traffic and growth. +But John, why don't you talk about some of the things we're doing at the store level with CVS? + +-------------------------------------------------------------------------------- +John Mulligan, Target Corporation - COO [20] +-------------------------------------------------------------------------------- +Yes, I think I'd start by first echoing what Brian said, we talked going into the deal, we had a great partner. And that is certainly what we have observed through the transition here, been a great partner to work with. Our teams have worked together very well to transition. +We've done the best job we can, in transitioning guests. But as Brian said change is change, and sometimes you just need to work through that. From a go-forward perspective, we're working with CVS, certainly on some of their capabilities that they'll bring to bear for Target. And as Brian said, unlock their PBM network into our stores. +But more importantly day-to-day, in the stores, we see great guest service -- continue to see great guest service from our pharmacists. CVS would note that probably the best score they've ever seen in a transition like this. And then starting to work with them, to engage the pharmacy more back into the store, through things like the opportunity here at back-to-school, back-to-college with flu shots, and having the pharmacy play a more prominent role as we go forward. +And so the teams continue to develop plans like that. They're very focused on it. We're focused on it, and we're very excited about the opportunity here, as we continue to move forward. + +-------------------------------------------------------------------------------- +Cathy Smith, Target Corporation - CFO [21] +-------------------------------------------------------------------------------- +Hey, Oliver, this is Cathy. I'll add a little bit more too around priorities for driving traffic in the back half, and that we're really excited to be going to this part of the year, where we have a lot of events, and that's where Target really has some great plans. We always have great plans, back-to-school back-to-college. +We're excited about, obviously, the launch Cat & Jack has started out very successfully, with a lot of learnings that we took away from Pillowfort, both online and in stores. And then obviously, we go into our prime time. And so standing tall on the events that we typically have always done, but we're really well positioned. +And then, it's the things that Brian and John have already mentioned, the rebalancing of our messaging, that we are re-looking at all of our grocery efforts around presentation, assortment and promotion, at the electronics, the newness that Brian mentioned. Then, obviously, the work that John just said around CVS. + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman and CEO [22] +-------------------------------------------------------------------------------- +Yes. So Oliver, as we think about the second half, we've got to continue to build on the things that are working today. Even in a challenging second quarter, we grew market share in the important apparel space. We saw very strong results in our home categories. +We continue to be a destination for toys. So we've got to build on the things that are working and ensure that we're also winning trips for those core household essentials. So we'll be focusing on rebalancing, on leveraging the improvements we've made both in-store, with our in-store pick-up process and also online. +And we're not altering our strategic focus, it's making sure we get our strategies in balance, and we deliver against both signature categories, and those important household essentials that drive traffic to our stores, and put cars in the parking lot. + +-------------------------------------------------------------------------------- +Oliver Chen, Cowen and Company - Analyst [23] +-------------------------------------------------------------------------------- +Thank you very much. Best regards. + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman and CEO [24] +-------------------------------------------------------------------------------- +Thanks, Oliver. + +-------------------------------------------------------------------------------- +Operator [25] +-------------------------------------------------------------------------------- +Your next question is from Kate McShane with Citi. + +-------------------------------------------------------------------------------- +Kate McShane, Citigroup - Analyst [26] +-------------------------------------------------------------------------------- +Hi, good morning. + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman and CEO [27] +-------------------------------------------------------------------------------- +Good morning. + +-------------------------------------------------------------------------------- +Kate McShane, Citigroup - Analyst [28] +-------------------------------------------------------------------------------- +I think when you gave guidance for Q2 originally, it was because of some of the higher inventories that you flagged at other channels, especially with regards to apparel. So I was just wondering how much you think you're benefiting from some of the weakness that we have seen at the brick-and-mortar department stores, especially when considering your women's apparel comp was up mid single-digits during the quarter? + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman and CEO [29] +-------------------------------------------------------------------------------- +Well, we certainly think we are winning in the apparel space. And I think a lot of that's really driven by the changes we've made, the improvement in our assortment, in quality, in being more on trend with some of our fashion assortment. I talked about Xhilaration performing very well in the quarter,. Who What Wear continues to be a real winner for us, and connecting well with our guests. +And we've also matched that up with an improved in-store experience. And we've been talking about mannequins for awhile, but the role that our visual merchandisers are playing. The investment that John and I made last year to ensure we had, not only mannequins and home vignettes, but the talent in our stores to maintain that experience 52 weeks a year is certainly connecting with the guests. +So we think we're benefiting by really executing against the strategy we've been talking about for several years, making sure we have the right quality, innovation, presentation in our stores, and we surround our guests with great service. And that's paying off with market share gains in a challenging environment, where we continue to see improvement in our apparel and home assortments. + +-------------------------------------------------------------------------------- +Kate McShane, Citigroup - Analyst [30] +-------------------------------------------------------------------------------- +Okay. Thank you for taking my question. + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman and CEO [31] +-------------------------------------------------------------------------------- +Thank you. + +-------------------------------------------------------------------------------- +Operator [32] +-------------------------------------------------------------------------------- +Your next question is from Greg Melich from Evercore ISI. + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman and CEO [33] +-------------------------------------------------------------------------------- +Good morning, Greg. + +-------------------------------------------------------------------------------- +Greg Melich, Evercore ISI - Analyst [34] +-------------------------------------------------------------------------------- +Good morning. I want to follow-up a bit on traffic, and then get into the guidance a bit. On traffic, if you think about it a different way, I think about a year ago, traffic had recovered nicely, to stay up 1%, and overall retail sales were growing roughly where they were, if you look at the government data. +And now the traffic is obviously down a couple percent. Do you see any differences, in terms of geographies or other things going on, the income demographics around your stores, where that traffic trend is different, just looking at the last 12 months? + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman and CEO [35] +-------------------------------------------------------------------------------- +Yes, Greg, we certainly do, and Cathy and I talked about this at the end of the first quarter. We've seen quite a bit of variability on a day-to-day, week-to-week basis between different markets. +We've seen particular strength in many of our West Coast markets, very strong performance in California, driven by great performance in LA and San Francisco, but other parts of the West Coast. We've seen pockets of softness on the East Coast. +And we've really tried to make sure market by market, we're looking at those dynamics, looking at the competitive dynamics, understanding what we can leverage from the markets where we are seeing increases like Los Angeles, and bring that into challenged markets. But we've seen over the course of this year in 2016, much more variability than I've seen in many, many years. So we're drilling down on that. +And as we think about our plans for the second half of the year, we're building market-specific action plans to make sure we address the market-specific needs of our stores and our guests. + +-------------------------------------------------------------------------------- +Greg Melich, Evercore ISI - Analyst [36] +-------------------------------------------------------------------------------- +That's helpful. And then Cathy, I think on the margins, just want to make sure I got the guidance right. If I take the midpoint, I get to the -- you mentioned the third quarter, flat EBIT margins, although I imagine ex the CVS sale, they would be down like 30 bps. + +-------------------------------------------------------------------------------- +Cathy Smith, Target Corporation - CFO [37] +-------------------------------------------------------------------------------- +Yes. + +-------------------------------------------------------------------------------- +Greg Melich, Evercore ISI - Analyst [38] +-------------------------------------------------------------------------------- +Is that right? + +-------------------------------------------------------------------------------- +Cathy Smith, Target Corporation - CFO [39] +-------------------------------------------------------------------------------- +Yes, so it's slightly down EBIT margin, we said gross margin and SG&A about where they were last year. + +-------------------------------------------------------------------------------- +Greg Melich, Evercore ISI - Analyst [40] +-------------------------------------------------------------------------------- +Got it -- but for the fourth quarter, does the guidance imply that EBIT margins will be flat? + +-------------------------------------------------------------------------------- +Cathy Smith, Target Corporation - CFO [41] +-------------------------------------------------------------------------------- +It is slightly up. So yes, so slightly down Q3, slightly up in Q4. + +-------------------------------------------------------------------------------- +Greg Melich, Evercore ISI - Analyst [42] +-------------------------------------------------------------------------------- +Okay. Just want to make sure I've got that right. +And then, I guess last on that, just to make sure the inventory up 4%, do you guys think -- I mean, that you're comfortable with that number? It's not like part of the third quarter is working that inventory down? + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman and CEO [43] +-------------------------------------------------------------------------------- +Greg, we're very comfortable right now with our inventory position. + +-------------------------------------------------------------------------------- +Greg Melich, Evercore ISI - Analyst [44] +-------------------------------------------------------------------------------- +Great. Thanks a lot. Good luck. + +-------------------------------------------------------------------------------- +John Mulligan, Target Corporation - COO [45] +-------------------------------------------------------------------------------- +Thank you. + +-------------------------------------------------------------------------------- +Operator [46] +-------------------------------------------------------------------------------- +Your next question is from Dan Binder with Jefferies. + +-------------------------------------------------------------------------------- +Dan Binder, Jefferies LLC - Analyst [47] +-------------------------------------------------------------------------------- +Thanks. It's Dan Binder. I had a question on the consumer electronics category. You talked a lot about that today, and I've noticed in your stores recently you've had some reset activity, particularly in TV as you offer more 4K. +I am curious, as you work through these plans to improve that business, do you think that can be a category that returns to positive comps by holiday, given all the changes you're making? + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman and CEO [48] +-------------------------------------------------------------------------------- +Dan, I think it's largely driven by the new innovation that we bring to the guests in the fourth quarter. So we've certainly seen pockets of strength. I mean, there's certainly winners and losers within that space. +We've seen continued performance with wearable technology. But it's not overcoming the softness we've seen in mobile, in tablets, and in some of the core items. So I think the success of that category, as always is going to be driven by new news, and news that connects with the guest, and drives traffic into those categories. +So again, it's why Mark and his team are very focused right now, in working with our electronics vendors to make sure we have the right innovation, we're presenting it in a way that's impactful for the guest, and we have to see improvements in a category that's been a big drag on our comps over the last couple of quarters. + +-------------------------------------------------------------------------------- +Dan Binder, Jefferies LLC - Analyst [49] +-------------------------------------------------------------------------------- +And then, a follow up on the food category. You mentioned you were reevaluating promotion in, I guess, food and consumables. +I'm just curious, it sounds like you'll increase it. So I'm just curious, are you seeing others out there being more aggressive in the category, is that what you would attribute softness to? And if that is the case, where -- which channels are you seeing it in? + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman and CEO [50] +-------------------------------------------------------------------------------- +Yes, I think, Dan there's been a lot written recently about the competitive nature of the food channel. And for us on one hand, we feel, I feel, really good about the progress we've made with assortment. If you walk our stores today versus even six months ago, aisle by aisle, you're seeing more organic, more natural, more gluten-free, more local items that are on trend. +The freshness and the work that John and his team have done from a supply chain standpoint is clearly connecting with the product we're delivering to the guests. And we've seen an uptick in categories like produce, because we're delivering better product. But at the same time, market by market, this is a very competitive space. There's clearly food deflation right now that we're facing, and it's a very competitive environment. +And back to the earlier question about traffic and performance trends by market, we're looking very specifically at food by market across the country, because we face a number of regional competitors, and we've got to make sure our presentation, our promotion, our approach enables us to compete market by market. + +-------------------------------------------------------------------------------- +Dan Binder, Jefferies LLC - Analyst [51] +-------------------------------------------------------------------------------- +Well, congratulations on the LA25. It sounds like you're getting good results out of that. +I was just wondering if you could share with us, the likelihood of being able to roll that out? Is it a cost efficient format, or are you primarily using it just for learnings? + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman and CEO [52] +-------------------------------------------------------------------------------- +Well, Dan, we've certainly used it as a learning lab, but our intention is to lift the winners from LA25, and quickly bring them into other stores across the country. And while it's still very early, we have effectively one quarter of learning under our belt, I'm very pleased with some of the results we're seeing in apparel, in home. +And certainly in food, whereas I mentioned during my prepared comments, we're seeing performance in those 25 test stores that are clearly, really encouraging from a food standpoint, particularly in the perishable space. So we'll be looking to leverage that learning. That's part of our strategy that we've articulated for several quarters now, that we want to use LA as a test market to lift and shift the winning concepts into more stores across the country. And we'll continue to lift and leverage the learning from LA25, to improve the experience in the presentation of product throughout our Target stores. + +-------------------------------------------------------------------------------- +Dan Binder, Jefferies LLC - Analyst [53] +-------------------------------------------------------------------------------- +Thanks. + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman and CEO [54] +-------------------------------------------------------------------------------- +Thank you. + +-------------------------------------------------------------------------------- +Operator [55] +-------------------------------------------------------------------------------- +Your next question comes from Scott Mushkin from Wolfe Research. + +-------------------------------------------------------------------------------- +Scott Mushkin, Wolfe Research - Analyst [56] +-------------------------------------------------------------------------------- +Yes, hey, I wanted to continue on the path where Dan was going. But before I got started I'd just say, in our store visits, you can definitely see the improving execution, so kudos to John in getting that done. But getting back to the food discussion, our research is showing some pretty aggressive moves and I think Dan was getting at this. +I mean, are you guys going to match what's going on in the market? And it looks like we're at the beginning end of a pretty aggressive price war. How do you see it? Where do we -- we're now seeing deflation reported by the government of [1.5%] -- [1.5%, 1.6%], and our pricing surveys are even greater than that. So where do you see this going? +What do you guys plan to do to combat it tactically in the short-term? And then, I wanted to address the longer term food business after that? + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman and CEO [57] +-------------------------------------------------------------------------------- +Well, Scott, I'll start with, we're playing to win. And we've invested heavily in that very important category. We've had a long-term commitment to food, we think it's very important for our guest. +And over the last couple of years, while we've done it in a very disciplined fashion, category by category, and I appreciate hearing you say that you've seen an improvement in execution, and hopefully in presentation. Now we've added thousands of new items, and we've worked with our vendor partners to make sure we're bringing the right innovation, category by category. Our team is absolutely going, literally item by item, commodity by commodity, to look at how we source, and how we flow product to improve freshness, and the quality we present to our guests. +So we've got to make sure we have the right assortment, the right presentation, the right quality. We have to have the right promotional strategy to compete, but we're playing to win both short- and long-term. We think that it's very important that we continue to make progress in this space. We're going to make sure we do it in a very focused manner. +We really like what we're seeing in LA25. We're not going to roll it out to 1,800 stores tomorrow. We're making sure we that can validate what's working, and how can we drive profitable sales in that space. +But we are playing to win in food. We're going to continue to roll up our sleeves, and make sure that we're into the details, finding ways to unlock the growth potential in that critically important category. + +-------------------------------------------------------------------------------- +Scott Mushkin, Wolfe Research - Analyst [58] +-------------------------------------------------------------------------------- +So Brian, thanks for that answer. So to dovetail more into the longer term, when you were at Safeway, you guys obviously did a lot of remodels and drove comp. LA25, it sounds like traffic positive there. +But in the article, I think it was in the Journal, they talked about the Board is very reluctant to put more capital behind the food effort. Talk us through this. I mean, you've got a traffic issue, consumables mean traffic. But if you want to invest, it's hard to get the traffic, so you're almost caught in a catch-22 here. +And I just want to get your outlook or your thoughts on what I'm saying, given the longer term need for traffic, and to drive traffic into the store, to make earnings rise continuously, as we look out into the out years? + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman and CEO [59] +-------------------------------------------------------------------------------- +Yes, and Scott, in all due respect to the Journal, let me speak on behalf of our Leadership team and the Board. We have no hesitancy at all, in investing capital in our business that drives growth and the right returns. +As Cathy has demonstrated throughout the last few calls, even in challenging times, we generate significant cash flows. And we want to make sure the first thing we do with that cash is invest back in our business. So it's why we're spending time, looking at LA25. +It's why we've been testing a number of different features throughout our stores, from apparel, to home, to food. It's why we're so excited about investing in flex formats, where we see a very strong response from the guest. Those are delivering very strong returns, well ahead of our original plans, and food plays an important part in those smaller flex formats. +So despite what you may be hearing, we have absolutely complete support from the Board to make sure we're investing capital behind the initiatives that are going to drive future growth. So again, we're not just playing for just the short-term, we're playing for the long-term. Those capital investments have to be done on behalf of the guest and our shareholders, but we're looking right now at a number of different opportunities to continue to invest to drive growth. +So there's no hesitancy at all in making those investments. And as you just said, food and perishable and consumable categories will play a very important role in driving traffic to our stores. And in the future, we've got to continue to bundle that with the work John's doing, to make sure and we're investing and improving our in-store pick-up processes and experience. +That's an investment we're making, and an investment we're making for the holiday season. We're continuing to invest in our digital assets. So there's no hesitancy at all, from this Management team nor the Board, in making the right investments in our long-term success. + +-------------------------------------------------------------------------------- +Scott Mushkin, Wolfe Research - Analyst [60] +-------------------------------------------------------------------------------- +Thanks, guys, and thanks for the answer. I appreciate it. Good luck. + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman and CEO [61] +-------------------------------------------------------------------------------- +Thanks, Scott. Operator, we've got time for one last call. + +-------------------------------------------------------------------------------- +Operator [62] +-------------------------------------------------------------------------------- +Okay. Your last question comes from Joe Feldman from Telsey Advisory Group. + +-------------------------------------------------------------------------------- +Joe Feldman, Telsey Advisory Group - Analyst [63] +-------------------------------------------------------------------------------- +Hi guys. Thanks for taking the question. Brian, one of the questions I had was, you guys have made a lot of changes in the stores, and we clearly see them, and obviously we've talked all -- for the past hour about a lot of them. +I'm curious about the marketing or communication of that though, to the -- just the consumer. I mean, we see it, because we're all following the Company pretty aggressively and in the stores. But I wonder if there's more could be done on the advertising side, to tell people that you've made so many changes in grocery, or that the home department looks better in a lot of stores? +Or can you talk a little bit about that, and where we're at in terms of when we'll see something like that communication-wise? + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman and CEO [64] +-------------------------------------------------------------------------------- +Yes. Joe, it's a great question for us to end on, and I'll take personal responsibility for this. I've talked earlier about the fact we've got to be rebalancing our messaging, and we've done a really terrific job of elevating our messaging and communication around our signature, and particularly our style categories. +As we go forward -- I've used this term before, we've got to make sure we're rebalancing, and we got to make sure we continue to elevate our messaging, our communication around style and those core household essential categories, which include food, that drive traffic to our store and are important to our guest. So making sure we go back to the brand promise. +We've got to make sure those expect more categories like style, we continue to elevate. And we've got to make sure we deliver the pay less component, and ensure that we balance the work that we're doing from a style standpoint, with the progress we're making on those core household essentials, which include food in that offering. +So it's really an important question. It's certainly a big area of focus for us, on the balance of the year, and into 2017. And I think, it's going to be part of the formula that drives traffic back to our stores, and improves comp store growth over the balance of the year and into 2017. +So operator, with that, we're going to conclude our call. And I thank all of you for joining us for our second quarter earnings call today. Thank you for participating. + +-------------------------------------------------------------------------------- +Operator [65] +-------------------------------------------------------------------------------- +Ladies and gentlemen, this does conclude today's conference call. Thank you for participating. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/exam/original-files/Problem_2_3_Sample_full_transcripts/2016-Feb-09-KO.N-140614720811-Transcript.txt b/exam/original-files/Problem_2_3_Sample_full_transcripts/2016-Feb-09-KO.N-140614720811-Transcript.txt new file mode 100644 index 0000000..8bd5229 --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_full_transcripts/2016-Feb-09-KO.N-140614720811-Transcript.txt @@ -0,0 +1,635 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q4 2015 Coca-Cola Co Earnings Call +02/09/2016 09:00 AM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * James Quincy + Coca-Cola Company - President and COO + * Muhtar Kent + Coca-Cola Company - Chairman and CEO + * Kathy Waller + Coca-Cola Company - CFO + * Tim Leveridge + Coca-Cola Company - VP and IR Officer + +================================================================================ +Conference Call Participiants +================================================================================ + + * Bill Schmitz + Deutsche Bank - Analyst + * Dara Mohsenian + Morgan Stanley - Analyst + * Brett Cooper + Consumer Edge Research - Analyst + * Steve Powers + UBS - Analyst + * Bonnie Herzog + Wells Fargo Securities, LLC - Analyst + * John Faucher + JPMorgan - Analyst + * Bryan Spillane + BofA Merrill Lynch - Analyst + * Ali Dibadj + Bernstein - Analyst + * Kevin Grundy + Jefferies & Company - Analyst + +================================================================================ +Presentation +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + At this time I would like to welcome everyone to the Coca-Cola Company's fourth-quarter 2015 earnings results conference call. Today's call is being recorded. If you have any objections, please disconnect at this time. +(Operator Instructions) +I would like to remind everyone that the purpose of this conference is to talk with investors, and therefore questions from the media will not be addressed. Media participants should contact Coca-Cola's media relations department if they have questions. I would now like to introduce Tim Leveridge, Vice President and Investor Relations Officer. Mr. Leveridge, you may begin. + +-------------------------------------------------------------------------------- +Tim Leveridge, Coca-Cola Company - VP and IR Officer [2] +-------------------------------------------------------------------------------- + + Good morning, and thank you for being with us today. I'm joined by Muhtar Kent, our Chairman and Chief Executive Officer; James Quincy, our President and Chief Operating Officer; and Kathy Waller, our Chief Financial Officer. +Before we begin, I would like to inform you that you can find webcast materials in the Investors section of our Company website at www.cocacolacompany.com that support the prepared remarks by Muhtar James and Kathy this morning. I would also like to note that we have posted schedules under the Financial Reports and Information tab in the Investors section of our company website. These schedules reconcile certain non-GAAP financial measures which may be referred to by our senior executives during this morning's discussion to results as reported under Generally Accepted Accounting Principles. Please look on our website for this information. +In addition, this conference call may contain forward-looking statements, including statements concerning long-term earnings objectives, and should be considered in conjunction with cautionary statements contained in our earnings release, and in the Company's most recent periodic SEC report. Following prepared remarks this morning, we will turn the call over for your questions. In order to allow as many people to ask questions as possible, we ask you to limit yourself to one question. Now let me turn the call over to Muhtar. + +-------------------------------------------------------------------------------- +Muhtar Kent, Coca-Cola Company - Chairman and CEO [3] +-------------------------------------------------------------------------------- + + Thank you Tim, and good morning everyone. In late 2014 we announced a clear five-point plan to reinvigorate our growth and increase profitability. We committed to transform the Company to one that is focused on our core value-creation model of building strong brands, enhancing customer relationships, and leading our franchise system with a goal of becoming a leaner, higher-margin, higher-return, and more focused Company. +I'm pleased to say that we made significant progress against our initiatives, including the very important announcement this morning about accelerating our re-franchising. Importantly, our progress against these initiatives is leading to improving performance, even in a very challenging macro environment. +Let's start with our key announcements today. One of our five strategic initiatives has been to re-focus on our core business of building brands and leading our system of bottling partners. As part of this, we continue to advance our global re-franchising initiatives. With the success of our efforts in Europe and North America, we have the confidence to accelerate our plans. +n North America we learned a significant amount from our initial territory transition efforts. Including the additional territories announced this morning, to date we've signed agreements or transferred territories representing over 40% of US bottle-can volume. At the same time, the performance of our North America businesses continue to improve throughout this process, delivering the highest revenue growth in three years while we executed this important transformation. +Based on our success and the knowledge we gained through the transitions, we're now ready to accelerate the pace. Today we announced we're committed to re-franchising 100% of our bottling territories, including cold-fill production by the end of 2017. This is a critical step for our entire system in North America. It will not be easy, and will require the hard work and dedicated efforts of our entire team, and close collaboration with our bottling partners. But we have a clear plan in place, and are confident that this is essential for our future success. +Moving on to China, our bottling system in this dynamic country has evolved to the point where re-franchising is the next logical step. Today, we are the bottler for roughly 1/3 of our dynamic China business. We have now entered into a non-binding letter of intent to re-franchise our bottling operations to our existing partners, COFCO and Swire. These bottlers have been excellent partners, demonstrating their willingness and capability to grow the China business for the long term. Therefore, we believe they are ready to take on additional territory, and look forward to strengthening our partnerships with them. +These new announcements, combined with the pending creation of Coca-Cola European Partners and Coca-Cola Beverages Africa, as well as our investment in our Indonesian bottler, will strengthen our global bottling system for the coming decades. To put it in perspective, adjusting for these transactions, the percent of our 2015 volume sold through Company-owned bottlers would have decreased from 18% to 3%. +None of this would have been possible without the continuous investments and hard work of our Bottling Investment Group. When we're finished, our Bottling Investment Group will be smaller, more focused, but will remain a critical strategic growth enabler for our Company. +Taking a step back, I'm proud of the progress we've made over the past 18 months, and look forward to completing the next critical phase of our journey. When we complete these re-franchising efforts by the end of 2017 we will look very different than we do today, as we return to a Company that is focused on our core strengths of building strong, sustainable, and valuable brands, creating value for our customers and partners, and continuing to drive system capabilities. As a result, we will become less capital intensive, with significantly higher margins and returns, which will enable our core strengths even further. +Another of our five strategic initiatives is targeting disciplined brand and growth investments. While much of this discussion has been about increasing the quantity of our marketing, we know that improving the quality of our marketing is just as critical for success. +That is why I'm particularly pleased by Coca-Cola's new global marketing campaign. Actually, this is not just a new global campaign, but a new business approach. While we've added a lot of choices to the trademark Coca-Cola portfolio over the years, drinks with calories, without calories, with caffeine, or without -- this is our first campaign ever to cover all the refreshing brands within our Coca-Cola trademark portfolio. +As the most valuable beverage brand in the world, people continue to love our brand, but we recognize consumers want to enjoy Coca-Cola in different ways. Regardless of which one they want, they want a Coca-Cola brand with great taste and uplifting refreshment. +Our one brand strategy transitions us to a single iconic brand campaign that celebrates both the product, as well as the brand. Importantly, this campaign gets back to our roots, featuring the product at the heart of the creative, and celebrating the experience and simple pleasures of drinking a Coca-Cola, any Coca-Cola. +This campaign is also an example of how we are transforming the way we work to be faster, with reduced costs. This campaign was built end to end from the start, from consumer through to shopper, digital, and music, and was developed to support the entire globe. This helps us reduce the number of agencies, and better leverage production costs as well. This discipline, combined with the inspiration of our talented marketing teams, is what will continue to fuel our growth. +While trademark Coca-Cola is the oxygen for our Company, we have the leading portfolio of strong valuable brands across multiple categories, and this portfolio continues to grow, with 20 $1 billion brands, and a strong pipeline of growing regional brands. This year we gained global value share across the core sparkling, package water, juice and juice drinks, energy drinks, and ready-to-drink tea categories. +In addition to internal innovation, we look externally for bolt-on opportunities to expand our still beverage portfolio and capabilities. Just last week we announced an investment in Chi Limited, Nigeria's leading value-added dairy and juice Company. This adds to our other recent investments, including Monster, Suja, and Fairlife, expanding our presence in the energy, juice, and value-added dairy categories. +Last quarter we also announced our intention to sell our shares in conjunction with JAB Holdings, pending acquisition of Keurig Green Mountain. We will recover our initial investment when that transaction closes, while continuing to drive our Keurig Cold opportunity in the market place. +In summary, we recognize we still have much work to do; but we have a clear plan, clear path to transform the Company, becoming more focused on our core business of building brands and leading our system of bottling partners, thereby giving us even greater confidence to achieve our long-term growth targets. I will now hand the call over to our Chief Operating Officer James Quincy, who will provide you with a more detailed look at our operating performance in 2015. + +-------------------------------------------------------------------------------- +James Quincy, Coca-Cola Company - President and COO [4] +-------------------------------------------------------------------------------- + + Thank you, Muhtar. Good morning, everyone. As Muhtar mentioned, let me spend a few minutes reviewing our 2015 operational performance before handing the call over to Kathy. +In 2015 we delivered our plan for our transition year, despite challenging macroeconomic environments. We gained value share in NERTD, sparkling, and still beverages, an important metric for us as we manage the business, especially during periods of slower economic growth and volatility. +For the full year, organic growth of revenues was 4%. Importantly, we delivered 2% global price mix. This was stronger price realization than we have generated in several years, reflecting our segmented revenue growth management strategies, and enabled by our increased investments in media. Unit case volume grew 2% for the year. We're pleased with this volume performance, given our focus on improving price realization during a time when consumer spending was pressured in many markets. +I'm also pleased to confirm that globally we captured over $600 million in productivity, ahead of the target we set for ourselves at the beginning of the year. Structurally adjusted, comparable currency-neutral income before tax grew 6% for the year, as we benefited from the productivity efforts and favorable commodities, although partially offset by our increased media investments. +During the year, we saw a slowing environment in China, and challenges in several key emerging markets, including Brazil and Russia. This was offset by solid performance in North America and many of our Latin American markets. North America itself delivered its strongest performance in three years, delivering 4% organic revenue growth, with three points of price realization, supported by our increased marketing efforts and a disciplined approach to volume, price, and mix management. +Consistent with this strategic focus our driving of consumption small packages could be seen across North America. We grew purchase transactions 3%, out-pacing the 1% unit case volume growth, as consumers increasingly reached for the mini cans, the smaller PET, the eight-ounce glass bottles, as well as our premium aluminum bottles -- all of which drive more value per occasion than our traditional packages. Hopefully many of you also saw an example of this strategic focus on Sunday night during the Super Bowl, when we had our latest commercial focusing exclusively on the mini-can package. +Our performance in 2015 gives us confidence that our strategies are working, and that our underlying performance will be within our long-term targets in 2016. However, let me be clear the global economy remains challenged and is not improving rapidly. We do see slightly better GDP growth rates in 2016 as compared to 2015; but to be fair, forecasts continue to be revised downwards, and there's still much uncertainty. Notable are Brazil and Russia continuing to deteriorate, while China's growth rate does also slow, putting pressure across many of the emerging and developing markets. +Now while helpful consumers, the lower price of oil is also causing volatility in the Middle East and other oil-driven export economies, with further implications for those nations. Given the erratic nature of the global economy, we will continue to focus on what we can control in order to deliver our plan. We will continue to build on the fundamentals of our strategy for long-term success, while delivering solid revenue growth and strong underlying operating margin expansion, through the effective continued management of our portfolio, price mix, and productivity efforts. +With that, I'm going to hand off to Kathy, who will give you additional detail on North American productivity programs, a walk through the 2016 outlook. + +-------------------------------------------------------------------------------- +Kathy Waller, Coca-Cola Company - CFO [5] +-------------------------------------------------------------------------------- + + Thank you James, and good morning everyone. In the interest of time this morning, I intend to cover just three topics: North America re-franchising, our updated productivity targets, and our outlook for 2016. +Let me start with our re-franchising efforts in North America. As we accelerate our re-franchising, we're returning to our core business of brand-building, driving customer value, and leading the system. At the same time, the re-franchising causes a lot of complexity in our North America P&L. Therefore, in order for Management to view the underlying performance of our core business in North America separately, we made the decision to adjust our operating segments such that starting in 2016, CCR will be reported within our Bottling Investments Group. +Going forward, the vast majority of any structural impacts to our business will now be reported within a single operating segment. We believe this will also be helpful to our investors for the same reason of assessing the continued underlying performance of our core business. We understand that the accelerated re-franchising, coupled with the shift in reporting segments, will likely result in a lot of modeling questions. We will provide the revised operating segment financial information reflecting this change before the end of the quarter. +With regards to modeling, we are providing detailed structural guidance for 2016, the majority of which is related to the North America re-franchising efforts. The remainder of the territories will transfer by the end of 2017, but the P&L impact will depend on the timing of transfers. We will share more with you at the appropriate time on the expected impact in 2017. +As we transition territories, we are committed to eliminating the temporary residual cost we have referenced in the past as quickly as possible, and we anticipate the majority of these will be removed in 2017. With that said, there could be a portion of residual cost remaining in 2018 as we wind down the final support of these operations. But this amount would be relatively small, and would be eliminated by the end of 2018. +Our productivity program is also evolving, due to the accelerated re-franchising. Approximately half of our $3-billion productivity program was expected to come from supply-chain savings. A significant portion of those savings were expected to come from North America, due to the size and finished-goods nature of the business. Now that we are accelerating our re-franchising, we will no longer be able to capture a portion of the identified supply-chain savings prior to divestiture. +However, we have built a disciplined process and capabilities that have allowed us to exceed our goals to date, and identify incremental opportunities within cost of goods sold, operating expenses and marketing, to replace the supply-chain savings being re-franchised, thus enabling us to maintain our $3-billion target. As we've communicated to you in the past, we said we would continue to look at every layer of spending as we move through the productivity work, and we have done just that. +Coupled with the success we've seen so far, we have the confidence to effectively raise our level of targeted savings across our remaining spend base. With the incremental savings identified in our core business, and the fact that our addressable cost base will substantially reduce post-2017, it should be even more evident that our $3-billion program represents a sizable opportunity. We look forward to providing further details at CAGNY next week. +Turning to outlook, despite challenging macro-environments in many key markets around the world, our focus on revenue and disciplined brand investments continues to improve our top-line growth. Also, we are seeing productivity flow through our P&L. +While much of this was obscured by currency and structural changes, we saw solid underlying margin expansion last year, even while we grew marketing expenses at a faster rate than growth profits. For those reasons, in 2016 we expect to be back on our long-term growth algorithm prior to any structural changes, which are primarily driven by our accelerated pace of re-franchising. +Organic revenue is expected to grow 4% to 5%, in line with our long-term target, as our marketing investments continue to pay off. Given the current macro-environment and lapping better comps in 2015, we believe this is a solid target. +We expect the commodity environment to be benign, but considering we hedge our exposure to many commodities, we may not see the full benefit you would expect when looking at today's spot prices. Given the general weak macro-economic environment and the associated pressure on top-line growth, we are focused on capturing more than $600 million of productivity in order to deliver our profit target. We will do this even as we continue to increase the investments in media behind our brands, and step up R&D investments in 2016. +Finally, we anticipate interest costs to increase in 2016 due to higher interest rates, as well as our decision to shift some of our debt from commercial paper to longer-term maturities that carried slightly higher interest rates. +After considering all of these factors, we expect comparable currency-neutral income before tax, structurally adjusted, to grow 6% to 8% in 2016, in line with our long-term targets, as strong operating profit growth is partially offset by net interest expense. +As Muhtar mentioned earlier, there will be significant structural impacts to our business as we accelerate our re-franchising efforts in North America, complete the mergers of Coca-Cola European Partners and Coca-Cola Beverages Africa, and cycle a half-year impact for the Monster Beverage transaction, which closed in mid-2015. We currently expect both Coca-Cola European Partners and Coca-Cola Beverages Africa to close during the second quarter. Taken together, we expect the net impact of acquisitions and divestitures to be a 4- to 5-point head wind to net revenue. +Because of the nature of the structural changes, we also anticipate that the impact will be slightly higher costs of goods sold and SG&A. We expect the benefit to equity income from Monster, Coca-Cola Beverages Africa, and Coca-Cola European Partners to partially offset that impact at operating income, resulting in a 3- to 4-point negative structural impact to income before tax. +Our underlying effective tax rate is expected to remain at 22.5% for 2016. Finally, we expect approximately $2 billion to $2.5 billion in net share repurchases for 2016. We therefore expect comparable currency-neutral EPS growth of 4% to 6%, inclusive of these 3- to 4-point structural head wind to income before tax. +As you well know, many of the world's currencies have continued to depreciate versus the US dollar. Since we operate in over 200 markets, we are not immune to this effect. In addition, we will be cycling the euro debt re-measurement gain we recorded in Other Income during the first two quarters of 2015. +Based on current spot rates, hedging activity, and what we are cycling, we expect a 4-point head wind to net revenue, and a 9-point head wind to income before tax. However, the currency head wind to operating income will be lower as we cycle the gain I just mentioned. +In terms of coverage, we are fully hedged on the euro, yen, and sterling for 2016. We also have near-term coverage in place across several other major currencies. +Finally, we expect to spend $2.5 billion to $3 billion on CapEx, as we continue to maintain our facilities in advance of transitioning territories and production assets. By the end of 2017, our capital needs will decrease significantly, as we re-franchise healthy businesses in North America and China. +As we model the first quarter, please remember that due to our reporting calendar cycle, there will be one less day in the first quarter of 2016 as compared to 2015. Based on current spot rates, hedging activity, and what we are cycling, we expect that currency will be a 5-point head wind on net revenues, and a 12-point head wind on income before tax in the first quarter of 2016. +We expect the net impact of acquisitions and divestitures to be a slight head wind on net revenues, and structural items to be a 2-point head wind on income before tax. +In summary, our financial performance for 2015 was slightly better than our expectations, and we executed our five-point plan effectively. We are already working diligently to deliver our commitments for 2016. We continue to focus on our core capabilities of building brands, driving customer value, and leading the system, so that when we complete our re-franchising, we will be a lower-risk, higher-return business, with even greater confidence to achieve our long-term growth targets. We look forward to sharing more with you at CAGNY. Operator, we are now ready for questions. + + +================================================================================ +Questions and Answers +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Thank you. We will now begin the question-and-answer session. +(Operator Instructions) +Bill Schmitz, Deutsche Bank. + +-------------------------------------------------------------------------------- +Bill Schmitz, Deutsche Bank - Analyst [2] +-------------------------------------------------------------------------------- + + Hi, good morning. + +-------------------------------------------------------------------------------- +Muhtar Kent, Coca-Cola Company - Chairman and CEO [3] +-------------------------------------------------------------------------------- + + Good morning, Bill. + +-------------------------------------------------------------------------------- +Bill Schmitz, Deutsche Bank - Analyst [4] +-------------------------------------------------------------------------------- + + I'm great. How are you? + +-------------------------------------------------------------------------------- +Muhtar Kent, Coca-Cola Company - Chairman and CEO [5] +-------------------------------------------------------------------------------- + + Great, thanks + +-------------------------------------------------------------------------------- +Bill Schmitz, Deutsche Bank - Analyst [6] +-------------------------------------------------------------------------------- + + Can you talk about why now is the right time to pull all this stuff forward on the re-franchising front, because obviously there's a ton of macro-volatility? I know there's some challenges as you wanted to standardized the IT platform and even some of the key accounts stuff, which I thought had a little bit of longer tail. Any thoughts you have on that would be appreciated? + +-------------------------------------------------------------------------------- +Muhtar Kent, Coca-Cola Company - Chairman and CEO [7] +-------------------------------------------------------------------------------- + + Yes, thanks Bill. Ever since I took over as CEO, I've always emphasized the importance of our franchise model. One of my clear priorities was to accelerate growth in our biggest profit pool, the United States. We bought the business of CCE US operations with that goal in mind. When you think about it, now we've been able to prove to ourselves we can accelerate the business in North America. We've had the best year in 2015. You saw the results from the quarter. +These results show our strategic focus on driving consumption of smaller package sizes is continuing to pay off. Transactions are growing. Price mix is healthy. Bringing those two things together, both the goal of going back, returning to our core model, which we've always emphasized -- even the first time we announced the purchase of CCE's US operations, we said there will be a role for partnerships going forward, as soon as we can put some things right. +We have got the three legs of the stool in place: the customer governance, production governance, and the IT platforms. We feel very confident. We have proven to ourselves that we can do it, and we feel very confident that this is the time. The new model is established, bottler performance is improving. We have a new structure to last us the next number of decades, and we've put the bottlers -- we're putting our bottlers in the right hands. As Kathy said, the bottlers a very healthy, and thanks to the great leadership and capability of our Bottling Investment Group. +Yes, we are now going to the core. This is the time, and we feel very confident that we can do the two things together -- accelerate momentum and bring the franchising to a bookend that really we feel is going to be very beneficial, both to our Company, our share owners, as well as leading to better customer service and better value creation on the bottler side. It's really a win-win from all those perspectives, Bill. + +-------------------------------------------------------------------------------- +Operator [8] +-------------------------------------------------------------------------------- + + Bonnie Herzog, Wells Fargo. + +-------------------------------------------------------------------------------- +Bonnie Herzog, Wells Fargo Securities, LLC - Analyst [9] +-------------------------------------------------------------------------------- + + Good morning. + +-------------------------------------------------------------------------------- +Muhtar Kent, Coca-Cola Company - Chairman and CEO [10] +-------------------------------------------------------------------------------- + + Good morning, Bonnie. + +-------------------------------------------------------------------------------- +Bonnie Herzog, Wells Fargo Securities, LLC - Analyst [11] +-------------------------------------------------------------------------------- + + I was hoping you could actually give us a concrete example that gave you the confidence to make the decision to accelerate your re-franchising plans? While your margin should certainly expand and your returns will increase, could you help frame for us the incremental dilution expected from the new system? Finally, I would like to hear what your plans are for the cash you will receive from the planned sale of the 39 production facilities, which I guess I assume should raise a fair amount of cash, considering I think the earlier sales of the nine sites had a book value of $280 million, if I'm not mistaken? + +-------------------------------------------------------------------------------- +Muhtar Kent, Coca-Cola Company - Chairman and CEO [12] +-------------------------------------------------------------------------------- + + Sure, Bonnie. I'll say a few words, and then I'll let Kathy and James comment, too. I'll say that certainly we have the proof point in the United States. Our Chinese business, for example also, is giving us great -- has great momentum, gaining share, and growing in that difficult environment, if you look at the quarter, if you look at the full-year results. The capability that has been put into place in all of our expanding bottlers everywhere is really giving us the confidence. +Also, just look at the momentum of the business. Our revenue growth was a priority. We've got it up to the 4% to 5% range. The increased marketing is working, clearly. Now better marketing is even going to enhance that. At the same time, we feel that every time the territory has transitioned, it's actually continued to do well, continued to gain share, continued to drive momentum, continued to drive incremental transactions. From that, any of the territories in the last four, five quarters that have been transitioned, we've seen without exception that to be holding true. +If you look at all these bottlers that we re-franchised, look at the performance of our German bottler. It really has the greatest momentum and the confidence of Europe right now. All of these bottlers are going in to a system, to a structure, to an architecture, to a geography that will continue to do even better when you combine it and when you create the synergies with the combination. We feel confident. +What took a little while to get right was the governance model around production in the United States, the governance model around the IT platform, the governance model around the customer service. All those are in place and working well. I'll hand over to James to add some flavor to that and more details, and then Kathy can comment also on your questions related to the financial aspect of the cash. + +-------------------------------------------------------------------------------- +James Quincy, Coca-Cola Company - President and COO [13] +-------------------------------------------------------------------------------- + + Bonnie, let me add one thought to what Muhtar's laid out there on we've been fixing and building and we're finding the right partners. A simple way of looking at why it's working is there's just more people coming to the table saying we want to be partners. Our existing partners want more territories, and new people who aren't in the system want to get into the system. They are seeing we fixed the business and we've built momentum, and so there's a lot of heightened interest in being part of a growing Coke system, particularly in North America. + +-------------------------------------------------------------------------------- +Kathy Waller, Coca-Cola Company - CFO [14] +-------------------------------------------------------------------------------- + + Okay, Bonnie I think the last part of your question you asked about the incremental dilution and the impact of that, as helping with the impact of that. For 2016 we gave you the impact. For 2017 we are doing several things, because we know you all have lots of questions about 2017. We are going to provide revised operating segment financial information later in the quarter. +At CAGNY, we're going to give you a look at what to anticipate the business will look like after everything is finished in 2018, because the actual dilution depends really on the timing of these transactions. The best way we can give you some indication of that is really to help you understand what our business will look like when everything is said and done in 2018 and beyond, which is what we're going to try to do at CAGNY. I would ask you just hold off on that, and more to come on that. +On your question about cash, we -- the cash will basically go into basically our capital structure and be part of our normal mix. At this point, no Board-level decisions have been made. We anticipate these proceeds will be used to strengthen our balance sheet. + +-------------------------------------------------------------------------------- +Bonnie Herzog, Wells Fargo Securities, LLC - Analyst [15] +-------------------------------------------------------------------------------- + + All right. Thanks, everyone. + +-------------------------------------------------------------------------------- +Operator [16] +-------------------------------------------------------------------------------- + + Dara Mohsenian, Morgan Stanley. + +-------------------------------------------------------------------------------- +Dara Mohsenian, Morgan Stanley - Analyst [17] +-------------------------------------------------------------------------------- + + Hi, good morning. Muhtar, you posted a couple quarters in a row with volume growth back up in the 3% range, along with solid pricing, despite the difficult emerging markets and macro-environment we're seeing. I wanted to get an update on your market-share performance. Obviously you're gaining share, but have you seen a relative change in terms of incremental market-share performance, and what level of payback you're getting on the higher marketing? As you look out to 2016, 4% to 5% organic sales growth is a fairly tight range. How much visibility do you think you have around that? Could macros pose a risk to the guidance, particularly given you're assuming higher GDP growth? Thanks. + +-------------------------------------------------------------------------------- +Muhtar Kent, Coca-Cola Company - Chairman and CEO [18] +-------------------------------------------------------------------------------- + + Thanks, Dara. As I mentioned, we're pleased with our market-share performance, value share gains across the world. I'll let James highlight some details on that. + +-------------------------------------------------------------------------------- +James Quincy, Coca-Cola Company - President and COO [19] +-------------------------------------------------------------------------------- + + Yes, thanks Muhtar. Dara, let me give you a quick run around the world in terms of share. Firstly, on an overall global basis, perhaps consistent with our strong fourth quarter, we gained a little more share in the fourth quarter than we had in the whole year, so a better performance at the tail end. +In terms of how that played out across the world, you see again in line with the volume performance, strong results in North America. We gained share in sparkling, we gained share in still, and we gained share overall in the quarter and in the year. Good momentum in North America coming through in share. +In Europe we're gaining share in sparkling and in stills. Given our different starting point, that's netting out to being flat overall; but we've got a strong growth in Europe as we build our stills business. Latin America, this is a long-term track record of success, so small gains there, building on a long history of building a great position. +Eurasia, despite some of the volatility in that part of the world we gained share in both sparkling and stills, and overall pretty strong momentum there in terms of share. Then in Asia-Pacific we focused more on re-staging and re-energizing the sparkling business where we're gaining share. We lost a little bit in stills and overall flat. I think wherever you look around the world, we're largely flat to gaining, so inconsistent with our volume growth, which is broad-based and across the world, we're also larger winning across the world. +In terms marketing pay-back, what you are seeing is there is results in the marketing pay-back. Our revenue in 2015, organic revenue growth in 2015 was better than 2014. We're guiding for a good number that's ahead of 2015 in 2016. We see the marketing pay-out beginning to build the momentum globally. +I think if you double down on that one and look under that, North America was one of the first places we started with the incremental marketing, and that's self-evidently building momentum. We see the underlying business results coming through in revenue very much tied to where the extra media money is going. +In terms of macro outlook and risk to top line, I think we feel we got underlying structural momentum in the business. Now when I said the macro, we are planning on the macros slightly better in 2016, and I really do mean slightly. I wouldn't be surprised if that was the same growth rate in 2015. But we think we have the right portfolio and the rate optionality to be able to deliver our financial numbers in that environment. + +-------------------------------------------------------------------------------- +Dara Mohsenian, Morgan Stanley - Analyst [20] +-------------------------------------------------------------------------------- + + Okay, great. If I could slip a detail question in, Kathy, I was hoping you could give us clarity on the impact to 2017 earnings from FX if spot rates stay at this level, given the hedging in 2016 and how much hedging you have in place for 2017 on some of the hard currencies? + +-------------------------------------------------------------------------------- +Kathy Waller, Coca-Cola Company - CFO [21] +-------------------------------------------------------------------------------- + + For 2017, we are also fully hedged on our major currencies. Obviously the emerging market currencies are the ones where you can't really hedge more than a quarter or so out. Obviously we have done nothing on the emerging market currencies. On the hard currencies we are hedged at rates slightly worse than in 2016. There will be a slight impact, but it's not -- I wouldn't think it would be terribly significant. + +-------------------------------------------------------------------------------- +Dara Mohsenian, Morgan Stanley - Analyst [22] +-------------------------------------------------------------------------------- + + Great, thank you. + +-------------------------------------------------------------------------------- +Operator [23] +-------------------------------------------------------------------------------- + + John Faucher, JPMorgan. + +-------------------------------------------------------------------------------- +John Faucher, JPMorgan - Analyst [24] +-------------------------------------------------------------------------------- + + Thank you very much. Good morning, everyone. Two questions here. First off, it's a little tough with all the restructuring, the re-franchising of the bottlers to get a handle in terms of what's truly going on, on the gross margin. Can you try and strip some of the impact out from the re-franchising, and give us an idea what the underlying gross margin's doing? +Kathy, going back to your points on the balance sheet, can you talk about what you're seeing out there that's causing you to maybe term out some of the longer-term debt? Is it the short-term market volatility, or is this something where you would expect to maybe go with a more conservative balance sheet approach on a go-forward basis? Thanks. + +-------------------------------------------------------------------------------- +Kathy Waller, Coca-Cola Company - CFO [25] +-------------------------------------------------------------------------------- + + The gross margins in the fourth quarter impacted by the six fewer days, and the currency and then the structural impact. If you take all that out, basically, we had good growth margin expansion in the fourth quarter and for the full year. +For the balance sheet, basically as we've got so much cash that's outside of the United States, we are taking a little bit more of a conservative approach with our balance sheet. It was just more prudent to manage with the longer-term maturities than with short-term maturities. We still have a robust portfolio of commercial paper. We're just balancing that out differently. + +-------------------------------------------------------------------------------- +John Faucher, JPMorgan - Analyst [26] +-------------------------------------------------------------------------------- + + Okay. If I can ask one quick follow-up on that, in terms of the interest income line and some of the cash balances overseas, any change in that approach, or is this mostly going to be on the interest expense line? + +-------------------------------------------------------------------------------- +Kathy Waller, Coca-Cola Company - CFO [27] +-------------------------------------------------------------------------------- + + Yes, basically it's going to be on the interest expense line. I think we're expecting much more interest expense given the rate changes, but also the longer-term maturities are also causing more interest expense. + +-------------------------------------------------------------------------------- +John Faucher, JPMorgan - Analyst [28] +-------------------------------------------------------------------------------- + + Got it, thanks. + +-------------------------------------------------------------------------------- +Operator [29] +-------------------------------------------------------------------------------- + + Brett Cooper, Consumer Edge Research. + +-------------------------------------------------------------------------------- +Brett Cooper, Consumer Edge Research - Analyst [30] +-------------------------------------------------------------------------------- + + Good morning. One of your stated strategies was to improve the balance of price mix and volume in your developed markets. We've clearly seen that in the US, but I was hoping you could walk around the world and offer us what you're seeing in other developed markets, provide with your prospects and confidence for improving price mix in other developed markets around the world going forward? Thanks. + +-------------------------------------------------------------------------------- +Muhtar Kent, Coca-Cola Company - Chairman and CEO [31] +-------------------------------------------------------------------------------- + + Brett, I think if you look at our overall for the whole year and as well for the quarter our price mix globally, you can see that has improved. As was mentioned, part of the reason for that is we're beginning to see the results of increased marketing play through, as well as our packaging strategies and mix management. Coupled with that, the value share gains, which is even more pleasing, given that we're able to get healthy pricing in our business and in our markets around the world. I will let James comment in terms of Europe and Japan, and what's being seen in some of those developed markets, in addition to the United States. Okay? + +-------------------------------------------------------------------------------- +James Quincy, Coca-Cola Company - President and COO [32] +-------------------------------------------------------------------------------- + + Yes, thanks Muhtar. I think firstly it's important to remember, starting with Europe, that our price positioning in Europe, we have over time substantially taken a lot of rate and mix in Europe, such that we are more premium priced compared to our competitors than we are in North America -- less runway in that sense. +Now having said that, we continue to focus on smaller packages, more premium offerings in terms of the brand portfolio, such that despite what is a pretty deflationary retail environment in a number of western European markets, we're getting price mix in Europe, both in the quarter and for the full year. I think going out one should not expect the same levels the US has been able to develop, especially given the macro environment in Europe at the moment. +In terms of Japan, we are very focused on rebuilding our ability to get positive price mix in Japan. We've recently been able to get some. Again, very focused on leveraging both packaging options and the brand portfolio to re-shape it to allow us to drive positive mix. Again, I don't think you will see in Japan the same sorts of levels as the US, as much as anything to do with the deflationary pressures in Japan. But we are starting to see chances of a better pricing environment in Japan. + +-------------------------------------------------------------------------------- +Operator [33] +-------------------------------------------------------------------------------- + + Bryan Spillane, Bank of America. + +-------------------------------------------------------------------------------- +Bryan Spillane, BofA Merrill Lynch - Analyst [34] +-------------------------------------------------------------------------------- + + Hi. Good morning, everyone + +-------------------------------------------------------------------------------- +Muhtar Kent, Coca-Cola Company - Chairman and CEO [35] +-------------------------------------------------------------------------------- + + Good morning, Bryan. + +-------------------------------------------------------------------------------- +Bryan Spillane, BofA Merrill Lynch - Analyst [36] +-------------------------------------------------------------------------------- + + I wanted to get a couple of points of color on the productivity program. Kathy, to start, you were keeping the original $3-billion plan, but a portion of the COGS opportunity is now going to go off with the re-franchising. Could you give us some idea of just how big that is, how much you had to make up in terms of keeping the $3 billion where it is? + +-------------------------------------------------------------------------------- +Kathy Waller, Coca-Cola Company - CFO [37] +-------------------------------------------------------------------------------- + + Certainly. We will lose about $500 million of productivity, primarily out of cost of goods sold. Again, we are committed to making up that lost amount, and we're going to make it up between cost of goods sold, operating expenses, and DME. + +-------------------------------------------------------------------------------- +Bryan Spillane, BofA Merrill Lynch - Analyst [38] +-------------------------------------------------------------------------------- + + Net, this productivity plan is actually now a little bit bigger than it originally would have been. Is that just a function of as you're doing more you're finding more savings, or was the re-franchising motivating you to look for more savings? I'm trying to get a sense if there's more momentum building on the productivity program itself? + +-------------------------------------------------------------------------------- +Kathy Waller, Coca-Cola Company - CFO [39] +-------------------------------------------------------------------------------- + + Well, we always said we were going to continue to look for additional productivity opportunities, and we have done just that. We've learned a lot about our costs as we have continued the programs -- ZBW, as well as other cost-optimization programs. Basically we've looked end to end, and we were able -- we saw additional opportunity, and we're going to take it. + +-------------------------------------------------------------------------------- +Bryan Spillane, BofA Merrill Lynch - Analyst [40] +-------------------------------------------------------------------------------- + + Okay. One last one. Of that $500 million that essentially goes off in re-franchising, will that actually still be realized within the franchise system? Does the Coke system itself still see the $500 million of savings, or is that lost because it needed to be integrated with Coke to get it? + +-------------------------------------------------------------------------------- +Kathy Waller, Coca-Cola Company - CFO [41] +-------------------------------------------------------------------------------- + + No, I think it will be captured by the system. + +-------------------------------------------------------------------------------- +Bryan Spillane, BofA Merrill Lynch - Analyst [42] +-------------------------------------------------------------------------------- + + Okay, great Thank you. + +-------------------------------------------------------------------------------- +Muhtar Kent, Coca-Cola Company - Chairman and CEO [43] +-------------------------------------------------------------------------------- + + We're even hoping they can find additional areas, Bryan, to even increase that going forward. Part of the whole plan around the production governance is also to ensure that we can actually lever and pull more synergies out of our production system in the entire template of North American production. Yes, the answer is a definite yes. + +-------------------------------------------------------------------------------- +Bryan Spillane, BofA Merrill Lynch - Analyst [44] +-------------------------------------------------------------------------------- + + Okay, from our systems perspective this is truly incremental savings, it's just a matter of where we're seeing it? + +-------------------------------------------------------------------------------- +Muhtar Kent, Coca-Cola Company - Chairman and CEO [45] +-------------------------------------------------------------------------------- + + That's right. + +-------------------------------------------------------------------------------- +Bryan Spillane, BofA Merrill Lynch - Analyst [46] +-------------------------------------------------------------------------------- + + Okay, thank you. + +-------------------------------------------------------------------------------- +Operator [47] +-------------------------------------------------------------------------------- + + Kevin Grundy, Jefferies + +-------------------------------------------------------------------------------- +Kevin Grundy, Jefferies & Company - Analyst [48] +-------------------------------------------------------------------------------- + + Thanks. Good morning, guys. I want to come back to the Asia-Pacific region. I have two questions, first is on price mix, and then second on China specifically. Price mix in the quarter was down 9%, and margins were down pretty significantly. James, I think you talked about re-staging the sparkling business, and I know there's been some negative geographic mix. A little more color there would be helpful? Then the second piece on China, 1% volume growth but you were cycling a pretty soft compare of down 1% last year. Maybe you could elaborate a bit on what you are seeing in that market, and your expectation here over the next 12 months? Thanks. + +-------------------------------------------------------------------------------- +Muhtar Kent, Coca-Cola Company - Chairman and CEO [49] +-------------------------------------------------------------------------------- + + Sure. Let me start with the price mix in Asia-Pacific. I think the most important thing to know here is because the different geographies in the Asia-Pacific group have quite different pricing, and concentrate shipments can be lumpy, you do get some erratic price mix numbers on a quarterly basis. That's exactly what you're seeing in the fourth quarter in Asia-Pacific. There were more shipments to somewhere like India than Japan. +You can actually see the flip side of this in the Eurasia group, where we get very strong price mix in the fourth quarter, which was the flip side. We had more shipments to places like South Africa than the Middle East. This is all about country mix. I think it's important for particularly those two groups, Asia-Pacific and Eurasia, to look at some longer-term four-quarter trend line on price mix, given the very impactful country mix issue, and the lumpiness of concentrate shipments. That's the key thing there. +In terms of China, clearly not as much as we would have liked to have grown in China in the first quarter. I think that the environment in China is pretty clearly having slowed down. But we think we had a strong momentum over the last couple of years coming back into China. We're looking to do better in 2016, but we don't actually provide country-based forecasts. What I would say, however, is we're continuing to do very strongly in terms of share, particularly in sparkling, as we have re-energized that business. + +-------------------------------------------------------------------------------- +Kevin Grundy, Jefferies & Company - Analyst [50] +-------------------------------------------------------------------------------- + + Very good, thank you. + +-------------------------------------------------------------------------------- +Operator [51] +-------------------------------------------------------------------------------- + + Steve Powers, UBS. + +-------------------------------------------------------------------------------- +Steve Powers, UBS - Analyst [52] +-------------------------------------------------------------------------------- + + Thank you very much. Actually, a relatively quick set of questions for each of you, if I could. First, Muhtar, on re-franchising and the decision to retain hot-fill and juice assets, is that an indefinite plan, or is that subject to further review? Similarly on China, or thinking about China and rest of world, should we be thinking differently about your plans in India in terms of future re-franchising in that market, as well? +Then Kathy, the 4% to 5% organic growth you were calling out for next year, can you give us a rough sense of volume versus price within that, and how much if any you expect to spend incrementally on A&P in order to achieve what amounts to underlying acceleration? +Finally, James -- sorry for all the questions -- we debated this a while back, and I'm wondering if you've got additional thoughts in terms of your longer-term growth -- how much you expect the portfolio to lean on stills versus sparkling? Do you think you have the right balance of demand-building support against each of that, in order to achieve your long-term goals? Thank you. + +-------------------------------------------------------------------------------- +Muhtar Kent, Coca-Cola Company - Chairman and CEO [53] +-------------------------------------------------------------------------------- + + Yes, Steve. Related to juice and hot-fill and stills, stills continues to perform very well in North America for us. The template for stills production is completely different in terms of how it's configured to cold-fill. Therefore -- and juice is an integrated business. +Given those aspects, we intend that for the future to not change the structure related to both hot-fill as well as to juice and our food service business all will remain as integrated in that respect. They're doing very well, and we feel they add value to the overall structure of North America. They're an important strategic part of how we move forward and continue to make increase momentum in North America. +India -- look, you saw that number. Given all these changes we're announcing, basically if you brought it back to 2015 the total bottling assets that we would have under our management and on our balance sheet would actually go down from 18% of the total mix globally to about 3%. Yes, India there are opportunities in other parts of the world remaining, but it's a very small template based on where we are. We'll look at opportunities. +As James said earlier, one of the litmus tests I've always said, one of the great litmus tests for the health of the Coca-Cola business is the desire of investors and franchise partners to have more territory -- that's at an all-time high. Remains that -- we expect that to remain high, and therefore there may be other opportunities in the remaining geographies. But I can't comment on that any further right now. +Then I'll pass it over to James to take you through the longer-term question on portfolio stills versus sparkling, and then Kathy the question of 4% , 5% organic growth volume versus price. James? + +-------------------------------------------------------------------------------- +James Quincy, Coca-Cola Company - President and COO [54] +-------------------------------------------------------------------------------- + + Sure. Look, I think our aspiration is to have both of them growing, both sparkling and stills. That's what we achieved in the fourth quarter and in the full year of 2015. Now I think in a total portfolio sense, much in the same way it's happened over the last decade or so, we've gone from about 10% of the portfolio being stills to roughly 25% of the portfolio being stills. I think mathematically the stills will grow as a percent of total portfolio. +I would note, as Muhtar commented earlier, I think we need to break out the stills, and not just look at them as one thing, but look at them in terms of their individual categories. We gained share in packaged water. We gained share in juice and juice drinks. We gained share in energy, and we gained share in ready-to-drink tea. We think we can do well in each of the categories that represent non-alcoholic ready-to-drink. +In particular, we can still grow sparkling. That growth of sparkling into the future is not just in aggregate; but I think over the long-term we will see increased growth of low-, no-, and reduced-calorie variants. I know that's not the case yet in North America, but globally in our international business, those drinks out-grow the regular drinks within sparkling, and they're fueling our growth, so broad-based growth. + +-------------------------------------------------------------------------------- +Kathy Waller, Coca-Cola Company - CFO [55] +-------------------------------------------------------------------------------- + + Okay. On your question of 4% to 5% organic growth, volume versus price mix, we expect that to be balanced, volume versus the price. As you know, we have the strategy where we are now focused more on net revenue and segmenting our markets, and we're focused on price realization. We do anticipate that strategy will continue, and that will be a balance between both volume -- and we will achieve a balance between both volume and price. +As advertising and promotions -- in 2014 we announced this program. We said $800 million to $1 billion that we would invest. We are still going to invest -- continuing to invest behind our brands on that program, although we're also going to start investing in R&D. Basically, we're still on our program we announced back in 2014, so you will continue to see investment in marketing slightly above gross profit. + +-------------------------------------------------------------------------------- +Steve Powers, UBS - Analyst [56] +-------------------------------------------------------------------------------- + + Thank you very much. + +-------------------------------------------------------------------------------- +Operator [57] +-------------------------------------------------------------------------------- + + Ali Dibadj, Bernstein. + +-------------------------------------------------------------------------------- +Ali Dibadj, Bernstein - Analyst [58] +-------------------------------------------------------------------------------- + + Hi guys. On re-franchisement, obviously good news that it's going faster, but I still have a few questions on this. One is I get the discussion about holding on to juice. I'm not quite there on hot-fill, so if you could elaborate on that, that would be helpful? Trying to get a better sense secondarily about when you think you will actually be able to grow out of the dilution. It's clearly dilution right now, then 2016 three to four, and then probably 2017. At what point will you be able to grow out of the dilution, given better margin top-line growth, et cetera? +The core question is you mentioned your goal was by buying North America bottling you would be able to accelerate momentum for sales and profitability. I agree you've done that, going to smaller pack sizes, increasing prices closing some plants, increasing media spend, improving IT. +I'm still confused why you have to buy the bottlers -- or one consolidated bottler, I guess, in North America, to do a lot of those changes. Why do you have to spend billion of dollars to push these changes through? Was there not a more efficient-for-shareholders way to do it? +In that context, how do you give investors confidence? I get this question a lot. How do you give investors confidence that five, 10 years down the line, you won't have to buy these bottlers back again in North America? + +-------------------------------------------------------------------------------- +Muhtar Kent, Coca-Cola Company - Chairman and CEO [59] +-------------------------------------------------------------------------------- + + Well Ali, let me start with the last first. When we announced the acquisition of CCE, it was essentially a 25-year-old problem. We said it would take a while to basically course-correct. The level of investment was not where it was needed. Also, the level of customer service was not where it was needed. +Essentially, we believe that having more than just one bottler essentially having that big a territory was a better way -- scalable-size bottlers, right ownership values, right structure and right capability. That's what we have today in North America. We feel very good that this is a model that is going to stay where it is and continue to add value. It's not going to require any further -- all the time they'll be tweaking necessary, but not the scale that was needed when we did the transaction back at the end of 2010. That was a core decision that was needed. There was a major surgery that was needed, and that's really what took place. +As far as the juice business is concerned, as I said before, it's an integrated business. It basically performs well as an integrated business, similar to other juice businesses that we have around the world. It's a very different model, it's a very different production, it's a very different growth to table model, and requires a different way in terms of its distribution, especially when it's chilled. That's really where a lot of the growth is in value-added dairy. +That's what you see, whether it's in Fairlife or that's what you see whether it's in juice. It's a very distinct production model, very different, as well as the hot-fill is also the same. Same within a sense in Europe, the same with many parts of the world. [Kukustevayey] is also very similar in terms of the way it's produced. That is just a needed aspect for success and for performance in the hot-fill and juice business -- very different. To your other question related to dilution from franchising, maybe I'll pass it over to Kathy. + +-------------------------------------------------------------------------------- +Kathy Waller, Coca-Cola Company - CFO [60] +-------------------------------------------------------------------------------- + + Certainly. We've given you guidance for 2016. 2017, it totally depends on timing. We plan to give you more information to help with that, with your modeling, between CAGNY and what we will give you before the end of the quarter. It's all based on timing. In 2018, you asked when will we grow out of this. The program -- we plan to complete the program by the end of 2017, so 2018 we are out of it. + +-------------------------------------------------------------------------------- +Muhtar Kent, Coca-Cola Company - Chairman and CEO [61] +-------------------------------------------------------------------------------- + + Yes, and our long-term outlook -- just to add for the industry -- remains very positive, Ali. Our system is extremely well positioned to take advantage of this. We're going to be a much more focused Company. We're going to be building brands, leading the system, and driving new growth platforms. Our core business will have attractive growth going forward, in terms of ROIC, free cash flow, and so forth. We're very confident and very excited about where the Company is going from that aspect. + +-------------------------------------------------------------------------------- +Ali Dibadj, Bernstein - Analyst [62] +-------------------------------------------------------------------------------- + + I apologize, maybe I wasn't clear on the dilution piece to it. I understand the timing of the program. I'm not looking for timing in terms of when in 2017 something happens. I'm more looking longer-term. If you're getting rid of these businesses, you will be a better-growing business, right -- better margin, better-growing business, that's the hope, that's I think all of us, as we're trying to estimate longer-term. +I'm just trying to figure out, because you're going to be better, when do you offset the dilution? You're growing faster, you've taken a hit. When are you going to offset the dilution? At what point in time effectively do you become net positive and go beyond? That was the question; maybe Kathy you can refine your answer. I'll leave it at that, if you could help there? + +-------------------------------------------------------------------------------- +Kathy Waller, Coca-Cola Company - CFO [63] +-------------------------------------------------------------------------------- + + Basically, 2018 obviously we will be -- there will be some dilution effect because of the -- we have -- the base hasn't been totally adjusted by that time. Once we get the base adjusted, short of other structural impacts -- which will not be North America re-franchising, obviously -- but other structural impact, we will have quote gone through that re-franchising impact. +Now we do have some residual costs that will come out, as I said, throughout 2016, 2017. There will be a little bit left in 2018. Certainly by mid to late 2018 even the residual costs will be gone. I think once the base is reset, short of other types of structural impacts, we will have transitioned through that. + +-------------------------------------------------------------------------------- +Ali Dibadj, Bernstein - Analyst [64] +-------------------------------------------------------------------------------- + + Okay. Just one last question, sorry, on diets. It looks like volumes were down 5%, but that's better than we've seen recently. Can you give us some color on whether you're seeing that actually stabilize or perhaps a little bit improve, or is it because Pepsi changed formulation and you guys are getting the benefit of it? Some idea whether that's getting better on diets would be helpful? Thank you, that's it for me. + +-------------------------------------------------------------------------------- +James Quincy, Coca-Cola Company - President and COO [65] +-------------------------------------------------------------------------------- + + Ali, it's James here. Look, I think in the US business we did reasonably well in growing Coke Zero, or getting Coke Zero back to flat, and there's still a decline in Diet Coke. I think the bigger picture is in the 80% of our business which is the international business, the diets and lights and Coke Zeros out-grew Coke Classic. We're seeing broad-based growth outside the US of those Coca-Cola variants. That's what gives us the belief that in the long term we will be able to turn around the business also in the US. + +-------------------------------------------------------------------------------- +Muhtar Kent, Coca-Cola Company - Chairman and CEO [66] +-------------------------------------------------------------------------------- + + To finally add on that, Ali, also with our recently announced one-brand approach to marketing trademark Coke, we are extending the strong brand equity of Coca-Cola across the trademark to offer consumers more choice, and to also better promote our great-tasting diet and light portfolio, which is going to no question help. I think that's going to also help us with the stability that is the target. I'll just leave it at that. + +-------------------------------------------------------------------------------- +Operator [67] +-------------------------------------------------------------------------------- + + Thank you. I would now like to turn the call back to Muhtar Kent for closing remarks. + +-------------------------------------------------------------------------------- +Muhtar Kent, Coca-Cola Company - Chairman and CEO [68] +-------------------------------------------------------------------------------- + + Thanks James, Kathy, and Tim. In summary, we delivered the plan that we laid out at the beginning of last year. We made significant progress against our five strategic initiatives that we laid out. Importantly, our progress against these initiatives is leading to improving performance, even in a very challenging macro-environment. We are evolving and strengthening our global bottling system as we accelerate re-franchising, and return to a predominantly cost-rate driven model, with significantly higher margins and returns. +The long-term dynamics of our industry remain promising, and we absolutely believe that the Coca-Cola Company is best positioned to capture that growth in non-alcoholic beverages, and to deliver long-term value to our shareholders. As always, we thank you for your interest, your investment in our Company, and for joining us this morning. + +-------------------------------------------------------------------------------- +Operator [69] +-------------------------------------------------------------------------------- + + Thank you, speakers. That concludes today's conference. Thank you for participating. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/exam/original-files/Problem_2_3_Sample_full_transcripts/2016-Feb-24-TGT.N-137915462232-Transcript.txt b/exam/original-files/Problem_2_3_Sample_full_transcripts/2016-Feb-24-TGT.N-137915462232-Transcript.txt new file mode 100644 index 0000000..da71d77 --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_full_transcripts/2016-Feb-24-TGT.N-137915462232-Transcript.txt @@ -0,0 +1,448 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q4 2015 Target Corp Earnings Call +02/24/2016 09:30 AM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * John Hulbert + Target Corporation - VP of IR + * John Mulligan + Target Corporation - COO + * Cathy Smith + Target Corporation - CFO + * Brian Cornell + Target Corporation - Chairman and CEO + +================================================================================ +Conference Call Participiants +================================================================================ + + * Simeon Gutman + Morgan Stanley - Analyst + * Kate McShane + Citigroup - Analyst + * Michael Lasser + UBS - Analyst + * Greg Melich + Evercore ISI - Analyst + * Matthew Fassler + Goldman Sachs - Analyst + * Sean Naughton + Piper Jaffray & Co. - Analyst + +================================================================================ +Presentation +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Ladies and gentlemen, thank you for standing by. Welcome to the Target Corporation fourth quarter and year-end earnings release conference call. +(Operator Instructions) +As a reminder, this conference is being recorded Wednesday, February 24, 2016. I would now like to turn the conference over to Mr. John Hulbert, Vice President, Investor Relations. Please go ahead, sir. + +-------------------------------------------------------------------------------- +John Hulbert, Target Corporation - VP of IR [2] +-------------------------------------------------------------------------------- + + Good morning, everyone, and thank you for joining us on our fourth quarter 2015 earnings conference call. We apologize for the delay. We were informed that some people were having trouble accessing our webcast and we delayed in order to make sure they could access this call along with everyone else. +On the line with me today are Brian Cornell, Chairman and Chief Executive Officer, John Mulligan, Chief Operating Officer, and Cathy Smith, Chief Financial Officer. This morning, Brian will discuss our fourth quarter performance, including results across our merchandise categories; then John will provide an update on our efforts to improve in-stocks and build our supply chain capabilities; and finally, Cathy will offer more detail on our fourth quarter and full-year financial performance. Following the remarks, we will open the phone lines for a question-and-answer session. +As a reminder, we're joined on this conference call by investors and others who are listening to our comments via webcast. Following the call, Cathy and I will be available to answer any follow-up questions you may have. Also, as a reminder, any forward-looking statements that we make this morning are subject to risks and uncertainties, the most important of which are described in our SEC filings. +Also, in these remarks we refer to adjusted earnings per share, which is a non-GAAP financial measure, and return on invested capital, which is a ratio based on GAAP information with the exception of adjustments made to capitalized operating leases. Reconciliations to our GAAP EPS and our GAAP total rent expense are included in this morning's press release, which is posted on our Investor Relations website. +Finally, one note. Given that we're hosting our financial community meeting next week, our remarks today will focus on Target's fourth quarter performance and our guidance for the first quarter and full-year 2016. At next week's meeting, we will provide insights into our strategy and priorities and how they will drive our financial performance in 2016 and beyond. As a result, we are shortening today's call to 45 minutes and will look forward to spending another couple hours with all of you, either online or in person, at next week's meeting in New York. With that, I'll turn it over to Brian for his comments on the fourth quarter and the holiday season. Brian? + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman and CEO [3] +-------------------------------------------------------------------------------- + + Thanks, John, and good morning, everyone. As we look back at both the fourth quarter and the year, we are very pleased with the progress we made throughout 2015. Traffic increased in all four quarters and the team delivered on our comparable sales and operating margin rate goals by driving rapid growth in our signature categories; and our full-year adjusted earnings per share of $4.69 was above the top of the range we provided last March, keeping us on track to deliver our longer term financial goals. +In the fourth quarter, our business generated adjusted earnings per share of $1.52, up $0.03 from a very strong performance in the fourth quarter of 2014. Comp sales grew 1.9% in the fourth quarter, building on a 3.8% increase in last year's fourth quarter. Target's great store experience, unique items at an unbeatable value, and broad, simple promotions resonated with our guests and drove this growth. +Transactions, our measure of traffic, increased for the fifth quarter in a row, up 1.3% in the fourth quarter, reflecting growth in all of our selling channels. Digital sales increased an industry leading 34% in the fourth quarter, on top of 36% growth in the fourth quarter of last year. Strong Black Friday and Cyber Monday weeks drove this increase. In fact, after setting a new digital daily sales record in the week of Black Friday, we shattered all previous records on Cyber Monday. Our offer was broad and simple, 15% off everything on our site, and the guest response was exceptionally strong. +Our holiday season merchandising and marketing plans were focused on delivering broad, simple, and compelling offers, like our 10 Days of Deals, Black Friday door busters, and a site-wide offer on Cyber Monday, and the bounce back coupon we offered to guests in our stores on Black Friday, all supported by cohesive marketing plans featuring outstanding creative work. This plan delivered record sales over the November and December period, driven by comp sales in our signature categories, Style, Baby, Kids and Wellness, which grew nearly 7% over that two-month period. +Sales in Kids were particularly strong, with the fastest growth in Toys and Kids Home products. In Style, we saw the fastest growth in Women's Apparel, led by double digit increases in Ready-To-Wear; and in Wellness, Wearable Electronics and Food led the way. Across our traditional category designations, Apparel grew in the low single digit range. In hard lines, Toys grew comp sales more than 10% in the quarter, marking the third quarter of double digit comp growth in Toys. This strength helped offset a sales decline in Electronics, where sales benefited from robust growth in Wearables, but also reflected the impact of industry-wide softness in tablets. +Consistent with the third quarter, fourth quarter comp sales in food grew faster than our overall sales, outpacing trends in the first half of the year, validating the changes we're making to the assortment, presentation and freshness. And finally, Home grew about 4% in the fourth quarter. With this performance, Home delivered a 4% comp sales increase for the full year, the strongest annual performance in this category in more than 10 years. +Finally, prior to the holiday season, we reimagined the See Spot Save area in the front of our stores, which is large and a very profitable business and transformed it into Bullseye's Playground. We modernized the environment, making it easier to navigate, more appealing and fun, incorporating our much loved mascot into store displays. While we love the new look, our guest reaction is what really matters; and the fourth quarter results showed they loved it, too, as comp sales in Bullseye's Playground grew more than 25% compared to See Spot Save in the fourth quarter of last year. +December marked an important milestone for the Company, as we closed on the sale of our Pharmacy business to CVS Health. Our team has been working closely with our colleagues at CVS, both before and after the sale, to ensure this transition is seamless for our team members and our guests. And while the transition is not yet complete, we're very pleased with the progress we've made so far. A small number of our store pharmacies have already been rebranded as CVS locations; and over the next six months, we'll complete the rebranding of all of our pharmacies and clinics in stores across the country. +We believe this transaction will create value for our guests, providing them access to the capabilities of a best-in-class healthcare provider while they're shopping our stores; and we expect both Target and CVS to benefit from this transaction, allowing both companies to leverage their respective strengths. +Importantly, we believe CVS will be able to grow traffic in our store pharmacies faster than we would have been able to do on our own, given our lack of scale when we ran this business. In addition to the ongoing value we would expect to realize from this arrangement, the sale has already provided more than $1 billion of net cash that we will use in support of our capital deployment priorities. +Turning to capital deployment, we generated very strong cash flow in 2015 which we deployed to the benefit of our shareholders. Beyond funding capital investments in support of our strategic and financial goals, in 2015 we returned nearly $5 billion through dividends and share repurchases, well ahead of the goal we set at the beginning of the year. Even with this robust return of cash, we ended this year with a very healthy cash balance, positioning Target for another strong year in 2016. +Now before I turn the call over to John, I want to pause and thank the entire Target team for what they accomplished in 2015. As I look back to a year ago, I believe we're operating on a much stronger foundation today. And while we've got much more to accomplish on this journey, the team today is agile and aligned around a small set of key enterprise priorities, allowing us to move much more quickly. Today, the team is taking an outside in approach to our work, understanding how Target fits into the consumer and retail environment, as we work to grow the Company on behalf of our guests. +When Cathy began working with us last year, her first observation was how talented this team is and how passionate they are about both Target and our guests. Not surprisingly, that was my first observation when I arrived at Target in 2014 and something I know John has experienced throughout his career with this great Company. With that, I'll turn the call over to John, who will discuss his team's progress in efforts to improve our operations. John? + +-------------------------------------------------------------------------------- +John Mulligan, Target Corporation - COO [4] +-------------------------------------------------------------------------------- + + Thanks, Brian, and good morning, everyone. Today, I'm going to provide you with a brief update on our work to improve operations and I'll provide more detail about our strategy and future plans at the meeting next week. +Our work to reduce out-of-stocks is continuing to pay off, as metrics improved sequentially from the third quarter and even more dramatically when compared with the fourth quarter a year ago. Specifically for the fourth quarter in total, out-of-stock metrics were 20% better than last year; and notably, by the end of the quarter, Target's out-of-stock metrics were 40% better than a year ago, as the improvements we've implemented allowed for a faster post-holiday recovery this year. We saw out-of-stock improvements across every category in the fourth quarter. +As I mentioned in the last conference call, our work has been focused primarily on essential items for which reliability is particularly important for our guest, and I'm really happy with our progress. For the set of focused items we've designated in Essentials, our out-of-stock metrics are better than we have ever measured. +While this progress is exciting, I'm even move pleased that this improvement has been accomplished through systematic and, therefore, sustainable changes. In other words, this isn't an example of temporarily adding resources to work around systems and processes. Rather, this is a case of making improvements to those systems and processes to support a sustainable improvement in performance. +Because upstream variability in the supply chain hampers our ability to keep our stores in stock and provide tight shipping windows to our guests, a key pillar of the team's work is focused on improving freight flow through the supply chain. As part of this effort, the team has created smart, systematic rules governing safety stock and distribution centers and they've optimized pick frequencies on priority items. +In the fourth quarter, the team began an array of tests to reduce variability of inbound shipments at our DCs, with a goal of reducing inbound variability by 50%. Similarly, the team plans to engage in tests to optimize outbound volatility, which will further improve overall freight flow. While we are still early in this journey, the team's work on flow was a key reason we saw a much faster recovery this holiday season and why we entered 2016 with a much better in-stock position than a year ago. +Beyond in-stocks, we are entering 2016 with very little clearance inventory, even compared to a strong position a year ago. As you'll recall, last year's fourth quarter sales were much stronger than expected, as we planned for a 2% comp and ended up with growth nearly twice as high. With last year's unexpectedly strong sales, we saw very high sell-through percentages on seasonal merchandise. However, as a result of great product and of the changes we've implemented this year, quarter-end sell-throughs on seasonal merchandise were slightly better than last year, putting us in a very clean inventory position at the beginning of the year. +These are just a few examples of the team's work to implement quick solutions that are already having a tangible impact on our results. At the same time, we are working to build capabilities that will support our future growth. I'll provide a lot more detail on these future focused efforts in my remarks at next week's meeting. +As you know, we have been building our flexible fulfillment capabilities for several years, and this holiday season highlighted the power of these capabilities to serve our guests and drive business performance. And while we've added capacity across our entire direct-to-guest network, our fourth quarter experience demonstrated the power of relying on our stores to fill digital demand. +This holiday season, our stores fulfilled 30% of our digital orders, through the combination of order pick-up and direct-to-guest shipments. On Black Friday weekend alone, our stores fulfilled more than 1 million digital orders. And even though the traditional view of Cyber Monday doesn't even include brick-and-mortar, Target stores set an all-time record for order pick-up on that day, with more than four times the volume compared with last year. And like last year, order pick-up became even more important in the days leading up to Christmas, growing to half our digital volume. +While our stores help us save meaningfully on shipping costs and allow us to fulfill guest demand faster, they also help us capture more sales. Because we now have a single view of inventory encompassing all of our distribution center and store locations, we can rely on our entire network when fulfilling digital orders, keeping us in stock on a greater percentage of digital orders. +Specifically, during the holiday season, about 40% of our order pick-up and store shipped volume consisted of items that were out-of-stock in our web fulfillment centers. This preserved sales on orders we would have otherwise missed had we only accessed inventory in our web fulfillment centers. +Before I turn the call over to Cathy, I also want to provide an update on our decision to bring visual merchandising talent into our stores. Last fall, we announced we were filling more than 1,400 new visual merchant positions in our store organization. In scoping responsibilities for these roles, we benchmarked industry leaders to define the necessary capabilities and enhanced our interview process to better assess for these skills when interviewing potential candidates. The majority of these positions have been filled by external candidates with experience at other retailers, but we have also tapped into talent that we identified within the organization. +Our visual merchants are focused on style categories in our Home, Apparel and Seasonal areas, and they are trained to rely on sales and inventory data while developing compelling visual presentations in our stores. As a result, their job requires that they balance art with science and productivity with creativity. And because of their unique qualifications, this team is responsible for training their store team colleagues to understand the latest product trends, so the entire store team can better assist our guest as they shop our stores. While the visual merchandising team is just ramping up its processes and tools, you can already see the early impact of their effort in our store displays; and we are very excited about the potential of this effort to elevate both signature categories and our store experience. +Thinking back to the year just ended, it's amazing for me to realize that we only formed our new operations team about six months ago. In that time, we have already seen meaningful improvement in our operations and we're entering the year with a much stronger in-stock position than a year ago. +As we look ahead, we see multiple opportunities to improve end-to-end processes and build the foundation for our future growth, while improving the shopping experience for our guests and enhancing our business results. I look forward to discussing these opportunities with you in New York next week. With that, I'll turn it over to Cathy, who will share her insights on our fourth quarter financial performance. Cathy? + +-------------------------------------------------------------------------------- +Cathy Smith, Target Corporation - CFO [5] +-------------------------------------------------------------------------------- + + Thanks, John, and hello, everyone. As Brian mentioned earlier, we are really pleased that our team delivered strong traffic and sales growth in the fourth quarter. Our financial results continue to validate the strategic changes we've made, confirming that we are focused on what's most important to our guests. +Our fourth quarter adjusted earnings per share of $1.52 was well within our guidance range and up $0.03 from last year's very strong performance. fourth quarter GAAP EPS from continuing operations of $2.31 was $0.79 above adjusted EPS, reflecting the $620 million pretax gain on the sale of our Pharmacy business to CVS Health. +Comparable sales grew 1.9% in the fourth quarter, on top of a 3.8% increase in 2014. Traffic was the primary driver of our comp growth, up 1.3%, building on a really strong 3.2% increase last year. This quarter marked our fifth straight quarter of traffic growth and we are committed to driving continued traffic growth in 2016 and beyond. +As I mentioned last quarter, results in our fourth quarter of 2014 reflected a bounce back from the impact of the breach in the fourth quarter of 2013. However, even on a three-year stacked basis, our traffic was stronger in this year's fourth quarter than earlier in the year, demonstrating continued momentum from the strategic changes we've implemented. One note, fourth quarter reported sales were down a little less than 1% from last year, reflecting our comp sales increase offset by the impact of the sale of the Pharmacy business, which closed in mid-December. +Digital sales grew 34% in the fourth quarter, and we saw the most dramatic increases in the Black Friday and Cyber Monday weeks. These increases were driven by our simple, broad and compelling offers; and, as John mentioned, our flexible fulfillment capabilities played a key role in driving our fourth quarter digital sales growth. +Red Card penetration was 23% in the fourth quarter, up about 190 basis points from 21.1% last year. This increase represents a moderate acceleration from the trends we were seeing earlier in the year, combined with the impact of the removal of our Pharmacy sales. Because a meaningful portion of our Pharmacy sales consisted of reimbursements from third parties, Red Card penetration on our total Pharmacy sales was very low. As a result, the Pharmacy sale will increase Red Card penetration throughout 2016. And to add clarity, we've provided an apples-to-apples comparison in our press release schedules. For the fourth quarter, Red Card penetration would have been up about 160 basis points from last year, had Pharmacy sales been removed from both years. +Our fourth quarter segment EBITDA margin rate of 9.8% was flat to last year's strong performance. Among the drivers, fourth quarter gross margin rate was down about 60 basis points from last year, reflecting a small benefit from sales mix, including the removal of Pharmacy sales, offset by investments in promotions. +As John mentioned earlier, last year's stronger than expected comparable sales growth drove very strong gross margin rate performance in fourth quarter 2014, as regular price selling on seasonal items was unusually high. This year, with sales in line with our expectations, our gross margin rate reverted to a more normal level, given the competitive dynamics we faced in the fourth quarter. +Every holiday season, we gain insights into the evolution of our guests' shopping behavior; and this year's results showed us that clear, compelling, broad based offers are appealing to our guests. This insight will inform our strategy as we work to further refine our promotional effectiveness in 2016. +Favorability in our selling, general and administrative expense rate offset the fourth quarter gross margin rate decline. This performance reflected an increase in our store payroll expense rate, driven by investments in our store team, including the visual merchants John mentioned earlier, partially offset by underlying improvement in unit productivity; however, the pressure from store labor expense was offset by favorability in our marketing and bonus expense rates and disciplined spending across the organization. +At the end of the year, our merchandise inventory was up about 4% from a year ago, a bit more than our current sales trend. As John mentioned, we ended the year with a very clean inventory position, and the year-over-year increase reflects intentional inventory investments which are supporting record in-stock levels in our focus categories. +Turning now to capital deployment, we paid dividends of $345 million in the fourth quarter, up 4.4% from a year ago. Our business results and cash position also enabled $1.3 billion in share repurchases in the fourth quarter, meaning we returned more than 110% of our net income through dividends and share repurchases. And even though we returned about $4.8 billion to our shareholders in 2015, we ended the year with a healthy cash position, including cash from the CVS transaction which closed late in the year. +Before I turn to our guidance for the first quarter and provide some insights of our financial plan for the year, I want to review last year's performance against the guidance we provided a year ago. Let's start with sales. A year ago, we laid out a plan to grow total sales 2% to 3% on comp sales growth of 1.5% to 2.5%, led by growth in our signature categories. We achieved our comp sales goal by generating very solid growth of 2.1%, and comp growth in signature categories was more than 2.5 times as high as our comparable sales growth overall. +Total sales grew slower than comps this year, due to the removal of the Pharmacy sales beginning in December. Of course, the sale of the Pharmacy business was not reflected in our guidance a year ago, as we didn't enter into the deal until June. However, while the sale of the Pharmacy business will continue to affect our total sales this year, we first articulated the expected benefits of the deal in June, which includes faster traffic growth, higher profit dollars and rates, and higher ROIC from the up front capital we received from CVS. +Now let's turn to digital. A year ago, we laid out a goal to grow Target's digital sales an industry leading 40%. And while we didn't quite make this ambitious goal, we did lead the industry, with 31% digital sales growth in 2015. With this growth, we delivered our financial goals and we gained deeper insights into how our guests want to interact with Target. +Moving down the P&L, a year ago we said we expected to grow our segment EBITDA rate 20 to 30 basis points in 2015, driven by modest improvements in both our gross margin and our SG&A expense rate. We ended the year ahead of that goal, up about 50 basis points, reflecting favorability on both the gross margin and the SG&A expense lines. +Turning to capital deployment. A year ago, we were expecting 2015 capital expenditures of $2.1 billion, planning for a 5% to 10% increase in the quarterly dividend in the middle of the year, and we expected $2 billion or more in share repurchases for the full year. +How did the year turn out? We spent about $1.4 billion on capital expenditures in 2015. We hit the middle of our guidance, with a Board approved 7.7% dividend increase in June; and we exceeded our share repurchase guidance, with about $3.4 billion in shares retired this year. Our 2015 share repurchase capacity reflected robust cash generation by our business and, of course, additional capacity from the closing of the sale of our Pharmacy business in December. +Regarding capital expenditures, our 2015 spending reflected the re-timing of certain projects resulting from prioritization efforts initiated by our new Chief Information Officer, Mike McNamara, and his team. Following his arrival in the middle of the year, Mike dramatically reduced the number of non-infrastructure technology projects in order to refocus resources on the highest priority initiatives and make faster progress. In addition, Mike's team began hiring hundreds of additional engineers, in order to reduce our reliance on contractors and vendors. +These changes reflect our commitment to prioritize spending, on both capital and expense, to best support our enterprise priorities. And in the current environment, our spending priorities are currently tilting towards expense, including investments in technology engineers, in our store team, including the hiring of visual merchants, and in our headquarters teams in the areas of data science and operational excellence. +So how did the elements of our 2015 P&L translate into adjusted EPS? By achieving our comp sales goal while exceeding our guidance for profit margin and share repurchase, we delivered $4.69 of adjusted EPS this year, above our guidance range of $4.45 to $4.65, and more than 11% higher than 2014. And while we didn't provide specific guidance for return on invested capital in 2015, we reported after-tax ROIC of 16% this year. +I'll quickly note, because the ROIC calculation doesn't adjust for non-recurring items, this year's performance included the gain on the sale of the Pharmacy business. Excluding this gain, our business generated a very healthy after-tax ROIC of 13.9% for the year, up well over 1 percentage point from 2014. +So with full-year 2015 performance as context, let's turn to our detailed guidance for first quarter. I will also provide some high level details of our plan for the year and discuss those plans in more detail at our meeting next week. +I'll start with our view of comparable sales for the full year. We are planning for comp growth in the 1.5% to 2.5% range in 2016, consistent with our performance throughout last year. Given that we're one year into a multi-year journey, at next week's meeting, I'll discuss why we believe we have the capacity to grow comps a bit faster than this range over time; however, in the current environment, we believe this is a prudent range to plan for this next year. +With that context on full year sales, I'll turn to the first quarter. As we plan our first quarter comp in light of competitor inventory positions, we are anticipating growth in the lower end of the 1.5% to 2.5% range we're planning for the full year. First quarter reported total sales are expected to decline 4.5% to 5%, reflecting removal of Pharmacy sales from this year's results. +One note on our sales guidance, we haven't specified a goal for digital sales growth. I'll discuss our reasoning for this change in more detail next week; but for now, I'll simply stress that our commitment to digital is as strong as ever. And while we will continue to include digital metrics in our financial reporting this year, we are going to gauge our success based on Target's overall traffic and sales growth, without making an arbitrary distinction between channels. This change is consistent with how our guests think about shopping, as we've confirmed our guest research. +Moving on to the first quarter P&L, on the EBITDA margin rate, we are expecting an improvement of 60 to 70 basis points in the first quarter, driven by an increase in our gross margin rate partially offset by a moderate increase in SG&A expense rate. The expected gross margin rate improvement primarily reflects the benefit of the removal of low margin Pharmacy sales from the mix, combined with a moderate improvement in the underlying business. +On the SG&A line, our forecast anticipates some pressure from the investments we're making in our store team, along with incremental expense from the reissuance of Red Card debit and credit cards as we move guests to much more secure chip and pen technology. +On the depreciation and amortization expense line, we are expecting 20 to 30 basis points of pressure in the first quarter, reflecting the removal of Pharmacy sales and a slight increase in D&A dollars over last year. We expect first quarter interest expense dollars to be flat to last year's. We're planning for a first quarter effective income tax rate of 35% to 36%, and we expect to continue to engage in meaningful share repurchase, given our cash position. Altogether, these expectations position us to deliver first quarter adjusted EPS of $1.15 to $1.25, compared with $1.10 a year ago. +Turning back to full year, we expect to deliver full-year 2016 adjusted EPS of $5.20 to $5.40; and I'll provide more detail on the individual P&L items next week. For now, I would note that this performance would exceed our longer term financial algorithm to generate annual adjusted EPS growth of about 10%, as it reflects the expected share repurchase benefit of the incremental cash we will deploy from the sale of our Pharmacy business. +Now I'll turn the call back over to Brian, who is going to provide a quick preview of next week's financial community meeting. Brian? + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman and CEO [6] +-------------------------------------------------------------------------------- + + Thank, Cathy. Before we take your questions, I thought it would be helpful to cover our agenda for next week. +In New York next Wednesday, I'll open the meeting with an update on our strategic priorities and the initiatives for 2016. Then John will provide deeper insights into the work his team's doing to transform supply chain and their efforts to drive operational excellence across the enterprise. And finally, Cathy will provide insight into how we expect to continue to deliver on the long-term financial algorithm we laid out last year. Following the presentations, we will have a Q&A session with all three speakers, along with several other members of our leadership team who will be attending this meeting. +At last year's meeting, I outlined our enterprise priorities and told you that I hoped they would remain consistent for years. So here's the spoiler alert. Our priorities today remain consistent with a year ago. We made progress, but we have a lot more to do. And our tactics will always be evolving, but this year's results demonstrate we're focused on the right work. +At this year's meeting, we plan to show you how we're getting even closer to our guests, gaining a deeper understanding of their wants and needs and how Target fits into their daily lives. We also plan to show you why we're so excited about all the new products we've developed for this year. And for those of you who will be with us in New York, you'll see vignettes showcasing newly developed products across multiple categories, including our incredible new Kids brand, Pillow Fort. +So whether you plan to be with us in New York next week or listening to our webcast, we hope you'll join us to gain a deeper understanding of our strategic and financial plans going forward and why we're so excited about the prospects in 2016. With that, we'll conclude our prepared remarks. And now Cathy, John and I will be happy to respond to your questions. + + +================================================================================ +Questions and Answers +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) +Your first question comes from the line of Kate McShane with Citi. + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman and CEO [2] +-------------------------------------------------------------------------------- + + Good morning. + +-------------------------------------------------------------------------------- +Kate McShane, Citigroup - Analyst [3] +-------------------------------------------------------------------------------- + + Hello. Can you hear me? + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman and CEO [4] +-------------------------------------------------------------------------------- + + We can now. + +-------------------------------------------------------------------------------- +Kate McShane, Citigroup - Analyst [5] +-------------------------------------------------------------------------------- + + Okay. Great. Thank you. My first question is on CVS. You had mentioned in your prepared comments that you've already converted some of the pharmacies. And I know it's early days, but wondered if you could provide any detail on if you've noticed any notable changes in traffic in those particular stores? And just how disruptive is the rebranding across the chain over the next six months? + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman and CEO [6] +-------------------------------------------------------------------------------- + + Well, it's still very early and we'll be tracking this carefully over the next few months. John Mulligan was actually down in the Charlotte market just a few weeks ago, where we've rebranded some of the very first CVS pharmacies inside of Target. So John, why don't I let you share some of your impressions? + +-------------------------------------------------------------------------------- +John Mulligan, Target Corporation - COO [7] +-------------------------------------------------------------------------------- + + Yes, I think overall, I don't think the rebranding will be a significant disruption for the store or the technology changes that are going to go on. As we walk the store, it looked fantastic. The CVS brand looks great. I think they've done a great job, between our team and theirs, tying it into the total Target store environment. When we did this, we spoke a lot about the tools that CVS would bring, not only to our guests, but to our teams. The teams were certainly excited about the tools that CVS is bringing to them to help them do their job, so that they can focus more fully on guest service. So we're very excited about that. And we're excited to see, like Brian said, as we go along later in the year, we'll see more marketing to talk about the relationship of the two companies and also see the reaction of our guests as those capabilities are made more front and center for them, as well. + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman and CEO [8] +-------------------------------------------------------------------------------- + + I'd only add, we've been working for months and months now with our colleagues at CVS to make sure this is a very smooth transition. And the plans we have in place will minimize the impact on the guest. So we're very excited about what this brings to Target, what it brings to our guests, and to our shareholders, and expect it to be a very seamless transition over the next six months. + +-------------------------------------------------------------------------------- +Kate McShane, Citigroup - Analyst [9] +-------------------------------------------------------------------------------- + + That's great. Thank you. + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman and CEO [10] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Operator [11] +-------------------------------------------------------------------------------- + + Your next question comes from the line of Michael Lasser with UBS. + +-------------------------------------------------------------------------------- +Michael Lasser, UBS - Analyst [12] +-------------------------------------------------------------------------------- + + Good morning. Thanks a lot for taking my question. Two parter. Number one is on the promotional activity. Can you give us a sense for how much you think that impacted the sales for the quarter and how is that going to influence your promotional posture moving forward? And then the second part of my question is on some of the stats, very helpful stats that Mr. Mulligan provided on the in-stocks, how much do you think that the increase in in-stocks helped in the fourth quarter? Thank you so much. + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman and CEO [13] +-------------------------------------------------------------------------------- + + Why don't I start by talking about the promotional environment? And we approach every year recognizing that the fourth quarter, this holiday season, is a very important time of the year for us, and it's going to be a very promotional environment. And as we sit here today, we really believe our playbook that we rolled out during the holiday drove traffic to our stores, drove traffic to our site, allowed us to accelerate our comp performance. And remember, we were comping a very strong Q4 from 2014. So we felt very good about the effectiveness of our promotions. They were broad, they were very simple, and they worked both in store and online. So we feel great about the performance during the holiday, where our signature categories performed well. We've worked with Nielsen and NPD to look at market share performance and clearly recognize that we gained market share as a by-product of our playbook in the fourth quarter. So feel very good about our approach. +But to your question about the future, we're always stepping back and analyzing promotional effectiveness, looking back at our playbook. And as we plan for next year, we'll continue to enhance and refine and make sure that we have very broad, very simple and very effective offers that continue to drive traffic and profitably grow our sales. John, do you want to talk about the impact of in-stocks? + +-------------------------------------------------------------------------------- +John Mulligan, Target Corporation - COO [14] +-------------------------------------------------------------------------------- + + Yes, I think we certainly can analyze, triangulate around the sales impact of in-stocks, but that would be providing you very rough estimates. What I think is much more important when you talk about essential categories, ultimately this is about the guests trusting that you will have the merchandise they want when they come in our stores. If a new mom takes her baby out in 10-degree weather for diapers and formula, you better have diapers and formula in your store. And so really, it's about the trust that they have in the Target brand to always deliver wherever and whenever they want. And over time, there is no doubt in our minds that will drive sales growth for the long term. + +-------------------------------------------------------------------------------- +Michael Lasser, UBS - Analyst [15] +-------------------------------------------------------------------------------- + + That's very helpful. Thank you so much. + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman and CEO [16] +-------------------------------------------------------------------------------- + + Thank you, Michael. + +-------------------------------------------------------------------------------- +Operator [17] +-------------------------------------------------------------------------------- + + Your next question comes from the line of Matthew Fassler with Goldman Sachs. + +-------------------------------------------------------------------------------- +Matthew Fassler, Goldman Sachs - Analyst [18] +-------------------------------------------------------------------------------- + + Thank you so much and good morning. + +-------------------------------------------------------------------------------- +Cathy Smith, Target Corporation - CFO [19] +-------------------------------------------------------------------------------- + + Good morning. + +-------------------------------------------------------------------------------- +Matthew Fassler, Goldman Sachs - Analyst [20] +-------------------------------------------------------------------------------- + + I'd like to talk for a moment about the SG&A line and just to put in context the cost cuts that you announced at last year's meeting, about $1.5 billion annualized, talk about where we are in recognizing those and just thinking about the expense performance that you had against that. And as part of that, if you could address whether there's any incipient wage pressure that you've noted in the market would be very helpful. Thank you so much. + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman and CEO [21] +-------------------------------------------------------------------------------- + + I'll start out, and then I'll let Cathy and John also build on it. But as we talked about last year, we've had a very clear multi-year plan. We targeted over $2 billion of savings. And in 2015, we've made very good progress against that plan. We're on or ahead of all of the key metrics that we're tracking and we expect that to continue as we go forward. +So John and Cathy are working across the organization to make sure that those initiatives stay in place. And as John continues to build his team and we bring people like [Anu] Gupta on board to focus on operational excellence, we expect to find even greater opportunities for further improvement. So I think we're well positioned today. I feel very good about the progress we've made to drive productivity across the organization, and you should expect that to continue in 2016 and beyond. + +-------------------------------------------------------------------------------- +Cathy Smith, Target Corporation - CFO [22] +-------------------------------------------------------------------------------- + + I'll just add on a little bit. With regards to our performance with SG&A, the beauty of what we're seeing with the plan we laid out last year is we're delivering upon it, but we're also recognizing how we can reinvest back in the business on the priorities that matter to our guests. And so if you think about our investment in visual merchandise leaders, that's a great example. 1,400 stores now have someone who is an expert at helping to showcase the categories that matter most to our guests. And so we're seeing ability, as we save on one line, we can invest in other areas in our business. +And you had asked about wage pressure. I'm going to just put a plug in. We believe in having the best team in retail. And that has always been a differentiator for Target, and we believe more today than ever that is going to be a differentiator is our wonderful team member engagement with our guests every single day, any way they interact with them. So we're going to be competitive in wage. We always assess it market by market, because we believe in fielding that best team in retail. + +-------------------------------------------------------------------------------- +Matthew Fassler, Goldman Sachs - Analyst [23] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Operator [24] +-------------------------------------------------------------------------------- + + Your next question comes from the line of Greg Melich with Evercore ISI. + +-------------------------------------------------------------------------------- +Greg Melich, Evercore ISI - Analyst [25] +-------------------------------------------------------------------------------- + + Hello. I just wanted ask a little more detail on the guidance, Cathy, that you outlined. If you think about all of 2016, how much buyback is there or isn't there in that guidance? And also, how should we think about CVS impacting the guidance, however you want to frame it, in terms of you mentioned sales, but also margin, should we expect a certain margin benefit, if it's 50 to 70 bips up in the first quarter, is that a good run rate for the year or how should we think of it? + +-------------------------------------------------------------------------------- +Cathy Smith, Target Corporation - CFO [26] +-------------------------------------------------------------------------------- + + Yes. So Greg, thank you. First off, I'm going to put a plug in to say we look forward to seeing you next week, because we'll obviously unpack a little bit more of it then. But with regards to the share repurchase comment, in our guidance we did assume a consistent level of share repurchases, like we've been talking. However, we're also ending the year with a pretty heavy cash position, because we closed the transaction late in December. And so you'll see us provide additional color into that. But suffice it to say, it will be at the level of this year or higher, and we've included that in our EPS guidance of $5.20 to $5.40. + +-------------------------------------------------------------------------------- +Greg Melich, Evercore ISI - Analyst [27] +-------------------------------------------------------------------------------- + + And on the margins? + +-------------------------------------------------------------------------------- +Cathy Smith, Target Corporation - CFO [28] +-------------------------------------------------------------------------------- + + Yes, so as we've said, it obviously was an impact on sales, but very little on the aggregate EBITDA line, which is what we've said longer term. + +-------------------------------------------------------------------------------- +Greg Melich, Evercore ISI - Analyst [29] +-------------------------------------------------------------------------------- + + So your full-year guidance assumes some slight EBITDA margin increase, it seems? + +-------------------------------------------------------------------------------- +Cathy Smith, Target Corporation - CFO [30] +-------------------------------------------------------------------------------- + + Yes. + +-------------------------------------------------------------------------------- +Greg Melich, Evercore ISI - Analyst [31] +-------------------------------------------------------------------------------- + + Thanks. Look forward to seeing you next week. + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman and CEO [32] +-------------------------------------------------------------------------------- + + Thanks, Greg. + +-------------------------------------------------------------------------------- +Operator [33] +-------------------------------------------------------------------------------- + + Your next question comes from the line of Sean Naughton with Piper Jaffray. + +-------------------------------------------------------------------------------- +Sean Naughton, Piper Jaffray & Co. - Analyst [34] +-------------------------------------------------------------------------------- + + Hello. Good morning and thanks for taking the question. Just on Q4, the gross margin was just a little bit lighter than I think consensus and we modeled that. Could you provide just a little more detail on the variances or puts and takes in gross margin versus the internal plan that you had, or was that 50 basis point decline in line with your expectations? + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman and CEO [35] +-------------------------------------------------------------------------------- + + Sean, as we think about our performance in the fourth quarter, it played out pretty much as expected. We know the fourth quarter is going to be very promotional, very competitive. We certainly saw the guests respond very positively to our offers and that drove great traffic. It allowed us to build market share in our signature categories, and I think it positioned us well for 2016. So as we sit here, there's a lot of variables that go into building our plans for a quarter like the fourth quarter, but we're very pleased with the way our plans drove traffic to our stores, visits to our site, allowed us to accelerate comps on top of a very strong quarter last year. And we saw very broad increases across many of our signature categories, as we reported. So I think our plans were in line with our expectation for the quarter. + +-------------------------------------------------------------------------------- +Sean Naughton, Piper Jaffray & Co. - Analyst [36] +-------------------------------------------------------------------------------- + + Okay. Great. And real quick, a follow-up on how you're thinking about 2016. Just from getting a number of questions about how you feel about cost of goods sold, where are you seeing any inflation or deflation potentially in those categories, and specifically in Food, how is that playing through on the P&L right now? Thanks. + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman and CEO [37] +-------------------------------------------------------------------------------- + + Sean, again, a number of puts and takes as we look at the impact of changes in currency and cost of goods, but it's all baked into our outlook for next year. And I think we approach 2016 with a lot of confidence that we've got great plans in place, terrific momentum. And as you'll see next week at the conference, the team's done a terrific job in building some exciting new brands that we'll showcase next week and we're already seeing some really positive responses from our guests to our new Kids line, Pillow Fort. So we're excited about 2016 and we look forward to seeing you next week. With that, Operator, we've got time for one last call today. + +-------------------------------------------------------------------------------- +Operator [38] +-------------------------------------------------------------------------------- + + Your last question comes from the line of Simeon Gutman with Morgan Stanley. + +-------------------------------------------------------------------------------- +Simeon Gutman, Morgan Stanley - Analyst [39] +-------------------------------------------------------------------------------- + + Thanks. Good morning. Thanks, Brian. Quick question that was follow-up on something, the top line versus gross margin tradeoff. First, I take it you're pleased with the outcome. I recognize it's very difficult to optimize, but can you tell us maybe at least the growth you saw in digital, was that existing customers versus new? I'm trying to gauge the stickiness of some of the customers that came to you in the fourth quarter. + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman and CEO [40] +-------------------------------------------------------------------------------- + + We're going to spend a lot more time unpacking this next week, but we recognize that today, our Target guests interfaces with the brand in a number of different ways. Sometimes they are in our stores, sometimes they're shopping online. We certainly heard many times, because of some of the proprietary items that we offered during the fourth quarter, they were shopping online, but as John referenced, quickly coming to our stores to pick up those items. So we felt really good about the way the guests responded to our offers during the fourth quarter. And a great combination of in-store traffic, more guests than ever before clicking and collecting items in our store, and then the fact that we were able to leverage our stores, this year over 460, where we were shipping from stores to our guests' homes, that overall package came together really effectively throughout the holiday. So we feel as if we had a winning strategy in the holidays. It drove great comps on top of a very strong performance last year. +And you and many of the others that are on the call have asked me repeatedly throughout 2015, would we be able to comp the 3.8% increase in 2014? Well, hopefully, we answered that question. We answered it with strong momentum, and we were able to see both strong performance in our stores and we delivered industry leading performance online. So we feel really good about the way we're exiting Q4 and well positioned for 2016 and beyond. +So we're looking forward to seeing all of you next week in New York and thanks for your patience this morning. I know we started a few minutes late, but hopefully it was worth your time, and we look forward to seeing you again next Wednesday. So thank you. + +-------------------------------------------------------------------------------- +Operator [41] +-------------------------------------------------------------------------------- + + This concludes today's conference call. You may now disconnect. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/exam/original-files/Problem_2_3_Sample_full_transcripts/2016-Jan-14-JPM.N-139240302492-Transcript.txt b/exam/original-files/Problem_2_3_Sample_full_transcripts/2016-Jan-14-JPM.N-139240302492-Transcript.txt new file mode 100644 index 0000000..4391470 --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_full_transcripts/2016-Jan-14-JPM.N-139240302492-Transcript.txt @@ -0,0 +1,963 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q4 2015 JPMorgan Chase & Co Earnings Call +01/14/2016 08:30 AM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Jamie Dimon + JPMorgan Chase & Company - Chairman and CEO + * Marianne Lake + JPMorgan Chase & Company - CFO + +================================================================================ +Conference Call Participiants +================================================================================ + + * Mike Mayo + CLSA - Analyst + * Steve Chubak + Nomura Securities - Analyst + * Erika Najarian + BofA Merrill Lynch - Analyst + * Gerard Cassidy + RBC Capital Markets - Analyst + * Betsy Graseck + Morgan Stanley - Analyst + * Brian Foran + Autonomous Research LLP - Analyst + * Brennan Hawken + UBS - Analyst + * Glenn Schorr + ISI - Analyst + * Eric Wasserstrom + Guggenheim Securities - Analyst + * John McDonald + Sanford C. Bernstein & Co. - Analyst + * Jim Mitchell + Buckingham Research - Analyst + * Paul Miller + FBR Capital Markets - Analyst + * Matt O'Connor + Deutsche Bank - Analyst + * Ken Usdin + Jefferies & Co. - Analyst + +================================================================================ +Presentation +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Good morning, ladies and gentlemen. Welcome to JPMorgan Chase's fourth quarter 2015 earnings call. This call is being recorded. Your lines will be muted for the duration of the call. We will now go live to the presentation. Please stand by. +At this time, I would like to turn the call over to JPMorgan Chase's Chairman and CEO, Jamie Dimon, and Chief Financial Officer, Marianne Lake. Ms. Lake, please go ahead. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Company - CFO [2] +-------------------------------------------------------------------------------- + + Thank you. Good morning everybody. I'm going to take you through the earnings presentation, which is available on our website. Please refer to the disclaimer regarding forward-looking statements at the back of the presentation. +Starting on page 1, the firm reported net income of $5.4 billion, EPS of $1.32, and a return on tangible common equity of 11% on $23.7 billion of revenue. Included in the results is legal expense of $400 million after-tax for a range of matters, and we continue to put some issues behind us. This is reflected in a reduction of more than $1 billion to our reasonably possible loss estimate this quarter. +In addition, we recognized the benefit of a settlement reached of $300 million after-tax, which related to moneys owed to Washington Mutual, in connection with a failed savings and loan institution. We've shown this on the page as legal related, and the benefits recorded in revenue in Corporate. +Much like we saw in the third quarter, the overall Company's performance benefited from diversification across our businesses. We saw strong growth in Consumer drivers, on the back of improvement in the US economy, in large part generating core loan growth of 16% for the Company. +Global markets remained challenged across a number of fronts, leading to lower client activity and lower inventory. Against this backdrop, the CIB delivered solid performance across products. And in the quarter, we continued our trend of strong balance sheet, capital and expense discipline, and exceeded targets. +Shifting to the full year's results, if you skip over page 2, on page 3, the firm earned record net income of $24.4 billion, and record EPS of $6 a share. And a return on tangible common equity of 13.5% on revenue of nearly $97 billion. Revenue was down 1%, or $1.3 billion, driven by non-core items, most notably by business simplification in the Investment Bank, and also in private equity. Adjusted, our underlying businesses were up modestly. +We're very happy with our expense story for the year. We delivered adjusted expense of $56 billion, down $2.4 billion, and a 2 percentage point decrease in adjusted overhead ratio. And while we did have a modest benefit from the strengthening dollar this year, we also self funded incremental investments. +Credit performance was strong, in line with our expectations, with net charge-offs at $4.1 billion. With obviously the biggest area of stress in Wholesale being Oil & Gas, against which we built about $550 million in reserves this year, including $124 million this quarter. And as the outlook for oil has weakened, we would expect to see some additional reserve built in 2016, but prices would need to remain at this level for an extended period for them to be significant. +We also built $68 million of reserves in metals and mining, including $35 million this quarter. We're watching this sector closely, and similarly, if commodity prices remain at current levels, we would expect some additional reserve build, but would not expect them to be significant. Finally, net capital distributions for the year were approximately $11 billion, including dividends of $1.72 a share. +Turning to page 4. Starting on the top left, overall, our average balance sheet is down $100 billion year on year, and our spot balance sheet down over $200 billion, with of course the biggest driver being the reduction of approximately $200 billion of Wholesale nonoperating deposits, ultimately reflected in lower cash balances. In addition, you can see notable reductions in all other balance sheet categories, except for loans, which reflects the 16% core loan growth we achieved. +Some portion of the other Wholesale balance reductions were purposeful and will be sticky, particularly the decrease in short-term Wholesale funding balances. The remainder resulted from volatile markets and general deleveraging, driving risk off and lower inventory across products. As client demand for leverage grows, we will likely out put some of that balance sheet back to work. +Moving to the right. The story on deposits continues to be a very positive one, as we delivered some incremental reductions in nonoperating balances, while consistently growing retail and operating deposits. On the bottom left, overall NII was up about $300 million, driving a 7 basis point improvement in NIM. The increase in NII reflects a mix shift to loans, but also includes gains on certain securities and the impact of the rate move in December on this quarter's NII was not significant. +Looking forward to the first quarter, expect firm NII and NIM to be flat to up slightly on higher rates and mix, substantially offset by the absence of those security gains, as well as normal seasonal day count. However, for the full year, with the December rate hike alone, so in a rate flat scenario, together with the loan growth that we have seen and expect, we would expect to deliver about $2 billion of incremental NII. +Perhaps the highlight of this page, on the bottom right, is that based upon the actions we've taken throughout the course of 2015, we believe that we have just reached the 3.5% Method 2 G-SIB bucket, and that we are in or close to the 2% Method 1 G-SIB bucket. So the task ahead is to solidify this position, which we'll talk more about at Investor Day. +Turning to page 5. We're ending the year well ahead of our capital targets, with the firm's advanced fully phased in CET1 ratio at 11.6%, and our standardized fully phased in ratio at 11.7%. The improvement to both ratios was driven by net capital generation, along with an overall reduction in risk weighted assets. With net loan growth being more than offset by lower market risk, reductions in derivatives, as well as secured financing balances and these deliver a more meaningful reduction under the standardized approach. But with reference to my earlier comments on redeploying balance sheet, a portion of this reduction will likely reverse in the near future. +Firm and Bank SLR were at 6.5% and 6.6%, respectively. Finally, we returned $2.6 billion of net capital to shareholders this quarter, including $1 billion of net repurchases, and common dividends of $0.44 a share. +Let's turn to page 6, and Consumer and Community banking. The combined Consumer businesses generated $2.4 billion of net income, on revenue of $11.2 billion, and an ROE of 18% for the quarter. And full-year expense was down by nearly $1 billion, or half of our commitment, if you adjust for legal, and $150 million of incremental investments this year. Going forward, we will look for opportunities to further reinvest. +You can see headcount was down by 12,000 for the year, and nearly 43,000 since 2012. The fundamental business drivers remain strong. Year over year, average loans were up 11%, with core loans up 25% driven by mortgage, but with strength across products. Average deposits were up 10%. We added nearly 600,000 households, and our active mobile customer base continues to grow, up 20%, to roughly 23 million customers, the largest of the major US banks. +Moving to page 7, Consumer and Business Banking. CBB generated strong results for the quarter, with net income of $968 million, and an ROE of 32%, on relatively flat revenue of $4.6 billion. Although NII was flat quarter on quarter, it was down 5% year on year on spread compression, largely offset by that 10% deposit growth. +And excluding an $85 million gain on the sale of a branch, non-interest revenue was down 3% seasonally and up 4% year on year, driven by higher service fees and strong debit volume. We expect NIR to show normal seasonal declines in the first quarter. Expense was down 3% year on year on lower headcount from branch efficiency. And additionally, client assets were up 2%, and Business Banking average loan balances up 6%. +Next, Mortgage Banking on page 8. Overall net income was $266 million, originations in the quarter were $23 billion, down seasonally, and we continued to add high-quality loans to our balance sheet, $16 billion for the quarter, and totaling $70 billion for the full year. Total revenue of $1.7 billion increased 8% sequentially, on strong loan growth, as well as on higher MSR risk management. +For the full year, our non-interest revenue was down relative to 2014 by $1.2 billion, broadly in line with our guidance and that downward trend will continue, as servicing balances continue to decline, and as we expect production margins will compress in the smaller market. We expect the decline in 2016 to be around $700 million. +Expense of $1.2 billion ticked up this quarter, related to exiting the OCC's consent order, but it was down 10% year on year, as we continue to manage costs. Finally, on credit, net charge-offs of 13 basis points reflects the quality of our portfolio. +Moving on to page 9, Card, Commerce Solutions and Auto. Overall net income of $1.2 billion, and an ROE of 24%. +Revenue was $5 billion, up 10% year on year, driven principally by two nonrecurring items. The first was a loss in the prior year of over $200 million that related to non-core portfolio exits, and a gain we saw this quarter of about $160 million, on the IPO of Square. Adjusted the revenue rate was 11.9%. And in terms of core performance, business drivers were strong, and growth offset the impact of co-brand renewals on non-interest revenues, while driving growth in NII. +Year over year, we saw growth of 12% in auto, loan and lease balances, 6% in card sales volumes, 3% in cards core loans, as well as 12% and 14% in merchant processing volumes and transactions, respectively. Expense of $2.2 billion, flat quarter on quarter, but up 4% year on year, reflected higher depreciation on auto lease growth. And we expect expense to be relatively flat into the first quarter, as we continue to invest. +While on auto, 2015 set a record for new car sales, with strength in the fourth quarter continuing through December. And we gained nearly 40 basis points of share year over year, with the strength of our manufacturing partnerships driving growth. +Finally, on credit, in auto, net charge-offs were 50 basis points, and while higher, they were still below our long-term expectations. And in cards, the net charge-off rate was 242 basis points for the quarter, 251 for the year. And given our underwriting discipline, client selection and the improving economy, we expect net charge-offs to stay at these levels in 2016. +Now turning to page 10, and the Corporate & Investment Bank. CIB reported net income of $1.7 billion, on revenue of $7.1 billion, and an ROE of 10%. In Investment Banking for the full year, we continued to rank number one in global IB fees, and number one in North America and EMEA. +In M&A, we maintained our number two ranking, and grew wallet share by 50 basis points. In ECM, we ranked number one globally, up from number three last year. And in DCM, we ranked number one across high yield, high grade and loans. +Banking revenue for the quarter of $1.5 billion was down 11%, driven by lower debt underwriting fees. It was another outstanding performance in advisory fees, up 43% for the quarter, in a market that was down 12, largely driven by North America. Equity underwriting fees were down 4% in a market down 12, with the US remaining somewhat slow, but a resurgence of large transactions in Europe and Asia. And debt underwriting fees were down 43% from a record last year, where we saw an unprecedented number of large fee events. +Treasury services revenue was flat quarter on quarter, but down 4% year on year on lower deposit spreads. In markets, a number of factors contributed to a quiet fourth quarter overall, across products. Investor risk appetite was significantly dampened by a series of market events, and clients retrenched and de-risked early. With that backdrop, the markets businesses delivered $3.6 billion in revenue, in line with our expectations and normal seasonal trends, with adjusted revenues down 16% sequentially and 1% year on year. +In Fixed Income, rates markets were up, given US and ECB monetary policy actions, offset by year-on-year declines in currencies in emerging markets, as the strong dollar and emerging markets uncertainty [things] persisted as well as the Commodities on reduced hedging and declines in credit on all those same things, plus a number of single-name corporate events. Equities delivered solid results, flat excluding the exit of broker dealer services last year, with strong performance in Europe being offset by lower deal flow in North America and Asia, compared to a strong prior year. +With respect to the first quarter, reflecting low levels of client activity, we were light risk going into the year end, and inventory was low and so far, our trading businesses are performing well. But as you know, it is early, and it's difficult to predict how the quarter will play out. +Security services revenue was $933 million, in line with guidance, given the continued impact of lower emerging markets on asset-based fees. For the first quarter, expect revenue to be approximately $900 million, which includes seasonality. +On credit, we saw a reserve build of $76 million, which included $63 million related to Oil & Gas. Finally, expense of $4.4 billion was down 20% year on year, mainly driven by lower legal, the comp to revenue ratio was 26% for the quarter, and 30% for the full year. +Moving on to page 11 and the Commercial Bank. The Commercial Bank generated net income of $550 million, on revenue of $1.8 billion, and an ROE of 15%. Revenue was up sequentially, but relatively flat year on year, with NII up 3% on higher loan balances, despite spread compression, offset by lower IB revenue from a strong quarter last year. However, for the full year, it was a record for Investment Banking, with gross revenue of $2.2 billion, up 10% from 2014. +Expense of $750 million included $50 million of impairment on leased Corporate aircraft. On the reassessment of residual values, the remaining balance sheet value of this portfolio is modest. +We saw record average loan balances of $166 billion, up 14% year on year, with growth in Commercial Real Estate of 17% exceeding the industry, as we continue to invest in this business and gain share. In C&I, loans were up 11%, largely driven by Corporate client banking on the back of several large transactions. +Finally, credit performance of the portfolio does remain strong, with only 4 basis points of net charge-offs. However, we did add $100 million to reserves, $60 million of which relates to Oil & Gas and $26 million for Metals & Mining. +Moving on to page 12, Asset Management. Asset Management reported net income of $500 million, with a 27% pretax margin and 21% ROE, on revenue of $3 billion, down 5% year on year, driven by lower performance fees in alternatives. Expense of $2.2 billion was also down 5% year on year, roughly equally explained by lower performance fee-driven compensation, as well as a benefit from refining the value of the health of that asset. Assets under management of $1.7 trillion, and client assets of $2.4 trillion, were down 1% and 2% year over year, respectively. +We saw mixed flows in the fourth quarter, resulting in long-term net outflows of $9 billion, with solid inflows in equities being more than offset by weakness in Fixed Income and the loss of select mandates. However, we had strong long-term investment performance, with 80% of mutual fund AUM ranked in the first or second quartiles over five years, which should be supportive of future flows And for the full year, we had positive long-term inflows of $16 billion. In lending, we had record balances of $110 billion, up 7% year on year, driven by both mortgage, as well as traditional loans. +Turning to page 13 and Corporate. Treasury and CIO reported net income of $138 million for the quarter. Included in this result, there is a pretax benefit of $178 million, relating to certain securities held at a discount, that were called at par. And this was in our NII. Other Corporate net income of $84 million included a net benefit of $60 million after-tax, for the legal related matters we discussed earlier, as well as a contribution to our foundation this quarter of $150 million pretax. +Turning to page 14. I've given you some guidance throughout the presentation, and this page is for your reference. Obviously, when we get to Investor Day, we will give you a comprehensive outlook for each of our businesses for the year. +So in summary, a solid quarter, and a record for the full year, both in terms of net income and EPS, which even on higher capital, translates to a good return on tangible common equity of 13.5%. We exceeded our targets on expense management, generating positive operating leverage and improving our adjusted overhead ratio by 2 percentage points. Delivered strong core loan growth of 16%, materially changed the mix of our deposit base, including growing retail deposits at 10%, and made meaningful progress on our balance sheet, our G-SIB surcharge, and capital levels. +With that, operator, we'll take Q&A. + + +================================================================================ +Questions and Answers +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Your first question comes from the line of Brennan Hawken with UBS. + +-------------------------------------------------------------------------------- +Brennan Hawken, UBS - Analyst [2] +-------------------------------------------------------------------------------- + + Good morning, Marianne. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Company - CFO [3] +-------------------------------------------------------------------------------- + + Good morning. + +-------------------------------------------------------------------------------- +Brennan Hawken, UBS - Analyst [4] +-------------------------------------------------------------------------------- + + So, curious about whether or not you all have seen the stress we've seen in some of the credit and equity markets, and some of the volatility impacting M&A velocity appetite, amongst Boards and C-suites, broadly, in your conversations and throughout the IB? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Company - CFO [5] +-------------------------------------------------------------------------------- + + So, again, I would say that the pipeline coming into 2016 in M&A was good, solid, up, in fact. Obviously, volatility can dampen the confidence of Boards and CEOs. Dialogues are pretty active, and we think the types of deals that we'll see in 2016 will look different. But I think, in the first couple of weeks, it's not been particularly strong, and we do need to see some of the stability come back, I think, for us to really see that conversion start to pick up. + +-------------------------------------------------------------------------------- +Brennan Hawken, UBS - Analyst [6] +-------------------------------------------------------------------------------- + + And just by different, is that a reference to size, or can you be a bit more specific on what you mean? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Company - CFO [7] +-------------------------------------------------------------------------------- + + Yes, less mega-deals, more mid-sized deals, more cross border. It's a little different. Actually, more deal count, less big mega-deals, could be very constructive for revenue, but we're likely to see it be a little bit different in 2016. But honestly, the pipeline is good, and -- yes. + +-------------------------------------------------------------------------------- +Brennan Hawken, UBS - Analyst [8] +-------------------------------------------------------------------------------- + + Okay. (multiple speakers) That's helpful. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Company - CFO [9] +-------------------------------------------------------------------------------- + + North America will be a tough comp. It was very strong in 2015, but Europe could be very constructive. + +-------------------------------------------------------------------------------- +Brennan Hawken, UBS - Analyst [10] +-------------------------------------------------------------------------------- + + Terrific. Helpful. And then, you referenced energy prices staying this low would lead to a significant reserve build, you expect, in your energy book. Can you maybe give a little bit more color around that? How would you define significant? And how long would oil need to stay down here, in order to see some of that reserve action? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Company - CFO [11] +-------------------------------------------------------------------------------- + + Yes. So, the way we do our reserves, just for context, because I think it's important is, obviously the oil price outlook is important and instructive. And it's very clearly going to drive how we think about probabilities of default and loss, given [default for] certain of our customers. +But I think it's also the case, just for context, to know that it is very name-by-name specific. Specific conditions at clients matter greatly. And so when we do these estimates, they are directionally correct, and order of magnitude correct. But that's just for context. +Oil -- we said last quarter, if oil reached $30 a barrel, and here we are, and stayed there for, call it, 18 months, you could expect to see reserve builds of up to $750 million. And that assessment hasn't fundamentally changed. +So, it is not the current market expectation that oil will flatline. It is the expectation, right now, that there will be a modest recovery. Based upon that, we would expect to take some additional reserves, but for them to be more modest, less significant. But that's the range; if oil's at $30 and stays here for a long time, up to $750 million. + +-------------------------------------------------------------------------------- +Operator [12] +-------------------------------------------------------------------------------- + + (Operator Instructions) +Your next question comes from the line of Mike Mayo with CLSA. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA - Analyst [13] +-------------------------------------------------------------------------------- + + Hi. I wanted to follow up on the Oil & Gas question. It just seems as though $124 million in additional provisions for Oil & Gas could be low, at least based on the one-year forward prices for oil, which are still in the $30s. And so, my question is for Jamie. As you look back, how does the Oil & Gas situation today compare to prior periods of stress? We have 2002; we had the TMT meltdown. +When you were at Bank One, you reduced the lines of credit. You got ahead of that early. In 2007, you weren't exactly at the start, but then you adjusted and you said -- hey, this is a big issue. +And now we have Oil & Gas, which could be another industry-specific stress, and you're only taking additional provisions of $124 million. Is that going to be enough? And one year from now, are you going to look back and say -- whoops, we didn't get ahead of this enough. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Company - Chairman and CEO [14] +-------------------------------------------------------------------------------- + + I think, first, I'd say we try to be very conservative, always, and so we're not trying to put up as little as possible. You know me, I'd put up more if I could. But accounting rules dictate what you can do. +And these are baskets of -- the real risk is in producing wells, cash flows are down. Surprisingly, the cost of getting the oil out of the ground has also dropped dramatically, and probably much more than most of us would have expected. +So, you take these producing wells, you take the cash flow, you discount it at 8% or 9%, you lend against it. And so these are our forecasts. +And our energy book isn't that large, relative to JPMorgan Chase. We're not worried about the big oil companies. These are mostly the smaller ones that you're talking about these reserve increases on. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Company - CFO [15] +-------------------------------------------------------------------------------- + + I also think, Mike, just -- + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Company - Chairman and CEO [16] +-------------------------------------------------------------------------------- + + And the forward curve is -- the end of the year, for 2016, I think is more like [$41] or [$42], or something like that. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Company - CFO [17] +-------------------------------------------------------------------------------- + + Yes, it's [$48]. So, hey, Mike, the other thing to know about the profile of reserves -- three things. The first is, it's not linear. +So, just the oil price decline, and the decline in the forward curve that we saw into December and to the end of the year, that's the impact it had on our reserves. It's fallen significantly in the first two quarters. That was not a knowable condition, and we can't reserve for that at the end of the year. That's why we said we would expect to take some more reserve increases in the next couple of quarters. +But again, it's a name-specific thing. And lots of other conditions at clients matter, including their hedging, their cash flows, the level of security, all those things. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA - Analyst [18] +-------------------------------------------------------------------------------- + + And how do you use CDS to help protect yourself on that portfolio? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Company - Chairman and CEO [19] +-------------------------------------------------------------------------------- + + We don't. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA - Analyst [20] +-------------------------------------------------------------------------------- + + Okay, you don't. And then, the last follow-up: Do you intend to keep lending to the Oil & Gas companies, as they run into problems? On the one hand, you have the risk of throwing good money after bad. On the other hand, if you stop lending as much, and you have the high-yield market retreating, and you have private equity firms retreating, maybe it becomes a liquidity crisis for some of the oil companies. +So, which is it? Do you lend more or less to the Oil & Gas sector? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Company - Chairman and CEO [21] +-------------------------------------------------------------------------------- + + First of all, the oil folks have been surprisingly resilient. And remember, these are asset-backed loans, so a bankruptcy doesn't necessarily mean your loan is bad. +So, you have to be a little bit careful in -- and it's also, Mike, a philosophical thing. A bank is supposed to be there for clients in good times and bad times. So, it's not a trading market, where you try to support clients. +So, to the extent we can responsibly support clients, we're going to. And if we lose a little bit more money because of it, so be it. +And we've done that around the world. We did it in 2007 and 2008 and 2009. We try to do it responsibly. If banks just completely pull out of markets every time something gets volatile and scary, you'll be sinking companies left and right. + +-------------------------------------------------------------------------------- +Operator [22] +-------------------------------------------------------------------------------- + + Your next question comes from the line of John McDonald with [Stewart] Bernstein. + +-------------------------------------------------------------------------------- +John McDonald, Sanford C. Bernstein & Co. - Analyst [23] +-------------------------------------------------------------------------------- + + Hi, good morning. Marianne, was wondering if you could remind us where you are on your expense reduction targets in the Consumer and the Investment Bank? And how does that translate to some thoughts about the expected trajectory of total Firm-wide expenses for this year? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Company - CFO [24] +-------------------------------------------------------------------------------- + + Yes, so, let me just deal with where we are against our targets. So, the most notable targets were $2 billion in the Consumer businesses in 2017 versus 2014, and $2.8 billion in the CIB in 2017 versus 2014. +You probably heard my comment, but to clarify, on an apples-to-apples basis, we're halfway through on Consumer. We've done $1 billion this year. You don't see that 100% translate into the results, partly because of legal expense, which is not something that we particularly can predict, and hopefully won't be there forever. Also, because we intentionally decisioned in 2015, in the fourth quarter in particular, or mostly, to increase our investments in the Consumer businesses by $150 million. +So, we've achieved the $1 billion. We chose to reinvest a portion of it. Another $1 billion we're on track for. We will potentially reinvest some of that, too. And Gordon and we will talk to you about the basis for that at Investor Day. +On the $2.8 billion in the CIB, we're $1.3 billion through at the end of the year. And we talked before about the fact that the first $1.3 billion is largely on business simplification. We've had the revenue decline. We need to have the expense decline, and we've worked hard to deliver that, and we have. +The next chunk is to do with technology and operations and infrastructure and organization, and it's harder. And so, we will continue with them on track to deliver it, but it's going to be a job through 2016 and into 2017. + +-------------------------------------------------------------------------------- +John McDonald, Sanford C. Bernstein & Co. - Analyst [25] +-------------------------------------------------------------------------------- + + And how does that all net in to an outlook for this year, if you're willing to give us some thoughts on that? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Company - CFO [26] +-------------------------------------------------------------------------------- + + Yes, I can give you some thoughts that won't totally satisfy you, which is our core expenses will continue to trend down, on the back of delivering against them. But we will make investment decisions that we think are good for the Company, accretive for shareholders, that will re-spend some of that money. And so we'll give you that shrink and grow at Investor Day. + +-------------------------------------------------------------------------------- +Operator [27] +-------------------------------------------------------------------------------- + + Your next question comes from the line of Ken Usdin with Jefferies. + +-------------------------------------------------------------------------------- +Ken Usdin, Jefferies & Co. - Analyst [28] +-------------------------------------------------------------------------------- + + Thanks. Good morning. I was wondering if you could talk to us a little bit about the benefits from rates, as they come through? Obviously, your commentary that NII will be even flattish in the first quarter, adjusted for day count, and even with some securities gains in the numbers this quarter, presumes a nice helper from that first move. +And you guys were really conservative on your deposit beta thoughts, when you talked about them previously. I know, probably you haven't seen much change yet. But how are you expecting the deposit behavior to act? And has there been any change to your modeling expectations about what might come through, as we get through the first couple of hikes? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Company - CFO [29] +-------------------------------------------------------------------------------- + + So, just on NII, yes, we are seeing, embedded in that NII, flat to up slightly. We are seeing a nice lift associated with the rate hike in December across businesses, as well as the continued benefit of the mix towards loans in our balance sheet. But we were flatted in our NII this quarter by $178 million on securities gains in CIO. So, that's going to mean the comparison is challenging, and then day count is obviously seasonal. +So, that's the dynamic. We are seeing the rate benefit. We do expect to see it, as I said in my remarks, for the full year. +Look, we think we are appropriately conservative on deposit [beta's]. It is not -- it is way too early to have any idea. There's -- virtually nothing has moved yet. And so, our job, and what we are doing, is paying very close attention to the competitive landscape. +These deposits that we're talking about, that have the high beta's, are valuable deposits with valuable clients for us, and we want to be competitive and pay fair rates. But it's so early in the movie that we haven't changed much in our modeling assumptions. + +-------------------------------------------------------------------------------- +Ken Usdin, Jefferies & Co. - Analyst [30] +-------------------------------------------------------------------------------- + + Okay. And my second question -- if I can ask an ex-energy credit question? A lot of concerns are that we're going to get into some type of broader deterioration, of which your numbers showed no signs of heading towards. What are you looking for? Are you seeing any signals of ex-energy changes in either delinquencies or watch trends? And are you still comfortable with that low [4%s] type of charge-off expectation that you guys had talked about previously? Thanks. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Company - CFO [31] +-------------------------------------------------------------------------------- + + So, energy, Metals & Mining, we're watching very closely, industries that could have knock-on effects like industrials and transportation. But we're not seeing anything broadly, in our portfolio, right now. +We're just watching very closely, which is why -- now, obviously, you can take our reserve build number, and you can say it's almost substantially all made up of Oil & Gas and Metals & Mining. And behind the scenes, we've had upgrades and downgrades of a number of other different companies, across sectors, but nothing particularly thematic yet. But we're watching. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Company - Chairman and CEO [32] +-------------------------------------------------------------------------------- + + I would just point our that Credit Card, Commercial Bank, middle market, large corporate credit is as good as it's ever been. So obviously, it's going to get a little bit worse. I wouldn't call it a cycle, per se. +If you have a recession, yes, you will see a normal cyclical increase in all those losses. We're not forecasting a recession. We think that the US economy looks pretty good at this point. + +-------------------------------------------------------------------------------- +Operator [33] +-------------------------------------------------------------------------------- + + Your next question -- + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Company - CFO [34] +-------------------------------------------------------------------------------- + + Based on that, with the obvious caveat of what happens with oil prices and energy over the course of the near future, yes, we would still expect our charge-offs to be relatively low. + +-------------------------------------------------------------------------------- +Operator [35] +-------------------------------------------------------------------------------- + + Your next question comes from the line of Glenn Schorr with ISI. + +-------------------------------------------------------------------------------- +Glenn Schorr, ISI - Analyst [36] +-------------------------------------------------------------------------------- + + Hi, thank you. So, I think you talked about some of this, Marianne, in terms of the Method 2 G-SIB surcharge now estimated at 3.5%. I'm just curious -- I think, if the numbers are right, you took down notionals, and that there's booked $3.4 trillion, $21 billion in level 3 assets, $50 billion in non-op deposits. +You've said that you don't want to be an outlier, so you're whittling that down. I'm curious of the driving force behind it. What kind of revenue give-up there is, in such a move like this, because we like it. And thoughts on the go-forward? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Company - CFO [37] +-------------------------------------------------------------------------------- + + Yes, so, look, we talked about achieving 4% last quarter, I think; and for disclosure, we were quite close to 3.5%. At that point, it becomes increasingly compelling to want to look at the margin, for what you could do to get within the bucket. And so that is what we did in the fourth quarter, is spend time really focusing on getting to that achievable boundary, which we thought at that point it was. +And remember, it's not nothing, in the year, that we started the year thinking we would exit $100 billion of non-operating deposits. And while there still could be some volatility in that number, of course, we've almost doubled that -- or doubled that, in fact. +So, we got some wind to our backs in doing it. It's also the case that, when you get the entire Business and Company attuned to the sense of urgency and desire to want to be increasingly efficient in this way, that, at the margin, in a 100 different things, little benefits accrue. +So, look, we're at about 3.5% -- we're just inside the 3.5% bucket, as best we estimate it. It's not as much important whether we're basis points or surcharge points below or above. It's much more what we do now to get safely in the bucket. And that's going to still take work. So that's why -- we'll obviously talk to you more about this at Investor Day. +In terms of the give-up, from an economics perspective, we wouldn't have done it at any cost. We have done it because we think it is important to do, because we think it's going to be constructive for the Company, and because the revenue give-ups were not significant. But they weren't zero, either. But to be able to reduce a constraint that is, in one way or another, likely to bind us -- or in multiple ways, in fact, likely to bind us, it was a, I think, very good trade. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Company - Chairman and CEO [38] +-------------------------------------------------------------------------------- + + It was done, effectively, client by client. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Company - CFO [39] +-------------------------------------------------------------------------------- + + Yes. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Company - Chairman and CEO [40] +-------------------------------------------------------------------------------- + + To make sure we were trying to do the right things for our clients; not just jamming our balance sheet down and hurting people. + +-------------------------------------------------------------------------------- +Glenn Schorr, ISI - Analyst [41] +-------------------------------------------------------------------------------- + + Fair enough. I just have one quick follow-up, on Ken's last question: If two-thirds of the economy is consumer-led, you look at all your early-stage delinquencies, like Ken said. And, Jamie, to your comments, things look okay. I hate putting words in your mouth, but what do you think the disconnect, then, is, between what's going on in the markets versus what's going on in the trends in your Business, both in terms of growth and forward-looking credit looks? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Company - Chairman and CEO [42] +-------------------------------------------------------------------------------- + + The US economy has been chugging along at 2% to 2.5% growth for the better part of five years now. In the last two years, it has created 5 million jobs. If you look at the actual household formation -- car sales, wage, people working -- it still looks okay. +Corporate credit is quite good. Small business formation -- it's not back to where it was, but it's quite good. Household formation's going up. +So obviously, market turmoil, we all look at it every day. But I'm not sure most of the 143 million Americans look at it that much, who have jobs; and you have a big change in the world out there. People are getting adjusted to China slowing down. When you have commodity prices go down like that, there are big winners and losers. +The oil companies are the losers; consumer is a benefit. Brazil gets hurt. India benefits. South Korea benefits. Japan benefits. And those cause troubling waters. And hopefully, this will all settle down, and it's not the beginning of something really bad. + +-------------------------------------------------------------------------------- +Operator [43] +-------------------------------------------------------------------------------- + + Your next question comes from the line of Brian Foran with Autonomous. + +-------------------------------------------------------------------------------- +Brian Foran, Autonomous Research LLP - Analyst [44] +-------------------------------------------------------------------------------- + + Hi. The disclosure around the Oil & Gas is really helpful. And I was wondering if you could just walk through something similar on Metals & Mining? So, you gave us the -- I think you said $68 million of full-year reserve build, and you gave us the not-significant, if things stay where they are. Can you give us the balance? +And then, is there a comparable $500 million to $750 million stress test for Oil & Gas, or stress case? Is there a comparable -- what is the stress case, if broader Commodities, and Metals & Mining, comes in worse? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Company - CFO [45] +-------------------------------------------------------------------------------- + + Okay. So our total reserves, on balance sheet, for Metals & Mining, or notwithstanding we built $60 million-odd this year, is over $200 million. So the coverage ratio is pretty good. +The exposure is about -- I haven't got the precise numbers in front of me. They're [about] a third the size of our exposure to Oil & Gas, so about 2% of our overall wholesale credit exposure; so, considerably more modest. Which is why, if energy prices and general commodities weakness and stress stayed where it is right now, even for an extended period, we would think that the incremental reserves would be considerably more modest. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Company - Chairman and CEO [46] +-------------------------------------------------------------------------------- + + And it's also -- that one is mostly name by name. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Company - CFO [47] +-------------------------------------------------------------------------------- + + Yes, for sure. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Company - Chairman and CEO [48] +-------------------------------------------------------------------------------- + + It's not big asset-based reserves. It's just -- they're big corporate credits, name by name. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Company - CFO [49] +-------------------------------------------------------------------------------- + + And for both Oil & Gas and Metals & Mining in our portfolio, Oil & Gas is close to 60% investment grade, and Metals & Mining about half. + +-------------------------------------------------------------------------------- +Brian Foran, Autonomous Research LLP - Analyst [50] +-------------------------------------------------------------------------------- + + And then on -- I guess staying with credit -- on home equities and the whole issue of free cash from interest [home-made] amortizing, can you lay out how it's progressed, relative to your expectations so far? And also remind us how big the allocation of the reserve is against that? +And I guess, not to lead the witness, but is that an area where things are trending, early days, better than expected, and could provide some buffer against, maybe, anything else that happens on the C&I side? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Company - CFO [51] +-------------------------------------------------------------------------------- + + Yes, so, with respect to home equity [re-class], remember, the majority of the problematic home equity underwriting was 2005 through 2008. So here we are, at the beginning of 2016, with [pig filling the python]. But we're monitoring it closely, and we have some re-class that have happened. +Obviously, interest rates are low. Home price appreciation, on the other hand, is your friend. So there are puts and takes. +We've been monitoring it, I would say, at the margin, or more than at the margin, at the early stages, coming in better than we had modeled. And remember, from an incurred loss perspective, we would consider these re-class risks to be largely incurred, so we've tried to reserve them, to the best of our ability. So we feel good about our reserve. I don't think we've disclosed them. But so far, from a performance perspective, I would say slightly better than our models. But we continue to monitor it, because it's still relatively early. + +-------------------------------------------------------------------------------- +Operator [52] +-------------------------------------------------------------------------------- + + Your next question comes from the line of Betsy Graseck with Morgan Stanley. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [53] +-------------------------------------------------------------------------------- + + Hi, good morning. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Company - CFO [54] +-------------------------------------------------------------------------------- + + Good morning. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [55] +-------------------------------------------------------------------------------- + + Marianne, I know that the Basel Committee put our their fundamental review of the trading book proposal this morning. So, clearly, no one's had time to really go through it in detail. However, I'm sure you have already gone through the prior proposals, and done the QIS for the last couple of years. The proposal is better than what had been -- the ruling is better than what the proposal -- the most recent one had been. +Just wanted to get a sense from you, as to how you can manage to this 2019 implementation time frame? Are there things set in motion already? Or is this something that you would start from here? And if you could just give us some broad strokes on how you think about overall impact, that would be helpful. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Company - CFO [56] +-------------------------------------------------------------------------------- + + So obviously, you'll forgive me because we've been on calls since it came out. But, yes, we have been working on this for years. +The problem with this particular rule is that, as you stated, based upon the four QIS's that were done, there were some, I would characterize, significant challenges, with respect to the rules as written. And we were expecting there to be a number of meaningful changes, and there have been; in many cases, meaningful improvements. +But it's very technical, and there's been a lot of changes, so we need to sift through it to figure out, net-net everything. Although it is clear that net-net, despite the fact of the stated intention of the committee wasn't necessary to increase market risk capital across the industry, it will be higher. But by how much, it's really going to need to be sifted through. +And for that same reason -- for both those same reasons, I'm sorry -- for the reason that the rule has not been stable and there have been significant questions, many of which have been either addressed or partially addressed, and many, I guess, that have not, it would have been premature to have taken any actions in advance of figuring out where this has landed. And, as you know, the period to comply is three years. So it's more of a start from here, to figure out how to manage with this, after we've sifted through the details. +So, I wish I were able to give you a little bit more of a detailed answer, but we're going to need to take the time to go through it. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [57] +-------------------------------------------------------------------------------- + + Right, I totally understand that. And I guess my basic question is: There's -- you can take action, as opposed to just deal with what the current decision would be for you. There are actions that you can take to reduce the impact? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Company - CFO [58] +-------------------------------------------------------------------------------- + + There are always actions that we can take to reduce the impact. And so, we have to think about them in the context of our overall capital optimization program. +And, again, if there are -- if some of the things that we hoped -- and I -- honestly, I've been on calls since it came out. So, if some of the things that we hoped were going to be addressed have not, they could have had, or may have, meaningful impact on specific types of activity. And we will have to react accordingly. And, yes, we will take actions, if that's the right answer. I wish I could give you more details, but we just need to go through it. + +-------------------------------------------------------------------------------- +Operator [59] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Steve Chubak with Nomura. + +-------------------------------------------------------------------------------- +Steve Chubak, Nomura Securities - Analyst [60] +-------------------------------------------------------------------------------- + + Good morning. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Company - CFO [61] +-------------------------------------------------------------------------------- + + Good morning. + +-------------------------------------------------------------------------------- +Steve Chubak, Nomura Securities - Analyst [62] +-------------------------------------------------------------------------------- + + I had a couple of questions on capital. The first relates to the RWA progress, which did surprise positively in the year, by about $50 billion ahead of expectations. And I was just hoping you can give a better sense, Marianne, just given some of your prepared remarks, as to how much of that incremental $50 billion reduction was a function of more proactive mitigation efforts? Maybe even tied to the G-SIB mitigation efforts that you guys had talked about, which should presumably remain in the run rate, versus balance sheet shrinkage that may be due to the risk loss environment that we're experiencing today? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Company - CFO [63] +-------------------------------------------------------------------------------- + + Yes, so, I would say that, based upon our fourth-quarter balance sheet, given that market risk was a driver, given that balance sheet levels was a driver, particularly on standardized, we could give back, on standardized, as much as 10 to 20 bps of capital, of the 10.7% capital accretion. But the bigger point, on the RWA outlook, is that we expect to be bound, over the medium term, by standardized. And standardized is going to always have a neutral to upwards pressure, as we continue to grow these high-quality loans. +So, even though the RWA, being at the $1.5 trillion-ish sooner than we expected, is obviously good news. Regardless of how much of that may, in the short term, revert, our job is going to be to continue to become more efficient, to try and keep it there, just given the natural upward pressure of the standardized calculations. We can become more efficient in advance, but we're unlikely to be bound by it in the medium term. So, that's what we're focused on. +So, I wouldn't take the $1.5 trillion, and read through that we'll be continuing to decline from here on standardized. We'll be continuing to work hard to make sure that we can grow those loans that we love, but that have (inaudible) [risk weights] under a standardized basis. + +-------------------------------------------------------------------------------- +Steve Chubak, Nomura Securities - Analyst [64] +-------------------------------------------------------------------------------- + + Understood, Marianne. That's very helpful. +And then, maybe just switching gears to the G-SIB surcharge, clearly the progress surprised positively, getting down to that 3.5%. I was just wondering how you guys are thinking about establishing minimum capital targets? I recognize you'll likely lay that out at Investor Day. +Just want to get a better sense as to what methodology are you employing, in terms of thinking about a management buffer? And all the different binding constraints that you have to manage to day-to-day? And thinking about through-the-cycle target that you guys would like to manage to? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Company - CFO [65] +-------------------------------------------------------------------------------- + + Okay. If I miss something at the end, remind me. +In terms of how we think about buffers, just really conceptually, the Firm manages, and the Board has set for the Firm, a risk appetite. That risk appetite has a number of features, and capital depletion in a stressed environment is one of them. And so, when we think about setting buffers, we think about it just broadly in the context of allowing ourselves enough room to absorb losses that are within our risk appetite, and not have to take premature actions, from a capital perspective. +So -- but having said that, our buffer has been pretty consistent, at the 50-basis-point level, for a reasonable period of time. And we'll update you on all of that at Investor Day. +With respect to our targets, it's a little bit more complicated than minimum regulatory capital, because as you say, we're bound, potentially, by multiple constraints, and one of them may be CCAR. Plus -- it is CCAR, I should say. Because as you know, the first two quarters of this year, our capital distribution plans have already been approved. And we haven't done CCAR, so this is not any kind of prediction, but it wouldn't surprise you to know that it's unlikely that we will pay out 100% of our earnings in CCAR, going forward. +So, we are on a path to continue to accrete capital, though we would like to move up in our pay-out range. So, given that we're still moving towards our 12% target, and we will update you if any of that changes at Investor Day. We're also, as you know, potentially going to understand whether or not the Fed changes any of the CCAR parameters, and whether that has an impact. +So, at the moment, the best we know is that we're going to continue to accrete capital, albeit more slowly, as we hope to move up in the pay-out range, but we haven't done CCAR yet. And that's if the rules don't change. So, 12% it is for now. + +-------------------------------------------------------------------------------- +Operator [66] +-------------------------------------------------------------------------------- + + Your next question comes from the line of Eric Wasserstrom with Guggenheim Securities. + +-------------------------------------------------------------------------------- +Eric Wasserstrom, Guggenheim Securities - Analyst [67] +-------------------------------------------------------------------------------- + + Thanks. Marianne, if I could just clarify your NII comment from the very beginning of the call, do I understand correctly that the $2 billion of incremental NII that you've cited is just a function of the repricing dynamics, as they move through your balance sheet, rather -- or is there also, I guess, a contribution from loan growth? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Company - CFO [68] +-------------------------------------------------------------------------------- + + It's both. So, think about -- in a [rate-sat] scenario, when you can pick whether you believe the market -- whether you think the market is -- or whether you believe the [FONC docs]. And I think it's going to be data dependent, so we're not going to have a stated opinion on that. +But because of the mix in our balance sheet in 2015, as well as our expectation of continued loan growth, we would expect mix to contribute about half of that. And defer 25 basis points about the next half because we are more sensitive to the front end of rates in the first 25 basis points. And you can see that in our earnings and risk disclosures. So -- even if we see nothing else. +Now, obviously, we believe, and the market believes that you're going to see a couple more hikes. That would be, on average, another 25 basis points, and that would be incremental NII again. + +-------------------------------------------------------------------------------- +Eric Wasserstrom, Guggenheim Securities - Analyst [69] +-------------------------------------------------------------------------------- + + Great. Thank you. And so, I know we just touched on RWAs, but how do you suggest we think about GAAP assets for this year? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Company - CFO [70] +-------------------------------------------------------------------------------- + + I would say I would think about them in a somewhat similar directional way, given that our balance sheet ended below $2.4 trillion, a little bit of it market delivered, a lot of it purposeful. But we do intend to continue to gather deposits and extend loans, and while you're -- and portfolio loans, as well. So, while you will see some securities balances decline and the like, I would say again, net modest growth, but modest, and very lending driven. + +-------------------------------------------------------------------------------- +Operator [71] +-------------------------------------------------------------------------------- + + Your next question comes from the line of Jim Mitchell with Buckingham Research. + +-------------------------------------------------------------------------------- +Jim Mitchell, Buckingham Research - Analyst [72] +-------------------------------------------------------------------------------- + + Good morning. I just wanted to -- I had a follow-up question on Fixed Income trading. I think Dan Pinto has talked about benefits from higher rates. And so, I guess number one, I wanted to see if you had any thoughts on that? Have you seen any initial benefits to spreads in the FICC trading market, with the first rate hike? +And in contrast, you've had a couple of competitors announce -- or at least it's reported -- that they're cutting headcount. That seems to be a little bit in contrast to the expectation that Fixed Income could pick up with higher rates. So, if you could talk through your thoughts on Fixed Income? +I do notice that you did mention 1Q is off to performing well, so maybe that's part of it, too. But if you could help on that, that would be great. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Company - CFO [73] +-------------------------------------------------------------------------------- + + Okay. So, in terms of the impact of rates, obviously there was a lot of monetary policy confusion. Broadly, in the fourth quarter, the ECB underwhelmed the Fed, was (inaudible). So there was a lot of confusion. But by the time the rate hike happened, it was obviously pretty well understood. We did see strong activity, or strong client activity, relatively speaking, on the back of that in the rates business, more so than necessarily about spreads. +With respect to the Fixed Income business, we've always been very disciplined about how we think about the staffing levels and the expenses in that business. We've managed it very carefully. The compensation has come down across the trading businesses, and it wouldn't surprise you that some of that -- a lot of that has been in Fixed Income. And our business is at scale and productive. So -- + +-------------------------------------------------------------------------------- +Jim Mitchell, Buckingham Research - Analyst [74] +-------------------------------------------------------------------------------- + + All right. So, you still feel pretty comfortable with your outlook that things could improve, and market share gain potential, as competitors pull back? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Company - Chairman and CEO [75] +-------------------------------------------------------------------------------- + + You've seen, in Fixed Income -- we have a very good Fixed Income operation globally, around the world. Rates themselves don't filter through FICC trading directly. I think what Danny was talking about is, if you have healthy economies and confident investors, you have more volume in things like that. +We do see a little bit of repricing taking place, in prime broker, repo, conduit, and some of those things run through FICC. So, that is going to take place as the world adjusts to all the new capital requirements. And obviously, there's a lot of seasonality in the business, which we've experienced for the last decade. + +-------------------------------------------------------------------------------- +Operator [76] +-------------------------------------------------------------------------------- + + Your next question comes from the line of Erika Najarian with Bank of America Merrill Lynch. + +-------------------------------------------------------------------------------- +Erika Najarian, BofA Merrill Lynch - Analyst [77] +-------------------------------------------------------------------------------- + + Hi, good morning. My questions have been asked and answered. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Company - CFO [78] +-------------------------------------------------------------------------------- + + Thanks, Erika. + +-------------------------------------------------------------------------------- +Operator [79] +-------------------------------------------------------------------------------- + + Your next question comes from the line of Matt O'Connor with Deutsche Bank. + +-------------------------------------------------------------------------------- +Matt O'Connor, Deutsche Bank - Analyst [80] +-------------------------------------------------------------------------------- + + Hi. If we look at credit spreads in the bond market, even ex-energy, they've widened considerably. And I'm wondering if this has resulted in wholesale credit being repriced at all? I realize the bond market doesn't set bank loan pricing, but just wondering if you've been able to reprice some of the wholesale customers, or expect being able to do so? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Company - Chairman and CEO [81] +-------------------------------------------------------------------------------- + + No, we've seen no real repricing in loans on the balance sheet. You have seen a little bit of -- people are getting other revenues to make up for their credit exposure. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Company - CFO [82] +-------------------------------------------------------------------------------- + + Yes. Think about the bank loans as being relationship loans that need to be in the context of [broader] relationship, and everybody is competing for them. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Company - Chairman and CEO [83] +-------------------------------------------------------------------------------- + + They barely repriced in 2008 and 2009. Banks were continuing to lend at the existing price. But that was because they -- these were long-term relationships. The bank loan market does not reprice like the markets do. + +-------------------------------------------------------------------------------- +Matt O'Connor, Deutsche Bank - Analyst [84] +-------------------------------------------------------------------------------- + + I guess I wonder why. We saw pricing in the debt markets come in considerably over the last several years. C&I pricing came in. I realize it might take some time. But I would think there's the opportunity for at least some repricing around the edges; no? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Company - Chairman and CEO [85] +-------------------------------------------------------------------------------- + + We haven't seen it. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Company - CFO [86] +-------------------------------------------------------------------------------- + + Also, it's very, very competitive. Everybody has been chasing these loans, and so that's a factor, too. So, we haven't seen it yet. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Company - Chairman and CEO [87] +-------------------------------------------------------------------------------- + + And then, if you -- the number in middle market lending, if I remember correctly, if you look at it by client, 60% of the revenues are not loan related. So, clients -- they also know what their relationship is to the bank. And while we need to make a good return on capital, the capital applied to the client is only partially loan related. And that capital, on its own, doesn't earn an adequate return. Simple lending, on its own, is generally not an adequate return business. + +-------------------------------------------------------------------------------- +Operator [88] +-------------------------------------------------------------------------------- + + Your next question comes from the line of Gerard Cassidy with RBC. + +-------------------------------------------------------------------------------- +Gerard Cassidy, RBC Capital Markets - Analyst [89] +-------------------------------------------------------------------------------- + + Thank you. Good morning. Jamie, to follow up on your comments about maybe some better pricing in prime brokerage and repo because of the capital requirements, or requiring you guys to raise prices, can you expand upon that? Do you see it growing, where you could get even better pricing going forward, because of less competition? Can you give just more color there? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Company - Chairman and CEO [90] +-------------------------------------------------------------------------------- + + I think the better way to look at it is that people seem, in certain of our businesses -- and I mentioned those, and there are some other ones -- capital has been deployed, people have adjusted to the new rules, and you've seen pricing go up. Whether it goes up a lot -- I wouldn't count on it going up a lot more from there. +The markets are going to be competitive at that point. But use of balance sheet, the cost has gone up; not loans, but most of the other stuff. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Company - CFO [91] +-------------------------------------------------------------------------------- + + And remember, we think about our prime brokerage business going hand in glove with equity. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Company - Chairman and CEO [92] +-------------------------------------------------------------------------------- + + That's correct. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Company - CFO [93] +-------------------------------------------------------------------------------- + + And so, while the repricing is helpful, and does -- at the margin, everybody is going to continue to always observe their pricing. We've built our platform internationally; Europe, we are seeing strong demand for our [synthetic pull-outs]. In Asia, we're adding clients -- we've got the wind to our backs. +So, it's an important business to our clients. You're right, there are some other people, potentially, not going to be as aggressive. And if we can take share, we certainly will. + +-------------------------------------------------------------------------------- +Gerard Cassidy, RBC Capital Markets - Analyst [94] +-------------------------------------------------------------------------------- + + Great. And then the follow-up question is: Obviously, the FASB is coming out this quarter with the new loan loss reserve methodology -- the current expected credit loss versus what we're using today -- obviously, the incurred loss model. There's going to be a true-up for everybody. Have you guys given any thought that, when this goes into place, when you may take that true-up? Assuming they say you have to implement it by 2019, or something like that, would you do it much before that, or can you give us some thoughts on your thinking about what's going to happen? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Company - CFO [95] +-------------------------------------------------------------------------------- + + Obviously, we expect any transition adjustment to go through equity. If we are able to adopt it early, we might do that. I'm not aware that we are. But I could be wrong about that. + +-------------------------------------------------------------------------------- +Operator [96] +-------------------------------------------------------------------------------- + + Your last question comes from the line of Paul Miller with FBR Capital Markets. + +-------------------------------------------------------------------------------- +Paul Miller, FBR Capital Markets - Analyst [97] +-------------------------------------------------------------------------------- + + Thank you very much. We know that you implemented a new disclosure form in the Mortgage Banking space tread. Did that have any -- you guys had very good Mortgage Banking results. Did that have any impact whatsoever on your operations in the Mortgage Bank? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Company - CFO [98] +-------------------------------------------------------------------------------- + + So, yes, obviously, it was -- I think if you add up [cleared plus] other servicing rules, print them out, put them on the floor and stand them next to me, they're a foot taller. So they are very complicated. There's a lot of operational complexity to complying, and we're working very hard at doing that. +I will say, in the quarter, we did -- as part of being cautious about making sure that we're complying, our cycle times were a couple days -- a few days worsened. And so, volumes, our origination volumes, are a little lower than we would have otherwise seen; not a lot. And that's just timing, and it's just days. But not really from a financial results perspective, because of the way we recognize the revenue. +So, I would call it a little bit of teething problems -- across the industry, by the way, not just us -- nothing significant. We are going to get the work finished, and so it's tough, but it is what it is. + +-------------------------------------------------------------------------------- +Paul Miller, FBR Capital Markets - Analyst [99] +-------------------------------------------------------------------------------- + + And then a follow-up question on your portfolio: You look like you grew your residential loans by about $11 billion. Last quarter, you said it was a mix between agency and jumbo. If a big chunk of it's agency, can you give us your thoughts on portfolio of that agency product? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Company - CFO [100] +-------------------------------------------------------------------------------- + + Yes, so, it's about 60% jumbo, 40% agency or conventional conforming, and it's a better execution decision. So, when we look at the better economics between selling or portfolio-ing the mortgage, we'll generally choose the better economics. But we also prefer the annuity nature of the NII -- the lower servicing risk, and the better capital efficiency. +So, it has been the case, over the course of the last several quarters, that it has been the best execution to portfolio these mortgages. And actually, they are generating a nice return on equity. + +-------------------------------------------------------------------------------- +Operator [101] +-------------------------------------------------------------------------------- + + And you do have a follow-up question from John McDonald with Sanford Bernstein. + +-------------------------------------------------------------------------------- +John McDonald, Sanford C. Bernstein & Co. - Analyst [102] +-------------------------------------------------------------------------------- + + One quick follow-up, Marianne: You've had some pretty big tax gains the last couple quarters, running below 30% of your tax rate. At some point, do you pull forward future benefits, and run with a higher tax rate in the future? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Company - CFO [103] +-------------------------------------------------------------------------------- + + So we have had pretty big tax gains over the course of the last -- most notably, obviously, last quarter, over the course of the last couple of years. Most of those related to the, call it, 2003 through 2008 tax periods, when we were going through the financial crisis. And so, some of the matters were more complex, and we took appropriate reserving decisions on that. +There are many less of those very complicated matters ahead of us, and so we wouldn't expect to see the same sort of size of tax benefits going forward as we've seen in the past. But we had some this quarter. So, we'll have a few. And generally speaking, they are, because of the nature of the reserving for tax, generally speaking, we take a conservative approach and the bias to the positive. But it could be much more plus or minus zero, at this point. + +-------------------------------------------------------------------------------- +John McDonald, Sanford C. Bernstein & Co. - Analyst [104] +-------------------------------------------------------------------------------- + + So, what's your natural tax rate, if you don't have those? Is it around 30%? Or is it closer to -- + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Company - CFO [105] +-------------------------------------------------------------------------------- + + 30%. + +-------------------------------------------------------------------------------- +John McDonald, Sanford C. Bernstein & Co. - Analyst [106] +-------------------------------------------------------------------------------- + + Thanks. + +-------------------------------------------------------------------------------- +Operator [107] +-------------------------------------------------------------------------------- + + You have another follow-up question from the line of Brian Foran with Autonomous. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Company - CFO [108] +-------------------------------------------------------------------------------- + + Hi, Brian. + +-------------------------------------------------------------------------------- +Brian Foran, Autonomous Research LLP - Analyst [109] +-------------------------------------------------------------------------------- + + I was wondering if I could just sneak in on credit cards. Do you think the competitive environment has hit a plateau? And on co-brands, are there any large upcoming repricing events? And is there any bigger than a bread box size you can give on [Marriott]? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Company - CFO [110] +-------------------------------------------------------------------------------- + + So, do I think it's plateaued? I think it remains incredibly competitive in card generally, in particular in the co-brand space. So, plateaued at a very competitive level, I suppose. +But in terms of -- I'm not going to talk about any specific names, actually, Brian, in terms of the potential for repricing. It's an important part of our Business, and we're going to defend our Business. + +-------------------------------------------------------------------------------- +Brian Foran, Autonomous Research LLP - Analyst [111] +-------------------------------------------------------------------------------- + + Thank you very much. + +-------------------------------------------------------------------------------- +Operator [112] +-------------------------------------------------------------------------------- + + Your next question is a follow-up question from Gerard Cassidy with RBC. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Company - CFO [113] +-------------------------------------------------------------------------------- + + Hi, Gerard. + +-------------------------------------------------------------------------------- +Gerard Cassidy, RBC Capital Markets - Analyst [114] +-------------------------------------------------------------------------------- + + Thank you. Hi, Marianne. If the regulators lift the dividend pay-out ratio in this year's CCAR to 40%, would you guys consider lifting your dividend pay-out ratio something closer to that? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Company - CFO [115] +-------------------------------------------------------------------------------- + + It's a Board decision, and so, neither have we received that guidance from the regulators, nor have we done CCAR, and had that discussion yet with the Board. But we have generally said that the Board likes to have the flexibility to increase dividends over time, and we have had our dividend most recently at or close to that soft cap. +So, we would love that capacity, and I would imagine that, over time, it may be used. But again, it is a Board decision, not a management decision. + +-------------------------------------------------------------------------------- +Gerard Cassidy, RBC Capital Markets - Analyst [116] +-------------------------------------------------------------------------------- + + Thank you. And then just one last follow-up: On the G-SIB buffer, obviously you guys have done an incredible job in bringing it down to where it is today. When do you expect the regulators to put you into that bucket, assuming you guys are obviously looking at the same types of numbers? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Company - CFO [117] +-------------------------------------------------------------------------------- + + From -- we do everything pro forma. So, first of all, I would say the following. Right now, my understanding -- and if I'm wrong, forgive me -- is that it's your spot balance sheet two years prior that would drive your G-SIB two years forward. But the reality, if you ask my opinion, given that we're going to be reporting quarterly going forward, and because of the likelihood that G-SIB may or may not feature into CCAR, I think it's going to be less important, necessarily, what you are at any one moment in time, but where you are projecting to be or stay. +So, I suspect that we will get the benefit, potentially, of this, not today. We just closed our balance sheet. But I think that it's going to need to be a little bit more dynamic going forward, as it gets potentially introduced into stress test. + +-------------------------------------------------------------------------------- +Gerard Cassidy, RBC Capital Markets - Analyst [118] +-------------------------------------------------------------------------------- + + Great. Thank you. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Company - CFO [119] +-------------------------------------------------------------------------------- + + But I don't know that. + +-------------------------------------------------------------------------------- +Operator [120] +-------------------------------------------------------------------------------- + + At this time, there are no further questions. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Company - CFO [121] +-------------------------------------------------------------------------------- + + Thank you, everyone. + +-------------------------------------------------------------------------------- +Operator [122] +-------------------------------------------------------------------------------- + + This concludes today's conference call. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/exam/original-files/Problem_2_3_Sample_full_transcripts/2016-Jul-14-JPM.N-140164291407-Transcript.txt b/exam/original-files/Problem_2_3_Sample_full_transcripts/2016-Jul-14-JPM.N-140164291407-Transcript.txt new file mode 100644 index 0000000..93ec7c1 --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_full_transcripts/2016-Jul-14-JPM.N-140164291407-Transcript.txt @@ -0,0 +1,795 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q2 2016 JPMorgan Chase & Co Earnings Call +07/14/2016 08:30 AM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Jamie Dimon + JPMorgan Chase - Chairman & CEO + * Marianne Lake + JPMorgan Chase - CFO + +================================================================================ +Conference Call Participiants +================================================================================ + + * Matt Burnell + Wells Fargo Securities, LLC - Analyst + * Steven Chubak + Nomura Securities - Analyst + * Gerard Cassidy + RBC Capital Markets - Analyst + * Brennan Hawken + UBS - Analyst + * Brian Kleinhanzl + Keefe, Bruyette & Woods - Analyst + * Brian Foran + Autonomous - Analyst + * John McDonald + Sanford C. Bernstein & Co. - Analyst + * Paul Miller + FBR Capital Markets - Analyst + * Erika Najarian + BofA Merrill Lynch - Analyst + * Mike Mayo + CLSA Limited - Analyst + * Eric Wasserstrom + Guggenheim Securities LLC - Analyst + * Jim Mitchell + Buckingham Research Group - Analyst + * Glenn Schorr + Evercore ISI - Analyst + * Ken Usdin + Jefferies LLC - Analyst + * Matt O'Connor + Deutsche Bank - Analyst + * Betsy Graseck + Morgan Stanley - Analyst + * Marty Mosby + Vining Sparks - Analyst + +================================================================================ +Presentation +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- +Good morning, ladies and gentlemen. Welcome to JPMorgan Chase's second-quarter 2016 earnings call. This call is being recorded. +(Operator Instructions) +We will now go live to the presentation. Please stand by. At this time I would like to turn the call over to JPMorgan Chase's Chairman and CEO, Jamie Dimon, and Chief Financial Officer, Marianne Lake. Ms. Lake, please go ahead. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase - CFO [2] +-------------------------------------------------------------------------------- +Thank you, and good morning everyone. I'm going to take you through the earnings presentation, which is available on our website. Please refer to the disclaimer regarding forward-looking statements at the back of the presentation. +Starting on page 1, the Firm reported net income of $6.2 billion, EPS of $1.55, and a return on tangible common equity of 13% on $25.2 billion of revenue, a strong result this quarter, particularly given the backdrop. While there are no significant items shown here on the page, our underlying performance was even stronger if you exclude the impact of other notable items primarily credit, legal and tax, all of which you'll hear about as I go through the presentation. That strength was driven by increased client trading activity across markets and an improvement in IBCs compared to the first quarter, as well as strong core loan growth of 16% reflecting good demand across both consumer and wholesale and record consumer deposit growth, up $54 billion. +Before I go through the results, let me spend a moment on two topics that are top of mind. First, an update on wholesale credit. You will see that the total wholesale credit costs this quarter were approximately $200 million. Within this, charge-offs of $150 million were principally driven by oil and gas and metals and mining. And those charge-offs were very substantially offset by reserve releases, so they were previously reserved, which means that underlying the net $50 million reserve build we saw incremental reserve actions this quarter of about $200 million, principally one energy name downgraded in the CIB. +Although the oil and gas sector remains stressed and reserves will continue to be idiosyncratic, overall trends have been somewhat positive with oil prices continuing to stabilize and firming sentiment in the sector improving access to capital markets. In addition outside of energy, we still have not seen contagion or deterioration in our wholesale or consumer portfolios. +Second, on Brexit, uncertainty running up to the referendum led to a risk-[off] environment. And following the decision the markets were quite volatile, as expected, and volumes were materially higher in the immediate aftermath. The market functioned quite well, absorbing the volatility. And despite the significant increases in volumes, our systems were stable and we continue to support client activity with decent trading performance. +With respect to next steps, as you know the ultimate relationship between the UK and the European Union broadly and access to the single market and passporting specifically will likely unfold slowly and over an extended period, depending on when Article 50 is invoked. We continue to work on plans for the full range of outcomes, but we will be appropriately patient. The most important point is that we remain committed to fully supporting our European and UK clients across businesses, and we will be fully able to do this. And while executing against certain of these options would be complex, ultimately we will protect the franchise and minimize any friction costs so that they will be manageable for the Company. +Moving on to page 2. Revenue of $25.2 billion was up $700 million year on year on higher net interest income. For the full year, expect NII to be up more than the $2 billion we guided at Investor Day, despite headwinds from a flatter yield curve, given that our sensitivity is significantly skewed to the front end of the curve, and as industry deposit read prices to date have remained low, coupled with continued strong loan and deposit growth. Non-interest revenue was flat year on year, with the increase in markets revenue being offset by declines in IBCs as well as Asset Management. +Adjusted expense of $14.1 billion was down $140 million, reflecting continued progress against our commitments. We still expect full-year expense of $56 billion, plus or minus, as the second half of the year includes our expectation of an increase in the [FDI] surcharge in the third and fourth quarters. +Moving onto capital on page 3. The Firm's advanced fully phased in CET1 ratio was 11.9%, with standardized at 12.1%, both up about 15 basis points from the prior quarter. The improvement in both ratios was driven by net capital generation, with RWA remaining relatively flat. Firm SLR remained flat to the prior quarter at 6.6%, as capital generation was offset by balance sheet growth. +This quarter we returned $4.4 billion of net capital to shareholders, including $2.6 billion of net repurchases and common dividends of $0.48 a share. Finally, we're pleased we did not receive an objection to our capital plan. And the Board authorized gross repurchases of up to $10.6 billion. +Moving onto page 4 and Consumer & Community Banking. Consumer & Community Banking generated $2.7 billion of net income with an ROE of 20%, reflecting continued strength in business drivers. We had record deposit growth again this quarter, up 10% year on year. Average loans were up 11%, with core loans up 23% driven by mortgage and auto, but with continued strength across all products. And we had record business banking loan originations of $2.2 billion, up 14% year on year, and with a strong pipeline, up 17%. +We added nearly 2 million households year on year, with an increase of 700,000 since last quarter, reflecting strong acquisition trends including the launch of Freedom Unlimited. And finally, our active mobile customer base remains the largest among US banks, up 18%. +Revenue of $11.5 billion included some non-core items which contributed a little under $200 million. Principally a one-time gain on Visa Europe and negative mark-to-market on Square. Adjusted for this, revenue was up 2%. +Consumer & Business Banking revenue was up 3%, reflecting strong deposit and account growth. Mortgage revenue was up 5%, with rates remaining low supporting production margins and on growth in NII as we added $14 billion of high quality loans to our portfolio this quarter, partially offset by lower servicing revenue. +Card, commerce solutions and auto revenue was up, but flat if you exclude the non-core items I mentioned, with gross in card and auto offsetting the impact of card renegotiations. Expense was down 3%, driven by lower legal expense and continued progress against our efficiency commitments, allowing us to fund the incremental marketing and auto lease growth that we talked about at Investor Day. +Finally, credit trends across the consumer businesses continue to be favorable, with charge-offs in card trending up slightly. Over the last two, three years we have responsibly expanded our credit box in card in the prime and near-prime space. As these vintages season, we would naturally expect a higher loss rate and performances in line with our expectations. These loans are coming on at ROEs higher than the portfolio average. So as the mix of our portfolio increasingly reflects these newer vintages, we do expect loss rates to continue to trend up but to do so slowly, and as such we built $250 million of reserves this quarter. +Moving to auto credit. Competitive pressures have caused some lenders to take more layered risk. We have maintained our underwriting discipline with average FICO scores and LTVs better than the industry, and with a very sharp focus on avoiding risk layering. Our credit performance is in line with expectations, and we built $50 million in reserves this quarter, largely reflecting volume growth. Against these reserve builds we saw releases of $125 million, principally driven by mortgage. +Turning to page 5 and the Corporate & Investment Bank. CIB reported net income of $2.5 billion on revenue of $9.2 billion, and an ROE of 15%. In banking IB revenue was $1.5 billion, down 15% in a market down 18%, largely driven by lower equity underwriting fees. We maintained share and ranked Number One in global IBCs, ranking Number One in North America and EMEA. Advisory fees were flat versus a wallet that declined 15%. This quarter we ranked Number Two globally and grew share by 50 basis points. +In equity underwriting, global issuance improved after a weak first quarter but was down from a strong quarter last year, with fees down 37% in a market down 42%. We continued to rank Number One globally, growing share by 30 basis points, and we ranked Number One in every product category for the first half of this year. [Debt] underwriting fees were down 2% from a strong prior year, largely in line with a market which was down 4%. And we ranked Number Two globally. +Moving onto the outlook for fees. Given the decline in M&A volumes, lower wallet is expected in the second half of 2016. We expect to see positive momentum in ECM, as the new issuance market continues to improve. And we expect DCM to be broadly in line with the first half, reflecting robust high grade bond issuance offset by lower acquisition finance. +Lending revenue of $277 million was down 8%, reflecting mark-to-market losses on hedges of accrual loans. Markets revenue of $5.6 billion was up 23% year on year. As I mentioned at the beginning, the Brexit vote triggered a spike in volatility and volumes across asset classes. We were able to meet our clients' needs, execute their transactions and provide liquidity. +Fixed income revenue of $4 billion was up 35% versus a weak second quarter last year. The positive momentum that we saw in March continued into the second quarter, with strong performance in rates and currencies in emerging markets on higher client flows. And performance also improved in credit and securitized products, as client risk appetite recovered in a more stable environment driving increased primary and secondary market activity. +Equities revenue was $1.6 billion, up 2% compared to a strong second quarter last year. With respect to the third quarter, client activity is returning to more normal levels and trading performance so far has been fine. Credit costs of $235 million were driven by a reserve build for oil and gas. And finally expense of $5.1 billion was down 1% year on year, with a comp-to-revenue ratio for the quarter of 30%. +Moving onto page 6 and Commercial Banking. Overall a solid quarter for Commercial Banking with net income of nearly $700 million on revenue of $1.8 billion, and an ROE of 16%. IB revenue rebounded from the first quarter. It was up 23% sequentially and flat year on year. And we continued to see strong momentum in loan growth, with average loan balances up 13% year on year. Commercial real estate loans grew 18%, reflecting continued outperformance in both commercial term lending and real estate banking. And C&I loans were up 9% on increased origination activity in both corporate client banking and middle market. +Revenue was up 4% year on year driven by higher deposit NII and loan growth. And expense of $731 million was up 4%, reflecting continued investments in bankers and technology. Finally, credit performance continues to be in line with our expectations, with net charge-offs of 14 basis points, driven by oil and gas but almost fully reserved. And outside of energy credit performance continues to be strong. +Moving onto page 7 and Asset Management. Asset Management reported net income of $521 million with a 29% pretax margin and an ROE of 22%. Revenue of $2.9 billion was down 7% year on year as we continue to feel the impact of weaker markets, lower performance fees and lower brokerage activity. Expense of $2.1 billion was down 13% year on year, largely driven by lower legal expense, and recall that the prior year included a non-core loss. AUM of $1.7 trillion and client assets of $2.3 trillion were both up 1% sequentially and down 5% and 3% year on year, respectively. +We had positive long-term flows of $3 billion as we continue to see strong net inflows into our fixed income products, with equity market weakness and volatility causing clients to derisk resulting in outflows in equity and multi-asset. Our long-term investment performance remained good, with 81% of mutual fund AUM ranked in the first or second quartiles over five years. Lastly, we had record loan balances of $112 billion, up 4% year on year, driven by mortgage, up 20%. +Turning to page 8 and corporate. Corporate reported a net loss of $166 million, which included two notable items. There was a net legal benefit reflecting some favorable developments in the quarter offset by a number of tax items, including additions to tax reserves for developments relating to open audit periods. As a result of the tax items our managed tax rate for the quarter was 39%. Adjusted it would have been closer to 36%. +Now turning to page 9 and moving onto the outlook. To reiterate, our Firm-wide guidance for the full year on each of revenues, expenses and charge-offs at this point is largely unchanged, obviously market dependent. +To wrap up. A strong quarter reflecting our leadership positions and the benefits of our diversified franchise, with the consumer businesses firing on all cylinders and with robust loan growth across all businesses. We had a good result in markets, continuing to demonstrate our ability to support clients no matter the environment. And just before I open up to Q&A, just for those of you on the phone, Jamie is here. He has a very hoarse voice, so we'll try and use it sparingly. If you hear him croaky, that's why. Operator, open up the line, please. + + +================================================================================ +Questions and Answers +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- +(Technical difficulty) comes from the line of Brian Foran with Autonomous. + +-------------------------------------------------------------------------------- +Brian Foran, Autonomous - Analyst [2] +-------------------------------------------------------------------------------- +Good morning. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase - CFO [3] +-------------------------------------------------------------------------------- +Good morning, Brian. + +-------------------------------------------------------------------------------- +Brian Foran, Autonomous - Analyst [4] +-------------------------------------------------------------------------------- +I know it's very early, and it's probably limited in what you can say because you mentioned it depends on the timeline of Brexit and how passporting works, but is there any qualitative thoughts you can give us around the operational and/or legal issues we should be watching as this develops -- legal entity restructuring, net impacts of moving people versus lower-cost geographies and things like that? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase - CFO [5] +-------------------------------------------------------------------------------- +Brian, I know that everybody is keenly interested to hear what we have to say, but the truth of the matter is it's very, very early days. The new government is just forming as we speak. Negotiations need to be given some time to unfold and take shape. So it's really too early to hypothesize. +We would hope that we can continue to operate the way we are right now. But we will just continue to evaluate the landscape, as I'm sure you will, over the coming weeks, months and quarters, and plan accordingly. The most important thing is that we intend to continue to support our European franchise and clients throughout. + +-------------------------------------------------------------------------------- +Brian Foran, Autonomous - Analyst [6] +-------------------------------------------------------------------------------- +I appreciate that. Maybe switching gears, you mentioned the Consumer business was firing on all cylinders. Clearly, there's some nervousness in the market that the credit cycle is turning. +I wonder if you could touch on two things, which are -- maybe a little bit more detail on the seasoning impact you saw -- you mentioned in Card. Is it just seasoning or is there any like-for-like deterioration? And then in auto, you mentioned risk layering. What particular factors are you seeing layered in the underwriting box that make you concerned right now? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase - CFO [7] +-------------------------------------------------------------------------------- +So, on the card space, as you know, we have loans running off. We're replacing them all of the time. Over the course of the last couple years, since the end of 2013, we made some changes to our credit box and our credit risk policies very, very thoughtfully. And we've been monitoring them very closely. +And what we're seeing in terms of the loss rates and the seasoning of them is fully in line with our expectations. And these loans are coming on at higher risk-adjusted margins. So, the ROEs are at or above the portfolio ROEs. So, nothing that would speak to anything other than our full expectations for our credit risk appetite. +And with respect to Auto, not to speak for others, but obviously when you look at lower FICO scores and high LTVs and longer terms on top of each other in an environment where you've already seen used car prices soften some and they're likely to continue to do so, it's something to watch. And so we've been very, very thoughtful about that, not just today but as we've been going through the cycle. And not only on an absolute basis do we compare favorably in terms of LTVs and FICO scores and even terms to the industry, but we've been very, very careful in -- and low percentage of subprime origination -- very, very careful about looking at those layered risks. +So nothing in our -- and remember, for Auto this year, I think the charge-off rate's going to be 40-ish basis points compared to a long-run average of more like 60. We're sort of reverting to a more normal level, if nothing else. And used car prices will ultimately come down, and we're being thoughtful about that. + +-------------------------------------------------------------------------------- +Operator [8] +-------------------------------------------------------------------------------- +Your next question is from the line of Jim Mitchell with Buckingham Research. + +-------------------------------------------------------------------------------- +Jim Mitchell, Buckingham Research Group - Analyst [9] +-------------------------------------------------------------------------------- +Hello, good morning. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase - CFO [10] +-------------------------------------------------------------------------------- +Good morning, Jim. + +-------------------------------------------------------------------------------- +Jim Mitchell, Buckingham Research Group - Analyst [11] +-------------------------------------------------------------------------------- +Maybe just talk a little bit about the net interest margin and the outlook there. It was down 5 basis points. It looked like it was mostly in the funding costs. I just wanted to get a sense of what was driving -- I think long-term debt was an up-trading. Liability costs were up. Can you give us a sense of what's going on there and how to think about that going forward? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase - CFO [12] +-------------------------------------------------------------------------------- +At the risk of not getting like overly complicated, the long-term debt expense -- our NII was flat with loan growth. And NII on loan growth being offset by long-term debt expense, which was largely to do with the hedging of non-dollar debt and just relative quarter-over-quarter small moves in currency levels and currency basis. So, I would honestly characterize it, not to sort of underplay it, as quarter-over-quarter noise. +Looking forward -- so when you look at our NIM, you have NII flat. You have the balance sheet growing, as we expected, both on loans and trading assets. So, NIM just naturally is down a few basis points. But we would be looking for NII to be up slightly in the third and fourth quarter, and for our NIM to be relatively stable. + +-------------------------------------------------------------------------------- +Jim Mitchell, Buckingham Research Group - Analyst [13] +-------------------------------------------------------------------------------- +Okay, that's helpful. +And maybe just one follow-up on the prior question of credit -- how should we think about the provisioning going forward in Consumer? Is that going to be a consistent build or is that a catch-up that we saw this quarter? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase - CFO [14] +-------------------------------------------------------------------------------- +So, I would say there's going to be two things. First of all, obviously when you talk about Consumer, it kind of gets dwarfed by Card. So let's start with Card. +We are growing the portfolio. We added 4% core loans year over year in Card. So naturally, as the portfolio grows over time, you would expect to add to reserves. So there will be some of that, but I would characterize it as modest. +And then, as these vintages continue to season, we've been experiencing very, very low loss rates at circa 2.5%. They will trend up slightly. So there will be a little bit of rates impact, too, but again, as I say, with very accretive ROEs. +I would look forward and expect there to be some reserve adds over the course of the next several quarters on a combination of those factors, but for all the right reasons. And similarly, volume-wise in Auto we should see some adds, but again, in comparison to Card, modest. + +-------------------------------------------------------------------------------- +Operator [15] +-------------------------------------------------------------------------------- +Your next question is from the line of Erika Najarian with Bank of America. + +-------------------------------------------------------------------------------- +Erika Najarian, BofA Merrill Lynch - Analyst [16] +-------------------------------------------------------------------------------- +Hi. Good morning. So my first question is -- given how well JPMorgan did on the CCAR relative to last year's results, and it seems like RWA and SLR exposure have stabilized over the past few quarters, how comfortable are you perhaps allocating more balance sheet to the investment bank, given that you seem to be very well positioned to continue to gain market share, especially in markets? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase - CFO [17] +-------------------------------------------------------------------------------- +So, as you know, Erika, everything that we do, we do with a view to, first of all, the client franchise and making sure that we're supporting our clients. And then secondarily, with a view to all of our binding constraints. We will provide capital and access to the CIB. But also take into consideration our overall objective of making sure that we stay in the 3.5% G-SIB bucket. So we will continue to try and find capacity to be able to recycle it and grow high-ROE/high-ROA business. + +-------------------------------------------------------------------------------- +Erika Najarian, BofA Merrill Lynch - Analyst [18] +-------------------------------------------------------------------------------- +Great. And was there anything to call out on the equities, the $1.6 billion equities number, that could be a little bit more one-time in nature for the quarter? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase - CFO [19] +-------------------------------------------------------------------------------- +Not anything significant, no. I think you've got to compare it to the prior year, which was stronger, particularly this time last year in Asia. And that's less true today -- stronger in Europe, less strong in Asia. It's more of a regional story than any particularly significant items. + +-------------------------------------------------------------------------------- +Operator [20] +-------------------------------------------------------------------------------- +Your next question is from the line of Betsy Graseck with Morgan Stanley. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [21] +-------------------------------------------------------------------------------- +Hi, good morning. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase - CFO [22] +-------------------------------------------------------------------------------- +Good morning, Betsy. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [23] +-------------------------------------------------------------------------------- +Okay, two questions -- one on the outlook page. I see on the printed page it's the same as what you had last quarter for the Company overall, obviously. But I heard the emphasis on NII was on the plus side, right, $2 billion year on year plus. Is that the right nuance that you were trying to communicate? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase - CFO [24] +-------------------------------------------------------------------------------- +Yes. So let me -- two pieces to the story. Yes, the guidance is $2 billion-plus year on year. You'll recall when we came in to Investor Day, we said we would expect $2 billion, rates flat. It looks like rates will be flat, at least in the front end at this point, at least for the majority of the year, if not the whole year. +You've seen already in the first two quarters that year over year we're up $1.4 billion. We were doing better than that on a combination of lower deposit bases reprices and also on strong loan growth. +But if you annualize that, that would be too high. We are going to have some impact in NII of the lower 10-year. It's not significant. But it will offset that to a degree. We would expect our NII to be between $2 billion and $2.5 billion up year on year -- largely strong loan growth, low reprice. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [25] +-------------------------------------------------------------------------------- +And then on the loan growth side, you've been funding this in part from just a mix shift, right, where your loan-to-deposit ratios moved up very nicely. It's still very low at 66%, but up 2 percentage points Q on Q, and up from 61% year on year. I'm just wondering how far do you think you can take that before you might want to look to fund loan growth with deposit growth more ratably? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase - CFO [26] +-------------------------------------------------------------------------------- +I would say we've been doing a combination. We've been growing our deposits more strongly than the industry. So we continue to be net-net attracting more deposits than the industry, and also, as you say, a mix shift out of securities and into loans. +Our outlook for loan growth through the remainder of the year is to be at the higher end of our range. We said 10% to 15% core loan growth, and at this point, demand still seems robust. So we would expect to be at the higher end of that range. We certainly have been this quarter. +So at this point I would say that it's a combination of factors. And remember that the way we think about our investment securities portfolio also takes into consideration how we think about positioning the Firm's duration of equities. So all of those factors will contribute. + +-------------------------------------------------------------------------------- +Operator [27] +-------------------------------------------------------------------------------- +Your next question is from the line of Glenn Schorr with Evercore ISI. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase - CFO [28] +-------------------------------------------------------------------------------- +Good morning, Glenn. + +-------------------------------------------------------------------------------- +Glenn Schorr, Evercore ISI - Analyst [29] +-------------------------------------------------------------------------------- +Good morning. One more rate question -- as you mentioned, you're super sensitive on the front end of the curve, and you just alluded to the curve is flatter. I'm curious about that great chart that you roll out on Investor Day that talks about -- we make $3 billion more through 2018 if rates stay flat, and $6 billion more if the curve goes down the implied path. The implied path is now lower. Just curious how much those numbers change if the current curve holds? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase - CFO [30] +-------------------------------------------------------------------------------- +If I get this wrong, I apologize. But I think it was actually we make $3.5 billion on the rates implied and $6 billion on normalized rates. But in any case, let me just talk about rates flat versus implied right now. And just because things can change so quickly, let's just focus on 2017. +Rates flat from here. So, with the 10-year at about 1.5% and IOER at 50 basis points, because of the loan growth, notwithstanding any sort of long-end pressure, we would still expect year over year our NII next year to be up between $1 billion and $1.5 billion, implied, which is actually not that much different from that. So it does have about 20 basis points better long-end rates by the end of 2017, but otherwise relatively flat through the end of 2017 would be about $0.5 billion more than that. + +-------------------------------------------------------------------------------- +Glenn Schorr, Evercore ISI - Analyst [31] +-------------------------------------------------------------------------------- +That is perfect, thank you. +Other question was -- there's some regulators chirping a little bit about concerns in commercial real estate. Some of the other banks have mentioned that you're growing like a weed, and your credit is great. So can we just talk a little bit about what you think you're doing differently to both get that growth and then what you're doing to avoid mistakes of the past? And that'll be good. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase - CFO [32] +-------------------------------------------------------------------------------- +Growing like a sunflower, not like a weed. + +-------------------------------------------------------------------------------- +Glenn Schorr, Evercore ISI - Analyst [33] +-------------------------------------------------------------------------------- +Fair. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase - CFO [34] +-------------------------------------------------------------------------------- +Look, I'll say a couple of things. The first is, a lot of that growth is commercial term lending. And it is the case that we have the technology and a process that has speed and certainty of execution, and competitive funding costs. So it is the case that it's a value proposition that we're able to bring to clients, I think, that differentiates us. We're able to close in times that are a fraction of what the industry is. +Secondarily, we're really concentrated on identified, supply-constrained markets, low-rent stabilized. So these are not the same properties that had problems in the past. We have -- since the previous cycle, we have looked carefully at our underwriting, and there are some things and some regions and some products that we either don't do or do significantly less of. So we're very, very careful. But we're looking at some really good credit quality in our commercial real estate portfolio right now. + +-------------------------------------------------------------------------------- +Operator [35] +-------------------------------------------------------------------------------- +Your next question comes from the line of Matt Burnell with Wells Fargo Securities. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase - CFO [36] +-------------------------------------------------------------------------------- +Hi, Matt. + +-------------------------------------------------------------------------------- +Matt Burnell, Wells Fargo Securities, LLC - Analyst [37] +-------------------------------------------------------------------------------- +Hi, Marianne. Thanks for taking my question. +Wanted to ask a couple -- wanted to ask a question on the cost side of things where the overhead ratios, both in the CIB and the Consumer Bank, dropped fairly materially quarter over quarter. I guess I'm just looking for some guidance here in terms of how much of the expense initiatives that you've already been talking about, both in the CIB and the CCB, how much progress did you make in this quarter on that, and was that an outsized contributor to the improvement in the overhead ratios? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase - CFO [38] +-------------------------------------------------------------------------------- +So I would say in the CIB, it's also a revenue story. So you need to consider both factors (multiple speakers). +So let me talk about where we are on the expense commitments. And you'll recall that -- whether you remember a $4.8 billion number or a $5.5 billion number in total, we're about 70% of the way through delivering against that across the CIB and the CCB at the end of the second quarter, and we continue to make progress. +In the CCB, obviously, it is generally more progressive. And in the CIB, it's a bit more about technology and operations, and it takes some time to deliver that. +But fundamentally we continue to chug through that. And we will get there over the course of the next several quarters. So I would say in line with our expectations, and is a contributing factor. + +-------------------------------------------------------------------------------- +Matt Burnell, Wells Fargo Securities, LLC - Analyst [39] +-------------------------------------------------------------------------------- +Okay. And then just in the CIB specifically, you mentioned the comp ratio there was 30%. That's sort of at the low end of your -- of the range that you typically talk about, which is 30% to 35%. +I'm presuming that's largely driven by the better-than-expected revenues. Was there anything else going on there, or was that just pretty much a result of a benign revenue -- a relatively benign revenue environment? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase - CFO [40] +-------------------------------------------------------------------------------- +So I would say the comp-to-revenue ratio is an outcome, just for what it's worth. Obviously we try to give the range to give people an idea. We pay competitively and we pay for risk-adjusted performance. +But there's nothing notable going on. We've been actually at the lower end of our range for a little while now. + +-------------------------------------------------------------------------------- +Operator [41] +-------------------------------------------------------------------------------- +Your next question is from the line of Mike Mayo with CLSA. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase - CFO [42] +-------------------------------------------------------------------------------- +Good morning, Mike. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA Limited - Analyst [43] +-------------------------------------------------------------------------------- +Hi. How is CIB doing in Europe and against European bank competitors in terms of revenue growth, share, the degree of competition? Some competitors are pulling back and you guys have stayed the course. Are you seeing the benefit from that? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase - CFO [44] +-------------------------------------------------------------------------------- +So it's always a little tricky. The share thing is going to become clearer with a rear-view mirror than it is necessarily at a moment in time. It does feel like we are doing fairly well competitively, not just against European banks, but just generally. And not just in Europe, but generally, because we, as you say, have continued to be there for clients across products, across the globe. +So I would say that we feel like we are doing fairly well. We'll know whether that is share gains when we are able to actually look at that in the rear-view mirror. +But there's still plenty of competition out there. So we're just focused on serving our clients the right way. But it does feel a little bit like we're doing well. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA Limited - Analyst [45] +-------------------------------------------------------------------------------- +And I know you were asked already about Brexit. Maybe if we could hear from you, Jamie, about the implications of Brexit. Marianne, you said, quote, minimize friction costs. If you can just give us some sense of what that means? +You've given us a lot of guidance about the recent quarter and the year ahead. But you have what could be a monumental event, and you haven't really talked to investors about that since Brexit's occurred. How do you think about the currency risk, the cost, the revenues? And are you delaying any investments, given the increased uncertainty? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase - Chairman & CEO [46] +-------------------------------------------------------------------------------- +I'm going to try to tell you as best I can, if you can hear me. So, number one, we do think it will reduce the GDP, the UK and the EU, a little bit. And obviously that's not going to affect our business plans. That will affect the economies a little bit. +Number two, we know it's going to create uncertainty for an extended time period. So we don't think we can answer or make certain all these things you want to know because there are a lot of parties involved. We are hoping that the political leaders are very sensible. It makes sense for both the EU and for Britain to think through the process to make it sensible, whatever changes they make, to give businesses time. I'm talking about years -- time to adjust to the new reality, which we don't know what it is. +I think the most important thing is that we will continue in every single country to serve our clients day in and day out. If it adds extra cost, so be it. I'm not really worried about it. It would be nice if it doesn't create huge turmoil. +I'm hoping the EU is sensible, but we're going to be prepared. As Marianne mentioned, there's a range of outcomes. Any one (inaudible) we'll try to be prepared for each one of them. +We're not going to, like, pull back on serving people in Italy, Germany, France, UK or Spain because it might lead to higher costs. I would accept the higher cost, as opposed to disrupt our clients. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase - CFO [47] +-------------------------------------------------------------------------------- +I would also point out, Mike, that competitively we are not in this situation alone. And so we're going to take our time to work out what the right course of action is. And obviously we'll update you as and when that becomes clearer. +We're not going to be at a competitive disadvantage. If anything, as we talked about earlier, we feel like we're in a position of strength. + +-------------------------------------------------------------------------------- +Operator [48] +-------------------------------------------------------------------------------- +Your next question is from the line of Brennan Hawken with UBS. + +-------------------------------------------------------------------------------- +Brennan Hawken, UBS - Analyst [49] +-------------------------------------------------------------------------------- +Good morning. Thanks for taking the question. I just, first off, had a follow-up. So on Brexit, post this development, have you seen any impact on your banking pipelines? Has this had any impact on appetite for M&A, particularly if there is a component that involves either the continent or the UK? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase - CFO [50] +-------------------------------------------------------------------------------- +The truth of the matter is, it's a bit early to say for that, too. I hate to continue to repeat that. +I will tell you that, generally speaking, uncertainty is not particularly conducive or constructive for M&A. But in this case, I think there are some offsets. So I would start with, in terms of the actual strategic dialogue with CEOs and at the boardrooms, it is as good as it's ever been. +If you think about the other factors that would be supportive of M&A, like cheap financing globally, low organic growth, good multiples, solid economy in the US and globally notwithstanding a bit of the steam taken out in Europe or the UK, all of that should continue to be supportive for strategic M&A. At the end of the day -- and currency could be supportive of cross-border activities. So there are puts and takes. +I'm certain that there will be some people who think carefully through the right timing and what to do. At the end of the day, the strategic proposition should ultimately win out in most cases. And similarly, volatility, generally speaking, is not particularly conducive in terms of ECM, but investor appetite is still there, and there have been deals priced post-Brexit. +It's a little early. There's still activity. Volatility is reasonably subdued at this point. And I think, because there are no event calendars out there right now, there's still quite a lot of opportunity in the space. Obviously, DCM, low rates would be a tailwind, notwithstanding the M&A and ECM landscape. + +-------------------------------------------------------------------------------- +Brennan Hawken, UBS - Analyst [51] +-------------------------------------------------------------------------------- +Great. Thank you for that. +And then one more on credit here -- so it seems as though we had 30-day delinquency rate actually go down quarter over quarter. So it seems like maybe -- in the Card, sorry, business. So it seems like maybe it's a cure rate issue. Is that the right assumption? And then, could you give maybe a little color on how much the non-prime growth has been -- has driven in recent vintages versus prior? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase - CFO [52] +-------------------------------------------------------------------------------- +So I'm going to start with the second part of the question. So we are still very much concentrated in the prime and near-prime space, but we have a higher percentage of our origination in the near-prime space, reasonably meaningfully higher over the course of the last couple years. +So where we may have previously been, I think 40%, above 760. Now that's less than that, and there's more like 20% or 30% below 700. By the end of the day, still pristine credit, relatively speaking. +With respect to delinquencies, is it a cure rate issue? Not specifically, no. + +-------------------------------------------------------------------------------- +Operator [53] +-------------------------------------------------------------------------------- +Your next question is from the line of John McDonald with Sanford Bernstein. + +-------------------------------------------------------------------------------- +John McDonald, Sanford C. Bernstein & Co. - Analyst [54] +-------------------------------------------------------------------------------- +Hi, Marianne. I'm not sure if this is too early, but when you think about expenses longer term beyond this year, if you think about 2017, if we find ourselves in a similar revenue environment next year, when you wrap in your cost save objectives and where you want to be on investment spend, do you think you'll be shooting for expenses to be kind of in the same range of that $56 billion next year, if things don't change on the revenue front? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase - CFO [55] +-------------------------------------------------------------------------------- +We're not really doing much in the way of 2017 guidance right now. It will ultimately honestly depend on the opportunities we see in front of us to continue to invest and to add customers. +I think we're at a very good run rate of investments. We've increased reasonably significantly in terms of marketing dollars and also lease growth. That will drive profitability in the medium to longer term. +So it's possible, if we see the opportunity to continue to do that, we would do it. But we have no specific guidance yet. + +-------------------------------------------------------------------------------- +John McDonald, Sanford C. Bernstein & Co. - Analyst [56] +-------------------------------------------------------------------------------- +Okay. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase - CFO [57] +-------------------------------------------------------------------------------- +Revenue environment can change reasonably quickly, particularly, as you know, with rates, and to a lesser degree, markets. We're not going to overreact to a short-term phenomenon. + +-------------------------------------------------------------------------------- +John McDonald, Sanford C. Bernstein & Co. - Analyst [58] +-------------------------------------------------------------------------------- +Sure. Just more near term, you talked at a recent conference about the tax rate going forward. Just with the kind of issues you had this quarter with the tax rate, looking at 39%, you said it would 36%. What should we think about going forward? Is it like in that 36%? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase - CFO [59] +-------------------------------------------------------------------------------- +Yes, taxes much -- generally speaking, the reserve changes are somewhat episodic. Outside of those, yes, 36% is a good central case for our managed tax rate. + +-------------------------------------------------------------------------------- +Operator [60] +-------------------------------------------------------------------------------- +Your next question is from the line of Steven Chubak with Nomura. + +-------------------------------------------------------------------------------- +Steven Chubak, Nomura Securities - Analyst [61] +-------------------------------------------------------------------------------- +Hi. Good morning. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase - CFO [62] +-------------------------------------------------------------------------------- +Good morning. + +-------------------------------------------------------------------------------- +Steven Chubak, Nomura Securities - Analyst [63] +-------------------------------------------------------------------------------- +Marianne, I had a question on the outlook. You reaffirmed the fee income guidance of $50 billion, plus or minus, for the full year. I'm trying to gauge, just given the tough start to the year in trading in 1Q, the subdued second-half M&A commentary, and second-half trading seasonality that we would typically expect, the $50 billion target does appear somewhat ambitious. I didn't know if you felt like that was a fair assessment, or just given what you're seeing across the businesses, that the $50 billion is still ready achievable? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase - CFO [64] +-------------------------------------------------------------------------------- +So starting with the qualification that obviously, as you suggested, it's going to be market dependent, but also remembering that we knew when we gave the guidance that we would expect the second half to be seasonally lower. So here's what I would say -- first half, market challenged; second half, markets better. Net-net, first quarter markets challenged; second quarter better. Net-net, first half relatively flat year over year. So, call it a wash, with the acknowledgement that we knew we would expect seasonal declines in the second half of the year. +Mortgage better -- so you may recall that we said we would expect mortgage revenues to be down year on year, actually by a reasonably significant amount. Given obviously where the rate environment is, as well as some positive MSR results in the first half of the year, we would expect mortgage revenues to be more like flat. And against that, to your point, lower IB fees and lower Asset Management revenues, given the environment. +The way I would characterize it is there are puts and takes, but net-net it's still a reasonable central case. So we are not changing it. But it's market dependent. + +-------------------------------------------------------------------------------- +Steven Chubak, Nomura Securities - Analyst [65] +-------------------------------------------------------------------------------- +Thanks, Marianne. One more for me on CCAR -- given that you've had some time to digest the latest set of results, the improvement in PNR was probably the most impressive aspect of the release, at least based on our own findings. From what you can gather, based on your own internal assessment, what were the primary drivers of the increase where maybe we have some limited visibility, such as areas like op risk? And does a favorable CCAR outcome inform your view in terms of which constraint is currently most binding and maybe how you might change your deployment tact across the different businesses? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase - CFO [66] +-------------------------------------------------------------------------------- +So I would say if you look at the last three years of PPNR, notwithstanding that there have been obviously differences in the scenarios, 2015 CCAR results, so not this year's but last year's, were low. Not to say that means that these results are more normal. I would say if you look at the three years and look at the PPNR results now, it's more consistent with the sort of portfolio risks, revenue generation we would expect. And you can see that because it's much more consistent with our results. +So I don't have insights that I can share with you specifically to try and reconcile the Fed's results year on year, nor do we really try to do that. You're right -- operational risk is likely a piece of it. And that was disclosed in that information. So I would just say, there can be volatility but I feel like this is not an unreasonable place to think the PPNR would start, and it's consistent as you can see, relatively speaking with what we calculated. +In respect to what that means for what's most binding, what it does mean is if you look at the analysis that we've done a couple of years in a row now, where we've said using the CCAR results from the Fed, what would that imply a CET1 ratio would need to be to pass, it had previously been a little less than 11%. With the improved PPNR and, therefore, the improved result, at this point, it would be a little less than 10%. +So in that context, as we sort of look forward, sometime in the near future, maybe in the third quarter, to getting the sort of 2017 CCAR changes in proposed form hopefully, it will alleviate to a degree a little bit of that pressure. But I still would suggest to you, as we said at Investor Day, that CCAR may, depending on how the G-SIB surcharge is included in the minimum, may become binding, if not likely will become binding. And so we'll continue to take that into consideration as we go forward. And we are already taking it into consideration as we think about optimizing against the multiple binding constraints we have. + +-------------------------------------------------------------------------------- +Operator [67] +-------------------------------------------------------------------------------- +Your next question comes from the line of Brian Kleinhanzl with KBW. + +-------------------------------------------------------------------------------- +Brian Kleinhanzl, Keefe, Bruyette & Woods - Analyst [68] +-------------------------------------------------------------------------------- +A quick question on the mortgage originations -- the correspondent channel didn't change all that much quarter on quarter, although I would have thought with seasonality and a pick-up in refis, that would have increased in the second quarter. Could you talk about how you're thinking about correspondent mortgage originations? And given that refi volume looks strong at the start of the third quarter, should we expect a pick-up in correspondent in the third quarter? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase - CFO [69] +-------------------------------------------------------------------------------- +We think about using all of our channels based upon obviously the demand, and our capacity and our appetite to want to continue to close strongly for our customers. We've obviously also been focused in the anticipation of it becoming a more purchase-oriented market very much on building out the retail channel and the retail distribution channel, and that's been very successful. +So there's less correspondent contribution this quarter. It is a lever we will likely use going forward. + +-------------------------------------------------------------------------------- +Brian Kleinhanzl, Keefe, Bruyette & Woods - Analyst [70] +-------------------------------------------------------------------------------- +Okay. And I know you can't really discuss too much on the legal side, but is there a right way to think about legal expenses going forward, like an ordinary cost of doing business for a bank your size? Is it 1% of revenues as kind of an ongoing run rate for expected legal expenses going forward, or is there not the right way to think about it and it's just episodic? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase - CFO [71] +-------------------------------------------------------------------------------- +At this point, I'd still say -- at this point, we would still say it will be episodic. And while we are hopeful that the overall structural costs will start coming down, or has come down, and that's a good thing, there will still be potentially some puts and takes in the legal space. +There's no real way obviously of forecasting a run rate. I would just do what many of you have done, I think, and go back and look at what the legal expense looked like in the years preceding the crisis, and make your own determination whether it's going to be structurally a little higher. But it probably wouldn't be multiples of that. + +-------------------------------------------------------------------------------- +Operator [72] +-------------------------------------------------------------------------------- +Your next question is from the line of Ken Usdin with Jefferies. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase - CFO [73] +-------------------------------------------------------------------------------- +Hi, Ken. + +-------------------------------------------------------------------------------- +Ken Usdin, Jefferies LLC - Analyst [74] +-------------------------------------------------------------------------------- +Thanks. Good morning. +Marianne, I was wondering just if you could -- I know it's a little backward-looking now and you've made your points already about what normal trading seasonality could be, but could you help us understand the products that drove the really strong [FIC trading] and kind of what happened in June? Was it volumes? Was it spreads widening? And then I guess I would actually ask what you typically consider what normal JPMorgan seasonality is, as you mentioned? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase - CFO [75] +-------------------------------------------------------------------------------- +Okay. So it was particularly strong in rates, but nevertheless also very strong year over year in currencies, emerging markets, credit trading, [SPG]. So it was pretty broad-based. +But remember, you also have to think about it relative to the equivalent course of last year, and we didn't have a particularly strong second quarter last year. So on a relative basis, that is an important factor, but it was pretty broad-based -- more volume than anything. +And then seasonality, I'm sorry -- look, it's anyone's guess. I think you can go back and look over time. But last year we saw -- we had a weak second quarter, as I said. So we didn't see as much seasonality. But if you look at the last quarter's run rate, I don't know that would be a bad place to start -- last year's third quarter run rate would not be a bad place to start. + +-------------------------------------------------------------------------------- +Ken Usdin, Jefferies LLC - Analyst [76] +-------------------------------------------------------------------------------- +Understood, okay. +The second question just is -- on the wholesale reserve, you mentioned -- it's been nice to see the energy prices start to stabilize, and it seems like you're able to stabilize the amount of reserve build outstanding, aside from that one credit. What needs to happen for you to get even more comfortable, where you could see some of that reserve start to come out, underneath the context of that you're also growing the wholesale business extremely fast as well? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase - CFO [77] +-------------------------------------------------------------------------------- +I'm going to start with a couple of general comments, which is, we talked about the fact that the charge-offs that we've experienced in the quarter were credits that we had previously reserved for. So we're at the point now where at least as a sort of basic matter as we're experiencing charge-offs, we feel like we're in a reasonably good reserve position, notwithstanding that idiosyncratically there may be additional adds. +What we would need to see is continued firming of sentiment in the sector, continued access to capital markets to allow companies to repair their balance sheets, and continued stabilization if not improvement in oil and gas prices. And so everything is constructive on that path, but it needs to continue along the same path. +And yes, we are growing our portfolio. And so even if it were not for energy, we would, all other things equal, be adding to reserves, but there are also time to (inaudible) pay down -- a lot of puts and takes, too. + +-------------------------------------------------------------------------------- +Operator [78] +-------------------------------------------------------------------------------- +Your next question comes from the line of Gerard Cassidy with RBC. + +-------------------------------------------------------------------------------- +Gerard Cassidy, RBC Capital Markets - Analyst [79] +-------------------------------------------------------------------------------- +Hi, Marianne. Thank you. +Marianne, can you give us some color -- obviously your consumer loan growth has picked up quite nicely. You pointed to, it's going to be at the higher end of the range for the year. What are you guys seeing on consumer behavior? Has it improved and they feel stronger about their own job prospects, which is enabling them to borrow more? Are there any metrics that you guys are looking at from that end? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase - CFO [80] +-------------------------------------------------------------------------------- +So, I mean, just to say -- we obviously have our own spend data to look at, and it continues -- the Card spend is up 8% year on year. Energy continues to be a tailwind for consumers. The labor market continues to be solid and improving. And sentiment is still good. Housing, still improving. +So I mean, really just looking at the same things you're looking at, and we obviously have a slightly different lens to it. But all other things equal, consumers are in very good shape, and demand is there for the product. And we've been investing outside of consumer in new products -- inside Consumer, sorry -- in the Freedom Unlimited space and also in marketing. We're growing, not only because the demand is there but also because we're investing. + +-------------------------------------------------------------------------------- +Gerard Cassidy, RBC Capital Markets - Analyst [81] +-------------------------------------------------------------------------------- +I see. And coming back to credit, obviously your first-quarter results had the results of the targeted shared national credit exam for oil. Traditionally obviously we have the shared national credit exam every year. Second-quarter results normally reflect that exam. +Do your second-quarter results reflect the shared national credit exam? Or is that going to -- ? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase - CFO [82] +-------------------------------------------------------------------------------- +Our second-quarter results reflect everything that we have and we know of at the end of the quarter. And we're not going to make any specific comments on regulatory exams. + +-------------------------------------------------------------------------------- +Gerard Cassidy, RBC Capital Markets - Analyst [83] +-------------------------------------------------------------------------------- +Okay. Thank you. + +-------------------------------------------------------------------------------- +Operator [84] +-------------------------------------------------------------------------------- +Your next question comes from the line of Eric Wasserstrom with Guggenheim Securities. + +-------------------------------------------------------------------------------- +Eric Wasserstrom, Guggenheim Securities LLC - Analyst [85] +-------------------------------------------------------------------------------- +Great, thanks. Marianne, just a couple of quick follow-ups on the auto lending business -- the originations came down a bit. And you talked about the dynamics around that previously in the quarter and at the Investor Day. +When I poll auto lender or auto dealers, they say that where they had primarily seen you retreat was from very high FICO, sort of super-prime new lending and leasing, but that their experience with Chase remained very consistent in the mid-FICO range. I just wanted to see if that was consistent with your view internally? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase - CFO [86] +-------------------------------------------------------------------------------- +Not specifically. I'm not sure; I haven't polled the dealers myself. We continue to have very high FICO scores. I'm not aware of that, but I can't comment. + +-------------------------------------------------------------------------------- +Eric Wasserstrom, Guggenheim Securities LLC - Analyst [87] +-------------------------------------------------------------------------------- +Okay. Just one follow-up on auto credit -- obviously the Manheim issue points to perhaps some rising severity, given default. But at this stage, is there anything that suggests to you that we should see a higher frequency of default? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase - CFO [88] +-------------------------------------------------------------------------------- +In our portfolio at this point, no. + +-------------------------------------------------------------------------------- +Operator [89] +-------------------------------------------------------------------------------- +Okay. And your next question will come from the line of Paul Miller with FBR. + +-------------------------------------------------------------------------------- +Paul Miller, FBR Capital Markets - Analyst [90] +-------------------------------------------------------------------------------- +Yes, thank you very much. One of the things about what we saw as mortgage rates -- I mean, the 10-year dropping down to record levels and mortgage rates probably following right behind it -- can you give us a little outlook? Are you seeing an uptick in refi's? We've seen the refi indexes go up very high. Any outlook on where you think the mortgage market's going to be in the next quarter or two? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase - CFO [91] +-------------------------------------------------------------------------------- +So we are expecting refi to be stronger in the coming quarters; and the mortgage market, as best we can tell, will be at around $1.7 trillion, $1.8 trillion this year. + +-------------------------------------------------------------------------------- +Paul Miller, FBR Capital Markets - Analyst [92] +-------------------------------------------------------------------------------- +And the other follow-up question is -- there's some news articles out there about JPMorgan securitizing conforming loans. This hasn't really been done a lot by anybody. I don't know if you can address that, the economics behind that, or what's the thought behind that, instead of getting Fannie and Freddie wraps, you're securitizing them yourself? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase - CFO [93] +-------------------------------------------------------------------------------- +So we've done one, and we're looking at more securitizations in the mortgage space. And we are keeping a vertical stripe. We're retaining the loans on our balance sheet -- or the securities on our balance sheet, I should say. And in doing that we've been able to get private capital to take the majority of the lower credit risk and get better capital treatment for ourselves, in terms of the RWA that it attracts. + +-------------------------------------------------------------------------------- +Operator [94] +-------------------------------------------------------------------------------- +Your next question is from the line of Matt O'Connor with Deutsche Bank. + +-------------------------------------------------------------------------------- +Matt O'Connor, Deutsche Bank - Analyst [95] +-------------------------------------------------------------------------------- +Thank you. Most of my questions actually have been answered. Just a quick follow-up on the credit card originations in terms of dipping down to the lower prime or below. You said something like 20% to 30% had FICO scores below 700. I didn't know if that was for new originations or for the portfolio overall that you were referring to. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase - CFO [96] +-------------------------------------------------------------------------------- +New originations. + +-------------------------------------------------------------------------------- +Matt O'Connor, Deutsche Bank - Analyst [97] +-------------------------------------------------------------------------------- +Okay. All right, that's it from me. Thank you. + +-------------------------------------------------------------------------------- +Operator [98] +-------------------------------------------------------------------------------- +Your next question comes from the line of Marty Mosby with Vining Sparks. + +-------------------------------------------------------------------------------- +Marty Mosby, Vining Sparks - Analyst [99] +-------------------------------------------------------------------------------- +Thanks. Wanted to ask you a little bit about the focus everybody has on the flattening of the Treasury curve, but yet earlier you were able to say that going into next year you would see 2016 NII growth of $2 billion to $2.5 billion, only really fall to $1.5 billion to $2 billion, which means that flattening of the yield curve is very manageable. Just talk about asset yields as your earning asset yield actually went up 1 basis point -- what you've been able to see in the market versus what's happening in the Treasury curve. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase - CFO [100] +-------------------------------------------------------------------------------- +I'll just start by sort of orientating you on why that would be the impact for us. If you look at our balance sheet and you look at what we have in fixed rate loans versus what we have in either IOER or in LIBOR loans, it's about $650 billion. So we're much more sensitive to the front end of the rate curve. +If you look at our earnings at risk disclosures, a 100-basis-point parallel shift would be around $800 million. And so obviously we haven't seen, and won't hopefully see, anything of that order of magnitude. That kind of gives you an ability to size up, notwithstanding compounding, why you've only seen our NII relative to prior expectations come down by that much. + +-------------------------------------------------------------------------------- +Marty Mosby, Vining Sparks - Analyst [101] +-------------------------------------------------------------------------------- +In this particular quarter, your funding costs went up. Is that a lag effect from what the rate hike in December still just now coming through, or was there something else maybe more unusual about the funding cost that we saw that drove the margin down this particular quarter? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase - CFO [102] +-------------------------------------------------------------------------------- +So I think earlier on the call somebody else asked the question, and I made the comment that it's really more related to the results from our hedges of non-dollar debt, long-term debt. And so in the first quarter, the dollar weakened. In the second quarter, it strengthened. And with some currency basis in the first quarter that we didn't see in the second quarter, it really is, not to dismiss it, but it really is accounting and nothing really else than that. + +-------------------------------------------------------------------------------- +Operator [103] +-------------------------------------------------------------------------------- +Your next question is from the line of Betsy Graseck with Morgan Stanley. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [104] +-------------------------------------------------------------------------------- +Hi, again. Just a follow-up on the Card new originations -- I know one of the key things that you've done for many years is to focus on relationship lending, relationship offerings. And so when I hear that 20% of the new originations are below a FICO of 700, is that a shift from the relationship strategy that you have or does it reflect the fact that you do have significant relationships on deposits, et cetera, with folks in that FICO band? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase - CFO [105] +-------------------------------------------------------------------------------- +No shift from our desire to want to be with engaged customers and our rewards programs. Our products are all geared towards that. So it's really just a credit decision. And, yes, we do have relationships with many, many customers in that still near-prime space. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [106] +-------------------------------------------------------------------------------- +Thanks. + +-------------------------------------------------------------------------------- +Operator [107] +-------------------------------------------------------------------------------- +Your next question is from the line of Gerard Cassidy with RBC. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase - CFO [108] +-------------------------------------------------------------------------------- +Hi. + +-------------------------------------------------------------------------------- +Gerard Cassidy, RBC Capital Markets - Analyst [109] +-------------------------------------------------------------------------------- +Thank you. As a follow-up, Marianne, your consumer business obviously has been very, very strong. Can you share with us the update on clearXchange? It's expected to be rolled out later this year, and what that might do to even grow the mobile business even more than it's growing now? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase - CFO [110] +-------------------------------------------------------------------------------- +Yes. So look, obviously P2P real-time payments is very important to our customers, so therefore it's important to us. It's also important for us on the industry that it's done in a safe and secure way. +And so early warning, the fraud protection that they are able to provide, as well as bank-level cyber security and the absence of a need to provide your bank credentials we think is very strongly positive for our customers. And we expect to see volume go across that. +As you know, we have QuickPay already, and we saw reasonably significant volume, $21 billion, on QuickPay last year and growing. So I would expect to see more and more P2P payments. And it's good for our customers, it's good for us. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase - Chairman & CEO [111] +-------------------------------------------------------------------------------- +If you look at the whole payment space, Chase Paymentech is gaining share. Chase Net is doing very well. Chase Pay, we've signed up lots of different people. One piece of that is the P2P. +Today, right now, if you use Chase QuickPay, it's very easy within Chase to Chase. It's now just as easy to go from Chase to a bunch of other banks, who I won't name now. We've just started rolling out -- it's soon to be rolled out to 60% of American banking accounts. +And then we're going to make it available to all banks. So you will be able to go P2P, real time, through Chase QuickPay, there will be a special app for Chase QuickPay. It'll also be branded under another name, which we haven't rolled out yet, which I think will be rolled out shortly. +I think it's a great success that the banks can get together and do this. This will be great service, which I think shows you the banks making progress on what you would have called prior fintech. + +-------------------------------------------------------------------------------- +Gerard Cassidy, RBC Capital Markets - Analyst [112] +-------------------------------------------------------------------------------- +Thank you for the color. + +-------------------------------------------------------------------------------- +Operator [113] +-------------------------------------------------------------------------------- +There are no other questions at this time. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase - CFO [114] +-------------------------------------------------------------------------------- +Thank you, everyone. Thank you, operator. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase - Chairman & CEO [115] +-------------------------------------------------------------------------------- +Thank you. + +-------------------------------------------------------------------------------- +Operator [116] +-------------------------------------------------------------------------------- +Thank you again for joining us today. This does conclude today's call. You may now disconnect. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/exam/original-files/Problem_2_3_Sample_full_transcripts/2016-Jul-27-KO.N-141070210688-Transcript.txt b/exam/original-files/Problem_2_3_Sample_full_transcripts/2016-Jul-27-KO.N-141070210688-Transcript.txt new file mode 100644 index 0000000..0081091 --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_full_transcripts/2016-Jul-27-KO.N-141070210688-Transcript.txt @@ -0,0 +1,441 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q2 2016 Coca-Cola Co Earnings Call +07/27/2016 09:00 AM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * James Quincy + The Coca-Cola Company - President and COO + * Kathy Waller + The Coca-Cola Company - CFO + * Muhtar Kent + The Coca-Cola Company - Chairman and CEO + * Tim Leveridge + The Coca-Cola Company - VP and IR Officer + +================================================================================ +Conference Call Participiants +================================================================================ + + * Judy Hong + Goldman Sachs - Analyst + * Mark Swartzberg + Stifel Nicolaus - Analyst + * Dara Mohsenian + Morgan Stanley - Analyst + * Bryan Spillane + BofA Merrill Lynch - Analyst + * Ali Dibadj + Sanford C. Bernstein & Co. - Analyst + * Nik Modi + RBC Capital Markets - Analyst + * Vivien Azer + Cowen and Company - Analyst + * Steve Powers + UBS - Analyst + +================================================================================ +Presentation +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- +At this time I would like to welcome everyone to the Coca-Cola Company's second-quarter 2016 earnings results conference call. Today's call is being recorded. If you have any objections, please disconnect at this time. +(Operator Instructions) +I would now like to introduce Tim Leveridge, Vice President and Investor Relations Officer. Mr. Leveridge, you may begin. + +-------------------------------------------------------------------------------- +Tim Leveridge, The Coca-Cola Company - VP and IR Officer [2] +-------------------------------------------------------------------------------- +Good morning, and thank you for being with us today. I'm joined by Muhtar Kent, our Chairman and Chief Executive Officer; James Quincy, our President and Chief Operating Officer; and Kathy Waller, our Chief Financial Officer. +Before we begin, I'd like to inform you that you can find webcast materials in the Investors section of our Company website at www.coca-colacompany.com that support the prepared remarks by Muhtar, James and Kathy this morning. I'd also like to note that we have posted schedules under the financial reports and information tab in the Investor section of the Company website. These schedules reconcile certain non-GAAP financial measures, which may be referred to by our senior executives during this morning's discussion, to our results as reported under Generally Accepted Accounting Principles. Please look on our website for this information. +In addition, this conference call may contain forward-looking statements, including statements concerning long-term earnings objectives, and should be considered in conjunction with cautionary statements contained in our earnings release, and in the Company's most recent periodic SEC reports. +Following prepared remarks this morning we will turn the call over for your questions. In order to allow as many people to ask questions as possible, we ask that you limit yourself to one question. If you have multiple questions, please ask your most pressing question first and then re-enter the queue in order to ask any further ones. Recognizing the number of companies reporting today, we have limited our prepared remarks to provide plenty of time for questions and complete the call at approximately 9:50. +Now I'll turn the call over to Muhtar. + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Company - Chairman and CEO [3] +-------------------------------------------------------------------------------- +Thank you, Tim. And good morning, everyone. Today I will touch briefly on a few key highlights in the quarter before handing off to James to provide a more detailed review of our operational performance. +During the quarter, we continued our progress towards transforming our Company to a higher margin and return business focused on our core value creation model of building strong brands, enhancing customer value, and leading our franchise system. Our continued focus on our five strategic initiatives enabled us to deliver another quarter of global value share gains while delivering 3% organic revenue growth in a worsening macroeconomic environment. +Importantly, our segmented revenue growth strategies drove 3 points of price/mix in the quarter. Further, our strong focus on productivity was instrumental in expanding operating profit margins and delivering our profit target. While we are pleased we accelerated our price/mix from 1% last quarter to 3% this quarter, our volume and top-line results still fell short of our expectations. This was largely due to a weakening demand in certain large emerging and developing markets which also impacted our Company-owned bottling operations revenue growth. +Within our bottling investment segment, positive pricing at our North American bottler was offset by challenges in our China bottling operations, resulting in even organic revenues for our Company-owned bottling operations globally. However, our core franchise operations continued to perform well, growing organic revenues a full point ahead of our consolidated organic revenues, and in line with our long-term targets. Despite weaker conditions in several emerging and developing markets, we continued to see a positive return on our marketing investments, with solid performance in key markets such as the United States, Japan and Mexico, which James will touch on in more detail. +While the macroeconomic headwinds we're facing in these emerging and developing markets are cyclical in nature and not secular downturns, we're not expecting a material improvement in the remainder of the year given the continuing volatility in the global economy. This outlook, coupled with where we are year to date, will make achieving our previous 4% to 5% organic revenue growth rate very challenging. Therefore, we are lowering our outlook for full-year consolidated organic revenue growth. James and Kathy will discuss this in greater detail later on the call. +With that being said, we remain fully committed and confident in achieving our underlying profit target despite this challenging environment. We're also confident that our core consolidated organic revenue will continue to outperform our consolidated organic revenue growth by a full point. +Finally, we remain on track with our refranchising efforts, and we are confident we will complete those efforts by the end of 2017. Over the past few months, we successfully completed the Coca-Cola European Partners and Coca-Cola Beverages Africa transactions, announced the transfer of certain territories of the United States to Arca Continental United Venture, and reached a new understanding with Coca-Cola FEMSA regarding joint value creation in Mexico and certain territorial expansion opportunities for Company-owned bottling operations, which was announced just this morning. As we work through the comprehensive re-franchising and near-term macro challenges, we will emerge a much stronger company, with higher margins and returns, and better positioned to deliver on our long-term growth targets. +I will now hand the call over to James who will provide you with a more detailed look at our operating performance. + +-------------------------------------------------------------------------------- +James Quincy, The Coca-Cola Company - President and COO [4] +-------------------------------------------------------------------------------- +Thank you, Muhtar. Good morning, everyone. As Muhtar said, our consolidated volume and revenue results came in below our expectations. So, let me first talk about where, why and what we are doing about that. +Our volume deceleration from the first quarter was concentrated in a number, a few number, of markets facing specific macroeconomic challenges. Firstly China, but also Argentina and Venezuela. The slowdown in our consolidated organic revenue versus our core organic revenue, which grew 4%, the consolidated slowdown was due to our bottling investment slowdown, segment slowdown. It's the mechanical effect of owning both bottling operations as well as concentrate operations in certain challenged markets. +BIG's slowdown was principally driven by the challenges the industry, the broad industry, is facing in China. So let's start with China, and what are we doing about it. +There are three factors impacting our performance in China. First, no question, the overall consumer environment is weakening due to the economic transition. Secondly, as this is occurring, wholesalers are adjusting to lower expected sales growth and bringing down inventory levels, which has a whiplash effect on our bottler's sales. +Third, there are some category mix shifts occurring as different consumer segments respond to these new circumstances. For example, juice and juice drinks category is the weakest performing, whereas premium water is stronger and positive. So there's an opportunity here to both innovate with more premium products positioned for the higher income new mainstream consumer segment, as well as opportunities to address strong affordability needs across the rural and blue-collar areas. +So, importantly, perhaps most importantly, what we doing about it? Firstly, we have a number of new premiumizing offers across multiple categories we compete in being launched. We're also focusing on better execution, particularly in the second tier and rural areas where they serve more of the mass consumer segment and upping the game in terms of affordable offerings. We are also rebasing the way we approach trade incentives to drive better performance with wholesaler and from our own distributors. +Now, despite these actions to improve our business, we still expect our China operation to be under pressure for the remainder of the year. This is a key factor driving the organic revenue outlook, particularly the difference between consolidated and core. But I think it is worth finally making a note that we're keeping a long-term perspective with regard to China. We always knew that for a country as large as China, transitioning to a consumer-led economy was going to have its challenges. Those may have turned out to be more than we expected in the short term; however, we absolutely believe in the long-term opportunity of this market of 1.4 billion consumers with relatively low beverage per capita compared to the global average. +Okay, so that's China. Let's move for a second to our core business. The core business, understood as the concentrate and the franchising business, this is where we grew organic revenues 4% for the first half of the year, as segmented revenue growth strategies continued to drive positive results. Yes, some markets are tough but others are doing very well. +Let me start perhaps with the more challenging markets. I've already touched on China so let me move to a couple of the other ones I name-checked earlier. Argentina -- we believe that the Argentinian government is taking the right steps to secure its economic recovery, but this is resulting in a contraction in the near term that accelerated in the second quarter, therefore impacting our business. +In Venezuela, severe shortages in certain raw materials resulted in us temporarily suspending production at the bottling partners' plants during the quarter, clearly impacting the results. Additionally, Brazil, our challenges there are well understood and we think will continue for the remainder of the year. However, we're focusing on key affordability packages and activating a strong Olympic marketing campaign in the coming weeks and months. +We have lived through downturns before in emerging and developing markets, and understand how to manage the business in these circumstances. It requires a disciplined approach to pricing relative to inflation and, of course, where necessary, aggressively moving to address consumer dynamics through adjusting the portfolio both in terms of affordability and product innovation. But as I said earlier, not every market is under pressure. In markets with relatively stable economies, we are executing our strategies and seeing strong results. +For example, in North America, we grew organic revenues 4% in the quarter, reflecting continued pricing initiatives for our sparkling business, as well as the ongoing strength of our stills portfolio. In Mexico and Japan, we are delivering strong performance across our portfolio driven heavily by innovation. And turning to some of the emerging markets, in Southeast Asia, we are growing volume double digits year to date behind strong integrated marketing and commercial initiatives across the core brands and key entry-level packaging. Taken together, these results give us confidence that in stable markets where we increase our investments in marketing innovation, combined with improving marketplace execution, we can continue to deliver strong performance. +Ultimately, we operate in over 200 countries and there will always be some markets with macro challenges. Our ability to grow doesn't require macro perfection. In fact, even with this current broader macro adjustment phase in a good number of emerging markets, our segmented revenue growth strategies are enabling us to capture solid pricing of 3% year to date for our core operations on top of 1% volume growth. And we're using the productivity to prudently fund marketing where there is momentum and where we see a solid payback. But we're also holding on and making sure that we can use it to deliver strong underlying margin expansion. These actions have enabled us to grow underlying profit before tax in line with our expectations for the first half of the year and despite more challenging conditions than we initially expected. +So, let me conclude by saying we are confident in our growth strategies. We continue to push in markets where we see success and proactively address those markets that are more challenged, of course while always keeping an eye on the long term. +With that, let me hand over to Kathy to take you through the numbers. + +-------------------------------------------------------------------------------- +Kathy Waller, The Coca-Cola Company - CFO [5] +-------------------------------------------------------------------------------- +Thank you, James, and good morning, everyone. I'd like to touch quickly on our financial performance in the quarter before providing our full-year outlook. +Starting at the top line, our organic revenue growth was impacted about 1 point by our segment mix, as our bottling investment segment grew slower than our core business. At gross profit, our comparable margin declined 20 basis points due to currency and structural headwinds. Excluding the effect of these items, our underlying gross margin expanded over 100 basis points, driven by solid pricing, a slightly favorable cost environment, productivity and segment mix. +Our comparable operating margin improved about 50 basis points. Similar to gross margin, currency and structural headwinds impacted our operating margins. Excluding the effect of these items, our underlying operating margin increased about 180 basis points in the quarter due to gross margin expansion as well as the timing of productivity savings and certain expenses. +Turning to outlook, as Muhtar mentioned, we are revising our full-year top-line target. For the full year, we now expect 3% organic revenue growth. With that said, we are confident our strategies will deliver stronger organic growth for our core business. And we are maintaining our full-year underlying profit target as we continue to manage our business. Therefore, we expect to deliver comparable currency-neutral ex-structural income before tax growth of 6% to 8%, in line with our long-term target. +For the first half of the year we generated strong underlying operating leverage. Consistent with our previously provided guidance, we expect this to moderate as we begin to cycle more difficult comparisons in the back half of this year. Coca-Cola European Partners closed about a month earlier than we estimated in our previous structural guidance, and we continue to move faster with our refranchising efforts in North America. Therefore, we are updating our full-year structural outlook. +We now expect a 6 to 7 point structural headwind on net revenue and a 4 point headwind on income before tax. Our currency outlook remains the same as our previous guidance, a 2 point to 3 point headwind on net revenue and an 8 point to 9 point headwind on income before tax. Taking all of this into consideration, we expect full-year comparable EPS to decline 4% to 7%. +There are a few phasing items to consider when constructing your models. Our fourth quarter has two additional days as compared to last year, which will result in stronger top-line growth in the fourth quarter than in the third quarter. In addition, the two additional days in the fourth quarter, coupled with what we are cycling in SG&A in the third quarter of last year, means operating leverage will skew strongly into the fourth quarter. Therefore, we expect virtually all of our growth and comparable currency neutral ex-structural income before tax to come in the fourth quarter. We expect structural items to be a 9 point headwind on net revenue and a 3 point headwind on income before tax in the third quarter. Finally, we expect currency to be a 2 point headwind on net revenue and a 2 point to 3 point headwind on income before tax in the third quarter. +In closing, our strategies are working in key markets. We are on track to deliver over $600 million in productivity this year and we continue to accelerate our refranchising efforts. While our expectations for top-line growth have softened, we remain confident in our ability to deliver our profit target this year. +Operator, we are now ready for questions. + + +================================================================================ +Questions and Answers +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- +Steve Powers, UBS. + +-------------------------------------------------------------------------------- +Steve Powers, UBS - Analyst [2] +-------------------------------------------------------------------------------- +Great, hi, good morning. Maybe we could start with a question for James on China mainly, because it sounds like that market was the biggest driver of the gap between your reported 3% organic growth and the 4% core number that you cited. And I'm guessing it cost you roughly 1 point of unit case volume in the quarter, as well. So, first, is that right? +But, more importantly, is there a way to parse how much of the adverse impact is tied to the macro slowing, which I think is more likely to persist, versus supply chain corrections and wholesaler inventory destockings, which might hopefully be more transitory? I'm really trying to assess just how much of a headwind China was in Q2, and then how severe you expect the ongoing headwind to be, acknowledging the improvement initiatives that you called out? +And then, finally, do the issues facing BIG in China impede at all your ability to refranchise that market on time and on favorable terms? Thanks. + +-------------------------------------------------------------------------------- +James Quincy, The Coca-Cola Company - President and COO [3] +-------------------------------------------------------------------------------- +Okay. Good morning, Steve. Let me try and get to China, and let me start from the top and work downwards, if I may. Firstly, it's clear that when you look at the whole company, almost half our revenue comes from bottling versus the other half comes from concentrate and franchise. But given, as you all know, that our bottling business comes with 4 to 5 times more revenue per drink sold and the accompanying cost, any effect on the revenue of the bottler is going to have a magnified impact on revenue and much less on profits, which is part of this dynamic. +In China, it's our largest international bottling operation. We own bottlers that are roughly 20% of the global business. But the business one outside the US is China. So, that's where it's coming from and it's the mechanical impact of being hit in China where we own about one-third of the system that is creating that whole difference between the 3% and 4%. +And what we have assumed in our outlook, just to be more confident and clear in our competence going forward, is we have not really assumed that China is going to get better in the rest of the year. If it did, that would be great, but we are assuming it's not in terms of our outlook and guidance, but obviously we're working to try and make it better. +Now, as I said, what's changing as you try to split the difference, what's changing is both the consumer and the supply chain. I think in round numbers from a revenue perspective, you've got about half the impact coming from the consumer and half coming from the supply chain. What's happening on the consumer, you can see it in the scan Nielsen, and the non-scan Nielsen is probably a bit worse than the scan Nielsen in terms of slowdown in sellouts to the consumers of all types of FMCG categories. So, it is a broad-based consumer slowdown. +Within that, from a beverage point of view, you have juice drinks and juices which are more to the rural areas and blue-collar. They are down double digits in terms of revenue from a consumer point of view. Something like Coke is down low single digits and premium waters is growing. +So, there's a shift in the category mix going on, which also actually impacts revenue because juice drink prices tend to be higher than sparkling or water. That doesn't flow through to profitability. So, there is a rebasing going on in there. +But, as I said, about half of it is the supply chain, the whiplash effect of the destocking by the customers. And that, as you say, is likely to be a much shorter-term impact. But, again, we're working on it but we're not including any improvement on that in our outlook, although clearly we want to get focused on it and get it to work. +I agree with you, the consumer thing will take a little more time to come back, which is why we are focused on the game plan we know that works in downturns where we focus on affordability, on premiumizing for those parts of the country, like the premium metro areas, and bringing out new products to them, and that way we believe we can gain value share, which we continue to do in China so that we are set up as the consumer starts recovering. So, about half and half, and we believe that the consumer will come back and the supply chain will sort itself out in the relative short term in the rest of this year. +Now, with regards to the refranchising, obviously can't really comment on the M&A, but I would say that we and our partners all believe in the long-term potential of the China market. We are very excited. And, as I said, because a large part of what's happening in the short term is destocking and inventory, everyone is looking past that and looking to the long term. And I think there is still good motivation and animation by everyone to get the deal done. And we'll obviously, from our point of view, make sure we do it on the right terms for ourselves, and they will be looking for the right terms for them, but we still think it is the right deal for everyone and with a good likelihood of getting done. + +-------------------------------------------------------------------------------- +Operator [4] +-------------------------------------------------------------------------------- +Dara Mohsenian, Morgan Stanley. + +-------------------------------------------------------------------------------- +Dara Mohsenian, Morgan Stanley - Analyst [5] +-------------------------------------------------------------------------------- +Hi, good morning. I wanted to better understand why you maintain the FX neutral income before taxes guidance despite the negative full-year top-line revision. I'm assuming part of that is just the top-line weakness in lower-margin areas, so probably less of a margin impact. But can you give us more detail on why the local FX profit goals have not been as impacted by top-line weakness, and how much visibility you have on the profit side, and any leverage you have to protect downside if macros weaken further? + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Company - Chairman and CEO [6] +-------------------------------------------------------------------------------- +Dara, I'll just comment first and then maybe I ask Kathy and James if they want to add anything. But certainly you've answered part of it by saying that, yes, revenue challenges are coming from those areas that have much lower margins, number one, for sure. And then, secondly, productivity efforts are continuing that is driving the margin expansion in quarter two. Kathy mentioned the significant margin expansions that we achieved and I think productivity efforts are going to continue. +And then, finally, I think there's also a mix. Some of our better markets are doing well, like the United States and Mexico, and also in the Far East and Japan. So there's a mix issue. +And then, finally, the commodities continue to be pretty benign in terms of the outlook. So, those are the things that play into altogether, but primarily also the one that you mentioned which is the revenue, challenges are coming from much lower margin areas in terms of our business there. Kathy, anything to add? + +-------------------------------------------------------------------------------- +Kathy Waller, The Coca-Cola Company - CFO [7] +-------------------------------------------------------------------------------- +No, I would say those are the reasons, which I would say probably you're picking up the fact that we do have more difficult comps in the back half for some of the things that Muhtar mentioned. But we are confident that we will still be on our guidance. + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Company - Chairman and CEO [8] +-------------------------------------------------------------------------------- +Yes, we are overall very confident. The changes in marketing, the strategy on innovation pipeline, the one-brand strategy which is just at the beginning, the promotions that we have in store in the summer around the Olympics, the price/mix expansion that we've experienced in quarter two, all of that we feel play into the equation, and give us confidence in the back half that there are slightly more challenging comps in the back, that we can actually cycle them and achieve them going forward, and feel confident that we can. + +-------------------------------------------------------------------------------- +Dara Mohsenian, Morgan Stanley - Analyst [9] +-------------------------------------------------------------------------------- +Okay. Great, thanks. + +-------------------------------------------------------------------------------- +Operator [10] +-------------------------------------------------------------------------------- +Ali Dibadj, Bernstein. + +-------------------------------------------------------------------------------- +Ali Dibadj, Sanford C. Bernstein & Co. - Analyst [11] +-------------------------------------------------------------------------------- +Hey, guys, just a couple clarifications. One is, back to guidance, and look at comparable currency-neutral income before taxes is still in the 6% to 8% range for 2016 relative to Q1 guidance, so you gave that same guidance in Q1. And the structural move only went from negative 3% to 4%, to negative 4%, so like a 50 basis points change there. Currency is still an 8% to 9% drag. +I'm confused about what's driving the EPS guidance effectively down by 2 points at the midpoint. So, what's going on between before tax and the EPS to drag it down another 2 points? Because the only thing that seems like it's changing is the structural, in what you've told us, relative to Q1. That's my first question and I have another one, if you permit me. + +-------------------------------------------------------------------------------- +Kathy Waller, The Coca-Cola Company - CFO [12] +-------------------------------------------------------------------------------- +Okay, Ali. Basically, it's in the rounding. So, yes, we gave comparable currency-neutral guidance on EPS of 4% to 6%, and that was comparable currency neutral. So, then when you either take out another rounded point of structural -- so it rounds it down but it's really a rounding point of structural -- and if you take out currency, that gets you basically in that, the actual numbers, if you take out only 1 point of structural, gets you to 3% to 6%. But then it's in the rounding, so that's how we came up with the 4% to 7%. +If you start with the 4% to 6%, you back out the currency and you back at a rounded point of structural, that gets you down to your 3% to 6%, and then it's really in the rounding you get to the 4% to 7%. + +-------------------------------------------------------------------------------- +Ali Dibadj, Sanford C. Bernstein & Co. - Analyst [13] +-------------------------------------------------------------------------------- +Okay. I have trouble getting there. Maybe I will follow. I still see it being an incremental point somewhere in there. But basically you are saying there's no real difference between -- there's no change in the gap between PBT and EPS, taxes and changing. There's no other things in there, right? + +-------------------------------------------------------------------------------- +Kathy Waller, The Coca-Cola Company - CFO [14] +-------------------------------------------------------------------------------- +No, that's correct. + +-------------------------------------------------------------------------------- +Ali Dibadj, Sanford C. Bernstein & Co. - Analyst [15] +-------------------------------------------------------------------------------- +Okay. Maybe I'll follow-up just about the rounding point to help me with my math. +The second piece is, in the press release, and, James, in some of your comments, I think, you said we are -- I'm quoting from the release -- re-assessing local market initiatives. Can you tell us a little bit more about what you mean exactly? So, where? Is it all about China, perhaps Argentina? And is advertising spend as a percentage of sales still up for you in the quarter? And does it impact in any way this confidence we had a year ago, six months ago, about really good ROIs on the marketing spend? Thanks. + +-------------------------------------------------------------------------------- +James Quincy, The Coca-Cola Company - President and COO [16] +-------------------------------------------------------------------------------- +Sure. I think perhaps that's two questions in the second question there, Ali. But let me have a go. In terms of re-assessing the actions, that's both on the places with momentum and the places that are suffering. There are parts of the business that are growing strongly, whether that's at one end of the spectrum like US and Japan where we've got good momentum. The US grew organically 4% in the quarter. Japan is growing well. +We are increasing the amount of spend as we see the tailwinds and the effectiveness of the market being the innovation or the execution. So, we are reallocating money to the places that have momentum. And that's on the developed end like the US and Japan, it's also on the emerging end like Indonesia and the Philippines and places like that. So, we are going where we see the opportunities to get the biggest bang for the buck. +Now, we're taking some of the money from those markets that are under the most pressure and in those places we are prioritizing. Yes, there's still some advertising, but we are doing innovations and we are doing execution, and, very importantly, doing affordability. The most extreme example, perhaps, is Venezuela where there was no sugar and we've actually doubled down and really driving Coke with zero sugar in Venezuela with a full read one-brand look. +There are places where we are adjusting to the need. Just because you advertise doesn't mean people are going to buy if it's an affordability problem. I think China is a good example of where affordability is in there, as well. And I think I've talked a bit about China. +But the game plan that we've used in those emerging markets under pressure, we're really rolling out. So, that reassessing is moving some top-line money to those with momentum, and doubling down on execution and affordability and innovation in those pressured markets. +That goes a bit to the advertising. Advertising is up this quarter as we continue to see the value of advertising as part of the marketing mix in combination with innovation and execution. It's only when you get all of those together that you really get the best returns. So, we always look to make sure that all three are there, otherwise we'll end up wasting our money. +We are out there and we're pushing ahead with it. And I think what we always have said is that advertising takes some time to work. So, for example, the one-brand strategy that we launched, announced, in the first quarter we started the rollout, the latest iteration of the graphics went into Mexico a couple of months ago. That sort of marketing innovation takes time to build up an effect. +So, we will keep pressing away with the investments and keep assessing. It's too early to call the success. We'd do that towards the end of the year. But we are focused on making that work. + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Company - Chairman and CEO [17] +-------------------------------------------------------------------------------- +Just to add to the point of ROIC on the marketing, when you take into account the price/mix expansion going from 1% to 3% in the quarter, when you take into account the core business that we have, which is really the Company that's emerging out of this very rapid transformation and refranchising, is growing still at a point ahead of the total Company currently, consolidated number, which is at 4, which is within our long-term growth targets that we've espoused to and talked about. I think that's also not maybe a micro metric but certainly an important metric to consider in terms of the payback on also all the activity. +We're still in the early days of the one-brand strategy just launched in Mexico a few months ago, just launched in Europe and parts of Europe. Again, we feel confident that is going to continue to work in our benefit, coupled with the marketing that James talked about. + +-------------------------------------------------------------------------------- +Ali Dibadj, Sanford C. Bernstein & Co. - Analyst [18] +-------------------------------------------------------------------------------- +I look forward to it. Thank you. + +-------------------------------------------------------------------------------- +Operator [19] +-------------------------------------------------------------------------------- +Nik Modi, RBC Capital Markets. + +-------------------------------------------------------------------------------- +Nik Modi, RBC Capital Markets - Analyst [20] +-------------------------------------------------------------------------------- +Yes, thanks for the question. Just two quick ones for me. There's a lot of stuff going on at Coke right now -- international organization, management, refranchising and accelerated pace. I'm just curious if you can give us some clarity on maybe how much of the volume issue this quarter was partly related to disruption. +And then just on the price/mix, it's a pretty good number. We've seen a 3% price/mix a couple times over the past two years. Just curious on what you think the sustainability of that magnitude of price/mix is as we think out the next one to two years? + +-------------------------------------------------------------------------------- +James Quincy, The Coca-Cola Company - President and COO [21] +-------------------------------------------------------------------------------- +Sure, let me start. I don't think any of the unit case pressure in the second quarter was due to the reorganization. I think the trends on unit cases -- and let me just put out another way of looking at it -- have started at the beginning of the year. +I think it is probably one of the few times we've seen the developed and our developing countries grow volume, and actually seen the emerging markets decline in aggregate. I know we only put out the numbers by groups but if you look at developed economies and developing economies, you see volume growth in both those blocks of countries. +In the end, our business, when you take the segmented roles, we've got volume growth and price/mix growth in developed and developing countries, which is very positive in terms of the long-term trajectory of the business. North America has got multi years of making that work in the revenue line. So, that's very strong. +The volume weakness is all in the emerging markets and it's all concentrated in a few of the emerging markets. It's big in some of those markets but it's very concentrated. And the people then on the country levels are all largely still the same and working on these problems. +So, hopefully that gives you a little insight on where the volume weakness is, but I don't think it has anything to do with the reorganization. In fact, I think the reorganization is helping us bring some refreshed views and some experience on what to do in emerging market weakness going forward in the downhill this year and into the future. +And then on the price/mix, 3% is a good result. I think we've always talked about, our long-term growth model calls for 4% to 6% revenue growth, and we see a balanced split between volume and price/mix into the future. So, that gives you a 2% to 3% for price/mix component of the long-term growth. So, 3% is a strong result. Long may it live. But the long-term growth model, we are looking for 4% to 6% in a balanced way. + +-------------------------------------------------------------------------------- +Nik Modi, RBC Capital Markets - Analyst [22] +-------------------------------------------------------------------------------- +Thank you. + +-------------------------------------------------------------------------------- +Operator [23] +-------------------------------------------------------------------------------- +Mark Swartzberg, Stifel. + +-------------------------------------------------------------------------------- +Mark Swartzberg, Stifel Nicolaus - Analyst [24] +-------------------------------------------------------------------------------- +Yes, thanks. Good morning, everyone. Two questions, one on Europe specifically, James. I am surprised Spain was down in the quarter. You cited weather but it's been doing pretty well. So, what is going on in Spain beyond weather? +And can you give us any color on Great Britain, because Europe overall had a nice sequential, or at least did better than where consensus was. So, looking for some color there. +And then, Kathy, on FX, really no change in your FX view for the year. Can you remind us how you are hedged on some key currencies and how that might play out the duration of those hedges and what those currencies are? + +-------------------------------------------------------------------------------- +James Quincy, The Coca-Cola Company - President and COO [25] +-------------------------------------------------------------------------------- +Sure. On Europe, I think Europe got a little bit better this quarter. There are things weighing on our business. I'm not a big fan of calling out weather as a driver of performance. The weather occurs for good or for bad all around the world. +Now, in the case of Spain and also France, that end of the Mediterranean, it was particularly poor in the middle part of the quarter. So, that's really what's driving, what's going on in the Spanish business, and also it impacted the French business. +We see Europe getting a little bit better. We had some good results out of Germany, and, as you said, some sequential improvement out of GB cycling out of some of the supply chain problems as they got fixed that came out of the first quarter. So, we see that starting to improve going forward. But I think -- I hate calling out the weather but I think that's really the reason in Spain and France, and I think we'll start to see those businesses get better. +Now, it is worth saying that we've got a lot of good programs in Europe, but the recent tragic events in Belgium, in France and recently in Germany, do weigh on consumer sentiment and consumer behavior. They go out less. We have strong on-premise businesses -- in fact, particularly in Spain -- and that is being dragged down as people respond to some of these tragic events by perhaps staying at home a little more. That hopefully will get better in time as the security situation improves. +But I don't want to get into weather and global events. I think the business in Europe can get better. We've got a lot of launches coming up and we've got some strong programs. So, I think Europe can continue to perform. + +-------------------------------------------------------------------------------- +Mark Swartzberg, Stifel Nicolaus - Analyst [26] +-------------------------------------------------------------------------------- +Great. And a quick follow-up on that specific to Spain. What does your work say about underlying health of the business either because of performance in July? You're saying it sequentially should get better but I'm just wondering what's underlying that? How are you getting to that? + +-------------------------------------------------------------------------------- +James Quincy, The Coca-Cola Company - President and COO [27] +-------------------------------------------------------------------------------- +I'm not going to comment on the beginning of July from a volume perspective. I would note that I think July was the biggest ever month for Spain last year, so they've got some tough comps to cycle. They had a record summer last year. +The underlying business in Spain is improving. Firstly, the economy's getting better. Secondly, the supermarket environment in terms of rational pricing and some of the activities is getting better. And the Spanish bottler made a massive investment going into last year to reinvest in returnable glass, which is one of the preeminent places in the world where this is true in the on-premise account, and that's starting to show good results, notwithstanding the weather and the security impacts in the year to date. +And now with the CCEP deal closed, and management fully focused on leveraging the best of the marketing, the best of the innovation, and really doubling down on the execution, I think we'll start to see improvements in Spain and the other CCEP territories. + +-------------------------------------------------------------------------------- +Mark Swartzberg, Stifel Nicolaus - Analyst [28] +-------------------------------------------------------------------------------- +Excellent. Great. Thank you, James. + +-------------------------------------------------------------------------------- +Kathy Waller, The Coca-Cola Company - CFO [29] +-------------------------------------------------------------------------------- +And on currency, yes, we did not change our guidance this quarter. We've had a lot of movement in some key currencies but basically they are offsetting each other. +Given the volatility that we've seen across the portfolio, some currencies are getting better, like Brazil; some are staying the same or getting worse like in Mexico. Our hard currencies, we are hedged 100% basically. And then we hedge our emerging market currencies on a short-term basis opportunistically. With 2017 being fully hedged for our hard currencies, obviously our exposure then would be basically in our emerging market currencies. + +-------------------------------------------------------------------------------- +Mark Swartzberg, Stifel Nicolaus - Analyst [30] +-------------------------------------------------------------------------------- +So, you said you are fully hedged for hard currencies for calendar 2017, for the duration of 2017? + +-------------------------------------------------------------------------------- +Kathy Waller, The Coca-Cola Company - CFO [31] +-------------------------------------------------------------------------------- +2017, that's correct. + +-------------------------------------------------------------------------------- +Mark Swartzberg, Stifel Nicolaus - Analyst [32] +-------------------------------------------------------------------------------- +Got it. Great. Okay, thank you. + +-------------------------------------------------------------------------------- +Operator [33] +-------------------------------------------------------------------------------- +Judy Hong, Goldman Sachs. + +-------------------------------------------------------------------------------- +Judy Hong, Goldman Sachs - Analyst [34] +-------------------------------------------------------------------------------- +Thank you, good morning. I wanted to go back and follow-up on the price/mix question. Clearly the 3% is a good number, but obviously you are benefiting from pretty high inflationary markets. So, I just wanted to better understand how much of this is really coming from your segmentation, the revenue segmentation strategy, versus the price growth that you are seeing in inflationary markets. Any granularity that you can give us will be helpful. +And then a little bit related to that, I think the flat volume growth that you've seen this quarter, I can't recall the last time you had this kind of volume trend. So, again, how much of this is really a function of your strategy to focus more on revenue and not chase unprofitable volume growth, and if this is something that you'd be willing to accept for some period of time? + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Company - Chairman and CEO [35] +-------------------------------------------------------------------------------- +Judy, good morning. Again, it's Muhtar. First, I think James talked in detail about where the volume shortfalls were coming from, and specifically related to certain large emerging markets that drove that number. That's related to Brazil, that's related to China, being the large ones, but also Russia. All of those emerging markets that used to have better disposable incomes, better macro conditions, basically drove some of that. And going forward certainly we expect some improvement in that area. That's number one. +Number two, I think important to note that, again, mentioned the developed markets grew and developing markets grew volume, and were ahead of the total Company number, which was flat, and ahead of emerging markets. That itself will tell you that certainly the price/mix coming from those markets and then the total geographic mix that coupled with that is something that was instrumental in driving our price/mix number in the way it landed in the quarter. So, all of those factors and all the algebra coming together is what made that -- the country mix coming out of that, the geographic mix, and then the volume coupled with the pricing that we got. +Today, when you look at our US business, with 4% organic revenue growth in North America, that tells you that is in the upper certainly and very much in the upper quartile of all large consumer businesses in the country. We're doing very well. Japan performed well. Again, Mexico performed very well in terms of the volume and pricing combined driving the total number, of price/mix. +So all of that really goes to explain and hopefully that answers your question on that. Anything to add James, there? Okay. + +-------------------------------------------------------------------------------- +Kathy Waller, The Coca-Cola Company - CFO [36] +-------------------------------------------------------------------------------- +On the price/mix question, Judy, we did have this quarter price/mix was positive across in all other groups -- yes, primarily driven by Latin America and inflationary pricing but also operational pricing in EAG. But then it was offset by segment mix coming from the bottling investment segment. +So, as James said, pricing of 2% to 3% is what we expect and what we would think would be very good pricing and in line with our segmentation strategy. Even though EAG was probably out of its normal range at this point, North America pricing is still very strong. We do believe in the segment strategy, and the 2% to 3% is what we expect going forward. + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Company - Chairman and CEO [37] +-------------------------------------------------------------------------------- +And then the sparkling segment, just to finalize that, continues to be a segment of the nonalcoholic ready-to-drink where consumers continue to spend a very large amount of money in terms of consumer spend and in terms of the dollar value. It's still very healthy and that's why it gives us confidence looking into the future about what we are doing in terms of the segmented revenue growth strategy and in terms of the marketing approach and the one-brand strategy in taking the lion's share of that spend going forward. + +-------------------------------------------------------------------------------- +Operator [38] +-------------------------------------------------------------------------------- +Bryan Spillane, Bank of America Merrill Lynch. + +-------------------------------------------------------------------------------- +Bryan Spillane, BofA Merrill Lynch - Analyst [39] +-------------------------------------------------------------------------------- +Hi, good morning, everyone. Just two quick ones. One, for James, you talked a lot, I think, on this call about some of the short-term things that have affected organic sales and changes sequentially in the environment since the start of the year. Can you just update us on what your view for the industry forecast is, maybe not so much for this year but just over the medium term? Has there been any change in terms of what you think the nonalcoholic ready-to-drink beverage industry is going to grow over the medium term? +And then, second question, you had mentioned Coke FEMSA earlier. It looks like you've got an agreement with them to negotiate on a preferred basis. Can you just expand upon that a little bit? Are they exclusively looking at some of these territories or is it a matter that they are just getting the first look? Thank you. + +-------------------------------------------------------------------------------- +James Quincy, The Coca-Cola Company - President and COO [40] +-------------------------------------------------------------------------------- +I think, in your first question, our medium-term outlook for the industry hasn't really changed. We're still expecting robust growth in the industry in the long term, driven by disposable income, urbanization, the middle class, innovation. We see these things expanding now. We've talked about that being in the 5% ballpark and then probably in the next few years talked about it being in the 4%. So, we do see it coming back over time, but we do see industry growth slightly moderated in the short term, as we talked a little bit about in some of the previous conferences. +Now, you did ask the question, we seemed short-term. Give me a second to just read on the line. From our point of view, the biggest mechanical impact in the quarter and the year to date is this asymmetry between where we own bottlers and where it's less than 20% of the volume, or about 20% of the volume, versus being in 200 countries. If you pass the bottling side and just look at the core concentrater franchise, we are running organic at 4% and we are meeting our profit guidance. +We are not trying to say small ups and downs in the macro economies is what should buffet us every quarter. We just need to deal with those things. I just think there's this one asymmetrical effect at the bottling thing, which is important, which is affecting the number. But I don't want to give the impression we're seeing a massive, or trying to signal a deterioration in outlook for the concentrater franchise business. +Now, with regard to Coke FEMSA, yes, we've talked about looking at some territories on a preferred basis. I'm not going to get into exactly how that means in terms of what preferred means versus exclusive, but they are our biggest bottling partner. We have a very strong relationship. We have made an agreement on how we're going to create more value together in Mexico and how they can look to participate in some of the refranchising of the territories that we own in bottling. And we're very excited about doing more stuff together. + +-------------------------------------------------------------------------------- +Bryan Spillane, BofA Merrill Lynch - Analyst [41] +-------------------------------------------------------------------------------- +Okay. Thank you. + +-------------------------------------------------------------------------------- +Operator [42] +-------------------------------------------------------------------------------- +Vivien Azer, Cowen and Company. + +-------------------------------------------------------------------------------- +Vivien Azer, Cowen and Company - Analyst [43] +-------------------------------------------------------------------------------- +Hi, good morning. Thank you for the question. As I look at some of the disclosure in the press release, it seems like you've broken from convention a little bit -- a lot less brand disclosure, trademark Coca-Cola only hold out in North America, you guys aren't breaking out sparkling and stills anymore. So, I'm just curious if we can get a little more color on trademark Coke outside of North America and China, and also whether the change in convention speaks to a broader shift in terms of how you are thinking about balancing volumes across your portfolio? Thank you. + +-------------------------------------------------------------------------------- +James Quincy, The Coca-Cola Company - President and COO [44] +-------------------------------------------------------------------------------- +Yes, in part, please read into this that we are moving the business to more of a revenue focus. Absolutely, under the heading -- everything communicates -- that is part of what we're trying to say. We believe in our segmented revenue approach. It's not that we have forgotten about volume or don't believe it's an underlying driver in the long term, particularly in the emerging markets, of what's going to create the business over the long term. +But as we look at places like North America and some of the other developed markets, clearly we're going after more of a revenue strategy that's driven by smaller packages, by some pricing actions. We do want to call out that perhaps the best way to think about health of the business going into the future is the revenue growth. And that's where I think what we're trying to say is, not just the beverage industry, the sparkling industry category and brand Coke all remain healthy in terms of revenue growth. All three of those are growing revenue globally, and we continue to see good attraction both in the US in terms of sparkling revenue growth and internationally in terms of sparkling revenue growth. + +-------------------------------------------------------------------------------- +Vivien Azer, Cowen and Company - Analyst [45] +-------------------------------------------------------------------------------- +Thank you. + +-------------------------------------------------------------------------------- +Operator [46] +-------------------------------------------------------------------------------- +Thank you. I would like to turn the call back to Muhtar Kent for closing remarks. + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Company - Chairman and CEO [47] +-------------------------------------------------------------------------------- +Thank you James, Kathy and Tim. I'd say we are on track with transforming The Coca-Cola Company to one that is even more focused on our core value creation model of building strong bands, enhancing customer value, and leading our franchise system, a transformation that will result in significantly higher margin and returns. +The macro headwinds are putting pressure on our top line but they are cyclical in nature and we're taking the right actions that give us confidence that we will emerge a much stronger company while we also deliver our profit targets. We remain confident that the long-term dynamics of our industry are promising, and we absolutely believe that The Coca-Cola Company is well-positioned to deliver long-term value to our shareowners. As always, we thank you for your interest, your investment in our Company, and for joining us this morning. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/exam/original-files/Problem_2_3_Sample_full_transcripts/2016-May-18-TGT.N-139736856349-Transcript.txt b/exam/original-files/Problem_2_3_Sample_full_transcripts/2016-May-18-TGT.N-139736856349-Transcript.txt new file mode 100644 index 0000000..3c04183 --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_full_transcripts/2016-May-18-TGT.N-139736856349-Transcript.txt @@ -0,0 +1,681 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q1 2016 Target Corp Earnings Call +05/18/2016 09:30 AM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * John Hulbert + Target Corporation - VP of IR + * John Mulligan + Target Corporation - COO + * Cathy Smith + Target Corporation - CFO + * Brian Cornell + Target Corporation - Chairman and CEO + +================================================================================ +Conference Call Participiants +================================================================================ + + * Oliver Chen + Cowen and Company - Analyst + * Unidentified Participant + - Analyst + * Bob Drbul + Nomura Securities Intl - Analyst + * Peter Benedict + Robert W. Baird & Company, Inc. - Analyst + * Scott Mushkin + Wolfe Research - Analyst + * Joe Feldman + Telsey Advisory Group - Analyst + * John Zolidis + Buckingham Research - Analyst + * Greg Melich + Evercore ISI - Analyst + * Chris Horvers + JPMorgan - Analyst + +================================================================================ +Presentation +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Ladies and gentlemen, thank you for standing by. Welcome to the Target Corporation first-quarter earnings release conference call. +(Operator Instructions) +As a reminder, this conference is being recorded Wednesday, May 18, 2016. +I would now like to turn the conference over to Mr. John Hulbert, Vice President Investor Relations. Please go ahead, sir. + +-------------------------------------------------------------------------------- +John Hulbert, Target Corporation - VP of IR [2] +-------------------------------------------------------------------------------- + + Good morning, everyone, and thank you for joining us on our first-quarter 2016 earnings conference call. On the line with me today are Brian Cornell, Chairman and Chief Executive Officer; John Mulligan, Chief Operating Officer; and Cathy Smith, Chief Financial Officer. +This morning, Brian will discuss of our first-quarter performance, including results across our merchandise categories. Then John will provide an update on our efforts to improve in-stocks and build our supply chain capabilities. And finally, Cathy will offer more detail on our first-quarter financial performance and our outlook for the second quarter. Following their remarks, we'll open the phone lines for a question-and-answer session. +As a reminder, we're joined on this conference call by investors and others who are listening to our comments via webcast. Following the call, Cathy and I will be available to answer any follow-up questions you may have. +Also, as a reminder, any forward-looking statements that we make this morning are subject to risks and uncertainties, the most important of which are described in our SEC filings. Also, in these remarks, we refer to adjusted earnings per share, which is a non-GAAP financial measure, and return on invested capital, which is a ratio based on GAAP information with the exception of adjustments made to capitalized operating leases. Reconciliations to our GAAP EPS and to our GAAP total rent expense are included in this morning's press release which is posted on our Investor Relations website. +With that, I'll turn it over to Brian for his comments on the first quarter and our priorities going forward. Brian. + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman and CEO [3] +-------------------------------------------------------------------------------- + + Thanks, John, and good morning, everyone. +Before I start with prepared remarks, let me set up the structure for our call this morning. We want to make sure we spend significant time talking about our first-quarter results, and Cathy and John and I will cover both our first-quarter performance, and also talk about the second quarter outlook. But we are going to make sure we leave significant time for Q&A. I want to make sure we have time today to address your questions, provide additional insights into our first-quarter performance, and the factors that are guiding our outlook for Q2. +Let me start with the first quarter. Our team delivered outstanding first-quarter financial results in a very challenging consumer environment, which became softer and more volatile as the quarter progressed. Our first-quarter adjusted EPS of $1.29 was well beyond the high end of the guidance for the quarter and more than 16% ahead of the $1.10 last year. These results demonstrate the value of our strategy in the face of a more challenging consumer landscape. +First-quarter comparable sales growth was driven by an increase in both traffic and average ticket, as traffic grew in both our stores and digital channels. Comparable digital sales grew 23% in the first quarter on top of 38% a year ago. We generated very healthy profit margins on our sales in the quarter, as our team did a great job managing the business in the face of a number of headwinds, particularly following the Easter holiday. +As planned, our first-quarter gross margin rate reflected the benefit of the sale of our pharmacy business, favorable merchandising mix, and our cost-savings initiatives. These benefits allowed us to offset mark-down pressure in a very promotional environment. +The team also delivered on the expense line, which benefited from the pharmacy sale and cost initiatives, offsetting pressure from investments we've made in our business, including our team. Cathy will provide more detail in a few minutes. +Sales in the quarter came in lighter than expected, and daily and regional shopping patterns were more volatile than in the prior periods. While guests generally maintain their pattern of larger pantry-stocking visits, we saw a slowdown in growth of smaller convenience strips. +Against that background, our results show that our strategy continues to resonate with our guests, as comparable sales in our signature categories, style, baby, kids, and wellness, grew more than 3 times as fast as the Company average. Given the concentration of signature categories in home and apparel, comparable sales in both categories outperformed the Company, driving market-share gains in both areas. +Comps in home grew nearly 4%, led by strength in domestics, decor, and seasonal areas. Highlights included our kids' home assortment, which saw comp sales in the mid-teens, driven by the successful launch of our new Pillowfort brand. We were also pleased with the results from our partnership with Marimekko, which attracted guests to explore our assortment in stores and digital, driving sales in both home and apparel. +Overall comps in apparel grew between 2% and 3%, led by sales in baby, kids, and women's ready-to-wear. Rapid growth in ready-to-wear is especially notable, given the tough comparison from last year. Specifically, the two-year stack of the first-quarter comp sales in ready-to-wear is more than 16% higher than two years ago. +First-quarter comps in food were down slightly, as an increase in perishables was offset by a decline in center store grocery. While results were impacted by deflation in some categories, they also reflected a meaningful disruption from the reset of our center store grocery area, which was executed in stores across the country in April. Despite the disruption, this effort better positions us for success over the longer term, as we've implemented changes to assortment, presentation, and category adjacencies. +Specifically, we've updated assortment and segmentation to align with local demographics and showcase wellness. And we integrated nutrition bars into the center store floor pad, creating an industry-leading destination for these items. +In total, we added about 1,000 new items with this reset, including 55 new better-for-you brands across 25 categories. And we've incorporated our Simply Balanced brand into an additional 30 categories. This represents an important step in the reinvention of our grocery business. Following the reset, we received very positive guest feedback, and the subsequent results have been better than expected. +Within hard lines, we saw high single-digit increase in the first quarter of comparable sales in toys, even as we comped over high single-digit growth last year. Offsetting the growth in toys, we saw declines in electronics and entertainment, reflecting the secular challenges these categories continue to face. These declines put about 70 basis points of pressure on our first-quarter comparable sales growth. +I want to pause and welcome Mark Tritton, who will be joining our team as the EVP and Chief Merchandising Officer, overseeing our enterprise buying, sourcing, product design, development, and merchandising operations. We've conducted an exhaustive search for a new CMO, and I'm confident Mark is the right leader for our merchandising team. +Mark comes to us with a wealth of retail and merchandising experience, including positions at Nike, Timberland, and Nordstrom, where Mark doubled their private-label business. Mark is a bold, decisive, and visionary retail leader and we're excited to have him on our Target team. +Once again this quarter, we were able to return a compelling amount of cash to our shareholders through dividends and share repurchase. All together, we returned more than $1.2 billion to our shareholders in the first quarter, up from just under $900 million a year ago. +In addition, given our strong financial position, this quarter we were able to refinance some high cost debt by issuing new debt at very attractive rates. Cathy will provide more details in a few minutes. +As we look ahead, we're approaching our business with appropriate caution, as sales trends at Target and many of our key competitors weakened and became more volatile in the first quarter. In addition, many of our competitors are sitting on meaningful excess inventory, which we expect will extend the very intense promotional environment into the months ahead. +Despite our near-term caution, we'll continue to execute the long-term strategy vision that we laid out 18 months ago, the vision which has been shaping our results ever since. We're very excited about the launch of our new kids' apparel brand, Cat & Jack, which will roll out in the second quarter, and we'll continue to invest in quality through our owned and exclusive brand assortment, with a particular emphasis on signature categories. +We'll continue to work to enhance our food offering, to become more fresh and local, with more natural and clean-label offerings. And we'll continue to partner with our colleagues at CVS to complete the rebranding of our pharmacies within our stores. Following the rebranding effort, we'll collaborate with CVS on an awareness campaign to ensure that both our guests and members of their PVM businesses are aware of the change within our stores. +As John will describe in a few minutes, we're also investing in store experience and flexible fulfillment capabilities, while modernizing our supply chain to become more agile in the way we serve our guests. We're very excited to be near completion of our LA25 remodels, which began before the holiday season. And we're eager to gain guest feedback to determine which enhancements will roll out more broadly in the future. +And finally, we're making investments in our team, adding specialized talent like new visual merchandising leaders, or ensuring the store presentation in our style categories highlight the investments we're making to enhance quality and innovation. Going forward, we'll continue to look for ways to simplify processes in our stores, freeing up time for our team to focus on serving our guests. +Before I turn the call over to John, I want to thank the entire Target team for their tireless work on behalf of our business and our guests. As we've said many times, we have the best team in retail, both in our stores and our headquarters, and I'm continually inspired by their passion to drive Target's success by better serving our guests. With this outstanding team, a strong brand, great looking stores, a resilient business model, and a strong balance sheet, I'm confident we'll successfully navigate the near-term retail environment as we implement strategies that will drive Target's long-term success. +With that, I'll turn the call over to John who will discuss his team's efforts to modernize our supply chain and improve our operations. John? + +-------------------------------------------------------------------------------- +John Mulligan, Target Corporation - COO [4] +-------------------------------------------------------------------------------- + + Thanks, Brian, and good morning, everyone. +Today I'm going to provide an update on our efforts to reduce out-of-stocks and improve inventory flow throughout our supply chain. Then I'll cover our current work to enable our existing supply chain infrastructure to operate more flexibly in support of our strategy. And finally, I'll turn to our efforts to elevate the store experience on behalf of our guests, including enhancements to the order pickup process. +Many of you have told us that you have noticed the improvement in our in-stock position in our stores, and our internal measures confirm what you have been seeing. Specifically, in the first quarter, we saw a 27% improvement in out-of-stock measures, compared with the first quarter last year. This represents a sequential acceleration from our fourth-quarter performance, and we are seeing improvements across all of our merchandise categories. +Some of the in-stock improvement is being driven by additional inventory investments in essential categories, which drove a portion of our year-over-year increase in our inventory at the end of the quarter. However, we have opportunities to make other changes that will allow us to streamline our inventory position over time. +Specifically, the team is taking a data-driven approach to reduce the number of SKUs in our assortment, making room for additional facings of the best selling, faster turning items on our store shelves. In addition, the team is collaborating with vendors to reduce case pack [stipends], which will reduce back-room inventory while increasing store labor efficiency by reducing the number of times an item is touched before it's displayed on shelves. +Beyond these improvements, the out-of-stock team has successfully tested other enhancements that will roll out of later this year. One test applied new replenishment algorithms for items with a regular demand patterns, like Seasonal sporting goods. And the results of the tests were dramatic, as out-of-stocks improved by 50% on test items. +Another test involved updates to our presentation standards for items that are typically purchased in multiples. This ensures that our minimum standards reflect the way our guests are shopping today, allowing us to better optimize the tradeoff between inventory investments and out-of-stocks. +And with our vendor partners, the team has worked to meaningfully reduce shipping windows, which will enhance speed and reliability throughout the supply chain. We're very pleased with the collaboration we've seen from our vendors on this effort and improving ship room windows will be implemented across all merchandise categories by this fall. +Beyond our work on in-stocks, we're making changes in our distribution centers to modernize our capabilities. These changes will allow our existing infrastructure to operate more flexibly, simultaneously reducing shipping times while efficiently leveraging our entire network inventory on behalf of our guests. +At our financial community meeting in March, I outlined the conversion of three of our traditional regional distribution centers into delayed allocation centers, which can house slower turning items with more variable demand, allowing the remaining DCs to process faster-turning SKUs more efficiently. In addition, these delayed allocation centers allow us to pulse the right amount of seasonal inventory across the country throughout the season, as demand patterns emerge, keeping us in stock longer in areas of unexpectedly high demand or reducing excess inventory in areas of unexpectedly low demand. +We successfully completed the conversion of all three delayed allocation centers in first quarter, and early results indicate that these additional nodes are improving product allocation compared with our past performance. +Among our other regional DCs, this year we're making changes to three facilities to enable them to ship directly to guests. This requires a meaningful transformation in the capabilities of these facilities, as direct-to-guest shipments require the team to pick and pack individual items, while shipments to stores require fast-moving shipments of case packs and pallets. +Despite the challenge, we are excited about this work, because like our ship-from-store capability, the ability to ship from our regional DCs directly to guests provides deeper access to network inventory, enhancing our digital in-stocks, while allowing us to reach our guests more quickly while controlling costs. In addition, adding direct ship capability to one of our existing facilities requires 85% lower capital investment compared to the construction of a new dedicated web-fulfillment center. +As you know, a meaningful portion of our capital expenditures in recent years has been devoted to technology and supply chain, and we've said that we expect these investments to continue in the future. At the same time, we know that investments in our store experience are more important than ever. And as a result nearly $1 billion of our CapEx this year will be focused on the store experience. +In addition to our store remodel program, which includes the LA25 stores Brian highlighted earlier, we continue to roll out new flexible format stores in dense urban and suburban areas, and we're really pleased with the performance of these new, hyper-localized stores so far. In addition, we continue to invest in presentation and experience across a broad set of our stores. This year, we're investing in self-checkout lanes, operational enhancements, and merchandising innovations across a meaningful portion of the store base. +A key area of focus in our stores is the elevation of our digital order pickup, and the team is taking steps to make the process more convenient and less transactional for our guests. Our goal in these efforts to is increase satisfaction with the order pickup experience, leading to more repeat usage of this capability by our guests. +Speed is key and our store teams continue to improve the speed with which they fulfill pickup orders. In the first quarter, approximately 90% of orders were ready for pickup in less than an hour, up nearly 10 percentage points from last year. This is one reason that guest satisfaction regarding the pickup experience is up meaningfully from last year, and repeat usage is increasing, as well. +Despite this progress, we have more work to do, and we intend to continually improve our performance in response to guest feedback. To maintain our momentum, we rolled out streamlined order pickup communication to our guests this month, and in select stores, we are testing a separate pickup area with additional holding capacity, dedicated team members, and enhanced merchandise presentation to encourage additional shopping on their store visit. +While we are still early in our efforts, I'm really pleased with the progress we've made in a short amount of time. By focusing on downstream outcomes and improving hand-offs between every part of the supply chain, from vendor to distribution center to our stores, we are making systematic repeatable improvements, which will sustain better operating metrics over time. +Now I'll turn it over to Cathy, who will share her insights on our first-quarter financial performance and our outlook going forward. Cathy? + +-------------------------------------------------------------------------------- +Cathy Smith, Target Corporation - CFO [5] +-------------------------------------------------------------------------------- + + Thanks, John, and good morning, everyone. +As Brian mentioned, we generated very strong financial results in the first quarter, even in the face of an unexpectedly choppy and weak environment. Our first-quarter adjusted EPS of $1.29 was $0.19 higher than last year and $0.04 better than the high end of our guidance. +First-quarter GAAP EPS from continuing operations was $1.02, $0.27 lower than the adjusted EPS, reflecting $0.26 of losses related to our debt tender offer and $0.01 of expense related to the sale of our pharmacy business. Our first-quarter comparable sales increase of 1.2% was driven by growth, both growth in traffic and ticket, average ticket. As expected, total sales declined from last year, reflecting the sale of our pharmacy business to CVS. +Within the quarter, we experienced solid results through the Easter holiday. Post Easter, sales and traffic trends softened noticeably, consistent with what you've heard from many of our competitors. +Also notable in the first quarter, we saw a meaningful increase in the volatility of our weekly sales performance compared with last year. Not surprisingly, weather patterns caused some of this volatility, as we saw a meaningful correlation between sales and temperature trends in different regions of the country. +We continue to invest in our digital and flexible fulfillment capabilities to drive sales in all channels, and we continue to see strong results. Comparable digital sales increased 23% in the first quarter on top of a 38% increase a year ago. +Red Card penetration was 23.4% in the first quarter, up nearly 200 basis points from last year. This represents the addition of nearly 700,000 new credit and debit accounts in the quarter, combined with the impact of the sale of the pharmacy business. Excluding the impact of the pharmacy sale, penetration was up about 80 basis points from a year ago. +Our team delivered a stronger-than-expected 11.5% EBITDA margin rate in the first quarter. On the gross margin line, we saw about 50 basis points of improvement from last year. This growth reflects the benefit of the sale of the pharmacy business and continued positive merchandise mix driven by strength in signature categories. These benefits offset mark-down pressure in an environment which continues to be very promotional. +On the SG&A line, we saw the benefit of strong discipline across the organization, along with the benefit from the sale of the pharmacy business. This allowed us to offset strategic investments we're making in our business, including our team. All together, first-quarter SG&A expense was about 50 basis points better than last year. +Quarter-end inventory was up a little bit more than 4%, rising faster than sales. As John mentioned, some of this growth reflected intentional inventory investments to support in-stocks and essential categories. However, given the recent slowdown in our sales and our caution regarding the second quarter, we are planning to manage inventory carefully throughout this quarter and beyond. +Turning to capital deployment, we returned $336 million to shareholders in the form of dividends this quarter and invested nearly $900 million in share repurchase. As Brian mentioned, we also took the opportunity to refinance some high coupon debt during the quarter, with the issuance of 10-year and 30-year bonds at very attractive rates. As a result, we recognized $261 million in debt retirement losses in first-quarter GAAP EPS. +And given that the settlement on the last tranche of the debt tender occurred at the beginning of the second quarter, we expect to recognize another $161 million of debt retirement losses in second-quarter GAAP EPS. Beyond these accounting losses, we expect this refinancing to reduce our ongoing interest expense by $5 million to $10 million per quarter. +I want to pause here and discuss our quarter-end cash position. We ended the first quarter with about $4 billion of cash on our balance sheet, essentially the same as when we started the quarter. However, this was the result of timing, and we expect to reduce our cash position by more than 50% by the end of the second quarter. +In fact, already this quarter, we've deployed nearly $1 billion to retire the final tranche of the debt tender, and we expect to apply another $750 million to fund a debt maturity in July. When you combine these uses with continued investments in the dividend and share repurchase, we expect to end the second quarter with a cash balance of between $1 billion and $2 billion. +I want to emphasize that our capital deployment priorities remain the same. We invest first in our business to support projects that meet our strategic and financial criteria. Second, we support the dividend and expect to maintain our record of consecutive annual dividend increases since 1971. And finally, we invest in share repurchase within the limits of our single A long-term credit rating. +One of our longer-term financial goals is to increase our after-tax return on invested capital, and we expect to reach the mid-teens or higher in the next five years. And I'm pleased that we are already making meaningful progress on this metric. For the 12-month period through the first quarter, we reported an after-tax return of 16%, including the gain on the pharmacy fail in the fourth quarter last year. Excluding that gain, our after-tax return on invested capital was a very strong 14% in the first quarter, up about 150 basis points from a year ago. +On another note, our effective income tax rate from continuing operations was unusually low in the first quarter at 31.6%. This was a result of the adoption of a new accounting standard for employee share-based payments, which reduced our tax expense by $17 million, combined with the impact of lower pretax earnings resulting from the loss on debt retirement. +Now let's turn to our outlook for the second quarter and the implications for the full year. While we're coming off a quarter of outstanding financial performance, Brian mentioned earlier with elevated short-term volatility and softer sales trends since Easter, it's clear that consumers are behaving more cautiously. +With that backdrop, we are planning for second-quarter comparable sales of flat to down 2%. This would represent slower than second-quarter performance than we were planning at the beginning of the year. But we believe this outlook is prudent given the trends we see, as many others have been seeing. +Given slower-than-expected sales, we are planning for a moderate year-over-year decline in our second-quarter EBITDA margin rate in the range of 40 basis points at the midpoint of our comp guidance. Compared with our plan going into the year, our updated expectations reflect continued gross margin pressure from a very promotional environment, combined with a deleveraging of SG&A expense on slower sales. All together, we expect to generate second-quarter adjusted EPS in the range of $1 to $1.20. +Given our performance over the last year and-a-half, we believe we're pursuing the right strategy, and our strategy is working. We have many levers we can deploy to drive our performance, even if the environment remains challenging. As a result, even with a more tempered view of the second quarter, we are still focused on achieving full-year adjusted EPS within the guidance range we provided at the beginning of the year. As we progress through the second quarter, all of us will gain more perspective, which will inform our outlook for the latter half of the year. +As I mentioned at our financial community meeting, one of my first priorities on joining this team last year was to dig in and understand in detail the factors that drive Target's financial performance. As a result of that view, I am confident in the resilience of our business model, which sustains our business through all consumer and retail environments. Importantly, our financial strength combined with our business model enable us to continue investing in our long-term priorities, even when others are having to pull back. It's one of the many reasons I was so excited to join this team and this Company last September. +With that, we'll conclude today's prepared remarks. Now Brian, John, and I are happy to take your questions. + + +================================================================================ +Questions and Answers +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) +Your first question is from Greg Melich from Evercore ISI. + +-------------------------------------------------------------------------------- +Greg Melich, Evercore ISI - Analyst [2] +-------------------------------------------------------------------------------- + + Hi. I had two questions. Thanks, Brian, and I think, John and Cathy, you all gave a nice overview there when you described how the quarter progressed. Could you help us understand where April was? Was it actually negative? And also, any geographic distinctions that you saw in the quarter? And then I had a follow-up on the margin. + +-------------------------------------------------------------------------------- +Cathy Smith, Target Corporation - CFO [3] +-------------------------------------------------------------------------------- + + Hey, Greg. I'll start. We did see -- obviously, we had a very strong February and March, and felt really great around our performance in Easter. We saw that we took share in apparel in Easter and so we were really good there. But we did see a slowdown in April. A lot of it, though, is that ad shift that we were seeing. So that's part of what we're seeing with regard to April. But we did see slowdowns throughout the course of April. + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman and CEO [4] +-------------------------------------------------------------------------------- + + Greg, let me provide some color as far as the geographic volatility, and I'm going to be really transparent with some of the examples. As we looked at business in April, and again in the start of May, we've seen a significant performance difference between our West Coast markets and, particularly, our Northeast markets. And significant variability, where we've seen some very positive growth performance across our entire portfolio -- in Los Angeles, in San Francisco, and many of our core West Coast markets -- offset by significant slowness in the Northeast -- in Boston, in New York, in Philadelphia, in DC. In given categories, we've seen dramatic performance differences. In the ready-to-wear category, on the West Coast and in parts of the Midwest, where we've seen an earlier spring, we're seeing double-digit growth in ready-to-wear, offset by fairly significant declines in the Northeast. +We had a review with our team yesterday. We looked at categories like fans. We have markets that are up 20% and markets that are down 90%, so we're seeing volatility driven by, certainly, climate, but I think a number of other factors that we're certainly analyzing. Cathy talked about an earlier Easter. We've certainly looked at weather patterns. We recognize that, year on year, fuel prices have increased. And our guests and the consumer is spending more than they did a year ago at the pump. +And we certainly recognize that within overall categories, today's consumer, our guest, is reinvesting in their homes. They're spending money on home improvement. We've seen that in our home category, which was up 4% in the first quarter. So, a lot of volatility, and it's both geographic and within category mixes. + +-------------------------------------------------------------------------------- +Greg Melich, Evercore ISI - Analyst [5] +-------------------------------------------------------------------------------- + + That's great, that's helpful. That's also a transition into the margin. If I got your guidance right, the midpoint of it, if I take the comp and to get to that EPS I get (technical difficulty) margins down around (technical difficulty) in the second quarter. One, is that right? And, two, it sounds like the real reason for that might be a little bit of deleverage and then basically mark-down risk on inventory given the rest of your comment. Is that fair? + +-------------------------------------------------------------------------------- +Cathy Smith, Target Corporation - CFO [6] +-------------------------------------------------------------------------------- + + Greg, I'm really sorry but you literally cut out right when you said what you were trying to ask about EBIT margins. So, I'm sorry, can you please repeat? + +-------------------------------------------------------------------------------- +Greg Melich, Evercore ISI - Analyst [7] +-------------------------------------------------------------------------------- + + Yes, it looks to us from guidance, EBIT margin is down 50 BPs in the second quarter at the midpoint. How much of that is just deleverage and how much of that is mark-down risk from the elevated inventories and categories? + +-------------------------------------------------------------------------------- +Cathy Smith, Target Corporation - CFO [8] +-------------------------------------------------------------------------------- + + We did talk about gross margin. We expect gross margin to be 40 basis points at the midpoint. And we still expect a promotional environment, and we're planning for that. + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman and CEO [9] +-------------------------------------------------------------------------------- + + Again, Greg, I think, under the circumstances, as we've looked at our competitors' reports, we recognize there's significant inventory in the marketplace. We expect the second quarter to continue to be very promotional, and that's factored into our guidance for the second quarter. + +-------------------------------------------------------------------------------- +Greg Melich, Evercore ISI - Analyst [10] +-------------------------------------------------------------------------------- + + That's great. Thanks a lot. Good luck. + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman and CEO [11] +-------------------------------------------------------------------------------- + + Thanks, Greg. + +-------------------------------------------------------------------------------- +Operator [12] +-------------------------------------------------------------------------------- + + Your next question is from Oliver Chen from Cowen and Company. + +-------------------------------------------------------------------------------- +Oliver Chen, Cowen and Company - Analyst [13] +-------------------------------------------------------------------------------- + + Hi. Thanks for all the details. We had a question regarding the smaller convenience trip slowdown. Could you just help us understand it, as you looked at the data, if there's patterns there that give you some insight into how that dynamic may be playing out and what's the opportunity there? +And, secondly, on the promotional pressure that you're seeing, what's the axes from which that may be happening in terms of, A, categories and, B, Amazon versus bricks-and-mortar competition? Are there different aspects of competition that you're facing as you look to determine what's optimal from an executional and strategic point of view? Thank you. + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman and CEO [14] +-------------------------------------------------------------------------------- + + Oliver, let me address the trips. And we talked about, in the prepared comments, we continue to see very strong performance in what we'll describe as that stock-up trip, where, as a Company, we performed very well throughout 2015 and again in the first quarter of 2016. Where we have seen some trip erosion is with the guest who is coming in for that fill-in trip. So, as we think about actions we're taking in our business right now, we want to continue to make sure we're serving the guest who's looking for that stock-up item, that stock-up trip. And we're going to be even more focused as we manage through the quarter and the balance of the year to make sure we're winning and driving more fill-in trips. +You'll see us enhance and change both our promotional calendar, our in-store presentation of more fill-in items to make sure that we're doing both -- continuing to win with the guest who's shopping Target for that stock-up occasion, but also making sure we're capturing more of that fill-in trip throughout the quarter. So those are actions that we're taking right now. The team's working on making adjustments in our promotional cadence and presentation to make sure that we're doing both. We're continuing to win with the stock-up shopper, but we're also capturing more share of wallet with that fill-in guest. +From a promotional standpoint, we would expect to see most of the intensity in the apparel space, where we certainly recognize that many of our competitors are sitting on high levels of inventory. We've got to be prepared for continued promotional intensity in that space. And I think we're well positioned, as both Cathy and John have noted, to manage through that throughout the quarter. + +-------------------------------------------------------------------------------- +Oliver Chen, Cowen and Company - Analyst [15] +-------------------------------------------------------------------------------- + + Okay. Thank you. Just a quick follow-up. As you've been monitoring, and you've been really ahead of thinking in terms of the omni-channel experience, Brian, are there any little changes that you've been seeing in terms of how customers view convenience or what you're seeing now in terms of the online plus offline experience that are different in terms of like the trends you've been recognizing? + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman and CEO [16] +-------------------------------------------------------------------------------- + + Well, I think, Oliver, the one thing that we continue to see, and we've embraced as an organization, is whether our guest is shopping in-store or online, it starts digitally. So we continue to make sure we're investing in our digital assets to make sure we're providing the ease and convenience for our guests, whether they're in-store or shopping online. It's why we've made such a commitment, as John talked about, to enhancing our order online, pick up in-store capabilities. It's why we've elevated our focus on making sure that we provide an easy shopping experience for our guest online. We continue to build out those capabilities. +So, we recognize that, even as we look at the start of 2016, the majority of the retail business in the United States continues to be done in stores, but it starts online. So we better have great digital capabilities to make sure, when our guest is shopping Target -- no matter how they shop -- we make it a convenient, easy experience. So that has not changed dramatically. And one of the numbers that we feel best about in the first quarter is the fact that, on top of a very strong 38% growth in the first quarter of 2015, we grew our digital sales by 23%. So we're continuing to connect with that guest that wants to shop Target online, and we'll continue to invest and build our capabilities in that space. + +-------------------------------------------------------------------------------- +Oliver Chen, Cowen and Company - Analyst [17] +-------------------------------------------------------------------------------- + + Thank you. Best regards. + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman and CEO [18] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Operator [19] +-------------------------------------------------------------------------------- + + Your next question is from Joe Feldman from Telsey Advisory Group. + +-------------------------------------------------------------------------------- +Joe Feldman, Telsey Advisory Group - Analyst [20] +-------------------------------------------------------------------------------- + + Hi. Thanks for taking the question. I wanted to ask, Brian, if you could talk a little about the in-fill trips again. Wanted to go back to Cartwheel. If I recall, I don't think you even mentioned it on the call this time, and I'm just wondering if there's any changes going on there or what you're doing. Presumably, that would be a way to help stimulate the in-fill trips like localization, personalized marketing. I know you guys do a great job with that with your mobile effort. So just, did something fall apart on that front or maybe some things weren't as effective? Could you talk about that a little? + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman and CEO [21] +-------------------------------------------------------------------------------- + + Joe, in some ways, you're looking inside of our current play-book. And, certainly, as we think about winning more trips with that fill-in guest, Cartwheel plays an incredibly important role. And we'll continue to make sure that we activate Cartwheel to drive those trips and meet that guest's need. +One of the things that we're certainly recognizing, as we look at 2016 shopping patterns, is there is a consumer and a guest who continues to look for value. And that value is expressed in more fill-in trips, buying smaller packs, smaller baskets. So, again, it's not a shift in our strategy; it's a recognition that we have to do both. We have to continue to delight the guests when they come to Target for that big stock-up occasion, and we have to have the right assortment, the right value, the right presentation for that guest who's coming to us for the fill-in trip. +So, Cartwheel plays a very important role in that. And, as we think about adjustments and modifications we're making to our plans, Cartwheel plays a very important role in driving more trips back to our stores and certainly meeting the needs of our guest who's coming to us for that fill-in occasion. + +-------------------------------------------------------------------------------- +Joe Feldman, Telsey Advisory Group - Analyst [22] +-------------------------------------------------------------------------------- + + Got it. Thanks. And then, you guys mentioned the center store disruption and all of the efforts you made -- that you are making to improve the healthy living and that category. Were you able to quantify how much of an impact that had? Presumably it was a decent disruption in April that could have had a bit of a drag. + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman and CEO [23] +-------------------------------------------------------------------------------- + + Joe, it was a significant disruption. You know our stores. You know the layout. And for all of our center store dry grocery items, we moved every one of those aisles in all of our stores. So, significant disruption for the guest. +Short term, it certainly has an impact on our performance in grocery and food. But, as we've made the changes, the response we're seeing from the guest is very encouraging. They're recognizing the new assortment, the new brands, more local items, the fact that we have more organic and gluten-free items on our shelves. And, in many of these categories -- like the significant change we made in bars -- we're seeing very strong sales results coming out of the reset. +So, it was an investment we had to make, in both labor and in disruption, to make sure we continue to move forward in the reinvention of food. So, short term, it had a meaningful impact on our food sales. But we certainly expect to see the recovery over the balance of this year as we provide a more relevant assortment to our Target grocery shopper. + +-------------------------------------------------------------------------------- +Joe Feldman, Telsey Advisory Group - Analyst [24] +-------------------------------------------------------------------------------- + + Got it. That's helpful. Thank you, guys, and good luck with this quarter. + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman and CEO [25] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Operator [26] +-------------------------------------------------------------------------------- + + Your next question is from Kate McShane from Citi Research. + +-------------------------------------------------------------------------------- +Unidentified Participant, - Analyst [27] +-------------------------------------------------------------------------------- + + Hi, this is Chris filling in for Kate. With the comp coming in below your expectations, is there a reason why you didn't choose to get more promotional this quarter? Could you walk us through how much of your gross margin was impacted by promotions and was it more than last year? + +-------------------------------------------------------------------------------- +Cathy Smith, Target Corporation - CFO [28] +-------------------------------------------------------------------------------- + + We were as promotional as necessary. We drove, as we shared, a 4% comp in our signature categories, which are the areas that tend to be more promotional. So we feel very good about our promotional cadence. Continue to work on being more and more effective, but still have a long way to go there. So I wouldn't say that we saved any on promotions, in particular. We were as promotional as we thought was appropriate and it showed up in our comp. + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman and CEO [29] +-------------------------------------------------------------------------------- + + Chris, I'd only add that, as we look at individual category performance, we felt like we were very competitive in categories like apparel, where, as we look at the NPD data, we look at the market-share results, we were one of the big market-share winners in the first quarter. And, clearly, in apparel, we picked up market share the two weeks leading up to Easter, during the Easter week, and the week following. +So, our assortment, our presentation, our promotions certainly connected with the guest. And, in important signature categories, we continue to advance market share. But we feel particularly good, in a tough apparel environment, that we posted positive comps, we grew market share, and, importantly, we grew market share before, during, and after the important Easter holiday, which is a critically important holiday for the apparel category. + +-------------------------------------------------------------------------------- +Unidentified Participant, - Analyst [30] +-------------------------------------------------------------------------------- + + And just looking ahead, you mentioned apparel's going to be very competitive. Are there any other categories you see that will also face pricing competition? And also, just really quickly, for your in-stock initiatives, how much did the improvement in those initiatives contribute to the comp in Q1? + +-------------------------------------------------------------------------------- +John Mulligan, Target Corporation - COO [31] +-------------------------------------------------------------------------------- + + Well, on the in-stock question, I think it's hard to parse that out, a very difficult question to answer. Certainly we have some estimates internally, but it gets into trading behavior, as you know, and how guests will trade out. But, overall, I think the in-stock definitely having it there when the guest wants it. +But, more important than that, is ensuring that they trust us, that no matter when they come in the store, we'll have what they want. And that's about building trust for the brand over the long term. And so there is an immediate impact, but this is much more about being sure we're reliable all the time for the guest. + +-------------------------------------------------------------------------------- +Unidentified Participant, - Analyst [32] +-------------------------------------------------------------------------------- + + Okay. Thank you. + +-------------------------------------------------------------------------------- +Operator [33] +-------------------------------------------------------------------------------- + + Your next question is from Peter Benedict from Robert Baird. + +-------------------------------------------------------------------------------- +Peter Benedict, Robert W. Baird & Company, Inc. - Analyst [34] +-------------------------------------------------------------------------------- + + Hey, guys, just a clarification. Just on the second-quarter gross margin outlook, I think you said down 40 basis points. I assume that's on a reported basis, right? So, excluding the pharmacy impact, it would be down maybe closer to 100. Am I right on that? + +-------------------------------------------------------------------------------- +Cathy Smith, Target Corporation - CFO [35] +-------------------------------------------------------------------------------- + + You know what, I thought I had said gross margin. I meant 40 basis points on EBITDA. So we should see actually a slight uptick in gross margin, a slight downtick in SG&A, and then the EBITDA was the 40 basis points. So, thanks for asking that for clarification. + +-------------------------------------------------------------------------------- +Peter Benedict, Robert W. Baird & Company, Inc. - Analyst [36] +-------------------------------------------------------------------------------- + + No, perfect. Okay. Thank you. That's helpful. Just on SG&A, is it fair to say that the SG&A dollars, if you exclude the pharmacy comparisons, were down slightly year over year in the first quarter? And I'm just curious if that's a trend that you think could persist over the balance of the year, given the tougher sales environment. + +-------------------------------------------------------------------------------- +Cathy Smith, Target Corporation - CFO [37] +-------------------------------------------------------------------------------- + + The team did a great job of managing expenses in the first quarter and will continue to do that. And, yes, it was down year over year, and we'll continue to manage our expenses. + +-------------------------------------------------------------------------------- +Peter Benedict, Robert W. Baird & Company, Inc. - Analyst [38] +-------------------------------------------------------------------------------- + + Okay. Last question, I apologize if I missed this. Any change to the CapEx plan for the year, which I think was around $1 billion? + +-------------------------------------------------------------------------------- +Cathy Smith, Target Corporation - CFO [39] +-------------------------------------------------------------------------------- + + No change. + +-------------------------------------------------------------------------------- +Peter Benedict, Robert W. Baird & Company, Inc. - Analyst [40] +-------------------------------------------------------------------------------- + + Or $1.8 billion, sorry. + +-------------------------------------------------------------------------------- +Cathy Smith, Target Corporation - CFO [41] +-------------------------------------------------------------------------------- + + $1.8 billion. No change at all. + +-------------------------------------------------------------------------------- +Peter Benedict, Robert W. Baird & Company, Inc. - Analyst [42] +-------------------------------------------------------------------------------- + + Okay. Terrific. Thanks, guys. + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman and CEO [43] +-------------------------------------------------------------------------------- + + Peter, thank you. + +-------------------------------------------------------------------------------- +Operator [44] +-------------------------------------------------------------------------------- + + Your next question is from Bob Drbul from Nomura. + +-------------------------------------------------------------------------------- +Bob Drbul, Nomura Securities Intl - Analyst [45] +-------------------------------------------------------------------------------- + + Hi. Good morning. I'd just follow on Peter's last question. But when you look at the sales results that you had the last few weeks, and especially April, does that make you rethink your longer-term sales views that you laid out back in March? + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman and CEO [46] +-------------------------------------------------------------------------------- + + Bob, it doesn't. Obviously, it's been a question that we've asked ourselves. And, as Cathy and John have both mentioned, we feel very good about the progress we're making from a strategic standpoint. We've talked multiple times now, certainly we talked to most of you on the call during our March Investor Day, our continued focus on building out our digital capabilities, we're making very good progress there. We think those are going to be essential to our future. +We feel very good about the progress we're making on signature categories, where we continue to build market share and drive differentiation. We're very excited about the early results of Pillowfort, and feel as if, when we launch our new Cat & Jack brand for kids, that is going to be another potential $1 billion brand in our portfolio. So, great progress from a category roll and signature category standpoint. +As John mentioned during his remarks, our flex formats continue to be very well received as we move into new urban markets. We're excited about our Tribeca store that will open up in October. But we've been excited about every one of these new flex formats, and they've been well received in both urban and college markets. We continue to think we've got significant opportunities in localization, and the work we've done in Chicago and now Los Angeles just continues to confirm that. +So, our strategy continues to perform well. John and the team continue to enhance our store and supply-chain capabilities to continue to meet the needs of our guests. So, as we sit here today, there's no significant change in our strategy, but, tactically, we recognize the consumer environment is tougher. +We've got to make sure we're delivering the right value, we're winning with both the stock-up and the fill-in trip. We're making sure that we have the right experience for our guests, where they're shopping in-store and online, and we don't see any structural change in the consumer environment. We think this is a short-term bump in the road. But we think we're well positioned. And everything we see from a GDP and consumer confidence standpoint gives us the confidence that this is going to be a short-term impact and we're going to see very solid results in both the third and fourth quarter, and keep us on our long-term guidance track. + +-------------------------------------------------------------------------------- +Bob Drbul, Nomura Securities Intl - Analyst [47] +-------------------------------------------------------------------------------- + + Great. Thank you very much. Good luck. + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman and CEO [48] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Cathy Smith, Target Corporation - CFO [49] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Operator [50] +-------------------------------------------------------------------------------- + + Your next question is from Scott Mushkin from Wolfe Research. + +-------------------------------------------------------------------------------- +Scott Mushkin, Wolfe Research - Analyst [51] +-------------------------------------------------------------------------------- + + Hey, guys. Thanks for taking my questions. So I just wanted to clarify, the resets in the dry grocery, when did that take place? Was that during the quarter or was that after the quarter closed? And, if it was during April, what was the drag? Do you guys know? + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman and CEO [52] +-------------------------------------------------------------------------------- + + Scott, it took place right after Easter, during the month of April. So, a major effort inside of our stores. We touched, as I mentioned earlier, all of those center store grocery aisles. We added a number of new items, over 1,000. We brought new brands into those categories, and we've expanded our Simply Balanced line. +So all that took place and it was very disruptive, and we planned for it in April. We now have the work behind us, and I'm very excited about the feedback we're receiving and the responses we're seeing in many of these categories. And certainly expect that we'll see those businesses accelerate, now that we have more relevant assortment. And we've significantly increased the representation of organic and natural and gluten-free and local items in those aisles. + +-------------------------------------------------------------------------------- +Scott Mushkin, Wolfe Research - Analyst [53] +-------------------------------------------------------------------------------- + + So, Brian, the weakness you continue to see into May -- because I think you say that reset went really well, that's a chunk of sales. So the weakness you see continuing into May would be non-consumable areas that are just, as you say, heavy inventory in some of these signature categories. Is that a good way to frame it? + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman and CEO [54] +-------------------------------------------------------------------------------- + + Yes, I think that's largely the case, Scott. Again, as I said earlier, and I want to make sure we're really transparent about this with examples, we've seen very slow sales performance in the Northeast. And, we have the same presentation. We had the same ad. We had the same value. We had the same great in-store experience. But on a day-in, day-out basis we're getting very different outcomes. +So, on one hand, it gives me confidence to say what we're doing is working, because it's working in many parts of the country. But we have isolated geographies where, whether it's a late spring, whether it's a change in short-term consumer behavior, we're not seeing the same results. But we're delivering the same great content. +So, I expect the Northeast to recover. I think spring will arrive there. And I think when the guest is out shopping, they'll continue to choose Target and we'll continue to provide them a great in-store and online experience. But we are seeing very significant geographic volatility, unlike anything I've seen in many, many years. + +-------------------------------------------------------------------------------- +Scott Mushkin, Wolfe Research - Analyst [55] +-------------------------------------------------------------------------------- + + Interesting. And so then I just wanted want to touch on the fill-in trip situation, and I think you talked about promoting a little bit more to try to get those trips. Is that promotion different? Is that promotion more in the consumable side of things as you look at it? It seemed intuitively that would be, but I just wanted to get your thoughts on it. + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman and CEO [56] +-------------------------------------------------------------------------------- + + Scott, you're spot on. It's much more about consumables, household essentials. And, to be very clear, it's probably less about promotional intensity, but ensuring that we are promoting and presenting the right items, particularly at the back end of the month when the consumer and our guest is more likely to look for single-unit items, more items at a value. So we've got to make sure we're making the tactical adjustments to what we advertise, what we present in-store, and making sure that we're winning both with the stock-up guest, but also with the guest that's looking for value and looking for smaller, single-unit packs at the right value. + +-------------------------------------------------------------------------------- +Scott Mushkin, Wolfe Research - Analyst [57] +-------------------------------------------------------------------------------- + + So then I had just one last one I want to sneak in because I was in your store in Long Beach, which I thought was wonderful, that small Target. + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman and CEO [58] +-------------------------------------------------------------------------------- + + It's a fabulous store. + +-------------------------------------------------------------------------------- +Scott Mushkin, Wolfe Research - Analyst [59] +-------------------------------------------------------------------------------- + + How close are you from test to actually rolling out more of those? And then I'll yield. Thank you. + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman and CEO [60] +-------------------------------------------------------------------------------- + + I'm smiling, and I may turn this over to John. We've all actually visited our Bixby store in Long Beach over the last few weeks. The store really captures the best of Target in a smaller, 30,000-square-foot environment. And very positive reaction from the guest. So as we think about future flex formats, that is a model that we're excited about, a model that certainly seems to be connecting with the guest, and you should expect to see more of those as we go forward. +But let me hand it over to John who's been intimately involved in the roll-out of flex formats and, specifically, the work we're doing in Long Beach. + +-------------------------------------------------------------------------------- +John Mulligan, Target Corporation - COO [61] +-------------------------------------------------------------------------------- + + I would just -- obviously, we're very excited about the performance of the stores. I think the financial performance, certainly, but I think, like Brian mentioned, really it's the guest reception of those stores. And, while they are very conveniently placed, like the Bixby store, they're not convenience stores. The intent is to lead forward with what Target does well -- home, apparel, our signature categories -- and that's what you really see in that Bixby store. +We will continue to increase the number we're doing as we go forward, but continue to test geographies and sizes of stores and how those two work together. Obviously, the Bixby store is quite large, and that's a little bit different neighborhood than we've done in the past. +So the Tribeca store that Brian referenced, again, very different. Very dense, urban store, two-level store. We continue to test configuration and neighborhood but feel very, very good about what we've found so far. And you'll see us continue to grow those number of stores that we open over the next several years. + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman and CEO [62] +-------------------------------------------------------------------------------- + + Just to finish up on that, Scott, I think the Long Beach store that you visited is a great example that really shows how we're approaching each of these initiatives. We are testing, we're learning, we're refining. The team's getting better and better at layout and assortment, and you've seen that when you walk the Long Beach location. +And the feedback that we've received from the guest is, even in a smaller box, it feels like Target. And it feels like the best of Target. The work that the team's done in the center of that store to merchandise our soft lines is really outstanding. We're getting great feedback around our food presentation in that store. We've got the right home assortment. So we're tailoring that for the local market. +But it's an example of the fact that we've been disciplined. We're not sprinting, we're making sure that we're really thoughtful. We're learning. We're adjusting. And you're seeing each of the new flex formats get better and better in layout, assortment, and tailoring to meet the local market. So, we are very excited about it, and we'll continue to take that learning and build it into new flex formats that we'll be opening up over the balance of this year and into next year. + +-------------------------------------------------------------------------------- +Scott Mushkin, Wolfe Research - Analyst [63] +-------------------------------------------------------------------------------- + + Thanks, guys. + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman and CEO [64] +-------------------------------------------------------------------------------- + + Thanks, Scott. + +-------------------------------------------------------------------------------- +Operator [65] +-------------------------------------------------------------------------------- + + Your next question is from John Zolidis from Buckingham Research. + +-------------------------------------------------------------------------------- +John Zolidis, Buckingham Research - Analyst [66] +-------------------------------------------------------------------------------- + + Hi. Good morning. Thanks for taking my question. Wanted to ask about the second half of the year. You've already addressed this a little bit, and you've provided us a lot of evidence, I think, that points towards weather as a significant culprit in the volatility in the sales at the end of the first quarter and the start of the second quarter. +But you also alluded, at some points, that maybe there's something else going on with the consumer. So I was wondering if you could just talk about what else might be negatively impacting the consumer -- or your consumer, that you're aware of. And do you have any data, for example, if you look by segment of consumer, income levels or REDcard usage, that would help you understand the trends to a greater extent? Thanks. + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman and CEO [67] +-------------------------------------------------------------------------------- + + Well, John, as you might imagine, we're spending a lot of time, and have spent a lot of time, as a team looking at performance from a number of different vantage points, both internally, but also certainly incorporating external data. Certainly it was an earlier Easter. We recognize the impact of that. Certainly weather in many major markets has been a factor. It's not an excuse. We've got to figure out how we perform under any circumstances. +We know, as the guest and our consumer has moved through the course of 2016, prices at the pump, fuel prices have risen, and that's certainly an impact. And then when we look at a macro basis on overall spending, we certainly recognize that consumers are spending more on travel, on leisure activities, they've been investing in their homes, as I mentioned before. But there's no structural change that gives us pause and has us changing our strategy, altering our outlook for the full year. +We think -- we're continuing to improve our digital capabilities. I think our store experience is improving each and every week. The response we're getting from the guest based on changes we made in apparel and home, and recently in food, are very encouraging. As John mentioned, our flex format's performing quite well. +So we feel confident that the content we have in place, the plans we have for the second half of the year, some of the enhancements we've made from a branding and in-store and online standpoint are going to continue to deliver solid results. So we see this as a momentary speed bump, but we see no reason to alter our strategy. These are tactical adjustments we have to make. And, market by market, we've got to make sure we're well positioned to compete going forward. + +-------------------------------------------------------------------------------- +John Zolidis, Buckingham Research - Analyst [68] +-------------------------------------------------------------------------------- + + Thanks very much. Good luck. + +-------------------------------------------------------------------------------- +Cathy Smith, Target Corporation - CFO [69] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman and CEO [70] +-------------------------------------------------------------------------------- + + We've got time for one more question, operator. + +-------------------------------------------------------------------------------- +Operator [71] +-------------------------------------------------------------------------------- + + Okay. Your last question comes from Chris Horvers from JPMorgan. + +-------------------------------------------------------------------------------- +Chris Horvers, JPMorgan - Analyst [72] +-------------------------------------------------------------------------------- + + Made it in. Thank you. So, following up on that question, just that thread of questions, so outside of the Northeast and California, has it been more consistent? And then, related to that, as you think about the second-quarter guidance, are you basically extrapolating current trends which have been weather impacted? Or are you taking a directional view, either more conservatively expecting to pick up as the quarter progresses or in either direction? Thanks. + +-------------------------------------------------------------------------------- +Cathy Smith, Target Corporation - CFO [73] +-------------------------------------------------------------------------------- + + So we, obviously, have insight into where May is at today, and then we've got Memorial Day coming. We've got great plans around -- leading into Memorial Day and have every confidence we're going to have guests come to Target, whether in our stores or online. And then, summer and warmer weather will come, and so we have an expectation that the trend we see today doesn't change overnight. But it does improve throughout the quarter because we've got some really great plans to deliver for our guests. +And then also, in the latter part of this quarter, we have Cat & Jack launching, and we're very excited about Cat & Jack launching before back-to-school season. And we expect that to be a leading Target-only brand that will be a $1 billion brand in time. + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman and CEO [74] +-------------------------------------------------------------------------------- + + So, Chris, thanks for your question. And I really appreciate everyone who called in today. We tried to make sure we allotted significant time for your questions. Hopefully, we had a chance to answer your questions, address some of your concerns. So, that will conclude our quarter. I appreciate your time today and thank you for dialing in. + +-------------------------------------------------------------------------------- +Operator [75] +-------------------------------------------------------------------------------- + + This does conclude today's conference call. Thank you for participating. At this time, you may now disconnect. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/exam/original-files/Problem_2_3_Sample_full_transcripts/2016-Nov-16-TGT.N-138221177745-Transcript.txt b/exam/original-files/Problem_2_3_Sample_full_transcripts/2016-Nov-16-TGT.N-138221177745-Transcript.txt new file mode 100644 index 0000000..8e0041e --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_full_transcripts/2016-Nov-16-TGT.N-138221177745-Transcript.txt @@ -0,0 +1,595 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q3 2016 Target Corp Earnings Call +11/16/2016 07:00 AM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Brian Cornell + Target Corporation - Chairman and CEO + * John Mulligan + Target Corporation - COO + * Mark Tritton + Target Corporation - Chief Merchandising Officer + * Cathy Smith + Target Corporation - CFO + * John Hulbert + Target Corporation - VP of IR + +================================================================================ +Conference Call Participiants +================================================================================ + + * Scott Mushkin + Wolfe Research - Analyst + * Matt Fassler + Goldman Sachs - Analyst + * Oliver Chen + Cowen and Company - Analyst + * Greg Melich + Evercore ISI - Analyst + * Brandon Fletcher + Bernstein - Analyst + * Dan Binder + Jefferies LLC - Analyst + * John Zolidis + Buckingham Research - Analyst + * Chris Horvers + JPMorgan - Analyst + * Bob Drbul + Guggenheim Securities LLC - Analyst + * Robert Ohmes + BofA Merrill Lynch - Analyst + +================================================================================ +Presentation +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Thank you for standing by. Welcome to the Target Corporation third-quarter earnings release conference call. +(Operator Instructions) +As a reminder, this conference is being recorded, Wednesday, November 16, 2016. I would now like to turn the conference over to Mr. John Hulbert, Vice President Investor Relations. Please go ahead, sir. + +-------------------------------------------------------------------------------- +John Hulbert, Target Corporation - VP of IR [2] +-------------------------------------------------------------------------------- + + Good morning everyone, and thank you for joining us on our third-quarter 2016 earnings conference call. On the line with he me today are Brian Cornell, Chairman and Chief Executive Officer; Mark Tritton, Chief Merchandising Officer; John Mulligan, Chief Operating Officer; and Cathy Smith, Chief Financial Officer. +This morning, Brian will recap our third-quarter performance and progress in pursuit of our strategic objectives, Mark will provide detail on recent category performance, along with our fourth-quarter merchandising and marketing plans. John will provide an update on our efforts to improve operations and modernize our supply chain, and finally Cathy will offer more detail on our third-quarter financial performance, and our outlook for the fourth-quarter and full year. +Following their remarks we'll open the phone lines for a question-and-answer session. As a reminder, we're joined on this conference call by investors and others who are listening to our comments via webcast. Following the call, Cathy and I will be available to answer your follow-up questions. +As a reminder, any forward-looking statements that we make this morning are subject to risks and uncertainties, the most important of which are described in our SEC filings. +Also, in these remarks, we refer to adjusted earnings per share, which is a non-GAAP financial measure, and return on invested capital, which is a ratio based on GAAP information, with the exception of adjustments made to capitalized operating leases. Reconciliations to our GAAP EPS from continuing operations and to our GAAP total rent expense are included in this morning's press release, which is posted on our Investor Relations website. +With that, I'll turn it over to Brian for his comments on the third quarter and our expectations going forward. Brian? + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman and CEO [3] +-------------------------------------------------------------------------------- + + Thanks, John, and good morning, everyone. We are very pleased with the financial results we announced earlier this morning. While we have much more work to do, this quarter, we saw meaningful progress in our efforts improve our traffic and sales, as both metrics improved by about a percentage point compared with the second quarter. +In addition, we generated much stronger than expected EPS performance, driven by strong signature category growth, favorable results in back-to-school and back-to-college seasons, and the continued benefit of our cost savings efforts. Our third-quarter adjusted EPS of $1.04 was 22.1% higher than last year, and well beyond the high end of the guidance range of $0.75 to $0.95. +With this outstanding third-quarter performance, Target's adjusted EPS has grown more than 10% through the first three quarters of the year. This is particularly strong performance, given that we've experienced flat comparable sales growth during this period. +In addition, our business continues to generate very strong after tax returns on invested capital. For the 12 months through the end of the third quarter, we reported a very healthy after tax ROIC of 14.3%, excluding the one-time benefit of the gain on the sale of our pharmacy business. This performance represents an increase of approximately 130 basis points from a year ago. +Of course, strong cash generation by our business allows us to continue to fund a healthy level of investment in our stores, supply chain, and technology, while funding robust cash returns to our investors. In the third quarter, we returned about $1.2 billion to our shareholders, in the form of dividends and share repurchases. Year-to-date, we've already returned over $4 billion to our shareholders. +I'd like to pause and thank our team for their boundless energy and passion to serve our guests, by offering them unique merchandise, outstanding service, and a best-in-class experience. They deserve all the credit for our outstanding financial results this quarter. +As I look ahead, I'm really excited about our holiday merchandising and marketing plans, and I'm confident that our outstanding team will bring those plans to life for our guests, in our stores and digital channels throughout the holiday season. +Our third-quarter results demonstrate continued progress on many of our strategic priorities, reflecting our work on category roles. Sales in strategic categories accelerated in the third quarter, out-comping the Company average by more than 3 percentage points. Signature growth was a key driver behind healthy comp increases in both home and apparel, and we continue to see market share gains in these important categories. +Consistent with our recent strength around events and holidays, third-quarter sales in the back-to-school, back-to-college season, were very strong, resulting in favorable gross margin mix in our sales. In addition, our gross margin rate continues to reflect the cost of goods benefits of our ongoing cost control initiatives. +Within our signature category results, we're seeing exceptional growth in our two new brands we launched earlier this year: pillowfort in kids' home and Cat & Jack in kids' apparel. We developed these new brands in collaboration with both kids and their parents, and our guests continue to respond to the unique combination of style, quality and value these new brands deliver. +We also continue to see robust growth in our digital sales. Digital sales grew more than 26% in the third quarter, and they've grown more than 20% year to date. This year we have devoted both capital and expense to improve the digital experience, increase reliability, and create additional capacity, and we're seeing really encouraging results. +This quarter we ran a promotion that, among other things, allowed us to stress-test our systems in advance of the fourth quarter. This promotion was an unprecedented and compelling offer for our guests, 10% off our entire assortment in both stores and digital channels. As you'd expect, the offer drove strong traffic and sales in all channels, but our digital comp on that day was particularly high. +In the face of a very strong surge in traffic, I'm happy to report that our system performed very well, providing us valuable insight as we prepare for even bigger days this holiday season. Last year, to support our strategic investments in Target's digital capabilities, supply chain, and store experience, we launched a comprehensive cost savings effort to free up resources and create capacity, and our team has really delivered. +We had an ambitious goal, to take a total of $2 billion out of Target's expenses and cost of goods over a two-year period, yet, as we approach the end of that two-year period, I'm pleased that our team has actually exceeded our $2 billion goal. And importantly, the team has identified additional opportunities we'll pursue in future years. The ability to create additional capacity is critical, given the sizable investment we'll continue to make as we position our business for long-term growth. +Finally, we are really excited about the continued strong performance of our new flexible format stores. These new locations allow us to reach new neighborhoods in dense urban and suburban markets. We opened another five of these stores across the country in the third quarter, including our fantastic new store in the Tribeca neighborhood of New York City. +When we open and operate these stores, we go beyond legacy systems and processes, customizing assortment and operations to fit the characteristics of the individual neighborhoods in which we operate. And we continue to see phenomenal responses from our guests. +Including this quarter's openings, we are now operating nearly 30 of these new format stores. Based on their performance, we are increasingly confident in the opportunity for Target to profitably operate hundreds of urban flex format stores over time, reaching new neighborhoods where consumers have a strong affinity for our brand. +As we look ahead to the fourth quarter and beyond, we are continuing to address the challenges I described on our last conference call. First and foremost is traffic. And while we saw considerable improvement this quarter, we are committed to growing our comp traffic and sales over time. +A key factor is our ability to deliver on both sides of our expect more, pay less brand promise, and our signature category performance demonstrates that we continue to deliver on the expect more side. However, earlier this year we began to fall short in communicating value to support the pay less side, both in our stores and in our marketing. +In the third quarter, we began to address that imbalance by communicating our commitment to value more clearly. We believe those changes were instrumental in driving improved traffic and comp sales in the third quarter. Going forward, we are committed to striking the appropriate balance in all of our marketing communications. +We also continued our work to improve the performance of our assortment of convenient, self-service food in our stores. We saw another small decline in food comp sales in the third quarter, reflecting near-term challenges presented by deflation and an intensely competitive environment. Despite these near-term challenges, we are focused on delivering stronger growth over time, and Mark will outline his team's plans in a few minutes. +In addition, comp sales in our electronics and entertainment categories continued to underperform the Company average. However, in the third quarter we were encouraged to see a meaningful improvement in sales of Apple products, driven by their introduction of several new product innovations. As you know, electronics, entertainment and toys are key gifting categories in the fourth quarter, and the team is excited about their plans to compete and win at this critical time. +Finally, we continue to work with CVS to drive script count growth into pharmacies in our stores. As a result of our coordinated marketing efforts, which include our stores, our weekly ad, and CVS direct communication to their PBM members, we measured an increase in consumer awareness of the transition of our stores' pharmacies to CVS, and we've seen a corresponding improvement in the script trends in these pharmacies. We continue to believe our CVS partnership will be an important traffic driver over time, and we expect to see significant improvement in 2017. +Before I turn the call over to Mark, I want to pause and reflect on the progress and the business results through the first three quarters of the year. When you focus on the top line, you'll see that we've generated essentially flat comps through the first nine months of the year. This is well below the expectation we had at the beginning of the year, and our first and highest priority is restore growth for the traffic and sales trends. +However, when you move to the bottom line, you'll see that we've grown adjusted earnings per share more than 10% in the first nine months of the year. This is outstanding performance, but it's particularly noteworthy in light of the sales challenges we've been facing. The performance is a testament to the resilience of our underlying business, our strategy, and of course our team, the best team in retail. +Now I'd like to welcome Mark Tritton onto the call. Mark comes to us with an impressive history in retail merchandising, with experience at Nike, Timberland, and most recently, Nordstrom. Mark is a merchant's merchant, and a strong leader. +Since he arrived at Target, I've been impressed with how quickly he's become immersed in our business and integrated into our team. We're excited to have Mark leading merchandising, and I know he's excited about our plans for the fourth quarter and beyond. So with that, I'll turn it over to Mark who can provide more details on category performance in the third quarter and our plans to win during the holiday season and beyond. Mark? + +-------------------------------------------------------------------------------- +Mark Tritton, Target Corporation - Chief Merchandising Officer [4] +-------------------------------------------------------------------------------- + + Thanks, Brian, and hello, everyone. I'm so happy to be joining all of you on the call today, and look forward to meeting with you in New York this spring. +As Brian mentioned, I have spent the last several months digging into our business, understanding Target's strengths, and exploring where we have the biggest opportunities to grow. And what I found is a strong business as it stands today, a powerful Target brand, an impressive owned brand portfolio, great-looking stores, a friendly and engaged team, and a huge base of passionate guests. +With these strengths, we also have an amazing opportunity in front of us. It has been energizing to dig in with the team to develop merchandising's plan to drive Target's future growth. I look forward to sharing our vision in detail with you at our financial community meetings. +For today, I'm going to focus on our recent performance and our plans for this quarter and the holiday season. In the third quarter, sales performance improved across nearly every part of our business. +Comp sales in apparel and home accelerated the most, providing a positive mix benefit on the gross margin line. Strong execution and markdown management compounded that benefit, leading to much stronger than expected gross margin in the quarter. +As Brian mentioned, we saw very strong trends in back-to-school and back-to-college, reflecting our focus on key growth categories, and the benefit of improvements we made to our promotional cadence. Digital growth played a big role in the season, particularly in home, which is already one of our biggest and most profitable categories online. +We have continued to see the fastest growth in signature category sales. A few of the highlights from the third quarter include kids, where we've seen outstanding performance in Cat & Jack and pillowfort. We've also continued to generate strong comps in women's ready to wear, on top of outstanding growth in 2015. +And within home, our results were strongest in the day core and seasonal categories. Given the strong growth in signature, both home and apparel saw low single-digit growth in comp sales this quarter, extending our record of market share gains in these strategically important categories. +As Brian mentioned, in electronics, recent product launches helped improve trends in Apple this quarter. However, we continue to see soft trends in mobile phones overall, which is what we've seen in the industry as upgrade cycles are lengthening. In food and beverage, we saw another small comp sales decline this quarter. +As we mentioned the last earnings call, we have an opportunity to more clearly convey and resonate value for our guests in this important category. This is being done through our end cap presentations, enhancing our use of local pricing, and making changes to our promotional cadence, and we expect to see the full benefit from these changes in the fourth quarter. +In essentials where we identified a similar opportunity, we've seen faster progress. As a result, comp sales grew in essentials in the third quarter and we expect to see continued progress this quarter. +Also, as Brian mentioned before, we've seen a meaningful improvement in script counts in the CVS pharmacies in our stores. We've also seeing higher guest services scores compared with the period prior to, and particularly during the conversion of our pharmacies. These improvements show that our guests are moving beyond the temporary disruption caused by those conversions. And with the disruption behind them, they're responding to the services and capabilities that CVS can provide. +As we look ahead to the fourth quarter, we expect to build on our momentum from the third quarter. Target is a destination for seasons, and no season is more important than the holiday. In home, we're looking to build on last year's success, when we saw the biggest comp growth in more than a decade. +Our holiday decor assortment will feature products based on three key seasonal trends: Traditional, Nordic, and modern. New this year, we've created Wondershop, a destination in our stores and on Target.com, that will grab guests' attention and put them in the mood to shop for the season. +Wondershop features thousands of new holiday trim items. In fact, about 70% of the assortment is new this year. We're also bringing back for the holidays our collaboration with stationery designer Sugar Paper, which was a big hit last year. This features a limited edition collection ranging from $1.50 up to $15. +Holiday is an important apparel season for families, and we're well positioned to deliver for our guests, with our you new Cat & Jack collection. This new brand has hit a sweet spot with millennial parents in particular, and we have high expectations for what it can deliver during the holiday season. Between October and December, we're introducing more than 1,000 new pieces to our Cat & Jack assortment. Each piece is under $30, which is an unbeatable value when you consider the design and quality. +As Brian also shared, toys play a key role in the fourth quarter. In fact, we do about 50% of our annual toy sales during this time frame. And this year, we're building on 10 consecutive quarters of growth in toys, reflecting our investments in newness, differentiation, and collectability. +This holiday season, we've added nearly 1,800 new and exclusive toys, up more than 15% from last year. As you recall, Target had the number-one market share in Star Wars last year. This fall we once again led the market with the launch of our Rogue One assortment, and for holiday, we're featuring more than 100 new products. +Beyond Star Wars, Disney Princesses continued to do very well. Elsa from Frozen remains our top-seller, selling more than the other 11 other princesses combined. An emerging trend in board games has been a bright spot for us this year, as families are looking for activities that bring them together. We're seeing double-digit growth in board games so far this year, and we've got 50 Target exclusive games this season for you. +In electronics this quarter, we're planning for strong demand for Apple new products, given that pre-order volume was three times higher than last year. We're also expecting a lot of guest interest in virtual reality, along with connected home devices like Google Home. Elevated service in our electronics department is also important to help make shopping in this area a more enjoyable experience for our guests, and drive incremental sales in our stores. +So in more than 1,500 stores we're transitioning from Target mobile reps who are focused only on mobile, to Target Tech, whose scope will include all of electronics. Last year our exclusive CD from Adele was a massive hit for the holiday season. This year, we've got a collaboration with Garth Brooks, and we expect it to be huge. +Target's 10-disk box set includes Garth's new album with two exclusive tracks, including the much hyped 25th anniversary edition of Friends In Low Places. By the way, Target is the only place you'll ever be able to find that track. The set went on sale for $29.99 on November 11, two weeks before Garth's new album will be available at other retailers. +This year in food and beverage, about 20% of our national brand holiday assortment is exclusive to Target, and we've more than doubled our assortment of craft beers from last year, growing from about 700 to nearly 1,500 options across the country. In our marketing and promotions, we're coordinating everything for our guests, inspiring them with providing ease and convenience during the stressful time of year. From the Wondershop to the Wonderlist gift card, and the kids' wish list app, we're making it easy and fun for guests to find the right gifts for everyone on their list. +Guests loved our 10 Days of Deals last year, so we're bringing back these popular promotions on the days leading up to and following Black Friday. Based on guest insights, we've optimized this year's cadence of deals, and simplified offers to make them easier to understand. In addition, we've worked with our stores to streamline guest communication, freeing up store teams to serve our guests during the busiest time of the year. +And finally, throughout the season, our broadcast ads will build excitement for the Toy Cracker, our take on the classic story of The Nutcracker. We'll release this new holiday story in two four-minute segments during the world broadcast premier of Frozen on December 11. Kids of all ages will not want to miss it. +With all these amazing content, I hope you can see why we are so excited about our merchandise, promotion, and marketing plans for the holiday season. However, as we all know, these plans will only come to life through the work of our operations team. So now, I'm going to turn the call over to John, who will outline how his team is prepared to deliver on those plans, and provide outstanding service to our guests throughout the holiday season. John? + +-------------------------------------------------------------------------------- +John Mulligan, Target Corporation - COO [5] +-------------------------------------------------------------------------------- + + Thanks, Mark, and good morning everyone. Across every aspect of our operations, we are excited and prepared for the peak holiday season, and as a result of this year's efforts to increase the speed, accuracy, and reliability of our network, we're well-positioned to deliver great guest service and a better experience in every channel. In our stores, we've hired and trained tens of thousands of seasonal team members, who are already serving our guests. +Notably, despite the tightest labor market conditions we've seen in some time, our hiring and training process went smoothly. In fact, we met our key training and hiring milestones earlier than a year ago. +When guests shop our stores this holiday season, in addition to great products, displays and services, they'll find our in-stock position is better than we've ever measured, reflecting improvement across every category we sell. And importantly, we're attaining those in-stock levels with lower inventory than a year ago. +Over the last 18 months, we've deliberately invested in our inventory position in key commodity categories, to ensure we remain in stock in categories where reliability is most important to our guests. However, now that we've annualized these investments, and we're beginning to see the benefit of our work to make our supply chain faster and more reliable, we'll be able to deliver outstanding in-stocks on a smaller base of inventory over time. +The accuracy of our inventory data is key to our speed and reliability, and we've been investing in our systems and processes to achieve greater accuracy. One example is our implementation of our FID technology, and a portion of our apparel assortment, which is currently in more than 1,600 of our stores. In affected categories, overall inventory accuracy has increased dramatically, meaningfully reducing the number of occasions in which we can't physically locate an item. +In addition, we've made system changes to optimize replenishment of products that our guests purchase in multiples, and made changes to minimum on-hand standards in higher volume locations, both of which have dramatically reduced out-of-stocks on affected items. We will continue to test and roll out these enhancements throughout next year. Because of our efforts to eliminate non-guest-facing work in our stores, the team is delivering outstanding service to our guests, while delivering efficiency in support of our cost control efforts. +Through the redesign of our in-store replenishment processes and algorithms, we've reduced store back room trips dramatically this year, delivering tens of millions of dollars of payroll savings that we've reinvested in service. Two areas in which we've invested store labor are the store pick-up process and our ship from store capability. +Guests love the flexibility of these capabilities all year, but especially during the holiday season. In fact, during the peak period from Thanksgiving through Cyber Monday, we expect our stores to fulfill more than half of our digital demand. While this is the third holiday season in which we've offered order pick up in all of our stores, we're planning for volume to grow another 50% from a year ago. +Since last year, we've added additional holding capacity to more than 80 of our highest-volume pickup locations, and we've invested in scheduling tools and additional digital devices to enable high-volume locations to deliver fast service, even in peak times. And this year, in more than 300 of our highest volume pickup locations, our stores team will wear unique shirts and deliver separately-branded reusable bags to underscore our commitment to the pickup experience. +By last year's holiday season, about 460 of our stores were shipping directly to our guests, up more than three-fold from about 140 stores in 2014. This year, we've extended this capability to another 600 stores, meaning that well over 1,000 of our stores are shipping directly to our guests this season. In total, these stores are expected to ship more than three times as many units as last year, accounting for about a third of our digital volume during the peak period from Thanksgiving through Cyber Monday. +Shipping from store delivers a number of benefits to our guests, and to our business. Most importantly, this capability reduces shipping times, given the proximity of these stores to the vast majority of the US population. With that proximity to guests, we also save on shipping, helping to relieve the pressure from shipping growth in our P&L. It also allows us to balance our inventory across our store network, maintaining in-stocks while reducing markdowns in store locations with heavy inventory. Finally, store shipping relieves pressure on our fulfillment centers, especially during peak season, allowing the entire network to function more effectively. +Our three delay allocation centers which have all come online this year, are another way we have created capacity. These facilities allow us to aggregate inventory in slower-moving but harder to forecast categories, allowing us to improve our store allocation without hurting lead times. During peak season, we will be fully utilizing these facilities to free up space in our regional DCs, to enhance the overall speed and reliability across our distribution network. +Finally, as a result of our efforts to optimize inbound processes, we expect to double the percentage of our holiday receipts that are processed within 24 hours of arrival. This will enhance our store in-stocks while freeing up meaningful space in our regional DCs, further enhancing speed and efficiency. While we're just getting started, our team is really excited about our progress in modernizing Target's operations, and we're pleased to hear from many of you that you're beginning to notice the difference when you shop with us. While that's great to hear, I want to emphasize that we are not slowing down. +Our team is energized and focused on our plans for the next year and beyond, and I look forward to sharing those plans with you in February. With that, I'll turn it over to Cathy, who will share her perspective on our third-quarter financial performance, and our outlook for the fourth quarter and full year. Cathy? + +-------------------------------------------------------------------------------- +Cathy Smith, Target Corporation - CFO [6] +-------------------------------------------------------------------------------- + + Thanks, John, and hello everyone. Our third-quarter financial performance was much stronger than expected, driven by strong execution across the board. Adjusted earnings per share of $1.04 was 22% higher than last year, and well above the top end of our guidance range. +This performance would be noteworthy in any environment, but it's especially impressive given our challenging sales trends. Comparable sales declined 0.2% in the third quarter. This was a full percentage point better than our second-quarter performance, and near the high end of our guidance range. However, it's well below the growth we expect to generate over time. +With the removal of our pharmacy and clinic sales from this year's results, total sales were down nearly 7% in the quarter. Digital sales increased more than 26%, contributing about 70 basis points to our comparable sales. Digital growth was fastest in our signature categories, and was particularly strong in kids, driven by the strength of our back-to-school offering, and the launch of Cat & Jack. This is particularly exciting because signature categories are items and brands uniquely Target. +Among the components of our comp sales, transactions were down 1.2% in the third quarter, and 1 percentage point improvement from the second quarter. Average ticket increased 1%, in line with our performance so far this year. I want to pause here and make it clear that while we have made significant progress, we are not satisfied with our third-quarter traffic and sales performance. First and foremost, we are focused on restoring growth to both of these metrics over time. +Our REDcard program is our most powerful loyalty vehicle, and it's continuing to grow. Sales penetration on our REDcards was 24.3% in the third quarter, in line with our expectations, and 2 percentage points ahead of last year. Excluding the benefit from the pharmacy transaction, penetration was up about 80 basis points in the quarter, which is consistent with our year-to-date performance. +Moving down the P&L, our third-quarter segment EBITDA margin rate was 9.9%, up from 8.6% last year. About two-thirds of this improvement was driven by an increase in our gross margin rate, combined with the benefit of a lower SG&A expense rate. Specifically, our gross margin rate improved about 80 basis points compared to last year, which was much stronger than expected. This improvement was entirely driven by merchandise mix, resulting from both the pharmacy transactions, and strong performance in our signature categories. +On the SG&A line, we saw about 40 basis points of improvement from a year ago, which reflects the benefit of our ongoing cost control efforts. As John mentioned, we continued to find ways to eliminate non-guest-facing labor in our stores. This creates capacity that allows our team to focus on guest service, while maintaining outstanding efficiency to support our financial performance. +For the first time this year, our quarter-end inventory was lower than a year ago. The team has done a fantastic job responding to the recent slowdown in our sales, by effectively managing inventory and receipts. With this strong execution, we've seen outstanding gross margin performance so far this year. And as we enter the peak of the holiday season, we feel very good about the level and the composition of our inventory. +Let's turn now to capital deployment. We paid $345 million in dividends during the third quarter, and returned another $878 million through share repurchase. A portion of our third-quarter repurchase activity was accomplished through an accelerated share repurchase agreement. A portion of this ASR was settled after the end of the quarter. +Through the first three quarters of 2016, we have repurchased more than $3 billion of our shares, which keeps us on track to invest $3.5 billion or more in share repurchase this year. One thing to note is that during the third quarter, our Board of Directors approved a new $5 billion share repurchase authorization. We'll begin repurchasing shares under this new program when we complete the current $10 billion program. As of the end of the third quarter, we had approximately $300 million of remaining capacity on the current $10 billion program. +And one other item to note. During the third quarter, we obtained a new $2.5 billion credit facility that expires in October of 2021. This new facility replaces a $2.25 billion facility that was scheduled to expire in 2018. +We have never borrowed under any of our prior credit facilities, and we would not expect to borrow under the new one, either. However, it provides an important source of backup liquidity, and it serves as a back stop to our commercial paper program, which we use to fund our seasonal borrowing needs. +Reflecting our focus on disciplined capital deployment, one of our goals is to grow our after tax return on invested capital into the mid-teens over time. I'm pleased to share that we are making significant progress toward this goal. +For the 12 months through the end of the third quarter, our business generated an after tax ROIC of 16.3%. However, that calculation includes the one-time gain from the pharmacy sale, which we recognized in the fourth quarter of last year. Excluding that gain, our third-quarter after tax ROIC was 14.3%, up about 130 basis points from a year ago. +Now let's turn to our outlook for the fourth quarter and full year. Consistent with last quarter, we are maintaining a cautious outlook, given the current environment, and the prospect of a very competitive holiday season. With that in mind, we are planning our fourth-quarter comparable sales to be roughly consistent with our third-quarter performance, in a range around flat, plus or minus 1%. +Total sales are expected to decline about 3% in the fourth quarter, reflecting the removal of pharmacy and clinic sales from this year's results. This will be the last quarter in which we'll be comping over pharmacy and clinic sales from the prior year. +In terms of operating margin, we're expecting our fourth-quarter segment EBIT margin rate will be up slightly, about 10 basis points higher than last year. This outlook is based on an expected 40 basis point improvement in our EBITDA margin rate, driven entirely by a lower SG&A expense rate. +Offsetting this improvement, we expect to see an increase of about 30 basis points in our depreciation and amortization expense rate. This will be driven by approximately $15 million of accelerated depreciation related to our 2017 store remodel program, along with the deleveraging effect of the total sales decline resulting from the pharmacy transaction. +Altogether, in the fourth quarter, we expect to generate both GAAP EPS from continuing operations and adjusted EPS in the range of $1.55 to $1.75. When we combine these fourth-quarter expectations with our year-to-date performance, we're expecting to generate approximately flat comparable sales for the full year, and full year adjusted EPS in the range of $5.10 to $5.30. +Notably, the top half of this updated EPS range is within the range we laid out at the beginning of the year. This demonstrates how effectively our team has performed in the face of unexpected sales challenges. +Looking into next year, our first focus is to restore growth in our traffic and comparable sales. With sales growth, a strong gross margin mix, and continued cost discipline, we believe we can sustainably grow both the top line and the bottom line over time. I look forward to discussing our longer-term aspirations and our outlook for 2017 performance at our meeting with you in February. +Now I'll turn the call back over to Brian, who has a few closing remarks. Brian? + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman and CEO [7] +-------------------------------------------------------------------------------- + + Thanks, Cathy. Before we open up for questions, I want to pause and recap our position, as we enter the final quarter of the year. Year-to-date, comp sales have been about flat, and we believe it's prudent to plan for a similar trend in the fourth quarter. That said, we're very excited about our plans for the holiday season, and our team is focused on outperforming our plans, gaining market share and delivering positive comp sales across our businesses, not just in signature categories. +On the adjusted EPS line, we have grown more than 10% so far this year, and based on our fourth-quarter expectations, our updated range for full-year adjusted EPS overlaps with the original guidance range we provided last March, reflecting the team's strong execution in the face of challenging sales trends. Signature category sales continue to far outpace the Company average, and we continue to gain market share in these categories. And because our digital growth continues to outpace the industry average, we continue to gain share in the digital channel, as well. +So while we continue to adjust our near-term tactics to better maintain the balance on both sides of our expect more, pay less brand promise, we believe we have the right long-term strategic plan to sustain Target's performance over time. I look forward to covering both our fourth-quarter results and our longer-term strategic and financial plans at our financial community meeting, which will we'll be hosting in New York on February 28. We'll be providing more details on timing and location soon, but in the meantime, please mark your calendars for that date. +With that, we'll conclude today's prepared remarks. Now Cathy, Mark, John and I will be happy to respond to your questions. + + +================================================================================ +Questions and Answers +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) +Our first question comes from the line of Bob Drbul with Guggenheim. + +-------------------------------------------------------------------------------- +Bob Drbul, Guggenheim Securities LLC - Analyst [2] +-------------------------------------------------------------------------------- + + I just had a couple of questions for you. On pricing throughout the quarter and into the holiday season, what are you seeing and what are you expecting in competition? +And you talk a little about your ongoing strength in toys. Can you just talk about the drivers to toys in the fourth quarter, and how you expect that to perform as a category? + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman and CEO [3] +-------------------------------------------------------------------------------- + + Bob, good morning. As we think about the holiday season, we expect it to be a very competitive promotional environment, like we've seen over the last couple of years. So we think we've got great plans in place. We're very excited about the merchandising, the marketing and promotional plans, and we think we're going to be very competitive throughout the season. +As it pertains to toys, again, we've had a multi-year positive run in that category. And one of the things that's really been important for us is working with key partners like Disney, Mattel, Hasbro, to make sure we bring new exclusive items to our assortment. As we go into the holiday season, we're excited to have 1,800 exclusive items in that category, and we think these are going to be very important to our guests throughout the holiday season. + +-------------------------------------------------------------------------------- +Bob Drbul, Guggenheim Securities LLC - Analyst [4] +-------------------------------------------------------------------------------- + + Great, Brian. Can I just ask one more follow-up? So when you look at the business over a longer period of time, this has historically been a relatively steady business. +I was just wondering when you look at the volatility between what you saw last quarter and your results, and your forecast for the fourth quarter, within three months, it's a dramatic change in the outlook. Can you just talk a little about exactly what factors are driving this? + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman and CEO [5] +-------------------------------------------------------------------------------- + + Bob, as we think about our strategy and our approach, while we're certainly very pleased with the progress we saw in the third quarter, it's a result of being very focused on the strategy we've had in place for almost 2.5 years now. Our results and the improvement we saw in the third quarter is really driven by, one, our focus on those signature categories, our commitment to apparel and home, baby and kids, where we continue to see very strong growth and market share improvement. +We've been very committed to improving our digital engagement and year-to-date we're up over 20%. We saw 26% growth in the third quarter. And the investments we've been making to improve functionality and ease online is certainly connecting with our guests. +We've been very focused, as we've talked about, in expanding our format into new urban neighborhoods. And every time we open up a new store, whether it's in New York in Tribeca, or Philadelphia, we're seeing a great response from our guests. +And we've been on a journey over the last couple of years to drive greater efficiency throughout our organization, and with John's leadership, we continue to see very strong improvement in operational efficiencies and costs that we're returning to the bottom line. So our focus over the third quarter is very similar to the journey we've been on for the last couple of years, and we've just intensified our focus on executing against our key strategic planks. + +-------------------------------------------------------------------------------- +Bob Drbul, Guggenheim Securities LLC - Analyst [6] +-------------------------------------------------------------------------------- + + Thank you very much. Good luck. + +-------------------------------------------------------------------------------- +Operator [7] +-------------------------------------------------------------------------------- + + Your next question comes from the line of Scott Mushkin with Wolfe Research. + +-------------------------------------------------------------------------------- +Scott Mushkin, Wolfe Research - Analyst [8] +-------------------------------------------------------------------------------- + + Good performance in controlling the controllable. Just kind of wanted to step back. We've got traffic that's negative, and trying to understand, as we get out to next year and the year beyond, where obviously you are doing a great job controlling SG&A costs, but it's very hard for a retailer like Target to run this balance with traffic down and sales flat, especially with wage costs rising as rapidly. +So Brian, if you could take us out and talk about the strategy to drive traffic, get the sales up. I think you threw the number out there, 3% comp growth 2017 and beyond. Just how do we get there? + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman and CEO [9] +-------------------------------------------------------------------------------- + + As we think about the next several years, you're going to continue to see us make significant investments in our assets, improve the in-store experience. We're already seeing the benefits of the investments we've made in apparel and home. We're very pleased with some of the learnings from LA25 that we'll be transitioning into our new remodels as we go forward. +So we think the importance of the in-store experience, great customer service, continuing to bring newness to our assortment, elevating and developing our own brands. I think one of the big highlights for Target in 2016 is the way our guest has reacted to two great new brands, both Pillowfort and Cat & Jack have been incredibly well-received. The style, the quality, the value we're delivering is connecting with our guest. +So the combination of great in-store experience, making sure we surround our guest with great customer service, whether they're shopping in our store or they've ordered online and they're coming in to pick up that order. And then delivering great Target brands at a value. So we think that combination is the strategy that drives traffic into our stores, cars into our parking lot, and even more engagement online. + +-------------------------------------------------------------------------------- +Scott Mushkin, Wolfe Research - Analyst [10] +-------------------------------------------------------------------------------- + + Perfect. And just as a follow-up to thinking about the 2017 and beyond. I know CVS was out, it was last week. They're losing a lot of scripts because of dynamics that are going on there. +Clearly you don't -- scripts don't matter anymore to you, but how about the traffic impact on Target as we get into 2017 and beyond? Have you thought about that, and what that could mean? + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman and CEO [11] +-------------------------------------------------------------------------------- + + Scott, I will start with, scripts matter a lot to us. And key to the partnership with CVS is making sure we're working together to drive scripts, because back to the importance of traffic, scripts will be an important part of driving traffic to our stores, and we were very pleased in the third quarter with the progress we were seeing. +We're seeing much greater awareness now that we've competed the new branding. The combination of our in-store marketing and CVS marketing at their PBM is driving increased traffic to the pharmacies, so that is a very important lever going forward. And we're very confident in our partnership. +John Mulligan works very closely with the CVS team. We've got great plans in place for the fourth quarter, and even stronger plans as we go into 2017. +So that is a very, very important part of the traffic equation. And we think over time that's going to be a key driver of traffic into our stores. + +-------------------------------------------------------------------------------- +Scott Mushkin, Wolfe Research - Analyst [12] +-------------------------------------------------------------------------------- + + Perfect. Thanks for taking my questions. + +-------------------------------------------------------------------------------- +Operator [13] +-------------------------------------------------------------------------------- + + Your next question comes from the line of Greg Melich with Evercore ISI. + +-------------------------------------------------------------------------------- +Greg Melich, Evercore ISI - Analyst [14] +-------------------------------------------------------------------------------- + + I really wanted to follow up on grocery and food and the strategy there, and how we're going to use that to drive traffic. Also on traffic, an update on your digital initiatives. I know you were doing some tests of combining Cartwheel with REDcard. Just wanted to hear how those were going, and how you think those could help drive traffic into next year? + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman and CEO [15] +-------------------------------------------------------------------------------- + + Greg, let me start on the grocery side. Clearly, we have more work to do there, but we feel like we're making very good progress. Changes we made to assortment, improvements we've made to the quality of our produce items, and we're certainly pleased with the reaction we're seeing as we enhance the experience in our LA25 stores. +That being the case, we've got to continue to make sure we build a greater connection with our guest, as it pertains to the convenient food offering we provide. Mark and I are working closely on the next phase of our grocery evolution, to make sure that we continue to provide the right assortment, the right value, the right quality our guest expects from Target, while they're shopping our store. So you'll see a lot more of that, when we get together in February, but we recognize that's an area that we've got to continue to drive progress in. +From a loyalty standpoint, we are working very closely with the marketing team, to ensure that when we get together with you in February, we'll be able to talk about the next iteration of our personalization and loyalty programs. Key to that, Greg, is bringing together some of the great assets we already have in place, leveraging our REDcard, leveraging Cartwheel, which continues to see great response from the guests, and making it easy for the guests to leverage the existing loyalty assets we have in place. So we think that's a key unlock as we go into 2017 and beyond, and that will be a key topic of conversation when we see you in February. + +-------------------------------------------------------------------------------- +Operator [16] +-------------------------------------------------------------------------------- + + Your next question comes from the line of [Brandon Fletcher] with Bernstein. + +-------------------------------------------------------------------------------- +Brandon Fletcher, Bernstein - Analyst [17] +-------------------------------------------------------------------------------- + + First time caller, long time listener. Great quarter, fantastic. Our core question is, who else can win in urban environments? +I know you only have a few dots with the flexible formats, but we think you are pretty far ahead in terms of the knowledge, how to run mass merchants in urban stores. And mostly of your competitors are pharmacy stores who are good competitors, but boy, they need a whole lot of price to make it work. Do you see somebody else who is dangerous around the corner for taking this spot in cities, obviously besides Amazon going ever more urban? + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman and CEO [18] +-------------------------------------------------------------------------------- + + We're very focused on our own opportunity. We're in 30 locations today. We think we have the opportunity to enter many, many new neighborhoods. We're really focused on making sure we build the back-end capabilities in supply chain, in assortment management, the in-store operating capabilities it takes to run these smaller stores. +We think the unique opportunity we have is bringing the best of Target to these individual neighborhoods, making sure that we custom tailor assortment, we bring the right assortment of apparel and home, baby and kids that's right for that neighborhood, complement it with convenient foods and household essentials that really make that local Target run impactful for the guest. So we're still learning. We're very pleased with the feedback. +But as we enter very competitive markets like New York, we're going to learn a lot from Tribeca, we'll take that to other locations. As we do more and more business adjacent to college campuses, we'll understand more and more about the needs of the college student. We really think right now, we've got a unique opportunity to leverage this new footprint as a future growth element in our strategy, and the guest continues to say thank you every time we enter a new neighborhood. + +-------------------------------------------------------------------------------- +Brandon Fletcher, Bernstein - Analyst [19] +-------------------------------------------------------------------------------- + + Thanks. + +-------------------------------------------------------------------------------- +Operator [20] +-------------------------------------------------------------------------------- + + Your next question comes from the line of Matt Fassler with Goldman Sachs. + +-------------------------------------------------------------------------------- +Matt Fassler, Goldman Sachs - Analyst [21] +-------------------------------------------------------------------------------- + + My question is focused on gross margin where you really turned the corner year-on-year when you back out the pharmacy business. You also spoke to the impact of mix. But can you talk about the impact that you're seeing from cost cuts at the point of purchase for you, and how deep we are into that effort, whether you expect that to be sustained going forward? + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman and CEO [22] +-------------------------------------------------------------------------------- + + Matt, I'd start with, we feel really good about the way Mark and his team have managed gross margin throughout the quarter. But it's really a byproduct of the strength we continue to see in those important signature categories, and both in store, but importantly online. Our growth has been led by apparel and home, great strength in baby and kids, those important high-margin categories that drive differentiation for our brand. +So the benefits that we're seeing in gross margin are a byproduct of the strategy we had in place, and really making sure that we're building market share, we're bringing great style and design and newness to those signature categories. The payback has been margin expansion while we continue to invest in value, and getting back to rebalancing our brand promise. We're bringing tremendous product to the expect more side. +And now we've rebalanced our value message on a pay less side. So we were able to invest in value throughout the third quarter, and still see gross margin rate expansion. So we feel really good about the balance we're bringing there, and think that could be sustained over time. + +-------------------------------------------------------------------------------- +Matt Fassler, Goldman Sachs - Analyst [23] +-------------------------------------------------------------------------------- + + Thank you, Brian. + +-------------------------------------------------------------------------------- +Operator [24] +-------------------------------------------------------------------------------- + + Your next question comes from the line of John Zolidis with Buckingham Research. + +-------------------------------------------------------------------------------- +John Zolidis, Buckingham Research - Analyst [25] +-------------------------------------------------------------------------------- + + Great to see the sequential improvement in trends. Question about some of the metrics within the comp. +Looking at the average unit retail up 3.5%, and units per transactions down, I noticed that has been the case for about 10 consecutive quarters now. So just curious if you could talk about what's driving the average unit retail up, and units per transaction down? Thank you. + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman and CEO [26] +-------------------------------------------------------------------------------- + + Again, John, it comes back to the mix of our business, and the strength we're seeing, particularly in categories like home. The strength we're seeing in apparel and accessories, some of the strength we're seeing in baby and kids. So those are important categories. +Obviously in many cases, higher ticket, still a great value for our guest, but higher ticket. And obviously offset by some weakness we've seen in the grocery category. +So the mix is clearly impacting those metrics you're seeing. And we feel very good about the way the guest has reacted to the quality, the style and the value we're offering in those signature categories. + +-------------------------------------------------------------------------------- +John Zolidis, Buckingham Research - Analyst [27] +-------------------------------------------------------------------------------- + + Is the e-commerce growth also a factor then? I would imagine that's more focused into the higher ticket categories. + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman and CEO [28] +-------------------------------------------------------------------------------- + + Absolutely, and again, as we noted in our earlier comments, while overall we saw our digital business grow by 26%, the bulk of that business, the high growth areas were in apparel and home. So again, higher ticket items, we feel really good about the progress we're making from a digital mix standpoint, and that's also coming through in the metrics you're seeing. + +-------------------------------------------------------------------------------- +John Zolidis, Buckingham Research - Analyst [29] +-------------------------------------------------------------------------------- + + Great. Thanks and good luck. + +-------------------------------------------------------------------------------- +Operator [30] +-------------------------------------------------------------------------------- + + Your next question comes from the line of Chris Horvers with JPMorgan. + +-------------------------------------------------------------------------------- +Chris Horvers, JPMorgan - Analyst [31] +-------------------------------------------------------------------------------- + + I want to think about the shift of the digital promotion in the second to the third quarter. How large of a contributor was that to your delta in comp performance in the third quarter versus second quarter? I ask this because if we look at these two quarters together, that's the low end of your 4Q guide. +And so as we look ahead, what are the big efforts or big drivers that you think drive the business to potentially the higher end of that range? Is it the focus on your customer tends to shop more around events? Is it the merchandising side? +What drives the higher end of the comp outlook for 4Q? + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman and CEO [32] +-------------------------------------------------------------------------------- + + Chris, backing up and I know there are a number of embedded questions there, there was some shift because of the promotion between Q2 and Q3. I'd really focus on the year-to-date number. Year-to-date from a digital standpoint, we've been growing at 20%. +As we talked about earlier in the call, we're very pleased with the reaction we're seeing during key event periods. Back-to-college, back-to-school, a very important period for us, both in-store and online. And we think the combination of the investments we've made to improve ease, functionality of our digital engagement, and the fact that we're certainly showing the ability to win during key holiday and thematic periods, that's the right balance for us going forward. +We think digital is going to be an important part of our growth strategy going forward. We think digital is certainly the way our guest interfaces with the brand, whether they're in-store or online, and we're very pleased with the progress we're making. Our overall growth rate is approximately 2X the digital industry. +So we're building market share. We're winning during key seasons. And we certainly expect that to be a key driver to our fourth-quarter success. + +-------------------------------------------------------------------------------- +Chris Horvers, JPMorgan - Analyst [33] +-------------------------------------------------------------------------------- + + And then just one quick follow-up question. Can you talk about how much -- I think CVS was 60 or 70 basis points to the gross margin in the third quarter. +You're going to start to lap that in the fourth quarter, it sounds like you're guiding to flat. Help us understand how that progresses out into the fourth quarter. Thanks very much. + +-------------------------------------------------------------------------------- +Cathy Smith, Target Corporation - CFO [34] +-------------------------------------------------------------------------------- + + Chris, this is Cathy. As we said, we're guiding for EBIT margin to be up about 10 basis points. We do -- CVS was -- we closed it remember, about halfway through the fourth quarter last year, so we'll get a little bit of that impact still. +The biggest driver in the fourth quarter as we said was the -- is SG&A. So we'll continue to see some improvement there, and that's going to get us that 10 basis of EBIT margin. + +-------------------------------------------------------------------------------- +Chris Horvers, JPMorgan - Analyst [35] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Operator [36] +-------------------------------------------------------------------------------- + + Your next question comes from the line of Robert Ohmes with Bank of America. + +-------------------------------------------------------------------------------- +Robert Ohmes, BofA Merrill Lynch - Analyst [37] +-------------------------------------------------------------------------------- + + Congrats, Brian and team on great work in what's not been an easy environment. + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman and CEO [38] +-------------------------------------------------------------------------------- + + Robert, we appreciate that. Thank you. + +-------------------------------------------------------------------------------- +Robert Ohmes, BofA Merrill Lynch - Analyst [39] +-------------------------------------------------------------------------------- + + The question I had was just -- was actually, this might be more of a John Mulligan question. I was hoping, John, you could give a little more detail on what the opportunities are from here in terms of in-stocks, RFID, the stuff you're working on, and how that could support store comps as you -- in the fourth quarter and as you head into next year? + +-------------------------------------------------------------------------------- +John Mulligan, Target Corporation - COO [40] +-------------------------------------------------------------------------------- + + Great question, Robbie. I think the team has made a lot of progress, and as we said, at least the way we measure it today, our in-stocks, out of stocks is actually the number we focus more on, is at our historically low number. So we feel great about that. +Having said that, we think there continues to be significant opportunity for us and I think we see opportunity first at a store level, ensuring we always have what the guest wants when they walk in, because even though we've improved meaningfully, there's still a lot of distance there to go. And then more important than that, digitally ensuring we have the right unit at the right place for the guest, whether they want to come in store and pick it up, whether we're going to ship that from a store, or ship that from a fulfillment center. +Today, we're not completely optimized there, either. While we've seen great progress, and there's absolutely benefit to the guest and their trust with us when they come into the store over time, we still think there's a lot of runway there for us to improve. And you'll continue to see us focus on reliability and speed in our supply chain, and those are the two things that we will continue to drive against, over not only next year but the next several years. + +-------------------------------------------------------------------------------- +Robert Ohmes, BofA Merrill Lynch - Analyst [41] +-------------------------------------------------------------------------------- + + Great. Thanks so much. + +-------------------------------------------------------------------------------- +Operator [42] +-------------------------------------------------------------------------------- + + Your next question comes from the line of Dan Binder with Jefferies. + +-------------------------------------------------------------------------------- +Dan Binder, Jefferies LLC - Analyst [43] +-------------------------------------------------------------------------------- + + You highlighted that back-to-school was strong for you and it seems that the consumers are shopping Target when there is an event, which could be good for holiday. I'm curious what you saw in the post back-to-school period, and just generally, when you look back over the last year or so, in between big events, whether it's Memorial Day event, or Father's Day event or such. And what you're seeing in those traffic trends between the big events. + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman and CEO [44] +-------------------------------------------------------------------------------- + + Dan, it's a great question and obviously we feel really good about the support we received during back-to-college and back-to-school. In those off holiday periods, we've got to make sure we've got the right balance between newness and those important style categories, and great value in our household essentials and food. +Mark and his team have spent a tremendous amount of time reshaping our promotional strategies, making sure that both in our circular, but also in store. It's really clear to our guest that we've got this great combination of newness and style, and the value our guest deserves and is looking for in those key household essential areas. So we've done a lot of work in-store. +I think with Mark's leadership, we're clarifying value on our end caps, clear assortment that connects with the guest in those off-holiday periods. So I feel really good about the progress. You'll see more of that as we go into the fourth quarter. +But why don't I let Mark talk about some of the work that he's been leading, as we think about really ensuring that value message is very clear to our guests, when they're walking our stores each week? + +-------------------------------------------------------------------------------- +Mark Tritton, Target Corporation - Chief Merchandising Officer [45] +-------------------------------------------------------------------------------- + + Yes, hi Brian. Thanks, John. What we've seen is a hyper competitive market in the first half of the year and it really made us take stock to look at how do we represent and resonate value to our guest more readily. +So what you're seeing emerging in third quarter and more in the fourth quarter and beyond is a representation not just of price and value in our circulars, as Brian talked about, but in store ensuring the guest clearly sees that value up front and center. Representation on our end caps, increasing single price point end caps to really generate a buzz about our value, and really delivering on expect more, pay less. +So this is a continuing trend, and then the spaces between the key seasonal events that you raised, as Brian said, we're hyper focused on that. We've seen some strength in some of our options that we've put in place, and really looking forward to our plans about how do we continue guest traffic and post major events, where we do win. + +-------------------------------------------------------------------------------- +Dan Binder, Jefferies LLC - Analyst [46] +-------------------------------------------------------------------------------- + + If I could just another question, the last quarter or two you've highlighted that the electronics business was I think about a 70 basis point hit to the comps. I was just curious if you could help us understand what that looked like in Q3. +On the scripts that you mentioned that are getting better, trend wise it sounds positive. But I was curious if you look at the script trends relative to what you were doing when you owned the pharmacy business, if there's some relevant measure could give us there, that would be helpful. + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman and CEO [47] +-------------------------------------------------------------------------------- + + Let me start with E&E. As I mentioned in my earlier comments, we feel really good about our plans for the fourth quarter. And obviously entertainment, electronics and toys are critically important gifting items for the fourth quarter. +So again, I think the work that Mark and his team have done to make sure, working with our vendor partners, we have a combination of new items, exclusive items, items that are on trend, we've seen a great reaction to our toy and gifting catalog, and we think that we're very well positioned for the fourth quarter. Those categories did trend downward in Q3, but the important part of the year is in front of us, and I think we're very well-positioned. +From a script standpoint, we are still rebuilding some momentum in that space, but sequentially we've seen improvement from Q1 to Q2 and Q3. We recognize that with time, as the branding's in place, as our in store marketing and the CVS marketing takes shape, we're going to be rebuilding and growing scripts in that very important part of our store. Operator, we've got time for one more call. + +-------------------------------------------------------------------------------- +Operator [48] +-------------------------------------------------------------------------------- + + Our final question comes from the line of Oliver Chen with Cowen and Company. + +-------------------------------------------------------------------------------- +Oliver Chen, Cowen and Company - Analyst [49] +-------------------------------------------------------------------------------- + + Solid margin and inventory control. Just wanted to ask you about fill-in versus stock-up. It's likely related to the progress you made toward the value messaging. So just curious about how you're feeling about that dynamic? +And then I wanted you to try to brief us on the reality versus Amazon. The near term strategies, in terms of how you'll be competitively positioned versus Amazon in the holiday season, and then, as you look to bricks and clicks in the seamless experience over the longer term for long-term investors, what should the key factors be, as we engage in that share opportunity versus Amazon? Thank you. + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman and CEO [50] +-------------------------------------------------------------------------------- + + Oliver, great way to wrap up the call. From a fill-in and stock-up standpoint, again, the work that Mark just talked about on the value side, is clearly addressing the fill-in guest. I feel very good about the progress we've made and will continue to make in that space. +I think to the broader question, it's a terrific way for us to wrap up before we all get together in New York City. We continue to feel very good about the strategy we have in place, and how that will allow us to be very competitive, and continue to win in the current retail environment. We think the investments we're making in our stores are critically important, and that store experience that we continue to elevate is a very important measure for our guest. +We've learned, as I hope you have, guests still like physical stores. And year-to-date, still almost 90% of all retail shopping is taking place in a physical store. So we've got to make sure we've got a great experience, we've got great service, we continue to elevate that experience and service, and combine it with outstanding merchandise and value every time our guests shop. +We think our strategy of moving into new neighborhoods, whether it's these densely populated urban centers or on college campuses, is a critical growth vehicle. And again, the reaction we've seen every time he we open up a store in Boston, Philadelphia, Chicago, and certainly in New York, tells us our guest loves the convenience of having Target right there in their neighborhood. +But we're also continuing to make investments online. And we want to make sure we continue to give our guest the choice of shopping any way they want. The ease of shopping online and picking up in our store, which we think is going to be a very important factor during the fourth quarter. +But building out those capabilities, leveraging our stores as flexible fulfillment centers. As we go into this holiday season, well over 1,000 locations will be locations that not only you can shop in and pick up, but we're using to deliver the last mile. We think that's a huge competitive advantage. +So we feel very good about the strategy we have in place. We think it's a strategy that will win, not only in the short term, but over the long term. We look forward to seeing all of you in New York in February. +So with that, operator, we're go to wrap up our third-quarter call. I appreciate everyone participating, and we look forward to seeing you in New York in February. + +-------------------------------------------------------------------------------- +Operator [51] +-------------------------------------------------------------------------------- + + Thank you for your participation. This does conclude today's conference call, and you may now disconnect. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/exam/original-files/Problem_2_3_Sample_full_transcripts/2016-Oct-14-JPM.N-136934024381-Transcript.txt b/exam/original-files/Problem_2_3_Sample_full_transcripts/2016-Oct-14-JPM.N-136934024381-Transcript.txt new file mode 100644 index 0000000..17565a2 --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_full_transcripts/2016-Oct-14-JPM.N-136934024381-Transcript.txt @@ -0,0 +1,536 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q3 2016 JPMorgan Chase & Co Earnings Call +10/14/2016 08:30 AM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Marianne Lake + JPMorgan Chase & Co. - CFO + +================================================================================ +Conference Call Participiants +================================================================================ + + * Gerard Cassidy + RBC Capital Markets - Analyst + * Erika Najarian + BofA Merrill Lynch - Analyst + * Mike Mayo + CLSA - Analyst + * Eric Wasserstrom + Guggenheim Securities LLC - Analyst + * Glenn Schorr + Evercore ISI - Analyst + * Tim Hayes + FBR & Co. - Analyst + * Ken Usdin + Jefferies - Analyst + * Matt O'Connor + Deutsche Bank - Analyst + * Steve Chubak + Nomura Asset Management - Analyst + * Betsy Graseck + Morgan Stanley - Analyst + * Jim Mitchell + Buckingham Research Group - Analyst + +================================================================================ +Presentation +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- +Good morning ladies and gentlemen. Welcome to JPMorgan Chase's third-quarter 2016 earnings call. This call is being recorded. +(Operator Instructions) +We will now go live to the presentation. Please stand by. +At this time I would like to turn the call over to JPMorgan Chase's Chief Financial Officer Marianne Lake. Ms. Lake, please go ahead. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [2] +-------------------------------------------------------------------------------- +Thank you. Good morning everyone. I am going to take you through the earnings presentation which is available on our website. +Please refer to the disclaimer at the back of the presentation. Starting on page 1 and taking a look at the quarter we had strong performance in each of our businesses despite the continuation of reasonably challenging conditions. +Bringing it all together this quarter's result was clean with no significant items and with the firm reporting net income of $6.3 billion, EPS of $1.58 and the return on tangible common equity of 13% on $25.5 billion of revenue. Highlights of the quarter include the highest reported revenue for a third quarter in CIB with IBCs up 15% and markets revenues up 33% with strong performance across the board. +Robust core loan growth for the Company of 15% on the back of sustained demand across businesses. And the continuation of strong credit performance including a net release for Oil & Gas. +Card sales are back to double-digit growth year on year and we saw a strong positive market reaction to new proprietary products. Finally, we had record consumer deposit growth up 11%. +Before I move on we recently submitted our 2016 resolution filing. The Board and management believes that we submitted a credible plan and more than met the requirements for the October submission. It was a tremendous effort across the Company involving all businesses and functions and we took many significant actions, perhaps most notably improving the firm's overall liquidity and pre-positioning our material legal entities for both liquidity and capital. +We determined this is in the best interest of the Company, albeit at some cost. We took many other important actions which hopefully you've had the chance to review in our public filings. +Moving back to the quarter and moving on to page 2 revenue of $25.5 billion was up $2 billion year on year or up 8%. On the back of continued strong growth in core loans net interest income was up $700 million and is trending for the full year to be above the $2.5 billion guided last quarter. +Non-interest revenue was up $1.3 billion driven by strong performance in the CIB. Adjusted expense of $14.5 billion was up $500 million both year on year and quarter on quarter, largely driven by two notable expense items in Consumer which I'll talk about later as well as the increase in FDIC surcharge which took effect this quarter and some higher marketing expense. +Credit cost of $1.3 billion in the quarter includes Consumer reserve builds of $225 million primarily Card. But against that we have a net reserve release in wholesale for Oil & Gas of about $50 million. +So as I said net income was $6.3 billion. And while down 8% year on year you will recall that there were a number of significant items in last year's results, most notably significant tax benefits. If you adjust for tax, legal expense and credit reserves net income is up over $800 million year on year. +Dealing with Oil & Gas here, we are encouraged by how quickly investor sentiment and risk appetite for the sector returned as the outlook for both oil and gas prices continued to improve. Capital markets opened more broadly to these clients and we experienced lower draws against our facilities than previously anticipated. +So a combination of paydowns, opportunistic loan sales and select upgrades more than offset the impact of downgrades. If the environment remains broadly consistent with today we would not expect further significant builds in the fourth quarter for energy. +Moving to page 3 and capital, key takeaways from this page, capital and leverage ratios were broadly flat quarter on quarter with a CET1 ratio of 11.9% as net capital generation was offset by strong loan and commitment growth. Our spot balance sheet closed a little over $2.5 trillion, principally a result of strong deposit growth as well as liability actions taken to raise liquidity in the context of resolution which also drove up liquid assets. +While HQLA was up $23 billion quarter on quarter, our liquid assets were up significantly more than that as excess liquidity at the Bank is not included in reported HQLA. Finally, we returned $3.8 billion of net capital to shareholders including $2.1 billion of net repurchases and common dividends of $0.48 a share. +Moving on to page 4 and Consumer & Community Banking. Consumer & Community Banking generated $2.2 billion of net income and an ROE of 16%. We continue to experience record deposit growth, more than twice the industry average, up 11% year on year. +More than half of that growth is from existing customers. Based on the FDIC survey for 2016 we were number one in absolute growth and grew share in each of our top 30 markets. +Core loan growth remained strong at 19%. And while it's primarily driven by Mortgage we also saw 14% growth in Auto, 9% in Business Banking and 7% in Card loans. +Card new account originations were up 35% with strong demand for Sapphire Reserve and Freedom Unlimited and with more than three-quarters of new accounts being opened through digital channels. Card sales volume was up double digits this quarter and we expect share gains to accelerate. +So to close on drivers, we saw merchant processing volumes up 13% and our active mobile customer base up 17%. Revenue of $11.3 billion was up 4% year on year. Consumer & Business Banking revenue was also up 4% on the back of strong deposit growth. +Mortgage revenue was up 21% on higher MSR risk management but also on higher production margins and growth in NII as we continue to add high quality loans to our portfolio. Card, Commerce Solutions & Auto revenue was down 1% as the strong momentum in Card and Auto volumes and balance growth was offset by higher Card origination costs and the remaining impact of co-brand renegotiations. And while the new account origination costs do cause a near-term drag on revenue it's a high-class problem to have as we expect these accounts will be strongly accretive over time. +Looking forward, assuming strong demand for Sapphire Reserve through the fourth quarter we would expect revenues for CCSA to be down about $200 million quarter on quarter on higher acquisition costs. But it will clearly be dependent on the number of new accounts originated. +Expense of $6.5 billion is up year on year, as I said, driven by two notable items totaling $175 million as well as the increased FDIC surcharge. The first item relates to liabilities assumed from a merchant in bankruptcy and the second is a modest increase in reserves for mortgage servicing. Underlying this expense performance is an incremental investment of $250 million in marketing and auto lease growth which is in line with Investor Day guidance and largely self-funded with expense efficiency. +Finally, the credit environment remains favorable. In Card we built $200 million of reserve this quarter, reflecting growth in the portfolio including newer vintages which have a higher loss rate than the portfolio average, consistent with our discussion during the second quarter and consistent with how we underwrite the loans. In Auto we built $25 million of reserves on the back of high-quality loan growth. +Now turning to page 5 and the Corporate & Investment Bank. Total revenues for CIB of $9.5 billion, up 16% year on year, was the best reported performance for a third quarter and included the highest IBCs on record for a third quarter, too, up 15%. With strong market performance across the board, revenues up 33%. +Expense was down 20% year on year on lower legal costs but also with strong expense discipline more broadly. Coupled with solid credit performance, including a modest reserve build for Oil & Gas here, the business delivered a pretty clean $2.9 billion of net income and a 17% ROE this quarter. +Diving deeper, IB revenue of $1.7 billion was up 14% year on year with strong performance across products. We ranked number one in global IDCs, maintaining share on a year-to-date basis, and ranked number one in North America and EMEA. +Advisory fees were up 8% year on year. And we continue to rank number two globally and have done more deals than anyone else so far this year. +In equity underwriting fees were up 38% year on year. With a stable market backdrop and strong investor demand issuance was up across products and particularly in IPOs. +We ranked number one in wallet globally and in North America and EMEA. And we also ranked number one on a number of deals basis for overall ECM and IPOs. +Debt underwriting had the highest third quarter on record with strong market-wide bond issuance, record high grade bond supply in August and yields near record lows. Fees were up 12% from a high water mark last year and we ranked number one. +In terms of outlook given the strength this quarter we expect IDCs to be down in the fourth quarter sequentially but relatively flat year on year. Markets revenue of $5.7 billion was up 33% year on year, clients were active and risk management conditions were favorable. Fixed income revenue was up 48% compared to a weaker third quarter last year. +Rates was a standout in terms of performance this quarter as markets stayed active post-Brexit with good client flow as well as anticipation of and uncertainty around central bank actions. Currencies in emerging markets matched a very strong third quarter last year but was slowed down slightly. Credit and securitized products came back from a weak prior period with a recovery in the energy sector and central bank actions motivating clients to put money to work, producing a much more constructive market making and new issuance environment, resulting in a particularly strong quarter. +Equities revenue was up 1% compared to a strong third quarter last year with Asia matching last year's strong performance and strength in North America flow derivatives offsetting weakness in cash volumes. Taking treasury services and security services revenues together, each were over $900 million with strong forward pipelines and levers to higher rates. +Moving on to page 6 and Commercial Banking. Commercial Banking reported record net income of $778 million on revenue of $1.9 billion and an ROE of 18%. Revenue was up 14% year on year driven by a trifecta of NII on loan growth, higher deposit spreads as well as higher IB revenues. +Loan growth continued to be strong across both C&I and CRE, outperforming the industry. C&I loans were up 10% year on year despite competition for quality loans as the investments that we've been making this year are delivering results. We've added over 100 net new bankers, opened seven new offices and further built out our specialized industry coverage and we've added nearly 600 new relationships in middle market this year. +CRE loans grew 19%, reflecting strong originations in both Commercial Term Lending and Real Estate Banking. We are also seeing favorable to improving new loan spreads. +IB revenue was up 57%, in part driven by a few large transactions, but bringing year-to-date IB revenues closer to flat versus last year which is a strong performance. Expense growth of 4% is driven by our investments and as I said these investments are already paying off. +Finally, credit performance remained strong with a net charge-off rate of 10 basis points, roughly half of which was driven by Oil & Gas. In addition, you see further reserve releases for Oil & Gas here as I mentioned earlier. Outside of energy, credit quality is good and the commercial real estate portfolio had no net charge-offs during the quarter. +Leaving the Commercial Bank and moving on to Asset Management on page 7. Asset Management reported net income of $557 million with a 29% pretax margin and an ROE of 24%. Revenue of $3 billion was up 5% year on year, driven primarily by strong banking results on higher loan and deposit spreads. +Expense of $2.1 billion was up slightly year on year and up 2% sequentially on higher incentive compensation. We saw positive long-term flows of $19 billion with strength in multi-asset, including the benefit of a large mandate this quarter, as well as inflows in alternatives and fixed income partially offset by outflows in equity products. +In addition, we were the beneficiaries of $22 billion of liquidity flows this quarter, capturing more than our share of money in motion given money market reform. AUM grew 4% and overall client assets 5% to $1.8 trillion and $2.4 trillion respectively, driven by market as well as long-term flows. Our long-term investment performance remained solid with 80% of mutual fund AUM ranked in the first or second quartiles over five years. +Lastly, we have record loan balances of $114 billion, up 5% year on year driven by mortgage. +Skipping over page 8 and Corporate where the results were very close to home and where there are no significant items to highlight. So turning to page 9 and the outlook. Looking forward to the fourth quarter, expect net interest income to be up modestly quarter on quarter on continued strength in loan growth even as we digest the incremental cost of resolution-based liquidity actions, which will be fully in our run rate in the fourth quarter. +Expect non-interest revenue to be down quarter on quarter based upon our current outlook for IDCs and assuming flat year-on-year markets revenues also including higher Card acquisition costs and seasonally lower mortgages. All else equal, expect NIR to come in at $50.5 billion plus or minus for the full year, market dependent. +Finally, expect adjusted expense in the fourth quarter to be flat year on year, bringing full-year expense in at approximately $56 billion, consistent with our guidance and self-funding the Consumer items I mentioned. +So to wrap up, strong performance whichever way you look at it this quarter. We are continuing to demonstrate that our operating model and our platform is working for our clients, that our scale across businesses gives us operating leverage and that our investments through time are paying off. +And while at the Company we are proud of this quarter's performance and, in particular, proud of the growth in the underlying business drivers, we take a long-term disciplined view and remain focused on delivering excellent customer experience, strong execution, particularly in risk management and expenses, so that we can continue to deliver best-in-class performance. +With that, operator, please open up the line and we can take questions. + + +================================================================================ +Questions and Answers +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- +-- from CLSA. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [2] +-------------------------------------------------------------------------------- +Good morning, Mike. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA - Analyst [3] +-------------------------------------------------------------------------------- +Hi, can you talk about the competitive environment in capital markets? You had a strong growth. Is that due to better markets, better share or both? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [4] +-------------------------------------------------------------------------------- +So I think there's three or four things to mention. The first is that I would say that the industry generally had a pretty weak third quarter last year. And so when you think about the year-over-year comparison we are a little flattered by last year's performance. +Not necessarily more so than our peers, but nevertheless we are. Then we talked about the fact that this quarter the conditions were relatively favorable broadly and compare and contrast that to last year where there were pockets of activity and client flow but there were also pockets where people were really sitting on their hands and not transacting. So I think client flow quite broadly across the environment would characterize the quarter. +In terms of the competitive performance I would say it feels like we did well. Obviously, we're the first to report, apart from Citi this morning. It feels like we did relatively well, so we may have gained some share. +Certainly, hopefully the momentum in terms of the business we've been building and the way we are serving our clients will service in that capacity, not just this quarter but through time. But, obviously, there can be a bit of volatility in the market share space. So we prefer to look at it more through time and we feel pretty good about the performance. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA - Analyst [5] +-------------------------------------------------------------------------------- +Specifically versus the European banks, are you looking to use your balance sheet more to gain share? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [6] +-------------------------------------------------------------------------------- +So I would say we don't specifically target a competitive set. But I will tell you that our balance sheet, we talked about it many times on this call before that we do have the capacity to put our balance sheet and our resources to work for our clients, for our best clients. +And we think about using those resources in the context of overall relationships. So if any period is more leverage constrained and has less access we may have competitive advantage. And certainly we will continue to make those resources available to our clients. + +-------------------------------------------------------------------------------- +Operator [7] +-------------------------------------------------------------------------------- +Glenn Schorr, Evercore ISI. + +-------------------------------------------------------------------------------- +Glenn Schorr, Evercore ISI - Analyst [8] +-------------------------------------------------------------------------------- +Hi, thanks very much. Curious on Card delinquencies ticking up. I know you've been guiding towards that but when you see it it's the only part of credit that has anything but great trends. +You mentioned on your comments newer vintages will have a higher loss rate than the portfolio average. Do you mind just drilling down a little bit more color on what exactly is driving that? Is that going down credit a little bit or is that just expected season as you'd thought? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [9] +-------------------------------------------------------------------------------- +So I don't know, Glenn, if you recall that we had a bit of discussion about this last quarter and guided to the fact that we would expect to see our loss rates go up slowly, partly because, obviously, at 250-ish basis points I think we could call that pretty low historically. But also because over the course of the last couple of years we have been changing the mix of our originations a bit to the prime, near prime space, still completely within our credit risk appetite and at risk-adjusted margins that are better than the portfolio average. +So we are getting paid for that. So we are doing it within our risk appetite, doing it judiciously. But as a result, as those vintages become a higher percentage of our overall population they will have a gentle upward pressure on the charge-off rate. +So what we are seeing in terms of the delinquency uptick and the charge-offs, gradual increases completely in line with how we underwrote those loans and our expectations. And so as you look forward for us over the course of the next several quarters and we would expect those phenomena to generally continue, again, slowly. We are growing our portfolio, we are going to see the seasoning of those vintages as the mix increases and as they become more seasoned cause us to build a reserve but for the right reasons. + +-------------------------------------------------------------------------------- +Glenn Schorr, Evercore ISI - Analyst [10] +-------------------------------------------------------------------------------- +Fair enough. Fair enough. Just one follow-up. +If I could get just a high-level comment on has anything materially changed in terms of rate or curve sensitivity as you remix the portfolio? And as you are getting all this great loan growth I'm just curious on the current positioning. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [11] +-------------------------------------------------------------------------------- +No, nothing significant, Glenn. No significant changes to our sensitivity. + +-------------------------------------------------------------------------------- +Operator [12] +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [13] +-------------------------------------------------------------------------------- +Hey, good morning. I had a question on the Card strategy, and I know we all know that you've created the closed loop and you are using that in part it seems to drive really efficient pricing in the marketplace on the credit card products. +What I'm obviously seeing is an increase in share on card issuance. You are taking some nice share in the merchant space, as well. I just want to understand what the goal is and how far you are willing to push this, market share versus ROA, ROE. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [14] +-------------------------------------------------------------------------------- +So I would say that all of the things that you mentioned, whether it's closed loop network, whether it's our new proprietary products, whether it's our investments in the technology platform and the business in merchant services are all at good returns that ultimately will drive the business to be profitable in the future as it has been in the past. So we haven't given specific guidance for ROE targets for this business but nothing has changed over the medium term for what we think that the performance of the business would be. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [15] +-------------------------------------------------------------------------------- +But is it fair to suggest that part of the market share improvement here is coming from some give-up of profitability and the underlying question is really how much market share do you want in this business? You are already at 18% to 22% market share of the credit card space depending on which numbers you want to use. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [16] +-------------------------------------------------------------------------------- +Yes, it's a very competitive business and it's very profitable. So all other things being equal, we would like to continue to gain share. + +-------------------------------------------------------------------------------- +Operator [17] +-------------------------------------------------------------------------------- +Ken Usdin, Jefferies. + +-------------------------------------------------------------------------------- +Ken Usdin, Jefferies - Analyst [18] +-------------------------------------------------------------------------------- +Thanks, good morning. Marianne, you mentioned that part of the increase in Consumer cost this quarter was planned investments and that you are continuing to self-fund. +I'm just wondering as you think forward and we get past this good gear that you've had, will that be an underlying expectation for you guys, again with the understanding that the revenue environment will always take things up or down? But do you have an aspiration that you can continue to keep costs flat? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [19] +-------------------------------------------------------------------------------- +So we haven't given specific cost guidance going out beyond this year at this point. But our objective will remain consistent with those that we stated previously which is we continue to try and become more efficient across our businesses. +As you know, we are at the tail end but not finished on a couple of large expense programs in our largest businesses so that we create capacity to be able to invest in the businesses broadly, whether that's in products, in marketing, in investment, in innovation, all of which we're doing as much as we can as long as we do it well. So it's going to come down to if we think we have investment opportunities that we can execute well that have an appropriate return we would like to keep doing that and in order to have the right to do it we would like to become more and more efficient in our core business operation. +So we haven't actually given guidance. I think I would characterize it as expenses under control creating capacity to invest. But we will decision investments based upon their merits and, obviously, explain them to you in the future at Investor Day, if not another venue. + +-------------------------------------------------------------------------------- +Ken Usdin, Jefferies - Analyst [20] +-------------------------------------------------------------------------------- +Understood. And if I can come back to another investment day point from earlier this year, you had mentioned that you felt comfortable with an 11% CET1. You plan to get to your CET1 to 12%. You are at 12.1% now already. +Just within the construct of Governor Tarullo's recent commentary, does 11% still feel like the right time? Did you sense anything from the commentary that would change your philosophy around where you'd like to live in that potential comment you made at February to potentially go above 100 if, in fact, this was the right mechanism? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [21] +-------------------------------------------------------------------------------- +So, first of all, I would say that based upon the speech and, obviously, you know that there are still some unanswered questions with respect to specific parts of the proposal which I will come back to, but based upon the speech moving to a baseline minimum standard is more consistent with how we think about our capital management policy. And using the capital stack add-up using, our G-SIB score and our stress drawdown actually you would come out with a capital constraint under CCAR that's pretty much on top of our regulatory capital minimum. +So in that sense because of the offset, because of the lack of balance sheet growth, lack of RWA growth and the curtailment of capital distributions, we've actually ended up in a place where we look to be approximately equally bound based on last year's test by both of those two measures, which is a space we've played in for a while. We've been, as we talked about before, we've been bound by many constraints, somewhat equally over a period of time and striving to operate within that constraint and maximize shareholder value. +I think the things we don't know are, obviously, how funding or liquidity shock will be incorporated. And in any case this is not for the 2017 CCAR cycle, so it's a whole cycle away from now. +So we will be operating in 2017 under the same basic test construct as we have previously. And so I don't think it's a clear and present danger necessarily that we will be able to look at payout ratios that are above the top end of our range. Meanwhile, we are at the top end of our range now. + +-------------------------------------------------------------------------------- +Operator [22] +-------------------------------------------------------------------------------- +Jim Mitchell, Buckingham Research. + +-------------------------------------------------------------------------------- +Jim Mitchell, Buckingham Research Group - Analyst [23] +-------------------------------------------------------------------------------- +Good morning. Maybe just a quick follow-up on FICC in your commentary and maybe you can have a broader commentary around how the widening LIBOR or rising LIBOR yields helped your businesses across the board in FICC or anywhere else? Just help us understand how that's playing through the income statement. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [24] +-------------------------------------------------------------------------------- +Yes, so I would just generally speaking with respect to our rate sensitivity, as I think you know we are most sensitive to the front end of the curve but to IOER and prime. So we do have LIBOR-based assets but also liabilities. +A good example would be commercial loans on the asset side or long-term debt on the liability side. But our notional mismatch is not particularly big. And so as a consequence, the impact of LIBOR curve moves has been not very significant on our P&L, we wouldn't expect it to be. +I will say that the LIBOR moves were one of the features that our rates business had a perspective around. And they got good client flow in and around that trade. +And so it was one of the catalysts, one of many, but one of the catalysts that we point to in terms of the ability for rates to monetize flow as we had a lot of client flow around that conviction. But I wouldn't be able to put a number on it for you. + +-------------------------------------------------------------------------------- +Jim Mitchell, Buckingham Research Group - Analyst [25] +-------------------------------------------------------------------------------- +Fair enough and maybe just a follow-up on deposits. You guys have had very good trends in retail but on the institutional side there was quite a bit of flow looked like, as well. Any particular drivers there, was it money market performed helping the flows in institutional or something else? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [26] +-------------------------------------------------------------------------------- +I think we, obviously, did get some good inflows, liquidity flows in terms of money market reform into our government fund. But we also have been very focused in our other wholesale businesses on continuing to attract operating deposits. +And so as I look at our overall strong deposit growth I wouldn't say it was equally but it was pretty much equally wholesale operating and retail deposit growth. So we feel good about both of those. + +-------------------------------------------------------------------------------- +Operator [27] +-------------------------------------------------------------------------------- +Matt O'Connor, Deutsche Bank. + +-------------------------------------------------------------------------------- +Matt O'Connor, Deutsche Bank - Analyst [28] +-------------------------------------------------------------------------------- +Good morning. In light of some of the selling issues over at Wells Fargo, I was just wondering if you've thought about reevaluating how you approach the consumer, how you compensate staff. And this was, obviously, not a JPMorgan-specific question, but just for the overall industry I think it's something folks are wondering about. +There's clearly some stuff that's black-and-white that you shouldn't do. But I think we also worry that there might be some gray areas that are somewhat less known. So just how are you thinking about the way you conduct business and compensate staff in light of what's going on? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [29] +-------------------------------------------------------------------------------- +I might just give for context remind you all, or maybe you recall, that for a number of years now, for a fairly long time we've been standing up at Investor Day and other venues saying that customer experience is the central tenet for how we think about engaging with all of our clients but certainly our retail clients in the branches. And we have been very, very focused on investing in customer experience broadly defined and have made great progress, I think, in doing that. +And also we had talked about the fact that what we are looking for very, very clearly is deep customer relationships, engaged customers. We want to be primary bank. We want to gather deeper share of wallet. +So balance is not necessarily products. And so, again, remember saying that cross-sell is an outcome, it's not an objective. And that certainly is a philosophy with which we have designed our compensation and performance structures for the branches. +We review them regularly, at least annually to make sure that they continue to be aligned with our objectives and, again, objectives about the engaged relationship with customers, good customer experience in the right products, all the right reasons the right way. So as we think about those objectives and how we've designed our plan and as we look inwardly not just, obviously, because of the news now but also regularly in our BAU capacity we feel like our plans are designed to incent those behaviors. + +-------------------------------------------------------------------------------- +Matt O'Connor, Deutsche Bank - Analyst [30] +-------------------------------------------------------------------------------- +Okay, that's helpful. Thank you very much. + +-------------------------------------------------------------------------------- +Operator [31] +-------------------------------------------------------------------------------- +Erika Najarian, Bank of America. + +-------------------------------------------------------------------------------- +Erika Najarian, BofA Merrill Lynch - Analyst [32] +-------------------------------------------------------------------------------- +Hi, good morning. Just a question you, back to CIB, you had a slide during Investor Day that showed a walk to $19 billion of expenses by 2017. +If some of the factors that you mentioned that drove revenues into CIB higher repeat for 2017 is that $19 billion number still achievable? Or I guess a better way to ask it, will any incremental revenue uplift from here fall to the bottom line? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [33] +-------------------------------------------------------------------------------- +So I would say, first of all, I would say we, I will tell you, we are on track with respect to the commitments Daniel made to you to deliver over time the $2.8 billion of expense saves. While we are not finished yet we are substantially through that program. So it's moved from being a plan through execution to being in the later stages of execution. +So we feel very good about that, which means that all other things equal that $19 billion is still a reasonable level of expense target. However, obviously we pay for performance. And so clearly if we have significant out-performance next year relative to our expectations at the time of setting those plans, there would be some variable cost associated with it. +But for every dollar of out-performance the variable cost may not always be the same. So, obviously, it also depends upon the mix and payout ratios and all those sorts of things. But a large, large portion of it would be, it would be, obviously, as you know incredibly accretive because we would be leveraging all of our scale, so the only variable cost would really be comp, largely. + +-------------------------------------------------------------------------------- +Erika Najarian, BofA Merrill Lynch - Analyst [34] +-------------------------------------------------------------------------------- +Got it. And just as a follow-up to that, a follow-up to Ken's question actually, he mentioned the stress capital buffer. Outside of the static balance sheet and capital distribution offset, is there an element to this in terms of just getting better at the test that you could do to reduce that stress capital buffer without actually taking risk down significantly? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [35] +-------------------------------------------------------------------------------- +So first of all based upon last year's results for us we are at the floor for the stress capital buffer. Not to suggest, by the way, that we wouldn't continue to want to properly understand and better understand how we can through time make sure that we are performing the best we can under stress within our risk appetite. But we are at that floor right now. +So within those constraints what we are trying to do is be within our risk appetite, manage risk properly but also add shareholder value. We have to carry that capital anyway, so we would want to use it well. + +-------------------------------------------------------------------------------- +Operator [36] +-------------------------------------------------------------------------------- +Paul Miller, FBR. + +-------------------------------------------------------------------------------- +Tim Hayes, FBR & Co. - Analyst [37] +-------------------------------------------------------------------------------- +Hi, this is Tim Hayes for Paul Miller. Can you give any color on your outlook for margin throughout 2017? +To me, Fed commentary suggests that rates could remain low and potentially hover around these levels over the next 12 months. So how can we think about your NIM in that type of scenario? And then what would a December rate hike do for your outlook? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [38] +-------------------------------------------------------------------------------- +So for your purposes I'm going to talk about NII. We don't really manage to NIM. But you can, obviously, back into it. +So if we ended up in a situation right now where rates were flat throughout all of 2017 which for what it's worth I don't think is pretty much anyone's central expectation right now, but if we were rate flat you've seen us grow our core loans and our loan balances pretty strongly, pretty consistently across businesses. And while we may not be able to replicate our 15% core loan growth forever, certainly we can continue to grow our loans. +So on that plus mix shift away from securities over time we should be able to deliver $1.5 billion of incremental NII next year rate flat. You know that if rates are -- if we are fortunate enough for the right reasons that we see a hike this year, at the end of this year and get the full benefit of that next year, it will be higher than that. And you've seen our earnings and risk disclosures, they've been pretty close to a $3 billion number on a 100 basis point move for a while, most of which is front end. + +-------------------------------------------------------------------------------- +Tim Hayes, FBR & Co. - Analyst [39] +-------------------------------------------------------------------------------- +Okay, thank you. And then switching gears, your CRE and C&I lending was pretty strong this quarter and regulators have, obviously, grown a little bit more cautious on those segments. So I was just if you could give any color for your outlook on lending to those segments going forward. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [40] +-------------------------------------------------------------------------------- +So look, we are aware, obviously, of the riskier types of CRE lending, the types of lending that attract scrutiny for reasonable reasons considering how they've performed in past cycles. We are also mindful of where we are in the cycle and take that into consideration in our underwriting. +So we have and continue to avoid what I would characterize as the riskier segments and those segments that performed poorly in previous cycles. And we really stick to our knitting, if that's an American expression, in terms of continuing to do what we are good at within our risk appetite. +And so if you think about our commercial real estate growth, Commercial Term Lending is about three-quarters of our portfolio. And you know that we are very focused on smaller loan size, term B -- sorry, class B, class C properties with low vacancy rates. So rent stabilized, supply constrained markets, underwrite to low LTVs, good debt service coverage. +We look at forward rates and current rents. And so we really have an expertise in a specific niche and we compete on speed and certainty of execution, not on credit and structure. +So we feel pretty good about our exposures and even in our more traditional real estate banking space we have avoided the riskier segments with limited construction lending exposure, homebuilders minimal exposure. We are pretty disciplined about it. + +-------------------------------------------------------------------------------- +Operator [41] +-------------------------------------------------------------------------------- +Eric Wasserstrom, Guggenheim. + +-------------------------------------------------------------------------------- +Eric Wasserstrom, Guggenheim Securities LLC - Analyst [42] +-------------------------------------------------------------------------------- +Thanks very much. Marianne, at a conference just before the end of the quarter another bank talked about improving underwriting conditions in the auto lending space, particularly in the mid to lower FICO range. Are you seeing anything similar? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [43] +-------------------------------------------------------------------------------- +So we are a primarily prime lender in Auto. We are the number one prime lender. +We actually have the lowest share in subprime among the national banks. So it is less than 5% of our origination. So I wouldn't speak specifically to underwriting in the lower FICO sectors, not where we play at this point. + +-------------------------------------------------------------------------------- +Eric Wasserstrom, Guggenheim Securities LLC - Analyst [44] +-------------------------------------------------------------------------------- +Sure, sure. I think the reference was to below 700 which includes the bottom end of the prime segment, which has been an area of intense competitive focus. I'm just wondering if you've seen anything in that segment? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [45] +-------------------------------------------------------------------------------- +So not that I would comment on except for we have recently decided to pull back on 84-month plus term loans on all FICO bands, just as where we are in the cycle as we see the risks of that type of lending. So we continue to calibrate our underwriting. But I wouldn't comment on seeing anything specifically. + +-------------------------------------------------------------------------------- +Eric Wasserstrom, Guggenheim Securities LLC - Analyst [46] +-------------------------------------------------------------------------------- +Got it. And is that influencing your reserve expectations for Consumer at all? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [47] +-------------------------------------------------------------------------------- +Auto? + +-------------------------------------------------------------------------------- +Eric Wasserstrom, Guggenheim Securities LLC - Analyst [48] +-------------------------------------------------------------------------------- +Yes. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [49] +-------------------------------------------------------------------------------- +We've built $25 million of reserves this quarter for Auto and we expect to continue. We think the Auto opportunity is still strong and we have a great franchise. +We have great manufacturing partnerships that are growing strongly, too. So as we grow that portfolio I would expect us to continue to grow reserves modestly in 2017. However, we are expecting charge-offs to stay under control. + +-------------------------------------------------------------------------------- +Operator [50] +-------------------------------------------------------------------------------- +Steve Chubak, Nomura. + +-------------------------------------------------------------------------------- +Steve Chubak, Nomura Asset Management - Analyst [51] +-------------------------------------------------------------------------------- +Hi, good morning. So, Marianne, I appreciated your remarks on the latest guidance from Tarullo relating to G-SIB capital. +One of the questions we've been getting from a lot of folks is because this SEB is calculated based on stress losses year-to-year and historically CCAR results have been pretty volatile, I'm wondering how you are thinking about the appropriate management cushion or buffer above the minimum? Historically it had been about 50 bps just for AOCI volatility and maybe operational risk losses, but do you now have to also handicap CCAR volatility when thinking about that cushion? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [52] +-------------------------------------------------------------------------------- +Yes, so you are right. And, obviously, even specifically for JPMorgan if you look at our stress results that [handicapped] by the Fed over the course of the last three years has been reasonable volatility. And clearly it's not the case that we will expect it to be completely stable. +I would not expect to see the same levels of volatility going forward as we've seen historically as the test has, as you know, over time occasionally included new not insignificant features. And while that may continue to be the case I would think that there would be a bit more stability. But we haven't actually gone through and finalized our thinking about what the buffers would look like. + +-------------------------------------------------------------------------------- +Steve Chubak, Nomura Asset Management - Analyst [53] +-------------------------------------------------------------------------------- +Understood. One more question, just thinking about capital management priorities, given that the new proposal as you noted allows for curtailment of the buyback or termination of the buyback and then curtailment of the dividend halfway through the test, do these changes as well as the softening of the 30% dividend cap alter your thinking about how you prioritize buybacks versus dividends? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [54] +-------------------------------------------------------------------------------- +Yes, before I talk about the prioritization of capital distributions I would just start by saying our capital management policies prior to this year's CCAR and this year's resolution had us making those actions regardless of whether they were allowed to be reflected in a test. And, obviously, as part of the resolution planning we have revised our policies to include more granular triggers. +So our policies do with some specificity run pretty granularly through time through a stress speak to the sorts of actions that we would be leaning into and taking, even if they don't get reflected in the test. +With respect to the prioritization, look, the soft cap on dividends has been lifted. Dividends are ultimately still a part of the baseline minimum standard, so there will be possibly some natural constraint there. It hasn't changed, at this point anyway, the Board's determination or management's determination about the order of priority. +We would like to continue to have the capacity to grow our dividend. And I think even though there may be some natural constraints I think it would be above 30. + +-------------------------------------------------------------------------------- +Operator [55] +-------------------------------------------------------------------------------- +Gerard Cassidy, RBC. + +-------------------------------------------------------------------------------- +Gerard Cassidy, RBC Capital Markets - Analyst [56] +-------------------------------------------------------------------------------- +Thank you. Good morning, Marianne. +I had a question, you pointed out that about three quarters of your credit card acquisitions organic growth were coming through mobile channels or digital channels I should say. Can that be moved over to other Consumer products or is it just unique to credit cards that you are going to be able to generate that much growth through the digital channel? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [57] +-------------------------------------------------------------------------------- +So we are very focused across the spectrum of our businesses on developing better digital capabilities to allow seamless engagement with customers and acquisition through digital channels. There are complexities associated with documentation and standards for know your customer and anti-money laundering that we're continuing to work through. But ultimately it should be achievable, and we are working on it. +So one of the things that we have previously mentioned is that the majority of our Consumer accounts are opened in branches. One of the reasons among others why branches are [still] important to us as well as advice centers. And we will continue to work on trying to see how far and how fast we can move people to be able to have a better digital experience opening accounts with us. + +-------------------------------------------------------------------------------- +Gerard Cassidy, RBC Capital Markets - Analyst [58] +-------------------------------------------------------------------------------- +Okay, thank you. And then as a follow-up, obviously third-quarter results in Investment Banking were very strong. +Fourth quarter seasonally is weaker than third quarter as you pointed out. Are there any other reasons why you think the fourth-quarter numbers may be weaker than the third quarter, other than the traditional seasonality? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [59] +-------------------------------------------------------------------------------- +Well, I will just start by pointing out that all of the businesses, all of our businesses, not just the ones that I talked about at the high level, not just macro spreads equities, but even if you go a level below that quite granular, all of our businesses did really quite well this quarter. So not to overuse the phrase firing on all cylinders but it really was pretty consistent. And normally you might see pockets of more strength and less strength. +So I think it would be hard to imagine replicating this kind of strength through time consistently. But the fourth quarter is seasonally low and we have no reason to expect that it would not be. + +-------------------------------------------------------------------------------- +Operator [60] +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [61] +-------------------------------------------------------------------------------- +I just wanted to follow up on FRTB and Basel IV and how you are thinking about the implications for JPM at this stage? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [62] +-------------------------------------------------------------------------------- +So there isn't a whole lot of really clear new news. So as we think about all of the -- FRTB we've talked about before, modest and manageable, nothing about that has changed for us. But, obviously, there's the advanced and standardized credit operational proposals out there. +The most important thing that we've yet to really, and there are pluses and minuses in it and different for us than others maybe. But the one thing that we haven't really heard about yet, Betsy, is how it will all be calibrated and calibration will be very important. +So we are expecting to hear over the course of the next short while, and maybe that will be delayed some just given some of the discussion. And we will update you when we hear a bit more about how it's all going to come together. But right now it's still a little unclear. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [63] +-------------------------------------------------------------------------------- +Okay, thanks. + +-------------------------------------------------------------------------------- +Operator [64] +-------------------------------------------------------------------------------- +There are no further questions at this time. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO [65] +-------------------------------------------------------------------------------- +Many thanks everybody. + +-------------------------------------------------------------------------------- +Operator [66] +-------------------------------------------------------------------------------- +This concludes today's conference call. You may now disconnect. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/exam/original-files/Problem_2_3_Sample_full_transcripts/2016-Oct-26-KO.N-140963352890-Transcript.txt b/exam/original-files/Problem_2_3_Sample_full_transcripts/2016-Oct-26-KO.N-140963352890-Transcript.txt new file mode 100644 index 0000000..6307733 --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_full_transcripts/2016-Oct-26-KO.N-140963352890-Transcript.txt @@ -0,0 +1,460 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q3 2016 Coca-Cola Co Earnings Call +10/26/2016 09:00 AM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * James Quincey + The Coca-Cola Company - President and COO + * Kathy Waller + The Coca-Cola Company - CFO + * Muhtar Kent + The Coca-Cola Company - Chairman and CEO + * Tim Leveridge + The Coca Cola Company - VP and IR Officer + +================================================================================ +Conference Call Participiants +================================================================================ + + * Bonnie Herzog + Wells Fargo Securities, LLC - Analyst + * Judy Hong + Goldman Sachs - Analyst + * Bill Chappell + SunTrust Robinson Humphrey - Analyst + * Dara Mohsenian + Morgan Stanley - Analyst + * Bryan Spillane + BofA Merrill Lynch - Analyst + * Ali Dibadj + Bernstein - Analyst + * Bill Schmitz + Deutsche Bank - Analyst + * Andrew Holland + Societe Generale - Analyst + * Nik Modi + RBC Capital Markets - Analyst + * Brett Cooper + Consumer Edge Research - Analyst + * Steve Powers + UBS - Analyst + +================================================================================ +Presentation +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + At this time, I would like to welcome everyone to the Coca-Cola Company's third-quarter 2016 earnings results conference call. Today's call is being recorded. If you have any objections, please disconnect at this time. +(Operator Instructions) +I would now like to introduce Tim Leveridge, Vice President and Investor Relations Officer. Mr. Leveridge, you may begin. + +-------------------------------------------------------------------------------- +Tim Leveridge, The Coca Cola Company - VP and IR Officer [2] +-------------------------------------------------------------------------------- +Thank you, Operator. Good morning, and thank you for being with us today. I'm joined by Muhtar Kent, our Chairman and Chief Executive Officer; James Quincy, our President and Chief Operating Officer; and Kathy Waller, our Chief Financial Officer. +Before we begin, I would like to inform you that you can find webcast materials in the Investors section of our Company website at www.coca-colacompany.com that support the prepared remarks by Muhtar, James, and Cathy this morning. I would also like to note that we have posted schedules under the financial reports and information tab in the Investor section of our Company website. These schedules reconcile certain non-GAAP financial measures, which may be referred to by our senior executives during this morning's discussion, to our results as reported under Generally Accepted Accounting Principles. Please look on our website for this information. +In addition, this conference call may contain forward-looking statements, including statements concerning long-term earnings objectives, and should be considered in conjunction with cautionary statements contained in our earnings release, and in the Company's most recent periodic SEC reports. +(Caller Instructions) +Now I would like to turn the call over to Muhtar. + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Company - Chairman and CEO [3] +-------------------------------------------------------------------------------- +Thank you, Tim, and good morning, everyone. +Today, I will touch briefly on a few key highlights before handing off to James to provide a more detailed operational review of our performance. I am pleased to report that we delivered third-quarter results in line with our expectations and we are on track to deliver against our full-year expectations. Our continued focus on our five strategic initiatives enabled us to report another quarter of global value share gains with 3% organic revenue growth and over 50 basis points of comparable currency mutual operating margin expansion. Our core business continued to perform well, delivering 4% organic revenue growth year to date, in line with our long-term target driven by our segmented revenue growth strategies, improving marketing, and portfolio diversification. Within our core business, developed markets performed well, delivering solid revenue results with 2% unit case volume growth year to date and a continued focus on price realization. +While we continue to see challenges in many emerging and developing markets, we are taking action to improve our performance. Importantly, we are delivering the profit targets we laid out at the beginning of the year. Excluding the impact of structural items, comparable currency neutral income before tax grew 7% year to date, and we are confident we will deliver our full-year profit outlook of 6% to 8% growth, excluding these same items. We continue our journey of transforming our Company to a higher margin and higher return business, focused on building strong brands, enhancing customer value, and leading a strong dedicated global franchise system. +This quarter, we continued to make solid progress to expand and evolve our global system. In North America, we signed definitive agreements on six territories and closed transactions on four territories, thereby remaining on track to complete our refranchising efforts in our flagship markets by the end of 2017. In Japan, our two largest bottlers, Coca-Cola West and Coca-Cola East Japan reached a definitive agreement to merge their operation and create a strong consolidated bottler representing over 85% of our system volume in Japan. In Latin America, we reached a long-term comprehensive agreement with Arca Continental regarding joint value creation in Mexico, along with a similar agreement with SENSA in July. Separately, Coca-Cola SENSA agreement to acquire Vonpar, one of the largest privately owned bottlers in the Brazilian Coca-Cola system, increasing its scale and leveraging SENSA's strong commercial capabilities. In Europe, Coca-Cola European partners finished its full quarter of operations as the combined company and we are executing in the line plan. And, finally in Africa, we recently exercised our call option to acquire ABI's stake in Coca-Cola Beverages Africa. +We are have a number of partners who are highly interested in and qualified for these bottling territories, and we intend to implement our long-term strategic plan for these markets. Over the coming months, we will negotiate the terms of the transaction with ABI, followed by a regulatory approval process. Simultaneously, we have commenced discussions with potential partners and plan to complete this important process as soon as feasible. +When I take a step back, and think about the magnitude of change we have implemented over the past couple of years, I am truly encouraged. We have implemented segmented revenue growth strategies for our markets, invested in capabilities, and created clear incentives for the entire organization to drive revenue growth rather than volume only. We are shaping our planned portfolio across the full range of sparkling and still beverage categories to meet changing consumer needs through leading marketing innovation and targeted M&A, which James will discuss in more detail. We launched Taste the Feeling, a new marketing campaign for trademark Coca-Cola at the beginning of the year, and are seeing positive response from our consumers and customers; and through our ongoing $3 billion product [dividing] initiative, we are taking costs out to both reinvest in the business and drive margin expansion. And as I have discussed, we are re-architecting the bottling system in key geographies and regions to better capture growth. +To put it in perspective, these affected regions account for almost half of our global volume, so the actions we are taking today are going to have significant impact on our system's future performance. Through these actions, we are becoming a much stronger Company, with higher margins and returns and better positioned to deliver on our long-term growth targets. +I will now hand the call over to James, who will provide you with a more detailed outlook at our operating performance. + +-------------------------------------------------------------------------------- +James Quincey, The Coca-Cola Company - President and COO [4] +-------------------------------------------------------------------------------- +Thank you, Muhtar, and good morning, everyone. +As Muhtar said, we continue to implement our five strategic actions for growth, and we are making the necessary changes to have the speed, agility, and the focused leadership needed to win today and into the future. So before I jump into the results, as you know, we made a number of changes to our operating leadership structure during the quarter. I would like to say these transitions occurred seamlessly, a testament to our leaders and associates, and these new leaders are bringing a fresh perspective and are working diligently to identify opportunities to accelerate our performance around the world. +Now, let me turn to the results. I would like to talk to you about these through two lenses. Firstly, the traditional operating results in the quarter, somewhat seen by geography. And second, how we continue to evolve our brand marketing and portfolio to stay relevant and meet consumer preferences. So our performance in the quarter: our results were in line with our expectations, with 3% organic revenue growth and 2% underlying income before tax growth. Our core business grew organic revenue 3% in the quarter, and as we expected, given the strong growth we were cycling from the third quarter last year, it is important to know that year to date, our core operations continue to grow organic revenue 4%, and we remain on track to deliver this performance for the full year. +Our Company-owned bottling operations grew organic revenue 2% in the quarter, an acceleration from the first half of the year, driven by North American bottling and an improvement in China. Unit case volume grew 1%, cycling a pretty strong 3% from last year and an acceleration from last quarter, due largely in part to the return to growth in China and a stronger performance in our Western European business. It is worth saying that the macro challenges persist in certain emerging markets, particularly, for example, Argentina and Venezuela, negatively impacting consolidated unit case volume growth by one point. +Turning and looking around the world, we continued to push out where we have momentum, takes action where needed, and managed through some of the difficult operating conditions. So we continue to do well in a number of key markets with momentum, including places like North America, Mexico, and Japan, and so seek to further advance our strategies. For example, North America: we grew organic revenue 3%, as we continued to successfully implement both our accelerated refranchising program while delivering top tier growth among FMCG companies in the US. The strength and breadth of our full brand portfolio led to value share gains in both sparkling and still beverages. So that actually overall we captured 40% of NARTD beverage retail sales growth year to date. Also, as I said, we did well in Japan and Mexico and both benefited from strong marketing and innovation as the combination of the One Brand strategy and new product launches drove continued solid performance. +Turning to some of the other key markets, we saw improved performance in the quarter. Our actions are starting to bear fruit. But we still have more to do. In China, we return to growth, driven by strong activation of our Olympic campaign, improved execution, and, frankly, better weather. Our system has largely worked through the wholesale inventory issue, and we are continuing to innovate across the business towards the premium segments with examples like the launch of ZICO coconut water through the e-commerce channel, but also at the same time we are paying proper attention to the mass consumer segment. There, we are driving the availability of entry level small packs such as the 300-milliliter bottles, to address affordability issues as the economy remains challenging and we expect continued near-term volatility. +Another key market that got better: Western Europe. Solid marketing, innovation, and commercial plans with the increased alignment with the new CCEP in its first full quarter as a new company and again a little bit of good weather resulted in strong performance in the quarter, with our system gaining both value and volume share. Now, while some markets -- while we are moving quickly in several markets and seeing success, it is true that we still compete in a number of markets with challenging macro economic conditions. +The economic environment in Russia is improving slightly as the price of oil stabilizes. However, Brazil, Argentina, and Venezuela all remain difficult operating environments for consumer products companies. Therefore we will continue to concentrate on what we can control. In Brazil and Argentina, we are focused on affordability, by maintaining key consumer price points, while evolving a price pack architecture to protect our market share. And in Venezuela, we are addressing raw material shortages by rapidly scaling the availability of our Zero Sugar portfolio. +Now, as we look at this quarter, but also at the future, I would like to build on what I have shared in the past about our productivity efforts, and evolving revenue growth strategies with an update on our growing and evolving brown portfolio. Of course we recognize that consumer taste and preferences change and are changing. And we are building a strong diversified brand portfolio across sparkling and the stills categories to meet these needs, including through internal innovation, bolt-on acquisitions, and the lift and shift geographic expansion model. +If you look at our still portfolio today, it includes 14 of our 20 billion-dollar brands, with number one or number two positions in juice, coffee, water, tea, and sports drink categories. Year to date, our system saw 5.8 billion incremental servings of our stills brands, capturing over 25% of the value growth in stills globally. This performance has been driven by action around the world to expand that stills businesses. For example, take our Japan business, which has one of our most diversified portfolios. On top of good growth in our sparkling brands, we continue to drive strong performance across multiple categories through innovations like new premium packaging for our Georgia coffee brand and new line extension of our Ayataka tea brand, and new flavors of our premium I LOHAS water brands. +In the US, we extended smart water into sparkling water. We revamped the packaging graphics on Dasani sparkling, resulting in retail value growth of over 80% in the quarter for these two products. We expanded the Honest Tea trademark into juice drinks, with Honest Kids becoming the number one organic juice drink chosen for kids. We see ready to drink coffee as an important growth category in the US. Today we are the global leader in ready-to-drink coffee category with strong positions in Japan and Korea. We are leveraging on this brand and launching Gold Peak ready-to-drink, cold brew coffee, and Dunkin' Donuts branded ready-to-drink coffee to begin capturing this opportunity in our flagship markets. +In Europe, we're expanding our stills portfolio by lifting our Smart Water and Honest Tea brands from the US and shifting them to Europe. We are also leveraging strong existing brands. For example, we are expanding Geographically Innocent, our very successful premium juice and smoothie business, into a strong regional brand, but also extending VIO, our popular water brand in Germany, into juice drinks and sparkling lemonades. This has resulted in strong double-digit volume growth year to date for both brands. +And finally, bolt-on M&A and investments. When available, we will continue to be a part of our portfolio expansion strategy particularly in the value-added dairy and plant protein beverage basis. We're pleased by the early results of Fairlife in the US, and Santa Clara in Mexico, and we look forward to closing our acquisition of plant-based brand added, in Latin America, in early 2017. +Now, turning to our sparkling business. I would like to talk a little bit about how we are doing things differently. We're evolving our sparkling portfolio strategy so that we can grow while reducing sugar consumption. Through these actions, we have been able to outpace a category that is growing retail value by 3% for the first nine months of the year. So let me give you a few examples of how we are doing this. First, our Taste the Feeling marketing campaign is engaging consumers with better advertising around both the extrinsics and the intrinsics of the brand. Second, we are also providing more sugar-free options. In several markets around the world, we have launched Coca-Cola Zero Sugar, with a new and improved taste, as well as a new visual identity system under our one-brand strategy. This is contributing high single-digit volume growth for this brand globally in the quarter. +Take GB, for example. While we are only 12 weeks in, we have seen a significant expansion in the consumption versus the former Coke Zero product, resulting in strong double-digit volume growth for Coca-Cola Zero Sugar during the quarter, and we are rolling this out, this new and improved product out across other European markets. +More broadly, we have been taking multiple action to shape choice, to address changing consumer preferences around added sugar, while working proactively with governments to provide positive solutions. We have been driving a systematic reformulation effort across our portfolio to reduce added sugar while delivering superior consumer taste and improving margins. For example, we currently have over 200 reformulation initiatives under way to reduce added sugar, and so an example of where that might take us, as a step forward, in GB, for example, we reduced the sugar and the calories in brands such as Sprite and Fanta by 30%. +In our Latin center business unit, we have reduced the sugar content in almost two-thirds of our flavored sparkling beverages. And then in combination with this reformulation and innovation effort, we have also focused on small pack sizes. A great way to enjoy a drink with less calories. These packs can provide both a premium experience as well as being affordable, yet profitable way to bring people into the franchise. In Mexico, for example, small packs such as our sleek can and eight-ounce glass bottles are growing rapidly through both increased distribution and higher velocity per outlet. In China, our premium-priced sleek can for Diet Coke and Coke Zero is growing strongly. And in India, where we recently launched our new lightweight affordable PEP bottle in just a few territories, we have already sold over 20 million servings. +These actions and the results we are seeing give us confidence that we can further accelerate our sparkling business. So looking forward, we are working to grow by ensuring ongoing relevance and engagement with our existing brands while also expanding our brand portfolio so that we can meet consumer preferences. So as I think about the rest of the year, from an operational perspective, I, like Muhtar, am confident that we will achieve our full-year outlook. +So with that, let me turn the call over to Kathy to take you through the numbers. + +-------------------------------------------------------------------------------- +Kathy Waller, The Coca-Cola Company - CFO [5] +-------------------------------------------------------------------------------- +Thank you, James, and good morning, everyone. +I am going to talk quickly about our financial performance in the quarter, before moving on to our full year outlook. Starting at the top line, organic revenue growth was driven equally by volume and price mix. Consolidated price mix in the quarter was driven both by rate and product mix initiatives across many of our markets, partially offset by one point of segment mix due to slower growth in our bottling investment group than in our core concentrate operations. At gross profit, our comparable margin increased about 45 basis points, as solid pricing, a slightly favorable cost environment, and productivity was partially offset by about an 80 basis point currency headwind. +Our North America refranchising roughly offset the benefit from de-consolidating our German and South Africa bottling operations, resulting in a structural benefit to margins. Excluding the effect of currency and structural items, our underlying gross margin expanded over 100 basis points. Our comparable operating margin declined about 35 basis points. Similar to gross margins, currency headwinds impacted our operating margins by about 90 basis points, while structural items, primarily the deconsolidation of our German and South African bottling operations positively impacted our operating margins. +Turning to cash flow, we continue to exercise strong cash flow management. Year to date, we have generated $6.7 billion in cash from operations. And we have returned $5.7 billion to share owners through a combination of net share repurchases and $4.5 billion of dividends paid year to date, and that includes our third quarter dividend that was paid on October 3, right after our quarter close. Net share repurchases year to date were $1.2 billion, and we continue to expect them to be $2 billion to $2.5 billion for the full year, in line with our initial guidance. +Looking ahead to the remainder of the year, with one quarter remaining, we continue to expect our full-year comparable EPS to decline 4% to 7%, in line with our previously communicated expectations. However, we now expect to trend slightly less than $2.5 billion on capital expenditures for the full year, down from our initial expectations of $2.5 billion to $3 billion. +As you construct your models, there are a few items to consider for the fourth quarter. Our fourth quarter has two additional days as compared to last year, which will result in stronger top line growth than we saw in the third quarter. We expect structural items to be an 11-point headwind on net revenue and a 6- to 7-point headwind on income before tax in the fourth quarter. And finally, we expect currency to be a 1- to 2-point headwind on net revenue and an 8- to 9-point headwind on income before tax in the fourth quarter. +In closing, our strategies are working in key markets. We are on track to deliver over $600 billion in productivity this year. And we remain confident in our ability to deliver our profit targets this year. +So with that, Operator, we are now ready for questions. + + +================================================================================ +Questions and Answers +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- +We will now begin the question-and-answer session. +(Operator Instructions) +Our first question is from Nik Modi from RBC Capital Markets. Your line is now open. + +-------------------------------------------------------------------------------- +Nik Modi, RBC Capital Markets - Analyst [2] +-------------------------------------------------------------------------------- +Thanks, good morning, everyone. So just a quick question for me on the refranchising. Now that you have kind of gone through the process, and we're getting toward the end of getting all of the announcements out of the way, can you give us any early indications on kind of what the growth delta has been in the markets that have been refranchised versus not? +And then also wanted to get some context on what is going on in Western Europe, obviously with the CCE integration going on there, have you seen any disruption? And if you think that will start to phase out over the coming quarters. Thanks. + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Company - Chairman and CEO [3] +-------------------------------------------------------------------------------- +Nik, good morning, this is Muhtar. Thanks for your questions. Look, I think first, once again, I want to reiterate the scale of what is being done here on a global basis. As I mentioned in my remarks, the geographies and the regions impacted by this refranchising, massive refranchising, is really, when you aggregate it all, is roughly around 50% of our -- it will impact 50% of our global volume. So this is really, really big, number one. +Number two, the early indications that we have from both the US refranchising efforts, which is the largest one, but also the European restructuring under the Coca-Cola European partners umbrella, which was the biggest refranchising in Europe in history, in its structure, essentially, has been -- early indications have been positive. In the United States, if you look at it, the last six quarters, consecutively, we have had volume growth and very encouraging price/mix in the United States continued. And the last sort of year, four quarters, have been the highest in terms of refranchising activity. +So early indications are positive. Europe, the same. And James mentioned the positive numbers coming out of the last quarter. Yes, helped by many other things other than just refranchising, but the impact is that there hasn't been the disruption, it has been going on very smoothly. And you know, when you look at this going forward, we've got four to five quarters of intense refranchising remaining, as we bring out at the other end of the tunnel a company that is going to be totally transformed, revitalized in terms of its organizational capabilities, leadership structure, revitalization of the brands, also with the investment in our brands as a new marketing, revitalization of our portfolio, of our bottling system, as well as our cost base. +So we are encouraged with what we see, as the transformed Coca-Cola Company coming out, and also the integrity of the refranchising, as evidenced by the continued good results in North America and in Europe. + +-------------------------------------------------------------------------------- +Operator [4] +-------------------------------------------------------------------------------- +Thank you. Our next question is from the line of Dara Mohsenian from Morgan Stanley. Your line is now open. + +-------------------------------------------------------------------------------- +Dara Mohsenian, Morgan Stanley - Analyst [5] +-------------------------------------------------------------------------------- +Hey, good morning. + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Company - Chairman and CEO [6] +-------------------------------------------------------------------------------- +Good morning, Dara. + +-------------------------------------------------------------------------------- +Dara Mohsenian, Morgan Stanley - Analyst [7] +-------------------------------------------------------------------------------- +Developed market volume growth outperformed emerging marks in the quarter, that is fairly unusual. I was hoping you could give us a bit of a review in the emerging markets. You obviously had a number of cautionary notes in the prepared remarks, but are you seeing any signs that the macros may be close to bottoming here, or are things pretty tenuous? +And more importantly, as we look out to 2017 and beyond, do you think the year to date trends are more of a new normal, or is there hope that with easier comparisons and some of the strategy adjustments have you made, we can start to see emerging markets rebound closer to historical levels? + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Company - Chairman and CEO [8] +-------------------------------------------------------------------------------- +Dara, this is Muhtar here, I will just mention very briefly, and then pass it over to James, that it is unusual, what you have just said is definitely is the fact that developed markets are growing at a higher pace than the developing and emerging markets, but it is not a surprise, given the volatility that we all know that is taking place. +But it is a mixed bag. It is not just a uniform, all emerging markets. Africa, for example, continues to be a very strong performer, both west Africa, led by Nigeria, but also other markets in Africa. So it is -- Mexico, to name another one -- so it is a mixed bag, but let me ask James to comment in more detail on how we see the future also in terms of the balance between emerging and developing versus developed markets. + +-------------------------------------------------------------------------------- +James Quincey, The Coca-Cola Company - President and COO [9] +-------------------------------------------------------------------------------- +Yes. I think it is worth, as we go into this, just underlining, the collection of the developed markets are growing volume, growing price, strong revenue growth. We think we are taking actions to sustain that. +The emerging markets, I think it is going to be a combination here of doing the things that we need -- we know we need to do and can control, and then of course there is the question of what do the macro economics do, and what actions do each country's governments take to put them on a better course or not. So that is part of the unknown going forward at this stage and the uncertainty. +I think quite clearly, you see, as Muhtar commented, a mixed bag, across the world you see those markets that are doing well, sustained growth, and he called out Nigeria, South Africa, the Philippines, and other parts of the emerging market. So it is good. But it is a mixed bag. And I think the actions are under way in a number of these countries to stabilize them, where they are a little tougher like Brazil, like Argentina, which are called out on the call earlier. +And we will have to see how long it takes for this to take hold in the countries from a macro view. We don't have a clear sight on that. But what we do know is we need to focus on what we can control in those countries and go back to affordability, go back to execution, go back to the basics and build ourselves a better position with more market share so when it does turn, and that combines with the growth in developed markets, we can be solidly in our growth rates for our long-term model. Thank you. + +-------------------------------------------------------------------------------- +Operator [10] +-------------------------------------------------------------------------------- +And our next question is from the line of Bill Schmitz from Deutsche Bank. Your line is now open. + +-------------------------------------------------------------------------------- +Bill Schmitz, Deutsche Bank - Analyst [11] +-------------------------------------------------------------------------------- +A couple of quick questions. The first one is how do you get 3% organic in the quarter from 1 and 1? Was volume better? Or price/mix better? I know they both probably rounded but I was just curious. +And then the second question is, the inflationary pricing in Latin America, is that mostly currency pass-through or is there sort of real price realization in the market and kind of what happens into next year if these spot rates hold when some of the currency cross rates are to ease a little bit? Thanks. + +-------------------------------------------------------------------------------- +Kathy Waller, The Coca-Cola Company - CFO [12] +-------------------------------------------------------------------------------- +Hi, Bill. So on your first question about the 3%, yes, we didn't find another way to make one and one equal three, it is rounding and it is really balanced. So it was in the rounding, but it was a balanced impact on volume as well as a balanced impact from pricing. + +-------------------------------------------------------------------------------- +James Quincey, The Coca-Cola Company - President and COO [13] +-------------------------------------------------------------------------------- +On your second question, Bill, James here, I think what is worth remembering is essentially we are not trying to pass through the devaluation. We focus on being competitive in each local market beverage and fast moving consumer goods industry, and especially when the economies are in tough times, focusing on staying competitive and gaining share for the long term. +The net of all of that means we are much more likely to follow or be close to local inflation rates rather than adopt a strategy of a full pass-through of the devaluation of the dollar, so obviously if the exchange rates change, that will mean different dollar numbers for the Corporation. But the local strategy remains, stay competitive in the marketplace, and it looks more like local inflation. Does that answer your question? + +-------------------------------------------------------------------------------- +Operator [14] +-------------------------------------------------------------------------------- +Thank you. And our next question is from the line of Steve Powers from UBS. Your line is now open. + +-------------------------------------------------------------------------------- +Steve Powers, UBS - Analyst [15] +-------------------------------------------------------------------------------- +Thanks, good morning. I would like to actually go back and focus on the stills versus sparkling portfolio changes, James, you referenced in your prepared remarks. Correct me if I'm wrong, I think your level portfolio still skews, at least 70/30 toward sparkling but as you look forward, I am curious as to what percentage of your growth you expect will come from traditional sparkling versus still, I am guessing it is probably not 70/30, but is it 50/50 or some other split you could frame for us? +And more importantly, do you think your growth investments today are in line with the distribution? In other words, if it is 50/50, for example, are your incremental growth investments aligned with that? Or is there still a legacy skew toward sparkling that might need to be rethought. +I think from the outside there is still a perception -- right or wrong -- that your incremental investments are a bit over indexed towards core CSDs versus their future value contribution and I was hoping you could help clarify your thinking around that. Thanks. + +-------------------------------------------------------------------------------- +James Quincey, The Coca-Cola Company - President and COO [16] +-------------------------------------------------------------------------------- +Sure. I mean let me start by saying you're approximately right, in volume terms, on the current split between sparkling and stills, about 70/30. I think it is worth noting that that split has been moving in the favor of stills by about a point a year. The turn of the century, 10, 15 years ago, it was a single digit percent of the mix. It is going up at about a percent a year. Now, part of that is organic on the things we are doing, and part of that is the net or some of the bolt on acquisitions but it is going up about a percent a year of mix. +I think as you look forward, clearly, we, given that we have 50% of the sparkling industry value share, and 15% of the sum of all the stills categories value share, we fully expect to be able to grow faster in the stills categories, because it will be the culmination of the category growth rate, plus our ability to gain share, which then feeds into your third question, which is how are the investments aligned? +I feel they are aligned. Obviously it is an ongoing process. Each year, we look at it in the business planning process and we will be doing that again this year, but I would not characterize it as we are over-invested in sparkling and under-invested in stills. We are invested behind what is growing. And actually just add a little more texture to it we are doing the right things on sparkling, and we tend to be pushing more money towards driving the zeros, the lights, the smaller packages in the sparkling business. +In the stills, it is not a one size fits all category. In fact, we model categories and there we are selective on which ones have a most on trend with the consumers and which ones have more premium pricing. And therefore, we are very selective on where we funnel the dollars and invest ahead of the curve or in line with the growth rates that we are expecting. + +-------------------------------------------------------------------------------- +Operator [17] +-------------------------------------------------------------------------------- +Thank you. And our next question is from the line of Andrew Holland from SocGen. + +-------------------------------------------------------------------------------- +Andrew Holland, Societe Generale - Analyst [18] +-------------------------------------------------------------------------------- +Hi could I just ask you, something, whether you could talk a little bit about the key qualities that are you looking for in a new bottler partner in Africa. Any particular experiences or qualities that you are looking for? + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Company - Chairman and CEO [19] +-------------------------------------------------------------------------------- +Yes, Andrew, this is, good morning, this is Muhtar, I think you would expect us to be looking for proven capability, alignment, and bottlers that have already got a track record in our system, and that we have actually delivered together in alignment, where -- and we have good examples of that, that we can refer to. But that is basically, it in a nutshell, and I think, I know you probably have a loaded question, but you know, in answering to your actual question, that is what I would say. + +-------------------------------------------------------------------------------- +Operator [20] +-------------------------------------------------------------------------------- +Thank you. And our next question is from the line of Bonnie Herzog from Wells Fargo. Your line is now open. + +-------------------------------------------------------------------------------- +Bonnie Herzog, Wells Fargo Securities, LLC - Analyst [21] +-------------------------------------------------------------------------------- +Thank you. Good morning. + +-------------------------------------------------------------------------------- +James Quincey, The Coca-Cola Company - President and COO [22] +-------------------------------------------------------------------------------- +Good morning. + +-------------------------------------------------------------------------------- +Bonnie Herzog, Wells Fargo Securities, LLC - Analyst [23] +-------------------------------------------------------------------------------- +I was actually hoping you could give us a little more detail on your stills portfolio in North America. You reported high single digit growth in Vitamin Water and then solid results in Smart Water, but your still portfolio only grew 2%, so curious what has been the drag there? And then do you expect some of the innovations that you mentioned to drive growth in your stills portfolio back up towards the mid or even high single digit range? + +-------------------------------------------------------------------------------- +James Quincey, The Coca-Cola Company - President and COO [24] +-------------------------------------------------------------------------------- +We certainly did well in a number of the categories, particularly some of the premium categories. What was a little weaker in this quarter was some of the juice businesses and some of the tea businesses, which are not as high value to us. So that is what netted out on the 2%. +What you think -- what I think you see is over the year, you see very strong growth in Vitamin Water, in sports drinks, and some of the other categories, as well, so I think it is a broadening of the portfolio, a focus on innovation, but yet there's some head winds on juice, linked somewhat to commodities. + +-------------------------------------------------------------------------------- +Operator [25] +-------------------------------------------------------------------------------- +Thank you. And our next question is from the line of Ali Dibadj from Bernstein. Your line is now open. + +-------------------------------------------------------------------------------- +Ali Dibadj, Bernstein - Analyst [26] +-------------------------------------------------------------------------------- +Hey, guys, I would just like a little bit of your perspective on two markets, kind of at the extremes of maturity right now for you guys. So first on North America, which obviously remains a key concern when I talked to investors, just given the views of consumer preferences, but North America is doing pretty well, pretty robust, stable growth, and 3% organic sales growth, you know, good volume, relatively good volume, relatively good price/mix. +And what is working well for you in that market? Is it price and pack architecture? Stills? Better marketing? I'm assuming it's all that stuff? And what are you learning from that, that might work for similar geographies like Western Europe or Japan? Should we expect kind of in those markets a little bit of a similar ramp-up as we are seeing in North America? +And then as the other extreme, can you tell us a little bit more about the China rebound so to speak. I know you mentioned weather there, clearly the weather must have helped, but can you give us a sense of what you think the underlying growth is? Has the market gotten any better? Clearly you have worked through thanks to weather some of your destocking issues. But I want to get a better sense of China at the other extreme. Thanks for your time. + +-------------------------------------------------------------------------------- +James Quincey, The Coca-Cola Company - President and COO [27] +-------------------------------------------------------------------------------- +Sure, good morning, Ali, James here. +Look, North America, I think is a combination of many, many things. I mean it has I think been the result of a number of years working on multiple fronts. Working on innovation across the portfolio, getting into categories, refining the propositions, learning, refining the propositions. It is about, in the sparkling business, the better marketing, the more media spend. It is about the focus on the pricing and packaging architecture, with more smaller packages, and it is about getting the execution right. It is the refranchising, bringing new excited bottlers in. +In the end this is a result that has been built by a great team of people, who have been very focused over a number of years about regenerating growth in the North American business. As Muhtar said, they have had six very solid quarters of volume and revenue growth. And I think there are a lot of learnings. There is no silver bullet, but there are a lot of learnings. +Having said that, Japan has also been on a good run, the past three quarters are very good volume growth, you know, doing well on offsetting deflationary pressure. Again a similar story. The team is very focused on a multiple category approach, innovation in the products, increasing the quality and quantity of the marketing. But always in parallel and in alignment with the bottler where you got to get better execution. Good marketing on its own is not going to get you the answers. There's got to be more and better marketing along with more and better execution. I think that's you see. +And to some extent, Western Europe, that kind of came, new Coca-Cola European partners came well out of the stables on the first quarter. I think the formula is going to be the same. More and better marketing. More and better execution. And a multilane focus on categories and cranking out the learning, the [trying stuff], the innovation, and pushing ahead. And I think that is something we are going to continue to press across the developed markets. +Now, turning to China, I think China, again, I don't think, if I gave the impression it was all weather, that would be unfair to the team on the ground in China, and the system there. They have done a lot of work to address the big change in how the consumer responded to the economic circumstances in China. I think part of it is, you know, it is a part of the world that has had such consistent growth rates over the last decade, but a little bit of a slowdown maybe towards some exaggerated pull-back on spending, so I think there is a little bit of stabilization coming through in the macros. We saw that. +We have definitely taken action in the things that we can control. Not just in the commercial policies, to strengthen the wholesaler and distributor network and working through the inventory problem, but also on the pricing and packaging. To give you one example, a very small example, but it is symptomatic of how fast China can change. If you go to the cafe channel in China, all of the noodle shops up and down the street, people go there at lunchtime. +Last year they were packed with people. This year, you go, they are a third empty. You go okay, maybe the economy slowed down. No, that's not what is happening. +The explosion of online to offline ordering and the availability of lots of people on bikes and motorbikes to deliver stuff and the apps the aggregate wraps to buy food, it has been an explosion of ordering online and delivery food. Such that there's just as many people buying from these cafes, but sometimes in some parts of China, a third of it is being delivered to people, whether it is work or to students, so we have to adapt that packaging. Having a returnable glass bottle in that cafe doesn't help you with offline delivery. So we have had to revamp the packaging offer so we are there with the right package to go where the consumer is going. +That is a micro example of the sorts of thing we have had to do in China to adapt to how the market is changing and is contributing to the stabilization. But it is as I said, a country undergoing change in its economic model and that will throw up new and different consumer behaviors to which we will have to adapt. + +-------------------------------------------------------------------------------- +Operator [28] +-------------------------------------------------------------------------------- +Thank you. And our next question is from the line of Bryan Spillane from Bank of America, Merrill Lynch. Your line is open. + +-------------------------------------------------------------------------------- +Bryan Spillane, BofA Merrill Lynch - Analyst [29] +-------------------------------------------------------------------------------- +Hi, good morning, everyone. + +-------------------------------------------------------------------------------- +James Quincey, The Coca-Cola Company - President and COO [30] +-------------------------------------------------------------------------------- +Good morning. + +-------------------------------------------------------------------------------- +Bryan Spillane, BofA Merrill Lynch - Analyst [31] +-------------------------------------------------------------------------------- +Can you give us an update on the Philippines? In listening to the Coca-Cola FEMSA results last night, it sounds like volumes are up there, margins are improving, it is one of those markets where it has been sort of a long-term project to get that turned around. Could you just give us a sense of sort of you with you feel the Philippines are at this point, and maybe what have you done to improve things there. + +-------------------------------------------------------------------------------- +James Quincey, The Coca-Cola Company - President and COO [32] +-------------------------------------------------------------------------------- +Hi, Bryan, it is James. Look, we have had a much better run in the Philippines in the last few quarters, actually, strong numbers the first three quarters. This year actually, last year, was three very strong quarters as well; so I think since FEMSA has been in, there they have built on the work that [BIG] did, they have gone about fixing the fundamentals. There were some fundamental structural stuff that still needed to be improved and I think they grasped that in the early days an we are starting to see the benefits of that coming through in the last six quarters. +Again, it is not silver bullet stuff. It is not too complicated in the sense of, you know, it has been about adapting the price package architecture, it is about some of the emphasis on of some of the sparkling brands in the Philippines, some of the local brands that we de-emphasized and re-emphasized some of the more global brands and the stronger local brands, rebuilding and continuing to construct a more solid distributor network. +Obviously Philippines is complicated given all of the islands and the issue of moving product around. I think they have kind of worked the system in terms of getting the thing nicely oiled in terms of the cogs so the product could get everywhere, backed up with a little more marking and a little sharper focus on certain categories and I think that's played through. I think the team on the ground has done a good job of taking the performance to a higher level. + +-------------------------------------------------------------------------------- +Operator [33] +-------------------------------------------------------------------------------- +Thank you. And our next question is from Brett Cooper from Consumer Edge Research. Your line is now open. + +-------------------------------------------------------------------------------- +Brett Cooper, Consumer Edge Research - Analyst [34] +-------------------------------------------------------------------------------- +Good morning. + +-------------------------------------------------------------------------------- +James Quincey, The Coca-Cola Company - President and COO [35] +-------------------------------------------------------------------------------- +Good morning. + +-------------------------------------------------------------------------------- +Brett Cooper, Consumer Edge Research - Analyst [36] +-------------------------------------------------------------------------------- +If we look back, we have seen you implement a pretty significant cost savings program. What I think we would describe as accelerated or accelerating M&A activity in your bottling system yielding synergies. +And now there is talk in the system of looking outside and seeking efficiencies in Japan. Are there more innovative ways that are you open to, to help the system find funds to be more competitive? + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Company - Chairman and CEO [37] +-------------------------------------------------------------------------------- +Hi, Brett, this is Muhtar. First, let me just say that over the last four or five years, we have been actually working really, really hard to reconfigure the Japanese bottling system. We had 13 bottlers what, back five years or six years ago, and now we are working towards having 85% of the total business in Japan, which as you know is a very large business for us, under one roof. And I think that [itself] first, and without looking outside, without looking anywhere, it is a huge re-architecture that is yielding substantial savings, and we can redeploy that into being, into route to market, into ways we actually get our products the most effective efficient way to the customer, and through the customer to the consumer in Japan. +Regardless of any encouragement from the outside, we are on track to end up in a very efficient, very 21st century bottling system and consumer goods delivery system in Japan that is working well +Now, are there other communities, as that is just not related to cost savings? And yes, there has been early, very early discussions in Japan. I can't say any more than that and we will continue to look at opportunities to see if we can even make our Japanese system even stronger. But that is very early days, again, in terms of the level of discussions that have taken place. + +-------------------------------------------------------------------------------- +Operator [38] +-------------------------------------------------------------------------------- +Thank you. And our next question is from Bill Chappell from SunTrust Robinson Humphrey. Your line is now open. + +-------------------------------------------------------------------------------- +Bill Chappell, SunTrust Robinson Humphrey - Analyst [39] +-------------------------------------------------------------------------------- +Thanks, good morning. + +-------------------------------------------------------------------------------- +James Quincey, The Coca-Cola Company - President and COO [40] +-------------------------------------------------------------------------------- +Good morning, Bill. + +-------------------------------------------------------------------------------- +Bill Chappell, SunTrust Robinson Humphrey - Analyst [41] +-------------------------------------------------------------------------------- +Just wanted to follow up, back on Steve Power's question. There is definitely a noticeable kind of increase in talk about the still growth and investment in the last conference and on the call today. And just trying to understand -- I mean I certainly understand there is an opportunity, but what that means for margins as we move, especially gross margins going forward, because I think it is still much lower gross margin; and so you expect margin degradation? Or has the mix of business, with tea or higher [intake] products offset so as we look at kind of 2018, '19, we don't see that kind of margin degradation? + +-------------------------------------------------------------------------------- +James Quincey, The Coca-Cola Company - President and COO [42] +-------------------------------------------------------------------------------- +Sure, let me say a couple of thoughts, and then Kathy will give you some comments on the margin. Look, the stills, if I can say one thing, which is the stills is not a category. It is a combination of many different categories and even those categories re-segment between premium, mainstream, and more affordable. And so what we are focused on doing, as we invest in the stills business, is yes growing in aggregate, in top line numbers, but we are being selective on focusing on those places where we think we can generate a better return in the long term. +It is not a growth of bulk water. It is a focus on where is the consumer demand, what is on trend, and if you just pick out a couple of things that are on trend, things like coconut waters, or premium juices or premium ready to drink coffees, these are all very high revenue products. Kathy, do you want to talk about the margins? + +-------------------------------------------------------------------------------- +Kathy Waller, The Coca-Cola Company - CFO [43] +-------------------------------------------------------------------------------- +Sure. Hi, Bill. You are going to see some impact on margins, but mostly initially, because as we are going into these businesses, whether we are developing them internally or whether they are through bolt-on acquisitions, they do have a margin impact. But then as we get scale, as we continue to work on the supply chain, et cetera, we do start to improve the margins. +So I would say the initial issue for margins and then over time, we are able to do things that will improve the margin impact. But initially, yes, as a category itself, a lot of these stills have higher cost of goods -- they have higher revenue but higher cost of goods, so that does impact margins. + +-------------------------------------------------------------------------------- +Operator [44] +-------------------------------------------------------------------------------- +Thank you. And our next question is from the line of Judy Hong from Goldman Sachs. Your line is now open. + +-------------------------------------------------------------------------------- +Judy Hong, Goldman Sachs - Analyst [45] +-------------------------------------------------------------------------------- +Thank you, good morning. I wanted to go back to China and ask a couple of follow-ups. So one is within the 2% growth in China, can you talk about sparkling versus still? +And then I think, James, we are seeing certainly in that market, the premiumization is one of the key trends and just wanted to get a sense of how big you think that premium segment within NARTD in China is, and what the growth rate is and kind of what you are doing to sort of tackle that consumer preference. +And separately, Kathy, the structural impact obviously the fourth quarter is still a pretty big headwind. Is there any color you can give us as we think about 2017, sort of how much the structural impact kind of lingers into 2017 and maybe even 2018? Thanks. + +-------------------------------------------------------------------------------- +James Quincey, The Coca-Cola Company - President and COO [46] +-------------------------------------------------------------------------------- +Sure. James here. Look, I think it is important to say that the premium opportunity in China is big, but it is not as big as the mainstream opportunity. We are absolutely focused on investing in that premium opportunity. It is very much about the big cities, the white collar. It is going to be also about some of the premium parts of the still categories. We are going to go after that. +But in the end, the biggest mass of consumers, the biggest mass of disposable income will be in the mainstream. So it will have to be a combination, of yes, addressing the premiums, but also going after the mainstream with the greater affordability, expanding the distribution reach, upgrading the execution into the third tier cities and in the rural areas, that is also going to be a big driver of our revenue. +In terms of the categories, I think what has been going really well, by example, is we have taken an approach of premiumizing our water business in China. One of our most recent billion dollar brands, Ice Dew, comes out of China. Effectively, we are driving the business from -- in the end -- a one RMB price point to a two RMB price point. That is one of the biggest drivers of growth, is the water at the two RMB. +The places where we have taken -- had a little tougher time is perhaps in the juice category, with sparkling in the middle. Again, when you look at what is growing in terms of the categories, what you do see is it maps quite closely to the consumer segments in terms of who is suffering and who is not suffering in terms of disposable income. The juices, the kind of ambient, more going to the rural areas, have been hit a little harder. The premium waters which are perhaps more in the cities have been doing well. + +-------------------------------------------------------------------------------- +Kathy Waller, The Coca-Cola Company - CFO [47] +-------------------------------------------------------------------------------- +And on the second question about the structural impact, so we will obviously give more information on 2017 later, as we get closer to the beginning of the year. But I will say that in the -- particularly in the North America refranchising, the impact will be significant in 2017, because as we are moving to get all of the refranchising completed in 2017, that is, we will be moving more than we have moved in all of 2015 and 2016 combined. So it will be a large impact in 2017, and we will work to give you all more color on that later in the year, or early 2017. +And as far as 2018 is concerned, the refranchising will be done, but it will be -- the impact will be basically the cycling of it, obviously the timing of these transitions will be significant, not only to 2017 but also the impact it will have on 2018. And then we have some costs that we have to get out in 2018 that we will be working to get out in early 2018, that will be basically a function of the refranchising as well. So we will give you more color as time passes. + +-------------------------------------------------------------------------------- +Operator [48] +-------------------------------------------------------------------------------- +Thank you. I would now like to turn the call back to Muhtar Kent for closing remarks. + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Company - Chairman and CEO [49] +-------------------------------------------------------------------------------- +Thank you, James, Kathy and Tim. We are working aggressively to evolve our sparkling strategy and expand our brand portfolio in order to address changing consumer preferences. And we are on track with transforming our company to a higher margin, higher return business, focused on building strong brands, enhancing customer value, and leading a strong dedicated global franchise system. +Looking forward, we remain confident that the long-term dynamics of our industry are promising, and we absolutely believe that the Coca-Cola Company is well positioned to deliver long-term value to our shareholders. As always, we thank you for your interest, your investment in our company, and for joining us this morning. + +-------------------------------------------------------------------------------- +Operator [50] +-------------------------------------------------------------------------------- +Thank you, everyone. That concludes today's conference call. Thank you all for joining. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/exam/original-files/Problem_2_3_Sample_full_transcripts/2017-Apr-13-JPM.N-138307122418-Transcript.txt b/exam/original-files/Problem_2_3_Sample_full_transcripts/2017-Apr-13-JPM.N-138307122418-Transcript.txt new file mode 100644 index 0000000..5c47aee --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_full_transcripts/2017-Apr-13-JPM.N-138307122418-Transcript.txt @@ -0,0 +1,685 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q1 2017 JPMorgan Chase & Co Earnings Call +04/13/2017 08:30 AM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Marianne Lake + JPMorgan Chase & Co. - CFO and EVP + * James Dimon + JPMorgan Chase & Co. - Chairman, CEO and President + +================================================================================ +Conference Call Participiants +================================================================================ + + * Betsy Lynn Graseck + Morgan Stanley, Research Division - MD + * Glenn Paul Schorr + Evercore ISI, Research Division - Senior MD, Senior Research Analyst and Fundamental Research Analyst + * John Eamon McDonald + Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst + * Eric Edmund Wasserstrom + Guggenheim Securities, LLC, Research Division - MD and Senior Equity Analyst + * Marlin Lacey Mosby + Vining Sparks IBG, LP, Research Division - Senior Analyst + * Matthew Hart Burnell + Wells Fargo Securities, LLC, Research Division - Senior Financial Services Equity Analyst + * Erika Najarian + BofA Merrill Lynch, Research Division - MD and Head of US Banks Equity Research + * Kenneth Michael Usdin + Jefferies LLC, Research Division - MD and Senior Equity Research Analyst + * Gerard S. Cassidy + RBC Capital Markets, LLC, Research Division - Analyst + * Matthew D. O'Connor + Deutsche Bank AG, Research Division - MD in Equity Research + * James Francis Mitchell + The Buckingham Research Group Incorporated - Research Analyst + +================================================================================ +Presentation +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Good morning, ladies and gentlemen. Welcome to JPMorgan Chase's First Quarter 2017 Earnings Call. This call is being recorded. (Operator Instructions) We will now go live to the presentation. Please stand by. +At this time, I would like to turn the call over to JPMorgan Chase's Chairman and CEO, Jamie Dimon; and Chief Financial Officer, Marianne Lake. Ms. Lake, please go ahead. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO and EVP [2] +-------------------------------------------------------------------------------- + + Thanks, operator, and good morning, everyone. I'm going to take you through the earnings presentation, which is available on our website. Please refer to the disclaimer at the back of the presentation. +Starting on Page 1. We're off to a good start this year with net income of $6.4 billion, EPS of $1.65 and a return on tangible common equity of 13% on revenue of $25.6 billion with a continuing momentum from last year driving strong performance across all of our businesses. Highlights for the quarter include: average core loan growth of 9% year-on-year, reflecting broad strength across products; continued double-digit consumer deposit growth; strong card sales up 15%; and merchant volume up 11%. +In addition, we achieved a number of records across our businesses, most notably net income and IB fees for our first quarter in the CIB; net income and revenue for the Commercial Bank; and asset under management and banking balances in Asset & Wealth Management. Overall, the credit environment remains benign. In Consumer, there were no reserve actions taken across our core portfolios, while in Wholesale, we had a net reserve release of about $90 million driven by energy, resulting in net releases in both the CIB and the Commercial Bank. +You see no significant items here on the page, but there are a few notable items in our results that I'll highlight here for you. The first is a tax benefit of a bit less than $400 million, and the benefit relates to the difference in stock price between vesting date and grant date for our employee equity awards. And while such an adjustment is business as usual, the recent appreciation in our stock price has caused the benefit to be outsized this quarter, with the largest impact occurring to the CIB and to a lesser extent, Asset & Wealth Management. +Second is a write-down of our student loan portfolio of approximately $160 million after tax as we move these loans to held for sale and explore alternatives to that portfolio. And last is firm-wide legal expense of around $140 million after tax relating to a number of matters across businesses, some positive, some negative, and with the most significant impact being in the AWM business. +Moving on to Page 2 and some more detail about the first quarter. Revenue of $25.6 billion was up $1.5 billion or 6% year-on-year, with the increase evenly split between net interest income and noninterest revenue. NII reflected the impact of higher rates and continued growth and NIR reflected higher CIB revenues, partially offset by Card acquisition costs and lower MSR risk management. Adjusted expense of $14.8 billion was up 7% year-on-year, mainly driven by higher compensation on increased revenue and higher auto lease depreciation. In addition, the combination of the impact of the FDIC surcharge as well as a foundation contribution this quarter accounted for nearly $200 million of the year-on-year expense change. Adjusted for the student lending write-down I just mentioned, credit costs of $1.1 billion would be down approximately $700 million year-on-year as higher charge-offs in Cards were offset by a Wholesale net reserve release this quarter versus a sizable build in the prior year. +Switching to balance sheet and capital on Page 3. We ended the quarter with both standardized and advanced fully phased-in CET1 of 12.4%, in line with our expectations and overall driven by net capital generation. We continue to manage our balance sheet with discipline. Total assets returned to above $2.5 trillion, reflecting the continuation of strong deposit growth as well as our trading balances normalizing from very low levels at the end of the year. From a liquidity perspective, HQLA was flat to year-end, and the firm remained compliant with all liquidity requirements. We continued to grow tangible book value per share while returning $4.6 billion of net capital to shareholders in the first quarter, which included $2.8 billion of net repurchases and common dividends of $0.50 a share. And it's $4.6 billion compared to $3.8 billion return last quarter. As you know, we've recently submitted the 2017 CCAR capital plan to the Federal Reserve. And as you would expect, we have no feedback to give you for now. +Moving on to Page 4 and the Consumer & Community Bank. CCB generated $2 billion of net income and an ROE of 15%. Core loans were up 11% with strength across products. Mortgage was up 15%, Cards up 9%, Business Banking up 9% and Auto loans and leases up 12%. Deposit growth continued to outperform the industry, up 11%, with about half of deposit growth from existing customers as we continue to deepen relationships. We continued to see very strong growth metrics in Cards for the quarter, with sales up 15% and new account originations up 9%. Merchant processing volumes were up 11% year-on-year and active mobile customers up 14%. Revenue of $11 billion was down modestly. +Consumer & Business Banking revenue was up 8% on strong deposit growth, and we are starting to see the long-awaited improvement in deposit margins. Mortgage revenue was down 18%, driven by lower net servicing revenue, reflecting lower MSR risk management as well as portfolio runoffs. And Cards, Commerce Solutions & Auto revenue was down 3%, driven by continued investment in Cards' new account acquisitions that will provide long-term value, which was predominantly offset by net interest income on higher loan balances as well as higher auto lease income. Expense of $6.4 billion was up 5% year-on-year on auto lease depreciation and continued business growth. +Finally, the credit trends in our core portfolio remain favorable. Net charge-offs increased year-on-year, primarily driven by a $470 million write-down of our student loan portfolio, against which we released $250 million of reserve. And card charge-offs were up in line with expectations and in line with guidance. Moving to mortgage and auto credit, our portfolios continue to perform very well. +Now turning to Page 5 and the Corporate & Investment Bank. CIB delivered a strong result with a reported ROE of 18% and net income of $3.2 billion. But remember, a significant portion of the tax benefit on the stock update is reflected in these results. Revenue of $9.5 billion was up 17% year-on-year, and IB fees of $1.8 billion were up 37%, partly due to a weak first quarter last year but also given strong absolute performance this year. In banking, IB revenue was up 34%, driven by higher overall issuance, especially in ECM, including a strong IPO market. And remember, the first quarter of '16 was particularly strong in M&A and weak in DCM for us. And this quarter, share normalized. +Overall, we gained share and ranked #1 in Global IB fees and #1 in North America and EMEA. Looking forward, sentiment is positive, the market remains broadly constructive and across products, we expect decent deal flow and the pipelines are healthy. Treasury Services revenue of $981 million was up 11% year-on-year, driven by higher rates and operating deposit growth. Lending revenue of $389 million was up 29% year-on-year on higher gains from securities received from restructuring. +Moving on to Markets & Investor Services. Markets revenue of $5.8 billion was up 13% as investor data market was characterized by low volatility and subdued client activity, leading us to be somewhat cautious. March ended up being stronger than expected, reflecting some recovery in volatility but also clients responding more to market themes, including European elections and to a lesser degree, a stronger U.S. rate outlook. Fixed income revenue was up 17% with Credit and Securitized Products as key drivers on stronger client activity and significant spread tightening broadly. Rates was also solidly up as the market reacted to central bank actions and we saw a pickup in flows in EMEA. We had a decent quarter in equities, with revenue up 2% year-on-year in somewhat quiet markets broadly, with corporate derivatives and prime being brighter spots. Securities Services revenue was $916 million, in line with guidance. And finally, expense of $5.1 billion was up 7%, driven by higher performance-based compensation and a comp-to-revenue ratio for the quarter was 29%. +Moving on to Page 6 and Commercial Banking. Another excellent quarter in Commercial Banking with a 15% ROE. Revenue grew 12% year-on-year due to higher deposit NII and continued loan growth as well as some strong IB revenues, up 34%, making this the third consecutive quarter of IB revenues of over $600 million. Expense of $825 million was impacted by a $29 million impairment on leased assets. Excluding this, we saw expense increase slightly above guidance as we made great progress on the pace of investments, which will continue to drive strong top line growth. Looking forward, we expect our underlying expense trends to be relatively flat. +Loan balances of $191 billion were up 12% over the prior year. Consistent with the industry broadly, we have seen a slowdown in C&I growth, with our loan balances remaining relatively flat sequentially, although up 8% year-on-year. There are a number of factors likely contributing, including potential noise in the data from large acquisitions in prior periods and a resurgence in capital markets activity, particularly in DCM, including high yield. Though not to dismiss the importance of the trends, we do need to weigh all the facts, and against that, other macro indicators remain supportive of the economy broadly, including CapEx data and surveys as well as very high levels of business optimism, all of which should be supportive of solid demand for credit over time. +In Commercial real estate, we saw sequential growth of 3%, slightly ahead of the industry but below the pace of prior quarters, impacted both by higher rates as well as a prudent approach to new originations, given where we are in the cycle, and maintaining discipline on risk-adjusted returns. Credit performance remained strong, with a net recovery of 2 basis points reflecting continued stability in both our C&I and CRE portfolios, and overall, a net release of loan loss reserves driven by energy. +Leaving the Commercial Bank and moving on to Asset & Wealth Management, on Page 7. Asset & Wealth Management reported net income of $385 million, with pretax margin and ROE each at 16%. Revenue of $3.1 billion was up 4% year-on-year, driven primarily by higher market levels and strong banking results on higher deposit NII. Recall that last year's first quarter included a one-time $150 million gain on the sale of an asset. Expense of $2.6 billion was up 24% year-on-year, predominantly driven by higher legal expense. +I want to emphasize that the underlying core business results remain very strong. In fact, in line with the strongest performance of the business ever. This quarter, we saw net long-term inflows of $8 billion, with strength in fixed income and multi-asset being partially offset by outflows in equity. Assets under management of $1.8 trillion and overall client assets of $2.5 trillion were both up 10% year-on-year, reflecting higher market levels and net inflows into both liquidity and long-term products. Finally, banking balances continued to be strong, with loan and deposits up 7% and 5%, respectively. +Moving on to Page 8 and Corporate. Corporate generated $35 million of net income for the quarter. Treasury and CIO's results improved, in part reflecting the benefit of higher rates, and Other Corporate benefited from the release of certain legal reserves. +Finally, turning to Page 9 and the outlook. With the addition of the March rate hike, we've updated our NII scenarios as follows. Rates flat from here, so the full year NII would be up around $4 billion. Based on the implied, NII would be up by around $4.5 billion. And of course, the Fed dots would imply the possibility of 3 rate hikes this year, which is not fully priced in. So expect second quarter NII to be up sequentially, approximately $400 million, consistent with what we saw this quarter. +To wrap up, these results reflect strength broadly across our businesses. We remain well positioned to benefit from client flows and a healthy economy as we serve our clients and communities, and we look forward to continuing to grow our business. +With that, operator, you can open up the line to Q&A. Operator? + + +================================================================================ +Questions and Answers +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Our first question comes from John McDonald with Bernstein. + +-------------------------------------------------------------------------------- +John Eamon McDonald, Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst [2] +-------------------------------------------------------------------------------- + + So I had a question about any early signs of deposit beta and elasticity. I guess, on the consumer side, in your retail banking area, are you seeing customers increasingly ask for higher rates in their deposit accounts or any activity where they're moving from kind of checking to savings and kind of early signs of pressure on deposit pricing? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO and EVP [3] +-------------------------------------------------------------------------------- + + So in the retail space, the answer is no, not really. And to be completely honest, we've been pretty consistent that we would not really have expected there to be much in terms of deposit reprice at absolute levels of rates that are still quite low. And so with IOER at 100 basis points, we're still in that sort of realm of the atmosphere, and so we would expect that to start happening a couple of rate hikes from here maybe. We'll have to wait and see. We've obviously never really been through exactly this before. On the other side of the equation, in the Wholesale space, we are in the process of seeing a reprice happen. + +-------------------------------------------------------------------------------- +John Eamon McDonald, Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst [4] +-------------------------------------------------------------------------------- + + Got it, okay. And in terms of customers, they're not really asking yet or behaving in a way that they're looking price-sensitive, you're not seeing early signs of it yet? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO and EVP [5] +-------------------------------------------------------------------------------- + + No. + +-------------------------------------------------------------------------------- +Operator [6] +-------------------------------------------------------------------------------- + + Your next question comes from Glenn Schorr with Evercore ISI. + +-------------------------------------------------------------------------------- +Glenn Paul Schorr, Evercore ISI, Research Division - Senior MD, Senior Research Analyst and Fundamental Research Analyst [7] +-------------------------------------------------------------------------------- + + I wanted to maybe get out in front of what could be some brewing issues in retail land. And the perspective I'm looking for is you have plenty of gross exposure to retail and retail-related. However, there seems to be plenty of collateral, and you're typically at the top of the capital structure, too. So can you talk about both direct exposure in some of the problem retail areas and the related exposure in, like, commercial real estate and on the mall side? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO and EVP [8] +-------------------------------------------------------------------------------- + + Yes, so I don't have all those numbers directly in front of me. I know that in the Commercial Bank, our exposure to mortgage is really pretty modest, it's around about a total of $3 billion in the commercial real estate space. And I would tell you that while there obviously is a lot of discussion around retail, and with some merit, it's very case-by-case, location-by-location-specific. And I kind of liken the discussions a lot to discussions we have around our bricks-and-mortar banking businesses, which is consumer -- the way consumers engage with retail isn't changing, it doesn't mean they will stop engaging with retailers. And so it will be very specific with respect to location and tenants. And it doesn't necessarily mean that retail is going to be in as much potential trouble as I think people are talking about. So we remain cautiously watching it but also cautiously optimistic that it's not -- that it's a bit overblown. + +-------------------------------------------------------------------------------- +James Dimon, JPMorgan Chase & Co. - Chairman, CEO and President [9] +-------------------------------------------------------------------------------- + + And you should assume that we've looked at not just direct retail or retail-related real estate, and all the vendors to any potentially covered retailers. When you put it all together, it's a little bit like there'll be something there, but it's nothing that will be dramatic when it's happening. + +-------------------------------------------------------------------------------- +Glenn Paul Schorr, Evercore ISI, Research Division - Senior MD, Senior Research Analyst and Fundamental Research Analyst [10] +-------------------------------------------------------------------------------- + + Is the main reason you're positioned in the stack, meaning I notice you have a lot of collateral against your exposure, and like I said, you tend to be at the top of the stack. Is that the main issue? I remember doing this with you guys 2 years ago in oil, while oil was dropping, and it turned out you barely came out with a few cuts and bruises. There seems to be more collateral here, but I don't want to put words into your mouth. + +-------------------------------------------------------------------------------- +James Dimon, JPMorgan Chase & Co. - Chairman, CEO and President [11] +-------------------------------------------------------------------------------- + + Are you talking about real estate related to retail? Or are you talking about retailers? + +-------------------------------------------------------------------------------- +Glenn Paul Schorr, Evercore ISI, Research Division - Senior MD, Senior Research Analyst and Fundamental Research Analyst [12] +-------------------------------------------------------------------------------- + + I'm talking both because you do have hundreds of billions of direct retail exposure plus the commercial real estate exposed to it. I'm just thinking you have... + +-------------------------------------------------------------------------------- +James Dimon, JPMorgan Chase & Co. - Chairman, CEO and President [13] +-------------------------------------------------------------------------------- + + No, you're way out of line. I mean, direct retail exposure, we're very careful. The retail business has always been violent and volatile. You can look back through our history, and half of them are gone after 10 years. That's the normal course. So we're usually senior, we're very careful with stuff like that. And then you go to real estate, okay, most of our real estate has nothing to do with retail. So we do have some shopping centers and malls and buildings and stuff like that. But those are generally high on the stack, well-secured and not relying on single retailers, et cetera. + +-------------------------------------------------------------------------------- +Glenn Paul Schorr, Evercore ISI, Research Division - Senior MD, Senior Research Analyst and Fundamental Research Analyst [14] +-------------------------------------------------------------------------------- + + Okay, I was just looking at taking a temperature. + +-------------------------------------------------------------------------------- +James Dimon, JPMorgan Chase & Co. - Chairman, CEO and President [15] +-------------------------------------------------------------------------------- + + It will be like oil and gas for us, it won't be a big deal. + +-------------------------------------------------------------------------------- +Operator [16] +-------------------------------------------------------------------------------- + + Your next question comes from Gerard Cassidy with RBC. + +-------------------------------------------------------------------------------- +Gerard S. Cassidy, RBC Capital Markets, LLC, Research Division - Analyst [17] +-------------------------------------------------------------------------------- + + Can you give us some color on the credit card area in terms of -- I know you upped your credit card losses earlier in the year at the Investor Day in the fall of last year. What's your guys outlook for the credit losses in the credit card portfolio? Where would you tolerate it to? And at what point do you really change the underwriting standards if you need to? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO and EVP [18] +-------------------------------------------------------------------------------- + + Yes. So look, I know that -- so one of the things that we want to remind everybody before we talk about the trend is that the credit card losses are still at absolutely very, very low levels. And notwithstanding whatever we would have done or have done or continue to do with our credit books, we would ultimately have expected them to normalize to higher rates regardless, so -- and then for -- obviously, the first quarter hasn't been that... + +-------------------------------------------------------------------------------- +James Dimon, JPMorgan Chase & Co. - Chairman, CEO and President [19] +-------------------------------------------------------------------------------- + + It's probably just the previous cycle stuff. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO and EVP [20] +-------------------------------------------------------------------------------- + + Yes, exactly. And obviously, first quarter has some seasonality. So I would just start by saying that the charge-off rates we're seeing are completely in line with our expectations and guidance that we gave you at Investor Day both in terms of 2017 being below 3% and over the medium term being between 3% and 3.25% for all of the reasons we articulated. A combination of positive credit expansion that took place over the last couple of years and the performance of those newer vintages is in line with our expectations and with high risk-adjusted margins. So it's not really about tolerating the charge-offs as long as we're getting paid properly for the risk, which is the case. And obviously, as we see those charge-off rates both normalize and reflect those newer vintages, they will go up modestly over time. And we expanded our credit in a targeted way, but it wasn't a significant expansion. And we will respond in our credit and risk appetite to whatever we're seeing in the environment. But it won't necessarily be predicated by charge-offs rates as long as (inaudible). + +-------------------------------------------------------------------------------- +Gerard S. Cassidy, RBC Capital Markets, LLC, Research Division - Analyst [21] +-------------------------------------------------------------------------------- + + Got you. And as a follow-up, obviously you had very strong investment banking on the FICC trading side, very strong capital market numbers. Are you guys seeing further evidence of taking more market share from your competitors in any of the product lines, whether it's investment banking or FICC trading or equity trading, et cetera? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO and EVP [22] +-------------------------------------------------------------------------------- + + So I would say if you look back over 2016 and even 2015 and '16, it's true and clear that we gained share, not just in fixed income -- reasonable share not just in fixed income but also in equities. And our business performed well last year. And I would suggest to you that we will defend that share. But the competition is back and healthy. And you can't expect us to continue to gain share at those kinds of levels. We want to defend it, but it's a healthy competitive market right now. So I would say not really. + +-------------------------------------------------------------------------------- +Operator [23] +-------------------------------------------------------------------------------- + + Your next question comes from Betsy Graseck with Morgan Stanley. + +-------------------------------------------------------------------------------- +Betsy Lynn Graseck, Morgan Stanley, Research Division - MD [24] +-------------------------------------------------------------------------------- + + A couple of questions, one on Card. How large are you willing to be in Card? I think on various metrics, you're between 15% and 22%, depending on if you're looking at things like merchant acquiring or the balances in Card in general as a percentage of total outstandings in the country? + +-------------------------------------------------------------------------------- +James Dimon, JPMorgan Chase & Co. - Chairman, CEO and President [25] +-------------------------------------------------------------------------------- + + We have a ways to go before we're concerned. + +-------------------------------------------------------------------------------- +Betsy Lynn Graseck, Morgan Stanley, Research Division - MD [26] +-------------------------------------------------------------------------------- + + I'm asking because in the last cycle, you were really nimble. And do you still feel that you can be nimble at this market share? + +-------------------------------------------------------------------------------- +James Dimon, JPMorgan Chase & Co. - Chairman, CEO and President [27] +-------------------------------------------------------------------------------- + + For merchant processing, there's a lot of share you can gain. And that's not even close, because you give products and services and a change in technology. And I think we're way, way in credit card when you say, "Well, that's too big for JPMorgan Chase." There is a point where it's going to be a good question, but it's not even remotely close to this one. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO and EVP [28] +-------------------------------------------------------------------------------- + + And I would also say that Cards continue to be a very competitive space. So we will continue to try and provide our customers with significant value and have deep, engaged relationships. But I don't think you're going to see material shifts in share in the short term. + +-------------------------------------------------------------------------------- +James Dimon, JPMorgan Chase & Co. - Chairman, CEO and President [29] +-------------------------------------------------------------------------------- + + And we also look strategically at credit card, debit card, online bill pay, P2P as all one big thing to do a great job for the client. + +-------------------------------------------------------------------------------- +Betsy Lynn Graseck, Morgan Stanley, Research Division - MD [30] +-------------------------------------------------------------------------------- + + And then when you're thinking about the credit box, I know a while back, you mentioned, okay, we widened the box to 680. Is there any interest in widening it further? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO and EVP [31] +-------------------------------------------------------------------------------- + + Not particularly at this point. I think we're very happy with the performance of the portfolios, with the growth rates we're getting. You saw that our core card loans were up 9% year-on-year. We're getting a lot of NII benefit from that. So I think we're pretty well positioned at this point. + +-------------------------------------------------------------------------------- +Betsy Lynn Graseck, Morgan Stanley, Research Division - MD [32] +-------------------------------------------------------------------------------- + + So loan growth should probably stay in line with where it is or slow down, is that how should we be thinking about it? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO and EVP [33] +-------------------------------------------------------------------------------- + + Yes, I would say loan growth should be in the mid- to higher single digits. + +-------------------------------------------------------------------------------- +Operator [34] +-------------------------------------------------------------------------------- + + Your next question is from Jim Mitchell with Buckingham Research. + +-------------------------------------------------------------------------------- +James Francis Mitchell, The Buckingham Research Group Incorporated - Research Analyst [35] +-------------------------------------------------------------------------------- + + I'm going to follow up on the NII question. I think your implied guidance of $4.5 billion higher than 2016 is now $500 million from where you were at the Investor Day. Is that the lower deposit beta experience? What's driving, I guess, the modest increase? And then just as a follow-up on that, in terms of if we do -- the implied curve, I think, has about one more rate hike in June. If we were to get another one realized, a dot plot, say we get another one in September, would that be a material increase in that expectation or just incremental or just how do we think about that? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO and EVP [36] +-------------------------------------------------------------------------------- + + So obviously, when we give you guidance, we give you sort of reasonably rounded numbers. So actually, the impact of current implied is a bit more than $500 million more than it was at Investor Day. But in the law of big numbers, that's a pretty reasonable amount. Yes, there is an element, of course, as we talked about, in the Wholesale space, where we are seeing reprice happen, and it does reflect our estimates of what we expect to see over the course of the year in cumulative deposit bases. And with respect to if there was -- and you know that the implied has priced in 1.5 more hikes, so it's -- obviously, March is earlier, so longer, there's a little bit more rate benefit. But it's sort of in line with our expectations. And if we had another rate hike, it would likely be later in the year, and ultimately have a relatively modest impact on this year but obviously be important going forward. + +-------------------------------------------------------------------------------- +James Francis Mitchell, The Buckingham Research Group Incorporated - Research Analyst [37] +-------------------------------------------------------------------------------- + + Okay. So anything in September would be sort of incremental? + +-------------------------------------------------------------------------------- +James Dimon, JPMorgan Chase & Co. - Chairman, CEO and President [38] +-------------------------------------------------------------------------------- + + You should be able to extrapolate those numbers on your own. + +-------------------------------------------------------------------------------- +Operator [39] +-------------------------------------------------------------------------------- + + Your next question is from Ken Usdin with Jefferies. + +-------------------------------------------------------------------------------- +Kenneth Michael Usdin, Jefferies LLC, Research Division - MD and Senior Equity Research Analyst [40] +-------------------------------------------------------------------------------- + + Marianne, you had noted the obvious slowdown we've seen in C&I, and Jamie, in the press release, you talk about the consumers and businesses being healthy and the pro-growth initiatives. Since the Analyst Day, we obviously had Obamacare not go through, and then there's been some doubts on tax reform. So just wondering, can you help us understand just where you're seeing that slowdown in C&I? And how would -- where are we in terms of that confidence turning into real results? And how much is just the wait and see versus where the economy actually is? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO and EVP [41] +-------------------------------------------------------------------------------- + + I think it's important to put that slowdown into context. I mean, we did have 8% growth year-on-year in C&I. We're just saying sequentially, things are a bit quieter, and there's a whole bunch of reasons that could be driving that. And importantly, you mentioned it, when we're in dialogue with our clients, they are optimistic and they are thinking about growing their businesses and hiring, and all of those things are true. And so putting aside those that have access to capital markets for a variety of reasons in newer bank loans, it's completely understandable that optimism would lead actions. And so as to what that lag will look like, we'll wait and see. But fundamentally, a pro-growth series of policies will be constructive to the economy, to our clients, and ultimately, will end up in them hiring, spending, and they already are, and we'll see that translate into loan growth. Whether that's in the second half of this year, we'll see. + +-------------------------------------------------------------------------------- +James Dimon, JPMorgan Chase & Co. - Chairman, CEO and President [42] +-------------------------------------------------------------------------------- + + I would just add that I wouldn't overreact to the short term in the loan growth because there are so many things that affect it. When you go through the episodic part, if you look at CIB, I wouldn't look at loan growth at all, because companies have a choice of doing loans and deals and -- or bonds, something like that. Look at credit card looks okay. Mortgage is obviously affected by interest rates. Autos is obviously affected by auto sales. And middle market was okay. It was like it was slow, but it was okay. So I wouldn't overreact to that. And the second thing is you all should expect as a given that when you have a new president and they get going, that the 9 months after the 100 days is going to be a sausage-making period. There will be ups and downs, wins and loss, stuff like that, okay? But it is a pro-growth agenda, tax, infrastructure, regulatory reform. And that is a good thing, all things being equal. And we think that if that took place, it would be helpful to Americans. But to not -- to expect it to be smooth sailing, that would just be silly. + +-------------------------------------------------------------------------------- +Kenneth Michael Usdin, Jefferies LLC, Research Division - MD and Senior Equity Research Analyst [43] +-------------------------------------------------------------------------------- + + Yes, fair points. And just one quick follow-up, just on the deal making side. M&A has slowed a little bit, but I'm assuming it's the same point, Jamie, just in terms of just pipelines and expectations that corporates have about transacting. Does that fit into that same vein? Or is there anything different in terms of just companies getting -- strategics getting more aggressive in terms of acquiring and adding to their businesses? + +-------------------------------------------------------------------------------- +James Dimon, JPMorgan Chase & Co. - Chairman, CEO and President [44] +-------------------------------------------------------------------------------- + + It looks fine. And of course, it's episodic. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO and EVP [45] +-------------------------------------------------------------------------------- + + Yes. And I would also say that while, of course, people's dialogues include a degree of discussion around regulatory reform and tax reform and the like, it isn't stopping the strategic dialogue and it isn't stopping people from -- or boards from considering strategic deals partly because of what you said, partly because there is a recognition that these things will take some time to ultimately get finalized, and that they don't want to put their strategic agenda on hold. So in some ways, you get both sides of the equation. People aren't going to wait indefinitely to get certainty on issues when there are good strategic deals that can be done, and that's past the dialogue. So not to say it has no impact, but it's still quite healthy. + +-------------------------------------------------------------------------------- +Operator [46] +-------------------------------------------------------------------------------- + + Your next question is from Marty Mosby with Vining Sparks. + +-------------------------------------------------------------------------------- +Marlin Lacey Mosby, Vining Sparks IBG, LP, Research Division - Senior Analyst [47] +-------------------------------------------------------------------------------- + + I wanted to focus on deposit pricing in the sense that before the Feds started moving up, deposit rates and the Fed funds rates were right on top of each other, around 15 basis points. Now the effective Fed funds rates is around 90 basis points and deposit costs are only 20. So that 70 basis points on your $1 trillion of deposits basically gives you about $7 billion worth of incremental revenue that's needed to cover the cost of branches and other things for those deposit franchise. At what point do you hit a targeted kind of spread? And where is that where you begin to at least breakeven on those costs versus revenues? + +-------------------------------------------------------------------------------- +James Dimon, JPMorgan Chase & Co. - Chairman, CEO and President [48] +-------------------------------------------------------------------------------- + + Can I just answer that? Marianne has given you guys some very specific guidance on interest rates. When interest rates got to 0, remember that when it floored, those -- no one expected the first 25 to 50 basis point to necessarily be paid out, because of the cost. Marianne also gave you at Investor Day a very forward-looking view of that, where it kind of normalizes, okay? And it's different for every different type of deposit. For wholesale deposits, commercial credit deposits, company deposits, treasury deposits. They're all different. So it's hard summarize it all. But at one point, you're going to go back to kind of a normalized spread, and in terms of just retail, I would say that's like 3%. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO and EVP [49] +-------------------------------------------------------------------------------- + + Maybe a little less than that. + +-------------------------------------------------------------------------------- +James Dimon, JPMorgan Chase & Co. - Chairman, CEO and President [50] +-------------------------------------------------------------------------------- + + Maybe a little less. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO and EVP [51] +-------------------------------------------------------------------------------- + + And I would also just say, I am glad that you brought up one point because it's something that I'd like -- a point that I'd like to make, which is when people think about the benefit we get from NII on rising rates, there's an element of people making it sound very passive. Yes, you're correct, we did build those branches, we acquired those customers, we built the product, we invested in the customer service to be able to enjoy the industry-leading deposit growth that we're having. But I would also make the -- and so as margins improve, then, we will obviously enjoy the benefit of that. And to your point, we invested to be able to. But I will say that if you -- we look at the performance of our branches every single week, month, individually, put together by market, and the very, very, very vast majority of them, meaning that only a handful do not, are profitable in their own right today at these spreads on a marginal basis. So the branches are doing very well. + +-------------------------------------------------------------------------------- +James Dimon, JPMorgan Chase & Co. - Chairman, CEO and President [52] +-------------------------------------------------------------------------------- + + There's another number we give you all that you should look at. We give you what we expect normalized margins and normalized returns to be in Consumer, Card, all these businesses. Those numbers include normalized credit card charge-offs, like the credit card, the number we now use is for in a quarter, something like that, and in retail, going back to normal spreads. That's what those numbers include. And of course, it all bounces around. But we kind of look at them to be priced for normalized results. We don't price for them to be overearning or underearning or to have too much credit or too little. And that's kind of how we run the business. + +-------------------------------------------------------------------------------- +Marlin Lacey Mosby, Vining Sparks IBG, LP, Research Division - Senior Analyst [53] +-------------------------------------------------------------------------------- + + A follow-up to that is really what I'm getting at is last year, everybody was assuming through the cycle kind of betas, and we were saying that they were going to be much lower early on. We do think once you get to a certain target, usually about 100 basis points of spread, you start to see a little bit more pricing pressure starting to kick in, just like you were saying, Jamie, in the sense of different products... + +-------------------------------------------------------------------------------- +James Dimon, JPMorgan Chase & Co. - Chairman, CEO and President [54] +-------------------------------------------------------------------------------- + + We've built that into every number we've given you. We've always told you the beta and gamma. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO and EVP [55] +-------------------------------------------------------------------------------- + + Yes, I can point you to a presentation in May of 2014 where we showed exactly what we expected the complexity of deposit reprice to look like based upon historical moves. So what we have actually seen to date looks incredibly similar in terms of realized reprice. You're absolutely right. I will tell you though that history may not be a precise predictor of the future because we've never really been in this exact position before and other things play into the equation, including the fact that the industry, but us specifically, have significantly invested in other customer service products, items like digital and the like, which will change the dynamic one way or another on reprice. So you're right, historically, 100, 150 basis points should dot [ph] see some movement, we'll see. + +-------------------------------------------------------------------------------- +Marlin Lacey Mosby, Vining Sparks IBG, LP, Research Division - Senior Analyst [56] +-------------------------------------------------------------------------------- + + And the last component of this is the balances continue to grow. So as long as we're seeing double-digit kind of sequential, annualized and year-over-year growth in deposits, that provides a little bit cover in a sense of what you're talking about as well. We may see a little bit more lag just because we're still continuing to get deposit growth. + +-------------------------------------------------------------------------------- +James Dimon, JPMorgan Chase & Co. - Chairman, CEO and President [57] +-------------------------------------------------------------------------------- + + Yes, but I'd be a little cautious there, too. I mean, we feel great about the deposit growth and the account growth. So you have new accounts that are growing and existing accounts are growing. Remember, there you also -- history -- you've got to be very careful, because if rates were higher, people do different things with their money, like CDs. And then how they view the stock market, that money -- some of that attracts lenders to the market. So we're always conscious of the fact those flows kind of ebb and flow, and history is only somewhat of a guide to that. + +-------------------------------------------------------------------------------- +Operator [58] +-------------------------------------------------------------------------------- + + Your next question comes from Erika Najarian with Bank of America. + +-------------------------------------------------------------------------------- +Erika Najarian, BofA Merrill Lynch, Research Division - MD and Head of US Banks Equity Research [59] +-------------------------------------------------------------------------------- + + I had a few questions on deregulation. Jamie, in your shareholder letter, you dedicated a lot of time on mortgage and having -- opening that up for banks to originate more of the percentage of mortgage in the United States. As we look forward, do we need legislative change for the banks to gain more market share from nonbanks and mortgage, like clarity in QM or the CFPB? Or would a change in supervisory attitudes be enough for that to shift on the mortgage side? + +-------------------------------------------------------------------------------- +James Dimon, JPMorgan Chase & Co. - Chairman, CEO and President [60] +-------------------------------------------------------------------------------- + + So I picked that category out precisely because it didn't take legislation and it was very important. And my point isn't about banks versus nonbanks. My point is about the United States of America and what these things did to the availability of credit to a certain class of people. I was very specific, and we actually published a research report in mortgage land, which you can go get, by Mr. Jozoff, that really breaks it out. But because of the cost of servicing delinquent accounts, $2,000 a year, because of the additional cost of origination, because of the potential litigation, because of the not clarity around the QM, because of the forward claims that the consumer's both paying more and the credit box is wider than it would otherwise be. And that we actually believe that credit box is hurting first-time buyers, younger, self-employed, prior defaults, someone who when they defaulted passed his reserve, who always say deserves a second chance. So that policy has restricted that. And the shocking thing to me is the absolute size of that, which we think could be $300 billion to $500 billion a year. That one thing alone could have added -- because of a secular stagnation, could have added 0.3% or 0.4% a year to growth. So if you'd changed it 5 years ago, you're talking about a lot of growth, a lot of jobs, a lot of new homes, a lot of young families into homes and a very positive thing without taking a lot of extra credit risk. It's not -- it was about America, is why I wrote it. I could care less whether the banks and nonbanks do it. My point about that was how it's hurting the growth of America and hurting that class of citizens. And I really think some of you should be writing about that more because that's how important it is. That was one example. + +-------------------------------------------------------------------------------- +Erika Najarian, BofA Merrill Lynch, Research Division - MD and Head of US Banks Equity Research [61] +-------------------------------------------------------------------------------- + + That's clear. And the follow-up to that is a couple of -- a week ago or so, there was a lot of talk from Washington about the current administration potentially supporting Glass-Steagall. And of course, a lot of your investors called in concerned. And Jamie and Marianne, a 2-part question, I'm wondering if that's a real worry for JPMorgan's shareholders? And second, Marianne, maybe at an Investor Day 2 years ago, you mentioned that the capital and the cost that a breakup would save was not that much. And I'm wondering if you could also, if you remember, refresh us on that analysis. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO and EVP [62] +-------------------------------------------------------------------------------- + + Okay. So I would just start by saying we've been consistent that our operating model, including the diversification of our businesses, has been and was a source of strength not just for us but also for the financial markets during the crisis. And there is strength in the way the company operates that can't be discounted. I would also say that the commentary feels unnecessary given where the industry stands on capital liquidity and regulatory reform broadly. And I would just point, as I'm sure you all read, to most recently, Governor Tarullo making comments about this but historically, other thought leaders in the financial stability space talking about it. And I would further say that it doesn't feel, for the reasons that you just articulated in terms of structural reform or structural change in the model of banks, that, that would be consistent with a level playing field and pro-growth agenda in the U.S. So that's kind of how we feel about it. I can't give you specific reasons to not continue to monitor the situation. But it doesn't feel consistent with the rest of the objectives of the administration. And with respect to Investor Day a couple of years ago, lots of things have fundamentally changed since then, but the ultimate conclusion hasn't, which is that we believe that there's significantly more value for our shareholders, and as I said before, for the economy with this company the way it is today than in some other form. + +-------------------------------------------------------------------------------- +Operator [63] +-------------------------------------------------------------------------------- + + Your next question comes from Matt O'Connor with Deutsche Bank. + +-------------------------------------------------------------------------------- +Matthew D. O'Connor, Deutsche Bank AG, Research Division - MD in Equity Research [64] +-------------------------------------------------------------------------------- + + We've obviously seen quite a bit of flattening of the yield curves. And it could reverse pretty quickly if there is progress made on the pro-growth agenda. But just talk about at what point does the flatter yield curve start to impact NIM. And I guess I'm thinking specifically if we get a couple of more hikes on the short end, but the long end either doesn't move or the long end comes down more, how do we think about the breakpoint in terms of NIM benefiting the short end being offset by the flatter yield curve? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO and EVP [65] +-------------------------------------------------------------------------------- + + First of all, we don't overthink the shape of the curve or the process of normalization in any one period. We think about the reason for the actions. And ultimately, as long as they're kind of growing, you'll see both of the short and the long end of rates ultimately go up. And even though I know that it's lower than what we've broken down, broken below a little bit of the lower bounds, it's been in the kind of 2.30%, 2.60% range for a while, so we're still within -- largely speaking, within the range. And our central case is that we're going to see the 10-year higher by the end of the year. And if you look at our earnings and risk disclosures, we're much more sensitive to -- as a pure NII, NIM matter, to the front end of rates. And so not to say it would not have an impact, but it would take a while for that to have an impact that would meaningfully offset any of the benefit of higher short-end rates. + +-------------------------------------------------------------------------------- +Matthew D. O'Connor, Deutsche Bank AG, Research Division - MD in Equity Research [66] +-------------------------------------------------------------------------------- + + Okay. And then separately, as we think about central banks winding down, some of the QE and the Fed actually shrinking their holdings, how do you think about that impacting your businesses? And obviously, there might be a rate impact. I think you talked about your rate expectations quite a bit. But just how do you think it might impact, say, the markets business with potentially more assets kind of out there to be purchased and sold? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO and EVP [67] +-------------------------------------------------------------------------------- + + Well, I mean, ultimately, sort of any actions by central banks, any change in the shape of the yield curve, anything that is presenting an opportunity for clients to transact and trade is an opportunity for our businesses. So as long as it happens in a reasonably rational fashion and there are no significant events, it should create an opportunity for clients and an opportunity therefore for us. + +-------------------------------------------------------------------------------- +James Dimon, JPMorgan Chase & Co. - Chairman, CEO and President [68] +-------------------------------------------------------------------------------- + + Always keep in mind that why they do something probably is more important than the what they do. So if they are doing it because the American economy is getting stronger, that is more important than the direct effect of adding -- letting securities mature, et cetera. + +-------------------------------------------------------------------------------- +Matthew D. O'Connor, Deutsche Bank AG, Research Division - MD in Equity Research [69] +-------------------------------------------------------------------------------- + + I guess there's 2 thoughts on -- there's the impact of QE on the economy, and then the impact of QE on some of the markets businesses that maybe there's been a crowding out from all the QE, so as they unwind, that it could actually boost activity levels. + +-------------------------------------------------------------------------------- +James Dimon, JPMorgan Chase & Co. - Chairman, CEO and President [70] +-------------------------------------------------------------------------------- + + It could, I just wouldn't put that in your models. + +-------------------------------------------------------------------------------- +Operator [71] +-------------------------------------------------------------------------------- + + Your next question is from Eric Wasserstrom with Guggenheim. + +-------------------------------------------------------------------------------- +Eric Edmund Wasserstrom, Guggenheim Securities, LLC, Research Division - MD and Senior Equity Analyst [72] +-------------------------------------------------------------------------------- + + Just a couple of questions on consumer. We've talked a lot about card losses. But one thing that seems to be a little bit unusual is that a lot of the commentary across many of the card issuers is for the expectations of losses to be higher in the first half than the second half. And I just wanted to get your perspective on the likelihood of that trajectory. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO and EVP [73] +-------------------------------------------------------------------------------- + + So well, I mean -- so in terms of rates, obviously, the loan balances are seasonally low in the first quarter and charge-off rates are higher in the first quarter. But overall, we're not expecting to see abnormal patterns in our charge-offs. + +-------------------------------------------------------------------------------- +Eric Edmund Wasserstrom, Guggenheim Securities, LLC, Research Division - MD and Senior Equity Analyst [74] +-------------------------------------------------------------------------------- + + Got it. And then just to follow up on auto, your release alluded a little bit to the impact of declining residual values, which has been, of course, a focus for the past couple of years. Was there anything unusual in your view about the pace of decline in resid values in this first quarter? + +-------------------------------------------------------------------------------- +James Dimon, JPMorgan Chase & Co. - Chairman, CEO and President [75] +-------------------------------------------------------------------------------- + + Because it happens every 5 to 10 years, so why would anyone be surprised? And we've always been very conscious of this and very careful about how we do leases, we do them conservatively, we've got... + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO and EVP [76] +-------------------------------------------------------------------------------- + + But we only do them to our strategic manufacturing businesses. + +-------------------------------------------------------------------------------- +James Dimon, JPMorgan Chase & Co. - Chairman, CEO and President [77] +-------------------------------------------------------------------------------- + + And only to strategic manufacturers, and we properly account for it. And we have loss mitigation. That's pretty important. So no, we're not surprised, it's going to happen every now and then. + +-------------------------------------------------------------------------------- +Eric Edmund Wasserstrom, Guggenheim Securities, LLC, Research Division - MD and Senior Equity Analyst [78] +-------------------------------------------------------------------------------- + + But in terms of the pace of resid values from here, similar or different in your view? + +-------------------------------------------------------------------------------- +James Dimon, JPMorgan Chase & Co. - Chairman, CEO and President [79] +-------------------------------------------------------------------------------- + + I have no idea. + +-------------------------------------------------------------------------------- +Operator [80] +-------------------------------------------------------------------------------- + + Your next question comes from Matthew Burnell with Wells Fargo Securities. + +-------------------------------------------------------------------------------- +Matthew Hart Burnell, Wells Fargo Securities, LLC, Research Division - Senior Financial Services Equity Analyst [81] +-------------------------------------------------------------------------------- + + Marianne, let me start with a question on the net revenue rate in the Card Services business. That's been relatively steady, a little over 10%, for the last couple of quarters. I presume, given your outlook, that, that would stay pretty close to the 10.1% level that you reported for the last couple of quarters? Or are you thinking about a change there as you slightly change your marketing strategy? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO and EVP [82] +-------------------------------------------------------------------------------- + + So it's actually got somewhat less to do with our marketing strategy than it has to do with the fantastic success we've had with the new products, particularly Sapphire Reserve, in the fourth quarter and in the first quarter of this year. But fundamentally, if you go back, I think, to a conference that Kevin Watters spoke at last year sometime in, I think, September, he said, look, we're going to see the revenue rate be lower about 10% and some for the couple of quarters while we acquire all of these accounts. Once we've hit a pace, we should see it middle out at 10.5% the full year of 2017, so the first quarter lower and subsequent quarters continuing to now start rising back up towards the 11.25%, which was our ultimate run rate target. And that's still fundamentally what we're expecting to see, which is we're at a -- assuming that our expectations of what we're going to see in account growth over the future period continues to hold, we would expect to see an increase from here in the second quarter, the overall year, to be sort of finish the mid-10s and the year 11-ish, and then go back to 11.25% over the course of the next couple of years. + +-------------------------------------------------------------------------------- +James Dimon, JPMorgan Chase & Co. - Chairman, CEO and President [83] +-------------------------------------------------------------------------------- + + (inaudible) + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO and EVP [84] +-------------------------------------------------------------------------------- + + And we have great new products. + +-------------------------------------------------------------------------------- +Matthew Hart Burnell, Wells Fargo Securities, LLC, Research Division - Senior Financial Services Equity Analyst [85] +-------------------------------------------------------------------------------- + + Fair enough. Jamie, a question for you, just another one on the regulatory landscape. There are a number of open positions inside the Beltway at a number of the primary bank regulators, and I'm just curious in terms... + +-------------------------------------------------------------------------------- +James Dimon, JPMorgan Chase & Co. - Chairman, CEO and President [86] +-------------------------------------------------------------------------------- + + I said I'm not interested. I'm kidding. + +-------------------------------------------------------------------------------- +Matthew Hart Burnell, Wells Fargo Securities, LLC, Research Division - Senior Financial Services Equity Analyst [87] +-------------------------------------------------------------------------------- + + Well, somebody should fill those spots if it's not you. And I'm just curious what you're thinking is of the timing of those appointments and how quickly those could get filled and what benefit that might provide to the banking industry. + +-------------------------------------------------------------------------------- +James Dimon, JPMorgan Chase & Co. - Chairman, CEO and President [88] +-------------------------------------------------------------------------------- + + Look, I've been clear. I think that Gary Cohn and Steve Mnuchin are doing the right thing. They want to find the right people for those jobs. They're talking about -- I gather they're talking to lots of people. But even after they announce it, remember, they need to be vetted and confirmed, and that's -- that normally could take 90 days. Well, the sooner, the better, but I think getting the right people is as equally important. + +-------------------------------------------------------------------------------- +Operator [89] +-------------------------------------------------------------------------------- + + And we have no other questions in queue at this time. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO and EVP [90] +-------------------------------------------------------------------------------- + + Okay. So just, Glenn, I don't know if you're still on. I've got a couple of numbers for you in terms of retail exposure. Our direct retail exposure in the wholesale space is about $20 billion, 70% -- more than 70% investment grade and more than 15% secured. And in terms of commercial real estate, about $11 billion, largely ABL, picked the right names, structural protection, all the things you talked about. So not that it's nothing, but it's -- in the context of our overall wholesale lending portfolio, it's not as concentrated, I think, as perhaps you were implying. So if you want to call Investor Relations and let us know what you were looking at, we can try and reconcile those numbers for you. Okay. Thank you, everyone. + +-------------------------------------------------------------------------------- +James Dimon, JPMorgan Chase & Co. - Chairman, CEO and President [91] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Operator [92] +-------------------------------------------------------------------------------- + + Thank you for your participation. This does conclude today's conference call, and you may now disconnect. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/exam/original-files/Problem_2_3_Sample_full_transcripts/2017-Apr-25-KO.N-138858781409-Transcript.txt b/exam/original-files/Problem_2_3_Sample_full_transcripts/2017-Apr-25-KO.N-138858781409-Transcript.txt new file mode 100644 index 0000000..abf70ca --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_full_transcripts/2017-Apr-25-KO.N-138858781409-Transcript.txt @@ -0,0 +1,433 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q1 2017 Coca-Cola Co Earnings Call +04/25/2017 09:00 AM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Muhtar Kent + The Coca-Cola Company - Chairman of the Board and CEO + * Kathy N. Waller + The Coca-Cola Company - CFO and EVP + * Timothy K. Leveridge + The Coca-Cola Company - VP and IR Officer + * James Robert B. Quincey + The Coca-Cola Company - President and COO + +================================================================================ +Conference Call Participiants +================================================================================ + + * Bryan Douglass Spillane + BofA Merrill Lynch, Research Division - MD of Equity Research + * Eunjoo Hong + Goldman Sachs Group Inc., Research Division - MD, Co-Head of the GIR Asian Professionals Network, and Senior Analyst + * Dara Warren Mohsenian + Morgan Stanley, Research Division - MD + * Brett Cooper + Consumer Edge Research, LLC - VP + * Kevin Michael Grundy + Jefferies LLC, Research Division - SVP and Equity Analyst + * Nik Modi + RBC Capital Markets, LLC, Research Division - MD of Tobacco, Household Products and Beverages + * Lauren Rae Lieberman + Barclays PLC, Research Division - MD and Senior Research Analyst + * Amit Sharma + BMO Capital Markets Equity Research - Analyst + * Mark D. Swartzberg + Stifel, Nicolaus & Company, Incorporated, Research Division - MD + * Ali Dibadj + Sanford C. Bernstein & Co., LLC., Research Division - SVP and Senior Analyst + * Laurent D. Grandet + Crédit Suisse AG, Research Division - United States Beverages Lead Analyst + * Stephen Robert R. Powers + UBS Investment Bank, Research Division - Executive Director and Equity Research Analyst + +================================================================================ +Presentation +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + At this time, I would like to welcome everyone to The Coca-Cola Company's First Quarter 2017 Earnings Results Conference Call. Today's call is being recorded. If you have any objections, please disconnect at this time. (Operator Instructions) +I would like to remind everyone that the purpose of this conference is to talk with investors, and therefore, questions from the media will not be addressed. Media participants should contact Coca-Cola's Media Relations Department if they have questions. +I would now like to introduce Tim Leveridge, Vice President and Investor Relations Officer. Mr. Leveridge, you may begin, sir. + +-------------------------------------------------------------------------------- +Timothy K. Leveridge, The Coca-Cola Company - VP and IR Officer [2] +-------------------------------------------------------------------------------- + + Good morning, and thank you for being with us today. I'm joined by Muhtar Kent, our Chairman and Chief Executive Officer; James Quincey, our President and Chief Operating Officer; and Kathy Waller, our Chief Financial Officer. +Before we begin, I would like to remind you that this conference call may contain forward-looking statements, including statements concerning long-term earnings objectives, and should be considered in conjunction with cautionary statements contained in our earnings release and in the company's most recent periodic SEC report. +In addition, I would also like to note that we have posted schedules under the Financial Reports & Information tab in the Investors section of our company website. These schedules reconcile certain non-GAAP financial measures, which may be referred to by our senior executives during this morning's discussion, to our results as reported under generally accepted accounting principles. Please look on our website for this information. +Following prepared remarks this morning, we will turn the call over for your questions. (Operator Instructions) +Now I'd like to turn the call over to Muhtar. + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Company - Chairman of the Board and CEO [3] +-------------------------------------------------------------------------------- + + Thank you, Tim, and good morning, everyone. This will be my last earnings call as CEO of this great company. First and foremost, I'd like to thank all of you for your support and collaboration. It's been my distinct privilege and pleasure to serve you and all of our share owners as CEO for almost 9 years now. +During this time, we achieved a lot. We delivered $110 billion of share owner value with continued annual dividend increases and growth in our share price. We embarked on the biggest refranchising and bottling restructuring effort in our history, transforming our company to a pure and effective consumer and brand business, with approximately 50% of our global bottling business in positive motion. +With today's announcement, we are on track to achieve almost $5 billion in savings from 2008 through 2019 through productivity and reinvestment programs. We completed a net total of around $16 billion of M&A, bringing in some of our strongest and fastest-growing brands, including smartwater, Santa Clara, Innocent, Jugos del Valle, Honest Tea and fairlife, just to name a few. We introduced almost 1,000 new products and added $9 billion brands, bringing our total to 21. We grew daily servings by nearly 0.5 billion, from 1.5 billion at the end of 2007 to more than 1.9 billion today. And we achieved 39 consecutive quarters of global value share gains. +And by focusing on our 3 Ws -- women, water and well-being -- we've created the most progressive, sustainable and connected business cycle, empowering 1.7 million women in our value chain through 5by20 -- through the 5by20 initiative to support economic empowerment of 5 million women by 2020, becoming the first Fortune 500 company to announce that it is replenishing 100% of its global water use and supporting World -- the World Health Organization's guidelines of limiting sugar intake. And finally, we expanded our portfolio to become the largest juice company in the world and strengthened our leadership in still beverages. +Our brands, our bottling system and our various partnerships are the strongest they have ever been. But most importantly and for which I am the most proud, in just a few days we will be completing the smoothest and most seamless leadership succession. The foundation of our company is as strong as it has been -- ever been. As we move to the next phase, I have every confidence that our company and our system will accelerate growth under James' new leadership as CEO. And I have -- I very much look forward to following and supporting him in every way I can. +As I've said before, the future is bright. We compete in a fantastic industry, with solid growth prospects. We have the greatest brands. Our strength in bottling system is comprised of passionate partners, and we have a great new CEO and a fabulous leadership team. It is with a great sense of pride therefore that I'm passing on the role of CEO to James in a few days, and I have great confidence in our future. +Thank you for your support and your trust and confidence over the past 9 years. So with that, I will turn the call over to James, The Coca-Cola Company's next Chief Executive Officer. + +-------------------------------------------------------------------------------- +James Robert B. Quincey, The Coca-Cola Company - President and COO [4] +-------------------------------------------------------------------------------- + + Good morning, everyone. And thank you, Muhtar. Thank you for your leadership over the last 9 years and for your unwavering partnership. It is truly a privilege to succeed you as Chief Executive Officer, and I look forward to your continued support as we take the next steps to further capture the full array of opportunities before us. +To do this, for these next steps, we have -- we've laid out how our strategies and operating model will evolve and provided guidance as to our expectations for the first steps and through 2017. +So let me turn then to the quarter firstly. Operating results were in line with our expectations, and we are on track to deliver against our full year guidance. As we anticipated, organic revenue was even in the quarter, with solid price mix offset by a decline in concentrate shipments. And it is worth noting, the 3% decline in concentrate shipments was primarily driven by a few factors that will self-correct over the balance of the year. +Our first quarter had 2 fewer days this year, impacting growth by about 2%, and of course Easter shifted into the second quarter. Additionally, there was a time lag between our unit case sales and concentrate shipments. +Price/mix, meanwhile, was a healthy 3%, with good performance across our operating segments. So the way I think about it is we delivered even unit case volume growth and 3% price/mix, so we're running at around a 3% trajectory, in line with our full year organic revenue guidance. +And while revenue growth is a key objective, we also intend to do this efficiently. And so the underlying operating margin expansion in the quarter underscores our commitment to value creation. +Now looking around the world. Many of our key markets, like North America, Europe, Mexico and Japan, continued to perform well. We also saw improved performance in China, in part driven by a strong Chinese New Year campaign. And India, while it began the year slowly, performance improved, with any remaining impact from the demonetization largely worked through by the end of the quarter. However, consumer demand challenges in Brazil and Venezuela in particular continued to pressure our performance, impacting total company volume growth by over a point in the quarter. +Now let's turn to the actions we're taking against the 5 strategic priorities we laid out at CAGNY. These are those that will help us realize our goal of becoming a total beverage company and to deliver our longtime -- long-term financial targets, namely: one, accelerate growth for the consumer-centric brand portfolio; second, drive revenue growth; third, strengthen the system; fourth, digitize the enterprise; and fifth, unlock the power of our people. So as we've made progress, let me give you a few examples. +For our portfolio, we continue to broaden and innovate with new product launches, reformulations of existing products to reduce added sugar and acquisitions in on-prem categories like plant-based beverages. During the quarter, we completed the acquisition of AdeS, the leading soy-based beverage in Latin America and the latest addition to our growing juice, dairy and plant category cluster. This adds to a list of successional acquisitions, including Jugos del Valle, Santa Clara and Tonicorp, that are building a strong presence in this nutrition-focused portfolio. +Within our hydration cluster, we continue to expand our premium smartwater brand, driving double-digit volume growth for this brand in Europe. And building off smartwater sparkling's early success in both the U.S. and the U.K., we will soon be launching flavored sparkling smartwater in GB. +In the sparkling soft-drink category, we are working to drive top line growth through innovation and reformulation. For example, we've seen the excellent results for Coca-Cola Zero Sugar. I told you at CAGNY, we'd be expanding this new and improved formula, supported by a new visualized entity, to more markets around the world. In the quarter, we rolled this out to 11 of our top markets, resulting in double-digit volume growth for the brand. By the end of the second quarter, we expect to be in 5 more markets, with the intent to be in most of our top markets by the end of the year. +We're also targeting the adult sparkling mix of categories, a key growth opportunity. We feel Schweppes, our premium tonic water, is relevant and appealing to the growing category of adult consumers. So starting in Western Europe, we relaunched Schweppes in early April, with the intent to roll out to other markets in Latin America, Africa and Asia this year. +In the U.S., we're leveraging our digital capabilities by using data captured through our innovative freestyle machines to identify new variants and flavors popular with consumers. As a consequence, during the quarter, we began bottling Sprite Cherry and Sprite Cherry Zero at the first national launch of new beverages in response to their popularity on freestyle. +Finally, we're looking to add functional benefits where applicable. In Japan, we've launched our new zero sugar products fortified with fiber, like Coca-Cola Plus and [ Canada Dry Plus ], in the fast-growing segment where ingredients added to beverages address specific dietary needs. So these actions, along with others, are part of our -- are part of growing our consumer-centric brand portfolio. +Of course, generating revenue and profits for the whole portfolio, new and existing, requires having the right package offering at the right price in the right channel. And that starts with a deep understanding not just of the consumer but the shopper's needs. For example, in Brazil, we are in the midst of resetting our price/pack architecture to hit key price points as consumers' purchasing power has decreased during the country's worst economic contraction. While we are still in early days, we expect by the end of the year, the actions we are taking will return our Brazil business to growth. +So having the right portfolio is critical, but so is having the best-in-class market execution to support it. To date this year, we have already achieved several milestones in strengthening our system across Africa, Asia and the U.S. During the quarter, we reached definitive agreement with ABI on its stake in Coca-Cola Beverages Africa. We are now working through the necessary regulatory approvals and expect to close these transactions around the end of the year. As previously announced, we plan to hold these bottling territories temporarily until they can be refranchised as our partners. +Also, earlier this month we refranchised the majority of our company-owned bottling operations in China to strong local partners, and our 2 largest bottlers in Japan completed their merger. +Finally, in the U.S., we closed several transactions in the quarter and, on the 1st of April, swapped our Southwest operating unit, comprised principally of Texas, for a 20% stake in Arca Continental beverage business. +At CAGNY, I also talked about the need to create a new, leaner, more agile operating model to enable this growth strategy going forward, which included anticipating the structure of our business post-refranchising, and that to capture fully the opportunity before us, we need to become more category focused to upweight resources to innovation, IT and digital. +So we've made some changes. We've created one new position in the center and elevated 2 others. Firstly, the new Chief Growth Officer. He will have a clear leadership mandate for global growth across category clusters, with marketing, customer, commercial leadership and strategy all reporting into this position. I've asked Francisco Crespo, previously President of our Mexico business unit, to take on this opportunity. Under Francisco's leadership, our Mexico business has shown remarkable strength, driving growth within our existing portfolio, expanding into new categories like value-added dairy and building a healthy, direct-to-consumer route to market. He is the right person to drive greater connectivity across our business, enabling our growth in each of the 5 category clusters. +Innovation will be critical to our goal for a consumer-centric brand portfolio. We have a need for hundreds of new products and continue the evolution of our beverages, packages, ingredients and other areas of our business. To do this, we are separating our R&D and making it a direct report to the CEO. Calling it the Chief Innovation Officer is reflective of the need for greater impact. +Additionally, as part of our work to digitize the enterprise, we elevated the information technology function on our Chief Information Officer role, which will also now also be a direct report to the CEO. +Lastly, we're working through redesigning the organization to be faster and more agile. When we first laid out the new operating model in February, we were clear that this is about a new way of doing business. It's about creating an environment that can enable growth for the long term. We are well underway to designing the new corporate organization with a clear understanding of what work we'll stop, what work that we'll shift to other areas and what that means to our people. As we create a more focused, lean Corporate Center and broadened, enabling services, we expect this will result in approximately 1,200 job reductions beginning in the second half of 2017 and carrying into 2018. While these necessary changes are always very difficult, they will help us do fewer things better to lead and support our operating units while upholding best-in-class corporate governance. +As a consequence of this new operating model and further productivity opportunities across our entire spend base, we now expect to achieve incremental savings of approximately $800 million. This will bring our current program to $3.8 billion or $4.3 billion including the $0.5 billion of productivity that will transfer to our bottling partners due to the accelerated pace of refranchising. +Given the phasing of the initiatives, we expect the majority of the upside to accrue in 2018 and 2019 as we have already included an estimate of the savings in -- we expect to capture in 2017 in the guidance we provided earlier this year. +To the question of how we will use this increased financial flexibility. Our goal, and we're clear on this, is long-term value creation. So to the extent we see reinvestment opportunities to improve our current revenue run rate through further category expansion, we'll take a disciplined approach to make that happen. But we will make the final determination on reinvestment when we move into the 2018 to 2020 business planning process as this decision will also depend on economic and currency environment. But based on our current expectations of the opportunities, we expect to reinvest at least half the savings. +So in summary, we are on track with our strategic transformation plan. And as to the remainder of the year, I am confident we will achieve our full year outlook and that the actions we are taking today will enable us to deliver margin expansion and higher EPS growth into 2018 and 2019. +With that, I'll turn the call over to Kathy to take you through the numbers. + +-------------------------------------------------------------------------------- +Kathy N. Waller, The Coca-Cola Company - CFO and EVP [5] +-------------------------------------------------------------------------------- + + Thank you, James, and good morning, everyone. As James mentioned, organic revenue growth was even in the quarter. We also continued divesting company-owned bottling operations, which resulted in a 12% decline in comparable net revenues. +Price/mix benefited from positive package mix, with immediate consumption packages outpacing future consumption packages across all operating groups. +Comparable gross margins increased 120 basis points, reflecting strong price/mix and the margin benefit from refranchising, partially offset by increased commodity costs and about a 60 basis point currency impact. And comparable operating margin grew nearly 140 basis points as our productivity initiatives remain on track and we sold our lower-margin bottling businesses. +Moving to cash flow. We generated $788 million in cash from operations, up 30%, driven by the cycling of the pension plan contribution, partially offset by the impact of 2 fewer days in the quarter and our ongoing refranchising efforts. And we received a $1.4 billion cash inflow from the sale of certain North American and Chinese bottling assets. +For 2017, we increased our annual dividend by 6% to $1.48 per share. Our net share repurchases during the quarter totaled $836 million. And for the full year, we expect to achieve the $2 billion in net repurchases as we communicated during our last earnings call. And we expect to return approximately $8.4 billion to share owners in the form of dividends and net share repurchases for the year. +Turning to outlook. We continue to expect to deliver 3% organic revenue growth and 7% to 8% underlying profit before tax growth, with momentum building throughout the year as our plans gain traction. +In addition, we expect our comparable gross and operating margins to expand as we continue to divest lower-margin bottling businesses throughout the year. +Due to a strengthening in several currencies, including the Mexican peso, we now expect a 3-point currency headwind on profit before tax, which is at the low end of our previously provided range. However, currencies continue to be extremely volatile. We remain hedged on the hard currencies, but fluctuations in spot rates will not necessarily impact our P&L to the degree that you might expect. Therefore, we will continue to update you as we move through the year. +As a result, we are tightening the range of our full year EPS guidance. We now expect comparable EPS to be down 1% to 3% this year as we return to a high-margin, capital-light business model. +As you model the second quarter, there are a couple of items to consider. First, we expect the net impact of acquisitions, divestitures and other structural items to be a 17- to 18-point headwind on net revenue and a 3- to 4-point headwind on profit before tax. And therefore, we expect this to result in greater comparable gross and operating margin expansion than we saw in the first quarter. +Second, we expect that currency will be a 1- to 2-point headwind on net revenue and a 3-point headwind on profit before taxes. +In closing, we are on track and fully expect to deliver our commitments for 2017. +Operator, we are now ready for questions. + + +================================================================================ +Questions and Answers +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) We have Mr. Nik Modi from RBC Capital Markets. + +-------------------------------------------------------------------------------- +Nik Modi, RBC Capital Markets, LLC, Research Division - MD of Tobacco, Household Products and Beverages [2] +-------------------------------------------------------------------------------- + + Muhtar, congrats, and James, congrats again on your new roles. I guess a quick clarification, James, and then a broader question. Just on the clarification, just when you talked about the global macros, you sounded a bit more constructive. So I just wanted to get a sense, because we're hearing from a lot of companies, yes, January and February were tough, but March seemed to have improved not just in the U.S. but globally. So just wanted to get a clarification there. And the broader question is, as I'm out in the market and talking to the bottlers, there seems to be some concern regarding the focus outside of CSDs. Not that Coke doesn't need to do it, but there's just too much emphasis outside the CSD business where, in fact, the bottlers make 85% to 90% of the profit from CSDs. So when you speak to them, how do you reconcile that dilemma? Any context around that would be helpful. + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Company - Chairman of the Board and CEO [3] +-------------------------------------------------------------------------------- + + This is Muhtar. And just let me say a few things on the global macros, and I'll pass it over to James also to reflect on your -- particularly your second question on -- and I assume the second question you had was mainly talking to U.S. bottlers, but you can clarify that. As far as -- the world growth based on recent -- latest numbers from IMF or taken from any other organization is expected to rise in 2017 from -- versus 2016 by about 0.5 percent point, so, like, going from 3.1 to about 3.5, just under 0.5%, and further expected to slightly improve in '18. Based on the latest numbers, always what we have seen in our business is that the industrial production index, IPI, kind of goes a little bit ahead of disposable income growth, and that's what we are experiencing once again here. So yes, some countries, growth looks better, China for sure. India, with the impact of the currency exchange initiative, still is moving out of that, as James mentioned. And as well as Brazil and Venezuela, I think we can term as being in deep recession. And then geopolitical factors in the Middle East and part of North Africa probably means the balance of risks remain still tilted to the downside, if you like. But there was a divergence in terms of the consumer confidence index since 2014, and that's narrowing down between the developing world and the developed world, which is a positive. That means the developing world is getting a little better from a confidence index point of view. And I think we're seeing that in parts of Africa, like particularly big markets, in Nigeria, and then, again, in -- our business in China also is reflecting the improved macros. And then we still see growth in Japan, Korea, in the industrial markets, which is a very positive sign. Again, as we -- as the emerging and developing markets get better, we see there's still growth coming from the developed markets, as in Western Europe and Japan and Korea. So that's sort of what I would like to just say on the macros. And then, James, go ahead and... + +-------------------------------------------------------------------------------- +James Robert B. Quincey, The Coca-Cola Company - President and COO [4] +-------------------------------------------------------------------------------- + + Sure. Thanks, Muhtar. So Nik, I think particularly as your question seemed more U.S. oriented, I mean, in the end this is an and answer. Our objective is not to run from one side of the ship to the other. This is an and answer. We need the company and the bottlers individually and collectively to make both work. And I think the U.S. is an example, where we have a vibrantly growing revenue line for sparkling and a vibrantly growing revenue line for the other categories. We're -- there, we're engaging the consumers. We're improving our execution. So I think it's about growth. It's about expanding and responding to consumer and customer needs. And I think we have demonstrated over the last number of years that we can vibrantly grow both, and that is absolutely our strategy going forward. And that'll be good for us, and it will be good for the bottlers. + +-------------------------------------------------------------------------------- +Operator [5] +-------------------------------------------------------------------------------- + + Next, we have Dara Mohsenian from Morgan Stanley. + +-------------------------------------------------------------------------------- +Dara Warren Mohsenian, Morgan Stanley, Research Division - MD [6] +-------------------------------------------------------------------------------- + + I think down at CAGNY and again today that you're focused on becoming even more of a total beverage company. But it seems like it'll be difficult to transform your revenue mix quickly or substantially from an organic standpoint. So, a, I was just hoping for any thoughts on how quickly you can shift the business mix over the next few years, maybe what your ultimate vision is, whether that's percent of sales mix outside of sparkling or mix in low-sugar products versus today. However you define it or however you think about the topic, I'll leave that up to you. And then second, how big a part do you think M&A will play? Because clearly, that's a way of more rapidly shifting your portfolio. And then within that M&A theme, Coke staying within beverages, I think, has been sacrosanct at the company historically. How open would you be or what are your thoughts on potentially acquiring outside of beverages? + +-------------------------------------------------------------------------------- +James Robert B. Quincey, The Coca-Cola Company - President and COO [7] +-------------------------------------------------------------------------------- + + Thanks. Thanks, Dara. And I'll probably go with the M&A and then the portfolio question. I mean, obviously, we're not going to comment on our outlook on likely M&A. I think we've said 3 things related to M&A in the past. I would re-underline them. One, anything we do needs to fit strategically in where we're trying to go. Secondly, it needs to be financially attractive, and that's not always the case. And third, there is some degree of opportunism because it takes 2 to tango. You need not just a willing acquiree; you need a willing seller. So I think whilst we have a view -- an ongoing view of what assets are out there, small, medium and large, that are attractive to us, of course, that is something that is not predictable in time. So whilst we imagine we will continue to do bolt-on acquisitions, everything else is not -- you can't predicate your strategy necessarily on that. So we focus on driving what we can organically. We have taken the rest of the portfolio outside of sparkling from a single-digit piece of our business at the turn of -- when -- 10, 15 years ago to over 1/4 of the business. Of course, we would love to increase the runway -- run rate at which we broaden our portfolio, and we were certainly seeking to do so. But the law of big numbers is also true. It's not going to magically change overnight. We need to build winning propositions with the consumers, with the customers and build the physical infrastructure that economically makes that happen in a profitable way. So yes, more acceleration outside of sparkling whilst -- and I return to the answer to the previous question, it's an and, continuing to grow the revenue of the sparkling category. And therefore, we will consecutively broaden out where we get to. At some point, will it be more balanced? Absolutely. Will it be broader? Absolutely. But we will look to do the right things at the right pace. + +-------------------------------------------------------------------------------- +Operator [8] +-------------------------------------------------------------------------------- + + Next, we have Mr. Steve Powers from UBS. + +-------------------------------------------------------------------------------- +Stephen Robert R. Powers, UBS Investment Bank, Research Division - Executive Director and Equity Research Analyst [9] +-------------------------------------------------------------------------------- + + I mean, James, maybe you could just round that up by talking about the -- just firstly, the cost side of that organic growth push. Just sort of we talked a lot about the objective, which I think we all agree with, but what's the cost side? Will structural investments and growth in new categories have to accelerate? And if so, for how long? But my broader question was actually with respect to the leadership appointments and really the new operating model that you've announced over the last few months. Can you talk more about just how the day-to-day work is to be impacted and improved as a result, and specifically, what Francisco's role as Chief Growth Officer is going to look like, maybe how large his organization's going to be, how he's going to interface with the other group presidents, et cetera? Because I guess at some level, I've always thought of the CEO of Coke as the Chief Growth Officer. So maybe just talk about why separating that function out as a dedicated role, I think, at the group president level, is set up to structurally improve things? + +-------------------------------------------------------------------------------- +James Robert B. Quincey, The Coca-Cola Company - President and COO [10] +-------------------------------------------------------------------------------- + + Sure. I'm not sure that I'd base the dynamic of one question at a time, but I'll give it a go and cover off some of those pieces. Look, on the categories and balancing, of course, as we approach into new brands or new categories in new countries, there is an investment curve as you build the brand. But this needs to be managed through a portfolio. I mean, one -- the fact that a new brand is being launched in country X doesn't mean it's not already developed in country Y, and therefore, it's already profitable and generating cash. So we need to manage the total portfolio effect, which is not just across categories but across the life-stage development of any one brand and category across the world because they're not equally developed everywhere. So there's a portfolio management thing. Of course, our objective, whatever the category, is to build brands and positions that are inherently profitable once we get to the appropriate scale. So we're not trying to build things that will never arrive. We're trying to build brands in categories, whether it's inherent in the brand or inherent in the package side, that can be profitable for us and the bottling system. In terms of the leadership appointments and how the work will be impacted, I mean, we've done a lot of things. I mean, a lot of the impacts on the work is the nexus of we're about to enter the post-refranchising stage. So we're going to go from well over 110,000 employees to under 40,000 employees by some point next year. There's just physically less stuff that needs to get done at the Corporate Center to support that organization. Secondly, technology keeps advancing, and what is possible to anticipate and get done using technology and change the way work can be done is a lot more today than it was a number of years ago. We need to embed that in, in the organization. And then the third thing is the ongoing efforts to define new ways of doing the same thing with less resources or getting more bang for the buck because we can be innovative in the way we run our processes. So that goes across each of the corporate functions, including the enabling transaction-based services and there's a plan in each place. Now as it relates to Francisco and that organization, I think one of the -- there's 2 points that I base our logic to. The first one is if our principal operating model is local and geographic, that is the franchise system. I mean, you got to choose one principal avenue to organize against. Anything you organize against will have its blind spots, and then you can mitigate against that. So one of the roles of Francisco's group is to provide the global perspective and the category perspective because it's the inverse -- it's a theme that the field -- the sum of the field might miss. So that's part of why the Corporate Center exists. The second reason to bring all the pieces together is as brands and experiences are created today and into the future, it's less cleanly delineated between a TV ad or a customer program or anything else. There's a much greater intersection and integration of how to engage with consumers and shoppers. And therefore, bringing together in one group the classical marketing pieces with a customer piece with a commercial piece and with the strategy, underpinned with the digital engagement, is what's going to allow us to more seamlessly operate in this new environment. + +-------------------------------------------------------------------------------- +Operator [11] +-------------------------------------------------------------------------------- + + Next, we have Lauren Lieberman from Barclays. + +-------------------------------------------------------------------------------- +Lauren Rae Lieberman, Barclays PLC, Research Division - MD and Senior Research Analyst [12] +-------------------------------------------------------------------------------- + + I was hoping you could talk a little bit more about Brazil. I know you've talked about addressing price/pack architecture and trying to hit key price points. But it just looks like the downdraft in Latin America has significantly worsened its quarter, and I know, again, you said better by the end of the year. But are these kind of tactical changes longer-term strategic changes in Brazil that you're making? And any kind of detail would really be helpful. + +-------------------------------------------------------------------------------- +James Robert B. Quincey, The Coca-Cola Company - President and COO [13] +-------------------------------------------------------------------------------- + + Sure. So I think the changes are structural and strategic. We need to reset the price/pack architecture. We're going to use more returnables as an infrastructure and investment channel. So we're resetting. I mean, it's worth remembering that the contraction in the Brazilian economy, it's contracted more in the last few years than it contracted in the last decade of the '80s and more than it contracted in the depression in the 1920s last year -- last century. So this is -- Brazil has undergone a major economic contraction. So we're resetting what we're doing in Brazil around pack/price architecture, how we go to market and how we push that forward. So it will take some time to get in place. And also, frankly, the stabilization in the Brazilian economy will continue to take time. Now the other thing impacting the Latin American numbers, it's worth underlining it doesn't always hit [ across our ] radar screen is Venezuela. And Venezuela is substantially negative in the first quarter, and I think that really is macroeconomic. And it's not about resetting our business. It's about the country is in the state it's in. But the Brazilian thing, just to summarize, the changes are strategic. They'll take some time. We expect that to play through this year. + +-------------------------------------------------------------------------------- +Operator [14] +-------------------------------------------------------------------------------- + + Next we have Ali Dibadj from Bernstein. + +-------------------------------------------------------------------------------- +Ali Dibadj, Sanford C. Bernstein & Co., LLC., Research Division - SVP and Senior Analyst [15] +-------------------------------------------------------------------------------- + + So I do have 2 questions. One is on the cost savings. Excellent that it went up. Want to better understand the drivers of change. And I also want to better understand the drivers of the increase. But want to -- also want to better understand the long-term "value creation" that you mentioned as well as that at this point, we expect to "reinvest" at least half. Is that of the incremental? Or is that of the $3.8 billion total or $4.3 billion total? Is it of the $3.8 billion at least? Because you've cut about $2 billion so far. It sounds like it should be roughly on pace to that in short order at the very least. And almost all of that, I think, has been reinvested. So if you take almost 2 on a 3.0, that's already 1/2. So how much of what's going to be on the [ come ], so to speak, what's going forward will be reinvested? Is that going to be at least half? Or is that of the total program? So a very specific question on that. And then the second thing is around refranchising. And if you can talk a little bit about some of the potential delays that may happen in refranchising, if you see anything going forward that's very much on plan. And importantly, if you see the benefit so far of the refranchise territories from an improvement of performance perspective, volumetrically perhaps but even just overall top line. And we have heard on the order of 1 point as you move from company owned to non-company owned. So would love some inkling of that from your own experiences. Sorry for the 2. + +-------------------------------------------------------------------------------- +James Robert B. Quincey, The Coca-Cola Company - President and COO [16] +-------------------------------------------------------------------------------- + + Sure. So starting with the additional $800 million, I mean, the driver of the change, the principal driver is the reorganization of the Corporate Center, the 1,200 positions I talked about. That's the majority of the $800 million or a little over half the $800 million. Then there are some parts in cost of goods and a little bit in marketing. So the majority is in operating expense and in the reorganization of the corporate organization that I've just talked about. So that's what's driving it, and it's about the 3 things I said. It's anticipating post-refranchising, it's the impacts of technology, and it's the choices on what work we're doing, doing the work differently. That's what's driving the extra $800 million. Now the $800 million -- the comment around reinvesting half was related to the $800 million very specifically. So that's, that one. Now obviously, we've seen some margin expansion. I mean, implicit in our guidance this year already is some dropping of the base productivity program through into margin because you'll calculate that the revenue currency-neutral structural is at the 3 and that when you take operating income is substantially higher than that, then obviously, that's offset by some negative financing leverage. So as -- the '14, '15 and '16, I think you're largely right. In '17, you're seeing much more drop into operating leverage. And the comment is about the $800 million going forward, half -- a little over half is reinvested. As it relates to refranchising, we don't -- we still believe we can meet the deadline and get the U.S. refranchised this year. Of course, we're not going to do the wrong deals for the sake of hitting a date. But we think the right deals are possible, and we think that we are still on track with our plan. And as you say, we're seeing benefits in the refranchised territories. I'm not sure I would give a specific number that can be kind of inserted over the top on everything else. But clearly, the idea of reorientating and rebuilding the U.S. system so that it's stronger, and putting in place the different pieces, the manufacturing, the governance, the IT, the way the system works, support our long-term strategy of rational pricing and some growth for continued revenue growth in the U.S. is underpinned by the success of the refranchisings in the U.S. And obviously, we closed out on the 1st of April in China and the merger of the Japanese bottlers. + +-------------------------------------------------------------------------------- +Operator [17] +-------------------------------------------------------------------------------- + + Next, we have Laurent Grandet from Crédit Suisse. + +-------------------------------------------------------------------------------- +Laurent D. Grandet, Crédit Suisse AG, Research Division - United States Beverages Lead Analyst [18] +-------------------------------------------------------------------------------- + + You specified the sales growth by cluster, and that's great to give us, I mean, some more granularity of where the growth is coming from. If I may, I mean, could you tell us more specifically what's your starting point by revenue, by cluster, by region? And also, what are your goals by cluster? And what will be the incentive for the new Chief Growth Officer to achieve those goals? + +-------------------------------------------------------------------------------- +James Robert B. Quincey, The Coca-Cola Company - President and COO [19] +-------------------------------------------------------------------------------- + + So firstly, Laurent, I hate to disappoint you, but we're not going to be disclosing that the starting point and break down the geographic groups as well by cluster and have all of that laid out. The goals by cluster, clearly, we have goals by cluster. The more they move from sparkling, the more they move from the things we've been building over the last 15 years, the faster we expect the percentage growth rate. But in terms in absolute, it is worth remembering that sparkling, still in absolute terms, provides the greatest incremental amount of revenue to the corporation of any one category. And the -- as I said, just let me make a detailed point. The growth officer, we're not moving to an operating model where we're having global category P&Ls and running the business through global category P&Ls. The operating model decision is to run the business locally, to drive local entrepreneurship and empowerment of the operating units but to use the growth opportunity setup to be strategic to make sure that we stay connected to what's happening when you take a top-down perspective or a category perspective and have the ripened -- and some authority on bringing those insights and those needs and those initiatives to the table so that when -- we, as the corporation, we're not going to try and run everything for the operating units, but we will make a few strategic bets, and some of those will be driven from the cluster approach. + +-------------------------------------------------------------------------------- +Operator [20] +-------------------------------------------------------------------------------- + + Next, we have Mr. Bryan Spillane from Bank of America. I'm sorry, next question is from Ms. Judy Hong from Goldman Sachs. + +-------------------------------------------------------------------------------- +Eunjoo Hong, Goldman Sachs Group Inc., Research Division - MD, Co-Head of the GIR Asian Professionals Network, and Senior Analyst [21] +-------------------------------------------------------------------------------- + + So wanted to ask just a quick follow-up to earlier question about reinvestment, the $800 million, half of that going back to reinvestment. Just how would the nature of these reinvestments differ versus sort of the prior reinvestments that Coke has made, whether it's different categories or different activities? And just a little bit of color there would be great. And then on the price/mix in the quarter and North America sparkling up 1%, I think you called out some timing issues. So can you elaborate on how much of that was a factor? And as it relates to sort of the broader price/mix question, if you look at the clusters outside of sparkling, can you just talk about how much the price/mix plays a role in growing that -- those segments' revenues? + +-------------------------------------------------------------------------------- +James Robert B. Quincey, The Coca-Cola Company - President and COO [22] +-------------------------------------------------------------------------------- + + Sure. I think the principal difference on the reinvestment of the half of the $800 million is up to now, I would say the majority of what we've done has gone into the sparkling category business around the world. I think here, the clear intent is that this is more directed to some of the newer categories or some of the other categories to drive growth there. So it's principally orientated around growth of the other categories. That's the headline answer there. Then in terms of the North American sparkling pricing, as you say, that's -- as we called out, that's principally timing, and it's really related to the different channels. The price, the average -- obviously, we have a large fountain operation, which we run directly in North America. And so the timing of gallon shipments, whether they go to the bottlers or through the fountain business, can move the average price/mix by North America. And it's the timing around those gallons that has created that unusually lower 1%, and that's the majority of the difference between what we would expect to happen on sparkling pricing and what actually you see in the first quarter North America. And that should correct itself. + +-------------------------------------------------------------------------------- +Operator [23] +-------------------------------------------------------------------------------- + + And next, we have Mr. Bryan Spillane from Bank of America. + +-------------------------------------------------------------------------------- +Bryan Douglass Spillane, BofA Merrill Lynch, Research Division - MD of Equity Research [24] +-------------------------------------------------------------------------------- + + Just one question. And I guess from our perspective, we get a lot of questions about the total beverage company model and kind of what it looks like going forward, and it's difficult to see with a lot of the moving parts in the business today. But I guess from our perspective, Western Europe is really the one market -- or it's one of the markets this year where you can really see it sort of in action. So, a, James, do you agree with that? And, b, can you maybe talk a little bit more about sort of your planning with the bottlers in Western Europe this year and sort of how it's -- this beverage -- total beverage company model has really sort of been different in the planning process now versus maybe prior years? + +-------------------------------------------------------------------------------- +James Robert B. Quincey, The Coca-Cola Company - President and COO [25] +-------------------------------------------------------------------------------- + + Yes. Look, I don't think I would say this is a kind of a night-and-day change for us. Look, we've been on the journey for us to expand our portfolio. I think this is about making the commitment to press further and faster and make -- kind of make the full kind of psychological journey, too. This is about a full set of categories and responding to the consumer, not a central portfolio with some periphery. We're making good progress with Coca-Cola European Partners. Obviously, we did a lot of planning last year at the setup of the new bottler and its integration and the plans for the marketplace. I think you've seen a number of actions, whether it's the rolling out of smartwater, the launch of Honest Tea, where we've taken some proactive steps with them in different categories. But also, I would underline we've been very proactive with European Partners on Coke, Coca-Cola Zero Sugar, which drove a lot of growth in GB in this quarter. So we've got a great new bottler that's been stood up. We're broadening the portfolio. We're taking action across more categories, and I think that's part of the future. Now would I say that's the one place to look at? No. I think if you look at the U.S. or Japan, to take 2 other examples, you'll see a broader portfolio. And that's continuing to invest and expand across categories and even within categories, resegmenting each category for multiple different reasons to drive value growth for ourselves, the bottlers and collectively as a system. + +-------------------------------------------------------------------------------- +Operator [26] +-------------------------------------------------------------------------------- + + Our next question is from Mr. Kevin Grundy from Jefferies. + +-------------------------------------------------------------------------------- +Kevin Michael Grundy, Jefferies LLC, Research Division - SVP and Equity Analyst [27] +-------------------------------------------------------------------------------- + + James, I wanted to come back to some of the changes you've put in place, specifically with the new growth officer and 5 category clusters. The first question would be, when should investors expect to see tangible benefits from the new structure, understanding that the macro is very difficult and the company's skew towards sparkling? Or said differently, would you be disappointed if the company couldn't return to 4% core sales growth looking out to next year even if the environment doesn't change very much, including the macro? Or is this just more of an evolution of the strategy to deliver on the company's objectives? And then related to that, James, do you feel like the company has the right incentive structure in place internally for your leadership to balance the growth agenda with profit objectives? Or do you see any potential conflict that may exist there? + +-------------------------------------------------------------------------------- +James Robert B. Quincey, The Coca-Cola Company - President and COO [28] +-------------------------------------------------------------------------------- + + I'll go in reverse order. I mean, the incentive structure is balanced between the top line and the bottom line today. Having said that, we're going to take this year to have a fundamental relook at our total compensation approach. That may result in no changes whatsoever. We may end up going, "There's no perfect solution, and the one we've got is the right one," or we may make some tweaks. That is yet to be determined. But it is worth noting, the incentives are half top line effectively and half bottom line. In terms of the tangible benefits, I mean, we're obviously not going to provide guidance for '18 and '19 and beyond at this stage. Having said that, we've been pretty clear that we want to be in our long-term growth model in terms of the top line and have some leverage within that. So to the extent that we've guided for 3% this year, we would be disappointed if the opportunities in the marketplace and the macros offered us opportunity to get back into our range, and we did not achieve it. + +-------------------------------------------------------------------------------- +Operator [29] +-------------------------------------------------------------------------------- + + And our next question is from Mark Swartzberg from Stifel, Nicolaus. + +-------------------------------------------------------------------------------- +Mark D. Swartzberg, Stifel, Nicolaus & Company, Incorporated, Research Division - MD [30] +-------------------------------------------------------------------------------- + + One question, James. On the larger subject of cost cutting and whether it's $800 million or some added number a year from now or 3 years from now, could you just characterize how far you believe the organization has gone and might yet go in the area of budgeting costs, whether it's on a ZBB basis or some other basis, to help us understand how you think about the opportunity to do what you're doing today as a habit, so to speak, versus something you do day 1, so to speak, as a new CEO? + +-------------------------------------------------------------------------------- +James Robert B. Quincey, The Coca-Cola Company - President and COO [31] +-------------------------------------------------------------------------------- + + Sure. We've been steadily learning and getting better at the zero-based work over the last number of years. I think we can get -- getting better at doing less one-off events then don't necessarily always think we're getting much better at making it part of our discipline of going, how do we use the resources available for the best means possible to get the results we're after? So I think that's been a steady organizational learning process that's been going on. The latest changes are just another iteration. The $800 million is another iteration of that. Every year, we look at it. The back end of last year, we looked at the strategy evolutions coming up, imagining the post-refranchise world, the impacts of technology. And we just considered what we could do and how we could do things differently, and that's reflected in the strategy. And as part of the strategy, it's reflected in the organizational changes we are making and the increased productivity savings. We will continue to run the zero-based work process and be clear that the efficient use of resources is one of the ways to drive the top line and to enable long-term value creation. + +-------------------------------------------------------------------------------- +Operator [32] +-------------------------------------------------------------------------------- + + And our next question is from Amit Sharma from BMO. + +-------------------------------------------------------------------------------- +Amit Sharma, BMO Capital Markets Equity Research - Analyst [33] +-------------------------------------------------------------------------------- + + A couple of quick questions. Number one, James, can you clarify your comments about M&A? You talked about bolt-ons are always in play. And then I think you didn't rule out if something larger or bigger came along, you would look at it. That's number one. And number two, from our retailers, we're hearing a lot more focus on pricing and maybe more promotion, private label. Are you hearing anything different from the retailers about price rationality that you have seen in the CSD category? Just rule out that, that's not at risk here in North America. + +-------------------------------------------------------------------------------- +James Robert B. Quincey, The Coca-Cola Company - President and COO [34] +-------------------------------------------------------------------------------- + + Well, on M&A, I mean, we have a track record of doing bolt-on acquisitions over the years. I think there should be a reasonable expectation that they will continue at some sort of similar rate. Larger opportunities, I think about are they logical. They have to be strategic, they have to be financially viable and they have to be available. As and when things are -- meet those 3 criteria, we will look harder at them. And that's as much as I can say at this stage. In terms of retailers in the U.S., look, I think they are looking -- they have their own -- each one has their own strategies, their own positions slightly differently. So I don't think one can look at them in an aggregate and say they're always trying to do the same thing. I think pricing rationalization is certainly our strategy. We are engaged with customers in how it fits their strategies, each one individually. And largely, I would say that we're finding how to create value together. Are there risks that for competitive reasons by customers or competitive reasons by our competitors, something happens in some quarters to knock that off course? Yes. But that risk is -- has existed and still exists, but we're clear on where we're trying to get to. + +-------------------------------------------------------------------------------- +Operator [35] +-------------------------------------------------------------------------------- + + And our next question is from Mr. Brett Cooper from Consumer Edge Research. + +-------------------------------------------------------------------------------- +Brett Cooper, Consumer Edge Research, LLC - VP [36] +-------------------------------------------------------------------------------- + + Two questions. Within your clusters, can you talk about where you have scale or the ability to lift and shift a subcategory from one country or region to another, where you see the most work needed? And then maybe as a reference for us, can you talk about the evolution of profitability in juice as you build that out to a global leadership position? + +-------------------------------------------------------------------------------- +James Robert B. Quincey, The Coca-Cola Company - President and COO [37] +-------------------------------------------------------------------------------- + + Sure. I think look, in -- we talked at CAGNY, we have about a 50% share of the sparkling category. And of all the other categories, we're somewhere between a 10% and 15% share on a global basis. But even that's a very average number. You can go to some parts of the world, and we are clear market leaders at the same sort of share levels that we have in sparkling in other parts of the world we're operating. So there's not a short answer, except to say that we have -- we are going through and have gone through and always updating the process of looking at where are the next stages of growth, both bottom-up, each country going, "Look, I think I need to grow out this category or that category"; and top-down, both a global view and a category view, saying, "Look, if we want to progress, actually, we think we need to push out smartwater into more countries or tea, for example, Honest Tea into more countries." And that's the intersection of the global growth perspective and the country perspective. And then evolution of profitability in juice, probably depends whether we build the business through bolt-on acquisitions or whether we did it from scratch. Either way, the evolution is, as you'd expect, as we build a good, either leadership position or a close #2, we tend to come into much, much more attractive profitability status, which is why, if we have small positions in categories, we've either got to get up, have a clear path to leadership or a strong #2 or not overinvest because being subscale is not our path to profitability. + +-------------------------------------------------------------------------------- +Operator [38] +-------------------------------------------------------------------------------- + + I would now like to turn the call back to Muhtar Kent for further closing remarks. + +-------------------------------------------------------------------------------- +Muhtar Kent, The Coca-Cola Company - Chairman of the Board and CEO [39] +-------------------------------------------------------------------------------- + + Thank you. I think James is going to do them this time. So... + +-------------------------------------------------------------------------------- +James Robert B. Quincey, The Coca-Cola Company - President and COO [40] +-------------------------------------------------------------------------------- + + Thank you. Thank you, operator. Thank you, Kathy, Tim, and thank you, Muhtar, for your leadership over the past 9 years, for the solid foundation created under your watch. I look forward to continuing our partnership as you remain Chairman of the Board. +We've already been on a transformational journey under Muhtar's leadership over the last few years as we completely reshaped our bottling system, jump-started growth in our flagship North American market, increased productivity and launched hundreds of new brands and products. Even so, we know there is more we can and must do. We laid out a clear path to transform the company to be bigger than our past, to be a company that is bigger than just the Coca-Cola brand, to be a total beverage company that is well positioned across a wide range of beverage categories, and we are successfully beginning to execute that plan. As always, we thank you for your interest, your investment in our company and for joining us this morning. + +-------------------------------------------------------------------------------- +Operator [41] +-------------------------------------------------------------------------------- + + And that concludes today's call. Thank you very much for your participation. You may disconnect. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/exam/original-files/Problem_2_3_Sample_full_transcripts/2017-Aug-16-TGT.N-138067107203-Transcript.txt b/exam/original-files/Problem_2_3_Sample_full_transcripts/2017-Aug-16-TGT.N-138067107203-Transcript.txt new file mode 100644 index 0000000..e91710c --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_full_transcripts/2017-Aug-16-TGT.N-138067107203-Transcript.txt @@ -0,0 +1,502 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q2 2017 Target Corp Earnings Call +08/16/2017 08:00 AM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Mark J. Tritton + Target Corporation - Chief Merchandising Officer and EVP + * Catherine R. Smith + Target Corporation - CFO and EVP + * Brian C. Cornell + Target Corporation - Chairman and CEO + * John Hulbert + Target Corporation - Vice President of IR + * John J. Mulligan + Target Corporation - COO and EVP + +================================================================================ +Conference Call Participiants +================================================================================ + + * Michael Lasser + UBS Investment Bank, Research Division - MD and Equity Research Analyst of Consumer Hardlines + * Peter Sloan Benedict + Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst + * Robert William Summers + Macquarie Research - Analyst + * Matthew Jeremy Fassler + Goldman Sachs Group Inc., Research Division - MD + * Robert Frederick Ohmes + BofA Merrill Lynch, Research Division - MD + * Christopher Michael Horvers + JP Morgan Chase & Co, Research Division - Senior Analyst + * Kate McShane + Citigroup Inc, Research Division - MD, Head of the U.S. Discretionary and U.S. Apparel and Retail Analyst + * Brandon Fletcher + Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst + * David Adam Schick + Consumer Edge Research, LLC - Director of Research, and Retail and Luxury Analyst + +================================================================================ +Presentation +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Ladies and gentlemen, thank you for standing by. Welcome to the Target Corporation Second Quarter Earnings Release Conference Call. (Operator Instructions) As a reminder, this conference is being recorded, Wednesday, August 16, 2017. +I would like to now turn the conference over to Mr. John Hulbert, Vice President, Investor Relations. Please go ahead, sir. + +-------------------------------------------------------------------------------- +John Hulbert, Target Corporation - Vice President of IR [2] +-------------------------------------------------------------------------------- + + Good morning, everyone, and thank you for joining us on our Second Quarter 2017 Earnings Conference Call. On the line with me today are: Brian Cornell, Chairman and Chief Executive Officer; John Mulligan, Chief Operating Officer; Mark Triton, Chief Merchandising Officer; and Cathy Smith, Chief Financial Officer. In a few moments, Brian, John, Mark and Cathy will provide their perspective on Target's second quarter performance and our plans and priorities going forward. Following their remarks, we'll open the phone lines for a question-and-answer session. +As a reminder, any forward-looking statements that we make this morning are subject to risks and uncertainties, the most important of which are described in our SEC filings. Also in these remarks, we refer to adjusted earnings per share, which is a non-GAAP financial measure, and return on invested capital, which is a ratio based on GAAP information with the exception of adjustments made to capitalize operating leases. Reconciliations to our GAAP EPS from continuing operations and to our GAAP total rent expense are included in this morning's press release, which is posted on our Investor Relations website. +With that, I'll turn it over to Brian for his thoughts on our second quarter performance and our priorities going forward. Brian? + +-------------------------------------------------------------------------------- +Brian C. Cornell, Target Corporation - Chairman and CEO [3] +-------------------------------------------------------------------------------- + + Thanks, John. Good morning, everyone. We are very pleased with our second quarter performance, which gives us increased confidence that we are focused on the right long-term strategy. Our team is energized and remains on track to deliver the ambitious agenda we laid out for the year, including the physical transformation of more than 100 stores in 2017 on the way to transforming more than 600 stores over a 3-year period; nearly doubling the number of small-format stores this year in support of our goal to open more than 100 new stores in dense urban, suburban and college campus neighborhoods over a 3-year period; development and rollout of digital capabilities that will continue to drive Target's digital sales growth in excess of the industry; completely transforming our supply chain from end-to-end; creating a smart network of stores and distribution facilities that will allow fast, reliable fulfillment regardless of how our guests choose to shop; rejuvenating our own brand portfolio by launching 12 brands over a 2-year period, replacing brands that represent more than $10 billion of our current sales volume; investing in systems, training and additional labor hours in our stores, enabling our team to provide an even better experience for our guests; and enhancing our value perception among consumers by reducing promotions and highlighting the right everyday pricing in key categories. Later in the call, John, Mark and Cathy will provide more details on our efforts to advance each of these priorities. +On our last conference call, I mentioned that beyond our focus on advancing our long-term priorities, we need to have equal focus on strong execution in every channel every day. That's why we're really proud of the execution of our team in the second quarter as they delivered better-than-expected performance in a continuing challenging environment. In particular, second quarter traffic, which was up more than 2%, was much stronger than our expectations and better than recent trends. And the strength was broad-based across the country, across categories and across channels. And while the consumer and competitive environment remains choppy, better-than-expected performance occurred throughout the quarter and wasn't limited to a short period within the quarter. +With better second quarter traffic, we saw improved performance across each of our 5 broad merchandising categories: Apparel, Home, Food and Beverage, Essentials and Hardlines. 4 of those 5 saw comp increases in the second quarter while comp sales in Food and Beverage were flat. However, given continued competitive and deflationary pressure in Food, we're pleased that we're seeing early signs of progress. Specifically, we saw really strong positive comps in adult beverages and produce in the second quarter, both categories in which we've identified opportunities and focused on improvement. The positive response from our guests demonstrates that we're making progress and we're taking additional steps to build on that momentum over time. +I also want to call out our progress on pricing and promotions. As we mentioned in the last call, we undertook this effort with a long-term view, knowing that we might create some headwinds in the near term. Specifically, as we move towards a stronger everyday price proposition in our business and pull back on excess promotions, we can expect an adjustment period before value perception improves and consumers respond. While we continue to face the risk in future quarters as we expand the scope of this work, it's notable that in the second quarter, we saw a meaningful increase in the percent of our business done at regular price and a meaningful decline in the percent on promotion. This demonstrates the progress we've already made and gives us confidence we're on the right track. +I also want to call out the team's progress on Target's digital capabilities, which continue to show up in our results. Target's digital sales grew much faster than industry in the second quarter, up 32% on top of 16% growth last year. If you do the compounding of these 2 growth rates, you'll see that this represents more than a 50% growth rate compared with 2 years ago. And importantly, as result of our comprehensive effort by our team to reduce friction and increase the reliability of our digital operations, we have seen meaningful declines in guest contact center activity related to digital. This is a tangible reflection of our work to create a stable digital platform and successful collaboration between our digital, operations and merchandising teams to create a more cohesive experience for our guests. +To build on this success, the team is rapidly testing and rolling out additional fulfillment options for our guests. This includes Target Restock, our next-day delivery option for everyday essentials, that we recently rolled to Twin Cities REDcard holders. It includes same-day delivery, which we began testing in our TriBeCa store in the second quarter. It includes an early test of curbside fulfillment, which we recently began testing with Twin Cities team members and which we'll expand to a guest-facing test in the third quarter. And of course, our efforts include the expansion of ship-from-store locations, in-store pickup capabilities and our work with third-party providers to speed up ship times from our stores and distribution facilities. In each of these efforts, the team is moving quickly, more quickly than ever before, to roll out, test and iterate and expand where we see positive results. We're really excited to see the engagement of our team and the collaboration occurring across our operations, which allows these tests to move quickly. And we intend to continue moving quickly in the months ahead. +Another area where we've increased our speed is in the development and rollout of new exclusive brands. With last year's rollout of Pillowfort and Cat & Jack in Kids, we've demonstrated the power of reinvention in categories that were already performing well. Specifically, both of these new brands grew double-digit comps following their launch last year. Regarding the Cat & Jack brand, we have long said that it was on pace to exceed $1 billion in sales in its year. But performance has actually exceeded those expectations. Cat & Jack just crossed the $2 billion mark only slightly more than a year after its launch. Based on the success of those brands, our team took on the ambitious goal of launching 12 additional new brands before the end of next year, and those plans are coming to life. +At the end of May, we launched Cloud Island, an infant brand, which we developed in partnership with our guests. And like last year's new brands, Cloud Island has generated double-digit comp increases in the period since the launch. In July, we launched a new maternity brand, Isabel Maternity, and announced plans to launch 4 more brands in the third quarter crossing women's apparel, men's apparel and home. I also want to comment on our recently announced decision to partner with Casper in advance of the Back-to-College season. I've spent some time with the leadership of Casper, and I've been really impressed with how they think long term and focus on outstanding execution on behalf of their customers. Their brand and products are a great fit with the Target brand. And we're proud to be featuring their products online and in our stores, including a couple of exclusive items they've developed only for Target. +This relationship is the most recent example of our ability to differentiate our assortment while helping outstanding brands extend their reach. During this period of rapid transformation in retail in which many others are shrinking, we'll continue to look for ways to partner and deliver incremental growth for high-quality brands while delivering differentiation and value for our guests. As we look ahead, we're committed to continued progress against our long-term goals. And we expect the environment will continue to be challenging. The pace of change in the consumer and competitive environment doesn't show any signs of slowing down. And we're well positioned to emerge as one of the winners in retail. +It starts with the underlying health of our business, a business that generated profits of nearly $700 million in the second quarter. Our business is backed by amazing assets, including our team, our network of stores and distribution centers, a unique merchandise assortment and a deep relationship with our guest. Beyond those assets, we have a very strong balance sheet and operations that generate a lot of cash, providing us the flexibility to undertake the ambitious 3-year transformation we first laid out at our Analyst Meeting in February. And we continue to look for ways to move faster. In February, we announced our plans to complete 250 store transformations in 2018 on top of the 100-plus we're on track to complete this year. However, based on our success so far and the hard work of our real estate and construction teams to grow our capabilities quickly, we now believe we can accomplish more than 300 store remodels next year. +While the scope of our transformation is large, we remain focused on what has made Target an outstanding retailer over the long term, all the way back to our first store in 1962. The key for us is embracing the power of "and", which makes us unique among our competitive set. When we're at our best, our model delivers the best of both mass and specialty retail. We deliver inspiration and convenience. And we invite our guests to expect more and pay less. Because we've delivered on all of those dimensions over time, we have developed a unique, emotional relationship with our guest. And we believe that relationship is positioned to thrive in the new era of retail. If we continue to offer our guests inspiration and aspiration, differentiated merchandise and experiences and deliver convenience, reliability and great everyday prices, we'll continue to standout and succeed in a crowded retail environment. +One way to see how the best of Target comes together is to visit one of our exciting, new small-format stores we've been opening across the country. I visited our new store that recently opened on the USC campus. And despite my loyalty as a proud UCLA graduate, I couldn't help being excited by what I saw. The store is already quite busy, even though most of the students have yet to return from summer break. Beauty, Baby, Food and Beverage are all selling well. And the store team is quickly evolving their assortment based on feedback from a diverse set of guests. It's truly inspiring to see the team interact with our new guests at an exciting, new shopping environment. And I'm proud of what they do every day. +So now I'd like to turn the call over to the team, who will provide additional detail on our strategic plans and recent performance. First, John will provide detail on our work in supply chain and our stores to enhance our fulfillment capabilities and provide a more reliable and inspirational experience for our guests. Then Mark will cover category performance and provide more detail on our recent and upcoming brand launches. Finally, Cathy will provide more detail on our second quarter financial results and expectations for the rest of the year. +So with that, I'll turn the call over to John for his comments. John? + +-------------------------------------------------------------------------------- +John J. Mulligan, Target Corporation - COO and EVP [4] +-------------------------------------------------------------------------------- + + Thanks, Brian. Across all the operations team, we are focused on modernizing Target's network to create a complete, seamless, efficient and reliable menu of fulfillment options for our guests. And while we are still in the early stages of a multiyear journey, the team continues to move with unprecedented speed, developing skills and processes that allows us to develop, test and iterate much more quickly than we have in the past. +Some of our fulfillment capabilities are already well developed. And in those cases, the team is focused on finding ways to increase our speed, reliability and reach. At the other end of the spectrum, we're in the early stages of testing completing new fulfillment options for our guests. In those situations, the work is fully focused on learning from our guests and vendor partners, understanding what is most important to our guests and beginning to evaluate reliable, repeatable processes that will allow Target to fulfill guests' rapidly evolving needs and expectations. +Among our more developed fulfillment capabilities, we have offered in-store pickup of digital orders across all of our locations for years. But we continue to find opportunities to improve execution. And we're seeing continued momentum. Specifically, through the first half of the year, Store Pickup volume has grown more than 30% above last year. And in July, we saw more than 40% growth. As more and more of our guests respond to the convenience of order pickup, we are investing in system enhancements and store labor hours to continue to elevate the guest experience. These investments will be especially important in the fourth quarter holiday season, when guests are particularly time-pressured and rely on this fulfillment option even more frequently. +Another way we can enhance the pickup experience is to offer a drive-up option, so guests don't need to leave their cars. And in the second quarter, we launched a new test of this service. Unlike the past, when we partnered with a third party to offer this service, this new test is being implemented with our own team members and internally developed technology. The offer applies to approximately 180,000 shelf-stable items currently eligible for in-store pickup. And in the early stages, we're offering it only to team members in a handful of Twin Cities stores. However, based on our early results from the test, we expect to move to a guest-facing pilot in select Twin Cities locations later in the fall. +While the capability for our stores to ship digital orders directly to guests' homes was also launched years ago, we are seeing even more rapid growth in this fulfillment mode. For the first half of the year, ship-from-store sales are running about twice as high as last year, accounting for more than 40% of digital units shipped. Since the rollout of this capability, we have added new ship-from-store locations every year. And this fall, we plan to roll it out to another 350 stores in advance of the holiday season. This will bring the total number of ship-from-store locations to more than 1,400 stores. In addition, we are creating additional capacity by ramping up the order volume running through our mature ship-from-store locations. Because so many of our stores can now ship directly to guests, we have been able to increase delivery speed while still controlling costs. +And that, in turn, has allowed us to offer new fulfillment options like Target Restock. This service allows guests to order a shopping cart-sized box filled with items chosen from an assortment of more than 15,000 essential items like coffee and paper towels and have it shipped to their house for a fixed $4.99 delivery fee. Because these orders are fulfilled from a nearby store location, we can promise that any Restock order placed before 2 p.m. will arrive at a guest's home on the following weekday. You'll recall that we rapidly developed this capability at a team member test in the first quarter. And we moved to the next stage of the test in the second quarter, rolling out to Twin Cities REDcard holders in late June. +Operationally, this guest-facing test has gone well. And as a result, we just rolled out Restock to the Dallas and Denver markets. And we plan to expand into another 7 markets before the holidays. With Restock available in these 10 markets, we'll already be reaching 1/4 of the U.S. market less than 6 months from the day we launched the test. Beyond geographic expansion, we began offering Restock to non-REDcard holders in all 3 test markets. We'll be extending the delivery window by adding Saturday delivery. And we'll remove the cutoff for next-day delivery later, beyond the current 2 p.m. cutoff. And given the strong store execution we've seen so far, we'll begin ramping up communication and marketing efforts in Restock markets, which will increase awareness in order volume, providing visibility into the capacity of our store team to reliably process higher-order volumes. +Beyond our internal fulfillment capabilities, our team is also working with transportation partners to improve the speed and cost-efficiency of last-mile delivery. To supplement these efforts, this week, we announced our decision to acquire Grand Junction, a San Francisco-based transportation technology company. Grand Junction has developed proprietary technology tools and has relationships with more than 700 carriers, allowing retailers to choose the most efficient option for last-mile delivery on an individual order. While this acquisition is not expected to have a material direct impact on our financial results, we are excited to bring Grand Junction into the Target team and believe their model will help accelerate our progress in delivery speed, efficiency and a high level of service to Target's last-mile fulfillment. +We worked with the Grand Junction team on the test of same-day delivery in our TriBeCa store, which launched in the second quarter. In this test, guests at checkout can choose to have their purchased items delivered to their home on the same day in a delivery window of their choice. We've been pleased with the results of the test and have gained some useful insights from the guests' response to the offer. For example, the value of the average basket for these same-day delivery orders is more than 6x the store average at the TriBeCa store and contains nearly 4x the units compared with the store's typical basket. Also notable, Home is the most common category in same-day delivery transactions, ahead of Essentials and Food and Beverage. And importantly, Net Promoter Scores for the same-day delivery service have been higher than for the TriBeCa store overall, demonstrating the quality of execution so far. Based on these encouraging initial results, we plan to expand this same-day delivery test to several other New York City locations in the fall. +Of course, the most common mode of shopping is still overwhelmingly in our stores. So while we're investing in new ways to leverage our stores for digital fulfillment, we are also interesting to bring a great store shopping experience to guests across the country. This includes our remodel program, in which we plan to transform the look and feel of more than 600 stores over a 3-year period. In support of this planned remodels in 2017, in the second quarter, we completed 42 remodels, bringing us to a total of 63 so far this year. And while we are obviously seeing a range of outcomes on an individual store level, we are continuing to see average sales lifts in line with our plan to deliver a 2% to 4% sales lift in remodeled stores. And as Brian highlighted, the team is doing a great job of scaling up our capacity, which will enable a faster pace of remodels in 2018 than we previously expected. +Beyond remodels, our team is delivering on our plan to roll out more than 100 small-format stores to dense urban, suburban and college campus environments over a 3-year period. For 2017, we are still on track to deliver our plan to add nearly 30 new small-format stores. In July, we opened 9 new small stores across the country on top of the 4 we opened in the first quarter. While we have only been opened a few weeks, our July openers have been particularly strong out of the gate. And as Brian highlighted, the guest response had been phenomenal. For the set of small-format stores that have been opened for more than a year, we're continuing to see sales productivity more than double the company average. And these stores have been delivering high single-digit comp increases so far in 2017. +So clearly, our team has been busy transforming our assets and developing new and more efficient ways to fulfill guest demand. But as Brian mentioned, we also need to focus on execution every day. Even though strong execution may not always grab the headlines, it has a real impact on our performance. An outstanding example is our work to improve the fundamentals of our digital business, which has dramatically reduced the number of guest-centered contacts related to digital transactions. Specifically, in 2017, guest contacts per digital order are running 30% lower than last year. This dramatic reduction is the result of concerted effort by our team, who looked end-to-end at the digital guest experience, all the way from our site and our apps to ordering, purchasing and fulfillment. Based on this foundational work, the team has worked methodically to reduce friction and pain points. And you're seeing the benefit both in our contact statistics and in our digital traffic and sales. +Another example is our partnership with CVS. As we outlined last year, the conversion of pharmacies created some inevitable friction for our guests, driving an initial decline in script count in our stores. Since the conversions began, we have been working closely with the CVS team to minimize the guest impact and build awareness of the benefits CVS can provide. As a result of our joint efforts, guest experience scores in our pharmacies have been climbing since the CVS conversion and are now running well ahead of our pre-conversion levels. And we've been seeing the impact in our business. In the second quarter, comparable pharmacy script counts turned positive for the first time in more than a year. While this is encouraging, we know we have more opportunities to build on this momentum. And we are working with CVS on marketing and guest engagement plans for the fall season. +Execution in our stores has been a big focus this year. And we're investing in hours, training and technology to allow our store team members to elevate the shopping experience. Depending on a store's volume and buying patterns, we're adding hours to enhance the order pickup experience and our visual merchandising teams in Apparel and Home, in Beauty and in Food and Beverage. And given all the brand launches that Mark's team is planning for the fall, we have invested in training and materials to help our store teams best present and sell these new lines to our guests. +Across all of our stores, we're asking the team to increase their engagement with guests and ensure they're finding all the items on their list. To support this effort, we're rolling out a new tool that will help our store teams locate items, colors and sizes not available in their store and allow them to sell those items directly to guests right on the sales floor. We're in the very early stages of rolling out this new capability and guest awareness is still low, but we are already gaining some initial insights. Not surprisingly, over half the activity on these devices has been related to Apparel, where the ability to find additional sizes and colors creates particular value for our guests. +So now before I close, I want to give a nod to the team. I'm incredibly proud of what they've already accomplished. And I'm energized by their passion to transform our operations and our business on behalf of our guests. And while I know I keep saying that we're just getting started, it's also amazing to look back and realize how much we've already accomplished. +With that, I'll turn the call over to Mark, who will provide more detail on our performance and plans in merchandising. Mark? + +-------------------------------------------------------------------------------- +Mark J. Tritton, Target Corporation - Chief Merchandising Officer and EVP [5] +-------------------------------------------------------------------------------- + + Thanks, John. As you've been hearing from many of our industry peers, this continues to be a challenging competitive and consumer environment. That's why we are particularly pleased by the ongoing progress we saw in the second quarter, when we gained further momentum in the areas that we're already performing well and saw improvement in the areas where performance needed more focus. And our growth has come from both stores and digital channels, wherever our guest wants to shop us. +From a market share perspective, we saw broad-based market share gains across all our discretionary categories. In Hardlines, comparable sales grew between 3% and 4% in the second quarter, the strongest performance we have seen in 10 years. Growth in this area was broad-based, including double-digit growth in both video games, driven by Nintendo Switch, and Apple within Electronics. Toys grew more than 3% with board games continuing to be a strong highlight. This is an area where we already enjoy a leading market share position but continue to grow and take further share due to our focus on innovation and differentiation within our assortment. +Our Apparel and Home categories both grew sales and market share in these tough markets. In Apparel, growth was widespread across subcategories as guests responded to fashion and newness, all underpinned by value through great priced-right daily items. We were particularly pleased with the ongoing positive performance in Kids, which continues to benefit from last year's launch of Cat & Jack and is now achieving strong year-on-year sales growth, and in our strong swim business. Like our performance in board games, we came into the year with the #1 market share in swim. And we extended our lead to become the clear destination for swim in the U.S. In Home, digital was an important growth driver. And we saw particularly strong performance from our Threshold brand. We're also very pleased with the performance of our seasonal businesses, from greeting cards to outdoor furniture. Within the Seasonal event moments, our Fourth of July holiday was strong as we quickly leveraged guests and business insights from Memorial Day. +In Essentials, comp sales were up almost 1%, benefiting from the launch of our Target Run and Done campaign that began in the first quarter. We are pleased with the response from our guests, specifically with awareness and return on ad spend for this campaign, where results are higher than average. The top 2 messages guests recall from the campaign are that, "Target is convenient", and "I can fulfill all of my needs at Target", which were our core campaign goals. Essentials are also seeing the early benefit from our work to improve our value perception. Specifically, when we are priced-right daily on key items in Essentials, we are seeing increased traffic and unit sales trends. +As Brian mentioned earlier, comp sales in the Food and Beverage category have stabilized and were flat in the second quarter. We are seeing improvement based on our work to improve freshness and reliability as well as our work on value perception. In produce, we saw high single-digit comp increases in the second quarter, driven by even stronger growth in organics. And in our adult beverage, we saw ongoing double-digit comp growth, driven by assortment and display enhancements we've been rolling out across the country. Importantly, we continue to build Food and Beverage expertise on our team. Following the hiring of Jeff Burt to lead Food and Beverage in merchandising at the end of the first quarter, we announced that we've hired 2 members of his team earlier this week. Looking ahead, Jeff and his total team are focused on building on recent momentum. We know we need to enhance our assortment of convenient options for our guests, food that's ready-to-eat, ready-to-heat or ready-to-cook and save families time and money. In addition, we're focused on enhancing our exclusive brand assortment in Food and Beverage while ensuring we are priced-right daily on key opening price point items. +While overall, we have much more to accomplish in the third quarter, our work to improve value perception across all of our assortment is already beginning to have an impact. Specifically, surveys are showing that consumers are noticing Target's investment in price and value. And we saw a much stronger mix of regular-priced selling in the second quarter as we sought to simplify our promotions, clarify our voice and bring great priced-right daily items into focus. And it's working. In fact, our second quarter balance of regular and promotional sales was consistent with levels we haven't seen since 2012, well before our credit card data breach that changed our promotional cadence and stance. Also encouraging was the fact that our unit share in key categories grew more quickly than dollar share, which is a key leading indicator of the impact of this work. +At a high level, our second quarter average ticket also reflects the impact of this work. At first glance, reporting a slight decline in average ticket might not sound like good news. But when it's more than offset by an increase in traffic, the picture is more positive. As we dig into the drivers, the change in basket reflected 2 key factors. The first was a reduction in general incentive offers, which were replaced by better daily value pricing and more category-focused discounts. The second was a meaningful increase in the number of quick trips and fill-in trips we saw from our guests. As we mentioned last year, we saw an opportunity to more appropriately balance between stock-up trips and these quicker, smaller trips, so we are pleased to see our strategy taking hold and generating both trips and conversion. This work on value perception is about ensuring we are priced-right daily on key items while delivering more thoughtful and effective promotions throughout our assortments. In many categories, this means we're reducing our everyday pricing and communicating with much more clarity, building confidence among our guests. We'll expand the scope of this work in the third quarter, and we will continue to measure and iterate based on the response. +Another aspect of our business where we are pleased with our progress is in our inventory position. We reduced our total inventory to last year by more than 4% while improving the quality of our inventory by bringing unproductive inventory levels down to historical lows. The savings and markdowns through better sell-through rates and lower inventory levels has created the capacity for us to invest in what's new and what's working, which will position us well in the back half of the year. And we do have a lot of newness planned for the rest of the year. Perhaps most notable are the new brands that either just launched or will roll out in the next few months. +In addition to Cloud Island, which launched in May and is already comping double digits, we launched Isabel Maternity in July. This new brand features 120 key pieces designed to make every stage of maternity easy, comfortable, stylish and affordable with a focus on fit, function and fashion. And this new brand is already posting strong growth. And as we move into September, we're rolling out 2 new exclusive apparel brands. In women's, we're launching A New Day, an apparel and accessories brand featuring a strong feminine aesthetic through modern prints and patterns with a focus on building confidence through stylish, seasonal and basic items and stories that provide the ultimate wardrobe versatility. And in men's, we're launching Goodfellow & Co., which brings a new modern interpretation of classic looks focused on the strong foundation of core items based on insights our guests tell us what they want: great quality, fit and fabric. +But there's more in store. In September, we'll also launch Project 62, a new home brand based on modern design that is thoughtful and approachable. We also built this brand from our Guest Insights to capture their growing demand for modern design with a focus on solving the challenges of urban living, including the need for easy mobility based on potential frequent moves. Items incorporate efficiency, simplicity and great design that make urban environments both highly beautiful and functional. Shortly after in October, we're excited to launch JoyLab, a new women's athletic fashion apparel brand. Items were designed based on emerging street styles that inspire fitness through fashion and building a community based on style and wellness, taking you from crunches to brunches. Given the investment in developing this portfolio of new brands, we plan to support these launches with meaningful 360-degree investments in the way only Target can: in marketing, in digital, on social media, in store experiences with fixturing, mannequins and signage and in training for our store and digital teams. It will be hard to miss the amount of newness you'll see during the third quarter. And we expect our guests will be excited to discover that there is indeed more in store. +And our product design and development, manufacturing, merchandising and marketing teams have been incredibly agile, having begun their work on these new brands less than 10 months ago. It's amazing what they have been able to accomplish together in this time by keeping truly aligned to our strategic choices. It adds up to a vast body of work. And we can't wait to see all of these new items in our stores and online. Our success last year in Pillowfort and Cat & Jack provided the proof of concept and gave us the confidence to begin work on these new brands. Both of those new Kids brands saw double-digit comps in the year following their launch and they are both still growing in their second year while building trips, category growth and store basket. And as Brian shared, Cat & Jack is now a $2 billion brand based on sales volume in the last 12 months through July of this year, exceeding our initial expectations. +Of course, we haven't forgotten the Back-to-School and Back-to-College key seasons, which play a huge role in our third quarter results. In Back-to-School, comps and market share have grown for 10 years straight. And we're focused on extending that record. We continue to invest in digital to support Back-to-School, including our School List Assist site that provides guests a convenient way to access their child's supply list and easily order any or all of those items to be delivered to their home. More than 1 million lists are already available on the site, well ahead of last year. And sales through the list site have been running 4x higher than a year ago. When students go back to college, mom plays a huge role in making everything happen. So we've made sure this year's marketing speaks to moms as well as students. And for those campuses that aren't lucky enough to have one of our new small-format stores, we're partnering with Barnes & Noble College, which operates nearly 800 college stores around the country, to offer the Target assortment to more than 5 million students. +And finally, given our past success, our team is really excited about the upcoming release in the Star Wars series. To get things started, we're launching our latest Star Wars assortments on September 1, which is being dubbed Force Friday. And to celebrate, we'll be opening at midnight in 500 stores across the country. So okay, that's a lot of newness. I hope you see why we're so excited at Target about all of our strategies and plans coming to life. All of our work supports our long-term vision, which is to build on the strengths that have made us such a unique retailer for decades. +As Brian shared, we build a brand from "ands", a brand that offers the best of both mass and specialty. And we have a unique multi-category offering that allows us to drive traffic by leaning into core items and trends. And our brand is known for featuring new, exclusive and truly differentiated items from both own brands like Cat & Jack and national brands like Apple and Casper. Because we are so unique, we're hard to put us in a box, and we like that. We are at our best when we connect with our DNA, unleash the potential of our brand promise to expect more and pay less, leverage our team and let Target be "Tar-zhay". +With that, I'll turn it over to Cathy, who'll provide more detail on our second quarter financial performance and outlook for the rest of the year. Cathy? + +-------------------------------------------------------------------------------- +Catherine R. Smith, Target Corporation - CFO and EVP [6] +-------------------------------------------------------------------------------- + + Thanks, Mark. In the second quarter, our traffic sales and financial performance were all better than expected. Notably, the upside to our expectations was broad-based across the country, across channels and in all 3 months of the quarter. Second quarter comparable sales increased 1.3%, driven by a traffic increase of 2.1%. We are particularly pleased to see this growth in traffic, which reflects strong execution by our team and the early benefit of the work we are doing to transform our business. +Our second quarter adjusted EPS of $1.23 was flat to last year. GAAP EPS was $0.01 lower than adjusted EPS, reflecting some small unfavorable tax items not related to our current operations. Both the GAAP and adjusted EPS lines reflect about $0.07 of favorability, resulting from the net tax effect of our global sourcing operations. This favorability was included in the adjusted EPS calculation because it reflects a structural benefit to our tax rate resulting from our operations. The amount recorded in the second quarter reflects the year-to-date benefit of our global operations on our tax rate. And we expect to recognize an ongoing benefit in the range of $0.02 to $0.03 in both the third and fourth quarters as well. +Our second quarter gross margin rate was down about 40 basis points to last year, driven by increased fulfillment cost and the impact of our efforts to improve pricing and promotions. Merchandise mix had a slightly positive impact on our gross margin rate in the quarter, reflecting healthy performance in our signature businesses, balanced by broad-based strength in Hardlines. One note, beginning this quarter in our financial reporting, we have reclassified depreciation expenses associated with our supply chain, moving them into the cost of goods line on our P&L. This elective reclassification, which resulted from an internal review of how we classify depreciation expense and discussions with the SEC during one of their routine reviews of our filings, is reflected in our second quarter 2017 reporting and we've reclassified prior year results as well. +Obviously, this reclassification has no impact on our sales, EBIT, net earnings or EPS, but it results in equal and offsetting reductions to both our gross margin rate and depreciation and amortization expense rate. To provide greater clarity, this morning, we posted a document on our Investor Relations website that shows the impact of this reclassification on our quarterly gross margin and D&A rates over the last 3 years. That document shows that the reclassification impact has been either 30 or 40 basis points reduction in our quarterly gross margin and D&A rates throughout that entire 3-year period. And one final note, with this reclassification, we will no longer include EBITDA metrics in our segment table. +On the SG&A expense line, we saw a year-over-year increase of about 50 basis points in the second quarter. This increase was driven by compensation costs, reflecting the store labor investments that John highlighted earlier as well as higher bonus expense, along with impairments related to anticipated store closures and our work to transform our supply chain. These costs were partially offset by the benefit of continued cost discipline throughout the organization. As I mentioned in one of our calls in 2016, for the last couple of years, we have been working to create a culture of thoughtful cost discipline. And I am really pleased to see the ongoing benefit of that effort. I want to pause and thank the team both for their passion to transform our company and for their thoughtful cost management, which is helping to fund our investments in this transformation. +At the end of the second quarter, our inventory was more than 4% lower than last year. This is vivid confirmation of the benefit of the work of both the operations and merchandising teams to reduce unproductive inventory and speed up our supply chain. These efforts are driving continued strong in-stocks and sales growth on a smaller base of inventory. Compounding that benefit, we are also beginning to see the impact of our work with vendors to ensure that Target's payment terms are in line with industry norms, which drove an increase in our payables in the second quarter. The combined benefit of these two factors was an increase in our inventory leverage of more than 10 percentage points compared to last year. The working capital benefit of this leverage improvement is substantial and will provide additional cash to support our transformation. In fact, we are now forecasting 2017 cash flow from operations will be higher than last year despite the operating income reduction we have planned for the year. +So now as always, I want to pause and reiterate our capital deployment priorities, which have remained consistent for decades. We first invest capital into our business on projects that support our strategic and financial objectives. Second, we support our dividend and look to extend our record of raising the dividend annually since 1971. And finally, we repurchase our shares within the limits of our current A credit rating. +In the second quarter, we devoted more than $700 million to capital investment, paid dividends in excess of $300 million and repurchased just under $300 million of our shares. For the year, we continue to expect that our CapEx will be in the $2 billion to $2.5 billion range. However, with the increase in 2018 remodels Brian mentioned earlier, we now expect next year's CapEx will be $3 billion or more, somewhat higher than our previous expectations. This highlights our continued discipline regarding investment deployment. We will increase investment where we have seen solid returns to accelerate our transformation and long-term growth. +Our second quarter ROIC performance also highlights the benefit of disciplined capital management. Specifically, in the 12 months through the second quarter, we generated a very healthy after-tax ROIC of 13.8%. This is about 10 basis points stronger than we reported in the second quarter a year ago if you exclude the gain from the sale of our pharmacy business. So even on lower operating income, we've seen an improvement in ROIC because we've taken working capital out of our business. +Now let's turn to our expectations for the third quarter and full year. As we look ahead, we will continue to move with urgency but plan prudently. Of course, we are facing a tougher prior year comparison in the third quarter, and we continue to expand the scope of our pricing and promotion work, which may create additional headwinds for the rest of the year. As a result, we expect our third quarter and fourth quarter comps will be within the range we established across the first 2 quarters of the year. For the full year, we expect that our comp will be in the range around flat, plus or minus 1%. +In the third quarter, we are planning for a decline in EBIT of approximately $230 million. More than half of this decline will be driven by D&A as we recognize accelerated depreciation related to the anticipated remodels we're planning for 2018. The remaining EBIT pressure will reflect this year's operating margin investment to support our transformation. Altogether, we are expecting GAAP and adjusted EPS in the $0.75 to $0.95 range in the third quarter. Based on our better-than-expected performance in the first half of the year, we are now raising our full year GAAP EPS expectation to the range of $4.35 to $4.55, representing an increase of about 11% from our prior guidance range. Adjusted EPS is expected to be about $0.01 lower than GAAP EPS, reflecting the tax matters excluded from adjusted EPS in the first half of the year. +Before I turn the call back over to Brian, I want to step back and look at the underlying strength of our business and how it is enabling our transformation. Through the first half of the year on sales of just over $32 billion, Target's operations have generated EBIT of more than $2 billion and nearly $3 billion of cash. We have deployed that cash to fund capital investment of more than $1.2 billion. We returned nearly $1.3 billion to our shareholders through dividends and share repurchases. And we retired about $600 million of our long-term debt. As I said at our Financial Community Meeting at the beginning of the year, we are so fortunate to have such a strong business and a balance sheet which allows us to invest while many of our peers are pulling back. Not only do we have a plan to create a company that will thrive in this new era in retail, we have the financial strength to get us there. +So with that, I'll turn the call back over to Brian for some final remarks. + +-------------------------------------------------------------------------------- +Brian C. Cornell, Target Corporation - Chairman and CEO [7] +-------------------------------------------------------------------------------- + + Thanks, Cathy. Before we move to questions, I want to thank you for your engagement and reiterate our commitment to moving quickly, thoughtfully investing in our long-term growth and strong execution every day. While we expect that the near-term environment will remain choppy, we're confident in our 3-year plan to build an even better Target. And our second quarter progress reinforces that confidence. +That concludes our prepared remarks. Now John, Mark, Cathy and I will be happy to take your questions. + + +================================================================================ +Questions and Answers +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) + +-------------------------------------------------------------------------------- +Brian C. Cornell, Target Corporation - Chairman and CEO [2] +-------------------------------------------------------------------------------- + + Operator, before we start taking questions, I just want to make a couple of points. I recognize that our prepared comments today were rather lengthy, but we thought it would be important to give you a sense for the breadth of the work taking place at Target today, an update on our progress. And I hope we provided clarity around the key areas of focus over the balance of the year and as we go into 2018. So with that, we'd love look to open it up for your questions today. + +-------------------------------------------------------------------------------- +Operator [3] +-------------------------------------------------------------------------------- + + Our first question comes from Matt Fassler with Goldman Sachs. + +-------------------------------------------------------------------------------- +Matthew Jeremy Fassler, Goldman Sachs Group Inc., Research Division - MD [4] +-------------------------------------------------------------------------------- + + I have two brief questions for, I think, for Cathy. The first relates to the implied fourth quarter guidance, which seems quite subdued relative to a tough fourth quarter a year ago despite the fact that I believe you have an extra week in the quarter, and correct me on that if I'm wrong. And then the follow-up to that is just that you mentioned D&A moving higher. So if you could just give us some color on the magnitude of the move you'd expect of the restated D&A numbers. + +-------------------------------------------------------------------------------- +Catherine R. Smith, Target Corporation - CFO and EVP [5] +-------------------------------------------------------------------------------- + + With regards to both third quarter, fourth quarter and full year remainder guidance, as we said, we'll continue to move with urgency but plan prudently. And I think that's what you should expect from us. We are finding every time we see results coming from our investments, we're choosing to continue to invest to accelerate our transformation. And so that's how I would think about the backside of the full year. With regards to the reclassification we did on the supply chain depreciation expense, we posted a great schedule, John and the team posted today to the IR website, gives you 3 full years by quarter. You can see the bottom line, it's 30 to 40 basis points a quarter change. And you would see that -- the shift from D&A to gross margin. + +-------------------------------------------------------------------------------- +Matthew Jeremy Fassler, Goldman Sachs Group Inc., Research Division - MD [6] +-------------------------------------------------------------------------------- + + We have that. But just in terms of the -- I think you said you expected D&A to be increasing at a faster rate as you accelerate the depreciation associated through upcoming remodels. + +-------------------------------------------------------------------------------- +Catherine R. Smith, Target Corporation - CFO and EVP [7] +-------------------------------------------------------------------------------- + + Yes. + +-------------------------------------------------------------------------------- +Matthew Jeremy Fassler, Goldman Sachs Group Inc., Research Division - MD [8] +-------------------------------------------------------------------------------- + + Can you try to contextualize the expected increase, how much the pace of D&A growth will change? + +-------------------------------------------------------------------------------- +Catherine R. Smith, Target Corporation - CFO and EVP [9] +-------------------------------------------------------------------------------- + + Yes, so it is. It's related to our increasing store remodels as we accelerate some of the depreciation there. And for the full year, I was just quickly looking here, we're -- you'll see a little bit of continued pressure coming through, so it will pick up. But we'll follow up with some specifics if you need it. + +-------------------------------------------------------------------------------- +Operator [10] +-------------------------------------------------------------------------------- + + The next question comes from Chris Horvers with the JPMorgan. + +-------------------------------------------------------------------------------- +Christopher Michael Horvers, JP Morgan Chase & Co, Research Division - Senior Analyst [11] +-------------------------------------------------------------------------------- + + You had a very strong Electronics quarter. The Switch, which has been a huge hit, double-digit comps in that. And then Apple iPad sounded like they're bouncing back. So it seems like there's a material contributor to same-store sales. How do you think about the sustainability of this benefit? Presumably, the Switch moderates. But do you think the Apple benefits on tablet compares and the new phone? And what other categories do you think could come in and pick up for what the Switch has provided? + +-------------------------------------------------------------------------------- +Brian C. Cornell, Target Corporation - Chairman and CEO [12] +-------------------------------------------------------------------------------- + + Mark, why don't you provide some insight into our view on Electronics? + +-------------------------------------------------------------------------------- +Mark J. Tritton, Target Corporation - Chief Merchandising Officer and EVP [13] +-------------------------------------------------------------------------------- + + Yes. Thanks, Chris. I think, firstly, just on the Apple comments, they weren't just driven by tablet. They were all driven across the board in categories. And we had really strong showing in Q2 on the iWatch, which we worked with Apple on clearly. And we have a lot in our plans to Q3 and Q4 with potential new launches as I've outlined. So we think that there's still room for growth and continuing the trend. In terms of Nintendo Switch, we worked really closely with those guys as well to develop not only a product but a marketing campaign that the guests really responded to. And so we've been able to secure inventory and a plan all through to the fourth quarter, so feeling positive about sustaining a trend there. + +-------------------------------------------------------------------------------- +Brian C. Cornell, Target Corporation - Chairman and CEO [14] +-------------------------------------------------------------------------------- + + And Chris, I think it's consistent with our focus on bringing newness to the guest, not only in Electronics but through our assortment. And I think Mark and his team have done a terrific job of working with our vendors and also building own-brands that bring excitement and newness to our guests each and every day. + +-------------------------------------------------------------------------------- +Christopher Michael Horvers, JP Morgan Chase & Co, Research Division - Senior Analyst [15] +-------------------------------------------------------------------------------- + + Understood. And then on the working capital CapEx side, you've seen some very nice benefits here on working capital this year. How do you think about this year, inventory outlook at the end of the year on the working capital benefit? And you raised CapEx a bit next year. Do you think that increased CapEx is largely offset by continued ongoing benefits in the working capital area? + +-------------------------------------------------------------------------------- +Catherine R. Smith, Target Corporation - CFO and EVP [16] +-------------------------------------------------------------------------------- + + So Chris, as we've said, we know that we've got a multiyear journey around the supply chain transformation, which will help that working capital continue to come through the business. And we want to just make sure we keep making that progress through time, so not going to commit longer term just yet as we -- it's really going to be associated with a lot of the supply chain transformation. On the increase in CapEx next year, again we're not giving all of next year guidance but thought important to signal where we were going with our CapEx. + +-------------------------------------------------------------------------------- +Operator [17] +-------------------------------------------------------------------------------- + + Our next question comes from David Schick with Consumer Edge Research. + +-------------------------------------------------------------------------------- +David Adam Schick, Consumer Edge Research, LLC - Director of Research, and Retail and Luxury Analyst [18] +-------------------------------------------------------------------------------- + + I really wanted to simplify into one question all these different tests and get at one issue, whether it's the roll -- test of curbside and same day, whether it's the rollout of in-store, all the work you are doing. Could you talk about all the new initiatives? And is it -- does it have more traction with existing customers, anything you can share, existing customers, capturing back more of their wallet? Or is it new customers that are new to Target as you go through these new initiatives? + +-------------------------------------------------------------------------------- +Brian C. Cornell, Target Corporation - Chairman and CEO [19] +-------------------------------------------------------------------------------- + + David, I would tell you it's a combination of both. And overall, we're very focused on improving the guest experience, whether they're shopping in store or online, making sure that we deepen the relationship with existing and new guests. And we are very pleased with the traffic increases we saw during the quarter. We're honestly very excited about the work that Mark and his team are doing around bringing new brands to our guests. And we recognize that to move forward and to continue to execute, we've got to continue to make sure we're providing fulfillment options that our guests are looking for today. So as John talked about during our prepared comments, we're very focused right now on testing and expanding different fulfillment options. We've seen some very positive responses to things like Target Restock. And we're going to continue to ensure that we could meet the needs of our guests no matter how they want to shop at Target. + +-------------------------------------------------------------------------------- +David Adam Schick, Consumer Edge Research, LLC - Director of Research, and Retail and Luxury Analyst [20] +-------------------------------------------------------------------------------- + + Just as a sort of an add-on to that, one of the things over the last decade that some retailers run into with all these attempts to reengage, a lot of which are very exciting, is either overdoing it or overcomplicating it. How are you guarding against at the store level the associates not being overwhelmed by these initiatives and managing through that? + +-------------------------------------------------------------------------------- +Brian C. Cornell, Target Corporation - Chairman and CEO [21] +-------------------------------------------------------------------------------- + + It's a very important question. And I'm going to turn it over to John here to build on that. But we're trying to make sure we are very, very focused right now and that we have the guest in mind first, that the initiatives that we're bringing forward are guest-centered. But importantly, that we have the right focus on execution each and every day. And I think what we saw in the second quarter is a by-product of our focus on execution each and every day in our stores, online, in our supply chain. And I think you're starting to see that focus really connect with the guests. + +-------------------------------------------------------------------------------- +John J. Mulligan, Target Corporation - COO and EVP [22] +-------------------------------------------------------------------------------- + + Yes, I think the only thing I'd add, you're 100% right about the focus. I think the key challenge there for us is to continue to take work that is not guest-facing out of the store. And guest-facing work there is, like we said, the investments we're making in Food and Beverage, in Beauty, in visual merchandising. That includes things like order pickup and shipping from the store. But there are opportunities everywhere else to pull work out of the store. And I think the stores' teams have done a great job optimizing within the box. We need to continue to optimize upstream to help them take work out. And that's a lot of the testing we're doing today. Now I didn't talk a lot about it, but we have test going on in multiple parts of the company focused on taking work out of the store, so they can be focused on the guest. + +-------------------------------------------------------------------------------- +Operator [23] +-------------------------------------------------------------------------------- + + Our next question is from Robbie Ohmes with Bank of America Merrill Lynch. + +-------------------------------------------------------------------------------- +Robert Frederick Ohmes, BofA Merrill Lynch, Research Division - MD [24] +-------------------------------------------------------------------------------- + + Brian, you guys have been mentioning the environment challenges, and we're seeing the very aggressive promotions out there in categories like Apparel. Your store traffic improved a lot this quarter. I'm just curious, are there -- can you give us any color, are you picking up more share from competitors' store closings than you would have thought? And then also as you shift more to EDLP while others are getting maybe more promotional, any insights from what you've seen so far in August that you can share with us on how all this is working out? And sorry, just to add on this also, and I don't know whether John Mulligan or Mark want to jump in on this, but as you pull back on the promos more, you shift more to EDLP, can you remind us where things like Cartwheel fit into that as you move forward and also how you see REDcard penetration playing out in your strategy? + +-------------------------------------------------------------------------------- +Brian C. Cornell, Target Corporation - Chairman and CEO [25] +-------------------------------------------------------------------------------- + + So Robbie, there's 4 or 5 different questions there. And we'll try to unbundle each of them. But as Mark talked about during his prepared comments, during the second quarter, we saw very strong market share growth across a number of categories. We continue to see share growth in Apparel, in Home, in Hardlines. And one of the things that, I think, we felt best about in the quarter, and it's a by-product of the work we've done from a promote standpoint as we continue to see our businesses in Essentials shift back to regular-priced sales and the impact of our new marketing and advertising campaign, the Target Run and Done campaign, which has driven really positive reaction from the guests and accelerated our business in Essentials. So that was a real big highlight for us in the second quarter. And we've talked about this before. We're at our best when we balance both style and household essentials. And you're seeing that balance come to play in the second quarter. And we certainly are going to continue that over the balance of the year and into 2018. So it was a period of time where we feel good about the progress we're making as we pick up market share in many of our signature and style categories. We've seen growth in our Essentials businesses. And we'll build off of that as we go into the balance of 2017 and '18. + +-------------------------------------------------------------------------------- +Mark J. Tritton, Target Corporation - Chief Merchandising Officer and EVP [26] +-------------------------------------------------------------------------------- + + Sorry, Robbie, around Cartwheel. Cartwheel remains a really viable promotional vehicle and guest engagement tool for us. And what we're doing though, in the simplification of our pricing message and creating great priced-right daily items, is we're using Cartwheel, but we're reducing the amount of stacking that's coming in. And that's really helping us to clarify and simplify our message to guests about what true everyday value is as well as what's an exceptional promotion. So the rescoping of that has been tremendous so far. And really, our regular business is shining and our promotional business is rescoped in a great way. + +-------------------------------------------------------------------------------- +Robert Frederick Ohmes, BofA Merrill Lynch, Research Division - MD [27] +-------------------------------------------------------------------------------- + + And any chance we can get you guys to comment on August? + +-------------------------------------------------------------------------------- +Brian C. Cornell, Target Corporation - Chairman and CEO [28] +-------------------------------------------------------------------------------- + + Obviously not. + +-------------------------------------------------------------------------------- +Operator [29] +-------------------------------------------------------------------------------- + + Our next question comes from Bob Summers with Macquarie. + +-------------------------------------------------------------------------------- +Robert William Summers, Macquarie Research - Analyst [30] +-------------------------------------------------------------------------------- + + Just a handful of questions. You've had some recent hires in sort of the Food umbrella. I'm just curious as to how the new individual fit into the current strategy and whether this is a catalyst for a shift and maybe something more into the prepared food sort of side of the equation. And then secondly, if you're willing to comment, I'd love to know what the trends look like, the business trends look like in and around Prime Day? + +-------------------------------------------------------------------------------- +Brian C. Cornell, Target Corporation - Chairman and CEO [31] +-------------------------------------------------------------------------------- + + Yes. Why don't we turn it over to Mark to talk about both Food and what we saw during that Prime period? + +-------------------------------------------------------------------------------- +Mark J. Tritton, Target Corporation - Chief Merchandising Officer and EVP [32] +-------------------------------------------------------------------------------- + + Thanks, Bob. I think that we outlined in our Q1 comment around the emergence of our strategy and that we're going to be on a journey of implementation as Jeff Burt joined us in the business. And Jeff has already come in and begun start testing and iterating new ideas and concepts on top of our strategies that are creating growth vehicles, so we're excited about that. The new people entering our business are just creating new strength against those strategic intents. So firstly, Liz Nordlie will add value to our own brand growth potential there and strengthen our efforts there as well as Mark Kenny, really with his expertise in general grocery but specifically in the convenient meal area and in bakery, et cetera. I mean, that is part of our ongoing strategic intent to strengthen and focus there. So these are key investments in our strategy and in our team, balancing them against existing talent. In regards to your query around Prime, we're really happy to see ongoing trends maintained during Prime period. And we had positive comps and a really strong growth in regular price business continuing through those days both in-store and online. + +-------------------------------------------------------------------------------- +Operator [33] +-------------------------------------------------------------------------------- + + Our next question comes from Peter Benedict with Robert Baird. + +-------------------------------------------------------------------------------- +Peter Sloan Benedict, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [34] +-------------------------------------------------------------------------------- + + Mark, just was hoping you could expand maybe a little bit on some of the merchandising assortment changes that you're making in the consumable side of the business, the Food area, particularly in pet food. What's going on there? And anything to note there from a remodel perspective? + +-------------------------------------------------------------------------------- +Mark J. Tritton, Target Corporation - Chief Merchandising Officer and EVP [35] +-------------------------------------------------------------------------------- + + Yes. Thanks, Peter. So let me start with pet. We announced this month the addition of Blue Buffalo to our assortment, which is the #1 brand in the U.S. and a really core assortment get. And so excited to add that into our mix, and we already have a lot of data from our guests who suggested they wanted to see that at Target. We also embarked on an agreement with BarkBox. So really refocusing our accessory and our total assortment of doing business inside pet. So an exciting uptick there because that brings further guest trips and conversion. Around the Food and Beverage area, in terms of general assortment, we're still working on there and more to follow. + +-------------------------------------------------------------------------------- +Peter Sloan Benedict, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [36] +-------------------------------------------------------------------------------- + + That's helpful. And then just leveraging on that, when you think about the private brand introductions, I mean, good color on what's coming this year. But when you think about next year, is it going to continue to be in kind of the signature categories? Or should we expect some private brand introductions to start to emerge on the consumable side of the store? + +-------------------------------------------------------------------------------- +Mark J. Tritton, Target Corporation - Chief Merchandising Officer and EVP [37] +-------------------------------------------------------------------------------- + + I think that we've talked openly about a roster of more than 12 brands that we'll be bringing to life over a period of time. We've begun that journey. That continues into 2018. It highlights definitely the signature areas, but the strength, providing differentiation, exclusivity and therefore, preference that Target through this is applicable to many different areas. So we're looking at all areas and opportunities, and we have some plans in place. + +-------------------------------------------------------------------------------- +Operator [38] +-------------------------------------------------------------------------------- + + Our next question is from Brandon Fletcher with Bernstein. + +-------------------------------------------------------------------------------- +Brandon Fletcher, Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst [39] +-------------------------------------------------------------------------------- + + The only questions I have are essentially just on the pick for store concept. I just want to share a comment we had from an industrial engineer that was working for me a long time ago that it's about as efficient as a driver who takes 3 rights to take a left. There's a massive cost when you have people walk the store instead of it being your customers who walk back out on a simulated basis. I get incrementality. I get that you don't have to have the checkout cost and it offsets it a little bit. Is there something that's coming that you guys are confident on the operational side that will make pick from store the way you guys are doing it better than lots of other folks so that we don't face as much inefficiency? And similarly, will the remodels make those operational changes you think less difficult or more efficient in terms of cost structure? + +-------------------------------------------------------------------------------- +John J. Mulligan, Target Corporation - COO and EVP [40] +-------------------------------------------------------------------------------- + + I think any time you focus on just one slice of the total fulfillment, you lose picture for the whole thing, right? We're trying to optimize the total economics for Target. And those economics include investments, capital investments we might otherwise have to make if we don't utilize the existing assets. So I think we can point to any one slice and say, "This one is going to be better or worse." But again, we're optimizing total economic picture. And I'd have you think about that. I think the remodels, where they will really help us, and it's in conjunction with us taking inventory out of the backroom, is our ability to optimize that backroom more efficiently to drive more productivity as we ship from the store. And so that's the real opportunity as we go through the remodel cycle. + +-------------------------------------------------------------------------------- +Brandon Fletcher, Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst [41] +-------------------------------------------------------------------------------- + + And so the micro fulfillment in the backrooms would be one of the benefits of remodels? + +-------------------------------------------------------------------------------- +John J. Mulligan, Target Corporation - COO and EVP [42] +-------------------------------------------------------------------------------- + + For sure. And in conjunction with operating changes to reduce inventory, like I was talking about earlier, and take work out of that -- other work out of the store. + +-------------------------------------------------------------------------------- +Operator [43] +-------------------------------------------------------------------------------- + + Our next question is from Michael Lasser with UBS. + +-------------------------------------------------------------------------------- +Michael Lasser, UBS Investment Bank, Research Division - MD and Equity Research Analyst of Consumer Hardlines [44] +-------------------------------------------------------------------------------- + + Can you quantify how much of the $1 billion of operating profit investment you plan to make has already been deployed thus far this year? + +-------------------------------------------------------------------------------- +Catherine R. Smith, Target Corporation - CFO and EVP [45] +-------------------------------------------------------------------------------- + + As you saw in the quarter, we are seeing the continued investment in both SG&A as well as gross margin. We also though are working really hard to make sure we can offset with efficiencies throughout the organization, where appropriate. And so you're seeing that -- you saw it come through in SG&A and in gross margin this first -- the second quarter, you saw in the first quarter as well to do that. So where we see the investments get the return that we expect and the results we expect, we're investing faster and heavier to accelerate the transformation. So I would say we're on path to what we said we would do. And you're seeing it come through in both Q1 and 2. + +-------------------------------------------------------------------------------- +Operator [46] +-------------------------------------------------------------------------------- + + Your final question is from Kate McShane with Citi. + +-------------------------------------------------------------------------------- +Kate McShane, Citigroup Inc, Research Division - MD, Head of the U.S. Discretionary and U.S. Apparel and Retail Analyst [47] +-------------------------------------------------------------------------------- + + I wanted to just ask about promotions a little bit more, if you don't mind. I know matching promotions are fluid. But how much more work do you need to do in moving your categories and products to EDLP? And what way are these changes impacting the second half outlook? And I know you've mentioned that there's been challenges in the past in terms of conveying value to your guests. And I just wondered how this messaging has changed. + +-------------------------------------------------------------------------------- +Mark J. Tritton, Target Corporation - Chief Merchandising Officer and EVP [48] +-------------------------------------------------------------------------------- + + Yes. Okay, I'll take that one. So our promotional efforts are really a roll through the quarter event. And we began them in first quarter in April. And our second round of taking key items that comprise our guest basket and focusing on priced-right daily items really took hold and then second wave by end of July. The next round of that is through October. And that's when we'll be coming together to have a more concise in-store marketing campaign and regular cadence of new brands to the guest to communicate value. So we think at that point that we have a strong base to maintain. And this is why in half 2, we've been prudent in how we forecasted our sales and margins based on also unit growth initially. We see trip growth initially. And we need to see that dollar growth balance out over time. But we know that we've been patient with that, hence some of our earlier discussions at the start of the year are about investing ahead of the curve. + +-------------------------------------------------------------------------------- +Brian C. Cornell, Target Corporation - Chairman and CEO [49] +-------------------------------------------------------------------------------- + + Kate, I think promotions, along with many of the other things we've talked about, are still obviously in the early stages. Now we're excited about the results that we've seen with remodels. But we have hundreds of stores in front of us. We've seen great responses in some of our small formats. But again, we'll open up dozens of additional stores over the next couple of years. The brands that we've launched have been well received. But we're really just getting into the heart of the brand launches as we go into the back half of '17 and '18 as well as the pricing and promo work. So we're very pleased with the progress. We know we've got much more work in front of us. But we thought today would be a great chance to give you a progress report and give you a sense for the amount of work and the scope of work that's taking place within Target. So that concludes our second quarter 2017 earnings call. I really appreciate all of you participating, so thank you. + +-------------------------------------------------------------------------------- +Operator [50] +-------------------------------------------------------------------------------- + + This concludes today's conference. Thank you for your attendance. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/exam/original-files/Problem_2_3_Sample_full_transcripts/2017-Feb-09-KO.N-138416362262-Transcript.txt b/exam/original-files/Problem_2_3_Sample_full_transcripts/2017-Feb-09-KO.N-138416362262-Transcript.txt new file mode 100644 index 0000000..a574907 --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_full_transcripts/2017-Feb-09-KO.N-138416362262-Transcript.txt @@ -0,0 +1,509 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q4 2016 Coca-Cola Co Earnings Call +02/09/2017 09:00 AM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Muhtar Kent + Coca-Cola Company - Chairman & CEO + * Kathy Waller + Coca-Cola Company - CFO + * Tim Leveridge + Coca-Cola Company - VP of IR Officer + * James Quincey + Coca-Cola Company - President & CEO + +================================================================================ +Conference Call Participiants +================================================================================ + + * Bill Schmitz + Deutsche Bank - Analyst + * Dara Mohsenian + Morgan Stanley - Analyst + * Mark Swartzberg + Stifel Nicolaus - Analyst + * Judy Hong + Goldman Sachs - Analyst + * Nik Modi + RBC Capital Markets - Analyst + * Robert Ottenstein + Evercore ISI - Analyst + * Steve Powers + UBS - Analyst + * Bryan Spillane + BofA Merrill Lynch - Analyst + * Bonnie Herzog + Wells Fargo Securities, LLC - Analyst + * Bill Chappell + SunTrust Robinson Humphrey - Analyst + * Ali Dibadj + Sanford C. Bernstein & Co. - Analyst + +================================================================================ +Presentation +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- +At this time I would like to welcome everyone to the Coca-Cola Company's fourth-quarter 2016 earnings results conference call. Today's call is being recorded. If you have any objections please disconnect at this time. +(Operator Instructions) +I would like to remind everyone that the purpose of this conference is to talk with investors and therefore questions from the media will not be addressed. Media participants should contact Coca-Cola's media relations department if they have questions. I would now like to introduce Mr. Tim Leveridge, Vice President and Investor Relations Officer. Mr. Tim Leveridge, you may begin. + +-------------------------------------------------------------------------------- +Tim Leveridge, Coca-Cola Company - VP of IR Officer [2] +-------------------------------------------------------------------------------- +Good morning and thank you for being with us today. I'm joined by Muhtar Kent, our Chairman and Chief Executive Officer; James Quincey, our President and Chief Executive Officer; and Kathy Waller, our Chief Financial Officer. +Before we begin I'd like to inform you that you can find webcast materials in the investor section of our Company website at www.coca-colacompany.com that support the prepared remarks by Muhtar, James and Kathy this morning. As a reminder, we will be hosting a separate modeling call at 11:30 AM this morning, to review our 2017 outlook in greater detail and allow sufficient time for questions pertaining to guidance. +I would also like to note that we have posted schedules under the financial reports and information tab in the investor section of our Company website. These schedules reconcile certain non-GAAP financial measures, which may be referred by our senior executives during this morning's discussion to our results as reported under Generally Accepted Accounting Principles. Please look on our website for this information. +In addition, this conference call may contain forward-looking statements including statements concerning long-term earnings objectives and should be considered in conjunction with cautionary statements contained in our earnings release and in the Company's most recent periodic SEC report. Following prepared remarks this morning we will turn the call over for your questions. +In order to allow as many people to ask questions as possible, we ask that you limit yourself to one question. If you have multiple questions please ask your most pressing question first and then reenter the queue in order to ask any additional questions. Now, I'd like to turn the call over to Muhtar. + +-------------------------------------------------------------------------------- +Muhtar Kent, Coca-Cola Company - Chairman & CEO [3] +-------------------------------------------------------------------------------- +Thank you, Tim, and good morning everyone. Today I'll cover a few key highlights before handing off to James to provide a more detailed operational review of our performance. We are committed to transform our Company to a brand centric organization leading a great franchise system. +This journey began back in late 2014 when we got behind a set of strategic actions designed to invigorate growth and increase profitability. Since then, we've been advancing on a path to deliver greater long-term sustainable value to our shareholders, associates, partners and stakeholders. +We've simplified our organizational structure for speed and flexibility. We're driving aggressive productivity. We are redeploying more and better marketing. We are driving revenues through segmented growth strategies and embarking also on the biggest refranchising and bottler restructuring in our history. +2016 was a critical year as we continue to make strong progress in transforming our Company while keeping focused on our consumers. We continued to gain momentum in building revenue growth through segmented market roles and disciplined brand investments Since launching our incremental media investment plan in early 2014, our core business has accelerated top-line performance even with slowing macroeconomic growth. We've strengthened our brands and portfolio through better and more marketing innovation and targeted acquisitions. +We've brought to market more than 500 new products nearly 400 of which were teas, juices, coffees, waters, or other still beverages. We generated over $600 million in productivity for a three-year total of over $1.7 billion taking a balanced approach to investing in our brands while leveraging our P&L in 2016. +Finally we continue to strengthen our bottling system. The world's largest independent Coca-Cola bottler based on revenue, Coca-Cola European partners began operations in a market that represents one of our most valuable profit centers. We signed definitive agreements to sell our bottling businesses in China and we expect to close these transactions during the first half of 2017. +Our two largest bottlers in Japan agreed to merge, which will create a single bottler covering roughly 85% of our systems volume in Japan, a very important profit pool again. We successfully helped to create Coca-Cola beverages Africa and we are now working to transition ownership from ABI to a strong partner of our choice. +Finally, we've made substantial progress refranchising our North America bottling operations. At the same time the North America business has flourished throughout the process delivering top tier FMCG performance with mid-single-digit organic revenue growth in each of the past two years. +Taken together half of our system revenue has been in motion through these actions. We accomplished a lot and built a very strong and purposeful foundation for the future. Now, it's time to write the next chapter in our growth story with the appointment of James Quincy as our next CEO. +I have every confidence in James and our Management team and, throughout his career, James has shown insightful leadership in addressing the changing consumer environment by expanding product offerings and, most recently, driving systematic portfolio reformulation to reduce added sugar with hundreds of initiatives in progress. He is absolutely the right leader at the right time. +James is well prepared to deliver the next level value creation. He knows that in order to deliver robust and sustainable value creation for shareholders we will also need to create value for all of our stakeholders. +I'm excited about what's ahead for Company and for our system and James will have my full and vigorous support as I continue to serve as Chairman of the Board. Now, I'll hand over the call to James who will take you through our operating performance in 2016 as well as provide thoughts on our performance this coming year. + +-------------------------------------------------------------------------------- +James Quincey, Coca-Cola Company - President & CEO [4] +-------------------------------------------------------------------------------- +Thank you. Good morning everyone. Thanks, Muhtar. And it will be an honor and a privilege to succeed as Chief Executive. +This is a pivotal time of change for our Company, our system, and our industry. We are seeing consumer preferences evolve, technology and e-commerce transform the retail landscape, and, of course, ongoing volatile global economic conditions. +In the actions we've taken over the past few years have set a strong foundation for Company and I look forward to steering us through our next phase of growth. I will take you through some of the how's when we present at Cagney in a couple of weeks. So, today, let me just cover a few topics. +Our top-line performance for the quarter, a summary of our actions and performance for the whole year, and a little on our expectations for 2017. Then I'll hand the call to Kathy to walk you through some additional financial details. +Let's start with our top-line performance in the fourth quarter. Here we delivered good organic revenue growth even allowing for the fact that the quarter had two extra days. Clearly this was driven by 6% price mix while volume didn't grow. Mostly this is a result of what we planned for and expected but with a couple of twists. +Firstly, those things we expected included our continuing focus on momentum in our developed country markets. For example North America which had another very strong quarter and also we expected to cycle negative price mix from last year in Asia Pacific producing a strong number this year. +Things we saw occur in the quarter and responded to included, for example, India where demonetization impacted the whole CTG landscape. Our system responded quickly by facilitating digital payments, extending credit to mitigate destocking, and increasing our emphasis on the modern trade. +Also macro conditions worsened in Brazil. Here we chose not to drive poor value promotions to over protect volume but focused instead on more fundamentally resetting the price package architecture to support affordability and this will take some time to fully implement. These not only hit our consolidated volume, but in curious ways mechanically improved our price mix as well. +Now, clearly 6 points of price mix is a one off and it's not our destination nor is a 1% decline in volume. So, rather than focus just on the quarter, let's look at the full-year results, which I believe are a better indicator of how we think about the full-year success in 2016 and going forward into 2017. +For the full year 2016 we delivered 3% organic revenue growth that meets more challenging macro conditions than we expected. Our core being the Company that will exist after the refranchising -- our core business grew organic revenue by 4% and we gained NARTD value share. +Given the refranchising of our Company-owned bottling businesses, we look at this core business as an important indicator of the longer-term trajectory of our top-line and remain encouraged that we are growing the core in line with our long-term revenue target, even if at the bottom and. Finally, we expanded our operating margin through strong price mix and by balancing over $600 million in productivity with disciplined investments given the overall macro environment in 2016. These actions enabled us to grow comparable currency neutral, ex-structural income before tax by 8% at the high end of the target range we laid out at the beginning of the year. +Now, for some texture on 2016 I'll touch on a few of our operations around the world. We performed well in certain key markets, we took action in others as needed, and managed through some other difficult operating conditions. +Our developed country markets performed well as we continue to execute against our strategy of transforming the system, investing in good marketing and better execution. In North America, we saw all elements of this strategy come together resulting in 4% revenue growth, Japan and Mexico both performed well, and in Western Europe, increased investments coupled with a new reinvigorated bottling partner, drove good results there. +Our developing and emerging market saw more of a mixed bag of performance. Markets like Nigeria and Pakistan performed very strongly. China, which began the year with a pretty challenging situation, but through a combination of adjusted strategies, focus on the consumer, our performance has improved as we moved into the back half of the year. +A few markets faced significant challenges. Brazil, Argentina, Venezuela and they impacted our overall results. There we focused on the basics like the example I gave on packaging in Brazil. +Turning and looking forward to 2017. We expect another year of volatility around the world. I don't need to tell you about the rapid changes taking place at geopolitical and macro level and how this will bring continued challenges and yet also opportunities across the portfolio. Some markets will get better and some will get worse. But net-net we see the overall environment to be similar as it did to 2016. +Historically our approach has been to grow the consumer franchise in each local market by driving consumer incidents. The effectively the number of consumers enjoying our brands, value share and transactions. And to deliver locally against our comparable, currency-neutral profit targets. +So, while we are pleased with our underlying trajectory, our comparable EPS has not grown over the last several years. So, going forward if currency swings aren't balancing out over time to let currency-neutral results be a [proxy] for US dollar growth, then we must adapt. +So, importantly we are intensifying our focus on delivering comparable EPS growth each year. We won't sacrifice the long-term health of the business, but we need to better balance investing to grow the business with delivering earnings growth in an environment like this. +So starting with 2017 even in the face of strengthening dollar, higher tax and interest rates, we expect to grow comparable EPS before the impact of our M&A transactions -- 2017 particularly those due to refranchising. So, while the refranchising in fact, in 2017, is meaningful, it ultimately has laid the foundation for accelerated growth and as you read in our release, this becomes a much less significant factor to overall growth as we move into 2018 and beyond. +Now, to deliver all of this, it starts with revenue growth and then getting the operating leverage right. Revenue growth will be built through a consumer centric brand portfolio by scaling in regions where we have leadership positions like US and Japan, expanding successful brands globally, and continuing to execute both on M&A in partnerships. +So, for example we launched Smartwater and Honest Tea in western Europe in the past year and plans to further expand in 2017. In the US, our investment in Fairlife milk is paying off. It captured over one-third of the retail dollar growth in value-added dairy during its second year on the market. And of course sparkling soft drinks remain a key focus as one of the principal categories in which we compete. +Within our sparkling soft drink portfolio we are reshaping our growth equations to continue to drive revenue growth building on the revenue growth we delivered in 2016. We will do this through a continued mix of great marketing, great execution, combined with helping reduce overall over-consumption of added sugar. +This includes the reformulated products to reduce content, leveraging our one brand strategy to expand the Zero sugar products, and driving the available of small packs. All of this we are approaching with a mindset of test and learn, knowing that not only every strategy will work in every market, but the speed, flexibility, and adaptation are paramount to success. I look forward to sharing more of what we are doing at Cagney. +So in summary we're going to make the right decisions for the business and for shareholders, looking out for the consumer franchise, tasking the local operations to grow locally, and managing across the portfolio and the levers of our business, to deliver comparable EPS growth. With that I'll turn the call over to Kathy to take you through our outlook. + +-------------------------------------------------------------------------------- +Kathy Waller, Coca-Cola Company - CFO [5] +-------------------------------------------------------------------------------- +Thanks James and good morning everyone. As I look back at 2016, I'm pleased with the progress that we've made against our strategic initiatives. +We drove organic revenue growth through segmented market roles and disciplined investments, further embedded productivity into our culture, and strengthened our system in several key markets. Importantly we delivered our profit target amidst a tough operating environment and we returned a $8.3 billion to share owners through dividends and net share repurchases. +Now looking at 2017 we have a strong foundation in place but we still have a lot of assets across the system in motion. In North America we will refranchise more this year than we have cumulatively to date. In addition China will close in Africa is on track. +We have strong plans in place and we recognize this level of change requires a disciplined focus to minimize any potential disruption. As with any endeavor of the size it is understandable the timetables may move. +So, the best way to think about our refranchising is take both the 2017 and 2018 expected impacts together to arrive at the total expected impacts of revenues and profits. That way you can understand the dynamics and effectively model what any change in timing this year means for next year. +Starting at the top, we expect a global environment in 2017 to be roughly similar to that of 2016 with continued macroeconomic challenges in the emerging and developing world and continued growth in the developed world. However, there's a significant amount of uncertainty and geopolitical tension which could result in a changing macro environment. +Therefore we expect 3% organic revenue growth led more by pricing than by volume growth and we expect the core business outpace our consolidated results consistent with our performance in 2016. We will take a disciplined approach to our marketing investments and our operating expenses in 2017 and we'll continue [flow] productivity through to the bottom line. +At the same time, CCR, our Company owned North American bottler, is eliminating stranded costs as quickly as possible while transitioning territories to new partners. We expect the elimination of these costs to contribute roughly 2 points of underlying operating income growth. Therefore with another year of price mix and expense management, we expect to drive very strong underlying operating margin expansion for the year. +Below the operating line, we expect an impact from higher interest expense thereby resulting in underlying income before tax growth of 7% to 8%. As you well know, currencies remain volatile and since we operate in over 200 markets, we are not immune to this effect. Based on current spot rates, hedging activity, and what we are cycling, we expect a 3 to 4 point headwind to income before tax. +We expect our effective tax rate will increase in 2017 to 24% due to geographic mix, the impact of currencies, and bottler transactions. So we are encouraged by the prospects for corporate tax reform in the United States, for business planning purposes we have not assumed any change to the US tax environment for the coming year. Finally, we expect net share repurchases of approximately $2 billion. +2017 marks a turning point in our return to a more efficient, capital-light model. It is the largest year for divesting profitable bottling businesses primarily in North America. Therefore we expect a 5 to 6 point structural headwind to income before tax which will negatively affect our comparable EPS growth. So while this is absolutely the right thing to do for our Company and our system, we expect it will result in a 1% to 4% decline in comparable EPS in 2017. +Now looking further out to 2018, while it is premature to talk about underlying growth, I wanted to provide some additional thoughts on a few items in 2018 given all of the complexity impacting our financial performances this year. First based on the timing of our 2017 actions we expect structural headwind in 2018 of 16% to 17% on revenue and 1% to 2% on income before tax. Please note this does not include any impacts on the transition of ownership of Coca-Cola beverages Africa or the acquisition of any other ABI territories, which would be minimal, as we intend to account for these as discontinued operations given our intent to immediately refranchise. +Second, we are hedged on a number of hard currencies through the end of 2018, but at slightly less attractive rates than for 2017. Assuming today's spot rates remain constant, we would expect a low single-digit currency headwind to 2018 income before tax. +Finally, we expect that absent US tax reform, our effective tax rate would increase to 26% in 2018. Again, we believe reform is possible in the year ahead, however, the details are still uncertain and therefore we have assumed no change to the US tax environment. +Returning to the immediate future, there are a few items to consider. Our first-quarter in 2017 has two fewer days than first-quarter 2016 and Easter will fall in the second quarter this year as compared to the first quarter last year. And some of the markets experiencing challenges at the end of 2016, these conditions will continue into early 2017. +For example in India, where we own the majority of our bottling systems, the tough operating environment stemming from demonetization, is likely to persist at the start of the year before gradually recovering. And due to the timing of when we issued debt last year and [fed] rate increases the year-over-year increase in interest expense will be more heavily skewed to the first half of 2017 than the back half. +We expect structural items to be a 12 to 13 point headwind on net revenue and a 1 to 2 point headwind on income before tax in the first quarter. Finally, we expect currency to be a 1 to 2 point headwind on net revenue and a 3 to 4 point headwind on income before tax in the first quarter. +Now for those of you who want to get into greater detail, the IR team will host a modeling call at 11:30 AM today to take you through additional details as well as answer any questions you might have. Prior to the call, we will post a separate modeling presentation on our website at 10:30 AM, so you will have supplementary materials to follow. Operator we are now ready for questions. + + +================================================================================ +Questions and Answers +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- +(Operator Instructions) +Bryan Spillane of BofA Merrill Lynch. + +-------------------------------------------------------------------------------- +Bryan Spillane, BofA Merrill Lynch - Analyst [2] +-------------------------------------------------------------------------------- +Good morning everybody. And I just wanted to offer my congratulations and best of luck to both you, Muhtar, and to James. + +-------------------------------------------------------------------------------- +James Quincey, Coca-Cola Company - President & CEO [3] +-------------------------------------------------------------------------------- +Thank you. + +-------------------------------------------------------------------------------- +Bryan Spillane, BofA Merrill Lynch - Analyst [4] +-------------------------------------------------------------------------------- +I had a question James regarding price mix. And I guess as you're looking out over what the environment is like over the next couple of years, can you just talk a little about how you are balancing the desire to get some price mix in, with how you think about that relative volume? And also relative to affordability especially in some of the emerging markets where the consumer environment is still pretty tough. + +-------------------------------------------------------------------------------- +James Quincey, Coca-Cola Company - President & CEO [5] +-------------------------------------------------------------------------------- +Sure. Good morning, Brian. A couple of thoughts there. Over the long term we said we are looking for a balance between price and volume, or price mix and volume, and that's certainly our long-term objective. +Now, given what's happening I think it's almost as you said, it's easier to divide the world into the developed and the emerging markets. In the developed countries, we are looking to drive, probably a little more price than volume and you can see that happening in the US marketplace as we focus on smaller packages, as we focus on higher value categories or subcategories. So, you see that across North America, Western Europe is a little more balanced and similarly into Japan. So, that's our approach for developed markets. +In the emerging markets, obviously over the long term, we expect them to be a bigger source of underlying volume growth and that will bring the total Company equation into balance. So they would be more volume driven and less price driven. Now what's happening is in some of the markets, say for example, a Brazil, where the macros are really under pressure, I mean GDP over the last three years in Brazil has probably declined by more than it did in the great recession or the lost decade of the 80s. +So there what we focus on is in any moment we will do those promotional things that make sense and return. So we don't over protect volume. We do what makes sense on a quarterly or monthly basis and the principal access we act on is trying to reform the packaging strategy to make it more affordable. Whether that be smaller one-way packaging or more returnable packages backed up by good marketing, that really empathizes with the economic situation the consumers are in, and obviously great execution by the bottling system. +So net-net, likely over time developed markets will get more price mix and slightly less volume and in the emerging markets more volume and slightly less price mix, with that caveat that those markets that struggle, we have a game plan that we've developed over the years and that we find helps us really build a good, strong consumer franchise going forward and balances the short-term. + +-------------------------------------------------------------------------------- +Muhtar Kent, Coca-Cola Company - Chairman & CEO [6] +-------------------------------------------------------------------------------- +Next question please. + +-------------------------------------------------------------------------------- +Operator [7] +-------------------------------------------------------------------------------- +Steve Powers of UBS. + +-------------------------------------------------------------------------------- +Steve Powers, UBS - Analyst [8] +-------------------------------------------------------------------------------- +Thanks. Just congratulations from me as well to both of you. + +-------------------------------------------------------------------------------- +James Quincey, Coca-Cola Company - President & CEO [9] +-------------------------------------------------------------------------------- +Thank you + +-------------------------------------------------------------------------------- +Steve Powers, UBS - Analyst [10] +-------------------------------------------------------------------------------- +Just following on Bryan's question on price mix. When you have a great price mix quarter like you did here in Q4, I guess the question that is in my mind is why aren't we seeing more flow through to the bottom line because in a vacuum you'd think 5 or 6 points of price and mix would be significantly margin accretive. +So, is it the case that what may be mix accretive on the revenue line is actually margin or even penny profit dilutive on the bottom line? And I'm thinking here really around the structural shift from sparkling to stills, but perhaps some of the packaging changes and geographic shifts, in the balance of your overall business, may play a role as well. Can you just talk about that -- why we are not seeing more profit flow through on the price mix? + +-------------------------------------------------------------------------------- +James Quincey, Coca-Cola Company - President & CEO [11] +-------------------------------------------------------------------------------- +Sure. Well, I think you saw lots of flow-through actually in the fourth quarter. Operating income, currency neutral ex-structure, was up 18% off of gross profit of 8% so there was 10 points of leverage, so we got a lot of leverage coming through. +The reason I didn't translate from operating income to PBT, is more of those other factors like interest or other corporate items. The underlying operation, actually when I talk about PBT growing at 8% in 2016 and what we've guided in 2017, actually, the underlying operating income performance is actually even better than that. And then we've got a bit of a headwind in interest in some of those other items. +So there's actually a lot of leverage coming through from the operation as we focus on segmented revenue, as we focus on higher value categories, as we focus on smaller packages, we are getting a lot of operating leverage between that revenue line and the operating income line. Some of its getting netted off in the headwind. So, it is there. +In the fourth quarter, just to make the point, 6% is not projectable going forward. You will see in the numbers, for example, we were cycling a big negative in Asia from Pacific from last year so we've got a big positive this year. We had some very good results in improvements where we own bottling operations like China which was very -- much weaker in the first half. +So there's some oddities in the fourth quarter. I would encourage everyone to look at maybe the full-year 2016, look through to the core operation where we were drawing at 4%, 8% PBT, bear in mind some interest headwinds as a higher operating income growth, lots of leverage. This is the game plan for 2017. + +-------------------------------------------------------------------------------- +Operator [12] +-------------------------------------------------------------------------------- +Dara Mohsenian of Morgan Stanley. + +-------------------------------------------------------------------------------- +Dara Mohsenian, Morgan Stanley - Analyst [13] +-------------------------------------------------------------------------------- +Good morning. + +-------------------------------------------------------------------------------- +James Quincey, Coca-Cola Company - President & CEO [14] +-------------------------------------------------------------------------------- +Good morning + +-------------------------------------------------------------------------------- +Dara Mohsenian, Morgan Stanley - Analyst [15] +-------------------------------------------------------------------------------- +James, in your prepared remarks you touched on plans to reinvigorate sparkling growth. Can you give us more detail on where you think you stand currently in terms of the areas you mentioned? The fact that its a marketing shift to lower calorie products, et cetera and any big changes you are planning going forward to drive improved trends. And then you also mentioned tuck in M&A. So how big a role should we expect diversification into other subcategories to play out over the next few years for your Company? Thanks. + +-------------------------------------------------------------------------------- +James Quincey, Coca-Cola Company - President & CEO [16] +-------------------------------------------------------------------------------- +Sure. Of course I'll save some things for CAGNY. Let me start with the sparkling business is growing revenue. It grew revenue in 2015, it grew revenue in 2016, momentum's rebuilding. If you look at the US sparkling was up 1% in the fourth quarter in the US, in aggregate, in volume and obviously much more in revenue so there is the sparkling category is growing revenue. +Another piece under that just take a couple of examples, in this quarter and last quarter as well, total if you take the combination of Diet Coke, Coke Light, and Coke Zero, they came into robust growth in the back of the year. The growth of those all together, so no calorie colas exceeds the growth of -- sparkling actually exceeds the growth of our total portfolio in most of our other categories. +So, there's robust growth that we press into Zero sugar colas. We're getting the growth and in North America and some of the other places where we are pushing smaller packages we're getting the good growth. Smaller packages in the US grew almost 10% in the fourth quarter. +So, the game plan out there of smaller packages, Zero sugar, re-engagement with the sparkling category, is driving the revenue growth and we believe it will continue to do so and the shape and the quality of that, in terms of sustainability, is looking better over time. Obviously tuck-on M&A won't sparkling related, we've consistently done a few things each year, hopefully we'll do a few in 2017e will do those that make strategic sense, financial sense, and where we find willing partners. + +-------------------------------------------------------------------------------- +Operator [17] +-------------------------------------------------------------------------------- +Ali Dibadj of Bernstein. + +-------------------------------------------------------------------------------- +Ali Dibadj, Sanford C. Bernstein & Co. - Analyst [18] +-------------------------------------------------------------------------------- +Hey guys, a couple questions on guidance, especially in the context, James, of your focus on EPS growth going forward. So, for 2017 very helpful in line with our thought process at least. Except, why only 3% organic sales growth? +For 2018, it seems like your EPS would be barely ticking up based on an assumption of high single digit, comparable currency neutral income growth before taxes -- so 2017-like, based to growth. So 2018 doesn't look like it's growing EPS very much at all. Does that sound right on 2018 and why? Or is your statement in the prepared remarks suggesting that, look in 2018, we are going to do things like incremental cost-cutting, we are going to do things to really grow the EPS? +And then I can't resist have to throw this one and as well, slightly different. But why does a total growth structural PBT headwind look like something like 9% to 11% versus what you said at CAGNY at 7.5%? Thanks for throwing all those. Thanks. + +-------------------------------------------------------------------------------- +James Quincey, Coca-Cola Company - President & CEO [19] +-------------------------------------------------------------------------------- +I'll start maybe and then, Kathy, if you feel like jumping in at any point let me know. + +-------------------------------------------------------------------------------- +Kathy Waller, Coca-Cola Company - CFO [20] +-------------------------------------------------------------------------------- +Okay + +-------------------------------------------------------------------------------- +James Quincey, Coca-Cola Company - President & CEO [21] +-------------------------------------------------------------------------------- +The 2017 3%, I think we see a similar year in 2017 in terms of macros that we did in 2016. And I think we are making a prudent call given everything that's going on in the world on a consolidated basis we are expecting a similar outlook and a similar number for the total Company. Obviously as Kathy said, we'd like to see the core business grow above that as we did in 2016 where the consolidated was 3% in the core was 4% which is at the bottom end of our range and then obviously lots of operating leverage. So, that's how we are seeing it, we just see the way the world is going. +In terms of 2018 obviously we are not providing guidance on 2018, we are just providing some of the elements that we know are important from a modeling perspective. So obviously 2018 conversation will have to wait. But we wanted people to understand the structural piece because obviously the timing of when we sell those transactions makes a big difference. And so as timing varies the structural adjustment can move backwards and forwards between 2018, so we just wanted to give people a total perspective. I don't know Kathy about number three. I'm not sure we have the thing in front of us, Ali. + +-------------------------------------------------------------------------------- +Kathy Waller, Coca-Cola Company - CFO [22] +-------------------------------------------------------------------------------- +The bridge of total structural versus what we shown at CAGNY. Part of what I think is a misunderstanding [stood in] structural adjustments, is particularly in this year we talk about the 5% to 6%. The two additional things you can factor in in your structural adjustments -- the CCR business is not standing still, it's continuing to grow, as well as the fact that they are taking out stranded costs. +Now, we think of stranded costs a lot like productivity, if you will, and so we have embedded those and that's why I said in my prepared remarks we have two points of productivity -- of two points of stranded costs that are coming out as well in our numbers. But the stranded costs are more like productivity and that they don't just transfer with the territories. There's work to do to get them out, and for some reason if they don't transfer, they are part of our business, and we have to do the work to get them out long-term. +So, the stranded costs, we treat that as part of the business and you can choose to net those or not to better understand the structural impact. But that's how they represent themselves in our numbers. And again we are not giving any other underlying growth guidance for 2018 at this point. + +-------------------------------------------------------------------------------- +Operator [23] +-------------------------------------------------------------------------------- +Bill Schmitz of Deutsche Bank. + +-------------------------------------------------------------------------------- +Bill Schmitz, Deutsche Bank - Analyst [24] +-------------------------------------------------------------------------------- +Good morning. + +-------------------------------------------------------------------------------- +James Quincey, Coca-Cola Company - President & CEO [25] +-------------------------------------------------------------------------------- +Good morning. + +-------------------------------------------------------------------------------- +Bill Schmitz, Deutsche Bank - Analyst [26] +-------------------------------------------------------------------------------- +Could you guys just give a little more color on what sounds like a little bit lower advertising spending next year. I think you mentioned that in the prepared comments. Is it something that you realize that maybe the advertising efficiency isn't as much. And how that -- what the numbers are, is it going to be lower as a ratio and in dollars? +And then, it seems like there's probably a lot of initiatives you [need] to support next year also, like the plan with getting Coke Zero Sugar out, beyond Europe if that's also in the plan for next year. So I tried to wrap two questions in one but it's the absolute and ratio of advertising spend and the rationale for reducing it. And then if you do in fact plan to take Coke Zero Sugar to other markets outside of Europe. Thanks. + +-------------------------------------------------------------------------------- +James Quincey, Coca-Cola Company - President & CEO [27] +-------------------------------------------------------------------------------- +Good morning, Bill. James here. Firstly, the aggregate amount of marketing spend is slightly below [gross profit] you are correct. Now, what is super important to know, within that, is we will continue to increase what we would call working spend of the marketing ahead of revenue, but we are driving material productivity in the way we organize and produce the marketing to become much more efficient. +So, we are able to grow media, if you like, in all its different forms ahead of revenue, but with the extra productivity initiatives we are actually growing total spend less than revenue. That's how that dynamic is working. So we will be able to do much more in the marketplace in a more efficient way. +And then secondly, on Coke Zero Sugar, absolutely, you should expect us to move around the world things that are successful and that had a great start in GB in the backend of 2016, was growing double digits, very good start. We are rolling out in Europe, it's just launched in Australia, so you can absolutely expect us to push it into those markets where we think it can be really effective, including Latin America soon. So, absolutely and I think that is part of why you are now seeing the continued acceleration of Coke Zero sugar each year. +We grew several points faster in volume in 2015 than 2014 and we grew several points faster in 2016 than the rate we were growing in 2015. And as I said aggregate, no calorie colas, is in good mid-single digits growth as we exited the year. + +-------------------------------------------------------------------------------- +Operator [28] +-------------------------------------------------------------------------------- +Judy Hong of Goldman Sachs. + +-------------------------------------------------------------------------------- +Judy Hong, Goldman Sachs - Analyst [29] +-------------------------------------------------------------------------------- +Thank you, good morning, And my congratulations to both of you as well. + +-------------------------------------------------------------------------------- +James Quincey, Coca-Cola Company - President & CEO [30] +-------------------------------------------------------------------------------- +Thank you. + +-------------------------------------------------------------------------------- +Judy Hong, Goldman Sachs - Analyst [31] +-------------------------------------------------------------------------------- +First, just a follow-up on price mix specifically in North America. Obviously we've all learned that the Nielsen data is not perfect, but there seems to be a pretty big disconnect between -- particularly in the fourth quarter, where you got the 4% pricing versus the softer pricing that we've seen in the data. So if you could just elaborate on that as a follow-up. James, I'm just wondering if you can talk a little bit about how much of a priority in 2017 is really a shift towards stills. If I look at 2016 performance, 3% growth that you got in still, it seems like it could be much stronger in the context of a lot of the categories that seems to be growing at a faster rate. So can you just talk about either on the innovation front or investment front, how much of that focus where really -- that you look towards in 2017 on the still category. + +-------------------------------------------------------------------------------- +James Quincey, Coca-Cola Company - President & CEO [32] +-------------------------------------------------------------------------------- +Sure. Clearly there's a -- I'm not -- disconnect. The Nielsen universe is a much smaller piece of our total business. Obviously when you look at the aggregate of North America, fountain is very important to us, it's almost a third of the volume in North America and that's not going through Nielsen and obviously there's a lot of warehouse business there, where we sell some of the still categories directly. +But we have not deviated from our strategy. We talked on previous quarters that sometimes the pricing will be, at least -- the apparent pricing and Nielsen look a little softer or a little better. The important message is we have not changed our strategy. We continue to focus on realizing pricing intelligently and through packaging and pricing in the sparkling category and focusing on those bits of the other categories that we believe have value in terms of revenue and profitability. And so every now and again you will see this disconnect between Nielsen and our total results, but know that our strategy has not changed and we plan to continue to pursue it into 2017. +In terms of the other categories, absolutely we continue to innovate and invest there. I think the underlying trend is even better than it what it jumps out in the volume. Bearing in mind the strategy is to participate in those categories of the highest value to us, both in revenue and in terms of profitability. +So for example if you went to China and you looked at what was happening, some of the stills categories, maybe water, you'd see a growth rate of x, but what you don't see in the volume is actually, we are selling less of the cheap water and more of the higher value water as we cycle and re-innovate our business to drive the positioning and the premiumness through different brands and reset the way we attack some of these categories. We are after driving a consumer franchise that's about incidence of consumers, the number of times they drink our beverages, even if that's a smaller package, and about competing for value on the top and the bottom line. + +-------------------------------------------------------------------------------- +Operator [33] +-------------------------------------------------------------------------------- +Nik Modi of RBC Capital Markets. + +-------------------------------------------------------------------------------- +Nik Modi, RBC Capital Markets - Analyst [34] +-------------------------------------------------------------------------------- +Thanks and congrats guys from me as well. The question, James, is when we look at North America, numbers have looked pretty good relative to I think most people's expectations going back about a year and a half. A lot of initiatives that you have put in place have started in North America. So I'm just wondering if you can help us map out how to think about what's happening in North America and the applicability to the rest of the world? That would be helpful. Thank you. + +-------------------------------------------------------------------------------- +James Quincey, Coca-Cola Company - President & CEO [35] +-------------------------------------------------------------------------------- +Yes, Nik, good morning. Absolutely North America's had a great run. The team's done a good job, the strategy's working. The numbers in 2015 in 2016 have put us at the top end of CPGs in terms of revenue growth with our customers. We are very pleased with that. +I think what you see in the North American strategy, which is absolutely what you should expect, is a fusion. And what I mean by that is things that they have done they have taken from other parts of the world successfully and they have blended it with new ideas and things that are relevant for the North American market. And that's what turned into the winning plan they put in place and they've executed and it's been doing well. +And so you should expect us always to be taking ideas from one place, applying the learnings in another place, and fundamentally, North America is a great example of where we reinvest marketing behind the right strategy and a balanced portfolio, with execution by the bottling system. And I underline there the importance of the execution by the bottling system and our own fountain and what wholesale business is during a time of tremendous change through the refranchising. + +-------------------------------------------------------------------------------- +Operator [36] +-------------------------------------------------------------------------------- +Robert Ottenstein of Evercore. + +-------------------------------------------------------------------------------- +Robert Ottenstein, Evercore ISI - Analyst [37] +-------------------------------------------------------------------------------- +Great, thank you very much. Two questions. To the extent that you are able to talk about, it I'd love to understand the thought process about not purchasing Bai which Dr Pepper ended up buying. It seemed to check a lot of boxes, is it the product, is it the timing any color on that? +And second, could you discuss whether all the refranchising, and particularly in Africa, has caused any disruptions in the business, any headwinds through that process, and a little bit more on the timing -- expected timing on Africa? Thank you very much. + +-------------------------------------------------------------------------------- +James Quincey, Coca-Cola Company - President & CEO [38] +-------------------------------------------------------------------------------- +Sure, I don't think it would be appropriate to comment on the M&A process of Bai so I'm going to skip that one, if I may. Refranchising in Africa, I think there's been a very robust process and I think the Management team of the bottler, both prior to the closing of the SAB transaction under ABI on the board as well and ongoing, the Management team has remained focused on doing the right things in the marketplace. So a creditable performance by the Management team in conjunction with the local business unit. +So we see no disruption there and I think everything is going well. The refranchising itself, as Muhtar commented, and as you've seen, we reached agreement with ABI at the close of last year and the rest of the process is ongoing, both from a regulatory process point of view and a selection and determination of the partner, from those that will be strongest and those that are interested. + +-------------------------------------------------------------------------------- +Operator [39] +-------------------------------------------------------------------------------- +Bonnie Herzog of Wells Fargo. + +-------------------------------------------------------------------------------- +Bonnie Herzog, Wells Fargo Securities, LLC - Analyst [40] +-------------------------------------------------------------------------------- +Good morning and congratulations to both of you. + +-------------------------------------------------------------------------------- +James Quincey, Coca-Cola Company - President & CEO [41] +-------------------------------------------------------------------------------- +Thank you. + +-------------------------------------------------------------------------------- +Bonnie Herzog, Wells Fargo Securities, LLC - Analyst [42] +-------------------------------------------------------------------------------- +I was hoping you guys could drill down a little further on headwinds and the consumer in some of your key emerging markets. And then how has the overall category been performing in these markets? And, really, how has it been holding up given some of the headwinds and pressures on consumer spending and whether you are taking share? And then specifically in China, things seemed to reaccelerate in the second half last year. So could you guys talk a little bit more about current trends, whether that be near and then long-term outlook for China? Thank you. + +-------------------------------------------------------------------------------- +James Quincey, Coca-Cola Company - President & CEO [43] +-------------------------------------------------------------------------------- +Sure, I think the emerging markets is a very mixed bag. I mean there are some which are doing well, I called out some like Nigeria, which had a very strong year even in the close of the year, as the currency came under pressure. Places like Mexico -- there are a number of emerging markets, South Africa, which we did well in. +There are others where the macros were tough, whether that be Venezuela, very tough, Argentina, Brazil, and there we applied our strategies, a combination of what's the right tactical use of promotions to balance the system. We don't want to [do] scale but we don't want to over invest in promotions, while resetting the pack price architecture to really drive long-term affordability. It's very much a mixed bag across the world. Obviously India is something that a lot of people commented on, I'm not sure any more I can add on the India example. +In terms of China, I think China is a great example where you see us executing the game plan I talked about for Brazil. So, the China back end of 2015 coming into the first and the second quarters of 2016, was a very rough period for CPG, a rough period for beverages in China. We went for our game plan, exactly what I said about Brazil, we started to do some promotional things and then we reset some of the pack price architecture, we focused on the right package sizes, and the right brands, doing the marketing in the right way, and a reset of what was important in terms of execution, where you should execute in terms of channels and focus of the cities. +So, in the case of China, the markets are actually doing pretty well in the top tier cities. There was lots of growth, it looked more like the strategy of focus on the value end, focus on the premium end of the business, and then in the more rural and lower tier cities, really affordability and smaller package sizes. And then in the second half of 2016 China rebounded. We grew in both the third of the fourth quarter in volume terms and in revenue terms in China. +So the game plan worked, obviously it's not instantaneous, but we know what to do when markets get into trouble if we focus on understanding the consumer, understanding the customer, and getting organized as a system. + +-------------------------------------------------------------------------------- +Muhtar Kent, Coca-Cola Company - Chairman & CEO [44] +-------------------------------------------------------------------------------- +Yes, I'll just add one point just to complement what James said is that this was the 38th consecutive quarter for us in gaining value share -- 38th in NARTD. And in sparkling this was the 12th consecutive quarter of share gains. And then in North America, importantly, 27th consecutive quarter of share gains. So we continue to gain share as we implement this play-book that's really working and the business is getting stronger over a much, much bigger base than any one of our competitors going forward. I just wanted to add that. + +-------------------------------------------------------------------------------- +Operator [45] +-------------------------------------------------------------------------------- +Mark Swartzberg of Stifel. + +-------------------------------------------------------------------------------- +Mark Swartzberg, Stifel Nicolaus - Analyst [46] +-------------------------------------------------------------------------------- +Thanks. Good morning everyone, and my congratulations as well, James and Muhtar. + +-------------------------------------------------------------------------------- +James Quincey, Coca-Cola Company - President & CEO [47] +-------------------------------------------------------------------------------- +Good morning. + +-------------------------------------------------------------------------------- +Mark Swartzberg, Stifel Nicolaus - Analyst [48] +-------------------------------------------------------------------------------- +I wanted to, if we could do a tale of three countries here, James. And what I mean by that is Mexico -- your results, Diageo's results, Walmex, ANTAD retail data, it seems that the consumer is doing rather fine there. And of course there's a lot of concern about Mexico since November 8. In Mexico specifically, could you just give us a feel for what you are seeing in terms of broad consumer behavior since November 8? +And then with Brazil and India with the pricing you have taken some of it invisible if you will because of what you are doing with price pack architecture, what's the level of confidence you have in those markets that the elasticity that you experience will not be worse than what you've actually -- you have an adverse elasticity impact greater than what your models say. + +-------------------------------------------------------------------------------- +James Quincey, Coca-Cola Company - President & CEO [49] +-------------------------------------------------------------------------------- +Sure, Mexico, in all honesty, I'm not sure the Mexican consumers, in terms of what happened to the marketplace, the purchasing patents, really changed that much pre and post that date. I think the Mexican economy, there's been a lot of focus on it. There were the reforms, I think it's performed well and we have a great business in Mexico. +I think our system there has been innovating. It's truly one of the places where we've been most innovative and most creative across the total portfolio where we compete in almost every category and they've done a really robust job of building a good business. And I think that is what you see in the Mexico results and they continued to build on strong a 2015, with a stronger 2016. And I think it's a wonderful operation down there and they did a very creditable result and hopefully that will all continue into 2017. Certainly we think that our system is up to the challenge come what may in Mexico. +In terms of Brazil and India I think they are two very different examples. India, it's certainly a truly one-off event. The demonetization effectively drained liquidity. I don't think that's about price elasticity, I think that's about the shock to the circulation and liquidity. +Clearly we're of the view that a formalization of the economy helps the formal players and I think it will be good in the medium term and the long-term. We expect the short-term disruptions to [mitigate] or to tail off as we come into 2017, though not from January 1. And I think what we just need to see is some stabilization there, and we will be able to then come back and execute our game plan. So I don't think that's particularly about resetting everything we do in India, I think it's about working through the effects of this one-off demonetization. +Brazil is a different thing. Brazil I talked about. I think we saw -- we've taken quite a bit of pricing in Brazil over the end of 2015 in the beginning of 2016. I think the consumer environment got worse towards the end of the year in Brazil. +I know a number of the states in Brazil had trouble with some of the public employee payrolls going into the back of the year. So there was a reduction in the mass of consumer disposable income, perhaps more aggravated Q3 going into Q4. And I think there, the elasticity's and the effects of pricing did become worse. +The value of the promotions wasn't as good as perhaps the high-lows, it wasn't as good as it was at the beginning of the year or even in 2015. And I think that's what's caused us to do some things in the fourth quarter to balance pricing and volume, but to recognize we need to come in for 2017 with a more aggressive reset of the pack price architecture. +Given the circumstances in Brazil they're not likely to be completely fixed overnight. I think there's some focus on improving things and we expect Brazil to slowly get better but we are going to execute and implement a packed price. Reset some parts of it with the expectation that it will start to rebuild the business as the economics get a bit better. + +-------------------------------------------------------------------------------- +Operator [50] +-------------------------------------------------------------------------------- +Bill Chappell of SunTrust. + +-------------------------------------------------------------------------------- +Bill Chappell, SunTrust Robinson Humphrey - Analyst [51] +-------------------------------------------------------------------------------- +Thanks. Good morning. + +-------------------------------------------------------------------------------- +Kathy Waller, Coca-Cola Company - CFO [52] +-------------------------------------------------------------------------------- +Good morning. + +-------------------------------------------------------------------------------- +Bill Chappell, SunTrust Robinson Humphrey - Analyst [53] +-------------------------------------------------------------------------------- +A quick question on commodities. Maybe I missed it, but the net exposure as we look forward for this year in terms of headwind/tailwind. And then also, maybe help me understand how that changes with the refranchising? Do you have less exposure to certain things or is it really unchanged? + +-------------------------------------------------------------------------------- +Kathy Waller, Coca-Cola Company - CFO [54] +-------------------------------------------------------------------------------- +Certainly, hi, Bill. So, this year the commodity environment was relatively benign and we anticipate that next year -- the same thing. As we said, next year will be largely the same as what we've seen in 2016. We do anticipate that with the refranchising that our exposure to commodities goes down significantly. As we talked about (technical difficulty) CAGNY. So there is a -- we will give you some more flavor of this in the modeling call but yes, there's a significant change in the impact to the Coca-Cola Company as it relates to commodity. + +-------------------------------------------------------------------------------- +Operator [55] +-------------------------------------------------------------------------------- +I would like to turn the call back over to Mr. Kent for closing remarks + +-------------------------------------------------------------------------------- +Muhtar Kent, Coca-Cola Company - Chairman & CEO [56] +-------------------------------------------------------------------------------- +Thanks James, Kathy, and Tim. Last year we made significant progress as we accelerated the transformation of our Company into a higher margin business, while keeping focused on consumers. +With a strong foundation set, now is the time for a seamless leadership transition and I have every confidence that James is the best person to take us through the next phase of our sustainable growth. There's no question that this phase will look different than the past driven by a broad consumer-centric portfolio across all categories, while enabling consumers to control their intake of added sugar. +And this is going to require a change to some of our strategies, many of which have already begun, and now need further scale in regions all around the world. As always, we thank you for your interest, your investment in our Company, and for joining us this morning. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/exam/original-files/Problem_2_3_Sample_full_transcripts/2017-Feb-28-TGT.N-138037321026-Transcript.txt b/exam/original-files/Problem_2_3_Sample_full_transcripts/2017-Feb-28-TGT.N-138037321026-Transcript.txt new file mode 100644 index 0000000..f1063a0 --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_full_transcripts/2017-Feb-28-TGT.N-138037321026-Transcript.txt @@ -0,0 +1,663 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q4 2016 Target Corp Earnings Call +02/28/2017 09:00 AM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * John Mulligan + Target Corporation - EVP and COO + * Brian Cornell + Target Corporation - Chairman of the Board and CEO + * Mike McNamara + Target Corporation - EVP and CIO + * Mark Tritton + Target Corporation - EVP and Chief Merchandising Officer + * Cathy Smith + Target Corporation - EVP and CFO + * John Hulbert + Target Corporation - VP of Investor Relations + +================================================================================ +Conference Call Participiants +================================================================================ + + * Scott Mushkin + Wolfe Research - Analyst + * Michael Lasser + UBS - Analyst + * Joe Feldman + Telsey Advisory Group - Analyst + * Craig Johnson + Customer Growth Partners - Analyst + * Peter Benedict + Robert W. Baird & Company, Inc. - Analyst + * Oliver Chen + Cowen and Company - Analyst + * Greg Melich + Evercore ISI - Analyst + * Dan Binder + Jefferies LLC - Analyst + * Matt McClintock + Barclays Capital - Analyst + * Mark Miller + Crystal Rock Capital Management - Analyst + * Bryan Cameron + Dodge & Cox Funds - Analyst + * Kate McShane + Citi Investment Research - Analyst + * Robby Ohmes + BofA Merrill Lynch - Analyst + * Brandon Fletcher + Sanford C. Bernstein & Co. - Analyst + * Chris Horvers + JPMorgan - Analyst + +================================================================================ +Presentation +-------------------------------------------------------------------------------- +John Hulbert, Target Corporation - VP of Investor Relations [1] +-------------------------------------------------------------------------------- + + Good morning, everyone. It's really nice to see you all out there today. Thank you very much for coming. +We have a lot to cover today, so we're going to get started in just a minute. But we have a couple of important disclosures up front that I'm just going to read verbatim to you. Any forward-looking statements that we make this morning are subject to risks and uncertainties, the most important of which are described under SEC filings. The second one is our earnings press releases and SEC filings available on target.com/investors provide reconciliations of adjusted EPS to our GAAP results and a reconciliation of the non-GAAP components of ROIC. With that, we will get on with the show. + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman of the Board and CEO [2] +-------------------------------------------------------------------------------- + + Thank you, John. Welcome, and thanks for joining us this morning. Today I'm going to provide an overview of our strategy. I will talk about where we've been and more importantly what's next. John will share more details about what we're doing to get there. +And then Cathy will walk through our financial model. At the end of that, we will spend the balance of the program taking your questions. As you all know, we've been on a multi-year journey to redefine the future of our Company, to compete and ultimately win in this new era of retail. For the past several years, we've been watching several key consumer trends emerge. People are placing greater value on experiences. +Often they would rather live it than own it, especially young people. When they buy, they want to buy into a greater purpose, not just a product. Taken together, these changes can only be described as a profound shift in the consumer mindset. Then combine that with the different behaviors around how and where consumers are choosing to shop. +Today there is total transparency. Ease and speed are paramount. The shift in channel preference is real and only gaining momentum. Our industry is the midst of a seismic shift. And, of course, you read the headlines. +In fact, many of you write the reports. We're operating in an incredibly challenging environment. All across the retail industry many of our competitors are aggressively rationalizing their assets. They are closing stores, exiting markets. They are cutting costs just to keep their heads above water. We've not seen this number of distressed retailers since 2009 in the Great Recession. +This contraction will create opportunities for Target to pick up market share over the long term. But aggressive promotional activity will create pressure on our business in the near term. At the same time, there are others who are thriving in this new environment. So the changes we're making squarely at moving Target into the retail winner circle. +Now I stood before you a year ago and I laid out five key priorities. I talked about on-demand shopping, establishing category roles, localization and personalization. I talked about small formats. And I talked about simplifying and controlling our costs. We've made good progress executing against these priorities. +But it's become very clear that our efforts were not enough to win in this changing and challenging environment. And you've seen that in our recent results. We will continue to have these same priorities, but today we will tell you what's going to be different. We all know the industry shift has begun to accelerate, and we believe that rate of acceleration will only continue to increase. You see it, our competitors see it. John, Cathy and I, well, we live it every single day. +But what I want to talk about today is how at Target we are embracing this new reality, how we are building a Company that's poised to lead and grow market share, in digital, and in our stores. And how we are laser focused on mastering execution and accelerating our efforts to become an even stronger competitor. Let's go back to 2014, the Black Friday weekend. +In 2014, more than 93% of our transactions took place in stores, less than 7% digital. That season we had just started shipping from a small number of stores. 2015, that same timeframe. Digital sales reached almost 10% of our total sales. We more than doubled our ship from store capability to nearly 500 stores. +We fulfilled 41% of all our digital orders inside of a store. 2016, just a few months ago, just last year, digital sales climbed to 14%, more than twice what we did two years earlier. We double shipped from stores again, more than 1,000 stores. Our stores were fulfilling 68% of our digital orders. +We finished December with record digital growth including record-breaking days on both Thanksgiving and Cyber Monday. We realize on more and more shopping journeys our guests are looking to save time by using digital. And we only expect that trend to continue. But I know and you know this channel shift comes with additional challenges. Today that essential base Target run doesn't completely translate to the new digital world. +Traffic drivers are fundamentally different and guests behave differently too. Put a guest in the store, they're looking for inspiration, they enjoy discovery, they enjoy shopping. But very often a visit to Target.com it is far more transactional. One item at a time, logon, check out, as fast as possible, friction free. +We've proven we can build baskets with more storytelling and inspiring site merchandising, like we've done in kids with Cat & Jack. So there's an incredible opportunity for us to more, but we also need to make sure we don't impede efficiency or complicate the overall experience in the process. So this combination of changing behaviors and expectation, it's certainly causing stress in our model. But the reality is this is where the guest wants to be. We will never be successful if we dig in and insist they shop the way their parents did. +So as I said before, given these realities we are embracing the change. We are reimagining and repositioning our assets to deliver even greater competitive advantage going forward. It's moving from a very linear model, supplier, distribution center, store-to-guest to creating a smart network. We are distribution centers, stores, digital channels they become guest-facing access points where Target is always on, where Target is always within reach, down the street, on your door step or simply in the palm of your hand. +So the challenge ahead is really about continuing to understand how consumer preference and expectations are evolving. Anticipating where they are going, what they will want before they have to tell us. Finding new ways to engage at every stage in every occasion. Offering and clearly communicating compelling value in every interaction, at every touch point, and building a new Target that's uniquely positioned to compete and win, delivering on two pillars of market share growth, one digital, and one physical. +So this morning I want to talk about what that looks like, the capabilities we are building, the investments we're making to emerge as a stronger competitor and ultimately grow. But I don't want to gloss over the important point. This is not work we just started, these aren't things we will eventually do. These are initiatives that are well underway, and we are making progress. +What is changing is our speed. Maintaining our current margin rate will not allow us to go fast enough. We are aggressively investing in the business to make sure we are highly competitive on price across our assortment, all day and every day. We are making significant capital investment that will position Target for the long run. Long-term sustainable growth. +And all the while as the investments take root, you will see a much sharper focus on execution, every day in our stores, every day online, every day throughout our enterprise. So let's start with some of those foundational capabilities we've been testing, building and beginning to scale. These are non-negotiables for any retailer that's going to win in this new era. These initiatives represent significant investments in terms of capital and talent, and they will continue to be among our highest priorities in the years ahead. +In the last three years, we've more than doubled our digital sales from $1.4 billion in 2013 to more than $3.4 billion last year. And we did that in large part because the investments we made to re-platform our site and mobile channels. Today we have an entirely new engine under the hood. It gives us vastly more power in terms of speed, stability, performance and capability. +We set up new functions investing in top engineering and data science talent, and trained them to make sure their scope impacted the entire enterprise. Now not long ago at Target this was a new function. Today it's one of our core strengths. When I think about stores, when you look at our store base, you can see that we have been highly intentional with our real estate strategies, prime first and second ring suburban locations. +By and large we are not tethered to shopping malls. We are isolated on some interstate far from guests. But as you move from coast-to-coast, this experience is uneven at best. In LA, Chicago, Boston we have some beautiful stores. But we also have a large percentage of the portfolio where the buildings just don't match the brand. +They are old, they're tired, and they have not been updated in years. As you know, we spent 2016 testing the best of our enhancements from our store prototype pilot in LA. And now we're rolling the best of the best, as well as some new features to hundreds of stores across the country. Each store is going to look and feel like a totally new Target. +We also see tremendous opportunity expanding our footprint into key urban neighborhoods and on major college campuses. The store's function in every respect as a store, a place you can shop, but they are also just as much hyper local fulfillment centers. Take a look at what we're doing right here in New York. Until now, we left this massive opportunity on the table because we did not have a solution to literally fitting Target into Manhattan. +I can tell you those days are gone. And just during the last six months, we've opened up three new stores in Tribeca, downtown in Brooklyn, and Forest Hills, Queens. Three very different sites, three different neighborhoods, three completely different experiences. Each one customized to fit the neighborhood. +And I can tell you, you can expect to see more and more of these across the city. In New York, and beyond, we've been purposely very disciplined in our approach. But now I can tell you it's time for us to accelerate this new format. Behind the scenes, our supply chain is in the midst of a total transformation aimed at leveraging our proximity to the guest to unlock even greater value. +How do we get just the right amount of product to exactly the right place at exactly the right time? The work underway is game changing for Target. It will significantly reduce costs and dramatically improved speed, efficiency and the reliability across our network. Target's scale and commitment to operational excellence has long been one of our true competitive advantages. +But in this new era, size is not the endpoint. How we leverage our size and scale not just in supply chain but the entire enterprise is supremely important. But size is only an advantage if we use it the right way. In football, a lineman who is big and strong but slow is easily outmaneuvered. But a player who is big, strong, quick on his feet is virtually unstoppable. +The key to our future success is the focus on greater agility. So you will see that in the way we are leveraging this network. But it goes deeper than that. You see the advantages we have in our multi-category portfolio and how it allows us to flex and manage trends in the marketplace. You see that in our balance sheet which gives us the ability to invest to grow, even during challenging times. +The third and final piece of our strategy is about standing proud and being confident about who we are, holding up the power and the potential of our brand as a beacon, and leaning into all the reasons guests fell for Target in the first place. So at the start this morning, I talked about how we're looking at this seismic and accelerating shift in our industry, and that's true. But you know better than anyone that these inflection points come around every generation or so. And strong retailers endure, while others, well, they don't. +Pick your era defining change throughout history, from downtown department stores to suburban malls, catalogs, e-commerce. Target not only weathered the storm, we emerged better positioned as a result, and that's for many reasons. One, we know our guest, and we're making sure that the changes we make continue to build guest love for our brand. We know our guests are rooting for Target to win, and those reasons are embedded in our DNA. +Our differentiated assortment, an easy and inspiring shopping experience, engaging marketing, a deep commitment to investing in the communities we serve, giving back 5% of our profit, a promise we've kept for more than 70 years. But as guest expectations evolve over time we have to evolve the way we deliver the things that are most important, ease, value, and inspiration. So today we are redoubling our efforts. +One example is the work underway to reinvent our portfolio of exclusive brands. Cat & Jack and Pillowfort was just the toe in the water for us. Our teams right now are busy building brand after brand, and they're prepared to unveil them one after another, season after season. In a moment, John will provide a lot more color and content, where we are today and what's to come. +But before I close out, I want to make sure one thing is really clear, that underlying all this work is an unbending commitment to continued operational efficiency. A commitment to invest in our core business, constantly elevating the in-store shopping experience and a commitment to learn and innovate. To get where we want to go, we know we can't fixate on short-term opportunity. Target is taking the long view. We can either bemoan the changing conditions in the marketplace, or we can embrace them and double down on our strengths. +Now in all candor, 2016 was not our best year. And we're facing some headwinds as we begin 2017. But we are asking shareholders to make a meaningful investment, to build a stronger growing Company for the future. The good news is that we've been working on this for a while, and we know how to align around the change rather than run from it. +Our goal today is to demonstrate that the investments we're making are the right investments for the future, are the right decisions for the long term and will create greater shareholder value. John and Cathy will address this in more detail in a few minutes, but in addition to making the capital investments, we are also investing $1 billion in operating margins this year. It will allow us faster growth over time and ensure we are competitively priced every day starting right now. +Clearly, this is a significant change in our financial model. But it reflects the new realities of the seismic shift that's occurring across our industry. Combine these investments with our unique asset base and we believe Target's opportunity is fundamentally different from any of our competitors. No one has our stores, no one has our assortment, no one has our brands, no one is closer to the guest, and no one is better positioned to compete in this next generation of retail like Target. +So while others are pulling back, Target is investing to compete and investing to grow. We're investing in stores, we are investing in our supply chain and in digital to fuel our business growth. We are investing to win share, not surrender it. There will be winners and losers in this new era of retail. +This plan is all about how we emerge on top. It's how we strengthen Target's value proposition to our guests and for our shareholders. It's how we build a Company that will deliver strong returns for many, many years to come. So thank you. + +-------------------------------------------------------------------------------- +John Mulligan, Target Corporation - EVP and COO [3] +-------------------------------------------------------------------------------- + + Good morning, everyone. You just heard it from Brian. Our brands, our smart network, the incredible value we offer our guests put together give us a unique position as we move into this next generation of retail. Over the past few years, we've made significant investments to make our assets work even harder. While we are seeing progress, we're nowhere near done. +Brian just talked about the record number of days this season when we saw all-time high digital sales. Make no mistake, we're proud of that performance, but what he didn't say, and what's just as important, is that behind the scenes our platform functioned flawlessly. Record online sales, record traffic, and more than enough capacity in the system to keep things humming right along. A year ago, as you well know, it was a different story. +Back in 2015, we introduced a general incentive offer for Cyber Monday, 15% off everything on our site. And our guests went crazy, which was great, right up until it wasn't. Demand was so high that quite candidly we had to throttle traffic to keep our site from crashing, frustrating guests and leaving millions of dollars on the table. Not good. But the message was clear, put together a compelling offer, straightforward, easy to understand with really clear value and our guests will respond. +But we also needed to really significantly increase our capacity to support the demand. So this year, our Chief Information and Digital Officer Mike McNamara and his team accelerated the reference to deliver a new adaptive platform that give us much more capacity, flexibility and stability. And when we put up record numbers this season our site did not falter once for our guests. In fact the new platform allowed us to adjust the site experience in real-time and drive additional sales, and still our site had 100% availability all season long. +We invested in going well beyond what would simply help us manage through the next year. We built for the long haul, allowing us to imagine our business far down the road. This is what we mean when we say we are investing to compete and grow. It's what we're doing across our business. +We're sharpening our operational performance so we can execute on our plans quickly, while at the same time we are making investments that set us up to compete in an increasingly fierce environment. We see enormous potential out in front of us and we're seizing every opportunity to capture it. First, let's talk stores, our key competitive advantage. +They are at the center of everything we do for our guests regardless of how we deliver. The 40% digital growth we saw in December, they enabled it. In the two days that followed our record-setting cyber Monday, our stores shipped more than 1 million orders to fulfill that demand. The week before Christmas, our stores fulfilled nearly 70% of our target.com orders, and on Christmas Eve they fulfill more than 80%, shipping about half of those to our guests and packing the other half for in-store pickup. +Our stores are a center for inspiration and discovery, they always have been and that's on changing. But when we look at them as buildings stocked with product, they are also local fulfillment centers. When you take the products our guests are already love and add in our store network, we have the unique potential to be incredibly competitive against both digital and traditional retailers. +Because for digital sales to work you have to be able to deliver, quickly, and with as little cost as possible. That's why getting near the consumer has become the Holy Grail in retail. Online-only competitors are investing rapidly to stand up warehouses that are storefronts that cut the distance between their products and the consumer. But we're already there. In fact, we're practically neighbors. 85% of our demand and three-quarters of all Americans are about 10 miles or less from our 1,800 stores. +So if we are talking about proximity, we already have it, no question. Brian mentioned that we're making investments to let us really exploit that advantage, to compete on a whole new level. Let me show you what we mean. Here are those 1,800 stores. We were really intentional about where we put these years ago, most in the suburbs, some in the exurbs, and a few in the city. +But now here are the 32 small format stores we opened in the last few years, prime urban neighborhoods, college campuses places where the suburban format just did not fit. These sites are unlocking tremendous value. They have more than two times the sales productivity of our average store. So even with higher operating costs they generate healthy returns. +They also serve as fulfillment hubs and a convenient pickup point for guests who would rather not have items delivered to the front step of their high-rise condo. In three years, we will add more than 100 to where we are today. To get there, we will open nearly 30 small format stores this year, doubling the number we have now. And we will open about 40 a year by 2019, with the potential for many more down the road. +Now this map does not outline every specific location, but it's representative of where we will focus. This will add fulfillment points in dense neighborhoods in cities like New York, LA and Chicago. And near more college campuses where lifelong shopping habits and brand affinities begin to take hold. As we expand, we will continue our hyper local approach. Before we plan store, we get to know the neighbors, who they are and what they need. +Then we design experience from the store's layout to the merchandise inside that fits. It's localization at its core. Take a look. (video shown) So I showed you how we are expanding our footprint with more than 100 small format stores over the next three years. At the same time, we will begin an effort to transform our existing locations. +As Brian said, our store asset base is a key differentiator for us, but there's a big gap between how those stores should look and feel for our guests and where we are today. We know that to really compete in a local market we need to make some big investments in those buildings, and so we are. Starting in 2017, we will reimagine 100 of our existing locations. We will pull elements from our new store prototype, which we designed based on how guests responded to a multitude of tests we have run over the past few years, like our LA25 pilot. +For this prototype, we took a fresh look at everything, from the front of the store to the back room layout, the entrance displays to the product presentation, food and beverage to apparel. As we build on what worked in LA25 and add even more enhancements with this new prototype, we expect to see a 2% to 4% sales lift per store. Not only will they feel like brand new stores, they will do even more than they can do today. +The design will be flexible so the store can be configured to reflect the needs of each community. We will have more space dedicated to visual storytelling, inspiring guests by showing products together, like entire outfits or table settings. And we will reallocate space to support digital fulfillment, such as adding more room for order pickup, and designing back rooms to grow our ship from store capabilities. +In 2018, we will touch more than 250 stores and do that once again the next year. But we won't be rolling out the same thing every time. We will iterate, so we're always delivering new services and enhancements based on what we are hearing from guests. By 2019, we will have reached 600 stores and that's just the beginning. +We will continue to make these investments so our stores can deliver the very best to our guests no matter the channel. With these enhancements, we will be able to expand ship from store capabilities beyond the 1,000-plus stores shipping today. Just as every store already serves as an order pickup location, by 2019 most stores will be shipping orders from the back room. And because we are improving how we flow product across our network, which I will talk about in a few minutes, each store will have even more of our assortment available to ship. +You can see how this map gets really rich over the next year and into the next three years. We continue getting closer to the guests, shipping from more of our assets and improving the in-store experience across the country. We are also doing work in all stores to make it easier for guests to shop, no matter if their trip starts online or in-store. Take order pick up, which after nearly three years, we still see growing rapidly. +Guests chose to have nearly 50% more items picked up in store this year than last. And they love that we will have it ready for them within an hour or two. We're making it easier and faster by separating the pickup and return areas, and we're moving toward a future where we will use technology to alert the team when guests arrive. We are also continuing to fold digital into the physical shopping experience. +Today guests use Cartwheel, our digital savings app, nearly 5 million times every week. They use it to plan their trips and shop the stores. Later this year, we will combine Cartwheel and our Target app to make shopping at Target even more easier and convenient. Guests will be able to make their lists, find items in stores, take advantage of great offers, and pay for their orders, all within a single app. +And in our refresh stores, we will test technology that gives the guest the ability to opt in and see what products around them are on sale with Cartwheel. It will be simple for them to find great value while checking things off their list. At the same time, we're making the shopping trip even more inspirational. For the past year or two, we've been testing new visual merchandising strategies and watching how our guests respond. +Now we're taking those learnings and cross-merchandising even more product categories. We're rearranging floor pads and standing up more compelling displays to help guests imagine how products work together and fit into their own lives. We're taking a similar approach to how we are featuring products on our site, so it's easier for guests to explore and find what they need, while discovering a few extra items along the way. +In our stores, we know that human interaction plays a big role in the guest's experience. It's why our talented store team is such an asset. Our expectation of store team leaders is a good example. Gone are the days when we sent a playbook from HQ and ask the teams execute word-for-word. +We are empowering and expecting store leaders to know their communities, know their guests, and do what's right. Let me tell you about a store leader in Orange County, California named Kerry Kiper. She has a guest space that is very passionate about beer, not wine, and not just the domestic big guys. Her guests love craft beer. +But instead of just stocking what our buyers in Minneapolis sent her way, she asked around, listened to her guests, shopped the competition and selected an assortment with the buying team that reflected what her guests want. And guess what, just like that Cyber Monday sale, give the guests what they want and they respond. And at Kerry's store they responded, big time. Her micro beer sales shot up 60%. In fact, she saw a lift across her whole adult beverage business. +As a result, we built process at headquarters to capture those insights from the front lines, so our teams can work together to localize assortments across the country. Kerry is just one example of how we're driving a cultural shift across the Company. And we're seeing what happens when we clear the way for the experts to do their jobs. +But we are not asking our store leaders to act on gut alone. We're giving star teams far more data, metrics and training to help make smart decisions. We're also giving the teams technology to improve a guest's experience and save the sale. This summer, we're implementing a program where when a guest wants a different size or color our team members will take care of everything. +They will be able to search our network's inventory, take payment from a mobile point-of-sale system, and arrange home delivery right from the sales floor. We expect to offer this level of service in all stores by holiday. Finally, we are simplifying operational tasks so our store teams can focus more of their energy on helping the guest. To make all of that work, we're leveraging the skills of our team members. +We've always cross-trained our teams so they can perform almost any task in the store. Now we're also standing up specialized teams like the crews that handle digital fulfillment, or food, and giving them more focused training so they can use their expertise to best serve the guests. Improving the store experience is an enormous body of work. But it's no secret that investing in our stores is only part of the equation. +And you know that our supply chain has been a major focus for our team. This past year, we hired a lot of talent with deep expertise and set wheels in motion for a major revolution of how we operate. We've honed in on two points we have to fix. To put it bluntly, we are slow, and we have too much inventory. And I can't tell you how painful it used to be to say that out loud. +But now I'm actually eager to share it because I'm so confident the work we're doing will position us to compete on a whole new level. Fundamentally, we're changing how we move product. For the last 50 years, our supply chain has moved big case packs of product and we've done it slowly. In the future, we know we will still have to move cases, but to replenish our stores faster and manage the growing digital demand we have to start moving individual items too. +The concept is really pretty simple. When a store sells one bottle of a certain shampoo, we put one of those bottles on the next store truck within hours. It's replenishing to actual guest demand and doing it fast. Now to someone not familiar with supply chains that might not seem like a big deal, but here's why it is. When we move with that much speed and precision all the product that comes into a store can go straight to the sales floor. Nothing sticks around in the back room. Out-of-stock goes down, safety stock goes down and our speed goes up. Way up. +Plus it's exactly how we need to move product to fulfill an increasing number of individual target.com orders. Above all, we get faster and more reliable and the guest wins. Then we can dedicate that back room space to more productive activities, like storing online only product for order pick, or shipping digital orders. And there's no extra product at one store when it could be used at another. I just talked about scaling our small format stores. This operating model is absolutely key to pulling that off. +In those stores where back rooms are typically tight or almost non-existent, we will be better equipped to send product needed in real time instead of relying on backroom storage. Today we have several pilots already underway and we will start transitioning to this model in the spring starting in the Northeast. The opportunities these changes open up in terms of last mile delivery speed are really exciting. +We will ship faster and at a lower cost, improving guest satisfaction and digital profitability. It has the potential to give guests more options for how to shop and how to truly get it whenever they want it. I'm very encouraged by the work already underway and about what our team expects will do in the next few years. We've set out to completely transform how we deliver for our guests, and I can't wait to share more as we make progress. +As we are investing in our stores and our supply chain, we are also undertaking an enormous effort to strengthen what our guests already love about us, our products. Target's assortment has always been the star of the show. It's why we hear about the guest who comes in for one thing and leaves with a full cart. We know our style categories are typically at the heart of those stories. +Home and apparel deliver about $26 billion in sales, or more than a third of our business, and continue to grow significantly faster than the rest of our assortment. But even with strong results, our team has seen the opportunity to do more. Take what we did with Cat & Jack, the kids apparel brand we launched last year. +Our research told us we could capture more of the market, so we retired two pretty successful brands and developed something new to reflect the needs of both parents and kids. Since it rolled out in July, Cat & Jack has consistently delivered double-digit comp growth. It's on track to be become a billion-dollar brand in its first year with the potential to be the largest kids brand in the US. +It wasn't just that we saw a new opportunity, it was how we went after it. We took a holistic approach, making sure every touch point guests had with the brand, whether in-store or online, was compelling, inspiring and easy to shop. While our stores featured product on mannequins and kid-sized fixtures, our site had a dedicated page that showcased Cat & Jack in a similar way, as a brand with outfits, not just a list of products. And made it easy to shop by item. +Both channels but the product front and center and our guests responded. Store traffic increased, digital conversion rates shot up, baskets grew. We saw strong sales across the business. In fact, the digital brand pages were so successful it is how we will present our products online going forward. +We learned a lot about our guests, the potential in the market, and how we could use our platforms together to drive growth. Now how many companies rolled out a new billion-dollar brand last year? I don't have a clue what the answer to that is, but I know it's not many. And now we're looking to do more. +With our new Chief Merchandising Officer, Mark Tritton, came on board last summer he challenged team to take the learnings from Cat & Jack and go further. They have been looking at everything, all of our brands, and seeing where we have a lot of value and where we don't. They're talking to our guests to really understand what they want, and matching that up with where Target has a unique opportunity to stand out. Now we are applying all of that in a really big way. +In the next two years, we will introduce more than a dozen new brands that Target guests will find only at Target. We will touch more than $10 billion of current volume with the expectation that we will accelerate growth within our most differentiated and profitable categories. And, of course, our marketing team will bring them all to life in the magical way that only Target does. Mark can give you plenty more color during Q&A, but I will say that we're confident that we will appeal to current guests and attract new ones. +So much of what we offer will feel completely fresh, and it will be grounded in what our guests expect from Target, while helping them discover new styles and trends we know they will love. Our exclusive brands have always been a huge differentiator. They are part of Target's DNA. This investment shows our commitment to making sure what has always driven guests to Target, like our great product at an incredible value will only keep getting better. +As you've seen, nothing we're doing is specific to a channel, stores or digital. Everything we're building is a combination of the best of each channel working together to provide a wholly seamless experience for our guests. We're transforming stores to help support our digital growth. We're building our supply chain to enable better experience in-store and online. And we're thinking about our assortment from every angle, so guests are inspired no matter how they shop. +Now we recognize that given our current results, where we are today, simply isn't good enough. As we put in the work over the next few years, it is going to be a difficult journey. The investments we're making aren't simple and they aren't going to all pay off right away. But they are significant and they are ambitious because we know that being successful requires playing the long game, and that's the game we fully expect to win. + +-------------------------------------------------------------------------------- +Cathy Smith, Target Corporation - EVP and CFO [4] +-------------------------------------------------------------------------------- + + John's last point is spot on. Our current performance is not where we need it to be. So I want to start today with a progress report on the last couple of years. That will provide important context for where we are today. +We have made significant progress on many of our strategies. Signature categories have grown much faster than our overall sales, consistently gaining market share. Target's digital performance has outpaced the industry, averaging 29% over the last two years. We've seen outstanding results in our new small formats which generate much stronger sales productivity, healthy profit margins, and return on investment. We've started investing to transform our supply chain. +Two years ago, fewer than 150 stores were shipping directly to guests. Today that's grown to more than 1,000 stores and counting. We've made changes to allow our team to focus on our core business in the United States with our decisions to exit Canada and sell our pharmacy business. And the team has done an outstanding job of controlling costs. +We beat our goal to take out a combined $2 billion of SG&A and cost of goods these last two years. And when you look back at our bottom line results, it's been a pretty good couple of years. In 2014, we earned an adjusted EPS of $4.22. It grew to $5.01 in 2016. That amounts to an average annual growth of 9%. +Over that same time period, we returned nearly $10 billion to our shareholders through dividends and share repurchase. That solid performance, better than many others have seen. Despite that progress, we haven't seen the growth we expected. On average our comp sales have grown less than 1% over the last two years. +More importantly, instead of building momentum we've been seeing a slowdown. Specifically, our comp sales and our traffic have moved from growth in 2015 to declines this last year. Given these results and the rapidly changing environment we must evolve our business model faster. By investing more aggressively, we can create a growth engine that will drive consistent, sustainable and profitable growth and market share gains. +The good news, we're not starting from scratch. We've been investing in the right things, but it's clear we need to pick up the pace, and that will affect our financial model. As always, our first priority is to invest in our business with a long view. As we look ahead, we have a big opportunity to grow share in a world where others will be scaling back. +Today, you've heard in detail about the investments we're making to transform all aspects of our business including our digital capabilities, small formats, existing stores, supply chain, exclusive brands, and core capabilities like data and analytics. To support these changes, we're planning to invest more than $2 billion of capital in 2017 and more than $7 billion over the next three years. In addition, we will invest about $1 billion of our operating profits this year. This will position us for faster growth over time. +Our investments will include enhancing store service. We know it's critically important to provide a distinctive service in a world where consumers have more choices than ever. We'll also see continued cost pressure from the rapid shift to digital. We will invest to develop and launch new brands with marketing support to make sure that they are top of mind for our consumers. +And finally, we will make gross margin investments to ensure we are always competitively priced everywhere and every day. Unlike the last couple of years, we don't expect the margin headwinds and tailwinds to balance out this year. As we all know, we could make changes to maintain our margins through this transition. We could cut store service and cleanliness standards. We could pull back on marketing, we could stop investing in brands and cut back on their quality, and we could stop investing in our stores. +Those changes would help our P&L in the short term, but they are absolutely the wrong long-term decisions. Of course, we will continue to reduce costs on those non-critical efforts, but the right path is to invest in lower margins. This will allow us to grow and gain market share in the future. Target is in a really unique position. We have a strong balance sheet and robust cash generation. Both provide us the flexibility to evolve our business model rapidly. +In addition to our assets, we are well-positioned for this change. First, consider our team, which has always been our greatest asset. We have long focused on hiring, training and retaining a store team that can provide a welcoming experience for our guests. And our team is already well-known for their guest service and fast checkout. +So today as we take our new store experience to a higher level, our team is ready and excited to do more. We will continue to give them new tools and empower them to manage their local businesses. Beyond our team, our unique assortment has always been an asset. It gives us the flexibility to present and curate all that our guests desire. +And finally, consider our stores. They are more than 1,800 strong and a key competitive advantage. They're mostly off mall, they are very close to consumers, and they universally generate cash. I want to pause here and talk about why our stores are so strong, especially at a time when others may not be so fortunate. +We have long applied a rigorous process to decide where to build our stores. And we have an equally rigorous process to decide when it's time to close them. Every year we conduct a close/continue analysis on the entire store base, individually for each location. As a result, we have closed hundreds of locations over time. +The key is discipline. It's the reason we have a very healthy portfolio of stores. Looking ahead, our stores will still be the center of our business. But their roles will evolve. Within our smart network, stores will fulfill many roles. In addition to serving as a place where guests can shop in return they will also be a digital hub. +They will provide online order pickup and deliver directly to guests, and importantly, they will continue to offer genuine human interaction and engage in their local communities. As we navigate this transition, we will continue to apply a disciplined returns-based approach to all of our investments. At the highest level, we are focused on sales growth with a relatively stable base of invested capital. +We're focused on growing sales in all channels by transforming our assets, both our distribution centers and our stores. In addition, we will look for ways to streamline our asset base as our business evolves. For example, as we increase the speed of our supply chain, we have a significant opportunity to reduce inventory without hurting our in-stocks. In the last two quarters, you've seen the early signs of this trend. +But we have a lot of opportunity to take inventory out of our network. Finally, I want to emphasize that our priorities for capital deployment remain the same as they've been for many years. First, we invest in our business with a long-term view. Second, we support our dividend. +This year we are on track to deliver our 46th straight year of annual dividend growth. And finally, we engage in share repurchase when we have excess cash beyond those first two uses. We will manage our repurchase program within the limits of our credit rating. We may have some capacity during this transition period, but we won't be close to last year's pace given the changes to our financial model. +As I mentioned earlier, our strong balance sheet is providing valuable flexibility, especially during this key inflection point in our history. Looking ahead, maintaining this flexibility will be essential. Now let's turn briefly to our 2017 expectations, which were included in this morning's press release. At a high level, our guidance reflects a prudent view based on current trends and what we need to accomplish. +Let's start with sales. We're planning for a low-single-digit decline in comp sales this year. While this is not where we want to be, we believe it's prudent based on a couple of key factors. First, it reflects strong digital growth that has not fully offset declines in our stores. And it reflects the view that our investments will not have immediate impact on our near-term performance. +As I've said many times, we stand ready to chase stronger comps when we have the opportunity. In the meantime, we will plan our business prudently. On the EBIT line, this year we are planning to generate about $1 billion less than last year. This reduction reflects investments in enhanced store service, the continued shift into digital, support to develop, launch and market new exclusive brands, gross margin investment to ensure we are competitively priced, and additional D&A from investments in existing stores. +Now I will give you some insights in how this will play out in our P&L this year. About half of the $1 billion investment will be on the SG&A line. Approximately $400 million will be on the gross margin line, and the remaining pressure will be in D&A. Obviously, D&A is a non-cash expense, but this pressure will show up in the P&L. +Altogether, we're planning for GAAP and adjusted EPS of $3.80 to $4.20. We know this is a meaningful departure from both our prior performance and expectations. But this change is essential to position our business for faster growth. Now let's turn briefly to our expectations for the first quarter. +In February, we faced a challenging and choppy environment. We saw some improving trends near the and of the month. While that's encouraging, we believe it's prudent to plan for challenging trends to continue for the rest of the quarter. As a result, we're planning for a low- to mid-single-digit comp decline in the first quarter. +This is the softest quarter comp that we're planning for the whole year. As a reminder, we're comping over our strongest quarter last year, and our full-year outlook includes the benefit of store remodels and brand launches. On the EBIT line, we're planning for a decline of about $400 million from last year. The majority of this decline will be on the gross margin line. +Altogether we're planning for both GAAP and adjusted EPS of $0.80 to $1.00. I know the magnitude of this change to our outlook is unexpected, but we must make these changes to position our business for the long term. Brian began the day by outlining the seismic shift we're seeing in the consumer and retail landscape. Our leadership team has spent a great deal of time studying what this shift means for Target. +Because of that analysis, we are confident this is the right path forward. We're fortunate to have tested, prepared, and built a foundation over the last couple of years. Now it's time to accelerate the transformation of our business model. Our goal today has been to clearly show you where we are investing in that new model. +We're building a smart network that's more agile and reliable than ever before. A network that will be equally capable of inspiring and fulfilling physical and digital shopping. We are investing in stores that will look different and function differently than they do today. We are completely transforming our supply chain, becoming meaningful faster, more efficient and more accurate. +And finally, we're delivering an even stronger portfolio of exclusive brands. So now, before turn it back over to Brian, I want to spend a minute talking about what makes our approach different. We anticipate a lot of disruption in the retail landscape. We want to position ourselves to gain share as those changes occur. +We've seen a lot of stories this year, you've seen a lot of stories this year. Retailers are closing stores and closing businesses across the country. We are positioning our sales to play offense. We're going after that share market by market, but it is going to be a little noisy in the near term. So at a time when many others are shrinking, we are investing. +We are investing in two pillars of growth, our stores as multi-purpose assets within a smart network, and our digital capabilities as we continue to gain share in e-commerce. Unlike the past, we are not providing explicit guidance beyond this year. I understand you have a desire for us to provide detailed, longer-term guidance. However, given the amount of uncertainty we are facing, providing multi-year guidance would be a case of false precision. +And given the transition we're planning, we believe it's important to focus on the Company we will become. With the investments we're making, we will be best positioned to deliver positive in-store comp sales and a rapid and profitable growing digital channel, stable to growing enterprise profit margins, continued strong cash flow, and the ability to return capital to shareholders, and superior ROIC over time. But let me be clear, this will be a multi-phase, multi-year journey. +This year will be an investment phase, we will move to lower margins to enable faster growth in the future. Beyond this year, we will continue into a transition phase. We will invest capital to transform our supply chain, digital capabilities, new stores and existing stores. As we move past the transition, our new business and financial model will stabilize. And we will deliver sustainable, reliable growth over time. +During the entire transition period, we will commit to transparency. Insights on our investments will serve as leading indicators of our future performance. Digital growth and the role of stores in fulfilling that demand, our pace of opening new stores with continued insight on their performance. Investments in existing stores and how those stores respond to those investments. Insight on how we are reducing delivery times and removing inventory from our supply chain. +And finally, timing of new brand launches and how those brands perform. Our Company was founded over 100 years ago, and the first Target store opened more than 50 years ago. We are investing to position this Company for success over the next 50 years. That's what we mean when we say we are taking the long view. Thank you. + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman of the Board and CEO [5] +-------------------------------------------------------------------------------- + + Thank you, Cathy. I know we have covered a lot of ground this morning, but I'd like to build on what Cathy just said. Target has been a great American retailer for more than 50 years. But our roots stretch back even further than that. As many of you know, our Company started out as Dayton's Dry Goods, just around the turn of the last century. +That business evolved into a prominent chain of department stores which led to a string of retail firsts, including the first indoor shopping mall, the first discount mass retailer. And later, the acquisition of Mervyns and Marshall Field. You know the story from there. Evolution is in our blood. +And out of every period of disruption, our Company has always forged ahead into the next era. So when you think about what's in front of us, the seismic shift in consumer behavior that's disrupting our industry, we're doing what we've always done. We're taking the long view, investing to compete, investing to grow, and we have the financial strength and the resources to build a new Company. One that's poised to lead, positioned to win in this next generation of retail. So look ahead three years from now. +We talked about what we will deliver, new stores, new formats, more than a dozen new brands, a coast-to-coast smart network enabled by new digital capabilities. To our guests, the entire experience will look and feel like a completely new Target. While many of our competitors are cutting costs and just trying to survive we are doubling down. We know there will be meaningful opportunities to capture additional market share now and in the long term. +So we are aggressively deploying capital to expand our reach, reimagine our physical stores, and transform our supply chain. We are investing in margin to accelerate and unlock even greater digital growth. We are investing in price to ensure we are competitive across our assortment every day, both online and in-store. And we're investing in speed to move faster than we ever have before. +This is the plan that will produce the Target of the future. This is the plan that puts Target back on the path to profitable growth. This is the plan that will create shareholder value and deliver guest love and loyalty for many, many years to come. So I want to close by thanking you for joining us this morning. +And now I'm going to invite John and Cathy, as well as Mike Tritton, our Chief Merchant, and Mike McNamara, our Chief Digital and Information Officer, to join me onstage so we can spend time taking your questions. We've got lots of mics, we've got lots of time. So we will try to work our way around the room. If you could, introduce yourselves, I would appreciate that, and we're happy to take your questions. So why don't we start right up front. + + +================================================================================ +Questions and Answers +-------------------------------------------------------------------------------- +Chris Horvers, JPMorgan - Analyst [1] +-------------------------------------------------------------------------------- + + Thanks, good morning. Chris Horvers, JPMorgan, and thanks for having the meeting. Trying to dig a little bit into the gross margin pressure, understand the first quarter you will have some pressure from markdowns and clearance. But then over the balance of the year, some channel shift pressure, as well as price investments. +Can you talk about the latter? What you're expecting in terms of gross margin pressure from the digital and pricing pressures? Will pricing largely be reset in 2017, and then we sort of neutralize from there? And is it your expectation that over time the supply chain improvements ultimately stabilize the gross margin, and is that an 2018 event? Thank you. + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman of the Board and CEO [2] +-------------------------------------------------------------------------------- + + Chris, let me talk about the pricing investments we're making. And I think, as most of you know, coming out of the data breach, we invested heavily in promotions. As we go forward, we're going back to our roots and reestablishing our everyday low price commitment. So that's going to take some time. It's starting today. +We're going to make sure that we reestablish our value with the guest. There's an investment we have to make. And we also recognize we have to continue to invest in digital, to grow that channel, to continue to make sure we are accelerating market share. You're going to see us invest in 2017. +As John talked about, we expect greater efficiencies over time. One, as we continue to optimize our digital performance, but importantly, as we transform our supply chain. But in the short term, we have to compete, we have to invest to make sure we're delivering the value the guest is looking for. We want to make sure we're taking market share, both in-store and online, and we think those are two very important investments in the near term that provide long-term benefits for the Company. + +-------------------------------------------------------------------------------- +Michael Lasser, UBS - Analyst [3] +-------------------------------------------------------------------------------- + + Hi, it's Michael Lasser from UBS. + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman of the Board and CEO [4] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Michael Lasser, UBS - Analyst [5] +-------------------------------------------------------------------------------- + + Thanks, Brian. I think the key question is we all appreciate that you don't want to provide long-term guidance, but how long are you anticipating it's going to take for you see a return on all the investments that you're making? Is it reasonable to expect that you are going to return to earnings growth in 2018, 2019? When should we expect that? + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman of the Board and CEO [6] +-------------------------------------------------------------------------------- + + I will go back to what Cathy talked about just a few minutes ago. We certainly view 2017 as year of investment. In 2018 we will continue to transition as these different initiatives begin to mature. As we get into 2019 and beyond, we certainly expect stability and a return to growth. That's the model we are looking at. +We can't lay it out for you quarter-by-quarter. We want to make sure we're properly investing and accelerating these initiatives. And if there's a message I want everyone to walk away with today, these aren't new initiatives. We've been working on these for several years. Now is the time for us to go faster. +This is about accelerating at the right pace for our business. But whether it's our digital channel, the work John talked about in the supply chain, the acceleration of remodeling our existing stores and reimagining that experience, or opening up these new smaller formats, we've got to step on the accelerator. And as they mature, we are going to return to growth, we're going to capture market share, and we're certainly going to see the benefits that our shareholders are looking for. + +-------------------------------------------------------------------------------- +Michael Lasser, UBS - Analyst [7] +-------------------------------------------------------------------------------- + + Great. + +-------------------------------------------------------------------------------- +Craig Johnson, Customer Growth Partners - Analyst [8] +-------------------------------------------------------------------------------- + + Craig Johnson at Customer Growth Partners. Brian, I understand the importance and the necessity that you've talked about doing here today. I want to look forward to how do you get back to growth. One pillar of growth, of course, is traffic growth, hallmark of all great retailers, is consistent traffic growth. And you showed to earlier in Costco and TJ Maxx and it applies to Wegman's and Home Depot. The question is, could you get more granular on how you can actually rebuild share-of-trip missions as a way of getting a share of traffic? + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman of the Board and CEO [9] +-------------------------------------------------------------------------------- + + Craig, it's a great question, and it's embedded in everything we've talked about today. The reinvestment in our stores, reimagining over the next few years hundreds and hundreds of stores. We've certainly learned in our tests in both Los Angeles, and as we've remodeled stores in Texas, that as we bring a new experience that drives traffic to our stores. +As Mark and his team continue to roll out these new proprietary brands that are unique to Target, that drives traffic to both our stores and our site, and we've seen that with Cat & Jack, a $1 billion brand in year one, on its way to being the number one kids brand in America. So as we continue to elevate brands, those drive traffic to both our stores and our site. As we move into our new urban neighborhoods, it's striving for traffic every single day. So as we think about how this smart network comes together, brands play an important role, that in-store experience is critically important, being in the right neighborhoods. +But then we also know from a digital standpoint, more and more of our guests are ordering online and conveniently coming to our stores to pick up that order. That allows us to really make sure that once they're in our store they continue to shop. All of these elements are all about driving traffic to our stores and more visits to our site, and as they mature, that certainly is going to be one of the key metrics that we will all be tracking. + +-------------------------------------------------------------------------------- +Robby Ohmes, BofA Merrill Lynch - Analyst [10] +-------------------------------------------------------------------------------- + + Robby Ohmes at Bank of America Merrill Lynch. As a follow-up to that question, can we get you guys to talk a little bit more about more about category outlooks, so how you're thinking about price investments in terms of food and consumables versus apparel, electronics, et cetera? +And also for the new brands, maybe some what categories you are thinking about launching some of these 12 new brands? And then, just a quick for Cathy, I guess, I might have missed it and I didn't understand, are you -- you have been disciplined about store closings, but is there a change in your pace of store closings? Thanks. + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman of the Board and CEO [11] +-------------------------------------------------------------------------------- + + Let me start with price, let Mark talk about brands, and the Cathy can talk about our real estate portfolio. I think you answered the question for us. As we think about the investments we're making in price, we will start with those core essential and food categories. Those trip drivers that Craig just referred to. We've got to make sure that we move from a promotional cadence back to our traditional every day low price and great value every time the guest shops in those core personal care, household essential, and food categories. +We will certainly make sure we're revisiting price across the box, but it certainly starts with making sure we are priced right on those trip driving items that our guests depend on Target for every day. Mark, why don't you talk about some of the brand work? + +-------------------------------------------------------------------------------- +Mark Tritton, Target Corporation - EVP and Chief Merchandising Officer [12] +-------------------------------------------------------------------------------- + + Yes, as we roll out the new brand work we're looking at guest insights about what brands and what spaces we should play in, but more importantly, what is the sweet spot on pricing for regular everyday pricing. So as we reset these brands, we are going to be defining great value every day for our guest as we introduce in every niche in the business. + +-------------------------------------------------------------------------------- +Cathy Smith, Target Corporation - EVP and CFO [13] +-------------------------------------------------------------------------------- + + Robby, I will quickly address store portfolio. As we said, we've had a very disciplined process forever. The team has done a great job. Our pace doesn't change, we've been closing about 10 to 15 stores a year, that has been consistent year in and year out. We will continue to do that, but that's just normal course for us. We look at every store every year and say does it make sense to keep open. Today the answer is, yes. Universally generate positive cash + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman of the Board and CEO [14] +-------------------------------------------------------------------------------- + + Cathy, on the store front, just to close that out, and I know we talked about it during our prepared remarks but our store portfolio is not mall-based. We are in some of the centers where most of the retailers are trying to migrate to. We're very fortunate that over time we built 1,800 stores that are effectively located. They are in the right neighborhoods, they are not off remotely on interstates, they are not tied to dying malls. +We have an obligation to revitalize some of those stores and re-image some of the stores, but one of the things that where most confident about is we have an exceptional store portfolio. So as we invest, as we bring those stores up to the expectation our guest has from Target, we expect those to drive traffic and continue to flourish in the years to come. + +-------------------------------------------------------------------------------- +Matt McClintock, Barclays Capital - Analyst [15] +-------------------------------------------------------------------------------- + + Hi, yes, Matt McClintock from Barclays. Clearly, the story today is about investment, right, you need to make substantial investments. And as I look back at the past two years, you've fallen shy of your capital plan by a significant amount. So as I look forward, one, can you help me understand where the shortfall to what the capital plan was this year? +Two, would you attribute some of the weakness today that you are seeing to some of the lack of investment, or shortfall, to your prior capital plans? And then, three, is the $2 billion enough for 2017 given that it falls to the low end of your prior long-term guide of $2 billion to $2.5 billion. Thanks. + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman of the Board and CEO [16] +-------------------------------------------------------------------------------- + + Matt, I'd start out by talking about the last couple years as being a time of very disciplined capital allocation. We've taken a very surgical approach to some of these initiatives. We've remodeled 25 stores in Los Angeles. We've been testing and learning and iterating, improving the expectation that the guest has, making sure we deliver against that. Now that we've got the feedback, we're ready to accelerate. +John talked about we have opened up 32 small formats, not 300. We studied each one of those very carefully to make sure we understood how to customize them for new local neighborhoods. Now that we understand the expectation, we are ready to accelerate. From a capital standpoint, we've actually benefited from the fact that Mike has taken a very disciplined approach to setting priorities within technology, and we've seen phenomenal improvement in our platforms, our capabilities at a lower cost. +Our approach to capital has been very disciplined. We've been testing and validating and learning. Now that the learning is complete we are ready to accelerate those investments. But we have been very disciplined. John talked about supply chain. +We know the changes that we need to make, but we have been very surgical, very disciplined in putting together that playbook. Now that it's in place, we will begin to accelerate. So from a capital standpoint, we will continue to make sure we're very thorough, we test and validate, but once we've completed the learning, we will be ready to accelerate. And that's what you're seeing as we think about the next three years. + +-------------------------------------------------------------------------------- +Peter Benedict, Robert W. Baird & Company, Inc. - Analyst [17] +-------------------------------------------------------------------------------- + + Peter Benedict of Robert Baird. I was hoping you could maybe speak in a little bit more detail about your view of grocery, that side of the store. How's that going to look in the reimagined store? And then, Cathy, maybe a little view as to how much it costs to do the remodels and how long it takes? Thanks. + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman of the Board and CEO [18] +-------------------------------------------------------------------------------- + + Why don't I start and then I will let Mark talk about some of the progress we've seen on grocery. And while we didn't spend a lot of time on it today, I want to make sure it's very clear. We're very focused on improving our grocery performance. But we haven't just been standing still. We've made significant progress in procurement, in supply chain, in making sure we've improved our assortment, in making sure in those test stores in Los Angeles and Dallas we understand the changes that need to be made in the in-store experience. +We're going to follow it up immediately with the right investment in pricing to make sure we are competitively priced every day in those key categories. So we've got more work to do, we're certainly not satisfied with where we are, but we have been making progress, and there's bright spots, Mark, that I think you can talk to? + +-------------------------------------------------------------------------------- +Mark Tritton, Target Corporation - EVP and Chief Merchandising Officer [19] +-------------------------------------------------------------------------------- + + Yes, just looking at the format, fresh produce is a really good example where we've changed our supply chain, our assortment and are focused on quality and value. So investing there has really made a difference where the guest has perceived and responded to with great growth in key categories. +So here we've invested in fresh, and we've gone from an organization that used to deliver multi-times a week to every single day, increasing the freshness and quality and guests are responding. Some of the tests that Brian talked about in LA and Dallas have really paid dividends for us. And one great example of that is our adult beverage business where we've seen great growth in 2016, and we're going to amplify that growth and accelerate in 2017. This is a business that for us was our number one growth category throughout all Target, and we see an upside of $1 billion business here that we're fast tracking on in 2017. + +-------------------------------------------------------------------------------- +Joe Feldman, Telsey Advisory Group - Analyst [20] +-------------------------------------------------------------------------------- + + Joe Feldman, Telsey Advisory Group, way in the back, sorry. I wanted to follow up on that. Can you talk of little bit on the merchandising side areas of the store that maybe are expanding or contracting? And then a little more specifically about those dozen brands that you will be adding in. What categories with those be in and any preview can give us and how to think about that? + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman of the Board and CEO [21] +-------------------------------------------------------------------------------- + + Mark? + +-------------------------------------------------------------------------------- +Mark Tritton, Target Corporation - EVP and Chief Merchandising Officer [22] +-------------------------------------------------------------------------------- + + Yes, so the key focus of the brand growth is really in what we talked about with John, and our key strength there is apparel, accessories, footwear and home. These are high margin and high strength areas for us. And we believe that Target has the right DNA on exclusivity and differentiation. Our guests love it, our brands, and have loved them. But we've been a little slow here in terms of the changing face of the guest. And I guess the insights showed that we could sharpen that and bring new ideas. +Great proof of concept in 2016 with the launch of who, what, where, Pillowfort and, of course, Cat & Jack, that showed us where we replaced our strengths with a new focus we could create double-digit comps and guest love and trips for our store. So we've taken key areas across -- men's, women's, home and kids and are going to amplify our offers there and redefine. In terms of overall space, we're just utilizing our existing space and really refreshing that. One of the things we're excited about in 2017 is this combination of new brands, capital investment in the space for those brands, but also the addition of extra resources like visual merchandising. They're really going to create a new experience for the guest in-store and create real excitement. + +-------------------------------------------------------------------------------- +Mark Miller, Crystal Rock Capital Management - Analyst [23] +-------------------------------------------------------------------------------- + + Hi, thank you. Mark Miller with Crystal Rock Capital. You talked earlier about making price investments across essentials. I wanted to ask, what do you think is a risk that you've taken too much margin on exclusive items? UPT has come down but average ticket has gone up with price per item. I thought also it might be helpful if you could share market research on the customer's perception of value on exclusives now versus several years ago? Thanks. + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman of the Board and CEO [24] +-------------------------------------------------------------------------------- + + Why don't I start. I think the proof is in the results we've delivered. Outstanding results, as we've talked about with the launch of Pillowfort. The same thing has been true with Cat & Jack. This is an example of where we've gotten the value equation right. +Great quality, on trend, at a great value and the guest response has been terrific. That's the same approach Mark is going to take with each one of those new brands, making sure we combine great quality, items that are on trend for the consumer with the right value that drives trips, but also makes sure the guest recognizes they're getting value from Target, so coming back to our brand promise. Expect more and pay less. Those elements have to work hand-in-hand with our new brands going forward. + +-------------------------------------------------------------------------------- +Kate McShane, Citi Investment Research - Analyst [25] +-------------------------------------------------------------------------------- + + Hi, Kate McShane from Citi Investment Research. I have two unrelated questions today, one a short-term question, one a longer-term question. With regards to your guidance for the year, I'm wondering how much in terms of your competitor door closure are in your assumptions for guidance? +And, second, on the longer-term question for supply chain, just curious, it was a year ago that you walked us through some of the changes in your supply chain. And just wondering how much the game has changed since the last time we have heard about that strategy and how your approaching the last mile? + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman of the Board and CEO [26] +-------------------------------------------------------------------------------- + + John, do you want to start with supply chain and we will finish up with guidance. + +-------------------------------------------------------------------------------- +John Mulligan, Target Corporation - EVP and COO [27] +-------------------------------------------------------------------------------- + + Sure. I think, the past year we spent doing really two things in supply chain. One was just optimizing what we do today to improve out-of-stocks in-store which had been a chronic problem for us. They have improved dramatically, they're not where they need to be but they have improved. +The second thing we focused on is right to the heart of your question, which is, how do we optimize the entirety of our supply chain, go back and relook at everything to, one, take work out of the store, and, two, be much more efficient in how we deliver and especially on the last mile. We spent the last couple years expanding our ship from store capability. We have believed for a long time that is the single best advantage we have in the supply chain is our store network. It puts us right next to the guest. And what we're working on today is how we move inventory more efficiently and more quickly in each because that is what is required for direct-to-guest. Out to the stores and then from the store directly to the guest and do that quickly. +You will see us this year, as I said, start to make those changes in the Northeast. Several pilots are already underway that have significantly improved our speed to guest. And, as I said -- as Cathy said, we will continue to come back and report on how we're doing. But that is the heart of what we're doing. That becomes the basis for improving. Everything Mike can do is giving him flexibility to put services on top and to deliver at whatever speed the guest wants. In a store like Tribeca that could be today. Hey, I came in, picked up my five things, I'm going to go run some errands with the kids, deliver this to my house in three hours. +It could also mean, hey, bring this to my house in 10 days, this patio set, bring it to the back of my house, set it up, detrash it and take the garbage way. It's really about flexibility and speed and allowing the guest to choose how they want to interact with us. And that's what we're building the platform of our supply chain around. + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman of the Board and CEO [28] +-------------------------------------------------------------------------------- + + Kathy, why don't I start by talking about the competitive landscape and let Cathy talk about guidance. But to your point, we certainly see over the next three years significant market share opportunities as we see the contraction in our competitive store base. And that is going to be particularly true in the apparel and home spaces where we're strongest. But we also recognize, as you do, as many retailers are closing stores, if not exiting the business. The short-term implication is massive promotional discounts which takes consumers out of the marketplace for a period of time. +So over the long haul, this is a growth story we are putting together. We think we are going to see significant market share opportunities across a number of categories. To capture that, we need to make sure we've got the right in-store experience and a very strong and easy digital experience for that guest. But in the near term, you're going to see deep discounting, you are going to see liquidation sales, which takes prices down and takes consumer trips out of the marketplace. But over time, we see significant market share opportunities. + +-------------------------------------------------------------------------------- +Cathy Smith, Target Corporation - EVP and CFO [29] +-------------------------------------------------------------------------------- + + Yes, the only thing I'll add on to that, because that's where I was going to go too, is we are absolutely investing to be able to play offense. We see this as a huge opportunity for Target when you think about the playing field that's going to be available. And so we are investing to play offense. But I don't anticipate, and we don't anticipate, that to be demonstrably changing this year. This year is an investment year for us. As we set ourselves up for that great success to take the share over the next multiple years, there is going to be a ton of disruption in this space. + +-------------------------------------------------------------------------------- +Dan Binder, Jefferies LLC - Analyst [30] +-------------------------------------------------------------------------------- + + Dan Binder with Jefferies. I had a few questions. First, there's been a few questions on food today, I am curious, as you think about the role of food, and at your competitors it's been used as a traffic driver. Today we're not really hearing that from you, we're hearing more about remodels and brands outside of food. Can you just talk a little bit about why you think food shouldn't be the traffic driver for you, why you shouldn't be reallocating space away from dying categories to expand the food assortment? +And my second question is, can you make money online longer term, and why doesn't a marketplace make sense for you, particularly as a source of fee income to offset maybe some of the pressure in your own business? + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman of the Board and CEO [31] +-------------------------------------------------------------------------------- + + Why don't I start by talking about food, let Mark add some additional color, and then give Mike a chance talk about our digital approach going forward. One of the things that we've talked about over the last year as it pertains to Target's food and beverage offering is the recognition that we don't have a full service grocery experience. We don't have meat and seafood counters, we don't have deli counters. We don't provide a full assortment of experiences and services that many of our full-line competitors do. +But we can offer a great self-service, convenient experience. And that starts with the right quality, the right assortment, the right in-store experience, great value. We've got to make sure we are supplying those products to our guests every single day to make sure the freshness is there. So we are embracing who we are. And we want to make sure that the guest knows while they're shopping at Target there is no compromise. +We've got to build trust, we've got to make sure that while they are there shopping for their baby, picking up a toy for a Saturday night birthday party, picking up something new to wear for dinner that night they have confidence in the selection and breadth of food products we offer. We are being true to who we are and we're not a full service grocer. We don't have rotisserie ovens in our stores, but we do have the right allocation of space and selection to compete and be that convenient alternative in food, and we're going to held on that going forward. +We're very pleased with the response we've seen in Los Angeles in Dallas where we enhance that experience, where we improve the assortment. The reaction, as Mark talked about, to categories like craft beer and wine that fit in very well with the Target guest. We've got to strengthen that offering, make sure we have got great quality, the right assortment, that we've got the right experience in-store. And that we provide the right value the guest is looking for. So we will continue to build off of that going forward and make sure that while our guests are shopping Target they are also shopping our food and beverage offering. + +-------------------------------------------------------------------------------- +Mark Tritton, Target Corporation - EVP and Chief Merchandising Officer [32] +-------------------------------------------------------------------------------- + + Yes, I think our space is set. We're not talking about flipping or divesting or investing in more space, it's how we utilize the space more definitively. And I think that what we've learned in these test markets is the role of fresh and convenience in creating trips and creating guest love as being very powerful. Reformatting the space and really curating the assortment is more of what we're focused on rather than wholesale changes to macro space. + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman of the Board and CEO [33] +-------------------------------------------------------------------------------- + + Mike, why don't you talk about where we are with digital? + +-------------------------------------------------------------------------------- +Mike McNamara, Target Corporation - EVP and CIO [34] +-------------------------------------------------------------------------------- + + Sure. + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman of the Board and CEO [35] +-------------------------------------------------------------------------------- + + We've spent very little time talking about our performance in 2016. We felt great about how we exited the year, comps up 34%, making really good progress, like we've doubled the business in the last couple of years. So why don't you talk about where we are and where we're going. + +-------------------------------------------------------------------------------- +Mike McNamara, Target Corporation - EVP and CIO [36] +-------------------------------------------------------------------------------- + + Look, I think, particularly in the last year the focus has been on guest experience and making our floor as a great guest experience. And while some of those investments may not have been obvious and they have pay dividends. We grew the business at almost twice the rate of the market last year. John talked about earlier how we expanded our ship from store capability which has been really, really important to as. We shipped about 1 million parcels to our guests in the two days following Cyber Monday. +And that's really important because that is our cheapest route to the guest at home is shipping from our stores. And as we can expand that model, we can be closer to our guests physically, and in time, and we have the lead time during the holiday period to guests, as well. So all of those investments have improved the guest experience. We've almost doubled our guest satisfaction rating over the course of the year whilst we grew the business at twice the rate of the market. And we see that again going into this year. +There will be a relentless focus on the guest experience going forward. All the work that John and his team are doing to reconfigure our supply chain will give us a lead time advantage and a cost advantage as we deliver more and more parcels to our guests doors. The work that Mark is doing on assortment and creating exclusive product, exclusive brand for Target that isn't available anywhere else will be vital to our online merchandising going forward. We will always look at other ways maybe of how we might expand our assortment online, but right now we've got our sites fairly firmly focused on how we can get to guests quicker, how we can execute flawlessly, and how we can bring exclusive brand and product to our guests. + +-------------------------------------------------------------------------------- +Bryan Cameron, Dodge & Cox Funds - Analyst [37] +-------------------------------------------------------------------------------- + + Good morning, this is Bryan Cameron, Dodge & Cox. Thank you for your presentation this morning. With all the seismic shifts that are going on in retail, as you outlined, I'm guessing you've considered other strategic alternatives to the one you outlined this morning. What were some of those alternatives and why is the one you outlined you think the best for the Company going forward? + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman of the Board and CEO [38] +-------------------------------------------------------------------------------- + + Bryan, we spent a lot of time as a leadership team looking at different alternatives. There was only one path forward. That's the path we've chosen. We've got to win best to grow. We've got to reimagine our stores, we've got to enter new neighborhoods, as we're doing with these small formats. We've got to transform our supply chain. We have to build out the digital capabilities required in this environment. +We have to continue to elevate our proprietary brands. And I think most importantly, we just have to embrace the realities of this new era of retailing, and make sure that we also embrace the way consumers are shopping today. We certainly debated whether there were other options. Every time we came to the table there was only one conclusion, and it's the path we've chosen to follow. We think this is the right path for our Company, the right path for our shareholders, and ultimately, it's a path back to growth and an expansion of market share. +We've done our homework, we've looked at this from every different angle. This was the path we kept coming back to, it's the right path for the Company today. It will be the right path for the Company 10 years from now. + +-------------------------------------------------------------------------------- +Greg Melich, Evercore ISI - Analyst [39] +-------------------------------------------------------------------------------- + + Hi, it's Greg Melich with Evercore ISI. I had three questions and I will make them quick, into one. Cathy, does the guidance for this year assume that comps turn positive by the fourth quarter? Second is on CapEx, when we look at that $7 billion budget over the next three years, if you could break that down into existing stores, new stores, supply chain and give us some sense of where the money is actually going? +And then lastly, and maybe, I don't know who this is for, but for everyone, I guess, Brian, what will you be watching to know that this is working so that basically we want to double down or not, or the go the other way towards the end of the year? And specifically, there was an interesting comment, can't remember who made it, that our cheapest way to fulfill is through the store. I would love to just hear -- that sort of shocks me given what we're seeing Amazon do and others, so just why is that true for Target, and maybe not true for some of the others? + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman of the Board and CEO [40] +-------------------------------------------------------------------------------- + + Greg, why don't I start with the metrics, the things that we're going to be watching closest. It's going to come back to, we're going to watch the guest. How does the guest respond when we reimagine a store? How do they respond when we move into new neighborhoods? How do they respond when a new digital offerings? How do they respond as we roll out new brands? +Ultimately, that guest satisfaction and that guest vote is the most important one. And when they are in our stores more frequently and visiting our site more frequently, and shopping with Target versus other retailers, we know we are winning. But we're going to clearly monitor the guest reaction as we remodel these next 100 stores in 2017, and we continue to accelerate with another 30 small formats. And as Mark introduces new brands throughout 2017, and Mike enhances our digital offering, it's going to come back to the guest reaction. And we are fighting for footsteps, we're fighting for clicks online and we're fighting for a share of mind. +So for this to be a growth story, it is all about gaining market share and that starts with building greater trust, greater loyalty with our guest. So we will be watching that each and every day across these initiatives we've laid out today. + +-------------------------------------------------------------------------------- +Cathy Smith, Target Corporation - EVP and CFO [41] +-------------------------------------------------------------------------------- + + Yes, Brian, maybe I can address the other two questions, Greg. This is a multi-phase, multi-year journey, and we tried to make sure we set that expectation. We are recognizing that the environment is going to be disruptive. And we've got a ton of work still to do, although, we're not we're not starting from scratch, we're going to accelerate that pace and that investment. +We are not, and we guided that in our guidance, planning for anything but low-single-digit negative declines this year. And that's what we said, it's an investment year. As we move into transition and then we will get into stability where we can sustainably, consistently drive profitable growth and market share gains, and so I want to make sure we do set that expectation appropriately. +On your question with regards to how the capital allocation is being spent over, that $7 billion investment over the next three years, it's really in the three areas of Brian talked about, the three big areas. The biggest ones being, obviously, as we reimagine our stores because they will still be central to our story. Their roles will evolve but they will be significant investments there, as well as the new stores, supply chain and digital. And that's exactly where you would expect us to be spending that money. + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman of the Board and CEO [42] +-------------------------------------------------------------------------------- + + Mike, why don't we come back to the shipping question? + +-------------------------------------------------------------------------------- +Mike McNamara, Target Corporation - EVP and CIO [43] +-------------------------------------------------------------------------------- + + The reality is that in a digital business one of your biggest costs, biggest marginal costs is transportation, and it is cheaper for us to drive, or to deliver from our stores which are, as we said, about 10 miles from 75% of the population. So that last leg being very shorter makes it our cheapest option. The marginal cost of us getting product to the stores on the back of our existing network, that already -- to the distribution center is already out there -- is very, very low for us indeed. The additional cost on that last mile is very low. We also have, of course, order pickup which is probably our most economic fulfillment channel. + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman of the Board and CEO [44] +-------------------------------------------------------------------------------- + + Why don't we, Oliver, you have been very patient waiting, waving your arm. Why don't we see if we can get him a microphone. + +-------------------------------------------------------------------------------- +Oliver Chen, Cowen and Company - Analyst [45] +-------------------------------------------------------------------------------- + + Thank you very much. Oliver Chen, Cowen and Company. Had a question related to that topic of fill-in versus stock-up tactically in terms of what you're thinking about the future of fill-in and the opportunity there? And longer term, as you do your consumer insights on Millennials and Generation Z, what do you think the five-year story is for reimagining the store as you think about what the newest customers really want to see with disruption and transformation? +And finally, on the topic of big data and data sciences, how does that interplay with how we should think about the model over the longer term and what does that mean for what consumers want versus where you can deliver data science, whether it be supply chain, re-channel or predictive analytics, giving people something they don't even know they want? Thank you. + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman of the Board and CEO [46] +-------------------------------------------------------------------------------- + + Oliver, let's try to unpack those questions. Let me start with the last one, as we've think about the role of data science and analytics. I made the comment that three years ago this was a nascent capability for us. It's now quickly become one of the strengths of the Company. We're applying that across all of our various functions. +It's helping Mark and his merchant team make better choices. It's certainly enabling some of the work that John is leading from a supply chain standpoint. It's influencing how we lead and manage our stores. +And Mike can talk about the important role it plays as we think about digital and the personalization of our communication. Data science is going to play an important role across all of our functions going forward to make the Company focused on the right decisions, smarter decisions, more personalized decisions. Mike, why don't you talk about the role that it has played just recently as we think about digital and how we are interfacing with the guest? + +-------------------------------------------------------------------------------- +Mike McNamara, Target Corporation - EVP and CIO [47] +-------------------------------------------------------------------------------- + + I think, as Brian says, it's an important, it's a very important growing area for us. Data sciences team out in Sunnyvale we have over 40 PhDs who are doing nothing but thinking of clever ways to how we tune our supply chain and how we personalize the offer to our guests, particularly online. One recent improvement they've made is on some of the bottom recommendations that we give on our homepage. +We've seen an eightfold improvement on conversion rate on that. We do note that as you make that experience more relevant to the guest that we will improve our sales online. It will improve our conversion rates. That's just one example. And I've seen a lot of examples in John's area around how we are improving sales forecasting and our ordering algorithms which has helped the flow of stock all the way through our supply chain. + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman of the Board and CEO [48] +-------------------------------------------------------------------------------- + + Let me try to come back to your question around the consumer trends, the role of the Millennial, how that takes shape over the next three to five years. I think as we look at it today, I will start with the investment we're making in our stores. And as we've looked at the outlook, as you've done the math, while we expect this continued accelerated shift to digital, stores are still going to be very important. And pick the number three years from now, the stores represent 85% or 80% or 75% of the business. I don't know? +But even if they are 75% of the business three to five years from now they are still the dominant portion. What we know every time we talk to the consumer, every time we talk to the guest, they crave experience. If they're going to shop a physical store, they want it to be a great experience. We've seen the reaction to the changes we've made with visual merchandising. +Some of the things that Mark and his team are bringing to light every day in our stores in our apparel and home categories. We have to make sure it's a great experience. If they're using our stores as a smart pickup point, we need to make sure when they come to our stores they are greeted by phenomenal team members who can quickly find their order and invite them to shop more often. So we've got to make sure that experience is critically important in our stores. +We know going forward that Millennial consumer that we serve, they are going to be digitally connected, and their shopping experiences are likely always going to start with that digital device. Then they will choose whether they want it delivered to their front door, they want to pick it up, or they just want to make sure they know where the products are placed inside of that Target store in their neighborhood. So we've got to embrace the way consumers are shopping, but we recognize when they come to a physical store they expect a great experience. When they shop online, they want it to be really easy. +When they come to pick up a product at one of our 1,800 stores, we've got to make sure the product is there, we've got the right items and we invite them to enjoy the convenience that we did the shopping for them. Now they can take the next 20 minutes and explore the store and discover and enjoy the merchandise that we have to offer. So physical stores will continue to be important. But we have to reimagine that store experience. +Today's Millennial shopper doesn't enjoy shopping one of our tired stores that has not been touched in 10 years. But they love the reimagined stores and they give us that feedback, as we've remodeled stores in Los Angeles and we have reimagine stores in Dallas, or as we open up new flex formats. The feedback we are receiving is sensational. And they use those flex formats, those smaller stores as places to fill in, but they're filling in two or three times a week. +We are looking at it very carefully, but we know stores will be very important, but it's going to be part of our smart network where we combine the digital experience, the store experience as one and make it really easy for the guest to connect with Target any time they want, any way they want in their local neighborhoods and towns. + +-------------------------------------------------------------------------------- +Brandon Fletcher, Sanford C. Bernstein & Co. - Analyst [49] +-------------------------------------------------------------------------------- + + Brandon Fletcher with Bernstein. We see your competitive advantage as assortment and service, so when you talk about new brands, we love it. When you talk about service online and integrated ordering, matching online, awesome. Doing the picking from DCs for each is genius and I think only you and the Home Depot are close there. The only place we get nervous is when you say things about price and convenience. I've sat across way from many CEOs who were desperately trying to drive traffic with price investments when they were not the low cost operator, and it just doesn't usually work. +And if you're seeing death in department stores and retailers and sub-scale groceries, where you guys are already way better on price, are you really sure you need to invest that heavily? And the, secondly, is, with the rollouts to new project touches in stores will folks with disconfirming evidence have as much access to leadership as those with confirming evidence? You guys have been extremely disciplined in the way you did LA25, but it's hard to get right. So those are our two questions. Thanks, guys. + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman of the Board and CEO [50] +-------------------------------------------------------------------------------- + + Let's go back to pricing. Let me make sure we are really clear about what we're doing and why. We spent a lot of time looking at the changes that we had made following the breach. We were very promotional. That promotional intensity has actually continued. +As we go into 2017, you're going to see us get back to our roots, get back to establishing every day low pricing in those essential categories. There will be a transition period, but it's really going back to it's always worked for us in the past, and moving away from that promotional intensity, the reliance on big promotions to making sure we give our guests the confidence and trust that every day they shop in our stores for those core essential items they're getting a great value. It's a transition, there's an investment involved in that, but it's really getting back to it's made as great going in the past and really making sure that's part of what we bring going forward. +We will continue to be very disciplined. As we talked about the question about capital allocation, we're still going to be Company that will continue to innovate, innovation is very important. Innovation is alive and well at Target. But we're going to make sure we test, we learn, we validate. The innovation has to benefit our core enterprise. It has to translate to driving more traffic to our stores, more trips to our site, greater guest loyalty and engagement. +Innovation will be an important part of our future. We will do it, as we've done in the past, in a very disciplined way. When things don't work we will shut them down. When we need to iterate, we will continue to iterate and learn, and when we've validated the model we will step on the accelerator, as we are right now, and we will move forward quickly. I guess we've got time for one only last question. Why don't we go over here. Scott? + +-------------------------------------------------------------------------------- +Scott Mushkin, Wolfe Research - Analyst [51] +-------------------------------------------------------------------------------- + + Thank you. Scott Mushkin from Wolfe Research. I wanted to ask a couple questions, one is just clarification, the cost of the remodels, I don't think we actually got that number, and I was wondering if we could get it? I was hoping for an update on store execution, specifically in-stock, I know that was a big focus? +And then the final question would be around price investments. You have two large competitors driving down price, most notably Walmart, but also Amazon is doing a lot of work with their Subscribe and Save and those prices are very low. What gives you the confidence that it's one and done here, as one of your largest competitors on a multi-year price lowering campaign? Thanks. + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman of the Board and CEO [52] +-------------------------------------------------------------------------------- + + John, you want to start with stores and then I will come back and talk about pricing. + +-------------------------------------------------------------------------------- +John Mulligan, Target Corporation - EVP and COO [53] +-------------------------------------------------------------------------------- + + Yes, just to check off really quick, cost of a remodel for a prototype, what we call a P store, $5 million, $5.5 million, a little less for lower volume stores, a little more for higher volume stores. Super Target, what do you think, Cathy, about double? + +-------------------------------------------------------------------------------- +Cathy Smith, Target Corporation - EVP and CFO [54] +-------------------------------------------------------------------------------- + + No, a little less than that. + +-------------------------------------------------------------------------------- +John Mulligan, Target Corporation - EVP and COO [55] +-------------------------------------------------------------------------------- + + A little less than double. Store execution, I would say two things about. One, on out-of-stocks, made a lot of progress. When we talked about it last year they had improved by about 40% last year, almost another 15% improvement. We've seen significant improvement in doing what we do today. The next leap in improvements in out-of-stocks in our stores will come from fundamentally changing the supply chain, which is what we talked about today. That's on course, and we will keep working on them and we'll update you as we go forward, I guess. + +-------------------------------------------------------------------------------- +Brian Cornell, Target Corporation - Chairman of the Board and CEO [56] +-------------------------------------------------------------------------------- + + And, Scott, I will finish by talking less about price and lot more about value. We know we have to be competitively priced every day on those core essentials. But we win when we deliver a compelling value, which means a great in store experience. Which means new exciting brands, which means surrounding the guest with great team members, which means a great online experience that's easy and friction free. +So it can't be just about price. It has to be about value. And value is the combination of all the things we do and historically have done so well. We've got to make sure we surround the guest with a great in-store experience. The reaction we've seen as we have brought visual merchandise to like in our stores has been fantastic. We've got to continue to build compelling brands that deliver great value for the guest. +We've got to surround them with a great experience, whether they're picking up an item or checking out in our stores. And that's got to translate to how we interface with the guest online. Value is critically important. We think we're positioned in a way that's unique in the industry with our assortment, our in-store experience, our multi-category portfolio, the capabilities we've now built online and the changes we're making in-store. +That's what gives us so much confidence that we are on the path back to growth. That it will take time, but there's going to be significant market share opportunities in front of us, and three years from now when we've reimagined stores, and we are in new neighborhoods, and we've rolled out new brands, and we've got it great new supply chain capability to complement what we've done from a digital standpoint, we will be sitting here talking about the new Target, a growth Company that's captured market share in this new era of retailing. So I appreciate your time and your patience today. Thanks for joining us, and we look forward to talking to you in the future. So thank you. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/exam/original-files/Problem_2_3_Sample_full_transcripts/2017-Jan-13-JPM.N-139316849748-Transcript.txt b/exam/original-files/Problem_2_3_Sample_full_transcripts/2017-Jan-13-JPM.N-139316849748-Transcript.txt new file mode 100644 index 0000000..bfc80d4 --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_full_transcripts/2017-Jan-13-JPM.N-139316849748-Transcript.txt @@ -0,0 +1,971 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q4 2016 JPMorgan Chase & Co Earnings Call +01/13/2017 10:00 AM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Jamie Dimon + JPMorgan Chase & Company - Chairman & CEO + * Marianne Lake + JPMorgan Chase & Company - CFO + +================================================================================ +Conference Call Participiants +================================================================================ + + * Matt O'Connor + Deutsche Bank - Analyst + * Mike Mayo + CLSA Limited - Analyst + * Erika Najarian + BofA Merrill Lynch - Analyst + * Gerard Cassidy + RBC Capital Markets - Analyst + * Betsy Graseck + Morgan Stanley - Analyst + * Steven Chubak + Nomura Securities Co., Ltd. - Analyst + * Brian Kleinhanzl + Keefe, Bruyette & Woods - Analyst + * Glenn Schorr + Evercore ISI - Analyst + * Matt Burnell + Wells Fargo Securities, LLC - Analyst + * Marty Mosby + Vining Sparks - Analyst + * Eric Wasserstrom + Guggenheim Securities LLC - Analyst + * Andrew Lim + Societe Generale - Analyst + * John McDonald + Bernstein - Analyst + * Paul Miller + FBR & Co. - Analyst + * James Mitchell + Buckingham Research Group - Analyst + * Ken Usdin + Jefferies LLC - Analyst + +================================================================================ +Presentation +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Good morning, ladies and gentlemen. Welcome to JPMorgan Chase's fourth-quarter and full-year 2016 earnings call. +(Operator Instructions) +At this time, I would like to turn the call over to JPMorgan Chase's Chairman and CEO, Jamie Dimon, and Chief Financial Officer, Marianne Lake. Ms. Lake, please go ahead. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Company - CFO [2] +-------------------------------------------------------------------------------- + + Thanks, operator. Good morning, everybody. Happy New Year. I'll take you through the presentation which is available on our website. Please refer to the disclaimer at the back of the presentation. +So starting on page 1, we had a strong end to the year, with record net income for a fourth quarter of $6.7 billion, EPS of $1.71, and return on tangible common equity of 14% on revenue of $24.3 billion, reflecting strong performance broadly across our businesses in a more constructive environment. You'll see on the page, a tax benefit of $475 million included in the result in the CIB, as we were able to utilize certain deferred tax assets. The quarter would still have been a record without that benefit. +Highlights for the quarter included core loan growth of 12% with strength across businesses, continued double-digit consumer deposit growth, ending with deposits over $600 billion, and record card sales volume up 14% on continued strong momentum. In addition, markets revenue was the highest on record for a fourth quarter, up 24% year-on-year, and credit performance remains, strong with net reserve releases across both consumer and wholesale. +Moving on to page 2, and some more detail about the fourth quarter, revenue of $24.3 billion was up $600 million, or 2% year-on-year, driven by net interest income on the back of continued strong loan growth, as well as the impact of higher rates. Non-interest revenue was flat year-on-year, with strength in markets offset by higher card new account acquisition costs. +Adjusted expense of $13.6 billion was flat year-on-year, and this quarter's results included nearly $200 million of after-tax legal expense. Credit costs of $860 million in the quarter included a net reserve release of a little over $400 million across consumer and wholesale. Energy remained stable, and we saw modest releases in both oil and gas and metals and mining. +Shifting to the full year on page 3, another full-year record net income of $24.7 billion, and a return on tangible common equity of 13% on $99 billion of revenue. And while net income was up 1%, our EPS of $6.19 was up more than that as we continued our disciplined capital return to shareholders. Revenue was up $2.5 billion, driven by NII, up $2.7 billion, on the back of loan growth and the impact of higher rates. +Non-interest revenue remained flat year-on-year, reflecting strength in markets and funding card new account acquisitions, as well as lower asset management revenues. Adjusted expense for the year came in at $56 billion as expected, and our adjusted overhead ratio improved to 57%, as we continued to execute on and near the end of our strategic cost programs in CCB and CIB, as well as self-funding incremental investments in growth of nearly a billion dollars year-on-year. In addition, legal expense for the year was a modest positive. +Credit costs for the year were $5.4 billion. Net charge-offs of $4.7 billion were in line with guidance, and included $270 million of charge-offs related to oil and gas and metals and mining. And we added [$670] million of net reserves, reflecting builds in card and energy, largely offset by releases in mortgage. Finally, net capital distributions for the year were approximately $15 billion, up $4 billion or 37%, including dividends of $1.88 a share, up 9%. +Turning to page 4 and capital, we ended the year above 12% for both standardized and advanced fully phased-in CET1 ratios, in line with our expectations. Net capital generation for the quarter, while positive, included a 16 basis point impact of higher rates on investment securities AOCI. The advanced ratio improved primarily due to lower account party and market risk, whereas standardized was up by less, reflecting the impact of high quality loan growth. +We've been disciplined managing our balance sheet, and our average balance sheet for the quarter was a little over $2.5 trillion, and $1.5 trillion of RWA. SLR was down slightly from the prior quarter at 6.5%, as our average balance sheet was higher this quarter, primarily driven by deposit. +Moving on to page 5, and consumer and community banking, consumer and community banking generated $2.4 billion of net income, and an ROE of 17%. We grew deposits a record $60 billion year-over-year, up 11%, exceeding $600 billion. +Core loans were up 14%, with mortgage up over 20%, but strength across all products, also up 11%, business banking up 9%, and card up 8%. We saw record card sales volume in the quarter, up 14% marking the strongest growth in a decade. Card new account originations were up 8%. They were up 20% for the full year, driven by strong demand for new products, and nearly 80% of those accounts were opened through digital channels. Merchant processing volumes were up 10% year-on-year, and surpassed the $1 trillion mark last year and our active mobile customer base continues to grow and was up 16%. +Revenue of $11 billion was down modestly year-on-year, reflecting a reduction in card revenue. Recall that last year included a $160 million gain on the Square IPO. And in addition, strong momentum in card and auto was more than offset by the investments in our card new account acquisitions. Consumer and business banking revenue was up 4% on strong deposit growth, and mortgage revenue was relatively flat as higher production margins and volumes were offset by lower servicing revenue on lower balances. +Expense of $6.3 billion was flat year-on-year, as growth in the business was largely offset by continued expense efficiencies and lower legal. Finally the credit trends in our portfolio remained favorable. We saw net reserve releases in the quarter driven by mortgage on lower delinquencies, as well as improving HPI, with releases of $275 million in the PCI portfolio and $150 million in NCI. +On PCI specifically, actual losses have been lower than modeled output, and the release this quarter reflects that trend. We will continue to observe actuals, and recalibrate our models as necessary, which may result in future releases. These releases in mortgage were partially offset by a build in card of $150 million, and $50 million in business banking, both on the back of strong loan growth. +Charge-offs increased year-over-year driven by card, as newer vintages continue to season in line with our expectations. And in auto, we are watching industry trends in sub prime and used car prices, but our heavily prime auto portfolio continues to perform well. +Now turning to page 6, and the corporate investment bank., CIB delivered a very strong result, with net income of $3.4 billion, and an ROE of 20%. Adjusting for legal, tax and credit costs, the ROE was a strong 17% for the quarter. Revenue of $8.5 billion, up 20% year-on-year, was our best reported performance ever for a fourth quarter. +As we look at the full year a moment on lead tables, in banking we ranked number one in global IB fees, and number one in North America and EMEA, and we were the only bank among the top 5 to grow share. In M&A, we continued to rank number two globally, and did more deals than anyone else last year. In ECM, we maintained our number one ranking, improved our share, and were number one in volume across all products, and in both North America and Europe. And in DCM, we ranked number one across high yield, high grade and loans. +Back to the quarter, IB revenue was $1.5 billion, up 1% year-on-year. Advisory fees were down 17% from a strong prior year quarter, and impacted by lower announced volumes in the first half of last year. Equity underwriting fees were down 5%, a little better than the market with strong performance in North America, and debt underwriting fees were up 32% relative to a weak prior year quarter on strong flow issuance, as well as acquisition financing. Treasury services revenue of $950 million was up 5%, driven by higher rates and operating balance growth, as well as higher fees on increased payment volumes. +Moving on to markets, another strong quarter with the highest revenue on record for a fourth quarter in total, and for each of 16 common equities. And like last quarter, the strength was broad-based. Revenue of $4.5 billion was up 24% year-on-year, in part flattered by a weaker fourth quarter last year, but on the whole driven by momentum carried forward from the third quarter, and the ability to capture flow from higher volatility and client activity. The back drop was that of a healthier global economic outlook, increased optimism, and global political developments. +More specifically, fixed income revenue was up 31%, as we saw increased client risk appetite for spread product, as well as client's actively hedging commodities in a better energy market. And equities revenue was up 8% reflecting strong performance in derivatives. Credit costs were a benefit of nearly $200 million, primarily driven by oil and gas and metals and mining. And finally, expense of $4.2 billion was down 6% year-on-year, primarily on lower compensation resulting in a comp to revenue ratio of 27% for the full year. +Moving on to page 7, and commercial banking, another outstanding quarter in commercial banking, with net income of $687 million, record revenue of $2 billion, and an ROE of 16%. Revenue was up 12% and expense down 1%, with a overhead ratio of 38%. Loan growth remains robust, credit performance remains strong, and client sentiment has improved. +Revenue growth was driven by higher deposit NII and loan growth, with loan spreads holding steady, as well as higher IB revenue with good underlying deal flow. For the full year, IB revenue was a record $2.3 billion, up 5% year-on-year as we gained share. Expense was down slightly, with the impact of impairment in the aircraft leasing business last year offset by investments we've made in bankers and technologies this year. +We ended the year with record loan balances of $189 billion, up 14% year-on-year, with growth in both C&I and CRE. C&I loans were up 9%, as the investments we've made in specialized industry coverage, as well as adding over 130 net new bankers this year contributed to growth. And CRE loans were up 19%. +Finally credit performance remains strong, with a net charge-off rate of 11 basis points, driven by a couple of oil and gas mains largely reserved for. And we saw a modest increase in loan loss reserves driven by select client downgrades. In CRE, we had no net charge-offs, and we reiterate three quarters of this portfolio is multi-family lending, to own as a stabilized Class B and C properties in supply-constrained markets. And the remainder is real estate developers that we know well, and we continue to be disciplined, and limit exposures to riskier segments of the market. +Leaving the commercial bank, and moving on to asset management on page 8. Asset management reported net income of $586 million, with a 30% pre-tax margin and an ROE of 25%. Revenue of $3.1 billion was up 1% year-on-year, driven primarily by strong banking results on higher deposit NII and continued loan growth, predominantly offset by prior period asset disposals. Expense of $2.2 billion was down 1% year-on-year. +For the full year, we had long-term net inflows of $23 billion in a challenging environment, driven predominantly by fixed income, multi asset and alternatives. In addition, we gathered $24 billion of liquidity flows this year. However, for the quarter, we saw net long-term outflows of $21 billion, obviously disappointing. But on a more positive note, we saw liquidity inflows of $35 billion this quarter, gaining share and strengthening our leadership position during this period of money market reform. +AUM grew 3% year-on-year, and overall client assets 4% to $1.8 trillion and $2.5 trillion, respectively, driven by net inflows, as well as higher market levels. And our long-term investment performance remained solid, with 80% of mutual fund AUM ranked in the first or second quartile over five years. And we had record loan balances up 4%, and record deposit balances up 9%. +Moving to page 9, and corporate, Treasury and CIO was flat quarter-on-quarter, with a net loss of around $200 million, and other corporate was a loss of $144 million primarily driven by legal expense. +Turning to page 10, and the outlook, looking forward to the first quarter, expect net interest income for the Firm to be up modestly, reflecting the impact of the December rate hike, as well as continued loan growth. For asset management, expect revenue will be slightly less than $3 billion, reflecting seasonality of performance fees. And recall that last year's first quarter included a $150 million gain on the sale of an asset. On expense, expect CCB to be up around $150 million sequentially on higher auto lease depreciation, as well as seasonally higher compensation and marketing, and expect expense in the commercial bank to be up quarter-on-quarter to around $775 million as we continue to invest. +Obviously, we're looking forward to Investor Day, and we'll give you more detailed 2017 guidance then. So to wrap up, a record fourth quarter and a record year, both net income and EPS demonstrating the strength of the platform. We enjoyed revenue growth, we met our expense and capital commitments, increased payouts to shareholders, and generated good returns on higher capital. As we move into the New Year, we remain well-positioned, and are excited about the opportunities to grow the Business by serving our clients and communities. +With that, operator, we'll take Q&A. Operator? + + +================================================================================ +Questions and Answers +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) +Your first question comes from the line of Ken Usdin with Jefferies. + +-------------------------------------------------------------------------------- +Ken Usdin, Jefferies LLC - Analyst [2] +-------------------------------------------------------------------------------- + + Hi, thanks. Good morning. Marianne, I was just wondering -- I know you'll give us more at Investor Day, but just in terms of that first quarter starting point for NII, and just how it translates between growth in the balance sheet? And then, you mentioned the benefit from the roll over in rates, can you help us just try to think about -- just you parse those views out, and think about volume versus rate? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Company - CFO [3] +-------------------------------------------------------------------------------- + + Yes. So hey, Ken, you guys have a busy day today. So I would say that, the first quarter is always a quarter in which we have a bunch of different factors. And most notably, you also have day count issues in the first quarter. So I can go through that, but I would say most of the benefit which we expect to be up modestly will be driven by the rate increase, with growth being offset by day count. That's sort of fundamentally how to think about it. +It's probably more instructive to think about the full year. And so, if you recall back to the third quarter, just to kind of reorient everyone, at that point when we didn't have the December hike, we said rates flat. So on growth alone, we would expect NII for the full year to be up about $1.5 billion. Obviously, we have had the 25 basis point hike in December. And based upon that alone, so now the new rate flat, that $1.5 billion would be about $3 billion, a little over $3 billon. So for the full year, we're expecting on the December hike alone, that it would be about half volume, and about half rate. + +-------------------------------------------------------------------------------- +Ken Usdin, Jefferies LLC - Analyst [4] +-------------------------------------------------------------------------------- + + Understood, great. And if I could ask a follow-up? Just on the volume side, you had another great year of double-digit loan growth. And obviously, we're at this intersection between kind of the what was, and then the what will be. Any change to that expectation you could just grow the loan [bit] book, a core loan book that is, as strongly as you have in the past few years? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Company - CFO [5] +-------------------------------------------------------------------------------- + + Yes. So I think the way to think about it, and again, I think we talked a little bit about it last quarter, and you maybe see it in the fourth quarter. So we've been growing our loans in the -- we said it was going to be a 10% to15%. We revised that, to be at the top end of that range. So we've been growing at around 15% core loan growth, the fourth quarter was 12%. So I wouldn't call it a deceleration per se, but it is a little bit lower. So I think going into 2017, our expectation is that we would continue to grow loans strongly, but possibly at the lower end of that range, rather than the higher. And of course, to a degree, it will depend upon our mortgage portfolio, but we intend to continue to add to that too. So sitting here today, I'd say more high single 10% plus or minus, and we'll give you more updates at Investor Day. + +-------------------------------------------------------------------------------- +Ken Usdin, Jefferies LLC - Analyst [6] +-------------------------------------------------------------------------------- + + Okay. Thanks very much. + +-------------------------------------------------------------------------------- +Operator [7] +-------------------------------------------------------------------------------- + + Your next question comes from Betsy Graseck with Morgan Stanley. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [8] +-------------------------------------------------------------------------------- + + Hi, good morning. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Company - CFO [9] +-------------------------------------------------------------------------------- + + Good morning. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [10] +-------------------------------------------------------------------------------- + + I just wanted to dig in a little bit on the forward look. NII up a bit, but also expense is up a bit. And I just wanted to understand is that because you've got the opportunity to reinvest in things that you haven't been able to? And if you could just speak to what kind of time frame the reinvestment will yield returns, because the question I've gotten from people is, why aren't you dropping the NII benefit to the bottom line here? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Company - CFO [11] +-------------------------------------------------------------------------------- + + So just taking the two things separately, Betsy, I would say the NII, up 5% is dropping to the bottom line. But as we, you saw all of our underlying drivers, across all of the businesses and volumes, transactions, everything is growing very strongly. And although we still have some work to do to finish the large expense programs, we're near the end of that. So just generally speaking, we're continuing to invest in the businesses, and we'll see the improvement in our expenses flatten out, and start to grow with volumes. And that would also support growth in non-interest revenue, outside obviously of the card phenomenon we talked to you about. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [12] +-------------------------------------------------------------------------------- + + And then related follow-up has to do with, how you're thinking about the excess cash you've got, and the balance sheet duration? And if there's anything in this new interest rate environment that you would be seeking to do -- (multiple speakers) to optimize -- + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Company - CFO [13] +-------------------------------------------------------------------------------- + + Sorry, carry on. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [14] +-------------------------------------------------------------------------------- + + Oh, to optimize your position. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Company - CFO [15] +-------------------------------------------------------------------------------- + + Right. So when we think about our investment securities portfolio, we think about it as responding to structural changes in our balance sheet, which predominantly is driven by loans and deposits. And it's always important I think, to remember, because we focus a lot on structural interest rate risk, but it also is liquidity and liquidity risk. In this quarter, there was a combination of things. You saw that we grew deposits more strongly than loans this quarter, so we had some excess cash, as well as the fact that rates rose. +So two things happened in our investment securities portfolio, mortgages extended, and we did add to duration. But we have a very disciplined risk management framework that's based -- that's been consistent through time, based on our expectations of normal rates in the future, and we just executed on that strategy. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [16] +-------------------------------------------------------------------------------- + + Okay. So no change to the duration? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Company - CFO [17] +-------------------------------------------------------------------------------- + + Yes, we added to duration, in accordance with our framework. + +-------------------------------------------------------------------------------- +Betsy Graseck, Morgan Stanley - Analyst [18] +-------------------------------------------------------------------------------- + + Okay. + +-------------------------------------------------------------------------------- +Operator [19] +-------------------------------------------------------------------------------- + + Your next question comes from the line of John McDonald with Sanford & Bernstein. + +-------------------------------------------------------------------------------- +John McDonald, Bernstein - Analyst [20] +-------------------------------------------------------------------------------- + + Hi, good morning. Marianne, I was wondering if you could comment a little bit about some more color in card trends? You have exciting new products out there. How are the economics of the Sapphire Reserve card been coming in relative to your expectations, and what factors drove the decision to cut the original promotion award back, and should that affect your account acquisition costs? Thanks. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Company - CFO [21] +-------------------------------------------------------------------------------- + + Great. So obviously, the Sapphire Reserve card is still quite young, or still quite new. But relative to our modeled expectations even at the intro promo premium, things are coming in, in line or better than our expectations. Now obviously, we need to continue to [back test] that [three] times. But we're very encouraged by, not only the excitement in our customer base, but also the way that the trends are performing in terms of spend and engagement. But when we introduce a new product, we intentionally introduce a very exciting premium promo, and it's intended to generate excitement. And I think you would agree it did. So we're delighted with the response that we've had. +And we've actually kept it up for longer than we initially expected, but it's normal for us to come down from those intro rates, as the product becomes more mature, and that's what we are doing. But to be very clear about our expectations of the performance of the card, even at 100,000 points, we still expected the card to be a strong return and very accretive. So obviously, at a lower premium, it would be more so. But one last thing I would say, is everybody gets very interested the up front points. It's our opinion that the real value to consumers of that card happens over time with their spend behavior, and to take the points down from 100,000 to 50,000 has less than a 10% reduction in the overall value through the lifetime of an engaged customer on average. + +-------------------------------------------------------------------------------- +John McDonald, Bernstein - Analyst [22] +-------------------------------------------------------------------------------- + + Okay. And just as a follow-up on that, in terms of the card, credit quality, it's been very good. Would you still expect to see though some seasoning as the book matures? What kind of outlook would you have on the card charge-offs? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Company - CFO [23] +-------------------------------------------------------------------------------- + + So the charge-offs came in for the year at 2.63%, which is in line with the guidance that we gave, I think in November that Kevin Watters gave. He's given guidance for 2017, as we continue to see the newer vintages seasoned, are 2.75% plus or minus. And that's still our expectation, so the newer vintages are performing in line with our expectations. + +-------------------------------------------------------------------------------- +John McDonald, Bernstein - Analyst [24] +-------------------------------------------------------------------------------- + + Thanks. + +-------------------------------------------------------------------------------- +Operator [25] +-------------------------------------------------------------------------------- + + Your next question comes from the line of Erika Najarian from Bank of America. + +-------------------------------------------------------------------------------- +Erika Najarian, BofA Merrill Lynch - Analyst [26] +-------------------------------------------------------------------------------- + + Hi, good morning. I know that you've said previously that regulatory reform or regulatory relief will unlikely have any fundamental change in terms of how you're thinking about budgeting. But I'm wondering if you could help us understand, sort of over the past few years, how much has regulatory costs grown, and has that peaked anyway? And can you give us a sense of how that could trend over the next few years, either the natural trend of it, or what the impact would be of regulatory reform? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Company - CFO [27] +-------------------------------------------------------------------------------- + + Yes. So I'll give you a couple of things, and hopefully that will help. So I think a year or so ago, we talked about the fact that -- I'm going to now talk about cost of controls more broadly than just regulatory, that the cost of controls had increased for the Company by about $3 billion over several years. But that we expected they would peak and start bending down, and that is indeed what we have been seeing. Now I'm not saying that bend down is a sharp bend, as we continue to be held to very sort of hard compliance burdens. But nevertheless, we are seeing some efficiencies as we mature our processes and automate them. +Offsetting against that, and one of the reasons why it may be less obvious, is that we've continued to increase our spend in cyber security, as we want to protect the bank and the customer's data. So naturally, that is happening. We are not going to continue at this point, carving out the costs of regulatory or control because that is our operating model, it's our new normal. And until we understand whether or not the forward-looking landscape is changed, we won't be able to give you any kind of idea about how and when that will impact our expenses. But we will continue to be more and more efficient. +And certainly, if we are able to take a step back, and look at the rules and regulations, and the way that they are being implemented, and make rational changes to it, if that is something that is -- allows us to become more efficient, then we will certainly do that, and keep you informed. + +-------------------------------------------------------------------------------- +Erika Najarian, BofA Merrill Lynch - Analyst [28] +-------------------------------------------------------------------------------- + + Great. And just as a follow-up to John's question on card trends, when you look at the card revenue rate declining about 200 basis points or so year-over-year, is your response to this question essentially implying that we've potentially hit peak promotion in 2016, and perhaps the revenue rate will have some stability to it in 2017? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Company - CFO [29] +-------------------------------------------------------------------------------- + + So I think in the conference in November, Kevin Watters said that as we look at the new products, and we look at them growing, coming out in 2016 and into 2017, we would expect the card revenue rate for the year next year to be about 10.5%, after which as the cards and the accounts season and drive revenue growth, we should see that continue to trend back up to a level in the past. + +-------------------------------------------------------------------------------- +Erika Najarian, BofA Merrill Lynch - Analyst [30] +-------------------------------------------------------------------------------- + + Got it. Thank you. + +-------------------------------------------------------------------------------- +Operator [31] +-------------------------------------------------------------------------------- + + Your next question comes from the line of Mike Mayo with CLSA. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA Limited - Analyst [32] +-------------------------------------------------------------------------------- + + Hi. Is Jamie on the call? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Company - Chairman & CEO [33] +-------------------------------------------------------------------------------- + + Yes. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA Limited - Analyst [34] +-------------------------------------------------------------------------------- + + So Jamie, your comment said that the US economy may be gaining momentum. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Company - Chairman & CEO [35] +-------------------------------------------------------------------------------- + + Yes. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA Limited - Analyst [36] +-------------------------------------------------------------------------------- + + If you can give some of the basis for that comment, is it more risk borne by investors, or more CapEx by companies, or is this more hope? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Company - Chairman & CEO [37] +-------------------------------------------------------------------------------- + + I mean, I think that it's actual detail of retail spend, auto sales, house prices, household formation, confidence numbers. So I'm not basing it on the market, I'm just basing it -- if you look at a broad range of things, it looks like growth may have gotten a little bit better in the fourth quarter. Plus if you take a walk around the world, Japan is doing a little better, Europe is doing better. In fact, one of the IMF [or someone else] came out yesterday, and [said] the global growth is going to tick up next year. So it's just those factors. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA Limited - Analyst [38] +-------------------------------------------------------------------------------- + + Is that enough for you to say you're going to invest a little bit more, or hire more people, or expand a little bit more? And along those lines, how do you see market share gains potentially from now? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Company - Chairman & CEO [39] +-------------------------------------------------------------------------------- + + We're not going to change our plans very much, because we don't really react that much to the weather, because we grow to add bankers and stuff. You know you have to do it through a cycle. I do think of it as some regulatory relief. You will see banks be more aggressive and growing, opening branches in new cities, adding to loan portfolios, seeking out clients they don't have. So I'm hoping to see a little bit of that too, but that will wait for regulatory relief. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA Limited - Analyst [40] +-------------------------------------------------------------------------------- + + Why are you saying this might be a little bit more than just weather, that this might be more sustainable, when you say the economy might be turning? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Company - Chairman & CEO [41] +-------------------------------------------------------------------------------- + + Well, I'm saying we don't react to the small change in the economy to how we grow and expand our business. But I just that it looks to us, if you look across the broad spectrum, capital expenditures, business confidence, consumer confidence, household building, household formation, wage income, wages going up, unemployment going down, auto sales going up, retail sales going up, it looks like it's getting stronger, not weaker. That's what it looks like to me. That's just my own personal belief. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Company - CFO [42] +-------------------------------------------------------------------------------- + + And maybe just if we give you a bit of insight into the philosophy about how we do our investment and expense budgeting. When we talk to our businesses, regardless to Jamie's point about necessarily whether the external factors are moving, the question is, what do we want to do in terms of products and services and technology and bankers and offices that we can execute on well and responsibly? And that is typically what defines us, not our appetite to invest the dollars. +So I think we've told you pretty consistently that, and you've seen it. We added 130 net new bankers, we opened eight offices in the commercial bank. We're investing in technology very, very broadly, payments, digital across the Company. So I would say that, we don't feel like we've been held back in terms of our appetite to invest, because of concern around the economy. And in the same way, a more confident outlook in the economy won't step change that. But we will continue to look for great investments everywhere we can and make them. + +-------------------------------------------------------------------------------- +Mike Mayo, CLSA Limited - Analyst [43] +-------------------------------------------------------------------------------- + + All right. Thank you. + +-------------------------------------------------------------------------------- +Operator [44] +-------------------------------------------------------------------------------- + + Your next question comes from the line of Jim Mitchell from Buckingham Research. + +-------------------------------------------------------------------------------- +James Mitchell, Buckingham Research Group - Analyst [45] +-------------------------------------------------------------------------------- + + Hey, good morning. Maybe we could talk a little bit about the investment bank? Obviously, your peers and a lot of investors have been growing in their optimism for this year, in terms of animal spirits and everything else, and just want to get a sense of how you're thinking about it? Do you share that optimism, and any commentary on how we can think about both banking and trading into the New Year, with all of the moving parts that we have around policy, et cetera? Thanks. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Company - CFO [46] +-------------------------------------------------------------------------------- + + So I would say, just if we separate the two, and just talk for one second about banking. The fundamentals for a solid M&A year are there, and obviously there will be puts and takes depending on what happens in the policy and reforms space. But we're optimistic about a solid M&A market, but with the continuing trend of fewer mega deals, but nevertheless good flow. At ECM, looks set to be quite active, and the IPO market continuing to recover, and debt capital markets have a solid pipeline in terms of the refinance arena, but having said that, interest rates may have an impact. So I think pretty solid pipeline coming into the year, but lots of factors will ultimately affect the full year. +With respect to trading, Jamie said, that we don't look at the first couple of weeks, but so far, so good. And what I would tell you is, we said this before, we're a client flow oriented business. And there will be a lot of micro and event-driven activity, and as long as it's not discontinuous, we should be able to intermediate transactions with our clients. And so far, generally there's been more risk appetite in the investor space, but that can change very quickly as we saw in previous quarters. So we will be there to support our clients. And if they are active, everything should be good, but it can change quickly. + +-------------------------------------------------------------------------------- +James Mitchell, Buckingham Research Group - Analyst [47] +-------------------------------------------------------------------------------- + + Okay, that's helpful. And maybe as a follow-up. On the expense side, the comp ratio in the investment bank, I think dropped around 240 basis points this year or last year. Do you think that's sustainable into 2017, assuming flat to up revenues, or was there anything unusual in there? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Company - CFO [48] +-------------------------------------------------------------------------------- + + So just reminding you about our sort of philosophy on comp to revenue, we pay -- or our comp to revenue is just a calculation, obviously we pay for shareholder value-added. So you need to take into consideration the fact that we've had overtime increased capital levels and liquidity levels, and that's reflected in a declining overall comp to revenue ratio. I would say that there are three factors to it being lower. +The first is the strength in performance, and the pay outs aren't linear. And as you have stronger performance, you would expect to see a lower ultimate outcome. But importantly, we were -- some tail winds in the numbers this year included a stronger dollar. So as we pay -- remember comp to revenue isn't just on the front office compensation, it all supports our salaries, benefits and compensation. And we have a large number of people that we pay not in dollars. So that was a bit of a tail wind. Some of that will carry on, but maybe not at the same level. And we also just did our normal regular hygiene and productivity, in terms of the -- how we think about the workforce and pay. At the end of the day, we pay for performance, we pay, we think very competitively, to retain the best team on the street, and make sure that our shareholders are getting a fair share of any outperformance. + +-------------------------------------------------------------------------------- +James Mitchell, Buckingham Research Group - Analyst [49] +-------------------------------------------------------------------------------- + + Okay. All right. Thanks. + +-------------------------------------------------------------------------------- +Operator [50] +-------------------------------------------------------------------------------- + + Your next question comes from the line of Paul Miller from FBR. + +-------------------------------------------------------------------------------- +Paul Miller, FBR & Co. - Analyst [51] +-------------------------------------------------------------------------------- + + Yes, thank you very much. Hey, Jamie, one of the things that we're seeing, some of the new politicians, coming in talking about opening up to credit box, especially in the mortgage world that has been really shut down over the last years, mainly due to the rules coming from all of the things, Fannie, Freddie, [UB]. What type of things do you need to see or do you think they can do to open up that credit box, where banks can take more risk and be protected? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Company - Chairman & CEO [52] +-------------------------------------------------------------------------------- + + Simplifying the securitization rules, because we've done some securitizations. We think they're excellent, but that would open up the market a little bit, clarifying the Safe Harbors on certain types of underwriting. For example, it's very hard and risky for a bank to make a loan to first time buyers, former bankruptcies, even though it could be very good people with brand new jobs, self-employed, it's hard to necessarily do all of the income verification, stuff like that. Simplifying servicing, the services standards now have, I think nationwide, we have 3,000 different standards. It's very costly. +It's very expensive. It's kind of risky. If you make a mistake, the punishment is pretty high. And all those things, that should be done for the good of the United States of America, not for the good of JPMorgan Chase. And so, I do think it's too tight and there's one thing, that if you get around too quickly, it will help the housing market a little bit, it will help the housing formation, it will reduce the cost of mortgages, and make it available to more people. + +-------------------------------------------------------------------------------- +Paul Miller, FBR & Co. - Analyst [53] +-------------------------------------------------------------------------------- + + Yes, okay, Jamie. Thank you very much. + +-------------------------------------------------------------------------------- +Operator [54] +-------------------------------------------------------------------------------- + + Your next question comes from the line of Glenn Schorr with Evercore ISI. + +-------------------------------------------------------------------------------- +Glenn Schorr, Evercore ISI - Analyst [55] +-------------------------------------------------------------------------------- + + Hi, thanks. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Company - CFO [56] +-------------------------------------------------------------------------------- + + Hi, Glenn. + +-------------------------------------------------------------------------------- +Glenn Schorr, Evercore ISI - Analyst [57] +-------------------------------------------------------------------------------- + + Hello, there. So I guess the question for either one of you is, if we do get some lower taxes and/or a better rate environment, I'm curious on your confidence on how much of that can fall to the bottom line? Because there's a lot of optimism about what can happen if stocks have moved well, we're expecting that to move to the bottom line. There's the big concern that people have is, that it gets competed away by irrational behavior. So curious to get your thoughts on that, just big picture in general, if things go well how much of that are you repaying? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Company - CFO [58] +-------------------------------------------------------------------------------- + + So starting off with sort of interest rates. And obviously, we've talked for an extended period of time about the fact we've positioned the Company to benefit when rates rise, we built the branches, we acquired the accounts, we've built the technology and the services. So we've been growing our deposits very strongly, and we're going to enjoy the benefits of that. With respect to how much will go to the bottom line, we have been we think appropriately conservative, when we've given you guidance about ultimately how much incremental NII we would expect in a more normal rate environment. +I mean, if you go back to Investor Days of past, you would see that we said when normalized, we would expect $10 billion-plus, and embedded in that are assumptions obviously around rate paid. We think that rate paid will be higher this time in this cycle, than in previous cycles for a bunch of reasons including as you said, competition for high quality liquidity balances. But also that we are coming off of zero rates and the improvement in technology. So we've been, we think appropriately conservative, but we'll find out in the fullness of time. +So far two rate hikes, absolute rates at 50 basis points, it's too early. And so far, you would expect there to be (inaudible) in there, and it's not linear, and everything is behaving quite rationally right now. So we, in fact, if anything a little better than we had modeled. So we'll keep watching it, and we think we've been thoughtful. We don't know the right answer, and we'll keep you updated as we see how things progress. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Company - Chairman & CEO [59] +-------------------------------------------------------------------------------- + + And just on the tax side, so other people understand, generally, yes, if you reduce the tax rates all things being equal to 20% of something, eventually that increased return will be competed away. That is a good thing. Okay, so it's not a good thing for JPMorgan Chase per se, but it's a good thing for the world, it's a good thing for growth. And a lot of studies actually show the beneficiary of that is wages. And so, it's important for people to understand that good tax policy is good for growth and the country in general. It's not just good for companies, it will eventually be competed away. + +-------------------------------------------------------------------------------- +Glenn Schorr, Evercore ISI - Analyst [60] +-------------------------------------------------------------------------------- + + So when should I take that lower tax rate out of my model? I'm kidding (laughter). + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Company - Chairman & CEO [61] +-------------------------------------------------------------------------------- + + Listen, you aren't going to really know for probably nine months to a year exactly what it is, so I wouldn't worry too much about it. And I also, just remember the most efficient companies do benefit from things like this, more than others. + +-------------------------------------------------------------------------------- +Glenn Schorr, Evercore ISI - Analyst [62] +-------------------------------------------------------------------------------- + + The real follow-up I had was, that the concept of interest deductibility, if that is the means that they use to pay for the tax hikes, it feels tough, like a bad thing. I'm just curious on how you think it impacts your franchise, from anything from debt underwriting to anything else? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Company - Chairman & CEO [63] +-------------------------------------------------------------------------------- + + I think if you look at -- I mean, again, there's a lot of wood to be chopped and sausage to be made before tax reform gets done. And some of these things are brand new, they've never been talked about or done before, so you can read a lot of studies in the next six months. Obviously, interest deductibility, for banks, from a net interest income, so it doesn't directly change how you look at it. For everybody else, it affects complete industries differently. How you leverage differently, and utilities will be in a different position, and unleveraged companies. And plus, I think people will be able to convert what would have been interest expense to some other kind of expense. So let the work get done, before we spend too much time guessing about it. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Company - CFO [64] +-------------------------------------------------------------------------------- + + I also think that while interest deductibility is one point, the repatriation of cash is another point. And there are puts and takes, and you have to think, you have to see the whole package, before you can see what the net impact is. But ultimately if these things get done rationally and grow the economy, then it's good for our franchise just broadly. So don't focus on DCM, focus on the whole thing. And I think when you get the whole package, if it's done well which we hope will happen, then it will be good for the economy, good for our clients, and good for our whole franchise. + +-------------------------------------------------------------------------------- +Glenn Schorr, Evercore ISI - Analyst [65] +-------------------------------------------------------------------------------- + + Okay. Thank you both. + +-------------------------------------------------------------------------------- +Operator [66] +-------------------------------------------------------------------------------- + + Your next question comes from the line of Matt O'Connor from Deutsche Bank. + +-------------------------------------------------------------------------------- +Matt O'Connor, Deutsche Bank - Analyst [67] +-------------------------------------------------------------------------------- + + If I could circle back to the discussion on net interest income and the rate leverage. I think the outlook for net interest income to grow over $3 billion versus $1.5 billion before the rate increase. That's obviously a nice lift for just a 25 basis point bump on the short end. So I guess, one, does that include the benefit of longer term rates since they've moved up as well since 9/30, which I assume it does, but just to confirm that? And secondly, what's the leverage to rising rates from here, as we think about movements in both the short and long end? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Company - CFO [68] +-------------------------------------------------------------------------------- + + Yes, okay. So yes, Matt, it does include the benefit of higher long end rates. And if you get the Q, and get our disclosure on net income risk, and do some math, you'll get pretty close to numbers that looks similar to that $1.5 billion or more. And then, with respect to rate sensitivity from here, clearly it's not linear. So you can see, if we just look at the third quarter, the first 100 basis points -- this is an illustration of $2.8 billion, 200 basis points is $4.5 billion. So as we clip away, 25 basis points a time, our $2.8 billion will start to come down. And so, that's broadly the outlook. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Company - Chairman & CEO [69] +-------------------------------------------------------------------------------- + + And the next 10-Q will show the next -- (multiple speakers). + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Company - CFO [70] +-------------------------------------------------------------------------------- + + And the next 10-Q will show the next. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Company - Chairman & CEO [71] +-------------------------------------------------------------------------------- + + But obviously, it's less and less as rates go up. It's not linear. + +-------------------------------------------------------------------------------- +Matt O'Connor, Deutsche Bank - Analyst [72] +-------------------------------------------------------------------------------- + + And then just -- + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Company - Chairman & CEO [73] +-------------------------------------------------------------------------------- + + Unless we actively change the ratio, which we may also do at one point. + +-------------------------------------------------------------------------------- +Matt O'Connor, Deutsche Bank - Analyst [74] +-------------------------------------------------------------------------------- + + And that is actually -- getting to my follow-up question. I mean, on the size of the balance sheet, you did talk about loan growth of about 10% this year. If you look full year 2016 versus 2015, the balance sheet or the earning assets only rose 1%. So maybe tie that into, as you think about duration, the fact that you're sitting on a lot of liquidity and cash, and how we should think about both overall growth in the balance sheet, and then potentially some more remixing? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Company - CFO [75] +-------------------------------------------------------------------------------- + + Yes. So I mean, what you saw happen in 2016 was not only obviously a rotation from securities and deploying deposits into loans, but also we took a very large amount of non-operating deposits out of the balance sheet in 2016. So that is having an impact. But we would expect to continue to grow our loans, to grow our deposits strongly to manage the overall balance sheet through our investment securities portfolio. And from here, if everything continues to be as the market implies, we should see margin expansion. + +-------------------------------------------------------------------------------- +Matt O'Connor, Deutsche Bank - Analyst [76] +-------------------------------------------------------------------------------- + + Okay. All right, thank you. + +-------------------------------------------------------------------------------- +Operator [77] +-------------------------------------------------------------------------------- + + Your next question comes from the line of Brian Kleinhanzl from KBW. + +-------------------------------------------------------------------------------- +Brian Kleinhanzl, Keefe, Bruyette & Woods - Analyst [78] +-------------------------------------------------------------------------------- + + Hi, good morning. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Company - CFO [79] +-------------------------------------------------------------------------------- + + Good morning. + +-------------------------------------------------------------------------------- +Brian Kleinhanzl, Keefe, Bruyette & Woods - Analyst [80] +-------------------------------------------------------------------------------- + + Just a quick question on the credit and reserve releases, as it relates to the energy and metals and mining portfolio. Now that you've actually seen some better credit in there, how much of the reserves are left in that portfolio, and can you still see reserve releases going forward? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Company - CFO [81] +-------------------------------------------------------------------------------- + + Yes. So answer is across the metals and mining and energy, we have a little over $1.5 billion of reserves. I mean, there is a normal level of reserves that we will have, that would be a large chunk of that. And as you saw in 2016, we did take charge-offs of a little less than $300 million. So we will continue to likely see on a name specific basis, as people work through their business models, that there will be more charge-offs. But ultimately, if energy stays stable or improves, and of course, we have to see that be somewhat sustained, and find its way flowing through the financial statements of our clients. Then as we upgrade them, God willing, then we will see more reserve releases. But it's going to take some time. +We'll start to see some of that -- and think about the large reserves we took. We took them at the tail end of 2015 and into 2016, we'll start to see new financial data from our clients. We'll start to do the borrowing base redeterminations, and look at the impact of prices on reserves in the spring. And so, we'll start getting some data this year, and so we may see some more releases, but it's going to come through over time. + +-------------------------------------------------------------------------------- +Brian Kleinhanzl, Keefe, Bruyette & Woods - Analyst [82] +-------------------------------------------------------------------------------- + + Okay, thanks. And then, also on CRE, again strong loan growth year over year. I mean, I understand that you're focusing in these housing-constrained markets, but is there a limit to how much you can grow in those markets? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Company - CFO [83] +-------------------------------------------------------------------------------- + + Yes, I mean, I would say that when I talk about the overall core loan growth going down, still being strong, it does reflect the fact that we've been seeing very strong outperformance in our growth over the course of the last couple of years, particularly in commercial term lending. And while we continue to believe there's great opportunities there, they will be lower. So we've been printing in the teens pretty consistently, and I would say, it will be less red hot, and maybe more in the high single-digits, but we're going to keep you updated. + +-------------------------------------------------------------------------------- +Brian Kleinhanzl, Keefe, Bruyette & Woods - Analyst [84] +-------------------------------------------------------------------------------- + + Okay, thanks. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Company - CFO [85] +-------------------------------------------------------------------------------- + + There's still plenty of opportunity. + +-------------------------------------------------------------------------------- +Operator [86] +-------------------------------------------------------------------------------- + + Your next question comes from the line of Eric Wasserstrom from Guggenheim. + +-------------------------------------------------------------------------------- +Eric Wasserstrom, Guggenheim Securities LLC - Analyst [87] +-------------------------------------------------------------------------------- + + Thanks very much. Marianne, just to follow-up, a couple more questions on card. I know you've talked quite a bit about it already. But one of the sort of conventional wisdoms at the moment is that 2016 represented the pinnacle of the intensification of the competitive environment. And I just wanted to get your thoughts on whether that's an accurate assessment or not? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Company - CFO [88] +-------------------------------------------------------------------------------- + + Well, I don't know that I would ever try to decide what moment in time, is the pinnacle. But I would say, you saw us invest heavily in the business in 2015 and 2016 across a number of different fronts. You saw us proactively renegotiating the card program deals for the vast majority of our portfolio, and investing very heavily in exciting new products. And in both cases, while it has had an impact on our revenues, in one case in the short-term, and another case more structurally, in both cases these are still very attractive returns. And so, card is still a very attractive ROE business, very important to our customers. We are after deep engaged relationships through time with them. And so, we are going to continue to invest in growth. + +-------------------------------------------------------------------------------- +Eric Wasserstrom, Guggenheim Securities LLC - Analyst [89] +-------------------------------------------------------------------------------- + + Great. And just on that point, the ROA expectations that you have as a consequence of the trends that you just underscored, do you consider these to be, sustainable as you get back to that 11% kind of revenue yield? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Company - CFO [90] +-------------------------------------------------------------------------------- + + At this point, yes. + +-------------------------------------------------------------------------------- +Eric Wasserstrom, Guggenheim Securities LLC - Analyst [91] +-------------------------------------------------------------------------------- + + Okay, great. Thanks very much. + +-------------------------------------------------------------------------------- +Operator [92] +-------------------------------------------------------------------------------- + + Your next question comes from the line of Steven Chubak from Nomura. + +-------------------------------------------------------------------------------- +Steven Chubak, Nomura Securities Co., Ltd. - Analyst [93] +-------------------------------------------------------------------------------- + + Hi, Jamie. I wanted to start off with a big picture question on the trading side. You made some recent remarks talking about the outlook for the [FICC] business, and alluded to roughly half of the declines versus the peak being attributable to cyclical as well as secular factors, and a lot of FICC optimism in particular that we've spoken with have really latched on to your remarks. And I was hoping you could provide context as to how you determine the 50/50 split. Should we be taking those comments so literally? And how you're thinking about the FICC fee [portfolio] trajectory overall, as some of those cyclical headwinds abate? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Company - Chairman & CEO [94] +-------------------------------------------------------------------------------- + + We did try to actually analyze it, because we got asked a lot about what was secular. So you could break apart your exotic derivatives, certain types of CDOs. Of course, across the whole spectrum, there are things that disappeared and won't be done no more, for better or worse. In some cases, by the way, like a CDOs it didn't go away, because the person is still a credit buyer. So they just went to another product, but that was our best estimate. I don't want to over do it or anything like that. +I also said that the actual market making requirements are going to be going up over time, I'm talking about over 20 years, I'm not talking about the next quarter or next month. And remember, we don't run the business next quarter, next month, because assets under management are going up, and needs of corporations are going up. The fixed income mortgage is going to go up, the needs for FX is going up, the needs for hedging is going up. So over time, we know there's going to be a cyclical increase. And we just try to estimate how much of the [downturn] is cyclical, and so, there will be a flip side of that. And I think you might have gotten to the end of the secular, end of cyclical decline. + +-------------------------------------------------------------------------------- +Steven Chubak, Nomura Securities Co., Ltd. - Analyst [95] +-------------------------------------------------------------------------------- + + Thanks, Jamie. That's extremely helpful color. And Marianne, maybe just switching over to the expense side for a moment. You also provided very helpful detail on some of the drivers of the strong expense progress that you're seeing in CIB in particular. And from what I recall, last year's update, Daniel actually guided to an expense target of about $19 billion by 2017. It looks like you've gotten there essentially a year early. And I'm wondering whether there are more savings initiatives that have not yet been filtered through, and could potentially accrete in the coming year? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Company - CFO [96] +-------------------------------------------------------------------------------- + + So I will obviously, give you a lot more detail about all of this at Investor Day, but really quick, because I knew the $19 billion would get some excitement. If you go back, and talk to yourself to look at the specifics on the slide, you should see that the $19 billion that he guided to did have some assumptions about some legal costs in there. The CIB didn't have legal costs in the year. And as a result, it's still a little higher on an apples-to-apples basis than that would imply. Additionally, I talked about the tail winds in terms of a stronger dollar. +Now for full disclosure we have intentionally reinvested some of that, but it was a tail wind that meant that apples-to-apples, it would still be a little higher. I'd tell you that compared to the targets that they set, we still have a few hundred million dollars to deliver on, and Daniel will go through that at Investor Day. + +-------------------------------------------------------------------------------- +Steven Chubak, Nomura Securities Co., Ltd. - Analyst [97] +-------------------------------------------------------------------------------- + + Great. Thanks for taking my questions. + +-------------------------------------------------------------------------------- +Operator [98] +-------------------------------------------------------------------------------- + + Your next question comes from the line of Andrew Lim from [SocGen]. + +-------------------------------------------------------------------------------- +Andrew Lim, Societe Generale - Analyst [99] +-------------------------------------------------------------------------------- + + Hi, good morning. Was just wondering if we could talk a bit about rate of trading. I mean, to my mind, that was a product that's done particularly well this quarter. But I was wondering looking forward, how you see that performing, whether it's supported by what's going on in the yield curve? Or whether do you see that supported more by sort of like one-off euphoria around the election, so maybe that might tail off a little bit? +And then just moving on from that, how do you view the opportunities for growth in your capital markets businesses, your CIB versus say, your lending businesses? Are you equally enthusiastic about both, and given the opportunity sets going forward, or do you see some being more positive than others? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Company - CFO [100] +-------------------------------------------------------------------------------- + + Okay, so just to talk about rate trading for a second. You're right, that it was a part of the strength story in the fourth quarter this year. It was also a strong fourth quarter last year, which is pretty much the only reason why we didn't call it out as a bigger driver of the year-over-year growth, but it was a strong performance in the quarter. And we would expect that to continue. It's much more interesting to -- for our clients to trade around a moving yield curve and rates above zero. So as we see rates normalize, we would fully expect that to be ultimately a beneficiary to the franchise in terms of clients trading, and positioning, and hedging around that over time. And so, [wonderful] if that would be the case. +In terms of the excitement and the enthusiasm of our businesses, lending versus we're enthusiastic about all of our businesses, and would want to defend share and grow them all. I mean, the reality of the CIB revenue performance in markets, and in general, it was very strong in 2016. So we will try our hardest to replicate that. But it will be a challenging comparison, but we're proud of it. So we gained share competitively over the course of the last couple years, and so I don't think you should necessarily expect that we can continue to gain share at that pace; but defend it we will. + +-------------------------------------------------------------------------------- +Andrew Lim, Societe Generale - Analyst [101] +-------------------------------------------------------------------------------- + + I mean, it sounds maybe that you'll (laughter) the pressures of year-on-year growth, in the CIB business but you're not really highlighting that in terms of your lending businesses, which obviously you'd expect further margins to grow, the loan books to grow. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Company - Chairman & CEO [102] +-------------------------------------------------------------------------------- + + I think the better way to look at CIB lending, is it's kind of episodic, and goes in and out. Corporations, a lot of corporations don't need to borrow, and when they do, it may be inconsistent. It might be because of M&A or something like that. Our [bridge] book will always be driven by certain types of activity, so the loan book isn't something -- the CIB loan book isn't something you're going to say, that you're growing. That is more serving clients in the way they need. +One of the things I just want to point out which is, of course, all of our businesses, but just take trading in particular is, we're always creating efficiencies. Part of what we're investing is big data, is [trade] through processing, electronic exchanges, online services. I think 97% of FX -- I think it's 50% to 60% of US interest rate swaps, all these things have become electronic and digitized, as trade through for clients. So that's where some of the investments are going. And you're going to see more of that not less, but it also creates another round of efficiencies every time we do that. + +-------------------------------------------------------------------------------- +Andrew Lim, Societe Generale - Analyst [103] +-------------------------------------------------------------------------------- + + That's great. Thanks very much. + +-------------------------------------------------------------------------------- +Operator [104] +-------------------------------------------------------------------------------- + + Your next question comes from the line of Gerard Cassidy from RBC. + +-------------------------------------------------------------------------------- +Gerard Cassidy, RBC Capital Markets - Analyst [105] +-------------------------------------------------------------------------------- + + Good morning, Marianne. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Company - CFO [106] +-------------------------------------------------------------------------------- + + Good morning. How are you? + +-------------------------------------------------------------------------------- +Gerard Cassidy, RBC Capital Markets - Analyst [107] +-------------------------------------------------------------------------------- + + Good. Can you give us some color, in the past you've talked about -- in the multifamily, I know you commented on that in your prepared remarks, on your multifamily book, some of the markets that you continue to be a little leary of, can you give us an update to those types of thoughts? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Company - CFO [108] +-------------------------------------------------------------------------------- + + Yes, so we talked before about -- we had in certain markets already pulled back, not necessarily because we had a crystal ball, but because we saw them getting soft before the energy decline. Dallas and Houston would be examples, parts of Brooklyn would be examples of that. I would say, watching more carefully -- you've seen us, we have that there is some supply coming through in markets, Seattle, Denver, D.C., San Francisco. We're still very active there, but just keeping an eye on those markets. But the supply pipeline, while it's real does not look like it did when we saw the real pressure on the term lending business, the real estate business back in the 1980s and 1990s. So we're keeping an eye on it. + +-------------------------------------------------------------------------------- +Gerard Cassidy, RBC Capital Markets - Analyst [109] +-------------------------------------------------------------------------------- + + Okay, great. And I know you talked about the duration of the securities portfolio, it's in line with -- (multiple speakers) + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Company - Chairman & CEO [110] +-------------------------------------------------------------------------------- + + (Inaudible) I'll add, we don't want to give you all of our secrets in that business, but we do (inaudible). But we're very disciplined about where we see supply, and supply and demand and pricing, and we would have no problem, not growing at all. We don't sit at meetings here and say, can you grow at 10%, can you grow to [12%]? No, if we can't meet what we think is proper risk return, we're not going to grow at all. We'll shrink. We have no problem doing that. And so, the other thing I want to point out about CTLs, the exceptional performance of the CTLs through the last Great Recession. I mean, we were really pleased with how that happened. So we try to look at all these things through the cycle, not just what are they doing in good times. + +-------------------------------------------------------------------------------- +Gerard Cassidy, RBC Capital Markets - Analyst [111] +-------------------------------------------------------------------------------- + + Certainly. And Marianne, coming back to the investment portfolio, obviously you talked a little bit about the duration. Do you have the actual duration of it in years, this quarter versus the third quarter? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Company - CFO [112] +-------------------------------------------------------------------------------- + + We don't disclose that. + +-------------------------------------------------------------------------------- +Gerard Cassidy, RBC Capital Markets - Analyst [113] +-------------------------------------------------------------------------------- + + Okay. All right, thank you. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Company - CFO [114] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +Operator [115] +-------------------------------------------------------------------------------- + + Your next question comes from the line of Matt Burnell from Wells Fargo. + +-------------------------------------------------------------------------------- +Matt Burnell, Wells Fargo Securities, LLC - Analyst [116] +-------------------------------------------------------------------------------- + + Good morning. Just a quick question for you, Marianne. In terms of the mortgage, in the overall picture, I understand why you're talking about maybe 10% core loan growth rather than 15% more recently. But just within the residential mortgage portfolio, it looks like that slowed in the fourth quarter, third and fourth quarter from a mid teens year-over-year rate, to a low single-digit quarter-over-quarter rate. Can you give us a little more color as to what's going on there? Are you buying -- or are slowing your purchases of your own originations, or is that -- is there something else going on there? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Company - CFO [117] +-------------------------------------------------------------------------------- + + So, there's a couple different things. First of all, we, about a little more than half of our originations are jumbo. We retain all of those. And then, when you look at the conforming space, it's really, honestly, consistently the best execution decision. And so in particularly in this quarter, it speaks a bit more to our correspondent conforming volume, it's the lowest margin product. And it does somewhat frequently toggle backwards and forwards in terms of better execution, whether we would retain or sell it. +But we intend to keep adding to our portfolio, we like the mortgage asset classes. Even those spreads have compressed in the fourth quarter, OAS and ROEs are holding up. And so, I would expect us to continue to grow it strongly. And from quarter to quarter, it may go up or down a few percent, but over a year, we'll continue to add to the portfolio. + +-------------------------------------------------------------------------------- +Matt Burnell, Wells Fargo Securities, LLC - Analyst [118] +-------------------------------------------------------------------------------- + + Okay. So no real change in your thinking there? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Company - CFO [119] +-------------------------------------------------------------------------------- + + No. + +-------------------------------------------------------------------------------- +Matt Burnell, Wells Fargo Securities, LLC - Analyst [120] +-------------------------------------------------------------------------------- + + Okay. Thank you very much. That's it for me. Thank you. + +-------------------------------------------------------------------------------- +Operator [121] +-------------------------------------------------------------------------------- + + Your final question comes from the line of Marty Mosby from Vining Sparks. + +-------------------------------------------------------------------------------- +Marty Mosby, Vining Sparks - Analyst [122] +-------------------------------------------------------------------------------- + + Thanks for taking my questions. The thing that jumped out at me was, if you looked at the asset management group, you had $21 billion of long-term product outflows, and you had $35 billion of liquidity products inflows. And it seems like now that we're getting past the financial crisis, when everybody was looking at liquidity, that combining that with continued deposit growth, we're not seeing a change in that perspective, but there's still a premium for increasing liquidity still? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Company - Chairman & CEO [123] +-------------------------------------------------------------------------------- + + I think there was a little bit of that in the fourth quarter, particularly around actively managed product. I think you're accurate. But we haven't seen everybody else yet, but I think you will be true, when we see everybody. + +-------------------------------------------------------------------------------- +Marty Mosby, Vining Sparks - Analyst [124] +-------------------------------------------------------------------------------- + + Do you foresee that premium for liquidity lessening, as we kind of go into the rerisking of a better economy, and some things that improve the outlook? + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Company - Chairman & CEO [125] +-------------------------------------------------------------------------------- + + That's a really hard question to answer. I'd have to think about that a little bit. + +-------------------------------------------------------------------------------- +Marty Mosby, Vining Sparks - Analyst [126] +-------------------------------------------------------------------------------- + + And then my last thought was, when you look at M&A, we had M&A kind of suppressed when things were more regulatory constrained, and the outlook was a negative on the overall economy and that uncertainty. Now we have this positive uncertainty. Wouldn't that delay some activity for at least a couple quarters, for people to kind of see where we're going to end up, and see where tax rates are, and see what we might get in deregulation that may change perspective on their long-term opportunities? So just thought there might be a little pause here. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Company - CFO [127] +-------------------------------------------------------------------------------- + + I think that -- I mean, everything is going to end up being reasonably named specific, so I mean, that may be true in some cases. But for some companies in industries, where deregulation and that would be more helpful. But generally as I said the trend is towards lower -- I'm sorry, less mega deals, more flow, and the fundamentals are in pretty good shape, and then there will possibly be tail winds, in terms of tax reform and other things. So I think net-net, we think the underlying flow in the M&A market, and the fundamentals are set to have a pretty positive year. + +-------------------------------------------------------------------------------- +Marty Mosby, Vining Sparks - Analyst [128] +-------------------------------------------------------------------------------- + + I just thought maybe in the second half versus the first half, but thanks for your response. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Company - CFO [129] +-------------------------------------------------------------------------------- + + We'll see. No more questions, operator? + +-------------------------------------------------------------------------------- +Operator [130] +-------------------------------------------------------------------------------- + + There are no further questions. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Company - CFO [131] +-------------------------------------------------------------------------------- + + All right. Thank you, everyone. + +-------------------------------------------------------------------------------- +Jamie Dimon, JPMorgan Chase & Company - Chairman & CEO [132] +-------------------------------------------------------------------------------- + + Thank you very much. + +-------------------------------------------------------------------------------- +Operator [133] +-------------------------------------------------------------------------------- + + This does conclude today's call. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/exam/original-files/Problem_2_3_Sample_full_transcripts/2017-Jul-14-JPM.N-138724678832-Transcript.txt b/exam/original-files/Problem_2_3_Sample_full_transcripts/2017-Jul-14-JPM.N-138724678832-Transcript.txt new file mode 100644 index 0000000..506f370 --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_full_transcripts/2017-Jul-14-JPM.N-138724678832-Transcript.txt @@ -0,0 +1,645 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q2 2017 JPMorgan Chase & Co Earnings Call +07/14/2017 08:30 AM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Marianne Lake + JPMorgan Chase & Co. - CFO and EVP + * James Dimon + JPMorgan Chase & Co. - Chairman, CEO & President + +================================================================================ +Conference Call Participiants +================================================================================ + + * Betsy Lynn Graseck + Morgan Stanley, Research Division - MD + * Glenn Paul Schorr + Evercore ISI, Research Division - Senior MD, Senior Research Analyst and Fundamental Research Analyst + * John Eamon McDonald + Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst + * Erika Najarian + BofA Merrill Lynch, Research Division - MD and Head of US Banks Equity Research + * Saul Martinez + UBS Investment Bank, Research Division - MD and Analyst + * Steven Joseph Chubak + Nomura Securities Co. Ltd., Research Division - VP + * Kenneth Michael Usdin + Jefferies LLC, Research Division - MD and Senior Equity Research Analyst + * Gerard S. Cassidy + RBC Capital Markets, LLC, Research Division - Analyst + * Andrew Lim + Societe Generale Cross Asset Research - Equity Analyst + * Matthew D. O'Connor + Deutsche Bank AG, Research Division - MD in Equity Research + +================================================================================ +Presentation +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Good morning, ladies and gentlemen. Welcome to JPMorgan Chase's Second Quarter 2017 Earnings Call. This call is being recorded. (Operator Instructions) We will now go live to the presentation. Please stand by. +At this time, I would like to turn the call over to JPMorgan Chase's Chairman and CEO, Jamie Dimon; and Chief Financial Officer, Marianne Lake. Ms. Lake, please go ahead. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO and EVP [2] +-------------------------------------------------------------------------------- + + Thank you, operator. Good morning, everyone. I'm going to take you through the earnings presentation, which is available on our website. Please refer to the disclaimer at the back of the presentation. +Starting on Page 1. The firm reported record net income of $7 billion, EPS of $1.82 and a return on tangible common equity of 14% on revenue of $26.4 billion. Included in the result is a legal benefit of approximately $400 million after tax from a previously announced settlement involving the FDIC's Washington Mutual receivership. +Other notable items, predominantly net reserve changes and legal expense, were a small net negative this quarter. So underlying adjusted performance was really strong. And highlights for the quarter include: average core loan growth of 8% year-on-year, reflecting continued growth across products; double-digit consumer deposit growth; strong card sales, up 15%, and merchant volume, up 12%; #1 Global IB fees, up 10%; and we delivered record net income in both Commercial Banking and in Asset & Wealth Management. +Moving on to Page 2 and some more details about the quarter. Revenue of $26.4 billion was up $1.2 billion or 5% year-on-year, with the increase predominantly in net interest income, up approximately $900 million, reflecting continued loan growth and the impact of higher rates. Fee revenue was up $300 million year-on-year, but adjusting for one-time items in both years, was down modestly, with lower Fixed Income Markets, Mortgage and Card revenues, all as guided, being offset by strong fee revenue growth across remaining businesses. +Adjusted expense of $14.4 billion was up a little less than $400 million year-on-year, with auto leases being the biggest driver, but also including the impact of the FDIC surcharge and broader growth being offset by lower compensation. +Credit costs of $1.2 billion were down $187 million year-on-year on [lower] reserve builds as a net reserve build in Consumer of a little over $250 million, driven by Card, was offset by a net release in Wholesale of a little under $250 million, driven by Energy. +Anticipating you may have questions, given the recent stress in oil prices, I would emphasize that we guided to expect reserve releases, given we started the year with $1.5 billion of energy-related reserves. And with oil prices having found a lower but seemingly stable level, we feel appropriately reserved. +Shifting to balance sheet and capital on Page 3. You can see in the red circle on the page here that we ended the quarter with binding fully phased-in CET1 of 12.5% under the standardized approach, with the improvement being primarily driven by capital generation, offset by net loan growth. We've been hovering around the inflection point under the Collins Floor for a while now and expect standardized to remain our binding constraint from here. Given that, we've replicated this page under standardized rules in the appendix for you to read. +Balance sheet, risk-weighted assets and SLR all remained relatively flat from the prior quarter. And while not on the page, I would also note that we remain compliant with all liquidity requirements. We were pleased to announce growth repurchase capacity of up to $19.4 billion over the next 4 quarters. And the board announced its intention to increase common stock dividends 12% to $0.56 a share effective in the third quarter. In addition, we recently submitted our 2017 resolution plan, which we believe fully addresses outstanding regulatory feedback. +Moving on to Page 4 and Consumer & Community Banking. CCB generated $2.2 billion of net income and an ROE of 16.5%. We continue to grow core loans, up 9% year-on-year, driven by strength in Mortgage, up 12%; Card and Business Banking were each up 8%; and auto loans and leases were also up 8%, driven by strong lease performance from our manufacturing partners. +Deposit growth continues to be strong, up 10% year-on-year, with household retention remaining at historically high levels. We saw improvement in our deposit margin, up 16 basis points. Sales growth in Card was very strong again this quarter, up 15%, as new accounts mature. And merchant processing volumes grew double digits, up 12%. +Revenue of $11.4 billion was flat year-on-year. But recall that last year included a net benefit of about $200 million, principally driven by the Visa Europe gain. So excluding that revenue, it was up modestly. +Consumer & Business Banking revenue was up 13% on both strong deposit growth and margin expansion. Mortgage revenue was down 26% as higher rates drove higher funding costs, which, together with lower MSR risk management and lower production margins, put pressure on mortgage revenue year-on-year. In addition, revenue included a reduction of approximately $75 million to net interest income related to capitalized interest on modified loans. +And Card, Commerce Solutions & Auto revenue was down 3%, but if you exclude the noncore items I mentioned, was up 2%, with NII growth on higher loan balances and higher auto lease income, predominantly offset by the continued impact of investments in Card new account acquisitions. Expense of $6.5 billion was up 8% year-on-year on higher auto lease depreciation, higher marketing expense and continued underlying business growth. +Finally, on credit performance. Card Services drove higher net charge-offs year-on-year, but still within our guidance for the full year of less than 3%. Net reserve builds were around $250 million, building $350 million in Card, $50 million in Business Banking and $25 million in Auto, in part due to loan growth and in part higher loss rates in Card. This was partially offset by a release of $175 million in Mortgage, reflecting continued improvement in home prices and lower delinquencies. +To touch on consumer delinquency trends, in particular in Card, we are seeing some early signs of normalization, which are generally in line with our expectations and our credit risk appetite. And in Auto, our trends are relatively flat. +Now turning to Page 5 and the Corporate & Investment Bank. CIB reported net income of $2.7 billion on revenue of $8.9 billion and an ROE of 14.5%. In Banking, IB revenue of $1.7 billion was up 14% year-on-year, with strong performance across products but particular strength in DCM. We ranked #1 in Global IB fees and #1 in North America and EMEA. We were also #1 in ECM and DCM globally, in each case gaining share for the first half of this year. +Advisory fees were up 8%, benefiting from a large number of deals closed in this quarter. Equity underwriting fees were up 29%, better than the market, but relative to a weak prior year quarter. With a strong market backdrop and supportive valuations, we saw continued momentum in global issuance, especially IPOs. And debt underwriting fees were up 5% from a strong quarter last year, driven by the high flow volume of repricing and refinancing activity, even with fewer large acquisition financings. +In terms of the outlook, we expect IB fees in the second half of the year to be down year-on-year, given that we had the highest IB fees on record for a third quarter last year. That said, overall sentiment remains positive. ECM issuance is expected to continue, given the stable market backdrop. And the M&A backlog is healthy, with conditions remaining constructive for refinancing activity. +Treasury Services revenue of $1.1 billion was up 18%, driven by higher rates as well as operating deposit growth. Lending revenue of $373 million was up 35%, reflecting lower mark-to-market losses on hedges of accrual loans. +Moving on to Markets, total revenue was $4.8 billion, down 14% year-on-year. Fixed Income revenue was down 19%, with decent performance across products relative to a very strong second quarter last year, which was driven by higher levels of volatility and activity broadly, including as a result of Brexit. This quarter conversely can be characterized by a lack of idiosyncratic events resulting in sustained low volatility, reduced flows and continued credit spread tightening, all of which impacted activity levels in rates, credit trading and commodities. +Emerging market performance was relatively stronger on a weaker dollar and lower rates as well as some regional events. Equities revenue was down 1%. In derivatives, on the structured side, we did quite well and outperformed. And on the flow end, we held our own in a quiet and therefore challenging environment. Prime was a bright spot as we are realizing the benefit of the investments we've been consistently making. +Before I move on, I would also like to remind you that the third quarter of 2016 markets revenue was also a record since 2010. In fact, it was about $1 billion more than the average of the previous 5 years. And so while that isn't guidance, it is context as this quarter has felt quiet, more like prior years. +Securities Services revenue of $982 million was up 8%, driven by higher rates and higher asset-based fees on higher market levels. And remember, the second quarter benefits from dividend seasonality. Finally, expense of $4.8 billion was down 5% year-on-year, driven by lower compensation expense and the comp-to-revenue ratio for the quarter was 28%. +Moving on to Page 6 and Commercial Banking. Another quarter of excellent performance with record revenue and net income and an ROE of 17%. Revenue grew 15%, driven by deposit NII as the rate environment continues to be favorable and on higher loan balances with spreads remaining steady. IB revenue was down due to the lack of large deal activity during the quarter, but underlying flow activity was solid across products as momentum continued and forward pipelines appear strong. +Expense of $790 million was up 8%, and we expect this to grow modestly in the second half as we continue to execute on the investments in bankers and technology that we outlined at Investor Day. +Loan balances were up 12% year-on-year and 3% quarter-on-quarter. C&I loans were up 4% sequentially, ahead of the industry, on broad-based growth across markets and within specialized industries. CRE saw a growth of 2%, in line with the industry, but below last year's pace on reduced origination activity as we continue to be selective at this stage in the cycle. Finally, credit performance remained very strong with a net charge-off rate of 2 basis points. +Leaving the Commercial Bank and moving on to Asset & Wealth Management on Page 7. Asset & Wealth Management reported record net income of $624 million, with pretax margin of 32% and an ROE of 27%. Revenue of $3.2 billion was up 9% year-on-year, driven primarily by higher market levels, but also strong banking results on higher deposit NII. Expense of $2.2 billion was up 4% year-on-year, driven by a combination of higher external fees and compensation on higher revenue. +This quarter, we saw net long-term inflows of $9 billion with positive flows across multi-asset, fixed income and alternatives being partially offset by outflows in equity products. We saw net liquidity outflows of $7 billion, largely due to specific client deal-related cash needs. Record AUM of $1.9 trillion and overall client assets of $2.6 trillion were both up 11% year-on-year on higher market levels. Deposits were flat year-on-year and down 5% sequentially, reflecting the beginning of balance migration into investment-related assets, as expected, and those balances remained with us. Finally, loan balances were up 9% year-on-year, driven by mortgage, up nearly 20%. +Moving on to Page 8 and Corporate. Corporate reported net income of $570 million, which includes the legal benefit I mentioned earlier of $645 million in revenue or $400 million after tax. And a reminder, this is the same $645 million that was publicly announced in August 2016 and represents partial reimbursement for costs that we have previously incurred and paid that remained the responsibility of the WaMu receivership. +Finally, turning to Page 9 and the outlook. Starting with the quarter, we guided second quarter NII to be up about $400 million from the first quarter, given the rate -- the March rate hike, but you'll see that the NII for the quarter increased by only $150 million. While we did fully realize the expected benefit of higher rates and continued growth, against that, we had the onetime $75 million mortgage adjustment as well as lower CIB market NII. +These effects, together with modest downward pressure from lower 10-year rates, with all other things equal, point to a full year number of closer to $4 billion up rather than the previous $4.5 billion, but with a potential to be higher if we continue to benefit from tailwinds of lower deposit reprice. So you will see we have adjusted the guidance on the page, but it will be market-dependent. And any near-term forecast is sensitive to a number of factors, none of which changes our conviction that we will ultimately deliver $11 billion plus of incremental NII as rates normalize, and we are well on our way. +On expense, we continue to expect full year adjusted expense of $58 billion. Second quarter was in line with our expectation and our guidance at a little better than $14.5 billion, which is also where we expect the third quarter to come in. +Finally, we have revised our full year core loan growth down to 8% year-over-year, but a couple of comments. First, we are seeing slightly lower growth than we expected coming into the year, it is only modestly lower. And more importantly, we remain encouraged by the consistency and breadth of client demand across products. +Secondly, we noted that mortgage could be a big driver. And with a smaller market and a more competitive environment, fewer loans have met our hurdle rate. And of course, we remain appropriately focused on quality and not quantity of growth. And as such, loan growth is an outcome, not a target. +So to wrap up, we are very pleased with the firm's performance this quarter, with all of our businesses showing broad strength. We maintained or improved leadership positions [above] delivering the benefits to both clients and shareholders of our operating model and our continued investments. We remain encouraged by the growth outlook for the global economy and expect continued solid growth here in the U.S., which positions us well going forward. +And with that, operator, you can open up the line to Q&A +(technical difficulty) + + +================================================================================ +Questions and Answers +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Line of Glenn Schorr with Evercore ISI. + +-------------------------------------------------------------------------------- +Glenn Paul Schorr, Evercore ISI, Research Division - Senior MD, Senior Research Analyst and Fundamental Research Analyst [2] +-------------------------------------------------------------------------------- + + During the quarter, Jamie had made a comment on potential disruptions related to the unwinding of the U.S. balance sheet. And I'm just curious, it's supposed to be slow and deliberate, but I'm curious how you think that impacts liquidity, the yield curve, trading, deposit betas and is there anything you can do to protect JPMorgan against those disruptions? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO and EVP [3] +-------------------------------------------------------------------------------- + + Yes. I would just stop for a second to just point out that what Jamie actually said was, "This is uncharted territory. It's not something that we've seen before." And so while it is the case that the Fed is communicating clearly and has every intention to make this gradual and predictable, things can change, and we should just be prepared for that. Not to say that, that would have a particularly significant impact necessarily on JPMorgan but that, that would just be a downside risk, not a probability. So on the balance sheet, it's still the case that we expect to start seeing normalization in the balance sheet in September; if not in September, by the end of this year. And we're still actually calling for the next rate hike in December; the market is calling for March of next year. And as we said, the communication has been pretty consistent and pretty clear across the Fed space, which is to say that it's mostly priced into the market at this point as far as we can tell. And so based upon what we've understood, all things equal, we would see the balance sheet shrink about $1.5 trillion over about the next 4 years. So that would ultimately slow growth, not stop growth. And if we saw $1 billion -- sorry, $1.5 trillion come out of the Fed's balance sheet, empirical evidence would suggest that we don't see dollar-for-dollar reduction in deposits. So if you just pick a point between $500 billion and $1 trillion of deposit outflows, at our 10% market share, that would be about $75 billion over 4 years. So it would slow growth. It would not stop growth. And it is what we've been expecting and what we've been talking about now for an extended period, and gradual is good in that sense. In respect of which deposits we would like to see, so that's the sort of growth scenario. In terms of liquidity, again, evidence would suggest, and we've been communicating this quite clearly, that we think the preponderance of that deposit outflow would be wholesale deposits and that would -- it would be nonoperating deposits. And those are deposits we ascribe little to no liquidity value to. So assuming that we're close to right, we would see those deposits ultimately leave the system, but it wouldn't affect materially, if at all, our liquidity position. So ultimately, the yield curve has priced, I think, all of this in. What I think the Fed had been clear about is that they expect the balance sheet or hope the balance sheet to be in the background and to use short rates as their primary monetary policy tool. And so as a result, we would ultimately expect to see perhaps a flattening yield curve, but with the front end ultimately pulling the long end up. And you heard Yellen -- Chair Yellen talk about being conscious of the shape of the curve as they go about normalization. I think you may have asked something else. Did I miss anything? + +-------------------------------------------------------------------------------- +Glenn Paul Schorr, Evercore ISI, Research Division - Senior MD, Senior Research Analyst and Fundamental Research Analyst [4] +-------------------------------------------------------------------------------- + + No, that was absolutely awesome. I do have one tiny follow-up. You always get a little more than you wanted. The one tiny follow-up, Marianne, is I just want to make clear, the whole $4 billion versus $4.5 billion, and you spelled out what happened in the quarter, it sounded like most of that full year guidance happened in this second quarter. But I'm just -- I just want to clarify that in terms of the second half NII, do you think it's overly different from where we were a quarter ago? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO and EVP [5] +-------------------------------------------------------------------------------- + + No, we -- that's correct. If you saw the -- compared to a $400 million expectation, we were up $150 million. So it would be fair to say that most of it was in this quarter. We had also -- when we gave the last set of guidance at $4.5 billion, we pointed out that the 10-year was low and that, that was ultimately pressuring that $4.5 billion. So it really isn't that significant of a change. The only thing I would caution you to remember is that when we think about asset sensitivity and we think about NII, market NII, which we wouldn't consider to be, in a traditional sense, core, can exhibit volatility geographically with NIR. If you think about a market-making business where we can have assets that are throwing off NII hedged by derivatives that ultimately have an offset in NIR, we actually think about that in total revenue numbers. So there could be a little noise in there, but no, I'm not expecting there to be significant changes. But I think what this makes me realize acutely is that no good deed ever goes unpunished. And chasing our tails, reforecasting the full year NII every 3 quarters isn't as important -- or every quarter isn't as important as keeping our eye on the long term, which is nothing has changed. We are absolutely realizing the benefits we expected in the banking book assets and liabilities, and that means that our long-term projections will be good and the path is a little bit less important. + +-------------------------------------------------------------------------------- +Operator [6] +-------------------------------------------------------------------------------- + + And your next question comes from Ken Usdin from Jefferies. + +-------------------------------------------------------------------------------- +Kenneth Michael Usdin, Jefferies LLC, Research Division - MD and Senior Equity Research Analyst [7] +-------------------------------------------------------------------------------- + + I want to follow up on the loan yield side, which were not much moved. You mentioned the $75 million in mortgage. Can you just help us walk through the loan portfolio and whether you're seeing the assets move, whether there's a lag or whether there's any spread compression underneath that? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO and EVP [8] +-------------------------------------------------------------------------------- + + Yes. So I understand why you're asking. As you look at the loan yields, they look relatively flat or even slightly down. If you adjust for the mortgage, it would be flat. If you decompose them into wholesale versus retail, we are absolutely seeing all of the yield improvement on the wholesale side, about 10-ish basis points. And on the consumer side, at this -- with respect to this quarter, there were some mix impacts in the Card business as we saw a higher level of transactors and saw a few other things. So it's not to say that the loan yields aren't moving in line with our expectations, and they are, but mix will matter for any one quarter. + +-------------------------------------------------------------------------------- +Kenneth Michael Usdin, Jefferies LLC, Research Division - MD and Senior Equity Research Analyst [9] +-------------------------------------------------------------------------------- + + Okay. So that -- would that naturally say that, as we go forward, that should -- if they're moving the right way, mix adjusted, they should kind of move the right way from here? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO and EVP [10] +-------------------------------------------------------------------------------- + + Yes, that's right. And if you look back last quarter, they did, too. It's just that we've had a couple of opposing things going on this quarter. + +-------------------------------------------------------------------------------- +Kenneth Michael Usdin, Jefferies LLC, Research Division - MD and Senior Equity Research Analyst [11] +-------------------------------------------------------------------------------- + + Understood, okay. And then my second question is, it was nice to see the card revenues on the fee side and the revenue capture rate move towards the way you've been saying. It actually eclipsed the 10.5% you'd said for the year already. Can you just help us understand like have we turned the corner then on card income and your expectations for that going forward? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO and EVP [12] +-------------------------------------------------------------------------------- + + Yes. So obviously, one of the biggest drivers over the last recent while in card revenues has been the extraordinary success we've had in capturing new Chase Sapphire Reserve accounts. And so the end of the third quarter both -- importantly, both the fourth quarter and the first quarter were extraordinary in terms of the number of accounts we acquired. And of course, we amortize or contra revenue out those expenses over 1 year. So at 10.5% revenue rate right now and with those -- having adjusted the premium with those originations stabilizing out into the second quarter, we will see ultimately -- we'll lap that impact a year from now. And we'll see our revenue rate start improving from here towards the 11.25% that we sort of guided to in the medium term. And we expect to get to that point, all other things equal, kind of mid-next year. And of course, that's just one facet. We're also seeing significant momentum on the sales front. Obviously, as a result of those accounts, we're growing our core loans, up 8%. And so we're having higher NII on those balances. So there's a lot of dry powder. We just need to get past these account acquisition costs, which we will. And I always feel compelled to point out that these are extraordinarily good customers. Their characteristics, their engagement, their spend, these are the customers that everybody wants to acquire. We now have them, and we intend to deepen relationships with them. + +-------------------------------------------------------------------------------- +Operator [13] +-------------------------------------------------------------------------------- + + Our next question comes from Betsy Graseck of Morgan Stanley. + +-------------------------------------------------------------------------------- +Betsy Lynn Graseck, Morgan Stanley, Research Division - MD [14] +-------------------------------------------------------------------------------- + + Two questions. One on M&A strategy. There was discussion that maybe you were interested in acquiring something. That's not really the question, to comment on that specific rumor. But more in this regulatory environment and the changes that we've had already, do you feel like there's a little more flexibility for your strategic actions or outlook than maybe a year ago? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO and EVP [15] +-------------------------------------------------------------------------------- + + So I would characterize our strategy as unchanged. We've always been pretty consistent over an extended period that we would prioritize, first and foremost, strategic investments for growth in our businesses, be that organic or otherwise. And obviously, you've seen us be investing, whether it's in growing loans or introducing new product, hiring bankers, opening offices in our expansion markets and the like. But yes, it's been heavily skewed to being organic over the most recent while. We've also been pretty clear and active, I would say, in terms of partnering with, investing in, collaborating with partners that can accelerate our growth potential. So we would always be interested, whether that's fintech or otherwise, in getting capabilities that allow us to accelerate our growth potential. We don't have big gaps, but we would always be interested in that. Having said that, I'm not going to comment on the state of the regulatory environment except to say you should expect, for any of these events or transactions, that we would have the appropriate regulators at the -- conversation with regulators at the appropriate time. + +-------------------------------------------------------------------------------- +Betsy Lynn Graseck, Morgan Stanley, Research Division - MD [16] +-------------------------------------------------------------------------------- + + Second question is on -- a little bit of a ticky-tacky, but on FASB. They're working on changing some of the hedge accounting rules. And I wondered how you're thinking about areas in your balance sheet you might be able to utilize that in a way that makes your business more efficient. I don't know if that's something that you're thinking about. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO and EVP [17] +-------------------------------------------------------------------------------- + + Yes. So obviously, we are supportive of the new hedge accounting rules, and it will allow us to consider taking advantage of hedge accounting for a wiser set of products than we currently do. But we actually have reasonably limited hedge ineffectiveness in our (inaudible) right now. So from a practical perspective, it won't make a big difference to the business, but it is more flexibility in terms of the scope. And we're looking at that. + +-------------------------------------------------------------------------------- +James Dimon, JPMorgan Chase & Co. - Chairman, CEO & President [18] +-------------------------------------------------------------------------------- + + I would just add, as a policy matter, we make economic decisions, not accounting decisions. Accounting is a fiction. And Marianne spoke about the credit card. You expense the acquisition costs over 12 months. The benefit comes over 7 years. So we make huge investments all the time based on economics. We will never make a decision based upon accounting. And then we'll describe it to our shareholders to understand why we're doing what we're doing. + +-------------------------------------------------------------------------------- +Operator [19] +-------------------------------------------------------------------------------- + + Our next question comes from John McDonald of Sanford Bernstein. + +-------------------------------------------------------------------------------- +John Eamon McDonald, Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst [20] +-------------------------------------------------------------------------------- + + Marianne, wanted to ask about credit cards. The outlook for charge-offs remains the same at about -- below 3% for the year, and you're about 3% now in the first half. So maybe you're expecting a little bit of improvement in the back half of the year. Is that seasonal? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO and EVP [21] +-------------------------------------------------------------------------------- + + Yes, it's seasonality. So you've seen the first half at or around that guidance level. We would expect that to go down slightly just from seasonality in the second half for a full year a bit below 3%. + +-------------------------------------------------------------------------------- +John Eamon McDonald, Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst [22] +-------------------------------------------------------------------------------- + + And then at Investor Day, the outlook for the medium term was not much higher, 3% to 3.25%. Does that allow for the seasoning over the next year or 2 of all the growth that you've had and allow for some normalization, too? Is that enough cushion to get all that in there? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO and EVP [23] +-------------------------------------------------------------------------------- + + So I would say, obviously anytime you reach an inflection point, you need to be cautious about understanding the pace of change. For -- at least for 2018, 3% to 3.25% feels right. I think as -- when you get beyond that, we'll be updating you with our views as we experience a bit more in reality. It doesn't feel significantly different from that, but I think 2018 is a good number. And 2019, we'll update you. + +-------------------------------------------------------------------------------- +Operator [24] +-------------------------------------------------------------------------------- + + Our next question comes from Erika Najarian of Bank of America Merrill Lynch. + +-------------------------------------------------------------------------------- +Erika Najarian, BofA Merrill Lynch, Research Division - MD and Head of US Banks Equity Research [25] +-------------------------------------------------------------------------------- + + I just wanted to follow up to the questions that Glenn and Ken had on margin. Marianne, could you give us a little bit of insight on how deposit betas trended wholesale versus retail during the quarter? And also, just back -- going back to your comments. If the Fed balance sheet reduction drives wholesale deposits out of the system, can we assume that, that should not affect deposit betas negatively for JPMorgan? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO and EVP [26] +-------------------------------------------------------------------------------- + + Yes. Okay, so just talk about what we've seen so far, I think the industry has been really quite disciplined, which is what we would have expected at this early stage of a normalization in terms of the rate cycle. It is a tale of 2 cities. We've said that (inaudible) the wholesale space necessarily experiences higher reprice more quickly, and we are seeing that pretty much in line with our expectations. It matters, you need to get granular. The type of deposit, that client segmentation, it matters. So in the wholesale space, we're seeing it. We're on that journey. In the retail space, we haven't seen that yet. So while there have been small changes in the industry in CDs, there's been nothing in checking or savings. But again, I'd just point out to you that we wouldn't have expected there to be at this point yet in the cycle. And I would say, with respect to deposit betas and the Fed's balance sheet, if we are right, and we believe we'll be close to right, and that we see the wholesale nonoperating deposit flowing out of the system, assuming everybody else has reached that same conclusion, then it really shouldn't materially impact the liquidity position of financial institutions. And if you couple that with the expectation of a very gradual and measured pace, which gives people a lot of time and opportunity to plan accordingly, we wouldn't expect there to be a significant impact on betas, if any. + +-------------------------------------------------------------------------------- +Erika Najarian, BofA Merrill Lynch, Research Division - MD and Head of US Banks Equity Research [27] +-------------------------------------------------------------------------------- + + And my second question, you mentioned in the beginning of the call that standardized will ultimately be your CET1 binding constraint. And I'm wondering, if you were allowed to float off your op -- current op risk floor, and I think it's still $400 billion, does that mean, if standardized is your constraint, that being able to float off the floor and model out your op risk may not be an incremental source of capital because standardized is binding? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO and EVP [28] +-------------------------------------------------------------------------------- + + Yes. I would say -- first of all, I would say, focusing on any one -- so we would be very supportive of changes to how operational the capital is treated under [reg] capital rules. But I think focusing on one facet and not the whole thing -- it's unlikely to be that only one thing changes. So we'd like to see changes made over time. But for the foreseeable future, as we're growing our loans quite strongly, and these are extraordinarily high-quality loans where the differential between advanced and standardized is quite big, we still expect standardized to bind us. + +-------------------------------------------------------------------------------- +James Dimon, JPMorgan Chase & Co. - Chairman, CEO & President [29] +-------------------------------------------------------------------------------- + + And as you pointed out, the standardized were 100% in the United States. In Europe, they're talking about 75%. So there are -- will be some changes over time in how all these capital ratios get calculated for international competitiveness reasons. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO and EVP [30] +-------------------------------------------------------------------------------- + + Yes. So whether it's because the operational risk rules change or whether it's because the standardized rules become at least somewhat more risk sensitive, there should be changes over time, but I think for the foreseeable future, this is what we expect. + +-------------------------------------------------------------------------------- +Operator [31] +-------------------------------------------------------------------------------- + + Our next question comes from Saul Martinez of UBS. + +-------------------------------------------------------------------------------- +Saul Martinez, UBS Investment Bank, Research Division - MD and Analyst [32] +-------------------------------------------------------------------------------- + + First question is on Commercial Banking. Can you just comment a bit on the sustainability of the growth in profitability you've had there? Your earnings are up 30% year-on-year; loan growth, C&I, 9%; CRE, up 15%. And we're not talking about small numbers anymore. I think your loan book now is about $200 billion in Commercial Banking. And can you just talk about some of the initiatives that you've discussed of the Middle Market, the IB and how sustainable that is and whether you're comfortable with the risk profile of the books you -- of the book you have there? Because you are growing quickly, it is a big book now, and you're certainly growing faster than the industry. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO and EVP [33] +-------------------------------------------------------------------------------- + + Yes. So I would start with, if you go back a couple of years ago, 2013, '14, '15, when we were doing our business simplification agenda and derisking and uplifting the controlled environment, the Commercial Bank was blocking and tackling and doing a lot of inwardly focused work. And we talked, I think, all the way back in 2016, that there were outbound calls, opening offices, hiring bankers, and that if you waited a minute, you'd see that come to our results. And this is the sort of fruits of that labor. So I do think it is sustainable. There's nothing in these results that is particularly noisy outside of reserve releases, which I'll come back to. And I would also say the partnership between the Commercial Bank and the IB in terms of covering our clients, the introduction of 16 specialized industries, which is an advantage we can bring to our clients nationally and, in fact, globally, that other competitors can't bring, all of those things set us up for continued solid growth. With respect to loan growth, I would say, if you look at our C&I loans, this quarter, as an example, was pretty broad based. There wasn't a specific -- in the Middle Market, there wasn't a specific industry or market segment that was strong. But over the last -- stronger, I should say. But over the last few years, a lot of our growth has been driven by the investments we've been making in the expansion markets. So we got into some new markets with the WaMu acquisition. We continued to build out those markets, add bankers, open offices. And that has been a source of growth for us that perhaps others haven't been able to enjoy. And also, as I said, specialized industries. And then... + +-------------------------------------------------------------------------------- +James Dimon, JPMorgan Chase & Co. - Chairman, CEO & President [34] +-------------------------------------------------------------------------------- + + And I would just add, we -- I think we're in all major 50 markets now, unlike retail, where, one day, we'll embark on an expansion in cities we're not in. And the product set is just fabulous. We're adding more and more online things. We're adding simpler and faster credit approvals. We're adding -- making it easier to do merchant processing when you sign up for Middle Market loans. The online systems are great. So all that stuff, I think is -- this is going to grow for a long period of time. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO and EVP [35] +-------------------------------------------------------------------------------- + + All right. And then... + +-------------------------------------------------------------------------------- +James Dimon, JPMorgan Chase & Co. - Chairman, CEO & President [36] +-------------------------------------------------------------------------------- + + And thanks for pointing out how well it did. And Doug Petno, if you're listening, congratulations. + +-------------------------------------------------------------------------------- +Saul Martinez, UBS Investment Bank, Research Division - MD and Analyst [37] +-------------------------------------------------------------------------------- + + Yes. No problem. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO and EVP [38] +-------------------------------------------------------------------------------- + + And then the only thing I would say on commercial real estate, just because I think it's really important, is commercial real estate, it depends what you do. And more than half of our commercial real estate exposure is Commercial Term Lending. It's a very specific strategy. We don't deviate from that strategy. And I would just point to you, because it was interesting to me, if you look at the Fed's CCAR stress results for commercial real estate across the industry and look at how our results compared to others, I think you can hopefully get somewhat more comfortable, and we are very comfortable with what we have right now. Now that said, the performance this quarter did benefit from reserve releases and benign credit, and at some point, there will be a cycle. But the risk appetite we have and the way we've managed with discipline, we're very happy with that. + +-------------------------------------------------------------------------------- +James Dimon, JPMorgan Chase & Co. - Chairman, CEO & President [39] +-------------------------------------------------------------------------------- + + And the IB, bringing JPMorgan Investment Banking to Chase corporate clients, we still think has a long way to go. + +-------------------------------------------------------------------------------- +Saul Martinez, UBS Investment Bank, Research Division - MD and Analyst [40] +-------------------------------------------------------------------------------- + + That's great. If I can follow up with a bigger-picture question. And Jamie, you've been -- and correct me if I'm wrong, you've been pretty vocal about believing that the underpinnings of our economy are healthy and strong and not buying into this whole secular stagnation argument. But at what point does political dysfunction and political paralysis really start to dent that confidence? And because you've also indicated that we do need structural reform to lift trend growth, whether it's infrastructure, tax reform, whatever it is. And can you just comment on that? And I guess as an adjunct to that, what are your conversations with clients like? And is there a risk that is materializing that clients are also starting to become more frustrated with the lack of progress politically? + +-------------------------------------------------------------------------------- +James Dimon, JPMorgan Chase & Co. - Chairman, CEO & President [41] +-------------------------------------------------------------------------------- + + I would look at it the other way around. So we've, for -- since the Great Recession, okay, which is now 8 years old, we've been growing at 1.5% to 2% in spite of stupidity and political gridlock because the American business sector is powerful and strong and is going to grow regardless -- when they wake up in the morning, they want to feed their kids, they want to buy a home, and they want to do things. It's the same with American businesses. My -- what I'm saying is that it would be much stronger growth had we made intelligent decisions and were there not gridlock. And thank you for pointing it out because I'm going to be a broken record until this gets done. We are unable to build bridges. We're unable to build airports. Our inner city schoolkids and are not graduating. I was just in France. I was recently in Argentina. I was in Israel. I was in Ireland. We met with the Prime Minister of India and China. It's amazing to me that every single one of those countries understands that practical policies that promote business and growth is good for the average citizens of those countries, for jobs and wages, and that somehow this great American free enterprise system, we no longer get it. And so my view is it -- and corporate taxation is critical to that, by the way. We've been driving capital and bringing it overseas, which is why there's $2 trillion sitting overseas, benefiting all these other countries and stuff like that. So if we don't get our act together, we can still grow. I would say it's unfortunate, but it's hurting us. It's hurting the body politic. It's hurting the average American that we don't have these right policies. And so no, in spite of gridlock, we'll grow at -- we can grow at 1.5% or 2%. I don't buy the argument that we're relegated to this forever; we're not. And if this administration can make breakthroughs in taxes and infrastructure, regulatory reform -- we have become the most -- one of the most bureaucratic, confusing, litigious societies on the planet. It's almost an embarrassment being an American citizen traveling around the world and listening to the stupid (expletive) we have to deal with in this country. And at one point, we all have to get our act together or we won't do what we're supposed to do for the average Americans. And unfortunately, people write about the thing like it's for corporations. It's not for corporations. Competitive taxes are important for business and business growth, which is important for jobs and wage growth. And honestly, we should be ringing that alarm bell, every single one of you, every time you talk to a client. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO and EVP [42] +-------------------------------------------------------------------------------- + + And then I would just say that in terms of how our clients are behaving and how the (inaudible) going, whether you look at Middle Markets, Corporate Client Banking, M&A, it's not to say that the possibilities of reform and the impact that, that could have isn't a part of the dialogue, but they're fundamentally really just getting on with things. And so if there's a client that has a compelling strategic deal to be done or some spending or hiring or growth, then they're pretty much getting on with it, which is why we're seeing solid growth. + +-------------------------------------------------------------------------------- +Operator [43] +-------------------------------------------------------------------------------- + + Our next question comes from the line of Matt O'Connor from Deutsche Bank. + +-------------------------------------------------------------------------------- +Matthew D. O'Connor, Deutsche Bank AG, Research Division - MD in Equity Research [44] +-------------------------------------------------------------------------------- + + You guys obviously had a very big approval for share buybacks on the latest CCAR here. And I just wanted your thoughts on terms of using it all, given where your stock price is, given loan growth has slowed a tad and given the flatter yield curve makes buying securities a little less interesting. How do you put that all together? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO and EVP [45] +-------------------------------------------------------------------------------- + + Yes. So look, obviously, you know the deal with CCAR approvals, which is it is capacity. It's not necessarily a commitment to utilize it, although we are -- as we fairly clearly articulated at Investor Day and as you see in the numbers here, we are at 12.5% in terms of our CET1. And we believe we ought to be able to, over time, operate the company lower than that, within the range of 11% to 12.5%, albeit that we would take time to do that. So we're in the market buying our stock every day. We're at 1.8x tangible book value. So in Jamie's shareholder letter, we still think that there's significant value in the stock. We believe in the earnings power in the franchise that we have here. And so I'm not to say that we will utilize all the capacity because other things can come up, but we put in the request based upon our desire to want to ultimately move lower. + +-------------------------------------------------------------------------------- +James Dimon, JPMorgan Chase & Co. - Chairman, CEO & President [46] +-------------------------------------------------------------------------------- + + Yes. And there's a very important policy issue here, too. So our preference is always to build organically, to not buy back stock but to build branches and grow and lend more. But there's an argument that people are making that banks can't lend it, and even if there is excess lending capability, they wouldn't have done it. And that is not true. The counterfactual would have been, had banks been free to use their capital and their liquidity 5 years ago, there would have been a lot more lending in the system. And we've pointed out 2 areas where it would have taken place. One is mortgages, where regulations have held back lending to first-time buyers, immigrants, self-employed, prior defaults, et cetera. And the second is small business, where it's not existing small businesses, think of it as start-up small businesses and that they are having a hard time getting capital maybe at the community bank level, et cetera. The counterfactual would have been that $1 trillion or $2 trillion would have been lent out had these rules been changed 5 years ago. That's the counterfactual. It's not that, well, the banks wouldn't have lent the money. And so again, there's a false notion that all this stuff didn't hold back the economy. Yes, it did. + +-------------------------------------------------------------------------------- +Operator [47] +-------------------------------------------------------------------------------- + + Our next question comes from Gerard Cassidy of RBC. + +-------------------------------------------------------------------------------- +Gerard S. Cassidy, RBC Capital Markets, LLC, Research Division - Analyst [48] +-------------------------------------------------------------------------------- + + Marianne, can you give us some color -- Federal Reserve Chairwoman Yellen indicated that she sees that there could be some relief on the horizon for the banks. And one of the areas that's been talked about is changing the calculation of the SLR. Have you guys modeled out what that could do to your SLR and then how that may change your view on capital going forward, if there are changes where, for example, they take the cash that's sitting at the central banks out of the equation? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO and EVP [49] +-------------------------------------------------------------------------------- + + Yes. So obviously, they haven't been specific. Although the Treasury report had some ideas, they haven't been specific about what the calibration would look like and whether there would be recalibration to the numerator and the denominator or one or the other. Clearly, we've been pretty clear that we think cash at central banks shouldn't necessarily be included, and there are other things. Different people have different opinions. So we've done the calculations. I would just point you back to the fact that we have some 20 potentially binding constraints right now, of which leverage in a variety of forms is part of that. So to the degree that we get the opportunity to recalibrate that, it could have impact at the margin. But we take all of those things into consideration when we think about the direction of travel of the company. So we're being as thoughtful as we can. We are not specifically leverage constrained right now. That doesn't mean we're not supportive of making those changes and we will obviously model it out. But we take the potential for those changes into consideration when we think about the direction we grow our businesses. + +-------------------------------------------------------------------------------- +Gerard S. Cassidy, RBC Capital Markets, LLC, Research Division - Analyst [50] +-------------------------------------------------------------------------------- + + Very good. And then as a follow-up and coming back to credit cards, obviously the Sapphire has been a huge success in growing your business there. Are the acquisition costs higher today than when you compare them to maybe 2 or 3 years ago? And in that vein, when you guys look at the economics of putting on new cards, is the net present value or whatever measure you use to determine the economics, has that improved, stayed the same or weakened from maybe a year or 2 ago? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO and EVP [51] +-------------------------------------------------------------------------------- + + So I think -- I want to point out something because I know that Sapphire Reserve gets a significant amount of attention for obvious and good reasons. But it is only one product in a platform of successful products, both proprietary and co-brand. And so in reality, while we obviously do all the modeling and the math, it's not about what the cost of any one individual card acquired is or the NPV of that, it's how the portfolios ultimately together perform over time. And it's still very early on Sapphire Reserve. I mean, it's not even a year old yet. And these are portfolios and products that develop and season over time. And as I said, these are extraordinarily good customer relationships. So you know we've done a bunch of things in the card business over the last few years. We've renegotiated our co-brands. That was ultimately with lower economics but still very good economics. We've been out on the front foot issuing new products, not just Sapphire Reserve but Freedom Unlimited, the Amazon Prime card, Ink. And so we think about everything in the total portfolio and its collective performance over time, and it's still generating very good returns. + +-------------------------------------------------------------------------------- +James Dimon, JPMorgan Chase & Co. - Chairman, CEO & President [52] +-------------------------------------------------------------------------------- + + Let me just mention about the regulatory SLR. So looking at it very broadly, if you look at -- it's not just capital liquidity but mortgage rules, requirements, capital liquidity, collateral rules, what collateral can be used and not used, if these things were just calibrated differently, the cost of credit would go down, swap spreads would go down, mortgage would become more available, the cost of mortgage will come down. And those are kind of important in total if they're done right without changing at all the risk to the system. In fact, the system is healthier if the economy is healthier. + +-------------------------------------------------------------------------------- +Operator [53] +-------------------------------------------------------------------------------- + + Our next question comes from Steven Chubak of Nomura Instinet. + +-------------------------------------------------------------------------------- +Steven Joseph Chubak, Nomura Securities Co. Ltd., Research Division - VP [54] +-------------------------------------------------------------------------------- + + So Marianne, I wanted to start off with a question on liquidity. You spoke of how the Fed balance sheet unwind should have little impact on your LCR. But just given the strength of your liquidity position and the significant excess reserves that you have at the Fed, how should we be thinking about the current capacity to deploy some of that excess into higher-yielding MBS? And maybe what's your appetite to redeploy, just given some of the tougher liquidity treatment for agency MBS in particular? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO and EVP [55] +-------------------------------------------------------------------------------- + + So when we think about the sort of liquidity position of this company, we're obviously managing not just to regulatory requirements but also to what we want the ultimate sort of duration of equity and position of our balance sheet to be through the cycle. So we take into consideration not just the amount of liquidity we have and how that could be utilized but also the mortgage portfolio we have, agency MBS. So all of that goes into our determinations. And we will continue to add to duration opportunistically when it makes sense to do it and manage our balance sheet with discipline. + +-------------------------------------------------------------------------------- +Steven Joseph Chubak, Nomura Securities Co. Ltd., Research Division - VP [56] +-------------------------------------------------------------------------------- + + Okay, understood. And then just one more question from me, just on capital targets, and I appreciate all the detail, Marianne, you provided indicating that, over time, there could be a path or trajectory towards getting to the lower end of that 11% to 12.5% range. And I'm just wondering, given some -- the very favorable CCAR results we saw this year, coupled with some of the Treasury reforms that have been outlined, is there the potential for you to actually manage to a target even below that 11%, especially if gold plating of G-SIB surcharges, in fact, goes away? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO and EVP [57] +-------------------------------------------------------------------------------- + + Yes. So I would start by saying that a lot can change between now and the next cycle of CCAR or the next 2 cycles of CCAR. And so we never did actually say that we necessarily wanted to get the low end of the range but just to operate for the short and medium term within the range while we let all of the potential changes to the sort of regulatory environment at large play out. And so as to whether or not, over time, there's a sort of recalibration of whether 11% is our minimum, that will play out over time. So for the next 1 or 2 cycles of CCAR, this cycle and the next one, I would just expect that we want to be on a measured pace to be within the range to allow us to better understand all of the changes that will take place over time and make appropriate decisions. I wouldn't start imagining necessarily how low that goes. I think we would want to operate with a sufficiency of capital and liquidity. + +-------------------------------------------------------------------------------- +Operator [58] +-------------------------------------------------------------------------------- + + Our next question comes from Andrew Lim of SocGen. + +-------------------------------------------------------------------------------- +Andrew Lim, Societe Generale Cross Asset Research - Equity Analyst [59] +-------------------------------------------------------------------------------- + + Just coming back to the Treasury's proposals for the new calculation of the SLR. Can you give any color as to whether that's actually even possible within the glib context as to how the Basel Committee wouldn't want harmonization across the whole world? Of course, if it did happen, then you would have a massive advantage along with other U.S. banks versus other European investment banks. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO and EVP [60] +-------------------------------------------------------------------------------- + + So I would say, of course, it's possible. We've seen a number of situations where implementing global standards in the U.S. have differed in meaningful ways from how they've been implemented elsewhere. You have rarely seen that be to the advantage of the U.S., and the SLR is no exception. So while there may be recalibrations of either the numerator or denominator, know that to the Europeans, 3% standard. Our current depository institutions are held to a 6% standard. So there's plenty of room for there to be adjustments before it would create an unlevel playing field. And my suspicion is there will also be adjustments elsewhere. And it's supposed to be, as I think Chairman -- Chairwoman Yellen said, a backstop, not binding in the way that perhaps it has become. So I think the answer is yes, but we'll see. + +-------------------------------------------------------------------------------- +James Dimon, JPMorgan Chase & Co. - Chairman, CEO & President [61] +-------------------------------------------------------------------------------- + + So -- and the key point Marianne said is almost every single thing that's been done in America added to Basel requirements, the gold plating, SLR, calculation of LCR, calculation of stress, G-SIB, almost every single thing. And remember, America doesn't have to listen to Basel either. And you may -- we may have noticed that basically France, Germany, India, China are all telling Basel they better take a deep breath and stop doing more of what they're doing. + +-------------------------------------------------------------------------------- +Andrew Lim, Societe Generale Cross Asset Research - Equity Analyst [62] +-------------------------------------------------------------------------------- + + Great. And just a follow-up question also on the reduction in the op risk. I mean, you talked about advances for standardized, but I mean, looking at CCAR, your SLR is a binding constraint there. So isn't it really a moot argument, a non-argument really, as to whether that happens or not, i.e., if you reduce your op risk, it doesn't really change your excess capital? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO and EVP [63] +-------------------------------------------------------------------------------- + + And so -- sorry, go ahead. + +-------------------------------------------------------------------------------- +James Dimon, JPMorgan Chase & Co. - Chairman, CEO & President [64] +-------------------------------------------------------------------------------- + + Go ahead, go ahead. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO and EVP [65] +-------------------------------------------------------------------------------- + + No. So look, there are a number of different people talking about the forward-looking standard for operational risk, Basel -- under Basel III.5 or IV or whatever is talking about it, there were some proposals in the CHOICE Act. So there's no question that there should be a revisitation of the mechanism to calculate operational risk. And then you're right, the way that all of these rules ultimately interplay with each other matters. And so from a pure stress test perspective, at the margin, we had a little bit more binding constraint on leverage than CET1. But if you look at just what we could run the company at if CCAR was the only constraint, it would be lower than where we are. So it's a complicated dynamic of trying to make sure that we're maximizing against all of these constraints and not just the mathematical ones but also the operational and practical ones. So I mean, it's necessary to go back and rethink the calculation of operational risk just because it's the right thing to do. Ultimately, how that plays out into how we optimize against our constraints is less of what we're focused on. + +-------------------------------------------------------------------------------- +Operator [66] +-------------------------------------------------------------------------------- + + Our next question comes from Betsy Graseck of Morgan Stanley. + +-------------------------------------------------------------------------------- +Betsy Lynn Graseck, Morgan Stanley, Research Division - MD [67] +-------------------------------------------------------------------------------- + + Just 2 other quick things. One, on the accounting with hedge, just to get back on that a little sec, the question also was, was there any opportunity for your clients, too, because if there is an opportunity for, say, institutions to hedge their books of business more, that could feed into your revenues? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO and EVP [68] +-------------------------------------------------------------------------------- + + I wouldn't imagine -- it's not going to change our risk management strategy in a meaningful way, so I wouldn't imagine it would be... + +-------------------------------------------------------------------------------- +James Dimon, JPMorgan Chase & Co. - Chairman, CEO & President [69] +-------------------------------------------------------------------------------- + + Just the (inaudible) corporations, though. The new hedging rules would affect other corporations are nonbanks. + +-------------------------------------------------------------------------------- +Betsy Lynn Graseck, Morgan Stanley, Research Division - MD [70] +-------------------------------------------------------------------------------- + + Yes. In the sense that you can potentially hedge your commodity risk, so wouldn't that be something? + +-------------------------------------------------------------------------------- +James Dimon, JPMorgan Chase & Co. - Chairman, CEO & President [71] +-------------------------------------------------------------------------------- + + We haven't looked at whether it creates more demand from the other -- from the corporate side. So we'll look at that and see. + +-------------------------------------------------------------------------------- +Betsy Lynn Graseck, Morgan Stanley, Research Division - MD [72] +-------------------------------------------------------------------------------- + + Yes, okay. And then is there a time frame here where you have to start telling us what your LCR is? I wasn't sure if that was coming up soon. Was that this quarter or next quarter? Has that just been put on hold? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO and EVP [73] +-------------------------------------------------------------------------------- + + No. It is still this quarter. There are requirements to make public disclosures in August. So depending on whether you make them in your Q, in your Pillar 3 or not will determine whether it's the beginning or middle or end of August. We, as you know, have -- as an industry, are being quite public about the fact that we think -- by the way, we provide an extraordinary amount of real-time granular -- same-day granular information on liquidity to our regulators in order for them to be able to properly supervise not just us but the system. And so we believe the regulators do have and can have anything they need when they need it. It's just a question about whether there is any added benefit of those informations being made public near real time. While it wouldn't matter today when everyone's running very significant liquidity surpluses, it could have unintended consequences if we were in an environment that was more stressful than we are today. So right now, the requirement is that we have to disclose. I suspect, although we've asked for a delay, as an industry, that we might have to disclose. We will continue to debate, I think, with regulators the merits of those public disclosures over time. + +-------------------------------------------------------------------------------- +Betsy Lynn Graseck, Morgan Stanley, Research Division - MD [74] +-------------------------------------------------------------------------------- + + I get that. I'm just thinking that there's the opportunity to show us the nonoperating deposits going away, which would help people understand the strength of the deposit franchise. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO and EVP [75] +-------------------------------------------------------------------------------- + + Yes. And we -- I mean, I would suggest, although it's not something we show you every quarter, that we've been pretty forthcoming about showing you the level of our deposits and the split, at least in Investor Day now and then, between operating and nonoperating deposits. And as we start to see the impacts of the Fed balance sheet unwind and the like, we will be very forthcoming. We try to be incredibly transparent, and we'll take that under advisement, regardless of what the regulatory disclosures are about the quality of our deposit franchise. But we have, I think, periodically, been more disclosive than most in terms of the quality of our deposits. + +-------------------------------------------------------------------------------- +James Dimon, JPMorgan Chase & Co. - Chairman, CEO & President [76] +-------------------------------------------------------------------------------- + + And knowing that, you could see that we have $500 billion of cash, $300 billion of securities, $300 billion of repo. I mean, it's a pretty liquid company, as liquid as any bank I've ever seen on this planet. And... + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO and EVP [77] +-------------------------------------------------------------------------------- + + And we removed $200 billion of nonoperating deposits proactively. So we manage it very carefully. + +-------------------------------------------------------------------------------- +James Dimon, JPMorgan Chase & Co. - Chairman, CEO & President [78] +-------------------------------------------------------------------------------- + + Yes. There's nothing that would happen because of all this that would affect JPMorgan that much. And the very important thing about LCR, it's not -- we -- it doesn't affect us, okay? We're fine disclosing whatever they want us to disclose. It's an issue of whether the monetary -- whether it's good for monetary policy. And would it -- will it cause a problem, not for us, for the system when there's a crisis. Like do they want banks to use their liquidity or not? Very simple. Because if the answer is you've got to maintain over 100%, then you can't use your liquidity. That's what it means. And then so they -- and they've said publicly -- some of have said publically that, "Well, if there's a crisis, we'll let you go below 100%." And we're saying, "Well, what bank is going to be the first to go below 100%?" And so it's kind of a policy issue. Whatever happens, we're completely fine at JPMorgan. If I were the regulators, I wouldn't want to put myself in that kind of position. + +-------------------------------------------------------------------------------- +Operator [79] +-------------------------------------------------------------------------------- + + And we have no further questions. + +-------------------------------------------------------------------------------- +James Dimon, JPMorgan Chase & Co. - Chairman, CEO & President [80] +-------------------------------------------------------------------------------- + + Okay. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO and EVP [81] +-------------------------------------------------------------------------------- + + Thank you. + +-------------------------------------------------------------------------------- +James Dimon, JPMorgan Chase & Co. - Chairman, CEO & President [82] +-------------------------------------------------------------------------------- + + Thank you very much. + +-------------------------------------------------------------------------------- +Operator [83] +-------------------------------------------------------------------------------- + + This concludes today's conference call. You may now disconnect. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/exam/original-files/Problem_2_3_Sample_full_transcripts/2017-Jul-26-KO.N-137990434146-Transcript.txt b/exam/original-files/Problem_2_3_Sample_full_transcripts/2017-Jul-26-KO.N-137990434146-Transcript.txt new file mode 100644 index 0000000..dee6409 --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_full_transcripts/2017-Jul-26-KO.N-137990434146-Transcript.txt @@ -0,0 +1,439 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q2 2017 Coca-Cola Co Earnings Call +07/26/2017 09:00 AM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Kathy N. Waller + The Coca-Cola Company - Executive VP, CFO & President of Enabling Services + * Timothy K. Leveridge + The Coca-Cola Company - VP & IR Officer + * James Robert B. Quincey + The Coca-Cola Company - President, CEO & Director + +================================================================================ +Conference Call Participiants +================================================================================ + + * William Bates Chappell + SunTrust Robinson Humphrey, Inc., Research Division - MD + * Eunjoo Hong + Goldman Sachs Group Inc., Research Division - MD, Co-Head of the GIR Asian Professionals Network, and Senior Analyst + * Kevin Michael Grundy + Jefferies LLC, Research Division - SVP and Equity Analyst + * Carlos Alberto Laboy + HSBC, Research Division - MD, Global Head of Beverages Research, and Senior Analyst, Global Beverages + * Andrea Faria Teixeira + JP Morgan Chase & Co, Research Division - MD + * Pablo Ernesto Zuanic + Susquehanna Financial Group, LLLP, Research Division - Senior Analyst + * Bryan Douglass Spillane + BofA Merrill Lynch, Research Division - MD of Equity Research + * Brett Cooper + Consumer Edge Research, LLC - VP + * Bonnie Lee Herzog + Wells Fargo Securities, LLC, Research Division - MD and Senior Beverage and Tobacco Analyst + * Lauren Rae Lieberman + Barclays PLC, Research Division - MD and Senior Research Analyst + * Faiza Alwy + Deutsche Bank AG, Research Division - Research Analyst + * Ali Dibadj + Sanford C. Bernstein & Co., LLC., Research Division - SVP and Senior Analyst + * Laurent D. Grandet + Crédit Suisse AG, Research Division - United States Beverages Lead Analyst + * Stephen Robert R. Powers + UBS Investment Bank, Research Division - Executive Director and Equity Research Analyst + +================================================================================ +Presentation +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + At this time, I would like to welcome everyone to The Coca-Cola Company's Second Quarter 2017 Earnings Result Conference Call. Today's call is being recorded. If you have any objections, please disconnect at this time. (Operator Instructions) +I would like to remind everyone that the purpose of this conference is to talk with investors, and therefore, questions from the media will not be addressed. Media participants should contact Coca-Cola's Media Relations Department if they have questions. +And now I would like to introduce Tim Leveridge, Vice President and Investor Relations Officer. Mr. Leveridge, you may begin. + +-------------------------------------------------------------------------------- +Timothy K. Leveridge, The Coca-Cola Company - VP & IR Officer [2] +-------------------------------------------------------------------------------- + + Good morning, and thank you for being with us today. I'm joined by James Quincey, our Chief Executive Officer; and Kathy Waller, our Chief Financial Officer. +Before we begin, I'd like to remind you that this conference call may contain forward-looking statements, including statements concerning long-term earnings objectives, and should be considered in conjunction with cautionary statements contained in our earnings release and in the company's most recent periodic SEC report. +Following prepared remarks this morning, we will turn the call over for your questions. And we have kept our prepared remarks brief this morning and intend to end the call at approximately 9:45. (Operator Instructions) +Now let me turn the call over to James. + +-------------------------------------------------------------------------------- +James Robert B. Quincey, The Coca-Cola Company - President, CEO & Director [3] +-------------------------------------------------------------------------------- + + Thanks, Tim, and good morning, everyone. As we pass the midpoint of the year, I'm pleased to say that we are where we expected to be and remain on track to deliver our full year guidance. +Importantly, we continue to accelerate the transformation of our business into a total beverage company by driving against the strategic priorities we laid out at CAGNY, namely, expanding our portfolio with new products, marketing platforms and a consistent strategy to offer our customers the best consumer-centric beverage portfolio; second, driving revenue growth through enhanced revenue growth management strategies and a strengthened system; third, digitizing our enterprise; and fourth and very importantly, unlocking the power of our people as we instill a growth culture and establish a new leaner operating model. +With this as the backdrop, I'd like to talk about our performance in the quarter and then drill down into actions that we are taking to drive top line growth and, finally, update you on refranchising and our new operating model. +So firstly, starting with the quarter. Ultimately, amidst a weak consumer retail environment in emerging markets, particularly Latin America, and some softness in North America, our actions are enabling us to win in the markets. Globally, we gained value share in total nonalcoholic beverages and in most of our category clusters. +As expected, organic revenue grew 3% in the quarter. Not only did we see a strong performance in rapidly expanding areas of our business, such as Innocent in Europe, but our revenue growth was also largely driven by innovation in sparkling soft drinks, where we have continued to roll out Coca-Cola Zero Sugar around the world. +Price/mix continues to benefit from a focus on smaller pack sizes. Globally, our immediate-consumption packs, which are typically sold at a higher retail price per ounce, grew unit case volume 3% in the quarter. Taken together, with the effective management of our portfolio and cost structure, solid pricing enabled us to deliver another quarter of strong underlying operating margin expansion. +Now turning to look around the world. Many of our developed markets, particularly North America and Europe, continue to perform well. In North America, improving performance in our refranchised territories, with a disciplined approach to volume, price and mix management and some favorable timing of shipments in our food service business, led to an organic revenue growth of 5%. +In our Europe, Middle East and Africa Group, solid marketing and innovation, along with improved alignment with our bottling partners, resulted in strong 6% organic revenue growth. +Importantly, though, some of our large emerging markets, like China and Nigeria, are also accelerating top line growth -- revenue growth this year as we accelerate the revenue management strategies. However, as I noted earlier, there are still regions around the world experiencing political instability and some challenging economic conditions. Most of Latin America, including Brazil, Argentina and Venezuela, remain difficult operating environments for consumer products companies. Additionally, while we believe India has taken the right steps towards modernizing its monetary and tax system, new policies have resulted in near-term uncertainty for retailers and consumers that impacted the beverage industry in the first half. In all of these instances, we are responding quickly to the volatile external environment and building strategies that will allow us to deliver value to our customers by responding to these new challenges faster than the competition. +Now let me turn and take a deeper look at some specific actions we're taking to drive revenue growth. These efforts are the result of a keen focus on innovation, small pack sizes and more robust segmentation strategies. For example, in China, we launched new innovative versions of Minute Maid Pulpy brand to serve the premium consumer segment at retail prices above the original version. In Europe, Innocent, our premium juice and smoothie brand, continued to outperform with double-digit revenue growth as a result of expanded distribution and product innovations, such as pack improvements and the launch of new higher value-added smoothies. +Within our sparkling soft drinks, revenue growth was driven by our no-sugar options, where we are perfecting recipes, expanding availability and supporting enhanced execution with the right level of marketing support. +Specifically, we continue to see excellent results from Coca-Cola Zero Sugar. This product has demonstrated strong consumer appeal in Europe, Mexico and other markets, resulting in double-digit global volume growth for the brand year-to-date. So we will continue to roll this new and improved product out across key markets, including the U.S., supported by substantial marketing and media support. And with its even more Coke-like taste, we expect to continue -- we expect it to continue to be a growing and important part of our portfolio. +You all know that small packs are an important part of our business. They enable us to provide price/mix accretive offerings at affordable consumer price points as well as high-value products in developed markets like the U.S. This year, success of the small pack initiatives in China, South Africa and Central and Eastern Europe is helping to deliver growth in these markets. +Finally, we are looking to grow through more robust segmentation of our existing portfolio. In West Africa, for example, we are tailoring our package offering and trade incentives for rural and urban markets even further. And as a result, we're delivering stronger top line results. +Now to support all of these initiatives, we have been taking significant action to strengthen our system. In May, we held our annual Global System Meeting, and the level of engagement among our bottling partners was very high. They are encouraged by the innovation we are bringing to the market and are committed to support our investments with enhanced focus on local execution. And over the past year, we started to see tangible results, starting, let's say, in North America. We've seen continued strong performance from our bottlers as we complete refranchising and are confident in the actions we have taken to complete the changes this year while also improving execution in the marketplace. +For example, we are seeing improved execution from Coca-Cola UNITED and Coca-Cola Beverages Florida across the state of Florida. In territories it acquired, UNITED is increasing outlet penetration in eat-and-drink channels whilst also improving same-store sales with local convenience stores and workplaces. These are the types of account where the local touch from our network of independent bottlers provides a significant strategic advantage and is one of the reasons why our overall performance in North America has consistently outshined our performance in measured channels. +And I'm pleased to say that we are getting close to finishing our planned refranchising activities. With the latest letters of intent to divest both West and the Tri-State Metro Operating Units, we now have 100% of the U.S. territories of Coca-Cola Refreshments under agreement or letter of intent. +Turning to Europe. We are already seeing better results than we have seen in several years from this important profit center as our new pan-regional bottler, Coca-Cola European Partners, leverages best practices from its 3 predecessors and we work together to bring new products to the market at a faster pace. +Turning to Asia. Coca-Cola Bottlers Japan completed its first quarter as an integrated company. And earlier this month, we completed refranchising of all our company-owned bottling operations in China with the sale of the Shanghai Bottler. +Finally, turning to Africa. We reached agreement with the South African government on conditions addressing public interest considerations in connection with our planned acquisition of ABI's stake in Coca-Cola Beverages Africa. Over the coming months, we will continue to work with the various regulatory approval processes and expect to close these transactions around the end of the year. As a reminder, we plan to account for these bottling territories as discontinued operations until they can be refranchised to other partners. +As I laid out earlier this year, we are also embracing a new operating model and changing our culture to smart risks and be more growth orientated. As we expand our portfolio, we are taking a test-and-learn mentality, which means some things will work right off the bat, some will need tweaking, and that's all okay. For instance, we launched Honest Tea in Europe earlier this year and learned that the brand resonates better with consumers in certain channels. So we've immediately begun to evolve the packaging format and go-to-market channel strategy. We're seeing what consumers want and making adjustments immediately. +At the end of the day, speed and agility are critical in this rapidly changing consumer landscape. +Now turning to our lean venture initiative. We are on track. Much of the organizational design work we outlined earlier this year is now complete, and we are rapidly implementing our new corporate structure to support faster growth. While these large-scale changes are never easy, our associates understand the need for our company to adapt, and I am very encouraged by how well the organization is embracing the transformation. +Our system has proven that it is taking the right actions to be successful in the market. And going forward, we will remain relentless in becoming more efficient, leaner, more agile while continuing to expand our portfolio, therefore, building a strong position for future growth. +Looking at the back half of the year. We will continue to face many of the macro headwinds we have seen year-to-date and over the past few years. However, we are building on a solid marketing calendar, an innovation pipeline and strong execution. And I am confident we will achieve our full year outlook. +So with that, I'll turn the call over to Kathy to take you through our numbers. + +-------------------------------------------------------------------------------- +Kathy N. Waller, The Coca-Cola Company - Executive VP, CFO & President of Enabling Services [4] +-------------------------------------------------------------------------------- + + Thank you, and good morning, everyone. We delivered good financial results in line with our expectations, with price/mix and operating expense leverage driving 6% growth in underlying profit before tax. +As James mentioned, we continue to refranchise our company-owned bottling operations, which, together with a slight currency headwind, resulted in a 16% decline in comparable net revenues. However, adjusting for the impact of currency and those divestitures, our revenue management initiatives led to 3% organic revenue growth in the quarter, with strong performance in North America, Europe and +Mexico. +Comparable gross margins increased over 200 basis points, reflecting the benefit from refranchising lower-margin bottling businesses and strong price/mix, partially offset by increased commodity costs and about a 40 basis point currency impact. Comparable operating margin grew over 375 basis points, driven by the divestitures, the timing of SG&A expenses and continued productivity. +Moving to cash flow. We generated $2.6 billion in free cash flow year-to-date and have returned to our share owners $1.6 billion in the form of dividends, reflecting a 6% increase in our annual dividend, and $1.3 billion in net share repurchases. +Turning to our comparable outlook. For the full year, we expect to deliver 3% organic revenue growth and 7% to 8% growth in underlying profit before tax. In addition, we expect divestitures of company-owned bottlers to result in a 5- to 6-point structural headwind to profit before tax. However, due to the strengthening of several currencies, we now expect a currency headwind to profit before tax of 2 points, slightly better than our previous guidance of a 3-point headwind. This will result in approximately a $0.02 benefit to full year EPS. So we now expect comparable EPS to be flat to down 2% this year as we complete the bottler refranchising process and return to a higher-margin, capital-light business model. +As you model the third quarter, there are a few items to consider. First, we expect the net impact of acquisitions, divestitures and other structural items to be a 19- to 20-point headwind on net revenue and a 9- to 10-point headwind on profit before tax. Therefore, we also expect this to result in greater comparable gross and operating margin expansion than we saw in the first half. Second, we expect that currency will be a 1- to 2-point headwind on net revenue and a 2- to 3-point headwind on profit before tax. And then finally, as a reminder, our calendar fourth quarter will benefit from 1 extra day versus the prior period -- prior year period. +So in summary, our performance during the first half of the year was in line with our expectations. And given that many markets remain volatile, we are maintaining our currency-neutral estimates. However, with a slightly better currency environment in the back half of the year, we now expect full year comparable EPS to come in $0.02 higher than our previous guidance. +Operator, we are now ready for questions. + + +================================================================================ +Questions and Answers +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + We have Bryan Spillane of Bank of America Merrill Lynch. + +-------------------------------------------------------------------------------- +Bryan Douglass Spillane, BofA Merrill Lynch, Research Division - MD of Equity Research [2] +-------------------------------------------------------------------------------- + + I guess my question is related to the flexibility to spend more. I guess as we're kind of watching the year evolve and watching the performance, it seems like you're having good traction with a lot of the revenue initiatives, packaging, product. So James, could you just talk to us about maybe sort of the flexibility you have within your plans to maybe increase some of the marketing investment or some of that investment to drive revenue growth given that it seems like you've got pretty good response to kind of what you're doing now? + +-------------------------------------------------------------------------------- +James Robert B. Quincey, The Coca-Cola Company - President, CEO & Director [3] +-------------------------------------------------------------------------------- + + Yes. I think the -- we've said that we're going to manage the year, and we're going to try and pull into that balance the obvious building of the business over the long term. We have stated that we'd like to get out of the trend of declining EPS, which has been the last few years, and that we are going to invest where it makes sense. So we are constantly looking at where that places our momentum, and should we invest more, and we have done so. And we have increased our plans in the downhill in a couple of places where we see really good momentum and a good reason to invest for better results. But the world remains volatile, and there are places where the environment is better suited to affordability, to returnables, to adjustments. And where markets are, just frankly, under a lot of macro pressure, extra investment is not going to drive us very far. So we will continue to manage it with flexibility. We know that going forward, we'll have some of the money we're going to generate out of lean enterprise to look across the portfolio, but we're going to decide that on an ongoing basis. + +-------------------------------------------------------------------------------- +Operator [4] +-------------------------------------------------------------------------------- + + We have Judy Hong from Goldman Sachs. + +-------------------------------------------------------------------------------- +Eunjoo Hong, Goldman Sachs Group Inc., Research Division - MD, Co-Head of the GIR Asian Professionals Network, and Senior Analyst [5] +-------------------------------------------------------------------------------- + + So I guess my one question is just around your organic revenue growth guidance for the full year and just kind of how you're thinking about the puts and takes around it in the back half. So obviously, you're doing 3% year-to-date. The full year guidance implies the continuation of the similar growth rate. I think a lot of your peers are actually guiding to acceleration in the back half, and there may be some unique timing situation for you guys, but just kind of the puts and takes as you think about the back half from an organic sales growth perspective. + +-------------------------------------------------------------------------------- +James Robert B. Quincey, The Coca-Cola Company - President, CEO & Director [6] +-------------------------------------------------------------------------------- + + Yes, sure. I think a couple of things. On an as-reported basis, you will indeed see an acceleration in the back half, principally because we have an extra day in the fourth quarter, and we had the less days in the first quarter. So I think as you look at the reported numbers, there will be some acceleration. Now underlying that and seeing it in its most simple sense of taking unit cases and price/mix, as you say, we did roughly 3 in the first quarter and roughly 3 this quarter. We're guiding to 3 for the rest of the year because frankly, the world has not changed. We are doing a lot of the right things in the places that are going well, and frankly, there are some of the ones that need to be fixed. But we don't see the world as improving rapidly, and therefore, we're not banking on that happening. And so we're more focused on doing what we know needs to be done and having a moderate view of how that's going to play out in the rest of the year. And I think the expectation for the downhill should be more of the same of what we've had so far this year, hopefully with some of those macro situations improving as we get towards the end. + +-------------------------------------------------------------------------------- +Operator [7] +-------------------------------------------------------------------------------- + + Our next question is from Bill Chappell of SunTrust. + +-------------------------------------------------------------------------------- +William Bates Chappell, SunTrust Robinson Humphrey, Inc., Research Division - MD [8] +-------------------------------------------------------------------------------- + + James, one of the things we've heard with regards to U.S. refranchising is that as they've taken it over, the territories, they're actually performing maybe better than Coke was when they were doing it. And you've seen an acceleration in some markets. They've been a little more aggressive. So I guess this is really one question. Is that the case? Why is that happening? And do you expect that to be kind of a tailwind for the business in the U.S. over the foreseeable future? + +-------------------------------------------------------------------------------- +James Robert B. Quincey, The Coca-Cola Company - President, CEO & Director [9] +-------------------------------------------------------------------------------- + + Yes. So I think the headline answer is yes, it's happening, and I think it was part of the design and the strategy. To be fair to the team running CCR, they have been improving their operations of Coca-Cola Refreshments over the years and have been getting increasingly better results over time and doing a lot of the things that set the platform for better local operations and better coordinated national operations. But there's no question that as the bottlers have taken over these new territories, they have been very energetic in trying to improve them. They've made good progress, particularly in some of the non-directly measured channels, the up and down the street, the smaller stores, where they build on their local expertise. So I think it is, in aggregate, a tailwind. It was part of the strategy that it should be that way, and I think it's a compliment to the local bottlers that they are driving that forward. + +-------------------------------------------------------------------------------- +Operator [10] +-------------------------------------------------------------------------------- + + Our next question is from Ali Dibadj of Bernstein. + +-------------------------------------------------------------------------------- +Ali Dibadj, Sanford C. Bernstein & Co., LLC., Research Division - SVP and Senior Analyst [11] +-------------------------------------------------------------------------------- + + Wanted to talk a little bit more about the margin expansion that we saw, so 375 basis points on a non-GAAP basis. Can you quantify the disaggregation that you lay out in words? So quantify how much comes from bottling divestitures, how much from expense management, how much from timing of expenses, which I assume that means it's coming back at some point. So really want to disaggregate that and quantify that and then think about how we should think about the sustainability of each of those going forward to really kind of draw the path on gross -- on, sorry, operating margin expansion going forward. + +-------------------------------------------------------------------------------- +Kathy N. Waller, The Coca-Cola Company - Executive VP, CFO & President of Enabling Services [12] +-------------------------------------------------------------------------------- + + So the operating margin expansion, the 375 basis points, I mean, clearly, we see that we are -- that operating margins have expanded when you see that we are at 6% of profit before tax and on organic revenues of 3. Yes, that is driven by that price/mix. And so you know exactly where the price/mix came from in terms of there's a lot of it being driven by North America and EMEA and -- in this quarter. And then timing of SG&A expenses, yes, part of that is -- yes, it will (inaudible) over the balance of the year, but that wasn't really the bulk of what was driving that. It's more about the productivity and cost management that we have in the year. So we have more plans over the next couple of years for additional -- for the rest of the productivity. And that will continue to drive operating margin expansion. First, just the refranchising itself drives -- has driven a lot of that 375 basis points. As we have gotten out of the capital-intensive businesses, the more people-intensive businesses, that specifically drove that 375 basis points. So we had guided to the fact that our operating margins were going to go up after the refranchising. We plan to be in that range and continue to look for, obviously, other opportunities to increase operating margins as we go forward. But -- so basically, think about it as the refranchising driving most of that, good price/mix and the cost management and the productivity that we will continue to get over the next couple of years. + +-------------------------------------------------------------------------------- +Operator [13] +-------------------------------------------------------------------------------- + + Our next question is from Bonnie Herzog of Wells Fargo. + +-------------------------------------------------------------------------------- +Bonnie Lee Herzog, Wells Fargo Securities, LLC, Research Division - MD and Senior Beverage and Tobacco Analyst [14] +-------------------------------------------------------------------------------- + + I was just hoping to get an update on your Gold Peak and Dunkin' Donuts ready-to-drink coffees and whether you think there's an opportunity to expand these brands globally at some point. And then curious to hear how you're managing the launch of these in light of Monster Caffe in terms of, I guess, positioning. And then what gives you the confidence that the 3 new coffee brands will all be incremental? + +-------------------------------------------------------------------------------- +James Robert B. Quincey, The Coca-Cola Company - President, CEO & Director [15] +-------------------------------------------------------------------------------- + + Yes, sure. I think we're very happy that we're doing well in teas and coffees both globally and in North America. Obviously, the Dunkin' one is early days, good start. I think Gold Peak is a good tea brand, and again, an early start on the coffee. The basis of our kind of ready-to-drink coffee business, the -- its strong global position is actually Asia. So we have some strong brands there. So I don't think you should see it as there's going to be one brand for ready-to-drink coffee and ready-to-drink tea across the world. We're going to see some strong growth coming out of Asia in Asian teas. Yes, we're launching Honest Tea in Europe as the joint venture with Nestlé winds down on teas in the European space at the end of the year. So you will see us use some of our brands more broadly, but it won't be one brand everywhere. Net-net, we're positive on the long-term growth opportunity for both ready-to-drink teas and coffees. We'll end up with a portfolio of brands, particularly as it relates to different geographies. And each will have its own positioning, but in the end, the consumer will decide the one it wants. And if all work, great. If 2 work, then we'll take one out. Maybe we'll bring one more in. But we'll continue to pay attention to what the consumer wants and help customers grow their businesses by selling our brands. + +-------------------------------------------------------------------------------- +Operator [16] +-------------------------------------------------------------------------------- + + Our next question is from Stephen Powers of UBS. + +-------------------------------------------------------------------------------- +Stephen Robert R. Powers, UBS Investment Bank, Research Division - Executive Director and Equity Research Analyst [17] +-------------------------------------------------------------------------------- + + James, I wanted to build on the test-and-learn comments that you made up front and the quest for speed and agility. There's some great examples that you've highlighted today in terms of the portfolio progress, especially in Europe with smartwater and Innocent and Zero Sugar and Honest. But what I'm trying to understand is, can you talk more about the specific -- any specific steps or tools or incentives that you're putting in place to facilitate that speed and agility? Because in the end, I'm just trying to get a better feel for what that looks like in terms of day-to-day changes and how you push for speed and, at the same time, efficiently manage risk and portfolio complexity as you accelerate into new SKUs and additional category-country combinations. + +-------------------------------------------------------------------------------- +James Robert B. Quincey, The Coca-Cola Company - President, CEO & Director [18] +-------------------------------------------------------------------------------- + + Sure. I mean, I'll give you a couple of ideas, but I think the net of the answer is it's more of a cultural process than a process process. Having said that, we're clear on when we're talking about test-and-learn or experiment, that people need to understand the scale and the potential impacts of the experiments they're undertaking. In other words, we are starting to use some frameworks to classify how people are going after things. So said in simple terms, if the test you're undertaking is not life-threatening, do lots of them, learn quickly and move on. I mean, if the experiment, it potentially creates a material risk if it goes wrong, then let's look at it more closely. So we're starting to push through some ways of looking at the portfolio and the market so they can categorize what sort of strategy and what sort of scale of experiment that they're undertaking, whether it's a launch of a product or a new marketing program, et cetera, et cetera. And so the risk can be managed appropriately, and it's all about what's the potential downside to the corporation and that if it's not big, or said differently, if it's very small, then it's okay to let them go. But as I said at the beginning of the answer, it's mainly a cultural mindset. It's the essential idea that the world is undergoing some important structural changes, multiple ones at the same time, and that is causing disruptions on many fronts. And we have to continue to do what we've done for 130-plus years, which is stay relevant to the consumer and help our customers grow their businesses. And that's cultural. So we need people to really be focused on where do we stand really, to be curious about what's going on in the world, to kind of look -- not look at things through rose-tinted glasses and come to quick conclusions and move on. Why? Not because it's -- we fancy it and it's a nice thing to have. It's because that's what's needed in the marketplace. And I think the employees understand that. I think that's why the lean enterprise is resonating, and I think that's why it'll get pushed through. And we'll back that up with some tools and processes to help people. We're making much more embedded into the organization the use of real agile processes and agile teams because that's the way that we're going to get to answers quicker. + +-------------------------------------------------------------------------------- +Operator [19] +-------------------------------------------------------------------------------- + + Our next question is from Andrea Teixeira of JPMorgan. + +-------------------------------------------------------------------------------- +Andrea Faria Teixeira, JP Morgan Chase & Co, Research Division - MD [20] +-------------------------------------------------------------------------------- + + We have seen continued weakness in sports drinks in the U.S. in the scanner data. And you highlighted also that water, enhanced water and sports drinks were down mid-single digits in the second Q. So could you maybe comment on what you are seeing in the category? And would you expect the trends to improve in the back half of the year? + +-------------------------------------------------------------------------------- +James Robert B. Quincey, The Coca-Cola Company - President, CEO & Director [21] +-------------------------------------------------------------------------------- + + Yes. Yes, yes, we saw some weakness in kind of the water and sports drinks categories in the second quarter. Some of that was weather in May. There was a particularly poor period there. I don't like throwing the weather under the bus, but that's for Q2. I think in the longer-term trend, we'll -- I think water will continue to grow. Particularly enhanced water, premium waters, I think you see a lot of activity by ourselves, by competitors in that space. So I think that is going to come back and will continue to be a source of growth for the industry. And we will participate very competitively, and it will be a source of growth for us. So I think it's a moment in time. + +-------------------------------------------------------------------------------- +Operator [22] +-------------------------------------------------------------------------------- + + Our next question is from Laurent Grandet of Crédit Suisse. + +-------------------------------------------------------------------------------- +Laurent D. Grandet, Crédit Suisse AG, Research Division - United States Beverages Lead Analyst [23] +-------------------------------------------------------------------------------- + + I think you will have surprised many with your 5% organic growth in the U.S., especially after the soft quarter for your major competitor and filled potentially with some disruption from transferring to a bottler. So how should we think about the price/mix going forward? Is 4%, I mean, the new norm in the U.S. and, by extension, in developed countries? And if you can give some colors about what's coming from price, what's coming from mix, that will be helpful. + +-------------------------------------------------------------------------------- +James Robert B. Quincey, The Coca-Cola Company - President, CEO & Director [24] +-------------------------------------------------------------------------------- + + Sure. Clearly, I'm not going to say that 4% is the projectable price/mix for the U.S. I think that's at the top end of what would happen. I think it's important as you look at the U.S. result, I mean, clearly, it was a good quarter. And we're pleased that it comes on top of multiple years of the U.S. business performing at the top end of large consumer products companies. A couple of points that are very important to note. Firstly, we benefited in the second quarter from a little bit of extra gallons in the food service business that was kind of inventory, call that a point. So it's really more of at 4%. Now we're getting a lot of that in the non-measured channels. We're getting it through the small packs. It's about a balance between mix and rates. We've got transaction packs growing mid-single digits in the quarter, high single digits year-to-date in sparkling. So it really is a bit of a sweet spot between rate and mix. As I said, it won't stay up at that high level because of the effect of the extra food service gallons. But they are executing strategy, and I think it's playing out very nicely. + +-------------------------------------------------------------------------------- +Operator [25] +-------------------------------------------------------------------------------- + + Our next question is from Lauren Lieberman of Barclays. + +-------------------------------------------------------------------------------- +Lauren Rae Lieberman, Barclays PLC, Research Division - MD and Senior Research Analyst [26] +-------------------------------------------------------------------------------- + + I was hoping you could talk a little bit about Japan. It wasn't called out much in the release. And just Asia, at least for me, was a bit softer than I had modeled. So could you just tell us anything about what's doing in Japan, overall trends across the bigger categories? + +-------------------------------------------------------------------------------- +James Robert B. Quincey, The Coca-Cola Company - President, CEO & Director [27] +-------------------------------------------------------------------------------- + + Yes. Let me start with Asia and then walk towards Japan, Lauren. I think there was some softness in Asia. We'd have liked to see Asia come in better. I would call out obviously the slight disruption in India from the general sales tax, obviously affected us in the back end of the quarter. As I said in the opening remarks, we think that's good for the country, but it did obviously make some impact in the second quarter. And we're seeing softness across some of the ASEAN countries. Each has their own reasons, but the ASEAN region has been soft. China bounced back a little bit. Japan had a solid quarter. It wasn't knocking it out of the park like it has on some of the previous ones. There are some kind of cycling things in there, but we've had some good launches with some local products in Japan. Coca-Cola FOSHU, it needs more time than I have now to explain it, but pretty solid results. Year-to-date, Japan is going reasonably well. Obviously, we've got the new bottler coming into being, which sort of affects the inventories that we sell into them, which kind of makes it looks like they're not doing as well as they should. But I think Japan is going to continue to do well. China bounced back. So coming back to the beginning, it's really about India and ASEAN. + +-------------------------------------------------------------------------------- +Operator [28] +-------------------------------------------------------------------------------- + + Next is Kevin Grundy of Jefferies. + +-------------------------------------------------------------------------------- +Kevin Michael Grundy, Jefferies LLC, Research Division - SVP and Equity Analyst [29] +-------------------------------------------------------------------------------- + + So James, question on the company's ability and then timing around accelerating top line growth for the company. So to your new team's credit, there's been a universally positive response from the investment community around the changes that you've implemented. But organic sales is now trending around 3%, and you're gaining market share, which is great, but the implication is that the NARTD category is broadly growing sub-3%. So the question is, how quickly can you deliver on that trajectory of about 4%, which is where I think you sort of pegged overall NARTD growth, at least something reasonable longer term? How much can you drive with strategic changes and share gains? How much of this is maybe just cycling Brazil, which is a big market for the company? How much do you need an overall improvement in the macro to sort of take this growth rate from 3% to 4%? And over what time period do you think is sort of reasonable for investors? + +-------------------------------------------------------------------------------- +James Robert B. Quincey, The Coca-Cola Company - President, CEO & Director [30] +-------------------------------------------------------------------------------- + + Yes. Thanks, Kevin. Look, I think a couple of factors. Just mechanically, if Brazil and Venezuela had been flat in the quarter, we'd have grown a point faster. So I mean to say, okay, well, by next year, Venezuela will have declined so much it won't matter. And Brazil, I think there's some belief that it will get better as we come out of the year. So if you want it on a mechanical basis, [you go yes]. Mathematically, if everything else stays roughly the same, then we'll get there next year as Brazil and Venezuela [sober]. Now other countries could fall off the wagon, and so that's always an uncertainty. Having said that, our underlying core revenue growth, organic growth in the second quarter was actually 4%. So if you strip out the bottling operations that we know we're going to sell, we talked about the core growing 4% last year. It grew 4% in this quarter. So I think, in there is the seeds of that number as we go into 2018. We're not making a projection on 2018 yet, but I think underlying are the breadcrumbs towards that conclusion. + +-------------------------------------------------------------------------------- +Operator [31] +-------------------------------------------------------------------------------- + + Our next question is from Brett Cooper of Consumer Edge Research. + +-------------------------------------------------------------------------------- +Brett Cooper, Consumer Edge Research, LLC - VP [32] +-------------------------------------------------------------------------------- + + From the outside, it seems bottler alignment is better than it's been in many times in the past. Just curious how dependent that is on you guys delivering better products to the market, whether that's organic, lift-and-shift, M&A or delivering better marketing, investing more in the market. And then how long do you think the grace period is for you guys to deliver something better than the bottlers before that alignment begins to break down? + +-------------------------------------------------------------------------------- +James Robert B. Quincey, The Coca-Cola Company - President, CEO & Director [33] +-------------------------------------------------------------------------------- + + Look, I think clearly, the company's role is to provide some leadership to the system and, obviously, the marketing -- the brands, the marketing and the innovation to create the business in the countries that they operate in. So to the extent the company doesn't do that, it's always going to be a problem on alignment. Similarly, the bottlers not taking advantage of when there are all those things and investing in execution, investing in the capabilities to develop the marketplace, to expand the number of outlets, to build a stronger base of cold drink equipment and the sales capability to help the customers develop their businesses, then there'll be alignment problems. So net-net, both sides need to come to the table with their piece of the equation and get it done. And when either side slips, yes, we have more robust conversations, but this is a business that really works well when both are coming to the table. + +-------------------------------------------------------------------------------- +Operator [34] +-------------------------------------------------------------------------------- + + Next would be Faiza Alwy of Deutsche Bank. + +-------------------------------------------------------------------------------- +Faiza Alwy, Deutsche Bank AG, Research Division - Research Analyst [35] +-------------------------------------------------------------------------------- + + So I just wanted to talk about Coke Zero, no sugar. How sustainable do you think the growth is of that brand in Europe? And I'd love to hear more about your motivation to bring this to the U.S. Is this really designed to sort of combat sugar taxes that we're seeing in a few of the markets? And are you -- how big do you think it can be? Are you going to phase out sort of Coke Zero over time? And is it meant to really target sort of the Coke Zero customer, the Coke Classic customer or more of a Diet Coke customer? + +-------------------------------------------------------------------------------- +James Robert B. Quincey, The Coca-Cola Company - President, CEO & Director [36] +-------------------------------------------------------------------------------- + + Sure. I mean, I think, firstly, it's gone really well. I mean, global volume growth for Coke Zero Sugar has stepped up over the last few years to mid-single digits to high single digits, and now it's running in the teens. So it's done well in Western Europe, and that's really good. But actually, the global growth continues to accelerate, and we think it has a long way to go. And in terms of bringing it to the U.S., of course, we're bringing it to the U.S. because we think it'll do better and help the U.S. business grow. And you asked a question about, are we phasing out? So it is a reinvention of Coke Zero, and it is a slight repositioning. And yes, it is about helping the zero-calorie part of the portfolio grow, which is linked to playing a role in tackling obesity, and by that, I mean part of what we call the one-brand strategy. So Coke Zero Sugar, of course, is an improved version of the Coke Zero Sugar formula, but it comes in more of a red visual identity, more of a red can with more of a red label and will actually help people stay in the Coca-Cola franchise, and whether they want the original with sugar or they want a Coke Zero Sugar without any, and it's less switching between brands, which will ultimately help us keep and attract more consumers. + +-------------------------------------------------------------------------------- +Operator [37] +-------------------------------------------------------------------------------- + + Next would be Carlos Laboy of HSBC. + +-------------------------------------------------------------------------------- +Carlos Alberto Laboy, HSBC, Research Division - MD, Global Head of Beverages Research, and Senior Analyst, Global Beverages [38] +-------------------------------------------------------------------------------- + + In order to realize the new strategic priorities, can you expand on the actual behaviors that are necessary for the next generation of leadership to succeed and how these might be different from the past? How do you provoke these behaviors, especially speed? + +-------------------------------------------------------------------------------- +James Robert B. Quincey, The Coca-Cola Company - President, CEO & Director [39] +-------------------------------------------------------------------------------- + + Yes. Good question, Carlos. Look, I think the first thing is it's got to be clear to the associates why we want change rather than just asking for it. And so part of the task is helping everyone understand the business necessity of the need to change. As I mentioned earlier, the world is undergoing a lot of structural change. And what it's driving towards is a place where the speed at which consumers, customers and the rate at which insights can be generated from data to give competitive advantage is changing such that the cycle of speed, experimentation and learning will create higher business value. I mean, firstly, you have to land the idea that it's got an ultimate competitive and business value underpinning rather than, "I prefer X versus Y." How do you drive it forward? Well, clearly, in order to get that done, you do need some technical skills. We'll need more consumer digital engagement-type skills, more e-commerce-type skills, more artificial intelligence-type skills and more collaboration-type skills. And in terms of the behaviors, in order to take advantage of that competitive cycle, you need greater transparency. So we need to push behaviors where the information is made available more broadly, more transparently, more quickly. We need to keep encouraging a candor of looking at where [we] really are opportunities and issues, no rose-tinted glasses because then you get to the insight quicker. That's got to go along with a greater curiosity. We've got a -- one of the dangers of being 130-plus years successful is you think you got the answer to some things, whereas we really need to have lots of curiosity about how things could be different, could be better and how we respond to the way things are changing. And then of course, it's -- there needs to be some courage to try new things. I talked earlier about that's going to be managed with risk appetite, all experiments are not born equal, and there'll be lots of tolerance for doing it in a sensible way. And then commitment to making things better, and I think all of that can be created. Of course, the tone needs to be set from the top. We need to put in place the training and the programs. And if people understand why, I think you get a much more empowered autonomous organization that's capable of creating a better future. + +-------------------------------------------------------------------------------- +Operator [40] +-------------------------------------------------------------------------------- + + Our next question is from Pablo Zuanic of SIG. + +-------------------------------------------------------------------------------- +Pablo Ernesto Zuanic, Susquehanna Financial Group, LLLP, Research Division - Senior Analyst [41] +-------------------------------------------------------------------------------- + + Look, when I think of refranchising being completed by the end of the year in the U.S., you're going to end up with a very, very segmented bottling system, which is the opposite of what you have in other parts of the world and [that you're asking for] consolidation. So why does it make sense? Isn't that a problem? Or should we assume that 5 years from now, that system would look a lot more consolidated? And related to that, the fountain business remains in the hands of Coke, seeing it's about 35% of volumes. Does it make sense for you to -- over time to gradually convert the fountain business into RTDs or that's just impossible to do? + +-------------------------------------------------------------------------------- +James Robert B. Quincey, The Coca-Cola Company - President, CEO & Director [42] +-------------------------------------------------------------------------------- + + Yes, let me talk about the question around the bottling system and refranchising. The -- firstly, yes, there are some legacy small bottlers, but principally, the U.S. bottling system, by the end of this year, will be a relatively small number of bottlers, distributed in a very logical geographic distribution across the country, which has moved away from the great mosaic of the past -- of the patchwork group. I think then what we will have if people are really strong locally in their [bottling] places where they know what to do -- and the U.S. is not one place. There are lots of local differences. But the important element of the strategy in the U.S. is the putting in place of the structures and mechanisms so the system can act as one, act as one with customers, act as one from a production system, act as one in terms of IP, act as one in terms of really working out what's the strategy. So it will be a strong combination of local knowledge and the ability to act across the system. It's in place. I think they've done a great job over the last several years in bringing it to life and delivering top-class results in the U.S. environment. And I think that's going to continue to be the system of the future. + +-------------------------------------------------------------------------------- +Operator [43] +-------------------------------------------------------------------------------- + + That will be the final question. And now I would like to turn the call back to Mr. James Quincey for closing remarks. + +-------------------------------------------------------------------------------- +James Robert B. Quincey, The Coca-Cola Company - President, CEO & Director [44] +-------------------------------------------------------------------------------- + + Thank you, Kathy and Tim. So midway through the year, we're on track. We'll continue to transform our business and culture, and we fully expect to meet our full year guidance. So as always, thank you for your interest, your investment in our company, and thank you for joining us this morning. + +-------------------------------------------------------------------------------- +Operator [45] +-------------------------------------------------------------------------------- + + Thank you. That concludes today's conference. Thank you for your participation. You may now disconnect. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/exam/original-files/Problem_2_3_Sample_full_transcripts/2017-May-17-TGT.N-137922466556-Transcript.txt b/exam/original-files/Problem_2_3_Sample_full_transcripts/2017-May-17-TGT.N-137922466556-Transcript.txt new file mode 100644 index 0000000..2834a32 --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_full_transcripts/2017-May-17-TGT.N-137922466556-Transcript.txt @@ -0,0 +1,454 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q1 2017 Target Corp Earnings Call +05/17/2017 08:00 AM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Mark J. Tritton + Target Corporation - Chief Merchandising Officer and EVP + * Catherine R. Smith + Target Corporation - CFO and EVP + * Brian C. Cornell + Target Corporation - Chairman and CEO + * John Hulbert + Target Corporation - Senior Director of IR + * John J. Mulligan + Target Corporation - COO and EVP + +================================================================================ +Conference Call Participiants +================================================================================ + + * Gregory Scott Melich + Evercore ISI, Research Division - Senior MD, Head of Consumer Research Team and Senior Equity Research Analyst + * Michael Lasser + UBS Investment Bank, Research Division - MD and Equity Research Analyst of Consumer Hardlines + * Simeon Ari Gutman + Morgan Stanley, Research Division - Executive Director + * Paul Elliott Trussell + Deutsche Bank AG, Research Division - Research Analyst + * John Michael Zolidis + The Buckingham Research Group Incorporated - Research Analyst + * Kate McShane + Citigroup Inc, Research Division - MD, Head of the U.S. Discretionary and U.S. Apparel and Retail Analyst + * Edward Joseph Kelly + Crédit Suisse AG, Research Division - Senior Analyst + +================================================================================ +Presentation +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Ladies and gentlemen, thank you for standing by. Welcome to the Target Corporation First Quarter Earnings Release Conference Call. (Operator Instructions) As a reminder, this conference is being recorded, Wednesday, May 17, 2017. +I would now like to turn the conference over to Mr. John Hulbert, Vice President, Investor Relations. Please go ahead, sir. + +-------------------------------------------------------------------------------- +John Hulbert, Target Corporation - Senior Director of IR [2] +-------------------------------------------------------------------------------- + + Good morning, everyone, and thank you for joining us on our first quarter 2017 earnings conference call. On the line with me today are Brian Cornell, Chairman and Chief Executive Officer; John Mulligan, Chief Operating Officer; Mark Tritton, Chief Merchandising Officer, and Cathy Smith, Chief Financial Officer. In a few moments, Brian, John, Mark and Cathy will provide their perspective on Target's first quarter performance and our plans and priorities going forward. Following their remarks, we'll open the phone lines for a question-and-answer session. +As a reminder, we're joined on this conference call by investors and others who are listening to our comments via webcast. Following the call, Cathy and I will be available to answer your follow-up questions. +As a reminder, any forward-looking statements that we make this morning are subject to risks and uncertainties, the most important of which are described in our SEC filings. Also in these remarks, we refer to adjusted earnings per share, which is a non-GAAP financial measure, and return on invested capital, which is a ratio based on GAAP information, with the exception of adjustments made to capitalized operating leases. Reconciliations to our GAAP EPS from continuing operations and to our GAAP total rent expense are included in this morning's press release, which is posted on our Investor Relations website. +With that, I'll turn it over to Brian for his comments on the first quarter and our priorities going forward. Brian? + +-------------------------------------------------------------------------------- +Brian C. Cornell, Target Corporation - Chairman and CEO [3] +-------------------------------------------------------------------------------- + + Thanks, John, and good morning, everyone. At our Financial Community Meeting in February, we outlined our multiyear plan to position Target to deliver consistent growth, market share gains and outstanding financial performance over the long term. This plan includes capital investments of more than $7 billion over the next 3 years, focused on continued investments in technology and our supply chain to build a smart network, a network that leverages all of our store and distribution assets to serve our guests more quickly and flexibly in every channel; investments to reimagine the shopping experience in more than 600 of our existing stores; and the addition of more than 100 new small-format locations around the country. +On top of these capital investments, we discussed our plan to invest $1 billion of operating margin this year to allow us to move faster in support of our strategic priorities. We said our biggest operating investment will be in our team, equipping them to deliver enhanced service, convenience and deeper product expertise as we prepare for the launch of 12 new and exciting brands over the next 2 years. +Beyond these expense investments, we outlined our expectation for gross margin pressure resulting from the continued rapid increase in digital fulfillment, combined with the price investments to support our everyday value proposition in key categories. Among all the things we covered in detail at that meeting, one message I don't believe we emphasized enough is our continued commitment to strong execution every day in every part of our business. While we certainly need to focus intently on delivering our long-term commitments, we need to maintain an equal focus on maximizing the performance of our business every day, both in store and online, delivering for our guests and our shareholders. +So I want to thank our team for very strong execution in the first quarter in a very choppy environment. They delivered sales and profitability that was meaningfully better than our expectations. +In February, when we provided first quarter and full year guidance, we emphasized that our goal is to plan prudently and prepare to chase business when the opportunity arises, and that's exactly what happened in the first quarter. Following very soft trends in late January and into February, we saw an acceleration beginning in late February, which was followed by better-than-expected sales in March and April. While our comp sales were strongest in April, if we adjust for the Easter shift, we saw our best results in March. +While we were pleased that our first quarter financial performance was better than expectations, our results are not where we want them to be, and we have much more work to do. Week-to-week results have been volatile since Christmas, and overall traffic declined nearly 1% in the first quarter. Along with this traffic decline, comp sales in both Essentials and Food and beverage were down as well. +As we've mentioned in previous calls, we believe that consumer perception of value at Target has not reflected how low our out-the-door prices really are. As a result, we are in the early stages of implementing merchandising and marketing efforts to improve Target's value perception with guests and reestablish everyday price credibility on key items. +As we implement those changes, we plan to measure carefully and adjust based on how guests respond. +To support these efforts on our marketing, late in the first quarter, we launched a new ad campaign focused on our convenient and low-priced assortment of everyday items, reminding guests that they can save time and money by making a Target run to their nearby store. And for guests that prefer to get their essentials at home, we recently announced that we're testing Target Restock, which will allow guests to order a large box filled with items they choose from a selection of thousands of essential items. We've been testing this service with team members here in the Twin Cities, and we're preparing to extend this test to local REDcard holders in the near future. While some specifics of the offer have yet to be finalized, we expect to have a very competitive service compared with alternatives that are already in the marketplace. +Beyond essentials, we are focused on growing the signature portion of our business, and we continue to be pleased with the performance of Cat & Jack and Pillowfort, the new Apparel and Home brands we launched for Kids last year. Based on our insights from last year's launches, Mark and his team are preparing to roll out additional brands later in the year as part of our plan to launch 12 new brands across our signature categories over the next 2 years. +Beyond these efforts to reimagine our exclusive brand portfolio, we continue to find new opportunities to partner with world-class designers and brands, and deliver unique style and unbeatable value for our guests. In the first quarter, we were pleased with the results from our limited-time partnership with Victoria Beckham, which proved to be one of the single biggest partnerships in our history. +In the digital channel, sales increased 22% in the first quarter, much faster than the growth rate of the industry. Mike McNamara and his team continue to work closely with both John's team and Mark's team to develop and roll out new capabilities, highlight our differentiated assortment and elevate the guest experience by providing more speed and convenience. +We invested nearly $500 million of capital in the first quarter, and we're on track to invest more than $2 billion this year. Our technology and supply chain investments are focused on delivering a superior guest experience in every channel. +In addition to new capabilities like Target Restock, which provide convenience, we're working to deliver a more inspirational digital experience, like the 360-degree shopping experience we just launched on our site. This capability was delivered by our CGI team, and we're investing to grow that team so we can rapidly roll out additional experiences over time. +Beyond our continued investments in technology and supply chain, we're in the early stages of work to transform our existing store base and add to our portfolio of new small-format stores around the country. In the first quarter, we completed 21 existing store remodels and opened 4 new small-format locations. For the year, we're on track to deliver our goal to complete 100 remodels and add 30 small-format stores. I personally visit many of these locations, and the results look terrific. +As we described in February, we are fortunate to have a strong balance sheet and a business that generates robust cash flow. Unlike many competitors, we have the resources that allow us to invest in the transformation of our business and position Target to compete in this new era in retail. Because our business is so strong, we expect to fund these long-term investments while continuing to support our dividend and annual dividend growth even during the period of transition. +As we look ahead to the second quarter, we're committed to maintaining the cautious posture that served us well in the first quarter. While consumer spending growth remains strong, we're seeing a continued shift towards experiences, which is absorbing a meaningful portion of that growth. In addition to these consumer headwinds, we expect to see continued pressure from competitive closings and liquidations, which represent a long-term opportunity but divert consumer spending in the near term. And finally, our efforts to enhance value perception and regain everyday price credibility will likely create some near-term headwinds before we gain traction over time. +So now I'd like to turn the call over to the team, who will provide additional detail on our performance and focus going forward. Later in the call, Mark will cover category performance and his team's efforts to support both sides of our "Expect More. Pay Less." brand promise. Then Cathy will provide more detail on our first quarter financial results and expectations for the second quarter and beyond. +But first, I'm going to turn the call over to John, who will cover the team's current efforts to modernize the supply chain, invest in our store shopping experience and roll out new capabilities for our guests. John? + +-------------------------------------------------------------------------------- +John J. Mulligan, Target Corporation - COO and EVP [4] +-------------------------------------------------------------------------------- + + Thanks, Brian. This morning, I'm going to provide an update on our progress in rapidly testing and rolling out supply chain and technology innovations. These innovations are designed to provide more convenience, inspiration and faster fulfillment on behalf of our guests regardless of how they choose to shop. Then I'll highlight investments we're making in our stores to reimagine the shopping experience and roll out new capabilities that will help us drive sales in all channels. +In our supply chain and technology areas, our teams are moving quickly, testing and iterating on our ability to increase speed and offer new services for our guests. In our TriBeCa store in New York City, we are ready to begin a test in which we will offer same-day delivery to guests at that store. At checkout, guests will have the option to choose to have their orders delivered to their home later that day in a scheduled delivery window of their choice. +This test presents an opportunity to gauge guest demand for this service in a high-traffic location filled with urban guests who will appreciate the convenience. Through this test, we will gain insights about potential operational challenges and determine appropriate pricing and delivery windows based on guest preferences. This will help us understand the potential to roll out a similar service more broadly over time. +When I moved into my role leading operations, one of the first things I learned is that any supply chain test has to be accomplished in tandem with our current operations. As a result, we have to be very thoughtful about how we conduct a test because we don't want to make changes that might impair day-to-day reliability. In the second quarter, we plan to open a new facility in the Northeast that will allow us to test differentiated distribution capabilities, including store replenishment based on the appropriate unit of measure on every item, including pallets, case packs and eaches. By testing out of a separate facility, we can implement without disrupting day-to-day operations in any of our current facilities. This new facility will help us learn quickly about both opportunities and complexities associated with this new distribution model. +I want to stress that we're opening this facility so we can test and learn quickly, not to create new capacity. In fact, given our opportunity to continue increasing the speed and flexibility of our entire supply chain and leverage our stores to enable digital fulfillment, we have ample capacity within our current network to grow for many years. As we gain insights from the test in this separate facility, we will be better informed and prepared to roll out this new model into existing facilities over time. +Prior to the launch of the new East Coast facility, we have been testing daily customer replenishment based upon eaches in a single store here in the Twin Cities market. This store is much lower volume than our stores in the Northeast which provided us a much lower risk environment for this early test. Results have been encouraging as we've been able to dramatically reduce store labor dedicated to unloading trucks and stocking the sales floor, freeing up time for the team to focus on serving guests. +In addition, we've been able to reduce inventory meaningfully and nearly eliminate backroom inventory of the items included in the test. And after some early bumps, we've done so without affecting out-of-stocks. With these insights, we are ready to move on to the next stage of testing with the new facility, and the team is eager to begin evaluating the results. +With a faster and more reliable supply chain, we can develop new ways to leverage our stores and enhance convenience for our guests. An example is our upcoming pilot of Target Restock, which will begin rolling out to Twin Cities' REDcard holders this quarter. This service allows guests to order a restock shipping box filled with essential items like toothpaste, diapers, coffee and cereal and have them delivered to their homes quickly for a low flat fee. +For the pilot, guests will have access to more than 8,000 items, and we'll continue to experiment and expand the offering based on our learnings and guest feedback. Because the items will be packaged and delivered from a nearby store, orders placed before 1:30 p.m. will be delivered on the following business day. We've built the Target Restock site and supporting back-end operations for a Twin Cities team member test in just 35 days. Based on what we learned in that test, we will launch an enhanced site for the Twin Cities pilot and continue to iterate on the experience. +As we discussed at our Analyst Day, we believe that the future of retail is both digital and physical, and successful retailers will need to provide an outstanding experience in both. That's why we're moving quickly to elevate both the digital and in-store shopping experience, driving guest engagement and sales in every channel. +For digital shopping, the challenge is to make it more experiential, delivering more of the inspiration you can find in a physical store. To elevate the digital experience in furniture and decor, which are already large and growing online businesses for us, we recently rolled out a 360-degree shoppable living room, which serves as a digital showroom. Seeing the products staged in rooms in relation to other products helps guests to better understand the size and style of an item, making it easier to shop. The experience will initially present about [120] products across 4 design aesthetics. +As you know, more than 40% of our digital volume already runs through our stores, and we peaked at more than 80% last holiday season because we can offer both order pickup and ship orders directly from our stores. While all of our stores have offered order pickup for several years, we've worked hard to improve the experience and encourage repeat uses by our guests, and we've seen a payoff from these efforts. In the first quarter, more than 95% of in-store pickup orders were ready for guests in an hour or less, up more than 3 percentage points from a year ago. Our Net Promoter Score for the order pickup experience is improving steadily and is now actually higher than the score for our stores overall. In light of these trends, it's not surprising that repeat usage of order pickup has increased meaningfully compared with a year ago. +First quarter ship-from-store volume was more than double last year's amount, accounting for 27% of our digital sales. This growth was partially driven by approximately 600 ship-from-store locations that we've added since last year. However, the increase was also driven by additional volume running through stores that had this capability for more than a year. +Specifically, for the 460 stores that were shipping directly to guests in the first quarter last year, year-over-year growth in ship-from-store volume was 32% this quarter. We continue to be very pleased with the ability of our stores to accommodate these higher volumes, and our supply chain team is enhancing end-to-end processes to allow for additional volume over time. And importantly, the ability to ship directly from stores to nearby guests reduces our last-mile shipping costs dramatically. +Beyond digital capabilities in our stores, we are also investing in our team in the front of the store. We're providing tools and changing processes to enhance our team's availability on the sales floor and making sure they are available during all hours the store is open. In addition, we're investing in training to equip our store team members with more product expertise in key areas like Food and beverage, Beauty, Apparel, and Electronics. +And of course, we've begun investing in our existing stores to elevate the physical environment along with our level of service. Given that our 21 first quarter remodels were only completed recently, we don't yet have a statistically significant read on post-remodel performance. But early results are very encouraging. +However, for the set of remodels we completed last fall, we have been measuring overall results in line with our expected 2% to 4% lift following completion. Most encouraging, for the 10 fall remodels in which the layout is most similar to the new layout we will roll out in Houston later this year, we have seen lifts near the high end of that range. +It's also important to note that we have a customized approach to remodels, and we have a low-cost, high-impact model that we can bring to our lower-volume stores. Even at a lower investment, in the range of $3 million, there is a meaningful change in the look and feel of the store, and we see guests respond to that change, driving very healthy lifts in the 2% to 4% range as well. +Finally, we continue to be pleased with the performance of our new small-format stores, which generate more than double the per-foot sales productivity of our larger-format stores. While we're happy with the performance of these smaller stores when they open, what's most encouraging is the continued growth we're seeing when the stores become mature. +Specifically, for our 10 mature small-format stores, we are seeing double-digit comp increases on average so far this year. So I hope it's clear that our team is busy and energized, moving quickly with purpose to improve speed and agility and better serve our guests in every channel. Despite a challenging environment, I have never seen the team more focused on what we need to deliver and more confident in our path forward. +Now I'll turn the call over to Mark, who will provide more detail on our performance and plans in merchandising. Mark? + +-------------------------------------------------------------------------------- +Mark J. Tritton, Target Corporation - Chief Merchandising Officer and EVP [5] +-------------------------------------------------------------------------------- + + Thanks, John. As Brian mentioned earlier, we have seen very choppy trends since the end of the holiday season, and our team has moved quickly to adjust in real time. We began seeing signs of improvement in late February, and we saw the strongest performance compared with our forecast in March. We maintained solid results in April, benefiting from both our Victoria Beckham partnership and the Easter holiday. +As we've said many times, Target is a holiday destination, and we certainly saw that during the Easter season. We saw the strongest growth in candy and Easter decor, but we're also pleased with performance in Toys and Kids' Apparel in the weeks leading up to the holiday. +And then there's Victoria Beckham. Given the brand she has created, we knew that our partnership with her would be big, and it delivered. More than half of our Victoria Beckham sales were made up by our most loyal guests. And in 5 cities, we hosted our best REDcard guests at exclusive events, providing early access to her products. Victoria Beckham baskets were more than twice the size of our average transaction, and they weren't just focused on her items. In fact, they were nearly balanced between Victoria Beckham items and items from our broader assortment. And not surprisingly, her items sold particularly well for us online. Overall, we are very pleased with the results of this partnership, which has proven to be one of the biggest in our history. +While macro factors likely drove some of the acceleration in March and April, we also saw the impact of warmer weather on our Seasonal categories and our Electronics business leapt forward with the launch of the Nintendo Switch. Nintendo has long been aligned with our brand, given their history of delivering hardware and games orientated around activity and families. We worked closely with Nintendo team to launch the Switch, supported by a multifaceted marketing plan that was visible both inside and outside our stores. +We also supported the launch online and saw great results by delivering a bundled offer for the Switch on our site. As a result of these efforts, we've enjoyed a mid-teens market share in Switch since the launch. This is a great example of the power of a successful collaboration with a national brand and why we love to partner with world-class brands to create Target-unique, differentiated experiences for consumers. +Beyond video games, Electronics also benefited from healthy growth in Apple Watch and iPhone during the quarter. As a result, for the first quarter in total, Electronics delivered a mid-single-digit comp sales increase, the strongest in 3 years. +In Apparel, trends have been challenging across the industry, and we saw a small decline in Apparel comps in the first quarter. However, when we compare our results to the industry, we continue to measure meaningful market share gains. Last year, our Apparel sales and market share gains were heavily concentrated in women's ready-to-wear and Kids' Apparel. This year, those categories continue to gain share, but we're also seeing gains across all of the subcategories, including Men's Apparel, intimates and Performance Activewear. Trends in activewear have improved meaningfully since the relaunch of our C9 brand after the holiday season. +Swim is another big first quarter story in Apparel, and we expect that to continue all year. As you know, we already have the #1 unit share in swim, but as other retailers began closing and exiting this business, we saw a big opportunity to gain an even stronger position. Our team worked quickly to launch our new brand, Shade & Shore, which has delivered strong results since its launch. Given this momentum, we expect to see continued growth in Swim in the second quarter and beyond. +For our less discretionary essentials and Food/beverage businesses, first quarter market share trends were more challenging. For the quarter, we saw low single-digit comp declines in both of these businesses, and we are taking steps to regain our value and everyday price perception in both of these. This work began in the first quarter, and we recently launched our "Target Run. And Done." marketing campaign to support that work, but we have much more to do. In the second quarter and beyond, we will continue to invest in our regular prices and reinforce our everyday positioning. +An important part of that work is to adjust our promotional posture on those items and categories so they better support that everyday message. In addition, we will work to balance our promotional posture between stock-up offers and factors important for fill-in trips, including an emphasis on individual items and a low opening price point. I want to stress that this work is very detailed and surgical. There isn't a single solution across items and categories so our team will be testing and iterating at a very granular level, and they'll be expanding the scope of their work as the year progresses. +Importantly, as Brian mentioned, as we are implementing these changes, we may see added pressure before we begin to see the benefit. However, we know this is the right thing to do, and we're committed to making these changes to better position our business over the long term. +While value and everyday price perception are a challenge in our Food and beverage category, I want to stress that we are seeing a couple of bright spots. First, we saw a small increase in produce comps in the first quarter, reflecting the work we've done to gain credibility in this key part of the assortment. We have worked with the produce vendors to reduce the time from their fields to our network, and John's team has increased the speed of produce items into our stores once they reach that network. As a result, freshness and in-stocks have been improving. We're also benefiting from the work in our stores to hire grocery experts and organize specialized teams who now own the end-to-end process in those stores. +Another great bright spot is our adult beverage business, which saw a mid-single-digit comp increase this quarter. We continue to focus on developing localized assortments and more compelling displays, and our guests are really responding. We plan to expand space for adult beverages in more than 100 additional stores in the second quarter, with more planned for the third quarter and beyond. +I also want to pause and welcome Jeff Burt, who joined us in April to lead our Food and beverage team. Jeff comes to us with more than 30 years of grocery experience, most recently leading Fred Meyer. Jeff is off to a great start, and I look forward to working with him to further strengthen this business over time. +At our Financial Community Meeting in February, we announced our plan to roll out 12 new exclusive brands across our signature categories through next year, and we're getting ready to launch the first of those brands later this month. It's called Cloud Island, and it's a new exclusive line of nursery décor, bedding, bath and layette products designed by our own internal design team. We've built this collection of more than 500 items to be both stylish and affordable with a focus on safety, durability and comfort. We'll roll out the décor and bedding items to all stores and our site beginning May 28, and we'll follow with the bath and layette pieces later in the summer. This new brand is a natural addition to the successful Kids brands we launched last year, Pillowfort and Cat & Jack, which continue to perform really well. +The guest response to Cat & Jack, in particular, has been amazing. Among guests who purchased Kids' Apparel from Target in the months leading up to the launch of this new brand, spending on Kids' Apparel increased more than 50% in the months following the launch. This increase in spend was driven by both frequency and spend per visit. Even more encouraging, the launch brought an energy and traffic to the whole category, leading to an increase in spending on Kids' clothes at Target even among guests who didn't buy Cat & Jack. This shows why we are so excited about our plans to launch additional signature category brands later in the year and even more next year. +So in closing, let me leave you with a final thought. We understand that we're in the midst of very challenging period in retail, and we're in the early stages of our plan to transform our business. That said, you wouldn't feel that way if you interacted with our team. They're energized and hungry to win, and focused on doing what it takes to get there. +With that, I'll turn it over to Cathy, who will provide more detail on our first quarter financial performance, and outlook for the second quarter and full year. Cathy? + +-------------------------------------------------------------------------------- +Catherine R. Smith, Target Corporation - CFO and EVP [6] +-------------------------------------------------------------------------------- + + Thanks, Mark. When we provided first quarter guidance at our Financial Community Meeting, we described the challenging results we had seen so far in February. At the time, there were theories for why things might improve, but we felt it was best to plan for those challenging trends to continue and react quickly if conditions improved. As we look ahead, we believe it's appropriate to continue to take this cautious approach as we plan for the rest of the year. After all, the environment remains volatile, and the disruption from competitor closings doesn't look like it will change anytime soon. +For the first quarter, comparable sales fell 1.3%. A little over half of this decline was driven by traffic, combined with a small decrease in average ticket. As we've said many times, traffic is the key metric for us. So we're taking steps this year to put us on the path back to growth over time. +First quarter gross margin rate was down about 40 basis points to last year, driven by increased fulfillment costs resulting from the growth in our digital sales. Merchandise mix had a roughly neutral effect on our gross margin rate this quarter, reflecting the acceleration in Electronics that Mark described earlier. While gross margin dollars declined about $130 million from last year, this performance was much better than expected, driven by better-than-expected sales and fewer clearance markdowns compared with our plan. +On the SG&A expense line, first quarter dollars and rate were better than expected as well. Consistent with our plan for the year, we began ramping up store labor on the sales floor. But in the first quarter, those investments in front-end labor were offset by savings in backroom logistics. In addition, we saw some timing favorability on several expense lines in the first quarter, which we now expect to see in the second quarter. +Our first quarter depreciation and amortization rate was up about 20 basis points compared with last year, reflecting increased costs from our remodel program on a lower base of sales. Altogether, our EBIT rate was 7.4% in the quarter, down from a very strong 8.2% last year. At the end of the quarter, inventory was more than 5% lower than a year ago, reflecting the early impact of our work to increase the speed of our supply chain. As I've mentioned before, we believe we have a compelling opportunity to free up working capital over time by increasing the speed and accuracy of our supply chain. We're in the beginning stages of that journey, but it is encouraging to see early signs of progress. +As Brian mentioned, we invested just under $500 million of capital in the first quarter. A portion of these investments was focused on our stores as we started to transform the shopping experience in existing locations. In addition, we continue to grow our portfolio of small-format stores. We also invested in supply chain and technology to support new capabilities, including those John described earlier. For the year, we will continue to focus our investments on these priorities, and we expect our full year CapEx will be in the range of $2 billion to $2.5 +billion. +On top of expenditures for new capital, we paid more than $330 million in dividends in the first quarter and repurchased just over $300 million of our stock, primarily through a preexisting trading plan that was put in place last year. As we consider full year capital deployment and cash flow compared with last year, higher CapEx and lower EBITDA will certainly put some downward pressure on cash flow. However, we also expect some offsetting tailwinds in 2017 as we continue to reduce working capital. +Altogether, as we discussed at our Analyst Day, we expect to continue to have ample capacity to support the dividend and grow it annually, and over time, to the extent we have excess cash beyond CapEx and dividends, within the limits of our current debt ratings, we expect to have the capacity to repurchase our shares. However, given the recent change in our operating model, we will stay relatively cautious about the pace of share repurchase in the near term. +My final comment on the first quarter is in reference to our return on invested capital. We earned an after-tax ROIC of 14.2% in the 12 months through the end of the first quarter. I hope you'd agree that is healthy performance in any industry and any environment, but it's also slightly better than Target's ROIC through the first quarter of last year, excluding the onetime gain from our sale of our pharmacy business. I think that's helpful perspective as we move through a year of meaningful transformation. We are blessed to have a business that continues to generate good returns and have a strong balance sheet. That powerful combination gives us the flexibility to make changes that will position our business for continued success in this rapidly changing period in retail. +Now let's turn to our outlook for the second quarter and beyond. We are planning for a low single-digit decline in comparable sales in the second quarter. Just like the decision we faced in the first quarter, we could plan for a more optimistic scenario, but that would create undue risk in a very choppy environment. On the EBIT line, we are planning for a decline of just over $200 million compared with last year. We expect SG&A expense to be the primary driver of that decline as we continue to invest in store service and new capabilities, and we see the impact of the timing shift on several expense lines from the first quarter. On the EPS line, these expectations translate to a range of $0.95 to $1.15 for both GAAP and adjusted EPS in the second quarter. +For the full year, we are not updating our prior guidance. As a reminder, that guidance anticipates a low single-digit decline in comparable sales for the year and adjusted EPS of $3.80 to $4.20. Clearly, given that first quarter performance exceeded our expectations, there's a higher chance that we'll finish the year in the upper end of that range. However, with most of the year still ahead of us and the prospect for continued near-term headwind, we believe these expectations are still appropriate. +Before I turn the call back over to Brian, I want to thank you for your continued engagement and support. Following our Financial Community Meeting, we've heard from many of you, and as always, we appreciate your perspective. What's most encouraging is your support of our strategy and the steps we're taking to position our business for the long term. Just as we do, you clearly see the risks and challenges in this environment, so it's been very helpful to know that you also believe in our strategy and the long-term investments we are making in our business. +With that, I'll turn the call back over to Brian for some final remarks. + +-------------------------------------------------------------------------------- +Brian C. Cornell, Target Corporation - Chairman and CEO [7] +-------------------------------------------------------------------------------- + + Before we turn to questions, I want to offer a few closing thoughts. First, while we're certainly pleased that Target's first quarter performance was better than expectations, we're not doing any high fives in the room here today. Our first quarter performance is not what we expect to deliver over time, and we're investing and moving quickly to deliver stronger, more consistent results in the future. +When we look ahead, we do so with our eyes wide open, aware of the challenges we're facing. But when I interact with our team, I see a lot of energy and optimism, a desire to deliver for our guests and win in the marketplace. What's most encouraging is the team's agility and responsiveness in a rapidly changing environment. Whether we're talking about the development of Target Restock by our technology and operations teams, the rollout of a new ad campaign like "Target Run. And Done." from our marketing team or the development and launch of a new brand like Shade & Shore from our merchandising team, everyone is focused on innovating rapidly like never before. I'm continually proud and impressed by what this team can accomplish. +This concludes our prepared remarks. Now John, Mark, Cathy and I will be happy to take your questions. + + +================================================================================ +Questions and Answers +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) Our first question comes from Paul Trussell with Deutsche Bank. + +-------------------------------------------------------------------------------- +Paul Elliott Trussell, Deutsche Bank AG, Research Division - Research Analyst [2] +-------------------------------------------------------------------------------- + + Wanted to just inquire about the initial guidance given this year around the $1 billion investment. You mentioned some timing factors between SG&A in 1Q and 2Q. But even looking at the guidance provided for 2Q, the first half is certainly running at a run rate below that of $1 billion in investments. Help us just understand, have there been meaningful offsets? Or should we expect a spike perhaps in that investment pace in the second half? + +-------------------------------------------------------------------------------- +Brian C. Cornell, Target Corporation - Chairman and CEO [3] +-------------------------------------------------------------------------------- + + It's Brian Cornell. Paul, we're very focused on executing the plan we laid out back on February 28. So you're going to continue to see us invest in store labor, making sure our standards continue to improve, and we saw very strong progress in the first quarter; invest in value and continue to invest in the growth of our digital business. So over the course of the year, we're committed to executing against that plan. We'll see that continue over the second, third and fourth quarter. But the plan we've laid out back in February is the plan we're going to continue to focus on executing throughout the year. Our overall focus is to continue to see traffic patterns grow in our stores, improve and accelerate our digital performance. We want to make sure we're capturing market share as we did in the first quarter; continue to build and invest in our brands and, ultimately, improve our value proposition with the guest. So there's going to be no change to the plan we laid out in February. We're committed to executing and making those investments over the balance of the year. + +-------------------------------------------------------------------------------- +Paul Elliott Trussell, Deutsche Bank AG, Research Division - Research Analyst [4] +-------------------------------------------------------------------------------- + + And just as a quick follow-up, Cathy, you gave guidance for negative low single-digit comps in 2Q. Just help us understand some more of the puts and takes from a category standpoint. How are you guys focused on improving traffic trends back into positive -- on the positive side -- yes, sorry, excuse me, on the positive standpoint. And then also, specifically, if you can speak on Food and essentials, is really what I would like to dig on, on how we get that positive as well. + +-------------------------------------------------------------------------------- +Catherine R. Smith, Target Corporation - CFO and EVP [5] +-------------------------------------------------------------------------------- + + Yes. So we are working to restore positive traffic and, more importantly, preference over the long term, and I think that's everything you continue to hear us say. And so over the course of Q2, we're going to just keep doing what we said we would do, and that is we're going to make sure we're continuing to invest in a great experience for our guests, both online and in stores, and you'll see us doing that. Mark and the team have some really exciting things coming into Q2, but don't want to dismiss the positives we saw around category mix in Q1 even. So I'm just going to tell you we're just in this for the long haul. We're going to keep doing what we said we'd do, and restoring positive traffic's high on our priority list. Mark, did you want to talk about anything in particular with regards to Food and beverage? + +-------------------------------------------------------------------------------- +Mark J. Tritton, Target Corporation - Chief Merchandising Officer and EVP [6] +-------------------------------------------------------------------------------- + + Yes. Paul, in terms of promotional posture and the price/value equation, we've made some rapid changes in a number of our signature categories, but probably the key areas that we're focusing on, of course, are Food and beverage and Essentials. So we've been testing and iterating quickly since Q4 and definitely in Q1, and we'll see an evolving pattern of change and evolution on how we'll roll out both the communication to the guests and the simplification of our everyday price positioning. And you'll see that evolve more deeply in Q2 and then beyond. + +-------------------------------------------------------------------------------- +Operator [7] +-------------------------------------------------------------------------------- + + Our next question comes from Simeon Gutman with Morgan Stanley. + +-------------------------------------------------------------------------------- +Simeon Ari Gutman, Morgan Stanley, Research Division - Executive Director [8] +-------------------------------------------------------------------------------- + + So just to follow up on the guidance for the second quarter, can you just talk about the change in momentum that you experienced in March? Do you think that was the environment improving? Or was it some of your actions? You mentioned, I think, Victoria Beckham, and I don't think these things have been material, but I know that, that product line came in March. And I don't know the timing of Electronics and Switch. And then the compares, I believe, get easier -- or got easier in April and stay relatively easy for the quarter. Can you give us a sense, is the run rate deteriorating? Or is your outlook just being conservative at this point? + +-------------------------------------------------------------------------------- +Brian C. Cornell, Target Corporation - Chairman and CEO [9] +-------------------------------------------------------------------------------- + + Simeon, let me start by really summarizing Q1 performance. And certainly, I think we saw some changes in the overall macro environment, but I also saw -- we also saw very strong execution, both from a digital standpoint where we grew the business by 22%, but also meaningful changes in-store. And I think our store standards and our store execution continues to improve. I also think we showed great adaptability in the marketplace, and I'll let Mark talk about some of the successes we saw in categories like Apparel. But I'd highlight the efforts that we've put behind our swim business, where we started out with a #1 share position, but we saw changes in the marketplace, competitive closures, competitive exits. And as we talked about back in February, we are absolutely focused on taking advantage of market share opportunities over the next 2 or 3 years, and this was a great example where Mark and his team recognized the consumer opportunity, saw a change in the competitive environment, quickly build a brand by partnering with our vendors and introduced Shade & Shore during the first quarter, which allowed us to take even more market share in swim. And it's a great example of the work that we're going to continue to focus on over the next few years: looking at the market, recognizing where we have competitive opportunities, where we can gain share and how we use both our digital and physical channels to meet the needs of the guests. Mark, why don't you spend a few minutes just talking about the work you and the team did to take advantage of the opportunity in Q1 with swim? + +-------------------------------------------------------------------------------- +Mark J. Tritton, Target Corporation - Chief Merchandising Officer and EVP [10] +-------------------------------------------------------------------------------- + + Yes. I think it's a great example of we're excited about our new brand launches as we've been testing, learning and constantly iterating to create new ideas, and they're really resonating with our guests. So as Brian talked about, the story here is really one about agility and market insight. So in -- where we already had a strong #1 unit market positioning in swim, we didn't rest on our laurels, similarly to our action in Kids, and we looked at this market with declining players and saw an opportunity to win even further. So we looked at deep guest insights, market insights and worked really, clearly, closely with our vendor insights to create a new brand, a new paradigm and a new service level for our guests all in a very rapid period of time. Launched in Q1, Shade & Shore gained share in hearts and minds of our guests and is creating accelerated growth and real confidence for us as we build our brand portfolio. And it's important to note, as Brian said, this was an omnichannel play. So we looked at both stores and online to meet the guest needs and get exemplary results. + +-------------------------------------------------------------------------------- +Brian C. Cornell, Target Corporation - Chairman and CEO [11] +-------------------------------------------------------------------------------- + + More work to do as we go into Q2. But as we talked about during our prepared comments, Q1, we remodeled 21 stores. We've got much more work to do over the balance of the year. We opened up 4 new small formats. We've started to make very surgical investments in value and simplify our value communication in-store and amplify that with a new advertising campaign that we call "Target Run. And Done." So in the early stages, we're going to continue to build off of that. We want to make progress every quarter. But we recognize it's going to take time, and we're going to stay very focused, very measured against the initiatives we've laid out. And quarter by quarter, we're going to strengthen our performance, continue to drive traffic to our stores, more visits to our site and capture market share as we improve our value perception and continue to build proprietary brands within our portfolio. + +-------------------------------------------------------------------------------- +Simeon Ari Gutman, Morgan Stanley, Research Division - Executive Director [12] +-------------------------------------------------------------------------------- + + And then, if I can ask one follow-up on investments. You mentioned you're starting to make some value investments. Can you give us any color on time frame, on categories? Is it broad-based? And back to the earlier question, it looked like this quarter, the decline in EBIT looked commensurate with the comp decline. It didn't look like this was a big period of investment. And again, behind the scenes, there might be that we don't see. So just curious of how we should lay that out for the rest of the year. + +-------------------------------------------------------------------------------- +Brian C. Cornell, Target Corporation - Chairman and CEO [13] +-------------------------------------------------------------------------------- + + I mean, as Mark and Cathy have both discussed, we are making investments in value, very much focused on household essentials and Food and beverage. Those are going to continue over the balance of the year, and we're going to be very surgical. We're going to measure and iterate. We've already made some significant progress in simplifying our overall value and promo communication and now enhancing it with additional advertising dedicated to those core household essential items that drive trips to our stores. So you're going to continue to see that focus, not only over the balance of this year but over time. + +-------------------------------------------------------------------------------- +Catherine R. Smith, Target Corporation - CFO and EVP [14] +-------------------------------------------------------------------------------- + + Maybe, Simeon, I'll add on just real quickly. So on -- let's look at the SG&A line, in particular, to give you an example. We invested more hours in the store, in store service and store experience, and obviously, we also invested in marketing. But it's being offset because of all of the work we're doing around -- in our supply chain and fulfillment. In the back rooms of our stores, we're starting to see some of the benefits there. Again, we're early days in a long journey, but you are seeing some of that offset. So it doesn't show up as apparently on the SG&A line. And then I'd remind you to look at -- I mean, clearly, not where we want to be with sales down slightly and EBIT down quite a bit more. So the investments are coming through as we said, and it's not going to show up in any given quarter. It's going to show up over the time. + +-------------------------------------------------------------------------------- +Operator [15] +-------------------------------------------------------------------------------- + + Our next question comes from Edward Kelly with Crédit Suisse. + +-------------------------------------------------------------------------------- +Edward Joseph Kelly, Crédit Suisse AG, Research Division - Senior Analyst [16] +-------------------------------------------------------------------------------- + + Could you talk about how your strategy in Food may evolve with the hiring of Jeff Burt from Kroger? And I guess, if you were to take a step back and really start to think about it, what are the 2 or 3 things that you really are looking for him to accomplish here? + +-------------------------------------------------------------------------------- +Brian C. Cornell, Target Corporation - Chairman and CEO [17] +-------------------------------------------------------------------------------- + + Let me start. First of all, Jeff has only been on board for a handful of weeks, so still in the early period of time, really trying to understand our business, assimilating to the Target environment. So we want to certainly give him plenty of time to assess our business and begin to build strategies going forward. But I think it's important to recognize he's not starting from square one. Over the last couple of years, we've been very focused on improving the quality of our fresh assortment. And the work that our merchandising team and our supply chain team have done, we've made significant progress in improving freshness, evolving our assortment to make sure we have more organic, natural, gluten-free items in our assortment in each and every category where we participate in Food and beverage. As you've heard us talk about time and time again over the last few quarters, we made significant progress in categories like adult beverages. So Jeff will build off of that work. We've certainly recognized, based on the work we've done in Los Angeles with the LA25 remodels and additional remodel activity in the Dallas-Fort Worth market, that as we change the in-store environment and elevate the presentation, the guest is responding very, very well. So we want to give Jeff plenty of time to take his own inventory, begin to build his own strategy that will enhance the work that we've been doing over the last couple of years. And we're very confident that over time, Jeff's going to build a plan that will allow us to continue to accelerate our performance in those important Food and beverage categories. + +-------------------------------------------------------------------------------- +Edward Joseph Kelly, Crédit Suisse AG, Research Division - Senior Analyst [18] +-------------------------------------------------------------------------------- + + Just a follow-up related to Food. On Monday, there was an article on -- in The Journal about you guys. I'm sure you saw. There was a mention in there about maybe your interest in Sprouts last year. I'm just curious as to -- how do you think about acquisitions generally? And are you interested, willing and thinking about out-of-the-box alternatives through maybe like M&A to reposition this business? + +-------------------------------------------------------------------------------- +Brian C. Cornell, Target Corporation - Chairman and CEO [19] +-------------------------------------------------------------------------------- + + Ed, we look at M&A opportunities all the time, but we look at them through a filter of what's going to really enhance our current business initiatives. So I would put out-of-the-box on the side and really think about M&A as something that's going to complement and strengthen our core strategy, help us accelerate, complement the interaction we have with the Target guest, and we'll continue to look strategically at M&A opportunities over time. + +-------------------------------------------------------------------------------- +Operator [20] +-------------------------------------------------------------------------------- + + Our next question comes from Michael Lasser with UBS. + +-------------------------------------------------------------------------------- +Michael Lasser, UBS Investment Bank, Research Division - MD and Equity Research Analyst of Consumer Hardlines [21] +-------------------------------------------------------------------------------- + + It's on the investments you're making this year. To what degree are you moderating and altering them based on the week-to-week and the sales trends that you're seeing? So if sales are better than expected, are you actually pulling back on some of those investments? + +-------------------------------------------------------------------------------- +Brian C. Cornell, Target Corporation - Chairman and CEO [22] +-------------------------------------------------------------------------------- + + Michael, we are very focused on executing against the initiatives and investments we outlined earlier in the year. So we'll continue to iterate as we learn through our remodel experience, as we continue to open up new small formats. We learn every day as we develop new brands. But our focus remains the same, so you shouldn't expect to see any drastic changes. And we'll continue to mature those initiatives over time. + +-------------------------------------------------------------------------------- +Catherine R. Smith, Target Corporation - CFO and EVP [23] +-------------------------------------------------------------------------------- + + If anything, what I would say, Michael, is we're accelerating. When we test and learn and validate, we accelerate our investment into that area. And so that's where we're looking across the company. When we see an opportunity to accelerate something that's working along our strategies, that's what we're doing. + +-------------------------------------------------------------------------------- +Brian C. Cornell, Target Corporation - Chairman and CEO [24] +-------------------------------------------------------------------------------- + + Look, Michael, over the next couple of years, you should expect us to continue to focus on reimagining our existing stores. Adding new small formats that bring us into urban markets and on to college campuses, our continued investment in supply chain and technology, the support of our new brands that we'll be launching over the next 18 months, those commitments will not change. And our focus is on execution. And I think what we saw in the first quarter is a company that's making progress, we still have a long way to go, but continuing to focus on executing each and every day, both in our physical and digital channels. And that's not going to change over the next few years. + +-------------------------------------------------------------------------------- +Michael Lasser, UBS Investment Bank, Research Division - MD and Equity Research Analyst of Consumer Hardlines [25] +-------------------------------------------------------------------------------- + + Brian, within the grocery and essentials category, can you give us a sense where you think your pricing gap is to the market today and where you think it needs to be over time? + +-------------------------------------------------------------------------------- +Mark J. Tritton, Target Corporation - Chief Merchandising Officer and EVP [26] +-------------------------------------------------------------------------------- + + Yes. I'm happy to take that, Michael. I think that -- we started work here in earnest in Q4 and continuing with healthy work in Q1. We actually show our indices are actually closer than the guest gives us credit for, and that's an issue for us because we know that's a bigger message that we need to convey. So we're continuing to sharpen our price and our value messaging at the same time and make sure that we move to a more regional-based pricing, localized pricing so we're more relevant to the guest and the competitive set, which is not what we're doing during '16 and we've rapidly iterated on in '17. So you'd see more of that activity and more of that benefit as we move through 2017. + +-------------------------------------------------------------------------------- +Operator [27] +-------------------------------------------------------------------------------- + + Our next question comes from Kate McShane with Citi. + +-------------------------------------------------------------------------------- +Kate McShane, Citigroup Inc, Research Division - MD, Head of the U.S. Discretionary and U.S. Apparel and Retail Analyst [28] +-------------------------------------------------------------------------------- + + With regards to moving to EDLP and the value messaging, I just wondered how much that move weighed on margins in Q1 and where you're seeing more success in that move and where you think you have more work to do. And then, in that same context, I think you've noted before that there's been fits and starts with how you've communicated your value message. Can you explain how and what you did during Q1 to convey that better to your customer? + +-------------------------------------------------------------------------------- +Catherine R. Smith, Target Corporation - CFO and EVP [29] +-------------------------------------------------------------------------------- + + Yes. So I'm happy to start, Kate, and then Mark can amplify as well. So on the impact that we saw coming through gross margin, as Mark shared and we've shared actually for a couple of quarters, our biggest work has got to be around making sure that the value we're delivering is really clear. And it's going to take a while for our guest to give us credit for that, and so that's the work that we're going to continue to do. So while we're sharpening and making it more regionalized, you'll see that come through slightly. But the bigger effort is all of the work we're doing like the "Target Run. And Done." campaign that we launched this last quarter and making sure that our guests recognize the value we are delivering. + +-------------------------------------------------------------------------------- +Mark J. Tritton, Target Corporation - Chief Merchandising Officer and EVP [30] +-------------------------------------------------------------------------------- + + Yes. I'd just add into that, Kate. Our efforts, as we've discussed, are quite surgical. So we're doing this area by area, classification by classification as an evolving transfer. And we've really begun those efforts through Q1 but more in the back end as we matched to the "Target Run. And Done." campaign. So what we're seeing here is, on the handle side, we've been clear that we've had up to 28 different handles that we've been using to resonate value across all our classifications. So rationalizing the voice and the nomenclature down is part of that. So we -- that's why we've come into Q2 with an evolving position, and we'll assess its impact and its opportunity. + +-------------------------------------------------------------------------------- +Operator [31] +-------------------------------------------------------------------------------- + + Our next question comes from Greg Melich with Evercore ISI. + +-------------------------------------------------------------------------------- +Gregory Scott Melich, Evercore ISI, Research Division - Senior MD, Head of Consumer Research Team and Senior Equity Research Analyst [32] +-------------------------------------------------------------------------------- + + I had a couple of questions. One, Cathy, sort of a housekeeping. You mentioned there was a timing issue in SG&A. Could you quantify how much that helped SG&A or how much we should expect it to come in, in the second quarter? + +-------------------------------------------------------------------------------- +Catherine R. Smith, Target Corporation - CFO and EVP [33] +-------------------------------------------------------------------------------- + + Yes. As we said in our Q2 remarks and guidance, that we expect a couple hundred million dollars of EBIT decrease, and we also said that the majority of that would be in SG&A. So it's pretty -- I think it's pretty safe to assume that, that would be how I'd quantify the shift from Q1 into Q2. + +-------------------------------------------------------------------------------- +Gregory Scott Melich, Evercore ISI, Research Division - Senior MD, Head of Consumer Research Team and Senior Equity Research Analyst [34] +-------------------------------------------------------------------------------- + + Got it. That's helpful. And then a bigger-picture question. We've talked a lot about traffic, but I don't think we've touched yet on the loyalty programs and the frequency you could drive from REDcard and Cartwheel. And been a lot of change in the market, whether it's Amazon Prime or Costco with their new credit card or Walmart with free shipping thresholds lowering. How are you guys thinking about integrating those programs to really help drive traffic? And is there a time this year we should expect to see that maybe enhanced or rolled out? + +-------------------------------------------------------------------------------- +Brian C. Cornell, Target Corporation - Chairman and CEO [35] +-------------------------------------------------------------------------------- + + Greg, we'll talk more about that in the second half of the year. We're spending a lot of time right now with Rick Gomez, who's now our Chief Marketing Officer, really stepping back and thinking about loyalty and, importantly, as you just said, the integration of the REDcard into that loyalty program. And one of the other highlights from the first quarter is the continued penetration growth of our REDcard. So we recognize that's a very important asset that we need to leverage going forward, and Rick and his team are working right now to think about the next phase of loyalty and how we continue to leverage the REDcard to build even a stronger relationship with our guests. So you're spot on, and we'll talk about that much more in the second half of the year. + +-------------------------------------------------------------------------------- +Gregory Scott Melich, Evercore ISI, Research Division - Senior MD, Head of Consumer Research Team and Senior Equity Research Analyst [36] +-------------------------------------------------------------------------------- + + And on sales, if I could just follow up, it sounds like sales improved in March and April, but we're still negative. I just want to make sure that's right. + +-------------------------------------------------------------------------------- +Brian C. Cornell, Target Corporation - Chairman and CEO [37] +-------------------------------------------------------------------------------- + + Greg, you know we don't break out monthly sales. As we said, we saw strengthening in the latter half of February, into March and April. But obviously, our comps were still down for the quarter, so we've got work to do. We're not satisfied with where we ended up. But we certainly feel good about the progress we made in the quarter and, importantly, the market share gains that we saw in very important signature categories. So we're focused on driving traffic. We are certainly committed to restoring positive comps throughout our system. But one of the other important metrics that we're going to be looking at every single quarter is how we're performing from a market share standpoint, and I feel very good about some of the market share gains that our team achieved in Q1. We're going to continue to focus on market share opportunities throughout the year. + +-------------------------------------------------------------------------------- +Operator [38] +-------------------------------------------------------------------------------- + + Our next question -- or final question comes from John Zolidis with Buckingham Research. + +-------------------------------------------------------------------------------- +John Michael Zolidis, The Buckingham Research Group Incorporated - Research Analyst [39] +-------------------------------------------------------------------------------- + + A question on the performance of the smaller-format stores. You mentioned that they had sales productivity roughly 2x that of the larger, more suburban-based stores. Aside from the difference in either being an urban or suburban location, what do you attribute -- or what can you tell us about why the productivity of those boxes is so much better? And is there any learnings you can take from the small-format stores to extend to the balance of the chain? + +-------------------------------------------------------------------------------- +Brian C. Cornell, Target Corporation - Chairman and CEO [40] +-------------------------------------------------------------------------------- + + John, there's a lot of learnings that we're bringing forward from those small stores, not only as we expand into new markets but as we think about application to our traditional stores. I think the biggest learning is, as we move into these new neighborhoods, consumers love Target and they love the brand. And the response we're seeing has been really outstanding. So we feel very good about our small-format strategy. As we move into new neighborhoods, we're getting better and better at curating and localizing assortments, understanding how to operate in various markets. And we're also encouraged to see the early comp results as we lap some of the new small formats we opened up last year. So encouraging signs, and we're going to build off of that as we go forward. So we feel good about the progress we made in Q1. But as a team, we're not doing high fives. We know we've got a lot of work to do. But I think it's important, as we end, to recognize, as a company, we have a very strong foundation. If you look at our results in the first quarter, we generated $16 billion of revenue. Our operating income was almost $1.2 billion. We were able to invest $500 million of CapEx and still see a very strong return on invested capital of over 14%. And as we did that, we were able to reduce inventories by over 5%. So we know we've got a lot of additional work to do, but I think it's important to recognize we're a fundamentally sound company. We've got a very clear strategy in place, and now our focus over the balance of the next 3 years is week-to-week execution, both from a physical and digital standpoint. +So we appreciate you dialing in today. We look forward to talking to you at the end of Q2. And operator, that concludes our call. Thank you. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/exam/original-files/Problem_2_3_Sample_full_transcripts/2017-Nov-15-TGT.N-137953624001-Transcript.txt b/exam/original-files/Problem_2_3_Sample_full_transcripts/2017-Nov-15-TGT.N-137953624001-Transcript.txt new file mode 100644 index 0000000..e7ce1d2 --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_full_transcripts/2017-Nov-15-TGT.N-137953624001-Transcript.txt @@ -0,0 +1,502 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q3 2017 Target Corp Earnings Call +11/15/2017 08:00 AM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Mark J. Tritton + Target Corporation - Chief Merchandising Officer and EVP + * Catherine R. Smith + Target Corporation - CFO and EVP + * Brian C. Cornell + Target Corporation - Chairman & CEO + * John Hulbert + Target Corporation - Vice President of IR + * John J. Mulligan + Target Corporation - COO and EVP + +================================================================================ +Conference Call Participiants +================================================================================ + + * Robert Scott Drbul + Nomura Securities Co. Ltd., Research Division - Former MD and Analyst + * Peter Sloan Benedict + Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst + * Matthew Jeremy Fassler + Goldman Sachs Group Inc., Research Division - MD + * Robert Frederick Ohmes + BofA Merrill Lynch, Research Division - MD + * Christopher Michael Horvers + JP Morgan Chase & Co, Research Division - Senior Analyst + * Kate McShane + Citigroup Inc, Research Division - MD, Head of the U.S. Discretionary and U.S. Apparel and Retail Analyst + * David Adam Schick + Consumer Edge Research, LLC - Senior Analyst & Director of Research + * Edward Joseph Kelly + Wells Fargo Securities, LLC, Research Division - Senior Analyst + +================================================================================ +Presentation +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Ladies and gentlemen, thank you for standing by, and welcome to the Target Corporation Third Quarter Earnings Release Conference Call. (Operator Instructions) +As a reminder, this conference is being recorded, Wednesday, November 15, 2017. +I would now like to turn the conference over to Mr. John Hulbert, Vice President, Investor Relations. Please go ahead, sir. + +-------------------------------------------------------------------------------- +John Hulbert, Target Corporation - Vice President of IR [2] +-------------------------------------------------------------------------------- + + Good morning, everyone, and thank you for joining us on our third quarter 2017 earnings conference call. On the line with me today are Brian Cornell, Chairman and Chief Executive Officer; John Mulligan, Chief Operating Officer; Mark Triton, Chief Merchandising Officer; and Cathy Smith, Chief Financial Officer. +In a few moments, Brian, John, Mark and Cathy will provide their perspective on Target's third quarter performance and our plans and priorities going forward. Following their remarks, we'll open the phone lines for a question-and-answer session. +As a reminder, we're joined on this conference call by investors and others who are listening to our comments via webcast. Following the call, Cathy and I will be available to answer your follow-up questions. +As a reminder, any forward-looking statements that we make this morning are subject to risks and uncertainties, the most important of which are described in our SEC filings. +Also in these remarks, we refer to non-GAAP financial measures, including adjusted earnings per share. Reconciliations of all non-GAAP numbers to the most directly comparable GAAP number are included in this morning's press release, which is posted on our Investor Relations website. +With that, I'll turn it over to Brian for his thoughts in our third quarter performance and our priorities going forward. Brian? + +-------------------------------------------------------------------------------- +Brian C. Cornell, Target Corporation - Chairman & CEO [3] +-------------------------------------------------------------------------------- + + Thanks, John, and good morning, everyone. We are really pleased with Target's third quarter performance, which reflected a continuation of the positive trends that emerged in the second quarter. We saw continued growth in both our comparable traffic and comparable sales in the face of more difficult prior year comparisons on both measures. +Digital sales grew 24%, on top of 26% a year ago. And we announced new innovative partnerships with both Google and Pinterest, that will continue to expand the digital reach of our brand. We saw a meaningful increase in the percent of our sales at regular price, reflecting the benefit of our work to communicate value more clearly and provide our guests confidence that Target assortment is priced right daily. +We rolled out 4 new owned brands across our Home and Apparel categories, all of which are off to a great start. And we generated an unprecedented amount of buzz when we announced an amazing new designer partnership with Chip and Joanna Gaines called Hearth and Hand with Magnolia, which launched last week. +We also remodeled 37 stores in the quarter, in support of our plan to transform 110 stores this year. And we opened 12 new stores in a single week in October. These stores are located in a diverse array of neighborhoods across the country, ranging from our new Herald Square location in New York City all the way to our newest location in Honolulu. +Beyond the direct financial returns we're seeing on these investments, our guests continue to confirm for us, both through their feedback and their shopping decisions that our efforts are paying off. +And finally, this quarter, we made some meaningful announcements regarding our team. In early September, we announced our intent to hire an additional 100,000 team members for the peak holiday season, up from 70,000 a year ago. And later that month, we announced we would increase our minimum wage nationally to $11 an hour in October in support of a commitment to raise our national minimum to $15 an hour by the end of 2020. These investments reflect the value of our team and our commitment to supporting them as they provide outstanding service to our guests every day. +The strength of our team is never more evident than in times of need, and unfortunately, we faced several natural disasters in the quarter from hurricanes in Texas and Florida to wildfires in California. In the face of these challenges, there are countless stories of our team coming together to support each other and their communities in the face of heartbreaking devastation. +While our team was focused on ensuring the safety of their own families, they also worked tirelessly to reopen stores quickly and move needed essentials from other parts of the country in support of our guests as they returned home and began the long process of rebuilding their homes. So I want to thank our teams not just for the hard work every day, but their dedication to our guests and communities in times of need. +It was only last February that we walked you through a detailed plan to accelerate investments in our business that will best position Target for continued success in a rapidly changing environment. Our plan included the investment of more than $7 billion of capital over 3 years to accelerate our progress in support of several key initiatives, including blending Target's digital and physical shopping experiences, reimagining our existing stores and the labor model to operate them; rolling out new fulfillment options through enhanced convenience for our guests, opening new, small-format stores in dense urban, suburban and college campus neighborhoods; and reinventing our assortment of exclusive brands to further differentiate Target from everyone else in retail. +On top of this capital commitment, we outlined an investment of $1 billion of operating margin this year. This commitment has allowed us to move fast, invest in our team and reset our value positioning in the marketplace. +With 3 quarters of the year behind us, I'm pleased that we are either on track or ahead in delivering all of our goals for the year, and supported by strong execution by our team, our financial results this year have been meaningfully ahead of our expectations. A key factor in delivering our goals is the ability of our team to move faster than ever before, and nowhere is that speed more evident than in our supply chain, where we are rapidly testing and rolling out new fulfillment options for our guests. +Already this year, we've taken Target Restock from only a concept to being fully operational in 11 key markets throughout the country. And we continue to expand a list of eligible items while extending the order deadline for next-day delivery. We've tested and rolled out same-day delivery in 4 locations in New York City, supported by our recent acquisition of Grand Junction, and we've rapidly tested and rolled out a new Drive Up service in 50 locations in the Twin Cities, where we're receiving positive feedback from our guests. +With each of these capabilities, the team is rapidly learning and iterating as we expand our reach, and we have plans to further build out all of these fulfillment options in 2018. We've taken the same approach to our ship-from-store capabilities, which we first rolled out to approximately 140 stores only a few years ago. +As we enter the holiday season this year, the count of ship-from-store locations has grown more than tenfold, and it's now in more than 1,400 locations across the country. You'll note that for each of these fulfillment options, our stores played the key role in delivering the experience. This is only one example of ways that we've been asking more from our team members than ever before, and that's why this year's investment in our team has been so important. +We've invested in additional hours to support new services while continuing to be available to assist our guests. We've invested in the rollout of a new operating model with more specialized roles that support stronger execution and deliver more product expertise on the sales floor. +We've invested in trainings to elevate the guest experience, moving away from task-driven models to a guest-focused mindset. And we've invested in wages to ensure we can attract and retain the right team members who consistently deliver a differentiated Target experience every day. +So as we move into the busiest time of the year, I feel confident that our stores are better prepared than ever before, and in more than 100 of our stores, guests will be enjoying a newly transformed environment this holiday season, courtesy of this year's remodel program. +Also, in nearly 30 local neighborhoods across the country, guests will be able to enjoy their holiday shopping at a nearby Target store for the first time. Across every store and on Target.com, guests this holiday season will be able to shop 8 new exclusive brands that we launched in 2017, in addition to our outstanding lineup of new and innovative items from our national brand partners. +And of course, throughout the holiday season, we'll deliver unique and inspiring marketing intended to highlight the joy of being together during the holidays. +It's important to remember the role that this year's investments have played in getting us to where we are today. We started this year with a very healthy business, one that generates lots of cash. We made a decision to ramp up the investments of that cash in both capital and operating margin to speed up our progress. +Today, we have a very healthy business that generates lots of cash, a business that is seeing 2 consecutive quarters of healthy traffic growth, giving us increased confidence as we enter the holiday season. +While the fourth quarter is always intensely competitive, we are entering this holiday season with lots of confidence, enabled by this year's investments and the tireless efforts of our team. We have an outstanding set of plans this year. And while it's still very early, we've been encouraged with the guest response to the launch of Hearth and Hand as well as last week's release of the Target-exclusive version of Taylor Swift's new album, Reputation. +While the bulk of the season is still ahead of us, we are very happy to see how these early efforts have set the tone for the season as we are already showing our guests that Target will offer unique holiday merchandise and experiences that you can't find anywhere else. +With that, I'll turn the call over to John for his comments. John? + +-------------------------------------------------------------------------------- +John J. Mulligan, Target Corporation - COO and EVP [4] +-------------------------------------------------------------------------------- + + Thanks, Brian, and good morning, everyone. As Brian mentioned earlier, a key priority of our work and operations is based on the goal to provide new and reliable fulfillment options for our guests. As of today, we have multiple new fulfillment options that are in some phase of testing or rollout across our network. We offer in-store pickup of digital orders, available in all of our store locations. We have a Drive Up service, which we just began testing at 50 locations in the Twin Cities. We now have same-day delivery, which we're testing at 4 stores in New York City. We offer next-day delivery through Target Restock, which is now available for 90 million guests in 11 markets. And we have a ship-from-store capability, which is now in more than 1,400 of our locations. +Of those 5 fulfillment options, only 2 were available as we entered the year: in-store pickup and ship-from-store. And while both of those options are relatively mature, we continue to increase the amount of our digital volume handled by our stores. +Today, the stores are already fulfilling more than half of our total digital volumes through the pickup and ship-from-store capabilities, and that will peak at well above 80% in the days leading up to Christmas. In fact, our stores are planning to ship over 30 million units related to digital orders in the peak 4 weeks of the holiday season, up from about 18 million units last year. +Among the new fulfillment capabilities we've launched this year, Target Restock has been ramping up quickly. During the third quarter, we rolled out this service to an additional 10 markets across the country. We also extended the deadline for next-day delivery to 7 p.m. and expanded the number of eligible items to more than 15,000. +The average value of a restock order is about 50% larger than an average store transaction, and we're pleased that our stores have been able to fill these orders reliably and efficiently. Another capability we've just begun rolling out this year is same-day delivery, which we're now offering at 4 stores in the New York City market. For a small fee, typically between $5 and $10 depending on the address, guests can leave their basket with us at checkout and arrange for delivery later the same day, in a time window of their choosing. Guests in these stores are enthusiastically responding to this service. Basket sizes for delivery transactions are running 6x to 9x the average transaction across the 4 stores that have this service. And our Home category continues to account for more than half of the total sales on these delivery orders. +And finally, our new Drive Up capability is in the earliest stage of testing. We rolled out this service to 50 stores in the Twin Cities in the third quarter, and we're pleased with the early results. Specifically, guest survey scores for this service are running well ahead of goal, and the stores are outperforming our goal for average wait time. +Last week, we began offering this service at our next-generation store in Houston. As we look ahead to next year, we'll continue scaling all of our new fulfillment capabilities, including same-day and next-day delivery. Our ultimate goal is to build a supply chain that can reliably deliver any item in our network to all but the most remote areas in the U.S. in 2 days or less with most items delivered in 1 day. +While a large percentage of our digital orders today are already arriving that quickly, we have more work to do before we can reliably deliver in that time frame across all of our assortment. To achieve this goal, and to be able to scale all these new fulfillment capabilities, we need to improve the speed, accuracy and reliability of our entire supply chain from end to end. +While we have already made progress on all of these measures, we still have a lot more to do. And our new flow center in Perth Amboy, New Jersey will help us get there. We added this building to our network not because we needed capacity, but because it will allow our team to learn in a separate facility without the distraction of operating in tandem with the rest of our operations. +It's managed by a very lean team that operates like a start-up, rapidly building solutions from scratch and iterating as they learn. They run their operations with all new systems and processes developed in-house, including their inventory planning system, order management system, warehouse management system and transportation. This facility is now serving 5 of our new small-format stores in New York City, which allows them to test these new systems under the most extreme conditions. Specifically, these stores generate very high sales per square foot and have little to nonexistent backroom storage space. As a result, they require rapid replenishment. +In fact, our new Herald Square and TriBeCa locations are receiving multiple shipments a day from this facility. When these stores receive merchandise, they don't have the room or the time to unpack and store anything more than they need. To address this constraint, the Perth Amboy facility packs custom shipments for each store, which are delivered in bins organized by aisle of the store. As a result, these stores can rapidly move deliveries right onto the sales floors and quickly replenish shelves from the presorted bins. +This minimizes the amount of store labor devoted to replenishment, allowing the team to devote more of their time to serving their guests. Once the new process reaches a higher level of maturity, we'll be able to scale up within the facility, incorporate automation into the process and begin replicating this model elsewhere in the network. So now while I hope it's clear that fulfillment and speed are huge areas of focus for the operations team, I want to be clear that's not our only priority. +We're also investing to reach guests in new neighborhoods and elevate the experience in all of our stores. To reach new, densely populated neighborhoods, we've completely changed our approach to choosing the location for our small-format stores. In the past, we had a relatively rigid prototype for store size and layout and our real estate team focused on finding sites that would accommodate that prototype. +Today, when we find space available in an attractive neighborhood, we custom design a store that can fit the available space. These stores generate high sales productivity and higher-than-average gross margin rates, driving strong returns on investment. And for the smaller group of these stores that have now been operating for more than a year, we continue to see very healthy growth in both traffic and comparable sales. +Beyond new stores, our team is quickly scaling up their ability to remodel existing locations as we're rapidly growing the program from fewer than 30 stores in 2016 to more than 325 next year. Like our new small stores, we apply a custom approach to our remodel projects based on condition of each store and characteristics of the neighborhood. +In all cases, when we remodel a store, we focus on convenience, including the incorporation of self-checkout and a separate area for Store Pickup. And we upgrade the shopping experience for our guests, incorporating more cross-merchandising opportunities. We carefully measure the financial performance of our remodeled stores, and we continue to see an average sales acceleration of 2% to 4%, right in line with our goals for the program. +But beyond our investments in the physical shopping environment, we're investing in our team and our stores. We're investing in more hours in training to elevate the level of service our teams can provide. We're also changing our operating model, creating specialized teams responsible for specific categories, so they can become category experts who can better assist our guests. And finally, we're investing in wages, so we can continue to recruit and retain an outstanding team, a team that will continue to differentiate Target from our competitors. +The strength of our team was evident as we rolled out 4 new brands in our stores in the third quarter. Our team presented these new brands better than we ever have before, playing a key role in their early success. +This has been an amazing year of change for our operations team. We're moving faster and thinking bigger than we ever have before as we create and implement plans to modernize nearly everything we do. So while I want to stress that our future focus isn't slowing down, I also want to make it clear that everyone across our team is laser focused on serving our guests during the holiday season. I want to thank the team for all their efforts to prepare for this season and for all their upcoming hard work during our busiest time of the year. Our team is the reason Target is a special brand and a great place to work. +With that, I'll turn the call over to Mark, who will provide more detail on our third quarter performance and our holiday plans in merchandising. Mark? + +-------------------------------------------------------------------------------- +Mark J. Tritton, Target Corporation - Chief Merchandising Officer and EVP [5] +-------------------------------------------------------------------------------- + + Thanks, John. Going into this year, 2 of our highest strategic priorities in merchandising were: first, to invest in our exclusive owned brand portfolio to further reinforce our differentiated positioning in the market; and second, strengthening Target's value proposition and positioning, making sure we're priced right daily every day, which we'd reinforce with thoughtful, meaningful promotions that resonate with our guests and support our brand. +As Brian highlighted earlier, we're encouraged by our progress on both priorities. In the third quarter alone, we launched 4 more new and exclusive owned brands across Apparel & Accessories and in Home, which we then followed at the start of the fourth quarter with the blockbuster launch of Hearth and Hand with Magnolia. +With this portfolio that we've rolled out this year, we are presenting our guests with new ideas and items across 8 new and exclusive owned brands in readiness for the holiday season to create a unique, differentiated offer that builds preference for our guests to choose Target. Beyond the immediate strong sales growth that we've seen from these new brands, consumer survey show they are contributing to the Target brand overall. +Specifically, consumer scores for Target differentiation have recently risen to a 10-year high, which will provide a benefit to traffic and sales in all of our categories over time, much like we saw when we launched Cat & Jack. To reinforce our value proposition with guests this year, our team has also moved at a rapid pace, and the response from our guests has exceeded our expectations. +Specifically, we've seen a multibillion-dollar increase in sales at regular price so far this year, more than offsetting the decline in sales on discount. This clearly demonstrates that guests are increasingly confident that Target is priced right daily and are not only relying on promotions to get a great deal. +Supported by our Run and Done marketing campaign, confidence in our pricing has driven a rapid increase in quick and fill-in trips, which you can see in both our traffic and basket trends. +As we look back at our third quarter results from a category and market share perspective, we're driving strong relative performance in our discretionary categories. And while we're seeing steady improvement in frequency categories, these areas are facing some near-term headwinds from this year's investment to be priced right every day. +As a result of this effort, which was completed late in the third quarter, we're seeing stronger unit share improvements in many frequency categories compared with dollar share. This is an important positive leading indicator for future dollar gains in these categories, which is only reinforced by our positive traffic trends. +Across our 5 broad merchandising categories, Hardlines led the way in the third quarter with a strong single-digit comp increase. This growth was driven by continued double-digit comp growth in Electronics, benefiting from newness, particularly in the videogame and mobile segments. +Our Home category also saw a healthy comp increase in the third quarter, led by the successful launch of our new exclusive Project 62 owned brand, along with the continued benefit from the consumer trend of spending on their homes. +In Apparel & Accessories, we gained strong share for the quarter, in a space which consumer spending in the overall market is currently declining. Despite lean inventories in the first half of the quarter as we got ready to replace brands and unusually warm weather across most of the country during the bulk of the quarter, our overall comp was down only slightly. +But following the launch of each of our 3 new exclusive Apparel & Accessories owned brands mid-quarter- A New Day in women, Goodfellow & Co in men and JoyLab in activewear- we generated strong sales and traffic results, and we saw even more market improvement when cold weather finally arrived near the end of the quarter. +Third quarter comp sales in Food and Beverage were up slightly despite a continued headwind from deflation in several categories combined with adjustments from our own work on pricing. We continue to measure steady progress in Food and Beverage, and most encouragingly, we're seeing the strongest results where we've been investing. +This is best evidenced in produce, where we've been investing in freshness, organics, in-stocks and specialized store labor, where we saw a high single-digit comp increase in the quarter. And our beverage also continued its strength, where we saw continued double-digit comp growth, reflecting our work on assortments and in-store presentation across the country. +And lastly, in Essentials, we saw a slight comp decline in the third quarter. Now this area more than any other area has seen the most change from our work on price and value. And as I mentioned upfront, because we're seeing much stronger unit share and trip growth in this category, we are very confident that this year's work will set us up for stronger performance over time. +One further highlight within Beauty, which has continued to gain market share. This category is benefiting from our investments to differentiate both the assortment and the store service model as we focus on emerging trends and first-to-market brand launches, supported by an increasing number of dedicated beauty experts in our store who are available from open to close, all delivered at an unbelievable value. +Before I look ahead to the holidays, our third quarter review wouldn't be complete without a recap of our key seasons. In Back-to-School, we added to our long record of logging comp growth year-after-year, and we saw the strongest results in Kids Apparel and supplies. In Back-to-College, we benefited from positive results in Electronics, reflecting all of the newness I mentioned earlier. +In Halloween, we saw our strongest share results in the early part of the season as the final late-season positive sales surge moved further into the fourth quarter based on the timing of the holiday relative to our fiscal calendar. +As we look ahead to this year's holiday season, we have made significant strategic changes to the quality and level of our inventory position. Our teams have reduced unproductive inventory, which has created room across our network for all the newness we are now delivering. +As we ended the third quarter, we plan for our inventory position to be higher than a year ago, reflecting specific early intentional investments to support the launches of new items in Electronics, along with inventory to support Hearth and Hand with Magnolia, which launched at the beginning of the fourth quarter. +Speaking of Hearth and Hand with Magnolia, we are really pleased with the initial results from the launch, which set the perfect tone for the holidays. The collection, which was co-created with our friends, Chip and Joanna Gaines, features more than 300 items in tabletop, home decor and giftables, most for under $30. +On the day the collaboration debuted, guests were shopping online in the early hours and lining up outside our stores across the country. And based on early demand, we're implementing our inventory contingency plans to quickly replenish items that are already selling through. +Also new to the holidays this year, we've made a meaningful investment in our gifting program, which features more than 1,700 items curated for women, men, kids and teens. Most of the items are exclusive to Target and priced under $15, and they'll be displayed permanently in both our stores and online to make it even more easy and convenient for our guests to find the right gift this season. +And of course, we'll be offering great deals on a huge assortment of new and innovative items across our Entertainment, Electronics and Toy categories. In Toys, we've added more than 1,400 new and exclusive items this year from sought-after national specialty and owned brands. This season, we'll also be featuring more than 70 exclusive boardgames, building on the continued strength in this category that we've seen all year. +In Electronics, we'll be featuring new and in-demand consoles across software, including the Nintendo Switch and Super Mario Odyssey game, along with a Target exclusive Xbox One S Minecraft bundle. This season will also feature our focus on a much broader assortment of voice-activated speakers like Google Home with an expanded assortment of wearable technology and accessories, and as always, we'll offer a full line of Apple products highlighting all of the recent launches. +In Entertainment, we'll continue to highlight Taylor Swift's new album, Reputation, which features 2 exclusive collectible magazines available only at Target. This album broke the record for the number of preorders in advance of its launch last week, and we've continued to see strong demand in sales since the debut. +Throughout the holiday season, we'll continue to offer outstanding value to our guests with meaningful deals on the items that they want the most. New this year, we've introduced Weekend Deals, which features market prices on new items every weekend based on what we know guests are looking for at different times throughout the season. +In addition, we'll continue to offer a regular cadence for our Weekly Ad and Cartwheel offers, and we'll offer some of our lowest price of the year during big events like Black Friday and Cyber Monday. All of these deals are designed to reinforce the work we've done all year to show guests that we are priced right daily, and we'll continue to highlight our new lower prices with signage in our stores and online. +So I hope it's clear that we feel really well-positioned as we enter our peak season. Everything we've planned for this year will reinforce for our guests why they love Target during the holidays by offering unprecedented newness, convenience and meaningful deals, all wrapped up with a uniquely Target marketing campaign that reminds guests of the universal joy that comes from togetherness in the season. +With that, I'll turn it over to Cathy, who will provide more detail on our third quarter financial performance and outlook for the rest of the year. Cathy? + +-------------------------------------------------------------------------------- +Catherine R. Smith, Target Corporation - CFO and EVP [6] +-------------------------------------------------------------------------------- + + Thanks, Mark. Consistent with the second quarter, our third quarter traffic, comparable sales and overall financial performance were all stronger than our expectations. +Third quarter comparable sales increased 0.9%, driven by a traffic increase of 1.4%. Both of these numbers decelerated sequentially as we faced a tougher prior year comparison. However, on a 2-year stacked basis, both traffic and comp sales accelerated in the third quarter. +Our third quarter adjusted EPS of $0.91 was near the upper end of our guidance range of $0.75 to $0.95. GAAP EPS from continuing operations was $0.87, $0.04 lower than adjusted EPS, driven by the net effect of 2 offsetting factors. The primary impact was $123 million pretax charge related to our October debt repurchase, which lowered GAAP EPS from continuing operations by $0.14. This was largely offset by a $0.10 positive impact related to income tax matters. +The majority of this $0.10 benefit was driven by a decrease in our 2016 net taxes related to our global sourcing operations. The remaining benefit was related to the favorable resolution of other income tax matters in the quarter. +One other note on our third quarter tax expense. In addition to the matters we've excluded from adjusted EPS, third quarter adjusted and GAAP EPS from continuing operations reflect a $0.03 benefit from our global sourcing operations related to our 2017 taxes. +Our third quarter gross margin rate of 29.7% was down about 10 basis points from last year. This decline reflects continued pressure from digital fulfillment and our work on pricing and promotions, mostly offset by our cost-control effort. Merchandise mix had a roughly neutral impact on our third quarter gross margin rate as healthy performance in higher-margin categories was balanced by strength in Hardlines. +Our third quarter SG&A expense rate of 21.1% was about 80 basis points higher than last year. This increase was primarily driven by compensation expense, reflecting a year-over-year increase in team member incentives combined with the impact of investments in store hours and wage rates. This was partially offset by the timing of some expenses and our cost saving efforts. +The third quarter depreciation and amortization line was about $70 million higher than last year. This increase reflects the impact of accelerated depreciation related to next year's remodel program, which will transform about 3x as many stores compared with this year. We recently finalized our specific store remodel plans for next year and subsequently refined our D&A forecast by quarter. +Specifically in the fourth quarter, we expect a similar or somewhat smaller year-over-year increase in the D&A expense line than we just experienced in the third quarter. And as we look ahead to 2018, our current view is that quarterly D&A will be about $80 million higher than 2017 in each of the first 3 quarters next year, reflecting the continued recognition of accelerated depreciation on next year's much larger group of remodels. +At the end of the third quarter, our inventory was a little more than 5% higher than last year. This represents a change from the trend we've seen in recent quarters in which our inventory has declined, even as we've maintained a strong in-stock position. This quarter's increase reflects a year-over-year change in the timing of our holiday season inventory. +One area that has increased is Electronics, in which the team has made early intentional investments in new and innovative items in the videogame and mobile categories. We expect our inventory will be roughly flat to last year by the end of the fourth quarter. Over the longer term, we continue to believe we have a meaningful opportunity to increase inventory turnover as we work to speed up our supply chain, and in the near term, we believe recent favorability in payables leverage will continue into next year, providing a benefit to working capital and cash flow from operations. +Our business continues to return a lot of cash. Specifically, we generated $1.5 billion of cash from operations in the third quarter. +In keeping with our goals and guidance for the year, we devoted more than $800 million of capital investment to our business this quarter, bringing our year-to-date total to just over $2 billion. In addition, we returned $339 million to our shareholders in the form of dividends and another $171 million through share repurchase. +Regarding the balance sheet, as I mentioned earlier, we invested $463 million to repurchase high-coupon debt in the quarter, which was offset by the issuance of $750 million of 30-year debt at very favorable rates. In January, we have $1.1 billion in debt maturing, which we expect to retire with cash. +Now let's look ahead to our expectations for fourth quarter and full year financial performance. As I have mentioned all year, we continue to plan prudently while developing the agility to adjust to changing conditions and market opportunities. +And while I hope we've shown today that we have outstanding plans going into the holiday season, we enter every holiday season knowing that it will be highly competitive and promotional. Putting all of those considerations together, we believe that Target is positioned to deliver comparable sales of flat or better in the fourth quarter with an upside potential for a 2% comp increase. +We expect to see continued pressure on our gross margin rate in the fourth quarter, reflecting the cost of digital fulfillment combined with the impact of our work to ensure we are priced right daily for our guests. +Our SG&A outlook reflects thoughtful investments in our team and in our stores to support outstanding service for our guests during the peak holiday season. Combined with the pressure on D&A I outlined earlier, we expect EBIT will be about $290 million lower than last year's fourth quarter. This performance translates to an expectation for both GAAP EPS from continuing operations and adjusted EPS of $1.05 to $1.25 in the fourth quarter. +Adding this expectation to our actual performance through the first 3 quarters, you'll see that our expected range for full year adjusted EPS is now $4.40 to $4.60, this is $0.06 higher than our guidance 3 months ago and $0.50 higher than our expectation going into the year. +Regarding full year GAAP EPS from continuing operations, we expect a range of $4.38 to $4.58, $0.02 lower than adjusted EPS driven by the net impact of debt retirement cost and tax benefits we recognized throughout the year. +One other note. Both our fourth quarter and full year expectations include the recognition of a 53rd accounting week this year, consistent with many other retailers. As we said before, this week is somewhat smaller than an average week in the year at about $1 billion in sales. +From an operating margin standpoint, for that week, we expect to see gross margin and SG&A rates relatively similar to our annual averages. In addition, we will benefit from leverage on D&A that week as that expense is recognized on an annual basis. +And one final note. Given that the holiday season plays such an important role in our fourth quarter performance, we announced today that we plan to issue a post-holiday season financial update on Tuesday, January 9. +As Brian mentioned earlier, the underlying health of our business and its strong cash flow have enabled the investments that are moving our business forward today. As we look ahead to the next few years, we're planning for continued investments in our business in new and remodeled stores, our supply chain, technology, unique brands, and importantly, in our team. The good news is that our business can sustain those investments while generating enough cash to support our dividend and, when we have room within our debt ratings, share repurchase. We entered the year with a confidence that we're making the right long-term investments in our business, and our results this year have only reinforced that confidence. As we look ahead, we expect to have ample capacity to invest in our business and return capital to our shareholders, allowing us to grow into an even stronger company. +Now I'll turn the call back over to Brian for some final remarks. + +-------------------------------------------------------------------------------- +Brian C. Cornell, Target Corporation - Chairman & CEO [7] +-------------------------------------------------------------------------------- + + Thanks, Cathy. We're going to quickly move to your questions, but I wanted to add one final note first. We are planning to host our Spring 2018 Financial Community Meeting here in Minneapolis on March 5 and 6. John Hulbert will send out more details in January. But for now, we wanted to let you know the dates so you can hold them on your calendar. We'll be scheduling the meeting to allow attendees to arrive on the afternoon of the 5th, and you'll be able to return home before the end of the day on the 6th. We hope to see you at that meeting. +So with that, we'll conclude our prepared remarks. Now John, Mark, Cathy and I will be happy to take your questions. + + +================================================================================ +Questions and Answers +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) David Schick from Consumer Edge Research. + +-------------------------------------------------------------------------------- +David Adam Schick, Consumer Edge Research, LLC - Senior Analyst & Director of Research [2] +-------------------------------------------------------------------------------- + + You mentioned several times throughout the call and, frankly, throughout the year that you're trying to take a conservative approach to planning, but you also mentioned -- and you also mentioned the strength and the confidence you have as this quarter that you just reported in the prior quarter happened in the traffic and the merchandising. Can you, sort of, square that circle for us because this is -- shares are obviously reacting to guidance this morning. So help us frame conservatism versus confidence. + +-------------------------------------------------------------------------------- +Brian C. Cornell, Target Corporation - Chairman & CEO [3] +-------------------------------------------------------------------------------- + + David, I think sitting here today, we feel very confident that we're making very good progress against the plans that we set out earlier this year. If I think about the state of our business today, we're seeing a great response to the 8 new brands that we've launched as we've remodeled now over 100 stores, which we continue to see the list that we're projecting of 2% to 4%. We've seen a tremendous response to our new small formats that we've been opening up in new neighborhoods and on college campuses. And as you know, we opened up a number of new stores in this last quarter. And whether it was the results we've seen in Herald Square or all the way out in Hawaii, the guests have responded very, very well. We continue to see very strong performance from a digital standpoint, outpacing industry by a 2x factor. And during the quarter again, we saw very strong digital growth. And that's been underpinned by the progress we've made from a digital fulfillment standpoint and some of the things that John talked about during his prepared remarks. So sitting here today, I think we're making great progress, and I think we'll continue to see that progress extend into the fourth quarter. So we entered the quarter with a lot of confidence. We know there's a lot of business that has to be done, and we're off to a very good start led by the reaction into Hearth and Hand as well as some of the other initiatives that are in place. So I think we're taking the right approach, but we entered the quarter with a lot of confidence and making a lot of progress against literally every initiative that we set forth earlier this year. + +-------------------------------------------------------------------------------- +David Adam Schick, Consumer Edge Research, LLC - Senior Analyst & Director of Research [4] +-------------------------------------------------------------------------------- + + Just a sort of follow-up to that, is there any -- what would be -- do you expect to backslide against any traction in key variables, comp, gross profit dollar comp? Help us understand that with this confidence in the guide. + +-------------------------------------------------------------------------------- +Brian C. Cornell, Target Corporation - Chairman & CEO [5] +-------------------------------------------------------------------------------- + + David, we don't expect to see any deterioration in the progress that we've been making throughout the year. So again, I think we entered the fourth quarter highly confident and in a very strong position with our stores performing incredibly well, great merchandise, a terrific marketing campaign, great digital capabilities and an expanded suite of digital fulfillment capabilities. So we feel very good about how the entire business is set to perform in the fourth quarter. + +-------------------------------------------------------------------------------- +Operator [6] +-------------------------------------------------------------------------------- + + Peter Benedict from Baird. + +-------------------------------------------------------------------------------- +Peter Sloan Benedict, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [7] +-------------------------------------------------------------------------------- + + Just on price perception, the work you've been doing, I mean, it sounds like you're pleased with where you've gotten that now at the end of the third quarter. Just -- I mean, do you think that, that's an ongoing process that you're going to have to do? How are you -- you mentioned some of the measurements you're using on that, but just trying to understand, is that something you let ride here for the fourth quarter and then reassess where you are next year? Or do you feel like you've gotten yourself to a spot where there's going to be no further adjustments required? + +-------------------------------------------------------------------------------- +Brian C. Cornell, Target Corporation - Chairman & CEO [8] +-------------------------------------------------------------------------------- + + Peter, I think Mark and his team have made tremendous progress over the course of the year. And as we've talked about a number of times now, we're seeing a significant shift of our business towards everyday regular price, which is really important over the long term. So we're going to continue to make sure that we're committed to offering great value, that we're priced right daily, and during the fourth quarter, we'll provide exciting promotions to support those items that we know our guests are going to be interested in shopping for at Target. So it's an ongoing commitment. We want to make sure we deliver great value across the season. And we're going to make sure that we couple that with exciting promotions in the fourth quarter. + +-------------------------------------------------------------------------------- +Peter Sloan Benedict, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [9] +-------------------------------------------------------------------------------- + + Okay. And then one maybe follow-up for John. You talked about a lot of the fulfillment options that you guys are working on. Help us through -- how does that impact the store labor model as you see kind of going forward? And within that, the $15 minimum wage plan. I understand it's not a fourth quarter question, it's more just as you lookout the next few years. How do you see that -- those having an impact on the labor? + +-------------------------------------------------------------------------------- +John J. Mulligan, Target Corporation - COO and EVP [10] +-------------------------------------------------------------------------------- + + Well, I think, clearly, as we do more fulfillment out of the store, we will add labor to support that. I think we've said since February, we're going to invest in the labor in our stores, invest in training, invest in having experts in the store, invest in having people on the sales floor and changing the operating model for those stores. So that's an important part of what we're doing. Almost separately and independently, we're building teams that -- so that we don't take hours away from everything else we're doing that are handling the fulfillment in the back room. So it's really a question of the operating model in the store that's evolving. And we feel really good about utilizing the stores, they're the closest, fastest and cheapest way to get merchandise to our guests. They have significant capabilities now. We're doing same-day, next-day, 2-day pick up, Drive Up, all kinds of ways to meet the guests' needs, and I think that's the important factor, all centered around using the store as the hub. And we think it's a highly efficient way to use our assets, and we have great teams that can meet the capabilities that we need for our guests. + +-------------------------------------------------------------------------------- +Operator [11] +-------------------------------------------------------------------------------- + + Our next question comes from Edward Kelley from Wells Fargo. + +-------------------------------------------------------------------------------- +Edward Joseph Kelly, Wells Fargo Securities, LLC, Research Division - Senior Analyst [12] +-------------------------------------------------------------------------------- + + Yes. So I guess, my first question really is around the fourth quarter and the comparisons that you're facing last year. So in-store comps were particularly soft, the gross margin was down a lot, there were issues around digital fulfillment. I guess -- you talk about the underlying momentum of the business not stalling at all, but can you talk about how you expect to cycle those issues from last year? + +-------------------------------------------------------------------------------- +Brian C. Cornell, Target Corporation - Chairman & CEO [13] +-------------------------------------------------------------------------------- + + Ed, again, as we entered this season, I think we're in much a stronger position. John underscored the fact that we've got an expanded array of digital fulfillment capabilities. Mark's talked about the progress we've made from both a brand standpoint but also a value standpoint. I think we continue to enhance our digital capabilities. So I think we entered this season in a much stronger position. And I think what's really important to recognize is the investments we've made in our team and our stores puts us in a very strong position as we enter the fourth quarter. So I feel great about the investments we've made in wages, in hours, in seasonal hiring. And I think our stores are going to drive both our digital business and our store business throughout the fourth quarter. So I think we entered the season in a very different position versus last year. And I think that's reflected in the start that we've seen to the season and the approach we're taking throughout the fourth quarter. + +-------------------------------------------------------------------------------- +Edward Joseph Kelly, Wells Fargo Securities, LLC, Research Division - Senior Analyst [14] +-------------------------------------------------------------------------------- + + Okay. And second question for you. I just want to -- I know you don't want to give guidance for next year, but I was hoping that maybe you could talk about the puts and the takes in terms of what we should be thinking about, areas that you could see outsized investment, D&A is going to be headwind next year, wages clearly seem like they'll be a headwind. Your thoughts on price investments from here, the Street's sort of looking for a modest decline in earnings, seems like something like that -- larger than that's possible. It's just -- I don't know how much at this point, Brian, you can help with that, but I think it is an area that we're all sort of wrestling with. + +-------------------------------------------------------------------------------- +Brian C. Cornell, Target Corporation - Chairman & CEO [15] +-------------------------------------------------------------------------------- + + Well, Ed, we're hopeful that you'll join us in March for next year's Financial Community Day. Obviously, we're not going to provide 2018 guidance today. But I'll give you a preview. You're going to hear us talk about many of the same things we've been talking about this year: our commitment to the store experience and continuing to remodel stores across the country, our commitment to opening up new small formats in new neighborhoods and on college campuses, our continued commitment to digital, our commitment to enhancing our fulfillment capabilities, our continued commitment to new brands and building our proprietary fleet of brands and an ongoing commitment to value. And all of that will be underscored by our commitment to our team. So we'll go through that in much more detail in March. But as a preview, we're going to be talking about the exact same suite of initiatives next year that we've been talking about this year. We feel great about the progress. Our strategy is working. Each one of those initiatives is on track or ahead of schedule, and we expect to accelerate those initiatives in 2018. + +-------------------------------------------------------------------------------- +Operator [16] +-------------------------------------------------------------------------------- + + Chris Horvers from JPMorgan. + +-------------------------------------------------------------------------------- +Christopher Michael Horvers, JP Morgan Chase & Co, Research Division - Senior Analyst [17] +-------------------------------------------------------------------------------- + + Two questions. So first, can you talk about how is the Essentials category? It was down slightly. You mentioned more share being taken on the unit side. Can you talk about unit growth in Essentials and how that's progressed over the past couple of quarters as you've put more muscle behind the price investments? + +-------------------------------------------------------------------------------- +Brian C. Cornell, Target Corporation - Chairman & CEO [18] +-------------------------------------------------------------------------------- + + Sure, Chris. Why don't we let Mark walk you through how we're approaching our investments in Essentials? + +-------------------------------------------------------------------------------- +Mark J. Tritton, Target Corporation - Chief Merchandising Officer and EVP [19] +-------------------------------------------------------------------------------- + + Chris, yes, let me share with you. So we've been sharing this year that we took a journey in terms of ensuring we're priced right daily and that we were able to create and communicate to our guests the right value. And that started in April of this year and we completed that through the end of the third quarter. What we've seen with that is we had an expectation that's not an immediate just that (inaudible) response we need to build ongoing, deeper trust with the guests and get them to connect with that priced right daily ethos, and we've seen a really fast reaction, a positive reaction to that. So we're creating in trips and traffic within our adjustment on -- to be priced right daily. And as a result, we've seen an increase in our unit velocity. We fully expected and baked in some of the short-term sales deflation that we would see as a result. But we're starting to see that equal out, and we expect that stability to continue through the fourth quarter into 2018. + +-------------------------------------------------------------------------------- +Christopher Michael Horvers, JP Morgan Chase & Co, Research Division - Senior Analyst [20] +-------------------------------------------------------------------------------- + + So I think in the second quarter, I think Essentials was up slightly. So did it -- was it essentially that the price investment accelerated and the unit velocity maintained? Or maintained its positive trajectory or did it accelerate? + +-------------------------------------------------------------------------------- +Brian C. Cornell, Target Corporation - Chairman & CEO [21] +-------------------------------------------------------------------------------- + + Chris, I think that's exactly what we're saying, continued investment across multiple categories. And as Mark talked about, the first thing we see is an increase in units, an increase in trips and ultimately that's going to drive positive comps over time. So I think the efforts are paying off relatively quickly, and we feel really good about the guest response. + +-------------------------------------------------------------------------------- +Operator [22] +-------------------------------------------------------------------------------- + + Our next question comes from Bob Drbul from Guggenheim. + +-------------------------------------------------------------------------------- +Robert Scott Drbul, Nomura Securities Co. Ltd., Research Division - Former MD and Analyst [23] +-------------------------------------------------------------------------------- + + I have two questions. The first one is on in-stocks or out-of-stocks. You look at the inventory levels that Cathy talked about, are you seeing the in-stock levels where you'd like them at this point? And then the second question that I have is around fulfillment costs. When you look at -- I think you said -- I think John said stores are fulfilling more than 50% of digital, take it to 80%. When you think about the fourth quarter and the costs around that increased fulfillment of digital by the stores, is it a one-for-one basis in terms of the level of increases there? + +-------------------------------------------------------------------------------- +John J. Mulligan, Target Corporation - COO and EVP [24] +-------------------------------------------------------------------------------- + + I'll start with the in-stock question. I think, Bob, we talked about in-stocks last year in February. It's a journey for us, we know. I think we've made a lot of progress in in-stocks given our current capabilities. But we also said, in order to really solve the problem, we need to fix some fundamental capabilities in our supply chain around speed, reliability, inventory placement. And that's where we're on the journey. So the inventory increase at the end of Q3, as Mark said, more related to us being sure we're ready for the fourth quarter in categories like Electronics, Hearth and Hand, where we took positions, intentional inventory positions to increase inventories in advance of the fourth quarter. Less to do with our management of day-to-day in-stocks/out-of-stocks. We continue to work on those. And as I said, there is the short term, working within our current capabilities and in the longer term solve that comes as we continue to improve our overall supply chain capabilities. Your second question, I'm not entirely clear, Bob, on where your -- maybe you could clarify how -- your question, the store labor related to fulfillment, I'm not -- I didn't quite understand it. + +-------------------------------------------------------------------------------- +Robert Scott Drbul, Nomura Securities Co. Ltd., Research Division - Former MD and Analyst [25] +-------------------------------------------------------------------------------- + + Sorry. Just from the perspective of the expense levels, like the pressure that you saw in the third quarter versus the expectation of the pressure, fulfilling more than 80% in the stores on the expense lines specifically. + +-------------------------------------------------------------------------------- +John J. Mulligan, Target Corporation - COO and EVP [26] +-------------------------------------------------------------------------------- + + Yes, I wouldn't compare it to third quarter. Compared to last year, we are doing more fulfillment in-store. As we said, we think that's the most cost-effective way given the total P&L. So shipping plus store labor, we think that's the most cost-effective way to do it. Compared to last year, we saw significant spikes last year near the end of the quarter, approaching 80% fulfillment. And I would say, when you get into that 80% range, what really goes up is store pickup, and we'll take that model all day long, highly efficient for us, highly profitable from a digital perspective. So when our mix gets that high in store, we actually like the economics a lot. + +-------------------------------------------------------------------------------- +Operator [27] +-------------------------------------------------------------------------------- + + Matt Fassler from Goldman Sachs. + +-------------------------------------------------------------------------------- +Matthew Jeremy Fassler, Goldman Sachs Group Inc., Research Division - MD [28] +-------------------------------------------------------------------------------- + + I've got 2 questions, and my first relates to gross margin. Just to revisit, the fact that you do have this very depressed compare from a year ago, and you're actually entering Q4 with pretty good gross margin momentum, down only very nominally in Q3 as some of your new brands are really starting to get traction. So is your thinking on the expectation of a decline in gross margin simply a factor of more business being done online each year and the cost of fulfillment associated with that? Or are some of the new fulfillment options that you're introducing just somewhat more costly and you're giving yourself room to absorb that pressure? + +-------------------------------------------------------------------------------- +Catherine R. Smith, Target Corporation - CFO and EVP [29] +-------------------------------------------------------------------------------- + + Matt, this is Cathy. I think I would look at it the way we -- we have all year been approaching it, which is, we're trying to be prudent as we plan into the fourth quarter. We're excited about what we've seen so far, but it's early in a very important quarter. The pressure that we are anticipating is around digital fulfillment as well as all the work we continue to do around value, and we're offsetting that with cost savings continuing into the fourth quarter. So I would look at it as just doing what we said we would do all year long, which is be prudent, plan appropriately and make sure that we set the business up for success. + +-------------------------------------------------------------------------------- +Brian C. Cornell, Target Corporation - Chairman & CEO [30] +-------------------------------------------------------------------------------- + + Matt, I'd only build on a couple of comments that Cathy made. One, we feel very good about the performance of our own brands and from a gross margin standpoint, both short term and long term, that's going to be very beneficial to our mix. Two, we are clearly investing in digital and digital capabilities and expect that we're going to continue to see strong digital growth in the fourth quarter. So it is the mix of our business that really makes sure that our gross margin returns stay on track. But the work that Mark and his team have done with our own brands and the results that we're seeing across our 8 new brands is very beneficial, both short term and long term, to our gross margin rate performance. + +-------------------------------------------------------------------------------- +Matthew Jeremy Fassler, Goldman Sachs Group Inc., Research Division - MD [31] +-------------------------------------------------------------------------------- + + That's super helpful. The quick follow-up relates to REDcard penetration. So we noted that the year-on-year penetration seems to have stabilized this quarter after having shown some increases for a period of time. Anything to glean from the stabilization of that trend? + +-------------------------------------------------------------------------------- +Catherine R. Smith, Target Corporation - CFO and EVP [32] +-------------------------------------------------------------------------------- + + We are really excited about some of the capabilities we're adding to REDcard coming into this fourth quarter. I have to tell you, I'm one of the early users for our wallet application and it is phenomenally fast and convenient and a great experience for the guests. So as we continue to ramp up some exclusives around REDcard, our guests are responding. We're seeing additional capabilities come into REDcard holders, our best guest, into the fourth quarter. So I would expect that we'll see that trend continue to be favorable. + +-------------------------------------------------------------------------------- +Brian C. Cornell, Target Corporation - Chairman & CEO [33] +-------------------------------------------------------------------------------- + + Yes, Matt, I think we also recognize that as a by-product of the investments we have been making in our stores, our plans moving into new neighborhoods, we're bringing in new guests to Target. So over time, we certainly want to convert them to REDcard holders. But I think what we're seeing is, as we move into new catchments, these are new guests that are shopping at Target. Over time, they'll start adopting our REDcard. I think our new brands are bringing new guests into our stores, and I think the focus that we placed around value is also attracting a new shopper. So over time that provides us tremendous opportunities to continue to build REDcard penetration. And one of the metrics that we haven't talked about on the call is the fact that traffic was up 1.4% as existing guests are shopping more often, but it also is new guests coming to our stores and our site. So over time, those are potential new prospects for REDcard. And we certainly expect to see that conversion as we go into 2018. + +-------------------------------------------------------------------------------- +Operator [34] +-------------------------------------------------------------------------------- + + Robbie Ohmes from Bank of America Merrill Lynch. + +-------------------------------------------------------------------------------- +Robert Frederick Ohmes, BofA Merrill Lynch, Research Division - MD [35] +-------------------------------------------------------------------------------- + + Just two quick questions. Just on the fourth quarter, the sort of the breadth of the range there, can you just give us the scenarios like, sort of, what brings you to the low end of the fourth quarter range, the $1.05 versus the $1.25? And the other question I had was just -- I was wondering if you would share some of the early results on the pickup customer versus the Drive Up customer? Which is better? Whose basket is bigger? How much bigger is the basket versus the store shopper or just plain online shopper that get shipped to home? Anything you can share about the metrics and what you're excited about there? + +-------------------------------------------------------------------------------- +Brian C. Cornell, Target Corporation - Chairman & CEO [36] +-------------------------------------------------------------------------------- + + Robbie, why don't we let John start by talking about that pickup shopper and then we'll come back to our guidance for the quarter. + +-------------------------------------------------------------------------------- +John J. Mulligan, Target Corporation - COO and EVP [37] +-------------------------------------------------------------------------------- + + I might start up with the Drive Up shopper there. I think our guest survey scores there, NPS scores are, frankly, off the charts. We see a high utility. It's mom with 2 kids in the back, right? A core Target shopper who just doesn't -- it's raining outside and doesn't want to get out of the car. So we've seen very, very high scores there. The baskets are mixed as you'd imagine, right? Sometimes they're larger, sometimes it's only one thing. And the same is very true for pickup in store, driven by -- it can be driven by promotional cadence, it can be driven by convenience. There's lots of different reasons people choose that option and so the basket varies. There's nothing really to glean from that other than for both of them, we see very high NPS scores for our guests, which is the most important thing from our perspective. + +-------------------------------------------------------------------------------- +Brian C. Cornell, Target Corporation - Chairman & CEO [38] +-------------------------------------------------------------------------------- + + Robbie, why don't I clear up the question around guidance for the quarter and, really, I'll focus on the full year. I think our fourth quarter guidance is a reflection of the performance we've been delivering throughout the year. And I'll go back and note as Cathy discussed, our full year guidance is up $0.50. I'll do the math for it. That's $500 million of improvement versus our original guidance. So we certainly approach the fourth quarter with a level of balance and conservatism, but feel good about the momentum we have. And we think the performance we've been delivering throughout the year will be reflected in our fourth quarter. So we feel confident, we're making good progress, there's a lot of business still to be done in the fourth quarter. And I think our range of comp of flat to 2 and the approach we're taking from an EPS standpoint just reflects the approach we've been taking throughout the year. + +-------------------------------------------------------------------------------- +Operator [39] +-------------------------------------------------------------------------------- + + Kate McShane from Citi. + +-------------------------------------------------------------------------------- +Kate McShane, Citigroup Inc, Research Division - MD, Head of the U.S. Discretionary and U.S. Apparel and Retail Analyst [40] +-------------------------------------------------------------------------------- + + My question was around fulfillment as well and a little bit longer term in nature. I had wondered with regards to the Drive Up and the same-day delivery, if there are any early indications of what the limitations might be in terms of where you can introduce that and then also with regards to the profitability of how those 2 fulfillment options relate to the ship-from-store? + +-------------------------------------------------------------------------------- +Brian C. Cornell, Target Corporation - Chairman & CEO [41] +-------------------------------------------------------------------------------- + + Yes, I'll let John talk about the profitability component. But Kate, I think one of the great things about our strategy is the important role our stores play. And as we think about Drive Up, we think about same day, those are going to be enabled by the 1,800 stores that are in neighborhoods around the country. So we should be able to continue to expand that over time and meet the needs of our guests no matter where they live and which store they shop in. + +-------------------------------------------------------------------------------- +John J. Mulligan, Target Corporation - COO and EVP [42] +-------------------------------------------------------------------------------- + + And on your question about profitability, clearly the closer we are to the store, the better we like it. When a guest comes in and picks it off the shelf, great. Only slightly disadvantaged to that would be pickup or Drive Up because there is one more touch. But really, again, economically, a great, great solution for us. As we get into shipping, same-day delivery is more expensive, there's no question about that. And at least today, our guest research leads us to believe, guests understand that. They want it priced right, they want the convenience and they understand there may be a charge to get it to them at the time they want it during that day, and we've seen that in the 4 stores in New York, no push back at all on the delivery charge. And the great thing is, we see the baskets, as I said, 6x to 9x larger. So that ends up being a highly, highly profitable transaction for us. And so there are markets where that will work, that type of transaction will work really well. There are other markets were, as you said, there will be standard 2-day shipping. And there, we're working hard to reduce costs throughout that shipping while improving the speed. So that's on our team so that the guest gets the great service and we make that a great economic transaction for Target as well. But we feel good about our ability to make it work. + +-------------------------------------------------------------------------------- +Brian C. Cornell, Target Corporation - Chairman & CEO [43] +-------------------------------------------------------------------------------- + + So with that, operator, that concludes our third quarter 2017 earnings conference call. I want to thank everybody for participating and wish everyone a happy holiday season. So thank you. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/exam/original-files/Problem_2_3_Sample_full_transcripts/2017-Oct-12-JPM.N-138888592504-Transcript.txt b/exam/original-files/Problem_2_3_Sample_full_transcripts/2017-Oct-12-JPM.N-138888592504-Transcript.txt new file mode 100644 index 0000000..6ba4445 --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_full_transcripts/2017-Oct-12-JPM.N-138888592504-Transcript.txt @@ -0,0 +1,727 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q3 2017 JPMorgan Chase & Co Earnings Call +10/12/2017 08:30 AM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Marianne Lake + JPMorgan Chase & Co. - CFO & Executive VP + * James Dimon + JPMorgan Chase & Co. - Chairman, CEO & President + +================================================================================ +Conference Call Participiants +================================================================================ + + * Betsy Lynn Graseck + Morgan Stanley, Research Division - MD + * Glenn Paul Schorr + Evercore ISI, Research Division - Senior MD, Senior Research Analyst and Fundamental Research Analyst + * Erika Najarian + BofA Merrill Lynch, Research Division - MD and Head of US Banks Equity Research + * Michael Lawrence Mayo + Wells Fargo Securities, LLC, Research Division - MD, Head of U.S. Large-Cap Bank Research & Senior Analyst + * Saul Martinez + UBS Investment Bank, Research Division - MD & Analyst + * Gerard S. Cassidy + RBC Capital Markets, LLC, Research Division - Analyst + * Andrew Lim + Societe Generale Cross Asset Research - Equity Analyst + * Matthew D. O'Connor + Deutsche Bank AG, Research Division - MD + * James Francis Mitchell + The Buckingham Research Group Incorporated - Research Analyst + * John Eamon McDonald + Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst + * Marlin Lacey Mosby + Vining Sparks IBG, LP, Research Division - Director of Banking and Equity Strategies + * Steven Joseph Chubak + Nomura Securities Co. Ltd., Research Division - VP + * Brian Matthew Kleinhanzl + Keefe, Bruyette, & Woods, Inc., Research Division - Director + * Kenneth Michael Usdin + Jefferies LLC, Research Division - MD and Senior Equity Research Analyst + +================================================================================ +Presentation +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + Good morning, ladies and gentlemen. Welcome to JPMorgan Chase's Third Quarter 2017 Earnings Call. This call is being recorded. (Operator Instructions) We will now go live to the presentation. Please stand by. +At this time, I would like to turn the call over to JPMorgan Chase's Chairman and CEO, Jamie Dimon; and Chief Financial Officer, Marianne Lake. Ms. Lake, please go ahead. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO & Executive VP [2] +-------------------------------------------------------------------------------- + + Thank you, operator. Good morning, everyone. I'm going to take you through the presentation, which is available on our website. Please refer to the disclaimer at the back of the presentation. +The third quarter was generally constructive across businesses and asset classes. Underlying business drivers grew broadly, and we maintained or gained share in a competitive environment. The U.S. and global economy continue to grow. Clients are active, with demand for credit remaining solid. All in all, resulting in 7% growth in net income, driven by positive operating leverage as revenue rises and expense remains controlled. On an adjusted basis, this is a clear record for a third quarter. +Of course, against this financial backdrop, I want to acknowledge the recent natural disasters. The impact on affected customers, communities and employees have been devastating, and supporting them is our priority as they rebuild. I will note that any financial impact is not significant to our results. +Starting on Page 1. The firm reported net income of $6.7 billion, EPS of $1.76 and a return on tangible common equity of 13% on revenue of $26.2 billion. Highlights for the quarter include average core loan growth of 7.5% year-on-year. And the FDIC recently released its survey, showing that the firm has surpassed the competition and now ranks #1 in total U.S. deposits and in deposit growth, driven by strong consumer deposit growth, up 9%. +Client investment assets, credit card sales and merchant volumes were all up 13%, and we continue to rank #1 in global IBCs. We have record revenue in the Commercial Bank and delivered record net income and assets under management in Asset & Wealth Management. +The credit environment continues to remain benign across products and portfolios. Card charge-offs were fully in line with our expectations and guidance. And outside of Card, our charge-off rates remain at historically low levels. +Now turning to Page 2 and some more detail about the third quarter. Revenue of $26.2 billion was up approximately $700 million or 3% year-on-year, driven by net interest income, up $1.2 billion, reflecting the impact of higher rates and continued loan growth, partially offset by lower markets revenue. +Adjusted expense of $14.4 billion was flat to last quarter and to last year if you exclude $175 million of onetime items in CCB in the prior year period. +Credit costs of $1.5 billion were up about $200 million year-on-year, driven by higher net charge-offs in Card. And in the quarter, we built Card reserves of $300 million, primarily due to seasoning of newer vintages. And we saw a Wholesale release of over $100 million, partly driven by select names in the energy sector and reflecting improvements in portfolio quality in commercial real estate. +Shifting to balance sheet and capital on Page 3. What is most notable on this page is that all of the numbers are basically flat quarter-on-quarter with the exception of growth in tangible book value per share as capital generation was fully offset by distributions, reflecting a payout of above 100% for the first time in a long time, in line with our approved capital plan. And from here, we expect the direction of travel for our CET1 ratio to be lower over time. +Moving on to Page 4 on Consumer and Community Banking. CCB generated $2.6 billion of net income and an ROE of 19%. We continue to grow core loans, up 8% year-on-year, driven by mortgage, up 12%. And Business Banking, Card and Auto loans and leases were each up 7%. Year-on-year, we saw 13% growth in each of client investment assets, card sales and merchant processing volumes. Nearly half of the growth in investment assets came from net inflows. And our deposit margin continued to expand, up 6 basis points this quarter. +Revenue of $12 billion was up 6% year-on-year. Consumer and Business Banking revenue was up 15% on higher NII, approximately equally due to margin expansion as well as strong average deposit growth. Mortgage revenue was down 17% on loan spreads and production margin compression as well as lower net servicing revenue driven by the MSR. Underlying that decline, the mortgage business is performing well relative to the market. Our originations are down only 1% versus the market down an estimated 15% as we gained share in purchase. +Finishing up on revenue. Card, Commerce Solutions & Auto revenue was up 7% as higher auto lease income and growth in card loan balances outpaced the continued impact of investments in new account acquisitions. Expect CCSA fourth quarter revenue to be relatively flat sequentially as higher net interest income will be offset by the anniversary net impact of Sapphire Reserve last year. +Expense of $6.5 billion was flat year-on-year, or up 3% excluding the onetime items I mentioned. Higher auto lease depreciation and continued underlying business growth are partially offset by lower marketing expense. The overhead ratio was 54% for the quarter as positive operating leverage, despite significant investments in the business, moves us closer to our medium-term target. +Finally, on credit performance. In terms of net charge-offs, as I said, Card increased in line with expectations and guidance. And in Auto, charge-offs included approximately $50 million of a catch-up, reflecting regulatory guidance on the treatment of customer bankruptcies. Excluding this, the loss rate in Auto was only 41 basis points. In general, it feels like the auto market has plateaued at current levels, with inventory, incentives, used car prices and SAR all having stabilized over the last few months. +And in terms of credit reserves, as previously mentioned, we built $300 million in Card reserves in the quarter as we grow. And although there were no mortgage reserve actions, portfolio quality improvements allowed us to absorb the expected impact of the hurricanes into our current reserves. +Now turning to Page 5 and the Corporate & Investment Bank. CIB reported net income of $2.5 billion on revenue of $8.6 billion and an ROE of 13%. The third quarter of 2016 revenue in both IBC's end markets benefited from a number of large-fee events and higher levels of volatility, creating tough comparisons across the board. This quarter in banking, IB revenue of $1.7 billion was strong and relatively flat from last year's record levels. Year-to-date, we've gained some share and maintained our #1 ranking in global IBCs. We also ranked #1 in North America and EMEA. +We printed record advisory fees for third quarter, up 14% on broad strength across sectors and deal sizes, particularly in Europe, making up for a smaller wallet in North America. And equity underwriting fees were down 21%. However, we ranked #1 in wallet, number of deals and volumes globally for the quarter and for the year-to-date. The market remains active and the pipeline healthy. And in debt underwriting, there was a reasonably high run rate coming into the quarter, and we broadly maintained it. Landing fee is slightly down year-on-year and quarter-on-quarter, driven by strong repricing and refinancing activity and high-yield bond issuance. We ranked #1 in fees year-to-date and gained share overall and across products. +Treasury Services revenue of $1.1 billion was up 15%. And while higher rates are a driver, we are also seeing positive momentum in organic growth in the business globally as our clients are responding favorably to the investments we've made in our platform and products. +Moving on to markets. Total revenue was $4.5 billion, down 21% year-on-year against an impressive third quarter of 2016 and a quieter and very competitive environment. Fixed income revenue was down 27%, a solid performance given a backdrop of low volatility and tight spreads. And at the risk of laboring the point, you may recall that we gained 240 basis points a share in FICC in the third quarter of '16, which will mean our year-on-year decline will look larger than most. +Equities revenue was down 4%, but underneath that is a diversification story. Consistent with last quarter, lower flow in exotic derivatives activity was substantially offset by strength in cash and prime, which continue to be a bright spot for us this year. +Before I move on, the fourth quarter environment so far feels consistent with the second and third, with no obvious catalysts on the horizons about to change. But of course, change occurred. So it's worth pointing out that the fourth quarter last year was also a record for a fourth quarter since the crisis. And as such, we expect next quarter's markets revenues to be lower year-on-year. +Securities Services revenue of $1 billion was up 10%, driven by rates and balances, with average deposits up 15% year-on-year, as well as by higher asset-based fees on market levels globally. +Finally, expense of $4.8 billion was down 3% year-on-year, driven by lower compensation expense on lower revenues. And the comp to revenue ratio for the quarter was 27%. +Moving to Commercial Banking on Page 6. Another excellent quarter in this business with net income of $881 million, with record revenue and an ROE of 17%. And although we recognize that our results are affected by a benign credit environment, the performance is very strong and broad-based and is driven by the investments we've been making in the business, the differentiated platform capabilities we can offer our clients and our commitment to business discipline. Revenue grew 15% year-on-year, driven by deposit NII and on higher loan balances, with overall spreads remaining steady. And while IB revenue was down some year-on-year, we grew 9% sequentially, with particular strength in middle market, which is starting to feel like a trend. +Expense of $800 million was up 7% on continued investment in the business focused on technology as well as banker coverage, having added over 200 bankers since the beginning of 2016. And since our investment agenda is ongoing, expect fourth quarter expenses to remain at about this level. +Loan balances were up 10% year-on-year and 1% quarter-on-quarter. C&I loans were up 8% year-on-year, driven by strength in expansion markets and specialized industries, but were flat sequentially, in line with the industry, on flat utilization despite decent deal flow and stable pipelines. Commercial real estate saw growth of 13% year-on-year and 2% quarter-on-quarter. And although growth rates are decelerating, we continue to outpace the industry. However, we remain very disciplined in client selection, products and pricing and are sticking to what we know well. +Finally, credit costs were a benefit of $47 million, predominantly driven by commercial real estate. Credit performance remains strong, with a net charge-off rate of 4 basis points. +Leaving the Commercial Bank and moving on to Asset & Wealth Management on Page 7. Asset & Wealth Management reported record net income of $674 million with pretax margin of 33% and an ROE of 29%. Revenue of $3.2 billion was up 6% year-on-year, driven by higher market levels and by strong banking results on higher deposit NII. +Expense of $2.2 billion was up 2% year-on-year, driven by a combination of higher compensation and higher external fees, for which there is an offset in revenue. This quarter, we saw net long term inflows of $21 billion, with positive flows across fixed income, multi-asset and alternatives being partially offset by outflows in equity products. We also saw net liquidity inflows of $5 billion and continued to increase our global market share. +Record AUM of $1.9 trillion and overall client assets of $2.7 trillion were up 10% and 9%, respectively, year-on-year on higher market levels globally as well as net inflows. Deposits were down 6% year-on-year and 4% sequentially, reflecting continued migration from deposit accounts into investment-related assets, and we are retaining the vast majority of these balances. Finally, we had record loan balances, up 10% year-on-year, driven by mortgage, up 19%. +Moving to Page 8 and corporate. Corporate posted net income of $78 million. Treasury and CIO's results improved year-on-year, primarily due to the benefit of higher rates. And you'll remember that last quarter, Other Corporate included a legal benefit, which is driving the quarter-on-quarter decline you see on the page. +Finally, turning to Page 9 and the outlook. All of NII expense, charge-offs and loan growth remain broadly in line with previous guidance. So to wrap up, this quarter and this year, we continue to consistently deliver for our clients. Our businesses are performing strongly across the board, maintaining or gaining share. Our financial performance clearly demonstrates the power of the platform, the benefits of diversification and of scale as well as an investment strategy focused on long-term growth and profitability. We remain very well positioned to continue to benefit in a growing global economy. +Operator, we can open up the line for questions. + + +================================================================================ +Questions and Answers +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) And our first question comes from the line of Betsy Graseck. + +-------------------------------------------------------------------------------- +Betsy Lynn Graseck, Morgan Stanley, Research Division - MD [2] +-------------------------------------------------------------------------------- + + Two questions. One, on the revenue lift in the Consumer & Community Bank. I know on Slide 4 you highlighted that the 6% up year-on-year is driven by the higher NII and deposit margin expansion. Could you just describe a little bit if this is just the start of an improvement in transfer pricing that the Consumer Banking division is benefiting from? And is there a lag that, we should expect, would continue to drive up this revenue lift over the next several quarters? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO & Executive VP [3] +-------------------------------------------------------------------------------- + + So Betsy, there's no change in our transfer pricing methodology or even the way we compute it. It's to do, as you appreciate, with, obviously, higher rates and the fact that we are in a very disciplined environment at this point on deposit reprice. We would expect to continue to see the margin expand over the course of the next several quarters, but we would also expect to continue to drive higher NII as we're growing our deposits. [And those remain] in FTP. + +-------------------------------------------------------------------------------- +Betsy Lynn Graseck, Morgan Stanley, Research Division - MD [4] +-------------------------------------------------------------------------------- + + And then -- right, but that FTP methodology should continue to drive up margin -- deposit margin over the next couple of quarters. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO & Executive VP [5] +-------------------------------------------------------------------------------- + + Yes, yes. + +-------------------------------------------------------------------------------- +Betsy Lynn Graseck, Morgan Stanley, Research Division - MD [6] +-------------------------------------------------------------------------------- + + Okay. And then the second question is just how you're dealing with the Equifax fallout. The real -- the question here is, does the breach that occurred drive any changes to how you are assessing credit requests that come in, how you're filtering for what you perceive as fraud risk and how you're managing the book of outbound credit requests that you're looking for from a proactive perspective on your loan book? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO & Executive VP [7] +-------------------------------------------------------------------------------- + + Yes. So I mean, I think the way to think about it, not to sort of diminish the importance of any individual breach or situation, is that we are, honestly, under constant attack both in a more general side, but also from a fraud perspective. And so while we will always react and learn lessons from every individual situation, this is not the first breach, nor will it be the last breach. And so as a result, we have been constantly evolving and refining the way we think about fraud prevention, detection, underwriting, continuing to move to multifactor protocols around customer identification, looking to leverage all of our data to sort of better inform our underwriting decisions. So the reality is that, as important as it is and as much as we -- as each individual breach could impact the overall equation, we have had to evolve over an extended period to the position that we're in now. And so as a direct result of this, there won't be specific, meaningful changes, but a continuous evolution. And so when we are looking whether it's at sending out preapprovals or marketing offers or receiving inbound applications, we are increasingly looking at a number of different data points and facts to be able to identify the customer and understand the application. + +-------------------------------------------------------------------------------- +James Dimon, JPMorgan Chase & Co. - Chairman, CEO & President [8] +-------------------------------------------------------------------------------- + + And just -- let me add. As part of a breach -- so if your name was taken, and we know that as Social Security, a driver's license, we can put in a lot of enhanced controls that we do about your name specifically. We don't have to rely on those things. We can reduce reliance. We can greatly, dramatically include antifraud on your account. So we do, do that to dramatically diminish any effect on our customers. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO & Executive VP [9] +-------------------------------------------------------------------------------- + + And the reality, Betsy, is that we kind of operated over an extended period now on the presumption that while we happen to know about this breach, there will be others either right now that we don't know about or over time. And so we have to be proactive, not reactive. And we'll obviously look to learn anything we can, but we continue to evolve so that we can use all of the information at our fingertips. And as a practical matter, we are not seeing a specific increase in fraud. + +-------------------------------------------------------------------------------- +Betsy Lynn Graseck, Morgan Stanley, Research Division - MD [10] +-------------------------------------------------------------------------------- + + And as a result, expense impact, loan growth impact, de minimis from your perspective? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO & Executive VP [11] +-------------------------------------------------------------------------------- + + Correct, correct. As a result, we're already spending the money that we need to spend to keep, hopefully, ahead of the curve on all of these things. Our operating losses are -- I will say, the combination of all of the information that has been compromised over the course of the last several years has put pressure on fraud costs, but nothing incremental from this. And so no impact on expenses or loan growth that would be measurable. + +-------------------------------------------------------------------------------- +Operator [12] +-------------------------------------------------------------------------------- + + Our next question comes from Erika Najarian of Bank of America. + +-------------------------------------------------------------------------------- +Erika Najarian, BofA Merrill Lynch, Research Division - MD and Head of US Banks Equity Research [13] +-------------------------------------------------------------------------------- + + I wanted to follow up to your responses, Marianne, on no pressure on deposit pricing. I'm wondering if you could -- especially in light of your deposit growth strength, and especially in the Consumer, give us a sense on how repricing trends are today in terms of the consumer wealth management versus wholesale deposits. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO & Executive VP [14] +-------------------------------------------------------------------------------- + + Yes. So look, we -- obviously, apart from the rate hike in June, nothing has really happened much since last quarter. And so the landscape is looking pretty similar, and -- not because that's surprising, so I'll come back to that in a second, which is to say that there's been very little to no movement in the repricing of deposit accounts. There's been some incremental movements in certain savings and CDs, but nothing systematic in the consumer space. But that's pretty much as we would have expected with rates at these absolute levels. And so at some point in time, and that may be a couple, 3 more rate hikes from now, the dynamic may start to change, and so we haven't changed our perspective about what we think the ultimate reprice will look like. In Asset & Wealth Management, the story on deposit pricing is somewhat similar. A little bit more movement, but nothing particularly meaningful or dramatic. The story there is very much, again, as expected. At these levels of rates, you are seeing customers start to make choices to move certain of their deposit balances into investment assets. That's normal migration, migration that we expected and that we've modeled, and we are retaining those balances. So we are starting to see some of the dynamics we expected play out. That started happening at the beginning of the year and has continued to progress. And then in the wholesale space, there is a spectrum as well. So I would start with we're firmly on a reprice journey in wholesale, no doubt. And depending on where you are in the spectrum, it ranges from the smaller and lower middle market companies, where the reprice is modest, but present to the higher end, where it's reasonably high. And so overall, if I step back, that's where we are. If I step back and say, "Have we learned something new in this cycle that we didn't know?" The answer is, "No, not really." If you look at the first 4 rate hikes of the previous normalization cycle, the overall cumulative deposit reprice was pretty much the same as it is now. So we continue to believe that the dynamics that we've been talking about over the last several years and that we've expected will play out. They may not play out exactly as we have them modeled, but they will ultimately play out that way and that we have appropriately conservative reprice assumptions. + +-------------------------------------------------------------------------------- +Erika Najarian, BofA Merrill Lynch, Research Division - MD and Head of US Banks Equity Research [15] +-------------------------------------------------------------------------------- + + Got it. And my follow-up question on that is you're one of the few firms that have been really talking about anticipating the impact from a Fed balance sheet reduction over the next several years. And the question I often get from investors is, obviously, in particular, retail is valuable not just for the price of it today, but on an LCR basis. And how would you respond to the question, given the 6% growth in digital in the consumer bank and 12% growth in mobile, does technology help with the stickiness of the consumer deposits? Or does it potentially aid in the velocity of switching? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO & Executive VP [16] +-------------------------------------------------------------------------------- + + So at the risk of sort of hedging, it's actually a bit of both. The reality is there's always been 2 different camps on the reprice theories for consumer. There's been the camp of acute market awareness, low for long, technology enhancements allow movement of money to be easier, competition for retail deposits and good liquidity deposit is high. Therefore, reprice higher. And the counter to that, which has merit and which we are seeing to a degree, is customers feel that they're weighing a more balanced scorecard of things when they choose where to keep their deposits. And customer satisfaction, the suite of products and simplicity, the digital and online offerings as well as the safety, security and brand all matter and that price is a factor, but not the only one. So I would say we certainly feel that having a leading digital capability is critical to, overall, our customer franchise, and it will, in all likelihood, have an impact on the stickiness of deposits because customers value that kind of convenience very highly. I would also say one other thing about where we are right now, is that, as you know, as much as you're right about the sort of potential demand for these sort of high-liquidity value deposits, there's a lot of excess liquidity in the banking system. And although loan growth is solid, it's solid. So we aren't seeing a frenzy, albeit that we're very proud of our deposit growth. + +-------------------------------------------------------------------------------- +Operator [17] +-------------------------------------------------------------------------------- + + Our next question comes from Mike Mayo of Wells Fargo Securities. + +-------------------------------------------------------------------------------- +Michael Lawrence Mayo, Wells Fargo Securities, LLC, Research Division - MD, Head of U.S. Large-Cap Bank Research & Senior Analyst [18] +-------------------------------------------------------------------------------- + + Can you hear me? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO & Executive VP [19] +-------------------------------------------------------------------------------- + + Yes, welcome back. + +-------------------------------------------------------------------------------- +Michael Lawrence Mayo, Wells Fargo Securities, LLC, Research Division - MD, Head of U.S. Large-Cap Bank Research & Senior Analyst [20] +-------------------------------------------------------------------------------- + + My question is on the consumer and the community bank, a 3-part question. First, what percent of your customers have online bill pay? I'm trying to get back to that stickiness of the deposits. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO & Executive VP [21] +-------------------------------------------------------------------------------- + + I don't have that off the top of my head, but we can get back to you. + +-------------------------------------------------------------------------------- +Michael Lawrence Mayo, Wells Fargo Securities, LLC, Research Division - MD, Head of U.S. Large-Cap Bank Research & Senior Analyst [22] +-------------------------------------------------------------------------------- + + Okay. Can you give a ballpark? I don't think you've disclosed that before. Is it, like, to the nearest quarter or... + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO & Executive VP [23] +-------------------------------------------------------------------------------- + + I fear -- here's what we'll do. I fear if I give you a ballpark, I'll get it wrong. While we're on the call, we'll get someone to send the details and let you know. + +-------------------------------------------------------------------------------- +Michael Lawrence Mayo, Wells Fargo Securities, LLC, Research Division - MD, Head of U.S. Large-Cap Bank Research & Senior Analyst [24] +-------------------------------------------------------------------------------- + + Okay. And then the second part is -- I mean, you're talking -- the deposit beta has been lower. You gave your caveat. But mobile bank customers are up 12% year-over-year. Why do you still need 5,200 branches? Isn't this a good time to close branches when deposit competition isn't as tough as it might be in the future? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO & Executive VP [25] +-------------------------------------------------------------------------------- + + So we're doing a bit of all of the above. So I'll start with the comment which you heard from us before, but which we still strongly defend, which is that branches still matter. That 75% of our growth in deposits came from customers who have been using our branches. That, on average, a customer comes into our branches multiple times in a quarter. So I know that all sounds like old news, but it's still new news at -- or current news. So the branch distribution network matters. Customer preferences are changing, and we are not being complacent to that. So we are, underneath the overall 5,000-plus branches, continuing to consolidate, close, move, grow, change all of our branches in line with the opportunity in the market that we're in. So net for the year, we'll be down about 125 branches. We've closed more than that, consolidated some and added some. So we're not being complacent to the consumer preference story. But branches still matter a lot, and we're building out all of the other sort of omni-channel pieces, as you know, so that we have the complete offering. And if the customer behaviors start changing in a more accelerated fashion, we will respond accordingly. + +-------------------------------------------------------------------------------- +Operator [26] +-------------------------------------------------------------------------------- + + Our next question comes from Ken Usdin of Jefferies. + +-------------------------------------------------------------------------------- +Kenneth Michael Usdin, Jefferies LLC, Research Division - MD and Senior Equity Research Analyst [27] +-------------------------------------------------------------------------------- + + A question first on the loan side, on the yields. So last quarter, they held flat. And this quarter, they're up 16 basis points. I just wonder if you could help us understand, was that more just the mechanics of timing of hikes moving through your variable rates? Was -- is it any element of pricing? Or any other things you could just help us understand why we saw that great, nice improvement there? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO & Executive VP [28] +-------------------------------------------------------------------------------- + + Yes. So I would characterize this as -- over the 2 quarters of normal. So you may recall last quarter, there were a couple of things that we talked about. First was that there was a $75 million sort of onetime interest adjustment in mortgage, which artificially reduced loan yields for the quarter. And secondly, that seasonality and mix in Card similarly. So we would normally, in the law of extraordinarily big numbers, expect for a 25 basis point rate hike that we'd see about 10-ish basis points of improvement in loan yields across the whole portfolio. We didn't see that last quarter. What you're seeing this quarter is the reversal of those factors and the normal benefit of the June rate hike. + +-------------------------------------------------------------------------------- +Kenneth Michael Usdin, Jefferies LLC, Research Division - MD and Senior Equity Research Analyst [29] +-------------------------------------------------------------------------------- + + Got it, okay. And my second question, with the Card build, you took the reserve for Card to around 3.3%. I know you had talked about staying below a 3% Card loss rate for this year. But I'm just wondering, as we get into next year, you kind of had a medium-term idea of 3% to 3.25%. How are you feeling about that in terms of the seasoning of the Card book and loss rates? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO & Executive VP [30] +-------------------------------------------------------------------------------- + + Yes. So as we look at the loss rates for this year, they're coming in, as we expected, at less than 3%. And as we look out to next year, based on what we know today, it's still in that 3% to 3.25% range, albeit maybe at the higher end of that range. So it's broadly in line with our expectations. So the reserve build -- and we -- in the consumer space, we move our reserves in -- not in dollar increments. But the reserve build is about a little less than 1/3 on the growth and a little more than 2/3 on normalization of rate. + +-------------------------------------------------------------------------------- +Operator [31] +-------------------------------------------------------------------------------- + + Our next question comes from Glenn Schorr of Evercore ISI. + +-------------------------------------------------------------------------------- +Glenn Paul Schorr, Evercore ISI, Research Division - Senior MD, Senior Research Analyst and Fundamental Research Analyst [32] +-------------------------------------------------------------------------------- + + I don't know. Maybe it's a little nitty-gritty, but you're definitely the person for this. Point to point, the yield curve was about the same. 10-year was about the same. + +-------------------------------------------------------------------------------- +James Dimon, JPMorgan Chase & Co. - Chairman, CEO & President [33] +-------------------------------------------------------------------------------- + + I think that was about... + +-------------------------------------------------------------------------------- +Glenn Paul Schorr, Evercore ISI, Research Division - Senior MD, Senior Research Analyst and Fundamental Research Analyst [34] +-------------------------------------------------------------------------------- + + 10-year was about the same, point to point. However, throughout the quarter, the curve was much flatter. I'm just curious if that has any dampening effect in any given quarter. And maybe the better way to ask it is, could it have a little bit more of a positive run rate as we go forward? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO & Executive VP [35] +-------------------------------------------------------------------------------- + + Yes. So -- yes, NII, so a couple of things. The first is just to sort of repeat the standard. Just as a sort of macro matter, we're more sensitive to the front end of rates than to the long end of rates, particularly over any short period of time. And so intra-quarter volatility in the 10-year, while it's not nothing, it's not like it would have a material impact on the run rate. We're -- clearly, an overall generally flatter long end of the curve, in general, on average, through the year, all other things being equal, will have had a dampening pressure on our expectations. And it's part of the reason why they went from 4.5% to 4%, not the only one, as we progress through the year. But generally speaking, intra-quarter volatility is not something that would have a meaningful impact on our run rate. + +-------------------------------------------------------------------------------- +Glenn Paul Schorr, Evercore ISI, Research Division - Senior MD, Senior Research Analyst and Fundamental Research Analyst [36] +-------------------------------------------------------------------------------- + + Okay, cool. And in terms of the loan growth, I think it's completely normal to see some moderation, and you're still doing reasonably better than the industry. I'm curious on the main source of maybe the moderation ticking down a little bit. And then more importantly, is it too soon to ask if any of this talk on tax reform and decent economic data is having a pickup in the conversations on the loans growth side? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO & Executive VP [37] +-------------------------------------------------------------------------------- + + Okay. So on the first, I think it's quite important to, like, not look at the average and to kind of decompose it into constituent parts. Because we've talked before about the fact that we use our balance sheet strategically in CIB, but loan growth is not really a thing there. And so this quarter, we saw no loan growth in CIB. So no big deal, but it means that, that 7.5% core growth for the whole portfolio would have been, outside of CIB, closer to 9%. So start with that. Consumer has been pretty consistent. So across the consumer space, whether it's our jumbo mortgages, whether it's the Business Banking, Card, Auto loans and leases, they've been growing at reasonably solid and consistent high single-digit territory or even low double digit for mortgage over the last several quarters. And at this point, we don't really see anything that is suggesting that, that will moderate meaningfully. So where you're seeing -- and similarly, in Asset & Wealth Management on the banking side. So really, where you're seeing the growth moderate is in commercial, and it's in both the C&I loans and the commercial real estate loans. And they each have a story. With the commercial -- with the C&I loans, for us, the story is about moving from meaningfully outperforming the industry to being more in line with the industry. So over the course of the last couple of years, as we've added expansion market, opened new offices, added a couple hundred bankers, developed our specialized industry coverage models, we've been growing meaningfully better than the industry. And so you see that even in this quarter in our year-on-year growth, 8%, as compared to the quarter-on-quarter growth, where it is flatter. And that, to me, is really a factor of the fact that in this stage of the cycle, our clients have strong balance sheets. They have a lot of liquidity. They have had access to the capital market. And so GDP-plus growth is not unlikely to be a level for the foreseeable future. With commercial real estate, it's slightly different. We're still outpacing the industry, but we've kind of gone from very strong to strong, and we would continue to expect that to slowly moderate. And that's a number of things. It's some higher rates. It's actually a lot of competition. And then it's a lot also about client selectivity given where we are in the cycle. So we are being very cautious about new deals that we add to the pipeline and the client selection that we have. So all of those factors, I think, weigh into the commercial real estate space. Just -- tax reform, so fiscal stimulus. The reality right now is, although I think everyone and ourselves included are hopeful, obviously, that tax reform is done for the right reasons and that the economy responds accordingly, at this point, it's not front and center in the dialogue we're having with our clients about whether they should or shouldn't do a strategic deal or take an action. So I would say it's neither holding up business, nor spurring business, but that could change. So at this point, I'd say it's a factor, but not a driving factor, and that could change. + +-------------------------------------------------------------------------------- +Operator [38] +-------------------------------------------------------------------------------- + + Our next question comes from Jim Mitchell of Buckingham Research. + +-------------------------------------------------------------------------------- +James Francis Mitchell, The Buckingham Research Group Incorporated - Research Analyst [39] +-------------------------------------------------------------------------------- + + Maybe just a quick question on the outlook on the net interest margin, if -- should we still expect some grinding higher of asset yields even without rate hikes? How do we think about that trajectory, assuming we don't get any more rate hikes from here? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO & Executive VP [40] +-------------------------------------------------------------------------------- + + Well, so -- I mean, we'll just deal with the fourth quarter because I think the landscape of rate hikes for 2018 is an open question. But no, we would expect loan yields to hold relatively flat, all other things being equal. It's a very competitive environment. We aren't seeing -- we're seeing some pressure in commercial real estate spreads. We're seeing, generally, spreads holding up. But I would expect competitive pressures to keep loan yields relatively flat. + +-------------------------------------------------------------------------------- +James Francis Mitchell, The Buckingham Research Group Incorporated - Research Analyst [41] +-------------------------------------------------------------------------------- + + Okay. And just maybe on the reserve build outlook. Should we still expect it to kind of track with growth and keep the reserve ratio kind of similar in Cards where we are now? Or do you still anticipate some additional building? How do we think about that? And if you could size the hurricane impact, that would be great this quarter. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO & Executive VP [42] +-------------------------------------------------------------------------------- + + Yes. So we are -- at this point, we are, at that 3% charge-off rate, rising to 3% to 3.25% next year and growing, so you should continue to expect that we'll be adding to reserves. Our outlook for reserve adds next quarter is below this quarter. But obviously, we will continue to observe that. And with respect to the hurricanes, right now, in this quarter's results, in the credit lines, in mortgage particularly, and to a much lesser degree, in wholesale, we built -- effectively built $55 million of reserves. To sort of contextualize that, we have used our unfortunate experiences of Sandy and Andrew and other natural disasters to calibrate the assumptions we're using. At this point, it's early to be able to say how the losses will actually manifest themselves. It could be that it's lower than that, but that's also the central case right now, $50 million in mortgage and just a handful of million in the wholesale space. + +-------------------------------------------------------------------------------- +Operator [43] +-------------------------------------------------------------------------------- + + Our next question comes from John McDonald of Bernstein. + +-------------------------------------------------------------------------------- +John Eamon McDonald, Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst [44] +-------------------------------------------------------------------------------- + + Marianne, I was wondering if you could discuss how you're balancing all the investments you're doing in IT and business growth with the efficiency mindset that you guys always have. I guess one of the frameworks is if I look at the 3-year simulation you provided in February, a lot of the expense growth seemed to happen this year. We have kind of a $2 billion increase in adjusted expense. And post-2017, the expense growth looks very modest. So maybe just talk about -- a little bit about the leverage you're using to keep expenses in check as you're doing all the investments. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO & Executive VP [45] +-------------------------------------------------------------------------------- + + Yes. So I'll just start with a bit of a philosophical discussion, which is it is our opinion that now, as much, if not more so than ever, the investments we're making in technology will effectively breed and deliver the efficiency. So to the degree that we are able to find incremental investments or accelerate them, we'll be willing to do that. And our expense numbers, our outlook has never -- have never been target. So that's just a sort of mental -- philosophical point of view that we would deliver any technology innovation and investments that we could execute well, that we think would be either accretive to our returns through revenues or efficiency. Specifically, when you look at the simulation, this is a point of technicality. In 2018, middle -- probably middle to third quarter of 2018, we are expecting that the FDIC DIF fund will reach its level at which the surcharge will be able to be reduced. That's a meaningful positive for us. And so if you look at the implied growth in expenses from '17 through the medium term, they are larger than is implied. But if we found the opportunity to do more or to accelerate more, we would do it and explain it to you. So we'll come back to that at Investor Day. + +-------------------------------------------------------------------------------- +John Eamon McDonald, Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst [46] +-------------------------------------------------------------------------------- + + Okay, and then just a follow-up. You mentioned the Card revenue run rate has moved up again nicely this quarter. It seems like you might be able to get to your target by the early half of next year. Is there upside to that revenue run rate target? Is that -- are things coming in better than expected in terms of the moderation of promo rates and things like that? Or maybe could you just give a little color there? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO & Executive VP [47] +-------------------------------------------------------------------------------- + + Yes. I think I'm -- so when we did some conferences at the end of the last year, I think that we said that we'd expect the revenue rates for the full year this year to be 10.5%, and it will be a little better than that. And the revenue rate increase in the quarter speaks to a little bit of spread and a little bit of lower premium. It will go down the next quarter because of the fourth quarter effect of the Sapphire Reserve travel credit for overall, call it, 10.6% for the year. But yes, we do expect to hit the 11.25% in the first half of next year. And we've reached the inflection point end of the third -- second quarter and into the third quarter, where growth is offsetting the impacts of the significant upfront investments in Sapphire Reserve. Then we'll see revenues grew from here. + +-------------------------------------------------------------------------------- +Operator [48] +-------------------------------------------------------------------------------- + + Our next question is from Saul Martinez of UBS. + +-------------------------------------------------------------------------------- +Saul Martinez, UBS Investment Bank, Research Division - MD & Analyst [49] +-------------------------------------------------------------------------------- + + Just following up on, Marianne, on the Commercial Banking business. You've had -- you've obviously -- you've had very good momentum there over the last couple years, and you did talk about credit dynamics in moderation in credit growth and sort of a normalization back towards industry trends. But can you just comment a little bit more broadly about some of the initiatives you've had there from a revenue standpoint, whether it be the middle markets initiative, BI -- the growth in IB, international and whatnot? The earnings growth has obviously been very, very strong in this business, and it's starting to move the needle a little bit. But if you can just give us a little bit of color on the opportunity set you see there. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO & Executive VP [50] +-------------------------------------------------------------------------------- + + Yes. So I'll just start with credit for a second because although we absolutely expect at some point that we're going to see normalization of credit -- we haven't seen that yet, I just want to make that clear, that we are appropriately cautious in sharing everything, but we're not seeing any deterioration or any thematic fragility in our portfolio that we're concerned about at this point. With respect to the revenue side of the story and the efficiency side, I mean, it really is a story of all of the things you mentioned sort of all coming together at the same time. So we have been adding to -- we have our expansion markets from the Walmart acquisition. We've been adding new markets and opening offices. We've been adding bankers. And as you know... + +-------------------------------------------------------------------------------- +James Dimon, JPMorgan Chase & Co. - Chairman, CEO & President [51] +-------------------------------------------------------------------------------- + + We're in all 50 of the top MSA now. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO & Executive VP [52] +-------------------------------------------------------------------------------- + + Yes. We are in all 50 of our top MSAs now. And we've been adding bankers. And as you know, when you add all of these investments, for a period of time, when they are still in the buildup mode, you don't see that drop to the bottom line or to the top line. And now we're starting to see our bankers hit their stride, become very productive, the balances are building. And then I would also say that this is a -- the epicenter of delivering the whole platform to our clients. So if you think about what we're able to offer our clients in terms of international capabilities, banking coverage across industries, core cash, global payments, we have a platform offering, I think, that is -- well, it's certainly complete, and it's somewhat differentiated. And then the third thing I would say is that it's a buttoned-up business. We have been looking at efficiency and expenses and really working on making sure that due to simplification processes that we went through in 2013, '14 and '15, that we are focusing all of our efforts on our core strategic clients, and it's paying off. + +-------------------------------------------------------------------------------- +Saul Martinez, UBS Investment Bank, Research Division - MD & Analyst [53] +-------------------------------------------------------------------------------- + + No, that's great. I guess sort of a related question on the Commercial Banking business that's a little bit of a follow-up as well on tax reform. Obviously, the Congress -- or the administration and House Ways and Congress released a blueprint so Congress can now start to flesh out a tax plan. And obviously, there's a lot of uncertainty as to the content, the timing, heck, whether it even happens or not. But how -- if we do see something that is sensible, however you want to define it, how quickly do you think that we could start to see that beating through into better sentiment and ultimately, into better demand or increased demand for credit? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO & Executive VP [54] +-------------------------------------------------------------------------------- + + Yes. So I would say it's almost -- like you said, there are so many uncertainties that it's almost talking about hypothetical at this point, as encouraged as we are with the ongoing dialogue. My view is sentiment is relatively high. In fact, it's ticked up slightly over the course of the last short while. So from that vantage point, we're in a position of strength. And there would necessarily be some lag, so whether that is a couple of quarters or longer. So certainly, in the foreseeable future, you would hope to be able to see increased demand and confidence leading to action. + +-------------------------------------------------------------------------------- +Operator [55] +-------------------------------------------------------------------------------- + + Our next question is from Matt O'Connor of Deutsche Bank. + +-------------------------------------------------------------------------------- +Matthew D. O'Connor, Deutsche Bank AG, Research Division - MD [56] +-------------------------------------------------------------------------------- + + Can you talk about how your -- can you just talk a bit about how you're managing the excess liquidity? You've obviously continued to build cash. The securities book has shrunk. It makes sense given the flatter yield curve, but you combine that with still good deposit trends and a strong loan growth and obviously, a challenge as you think about protecting them going forward. So maybe you just talk about the dynamics there and how you're thinking about the yield curve, how to manage that. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO & Executive VP [57] +-------------------------------------------------------------------------------- + + Yes. So I'll start with the excess liquidity question because while we feel very, very good about our liquidity position, and you will have seen in the recent disclosures where everyone is positioned and necessarily, even if LCR was the only consideration, people would want to be running a Basel II LCR. So -- but LCR is not the only consideration. And the other most notable one I would point out to you would be resolution planning. So know that when we have our overall liquidity position, we're taking into consideration a combination of constraints. And so what may look excess in one -- on one lever may not be as excess on another. The second I would say is that when we look at the deployment of our HQLA, we look at it in the context of our sort of target for what we want the duration of equity for the company to be over the course of the normalization in rates. And obviously, it's not just about liquidity. It's also about duration. So we're comfortable with our liquidity position. We have a framework for deploying it and for thinking about the spot and forward-looking duration of the company. That's not to say that we are not opportunistic in taking advantage of moves that are technical in the long end of rates to either deploy or to undeploy dry powder, and we still have some. So it's more than just liquidity. It's also duration, and we've taken the overall balance sheet and our expectations and our target into consideration, albeit that we still have some dry powder. + +-------------------------------------------------------------------------------- +James Dimon, JPMorgan Chase & Co. - Chairman, CEO & President [58] +-------------------------------------------------------------------------------- + + And we maximize for between loans, securities. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO & Executive VP [59] +-------------------------------------------------------------------------------- + + Yes, yes. + +-------------------------------------------------------------------------------- +Matthew D. O'Connor, Deutsche Bank AG, Research Division - MD [60] +-------------------------------------------------------------------------------- + + And then just a follow-up on the rate sensitivity. I mean, you mentioned before -- or you reiterated before you're more leveraged through the short end of the curve. If we get continued increases on the short end of the curve but the 10-year doesn't go anywhere, is that still NIM-accretive as it's been thus far? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO & Executive VP [61] +-------------------------------------------------------------------------------- + + So it will be over the short while, and our full expectation outside of any other, like, stimulation is that as the front end of rates goes up and as gradual QE unwind happens, that you're going to see the long end of rates go up, albeit more slowly. So it's pretty typical at this point in the normalization cycle to have a curve flattened. That's what we're seeing. That's what we would expect. I would expect to continue to see the long end rise. And yes, it should be NIM-accretive. + +-------------------------------------------------------------------------------- +Operator [62] +-------------------------------------------------------------------------------- + + Our next question is from Gerard Cassidy of RBC. + +-------------------------------------------------------------------------------- +Gerard S. Cassidy, RBC Capital Markets, LLC, Research Division - Analyst [63] +-------------------------------------------------------------------------------- + + You touched on this a little bit, but maybe you can give us a little more color. You mentioned in your opening remarks you increased your market share in investment banking. Can you share with us, is it -- are you getting a bigger wallet share? Or are you winning more customers? And also, are -- some of your competitors are still struggling. Is that also a factor? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO & Executive VP [64] +-------------------------------------------------------------------------------- + + So I would say it's wallet share. It's blocking and tackling. We did pretty well in Europe, and -- but there is still a lot of competition. So I would say it's less about the specifics of any one competitor because the environment is pretty competitive and just about sort of reasonably broad strength. Two things that I would also point out is, the first, in equity underwriting, similar to -- in FICC, we gained a couple hundred basis points a share in the third quarter of last year. So on an apples-to-apples basis to where we would normally expect our shares to be, we're still doing very well. + +-------------------------------------------------------------------------------- +James Dimon, JPMorgan Chase & Co. - Chairman, CEO & President [65] +-------------------------------------------------------------------------------- + + I would just say, I think the competition is fundamentally fully back. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO & Executive VP [66] +-------------------------------------------------------------------------------- + + Yes. + +-------------------------------------------------------------------------------- +James Dimon, JPMorgan Chase & Co. - Chairman, CEO & President [67] +-------------------------------------------------------------------------------- + + It's not that they're -- or most of these players are all out there. Some specialize in certain areas, but it's fully competitive. And you have new entrants soon, like the Chinese banks, et cetera. + +-------------------------------------------------------------------------------- +Gerard S. Cassidy, RBC Capital Markets, LLC, Research Division - Analyst [68] +-------------------------------------------------------------------------------- + + Very good. And then possibly, Jamie, if you want to weigh in on this, what's your guys read of the new Treasury report on changes coming in the capital markets that was released in early October? Any specific items in there that you guys looked at that would be specifically beneficial that you'd like to see change? And what's the probability of it happening? And could it happen sometime next year? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO & Executive VP [69] +-------------------------------------------------------------------------------- + + Okay, that was a lot. So look, first of all, we welcomed the report. And it's a long report, a couple hundred pages. There's a lot of recommendations, very comprehensive. So kudos to the Treasury for delivering it. And we are supportive of those recommendations kind of at large. And I think the most important thing to remind you is that this is not about materially changing the legislative landscape. It's about recalibrating -- sensibly recalibrating the specifics of individual rules over time. And so we're still digesting the report, but we are supportive. It is very comprehensive, and it could be very beneficial to the liquidity and depth of the capital market, which is what we should all hope for and not contrary to safety and soundness. So in that sense, very supportive, all good. It's going to be complicated, and it will take time, but the will is there. And so whether it's the administration or the regulators, there's a general recognition that there's the ability and the appetite to want to make rational change. And so if that helps to grow the economy and all the things that come with that, we're working as constructively as we can on that. + +-------------------------------------------------------------------------------- +Operator [70] +-------------------------------------------------------------------------------- + + Our next question is from Steven Chubak of Nomura Instinet. + +-------------------------------------------------------------------------------- +Steven Joseph Chubak, Nomura Securities Co. Ltd., Research Division - VP [71] +-------------------------------------------------------------------------------- + + Jamie, I was actually hoping you could update us on your efforts to launch your online brokerage offering, it's something that you had mentioned in your last letter, and was curious, since it comes up with investors quite often, how you view the opportunity set in that business for JP, whether it's an effort to just build a moat around your current client cash balances and maybe fill a void. Or is your intention to become a bit more disruptive in the space and actually attract many more customers and potentially even offer more aggressive pricing and terms? + +-------------------------------------------------------------------------------- +James Dimon, JPMorgan Chase & Co. - Chairman, CEO & President [72] +-------------------------------------------------------------------------------- + + Yes, so we're building, obviously, kind of beta platforms for trading and investing and things like that. And also, the P2P, Zelle which is doing quite well. We look at all those things as things you want to -- from the client standpoint, we want to offer to a client. And at one point, we'll be talking about a more -- testing what we think might or might not work, and then we'll give you more of a strategic view of that probably around Investor Day. + +-------------------------------------------------------------------------------- +Steven Joseph Chubak, Nomura Securities Co. Ltd., Research Division - VP [73] +-------------------------------------------------------------------------------- + + Got it, okay. And Marianne, just wanted to follow up on some of the discussion around excess liquidity management. And I appreciate the fact that you guys certainly want to be conservative in thinking about duration and maybe taking a more holistic view of the asset side of the balance sheet. But looking at the LCR disclosures and just given the stark contrast in terms of how much you have parked in the way of excess reserves and relatively low levels of MBS compared with your peers, how you're thinking about duration management and whether you do have additional capacity to actually remix some of that cash of the Fed into higher-yielding MBS, especially as we think about the Fed balance sheet unwind dynamics. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO & Executive VP [74] +-------------------------------------------------------------------------------- + + So we have a fairly large mortgage loan portfolio in addition to having a large portfolio in our investment securities in MBS. So we are already reasonably equivalently mixed in terms of our percentage of mortgage exposure to our total assets or loans to the competitive landscape. And so trust me when I tell you that you talk about excess liquidity because of LCR and we are thinking about more than just LCR. And we do -- as I said, while we do maintain a short position and the cost of being short is relatively cheap, we don't have the kind of capacity to invest $100-plus billion in MBS right now or anything that's meaningful like that to generate higher returns without blowing through our duration target. + +-------------------------------------------------------------------------------- +Operator [75] +-------------------------------------------------------------------------------- + + Our next question is from Brian Kleinhanzl of KBW. + +-------------------------------------------------------------------------------- +Brian Matthew Kleinhanzl, Keefe, Bruyette, & Woods, Inc., Research Division - Director [76] +-------------------------------------------------------------------------------- + + Just a quick question on loan growth. You just had another decent quarter of the growth in residential mortgage. Maybe looking across Consumer, is there anywhere where you've had to kind of open up a credit box in order to growth there? I know you mentioned that loan yields are expected to be tight on competition, probably not increase as much, but have you had to go down market at all for loan growth? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO & Executive VP [77] +-------------------------------------------------------------------------------- + + No, no, no. We haven't. We -- as we talked about before -- a while ago, we made some surgical changes to our credit box in the Card space, but that's, if anything, I would say, incredibly granular, incredibly surgically tightening, not the reverse. Whether that's in Card, in certain micro sales or whether that's in Auto, I would say we've been pretty conservative. And we're probably doing, at the very margin, a little bit of tightening. + +-------------------------------------------------------------------------------- +Operator [78] +-------------------------------------------------------------------------------- + + Our next question is from Andrew Lim of Societe Generale. + +-------------------------------------------------------------------------------- +Andrew Lim, Societe Generale Cross Asset Research - Equity Analyst [79] +-------------------------------------------------------------------------------- + + I was wondering if you could talk a bit more about the quantum and timing of return of excess capital. Of course, one of your notable competitors has given a very detailed strategy of how to do this by the end of 2019. Are you in a situation to adopt a similar strategy? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO & Executive VP [80] +-------------------------------------------------------------------------------- + + No. So I mean, congratulations to them if they have a high degree of confidence on what 2018 CCAR is going to look like. So I will tell you this. We said very clearly that we feel that the company should operate within the range of 11% to 12.5%. We feel like it should be lower in that range. And having a capital plan approved of $19.4 billion of share buybacks over the next 4 quarters and over 100% payout based on analyst estimates is a start. So nothing has changed about that objective, but we would want to be measured about the pace at which we do it until we have a bit more final clarity on what the new generation of capital rules will look like. So we hopefully will know more as we go into the next cycle of capital planning. We haven't changed our point of view that we should be able to continue that journey down into the range, and that would be our objective. To tell you that we can give you the road map for that today, I think, is not accurate. So -- but you can do your -- you can and you have done your own math. You can -- your base -- look at our earning outlook in your earnings models and payouts of over 100%, and you can see that we can move down in that same time frame to something much lower than we are now. It's not towards the bottom, but that's not to say that we will be able to do that. We need to go through tests. + +-------------------------------------------------------------------------------- +Andrew Lim, Societe Generale Cross Asset Research - Equity Analyst [81] +-------------------------------------------------------------------------------- + + Okay, fair enough. And I have a different question. MiFID II is high on everybody's minds. I think everyone's focused on the impact on equity research and FICC research. But I mean, there's broader implications possibly for how that might impact trading, not just from your own point of view but also from the point of view of clients who might not be compliant by the end of the year. How does that weigh on your mind? And what impacts could we expect there? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO & Executive VP [82] +-------------------------------------------------------------------------------- + + Yes. So I think I got that. So the compliance burden and the readiness and the work to be ready is a significant heavy lift not just for us, but, as you say, for all market participants. And so there is the possibility that effective at the beginning of the year, there will be ongoing work that needs to get done. We feel like we're reasonably well positioned and -- to defend our position. But there's no doubt that over the course of the year and beyond that people get clearer and clearer on transparency and cost to execute versus advice versus content that there may be competitive dynamics to change. And we feel like we've been building for the last several years to be ready for those dynamics. So there could be some bumps. I don't think it's anything that we're concerned about at this point, and we will all learn a little more as we go through 2018. + +-------------------------------------------------------------------------------- +Operator [83] +-------------------------------------------------------------------------------- + + Our next question is from Marty Mosby of Vining Sparks. + +-------------------------------------------------------------------------------- +Marlin Lacey Mosby, Vining Sparks IBG, LP, Research Division - Director of Banking and Equity Strategies [84] +-------------------------------------------------------------------------------- + + I was going to ask you about the credit. You pulled out and highlighted auto after we went through kind of an episode of possible deterioration. You put that together with energy and what we experienced last year, those are our first 2 pressure points on the credit cycle. And really, we've come through without any real heartburn from either. Does that tell us something about the derisking and underwriting discipline that the banks in particular have adopted since the financial crisis? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO & Executive VP [85] +-------------------------------------------------------------------------------- + + So I would say that, for sure, has to be part of it. And even with the auto situation, what you're seeing is, I think, a marketplace that is much more responsive. So while we felt like we got ahead of the issues and tightened early, you've seen the sort of industry generally move in that direction. So I think there's no doubt that the environment, in totality, sort of capital liquidity controls regulation has led to higher-quality loan books. And so yes, we have been pressure-tested. Energy was a 1 in 100-year flood. And I think the industry, and specifically our portfolio, performed really quite well. And that's not to say that there isn't a point of pain out there somewhere we just -- that we won't see. We just feel like we'll be in a good position to get through that. + +-------------------------------------------------------------------------------- +Marlin Lacey Mosby, Vining Sparks IBG, LP, Research Division - Director of Banking and Equity Strategies [86] +-------------------------------------------------------------------------------- + + And then flipping over to deposit growth. What we saw -- as you kind of layer deposits and institutional deposits, corporate deposits, retail deposits, we're starting to see a little bit of a pressure in the sense of institutional deposits and wealth management began to decline. Corporate and retail still show a lot of strength. Just kind of think about that dynamic because that's really where you begin to see pressure on betas as typically when you see pressure on volumes, we just haven't seen it in the core deposit base yet. So a premium for liquidity that's been kind of pushed into those core customers from corporate and retail seems to be pretty persistent, which will mean the duration and the length and the growth of deposits will be much longer than what we probably anticipated before. + +-------------------------------------------------------------------------------- +James Dimon, JPMorgan Chase & Co. - Chairman, CEO & President [87] +-------------------------------------------------------------------------------- + + Yes. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO & Executive VP [88] +-------------------------------------------------------------------------------- + + Yes, but no. Yes, (inaudible). So I would tell you that we are seeing that rotation start. If you go back even 3 years ago, we kind of gave you an outline of what we thought would happen. We said we're going to see rotations from the high wealth segment into investment assets, followed ultimately by the consumer space. We'll see retail deposits move into money funds. We'll see outflows of wholesale, not deposits, as the Fed shrinks its balance sheet. But those things are going to play out over the course of the next -- depending on the rate cut, over the course of the next 2 to 4 years. So we've begun to see it. It should be expected. I don't think it tells us anything new or different necessarily at this point. + +-------------------------------------------------------------------------------- +Operator [89] +-------------------------------------------------------------------------------- + + Our next question is from Mike Mayo of Wells Fargo Securities. + +-------------------------------------------------------------------------------- +Michael Lawrence Mayo, Wells Fargo Securities, LLC, Research Division - MD, Head of U.S. Large-Cap Bank Research & Senior Analyst [90] +-------------------------------------------------------------------------------- + + A follow-up question. So Card revenues are tracking well per your other comment, but the year-over-year Card spend growth has moderated some. Can you talk about the trend with the Sapphire Reserve card? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO & Executive VP [91] +-------------------------------------------------------------------------------- + + Yes. So look, our card spend growth at 13% up year-on-year is still very strong. So when we say moderated, it's from very strong to very strong. And it is in part due to the number of new products we've had. So we would continue -- the Sapphire Reserve card spend engagement is very strong, and we're very pleased with it. So it's not -- I wouldn't say it's a moderation necessarily. It's just, at these very high levels, from a slightly higher to very strong is still a great story. + +-------------------------------------------------------------------------------- +Michael Lawrence Mayo, Wells Fargo Securities, LLC, Research Division - MD, Head of U.S. Large-Cap Bank Research & Senior Analyst [92] +-------------------------------------------------------------------------------- + + And with such a great deal a year ago, are you -- what's the attrition like with the customers? + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO & Executive VP [93] +-------------------------------------------------------------------------------- + + So if you think about -- our first acquisitions were in August and September. So we're kind of at the early stages. So far, very encouraging. So far, better than our expectations. But a little early to sort of draw firm conclusions on it, but very encouraging. + +-------------------------------------------------------------------------------- +Operator [94] +-------------------------------------------------------------------------------- + + And we have no further questions at this time. + +-------------------------------------------------------------------------------- +Marianne Lake, JPMorgan Chase & Co. - CFO & Executive VP [95] +-------------------------------------------------------------------------------- + + Okay. Thank you, everyone. + +-------------------------------------------------------------------------------- +Operator [96] +-------------------------------------------------------------------------------- + + This concludes today's conference call. You may now disconnect. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/exam/original-files/Problem_2_3_Sample_full_transcripts/2017-Oct-25-KO.N-136945571518-Transcript.txt b/exam/original-files/Problem_2_3_Sample_full_transcripts/2017-Oct-25-KO.N-136945571518-Transcript.txt new file mode 100644 index 0000000..945b8b2 --- /dev/null +++ b/exam/original-files/Problem_2_3_Sample_full_transcripts/2017-Oct-25-KO.N-136945571518-Transcript.txt @@ -0,0 +1,539 @@ + + +Thomson Reuters StreetEvents Event Transcript +E D I T E D V E R S I O N + +Q3 2017 Coca-Cola Co Earnings Call +10/25/2017 09:00 AM GMT + +================================================================================ +Corporate Participants +================================================================================ + + * Kathy N. Waller + The Coca-Cola Company - Executive VP & CFO + * Timothy K. Leveridge + The Coca-Cola Company - VP & IR Officer + * James Robert B. Quincey + The Coca-Cola Company - President, CEO & Director + +================================================================================ +Conference Call Participiants +================================================================================ + + * Andrew Holland + Societe Generale Cross Asset Research - Equity Analyst + * Kevin Michael Grundy + Jefferies LLC, Research Division - SVP and Equity Analyst + * Nik Modi + RBC Capital Markets, LLC, Research Division - MD of Tobacco, Household Products and Beverages + * Carlos Alberto Laboy + HSBC, Research Division - MD, Global Head of Beverages Research, and Senior Analyst, Global Beverages + * Mark D. Swartzberg + Stifel, Nicolaus & Company, Incorporated, Research Division - MD + * Robert Edward Ottenstein + Evercore ISI, Research Division - Senior MD, Head of Global Beverages Research and Fundamental Research Analyst + * Andrea Faria Teixeira + JP Morgan Chase & Co, Research Division - MD + * Bryan Douglass Spillane + BofA Merrill Lynch, Research Division - MD of Equity Research + * Dara Warren Mohsenian + Morgan Stanley, Research Division - MD + * Judy Hong + Goldman Sachs Group Inc., Research Division - MD, Co-Head of the GIR Asian Professionals Network, and Senior Analyst + * Brett Young Cooper + Consumer Edge Research, LLC - Senior Analyst & Co-Head of Global Consumer Staples + * Lauren Rae Lieberman + Barclays PLC, Research Division - MD and Senior Research Analyst + * Bill Chappell + SunTrust Robinson Humphrey, Inc., Research Division - MD + * Amit Sharma + BMO Capital Markets Equity Research - Analyst + * Ali Dibadj + Sanford C. Bernstein & Co., LLC., Research Division - SVP and Senior Analyst + * Laurent D. Grandet + Crédit Suisse AG, Research Division - United States Beverages Lead Analyst + +================================================================================ +Presentation +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + At this time, I would like to welcome everyone to The Coca-Cola Company's Third Quarter 2017 Earnings Results Conference Call. Today's call is being recorded. If you have any objections, please disconnect at this time. (Operator Instructions) +I would like to remind everyone that the purpose of this conference is to talk with investors, and therefore, questions from the media will not be addressed. Media participants should contact Coca-Cola's Media Relations Department if they have questions. +Now I would like to introduce Tim Leveridge, Vice President and Investor Relations Officer. Mr. Leveridge, you may begin. + +-------------------------------------------------------------------------------- +Timothy K. Leveridge, The Coca-Cola Company - VP & IR Officer [2] +-------------------------------------------------------------------------------- + + Good morning, and thank you for joining us today. I'm here with James Quincey, our Chief Executive Officer; and Kathy Waller, our Chief Financial Officer. +Before we begin, I'd like to remind you that this conference call may contain forward-looking statements, including statements concerning long-term earnings objectives, and should be considered in conjunction with cautionary statements contained in our earnings release and in the company's most recent periodic SEC report. +In addition, I would also like to note that we have posted schedules under the Financial Reports & Information tab in the Investors section of our company website. These schedules reconcile certain non-GAAP financial measures, which may be referred to by our senior executives during this morning's discussion, to our results as reported under generally accepted accounting principles. Please look on our website for this information. +Following prepared remarks this morning, we'll turn the call over for your questions. (Operator Instructions) +Now let me turn the call over to James. + +-------------------------------------------------------------------------------- +James Robert B. Quincey, The Coca-Cola Company - President, CEO & Director [3] +-------------------------------------------------------------------------------- + + Thank you, Tim. Good morning, everyone. +We were encouraged with our performance this quarter, and we can report that we are on track to deliver our full year plan. +Today, I'd like to talk to you about the performance in the quarter and then drill down a little bit into the actions that we're taking to expand our portfolio and drive top line growth and, finally, update you a little bit on the refranchising process. +In the quarter, we gained global value share and grew organic revenue 4%. This was driven by North America, Europe, Mexico and China. We also benefited from improvements in certain large emerging markets like India. Our strategic focus on small baskets and packs continued in the quarter, resulting in strong 3% price/mix and transactions outpacing volume by 2 points. Finally, our ongoing productivity initiatives helped drive strong underlying operating margin expansion in both the quarter and year-to-date. +Turning to our operations around the world. We're pleased with our continued good performance in North America, and we have full confidence in our sustainable growth strategy. As we announced on Monday, Sandy Douglas will retire as President of Coca-Cola North America after a remarkable 3-decade career with the company. He'll be succeeded by Jim Dinkins, who currently serves as Head of the Minute Maid business unit and Chief Retail Sales Officer for Coca-Cola North America. Sandy's done an outstanding job leading our flagship market through a period of enormous system change and has set it up for success in the coming years. We thank him for his leadership and wish him well in his retirement. +Jim, who is a highly experienced and respected leader within the Coca-Cola system, will assume the leadership of our North American segment as of January 1, 2018. We look forward to introducing him to many of you at our upcoming Investor Day on November 16. +Turning to Mexico. Our volume did decline 1 point in the quarter, negatively impacted by some cooler weather and natural disasters as higher rainfall as well as slightly softer consumer environment. And in our Europe, Middle East and Africa Group, solid marketing and innovation, coupled with improved execution, continued to drive mid-single-digit organic revenue growth. +In our emerging markets, China saw another quarter of improving performance, with volume up 2% due to strong marketing campaigns across sparkling soft drinks, juice and premium water. At the same time, the business has made a strategic decision to deemphasize low-margin water, which follows the strategy we are executing with success elsewhere. Whilst this resulted in a 3-point impact to China's volume growth in the quarter, it did not impact our profitability. +Also, during the quarter, India returned to growth, with volume up 6%, driven by solid performance across the portfolio. Our business successfully moved past the recent difficulties related to demonetization and the implementation of a goods and service tax during the first half of the year. +With that said, we are still facing difficult conditions in certain markets, notably in Latin America. Venezuela and Brazil were a 1-point drag on our overall global volume. However, there are some indications of light at the end of the tunnel in Brazil where we've seen the first signs of recovery in GDP for the country. However, consumption of consumer goods appears to be lagging behind durable goods and services, so it may take further time for recovery to translate into faster FMCG growth. +So we're continuing to build out our returnable packaging infrastructure and adjust our price/pack architecture, which has resulted in sequential improvement in volume trends as we have progressed through the year. Since launching our affordability plan, we're seeing good results from entry packs, which grew double digits in the quarter. +Now while we see various opportunities and challenges in each of our markets, one thing is consistent across all of our businesses: the consumer landscape is changing. We see an increasing number of small and fast competitors. Consumers' desires are revolving, whether they're seeking low- or no-sugar options, drinks with functional benefits or simply more variety. In order to thrive in this kind of environment, we need to be more entrepreneurial and agile to take intelligent risks and build a broader, consumer-centric portfolio. +As we accelerate our way forward to becoming a total beverage company, new categories and premium segments will play key roles in our growth. We are growing our portfolio in multiple ways whilst leveraging the strength of our core brands at its foundation. First, we're identifying and incubating high-growth brands. For example, in the U.S., we acquired the rights to Topo Chico, a premium sparkling mineral water from Mexico that has earned a strong following in Texas and beyond. +Our Venturing & Emerging Brands unit will serve as an incubator for Topo Chico and will guide the development of the brand's distribution footprint. Within VEB, this approach has been highly successful for other investments, like Honest Tea, maintaining the essence of the brand and the entrepreneurial culture of the company whilst supporting its rapid growth phase within the power of the Coca-Cola system. +Second, we're building stronger capabilities to nurture and expand small brands internationally. We've learned a lot from VEB model in the U.S., and we're leveraging those lessons to develop similar structures and processes in other markets. For example, in Central and Eastern Europe, we recently launched a unit in partnership with our bottling partner, Coca-Cola Hellenic. We will seek emerging brands for potential partnerships, but we will start by testing premium brands in high-value outlets and channels through a separate and dedicated sales force. Many of these, like smartwater, ZICO, Appletiser, will be lifted and shifted from other places. Products will follow the incubate, grow and scale path, with a goal to expand fast and discontinue quickly, if necessary. +Third, we're looking at opportunities in growing premium segments such as adult craft beverages. As you know, more consumers, most notably adults, are seeking unique and distinct products with sophisticated flavors, quality ingredients and smaller-scale crop production. Mixes are seeing a resurgence in many parts of the world as part of this trend. So earlier this year, in Spain, we introduced a line of premium mixes in glass bottles called Royal Bliss for sale only in the on-premise channel. In Great Britain, we've just relaunched the storied Schweppes brand to offer mixers, designed to pair even better with premium spirits, including a new range of premium mixers called Schweppes 1783. +We're also building on a solid foundation in sophisticated flavors through brands like Blue Sky, Barrilitos Aguas Frescas in the U.S. and Appletiser and [VOBO] in Europe. And we plan to leverage these in the appropriate channels where these premium products can excel. +Now while innovating and growing small brands in these new categories is critical, it is only part of the equation. That's why we're continuing to invest in our core billion-dollar brands to drive relevance. We increased our media investments behind our sparkling brands before moving aggressively into non-sparkling categories, and we will continue to innovate within these core brands as well. For, in the end, a healthy core will fuel our expansion as a total beverage company. +So for example, we launched Coca-Cola Zero Sugar in the United Kingdom last year. And with the combination of a great-tasting, reformulated product, better marketing, new packaging and improved execution, this product has been in the market for more than a year, and we continue to see double-digit growth in the U.K. Then we started to roll out Coke Zero Sugar to other markets around the world, including the U.S., which leveraged the U.K. marketing and execution playbook to launch in the third quarter. We've seen positive results, including a meaningful acceleration in Coke Zero's trends in the U.S. since launch. And year-to-date, global volume and revenue for the brand is growing double digits. +We're applying the same concept to refresh our important Fanta brand. We relaunched Fanta globally this year, reaching most of our major markets by the end of the second quarter. We did this with a 4-pillar playbook. That was a new look and a new integrated marketing campaign, a new recipe that tastes great and reduces added sugar, a new spiral bottle that differentiates Fanta on the shelf and improved execution and more media investment. Thanks to this work, we've seen a return to volume growth and an acceleration in revenue growth for Fanta. +Now obviously, not everything is going to work. That is why an agile testing and learning approach is essential. For example, in Costa Rica, we launched Fanta sweetened only with juice and with no added sugar. And we learned that consumers saw the new formula really as an incremental brand rather than an improvement to the existing brand. So we had to bring back the original formula and are retooling the market for this new approach. +The lesson. The lesson is, ultimately a single approach across all markets will not work. We need to tailor our approach based on consumer mindset and tastes in each market. Further, our model needs to be flexible so if a brand introduction isn't successful, we can adapt and change strategies quickly. And we have empowered our local leaders to make these key brand decisions. +Lastly, moving on to our system. As we approach the end of 2017, we're nearing the completion of the refranchising process. In the U.S., our refranchising will be complete when the Tri-State Operating Unit and the West Operating Unit transactions close, which we expect to be in the coming weeks. This will leave Canada to be refranchised, and our expectation is to transition to a partner in 2018. Also, in early October, we closed on a transaction that makes our company the majority owner of Coca-Cola Beverages Africa. As we'd previously disclosed, we're in discussions to refranchise this territory and also expect this to happen in 2018. +Before I hand the call over to Kathy, I'll end by saying this was a solid quarter and that we're committed to delivering against our full year targets. We will continue to execute our plan with innovation and marketing by focusing on the consumer and building a culture that embraces change, focuses on growth and is entrepreneurial in spirit. +Thank you, and Kathy, I'll hand over to you for the key financial results. + +-------------------------------------------------------------------------------- +Kathy N. Waller, The Coca-Cola Company - Executive VP & CFO [4] +-------------------------------------------------------------------------------- + + Thank you, James, and good morning, everyone. I'll start by highlighting a few key items we've reported today before moving on to talk about guidance. +We delivered solid financial results, in line with our expectations, with strong organic revenue growth and operating expense leverage driving double-digit growth in underlying profit before tax. As James mentioned, we continued to refranchise our company-owned bottling operations, which resulted in a 15% decline in comparable net revenues. However, adjusting for those divestitures, we grew organic revenue 4% in the quarter, with positive performance across all operating segments. +Comparable gross margin increased over 150 basis points, reflecting the benefit from refranchising our bottling businesses and strong price/mix, partially offset by increased commodity costs and a slight currency impact. The comparable operating margin grew over 400 basis points, driven by the divestitures and continued productivity, including the ongoing removal of stranded costs in Coca-Cola Refreshments. +Moving to cash flow. We generated $4.7 billion in free cash flow year-to-date and have returned that excess cash to our shareowners. Year-to-date, we've returned $3.2 billion in the form of dividends, reflecting a 6% increase in our dividend this year and $1.7 billion in net share repurchases. +Now turning to outlook. We continue to expect comparable EPS to be flat to down 2% this year as we complete the bottler refranchising process and return to a higher-margin, capital-light business model. We continue to expect to deliver 3% organic revenue growth and 7% to 8% growth in underlying profit before tax. +We now expect currency to be a 1-point headwind on profit before tax for the full year. The improvement in the currency outlook is offset by an increase in the full year structural outlook. The higher structural headwind is due to the transition of our interest in Coca-Cola Beverages Africa, which we will account for as a discontinued operation as we intend to divest the operations in 2018. As such, we will no longer derive equity income from our previous minority stake in CCBA. +In addition, the largest driver of the structural impact in Q4 is from the onetime impact from eliminating intercompany profit from our concentrate sales. In addition, because CCBA will be accounted for as a discontinued operation, we will exclude CCBA's net income from our comparable earnings. +So in summarizing the above, for the full year, we expect a $0.02 lower currency headwind to offset a $0.02 higher structural headwind, so our full year comparable guidance remains the same. +In terms of phasing, the improved currency outlook was a $0.01 benefit to the third quarter, and we expect it to be -- to benefit the fourth quarter by roughly $0.01. Now however, we expect the $0.02 increase structural headwind to impact the fourth quarter. +As you model the fourth quarter, there are a few other items to consider. First, our calendar fourth quarter will benefit from 1 extra day versus the prior year period, which equates to roughly 1 additional point of top line growth for the quarter. Second, the hurricanes that occurred in North America during the third quarter caused disruption to our supply chains, leading to an estimated $50 million increase in costs, the majority of which will impact the fourth quarter. +Third, we expect the net impact of acquisitions, divestitures and other structural items to be a 27-point headwind on net revenue and an 11- to 12-point headwind on profit before tax. And finally, we expect currency to shift to a 0- to 1-point tailwind on net revenue and a 4- to 5-point tailwind on profit before tax as we cycle significant volatility in the U.S. dollar from the fourth quarter of last year. +Now looking beyond the fourth quarter, we will provide more comprehensive 2018 guidance on our fourth quarter call in February. However, we are reaffirming the outlook on certain items provided at the beginning of this year. We continue to expect structural items to be a 1- to 2-point headwind on profit before tax. Remember, we have a rolling hedging program on hard currencies. So the currency benefit we expect in the fourth quarter should not be taken out of context and extrapolated into a similar benefit for 2018. As such, we still expect currency in 2018 to be a low single-digit headwind on profit before tax. And finally, we continue to expect that our effective tax rate will increase to 26% in 2018. +As you will recall, we are holding an Investor Day on November 16. During that time, we'll focus on our longer-term opportunities and how we'll get there. We look forward to sharing much more with you then, so please plan to join us via our webcast. +And with that, operator, please open the call for questions. + + +================================================================================ +Questions and Answers +-------------------------------------------------------------------------------- +Operator [1] +-------------------------------------------------------------------------------- + + (Operator Instructions) Speakers, our first question comes from Dara Mohsenian from Morgan Stanley. + +-------------------------------------------------------------------------------- +Dara Warren Mohsenian, Morgan Stanley, Research Division - MD [2] +-------------------------------------------------------------------------------- + + So my question was really around North American pricing long term. Obviously, there's been a lot of concern in general over the pricing environment in the U.S., not just in beverages but across the CPG industry, with brick-and-mortar retailer struggles and theoretically pushback as they look for lower pricing to differentiate themselves or just the margin grab versus CPG suppliers. So I was hoping, in that context, you could give us a review on if Coke's increased focus on pricing in the U.S. over the last few years, is that pressured at all longer term by these retailer dynamics? How do you manage through that? What are you hearing from your customers? And also, just given the new leadership in North America as well as the bottler refranchisement, how does that play into that pricing focus longer term? And how do those changes impact that? + +-------------------------------------------------------------------------------- +James Robert B. Quincey, The Coca-Cola Company - President, CEO & Director [3] +-------------------------------------------------------------------------------- + + Yes, sure, Dara. Look, a few thoughts. Firstly, I think the most important thing we focus on as a starting point is making sure we are bringing the innovation, the marketing and the execution to bear for each customer such that the beverage category grows faster than their overall business. And that is the basis on which you get better in-store placements, execution, and the pricing conversation becomes more manageable because the end, you're -- in the end, you're creating disproportionate value for the customer. So that's the first objective. +The second point I would make is we -- perhaps different to some people, we are a very multichannel business. Yes, we have large presence in the grocery channel, but we have multiple other environments where we sell our beverages. And therefore, part of it is being in lots of different places that helps manage the pack/price architecture dynamics and creates value for all our customers in the different channels. +And I would perhaps leave a last third thought on the marketplace, which is, yes, some of the extra pressures are from private labels or the stratification of retailers' own strategy in pricing is somewhat of an emerging dynamic in the U.S., but it has been present in other parts of the world, and we have found ways to work with each of our customers to make it work for them and for us. So we are believers in our ability to create value for ourselves by creating value with the customers even in this ongoing changing environment. +And I'll leave you with the last thought, which is there's no one better positioned to understand this in the context of North America than Jim Dinkins because he's run the national sales company for the U.S. system for a large number of years. He's worked as -- leading accounts in lots of other channels, too. So he understands this dynamic very clearly, and he has been at the forefront of leading a team to build value with our customers in collaboration with our bottling system. + +-------------------------------------------------------------------------------- +Operator [4] +-------------------------------------------------------------------------------- + + The next question comes from Carlos Laboy from HSBC. + +-------------------------------------------------------------------------------- +Carlos Alberto Laboy, HSBC, Research Division - MD, Global Head of Beverages Research, and Senior Analyst, Global Beverages [5] +-------------------------------------------------------------------------------- + + James, what might be some of the green shoots of performance lift that you're seeing in the North American territories that were first refranchised? + +-------------------------------------------------------------------------------- +James Robert B. Quincey, The Coca-Cola Company - President, CEO & Director [6] +-------------------------------------------------------------------------------- + + I -- well, I think the first and most important green shoot is to look at the performance once you get past the 12-month mark, by which I mean that it's much like having any new thing, management attention and focus gets heavily directed to new things. And so of course, you would expect better performance initially on refranchising, and we have got that in the vast majority of territories. +But I think the most interesting thing is that after 12 months when it's cycling and people have got the real hard work of building for the long term, we're still seeing the vast majority of the refranchised territories performing ahead of where they were before. So they've been able to build on the great refoundation work that CCR, in conjunction with the North American team, did. And the sorts of places we're seeing that performance coming from is not just doing better with the existing customers, which is true, but also in finding new customer outlets, expanding the universe of the customer outlets and performing better in the small formats, which in a way is partly the theory of the case of why refranchise to local partners. + +-------------------------------------------------------------------------------- +Operator [7] +-------------------------------------------------------------------------------- + + The next question comes from Nik Modi from RBC. + +-------------------------------------------------------------------------------- +Nik Modi, RBC Capital Markets, LLC, Research Division - MD of Tobacco, Household Products and Beverages [8] +-------------------------------------------------------------------------------- + + James, a quick question on Coke Zero Sugar. When you think about the launch in the markets that you have and also the early data points from the U.S., how much interaction is there with Coke Classic? And if you could just give us some context on kind of overlapping cannibalization rates. + +-------------------------------------------------------------------------------- +James Robert B. Quincey, The Coca-Cola Company - President, CEO & Director [9] +-------------------------------------------------------------------------------- + + Yes. I mean, I'm not going to get into the mathematical specificity, but I think, look, the headline is that as Coke Zero Sugar is coming to marketplaces, and particularly interesting those ones where it's been there for more than 12 months, a bit like my comment on refranchising, we're seeing continued acceleration of Coke Zero Sugar. It's lifting the whole franchise. +Yes, it is cannibalizing at times either Coke Light or sometimes Coke Original, but in the net, there is additional volume and additional consumers coming back into the franchise. I think it's unrealistic to expect cannibalization to be 0, but obviously, the key is that it be a net positive. So we're pleased with how it's playing out. It's slightly different in different countries, depending on the mix of the Coke franchise in those countries, but it's a net positive, and we are encouraged. + +-------------------------------------------------------------------------------- +Operator [10] +-------------------------------------------------------------------------------- + + The next question comes from Ali Dibadj from Bernstein. + +-------------------------------------------------------------------------------- +Ali Dibadj, Sanford C. Bernstein & Co., LLC., Research Division - SVP and Senior Analyst [11] +-------------------------------------------------------------------------------- + + Wanted to get an update on the progress from a productivity perspective, so the $3.8 billion that you'd mentioned last time. Where are we on reinvestment phase versus dropping to the bottom line phase? And essentially, coming to brass tacks, how much in billions of dollars should we expect to drop to the bottom line? And then if you want to be generous and answer a second question, a lower-priority question, but can you talk about the Topo Chico brand positioning versus a LaCroix, for example, in the marketplace? Please choose the first one if you're going to choose one. + +-------------------------------------------------------------------------------- +Kathy N. Waller, The Coca-Cola Company - Executive VP & CFO [12] +-------------------------------------------------------------------------------- + + Okay. So I will take the first one, and James can decide if he plans to be generous or not. +So first of all, we separate those 2 programs, Ali, from the $3 billion program, the original program that we announced earlier and then the $800 million program that we added on. On the $3 billion program, I would say we are on target, that the productivity is clearly coming from 3 different places: cost of goods, DME and OpEx. And we have targets to do about -- around $400 million this year. And we had always said about half of that would be reinvested and -- to drive growth. +Of the $800 million program, that is associated with our lean enterprise activities. Those activities really just got started last quarter, so this year. So it -- they really will -- and we've said that you'll see the benefits of those in 2018 and '19, and they will be split between those 2 years. And again, about half of that will go to reinvestment, and half will hit the bottom line. So we are on target with both programs, and the lean enterprise programs have started off well so far. And we will plan to update you as we continue to go along. + +-------------------------------------------------------------------------------- +James Robert B. Quincey, The Coca-Cola Company - President, CEO & Director [13] +-------------------------------------------------------------------------------- + + And if we have time, we'll come back to Topo Chico, Ali, so that we can respect everyone's one question at a time. + +-------------------------------------------------------------------------------- +Operator [14] +-------------------------------------------------------------------------------- + + The next question comes from Laurent Grandet from Crédit Suisse. + +-------------------------------------------------------------------------------- +Laurent D. Grandet, Crédit Suisse AG, Research Division - United States Beverages Lead Analyst [15] +-------------------------------------------------------------------------------- + + My question is about e-commerce. I mean, your competitor in the last earnings laid down the size of the opportunity for -- of e-commerce and the way they were investing ahead of the curve in people and big data, saying that they had a larger market share in e-commerce than elsewhere. Could you please tell us, I mean, how you are doing as to that channel, your objectives and how you plan to get there? + +-------------------------------------------------------------------------------- +James Robert B. Quincey, The Coca-Cola Company - President, CEO & Director [16] +-------------------------------------------------------------------------------- + + Sure. I mean, firstly, we over-index in terms of share, generally speaking, online. I think the second thing I would say is e-commerce is not one thing; it's a spectrum. And in part, what I mean by that is there are pure-play e-commerce players. There are bricks-and-mortars who have e-commerce. And you could say that's the omnichannel. There are aggregators -- remember, we're not just grocery. We work with a lot of restaurants, and there are all sorts of restaurant aggregator platforms and restaurants or some QSR chains have their own platforms as well. +So there's a wide spectrum of different versions of how consumers are interacting with customers that is digitally enabled. As I said, we very generally over-index. Our objective is to work with each customer, helping them drive value for the beverage category with their consumers. And generally speaking, we do better when that happens. And so you can see progress in the traditional grocery idea of e-commerce, whether omnichannel or pure play. You can see progress on restaurant or quick-service platforms. +So there's a lot of growth, a lot of activity. But in the simplest sense, it comes back to the central idea: if we can work with them to help the beverage business grow faster than their overall business and be a key participant, it creates a lot of value for them. And therefore, we have a lot of engagement with many of these companies on how can we help create value for them within the context of their strategy. + +-------------------------------------------------------------------------------- +Operator [17] +-------------------------------------------------------------------------------- + + The next question comes from Bryan Spillane from Bank of America Merrill Lynch. + +-------------------------------------------------------------------------------- +Bryan Douglass Spillane, BofA Merrill Lynch, Research Division - MD of Equity Research [18] +-------------------------------------------------------------------------------- + + I have a question about Latin America. And James, if you could just maybe give us a little bit of an update on -- it's been a drag to organic sales growth in unit case volume or I guess you'd say it's been a drag on unit case volume. A lot of that is Brazil, Venezuela, I guess, the Central America business unit as well. +Can you kind of give us a description of, a, how far away from -- are we from maybe the environment bottoming; second, maybe just some of the actions that Coke has taken to sort of adjust to the environment? Just trying to get a sense of how far away we are from being at a -- maybe a clean base where you can start to grow again. + +-------------------------------------------------------------------------------- +James Robert B. Quincey, The Coca-Cola Company - President, CEO & Director [19] +-------------------------------------------------------------------------------- + + Yes. I think let me take them in pieces as each one is a slightly different story although I -- the headline is I'm hoping to see the light at the end of the tunnel by the end of the year. What does that mean? In Brazil, we've talked about the actions we've been taking around price/package architecture, around returnables, investing in new infrastructure, not overpromoting to try and protect the volume but to try and reestablish our price/pack architecture that's going to work for the medium term. +It's -- Brazil as a country is struggling or has struggled. There are some signs, as I commented on the script, of light at the end of the tunnel. FMCG is lagging durables a bit in that. +Am I completely happy in Brazil? No, I wouldn't say so. I think there's more that we can do that's within our control. But I'm still somewhat hopeful that, that will all play out by the end of the year and things will start bottoming out in the fourth quarter. It has been sequentially improving as we've gone through the year. I think with more focus and more effort, we can see this play through, and so it'll bottom out by the end of the year. We'll see, but I think the signs are encouraging. +Venezuela. Venezuela is really a very tough human situation. It's almost a tragedy. And I think that the simple reality is the fourth quarter of significant declines in Venezuela will be the fourth quarter this year, at which point it'll have got to -- it'll have shrunk to a size that it won't be able to impact our overall numbers to the same extent in 2018. I would love to think it's going to get better. I'm not hopeful in the short term, but I would say it's going to stop impacting our numbers heavily once we get into 2018. +And then Colombia, similarly to Brazil. So I think the sum of all that is what I said at the beginning. We've been through a very tough year. We've been taking action. We are happy with some of the things we've done. We've got more work to do in places. But the floor should be set by the end of the year. + +-------------------------------------------------------------------------------- +Operator [20] +-------------------------------------------------------------------------------- + + The next question comes from Judy Hong from Goldman Sachs. + +-------------------------------------------------------------------------------- +Judy Hong, Goldman Sachs Group Inc., Research Division - MD, Co-Head of the GIR Asian Professionals Network, and Senior Analyst [21] +-------------------------------------------------------------------------------- + + James, can you give us your perspective around your performance in some of the non-sparkling category clusters? If you look at the quarter, I think the growth actually softened across all of your segments there. Why do you think we aren't really seeing stronger growth, setting aside what you're doing in China? And then I think you talked about maybe increasing investment behind some of your bigger brands. So -- and then maybe you can elaborate on your strategy in the investment, whether that will be funded by shifting investment from sparkling to these brands or the total portfolio you're really looking to further increase investments. + +-------------------------------------------------------------------------------- +James Robert B. Quincey, The Coca-Cola Company - President, CEO & Director [22] +-------------------------------------------------------------------------------- + + I think there're a few questions in there, Judy. Look, I think as we disaggregate the categories, obviously, the categories intersect with the geographies. And so the story is not -- neither clean by geography nor by category. But let me try and add a little texture to what we see going on. +I think sparkling beverage growth got a little bit better volumetrically in the quarter, and I think that, that shows a slightly improving trend. So I think that's -- firstly, the sparkling has got volumetrically better. It's back to slightly across the 0 line, whereas it was negative at the beginning of the year, and that's coming with better revenue growth. So our focus on Coke Zero Sugar, the relaunch of Fanta, Sprite in some places, smaller packages, working with customers who are getting a better volume trend sequentially and good pricing. So I think there's good progress there. +In terms of juices, what we're really seeing there is doing a lot better on the top end, things like chilled juices, plant-based drinks, fairlife, the premium dairy, going strongly, would love to have more capacity to grow even faster. You're seeing some growth in the juice drinks end of the spectrum where there's some volume has come out. It's more in the nectars, and I think that's part of people converting up and converting down. So I think there's continued trend there. +In terms of teas, good growth there, volume growth, price growth. We're pleased with our performance in teas. We're going to continue to invest in tea. +Coffee, lots of up in coffee. In the U.S., we've launched our own brands. We've launched some brands in partnerships with some other players. All of those have gone successfully well. We've got new innovations coming. We did -- we had a bit of a bump in coffee in Japan in the quarter, not so pleased about that. But we have the plans in place to do better. The one where we have done less well, and it was a choiceful decision, is on water. In some parts of the world where we have been too heavily into very low-margin, large-bulk water, we have pulled back deliberately in the quarter, and that has affected some of our water growth rate numbers. + +-------------------------------------------------------------------------------- +Operator [23] +-------------------------------------------------------------------------------- + + The next question comes from Lauren Lieberman from Barclays. + +-------------------------------------------------------------------------------- +Lauren Rae Lieberman, Barclays PLC, Research Division - MD and Senior Research Analyst [24] +-------------------------------------------------------------------------------- + + Just wanted to ask a bit about, in North America, to stick with the conversation around price/mix, so it just jumped out at me that sparkling price/mix is up 3%, but total for North America was 2%. So what was the drag there? Was it price? Was it mix? Was it category performance? And then in particular, if the answer, since I get one question, is that it was something in water and particularly with smartwater, are there plans in place for reaccelerating that business? + +-------------------------------------------------------------------------------- +James Robert B. Quincey, The Coca-Cola Company - President, CEO & Director [25] +-------------------------------------------------------------------------------- + + So yes. I mean, we're going to reaccelerate smartwater. Look, I think the key in terms of North America is to see a bit of a trend on the price/mix. You'll remember from last quarter, for example, that we talked about a point of the revenue growth was extra inventory in our fountain business ahead of the summer. Obviously, that's been backed out in the third quarter. +So said in simple terms, I think the easiest way to understand North America and look through inventory and look through natural disasters is, if they look to summer as the period, let's add the second quarter and the third quarter together and look at what we've got. And there, I could -- I think you can see revenue is 3% to 4%, price/mix is on average 3%, which is in line with the year-to-date trend and is in line with what we did in previous years, more or less. +But I think when you just look past some of the blips, what you see is an ongoing successful track record of driving the North American strategy; reinvigorating the portfolio; a focus on revenue; a focus on smaller packages; a focus ultimately that drives price/mix ahead of volume, with transactions ahead of volume. And I think that's what you saw once you ignore the blips in the third quarter. And so we're committed to our strategy, and we continue to drive it. + +-------------------------------------------------------------------------------- +Operator [26] +-------------------------------------------------------------------------------- + + The next question comes from Kevin Grundy from Jefferies. + +-------------------------------------------------------------------------------- +Kevin Michael Grundy, Jefferies LLC, Research Division - SVP and Equity Analyst [27] +-------------------------------------------------------------------------------- + + So James, just sticking with the topic of North America, but my question relates to your expectations with respect to competitive activity. And I guess I ask you in the context that your key competitor had probably one of the most difficult quarters they've had in a long time in North America beverages, and they've discussed ramping investment in key categories to address some of these market share losses, which will include carbonated soft drinks and sports drinks. +So can you talk about -- you've talked a lot about your strategy, which has been helpful. Can you talk about your expectations with respect to competitive -- the competitive environment in the near to intermediate term and your ability to flex up spending to respond, if necessary, within your guidance? + +-------------------------------------------------------------------------------- +James Robert B. Quincey, The Coca-Cola Company - President, CEO & Director [28] +-------------------------------------------------------------------------------- + + Look, I think we got -- the North American market is certainly one of the most competitive markets around the world. It's not just one large competitor we face. There are multiple competitors, large, medium and small. There's a lot of activity, a lot of innovation, a lot of jockeying. +In the end, we will continue to focus on our strategy. We have a clear strategy that's driving the portfolio inspired by the consumer, working with customers to create value for the beverage category and our underlying category because that includes all peoples, brands and products. We work with the customers to create value for the beverage category, which will drive ultimately growth. And I think that has shown that we have been able to gain share over the long term on a steady basis as we have deployed this strategy, supported, of course, by the increased and improved bottler execution investment through the refranchising. +It's a long-term game plan. I've commented on previous quarterly calls, will there occasionally be quarters where customers take certain decisions that cause disruption to that or competitors do? Of course, that may happen, and we will respond. But we believe in our strategy, we think it's the right long-term play, and we will always look to get back to it even if we respond to short-term actions. + +-------------------------------------------------------------------------------- +Operator [29] +-------------------------------------------------------------------------------- + + The next question comes from Andrea Teixeira from JPMorgan. + +-------------------------------------------------------------------------------- +Andrea Faria Teixeira, JP Morgan Chase & Co, Research Division - MD [30] +-------------------------------------------------------------------------------- + + James, if you can expand on the comment about better execution of the refranchised bottlers in North America. And how -- so how was the performance gap of the refranchised territories against BIG in terms of volumes and pricing and as it relates to better execution at the trade? Or would you say the [flat 50] volumes, I guess, negative before has been mostly driven by innovation by Coke Zero Sugar, smaller packs? So basically, I wanted to ask you if the 3% is coming -- performance that you had is coming from better execution or just better mix. + +-------------------------------------------------------------------------------- +James Robert B. Quincey, The Coca-Cola Company - President, CEO & Director [31] +-------------------------------------------------------------------------------- + + I think the top part of the answer is it's -- all the pieces work together. It's about having the right portfolio for the consumers, the right marketing, the right innovation and the right execution. There's no question that when you bring all those things together, that's when you get the best possible result. +In terms of what better execution from the refranchised bottlers, I think that they have been able to build on the foundation that was created by the CCR team. That was -- we pushed more devolution of accountability, of empowerment down into the organization of this national bottling company. We were -- refounded some of the manufacturing, supply chain and executional processes. +And I think the local bottlers have been able to take that, bringing their passion, their entrepreneurialism, their local knowledge, and turned that into an even better result. As I mentioned earlier, that's typified by things like more outlets, typified by things like working better with the smaller formats, yet also, at the same time, being able to increase the degree of execution and service to some of the larger customers. +So it's been an ability to work across the board. It wasn't a silver bullet. It was, in fact, getting a little bit better across the spectrum, from the largest customers to the smallest customers, in support of our portfolio marketing and innovation plan. + +-------------------------------------------------------------------------------- +Operator [32] +-------------------------------------------------------------------------------- + + The next question comes from Brett Cooper from Consumer Edge. + +-------------------------------------------------------------------------------- +Brett Young Cooper, Consumer Edge Research, LLC - Senior Analyst & Co-Head of Global Consumer Staples [33] +-------------------------------------------------------------------------------- + + Question on reinvestment. And when the company started the program of savings and reinvestment, emerging markets returning negative or, in some cases, were already negative, they probably didn't get as much investment as they otherwise would have. As we're seeing some signs of emerging markets improving, is it safe to assume that we'll see investments accelerate there? And then can you just expand on what you've learned from the activity you've undertaken in developed markets and then, finally, where those funds, if my assumption that increased investment is coming, will come from? + +-------------------------------------------------------------------------------- +James Robert B. Quincey, The Coca-Cola Company - President, CEO & Director [34] +-------------------------------------------------------------------------------- + + So yes, it's safe to assume that we're going to invest where we see the opportunity for growth. And therefore, as the emerging markets begin to bounce back, I'm not sure they're all are going to bounce back to the same sort of degree as they were precrisis, but we absolutely will be investing to drive our market position. Now I would just underline that other than some situations very specifically, we don't tend to try and pull back very aggressively when markets turn down. +We, generally speaking, adopt the strategy of when there's a downturn, and particularly, in some of the emerging markets, it's better to invest through it to gain competitive position so that you're positioned even better for the upturn. So it's not the case that we pulled the cord on lots of markets. Having said that, as I said at the beginning, we will up the investment as we start to see the acceleration, and you can see that we've talked about things we started to do in India, things we started to do in China. +As we see the momentum starting to come back, we're investing behind those. Will it be across the portfolio? Yes. It won't be -- [shock them]. It needs to be focused on helping us achieve category leadership positions or near-leadership positions or driving new interest in consumer innovation in conjunction with the execution of our bottling partners. We're not trying to do more mediocre stuff. We're trying to generate good strong consumer brands, whether they be large or they be niche, whether they be profitable and they be successful. + +-------------------------------------------------------------------------------- +Operator [35] +-------------------------------------------------------------------------------- + + The next question comes from Mark Swartzberg from Stifel. + +-------------------------------------------------------------------------------- +Mark D. Swartzberg, Stifel, Nicolaus & Company, Incorporated, Research Division - MD [36] +-------------------------------------------------------------------------------- + + My one question, James, is refranchising related and how much runway you think you face for sustained improvement in price/mix in Western Europe where you're a little more into the exercise of refranchising and also China and Africa where refranchising has begun or will soon begin. Simply, the price/mix opportunity in front of you in those markets. + +-------------------------------------------------------------------------------- +James Robert B. Quincey, The Coca-Cola Company - President, CEO & Director [37] +-------------------------------------------------------------------------------- + + I think, in Western Europe, we've had a very good start to the creation of CCEP. Yes, it was a little bouncy in the third quarter with some localized poor weather that offset the better weather that was in Q2. If you look past those blips, I think you see momentum in Western Europe coming back in and good growth. +I've talked previously about expectations on price/mix where in Western Europe, I think we can have, in comparison perhaps to the U.S., a little more volume growth and therefore a little more balance between volume and price in Europe as we go forward. The U.S. is more assertively looking for a package/price architecture mix-led part of the equation. So I think that the sustained idea for Western Europe is a balance. +In terms of China and Africa, there are slightly different situations. In Africa, clearly, there's more opportunity for expansion of the portfolio volumetrically although of course, there'll be a price/mix element. And China is, again, a place where we're looking to get -- rebuild the volume momentum with a moderate degree of price/mix. + +-------------------------------------------------------------------------------- +Operator [38] +-------------------------------------------------------------------------------- + + The next question comes from Bill Chappell from SunTrust. + +-------------------------------------------------------------------------------- +Bill Chappell, SunTrust Robinson Humphrey, Inc., Research Division - MD [39] +-------------------------------------------------------------------------------- + + James, can you just talk a little bit more about Mexico? I think you alluded both to the weather, and then you did a little bit of a slowdown in the category. Any way to quantify what the hurricanes or anything had impact on the quarter and then if there's any lingering impact? And then -- and just kind of touching on the slowdown you said for the quarter. + +-------------------------------------------------------------------------------- +James Robert B. Quincey, The Coca-Cola Company - President, CEO & Director [40] +-------------------------------------------------------------------------------- + + Yes. I mean, there's -- I mean, clearly, the natural disasters in the whole Caribbean basin, whether we're talking Florida, Texas, Puerto Rico or Mexico with the earthquakes, all kind of occurred in the same quarter. So there's clearly an impact. I'm not going to attach a number to it because I'm not really a big fan of putting it all into the one-off temporary basket. But clearly, there was an impact. +The weather was a bit more miserable in the third quarter. And there is a bit of -- there was a bit of softening of consumer sentiment through the third quarter in Mexico. I don't think these are new enduring trends. I mean, certainly not the natural disasters, hopefully not, but nor is the consumer one. I think that will slowly reverse over the balance of the year. We'll see. +So I don't think there's a big issue in Mexico. Of course, it's one of those places, too, where we're looking to work on our price/package architecture and the full portfolio that we've developed as a system over the last few decades there to really be able to continue to drive revenue. And I think it was a strong revenue quarter for the system in Mexico, and I think that will continue. + +-------------------------------------------------------------------------------- +Operator [41] +-------------------------------------------------------------------------------- + + The next question comes from Amit Sharma from BMO Capital Markets. + +-------------------------------------------------------------------------------- +Amit Sharma, BMO Capital Markets Equity Research - Analyst [42] +-------------------------------------------------------------------------------- + + James, talking about the leadership change in CCR, can you talk about what Jim Dinkins' key priorities would be? And then as this leadership transition happens here, do you see that as an opportunity to maybe reorient the organization to develop new muscles as you transition the portfolio? + +-------------------------------------------------------------------------------- +James Robert B. Quincey, The Coca-Cola Company - President, CEO & Director [43] +-------------------------------------------------------------------------------- + + Look, I think the leadership change in North America -- I mean, leaders don't last forever, and this is another one of those changes. There's a new chapter about to begin in North America. We've had a great run of a few years. We've successfully carried out a humongous refranchising task. And I think Sandy made the decision this time for a new leader, and I think Jim is the right person. He's got full portfolio experience. He's got marketing experience. He knows the customers across the whole spectrum, and he has the right capabilities as a leader to take us to the next stage of growth. +What does that need to be? Clearly, it needs to be about continuing to execute the strategy we've got in place. But like all strategies, they need to evolve. In the same way that company's global strategy evolves for the circumstances we face, so will the North American one. It's not just due to the fact of the leader changes that you know you need to continue to evolve and build new capabilities. We knew that before. We had some things under development. Of course, we'll learn new things, and we'll identify new ideas. So I think it's about a continued journey of the North American business. It's a great team. It's a great system. They've got their mojo back. They know they need to do more things to execute and complete the mission in the short term and to evolve and build new capabilities for the long term. + +-------------------------------------------------------------------------------- +Operator [44] +-------------------------------------------------------------------------------- + + The next question comes from Robert Ottenstein from Evercore. + +-------------------------------------------------------------------------------- +Robert Edward Ottenstein, Evercore ISI, Research Division - Senior MD, Head of Global Beverages Research and Fundamental Research Analyst [45] +-------------------------------------------------------------------------------- + + Great. James, in the beginning, you talked about increasing desire of consumers for variety that'll help drive innovation and many new brands, new competitors. I think that's mostly a comment about the U.S., but I'm wondering if you could take that comment and those trends and talk about how that is playing out in the rest of the world and whether that is something that, if you've seen it sort of first in the U.S., you can kind of get ahead of it and take advantage of perhaps learnings in the U.S. to perhaps capture more of those opportunities in other countries. + +-------------------------------------------------------------------------------- +James Robert B. Quincey, The Coca-Cola Company - President, CEO & Director [46] +-------------------------------------------------------------------------------- + + Yes. Look, I think it's not just a U.S. trend. You can look at Japan where arguably, beverage diversity is even greater than the U.S. But I think the central point is the following. If you look back over time and you look at what is the behavior of teens and young adults of each generation as it comes through, there's one key fact: each generation consumes and, importantly, buys more commercial beverages than the previous one. The second important fact is they do so across a greater variety of drinks. It's not that they buy more commercial beverages and drink ever-increasing amounts of the same thing. They go for diversity. +Therefore, you can see around the world that those places which have the highest amounts of disposable income, each generation is coming along and looking for that diversity. That's true in the U.S. It's true in Japan. It's true in other developed markets and other wealthy parts of even emerging markets. And so the learnings that are available are actually not just one-directional. They are actually from many different places across the world. +We've got to find ways to take new learnings from the U.S., from other parts, Japan, from Europe, from Australia and finding the best of the best and allowing ourselves to fuel the diversity of the portfolio yet understanding that, in the end, what grows are the global brands. I mean, the world, over the last number of years, has been typified, at least in beverages, by outsized growth by global brands and the entry of lots of new smaller brands. The bit in the middle was tougher. +So you either have to -- so you have to keep fueling the machine by having innovation and testing the frontier of variety yet, over time, graduating those to large-scale consumer franchises, not necessarily single-flavor franchises but consumer franchises. + +-------------------------------------------------------------------------------- +Operator [47] +-------------------------------------------------------------------------------- + + The next question comes from Andrew Holland from SocGen. + +-------------------------------------------------------------------------------- +James Robert B. Quincey, The Coca-Cola Company - President, CEO & Director [48] +-------------------------------------------------------------------------------- + + Andrew, are you there? + +-------------------------------------------------------------------------------- +Andrew Holland, Societe Generale Cross Asset Research - Equity Analyst [49] +-------------------------------------------------------------------------------- + + Oh, yes. Can you hear me? + +-------------------------------------------------------------------------------- +James Robert B. Quincey, The Coca-Cola Company - President, CEO & Director [50] +-------------------------------------------------------------------------------- + + Yes. + +-------------------------------------------------------------------------------- +Kathy N. Waller, The Coca-Cola Company - Executive VP & CFO [51] +-------------------------------------------------------------------------------- + + Yes. + +-------------------------------------------------------------------------------- +Andrew Holland, Societe Generale Cross Asset Research - Equity Analyst [52] +-------------------------------------------------------------------------------- + + Okay, sorry. I'll try again. Yes. So just related to CCBA, you're saying that you're now expecting completion in 2018. I'm pretty sure that this time last year, you were expecting it in the second half of 2017. I'm just wondering what on earth is taking so long, mindful that, for example, Coke Icecek dropped out of that process, I think, as long ago as March. Are we left concluding that the business that is up for sale is not in a state where anybody wants to buy it? + +-------------------------------------------------------------------------------- +James Robert B. Quincey, The Coca-Cola Company - President, CEO & Director [53] +-------------------------------------------------------------------------------- + + No, that's the wrong conclusion, Andrew. The simple answer is that the regulatory process in South Africa is not time regulated. And the fact is we got regulatory clearance in the last month or so, and that then led us to closing. And now we will proceed to work with our -- the prospective partners that are interested, and there's substantive interest. And when we say 2018, that's because it includes regulatory and closing approval. So that's the simple answer. +So I think that's it. That's time, ladies and gentlemen. Thank you for joining in. To conclude, I think we delivered a solid quarter. We're on track to close out a successful year. And as always, we thank you for your interest, your investment in our company and for joining us. And again, we look forward to sharing with you more during our Investor Day on November 16. Thank you. + +-------------------------------------------------------------------------------- +Operator [54] +-------------------------------------------------------------------------------- + + And that concludes today's conference. Thank you for your participation. You may now disconnect. + + + + + + + +-------------------------------------------------------------------------------- +Definitions +-------------------------------------------------------------------------------- +PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the +Transcript has been published in near real-time by an experienced +professional transcriber. 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All Rights Reserved. +-------------------------------------------------------------------------------- diff --git a/exam/original-files/Problem_2_template.py b/exam/original-files/Problem_2_template.py new file mode 100644 index 0000000..7d8efbe --- /dev/null +++ b/exam/original-files/Problem_2_template.py @@ -0,0 +1,149 @@ +# -*- coding: utf-8 -*- +""" +Created on Fri Jul 29 10:42:03 2022 + +@author: Alexander Hillert, Goethe University +""" + +# import packages +import re + +# define working directory +# adjust it to your computer +directory = "YOUR DIRECTORY" + + +# Open the dictionary +# It is the 2018 version of the LM (2011) dictionary. +file_word_list = open(directory+'LMD_pos_master_dictionary_2018.txt', 'r', encoding="utf-8") +word_list = file_word_list.read() +# use a consistent case format +word_list = TO BE COMPLETED +# create the list of positive words +positive_words = TO BE COMPLETED + + +# Create output file according to the exam instructions +output_csv_file = open(directory+'Problem_2a_Percentage_Positive_Words.csv', 'w', encoding="utf-8") +# Write variable names to the first line of the output file +# 1) Call-ID +# 2) Answer-ID +# 3) Total number of words in the answer +# 4) The number of positive words in the answer +# 5) The percentage of positive words in the answer +# 6) the text of the answer +output_csv_file.write('TO BE COMPLETED') + + +# Iterate over the 60 answer files +for i in range(TO BE COMPLETED): + # If you want you can print the progress of your script + print(str(i)) + + + # Open the ith answer file + input_file_answer = open(directory+'/Problem_2_3_Sample_QandA/'+TO BE COMPLETED, 'r', + encoding='utf-8', errors='ignore') + + # read the text from the answer file + input_text_answer = input_file_answer.read() + + # use a consistent case format + input_text_answer = + + # Split the text into individual answers + answer_list = re.split(TO BE COMPLETED, input_text_answer) + + # Check whether there are empty elements in the answer list + # If so, remove them + while answer_list.TO BE COMPLETED: + TO BE COMPLETED + + # iterate all answers of the ith call + for TO BE COMPLETED: + + # Preprocessing steps according to the exam instructions and hints + TO BE COMPLETED + # re.sub() commands are useful here. + + + ######### Begin of the placeholder ######### + # Here is the placeholder for the further editing steps that you + # should identify by looking at the file from Part b) of this problem. + # Having created a first file in Part b), you will see that the measurement + # of positive tone can be improved. + # Please add these commands here and then return to part 2b) + # See also the exam instructions. + + + + + ######### End of the placeholder ######## + + + # Split the text in words + list_of_words = TO BE COMPLETED + # Check for empty elemments + TO BE COMPLETED + + + # Determine total number of words + word_count = TO BE COMPLETED + + # Reset the number of positive words to zero + positive_count = 0 + + # For each positive word, count the number of occurrences + for TO BE COMPLETED + # Check whether the positive word of interest shows up + positive_words_found = TO BE COMPLETED + + # Loughran and McDonald (2011, JF, p.44): "We account for simple negation + # only for Fin-Pos words. Simple negation is taken to be observations + # of one of six words (no, not, none, neither, never, nobody) occurring + # within three words preceding a positive word. + + # While the positive word is found, implement the LM (2011) negation check. + while TO BE COMPLETED: + # identify the position of the matched positive word in the list of all words + position_of_word = TO BE COMPLETED + # identify the three words before the positive word + list_negation = TO BE COMPLETED + + # check whether one of the three words in list_negation is a negation + negation_found = TO BE COMPLETED + + if negation_found TO BE COMPLETED: + positive_count = TO BE COMPLETED + + # delete the matched positive word in the original document + list_of_words[position_of_word] = TO BE COMPLETED + # check whether there are further matches of the positive word of interest + positive_words_found = TO BE COMPLETED + + # compute the percentage of positive words adjusted for negations + # it could be that the total number of words of an answer is zero. + if word_count > 0: + percentage_positive = TO BE COMPLETED + else: + percentage_positive = "NA" + + + # Remove line breaks of the text that you write to the csv. + # Line breaks would mess up your output file. + # In addition to line breaks, you may also want to remove extra + # whitespaces and tabs at the beginning and end. + answer_text_print = re.sub(TO BE COMPLETED) + # replace the symbol that you use as delimiter, e.g., semicolon + answer_text_print = re.sub(TO BE COMPLETED, answer_text_print) + + # Write the call-ID, answer-ID, total number of words, number of positive words + # adjusted for negations, percentage of positive words adjusted for negations, + # and the edited answer text to the output file + output_csv_file.write(TO BE COMPLETED+'\n') + + # Close files + input_file_answer.close() + +print("Finished") +output_csv_file.close() diff --git a/exam/original-files/Problem_3_template.py b/exam/original-files/Problem_3_template.py new file mode 100644 index 0000000..67da3f1 --- /dev/null +++ b/exam/original-files/Problem_3_template.py @@ -0,0 +1,216 @@ +# -*- coding: utf-8 -*- +""" +Created on Sun Jul 31 14:37:49 2022 + +@author: Alexander Hillert, Goethe University +""" + +# import packages +import re +import nltk +import collections + +# define working directory +# adjust it to your computer +directory = "YOUR DIRECTORY" + +# ============================================================================= +# Part A: Identifying the answers to market-related sentences +# ============================================================================= + +# Create output file +output_csv_file_3a = open(directory+'Problem_3a_Market-related_Questions.csv', 'w', encoding="utf-8") +# Write variable names to the first line of the output file +# 1) Call-ID +# 2) Number of questions in the call +# 3) The number of market-related questions +# 4) The percentage of market-related questions +output_csv_file_3a.write('Call_ID;Number_Questions;Number_Market_Questions;Percetage_Market_Questions\n') + +# create a text variable to store managers answers to market-related questions +answers_market_questions="" + +# Iterate over the 60 questions and answer files respectively +for i in range(1, 61): + + # If the execution of your scripts takes some time, printing the iterator + # gives you an impression of the overall progress + print(str(i)) + + # reset variables + market_question_count=0 + + + # Open the ith question file + # IF YOU HAVE PROBLEMS OPENING THE FILES DOUBLE-CHECK THE DIRECTORY AND FOLDER NAME + input_file_question = open(directory+'/Problem_2_3_Sample_QandA/'+str(i)+'_questions.txt', 'r', + encoding='utf-8', errors='ignore') + # read the text from the question file + input_text_question=input_file_question.read() + + # To identify managements' answer to a market-related question, also open the + # answer files and create a list of the individual answers. + # the jth list element in the answer list will correspond to the jth list + # element in the question list. + # Open the ith answer file + input_file_answer = open(directory+'/Problem_2_3_Sample_QandA/'+str(i)+'_answers.txt', 'r', + encoding='utf-8', errors='ignore') + input_text_answer=input_file_answer.read() + + + # Split the text into individual questions + question_list = re.split(TO BE COMPLETED, text_questions) + # Check whether there are empty questions, if so remove them + while TO BE COMPLETED > 0: + TO BE COMPLETED + + # get the total number of questions + number_questions=TO BE COMPLETED + + + # Split the text into individual answers + answer_list = re.split(TO BE COMPLETED, input_text_answer) + # Check whether there are empty questions, if so remove them + while TO BE COMPLETED > 0: + TO BE COMPLETED + + # search for the term market/markets in each analyst question + # iterate over the list of questions + for j in range(TO BE COMPLETED): + question_id=j+1 + + # it might be helpful to get the text of a question to a new variable + # of course, you can also work with the jth element of the question list. + question_text=TO BE COMPLETED + + + # search for market/markets in the list of words + + # remember that searching for a word in a text is NOT the same as searching + # for a word in a list. Make sure that you only count actual matches!!! + # ADD necessary commands here + YOU MAY NEED TO ADD A COMMAND HERE. + + # Are there upper case letters? Are there lower case letters? + # Remember to use a consistent format of the text and the search term. + + if TO BE COMPLETED.count("market")>0 or TO BE COMPLETED: + # it is a market-related question + market_question_count=TO BE COMPLETED + + + # For Part b) you need the text of the answers to market-related + # questions. So, we identify the corresponding answer. + # question j relates to answer j. + # --> pick the right element from the answer list + market_answer=TO BE COMPLETED + + # add the text of answer j to the total text of all answers + answers_market_questions=answers_market_questions+"\n"+market_answer + + + # compute the percentage of market-related questions + pct_mkt_questions=TO BE COMPLETED + + + # Write the call-ID, the total number of questions, the number of market questions, + # and the percentage of market questions to the output file + output_csv_file_3a.write(str(i)+';'+str(number_questions)+';'+str(market_question_count)+';' + + str(pct_mkt_questions)+'\n') + +# close files +output_csv_file_3a.close() + +print("Part a) of Problem 3 completed.") + +# ============================================================================= +# Part B: Most frequent trigrams in the answers to market-related questions +# ============================================================================= + +# import english stopwords +nltk.download('stopwords') +from nltk.corpus import stopwords +NLTK_stop_words=set(stopwords.words('english')) + +# import sentence tokenizer +# even though we discussed the weaknesses of the tokenizer in class, for this +# text corpus it is fine to use the tokenizer. +nltk.download('punkt') +from nltk.tokenize import sent_tokenize + +# list and counter for building trigrams +trigram_list=[] +trigram_counter=collections.Counter() + + +# Create output file +output_csv_file_3b = open(directory+'Problem_3b_Most_Frequent_Trigrams.csv', 'w', encoding="utf-8") +# Write variable names to the first line of the output file +# 1) rank of the trigram ranging from 1 to 30 +# 2) trigram +# 3) frequency of the trigram +output_csv_file_3b.write('Rank;Trigram;Frequency\n') + +# the managers' answers to market related sentences are stored in the text variable +# "answers_market_questions" + + +# split the entire answer text into single sentences +list_sentences=TO BE COMPLETED + +# iterate all sentences +for i in range(TO BE COMPLETED): + # transform the ith sentence to lower or to upper case. + # make sure that the upper/lower case spelling is consistent with the + # stop word list! + sentence=TO BE COMPLETED + + # remove numbers + sentence=TO BE COMPLETED + # delete single letter words + sentence=TO BE COMPLETED + + # split the sentence into words + list_of_words=TO BE COMPLETED + # remove empty elements from the list of words + while TO BE COMPLETED>0: + TO BE COMPLETED + + # remove stopwords + list_of_nonstop_words=[] + for TO BE COMPLETED: + if TO BE COMPLETED: + list_of_nonstop_words.append(TO BE COMPLETED) + + # go over all potential three word combinations in the sentence. + # check whether you have at least three words remaining in the sentence. + if len(TO BE COMPLETED)>=3: + # go over all words in the sentence. + # remember to pay attention to the upper bound. For example, if there + # are 5 words in a sentence, you can only form 3 trigrams + for TO BE COMPLETED: + # append the three words of the trigram to the list of trigrams + # put a single whitespace between the three single words. + trigram_list.append(TO BE COMPLETED+' '+TO BE COMPLETED+' '+TO BE COMPLETED) + + +# add the list of trigrams to the counter of trigrams +trigram_counter=collections.Counter(TO BE COMPLETED) + +# Get the 30 most frequent trigrams +top_30_trigrams=TO BE COMPLETED + +# Write the 30 most frequent trigrams to the csv file. +# Remember Python starts counting at 0, while humans start at 1. +# So, the most frequent word (rank 1 in human counting) is element 0 for Python. +# Consequently, to get a consistent table, we must use the value i for the rank +# but call the element i-1. +for i in range(TO BE COMPLETED): + output_csv_file_3b.write(str(i)+";"+str(TO BE COMPLETED)+";"+\ + str(TO BE COMPLETED)+"\n") + + +# close files +output_csv_file_3b.close() + +print("Part b) of the Problem has also been completed.") diff --git a/exam/original-files/Textual_Analysis_Exam_20220802.pdf b/exam/original-files/Textual_Analysis_Exam_20220802.pdf new file mode 100644 index 0000000..4545325 Binary files /dev/null and b/exam/original-files/Textual_Analysis_Exam_20220802.pdf differ